Newsletter – March 2011

CHARTING THE COURSE

Parsing the Great Recovery

By Mitch Siegler, Senior Managing Director

The past few weeks have brought an amazing array of news. Earthquakes and tsunamis in Japan. Governments toppled in Tunisia and Egypt. Riots in Bahrain, Yemen and Syria. Saudi police firing live ammo over protestors’ heads in the world’s largest oil exporting nation. Cruise missiles raining down and a “no fly zone” in Libya. Closer to home, of course, the big story is Nevada Senate majority leader Harry Reid tackling the defining issue of our time – whether to legalize prostitution in his state’s brothels. But, we focus on more mundane matters, those of an economic sort.

It’s now been six quarters since the National Bureau of Economic Research pronounced the end of the Great Recession of 2007-2008. The slope of the recovery curve is generally highest in the early quarters following the end of a recession. And, that should be doubly true this time, with the untold trillions of economic stimulus and the bailouts of Fannie, Freddie, AIG and GM that surely propped up the economy and accelerated the recovery. So, we thought we’d take stock of the recovery, how we’re doing and all that jazz.

More bright spots are visible with each passing day. The stock market has doubled off of its 2009 lows. Corporate profits are robust and companies’ balance sheets are loaded with cash. Real estate investors are tripping over themselves to pick up trophy assets in gateway markets at premium prices. Even the unemployment rate has begun heading south with February’s 9.5% rate down from December’s 9.9% peak. Much of the credit, of course, is due to Fed Chairman Bernanke and his merry band of quantitative easers (QE’s long-term effects will likely be felt for years). All that happy talk aside, if the economic recovery were a pleasure cruise, the captain would surely be reporting the “headwinds”, too. Consider the following:

• Despite all the hoopla, the banks still aren’t lending – In 2010, U.S. banks posted their sharpest decline in lending since 1942. During the fourth quarter, total loan balances declined for a sixth quarter in a row;

• Consumer credit continues to decline, down 18% in the past two years – Consumer credit has fallen from $989 billion in 2008 to $894 billion in 2009 to $826 billion in 2010 (after a “strong” Christmas);

• Unemployment remains stuck at 9.5% – When we hear the phrase “jobless recovery,” we’re reminded of other oxymoronic combos like “military intelligence” and “jumbo shrimp.” (Or, perhaps the old saw “Other than that, Mrs. Lincoln, how did you enjoy the play?”) We shed 8.7 million jobs during the 2007-2009 recession. Since the early stages of the recovery are usually the strongest, we should now be creating oodles of jobs. And, of course, the deck has been stacked in favor of job creation with QE1 and QE2 – all of those road repairs and new bridges brought to you by the Making America Work program. The jobs? We’ve now created about a million of them – 12% of the number recently lost. At this rate, we should be back to where we were by 2017; even if we create twice the jobs for the next three years, it’s still 2014-2015 before we’re back to the 2007 level;

• Real estate is still in the doldrums – As we’ve noted on prior occasions, residential real estate values are down about 40% from the peak. There are clearly more trades at the entry level and prices there have firmed (it helps when mortgage rates are so low it’s often cheaper to own than to rent and it’s kind of a no-brainer to buy a starter home for less than it costs to build one). Qualifying for a loan is challenging and down payment requirements are certainly higher than back in the day. The outlook for more expensive homes, second/vacation homes and the like: not so fabulous. Meanwhile, commercial real estate values are down about 45% from the 2007 peak. Sure, there are bright spots – like larger apartment projects, which are in über-high demand (buoyed by cheap debt from Fannie Mae and Freddie Mac) and trophy properties in “gateway” markets like New York, Washington, D.C. and San Francisco (it’s a feeding frenzy for these assets). Yet, tighter loan underwriting standards and higher vacancy rates make it challenging for sellers of everything else;

