Rule #2 is that if the Buyer is trying to oversell you on their capabilities to do deals, run.  There are a number of behaviors that fit into this rule.  If the Buyer sends their company brochure with offers, run.  If the Buyer spends the first 20 minutes of your conversation telling you a story about why they are able to pay more than other Buyers, run.  If the Buyer gives you a lot of back story that you don’t need to know about, run.

There’s generally one item on a Buyer’s resume that matters.  They should be able to tell you what they’ve bought recently.  If they haven’t bought anything recently, they should be able to tell you the last thing they bought and why it’s been awhile since they bought anything.  For instance, if the Buyer acquired 10 deals in 2006, but didn’t buy anything in 2007-2009 because they didn’t see anything that made sense, I’m not going to hold that against them.  Their word that they are jumping back into the market will suffice.

But here’s a behavior that I see from time to time and is a huge red flag.  The Buyer hasn’t acquired anything recently, but has some story about access to a fund.  They have a company brochure that might look nice, but in reality probably cost a couple of hundred dollars to have designed and printed.  The story is too good to be true, and the cost to design the brochure is irrelevant when the offers they need to be submitting need to be in the millions.

Maybe you’re talking to someone and your antenna goes up because it seems like they’re trying to “overconvince” you of their capabilities as a Buyer (maybe they’re telling a story about their experience, maybe it’s a story about how they got access to a fund).  Whether you’re the Seller of the property, or a Broker representing the property, you’re wondering what all of the convincing is for.  Then the kicker comes.  They send an offer with a company brochure attached, a proposed earnest money deposit of $5,000, a purchase price that seems too good to be true, and 180 days of due diligence time.  The only question in your mind is whether you should actually light the offer on fire and watch it burn, or create a fake Wikipedia entry for “Total Waste of Time” and post the offer as an image on that page.

I’ve seen several reports of recoveries in imports leading to increased strength in the industrial space market.  In reality imports are fairly important for the entire economy.  The graph below from Calculated Risk shows a fairly steady rebound in imports.  I’ve annotated the graph to show that imports are now at Q2 2006 levels.

I’m shooting from the hip here, but I suspect that industrial vacancies are probably highly correlated to the dropoff in imports (along with some fluff for overbuilding).  So getting back to 2008 import levels is probably pretty important for the recovery of the industrial property sector, and it’s important that it takes place without further deliveries impacting the supply/demand balance.  The interesting thing is that the recovery in imports is on a pretty aggressive trendline that matches the dropoff in imports that occurred at the end of 2008.

Lately I’ve been thinking about some shorthand rules for being able to figure out whether you’re going to be able to complete a transaction.  These are almost warning signs that if they pop up during the negotiation of a deal, I can make an internal bet with myself as to whether or not the deal will actually happen.  In reality these aren’t really even rules.  They are more like guidelines that I use and when I see more than one of them materialize in the same deal, I usually look for the exit.  Sort of like if you’re driving and the check engine light comes on.  It may or may not be serious.  But if the oil pressure light comes on at the same time, you’re going to be worried.

Rule #1 – Don’t Screw Around With Buyers That Screw Around With Earnest Money

This is something you have to sort of play by feel.  If you are negotiating a transaction and it looks like the actual amount of the earnest money deposit is becoming important to the Buyer, look out.  Is the amount in the offer unusually low?  If the Seller proposes to increase the deposit, what is the Buyer’s reaction?  Does the earnest money deposit get adjusted in multiple iterations of the offer/counter-offer cycle?

In our typical deals the earnest money is refundable until the Buyer has approved feasibility.  So if the amount of a refundable deposit becomes an issue during negotiation it’s a red flag that something is going on.  A few potential explanations:

• The Buyer has limited funds and is going to try to flip the deal.  You can go ahead and set an Outlook reminder for the 4:45 call on the due diligence end date when the Buyer calls and asks for an extension to “wrap up their feasibility” when in reality they just haven’t found anybody to flip the deal to.
• The Buyer isn’t limited in funds, but they are out tying up 5 different deals and they’re going to choose the best deal to close on, so they have to conserve cash in order to be in 5 different escrows at the same time.  This is a huge waste of the Seller’s time.
• The Buyer doesn’t have the money and is going to try to syndicate the deal.  Slightly different than flipping, but the easy solution here is to force the Buyer to syndicate at their risk, not at the Seller’s.  So they should be prepared to close whether or not their syndication is complete.

