How to Bet Against Office and Apartment Buildings
Let's learn about REITs, short selling, vacant office, and distress in the market
From the March 21st Bloomberg article Short Sellers Up Their Wagers Against Commercial Real Estate Again
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People “short” stocks when they think the stock’s price will drop in the future.
If you’re not familiar with shorting stocks, it works like this:
Imagine the price of a pair of sneakers is $300.
But you think the price of those sneakers will drop to $100 in the next 6 months or less (maybe you know something about the sneaker market that others don’t).
So you borrow 10 pairs of sneakers from the sneaker store for 6 months, and then immediately sell all 10 for $3,000.
Then, in 5 months, when the price of the sneakers drops to $100 (as you predicted), you buy 10 new pairs of the same sneakers for $1,000.
You return those 10 pairs to the store where you borrowed them – and pocket $2,000.
This is what investors like Muddy Waters are doing with the shares of publicly traded commercial real estate investment firms (like Hudson Pacific (HPP) and Boston Properties (BXP)) and lenders (like Blackstone Mortgage Trust (BXMT) and New York Community Bank (NYCB)).
Investors like Muddy Waters believe these stocks are going to drop significantly in the near future, and so they are “shorting” them – borrowing shares from other shareholders; selling them at today’s market price; and then planning to buy them back at a lower price in the future, pocketing the difference.
Why do they think the stock prices for these CRE companies will drop?
Let’s start with the investment firms like Hudson Pacific and Boston Properties – who are landlords and operators of office and apartment buildings.
Office buildings make up a large percentage of both of these firms' portfolios. And values for office buildings are in a free fall due to uncertainty regarding future market demand – driven largely by companies transitioning from in-office to hybrid and remote work models.
Except for the top office buildings in major markets, vacancy rates are climbing quickly as tenants are moving out when their leases expire — without the same volume of new leases being signed, driving revenue and net operating income (NOI) down.
So the market is struggling to value buildings, and therefore they aren’t selling.
To make matters worse, interest rates are not coming down.
Many investors hoped interest rates would drop significantly in 2024. But it is becoming clear the Federal Reserve, our centralized US banking system who sets interest rates, does not plan to do so. This is largely because the overall job market remains strong.
This is bad news for commercial landlords because without low interest rates, no one will buy their struggling buildings as the cost to get a loan for new buyers is too expensive.
And for this same reason, HPP and BXP cannot buy new buildings either.
So if HPP and BXP can’t sell their struggling buildings, or buy new buildings to create new value, it seems like a logical bet that their stock values will fall!
Now let’s turn to the lenders, like BXMT and NYCB.
If they’ve made loans to groups like Hudson Pacific and Boston Properties, and their buildings cannot attract new tenants (either because there is no office demand, or because they can’t get another loan to improve their buildings with better amenities, etc.) then those buildings will not be able to make their monthly loan payments to lenders like BXMT and NYCB.
And what’s worse: many of these commercial loans – $2.2T worth to be exact – are coming due between now and 2027.
Note: loans for commercial real estate buildings are typically “interest only”, which means the landlord just pays interest every month until the end of the loan; at which point the full amount of the upfront principal (the original loan amount) is due – which usually coincides with when the landlord plans to sell the property.
So if landlords can’t sell their properties, or if they have to sell at an extreme discount, then the principal will not be repaid to BXMT and NYCB either... And their stocks will, in turn, drop significantly!
So commercial real estate owners and lenders alike need the office market to stabilize and interest rates to fall.
Otherwise short investors are going to have a field day at best; and at worst this could cause a systemic global credit event similar to 2008.
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I think this piece could reinforce a common misconception about price and value. Stocks trade every day based on an expectation of future value, so the decline of office demand and future property values is already baked into the stock price. Unless you have a unique insight - and decreasing office demand isn’t one - you won’t be able to buy a lower price stock in the future to cover your short. It’s already low today based on that common market knowledge.