REIT Wrecks'  Instablog

In 1968 at the height, so to speak, of the Vietnam War, U.S. Air Force Major Chet Brown was fresh out of ideas and common sense. Tired, frustrated and on the wrong end of a microphone after a battle for the provincial capital of Ben Tre, he famously allowed that it had become necessary to destroy the town in order to save it. Such is the logic surrounding a spate of REIT equity offerings in the first half of 2009.

Undercapitalized and over-leveraged, many REITs had no choice but to enter into dilutive transactions in order to survive. But like Ben Tre, these 9 REITs have been flattened by massively dilutive equity offerings, and nobody can predict when they will be able to meaningfully grow their dividends again.

Most of these "re-equitizations" were completed overnight within hours of being announced, which is no wonder as they were priced at a huge discount (over 10%) to the previous day's close. Many of these overnight REIT equity offerings more than doubled the amount of shares outstanding.

The decision to sell massive amounts of discounted stock at a time when rents are declining across the board is tantamount to destroying these REITs. Indeed, dividends were cut almost immediately after these offerings closed. While it's unclear how the new shareholders felt about this little welcoming gift, what is clear is that these stock deals were hugely dilutive, and that will make it extremely difficult to show any meaningful dividend growth for at least the next several years.

NINE NOT SO GOOD REIT DEALS

Maguire Properties (MPG), the Office REIT that bought 24 office properties and 11 development sites from Blackstone for $2.88 billion at the height of the market, just got a market read on its Orange County holdings. According to the Wall Street Journal, Emmes Holdings in New York recently agreed to buy MGP's stake in a newly constructed office property in Irvine, Calif., for about $160 million, representing a 40% discount to its construction cost.

Maguire's heavy concentration in Orange County gives it exposure to the subprime debacle that probably rivals AIG, given that Orange County was subprime central HQ for many mortgage lenders. This exposure is resulting in an epic struggle to dig out from under the debt incurred in that 2007 purchase. Making matters even worse, the FDIC's grim reapers are out in full force in Orange County, shuttering bank offices and rejecting leases without the customary remedies afforded to landlords under Chapter 11.

Federal bankruptcy laws are complex, but in general, Chapter 11 default remedies for owner/lessors of commercial real estate typically allow 60 days for bankrupt lessees to affirm or reject their leases. For those leases that are rejected, the properties are thrown back on the market in search of a new lessee, and the owner/lessor receives an unsecured claim limited to three year's worth of rent.

REIT earnings season got into full swing last week, but there's a lot more on investor's minds these days that last quarter's earnings.  Transaction volume has continued to plunge, and CMBS loans placed in special servicing have continued  to rise like a poodle in a jetpack.

This can mean only one thing, and in the words David Hamamoto, CEO of Northstar Realty Finance (NRF), it is that there is a growing backlog of motivated sellers who "will begin to transact later this year and who will establish market pricing as deals are completed."  That people will need to sell is not in dispute, but exactly what "market pricing" will be is the $64,000 question.

Globally, commercial real estate sales plummeted more than 70 percent in the first quarter from the end of 2008, according to Real Capital Analytics.  In the United States, first quarter sales were not only anemic, they may also be a form of karmic justice to CRE brokers who are now fond of saying that distressed buyers simply 'overleveraged'... Really?

Even apartments, which still enjoy the availability of buyer financing from Fannie Mae and Freddie Mac, saw transaction volume fall 62 percent in 2008, and another 86 percent in the first quarter of 2009 alone.  With an average of only 50 apartment sales taking place each month across the entire country, it's simply no wonder that pricing is unclear.

What is clear, however, is that prices are dropping.  And as prices drop, "overleveraged" buyers, or those who were basically convinced to overpay for their assets, are unable to refinance their loans.  CMBS loans placed in "special servicing", which indicates that the borrower is in some form of distress, were dramatically up and to the right at the end of 2008: