July 08 – July 14, 2016 – the janus observer

AR Global REITs paying out more than they make by a wide margin. Commercial property prices vulnerable to bank regulatory pressures.

Headlines

WSJ – Why Banks Aren’t Giving You a 3%, 30-Year Mortgage…Yet 7/7. Lately 10-year treasuries have come down way more than 30-year mortgage rates, give it a little more time.
FT – Venezuelans cross border in hunt for food 7/11. Yes, it’s that bad.
FT – China’s South China Sea Claims Dashed by Hague Court Ruling 7/11. Basically, the Hague says China has no legal precedent over the all of the South China Sea, but China has warned its neighbors not to get cheeky and that it will “take all necessary measures” to protect its interest there.
FT – US shale is lowest-cost oil prospect 7/12. In regard to future oil exploration/production, “about 60% of the oil production that is economically viable at a crude price of $60 a barrel is in the US shale.”
FT – Germany claims eurozone first with negative yield bond sale 7/13. First Switzerland, then Japan, now Germany is the third country that is charging investors for providing them money.

Briefs

The Economist covered why the IMF (or anyone else for that matter) should no throw Zimbabwe a financial lifeline.
- “Right now we literally have nothing.” – Patrick Chinamasa, Zimbabwe Finance Minister
- This isn’t the first time. “In 2009 Mr. (Robert) Mugabe’s (President) inept and murderous regime printed so much money that inflation topped 500 billion per cent at its peak.” The government eventually had to dollarize the economy which worked to stabilize the country in tandem with the opposition government party gaining some seats to check Mugabe.
- “But then Mr. Mugabe’s cronies rigged elections in 2013 and took back full control of the country. They celebrated by doubling the size of the civil service. After three years of misrule and dazzling corruption, the treasury is bare again.”
- Now the country is seeking $1 billion to pay off arrears amounts owed to the World Bank. But “by Mr. Mugabe’s own admission, $15 billion has been stolen from the country’s diamond mines in the past seven years.” The culprits according to Global Witness, a watchdog, are the party elite…

In this week’s Economist there is a special report on Chinese Society. Among the articles was an interesting piece on how now those that emigrate from China are the wealthiest and brightest.
- “The extraordinary outflow of people from China is one of the most striking trends of recent decades. Since the country started opening up in 1978, around 10m Chinese have moved abroad, according to Wang Huiyao of the Centre for China and Globalization, a think-tank in Beijing. Only India and Russia have a larger diaspora, both built up over a much longer period.”
- “Since 2001 well over 1m Chinese have become citizens of other countries, most often America.”
- How, well mostly through school. “Studying abroad has become an ambition for the masses: 57% of Chinese parents would send their child overseas to study if the family had the means, according to the Shanghai Academy of Social Sciences.”
- Bottom line, “China has long been a land of emigration, establishing small outposts of its people in almost every country in the world. Their main motive was to escape poverty. But those now bowing out are among China’s richest and most skilled. It is a profound indictment of their country that being able to leave it is such a strong sign of success.”

Eliot Brown of The Wall Street Journal pointed the spot light on WeWork’s competitive position in light of its rich valuation.
- Talk about a trend, “throughout the U.S., the number of co-working spaces rose to nearly 3,000 in 2015 from about 250 in 2010 (which is also when WeWork opened its first location in Manhattan), said Steve King, a researcher who studies co-working at small-business-focused data firm Emergent Research.”
- “The market’s rapid growth underscores a big challenge for WeWork: low barriers to entry. Competition can come from anyone who has a lease and the money to set up offices.”
- Will WeWork’s brand and network win out or will have they to erode margins to maintain/grow market share? Either way, their private “$16 billion (valuation) is greater than all but two publicly traded office landlords, despite controlling a fraction of their square footage.”

Michael Mackenzie of the Financial Times provided some interest perspective on the current stock and bond environment as both reach new highs.
- For some perspective, “it has taken the S&P 14 months to reach a peak of 2,168. The nominal gain since the market ascended to 2,130 back in May 2015 is a paltry 1.7%. Including dividends, the performance improves to about 3.6%.”
- “A fresh market peak tends to signal one of two outcomes: the start of an extended breakout for prices such as investors enjoyed during 2013, or a topping-out process that ultimately defines the end of a bull run as seen in 2000 and 2007.”
- “The bottom line for investors is that both US equities and bonds – corporate bonds have not missed out on the sovereign rally – trade at expensive levels and face a reckoning of epic proportions at some juncture.”
- “However, unlike Japan and Europe – where negative yields dominate and equity markets remain well under water for the year – the US remains an outlier, or what some traders are saying: ‘The only game in town.'”
- “Plenty of juice remains in US bond yields that can be squeezed a lot lower from their present levels, helping drive equity prices higher.”

Special Reports

Mauldin Economics – Bill Gross at His Best – John Mauldin 7/6
- “The bond market’s 7.5% 40-year historical return is just that – history. In order to duplicate that number, yields would have to drop to -17%!”

Mauldin Economics – When the Future Becomes Today – John Mauldin 7/10
- “Right now the problem is that monetary policy is carrying a load it was not designed to bear. Strong central bank action during the crisis was necessary and appropriate, says the BIS report, but the extended wind-down hasn’t served the desired goals. This protracted reliance on extraordinary monetary policy carries the risk of causing the rest of us to lose faith in the policymakers.”

