How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?

“Australian REITS Retreat Home After A$19.5 Billion in Losses,” reports Sarah McDonald from Bloomberg. “Australian property trusts are unloading failed overseas investments from Munich to Michigan after piling up losses equal to almost a third of their market value in the last 12 months.” She identifies the usual suspects: Westfield Group, GPT Group, Centro etc.

How did Australia get caught up losing money in commercial U.S. real estate? In yesterday’s Age, Bwembya Chikolwa, a lecturer in the School of Urban Development at Queensland University of Technology, says Aussie super funds had money to burn and listed property trusts, with their large portfolios of U.S. assets, were liquid enough to do the trick.

“Unfortunately they were caught up in circumstances to do with the financial crisis,” she says. “Moving into the US wasn’t a problem because it had more or less the same settings…It was driven by large investment inflows into the super funds…The super funds needed new investment avenues and the trusts were a good avenue. So they invested through the listed property trusts. They had the funds and had no choice but to move offshore and the US market because of its size.”

No choice? A portfolio manager always has a choice. It’s the retail investor who is forced into compulsory super that has less choice. But this does highlight the obvious fact that fund managers are not paid to put clients into cash. Self managed super investors can do this easily enough, and many did (whether by design or indifference), thus avoiding the share market wipeout. But big fund managers have to buy big stocks. They are too big to buy small stocks, by the way, which creates a niche for Kris Sayce at the Australian Small Cap Investigator.

But now we have yet another seemingly external threat to your cozy domestic retirement: U.S. commercial real estate. Yesterday’s Wall Street Journal reports that the $700 billion U.S. commercial mortgage backed securities market saw a delinquency rate of 3.14% in July. That was up six times from the year before.

The Journal reckons that over $153 billion in loans need to be refinanced by 2012. Of that amount, at least $100 billion could be in trouble. Why? The underwriting on the original commercial real estate loans was dodgy (as it always is in a credit bubble). But more importantly, with property values on commercial real estate down by 50% in some areas, refinancing at the same loan to value ratio as before just isn’t going to happen.

Cash flows are fine for debt service and principal repayment now, according to the Journal story. It’s the write down in property values that will scupper the refinancing. What’s more, because the loans were securitised, it’s often hard to figure out who you should be renegotiating with. This is reminiscent of the residential mortgage backed securities market where Deutsche Bank couldn’t proved it owned the properties it wanted to foreclose on.

Mortgage servicers, banks, and investors would all prefer the problem to go away so no one has to take a write down on their asset values or a loss on their securities. But Aussie firms already know better. The only question now is if a pear-shaped U.S. commercial real estate market will do as much (or more) damage to the global financial system as the residential housing market. Stay tuned….

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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Retire Guy

It is worth noting that over 80% of the institutional-grade real estate in Australia is already locked by institutions. Compare this with around 50% in the US and lower again in Europe. Property is also tightly-held in this country. This keeps prices high and yields low, hence the move offshore to access properties at a reasonable price.

It is bound to happen again – we simply have too much capital and not enough investment-grade assets.

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