Invisible Hand Shakes City REITs

On Sept. 19, a full six months after Wall Street began its catastrophic decline with the demise of Bear Stearns,

On Sept. 19, a full six months after Wall Street began its catastrophic decline with the demise of Bear Stearns, and just four days after Lehman Brothers, New York real estate financier extraordinaire, collapsed, two publicly traded real estate companies rode high on the stock market, functioning, apparently, in an alternate universe.

That Friday, SL Green, New York City’s largest commercial property holder, traded at $73.75 a share. AvalonBay Communities, which has luxury residential developments downtown and in Long Island City, traded at a stunning 52-week high of $113.07.

They weren’t the only REITs defying the gravity of the situation. On Sept. 26, the day after federal officials seized the assets of Washington Mutual, the country’s biggest savings and loan, and four days after Goldman Sachs and Morgan Stanley announced their transformations from investment to commercial banks, Vornado Realty Trust, chaired by Steve Roth, traded at $94.71. On Sept. 30, Boston Properties, led by Mort Zuckerman, traded at $93.66.

You get the picture. Well, that picture has changed, and some analysts and investors are saying, finally! Finally, the stock market has noticed that these REITs, both residential and commercial, are part of, and vulnerable to, the larger economy.

“[L]ots of investors were thinking that REITs were way overvalued given the current recession (some of them were trading very close to their historical HIGHS a few weeks ago!!!!! Smart money was aggressively shorting the REITs),” wrote Tomasz Piskorski, an assistant professor of finance and economics at Columbia Business School, in an email. “Now, after the big correction, they might be getting more in line with the long term prospects.”

For his part, Ashwin Deshmukh, fund manager of AD Capital, LP, has been shorting none other than Avalon Bay Communities. He’s particularly skeptical of Avalon’s ability to rent out two expensive luxury developments now under construction in Harlem and downtown Brooklyn.

“They really have these notions that rent will always rise,” Mr. Deshmukh said. “That’s just the way they’ve been buying their land, the way they’ve been financing their purchases. I think their assumptions are a little too forward-looking and they’ve been really unwilling to scale those back in the

What about the stalwarts, like Vornado and SL Green? No one, it seems, is invulnerable to market forces. Vornado, which on Tuesday afternoon was trading at $48.90, has seen its stock drop dramatically since its 52-week high of $108.15 on Sept. 19. And SL Green, led by CEO Marc Holliday, has seen its stock price shift with the reported fortunes of its largest tenant, Citigroup, which leases 4.8 million square feet of office space from the REIT.

“They’re pretty diversified and they have a good handle on the market ,” Mr. Deshmukh said of SL Green and Vornado. “Class A commercial real estate has not fallen off completely. But people paying $150 a square foot, those days are over.”

Mr. Piskorski agreed: “There’s a general economic slowdown. So there’s not an enormous lineup of companies that want to pay these high rents.”

There are, of course, dissenting opinions. Dan Fasulo, managing director at Real Capital Analytics and an investor in Avalon and Vornado, was more bullish.

“Avalon has very low leverage, their assets are located in the very best markets,” Mr. Fasulo said. “Will they take a hit on net operating income? Sure. But they do have a couple of significant developments coming online, which will add a significant amount of income. In New York City metro, there’s always a renter. So you won’t lose all your money. In other markets, there are no renters at any price. … I truly believe that the market has overreacted right now.”

But Mr. Fasulo has his doubts: “If a particular REIT needed to liquidate every asset today, who knows where the values would be. That’s the problem. You could actually make an argument that they’re undervalued.”

Invisible Hand Shakes City REITs