As Banks Struggle, Fewer Worries for REITs

As commercial and investment bankers covered their eyes over the weekend, real estate investment trust executives were likely looking for opportunities. “If you are an illiquid, non-transparent and highly leveraged commercial real estate owner right now, you are in deep trouble,” Brad Case (pictured), vice president of research and industry information with the Washington, D.C.-based National Association of Real Estate Investment Trusts (NAREIT), told CPN. “REITs are none of these.” According to Case, the REIT industry on average maintains about 40 percent leverage. At that level, if credit is available, they can borrow. If credit is not available, they can issue stock and raise equity. “After hitting bottom in February, REIT stocks have risen 7 percent,” continued Case. “I don’t see anything that happened over the weekend that changes that. This weekend’s events will affect REITs with exposure to the New York Office market because there will be a lot of job losses in the financial industry, but nothing else has really changed for REITs.” In fact, while the Dow Jones average fell by 260 points, around 2.25 percent, this morning, many REITs fell less. At 12:30 P.M., Chicago-based Equity Residential stock stood at 41.95, down 2.1 percent from its 42.85 opening number. Likewise, Simon Property Group, the giant Indianapolis based retail REIT, has lost just 1.1 percent, of its value falling just over 1 point from its 98.05 opening. Denver-based ProLogis, an industrial REIT, was down less than a half point from its 43.69 start. Boston Properties with its sizeable New York City office holdings was down 6.62 percent for the morning, from 103.15 at the start of the session to 96.96 at 12:30 P.M. Vornado and SL Green, both with large New York City office portfolios, were down between 6 percent and 7 percent in morning trading. This morning’s chaotic stock market may have calmed at least in part thanks to liquidity support arranged by the Federal Reserve Board over the weekend. “In close collaboration with the Treasury and the Securities and Exchange Commission, we have been in ongoing discussions with market participants, including through the weekend, to identify potential market vulnerabilities in the wake of an unwinding of a major financial institution and to consider appropriate official sector and private sector responses,” said Federal Reserve Board Chairman Ben Bernanke in a prepared statement. “The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets.” “We have been and remain in close contact with other U.S. and international regulators, supervisory authorities, and central banks to monitor and share information on conditions in financial markets and firms around the world,” Chairman Bernanke said. The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities. The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged. These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally. Also, Schedule 2 TSLF auctions will be conducted each week; previously, Schedule 2 auctions had been conducted every two weeks. In addition, the amounts offered under Schedule 2 auctions will be increased to a total of $150 billion, from a total of $125 billion. Amounts offered in Schedule 1 auctions will remain at a total of $50 billion. Thus, the total amount offered in the TSLF program will rise to $200 billion from $175 billion. While regulators shore up the credit markets, the Lehman Brothers’ bankruptcy may produce buying opportunities for REITs. “Lehman Brothers commercial real estate portfolio will be forced into the market, and it will be acquired at a low price that will force other highly leveraged owners to recognize that their property portfolios are not worth what they paid for them,” Case said. That will likely drive commercial property prices down further. Eventually well-capitalized REITs will take advantage of the low prices. Case believes the current property market turmoil resembles the 1987-1990 downturn, despite the fact that the problems of those years began with overbuilding. “It started with overbuilding, but it wiped out financing alternative for commercial property buyers: savings and loan funded limited partnerships,” he said. “But capital was still available in that market in the form of equity. And REITs went through a wave of IPOs, raised equity and started a huge acquisition boom. “REITs were eventually affected by that downturn. They lost 24 percent. But everyone else was affected much more substantially. That’s the situation we’re in now. REITs exposed to New York City will be affected. But others, like Lehman Brothers will be affected a lot more.”