General Electric Pays Price for Real Estate, Debt Investments

General Electric Co. Chief Executive Officer Jeffrey Immelt is paying the price for his investments in commercial real estate and U.K. property debt.

Profit at GE Real Estate dropped by $1.1 billion last year, according to the annual report from the parent company’s GE Capital finance arm. Fairfield, Connecticut-based General Electric’s real estate earnings are likely to fall further as occupancies and rents drop in a U.S. recession that’s now in its second year, said James S. Corl, who oversees distressed real estate investments at Siguler Guff & Co. in New York.

“They spent a huge amount of money in real estate,” Corl said. “They paid a full price for what ends up being a lot of mediocre real estate.”

General Electric shares this week dropped below $6 for the first time since December 1991 on concern that GE Capital may require additional cash. GE Vice Chairman and Chief Financial Officer Keith Sherin said in a statement yesterday that he sees no need to raise additional capital, and that the company’s financial services businesses expect to be profitable in the first quarter of 2009 and all year.

Sherin also said the company will host a GE Capital investor meeting later this month and examine the “hot spots in the company, including real estate, U.S. consumer, global mortgage with a focus on U.K. home lending, and central and eastern Europe exposure.”

GE said on Jan. 23 that its real estate unit will post a loss of $500 million this year as it absorbs $4 billion more in pretax losses. That will help drag GE Capital’s profit down to $5 billion from $8.6 billion in 2008, the company said.

‘Too Much Exposure?’

“Did we end up with too much exposure in certain areas during the credit bubble? Maybe, a few,” Immelt said in his annual letter to shareholders, released March 2. “Today, I wish we had less exposure to commercial real estate and U.K. mortgages.”

GE’s commercial real estate business consists of both property and real estate loans. It has stakes in or financing on 8,000 properties in 2,600 cities, with an average investment of less than $10 million, according to regulatory filings. GE’s property includes office buildings, warehouses and apartments, with about 71 percent located outside the U.S., primarily in Europe, Asia, Canada and Mexico, the company said.

‘Cash-Flow Positive’

“Our conservative underwriting of properties for which a valid value-add strategy (improve the building, re-lease, raise rents) was appropriate makes us comfortable with our portfolio,” GE spokesman Russell Wilkerson said in a statement yesterday. “We have business plans in place to improve properties where necessary. Many of these properties still carry below-market rents, providing us with protection and some upside.”

The company’s property “portfolio generates $1.7 billion in net operating income, while we depreciate the assets by about $1.1 billion per year,” Wilkerson said. “This makes the properties cash-flow positive in the aggregate.”

GE in 2006 purchased Arden Realty Inc. for $3.2 billion. Arden was then the largest publicly traded landlord in Southern California. The company also bought self-storage company Storage USA in 2002 and sold it for $2.3 billion in 2005.

Cutting Costs

“It’s an understatement today to say operating in this environment is tough,” Joaquin de Monet, chief executive officer of GE’s Arden Realty, said yesterday at Incisive Media’s Real Estate 2009 conference in Los Angeles. Arden is working on cutting costs during the slump, he said. “It’s really a focus on how diligent you can be.”

The vacancy rate at U.S. office buildings likely will rise to 16.7 percent this year from 14.5 percent at the end of 2008 as tenants cut jobs, research company Reis Inc. said last month. Vacancies at U.S. retail centers approached a 10-year high in the fourth quarter, and apartment rents fell as the national vacancy rate climbed to a four-year high, Reis said in January.

Sherin said the company has about $50 billion of commercial real estate loans, and about $34 billion of equity. “That’s the actual value of the properties, with over 80 percent of that with no third-party debt,” Sherin said in yesterday’s statement. The company has $2.9 billion of commercial mortgage-backed securities.

The company accounts for its real estate holdings at the price they paid for them, depreciating the values over time, rather than periodically marking them to their current market values, arguing that the company is a long-term investor, CreditSights Inc. analysts led by Richard Hofmann said in a March 3 note to investors.

“We are an owner-operator,” Wilkerson said in the statement. “We expect to hold the properties for the long term, so therefore they need to be accounted for in a different manner. If we did mark to market we would remove the depreciation from our net income calculation, so this would be an offset.”

‘Look Out Below’

GE Capital “has staunchly defended its long-term hold position for real estate assets, allowing it to carry positions at historical cost (and depreciate those values over time), rather than marking-to-market, which we imagine could turn into a ‘look out below’ type exercise in the current climate,” Hofmann wrote.

