REIT Wrecks | High Yield REITs and Commercial Real Estate

Commercial Real Estate: 6.8 Trillion Reasons Why it Won't Derail the Recovery

2010-01-26T09:08:00.000-08:00

2/2/2010 -- Not even Joe DiMaggio could have hit this change up. Just one year ago, the United States financial system stood on the brink of failure. GDP had declined by 6.25%, the most severe contraction since 1982. In November 2008, non-farm payrolls were cut by 533,000, the most severe contraction since 1974. But just a few months later, right after the ink had dried on largest corporate bankruptcy filing in American history (Lehman Brothers), U.S. GDP managed to grow at a 5.7% annual rate -- the the fastest expansion in 6 years.

It's a remarkable turnaround, but the problems in commercial real estate persist. CMBS defaults at the end of 2009 registered a five-fold increase over 2008. In two of the hardest hit sectors, hotels and apartments, almost 10% of all CMBS loans were delinquent at the end of 2009. Fitch says overall CMBS default rates could reach 12 percent by 2012.

Indeed, even God is losing money on commercial real estate. Lenders are foreclosing on Stuyvesant Town and Peter Cooper Village, which was acquired in 2006 for $5.4 billion. Stuyvesant Town is a huge property, so it's not surprising that the acquisition set the mark for the highest price ever paid for a multi-family residential asset. What is surprising is that just four years later, the value of the property is estimated to have declined by 70%. The investor group included the Church of England, and the foreclosure completely wiped out its $250 million investment.

Since divine intervention appears to be out of the question, investors are understandably nervous about the $1.5 trillion in commercial real estate debt maturing over the next three years. Nevertheless, despite the carnage yet to come, the decline in commercial real estate prices is unlikely to cause a rain delay in the nascent economic recovery.

This is primarily because the U.S. commercial real estate market is much smaller in comparison to other important markets. Based on flow of funds data from the Federal Reserve at the peak of the market in 2007, the corporate bond market was worth $3.5 trillion; U.S. government securities $5.1 trillion, single family securitizations stood at $6.8 trillion and all single family mortgages amounted to $11.2 trillion. Meanwhile, the commercial real estate market was worth about $6.8 trillion in total, with only $3.3 trillion of that comprised of debt.

Just as important, the problems in commercial real estate have been well-telegraphed, while the full extent of the problems in single family were not clear until we were well into the crisis. Not only have the problems been well telegraphed, and well documented, but Jamie Dimon (CEO of Chase) is already declaring a bottom. "Commercial real estate is a train wreck, but it's already happened," Dimon said during a speech at a J.P. Morgan health-care conference in San Francisco last month.

While commercial real estate debt maturities are clearly still a problem, sophisticated investors from all over the world have lined up piles of dough for America's distressed real estate play. Combine that with banks and special servicers that are determined not to sell into a weak environment, and the result is 30 or more bids for distressed commercial property sales in major markets, with some bids coming from as far away as Germany and South Korea.

I personally was involved in the recent bank sale of a non-performing loan for 60 acres of entitled but otherwise empty desert outside of Phoenix, and that sale attracted 26 bids. If entitled single family residential land in Arizona isn't the absolute belly of the beast I don't know what is, yet most of the bids for that flaccid loan were all cash.

What we're witnessing is the market's sometimes noisy process of converting debt to equity. That process is working, greased by baksheesh from all over the world. So why all the unrelenting gloom and doom with regard to commercial real estate and the economy? It's pretty simple really: in this era of populist schadenfreude, people love to read about it.

Direxion's New REIT ETF Posts 168% Gain In Six Months

2010-01-13T00:25:00.000-08:00

As the world was coming to an end in March of 2009, REITWrecks wrote a rather forward-leaning post entitled REIT Stocks: 4 Ways to Play the Carnage. REITs have rallied strongly since then, and even more strongly since Direxion launched its new levered REIT ETF series in early July. The launch could not have been more well timed. DRN (shown in green, below) is up more than 160% in just six short months:

However, our somewhat disturbing obsession with Real Estate Investment Trusts shouldn't obscure a basic truth: REITs are strongly correlated to the broader stock market, and they are often even more volatile than stocks. If you are an asset allocator seeking diversification, and you include REITs as a substitute for direct investments in real estate, your portfolios suffered badly in 2008 and 2009.

Although REITs were thought to help Mom and Dad sleep soundly, Freddy Krueger can actually make a lot of noise in the inky black night. In the darkest days of September 2008 through March of 2009, according to the Wall Street Journal, the Dow Jones Equity All REIT Index closed up or down by more than 5% on 64 occasions. REITs are typically more volatile than direct investments, but this kind of volatility is unprecedented. Since its inception in 1990 through the end of 2007, that had happened only three times.

As far as correlation goes, not only did REITs experience three times more negative return years than privately held real estate (1972-2000), but the magnitude of negative REIT returns was much greater than privately held real estate (read the full study here). What's the last word on correlation? Why bother with words when one can simply use pictures. Compare Direxion's performance chart above with Moody's Real Property Price Index below:

What's the point? Simple: it's time to buy commercial real estate. If you're an asset allocator, REITs are a flawed substitute for direct investments in real property. However, they are also known as a leading indicator for the real property markets, and REITs often lead real property into and out of deep valuation troughs. If you use REITs as a substitute for direct investments in real estate, it may be time to re-evaluate that strategy and buy the real thing.

The State of Commercial Real Estate: Sternlicht and Zuckerman Have a Few Things to Say

2010-01-10T12:54:00.000-08:00

Barry Sternlight and Mort Zuckerman are in the thick of it. Both run REITs that focus on two of the most battered sectors in the business: mortgages and office buildings. Sternlicht, a commercial real estate veteran, took Mortgage REIT Starwood Properties Trust (STWD), public in August, while 72 year old Zuckerman has been running Boston Properties (BXP), an Office REIT, for forty years.

Boston Properties has 143 office properties concentrated in cities hard hit by the financial meltdown (Boston, New York and San Francisco) and one city not so hard hit (Washington D.C.), while Starwood has deployed almost $450 million in cash to buy loans and distressed CMBS since going public.

In these two separate videos, Zuckerman and Sternlicht talk about the current market, property valuations, the economy, and where we go from here. In this interview on January 8, 2010 (click "continue" after the ad") Zuckerman, says the major markets may have bottomed:

Sternlicht, in a less sanguine Bloomberg TV interview one month earlier (December 9, 2009), is not so sure about a bottom. For what it's worth, I agree with his primary point: the government's policy measures with respect to the bank owned commercial loan portfolios has had a huge dampening effect on transaction volume - and therefore price discovery. Many investors are still not sure what these assets are worth. As Sternlicht points out, not all banks are able to hold on, and some owners are also being forced to sell, but the only real game in town when it comes to distressed assets is still FDIC loan sales

Whether you refer to this reticence among bankers as "extend and pretend" or "delay and pray", there is no question that the lack of selling is delaying the necessary catharsis in commercial real estate. REITs managed to recapitalize last year with billions massively dilutive equity offerings, but without new investments they will remain just that. Instead of delay and pray, we'll all be better off when the government tells the banks to just "confess that we made a mess". Enjoy the vids!

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Mortgage REIT Annaly Downgraded by Piper Jaffray

2010-01-09T21:48:00.000-08:00

REIT Wrecks avoids the daily ugrade/downgrade wars on Mortgage REITs in favor of longer term trends, but Annaly is a bellwether and for that reason Piper Jaffray's downgrade of NLY from Neutral to Underweight is worth noting. Piper Jaffray lowered their price target by $3, or over 15%.

The most interesting aspect of the downgrade was revealed in Piper Jaffray's commentary: they expect the economy will steadily recover in 2010. "We view NLY as one of the premier mortgage REITs with a top-notch team. However, NLY is the only mortgage REIT in our coverage universe. We expect NLY to underperform the rest of our coverage universe over the next year as we believe the economy will continue to gradually strengthen, prompting the Fed to begin raising rates in mid-2010 from the emergency level of 0%-0.25%."

"We are forecasting NLY's earnings power and dividend to peak in the 1H10 and to then recede as Fed rate hikes increase funding costs. We are maintaining our '09/'10/'11 EPS estimates at $2.73/$3.00/$2.52, as the continued signs of have increased our confidence that the Fed will begin raising rates by mid-2010. We are forecasting NLY's net interest spread to peak at 2.80% in the 1Q10 and recede to average 2.00% for the full-year 2011."

Mortgage REITs, especially residential Mortgage REITs like Annaly, AGNC and CMO have been absolutely killing it on net interest spreads. However, as the economy recovers, those margins will fall. This is what prompted Piper Jaffray's downgrade, but a recovering economy is not all bad. If the economy is indeed recovering, upside can be captuured through Apartment REITs or Healthcare REITs. But don't put the cart before the horse! It's still way too early for Hotel REITs and Retail REITs.

