FINALLY!! Puerto Rico Has a Possible Solution!

The day has finally come. We finally have an answer. A possibility to bring sense to the chaos. A ray of hope. The US House of Representatives finally introduced legislation to help alleviate the 72 Billion USD debt problem plaguing the island. There were a few concessions in the legislation on the part of both parties:

1) Wages will be allowed to go below US Federal minimum wage for a period of time
2) Vieques will remain under its current jurisdiction as a Federal Wildlife Refuge

The Federal Control Committee may end up having a positive influence on the Island. At the very least there is action. The most important thing is that things are changing. A sense of urgency exists in the white collar, blue collar, political, and working class of communities throughout the territory. It is how Puerto Rico responds that will define its legacy during this time. If the new system of government can be implemented efficiently, there is a way out of the this enormous hole.

Let's see how the deal unfolds. The Bill must still pass the House, Senate, and be signed into law by the President for Puerto Rico to experience the effect. Let's keep our spirits high and our hopes up. After all, as mentioned in previous posts, Puerto Rico has nothing to lose.

Puerto Rico Relief Bill

In response to the Puerto Rican Government emergency welfare act, where the Governor called upon Puerto Rico to cease paying bondholders in favor of supporting essential public works necessary for the welfare and health of the Island, Congress has been pressured to come up with a relief plan. A May 1st debt payment of 422 Million USD looms in wait. Thus far investor lobbyists have been successful in blocking any federal government aid to Puerto Rico. Legislators in favor of doing nothing are taking the position that they should allow the problem to work its way through the courts like most defaults would.

Puerto Rico may have planned this maneuver all along. It's brilliant. Since the Federal government won't allow a bankruptcy they realize they fit into the grey area that allows them to simply not pay, forcing the hand of the government they must answer to. There really wasn't any other option. The full debt isn't payable, the tax base is eroding, and public works would suffer under any austerity measure previously suggested by bondholders and Congress. Both parties probably knew this was a likely outcome. The stance of allowing the Courts to work through the problem may be the right one. After all, this is a simple matter of not paying debt once it all comes down to it.

This is certainly good news for the people of Puerto Rico. At least they can, in the short run, continue to fund water, schools, hospitals, and other essential services. I hope the voters understand their Governor took a bold step by introducing this emergency legislation during the early morning hours last week. It was the best option given optimal game theory and the legal and financial constraints at his disposal. He should be commended for these actions during a time when the Puerto Rican Government has been highly ridiculed and scrutinized for being incompetent and corrupt.

(Condado, Ashford Avenue area, October 2014)

PROMESA

A proposed solution has finally arrived but it doesn't seem to be in Puerto Rico's best interests. A brief summary of the bill is provided below.

PROMESA (Puerto Rico Oversight, Management, and Economic Stability Act)

1) Establishes 5 member committee appointed by the President of the USA
2) 4 of 5 members from lists provided by Senate Majority Leader and House Speaker
3) Governor of Puerto Rico would sit on board but have no voting rights
4) Injunction on debt payments for 18 months and preventing firms from filing lawsuits

The proposed legislation clearly limits the involvement of the people of Puerto Rico. The injunction on debt payments is a positive start but not requiring firms to take a haircut is an insult to an already dire situation on the island. A situation approaching humanitarian crisis levels.

Senator, and Democratic Presidential Candidate Bernie Sanders, believes firms should take a haircut and the people of Puerto Rico should be more involved in the proposed solution. The solution doesn't include any bankruptcy protection or federal funds for the island. The only thing the proposal provides is for a Federal oversight committee.

If this is the proposed solution, why wait until 2016 to implement such a committee? The crippling situation in Puerto Rico has been going on for quite some time. Perhaps Bernie Sanders is Puerto Rico's best friend at the moment since he is in the spotlight and brining attention to the islands problems may help. He believes the Island should have the same protections as any municipality, and he's right.

Santurce, San Juan (October 2014)

Investment in Puerto Rico - Initial Findings

I wanted to share an analysis that I conducted after my first week in Puerto Rico. Looking back on it I am amazed as to how valid much of it was and how much of it has come true. I have included my comments from October 2014 for your review.

