…wait until you see what’s in the cards for commercial real estate.

That’s right, the next train wreck will be in commercial real estate. Couldn’t be worse than last year’s residential market crash? That remains to be seen. But it’s coming soon, probably as early as the second quarter of next year, and there’s nothing that can prevent it. The government will intervene, trying desperately to delay the day of reckoning, and may even succeed. For a while. But make no mistake about it, that train is going off the tracks no matter what.

Every part of the sector – from multifamily apartment buildings to retail shopping centers, suburban office buildings, industrial facilities, and hotels – has accumulated a huge amount of defaulted or nonperforming paper. It’s an impossible, swaying structure that cannot long stand.

Just ask Andy Miller.

Andy is one of the most knowledgeable people around when it comes to commercial real estate. Co-founder of the Miller Fishman Group of Denver, he has spent twenty years buying and developing apartment communities, shopping centers, office buildings, and warehouses throughout the country. He’s also worked extensively – especially lately – with asset managers and special servicers (those who handle commercial mortgage-backed securities, or CMBS) from insurance companies, conduits, and the biggest banks in the U.S., advising them on default scenarios, helping them develop realistic pricing structures, and making hold or sell recommendations.

It isn’t easy. Commercial real estate sales are off a staggering 82% in 2009, compared with 2008, and last year was worse than ’07. No one is selling at depressed prices, but it hardly matters as there are no buyers, either because they’re afraid of the market or can’t meet more stringent loan requirements. Two years ago, the value of all commercial real estate in the U.S. was about $6.5 trillion. Against that was laid $3-3.5 trillion in loans. The latter figure hasn’t changed much. But the former has sunk like a bar of lead in the lake, so that now between half and two-thirds of those loans will have to be written down, Andy estimates.

“If the banks had to take that hit all at once, there wouldn’t be any banks,” he says.

And it’s actually worse than that. As even average citizens became aware during the subprime meltdown, loans in recent years were bundled into exotic financial vehicles that could be sold and resold, a class generically known as conduits. These commercial mortgage-backed securities, while less well known than their cousins built upon home loans, are nonetheless ubiquitous.

Three guesses who were among the significant buyers of CMBS. If you said banks, banks, and more banks, you got it. Thus these folks are sitting not only on their own malperforming loans, but on a whole lot of everyone else’s toxic junk, too.

This is how bad conduits are: A 3% default rate last year jumped to 6% in 2009 and is expected to double again, to 12%, in 2010. An entity that takes a 12% hit to its portfolio – and this includes countless banks, pension and annuity funds, international institutional investors, and others – is in deep, deep trouble.

The real tsunami is coming, probably in the second quarter of 2010, Andy estimates. Because that’s when banks will have to start preparing for the wave of mortgages that were written near the market top and are maturing in 2011-12. Unlike home loans, commercial loans tend to be relatively short-term in nature (average 5-7 years), because – outside of apartment building loans backed by Fannie or Freddie – there are no government programs to subsidize longer-term ones. These guys mature in bunches.

According to a recent Deutsche Bank presentation, the delinquency rate on commercial loans as of the end of 2Q09 was greater than 4%. Of these, they expect that north of 70% will not qualify for refinancing. Imagine what will happen to the estimated $2 trillion in commercial mortgages that mature between now and 2013.

And even that is not the end of it. There’s a second huge wave on the way in 2015-16.

Problem is, instead of trying to meet this inevitable challenge head on, asset managers have decided to believe in such phantoms as the tooth fairy, honesty at the Fed, and an economic turnaround powerful enough to bail them all out. De Nile is not just a river in Egypt.

To be fair, it’s difficult to envision what an intelligent, aggressive response would look like, given the breadth and depth of the crisis, and the lack of resources available to deal with it. Miller recently met with a group of asset managers from a number of different, prominent banks. They reported that they’re completely overwhelmed and can’t even begin to cope with the sheer volume of problem loans on their calendar. It’s so bad that they’re now dealing with some borrowers who haven’t paid a cent in a year and a half.

What do you do if, as Andy thinks is the case, 85-90% of the entire commercial real estate market is under water relative to its financing? What happens to a property when its value drops way below the loan, a seller can’t get enough money to get out, a buyer can’t raise enough money to get in, and the bank can’t afford to foreclose? Simple. It just sits there, carried along on the bank’s books at some inflated “mark to fantasy” price that makes the institution’s balance sheet look passable. The industry even has a catchphrase for the situation: “A rolling loan gathers no moss.”

In the case of a retail store, a bankrupt tenant walks away. Andy looked at just the part of Phoenix where his firm does business and found 90 vacant big box stores, with an aggregate floor space of 8 million square feet. If Christmas season is as lackluster as cash-strapped consumers are likely to make it, there will be many others to follow.

The hotel business is terrible. Overbuilding based upon travelers who went into debt to finance lavish vacations is taking its toll on tourist destinations. At the same time, business travel has seriously contracted. Flights into Las Vegas, which caters to both, have been slashed so much that even if every seat on every remaining flight were filled and visitors stayed for an average number of days, the hotels still couldn’t break even. In industry parlance, banks are now engaged in “extend and pretend,” i.e., giving hotels three- to six-month loan extensions in the hope that things will somehow improve in the near future.

Office space is doing okay in central business districts, but not faring well elsewhere. Some estimates tab the national office vacancy rate at over 16.5%, compared with 12.6% in January 2008. It exceeds 20% in parts of Atlanta and San Diego, and in many places in between.

Multifamily apartment buildings – and the very creaky Fannie and Freddie are carrying a load of them – may be the next to topple. As values deteriorate and landlords are faced with loans coming due, there is no incentive to fix whatever goes wrong. If, for example, you have a $10 million loan maturing in two years, and the property value has declined to $6 million, why would you spend half a million to fix leaky roofs? The question answers itself. Yet, as capital spending needs are not attended to, the apartments deteriorate. Which leads to working-class tenants replaced by meth labs. Which leads to even lower property values. And so on. In the end, when the banks are forced to take possession, they will be left with either expensive repair jobs, or the cost of demolition and a total write-off.

As the overall commercial real estate crisis escalates, the banks will do the same thing they did last year: run to the government, palms outstretched.

How will Washington respond? Good question. On the one hand, further bailouts will further infuriate the public. But on the other, the political sentiment will be that allowing the banks to fail will have even more dire consequences.

The Fed has already tried to let some of the relentlessly building pressure out of the balloon through TALF (Term Asset-Backed Securities Loan Facility). But that hasn’t worked, because TALF only backs the most senior, creditworthy bonds in a CMBS pool. Those aren’t the problem. The problem is the junior notes no one wants.

In order to increase market liquidity and get conduits moving again, the government will likely be forced to create a guarantee program similar to the FHA, Miller thinks, whereby short-term money (on the order of 5-7 years) is made available. Will that just push our problems five to seven years down the road? Quite possibly. But what is being purchased is time, the only thing left to buy. The hope, of course, is that it’s enough time – for the real estate market to stabilize, prices to return to more “normal” levels, and the world to turn all hunky dory.

Rock, meet hard place. Let all the troubled banks fail, and the consequences will range from some excruciating but short-term pain, to a plunge into full-bore depression. Prop them up with yet more newly printed fiat money, and anything from high to hyperinflation will inevitably result, along with the possibility of extending the problem well into the next decade.

