GEM Three?: Extrapolated

Don Gilbert is a Specialist Retail Valuer (“SRV”), a 3D Economist and an arbitrator. He provides independent, impartial advice to landlords, prospective investors and tenants.

He is also the inventor of the GEM Method of evaluating the ‘reasonable’[1] rent. 

TITLE

‘GEM Three?: Extrapolated’ ? Donald E Gilbert as Trustee Gilbert Family Trust 2019 all material including charts in this article are copyrighted and Intellectual Property is owned by me and or my Family Trust

TARGET AUDIENCE

Retail Tenants, Landlords, Investors, Valuers & Property Professionals, Banking and Finance Industry, and other professionals eg. perhaps investment advisors

CATCH WORDS

#marketrent #marketvalue #evaluation #GEMOne? #duediligence #retailproperty #valuation #appraisal #caveatemptor #Microsoft #Google #LinkedIn Microsoft #PWC #Deloitte #Blackstone #KPMG #PhD

INTRODUCTION

# Update 28/8/2020

This article covers extremely valuable modelling I did in about 2017. In it I address:

1. GEM Three? the original to test the veracity of current market value PhD opportunity income producing property;
2. GEM Three? stress-tester residential housing market debacle PhD residential property stress-tester;
3. GEM Three? other applications and PhD opportunities for: monetary policy settings and outcomes; stress-testing net income of given Corporation and Share Price;
4. ASX or any other share market index and market cap; an Industry eg. Mining against net income streams and market caps;
5. Bond markets; commodity prices; etc.

These things look at the relationships of: low falling yields against riskier income streams and the supposed (sic) high market valuations that flow from same; lo low lower interest rates and so called higher market value of an asset, eg. house prices; lo low lower interest rates until Monetary Policy stimulation runs out, etc.

Particularly with the US Presidential Election around the corner; the folly of Wall Street's indices sitting in the stratosphere with no doubt the President sitting on the Independent Federal Reserve to keep cash rates at an all time low.

I wrote this article a hundred times last night. Between say 2.00 to 4.00 AM.

How to write it; what to say. Will it be clear, etc. There are at least 6 / 7 PhD papers to tease out here in: valuation/appraisal X 2; Monetary Policy X 1; Investment X1; Finance X2; etc.

GEM Three? started very early on in my career; perhaps in my second year in 1985. I started to realise that the physical dimensions of property, particularly in retail and the resultant rental rate produced eg. $500.00 a square metre (sq. ft.) had perhaps had nothing to do with market. At that point I had not even dreamt about market value; market rent was not even a concept that I had got my head into.

I then studied property valuation. With a comprehensive commerce, economics, law and then valuation degrees / diploma had an exciting and intense stint in property management, in a broken portfolio, under the then stewardship of Mr Kingsley Rowland. He had just gleaned the latest in commercial management in an 8-week World-Wide trip sponsored by SAPerm who were members of SAPOA (‘South African Property Owners Assoc’).

I soaked it up; was on my way turbo charged to fast asleep Adelaide (with a young family), who were doing DCF Cash-Flows, with a 10-year horizon, and spending the State Bank of South Australia’s money like drunken sailors. Unfortunately I ended up working under one of those drunken sailors.

After weighing up my skills, I realised I had a gift for writing. I wrote: “Economics: a most useful tool for the valuer” (Gilbert, D. 1993) [update 6/6 here is an electronic copy https://leaseconsultant.com.au/papers-article/economics-a-most-useful-tool-for-the-valuer/ which has withstood the test of time]. That paper anticipates the mayhem of valuers, who face the wind, lick their fingers and point them to the wind, using untested current market rent (Gilbert, D. 1995) X given multiplier = current market value and explores ways to prevent that.

It took years for GEM Three? (Gilbert, D. 2017) to evolve, but I teased it out, until I could present my modelling properly. That I did in papers from 2003 to 2017, hence, the following formula evolved:

WRONG3 X WRONG2 = WRONG?

And then I realised that GEM Three? had many many more applications.

BACKGROUND

I guess from early on as a young adult at school, doing Officers Course listening to fighter pilots, furiously debating the pros and cons of apartheid, etc. I was a sceptical participant.

My partner and I share many many things in common. We are well educated but practical; we are from well educated families (male and female); we did not want to become too educated ourselves but prefer to be practical. She is from the USA, me Southern Africa.

I realised that “locked” up in me was a willingness to write. Part of writing is to explain one’s self. In a discussion I had last week, by going over the same issues, one can explain one’s self better. The art of communicating.

Along the way, I realised that Landlords and Tenants (and their representatives) speak a different language. Valuers appraisers and their interpretation of market value of income producing property evolved in my formula that I created above.

Hence my target audience has grown wider and wider.