• Soaring oil prices – Cocktail party conversation is reminiscent of 2008 (“It cost me 100 bucks to fill up my SUV,” was recently overheard). Many analysts say $100 oil will shave a percentage point from GDP. Two points for $120 oil. Middle East strife doesn’t help; and

• Weak capital spending – At the end of February, the Commerce Department released January’s durable goods orders and shipments data. While the headline number wasn’t bad at +2.7%, peel the onion and you’ll see that the entire increase came from transportation, notorious for its wild monthly swings. Orders for other long-lived assets, like machine tools, production equipment and computers/technology, declined 6.9%. These sectors provided the catalyst for 2010′s robust 15% increase in capital spending, which gave a big impetus to the recovery. January’s fall was the worst since January, 2009, when we were in the doldrums of the Great Recession. The January shift doesn’t bode well for the next few months’ Capex, which suggests the economy might be less robust in the quarters ahead.

So, how best to reconcile the bullish tailwinds (robust stock market, strong demand for trophy real estate, solid corporate profits/balance sheets, low interest rates and the beginnings of job creation) with the bearish, can’t-really-ignore headwinds (tepid lending, declining consumer credit, high unemployment, continued weakness in residential and commercial real estate, high oil prices and weak capital spending)? And, more importantly, how to play it?

• In uncertain times, emphasize quality – In equities, that means best of breed, blue chip companies with rock solid balance sheets. In fixed income, infrastructure (roads, water systems and the like) trumps general obligation bonds. In real estate, we’re not keen to speculate on empty office buildings or land, even though the returns from such investments can be phenomenal, if the stars align. Instead, we’ll pay a premium for well-located, infill properties with solid cash flow that provide us with multiple exit strategies (e.g., if we can’t sell, we can rent);

• Protect the balance sheet – We like to keep the debt manageable and lock in fixed rate, longer-term loans. Mortgage rates have ticked up 80 basis points in just the past couple of months. Taking a longer (25 to 50 year) view, mortgage rates remain at historically low levels and are likely headed north in the next couple of years; and

• Mitigate risk/don’t be greedy – If we can strike a quick deal with a quality tenant, we’ll do so rather than hold out for the last nickel or jump in bed with a second-tier tenant, even when he’s willing to pay a bit more. Today’s decisions have implications tomorrow and beyond. Choose carefully.

As Sergeant Esterhaus famously advised his patrolmen in the 1980′s cop series Hill Street Blues, “Let’s be careful out there.”

Mitch Siegler is Senior Managing Director of Pathfinder Partners, LLC. Prior to co-founding Pathfinder in 2006, Mitch founded and served as CEO of several companies and was a partner with a boutique investment banking and venture capital firm. He can be reached at msiegler@pathfinderfunds.com.

SELECTED PATHFINDER CLOSED TRANSACTIONS

FINDING YOUR PATH

Where Do You Think We’re Heading?

By Lorne Polger, Senior Managing Director

A good friend of mine passed away this week after a lengthy battle with cancer. Whenever we had a chance to get together, he would always start the conversation with a hug, followed by questions about myself, my family and my business. In the hyper competitive worlds of private equity, real estate and finance, kind and sweet men are hard to find. I’ll dedicate this column to him.

We attend real estate and investment conferences on a regular basis. We also hold regular meetings with current and prospective investors in our funds. The most common opening topic of any speech or conversation seems to be, “Where do you think we’re heading?”

The answer isn’t easy, and my oft repeated response is, “It depends.” It depends on geography, asset class, federal, state and even municipal political policies and job creation. It depends on the Fed, Fannie, Freddie and the FDIC and on the ability and desire of the banks to lend money. It depends on the Middle East and Japan. It just depends. So, how are we investing in an “it depends” environment?

