Play Falling Commercial Real Estate with SRS

SRS is an inverse ETF that will perform well as REITs, and more specifically, the commercial real estate space, falls. Know what you are investing in: SRS does not have primary exposure to the residential real estate market. It holds primarily REITs. REITs are not focused on mortgages. REITs are oriented toward commercial property.

Product Description:

UltraShort Real Estate ProShares is an exchange-traded fund incorporated in the USA. The Fund seeks daily investment results that correspond to twice (200%) the inverse (opposite) of the daily performance of the Dow Jones U.S. Real Estate Index.

Fundamental Analysis

Macroeconomic fundamentals in the health of the real estate sector will govern the direction of this asset. Over the past two years, home prices, home sales, volume, starts, etc. have all be focused on the consumer side of real estate. Commercial real estate has not received the same attention. In fact, commercial real estate has held up better in relative terms than the homes. This concerns me.

There has been a fundamental shift in consumer behaviour, most especially seen in Q4/2008. In the U.S., savings rates have increased. If savings is increasing, consumers are spending less. If consumers spend less, the demand for consumer goods will decline. We have already seen these figures.

Even that simplistic analysis above is already well known and is nothing new. Thus the next item to factor in is unemployment. 8.1%. Friday’s unemployment increased over 600,000 in the U.S. Fewer jobs means fewer office cubical needed. If you read commercial real estate news the impact to REITs is significant:

• Tishman Speyer’s 556,000 sq. ft. 555 Mission Street, opened in late-2008. It remains 70% empty.
• The hit on the legal profession is jaw-droping. In investment terms, this is hitting landlords. The dissolution of Heller Ehrman has emptied 350,000 sq. ft; 388,000 sq. ft. on 101 Second Street has been vacated due to the dissolution of Thelen LLP., another law firm

Technical Analysis

The use of technical charting for 2x beta ETFs is discouraged. This product is also only 2 years old, so there is no historical context for which to base a meaningful analysis. See SRS charts here: http://stockcharts.com/charts/gallery.html?srs

Chart technician die-hards are still welcome to review the chart. Note that in the short term, the SRS rally from $48 to $100 may be subject to a correction. Volume has not increased significantly. The ETF cut past the moving average in the $80s (weekly) and ~$58 (50 day moving average), ~$90 (200 day moving average).

Conclusion

Include a small percentage of the portfolio in SRS. This is not a guaranteed winner, for the gains and losses are spectacular: it can go either way. At this time, the real estate market collapse has not seen even a hit of abating. Unemployment has grown steadily from Q4/08 to Q1/2009. Economists and analysts all predict this to increase. My comment on this is that straight-line projections are not necessarily an accurate one. Monitor unemployment rates week-to-week if not month-to month, but do not forecast total unemployment in 2009 and then apply that valuation analysis on REITs.

My target price is $80 – $120. A break above $120 suggests a price target revision of $145-$190. Best not to be greedy if that latter price is reached. Accumulate on weakness. Take profits and balance it against any losses in long positions.

See my KaChing portfolio here .

Disclosure: Long

Comments

[Rocknbob:]

Mr. Lau, thank you for the treatment on this topic. Commercial real Estate is bound to continue to be under severe pressure with Mall tenants disappearing left and rightdue to economic pullback of the consumer...

Mar 16 11:46 AM

[Carl Spackler:]

Just like the financials, Commercial Real Estate (CRE) will take a while for the harsh realities to set in. Dividends will be reduced, then reduced further at a later date. Like the banks, this is a market that catered to investors who sought high dividend output. When these high dividends disappear, the CRE market will have to transition to a different type of investor. The temporary shift from income seekers to capital appreciation seekers usually causes the downward move to over-react. The ownership of these structures will experience a near complete turnover as this occurs.

I agree with the author's comments that the charts for this ETF are somewhat unuseable. 2x inverse ETF's that are releatively new are hard to draw concrete conclusions from. You have to buy and sell this animal on a fundamental basis and close your eyes. If the fear returns in spades, 120+ is more than a target on a long term basis (6 month). On a shorter term, there is no reason why 80 should not be broken. Yes, some of you will wince when I consider 6 months as long term, but you should not be using this ETF for long term investing. The taxes and its use of swaps as its sole investment do not make it useful for multi-year plays. On a shorter term, however, I love it. This ETF has great swings!

Mar 16 10:52 PM

[Alan Young:]

Good fundamental thesis, although using San Francisco as a proxy for national REITs is somewhat questionable.
SRS is double-inverse to IYR, I believe, so I do TA on the straight index fund.

Mar 17 09:29 AM

[AndrewBaker:]

Charts are deceptive when looking at 2x and 3x leveraged ETF, because to get back even after a fall requires a greater percentage move than the fall itself, and after anything over a day this distorts the chart so terchnical indicaters don't work properly. As a rough and ready guide, where a day closes against me, I look at the chart and consider the volatility I expect for the given instrument: if I feel it's enough, I'll hang in there. But if I feel not, then I'll either set a lower sell level than I had in mind, or take the hit (and maybe buy the opposite direction ETF if I really got it wrong!)

Mar 17 09:45 AM

[omooc:]

Well done; I learned a great deal. May I suggest someone (the author of this post as well as several commentators) give a tutorial on evaluating reverse 2x ETFs such as SRS for people other than day-traders (since, by reading the various entries, positions in SRS and other similar reverse 2x ETFs are to be closed on a daily basis). Aalan also provides a valuable piece of info (re IYR); thanks -- ditto to AndrewBaker.

Mar 17 10:10 AM