By going in at Ground ZERO and by understanding and teasing out (and inventing the current market rent definition) I really got to understand what was at stake and by taking a keen interest in other stakeholders, with obvious tangible examples that current methodology has more holes in it than Swiss Emmental cheese https://simple.wikipedia.org/wiki/Emmental_cheese

GEM Three? modelling evolved, both as a “stress-tester” as well as to explain (and question) the possibility of a double WRONG of two WRONGS multiplied out = Double Wrong PLUS in market value. And so the other applications. Hence this article.

GEM Three? the original to test the veracity of current market value PhD opportunity income producing property

GEM Three? and the model has been presented and published at conferences at the highest levels in the World aka IVSC - WAVO, Singapore June 2018, IVSC - ANEVAR, Bucharest, Romania Sept. 2018 and of course repeatedly since I invented it in 2017.

The logic behind how I could explain the concept visually came to me when Westfield (SCentre) announced again how rents are up, vacancies are still at less than 99.0% and that yields had firmed. And market value was up.

It was similar to the Australian Banks. On a wild bucking bronco lending to all and sundry, pumping out dividends, bolstering share price, and no doubt coining Executive Bonuses.

For me it was akin to sitting on a dogs tail and wagging the dog with ASIC and APRA sipping lattes!

And so using only one axis (I strictly have two data series and should be using a second Y-axis), I realised by using simple numbers I could explain the logic (sic) of this folly.

How could compounding rents, keep producing lower yields (larger multipliers)? Actual modelling and research and analysis hence a PhD opportunity and using a second Y-axis will produce a working model.

So here is the original GEM Three?.

If one assumed that a lease started on a rent of $10.00 (per square metre, square foot, total lease) and escalated at 6.5% per annum including 2 X options over a 3 X 5 year lease, with Tenant’s goodwill locked in, hence artificial increments on lease renewal eg. Duress, unconscionable conduct, misrepresentation, etc. by year 15 that same rent = $24.15.

The benefits within the lease turned the lease from an Intangible Asset into a Debt Obligation. A negative annuity obligation.

How then could progressive yields decline, and multipliers increase from say 12.5 X to say a 25 X multiplier. “Look mum. I have just made this piece of concrete more valuable”.

The original current market rent (sic + 142%) X 25 say to = current market value = WRONG?

Wrong.

And that is part of the reason, why no matter how IVSC, WAVO, ANEVAR, PINZ, API, ASA, ISA, RICS, CASA, IACVS, IACVA, etc. seek to improve valuation appraisal standards, unless one delves into the bowels of what valuers appraisers are doing, not much will happen! Not much will change either.

Because what valuers are doing, is using the Letter Box method. Adding up letterbox numbers, not testing the veracity of their “evidence”, oft dividing out the sum of the Letter Box Numbers by a pre-determined denominator and using same and applying a “supposed” untested multiplier to produce purported market value. And it is as bad as that. I have this on file! It is industry wide.

And so, one needs to go back to GEM One? (my rental invention to evaluate the reasonable rent of individual leases, taking a sample of say 10.0% or 15.0% on key leases to evaluate the veracity of income streams) and GEM Two? a whole body of leases, and revisit the yield multiplier argument.

And so by stress-testing your current market rents (Gilbert, D. 1995) some giant mistakes could have been mitigated. And so Top Ryde City, valued $840.0 million 2009, valued sold to Blackstone 2013 for $341.0 million, with some $80.0 expended and flicked on for $700.0 million tells a sad story of big winners and losers. How much better would the receiver managers and or bank finance have done if a more informed argument was presented via my rental valuation software?

This modelling can be used for individual properties including portfolios, including the industry as a whole!

And here it is. It is presented above.

GEM Three? stress-tester residential housing market debacle PhD residential property stress-tester

I am on Public Record (yes after you have expressed yourself on line; well it is there for ever) for passionately arguing for fiscal intervention aka APRA ASIC into bank lending practices on Business Spectator in 2011 / 12 or thereabouts, presumably until Rupert Murdoch intervened, as I was interrupting in his little games to influence the show!

Today as time has passed, well, we have are in a Royal Ripe Pickle!

But as the GEM Three? stress-tester unwound, it became perfectly clear here was an excellent tool to evaluate the influences of lower interest rates on the “price” of housing stock: in a given suburb; geographic location; State; as a whole, etc.

I have modified the original GEM Three? model, and linked it to residential assumptions. The blue bar chart simply shows that lower and lower interest rates cause “house price” to go up. Until other real metrics kicked in. Oops I have just paid X. been “given” a huge huge mortgage on a 1.0% return. And the tenant is paying 35.0% + on his pre-tax income in rent!

