How To Make A Fortune*

Transcription

1 How To Make A Fortune* November 3, 2010 * My compliance team cautions you that this is a tongue in cheek title Pershing Square Capital Management, L.P.

2 Disclaimer The analyses and conclusions of Pershing Square Capital Management, L.P. ("Pershing Square") contained in this presentation are based on publicly available information. The analyses provided may include certain statements, estimates and projections prepared with respect to, among other things, historical and anticipated performance of certain assets, and the values of assets and liabilities. Such statements, estimates, and projections reflect various assumptions by Pershing Square concerning anticipated results that are inherently subject to significant economic, competitive, and other uncertainties and contingencies and have been included solely for illustrative purposes. No representations, express or implied, are made as to the accuracy or completeness of such statements, estimates or projections or with respect to any other materials herein. This presentation and the information contained herein is not a recommendation or solicitation to buy or sell any securities. Pershing Square hereby disclaims any duty to provide any updates or changes to the analyses contained in this presentation. 1

3 What We Look for in Our Investments Low valuation Forced Sellers Attractive capital structure Favorable long-term supply dynamics Favorable long-term demand dynamics Out-of-favor 2

4 We Believe We ve Identified an Investment with: A low valuation Lowest valuation in at least a generation Forced sellers A large number of distressed transactions Extremely attractive financing available High LTV, low-rate, fixed-rate, long-dated, non-recourse debt, pre-payable without penalty Favorable long-term supply dynamics Short-term oversupplied market, but long-term supply is controlled Favorable long-term demand dynamics Demographically driven demand growth Out-of-favor Currently, this is a somewhat shunned asset class 3

5 So How Can You Make A Fortune? Not for Public Distribution

6 The American Dream - On Sale 5

7 What Happened? Not for Public Distribution

8 What Happened in the Credit Markets? Freely Available Credit Relaxed lending standards More Leverage / More Buyers Increasing Asset Values Financial innovation CDO Demand Decreasing Defaults Source: Who s Holding the Bag?, PSCM, May

9 Leverage Increased The second lien market allowed borrowers to layer additional leverage Total Second Lien & Piggyback Second Lien Issuance Source: Standard & Poor s, and Who s Holding the Bag?, PSCM, May

10 Financial Innovation The popularity of Interest Only and Negative Amortization loans grew rapidly IO and Neg. Amortization Originations (% of dollar volume) 35% 30% 29% 25% 25% 23% 20% 15% 10% 5% 0% 6% 4% 2% 1% Source: Loan Performance, Credit Suisse 9

11 The ABS Market Provided Liquidity for Originators Sub-prime and Second-lien ABS Issuance Volume Facilitated by Rating Agencies and Bond Insurers Source: Thompson Financial, Deutsche Bank, Who s Holding the Bag?, PSCM, May

12 Asset Values Went Up Between January 2001 and June 2006 home prices rose at a 13% CAGR Home Price Appreciation (Case-Shiller 10-City Index) Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Source: Case-Shiller Home Price Indices 11

13 Valuation Not for Public Distribution

14 Asset Values Have Declined Meaningfully Home prices are down 28% nationwide Home Price Appreciation (Case-Shiller 10-City Index) Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Source: Case-Shiller Home Price Indices 13

15 Housing is More Affordable Today Falling home prices and lower interest rates dramatically improved affordability¹. Median family income is now 78% higher than what is required to qualify for a loan to purchase the median price single family home using 80% loan-to-value, fixed-rate financing NAR National Housing Affordability Index Fixed Rate Composite Source: National Association of Realtors ¹Affordability = Median Income/Qualifying Income

16 Cheap Compared to Renting The breakeven appreciation rate for rental equivalent value is the best since the 1970s Housing as a hedge: Home ownership with fixed-rate financing protects buyers from asset and rent inflation Source: Beracha and Johnson, Lessons from Over 30 Years of Buy versus Rent Decision: Is the American Dream Always Wise? Assumptions in appendix 15

17 Forced Sellers Not for Public Distribution

18 Foreclosures and Short Sales Nationwide, ~30% of sellers are in or are approaching foreclosure Distressed Sales (% of total re-sales) Long-term the foreclosure crisis is good for housing. Over-priced and overleveraged homes will be transitioned to new, stable owners at more reasonable prices and on more favorable financing terms Source: Deutsche Bank, Whither the distressed inventory flood 17

19 Short Sales Short sale transactions are increasing Number of Short Sales Per Month Source: HUD, Core Logic 18

20 Distressed Sales are an Opportunity for Buyers REO sales tend to be priced below the broader market Houston REO vs. Overall Pricing ($ thousand) Source: Deutsche Bank, Whither the distressed inventory flood 19

21 A Sellers Race to the Bottom in Vegas Buyers benefit when conventional sellers compete with distressed sales. Las Vegas is an extreme example, where distressed and non-distressed sale prices have nearly converged Las Vegas REO vs. Overall Pricing ($ thousand) Source: Deutsche Bank, Whither the distressed inventory flood 20