GE’s position on mark-to-market accounting is similar to the approach of U.S. real estate investment trusts, and has led analysts such as Nicholas P. Heymann at Sterne Agee, a Birmingham, Alabama-based brokerage, to reach their own conclusions about the value of the company’s holdings.

“We conservatively believe there could be 5 to 13 percent, or $4.3 billion to $11.0 billion, of cumulative losses/write-downs in the commercial real estate portfolios,” Heymann and his fellow Sterne Agee analysts said in a note to investors this week.

GE’s Wilkerson said the company will update investors on details of the company’s real estate holdings at the presentation the week of March 16.

Early in Cycle?

With a tougher refinancing market and property income being hurt by a rise in vacancies, “we believe asset values will experience significant weakness for the next several years,” Heymann wrote. “Furthermore, our analysis of the commercial real estate portfolio indicates the company’s holdings are concentrated in markets that are early in the credit deterioration/vacancy cycle.”

GE officials have argued that the company has acted quickly to avert trouble. It left the U.S. mortgage business in 2007, ahead of the surge in residential loan defaults. More than 8.3 million U.S. mortgage holders owed more on their loans in the fourth quarter than their property was worth as the recession cut home values by $2.4 trillion last year, First American CoreLogic said yesterday.

GE “exited U.S. mortgage as soon as we recognized the issues,” Sherin said in a presentation at a Barclays Plc conference last month.

‘Manage Through’

“Yes, our real estate business is larger than we want in this environment, but we can manage through,” he said.

In Europe, GE has $22 billion of real estate assets. About a third of that was real estate debt and non-performing loans at the end of the second quarter of last year, according to its Web site.

In November 2007, GE bought 2 billion pounds ($2.8 billion) of commercial real estate loans from Bradford & Bingley Plc, the U.K. mortgage lender that was nationalized last year. At the time, U.K. commercial property values had fallen 3 percent from their July 2007 peak, according to Investment Property Databank Ltd. They have now fallen 37 percent from that peak.

Arabtec’s Cash Position Improves on Payments Influx

Arabtec Holding PJSC, Dubai’s biggest construction company, said developers boosted bill payments in the last two weeks, signs last month’s $10 billion government bond is helping to ease cash flows in the emirate.

“We are beginning to see some liquidity being pumped into the system,” Riad Kamal, Arabtec’s chief executive officer, said at a news conference in Dubai today to announce the startup of a Saudi Arabia unit. Arabtec has received almost all outstanding payments up to December 2008 “and we have been promised that the flow will continue for our receivables in the coming few weeks and months,” Kamal added.

Arabtec, which has an order book of 39 billion dirhams ($10.6 billion), had receivables or unpaid bills of 4.98 billion dirhams at the end of 2008. The company is the biggest supplier of construction services to Dubai government-owned developers including Emaar Properties PJSC. It is the contractor for Burj Dubai, the world’s tallest tower that Emaar is building.

Dubai’s property companies will probably be the first to receive support from the emirate’s $10 billion bond sale as the Persian Gulf tourist and financial hub battles the effects of the global credit crisis, Nasser Bin Hassan al-Shaikh, director general of Dubai’s Department of Finance, said Feb. 25.

Dubai said Feb. 22 it had sold half the bonds from a $20 billion medium-term note program to the United Arab Emirates central bank to assist state-owned companies struggling to raise cash amid the worst financial crisis since the 1930s.

Real-estate Slowing

Dubai, which is building the world’s biggest man-made islands, is facing a slowdown of its once-booming property industry after residential prices quadrupled in the past five years and the seizure of global credit markets hurt mortgage lending. Dubai house prices have fallen 25 percent from the market’s peak in September, while Abu Dhabi prices have declined 20 percent, Morgan Stanley said in a report Jan. 30.

Arabtec announced today it had started a venture in Saudi Arabia in partnership with CPC Services Co., a unit of the Saudi Bin Laden Group and Prime International Group Services Ltd. Arabtec will hold 45 percent in the venture, which has equity of 150 million riyals. CPC will take 35 percent and Prime, the rest.

Arabtec’s unit in Saudi Arabia, the biggest Arab economy, expects to generate revenue of 1.5 billion riyals ($400 million) in the first year and 3 to 5 billion riyals in three years, Kamal said. Arabtec Saudi Arabia “has the potential of becoming one of the leading construction companies in the Kingdom.”

