Merrill's Ability to Negotiate Cheap Lease Key to Future Success

New York Downtown commercial real estate takes center stage with Merrill Lynch (MER) in crises mode pitted against real estate developer Mr. Silverstein and landlord Brookfield Properties. As Mr. Bernanke mulls his decision on Fed Funds, it will be compelling to measure Merrill’s move with headline inflation roaring to an annual pace of 5% after decades of hibernation. With an estimated 2 million square feet in negotiation over an anticipated ten-year lease term, the numbers are potentially larger than the recent sale of the Chrysler building at $800 million.

Merrill has stepped up the pressure on the New York Downtown market, withdrawing from recent negotiations on the World Trade Center. Having opted out of the continuing negotiations, it seems Merrill believes the New York market has softened, and is looking for significant rent concessions during a difficult inflationary environment. New York Downtown real estate may have a different view with development costs on the rise and project delays limiting availability of large block space.

Interestingly, New York Downtown, headline inflation and Fed Funds put the Rexx Index on the leader board. Rexx Index and modern fundamentals are key components to track commercial real estate. CPI, Fed Funds and the supply and demand for commercial office space are primary drivers of the Rexx Index with Market Trax and Market Simulators for New York Downtown as one of its fifteen individual markets. Given the ability to hedge inflation, fed funds and rent, the Rexx Index would seem a natural option for Merrill, Mr. Silverstein and Brookfield in the negotiation process.

Up to this point, Merrill has been forced to capitulate and watch their stock price plummet. As the continued quarter over quarter write-downs decimate shareholder value, the grappling of mark to market pricing for commercial real estate in short term market conditions has increased. Transparent indices are critical components to VAR and the view of the thinly traded CMBX market should prompt Merrill to seek hedge positions in the evolving Rexx Index options market. With the next surge of economic conditions, fixed costs of rent will be key determinants of future profitability. The potential sale of their Bloomberg stake makes for instant liquidity and a critical step in the process of long term cost control.

Perhaps, this summer signals the end of the carnage. With new regulations on short selling and improved risk awareness, standards for transparency and counter party risk are fully engaged. The actions by the Treasury, the Fed and the SEC to enforce stable markets have brought the short sellers to contrition. These factors should set the stage for Merrill to build liquidity and price improvement as markets regain stability. In the narrower view, real estate rent options should benefit their own situation and the long term outlook for their clients.

Comments

[Look at myshorts]

No contrition here.