Sunday, 06 January 2008 00:00

The Commercial Real Estate Crash Cometh, and I know who is leading the way!

A couple of weeks ago I informed readers that I was working on a big project concerning commercial real estate short candidates. I stated last year that I was sure CRE was headed down, hard. Well, I am now ready to start releasing the results of my research over the next week or so. Unfortunately, the market has moved against the subject of my research fiercely as I was completing it, but it appears to be far from over. Who is the subject of that research, you ask? General Growth Properties (GGP). I have actually seen this company pop up in the media and a few discussion groups from time to time, but they have no idea what the management of this company has been up to. First, a little background on how I got here. Those who are not versed in commercial real estate valuation are urged to read my quick and dirty primer on CRE valuation .

I told members of my analytical team to screen the commercial real estate trust, service, and development sector for the usual suspects, starting with the the guys that purchased Sam Zell's flipped properties from Blackstone. I made some of the companies available via blog post and download: icon Commercial Real Estate Cos. (43 kB). icon Forest City Enterprise Peer Comparison (198.98 kB), icon Vonardo Realty Trust (146.49 kB). After and exhaustive screen and resultant short list, we chose GGP. I then instructed the team to canvass local and national brokers (4), databases (5) and data aggregators (several) to get the most precise localized rental and expenses figures possible. This data, as well as purchase dates, prices, management actions, capital improvements, etc. were used to plug into models such as this 33 page illustrative example, icon GGPs Woodlands Village (612.34 kB), to ascertain the true value of GGP's portfolio. We also measured and valued their development operations, joint ventures, CMBS financing, off balance sheet vehicles and master planned communities. Sum total, I now have roughly 2 gigabytes of "REAL" valuation data on my servers covering 260 properties owned or partly owned by GGP. A this point, I may know more about their operations than they do.

What is more telling is the window of understanding this opens into the commercial real estate space in the US. It is my opinion that most are extremely over-optimistic regarding the prospects for this space.

An Overview of What I Found

  1. Valuing the company - After including the proportionate valuation of the properties in which GGP has minority stakes, we got a total portfolio valuation of around $30 bn based on the NOI stream. Adjusted for the current o/s debt of $24 bn. The net valuation comes to $6.5 bn. Note this is nearly the same as the $6.6 bn. valuation based on CFAT (after debt service) stream as per the aggregation of the 260 individual valuation models, which lends signifcant credence to the numbers. Finally, including an estimated $2.8 bn for the PV of the stream of other income, the total valuation of GGP stands at $8.8 bn which is a 5% downside from the current market cap.
  2. Our present rental growth assumptions are based on reasonable estimates of GDP growth, population growth and household income growth in the company's operating locations. We believe these assumptions represent a best case scenario. We have yet to build the impact of the slowdown over the last few months as reflected in falling retail sales and consumer spending. Incorporating these factors, valuation may decrease 10-15%. The worst case scenario assumptions considering expected recession conditions will drive valuations down to around 20%. This is probably mislabeled as "worst case scenario", since I strongly believe we are already in a recession - one that looks to be rather severe. We would incorporate the different scenarios and work out the precise numbers later on in the week. Keep in mind that I am being conservative here. My gut feeling puts these numbers much lower.
  3. Referring to the Leverage portion of our models, we identified the properties with leverage higher than 80%. It can be observed that around 73% of such properties have negative PV based on CFAT (including debt service), validating the fact that highly leveraged properties are already running into negative values - and this is at the onset of recession - much worse is to come.

  4. The Cap Rate Analysis in the same file shows that the properties purchased over the last 3-4 years are earning lower cap rates (3-4%) than those purchased in late 1990s and early 2000s owing to higher relative purchase prices in the last couple of years. Since a large lot of GGP's portfolio has been added in the last 3-4 years, the overall cap rate of the company is being negatively impacted by the lower cap rates for such properties. Further, with macro-economic conditions turning adverse, such properties may already stand overvalued in GGP's books and may soon turn into losses. Up until this point and as I did with the homebuilders, stated book was pretty much ignored and I went about constructing book value independently. I am now having the mod squad delve into the reported numbers for comparison's sake.

