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Harry Newton's In Search of The Perfect Investment Newton's In Search Of The Perfect Investment. Technology Investor.

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8:30 AM EST Tuesday, January 8, 2008: Capital markets have shut down. This is not entirely true. But it's a "great" headline. A simple example. A friend is a big real estate muck-a-muck. He buys big buildings -- commercial and residential -- fixes them up and sells them, either whole or as condos. Six months ago, he'd call an investment banker (like Merrill Lynch) and secure six offers to lend him 90% of the value of his project. Today, the loan departments of most investment bankers have shut down and he gets no offers. He scrounges and trolls elsewhere. For example, his latest loan came from Germany. The rate was pretty good at 6.08%.

The real estate market has become two markets -- one good one for New York City -- and one for the rest of the country, which sucks. New York commercial and residential prices have not fallen. In fact, many have risen and are rising. Did I tell you about my friend who signed for a $30 million apartment (at $5,000 a square foot) in a new high rise? He hasn't moved in. He just received an offer of $48 million.

Elsewhere -- like Florida and Arizona -- you can't give houses and apartments away. My friend reports his Florida operation is a "mess," and declines to talk about it. The press is loaded with stories reporting and projecting price drops. It's very difficult to figure how bad things really are out there -- since many people who would like to sell are not selling at what they perceive as absurdly low prices for their gorgeous palace. Suffice, we know two things:

1. Cash remains king. Cash gives you the option of waiting it out.

2. The present mess in capital markets, real estate and corporate profits will work itself out. It always has. But meantime, it's ugly and getting uglier. Standard and Poor figures operating earnings for the companies in the Standard & Poor’s 500-stock index to be 8% lower for the final three months of 2007. Thomson Financial, which compiles forecasts from estimates of analysts at outside firms, puts the decline for the quarter at 11%. Since the stockmarket is driven by earnings, declines are not good.

The big hits on the stockmarket have come and are coming in high-priced tech stocks, like Apple, Research in Motion, Google, Garmin. All of these are now touching their 15% drop from their months-earlier peak. Hence Newton's Inviolate 15% Rule prevails: Sell.

Meantime, the consumer is not happy. My political pundit friends say the reason Barack Obama is doing so well (this is not an endorsement) is that he is pushing a message of faith, hope, change, and not being a Washington insider.

Reading the market.
Yesterday I wrote "This chart (of the Dow) is instructive. For the past six months, the Dow has been bouncing violently around -- but staying within a range. ... There are sufficient people who believe these charts. It looks like a triple bottom. If we bust through support with volume, this market is in big trouble, many chartists believe. From reader Don Craig came this perceptive email.

Regarding today´s Dow chart: (See below). Where you see a triple bottom on the Dow chart, I and most technical analysts would see a head-and-shoulders top, whose neckline was broken intraday on Friday. Today (Monday) The Powers That Be appear to be defending that neckline rather desperately. You´re quite right that a definitive break likely will trigger heavy selling.

The chart is now updated for yesterday's trading. Yesterday, fortunately, the Dow rose 27 points:

Lessons from the edge.
For the past two weeks I have wanted to write a piece on how fast things are changing, and draw the lesson that the ONLY weapon against change (especially unforeseen change) was cash. My research finds that change has always been a constant in U.S. business and it probably isn't speeding up. Think of the poor investors who, in 1860 dumped money into the Pony Express to carry mail from the end of railroad in the midwest to California. The best time ever achieved was in March 1861, when Lincoln's inaugural address was carried from Missouri to California in seven days, 17 hours. Sadly (for the investors), the Pony Express lasted only 18 months before the telegraph took over and communications became instantaneous.

My father, a wise man, used to say, "Default on a loan of $1 million to the bank and you're in trouble. Default on a loan of $100 million and the bank is in trouble." With that in mind I want you to read the following long article from this Sunday's New York Times.. My real estate friends say the story and its facts are accurate. The bolding is mine.

Oh yes, please don't buy real estate where the rents minus the expenses don't cover your interest payments.

Harry Macklowe’s $6.4 Billion Bill

IN August 2003, Harry B. Macklowe raced from lender to lender to round up a record-breaking $1.4 billion to buy the General Motors Building, the 50-story commercial skyscraper in Midtown Manhattan that is one of New York’s trophy properties.

