Trump real estate finance #4 – What’s at risk?

  

In the prior post in this series, I looked at where the likely differential between Trump’s self-proclaimed net worth of $10 billion and Forbes’ $3.1 billion estimate came from. In this last post in this series (for now) I want to take a harder look at the Forbes valuation. Skip to the “Trump Businesses at Risk” section at the end if you want a summary of the Trump businesses that I think are most in jeopardy of a “valuation crash.”

One winter not long after the 2008 real estate crash, we rented a lovely vacation home for a month on northwest Florida’s St. George Island, just off the gulf coast from Apalachicola. It is a tranquil, remote place free of high-rise resorts, and because of the crash collapsing the value of, and lower demand for, Florida real estate, you could rent a gulf-front home for a decent price. In fact, the house next to ours had just sold in a bank sale for only $400,000. I looked up its prior sale, which had occurred just before the real estate crash, to find that it had sold then for $1,100,000.

What had changed to cause the selling price of this house to drop over 60% in such a short span of time? We even talked to the new owner and rented that very house the next year, as much to satisfy our curiosity as anything. It was a wonderful house in all respects. This is the mystery that is real estate valuation.

Forbes reduced their estimate of Trump’s net worth down from 2017’s estimate of $3.4 billion to $3.1 billion for 2018. They don’t give a lot of detail in how they arrive at their estimates, but they do say that the change was mostly due to a decline in the value of luxury real estate in Manhattan, as well as continuing cashflow problems with his golf courses. [1] There are some standard methods used to estimate net worth that they have likely used, but even these are subject to assumptions that, like my Florida example, can cause valuations to change dramatically.

Top-down estimates

The easiest way to value many assets is to see what similar assets are selling for, and like a classic real estate appraisal, adjust that value up and down depending on how comparable other properties are. This is likely where Forbes found the data to discount existing Trump Manhattan properties as the luxury market has cooled off there.

In the past, the Trump brand name may well have provided an incremental value to the properties, but as noted in the prior post of this series, the value of this “intangible” asset can be very fickle. In addition to condominium owners having trouble selling units in the signature Trump Tower due to increased security and notoriety, his hotel/condo properties in Toronto and Panama have both had the Trump name stripped from the marquee due to financial difficulties. [2]

The biggest problem in any top-down estimate of Trump properties is the lack of transparency and outright fabrication regarding any private financing and collateral arrangements putting the property value at risk. As I described in a prior post, there are some 500 corporations, LLCs, trusts, and private partnerships behind Trump Organization properties. For virtually all major real estate developers, these entities serve to isolate risks of various stakeholders, obscure beneficial ownership and evade taxes. Indeed, real estate development is usually only possible and profitable because of the leverage that these arrangements provide, and this is the primary reason why private, rather than public, ownership is the norm.

The reality is that we don’t know the extent of these private financing arrangements, which could reduce the actual Trump family equity in these projects substantially. My take is that the Trump blatantly lies about everything else, therefore the odds are that he does not really have the $2 billion equity in real estate that Forbes says he has.

Bottom-up estimates

Bottom-up estimates typically start with annual accounting income or cashflows and attempt to compute the present value of these projections over the foreseeable future. Present value calculations discount each future cashflow from an invested property by calculating the amount you would need today which, if invested at a particular interest rate, would yield that projected cashflow in the future. Add them all up, and theoretically you have the total value of the property by comparing it to an alternative investment with similar risks.

While expected future cashflows can often be derived from accounting income in normal businesses, this cannot typically be done in private real estate development. As was discussed in the first part of this series, “accounting income” is a bookkeeper’s fiction in most private real estate companies, since a key goal is to show a taxable loss, or at least minimal taxable income, while still generating enough in cash flows to pay debt obligations and to maintain a certain “lifestyle” level (the latter especially in the case of Trump).

The interest rate, or the discount rate, of the present value calculation is usually set at a level that indicates expected returns from comparable or alternative investments. The way the discounting formula works is that a low discount rate would create a high present value of future cashflows, but such interest rates only apply to very safe projects. Most real estate projects are far riskier than the average return on the U.S. stock market, which is about 7% over time adjusted for inflation, and so should have much higher discount rates applied. [3]

In short, each future year’s expected cashflow for each project is divided by the factor calculated as (1 + discount rate) to the nth power, where “n” is the number of years the projected cashflow is away from coming in. So, an expected cashflow of $1 million three years out, if discounted at 10%, would be worth only a bit over $750,000 today. [4] At a 15% discount rate, however, indicating a riskier project, the present value drops to only $658,000 today.

