Monday, May 29, 2017

A New Look at Mall REIT Valuations: Part 2

Earlier this month I posted my view on how to approach mall REIT valuations given the stresses engendered by online competition. (See Since then the mall REITs drifted lower rallied and then fell back a bit. Nevertheless I believe that the burden of proof is on the bulls with the mall REITs continuing to trade at substantial discounts to Street net asset values. (See below) If the Street is right then back up the truck, but my question with the world still awash in a sea of liquidity, where are the sovereign wealth funds and private equity? This is especially true for GGP whose CEO all but announced the company is for sale and where Brookfield already owns 29% of the company. The silence, up to now, is deafening. Thus if private equity or sovereign wealth funds don't come in soon to scoop up the apparent bargain, the Street, as I argued, is way off.

REIT   Street   Market Price   Discount   Mkt. Cap.
             NAV                                              (in $bil)

SPG       214                 157             27%        50
GGP         32                  23              28           20
MAC        79                  59              25              8.5
TCO         95                  62              35              4

In my view sophisticated buyers understand two things. One, there is a structural revolution going on in retail as result of online commerce and two, the retail bankruptcies that we have seen this year will look like child's play during the next recession. Remember we are witnessing an onslaught of retail bankruptcies when income, consumption and employment data are relatively benign, what will happen when the economy turns more hostile.

As a result the clock is ticking. In the absence of a major deal or a portfolio sale/jv (a one-off transaction won't really count) over the next few months, Street estimates of net asset value will have to come down. As they say, time will tell.

Thursday, May 25, 2017

My Amazon Review of Richard Bookstaber's "The End of Theory: Financial Crises, the Failure of Economics and the Sweep of Human Interaction"

Stuff Happens

Richard Bookstaber a long time finance practitioner/risk manager who has worked for Morgan Stanley, Salomon Brothers, Moore Capital and Bridgewater as well as the Financial Stability Oversight Council and the Office of Financial Research has written a broad-based attack on financial economics and the DSGE models now used by most central banks. Trust me he knows what he is writing about and in the interests of full disclosure I interacted with him when I worked at Salomon Brothers.

Although not cited he is writing in the tradition of Nicholas Nassim Taleb (“The Black Swan”) with his fundamental disagreement with the theoretical underpinnings of financial economics. Simply put in a world of radical uncertainty we don’t know the underlying probability distributions of future financial returns and we don’t even know the potential states of the world needed to calculate a probability distribution. He argues that modern finance theory is built around top down axioms based on deductive reasoning where an all knowing representative individual calculates the future probabilities for all of the known states of the world. And importantly the future probability distribution is based on historical evidence. Under radical uncertainty that simply does not work.

Instead he argues for agent based models built upon inductive reasoning where the actors are “reflexive” in the word used by George Soros, in that they respond to the actions of others. As much as economists envy physics, Bookstaber turns the Heisenberg uncertainty principle on them. Thus while financial theory works in normal times, in a crisis all bets are off as “stuff happens.”

What Bookstaber would like is to use agent based models that are used to model automobile traffic and schools of fish, for example, through the use of complexity theory. All this is fine and good, but aside from a narrative Bookstaber does not offer up a formal model for the financial markets. Perhaps he has one, but it is not here. Nevertheless he offers a road map for future research.

At times Bookstaber’s writing style is clear and lucid with analogies from literature motion pictures and military combat. He is a student of “OODA”, observe, orient, decide and act. He is particularly acute in his discussion of the origins of the financial crisis and is highly critical of the role played by Goldman Sachs in their failure to honor a small “novation” request from Bear Stearns, which brought that firm down. However, at other times his writing is dull and staid

Bookstaber has written an important book and it should be read by risk managers and policy officials. The old models failed in 2008, now almost ten years later it is time for new ones.

