Rockin' REITS Report!

The residential sector is definitely in the process of a substantial correction. On Wednesday, new home data was released, revealing that new home sales declined by 17% in January-making the biggest percentage decline in 13 years. The West fell the most sliding at 37.4%. Real estate has done well over the past 2-3 years because of incredibly low interest rates, which are now costing lenders like HSBC millions. Unfortunately, I see the sub-prime loan default situation affecting almost all mortgages, taking a toll on even luxury builders like Toll Brothers. With the resurgence of sub-prime defaults, China likely in the process of a change in their policy on foreign reserves, and data indicating the Fed might make rate hikes at the end of the year, I predict a bust in the bond market which will strengthen the blow to real estate. Property owners have been renting out their properties instead of selling them at low prices, bringing down rental prices and threatening profits at large apartment REITS like AvalonBay. Although I still see residential REITS in the process of a correction, not bust, I believe the optimal time to make an investment will be in at least 3 quarters, when the Fed's policy decision becomes more clear, defaults have played their toll on the market, and there are more indicators on China's future foreign reserve policy. However, there is a chance a value investment opportunity will come sooner (I'm keeping my eyes on TOL with low P/E and a niche focus).

While residential REITS take a hit, the commercial sector is in a better situation. Commercial properties are usually always rented, not sold-therefore, the interest rates do not affect demand in the same way. Commercial REITS do well in two environments: increasing rents and new building rents. Construction of new commercial buildings will be modest over the next year (due to the expansion last year) and since the economy is still showing strength (assuming last week's losses are a correction) demand for offices will be consistent, yielding an attractive rental environment and steady profits for commercial REITS. If we are interested in lowering our risk over the next few quarters and making an income investment, commercial REITS will be a good place to start looking.

Jesse