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Real Estate Revival

Housing may have hit a bottom, and commercial REITs might also still be compelling.

Fidelity Viewpoints – 10/10/2012Investing Strategies

Are you counting on the equity in your house for retirement, or do you own income-generating property or other real estate investments? If so, recent trends in real estate suggest a nascent recovery might be taking place, and that could be good news for you.

After falling off a cliff in the mid-2000s and helping drive the global economy into a deep recession, residential housing appears to be finding a bottom (see graph below). Indeed, many experts have pointed to housing as one of the relatively bright spots in the economy. (Read Viewpoints: “Business cycle update: Home prices rising.”)

Will the recent uptick continue? And, what segments of the market might be well-positioned to outperform? A few Fidelity fund managers we interviewed are relatively upbeat.

Residential housing trend is looking up

Sales seem to be picking up, and homebuilder sentiment—generally a good early indicator of forthcoming activity—is improving. Sales of previously-owned homes were 10.7% higher in August this year, compared to the same month in 2011, and new home sales rose 17% during the same period. “Year-on-year demand for new houses has accelerated every quarter this year,” says Jim Morrow, portfolio manager of the Fidelity Equity-Income Fund (FEQIX | Get Prospectus), which invests in Real Estate Investment Trusts (REITs) as well as dividend-yielding stocks and other income-producing investments.

Moreover, during the week of September 2, the NAHB Housing Market Index reached its highest level in more than five years.1 Housing starts and building permits, both of which are also seen as early indicators because they represent initial approval and construction of new homes, have been steadily rising over the last several months.

Another crucial metric is home prices, which plummeted when the housing bubble burst. While there are still a number of depressed cities around the country, average prices have really strengthened. In fact, the median home sale price for August 2012 rose 17% versus last year, to $256,900, the highest reading since March 2007.2 What’s more, there may be some pent up demand, given steady population growth and the steep drop in housing starts (see graph below).

Will pent-up demand propel the housing recovery?

Even considering the significant improvement in prices, Morrow thinks homes are extremely affordable right now, and that could support prices for the foreseeable future. “Since 2001, principal and interest payments on the median-priced home are down 20% in absolute terms,” says Morrow, “and are now well below median apartment rents.”

Commercial market still hot?

Residential housing usually gets all the press, but commercial property (office buildings, retail stores, hotels, etc.) might be the best investment option in real estate now, according to Steve Buller, portfolio manager of the Fidelity Real Estate Investment Portfolio (FRESX | Get Prospectus), which invests in commercial properties and REITs. “We believe that commercial property is in the midst of a long-term uptrend, as the fundamentals—specifically occupancy and rental rates—are improving,” Buller says. Year-to-date, the Dow Jones Composite ALL REIT Index (RCI) is up 14% as of October 5, 2012.3“We expect those factors to continue to improve as any new competitive supply of commercial real estate appears to be quite limited.”

Certain segments of the commercial market could be better positioned as well. “Shorter-lease sectors, including lodging, self-storage, and apartments, have generally performed better, as they can adjust more quickly to conditions on the ground,” Buller says. “Currently, we prefer the industrial/logistics segment of the commercial real estate market, as it looks to be benefiting greatly from demand by e-commerce distributors.”

Buller likes coastal markets that have a higher barrier-to-entry, such as Boston, San Francisco, and Seattle. “These areas have better commercial real estate fundamentals, as demand is a little better and supply is obviously more difficult to build.”

That doesn’t mean all coastal regions appear attractive. “I am somewhat concerned about the New York City office space market because of all the pressure on financial firms,” notes Mark Snyderman, manager of the Fidelity Real Estate Income Fund (FRIFX | Get Prospectus), which focuses on investment in preferred and common stock of REITs, and debt securities of real estate entities.

Can real estate diversify your portfolio?

Of course, investing in real estate—commercial or residential—may not be suitable for everyone. Managing income-generating properties takes time and capital for maintenance and management costs. Real estate is an illiquid asset; in specific cases it can be tough to sell. Also, prices are sensitive to changes in interest rates and bank lending practices, and individual asset values can be hard to determine.

However, real estate can provide several significant benefits to investors. It can help diversify a portfolio of stocks and bonds, and offer income and capital appreciation potential.4 Additionally, real estate prices have historically tended to be less volatile than financial securities, which are more liquid and can quickly change in value.

Of course, it’s not necessary to buy a physical piece of property to have real estate in your portfolio. Through different investment products, such as REITs and real estate mutual funds, investors can obtain exposure to various segments of the property market.

Investing implications

Despite the improvement in the recent data, there are still a number of concerns that could slow housing’s recovery. Among them: a glut of shadow inventory (homes that are seriously delinquent, in foreclosure, or have already been repossessed by banks) and the slow pace of jobs growth. But other factors suggest that the momentum could be sustained.

“People moved in with family members or looked for roommates to share costs longer than normal during the recession,” says Morrow, “and so we estimate that between 500,000 and 1,000,000 households should have been formed during this time frame and were not.” That could result in a lot of pent-up demand that, if unleashed, might continue to support a housing recovery.

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Seasoned chief executive and entrepreneur with proven track record. Mr. Zar brings more than twenty years experience in operations, evaluation, investment and management of real estate assets. Sean is responsible for new asset origination, evaluation, analysis and due diligence as well as overall executive direction. Mr. Zar also gained insight into capital markets as the founder and president of CBA Capital, Inc., a Newport Beach, CA based investment bank and venture capital company. He also was the founder and CEO of American Income Securities, an investment company with more than $50 million in client assets. He also managed a technology venture capital fund where he was responsible for equity and debt investments in a wide variety of companies. Mr. Zar sold his interest in American Income Securities in 1999. Mr. Zar has been an active real estate investor in Arizona as well as Colorado and Southern California. Mr. Zar is focused on discovering undervalued properties.
Published inPhoenix Real Estate