Archive for April, 2009

Are we Living in the Bizarro World?

The government has seized the opportunity of not letting a good crisis go to waste.

They have forced banks to take TARP money, against their will in some cases, and when those banks want to pay it back they are discouraged from doing so. Why? The government wants to control the banking industry and dictate what bankers can earn. You know that the TARP money “lent” to the auto industry will likely be converted to common equity in order to provide additional control. Even without common equity they had enough influence to fire the chairman of GM.  Money is being printed and spent at unprecedented levels because we are told that, “The world will end if we don’t do this”.

All of this spending could balloon the deficit to the point where our interest payments could approach $500 billion per year. That would be just the interest and that is more than any deficit we have ever had.

For more than 50 years, democratic capitalism constructed its modern framework against the backdrop of its death match with totalitarian communism. In the last 20 years, the American model of capitalism was largely unchallenged by ideological alternatives and became increasingly dominant around the world. It drifted toward what conservatives viewed as a more pure form of economic liberty and what liberals came to view as misguided free-market fundamentalism.

Today, we hear a lot of ideas coming out of Washington regarding the need to diminish the consumerism that has been the backbone of economic growth in the United States. They say we should move away from consumerism and reorient towards saving and investing. They say wealth should be redistributed and we should make the rest of the world less dependent on the US market for their prosperity.

They argue that an activist government is an acceptable and necessary partner for a stable, market based economy. Smart political advisors describe the philosophy in terms of pragmatism rather than ideology.

Transparently, the government is trying to have much easier access to manipulating the private market economy. This philosophy and approach is not limited to the federal government as state and local governments have been following suit.

In New York, our multi-family housing market is subject to a rent regulation system which is advantageous for tenants at the expense of the property owner.  Rent controlled and rent stabilized housing is misallocated, as financial need is not part of the equation. The laws provide maximum benefits to those who have been in place for a long time reegarless of their financial status and need. This results in a system that makes tenants resistant to moving which constrains the supply of available units and puts upward pressure on the average rent a New Yorker pays.

Recently, the New York State Assembly passed a package of bills to strengthen the laws to an even greater extent in the tenants’ favor. Even before the present package was passed, over the long term, allowable rent increases did not keep pace with the increases in operating expenses. If the Senate passes these bills in June, making ends meet will be even more difficult for owners. (go to and check the “Reel” for a commentary piece I wrote on April 20th which goes into greater detail about  the potential impact of the pending bills).

Moreover, this past week, Housing Preservation and Development Commissioner, Rafael Cestero, announced that he is concerned about how much debt property owners place on their properties. He claims he has spoken to officials in Washington “to discuss how to make sure future property sales are sound” and that they are “looking at ways in which we could potentially work with the federal government to bring resources to bear that will help us ensure that ownership – when it needs to be transferred – is transferred to responsible owners.”

Is “property ownership” becoming an oxymoron?

If Jane owns a 50 unit property and wants to sell it to Joe, will Jane have to get approval from the government to sell the property? Will it be rubber stamped if the price is low enough? Will the sale be disallowed if the price is too high or if the amount of the mortgage exceeds some limit? What will Joe have to do to prove that he is “responsible”?

The argument is that the quality of life for the tenants is jeopardized if debt service eats up too much cash flow to allow the owner to make improvements. Oddly enough, most of the owners on the “slumlords” list published each year are long time owners with little or no debt on their properties. Additionally, more capital improvement money is poured into properties in the first two years of new ownership than at any other time.

George Orwell would love our Bizarro world……Remember, Big Brother is watching!


The Government Should not Change the Rules

For those of you who are golfers, you will appreciate the following tale.

I was playing my first round of the year this past weekend and thought I was having one of the best rounds of my life. I warmed up on the range for an hour before I teed off and spent another thirty minutes on the practice putting green. I approched the first tee and launched a drive 275 yards right down the middle of the fairway. My approach shot landed 5 feet from the pin. I walked up the fairway looking around at the trees and the blue sky and feeling like “Wow, this is great”. I stepped up to the ball and confidently sunk my 5 footer for a birdie on #1.

The round continued, in pretty much the same way, for the rest of the afternoon and, after 15 holes, I was even par. Boy, I felt great. A beautiful day, a fantastic round, life was good. Then, on the 16th tee, I was approached by the Starter, who is the policeman of the course. It was not Harry, the usual Starter on Saturdays, but some guy with  “DC” on his golf hat. As he approached he said, “Hi, I’m from Washington and I’m here to help”.

I was perplexed by his approach and even more so by what DC started to tell me.