22 Financing Not for Public Distribution

23 Mortgage Rates are Very Low Mortgage rates have fallen to historically low levels. Fixed 30-year rates are now below 4.5% for the first time in the history of the Freddie Mac lender survey 30-Year Fixed-Rate 80% LTV Mortgage 19% 17% 15% 13% 11% 9% 7% 5% 3% Source: Freddie Mac 22

24 What Makes a Home Mortgage So Attractive? Typical Conforming Mortgage Term Sheet Low Fixed Rate 4.43% APR Long Term 30-Year Amortization High LTV 80% (97% for FHA loans) Non-Recourse Loans are explicitly or effectively non-recourse Adequate Financing Available $417k to $730k, depending on location No Prepayment Penalties Creates refinancing optionality Tax Deductible Interest More valuable with coming tax increases No other business or investor can get financing on such favorable terms 23

25 The Mortgage Market Benefits from Government Support Support from the federal government provides qualified borrowers with access to credit on favorable terms GSE and FHA mortgages are now >90% of the origination market The target Fed Funds rate is 0% The Fed has purchased more than one trillion dollars of Mortgage Backed Securities FHA high LTV refinancing programs are helping distressed borrowers 24

26 What Are the True Economics of Home Ownership? Our Assumptions: Conventional Loan Transaction Costs Down Payment 20% Closing Costs (% of Purchase Price) 2% Mortgage 30yr Fixed Rate Selling Fees (% of Sale Price) 6% Interest Rate 4.40% Annual Fees FHA Loan Property Taxes (% of Home Value) 1.50% Down Payment 3.5% Maint. + Insurance (% of Home Value) 2.00% Mortgage 30yr Fixed Rate Annual expenses grow with home appreciation Interest Rate 4.25% Upfront Mtge Insurance (Financed) 1.00% Tax Rate Annual Mtge Insur. Premium (First 5yrs) 0.90% Income Tax Rate 25% Rent Implied rent grows with home appreciation Holding Period 10 Years 25

27 What Are the True Economics of Home Ownership? (cont.) Not for Public Distribution After a small down payment, a buyer s monthly after-tax cost of carry is at or below the monthly rental expense Average Two Bedroom Home in Baltimore: Conventional FHA Home Price $ 187,998 $ 187,998 Equivalent Monthly Rent 1,300 1,300 Owner's Monthly Out of Pocket 1,072 1,362 Downpayment + Closing Costs 41,360 10,406 LTV 80% 96.5% Source: Trulia - home price and rent expense data 26

28 The Benefits of Low-Cost, High-LTV Financing Homebuyers can make an excellent after-tax return on their equity investment, even under modest appreciation assumptions Conventional 80% Financing IRR Assuming 10yr Hold Annual Appreciation Residual Return Current Return Total Multiple of Equity 1% 3.8% 6.6% 10.4% 2.7x 2% 6.9% 6.8% 13.7% 3.6x 3% 9.5% 7.0% 16.5% 4.6x 4% 11.8% 7.3% 19.1% 5.7x 5% 14.0% 7.5% 21.5% 7.0x 6% 15.9% 7.8% 23.7% 8.4x If the borrower has the opportunity to refinance at better rates, returns would be even higher 27

29 The Benefits of Low-Cost, High-LTV Financing (Cont d) Homebuyers can make an excellent after-tax return on their equity investment, even under modest appreciation assumptions FHA 96.5% Financing IRR Assuming 10yr Hold Annual Appreciation Residual Return Current Return Total Multiple of Equity 1% 16.3% 0.4% 16.7% 5x 2% 20.5% 1.7% 22.2% 7x 3% 24.0% 2.8% 26.8% 11x 4% 27.0% 3.8% 30.8% 15x 5% 29.7% 4.7% 34.4% 19x 6% 32.1% 5.6% 37.7% 25x If the borrower has the opportunity to refinance at better rates, returns would be even higher 28

30 Favorable Long-Term Demand Dynamics

31 Household Formation Trends Household Formation has been positive, with some degree of cyclicality, since at least the 1970s. Household growth will likely accelerate as the recovery gains traction Annual Household Formation (% growth) 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% Household growth is cyclically depressed 2.0% 1.5% 1.0% 0.5% 0.0% Source: US Census Bureau 30

32 Homeownership Rates have Normalized Homeownership rates have declined to pre-bubble levels. While ownership is above pre-2000 rates, higher affordability and an aging population should support an ownership rate near today s level Homeownership (% of households) Source: US Census 31

33 The Number of Owner Households Will Rebound Accelerating household formation and a stabilization of the homeownership rate should lead to growth in owner households Change in Owner Households = (Household Formation x Homeownership Rate) + [Number of Households x (Change in Homeownership Rate)] Source: US Census Bureau, BLS, Maximus Advisors 32

34 Long-Term Demand for Housing Projected Long-Term Demand for New Housing Units (single and multi-family) Household Formation Growth needed to maintain constant vacancy rate X Homeownership Rate Assumed: 66%¹ LT Annual Single Family Home Demand 1,101 1,253 Source: Joint Center for Housing Studies, Harvard University, Updated Household and New Home Demand Projections ¹Applies 66% to all figures excluding: Vacant Rental (0%) and Second Homes (100%) 33

