Does the market feel like you are in the opening sequence from Terminator II?  Are you fighting amidst the wreckage of the previous boom? Surrounded by foreclosures, scarce money, economic gloom and doom? Real estate going into nuclear winter? That’s what market bottoms feel like and as investors we need to get comfortable with that feeling because this is our time to make solid, reasoned investments that produce good results on improving fundamentals. Conditions like this create the opportunities for savvy investors who were patient through the bubble and have waited for the speculative, greater fool market to come to its inevitable end.

Many great real estate investors got their start in rough times like Sam Zell of Equity Residential for instance. He started out buying properties from distressed owners in the late sixties. Tom Barrack of Colony Capital waded through the carnage of the S&L meltdown to buy properties at a discount. Barry Sternlicht of Starwood Capital also started in the wake of the S&L crisis buying multifamily properties. What will your story be?  It’s time get to work and seize the opportunities. Put on your hardhat though because it’s about to start raining real estate, and while not every distressed property is worth pursuing  if you stick to your niche and learn your market good deals will surface.

At Ashworth Partners Ltd we are focused on multifamily properties in selected markets that we’ve identified as being positioned for growth through the 2020s. We believe that demographics and market forces favor this sector and are actively pursuing deals that fit our model now. We operate under Warren Buffett’s advice to never count on making a good sale; have the purchase price be so attractive that even a mediocre sale gives good results.

That feeling in the pit of your stomach that there’s nothing good in the world? Get comfortable with it, make it your friend. To put it succinctly, buy when you are depressed and sell when you are happy.

For up to date news and info on real estate, finance and the economy follow @GiovanniIsaksen on Twitter.

Welcome to the new home of the Ashworth Partners blog version 3. This is were you will find our latest insights on Commercial Real Estate Loan Modification, Multifamily Investments, The Dealizer analysis software as well as our take on the financial, economic and current affairs effecting business. We invite you to participate by sharing your comments and suggestions.

In the coming days I will upload our previous blog posts from the old site. These posts will be added with their original publishing date for clarity and continuity.

I am running a friend’s campaign for city council so I’ve been talking to a lot of people the last few months. Most of the conversations have been about our home town of Bellevue WA and the local issues the city is facing but I’ve also had a number of conversations about the economy, real estate and the credit markets. The majority of the people, many of whom are developers, property/asset managers or owners, are searching for the turn in the cycle and are looking forward to the opportunities that will arise when things return to normal.

I too am looking forward to the upswing in the real estate cycle but I’m not sure that back to ‘normal’ is where we headed. I believe for the last two decades we have been and are living in the ultimate payoff of the Marshall Plan and its siblings. We have successfully avoided a third world war by creating market based economies where enemies might have arisen. This is an entirely positive outcome and surprising to me, a child of the cold war era.

Economically this means that we are living on a planet full of competitive market economies where prices are set by the lowest cost producer and the only margin available to pay our workers more is the cost of shipping the product from the low cost producer to our markets. Any industrial age product and even most modern technology based products can be produced competently in hungry economies around the world and the premium US workers enjoyed in the past is now gone. While productivity gains can help hold wage rates up they ultimately reduce the number of workers required to produce a product and in the aggregate tend to be neutral to negative on the amount of total wages.

Since these workers are also tenants, consumers and clients we are directly effected by their fortunes. Going forward their wages will continue to fall or at best be flat while the world catches up. In this environment I believe the demand for different housing types will change and will be to the advantage of long term multifamily owners. With dimming economic prospects and conservative banking back in favor, fewer people will want or qualify to buy a house, especially since single family homes won’t be viewed as wealth creation machines.

That means renting will be much more in favor. With multifamily construction starts falling precipitously a real shortage of units will arise in the next 4 to 6 years, presenting investors a great opportunity to acquire properties at distressed prices today and liquidate at the top of the cycle when new stock begins to come on line. Long term rent growth will be moderated by wage growth but multifamily properties should enjoy a premium because of their better inflation protection compared to other income property types.