October 19, 2014

Macro View
     The opportunity in Puerto Rico to acquire land, residential and commercial real estate is very real. The best way to describe this opportunity is "home steading" (similar to the great land grab of the 1850s).  Yes, there are expats here, but the nature of the environment still makes it a difficult place to maneuver. The expats (for the most part) are located in 5 mile radiuses with Condado San Juan, and Humacao (Palmas Del Mar). Outside these two areas, I didn't see 1 westerner and I traveled around the island 3 times already. This is good news in terms of an investment.
The cost to build is the same around the world relative to cost of materials. The difference between a property in a higher end and lower end market is not the structure itself but the land that it sits on. For example, it costs the same for us to build in Mclean VA as Bakersfield CA, the only different is the price of the land. 
  The value in Puerto Rico is in the land due to the aging infrastructure that has already greatly depreciated. Given substandard building techniques from (30-50 years ago) it makes no sense to buy an older property that will ultimately have to be torn down.  It is also not rational to buy a newer structure since all the "value creation" has also taken place. After considering these comments, only the land remains. The land in Puerto Rico is extremely undervalued.  Relative to the per square ft price of land elsewhere in the US, the land in PR is cheap. Here is where the opportunity lies. There is a large difference between the price of land in San Juan versus surrounding areas. As you move away from San Juan the land becomes cheaper and cheaper. This holds true for beach front property as well. In the US there is not any beach front property available at a reasonable price (relative to other opportunities). In PR, there is still much unchartered territory all around the coast of the island. The hot spots (moving west from San Juan around the island are Durango, Arecibo, Hatillo, Rincon, Ponce (southern coast), and Humacao (Palmas Del Mar). 
  An additional factor is rent. The operating spread from rent revenue relative to financing costs and acquisition costs is not sufficient. In the heart of Condado, San Juan where the expat community resides, you will find 1 MM$ condos next to 50k$ condos in many places. I see no difference between these two apartments because you have the same values in terms of view and geographic location. The more expensive apartment is newer, includes amenities, but certainly not enough to warrant the huge jump in price. These complexes are for rich foreign investors who have cash to burn and want a place in SJ.  When these complexes try to rent (vs owner occupancy) the rent needed to justify the investment is not adequate. 
  A huge obstacle in terms of renting condos is that most HOAs do not allow renting to tenants. This creates a whole set of obstacles on its own. For these reasons, I would stay away from condos in PR in general. The price of new vs. old real estate is very elastic but the rent between the two is inelastic respectively.

Speculation
  To justify an acquisition, normally a series of conditions are needed. Given the unique opportunity in Puerto Rico, speculation is the name of the game. Low price points for land with enormous upside potential make this the play. We have little downside with great upside potential.

San Juan
I see opportunities to buy land here but there is a huge opportunity cost given we can buy a much larger quantity of land a short distance outside the city near the growing beach communities. These properties have the greatest upside potential. 

Arecibo
This is the place to invest. 45 minutes west of San Juan. Home of UPR-Arecibo which is the second best public university in Puerto Rico. A short distance to San Juan, great infrastructure, and a growing tourist community make this a highlight area. Walmart, Home Depot, YUM Brands (KFC/PHUT/TBELL), Walgreens, CVS, along with the Premium Outlets, make this a high desirable area for growth. There is a community in Arecibo called Islote, Arecibo (Wikipedia article available). I would compare this to Malibu CA. You can buy beach front property in this area all day long and I saw many "Se Vende" signs. This is the location of the quarter acre lots for around 15,000. These lots are about 1/2 mile to a mile inland but still within the beach community. Lots can be purchased directly on the water. I am still working on a price point for this but I feel you can buy a quarter acre, beach front lot for around 35,000 from the few listings I have seen. 

Humacao (Palmas Del Mar)
Humacao (Palmas Del Mar), home of the largest tennis and golf resort in the Caribbean. The price of land here is quite high and I think there is not opportunity. Microsoft, Costco, Walmart, Sams, all the usual suspects are present here as well. This is the highest concentration of expats and the prices reflect this. I see no opportunities here given finite resources.

