Monday, 07 December 2009 00:00

A Granular Look Into a $6 Billion REIT: Is This the Next GGP? Featured

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This is a corrected and extended update of my glance into the Macerich update. This post was delayed due to material data input errors which have been rectified. I've decided to offer a peak into the ongoing analysis of its property portfolio, which combined with its credit and cash flow situation brings to mind the concerns that I have had about GGP about a year before it collapsed (see "GGP and the type of investigative analysis you will not get from your brokerage house.").

In looking at the data that I am about to display, I want readers to think of MAC as an investment entity that you, yourself, would run as a real estate investor. Think of your ability to make money over time, and the viability of your entity if you would actually lose money. As a property investor, I view MAC's properties in terms of being underwater or being profitable on a capital appreciation and NOI basis. As of 11/09, many of MAC's properties are significantly underwater, the ramifications of which depend on the financing utilized, since the use of debt has literally wiped out all of the equity in some, has made others require an equity infusion to roll over the mortgage, and has simply destroyed shareholder capital in other cases.

Even those properties that are 100% equity financed represent a material loss to shareholders where they are underwater. As you will read below, this has occurred in many instances. Very few publicly disseminated REIT analyses seem to take into consideration the ramifications of REITs actually losing money on investments that don't have large loans against them. They should, though. A loss, is a loss, is a loss.  Leverage simply amplifies the loss. That being said, if I paid $30 million in cash for a property that is currently worth $20 million, I lost $10 million (less the real income derived from that property since acquisition) - no matter which way you look at it. At least with a cash purchase, I may have the option of riding it out to hope that the market returns. If I bought the property with a 70% LTV, $21 million loan), not only have I taken a 110%+ loss, but I would probably be forced to write the property off come time to refinance the loan. The leverage significantly reduces my flexibility. This is what happened to GGP.

The next question is, "Will the market come back to where it was when I made these high priced, high leverage purchases?". Reggie's assertion is, "No time in the near future!". Let's take a look at Richard Koo's chart on the Japanese asset bubble, after GDP started to ramp up...


If we are anywhere near the Japanese "lost decade" experience, we have a long sloth ahead of us. Now, let's take a look at the most recent bubble that got us into this mess. There are two major reasons most REITs are in a financing bind. The first is that there was a credit bubble that allowed REITs to borrow more than was fundamentally feasible, and/or viable. This bubble was blown, in large part (at least in regards to REITs), through the CMBS market. As you can see below, CMBS (credit) peaked in the 2nd quarter of 2007 after a run up that started in the 2nd quarter of 2003.


Sourced from

The same can be said for the rent bubble, where companies apparently were signing leases with monopoly money, almost to the exact monthly range  as the credit bubble. The rent bubble was blown through the free access to credit by both companies that sought leases and by consumers who used debt to finance purchases from said companies. Economic activity was grossly exaggerated, and this gross exaggeration was transformed into grossly exaggerated rents.


Sourced from BoomBustBlog proprietary research

  These grossly exaggerated rents helped to justify grossly exaggerated business plans that required grossly exaggerated financing to build grossly exaggerated development projects (residential, office and retail). Now, that the CMBS/lending spigot has been shut down, bubble consumer credit has popped, and fundamentals are now ruling commercial real estate markets (having taken the place of euphoria):

  1. rents are dropping rapidly;
  2. CRE values are collapsing;
  3. CAP rates are exploding;
  4. the refinancing market is looking for much lower LTVs while the property values of recently purchased properties are dropping simultaneously,
  5. and an often overlooked occurrence - REITs are selling off the more valuable assets to fund the gaps necessary to rollover overpriced debt, further reducing rent rolls and dramatically reducing the overall value of the existing portfolios.

These five ingredients combine to make a deadly elixir. Click any of the charts below to enlarge...


Now, let's take a look at an excerpt of Macerich's property analysis (subscribers should reference pdf  MAC Report Consolidated 051209 Retail 2009-12-07 03:46:49 580.11 Kb , pdf  MAC Report Consolidated 051209 Professional 2009-12-07 03:48:11 1.03 Mb ) that we have so carefully developed, keeping in mind the dates determined as a bubble in the charts above.


As you can see above, MAC has ramped up their real estate investments to full speed at nearly the exact bottom of US retail cap rates. It actually takes skill to time your investments so accurately to the inverse of potential profitability. 

