Tag Archives: Real Estate

Cap Rates: Market Multiples for Real Estate

In the world of corporate finance and valuation multiples are a familiar concept. As I have discussed in several past posts, multiples give an idea of relative valuation or what others are willing to pay for an asset. Over the weekend, I was home visiting my family and was discussing corporate finance concepts with my father, who is does real estate valuation for a living and he explained to me a similar concept. In real estate, the analogous concept would be the capitalization rate, or cap rate for short. I thought it would be interesting to explore this concept further in a blog post for an asset class (real estate) that I am not as familiar with as equities.

By definition a Capitalization rate is the ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset) or alternatively its current market value. Essentially, the cap rate is the inverse of traditional corporate finance multiples where the price is the numerator and the earnings are the denominator, so it is expressed a percentage. They can also been seen as a quick approximation of a property’s yield. An investment property, i.e., one that generates rental income, is viewed in the context of its net income which is rental revenue less operating expenses.  This net operating income would be akin to an EBITDA in the corporate finance world. To derive the value of a commercial property, its net operating income is divided by a market cap rate, or a rate of return prevalent in the market, to arrive at a value one might pay for the benefits (cash flow) of that particular asset.

One way to think about the cap rate intuitively is that it represents the percentage return an investor would receive on an all cash purchase.  For example, if a building is purchased for $1,000,000 sale price and it produces $100,000 in positive net operating income (the amount left over after fixed costs and variable costs is subtracted from gross lease income) during one year, then the indicated cap rate would be 10%:

$100,000 / $1,000,000 = 0.10 = 10%

Capitalization rates are an indirect measure of how fast an investment will pay for itself. In the example above, the purchased building will be fully capitalized – or pay for itself – after ten years (100% divided by 10%). If the capitalization rate were 5%, the payback period would be twenty years.

Another way cap rates can be helpful is when they form a trend.  If you’re looking at cap rate trends over the past few years in a particular sub-market then the trend can give you an indication of where that market is headed.  For instance, if cap rates are compressing that means values are being bid up and a market is heating up. According to the Wall Street Journal’s Property Pulse, cap rates for office buildings fell from 7.15% in 2012 to 6.93% in 2013. Cap rates are market based and fluctuate with the ups and downs of the commercial real estate markets.  Although they have some similarity to multiples in the corporate valuation sense, cap rates represent a very different asset class – commercial real estate – and are driven by very different factors over time. Overall, they are a useful tool to understand for anyone planning to invest in real estate.

Chinese real estate market start to collapse (Part 2)

The local governments relay on the prices and sales of houses to increase their GPD target, so they have incentive to support the real estate bubble and maintain the house prices. However, the new Chinese centre government limited loans provided by bank to those developers, this policy was determined by the centre bank in Beijing and no other local branches can disobey that. Thus the local government can’t help the real estate firms much even if they wished to.

However, a large scale bankruptcy of real estate development firms may not be acceptable. Reported in WSJ, (the current number bankruptcy) this is acceptable as long as not too many companies go broke at the same time and doesn’t result too much disruption, Mr. Chan added. In other words, they don’t want a “Lehman Brothers” moment. The real estate regulation is sure to be more influential to those developers who don’t have much fund support. Said by John Allen, chief executive officer of private investment firm Greater China Corporation in a later speech. “Bankruptcy is one of the healthiest things around. You want to get rid of the weak players.”

The current goal of Chinese centre government is to regulate real estate market and try to “shrink” the bubble, no one wants to cause a larger bubble or burst the bubble so early. The current situation is favored by Beijing, small real estate firms go bankruptcy in a moderate rate. According to WSJ, now that measures by Beijing to rein in the availability of credit and cool the housing market are beginning to bite, some developers are feeling pinched.

In 2010, Beijing start its curbing on lending to real estate developers, the centre government trust that the house market will be cooled in several years. For real estate property developers, the fund is most important thing for their sustainability. With enough fund, the house prices can stay high, without enough fund, the developers must sell their houses at a lower price because they must recollect the fund and pay the debt. The actual effect of policies from Beijing was quite effective. According to the chart from WSJ below, the difference between sold and construction has becoming larger. And the surging number of constructed houses stopped and went down at from the end of 2011.