  5. Another important observation is that around 100 properties (38% to 43% depending on how one includes ownership under JVs) have negative equity. Around 70% of those were acquired in the last couple of years (when credit availability was easy and cost of debt low), reiterating the finding that a large amount of these properties may be significantly overvalued in GGP's books.

We have also looked for the historical NAV trend for GGP. However, since NAVs are not publicly available (GGP does not report NAV for its portfolio), we haven't had much luck thus far. Specifically, the REIT NAVs computed by Green Trust Advisors, one of the most popular REIT investment advisory concerns, are also not publicly available for the recent periods. The latest NAVs we could find from this source were for early 2007 when GGP stock was trading at around 10% discount to NAV. However, we believe that due to the subsequent difficulties in the credit market, the situation may have reversed of late. I have the Mod Squad continuing to explore this area and will post the findings on the blog.

Other issues of note

  1. Rise in Insider Transactions: There has been more than a couple of insider transactions for sale of company shares by senior executives in last 1-2 months. This may indicate GGP management's indirect response to overvaluation of company's share price at current levels of $39.36.
  2. Huge Mortgage Obligations: The company has huge mortgage obligations (approx $24 bn as of Sep 30, 2007), due for payment in next couple of years. In view of the credit crunch in the global financial markets, the company would be mandated to refinance its financial liabilities at a considerably higher interest rate, thereby adversely impacting its cash flow.
  3. Overvalued Stock: Based on our initial work on valuation of GGP, the company's stock seems overvalued by approx 15% at current level of around $40, indicating a minimum potential downside risk of $6 per share. Again, this is an optimistic scenario, excluding the possibility of recession. GGP is highly reliant on 2nd tier retail shopping centers and to a lesser extent Master Planned Communities. I expect both of these segments to take a bath in the upcoming years.
  4. Property Overvaluation: Our working on individual property valuation indicates a number of instances where the Company's properties seem to be overvalued. These properties have mostly been purchased in late 2006 and 2007. There are also quite a number of such properties which were purchased in 2001 and 2002. This is paradoxical, since the commercial real estate was quite soft during this period. I consider it management's error to overpay for properties during an era when it should have been relatively easy to get the properties at decent prices. This could also be a result of mismanaging the properties as well.
  5. Lower than expected 4Q2007 retail sales: Many US retailers have witnessed lower-than-expected sales in 4Q2007 owing to slow-down in US consumer spending. This may (most likely will) dampen demand for commercial rental space in the US, thereby creating downward pressure on commercial real estate rentals.
  6. Stock Trading at 52 Week Low: The company stock is trading at 52 week low price of $39.36. Despite this, there is still noticeable insider selling.

The above observations are based on initial assessment and valuation of GGP properties in different geographies in the US, and we shall come out with some more and refined observations as we advance our research on the company.

Cap Rate Analysis

Year of purchase

Cap rate

No of properties

Unlevered risk premia received

Mgt performance










Call the LAWYERS!





More awful





Mo' better





Mo' awful





Dull average






Equity Summary

Year of purchase No of properties Properties with negative equity % of Properties with negative equity
2007 107 37 45%
2004 39 21 26%
2003 17 11 13%
2002 47 4 5%
1999 3 2 2%
1998 13 4 5%
1997 9 3 4%
Total 235 82 100%

Leverage Summary

Properties with negative equity and leverage >80% 32
Properties with leverage >80% 44
% of properties with negative equity (based on CFAT after debt service) 72.7%

Summary of GGP Valuation
GGP valuation on NOI basis
Consolidated valuation as per Portfolio Valuation sheet (NOI based) 30,553,483,142
less: Debt outstanding 24,073,812,000
Estimated portfolio PV 6,479,671,142
Add: PV of the other net income 2,383,540,286
Estimated valuation of GGP 8,863,211,429
No of shares 243,810,000
Estimated share price 36.35
Current share price 38.4
Upward (Downward) -5.3%
GGP valuation on CFAT (after debt service) basis
Consolidated valuation based on CFAT (after debt service) 6,605,261,299
Add: PV of the other net income 2,383,540,286
GGP's estimated market cap (CFAT basis) 8,988,801,585

Read more on Commercial Real Estate and Residential Real Estate.

