Karbank Blog

What is the worst economic development policy ever?  Perhaps it is the one that incentivizes tax-paying businesses to move off the tax rolls, permanently.  Regrettably, that is the current policy of the City of Kansas City, MO (“KCMO”).  

This Karbank letter to Kansas City's Mayor James explains the corrosive impact of the City’s “tax-abatement-forever” policy.  In summary, the policy drives down private property values, decreases the tax base, deprives resources from the school districts, libraries and essential civic services, and drives away tax-paying development.  

This is not rocket science, it is Economics 101.

When bureaucrats don’t understand how the private sector economy works, bad policy is made.  By the time the policy is overturned, and inevitably it will be if rationality is indeed a hallmark of the human species, the question is how bad the damage will be to the City’s economy and image.

An article from yesterday's Kansas City Star doesn’t adequately explain the consequences of the policy.  However, the last sentence of that article is enormously telling about how KCMO City Council’s hyper-sensitivity to development in rival Johnson County, Kansas has led to KCMO’s monumentally misguided “tax-abatement-forever” policy.  The City Councilman is quoted as saying: “…I don’t mind competing unfairly with Johnson County [Kansas]”.  Astonishingly, he doesn’t seem to realize that the City is also competing unfairly with the dutiful taxpayers of KCMO…using the taxpayer’s money to do so.

The reality is that KCMO suffers all the collateral damage from the tax-abatement-forever policy; it accelerates development in Johnson County, as it is no longer desirable to develop in KCMO.  Investors and developers will work where their efforts and capital are, to put it broadly, respected.  Right now in KCMO, they are not.  

This is not rocket science, it is Psychology 101.

Kansas City’s leaders need to go back to school to take Economics 101 and Psychology 101.

Steven Karbank

 

I have a lease proposal on my desk, presented by a broker, a “Senior Vice President” of a national brokerage company, on behalf of a prospective tenant, an international food company.  The proposal states “Lease Type:  The Lease type will be NNN.” 

NNN or “Triple Net” in real estate parlance means that the tenant would pay all occupancy costs including taxes, insurance, utilities and maintenance (as opposed to a “gross” lease in which landlord pays some occupancy costs).  Yet the so-called “NNN” lease proposal includes this language:

“…provided that Landlord agrees to be responsible for general building structure, foundation, 
plumbing/electrical, roof and parking lot.” 

Moreover: 

“Controllable operating expense passthroughs…shall be capped in subsequent years at
an annual increase of 5% over prior year's controllable operating expense cap." 

Further: 

“Landlord shall warrant [the HVAC equipment] for sixty-six months [the entire lease term].”

In the spirit of the broker’s concept of a “NNN” lease, I would describe the broker’s work on the transaction over many months as CCC...with "gross" shortcomings.   

Steven Karbank

In a recent New York Times article entitled,“Class-Consciousness in the Office Building Market”, the description of what constitutes Class A office space begins with “well maintained, with stellar ownership…”.    

When looking for office, industrial or retail space, companies should always inquire about the landlord quality.  Landlord quality incorporates many aspects, among them: responsiveness to tenant needs and problems, financial capacity to fund tenant improvements and to maintain the property, quality and attitude of landlord’s employees and contractors who interact with the tenants and work on the property, quality of record keeping and documentation, and so on.  

Sometimes the landlord quality is apparent when touring buildings.  In office buildings, are the building exterior and public spaces well maintained, HVAC grills and restrooms clean, building interior temperature comfortable and consistent, parking areas well lit, etc.?  In industrial buildings, are there indications of roof leaks and are the floors, parking lots, dock doors and equipment well-maintained, etc.?   If a space doesn’t show well, often (but not always) it’s indicative of a landlord who is not proactive, or at least responsive, in maintaining its properties and solving tenant’s needs and problems.

Throughout a tenant’s lease term, many issues will come up that will test the landlord quality, including maintenance and construction issues, tenant space expansions or contractions, subleasing or lease assignments, landlord waiver documents, safety, and many, many other matters.  Lease documents may codify the legal relationship between the tenant and landlord, but landlord quality can make enormous difference to a tenant’s satisfaction and prosperity during the lease term.     

Steven Karbank

Numerous times in the past five or six months, I’ve driven past a commercial building that has a real estate sign in the front yard.  Each time the building and grounds have looked more and more dilapidated and untended. 

Out of curiosity, a few weeks ago I called the telephone number on the real estate sign.  The number was not in service.  Puzzled, I called 411 and asked for the telephone number of the real estate company.  It turns out that the sign had the wrong area code.  It was astonishing that neither the agent, whose name was on the sign, nor anyone else from his company (a franchise of a national real estate company), realized that the sign had the wrong telephone number. 