NYT – Climate Change Claims a Lake, and an Identity – Nicholas Casey 7/7

NYT – How Private Equity Found Power and Profit in State Capitols – Ben Protess, Jessica Silver-Greenberg, and Rachel Abrams 7/14

Graphics

WSJ – The Big-Bank Bloodbath: Losses Near Half a Trillion Dollars 7/6

FT – Beijing warns neighbors after South China Sea ruling 7/12

Economist – Keeping up with the Wangs

Economist – China’s debt: Coming clean

FT – US shale is lowest-cost oil prospect 7/12

Economist – The long march abroad: China’s brightest and wealthiest are leaving the country in droves 7/9

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

Dividend cuts possible at AR Global REITs, analysts say. Bruce Kelly. Investment News. 11 Jul. 2016.

Nicholas Schorsch again…

“Investors in a number of AR Global-sponsored real estate investment trusts face the potential danger of a cut in distributions, according to industry analysts and consultants.”

“The culprit is a REIT cash flow metric known as MFFO – or modified funds from operations, or cash flow – at seven AR Global REITs that in the first quarter of 2016 failed to match or exceed their distributions by wide margins.”

Exsqueeze me… what did you say?

Basically “it is typical for nontraded REITs to overpay distributions to investors in their initial stages while the companies buy properties, find tenants and negotiate leases. Over time, however, REITs cash flow and distributions – or dividends – should match up, or investors will see the value of the REIT erode.”

“Nontraded REITs also use the lure of 6% to 7% initial annual distribution rates as a marketing tool for advisers to hook clients.”

“This is what I call sucker yield. It’s the chase for yield that leads investors to impulsively react to dividend quantity over dividend quality. When a company is paying dividends beyond its earning power, it is eroding capital.” – Brad Thomas, editor of Forbes Real Estate Investor newsletter.

Fishy.

“Meanwhile, the AR Global REITs, which control more than $10 billion in real estate assets, are continuing the process of seeking to merge with each other under the roofs of two AR Global REITs that have unusual 20-year management contracts, according to REIT executives.”

Doesn’t seem to be in the best interest of the investors…

“Five of the AR Global REITs in the quarter that ended in March had dividends that far exceed cash flow, while two REITs, American Realty Capital Global Trust II Inc. and American Realty Capital New York City REIT Inc., had negative cash flow.”

“American Finance Trust has $2.2 billion in total assets, and its “payout ratio,” or dividend divided by its MFFO, was 149.4% during the first quarter of the year, according to Robert A. Stanger & Co. Inc., an investment bank that focuses on nontraded REITs.”

“According to Stanger, other AR Global REITs with high payout ratios are: the $2.4 billion, American Realty Capital Hospitality Trust Inc., at 280.8%; the $2.3 billion Healthcare Trust Inc., at 185.9%; Realty Finance Trust Inc., a mortgage REIT with $1.3 billion in assets, at 176.5%; and American Realty Capital Healthcare Trust III, Inc., with just $144 million in assets, at 183.5%.”

“The AR Global REITs are ‘paying out a lot more than they’re earning,’ said Kevin Gannon, managing director at Stanger. ‘At the end of the day you have to address what those companies are going to do dividend wise, relative to what they’re earning. At present, the payout ratios are not sustainable. The REITs have to acquire more assets with decent yields or cut the distributions.'”

Regulator sounds new alert on banks’ property lending. Alistair Gray. Financial Times. 11 Jul. 2016.

“A top US regulator (Thomas Curry, comptroller of the currency) has sounded a new alert over banks’ commercial real estate lending, adding to concerns that bubbles may be forming in parts of the country’s property market.”

“CRE (commercial real estate) loans originated by banks in the first quarter leapt by 44% from the same period in 2015, according to Morgan Stanley. Banks’ share of CRE originations has risen from just over a third in 2014 to more than half in the first quarter of 2016 – a record.”

“Mr. Curry suggested CRE was of even greater concern to regulators than both car loans – an area into which some banks have expanded aggressively – and lending to already-indebted companies.”

“Our exams found looser underwriting standards with less-restrictive covenants, extended maturities, longer interest-only periods, limited guarantor requirements, and deficient-stress testing practices.” – Thomas Curry

Mr. Curry “singled out small banks. More than 180 institutions, he added, had more than doubled their CRE portfolios within the past three years.”

“While two-fifths of banks with more than $20bn in assets said lending standards for apartment blocks had ‘tightened somewhat,’ for instance, only one-fifth of smaller banks said they had.”

“Banks have pushed into CRE as other lenders – notably capital market investors – have retreated from the market. Issuance of commercial mortgage-backed securities has dropped to four-year lows.”

“In a report published separately on Monday, Morgan Stanley warned of the risk that commercial property prices would decline if regulatory pressures caused banks to pull back from CRE.“

“A withdrawal by banks would have a knock-on impact on commercial mortgage-backed securities, more of which could default, Morgan Stanley added.”

“The report said the retail sector was especially vulnerable. ‘We are already seeing increased defaults on loans secured by shopping malls, which is a trend we expect to continue.'”

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Global Cloud Coverage Shifting in Ominous Sign of Climate Change 7/11

Bloomberg – Pimco Loads Up on Treasuries; Gundlach, Gross Voice Caution 7/12

Bloomberg – The Housing Market Is Waving a Red Flag 7/14

FT – Negative interest rates: a remarkable financial moment 7/7

FT – Rare governance and takeover battle breaks out in China 7/10

FT – Strong performance of real estate suggests top for the sector 7/12

FT – Bank of Tokyo quits as primary dealer for Japanese government bonds 7/13

Miami Herald – Many boomers in denial over problems they face growing old in suburbs 7/11

NYT – What the Seesaw Jobs Numbers Are Really Telling Us 7/8