Common Sense Proposals

Finally! After months, US lawmakers have compromised to take a more rational approach to solving Puerto Ricos debt crisis. House Speaker Paul Ryan directed financial committees to take a common sense approach to preventing Puerto Rico from defaulting on January (or May) debt payments.

One approach will be allowing Puerto Ricans to qualify for the Earned Income Tax Credit currently available to citizens living in the States. This is a step in the right direction. Congress may not be able to legally allow the Island to default but they can even the laying field for its residents. Medicaid is another area where the government can help alleviate financial pressure.

Puerto Rico's position has not changed although policiticians are becoming more anxious that default is inevitable. There is no question about it. Puerto Rico will default. The impact on the people of the Island will be a directly proportional to the governments ability to toe the line of default to maximize negotiations between the municipalities and debt holders. 

Rising interest rates should also throw a wrench into the equation. Let's see what happens.

Palmas Del Mar (October 2014)

Where Are We Going?

We still don't know what the future holds for Puerto Rico. There have been numerous studies and articles describing the situation and desperate and possibly, as Forbes described, leading to a humanitarian crisis. We know what the problem is but what are the possible solutions. Remember the game of Battleship where you would call out your opponents position in an attempt to sink their ships? We can describe the situation between Puerto Rico and bond holders in his manner.

Goal = Balanced Budget

Possible Solutions:

1) Raise Revenue to balance budget

The government can raise revenue by increasing the amount of taxes collected. There are a variety of ways to do this but almost all will lead to an exodus of residents from the island. An eroding tax base will lead to an incurable problem. Raising taxes is not a long term solution to the problem.

2) The budget can be balanced by increasing revenues, reducing costs, and usually the combination of both. Cost cutting is the best way for Puerto Rico to balance the budget and pay bond holders. Since the government has already increased taxes, witnessed an erosion of tax base, they should cut costs to demonstrate government austerity and restore confidence to all involved. 

Governor Padilla has atleast taken a realistic approach that the debt cannot be paid and unless restructuring occurs there will not be a meeting of obligations. He had also increased taxes and reduced some government services in an effort to balance the budget.

Opportunities: Padilla had already ordered an end to marajuana related prosecutions stating it was costing the territory millions a year in administration. This can also be a revenue producer for the island should the laws become favorable to the medical marajuana industry. This kind of cost cutting is a good example of measures that can be taken. Any unnecessary cost should be cut if there is not a clear positive benefit.

If the territory makes an effort to increase economic efficiency then bond holders may be able to compromise. For example of the government shows austerity by changing the laws of the general obligation fund GOF to meet financial obligations they are showing a real desire to balance the budget.

Certain agencies are already facing pay freezes for the uncertain future. Given that the entry level salary is almost minimum wage and dramatically increases in years 2-4, this had a dramatic impact on the population. Unfortunately, this is a step in the right direction.

Palmas Del Mar (October 2014)

Puerto Rico Walks Away From Talks With Bondholders

Today, 21st of October, Puerto Rico walked away from the table with bond holders. That must be nice. We all knew this was bound to happen. It was a game of brinksmanship that had already been decided long ago. The only difference is the number of sunk ships was yet to be determined. The only reason both sides kept slow playing is because the bond holders wanted to lose the fewest ships.

So, what next? Well, I don't know. If Puerto Rico loses it's credit rating, they have no ability to borrow money and restructure debt. They also have no incentive to pay back debt since it's so insurmountable it would be like putting out a forest fire with a single bucket. The next thing that is likely is a series of judgements which should prove interesting given the jurisdiction of the island and the mainland.

But as always, I see an opportunity to buy real estate. Why not? The value is intrinsic to the value of the land itself. The land sells itself. Those looking for good long term investments should still consider buying land and holding for a horizon no less than 20 years. There are many hot spots around the island. Anything close to the close will be hard to mess up.

Palmas Del Mar (October 2014)

The Good, The Bad, and The Ugly

Let's start off with The Ugly.

The current drought and water rationing scenario in Puerto Rico demonstrates a lack of planning and foresight by those in charge. With only a 3 month supply of water in reserve, many municipalities are left with water 1/3 days. Of course, in the tourist areas, this policy doesn't apply. 

