💵 Commercial Real Estate is Gonna Collapse Bro

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🔜 Merchant Yield. https://t.co/XcemXjNcRJ— Utrust (@UTRUST) October 6, 2022 

Tighter credit conditions are likely to weigh heavily on CRE. Banks play a key role in the CRE financing system, and increased scrutiny on lending practices means tighter credit for CRE borrowers could be in the offing.

Commercial property valuations have already started to downshift and are set to fall further. In addition to limiting new CRE funding sources and investment, tightening credit conditions increase the likelihood the U.S. economy experiences a recession later this year.

An economic downturn is likely to weigh on demand for space and new development, which will impact rent growth and valuations. If history is any guide, property prices are likely to fall further if interest rates remain elevated and a recession occurs, as we currently anticipate.

Declines in office property values could be more acute, especially for outdated supply which makes up the vast majority of the office market. Of course, there is likely to be a great deal of variability by geography as well.

There's really three ways for an enterprise to maintain its data. One, you do it yourself on-site and you have your own IT department. They keep the servers running, maintain the software and the cybersecurity. Second, and that which the legacy data centers that we short epitomizes, the colocation data centers, whereby you keep your server at a third-party location. The third-party maintains the servers, keeps the air conditioning on, does whatever routine maintenance is needed to do, and provides the network connections.

And those are the so-called legacy data centers. That is the focus of our big short. And then the third way, which is the way that is garnering the most market share now is the so-called cloud providers. These would be what we call and others call the hyperscalers. Amazon AWS, Microsoft Azure, Google Cloud, et cetera. Oracle has one. And this is just simply you keeping your data on their servers and they maintain them, try to sell you add-on services on top of just a hosting fee. So that's the three ways in which data is kept for enterprises.

If you go back and look at the returns on this business and returns on incremental capital, the business peaked pretty much around 2016. Ever since then, incremental returns have been terrible and in some cases, negative on capital. And so although the stocks continued to perform for a few years after that, really was on the back of a narrative than it was analysis in our view. And we love those kinds of shorts where the business is quite a bit different than the narrative.

And the narrative was these are the beneficiaries of growth in data. And therefore, you should -- if you're a real estate investor, the one way to play growth in tech and growth in data is to buy the data center REITs. And the problem with that, of course, is that on a same-store basis, the returns are, in many cases, flat or in the case of Digital Realty, DLR, negative on a same-store basis for the last handful of years.

So really, the unit economics have just gotten worse and worse and worse as the hyperscalers have taken more and more share. And that's the real problem here is that at the end of the day if your incremental return on invested capital is negative then it doesn't matter how fast you grow. In fact, if you grow, you're liquidating faster.

Yes, you're liquidating. And so just to give you an idea, we did some numbers last year, they're still pretty valid. Since 2016, we calculated that Digital Realty, the largest of these players, Digital Realty required $11 in new capital since 2016 to generate $1 in new revenues at a 50% EBITDA margin. And we'll get to that why EBITDA is not the right metric for these companies in a little bit. But given that, so it costs them incrementally $11 of new capital to generate $0.50 of gross cash flow.

 Singapore press connecting the dots between troubled $CYXT and $DLR’s $DCRU subsidiary. https://t.co/KrcGIJ8KKY— Diogenes (@WallStCynic) March 21, 2023 

 (2) And here’s what that means. With data center private sales/small caps ($CYXT, $DCRU) at 8-10 caps, the public DC REIT darlings($DLR, $EQIX) are trading at 5 caps. Both have a long way to fall in a re-rate. pic.twitter.com/AJC5pzOXKN— Diogenes (@WallStCynic) March 21, 2023