No doubt that the downward trend of house market has already began, but there will still be few more years before the market returns to its normal health. The next question for Beijing is: how to minimize the harm caused by the burst of bubble.

Chinese real estate market start to collapse (Part 1)

Last month, one real estate developer Zhejiang Xingrun Real Estate Co. experienced an insolvency. It couldn’t pay 2.4 billion Yuan to bank and nearly 1.1 billion Yuan to other creditors, which was almost $600 million. This was the biggest ever real estate firm default since 2008. The local government in Fenghua hold a meeting to determine what to do with a default of such a huge amount of money. As reported in WSJ:

While China has seen developers default before, government officials have arranged bailouts for troubled firms that allow their underlying financial problems to fester. On Thursday, analysts argued that authorities have to be willing to address the other option: Let the companies go broke, and send a warning to markets, even if it leads to some financial turmoil in the near term.

It’s not a news that Chinese real estate market is slowing down, more and more people start to wait for a lower price. More potential house purchasers anticipated that the rapid growth of house market in China has comes to an end, as the new centre government carried out executions rigorously, now more and more small real estate developers can’t get enough support fund from bank, either they will go bankruptcy or refer to usury.

There are many reasons why more and more real estate firms in china are suffer from default. Few years ago, as Chinese house market start its surging in scale and price, more and more small real estate developers without much fund thought they could win a tons of money from the market. Some houses were built without enough fund support, so the properties developers thought of a new strategy: they sell the houses first, and use those huge amount of money from house purchasers to build their projects. Because the cost of construction is far lower than the price, this is a win-for-free strategy. However, now they are suffering from the risks they buried years before. With less and less people willing to buy houses at such a historical high price, now the properties developers can’t get enough fund to support their construction, which turns out to be “unfinished residential flats”. That is, the building projects are far away from available, developers has no money to continue construction, and those who already paid for their houses can’t either get the house or their money back, and they still have to pay their mortgage loans to bank. Witnessed more and more “unfinished residential flats” in China, Chinese house purchasers have more incentives to stop their purchase plan.

Crowdfunding in New Places

Crowdfunding is a relatively new phenomenon that is quickly growing and being more widely utilized. I wrote a post about crowdfunding before, but I thought the practice was limited to small, independent projects that needed public funding from strangers. It turns out, however, that crowdfunding is being used in many different markets. Two of these are real estate and roof-top solar power. The difference between these kinds of projects and the small, independent ones that utilize crowdfunding, is that in real estate and solar power projects people are investing in the project and not simply making a donation. Investors are essentially buying a share in the project, which will provide gains from rent, electricity sales, or the sale of the project itself.

An article in the Wall Street Journal explains that new websites are being formed that allow investors to buy stakes in projects from self-storage facilities to luxury hotels. Apperantly, the demand is huge. Both sides, entrepreneurs who want to gain more access to capital and people to want to invest their capital in potentially-lucrative projects, have a real interest in participating in this crowdfunding. Developers use the capital to construct apartment buildings, hotels, storage units, etc. and investors receive a share of rental income once the property is in use. Though returns vary, most investors can expect an 8% or 9% return on investment. If the property is sold, the investor will also receive a share of any profits. However, “Jilliene Helman, co-founder and CEO of Realty Mogul, says that while returns vary and aren’t guaranteed, the company aims to provide investors with a 14% to 15% annual return, including quarterly payments and price appreciation.” The minimum amount of investment required varies by website, but (for example) Fundrise LLC of Washington, D.C., accepts investments as low as $100. Though this may be a rather extreme case, the average investment in these websites is below $10,000. Thus, it is certainly not limited to wealthy investors and provides a unique way to diversify investments (through different real estate projects).

Another interesting place where we are seeing crowdfunding is in supplying roof-top solar projects. An article in Bloomberg claims that “crowdfunding may supply the rooftop solar projects with $5 billion of investment within five years, more than 50 times the amount raised to date.” This figure would represent more than one quarter of all annual investment in that field of the solar industry. Increasingly, roof-top solar developers are looking to fund projects directly from retail investors, through websites that gather a large amount of small investors (as previously discussed). To date, crowdfunding has provided around $100 million in the solar energy industry. The article interestingly points out that this is one of few ways that individuals can back renewable energy projects, which gives long-run returns from selling electricity.