You know what they say in the real estate biz... "Location! Location! Location!" Where you buy is often more important than what you buy. On that note, let's take a look at where MAC bought.


California and Arizona are two of the worst hit states in terms of both residential and commercial real estate decline.and by a very significant margin...


 The results of these activities have been congealed in our analysis of Macerich's entire portfolio of properties (118+ properties), including wholly owned, joint ventures, new developments, unconsolidated and off balance sheet properties. Below is an excerpt of the full analysis that I am including in the updated Macerich forensic analysis. This sampling illustrates the damage done to equity upon the bursting of an credit binging bubble. Click any chart to enlarge (you may need to click the graphic again with your mouse to enlarge further).


Notice the loan to value ratios of the properties acquired between 2002 and 2007. What you see is the result of the CMBS bubble, with LTVs as high as 158%. At least 17 of the properties listed above with LTV's above 100% should (and probably will, in due time) be totally written off, for they have significant negative equity. We are talking about wiping out properties with an acquisition cost of nearly $3 BILLION, and we are just getting started for this ia very small sampling of the property analysis. There are dozens of additional properties with LTVs considerably above the high watermark for feasible refinancing, thus implying significant equity infusions needed to rollover debt and/or highly punitive refinancing rates. Now, if you recall my congratulatory post on Goldman Sachs (please see Reggie Middleton Personally Contragulates Goldman, but Questions How Much More Can Be Pulled Off), the WSJ reported that the market will now willingingly refinance mall portfolio properties 50% LTV, considerably down from the 70% LTV level that was seen in the heyday of this Asset Securitization Crisis. Even if we were to assume that we are still in the midst of the credit bubble and REITs can still refi at 70LTV (both assumptions patently wrong), rents, net operating income and cap rates have moved so far to the adverse direction that MAC STILL would not be able to rollover the debt in roughly 37 properties (31% of the portfolio) whose LTVs are above the 70% mark - and that's assuming the credit bubble returns and banks go all out on risk and CMBS trading. Rather wishful thinking, I believe we can all agree. 

Now, let's assume that the markets can be convinced to rollover the debt at 70LTV, with some pretty onerous (yet potentially sweet to the lenders) terms. Despite the significantly higher debt service, MAC will still need to come up with the equity to patch those rather large holes. I point subscribers to our MAC 3Q09 Results Analysis in order to illustrate MAC's attempts at financing said gaps.

Out of the total 43 consolidated properties (excluding new developments), the fair value of 17 properties (40% of the total) currently stands below the net cost/ carrying value in the balance sheet. In the case of unconsolidated properties, 24 properties out of total 48 properties stand below carrying cost. This is a reflection of the MAC management’s failure to create value for its shareholder, which is now becoming increasingly apparent in this litmus paper environment of distressed market conditions.  

As mentioned earlier in this missive, I find that many REIT investors have been focusing on property LTVs, which may cause one to miss sight of the forest due to that big tree that's in the way. When one takes a loss on a real asset purchase, leverage simply amplifies the loss. The lack of leverage does not remove the fact that a loss was taken. In the last column of the table above (Property Appreciation since Acquisition), you can see where Macerich has taken significant (capital appreciation) losses, and in the full version of the analysis, you can see some of the properties even have relatively low LTVs or no mortgage at all. Alas, a loss, is a loss, is a loss. As a matter of fact, for the history of the entire on balance sheet portfolio, MAC has added a mere 2.2% of appreciative value since acquisition.

Reposting that Richard Koo/Nomura graph of what we are likely to see in the near future should make the purchasers of MAC's recent equity offering and any subsequent offerings shudder. After all if no gains in value were made over the last few bubblicious decades, what does this portend for the future when all macro and fundamental factors are pointing downwards...


Do I feel Macerich is in trouble? Well, I'll let my readers hazard a guess. There is a wealth of stuff that my team dug up, and even more we were able to extrapolate as a result of our deep dive into the netherworld known as off balance sheet accounting. This may very well be a situation where "extend and pretend" and "kicking the can down the road" may not be enough fantasy to overcome the economic reality of the fundamentals. We shall see. Banks beware!You see how profitable ignoring the problem was for GGP's lenders and creditors.

