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Jnf Commercial Real Estate And Capital Group Economy 2008 Lecture
 

Jnf Commercial Real Estate And Capital Group Economy 2008 Lecture

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Key Note on Economy on USElection Eve 2008

Key Note on Economy on USElection Eve 2008

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    Jnf Commercial Real Estate And Capital Group Economy 2008 Lecture Jnf Commercial Real Estate And Capital Group Economy 2008 Lecture Presentation Transcript

    • Peninsula Hotel Beverly Hills, California November 3, 2008
    • Presentation by Robert H. Edelstein University of California at Berkeley
    • A Quagmire of Long-Run and Short-Run Issues
    • Fundamental International Economic Drivers • Competition – The World is Flat and Crowded (Friedman) • Globalization and Economic Integration: A Two-edged Sword (Stiglitz) • Capital Market Integration and Securitization – The Limits are Imagination • World Melting Pot of Socio-Political Ideology, Resource Environmental Competitiveness, Technology and Innovations • Enhanced Volatility and Responsiveness – Integrated, Compacted World
    • Long View of Fundamental Economic & Financial Determinants: Summary • International Growth Locomotives: China, India & United States • Future Growth Determinants: Frontier Technologies, Globalization, Demographics, Environmental Degradation and Energy Resources
    • Annual Percentage Change in GDP -4 -2 0 2 4 6 8 10 12 14 16 18 19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 Source: IMF (World Economic Outlook) 92 China 19 93 19 94 GDP Growth 19 95 USA 19 96 19 97 19 98 Germany Time (Years) 19 99 20 00 India 20 01 20 02 20 03 Japan 20 04 20 05 20 06 20 07 20 * 08 20 * 09 20 10 * are estimates. 20 11 * 20 * Data after 2007 * 12 20 13 *
    • Energy Use Per Capita 100000 E 90000 n e 80000 r g ( y 70000 k W U h 60000 s / e c 50000 a p p e i 40000 r t a C 30000 ) a p 20000 t i a 10000 0 Year 2002 China USA Japan Germany India Source: International Atomic Energy Agency – Energy and Environment Data Reference Bank
    • U.S. Economy and the Deadly “D’s” Deluxe Living Dis-saving Debt – private and Public Deficits – Trade, Governments and Households De-Regulation Degradation – Environment, etc.
    • Total Credit Market Debt Held by Rest of World as Share of Total US Credit Market Debt Outstanding; 1945-2007 Source: Flow of Funds; Table L 1
    • Foreign Holdings of US Securities as Share of Total Amount Outstanding Source: US Treasury TIC data; Federal Reserve Flow of Funds
    • Share of Global Reserves 2007 Source: BIS, IMF
    • Share of Chinese Reserves in Dollar Denominated Securities $, Bill 73% 56% Source: Peoples Bank of China, US Treasury, Estimates by Authors
    • Official Institutional Share of Holdings by Foreigners Source: US Treasury
    • Capital Markets and M&A Overview Privatization Trends – 2005/2006 Drivers for Buyers • Abundant supply of institutional and opportunistic capital • Strong financing markets and attractive interest rates • Reasonable return expectations • Improving fundamentals for many asset types • Arbitrage between public and private markets / Ability to line-up sales of specific assets / portfolios Additionally, many Public Companies played a role in Privatizations through institutional / jv model: • Boards acted strategically and empowered by strong currencies and availability of low-cost debt and JV equity • Public markets were much more receptive to strategic transactions than in the past
    • Capital Markets and M&A Overview Privatization Trends – 2005/2006 Drivers for Sellers Motivated seller base influenced by attractive valuations and purchase price premiums / multiples Valuations / proposals above most NAV estimates Aggressive suitors and increased review of strategic alternatives Constraints of public market Short-term accretion attention Leverage constraints Analyst and Investor perceptions Active Boards More attention to procedures, responses and corporate governance Roles for management in private forum, including growth of platform Increased scrutiny and costs of being a public company