Rincon
Surfing hot spot on the western face of the island. 1 hour 45 minutes west of San Juan. An area I need to investigate further. Beach front property and land much cheaper overall but the tradeoff is not as much infrastructure and less potential for growth compared to areas closer to San Juan. 

The best investment will lie in a property that is located with close proximity to San Juan so an individual/family can migrate back and forth with ease between the city and countryside. This is Arecibo (Islote beach). 


Regulatory Issues
I am still carving out all the regulatory problems. The largest problem is residency. Yes, US and Puerto Ricans share the same citizenship but residency creates a divide. Residency and establishing residency are used to create restrictions on investment and opportunities in general. This is the piece that I'm most concerned about. Another reason I feel that holding land for speculation is the safest play now since we won't encounter any social problems with this kind of investment. I've already read a half dozen or so articles on starting a business, establishing residency, etc, but will need time to sort out the details.

Other business opportunities
Parking lots, trailer parks, consulting firms, recycling, call centers, food (not really any Asian/Southeast Asian/Indian/Russian/European) food here all possible. Again, the issue is doing business in Puerto Rico. Great value can be created by just figuring out how to get around. At the local level, permitting is a big issue. For a nonresident, I'm pretty sure they make your life a living hell. Everyone knows everyone here, it's an island! It's the good old boy system at it's finest. You cannot even pass the law bar here unless you are politically connected according to a Professor I talked to at UPR-Arecibo (it's insanity). I believe these statements because the feel is present in day to day life. Equality and fair treatment is an issue. Of course I thrive in these kind of environments so I'm looking forward to showing up to the party.

Global Environment
Given the current and ever worsening Puerto Rican debt crisis, the uncertainty in the US, and the unique nature of PR, we will have an opportunity very soon. Within the next 12-18 months prices will slide, demand will decrease, and something can begot for nothing. 
My sentiment in general is that everything will start to crash immediately after the fiscal year. Winter '15/'16 will not be a good time for the US economy in the run up to the Presidential election. The good news is I feel the economy will rebound but continue to oscillate in this fashion (with swings of 10-20 percent in the price of real estate for the next 5 years. PR will be disproportionately affected given the current crisis and lack of financing alternatives.

Faro Los Morrillos de Cabo Rojo (December 2015)

Puerto Rican Real Estate Undervalued

All of the economic and financial uncertainty on the island are making is a great target for undervalued real estate. There is nothing wrong with the land of Puerto Rico, there is nothing wrong with the people of Puerto Rico. High education and literacy rates make it a great place to find bilingual skilled labor without the headaches of visas. The problem with Puerto Rico is the administration of government and inefficiencies associated with it as already discussed in numerous previous postings. 

An outflow of talent and capital to the mainland US is presenting a great opportunity for those who want to take risk in investing in Puerto Rico. The front page of the Money section of CNN online recently had an article about undervalued beach front. The cat may be out of the bag, but who has the guts to actually invest for the long term?

Link to article from CNN Money:

http://cnnmon.ie/1KAG8yf

La Perla, Old San Juan (December 2014)

How Much Debt Can Puerto Rico Support?

We have heard a lot of news about Puerto Rico's mounting debt but we have not heard much about a sustainable repayment plan. We know Puerto Rico needs restructuring of debt, a bailout, or a combination of both. We know how much debt the island has but how much can it support? 

Step 1: What are sustainable debt levels for US states and territories on average?

The average state spends 5% of its annual revenue on total debt payments and interest to bond holders.

Step 2: What are sustainable debt levels for US states with similar profiles to Puerto Rico?

Hawaii has the most similar debt profile to Puerto Rico at 13% of annual revenue allocated to total debt payments. Puerto Rico is sitting at an unsustainable 36% of revenue going towards debt and interest payments.

Step 3: What is sustainable for Puerto Rico?

