Harry Newton's In Search of The Perfect Investment
Technology Investor. Harry Newton
9:00 AM EST, Wednesday, April 1, 2009.
I'm in two real
estate funds. We own large office buildings. Nobody really knows what they're
worth since they have been so few sales of big buildings in the past nine
months. But the few that have happened suggest that the value of large office
buildings in places like New York, Boston and Los Angeles has fallen by 50%
in the past nine months.
or funds buy office buildings, they borrow money. Until recently, the typical
number was 75%. You put $25 million in equity, you borrowed $75 million
from your local friendly bank and you bought a building for $100 million.
Now that the building is worth $50 million, you've lost all your money and
the bank has lost one-third its money.
sold the building -- you probably can't. And maybe, with luck, the rents are
still paying the building's expenses, including the mortgage. So you can always
fantasize about what the building may be worth in five years time. And you
can leave the building on your personal net worth statement as the price you
But your bank
can't. There's a rule called "mark-to-market." Your bank has to
put your building's loan on its balance sheet for its worth -- i.e. show a
loss of 33%, and it should probably take that loss on its income statement.
A loan is an asset to a bank. By reducing its assets, a bank reduces its capital.
When observers say the banking system "is insolvent," they
mean the banks don't have near enough assets to pay off their depositors.
When word gets around about one especially bad bank, there's a run on that
bank. The FDIC then steps in and closes the bank. (Sometimes the FDIC sniffs
the balance sheet and closes the bank, without the run.)
also applies to financial institutions like insurance companies and investment
banks. When banks and other financial institutions sense they're insolvent,
their management freaks. They will lose their jobs (think GM's Wagoner) and
their shares in their banks will become valueless. This doesn't make for happy
campers. Their first reaction is to change the rules. According to yesterday's
Wall Street Journal, "Accounting rule-makers will vote Thursday on proposals
to soften "mark-to-market" accounting -- the controversial rules
requiring companies to peg the value of their investments to the market's
ups and downs. Many banks blame the rules for worsening their current problems
by locking in losses that they insist are merely temporary." (For more
Journal news on mark-to-market, click here.)
Loans that have
dropped a third in value are often called "toxic." Some financial
institutions don't want these toxic loans on their balance sheets and they're
working deals with the people they lent the money to -- the building owners.
"Repay part of the loan now, and we'll let you off the hook for the rest,"
say the institutions. The president of my two funds refers to this as "capital
stack management" and says he's "now in hand-to-hand combat."
That's his night job. His day job is running the buildings -- collecting rents
and keeping the lobby clean. The worst part of his day job is having tenants
who are in the finance business -- like banks. They're firing people. Hence
they need less space. So they sublease his space at any price they can get
-- typically a lot less than my president (the landlord) would. When his own
tenants compete against him, he gets really peeved.
getting better in my president's day or night job. The value of his buildings
continues to fall. Tenants are leaving and rents are falling. The worst part
is that "there's no visibility." When you buy a building you always
make projections on rents and expenses. Having no visibility means you have
no clue what the building will be worth 12 months from now, or what tenants
will by paying for space 12 months from now. The big unknowns are financial
institutions as tenants. At the height of the boom back in 2006, finance was
20% of America's GDP. Now it's maybe half that -- or headed there?
That's a double
or triple whammy in an industry - commercial real estate -- that, once upon
a time, was so wonderful.
For me personally,
I'm adopting mark-to-market accounting rules and writing down my two fund
investments to $2. I'm not writing them down to zero because I want them to
continue to appear on my (substantially diminished) monthly net worth statement.
and every bank wrote their investments down to what they're really worth,
things would look very bleak. Fortunately, many institutions have adopted
the Ostrich Stance -- their heads are firmly in the ground. And others are
fighting the rules, i.e. postponing the inevitable. Read the Journal, click
world economy is worsening. Economists now
believe that unemployment will hit 20% in many countries before this
mess is over. As you know the big 20 are meeting. From Professor Roubini's
consulting group this morning:
31): Economic activity is expected to plummet by an average 4.3% in the
OECD area in 2009 while by the end of 2010 unemployment rates in many countries
will reach double-digits for the first time since the early 1990s. International
trade is forecast to fall by more than 13% in 2009 and world economic activity
will shrink by 2.7%
The big emerging economies will also suffer abrupt slowdowns in growth.
