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Commercial Real Estate: Too Late to Be Early

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To repeat again the reasons why positions in CRE should be getting crushed would be utterly disingenuous.

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Russ writes:
"Fil,

For the last couple of years, I've been watching all your articles on Commercial Real Estate and the ProShares UltraShort Real Estate (SRS) ETF with particular interest. I deeply shared the belief with you that it was only a matter of time before commercial real estate literally dropped off the face of the earth, at least in the US. I know several local investors (small mini-malls, office buildings, etc.) all saying the same thing: They're underwater and are getting ready to hand the keys in when the time comes as they won't be able to refinance their 3- and 5-year notes that are coming due. (Granted, I'm in Michigan and this has to be the hardest-hit state for Commercial Real Estate.)

Why isn't any of this translating to Vornado Realty Trust (VNO), Boston Properties (BXP), Simon Property Group (SPG), and any other property-management groups? I keep wanting to get SRS and just sit on it, but every time I think I see an entry point, it ends up being a false alarm. I'm really starting to like some of the charts from a bullish position (Boston Properties appears to have broken resistance); but I know fundamentally that has to be WRONG! Help me again and others like me to discern what's happening in this area."

I can only offer you my deepest sympathies for having been subjected to my articles on commercial real estate over the last couple of years. The last time I got something this wrong was when I got beaten senseless shorting homebuilders in 2005 and 2006. I'd been preaching seemingly forever the impending doom of that sector, and it laughed me into submission. The same is happening with commercial real estate now. To repeat yet again the 1,001 reasons why REITs stocks and other equity positions in CRE should be getting crushed would be utterly disingenuous. All of the fundamentals for a train wreck are still there in spades, but it simply doesn't matter. Readers know that the difference between being early and being wrong is whether one is still involved when the trade hits. That's true -- but to a point. I turned the "early" into a long enough period that all I'm left with is "wrong." I'm not inclined to reassert that shorting the iShares DJ Real Estate (IYR), going long the ProShares UltraShort Real Estate (SRS), or taking dark shots at the Vornado and Boston Properties of the world, will ultimately be a home run. "Ultimately," we're all going to be dead. Perhaps having reached this level of despondency toward this trade will prove to mark the top, but I have no idea.

I'll offer that the underpinnings of what's happening right now in the equity markets as a whole are very similar to those we saw in 2004-2006: a famished hunger for yield from fixed-income assets -- risk and leverage be damned. Whether because of macro shocks, protectionism, or other catalysts that cannot be timed, this credit frenzy will end and the consequences will likely make 2008 and 2009 feel like a walk in the park.

But this isn't a suggestion to start positioning for that day. Fighting liquidity with logic is a losing proposition, and I currently have multiple tire tracks on my back to prove it. Furthermore, there's no better cloak than liquidity to mask the rot of CRE fundamentals. And in hindsight, say what you will about what the government did in response to the financial crisis (and what I'd say has no kind words for it), but one thing is certain: The "relaxation" of fair-value accounting served its intended purpose, which was to allow banks and borrowers -- especially in the commercial real estate setting -- to lie their way out of the insolvency created by their prior lies. As long as the "greater interest" is served by ignoring bad loans on upside-down properties, and by pretending that cash flows will eventually support some kind of value for CRE equity, facts and logic stand no chance.

If my whining sounds like sour grapes, you bet your "arse" it is. But don't interpret my words as a rationalization of where my thinking (or lack thereof) went south. I've been completely and totally wrong on investing and trading CRE equities, and that's that. Whether at some point I'll be proven right on my read of the shape CRE is in, is pretty much irrelevant. The only suggestion I can offer is to religiously ignore anything else I may post on commercial real estate, assuming I were to have the guts to do such a thing.
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Position in IYR, SRS
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