One Trillion Dollar Commercial Real Estate Time Bomb Now Ticking

Imminently, Zero Hedge will present some of its recently percolating theories about some oddly convenient coincidences we have witnessed in the commercial real estate market. However, for now I focus on some additional facts about why the unprecedented economic deterioration and the resulting epic drop in commercial real estate values could result in over $1 trillion in upcoming headaches for financial institutions, investors and the administration.

When a month ago I presented some of the projected dynamics of CMBS, a weakness of that analysis was that it did not address the issue in the context of the CRE market's entirety. The fact is that Commercial Mortgage Backed Securities (or securitized conduit financings that gained a lot of favor during the credit bubble peak years for beginners) is at most 25% of the total commercial real estate market, with the bulk of exposure concentrated at banks (50%) and insurance companies' (10%) balance sheets.

But regardless of the source of the original credit exposure, whether securitized or whole loans, the core of the problem is the decline in prices of the underlying properties, in many cases as much as 35-50%. When one considers that with time, the underlying financings became more and more debt prevalent (a good example of the CRE bubble market is the late-2006 purchase of 666 Fifth Avenue by Jared Kushner from Tishman Speyer for $1.8 billion with no equity down), the largest threat to both the CRE market and the bank's balance sheet is the refinancing contingency, as absent yet another major rent/real estate bubble, the value holes at the time of maturity would have to be plugged with equity from existing borrowers (which, despite what the "stress test" may allege, simply does not exist absent a wholesale banking system nationalization).

The refinancing problem thus boils down to two concurrent themes: The first is the altogether entire current shut down in debt capital markets for assets, which affects all refinancings equally (for the most immediate impact of this issue see General Growth Properties (GGP) which was not able to obtain any refinancing clemency on the bulk of its properties). The government is addressing this first theme through all the recently adopted programs that are meant to facilitate general credit flow. Readers of Zero Hedge are aware of our skepticism that these are working in any fashion, especially with regards to lower quality assets. The second theme is the much more serious and less easily resolved issue of the negative equity deficiency on a per loan basis, which is not a systemic credit freeze problem, but an underwater investment problem.

This analysis focuses on the second theme. The reason for this focus is that there seems to be an unfortunate misunderstanding in the market that lenders will simply agree to roll the maturities on non-qualifying loans, and that the expected percentage of loans that need special lender treatment is low, roughly 5-10% of total loans. In reality the percentage of underwater loans at maturity is likely to be in the 60-70% range, meaning that refi extensions could not possibly occur without the incurrence of major losses for lenders.

In order to demonstrate the seriousness of the problem it is important to first present the magnitude of the refinancing problem. To quote from an earlier post as well as data from Deutsche Bank (DB), and focusing on the CMBS product first, there are approximately $685 billion of commercial mortgages in CMBS maturing between now and 2018, split between $640 billion in fixed-rate and $45 billion in floating rate. The figure below (click to enlarge) demonstrates the maturity profile by origination vintage. As noted previously, vintages originated in the pre-2005 bubble years are likely much less "threatening" as even with the recent drop in commercial real estate values, the loans are still mostly "in the money".



As Zero Hedge has pointed out previously, the biggest CMBS refi threat occurs in the 2010-2013 period when 2005-2007 vintaged loans mature. These loans, originated at the top of the market, of which the Kushner loan for 666 Fifth Avenue is a brilliantly vivid example, have experienced 40-50% declines in underlying collateral values, and the majority will have material negative equity at maturity (if they don't in fact default long before their scheduled maturity). Of these loans, only a small percentage will qualify for refinancing at maturity.

At this point cynical readers may say: well even if all CMBS loans are unable to be rolled, it is at most $700 billion in incremental defaults. Is that a big deal - after all that's what the government prints in crisp, brand new, sequentially-numbered dollar bills every 24 hours (give or take). Well, the truth is that CMBS is only the proverbial tip of the $3.4 trillion CRE iceberg. To get a true sense for the problem's magnitude one has to consider the banks and life insurance companies, which have approximately $1.7 trillion and roughly $300 billion in commercial loan exposure.

