REIT Analyst Report – “Deteriorating Fundamentals” For CRE Through 2012 or 2013
The following are exerpts from a report just issued today by CreditSights‘ REIT analyst Craig Guttenplan titled “REIT 2Q Fundamentals: Protracted Pain Despite Gain.”
From the report (emphasis mine):
Commercial real estate (CRE) fundamentals for the core domestic property types continued their downward progression during the second quarter. Vacancy rates rose and market rents declined on a national level across-the-board in retail, office, and multifamily as continuing job losses and other negative economic news weighed on both consumer and business sentiment. While this no doubt is negative for the CRE market, it is also not a surprise. CRE fundamentals notoriously lag the economic cycle with their severity and timing driven by how bad the downturn is and how long it lasts.
And on the effect lease rollover schedules may have on REITs:
Going along with the consensus view for a near term bottoming of the economic downturn in late 2009 or early 2010, we envision an environment of deteriorating fundamentals that persists through sometime in 2012 or 2013. Given this expectation, we looked at the lease expiration schedule for our retail and office universe to see who is most exposed over this time frame. However, we would point out that the longer duration of these lease types (5-15 years) means that many expiring lease rates are not necessarily going to be significantly lower than when they were originally signed and in certain cases there may still be positive marks-to-market. That said, it is clear that significantly positive marks are no longer going to be the norm or there should at least be some moderation of positive marks relative to more recent periods. For those companies whose portfolios are currently fully marked, lower lease rates should impact revenues more immediately than those with still positive embedded marks.
Despite our expectations for a bottoming of CRE fundamentals in 2012 or 2013, we note that rental rates should remain at depressed levels for the subsequent few years relative to the recent boom period as fundamentals slowly strenghten. So even if a company has a small percentage of its leases rolling during 2009 through 2013, market rents in 2014 and 2015 will likely be lower than market rents in 2006 and 2007 as they recover from their lows. Additionally, while good diversification by most major REITs limits exposure to single tenants, tenant bankruptcies can speed up the lease expiration timetable and force space that was once considered occupied for the longer term back on the market. We note that disclosure around lease expirations can vary by company so our figures are based on what is most readily available in the companies’ quarterly financial supplements.
So rents are going to drop dramatically in the near term (we are well into this trend) and are not expected to recover to 2006/2007 levels for 5 to 6 years.
Again, hat tip to Zero Hedge.