Last modified on Sunday, 06 January 2008 00:00


  • Comment Link Eric Johnson Sunday, 15 June 2008 23:21 posted by Eric Johnson

    I live in Houston Texas where at least the economy is still fairly strong thanks to the oil biz. We are seeing foreclosures rise, however, and new home building has slowed way down (but mysteriously not stopped yet). The Rental market and commercial market is way over built right now in all parts of the city. But the strip markets have been growing like mushrooms after a rain. They are everywhere now and are almost all 25% to 50% empty -- and still building! Even more confusing to me is that most of the tenants look like they must be very marginal businesses in good times, let alone a recession. How many nail/day spa salons can there be? Do we need a dry cleaner in every block of the city? What about pool builders and specialty retail shops catering to Christian book readers and Comic Book/Game players, etc. This area of the economy is a sinkhole that just hasn't opened up yet, but when it does, it's going to make the housing crisis seem tame.

    I don't know. I do know this is great site. Thank you, Reggie.

  • Comment Link Reggie Middleton Sunday, 06 April 2008 19:39 posted by Reggie Middleton

    From [url=][/url]

    The vacancy rate at U.S. strip malls rose to the highest level since 1996 in the first quarter of 2008, while that for big malls reached levels unseen since 2002, research firm Reis said on Friday.

    The amount of space occupied by retailers fell for the first time since Reis began tracking the sector in 1980.

    "Retailers are grappling with the implications of the housing and job market downturns for consumer activity, with the result that retail sector fundamentals -- occupancy and rent levels -- are being strained by anemic demand for space," Reis Chief Economist Sam Chandan said in statement.

    Strip-mall vacancies rose 0.2 percentage points from the preceding quarter to 7.7 percent.

    By the end of the year, the rate likely will reach or surpass 8 percent, Reis said.

    The vacancy rate for big regional malls was the highest since the fourth quarter of 2002, the report said.

    Asking rent ticked up 0.4 percentage points after falling 0.4 percentage points in the fourth quarter of 2007.

    Chandan said community shopping centers have some protection against economic downturns through long-term leases and tenants that supply necessities, such as groceries and drugs, but he noted that "increasingly value-conscious shoppers have alternatives in discount retailers such as Wal-Mart and Costco ."

    Less-frequent shoppers spending fewer dollars affects the demand for space and the time needed to lease available space.

    Space occupied by retailers in the first quarter fell by 1.36 million square feet from the prior quarter.

    Asking rent growth was the most anemic since the fourth quarter of 2001, inching up just 0.4 percentage points to an average rent of $19.57 per square foot.

    Factoring in months of free rent and other concessions, effective rent growth was a mere 0.1 percentage point, rising two cents to $17.62 from the previous quarter.

    Of the 76 markets that Reis tracks, rents effectively fell in 31. "Not only have concessions widened further, conditions have softened to a degree that landlords are unable to raise rents," Chandan said.

    Publicly traded real estate investment trusts (REITs), such as Equity One and Kimco Realty , often have properties that are in better locations and are operated more efficiently.

    Their vacancy numbers are often lower and rents higher, said Nicholas Vedder, senior associate analyst at Green Street Advisors.

    "The Reis numbers are generally a little bit more negative," Vedder said.

    "That said, they're not entirely insulated from what's going on in the general economy, so we do anticipate further occupancy decline going forward."

    Because of their long leases and differences in the mix of tenants, regional mall fundamentals typically don't reflect economic changes as quickly strip malls.

    "Indications of stress are becoming visible in regional mall performance," Chandan said. "A growing list of national chains are adjusting expansion plans."