The sad part is that with a little capital investment, the whole problem could be avoided. Yes, the carribean is experiencing its worst hurricane and rainfall drought in 9 years, but that doesn't excuse the island from only capturing 20% of rainwater. International reports indicate a strategically placed dam would alleviate the island of its water shortage problem. The project would cost upwards of 350 MM USD and obviously PR lacks the fuss to engage such a capital intensive project.

The Bad

It's official. Moodys has downgraded the island and labeled them as default on their obligations. Now what? More people are going to leave for th mainland. The tax base will continue to erode. The underground economy will continue to grow as a result of fewer industry level jobs. The government will be in a worse position to negotiate debt. The only answer is foreign direct investment, whether it be mainland US or elsewhere.

The Good

Tourism. Luckily the island is still flush with tourists. Real estate opportunities are increasing as people have to leave their homes and move to where the jobs are. Acquiring a distressed asset in Condado is my best bet. You can always rent it out to tourists of the rest of th island is a ghost town. 

Puerto Rican Debt: Now What?

The island was able to meet its debt obligation over the past week but it's a small victory in the big picture. Governor Padilla already stated the debt is "unpayable". These statements already put investors and creditors in a tailspin. The advantage of a good credit rating is that you can borrow at favorable rates. After saying the debt isn't payable, how favorable of a rate is possible? 

I understand Padilla is meeting the problem head-on with the statement but he is not leaving himself room to negotiate. Creditors will likely allow for a restructuring of payments but the terms will be less favorable given the Governor had already shown his hand. How is Puerto Rico expected to pay off the debt with a shrinking tax base? As more people leave the island, the tax base shrinks. The current state is only encouraging a larger and more drastic exodus. Creditors also realize the impact of this scenario. 

Act 20/22 were supposed to help alleviate the problem but it's a case of too little too late. The tax benefits largely only benefit the Americans moving to Puerto Rico to take advantage of them. The island was supposed to experience the secondary effect of increased consumption from the 20/22 participants 

Where do the opportunities lie? Land! Property! Real estate! These assets will become distressed as the island navigates the debt fiasco. Given the relationship with the U.S., it is highly likely that actions and regulations will be favorable for Puerto Rico. Relief in the form of direct investment, favorable legislative actions to promote American business, or bailout will all promote a recovery in Puerto Rican hard assets. When will it happen and timeline? Considering the layers of uncertainty, only long term plays are viable. 

Impact of New Marijuana Legislation

The Governor of Puerto Rico issued an executive order on May 4, 2015 granting the legal use of marijuana for medical purposes. This legislation poses an interesting scenario when paired with the Act 20/22 laws of 2012. Legal medical marijuana is nothing new for the United States and its territories. Twenty-three states along with Guam and the US Virgin Islands have already outlined legislation to legalize marijuana for medical use but Puerto Rico is a special case.

Puerto Rico holds the trump card in the medical marijuana game. The US began adopting the legalization and regulation of marijuana for the obvious reason of trying increase tax base. What would happen to this tax base if US marijuana startups began moving to Puerto Rico to conduct business? Would these companies be exempt from State and Federal income taxes? What if only the downstream (end product) component was outsourced to Puerto Rico. What would the implications be?

Given Puerto Rico is an island of approximately 360 square miles, there is limited space to grow and cultivate the product in the upstream supply chain. However, as was seen in the 1990s, pharmaceutical companies are no stranger to the island and opportunities may exist to manufacture an end product here with great tax advantages. There is a great amount of uncertainty regarding how this will all play out but I have presented just one scenario to think about. It will be interesting to see how this all plays out in the coming months. It will all depend on how well Puerto Rico adopts and embraces the idea of medical marijuana. The regulations regarding growing, distribution, and sale of the product will be integral in determining Puerto Rico's role in the US scheme. 

San Juan Metro Area

To better focus the research aim of the following entries, only properties and opportunities within the San Juan metro area will be included. The investment areas of interest include the neighborhoods of Condado,  Santurce, Ocean Park, and the Isla Verde/Carolina border. A focused discussion approach is necessary because there are so many opportunities and a finite amount of investment capital. 

