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The biggest investment opportunity today and tomorrow — distress office buildings. Also bad Thanksgiving humor.

To the new graduate, the question was: “What job are you looking for?”

One I can work at home.”


That’s our super-intelligent, (super-entitled) younger generation.

In 2016, an office building out west sold for $150 million, financed by a $90 million mortgage. That was a “reasonable/conservative” 60% loan to value. The price of the building was fueled by 20+ years of ultra-low interest rates — a golden era for real estate.

Sadly, the proud owner lost tenants to covid, work-at–home, mergers, layoffs, efficiency, automation, AI, etc. and he jave the keys back to the bank.

The bank put the building on the market and got several offers with the highest one at $30 million.

Borrowing has suddenly become hugely more expensive. And office buildings have become hugely less valuable.

There was too much borrowing — not just mortgages but also mezzanine financing, which The Wall Street Journal reported on in great detail:

The Clearest Sign Yet That Commercial Real Estate Is in Trouble
Lenders are issuing a record number of foreclosure notices related to risky property loans

Click here.

Office buildings, for a long, long, time had an established (and simple) “business model.” Elements:

+ Find a nicely-located building with well-heeled tenants.

+ Find a nice bank that would lend you 50% to 80% of what you paid for the building.

+ The more you borrowed, the more you made. Leverage was good when borrowing was essentially free.

+ Along the way, you painted the lobby, replaced the roof, fixed the air conditioning, spoke nice to the tenants and bumped their rents.

+ In five years, you had higher rents and a more profitable building. You could go to your friendly bank and borrow more money. It was called refinancing. If you received cash after using the proceeds to pay off the first loan, you could pocket the money tax-free.

+ Maybe in ten years , you could sell the building for much, much more than you paid for it.

+ The good news about the profits you made on selling the building is you probably won’t pay taxes on the sale. There’s a gigantic loophole in the tax code called 1031 exchanges.

Along the way, you’ll declare distributions/dividends to yourself and anyone else who may be your partner in the building. That’s often called syndication.

You won’t pay much income tax on those distributions because they’re covered by depreciation expenses.

All this is nirvana until it isn’t.

Something often comes along to mess up your best laid plans. The “something” has come along regularly in recent years. The big something was covid. While it raged a lot of people didn’t go into their offices. Worse was its legacy. Office employees come to believe they liked working at home. Employers came to believe that they needed less office space to house their dwindling workforce — or least the workforce that came into the office.

Hence, demand for office space plummeted.

Office buildings are valuable if they earn money to pay off the expenses of running the building — like lights, AC and taxes — and, most importantly, make your loan payments to the bank.

If suddenly your debt service, and running expenses are more than the rent you’re getting on the building, you’re in trouble.

There are things you can do:

1. Take the shortfall out of your own savings, and/or your partners’ savings. The can also be called “making a capital call.”

2. Give your building back to the bank. Now it’s their problem. That means you lost everything on your “brilliant” office building investment.

Herein lies the opportunity for you and me.

The building that is selling for $30 million now won’t be worth $150 million any time soon. But it could easily be worth $90 million in five years time. That’s after finding new tenants and perhaps convincing some of the present ones to get their employees to come to work.

I have talked to many young people since the pandemic — called Harry’s Research. All of them talk about the distractions of working at home, their lack of contact with their fellow workers, etc.

A Welcome to our company” postcard and a laptop in the mail don’t make an effective employee.

Even in my semi-retirement, I crave the company and the creativity of my fellow human beings. This story wouldn’t exist without them.

Which brings me to: Office buildings are among the most borrowed against assets in the entire world. As their rent rolls evaporate, more will get returned to their lenders, i.e. banks.

There several problems with banks owning office buildings:

First, that’s not their business and they don’t have any employees who know how to deal with tenants, which roof AC unit is the best, which color to paint the lobby etc.

Second, the regulators are insisting they sell their handed-back real estate asap. This is a decision made in haste. And like all of them, probably wrong. But as my breakfast friend, David, pointed out young bright graduates would prefer working for hedge funds, venture funds and banks (where they can get rich) rather than working for a boring, badly-paying regulatory agency.

Soon, banks will be flooded with busted office buildings — that aren’t worth what they sold for a few years ago. But, bought cheaply, enough today will be worth two or three times in a few years what you paid for it today. $90 million in five years time is a 24.57% annual return on your money. Not shabby.

One banker told me he’s thinking of quitting his bank and starting a distress office building fund.

I was in one of those funds once. How it worked out (not well) is the subject of another blog.

For now, there are several things I know about real estate:

+ The price you buy it is the major factor in its success as an investment.

+ Real estate is not a national sport. It doesn’t tick up or down by the second, like Tesla, Nvidia and Microsoft. But if you keep close to your local bankers, you might snag a bargain.

+ If you borrow to buy, don’t borrow a lot, at a high interest rate, especially a variable rate one. I once bought an office building and paid 14%. If you think today’s interest rates are high, you’re wrong. (I paid off that 14% mortgage as soon as I had the money.)

+ Enticing tenants, enticing brokers, is not easy, nor cheap. The tenants demand free rent, free fixup (called tenant improvement) and God knows what other motivations.

+ These days they need gyms, charging stations (for Teslas), outdoor picnic areas. I haven’t yet heard of a demand for an on-site tenant-exclusive bordello. Yet.

+ Patience is a virtue. Not short-term patience. But long, long patience. Maybe 20 years.

Warren Buffett said famously that we should buy when there’s blood in the street.

There’s plenty of it in office buildings today. And more coming.

If you find something super-appealing, call.

Good luck.

Starlink, YouTubeTV and Streaming

+ Elon’s third generation Starlink satellite receiver is flat, larger, and uses more power. It’s also reputed to deliver higher Internet speeds. I don’t know the speeds nor the cost. But, if you live in the boonies, this is your Internet access.

+ YouTubeTV is my preferred streaming TV service. I work reliably and picture is as clear as satellite or cable TV. You can also easily record shows. One click and you’ve recorded them forever. But there’s a catch: YouTubeTV’s user interface is awful. It’s a lot of fiddling. If you want sports (including tennis), you got to pay $11 a month extra. Sadly, they don’t tell you. You got to figure that out for yourself.

My preferred way to watch YouTube is in bed with a my laptop on a pillow and plugged-in headphones. That way I can see the tennis ball. If I want to punch up a TV screen,

+ Meantime, DirecTV is in big trouble. If you have them still, tell them you’re leaving. You’ll get a bargain price. Otherwise, kill them and use your laptop,  Roku and YouTubeTV.

Thanksgiving “Humor”

+ I’m excited about Thanksgiving because I love unwelcome parenting advice from relatives I see twice a year.

+ Thanksgiving is an emotional holiday. People travel thousands of miles to be with people they only see once a year. Then they discover once a year is way too often.

+ If the Pilgrims were alive today, what would they be most famous for? Their AGE!

+ My cooking is so bad my kids thought Thanksgiving was to commemorate Pearl Harbor.

Bruce’s two wonderful cartoons

New Yorker joys

I have a rip-roaring cold, with mega coughing. It’s not covid, though three members at our tennis club called in this morning with covid.

Lots of lemon tea and rest. I really don’t want to infect the grandkids when I see them this week. Normally they infect me.

Something is going around. A friend has pneumonia. They put him on prednisone, which is strong stuff.

I’m feeling guilty that our stocks are doing so well, when the people in Ukraine and Gaza are not.

Stay well, — Harry Newton