Again I will say that crowdfunding seems like a great idea. Much like buying a share in a company, it is an excellent way for individuals to invest in new things and support renewable energy projects, if they want. Experts do advise, though, to be cautious of the projects one invests in and to research those in charge. But if investors are smart about it, as they should be with any investment, there is no immediate reason to think that crowdfunding is anything other than a great innovation.

Miami Real-Estate

Around the world, Miami is best known for its beaches and partying. But what many may not know, is that this city was one of the hardest-hit by the housing bubble. Not only was it negatively impacted when the housing bubble burst, but it saw some of the most rapid and significant rises in home prices in the country.

Since I have lived in Miami for many years now, I can give a personal example of just how aggressively prices changed within five years. When we bought our home in 2003, it was valued at around $300,000; with the housing bubble growing, the value of our house rose to about $700,000 by 2008. And after the bubble burst, it went down to around $400,000. Of course this relative change wasn’t equal all over the city and it varied by area and type of real estate. But this is just one example of the extent of the housing bubble.

A recent article in The Economist does a nice job of outlining the unique real estate market in Miami today. After the crash, the market has been steadily growing, and there is reason to believe that it will continue to do so in a stable and secure manner. In fact, the speed of Miami’s real estate recovery has surprised many. Condo prices are back near peak levels in areas with highest demand, and at 75%-80% everywhere else in Miami. The effect of the building boom seen before the crash, has now leveled off: the available supply of units is now around 6-9 months (range of time since the sale is made), from 40 months back in 2008. Only 3% of condos are unoccupied and the volume of sales of single-family homes are above pre-crisis levels throughout Miami-Dade County. And as far as avoiding another housing bubble, the article notes that “in a few years Miami has gone from the most- to the least-leveraged property market in America. Buyers of new condos typically have to put 50% down, half of that before building starts. Banks are loth to extend construction loans unless 60-75% of the units are already sold. In both residential and commercial projects, they require developers to put in much more equity than before.” Thankfully, the lesson was learned.

However, the interesting aspect of the Miami real-estate market is the fact that most of its demand comes from Latin Americans looking to invest (or live in) this area. Miami is sometimes called the “capital of Latin America,” and from personal experience I can say this is absolutely true. Though it varies by area within Miami, there are predominantly Hispanics throughout (myself included). Wealthy people from Brazil, Argentina, and Venezuela (among others) are flocking to Miami to get their share of paradise and/or investment opportunity. As the situation in these countries disfavor their status, more and more are looking to Miami. The area where I live, Doral, is especially unique because it is filled with Venezuelans. Doral is often referred to as Doralzuela because it is around 99% Hispanic, 40% of whom I would estimate to be from Venezuela (while the rest are from other Latin American countries). In Doral, there are now projects that are accepting payment (which is often in cash) in Bolivares, the Venezuelan currency.

The author of the article states “somebody said to me, ‘Give me three reasons why this will continue.’ My answer was: Maduro, Kirchner and De Blasio,” chuckles Marc Sarnoff, a Miami city commissioner, referring to the leaders of the capitalist-bashing regimes in Venezuela, Argentina and New York.” This is a very accurate prediction for Miami. As long as Latin Americans have reason to invest outside of their own country, or as long as they continue to join their friends and family in this wonderful city, the Miami real-estate market will continue to grow.

South European Real Estate

Past have decade had been a roller coaster ride for most members of the Eurozone. What had happened in Euro? Starting with Greece’s danger of credit default, this brought about domino effects on several companies. Ireland, Spain, Portugal and Cyprus all experienced financial crisis due to interconnectedness of debt obligation to each other in this single currency confederation.

The countries mentioned above were simply spending way above what they could afford pay back, and when the trust broke, so did their financial health. Greece, Spain and Portugal, especially, were spending enormous amounts of money into investments in real estates.

Screen Shot 2014-03-26 at 9.54.37 PM

At one point in time around 2009, the cement consumption per capita in Spain and Portugal was higher than that of China, which is quite significant considering that China is the fastest growing countries in terms of real estate. Spaniards and Portuguese were busy building vacation homes on the West coast of their country. For these two countries, the real estate bubble emerged and popped as the realization of implausibility of financial health in few countries.

