Capital Thoughts

analysis and commentary on critical business and legal issues

Real Estate

A Tale of Two Worlds

By Willy Walker, Walker & Dunlop

 

In commercial real estate, it’s “bulletproof” and everything else

 

 

C

ommercial real estate, after holding up initially in the downturn, is now at a crossroads. While single-family housing is starting to come back, commercial real estate—particularly multifamily, which was the last into the cycle—has been showing signs of stress. Yet the multifamily market promises to stabilize more quickly because of some interesting dynamics. And there are plenty of opportunities for investors willing to heed the lessons from the past few years.

Here are some of the axioms emerging:

 

Big money is still interested. With the stock market stable and interest rates at rock bottom, life insurance companies are looking to commercial real estate for solid returns. Somewhere between $30 billion to $40 billion of life insurance money may be put into commercial real estate this year. From a portfolio management standpoint, there’s a need to put money back into commercial real estate, and hence a degree of built-up demand.

 

Borrowers are being scrutinized. Investors are cautiously returning to commercial real estate, but they’re seeking a bulletproof investment. With today’s lending conditions, you need to really understand the borrowers, their track records and their other exposure. You want to avoid a situation where a borrower refinances an asset that is in good shape and takes the money out to take care of a problem asset. Asset-specific underwriting has been replaced by borrower-specific underwriting.

 

There are two worlds: the haves and the have-nots. With investors still feeling their way in the brave new world, there is too much capital chasing the great deals, particularly in hot markets such as Washington, D.C. At this point in the cycle, if you’ve got a less-than-perfect asset or market, you are starved for capital. If you’ve got a great asset and a great market, you have more capital than you’ll ever need.

 

Geography still matters. We’re going to continue to see growth in the major metropolitan areas of the country, particularly with rising fuel costs and people wanting to be close to public transportation. Moreover, jobs, educational institutions and medical services are all in the big cities and suburbs. Also consider the recent relocations of companies such as Lockheed Martin and Volkswagen, which both moved to Washington, D.C., to be nearer decisionmakers that affect their industries. Bruce Katz, director of the Brookings Institution Metropolitan Policy program, has documented a big shift to living in major metropolitan centers: That’s where the money is, that’s where the lending is going to be, and that’s where real estate investors want to be as well.

 

Interest rates still matter too. The Federal Reserve is going to work very hard to keep short-term interest rates as low as possible, but that doesn’t influence the 10-year Treasury rate, which is the basis for most commercial real estate lending. The market is going to dictate what happens on the 10-year, and the ability to sell 10-year paper to the international community—Japan, China, the Middle East—is all market-dependent. If the stock market rises, yields on Treasuries are going to have to increase, and that’s going to increase the cost of borrowing for everyone.

 

Yet the Fed’s influence on interest rates plays out in another dynamic. About $130 billion of commercial real estate will require refinancing in 2010, and of that, at least $100 billion sits with banks. Banks are holding the majority of the risk in commercial real estate right now, and the Fed is keeping short-term rates very low to allow banks to continue to heal their balance sheets and boost their profits.

 

As they continue to make money, taking write-downs on assets or extending those loans becomes far more palatable. If the banks can refinance all of the commercial and single-family inventory they have sitting on their balance sheets, they can start lending again—and the economy, at some point, begins to heal itself.

 

“Trickle down” will get the economy moving up. It makes perfect sense right now that investment capital is going to the best markets and the best projects. But as the economy heals, you will start to see a shift in deals. For a life insurance company that wants to put money into the Washington, D.C., area but can’t get in on the best deal, maybe the next best is an almost-perfect deal in Baltimore, or Richmond, or New York City, or New Jersey. The result is a sort of a trickle-down effect, where everybody goes from what they really want to do to the next level. That’s what starts the markets fully healing—when you get capital going to the places where it won’t go now.

 

Willy Walker is president and CEO of Bethesda, Maryland-based Walker & Dunlop Inc., one of the largest multifamily lenders in the United States.

