CMBX Predictions

Readers of this blog know I have an ongoing fascination with the CMBX index. What is it exactly? Why was it so high? And why has it come down again? What exactly does it tell us about the future of commercial real estate?

Here are links to my earlier posts:

• Markit CMBX
  
• How Vulnerable is Commercial Real Estate?
  
• What is CMBX exactly?
  
• CMBX Index
  

Well, here's an updated picture of what it looks like today:

Apparently the CMBX index - the oracle that it is - no longer believes that there is a high risk for defaults in commercial real estate in the coming year. Remember that when the CMBX goes down, it indicates a lower 'spread' and therefore the prediction of a lower risk for default. This trend is happening just as real economic data is emerging that contradicts this sentiment: take a look at this post on Mish's Global Economic Trends. Here are some highlights:

Vacancies in commercial real estate is increasing rapidly -it is expected to peak at 18% in 2008. Architectural billings in the US are down almost 78% over one year. look at the right-hand side of this chart :

Shopping centre vacancies are increasing rapidly - already at 28%:

And yet the CMBX index seems to suggest that the likelihood of defaults in commercial real estates has now gone down? Is this realistic? Or is this index too heavily influenced by short selling and speculation to be meaningful?

I found an interesting opinion on this on another blog. Myles Lichtenberg writes on
Maryland Commercial Title's corporate blog about this. He quotes a report by Moody's:

“If sellers were forced to sell, as can occur when banks foreclose on loans and subsequently sell off the collateral property, a more dramatic drop in prices would likely result.
However, when sellers are not compelled to sell, prices do not or can not adjust. In fact, prices can hover at some level in nominal terms for an extended period before responding to a changed market environment.”

The insight here is that even though the performance of commercial real estate might decline on a cash-flow basis, this will not mean that prices will fall. Large financial and institutional investors will choose to weather the storm. the number of transactions is likely to drop off, but prices are likely to remain much more stable than in residential sector. Asset price stability and the presence of well capitalized buyers will protect even the over-leveraged in the commercial real estate market. If the market value of the assets remain and as long as there are a few buyers, an cash strapped owner can get out by selling. The value of the asset as collateral will also help in any 'work-out' with lenders.

So have investors realized this difference? And has this insight been reflected in the CMBX index? Or am I reaching here? -just to maintain my faith in the value of a derivative index?

Factoid: Markit, the creators of the CMBX index is a spin-off from the TD bank - a Canadian connection!

Marketing Blogs

I've come across two excellent blogs on marketing. The first one is by Guy Kawasaki. Guy used to be the chief 'evangelist' at Apple and is now a VC, writer and all round guru. The blog covers a wide range of topics from new technology to marketing and management. It's got a lot of humour and the scope is very wide. My suggestion is to start from the 'Categories' list half way down the page on the right hand side and pick what you are interested in.

Here's the address: http://blog.guykawasaki.com/

The second marketing blog is by Paul Dunay. Paul currently is Global Director of Integrated Marketing for BearingPoint. This blog is more focused on specific marketing techniques. Paul has done a lot of work on integrated marketing and he has a great deal of experience with web based marketing, lead generation and social networking. A nifty aspect of this blog is that Paul conducts interviews with other thought leaders and managers. He makes these interviews available as pod-casts. He's in the iTunes store and you can subscribe to him for free! I've been listening to these podcasts on my way into work. They're really good. This blog (and podcast) is excellent for anyone who is interested in effectively using the web to expand business.

The web address is http://buzzmarketingfortech.blogspot.com/

You can find the podcasts in the iTunes store if you search for 'Buzz Marketing for Technology'

What Real Estate Can Teach Banking

There's a lot that banking can learn from the real estate industry. I still vividly recall the real estate driven recession in the early nineties. This was the environment I graduated into with a fresh, new architecture degree! There was no work around. Real estate had collapsed as a business and was dragging the rest of the economy down with it. Rampant speculation had led to massive over building. There was a glut of empty office space that could not be leased. Solid reputable builders and owners were destroyed and lenders lost billions.

Look at real estate in Canada now. It is probably one of the most open and transparent sectors that you can find. Long term investors such as pension funds and REITs have brought financial discipline to the industry. Buildings are bought and sold on verifiable financial metrics. Tenants lease space based on the expectation of accurate areas (which has contributed to Space Database growth!) and they expect landlords to justify and disclose all operating expenses. This stable sector is able to develop in close coordination with market demand. Our open and transparent market has become very attractive to foreign investors which has led to an inflow of capital and a stable rise in prices.

