Ignore the Crowd … It's Time to Invest in Commercial Real Estate

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Of all the independent institutional research that I receive, some of my favorite comes from Justin Mamis, a veteran of all the financial wars we've seen over the past five decades.

Although he's steadfastly bearish, no matter the climate – like those codgers you see wearing heavy coats on sunny days in Florida – the Canadian analyst has lasted so long because he's quick with colorful phrases, and his research is amusing and insightful.

Just last week, Mamis recounted a conversation he had enjoyed years ago at the table of his new boss, the legendary analyst/historian/portfolio manager Don Coxe: "At dinner, [Coxe] would lean back in his chair in that professorial manner of his and "remind" the guests that the Sanhedrin, the Hebrew Court of Law, had a rule that if every member voted the same way, the decision went the other way," Mamis wrote. "Unanimity had to be misguided."

That story got me thinking: What is one investment theme that the public and/or pros could agree on today?

Of all the independent institutional research that I receive, some of my favorite comes from Justin Mamis, a veteran of all the financial wars we've seen over the past five decades.

Although he's steadfastly bearish, no matter the climate – like those codgers you see wearing heavy coats on sunny days in Florida – the Canadian analyst has lasted so long because he's quick with colorful phrases, and his research is amusing and insightful.

Just last week, Mamis recounted a conversation he had enjoyed years ago at the table of his new boss, the legendary analyst/historian/portfolio manager Don Coxe: "At dinner, [Coxe] would lean back in his chair in that professorial manner of his and "remind" the guests that the Sanhedrin, the Hebrew Court of Law, had a rule that if every member voted the same way, the decision went the other way," Mamis wrote. "Unanimity had to be misguided."

That story got me thinking: What is one investment theme that the public and/or pros could agree on today?

It's a totally subjective question, meaning everyone will have a different answer. But I figured that would be a great "thought exercise" and came up with three statements I'll bet virtually everyone would agree with. They are:

  • U.S. healthcare reform will fail.
  • The U.S. budget is out of control.
  • China will dominate this century.
  • Commercial real estate is still a disaster waiting to happen worldwide.

The odd thing about that last statement is that – across the board – commercial real estate stocks have been among the strongest performers over the past few months. But it's been a very quiet move, generating little in the way of attention.

Coming off a hellacious decline, these stocks are now enjoying solid uptrends. Although not quite as cheap as they were a year ago, these stocks are still well off their highs, and feature still-low valuations. Add in their expected income streams and it's understandable why these stocks are still the "go-to" choices for a lot of fund managers.

These stocks make a lot of sense. Unlike manufacturers who are dependent on hit products and flaky vendors, most real estate owners have long-term contractual obligations that have offered surprising stability in this tough economy. For instance, take SL Green Realty Corp (NYSE: SLG), the largest owner of office real estate in New York.

As you may have heard, that's a city where a lot of too-big-to-fail financial companies reside.

Since real estate is such a capital-intensive industry, it is battered during the sort of capital famine seen last year. But the credit bull market is enabling companies with good collateral to refinance their debts, a transformation that's helped real estate investment trusts (REITs) to raise more than $17 billion since the start of 2009. The REITs have used this infusion to shore up their balance sheets and to acquire properties from less-adroit owners. As part of its recent earnings reports, SL Green has reported that the government's direct aid to banks has directly it to maintain a high occupancy rate and steady rents.

I talked about this a lot in the summer, and will stick to my guns: There's no reason that REITs like SL Green can't get back to their share-price levels of September 2008 at minimum over the next year or two. For SL Green that would require a return to an $85 share price – a 78% return from Wednesday's closing price of $47.70.

The REITs are not yet back to paying the big dividends for which they used to be loved — which is why oil-and-gas master limited partnerships (MLPs) like our Linn Energy LLC (NASDAQ: LINE) have become so popular. But those REIT payouts will return.

I recognize it's still tough out there for property owners: My office lease in downtown Seattle is up, and the owner offered me twice the space in a better building (with an awesome Puget Sound view) for nearly the same amount I'm paying now – if I agreed to take a longer contract. I'm taking them up on the offer, recognizing that's the kind of deal-making going on now to get the real-estate industry through 2009-2010 rough patch.