Banks have $1.1 trillion in core commercial real estate loans on their books according to the FDIC, another $590 billion in construction loans, $205 billion in multifamily loans and $63 billion in farm loans. The precise maturity schedule for these loans is not definitive, however bank loans tend to have short-term durations, and the assumption is that all will mature by 2013, exhibiting moderate increases in maturities due to activity pick up over the last 2-3 years.

Adding the life insurance company estimate of $222 billion in direct loans maturing through 2018 per the Mortgage Bankers Association, increases annual maturities by another $15-25 billion.

In summation as presented below (click to enlarge), the total maturities by 2018 are just under $2 trillion, with $1.4 trillion maturing through 2013.





Combining all sources of CRE asset holdings demonstrates the true magnitude of this problem. The period of 2010-2013 will be one of unprecedented stress in the CRE market, and a time in which banks will continue taking massive losses not only on residential mortgage portfolios but also on construction loan portfolios, the last one being a possible powder keg: Foresight Analytics estimates C&L loan losses at a staggering 11.4% in Q4 2008.

And the bad news continues: there is a risk that commercial mortgages will under-perform CMBS loans, and delinquency rates for bank commercial mortgages will be magnitudes higher than those for comparable CMBS. The figure below (click to enlarge) demonstrates the underperformance of bank commercial mortgages: as of Q4 2008 the delinquency rate for CMBS was less than half of bank CRE exposure.



Reflecting on this data should demonstrate why the administration is in such full-throttle mode to not only reincarnate credit markets at all costs (equity market aberrations be damned) but to boost credit to prior peak levels, explaining the facility in providing taxpayer leverage to private investors who would buy these loans ahead of, and at maturity. Absent an onslaught of new capital, there is simply nowhere that new financing for commercial real estate would come from and the entire banking system would crash once the potential $1 trillion + hole over the next 4 years becomes apparent, as there is less and less capital left to fill the ever increasing CRE cash black hole.

An attempt to estimate the number of loans that would not conform for refinancing, based on two key criteria of cash flow and collateral presents the conclusion that roughly 68% of the loans maturing in 2009 and thereafter would not qualify. The amount of refinanceable loans is important because borrowers will either be unwilling or unable to put additional equity into these properties. Instead borrowers will be faced with either negotiating maturity extensions from lenders or simply walking away from properties. And despite the banks' and the administration's promise to the contrary, loan extensions will not provide the way out (see below, click to enlarge), meaning losses taken against CRE is only a matter of time.

For the purposes of the refi qualification analysis, the criteria that have to be met by an existing loan include a maximum LTV of 70 (higher than current maxima around 60-65), and a 1.3x Debt To Service Coverage Ratio (equivalent to a 10 year fixed rate loan with a 25 year amortization schedule and an 8% mortgage rate).



The simple observation is that nearly 68% of loans in the next 4 years will not qualify for a refinancing at maturity putting the whole plan to merely delay the day of reckoning indefinitely at risk of massive failure.

The underlying premise of maturity extension as a solution to a loan's qualifying problem is that during the extension period the lender is either able to increase the amortization on the loan by some means (i.e. increasing the interest rate and using the extra cash flow to accelerate the loan's pay down), or achieve value growth sufficient to allow the loan to qualify by the end of the extension period. As the equity deficiency for many loans is far too large to be tackled by accelerating the amortization over any period of time, and as for "value growth", with hundreds of billions in distressed mortgage building up over time via these same extensions (even if successful), the likelihood of property price appreciation is laughable: the flood of excess supply of distressed mortgages to hit the market is about to be unleashed.

Then there is the logical aspect: maturity extensions merely delay the resolution and push the problem down the road. And as for CMBS, the issue of extension may be dead on arrival - not only are CMBS special servicers limited to granting at most two to four year maturity extensions, but AAA investors are already mobilizing to stanch any more widespread extensions as a means of dealing with the refi problem.

And, at last, there is the view that the refi problem could fix itself, based on the argument that CRE cash flows are likely to rebound quickly as the economy begins to improve due to pent-up demand. This argument is nonsense: even if cash flows recover to their peak 2007 levels, values would still be down 30% as a result of the shift in financing terms. Ironically, it would require cash flows rebounding far beyond their peak levels to push values up sufficiently to overcome the steep declines. This is equivalent to predicting (as the administration is implicity doing) that the market will be saved by the next rent and real estate bubble, which the U.S. government is currently attempting to generate.

