My Rebuttal to the Return of REITs

REIT CrashOne of the several optimistic headlines that were featured on CNBC's front page today, one in particular stood out to me. The article entitled After Two-Year Slide, REITs Showing Signs of Recovery perked my interest, considering that I work mostly within the Real Estate market, and know the industry from first hand experience. This is just one of several articles that I believe are written by inexperienced online writers, who maybe put two data points together to come to a certain conclusion, only to then post the article on the front page of one of the most read and influential financial sites on the web. Being a professional in the industry, I thought I would give my argument to this writer's optimistic write up.

The commercial real estate market is heading into, probably, one of the worst downturns we have ever seen. Many of my associates are those that have been very active in the real estate market since the 60's, and all of those all-timers agree that this is, by far, the worst condition they have seen the real estate market since they've been in the business. Why it may not necessarily seem that way, at this time, to people who are not in the business, the current problems that landlords are faced with, are looking to last for years down the road and is also looking to take down thousands of properties to bankruptcy.

The above article made the argument that many of the REITs have become oversold, since many of the REIT's stock price have been falling since the end of 2006. However, what many of these non-real estate professionals are missing, is that the REIT's stock price, just as was the case for actual real estate market, were much too inflated to begin with. Properties were doubling in months, due to the massive compression of interest rates, which in turned brought down CAP rates to record lows. All you need was a million dollars and you could turn it into two in a matter of months. Many had little, if any, experience and the appreciation of the market as a whole was an illusion based on the little money down needed, and the extremely low cost of borrowing for large loans. So as investors thought it was actual demand that was increasing in the industry, it was a mirage constructed by the banks, which is what we are seeing crash as we speak. This huge balloon in the real estate market was directly factored in to the huge gains in many commerical REITs stock price.

Considering that the lending markets pretty much came to a halt in 2008, this caused for the demand for properties to almost completely go away. Not only that, but due to the deepening recessions, tenants began seeing their profits get cut in half, which forced many mom and pop (and even several national tenants) to go under. Unfortunately, many of these highly leveraged, low interest rate loans were only offered for a 5-10 year term, which causes for many of these loans to be coming due in the next 2-5 years. There, currently exists a very large gap in loans coming due compared to what is available by the banks that should cause a whole new set of problems for many of these lending institutions. It is this reason, we have seen the value for many commercial properties get cut in half in only a year (especially in secondary and tertiary markets). The reason why this is real scary, is because we are just in the beginning phase of it.

Many landlords are hanging on by reserves, as others are getting one or two year loan extensions by certain banks. However, a bottom is not expected in the commercial real estate market until, earliest, end of 2010, so it will be survival of the fittest. Currently, the market is at a full stand still, with a huge gap between the buyer's and seller's price. I don't see this gap fully closing until the entrance of the banks in selling off "bad bank" assets (essentially the RTC) to set the new comparable standards for sellers. We are still quite distant from that time as banks are still trying to resolve residential problems.

We saw what the fate was for GGP (bankruptcy), a REIT mostly focused on retail shopping centers. I do not rule out any REITs, at this point, that are not vulnerable to bankruptcy. In past real estate recessions, we saw SEVERAL false bottoms, which caused even more pains for landlords and two or three rounds of foreclosures. If such things were seen in recessions of past, we can only expect them to exist currently, but only worse. We have, in past times, seen inflated interest rates, sharp declines in property values, difficult credit markets, slow retail sales, and dilution of the dollar. However, never have we seen this storm combine at once, with a global recession, to the degree that it has at this point.

So, I strongly disagree with the above article and continue to believe that we are far from seeing the bottom of this crisis. Yes, the market did end up a bit today, but trading remained relatively flat throughout the day and financials and REITs struggled. Volume remains considerably low, as I feel many bears have been spooked of recent manipulation, and there just aren't many people buying (outside of the government). Auto sales were horrible and even though pending home sales were up, there was a 17% drop in home values, which I continue to stress is the important number to look at. I remain bearish and I still see a sharp downturn in the near future, which should yield some strong profits in my account. I believe unemployment should be an eye opener for many optimists believing that the worst is behind us. Time will tell. Happy Trading.

PS - In today's premium podcast (subscribe here), I discuss some of the moving trends I am following (which have an almost flawless track record) that are showing some interesting movements and indicators. These have been very reliable in times past.


  1. Doug Says:

    Hey FF and others, check out john stewart's segment of GM showing rightnow. I'm sure you can find it online. Pretty funny segment, although in reality not really. If people see Obama's plan to give GM another $30bil, so we get 60% stake in a company $90bil in debt as a good idea, I'm moving to China.

  2. Finance Fanatic Says:

    I couldn't agree with you more Doug. The government is only digging a deeper whole, and they're using us to dig.

  3. denis Says:

    great post, keep it up!

  4. Wow! That was a funny read Says:

    This article is pretty humorous on a couple of different levels. I've thoroughly enjoyed my REIT stocks over the last several months.

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