All good things must come to an end.  In the case of my ownership of General Growth Properties stock (GGP was its ticker before bankruptcy filing), the end is near.  Why? Anyone following GGP will already know this, but just in case you don’t, the price per share moved from $4 to $7 in a matter of a couple weeks.  This move, and the reasons for it, mean it is now time to part ways with a very good stock pick (originally bought in April at $0.63 / share).

Three good things happened for GGP the past two weeks:

1. GGP released its 3rd Quarter financials on Monday, November 9.  They were better than expected.  Year over Year (YOY) results were down, naturally, given the near depression we have experienced since Q3 2008.  But they were down much less than had been expected by analysts still following the company.  Cash Flow (FFO) was actually positive by $671M ($2/share) when $700M of one-time, non-cash expeneses are added back while revenue and operating earnings were down only marginally (less than 5%).  The ”comprehensive” earnings were down substantially because of the large non-cash impairment charge to reserve for future unknown expenses attributable to the very weak economy.  But all in all, the Q3 report was very encouraging.

2. The second big news event happened early last week (November 17) when  Simon Properties (SPG), the other really big mall REIT other than GGP, did a SEC filing that it had retained a law firm (Wachtel, et al) and investment firm Lazard to explore acquiring some or all of GGP’s assets.  This creates a market for the malls owned by GGP, which will definitely help its valuation.  Part of the problem for GGP and other CRE companies the past 18 months has been an increasingly dreary commercial real esatate market as financing disappeared.  Just as with the derivatives market, when buyers disappear, the market value of the assets get marked down dramatically.   Now that there is a buyer on the horizon, I expect the GGP Board of Directors to work towards a sale of the properties at a price near the current market value.  Bill Ackman and Pershing Square Capital have a large equity stake in GGP and sit on the board.  It is Ackman’s job to realize value for his fund investors and will therefore likely work towards an exit strategy.   He needs a large buyer to absorb his 23% share and SPG looks like just that buyer.

3. And third, on Thursday this past week, mortgage holders / lenders on (170) of the mall properties that were in bankruptcy, agreed “in principle” to refinance $8.9B of the mortgages for GGP properties by extending maturities.  This agreement eliminates the pressure to liquidate those properties which were in technical default when many mortgages came due at a time late last year and earlier this year 2009) when there was no ability to refinance in a frozen credit market. 

All these are very positive situations and increased the value of GGP in some ways that are admittedly hard to measure at this point in time.  How much are GGP’s assets worth to Simon Properties?  Are they willing to pay a fair price based on cash flow (FFO) or do they think they can get a steal based on the depressed CRE market?  And how fast does the economy recover? 

For the reasons that the stock now seems fully valued with the balance sheet owners equity at $5 per share and a small premium now available due to the brighter  future prospects, I have liquidated all my position in GGP as of Monday, November 23.  Sure, the stock could even go higher.  It was near $60 in early 2007 and could be worth north of $20 if everything goes perfectly from here.  But best not to get greedy.  It was a very good ride while it lasted.

A real estate investment trust (REIT) is a company that owns and manages income-producing real estate. REITs were created by an act of Congress in 1960 to enable large and small investors alike to enjoy the rental income from commercial property. REITs are governed by many regulations, the most important being that they must distribute at least 90% of their taxable income to shareholders each year as dividends; the REIT is permitted to deduct dividends paid to shareholders from its taxable income. Other important regulations include:

• Asset requirements: at least 75% of assets must be real estate, cash, and government securities.
• Income requirements: at least 75% of gross income must come from rents, interest from mortgages, or other real estate investments.
• Stock ownership requirements: shares in the REIT must be held by a minimum of 100 shareholders.

REITs specialize by property type. They invest in most major property types with nearly two thirds of investment being in offices, apartments, shopping centers, regional malls, and industrial facilities. The rest is divided among hotels, self-storage facilities, health-care properties, and some specialty REITs that own anything from prisons, theatres, and golf courses to timberlands.

Some benefits of REITs include:

High Yields. For many investors, the main attraction of REITs is their dividend yield. The average long-term (15-year) dividend yield for REITs is about 8%, well more than the yield of the S&P 500 Index. Also, REIT dividends are secured by stable rents from long-term leases, and many REIT managers employ conservative leverage on the balance sheet. 