But don't get hung up on what's happening now. Investors should be valuing REITs on their prospects for 2011-2012 prospects. For now the vote is that they'll be much better. 

We'll discuss this more as the New Year advances. In the meantime, if you are a commercial property lessor, lesee, broker or developer, I welcome your thoughts.

[Editor's Note: With the U.S. economy picking up steam, there has seldom been a better time to invest. Valuations are low and the potential for profit is extraordinarily high. But picking the right investments is key - and having a guide is crucial. Jon D. Markman should be that guide. Markman, a veteran portfolio manager, commentator and author, is offering investors a unique opportunity to capitalize on the current bull market by subscribing to his Strategic Advantage newsletter. For more articles like the one you just read, or for more information about Markman's Strategic Advantage service, please click here.]

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  1. Mr. H. | January 8, 2010

    You're totally nuts & haven't a clue what is going on out there.If not for the gov't money which will end in a few months, more of these lousy debt ladden reits would have foreclosed like GGP did earlier last year…I just came back from Az. last month & it's a disaster out there both residential & especially commercial. This summer I walk a 3 block area of Main St. in Huntington L.I. where the rich shop.In the 3 blocks I walked, there were "9" empty store fronts with signs in the windows asking to call the landlord to rent space.I wonder how many more store fronts are vacant 5 months later.This Mamis guy must be long the .djusre or has been paid by GS to put B.S. out to the public.Every publication I've read over the last year, plus I go on blogs to different cities to inquire about the re market have all horror stories about the re market for both residential & commercial.THIS IS A GAME ABOUT SHORT SQUEEZING THE INVESTORS WHO HAVE BEEN BETTING AGAINTS THE RE MARKET FOR OVER A YEAR NOW. ALOT OF THESE REITS ARE DOING OFFERINGS TO RAISE CAPITAL TO STAY ALIVE & ITS THE GOV'T MONEY WHO'S BUYING THERE SHARES.The gov't is trying their best to keep the re market from collapsing & alot of chatter has GS running up these reits as well…..SO after speaking to 5 different re agents in Az last month with 20 plus years expirence about the market, Mamis has his head so far up his ass or this dude doesn't even exist…………………….HAPPY NEW YEAR………….

  2. Mr. b.s. | January 8, 2010

    liar

    • Eddie | January 8, 2010

      Wow a statement without a reason? You call the man a liar why? Your stocks not doing well today? The wife upset you? You followed one of his recs that hasn't worked out yet? Whatsup?

  3. Danny Campbell | January 8, 2010

    Jon, I liked your RE article, but there is a trememdous amount of problems down the road for the retail owners. Re fi is impossible. Many of us are very upside down.

    By the way Our seattle projects are doing best overall, our AZ the worstl

    I see no improvement in the near future at all.

  4. Steve Lombardi | January 8, 2010

    I've started to analyze commercial real estate because I do agree with you. I own CRE and believe the doomsday predictions are as overstated now as the bankers/appraisers were five years ago when selling or financing the dream that didn’t exist. There are those REIT’s with good management looking and buying at depressed prices, taking tenants from landlords who bought the dream that didn’t exist and who will lose their shirts. But those who are leasing at lower rates will keep their tenants and prosper. Like every decision when buying real estate, it’s about the lease and quality of tenants signing the lease. I agree with the conclusion you reach, but I would say use a lot of caution. Look for strong balance sheets that can weather any further downturns. Read about the tenants who are in the space. Learn how to calculate an NOI and don't be fooled by the "NOI" used by some who ignore real expenses as well as real income sources. Now if I knew a source that listed all the REITs and segregated them into types of properties I'd be a lot further along in terms of knowing which REIT to buy.

  5. Tom S. | January 8, 2010

    FWIW My small commercial building in downtown Hot Springs is once again fully occupied. However, it sat 50% empty for almost a year, and to get it leased out I had to cut the monthly rent by 25%.