Then 66, he gambled mightily to outmaneuver rival bidders and to vault back into the top ranks of New York developers. He went so far as to put down a nonrefundable $50 million deposit and sell many of his residential buildings to raise cash. Some bankers and real estate executives scoffed at the deal, privately suggesting that Mr. Macklowe had overpaid and would drown in an undertow of debt.

Not for the first time, Mr. Macklowe, an acknowledged master of winner-take-all real estate poker, proved his skeptics wrong. He expanded and enhanced the valuable retail space of the G.M. Building — on Fifth Avenue at 59th Street — by creating a glass cube for an Apple store that has become a popular tourist destination. As the market soared, Macklowe Properties refinanced the tower twice, most recently in a deal that values it at about $2.7 billion.

But these days Mr. Macklowe is scrambling for financing yet again. He has a $6.4 billion debt payment coming due next month in connection with his purchase of seven other Midtown Manhattan office buildings a year ago. When he bought those buildings from Equity Office Properties, he more than doubled the size of his real estate portfolio and used only $50 million of his own money to do so; he borrowed $7 billion to finance the rest of the purchase.

As often happens in real estate, a once-frothy national cycle is losing steam and the market has turned against many buyers. Mr. Macklowe, with his empire of 15 prime office towers and two development sites in one of the world’s best business districts, is awash in expensive, short-term debt at the very moment that financial backing for megadeals has all but shut down. One of his loans is backed by a $1 billion personal guarantee, and he is already in default on $510 million in development loans for a Park Avenue project.

Mr. Macklowe’s predicament marks the denouement of an unprecedented four-year period in which developers threw gobs of money at real estate as prices for office towers, especially in Manhattan, doubled and tripled almost as fast as sales could be recorded. Investment banks avidly underwrote the binge, often basing loans not on existing rents but on projections of rental income well into the future.

All of this worked swimmingly so long as the economy hummed along and banks could pool the loans and sell them to investors. Now, the economy is showing signs of stress, and Wall Street’s repackaging machine is sputtering.

“In hindsight, everybody should have been more cautious,” said Robert Bach, the chief economist at Grubb & Ellis, the national real estate brokerage firm. “We all knew this wasn’t going to last, but we hoped it would end with a whimper, not a bang.”

Analysts, bankers and developers are not predicting the imminent collapse of the commercial real estate market, a reprise of the early 1990s, when property values dropped by half, vacancies soared and banks were crushed under the weight of soured real estate loans. But developers who jumped in at the top of this market are likely to feel some pain because purchases were built on the assumption that rents would keep escalating and that the value of buildings would keep appreciating.

With building owners no longer able to refinance their properties and pull out cash, Mr. Macklowe and his son, William S. Macklowe, have only a month to repay $7 billion, work out a new deal with their bankers or risk the breakup of their empire. There is widespread speculation in the real estate industry that the Macklowes may be forced to unload some of their properties at a discount to creditors — including a sizable stake in the G.M. Building. At worst, they could be forced to shed much of their portfolio.

“This is very high-stakes poker,” said Scott A. Singer, the executive vice president of the Singer & Bassuk Organization, a real estate finance and brokerage company in New York. “To owe more than $5 billion in this environment is tremendously risky. There are a very, very limited number of lenders who can make multibillion-dollar loans now.”

For his part, Mr. Macklowe — a fierce competitor who still races his custom 112-foot yacht in regattas off the coast of Sardinia — coolly plays down the crisis. He went sailing in the Caribbean three days before Christmas while his son stayed home negotiating with the family’s bankers.

“Our lenders have supported us in the past to an extraordinary degree,” Mr. Macklowe said in an interview in his stark white offices on the 21st floor of the G.M. Building, the evening before he flew south. “We’re pretty confident that, going forward, we’ll be able to achieve accommodations and extensions from our group of lenders.”

THE Macklowes aren’t the only real estate barons in a tight spot. The Kushner Companies, also family owned, plunged into the Manhattan real estate market in 2006, paying $1.8 billion for 666 Fifth Avenue, at 53rd Street. The cash flow from 666 Fifth represents only about two-thirds of the amount needed to service the debt on the building — a shortfall of about $5 million a month — according to Real Capital Analytics, a research company in New York.

