As equity markets worldwide rebounded sharply in 2009 and 2010, investors remained cautious. Scars were still fresh from the crash in 2008, unemployment continued to rise throughout developed economies, commodity prices outperformed equities, and residential real estate, the greatest asset for a not-so-long-ago flourishing middle class, depreciated month after month.
American residential real estate remains largely in the hands, and on the dwindling balance sheets, of individuals. Commercial real estate, however, is almost exclusively owned by financial institutions. With a challenging economic environment highlighted by "retail space available" signs in greater abundance than rays of sunshine in the United States' leading consumer and tourist markets, such as Southern California, Las Vegas and Florida, commercial real estate has been as heavily shorted a sector as any over recent years.
In 2011, I successfully shorted CB Richard Ellis Group (CBG), explained here. In the article I cited a perpetual short-squeeze cycle fueled by mutual fund buying as having propelled the stock to unsustainable levels. Shares of CBG remain over 30% below 2011 highs and, while they appear susceptible to significant downside, other names in the commercial real estate space present potentially greater opportunities to profit for short sellers, particularly via put options.
Lehman Brothers' (OTC:LEHFQ) 30-1 leverage is often cited as a barometer for excess. With massive leverage comes massive sensitivity to changes in the business climate.
Commercial real estate investment trusts own, manage and lease retail and office space. When demand for space is strong and vacancies are minimal, these financial institutions have good reason to borrow and grow without much inhibition. Investors in REITs demand dividend yields well above those offered by more conservative, better integrated business models such as McDonald's (MCD), Wal-Mart (WMT) and Chevron (CVX).
Leading REIT Simon Property Group's (SPG) valuation has soared to heights that defy all the metrics. A trailing P/E of 40 is unconscionable in such a challenging and sensitive sector. A debt to equity ratio approaching 400-1 screams desperation for revenue and a highly convoluted recipe for growth. It's outright shocking that investors would accept a lower dividend payout from Simon Property Group than McDonald's or Chevron, but they do.
Having traded just above $20/share in 2009, Simon Property Group offers tremendous downside if recent weakness continues in equity markets. Put options are relatively inexpensive as the stock continues to trade near its all-time high.