I called the agent whose name was on the sign.  He agreed to meet me at the building a few days later. 

When we met, he was 20 minutes late.  He had no brochures on the property, no plans, no tax information.  He looked like he had spent the last few days fixing an oil leak under his car. 

As bad as the property looked on the outside, it looked a lot worse on the inside.  The place was filthy.  Apparently the heat hadn’t been on all winter.  There were squatters living in the basement.  The agent, who was also serving as the property manager, looked dumfounded, as if he hadn’t been in the building in a long, long time (and he probably hadn’t been).  

It turns out that the owner of the property was an out of town financial institution that had foreclosed on the property last year.  Unfortunately, they hired the wrong agent (with the wrong number) and the wrong property manager.

The owner deserves better.  The property deserves better. 

Steven Karbank

 

The most promising comment I heard in 2010 about the real estate business, and the economy in general, was made by a recent college graduate now working as a real estate broker.  He said:  “The real world is not as easy as it looks.”

Those of us who have been through a few market cycles (the “real world”) know that the worst thing that can happen to a young person is for success to come too easily and too soon.  It leads to bad work habits, a disregard for the fundamentals and a big head.

Boom markets make success look easy.  Recessions offer up the reality principle.  They cure people of false impressions and bad habits…at least for a while. 

Hard work, responsibility, respect for the fundamentals and sensible decision making are tonics for the real estate markets and for the economy.  If the real world is not as easy as it looks, the future should be good. 

Steven Karbank

 The implosion of the ill-conceived, unduly complex and risky Collateralized Mortgage-Backed Securities (CMBS) market brings to mind a couple of stories.

In the early 1980’s I traveled to China. It was a fascinating trip, especially so when reflecting on the country’s transformation since then. In those days it was pretty tough for a westerner, particularly as I was on my own (my parents had traveled to China with a group in the 1970’s…my father took with him a paper Karbank Real Estate Company ‘Offered By’ sign and draped it on the Great Wall for a photo). I couldn’t speak Mandarin, Shanghainese, Cantonese or any other Chinese dialect, except maybe to say ‘thank you’ (though I found out after the trip that I was using the wrong words in the wrong places---no wonder I was often greeted with blank stares when I attempted to say ‘thank you’) and in those days very, very few Chinese spoke or understood English.

I remember going to a restaurant that I had read specialized in a local delicacy that time of the year: hairy crab. After pointing at the crabs on the tables nearby, I managed to communicate to the waiter what I wanted and in a few minutes he brought me a large plate of steaming hot hairy crabs…in the shells.

I had only been in China for a day or two and I didn’t know the ropes or the etiquette. Not knowing quite what to do, I tried to eat the crabs with the chopsticks, couldn’t crack the shells and was making a mess. I looked over at a man at the next table who made the simplest of gestures to me indicating that it was OK to eat with my hands. No pointing, no waving…his gesture and nod were so slight that in that instant, only I could see it. He spared me embarrassment. After I began eating the crabs (which were delicious) with my hands, he nodded again as if to say “enjoy!”.

Given enough time and energy, it would have been possible to eat the hairy crabs with chopsticks. Yet as the man at the next table knew, and apparently everyone else in China knew, chopsticks were not the right tools to use. The simple method of eating with the hands was much better suited to the task and made a lot more sense.

When my son was young, we went for a visit to San Antonio. While there, in addition to visiting the usual notable San Antonio landmarks, we went to a wax museum. The first portion of the museum was dedicated to historical figures, movie stars, sport figures and the like. To me the exhibits seemed pretty hokey and the figures more creepy than realistic: the skin on the figures appeared rubbery and sweaty; the facial expressions looked like those in photos in abnormal psychology books.

Oddly, the museum was rather hot (I would have thought the wax would have stayed better preserved at a cooler temperature). Moreover, the air was stale and thick and as we progressed through the exhibits, the rooms became darker and darker, except for the intense spot lights on the figures. The exhibits seemed to go on and on and on and the entrance from where we came, ever more remote. I was feeling claustrophobic and began peering around corners to see if I could spot daylight, or even an exit sign. I was ready to turn-back, but figured that we had to be closer to the end than to the beginning. I was uneasy and even feeling unsteady on my feet (though, remarkably, my son was blithely enjoying the exhibits). Frighteningly, the figures in the exhibits looked more and more like zombies, the familiar-faced but motionless dead…and that was before we crossed into the special horror section!