Let us look at few seconds before this bubble popped. This could be a one of the prime examples of ‘castle in the air’ in Spain and Portugal as whatever real estate in the West coast were being evaluated through the roof into the sky. What happened when the bubble did burst though?

In my opinion, none like equities and other financial instruments, real estate has a very special characteristics of its own. When the bubble did pop, and the castle-in-the-sky fell, the castle in the air simply came down, and establish itself as a castle-on-Earth instead. Those real estates that went into massive sales for pennies worth of what they used to be in the market few years ago is making a slow come back. Castle is still a castle indeed whether be in sky or on Earth. These high quality vacation homes are receiving new attention.

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The largest capital inflow change is from the Asia Pacific in the past year with more than doubling.  However, the largest investors are still American funds both public as well as private. Especially with the Eurozone experiencing record low inflation, and European Central Bank’s willingness to maneuver to stimulate further in to the economy, real estate in South Europe may be a viable option for people who have money to invest. ECB actually announced that it may further lower interest rate to guard against dangerously low lingering around 0.7%.

There could still be concerns for investors regarding these assets–low inflation, still not fully recovered eurozone, political variabilities, etc. However, the innate stature value of real estate is decreasing only at its depreciation value. If you are looking for a long term investment opportunities, look into vacation homes in Europe.

 

(Revised) Will the Real Estate Bubble Burst in China?

It’s always the hottest topic among Chinese people about the real estate price since the bubble is becoming bigger and bigger since the 1990s. In this blog, I will explore what people think about the real estate bubble, what efforts the government is taking and provide possible assumptions about whether it will burst or not in the end.

Not like US, you cannot even imagine that for the majority of Chinese people they couldn’t even afford a house after working hard for the entire lifetime based on current real estate situation. The fact is that China’s real estate price have been undergoing a lot of changes with prices soaring in the past we now see an environment of declining prices. This phenomenon let investors question: will the real estate bubble really burst in China? (China’s Home Prices Rise to Record Levels)

I have to mention the definition of the bubble here: an unsustainable rise in the price of an asset, well above the market price given fundamentals. The bubble was indicated by three indicators: gap between disposable income and home prices, rising inventory and number of properties per person.

To save the market, right now Chinese government is taking great efforts from both policy and investment sides. From policy intervention, they have had four stages. From 1998 to 2003, they regulated and supported the under developed housing market. From 2003 to 2008, they curbed the rising housing price. From 2008 to 2009, they stimulated the housing market during the recession. And from 2010 to 2011, they took actions to prevent the rising bubble. From 2012 till now, they are stimulating the housing market again.

To indicate the future of the real estate, I’d like to mention the property tax pilot program which I think is pretty useful seen in the market. The program asks for more tax if you buy more houses in China. And it’s started in Shanghai and Chongqing already. (Many Chinese Welcome Idea of Property Taxes)

Also, as the mature of China’s financial market, people might be less likely to purchase houses because they would have more options for investment in future.

From population side, statistics show that the population will reach the peak in 2018 and labor force will shrink from 2015. Thus people predict that the property prices will start to fall between 2017 and 2018 thanks to the “one child policy” and China’s aging population composition. According to this information, pessimists predict a 40% decrease in the next five years since there will be fewer people willing to purchase a house but the supply is still large. Anther great concern of mine is the money chain of the real estate company because the majority of them burn a large percentage of loan. Once the supply is bigger than the demand, they’ll face a money chain rupture. They have to decrease the price attracting more buyers to save the company.

But optimists insist that the prices won’t decrease a lot due to the large population and demand in China. They also mentioned that right now in the bubble, China’s residential mortgage debt was only 15% but U.S. always has a mortgage rate as high as 80%. (Why China’s property market isn’t in a bubble)

Prices might be controllable in future thanks to the government policies but so far, recent policies have not been given deadlines. In short run, volatility may be seen due to uncertainty and in long run, there’s still a question for us to see whether the bubble will burst or not.