Comparing Top-down and Bottom-up estimates

Theoretically, the top-down estimate of a project’s worth and the bottom-up estimate should be close to one another. If they are widely different, then there is likely a bad estimate or bad assumption somewhere in the analysis. For instance, how risky is this particular project, given that I could invest the same amount of money in another project of similar risk and perhaps get a better return on my investment?

Several estimates have been published showing how much Donald Trump’s inherited wealth could have grown if invested in alternative projects of much less risk (or even simple passive “buy-and-hold” mutual fund investments). Invariably, these analyses show that Trump certainly would have been much richer than Forbes’ $3.1 billion estimate, or even his own $10 billion estimate, without ever going bankrupt. Write your own conclusion here.

Trump Businesses at Risk

Based on what has been disclosed through various sources, which Trump businesses are at the most risk of a “valuation crash,” where the market value of his assets falls precipitously from one of the valuation methods above? Here is my list:

Consumer brands. The ties, the steaks and other consumer brands are basically dead already, according to a recent Washington Post article. [6] This part of the business won’t go bankrupt, however, because there is no real equity beyond some royalty contracts, and likely no debt. It is cashflow-based only, and worth only the present value of future royalties, as shown above.

Real estate brands. Since conventional financing has been so hard to obtain after Atlantic City, most recent Trump real estate projects have been mostly about branding, with apparently little actual Trump cash in the properties. At least three properties have recently seen the Trump name removed, and there will likely be more. Polarization of the brand is likely more significant here than agreement or disagreement with Trump’s politics. If you are a corporate events manager scheduling a big convention, will you book it at a Trump hotel? Is it worth the complaints you will get from staffers when there are “safer” alternatives?

Hotel management. The Trump Organization retains operating agreements with a number of Trump-brand-only properties. In the hotel business, it is common for the management company to be separate from the branding and ownership. The best ones are efficient, provide great customer service, and yet often are (intentionally) invisible from a corporate point of view, known mostly only to insiders as very good at their jobs. For instance, how many people know of the Pyramid Hotel Group, which manages many high-end properties for Marriott and others. Trump has no real advantage here anymore other than contract guarantees on existing properties.

Golf Courses. The risk of a bankruptcy or two is likely the highest here. We know the Scottish courses are bleeding cash and likely his Los Angeles course as well. In general, the golf course business has bad demographics going against it, and the real estate often has alternative uses for commercial or residential development. Finally, recorded comments from both Trump sons suggest there is a lot of private investment, often of dubious provenance, in these businesses. We don’t know the collateral details here, but there is little to indicate that this business will get healthier. A Trump-branded golf course in Puerto Rico went bankrupt in 2015, well before Hurricane Maria. [6]

Commercial/Residential Real Estate. Again, there is a lack of transparency in these businesses. How much private money of questionable origin is in these projects, either as investors with “under the covers” collateral rights, or as foreign buyers paying above-market prices to get their assets into the United States? [7] Continued investigation into these aspects of Trump’s businesses is likely only just beginning, and every messy lawsuit and deal-gone-wrong will reduce the value of these properties, as well as put them at increased risk for failure.

In summary, the total value of Donald Trump’s properties is heavily dependent on assumptions of cashflow, reputation, and risk. Small changes can have big impacts in total valuation. How confident are you on his assumptions? Place your bets.


Notes:

  1. Drange, Dan, and Alexander Matt. “Trump’s Net Worth Tanks On New Forbes List Of Richest Americans.” Forbes Magazine, 14 Dec. 2017.
  2. Cerrud, Ana, and David A. Fahrenthold. “Trump’s Name Is Stripped from Panama Hotel.” The Washington Post, 5 Mar. 2018.
  3. Stay tuned to this blog for an upcoming post on “Visualizing 7% investment risk.”
  4. The factor (1 + 0.10) to the 3rd power is 1.33. Divide the $1 million by that number to get $751,314.80.
  5. Anthony, Zane, et al. “Whatever Happened to Trump Neckties? They’re over. So Is Most of Trump’s Merchandising Empire.” The Washington Post, 13 Apr. 2018.
  6. Wattles, Jackie. “Trump-Branded Golf Resort Files for Bankruptcy.” CNNMoney, 13 July 2015.
  7. Unger, Craig. “Trump’s Russian Laundromat.” The New Republic, 13 July 2017.

One thought on “Trump real estate finance #4 – What’s at risk?

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