Behind the Rebound in Commercial REITs

Inquiring minds are upon a Reuters article on the rebound in commercial REITs as the U.S. commercial real estate market so far has averted the catastrophe that many strategists were predicting last year.

Vacancies for apartment buildings, office complexes, retail malls, and self-storage facilities are no longer rising meaningfully, rents are no longer falling, and many real estate investment trusts, the main vehicle for individual investors to participate in the sector, continue to reduce their debt loads.

So, what’s up?

At lunch yesterday with the CEO of one of the largest commercial real estate companies in the country, he told me this exact belief in using his own companies examples. Their recent purchases have used exactly this strategy. With one caveat:

He said that many of his companies purchases were because of tax issues coming due at the end of the year and sellers needing to make sure a deal would go through.

But are the commercial real estate firms making the same mistake many have already made in the residential market? That of not taking into account the second foreclosure wave already in process?

Equally striking is how much more confidence investors have put in U.S. mutual funds and exchange-traded funds that focus on real estate assets than they have in equity funds in general. Year-to-date through October, $2.35 billion flowed into U.S. real estate mutual funds and ETFs, while $54.4 billion flowed out of U.S. equity funds and ETFs, according to fund research firm TrimTabs.

However, the popularity of real estate funds is worrisome, says TrimTabs. “When big investment inflows coincide with lots of equity issuance, it is often a sign of trouble ahead,” says a Nov. 4 report from the firm. New equity offerings for REITs already total $2.0 billion in the fourth quarter, putting it on track to be the highest since the second quarter of 2009, TrimTabs warned. Normally, such oversupply would mean stock prices are near a peak, but the Federal Reserve’s encouragement to buy assets could delay a pullback, TrimTabs chief executive Charles Biderman told Bloomberg Businessweek.

Also, one must take into account the dreaded two-humped camel shown above. With another down leg in the residential market, where does this leave the commercial market since, historically, it lags by about 18 months.

In addition, has anyone actually thought of the just ‘who’ is leaving California? See “Companies Fleeing California” This downturn is much different than previous downturns with who is migrating. In prior downturns, it was construction and other blue-collar types who have left the state. Today, it is hi-tech companies that are leaving and taking with them the state’s most treasured workers.

It seems that the professionals are just expecting that the market has always ‘come back’ and aren’t seeing that this is a very different cycle.

Stay tuned. This is not over by a long shot.


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