Daily Gains Letter

Why the Real Estate Market Is Still a Guessing Game

By for Daily Gains Letter |

Real Estate MarketTwo housing indicators were released earlier this week, and while the numbers seemed divergent, they both really say the same thing—that the U.S. real estate recovery is chugging along, but the current pace is unsustainable.

On Tuesday, a report from S&P/Case-Shiller showed property values in 20 U.S. cities had increased 12.4% year-over-year in July. This marked the largest annual gain since February 2006, when the market was nearing the height of the U.S. housing bubble. (Source: “Home Prices Steadily Rise in July 2013 According to the S&P/Case-Shiller Home Price Indices,” Spice-Indices.com, September 24 2013.)

On top of that, July marked the fourth consecutive month that all 20 cities in the index recorded monthly gains. However, 15 of those cities experienced slower month-over-month gains, suggesting the rate of home price growth may have peaked.

That said, it’s pretty hard to argue we’re in a housing bubble. Since bottoming in March 2012, home prices have rebounded by 21%—but they’re still 22% below their July 2006 pre-Great Recession peak.

Not so coincidentally, mortgage rates have been running in step with the U.S. real estate market and are up more than a full percentage point since May; today, a 30-year fixed mortgage rate averages around 4.5%. Erring on the side of caution, investors sent rates higher as they speculated about whether or not the Federal Reserve would begin to taper its $85.0-billion-per-month quantitative easing program.

Not only has this made borrowing more expensive, but it has also made home ownership less affordable. Those on the cusp have been rushing in from the sidelines to beat the banks’ higher mortgage rates, and in an excited market, there’s a temptation to overpay for a home just to lock in at a low rate.

On Wednesday, the Census Bureau announced that new home sales in August climbed 7.9% to a seasonally adjusted rate of 421,000 from 390,000 in July; that was less than the 425,000 forecast and also caps the two worst months for new home sales so far this year. During the first three months of the year, new home sales averaged 449,000, while over the last three months, sales have average 422,000. (Source: Chandra, S., “Sales of New U.S. Homes Rose in August Following July Plunge,” Bloomberg web site, September 25, 2013.)

Why? As the S&P/Case-Shiller report noted, rising interest rates are having a negative impact on new home sales. New U.S. real estate home sales activity in July declined 13.5% month-over-month, in large part because buyers cannot lock in on rates on homes under construction.

While the continuation of quantitative easing should keep interest rates low, ongoing growth in the U.S. real estate market, for both existing and new homes, is contingent upon the cost and availability of credit—along with improving consumer confidence and stronger job prospects, that is. You can’t have one without the other.

Despite the recent housing numbers, the U.S. real estate market feels like it’s not on solid footing and could, with any number of economic data reports, rise or fall quickly. This means investors, regardless of if they’re bullish or bearish on the U.S. real estate market, might want to manage their risk and diversify their holdings.

Those with a bearish view on the U.S. real estate market might want to consider an exchange-traded fund (ETF) like ProShares Short Real Estate (NYSEArca/REK). Investors who think the U.S. real estate market has turned the corner should put the iShares U.S. Home Construction ETF (NYSEArca/ITB) on their radar.

Or, instead of guessing which way the U.S. real estate market is heading, you could look at those companies or ETFs that are already generating revenue. One example is Inland Real Estate Corp. (NYSE/IRC), which develops shopping centers and retail properties in the Midwest region of the U.S.

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