By Dan Ferris in the S&A Digest:
A hotel REIT, Sunstone Hotel Investors, is handing over its 258-room W San Diego hotel to lenders because it can't renegotiate terms on the hotel's $65 million securitized mortgage. The company bought the W for $96 million in 2006 and hasn't produced enough monthly income to cover operating costs and interest since 2007.
The hotel has an occupancy rate of 69% and generated revenue per available room of less than $153. Sunstone estimates the value of the W hotel is "much less" than the $65 million balance on its mortgage.
And the REIT may be handing over the keys to some of its other 43 hotels... It recently changed a major bondholder provision, saying any default on a separate Sunstone loan of up to $300 million wouldn't trigger default with Sunstone bondholders (or cross-default). Previously, the cross-default threshold was $25 million.
If Real Estate Econometrics is right, there'll be a lot more Sunstones by the end of the year. The property research firm says defaults on commercial mortgages held at U.S. banks could hit a 17-year high by the fourth quarter, after hitting a 15-year high in the first quarter. Falling rent collections make it hard to service high debt loads… and the ensuing drops in real estate values make it hard to restructure loans. Commercial real estate is in a sort of deleveraging death spiral.
John Levy of John B. Levy & Company, a real estate investment bank in Richmond, Virginia, expressed the same general sentiment on a recent podcast: "There's no doubt about it. We are in the throes of a violent deleveraging." Levy says he's "never seen anything like these current conditions" and expects values to decline 25%-40% from their peak.
That's almost certainly optimistic, since deals like the John Hancock Tower in Boston have happened at prices 50% below peak.
Even though property values are falling, and real estate deals are imploding left and right, the recent market rally has helped more than three-dozen REITs raise more than $12 billion of new equity, which seems eerily familiar...
The combination of a market rally and rampant new share issuance from issuers whose future isn't terribly bright reminds me of 1999 and early 2000. That's when the Nasdaq soared from about 2,500 to a peak of just over 5,000, and IPOs were popping up everywhere like stretch marks on a fat man at a pie-eating contest.
Back then, nobody thought stocks were risky, and hot tips oozed from every cabbie, bartender, and shoeshine boy.
Well, maybe it's not exactly like the tech bubble, since IPOs aren't the hot ticket today. But new equity is nonetheless being printed at a record pace... According to a recent Bloomberg story, more than 150 companies raised $82.2 billion in new equity last quarter - a faster pace of equity issuance than at the height of the equity bubble in 2000.
All the new shares have diluted corporate earnings by a little over 3%, using the S&P 500 as a benchmark. The widely watched index's total shares have grown 3.4% since March 31, meaning earnings are now divided by a larger number... making earnings per share into a smaller number. Standard & Poor's has reduced its 2009 earnings-per-share estimate to $57.23. With the S&P 500 around 940, it's selling for over 16 times earnings. That's historically about average.
Crux note: Dan Ferris is the editor of the value advisory service Extreme Value. He's incredibly bearish on commercial real estate right now and has recommended selling short shares of one financial company in particular... This company is one of the largest holders of commercial mortgage-backed debt in the country, but its stock is rallying - even though the CIO admitted "the worst is yet to come." It's a prime short sale candidate. To learn more about Extreme Value, click here...
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