In Los Angeles, the developer Robert F. Maguire III may be forced to sell his publicly traded company, Maguire Properties, after buying a portfolio of buildings from the Blackstone Group just before the subprime credit crisis sent many of his tenants into bankruptcy. An Australian company, the Centro Properties Group, is putting itself up for sale after failing to refinance billions of dollars of short-term debt stemming in part from its acquisition of an American shopping center company.

To be sure, some bright spots remain. Though vacancy rates are up nationally, the Manhattan market remains healthy, with the vacancy rate in Midtown, the most desirable business district, just 5.5 percent. Because relatively little new space is coming on line in Manhattan in the next few years, the New York market appears to be relatively solid.

But fewer deals are being made and rent increases have slowed, if not stopped. If financial institutions continue cutting payrolls, much vacant space could come back on the market and drag down rents, even in Manhattan.

Despite the problems hanging over Mr. Macklowe’s holdings, some analysts say that it would be a mistake to count him out. This is the third time Mr. Macklowe has stumbled since he started in the real estate business about 48 years ago, and each time he has come roaring back. He has a knack for enhancing the look and cash flow of his buildings, and he is regarded as a shrewd, brass-knuckled negotiator in a rough-and-tumble industry.

A senior member at a major real estate investment firm, who described Mr. Macklowe as a friend and asked not to be identified so as not to jeopardize their relationship, said the developer has “assets with enough value to pay off his bridge loans.” But, this person asked, can Mr. Macklowe “do it with everybody smelling blood in the water and looking to buy a bargain?”

Some of the wiliest players in the real estate business have already been circling Mr. Macklowe.

This past fall, Vornado Realty Trust, of which Steven Roth is chairman, bought a stake in loans collateralized by four of Mr. Macklowe’s buildings on an apparent bet it might snare some great real estate on the cheap, bankers and real estate executives said.

For the last month, Stephen M. Ross, the chairman of the real estate company Related, has been talking to Mr. Macklowe about a deal for Macklowe Properties’ coveted Drake Hotel site, at Park Avenue and 56th Street, an executive involved in the talks said. Real estate executives say another rival developer, Sheldon H. Solow, may buy some of Mr. Macklowe’s debt in a bid to gain control of the G.M. Building, although a spokesman for Mr. Solow said Mr. Solow was not trying to acquire any of the debt.

THE Macklowes readily acknowledge that they are looking for equity partners. Mr. Macklowe’s son, William, emphasizes the quality of the buildings in his family’s Manhattan portfolio, which includes 2 Grand Central Tower, Park Avenue Tower and Worldwide Plaza. He points out that the buildings are also largely full.

“It’s not a real estate crisis but a capital markets crisis,” the younger Mr. Macklowe said. “Our legacy and acquired portfolios are renting at market rates or better. In August, when the world took a 180-degree turn, we and others got caught up in it.”

As it now stands, the Macklowes say they owe Deutsche Bank a $5.2 billion payment in February, in connection with the Equity Office transaction. They owe the Fortress Investment Group, a leading private equity and hedge fund firm, $1.2 billion for a bridge loan backed by a limited partnership interest in the G.M. Building, stakes in 11 other Macklowe buildings and a personal guarantee from the Macklowes for $1 billion.

The Macklowes are in default on a $510 million loan connected with a project planned for the Drake site. Although the Macklowes have a nonbinding agreement with an anchor tenant, a Nordstrom department store, they have not acquired all the land for the project. A spokesman for Nordstrom said the company was also talking to other developers.

At the same time, the family is trying to obtain a new construction loan for a 30-story office building being built at 510 Madison Avenue, at 53rd Street.

Even during this tense period, Mr. Macklowe often interrupts an interview with jokes. And those who know him say that he can be both endearing and notoriously tough. He has tangled with lenders, regulators, city officials, tenants and even his former East Hampton neighbor, Martha Stewart.

“Dealing with Harry can be a charming experience, and it can be like a trip to the dentist without anesthesia,” said Peter Hauspurg, chairman of the real estate investment services firm Eastern Consolidated. “At the end of the day, Harry’s operative phrase is: It’s just business.”

DESPITE Mr. Macklowe’s hard-edged business reputation, friends say he also devotes considerable time to his grandchildren, his collection of modern art, golf at the Atlantic Golf Club in Bridgehampton and, of course, sailing.