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Federal Court: Denial of Loan Modifications May Constitute Violation of Fifth Amendment

2010-01-07T16:21:00.000-08:00

These days, the only thing more cramped than a Hong Kong cemetery is office space for special servicers. Nevertheless, if you're a borrower in trouble, it's unlikely that you'll be outnumbered. CMBS default rates ballooned by almost 500% in 2009, up from 1.21% in the beginning of 2009 to over 6% by the end of the year. According to Trepp, this is highest default rate since the inception of CMBS. Jefferies & Co estimates that the CMBS default rate could reach 9-14% by the end of 2010.

So the last thing a special servicer would want to hear is that a Federal District Court in California has opened the door to a novel new foreclosure defense related to constitutional law. While this case deals specifically with single family residential loans, the RMBS market is much larger than the CMBS market, and at least one far-reaching rule change - the IRS's 2009 modification of the REMIC provisions - can be traced to controversy that first arose in the RMBS market.

The case involves non-judicial foreclosure proceedings on a single family home in Ramona, California. The borrower defaulted on the mortgage in November 2007. In February 2008, a notice of default was recorded and served. And in December 2008, a notice of sale was recorded and served, setting a date for the public auction of borrower's home. The borrower has alleged that their Fifth Amendment rights to due process have been violated, and a federal court has refused to dismiss the case.

California is a non-judicial foreclosure state, which means that Newport Beach property flippers are generally not entitled to their day in court in the event of a mortgage default. However, this case challenges that notion (although it is limited in scope), and the court has agreed to postpone the sale of the lender's collateral until the case is resolved. Translation: the defaulting borrower gets to live in their 2 bedroom, 1.5 bath bungalow with carport until whenever forever the case is decided.

The most interesting aspect of the case is that the borrower alleges that the lender violated their Fifth Amendment procedural due process rights, even though the Fifth Amendment only applies to governmental actions, not those of private corporations. The court, in refusing to dismiss the complaint, agreed that in some circumstances the Fifth Amendment does apply to private entities, so long as there is sufficient nexus between the government and the private entity.

There are four different tests used to determine whether private action can be attributed to the state: (1) public function; (2) joint action; (3) governmental compulsion or coercion; and (4) governmental nexus. The court said that "satisfaction of any one test is sufficient to find state action, so long as no countervailing factor exists.”

The court also said that the mere fact that a business is subject to extensive regulation is not sufficient to find joint action, but that because the case involves the Home Affordable Modification Program ("HAMP"), which is a federally funded program, there could be a nexus over and above just extensive regulation.

The court acknowledged that the facts developed through discovery may ultimately show that Plaintiff cannot establish a nexus. At this early stage in the litigation, the court did not have sufficient information to assess the government's level of involvement in the administration of individual HAMP requests, as well as the financial arrangements 10% cumulative preferred between the government and the lender regarding HAMP. The case is unlikely to get very far, in my humble opinion, but it's an interesting decision for interesting times. The full decision is posted on Foreclosure Combatant.

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San Francisco Apartment Loan Portfolio Sells For 64% of Face Value

2010-01-03T21:05:00.000-08:00

Whew! Talk about a REIT Wreck. Landing head first in a rock pile would be a much better metaphor for the 2009 commercial real estate market than an explanation for my year-end absence. However, that's exactly what happened in a biking accident early in November, and my right arm spent the waning days of 2009 bound up in an "immobilizer". And while it could have been appropriate to begin my recovery with a post on Healthcare REITs, I thought the news coming out of San Francisco multi-family market was much more interesting.

As I noted in my last post, the San Francisco multi-family CMBS default rate rivals that of Detroit. However, the cause is not entirely due to a horrible economy, though Bay Area unemployment now exceeds many areas of the Midwest. In San Francisco, high default rates can be traced more directly to the ebullient capital markets of the boom years, coupled with the strong desire of many institutional lenders to get a piece of the previously impenetrable rock.

As everybody knows now, loose credit enabled many buyers to pay ever higher prices for assets whose cash flows weren't entirely up to snuff. Combine that with a highly desirable market dominated by mom and pop landlords and their local banks, and you've got a recipe for trouble. These chickens are finally coming home to roost in San Francisco, but not in the way I would have expected.

I love this graph from Moody's, which illustrates how the traditional loan-to-value criteria became more and more relaxed during the boom. Moody's estimated that the gap between its estimate of actual LTVs and underwritten CMBS LTVs reached a record in the first quarter of 2007 (nearly 45%). The Moody's estimate of actual LTV also reached a record of 106.5%. Who needed equity when lenders would write you a check for more than the property was worth?

It may have been the only thing they got right, but Moody's warned at the time (Q3 2007) that "Junior classes have become exceedingly thin, exposing them to the risk that if one of the larger conduit loans defaults, several classes at a time may be entirely wiped out."

However, Bank of America, UBS and Credit Suisse did not particularly care about the investors in the junior classes of the securities they were selling, only the fees they could earn from originating the loans and structuring the bonds. Armed with the ability to sell down their loan exposure to investors around the world, they marched into the San Francisco multi-family market with hundreds of millions of dollars in underwriting capacity.

In response, the San Francisco apartment market, which is still dominated by a few small local landlords trading 10 and 20 unit buildings, exploded.

Much of the money was showered upon Walter Lembi, who used more than $1 billion in CMBS proceeds to purchase over 170 San Francisco apartment buildings between 2003 and 2008. In 2007, fully 75% of all San Francisco apartment trades were purchased by Lembi, who briefly became the largest private landlord in the city using OPM (Other Peoples Money). However, by late 2009 the tide had turned dramatically: Lembi overpaid and over 100 of these properties had either already been repossessed by lenders or were in the process of being repossessed.

The trouble is, not much seems to have changed. In the latest San Francisco apartment trade, a $37.4 million portfolio of non-performing loans owned by troubled Tamalpais Bank of San Rafael was sold to Coastal Capital for $24.1 million, or 64% of face value. For the 12 Lembi properties securing the loans, The $24.1 million purchase price equates to a capitalization rate of 7% on reported NOI.

What do these numbers really mean? It depends on how much faith you choose to place in the operating statements produced by Lembi, and how much trouble you expect while trying to get your hands on the actual deeds.

In addition to briefly becoming the largest private landlord in the city, Lembi is also known for trying to pass $300,000 in bad checks at Caesars Palace in Las Vegas, for systemically failing to refund security deposits, for an ability to ignore property taxes (this particular portfolio came complete with a $450,000 delinquent tax bill) and for using, shall we say, aggressive retenanting programs on rent-controlled buildings.

REIT Wrecks didn't sign a $24.1 million purchase contract for a portfolio of non-peforming loans, but we did examine Lembi's rent rolls and operating statements. Along with several co-conspirators, we may also have inspected the interiors and/or the roofs on 6 of the Tamalpais bank buildings on more than one or two occasions. In fact, while walking out the front door of 1895 Jefferson, the door knob might have fallen off in my hand.

At a 7 cap on reported NOI, with apartment rents in San Francisco still dropping and a borrower reknowned for being nasty, I would be amazed if the good folks at Coastal Capital didn't encounter even more unpleasant surprises.

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San Francisco Leads Detroit In CMBS Delinquencies for Apartment Properties

2009-10-13T23:50:00.000-07:00

San Francisco, once considered one of the strongest commercial real estate markets in the country, had one of the largest increases in overall CMBS default rates in the second quarter of 2009, up 444 basis points to 5.15% (and yes, this was even worse than Miami). Detroit was still the worst performing market, with an overall CMBS default rate of 5.62%, up 562 basis points from Q1. However, San Francisco’s multi-family sector now has a CMBS default rate of 21.7%, which is almost double the 12.93% multi-family delinquency rate in Detroit.

The amazingly high default rate in multi-family is being driven by one just one buyer and a lot of brokers in nice suits. Well known for not only paying top dollar (over 20 times gross rents) but also for pursuing, shall we say, aggressive retenanting programs, this buyer actually pocketed 75% of all San Francisco apartment properties that traded in 2007. And who is surprised? At 20 times gross rent, anybody who wasn't selling was living under a rock. About $1.2 billion was "invested" from 2003 through early 2008, financed primarily with two year, interest-only, cross collateralized debt complete with personal guarantees who's your daddy now?

The answer is UBS, which has already taken back about 1,500 units, and CIM, which bought the senior debt on 24 properties from Credit Suisse. This is only the tip of the iceberg though, and so far only about 700 units have actually been sold to new buyers. San Francisco apartment brokers, who were only too happy to cheer 20 GRMs on the way up, are now complaining publicly about comps that are "artificially low". Predictably, the view on that side of the fence is not that this guy overpaid, but that he simply over-levered! That aside, I'll give you one guess where prices in San Francisco are heading:

Despite the mess in San Francisco now, the S&P/Case-Shiller Index for Bay Area multi-family prices shows a 10.83 percent growth rate from the year of its inception (1995) through 2002. Growth in prices was strongly influenced by the Bay Area's healthy population growth, and as a result growth in Bay Area multi-family prices far outstripped the S&P/Case-Shiller Index for the top 10 metropolitan areas over the same period.

