Housing headlines

02Oct06

The state of the residential and commercial real estate markets are nothing if not multi-faceted. While the residential housing market is generating a raft of negative headlines the market for commercial real estate, somewhat paradoxically, continues to remain firm. The question is what can investors take from the headlines generated by the real estate markets?

The Stalwart looks at the question of whether residential housing weakness could in fact be good for REITs. In a narrow sense one could make the argument for a substitution of demand for stand-alone housing for multi-unit housing (apartments). That is at best, a narrow argument. In fact they make a well-reasoned argument that on any number of levels the case for an extended run in REITs is tenuous, at best. Not least is the argument that REITs are already trading at valuation levels that, at least historically, has been indicative of a top as opposed to a bottom.

If indeed these REITs are a great value despite trading at 10-year yield lows, then there must be a huge dividend growth story ahead, larger than we’ve seen in the last 10 years. But… if it turns out that there isn’t such a massive dividend growth story, then investors could suddenly decide risk-bearing yields below the risk-free rate don’t make much sense. If massive growth doesn’t pan out, REITs would have to go back to paying their more historical yields- which means we’d see a reversion to the mean.

Nichols Yulico at TheStreet.com has a different take on what has been a seven year run in REIT outperformance vs. the stock market. He notes that trying to bet against REITs based solely on valuation has, at least to-date, been a loser’s game. Yulico argues that this is based on a wave of cash that has transformed the REIT market and has changed valuation parameters.

Although gains at that rate will be hard to continue — and returns likely will drop — industry watchers note that commercial real estate has undergone a significant repricing in recent years as investors pour money into the market. This wall of money from private equity and pension funds shows no sign of slowing, which in turn will hold up REIT stocks.

No one can guarantee that investor sentiment towards REITs will continue to accept the new found (low) level of returns, but it is not altogether clear what catalyst would drive investors away from the sector.

Just as it has been difficult for REIT bears to make a buck shorting the sector, it has also been more difficult than one would think to make money off of the housing bust. Eddie Elfenbein at Crossing Wall Street points to a piece in the Wall Street Journal that discusses the cross-currents facing housing bears.

Henny Sender in the aforementioned Wall Street Journal piece notes how the poor housing news has been offset by the Fed pausing its campaign of rate hikes. This has given some investors the confidence to continue holding mortgages and other higher yielding real estate securities. The caveat being that these investors can hedge their exposure to the housing market with a wider variety of instruments than that available to individual investors.

Given the scope of the housing market and its impact on the economy it is not unreasonable to look for a relationship between the state of the housing market and other sectors. Mark Hulbert at Marketwatch.com takes a closer look at the correlation between housing prices and the retail sector. Surprisingly Hulbert finds no predictive relationship, but does find a coincident relationship. In short, housing and retail are reacting simultaneously to common economic factors.

The mainstream media is right to focus on housing and commercial real estate. It is hard to think of sectors that so pervasively affect each of us. That does not mean that headlines are an useful way to trade these markets. Despite the best researched case, pervasive demand for REITs has offset any sort of valuation concerns. Nor can we look to weakness in housing as a means to trade the retail stocks. We do not know what will happen to either real estate sector, but we do know that one will have to look beyond the headlines for the answers.

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