Markit CMBX

Look what happened to the CMBX today! After climbing to a height of 275 a few days ago, it is now down to 150. Basically this means that the spread on triple AAA commercial real estate bonds was north of 2.75% over the risk free rate but now only has a risk premium of 1.5%. As an indicator of risk, this would mean that the risk of default has just been cut in half. Half as many commercial defaults are predicted.

But how realistic is this?

The actual number of commercial defaults is at an historical low. Are the bond prices falling because they have a lower expected return? Or are the prices falling because there are no buyers? And what about speculation: is short selling having an influence?

An article in the Economist suggests that the CMBX and other indexes may be overly sensitive to downward distortion.

And why did CMBX so dramatically improve?

There are two pieces of news that influenced this. First, the offer for Bear Stearns was increased from $2 per share to $10, which would suggest that there is still some value in some of their financial assets. The other piece of news was that housing sales in the U.S. had risen slightly in February - even if prices had continued to fall.

The market does not seem to be behaving rationally. "Psychology has now overwhelmed economics," wrote Alan Blinder, former Fed vice-chair, in the Washington Post.

Secure FTP Software

We are testing a system of secure file transfers over the web. To maintain up-to-date copies of servers and data we need an automated and secure system to move new and updated files.

There is quite a wide choice of software in this area so we have had to a bit of research.

At the receiving end - the secure remote server - we are using a product called Gene6. http://www.gene6.com/ This software can accept secure encrypted connections and we are able to set up these transaction on custom, non-standard port numbers. This software has been working very well. It accepts up to twenty five concurrent connections and has several nice reporting tools to monitor traffic and bandwidth.

At the client end we have had to do a bit more work. We originally set up a software that was recommended to us: BatchSynch. This software is designed to first make a secure connection, then analyze the files at either end and build a list of files that need to be transferred. Like Robocopy, it will then only copy new and updated files. The program works well during the comparison stage but it had a tendency to crash during the transfer phase. As these initial copy jobs could be very large: ten to twelve hours, this was very annoying.

I spent a lot of time obsessively watching the band width graphs and restarting jobs remotely. Of course, jobs would inevitably fail as soon as I stopped watching them!
Here is an example. The red line indicates the number of threads running - the scale is on the right. The other lines reflect the amount of data being transferred. You can see that at 10:48 the jobs crashed and had to be restarted. Everything is running fine at 11:15 PM:

And here is the chart from another night. A job I had hoped would run all night crashed just after midnight. It was restarted at nine and then crashed again while I was at lunch!

This was wasting a lot of time and was not a reliable solution. I searched for other software and found Other contenders:

• Acronis: http://www.acronis.com/enterprise/download/ATIESWin/
  
• Backup Platinum: http://www.backup-platinum.com/
  
• Almersoft: http://www.almersoft.com/products/backup/
  
• CuteFTP Professional. http://www.cuteftp.com/
  

Acronis offers a suite of network backup and restore software that sounds very powerful. We could not find a way to make it work over our secure FTP setup however.

Backup Platinum is another backup software. One of the features is that it can send a backup image to an FTP site. But we could not get it to work using secure FTP. It would not log in to make the connection.

Almersoft also provides a backup software. As with Backup Platinum, we could not find a way to configure it to connect to our secure FTP server.

CuteFTP is a popular software that has been around for a long time. CuteFTP Professional was a solution that looked like to could work for us. This software is similar to BatchSync. It can communicate through secure FTP. It does not build a list of changed and new files first, but it can be programmed to skip unchanged files. Functionally, this delivers the same result. So far CuteFTP has not crashed during an upload, but the interface does have a tendency to freeze during long sessions. After it freezes, one cannot get a report on whether the job ran successfully or not.

Both BatchSync and CuteFTP can be scheduled, which is very important for our application. BatchSynch uses Windows task scheduler to run a command line version of itself. It can also be set up to send email reports on the success of failure of tasks. CuteFTP uses it's own scheduling tool. It appears that CuteFTP requires the local user to be logged in for the scheduled task to run.

Both of these tools accomplish the same thing in slightly different ways. We will be using CuteFTP for the simple reason that it is more stable in our environment. Testing before selecting software is economical in this case as all the products mentioned above are available in thirty day trial versions.