The credit crisis will in time be seen as a final chapter in the Marshall Plan success story and will be revealed as a symptom of the end of US preeminence as an economic power rather than the disease.

At the end of last year (See my Dec. 28 post Why buy Multifamily in ‘09) I laid out a number of factors pointing to the opportunity to secure good returns on income producing apartments this year. As time marches on we are receiving more corroborating evidence of a market bottom for multifamily at the same time as the credit market for these properties still has money available for acquisitions.

From a diverse range of reports starting with the ULI/PricewaterhouseCooper’s Emerging Trends in Real Estate 2009, Real Capital’s report published mid-Feb to Marcus & Millichap’s conference call last week (Feb. 24th) we are seeing a real buyers market develop in multifamily.

First of all multifamily starts are projected to be down at least 30% this year on top of being down 50% in ‘08, meaning starts are down 85% from two years ago. Balanced against this lack of supply is the fact that Census Bureau projections show the growth in the prime renter segment of the population (20-34 year olds)will accelerate significantly over the next five years forcing rents higher over that period. There will also be a steady if not growing stream of immigrants who tend to long term renters.

Even in the markets that dodged the worst of the mortgage meltdown (remember that the vast majority of the damage was done in only four states: CA, AZ, NV, FL) home prices and mortgage availability are keeping many from buying a home, or from considering home ownership to be a good investment. Net-net, supply down and demand about to rise. Markets that are poised to benefit from stimulus spending, especially in infrastructure and energy will experience the economic recovery sooner than other locations in the country and multifamily properties in those markets will turn around sooner as well.

Financing while requiring more equity, is still available. The GSEs are full of cash, are actively lending on multifamily and are authorized to continue doing so through the end of 2009. Regional and local banks are also lending on multifamily, albeit at slightly higher rates than the GSEs. There is also foreign capital finding good multifamily values here in the continental US.

With all these positives, why isn’t everyone out there acquiring? There are both challenges in the short term and a large group of buyers waiting for ‘the bottom’ of the market before they wade in. The primary challenge is that vacancies in most markets are rising and rental rates are projected to be flat to down through ‘09 and maybe into the first part of 2010. This has many buyers afraid of ‘overpaying’ for properties which puts them in the waiting for the bottom group.

Our strategy is to buy based on higher vacancy and lower rental rates so that the property will operate positively while we wait for demand (and inflation) to pick up. During the latter part of the anticipated seven or eight year holding period the property will benefit from increased demand, inflationary pressure on rents as well as the return of growth in the economy and amortization of debt. We will also utilize technology to insure operating costs are kept to a minimum.

Those waiting for ‘the bottom’ will naturally be paying more for their properties because the confirmation of the bottom is rising prices of course. There is an old saying that the smart money is typically thought to be ‘early’ and we believe now is the time to be part of that group.

For the statistics and charts we are seeing or to learn more about apartment investments and the multifamily deals we are uncovering please contact us:

Giovanni Isaksen
Ashworth Partners Ltd.

Vince Farrell of Soleil Securities Group sent me his take on what key credit spreads are indicating about the financial landscape and economic prospects. For a little background, a ’spread’ is trader talk for the difference between two financial instruments, in this case the interest rates offered different debt instruments. As with most spreads these have a historical ‘normal’ range and their trend away from or back towards normal are used to measure optimism or pessimism in hearts and minds of those who create or invest in the referenced instruments.

Vince finds that while most of the credit spreads he follows are wide by historical norms, they are narrowing and the trends are positive for the credit markets and eventually the economy. Here are his comments:

The TED spread – the difference between three-month dollar LIBOR and the three month Treasury bill – is about 96 basis points today. The normal spread is 50 basis points or so but this is vastly improved from the almost 500 basis points that was touched in September when Lehman failed. This is a measure of fear in the short term money markets and the fear hasn’t completely gone but, as I said, is much improved.

The spread between the thirty-year fixed rate mortgage and the 10-year Treasury bond is about 235 basis points. The historic spread is about 170 basis points and this, like the TED, is much better.