35 Favorable Long-Term Supply Dynamics Not for Public Distribution

36 Temporarily Elevated Inventory Levels In the short-term, for-sale homes and shadow inventory will weigh on home prices. This provides an opportunity to buy a long-term investment at an attractive valuation in a market facing short-term distress Change in Home Prices vs. Months of Inventory -25% Price 14-20% 12 Home Prices (YoY%, Inverted) -15% -10% -5% 0% 5% 10% 15% Supply Months of Supply (6 Month Lead) 20% Source: US Census Bureau 35

37 New Supply Growth Will be Slow Builders have sharply reduced their construction capacity, increasing lead times when the market does recover Community Counts for Public Builders It can take three to seven years to get land permitted in many of the more desirable markets¹ Sources: Deustche Bank, Builder Community Analysis ¹Toll Brothers Management 36

38 Housing Starts are Now Below Long-Term Demand Growth Housing starts have fallen sharply and are now lower than at any time in at least the past 50 years. Starts today are less than half of average long-term demand Seasonally Adjusted Housing Starts (thousands) 3,000 2,500 2,000 1,500 Projected LT Demand: mm new single family homes per year 1,000 Inventory Depletion New Supply Growth Will be Slow Source: Chart: US Census Bureau ¹Joint Center for Housing Studies, Harvard University, Updated Household and 37 New Home Demand Projections

39 Out-of-favor Not for Public Distribution

40 Everybody Else is Afraid The best investments we have made are the ones no one else would touch So even at 89 cents a share, it still looks pretty bleak out there for General Growth Shareholders - Businessweek, April 2009 The U.S. housing market is headed for a complete and total nightmare - Business Insider, August 2010 Now They Tell Us: Experts say housing is a lousy investment and it always will be - Yahoo Finance, August

41 Concluding Thoughts Not for Public Distribution

42 Why Now? Interest rates won t stay this low forever New monetary easing increases the risk of inflation Even with the current inventory levels, at today s valuations, it is unlikely we will see another substantial decline in prices Forced selling may abate as lenders balance sheets improve Generally, there is more liquidity on the way down than on the way up An economic recovery could cause housing to recover faster than many people think 41

43 The Housing Purchase is One of the Most Emotional Investment Decisions a Family Can Make Not for Public Distribution Once a family is able to purchase a home, the decision is based on psychological factors: Confidence in the, and one s, future The fear of missing the opportunity to buy at the bottom These psychological factors have self-reinforcing qualities that are similar to the forces that drive financial markets Catalyst Housing Prices Increase Increase in Buyer Confidence 42 Decision to Purchase

44 An Institutionally Under-Owned Asset Class Institutional investors have almost no exposure to singlefamily home rental properties ( SFHRPs ) as an asset class Low valuation, high current yield and long-term appreciation potential make SFHRPs an intelligent investment for institutional investors Despite these investment characteristics, we are unaware of any large pools of capital that have been raised to pursue this opportunity. This will change 43

45 The SFHRP Investment Opportunity Is Best Understood By Analogy For the vast majority of the 20 th century, timber was never considered an institutional asset class Led by forward thinking investors, institutional investments in timberland emerged in the USA in the 1980s With the advent of timber institutional management organizations (TIMOs) and timber REITs, institutional timberland investments have grown significantly DANA Limited estimated that institutional investors had invested ~$50bn in timberlands as of early 2008 In 2007, the first timber ETF launched The same features that attracted institutional investors to timber: current yield, inflation-protection, portfolio diversification, demand for hard assets, and the ability to create long-term tax-deferred gains, also apply to SFHRPs 44

46 Potential Institutional Investment Demand is Material If global institutions and private wealth funds allocated approximately 1% of their assets under management to SFHRPs, it would absorb the entire U.S. for-sale inventory of single-family homes Median Priced Single Family Home $172,000 U.S. For-Sale Inventory of Single-Family Homes 3,970,000 U.S. For-Sale Housing Inventory ($Tn) $0.7 Global Institutional & Private Wealth AUM ($Tn)* $64.3 U.S. For-Sale Inventory as % of Global AUM 1.1% * Source: IFSL, US Census Bureau 45

47 Appendix Not for Public Distribution

48 Appendix Buy vs. Rent Assumptions: Not for Public Distribution Home Buyer's Assumptions Renter's Assumptions Down Payment 20% Down Payment seeds investment portfolio Mortgage 30yr Fixed Rate Diff between mtge and rent is invested Closing Costs 2% Portfolio is made of stocks and bonds Holding Period 8 Years Rent Growth Same as home appreciation Selling Fees 6% Income Tax Rate 25% Income Tax Rate 25% Capital Gains 20% Capital Gains 20% Property Taxes - Annual 1.50% Maint. + Insur - Annual 2.00% Annual expenses grow with appreciation Source: Beracha and Johnson, Lessons from Over 30 Years of Buy versus Rent Decision: Is the American Dream Always Wise? 47