Commercial real estates the next leg down?

With all the fuss about a slowing economy and increasing tighter capital market with QE2 winding down, one would probably start to find cracks in cyclical sectors, sectors that are most vulnerable should the economy slow.

Commercial real estates (CRE) have historically been one of the most sensitive to economic conditions and capital availability. With the Fed's two rounds of quantitative easing, recovering businesses and confidence among investors, CRE has been able to utilize leverage to significantly improve return on investment. Real-estate research firm Green Street Advisors reported that its index of Midtown Manhattan office-building values is up 88% since its mid-2009 nadir, back to within 15% of their 2007 peak. The index is tilted toward better quality buildings.

Stock market noted this sharp rise in valuation. Dow Jones Equity All REIT Index has almost tripled since the market's low on March 9, 2009. CRE big names like Vornado Realty Trust (VNO), Boston Property (BXP), Simon Property (SPG), has each almost quardupled its share value in March 2009. However, hints of caution have crept in these waves of euphoria. Big players may have started their way to take some chips off the table.

According to a recent article from Wall Street Journal, high-profile office buildings in large cities have been put on the sell block, including Willis Tower in Chicago, Constitution Center in Washington, the Seagram Building in New York, to name a few.

In April, the total value of new sales listings of U.S. office buildings was $8.7 billion, according to real-estate research firm Real Capital Analytics. That was the highest level since 2008. Preliminary data for May show $10 billion in new listings, which would be the highest monthly total since late 2007.......................................................................

The sharp rise in values has come over the past year, a relatively short time frame in the real-estate market. Recent deals include the sale of 750 Seventh Ave. in New York's Times Square by Hines Interests for a surprisingly high $485 million and Beacon Capital Partners' sale of Market Square in Washington for a record $905 a square foot........

Beacon also is considering bringing to market 1211 Ave. of the Americas in coming weeks, for which the company would look to retrieve well above the $1.5 billion that it paid in 2006, according to people familiar with the matter. The 45-story property houses the headquarters of News Corp., publisher of The Wall Street Journal.

This rush to sell is likely to result from worries that there will no longer be easy money, namely easy access to financing. Since April, rallies of high yield corporate bonds and commercial real estates debt came to a halt as yields rose, a sign that lenders now require higher risk premium before they provide the financing. In an article of Wall Street Journal,

Some of the selloff can be attributed to a heavy supply of these bonds, both from the Fed and from companies taking advantage of better market conditions since the crisis. Companies issued a record $114 billion worth of junk bonds through June 2, a 27% increase of the same period last year, according to Standard & Poor's Leveraged Commentary & Data.

"The timing couldn't be worse for the market," said Marina Tukhin, head of asset-backed securities trading at Gleacher Descap in New York, referring to the effect of the Fed's auctions on the mortgage market, which she calls "oversaturated" with troubled assets.

Meanwhile, other measures that gauge the ease of obtaining financing or risk attitude, such as TED spread (the difference between LIBOR and treasury securities yield) has remained quite subdued although its current level is much higher than the one in March. Fundamental wise, most REITs are showing growth in net operating income (NOI) and funds from operations (FFO) which measure strengths in CRE companies.

That said, for those who anticipate no more quantitative easing and a slowdown in the eocnomy, gradually building shorts position in REITs into the summer should provide fairly handsome risk/reward profiles.

DDR's Deal Signals Recovery in Credit Market?

Commercial real estate industry has long been  the alleged next leg down for the economy and financial markets. The industry not only has been plagued by defaults, declined occupancy and rent, but also the shut-down of credit market to finance property purchase and development. Since March, the credit market has been gradually easing, as shown by significant drops in credit spread. The recent success in U.S. mall owner Developers Diversified Realty Corp (DDR) in debuting the first Term Asset-Backed Securities (TALF) loan is a further evidence that commercial loan market is back to business. Under TALF, investors apply for low-cost non-recourse loans that are backed by the bond collateral. TALF has cut borrowing costs for consumer auto loans and credit cards.

