10-K Review: Hines

Financial reviews continue.  I have run a basic financial statement analysis on the Hines  offerings – Hines REIT and Hines Global REIT.

In  Millions	Hines REIT	Hines Global REIT
Total Assets	$3,150.016	$775.684
Total Liabilities	$1,887.872	$411.299
Equity Raised	$2,534.600	$531.800
Net Real Estate	$2,213.212	$449.029
Direct Debt	$1,521.544	$378.295
Leverage Ratio	68.7%	84.2%
Revenue	$334.471	$24.874
Net Income	($35.383)	($31.416)
FFO	$77.070	($12.629)
ModFFO[1]	$84.174	$4.141
Dividends	$122.348	$13,697
Yield ($10 share)	5.0%	7.0%

Hines Real Estate Investment Trust, Inc. (Hines REIT), closed its offering in January 2010.  At December 31, 2010, the REIT had $3.15 billion of assets including $2.213 billion of real estate owned directly.  Hines REIT realized $334.5 million total revenue and a $35.4 million net loss in 2010.  The shareholder 5.0% dividend is only 63% covered by Funds from Operations and 68.7% by Modified Cash Flow as reported by the REIT..   Property operations in 2010 capitalized at a 6.0% rate suggest net real estate value of approximately $2.6 billion, about 18% higher than the book value of the real estate.  This estimate would suggest a share value of approximately $7.84, about 22% lower than management's estimate of $10.08 per share as of December 31, 2010.  On May 24, 2011, the Hines REIT board of directors established an estimated per-share value of Hines REIT's common stock of $7.78.

Hines Global REIT, Inc. (Hines Global), commenced its initial equity offering in August 2009. As of March 23, 2011,  the company had raised $531.8 million of equity.  As of December 31, 2010, Hines Global had $775.7 million of assets, including $449 million of net real estate, and $411.3 million of liabilities.  The company reported a net loss of $31.4 million on $24.9 million of total revenues.  The REIT used $12.6 million of Funds From Operations and generated $4.1 million of Modified FFO, compared with declaring $13.7 million in dividends. 

If you are interested in seeing  a similar report for another REIT or REIT family, please leave a comment, or send me a note.

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[1] As reported in the 10-K

Here Comes Another One, Just Like the Other One

I saw this article in Investment News today.  Calling them a "new breed" of REIT, it discusses the effectiveness of non-traded REITs being offered American Realty Capital and Clarion Partners Americas.  I glanced through the prospectus for the Clarion Partners Property Trust, Inc, and have come to the conclusion that the liquidity function will be similar to that of Hines REIT.  The article notes that the innovation of these two funds is in investing 20% of the portfolio in liquid real estate-related assets.

Clarion and American Realty Capital are to be commended for trying to bring some liquidity to real estate investing with out losing the advantages that come with private market transactions and the deliberate nature of real estate markets.  In general this structure will serve all participants effectively; institutional real estate investing followed a similar model through the 90s.

The model comes apart in a market in which valuations decline precipitously.  That is because the sticks and bricks portfolio will continue to be valued based on appraisals that are on average six months old.  and these appraisals are based on transactions that have taken place as much as three years earlier.  As Hines REIT found out in 2008 and 2009, investors can figure out that share valuation lag actual portfolio valuations, and the will stampede for the redemption window.  The negative arbitrage (from the REIT's perspective) will be deemed detrimental to the REIT, and management will close the window.  And it becomes just another non-traded REIT.  In other words, liquidity is provided as long as shareholders in general do not need it, but once they do, it will be taken away.

Shared vs. Growing Value

Every now and again, it seems that a theme is developing across my reading list.  Such was the case about two weeks ago when a LinkedIn post led me to a blog that I had not seen.  Then I caught a New York Times column by Steve Lohr that referenced a piece written by Milton Friedman and a presentation by Professor Michael E. Porter of the Harvard Business School.  There have also been several more pieces along the same lines that I have seen since then that I can't put my hands on at the moment.