The global recession will worsen in 2009 before a policy-induced recovery
gradually builds momentum through 2010. Forecast for U.S.: -4% in 2009 and
0% in 2010; Japan: -6.6% in 2009 and -0.5% in 2010; Eurozone: -4.1% in 2009
and -0.3% in 2010. Brazil's GDP is expected to decline by 0.3% in 2009 while
Russia's is projected to fall 5.6%. Growth in India will ease to 4.3% in
2009 and in China to 6.3%
friend Joe still likes the stockmarket, sort of. Remember yesterday's
column? I pointed out to my friend Joe Daley that the last ten years in the
stockmarket had been a bust. Joe emailed me:
a great 10 year period to make your point. Only one other 10 year period
would have supported your thesis: 1930 to 1939. All other 10 year periods
since the DJIA was started, in 1896, would have shown an increase.
to 1989 the DJIA went from 814 to 2600. From 1990 to 1999 it went from 2600
I agree that the market is a crapshoot, and that the majority of investors
will not make any money to speak of. However, investing in the market is
better, for the small investor, than any other vehicle I'm aware of.
investors should do better investing in real estate. In fact the best investment
a small investor can make is buying his/her residence.
small investor to do with, say, $500., $5000. or the like. Real estate is
not feasible; savings probably won't keep up with inflation, and the earnings
are taxed at ordinary rates. So it's either spent on depreciating assets,
or put into the market, probably a fund.
the matter of sophistication. If you're working in a factory; driving a
cab, teaching school, and at the same time raising--seriously raising--a
family, you have no time to become a sophisticated investor.
A moment of
candor. The market's a crapshoot for everyone.
market observers get even more bearish. GM and Chrysler will go
Chapter 11. Richard Russell of Dow Theory Letters writes in his latest newsletter:
2009 -- Yes, it's hard to believe, the whole US auto business going down
the drain in one fell swoop. Remember CEO "Engine Charlie's" famous
remark, "As GM goes, so goes the nation."
or bear market provides us with a "surprise." I've thought long
and hard about what kind of a surprise this bear market could give us. My
answer -- I think this bear market is going to be worse than almost anyone
is envisioning. I'm afraid that unemployment could rise to almost 20 percent.
As for the stock market, I'm thinking that we could see the Dow fall into
the 3000 zone. It seems to me that the public is taking the current situation
as "just a severe recession." It will prove to be a lot more dangerous
than that. And I don't think people are prepared for a real depression.
In fact, most analysts won't even use the expression "Depression."
I'm not that bearish. My local La Quinta Baking Company restaurant
me his receipts for March are up 6% over March, 2008. But he cautions that
March 2008 was "pretty awful."
Retirement Center -- Part 1
80-year old Bessie bursts into the rec room at the retirement home. She holds
her clenched fist in the air and announces,'Anyone who can guess what's in
my hand can have sex with me tonight!!' An elderly gentleman in the rear shouts
out, 'An elephant?' Bessie thinks a minute and says, 'Close enough.'
Retirement Center -- Part 2
Two elderly ladies had been friends for many decades. Over the
years, they had shared all kinds of activities and adventures. Lately, their
activities had been limited to meeting a few times a week to play cards.
One day, they
were playing cards when one looked at the other and said, 'Now don't get mad
at me. I know we've been friends for a long time but I just can't think of
your name! I've thought and thought, but I can't remember it. Please tell
me what your name is' Her friend glared at her. For at least three minutes
she just stared and glared at her.
says, 'How soon do you need to know?'
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
is . You can't
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