Unlike some cities in the Lone Star state, for example, where increased supply typically rises to the occasion, Bay Area multi-family prices have been influenced by a fundamental supply and demand imbalance even before the credit/real estate hysteria of 2003 through 2006. Between 1987 and 2002, the Bay Area population increased by 18 percent. The growth was fairly evenly spread over nine Bay Area counties, with Solano County having a growth rate of 28 percent, which was the highest growth rate in the area. The largest population growth in terms of total residents occurred in Santa Clara County, which added 301,000 people, followed by Alameda County and Contra Costa County, both of which added approximately 250,000 people. Combine that with natural and political barriers to unfettered new development, and Northern California doesn't look so awful even in you're a Bears fan.

Granted, the current San Francisco foreclosure saga is far more interesting than plodding through Bay Area demographic statistics. But when all those "artificially low" comps get set, is there any place you'd rather be with your money?

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Long Odds For Apartment Owners In Vegas; Prices Down By At Least 60%

2009-10-12T03:00:00.000-07:00

If you are investing in REITs right now, life is good. The US MSCI REIT index has doubled since hitting its lows in March, and in the second quarter Mid America (MAA) generated $.05/share in earnings from the sale of just one asset, a 36 year old, 96 unit apartment building in Grenada, Mississipi. Indeed, gambling on a little property in Grenada, Mississipi looks like a much safer bet right now than rolling the dice in Las Vegas, the gambling capital of the world.

Las Vegas is so volatile that 2009 transaction volume has dropped almost to zero, and prices prices appear to have declined by at least 60% from the peak. However, with virtually no sales taking place, it's hard to know what the market is. Amazingly, sales by dollar volume in Las Vegas have plunged by 99%, from almost $2.5 billion in 2005 to just $25 million for all of 2009:

Although only one sale had taken place through August, GlobeSt.com reported that in September, a 352-unit, 20-year-old apartment complex was sold in a short sale for $15.6 million. This price represents a 58% decrease from 2006, when the property last traded for $36.8 million. While a 58% decrease in value is frightening, it appears to be mild compared to where it could have traded.

The buyer, a San Diego socialite, was somehow convinced to pay a 5.5% cap rate on trailing-three-month NOI and a 6.1% cap on a trailing 12-month NOI. Even more incredibly, because the property was only 65% occupied by the time the sale closed, no lender would touch it, and the purchase had to be an all-cash deal. Can you say no competition?

Given the crummy fundamentals in Las Vegas, this sale is yet more evidence that the distress in commercial real estate may be cushioned by patient capital much more so than some currently expect.

Apartment values in New York City have declined at least as much as in Las Vegas. As I wrote earlier this year, the yawning gap between cap rates and GRMs means that New York City apartment values are heading in but one direction: Staten Island.

The Riverton, a massive 1232 unit behemoth of bricks that was purchased in 2006 for $340 million, is a great example. The buyers purchased the property using a first mortgage with day one debt coverage of .39x, which meant that the loan had absolutely no hope of being paid through existing cash flow.

Of course, the CMBS loan promptly became delinquent and the property is now in the hands of its special servicer, appraised at $108 million barely three years after Deutsche Bank wrote a check for its $225 million first mortgage. And the REIT goes on!

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apartment reits
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Annaly's New Mortgage REIT Falls Short, While Lehman's Limited Partners Cry Foul

2009-09-20T21:48:00.000-07:00

It's true; I was feeling a bit continental so I decided to take an entire month off from the world of REITs and commercial real estate. But Labor Day is no longer the summer sanctuary it once was. Not only does the holiday fall in September, preceding the month that has become known for Black Monday and the Crash of 1929, but September is now known as the month in which capitalism itself was nearly killed for good. It would have been hard to believe then, but the cynical attack on its iconic symbols eight years earlier is now even more poignant.

Nevertheless, Teddy Roosevelt implores us to get back in the arena, to strive valiantly, even through dust and sweat and blood and tears; to keep fighting even if we come up short. And that is exactly what Annaly did last week with the launch of its new commercial mortgage REIT, CreXus.

While CreXus did manage to raise $200 million to go shopping for distressed commercial mortgages, it had to cut the size of the offering by more than half, and even then it had to sell Annaly almost 30% of the deal in order to clear the market.

CreXus plans to use the proceeds to acquire commercial mortgage real estate related debt and other commercial real estate-related assets, and this was the problem. Buy side managers were not convinced that CreXus management knows its way around the CMBS market as well as Annaly management knows its way around the RMBS market, and several said they would rather wait for Tom Barrack's new commercial Mortgage REIT to come next week, rather than invest in the unproven CreXus.

While avoiding buyer's remorse may be the theme of the day with Mortgage REIT IPOs, creating it may be the intention of some limited partners in one of Lehman Brothers' real estate private equity partnerships. Indeed, the sale of the remants of the Lehman's real estate group to former management (including Mark Walsh who was "present at the creation", shall we say) appears to be pretty much on rails.

However, citing "greed, fraud, hubris, deceit, gross mismanagement and disregard of fiduciary obligations", a committee of limited partners in a real estate fund Walsh helped assemble is building what appears to be a fraudulent conveyance claim against Lehman and some of its affiliates, alleging that they used one of these partnerships to help eject toxic real estate assets from Lehman's balance sheet in 2007.

The informal complaint, sent in an email to investors and the General Partner, cites Lehman's "deceit in selling LP interests" to investors in LBREP III, including allegedly selling property to the partnership for $157 million more than Lehman paid for the same property just a few months earlier.

Both sides acknowledge that the investments are now worth about half the what LBREP III investors paid Lehman, and not surprisingly a large number of limiteds balked at a recent capital call to fund on-going expenses, including a retro-active increase in the management fee! Not only that, it appears that Lehman was charging management fees to its investors before they even owned the assets.

Although the email alleges "breach of fiduciary obligations", astute observers will note that securities firms like Lehman have no such obligations. Lehman was simply obligated to determine "suitability", which is a much different and much lower standard than a fiduciary standard.

In an oversimplified paragraph, if Lehman determines that it's suitable to charge investors $157 million more for a pool of assets than Lehman paid, then so be it. Private equity is a caveat emptor world, and the investors in LBREP III may be about to learn an expensive lesson in Latin. CreXus investors on the other hand, by demanding that Annaly buy 30% of its own REIT, appear to be taking no such chances.

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Bad Commercial Real Estate Loans Are Coming in Hot! And They're Right on Schedule

2009-08-12T00:05:00.000-07:00

It's summertime and the living is easy, but if you're a distressed debt broker, this is no time to be mixing Cuba Libres at the beach. There have been 72 bank failures in the first eight months of 2009, compared with 26 in all of 2008 and just 3 in 2007. So it should be no surprise that distressed debt offerings are taking off like a teenager after a paternity test, and distressed debt traders are definitely going to have their day in the sun, whether it be by hook or by crook.

Last week, $487 million of bad commercial real estate loans were offered for sale, and $235 million of it was on behalf of just one seller. The collateral was literally all over the map: Arizona, Illinois, Wisconsin, Tennessee, Indiana, Kansas, Florida, Nevada, California, Texas, North Carolina, Missouri, Minnesota, Ohio, New Mexico and Arkansas. And this week, the Wall Street Journal chronicled the mess at Maguire, which will soon let loose another $1 billion in bad debt on the market, with collateral concentrated in Southern California.

What's happening is no mystery. These loans are succumbing to conditions that can't be contemplated if your stock in trade is acquiring property with OPM using interest-only debt at 90% LTV, and this is just the tip of the iceberg. While many 2005 and 2006 borrowers are still alive, the hold your breath and hope strategy they have adopted will come to an end in 2010 and 2011. And just like the mid-market loan barons at CIT, these commercial real estate contessas are pressing for an assist from Uncle Sam. However, aside from TALF and PPIP, and just like the situation at CIT, additional government assistance is unlikely to materialize.

The reason is that the magnitude of the problem is being overstated. One could produce a graph showing all commercial loan maturities through 2013, and if one were to do that, it would show that there are $1.4 trillion in commercial loan maturities through 2013, and it would also show that the majority of those loans, over $1 trillion worth, are held by banks and thrifts. With bank failures increasing at an exponential rate, these the figures are the ones that the Real Estate Roundtable would use to bully congress into smothering the grenade with tax dollars:

Data: Intex, Trepp, FDIC

However, the data on commercial real estate loans held by banks and thrifts comes from the FDIC, and the FDIC does not publicly release data that is granular enough to analyze the collateral backing these loans. It's true that all of these loans are secured by commercial real estate, but many of them are actually business loans in which real estate happens to be just one small component of a much larger collateral package. Accordingly, the data does not distinguish a $5 million loan for an office building in Topeka from a company in Topeka that obtained a $5 million line of credit secured by an office building, accounts receivable and inventory.

