General Electric Pays Price for Real Estate, Debt Investments

General Electric Co. Chief Executive Officer Jeffrey Immelt is paying the price for his investments in commercial real estate and U.K. property debt.

Profit at GE Real Estate dropped by $1.1 billion last year, according to the annual report from the parent company’s GE Capital finance arm. Fairfield, Connecticut-based General Electric’s real estate earnings are likely to fall further as occupancies and rents drop in a U.S. recession that’s now in its second year, said James S. Corl, who oversees distressed real estate investments at Siguler Guff & Co. in New York.

“They spent a huge amount of money in real estate,” Corl said. “They paid a full price for what ends up being a lot of mediocre real estate.”

General Electric shares this week dropped below $6 for the first time since December 1991 on concern that GE Capital may require additional cash. GE Vice Chairman and Chief Financial Officer Keith Sherin said in a statement yesterday that he sees no need to raise additional capital, and that the company’s financial services businesses expect to be profitable in the first quarter of 2009 and all year.

Sherin also said the company will host a GE Capital investor meeting later this month and examine the “hot spots in the company, including real estate, U.S. consumer, global mortgage with a focus on U.K. home lending, and central and eastern Europe exposure.”

GE said on Jan. 23 that its real estate unit will post a loss of $500 million this year as it absorbs $4 billion more in pretax losses. That will help drag GE Capital’s profit down to $5 billion from $8.6 billion in 2008, the company said.

‘Too Much Exposure?’

“Did we end up with too much exposure in certain areas during the credit bubble? Maybe, a few,” Immelt said in his annual letter to shareholders, released March 2. “Today, I wish we had less exposure to commercial real estate and U.K. mortgages.”

GE’s commercial real estate business consists of both property and real estate loans. It has stakes in or financing on 8,000 properties in 2,600 cities, with an average investment of less than $10 million, according to regulatory filings. GE’s property includes office buildings, warehouses and apartments, with about 71 percent located outside the U.S., primarily in Europe, Asia, Canada and Mexico, the company said.

‘Cash-Flow Positive’

“Our conservative underwriting of properties for which a valid value-add strategy (improve the building, re-lease, raise rents) was appropriate makes us comfortable with our portfolio,” GE spokesman Russell Wilkerson said in a statement yesterday. “We have business plans in place to improve properties where necessary. Many of these properties still carry below-market rents, providing us with protection and some upside.”

The company’s property “portfolio generates $1.7 billion in net operating income, while we depreciate the assets by about $1.1 billion per year,” Wilkerson said. “This makes the properties cash-flow positive in the aggregate.”

GE in 2006 purchased Arden Realty Inc. for $3.2 billion. Arden was then the largest publicly traded landlord in Southern California. The company also bought self-storage company Storage USA in 2002 and sold it for $2.3 billion in 2005.

Cutting Costs

“It’s an understatement today to say operating in this environment is tough,” Joaquin de Monet, chief executive officer of GE’s Arden Realty, said yesterday at Incisive Media’s Real Estate 2009 conference in Los Angeles. Arden is working on cutting costs during the slump, he said. “It’s really a focus on how diligent you can be.”

The vacancy rate at U.S. office buildings likely will rise to 16.7 percent this year from 14.5 percent at the end of 2008 as tenants cut jobs, research company Reis Inc. said last month. Vacancies at U.S. retail centers approached a 10-year high in the fourth quarter, and apartment rents fell as the national vacancy rate climbed to a four-year high, Reis said in January.

Sherin said the company has about $50 billion of commercial real estate loans, and about $34 billion of equity. “That’s the actual value of the properties, with over 80 percent of that with no third-party debt,” Sherin said in yesterday’s statement. The company has $2.9 billion of commercial mortgage-backed securities.

The company accounts for its real estate holdings at the price they paid for them, depreciating the values over time, rather than periodically marking them to their current market values, arguing that the company is a long-term investor, CreditSights Inc. analysts led by Richard Hofmann said in a March 3 note to investors.

“We are an owner-operator,” Wilkerson said in the statement. “We expect to hold the properties for the long term, so therefore they need to be accounted for in a different manner. If we did mark to market we would remove the depreciation from our net income calculation, so this would be an offset.”

‘Look Out Below’

GE Capital “has staunchly defended its long-term hold position for real estate assets, allowing it to carry positions at historical cost (and depreciate those values over time), rather than marking-to-market, which we imagine could turn into a ‘look out below’ type exercise in the current climate,” Hofmann wrote.

GE’s position on mark-to-market accounting is similar to the approach of U.S. real estate investment trusts, and has led analysts such as Nicholas P. Heymann at Sterne Agee, a Birmingham, Alabama-based brokerage, to reach their own conclusions about the value of the company’s holdings.

“We conservatively believe there could be 5 to 13 percent, or $4.3 billion to $11.0 billion, of cumulative losses/write-downs in the commercial real estate portfolios,” Heymann and his fellow Sterne Agee analysts said in a note to investors this week.

GE’s Wilkerson said the company will update investors on details of the company’s real estate holdings at the presentation the week of March 16.

Early in Cycle?

With a tougher refinancing market and property income being hurt by a rise in vacancies, “we believe asset values will experience significant weakness for the next several years,” Heymann wrote. “Furthermore, our analysis of the commercial real estate portfolio indicates the company’s holdings are concentrated in markets that are early in the credit deterioration/vacancy cycle.”

GE officials have argued that the company has acted quickly to avert trouble. It left the U.S. mortgage business in 2007, ahead of the surge in residential loan defaults. More than 8.3 million U.S. mortgage holders owed more on their loans in the fourth quarter than their property was worth as the recession cut home values by $2.4 trillion last year, First American CoreLogic said yesterday.

GE “exited U.S. mortgage as soon as we recognized the issues,” Sherin said in a presentation at a Barclays Plc conference last month.

‘Manage Through’

“Yes, our real estate business is larger than we want in this environment, but we can manage through,” he said.

In Europe, GE has $22 billion of real estate assets. About a third of that was real estate debt and non-performing loans at the end of the second quarter of last year, according to its Web site.

In November 2007, GE bought 2 billion pounds ($2.8 billion) of commercial real estate loans from Bradford & Bingley Plc, the U.K. mortgage lender that was nationalized last year. At the time, U.K. commercial property values had fallen 3 percent from their July 2007 peak, according to Investment Property Databank Ltd. They have now fallen 37 percent from that peak.