Qatar Operations

Arabtec operates in the U.A.E., Qatar, Jordan, Syria and Pakistan, although Dubai contributes more than 50 percent of its orders, the company said in December. It is managing projects valued at more than $1 billion in Qatar, Chief Financial Officer Ziad Makhzoumi told reporters at the conference today.

Arabtec’s revenue in 2009 will be about 9.5 billion dirhams, about the same as in 2008, and its net margin will be “slightly less than 10 percent,” Makhzoumi said.

Wolseley Slumps on Plans to Sell Shares, Exit Stock

Wolseley Plc, the world’s biggest supplier of heating and plumbing gear, dropped 15 percent after saying it plans to raise 1.05 billion pounds ($1.48 billion) in a share sale and sell its U.S.-based Stock Building Supply unit.

Wolseley fell to 140.4 pence. The builders’ merchant will raise 270 million pounds by placing new shares and 781 million pounds via a rights offering with existing shareholders, the Reading, England-based company said today in a statement.

Investors who had hoped to benefit from an eventual recovery in U.S. housing may be “frustrated” by plans to dispose of Stock, which gets 72 percent of its sales from that market, Exane BNP Paribas analyst Nicolas Godet said in a note.

The steps announced today are aimed at helping Wolseley avoid breaching the terms of its loans. A collapse in bank lending and house prices dragged down U.S. housing starts to their lowest since World War II, pushing the Stock lumber and building materials unit to a loss and Wolseley towards breaking debt terms. A process is underway to find a joint-venture partner for Raleigh, North Carolina-based Stock, close it or sell it by August.

“The move is clearly one of necessity,” Davy Stockbrokers analyst Barry Dixon said. The discounted price of the share sales, 120 pence a share for new buyers and 40 pence for existing investors, “may not prove attractive enough,” he said.

Losses Mount

Wolseley had a first-half net loss of 777 million pounds compared with a 65 million-pound profit a year earlier, the company said today. It won’t pay an interim dividend. Chief Executive Officer Chip Hornsby said he expects Wolseley, which has cut 17,000 jobs and closed 713 branches since August 2007, to make further cutbacks during an “extremely difficult” 2009.

“The market moved so quickly. Everything stopped,” Hornsby said in a conference call with journalists today. “We began to see jobs stopping in midstream because of lack of financing.”

The company has already received expressions of interest in buying Stock, the chief executive said. Hornsby declined to comment on the identity of any potential buyers and refused to say whether Irish-building materials supplier CRH Plc, which announced a 1.24 billion-euro ($1.57 billion) rights offering this week, was part of any talks.

“We continue to have approaches and we’re in discussions with a number of groups,” Hornsby said. “It’s proceeding well. We are in the due diligence process and we anticipate we will make a decision by no later than the end of April.”

Second Sale Attempt

Parties interested in buying Stock during a failed attempt to sell the unit last year included private equity-owned U.S. building-material and equipment distributors HD Supply and Pro- Build Holdings Inc., as well as Builders FirstSource Inc., Triangle Business Journal reported on Aug. 1.

With the sale or exit of Stock, Wolseley will increase the proportion of sales coming from the U.S. commercial construction industry, which will take longer to recover, Collins Stewart analyst Imran Akram said in a note today.

Wolseley also said it will also carry out a strategic review of operations in central and eastern Europe as the company doesn’t have the funds to realize its potential in the region, Hornsby said.

After discussions with investors holding about 60 percent of the company’s existing shares over the past four days, Wolseley concluded that any rights offering had to be supplemented by a share placement due to a lack of so-called sub-underwriting capacity, Chief Financial Officer Steve Webster said.

‘Dozens of Meetings’

Rights offerings are often underwritten by banks that typically seek to share the risk through sub-underwriting. BNP Paribas SA, Deutsche Bank AG, Royal Bank of Scotland Group Plc and UBS AG are managing the stock sales. In the rights offering, existing investors will be offered 11 new shares for every five they already hold.

“After having dozens and dozens of meetings literally over the course of the last couple of days, the expression of support that we’ve gotten for the direction we’re heading in was overwhelming,” Hornsby said. “There was no lack of support.”

Wolseley will also secure a new 1 billion-euro, two-year so- called forward start banking facility available from August 2011 on the condition the placing and rights offering are successful, Wolseley said.