According to Bloomberg,

DDR's $400 million issue is the first new U.S. commercial mortgage-backed backed security since mid-2008. The $323.5 million AAA-rated portion is expected to sell at a 1.45 to 1.60 percentage point premium to the five-year interest rate swap benchmark, or a yield of about 4.21 percent, IFR reported. Underwriter Goldman Sachs at midday lowered the yield premium from a range of 1.60 to 1.75 points, indicating it was seeing good demand from investors. By comparison, top-rated issues done under relatively conservative underwriting standards in 2004 are selling at premiums in the mid-2 percentage point range, according to Guggenheim Capital Markets.

The deal may signal some relief for the $700 billion commercial mortgage-backed securities market, which became key funding for office, retail and apartment buildings during the real estate boom.

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Disclaimer: This blog is for general information purpose only. Stocks/financial instruments mentioned in this blog are not to be taken as investment advice/recommendation. Readers must consult their own financial advisors and/or consider their own risk/reward profile before making investment/trading decisions. The blog author is not liable for any investment/trading decisions of readers should readers decide to base the decisions on information provided by the blog.

Disclosure: The blog author owns DDR in her personal account as of November 17,2009

Simon: Ready to Shop?

Simon (SPG), the largest U.S. real estate investment trust (REIT) that developed and operated shopping centers shed some lights on better retail atmosphere toward the end of this year.

The people that we’ve been talking to, their inventories are down anywhere from 15% to 22% from last year. So while that is not going to drive top line sales, they are much more optimistic because they have less inventory they have to push out the door, they’re going to be able to be much more disciplined on their pricing and drive a lot more margin improvement and most importantly, cash flow.


......based on talking to the retailers, which David and I are doing a whole lot of everyday that they’re feeling better and we have absolutely seen several instances of retailers that were in here in the second quarter asking for rent relief and modifications and then came back in the third quarter and said, “Looks like, we’re okay.” We don’t need anything. We’re going to make it.

“as I read all of the retail analysts and all of their ratings and their movements virtually all of the retailers are getting upgrades and more positive outlooks based on the expectation that there’s going to be a more profitable Christmas, which may or may not be related to more sales.”

Retailers have started to gain their footing and certain retailers are growing store counts including Aeropostale, Gachi, Apple, the Buckle, California Pizza Kitchen, Fresh, Forever 21, H&M, Michael Kors and Red Robin, to name a few. In a number of predominantly outlet ,tenants are also increasing their store counts. We have a significant amount of leasing volume in our pipeline over 500 deals and 8 million square feet of leases in process across all of our domestic platforms.


In particular, it is good to note the volume of big box activity has significantly increased in the second half of the year. Since mid July we have completed 20 big box deals across the four platforms and discussions are underway on 20 to 30 more retailers will include Forever 21, H&M Dave & Buster’s, Bed Bath & Beyond. We are seeing a slight quality of the big box retailers they want to be in malls, outlets, mills or strip centers where they benefit from shopper quality and traffic.

Preliminary reports from retailers regarding October have been encouraging. We believe our retailers will have a decent holiday season.

Sales Per Square Foot

Occupancy in all of the four platforms was up sequentially from 6/30/09, Mills was up a 150 basis points and Regional Mall and Premium Outlet Centers increased 50 basis point and Community, Center, Lifestyle platforms increased 40 basis points.


Regional Mall retail sales in the third quarter were $430. The decline in sales for September over September was much lower than any month year-to-date. Mall leasing spreads were $4.04 for the first nine months of 2009, average base rent was at 9/30/09 was $40.05, up 2% for the year earlier period.


Premium Outlet comparable sales were relatively stable in the third quarter at $492 per square foot, down only $1 from 6/30/09, and actually were up in September on a comparable sales per square foot. Premium outlet releasing spread continues to be strong at $9.25 per square foot for the first nine months of ‘09. Average base rent for the outlets at 9/30/09 was $32.95 per square foot up from the year earlier period.
 
My Takes
 
SPG's remark on retailers was consistent with most of the "stabilizing" and "getting better" pictures. However, the multi-billion question at this stage is: How much better?
 
 

PLD Sees Light in Commercial Real Estates

Things are getting better
The world's biggest industrial REIT, Prologis (PLD) on Thursday shed some lights on the struggling commercial property market. While many argued that commercial real estate market is the next shoe to drop in the economy, PLD CEO's statement hinted that at least in the industrial area, things are getting better.

