There is always money to be made in commercial real estate, even when its value plummets. Rather than investing in the market, people are looking to bet against it. Covid sent workers home, and once they got there, many resisted returning to the office. Adding to the office abandonment is a series of tech layoffs. Thus, the temptation to short the commercial real estate market.
Shorting the commercial real estate market takes an incredible amount of research, timing, and the ability to ride an extended timeline. Three popular strategies are shorting real estate investment trust (REIT) exchange-traded funds (EFTs), individual commercial real estate stocks, or a CMBX index.
Choosing the shorting strategy that fits in with your acceptable terms of risk and knowledge is essential. Playing the market typically offers the greatest returns for the biggest gambles. So, if you don’t like to lose hard, selecting a safer strategy might suit you. Even better, forget betting against commercial estate, wait for prices to plummet, and scoop up some excellent deals.
How To Short Commercial Real Estate
Figuring out how to bet against commercial real estate and coming out a winner is complex. Research is the most significant ingredient to playing the market.
For starters, the sector is far more diverse than office buildings, where the bulk of the downturn is focused. Nor is the impact evenly spread. While New York and San Francisco have seen a drop in office space demand, other places, such as Houston, are doing well.
Research will also give you an idea if the timing is right. Bet too soon, and you might find yourself financially exposed. Bet too late, and there won’t be enough of a plunge to make the move worth it.
Short A REIT EFT
Shorting a real estate investment trust (REIT) exchange-traded funds (EFTs) is a way to make money off a downturn. Like shorting any other stock, you hook up with a broker and sell high, buy back low, and then return them to the broker, keeping the difference. The other option is buying a put, which is like shorting but with some guard rails.
Of course, with shorting, you risk the price going up instead of down, although that impact is softened with a put.
Another challenge is that most of these EFTs don’t focus strictly on the commercial market but are broader real estate funds, which include residential real estate. Thus, it is far more difficult to calculate how the numbers will shift.
Those wanting to avoid residential real estate will have an easier time finding options with an inverse REIT EFT. Investing in these provides profits when there is a decline in the sector rather than your typical stock where profits are made on the rise.
Their design makes them ideal for short-term leveraging rather than a long-term investment. Timing is everything. But the quick money also comes with higher risk than a typical EFT, especially as a spike upward can amplify the leverage in the wrong direction. In addition, they can have higher trading costs. Ensuring that the “better deal” isn’t canceled out by higher fees and expenses is crucial.
Short Commercial Real Estate Stocks
Commercial real estate stocks can be shorted like any other company stock. The key to making this work is finding those with a portfolio exposed to the worst impacted areas, such as New York, San Francisco, and Chicago.
In addition, look for those heavily invested in properties outside of mixed-use areas. For instance, while New York is one of the biggest areas plagued with empty office space, it isn’t a city-wide problem. Areas with mixed-use are doing pretty well. So, it’s essential to investigate the neighborhoods of vulnerable portfolios, not just the cities.
Be wary of headlines proclaiming specific commercial real estate stocks as vulnerable. If shorting a particular stock becomes popular, the price will rise rather than fall, creating a short squeeze. Some try to wait it out, hoping the numbers will plunge. But the loss can grow to alarming levels if it keeps going up.
Shorting The CMBX
Shorting the Commercial Mortgage Backed Securities Index is a complicated game that can make people filthy rich. But the game’s nickname serves as a warning: The Widowmaker. It’s not a strategy to enter into lightly.
Even those whose hunch is correct can still have the strategy blow up in their face, as was seen back when malls were dying. The problem is that even commercial real estate that is genuinely failing can take a long time to crash. Extended loans can serve as a temporary lifeline to an asset, and while it might not be enough to save it, it can delay a plunge by five years.
The problem is that shorting a CMBX index involves a credit default swap. There are monthly costs that add up. The longer the wait, the more payments made, the greater the crash has to be to make it even, let alone a profit.
Shorting Regional Bank Stocks
Shorting the stock of regional banks is a way to make money off the downturn in demand for office space and is less risky than shorting the CMBX. Regional banks have greater exposure to commercial real estate than big banks. The latter has more diversity, which lowers their risk.
Saying that, big banks are not immune to the tighter times in the commercial real estate sector, and some are deep enough to make things interesting. If it is sufficient to make trying to short the stock worth your time, it is another matter.
Wait And Buy Instead Of Shorting Commercial Real Estate
If playing the market is starting to sound too risky, consider waiting for these properties to become cheaper and scoop up some excellent deals. US zoning laws are catching serious grief due to the housing crises, and mixed use properties are rising.
But local governments all operate at a unique pace, so some will be slower to update zoning laws than others. People who have left themselves overexposed will be forced to sell rather than take advantage of opportunities on the horizon.
Remember that not all commercial real estate is as suited for mixed use as others. But with the right deal and creativity, money is waiting to be made.
Conclusion
Shorting commercial real estate isn’t straightforward and requires research, timing, and fortitude. But there is money to be made for those who execute their strategy with market precision. Unfortunately, some of that comes down to luck. For those who have lost their taste for it, there is still money to be made in commercial real estate, especially those with a keen eye for a deal.