The REIT sector is in all sorts of unprecedented trouble. They depend on leverage, and to the extent that it can be had at all, it's become more expensive and tougher on terms. Consequently, the weighted average cost of capital (debt and equity combined) for REITs will increase by an average by 100-200 basis points, to 7-8% all-in, according to Goldman Sachs. With the cost of capital going up, cap rates must also increase and consequently commercial real estate values will inevitably drop further. This creates a kind of negative feedback loop that even Harry Houdini could not escape.

This will not only affect the ability of REITs to refinance their own debt, reduced availability of capital will dramatically impact the clients of many Mortgage REITs. These borrowers have historically sold assets or refinanced their loans via the secured debt markets to repay Mortgage REIT loans. They can no longer do so, and Mortgage REITs like iStar financial (downgraded to junk status by Moody's yesterday) have seen their balance sheets turn to cement. If this environment persists, there could be a massive wave of defaults on REIT-related debt.

While Goldman Sachs's REIT research team recently issued a report that was cautiously optimistic on a few names, they also noted that commercial real estate is eroding at a pace indicating that occupancy and rental declines should match the deep recession of the early 1990s. Read Goldman's full report on REITs here (courtesy of Zero Hedge)

With the availability of credit vastly reduced and commercial real estate values likely to drop by 30-40%, REITs will need to contribute a considerable amount of equity in order to successfully refinance approximately $20-$30 billion of debt coming due in 2010.