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Wechsler: Why REITs Are Ahead of the Recovery Curve

WASHINGTON, D.C. — The recapitalization and recovery of the nation’s commercial real estate industry promises to be a “difficult and painful journey” over the next few years, but major steps taken by publicly traded real estate investment trusts (REITs) provide a potential roadmap to renewed financial health.

U.S. REITs have raised $15 billion of equity from the public capital markets year-to-date and several billion dollars more in debt from the public bond markets. The moves have helped boost REIT stock prices significantly in recent months, Steven Wechsler, president and CEO of the National Association of Real Estate Investment Trusts, told a group of real estate writers and editors gathered last week for a national conference.

The capital-raising efforts follow a prolonged downward spiral in the performance of REIT stocks. Indeed, the FTSE NAREIT Index declined approximately 75% between February 2007 and early March of this year. Since then the index has risen about 50% off its lows, but still remains 50% below peak levels. “As investors see that companies have a way forward by raising more equity, stock prices go up because there is less concern about their ability to refinance in 2010, 2011 and 2012,” said Wechsler.

Historically, the public real estate market leads the private real estate market by four to six quarters, he emphasized. “If you think that March of this year was the bottom for publicly traded real estate, which may very well prove to be the case, we will not hit bottom in the non-public part of the commercial real estate market until some time next year.”

Wechsler’s insights came during a panel discussion titled, “Commercial Real Estate in the Obama Era: Next Domino to Fall?” Jamie Woodwell, vice president of commercial and multifamily research for the Mortgage Bankers Association, and Chip Rodgers of the Real Estate Roundtable also participated on the panel.

REITs account for about 10% of the $6 trillion commercial real estate market, according to Wechsler. “Is commercial real estate the next shoe to drop? My response in looking at the 10% is the shoe has dropped.”

Today’s Great Recession and persistent credit crunch are putting downward pressure on building valuations, he added. For starters, investors require a higher risk premium in this uncertain environment. Secondly, the mounting job losses are taking a toll on property performance because tenant demand for space has waned.

“Because real estate tends to lag the economy, there is an expectation that we’ll continue to see operating level income from commercial real estate around the country decline for a period of time,” said Wechsler. “That further erodes valuations in the commercial real estate market.”

While it’s not uncommon today for banks to grant loan extensions to struggling borrowers, Wechsler doesn’t expect that trend to last. “At some point in time when the banks get healthier, there will be much less appetite to extend those loans. They will either want the owners to come up with more equity, or they’ll take the property back and sell it off to owners who have equity and are strong enough to acquire the properties.” Overall commercial real estate values have fallen anywhere from 35% to 50% in this current cycle from its peak, according to Victor Calanog, chief economist for New York-based research firm Reis.

The need to recapitalize portfolios could become especially acute for private investors who acquired real estate assets at the height of the market frenzy in 2005, 2006 or 2007, said Wechsler. “It will be played out increasingly in a public fashion. To date it’s only been played out publicly in the REIT space.”

The three-day conference of the National Association of Real Estate Editors runs through Saturday at the Hilton Washington Embassy Row.

Quotable: Jamie Woodwell, vice president of commercial and multifamily research for the Mortgage Bankers Association, reflecting on the perfect calm of January 2007:

“What we saw across the market was the exact opposite of [today’s] perfect storm. You had rapid appreciation of property prices, you had strong property performance, you had capital markets innovation. You had lots of capital coming into the market. You had all these things that were pushing mortgage debt outstanding to record highs, origination levels to record highs, and delinquencies to record lows.”

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