Notably, this chart also shows that commercial real estate loan maturities climb relentlessly through 2010 and 2011, ascending to a peak in 2012, but it's also notable that billions of dollars have been raised in anticipation of this eventuality.

As of the end of June, REITs had raised almost $15 billion in 45 public offerings, and even the beleaguered Mortgage REITs managed to scratch together $4 billion. HCP, a Healthcare REIT, closed yesterday on a $441 million stock offering, and Starwood Capital, Barry Sternlich's new Mortgage REIT, just announced that it was increasing the size of its IPO to $800 million, which would make it the largest IPO of the entire year.

Raising money in the private market has been less productive, perhaps another $5 billion has been coaxed from the coffers of private equity investors. However, the market is nevertheless working as it should: bad debt is being recycled into equity, and amazingly enough, prices have not dropped as much as one would expect. Should the government get even further involved, using our ever-more scarce tax dollars, when private capital already seems to be doing the job?

If the real estate exposure is overstated in the bank and thrift world, where will all this new money find a home? One place where the turkeys are definitely coming home to roost is in the CMBS market, where 2005 and 2006 vintage loans with five year maturities will have very little hope of being refinanced without additional borrower equity. Opportunities for new investments in pear-shaped CMBS deals will be especially abundant in 2010 through 2012:

Data: Green Street Advisors

So, if you're looking for deals in commercial real estate, you'll need to look even harder than everybody else. Barry Sternlicht is no dummy, and he's definitely not alone. The truth is out there, and it congregates here!

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Dynex Looks Like a Mortgage REIT That's Built to Last

2009-08-10T01:19:00.000-07:00

Dynex Capital Inc. is a rather small US-based Mortgage REIT that invests in securitized residential and commercial mortgage loans and non-agency MBS. Management has a significant stake in the common stock, so it shouldn't be surprising that the company made almost no new investments in 2006 and 2007.

As of June 30, 2009, Dynex Capital had carrying assets of $245.1 million in non-Agency MBS, which was financed with $192.5 million in securitizations and short term debt repurchase agreements. Shareholders’ equity amounted to $52.6 million or 21.5% of the total portfolio.

The most recent quarter benefited from historically wide spreads, resulting from costs of funds that are near zero. "The story of this quarter is the performance of our Agency MBS investment portfolio. We earned a net interest spread of 3.70% on Agency MBS as our borrowing costs continued to decline. Our highly seasoned non-Agency investments continue to generate solid earnings and cashflow for the Company." In the year earlier quarter the spread was much smaller, only 1.45%. The conditional prepayment rate (CPR) also decreased from 27.3% a year earlier to 19.9% during the last quarter.

Delinquencies on Dynex's securitized mortgage loans increased from April to June of 2009 to $15.0 million from $9.1 million at December 31, 2008, but the company incurred no credit loss during the quarter.

Shareholder equity was $136.3 million during the quarter, or 20.2% of the $672.4 million of the commercial and single family loan collateral combined. During the summer of 2006 non-Agency portfolio leverage of equity capital was therefore about 5 times, essentially unchanged to the most recent quarter, despite the horrible conditions in CRE.

There will be more on Dynex here in the coming months. Mortgage REITs are not for the faint of heart, but this is definitely one worthy of additional time and research.

reit investments
mortgage reits
reit stocks
reits

Hotel REITs Default and Deflate - Can Shareholders Benefit?

2009-07-27T03:15:00.000-07:00

It's almost factual at this point: most 2006 and 2007 buyers of hotel properties will likely default on their mortgages. The reasons are simple: pro forma room rate and occupancy assumptions are being crushed, existing mortgage debt cannot be serviced, and the resulting drop in property values is preventing any kind of loan workout (other than through receivership and foreclosure). The interesting aspect of all this is that some hotel REIT shareholders could actually benefit from this huge mess.

First though, here is a hit parade, if you will, of defaults related to hotels located in "superstar" cities that were previously thought to be impervious to market downturns:

The St. Regis Monarch Beach hotel, an Orange County luxury resort in Dana Point, has completed a "consensual transfer" of ownership (it was late, and they were drunk) from its owner to its lender, Citigroup.

The Four Seasons Hotel in San Francisco has defaulted on a $90 million mortgage loan.

The Stanford Court Hotel, also in San Francisco, has gone into receivership after defaulting on an $89 million mortgage. JE Roberts bought the place for $93 million in 2007 and then dumped $32 million more into renovations.

Sunstone Hotel Investors chose to make an "elective default" on its the June 1 payment for the $65 million mortgage on the W Hotel in San Diego, which reflected "significant and continuing deterioration in demand for luxury lodging." According to Sunstone's CFO, the value of the W San Diego is "meaningfully below" the what it owes on the property. This is only natural, as they "elected" to overpay in the first place.

According to Commercial Real Estate Direct Sunstone's 366-room Embassy Suites Chicago, is also not generating anywhere near the amount of cash flow needed to service its debt, nor is the 284-room Marriott Del Mar in San Diego, or the 299-room Ontario Airport Marriott.

The 469-room Marriott in downtown L.A., purchased by Ezri Namvar's Namco Capital Group in 207 for approximately $115 million, recently filed for bankruptcy protection.

Luxury hotels in "superstar cities" aside, every day cities are feeling the pinch too. Red Roof Inn Inc., a hotel chain popular with budget-mided business travelers, defaulted on $367 million in mortgage debt earlier this year. Red Roof Inn was acquired for $1.3 billion by a syndicate led by Citigroup's Global Special Situations Unit. It remains unclear whether the unit's mandate is to create special situations, or to invest in them.

Not to be outdone, the Lightstone Group bought Extended Stay Hotels, a chain which operates 680 hotels catering to budget-minded travelers on longer trips, for $8 billion. Lightstone agreed to the purchase in 2007, and financed it at at 92.5% leverage. Unable to service $7.4 billion in debt, the chain promptly filed for Chapter 11 bankruptcy protection 24 months later.

As many as 500 properties could be in default by year's end, according to Atlas Hospitality Group. "The bright spot is that this is going to be the best buying opportunity since the Great Depression," said Alan Reay, the group's principal.

This, perhaps, is what's causing vulture investors to pick at these carcasses. This weekend, REIT Wrecks reader NS alerted me to the Vector Group's (VGR) purchase of over 7% of Strategic Hotels and Resorts's (BEE) common stock. Vector bought the shares for between 96 cents and $1.74 per share in the first and second weeks of July. At this point, despite BEE's hyper-leverage relative to it's underwater NAV, Vector Group and Bill Gates's Cascade Investment Company, another early vulture, now own slightly over 13% of the Company.

Vector is not the only one picking through the rubble. Hong Kong's Keck Seng Investments Ltd. just agreed to buy the San Francisco W Hotel for $90 million. According to The San Francisco Chronicle, although the price represents a 50 percent drop from peak values two years ago. The seller was Starwood Hotels & Resorts, which sold in order to "further reduce its debt levels."

Ironically, Hotel REIT investors could wind up benefiting from these moves, since dumping underperforming properties, even at a loss, will ultimately be accretive to both net asset value and FFO. This may be what is attracting intrepid investors back into the space, but if you choose to play a Hotel REIT recovery, you may need some need patience: Cascade Investments is down about 50% on its initial 2008 investment in BEE (Although BEE is well-managed, it's not worthy of investment in my opinion).

reit investments
hotel reits
reit stocks
reits
reit news

Mortgage REIT IPOs: There is Vibrant Life After Death in CRE Debt

2009-07-23T15:12:00.001-07:00

In just the past two months, 8 Mortgage REITs have filed to raise $3.9 billion in fresh cash, which should not be all that surprising. Retail financial advisors are saying that buckets of high net worth cash are sitting on the sidelines, waiting for opportunities in distressed commercial real estate. With several REIT follow on offerings up 150 percent so far this year, the public market is clearly betting on a turn around. Indeed, back in May, it appeared that the 52 week lows for REITs had already come and gone. Investors are now feeling safe enough to travel even farther down the curve and back into CRE debt, and a slew of new Mortgage REITs are emerging to greet them.

Ladder Capital is the latest aspiring Mortgage REIT, with plans to raise raise $400 million to invest in distressed whole loan mortgages. Ladder Capital Realty Finance (LCRF), as the new firm will be known, will primarily target first mortgage originations as well as senior participations in fixed and floating first mortgage loans.

Regulatory filings indicate that LCRF may also originate and acquire CMBS using TALF money, invest in some B-note and mezzanine loans, as well as provide financing for third party purchases of CRE notes and first mortgages.

