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December 09, 2007



Forgive my ignorance but how do you calculate the "implied cap rate"?

For example, VNO from google finance:

Quarterly (Sep '07)
Total Revenue 853.04
Gross Profit 393.67
Operating Income 222.95
Net Income 145.90
Balance Sheet
Total Assets 22,253.77
Total Liabilities 16,047.41
Total Equity 6,206.36



Thank you for your insight. I assume you mean Blackstone (not Blackrock) talking about the Sam Zell Equity Office Properties Trust transaction.


Rock, stone, pebble, you get my drift:-)

Thanks for the correction


@ Calvin
When analyzing companies, you can't rely on data aggregation sources like google or yahoo. You have to do it the old fashioned way and open up the companies' financial statements. Do that and all will be found.


@ Calvin
When analyzing companies, you can't rely on data aggregation sources like google or yahoo. You have to do it the old fashioned way and open up the companies' financial statements. Do that and all will be found.


Apologies for contaminating this discussion by reverting back to MBIA, but I can't help but ask if you have any thoughts on the capital infusion from Warburg that was announced today? Do you have any idea if the additional $500M commitment is based on the current share price or the approximate market price in the first quarter?

The $1B seems like a drop in the bucket compared with MBIA's exposure, but to be honest, I was somewhat surprised that MBIA was able to find an outside investor willing to make what appears to be a genuine capital commitment. If Warburg already has a stake and is trying to minimize the loss, this is a different story. Who knows, maybe it will be enough for MBIA to hold onto the AAA ratings until fourth quarter results are released.

The mark-to-market write-downs were no surprise (perhaps even on the low side), but case reserve emergence of $500M to $850M seems like a lot for this early stage.


Financial debt/equity values for REITs are not very meaningful. It merely shows the relationship between the price paid for the building and physical capex, minus rather hefty depreciation, and existing debt. Since they could have bought the building many years ago, at much lower rents, this book value can be very dinky.

Real debt/equity values are a little trickier, and involve placing a true value on the properties. This includes applying a capitalization rate, and typically a market rate is used. This may not be appropriate, since, as you mention, market cap rates may be totally whack -- 4%?

Also, debt/equity values are not comparable to LTV. The debt/asset ratio is more like LTV, although once again we're talking real asset value (whatever that may mean), not book.

In general, REIT managements are fairly conservative, and apply about 50% debt/assets (LTV) on conservative valuations of property.


Thanks for the correction on the LTV bit, my error (trying to be funny as I write the post at midnight with no sleep:-) I'll correct that. As for how reliable the debt to equity or asset ratios are, for the sake of my analysis it is irrelavent for the prospects that I have selected (I am familiar with some of Vornado's purchases). Once I select a target, I calculate book by hand (as was done for the homebuilders and the monoline insurers - see those pdf reports). I don't trust published numbers. In reference to the particular short that I am fosusing on, I am evaluating each property individually - each property with it's own valuation model (or at least most of them), then a portfolio model to aggregate the properties which then feeds into a model of the corporate entity/trust/etc. The target company has a portfolio of approx. 200 properties. This is why it takes so long, but I have to be sure of my position.

As for the conservative nature of REITS, I have seen several instances of their catching the same fever that everyone else did. That is what makes a trade, you need two guys with differing opinions. Like stated in my thought on the builders post linked in the first paragraph of the article, recent buyers were totally too optimistic concerning rates of return and potential for rent increases - which they cannot get in the current environment. If I am right, we will see in a few quarters.

Ralph Allen

I am an amateur to investing but have done systems engineering analysis for years. I have read other analysts opinion about the over valuation of Commercial REITS. I took that along with the realization that the market will have a huge correction once the average guy gets a glimpse of what’s coming in the economy. A correction of 50 to 75% in stock value is due. SOO I bought puts a year out for leverage with the belief that the correction will occur during that time. I stayed with companies that had at that time a yield of 4% or less and where the options cost 10-14%. If the yield returns to historic levels a 50% price reduction will be easy. I will be waiting with baited breath for your short company disclosure.

By the way Vornado was one of my shorts. GGP was another since they were heavily into development with 50% of earnings.


