Friday, April 3, 2009

U.S. Office Vacancies Surging, Rents Biggest Drop in 7 Years

Folks, this is why it is so much easier being a strategist than money manager. As we spoke about just this morning - the disassociation between "reality on the ground" and stock prices will only be widening. The REITs are heavily shorted and this sector, along with many stocks in the $1-$10 range (speculative junk) are surging. I wrote yesterday

What happens in the latter part of a bull run is small cap speculative stocks will begin to dominate - we saw that at the top in October 2007 when you could buy any chinese stock under $5 and triple your money in a week. We don't own that type of stock so as people begin to get rabid looking for stock, you are starting to see these type of stocks pop ...

So we're getting popped on our shorts below $10 - generally this sort of behavior occurs as a move reaches its latter innings so I'll assess later today and into early next week if I continue to take water onto the ship. If the buying continues we'll have no choice but to cover some exposure and wait for better opportunities. Fighting a mob with a single knife will be a losing battle.

Specific to REITs, what I wrote in the Kimco piece last night was

To do such a massive offering at such a low price is not a great sign, but as long as Kool Aid is flowing it can be a signal of "good" - see the performance of Alcoa (AA) the past few weeks after a major equity offering in the single digits. The stock is down 5% in after hours but we'll see how it goes - if the tide turns to "we're just thankful we kicked the can down the road for a while" these sort of things can be short term positives.

As I always say its not the news, its the reaction to the news - it turns out people took the path I laid out above. Diluting shareholders to the nth degree is a great thing... many banks also surged on similar news through late 2007 and all of 2008.

These are still good fundamental shorts as the data below will point out; but everything is about time frame and if they want to ramp them up, we can't sit and take 40-50% type of losses; we''ll have to attack from a future date. (which is exactly why we covered Harley Davidson, Whirpool, Whole Foods) No matter what the fundamentals on the ground say.

Our 2 favorite REIT sectors are office and retail; the piece below deal with offices. Remember the damage in office space will have a lagged effect since leases are not negotiated monthly (in most cases) - at the end of the year or whatever time length, renters will either be pressuring for lower rates and/or ceasing to exist (leaving empty spaces). So even when the economy flattens out, REITs are late to recover due to this situation. They are not "early cycle".

WSJ: U.S. Office Vacancies Hit 15.2% - And Rising
  • Struggling to cut costs in a raging recession, companies dumped a near-record 25 million square feet of office space in the first quarter, driving vacancy up and rents down, according to data to be released today by Reis Inc.
  • The office vacancy rate rose in 63 of 79 primary metropolitan areas and effective rents fell in 64 of 79 markets, indicating a continued rise in concessions from the fourth quarter of 2008 to the first quarter of 2009.
  • Businesses that needed to lease space took advantage of the market weakness to extract concessions out of landlords. But the trends exacerbated financial woes for owners, especially those who owe more on their mortgages than their properties are worth.
  • The office vacancy rate nationwide rose to 15.2% from 14.5% in the previous quarter, and likely will surpass 19.3% over the next year, according to Reis, a New York firm that tracks commercial property. That would put the vacancy above the level seen in the real-estate bust of the early 1990s, the worst on record.
Let's stop there... 1 out of every 5 square foot will sit empty a year from now according to this projection... and we are already at 1 out of 6.
  • Effective rents, which include free rent and other landlord concessions, fell 2% in the first quarter to a national average of $24.16, the largest drop since the first quarter of 2002, according to Reis. Sublet space, on average, is going for between 10% and 15% less than what landlords are charging.
  • But New York City is getting clobbered. Suffering from an unprecedented contraction in the financial-services sector, Manhattan is registering record-high deteriorations in both empty space and rents. Vacancy in New York increased two percentage points in one quarter, from 8% to 10.2%, the single largest quarterly jump in vacancy since Reis began publishing quarterly performance data in 1999. New York rents fell 5.2% to $52.83.
  • The weakening commercial real estate market is posing yet another threat to the ailing economy because it's causing the value of buildings to plummet, often to less than the amount of their mortgages.
  • Up until now, many have expected commercial real estate to fare better than the housing market, thanks to the lack of rampant overbuilding in the recent cycle. But supply is being dumped on the market instead from layoffs. With as many as 1.5 million jobs expected to be cut this year, more than 50 million square feet of office space is expected to be emptied out for the full year, projects Reis.
  • Meantime, nationwide, more landlords are being forced to sell properties as they struggle to repay debt. Currently, there are about $8.8 billion worth of distressed office assets, or 211 properties, and that number is growing by about 30 properties each month, according to Real Capital Analytics.
So where does this head?
  • Landlords who are "under water" – and those who lent to them – are facing greater losses. More than a quarter of the $524.5 billion of commercial mortgages on banks' books that will mature in the next four years are backed by real estate that is now worth less than the mortgage, according to Foresight Analytics, a research firm in Oakland, Calif.
  • "You really only fell off the cliff in the fourth quarter 2008," Victor Calanog, Reis director of research, said. "It's really sobering to see that even though we're technically at the beginning of this downturn, the magnitudes of the declines, the fact that they're registering historic levels, is really sobering."
So as a 'strategist' I could say, wow look at all my predictions coming true - brilliant! As an investor - it's not quite so easy :) Suffering losses of a significant nature here but remember we've already trading this group for round trip profits 4x in the past 3 months, and more profits will come in the year ahead.

Anyhow let us clasp hands together as a Nanny State and rejoice that the taxpayer peasant is responsible to bailout the well heeled financiers.... corporate socialism is an excellent system if I do say so myself.

Never fear! There is always a solution. [Dec 22, 2008: Wall Street Journal - Property Developers Ask for Government Bailouts] [Jan 13, 2009: Bailout Nation Continues in Commercial Real Estate Land - "Lemme In on that Money"]
  • Washington policy makers are scrambling to extend bailout programs to help shore up commercial real estate.
[Mar 30, 2009: WSJ - Commercial Property Faces Crisis]
Feb 23, 2009: Fed May Need to Recast TALF on Commercial Real Estate]
[Jan 27, 2009: As Hotel Vacancies Rise, So Do Risks of Default]
[Jan 6, 2009: As Vacant Office Space Grows, So Does Lenders Crisis]
[Dec 15, 2008: Commercial Real Estate - You Can't Go Wrong]
[Nov 20, 2008: Commercial Real Estate Finally Hitting Home in Financial Media]
[Nov 12, 2008: REITs Continue to be a Gold Mine on the Short Side]
[Nov 11, 2008: General Growth Properties Looks to Join Its Tenants]
[Oct 18, 2008: CNNMoney: Mall's Demise Could Doom Communities]
[Jul 21, 2008: Add Mervyn's to Our Growing list of Retailers Heading to the Great Sunset]
[Mar 4, 2008: WSJ - Building Slowdown Goes Commercial]
[Dec 2007: Credit Downturn Hits Malls]

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