The Clarus Blog

It was only a matter of time before deteriorating market fundamentals began to affect every asset class, and it’s a rare property that hasn’t been hurt by falling rents or occupancy.

National apartment and retail vacancy is now at record highs (going back to the 1980s), and office vacancy is approaching the highs of 1992. Hotels have had a disastrous year (revenue per available room is down over 18%); malls are still wretched investments (and will likely remain so after what is expected to be a poor holiday shopping season); and industrial properties have been hurt by continuing convulsions in the manufacturing sector, shipping and storage sectors. Even real estate such as parking lots, storage sheds, and farmland has been undercut by the recession.

The time still isn’t ripe, but by mid 2010 or early 2011 it will make sense to purchase commercial real estate loans. For many people, real estate is a large headache, and loans/mortgages are a way to gain access to the real estate market without assuming real property risks. (There are other risks, of course, but many investors understand loan/mortgage risks better than real property risks.)

Still, this is something to wait for. Defaults and bankruptcies are going to drastically alter the commercial real estate market this year, but until that happens, there won’t be too many discounts.

Quite a few U.K. funds are preparing to target commercial real estate loans, according to The Guardian:

Real estate funds are spying rich pickings from carnage in commercial real estate, stockpiling cash to buy discounted loans that may cost banks billions of pounds in the coming years.

Mortgages supporting high-profile office or shopping mall deals are in dire need of refinancing after a record crash in prices in 2008 that has hit commercial property markets much harder than its residential counterpart.

Much has been made of American and European policies toward the real estate industry (to nationalize or not to nationalize, to support homeowners or to let them default on mortgages, etc.), but nothing has been as bizarre as this approach by a local Chinese government (via Reuters):

A local government in an eastern Chinese city has taken its efforts to prop up the economy to new heights, ordering cadres to act as real estate agents with a quota of selling — or buying — at least one flat each.

The order by Hanting District, in the city of Weifang in Shandong province, marks one of the more extreme measures that local officials have come up with as they try to tackle the economic slowdown.

It’s a refreshing reminder that as novel as our situation is, our markets are still free.

I guess the worst is over and we can all start flipping houses again (via CNN):

Sales of existing homes unexpectedly rose in February, recovering from a sharp drop in the previous month, according to an industry report released Monday.

The National Association of Realtors said that existing home sales rose last month to a seasonally adjusted annual rate of 4.72 million million units, up 5.1% from a rate of 4.49 million in January. February sales were down nearly 5% from year ago levels

This is why real estate investors shouldn’t trust mainstream media, by the way. Month-over-month figures are meaningless because of the cyclicality of the real estate cycle. From January until mid-to late summer, sales volume increases. It’s like a wrapping paper company on the verge of bankruptcy telling its investors that all is saved because wrapping paper sales increased 5% in November.

The important numbers were buried in the second half of the article:

The national median existing-home price was $165,400 in February, down 15.5% from last year, when the median price was $195,800.

. . .

Meanwhile, the total number of existing homes on the market at the end of February rose 5.2% to 3.80 million units. At the current sales pace, it would take an estimated 9.7 months to sell down that inventory of properties.

And what conclusion are analysts making from these statistics?

Ian Shepherdson, chief U.S. economist at High Frequency Economics, said there’s a “good chance” the collapse in home sales that has been going on since September is “now over.”

The correct analysis is that home prices are still continuing a downward trend that is looks likely to continue because of high supply. Individual markets may vary, and you can probably find distressed assets at attractive prices, but recovery is still distant.

Never trust bottom-callers, by the way. The statistical likelihood of a correct call is tiny. As an investor, I would rather see broad and consistent movement in a positive direction before redeploying large amounts of capital in the single family market.

For an in-depth analysis, look at Calculated Risk, and then Calculated Risk again.

Oversupply is always a problem, but in many nations–China, Latvia, the UAE–the oversupply verges on the ridiculous. It’s unfair and unwise to make investment decisions based on national trends–for example, there’s a large differnce between Riverside, CA, and Seattle, WA, and intelligent investors don’t let the statistics of one city cloud their analysis of another–but on the whole, these nations have a glut of properties.

Another article on the oversupply in China made its way into FinanceAsia:

Oversupply is likely to be a key theme in China’s property market in 2009 and will keep prices under pressure, according to Soho China’s chief executive officer Zhang Xin. On the residential side, the government’s plan to build almost 10 million new units of social housing over the next three years is contributing to this glut, while on the office front, numerous foreign funds that have eagerly bought properties in China’s major cities over the past couple of years are now just as eager to sell as they deleverage their portfolios.

. . .

“The overcapacity is not going to get digested immediately. It will take a few years. So, prices are still under tremendous pressure to go down,” Zhang says, noting that the current overcapacity or oversupply is affecting not only the property market, but applies to lot of industries as well as to labour and raw materials. Unless it feeds through to an increase in consumption, the government’s Rmb4 billion stimulus package will exacerbate this problem.