Simple Tax Treatment. Unlike most partnerships, tax issues for REIT investors are fairly straightforward. Each year, REITs send Form 1099-DIV to their shareholders, containing a breakdown of the dividend distributions. For tax purposes, dividends are allocated to ordinary income, capital gains, and return of capital. As REITs do not pay taxes at the corporate level, investors are taxed at their individual tax rate for the ordinary income portion of the dividend. The portion of the dividend taxed as capital gains arises if the REIT sells assets. Return of capital, or net distributions in excess of the REIT’s earnings and profits, are not taxed as ordinary income, but instead applied to reduce the shareholder’s cost basis in the stock. When the shares are eventually sold, the difference between the share price and reduced tax basis is taxed as a capital gain.    

Liquidity of REIT Shares. REIT shares are bought and sold on a stock exchange. By contrast, buying and selling property directly involves higher expenses and requires a great deal of effort.

Diversification. Studies have shown that adding REITs to a diversified investment portfolio increases returns and reduces risk since REITs have little correlation with the S&P 500. 

Drawbacks of REITs

 REITs also have some drawbacks, including:

Sensitive to Demand for Other High-Yield Assets. Generally, rising interest rates could make Treasury securities more attractive, drawing funds away from REITs and lowering their share prices.

Property Taxes. REITs must pay property taxes, which can make up as much as 25% of total operating expenses. State and municipal authorities could increase property taxes to make up for budget shortfalls, reducing cash flows to shareholders.

Tax Rates. One of the downsides to the high yield of REITs is that the taxes due on distributions are typically higher than the 15% most dividends are currently taxed at. This is because a large chunk of a REIT’s distributions (typically about three quarters, though it varies widely by REIT) is considered ordinary income, which is usually taxed at a higher rate, up to 33% currently.

REITs were quite cheap until recently. They suffered greatly during the financial crisis as a proxy for the financial business. REITs as a class hit their lows in early March 2009. Since that time, the average REIT is up 50%, so much of the opportunity for REITs has passed. Still, the average REIT is offering a 6% distribution, which compared with short term interest rates around Zero, is very attractive.

There may be more shoes to drop as commercial RE looks challenged for the next two years. Commercial RE lags the general economy because of the longer term nature of their revenue structure in the form of leases. As leases expire, they will be renegotiated at lower levels than previously. In the area of retail RE, there may be too much space after the economic contraction led by a reduction in consumer spending. This will result in a contraction of lease revenue which will affect RE profits.

AN ALTERNATIVE : RESIDENTIAL HOUSING ETF

An alternative to the REIT is the new Residential ETFs “UMM” and “DMM”. This ETF is a zero-sum wager on both sides of the housing market index sponsored and managed by Case-Shiller.  It makes possible a positive or negative wager on the performance of the private  residential real estate market and sidesteps the problems of commercial RE.

The Case-Shiller product is described as follows:  The investment seeks to replicate, net of expenses of the return of the Composite-10 Home Price Index. The index is a value-weighted average and tracks the price path of typical single-family homes located in each metropolitan area: New York City, Los Angeles, San Francisco, Chicago, Washington D.c., Boston, San Diego, Miami, Denver and Las Vegas.

A good strategic use of the housing ETFs: to replace the asset value of a home in an investor’s portfolio once sold. It might make sense for a person in transition and not in need of a permanent home, to use the housing ETF to replace that asset class in a diversified portfolio. This is especially true with residential RE near a long-term bottom and with much appreciation potential over the next 15-20 years.

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It is time for another update on General Growth.  What a great day / week GGP has had in the stock market.  Today, GGP (GGWPQ.PK on OTC) was as high as $3.35 and closed at $3.12.  The reason for the run is the accumulating market knowledge that:

(A) the bankruptcy court (Gropper) is going to allow time and market forces to work out the debt refinancing issues of GGP;

(B) the marketplace for Commercial Real Estate (CRE) continues to improve as does the lending industry to the CRE .  Further, it appears TALF funds will be available to resolve troublesome CMBS securitized loans in particular, if needed;

(c) the financial performance of GGP as reported to the SEC on August 4, was very positive for the current market, which many in the press and blogosphere continue to (incorrectly) say is experiencing a consumer boycott.  Not according to the financials of GGP;

I will take each subject in order with supporting data and reports.  From the Chicago Tribune, today, Wednesday, August 12:

CHICAGO (AP) — Shopping mall operator General Growth Properties Inc. said Tuesday night that a bankruptcy judge has denied a motion by a group of lenders to keep a handful of its subsidiaries out of bankruptcy.