The difference between the jumbo mortgage interest rate (30-year mortgages for over $417,000) and the 10-year Treasury is around 400 basis points. This still has a way to go, as the long term average is closer to 250 basis points. This is a loan a bank would make knowing it can’t be sold to Fannie or Freddie (too big), can’t be securitized (that market isn’t there), so it would stay on the banks balance sheet. To me this is a critical mark for judging if the credit markets are truly improving.

The TIPS spread – the difference between the 10-year Treasury and the 10-year Inflation Protected Treasury – is about 110 basis points. That would be read as the expected rate of inflation for the next 10 years. It was close to 0 not long ago and I am greatly relieved the market has backed off that deflation scenario.”

You can catch more of Vince’s insights and analysis on CNBC where he appears regularly. He is the CIO of Soleil Securities Group who provide research, brokerage, marketing and investment banking services to institutional and corporate clients.

Giovanni Isaksen
Ashworth Partners Ltd.

As I sit here looking out at the snow while I’m taking time out to review and update my goals for the year there are stars aligning to make the new year a positive one. Especially if you are looking for alternatives for your investment and retirement money. The stock market hasn’t been good to us (I look at my account statement from between my fingers!) and the prognosis for the next year or two isn’t much better.

In contrast there are a number of reasons to consider owning multifamily properties, specifically apartment complexes with more than 100 units. Before I go into the reasons why now is a good time let me first be clear about what I’m NOT recommending, the landlording business. The reason to focus on properties with more than 100 units is that they are large enough to support both professional management and professional maintenance; most likely having both onsite full time if not living there. As an owner of this type of property your job is to review the management reports and manage the managers, not unclog toilets or take phone calls from tenants.

Reason #1- Show me the money! The properties we’re talking about produce cash flow in the low to middle double digits and total annualized returns in the high teens to mid twenties on five to ten year holding periods. Before you say 10% cash and 19% total a year doesn’t sound like much let me be clear that we’re talking about existing buildings with existing tenants and provable revenue, not dream stage tech start ups or land speculation in Vegas. Besides what are treasuries, money markets or even dividend stocks paying lately?

Reason #2- There are 100 or more people paying the bills for you. One of the things that make multifamily a good investment in tough times is the diversification of income streams for the property. As opposed to a rental house, or even a commercial building, strip mall, etc., no one tenant moving out will destroy your cash flow. A certain amount of turnover is expected and your professional managers will have a marketing plan in place to provide the necessary replacement tenants.

Reason #3- Good supply/demand characteristics. No one is lending on property development now, developers are shuttering any project not already out of the ground on construction and the number of new completions are dropping every month. There is some new supply on the upper end as condo projects are switched to rental (or being UN-condo-converted) but the multifamily properties we’re interested in are the mid-level complexes that have good characteristics not top of the line luxury properties.

On the demand side there are three sources of tenants: Those who are renters by necessity because they can’t afford to buy; Renters by choice who don’t see the value in purchasing a home; Former homeowners who have been driven out of their homes because of the mortgage meltdown. For the ‘B’ properties, as they are called, there is an additional source of new tenants, ‘A’ renters moving down to reduce monthly expenses. B properties have most of the amenities of A properties but typically are a little older. Most were A properties when new and are in good neighborhoods which is also a factor that keeps B renters from moving down to C properties.

Reason #4- Competition for properties is low. While there a good deals to be had, especially from over-leveraged owners and bank REOs, most of the institutional money and foreign money is sitting on the sidelines waiting for the next upturn. Of course waiting for the upturn means that they’ll be paying up for properties, maybe even for one that you acquire now.

Reason #5- Buy low, sell high. Prices in most markets have come off their highs and sellers are starting to become reasonable in their understanding of market fundamentals; they’ve been watching the same news reports as everyone else.

