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Real Estate In Trouble – Could A 2008-Like Decline Be Next?

Nov 18, 2009
Simon Maierhofer

With stocks up most of the time, it takes a keen eye to see what’s going on behind the facade of rising prices. Real estate is once again in trouble. Fannie Mae, Freddie Mac, and the FHA all need money, prices are down and real estate ETFs have already started their very own bear market. Will it be 2008 all over again?

When reminiscing about the almost forgotten post 2007 decline, many – with a feeling of relief and nostalgia – consider the 2008 decline to have been the perfect storm – emphasis on “have been.”

Aside from a few bad memories and lessons to be learned, that storm left fertile grounds for tons of green shoots to sprout and propel the major indexes a la S&P 500 (SNP: ^GSPC), Dow Jones (DJI: ^DJI), and Nasdaq (Nasdaq: ^IXIC) higher.

To the dismay of Main Street, the green shoots seen on Wall Street haven’t really carried over to the average consumer just yet. Looking at averages, and based on the Bureau of Labor Statistics (BLS) real number of jobless workers (called U-6), almost 1 out of 5 (17.5%) Americans are without job.

Even though it’s not visible on Wall Street, at least not yet, there are repercussions. In fact, you don’t even have to look too hard to find them.

Today's top story is that housing starts in October unexpectedly fell to their lowest level in six months. Keep in mind this is despite the tax credit for first-time home buyers. But that's not all.

Nicolas Cage forecloses 2 homes

As CNNMoney points out, even Academy Award winners are suffering from financial woes. Actor Nicolas Cage lost two homes in New Orleans worth a total of $6.8 million in a foreclosure auction Thursday. Unlike the average working man, Nicolas Cage has five new movies slated for 2010. This should help heal his bruised ego and real estate portfolio.

Goldman Sachs sells Miami condos for a 66% loss

Bloomberg reports that Goldman Sachs sold 158 condominiums in a foreclosed project outside Miami for about $113,000 each, roughly the cost of land and construction. Condo prices in Miami fell close to 40% compared to a year ago.

Fannie Mae and Freddie Mac – in trouble again

This is not widely publicized, but Fannie Mae is asking for an additional $15 billion in government aid after posting a $19.8 billion loss. Fannie Mae and Freddie Mac own or guarantee almost 31 million home loans worth about $5.5 trillion, or about half of all mortgages.

The Federal Housing Administration (FHA), another government agency, is heading for the same kind of financial trouble. The FHA has insured about 1 out of 4 new loans made this year. 17% of FHA borrowers are at least one payment behind, or in foreclosure.

Keep in mind that Fannie, Freddie, and the FHA are struggling despite the third quarter being the best quarter for real estate prices in quite a while.

Of course, large housing agencies are just reflecting what’s happening throughout the country. Median home sales prices declined in 123 out of 153 metropolitan areas year-over year, or 11%.

The curious case of real estate ETFs

Even though real estate prices have never really recovered, real estate ETFs – or REIT ETFs – have done quite well. From their March lows to their respective recovery highs, the major U.S. real estate ETFs, such as the iShares Cohen & Steers Realty Majors (NYSEArca: ICF), SPDR Dow Jones REIT ETF (NYSEArca: RWR), Vanguard REIT ETF (NYSEArca: VNQ), iShares Dow Jones US Real Estate (NYSEArca: IYR), and SPDR S&P Homebuilders (NYSEArca: XHB) have gained more than 100%.

Any homeowner in the country will tell you that there is a huge discrepancy between the performance of ETFs and “real life” real estate prices. If home prices had doubled since March, there would be very few foreclosures.

The ETF Profit Strategy Newsletter predicted the strong correlation between REIT ETFS and stocks back in February, when it said: “Similar to U.S. stocks, real estate prices should recover temporarily.”

Via the March 2nd Trend Change Alert, the newsletter recommended to buy, buy, buy long and leveraged long ETFs, in particular high dividend paying ETFs with high allocations to financials and real estate. The market certainly delivered.

Real estate – more than just a sector

The troubles in real estate are truly alarming. Real estate is more than just a plain U.S. industry sector – it’s the cradle of the post 2007 financial meltdown. As real estate goes, so go the banks and the economy.

The unemployment rate of 10.2% has already gone beyond the worst-case scenario projections of the banks’ stress test. This worst-case scenario assumed unemployment of 8.9% for 2009 and 10.3% for 2010.

Unemployment has a direct impact on real estate prices. There are very few jobless Americans who can afford to support their family and home on a fraction of their income, via unemployment checks. This means big losses for big banks.

What’s ahead for real estate?

The direction for real estate as an asset class seems harder to predict than stocks. In general, real estate data doesn’t go back as far as data for the Dow Jones. At times, there is a correlation between real estate and equities which allows formulating a fairly high probability forecast.

The last time we’ve seen a real estate bubble followed by a stock bubble was in 1926, when real estate topped and in 1929 when stocks topped. We’ve seen the same correlation just recently when real estate peaked in 2005, followed by stocks in 2007.

The Great Depression was ruled by deflationary forces. All asset classes, aside from the price of gold, which was fixed, lost value. The decline made no exception for real estate.

Appropriately, there is no other bear market other than the Great Depression, that measures up to the post 2007 bear market. Even this rally mirrors the Great Depression. Until today, the 1929 – 1930 rally was the mother of all sucker rallies. It is quite possible that the current rally may actually eclipse the prior record.

Hand in hand to lower prices

A few months ago, the ETF Profit Strategy Newsletter pointed out that the Great Depression bear market rally retraced just about 50% of the points lost during the initial decline.

Today’s equivalent of the 50% retracement for the Dow is right around 10,500 (NYSEArca: DIA), 1,125 for the S&P 500 (NYSEArca: SPY). Those levels have either been reached (Dow), or are very close (S&P).

If the parallels remain intact, a significant decline is about to happen – for stocks, commodities, (NYSEArca: DBC) and real estate. One of the only ETFs to benefit from declining real estate prices should be the UltraShort Real Estate ProShares (NYSEArca: SRS). SRS aims to deliver twice the daily inverse performance of the Dow Jones US Real Estate sector. SRS's cousin, the Ultra Real Estate ProShares (NYSEArca: URE) magnifies the performance of the same sector.

The December issue of the ETF Profit Strategy Newsletter provides a detailed short, mid, and long-term outlook for stocks, gold, silver, and by default of correlation, real estate.

Perhaps the current calm is not the calm after the storm, but the calm before the storm. 

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