Using Hawaii as a benchmark and settling on 15% of annual revenue as a model, Puerto Rico can support 1.7B USD in debt and interest payments per year. Looking at a 30 year horizon and discounting at 5%, at a 1.7 B USD debt service for year, Puerto Rico can sustain a present value debt level of 26.7B USD instead of the current 49B USD of debt. 

This is the formula used to forecast how much debt burden Puerto Rico can support. The next step is to come up with a proposal considering these calculations. 

Ocean Park, San Juan (February 2015)

Puerto Rican Proposal

The Island has made a definitive offer to its creditors: lower debt payments by exchanging debt and separate bond issue based on future growth to make up the difference. This would help reduce approximately 50B of the 70B in debt to 25B. This would leave 50B total on the table. It represents a 30% reduction in overal debt which is a commendable start.

The strategy is brilliant. It is a reverse bailout in the form of debt forgiveness. Adding the sweetener of the bond issue based on future payouts almost forces the hand and gives parties an excuse to let the island off the hook. Well played. 

On the other hand, they are now indebted in the future should the economy grow. They are giving a disincentive for the economy to grow. Parties will argue the payout is proportional to growing and won't hinder it, but that is not realistic. 

There is also the chance that the Federal government will bail them out. In this case the Island might be playing their hand too early. Or maybe the proposal to restructure debt is gesture that can lead to a supplemental, and more reasonable bailout. 

Perhaps, this model of future growth dependent bond issue can serve as a case study for future municipalities.

La Cueva Ventana - Arecibo (October 2014)

Oil and Gas Issues - Puerto Rico

In addition to a corrupt and inefficient power company, Puerto Ricans have to deal with predatory practices from the oil industry. Low oil prices have not cascaded down to the consumer. They have not even reached the retailer. The oil companies are in dire straits with low fuel prices so it makes sense that they would squeeze the island for more margin.

Link to the article in spanish below. Use Google Translate to translate easily to english.

Link to Article

Puma gas station (2014 Puerto Rico)

Inside the Billion-Dollar Battle for Puerto Rico's Future - The New York Times

Inside the Billion-Dollar Battle for Puerto Rico's Future - The New York Times

Link to Article

I wanted to share the above named article from the December 19, 2015 edition of the New York Times. It provides a great background and overview of events leading up to the current situation. Insight into the political and financial landscape is explained in an easy to understand way. The article  effectively explains the "sides" to each argument. Although they seem clear, they are indeed ambiguous.

Total Debt: 70 Billion USD maturing over 5-10 years

Party 1 - Debtors (Puerto Rican Government (65% of debt, PR Power Authority (35% of debt))
Party 2 - Lenders (20% Puerto Rican; 35% Hedge Funds; 45% Bondholders)
Party 3 - The US Federal Government

What do lenders want?
To get paid. This is the only possible solution for them. They aren't even willing to take a haircut on the debt owed. They will go to any extent to ensure they get what they want. Political contributions, lobbying efforts, will all protest a bailout or debt restructuring of any kind. Even a deal where the Power Authority was allowed to declare bankruptcy (or restructure debt) in an effort to restructure debt (33%) was strongly lobbied against by the holders of that specific debt. The deal would have cost US taxpayers nothing yet it was not even considered. Marco Rubio, for example, is stuck in the middle of a Tea Party base and a Puerto Rican constituency that helped elect him to Senate in Florida.  A supporter of relief for Puerto Rico 6 months ago, Rubio has since backed away from sponsoring a relief bill and now says a "bailout" should be a last resort. Just the fact they are calling it a "bailout" and not "debt restructuring" (like many companies engage in on a regular basis) shows the power of politics.

What do debtors want?
They want to pay the debt but they can't. If they can't pay they want someone to give them the money (bailout) or they want debt restructuring (loan forgiveness). They know they can't pay so they are just waiting for situation to necessitate relief described in the previous sentence. They are also hiring lobbyists of their own to promote a bailout.

