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Commercial Real Estate: Comfort for the Bears


CDS curves show widening gulf between stock prices and reality.

As Commercial Real Estate (CRE) bears suffer through the ongoing disconnect between delusion (stock prices) and reality (CRE fundies are imploding), here are a couple of charts that may give Boo some comfort.

First, you can see the 5-year credit default swaps (CDSs) of 3 of the highest quality REITs: Vornado (VNO), Boston Properties (BXP), and Simon Property Group (SPG).

Click to enlarge

As you can tell, the 60-80% rally the stocks have enjoyed has coincided with a similar shrinkage in the CDS spreads. What should give Hoofy some pause, is that during the 20% or so retracement of the last week, the CDSs have also widened out. Intuitively, bulls wouldn't mind seeing a pull-back in stock prices as long as the credit area was able to hold its gains.

More interesting, and far more daunting for Hoofy, is the persisting shape of the term structure of the CDSs - i.e., the CDS spreads for different maturities.

Click to enlarge

In a healthy environment, bulls would want to see spreads for near-term maturities lower than spreads for longer-dated maturities. This would suggest that the increase in the bonds' default risks are simply a function of time, rather than the health of the company/industry - much like longer-term bonds usually command higher rates than shorter maturities, just because the longer one has to wait, the greater the time uncertainty.

In the REITs case however, the CDSs' curves have remained remarkably inverted. This is a strong indication by credit players that there remain fundamental company/industry risks that front-load the risks of default in the near term. The more inverted the curve, the more these players question the viability of the underlying debt.

I remain short the iShares DJ Real Estate (IYR) and continue trading the ProShares UltraShort Real Estate (SRS) from the long side.
Positions in IYR, SRS
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