Tuesday, 19 February 2008 00:00

REITs are the most expensive they have ever been, and CMBS are time bombs waiting to implode

You know they say, a picture is worth a thousand words...

image002.png

The skinny black line represents the value (spread between price and yield, unadjusted for inflation) in investing in REITS over the last 33 some odd years. As you can see, the spread between price and yield went negative about the beginning of '06, right about the time that asking commercial rents dipped below existing commercial rents that had just shot through the membrane of a bubble. Is it a coincidence? I don't believe in coincidences! The last 24 months has seen REITs the most expensive they have been in over 30 years!

That first bright yellow line you see are the implied cap rates of these gems. Too close to, if not below, the risk free rate. These guys are far from risk free. Looking at the first chart, try to figure out the risk premia recieved over treasuries historically. We are far from that.

Now, the second yellow line is what I see as either distressed sales or defaults coming up this fiscal year.

VNO
Boston Properties
Equity Residential
Simon Property
General Growth Properties
Alexander’s Inc
Equity Lifestyle Property
Maguire Properties
Parkway Properties
Avg.
Cap Rate (FFO / Fixed Assets) adj. for dep.
5.3% 5.5% 4.1% 5.7% 3.4% 3.6% 4.9% 0.4% 4.0% 4.1%

Debt position
2007 0% 0% 0% 5% 4% 0% 2% 0% 0% 1.2%
2008-2009 9% 15% 15% 15% 25% 8% 18% 14% 11% 14.3%
2010-2012 50% 30% 36% 46% 58% 26% 24% 9% 49% 36.5%
2012 -and beyond 40% 56% 49% 34% 13% 67% 58% 77% 40% 48.0%
Total debt/ Investment in real estate adj. for dep. 67.4% 53.6% 51.9% 70.5% 90.4% 134.9% 87.2% 92.1% 59.2% 78.6%
Total debt / Shareholders Equity 163.1% 127.1% 175.4% 374.1% 1594.3% 1030.7% 2339.1% 1399.1% 178.1% 820.1%
Net debt/ Investment in real estate 63.0% 38.9% 51.6% 68.5% 90.2% 67.4% 86.9% 88.9% 58.4% 68.2%
Net debt / Shareholders Equity 152.3% 92.2% 174.5% 363.2% 1591.1% 514.8% 2331.0% 1350.3% 175.9% 749.5%

52 Week High 136.6 133.0 56.4 124.0 67.4 471.0 59.7 43.2 57.9
52 Week low 77.4 79.9 31.1 74.8 31.0 308.3 39.7 22.0 31.0
- Price as % of 52 week high 62% 64% 65% 67% 52% 73% 76% 56% 61%

Price Performance (Absolute)
1 months 11% 7% 11% 14% 4% -1% 9% -11% 10% 6.0%
3 months -11% -7% -1% -4% -22% -8% -2% -14% -12% -8.8%
12 months -25% -24% -30% -17% -35% -22% -22% -42% -37% -28.3%
Price Performance (Relative to SPX)
1 months 17% 13% 17% 20% 10% 5% 15% -4% 16%
3 months -2% 2% 8% 5% -14% 1% 7% -5% -4%
12 months -18% -17% -23% -10% -28% -14% -15% -35% -29%

It appears as if someone was studying thier charts (fundamental, not technical) becaue the AAA spreads are going through the roof!

The A, BBB, and BIG spreads are even uglier, much uglier. So where does that leave BSC, MS, AGO, MBI, and ABK as well as all of those other CMBS structured product mavens (LEH has been giving commercial loans up tll last quarter or so)? I'll let you come to your own conclusions.

Last modified on Tuesday, 19 February 2008 00:00

3 comments

  • Comment Link Reggie Middleton Thursday, 13 March 2008 11:18 posted by Reggie Middleton

    You need to add back depeciation and certain amortizations when calculating REIT numbers in order to compare them to other companies on a P and E basis, but otherwise you pretty much see it the way I do.

    Not all REITS are in the same boat, but enough are.

    Report
  • Comment Link Mark Edmunds Thursday, 13 March 2008 11:12 posted by Mark Edmunds

    As indicated by the attached link, it looks like Goldman is about a month behind you. It probably would have taken 3-6 months if you had not made your position public.

    The REITs seem like all-too-simple short candidates, as easy as 1-2-3.

    1. Current margins (after debt service) are basically hovering around 0%.
    2. All indications are that rents will decline, and debt maintenance costs will increase, thus making margins negative.
    3. Current valuations (multiples of current revenues) imply expectations that revenues and/or margins will increase.

    When all these pieces are put together, valuations half of current levels seem reasonable assuming no major correction in commercial real estate. A major correction could bankrupt some of the REITs. This seems too easy and is outside my area of expertise so I need to ask: am I missing something?

    http://biz.yahoo.com/ap/080311/reits_ahead_of_the_bell.html?.v=1

    Report
  • Comment Link Mark Edmunds Monday, 25 February 2008 17:30 posted by Mark Edmunds

    I am not a real estate expert by any stretch, but your blog has gotten me interested. To my ignorant eyes, some of the valuation metrics seem insane. For example, the ratio of debt to shareholders equity of 23 for ELS, and debt coming due in 08-09 is four times shareholders equity (not shown in your chart but calculated based on numbers in the chart).

    In addition, I cannot make any rational sense out of some valuation metrics when comparing REITs with builders. For example, the ratio of Lennar's share price to sales is around 30% as compared with 270% for ELS. ELS's revenues have more of an annuity-like nature as compared with the builders, which means that any real estate market pain will not show up in reported earnings as quickly, but it seems like the ultimate damage should be similar. Do you agree? Can you provide a logical explanation for the valuation differences?

    Are property valuations on REIT's balance sheets more conservative than the builders? My (admittedly ignorant) guess is that both carry real estate at some cost-based accounting valuation (e.g., cost less depreciation). For the REITs, the real estate is held for longer, which means the cost basis is likely to be lower, whereas the real estate owned by the builders has been predominantly purchased over the past few years, when real estate values have been most inflated. Perhaps some of this has to do with tax advantages of being a REIT or the fact that REITs hold more commercial real estate.

    Report
Login to post comments