Sunday, May 21, 2017

My Amazon Review of Henry Kaufman's "Tectonic Shifts in Financial Markets: People, Policies and Institutions"

Too Big to Fail is Still with Us

Henry Kaufman, my former boss at Salomon Brothers, has written an easy to read and an important book about our nation’s financial structure. Simply put, Dodd-Frank did not solve the “too big to fail problem” and in fact made it worse by ratifying the undo concentration of the giant “financial conglomerates” that rule finance today. He further argues that this financial concentration impedes Federal Reserve policy. In a crisis that might be true, but it is not clear whether that is true in more normal times. After all Canada has run monetary policy for decades with a highly concentrated financial system with few issues than what occurred in the United States.

His book is part autobiographical as well in that he discusses his years at Salomon Brothers where in the late 1970s and early 1980s the financial world waited with baited breath for his comments. He notes his great friendship with Paul Volcker where he is very kind; he is not so kind to Alan Greenspan where the he believes the Fed became more political. This is not to say it wasn’t political in earlier times.
He makes an acute observation about Margaret Thatcher who impressed him with her sophisticated knowledge of macroeconomics.

What troubled me about his book is his discussion of Lehman Brothers where he was a board member before and at the time of its high profile bankruptcy. He argues that the Fed had more options than letting the firm go bankrupt and suggested that Treasury Secretary Henry Paulson was driving the bus, not the Fed. That could very well be true, but I wish he discussed what happened in the Lehman boardroom when the firm ran up its debt/equity ratio to 33-1 and loaded up their books with highly illiquid real estate, including the giant Archstone transaction. Further in late 2007 Lehman had a chance to walk from that transaction, but didn’t. Were it not for their real estate heavy transactions in both physical real estate and what was to become highly illiquid positions in commercial mortgage backed securities, the firm could very well have survived. In the interests of full disclosure I left Lehman in 2005.

Thus having opened the discussion about Lehman, I wish he would have given us more details. Otherwise this is a fine book for those interested in how our financial system evolved over the past 60 years.

The full Amazon URL is:

Tuesday, May 16, 2017

My Amazon Review of Duff McDonald's "The Golden Passport: Harvard Business School, The Limits of Capitalism, and the Moral Failure of the MBA Elite"

Put the Blame on HBS

Duff McDonald has written a very long (672 pages in the print edition) minutia filled anti-American business and anti-Harvard Business School screed. For the most part he believes that American business can’t do almost anything right and he places the blame on the “West Point of Capitalism,” the Harvard Business School for practically everything that is wrong with America.

He doesn’t like the managerial capitalism of the 1950s that ran aground in the 1970s and the shareholder capitalism that began to evolve in the 1980s. What he would prefer is some broad version of “stakeholder” capitalism that protects the environment and combats income inequality, but my question is whether business is the vehicle to do that. My guess is that if business tried as it did minimally in the late 1960s he would use the leftist pejorative term “corporate liberalism.”

The villain of his piece is finance professor Michael Jensen who laid the intellectual foundations for shareholder capitalism in the late 1970s. Out of this flows leveraged buyouts, mass layoffs and the philosophy of short-termism with respect to the undo focus of corporate management on meeting quarterly earnings expectations. He however conveniently ignores such successful corporations as Amazon, Google and Berkshire-Hathaway who invested for the long run and mightily succeeded.

McDonald is highly critical of HBS’ case method of instruction which by its very nature lacks real theoretical underpinnings. That is true, but the case method is useful in organizing how to think about very real business problems. It also leads to superb teaching. He admits that pretty much every professor at HBS is a great teacher, a skill that is lacking at other business schools.

He does favorably mention Harvard professor General Georges Doroit who was an expert on logistics and went on to found the venture capital industry in the early 1950s with his American Research and Development. He also singles out for praise Arthur Rock who was one of the earliest venture capitalists in Silicon Valley.