These metrics will differ in different locations and for different types of property, but that is some of what I have gleaned from press reports.

Another two metrics could be “stress testers” for:

1.     Average or purported price over time presented by nominator bar graph and net return is presented by denominator bar graph; and

2.     Average or purported price over time presented by nominator bar graph and post tax gross rent as a percent of wages presented by denominator bar graph.

It may even warrant other PhD opportunities.

GEM Three? other applications and PhD opportunities for: monetary policy settings and outcomes; stress-testing net income of given Corporation and Share Price; ASX or any other share market index and market cap; an Industry eg. Mining against net income streams and market caps

Given the recent reduction in the Central Bank Cash Rate in Australia, let us try to understand what this means, which I have elaborated before in earlier articles papers.

[# 6/6 update: my economics Prof. Mike Truu was great on Business Cycles and Fluctuations ref. 1993 paper. Australian bank executives and other corporations and entities would be purged during higher interest rate cycles, where the opportunity cost of money tested the metrics and balance sheets of weaker companies. And cleaned them up and ensured the strong ones survive as part of a cleansing process].

I have used exactly the same set of “numbers” as in the modelling above and have changed some of the labels and or messages in label boxes.

The current methodology in regard to Monetary Policy is that one can keep dropping the Central Bank Cash Rate (or let the Bond Market futures predict one’s path; which means the Central Bank is on auto-pilot with bond futures setting the cash rate to bolster the share market which has to be a certain winner) to stimulate economic activity! Until the main event ……….

Forget the raft of other concerns. Debt. House prices (returns and rent as percent of pre-tax income). Quality of bank Loan Books through tardy lending. Period of stimulation. Falling GDP, deflation. Employment rate = 1.0 hour per week to be employed. Direct correlation to bank Balance Sheet as house prices deleverage on 100.0% loans. Less liquidity in the mix with lending “growth” coming off say 3.0% per annum. Ooops sudden starvation of cash into the system as new metrics have to set in (sink in)!

Forget about, that if value multipliers and lending borrowing settings were off a cash rate of 5 or 6 or 7% that loans would be lower, that with the opportunity cost of money “set” properly, real “value” might be considered as a cash option vs riskier Stock Markets. By increasing or decreasing the cash rate on 5.0% or 6.0%, by 0.25% the “change” is circa 4.0 to 5.0%, so the “value metric” or value swing assume there was a direct correlation on the “average” price of $500,000 would be say $25,000 or $30,000.

Whilst there is not or would not be a direct correlation in the significantly over-stimulated housing market, what if the decline of 0.25% in the current cash rate of 1.5% would cause the house price to increase by 17.0% or thereabouts?

How about an overstretched market with an average mortgage coping with that same 17.0% on a $500,000 loan? The “loan” came about because the monetary settings and or other stimulatory measures were hopelessly wrong. And that has been over a sustained period now.

That same small percentage change off a lower denominator makes a significant change in relative terms to the “value” or “cost” metrics.

Why have they let it get so out of control? Why are they Hell Bound in trying to make it worse?

Even if the cash rate was at 4.0%, a 0.25% change in simple terms = 6.25% up or down.

Here is a great PhD opportunity in economics in my opinion.

We, and the World’s “value” metrics would be in a far far better place.

Lets turn to value metrics linked to companies, industries eg. IT, mining, major retail, etc. presented via this bar graph.

I have adjusted the figures. One assumes IFRS Reporting Standards. Like the Shopping Centre Model, different industries trade within a narrower range and yield / multiples mirror and price the risk reward value.

Higher risk expects a much higher return eg. 25.0% on a 4 X multiplier; good retail 16.0% on a 6 X multiplier; property say 12.5 X to 20.0 X plus. The whole ASX might be 7 X on average.

So by applying different data series, and superimposing different income streams under a narrow band of yield / multiplier to reflect that industry, one can stress-test a business, businesses within an industry and or an industry or the whole ASX or the whole Dow Jones or NASDAC itself, “backed” by the Trump led US Government via large tax deductions.

This modelling becomes natural mechanism of checks and balances and I suggest another PhD opportunity

Commodity prices, interest rates and bond prices, bank borrowing and lending levels can be measured and benchmarked at different interest rates!

Here are several other PhD opportunities for Merchant Banking, Finance, etc.

Conclusion

I now believe I have teased out this modelling in just about every way I can think of.

No doubt there are and will be more ways.

I hope this is of more interest and stimulates ideas and thought.

I have heard nothing to the contrary.

? Donald E Gilbert as Trustee Gilbert Family Trust 2019

[1] Please note: in previous articles I have wrongly used the words ‘current market rent’ when linked to my software. I do not believe that it warrants being accredited as a tool to “value” a lease until it has gone through thorough Beta Testing