For those who are interested, the headline Chinese cities may be acquisitions target in late 2009 and 2010, but for now, there are better and safer opportunities elsewhere.

For what it’s worth, Sam Zell is picking up real estate assets in Brazil (via Reuters):

Equity International, the privately held investment company headed by U.S. real estate titan Sam Zell, said on Thursday it bought about 20 million shares, or 5 percent, of Construtora Tenda SA (TEND3.SA), a Brazilian homebuilder focused on the entry-level home market.

Tenda marks Equity International’s fifth investment in Brazil, Equity International said.

In October, Gafisa SA (GFSA3.SA), another Equity International portfolio company, acquired a 60 percent majority ownership stake in Tenda through the merger of its Fit Residencial business unit with Tenda.

Of the BRICs (Brazil, Russia, India, China), Brazil is poised to weather the recession best. In the long term, Brazil has better demographic trends than China and Russia (population growth, balanced male/female ratios), and its growing middle class and highly developed infrastructure bode better for future growth than India’s impoverished millions and terrible infrastructure.

I wouldn’t bet against Zell in the long-term. There will be other opportunities in Latin America (Peru, Colombia, Uraguay), but none with the same long-term prospects as Brazil.

I still don’t understand why people keep calling a bottom in single-family housing in the U.S. I’m even more confused by the people who continue to believe the bottom-callers. Sure, there was a slight rise in December, but one small increase doesn’t not reverse a serious, long-term trend. Courtesy of the WSJ, here’s a collection of economists writing about the dismal January existing home sales:

So much for signs of stability. Despite the seemingly constant chorus of calls that the housing market is showing signs of stabilizing, the actual data just don’t seem to want to cooperate… Some will take consolation from inventories of homes for sale having fallen in January to 3.6 million units, the lowest level since January 2007. But, given that the pace of sales dropped off, the months supply of homes for sale, the more meaningful inventory metric, rose to 9.6 months in January. It should be noted that the inventory data contained in the existing home sales report are not seasonally adjusted, and in recent years inventories have tended to rise in January. That they fell this January is likely more a reflection of prospective sellers giving up on selling their homes in this economic environment, at least at a price they are willing to accept. –Richard F. Moody, Mission Residential

January existing home sales fell 5.3% to 4.49 million, below the consensus 4.79 million and a new cycle low, with sales at their lowest level in 11 years. This is very disappointing, because the pending sales index pointed to sales nearer 4.9 million. Pending sales are not a perfect guide to actual sales but they are all we have on a month-to-month basis… In January, it appears, the growth in sales of foreclosed homes was offset by the continued drop in sales by private sellers. –Ian Shepherdson, High Frequency Economics

The drop back in the number of existing U.S. home sales in January dashes hopes that housing activity had found a floor. The fall from 4,740,000 in December to 4,490,000 more than reversed the rise seen the previous month and took existing sales down to a new cycle low. Sales are now about 40% below their peak and 8.2% below the level seen this time last year. The pending home sales index had suggested that sales would build on December’s rise and anecdotal evidence had reported a rise in sales of foreclosed properties. Instead, and barring a surge in the number of new home sales (due tomorrow), it appears that the inventory overhang that is pulling down prices is still rising. At the same time, this morning’s mortgage applications figures revealed a drop in the application for purchase index to 250.5 last week from 257.3 the week before. The spike in applications seen after the sharp fall in mortgage rates towards the end of last year has now more or less been reversed. Overall, the longer housing activity remains in the doldrums, the less likely it is that the economy will see a decent recovery in 2010 as Fed Chairman Ben Bernanke hopes. –Paul Dales, Capital Economics

The National Association of Realtors, who compile these data, estimated that 45% of the non-seasonally adjusted sales that occurred in the month were foreclosure-linked or otherwise distressed, which followed an estimated similar share in the preceding three months. While distressed sales continue to account for a huge chunk of overall activity, part of the market clearing process is that distressed properties must be sold, so the fact that this is occurring is good. Still, it certainly depresses prices, and there are plenty more foreclosed (or soon to be foreclosed) homes in the pipeline. The inescapable conclusion, therefore, is that median sales prices will continue to decline for the foreseeable future. –Joshua Shapiro, MFR Inc.

The number of homes available for sale fell 2.7%, failing to keep up with the drop in the sales pace. As a result, the months’ supply of unsold homes rose to 9.6 months from 9.4 months. While this represents some improvement from levels of 11 months or more hit several times last year, it still remains far above more balanced levels near 6 months. –Ted Wieseman, Morgan Stanley

The rate of decline in existing home sales over the last three months suggests that the market has not yet entered a bottoming phase and housing remains under considerable pressure. The only silver linings within the report (and this may be grasping at straws) are i) the continued outperformance of sales in the West and ii) that fact that the rate of decline in home prices did not intensify in January. –RDQ Economics