Landmark Links May 22nd – Harder Than It Looks

Abs

One Big Thing

As the economy begins to reopen, there is still going to be a substantial amount of distress in two real estate property segments in particular: retail and hospitality.  In the retail space, the pandemic has greatly accelerated a years-long decline due mostly to a combination of competition from ecommerce, over-supply and too much leverage.  The hospitality space was far healthier when the pandemic hit but demand has now been damaged and will likely be substantially lower until there is a vaccine or treatment.

At the same time, residential real estate has been a bright spot, but is still suffering from a crisis of low supply.  The obvious solution in a truly efficient real estate market would be to convert underutilized retail and hospitality properties to badly-needed housing uses.  Unfortunately, we are about as far from efficient as one could get when it comes to land use.

The first issue is the type of structure.  Can an existing hospitality or retail building be converted into housing of some sort as an adaptive re-use project?  Sometimes the answer is yes, oftentimes no and even when it can the process is often so daunting that it makes more sense to bulldoze the existing structure and start over with something purpose-built.  Either way, the physical development is typically challenging, expensive and time consuming.

That being said, the biggest issue isn’t physical development and construction but rather politics in general and municipal finances in particular.  In a bit of a twist of irony, hospitality and retail properties are the biggest moneymakers for cities thanks to occupancy and local sales taxes (this absolutely plays a role in the retail oversupply story, but that’s another issue for another day).  As you can imagine, cities are very reluctant to allow a developer to re-zone a potential cash cow like an under-performing or even vacant retail center or hotel to something that generates little revenue but consumes municipal services like housing.  To be clear, there is absolutely an opportunity here but its not for the faint of heart.  When something seems this obvious, there is a reason that it isn’t being done in greater scale.

What I’m Reading

Against the Grain: Oaktree’s Howard Marks on great investments:

“Every great investment begins in discomfort. If everyone else didn’t hate the investments, they wouldn’t be cheap.”

The Big Bet: Lenders are allowing borrowers to miss payments on credit cards and auto loans with the hope that they will be able to catch up on payments when the economy starts back up again.

Netflix and Chill: A new survey found that 70% of consumers would now rather watch newly released movies at home than in a theater.  The trend was headed in this direction for years but COVID could push it over the edge.  If it holds up, there are a lot of movie theaters that will need to be repurposed.

Inverse: The housing market, household finances and the banking system were the epicenters of the last crisis while the oil industry and urban real estate were areas of strength.  So far its been the exact opposite this time around.

Winners and Losers: Firms like Macy’s and Boeing are selling their warehouses which are getting bought up by Amazon. and other eCommerce giants.

Falling Behind: The national mortgage delinquency rate increased by the most in recorded history in April when loans in forbearance are included.

Chart of the Day

Financial conditions are easing at the quickest rate in history, opening a massive gap between financing conditions and economic activity.  Financial tightening was a leading indicator of the plunge in economic activity back in March.

Source: Bloomberg

Will corporate debt in the post-COVID era follow a similar path to household debt after the Great Recession?

Source: BofA Merrill Lynch Global Research

WTF

Take That: A woman in China sent her ex-boyfriend 1,000 kg of onions in order to “make him cry.”  Speaking as someone who ate onions like apples as a kid (the ladies loved it), this actually sounds amazing.

Jackpot: A Virginia family reportedly stumbled upon nearly $1MM in cash left in a bag in the middle of a road.  They promptly called the local police who are investigating where it came from.  Idiots.

Boomer FIGHT: Four old men got in a paint fight that included throwing of cans at a Home Depot because Florida.  There is video in the link and it is awesome.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarklc.com

Landmark Links May 22nd – Harder Than It Looks

Landmark Links May 21st – Inflexible

cat

One Big Thing

While balance sheet lenders like banks and insurance companies have wide latitude to extend forbearance to borrowers during the pandemic, CMBS and debt funds that use backleverage do not, thanks to a heavy reliance on OPM.  (h/t John Meek)

IMO, this is a big part of the reason why distress is more likely to come more from aggressive debt funds and CMBS lenders than it is from banks and life insurance companies.  While banks and life insurance companies may very well see some level, they typically have the ability to provide borrowers with the time and resources to cure the default because they hold loans on their books.  CMBS and debt funds that are leveraged cannot offer these accommodations because the lenders and servicers aren’t the ones making the ultimate call.

I suppose that the irony in this is that the backleverage used by debt funds is often provided by none other than the banks themselves who will ultimately decide what happens to a debt fund that violates its covenants and can’t make margin calls.

What I’m Reading

Chain Gang: Big restaurant chains are licking their chops and eyeing prime real estate as they watch small restaurants in great locations struggle.