The Shared Value concept is just Business 101 dressed up to make it acceptable in polite company.  At its core, it says that when businesses identify human needs and wants and find a way to fulfill them at a price that the market can afford and allow the company to make a profit, then value is created for all participants.  By pursuing profit, business makes society better.  Professor Porter puts a lot of decoration on it, but the fundamental tenets are there.

Economic theory says that any time a transaction takes place both parties are better off after the transaction.  A business will be improved by the profit on the transaction; the customer by the improvement in his ability to survive or thrive as a result of the product or service delivered.  Of course, in doing the arithmetic,  all of the costs of providing the good must be considered, and as a society becomes more sophisticated and prosperous, it has better tools to measure and more resources to address the costs which have traditionally been overlooked.  Professor Porter is correct that some profits are more noble than others.  Yet it is not the product or the customer that is the determining factor, it is the completeness of the costs being accounted in measuring the profit. For if all of the expenses have not been paid, then society has not been left better from the transaction.

I am with Professor Friedman on this one.  There is a place for philanthropy in our society, but it is separate from commerce.  Philanthropy is in the business of sharing the wealth in society.  Commerce is in the business of growing it.

Liquid Alternatives

Brandon Thomas,co-founder, managing director and chief investment officer of Envestnet PMC, wrote a column that recently appeared in Investment News.  He writes about investing in exchange traded securities representing alternative portfolio management strategies.  Without coming out and saying it, he is describing publicly traded hedge funds.

Liquid alternatives are not new.  Real Estate Investment Trusts have been traded since the 1960s.  Exchange Traded Funds investing in commodities have been around since the late 1990s.  Funds using some hedge fund strategies have had their units traded in other markets, particularly the UK. 

I presume that Mr. Thomas is referring to the growing list of ETFs that are designed to track an index intended to replicate a hedge fund strategy.  All of the strategies invest primarily in liquid instruments, so they should translate to exchange trading fairly well.

Three factors will have a negative influence on these funds' ability to provide the performance that investors expect.  First, providing liquidity to previously illiquid investments revealed that the low volatility and non-correlation of returns was actually just a function of relatively infrequent valuation.  For example, REITs have shown correlations of returns on the order of 60% to 80% of the stock market, despite studies suggesting that real estate has only 20% of the volatility.

On a largest note, the fee structures of hedge funds are very large compared with mutual funds.  This may end up being a vary large drag on the returns of even successful strategies.

The last factor is the hardest to analyze.  Hedge funds are particularly susceptible to "fat tail" risks, rare occurrences of performance events of a very large magnitude.  These events are what catch the headlines for a Paulson on the upside or Amarind or Long-Term Capital Management on the downside.  And while, these ETFs are based on an index of funds, providing some diversification, a large adverse event can have a significant effect on the return of the index.

In sum, the liquid alternatives are worth the interest being generated.  But like the hedge funds they are emulating, they deserve a careful understanding of the strategies, and close scrutiny on an ongoing basis.

Evergreen Solar R.I.P.

I saw this small column on the Op Ed page of The Wall Street Journal.  It is something of an obituary for Evergreen Solar.  As the name implies, the company was a manufacturer of solar panels.  As is the Journal's wont, it concentrates on the role of subsidies in driving the company's business plan.  So I checked Bloomberg and found this article about the bankruptcy filing.  This one has a little bit more of substance about the company's operations, but it still relies heavily on the role of subsidies, or their lack, in the demise of the company.  The money quote:

The company, based in Marlboro, Massachusetts, blamed the bankruptcy on increased competition from government-subsidized solar-panel makers in China and the failure of the U.S. to adopt clean-energy policies.

Prices for solar panels fell in 2010 and 2011 because of “massive overcapacity” in the industry at a time of lower subsidies, El-Hillow said in court papers.

 All of Evergreen's woes are related to the subsidies that other firms are receiving, how the subsidies encouraged the development of excess capacity, and how firms become unprofitable when those subsidies are removed.  Now the tax payers of Massachusetts are $58 million smarter.

This demonstrated once again ow fragile a business plan built on government benefits can be.  It is also another cautionary tale of how far the U.S. is from alternative energy sources that are economically viable.

Gold Topping Out?

Smart Money has an article about preciously skeptical investors capitulating and buying gold.  Apparently, the spike in gold prices last week has convinced reluctant investors to add the metal to their portfolios.

I wrote about gold as an inflation hedge back in April.  At the time, gold was trading for about $1400 an ounce. Today, it is trading around $1800.  There has been no significant inflation over the past four four months.  Indeed, gasoline prices are lower, and the second round of quantitative easing by the Fed (QE2 or monetizing the debt) was concluded over a month ago.  Granted, the Fed announced last week that it would keep interest rates at their current low levels for two more years, but it does not appear that any major market activities are taking place to implement that policy right now.

What is driving gold prices now is economic uncertainty and turmoil in the capital markets.  As a store of value against calamity, gold performs exceptionally well.  The relative scarcity and its general acceptance as valuable ensure its place as portfolio insurance.

In my view, it is time to cash in some of that insurance. Whether  purchased at $300, $800 or $1400, gold has paid off in providing a very nice return over the past three years of economic tumult,  Now it is reaching extreme levels.  Many institutions are taking some of their chips off the table.  I would recommend the same.

Fallout From the Downgrade

This is not the immediate result that I expected.  Standard & Poor's downgraded Treasury debt from AAA to AA+ on August 5.  Yields on Treasury bonds have since come down across the yield curve. For example, the ten year Treasury closed today at a yield of 2.22% (all quoted from Bloomberg) after touching 2.03% briefly last week.  Of course, the reasoning has more to do with the weak economic performance than the ratings, but it is still unexpected.


The municipal market continues to be relatively attractive.  The tax free yield curve is right on top of the Treasury curve, with a benchmark ten year AAA bond yielding 2.295%.  Same credit quality, same maturity, same yield, plus the interest is tax exempt.  Buying tax exempts is a taxable account is a no brainer.  It is even worth considering buying munis in a tax deferred or tax exempt account  Consider it another dimension of diversification.


With the downgrade, we must also consider the question of the risk free benchmark.  An argument could be made for the short Swiss sovereign or LIBOR.  Both represent stable high quality credits, are transparent, and are investable.  Each can also be be fairly easily and cheaply hedged to the dollar.  However, the market has indicated that Treasuries are still considered of the highest quality.  Therefore, I am inclined to continue to use T-bills as the risk-free proxy.


We live in interesting times, but that does not make decision making any easier.  At the moment, it appears that the markets are valuing Treasuries as if they are risk-free.  Municipals, on the other hand, are being priced with a yield premium of 28%.  Looks like an arbitrage opportunity to me.

One Economic Analysis Following the Downgrade

Stuart Thomson,chief economist at Ignis Asset Management, posted an analysis of the economic environment following S&P's downgrade.  The highlights:

1. "We do not expect any material selling of Treasuries as a result of this action. Indeed, the economic consequences of S&P’s puritanical austerity demands are likely to be bullish for Treasuries because the pressure for greater fiscal austerity is likely to be bearish for nominal growth" 
2. "This suggests that growth will be 1.75%-2.0% over the next few years. Failure to extend these temporary tax proposals could push growth towards 1%."
3. "The Federal Reserve and Ben Bernanke in particular have absorbed the lessons of the past and will pursue further quantitative easing to prevent recession and deflation."
4. "(T)he resulting growth will resemble Japan’s lost decade rather than the Great Depression."

I highly recommend reading the entire note.

Let QE3 Begin!

In April, I wrote about the pending close of Quantitative Easing 2, and a couple of announced transactions that indicated that the Fed may be starting the process of mopping up the liquidity.  In June, I followed up with comments from economists on the accomplishments of QE2 and the wisdom of initiating QE3.

Since then we have had an estimated 1.4% growth in the second quarter of 2011, and restated growth of 0.4% in the first quarter.  Greece restructured its debt, again, and the U.S. nearly maxed out its borrowing authority and ultimately had its credit rating cut.  Markets are fearing a double dip recession.  So now, the Fed has committed to maintaining low interest rates through the middle of 2013.  And the Fed Chairman is willing to pursue the policy despite dissension on the board of Governors.