Both are frightening prospects. We don’t want either, but realistically, we’re going to get one or the other. Let’s be clear, it won’t be the end of the world. However, it will be the end of the world as we know it. That makes it imperative to prepare for the new one that’s coming.

The editors of The Casey Report, supported by real estate pro Andy Miller, have been warning of the coming commercial real estate debacle since September 2008. This one’s rather easy to time – because they know when the loans will come due. And as subscribers can testify, accurately predicting big trends is the forte of Doug Casey and his expert team. To learn how you can profit from making the trend your friend, click here.

Good day… And a Thunderin’ Thursday to you! It’s Thundering and raining here, so I felt that naming today a “Thunderin’ Thursday” was bang on! We had a wild and wacky Wednesday yesterday, with the Fed Heads playing the part of the court jester… And… I want to know, right here, right now, why the media isn’t blasting Fed Head Honcho Big Ben Bernanke! I’ll tell you why they should be, in a minute…

OK… As I said, we had a wild and wacky Wednesday yesterday, as the non-dollar currencies went for a spin on Mr. Toad’s Wild Ride, with Big Ben Bernanke in the role of Mr. Toad! HA! That makes me chuckle! Here’s the skinny, and what everyone should be up in arms about…

The FOMC meeting concluded with interest rates remaining at near zero… But what happened next was, well, exactly as I said it would happen, but we’ll get back to that in a minute… What I’m talking about here is that the Big Ben’s band of merry men announced that the U.S. economy’s return to growth was insufficient to withdraw stimulus, and that quantitative easing would remain until March next year… WHAT!

HEY BIG BEN! I read in the Financial Times the other day, yes, the Financial Times, that you said the recession was likely over! I also read in another publication that you said basically the same thing… So! If what you told these fine publications is true… Why then do we need stimulus in place along with Quantitative Easing until next March? You could almost hear Big Ben saying… “Oops, did I say that out loud?” HA!

Doesn’t that just tick you off? Big Ben and the President going around telling people that it’s all clear and consumers can come out now and resume their spending, only to find out it was nothing but “feel good” stuff… Yes, stuff to make us “feel good”… So we would take our eye off the ball… But not me! You can’t fool a wiley old veteran like me, right Jack Milner? I’m not falling for that change-up… And it ticks me off that they thought I was so stupid to fall for that!

Ok… Let’s take a trip back to Monday of this week, when I was trying to explain why the dollar had reversed the negativity toward it… I said this in the Pfennig on Monday… “Seriously though, the markets are of the belief that the Fed will keep rates near zero, but will announce that they will begin to remove stimulus, as Head Fed Honcho, Big Ben Bernanke, believes the recession is over…

I think this is wishful thinking on the markets’ part, as I really don’t see the Fed Heads doing anything, but talking about doing this, that and the other thing. You see, the Fed Heads know all too well that the Commercial Real Estate problems are just beginning and with Unemployment.”

I’ve been more right about what the Fed Heads were going to do, for the last 2 years, than Big Ben!

OK… So, here’s where the wild and wacky comes in… The non-dollar currencies were hanging around on a corner trading in a tight range, when the announcement of further stimulus and Quantitative Easing was made… You should have seen the non-dollar currencies begin to run up VS the dollar… It was crazy, I mean in a manner of minutes the euro traded from 1.4765, to 1.4850, and Gold? It was soaring too! But then it was one of those a-ha minutes, and no, I’m not talking about the 80’s group singing Take Me On! No, it was one of those head slapping moments when you say… Wow, I could have had a V-8!

Basically, investors figured out that by leaving the stimulus in place longer than originally planned, the Cartel, I mean the Fed, is confirming that the U.S. economic recovery isn’t nearly as robust as Big Ben and his compatriots have led everyone to believe. Stock markets fell, and the Treasury rates rose.

With the stocks backing off, the risk assets of currencies and precious metals backed off VS the dollar… And, we ended the day, where we started it… A wild and wacky Wednesday for sure!

The overnight markets were very confused as to what direction they should take… So, as I turn on the screens this morning, the euro is 1.4775, and Gold is $1,014… About the same as yesterday morning… If you weren’t around for the spin on Mr. Toad’s Wild Ride, then you would think… “How boring these currencies and metals are”… HA!

The thing that keeps haunting me here with yesterday’s stock sell off… Could it be the next leg down that I keep warning you about? Could yesterday’s sell off be the harbinger of more selling? We’ll have to keep an eye on this, folks… If we see 3 or 4 days of consecutive selling, it could very well be the indication that the next leg down is here…

Well… The other day I mentioned that the dollar could very well be the last man standing when it comes to near zero interest rates, and that could lead to the dollar becoming the next funding currency for the Carry Trade…

Ty brought to my attention this fact that plays quite well with that thought… For the 1st time since 1933, 3 month LIBOR rates in the U.S. (.28563) are lower than Japanese Yen 3 month LIBOR rates (.34875)

And one wonders why, the dollar is getting beaten like a rented mule? (no animals were hurt!)

A reader called in yesterday and wanted to know what I thought regarding… how a new SDR would affect the currencies. (Specifically NOK, AUS, BRL, CHF)

Well… That’s a tough one! Because if we do end up with a new SDR, no one knows what the makeup of that SDR will be… So, I can’t say how it would affect any currency until we begin down that road to a new SDR… If the current makeup of an SDR is used, then euro, yen, sterling and dollars would benefit… But one has to think that if things come to pass and we start down that road of a new SDR (Special Drawing Rights) that the makeup would be quite different, and could possibly even have some Gold as a component!

So… Sorry, I can’t really answer the question, because it’s an unknown… I hope my beautiful bride reads this part, as she usually only reads the first and last paragraphs, because she always contends that if I don’t know the answer to a question that I just make something up… See, dear? I said I couldn’t answer the question!

Ok… G-20 begins today… Look for these knuckleheads to take a toughened stance on speculation, with Oil in mind… I think that all they will do is make things tough for the Commodity Currencies of Australia, New Zealand, Brazil, Canada, South Africa, and Norway… There’s also an outside chance that these knuckleheads will attempt to do something to limit the rise in currencies VS the dollar… In other words, prop up the dollar… I’m not convinced they could do that, and I am convinced they shouldn’t do that!

Speaking of Norway… The Norges Bank (Norway’s Central Bank) did as I thought they would with rates, and what I hoped they would do with their statement… Here’s the skinny… The Norges Bank left rates unchanged… But… Said after the rate announcement that “they were CONSIDERING a rate hike”… The Norwegian krone went on a moon shot immediately after that statement.

In the race between Norway and Australia as to which will be the first to hike rates, Norway takes the lead, with that announcement yesterday… But, it really doesn’t matter, as no one will get the checkered flag or anything… The thing that makes the difference is that the yield differentials to the U.S. will begin to grow wider… And that, my friends, will go a long way toward currency strength for the currency that rewards investors with higher yields!

