Increased Uncertainty for REITs
Our rationale for increasing the fair value uncertainty ratings for many of the real estate investment trusts that we cover.
We've decided to increase the fair value uncertainty ratings for many of the real estate investment trusts that we cover to better account for the wide range of possible outcomes for these firms over the next few years. In the fourth quarter of 2008, we moved our entire coverage universe of 68 REITs to either high or very high uncertainty as it became clear that falling asset values and excessive leverage in most property types was a toxic combination. Given recent signs of additional distress, we're moving 21 companies to very high uncertainty from high. After this update we'll have 19 REITs at high and 49 at very high. In addition, we're raising some of our assumed credit spreads--which increases the firm's cost of debt and overall cost of capital in our valuation models--to more accurately reflect the exceptionally difficult lending environment.
Increased uncertainty ratings lower our Consider Buying prices, meaning that we believe a larger margin of safety is necessary to properly account for the possible spectrums of cash-flow generation and discount rates. The only certainties right now in commercial real estate are that rents and asset values are falling and are likely to fall further. The primary uncertainty--which our larger margins of safety should capture--is the magnitude of these declines. Although we've modeled material, and in some cases severe, downturns in each of our discounted cash-flow models, the constant stream of abysmal economic data makes it nearly impossible to peg where fundamentals will ultimately find a floor.
Joel Bloomer does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.