Mr. Marks: In looking at equity REITs' business models during the upturn in the economy during 2005, 2006, 2007, a lot of REITs ventured into certain businesses, like merchant building - a gain-on-sale development program, whereby they would develop assets on balance sheet and then contribute those assets into funds or attempt to sell those assets - and basically went into endeavors that we believe were more aggressive. And so the "Back to Basics" title was intended to capture our belief that most REITs are going to return to the blocking and tackling of managing their assets, looking to improve or maintain occupancies and the quality of their assets, and not venture so far out into alternative investments or more aggressive types of investments.
TWST: Your overall outlook is negative, although there are some differences among the various property types. Explain why your overall sentiment is negative.
Mr. Marks: The negative outlook that we have heading into 2010 is consistent with our negative outlook that we had heading into 2009, and this is driven by our belief that the sector generally is overlevered. We measure leverage primarily by looking at a metric called "net debt to recurring operating EBITDA." Across our rated universe, that metric comes in at about 6.4 times as of September 30, and that's significantly above a historical average. Over the last 10 years, that number has been closer to around five times. So what we have said is that if that number gets closer to or below six times, we'd feel a little more comfortable about where leverage is in the sector. That's the first element driving the negative outlook.
The second element is our belief that commercial real estate fundamentals are going to continue to be soft in 2010 relative to 2009. When we think about fundamentals for commercial real estate, the primary metric that we use is same-store net operating income (NOI) growth, and our expectation is that that number is going to be negative from 2009 to 2010. It was negative from 2008 to 2009 by approximately 5%, and we think that it's going to be down another 5% from 2009 to 2010. So between slightly elevated leverage and fundamentals continuing to be soft, and also with a view that to the extent there are any surprises, they are more likely to be towards the negative - whether we are talking about capital markets access or otherwise - we have a negative outlook. While liquidity and access to capital are good right now for equity REITs, there is certainly a chance that there could be capital markets disruptions like we saw in late 2008 and into early 2009. And to the extent that there is a real pullback in access to capital, that would impact REITs fairly significantly because while they don't need continual access to the markets, they do need consistent access to the markets. So any pullback in availability of access to capital would likely have a negative impact on equity REITs.
Tickers included in this excerpt: DDR, EQR, SPG, VNO
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