Four Commercial Real Estate ETFs to Consider as the Next Shoe Drops

There’s another shoe that’s quietly starting to drop in the commercial real estate sector… one that could deal a fatal blow to some of the largest banks like Goldman Sachs (NYSE:GS), Bank of America (NYSE:BAC), Morgan Stanley (NYSE:MS) and most of the other big boys in the news of the last year.

But you wouldn’t know that by looking at the headlines…

Last week, Goldman Sachs announced a huge upside surprise in earnings, a $5 billion share offering, and its intention to pay back federal TARP funds ASAP.

The average investor might view this as a sign that things are returning to normal in the banking sector, and be tempted to start shoveling money back into banking stocks.

Let me suggest you wait a while. “A fool and his money are soon parted,” as the old saying goes.

Put another way, if you think a one-month rally in the stock market can begin to erase a financial crisis that’s been going on for the better part of two years now, I’ve got some great Florida swampland for you.

Thursday morning investors got a taste of what lies ahead as General Growth Properties (GGP) filed the biggest real estate bankruptcy in U.S. history. The impact of a commercial real estate collapse will continue to ripple across the markets, and it’s why we need to take a closer look…

Commercial Real Estate: Sad State of Affairs & Getting Worse

It’s no surprise that the market for commercial office space has come to a crashing halt. Last year, commercial real estate sales fell off a cliff, plunging 73%, according to data from Real Capital Analytics.

But it’s going to get worse… much, much worse.

At the end of last year, the vacancy rate for commercial office buildings was 14.5%. This year it’s expected to hit 16.7%, as more and more companies and individuals file for bankruptcy. This chain reaction has led to an explosion of commercial property defaults.

According to Mark Scott - Senior Vice President of NorthMarq Capital LLC, a New Jersey commercial real estate brokerage and property management company - 2009 could be a banner year for commercial defaults:

“In the office market, you’re starting to see signs of mammoth job losses, and as people aren’t buying as many goods, they’re not shipping as many goods, so [now] we have stress in the industrial market.”

Namely, banks seized 464 commercial office properties worth $7 billion in March alone, nearly triple what was seized in December. And that leaves banks holding millions of square feet of space that’s plunging in value by the minute.

Part of the problem is certainly lack of demand, but part of the reason for the increasing default rate on commercial loans is the way they were structured in the first place. Many of them were based on a payment structure that included increases in future rental rates and revenues.

And as if exploding office vacancies and mortgage defaults on the properties weren’t bad enough, now there’s another problem area surfacing in the commercial real estate market: industrial properties.

Industrial Property - The Other Shoe

When it comes to industrial property, two-thirds of the space available consists of warehouse and distribution centers. Torto Wheaton Research - the commercial research unit of CB Richard Ellis - predicts vacant space will climb to 12.6% in 2009 from 11.4% in 2008.

But according to NAI Mertz Corporate Service’s Director Stephen L. Blau, the commercial market shows nary a sign of stabilization. In fact, he says we’re just now seeing the beginning of what he expects to be a huge wave of commercial mortgage foreclosures.

And Jeffrey DeBoer, President of the Real Estate Roundtable agrees, “This is a rolling problem that’s only going to get worse.” This year, DeBoer estimates $400 billion worth of commercial real estate mortgages will be due and payable.

Tougher, loan underwriting standards combined and declining property values will make it virtually impossible for some owners to refinance, setting off a chain of events that usually culminates in bankruptcy and foreclosure.

There are a number of ways we can profit from this “next” loan crisis…

Shorting Commercial Real Estate With ETFs : 3 Ways to Profit

You might think the best way to play this new problem for the big banks would be to short them directly, or to invest in one of a number of bank-shorting ETFs. But there are more direct ways. Here are three commercial real estate ETFs ripe for short plays and their losses for 2009:

• iShares FTSE Industrial/Office Index (NYSE: FIO) down 15.5%

• Vanguard REIT Index (NYSE: VNQ): down 22.2%

• Dow Jones Wilshire REIT (NYSE: RWR): down 23.6%

Investors might also want to consider going long the ProShares UltraShort Real Estate (NYSE: SRS). This seeks investment results equal to twice the inverse of the daily performance of the Dow Jones U.S. Real Estate Index.

Commercial and industrial loan failure represents a risk that few have talked about, and even fewer know what to do about. The impacts from this fallout are only starting to be recognized, and it’s only going to get worse.

And going long banks with this shoe starting to drop? Not with my money.

Comments

[arlin:]

Great thinking,have been watching SRS for a while now,and was unaware of the other etf's
many thanks.

Apr 19 09:56 AM

[granger:]

Any thoughts on the RWX puts for global downside exposure? or is the US a better focus?