    • Capital Markets and M&A Overview 2007 Mid-Summer Correction - Context for the Current Situation Since the 2007 mid-summer correction, the capital markets have undergone a significant re-pricing of risk Risk premiums on high yield bonds have ballooned to levels well above their 12-month average of 455 bps and all-time low of 262 bps seen 6/1/2007 (1) In contrast, high yield default rates remain at an historic low of 0.9% - a record gap between risk premiums and defaults (2) Since July, financial firms have announced $181 billion of write-downs linked to sub-prime exposure (3) Major firms have raised $72.3 billion of new capital to shore up balance sheets (4) In 2007, an estimated $326 billion of residential mortgage payments reset; $412 billion are scheduled to reset during 2008 (5) (1) Source: BAS High Yield Bond Index. (2) High yield default rates of 0.9% as of 12/2007. Record gap between risk premiums and default rates as per Moody’s economist John Lonski (Source: Wall Street Journal). (3) Source: Bloomberg as of 2/29/08. (4) Source: Bloomberg as of 1/15/2008 and company reports. (5) Source: Deutsche Bank, Loan Performance and Rosen Consulting Group. Includes rate adjustments and IO expirations.
    • Capital Markets and M&A Overview CMBS Market Overview
    • Real Estate Company Valuations Sources: FactSet, Company reports and Wall Street Research as of 2/1/08.
    • What Are The Follow-up “D’s” for Now? De-leveraging – Farewell Cheap Debt Distrust and Dismay Deflation – Asset Market “Booms” Farewell Disarray Defaults
    • Capital Markets Overview Market Current Situation & Outlook The M&A market has slowed significantly since its late July 2007 peak as a result of the credit market “backup” The current M&A market slowdown is marked by the following dynamics: Large, highly levered financings not available Short-term asset flipping is no longer a viable strategy Seller’s pricing expectations have been slow to adjust despite market expectation of cap rate expansion Going forward, key capital market themes in M&A will include: Opportunistic investors, especially sovereign wealth funds, exerting pressure on distressed situations Likely contraction of valuation multiples / widening of cap rates Credit re-pricing and overall leverage reductions Increase in joint ventures as institutional real estate capital remains available Capital structures increasingly funded by opportunistic players such as hedge funds, commitments from multiple institutions, or SWF
    • House Prices Inflate to Create an Historic Bubble Relative to underlying household income, the median house price appreciated far to fast. About two-thirds of the bubble has already been deflated. Our expectation is for the housing market to overshoot the historic price-to-income ratio. Median House Price/Avg. HH Income February 2008 MML (Recession) 2.60 2005Q3 2.40 Foreclosures Wells Bubble Policy Instituted, break-out to First in the Nation, 2003Q4 the upside. 2.20 Start of the housing bubble, 2001Q4 2.00 Ratio 1.80 1.60 Correction will overshoot. 1.40 1.20 1.00 19 8 19 9 70 19 1 72 19 3 19 4 75 19 6 19 7 19 8 79 19 0 19 1 19 2 83 19 4 85 19 6 87 19 8 89 19 0 91 19 2 93 19 4 95 19 6 97 19 8 99 20 0 01 20 2 03 20 4 05 20 6 07 20 8 09 20 0 11 12 6 6 7 7 7 7 7 7 8 8 8 8 8 8 9 9 9 9 9 0 0 0 0 0 1 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20
    • Recent Events of Concern • What Happened to Bear Stearns? • Why did IndyMac Fail? • How do FNMA and FHLMC fit into the Sub-Prime Crisis? AIG? • The BIG five: G-S, M-S, Lehman, M-L, and B-S
    • Policy Action!? • Why has the Fed acted as the Ultimate Source of Liquidity? • Can the U.S. let a Large Institution Fail? • What needs to be done in the Short-Run and the Long-Run?
    • ABX-HE Index Prices Have Deteriorated This chart shows the ABX index for AAA bonds backed by home equity loans issued in February 2007 (as of April 22). Even AAA bonds have lost about 43% their value in 14 months.
    • Summary The financial markets are still under stress. Losses from mortgage derivatives are creating counter-party risk, and they have prevented the normal flow of transactions and credit as a result. The result is that risk spreads are elevated. The poor economic outlook has also boosted the risk spread in the corporate sector foreshadowing increased corporate bankruptcies, loan and bond defaults. The Fed and the Treasury are still engaged!?
    • Elements for the Short-term and Long- term Resolution of the Subprime and Other Financial Crises Devise Programs to Stabilize the Housing Market and Housing Finance System Engender Housing and General Financial Market Viability Implement Policies that Avoid Recurrence and Moral Hazards Prepare for Potential Wider Domestic Economic Implication of the Sub-prime Crisis Recognize and Plan for Potential Global Economic and Financial System Interactions 29
