Tag Archives: commercial real estate

Video presentation: Chanos on China’s state-sponsored bubble

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Thanks to Pej for finding this:

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Chanos relays a great quote from Milton Friedman: He was brought to watch the Chinese built a canal, and when he asked why they were using shovels and not bulldozers, he was told that machinery was being eschewed in order to create more jobs. Friedman replied with something like, “Oh, I thought you were building a canal. If it’s jobs you want, why don’t you give them spoons?”

Like the Chicago school that he founded, Friedman was great on most issues except for money. He couldn’t come to terms with the idea that the very existence of a central bank and legal tender laws create insurmountable moral hazard and will always lead to bubbles.

Ok, so how big is China’s commercial real estate bubble? Under construction right now, there are 25 square feet of office space for every person in China.

Family savings are being invested as down-payments for investments in highly-speculative developments. The bust will take care of a lot of the middle class’s much-touted savings.

What do REITs think they’re doing at 2005 prices?

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IYR is an ETF loaded with commercial and residential real estate investment trusts:

Prophet.net

At 4.44%, you can get almost as much yield from a 10-year Treasury note (3.8%). Why mess around with these debt-laden monsters?

SRS of course is the 2x inverse of IYR, and URE is the 2x bull version (not a bad way to short, IMO).

Hugh Hendry walks around China

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Hendry is the founder of Eclectica Asset Management.

“Who is going to pay the debt that that building is resting on? …A building with no tennants. Half a billion dollars of someone else’s liabilities.”

“…very expensive, empty building where the developer went bust.”

“I haven’t seen any sign of a manufacturing base anywhere close to here.”

Commercial Real Estate Shoe About to Drop

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The opportunity to short REITs (or IYR, a REIT-heavy ETF) is fantastic at right this moment. This is about as perfect a short set-up as you could ever wish for: securities of companies in a rapidly deteriorating sector have rebounded to near where they were a year ago when optimism was abundant and the stock market was making new highs. The ETF is actually trading where it was in the first quarter of 2006, the exact peak of real estate prices in the US.

Here is a 5-year look at IYR (I like to take the long view):

Click for sharper view. Source: Yahoo! Finance

There is a heavily traded double-short ETF, SRS, that tracks the opposite of the Dow Jone Real Estate Index with 200% magnitude on a daily basis. My preferred way to short is with LEAP puts, because despite common notions to the contrary, these options are more dummy-proof and safer in some ways than short-etfs, while allowing greater leverage so you can risk less capital on your shorts.

One more thing that makes this such a great short is that, in contrast to financials, there has not been much of a panic sell-off yet. XLF (a popular financial ETF), made a waterfall plunge from June to mid-July, which, while certainly not the final bottom, served to blow off some steam for the short-term.

I haven’t said anything about fundamentals here, but it should be obvious to anyone that commercial real estate, like residential, was heavily overbuilt because of cheap credit readily extended to Joe Blow Developers, Inc. We now have way more shopping malls, office parks and trendy urban condo complexes than we could possibly use at prices high enough allow Joe to cover his debt payments.

As the consumer gets frugal, the corporate sector contracts, and inner cities get scary again, vacancies in the respective developments will soar and rents will drop. And because this game, like housing, is played with leverage, holders of CRE are in big trouble (as are the banks that hold these loans on their books – they will soon be the not-so-proud owners of shiny new rental properties).

It should also be noted that as Treasury rates have fallen (a big red flag for the economy), there has been a little fad to buy CRE or REITS for the slightly better yield, as though they can be compared to Treasuries! Gimmie a break! Holders of this junk are in for a world of hurt, sooner rather than later.