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.

Let the Housing Cycle Run its Course - Without the Training Wheels

The housing recovery is in an interesting stage. Even as more reports affirm a positive direction for the real estate recovery cycle, the push for additional government support is gaining momentum. Granted, intentions are noble, however, additional activity to assist the cycle could, in reality, bring headwinds to slow its progress.

What we’ve seen so far in 2012 is a dramatic reduction in mortgage delinquencies and foreclosures compared to 2011, due in part to a host of government programs and legislation already implemented throughout the mortgage crisis. Government influence began with the Obama Administration’s “Home Affordable” program suite of cures providing short sale incentives, loan modification help, and refinancing relief for homeowners in negative equity -- known as HAFA, HAMP, and HARP, respectively, and culminated with a landmark $25 billion settlement between individual states and big lenders providing relief on the state level.

Additionally, states have enacted their own strategies to slow the progression of distressed homeowners into the foreclosure pipeline. California being a case in point with the recent passage of its “Homeowners’ Bill of Rights” which affords homeowners increased protection from foreclosure above and beyond actions taken on a national scale. These steps have not only prevented more borrowers from reaching the foreclosure stage, they’ve also served to shrink the flow of distressed homes into the “shadow inventory” of residential housing, resulting in less distressed properties depressing overall home values. These are great developments. Not only are fewer people losing their homes, existing homeowners are seeing the value in their homes begin to rise and buyers are returning to a market now struggling to keep up with demand. Not all markets have seen this phenomenon but it is clearly becoming more frequent in most major markets.

Bottom line: existing programs to help borrowers, combined with small gains in the overall economy, are proving sufficient to support a healthy recovery. Additional intervention at this point could prove costly. Case in point: more widespread application of principal reductions at the GSE level striking a resonant chord with consumers, politicians, and the media, comes at a taxpayer cost and could drive private investors out of the market. Recent analysis from the FHFA, the conservator for Fannie Mae and Freddie Mac estimates principal reductions would prevent $1.7 billion in defaults, but cost taxpayers $2.1 billion in implementation and incentive payouts.

At the local level, recent Eminent Domain proposals allow municipalities to purchase loans at “fair market value” and pass on the savings in the terms of principal reductions. Championed by the newly- bankrupt California city of San Bernardino as a way to protect its distressed homeowner base and stop the hemorrhaging of tax revenue, if implemented; these plans could ultimately incur significant losses for private investors in securities collateralized by any of these mortgages. Moreover, principal reductions through Eminent Domain or at the GSE level provide little backstop for losses on homeowners who simply cannot make their mortgage payments.

Future prescriptive actions by the government could only serve to continue taxpayer participation in the recovery, prolong the recovery, or both. Where the housing sector can benefit, however, is by lenders playing a larger role. Borrowers in 2012 understand the responsibilities (and consequences) of a mortgage payment better than their predecessors of the previous housing cycle, and as such represent a better credit risk. It’s time for lenders to relax underwriting guidelines and qualify more borrowers for loans. In addition, while lenders have made significant strides in working with delinquent borrowers, they can do more to streamline the short sale process to dispose of properties before they come up for auction or end up contributing to an REO inventory.

Government has proven itself a strong ally in breathing life into the housing cycle. It’s now time for the cycle to run its natural course. The fundamentals are in place for it to succeed.

The Short Tunnel for Real Estate's Recovery

The overused "light at the end of the tunnel" symbolizing the arrival of the real estate recovery may just have gained some credibility as we enter the last half of 2012.  Or at the very least, the tunnel's gotten much shorter.  The guarded optimism that the downward cycle is over is being supported by some very encouraging news on a number of different fronts. While it’s still premature to proclaim the official demise of the housing crisis, encouraging trends developing over the first six months of the year may portend overall good news for the real estate industry for the last six months of the year.