    In January, women's clothing retailer AnnTaylor Stores said it would close 117 stores and Pacific Sunwear said it would close 154 of its urban-inspired clothing stores called demo.

    Home-furnishing retailer Bombay Co., which filed for bankruptcy in September, said it would close 384 U.S. stores.

  • Comment Link living off dividends Saturday, 09 February 2008 15:21 posted by living off dividends

    how the hell can they justify buying a property with a less than 3% cap rate?

    borrowing money at 5% means you're negative straight off the bat (and I'd be amazed if
    they found commercial loans at less than 7%, even 2-3 years ago).

  • Comment Link Reggie Middleton Tuesday, 08 January 2008 18:18 posted by Reggie Middleton

    It would be ideal to have the collective community add to the ideas here. There are a lot of funds, investment advisors and institutional investors who download the research that I make available for free. I think it is only polite to add back to the pot.

  • Comment Link DJ Tuesday, 08 January 2008 17:13 posted by DJ

    For those who are interested . . . attached is a quick write up on another CRE short idea. I'd be curious to know if anyone thinks it is a crazy idea as well.

    Maguire ("MPG") is the largest owner of Class A office properties in Southern California. Almost 91% of its portfolio is in three markets: Los Angeles (47%), Orange Country (42%), and San Diego (2%).

    I believe MPG will trade down to a cap rate of ~8% comparable to nationwide cap rates in 2001/2002 as the commercial real estate market declines from its 2007 peak, which would imply a tock price of $20, or ~30% downside from the current price. In addition, the prior cycle peak multiple of FFO was 12.5x FFO. MPG currently trades at ~30.0x 2009E FFO, which suggests massive downside if multiples contract.

    The downside to shorting Maguire is 10% - 15% if the Company is actually taken out at a ~5.3% cap rate (5.3% would imply a share price of ~$33). (MPG announced an intention to pursue strategic alternatives on 12/11/2007 when the stock was at $25.26. The stock closed on 12/26/2007 at $30.55, a 20% increase, so much of this is priced in.)

    Investment highlights
    Ÿ Commercial real estate market has peaked - The U.S. commercial real estate market is beginning to show a negative inflection points after a seven year bull run. Some of these indicators include: a) prices falling 1.2% nationwide in September for the first monthly decline in seven years per Moody's, b) U.S. office sales falling 70% y-o-y in October per Real Capital Analytics, and c) a recent report by J.P. Morgan suggests that banks will be stuck with $40BN in CBMS (commercial mortgage back securities) at year-end which will limit future deals and re-financings (Centro is a prime example) and lead to a decline in property values.
    Ÿ Pending dividend cut - The Company has debt to capitalization of ~75%, which is at the high end of its peer group. MPG is currently paying a $1.60 per share dividend, which is well above the $1.00 in FFO it will generate in 2008E. In my current base case, the Company's dividend will be under-funded in 2008 and 2009, suggesting that a dividend cut may be unavoidable. In addition, the Company has 400,000 square feet (totally unleased) in its development pipeline that will require capital investment.
    Ÿ Weak markets - As mentioned, MPG is heavily exposed to the Southern California market, which has been softening. In its recent Q3 results, MPG reported a 10% decline in occupancy in its Orange Country portfolio (sub-prime lenders Ameriquest and New Century terminated 210K square feet in leases) and overall Company vacancy increased to 14.4% from 9.7% sequentially.

    Investment risk
    Ÿ MPG is acquired at a large premium - My view is the Company will not get sold due to an inability to finance the deal. That said, if the Company were to sell in the 5.3% - 5.0% cap rate range, on current vacancy rates, the implied price would be $33.00 - $35.00.

  • Comment Link Reggie Middleton Monday, 07 January 2008 21:29 posted by Reggie Middleton

    @ Rob Dawg
    I noticed I never answered your question re: vacancy assumptions. If you download the woodland properties model, you will see how vacancies are handled. I didn't not run sensitivity on vacanciss, but did (am) running sensitivity on revenue growth/ delinquincies. The vacancies were input after queryig local branches of national brokers such as MArcus and Millichap and local brokers when available. We used forward looking opinions from these brokers, who knew they were supplying data for a study.

