Monday, May 18, 2015

First Quarter 2015 Perspective – What “Momentum” Feels Like for Real Estate

Real estate’s performance during the first quarter of 2015 demonstrates the sector’s true resilience during this cycle, and gives investors reason to replace guarded optimism with real confidence. Thanks to a strong economy, consumers and investors alike found opportunities on both residential and commercial fronts. The results we’ve observed from our participation in the market affirm that yes, real estate has truly stabilized and is poised for growth. Here’s our brief summary of market indicators for the last quarter, and how they impact the industry through the rest of 2015. 

Residential Markets on the Right Trajectory 

Residential markets have demonstrated tremendous improvement in light of the diminishing impact of distressed assets on the category. The following indicators supporting the notion that “distressed” has become a passing footnote affecting industry performance:

  • Delinquency rates for mortgages 30 days or more past due down 14.72%
  • Pre-foreclosure (short sale) inventories nationwide down 27.41%
  • Homeowners facing negative equity down 40% since 2012
  • Median home values increased 7.2% for California and up 8.9% nationwide since March 2014
We attribute stabilization of residential markets first to more Americans finding jobs and second, to the participation of all-cash investors early on in the cycle bolstering home values. Unemployment rolls dropped from 7.4% in 2013 to 5.9% in 2015, with California unemployment numbers tracking slightly higher at 8.2% and 7.1% respectively. The stabilizing employment picture enabled consumers to meet financial obligations, specifically mortgage-related obligations, as well as providing them with the confidence to consider looking at the market again.

Homeowners welcomed rising equity that accompanied appreciating home values that resulted from the participation of all-cash investors and more potential buyers returning to the market. First-time homeowners, on the other hand, encountered a dearth of entry-level homes at affordable price points – in spite of a lower interest rate environment and favorable lending programs offsetting the constraints Qualified Mortgage (QM) guidelines required lenders to follow. Rising home values affected investors in a different way. Buying into the market low, all-cash buyers adhered to a prudent “Buy and Hold” course investing in pools of distressed single family assets and enjoyed strong returns generated by a strong demand for rental homes. As home values appreciate and bargain assets become scarce, we’re seeing investors returning to a “Fix and Flip” strategy, realizing better returns by putting properties on the market to meet demand. Some markets have saturated but many areas are still offering great returns on this strategy.

Our strategy to engage this cycle addresses the inventory side of the equation:  we’re in a market with high demand on both ends of the affordability spectrum, and we’re finding success in adding product to that inventory. The first quarter of 2015 marked the sale of all phases of a 156–unit affordable housing complex in Oxnard, Ventura County, along with the completion of several upscale homes in the San Fernando Valley and West Los Angeles areas. We will also be completing a townhome project in Thousand Oaks this year. In a move to address the needs of a growing Baby Boomer segment looking to downsize and as a result, free up housing for growing families, we’re firmly committed to senior housing projects such as our Moorpark Casey Road project – a 390-unit retirement community comprised of a mix of villa, assisted living, and independent living units with a variety of floor plans. 

The Commercial Market – Strong Fundamentals Yielding Strong Returns

Investors holding positions in commercial real estate had a great first quarter. Based on indicators also driven by an improving economy, a stronger dollar, lower unemployment and higher GDP, we anticipate continued expansion in the commercial sector. Investors should expect consistent returns with a supply-demand equation favoring demand and supporting above-average rent growth for multifamily, retail and office asset classes.

Key findings from industry analysts support our conclusion that fundamentals in the commercial sector are stronger than ever, including:

  • Commercial property transactions expected to reach the $500 billion mark by 2015
  • Lower cap rates averaging 8% nationally, and in selected California markets at low as 5%
  • Repeat sales activity in the commercial sector up over 7% since 2014

The affordability issue plaguing residential markets drives demand for affordable rental housing, which is answered by multifamily housing. During this phase, the market has seen a near record number of new multifamily development starts to meet demand. Analysts are watching the multifamily market carefully for signs of oversaturation of multifamily units in upcoming quarters.

Activity is brisk in the office and retail sectors as well, as businesses start to thrive again and hire more employees. Vacancy rates are holding steady in office and retail sectors at 12% and 9%, and are attracting overseas capital acquiring high-value assets in major markets.  The resulting fierce competition for profitable commercial assets has forced investors to look for deals in surrounding suburban markets, and having a positive impact on prices. 
Our entities providing brokerage, qualified intermediary, and financing services to the investor community have reported a promising first quarter. Our commercial brokerage unit processed a surge in deals closing during the first quarter as well as our 1031 Exchange division; our loyal clientele of repeat investors leveraged the tax deferral benefits allowed under Section 1031 of the US Tax code to complete deals. And, participated in connecting investors with nearly $19 million in capital for the acquisition of commercial assets inclusive of all sectors – multifamily, retail, and office.

Looking forward into our current quarter and the remaining six months of the year, we anticipate home values appreciating at a slower pace but still generating equity needed for existing homeowners to consider moving options to create additional inventory for a wave of new homeowners. Investors will continue to create pockets of profitability in new markets in this era of low unemployment and strong business growth. The direction of interest rates could impact this momentum, however. We will continue to monitor pressure to raise interest rates as this will become a key factor to consider over the next couple of years.

