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The Reckoning Is Here for Commercial Real EstateBy
Saturday, September 26, 2009
This weekend, I had pizza and beer with an executive at a commercial real estate company...
My friend's company is one of the largest office landlords in America, with big investments up and down the East Coast. My friend manages the debt-finance division. "So is there a commercial real estate crisis coming?" I asked. "Yes. Absolutely," he said. "It's definitely coming." "How do you know?" "Nobody can refinance their loans. You have to be able to roll your debt. But if the property isn't worth as much as the debt, you can't roll it over. And there's a lot of debt coming due soon. We were fine... But we've slowly lost tenants. Now we've got a couple of buildings where rent doesn't cover the mortgage. We're giving these buildings up soon..." He said his company is sending the keys back to the bank. "It'll damage our reputation," he said. "We've never given up property before. But we don't have a choice." Over the last decade, commercial real estate boomed. All over the country, players took on trillions of dollars in debt to buy malls, warehouses, office towers, and industrial parks, believing prices and rents would rise forever. The recession caused consumers to stop shopping and retailers to stop hiring. Occupancy levels and rents started falling. Commercial real estate prices should have collapsed... Here's the thing: So far, the commercial real estate market has held up better than the residential market. According to my friend, this is for two reasons. First, commercial real estate is mostly leased to tenants. In the residential market, you walk away as soon as you get underwater. But in the commercial market, you don't mail the keys back to the bank until your tenant leaves. Because occupancy erodes slowly, there's a delay in defaults. Secondly, the new mark-to-market accounting rules kept the game going. These rules free banks from reporting loan losses until their loans mature. And they free commercial real estate owners from reporting investment losses until they sell the property. In other words, they give banks a huge incentive to extend bad loans and companies a huge incentive to keep holding properties. Investors and banks hoped if they could hold on for long enough, the turnaround in the economy would rescue them. But it hasn't happened. Now, according to my friend, the reckoning is here for commercial real estate. One way to play the coming crisis is to short the stock prices of commercial property REITs, like Boston Properties, Simon Properties, Prologis, and Vornado. These companies hold billions of dollars in investment property that needs marking down, and their stock prices have soared in the last six months. Shorting regional banks is another way. Many regional banks have huge exposure to commercial property. Finally, you could just short the stock market. When the residential real estate market collapsed, it brought America's financial system to its knees. The commercial real estate market is half the size of the residential market. Its collapse may not cause another credit crunch, but it'll definitely knock a few points off the S&P... One word of warning: Standing in front of a freight train is never a good idea. These investment ideas are all rising in a powerful uptrend right now. I’d wait for a 10% decline in the S&P before you start placing these short trades. Good investing, Tom
Further Reading:
What I Learned from a Salesman at Lowe's Market NotesTHE GOLD STOCK MARKET IS TINY
This week's chart comes to us courtesy of our friends at Casey Research.
Casey's analysts specialize in the natural resource business... and they're long-term bullish on gold stocks. Here's one big reason why: If there's a worldwide rush to own gold and gold stocks in the coming years, well, there's just not many places for that money to flow. As you can see from this chart featured in Casey's Gold and Resource Report, the market cap of the entire gold mining industry is miniscule compared to the drug and banking industry... or even Wal-Mart. In other words, if there's a rush to own gold stocks, the small size of the market could make for a giant run higher. – Brian Hunt |
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