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.