In this light, anything that the government can try to do, absent continuing to print massive amounts of dollars, is irrelevant. The equity market can easily go up indefinitely, short squeezes can be generated at will, TALF can see 10 new, increasingly more meaningless permutations, the administration can prepare worthless stress tests that are neither stressing nor testing, and talk up a storm on cable TV to convince regular investors that all is well, yet none of these will do one thing to provide the banks and CMBS borrowers with the massive capital they will need to plug the value gap either during a CRE loan's term or at maturity.

The multi-trillion problem is simply too massive to be manipulated and is also too large to be simply swept under the carpet for the next administration and generation. It is inevitable that the monster hiding in the closet will have to be addressed head on, and the sooner it happens, the less the eventual destruction of individual and societal net worth (however, it still would be massive). Delaying the inevitable at this point is not a viable option: Zero Hedge hopes the administration realizes this, ironically, before it is too late.

Gratitude to Deutsche Bank for data.

Comments

[cameroni:]

Scary stuff indeed.

Nice work Tyler. Don't know if I will sleep so good tonight.

My own worry about Commercial Real Estate revolves around this weeks headline story about a possible flu pandemic. We do not yet have all the facts but if this thing is really killing 5 to 6% of all the people it infects then commercial space will take a huge hit as companies encourage workers to start telecommuting and staying at home. A major pandemic could freeze up the whole economy for the better part of a year as there is no vaccine available yet and producing one in quantity takes 6 to 8 months. (World Health Organization comment).

Further, any space (and business) that depends on revenue derived from gatherings of large numbers of people, like stadiums, theaters, restaurants office buildings etc will take a huge hit if people shun them fearing disease transmission.

This could readily be the straw that breaks the camels back and sends Commercial Real Estate tumbling in value. A trigger. It remains to be seen how this will play out but we won't have long to wait. We should hear as early as Monday or Tuesday how dangerous this swine flu is and know what contgagion risks we face.

This is a good time to keep posted to the nightly news.

Cam

Apr 26 07:36 PM

[RonaldReagan:]

When it's all over, I would like to buy you a cold one bro. When you had 650+ followers 2 weeks ago. I worked hard to publish your links on Yahoo finance message boards, because you speak the truth - and how refreshing. I owe owe.

Apr 26 08:58 PM

[TeresaE:]

Excellent analysis.

But, one thing your figures don't take into account: the major banks are pulling performing loans MID-CYCLE, based on companies financials (things like tanking sales and falling asset values).

So, the estimate of how far out this is, may be a little off. It is happening now.

And, how's this for cooking the books to destroy a nation, in 7 years, we have never been one minute late on our commercial mortgage, late last month we were notified they are yanking the loan and even though we have 3-1/2 years left before we have to requalify, we have to pay it off now. Ha! No one will pick up this loan even though we pay every bill. So, the banks quit accepting our monthly payments and even though the money sits in their account waiting to be paid, they are now sending us foreclosure notices.

Where is the sense in firing paying customers based on balance sheets when the banks are getting government handouts based on balance sheets? What is the sense in not taking payments that are sitting in your bank?

The banks, under the protection of Congress, are bankrupting our country.

Apr 27 09:37 AM

[Ben Young:]

It almost doesn't matter how serious the swine flu danger is. The massive inflation in media outlets all clamoring for the newest/scariest "if it bleeds it leads" story will guarantee that there will be a significant reaction. The key thing holding back the telecommuting is the baby boomer generation (of which I'm a "member"). They are still unconvinced that people they can't see will work. Someday there will be a swine flu style tipping point that will validate/actualize the potential order of magnitude (deflationary) cost efficiency that telecommuting represents.