 

 

Manufacturing

Waste Not, Earn More

By Jim D’Addario, D’Addario & Company

 

"Lean” manufacturing can reduce costs, save jobs and even improve morale

 

 

About five years ago, consultants came to my office and pitched me on something called “Lean.” Frankly, I didn’t understand it, and I didn’t take the time to understand it. It sounded like a way to improve the bottom line by laying off staff. So, like executives at many other companies, I assumed it wasn’t going to work for us.

 

That was then. These days, I’m a fierce advocate for Lean.

 

The Lean approach was first described in an influential 1986 book, Kaizen: The Key to Japan’s Competitive Success, by Masaaki Imai. Lean (as used to describe something that has no fat) wasn’t just about saving jobs; it was about making sure that a company (in this case, our company) would succeed long term. And that meant eliminating waste.

 

All too often, even if employees see better ways to do things, they are afraid to suggest them, and their managers are afraid to implement them. Lean appealed to me because it allowed everyone to participate on a daily basis, whether they were an executive, a machine operator or a bookkeeper. Once we got all of our managers on board, we had the core to drive the rest of the team. Input was encouraged from everybody. They felt valued. Each became a quality inspector, and everyone benefited.

We separated each step involved in manufacturing guitar strings into value-added activities (those things that the customer is actually willing to pay for, such as production and packaging) and non-value-added activities (those things that the customer is not willing to pay for, such as poor quality control and inefficiencies of all types). We mapped out the whole process, timed every step and got a clearer understanding of our operation.

 

The idea is to get incrementally better every day with very little capital investment. It’s more about what you do, and could do, with what you have. By reducing the number of hours to produce a set of strings, maintaining the right amount of inventory at every step, and eliminating the need for “do-overs” and wasted materials, we were able to lower our costs and increase our profitability. We saved jobs because we were able to concentrate on getting more business and by pricing more competitively. And we hired almost 100 people to do the work that had been done overseas.

 

Initially, we manufactured our guitar straps here in the States. But in 2000 we decided that we could cut costs by importing them from China. When we implemented Lean and started analyzing our value stream map, we discovered all kinds of hidden costs when importing outsourced products. The lead time was 110 days, so we needed to maintain a large inventory here. We had to pay inspectors to go to the factories in China in addition to paying freight costs and tariffs. So last year we took our mothballed sewing machines back out, created a Lean Work Cell for strap sewing and began making straps here again.

 

Now, even though it costs us about 12 cents more to make a guitar strap here, we only have to keep two weeks of inventory because every time it drops down to a certain level, we can produce just the number we need. We implemented a “quality at the source” program in the string-winding department. At one time, we had 2.7 percent scrap; almost every third string out of a hundred was rejected. We’ve gotten that down to 0.19 percent.

 

We received additional benefits through Lean. First, it has helped cut down on accidents (most of them minor) by 50 percent at our headquarters, our wire mill in Massachusetts and our reed factory in California. Second, although there aren’t enough tax breaks, New York state and our local town have reimbursed a sizable portion of our consultant costs and we’ve been given electrical utilities credits as well. Third, following the airing on CNN of a piece on our company, we received almost a thousand emails and letters, many of them expressing appreciation that we’ve made the commitment to manufacture our products in the U.S. “Made in America” still means quality to a lot of people, especially those who have become fed up with value-engineered products made in China that fall apart.

 

Some executives are still skeptical about Lean. I tell them it’s really the company’s job to make it work. “If you want it to work, you can,” I say. “You just have to believe in it. Give it two years, invest in it, and see what happens.”

 

I sometimes wonder whether some of the big corporations that had to be bailed out might have escaped those problems if they had embraced Lean.

 

Jim D’Addario is chairman and chief executive of D’Addario & Company, one of the world’s top makers of strings for musical instruments and musical instrument accessories, which is based in Farmingdale, New York.

