Are We Up...or Are We Down?

I say we're up, but as you probably know, there are plenty of analysts arguing that the real estate market and overall economy are still slipping toward the center of a whirlpool. I don't think so, though. It does seem as if the market is dancing in a take-two-steps-forward/one-step-backward mode. Every time we begin to think the recovery has strengthened to a genuinely sustainable stride, something comes along to make us doubt...and to fuel the fires of the gloomsters who are anticipating a second recession.

But here are a few salient points to consider. Several large hedge funds--Caxton comes to mind--have decided that real estate is almost surely heading toward recovery. Note this lengthy quotation from The Wall Street Journal:

"Big money is starting to wager on housing. Hedge funds run by Caxton Associates LP, SAC Capital Advisors LP, Avenue Capital and Blackstone Group LP have been buying housing-related investments, betting on a rebound. And formerly bearish research firm Zelman & Associates now predicts a housing pickup, as does Goldman Sachs Group Inc. Other investors seem to be making the same bet. Shares of homebuilders are up nearly 32% since the end of the third quarter, as measured by the Dow Jones index tracking those shares, topping a nearly 10.5% gain for the Standard & Poor's 500.

"These stocks rallied during certain periods over the past three years, only to fall again when hopes of a housing rebound proved unfounded. However, homebuilders haven't outperformed the broader market by this much in a quarter since the end of 2008. ‘We turned bullish on housing. A rebound is coming,’ says Andrew Law, chief investment officer at $10 billion hedge-fund firm Caxton. He expects that home prices and construction will rise in 2012." [Gregory Zuckerman and Nick Timiraos, The Wall Street Journal]

[By the way, Nick Timiraos has proven to be an excellent real estate/economic reporter in the Journal...always worth reading.]

Here's how this works. In a real estate downturn, such as the one we're currently growing slowly out of, builders reduce the number of homes they construct as much as they can, trying for a golden mean in which they have enough inventory to be able to sell a home to the rare customer, but not so many homes that maintaining them eats the builder's capital needlessly.

At the same time, the number of existing homes on the market gradually declines in most real estate crunches, as sellers tire of trying to find a buyer in such a slow market. And that, more or less, is where we are now--or were until recently. The latest data from California shows an increased number of sales in many areas, but an inventory of homes for sale and that inventory has withered on the vine. Expressed in terms of the number of months it would take to sell off today's inventory at today's rate of sales, there are about 4.6 months worth of homes available.

What happens when a few more people decide they want to take advantage of today's superb interest rates and lower home prices? Pretty soon there is a squeeze and buyers are finding it difficult to meet their needs.

Looking again at the new home builder...imagine his new neighborhood sitting there waiting for an interested buyer of two. What happens when the number of buyers starts to multiply? This is tricky. The builder wants enough product to be able to meet the buyer's needs without forcing the buyer to wait a long time while the builder puts more homes together. Ideally, many buyers would like to settle into their new home in maybe a month or two, not six months or more.

Builders reach a point in a recovery--and it isn't far away, unless this market turns south again for some reason--where they have to take a deep breath and start building a lot more homes. And at that point, contractors and construction crews are back at work, plumbers and carpenters are hired, ancillary services like carpet installers and landscapers are pulled back into work. Before you know it, (1) the local area is starting to show the signs of a reviving economy and (2) people have enough money in their bank accounts and pockets to buy a few needed items. And (3) there is a vital buzz in the air again, as everyone responds to the economic vitality.

You can probably tell that we're moving toward that point--though, as I keep saying, I could be wrong. The point is less that I'm right than that this scenario could indeed be playing out. If it is, you probably won't want to miss it, so it is worth planning and preparing for the possibility of a much stronger real estate market.

I will continue to write about the signs--the economic indicators--that are telling us the real estate sector is (or is not) moving closer to recovery. I will also talk about the ways real estate professionals, mortgage loan officers, investors and homeowners might consider positioning themselves in light of the very possible changes ahead.

In the meantime, thanks for reading!