September 09, 2009 - 10:06pm EST by
2009 2010
Price: 40.94 EPS na na
Shares Out. (in M): 55,900 P/E na na
Market Cap (in $M): 240,000 P/FCF na na
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT na na
Borrow Cost: NA

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This is a macro idea to short the IYR – Dow Jones Real Estate Index Fund – an ETF.  The ETF is very liquid and has an active options market.  I propose shorting the ETF as a means of shorting REITs.  The index is up over a 100% from its March 2009 lows. 


REITs have exhibited incredible volatility and some truly irrational trading in this great recession.  I propose IYR as a means to short a very overvalued asset class with significant issues, headwinds and fundamental deterioration over the next 2-3 years.  REITs today trade at under a 7% forward cap rate, historically tight dividend spread to the 10 year and very tight in relations to corporate credit spreads.   Given where CMBS (commercial Mortgage Back Securities) are trading and where recent asset sales have been across all aspects of commercial real estate, there is significant pain coming over the next 3 years in the sector.


So why am I proposing a macro ETF trade instead of digging into a specific company/stock/credit and laying out a short case for the Value Investor Club?  Because this equity market in REITS is irrational and shorting based on fundamentals or catalyst regarding any single company can be more risky (and outright dangerous) in this market environment. 


Individual equity valuations and fundamentals have been totally dominated by the “survival factor” – any corporate action to improve liquidity and corporate survival such as diluting the equity 50% (AMB) or issuing debt has been viewed as very positive and stock prices have increased on massive dilution, dividend cuts, fire sale asset sales and debt issuances.  At a certain stock price one could argue that survival factor mattered but recent rally, current valuations (cap rate of under 7% going forward) and equity market capitalizations point to issues other than just survival. 


The argument made by some REIT bulls and analysts is that REITs will be the main benefactor of buying distressed assets as they have access to capital markets.  That sounds nice but the logic is weak.  A REIT trading at a 6% cap rate may be able to issue equity or raise debt to buy a distressed asset.  But buying assets above its current cap rate by issuing equity to fund the purchase would imply that its equity and assets are overvalued.   It is unlikely REITs can use it stock as currency to buy distressed assets in a fire sale as they are primarily cash transactions/auctions.  


The risk in shorting individual REITs is that large REIT specific institutional investors have been anchoring secondary deals and may infuse capital to allow a particular REIT to buy assets or have access to capital.  There is little rationality in how REITs current trade – a historically low volatility dividend yield security has been a high volatility high beta asset class.  


The IYR with its liquidity and options allows one to express a negative view on REITS, on commercial real estate and on the excess speculation in the REIT sector with being subject to any company specific event.  It sounds kind of weird for having a short thesis on a sector but not wanting to short individual names in the sector.  But this market has been extremely dangerous to short individual names in the REIT sector because of trading dynamic, funding of secondary issues, ultra short/ultra long sector funds and excess speculation in the market.  The IYR and specifically put options on the IYR allows one to take a short view on REITs and commercial real estate with managed downside risk.  



Valuations coming in line with reality

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