Return To Reality

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A new malaise has set in which is inhibiting the economy andwill continue to inhibit value enhancement of substance for a longtime. Obama and Congress seem to have thought they could just dowhat they wanted to push through their agenda and there would be noeconomic consequences. I think Nancy still does not get it, and shethinks she can still push through more economy killing legislationin the lame duck session, like card check, cap and tax, highertaxes on many of you reading this, and other things like these.

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With the digital revolution, globalization, and a truly terribleeducation system in many cities in the US, it will be a long timeto re-employ the millions who need to be working. The digitalrevolution is now materially impacting how jobs are done and theskills needed to get a good job. We are at the beginning of thisrevolution and it will severely impact those with a lesser qualityeducation and it will be a very different skill set than many nowpossess who are older. Companies have extraordinaryamounts of cash and will be more likely to spend it on capitalequipment which does the job of those with less education andlesser skills. Computers do not get covered under the newhealthcare bill. You can just fire the machine with no lawsuits byflipping the on off switch. You can yell at the computer with nolaw that says be nice. It is getting to where hiring an additionalperson becomes expensive and hard to terminate. Machines now thinkand even talk and take down information.

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The other issue is that with digital speed, companies cancontinue to outsource many tasks. There are now well educated andproductive people in other countries at a fraction of the wage andno benefits. This all will affect office occupancy and industrialusage. There is no way to measure what it would be were it not forthese new things like digital capability.

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Consumers are not returning to their irresponsible spending formaybe a generation as happened to my parents who lived through thedepression. Losing your house and your job has a lasting effect onmost people. They will not rush to spend again and they will notget the mortgages, home equity loans and lines of credit they had afew years ago to fund the big house, and extra car and the fancyvacation.

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The optimism of earlier this year outran reality. The debtmarkets had come back, spreads narrowed substantially, a tiny bitof CMBS got issued, a few trophy properties traded, the stockmarket got ahead of itself, the bank stress tests let everyone makebelieve all is well, and extend and pretend hid the real estatevalue devastation which has occurred. For whatever reason in May,reality seems to have sunk in again. Maybe that is when themajority of voters lost confidence in Obama and when the majorityrealized that healthcare was just the start of a trend that peopledid not agree with. Unemployment did not get better andforeclosures got worse with no end in sight. The magnitude of thedeficit at all levels of government finally sunk in and servicesstarted to get reduced materially in many cities. Everyone seemedto realize all at once that we have a very long road ahead and theuncertainty generated by Washington just added to the malaise.

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Investors need to understand there are no instant profits. Youneed to have patience again in real estate, and you need to knowwhat you are doing. The servicers and banks are overwhelmed andlack real in depth knowledge of real estate so working through themess is going to get extended for years to come. While we may be atthe bottom-I do not believe we will have deflation- there is no V,just good old time real estate fundamentals and long term holds torealize good returns. I do not believe the old PE fund returns of20% IRR + is realistic for most deals. A reset to 15%-18%, withreasonable leverage is much more realistic going forward.

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Be patient, be smart and stick to good, fundamental real estateinvesting and you will be fine.

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Joel Ross

Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.