A Return to Equity: "An interesting opportunity for arbitrage opens for real estate"

John Dizard:

Whenever the US economic recovery does come, you can take it as read that the recovery and refinancing of the property sector will follow only with a very lengthy delay.

And that's at the macro level. At the level of particular locales and properties, there will be "assets" that never recover. Think of those ghostly outlines of town walls you see when flying low over the European countryside, or abandoned cities in the Andes.

There are Atlanta subdivisions and central California malls that will be mounds of dust and discarded fast food packaging. The difference is that centuries from now there probably won't be any tours of shopping centre excavations.

I would not count too much on any more initiatives from the US Treasury's crack recovery team. The PPIP (public-private investment plan), Talf (term asset-backed securities loan facility), and Tarp (troubled asset relief programme) haven't done the trick. Also, they are at, or past, the public's and the market's limit on aggressive new borrowing to fund work-outs. Two processes have to play out: losses must be incurred and recognised, and debt must be replaced with equity. The loss incurring and recognising part has been a staple of financial analysis. The re-equitisation part is only just beginning to happen.

The rationale for a property owner or developer to borrow was simple: debt has been cheaper than equity, because interest rates for debt secured by property have "always" been lower than earnings on equity, and because interest charges are deductible from operating earnings in computing tax.