A housing market described so often as distressed for the past four years is currently getting relief that is constant, sustained, and showing measurable signs it’s providing a cure.  Predictions that lenders would ramp up foreclosures at a rapid scale in 2012 as a result of a landmark settlement with states simply haven’t materialized.  Aggregate foreclosure starts, especially in non-judicial states, dropped over 18% on an annual basis.  The widespread acceptance of short sales by both lenders and borrowers have served a dual purpose in keeping borrowers off the foreclosure rolls and preventing properties from ending up as REO on lenders’ balance sheets.  Moreover, the distressed borrower of 2012 is more qualified, educated and proactive than in years’ past to take advantage of lender solicitations and government programs to modify their loans.  As a result, mortgage delinquencies are at all-time lows, and more borrowers are avoiding Notices of Default.

The non-distressed sector provides some of the best signs of a sustained recovery as well.  In short, buyers have returned.  When bargain-price homes weren’t enough to jumpstart sales, record-low interest rates enticed buyers back to the market.  In fact, selected markets have even seen the return of multiple offers on properties, and the scarcity of housing product is contributing to modest appreciation of home values in selected areas.  We are certainly experiencing this market improvement in our immediate area in the western San Fernando Valley and the Westside of Los Angeles.  In a direct parallel to the distressed borrower of 2012, the prospective homebuyer of 2012 is better prepared for the responsibility of a long-term mortgage commitment and making more prudent choices regarding what they can afford and the right type of loan program to finance the purchase.

Investors have reason to smile as well as they furnish housing for a specific niche of the market not able to take advantage of the aforementioned buying market.  Today’s rental market is booming, generating strong returns for both multi-family and single-family property investors.  The forward-thinking all-cash buyer of SFR bargains in 2010 and 2011 foresaw the environment would be more conducive to generating revenue through renting as opposed to flipping. This strategy has been extremely popular in 2012.  Moreover, the slowdown in new apartment construction during the height of the housing crisis paved the way for a shortage of available units now that has brought back demand.  Low vacancy rates and higher rents prevail.  As a welcome footnote, new building starts and permits for new construction are on the rise to feed the appetite for new rental units.

Yes, for all practical purposes, it appears that real estate’s recovery has begun.  But at best, it is a fragile recovery that can be derailed by any new bumps in the economy.  Job and GDP growth, key metrics indicating economic stability, have improved but at tepid pace.  And a rash of recent near-defaults of foreign economies poses a lurking threat to ours.  Any unexpected economic shocks caused by unemployment, poor retail performance, European recessions, or any combination of these factors will serve to undermine real estate’s stronger performance this year.  The good news is that after six months of shrinking foreclosures, lower interest rates, more buyers returning to the market, rising rents, contracting REO inventories, and new construction activity, we’re significantly through the tunnel. The positive momentum of the first two quarters in 2012 may just be enough to propel real estate through any new headwinds it could encounter for the rest of the year.  

The Truth Behind the Numbers on Declining Foreclosures

Recent first quarter research from numerous sources supports industry sentiment that the bottom of the current real estate cycle has been reached, and the new cycle has begun. In an unlikely alliance, government, the private sector, and even the media have all identified the unrelenting wave of foreclosures as the source of the problem and directed all of their efforts to hunting down the beast and killing it. Based on recent numbers, the foreclosure crisis could appear to be contained. According to the numbers:

• Overall foreclosure filings are down 19% -- their lowest level in four years.

• The volume of “pre-foreclosure” sales hit a record 109,593 transactions as homeowners and banks adopted short sales as a preemptive strike to losing their homes.

• Analysts monitoring mortgage delinquency rates, the accepted metric predicting foreclosure volume, are reporting continuing month-over-month declines in delinquencies.

• Credit-reporting agencies, well known for keeping falling FICO scores top of mind, are now proud to report that consumers shed mortgage debt to the tune of $350 billion over the last year and are continuing to trim the fat.

• The Obama Administration’s assault on the housing crisis through no less than 12 separate programs since 2009 have provided millions of distressed homeowners permanent modifications, refinancing opportunities, forbearances, short sale incentives and even in some cases, mortgage forgiveness.

