Market Radar 23. March 2023


Short-sell office and commercial real estate?
Jerome Powell seems a bit perplexed

After yesterday’s Fed meeting, we’re not much smarter than we were before the Fed meeting.
Surprises were not only missing – some market participants are now wondering what kind of surprises we have been waiting for.

Not only the Fed seems to be at a loss after the upheavals at regional banks, which are also interpreted by US Federal Reserve Chairman Jerome Powell as a result of the aggressive interest rate policy: the Fed has made no mistakes. However, the Fed now sees consequences of its actions that pose problems for it. If the Fed had acted differently, we would have very different problems.

“Recent developments are likely to lead to tighter credit conditions for households and businesses,” the Fed wrote in a statement after its two-day meeting.
As a result of this forecast, three scenarios are now expected:

1.Economic activity will be weakened.
2. Unemployment will rise.
3. The Fed’s hands are now tied to fight inflation.

The extent of recession, unemployment and inflation remains uncertain. However, Jerome Powell made it clear during the press conference that interest rate cuts are not planned. The Fed’s focus will continue to be on the risks posed by inflation.

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What do we see under the radar of the major stock indices?

Let’s take a look at the sectors in which we saw new intermediate lows yesterday at the end of the day: We actually only see these in two sector ETFs: Real Estate (XLRE) and Biotechnology (XBI).

Today we want to take a closer look at REIT’s shares from the office and commercial real estate sector.
Many experts expect that the office and commercial real estate sector may soon face similar problems as the regional banks: numerous office spaces in the USA are empty – in the event of a sale or even demolition of such properties, value write-downs would have to be made in balance sheets, which will inevitably reveal imbalances in future quarterly reports.

Rising interest rates, unpredictable economic prospects and the tendency to work from home are actually forcing the industry to revise its strategies. But how can a strategy be revised if the entire business is geared towards it?

First, the pandemic hit the US commercial real estate market, then came rising interest rates. Anyone renting out skyscrapers in New York or Los Angeles today has to accept that interior surfaces of these buildings are less in demand because many employees prefer to work from home.

Let’s take a look at the chart of the Empire State Realty Trust (ESRT; market capitalization approx. 1 billion US dollars). The REITs firm operates and manages office and retail properties in Manhattan and the New York metropolitan area, including the Empire State Building.

The Empire State Building is certainly protected from demolition, if only because of its “landmark character” for the city of New York.

With the onset of the banking crisis on March 9, ESRT shares have lost over 20% of their value. Currently, the company pays an annual dividend of 2.24% at a share price of $6.24. Since the beginning of the year, however, the stock has lost only about 7% because the stock was able to rise over 25% in January of this year alone.

The share of Empire State Realty Trust shows – comparing the price development with competitors – relative strength: perhaps the Empire State Building is significantly less affected by vacancies than office buildings, which are threatened with demolition at some point after permanent vacancies.

If you look at the charts of stocks such as Douglas Emmett (DEI), Hudson Pacific (HPP), or SL Green Realty (SLG), you will immediately see that they have been losing value almost daily since the beginning of February 2023:
Douglas Emmett has lost about 35% of its value since February 2.
Hudson Pacific has lost about 50% of its value since Feb. 2.
SL Green Realty has also lost about 50% of its value since February 2.

In all of these REITs stocks, we have seen a significant increase in trading volume compared to previous months since the banking crisis began on 9 March. A sign that institutional investors are parting with these stocks in droves. No one expects that this sell-off could be stopped after the Fed meeting. The media hype has recently focused on regional banks. If this subsides, then stocks such as SL Green Realty could move more into the focus of the crash prophets.

It is likely that these stocks will lose another 30 or 50% or more in value until the topic dominates the headlines every day and after a sell-off bargain hunters and scalpers from the day trading sector finally become aware of these stocks.

Until then, you could sell these shares short according to the trend – and bet that numerous office properties will eventually no longer be vacant, but demolished.