"Looking ahead, we see a global market that’s beginning to show signs of stability. Perhaps growth and expansion will come sooner than we thought. We'll see..................

Globally, industrial demand is still soft, but we are seeing signs of increased customer activity. We recently polled our top customers and not surprisingly, about two-thirds of those who we spoke with, expect a more positive outlook on their business by some time in 2010, although many of them felt that it may not occur until later in the year.........................................

Importantly, several of them mentioned supply chain reconfiguration, which sometimes means expansion and sometimes simply a search of greater efficiencies. Either way, it's good for us because there is likely to be movement in the higher-quality, well-located and in many cases, newly-built facilities and that’s our business."

Occupancy increases
The company's core occupancies trended up by 20 basis points in the third quarter, as the overall leasing activity was up 13% from the second quarter. During the quarter, PLD increased the lease percentage in its static 12/31/2008 development portfolio to 61.7%, up substantially from 54.1% in the second quarter and 41.4% at the beginning of the year. As a result, the company has reached the low-end of our 60% to 70% year-end goal for leasing in this portfolio.

"I never thought I would say this in 2009, but it seems like there are more buyers then sellers in the market right now. Market rents are still of course lower than a year ago, and we expect this to remain the case for the foreseeable future. Our rents on lease is turning, we're down 14.7% in Q3, versus down 12.6% in the second quarter...............................................

However, we believe this situation will reverse itself, when market occupancies trend upward, and as we’ve mentioned in our second quarter call, rental rates today make no sense relative to replacement cost, values and will certainly need to rise substantially to justify new developments spurred by any growth in the global economy..........................................

Remember, most markets did not get substantially overbuilt in this downturn and there is no new supply on the Horizon. As a result, we're clearly seeing an increase in request for build-to-suit proposals."

Cap rates decline

"Yields have declined by 75 basis points in the UK, with anecdotal evidence of them declining in other 50 basis points on deals not yet closed.

We’ve also seen a recent 50 to 100 basis points decline in cap rates on our assets dispositions in the US. There is capital on the side lines and we’re seeing evidence of this in the number of solicited offers and unsolicited increase we’re now receiving. "

My Takes
There are a few things that I look at to gauge the progress of commercial real estates (CRE) from going-on-bankruptcy to near-bankruptcy to stabilizing and then to getting better, and eventually to grow:
1. Occupancy
2. Cap rates or the credit market
3. Funds from operations (FFO)

Per the CEO of Prologis, we do get the vibe of "getting better" with occupancy and cap rates although this may just be limited to industrial CRE instead of CRE as a whole according to "Headlines on CRE" . As far as FFO is concerned, the 2009 guidance of PLD is $1.39-1.43 per share, doubled that of 2008 at $0.68 per share but disastrous if compared to the peak period of 2007 that generated $4.61 per share. It is getting better!

By looking at how these metrics evolve over the last 12 months, I do buy the "getting-better" story. How about you?




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Disclaimer: This blog is for general information purpose only. Stocks/financial instruments mentioned in this blog are not to be taken as investment advice/recommendation. Readers must consult their own financial advisors and/or consider their own risk/reward profile before making investment/trading decisions. The blog author is not liable for any investment/trading decisions of readers should readers decide to base the decisions on information provided by the blog.



Disclosure: The blog author does not have positions in PLD in her personal account as of October 23,2009

Headlines on CRE

The weather has never been better in New York City this Fall. Every morning, I put a pot of coffee to brew while watching down at the street. Breezy and nice temperature,men and women briskly hustle and bustle across the concrete jungle  while tourists are strolling down the streets. Always filling the air was the energy (erhh, sometimes pollutants). For a moment , it does seem like there is nothing more poetic than living in this ever so alive city until I open the New York Times (Well, I figure you, like me, feel more nostalgic with that scene than me turning on my PC to read reuters online).

Commercial real estates (CRE) were not short of depressing headlines in Reuters this week.
US apartment vacancy rate hits 23-year high

"It makes me wonder whether the avalanche is on its way for office and retail (real estate) unless things change really quickly and really drastically," Victor Calanog, Reis director of research, said.

