Real Estate in 2013: A More Selective Market

After several substandard years of performance, the real estate market finally came back to life in 2012. And while still not exactly healthy yet, the sector should keep building on this nascent momentum off the bottom — albeit slowly — into 2013.

As 2012 ends, it’s apparent that the positives have outweighed the negatives. This year saw the continuation of historically low interest rates and selling prices 35% to 60% below the inflated levels of 2006. This combo turned 2012 into a buyer’s market once more, with inventories of distressed sales shrinking from previously elevated levels, and median housing prices up nationwide from year-ago figures.

Housing Recovery? Take Another Look
Housing Recovery? Take Another Look

Also providing support to the market are moves by Fannie Mae to reduce its foreclosure inventory with bulk  sales to hedge funds and rule changes to the Home Affordable Refinance Program (HARP), first created in 2009, to help more underwater homeowners to remain in their houses. And don’t forget the Fed’s QE3, which features the monthly purchase of $40 billion in mortgage-backed securities (MBS).

No wonder homebuilders had their best year in the last five, with profits exceeding analysts’ expectations throughout 2012. Even the year-end closing delays caused by Hurricane Sandy won’t change that. By December, the National Association of Home Builders/Wells Fargo confidence index had risen to 47, the highest level since April, 2006, and capping off a terrific year.

However, major obstacles remain. Among them: still-tight lending standards, appraisals that are coming in below sales prices due to the lack of comparative sales and lenders’ new insistence that distressed properties get necessary repairs prior to closing.

Barriers to Progress

Despite the improvements in 2012, mixed results are possible in 2013, for at least four reasons.

First, despite making public statements about helping homeowners, the U.S. government has been doing just the opposite. The Federal Housing Authority (FHA) has raised mortgage insurance fees, which reduces the loan amount borrowers can qualify for because of higher total monthly payments. Plus, the FHA, Fannie Mae and Freddie Mac keep adding new rules onto the borrowing process, making it more difficult for people to get loan approvals.

Second, the shadow inventory of foreclosures is still substantial. Banks were in no hurry to release these properties in 2012 in an effort to artificially prop up market values. As a result, a huge backlog of empty homes remains, and we’re likely to see more of them pushed onto the market in 2013.

Realty Trac says bank repossessions jumped 11% month-to-month in November and were up 5% from November 2011 — the first annual jump in over two years. In my area of Florida, foreclosures rose about 40% from October to mid-December. Many homes have been in pre-foreclosure status for as long as two or three years, and are likely to be added to the foreclosure pools. States that have been slowed in recent years by the robo-signing scandal are now increasing their efforts to move these homes through the court system and into the foreclosure ranks.

Third, the job market continues to creep along, without the numbers and type of jobs that are necessary to really propel the real estate market forward. New jobs continue to languish below 150,000 per month, and many of them are low-paying service positions that aren’t likely to help first-time homebuyers qualify for a loan. Numerous questions remain about how Obamacare may affect layoffs or push full-time workers to part-time status.

Fourth, home ownership is losing its luster among those aged 24 to 35. Many of them have no sense of history beyond the 2002-2007 bubble and crash, and fear that the home they buy today will be worth much less in five years. Others have seen the negative headlines about millions losing their homes to foreclosure, and wonder if it will happen to them. Many clearly prefer renting in complexes that provide high-end amenities that most homeowners can only dream of.

All told, the percentage of Americans owning homes has now declined to around 65%, the lowest nationwide rate since 1997.

Clearly, there’s plenty to worry about for real estate in 2013. Other factors, however, may help boost the market in 2013.

Hopeful Signs

Many homeowners who lost their homes to foreclosure from 2007 to 2010 have since taken steps to improve their credit scores and are once again eligible for a mortgage. The question is: Have they lost their taste for homeownership, or will they jump at the chance to own a home like they once lived in at prices that are 30% to 40% less?

An ironic result of new releases of shadow inventory may be to moderate recently rising prices, which could threaten to make homeownership unaffordable for some first-time buyers. At least interest rates should remain low throughout 2013 and perhaps even beyond, given the Fed’s concern with slack economic growth and anemic job creation.

Also, the percentage of homes sold to move-up buyers increased in the last few months of 2012, and should continue into 2013. Many of these buyers have lived in their homes for many years and have paid their mortgages down to levels where they’re no longer underwater.

Given these conflicting factors, I expect that we could have a long, slow bottom in the housing market, with an L-shaped recovery over several years.

Investor Strategies

Among homebuilder stocks, these mixed trends will create more of a selective market. Companies such as Pulte Group (NYSE:PHM) and Lennar (NYSE:LEN) have now branched into the mortgage loan business and are thus enjoying large revenue boosts, even during months when sales are slower. So, 2013 could be another good year for those two firms.

However, it could be tougher ride for many of the other homebuilders, especially if owner-occupant rates continue to decline and more foreclosures hit the market. Foreclosures, especially in recently built homes, create enormous competition to the new-home market. Investors should watch these trends to help them decide which, if any, homebuilder stocks to own.

With rental demand still going strong, investors might look for value among some of the apartment-related real estate investment trust (REIT) stocks such as Mid America Apartment (NYSE:MAA) and exchange-traded funds like iShares FTSE NAREIT Residential (NYSE:REZ). Mid America’s dividend is currently 4.40%, while REZ pays 3.13%.

So, despite the uneven forecast for 2013, investors still have plenty of ways to profit as real estate continues its slow healing.

As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.

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