Geography. We like the West for the same reasons the principals of Pathfinder moved west in the 1980′s. We like the weather, intellectual capital, big open sky, opportunities, cultural diversity, outdoor activities, creativity, influx of green businesses, technology hubs, and by the way, did we mention the weather? As a friend of mine likes to say, you can’t surf in Iowa, and the skiing isn’t very good in Ohio. More people have been drawn to the West than any other U.S. area over the last 100 years. We don’t see that changing, notwithstanding the significant challenges in education, budget deficits and weakening infrastructure. So, we’re more bullish on the West than the other areas of the country.

Asset Class. We like multifamily, plain and simple. Historically, it has offered the best risk adjusted returns over other real estate asset classes. We like it even more in the current environment because our population base continues to grow while new construction starts are at 40-year lows, because homeownership is down and rentals are up, and even in the hardest hit markets of Phoenix and Las Vegas, occupancy is stabilizing. We like multifamily because it provides stabilized cash flow in an era where cash yields have been driven near zero. Do we also like industrial, office and retail? Yes, at certain price points, in certain geographies. Arguably, there are certain office and retail properties that never should have been built, properties that won’t recover even through the next cycle because they were poorly located. We see appreciation across the board in multifamily. For the other asset classes, we’re highly, highly selective.

Political Policies. Does the residential mortgage interest deduction go away or get reduced? What services do state governments eliminate to balance budgets? How badly will public education be impacted? What will it mean when parents of college age kids have to write $30,000+ annual checks/per child for public school education? What services do municipal governments cut back on to compensate for the drain caused by dramatically underfunded pension obligations? The more protracted these issues, the harder that they become to solve. And, don’t think that any of these issues are easily resolvable without significant pain. The longer the wait, the greater the pain. The greater the pain, the greater the impact on job growth, economic recovery and price stabilization in commercial real estate. I think we’ve seen just the tip of the iceberg on some problems faced by state and local governments.

Job Creation. It’s all about jobs. Prior recessions have demonstrated that jobs have been the driver for economic growth. I don’t think the current recession is any different. Although the unemployment numbers have begun to show a moderate decline over the last twelve months, many economists have noted that this may be a reflection on the unemployed abandoning their claims for benefits, as much as an increase in job growth. Increased job growth also stimulates retail sales and residential construction. Will job growth return in earnest at some point? Of course. But the strength and the timing are the “it depends” factor.

Fannie, Freddie, the Fed and the FDIC. We believe it’s not a question of if, but of when Fannie and Freddie slow their purchasing of residential mortgages. What affect will that have on homeownership? It’s not going to make it any easier to get a loan and it can’t have a positive impact on interest rates. Will the Fed continue to undertake actions that artificially prop up markets? If they do, what will be the long term costs of those programs? Who’s going to pay for it? Will the FDIC (finally) pursue more aggressive strategies in dealing with crippled banks that focused on real estate lending, or will it allow the 884 banks on the “Watch List” to continue to limp along? If the former, could be a big spur in getting the banking system back on track to lend; the latter could result in a much more extended recovery period. So, it depends.

Loans. I’ve been preaching for two years that the main road out of the maze of economic doldrums is paved with debt. Not stupid debt, of course. But moderate debt based on conservative projections, modest loan-to-value ratios and significant debt-to-income coverage. It hasn’t happened yet, but we’re starting to see glimmers of hope. What’s most interesting is that the push in lending hasn’t come so much from the big institutions which have shored up balance sheets and are now earning significant profits, but from the reemergence of the CMBS market and regional banks. A surprise to any pundit who would have made a prediction back in 2008.

Middle East. Does the U.N. Security Council’s passage of the Libya “no fly zone” resolution this past week result in a long term, expensive deployment in the area, or will we just take out the Libyan Air Force and anti-aircraft installations and call it a day? If nothing else, Gaddafi has shown incredible resiliency in maintaining power over four decades. He’s shrewd and powerful. I can’t see him waving the white flag any time soon. According to a Congressional Budget Office report published in October, 2007, the U.S. wars in Iraq and Afghanistan could cost taxpayers $2.4 trillion, including interest, by 2017. If we add an extended stay in Libya to the tab, how will that affect us? Will continued instability have a long term effect on the price of oil? If it does, what will the overall cost be? Conversely, if Gaddafi gives up, how much influence will that have on other Middle Eastern leaders to modernize social and political systems, share the wealth, along the model of the UAE, and keep the oil flowing?