Speaking of Australia… The Reserve Bank of Australia’s (RBA) semi-annual Financial Stability Review gave a generally clean bill of health to the banking system and noted sentiment among households and business had improved considerably in recent months… But… The RBA went on to caution that it was not strong enough yet… Which then puts the Aussie rate hike forecast further behind Norway’s…

In New Zealand overnight… It’s been a good week o’ data for the Kiwis… Last night, it was the latest Consumer Confidence Index which jumped to a 4 – year high of 120.3 (previous reading was 106)! WOW! So… The highest Consumer Confidence in 4 years! This news helped kiwi to remain above 72-cents… Even with the risk assets sell off…

In Germany this morning… The Business Climate Index, as reported by the think tank IFO, disappointed a bit, as it came in (91.3) lower than forecast (92), but… The 91.3 marked the 6th consecutive monthly increase for the data… So, the trend is still in place…

And it’s good to be the yen, eh? I mean, recently, we’ve seen yen rally when the other currencies rally VS the dollar… And before that, we’ve seen yen rally along with the dollar… Last night, yen rallied alongside the dollar, and is trading with a 90 handle this morning…

And then there was this… The Federal Reserve System has disclosed to the Gold Anti-Trust Action Committee Inc. (GATA) that it has gold swap arrangements with foreign banks that it does not want the public to know about. WOW! This is a BIG DEAL folks, as the Fed as recently as 2001 (Big Al Greenspan) denied that these swap arrangements existed…

GATA believes that this letter suggests that the Fed is indeed very much involved in the surreptitious international central bank manipulation of the gold price particularly and the currency markets generally.

So guess what I think regarding the Fed now? That Ron Paul’s bill to audit the Fed needs to get on a roll! Remember, it comes before a committee tomorrow, I believe, where it will be decided to forward the bill on or kill it… So, call your representative and tell them you believe they should back Ron Paul’s bill to audit the Fed! I’ve got a bag full of names to call these guys at the cartel, I mean Fed… But, those are verbally used only… Nothing in writing… Hey! This is a family safe letter!

OK… So, to recap… The Fed is leaving stimulus in place along with Quantitative Easing until next March. So much for Big Ben, and the President’s claim that the recession is over, eh? The currencies rallied at first on the Fed’s announcement, but later realized the rot on the economy’s vine has been exposed by the Fed, and then the currencies sold off VS the dollar to end the day unchanged…

Currencies today 9/24/09: .8745, kiwi .7235, C$ .93, euro 1.4775, sterling 1.6220, Swiss .9770, rand 7.3850, krone 5.7630, SEK 6.8380, forint 183.15, zloty 2.82, koruna 17.04, RUB 29.99, yen 90.60, sing 1.4110, HKD 7.75, INR 48.03, China 6.8273, pesos 13.37, BRL 1.7980, dollar index 76.25, Oil $68.36, 10-year 3.41%, Silver $16.81, and Gold… $1,014.10

That’s it for today…I hope everyone arrives to work dry, as it’s a Thunderin’ Thursday!

Chuck Butler

Source: Oops, Did I Say That Out Loud?

First, the political left and National Association of Realtors are in the process of extending the now famous “first time homebuyer tax credit.” The initial plan, which was passed around this time last year and allows first-time homebuyers an $8,000 tax credit, is on track to cost about $15 billion — double the projected budget.

Heh, and just like “cash for clunkers” going massively over budget must be a sign of scorching legislative success. Thus, the new plan is to extend the tax credit into the summer of 2010, boost the credit to $15,000 and make all potential homebuyers eligible. Those who are content with their current home and/or unwilling to invest in a new one… well, they get the prideful assurance of knowing they played it safe — and their kids get the bill.

Also, the IRS has changed some rules to help keep commercial real estate afloat. It’s a technical matter (aren’t all American tax laws hard to understand?), but basically, the IRS fudged their rules on tax penalties for real estate investment pools. Under the new laws, certain commercial real estate loans could be modified or refinanced without hitting investors with a tax penalty.

We’ll save the details for more seasoned analysts, like our resident CFA, Dan Amoss. But you get the gist… the government is going out of its way to keep commercial real estate from going down.

“The fundamental outlook for REITs and commercial real estate remains bleak,” says Mr. Amoss, “and the market will soon wake up to this fact.

“The core of the bear case for REITs rests on falling comparative property values, falling rents, falling occupancy rates and tight to nonexistent refinancing conditions. Refinancing conditions are important because if lending remains tight, this will push up the amount of property foreclosures and liquidations. And conditions will remain tight because the regional and community banks that typically lend against commercial real estate collateral are not answering phone calls from desperate borrowers. They’re nursing hangovers from their existing commercial real estate loans, and have regulators watching their every move…

“Richard Parkus, head of mortgage-backed security research at Deutsche Bank, estimates that cumulative commercial real estate charge-offs will be in the range of 10% of the banking system’s $1 trillion in core commercial real estate loans. That’s a $100 billion hole in the banking system’s capital that many banks will not be able to ‘earn their way out of.’ I think 10% cumulative charge-offs could be conservative.

“Thus far, according to SNL Financial data, commercial banks have charged off just 1-2%. So in baseball parlance, ‘We’re only in the first inning’ of the process of recognizing and writing off whole commercial real estate loans sitting on bank balance sheets.

“As this occurs, this will lead to a flood of foreclosures and liquidations, which will push down market prices for commercial properties — the same types of properties owned by REITs.”

Source: The Coming Commercial Real Estate Crisis

There are a lot of uncertainties permeating the market right now, not the least of which is healthcare reform. Will that reform entail a public option that could add $1 trillion to the deficit?  How is reform going to be financed?  And is it going to mean higher costs for employers across the board, or just the healthcare insurers?

Investing is made infinitely more difficult when 18% of U.S. gross domestic product (GDP) is hanging in the balance.

And you still have to consider:

• That unemployment is likely to keep rising, perhaps over 10%.
• That the U.S. Federal Reserve’s policy of quantitative easing is slowing down.
• That there is almost certainly a second wave of home foreclosures on top of the current commercial real estate epidemic.
• And that retail sales are still a long way from recovery.

There is also reason to believe that the U.S. dollar will continue to be weak, though it probably won’t sell off precipitously.

The U.S. dollar has weekend against the Euro lately, having fallen 0.8% Friday.  Technically speaking the chart shows a traditional “cup and handle” formation that could lead to an acceleration of the dollar’s downward trend.  Gold prices, up about 13% Friday, confirm this trend and could soon break through the $1000/oz resistance.

Fundamentally, if the economy – encumbered by high unemployment and a relapse of the housing market – does not pick up the dollar could be further imperiled.

Weakness in the dollar will also be affected by the Fed’s withdrawal of liquidity, which is likely to proceed at a gradual pace.

Finally, diversification away from the dollar among the world’s central banks is taking place, albeit at a slower pace than many analysts have suggested, and that too, is weakening the dollar.

Let’s concede that there is no currency that could supplant the dollar as the world’s major reserve currency. So, it’s unlikely that the world’s central banks will simply abandon the dollar anytime soon. However, we must also acknowledge that a reduction in the weightings of the U.S. dollar within central bank reserves is already underway.

An Aug. 14 article by BNP Paribas currency strategist Ian Stannard in Euromoney recently described this gradual shift in currency reserves.  The article noted that only 62.5% of global currency reserves are in U.S. dollars, down from about 66% in 2005.

So I do not anticipate a sudden shift in central bank reserves, but rather a continuation of the measured restructuring we’ve seen so far. Thus, the slow weakening trend in the U.S. dollar is likely to continue.

So, in this very uncertain investment scenario, I prefer to go for more secure returns in bonds.  And we can achieve great diversification at a cheap cost with the iShares iBoxx $ Investment Grade Corporate Bond Fund (NYSE: LQD).

