There's the famed walk up the 18th on the final day at Augusta. Then there's the walk down the first fairway at Bushwood CC in 1980. On this walk, we meet the bombastic buffoon, Al Czervik, who opines, "Country clubs and cemeteries are the biggest wastes of prime real estate! Dead people? They do not need to be buried nowadays! Ecology, right? Ask Wang. He’ll tell you. We just bought property behind the Great Wall. On the good side!...I'll put a mall there, condos here."
At the risk of sounding trite, this scene from Caddyshack
is -- in this humble writer's opinion -- timeless. Al Czervik (and by extension, producers of this oft-quoted comedy) also proved to be a bit prescient; there is a good chance Al and Wang were at the forefront of property development in China, and at the same time, may have gone toe-to-toe with the condo glut of the '80s, and the subsequent S&L crisis.
I’ve gotten a lot of questions lately regarding housing, construction, and commercial real estate. I’ve seen shorts/sellers of the homebuilders, as well as existing holders, sell to pare back positions, given the year-over-year move with the group. I have also seen buyers of REITs as investors, both individual and institutional, remain starved for yield. So I set out on a quest, to talk to people in the trenches, so to speak -- sources (one in particular for the purposes of this piece) that I wanted to give readers access to, who play out the battle behind the indicators every day.
The first leg on my Jean-Claude Van Damme quest led me to the Pike School in Andover, Massachusetts, for a conversation with Andrew Chaban, CEO of Princeton Properties, and Chairman of the Federal Government Affairs Committee, and Executive Board Member of the NAHB. To better put Andrew in context, visit Princeton Properties website
. But suffice to say, he’s regarded as one of the foremost industry experts in multi-family housing.
Princeton Properties was founded in 1973 by James Herscot, a Lowell, Massachusetts, native. It was named after…well, Princeton Boulevard in Lowell. For Mr. Herscot, the original idea was merely for Princeton to be a tax shelter, a side venture. But before he knew it, he woke up one day with 400 units and had an epiphany. In the vernacular, the company morphed (much under Andrew’s leadership in combination with Jim's) into what it is now one of New England’s largest and best-in-class purveyors of suburban, garden-style multi-family homes. Princeton currently owns and manages more than 6,000 apartment homes, spanning Massachusetts, New Hampshire, Maine, and Georgia, and it is growing and continuing to innovate.
I do not want to get off track here, but at the least, I want to set the table. Andrew summed up Princeton’s ethos by saying, “We raise funds; buy and/or build to create value; then typically HOLD.” Stay with me, people -- we’re getting to some nuts and bolts here. When seeking financing, there are several routes Princeton takes. What has been most appealing to lenders and investors is Princeton’s low leverage, or 65%-35% equity-to-debt ratio for a deal. For the small raise, say $3 million to $6 million, the funds come from family and friends after a couple martinis and perhaps a bowl of deep fried chick peas at Andolini’s. For traditional larger ventures, Princeton seeks any appropriate combination of institutions, bank loans, and mezzanine financing. It was at this point that Andrew dropped, in Randy Jackson’s words, “the hot lava bomb!” He said, “For our model, thank goodness for Fannie Mae
(OTC:FNMA) and Freddie Mac
(OTC:FMCC). They have been terrific for us.” This was my cue -- enough of the softballs. I then asked Mr. Chaban, as he is clearly someone with a vested interest, what kind of faith he had in FNMA/FMCC as constituted, and what his opinion was on their viability going forward. Moreover, I asked how he looks at them as investments. He looked at me like Judge Smails looked at Danny Noonan after hurling his putter and knocking out Mrs. Havercamp, and then indignantly blaming Danny for a “worn grip.” He said, with the caveat that the regulator (the Federal Housing Finance Agency) is doing its job, “FNMA/FMCC are simply the best for securing long-term, fixed, non-recourse financing," and then issued this warning: “Whether merged or not (as one would imagine, this prospect is mired in gridlock on Capitol Hill -- shocking), there still needs to be a Fed backstop, and there still needs to be the ability to sell on an agency basis, to the secondary market. If the greed of years past is taken away, the model works.”
Okay, but as an investor Andrew, would you buy Mortimer!? Andrew said without equivocation, “On a purely theoretical basis, absolutely... again, at equilibrium, under the premise the regulator is doing his job, the business model is necessary, and works…and I still believe an investor would be buying them near their lowest point…again, if you can get past the name(s), it’s a very viable business model.” When pressed for specifics in regards to Washington, DC, his crystal ball was as foggy as anyone else’s. (Please note that multi-family housing is approximately 4.5% of the FNMA/FMCC portfolio, with the other 95.5% being single-family housing. On Wall Street, Keefe Bruyette & Woods, the only analyst researchingh FNMA, rates it Underperform. There are two analysts rating FMCC; Keefe Bruyette & Woods and FBR both rate the entity Underperform as well.)
Now to be fair, I spoke to a couple of wily agency traders, one of whom who retorted, “I get why there is a story... I have a lot of baggage with GSEs [Government-sponsored enterprises]! On the debt issuance/portfolio side, they are shrinking; their future as an entity is so uncertain. If they start to really make money, I feel the government will try to grab the lion's share in new fees, etc…. just a point of view. I’m unsure of the potential for continued upside relative to housing, but the multi-level housing recovery is definitely for real. Overall, I’m just not sure how it can be monetized at the GSE shareholder level (equity), meaning FNMA/FRCC.” That, my friends, is what makes a horse race; and frankly, after hearing this view, I felt like Sonny’s crew at the track in A Bronx Tale
when Benny “the Mush" yells, “C’mon Kryptonite!” and they all rip up their tickets.