Japan. Our sympathies and emotions were heightened by the incomprehensible disasters in Japan. But what about the short and long term effects on business in the U.S.? One economist wrote that the rebuilding effort over the next decade will be a boon to both Japan and the world as vast sums of money are put to work. Will it do that or will the long term costs to rebuild infrastructure, energy programs and public confidence lead to more of the same protracted stagflation that Japan has endured for nearly 20 years? We’ll see.

So in the end, it depends. Now, more than ever, it’s time to be careful. The markets love certainty and predictability. We’re pretty far from both these days.

Lorne Polger is Senior Managing Director of Pathfinder Partners, LLC. Prior to co-founding Pathfinder in 2006, Lorne was a partner with a leading San Diego law firm, where he headed the Real Estate, Land Use and Environmental Law group. He can be reached at lpolger@pathfinderfunds.com.

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ZEITGEIST – SIGN OF THE TIMES

A compendium of notable news articles relating to the economy, commercial lending and real estate which we’ve edited and commented upon.

Case-Shiller National Home Price Indices Near 2009 Trough

Data on home selling prices through December, 2010, released in February by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices, show that the U.S. national home price index declined by 3.9% during the fourth quarter of 2010. The national index is down 4.1% from the same quarter of 2009 – the lowest annual growth rate since the third quarter of 2009, when prices were falling at an 8.6% annual rate. As of December, 2010, 18 of the 20 MSAs covered by S&P/Case-Shiller Home Price Indices and both monthly composites were down compared to December, 2009.

The graph to the right shows the seasonally-adjusted Composite-10 and Composite-20 Case-Shiller indices. The Composite 10 index (ten largest cities) is down 31.2% from the peak and down 0.4% in December (seasonally-adjusted). The Composite-20 index is also off 31.2% from the peak and is down 0.4% in December (seasonally-adjusted). The Composite-20 is only 0.8% above the May, 2009 bottom and is expected to reach a new low in spring, 2011.

The graph to the left shows the price declines from the peak for each city included in the S&P/Case-Shiller indices. Prices increased (seasonally-adjusted) in only seven of the 20 Case-Shiller cities in December. Prices in Las Vegas are off 58% from the peak and prices in Dallas off just 8% from the peak. New index lows were posted in December in 11 MSAs – Atlanta, Charlotte, Chicago, Detroit, Las Vegas, Miami, New York, Phoenix, Portland, Seattle and Tampa. Nine cities had also posted lows in November. (New York and Phoenix are the new entrants to this group with December’s data.) Prices continue to fall in most markets with more cities hitting new post-bubble lows.

[Editor's Note: Both composite indices are slightly above the post-bubble low but we expect the indices to hit new lows in the next few months.]

January Existing Homes Sales – Yech

It’s not just the weather that was awful in January. The “raw” (not seasonally adjusted) home sales data showed a massive 13.6% month-over-month decline. You have to go back half a century, to 1963, to find anything of that magnitude. Actually, January is typically a positive month for new home sales despite the bad weather (buyers are making up for hibernating during the November-December holidays). Generally, January home sales gain 13%; this year, they fell that amount. Per Gluskin Sheff’s Dave Rosenberg, that equates to an annual decline of 80% on a seasonally-adjusted basis. Mortgage applications – which signal sales a couple of months down the road – aren’t putting smiles on the faces of too many realtors. Mortgage apps were down 2% in February.

[Editor's Note: Earthquakes in Japan and riots in the Middle East, coupled with $4.00/gallon gasoline don't inspire confidence among prospective home buyers.]

