Cole Entering the Daily NAV REIT Business

Financial Advisor magazine has an article about Cole Capital's announcement of a no-load, daily liquidity REIT.  The Cole Real Estate Income Strategy is intended for fee-based advisors.  "Cole will be able to redeem shares daily because 10 percent to 15 percent of the fund will be in liquid, fixed-income assets managed by BlackRock,"says the article.

I wrote about this new product class in August.  The same applies to the Cole product, but Cole is doubling down.  By targeting the REIT to fee-based advisors, and offering it "no-load," Cole is almost guaranteeing tension between a true daily NAV (which would require appraising each property daily) and cost-based par value.  The only advantage of this structure from and investor's standpoint is the possibility of arbitraging and old appraisal.

Allegheny Natural Resources Disappoints

Recently, I was asked to look into Allegheny Natural Resources.  Allegheny had a program open last year and raised a bit less than $1 million.  Allegheny told investors that they would be drilling between 4 and 6 natural gas wells in the Appalachian Basin, specifically in Pennsylvania.  Apparently, that was the last communication with investors, thus the call to me.

Allegheny has pulled only one permit in 2011 in Pennsylvania.  The company has not applied for a permit in West Virginia and is not listed as a licensed operator in New York or Ohio.  The company is also the target of an involuntary Chapter 7 filing by three entities.  The syndicator has made claims that the state of Pennsylvania has recently issued regulation restricting disposal of well cuttings (Which I have not been able to corroborate) and that his well permits won't show because they are such shallow wells (unlikely).  The program looks to be in serious trouble.

Is there anything that indicated that the syndicator would disappoint?  I read some of the materials related to the due diligence of the offering and asked a few questions of some people that would have some knowledge.  The one red flag that showed up was that financial statements had been requested and promised, but that several deadlines passed without the financials being produced.  There may have been other issues, but I heard this from enough people to know that something was going on last fall.

I haven't yet put together my Ten Commandments of Due Diligence, but this is certain to be on the list:  Thou Shalt Receive All Information Promised.  And that goes double for financial statements.  Client funds are too important to trust to a firm that does not keep orderly financial records...or its promises.

A New Product Has Been Discovered

Investment News has an article about the factoring of annuities purchased in settlement of civil disputes.  It goes something like this: Plaintiff sues for compensation for an injury, defendant settles by agreeing to pay a stream of payments, an annuity is purchased to provide those payments, plaintiff decides he wants cash now, and so decides to sell the annuity.  There have long been a couple of companies that have purchased these contracts in a word-of-mouth market.  Apparently, now the business is ready to "mainstream."

If the structured settlements business follows the same arc as the life settlements business, this is what we will see:

1. Local agents providing a service in their community looking for investors to share in the great yields afforded.
2. Financial advisors solicited for client introductions, under the assurance that "this isn't a security."
3. States bust promoters for selling unregistered securities.
4. Syndicator creates a pool and sells securities through broker dealers to capitalize the fund.
5. Annuities will be written for the express purpose of selling them to structured settlement factors.

All along the way, there will be debates over the ethics of the transactions, and the appropriate regulatory response.

The product development will take several years; the life settlements business started as viaticals in the late 1980s.  The players involved will improve in station and reputation as the investment becomes more mainstream.  The ultimate validation is a mutual; fund and/or ETF dedicated to the trade.  Look for it sometime after 2020.

Hazardous To Your Wealth

That would be Smart Money.  Today's column is a staple of the mass media investing magazine: "10 Money Moves To Make Now."  After a nod to the unknown of the future, ten transactions are recommended as if there could be no uncertainty.  Sell TIPS, T-bonds, and small cap stocks and buy blue chips and gold?  Sounds like a speculative trade to me.  Fund your 402(k) and 529 plan and refinance at lower rates? Boilerplate. Secure credit and cut costs? Always sound advice.

Now is the time to review return objectives and risk tolerances, and verify that the portfolio is within tolerances.  Times of uncertainty are not times to be making speculative bets on commodities and under weighting what markets still consider a safe haven.  Clients deserve better: clear-eyed confidence and courageous discipline.