Boom: Mortgage refinancings are set to hit a 17-year high in 2020 with rates at record low levels.  Expect this to surge even more as things stabilize and spreads fall back towards their historical level.  See Also: Weekly mortgage applications, down just 1.5% from a year ago, are pointing to a remarkable recovery in home buying (h/t Jeff Lemieux).

Long Road Back: The CBO estimates U.S. unemployment will exceed 15% through September, remain above 11% the rest of the year and hold above 9.3% for all of 2021, just a percentage point below the Great Recession high

Sketchy AF: Biotech company Moderna announced positive data for a potential COVID vaccine on Monday.  It’s stock surged 30% and ignited a massive stock market rally.  The company promptly announced a $1.2 billion secondary stock offering to raise capital after the spike.  Now vaccine experts are calling into question the data behind the announcement and saying that its too short on detail to tell if the vaccine shows promise or not.

Risk On: Herbalife is targeting a $600mm junk bond sale where the proceeds will be used to buy back stock.  Pyramid scheme companies are using junk debt to buy back stock again.  Nature is healing.  Humans are the virus.

Chart of the Day

Lower bond yields have not helped REITs

Source: Bloomberg

WTF

Raising Spirits: A nurse was suspended from her job in in the all-male coronavirus wing of a hospital after wearing nothing but underwear under her transparent gown because Russia.

Let it All Hang Out: A homeowner was awakened by his dogs barking to find a naked man in his kitchen because Florida.  I’ve said this before: if you can’t trust a man with a full neck tattoo, then who can you trust?

Snake Oil: Tom Brady is selling a $45 vitamin that he claims will make you immune to COVID.  NEVER go full Florida Man.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarklc.com

Landmark Links May 21st – Inflexible

Landmark Links May 20th – The Great Divide

misaligned bridge

One Big Thing

The world’s largest real estate investors are sitting on an unprecedented pile of cash, preparing for distressed opportunities created by the pandemic.  However, the bid/ask spread between buyers and sellers is still massive.

In an environment like this, buyers are likely to be patient as they will want to be able to demonstrate to LPs that they got an exceptional deal if it closes before the dust settles.  No one want’s to hold a May or June 2020 asset on their books unless they can label it a distressed buy.

What I’m Reading

No Takers: Home goods retailer Pier 1 is winding down its business after not being able to find a buyer.  Get ready for some more empty retail space.

Perfectly Positioned: Green Street Advisors is betting that for the next two-to-three years, the single-family rental home sector will outpace multifamily in terms of rent, revenue and NOI growth.

In the Cross-Hairs: In its recently-released bi-annual Financial Stability Report, the Federal Reserve issued a grim warning that asset prices remain vulnerable to significant price declines should the pandemic take an unexpected course.  It called out commercial real estate in particular, saying that the prices were already high relative to fundamentals before the pandemic hit, pointing out that asset prices have risen faster than rents during the expansion.

No End in Sight: SoftBank’s earnings report released last week gave WeWork a valuation of $2.7 billion less than 6% of its peak “value” less than a year ago.

Failed Model: NY Magazine’s Josh Barrow has the best explanation that I’ve seen as to why delivery apps aren’t profitable:

I think the missing element for profitability is different: productivity. The hope with a lot of business models that bring app intermediation to a preexisting element of the economy like ride services or food delivery is that technology will make workers more productive. You can see instances where this is obviously true: a Peloton instructor who teaches a class to tens of thousands of people is more productive than a SoulCycle instructor who can only teach about 60 people at a time. But with a lot of apps, the promised boost to productivity never materializes. The worker still has to render personal service to one customer at a time, and the app doesn’t do much to reduce the worker’s downtime or help him or her complete the task faster. As such, the productivity boost that is needed to make the financial model pencil — paying the worker a high enough hourly rate while charging a fee the customer is willing to pay and still having a positive profit margin — does not materialize.

Chart of the Day

Your guess is as good as mine.

Source: Financial Times

WTF

Perfect Disguise: Two men wearing hollowed-out watermelon rinds on their heads stole alcohol from a Virginia convenience store, even posing for a picture before the heist.

