Why Shorting Commercial Real Estate is a Good Idea

By Forrest Lowell

There is one more shoe to drop before the market can truly move higher in a convincing way. In my view this Shaquille O’Neal sized shoe is the commercial real estate market. The troubles of General Growth Properties (GGP) has been well publicized, but what about the other similarly structured companies? Just as a quick comparison I have included screen shots of General Growth’s and Simon Property Group’s balance sheets. Look at the two balance sheets and tell me which one is trading at 40 cents and which one is trading at $31.50.

General Growth vs. Simon Property Group

Give up? (General Growth is on the right.) Good, now obviously there is more to a company than just the balance sheet as I have argued in the past with General Electric. But the balance sheet is worth looking at and at face value these two balance sheets appear to be predicting the same fate for the companies. General Growth Properties has had several debt payments come and go without paying and is now effectively in bankruptcy to be filed before the first of the month. Simon Property Group, Vornado Realty, and similar companies that have been established a while have been able to better withstand the credit crisis to this point. I argue however that the commercial real estate market is just starting to really accelerate downward. Many retailers stayed open thru Christmas because it is a very profitable period, but now that the reality of the recession has hit the American consumer has started saving instead of spending, retailers will be forced start to take a hard look what outlets to close. I think there are going to be two different but related problems for the commercial real estate markets going forward. First, their cash flow is going to be severely curtailed from their increased vacancy rate and decreased revenue sharing with stores. Second, they will not be able to either refinance existing expensive debt or obtain new credit for expansion during the current financial turmoil. This means their growth going forward will be very limited which should lead to additional multiple contraction.

All commercial real estate companies are not created equal so I don’t advocate picking out one in particular to short, instead you can get short the whole basket of commercial real estate thru various ETF’s including SRS. I view the General Growth troubles as similar to Bear Stearns; they were the first and most widely reported only to be followed into oblivion by many similar companies several quarters down the road. You can argue that GGP is a special case of too much debt too quickly, but regardless, the market runs off of fear these days and a few more smaller collapses I think could bring the whole house down. I do own SRS as downside protection for financial stocks, and this has worked very well over the last few days. SRS was up 15% today with the financials also up, this just reaffirms that the commercial real estate sector is significantly weaker than the market as a whole. Disclaimer.

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