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How Long Can Commercial Real Estate Remain Irrational?


No rebound is forthcoming. Here's why.

Dear Professor Zucchi,

I know this is probably a redundant question, but when do you think reality will realign itself and the Proshares Ultrashort Real Estate (SRS) show some upward spunk?I read your article, Commercial Real Estate Comeback: Comfort for the Bears and wondered if it's difficult to wait out the commercial real estate euphoria that keeps pushing the index higher.

Minyan Tim

Dear Minyan Tim ,

Unfortunately, I have very little to add about what's happening to Commercial Real Estate (CRE). In the last couple of months, I laid out in fair details the fundamental and structural reasons why CRE is on the edge of the abyss in the article you mentioned, as well as in Commercial Real Estate Comeback? and Ten Reasons Commercial Real Estate Won't Rebound. It seemed every time I published something, buyers of the iShares Dow Jones Real Estate (IYR) lined up to hose me.

I've yet to hear a cogent argument or see a set of facts refuting my take on where CRE is heading. And just yesterday, the CEO of Starwood Capital was fairly candid in his outlook for CRE. As I write this, Boston Properties (BXP) is shopping a $550 million secondary for "general corporate purposes and to repay debt." The amount is curiously similar to Boston Properties' 2010 secured-debt maturities of $565 million. So BXP is diluting shareholders some 9% to pay off next year's mortgages.

Meanwhile, cash flows are shrinking, interest rates are rising, rental rates are falling (hard), and values are tanking. There's no way on earth the Boston Properties of the world can justify their market-equity value, but dollars to donuts that those who can get a piece of the secondary (full disclosure: I have a bid in for an allotment) will likely be able to flip it for a profit. That's just what's happening, and it makes no sense arguing about it.

Since from your email, it sounds like you're on the short side of CRE via the SRS, I'll point you to my previous articles and my concerns about the SRS as a buy-and-hold vehicle. And while as a rule, I shy away from talking up my writings, I'd urge all hurting bears out there to read Fool Me Once... - a stream-of-consciousness piece I wrote after getting my ass handed to me by the homebuilders back in 2005. I was as right as the day is long about everything concerning the housing market - and I got pasted in the process.

Let me be absolutely clear: By all objective measures, the idea of being short CRE has moved so much against me since I began writing about it that it qualifies me as having been totally wrong. What I learned from my earlier debacle was to manage my positions so I can remain solvent longer than the CRE market can stay irrational. In 2005, it almost seemed like Mr. Market waited for my "towel toss" before turning its anger on the Beazer (BZH), Standard Pacific (SPF), Hovnanian (HOV) and Toll Brothers (TOL) of the world. The rest, as they say, is history. The parallels between the homebuilders then and CRE today are striking, and this time around, I'm going to make sure to be there when the trade finally hits.

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Positions in IYR, SRS
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