The beach neighborhoods of San Juan are of greatest interest in the short term since the tourist effect is widely felt and potential investors and transplants have an already established presence in these areas. 

An index will follow to track property values in these neighborhoods, coupled with analysis, to provide insight into the the changing amount of demand in the real estate market as a whole. 

Condado, San Juan - Buy or Rent?

The answer to this questions always depends on the terms of financing and the purchase price of the underlying asset. If you are able to buy a property for less than the cost to build new (replacement cost) financed by a relatively low interest rate, it is probably better to buy than to rent. The worst case scenario in this case is that you have to rent in the event of a move. For example, let's say that properties are yielding 6-8% net returns on average. Any interest rate less than 6% will do the trick. This is not always the case but given the price points to buy and rent are so low all over the island it makes sense in many cases. Of course, it does not make sense in all cases. There are many high rise apartments and houses that are ridiculously priced with outrageous rents but these are the exception and not the rule. The deals are out there if you look for them. An example below helps illustrate the point.

The following is a 1 bedroom, 1 bath condo located in the heart of Condado. It's across the street from the Marriott hotel and generally thought of as being in the heart of Condado. The asking price is $170,000 and the rent estimate is $800-900 per month (We will use $850 per month for our analysis). At current fixed mortgage rates, one can secure a loan for around 4% amortized for 30 years.

The numbers play out as follows:

		Units
Purchase Price (USD)	170,000	USD
Monthly Rent	850	USD
Taxes	2,550	USD
Insurance	1,700	USD
Management Fees	1020	USD
Annual Gross Income	10200	USD
Annual Net Income	4930	USD
Annual Net Cash on Cash Return	2.90	%

As you can see the return here is only 2.9% and we haven't even accounted for the common area fee. This does not meet our hurdle requirement of 4% return. 

We are talking about a cash on cash return and we have not built in leverage. Depending on the downpayment of 0-20%, you may be able to increase your return on equity and meet the 4% hurdle. A quick and dirty calculation just for the sake of discussion as follows (not including tax benefits from interest rate deduction, repairs, etc):

Downpayment of 20%	34,000	USD
Annual Interest Rate	4	%
Gross Return on Equity	14.5	%
Net Return on Equity	10.5	%

After plugging the numbers into a more complex model to include vacancy, repairs, interest expense, depreciation, and tax benefits the number comes out to be 13.96% net return on equity (ROE). Please comment or email me privately and I will share the model with you. 

As you can see in this scenario, leverage is your friend. With a leveraged property, you can afford to rent it out and meet your hurdle of 4%. On a cash basis, it doesn't make sense mathematically. 

We didn't discuss the price to build but in this case the cost is $170,000/800 square ft = $212.50 per square ft. This is relatively cheap for the area but keep in mind you can build for between $80-120 per square foot depending on the design of the property. The real value is in the land. Where would one find land this close to the beach and the heart of the city in the mainland USA? Does the property have appreciation potential? Will rents go up? These are questions you have to repeatedly ask yourself like a broken record given the changing economic landscape.

The above exercise was simplified to make it easier for a lay person to understand. Anyone seeking a more elaborate explanation or model can email me directly with questions. To be continued. 

San Juan Condado/Miramar/Ocean Park

A discussion of the buy to rent model in San Juan (Condado/Miramar/Ocean Park) neighborhoods is presented below. To simplify the analysis, only a direct cash on cash, gross and net calculation is presented. For a more thorough financial model, please comment or e-mail a private message. The following is a 1 Br/1 Ba condominium with no utilities included for sale for 82,000 USD in the neighborhood of Condado, San Juan in the Parque Condado building. Approximately 700 square feet of space with living room, kitchen, 1 bedroom, 1 bathroom, and a balcony. The common area fee is approximately 85 USD.

The following is an apartment for rent in the same neighborhood with the same amenities. It is the best comparable of a current unit for rent similar to the above. The rent is $650 and does not include any utilities but does include a parking space.