The son of a Westchester County garment executive, Mr. Macklowe was a college dropout when he started as a low-level real estate broker in 1960. Three years later, he and his supervisor formed their own company, Wolf & Macklowe. By the 1980s, he was building a succession of towers, including the angular black-glass Metropolitan Tower, on 57th Street between Sixth and Seventh Avenues; 2 Grand Central Tower; and the residential building RiverTower, on the East Side, where he and his wife, Linda, have a duplex.

Mr. Macklowe would like to be known for his building designs, or his art collection. But what many New Yorkers recall is that in 1985, Mr. Macklowe’s company was involved in the illegal, nocturnal demolition of two single-room-occupancy hotels near Times Square, only hours before a law went into effect protecting the buildings. He was not indicted in the incident, but one of his executives pleaded guilty to a misdemeanor charge of reckless endangerment. Five years later, he opened the Hotel Macklowe on the site.

As his purchase of the G.M. Building demonstrated, Mr. Macklowe often gets the timing right. On the day the stock market crashed in October 1987, he sold a package of 15 buildings to Joseph Neumann for $350 million, or $120 million more than Mr. Macklowe and his partners paid for them 10 months earlier. Mr. Neumann’s empire subsequently collapsed.

Like many other developers in the early 1990s, Mr. Macklowe took a beating during a severe real estate recession, ultimately returning both the Riverbank West tower on 42nd Street and the Hotel Macklowe, now known as the Millennium Broadway Hotel, to the lenders.

Rather than disappear, Mr. Macklowe did a series of smaller projects in the mid- to late 1990s, building less-glamorous apartment houses or renovating office buildings on Madison Avenue. In 2003, he bought the G.M. Building, a move that left many of his peers describing him as a real estate genius. The building was built for General Motors in 1968 and now houses tenants like hedge funds, the investor Carl C. Icahn and the law firm Weil, Gotshal & Manges. Mr. Macklowe suggests that the building is worth $3.5 billion or even $4 billion, though it may be hard to find a lender or investor who agrees.

By the fall of 2006, Mr. Macklowe was sitting pretty, primarily because the value of the G.M. Building had jumped so handsomely. He was putting together a premier development centered on what was once the site of the Drake Hotel, which he bought in 2006 for $418.3 million. He and his son were also building a hotel and apartment house at Madison and 53rd Street. After the residential market appeared to slow, they nimbly converted it into an office building for hedge funds, complete with a swimming pool and a luxurious health club.

Earlier this year, Mr. Macklowe decided to try his luck again. After the Blackstone Group, a private equity powerhouse, beat back Vornado to take over Equity Office with a $39 billion bid, Blackstone quickly decided to sell most of Equity Office’s Midtown Manhattan buildings without taking possession of all of them. During 10 days of whirlwind deal-making, Mr. Macklowe secured financing and stepped in to buy seven of the buildings for $7 billion.

The timing looked propitious. Credit was so readily available that Mr. Macklowe needed to put down only $50 million. He borrowed the rest in short-term loans from Deutsche Bank and Fortress. But that left him in the dicey position of having to find new sources of permanent financing or equity to pay off the short-term debt.

“He went from utter comfort to being on the precipice again,” said one real estate executive who has worked with Mr. Macklowe and asked not to be identified to retain a relationship with the developer.

The annual rent for the seven Midtown buildings was generally $55 to $59 a square foot, according to William Macklowe, but Deutsche Bank and Fortress underwrote the deal on the assumption that rents would soon rise to $100 a square foot.

After all, the commercial real estate market was higher than ever. The vacancy rate had fallen to record lows, while high construction costs made new buildings prohibitive. Landlords at prime office buildings were getting more than $100 a square foot annually, while the average rents for first-class Midtown buildings rose to $73.31 by the first quarter of 2007 from $55.21 in the first quarter of 2005, according to Reis Inc., a New York office research company.

At the same time, average prices for large office buildings in Midtown more than doubled, to $745 a square foot from $357, according to Real Capital Analytics. Investment banks and foreign companies began pouring capital into real estate. Lenders, in turn, took more risks, often providing financing for 90 to even 100 percent of a building’s price. Investors became ever more willing to accept a lower initial rate of return, known as the capitalization rate.

As with the residential market, the money flowed easily because lenders did not keep these risky loans on their balance sheets — as the commercial banks and savings-and-loan associations did to their peril in the early 1990s. Instead, Wall Street repackaged hundreds of billions of dollars of loans as commercial-mortgage-backed securities and sold them to investors.

