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Lehman’s Commercial Real Estate Spinoff: Part Of A Fear Frenzy?

Lehman Brothers
Bert van Dijk
Lehman Brothers

So Lehman Brothers is getting out of the commercial real estate investment business by ridding itself of $25-$30 billion worth of CRE assets.

This includes equity investments in companies such as US residential apartment REIT Archstone-Smith and California residential developer SunCal, not to mention an unclear amount of commercial mortgage backed securities.

Now given the fear that roils Wall Street these days when it comes to real estate investments in any form, one might think that the spinoff of these assets to the shareholders might be considered an indictment of the commercial real estate market as a whole. The assets would transfer to a new publicly traded company which will be called Real Estate Investments Global (some are calling it a “bad bank” that would be designed to protect the other parts of the firm from commercial mortgages). Lehmanalready wrote down the value of its commercial real estate assets by $1.7 billion in the third quarter.

But the fundamentals of commercial real estate, that being vacancies and rents, etc. are still strong. The problem is credit and confidence. I can’t say it any better than Dr. Sam Chandan of REIS, so I’ll let him do the talking, first on commercial mortgage backed securities:

As market conditions have deteriorated, the spreads on these securities have grown wider and the discounts at which they have been trading in the market have been growing increasingly large. There is the sense that the spreads are much wider in terms of what they imply for defaults, than what we'll actually observe in terms of the number of defaults that we'll see over the next couple of years.

Do people really want to buy these securities right now and if there isn't much interest then the spreads may be much wider than what you'd think they should be based on the likelihood of defaults.

And as per risk of these investments:

There is a spillover and the spillover is not related to an expectation that defaults in the commercial sector will rise to the level of residential...it's perception of risk uncertainty and our capacity to measure and manage those risks.

I don't think that today's announcement is an indictment of the commercial real estate sectors and the performance expectations for commercial real estate properties. If we look at the fundamentals trajectories, what's going to happen with rents, what's going to happen with vacancy rates for office buildings for retail properties over the next couple of years, it's not going to be appropriate for every investor in commercial real estate assets to say at this point at this juncture it makes sense to begin to sell off all of my assets.

There's also the problem that very few investors want to get into commercial real estate right now, especially given the tight credit markets. Commercial property sales are down 65% from their peak last year, so the values are falling as well.

Why get in now, when you can wait until it all shakes out. I tell you, it's a fear feeding frenzy based on the fact that nobody really trusts asset valuations at all anymore.

Questions? Comments? RealtyCheck@cnbc.com