  6. Ted | January 8, 2010

    I invest for a large midwestern institution who would like for me to put $100-200 million into commercial real estate assets. Harder than it looks if you are value driven but require quality assets and higher risk adjusted cap rates. The nations largest asset servicers advise us that the inventory of non performing commerciall paper continues to grow quarterly. Much of it still mispriced by 30-50% to reach market clearing levels. This level of distressed REO & mortgage paper will have to ultimately be absorbed and vacancy rates decline before the REITS and other owners have pricing power to improve returns much. Low cost providers and those with strong equity and longer term leases with better tenants will be safer havens in these tough times…….. That said, even in this market, the top REITS, well managed and well capitalized stand to be winners as this market finally clears.

  7. Daddy Paul | January 8, 2010

    "But don't get hung up on what's happening now. Investors should be valuing REITs on their prospects for 2011-2012 prospects. For now the vote is that they'll be much better. "
    Great advice

  8. keithers | January 8, 2010

    good luck folks….you are about to take the beating of your lives. but then again, there is always a sucker on the other side of the trade…thats for buying my shorts.

  9. Bill Farrell | January 9, 2010

    Being a contrarian is fine. Being blind is quite another matter.
    NYC, Seattle wonderfull.
    Most of the USA is dead. No business, no lending, empty factories and offices. Empty stores.

  10. Michael Timothy | January 9, 2010

    Jon, I agree with you that we should be concentrating on 2011 and 2012 prospects. There are too many people out there who are negative to real estate and commercial lending. Most likely because they got hurt during the last 5 years. From lessons learned many of the REITs out there will become stronger and more effecient with better management and better balance sheets.

  11. David Chester | January 9, 2010

    What a bad time to start messing in real-estate. It was the greed of types like those you wish to advise that brought the US economy down ehrn the real-estate market and land values in particular crashed. And now you are setting out to do it again and nobody wants to stop you. Shame on you.

    By raising land prices with your speculative ways there will be an increase in the leasing of land and its cost of accquision for purposes of production. That will keep up the cost of produce and the poor old US will continue to need to import cheaper produce from China. That means more printing of Dollar bills by the Fed and eventually losses on the foreign exchange rate and inflation.

    What you are proposing may be temporary and good for a few rich and bloted land owners, but it shure as hell stinks for the rest of the macroeconomy. There should be a tax on land values (as Henry George proposed 131 years ago, in "Progress and Poverty").

    TAX TAKINGS NOT MAKINGS.

  12. Matthew | January 9, 2010

    My partner and I are in a holding pattern waiting for the second default wave to hit. I can't really see investing in anything until the next reset of the economy hits, especially seeing as the governments of the US & Canada have already emptied the gerry cans of stimulus programs. I just can't see buy into much before valuations bottom and I don't think real estate has yet.

  13. Steve Lombardi | January 10, 2010

    Matthew: Are you currently evaluating REITs to watch waiting for the dip; and what do others recommend as presently having strong balance sheets and good prospects for 2010-2012?
    Keithers: I appreciate that many people hold your opinion, but do you own any investment real estate (not your home) or have you ever purchased and managed commercial real estate? I don't think your approach across the board is an informed position. Your negative opinion is true for some REITs, but not for all REITs. You are missing a key fact that many don't seem to get. Some REITs are purchasing distressed properties, then taking AAA tenants from other commercial properties owned by other landlords and signing them up at lower leases per square feet rates and allowing impressive TI's for long term leases. Those landlords/projects will do just fine long term. The CAP rates on those properties is up around 20% or higher, while their competition is dying with increasing vacancy rates. The return on the stream of income is considerable and a lot greater than their competition in the same markets. Look for REIT's with low D/E ratings, strong balance sheets and good management. Look for those taking advantage of the situations that distressed markets create. Perhaps the REITs to consider aren't large caps. So if your shorting, what exactly are you shorting?
    Mr. Markman: Which REITs do you recommend?

  14. walter mitchell | January 10, 2010

    this market and others will return in 3 years if we have a republican in the white house. perhaps this year if dems lose and repubs win. for those of us out there who can invest now and continue to invest on a down market, jump in.

  15. Goodonya | January 11, 2010

    Good frickin luck!

    As long as we have a socialist at the helm- most capital intensive markets will wallow in the mire. As a fundamental example- no one out there is hiring because they have no idea how much cost they face in the future from our government. Uncle has his hand out in a big way, and that simply frightens anyone with money in their pocket.

  16. William | January 11, 2010

    Are you living in a nut shell ? 25 million people plus going bankrupt,for every home that sells three more go in to default,zero job growth,landlords lowering their rents trying to attract renters.The feds removing caps,interest rates going up up up,banks not loaning money to people or small business.People are leaving banks for credit unions due to interest rates, china geting ready to forclose the stockmarket is growing because of foreign investers. I have never seen so many empty storefronts in my lifetime, keep your money for better times.

  17. Steve Lombardi | January 25, 2010

    What do you think is going to happen to the office buildings, strip malls and industrial warehouses? I doubt they will just pick up and disappear. I suggest you stop analyzing the real estate just as a physical structure and learn to value the stream of income. If the income is down then so is the value. When it turns around and the income stream increases so does your rate of return. Read the article in the WSJ about the Samsung lease. Look at this article from the WSJ. Read it and I'll tell you later what they did investment wise. This is an incredibly shrewd and wise investment strategy. The REIT management that understands this, has cash to take advantage of the opportunities along with buying paper on distressed properties and turning them around is the REIT to own because in 36 to 48 months they will be making a killing. Here is the article I’m referring to. At the end of this explanation I’ll lay out the return on the Ridgefield Park property.

    http://online.wsj.com/article/SB10001424052748704157304574612493167313798.html?mod=WSJ_Commercial_MIDDLETopNews

    “By MAURA WEBBER SADOVI – Opportunistic investors who have bought buildings at steep discounts are beginning to pass on their savings to tenants, much to the distress of other landlords in the area.
    Bruce Goldsmith at Goldsmith Studios – Samsung Electronics America leased space in this Ridgefield Park, N.J., building at a discounted price.”

    As investors, if a company you really like has a few problems do you wait for the price to increase before buying the stock or do you expect to pay less for the stock? If you can buy the stock at a price that reflects its present value do you buy or wait for the price to go back up? Don’t shy away from REITs or commercial real estate because it’s under the weather; just demand a price that reflects its present value.

    Now back to Samsung. What if after they turned it around they turn around and sell? If they can get an 8 cap they can sell it for $56,125,000 pay off the $19,900,000 and net $36,225,000. And that's figuring they put no money down. If they maintained ownership and just took in the monthly checks it would be a 22.5 cap rate. Anything over a 13 cap and you don't need to put anything into the deal.

    That is an absurd return….and one sweet deal. Balls or brains or both?

  18. kiramatali shah | January 26, 2010

    There's a movement to radically change California government, by getting rid of career politicians and chopping their salaries in half. A group known as Citizens for California Reform wants to make the California legislature a part time time job, just like it was until 1966.

    http://www.onlineuniversalwork.com

  19. Stuart Sugden | January 28, 2010

    There are new real estate investors and old ones. If you started 3 years ago you are not looking pretty; if you start now maybe or maybe not. In Richmond CA, a poor working class area I am thinking hard about investing in real estate which has halved in value. I can't tell whether an apartment complex I am interested in has reached its nadir in price or not. The last owner bailed through foreclosure. The property has positive cash flow but where will the job market be 5 years from now? Can I keep the apartments fully rented? Will my tenants have jobs? For now I am playing it conservatively thinking we may well get at least one more wave of foreclosures.

    • Steve Lombardi | February 9, 2010

      Stuart: For the answer to your questions about the future look to the area where the apt bldg is located. Real estate investing is still about location, location, location. Check to see if new jobs are being created in the area. Is new industry moving in or existing industry expanding? Check out the demographics. Are grade schools expanding or consolidating? What does the neighborhood look like? Up and coming or blighted? Learn about CAP rates and how to use them as risk factors to discount the cashflow created from rents; the cash flow creates the basis for the price you should pay. Is there deferred maintenance in the project? If so subtract the cost of that maintenance from the price you offer. Get ahold of Milt Tanzer's book on investing in real estate. It's a good place to start. You're smart to be looking at it and asking questions.

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