The first quarter’s solid performance should generate more than enough momentum for the rest of 2015, and present more opportunities to both consumers and investors. The cycle continues in the right direction for real estate.

Wednesday, February 12, 2014

The Law of Diminishing Returns as Distressed Housing Becomes a Footnote in our Current Cycle

It was a perfect idea that may have run its course the way ideas often do in the real estate market. Distressed single family homes saturating the market in 2011 and 2012 proved a sure bet for private investors and larger private equity funds alike. GSEs even saw an opportunity to shed toxic assets through bulk sales to qualified private equity firms. The plan was successful. Too successful. Today, investor participation has effectively driven prices to an inflection point where finding undervalued properties is becoming harder. Distressed housing no longer yields strong enough returns to remain top on the list of options for the investor community.

“Buy and Hold” was the prevailing strategy of the previous cycle with investor participation shoring up the market. Investors firmly positioned themselves to benefit when prices would eventually appreciate, and in the meantime enjoyed revenue generated by a growing single family rental market. Meanwhile, larger institutional investors garnered much of the attention resulting from government partnerships involving bulk distressed real estate sales in California, Las Vegas, and other areas hard-hit by foreclosures. Independent investors found room to participate as well. It’s estimated that investors have injected up to $15 billion in capital into the housing sector since 2011 in pursuit of distressed properties. Peak has also participated in accumulating a pool of these rental homes in the Las Vegas and Los Angeles areas.

Fast forward to 2014. More than Federal programs, monetary policy, and an improving jobs market – all cash investor activity in the housing market has arguably had the most impact on bolstering home values and boosting the economy. As private capital returned to the financial ecosystem, homeowners saw equity return and distressed borrowers displaced through foreclosure or other actions had the opportunity to regain their footing through the availability of single family rentals. The market has now reached a point where “Buy and Hold” is generating diminishing returns resulting from:

  • Rising home prices. Investor purchases provided a much-needed floor for home prices that halted plummeting home values and provided the groundwork for equity to return.  Unfortunately, as prices rise on existing inventory, investor returns fall.
  • Reduced inventory. An improving economy, government programs, and more proactive lender workout programs have resulted in the lowest numbers of foreclosure filings since 2007. In addition to rising home values deterring investors, the supply of available distressed opportunities are simply drying up as the cycle shifts.
  • The “own versus rent” choice for households. Strong rental revenue for investors simply translates to higher monthly rents for dwellers. Despite higher interest rates, higher home prices and new underwriting criteria, current renters are exploring options to trade in their rent check for a mortgage check. Moreover, “boomerang buyers” – homeowners displaced by short sales and foreclosures during the last decade have regained their economic footing and are looking to buy again. Investors are encountering a plateau on rising rental revenue. Additionally, the cost of turnover, repairs, and down time for rentals is eating into the return as the properties and the investment sits.

Patterns are emerging signaling an end of this cycle as major players who acquired thousands of properties early in the game are now cashing in the chips. First, investors are scaling back pursuit of foreclosed properties. Second, investors have taken notice that home appreciation is slowing, and see this as the perfect opportunity to “hold” no longer and to sell. In Las Vegas, once dubbed the “Foreclosure Capital of the U.S” where prices at one time appreciated as much as 25% in one year, private equity firms are exiting the market.   

We’re currently evaluating our portfolio, and see merit in pursuing disposition of the residential side, while pursuing other acquisition opportunities on the commercial level. While there will always be a distressed sector and opportunities, it’s time for investors to evaluate if the cycle is winding down an acquisition strategy for their own long term goals. 

Wednesday, October 30, 2013

The Qualified Mortgage Rule - Who Truly Wins?

As Washington continues to find ways of scuttling our economic recovery, the real estate recovery has fallen out of the spotlight for a moment. Delinquencies continue to fall, home equity is on the rise, and investors continue to find a more stable haven in real estate than traditional investment vehicles. What’s proven to be real estate’s missing piece has been credit -- a meticulous balancing act of making it available to sustain housing growth at an affordable price while at the same time maintaining fail-safe protocols to deter abuses rampant in the last cycle.

January 10, 2014 looms as yet another housing industry witching hour with implementation of the Qualified Mortgage Rule (QM). QM carries with it the potential to restrict consumers as well as traditional sources of capital for the market, which will inevitably impact growth in our sector. However, QM aspires to bring stability and additional credibility to a mortgage industry often cited as a key factor in the recession of the last cycle. Restrictions versus credibility --- that’s the question to ponder today.

