Weekly Market Update for September 17th, 2012

Keeping you updated on the market!
For the week of

September 17, 2012

MARKET RECAP

Last week, we broached the possibility that the residential rental real estate market could be forming a bubble. We found it interesting, even if it were only coincidental, that the the Wall Street Journal ran a piece this week on institutions piling into single-family residential rental real estate.

The Journal article featured a private-equity firm, Colony Capital, that has been buying single-family homes, refurbishing them, and then renting them. Colony has accumulated 3,600 homes, most purchased out of foreclosure. Business, so far, has been remunerative.

Colony Capital isn't the only institutional player in single-family rentals. According to investment bank Jefferies & Co., big private-equity players Blackstone Group, Och-Ziff Capital Management, and Oaktree Capital have raised more than $8 billion to buy houses, which they plan to refurbish and rent.

This flood of institutional investor money into the single-family rental market is a big reason we are less concerned about distressed shadow inventory than most market observers. A lot of demand has developed to soak up supply. Over time, that supply will continue to dwindle.

The trend in multi-family residential rentals is also revealing. Data from the National Association of Real Estate Investment Trusts (NAREIT) show money flowing freely into this market as well. In fact, REITs that focus on multi-family residential properties have been some of the best performers in the real estate segment over the past year.

The point we want to emphasis is that investors and market watchers should become more alert when markets heat up – and the rental real estate market is certainly heating up. More risk resides in the hot market, because the hot market doesn't stay hot forever. We reported a couple week ago that rents, which have been on a tear the past two years, are already showing signs of slowing. Trulia's data show rents rose 4.7% in August from a year ago, but that growth is lower than the 5.8% year-over-year growth reported in May.

We obviously can't say for sure if a bubble is forming in the residential rental market, but we can say the bullish sentiment is starting to sound like the sentiment that prevailed in the single-family purchase market circa 2004.

There is another reason we should maintain our perspective on rentals: People still prefer to own their own home, which is why we expect to see sustained growth in the owner-occupied market over the next couple years.

Risk aversion is the impediment to more owner-occupied activity. The financial firm Redwood Trust recently issued a private jumbo mortgage-backed security. The security was backed by mortgages with an average FICO score of 771 and a loan-to-value ratio of 67%. Such issues have been the norm in recent years.

We'd like to see more investor interest in more speculative mortgage-backed securities. More interest in more speculative issues would indicate more risk taking by investors and a more liquid, more inclusive lending environment.

Economic
Indicator

Release
Date and Time

Consensus
Estimate

Analysis

Home Builder Index
(September)

Tues., Sept. 18,
10:00 am, et

37 Index

Important. Builder confidence continues to rise on greater sales and building activity.

Mortgage Applications

Wed., Sept. 19,
7:00 am, et

None

Important. Purchase applications remain volatile, suggesting choppy near-term sales volumes.

Housing Starts
(August)

Wed., Sept. 19,
8:30 am, et

770,000 (Annualized)

Important. Starts continue to move higher and are becoming a bigger contributor to economic growth.

Existing Home Sales
(August)

Wed., Sept. 19,
10:00 am, et

4.6 Million (Annualized)

Important.Sales are still trying to establish a sustained trend for 2012.

What QE3 Means to Us

QE3 sounds like a luxury British ocean liner; it's actually an abbreviation for a third round of quantitative easing, which itself is a euphemism for the Federal Reserve pumping more money into the economy. On Thursday, the Fed said it would implement QE3 in the near future.

The mechanics of QE are straightforward: The Fed adds more money to the economy by buying mortgage-backed and U.S. Treasury securities from banks. The securities are paid for with new money the Fed conjures into existence. The Fed's demand for these securities drops the yield on these securities. These lower yields, in turn, are expected to produce lower mortgage lending rates, or at least sustain today's already low rates into the future.

 At least that's the theory. The problem is that price inflation fears – due to the new money – can rise. Should investors' inflation fears trump Fed demand for the aforementioned securities, that means mortgage lending rates could actually go up, thus thwarting the Fed's intended outcome.

In short, there is no sure thing. Many borrowers are waiting on the sideline, anticipating lower lending rates. We think that's a dangerous game, because even if QE3 lowers lending rates, we doubt they will lower them by a significant margin. On the other side of the coin, rates could easily go higher if investor concern switches to inflation from slow economic growth.