While these are impressive metrics, the real estate industry would be wise to season its interpretation of the data with a dose of skeptical pragmatism. Too much emphasis is being placed on surveys and reports to validate a recovery instead of taking a hard look at what is transpiring on a day-by-day and case-by-case. Albeit mitigated, the foreclosure crisis is still very much alive and well.

When the pundits are silenced, and the analysts are deprived of their spreadsheets, what remains is a staggering number of homeowners, over 3.5 million, having lost their homes since 2008. No metric accurately represents this devastation on families, their surrounding communities, and the overall economy. Granted, foreclosure filings are at record low levels and continue to fall. Nevertheless, nearly 200,000 new borrowers received Notices of Default during the first quarter of 2012.

Looking at the crisis from the lender perspective, the numbers don’t fully portray the battle lenders face to minimize losses. While data publicizing lower defaults points to a possible end to the drag of REO on lender balance sheets, that end is years away and the current cost of loss mitigation has proven to be expensive. Case in point: recent settlements with individual states over foreclosure improprieties cost lenders $25 billion, and still provide loopholes for more claims. Tougher standards implemented to avoid lax processing of foreclosure filings require more auditing and personnel to implement. And clearly, lenders have been forced to accept larger losses on REOs and to embrace short sales to prevent further hemorrhaging. In short, the numbers use a wide brush to paint a possible outcome of the foreclosure crisis, but ignore the present reality that homes are still being lost today.


A more holistic approach is needed to properly measure the effectiveness of the war on foreclosures. To be fair, the real estate industry and consumers alike should feel real hope as a result of data showing a consistent downward trend in new foreclosures quarter after quarter. The housing industry is at its strongest place in three years and is getting stronger. However, we shouldn’t allow backwards-looking or forward-projecting reports distract us from the ever-present reality of the severity of the foreclosure crisis. Conditions are improving, but the battle is far from over. Success is measured not by aggregate numbers, but by one homeowner at a time who avoids a foreclosure.

Experts Agree: Commercial Real Estate Endures through Tough Times and is Poised to Grow

At a recent USC-sponsored conference featuring many of the top minds in the commercial real estate sector, the "end-of the-world" scenario predicted for the commercial sector was given last rites. Almost all were in agreement that all indicators reflecting the downward spiral in the sector are bottoming out and recovery is around the corner. This new recovery will be more measured, unlike the artificially-stimulated growth of the last bubble. Most feel that a new real estate “Peak” will be the norm around 2015.

As an improving economy led by job growth, affordable home prices and growing commercial opportunities opening in tertiary markets, the general consensus of the conference affirms the trends we’ve identified in the market – that new lending sources are opening up daily, the flow of credit is increasing and significant improvement is being made in making more loan products available to meet both residential and commercial demands.

2012 should also see a release of properties being held by both regional and large banks in the $10 billion and $50 billion in assets range. As the FDIC turns its scrutiny from the larger banks to smaller institutions, these banks recognize that to meet the minimum capital ratios required to pass stress tests they will either need to shed assets or set aside large reserves to cover potential losses on questionable assets. Asset disposition will be the preferred method over large loss reserves, and as a result of improving balance sheets, financial institutions are in better financial shape to sell assets at a discount. This means more properties will be coming to market but not to be dumped at fire-sale values. Larger private equity firms are fully-funded and are aggressively scouring the market for discount notes and assets.

Conference attendees also affirmed the potential for more activity in the acquisition and disposition of distressed notes. Over $350 billion in vintage 2007 commercial loan originations are expected to mature this year, and it’s projected that half of these notes will not be able to meet refinancing criteria and will be classified as distressed or non-performing assets. While this may constrain full market expansion, it presents some real opportunities to acquire commercial notes.