For starters, its weighted average coupon of 6.26% offers a current yield slightly north of 6% at today’s prices.  Investors are assuming interest rate risk, which means that if interest rates climb, the value of the bond has to come down.  But in the short term, there is no immediate threat of inflation.

Looking at the major holdings of the fund – which has no single position that accounts for more than 1.26% of its total holdings – I see some names that have demonstrated continued stability and others that have shown recent signs of improvement, such as American Express Co. (NYSE: AXP).  So I do not expect any major credit spread hiccup here.  I certainly do not see any hiccup that a 6.26% coupon would not compensate for.

For an additional hedge against dollar weakness, I suggest you revisit my June 8 recommendation of the iShares SPDR Gold Trust ETF (NYSE: GLD). You may also consider buying a bit of the PowerShares DB US Dollar Index Bearish (NYSE: UDN) fund.  Do not go overboard. Err on being light, rather than heavy on hedging, since timing currency moves is very difficult.

Recommendation: buy iShares iBoxx $ Investment Grade Corporate Bond Fund (NYSE: LQD) at market.  Consider hedging part of the US dollar risk by buying the iShares SPDR Gold Trust ETF (NYSE: GLD) and PowerShares DB US Dollar Index Bearish (NYSE: UDN). Both funds should account for a fraction of your position.  Have a 5% stop loss on UDN (**).

Source: Buy, Sell or Hold: The iShares iBoxx $ Investment Grade Corporate Bond Fund

“Investing in this market is like trying to take cheese out of a set mousetrap,” Chris Mayer begins today. “It’s very tempting to make a grab, but you are also fairly certain about what will happen if you do. The market’s 50% rise from its March lows is stunning. It’s like the cheese in the trap. But we also know that no market moves up like that for long. The kill bar is never far from such rallies.”

Check out Asia early this morning… you can almost hear that bar whipping through the air:

Today’s global stock sell-off really started on Friday, when the U.S. suffered its worst bank failure of 2009.Alabama-based Colonial Bank gasped its last breath late Friday. With roughly $25 billion in assets, it was the biggest bank failure since Washington Mutual back in September.

Like WaMu, the FDIC brokered most of Colonial’s burden onto another bank’s balance sheet. BB&T picked up the lion’s share. And just like the WaMu/JP Morgan deal, the FDIC greased the gears by including some kind of backstop provision. In this case, BB&T and the FDIC (read: your tax revenues) will enter a loss sharing agreement on $15 billion in shaky Colonial assets.

Colonial’s failure took a $2.8 billion chunk out of the FDIC’s deposit insurance fund. With just $13 billion left — at best — the fund is at its lowest level since 1993. Along with four other banks that failed over the weekend as well, the FDIC has closed 77 banks this year. One more and we’ve tripled last year’s count.
“The FDIC has been tardy in resolving banks and cleaning them up,” says Dan Amoss, “which will result in higher costs to the FDIC in the long run. Plus, with these ‘loss sharing’ deals (Colonial/BB&T), the FDIC is putting off the recognition of losses over a period of years, and its estimates of ultimate losses will likely be low, whether they’re ultimately absorbed by the deposit insurance fund or acquiring banks like BB&T.

“A perfect example is Integrity Bank in Georgia, which should have been shut down long before it was allowed to attract new deposits with high CD rates.

“Also, note to 5 readers: If your CD rates seem too good to be true, your bank may not be healthy, and you may have to deal with the hassle of not accessing your money while the bank is resolved.”

Dan has quite a knack for spotting bad banks. His Strategic Short Report readers bagged gains of 162% betting against Allied Capital, 220% on PNC Financial and the whopping 462% winner shorting Lehman Brothers. We just published his latest short-financial play… available to readers of The 5 for just $1.
Already anxious over Friday’s lousy U.S. consumer confidence number and Colonial’s failure, Chinese traders slammed the bid today on rumors that the Chinese government is going to tighten lending standards. No official word yet from Beijing, but rumor alone was enough to knock the Shanghai Composite down almost 6%. The Chinese benchmark is down 12% so far this month.
Thus, the foundation of the U.S. bear market rally is quickly eroding: The consumer is pulling back again, the banking crisis (as we noted Friday) is alive and well, and China — the world’s great hope for growth — is looking tired. Add all that up and the S&P 500 opened down almost 2% this morning.
“Investors might forget we’re in a bear market because investing this year has looked easy,” continues Chris Mayer. “Those who have missed out on the rally must be tearing their hair out. Their money burns a hole in their pockets.

“In fact, the evidence is that most investors have the attention span and patience of a field mouse. Here’s the average holding period for a stock on the New York Stock Exchange:

“What jumps out at you right away is that the average holding period is less than a year. That means that, on average, an ‘investor’ typically holds an NYSE stock for a matter of months. This is not investing, which is why I put the term in quotes. I don’t know what it is. Mindless gambling comes to mind.

“It’s no surprise that the last time we were down here was in the Roaring Twenties. We all know what that was the opening act for.

“This chart also speaks to a larger problem in the markets today — there are too few owners and too many renters. Just as in real estate, owners generally take better care of a property than renters. Why should it be different with companies?”

If you’re among the few long-haul investors left, you should team up with Chris. Check out his long-term “paycheck portfolio” here.
Commodities are under lots of pressure today, thanks mostly to Chinese investor anxiety. Oil’s down about $5 from Friday’s high, to $65 a barrel. Gold has fallen over $20 since Friday and goes for $932 an ounce as we write.
Thus, the dollar and U.S. Treasuries are today’s winners.The dollar index is up a full point, to 79.4. Bond demand has pushed the yield on a 10-year down 5 bps, to 3.5%.
Ben Bernanke is taking extra steps to save commercial real estate. The Fed announced this morning a three-six month extension of the Term Asset-Backed Securities Loan Facility (TALF).

The trillion-dollar program was set to expire at the end of the year. The Fed said today — conveniently, right before the market was about to open into a big sell-off — that it would bump the program back to June 31, 2010, for commercial mortgage-backed securities and to March 31, 2010, for other asset-backed paper. That should, in theory, encourage banks to securitize lots of new mortgage and consumer loans… the kinds they would avoid in a normally functioning free market. God bless the Fed!

The TALF has been in action since November 2008.
China’s sovereign wealth fund is preparing to buy up to $2 billion in U.S. mortgages. Having not felt quite enough pain from their Morgan Stanley and Blackstone investments, China Investment Corp. is rumored to be vying for a seat at the Public-Private Investment Plan — the yet-to-be-launched scheme the U.S. Treasury cooked up to get mortgage backed sectors off of U.S. bank balance sheets.
“We’re watching Far East telecoms,” Penny Stock Fortunes’ Greg Guenthner tells us. “Chinese Internet population is increasing at an astronomical rate, growing 42% last year alone, to nearly 300 million users, according to the China Internet Network Information Center. Now the government is setting its online ambitions toward the countryside, vowing to hook up every village with broadband lines by 2010.

“Still, the region’s penetration rate is only 17%, compared with 75% here in the U.S. The opportunities are boundless.

“Most of the time, backdoor plays offer the largest profits in growth industries like this one. Sometimes, however, a straightforward approach is your best chance at the quickest gains. This is one of those times.

