March 16, 2008Kyle KazanComments 1
As you may recall, in recent years as others rushed in to buy Southern California residential and commercial real estate, with the exception of one purchase, I was not a buyer. I could not make economic sense of the premium prices being paid and therefore refused to pay them (but did sell many properties during this exuberant time). Now those who paid those premium prices are vulnerable to a potentially steep market price decline. If rents should decline, those of us who bought at much lower prices can cut our rents and remain profitable as we keep our apartments filled.
In my letter 6 months ago I predicted that foreclosures would continue to increase and the credit tightening would become a credit crunch. My forecast today is that things will continue to get worse but at a faster pace than last year. While I think the US real estate market will suffer, the local markets of Southern California will deteriorate including the prime locations in Los Angeles and Orange County which will be hit harder then the macro US real estate market in general because the speculation here was so intense. I believe we are still in the early stages of this downturn and that the underlying valuations got so skewed (through undisciplined financing and rampant speculation) that a correction albeit painful is the healthy solution. The more the government involves itself, the longer it will take for the mess to resolve itself.
We are in an interesting economic pickle, the Federal Reserve is lowering the overnight rate which has caused the treasury yields to fall yet on commercial loans (see Beach Front IV and NPI Beach Front in this letter) the spread has widened which has kept interest rates up. On the operations level, we get many resumes when we post for job openings showing a weakening job market yet our employees are feeling the same inflationary pressures that we do in higher maintenance costs and thusly we have to pay them more. I do not believe that the Federal Reserve will be successful in inflating out of this housing crash. . .
Yes, I’m still the bear in the room!
In my observations of the real estate market, I believe the sweet spot will be in single family houses. My eyes are on Phoenix and Las Vegas. I’ve chosen those markets due to the huge opportunities we expect along with the strong population growth history and future potential (Sunbelt). Traditionally in real estate downturns, the housing market hits bottom when investors step in and purchase which happens when pricing makes sense for rental ownership. The homes become “shadow rentals” which are difficult for the apartment industry to track yet it is hard felt on their occupancy. As my focus has always been opportunistic real estate investment, I have been waiting years for the coming crash which I believe will be a vulture’s paradise.
The apartment market that will get a boost when people lose their homes to foreclosure and rent at multi-unit properties will conversely be hurt when those same foreclosed homes become shadow rentals for investors. This will create opportunity to buy apartments in those same markets that we bought houses. We will see apartment foreclosures and properties where the owner just wants to recover as much equity as they can (take their lumps and move-on).