April 22, 2007
Deploy a Little Capital, Get a Lot of Profit
Good interview with Michael Pralle, CEO of GE Real Estate, in the week’s Barron’s. He has interesting things to say about commerical real estate around the world — I found his take on Mexico (he’s super bullish) especially telling.
“Ignoring the residual value, the current yield for real estate is about 7% or 8%. And when you look out at the rest of the world, Russian debt is about 5.6%, Brazilian debt is 6.2%, and junk bonds are 7% or 8%. The 10-year Treasury yield is about 4.7%. You’re in a world where there is very, very little risk premium. When you look at what you can earn on real estate compared to what you can earn everywhere else, real estate doesn’t look that bad. It’s expensive only in a historical context, but it’s not expensive relative to the other asset classes. Besides, it’s a hard asset so it’s always going to be there.”
Another good bit:
“When I took over GE Real Estate seven years ago, I looked at the kind of profits property owners were earning — how they can deploy very little capital and get a lot more of the potential profit.
Say you have a $100 project. You might have a $75 first mortgage on it, and a $15 slice of mezzanine debt. For the last $10, you bring in an equity partner for $8 and you, as the real-estate guy, would put in $2. The way it would work is your mortgage guy ends up earning $1, the mezzanine guy would get another $1 or $1.50. The equity guy, for putting up 80% of the last $10, might get $2 or $3 or $4. But the real-estate guy putting in the $2 is getting $5 or $6.
To me, it was obvious that returns were accruing to the people who own and operate real estate. In fact, 85% of all profit in global real estate is made in owning real estate.”
April 23rd, 2007 at 1:24 am
chairman, did i understand this correctly… if the mortgage guy earns $1, that means the yield is 1.33%. now which morgage guy in their right mind would invest in something that yields 1.33% ?
April 23rd, 2007 at 1:24 am
replace ‘did’ with ‘if’.. my english not very tall..
April 23rd, 2007 at 8:21 am
Who is that Girl below???
April 23rd, 2007 at 10:20 am
ryuu: I didn’t understand these numbers completely either, but I will ask someone smarter than me and get back to you.
Jeff: Stay away from my little sister! ;-)
April 23rd, 2007 at 10:26 am
the $1 is relative to the earnings. In other words, the real estate guy makes 5-6 times more money than the mortgagor on the deal. The flip side is that the mortgagor has the least risk because his/her loan is secured by the actual real-estate.
In a classic Credit Default Swap the mortgagor’s risk is rated at AAA and the real-estate developer’s will be much lower.
April 23rd, 2007 at 10:31 am
Born2: OK, I get it, thanks — I’m glad that my smart readers can explain things to me. ;-)
April 23rd, 2007 at 11:30 pm
ah… soka.. thanks b2c!
April 26th, 2007 at 10:34 pm
In another word, real estate give MASSIVE leverage if you can find people to give you the dough. Much like a guy who starts a hedge fund with 0 or very little equity in the fund.
April 26th, 2007 at 10:35 pm
Chairman,
I didn’t know you have a victoria secret model as your sister. :)
April 26th, 2007 at 10:46 pm
yin, people give you the dough all the time. In the US you can buy a house with 5% down… that’s 20-1 leverage given to the average person with no special requirements. subprime lenders were giving out mortgages with $0 down, that’s infinite leverage.
April 27th, 2007 at 6:16 am
ryuu - I understand, my ingles is short also.
This appears to be a very poor example. Using Pralle’s lowest numbers and an 8% mortgage, this thing would be cash flowing at 54%. Not too likely. He must be factoring in a holding period, appreciation and then sale for the return distribution.
April 27th, 2007 at 8:12 am
pancho: Yes, it ’s impossible to figure out Pralle’s numbers exactly without knowing all his assumptions, but it’s safe to say that the guy who takes the most risk reaps the greatest reward.