“Take China Mobile, for instance. This telecom behemoth is the most obvious play in the region. In the last three years, the company doubled the number of subscribers and grew its bottom line 107%. That’s a rare feat for a $230 billion company.

“China Mobile’s growth is impressive, but it’s nothing compared with what a small-cap player can do in this field. There’s plenty of room to grow in the telecom industry of the Far East.

“That’s why we’ve been looking for under-the-radar Internet providers in Asia. And we just we found a beauty.”

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Japan has joined the ranks of recession-emerging nations. This morning, the Japanese government claimed the country’s GDP grew 3.7% in the second quarter. That puts an end to a five-quarter losing streak and the longest period of Japanese GDP contraction since World War II. As with Germany, France and Hong Kong last week, there’s little expectation for Japan to maintain this growth in the coming quarters.
Employees of the Chicago city government might be reading The 5 in their pajamas today. In a sign of the times, the city closed up shop to help close its budget gap. Running a skeleton crew will save ’em about $8 million a day
Last today, another strange reoccurring theme: Even the dead can’t escape the credit crisis.

An LA widow is auctioning her husband’s famous gravesite so she can afford the mortgage payments on their $1.6 million house.The deceased, Mr. Richard Poncher, is a relative unknown. But you might recognize the tenant immediately below his crypt:

At the end of the eBay auction — currently up to $4.5 million — Mrs. Poncher will rip her hubby out of his resting place and deed the crypt to the whoever the winner chooses. Before you fret for Mr. Poncher, we should add that he bought the place from Joe DiMaggio and insisted he be buried face down, in everlasting creepiness.

The new tenant will have to share Marilyn with Hugh Heffner, who has the crypt next to her reserved.
“Are you serious?” a reader asks. “How can this recession/depression possibly be over?” We enjoyed an overwhelming response to Friday’s issue, when we asked you to guess when the government/NBER would claim the recession is over.

“The causes of this man-made disaster have not been addressed and the same banksters-political class-financial oligarchy are still actively proceeding backward with their own hidden agendas. To quote Albert Einstein: “Never expect the people who caused a problem to solve it.” In other words, business as usual on the USS Titanic with its numerous enormous self-inflicted holes. Full speed ahead to the 1930s.”

The 5: We’re not suggesting it’s all sunshine from here on out. Here’s an example of someone who was closer to “pickin’ up what we were puttin’ down”:
“By my statistical analysis, the recession ended in May of this year; and that’s the good news,” he writes. “The bad news is that the DEPRESSION began in the following June. If anyone believes these smoke blowers at the gov’t and/or financial institutions (perhaps that’s redundant), they deserve what is upon us. It is not all sweetness and light. Bitterness and dark is the life we will lead until we restructure and begin the long pullback.”

The 5: Not a bad guess. Off the cuff, the average guess for when the government/NBER will officially declare an end to the recession is around November 2009. Most readers added that it won’t feel like it’s over for years to come. Lots of double-dip guesses too, which seems to make a lot of sense these days. And there were outliers, of course, which we’d be remiss not to share:
“2015,” a reader wrote. “No sooner — no way. Expect to defend yourself. It will get ugly.”
“It will officially end sometime in 2025-2028,” declared another.
“This depression should end technically around mid-2016 with the Dow under 1,000,” opined another. “So-called normalcy will not return until the mid-2020s. God only knows what this country will look like when it’s all over. Good luck to us all.”

Source: Global Sell-Off, Long Haul Investing, A Small Cap Opportunity, Commercial Real Estate and More!

The 1990s were an ideal period to have timber as an investment:

• Housing was doing well, and growth was beginning to take off in major cities.
• The world was still pre-digital, and business still relied heavily on shuffling paper.
• Electronic news was still a novelty; magazines and newspapers were still going strong.

What a difference a decade makes…

• Housing is in the dumper, with no clear sign of a resurgence on the horizon.
• Business has embraced the smartphone and has gone digital, shunning paper.
• The world is increasingly getting its news in electronic form, as evidenced by the number of newspapers that are no more.

This shift away from stuff that comes from trees has resulted in an almost complete lack of demand for wood or wood pulp. As a result, prices for paper and lumber have hit multi-year lows. Lacking any catalyst for change, it’s the perfect setup for an extremely overvalued scenario in the timber industry.

Timber REITs… Look Out Below

Whereas timberland prices hovered in the $1,500 to $2,000 per acre range in the mid 1990s, a more realistic valuation today is less than half that. And therein lies the problem: Many of the timber REITs haven’t devalued their land.

If it sounds a little like the looming overvalued commercial real estate mess we’re in right now (a story we broke long before anyone else did), it’s no accident. The biggest problem? REITs are managed by human beings.

Just like they’ve been doing in the commercial real estate market, timber REIT managers have adopted a “wait it out” strategy, in the hope that timber values – and by extension the land it’s growing on – will suddenly reverse. Don’t bet on it.

Unfortunately for the REITs and their shareholders, hoping and praying for a resurgence in the housing market isn’t going to work.

It’s going to get even worse: Timber prices could drop another 50% in the next few years, as an anemic housing market – the only possible timber demand catalyst – isn’t looking at a recovery for as long as five years.

Most timber REITS, however, haven’t taken a big hit to their balance sheets. Not yet anyway. But that’s all about to change.

As a result of the aforementioned head-in-the-sand mentality, Plum Creek Timber (NYSE: PCL), Potlatch (NYSE: PCH) and Weyerhaeuser (NYSE: WY) are all on the verge of imploding. Weyerhaeuser isn’t a REIT, but it suffers from the same issues.

At a minimum, all are going to have to significantly cut their dividends, which aren’t based on anything remotely resembling ongoing operations. Nearly all of their 2009 income – and I use that term loosely – will come from land sales.

That’s a problem, too, and not just because of depressed prices for timber. Much of the hopes of the REIT management are that they will be able to sell land to real estate developers to generate cash. Huh?

You’ve got to be kidding: With the current depressed state of the housing market, developers aren’t exactly chomping at the bit to buy more land. After all, many of them are still writing down the value of land they already own.

Timber REITs Taking A Big Hit Before The Dust Settles

While it’s clear that timber REITs are going to take a big hit to their balance sheets before all the dust settles, there are others that will likely be the biggest losers of all.

You see, over the past few decades, university endowments, pension funds and Timber Investment Management Organizations (TIMOs as they’re referred to) plowed an estimated $40 billion into timberland.

TIMOs are privately run organizations that hold and manage timber on behalf of institutional investors. Here’s the big problem: The funds that the TIMOs manage have predetermined liquidation dates, and many are coming due in the next several years.

When that happens, timber industry land prices could fall even further.

One notable exception to the REITs woes is Rayonier (NYSE: RYN). It has a much more diversified stable of holdings; namely its performance fibers division, which are used by customers around the world to make certain kinds of plastics, LCD screens, pharmaceuticals, food products and more.

The bottom line is that investors who own any of the timber REITs – with the exception of Rayonier – may want to consider lightening their position or eliminating it all together. Investors could also consider establishing a short position in Plum Creek, Potlatch, or Weyerhaeuser, the three stocks most likely to fall the hardest over the next 12 to 18 months.

Good investing,

David Fessler

Source: Overvalued Timber REITs: Why Timber Investing Isn’t What It Used To Be

Good day… We had just an amazing weekend of weather here in St. Louis, and this morning is shaping up to be another beautiful day. Friday turned out to be a beautiful day for those who have taken our advice and diversified their holdings out of the dollar. Risk aversion was placed on the back burner again, and investors moved money back out of the dollar into higher yielding currencies. The dollar and yen got sold but all other currencies rallied, and investors also turned back toward gold pushing the metal above $950 for the first time in over a month.

So what caused all of this confidence? First, the housing data released Friday morning in the US showed a slight pick up in both building permits and housing starts. While the housing markets have a long way to go, the data have given investors an indication that construction may have found a bottom. Not to throw cold water on investors confidence in the building numbers, but while the residential market may be bottoming out, the commercial market continues to tumble. I spoke to a good friend over the weekend who is a commercial real estate developer down in Memphis. He told me that his development pipeline has completely dried up, and even the brokerage side of his business has slowed. The only part of his business which has picked up is the marketing of foreclosed properties. He has shifted his concentration to helping banks and lenders ‘work out’ of commercial projects which they have taken back onto their books. The economy has kept most companies from opening new stores, and many continue to shut down under performing ones. My good friend tells me most of the people he talks to don’t believe the commercial real estate market will turn around until the end of next year. Not good news for the banks who are still reeling from the residential real estate bust.

But I digress. Investors weren’t focused on the commercial real estate market on Friday, they were just happy to see a possible bottom in the residential sector. Their confidence was boosted further after rumors spread that CIT would likely be saved from bankruptcy. Sunday these rumors were confirmed as it was reported that the CIT Group board had reached an agreement with bondholders that should keep the struggling business lender out of bankruptcy court. According to the Wall Street Journal, the deal won’t permanently fix the company, but it buys time for the lender to restructure itself.

We have blasted the administration in the past for the way they are handling the economy, so to be fair I will have to give them kudos for the way they handled the CIT meltdown. Instead of throwing good money after bad (the taxpayers have already given CIT $2.23 billion of TARP funds), Geitner and Bernanke passed on an AIG type bailout, and even stayed away from arranging a Merrill Lynch style ’shotgun wedding’. Instead, they did exactly what they should have done and let the markets rescue CIT. It is still yet to be seen if the restructuring will ultimately work, but it is good to see the private capital markets are being left to their own accord, without intervention by the Fed. (Yes, I know the Fed is still involved, but not AS involved as they could have been!!)

The Euro climbed on Friday on some good economic reports. It was reported early Friday that Europe posted a trade surplus for a second month in a row. May’s trade surplus rose to 800 million euros as exports fell less than imports. The data add to evidence that commerce with the rest of the world will likely pull the Euro region out of the recession. Another report showed German producer prices fell at the fastest rate in more than 40 years last month as energy costs declined and demand weakened. The June decline of 4.6% from a year earlier was the biggest drop since December 1968. Lower producer prices are a good for the European economy where industrial production rose for the first time in nine months in May and manufacturing orders in Germany increased the most in two years.

The rally by the Swiss franc was dampened by intervention as the Swiss National Bank sold the currency to halt its rise. The sales, which occurred over the past few weeks, were the SNB’s first solo currency market interventions since 1992. While they have been able to beat back the currency markets for now, the SNB doesn’t have deep enough pockets to fight a long protracted war against the currency market. As Chuck has pointed out several times in the past, intervention can move the market in the short term, but it takes a very large amount of reserves and an iron willed effort to fight the longer term trend. The Swiss franc will likely keep pace with the Euro, as both gain vs. a falling US$.

As investors regained their confidence, the higher yielding currencies of Australia and New Zealand advanced. Both currencies moved up over 1.5% vs. the US$ and hit the highest levels in two weeks vs. the Japanese yen. The Canadian dollar also rallied, completing its first five-day increase since May. A run up in crude oil helped strengthen the loonie by over 4% vs. the greenback last week.

Chuck is waking up in Vancouver this morning, his favorite city located north of St. Louis. While he spent most of the day yesterday traveling, he was able to send me the following from David Rosenberg, who is usually pretty good with his thoughts….

“It is the second anniversary of the credit crunch and after all of the fiscal and monetary policy initiatives, the best we get are “green shoots” and now that story is getting stale. Go back two years and you will see that the Fed Funds rate was 5.25%, Today it is zero. The fiscal deficit was 2% of GDP two years ago. Today it is 13%. Mortgage rates were 6.5%. Today they are 4.7%. Homeowner affordability with all the government measures is 70% stronger today than it was then too. The Fed’s balance sheet then was $850 Billion. Today it is bloated at $2 Trillion. The government has tried just about everything. Or has it? What if we were to tell you that the one policy tool that is unchanged since the summer of 2007 is… The U.S. dollar? It is exactly the save level now, on any trade-weighted measure, as it was back then. The greenback is struggling at the 50-day moving average, and this could well be the next policy shoe to drop… ”

David makes an excellent point. In spite of all of the negative numbers with regard to the US economy, the value of the dollar is basically unchanged over the past two years. This is bound to change, as US policy makers will have to let the dollar fall in order in the face of rising inflation and skittish foreign investors. As we have repeatedly pointed out, the administration has three choices with regard to the tremendous debt load which has been built up in recent years. 1) They can increase revenues (yes, they are increasing taxes, but these increased taxes are already spent on the new health care program). 2) They can decrease expenditures (big government is back, expenditures aren’t going to fall anytime soon!). 3) They can let the dollar fall in order to pay back the debt with cheaper dollars (the most likely scenario!!).

As always, we encourage you to protect yourself from the eventual drop in the value of the dollar by diversifying your investments into other currencies and gold or silver.

We start what looks to be a pretty light week of data here in the US with the Leading Indicators index which will be released later this morning. This is the Conference Board’s gauge of the economic outlook for the next three to six months and is expected to show an slight increase. If so, it would be the first time the index has shown three consecutive months of increases since 2004. But even those that are expecting the index to show another rise are preaching caution. Most economists believe that even if the index indicates the recession is ending, recovery will be slow. High unemployment and cautious consumers will keep the US economy under pressure.

After today, the markets will have to turn their attention to the weekly jobless claims to be released on Thursday as tomorrow and Wednesday will only bring the ABC consumer confidence number and MBA Mortgage application data neither of which are closely watched. We will also get more data on the housing market on Thursday with the release of Existing home sales data. Friday will close the week out with the U of Mich confidence number. As I said, should be a rather slow week on the data front. Now on to the currency wrap-up:

Currencies today 7/20/09: A$ .8113, kiwi .6535, C$ .9057, euro 1.4216, sterling 1.6522, Swiss .9366, rand 7.9646, krone 6.3411, SEK 7.7407, forint 192.16, zloty 3.0236, koruna 18.1879, yen 94.61, sing 1.4399, HKD 7.750, INR 48.255, China 6.8320, pesos 13.26, BRL 1.9261, dollar index 78.92, Oil $64.74, 10-year 3.69%, Silver $13.7175, and Gold… $952.98

That’s it for today… As I said in the opening paragraph, the weekend weather was just phenomenal here in St. Louis. I competed in another triathlon yesterday, and did ok; not a personal best, but ran through some pretty bad leg cramps. Congratulations to my training partner, Matt B. who ended up the overall winner. And a big congrats goes out to Tom Watson, who just missed an 8 foot birdie put to become the oldest person to win a major. It is an inspiration when a guy almost double the age of his competitors can go out and beat all but one! Hope everyone has a great start to your week and a Marvelous Monday!!

Source: Risk Aversion Disappears Again

REITs are still in the early stages of a huge deleveraging cycle that will last for years, which means that the REITs that concentrate on commercial real estate may be a deceptively dangerous asset class.

Our story begins with the massive credit bubble – and related housing bubble – of the last several years. These twin bubbles powered a dramatic rise in consumer spending. Some significant portion of commercial real estate sprouted up to serve and satisfy this artificial demand. From the top to bottom of the U.S. economy, easy access to credit during the last several years powered excess consumption – and a frenzy of knock-on commercial ventures.

Accordingly, shopping boutiques popped up everywhere, along with restaurants, real estate offices, home-furnishing stores, art galleries, etc. All of these enterprises unwittingly relied on credit-fueled demand, and believed that this demand was “normal.”

But now that credit has disappeared from the U.S. economy, thousands of businesses are discovering that they cannot survive the new normal – the one that relies on actual paychecks and savings, NOT credit. And so, one by one, business doors are closing and the empty commercial spaces are piling up.

“The severity of the recession is turning some malls that were once viewed as viable into potential casualties,” the Wall Street Journal recently observed. “‘Any mall that’s sitting on life support is probably going to get its plug pulled as the economy stalls,’ says Michael Glimcher, chairman and CEO of Glimcher Realty Trust, which owns 23 U.S. properties, including Eastland Mall in Charlotte.”

The distress in the commercial real estate market would be serious, even if credit were still flowing freely. But credit is contracting, which means that commercial real estate is in especially dire circumstances. Refinancing commercial properties has become an extremely difficult task. Without the ability to refinance – or to sell at a profitable level – properties will continue to stumble into foreclosure and liquidation, which will put continuous pressure on property values.

Owners of underwater properties will have to either default and hand the title over to the lender, or they’ll have to inject an impractically large amount of new equity into the property to qualify for refinancing. And in these cases, we are talking about face-to-face negotiations between borrowers and lenders. In the modern “securitized” economy, face-to-face negotiations have become as rare and quaint a concept as the corner malt shop. In the modern economy, most mortgages are sliced and diced into unrecognizable portions of various mortgage-backed securities (MBS).

Think of securitization this way: Image your pet pig ran away from home and stumbled into a sausage factory. If you searched for your pig at the end of the sausage production line, you probably couldn’t find him. He’d be there alright, but not in a form you would recognize. He is there; but he is now everywhere. So is your mortgage.

Securitization is, therefore, a very toxic aspect of this particular commercial real estate bust. Simply stated, securitized mortgage structures are not designed to function in our current environment — one with falling collateral values and soaring defaults. Let me highlight the loan restructuring challenge ahead for troubled commercial property owners and their lenders.

Take just one example of evaporating equity in commercial properties. It shows why stressed property owners cannot easily renegotiate terms with their lenders. A few weeks ago, Sunstone Hotel Investors Inc. defaulted on its mortgage on W San Diego hotel. Sunstone bought the W for $96 million in 2006. The transaction was financed by a $65 million mortgage that was sliced, diced, and sold into the commercial mortgage-backed security (CMBS) market. The W’s value is now below the face amount of the mortgage, so Sunstone will likely write its equity down to zero and turn the deed for the W (i.e., the mortgage collateral) over to creditors in order to eliminate its mortgage obligation.

Sunstone defaulted when it skipped its June 1 payment on the W hotel’s mortgage. Thus, Sunstone basically invited its servicer, Centerline Servicing, to foreclose on the hotel. Centerline represents the interests of the lenders, who are spread throughout the ownership structure of CMBS. Without the chance to renegotiate, the only real option is for lenders to foreclose and auction off collateral. Even worse, if Centerline were to approach the lenders about restructuring the mortgage, the lenders would have different objectives — some would want to liquidate collateral to get paid, while others would prefer to renegotiate and hope for a rebound in collateral value. This is known in the securitization business as “tranche warfare.”

From a legal standpoint, borrowers are too far away from ultimate lenders. The complex legal structure of CMBS practically guarantees that sensible loan restructurings, including debt-for-equity swaps, are very difficult.

Now apply this situation to hundreds of other properties around the U.S., and you can see how securitization (CMBS) practically eliminates the potential for property owners to meet with their creditors and renegotiate. Private sector creditors who want to participate in fire sales and in very attractive loans are waiting for property to fall to more reasonable levels first. Banks are not going to refinance commercial mortgages coming due on properties that are down 50% from peak values, and no equity is left. This means that the foreclosure market will dominate the overall market, pushing values for every comparable property down even more.

There will not be any legitimate bottom in the REIT market until there is a bottom in the prices of commercial real estate mortgages. The smart institutional money will initiate its investment in real estate by buying the distressed mortgages of attractive properties, NOT by buying REIT shares. These investors will want to buy claims on commercial property market that are high up in the capital structure, not gamble on equity in properties, which may be worth a fraction of peak values — or zero. That’s why I’m monitoring transactions in the commercial real estate debt markets, looking for signs of a true bottom.

The “bottom” we saw in early March was almost entirely due to the Fed’s extraordinary commitment to print money in an attempt to prop up old bubbles. This caused a temporary rally in CMBS and REITs. The most stressed REITs used this as an opportunity to de-lever their balance sheets just a smidge by flooding the market with new shares. With the window for REIT secondary offerings closing, by fall we should see another leg down in the Dow Jones U.S. Real Estate Index.

The real buyers for CMBS and commercial property are professional investors – not the Fed or taxpayers. By and large, these professionals are waiting for bargains, with bids far below the current market.

So should you.

Source: Sell REITs

Yet the stocks of real estate investment trusts (REITs), which are popular among income-oriented retail investors, are still trading at high enough levels that discount just a garden-variety recession in commercial real estate. REITs were designed to invest in portfolios of rental properties, and generally pay no corporate income taxes if they distribute at least 90% of their profits as dividends to their shareholders.

REITs were designed to thrive in an environment of steadily rising property values and rents. But in this ice age for commercial real estate, the REIT business model will cease to function properly; a REIT’s tax-free status doesn’t allow it to retain much excess capital during lean times. Since REITs pay out all their earnings, they cannot grow without taking on more debt. During the boom, a REIT strategy encompassing growth, leverage, and acquisitions was a virtuous cycle that led to juicy dividends and soaring stocks; in this bust, it’s morphed into a vicious cycle of dividend cuts, dilutive equity offerings, debt offerings at double-digit interest rates, and bankruptcies.

The REITs that levered up and grew too fast at the peak will go to zero in bankruptcy. Others could fall into the low single digits by year-end as the market anticipates that creditors will take title to many properties in 2009 and 2010. These developments would push the value of the REIT Index dramatically lower.

$1.6 Trillion in Commercial Real Estate Debt Needs to Be Refinanced

The REIT sector is undercapitalized – just as the big banks were last year. If you mark the value of commercial real estate to market, it tells you that REIT debt in all its forms – commercial mortgages, unsecured notes, secured lines of credit – is much too burdensome. Equity cushions that seemed adequate at the commercial property market peak are now thin. REITs don’t have to mark their assets to market each quarter like investment banks. But you can be sure that before committing a single penny to a secondary offering of REIT stock, institutional investors will mark property portfolios to market.

Marking property to market will result in many underwater commercial properties. This is critically important because the combination of underwater properties (insolvency) and imminent debt maturities (illiquidity) tends to wipe out equity. The maturities over the next five years are staggering, and these debts were sloppily underwritten near the peak of the credit bubble. According to Goldman Sachs research, roughly $1.6 trillion in commercial real estate debt is coming due 2009-2013.

Lenders will not be willing to refinance mortgages in situations where mortgage debt exceeds the value of the property – so-called “underwater” properties. In order for all of these $1.6 trillion in loans to qualify for refinancing, hundreds of billions in new equity will need to be injected into properties. This much new equity capital dedicated to commercial property ownership will not exist in the investing environment of 2009-2013, so many of these loans will default.

In a scenario of paying off staggering debt loads under stress, the claims of common shareholders are either diluted or wiped out completely. This is the scenario facing General Growth Properties, and shareholders will be lucky to recover anything. You can find shades of the General Growth saga throughout the REIT space.

The Credit Markets Are Signaling Danger for REITs

Bulls argue that REIT stocks are cheap enough to buy. After all, they’ve declined to the point that you’d be buying ownership stakes in commercial real estate at prices well below peak values. Also, the high dividend yields already reflect plenty of pessimism.

What is the credit market’s response to REIT bulls? Creditors will take title to many properties in bankruptcy, and dividends will be paid mostly in new shares of REIT stock, rather than cash. I side with the credit markets.

A review of the aggregate REIT balance sheet – and the delusional commercial real estate purchases during the 2006-2007 peak – will tell you that this won’t be a garden-variety bear market in REITs. Supply of retail, office, hotel, and industrial space will greatly exceed demand for several years. In most cases, tenants will have the upper hand in lease renegotiations. This bear market, which is still in its early stages, will go down as the worst REIT bear market in history.

Will the TALF Bail Out REIT Shareholders?

So will the TALF come to the rescue? Wasn’t the Federal Reserve’s “term asset-backed securities loan facility” (TALF) designed in part to mitigate the systemic damage from the time bombs ticking inside of CMBS? A primary reason for the recent rally in REIT shares is hope that the TALF will help restore value to equity of the most-indebted REITs by loosening up lending for commercial mortgages. The Dow Jones U.S. real estate index rallied from an intraday low of 80 in early March to a recent 130 (see chart below). But this REIT rally is based on hope, rather than strong fundamental evidence.

The Fed does not restore equity value to leveraged financial companies sitting on toxic assets; it merely tries to prevent stressed borrowers from unwinding positions too quickly. Look at how little equity value the Fed’s unprecedented lending facilities salvaged for Citigroup (NYSE:C) shareholders. TALF will do little to preserve equity value for highly indebted REITs. The Fed did not eat the losses on Lehman Bros.’ garbage securities, nor will the Fed or the Treasury eat losses that must be first absorbed by shareholders of overleveraged REITs.

Plus, potential limits on executive pay could limit interest in TALF participation. Special Inspector General Neil Barofsky said in a recently published report that executives involved with the TALF program “could be subject to the executive compensation restrictions.” Whether or not compensation restrictions are enacted as part of TALF, the mere threat of capricious rule changes and taxes imposed by Congress and the administration will scare many potential managers away from TALF.

While there are certainly opportunities to be had in this market, as I see it, REITs aren’t one of them. That said, after the closing bell today, I’m recommending an exciting new play to my Strategic Short Report readers that could generate as much as $200,000 in profits. If you want to be one of the first to act on this opportunity, visit the Strategic Short Report website for more details.

Regards,
Dan Amoss

Source: Beware of the REIT Reality

Given that home ownership is a cornerstone in almost every wealth-building plan, this is astonishing.

Even if the days of selling a house for an enormous profit are over, building equity in a home beats the pants off paying rent.

Of course, ownership is not always better than renting, but in most cases, it still is. And even if home prices are flat, building a little bit of equity makes it worth the cost of ownership, especially when you add in the tax breaks associated with owning a home.

Trouble is, some of the statistics are frightening:

• One-third of those surveyed don’t believe they’ll ever be able to afford a home.

• Forty-two percent of those who once purchased a home, but no longer own it, don’t think they’ll ever be able to afford to buy another one.

Recently, Karim Rahemtulla detailed the problem that the large number of short-sales are causing in the real estate market. Today, I’m going to give a couple of tips to both house-hunters looking for bargains and investors looking to “buy on fear.”

Buying Property With “Blood in the Streets”

There’s an old Wall Street axiom that says you should “buy when there’s blood in the streets.” And throughout the real estate market, there is clearly blood in the streets.

In some markets like in Oakland, California – where prices have dropped 32% in the past year and 75% of first quarter home sales were distressed sales – there’s not only blood in the streets, there’s a virtual river of the stuff flowing down Broadway & 17th St.

But if you’re considering buying a property – either as a primary residence, investment property, or vacation home – now is probably a good time to start looking. Desirable vacation and retirement spots such as Southern California, Miami and Naples, Florida, Phoenix, Arizona and Las Vegas, Nevada have suffered a particularly bad beating and likely contain many desperate sellers and foreclosed properties.

And even in markets that have held up relatively well compared with the rest of the nation, you can likely find some bargains…

Use Homeowner Desperation to Your Advantage

Take Asheville, North Carolina, for example…

The average sales price of a home there is only off by about 15% from the peak, but homes are now sitting on the market for an average of 144 days, up from 94 days. The number of houses sold in 2009 is down by one-third from last year.

Even Austin, Texas, which has weathered the real estate storm better than most, has seen the average price of a single-family home decline by just 3% from a year ago, but volume has slipped 25%.

As Karim suggested on Tuesday, the best strategy may be to find a desperate seller who is forced to compete with short-sales and the foreclosures. Plus, you’re likely to get the deal wrapped up in a much more timely fashion than if you’re dealing with the banks’ lawyers. Sure, you may find bargains on foreclosed properties and short-sales, but the process will take much longer.

For those of you not looking to buy a house but still like the idea of buying fear, consider this option…

Go Contrarian on Commercial Real Estate

Many experts believe commercial real estate will be the next big shoe to drop. And my colleague David Fessler, recently published some alarming statistics about it. Take a look:

• During the first quarter, businesses vacated 8.7 million square feet of retail space. Not only was that a 10-year high, it compares with 8.6 million square feet vacated for all of 2008.

• Vacancy rates at regional malls, strip malls and neighborhood centers are increasing at the highest rate in 30 years.

But if you’re looking for an uber-contrarian way to play this commercial real estate trend, consider REITs (Real Estate Investment Trusts) that specialize in commercial property.

Take a look at Kilroy Realty Corp. (NYSE: KRC). Founded in 1947, it develops and manages office and commercial property in Southern California – one of the hardest hit markets in the country.

The firm just cut its dividend to $1.40 per year, but that still equates to a beefy 7% yield. It’s cash flow positive and has a healthy return-on-equity.

Currently trading at just under $20 per share, it’s down considerably from its high of $88 back in February 2007.

And while it’s not always easy to buy when everyone else is selling, history has proven time and again that it is precisely those who are able to buy in scary times are the ones who make that make the most money.

Hoping your longs go up and your shorts go down.

Good investing,

Marc Lichtenfeld

Source: How to ‘Buy on Fear’ in Real Estate