2015 In Review --- A Stable Foundation for a Promising 2016

2015 proved to be a year of stability for real estate, a welcome change from previous years of volatility and uncertainty.  A strong economy provided the backdrop for the industry to meet, and in some cases exceed expectations for the year.  We’ve had the opportunity to participate in both residential and commercial markets through a variety of cycles over the years, and can affirm that 2015 quelled many of the shocks that plagued the industry during previous quarters.  But there’s no such thing as a market without headwinds.  Firmly rooted in the fundamentals of an overall economic recovery, our industry continued to perform despite factors that would have hampered growth in previous cycles.  Here’s our brief overview of market indicators for 2015, and our forecast on their influence on consumers, investors, and developers for 2016.

Balance Returns to Residential Markets

The absence of new buyers, along with lackluster equity in existing homes that plagued previous years, gave way to a more optimistic outlook in 2015 thanks to the economy. The following key benchmarks are just a few of the positive indicators impacting our industry:

• GDP up 2.4% in 2015

• Unemployment rolls dropped from 5.6% in 2014 to 5.0% in 2015 (7.1% to 5.8% for California)

• Inflation rates holding steady under 1%

• Falling oil prices creating more disposable income for consumers

Monetary policy shifts implemented during the last quarter of 2014 and throughout 2015 are arguably the strongest signals of a resilient residential market.  The end of Quantitative Easing, the Federal Reserve’s initiative incorporating the purchase of mortgage securities from the market in order to lower interest rates and increase the money supply, combined with the first increase in interest rates above 0% since 2008, reflected the government’s confidence in the economy that it was stable enough to grow without interference. 

These benchmarks contributed to a stronger housing market as seen on numerous fronts. First, 32% of home purchases in 2015 were generated by first-time homebuyers, up over 21% compared to 2014 according to the NAR.   A new wave of first-time homeowners driven by new millennial household formation entering the market played a major role in creating demand for homes.  Additional NAR data supports the resilience of the housing sector in spite of the uptick in mortgage rates at the end of 2015, including:

• 2015 existing median home prices up nationally 7.6% over the previous year

• Existing home sales exceeding 5 million units

• Total inventory of available homes diminishing 3.8% 

An increase in home sales and median home values, diminishing inventory and shorter days on market for listings translated to increased equity for existing homeowners in 2015 as well rising consumer confidence.  

Peak expects residential markets to continue to yield positive results, albeit at a slower pace than in 2015. It is likely that some overheated markets may actually stay flat for the year.  We’ve positioned ourselves to better serve our market and take advantage of residential opportunities by creating the CENTURY 21 Peak brokerage to expand our reach and the acquisition of an additional franchise in the San Fernando Valley boosting our coverage to 150 agents.  We are also in advanced negotiations for other strategic acquisitions.  Additionally, our residential loan origination unit generated an impressive 40% increase in production in 2015 compared to the previous year.  We’re anticipating continued growth in loan volume this year as a result of expanded capital sources and the ability to compete with the lowest competitive rates.

Commercial Markets Stay the Course

2015 proved to be a very good year for commercial real estate.  A healthy economy benefitted residential and commercial real estate.   A stronger GDP in 2015 meant more confidence in the business sector to expand and acquire more space.  Increased household formation by consumers not yet ready for home ownership drove the needed demand for apartments in the supply-demand equation.  Investors holding positions in both multifamily and office properties saw strong returns, especially those holding A-class assets.   Key findings from industry analysts confirm the resilience of the commercial sector in 2015, including:

• $115 billion in national sales volume for major asset classes, up 3% from 2014

• Los Angeles ranked second in behind Manhattan in most active capital markets for 2015

• Retail vacancies in Los Angeles area down 0.6% in 2015

• Cap rate average for all commercial asset types averaged 7.9% nationally down slightly from 2014

The elephant in the room is a growing multifamily inventory and compressed cap rate sales.   While there was still a strong market for apartment units in 2014, in 2015 national multifamily vacancy rates showed a slight uptick to 4.3% at the end of the third quarter—without factoring into the equation multifamily developments  still under construction.  

While we’re still confident that the commercial sector will continue to perform for investors, we’re closely watching multifamily performance, as 2016 could be the year that the supply / demand ratio reaches an inflection point causing a significant rise in vacancy rates.   Cap rates are hovering at dangerously low levels for A and B asset class types.  Any uptick in vacancy, interest rates, on any unexpected economic shocks could squeeze the cash flow out of these investments.    On a more positive note, there shouldn’t be a significant drop in in property values in this sector due to the flight to safety that multifamily provides, and other opportunities will be available in office and retail markets.   As part of our CENTURY 21 franchise agreement, CENTURY 21 Peak Commercial opened its doors for business in the 4th quarter of 2015 to take advantage of new opportunities.  Our entities providing brokerage, qualified intermediary, and financing services to the investor community reported that 2015 was one of their most profitable years, thanks to a near record number of commercial transactions handled. 

Peak’s investment strategies in multifamily markets yielded very stable and improving returns.   We are focused on a “de-malling” project of our Myrtle Beach Mall in South Carolina, a senior living community in Moorpark as well as several home developments in Southern California. The retail sector requires close scrutiny, as the challenge for brick and mortar shopping centers attracting shoppers is increasing as they compete with online alternatives.  We believe that food and entertainment concepts hold the key to revitalizing that sector.

What’s next for 2016?

While we’re waiting to evaluate activity for the first quarter of this year, we anticipate home values appreciating much slower this year resulting from rising interest rates and a cooling-off of the GDP, but still generating equity needed for existing homeowners. The first two quarters of the year could see the pendulum swing back to a buyers’ market as the scarcity of single-family residence inventory restores balance.   Investors will continue to find opportunities in new markets.    However, the direction of interest rates and rising vacancy rates in the multifamily arena could impact this momentum. We will continue to monitor rising interest rates and a potential surplus of multifamily units as two key factors potentially contributing to a slowdown in commercial transactions.  Market fundamentals demonstrated in 2015 will provide a strong base for continued momentum in 2016 to withstand any potential headwinds on the horizon. 

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.

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. 

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.