Why We Shorted SL Green

We have recently put on a short on SL Green (SLG). The REIT’s stock has run up almost 700% from its March 2009 lows but the fundamentals for the company have never been worse. A look back at several years of 10k's shows that SL Green has grown its commercial real estate holdings on its balance sheet from $2 Billion at the end of 2005 to $7.5 Billion at the end 2009 with almost all of the increase occurring in 2007 at absolute peak prices. During that time period the following table shows what has happened to Occupancy rates:

		Percent of Manhattan Portfolio Leased(1)			Occupancy Rate of Class A Office Properties In The Midtown Markets(2)(3)			Occupancy Rate of Class B Office Properties in the Midtown Markets(2)(3)
December 31, 2009			95.0	%		86.8	%		90.3	%
December 31, 2008			96.7	%		90.8	%		92.1	%
December 31, 2007			96.6	%		94.1	%		93.5	%
December 31, 2006			97.0	%		95.7	%		93.7	%
December 31, 2005			96.7	%		94.4	%		92.5	%

Occupancy fell to more new lows in the recently announced Q1 2010 results despite SL Green dropping starting rents by 5.1% in Manhattan and 10.9% in its Suburban portfolio.

We conservatively estimate that the $5.5 Billion spent to purchase and fix up office buildings during this time period has fallen in value by 25%, wiping out $1.375 billion in value of the assets that the company has yet to write off; putting the company and of course its shareholders in severe peril longer term.

Management missed the opportunity to raise more equity probably because they were too nervous about dilution to FFO and the already ridiculously low 0.6% yield; that opportunity may no longer be available to the company with the recent turmoil in equity markets around the world. Management bet the future of the company on a rebound in Manhattan commercial real estate. Not only have they refused to raise more equity to reduce the risk but they are also using revolving credit lines to make high-risk loans to other commercial real estate investors. The company currently has $900 mm drawn down on its revolving credit facility and has structured finance investments of $786 mm. We feel that this is a disaster waiting to happen.

The stock is currently trading at an implied cap rate of just over 5%. We feel that this is extremely over valued and that the shares most likely will drop at least 50% in the next 6 months. Even at those prices the yield will still be too low to compensate investors for the extreme risk inherent in SL Green's portfolio.

Disclosure: Short SLG.