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Are REITs Choking?

In 2005, 2006 and 2007 New York City experienced a $106 billion sale in investment property. As of mid-August 2009, based upon loan-to-value ratios available during these years and the reductions in value that we have seen, an extrapolation would indicate that approximately $80 billion of this total or about 6,000 properties have negative equity today. Even today, any owners have the ability to service the debt and want to own the assets for the long term. Notwithstanding this fact, a substantial percentage of these properties will come to the market needing to be sold.

Refinancing requirements will add to stresses in the market and will prove challenging, particularly for larger loans which are not generally available from community banks and regional banks due to their magnitude. They will also be challenging due to reductions in value and more conservative LTVs which will exacerbate the massive deleveraging that the market must go through. It has been projected that well over $2 trillion in commercial mortgages will be maturing between now and 2013. Much of this financing was delivered to the market by banks, life companies and CMBS intermediaries.

US REITs may not get a breath of fresh air from the Government to relieve them of the choking they are going through. I believe they will move quickly to reduce the debt that is weighing down so heavily on their balance sheets. One method would be to aggressively engage in asset sales. In order to bring the loan to value ratios to more manageable levels, REITs will need to offload.

Capital values have more than halved in the past two years and even the REITs who had been really conservative have come under pressure to fulfill their covenants. A $100 property probably 2 years ago would extract an $80 loan considering an 80% LTV ratio. However, since the decline in the property values, today, the same $100 property would cost around $50 and the loan we have drawn on this property really means to have an LTV of 160%!!! Imagine if you had to refinance this debt, you would be financed to a property value of only $50 i.e. only $40 (assuming the same 80% LTV, which today has declined further) to pay off a debt of $80. To add to the troubles, cash inflows have consistently been on the decline.

We have recently seen and will continue to see equity issuances across the industry. This will probably create volatility in the markets but in the long run, this will lead to stabilization in the underlying property market.