Stop Me of You've Heard This One Before

Condos selling in record numbers and at record prices.  Teaser rates on mortgages of 1%.  Resale home prices up 66% over the most recent four year period. Sixteen percent of housing units are being purchased by absentee owners.  Developments with funny names: "The Foresta@Mount Faber" anyone?

This is not Las Vegas 2007.  This is Singapore 2011, according to The Economist.  In 2010, 17,645 housing units were sold, besting the records set in 1997 and 2007.  One building was selling units for $4,717 per square foot.  Speculators from around the Pacific Rim, especially mainland China, are heading to Singapore where property availability is greater, and, according to the article, pricing "is closer to fair value."

Singapore is taking steps to try to cool the market.  Deposits on second homes are now 40% of the purchase price, and the costs of completing a sale within a year of purchase have increased.  The government also has 25,000 units under construction.  The strong Singaporean dollar is also a brake on prices.  The result is housing price gains of only 1.9% for the second Quarter of 2011.

It's nice to see someone learning from the mistakes of the recent real estate bubble.  Let's hope for their sake that it's not too little, too late.

The Future Of Natural Gas

  

A recent edition of The Economist ran a fantastic article on natural gas and its emergence as a global commodity.  Three factors are coming together to achieve this convergence: Demand is exploding as a response to environmental concerns; Supply is expanding due to technologies being applied to improve recovery rates; and Capital is going into projects to provide inter-regional transportation.

Increasing demand is being driven by a switch from dirtier fuels, especially coal.  (See the companion piece.)  Natural gas produces less carbon dioxide, sulfur dioxide, nitrous oxides, and particulates per megawatt hour of electricity produced than coal.  The technology to convert a coal fired plant to natural gas is decades old and proven in terms of efficiency and effectiveness.  And supplies have been plentiful, for the most part.

The supply side of the natural gas revolution is being driven by two technologies: horizontal drilling and hydraulic fracturing.  These two technologies are allowing  energy exploration and development companies to drill wells that will produce five to ten time the hydrocarbons that a conventional well in the same basin would produce.

Finally, transportation methods are being developed that will encourage gas trading across regional borders.  The increased supply and demand justifies the capital expenditures for liquid natural gas facilities in shipping ports and the production of LNG tankers. Increasing transportation capacity will drive pricing convergence, and will erode the market dominance of any particular producer or pipeline in a region.

These development are going to support the stabilization of gas prices.  Multiple producers serving multiple markets, all with growing quantities are indications of a strong, healthy industry.

The Perfect As The Enemy Of The Good

Haresh Sapra is a professor of Accounting at the University of Chicago Booth School of Business.  He has written an column for Bloomberg, in which he argues that more transparent financial statements would lead to adverse market effects.  He points to two "insights" that he suggests support his thesis: 1) removing one imperfection from a financial system may make the system worse, and 2) company managers are influenced by the information that is disseminated as a result of the more transparent statements.

The argument that fixing only one flaw in the reporting system would harm the system is intellectually lazy at best, a red herring at worst.  What impact fair value accounting had in 2008 - 2009 is irrelevant.  To claim that fixing a flaw should not be undertaken because other flaws remain is ludicrous.  All market participants should be pushing for all weaknesses to be repaired in the most timely fashion.  That all of the issues can not be resolved at once is no excuse to allow others to continue to linger.

Professor Sapra states that "Companies aren’t passive technologies, but are managed by insiders who respond to changes in the disclosure environment."  Well of course, and we would not be concerned about accounting standards if management is not influenced by the standards.  In fact, the standard setters are counting the reactions of management in response to any new standards.  What can not know for sure is the precise nature of these reactions, or the reactions of any specific market participants.

What both of these "insights" fail to acknowledge is that the purpose of financial statements is not to produce any particular characteristics in the securities markets, not is to influence the behavior of management.  Financial statement are intended to reflect the economic reality of the entity issuing them, the activities and position as of specific dates.  Markets will set prices to discount expected cash flows, and market participants will estimate the cash flows and set discounts rates based partly, and only partly, based on the statements.  More transparent financial statements will engender confidence on the part of the participants, more participants entering the market, and a likely decline in the cost of capital.  And if that is not a perfect outcome, it is certainly a good one worth pursuing.