Broadly defined, QM sets specific criteria for a home loan that meets certain standards set forth by the federal government as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010. Interpretation and implementation of QM is overseen by Consumer Financial Protection Bureau (CFPB), the agency created as part of that legislation for enforcement purposes. After more than two years of discussion and debate, the following provisions stand out as key concepts of QM for lenders to follow.  These in turn will provide legal protection against borrower lawsuits as well as increased confidence that GSEs won’t require “buybacks” of defaulted loans that have been guaranteed by Fannie or Freddie:

  • Elimination of "low doc" or "no doc" loan programs
  • Adherence to "ability-to-pay" provisions, inclusive of tighter underwriting based on borrower's ability to pay over the long term
  • Elimination of interest-only, negative amortization, teaser-rate, or other loan programs deemed "exotic"
  • Loan term not exceeding 30 years
  • Debt-to-income ratios not exceeding 43%
  • Total disclosed fees not exceeding 3%

While QM hopes to rid the mortgage industry of risky loan products and ensure that borrowers have the ability to meet their mortgage obligations, it poses three very clear and present dangers that can’t be ignored. First, QM excludes a huge segment of borrowers who have difficulty meeting stricter underwriting standards, but aren’t necessarily credit risks. Second, while more risky products will be eliminated as a result of QM, so are the choices borrowers have in choosing loans that fit their budget and lifestyle. Remember, our current culture of tight credit has made “exotic” loans harder to qualify for as well, so our current environment has actually generated a strong class of qualified borrowers with less likelihood of defaulting on a mortgage. Third, and potentially crippling to the industry, is the 3% fee cap. Mortgage brokers stand to suffer the most from this cap. Already operating under tight margins as well as a host of regulations limiting what they can charge, broker fees may not be able to exceed 1% of the proposed 3% total disclosed fee rule on conforming loans. Today’s mortgage broker fills an invaluable niche for borrowers who don’t fit the standard underwriting mold. We could lose yet another borrower financing avenue if there is a new shakeout in the mortgage broker industry, and this could eventually impact demand with fewer borrowers in the mix.

It appears, then, that QM is more about choice --- from the borrower perspective --- than it is about restrictions or credibility. While GSEs and lenders win by only writing loans for a predefined criteria, borrowers that don’t fit the criteria lose. Peak has been exploring a number of opportunities for 2014 to create more options for borrowers that find themselves even more disenfranchised by lender and government standards. A healthy housing sector requires a strong mix of investors, inventory, credit, and buyers. More choices of credit for buyers equates to long-term stability for the housing sector.

Monday, August 12, 2013

Rising Prices and Rising Rates - And the Recovery Continues

If there's one thing about cycles - what goes down eventually comes up. We are enthused to be involved with a number of residential projects as a capital partner in Southern California during this "Conservative Renaissance" of real estate. The great response from the market to these single family offerings clearly affirms our sentiments that a recovery is in full swing. This in addition to our commercial holdings, clearly supports the conclusion that the recovery is across the real estate product types. But as always, smart investors practice cautious optimism even during a positive period. The road ahead looks promising for continued growth in real estate, but a few trends are worth keeping our eye on that could impact the cycle down the road.

We all recall too well the dark days of the housing crisis characterized by plunging property values and growing shadow inventories before disparate forces in real estate actually converged to create opportunities investors are currently enjoying today. First, strong government initiatives in the form of legislation, regulatory reform, and programs benefitting distressed homeowners mitigated the flow of foreclosed properties ending on the auction block or as REO. Second, monetary policies and other market conditions maintained a low ceiling for interest rates, allowing investors and consumers (that could meet strict underwriting guidelines) to borrow at cheap rates. Third, the economy following its own cycle of growth finally showed sustained month-after-month improvement, with the much welcomed inverse relationship of falling unemployment and rising GDP. The result has created a market of increased demand caused by the lack of distressed properties available at a discount, affordable mortgage payments due to low interest rates, and more consumer confidence that they will have an employment base to support a mortgage.

Vista Urbana, an affordable home project in the Ventura area is one of our success stories.  Peak served as the capital source for the endeavor. Construction commenced in October 2011. The affordable housing development consists of 156 condominium units, recently completing phase I and II of construction with all units reserved or sold. Units in phase III, currently in the final phases of construction, have all been pre-sold. Oak Terrace, a mixed townhouse / single-family residence project in Thousand Oaks catering to a more upscale audience is another Peak capital project that boasts 84 units upon completion. With almost 50% of units built and occupied, the remaining units have also been pre-sold. In both of these ventures, favorable market conditions have contributed to their success.

Rising interest rates is the one factor posing a potential threat to the current momentum. So far, the market has been able to operate smoothly in light of tight inventories. The upward pressure this is applying to home values is starting to entice more homeowners to sell, and some analysts anticipate home values to appreciate more than six percent in 2013. However, rates have incrementally increased over 100 basis points in a year, and some fear the combination of higher rates with higher valued homes could price many consumers out of the market. Moreover, investors could begin looking for better returns in other investment vehicles. 

As affordability decreases, urgency increases. Rising home values, along with rising rates,can continue the momentum by spurring ambivalent buyers that can afford to participate into the market while they perceive they can still afford to buy. That, coupled with increased inventory generated by new sellers benefitting from rising equity in their homes, should prove to modulate the increased cost of homeownership in line with continuing improvements in the economy. In light of appreciating home values and interest rates, we’re confident we are still at the beginning of a great cycle for real estate, and are anticipating great returns from additional residential projects we are involved in as financing partners that should complete construction in the next twelve months. Investors and consumers alike can both benefit from today’s market. Appreciating values and rates reflect the fortitude of a market and economy that can support it.