Keep in mind that our testing was only on our network and we evaluated these products based on our criteria. You may have different needs and a different environment. You should take the time to evaluate each product for your specific needs.

I would think that this type of software will become more common. Replicating data to a live, web accessible server is a far superior solution to using backup tapes or removable drives. The cost of hardware and bandwidth capacity now make this a cost effective and viable.

Rotten Reputation

There's a new site that has recently been launched. It is a mash-up that uses the Google Maps api and adds on a layer that allows users to comment on their neighbours. The comments are usually negative and the site is called Rotten Neighbor.

I'm not sure how useful this will be. It will simply be a site to vent anger and hatred; or as a way to play pranks on friends. It's fun as a bit of entertainment but I doubt it will be a useful tool to help pick a neighbourhood in which to live. But it still may be successful in terms of web traffic!

This site does illustrate an interesting point however. Our reputations are vulnerable online. If we do not have a strong online presence, we do not have a voice to defend against sites like these. As the web becomes increasingly interactive and social, it will be very easy to trash someone else. As individuals we need to be involved in the discussion in order to protect our own reputation.

Take these two landlord reviews for example:




Mold Problem:

Landlord renovated basement without permits. Black mold problem that has spread throughout three units of house, making previous tenants sick. Building not maintained well, freezing cold in winter. Landlord is also quite sexist and derogatory to female tenants.




Tight Ass:

The owner is a slum lord. Doesn't like to spend money to fix his investment.

Who knows if these statements are true or not. The landlords are unlikely to know that these comments exist and they're unable to give their side of the story.

Landlords rely on their reputation to attract and retain tenants. To protect themselves, they need a strong online presence. They need to be aware of where discussions that affect them are happening. As in the real world, landlords need to be approachable and responsive online. If landlords are not available to engage in an online conversation, if they can't address their critics, disgruntled individuals will take their comments elsewhere.

How Vulnerable is Commercial Real Estate?

There are rumors of trouble on the horizon for commercial real estate. The CMBX index (see earlier post) suggests that we can expect a substantial increase in defaults of commercial real estate backed bonds in the next year.

If we look at the current economy, we can see that there are three factors that will put pressure on commercial real estate. The first is the slowdown in the U.S. economy which is likely to put pressure on many classes of tenants. Some will be pushed into bankruptcy and others will be forced to scale back operations. We can therefore expect a substantial increase in vacancy rates. The second is that recent high valuations on commercial real estate have justified the use of significant leverage - it's been easy to take on debt. The third factor is that debt capital is drying up. Loans will be harder to get and interest rates will be higher as lenders worry about risk.

So how much pressure can owners withstand? We can build a simple model to analyze the effect of increasing vacancy and rising interest rates. Here's the scenario:

• Building X is a 100,000 sq. ft. commercial building.
  
• The operating costs are $10 per sq. ft.
  
• Tenants pay $20 per sq. ft. (S10 for operating costs and $10 as rent)
  
• The building is 95% occupied
  
• Current cap rates are at 7%
  

Based on these parameters, the building would generate $900,000 in cash flow each year. It would be valued at $12.86 million. In our scenario, we will purchase the building at this price using a conservative capital structure of 50% equity and 50% debt.

• Total debt will be approximately $6.43 million
  
• Invested equity will be approximately $6.43 million
  
• Interest rate: approximately 6%
  
• Annual interest payments: approximately $386,000
  

With this scenario we will generate a return on equity of around 8% each year. Our cash flow is more than twice our debt obligation, so the project seems secure. But what happens if the vacancy increases and the interest on our debt starts to creep up? The following table shows what will happen to our return on equity (ROE) as these conditions change:

The yellow colour indicates where we would exceed our debt coverage ratio (in this case 1.2) and the red fields indicate negative cash flow. As you can see, if interest rates rise by 2% (realistic since the CMBX has risen 200 basis points recently) and if vacancy increases by 20% (realistic in light of an economic slow-down) we will have negative cash-flow. At the same cap rate of 7%, our building is only worth $7 million. If cap rates also increase a bit, we will have lost all of our equity and we'll be in debt to the bank.

Keep in mind that this example is conservative. There are many buildings that have been purchased at less than a 7% cap rate. And there are many buildings that have more than a 50% mortgage against them. As credit dries up and as vacancies increase, many landlords will feel the pain.