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Minyan Mailbag: The Macros Of Mega Real Estate Deals


$2000/month for an 800 sq.ft 1-BR?!?


Sometimes procrastination pays. Minyan Mike emailed me the following several days back:

Professor Zucchi,

Just a quick question about the Equity Office Partners (EOP) bidding war, I know you have addressed this before, but it's worth revisiting. So, with the latest offer by Vornado Realty Trust (VNO) to buy EOP at $52, they have pushed the div. yield to around 2.6%. This is 2% below the 10-year! REIT's normally have a yield 1-2% HIGHER than the 10-year, so I'm unsure of the motivation behind these offers. Do they believe their economies of scale and superior property management skills can lower expenses enough to make this profitable? And isn't this a massive bet that the economy will stay strong enough to keep vacancy rates low, rents high and justify the low cap rates (whatever happened to buy at 14% and sell at 6%)? Or have their egos gotten in the way and the thought of being the largest REIT in the world clouded their thinking?

A few other notes...iShares Dow Jones US Real Estate (IYR) is up 140% or so since the bull market started in March of 2003. The last time the yields on REIT's were below the 10-year was 1998, and they were down a quick 20% or so that year. The bond market and Asian crisis helped that sell off in 1998, but the risks are high here.

Of course, all of this means that REIT's will go up another 50% and make me look dumb....

Minyan Mike

I was going to rehash the somewhat cynical arguments I made last year, but then John Mauldin's weekly InvestorInsights letter bailed me out. This Saturday's edition deals with the precise issue raised by Minyan Mike, as well as offering up some thoughts on housing. It's all laid out in a very simple yet comprehensive way. The article - "Capital Keeps Falling On My Head" - is a must read in my humble opinion.

Two quick thoughts on the dynamics of the rental apartment business in the Washington area:

  • We are seeing the frenzy for prime land still on an upward slope. Once construction costs are factored in, it is hard to imagine how some of the current projects will be anywhere near cash flow positive unless they can command rents north of $2.50/sq.ft. for Class A rentals - that's $2000/month for an 800sq.ft 1-BR. If such rates catch on, that would represent roughly a 100% increase in rents since 1998.

  • "Homeowner equivalent rents" is the largest component of the Consumer Price Index (CPI).

Have a great week Minyans!!

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