Commercial real estate investors are now finally experiencing an uptick in acquisition opportunities after several years of limited options. Investors generally expect the note market to remain active for another two to four years. In the next five years, close to $1 trillion of commercial loans will mature, putting additional pressure on US banks to step up efforts to shed more than $100 billion of non-performing loans currently on their books. They also cited the high number of construction, acquisition and development loans made by regional and local banks nationwide, now labeled as distressed. Two-thirds of potential loan purchasers last year completed their transactions. In the previous year, less than 50 percent were successful.

The Conference also highlighted some emerging trends that have the potential to hinder a robust recovery:

• The financial strength of municipalities and pension funds. Retirement obligations that are coming due will bankrupt many institutions that are already in trouble. Taxes, taxes and more taxes will be necessary thereby creating a recessionary impact.

• The loss of manufacturing jobs. This is a huge problem as is the outflow from California of these valuable jobs. Manufacturing jobs present one of few opportunities for disenfranchised groups to move out of a lower-income status into the middle class. As these jobs disappear, so will middle class productivity and wealth. A sobering statistic: 65% of U-Haul’s business in 2010 and 2011 was moves out of Southern California.

All in all, the tenor of the Conference was the over-whelming feeling that commercial real estate is working its way back; good news for all.

Real Estate Recovery: The Race is On

Real Estate’s journey in 2011 has been a wild ride based on the criteria many use to measure success. Optimistic expectations at the beginning of the year have not produced sustainable returns at year’s end. Or have they? The saga of the real estate recovery in 2011 seems to enact the familiar fable of the tortoise and the hare. Which approach would be the most accurate in characterizing the sector’s performance --- an aggressive approach seeking tangible, quick returns or a more measured approach whose success is measured by long-term results? While the inclination may be for instant gratification, perhaps a “slow and steady” perspective provides the best evaluation of how well real estate has performed this year and where it’s headed in 2012.

2011 started, and the race was on, driven by hopes of a much better year than 2010. In some instances, optimism had merit. There was a general, shared sentiment that the economy, overall, would rebound, creating jobs and a stronger environment for small business to begin to grow again. High-profile commercial property acquisitions and note purchases driving up the values of assets in key urban markets captured the real estate headlines. Businesses felt confident enough to expand into new square footage, while both existing households and newly-forming “echo boomer” households valued renting over ownership which drove down vacancy rates in both office and multifamily sectors resulting in steady revenues for commercial investors.

The average consumer had reason to be optimistic as well, as seemingly negative economic influencers created new opportunities. The deluge of foreclosed homes on the market (which drove sale prices down), combined with political and financial volatility abroad drove fixed mortgage rates tied to Treasury yields to record low levels affording consumers with new buying power not seen in years. Even distressed borrowers had reason for optimism as the government promoted a dizzying number of “Home Affordable” programs; and lenders, under the scrutiny of regulators, slow-tracked foreclosure filings due to processing improprieties like robo-signing.

But along the way in 2011, the hope for a brisk recovery took a cat nap, as evidenced by the following:
• Threat of a “double-dip” recession reflected by anemic GDP growth and stubborn unemployment
• Scarcity of commercial deals in top markets accompanied by a stall in the ascent of commercial asset values
• Homeowners unable to qualify for historically-low mortgage rates to purchase bargain-priced homes
• Decline in equity in non-distressed home values as a result of a market flooded with distressed properties
• Less Americans seeing the long-term value of owning a home versus renting
• Lenders, now confident about their back-office procedures, filing foreclosures at a stepped-up pace starting in the 3rd quarter 2011
• Extremely tight guidelines for loan qualification

Those seeking signs of a speedy housing recovery could point to the above as proof that 2011 was a year the industry should forget. However, the following represents just a few of the areas quietly developing this year to support the notion that real estate is showing signs of improvement:
• Commercial opportunities emerging in “out-of-market” areas (suburban or “B” class office assets)
• New construction to meet demand (unexpected demand for rentals and short supply sparked new construction in the multifamily arena)
• All-cash investors sustaining the market (all-cash investors accounted for up to 31% of all purchases in 2011, filling the vacuum created by the absence of first-time buyers)
• Surge in loan modifications, short-sales as an alternative to foreclosure (over 5 million approved as of the third quarter 2011 involving both interest and principal reductions to keep borrowers in their homes )
• Non-distressed home values appear to be stabilizing in many markets