Reis still expects the U.S. apartment vacancy rate to pass the 8 percent mark by perhaps next quarter but certainly by next year, Calanog said. That would make it the highest vacancy rate since Reis began tracking the market in 1980.

In the third quarter, the U.S. apartment asking rental rate fell 0.5 percent to $1,035 per month, the fourth consecutive declining quarter. Factoring in months of free rent and other perks landlords have been using to lure or keep tenants, effective rent fell 0.3 percent to $972, also the fourth consecutive quarter of declining rent.

"We have not seen that before," Calanog said............

Reis does not foresee a turnaround in the apartment market until at least the second quarter of 2010 at the earliest..............................

In New York, the largest U.S. apartment market, the vacancy rate fell 0.10 percentage points to 2.9 percent. Effective rent fell 0.9 percent to $2,657 per month.

"With job markets still being lost at the national level and with New York being relatively more dependent on the still-embattled financial services sector, it may take a few more quarters before we see rents bottoming out in the Big Apple," Calanog cautioned.

US office market vacancy rate at five-year high

The national vacancy rate rose 0.6 percentage point to 16.5 percent from the prior quarter and is up 2.3 percentage points from a year earlier, according to a report Reis released on Wednesday.

"The last time we saw vacancies in the mid-16s was at the end of 2004," Victor Calanog, Reis director of research said.......................

Even worse, since the first quarter of 2008 about 106.5 square feet of extra space have piled up, nearly wiping out the 107.9 million square feet that was snatched up during 2006 and 2007.

"So in seven quarters, the current recession has almost undone all additions to occupied space that occurred during the years when office rents peaked," Calanog said................

Asking rent slipped 1 percent from the prior quarter to $28.15 per square foot. That was down 4.3 percent from a year ago, the largest year-over-year decline since 2002.


Factoring months of free rent and other perks, effective rent fell 2.2 percent from the second quarter to $22.91 per square foot and a whopping 8.5 percent from the third quarter of 2008.

"We have to look back to 1995 to observe a similar time period when office property landlords were under such pressure to retain existing tenants or attract new ones," Calanog said.......

New York -- the largest U.S. office market, saw its vacancy rate rise 0.6 percentage point to 11.4 percent. Effective rent fell to $47.16 per square foot, down 4.4 percent. It was the largest quarterly drop Reis recorded since it began tracking the figures in 1999.


Even worse, year-over-year the effective rent in the New York area fell 18.5 percent, just about twice the decline New York saw in 2002 and surpassed only by the 20-plus percent dive in 1983.

The third-quarter vacancy rate at U.S. strip malls, which include local shopping and big-box centers, rose 0.3 percentage points from the second quarter to 10.3 percent, the highest since 1992, Reis said...............

Shopping center vacancy rate hits 17-year high

Asking rent at strip malls slid 0.3 percent from the second quarter to $19.22 per square foot and were down 1.9 percent from the prior year. Asking rents were the lowest since mid 2007.

Factoring in months of free rent and other perks, effective rent fell 0.8 percent from the second quarter to $16.89 per square foot or down 3.8 percent from the third quarter 2008. Rents were the lowest since mid-2007

"Since asking and effective rent growth only turned negative about one year ago, it is daunting to observe this acceleration in decline in what has traditionally been regarded as a stable property type," Calanog said.


Reis expects rising vacancy levels and declining asking and effective rents for neighborhood and community centers through 2011.

"We have yet to observe any unexpected systematic resumption in hiring and strength in consumer spending that may lead us to revise our projections with a more optimistic bent," Calanog said.................

U.S. mall vacancy rate rose 0.2 percentage points to 8.6 percent in the third quarter, the highest vacancy level since Reis began tracking regional malls in the first quarter 2000.

Asking rent at big U.S. malls fell 0.6 percent from the prior quarter to $39.18 per square foot and was down 3.5 percent from a year earlier. It was the fourth straight decline in rents and the largest one-year decline Reis has seen.