The lenders, led by ING Clarion Capital Loan Services, had argued that some of the company’s shopping centers, including the Tucson Mall in Arizona and the Stonestown Mall in San Francisco, were financially stable and did not need to seek Chapter 11 protection.

The creditors claimed General Growth had “swept” the properties into bankruptcy to benefit from their slightly better financial condition.

“We are pleased with the court’s decision and we look forward to moving ahead with the restructuring of the company,” said Adam Metz, CEO of General Growth Properties, in a statement….

…General Growth owns and manages more than 200 U.S. malls, including Glendale Galleria in Southern California and the South Street Seaport in Manhattan. The company included about 166 properties in the bankruptcy filing.

Another ruling by Judge Gropper in July was even more persuasive in that he declared he postponed any rulings until at least April 2010, to buy time and force the lenders to negotiate.  It worked.  A few days later, GGP was able to renegotiate its leases on excellent terms.

NEW YORK, Aug 3 (Reuters) – General Growth Properties last week, possibly in a shrewd negotiating tactic, said it may yet pursue a controversial strategy in its bankruptcy that could upset the legal basis for thousands of asset securitizations.

The second-largest U.S. shopping mall owner at a hearing said it was considering ways to treat some of its subsidiaries as a single debtor and override their status as separate companies, according to a transcript of the hearing.

Potential for such a move is raising concern among investors because borrowing against commercial real estate and other assets is tied to the notion that borrowers are isolated from external events at a parent or other units. It is enough to sound alarms over the credibility of billions of dollars in bond agreements, even though a “substantive consolidation” is tough to achieve, analysts said.

“This was a surprising development that was probably saber-rattling on General Growth’s part,” said Daniel Rubock, a senior vice president at Moody’s, who attended the hearing……

…Consolidating the special-purpose entities (SPEs) would hit at the heart of asset securitizations, which helped fund more than $600 billion for office buildings, apartments and shopping malls in 2005 and 2006. The threat comes as Federal Reserve and Treasury officials have focused on restarting lending to commercial properties in a bid to reduce the sector’s drag on the U.S. economy.

Addressing concerns at a hearing last week, General Growth attorney Marcia Goldstein affirmed the judge’s understanding that consolidation was not in court papers but noted the company needs to assess “inter-relationships” of the debtors.

“And one of the things we’re looking at is whether there are some subgroups that should be appropriately substantively consolidated,” Goldstein said at the hearing, and confirmed to Reuters on Monday. “We have not reached any conclusions on that at this point.”

General Growth may be looking to negotiate a “global settlement” that rewrites all loans to easier terms with its creditors, said Richard Jones, co-chair of Dechert LLP’s finance and real estate group.

More good news:  In late July, Prudential Insurance filed with the court indicating it will agree to extend financing to GGP on the properties it has liened.  This should be the first of many agreements due to the court’s obvious direction to encourage the parties to work out their differences:

“Prudential reaffirms that it is ready and willing to take concrete steps to reach understandings with Harbor Place, 1160/1180, and Rivertown Crossing with respect to plan treatment and reiterates that the primary issues to be resolved – extension of maturities and establishment of new market interest rates”

http://www.scribd.com/doc/17596889/Prudential-GGP

Karl Denninger, another regular contributor on SeekingAlpha.com, also made a post today regarding how the concept of SPE (Special Purpose Entities) which the lenders are trying to use against GGP to break it into pieces by mortgage package, is also being challenged by Judge Gropper through his rulings in the GGP case:

The judge in General Growth Properties Inc.’s bankruptcy case rejected creditors’ motions to dismiss several properties from the case, clearing the way for the mall owner to begin talks with its lenders about long-term debt extensions that would eventually allow it to exit bankruptcy court.

In a decision Tuesday, Judge Allan Gropper of the U.S. Bankruptcy Court in Manhattan ruled against the arguments of loan servicers ING Capital Loan Services LLC and Helios AMC LLC and lender Metropolitan Life Insurance Co. The three had separately argued that the General Growth malls they financed with mortgages are structured as individual “special purpose entities” that shouldn’t be included in a broad corporate bankruptcy filing.

Although General Growth reported last week that its revenue and profits were down, still very notably, there were profits.  Not many bankrupt companies are profitable three months into their bankruptcy.   Given the very tough consumer retail climate, this news is very encouraging.   To provide the highlights:

NEW YORK (Reuters) – General Growth Properties Inc (Other OTC:GGWPQ.PK – News), the large U.S. mall operator that filed for bankruptcy in April, on Tuesday (August 4)  reported a 2.1 percent decline in quarterly net operating income from its retail properties, citing weakness in the economy and falling occupancy rates.

Second-quarter net operating income in the “retail and other” segment, measuring cash flow that properties generate, declined to $615.8 million from $629.1 million a year earlier. (but note: still quite positive)  The Chicago-based real estate investment trust said a sale of three office buildings in 2008 contributed to the decline.

Overall, quarterly funds from operations (FFO) fell 74 percent from a year earlier to $58.2 million, or 18 cents per share. Core FFO, excluding net operating income from the master planned communities segment and a provision for income taxes, fell 44 percent to $124.6 million, or 39 cents per share.

And finally, to culminate our update, here is the most recent 10Q filing from GGP to the SEC on Monday,  August 10:

http://biz.yahoo.com/e/090810/ggwpq.pk10-q.html

A Mid-Year Checkup on some of Doug Kass’ 2009 Predictions (made on December 31, 2008).  If he would review his own work from 8 months ago, he would not be so negative today:

2.  Housing stabilizes sooner than expected. President Obama, under the aegis of Larry Summers, initiates a massive and unprecedented Marshall Plan to turn the housing market around. His plan includes several unconventional measures: Among other items is a $25,000 tax credit on all home purchases as well as a large tax credit and other subsidies to the financial intermediaries that provide the mortgage loans and commitments. This, combined with a lowering in mortgage rates (and a boom in refinancing), the bankruptcy/financial restructuring of three public homebuilders (which serves to lessen new home supply) and a flip-flop in the benefits of ownership vs. the merits of renting trigger a second-quarter 2009 improvement in national housing activity, but the rebound is uneven. While the middle market rebounds, the high-end coastal housing markets remain moribund, impacted adversely by the Wall Street layoffs and the carnage in the hedge fund industry.

Comment:  This would have been a great idea to turn around housing; but it looks like housing prices are bottoming anyway, without much help from the Feds (I don’t count the $8000 First Time Buyers program; way to narrow to have much effect);

3. The nation’s commercial real estate markets experience only a shallow pricing downturn in the first half of 2009. President Obama’s broad-ranging housing legislation incorporates tax credits and other unconventional remedies directed toward nonresidential lending and borrowing. Banks become more active in office lending (as they do in residential real estate lending), and the commercial mortgage-backed securities market never experiences anything like the weakness exhibited in the 2007 to 2008 market. Office REIT shares, similar to housing-related equities, rebound dramatically, with several doubling in the new year’s first six months.

Comment:  Check out the REIT index and GGP; the Commercial RE market is recovering as Kass predicted with good benefits to banking and the economy;

4. The U.S. economy stabilizes sooner than expected. After a decidedly weak January-to-February period (and a negative first-quarter 2009 GDP reading, which is similar to fourth-quarter 2008’s black hole), the massive and creative stimulus instituted by the newly elected President begins to work. Banks begin to lend more aggressively, and lower interest rates coupled with aggressive policy serve to contribute to an unexpected refinancing boom. By March, personal consumption expenditures begin to rebound slowly from an abysmal holiday and post-holiday season as energy prices remain subdued, and a shallow recovery occurs far sooner than many expect. Second-quarter corporate profits growth comfortably beats the downbeat and consensus forecasts as inflation remains tame, commodity prices are subdued, productivity rebounds and labor costs are well under control.

Comment:  Kass needs to drink his own Koolaid (nutritious), not that of the Ultra Bear crowd (poison)

5. The U.S. stock market rises by close to 20% in the year’s first half. Housing-related stocks (title insurance, home remodeling, mortgage servicers and REITs) exhibit outsized and market-leading gains during the January-to-June interval. Heavily shorted retail and financial stocks also advance smartly. The year’s first-half market rise of about 20% is surprisingly orderly throughout the six-month period, as volatility moves back down to pre-2008 levels, but rising domestic interest rates, still weak European economies and a halt to China’s economic growth limit the stock market’s progress in the back half of the year.