We then moved away from the wasteland that is currently government agencies, and moved on to the American Dream: housing. As stated previously with regards to the NAHB, Mr. Chaban is currently the Chairman of the Federal Government Affairs Committee, and sits on the Executive Board. His company has won a NAHB’s Pillar of the Industry Award eight times -- one can only imagine the red carpet at that event!
Andrew described the NAHB quite simply as “the voice that helps promote the policies that make housing a national priority.” It represents both the property manager and builder in every arena: legislative, regulatory, and judicial. In this vein, he continued, "[The NAHB] is one hell of a large lobbying group.” By extension, the NAHB Wells Fargo Housing Market Index is, as Andrew puts it, “a statistically relevant sample (approximately 400 respondents, both large and small) of builder sentiment.”
At the nadir of the housing crisis, we know we were pulling readings in the mid-teens. On February 16, we got a reading of 48, which was inline with January’s reading. We know that a reading of 50+ is generally positive and signals expansion. So I again asked Andrew to put his Wall Street hat on (a hat he usually does not wear), and view recent readings in the context of an analyst looking at a stock or industry. He said, “Right now, we’re obviously near the cusp…to make the analogy of placing a stock rating…I guess I would have to put a 'neutral” on the Index.' We’re just at the midpoint right now, after crawling out of a very big hole.” In January, Andrew attended the annual International Builders Show, which is the Mac Daddy, the largest light construction trade show in the US. I asked him for some takeaways. His first was that overall, single-family credit at the consumer level, and also for the builders, remains “very tight.” Banks are giving buyers a very hard time with more documentation than ever. The lenders, in general, are looking for “perfection” with regards to credit history. According to Mr. Chaban, appraisals have also become a big issue. The lenders are also looking for larger downpayments to try to guard against defaults. But therein is a paradox, according to the Chabes. (We were, in Coolio’s words, “Rollin’ with the Homies” at this point). At the lender level, there’s little real understanding that statistically, there’s little correlation between the amount of downpayment and the default rate. Take that, Wells Fargo!
I wanted more at this point, given Andrew’s willingness to share his unabashed opinion on Fannie and Freddie as they relate to Princeton. I wanted more granularity on the homebuilders, the big companies, and opinions on where we go from here. Andrew said, “Well…the big boys should be giddy…their markets in places like Florida, Nevada, [and] Arizona were so far down. Again, at the nadir, they spent a ton of time acquiring land and permits, so that at equilibrium, they were primed for recovery; but they have held and waited for the market cycle to turn…well…it’s now turning.”
He then cautioned, "We were at -50% in some of those markets…okay, well, now we‘re back +25% (i.e., Arizona) …so that tells me we’re only halfway way back to the top. But these depressed markets are an indicator of where people are shopping.” As a fundamental business risk, “they bought low and held, and now they’re starting to cash in again.” I then asked him what inning we’re in with the homebuilders. He said, “Let me say this: I believe there are several years of blue skies ahead.”
I then pressed for his favorites. For Andrew, it’s a coastal perspective; again, he is not an industry analyst with specific stock picks. So here we have to read the tea leaves. Historically, the homebuilders on the far East Coast and the West Coast including the Texas markets have “stood the test of time.” Examples of two names that have this type of exposure are Toll Brothers
(NYSE:TOL) in the east and DR Horton
(NYSE:DHI) in the west. Speaking generally, he said, “Anyone who places themselves in markets that are relatively fixed has the supply/demand curve working for them the fastest." (Random aside: As Minyanville's own Michael Sedacca
pointed out earlier this week, PulteGroup
(NYSE:PHM) Chairman Richard Dugas exercised and sold 500,000 shares, reducing his stake by 29% to 1,236,569 shares.)
In the words of Gordan Gano of the rock band Violent Femmes, let’s “Add it Up.” In full disclosure, I want to state that I’m certainly not an analyst by trade, and neither is Andrew Chaban. However, I do feel (and feedback dictates) that providing access to esteemed industry experts can prove to be invaluable; a baseline is just another bullet in the holster as we as investors try to navigate our way through the landscape. Starting with Fannie and Freddie as a baseline, Mr. Chaban conveys his opinion that whether merged or otherwise, a government backstop is needed, and secondary agency distribution capability is needed.
As far as an investment at the equity level -- again, from a purely theoretical perspective -- Andrew would be a buyer. He quite simply states that again, providing the regulator is doing the job, taking away the greed of days past, the business model is necessary, and it works like no other in the context of its intended purpose. It’s fair to say that he may be in the minority here. But as I was told my first year at Morgan Stanley, “At least he has an opinion.” I mean, even country music icon Toby Keith in “Red Solo Cup” says, “Freddie Mac can kiss my [bleep]!” Additionally, Chaban also has a ton of credibility on the matter.
Secondly, we looked at the housing market and its foremost proxy, the NAHB, where Andrew sits on the Executive Board. As far as the NAHB Index, we’re pulling close to even; we’re again “on the cusp” of expansion. However, Mr. Chaban feels the homebuilders, given the unprecedented conditions, executed quite well in general. They bought low, held until they saw the whites of the buyers' eyes, and are now really just starting to cash in. Specifically, he prefers (and remember that I pressed him for this opinion) an East /West coastal bias, referencing TOL and DHI respectively from that geographical point of view. As history bears out, supply/demand models there have simply done better over time. Again, he sees “several years of blue skies ahead.” Somewhere, Al Czervik is dancing to Kenny Loggins. Anyone know if Wang is still around? Stay thirsty, my friends.