A Publication of Paramount Capital Corporation. Strategy and Insight for the Commercial Real Estate Industry

Transcription

1 Volume V Issue 1 A Publication of Paramount Capital Corporation Jan 15, 2013 Strategy and Insight for the Commercial Real Estate Industry A REVIEW AND UPDATE OF OUR PREDICTIONS FOR 2012 AND A DISCUSSION OF LIFE COMPANY LENDING, THE BALANCE SHEET OF THE FEDERAL RESERVE AND REIT FOCUS ON CAMDEN PROPERTY TRUST, AN APARTMENT REIT In this month s issue; Real Estate Focus will discuss our predictions for 2012 and new ones for 2013 and a review of Life Company CRE financing, Economic Focus will discuss the financial position of the Federal Reserve during the last few years and REIT Focus includes an analysis of Camden Property Trust, an apartment REIT. REAL ESTATE FOCUS Real estate and Economic Predictions I. Capitalization Rates: Our prediction for 2012 was that the average cap rate for the four primary property types would be about 7%. In fact, it was lower at about 6% per NCREIF

2 and other CRE research firms. This was due to very low interest rates and luxury apartment properties which are still trading at low cap rates of 4%-5%. Our prediction for 2013 is for the average cap rate to rise to 7% as the economy and CRE improve (not withstanding higher taxes and convoluted government fiscal policy) and interest rates begin to rise. II. Property Fundamentals: Our prediction for 2012 was that apartments would continue to be the strongest property type with average rents increasing 5%-10% depending on type and location, followed by industrial with up-trending global trade flows, retail and then office. We were correct as apartments have performed very well with hefty rent increases, especially in supply constrained markets. Our prediction for 2013 is for apartments to continue to do well, however, rent increases will taper off somewhat to 3%-5%, as there are more than 240,000 units slated to be built in the US this year. III. Dow and S&P 500: We predicted the Dow and S&P 500 would rise to 13,000 and 1,350, respectively at the end of the 2012 and we were too conservative as the Dow ended at 13,488 and the S&P 1,472. With the US economy and job growth improving, we think the markets will rise 10% in 2013 to 14,900 for the Dow and 1,600 for the S&P 500. IV. California Economy: Our prediction for 2012 was that California would have a multibillion dollar budget deficit, businesses and individuals would continue to flee the state, job growth would be anemic and the November 2012 ballot issue to raise income and sales taxes would be defeated by California voters (see the December 2012 VOM issue for a discussion of California s budget deficit and ballot initiatives). We were correct on everything except the ballot issue, in which voters (to our dismay) approved higher sales and income taxes. Our prediction this year is for more red ink with another multi-billion dollar deficit, more individuals and companies fleeing the state and tepid job growth.

3 V. Budget Deficit: Our prediction for 2012 was an annual budget deficit of at least $ 1.2 trillion and a change in the Presidency and a GOP majority in the Senate. We were correct on the budget deficit but wrong on the election as Obama was reelected and the Senate has a higher Democrat majority. Our prediction this year is for another budget deficit of at least $1 trillion and minimal, if any, spending cuts. We don t believe politicians in Washington want to cut spending and when they say cut, they mean a reduction in the spending increase from one year to the next. Currently, Washington uses baseline budgeting which means that all budget line items are automatically increased every year by 3%-8%. When a politician says they want to cut spending, they only mean cutting the rate of growth, instead of a budget item growing 6%, it will only grow 3% and this is considered a draconian spending cut. Only in Washington is the budget and spending process so perverse. Voters should demand that budgeting be zero based, wherein, each department begins each new period with a zero budget and must determine how much money they need to run their department or group. VI. Oil: Our prediction for 2012 was an average oil price of $120 a barrel. We were way off as the average price of WTI oil was $94 per barrel in We thought that demand for oil from China would increase due to an improved economy and prices would rise. Our prediction for 2013 is for the average price of WTI crude to increase to $110 per barrel, as the US economy improves and demand from Europe and China begin to recover. VII. Unemployment Rate: Our prediction for 2012 was that the employment rate would stay above 8% with tepid job growth. We were close, as the unemployment rate ended at 7.8% even though we believe the only reason the rate has decreased is the large number of workers who have left the labor force and are not counted in the denominator. Our prediction for 2013 is a year-end unemployment rate of 7.5%, as discouraged workers reenter the labor market and keep the rate elevated VIII. Ten Year Bond Yield: Our prediction for 2012 was that the 10 year bond yield would rise to 2.5% as economic growth pushed up interest rates. We were way off as the 10

