Landmark Links January 17th – Its All Relative


Lead Story….. Just last week, I had lunch with an old friend/investor client of ours.  This is a person who has invested in dozens of small builder/developer equity deals (mostly residential but some commercial as well) in the current cycle.  The topics of recent deals and investment outlook for 2017 were discussed in depth.  There was one project in particular that his investor group had just sold that I found particularly illustrative of something that we are seeing quite a bit in the market.

The deal in question was a land development (entitlement) play in a good part of a traditionally strong production home builder market in Southern California.  It had strong sponsorship, a solid business plan and was clearly in a segment of the market – in regards to both location and unit count – that is usually attractive to public home builders.  Landmark was not involved in this deal but we did have some knowledge of it from past conversations.  On the surface it had looked like a strong play when it was purchased back in 2013.

Trouble is that it became somewhat of a Murphy’s law project in that pretty much everything that could go wrong did.  For starters, entitlement took substantially longer than initially projected due mostly to a backlog at the city planning department.  During the processing delay, the market for paper lots (the original business plan was to entitle and sell to a builder but not improve the site) took a swan dive as builders retrenched following 2013 and focused on improved sites that could be built upon more quickly, leading to better internal rates of return.  Of course, costs kept going up over that time frame as well when the labor shortage in Southern California continued to grow.  The Sponsor and investors were left with a choice: sell at a discount to their proforma or borrow money to either 1) improve the site to sell to a builder; or 2) build the homes themselves.  Eventually a large builder offered a good enough price that the partnership decided to sell rather than sticking it out for another few years.

As you can imagine imagine, the returns were less than stellar.  While both the Sponsor and Investor didn’t lose money, they didn’t receive any profits above their preferred return of 12%.  As such, the Sponsor didn’t get into his promoted interest.  When the question of returns came up, our investor client made an astute observation: when viewed through the lens of current commercial real estate, fixed income and stock market yields, a 12% return on the absolute downside (short of another 2008-like event, pretty much everything went wrong) really isn’t all that bad – with the important caveat that the Sponsor obviously wasn’t happy with the result since he didn’t get his promote.  I agreed with him but for one important caveat: all returns are relative.  A 12% return is terrific if you were expecting 10% – 12%.  It’s not great if you invested in raised a fund promising investors 20%+ returns.  Then it’s a disaster and dilutive to fund performance.

I’ve long been of the opinion that returns being sought in the residential builder and developer space don’t make a ton of sense considering where interest rates are today. They are relatively unchanged from the days when the 10 year treasury was double or triple where it is today.  The problem is that most of the capital in the space remains opportunistic in return profile and priced to capitalize on distress, even as the market has matured.  It’s a classic square-peg-in-a-round-hole conundrum and the outcome has been to turn all but the largest private builders into bit players who cannot compete with the publics.  I am in no way saying that a 12% IRR is adequate for all or most development deals that we come across.  It isn’t, but then again neither is a 25% return in many cases. The problem with over-targeting returns is that it leads to shoddy, overly aggressive underwriting that is nearly always doomed to under-perform.  At some point projected returns have to come back to reality and start reflecting actual performance rather than aggressive projections.  I hope that it happens sooner rather than later.


False Narrative: The pervasive and often anecdotal narrative that people are leaving California in droves for other states has a problem – it doesn’t hold up under closer statistical scrutiny.

Depressing: New research shows that Millennials make 20% less than Boomers did at the same stage of life.  Mom’s basement never looked so good.

Crowded Trade? Hedge funds may have gotten ahead of themselves by taking a massive short position against treasuries in expectation of higher bond yields.

Trouble Ahead: Brick and Mortar retailing, asset management and offshore energy supply companies are likely to be difficult places for investors to make money in 2017.


A Tale of Two Malls: Your local mall is probably dying…..unless you live in an affluent area.

Can’t Stop, Won’t Stop: CBRE says that foreign investment in US real estate will remain strong in 2017 despite potential strengthening headwinds.


Disparate Impact: Here’s a list of places where increasing mortgage rates will hurt the most, and where they will hardly matter. See Also: Cities where less than $1,000 per month buys a home (Spoiler – none are in California).

Pushing in the Right Direction: Builders weighed in for a recent Builder Magazine piece on what the incoming administration and congress can do to help the home building industry and help solve the affordability crisis.


Power Struggle: Advances in battery technology don’t come easy but scientists now believe that we are on the cusp of a major breakthrough.

Backlash? Technology is going to have to become a better jobs engine for the middle class if it wants to avoid a coming populist backlash.

Drone Wars: There is now a drone being built that has the sole purpose of taking down other drones.

Sweat it Out: How gyms are becoming more like weekend night clubs.

Chart of the Day


Time to Retire: A 70 year old woman was arrested for prostitution in (you guessed it) Florida.

Cravings: A naked Florida man used a butter knife to break into his neighbor’s house in the middle of the night because he wanted some sesame seeds to put on his hamburger bun.

Video of the Day: Watch a man in a polar bear costume repeatedly eat shit on ice skates while filming a local car dealer commercial in Minnesota.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

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