I use a rule of thumb of +/-3% of the purchase price for the earnest money deposit.  So if the deposit is in that range, I’m good.  If it’s lower than that percent, but is still a substantial amount of money like over $100,000, then I’m also fine.

Rule #1 is first because it’s the most reliable.  Not because it’s the most important.  When doing repeat business, or dealing with Buyers that have already closed on deals, it’s not necessary to screen them based on this criteria, although I would offer that it still works.  For instance, if you get an offer through another Broker and the earnest money is light, but the Broker represents that the Buyer has multiple recent closings, it could be the case that the Buyer is using the “tie it up now and decide later” method of Buying.  In that case you’ve got some mitigating information to discuss with the Seller.

I’ll try to post a few more of these rules that are pretty straightforward and simple for anybody that has been doing this for longer than 10 minutes (although I see people who have been doing this for years somehow still miss warning signs).

This item has been picked up by a few people already (RetailChatr and @Maggiacomo) but I saw another side to the story that I thought was worth exploring.

The Cliffs Notes version of the story is that a broker that represented Landlord #1 tried to keep a tenant of Landlord #1’s from relocating to a new space which the broker also represented, but which was owned by the less powerful Landlord #2.  There are all sorts of issues related to ethics, greed, legality, and in general just being kind of a jerk.

My take is probably a little bit different.  I see this not as an issue of greed (often thought to be the primary motivator of brokers) although it may be a simple as that.  I see this more as an issue of arrogance.  A good broker has to be naturally good at navigating complex situations and arriving at the brokers desired outcome (and for the avoidance of doubt I will say that the broker’s desired outcome should be in line with the principal’s desired outcome).  The broker needs to be good at essentially getting what he/she wants.  The better a broker is at this part of the business, the more successful they become, which only increases the confidence in being able to accomplish their goals.

The problem is that the line between confidence and arrogance isn’t just slim, it’s often non-existent.  It sounds like the broker in the story was sort of widely known to be a pretty effective broker, so it’s not a leap to assume that the broker probably ran into instances where the broker’s perception of his skills differed from reality (“Son, your ego is writing checks your body can’t cash” – to steal a line from Top Gun).  Or, if you’re a nerd like me, fastforward to about the 4:15 mark of this Star Wars clip to see an example of someone overestimating their abilities with a disastrous outcome.

So in the case of the broker acting dishonorably when the tenant wanted to relocate, it would have been an act of humility that would have saved the situation.  It would have required the broker to understand the limits of his powers to reach a successful outcome.  A simple “I am not good enough to navigate this complex situation, and I cannot make everyone happy here (or even mislead/confuse people into thinking they are happy) ” might have kept the broker out of a blog post that is now making its way around the industry (and when I say “the industry”, I mean “the biz”).

I’ve written in the past on the “vicious cycle” aspect of the real estate downturn and credit collapse.  Banks are frozen and can’t lend for commercial real estate, which hurts deal volume, which drives down prices, which further hurts the banks’ underlying collateral (the same banks mentioned at the start of that sentence – in case there was any doubt).  This is the reverse of the cycle that begins with easy lending followed by increased deal flow and rising prices, all of which create a false sense of security on the risk side generating more lending (that’s the fun side of the cycle).  But this post is about the ugly side of the cycle.

This item from iStockAnalyst picks up on the theme and has a nice graph to illustrate the banking trend that would be personified by a boxer putting his gloves up and leaning against the ropes.  Since July of 2008, banks have been increasing excess reserves at a fairly consistent pace in anticipation of the beating they are going to take.

The article quotes Elizabeth Warren as follows:

"We’re seeing banks that don’t want to lend because they see every dollar that comes in the door and say I’ve got to hold on to it to try to fill my commercial real estate hole or else I will be gone."

So what can CRE participants do to counteract the cycle mentioned above?  Probably not much.  There is an unwinding that needs to happen and will likely take some time.  Because many of the loans in the marketplace aren’t due until 2012, the correction of the market will likely drag out for sometime.  Instead of being a sudden and intense sickness, the pain is likely to be of the consistent and dull variety.  This commentary comes with the usual caveats.  I suppose that if the economy suddenly caught fire (in a good way), it would bail out many CRE investors and lenders.

