Tuesday, January 15, 2008

Property, CDOs, SIVs

Citigroup plans to announce a “sizable” cut in its dividend, a cash infusion of at least US$10 billion and a write-down of as much as US$20 billion in mortgage-related investments as part of its fourth-quarter earnings report Tuesday morning, the Wall Street Journal reported Monday. There is also a strong chance that some 20,000 jobs will be cut.

The unwinding of the sub prime mess exaggerated the correction that was needed in property. Let's re-examine how we got here. Property, largely commercial had new legs beginning 2000.

The spectacular performance by REITs from 2000-2006 was largely due to the property boom in the US. The property boom was largely ignited by the "invention" of REITs itself. The availability of REIT allowed many commercial property owners to unlock cash from their long term hold type asset. The unlocking of cash also helped charge up the rise and rise of private equity and hedge funds (where most of these excess cash went to).

If you chart the absolute rate of returns year by year on REITs:
2000: 31%
2001: 12%
2002: 3.6%
2003: 36%
2004: 33%
2005: 14%
2006: 36%

What we didn't see was the invention of CDOs repackaged into Structured Investment Vehicles from 2004 onwards - that contributed to the jumps in private housing as these instruments caused mortgage brokers to lend recklessly to buyers who did not qualify, but there were substantial lenders via buyers of CDOs and SIVs.

Property had a decent run in the late 90s already but took steroids over the last 8 years. The sub prime mess and the beginning of the property correction in the US also contributed to the negative 17% returns for 2007. Safe to say that from the above that there may be quite some distance to go for the excesses to be unwound from the US property market still after such a prolonged run. Can expect 2008 to post negative returns as well. What we are seeing in all the investment bank write downs is not the end. After such a prolonged run, there will be more excesses that needs to be wrung out from the system.

The whole thing is being replayed, albeit less severe, in the UK. That's because CDOs and SIVs did not play a huge part, but their property run was more robust than in the US. There will be more companies failing and funds falling by the wayside.

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