REIT Power Likely to Increase in 2010

Real Estate Investment Trusts (REITs) are a form of ownership which have been around for quite a while but really began going public in earnest to delever their balance sheets in the early 1990s. And thrive they did in the mid to late 1990s. However, their dominance was somewhat muted in our most recent bull market in the mid- 2000s. I would like to share a perspective with you that I think is very interesting. REITs have the potential to become an even more dominant force in our investment sales market beyond where they are today. Let’s take a look at why this could be the case.

Let’s consider current market conditions. The speed of deterioration in loan performance is unprecedented, even relative to what was experienced during the Savings & Loan crisis in the early 1990s. The total delinquency rate has reached 4.1% recently which reflects an increase of over 350% from the rate at the end of 2008. Deliquency rates are likely to increase substantially over the next two to three years as billions of dollars of pro-forma loans that never reached stabilization mature. Loans which have interest-only periods expiring or interest reserves burning off will fall into this category as well. Additionally, numerous properties are hanging on by a hair only because the mortgage rates are floating over LIBOR, which is minscule today.

In New York City, we had $106 billion of investment property sales in 2005, 2006 and 2007. Based upon loan-to-value ratios available during these years and the reductions in value that we have seen, an extrapolation would indicate that approximately $80 billion of this total or about 6,000 properties have negative equity today. Clearly not all of these properties (or the notes on them) will come to the market as distressed assets as many owners have the ability to service the debt and want to own the assets for the long term. Notwithstanding this fact, a substantial percentage of these properties will come to the market needing to be sold.

Refinancing requirements will add to stresses in the market and will prove challenging, particularly for larger loans which are not generally available from community banks and regional banks due to their magnitude.  They will also be challenging due to reductions in value and more conservative LTVs which will exacerbate the massive deleveraging that the market must go through. It has been projected that well over $2 trillion in commercial mortgages will be maturing between now and 2013.  Much of this financing was delivered to the market by banks, life companies and CMBS intermediaries.

The CMBS market has evaporated. In 2007, there were $230 billion of issuance and in 2008, this number dwindled to just $12 billion (all of which was in the first half of the year). Since July of 2008, there have been no new issuances. A disturbing fact is that even if the banking and insurance industries were operating at full throttle, they do not have the capacity to meet the refinancing demand. Access to public capital is crucial. Enter the REITs.

Not surprisingly, REITs have been negatively affected by current market fundamentals, as all sectors have.  The Dow Jones Equity and REIT Total Return Index, which tracks 113 stocks, had posted a negative return of approximately 68% from its peak in February of 2007. While the Index has improved, it is still well below peak levels and REIT stocks are trading at double digit percentages below net asset value (net asset value was nearly impossible to determine 8 months ago and, while it is not much easier today, there are some data points from which to form a reasonable estimate). By contrast, REITs traded at a 25% premium to NAV between 2004 and 2007. Presently, the REIT dividend yield spread to the 10-year Treasury note is approximately 260 basis points, well above the long term average of 118 basis points. They are also trading at approximately 325 basis points below their long-term average FFO multiple of 12.8x. These facts should help REITs facilitate capital raising efforts.

REITs own a significant portion of the better quality properties in the United States. They currently have access to over $30 billion in credit lines and have generated in excess of $5 billion of liquidity since mid-2008 via dozens of dividend reductions, eliminations and in-kind payments. Most importantly, REITs have access to the public capital which was regularly accessed via the CMBS market. Several well capitalized REITs have successfully raised capital recently, an extremely positive sign in a market sorely missing them.

Fortunately for the sector, relative to other professional commercial real estate investors, REITs were among the least active buyers as cap rates declined significantly between 2005 and 2007. REITs were the purchasers of only about 11% of investment properties during these years. During this same period, private equity funds and private owners acquired in excess of 55% of the investment properties sold. Therefore, a number of REITs should be well positioned to acquire assets from these entities at significantly more attractive prices as these over-leveraged properties and owners become distressed. Surely, some REITs will face challenging times and may need to be folded into other entities. The well capitalized players should be in great shape.