11.1 Million Homes (23% of Homes with Mortgages) Underwater; 1.2 Million Foreclosures Forecast for 2011

The housing market continues its downward trend, as fourth quarter, 2010 data indicates that 23.1% of all residential properties with a mortgage now have negative equity. Additionally, 2.4 million borrowers had less than 5% equity, referred to as “near-negative” equity. As we have seen, negative equity can lead to foreclosures or short sales. Collectively, negative and near-negative equity mortgages account for 27.9% of all homes with a mortgage. Consequently, many economists predict that we will see an additional drop in home prices of 5-10% in 2011.

“Negative equity holds millions of borrowers captive in their homes, unable to move or sell their properties. Until the high level of negative equity begins to recede, the housing and mortgage finance markets will remain very sluggish,” says Mark Fleming, chief economist with CoreLogic. The chart to the right from CoreLogic outlines the distribution of negative equity among homeowners with a mortgage. About 10% of homeowners with mortgages have more than 25% negative equity, placing them at higher risk of losing their home.

Lenders are poised to take back more homes this year than any other since the U.S. housing meltdown began in 2006. About five million borrowers are at least two months behind on their mortgages and it is estimated that 1.2 million homes will be repossessed in 2011, up from 2010, when a record 1.0 million homes were lost.

When comparing home equity by state, 65% of Nevada homeowners with mortgages owe more than their homes are worth. The chart to the left from CalculatedRiskBlog.com ranks states by percentages of homeowners with negative equity; the most troubled states are the usual suspects – Nevada, Arizona, Florida, Michigan, Georgia and California.

Nevada, Arizona and Florida– the Leaders in Underwater Mortgages

More than 2,000,000 Florida mortgages – 47.3% – are currently underwater (meaning the borrower owes more on the mortgage than the home is worth). This data comes from CoreLogic’s fourth quarter, 2010 “negative equity report.”

As bad as the situation is in Florida, residents of the sunshine state can take solace in the fact that Arizonans and Nevadans have it even worse (underwater mortgages in those states are 50.9% and 65.4%, respectively.)

[Editor's Note: In her recent edition of MacroMavens, analyst extraordinaire Stephanie Pomboy points out that the average homeowner with a mortgage has just 2.6% equity in his house.]

Homes Becoming More Affordable

NAHB/Wells Fargo’s Housing Opportunity Index (HOI) rose to 73.9 in the fourth quarter of 2010, the highest level in the 20 years home affordability has been measured. The measure indicates that 73.9% of all new and existing homes sold nationwide in the fourth quarter of 2010 were affordable to families earning the national median income of $64,400.

Indianapolis was the most affordable housing market in the country – 93.5% of all homes sold were affordable to households earning the area’s median family income of $68,700. The New York City area was the least affordable market – just 25.5% of homes sold there during the quarter were affordable to those earning the median income of $65,600.

[Editor's Note: The 73.9 Q4 HOI marked the eighth consecutive quarter that the index has been above 70%. Until 2009, the HOI rarely topped 65% and never reached 70%.]

Foreclosure Sales Weigh Down Home Prices

Home prices in 23 U.S. metropolitan areas fell 2.2% in December, the largest one-month drop for 2010 and a sign that foreclosed properties continue to weigh down home values across the nation, mortgage technology firm FNC, which publishes an index to track home prices, reported in February. According to the report, December home values fell for the seventh straight month. Between January and December, 2010, home prices fell 3.4%, according to the report. Of the 30 metropolitan areas surveyed, 23 experienced price declines in December.

The biggest losers were Atlanta, Chicago, Las Vegas, Orlando and Phoenix – all of which experienced double-digit declines in December. The big gainers were in California – San Diego, Los Angeles and San Francisco all experienced 5% price increases on a year-over-year basis in 2010.

[Editor's Note: We attribute the significant home price declines to an increasing rate of foreclosures; distressed property sales accounted for 27% of total home sales during Q4.]

