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Friday, January 16, 2009 - Vol. 11, No.
14
Also in this Issue:
A warm good afternoon to you!
It's
9 degrees at our offices in Baltimore, 8 in Kansas city and -15 in the
windy city. They're calling it a "Saskatchewan Screamer," and we're
trying to remember if that was ever the name of a professional wrestler
(if it wasn't, it should've been).
In
yesterday's
A-Letter, we talked about the three attributes necessary to
make a portfolio successful in this kind of market. One of those
attributes was yield...something that's become easier to find as equity
markets take more and more of a beating. But you have to be careful,
because yield isn't always the mark of a high-value investment.
Sometimes it can be the siren's song that lures you - and your
portfolio - onto the rocks.
Doubting Those 16% Yields
On
October 7th, Investment Director Eric Roseman wrote to you about Real
Estate Investment Trusts (REITs), one of investors' favorite asset
classes, "One of the biggest casualties of the global financial crisis
is the big bust now underway in REITs, or real  estate investment trusts.
Until mid-2007, U.S. REITs dominated global investment performance in
the post-2000 tech stock "bubble" era with eye-popping 25% annualized
returns."
If they're new to you,
then think of a REIT as an index fund for real estate. Instead of
holding a bucket of commodities or currencies, REITs - as their name
implies - hold a variety of real estate titles and allow shareholders
to profit from the appreciation of said real estate. And since 2008 was
a bad year for real estate, you can imagine how these trusts are faring
today.
Since peaking in 2008, Real
Estate Investment Trusts have fallen in value by as much as 70%, and
many investors are wondering whether it's time to start picking up the
pieces. And with distributions as high as 16% or more on some
commercial-property-based REITs, it can be a pretty tempting
proposition.
Having already declined
70%, wouldn't you expect that a rebound might be in the works? Not
necessarily...
Commercial Real Estate goes "Subprime"
Most
Commercial Real Estate (CRE) in the U.S. is financed and developed by
large REITs. And conversely, many REITs are dominated by CRE holdings,
so one could say their fates were relatively intertwined. So what's in
store for CRE?
Close watchers of
the mortgage market and insider experts have been warning about
problems in CRE since before the subprime bubble gained critical mass.
And as the subprime mess started to unfold, they continued to warn of
the hazards in CRE loans.
To be
sure, the underwriting standards weren't as lax as they were for
subprime paper, but there are different psychological factors at play
here too. While a homeowner is likely to fight tooth and nail to keep a
roof over their heads, small business owners are more likely to throw
in the towel when they know they're faced with a losing proposition.
Some can set up shop at home, consolidate their operations, or even
just sell off for fear of losing even more - like their house - in such
a terrible marketplace.
 That
we're already seeing a "terrible marketplace," is painfully clear. In
the words of one anonymous web-poster, Q4's retail sales "jumped off a
cliff, hit the ground and started digging." The Baltic Dry-Shipping
Index - an esoteric indicator of the levels of total demand, measuring
the total number of containers shipped overseas - sustained a
horrifying and unprecedented 93% drop this past autumn.
Businesses
& consumers are already starting to gear up for the worst.
Granted, you might not be able to call it "Depression Mentality" just
yet, but "Bubble-based Optimism" is wearing off quickly. As a result,
the CRE sector is rapidly deteriorating.
CoStar
- one of the best sources for information on CRE - is reporting an
alarming rise in the number of CRE loans being moved into "special
servicing." According to CoStar, this is "generally an indication of a
delinquency or failure to pay off a mature loan."
Looking
at data like this, you can't help but think CRE - and in turn, the
REITs holding Commercial Real Estate - have  still got a ways to go before putting in a bottom. Despite the
fact that they've already taken a serious blow in the last year and
some of the trusts are yielding double-digit dividends, it's likely
still too dangerous to go bottom-fishing.
But
Eric believes there might be some handsome deals for individual
investors on the way there, "The United States can expect more
government auctioned foreclosures in 2009, and that means big bargains
for speculators and investors alike. Banks are desperate to remove
non-performing loans from their clogged portfolio of real estate
deals."
We'll give all this a few
months to unwind and then re-visit it mid-year. Eric believes that the
U.S. REIT sector could lead the rest to recovery. It's also possible
that real estate could lead market recovery in general. If that's the
case, then REITs could offer a windfall opportunity to cash in on a
recovery, or even just a short-term bounce. Just not yet.
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