Thursday, May 21, 2009

Goldman Expects Large Drop In Rents; REITs Impacted

In a research piece titled "REITs Cutting Residential Rents, Setting Stage for Further CPI Disinflation" Goldman Sachs analysts conclude that based on recent declining rent trends from residential REITs, the impact on price levels in the housing market (especially in major metropolitan centers where rent are only just now starting to unravel) will get progressively adverse, but will also feed ongoing general asset deflationary pressures, and by implication, added weakness to REIT cash flow. From Goldman:
With unemployment approaching double-digit levels, housing vacancies hovering near all-time highs, and industrial capacity utilization plumbing record lows, pricing power is nowhere in sight. And if our forecast of a sluggish economic recovery is correct, pricing power is unlikely to return soon in most industries.

Disinflation seems particularly likely for rental prices given the large overhang of available housing. Vacancy rates in the owner-occupied housing sector and the rental housing sector are both near all-time highs, so any “output gap” model of inflation points strongly towards disinflation in this sector. Furthermore, rent and owners’ equivalent rent (imputed rent for owner-occupied households) make up 39% of the core Consumer Price Index and 18% of the core price index for personal consumption expenditures. Thus, not only does a further decline in rental inflation look likely, but it is near-essential in order for overall core inflation to drift down towards zero as we expect.
This brings up the ongoing question of just why are REITs of all shapes and sizes, across all verticals (office, industrial, multi-apartment, etc), clamoring to be raising cash in order to "buy distressed properties?" If anything, SPG et al should be buying wrecking balls instead of bankrupt malls. The wave of overcapacity, coupled with rents which are only now starting to turn, will force REITs to be hit with the double whammy of i) increased interest expense from higher cap rates once they discovered that absent TALF version 29938.444, any refinancing is impossible, and ii) lower rent income... all leading to the conclusion that the current wave of equity follow on offering will be a great benefit to all REITs... when they seek to satisfy 2-3 quarters of cash burn at best. Sphere: Related Content
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