Last Saturday I posted some thoughts on investing, NY real estate, and my macro outlook - Boo!!! Will Halloween Scare the Market into Respecting the Fundamentals?, and I will continue that rant today since it leads into my most recent endeavors - gathering shorts and puts in the commercial REIT space again. These positions were very lucrative in 2008 and the first quarter of 2009. Be aware that they are like private equity investments and take time to develop. My first bear positions were in 2007 (residential homebuilders and mall owners). It took about a year and a half to come to fruition, but threw off a blended return of about 400% - Mostly from GGP going bankrupt after I loaded up with puts and shorts at around $60. Well worth the wait in my opinion. Examples of the research that powered this and other related gains are available at the end of this article for those of you who are not familiar with my work.
The recent bear rally has driven most of the solvent, semi-solvent and absolutely insolvent CRE stocks up, quite a few approaching 100%, while their macro outlook has deteriorated significantly, along with their fundamentals. Quite a few have actually acted in cahoots with the banks that held their increasingly worthless debt, having issued secondary offerings basically converting the bank holdings of debt that didn't have an icicles chance in the hottest portion of Hell of getting repaid, into worthless toilet paper, heretofore marketed as stock certificates. They have also begun offering this used toilet paper as dividends. That's right, worthless stock issued in lieu of loans that couldn't be paid back are also being issued as dividends to cash flow investors from companies that can't afford cash dividends out of their cash flow. If this isn't the sector screaming for me to come back and short it, I don't know what is.
2010 is the first of a series of heavy CRE debt rollover years, and the CMBS market is close to dead. The insurance companies and pension funds are having their own asset/liability mismatch problems (see "This supports both the HIG research and the recent reinsurer research"), and although they have benefited from the most recent market run, I believe it is just a bear market rally that has pretty much run its course. If I am right, they will be seeing devastation in their portfolios that will make March of this year look like a bull market. The banks aren't lending due to the many issues that I have elaborated on in my other articles, such as:
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 2 - JP Morgan
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 3 - Bank of America
- And the next AIG is... (Public Edition)
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It? Pt 4 - Wells Fargo
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It? Pt 5 - PNC Bank
In addition to a lack of available credit, credit terms are tightening. On top of tightening credit terms is the difficult to overcome issue of many investors that simply overpaid for properties over the last 5 years - producing LTVs in this higher cap rate environment that simply wouldn't get refinanced even if we still had a credit bubble. You see, when you buy a property for $100 million using a loan of $75 million, it is hard to refinance that $75 million loan with collateral that is now worth $60 million. Many CRE investors simply have not wrapped their head around this valuation issue as of yet. I am confident the credit markets will wrap their head around it for them.
If these problems don't sink the ship, the dwindling cash from operations may, for many REITs are literally relying on lease cancellation penalties as recurring income. This is a bad omen. If they can replace the tenants that leave (and in this environment, that is a "if"), it will be at drastically reduced rents. This smashes head-on with the pie-in-the-sky business plans that were proffered to banks and investors in the CRE bubble that promised big rents now, to be rolled into bigger rents later, that will eventually bloom into the biggest rents of all time as the projections of cap rates that approached ZERO marched on.
So, I had my team perform a fresh, new scan of RE investors with no limitations except minimal capitalization (some very weak companies are so thinly traded it is hard to get in and out of the positions), minimum share price and, of course, being a public traded company.
We came up with a lost less candidates this time around than we did in 2007 and 2008. On balance, the opportunity is just about as good how as it was back then though, thanks to the Bernanke put option that caused the market to bounce nearly 100% on top of deteriorating fundamentals. The initial shortlist came down to 59 companies, out of which we handpicked 11, and reduced that group to two after studying the filings and footnotes. Both of these companies will run out of money in 2010 sans some miraculous financing event. Even if that miracle does occur (you do believe in miracles, don't you), it would most likely occur via a significantly shareholder destroying, event. Dividends and capex will have to be cut, and/or properties will have to be sold on a distressed basis. Do you guys remember when I made the same claim about GGP and they attempted to attack me because of it? Well, GGP filed for bankruptcy after swearing in their press releases and conference calls that any mention of the words "bankruptcy", distressed sales or "foreclosure" was heresy. Here is the chronology:
- GGP: Foreclosure vs Asset Sale
- GGP Refinancing Sensitvity Analysis
- GGP part 7 - Share value under the foreclosure analysis
- GGP part 8 - The Final Anaysis: fire sale of prime properties
- For those who were wondering what sparked that silly press release from GGP...
- My Response to the GGP Press Release, which seems to respond to blogs...
- General Growth Properties Files for Bankruptcy - DealBook Blog ...
This is simple cash flow and valuation math. It can be done with a calculator. There are many CRE companies that are at risk of doing the GGP! I will release research on the first one for subscribers next week, and the next company the following week. Currently, we are in the process of valuing each property, both consolidated properties and those in unconsolidated JVs as well as off balance sheet debt and contingent liabilities, of the respective companies' portfolios and rolling them up into our entity models.
Of course, CNBC, that bastion of investigative fundamental analysis, offers a counter-opinion:
The prices of investment-grade commercial real estate rose more than 4 percent in the third quarter, possibly signaling an end to the sector's year-long downward spiral, according to an leading property index released Tuesday.
Relevant and Sample Research
Research samples on companies in various sectors from food processors to insurance companies to investment banks and industrials/manufacturing - free to download. I dare you to compare this to what you get from your local brokerage house: Research_Samples 11/17/2008 for examples). Show it to them and tell them you got it from a blog! I would like all retail and institutional investors to think long and hard about what you are getting for your commission dollars at the big sell side banks. As times get harder, their already conflicted analysts are being pared back even more!
Relevant Real Estate Research: There is the venerable "GGP and the type of investigative analysis you will not get from your brokerage house" and my work on dated Macerich (subscriber only):
- March Real Estate Sector Intelligence Note 2009-10-22 01:47:20 143.74 Kb
- Macerich Summary 2009-10-22 01:44:45 910.94 Kb
- Macerich Statistics Spreadsheet - Pro 2009-10-22 01:47:00 356.00 Kb
- Macerich Sensitivity Analyis - Pro 2009-10-22 01:46:36 344.92 Kb
- Macerich Forensic Valuation - Retail 2009-10-22 01:46:14 192.71 Kb
- Macerich Forensic Valuation - Professional 2009-10-22 01:45:52 344.92 Kb
- MAC Intelligence Note - 1Q09 Earnings 2009-10-22 01:45:34 307.68 Kb
On the residential builder side there was (these are free to download for non-subscribers):
- Lennar Forensic Analysis and Valuation update - 2/2009 2009-02-23 09:12:53 485.65 Kb
- Voodoo, Zombies, Lennar's Off Balance Sheet Accounting and Other Things of Mystery & Myth
- Lennar Insolvent: Enron redux???
- Lennar, Voodoo & the Year of the Living Dead!
- Now, a "Realistic" View of Lennar's Solvency
- Bubble, Banks and Builders
- Even as the corporate management, the treasury secretary, the Fed Chairman and the sell side called a bottom in 2007, 2008, and even now in 2009 (sound familiar) - see Bubbles, Bank, & Builders - Pt IV: I can't believe this guy and Again, I say, Credibility is the key, Mr. Hovnanian.