Ladder was founded back in October of 2008, when optimism was in even shorter supply than cash. Ladder has already raised $611.6 million from investors, including investments from founding partners TowerBrook Capital Partners, GI Partners and Meridian Capital. The firm has since invested $428 million of that in various deals, including the purchase of Florida's FirstCity Bank of Commerce, which will be renamed Ladder Capital Bank.

In addition to LRCF, Alliance Bernstein, Angelo Gordon, Apollo Global Management, Colony Capital, Starwood Capital and Western Asset Management have all registered to raise equity for their own Mortgage REITs. Invesco's pet Mortgage REIT is already trading, but it had to cut the size of it's offering in half, to $170 million, in order to clear the market. If these new entrants are successful, it will be a strong vindication of the much derided TALF program, and even more evidence that we are not sailing over the cliff into deflation, perennial depression and complete financial oblivion.

The filings make for great reading. Ladder said there is now an “unprecedented market opportunity" to originate well-priced loans. Colony said that the the credit crisis was causing an "over-correction" in commercial real estate debt and that there would be a "protracted opportunity" originate attractive loans. Alliance's new REIT, Foursquare Capital, said that the "current distressed condition in the financial markets" would allow it to buy mortgage assets at "significantly depressed trading prices and higher yields." As for Barry Sternlicht and Starwood, their filings were even more emphatic: "the next five years will be one of the most attractive real estate investment periods in the past 50 years,"

Vornado Realty Trust, much to the chagrin of public shareholders, is raising a $1 billion private real estate fund that will be its "sole vehicle" for investing in distressed office and retail assets in New York and Washington DC. Vornado may have an easier time of it in the public markets: since the start of 2009, 51 REITs have raised more than $16 billion in public equity, according to NAREIT. These numbers tell a compelling story, and there is a lot of "smart" money out there waiting for a bottom that if not already here, soon will be.

commercial real estate
reit investments
mortgage reits
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reits
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Billions, Literally, Chasing Distressed Commercial Real Estate

2009-07-15T19:31:00.000-07:00

Even with all the capital now chasing distressed commercial real estate, it's still not clear whether these bargains are really much of a bargain. 250 Montgomery St., a downtown San Francisco office building that traded via a distressed note sale is the latest example of the uncertainty. The building, located on San Francisco's "Wall Street of the West", was purchased by Lincoln Properties for $400 a square foot in 2006, but it just sold in a deed-in-lieu-of-foreclosure for $172 a square foot.

Clearly, this is a huge decline in price, and even the senior lender, Realty Finance Corp, took a $22 million hit. It was also the first San Francisco office building to trade in a year, and the first “round trip” sale, where a property goes from a one new owner directly to another new owner via a deed in lieu of foreclosure. The total sale price of $19.9 million represents about 25% of replacement cost.

From that standpoint, the buyer got a fantastic deal. But a broker familiar with the sale said the building actually traded about 40% ABOVE his initial BOV and also attracted three times as many bidders as a traditional fee-simple sale would have seen. The broker said they are advising all of their lender clients to do note sales to the high level of interest in properties marketed as "distressed assets."

Part of the reason for the lower opinion of value was rent growth, or the lack of it. The broker, who has been selling instutional office property for the better part of 20 years, doesn't see any. In fact, he is reducing typical rent rolls by 20%, and then assuming no growth for 5 years.

Who was the buyer? It was Argonaut Capital, a Tulsa-based private equity firm controlled by just one investor, billionaire George Kaiser, who was nowhere on the commercial real estate radar until this purchase. Argonaut is neither a distressed asset neophyte nor a stranger to alternative assets (one of its most recent purchases was $412 million in natural gas assets from Chesapeake Energy), but real estate doesn't appear to be a major area of focus for the firm.

Surely 25% of replacement cost for an office building in downtown San Francisco can't be all bad, but given the fundamentals, it may be quite some time before any new money is pulled out of this deal. Nevertheless, if you're a billionaire with plenty of cash and other interesting things to do in the meantime, who cares? These are the kinds of buyers now swimming in the distressed asset pool, and with approximately 30 of them all clamoring a piece of San Francisco dirt with no clear value, it's practically deja vu all over again.

Mauldin Says Deflation Is Coming: Why He Is Wrong, Stuck "Inside the Box" & Hopelessly Conflicted

2009-07-09T03:00:00.000-07:00

While John Mauldin may read "hundreds of articles, reports, books and newsletters" in order to bring you the one essay each week that will "stimulate your thinking", he will also roll for commissions, and that's pretty much all you need to know about his weekly email. More on that later, but first, what about his most recent electronic dirge, in which his illustrious guest scribe heaped upon us innocents the same lost decade of deflation and despair that befell Japan in the wake of its banking crisis?

Presumably, those who choose to heed the call of Mauldin's high-end affiliate marketing scheme shall be saved from this particular despair, but there's really no need to bother. My colleagues and I spend an awful lot of time thinking about the risks of deflation and inflation relative to commercial real estate investments (ironically, REIT Wrecks also spent the weekend at an undisclosed location with an official from the Treasury Dept., and we happened to talk about this very same issue), and in our carefully considered, pretty much conflict-free opinions, Mauldin's lost decade deflation scare is nothing but a bunch of self-serving, poorly researched crap.

REIT Wrecks is far from achieving Mauldin-like internet nobility, but I'm also not an Introducing Broker. I have actual dirt underneath my fingernails, and a decided lack of sycophantic staff willing to manicure them on a daily basis. However, since I must still add, multiply, divide and subtract on my own, I have decided to use this golden opportunity shooting ducks in a barrel!! to show you, my REIT crazy comrades, why the Mauldins of the world are not to be entirely trusted.

Mauldin's guest "analyst" in last Friday's email was a glorified stock broker named Niels Jensen. He runs a firm called Absolute Return Partners, and he is probably a really nice guy. It's an innocuous compliment and also Wall Street code for not being all that bright. Indeed, the first time I heard that expression used in this manner was when he and I shared the same employer some years ago, and sadly it's the best I can do given the quality of his "analysis". To conclude otherwise would be to claim that his analysis is intentionally misleading...and I will leave that dirty bit up to you.

So what about Jensen's claim that we face the same lost decade as Japan? Is there anything to it? On the surface, the parallels are alarming. It's true, the Japanese did experience a banking crisis, and they learned that "recovering from a deflated credit bubble is a long and very painful affair." Redundantly, barely one paragraph and a colorful but mostly irrelevant chart later, he goes on to write:

Another lesson learned from Japan is that once you get caught up in a deflationary spiral, it is exceedingly hard to escape from its grip. The Japanese authorities have used every trick in the book to reflate the economy over the past two decades. The results have been poor to say the least: Interest rates near zero (failed), quantitative easing (failed), public spending (failed), numerous attempts to drive down the value of the yen (failed); the list is long and makes for painful reading.

Finally, after more gee-whiz gobbledy-gook on such esoterica as the output gap and inelastic commodity demand, he concludes that "the ultimate outcome of this crisis will turn out to be deflation – not inflation. Inflation may eventually become a problem, but that is something to worry about several years from now. The Japanese have pursued an aggressive monetary and fiscal policy for almost 20 years now, and they are still nowhere."

Wow! All those pretty charts and this is the best he can do? Clearly, REIT Wrecks suffers from a chart deficiency, and anyone who can send me some pretty new ones will get a free subscription to Mauldin's newsletter. In the meantime, as usual, I have made my own.

Now, with respect to Japan being "nowhere", there is actually good reason for that, and while the charts below are in fact hand crafted by yours truly, I must credit Foreign Affairs for publishing - barely two months ago - a convenient and timely article on the the "Japan Fallacy", as they refer to it (Volume: 88, Issue: 2, March/April 2009). Evidently, Jensen was too busy churning client accounts to bother reading it, and somehow Foreign Affairs isn't anywhere on Mauldin's radar.

That aside, while it is true that Japan suffered a banking crisis in the early 1990s, and that in response the Japanese government pursued strategies similar to those now being employed by the U.S. Treasury and Federal Reserve, the similarities end abruptly there. Any further comparisons to Japan then and the crisis in United States now are just not accurate.

The reason is that Japan's banking crisis was dramatically different from ours, and for reasons known only to him, Jensen spends no time evaluating those differences. Fundamentally, the crisis in the U.S. was caused by narrow dysfunction in our financial sector, and that caused an economic crisis. In Japan, the problem was pervasive dysfunction in the entire economy:

Japan's malaise was woven into the very fabric of its political economy...weak domestic firms and industries were sheltered from competition by a host of regulations and collusion among companies. Ultimately, that system limited productivity and potential growth. The problem was compounded by built-in economic anorexia. Personal consumption lagged, not because people refused to spend, but because the same structural flaws caused real household income to keep falling as a share of real GDP. To make up for the shortfall in demand, the government used low interest rates as a steroid to pump up business investment. The result was a mountain of money-losing capital stock and bad debt.

