REIT Warnings Suggest Looming Commercial Real Estate Pain

Election's over--back to reality. And the reality is: while credit conditions have indeed loosened somewhat recently, the financial de-leveraging continues.

Today's reminder of this reality came from the high-profile misses from leading retail REITs, General Growth (NYSE: GGP) and Kimco (NYSE: KIM). It might be tempting to write off General Growth's FFO shortfall as simply being due to a misstep in a residential condo project, but don't be too sanguine; more such problems are very likely to materialize across the office and retail REIT spectrum.

We've been saying for months that commercial real estate pain was on the way because we've looked back and simply could not find an instance in which a residential housing decline followed by a consumer credit decline has not also been followed by a commercial real estate bear. This makes perfect sense since retail, office and other commercial property markets are really derivatives of the overall economy.

Many REIT shares have traded down in anticipation of this outcome, but they may still not be fully embracing reality. Deals were done at ridiculously low cap rates, leaving no margin for anythin but the rosiest of business conditions. The cost of credit today is higher. Thus, if values decline, as they are almost certain to, commercial borrowers are going to be in trouble in a big hurry.

Real estate guys are classic. They never seem to learn their lessons from past downturns and they always lever right up into the bull markets. Indeed, around these parts we're already seeing once-spectacular net worths get tuned inside-out, are hearing how some of Orange County's leading real estate developers are struggling to work out of projects with lenders and how a couple of the area's REITs have recently shut down all new and ongoing developments.

Sorry to say, the post-election reality is that the end of our financial sector crisis is not at hand and that a commercial real estate bust is underway. Don't ignore today's warning signs.