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 Impact of Inventory on Both Ends of the Housing Spectrum

Inventory, Inventory, Inventory. The return of housing to better days has mainly been attributed to lower interest rates, fewer defaults and a gradually healing economy. But what has brought the biggest smile to the face of analysts and homeowners alike is steady appreciation in home values as part of this new cycle. Since the end of 2011, home values have risen over 5% nationally, and are forecast to rise at least 6% over the next five years. The increases have been much higher in many major cities. It all has to do with supply, or the lack thereof, that’s driving home values north. While everyone is encouraged to see the return of equity of home values, a protracted period of tight inventories could have a negative impact on the current cycle. Simply put, if buyers can’t afford to buy, the process stalls.

Attaining the right balance of all the ingredients that have led to the current recovery phase can be tricky. The combined result of fewer foreclosures and mortgage delinquencies combined with brisk all-cash investor activity is effectively containing the specter of a looming shadow inventory of distressed homes that had once been seen as one of the major headwinds preventing a full housing recovery. The downside of this is, of course, an overall reduction in available, affordable homes on the market.

Fortunately, those developers and investors wise enough to understand the nature of the real estate cycle foresaw the scarcity in inventory and the resulting opportunity as they brought more units online. Investors in new multifamily housing flourished in 2011 with units becoming available now, and overall construction in housing for both apartments and single family dwellings actually helped to boost the economy out of recession. We have been involved in a number of new projects in Southern California aimed at bringing affordable units to the market. Case in point: we served as a major capital partner for a 156 unit condo development in the Ventura County area that broke ground in the 3rd quarter of 2011, and the developer is currently in the second phase of development to meet demand with most of these units already pre-sold. Another project we’re involved in is a 10 unit townhome subdivision in the Tujunga community that will be bringing 10 new homeowners into that market shortly. We are also online and committed to begin a residential gated development and a Thousand Oaks home development in the area.

What’s often ignored in the inventory equation is the participation of the “move-up” buyer and having available product to meet demand. For a fully functioning housing cycle to occur there has to be an upward migration of current homeowners to larger homes to allow first-time home buyers and growing family households an opportunity to purchase at affordable prices. Of course, as the last period saw home values depreciate, the cycle stalled as homeowners found themselves held hostage by falling equity and the inability to leverage it toward a larger purchase. Today paints a different picture, as homeowners are starting to test the waters with rising home values and multiple offers on listings. Inventory now becomes a welcome problem to have at the affluent end of the housing scale. In March, homes sales over of $800,000 are up over 33% from last year in Southern California. The current housing cycle requires adequate supply for move-up buyers to continue its progress. We have positions in the affluent market as well as the primary partner in a 20 acre, 15-estate equestrian development project in the Sunland community.

Home values for entry level as well as larger homes are skyrocketing, to the delight of homeowners, potential sellers, real estate professionals affirming that for the long term, real estate is and always has been, a sound investment choice. Additional housing units coming to market to balance the supply/demand equation won’t dampen appreciating values, but should modulate increasing values just enough to allow more new buyers into the market and persuade more owners that they can locate replacement properties if they list their current home.

The Balancing Act between Affordability and Inventory

What a difference one year makes in virtually changing the course of real estate. The specter of the shadow inventory and its predicted drag on the industry has been dispatched in a flurry of workout solutions, bulk REO to Rental strategies employed by GSEs, and the influence of all-cash investors snapping up bargains at a rapid pace. When combined with cautiously optimistic reports on the economy’s performance and improved consumer sentiment, the average American homeowner is enjoying the return of rising equity. What has not seen improvement at the same pace is the availability of affordable housing for rank and file consumers.

In today’s market, affordability is an elusive target due to the number of factors that define it. What homeowners applaud as “increasing equity” as the price of homes in their neighborhoods rise, potential buyers perceive as homes pricing themselves out of reach requiring a larger mortgage. The 30-year fixed rate mortgage benchmark is inching its way north of 3.5% as the economy improves, becoming another barrier to affordability for potential homeowners. Affordability is equally a concern for rank-and-file renters who face the never-ending cycle of rising rents, as demonstrated by the greater Los Angeles market where rents have increased by nearly 30% since 1993 while renter incomes have decreased by 6% over the same time period.

The real culprit here is not affordability, but available inventory, or rather, the lack thereof.  One of the consequences of the last cycle was a contraction in single-family and multifamily construction as developers felt the crunch of a debilitating housing downturn. Moreover, the growing numbers of foreclosures and REO created the new “shadow” inventory class that gave the perception of surplus housing units available to the market. But that same downturn created opportunities for cash investors to snap up those distressed bargains in bulk from lenders and government entities. Additionally, foreclosure prevention activity initiated on both the state and government level capped the flow of new distressed assets into the available inventory. Now with a perceived end to the housing crisis and a return to stability, the industry finds there are simply not enough housing units at reasonable prices for renters and entry-level homeowners to comfortably afford. We are currently partnering in an affordable housing condo project in Oxnard, California and can attest to the overwhelming demand we have experienced from qualified buyers unable to find any housing.

If affordability is tied to available inventory, investor participation is absolutely critical to restore equilibrium. During the darkest moments of the housing crisis, multifamily property activity was the one bright spot in a lackluster housing market providing housing for those displaced as a result of foreclosure or other relevant lifestyle shocks. Developers in the single-family sector have already begun to seize the moment of a post housing crisis with new projects. New projects require fresh sources of capital. While the “thawing” of traditional capital channels via commercial lenders is continuing, lenders should bring more to the table in terms of flexible credit conditions to support more development in both multifamily and single-family arena.

Bringing more new units to market overall should also coax more existing single-family units into the housing supply. Many potential sellers are still waiting on the sidelines waiting for prices to appreciate even further before listing their property with an agent. As prices stabilize with new inventory, sellers should be motivated to put their property on the market before values begin to level off. The principles of supply / demand economics should modulate appreciating home values in such a way to allow more buyers into the market with more homes for sale.

This market is on the verge of a breakout year, but only if more buyers gain access to the market with available inventory to meet demand. The market must create favorable conditions not only for sellers with fair home values, but also for buyers whose purchase power can afford the homes on the market.