 

TRANSPORTATION

Why We Need
High-Speed Rail

By Carolina Mederos & Rodney Slater, Patton Boggs

 

It can increase productivity, cut carbon emissions and create jobs

 

 

When President Dwight D. Eisenhower signed the Interstate Highway Act in 1956, he transformed America with one stroke of a pen. By approving the first sophisticated effort to tie the entire country together through a web of highways, Eisenhower made a bet that a national interstate highway system would fuel our economy and improve our quality of life. He was right. The Interstate System has shaped our lives, affecting everything from where we live and work to the development of cities and entire industries.

 

Today, we have another opportunity to impact our economy, this time through the development of high-speed rail. Once again, the creation of a national transportation network can reshape America, revitalizing our economy, improving the environment and boosting quality of life.

 

The idea of high-speed rail in the U.S. first developed during the 1930s when such companies as the Union Pacific and Burlington Railroad competed to create trains that could go 100 mph. Under the administration of Bill Clinton, the government took the first major step forward with the introduction of the Acela Express service along the Northeast corridor. But the possibility of building a nationwide system took on new life in April 2009 when President Obama announced $8 billion in funding, part of the stimulus package, aimed at jump-starting the development of such a plan. Targeting 11 regions around the country, the effort would create train lines covering distances of 100 to 600 miles.

 

Some of the funding is for improving existing rail service. For example, more than $1 billion targets speeding up travel from Chicago to St. Louis with trains going up to 110 mph. A significant part, however, is aimed at building bullet trains like the systems in Japan and Europe. There is $2.25 billion allocated to help California in its ambitious effort, approved by voters in November 2008, to develop a system allowing passengers to travel from San Francisco to Los Angeles at 220 mph. And $1.25 billion has been allocated to build 84 miles of track in Florida from Tampa to Orlando.

 

The stimulus money is only the tip of the iceberg, however. Much more money will be needed to bring the plan to fruition. The House Transportation and Infrastructure Committee draft of surface transportation legislation now being considered by Congress includes a $50 billion authorization for high-speed rail development. But federal money won’t take care of the whole tab. Creative public-private partnerships could provide a significant share of funding over time.

 

In the short term, a national system will create jobs in everything from construction to manufacturing and integrating complex parts and technology. While the U.S. can tap the resources of foreign companies already providing train parts to Europe and Japan, there’s also significant opportunity for U.S.-based manufacturers. The city of Detroit, for example, is poised to take on a major role. Producers of highly sophisticated train engines, like GE, as well as defense industry manufacturers could clearly be part of the effort.

 

In the long term, high-speed rail can have a major impact on productivity. For example, it will allow people to live in one city and work in another easily, contributing to the development of new industrial regions. There also are significant environmental considerations. According to Environment America, high-speed rail uses a third less energy per mile than automobile or air travel. A nationwide system could cut oil use by 125 million barrels a year.

 

Alternative forms of transportation are vital to lowering carbon emissions. In recent testimony before the Senate, American Public Transportation Association President William Millar said, “If we only address vehicle efficiency and carbon content of our fuels, we will fall far behind in achieving environmental goals. Without action to address the growth in vehicle travel, greenhouse gas emissions from on-road sources will remain roughly at 2005 levels through 2050.” That would fall far short of the Obama administration’s goal of an almost 20 percent reduction in emissions by 2020.

 

It comes down to a matter of choice. By making high-speed rail travel attractive and efficient, Americans will be able to select the type of transportation that best suits their needs. In some cases, air travel will continue to be the best route. In others, it may be easier to hop in a car. And in others, traveling on a high-speed train will be the fastest, most cost-effective and convenient choice.

 

For those interested in improving productivity, creating jobs and reducing carbon emissions, high-speed rail holds great promise. It’s an idea whose time has come.

 

Carolina Mederos is chair of Patton Boggs’ Transportation and Infrastructure Practice. Rodney Slater, a partner at Patton Boggs, is a former U.S. Secretary of Transportation.

 

 

 

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