26 May 2009

Trading the Woes of Commercial Real Estate

The real estate bubble is old news, priced into the market long ago. The focus has been on the housing side of things, but with the recent bankruptcy of General Growth Properties, the #2 mall operator, some media is starting to notice the shit's hit the fan in commercial real estate.

At the center of the worries is some $3.5 trillion in debt backed by everything from strip malls to offices and apartments across the nation -- the lion's share of which is badly underwater because this recession followed a five-year commercial property boom fueled by easy money and loose underwriting standards.

Now the owners of the less-than-full malls, apartment complexes and office buildings are succumbing to the worst economic collapse since the Great Depression -- because they can't refinance the debt.

The commercial debt securitization market is dead.

"Because there is no securitization the system cannot process the wave of maturities coming due," said Scott Latham, commercial property broker at Cushman & Wakefield.

"This is arguably the most important fact we're going to be dealing with. If there's no mortgage market that can feed the machine you're just not going to have deals," he said. "It's going to be years before we recover and even when that happens we're going to discover that we're in a new paradigm," Latham added.

About $1.4 trillion in real estate debt is set to mature over the next four years, with some $204 billion coming due this year alone.

The fundamental story is clear. Let's look at the technical side of things with an annotated chart of IYR, the iShares Dow Jones U.S. Real Estate ETF:

The nice upward channel recently ended. Now we're looking at a triangle formation with decreasing volume. It looks to me like this real estate rally has petered out.

How will I play this? I'll take a look at the 2X-levered short ETF, SRS. As you can see below, all of the cool kids are checking out SRS:

This chart of SRS shows that lots of money has evaporated during this bear-market rally. Shares of SRS have fallen from ~$111 down to ~$20.

My plan for this week is to look at picking up some shares of SRS, or at the very least, some June $25 calls.

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