Thursday, March 10, 2005

Expert Sees Home-Sale Dip Down the Road

As the economy improves and interest rates rise, people might find places to invest other than in real estate.

By MICHAEL W. FREEMAN
The Reporter Editor

ORLANDO -- For the past decade, the real estate industry in the United States has withstood a major terrorist attack, a national recession, a declining job market and troubling overseas events that have rocked world economic markets.

"Real estate returns crushed all the other (financial) markets in the past five years," said Stephen R. Blank, a senior fellow in finance with the Urban Land Institute in Washington. He added that as a strong investment tool, the real estate industry has "a 20-year track record. The stock market goes up and down and you can have some violent patterns. But real estate has very little volatility compared to stocks."

The big question in 2005, Blank said, is whether all that available capital driving home sales and home prices up and inventories down in many locations will tighten up significantly as interest rates begin edging up with an improving economy. He predicted that those rising interest rates would make it harder for someone to snatch up a pricey home with little in the way of a down payment.

"If there is a crisis, it will be a liquidity crisis," Blank said. "It won't be that there's an oversupply (of homes). It won't be high interest rates.

"It will be that liquidity will be drawn from the system on a very fast basis," he added. "Liquidity will be drawn from the system and it will go somewhere else. People will find a new place to invest."

Does that mean the red hot real estate market in places like Central Florida and Four Corners is a huge bubble about to burst? Blank said that's difficult to predict, but he sees some danger signs on the horizon -- particularly from people taking on huge mortgages in the hopes of a large return in just a year or so.

"It's disturbing today, you can get into a house with little or no money," he said. "Some people are going to get hurt by this if there's a spike in interest rates."

Blank was the guest speaker last week at a seminar sponsored by the Urban Land Institute, a research and development organization that aims to provide responsible leadership in the use of land.

The seminar was held at the Orlando Museum of Art.

The real estate industry in Four Corners remains very much a seller's market. Homes in subdivisions still being built often sell out years in advance, and prices in this region are rising well above $200,000 in many new developments.

One factor contributing to the rising prices is demand: Central Florida remains a magnet for newcomers. The U.S. Census Bureau said Florida was the third fastest growing state between 2000 and 2004, behind only Nevada and Arizona, and it has been estimated that 1,000 people move to Orlando each day.

Another factor helping to spur the high home prices is foreign investors. With the dollar weak, buyers from the United Kingdom and other foreign countries see Central Florida as a great investment, and prices starting at $200,000 seem modest compared to European cities like London and Paris.

The seminar, entitled "Show Me The Money: Real Estate Industry and Capital Market Trends," was sponsored by the Ginn Co., developer of one of Four Corners' hottest subdivisions, Reunion.

"About a dozen times a year, we get together and talk about things that can impact us," said Ken Simback, vice president of development for Veranda Park of Orlando, and the moderator of the March 3 event.

Blank, a former Wall Street analyst, said his father spent a lifetime in the real estate industry and taught him many of the tricks of the trade.

"My father taught me the real estate industry is a get-rich-slow business," Blank said, adding that in today's market, many buyers view it the other way around, as a great investment tool for turning over a high profit in a short period of time.

Blank said the real estate industry has remained durable and probably will survive this year's round of anticipated interest rate hikes, saying, "We will not be buying condolence cards for the real estate industry."

Still, interest rates are not expected to remain at record lows for long. On Friday, the U.S. Labor Department reported that the economy created 262,000 jobs in February, nearly twice the 132,000 jobs gained in January, indicating that the sluggish job market could finally be gearing up for a stronger expansion.

Throughout much of this decade, the Federal Reserve lowered interest rates to help spur economic growth. Then the central bank began raising its target for a key short-term interest rate last June, after three months of strong payroll growth. Although the monthly job reports have run hot and cold since then, the Fed has continued to tighten interest rates, in part out of concerns about inflationary risks in a growing economy.

Despite the slow rise in those rates, Blank said the real estate market has remained the hot investment tool of the decade.

"Now it's not whether to own real estate, it's how -- structure -- and where -- geography," he said. "The industry now has truly proven itself to be resilient. We had record everything last year -- record sales, record prices. We had a seemingly insatiable appetite for yielding income."

He added, "There are three drivers in all this. One is the aging boomers, people taking their (financial) portfolios and reorienting them. The second is pension funds, as a means of funding increases. The third is offshore investors, attracted to the United States because of the geopolitical safety of investing here."

But he cautioned that "2005 will be the first test of (available) credit, as higher interest rates tighten the supply of easy lending dollars."

Blank said to keep an eye on the monthly employment reports.

"We know that jobs drive real estate," he said. "Until we get consistent job growth, with 150,000 to 200,000 new jobs every month, it will be hard for people to believe it has traction. For 2005, the trend will be a horse race between interest rates, capitalization rates and income."

Blank sees some dark clouds on the horizon.

"When interest rates go up, capitalization rates go with them," he said. "If net operating income declines, a number of the buyer sources will have a much more difficult time raising capital for their investments and look elsewhere.

"So what should people be doing from a strategic point of view?" he asked. "Sellers are going to start losing pricing power as interest rates go up. As we all know, it's been a seller's market. Now is the time to look at fixed rate financing."

While the single-family home industry is booming, Blank said there are more problems with investor properties.

"I think if we look at the multi-family (home) business, if you look at most (real estate) markets, it is very hard to get rent increases today," he said. "There's still a lot of incentives being offered to renters, like one month free. I think it will be a while before the apartment field gets better."

Likewise, he said a disturbing number of people are buying up condominiums in the hope of renting them for a year, then quickly selling them for a profit. That may quickly become a pipe dream, he said.

"People buying five or six condos to flip, that's not a healthy business to be in," he said.

How will a region like Four Corners, which remains a magnet both for new residents and developers eager to accommodate them, fare during a period of higher job growth and higher interest rates?

"That's hard to know," Blank said. "When we have those cycles of low interest rates and high demand, people believe they can buy at one price and sell at another."

But, he cautioned, "That's not a sustainable trend."

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