There can be no disputing the fact that Real Estate was in a huge bubble that burst in the 2006 to 2007 time frame. This was most evident in the Sand States of California, Nevada, Arizona, and Florida. The carnage from the bursting bubble drove home prices to below replacement costs enabling rental returns to soar from a minimum of 8% to 15 or 20%+ for a very profitable Return On Investment ( ROI ). Just as discounted distressed properties became readily available, 70-80% of Mainstream America became ineligible to purchase due to foreclosure or short sale lender issues, thus missing an enormous buying opportunity. A huge vacuum temporarily existed in the marketplace until organized investment groups entered and purchased the discounted distressed inventory; clearing the bottleneck and eventually allowing housing to normalize. Home prices rose to reflect a stabilizing environment and distressed properties slowed to a much more manageable pace. A stabilized marketplace allowed prices to rise from the discounted extremes as prices returned to the mean.
The pent-up selling pressure from homeowners that chose to honor their contractual agreement and not allow their property to be foreclosed or short sold has been unleashed as their homes are no longer underwater. However, a new vacuum is present in the market as all of the low hanging fruit has been picked, leaving investors absent. Penalized buyers are just becoming eligible for new loans creating a supply-demand imbalance. This is or will shortly cause a correction in home prices that has the potential to accelerate should economic or geopolitical events cause disruption.
Walter Zimmerman of United-ICAP, a renowned technical analyst, believes there is a transition underway from paper assets into real assets. Further, Walter Zimmerman's work is forecasting trouble ahead for the stock market and junk bond market; both, he believes, are in a very large unsustainable bubble. The bursting of these bubbles will eventually be bullish for housing as money flows out of stocks and high yield bonds into hard physical assets. Additionally, he sees a bottoming and a strengthening of the US Dollar further depressing the commodity market which has been sliding. Should these markets implode as Walter Zimmerman fears, deflation will affect all asset classes. Real estate will be affected, but not to the extent it had in the previous downturn. Rentals should remain in demand, although the rate may be slightly affected. The catalyst for a global meltdown may be China.
China has financed its' prosperity, and problems abound: Issues range from local banks unable to meet small investors’ bond payments to missing hypothecated copper and aluminum ingots supposedly stored in harbor warehouses, but missing and feared to have been used as collateral with multiple lenders. With over 52 million vacant residential housing units, the Chinese housing bubble is of epic proportions. As the world economy slows the risk of red flags and black swans increases dramatically. A global slowdown will have widespread effects: Japan's debt laden economy may collapse the currency; Russia could finally descend into recession; and the US stock and bond bubble are at risk. Real estate will eventually benefit as the economy again begins to recover, but that event's time frame will probably not bottom until 2016-2017 when the inflation cycle may begin. What is a possible strategy?
Over the last year,
I have been recommending selling marginal properties, trimming stock and bond holdings, preparing an exit strategy, and raising cash. Spring of 2013 seems to have marked the high point in many formerly distressed markets (including Phoenix) that had the greatest investor activity. Prices have slightly declined as inventories have risen; curiously, rentals are very strong. As previously mentioned, a correction in housing is possible, but with much of the thousands of homes purchased by investors with cash and very little encumbered leverage, the asset itself should be secure. The junk bonds used to raise the cash may be at risk with consequential problems. Both Charles Nenner and Walter Zimmerman see inflation beginning in 2017 and a normalization to an actual boom market by 2020.
Strategic real estate delivers dependable cash flow, is located in markets that will retain value, and will experience growth in a normal environment. Cash flow in a difficult marketplace will be of paramount importance and mitigate the effects of any economic turmoil. Although there must be careful selection, opportunities to add good quality properties to a cash flow/income oriented portfolio should be considered. They may boom in the outlying years while providing scarce income in the near term. Further, an opportunity to place long term financing at these current near historically low rates, may not be available in the near future. As Walter Zimmerman has stated, expectations that property values may slide during a downturn should be tempered by the belief that the crash that followed the Real Estate Bubble will not be repeated; rather any downturn is a correction in a long term real estate bull market. Investors negatively impacted during the bursting of the bubble experienced problems due to over-leveraging the debt, not the property itself.
This article should interest investors in residential REITs like American Campus Communities (NYSE: ACC), American Capital Agency (Nasdaq: AGNC), Annaly Capital (NYSE: NLY), Apartment Investment and Management (NYSE: AIV), Apollo Residential Mortgage (Nasdaq: AMTG), ARMOUR Residential REIT (NYSE: ARR), Associated Estates Realty (NYSE: AEC), AvalonBay Communities (NYSE: AVB), BRE Properties (NYSE: BRE), Camden Property Trust (NYSE: CPT), Campus Crest Communities (NYSE: CCG), Colonial Properties Trust (NYSE: CLP), CYS Investments (NYSE: CYS), Education Realty Trust (NYSE: EDR), Equity LifeStyle Properties (NYSE: ELS), Equity Residential (NYSE: EQR), Essex Property Trust (NYSE: ESS), Hatteras Financial (NYSE: HTS), Home Properties (NYSE: HME), Maxus Realty Trust (OTC: MRTI.PK), Mid-America Apartment Communities (NYSE: MAA), New York Mortgage Trust (Nasdaq: NYMT), PennyMac Mortgage Investment Trust (NYSE: PMT), Post Properties (NYSE: PPS), Senior Housing Properties Trust (NYSE: SNH), Sun Communities (NYSE: SUI), Two Harbors Investment (NYSE: TWO) and UDR (NYSE: UDR).
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Labels: Douville, Editors_Picks, Editors-Picks-2014-Q3, Real-Estate, Real-Estate-2014-Q3