The Japan Fallacy: Today's U.S. Financial Crisis is Not Tokyo's Lost Decade. Foreign Affairs, March/April 2009.

The Japanese and U.S. crises differ in numerous other ways, but one of the starkest contrasts is in the response of policymakers. Denial, dithering, and delay were the hallmarks in Tokyo. Jensen doesn't bother to mention that it took the Bank of Japan nearly nine years to bring the overnight interest rate from its 1991 peak of eight percent down to zero. The U.S. Federal Reserve did that within 16 months of declaring a financial emergency, which it did in August 2007. It has also applied all sorts of unconventional measures to keep credit from drying up.

Furthermore, Jensen fails to mention that Tokyo lacked the political will to allow widespread bank failures. The collapse of Lehman Brothers remains the largest corporate bankruptcy ever in the United States, but nothing like it was ever allowed to happen in Japan.

On the contrary, Tokyo used government money to help its banks keep lending to insolvent borrowers and protect their shareholders. The result was a country that became even more deeply indebted, supported by an economy that was not productive enough to pay it all off. Consequently, Japan’s public debt, already the world’s largest (second only to Zimbabwe!), will surge to 197 percent of gross domestic product in 2010, according to the OECD:

The United States, over there near its more quiet neighbor, Canada, is not even close. What about the massive $787 billion fiscal stimulus just signed into law, will that squeeze the U.S. into a cell next to Japan in debtor's prison? It's unlikely. The reason is that the Japanese economy is much smaller than the U.S. economy, and unlike the U.S., Japan's population is contracting. On average, Japan's population is also much older. As a result, Japan is much less productive than the U.S., and even though U.S. government debt is forecast to swell to about 70% of GDP through 2014, that would still be less than half that of Japan today, and far below that which was incurred by the U.S. during World War II:

Note: This graph represents the cumulative total of all government borrowings in U.S. dollars, less repayments. It does not include liabilities related to funds held in trust (like Social Security) or financial assets (like agency securities). "Debt Held by the Public" is not "external debt", which reflects the foreign currency liabilities of both the private and public sector.

Ironically, Jensen does note that most observers condemned the Japanese approach as hopelessly inadequate, which it was, but he also implies that it was identical to what was employed by the U.S., which it wasn't. Is this the kind of work they do over at Absolute Return Partners? If so, why would Mauldin be so devilishly fond of them??

Policy mistakes -- from Japan's mismanaged fiscal and monetary policy to the government's failure to address the loan crisis -- made a bad situation even worse. But even if policymakers had done everything right, Japan's economy still would have stagnated until Tokyo addressed its more fundamental flaws.

A far better comparison might have been the Asian financial crisis, which proved that once financial markets are calmed and policy mistakes are reversed, economies recover. Even clumsy Russia managed to recover from its 1998 financial crisis and currency devaluation. Apparently, neither of these two examples suited Jensen's needs.

As for the hopelessly conflicted Mauldin, what's black and white and read all over? Unfortunately, it's not a newspaper, as nobody reads them anymore. It's the disclaimer in small print located at the bottom of Mauldin's "E-letter", conveniently overlooked by most, and which I have edited slightly for clarity:

Mauldin cooperates in the marketing of private investment offerings with Absolute Return Partners. Funds recommended by Mauldin may pay a portion of their fees to Absolute Return Partners, who will share 1/3 of those fees with Mauldin. Mauldin only recommends products with which he has been able to negotiate fee arrangements.

In other words, Mauldin will treat his loyal readers to the worst ideas from any old crap fund, so long as the fund managers can afford to pay him off for the favor. In Brooklyn, they might call this racketeering, were they not so stupefied as to how it's all completely legal. My advice? Just go read Foreign Affairs.

JP Morgan Likes Brandywine (BDN) and Entertainment Properties Trust (EPT)

2009-07-08T09:44:00.000-07:00

JP Morgan analyst Anthony Paolone is understandably not bullish on commercial real estate fundamentals, but since the public market is typically ahead of the private market in terms of valuations, he does like certain REITs.

Brandwine in particular has both refinanced existing debt, and repurchased its own debt on the open market (for a quick explanation of the accounting behind debt repurchases, read Muddled REIT Book Values Create Opportunity). The ability to delever in this market is obviously muy bueno, even though Brandywine also diluted shareholders to death in the process.

Paolone also thinks (BDN) will pay a special dividend in Q4. Be aware of the fact that JP Morgan was joint lead underwriter on BDN's very dilutive equity offering, so do look carefully beneath the hood before plunging in.

Enjoy the vid!

office REITs
reit investments
reit stocks
commercial real estate

Real Estate as an Inflation Hedge? Don't Bet On It

2009-07-07T12:36:00.000-07:00

One major reason for investing in commercial real estate and REITs is that real estate is thought of as an effective hedge against inflation, yet commercial properties were an abyssmal inflation hedge in the early 1990s. So why are they still considered to be an inflation hedge if that isn't always the case? As usual, it's mostly about timing and location. (Note: For the time being, I am ignoring the actual likelihood of inflation or deflation - more on deflation here; more on inflation to follow. You may also be interested in a recent Brookings Institute report on recession proof real estate)

As this NAREIT chart conveniently shows, equity REITs (in green) declined in the early 1990s (circled in blue), even though the Gulf War and high oil prices were driving commodity prices (in black) higher:

Even more conveniently, this NAREIT chart, with inflation added in via the CPI, shows that REITs were actually highly correlated to the S&P 500 (i.e. stocks!), and that both performed horribly during the early 1990s:

These NAREIT charts help illustrate that the market value of all types of commercial properties actually collapsed after about 1989, even though the CPI and commodities rose. So why did this happen? The lesson from the early 1990s is that in the short run, private real estate equity and public real estate equities are not effective hedges against inflation if there is a large overhang of supply. Indeed, this video on retail big box vacancies in Orange, CT shows that one result of oversupply is high vacancy rates:

For those of you who prefer more excruciating detail, this study by Wurtzebach, Mueller and Machi (circa 1991) takes an academic approach to explain what may already be intuitive to those of you that own and operate commercial real estate: real estate is an effective hedge against inflation only if the markets are in balance. If the markets get out of balance (defined as vacancy rates above 10%), high vacancy rates make it impossible to raise rents to combat inflation:

According to Wurtzebach, et al., imbalances are especially pronounced after periods of capital markets excess, such as the one we just experienced. No property sector is totally immune to the current imbalance, but retail real estate in particular faces a lot of pressure given bankruptcies at GM, Chrysler, Circuit City, Mervyns, Steve & Barry's, Linen's 'N Things, etc.

In the auto industry alone, 881 car dealerships were closed in 2008, and GM and Chrysler have announced closings of over 2,000 more in 2009. Skyrocketing vacancy rates mean that the vast majority of these sites will languish and sit empty for several years, nevermind generate any income or appreciate in value.

REITs and commercial real estate can be an effective inflation hedge if you have a longer-term investment horizon, or if you invest specifically in REITs that own quality assets in protected markets that provide pricing power (Federal Realty Trust (FRT) being a good example). But not all investors have the luxury of the buy-and-hold approach, and if you're hoping that inflation will be the panacea for a poorly-timed asset purchase in a weak market (e.g., Phoenix, Las Vegas, Tampa), it's definitely time to implement Plan B.

retail REITs
reit investments
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commercial real estate
reits and inflation

Agency Mortgage REIT Dividends Get Better & Better

2009-06-25T09:30:00.001-07:00

Shamefully, I haven't done much with Agency Mortgage REITs here, but the times they are a changing. Agency REITs are killing it on net interest spreads, and that is causing higher net incomes and increased dividends. What else could an investor want, next to a portfolio of government-guaranteed mortgage debt? Not surpringly, many investors screech to a halt on mention of the latter, and that's one of the reasons these REITs deliver high teens yields quarter after quarter.

But those who had been yawning at the mention of an Agency Mortgage REIT are probably taking a closer look now. (AGNC), which is a relatively new Agency REIT, surprised everybody on Tuesday when they announced a quarterly dividend of $1.50 per share, a whopping 76% higher than the previous quarter (the dividend is payable July 27th, and the ex-dividend date is June 30).

AGNC's dividend increase follows dividend increases from Annaly Capital (NLY) last week and Capstead Mortgage (CMO) the week before.

What's causing all this? The earnings driver is the so-called "steep yield curve", as it's known in industry speak. In this market, a steep yield curve basically means nobody wants to own anything with a maturity beyond next week, especially if it has a mortgage attached to it. This is resulting in a huge spread between short yields and long yields, and Agency Mortgage REITs are busy collecting the difference. The difference between these Mortgage REITs and others is that Agency REITs are doing it with portfolios of AAA-rated government paper, not a bunch of dodgy TRUPS and CDOs.