On Apr 26 07:36 PM cameroni wrote:

> Scary stuff indeed.
>
> Nice work Tyler. Don't know if I will sleep so good tonight.
>
> My own worry about Commercial Real Estate revolves around this weeks
> headline story about a possible flu pandemic. We do not yet have
> all the facts but if this thing is really killing 5 to 6% of all
> the people it infects then commercial space will take a huge hit
> as companies encourage workers to start telecommuting and staying
> at home. A major pandemic could freeze up the whole economy for
> the better part of a year as there is no vaccine available yet and
> producing one in quantity takes 6 to 8 months. (World Health Organization
> comment).
>
> Further, any space (and business) that depends on revenue derived
> from gatherings of large numbers of people, like stadiums, theaters,
> restaurants office buildings etc will take a huge hit if people shun
> them fearing disease transmission.
>
> This could readily be the straw that breaks the camels back and sends
> Commercial Real Estate tumbling in value. A trigger. It remains to
> be seen how this will play out but we won't have long to wait. We
> should hear as early as Monday or Tuesday how dangerous this swine
> flu is and know what contgagion risks we face.
>
> This is a good time to keep posted to the nightly news.
>
> Cam

Apr 27 10:27 AM

[JK Corcoran:]

Get Soma, Take Soma, all your troubles will melt away....welcome back Mr. Orwell.


On Apr 26 11:21 AM GoldMoney wrote:

> The thing you have to keep in mind is that Ben Bernanke, Tim Geithner,
> Neil Kashkari, Barack Obama, Chris Dodd, and Nancy Pelosi are experts
> and know what they are doing. It really is different this time. They
> know how to fix things now. Trust them. They understand that for
> efficient markets to remain efficient the guiding loving hand of
> mother government is needed. They are looking out for the best interests
> of us little guys. You should invest in America by buying stocks
> now and holding them forever. Increase your 401K contributions and
> put the money into domestic bonds and stocks.
>
> (For the clueless readers, the above was sarcasm)
>
>

Apr 27 11:01 AM

[LKofScotland:]

Don't forget Uncle Sam is not just a bank but a real estate developer, too. Not all this money going to "prop up lending." A massive amount is going directly into the "roads and bridges" department, too. And when you say "just walk away from it" you need to define that. There are always buyers of real estate (believe it or not some of the biggest holders are churches.) Our government is also spending trillions on a so called "war." This is nothing like WWI or WWII in which those similarly situated amounts were directly injected into the goods economy. Most of this government money is injected into the "service" side of war (logistics, planning, deployment) and very little into actual "gear" because there's actually very little fighting going on. We do launch space shuttles on a somewhat regular basis and Uncle Sam still cuts those Social Security and Medicare checks. He also employs millions of "workers" and pays them as well (quite well I might add.) I think the next domino is not the real estate market but state and local bonding authorities. This is why its better to let the banks fail and with them their corrupt state and local pay-pals. State and local governments still think its not only the 90's but the 80's as well and if "the old bank" fails that's not a problem because they'll just go to the "new bank." Those workforces are truly staggering in size and importance and don't just include "essential" government services, either. They also include doctors and hospitals among other things.

Apr 27 11:44 AM

[conceptwizard:]

This has been on the horizon for some time. It is going to have as big an impact as the residential mortgage crises. I wonder how come with the media being as well connected as they are and even purusing web sites like this fail to promote these potential catastrophes. No investigative reporting or lack of control on what they report.

Apr 27 12:21 PM

[wobatus:]

We don't hear about that?


On Apr 26 09:46 AM Lilguy wrote:

> This is an important story, and one that has gotten little attention
> in MSM so far. While we hear about CRE defaults on current loans
> increasing due to growing vacancy rates, we don't really hear about
> the re-qualifying problem on commercial loans that mature in the
> next few years for those companies still in the game.
>
> Thanks for filling in the holes with this thorough, credible, and
> understandable analysis.

Apr 27 01:05 PM

[cyberclark:]

An interesting market to watch is Calgary Alberta. Calgary became the western Distribution point as companies built big box warehouses to distribute their products across western Canada and the US.

Over the years the twinning of the highway between Vancouver and Winnipeg has taken place. Many of the big box places and new warehouses in Calgary are no longer required. Rocky Mountain Double trucks can now run between Vancouver and Winnipeg. No need to stop in Calgary now.



There will be more tears there as money for selling their unwanted warehouses continues to dry up.

Apr 27 01:07 PM

[wobatus:]

Excellent analysis, yet your situation belies some of it; you are paying. There are cash flow positve entities out there, even if retail and rents are suffering. Crises in other areas are forcing this situation where paying loans are being pulled. It is counter-productive, but also shows that the most pessimistic analysis is wrong, and the market is pricing things based on bank rollover abilities and not on where cash flows are expected to be.