But it was not easy to get to this situation. Our biggest and boldest developers went bankrupt. The builders of all today's prestigious addresses in Toronto have been wiped out. The fallout included huge financial losses and a major recession, but in the end we have in Canada a mature, healthy and safe commercial real estate industry.

So what lessons can the banks learn from real estate?

The first lesson is that losses have to be taken to clean up the system. Failures have to happen for there to be a turn-around. In order for pension funds, foreign investors and REITs to reshape the real estate industry, the old developers had to be dismantled. In banking we must expect more firms like Bear Sterns to disappear. Protecting them will only extend the agony.

The second lesson is that reality will always catch up. In the late eighties, there seemed to be no limit for developers. New, big buildings were appearing at a furious pace. The problem was that the underlying economy was not growing at the same pace and there were not enough tenants for the space. Similarly today, finance has rushed ahead of the economy. According to The Economist, financial services companies in the U.S. accounted for around 40% of all corporate profits in 2006! This grew from a more reasonable 10% share in the early eighties. Just as there turned out to be no real tenants to pay for the new buildings in the eighties, so too now, it turns out that there are no real backers of the 'products' that banks have created.

The third lesson is that real value survives its creators. If you look at the skyline of Toronto, we still have the TD Centre, Scotia Plaza and BCE place. The builders are bankrupt, but what they created had real and lasting value. We are likely to benefit from what these developers created for another hundred years. What value does a company like Bear Sterns leave behind? Does securitization create value? Is it the concept or the implementation that was flawed? An industry that does not create, but only redistributes wealth is not sustainable and will hurt us all in the long run. If anything is to be salvaged, then banks have to figure out what elements of what they do create real value for society.

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.

What is CMBX exactly?

If you search for information on this index, you will see that it is used a great deal on the web but I have not found a simple explanation for what it actually is and the precise role that if plays in finance. Here's what I have been able to piece together.

The CMBX is an index published by a company called Markit . It is simply an index that tracks performance of several baskets of bonds. The CMBX AAA index tracks the yield on a group of triple A bonds that are backed by real estate loans.

So, first we need a quick explanation of yield. Current Yield is the ratio of the annual interest payment and the bond's current price. If a bond costs $100 dollars and has an annual coupon Interest payment) of $10 the yield is 10%. If the price falls to $80, then the yield increases to 13%. The value of the bond would fall if the market believed that the bond became more risky. Riskier investments have a higher yield to compensate the holder for the risk of default.

To make things more confusing, the CMBX does not track the bond yields directly. The index is expressed as a 'spread'. In this case this is the difference (spread) between the yield of the bonds being tracked and the current yield offered by government bonds (commonly called the 'risk-free' rate).
The result is that when the bond prices fall, the spread increases and the index goes up. A high index value means that the financial community sees these bonds as being at a higher risk of defaulting. We can see from this chart that the spread for triple A rated bonds has increased from less than 0.5% in October to over 2% in February.

And how is the CMBX used? It is not a product you can buy directly. See CORRECTION in comments. This index is used as a benchmark for pricing other financial products: Credit Default Swaps. A CDS acts like an insurance policy on a bond. The seller of the product will assume the default risk of a bond. If the bond defaults, the seller will pay the buyer the value of the bond. For this insurance, the buyer pays the seller a periodic premium that is related to the riskiness of the bond. And how do they agree on the riskiness of the bond? The use the CBMX index!

You don't have to own the bond in question to buy a CDS against it. If you want to, you can bet against the commercial real estate industry. When real estate companies default, you will collect a windfall!

Long Tail Evidence

The 'Long Tail' is a popular term these days. It is the idea that the aggregate of all the little niche markets is bigger than the mainstream markets. The total number of book sales for obscure books (less than 1,000 copies) is greater than the sales of the top ten list of books that sell over a million copies.

The internet and the power of search mean that we are now opening up all of these small, obscure niche markets. Buyers and sellers can now find each other. For example, today you can have an active market for salt shakers on Ebay that was not possible before.

The market for information is no less affected. Look at this example of news media. Not only are niche web publishers creating new content, they are also taking market share from the big players. Here we see a chart that displays the percent of total page views for a selection of information sources. You can see that Wikipedia and Blogger which are published by many individuals have grown exponentially in popularity. At the same time the commercial news media - published by editors - has been loosing market share since 2006.

Factoid: The term "Long Tail' was coined by Chris Anderson who is the editor of WIRED magazine. He now has a book called "The Long Tail: Why the Future of Business Is Selling Less of More"

UrbanDB

We've found this to be a great resource for getting basic building information before we start work on a job. It's a website with a detailed database of buildings. It's especially well documented and detailed in the Toronto area. You can find it at www.urbandb.com .