Data derived from FDIC.gov.

Real estate related loan auctions for 2009 show that non-performing CRE debt traded at a premium to non-performing residential real estate debt.  Non-performing CRE debt sold for 37% of book value on average, while non-performing residential debt sold for 23% of book.

The thing that is striking though is that when both loan types are performing, there is no discount given for the residential debt.  Performing loans of both types sold for 57% of book value.  This seems odd to me and maybe a reader can tell me why it’s not odd.  But I would look at those breakdowns and say that either Buyers of non-performing CRE debt are overpaying, or Buyers of performing CRE debt are getting a relative bargain (you could also make the opposite case for Buyers of residential debt).

Taken another way, the graph below shows the performing/non-performing gap in loan prices.  The gap between performing and non-performing for residential loans is 35% of book value, while for CRE is just 20% of book value.

I have some theories on the difference in discount applied, but I’m not sure that the theories are coherent.  Some thoughts:

• The important difference might not be between the two types of loans at the non-performing level.  The important difference might be at the performing level.  Buyers of residential loans might be assuming that if the loan isn’t in default by 2009, it might hold up.  Whereas Buyers of CRE loans have to figure in a greater risk of future default (because the commercial market is lagging residential).
• The cost of foreclosure as a percent of book value is higher among residential loans, which means that you have to apply a formula like ((Loans In Default * Market Pullback) + (Loans in Default * Cost of Foreclosure)) * Average Hold Time * Required Return in order to arrive at the property discount.  Don’t quote me on that one – I’m getting an icecream headache just looking at it.  Anyway, the cost of foreclosure is likely to be similar for a house and a commercial property, though the loan amounts are quite different (the average residential loan sold had a book value of $167,000 and the average CRE loan had a book value of $466,000).

Again, any readers that have any relevant thoughts are encouraged to post them in the comments.

The moneyline from this Bloomberg interview: The Fed is going to stop purchasing MBS at “exactly the wrong time for the consumer.”  Is there a good time for the consumer?  Last time I checked, asking the consumer if there is a need for cheap mortgage money is similar to asking a college freshman whether the party needs another keg.  They’re going to look at you and wonder if they’re missing something.  Of course the party needs another keg!  And the answer doesn’t change based on circumstance.  It’s always a good time for another keg!

In the clip Gross discusses the potential that the Fed might start to dispose of some of the MBS that it has acquired, a move that would be a 180 from current policy and would put further pressure on mortgage rates.

My general stance on the housing market for the past five or so months is that I would have preferred to see a stable real bottom form in the market before the bidding wars ensued.  I don’t think that happened.  There are about ten different things that could trip this market up and end the six month rally that we have seen.  Unemployment and further problems with the credit markets are probably the leaders.  I suppose REO inventory and expiration of the homebuyer tax credit have to be close behind.

Via Calculated Risk is this graph showing growth of the Fed’s MBS assets.

And then this graph showing new and existing home sales (incidentally, look at the right side of the existing home sales graph and tell me it doesn’t look like an energy graph for an 8 year old on Redbull!).

Like I said, I would have preferred to see a real bottom form in the housing market.  I’m not even saying that people shouldn’t be buying housing (or housing related investments) right now.  but I do think that in the next 18 months we will at some point see buying opportunities superior to those in the market right now.

Further to my comparison of the housing market to an 8 year old on Redbull is this post from The Big Picture on residential mortgage rates.  If/when the Fed stops buying RMBS, supply-demand would dictate that mortgage rates would have to go up.

Another article on the embattled CityCenter.  This article does a pretty good job of breaking down the issues that the property has had with opening.  Some highlights:

“Thanks to City Center, MGM hasn’t made a profit for two years. The firm’s latest figures, for the final quarter of last year, show overall revenue fell 6% to [...]

Image via Wikipedia

Buffett’s annual letter to shareholders has been making its way around the blogosphere for the past couple of days.  In addition to the usual great folksy one liners (like “Don’t ask the barber if you need a haircut”), Buffett also provides some thoughts on the housing market.
"Within a year or so, residential housing [...]