Multifamily pricing is often described in terms of ‘Cap Rate’ which is similar to the dividend yield on a stock. Buyers are demanding a higher return on their investment which means that Cap rates have been rising, in many places by as much as one to one-and-a-half percent. A one percent move in cap rate can mean a significant change in price. For example a 100 unit property selling for 3.5 million at a 7% cap rate would sell for just over 3 million and an 8% cap rate. We typically want to buy at cap rates of 8.5-10% or higher and are uncovering properties now in that price range.

Reason #6- There is money for apartments! Fannie Mae and Freddie Mac are being pumped full of liquidity by the government and while it’s not publicized, they would MUCH rather lend that money on multifamily properties with steady revenue than on single family houses whose value may fall to the point where borrowers just walk away. Lending standards have tightened, which means that financially strong buyers have more opportunities and fewer competitors for the good deals. Commenting on the announcement that the Fed would aggressively buy Fannie and Freddie paper, even stock guy Jim Cramer announced on his show that now is the time to buy real estate.

Reason #7- Interest rates are low and inflation is coming. Interest rates are being held as low as possible to stimulate the economy and multifamily borrowers can lock in 30 year fixed rates as low as 6%. At the same time the government and the Fed are printing and pumping out money as fast as they can and when that money starts moving through the economy interest rates and prices will rise. If you’ve already locked in a low interest rate you will be perfectly positioned to benefit from rising rents. Just think about it, fixed expense with rising income, just the opposite of having a job and paying bills!

Remember the multiplier effect of cap rates, every dollar per month that rents go up in a 100 unit property is $15,000 of additional value added to a property at an 8% cap rate, with fixed expenses. Raise rents 10 dollars a month and you’ve created $150,000 in value instantly.

Now is the time to get in at low prices with good returns on conservative deals before the big money and inflation start driving up prices on properties, that you own. Market selection, property selection and manager selection are all critical of course but in a tough market and in any economy short of dig a hole and crawl in with freeze dried food and crossbow, owning multifamily will provide both current income and positive growth.

Here’s to a happy, healthy and profitable New Year everyone!

Giovanni Isaksen
Ashworth Partners Ltd.

We’ve cornered ourselves trying to bail out the “Too Big To Fail” banks. In trying to keep them alive in the name of saving the financial system we’ve been pumping them full of our childrens’ tax dollars to little effect and we wonder why they’re not really lending. The downward spiral of their balance sheets from both toxic assets and falling stock price continues but how to stop that spiral is being debated hotly in boardrooms, financial markets and congress.

What’s preventing a solution from emerging is the “Too Big To Fail” trap. Until we recognize that these banks have already failed and we are throwing good money after bad we will continue pouring money down a bottomless hole. It’s like lending ‘grocery money’ to a junkie. We can’t allow ourselves to be held hostage by a handful of big banks.

I believe the only a comprehensive solution will get the financial system working again on a long term basis. Below are eight steps that are critical components of such a solution.

1- Place the insolvent banks into receivership now matter how big they are. This can be done by forcing failed banks to be split into a deposit bank and an investment bank preserving the deposit bank if possible and liquidating the investment bank portion.

2- The assets of these liquidated banks should be placed into Resolution Trust Company 2.0 (RTC) and sold off. The majority of these assets are mortgage backed securities (MBS) and credit default swaps (See 7 and 8, below for more). It’s the proper valuation of these assets is the real sticking point. It has been reported that 90-95% of the loans in the MBS are performing therefore the loans in each may have to be broken out individually so that the good loans can be sold at a price that reflects their value. As an alternative a regulated trading market along the lines proposed by the Chicago Mercantile Exchange could be created to trade these securities with a minimum price set by the Treasury with the funds from TARP.

3- The cleaned up banks then can be sold themselves, with new management in place or to come on board. If no buyers come forward for a particular bank it will be shuttered. The idea is that sales of the assets and the cleaned up banks will help offset some of the billions Treasury and Fed (read Taxpayers) have and will spend to save the financial system.

