About 2,000 years ago, the decider of all matters of importance in Jerusalem was the Great Sanhedrin, a council of 71 judges. The council (or part of it) met every day, except on festivals and the Sabbath, and was a combination of something like the Supreme Court, Congress and CNN's "Situation Room."
As you can imagine, the Sanhedrin's members normally disagreed as they hammered out their daily opinions. But occasionally they came to a unanimous decision, and they had an amazing and very wise rule when that occurred: The decision was immediately overturned because the sages believed that a unanimous conclusion among so many individuals just had to be wrong.
I was thinking about this rule while reading about five dozen 2010 forecasts over the recent holiday break. I was struck by the fact that if there is one idea around which you can get at least 90%, if not quite 100%, agreement from the world's financial punditocracy, it's that commercial real estate, often referred to as CRE, is bound to be annihilated this year.
The experts observe that dozens of large buildings and shopping centers are mostly empty in cities large and small, vacancy rates are high and rising, many supersized mortgages are coming due soon and several big buildings are already on the verge of foreclosure.
Close-up view: In Seattle this month, I was offered twice my current office space in a much better building at a third of the rate I'm paying now if I would agree to sign a four-year lease. That's desperation.
It looks to me like you need to score one for the Sanhedrin, because the nearly unanimous skeptics appear to be missing a few key pluses about REITs that make them a good investment. I'll identify a few favorites in a moment.
Land grab
First, as long as the credit market is willing to keep rolling over most property owners' debts with new low-interest loans or bonds, and as long as the equity market is willing to let REITs sell more shares from time to time, their problems can be pushed out to a future point when the U.S. economic recovery finally gets real traction.This is where the new credit bull market -- the greatest in 25 years, by the way -- comes in. Pension funds worried about industrial companies and iffy sovereign bonds crave the high levels of dividend income that REITs, by law, uniquely provide.
Second, bears forget that REITs are unlike most other companies in that they own real landmark assets in real cities that have real value and have truly been crushed in price. If you are the portfolio manager of a large sovereign wealth fund or run a $20 billion portfolio at a big insurance company, you need to buy real, big things at low values to make a difference in your portfolio.
Let me put it this way: Would you rather buy paper shares of a technology company that could lose its innovation edge at any time? Or half a block of Manhattan at a 50% discount? Yeah, me, too.
I heard this angle from a friend who attended a Goldman Sachs-hosted hedge fund dinner recently. He learned that the big sovereign wealth funds and insurance companies, which had representatives at the dinner, are among the quiet but big bidders for major hunks of prime U.S. real estate through private-equity funds, private transactions and public-equity companies.
They apparently believe that the only real problem with U.S. commercial properties is their underlying high-cost debt. So to the extent that they can take out the debtors with cash, they can wait out the rest of the property recession and be ready for the next upswing. This is the advantage of being well-capitalized and having a 20-year time horizon.
At the same time, REITs that zealously guarded their cash during the recent downturn are themselves helping to lift commercial real estate out of its epic slump. The Globe and Mail newspaper in Toronto reported last week that $5.4 billion had been spent on 990 transactions in the Toronto area alone last year, as strong REITs pounced on distressed properties owned by their weaker brethren.
"REITs are in a good position today as capital, which is the life blood of the sector, is both cheap and plentiful. I think they are in a sweet spot and will be major buyers during the course of 2010," Michael Smith, an analyst at Macquarie Securities, told the newspaper.
Foreign and pension fund buying is more likely behind the surprisingly solid upturn we see now in REITs such as New York property giant SL Green (SLG, news, msgs). As the old Rodgers and Hart song said,"I'll take Manhattan, the Bronx and Staten Island, too."