The Wall Street Journal-20080126-The Buzz -- MarketWatch Weekend Investor- REITs Point to Further Decline In Commercial-Property Values
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The Buzz -- MarketWatch Weekend Investor: REITs Point to Further Decline In Commercial-Property Values
Memo to buyers of commercial real estate who might have cash burning holes in their pockets: Sit tight.
Prices of properties are going lower -- probably a lot lower than you think.
Don't take my word for it. The proof can be found in the shares of real-estate investment trusts, which have a remarkable track record when it comes to predicting what will happen to the prices of commercial real estate. "The public market is saying the drop is going to be dramatic," says Mike Kirby, chairman and research chief for Green Street Advisors, which specializes in REITs.
Mr. Kirby's observation reflects a natural tension between the public-market and private-market values of commercial real estate -- a tension that not all real-estate players either know or care about or believe.
Commercial-real-estate prices across the country, feeling a spillover effect from the residential-credit calamity, are believed to be down 5% from last year's highs. At real-estate conferences these days, Mr. Kirby says he hears people saying values will maybe fall "another 5% but will clear up and we'll be fine."
What they don't realize, he says, is that six months after REITs start trading at premiums or discounts to their net assets or underlying values, commercial real estate typically turns in robust or dismal returns over the subsequent 12 months.
According to Green Street, REITs in general already are trading at 14% below their underlying asset values. Office REITs are trading at an 18% discount. But perhaps the best illustration of how harsh the situation may be is the 23% discount of SL Green Realty Corp., which Mr. Kirby regards as "one of the best" office REITs, with a focus almost exclusively on New York.
"The market isn't saying that [SL Green Chief Executive Marc] Holliday is stupid," Mr. Kirby says. "It's saying that Manhattan has further to correct."
For current REIT pricing to make sense, Mr. Kirby says, real-estate values need to fall another 15% nationally. The decline would be steeper in New York, he says, with a total drop of 25%.
Mr. Holliday strongly -- no, make that vehemently -- disagrees. While REIT prices may be a leading indicator of real-estate prices nationally, he doesn't believe they are in New York City, where he says the market at times still appears to be "frothy." New York, he says, "has its own set of dynamics that seem to hold up better in times of distress."
However, just as housing prices fall when a neighborhood is hit by foreclosures, commercial real estate can be revalued downward if financially strapped developers are forced to bail out at fire-sale- like prices.
Along those lines, all eyes in New York are on Harry Macklowe, owner of the General Motors building, who is believed to be scrambling to refinance more than $6 billion in debt by early next month. The situation in New York is in so much flux that commercial-real-estate adviser Lawrence Russo, of Russo Capital in New York, says flatly, "New York City commercial values already have fallen 20% from their peaks."
Much of the decline, or perceived decline, is tied to the near- equivalent of a freeze on commercial-real-estate lending. If the situation isn't resolved soon, Mr. Russo says, it is "uncertain if prices will stabilize here." Until then, he says, all bets are off.
The last time REIT readings were this gloomy was just before the multiyear real-estate recession in the early 1990s. While the overall environment is different from what it was then, when there had been a flood of new construction in places like New York, the pricing of REITs tell a different story.
The good news for REIT investors, Mr. Kirby says, is that real- estate declines already are "baked into REIT pricing." REITs, he adds, are now "on the cheap side" of being fairly valued.
That hasn't gone unnoticed by SL Green's Mr. Holliday, who told investors recently that "nobody is more focused on rebuilding our stock price" than he and his team.
But investors in any REIT, Mr. Kirby says, will need patience and a strong stomach because they are likely to see "negative headline after negative headline" if real-estate prices fall.
In the end, either REITs are too cheap or real estate is too expensive. History isn't on real estate's side.
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Herb Greenberg, MarketWatch senior columnist, doesn't own stocks except his employer's -- nor sell individual stocks short or invest in hedge funds. MarketWatch is a unit of Wall Street Journal publisher Dow Jones. Email [email protected].