Social Networking: Porn is booming during the pandemic, but it’s also becoming a lot more social, with things like cooking classes with models and fan subscription sites.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarklc.com

Landmark Links May 20th – The Great Divide

Landmark Links May 19th – Opportunists Part II

cat

One Big Thing

With growing hostage demands from the likes of Starbucks, Staples and The Cheesecake Factory, it’s becoming clear that we have entered the looting portion of the economic crisis where everyone looks to take advantage of chaos to improve their own position, whether they experiencing actual distressed or not.  In addition to the bad corporate actors, opportunist politicians are also getting into the act with asinine policies that would generate even more economic upheaval but will resonate with select constituencies come November.  Today’s example: California Senate Bill 939 (h/t Ron Harari).  From California Globe (emphasis added):

Senate Bill 939, written by Senators Scott Wiener (D-San Francisco) and Lena Gonzalez (D-Long Beach), would give tenants much greater power in rent renegotiations due to decreased business caused by the lockdown. If landlords and renters don’t agree to a new rent price based around how much the business is now taking in with only take-out and limited dining capacity customers, renters could end their lease without declaring bankruptcy or being sued by the property owner. The renter would not have to pay any future rents as well, but with the caveat that all back rents up to lease termination would still need to be paid.

Publicly traded companies would not be covered under SB 939.

A halt of commercial evictions for small businesses and non-profits affected by the lockdown would also be enacted as part of the bill. These businesses cannot be evicted until either 2 months after the end of the statewide lockdown or by the end of 2021, whichever comes sooner.

First off, this is clearly well-intentioned- if terribly executed.  Unlike say, Starbucks, who doesn’t want to help out struggling small businesses?  The problem is that it opens up a Pandora’s box of unintended consequences and is incredibly naive in its structure.  Here are four major issues with the legislation (I’m sure there are more):

  1. This is a blunt solution to a complex problem and is not holistic in its approach.  If the landlords have debt against their properties, they are now stuck in between a rock (a tenant with one-sided bargaining power under this bill) and a hard place (a lender to whom they own a monthly mortgage payment – not to mention other operating costs, property taxes, etc).  The resulting fallout would likely be a wave of defaults and, eventually would impair lender balance sheets, unleashing an even larger crisis.
  2. Landlords and tenant enter into a legally binding agreement when they execute a lease.  If one of the parties runs into financial  difficulties, they are free to approach the other one to request an amendment to said agreement.  However, this should be handled by the parties that are principal to the agreement, not by government fiat that favors one side.  One of the main attributes of the United States that makes investing it so attractive is the rule of law.  If California takes this step to invalidate contracts, it becomes a virtually un-investable banana republic.
  3. “Small business” is only defined in the bill as a business that is not public.  Under this definition, a VC backed unicorn worth billions would benefit and be able to legally stiff its landlord.  This is a classic example of politicizing the big bad landlord versus poor little tenant trope.  It is not at all how things work in the real world.
  4. There are huge incentives for tenants to sandbag numbers in order to get a better deal from their landlord.  Bad actors will absolutely take advantage of this.  To think otherwise is childishly naive.

Under normal circumstances, I would read something like this and write it off as another kook in Sacramento trying to make a with a bill to win over a certain constituency in the next election.  The bill would never pass and the legislator would be able to use his or her support for it in an election mailer.  However, these are not normal times and desperate people are more willing to make irrational decisions under pressure, consequences be damned.

The solution here is as simple as it is painful.  Every tenant, landlord and lender that is struggling needs to communicate with each other and work together to ensure that each of them has the best chance of survival possible.  Its not in the interest of a landlord or lender to see a tenant go out of business or vice versa.  However, this should be handled by those parties, not the government.  We are headed in a dangerous direct, and if this passes, there is likely no going back.

What I’m Reading

Roll Up: The post pandemic fallout will spur both hotel industry consolidation and conversion of some hospitality properties to other, more productive uses.

Designed to Fail: This fascinating blog post about a pizza restaurant arbing its own product on Doordash perfectly sums up SoftBank’s business plan:

He messaged me asking me if I knew anything about Doordash, and oh boy, did I get Softbank-triggered. I had just read about their $400 million Series F and it was among the WeWorkian class of companies that, for me, represented everything wrong about startup evolution through the 2010s. Raise a ton of money, lose a ton of money, and just obliterate the basic economics of an industry.

Echoes of the Past: A whistle-blower complaint submitted to the SEC last year throws some major shade at big banks and their CMBS desks.  Not sure if this is legit or not but it sounds rather familiar.  From Pro Publica (emphasis added):

Lenders and securities issuers have regularly altered financial data for commercial properties “without justification,” the complaint asserts, in ways that make the properties appear more valuable, and borrowers more creditworthy, than they actually are. As a result, it alleges, borrowers have qualified for commercial loans they normally would not have, with the investors who bought securities birthed from those loans none the wiser.

On the Road Again: The hospitality industry’s pain could become the RV industry’s gain.

Maybe I’ll Just Drive: From miles of lines to temperature check stations, masks and Plexiglas everywhere, the new normal for airports sounds like a dystopian hell.