The administration and "they" are trying to copnvince the situation isn't so bad, but other "theys" are trying to convince people it is worse than it actually is.


On Apr 27 09:37 AM TeresaE wrote:

> Excellent analysis.
>
> But, one thing your figures don't take into account: the major banks
> are pulling performing loans MID-CYCLE, based on companies financials
> (things like tanking sales and falling asset values).
>
> So, the estimate of how far out this is, may be a little off. It
> is happening now.
>
> And, how's this for cooking the books to destroy a nation, in 7 years,
> we have never been one minute late on our commercial mortgage, late
> last month we were notified they are yanking the loan and even though
> we have 3-1/2 years left before we have to requalify, we have to
> pay it off now. Ha! No one will pick up this loan even though we
> pay every bill. So, the banks quit accepting our monthly payments
> and even though the money sits in their account waiting to be paid,
> they are now sending us foreclosure notices.
>
> Where is the sense in firing paying customers based on balance sheets
> when the banks are getting government handouts based on balance sheets?
> What is the sense in not taking payments that are sitting in your
> bank?
>
> The banks, under the protection of Congress, are bankrupting our
> country.

Apr 27 01:10 PM

[LOLcapitali...:]

Excellent piece - just the sort of thing we've come to expect from you.

I'd like to expand the discussion to the broader asset market. At the end of the day, the problem is that asset values have fallen below the value of associated debt. This is true across virtually every asset class and geography. The leadership at the Fed and the Treasury appear to be flailing about because they are bouncing along trying to appear to deal with the asset-bubble-of-the-day with no apparent cohesive plan. Unfortunately, this seems to be the furtherest thing from the truth.

Ultimately there are only two resolutions to this situation. Either lenders continue to take massive and repeated write-downs or the Fed and Treasury inflate away enough of the debt to create an acceptable amount of equity in the aggregate capital structure (remember, the debt is priced in fixed dollars while the asset values rise in an inflationary environment). The latter seems to be the broad strategy being pursued by our financial leadership. While there are many obvious problems with this approach, the one that bothers me most is that they appear to be operating under the delusional assumption that they can create some kind of controlled inflation.

Thoughts?

Apr 27 03:10 PM

[Blair:]

I heard in passing that the commercial bank loan amounts had changed in recent years. Prior, the loan amounts were based on actual income. Recently, the loan amounts are now? based on income projections.

My emotional reaction to this whole business is that the matter is so unbelievable it has to be believable.

I know that many have congratulated you on your excellent articles. But, let my add my name to the list.

Apr 27 03:55 PM

[REITBull:]

Many of these conclusions in Tyler's piece are correct today. However, it is impossible to tell what the LTV's and DSCR's will be in the coming years. Any analysis being done after a sharp move in value needs to be taken with a grain of salt. A year ago all I was reading about was oil going to $200 and how we would never see it fall below $100 again. CMBS will return in some form once the decline in values of CRE create enough speculative interest. This should happen shortly after a period of price discovery from distressed sales. This will not be a silver bullet but pension funds, life insurance companies and foreign investors will be looking to invest in hard assets again once the dust settles. Consumers will not maintain the current savings rate (budgets are like diets, noone sticks to them). I am not smart enough to pinpoint the catalyst that will revive CRE, but I am confident in the real estate cycle playing out over the long term.

Disclosure: I'm long REITs

Apr 27 04:18 PM

[SpongeDaveN...:]

