Goldman Sachs: REIT Valuation Back To "Bubble Levels"
Goldman is out with a new piece which highlights some substantial cautionary language on perspectives before the REIT landscape. Not surprisingly, the biggest question mark is the digestion of the peak in CRE delinquencies which is expected to occur over the next 12-24 months. This is no surprise to anyone who has walked along Madison Avenue golden mile: the mecca of ultra high real estate, where a deluge of recently emptied storefronts demonstrates the deterioration for the highest tier of CRE. One can only presume how much harder hit the middle and lower end of commercial real estate across America must be.
While the worst of the current US recession appears to have passed, we caution that CRE trends are just starting to soften and will remain weak into 2011; as such, REITs should underperform the broader equity markets during the next stage of the recovery (6-9 months). In fact, we anticipate a decline in FFO of more than 10% for REITs next year, on top of the 15-20% expected decline in 2009. Hence, 2011 should be the bottom with growth resuming thereafter. Over the next 12-24 months, we see the combination of rising CRE loan defaults, deteriorating fundamentals (similar to the 2001 downturn), and more stringent lending standards (50% LTV loans at higher rates) resulting in a “challenging road ahead” for REITs.
And this most notable disclosure from Goldman on REIT valuations:
We believe investors should use the recent rally in shares (+42% since July 13) to reduce exposure to the REIT sector. REIT shares now trade at levels not seen since the “bubble years” in credit from 2004 to 2007, based on a current EV-to-EBITDA multiple of 14.3X, or an implied cap rate at the mid-6.0% level. In our view, the stocks are indicating one of two outcomes: (1) low cap rates are here to stay (similar to Europe and Japan) or (2) growth rates will be significantly higher than we have projected in the near term. We do not see either outcome as likely.
A peculiar change to a very cautious posture for Goldman, which does present some of the positives in the space, virtually all derivatives of "unlocked" equity and credit markets. Then again, while it took a few brief months to go from systemic gridlock to credit bubble mania courtesy of trillions of liquidity pumped into the market by the Federal Reserve, the inverse is just as likely, and any sharp and dramatic reversal in equities is likely to lead to a freeze in funding of the kind we say in December 2008 and again in March 2009.
At the same time, we are beginning to see signs of life in the CRE funding market with several recent unsecured debt issuances in the 5.5%-8.5% range, depending on the credit profile of the issuer. This compares with all-in rates in the 10%-13% range only a few months ago and, thus, a materially improved market for raising capital.
And here are some representative charts demonstrating the euphoria that has gripped investors looking for yet another bubble.