“Loans with more aggressive terms that weren’t available in ’03 and ’04 became the norm in ’06, when suddenly lenders became very accommodating,” said Mike Kirby, a principal of Green Street Advisors, a research company in Newport Beach, Calif., that specializes in real estate investment trusts. “The attitude was, ‘Gee, we’re not going to own this stuff; we get terrific fees for underwriting these loans, and we can blow it out in a C.M.B.S. deal in three months.’”

EARLIER this year, however, the real estate winds shifted. In April, just two months after Mr. Macklowe bought the Equity Office properties, Moody’s Investors Services, the bond rating agency, said it planned to readjust how it rated commercial-mortgage-backed bonds to better reflect their risk. The agency complained that lenders were making overly optimistic projections about rent growth.

By last summer, as the subprime mortgage crisis hit residential lending and credit markets tightened, opportunities evaporated for developers like Mr. Macklowe to refinance expensive short-term debt.

Perhaps slow to realize the severity of the credit problem, Mr. Macklowe paid nearly $60 million in June for virtually the entire seventh floor of the Plaza Hotel, the Manhattan landmark that has been converted into condominiums. He hired the architect Charles Gwathmey to design a 13,000-square-foot apartment, which offers a view across Fifth Avenue to the G.M. Building.

But in September, the Macklowes hired the investment banking guru Joseph R. Perella to help them find new equity partners. They flew to the Middle East to visit what cash-starved developers call “the Big Four” — Kuwait, Qatar, Abu Dhabi and Dubai — in an unsuccessful hunt for fresh capital.

“We knew we could get higher value” for the Equity Office buildings, “but it wasn’t going to come in years two, three or four,” William Macklowe says. “We had a plan for a permanent capital solution. The events of the late summer slowed that down.”

The Macklowes say they also spent more than $150 million paying off short-term lenders at the Drake Hotel site and received an extension on their senior debt, which has since expired. But the Macklowes still have to contend with a $510 million note backed by the site.

“There are people out there who are very eager to acquire it if Macklowe decides not to build, or something untoward happens,” Harry Macklowe said. “We’re talking to several of our peers who’ve asked to join us in that development. We’re evaluating.”

There is increasing pressure, meanwhile, to persuade Deutsche Bank and Fortress to extend their deadline beyond Feb. 8 for at least $6.4 billion in debt, allowing the Macklowes more time to find new equity partners.

Bankers and real estate executives are divided over whether the Macklowes will be forced to sell some properties — maybe even some of the most valuable assets. Some also argue that layoffs in the financial industry this year will almost certainly depress the market and the value of commercial property.

Others, like Scott Latham, a broker at Cushman & Wakefield, contend that the vacancy rate is so low that it would take tens of thousands of layoffs to turn Midtown into a tenants’ market. Rents will not go up as fast as they have in the past 12 months, he said, but almost no one is predicting that rents will fall.

Mr. Macklowe “may shed some assets, just because it allows him to control whatever he holds onto,” Mr. Latham said. But there are still enough foreign investors interested in the Manhattan market, he said, “that Mr. Macklowe may not have to sell his core properties.”

A friend of Mr. Macklowe, who asked not to be identified to preserve a business relationship with him, put it another way. “Somehow he always manages to pull it off,” the friend said. “But he won’t do anything until the bitter end. He will play it out all the way.”

The tired dog.
An old, tired-looking dog wandered into the yard. I could tell from his collar and well-fed belly that he had a home. He followed me into the house, down the hall, and fell asleep in a corner. An hour later, he went to the door, and I let him out.

The next day he was back, resumed his position in the hall, and slept for an hour. This continued for several weeks. Curious, I pinned a note to his collar: "Every afternoon your dog comes to my house for a nap."

The next day the dog arrived with a different note pinned to his collar:

"He lives in a home with ten children -- he's trying to catch up on his sleep. Can I come with him tomorrow?"

My bronchitis, improved but boring.
It's been two weeks. I've stopped having technicolor yawns. I still cough and most of my energy is back. I'm dubious that anything I did -- from antibiotics to Mucinex, from chicken soup to excessive sleeping -- did me any good. Patience is not one of my virtues. I'm playing tennis and exercising. This is good.

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 click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads on this site. Thus I cannot endorse, though some look interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Michael's business school tuition. Read more about Google AdSense, click here and here.

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