The dreaded horror section: Vincent Price with that toothy, foreboding smile; the shower scene from Psycho (supposedly Janet Leigh was never able to take a shower again after shooting that scene); the demented looking, wide-eyed Jack Nicholson in the Shining, and the like. Whereas the earlier exhibits were creepy, the horror exhibits were positively scary, in part because by that time I had lost all sense of direction and was completely discombobulated. Also, there were strategically located ‘fun house’ mirrors which, in that environment, made me look every bit as scary-looking as the figures in the exhibits. I was light-headed, very queasy and found myself muttering: “ Wait a minute, I sure don’t remember blood dripping from Norman Bates’ knife the last time we passed here" and “Wasn’t the guy with the hockey mask and knives-as-fingers over there before “ and ”That guillotine blade was not in the down position a minute ago…aaoooohhh, and there was no head in the basket then either!” and “This is the bloody Twilight Zone!!!”.

When the exit finally appeared and we stumbled out into the sunshine and fresh air, I was only modestly relieved. I was queasy for the next week. Even now, when my son mentions the wax museum to me, usually to razz me, that queasiness returns.


Financing real estate with collateralized mortgage-backed securities is like trying to eat hairy crabs with chop sticks: it’s clumsy, it’s messy and there’s a much simpler and more sensible way to do it. It is also like wandering through the horror section of a wax museum: it’s unnerving enough when things are OK, but it's terrifying when you want to get out.


Collateralized mortgage-backed securities try, in essence, to fit disparate pieces of real estate into a neat, uniform, commoditized, sliceable and diceable package to provide lenders (the investors) the illusion that they are buying financial instruments rather than a piece of a motley and unwieldy collection of mortgages. Yet anyone who understands real estate (apparently not Wall Street) knows that doesn’t work.

Real estate, particularly commercial real estate, is not well suited to being financed as part of a large, disparate pool of property. Each property is unique. Each has its own particular physical characteristics and its own niche in the real estate market place. Even if two properties are quite similar, at times those similarities will diverge: different tenancies and lease terms, different repair or refurbishment needs, different capital requirements, different tax assessments, different neighbors, different title issues, and so on. There is no ’one-size-fits-all’ for real estate.

Moreover, there are too many day-to-day and long term decisions that have to be made in the course of owning of real estate. After all the slicing and dicing and the myriad traunches of debt syndicated to a large and diverse pool of investors, with whom does the borrower talk to get lender approvals or decisions? It is ridiculously impractical (think eating hairy crabs with invisible chopsticks).

For example, a standard provision of most real estate loans requires that the borrower seek lender approval for a variety of matters including significant lease and building modifications. With a conventional mortgage loan, the borrower calls the lender…who knows the borrower, the property and the market… they talk through the issues and act accordingly. With a CMBS loan, the borrower may not even know who to contact.

If the lender’s representative can be found, he (or she) probably knows nothing about the borrower, nothing about the property, nothing about the tenant, nothing about the market, and nothing about the investor… other than what is in the file (which is probably incomplete). If any decision is time-sensitive, like getting an estoppel, forget it. If there is a problem that needs to be resolved, the borrower is stuck, the tenant is stuck and the lender (investors) is stuck. If there is a borrower default, as is the case with a huge number of CMBS loans, it can be a long, laborious, painful process to get a resolution. When things go bad on a CMBS deal, it's like being stuck in the horror section of the wax museum, except that this one is populated with really scary lawyers, unrealistic accountants and clueless real estate people.

From a borrower's perspective, the simpler, better solution (think eating crabs with the hands) is to finance property with a conventional, stand-alone mortgage rather than CMBSs. Even if it costs a little more in interest rate, stand-alone mortgages offer greater flexibility to lease, manage and sell property. From a lender's (investor's) perspective, when it comes to the CMBS wax museum, as my father used to say, "It's easier to stay out than to get out".

Steven Karbank

Shortly after my father started Karbank Real Estate Company in 1950, he was asked by a client to manage some apartments in a less than desirable part of town.  On Thanksgiving Day that year, he received a phone call from the police saying that there had been an explosion in one of the apartments.  Hat in hand, he explained apologetically to my mother and the other guests at the Thanksgiving dinner that he had to leave to respond to an emergency.

It turned out that a deadbeat tenant at the apartment had skipped-out on his lease in the middle of the night and took the stove with him.  Not bothering to turn off the gas, the tenant plugged the gas line with a potato.  The inevitable explosion, which fortunately injured no one, resulted in my father enduring endless ribbing from family and friends about new recipes for potato-based dishes (flaming potato soufflé, flash roasted potatoes, potatoes baked Alaskan, instant French fries, etc.).  It also convinced my father to get out and stay out of managing residential real estate.

Steven Karbank