By Porter Stansberry in the S&A Digest:

Real estate investment trusts (REITs), which own everything from shopping malls to apartment buildings, have soared 60% since bottoming on March 6. But we think there's much more pain to come in the commercial real estate (CRE) sector. Here's what the REIT bulls don't know - or are choosing to ignore...

REITs have $152 billion of debt coming due through 2013. These companies will either be forced to roll over the debt - a difficult task in the midst of a credit crunch - or default. And a lot of these companies already have dangerously high debt levels. Maguire Properties has 94% debt to capital. Meanwhile, occupancy rates are still decreasing, meaning cash flow is decreasing... Office REIT Kilroy Realty saw its occupancy rate approach 85% - the minimum level allowable under its loan covenants. It had to get the banks to waive them.

Investors buy REITs for their large yields. Near the March bottom, the average REIT yield was an impressive 10% (T-notes were yielding 2.65%, corporate bonds 7.35%). Now, they're down around 4.7% - less than much safer and stable investment-grade corporate bonds.

Plus, Samuel Lieber, president of Alpine Woods Capital Investors, has found the commercial real estate market lags housing. He told Bloomberg, "Housing stocks peaked in 2005, and REITs in February 2007, so REITs have two more years in their recovery cycle."

We're not the only CRE bears out there. At the end of the first quarter, Deutsche Bank expected the delinquency rate for CRE loans to reach 3.5% by the end of the year. But last week, Deutsche released some revised numbers... saying things will get much worse. As of June 30, Deutsche now expects defaults to reach 7% (from a current 4.1%) by year's end - doubling its previous estimate in a matter of months. The bank says the rate of deterioration exceeds the 1990s, following the S&L crisis, and has increased by 360 basis points (3.6%) in the past 10 months.

Crux note: The S&A Digest comes free with a subscription to Porter Stansberry's Investment Advisory. In this month's edition, Porter is recommending a stock that he believes to be his best pick in three years. Shares will have to triple in order to reach their intrinsic value. To learn more, click here...

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