In the interests of full disclosure I have an MBA, not from Harvard, and taught MBAs. As a professor I used discussion of formal finance theory with an occasional case study in corporate finance. Indeed in the most case intensive course I taught, I so inspired one student that many years later he endowed a teaching award in my name. As a result it is hard for me to get too worked up about McDonald’s criticism of the case method.

With McDonald continually in the attack mode his book makes for a very difficult read so I would recommend readers to find better things to do with their time.  

The full Amazon URL is:

Thursday, May 4, 2017

A New Look at Mall REIT Valuations

As most REIT practitioners know all too well, the mall sector has been hammered of late by fears of obsolescence engendered by the explosive growth of e-commerce causing the group as a whole to trade at a 30% or so discount to Street net asset value estimates. My explanation is that the estimates of value are way too high. How so?

At the present time the Street seems to be assuming that high quality malls are valued at a 4.5% cap rate, but in my opinion that doesn't take into account the increased capital spending required by mall owners to compete with the likes of Amazon. So instead of using a 4.5% cap rate lets use 5%. There is more though. Simply put some of the high quality malls are going to be degraded over time. My very rough estimate is that about 15% of the high quality malls will be re-rated over the next five years causing a cap rate increase to say 6% for those malls. Thus the weighted average cap rate should be 5.15%.

Now lets add another 50 basis points to allow for higher long term interest rates over the next few years yielding an adjusted cap rate of 5.65%. When you do this exercise you end up with a net asset value approximating current market prices. The arithmetic is below.

Net Operating Income   $45
Cap Rate Today                 4.5%
Firm Value                    $1,000
Debt @30%                       300
Equity Value                      700
Market Value                      490  (30% discount)

New Cap Rate                     5.65%
Firm Value                         $796
Debt                                     300
Pro forma Equity                  496
Market Value                        490

Thus the market might just have it right. You can play with my assumptions to your heart's content, but I think this is a reasonable analytical framework.

Monday, May 1, 2017

My Amazon Review of Charles R. Morris' "A Rabble of Dead Money: The Great Crash and the Global Depression: 1929-1939

The Great Depression: Who done it?

Charles R. Morris has presented us with a very thoughtful popular history on the origins of the Great Depression. He pulls together the thoughts of four really good books on the subject without getting too bogged down in technical jargon. They are Barry Eichengreen’s “Golden Fetters,”  Liquat Ahamed’s “The Lords of Finance,” Robert Gordon’s “The Rise and Fall of American Growth,” and Frederick Lewis Allen’s popular history of the 1920’s “Only Yesterday.”

To Morris and most of the economics profession the cause of the Great Depression was the imbalances that arose out of World War I with its interaction with the gold standard. This is more a Hooveresque version of the cause compared to Roosevelt’s view that causes were domestic; namely rampant speculation, the unequal distribution of income and the 1920’s depression in agriculture. Morris debunks all of the Rooseveltian causes and notes that agriculture wasn’t that bad off in the late 1920s. He does not however note the revolution in agricultural technology caused by the introduction of tractors eliminated the need for forage crops that accounted for 40% of the U.S.’s agricultural output. That alone would have triggered a fundamental restructuring of the industry.

Morris is very good at discussing the impact of electricity, automobiles and radio on production and the lifestyles of average Americans. The 1920’s truly brought with it a revolution in production and consumption. He also has vignettes about the rise and fall of the Samuel Insull, the utility mogul and Ivar Kreuger, the global match king as there empires collapsed under a mountain of debt.

If he holds out one party for special opprobrium it is Germany in its failure to step up to its reparations obligations after the 1924 Dawes Plan knocked them down enough to satisfy Keynes. Simply put they never were going to pay and it was the entire reparation process that put an inordinate amount of stress on the global financial system. However it is unrealistic to assume that any 1920’s social democratic government would have put on such a squeeze on their domestic economy as the French did following their defeat in the Franco-Prussian War of 1870.

As a result if a lay reader doesn’t want to slog through the four books I mentioned above, Morris’ alternative is well worth the read.

For the complete Amazon URL see: