by David Fessler, Advisory Panelist
Thursday, June 18, 2009: Issue #1021
On April 17, I wrote about the massive train wreck coming in commercial real estate.
As it turns out, my estimates of the coming devastation – which seemed outlandish to some at the time – have actually turned out to be too conservative.
The problem is far worse than anything that’s been reported so far, particularly when it comes to our icon of consumerism: the shopping mall.
With retail losses continuing to accelerate and vacancy rates skyrocketing, malls are going to be one of the biggest losers from the consumer spending slowdown…
Here’s why our shopping malls, and by extension the commercial real estate market, aren’t going to be moving anywhere but down over the next few months – and what you can do about it in the meantime.
Don’t Be Fooled By Housing Starts Recent Uptick…
Much has been made of the recent uptick in housing starts in May, but don’t be fooled – this is simply seasonal. In the northern half of the country, foundations can’t be dug during the winter months, so there is always a “spring surge” in housing starts.
The Obama administration predicted that without the recovery plan, unemployment would peak around 9% in 2010. With the plan in place, the estimate was 8%, and that we’d hit it this year…
- The official Bureau of Labor Statistics number is at 9.4%. But even though unemployment rates are easing slightly, the overall number of unemployed is still rising.
- And it gets even worse when you throw in the 2.2 million additional people that are so discouraged they’ve quit looking for work, and today’s number jumps to 10.8%. These individuals haven’t even shown up on the rolls yet.
- With few companies announcing even minimal hiring plans, it’s highly likely that the ranks of the unemployed will continue to swell to 11% to 12% sometime in 2010.
What does this have to do with commercial real estate and shopping malls? Plenty. As I’ve said before, it all starts with the consumer.
- In America, the consumer’s long-term contribution to our Gross Domestic Product (GDP) is around 65%.
- But for the last five years or so, it’s been over 70%.
- That is, until the fourth quarter of 2008, when it dropped off a cliff.
And therein lies the problem: Fewer employed workers means less discretionary spending, fewer homes being built, bought and sold, fewer trips (or none) to the local mall, fewer warehouses needed, less manufacturing, less transportation… all resulting in a big pullback in GDP.
Consumers are spending less, not more. When they do spend, it’s on staples: food, gas and clothing.
The normally big-spending teenage segment is currently experiencing a 22.7% unemployment rate. So instead of going to their former favorite hangouts – the shopping malls – they’re hanging out at each other’s houses. (I know this to be true, as my son is entertaining a group of friends at our house as I write this.)
Are Fears of Commercial Real Estate Fallouts Overblown?
Many so-called “experts” in the commercial real estate field have said the fear of commercial real estate fallouts and failures are overblown… that it won’t be as nearly as bad as people like myself are predicting.
They’re dead wrong.
They’re ignoring the fact that there’s always a lag between when the economy heads south and when commercial real estate does. Let’s face it: Some stores can coast for a few months – or even a year – while they wait for a pickup in business. But that pickup isn’t coming anytime soon.
The reality is that many mall-based stores haven’t renewed their leases – their lack of income is forcing their hand. Many others are underwater financially, and only months away from closing.
When national chain Ritz Camera filed for Chapter 11 bankruptcy protection, 300 stores in malls all across the country immediately closed. The result isn’t hard to picture.
- A report from the New York-based research firm Ries, Inc. indicates that retail tenants vacated a 10-year high 8.7 million square feet of retail space in just the first quarter of 2009.
- That compares to 8.6 million square feet… for all of 2008.
- Kyle McLaughlin, an analyst at Ries, says that vacancy rates at strip malls, neighborhood centers and regional malls are increasing at rates not seen in 30 years. “We’ve never really seen deterioration of this order in occupied space since 1980. We don’t see much in expectations for improvement throughout the rest of this year and next year.”
Reis indicated that their forecast assumes positive job growth and an increase in consumer spending starting in 2010.
Here’s the problem with that assessment: It’s ignoring what’s really going on outside their offices – unemployment is still rising, and that means fewer consumers spending less money.
Don’t look to the emerging markets to bail us out, either. The Chinese, Brazilians, Russians and Indians can’t just run down to our local malls to shop.
The problem is made worse by vacant storefronts, which hurt the few remaining stores. When the stores on either side of a remaining store closes, less traffic comes by and, well, you get the picture.
All this puts shopping mall owners and landlords in a big financial squeeze play: They’re forced to drop rents at a time when less money is coming in due to rising vacancies.
Commercial Real Estate Loans Mature - Bigger Problems Arise
The problem is about to get very, very big: Between now and 2011, as much as $814 billion in commercial real estate loans will mature – and need to be refinanced. The problem is that the credit markets are still too tight for most commercial projects.
Most banks have tightened their lending standards, reduced the amount they are willing to lend and significantly reduced the value of the collateral (malls). This leaves many owners with little choice but to turn to the Feds.
Back in May – and with much fanfare – the Federal government announced it would soon be expanding its Term Asset-Backed Securities Loan Facility (TALF). It now plans to include existing securities backed by loans for apartment buildings, office complexes, shopping centers and other commercial property.
But these programs aren’t an industry panacea. If you read the fine print, they provide backing only if the securities are rated AAA by major rating agencies. This excludes just about all the needy real estate – and the REITs that own it – from participating in the program.
How to Play the Commercial Real Estate Fallout
So, how do we play the commercial real estate fallout? The bottom-line is this: Many shopping malls in this country are simply going to disappear. Supply and demand will ultimately determine how many. All this bodes well for really big operators like Kimco Realty (NYSE: KIM) and Simon Property Group (NYSE: SPG), long-term plays that are large enough to weather the lengthy storm.
But for short-term investors looking to pick up some companies on the bottom, beware of going long just yet: While the market has already baked in a lot of bad news, uncertainties surrounding any additional big chain bankruptcies persist.
That means many REITs still have further to fall.
If you’re looking for an investment option that plays this angle, a dropping real estate market bodes well for ProShares UltraShort Real Estate (NYSE: SRS). It seeks investment results equal to twice the inverse of the daily performance of the Dow Jones U.S. Real Estate Index.
In the coming weeks, I’ll take a look at the office and industrial property side of commercial real estate that, unfortunately, isn’t much better off than the malls.