To price and plan a survey job properly we need to know what kind of building we are dealing with. This site gives us the year the building was built, the number of floors and a picture of the building.

The site has details on 3,949 buildings in Toronto. If you search on a Toronto address in Google, chances are urbandb will be somewhere at the top of the list. So is this a large company with a dedicated team of researchers to maintain the site and enter all of these details?- No!In fact it is the part time 'hobby project'of one guy.

Taylor is his name and he has built this site using open source technology. He has opened up the site to anyone who wants to help out by contributing information. He has succeeded in building his own Wikipedia of buildings!

Rod is modest about the success of his site "it takes a large number of volunteers to keep things running. Every little piece of information helps."

UrbanDB illustrates three important points. The first is the power and sophistication of open source technology that exists today. The tools that are now available enabled one person (although technically skilled) to put together an incredibly sophisticated site in their spare time. Secondly, web collaboration - getting users to contribute the content - is a great way to gather data. This site is populated by the work of volunteers that just happen to be interested in buildings. Finally, this project demonstrates how 'flat' the internet is. This site is more popular and probably has more traffic than dedicated commercial broker and building owner sites could ever hope for.

News, news, news

We are on a mission to raise our profile and to add more value to our clients. One of the ways we can do this is through knowledge. We work very hard to understand out clients needs and the issues that they face.
We all follow the news to some extent to make sense of the world around us. We pick and choose the topics and items that are meaningful to us. As we scan the paper and the web we filter and select from vast content the few items that effect us in some way.
I will suggest that one of the ways we can help our clients is to slightly alter the way we read the news. If we look at the news from the point of view of our clients we will both be better informed about their needs as well as more aware of ways that we can help them. So when we follow the news, online, in print, on TV and on the radio, let's pay a little extra attention to news that might effect or help commercial real estate people.
We want to raise the level of knowledge that we all have in regard to our clients' concerns. To support this goal we have added two new web tools. First we have a rotating block of news on the front page of the main website. This is pulled from Wall Street Journal articles on commercial real estate. The other new tool we have is a blog that contains a compilation of relevant news items. It can be found at http://news.spacedatabase.com
Take a look at our news items each day and please let us know if you come across anything interesting that you think we should share!

Strategy and Our Website

Over the last year, a great deal of thought has gone into what the direction of our business should be. The results are reflected in our new website. Besides updating the design and the graphics we have also refined our positioning. There are two key points. The first is that we do not just produce data - rather we turn data into valuable 'strategic assets'. The second point is that we provide integrated solutions that support and leverage the work that our clients are engaged in.The most important message on the site is the value proposition is 'turn your building drawings and related data into strategic assets'. We then invite people to see how we do this for their specific roles: 'find a solution designed for you:'
We then have a series of pages that focus on the needs of each type of customer we have and the ways in which our products support them. Every product is not for everyone - and certain combinations are more valuable as integrated solutions than they are as stand-alone services. Here is the 'grid' of solutions:

In addition to presenting our products as part of a bundled solution, we have retained the left hand navigation which has become somewhat of an internet standard. You can get to each product through this navigation tree also.

Whenever a visitor drills down to one of these topics from anywhere, the left-hand menu is highlighted, so you always know where you are in this grid.
The goal here is to illustrate the value that our products bring to our prospective clients and to deliver the message in a way that is clear, memorable and compelling!

The Way Back Machine

The Internet seems so commonplace and familiar it is easy to forget that is still very new. On November 13th the first web site was launched at CERN in Switzerland. Here is a link to the oldest web page in existence: http://www.w3.org/History/19921103-hypertext/hypertext/WWW/Link.html , last changed Tue, 13 Nov 1990 15:17:00 GMT (though the URI changed.)
 

The world wide web had a slow start. Here is a link to the world wide web project page from Nov 3, 1992 (two years later). It lists the 30 odd servers that constituted the web http://www.w3.org/History/19921103-hypertext/hypertext/WWW/TheProject.html
 

In November, the world wide web will be eighteen years old! If only there were a way to go back in time and visit old pages and sites and see this history. But of course, someone already thought if this and it exists: "The Way Back Machine"! Go to http://www.archive.org type in a web address and hit the 'Take Me Back' button. This site has a saved version of the entire Internet going back to 1998.  
 

I tried it with http://www.spacedatabase.com and found all the old website designs that I was so proud of. Here is an old version from 1997:

For our photos we took pictures with a film camera and had them scanned onto a 'CD' This was before digital cameras were widely available. We made desktop software at the time - one of the features was that "Drawings can be faxed or modemed directly from your system." -- 'modemed'?

In 2000, I came up with a snazzy new design for the website. It had an embossed effect and the buttons lit up with a scroll-over effect which was advanced at the time:

On this site we also had our 'Online' application. Users could log in and use our application online! Wow-wee!:

In 2003, we decided that it was time to update our corporate image and develop a new brand identity. We worked with Jump Communications and came up with this elegant new look:

We kept this framework for several years - slightly updating with some more graphics.

We have continued to use these basic design elements in the latest iteration. You can see the connections in our current site (as of August 2007)

I am sure this page will look quaint a year from now!

Thinking Creatively

People in the business world are taking an interest in how designers think. Product and service innovation and new design are creating a lot of value for many companies. As we move further into a knowledge economy, innovation is becoming THE way to compete successfully.

But creativity seems to be rare. Innovative problem solvers appear to be scarce. Are there so few people capable of creative thought, or is there another problem at work? What if creativity is not an unusual skill? What if we are being constrained by the way we have been taught to think?

I saw an interesting presentation by Dev Patnaik from Stanford University. One of his points was that the way we reason restricts the solutions we can come up with. In modern culture we have focused our intellectual training on deductive reasoning. We are taught concepts, we learn the laws of physics and the underlying principles of various disciplines. We then apply these principles to the situations and problems that we face in the world around us. With good models we can come up with consistently good solutions. The problem is that we are restricted. Deductive reasoning can only operate within a certain boundary. Deductive thinkers limit themselves by their models.

Dev suggests that if we want to be creative problems solvers we should employ inductive reasoning. We should bring together many things - many points of view and many observations. When we look at all of the specifics, is there a pattern that emerges? Can we induce new relationships or a new model that we had not seen before? The point of inductive reasoning is not to jump to conclusions, not to frame situations by the rules that we know but rather to suspend judgment and to look for something new.

Roger Martin in his article 'The Business of Design', http://www.rotman.utoronto.ca/pdf/rotman_mgmt_winter03.pdf, takes this concept of reasoning one step further and suggests that beyond the inductive model there is the abductive one. He sees this as the mental model that designers use. Abductive reasoning strives to come up with new ideas and explanations that might be true and then seeks to explore and test them.

Creative thinking requires that we NOT apply what we have learned, or at least not right away. To be creative means not applying best practices, or rules of thumb, or standard procedures. We have to be - for a period - indecisive. To reach a creative solution we must carefully consider all aspects of a situation and be prepared to see things in unfamiliar ways. If we can change the way we think, we can all unshackle our creativity - and come up with valuable new ideas!

Creative Process

If we consider the development of the economy over the coming years it is clear that intellectual capital will be the primary generator of wealth. It will be ideas, new technologies, new products and new processes that will drive the global economy forward. For companies, it will be the ability to foster creative thinking in their people that will differentiate the winners from the losers.

If creativity is the source of value, having so many of our team involved in the design profession should give us a strategic advantage in business. To gain from this advantage, we will need to expand the scope of creativity beyond the design services provided to clients. We need to expand our creative approach to everything that we do.

How can creative thinking build value for us? I suggest that creativity is the ONLY way we can successfully build our company. We will be successful only if we can bring value to our clients:

• Offer new and integrated solutions.
  
• Provide ideas and valuable advice.
  
• Design new and innovative software tools.
  
• Communicate our value through compelling marketing messages.
  
• Streamline our integration with client systems.
  
• Build a workplace that attracts smart and creative people.
  
• Since creativity will be the source of value creation, our collective success will be based on two things: First, we will need to develop all of our creative talents. We must learn to become more creative in every aspect of what we do. Second we will need to create a culture that will foster, develop and implement new and innovative ideas.
  

Here some of my research on this topic. I have focused on ideas for how we can hone our creative talents and harness them for success.
 

Here is a list of techniques to help teams and individuals become more creative. I got these from Dilip Soman, a professor at the Rotman School of Business at U of T. His idea is that creativity is innate but our mental habits restrict us from fully using our talents. People are judgment machines. We are particularly fast with their judgments, especially if it is negative. The problem is that we are often too quick to dismiss ideas before we have fully thought them through. We need to train ourselves to avoid being judgmental before critically evaluating ideas. Here are some techniques for achieving this:

Technique 1) Constrained Brainstorming:

This is a technique to widen the total number of ideas and points of view when considering a problem. The technique involves team members coming up with as many ideas as possible even if they are obscure or seem silly. The rest of the team then has to add comments under each idea about why it is good. No negative comments are allowed. At the end of this process the team should have many more options to explore further. Some of the crazy ideas (that would normally have been dismissed out of hand) many not be so crazy after all!

Technique 2) Problem Reversal / Reframing:

Look at the reverse problem. How can I make customer service bad? How can I damage the health of Canadians? How can I decrease sales? Worsen public relations? As absurd as these reversed objectives sound they can give us insight into root causes of problems that we have not yet considered. By looking at a problem in reverse, we may seen things that we were previously blind to.

Technique 3) Imitation:

In this technique we look for ideas in other fields and disciplines. If someone else is doing it right, it doesn't hurt to imitate them. The revolutionary distribution system that FedEx's founder Fred Smith came up with was based on his study of how cancelled checks were cleared and returned between banks. The original typewriter design borrowed a great deal from organ mechanics. The imitation techniques are used in other fields as well: Inventory managers study ants; town planners study beehives. The idea here is that the problem we are facing may already been faced and addressed in another context.

Technique 4) Assumption Smashing:

When considering a problem we should look at the constraints. What assumptions are you implicitly making? Is there any way in which the most obvious assumption could be overcome? What would be necessary to do that? Can that be done? If not, is there another implicit assumption? The idea here is that we may be looking at a problem too narrowly. The solution may not be in the scope that we have defined for ourselves but within the bigger context - a context that we are incorrectly assuming to be immutable.

The underlying theme in all these techniques is that we all have the capacity to come up with creative solutions. To develop our creative abilities we have to delay our judgment of ideas and we have to expand our view of the situation we are considering.

Development, History and Memory

There's a stretch of King street that I've been going past every day for about fifteen years now. Fifteen years is not really very long in the life of a city - but now it's hard to remember what it looked like then. There were large empty buildings that had been the Massey Ferguson plant in Toronto. There were large brick buildings - some modern some ancient. There was a vast - and quite elegant - plate glass showroom. A few years later, nearly everything was pulled down. New roads were put in, lampposts were put up. Big signs proclaiming a three million square foot Olympia & York office development were erected in the late eighties. And then nothing happened… The signs stayed up for a couple of years, faded and eventually fell over in the mud. Chain link fences blocked off the new un-traveled new roads.

And then, about five years ago - something changed again. Hoardings were put up, deep holes were dug and construction cranes moved in. New buildings went up. No office buildings this time - it was all condos. Today, most of these buildings look like they've been there for ever. It's hard to imagine the street ever having looked different. The last remaining land is quickly being filled in.

There are very few traces of what is left - the Massey office building is a notable exception. All of this history is almost completely erased. Which is really a huge loss. Of course, we need the new housing and the factories were not viable - but it is a shame that history can so quickly disappear.

If you are interested in history there are some interesting sources. At the Toronto Reference Library there are two great resources. One is in the Baldwin Room - a collection of photographs. The other is the collection of Goad maps. Both of these rare rich sources of information. Neither of them were intended to be the valuable historical records that they are today.

In the Baldwin room there is an index of photographs sorted by street addresses for most of 19th century Toronto. These were compiled by a news paper as they documented locations in the city for various newspaper stories. Chances are you can find your street and see what it looked over 100 years ago.

Goad maps were prepared in the insurance industry. Their purpose was for insurers to assess the risk of the properties that they insured. They needed information on not only their clients, but their neighbours and their business activities. How likely was fire or accidents. How far away from each other was each establishment that was being insured? The maps show detailed information about each building, the tenant and business activity. Every lumber yard and coal pile. These were utilitarian drawings - the authors did not intend them to be the incredible historical records that they are now.

It is interesting to think about what may become the historical documentation of our time. In our economy we generate and enormous amount of data - but how much would be of interest to future generations? It's hard to tell, but most of it probably won't be that interesting. Documentation about buildings, were they were and how they were used will probably be quite interesting. Our drawings, designs and data are likely to have historical value, even as for the Goad maps, the authors aren't intending it.

If we can develop an extensive database of information including drawings, 3d models and usage information - this may well be something of historical value. Maps and photographs printed on paper can survive a very long time if preserved carefully. They do not need any infrastructure other than storage to survive. Will our information survive as easily? It requires media for storage (which degrades) it must be backed up and cared for. Will future generations have the tools to read it even if it survives?

Are there things we can do to preserve this potentially valuable information?