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.

Real Estate's Temporary Reprieve with Fiscal Cliff Legislation

The threat of falling off the fiscal cliff has been averted for 2013 -- Or at least, the consequences that could have triggered wide-spread recession. The real estate industry received a reprieve through extension of key components of the American Taxpayers Relief Act of 2012 signed on January 1st of this year.  A major concern was the Mortgage debt forgiveness rule that ensures that lender losses through short sales, foreclosures and principal reductions don’t end up as taxable capital gains for distressed homeowners was extended for yet another year, along with the private mortgage insurance (PMI) income tax deduction. On the flip side, expiration of Bush-era tax cuts and a 5% hike on top marginal tax rate for capital gains have many investors evaluating their options for 2013, along with weighing the consequences of a new 3.8% tax on investment income to subsidize health care reform.  In addition the state tax rate and new associated taxes have increased further creating a chilling effect on contemplated real estate investments. Opportunities do exist for both consumers and investors in this “post-cliff” cycle, but it requires a different perspective to make the most of them. I feel comfortable saying that the momentum will continue to be favorable due to the cliff avoidance unless further unknown developments take us down.

Allowing the Mortgage Debt Relief Act to expire would have signaled the beginning of the end for the housing’s recovery, and it was a prudent choice on the part of lawmakers to extend it. The impact of short sales on helping lenders and servicers cure their non-performing asset problem more than proved itself in 2012, and the extension serves to continue that momentum. Both distressed homeowners and lenders win. And, by allowing the deduction for PMI to continue through the end of 2013, first-time buyers without the traditional 20% for a down payment receive some relief from the additional premium MI adds to their mortgage. With 46% of first-time buyers utilizing FHA loans with mandatory MI in place during 2012, there are widespread effects of the deduction. In light of still-constrained underwriting standards for conventional loans, originators have found a way to offer mortgages to borrowers that don’t meet their minimum criteria through FHA-backed loans. In this case, first-time homeowners and lenders benefit.

Opportunities for investors in 2013 may seem a bit more elusive. Anticipating changes in the capital gains taxes this year, many investors that didn’t take a “wait and see” stance scurried to finalize transactions by the end of 2012. Those wishing to take advantage of opportunities in 2013 still have options at their disposal. Smart investors will embrace the benefits of the 1031 Exchange process that allows an investor to sell a property and to reinvest the proceeds in a new property as a way of deferring all capital gain taxes. The 3.8% Medicare tax from the investor perspective will have significant ramifications as the “investment income” qualification includes net gains from property held by investments.  While most homeowners will escape taxation on the sale of personal residences under the new law, investors that decided to wait for the fiscal cliff dust to settle may find the tax implications of real estate deals play a larger role in evaluating short and long term returns.  Deferring taxes should be part of the overall strategy and should be good news to the qualified 1031 intermediaries.

2013 may also bring new opportunities for investors in the bulk sales arena. The FHA, reeling from losses of vintage pre-2009 loan guarantees, has embraced distressed note sales as one of its strategies to remain solvent. Bank of America is shedding billions in mortgage servicing rights and through auctions of toxic assets acquired from its ill-fated Countrywide acquisition. Investors have found a new asset class in bulk purchases to fuel the newest REO-to-rentals market. While housing inventory at the consumer level is still constrained and driving up home values, bulk sales available to the investor class is developing as a new sector for 2013. This was being handled internally with a very limited number of qualified investment funds and not really open to a large class of smaller investors. Perhaps this year, they will open it up. 

While stopgap measures signed into law on January 1st extended consumer relief without a major disruption in investor activities, the jury is still out on the long-term consequences changes in taxation will have on the industry’s momentum achieved in 2012. The tougher decisions on debt ceiling and program cuts still lie ahead that now may have greater implications for the economy. Now that we’ve taken a few steps away from the edge of the cliff, the real estate industry can take a breather --- for now.