Wednesday, December 24, 2008


Hey...Merry Christmas!!!

The market is always boring on Christmas Eve. You can tell if someone may be a trading junkie if they sat through today's entire 9:30AM-1:00PM session, despite me telling them to occupy their time with important life stuff, such as bartering with desperate retailers. Sometimes, alleged junkies will get hostile towards you if you ever try to stop them in their quest to make a few bucks on one of the lowest volume days of the entire year. I did say 'go shopping', didn't I?

The market struggled as we traded in an upward channel today. It's nothing special since we're still in the neutral range that's bound by 855-880 on the SPX. The wedge is clearly broken, but that doesn't mean the market cannot trade sideways for some time. We have to wait for confirmation. What's interesting is that the VIX is forming a flag (so far). This too needs some type of directional confirmation before I get serious.

I think it's official: retailers are screwed. They usually get 15% of their sales in the 2 weeks after Christmas, with December (plus Black Friday week) usually making up 40% of annual sales for many retailers. I don't think they're going to see that 15% and they're definitely not going to see 40% for December. They'll be lucky to have 40% sales for the entire calendar year.

Of course, retailers are giving stuff away at huge discounts, but they're not getting as much traffic as they should be getting. People are actually negotiating at the stores and I hear that deals are being made regardless of stick prices. The worst environment for retail, perhaps since the Great Depression, will mean only one thing: massive closures, liquidations, chapter 11's, and whatever else you want to call it.

This will weight heavily on commercial real estate. I've been a commercial real estate investor for 4 years, so I've never actually experienced a downturn, but I can tell you what will happen. Here's a short lesson on what will happen shortly:

Cap rates and cash-on-cash returns will be horrendous. I think that cap rates will be sub 4-5% for Class A's, 6-7% for B's, 8-9% for C's, and 10% for the crappiest properties on Earth (D's). Property sub-classes are determined primarily by cap rate, net income, age of the property and location, among other factors.

There are 4 cycles in the real estate market. We are in the Buyer's Market Stage I, going onto Stage II. If you're buying stuff, I hope you're buying for cash flow, and not for capital appreciation. What's going to happen is that there will be a massive oversupply in commercial real estate fueled by a large % of vacancies. Many investors have millions of dollars in upcoming debt service obligations, but with the lack of available credit and cash flow (or just regular cold, hard cash), they will be forced to surrender their properties.

The value of commercial properties are determined in three different ways: 1) sales comparison approach, income approach, and replacement costs approach. Unfortunately, 2 out of 3 (sales & income) will work against investors. By the way, the cap rate is determined by dividing the net operating income (NOI) by the value (selling price). The cash-on-cash return (CCR) is the cash flow (NOI - debt service) divided by the acquisition costs (down payment + all cash needed for the deal).

The CCR basically tells you that for every $1 you spent, how much of that $1 you'll get back after the first year. Unfortunately, for those investors that bought all sorts of office space, strip malls, public storage, and other stuff in 2006, 2007, and 2008, their CCR will be terrible because the lack of cash flow will cut the CCR down to the single digits (I look for 15-20% in this stage of the market). After the first year, the return-on-investment (ROI) can be calculated. That is, the NOI - debt service + principal reduction divided by acquisition costs. Unfortunately, this number will be horrible as well because it's based on the NOI.

This process takes many, many, many months because the commercial real estate market is much slower than it's residential counterpart. Closed residential sales usually take 30-45 days (if you're lucky). From due diligence, site investigations, surveys, and everything else until actual closing, a single commercial deal takes between 2-5 months. You can be assured that this shoe will drop well into 2010 and the secondary effects will still be felt in 2011.

And you thought I was just some kinda chart junkie...

Anyway, I hope people didn't get too depressed by that. Indeed, that was the short version.

I wish everyone here a wonderful, safe, and fun-filled Merry Christmas! See you Friday!

SPX 1-day

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8 comments: said...

Hi John!!! Merry Xmas and happy holidays!!!
I finally have your link posted at my membership site, so all My members can come over here and see what you are looking at for the day.
I need to get 100 more sign-ups. I wish I had a good idea. I posted 182 - 10 winning trades since Sept, but that doesn't seem to matter to anybody.
Oh well C'est la Vie.

John C. Lee said...

serious? Thanks Z. You're already linked in my blog roll. Why don't you shoot me an email, maybe I can help.

Matt SF said...

You're spot on about the capital appreciation issues... I sold my investment properties in 06 b/c they were up 50% in value in 5 years -- ridiculous!

In terms of optimizing cash flow, got any tips on the types of properties (condos, single family, etc) that you're looking at? I'm thinking of jumping back in next year. Perhaps in college towns with exceptional graduate schools.

And yes -- I did think you were nothing but a charts guy!!!

Anonymous said...

Happy Xmas! I read your candlestick article (really good). I know you have said TA works best in a short time horizon so then I started to wonder about time applied to candlestick patterns. For instance, I notice the shooting star can signal a long pattern change sometimes. Do you know where I might find some good info on this or if you have time maybe you could write abeout it from your experience.

tmi said...

Sooner or later John will have a real estate blog LOL. Did you memorize those formulas? Anyways another great articles always enjoy reading your blog! Thanks John!


VKC said...

Merry Christmas.
Just out of curiosity, what were cap rates 3 to 5 years ago under more normal circumstances for Class A, B, C, & D properties?

John C. Lee said...

Matt - I focus on multi-family properties with 50+ units in only Texas. There are many emerging markets in that state. I will then seek out B & C class properties with a 9%+ cap and 15%+ cash-on-cash return. They're out there.

Anon - sometimes candles do work for longer time frames, but we only know that in hindsight. All long-term signals start out as short-term ones. You just have to go with it.

TMI - I use those formulas all the time when I evaluate potential deals.

VKC - typically:
Class A: 6-7%
Class B: 8-9%
Class C: 10-11%
Class D: 12%+

You want your cash-on-cash to be 10-20%, depending on which market cycle you're in. I look for a minimum of 15%.

Anonymous said...

Hi john first time here, terrific site ! During january with obama coronation about to happen, FSLR (alternative energy) there has to be a trade here to make dinero. problem is make sure buying it at uptrend not down,,big mover either way. your thoughts ? happy holidays to you and all you care for