Comment:  Not optimistic ENOUGH; First half was right on, but 2nd half looks to be better than Kass’ “surprise”

6. A second quarter “growth scare” bursts the bubble in the government bond market. The yield on the 10-year U.S. Treasury note moves steadily higher from 2.10% at year-end to over 3.50% by early fall, putting a ceiling on the first-half recovery in the U.S. stock market, which is range-bound for the remainder of the year, settling up by approximately 20% for the 12-month period ending Dec. 31, 2009. Foreign central banks, faced with worsening domestic economies, begin to shy away from U.S. Treasury auctions and continue to diversify their reserve assets. By year-end, the U.S. dollar represents less than 60% of worldwide reserve assets, down from 2008’s year-end at 62% and down from 70% only five years ago. China’s 2008 economic growth proves to be greatly exaggerated as unemployment surprisingly rises in early 2009 and the rate of growth in China’s real GDP moves towards zero by the second quarter. Unlike more developed countries, the absence of a social safety net turns China’s fiscal economic policy inward and aggressively so. Importantly, China not only is no longer a natural buyer of U.S. Treasuries but it is forced to dip into it’s piggy bank of foreign reserves, adding significant upside pressure to U.S. note and bond yields.

Comment:  Right on with 10 year Treasury

7. Commodities markets remain subdued. Despite an improving domestic economy, a further erosion in the Western European and Chinese economies weighs on the world’s commodities markets. Gold never reaches $1,000 an ounce and trades at $500 an ounce at some point during the year. (Gold-related shares are among 2009’s worst stock market performers.) The price of crude oil briefly rallies early in the year after a step up in the violence in the Middle East but trades in a broad $25 to $65 range for all of 2009 as President Obama successfully introduces aggressive and meaningful legislation aimed at reducing our reliance on imported oil. The price of gasoline briefly breaches $1.00 a gallon sometime in the year. The U.S. dollar outperforms most of the world’s currencies as the U.S. regains its place as an economic and political powerhouse.

Comment:  Wrong; stronger oil pricing than expected; no violence required;

11. State and municipal imbalances and deficits mushroom. The municipal bond market seizes up in the face of poor fiscal management, revenue shortfalls and rising budgets at state and local levels. Municipal bond yields spike higher. A new Municipal TARP totaling $2 trillion is introduced in the year’s second half.

Comment:  Wrong; stronger economy than anticipated; (he cheats a little here with surprises in both directions, so that at least some of them will be right!)

12. The automakers and the UAW come to an agreement over wages. Under the pressure of late first-quarter bankruptcies, the UAW agrees to bring compensation in line with non-U.S. competitors and exchanges a reduction in retiree health care benefits for equity in the major automobile manufacturers.

Comment:  Right on

15. Focus shifts for several media darlings. Though continuing on CNBC, Jim “El Capitan” Cramer announces his own reality show that will air on NBC in the fall. At the time his reality show premieres, he also writes a new book, Stay Mad for Life: How to Prosper from a Buy/Hold Investment Strategy. Dr. Nouriel Roubini continues to talk depression, but the price of his speaking engagements are cut in half. He writes a new book, The New Depression: How Leverage’s Long Tail Will Result In Bread Lines. “Kudlow & Company’s” Larry Kudlow proclaims that it’s time to harvest the “mustard seeds” of growth and, in an admission of the Democrat’s growing economic successes, officially leaves the ranks of the Republican party and returns to his Democratic roots. Yale’s Dr. Robert Shiller adopts a variant and positive view on housing and the economy, joining the bullish ranks and writes a new book, The New Financial Order: Economic Opportunity in the 21st Century.

Comment:  Funny comments on Nouriel Roubini; I bet he isn’t even getting 1/4 of his price late last year

20. The Middle East’s infrastructure build-out is abruptly halted owing to “market conditions.” Lower oil prices, weakening European economies and a broad overexpansion wreck havoc with the Middle East’s markets and economies.

Comment:  He was pretty close on this as the infrastructure projects were shut down in the first quarter, but are already coming back;  this is a good reason to own FLR;