What does the US Federal Government want?
They promote stability. They know the debtors can't pay and the lenders will have no mercy. They won't approve a bailout because the lobbyists have done their job with the Republican led Congress. Obama can't successfully pass special Chapter 9 bankruptcy protection for US Territories in a Republican Congress. They don't want a humanitarian crisis to take place on an island where 40% live in poverty so they offer a bandaid in the form of $3 Billion USD if the island submits to financial oversight.

La Perla (North Corner) October 2014

Kicking The Can Down the Road

The Governor of Puerto Rico recently announced a $16 Billion gap over the next 5 years (up from $14B previously forecasted). Furthermore, the gap has been extended from 5 to 10 years. The committee assembled to balance the budget and draft an economic recovery plan (in collaboration with the General Obligation committees) have not been able to accurately realize the true nature of the economic disaster since its inception. Any plan or budget will be futile as the Island only faces an uphill battle with an exodus of the working class and shrinking tax base. These are mere gestures to try to please bondholders (2 have recently filed suit against the Island).

In the last weeks of 2015, Democratic members of Congress tried to persuade members to include bankruptcy protection for the island in a year end spending bill. Speaker Paul Ryan has called for a "responsible" solution by March of 2016. The language was not included and the bill barely passed due to Democratic (and some rebel Republican) pushback.

The Island is using clawback measures to desperately try to meet obligations. Instead of income tax returns, the Island is issuing IOUs. Residents can use tax return credits to pay other municipal fines, fees, and bills. For example, a resident won't get a tax return but they can pay a parking or speeding ticket with funds they should have received.

So the questions remains, who is responsible? Well, everyone is responsible. The banks are responsible, the bondholders are responsible, and the Island lawmakers are responsible. In any agreement there are obligations and each party has risk. Bondholders and lawmakers on both sides (US and Puerto Rico) failed to adequately calculate risk. This seems to be more prevalent in recent times. The only difference is that Puerto Rico doesn't have a golden parachute (i.e. bankruptcy protection or the ability to print money). Should they have protection? This writer thinks YES but that is to be determined. How can other municipalities within the US declare bankruptcy and go on about their daily lives.

At the very least the Puerto Rican people are LEAST responsible because they after all didn't have any say in their territory status (yes it was voted on about 70+ years ago but only after the issue was forced onto the Island). Corruption and an inefficient government have plagued the Island for as long as anyone can remember. Taxes, fuel, and energy prices, unemployment, and the shrinking middle class have plagued the island. The pharmaceutical tax incentives of the 1990s and the recent Act 20/20 legislation are good attempts to draw outside investment but they are also not enough to tackle the whole problem.

What we are witnessing now is just a game of back and forth, a dance, an exhibit of smoke and mirrors, awkward and puzzling actions to keep everyone wondering on the edge of their seats. There is no need to be anxious if you are living on the Island. It can only get better. It can't get worse. The US won't let it become a humanitarian crisis. Not on their watch. The money will come. Puerto Rico will be bailed out in one way or another. The likely source is long duration bonds to restructure debt and reduce obligations outstanding. A general restructure of debt will be necessary. Someone will have to take a haircut.

Islote, PR (near Arecibo) October 2014

Winners and Losers

The moment we have been waiting for us finally here. Puerto Rico has officially defaulted on part of its debt obligations. The island will still make payments to finance its general obligation fund but will not be able to fulfill other bond payment obligations.

The government and the markets are entering unchartered waters due to the unique nature of the island territory to the United States. Bondholders will be sitting on the edge of there seats waiting to see if they are the chosen few that will actually receive payment. This uncertainty will not have a positive impact on the markets. What will other US municipalities do? Detroit, Orange County, and other municipalities facing the same dilemmas now and in the past do not have the luxury to selectively make bond payments. The nature of credit markets is "all or none". Either you pay your bills or you don't. This is a very interesting case study. 

Institutional funds and other investors  will be left holding the bag at the whim of Puerto Rican legislators. Puerto Rico is actually the winner in this situation. How do you squeeze blood from a stone? You can't. Will Puerto Rico be able to borrow money? No. Will the US let one of its territories fall into a humanitarian crisis? Probably not.

Castillo San Felipe del Morro 2014