Read the article at: http://www.realestateportfolio-digital.com/reportfolio/20090708/?pg=46&pm=2&u1=friend
Fosheim's conclusion may well prove correct, but his argument is flawed. Hindsight is easy in economics and he argues that he and his former cohorts at Green Street got it right. We shouldn't be so quick to pat him on the back. He makes the point that as REITs add debt, their equity multiples (similar to cap rates for the real estate folks) adjust to meet the new risk. What this article fails to explore, however, is a very important point. Adding debt to a REITs balance sheet, whether at the property level or at the entity level, is simply a bifurcation of risk. That is, a lender takes on the least risk, but in return gives up yield and control. The equity holder increases its risk, but retains control and increases its yield potential (it also gets ALL the tax benefits for less capital in the case of privately held RE).
This is an important distinction, because it doesn't mean that REIT CEO instincts were wrong, it simply means they took on more risk for their equity stakeholders. Unfortunately, I don't think anyone saw this type of a recession coming. In many property types, fundamentals were still improving. Real estate equity holders simply got caught in a horrible market decline. Real estate debt holders, who were transferred the least risky part in the bifucation, will ultimately not be hurt as badly. In essence, the market worked as it should have.
Don't belive me? Try this example: An extremely conservative invstor buys all debt, no equity. He got hurt in 2008, but didn't lose everything. An agressive investor bought all equity, no debt. He got hurt, badly, maybe lost everything. On the other hand, assuming most properties were leveraged at 75%, a market neutral investor would have bought 75% debt and 25% equity. His returns would be market neutral.
So please don't discount debt, Mr. Fosheim. Without it, we would all be market-neutral and none of us would have anything to talk about.
This is an important distinction, because it doesn't mean that REIT CEO instincts were wrong, it simply means they took on more risk for their equity stakeholders. Unfortunately, I don't think anyone saw this type of a recession coming. In many property types, fundamentals were still improving. Real estate equity holders simply got caught in a horrible market decline. Real estate debt holders, who were transferred the least risky part in the bifucation, will ultimately not be hurt as badly. In essence, the market worked as it should have.
Don't belive me? Try this example: An extremely conservative invstor buys all debt, no equity. He got hurt in 2008, but didn't lose everything. An agressive investor bought all equity, no debt. He got hurt, badly, maybe lost everything. On the other hand, assuming most properties were leveraged at 75%, a market neutral investor would have bought 75% debt and 25% equity. His returns would be market neutral.
So please don't discount debt, Mr. Fosheim. Without it, we would all be market-neutral and none of us would have anything to talk about.
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