Charts of the Day

These charts perfectly encapsulate conditions that lead to what I have been referring to as balance sheet fortification.  When people anticipate that their financial condition will deteriorate, they will cut spending and put off large purchases.  While households are now more optimistic about their current financial condition, their expectations about their future finances continue to deteriorate.

Source: @TheTerminal

The NY Fed’s survey confirms this trend.  Again, someone who expects their finances to deteriorate in the next 12 months will put off big life decisions and purchases consistent with economic expansion.

Source: FHN Financial

WTF

Only Fans: A South Korean soccer club has issued an apology for filling a stadium with x-rated sex dolls during a match.

Let it All Hang Out: A man was arrested for exposing himself to a woman drinking coffee on the porch of her condo because Florida.

Food Fight: A man was arrested for striking his wife in the head with a piece of raw chicken during an argument because Florida.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarklc.com

Landmark Links May 19th – Opportunists Part II

Landmark Links May 18th – Opportunists

Dog theif

One Big Thing

One potential problem in this sort of business environment is that, in the middle of all of the chaos, everyone is sort of on the honor system.  What do I mean by this? Let’s say that several tenants in a shopping center are struggling and go to the landlord for help and the landlord agrees.  What’s to stop other tenants who are not financially impaired but sense that the landlord is now in a vulnerable position from doing the same thing? Apparently very little and the latest to prove this point is none other than Starbucks. From The Seattle Times (emphasis mine):

“Effective June 1 and for at least a period of 12 consecutive months, Starbucks will require concessions to support modified operations and adjustments to lease terms and base rent structures,” read a May 5 letter to landlords, signed by Starbucks Chief Operating Officer Roz Brewer.

Starbucks company-owned shops have long been considered a gold standard of sorts for landlords looking to fill smaller spaces in shopping centers.  Much like Staples skipping rent while remaining open, what they are asking for here is straight-up looting in the midst of a crisis.  Starbucks has more US locations (8,900 company owned) than nearly any other chain so the impact of this will be felt far and wide.  Their primary business of selling coffee and prepared goods is much more suited to our new social distancing reality than so many other restaurants, especially since they already have a robust mobile app.  In addition, its an investment grade credit and has over $2.5 billion of cash on hand as of the end of the first quarter of 2020.

In normal times, if Starbucks tried to pull this, their landlords would collectively tell them to f&%k off and remind them of their obligations to pay per the lease agreement.  However, in our current situation, they are likely to get more traction since landlords are going to be concerned about the consequences of losing a shopping center anchor and having to sue for the their lease payments.  Every dollar of landlord assistance that goes to Starbucks is a dollar that doesn’t go to a struggling mom and pop restaurant or store that doesn’t have billions of dollars in the bank and is on the verge of going under.  Perhaps the biggest problem with this sort of corporate behavior is that, if successful, it will embolden other bad actors who see an opening to lower their rental costs, leading to a worse crisis. I hope that I am incorrect.

What I’m Reading

On the Hot Seat: Colleges are finding out the hard way that no one wants to spend $50k+ a year for a bunch of Zoom lectures. Students at more than 25 schools are already suing their colleges for their spring tuition money and campus fees back.  If colleges end up being virtual in the fall, this will turn into a blood bath.

Uneven Impact: Nearly 40% of low-income workers lost their jobs in March.

Feeding Frenzy: It’s a landlord’s market in the Hamptons this year as well-healed New Yorkers look to escape the tight confines of the city.

Armageddon: OpenTable is forecasting that one in four US restaurants will go out of business due to the pandemic shutdown.  See Also: RIP JC Penney.  The long-beleaguered retailer is being put out of its misery.

Chart of the Day

I wonder what all the people who bet on sports are doing now that they can’t bet on sports….

Image

Source: @sentimentrader

WTF

Ricochet: Police are looking for a woman who (allegedly) flung human waste on employees at a Georgia Taco Bell.

Cut Off: When drug kingpin Pablo Escobar was killed in 1993, 4 of his “pet” hippos escaped his compound and have been breeding.  Now there are up to 150 of the aggressive animals in Colombia and local vets have begun castrating them in an effort to control their numbers.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarklc.com

Landmark Links May 18th – Opportunists

Landmark Links May 15th – Gotcha

sneak attack

One Big Thing

Here’s an amazing capital markets fact: there has never been a default of a senior, triple-A rated tranche of debt issued by a CLO since the instrument was created.  However, we have also never seen an environment quite like this one and defaults on the loans behind CLOs are piling up at a rapid pace, which could lead to the next phase of financial crisis.