    • Overview Subprime Issues Direct Effects Delinquencies Foreclosures home prices Lender Industry and Secondary Market Behavior New Profit Model Underwriting Standards Fee Structures Accessibility of Secondary Market Risk Contagion Effects New Construction Real Estate Services Equity Loans Financial Institutions Global Effects Risk Spread “Adjustments” U.S. Consumption and International Trade, World-wide Stock Market/Bond Market 30
    • Why Were We So Susceptible to the Subprime Crisis? • Diminution of Underwriting Quality • Inexperience of Owner-Borrowers • Financial “Wizardry” • Aggressive, Risk-Taking Investors 31
    • How Exposed Are We? Total US housing stock is 128 million units Annual sales since 2000 represent between 4-6% of stock States with high levels of price declines account for a large share of housing stock; and larger share of mortgages outstanding Nationwide, the ability to buy a home has not changed dramatically, but regional variations show large areas of vulnerability Subprime loans are 12 percent of all outstanding mortgages 32
    • Per Capita Income and Home Price Indices Compared, Far West, 1975-2008 1600 1400 1200 1000 800 600 400 200 0 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 19 OFHEO index Per Capita Income Index Source: Indices created by authors using Office of Federal Housing Enterprise Oversight index (adjusted to 1975 base); US Bureau of Economic Analysis data. 33
    • Understanding Variation in Exposure and Experience Can Help Shape Policy Wide variation within the US in housing markets (median 2007 home value ranges from $88,000 in Mississippi to $536,000 in California) Wide variation in exposure to subprime loans (low of 6% in South Dakota, high of 20% in Nevada) Share of subprimes in foreclosure range from 3% in Utah to 18% in Michigan Factors, such as age, household size, ownership rates, and government regulation, can influence the level and outcome of exposure. 34
    • Local and State Revenue Impacts Loss of Capital Gains Tax Loss of Property Tax Base Other Transactions Based Fees and Taxes
    • Some Troubling Conclusions Regional differences are significant? Homeownership at what social costs? Credit tightening needs to be selective, especially where economies are weak? 36
    • Policy Objectives Stability in Housing (and other asset) Markets Retaining high home ownership rates Arresting drastic value slide Maintaining ownership incentives for households with negative equity Normalizing new and existing market activity Liquidity in Mortgage (and other asset) Markets Stabilizing financial markets Efficient securitization Reorganizing Fannie and Freddie to be viable entities (at low social costs) 37
    • Whose Problem? • Homeowners/Borrowers • Homebuyers • Home-sellers • Builders • Lenders • Securitizers • Investors • Regulators • Taxpayers • Government sector • International Components 38
    • Policy Evaluation Criteria/Benchmarks Moral Hazard Issue or Chance of Recurrence Fairness and Equity Bang for the Buck (Efficiency) “Good” vs. “Bad” Subprime Loans Distributional (Income and Geographic) Impacts Linkages of Housing finance System with Broader Financial System and Economy 39
    • The Secondary Market Enigma 1. FNMA and FHLMC 2. FDIC and Banks 3. IB and Securitization 4. Monoline Insurers 5. CDS 40
    • Real Sector Constraints for Policy Economic Environment Job Creation Household Formation Wage Growth Prospects 41
    • Policy Perspective No Single Policy is the Silver Bullet Complex Benefits-Costs Analyses Require Multi-faceted Solutions Regional-State Differences Require Regionally Differentiated Approaches Reinvigorate Securitization Process Triage “Bad” Loans 42
    • Targeting Policy Economic Slow-downs Credit Tightening Loss of Confidence in System 43
    • What Should We Focus on Next? Credit Crunch Synchronized World Recession China Bubbles Burst Dollar Crash (Inflation Risk) Geopolitical Risks
    • Flux = Opportunity
    • Positive Demographics – Echo – Baby Boom; 72 Million People in Next 10 Years Expensive Energy Scenarios – Changing Urban Form and Urban Density Financing Real Estate – What’s Next? U.S. May Represent Best Real Estate Investment “Opportunistic Plays” During Next Five Years!?
    • Office – Not Overbuilt, Except O.C., Seattle Residential – Rebound in Values Over the Next Five Years; MF vs. SF Retail – Well-Situated (LxLxL) Hotels – Dangerous Sector? Industrial/Warehouse – If Globalization Continues?! Securitized Real Estate Markets -- ? Land Play – Have a Hunch---Buy a Bunch will Not Work!? -- Not for the Meek!