Outstanding article Tyler. Additionally, the many comments by other readers add valuable 'trimmings' to your core observations. In the 'real world' my professional task was to create actual value and strategically plan a path ahead at the epicenter of the discussion...commercial and residential real estate. In real estate development and/or finance real 'value' simply cannot be created right now - period. When in the last few decades, nationwide, could you assert that? likely never. As a former executive in acquisitions for Centex Homes, and most recently as an acquisition/finance executive for one of California's largest affordable apartment developer/builder/oper... I have only this to say regarding commercial real estate and CMBS scenario - bottom line: it's happening now, it's getting worse, and the 'solution' some see in hyper-inflation won't save the day: it's a structural, social and global log-jam that stand in the way - the media and politicians are making it even worse- they can't get out of their own way and are blurring the issues to our collective detriment. Plenty of smart, experienced individuals know what to do but cannot affectuate meaningful change due to the macro structure of the battlefield. We've all been trained to 'thrive'....it's time to re-train ourselves to survive (a different mindset and skillset). I'm not a pessimist...this too shall pass, but let's not kid ourselves into thinking that in the aggregate our country is set up (laws, unions, lifestyles, mass marketing mantras) to provide fertile ground for re-emergence into a stable, growth economy. The terms 'service economy' and 'consumer driven economy' don't mean much there's severely impaired ability to spend and marked deterioration in the sectors in need of 'services'. The natural instinct to look to the horizon, read the tea leaves, or 'time' a recovery is a strong one....its just not going to provide any results. In closing, I'd like to warn folks to avoid being logged onto Seeking Alpha while your television is tuned to Bloomberg Television channel because taking in cogent, fact based arguments online here while simultaneously taking in auditory stuffed shirt, force-fed optimism with NO 'meat on the bone' is a very distrubing, unpleasant experience!

Good Day All - DH.

Apr 29 02:03 PM

[bigmoney:]

.

May 01 11:21 PM

[johnthebears:]

Bear Market Rally or a new Bull?

Too soon to say for most folks. Remember that there have always been cheerleaders in the stands making lots of noise to influence the folks, only to see them all sit down with a fumble and a touchdown for the bears.

In my opinion, the big question concerning the stress test is will Treasury or OCC win the day regarding transparency? It was the currency folks that prevented state governments from going after predatory lending... saying that was the job of the Washington to control the banks. (32 closed this year to date)

Some mention has been made of "OFF BALANCE SHEET ITEMS" in the press, but the subject is immediately dropped. No one knows what they don't know!

When life insurance and other kinds of companies are included with banks supported by TARP, you have to wonder what is next to hit the fan in addition to commercial real estate.

Remember "Enron" 2001, largest bankruptcy ever? That was due to "OFF BALANCE SHEET ITEMS" that investors and regulators did not know about.

I think the delay in releasing the stress test is due to concern about what "off balance sheet items" need to be revealed to the public in addition to correct valuations of commercial mortgages. When do they have to adjust capitalization rates and NOI to reflect current conditions?

I would appreciate hearing comments by others that can calm my fears. For now, I think that the other shoe is about to drop for the banks.... then more collapse of commercial real estate and REIT's with falling occupancy, rents and income, leading to major commercial foreclosures comparable to the housing foreclosures we have heard so much about.

If I am right about this, look for a Dow of 4000 before the end of 2009!

In my judgment there is at least a 60% probability of major global depression coming in the next 5 years. China will do better than most countries, but US, Europe, S America, Japan are all vulnerable to the same prolonged downturn, in spite of the cheerleaders comments in the press to calm our fears. Truth will out.

I began with the question of bear market rally or new bull market. Obvious from the above and Tyler's great article, I think the current trend is a bear market rally that will trap a lot more small investors before the next big drop. A earlier writer suggested September for the next big drop, but if the "off balance sheet items" are taken into account along with appropriate capitalization rates for commercial loan values, the drop could begin just after the announcement of the results of the test. I suggest taking profits Monday and dollar cost average over the next 2 years in small, mid and large cap index funds. No need to be in a big hurry to lose money!

Tyler suggested that current L/V ratios are currently less than 70%? Is that info also from D bank? When did that standard come into being? The building highlighted had a 100% loan. I am afraid that those properties are far too numerous, based only on the supposed strength of the borrower.

I look for typical cap rates to exceed 12% for average commercial property (and 20% for rural commercial properties) divided into much lower NOI as a result of rent concessions and higher vacancy. This suggest that 50% reductions of average "appraisal valuations" from what would have been previously assumed as value in 2007.

3-4% cap rates were common for top tier locations and new quality buildings in 2007. Those could easily climb to 8-9% at the bottom of this market, based on experience in the 1982 recession.

So when do the REIT's reflect true appraised value rather than the dream values REIT managers have been relying on Mr. "REITbull"? Will this be part of the stress test? How will they continue paying those high promised dividends? Will they pay if with additional stock sales to new investors in a Ponzi scheme?