In AGNC's case, the weighted average yield on its portfolio last quarter was 5.13%, but its average cost of funds was 2.11%, resulting in a margin of 3.02%. This is pretty good work if you can get it, and last quarter AGNC delivered a 24.1% return on equity for sitting in between.

AGNC is not alone. Annaly Capital Management increased its dividend last week - by 20% to $0.60 per share (payable July 29, ex-date is June 25). NLYs net interest margin went from 1.71% to 2.11%, and they rode the recovery in mortgage bonds with a $5 million gain on sale. Combined, this drove earnings to $0.63 per share, up 19% from the year-ago quarter.

CMO's dividend increase was less spectacular, up 4% to $0.58 per share for the third quarter of 2009, but the story is the same: their net interest margin increased to 2.16%, and they have plenty of cash to invest after participating in the recent frenzy of REIT stock offerings.

Other cashed-up REITs investing in agencies, though not exclusively, include Redwood Trust (RWT) and Chimera (CIM). Incidentally, RWT sold its stock in two separate overnight offerings, the latter at a 10% discount to the previous day's close.

Despite these rich dividends, Agency Mortgage REITs are not for widows and orphans. Concerns over the government losing its AAA rating (which Annaly management calls "gossip"), interest rate wories, news about Asians selling their dollar assets, inflation prospects, high leverage ratios and re-investment risk all amount to a big detour sign for a lot of investors. From my perspective, owning these things right now amounts to a front row seat for the greatest show on earth (at the very least), and it's probably worth the risk.

Disclosures: None at the time of publication

Mortgage REITs
reit investments
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reits
reit news

20 Recession Proof Real Estate Markets

2009-06-24T09:14:00.000-07:00

Like politics, all commercial real estate is local. The Brookings Institute has just published a study on the 100 largest MSA's in the country, and it concludes that there actually are green shoots in commercial real estate, and many of them are to be found in over-looked, secondary markets in the middle of the country.

The report shows that in 38 of the top 100 metro areas, housing prices remained flat or actually increased over the past year, even as prices nationwide dropped. Most of these metro areas also experienced below-average employment declines, and they lie in some interesting areas somewhat off the beaten path (Pittsburgh, Rochester, Tulsa, Des Moines and Baton Rouge, among others).

All of the top metros also have below-average shares of single family foreclosures, which is not surprising. This is not also not an isolated finding, and I wrote about Zillow's distinction between "hot" markets that were actually "not" in The Best Performing Apartment REIT for 2009.

In terms of extrapolating the findings to other markets that may have similar-recession proof characteristics, it shows that areas with heavy concentrations of education and healthcare-related jobs are performing well, and that cities with concentrations in finance jobs are not all the same. Oklahoma had two cities in ranked in the top 20: Oklahoma City and Tulsa. Other cities doing well include Little Rock, Harrisburg and Albuquerque:

"All metropolitan areas are feeling the effects of this recession, but the distress is not shared equally,” said Alan Berube, the program’s research director and report co-author. "While some areas of the country have experienced only a shallow downturn, and may be emerging from the recession already, people living in metro areas that are now performing the weakest economically should prepare themselves for a long recovery period.”

commercial real estate
reit investments
reit stocks

9 REITs That Had to be Destroyed in Order to be Saved

2009-06-20T12:18:00.001-07:00

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 9 REIT stock 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 REIT 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
REIT Name	Increase In Shares Outstanding	Dividend Cut	News
Brandywine Realty Trust	+34%	-67%	BDN
Cogdell Spencer	+74%	-51%	CSA
Camden Living	+13%	-36%	CPT
Duke Realty	+40%	-32%	DRE
Kilroy Realty	+27%	-40%	KRC
Kimco Realty	+39%	-86%	KIM
Prologis	+65%	-40%	PLD
Regency Centers	+14%	-36%	REG
Weingarten Realty	+30%	-52%	WRI

There are many good reasons to invest in REITs right now. REITs typically lead property markets into and out of recessions, and these successful equity offerings indicate that the market is anticipating a recovery. Nevertheless, these 9 REITs are best avoided in favor of others that have not had to conduct such radical recapitalizations.

Suggestions: the adventurous could take a look at Simon Property Group (SPG). SPG also just closed a large equity offering, but dividends were not cut and management said recently that SPG would resume paying all cash dividends in early 2010 (SPG is currently paying dividends in stock, click here for a complete list of REITs paying dividends in stock). SPG owns a portfolio quality assets in good locations, and they have cash to pick up more.

Apartment REITs will benefit from tighter single family lending standards, very favorable long-term demographic trends, and a precipitous drop in the construction of new apartment stock. Check out Mid-America Apartments (MAA), which will definitely be the best performing Apartment REIT for 2009. Equity Residential (EQR) is another Apartment REIT that reported solid Q1 earnings. The Fed's plunge into CMBS via TALF is causing lots of intrigue in the Mortgage REIT world, particularly with Dynex (DX) which invests in both agency and non-agency RMBS and CMBS.

Disclosures: None at the time of publication

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REITs Queuing Up To TALF Trough By the Dozen; Debt is the New Equity

2009-06-18T16:59:00.000-07:00

REITs cracked the capital markets code this quarter. What looked like one of the biggest incipient financial train wrecks since the Great Depression has turned into a scramble for REIT scrip of almost any stripe. The MSCI US REIT index is up 55% from it's March lows, and $15 billion in credit lines have been issued and refinanced with equity faster than slum dog can phone a friend.

This is not be entirely surprising: REITs always lead the private market into and out of real estate recessions, but the alacrity of this recovery probably has champagne corks ready to fly at the Fed. While the Fed's first deadline for issuers seeking TALF funds for CMBS passed this last Tuesday without any takers, all of this REIT stock activity has been in anticipation of REITs being able to borrow again, finally...even if it's from a government-subsidized bailout fund.

Gushers of TALF cash cannot arrest the inevitable bust in commercial real estate prices, but government liquidity can and may already be averting massive, wholesale defaults in REITs and commercial real estate.

And that is the goal. William Dudley, president of the New York Fed, on June 4 underscored the importance of the CMBS TALF program, noting that a continued lack of funding would increase loan defaults and further pressure the capital positions of banks that are holders of commercial real estate assets. Reiterating this, Dudley said the CMBS roll-out is key for the overall success of the TALF program.

So it shouldn't come as any surprise that the availability of TALF cash has creditworthy REITs scrambling to hock every last speck of unencumbered dirt in search of fresh liquidity, even if (ironically) it's in the form of even more debt.

There are at least a dozen REITs working on TALF deals, including a number of Mortgage REITs ready to re-pledge AAA CMBS collateral. One such Mortgage REIT, Dynex Capital (DX) estimates that it can re-pledge existing AAA CMBS to the Fed through TALF and get a funding pickup of 800 bps in the process.

Developers Diversified Realty Corp. (DDR), an Ohio-based retail REIT, could be one of the first REITs to reliquify physical assets through TALF. According to the Cleveland Plain Dealer, DDR is working with Goldman Sachs and Citibank to prepare two groups of properties -- each worth about $800 million -- as collateral for new TALF loans.

The properties DDR has identified are either unencumbered or have near term debt maturities. The latter is obviously be a big, big problem for many highly-leveraged REITs, but the new TALF money now looks like it will alleviate at least some of that risk, as is intended.

Developers Diversified hopes to borrow about $300 million against each of these groups and use the money to repay unrelated debt and/or refinance existing mortgages. Simon Property Group (SPG), another retail REIT, is also in line. Either way you cut it, the ability to swap old debt for new debt makes new debt the new equity, and the first deal should close by early September.

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Iran

2009-06-18T02:20:00.000-07:00

"The issue today is the same as it has been throughout all history, whether man shall be allowed to govern himself or be ruled by a small elite."

Thomas Jefferson

Maguire (MPG) Sells Orange County Property at 40% Discount to Cost

2009-06-15T09:40:00.000-07:00

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 MPG'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.

I am not a lawyer but I live in San Francisco and like to play dress up every now and then and 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 get in line, buddy limited to three year's worth of rent.

However, The FDIC's authority to reject leases does not fall under Chapter 11 of the Code, and it is even more draconian. If a lease is rejected by the FDIC as receiver, the owner is simply handed the keys imminent default and the contract is extinguished - with absolutely no claim on the estate of the dearly departed. This obviously makes it tough to pay your friendly banker on the first of every month.

This is exactly what has happened with Quintana, an office property jointly owned by Maguire (20%) and Maquarie Office Trust (80% - ASX: MOF). Maguire announced today that the FDIC has rejected the majority of WAMUs lease at Quintana, which is also in Orange County. According to the press release, the FDIC surprise! is "not obligated to pay any rent or other compensation in connection with the lease termination".

This brings the occupancy of Quintana to approximately 40%, which is unsustainable in relation to the debt (a now completely underwater $106 million CMBS loan maturing in December 2011). Maguire has commenced discussions with the special servicer, and a deed-in-lieu of foreclosure deal is the most likely outcome. This will probably wipe out all of MGP's equity in the property.