Allow property taxes to cost 1.5% of purchase price (or assessed value) and insurance to be 1% of purchase price (or assessed value). Further, allow management fees to be 10% of gross income. We will not include leverage, appreciation, vacancy, or any other variable to simplify the analysis. In this case the model of rent to buy, on a pure cash basis, is as follows:

		Units
Purchase Price (USD)	82,000	USD
Monthly Rent	650	USD
Taxes	1230	USD
Insurance	820	USD
Management Fees	780	USD
Annual Gross Income	7800	USD
Annual Net Income	4970	USD
Annual Net Cash on Cash Return	6.0609756097561	%

The net cash on cash return is slightly more than 6%. This, of course, does not account for the tremendous appreciation potential. You speculate on appreciation so any increase in price is purely a bonus. However, in the case of Puerto Rico, the upside could be massive and the downside is less of a risk since price levels are already so low. How low can you go? Given you have a net return of 6%, the possibility to cover a mortgage and crank up the ROE (return on equity) is present if one can secure a mortgage of less than 6%. This is possible through a US bank given the FED announced it will likely not raise rates until the end of the year. If the math works, do it. 

PR - Residential Real Estate

Real estate is now everyones' favorite hobby. Real estate prices have risen dramatically since 2008 in the wake of the prime mortgage crisis. Yields on residential real estate have plummetted in the United States with most of the "smart money" exiting the market as investment property has proven difficult to manage and scale. Warren Buffet himself said he would love to buy a few thousand houses but he doesn't believe the investment can be efficiently managed in a large scale.

Puerto Rico is in an interesting situation given their unique status and positioning within the hierarchy of the United States. The population is extremely literate with over 94% of the island having the ability to read and write (with most also having a decent grasp on the english language). Unfortunately a lack of jobs has caused the island to experience a "brain drain" with may Puerto Ricans leaving for the US and elsewhere to pursue careers that better reflect their education. A distressed credit market and lack of capital have hurt the price of real estate and investment in much needed infrastructure all over the island, including some of the most desirable areas. 

One example is the fact that beach front property outside of the major metro areas can be acquired for pennies on the dollar relative to comparable beach front property in many areas of the United States. The price per square foot of beach front land does not coincide with what has been realized in the US in recent periods. 

To kick off the blog, let's start small. Dip your feet in, the waters warm.

The following parcel is located 20-30 minutes east of the capital San Juan in the neighborhood of Islote and the neighborhood of Arecibo. It is located 4 minutes from the beach and is about 698 cubic meters (about 7000 sq ft or 1/6 acre). Water, electricity, and utilities are available on site. 

Priced at 20,000 USD, the property is selling for approximately $2.85/sq ft. A home can be built on this property for roughly 80$/ft. A standard beach house, ranch style, runs about 1,000 - 1,500 sq ft. The all-in cost of acquiring the property and building a nice, new, quaint beach house will be 100,000 to 140,000 USD. The home can be rented for roughly $1,200/month. This would yield a GROSS return in the neighborhood of 10.3 to 14.4%. Of course, taxes and insurance must be considered so your return will be slightly less. That being said, leverage is not included in this model so we are not observing a return on leveraged equity (as you would with a loan). 

In future posts, more elaborate financial models will be included but a few concepts need to be demonstrated. So what is the upside? Where can you get a 10% return in the equity or real estate markets? The S&P500 has returned on average 10-11% over the past few decades but equities can't be leveraged (unless you want to talk about derivatives). We have also not considered tax implications. More on this later, but as mentioned, we are only dipping our feet in the water. 

THE UPSIDE: Ask yourself what will happen if more and more mainland Americans (high net worth individuals) move to Puerto Rico. Stay tuned.

Bienvenidos a Puerto Rico!

Buenas tardes from San Juan, Puerto Rico. Mainland American citizens have been coming to the US territory of Puerto Rico in droves to take advantage of the new Act 20/22 laws passed by Congress in 2012. The laws will be discussed in more detail in later posts but the legislation is aimed at providing tax breaks for US citizens and entities residing on the island. The overall goal is to provide much needed stimulus to the island while preserving the interests of the United States.

The purpose of this blog spot will be to provide, discuss, and analyze investment opportunities in real estate and business. Daily and weekly posts will identify opportunities and topics of interest and then evaluate for upside potential and yield. Light will be shed on alternative investment ideas that may not be realized otherwise to mainland Americans. Land and property are available at a discount and foreign direct investment dollars have already started pouring into the island. More to come. Enjoy.