In mid 2007, a friend gave me his market news letter that suggested a 20,000 Dow, up from 14,000 by the end of the year!

I told him that 8,000 was more likely. We haven't been able to talk about it since then! I now believe we will be lucky to stop at 4,000 in a depression, and it may be 2020 before recovery to 14,000. Sorry to ruin your day.

May 02 05:02 PM

[REITBull:]

"So when do the REIT's reflect true appraised value rather than the dream values REIT managers have been relying on Mr. "REITbull"? Will this be part of the stress test? How will they continue paying those high promised dividends? Will they pay if with additional stock sales to new investors in a Ponzi scheme?"

john,
This statement seems to imply that REIT assets are valued on the books using market value accounting. The truth is that most equity REITs use historical cost accounting to value their hard assets. My apologies if I have misinterpreted this part of your statement. These equity offerings are a legitimate means of raising capital. An investor who buys stock knows that dilution part of the risk of ownership. The premise of REIT offerings being a Ponzi scheme is based on an assumption that the accuser knows more than the investors purchasing the equity. You know what they say about assuming.

May 04 01:22 PM

[johnthebears:]

Thanks for your comment REITbull

You have a point about historical cost vs market value accounting, but I still wonder if they ever adjust to market value?

Dividends are being cut for many REIT's which is vital to stock value in addition to dilution risk. How do you see IYR share price by end of 2009?

How do you see stress test and lack of available bank funds for refinancing loans impacting REIT values? This factor caused GGP to take bankruptcy a couple of months ago. GGP was second largest shopping center owner in country.

Look forward seeing your comments.
John

May 06 12:40 AM

[REITBull:]

Thanks John.

I am not an accountant but my understanding is that they do have to mark to market their development pipeline and any land held for sale. Also, if a REIT provided a loan to another company, this would be marked to market as well.

You are right that dividend cuts have effected the value of IYR. My belief is that any new investors to IYR will have low expectations in regards to dividends and will price in further dilution in the underlying stocks. IYR used to attract dividend oriented investors, but with the creation of SRS and URE, IYR seems to have become more attractive to shorter term investors due to its volatility. I wish I knew where it would be at the end of 2009. My best guess is that it will stay within a range of $30-$40. My plan is to hold for 3-5yrs. I don't see a lot of downside potential as IYR has been rebalanced with some of the better capitalized REITs.

I really do not know enough about the stress test to be able to predict its impact on REITs. GGP ran into trouble due to maturity defaults. I do not know all the details on this bankruptcy. But it is my understanding that the bondholders pushed GGP into BK, not the secured lenders. The portfolio lenders may be more open to extensions than securitized lenders (due to the constraints of REMIC).

In light of what happened to GGP, many of these REITs are paying down their revolving lines of credit through these equity offerings. If a REIT cannot refinance a loan before the maturity date, they can tap the revolving line of credit to avoid maturity default. Some of these lines of credit are upwards of $1 billion. Certainly not an ideal position, but it gives them some flexibility and time to sell or hold until financing conditions improve. GGP did not have this option.

Sorry for writing a book here. I agree their is some short term pain that still lies ahead. I'm trying to get ahead of the crowd by looking out 3-5 yrs from now.

May 06 01:25 PM

[djones44:]

Hyperinflation is what Tyler overlooks.

There's a race on to devalue the USD, Yen, Sterling and Euro to close the 25:1 wage disparity between the West and Asia, and to render all debt down to a fraction of what it was in 2007 dollars. It's a race because the USG wants to sneak in the capital before things hyperinflate on their own owing to other western countries doing the same. Having inflation without the free currency would indeed be sad.

Bubbles can be printed, and inflation is a currency bubble. Devaluation could work because the USD was way overvlaued to begin with, and hyperinfaltion rationaizes that, just as the Yuan is undervalued and will come up closer to reality when Asian workers begin to get pensions and benefits.

But these trends take time, and CRE is on a short leash, so the printing presses will indeed run hot for while.


On Apr 26 11:21 AM Tricky wrote:

> Well that was a depressing read to start my day. Now throw on top
> of the heap the emerging problems with residential Alt-A and even
> prime loans. I don't know how we get out of this one, even with
> hyperinflation.

Jun 19 07:10 PM