Access to public capital and large stockpiles of dry powder should make REITs even more powerful as we try to manuever our way out of current market conditions. We clearly have a long way to go to get through this cycle. As we emerge, look for the well capitalized REITs to lead the way, particularly if CMBS fails to make a tangible comeback.

9 Responses to “REIT Power Likely to Increase in 2010”

  1. 1 Carl Todd August 18, 2009 at 12:20 pm


    The advantages of owner REIT stocks over direct property ownership gives the small investor an easy liquid way to invest in various segments of the R. E. market without the hassle and time consumption of direct property management. The UP-REIT is a good way for small property owners to tax free consolidate their property holdings into a more liquid type of holding assets and their stock can then even be exchanged tax free with a larger REIT giving them a more diversified and more liquid asset.

    What I do not like about REITs is the lack of property specific details in their portfolios such as the building’s addresses, I.Es, tenant lists and lease data and rent payment history (promptly, late or in arrears). The heart of the REIT is the property portfolio. Using the stock market analogy the heart of the hedge funds was their portfolio and the contents thereof was never divulge to the buyers of the hedge fund stock. We all witnessed the result of that lack of transparency. I still believe honest transparency and easily available complete assesset and management information is a must so that the true risk of the investment in that enterprise can be evaluated buy the investors therein.

    There is no doubt that technological changes have and will continue to change the nature of use and demand for existing a new buildings and a sharp REIT management team offers the investor a level of expertise that most small property owners lack.

    As a 94 year old client said to me – “Wake me up after every new innovation and/or product is made and then again after 100 years”

    I’m with him on that one as the most interesting facet about being a RE professional is that every human activity takes place on or in real estate and it is our industry that supplies and services that commodity.

  2. 2 rknakal August 18, 2009 at 2:31 pm

    Hi Carl, thanks for your post. You make some very good points here. Economies of scale become more important as markets become more competitive. That is an additional benefit of running a substantial portfolio.

  3. 3 Tom Silva August 20, 2009 at 3:07 pm

    Excellent post. 35 REITs have raised $11 billion. They will become serious opportunity players in the distressed side of the business. They also do well during a capital crunch. 46% of lenders say they wont be lending this year making REITs hard to beat in terms of liquidity.

  4. 4 rknakal August 20, 2009 at 3:41 pm

    Hi Tom, thanks for your post. The stats you mentioned are very interesting and the access to public capital will certainly create a tremendous competitive advantage for the REITS.

  5. 5 Carl Todd August 21, 2009 at 1:20 pm

    Scale is not always beneficial especially when you run into the law of diminishing returns. There is a limit to how much the final decision maker can handle. A close friend of mine who retired from Bell Labs when it was in at the peak of it’s prime said that they did an extensive study of the creative/decision making capacity of their top performers daily ability to function at their required best and guess what – it turned out to be only 4 hours a day.

    A perfect example how excess size exceeded the law of diminishing returns was the collapse of Citibank – too large to manage.

    Jack Walsh’s philosophy was it was better to be #1 in a few areas than an also player in a large number.

    On the other side of the coin we have the classic definition of a specialist: “Someone who knows more about less and less till he knows all about nothing”.

    Knowing when to say no is a sign of professional maturity if saying yes will exceed your energy capacity from being #1 on what ever assignments you are involved with. The secret of professional and personal life is one word: “Balance”

  6. 6 Andrew January 16, 2010 at 2:51 pm

    Great read! What is your contact info – email? Thanks!

  7. 7 rknakal January 17, 2010 at 12:17 pm

    Hi Andrew, I can be reached at or 212-696-2500. Thanks for your post.

  1. 1 debt management the way to go Trackback on September 15, 2009 at 7:00 am
  2. 2 landlord web » ontario rent increase 2010 Trackback on July 24, 2011 at 9:53 am

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