4- Glass-Steagall should be un-repealed so that banks cannot be in both commercial banking and investment banking. This is one of the most important lessons ‘unlearned’ from the banking crises that triggered the Great Depression. See my post Nov. 19 Entitled “Those Who Fail To Learn From History…“.

5- Deposit (Commercial) banks will funded by deposit accounts, make only portfolio loans or loans guaranteed by a revamped Freddie/Fannie and be backed with Federal depositors insurance. The new Freddie/Fannie will only back loans originated by deposit banks and will carry the full faith and credit of the US Government which should (or be mandated to) keep loan rates below what is available on securitized loans which will not have govt. backing. Deposit banks will serve the needs of depositors and borrowers looking for secure institutions backed by the government.

6- Non-bank lenders and investment banks will have capital requirements and be regulated by a revamped SEC as manufacturers of securities. Their loans can be held in portfolio or sold in the MBS market. These entities will not be allowed to take deposits nor will they have any government protection beyond SIPC. The ownership of these entities will be restricted to accredited investors, institutions, mutual funds and ETFs.

7- Mortgage backed securities will be treated as securities and regulated by the SEC. The regulation needs to include provision for standardization of the contracts so that the mortgages contained in each are clearly stated and easily identified.

8- Credit default swaps (or whatever name given them), which are actually an insurance product need to be regulated as such and their issuance restricted to nationally regulated insurance companies with specific capital requirements.

Someone was quoted recently saying that any institution to big to fail is too big to exist and I agree, particularly when it comes to our financial system. That a few large banks getting caught with bad speculations can bring our (and the entire world’s) financial system to the brink of disaster is confirmation of that fact.

We are also enduring the proof stage of an experiment testing whether human nature has evolved sufficiently since the 1920’s to function long term in an unregulated financial system. Clearly human nature has not evolved and it is just as clear that our financial system needs regulation to insure it’s integrity. A viable financial system should serve as the foundation of our dynamic economy but to do so it must be protected from our tendency to employ ‘creativity’ in the service of greed. The eight steps I’ve outlined above should be the starting point for rebuilding and maintaining that viability.

Giovanni Isaksen
Ashworth Partners Ltd.

…are doomed to repeat it”. Winston Churchill’s advice is very timely because it seems like 60 years is about as long as we can go before having to RE-learn the important lessons from The Depression.

The repeal of the The Banking Act of 1933 (AKA The Glass-Steagall Act) in 1999 was the beginning of the failure that ultimately led us to where we are now. One of the big lessons that the Crash and Depression taught us was that banks who took deposits and made loans should be separated from investment houses so that problems on Wall St. wouldn’t wipe out the whole financial system. When we unlearned the lesson in ‘99 the banks and Wall St. had a heyday of buying each other up in a rush to create ‘financial super markets’. The idea was that once you came in to deposit your paycheck, they could sell you a few stocks, bonds, mutual funds and even some insurance.

Eventually we ended up with a couple of these huge financial institutions and the smaller regional players followed suite, merging and buying each other up to get big enough to stay competitive with the giants. Those from the Northwest may remember when Washington Mutual was a regional savings bank in the Puget Sound area and ran ads saying that they were your friendly local bank and would never do the bad things that the huge evil banks do.

Unfortunately the net result of combining low risk depository institutions with high risk investment houses is that the banks now had Wall St. risk and could be endangered by the very threats that we learned to keep them separated from. Worse yet, a handful were allowed to get “too big to fail” which meant taxpayers, open your wallets when the inevitable happened on the investment side.

The second lesson we unlearned was allowing the SEC to fail to enforce the rules against naked shorting. As far back as the Securities Exchange Act of 1934 speculators who wanted to make a bet that the value of a particular stock would fall had to borrow and have it in their possession within three days the stock that they were shorting. ‘Shorting’ a stock is the opposite of buying a stock hoping it will go up, the stock is sold first and bought back later theoretically at a lower price. For example ABCo is shorted at $100 and bought back later at $50. The profit is the difference less the cost of borrowing. Having to borrow the stock first meant that there was a limited supply of a stock and therefore speculators only had so much fire power in driving down the price to create their profits. When there is no limit on the amount of shorting that can be done to a stock, speculators can crush a stock or even a whole market sector. The SEC had the rules in place, but failed to enforce them. When this is combined with the next lesson un-learned the effects can and were devastating.