  • Comment Link Test Monday, 07 January 2008 07:59 posted by Test

    There are couple other guys who did similar research on CREs and concluded that PKY is the most vulnerable in the lot.

  • Comment Link Reggie Middleton Monday, 07 January 2008 00:09 posted by Reggie Middleton

    @ Istewart et. al.
    My lawyers have given me a good talking to, and want me to reiterate that I do not offer or give investment advice. I simply give my opinions of my experiences and views of trends in the global markets. That being said, I don't have a gut feeling of a particular stock price. I do feel that the macro trend for the economy is negative though, thus those that are sensitive to the economy will feel it more than they do now. I haven't focused on any other CRE cos. in the detail that I have given GGP. As I said earlier, I will spread around if I feel it is worth while.

  • Comment Link Capital Gain Sunday, 06 January 2008 20:27 posted by Capital Gain

    Funny stuff.

    I'm a lease paying tenant in a number of power centers owned by GGP and DDR, so of course I've been shorting them. Paying my rent to them with the gains from their haircut was just too tempting to pass up.

  • Comment Link Anonymous_1 Sunday, 06 January 2008 19:16 posted by Anonymous_1

    Hi Boombastic,

    Thank you for your research. The first day you mentioned CRE, I showed my husband and he went ahead and shorted some random 12 of the CRE companies, GGP being one of them. We are young, 29/28 olds, with very little savings n on top of it with our education loans... so put 800/stock and made some moolah to compensate unstoppable inflation which is on the way.

    Thanks for your blog and helping out small families like us who have zero means or time to do all the research that you do, but are ultimate victims of inflation with disappearing savings. We got burned with our initial foray in 06-07 into the stock market following cnbc and mr.cramer, but this time around all we do is to get our info from internet.

    Thank you for your unselfish posts.

    -SK & JK

  • Comment Link Robj Sunday, 06 January 2008 14:55 posted by Robj

    Great analysis!

    The formatting in Firefox is messed up as well.

  • Comment Link isaac stewart Sunday, 06 January 2008 14:14 posted by isaac stewart


    First Thanks for the wondeful analyssis

    2 questions.

    1. What does your gut say GGP's stock price will be at the end of 2008?

    2. What other 3 CRE stocks would be your short candidates in order of vulnerablity to a crash in their stock price IN 2008?


  • Comment Link Reggie Middleton Sunday, 06 January 2008 11:12 posted by Reggie Middleton

    @ R
    I have looked at a lot of companies, and chose GGP. I will probably move on to others if it is worthwhile. I will try to look into the IE6 issue.

    @ Rob
    I'm sure many of you are smarter than I am. The reason many of my posts are hard to follow is because they are written at 3:30 in the morning when I am semi-comatose. I will go back and clean it up. Thanks.

  • Comment Link Rob Dawg Sunday, 06 January 2008 11:04 posted by Rob Dawg

    Excellent as usual. The real problem with so many negative equity properties is portfolio dilution. They'll be forced to sell/encumber the better properties to cover failures. But my question: What kind of vacancy rates did you assume in your best/mid/worst case analysis?

    GGP also seems to be carrying a lot of raw land. Enough to make a difference if marked to market?

    One minor criticism. I can understand what you are saying with careful reading and context but for instance this next fragment you wrote; "the downside to the valuation may increase to 10-15% while with the worst case scenario assumptions considering expected recession conditions, it may further move up to around 20%." The phrasing has many possible interpretations. The first part could be taken to incorrectly) mean that the stock may be worth 10-15% more as the downside. Downside/increase, percentages all positive numbers, move up 20% referring to the potential overvaluation...we all aren't as smart as you Reggie. For we slow readers could you try to use consistent descriptors so we can keep up? Thanks.

    Oh, and awesome call seeing as your price point was immediately confirmed by the market.