With respect to the sale of the aforementioned newly-constructed property to the Emmes Group, it's noteworthy that financing was provided by EuroHypo, itself a struggling lender. But don't get your hopes up - the loan was not new money. EuroHypo simply allowed Emmes to assume the original construction loan in return for injecting fresh equity.

Until Emmes showed up with its $160 million check, EuroHypo was in about as much distress on this deal as MPG. Last month, Maguire took a $23.5 million first-quarter noncash impairment charge on the property, following a $50 million noncash impairment charge on the same property in prior quarter. EuroHypo's $165 million construction loan was set to mature in September 2009, but it will now live on (with principal reduced) as term financing for a brand new borrower. And the beat goes on!

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How to Make A Fortune with REITs in 2010

2009-06-13T08:30:00.000-07:00

Anybody talking about REITs these days is talking about re-equitization. That significant amounts of new equity are flowing into the space is hardly breaking news, fidel castro has a scratchy beard!! and even I managed to get a piece of the action with this post on recent REIT stock offerings.

What is the real significance of all this fresh cake? Obviously, it's about delevering, but it's also about 2010. These equity offerings are separating the winners from the losers drowning in debt, and the latter will be forced to sell into one of the best buyers markets in decades.

In short, 2010 will bring a flood of distressed assets to the market, and everybody knows it. Cash will be king. Accordingly, REITs with access to equity capital markets will be able participate in this smorgasbord of distress, while those without cash will be locked out. Most important: Public REITs always lead property markets out of recessions, so buying into these freshly recapitalized REITs now could lock in big gains for 2010.

But don't make me prattle on in order to prove it - it's Saturday morning after all. Just sit back, relax and hit the play button (batteries not included...):

When it comes to investing in distressed assets, Mike Kirby of Green Street Advisors thinks REITs will be the only game in town. In this next video clip, he discusses some of the key risks facing REIT investors, as well as the opportunities for public REITS to buy quality assets on the cheap starting in 2010. Kirby foresees a a 1990s-like consolidation, followed by a much bigger REIT industry five years from now:

While Kirby and Pire cover the institutional side of the business, Cramer, everyone's favorite retail hyperventilator, likes Boston Properties (BXP). REIT Wrecks, however, is confused by Cramer's enthusiasm for BXP. The Company has an NOI concentration in New York City and heavy exposure to the financial sector in New York, Boston and San Francisco. Rents are down in the latter city by 40% and are still dropping [Update: Watch this January 2010 interview with Mort Zuckerman, CEO of BXP, for his latest thoughts on BXP's markets]. The Company has already guided FFO down by 5% for 2009. This pick could become another member of the Cramer Crap Club (alas, CNBC seems to have pulled this vid. If it doesn't load in your browser, you can see it here. Suffice it to say, don't stick with Cramer on this one):

In addition to BXP, Numerous REITs have recapitalized, and an increasing number of brand new REITs are coming public. In anticipation of a recovery, the Dow Jones Equity REIT Index is already up 57% since the lows in March. However, REIT Investors need to be selective.

Obviously, you still need to avoid REITs with high levels of debt (click here for a list of Apartment REITs by leverage ratio). Look for REITs that are covering dividends from operating cash flow, and most of all, look for those REITs with assets in strong, protected markets. This will provide the pricing power they'll need to combat the effects inflation, which seems almost inevitable at this point. For a quick but by no means comprehensive buying guide, see REIT Stocks: 4 Ways to Play the Carnage.

Click here for a list of Apartment REITs
Click here for a list of Healthcare REITs
Click here for a list of Hotel REITs
Click here for a list of Industrial REITs
Click here for a list of Mortgage REITs
Click here for a list of Office REITs
Click here for a list of Retail REITs
Click here for a list of Storage REITs

Click here for a REIT ETF List
Click here for a list of REITs paying dividends in stock

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REITs Quietly Sell Stock Overnight at a Discount; Next Day Pop Fries Shorts

2009-06-08T03:00:00.000-07:00

If Frank Quattrone could start over, he would be a REIT banker. REITs staged a huge rally this quarter, almost $15 billion in new equity has been raised through 45 public offerings this year, and even the Italians are descending upon New York to list new deals. With REIT stocks now being served up like Cannolis on Columbus Day, and consumed almost as fast by shell-shocked but somehow still hungry investors, you may have one question: What is Going On?

One reason is that REITs cram down desperately need the money, and while not all are teetering on the brink insolvency, most will do almost anything for fresh cash. This includes diluting their long-suffering shareholders bang zoom! to the moon, and cutting dividends prego! to the newly annointed.

How is this happening? Some intellectual honesty is called for here: REITs were simply oversold. Furthermore, no portfolio manager that I know of was willing to scale the ramparts for General Growth, no matter how many bankers GGP put to work pounding the phones, or how much they were being paid. Still, when there's an abundance of supply, demand needs to be stoked, and that's exactly what's being done. Almost all of these REIT equity offerings are being sold in "over-the-wall deals", much like tech stocks were in the late 1990s.

"Over-the-wall" deals are pre-arranged sales with leading investors at discounted prices, executed overnight. The news hits the tape the following morning, and the stock jumps. Basically, if you're not "over-the-wall" you're trapped beneath it, especially if you're short. Indeed, one goal of the strategy - to scare the pants off of short sellers - is surely working. Nobody wants to be short a company whose balance sheet can be de-levered overnight, and that (re-equitization) is the other goal.

Unlike GGP, investors are flocking to these deals like moths to a porchlight. At a securities conference several weeks ago it's just not true, there is a free lunch Mortgage REIT management presentations were standing room only. One of them, Chimera (CIM), had just used an $850 million offering to transform itself from a smoking heap of 2007 trade confirmations into a potential Microsoft of Mortgage REITs. Another, Redwood Trust (RWT) executed not one but two new issues, the latter just days after the conference, raising almost $500 million in equity.

REIT new issues have included such varied names as Alexandria Real Estate Equities (ARE), AMB Property (AMB), Pro-Logis (PLD), SL Green (SLG), Ventas (VTR) and Vornado (VNO). The AMB deal is a good example of how the REIT equity syndicate pot is being stirred. AMB's $575 deal combined pre-launch "over-the-wall" meetings with the chosen ones, followed by overnight execution. The deal was 80% sold before it was even offered to the public - and then upsized 24% for good measure. It was sold at a discount of 8% to previous close, which isn't bad considering that it represented almost 50% of the current shares outstanding, and that the stock traded up 16.5% the next day, resulting in an instant 25% gain for the new shareholders.

Who's next? Everybody wants to know. Significantly, IPOs in registration are dominated by Mortgage REITs. These include Cypress Sharpridge (agency RMBS), Invesco (agency & non agency RMBS; CMBS; TALF loans) Penny Mac (non-agency RMBS), Sutherland (agency & non-agency RMBS) and Starwood Property Trust (CMBS/RMBS). These initial public offerings will list under the symbols CYS, IVR, PMT, SPT and SLD, respectively.

Others in registration are Brookdale Senior Living (BKD) and Investors Real Estate Trust (Nasdaq: IRET). Recent shelf offerings include Northstar Realty Finance (NRF), with JMP Securities (a large investor in New York Mortgage Trust (NYMT) and manager of its mortgage assets) as sole manager.

Even crippled Anthracite (AHR) may be getting into the act. Miraculously, the company was able to restructure its secured and unsecured debt last month, and a round of fresh equity is undoubtedly next on the list. Anthracite's cozy relationship with Blackrock, which backstopped AHR with a line of credit in its darkest days, gives it an almost unparalleled window on the Fed's growing portfolio of "toxic" mortgage assets. In this latest game of "if you're not inside, you're outside" being played with REIT equity, that may be all AHR needs to push it over the finish line.

Disclosures: Long NRF at the time of this writing.

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REIT Wrecks | High Yield REITs and Commercial Real Estate

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Direxion's New REIT ETF Posts 168% Gain In Six Months

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Mortgage REIT Annaly Downgraded by Piper Jaffray

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Dynex Looks Like a Mortgage REIT That's Built to Last

Hotel REITs Default and Deflate - Can Shareholders Benefit?

Mortgage REIT IPOs: There is Vibrant Life After Death in CRE Debt

Billions, Literally, Chasing Distressed Commercial Real Estate

Mauldin Says Deflation Is Coming: Why He Is Wrong, Stuck "Inside the Box" & Hopelessly Conflicted

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Real Estate as an Inflation Hedge? Don't Bet On It

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REITs Queuing Up To TALF Trough By the Dozen; Debt is the New Equity

Iran

Maguire (MPG) Sells Orange County Property at 40% Discount to Cost

How to Make A Fortune with REITs in 2010

REITs Quietly Sell Stock Overnight at a Discount; Next Day Pop Fries Shorts