4 Year bond ended 2012 at 1.86%. We predict that the rate will rise and close 2013 at 2.75% due to a better economy and investors reallocating funds from bonds to stocks and other riskier investments. IX: Federal Funds Rate: Our prediction for 2012 was for the rate to remain at zero percent as the US economy was still growing slowly and the reluctance of the Fed to raise interest rates anytime soon. Our prediction for 2013 is for the funds rate to stay at zero percent as the Fed has just announced QE3 in which the Fed will be purchasing $40 billion of mortgage securities per month in addition to Operation Twist, which is selling short term Treasury securities to buy longer term issues. X. Inflation/Gold: Our prediction for 2012 was a CPI increase of 3.5% and a high in gold of $1,800 per ounce. We were almost right on with gold as the high price in 2012 was $1,794, but we were way off in the CPI prediction. The actual CPI for 2012 was only 1.8% versus our call of 3.5%. We predict that the CPI will rise 2.75% in 2013 as an improving economy will increase demand for goods and services therefore increasing the CPI. We think the price of gold will hit a high price of $1,750 per ounce from a current price of $1,660 per ounce. Life Insurance Company CRE Financing Life insurance companies have always been and still are a major force in the financing of commercial real estate. They have been somewhat in the background during the financial crisis and we thought it would be a good time to look at their CRE business. As of the fourth quarter of 2012, total CRE loans held by life companies were $323 billion. Although they are a viable financing candidate their underwriting has become very stingy and they will only finance the top properties, with well capitalized owners, at loan to value ratios in the 50%-60% area and at debt service coverage ratios of at least 1.2X. Table I below shows a distribution of life company CRE loans by property type.

5 Table I

6 Table II below shows the percentage of CRE loans in default and foreclosure. As shown, the amounts are very small due to their conservative analysis and underwriting as mentioned above. Table II Table III below shows the delinquency rate for commercial CMBS, Fannie Mae, Freddie

7 Mac and the life insurance industry. As shown, the highest delinquency rate is in the CMBS sector which has a current loan outstanding balance of approximately $675 billion and at the delinquency rate of 9% below, equals about $64 billion in delinquent loans. The CRE industry is on the road to recovery, but, it is by no means out of the woods, as there is still a sizable amount of distressed loans. Table III

8 ECONOMIC FOCUS An Inside Look at the Federal Reserve For this month s Economic Focus, we wanted to take a look inside the balance sheet of the Federal Reserve. Many pundits have commented on the Feds money printing programs during the last few years, but few have actually looked inside the numbers. The Fed has consummated four money printing operations since First was Quantitative Easing One (QE1), which began in November 2008 and ended March 2010, to buy $2.1 trillion of Treasury Securities. In November 2010, QE2 was initiated, which bought an additional $600 billion of Treasury securities. Then in 2012, the Fed started Operation Twist, to sell short dated Treasury securities and buy longer term ones. Finally, in September 2012, the Fed began QE3, to purchase $40 billion of mortgage securities per month. As shown in the table below, the Feds balance sheet has swollen to $2.9 trillion in assets. With Operation Twist and QE3, many economists are predicting that the Feds balance sheet will further increase to $4 trillion or more in early These are huge numbers and beg the question, What happens when interest rates begin to rise? If rates do begin to rise the Fed will have to cease these QE programs and seek an exit strategy for its bulging security portfolio. Depending on the duration of the securities, it could cause huge multi-billion dollar losses for the Fed and Treasury if they are sold. It will also cause havoc in the funding markets with such a large inventory available for sale. Summary of Federal Reserve Balance Sheets (Billions) 1/ / / / / /2007 Securities, Repos and $1,753 $1,785 $1,208 $1,102 $1,628 $830

9 Loans Mortgage Backed Securities (1) Other Assets (2) Gold Total Assets $2,930 $2,928 $2,423 $2,237 $2,259 $894 Total Liabilities $2,876 $2,875 $2,367 $2,185 $2,216 $857 Total Capital $54 $53 $56 $52 $43 $37 (1) The Fed started buying mortgage backed securities in early 2009 (2) Includes US Treasury securities, loans, foreign currencies and other assets REIT FOCUS This month s REIT Focus is on Camden Property Trust ( CPT ), a publicly traded, selfmanaged real estate investment trust that owns multifamily apartment communities. CPT owns a 1% general partner interest and 89.8% limited partner interest in Camden Operating, L.P., its UpReit general partnership. As of 9/30/12, CPT owned interests in, operated or was developing 209 multifamily properties containing 70,871 units. Six of the properties under development represent 2,404 units. The properties are located in the Western, Southwestern and Southeastern US. The highest concentration of apartment units is located in Houston, TX, Las Vegas, NV, Dallas, TX and Tampa, FL. The average occupancy and monthly rental rate of CPT s portfolio as of 9/30/12 were 95.2% and $1,163, respectively. CPT was incorporated in the State of Texas in 1993, is traded on the NYSE and is based in Houston, TX. CPT has 84 million shares outstanding and a market capitalization of approximately $5.8 billion. CPT has a well regarded and veteran management team that includes

10 Richard Campo, Chairman of the Board and CEO, who has been with the company since 1993 and Dennis M. Steen, Senior Vice President and CFO, who has been with the company since Select financial data for CPT as of the 9/30/12 10Q and for the period 1/1-9/30/12 is as follows (in millions where applicable): Real Estate Assets, Gross $6,289 Total Assets $5,218 Notes Payable, Secured and Unsecured $2,394 Stockholders Equity $2,533 Revenue $557 Net Income $141 Earnings Per Share $1.66 Cash Flow from Operations $250 Unsecured Credit Facility ($500 with $10 used) $490 Market Capitalization $5,800 Debt to: Gross Real Estate Assets 38% Market Capitalization 41% Real Estate Assets Per Unit $89,000 Dividend Yield ($2.24/sh.) 3.2% Valuation Methodology: Revenue Per Above Annualized $743 Less: Operating Expenses (excluding depr., amort. & int.) $327 Projected Net Operating Income 2012 $416 Projected Inflation Rate x103.5% Projected NOI for Next Year $431 Projected Cap Rate 7.5% Projected Value of Company $5,747 Less: Total Debt Per Above ($2,394) Projected Value of Company Equity $3,353 Shares Outstanding 84 Projected Value Per Share $40

11 Current Market Price Per Share $69 As shown above, our value for CPT is $40 per share versus a market price of $69 per share. Current average cap rates for apartment properties per CBRE, Price Waterhouse Coopers and the Urban Land Institute are in the 6% to 9% range, depending on the location, occupancy and quality of the property. We have used a cap rate of 7.5% due to CPT s portfolio being primarily located in low barrier to entry or high beta markets. High beta markets are states and Metropolitan Statistical Areas with low impediments for new apartment development, a lot of available land for development and a boom and bust CRE cycle. These markets include Texas, Florida, Arizona and Nevada. At its current price of $69 per share, CPT is trading at a 5% cap rate and is overpriced as many of the other apartment REITs. Apartment fundamentals are excellent with rent increases in 2012 of 5%- 10% depending on the specific property and location. However, there are more than 240,000 units scheduled to be developed in 2013 and with the increased competition from single family home rentals, rent increases in 2013 should be in a lower 2%-5% range. The gross real estate assets, net income and funds from operations for 2010 to 9/30/12 are shown in the table below: (millions) /30/12 (9mos) Gross Real Estate Assets $5,441 $5,520 $6,289 Net Income $23 $49 $141 Funds from Operations $194 $207 $227

12 A five year price chart of CPT is shown below: CPT strengths include; moderate leverage, diversified portfolio, solid and experienced management team and a portfolio that is 95% leased. Weaknesses include; portfolio is

13 primarily located in high beta markets and high stock price with lower dividend yield. CPT is a well managed apartment REIT; however, we do not recommend purchase of the stock price at this level and would hold the stock if already owned. REIT Focus reviews in prior issues of VOM are as follows: 1. BRE Properties, Inc., June 15, Boston Properties, Inc., July 15, Simon Properties Group, Inc., August 15, First Industrial Realty Trust, September 15, Public Storage, October 15, Ashford Hospitality Trust, Inc., November 15, AvalonBay Communities, Inc., December 15, Alexandria Real Estate Equities, Inc., January 15, Federal Realty Investment Trust, Inc., February 15, Digital Realty Trust, Inc., March 15, Lasalle Hotel Properties, April 15, Apartment Investment and Management Company, May 15, Equity Residential Apartment Company, June 15, The Macerich Company, July 15, SL Green Realty Corp., August 15, 2012

14 16. Kimco Realty Corp., September 15, Cole Credit Property Trust II, Inc., October 15, Realty Income Corporation, November 15, Piedmont Office Realty Trust, Inc., December 15, 2012 THE VIEW OF THE MARKET NEWSLETTER ARCHIVES For a Subscription to this letter see Copyright Paramount Capital Corporation 2013 Disclaimer: The information, strategies and material presented in the newsletter are for information purposes only and not to be considered as an offer or a solicitation to sell or an offer or solicitation to buy or subscribe for securities, investment products or other financial instruments. This newsletter is available only by paid subscription and should not be reproduced, copied, ed or disseminated in whole or in part without the express written consent of Paramount Capital Corporation.