Unlearned lesson #3, the SEC repeals the uptick rule in July ‘07. Instituted in 1938 to prevent ‘bear raids’ by then SEC Commissioner Joseph Kennedy Sr. (Yes, the Kennedy dad was the first SEC commish partly because he knew all there was to know about stock manipulation). The ‘uptick rule’ was another rule limiting the ability of speculators to perform a bear raid (drive down a stock) by requiring the price had to move up at least a fraction before successive short positions are initiated. Since the repeal in ‘07 the S&P 500 has fallen more than 50%, certainly not only because of bear raids but the ability to pile on a falling stock clearly shows up in the volatility in the markets which has risen to all time highs in the last year.

I hate to use the word synergy in the negative but the combination of these three unlearned lessons built a huge bonfire under the banking system. Add the accelerant of the mortgage mess created by congress forcing Fannie and Freddie to back loans to sub-prime borrowers all that was needed was a match. The spark came from the crash of the securitized debt markets and woof! Up went the flames, down went the banks and trillions of our childrens’ earnings were turned into tax dollars.

The problem is that banks, the heart of our financial system were allowed to stuff themselves full Wall St. speculations, when those ‘investments’ value declined the banks’ balance sheets were damaged and that damage was compounded when speculators began their bear raiding, which further damaged the balance sheets causing them major shortfalls in the capital they are required to have. Even worse, because they are considered market savvy ‘investment banks’ they were allowed to leverage their assets three or four times more than back when a bank was a conservative institution for the preservation of depositors’ money. Leverage is all good on the way up but it’s a killer on the way down. So now as the downward cycle began their balance sheets were being eroded four times faster and there were no limits on the raiders.

With their assets (stock value + loan portfolio) disappearing unchecked it’s no wonder that ‘banks’ don’t have any money to lend, even the bailout money must go towards propping up the balance sheet. As Harry Truman said: “The only thing new in the world is the history you don’t know”

Giovanni Isaksen
Ashworth Partners Ltd.

In a series of emails with Vince Farrell, CIO of Soleill Securities we were discussing his comments on CNBC about the contrast between 1929 and now. His point was that the policy decisions being made now are the correct ones and that there are a number of protections in place, as a result of the depression, that will prevent this recession from becoming a depression.

Briefly here are Vince’s points that are both necessary steps to preventing depression and signs of hope for the future:

On World Trade-
Then: Smoot Hawley Tariffs enacted, result, world trade falls by two-thirds (66%!)
Now: During the last G7 meeting, members agree to “do no harm” in terms of protectionism.

Money Supply-
Then: Money was kept tight and the supply of money contracted by 33%.
Now: The Fed balance sheet has been doubled and they are flooding the market with liquidity.

Taxes-
Then: Taxes were raised to confiscatory levels, >60% on income as an example.
Now: Taxes are much lower except on corporations and need to be kept there.

Unemployment-
Then: There was no unemployment insurance and unemployment reached 25%
Now: There is insurance and the unemployment rate may reach 9%, or only roughly a third of depression levels.

Deposit Insurance-
Then: There was no insurance for the depositors, so that when banks failed (2,500 in 1933 alone) their money was just gone.
Now: Deposit Insurance levels have been raised to $250,000 on accounts including money market funds and most non-interest bearing business accounts have unlimited coverage.”

If we as a nation, and our policy makers in particular can continue to remember the lessons from the past Depression 2.0 will turn out to be just hype and babble from the talking heads. It will be a tough recession and there are many serious structural changes needed but having been through a few recessions before I can report that each one looks like the end of the world when they appear; Now is a good time to tape Kipling’s quote about keeping your head while others are loosing theirs to your bathroom mirror.

Giovanni Isaksen
Ashworth Partners Ltd.