[R E C O M M E N D A T I O N]
Please be advised that recommendations provided below are cursory and may include sections from our comprehensive reports provided to clients. Recommendation offered below are not always up to date and real time advice is available to current clients.
This recommendation last updated June 2010.
Mathematics and economics would indicate that today’s residential real estate prices should have suffered much more than the declines seen in the last two years. While some markets, have seen substantial decreases, a majority of metropolitan areas have seen much lower that anticipated returns. Our latest ‘Real Estate Outlook’ looks into the four main factors behind today’s residential real estate market including:
- Phantom Inventory – Many financial institutions are holding onto defaulting inventory in light of the governments assistance in shoring up the balance sheets of these major banks.
- The Responsible Buyer – In every bull market there exists a set of reluctant would-be buyers who for several different reasons opt out of purchasing the asset. In the case of homes the types of would-be buyers who refrained from buying homes included 1. the chasers, 2. the conservative, and 3. the fearful. These buyers now become emboldened as every prices retreat represents a buying opportunity.
- Foreign Investment – The strength of foreign currencies until fairly recently (specially the EURO) offered foreign investors a perceptually higher purchasing power encouraging such buyers to step in.
- Fanni Mae-Freddie Mac – The majority of mortgage originations came from Fannie Mac and Freddie Mac government sponsored entities.
Single Family Residential (SFR) – REcon maintains its sell recommendation initiated in October 2005 on SFR in most areas of the United States. Despite the retraction of home prices commencing at the end of 2007, median home prices continue to represent 165% increase from January 1, 2000 to March 1, 2008 (Source: Standard & Poor’s) . Sell recommendation continue for the United Kingdom (+208 %), Spain (+246 %), France (+212 %) and Ireland (+191 %) residential markets. Current ability to actually sell existing inventory and price discovery is skewed by the inability of willing purchasers to obtain the necessary financing. The excessive demand created by various forms of “creative financing” structures have largely evaporated from market; however, their negative effect on the conventional mortgages will continue for the foreseeable future. Clients may refer to “The Strata of Home Price” published in our research note.
We forecast a bottom in the United States single family residential market within 9 to 18 months followed by a protracted sideways movement in prices up to 36 months from now. The prediction is based on the time period required for adjustment of US Homeownership Rates to historical means. Homeownership rates have averaged 65 percent from 1980 to 2000 during a period lacking the marketing and availability of creative financing structures. From 2000 to the second quarter of 2008, ownership rates increased to a high 69.2 percent in the first quarter of 2005 with the second quarter of 2008 recording 68.1 percent. The paramount contributing factor to this historic increase had been excess liquidity and unconventional financing vehicles not designed for the common homeowner. The typical consumer did not experience unproportional increase in income or rate of savings as it continued its spending binge. We expect ownership rates to return to historic rate of 65 percent with the possibility of lower ownership rates as low 63 percent-reminiscent of the early 1990’s. The US Census Bureau reported 129.9 and 130.4 million housing units in the United States in the second and third quarter of 2008, respectively (see report Q2) (see report Q3) (see report Q4). Approximately 111.2 million (111.7 for Q3) housing units were occupied: 75.7 million by owners and 35.5 million by renters. Currently, the homeownership rates stand at 67.9 as reported for Q3 of 2008.
At a historic rate of 65 (or low of 63) percent, approximately 3.5 million (5.5 million) of the 75.7 owner occupied units are allocated to owners (as opposed to renters) due to ‘creative’ financing options that were available prior to the financial meltdown (AKA awakening) of 2008. We estimate that between 3.5 million to 5.5 million homes are candidates for foreclosure. The market would require absorption of a mix of net incoming inventory including new homes and foreclosures to reach equilibrium (bottom). The matter is exacerbated by a much slower than typical rate of absorption due to qualified buyers inability to obtain conventional financing for home prices uncorrelated to real income.
A major reason for the slow rate of price deprecation over a prolonged period (as compared to the 1990’s) of time is the demographic and psychological characteristic of the novice homeowners. While exuberance in the real estate market of the 1980’s was attributable to investor grade entities, the market of the mid 2000’s was inundated with novice home buyers and “flippers.” Experienced investors in all markets better understand market dynamics and exit (enter) markets at the slightest sign of weakness (strength). Such investors understand the value of a small loss with the promise of alternate or future investment opportunities. On the contrary, novice market participants lack fundamental understanding of market variables and experience extended periods of market decline on the false premises of hope. These partakers either are the last to exit the market or are forced out by numerous factors including the inability to sustain the investment. Permanent avoidance of future investments is the typical path for those distressed investors.
In all markets the period of decline is directly correlated by the pace of rebalancing between supply, demand, and return (overshoot) to the historic home ownership levels (mean reversion). The return of available credit (from over stringent standards resultant of the credit crises commencing in 2007) to the consumer will provide the liquidity required to establish the bottom of the residential real estate market. The Federal Reserve is providing and will continue to offer liquidity to lending institutions; however, fearing further loss of equity, banks are maintaining strict lending standards.
Multi Family Residential (MFR) – Our recommendation for Multi Family Residential is market and project specific. Clients may request market specific research notes.
Commercial/Industrial Real Estate – Regional employment and local socioeconomic demographics provide the bases of commercial (retail and office) and industrial real estate demand. Our current recommendation is to avoid these sectors with only few market specific opportunities. Clients may request market specific research notes.
Clients: Please refer to the ‘Real Estate Outlook’ updated quarterly or earlier dependent of market dynamics.
*DISCLOSURE: Potential investors should always consider a variety of factors prior to seeking investments and corresponding advice. The opinions and recommendations expressed on the REcon website and public reports are the opinion of REcon. We are a research intensive operation and while we practice diligence in our work, are not formally bound by any regulatory institution (i.e. SEC). The use of this data to make any investment decisions is the sole responsibility of the user and REcon takes no responsibility, expressed or implied, for the use of this information and its consequences. You may consider contacting REcon or your own financial adviser before acting on any recommendation or information.