NEW YORK The commercial real estate sector is taking a beating as investors find risk and values difficult to determine because of global economic worries.
Friday night's downgrade of U.S. sovereign debt by Standard & Poor's sent the financial markets into yet another round of turmoil, battering publicly traded real estate companies, mostly real estate investment trusts.
Since last year, REITs had been leading the rebound in commercial real estate because they have been able to raise cash via equity markets and the corporate bond market, unlike their much bigger private market counterparts. This allowed REITs to bulk up their balance sheets and buy property.
On Monday, investors fled to the safety of cash and U.S. Treasuries, sending the S&P 500 .SPX down 6.66 percent.
U.S. REITs fared even worse, down 9 percent.
"I think all buyers of commercial real estate are ratcheting down their expectations for future rent and occupancy growth based on all the recent dour economic news. That has to negatively impact values," Jim Sullivan, managing director at Green Street Advisors, an independent REIT research firm.
REITs that are still working out their balance sheet problems from the last recession were crushed. Shares of mall owner General Growth Properties Inc (GGP.N) on Monday fell 14.9 percent, to close at $11.75, well under the $15 per share price its major backers were given when it emerged from bankruptcy in November. Its shares have fallen 30 percent so far this month.
Shares of shopping center and mall owner Developers Diversified Realty Corp (DDR.N) fell 12.3 percent on Monday to close at $10.80. The shares have lost a quarter of their value since the start of August.
Fear has gripped even investors in some of the strongest and best capitalized REITS. Shares of Simon Property Group Inc (SPG.N), the largest U.S. REIT, fell 8.4 percent on Monday and are down 17 percent for the month. Office building owner Boston Properties Inc (BXP.N) lost 8 percent of its value on Monday and is off 17 percent for the month.
The apartment sector, one of the first commercial real estate sectors to bounce back, also was hurt, as the prospect for raising rents dims in light of an economic slowdown. AvalonBay Communities Inc (AVB.N) lost 4 percent on Monday and Equity Residential (EQR.N) shares fell 6.67 percent.
Although most U.S. commercial real estate rents and occupancy rates have not recovered from the last recession, REIT stock prices last year outperformed the overall market. In the public and much larger private markets, prices for buildings in the most restrictive and expensive areas of Manhattan, Washington D.C. and San Francisco have rebounded significantly.
But overall, U.S. commercial real estate prices are still more than 45 percent below their peaks in 2007.
Monday's cratering capped off a week of reckoning by investors who may have ignored the high level of risk that still haunts investment.
"At the end of the day, the implication of the downgrade on U.S. debt is that global risk has been underpriced," said Pamela Hannigan, associate clinical professor of real estate at New York University's Schack Institute of Real Estate.
Risk plays a big part in commercial real estate investments because of the slow process of buying and selling big buildings. That risk is usually reflected in the interest rate lenders charge and the yield buyers expect on their property investments.
Commercial real estate transactions are financed by with at least 50 percent debt -- usually much more --making cost of debt critical in prices offered.
The repricing of risk is likely to result in higher borrowing costs, which would bring down property prices.
A slowdown now in the U.S. economy could lead to higher interest rates for borrowers, as risk is factored into probability of being repaid.
A second recession could translate into less demand for hotel rooms, office and warehouse space and retail space at malls and shopping centers.
"No one knows what any of this means," said Rick Lechtman, managing director at Ackman-Ziff Real Estate Group LLC.
In the longer term, the risk epiphany that has wrecked so many markets may favor both REITs and private real estate.
"What's a real asset that investors can turn to when they want to be conservative, keep their principal and earn some income?" Hannigan said. "Well, that turns us to real estate."
(Editing by Steve Orlofsky)