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REITs with Positive FFO Growth

Growth is hard to find these days, not to mention one of the most distressed sectors such as real estate. I dug through the estimates of fund from operations (FFO) by National Association of Real Estate Investment Trust  (NREIT) and made a list of reits with estimated positive FFO growth. [Click on the image to enlarge]

Disclaimer: Stocks/financial instruments mentioned in this blog are not to be taken as investment advice/recommendation. Readers must consult their own financial advisors and/or consider their own risk/reward profile before making investment/trading decisions. The blog author is not liable for any investment/trading decisions of readers should readers decide to base the decisions on information provided by the blog.

Disclosure: The blog author owns DDR in her personal account as of October 7,2009

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Real Estate Moguls’ Views on CRE

On Monday, October 5, 2009 Bill Rudin, president of Rudin Management, and Steven Roth, chairman of Vornado Realty Trust, shared their insight and outlook on the real estate market.

“There is not doubt this is a slow motioned recovery that will take longer than most have anticipated, “ said Roth. The bottoming process can probably take 2 years, or longer than that according to Roth

There is a hint of optimism, however.

“In terms of commercial real estates (CRE) in New York, we are seeing activities,” said Rudin. According to Rudin, 12 major leases signed for properties of over 100,000 square feet in the third quarter 2009 compared to a virtually dead market 6 months ago. Among the lessees were CV Starr, Hank Greenberg’s company, Gaps, etc. Obviously, these came at much lower rents, 30-40% off .

Roth acknowledged the drastic reprising in CRE but stressed that the psychology had  improved.

“But the psychology has changed. The brokers and the tenants now feel that we are in a bottom….. signing long term. When the tenants want to go long term, traditionally that is the bottom. We are in the beginning of it, we are at the heart of it ,” stated Roth.

Rudin pointed out there are also “flights to quality . “ You are seeing people moving from 3rd avenue to Park avenue, from other part of the city to 6th avenue…”

Roth also referred to the history. The last cycle which was in the 90s lasted for 18 years, peak to peak,1988 to 2006. The cycle was followed by a period of vicious down drift that typically lasted for 2-3. Roth explained, “2006 is the top, we are now in 2009, there has been a flood of what they call reequitization in the public market…. the public market reequitized. The unsecured debt market has come back and they are roaring back. We just did a $460m deal 10 days ago for 30 year......” According to Roth,the re-equitization is typically the time to do bottom fishing. The base building typically takes 3 to 5 years.

Rudin and Roth also touched a little on the role of TALF plays in CRE. Both of them welcomed the move of the government, especially when TALF was extended from 3-year-loans to 5-year-loans

VNO is in the TALF queue. The company has $2.6 billion.

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REIT and Credit Market

Real estate investment trusts have been one of the outperformers in the stock market rally since March 2009.

The chart of URE, a real estate ETF that consists of mostly commercial REIT versus Standard & Poor 500 Index (S&P500) is self-explanatory.

The same goes for individual REIT such as KFN, CT, DDR, BEE, SPG, CIM, etc. Naysayers have every reason to doubt this bullishness. Think about the sharp increase in delinquency rate, the sharp decline in the occupancy rate and the rent. Think about how desperate the credit market since Lehman collapse. All are solid points and no wonder every other person was talking about commercial real estate would be the next leg down for the economy. But wait a minute. Several indicators have suggested since March that things are getting a lot better in credit markets as we speak. Ted spread measured by the difference between 3-month Treasury bill rate and LIBOR has fallen back to the level of early 2000.

Credit spread measured by the difference between corporate bond yields and 10-year treasury note yield have been narrowed to the level of late 2002 when the last economic recovery began.

Although occupancy rates and rent are expected to be dismal for a while, the credit market has certainly cranked up the REITs. With Public-Private Investment Fund (PPIP) prepared to go into full force by the end of October (four of the nine PPIP funds are funded and ready to go), we have a lot of reasons to believe REITs are the way to go.

Disclaimer: Stocks/financial instruments mentioned in this blog are not to be taken as investment advice/recommendation. Readers must consult their own financial advisors and/or consider their own risk/reward profile before making investment/trading decisions. The blog author  is not liable for any investment/trading decisions of readers should readers decide to base the decisions on information provided by the blog.

Disclosure: The blog author owns DDR, KFN, CT, BEE and URE in her personal account as of September 30,2009.

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