But perhaps the most important evidence of a recovery can be seen in the segment most affected by the housing crisis: the consumer. As noted before, more borrowers are taking advantage of modifications and short sales to avoid being a foreclosure statistic. Additionally, consumer debt and delinquency levels in mortgage and in all other credit products dropped significantly in 2011. Compared to the consumers during the housing boom of the last decade, today’s consumers are significantly better-educated in managing debt and knowing the consequences. A key component is the accountability of appraisers deciding true values based on the reality on the street and not on the number needed to complete a loan.

When credit conditions make home ownership a viable option again, these consumers will be ready to jump-start a new phase of responsible home purchases from a stable credit footing. And what benefits the average borrower in the future will also benefit the smart investor who is ready to leverage opportunities in a new cycle of real estate growth.

The race isn’t over for real estate. Fundamental gains took place in 2011 that will bear substantial fruit in the years to come for investors and consumers alike. “Slow and steady” wins every time.

Cautious Optimism for Market Recovery

The country has gone from one extreme — lax oversight in financing — to the other, making it nearly impossible for potential homeowners to qualify for loans and purchase property resulting in a large inventory of homes and unstable markets. It’s now up to the banks. The only way for the residential real estate market in the U.S. to recover is for the banks to return to more flexible lending processes. At the commercial level, however, deals are taking place as pent-up cash rushes to well-priced real estate.

At Peak, we are more optimistic in the real estate market’s recovery and see buyers ready to commit to developments in both residential and commercial property, creating both opportunities and new jobs. We lend our own capital and are committing to new townhouse developments and shopping centers nationwide.

Three trends to watch in 2012:
1. Banks will increasingly embrace both short sales and modifications to loan principals. Over the past few years as new bills were introduced to protect homeowners, it’s become harder for banks to foreclose on properties, though in California alone over 800,000 properties were lost to foreclosure in the past five years, according to property information service DataQuick.

In reality, legislation has only delayed the inevitable foreclosure, exposed banks to legal issues and provided no real motivation for lenders to make the system move again. Banks have several options available to them to maximize cash flow in 2012 including short sales, which allow a third party to buy the property and the bank to recoup more of its investment than with foreclosures and loan principal modifications which incentivize homeowners to not abandon property and keep paying mortgages while recalibrating the system to current fair market values. With California’s Bill SB 458 signed into law in July, we’ve seen an uptick in short sales as homeowners feel protected against any future lien holder payments on the property. In 2011, the number of federally-sponsored and proprietary loan modification programs increased substantially despite the wave of new foreclosures.

2. Demand will return and necessitate new construction. While the building industry has suffered along with every other sector of real estate and construction of new homes – a key indicator of economic health – recently posted its largest decline in 27 years. Smart investors see potential in the building and construction industry.

Analysts at Fannie Mae and other organizations predict that the available rental units many consumers are turning to – away from single family homes – will not meet the growing demand for affordable housing. Also, on the retail and office front, as businesses expand, there will be shortages in commercial square footage. With new capital from private equity and large banks, selecting the right location to build in good markets is key to achieving a fair return on investing in new construction.

3. Revolutionary ideas will help kick-start the industry. From sanctioning Freddie Mac and Fannie Mae to act as landlords, effectively managing and renting distressed properties, to razing large numbers of homes to reduce the sprawling inventory and stabilize home prices, there are a number of expert recommendations on how to save the real estate industry. Enticing home occupancy to improve a community’s overall property value may be the best option. Without it, properties will depreciate.

As the natural cycle of short sales, loan modifications, and foreclosures runs its course, coupled with new construction driven by demand and implementation of strategies to liquidate the governments’ inventory of distressed properties, we feel a market recovery benefitting homeowners as well as investors is within reach.