I am also working on a macro report that extends and builds upon the work of Richard Koo from Nomura (the author of that oft-used Japanese lost decade chart above), in an attempt to verify (or disprove) the US as Japan in the 19 year "lost decade" thesis. This should have significant ramifications for banks and real estate investors, alike. Again, I welcome any banks, lenders or those with economic interests in MAC's (or Taubman's [TCO] or any other REIT) properties to reach out to me to discuss my forensic analysis. I can be contacted through this link.

Key assumptions and metrics

Our Research team conducted a detailed valuation of each of the properties in the MAC portfolio of 118 properties - consisting of 70 consolidated properties and 48 properties under unconsolidated JVs. The property valuation required assumptions on rentals, cap rate, discount rate, rental growth, occupancy, etc as detailed below.

Rental Assumptions:
1.    For each property, the team sourced information on likely rentals based on rents prevailing for similar properties in the same locality or area. We sourced the initial information from Loopnet and CB Richard Ellis (CBRE). The median rentals from these two sources were averaged to get information on rentals that MAC’s property should command amid the current distressed real estate scenario.  
2.    For properties which required some premium to the above derived average rents due to their nature (regional and super regional, location, ranking among the top malls in an area or region, higher sales per square feet), we applied a premium to arrive at what we considered to be the most likely rentals.
3.    The BoomBustBlog team also solicited quotes for certain properties from other brokers and MAC’s management (since most of these properties are managed by MAC’s management for rental and other purposes), both categories of which we assumed would be on the optimistic side but whose numbers stood for the sake of creating a conservative analysis. These quotes were used in cases where there was additional evidence such as sales per square foot, ranking (popularity), etc to substantiate quotes.

Assumption on Cap rate and Discount rate
The team considered cap rate of 7.5% to value each property. The cap rate used was lower than the average US retail cap rate of 8.71% (as per CBRE in 3Q09) to incorporate the premium of the upscale regional and super regional malls, as well as to err on the conservative side, if we were to err at all.
A discount rate of 7.5% for PV calculations was used, which is in line with MAC’s weighted average cost of capital (WACC) of 7.27%.
Occupancy Rates
For property valuation purposes, the occupancy rates were assumed at roughly the current levels (on an average basis) for each year as we assume them to decline in coming years and then rise a little after the current crisis subsides.
Rental Growth
The rental growth in future years was forecasted based on region-wise population and consumer spending increases. 

Quality Control via Cross Reference of Assumptions with Data Attained from Bloomberg

In order to compare our NOI estimates with the property level data available from Bloomberg (via the reported operating data of the properties of CMBS), we performed a comparison for a number of properties owned by MAC, by collecting data for nine wholly owned consolidated properties which have significant contribution to Company’s total NOI.

The variations primarily stem from two reasons:

  1. Our NOI estimates are based on current rentals in the market for similar properties while the property may be earning rents higher or lower than the market rate owing to long term contracts which have not recently renewed (but may very well be under pressure for renegotiation due to the sharp compression in leasing rates) and
  2. Expense ratios and recovery ratios at the individual property level may vary from our assumptions owing to a lack of precise property wise data. We assumed expense and recovery ratios to be equal to the levels observed on consolidated company level.

Additionally, data from Bloomberg, in many cases, references older periods that pre-date the rout in CRE rents. Out of 9 properties, our estimate for NOI is lower in 5 cases and higher in 4. Notably, in two of the cases where our data is lower, Bloomberg reports significantly older data – more than old enough to miss the bulk of the drop in CRE rental values.


More of my opinion on MAC and CRE 

The professional level of the MAC updated is data heavy, and about 30 pages long. I will be following up on both the TCO and MAC reports with analysis of the CMBS performance in which the mortgages of many of the properties of these companies are packaged. Goldman Sachs is the originator of most of the CMBS, which is interesting since they just upgraded the sector in direct contravention to my opnion of the CRE outlook. My next post will review the performance of Goldman's vintage CMBS products the last time they hawked issues like these to their clients. As a hint, it doesn't look very pretty.

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Read 8218 times Last modified on Monday, 07 December 2009 06:55
Reggie Middleton

Resident Contrarian Badass at BoomBustBlog (you can call me Editor-in-Chief)...

Disruptor-in-Chief at, where we're ushering the P2P Economy.