He said that, although I may have thought I knew what the rules were, they had been changed. It did not matter that DC was actually involved in writting the original rules and voting on the rules to make them valid. The rules were now changed. “How could the rules change in the middle of my game?” I asked. He said, “I am DC, and I can do anything I want”.

DC went on to tell me that under the new rules, (which were formulated because I was having such a good round) each time I hit my tee shot in the fairway, I was penalized one stroke. Each time I put my approach shot on the green, I was penalized one stroke and each time I sank a putt on the first try, I was penalized two strokes. If I hit the ball into the water or into a bunker or off the roof of the clubhouse, I could deduct one stroke from my score. After the recalulation of my score, it turns out that my scratch game (even par) equated to a score of +38. Moreover, my score is to be posted on a nationally advertised website, national tv advertisements and multiple print ads in national publications. Additionally, politicians go on tv and revel in saying how badly I played even though I did not know the new rules they created after the fact.

People who think my score stinks, blog about how much I suck, harass my kids at school and a bus load of crazy people show up at my house in the suburbs with hurtful signs and chant profanity at my family. Would you like this to happen to you?

This is what the government has done to AIG employees. The government passes legislation which provided for “bonuses” to be paid to employees. After these knuckleheads read the legislation they passed, (why read the stuff you actually vote on?) they decided they were wrong and wanted to tax these same bonuses they approved to be taxed at 90%. And if you took TARP money, the government now, after you took the funds with “no strings attached”, decides that you can’t pay employees what they are worth. Who cares that these rules will eliminate the possibility that you can pay back the $173 Billion you received from the government, we don’t want you to give out 1% of that to keep the very people that will enable us to pay that money back. How can you trust this government?

The real estate industry has been hopeful that the TALF and its PPIP would stimulate the secondary market for CMBS and, therefore, make the availability of credit more abundant. TALF 1.0 was supposed to create $250 billion of transactions in the asset backed security market. The first auction raised $4.7 billion. The second raised $1.6 billion. Hardly a success. Why?

Who can trust the government to not change the rules in the middle of the game? I have many clients considering participating in the PPIP but they ALL feel like they would be taking a big risk that the government will screw them if they end up making large profits. Will the president villify those making big buck, will the House tax these profits at 90%, will people in busses show up at the homes of the employees of the companies profiting from this program? Who wants to deal with this?

The TALF and the PPIP will not hurt our commercial real estate market. The question is, Will they help our market? The jury is still out on this. If the government can’t make rules and stick to them, the programs will surely fail. Investors will not play a game in which the rules might change after a commitment is made.

Our market participants need to get credit for a birdie. Don’t change the rules after people have put their faith into the program.  If no one plays, no one wins….

Why the National Housing Market is so Important

Yes, I know that I am a commerical investment property sales broker, so why do I track the national housing market so closely? The answer is that this market has the most profound impact on our financial system, which affects our capital availability, which in turn affects our commercial real estate markets. Let’s look into this dynamic.

The most recent housing bubble that we experienced has upended our financial system. History helps us to understand where we are today. Since 1970, there have been two other major housing bubbles, with peaks in 1979 and 1989.

The most recent bubble started in 1997, ignited by rising houshold income which began in 1992 in concert with the 1997 elimination of taxes on residential capital gains up to $500,000. Investors are attracted to markets with rising values and the early stages of this cycle had this usual, self-reinforcing feature.

The collapse, which created the recession beginning in 2001, could have ended the bubble but unusually expansionary monetary policy was implemented by the Fed to counteract the downturn. As the Fed increased liquidity, money naturally flowed into housing which was the fastest expanding sector. Both the Clinton and Bush adminestrations aggressively pursued the goal of expanding the homeownership rate. They encouraged Fannie Mae and Freddie Mac to purchase just about any mortgage in sight and lender’s credit standards eroded.

Lenders and the investment banks that securitized the mortgages used ever increasing housing prices to justify loans to buyers with limited income and assets. Rating agencies accepted the supposition of ever increasing house prices and issued investment grade ratings which lured buyers for these securities from around the globe. Mortgage loan originations increased an average of 56% per year for three years – from $1.05 trillion in 2000 to almost $4 trillion in 2003! This trend continued.

Home prices started to decline in late 2006. The latest Case-Schiller index, which tracks housing prices in 20 major metropolitian areas, fell by 19% for the three months ending January 31, 2009. This is a new record low for this index. Many of the buyers of houses in this bubble had far less than 19% equity in their homes, some with 3.5% or less. According to First American CoreLogic, 10.5 million households had negative or near negative equity in December of 2008.

