When the current downturn in commercial real estate comes to an end, the U.S. REIT sector might look a lot smaller, according to participants at New York University's 14th annual REIT symposium, which took place on April 2. With even the strongest REIT operators suffering from steep stock price depreciation over the past 18 months, many companies are seeing the benefits of being public disappear. As a result, the U.S. REIT sector might shrink by up to 85 percent over the next several years, according to estimations by the most dire symposium participants.

Experts think the REIT industry may be standing at a crucial crossroads. The industry has largely thrived since the "REIT revolution" of the early 1990s, when new laws made it very attractive for real estate firms to go public. Between 1990 and 1994, the number of REITs in the U.S. rose by almost 90 percent, from 119 to 226. Today, 134 REITs remain in operation. But that could be changing. “We’ve reached a Darwinian moment,” said Sam Zell, chairman of Equity Group Investments, LLC, a Chicago-based privately held real estate investment firm. “Of the 100 plus REITs, maybe 20 or 30 are relevant. The small guys are going to go private.” When the current downturn is over, he expects that only the largest players, with the best assets and the strongest balance sheets, will remain in the public market.

The problem is that given current worries about liquidity, most REIT stocks are being valued based on companies' debt maturity schedules rather than the inherent values of operating businesses, according to Timothy H. Callahan, CEO of Callahan Capital Partners, a Chicago-based real estate private equity firm. Any player with leverage above 65 percent and significant debt maturities coming up before 2011 remains suspect regardless of the quality of its assets. As a result, in the past year alone, the total market capitalization of U.S. REITs declined by approximately 30 percent, to $134 billion from $191 billion in 2008. Total market capitalization is also off 57 percent since valuations peaked in 2007 (at the time, there were 152 firms in the REIT sector, with a market cap of $312 billion). That has left many companies with too little cash on hand, putting their very survival at risk, according to Steven Roth, chairman and CEO of Vornado Realty Trust, a New York City-based diversified REIT. In today’s environment, “If you don’t have equity, you are dead,” he said.

In the retail REIT sector, which includes 23 firms, total returns have fallen 36.6 percent year-to-date, after a decline of 48.4 percent in 2008, according to NAREIT. Simon Property Group, the largest retail landlord in the U.S. with 246 million square feet, saw its stock price fall 62.9 percent in the past year, from a 52-week high of $106.43 per share to $39.95 per share at the open of the trading day on Monday. Chicago-based General Growth Properties, which owns the second largest retail portfolio in the country at 182 million square feet but continues to struggle with mounting debt maturities, saw 98 percent of value wiped out from it stock in the past 12 months. Its share price is down from a 52-week high of $44.23 per share to $0.87 per share on Monday morning.

The popular opinion at the symposium was that General Growth, which already missed $1.2 billion in debt payments and has an additional $3.3 billion in debt coming due in 2009, has so far avoided a bankruptcy filing only because its lenders and special servicers remain at a loss about what to do with its massive holdings. Most industry insiders, however, including Zell, expect that the REIT will file for Chapter 11 at some point in the future, reorganize and re-emerge as a more streamlined operation. A liquidation of General Growth at this point in time would serve no one well and its assets remain valuable enough to save it from total destruction, Zell said.

Also pushing for Chapter 11 filing was William A. Ackman, founder and managing member of Pershing Square Capital Management L.P., a New York city-based hedge fund with a 25 percent stake in General Growth. “I think it’s a great company, it’s got great assets,” Ackman said. “It’s one of the more interesting investment opportunities I’ve seen in my career.”

In fact, the next several years should offer a number of great buying opportunities for both private equity players and those REITs able to survive the credit crunch and the stock sell-offs. These will come in the form of mergers and acquisitions of whole companies, as well as one-off asset buys at steep discounts. One of the first inklings of things to come took place last week, when shopping center REITs Ramco-Gershenson Properties Trust and Equity One, Inc. revealed they might be considering a merger. Over the next five years, such deals will begin taking place on a major scale, according to Roth.

For the healthy REITs, the game plan will be to raise equity, “buy a toy, the stock goes up, buy another toy,” Roth said.