Apr 19 10:41 AM

[Mad Hedge F...:]

This is where the next big headlines are going to come from. George Soros says that it is “inevitable” that commercial real estate falls another 30%. Rents are falling, tenant bankruptcies are rising, there is tons of debt to be refinanced for which there is no market, so cap rates are rocketing and “ghost mall” has joined the recessionary lexicon. This all adds up to lower prices. Some credit default swaps are trading at levels suggesting that a major REIT bankruptcy is imminent. I know George is sometimes prone to extreme statements, but this time he may be on to something. If you want a short play, or if you have an existing long position in commercial real estate which you can’t get out of and want to hedge, try a short position in the (IYR), although it has already dropped from $85 to $21. You can also play one of the sicker REIT names like Brookfield Properties (BPO).

Apr 19 11:20 AM

[searcher:]

I wouldn't play the 'anointed' banks on the valid premise of a commercial bust. The property players and their aggregators are the best plays.

Apr 19 12:13 PM

[Old Trader:]

Arlin,

As I read the article, the first 3 ETFs are "longs", which would have to be shorted, which may well not be possible if you're trading within a tax-advantaged vehicle (IRA, 401k, etc.). I wonder how "pure" a play SRS is on the CRE sector?


On Apr 19 09:56 AM arlin wrote:

> Great thinking,have been watching SRS for a while now,and was unaware
> of the other etf's
> many thanks.

Apr 19 12:16 PM

[realold:]

I have followed this closely, as I used to be heavily invested in REITs. It looks like the biggest decline has already occurred and many are rallying at the moment. So, I still agree but advise caution as something strange is going on with SRS at the moment.

Apr 19 03:03 PM

[Hman:]

What etf would you recommend if SRS is not the way to go?


On Apr 19 12:16 PM old trader wrote:

> Arlin,
>
> As I read the article, the first 3 ETFs are "longs", which would
> have to be shorted, which may well not be possible if you're trading
> within a tax-advantaged vehicle (IRA, 401k, etc.). I wonder how "pure"
> a play SRS is on the CRE sector?

Apr 19 04:57 PM

[Alan Young:]

Good suggestions, if you have the ability to short these ETFs.
This would be a slam-dunk but for one catch: who knows what assistance the Fed might suddenly decide to offer the CRE sector?

Apr 19 08:42 PM

[Gruber:]

You may be a little late to the real estate "short" party.
This would have been good advice 6 months ago but its old news already discounted into the stocks. REITs have been successful at raising capital and this market segment is not headed for wholesale bankruptcy. GGP bankruptcy may be a lagging indicator. Additionally, CMBS will likely be added to the TALF program easing some pressure.
While there is more pain to come for commerical real estate and there is a "short" trading opportunity now that the an ETF like VNQ is up almost 30% in the last three weeks, pay attention to covering your short position. This is not a "no-brainer."

Apr 19 11:41 PM

[Delojozafado:]

We may surmise that the Fed will provide SRS the same impetus it has provided for TBT. The Chinese are fleeing the +ten year Treasury issuances. 30yr Mortgages actually rose last week to an average of 4.87%. SRS has just been punished these last two or three weeks, down to $27.xx from +$50. In the end the US Government and it's huge debt capacity can not overcome the sum of what is happening. Congress is already looking towards the mid-term elections. Sen Shelby of AL is up for re-election. The ranking member of the Senate Banking committee is not going to assist in the handing out of any more welfare to bankrupt enterprises. "The next shoe to drop" C/R is just another symptom as to why this is to be a very long and severe recession. In the end it is about the survivors. The mini-malls anchored buy a major grocer that competes with Wal-Mart and a predatory bank that charges outrageous fees to customers who paid to bail them out. These are not the high tech jobs of the future we used to hear about. GE is finishing up on their new research and development center in Bangalore. Many other US companies have moved R &D overseas as well. In the end we exported our skilled labor & manufacturing jobs over seas over the last 30 years, expecting to have some success economically as a service economy. We have imported tens of millions to do the jobs Americans did not want. Ralph Cramden's friend Norton was fine with working in the sewer as it paid a decent living wage with benefits. There are no jobs Americans don't want! Advertise any job an American doesn't want for $20/Hr plus pension, medical and training benefits and you will get +10,000 applications. In the end the US has fallen prey to one of the most dangerous aspects of democracy. The ability of mob rule to vote themselves largess. Add to that the political opportunists that will use the big lie to advance their own agendas. We get the whole mess of the house of cards collapsing on a society that has promised way to much to it's elderly and taxed the subsequent generations ever more to pay for it. I own TBT and SRS in my IRA and am adding to them. I also own AGQ which I just added another big position to on silver dropping through $12. I own the DGP and PTM as well. Eventually the global economy will wake up to the US economy as a Ponzi scheme. As the Treasury embarks on "Q" easing we find that 4 of the last 5 of their "TIC" reports were negative. By one measure the Treasury's own reports are showing that money is flowing out of the country. China is now stock piling copper in addition to continuing to fill it's SPR. They actually are paying attention to the man behind the curtain. With out decent paying jobs with benefits you can not support an "ownership society". House prices cannot stop falling until the mini mall workers cut back on the $20 a week they are barely able to contribute to their 401-ks and are able to support the total cost of home ownership. But first the politicians have to stop giving away the store before that ever happens. With out skilled decent paying jobs the economy will never stop the crumbling of the foundation of the pyramid that continues to collapse. So far "they" have not been able to keep that TBT down below $45 for more than a day or two. SRS is going to find a similar bottom as well. My total cost basis on 3 lots so far is $34.78. Let the SRS drop to $25 and I will jump on some more shares! Real jobs, real immigration reform, real entitlement reform on both the State and Federal levels, and a health care system that does not put us employers and small business at an unfair advantage to foreign employers, is just not happening. We can standby and be slaughtered in the markets or take a proactive strategy that more of the same is what will beget more of the same.