You sound like a smart guy. Let's wait and see how your picks pan out.


I haven't been ignoring you. I actually dedicated an entire post to your questions. I don't think the guys at Pincus fully understand what it is they bought. They got a good price for it though. Less than market price.


Hi Reggie,

Certainly there have been people buying buildings at vastly exaggerated prices. There is always some justification for such behavior at the top, typically something (sales, profits, eyeballs) that "only goes up," in this case rents. I have had the impression that the biggest suckers here were institutional buyers (esp. pension/endowment fund types) looking to "diversify" into "alternative investments." (All bubbles come with their own terminology as well.) Some real-estate pros (Kushner) got pretty silly as well.

However, there is a difference between the valuation of the STOCK and the buildings/REITs themselves. Even if there were stupid assumptions of rent increases on a few recent purchases, that wouldn't show up in the trailing earnings reports. Most REITs are pretty religious about keeping debt service to around 50% of trailing cashflow, as the REITs themselves, as a group, were born of the commercial property bust of the late 1980s where too much leverage led to insolvency.


It is not the trailing earnings reports that I look at. I look at, and value, actual assets and cash flows. The company(ies) in question get a thorough forensic examination, independent of published numbers and management commentary. Both management's and investor's reliance on trailing numbers is what causes problems. It is akin to looking in the rear view mirror while driving fast forward. One of the main reasons stocks trade at a premium/discount to underlying assets is that many investors never bother to look at and properly value the underlying. Lennar, Hovnanian and Ambac are three perfectly good examples. REITS and closed end funds often are subject to the same misvaluation until an exogenous event occurs that wakes everybody up.

If rents drop appreciably and companies bought a lot of buildings at 50% trailing cash flow to debt and at very high prices (since rents were sky high for the last couple of years and money was very cheap) then the next few quarters/years should look pretty ugly since 50% of $100 rents is really 66% of $75 reduced rents, if you know what I mean:-) I sat back and witnessed this buying first hand over the last 2 years.

Notice how the homebuilders, banks and monolines all failed to warn mid year '06, when a good look at their actual business would have told a different tale. Take WaMu for instance. If you go back to my first (or second) post on WaMu, I noticed that hey had 5 quarters running (2 quarters ago) of losses in their mortgage division. A forensic accounting of their holdings would have led to a very profitable short. The same goes for the homebuilders, whose inventory showed obvious signs, as well as the macro environment.

I am valuing the holdings of a company or two, one by one (the short list does not consist of only reits). I believe one to have real problems, but we will see exactly where it stands in a week or two. If I am right, then the stock will eventually reflect my findings because the shareholders should be noticing cash flow and valuation issues, albeit a little late. Like I said, time will tell and if I am wrong and you are right I will be the first to admit it (okay, maybe the second:-) I really do like the attention you pay to this and your apparent knowledge an background though. I am developing a new site and need a beta tester. Email me if you are interested.


Hi Reggie,

It's not about being "wrong or right." Actually I've been short the REITs since June. Too expensive, and things are not going their way. Although I did quite a bit of work on the apartment REITs back in 2004 (backing long positions, which worked), I'm not that familiar with the office/retail type stuff and how it could perform in a recession. I'd love to see estimates of cashflow impairment going forward. It's one thing to have disappointments of expectations, and another to actually have declines from trailing cashflow. As you mention, the combination of cashflow impairment, leverage and more conservative valuation of remaining cashflow would be quite the one-two-three punch.


I'll post some highlights of my research when it is complete. I have also taken a hard look at banks (again) and have some interesting info there as well.

San Diego Real Estate Blog

Hey I agree I think Commercial Real estate is going to take a tumble as well. Residential has been falling adn commercial is sure to follow. You know, I wrote a related article called Government is Real Cause of The Real Estate Bust. Check it out if you have time: http://www.brokerforyou.com/brokerforyou/?p=332

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But, there hasn't been an oversupply of commercial real estate, you say. Well, the oversupply is not the core reason why residential is falling right now.

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The downfall of CRE is the rampant speculation that caused many to significantly overpay for assets that are quite illiquid and take significant expertise and time to improve (or even sell), even incrementally.

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