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Neuberger Berman Real Estate Se Message Board

  • chazcpa7 chazcpa7 Feb 15, 2008 12:12 AM Flag

    Auction Market Rate Securities

    Does anyone have opinions on the effect of the problems in the Auction Rate Securities market on Closed End Funds such as NRO?

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    • I was under the impression that this market was just a means of making preferred shares more liquid for those wanting to sell their securities while enabling NRO to set rates to attract buyers.

      NRO does not have to issue more preferred shares if the rates are not attractive enough. The use of cheap leverage to squeeze returns out of a low yielding environment was useful in the past. However, with plenty of REITs yielding 10% to 15% today, leverage is not as necessary as it once was to generate competitive returns.

      The auction rate securities market will be fine when investors get a more attractive spread for their capital. Adequate compensation for risk is the real issue - plenty of liquidity out there at the right price.

      Commercial REITs probably offer the lowest relative risk opportunities for investors today. For example:

      Corporate earnings fall 30% - still have to pay rental leases.

      Corporate earnings fall 50% - still have to pay rental leases.

      Corporate earnings fall 100% - still have to pay rental leases.

      Corporate earnings negative - still have to pay rental leases.

      Estimated M3 money supply:

      Higher inflation allows companies to raise prices to keep pace with soaring costs that eat into earnings - rental lease rates go up (Cha Ching for commercial real estate landlords).

      Who would you rather be in this economic environment - business or landlord to business?

    • They will be taking a write down next week because of a failed ARS. Just spoke to I.R.
      They are in reactionary mode right now.
      NRI's A.R.S. went through.

      • 2 Replies to marketslip
      • I see no reason to get upset about the cost of capital going up when the yields on REITs have gone up so dramatically in the last four months.

        The current 1-Month Libor rate is 3.12%, making 3.87% (.75% spread) a competitive going rate on short-term capital. I do not mind if NRO temporarily pays about a .50% premium at the maximum rate knowing that it can rotate into REITs paying much more than what was available a few months ago. Even if rates went to 5%, NRO can still make a 5% to 10% spread off this capital. This is much better compensation for risk than last summer when spreads were at historical lows.

        Reactionary mode? Yea, with opportunities to acquire REIT cash flows on the cheap at yields as high as 15%, I expect NRO to REACT by taking advantage of the significantly improved spreads. Regardless of how high rates go, the change in spread is all that really matters.

        Preferred shares exist for NRO because it is profitable (positive cash flow) to have them. At current spreads, they are significantly more profitable today than they have been in years.

      • I think you are wrong. When the auction fails the securities remain outstanding as they are perpetual. What happens is there is a maximum built in "fail rate" which is used for the next 7 or 28 days. Thais rate will be higher than what would have been available in auction and causes expenses to go up but no mark downs. By the way, the "fail rate" this week is much lower than the auction rate was 6 weeks ago. So my guess is this will right itself soon.

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