China’s Real Estate Market

Recently I saw few posts from my classmates regarding Chinese market. There were common points those blogs posts had and that is worry over inflation. One theory was that Quantitative Easing program from the Fed had ultimately lead to hot money being channeled into Chinese market. Even without the QE program, China has experienced very high rate of growth despite many setbacks in the past decade, including the great recession and the eurozone crisis.

There could be a lot of theories that could support how China survived while other countries suffered so much, but one thing for sure is that government spending on infrastructure had been a driving force to keep the economy going. Cities like Chongqing or Xi’an is experiencing very fast paced urbanization. The ramifications of these are of course environmental issues as well as possible bubble that might be underlying beneath the growth.

Drawing from the old idiom, “Rome was not built in one day” –the phrase is used to describe that something of its grandeur and magnificence takes time to establish. However, taking this more literally, China is building a city size of Rome every two weeks. That is unbelievably at a high rate. China is ranked at top in the use for cement per capita next to United States (Spain used to be the number one, but its cement consumption dropped dramatically after the Eurozone Crisis). Considering the population difference between the two countries, the absolute amount of cement consumption in China is quite astronomical.

Real estate prices in majors cities like Beijing and Shanghai parallel those in more well-known cities for their real estate price such as New York and Tokyo. The housing industry in China enjoyed this real estate boom until recently. The steel industry, for example, is one of the biggest beneficiary of aggressive spending on infrastructure. Although the target output is leveling to certain point, China is still looking to spend money to build more cities.

Starting from 2010, the Chinese government took measures to curb the real estate market overheating, such as property sales tax, raise in interest rate and downpayment rate. Was this the end of Chinese real estate bubble? It surely did have a degree of down pressure on prices for a moment and was the cause of slowing down of growth. However, while the rapid pace that China is keeping up with its infrastructure program and the social issues stemming from hukou system and urban-rural problems are still in place, disproportionate level of urbanization might continue and the overheating of Chinese real estate just may resurface.

Will the Real Estate Bubble Burst in China?

It’s always the hottest topic among Chinese people about the real estate price since the bubble is becoming bigger and bigger since the 1990s. You cannot even imagine that for the majority of Chinese people they couldn’t even afford a house after working hard for the entire lifetime.

The fact is that China’s real estate price have been undergoing a lot of changes. With prices soaring in the past we now see an environment of declining prices. This phenomenon let investors question: will the real estate bubble really burst in China.(http://www.expatfinder.com/china/articles/chinas-home-prices-rise-to-record-levels-ref1674.html)

I have to mention the definition of the bubble: an unsustainable rise in the price of an asset, well above the market price given fundamentals. The bubble was indicated by three indicators: gap between disposable income and home prices, rising inventory and number of properties per person. 

Right now, Chinese government is taking great efforts to save the real estate market. From policy intervention, they have had four stages. From 1998 to 2003, they regulated and supported the under developed housing market. From 2003 to 2008, they curbed the rising housing price. From 2008 to 2009, they stimulated the housing market during the recession. And from 2010 to 2011, they took actions to prevent the rising bubble. From 2012 till now, they are stimulating the housing market again.

To indicate the future of the real estate, I’d like to mention the property tax pilot program which I think is pretty useful seen in the market. The program asks for more tax if you buy more houses in China. And it’s started in Shanghai and Chongqing already. (http://online.wsj.com/news/articles/SB10001424052702303755504579205453028052262?KEYWORDS=china+real+estate+bubble)

Also, as the mature of China’s financial market, people might be less likely to purchase houses because they would have more options for investment in future.

From population side, statistics show that the population will reach the peak in 2018 and labor force will shrink from 2015. Thus people predict that the property prices will start to fall between 2017 and 2018.

Pessimist predict a 40% decrease in the next five years and optimists insist that the prices won’t decrease a lot due to the large population and demand in China. They also mentioned that right now in the bubble, China’s residential mortgage debt was only 15% but U.S. always has a mortgage rate as high as 80%. (http://www.marketwatch.com/story/why-chinas-housing-market-isnt-in-a-bubble-2013-10-10)

Prices might be controllable in future thanks to the government policies but so far, recent policies have not been given deadlines. In short run, volatility may be seen due to uncertainty and in long run, there’s still a question for us to see whether the bubble will burst or not.