What I’m Reading

Moving the Goalposts: Companies attempting to present their financial results in the most flattering light have created a new customized metric called EBITDAC: earnings before interest, taxes, depreciation, amortization – and coronavirus.  And no, this is not satire.

Data Play:  Data giant CoStar is purchasing commercial real estate division of Ten-X as a play on distressed property following the pandemic.

Never Enough: With Americans stuck at home, it would be reasonable to think that food delivery companies would be having their day in the sun.  In some ways they are, with order volume surging substantially.  However, they still are either losing money or barely breaking even, which calls into question the entire business model.  If these companies can’t make money in this environment, its very likely that they never will be able to.

Paying Up: US grocery costs jumped the most in 46 years, led by rising prices for meat and eggs.

Can’t Stop.  Won’t Stop: According to Redfin, home-buying demand has come roaring back, now 5.5% higher than it was pre-pandemic, while inventory has fallen 24%.

Charts of the Day

Mortgage applications to purchase have been incredibly resilient.

Source: The Daily Shot

And rates could fall fairly substantially from here.

Source: Piper Sandler 

WTF

Let it All Hang Out: A man was arrested after deputies said he exposed himself to a woman while driving because Florida.

This Was Inevitable: A church is suing Zoom after a bible study class was hijacked by porn-posting hackers.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarklc.com

Landmark Links May 15th – Gotcha

Landmark Links May 14th – That Sinking Feeling

sinking inflatable

One Big Thing

There is a popular narrative that has been around forever but has received even more attention since the pandemic began: that of the zero sum game between wealthy landlords and less well-off tenants.  The problem with this narrative is that it is largely untrue.  About half of the 43 million rental units in the US are owned by small businesses.  If those small businesses fail, large Wall Street investors stand ready to pick up the pieces and consolidate assets in the rental market, which could be a negative development for a market that already has major affordability issues.  From Bloomberg (emphasis mine):

Small investors own much of the naturally occurring affordable housing in the U.S. If they’re forced to sell or abandon properties, more of the market might wind up in the hands of Wall Street firms, some of which have built up large portfolios of rental properties over the last decade or so. New owners with deeper pockets might opt to reposition low-income units to target wealthier occupants.

“Landlords are not a popular class of business people, for valid reasons and not,” Barry Zigas (senior fellow at the Consumer Federation of America) says. “But that obscures what’s now the very symbiotic relationship of renters and owners.”

It makes sense that there would be a large amount of animosity between landlords and tenants at a time when both are experiencing a high level of economic hardship.  However, once-fringe ideas like a national rent strike that are being seized on by opportunistic politicians will only make matters worse.  If it comes to pass, this will likely have a negative impact on already-stretched affordability by consolidating more naturally-occurring affordable housing units under the ownership of large corporate landlords and reducing competition.

What I’m Reading

Yikes: LA County is now looking to keep its stay-at-home order in place for the next three months.  If other urban areas follow suit, this summer and fall could be a very chaotic time in the economy.

Uniquely Exposed: Perhaps no place in America faces more post COVID fallout then Manhattan.  From the NY Times:

Manhattan has the largest business district in the country, and its office towers have long been a symbol of the city’s global dominance. With hundreds of thousands of office workers, the commercial tenants have given rise to a vast ecosystem, from public transit to restaurants to shops. They have also funneled huge amounts of taxes into state and city coffers.

But now, as the pandemic eases its grip, companies are considering not just how to safely bring back employees, but whether all of them need to come back at all. They were forced by the crisis to figure out how to function productively with workers operating from home — and realized unexpectedly that it was not all bad.

If that’s the case, they are now wondering whether it’s worth continuing to spend as much money on Manhattan’s exorbitant commercial rents. They are also mindful that public health considerations might make the packed workplaces of the recent past less viable.

Lagging Indicator: Even in a run-of-the-mill recession, it typically takes two or more years for employment to recover.

Size Matters: The COVID pandemic could be the final nail in the coffin of the small businesses that have historically defined America’s economy.

Time to Walk?  With tourism imploding and lenders wary, some hotel developers are starting to consider whether it is time to send their construction lenders the keys to partially finished projects.

Chart of the Day

The historical correlation between unemployment rate and mortgage delinquency is very high.  So far, enhanced unemployment and forbearance has held delinquencies down but this cant’ last forever.

Source: Oxford Economics

WTF

Gratitude: A woman was arrested for battering her husband with a bouquet of Mother’s Day flowers because Florida.

Trailblazer: How lessons from the porn industry could help Hollywood adapt to coronavirus.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarklc.com

Landmark Links May 14th – That Sinking Feeling