The result of all of this was: Bear Sterns, Merrill, Lehman, AIG, Fannie, Freddie, IndyMac, Countrywide and the dozens of other bank failures and general distress in our financial system. Government intervention we are seeing at every turn. The FDIC has asked for and received access to an additional $500 billion in government funds in anticipation of future needs.

Not many people are talking aobut it but rising mortgage defaults could force the FHA to seek a taxpayer bailout for the first time in its 75 year history. The Obama administration will have to decide whether to ask Congress for taxpayer money or raise the premium it charges to borrowers. Roughly 7.5% of FHA loans were seriously delinquent at the end of February, up from 6.2% a year earlier. The FHA’s reserve fund fell to about 3% of its mortgage portfolio in the 2008 fiscal year down from 6.4% the prior year. By law it must remain above 2%. A strong FHA is essential for a recovery in housing.

We have seen reports recently that the housing market has bottomed out. It is difficult to believe this is the case as we are not close to seeing unemployment peak, which will be critical for housing to bottom.

The lack of equity in homes has greatly effected consumer confindence and consumer spending both of which effect corporate earnings which effects demand for office space, retail space and apartments. As housing prices stabilize and begin to rise, the wealth effect will be tangible and the downward spiral will reverse. Housing got us into this mess and housing must pull us out of it. Let’s hope it is sooner rather than later.

It is Time to Modify FIRPTA

The commercial real estate market needs money. We need investment dollars to pour into the market. Should we encourage foreign investment? Do we really care where the cash comes from? As Jerry McGuire’s client  said, “Show me the money”! FIRPTA creates a speed bump for foreign capital. It may be time for a change.

The Foreign Investment in Real Property Tax Act (FIRPTA) is a statute that requires that a seller, who is a foreign person, permit a withholding of a part of the selling price (generally 10%) against the United States gains taxes that the foreign person will owe on capital gains earned on the sale of  real property.

A foreign person, for federal income tax purposes, is generally any person who is not either a resident alien or a United States citizen.  If an owner of real property is an entity formed outside of the United States, it is also deemed a “foreign person” under the IRS code.

The FIRPTA law creates a tremendous disincentive for foreign entities to invest in domestic real estate.  This primary obstacle facing non US investors who invest in US real property – the FIRPTA – should be repealed. The law has profound implications for non US investors in US real estate. FIRPTA’s discriminatory application (aimed solely at real estate) coupled with onerous reporting requirements impedes foreign investment in US real property, which in turn, has negative effects on the vitality of the US economy.

FIRPTA was enacted in 1980.  A senator from Michigan was concerned about farm land and wanted to protect “the American heartland” from foreign interests. The world has changed, but FIRPTA has not. Many of the rules that were written in the 1980s look outdated and unsuited to modern investment  practices because they were written with a particular paradigm in mind, that being a single foreign investor or a small group of foreign investor acquiring US real property.

Today, investments in US real property are being made in many different forms. They include REITs owned in part by foreign persons, private equity partnerships, and collective investment funds organized outside the US, making ultimate ownership difficult to determine.  

The United States generally has no jurisdiction to tax foreign persons on capital gains that are sourced within the US, unless those gains are “effectively connected with a US trade or business”.  The US taxation of international investors is governed by either the Internal Revenue Code or income tax treaties that the US has signed with other nations.

Non US investors in US real property are subject to fundamentally different US federal income tax rules than those that apply to their investments in US corporations or other capital assets.  Most notably, a foreign person’s gains attributable to the disposition of capital assets other than US real property interests are not subject to US tax. FIRPTA discriminates against the asset class of real property.

Credit availability in our market today is scarce creating a greater need for equity. Foreign investors and entities are a tremendous potential source of this greatly needed equity. Unfortunately, many foreign sources of equity investment have expressed little desire to make investments in US real estate when future gains will be taxed at marginal rates ranging from 35 to 50 percent, according to The Real Estate Roundtable.  These sources of potential investment are looking for positions as lenders with contingent interest debt instruments to minimize their incidence of taxation in the United States.  Property owners are reluctant to offer senior positions in the capital stack that could effectively diminish future upside in their investments.

The US tax system should not be a barrier in the competition for institutional investment in real estate.  As emerging economies grow, destinations for international institutional capital will grow and the US has to be competitive in this global market.

The US real estate market has benefitted immensely from having an open ecomony that allows for the free flow of capital and goods with foreign trade partners.  The continuation of policies such as FIRPTA will have negative effects on both real estate markets and the US economy. Foreign investors should be allowed to invest in US real property without any more disclosure other than that required of a US investor.  Similarly, tax law affecting foreign investment in US real property should not be any more burdensome to foreign investors in the US than those that apply to US investors.

Our market needs capital and if the foreign market wants to provide that capital, we should encourage that investment.