Thursday, November 20, 2008

Commercial Real Estate Finally Hitting Home in Financial Media

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Starting to see stories of commercial real estate weakness everywhere now... imagine that. Made Fast Money even... shocker. To be fair, Karen Finerman has been on this case for a while, unlike most. The normal crew is too busy wasting time shouting at each other - the show has gotten old when all it is nowadays is seeing who can yell louder, Macke or Najarian. Yawn.

Back to commercial real estate, it appears people are finally seeing the light we've been preaching for a very long time. [Dec 2007: Credit Downturn Hits Malls]

Since we cannot short individual names we've been using Ultrashort Real Estate (SRS) [Nov 12: REITs Continue to be a Gold Mine on the Short Side] One great thing for individual investors is these ETFs on the short side were not around in the last bear (2000-2002) so they are an easy way to be "long" and something a person can use even in retirement accounts. But the volatility is monstrous. It will soon be time to let go much of this position and then rebuy on the inevitable "the worst is behind us bounce" - don't want to get overly greedy because this is something that could reverse 75 points in a matter of 1 to 2 days. In fact it did just a few weeks ago.


  • The prices of bonds and stocks with exposure to commercial real estate plunged on Wednesday on fears the weakening U.S. economy could lead to a wave of defaults on loans for office buildings, retail stores, and hotels.
  • The value of commercial mortgage-backed securities (CMBS) has tumbled this year amid fears that poor underwriting standards and slower economic growth will boost defaults from historically low rates.
  • Yield spreads on the CMBX-5 index of "AAA" CMBS surged more than 100 basis points for a second day to 714 basis points over the benchmark of interest rate swaps, dealers said. Spreads, which measure perceptions of risk, on the derivative index are up from 200 basis points in October. Top-quality CMBS spreads are near 1,100 basis points, for junk bond-like yields of 15 percent or higher. Those spreads were around only 30 basis points before the global credit crisis began last year.
  • Selling of CMBS accelerated last week after U.S. Treasury Secretary Henry Paulson said a $700 billion rescue plan would be geared toward providing banks with fresh capital, rather than used as a fund to take illiquid mortgage assets -- such as CMBS -- off bank balance sheets. Paulson reiterated that stance this week.
  • "The mall operators are really, really in trouble," said Kevin Quinn, a managing director of equity trading at Stanford Group Company, mentioning Vornado Realty Trust VNO.N as a key player. "There aren't even signs on the empty stores in the malls. They've been empty for a while, barren, tumbleweeds blowing through." (sounds familiar to a blog I visit daily)
  • "I don't expect any improvement," said Chris Sullivan, chief investment officer at the United Nations Federal Credit Union in New York. "Most of the deterioration to this point has been technical (including deleveraging), but now worsening macroeconomic fundamentals, along with large deal-specific delinquencies, are beginning to weigh."

**************** FAST MONEY story below...

The Problem

Many loans in recent years were made on expectations that property values and cash flows from rents would continue to rise, leaving them the most vulnerable.

"There is a growing concern that (commercial real estate) is going to be another tripping point in the economy," adds William Larkin, portfolio manager with Cabot Money Management in Salem, Massachusetts. "No one wants to touch anything to do with real estate."

Selling accelerated last week after Treasury Secretary Henry Paulson said a $700 billion rescue plan would be geared toward providing banks with equity, rather than used as a fund to take illiquid mortgage assets -- such as CMBS -- off bank balance sheets. Commercial mortgage holdings contributed to the downfall of Lehman Brothers Holdings Inc. in September.

Taking The Hit

Big real estate companies were hardest hit in Wednesday with shares of Simon Property Group [SPG 41.07 -6.16 (-13.04%) ] the No. 1 mall operator and Boston Properties [BXP 43.60 -5.99 (-12.08%) ], which owns skyscrapers and other office buildings taking the biggest hits.

But the trouble isn't just with mall and office REITs. According to Karen Finerman the trouble also lies with, "heath care property investors such as HCP Inc.[HCP 17.60 -2.32 (-11.65%) ] and banks such as BB&T [BBT 23.57 -2.98 (-11.22%) ] which has huge commercial exposure."

"And keep an eye Phillips Electronics and Acuity Brands [AYI 26.33 -2.27 (-7.94%) ]. Both make commercial light fixtures and may have more room on the downside," adds Guy Adami.

Outlooks on commercial properties are darkening as economic reports point to disappointing retail sales, amid rising unemployment and rising foreclosures. Forecasts for a mild recession are now "off the table," in favor of an average or severe downturn, said Jay Mueller, a portfolio manager at Wells Capital Management in Menomonee Falls, Wisconsin.

“The commercial real estate problem is not over by a long shot," says Karen Finerman. It’s the kind of unwind that happens in slow motion.”

Long Ultrashort Real Estate since summer 2007 in fund; currently long in personal account


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