This has all the earmarks of panic.  The articles I have seen all describe the two-year commitment as unique.  the level of disagreement over the policy is unusual.  And no mechanism for implementation has been announced. All of these suggest that the Fed desires to be seen as doing something as opposed to having a sharply defined strategy.

It is also an indication that the Fed's concern over deflation is much higher than for inflation.  Continued loose money will exert more inflationary pressure on markets.  The only question is whether or not that pressure will be overwhelmed by the disinflationary pressure of a weak economy.  So far, we have not seen the expected  inflation, because pricing weakness, especially in the housing and real estate markets, have offset increasing pricing in the food and energy sectors especially.

Be vigilant.  Inflation is always and everywhere a monetary phenomenon.  Central banks have a horrible track record in managing the excessive liquidity created in these easing periods.  There has been a lot of currency pumped into the economy.  Inflation could arrive and wreak havoc on portfolios in the blink of an eye.

The Enemy of Prudent

Tom Kostigen at Financial Advisor magazine is at it again.  His premise: clients want to invest in "private equity investments in the emerging markets that have potential to do good and provide good returns."  The problem is, "advisors don’t know how to sell these investments."  The author claims that the problem is that advisors don't know how to get paid.  I beg to differ.  Fee only and fee and commission advisors can easily get paid under a fee structure based on hourly or AUM structures.  The overwhelming majority of advisors to clients with an interest in this arena operate under one of these compensation structures.

No, the biggest obstacle to overcome is the risk and due diligence necessary to vet this (or any) investment.  The regulatory environment is such that disappointing performance is grounds for seeking legal recourse.  Recommending an investment with an objective expressed in terms other than risk and return is exposing one's self to unnecessary risk of litigation. And the illiquidity and lack of transparency that are characteristics of private equity and their funds exacerbates that risk.

Now the industry is moving toward a fiduciary standard for all advisors, raising the expectations of clients, and the risks to advisors.  How can an investment objective of "doing good" be measured, in the face of requiring that all actions be taken in the best interest of the client?  Isn't forgoing some portion of a market return in order to achieve some societal goal, a failure against such a fiduciary standard?

By and large, the impact investments I have reviewed do not qualify as prudent investments.  Either they rely on subsidized operations, or require a reduced cost of capital.  Usually, they are inefficient solutions to problems that are being resolved on a more rational basis, but at a slower pace that desired.  That is a recipe for disappointed capital.

Advisors' Favorite Bond Funds

Mark Hulbert reports on a survey that he conducted among 200 advisors of the funds they recommend to clients.  The five most popular funds are bond funds, which, on its face, is surprising, given that most advisors expect interest rates to increase.  However, looking over the lost, it makes sense, especially since bonds are an essential portfolio allocation.  The funds, in order of their popularity:

1. Vanguard GNMA (VFIIX)
2. Fidelity Floating Rate High Income (FFRHX)
3. Vanguard Inflation Protected (VIPSX)
4. Vanguard Short Term Investment Grade (VFSTX)
5. Vanguard High Yield Corporate (VWEHX).

That Vanguard dominates the list is no surprise, since portfolio costs are the most important factor in determining the difference in returns between similar funds.  he Inflation Protected, Short Term Investment Grade and the Fidelity Floating Rate funds all have very low price sensitivity to changes in interest rates.  Finally, the GNMA and High Yield funds will tend to have high coupons for the average maturity of their portfolios.

Of the five, the Short Term Investment Grade is the most straightforward; I have known institutions that use the fund as an alternative to money markets once a prudent reserve is established.  The other four have some hidden weaknesses that an advisor must recognize to use the funds effectively.  The GNMA fund is invested in mortgages, subjecting the fund to the risk of maturity extension.  The Fidelity fund invests in floating rate bank loans, which have a higher credit risk than might be immediately apparent. The Inflation Protected fund is invested primarily in TIPs which currently have extremely low current yields, which could lead to increased volatility.  And the high yield Corporate is a junk bonk fund.

Nothing particularly wrong with any of these funds, but it is important to understand the nature of each to accurately anticipate the performance when risks are realized.