Apr 19 11:43 PM

[Patrick Bat...:]

Be a man and buy put options.


On Apr 19 04:57 PM Hman wrote:

> What etf would you recommend if SRS is not the way to go?

Jul 26 02:12 AM

[Patrick Bat...:]

paragraphs are a great way to get people to actually read your comments.


On Apr 19 11:43 PM Delojozafado wrote:

> We may surmise that the Fed will provide SRS the same impetus it
> has provided for TBT. The Chinese are fleeing the +ten year Treasury
> issuances. 30yr Mortgages actually rose last week to an average of
> 4.87%. SRS has just been punished these last two or three weeks,
> down to $27.xx from +$50. In the end the US Government and it's
> huge debt capacity can not overcome the sum of what is happening.
> Congress is already looking towards the mid-term elections. Sen
> Shelby of AL is up for re-election. The ranking member of the Senate
> Banking committee is not going to assist in the handing out of any
> more welfare to bankrupt enterprises. "The next shoe to drop" C/R
> is just another symptom as to why this is to be a very long and
> severe recession. In the end it is about the survivors. The mini-malls
> anchored buy a major grocer that competes with Wal-Mart and a predatory
> bank that charges outrageous fees to customers who paid to bail them
> out. These are not the high tech jobs of the future we used to hear
> about. GE is finishing up on their new research and development
> center in Bangalore. Many other US companies have moved R &D
> overseas as well. In the end we exported our skilled labor &
> manufacturing jobs over seas over the last 30 years, expecting to
> have some success economically as a service economy. We have imported
> tens of millions to do the jobs Americans did not want. Ralph Cramden's
> friend Norton was fine with working in the sewer as it paid a decent
> living wage with benefits. There are no jobs Americans don't want!
> Advertise any job an American doesn't want for $20/Hr plus pension,
> medical and training benefits and you will get +10,000 applications.
> In the end the US has fallen prey to one of the most dangerous aspects
> of democracy. The ability of mob rule to vote themselves largess.
> Add to that the political opportunists that will use the big lie
> to advance their own agendas. We get the whole mess of the house
> of cards collapsing on a society that has promised way to much to
> it's elderly and taxed the subsequent generations ever more to pay
> for it. I own TBT and SRS in my IRA and am adding to them. I also
> own AGQ which I just added another big position to on silver dropping
> through $12. I own the DGP and PTM as well. Eventually the global
> economy will wake up to the US economy as a Ponzi scheme. As the
> Treasury embarks on "Q" easing we find that 4 of the last 5 of their
> "TIC" reports were negative. By one measure the Treasury's own reports
> are showing that money is flowing out of the country. China is now
> stock piling copper in addition to continuing to fill it's SPR.
> They actually are paying attention to the man behind the curtain.
> With out decent paying jobs with benefits you can not support an
> "ownership society". House prices cannot stop falling until the
> mini mall workers cut back on the $20 a week they are barely able
> to contribute to their 401-ks and are able to support the total cost
> of home ownership. But first the politicians have to stop giving
> away the store before that ever happens. With out skilled decent
> paying jobs the economy will never stop the crumbling of the foundation
> of the pyramid that continues to collapse. So far "they" have not
> been able to keep that TBT down below $45 for more than a day or
> two. SRS is going to find a similar bottom as well. My total cost
> basis on 3 lots so far is $34.78. Let the SRS drop to $25 and I
> will jump on some more shares! Real jobs, real immigration reform,
> real entitlement reform on both the State and Federal levels, and
> a health care system that does not put us employers and small business
> at an unfair advantage to foreign employers, is just not happening.
> We can standby and be slaughtered in the markets or take a proactive
> strategy that more of the same is what will beget more of the same.

Jul 26 02:13 AM

[Pete Boondo...:]

Ruinous advice, in hindsight. If you had bought the UltraShort real estate ETF (SRS) on April 20, then by December 20th you'd have lost more than 70% of your money.

But if you didn't think that was a good idea, this author has some swampland in Florida to sell you...

Dec 21 03:18 PM