  • Comment Link R Sunday, 06 January 2008 10:35 posted by R

    Incredible analysis Reggie.

    Have you looked at ARE?

    BTW, the site formatting in Internet Explorer 6 is messed up.

  • Comment Link Reggie Middleton Sunday, 06 January 2008 10:18 posted by Reggie Middleton

    Then you know companies like GGP are in trouble with 40% of their portfolio over 80% LTV. It looks as if the market has frozen. They just completed a refinancing, but have a big nut coming up.

    Refinancing to the Rescue?
    January 2, 2008; Page B4
    Many investors surely hope that 2008 will be the year of refinancing.

    For the final six months of 2007, commercial mortgage lending was at a near standstill. Though total transaction volume will close 2007 at a record of about $515 billion, most of the transactions took place in the first half of the year before the credit crunch took hold.

    Now, many of the investors who bought during the frenzy are unable to refinance the short-term debt that facilitated these purchases into longer-term loans. A new report by Chicago-based brokerage Jones Lang LaSalle estimates more than $50 billion of five-year, full-term interest-only loans in the market that were written at aggressive loan-to-value ratios could turn to defaults "at a significant level" if the loans can't be refinanced in 2008.

    "There will be a refinancing frenzy of investors searching for equity infusions next year," says Earl Webb, chief executive of Jones Lang LaSalle's capital-markets group.

  • Comment Link Reggie Middleton Sunday, 06 January 2008 10:13 posted by Reggie Middleton

    Art of a Credit-Crunch Deal

    Michael Reschke's experience financing a J.W. Marriott hotel exemplifies the havoc the credit crunch is creating for developers. The Chicago developer is retooling a Daniel Burnham-designed office tower in the financial district, an underserved area of the city for luxury hotels. But he has faced difficulties.

    Last summer, he planned to borrow $315 million on a project with an appraised value of $450 million -- or about 70%. But he lost financing in August, at the height of the credit crunch. So he brought in a joint-venture partner and decided to borrow less, paring down the amount to between $250 million and $275 million.

    Even at $275 million, which is just over 60% loan to value, the loan isn't certain given current market conditions. If necessary, Mr. Reschke and his partner will put even more cash in the deal. Now -- six months later -- he says he is confident that the loan will close.

    "Deals are still getting done but it's a lot tougher," says Mr. Reschke.

  • Comment Link Reggie Middleton Sunday, 06 January 2008 10:06 posted by Reggie Middleton


    "[i]But these days Mr. Macklowe is scrambling for financing yet again. He has a $6.4 billion debt payment coming due next month in connection with his purchase of seven other Midtown Manhattan office buildings a year ago. When he bought those buildings from Equity Office Properties, he more than doubled the size of his real estate portfolio and used only $50 million of his own money to do so; he borrowed $7 billion to finance the rest of the purchase.

    As often happens in real estate, a once-frothy national cycle is losing steam and the market has turned against many buyers. Mr. Macklowe, with his empire of 15 prime office towers and two development sites in one of the world’s best business districts, is awash in expensive, short-term debt at the very moment that financial backing for megadeals has all but shut down. One of his loans is backed by a $1 billion personal guarantee, and he is already in default on $510 million in development loans for a Park Avenue project.

    Mr. Macklowe’s predicament marks the denouement of an unprecedented four-year period in which developers threw gobs of money at real estate as prices for office towers, especially in Manhattan, doubled and tripled almost as fast as sales could be recorded. Investment banks avidly underwrote the binge, often basing loans not on existing rents but on projections of rental income well into the future.

    All of this worked swimmingly so long as the economy hummed along and banks could pool the loans and sell them to investors. Now, the economy is showing signs of stress, and Wall Street’s repackaging machine is sputtering.

    “In hindsight, everybody should have been more cautious,” said Robert Bach, the chief economist at Grubb & Ellis, the national real estate brokerage firm. “We all knew this wasn’t going to last, but we hoped it would end with a whimper, not a bang.”[/i]

Login to post comments