The World After Fannie and Freddie

In mid-February, the Obama administration set forth its plans to begin scaling back the government’s support of the mortgage market, a five to seven-year process that would include phasing out Fannie Mae and Freddie Mac. Analysts expect a housing-finance system that would include both public and private components but with a dramatically reduced government role than presently exists. Loan underwriting standards would also be tighter and borrower equity requirements would be increased to a minimum of 10%. The idea is that Fannie and Freddie would gradually price themselves out of the mortgage finance market. Today, these agencies and the Federal Housing Administration (FHA) account for a whopping 95% of mortgages.

Specific proposals include reducing the maximum loan size that Fannie and Freddie could purchase (from $729,750 to $625,500) and gradually increasing the fees they could charge lenders. These steps would help bring private capital into the mortgage market to fill the void created when Fannie and Freddie scale back. “The cost of mortgages is probably going to go up and home ownership is probably going to go down,” said Daniel Mudd, former CEO of Fannie Mae who is now CEO of Fortress Investment Group.

[Editor's Note: The changes are a break from decades of bipartisan support for the agencies. Fannie, which dates back to the Roosevelt administration, has benefited greatly from lobbying efforts by bankers, mortgage lenders, realtors and homebuilders, who have urged Congress to subsidize mortgages to make homes affordable for the poor.]

K.C. Fed President Hoenig calls for Break-up of Big Banks to Avoid Another Crisis

Kansas City Federal Reserve Bank President Thomas Hoenig says financial regulation won’t prevent the largest U.S. banks from taking excessive risks.

“I am convinced that the existence of too-big-to-fail financial institutions poses the greatest risk to the U.S. economy,” Hoenig said in late February. “They must be broken up. We must make sure that large financial organizations are not in position to hold the U.S. economy hostage. We must not allow organizations operating under the safety net to pursue high-risk activities and we cannot let large organizations put our financial system at risk,” Mr. Hoenig said.

Mr. Hoenig also argues that the most sweeping overhaul of U.S. financial regulation since the Great Depression won’t prevent the largest banks from taking excessive risks and increasing market share. “In my view, it is even worse than before the crisis,” he said. “As well-intentioned as the Dodd-Frank Act may be, it will not improve the outcome.”
The Dodd-Frank Act created a mechanism to unwind the largest financial institutions. Hoenig called for “Glass Steagall-type” provisions – referring to post-Depression prohibitions that prohibited deposit-taking commercial banks from engaging in the riskier trading activities of investment banks.

[Editor's Note: Fed President Hoenig talks a great deal of sense on many issues. He has been a lone dissenter on many Fed votes but the wind has clearly not been blowing in his direction for the past few years.]

CoreLogic Says NAR’s Existing Home Sales Data Overly Optimistic

CoreLogic, the leading aggregator of property and mortgage info, just released a report that questions the veracity of home sales data published by the National Association of Realtors. CoreLogic says NAR’s data is overly rosy. (Not a huge shock to those of us who have long chided NAR’s rosy home sales forecasts, even in 2006-2007, as the market was steadily declining.)

According to NAR, 2010 existing-home sales fell 5%, to 4.9 million. CoreLogic calculates 2010 existing-home sales at 27% less, just 3.6 million – down 12% from the 2009 level. Expressed differently, NAR’s number would equate to a nine-month supply of homes while, when CoreLogic does the math, the overhang is 16 months. (It’s six months in a healthy market.)

Looking ahead, CoreLogic predicts spring, 2011 prices will be down more than 10% from spring, 2010 levels. That jives with our predictions for several quarters, based on declines in traffic, offers, escrows and prices – and increases in mortgage rates.

[Editor's Note: The already sky-high loan delinquency and foreclosure rates seem poised for a fresh increase, spurred higher by escalating mortgage interest rates, continued high unemployment and the situation in Japan and the Middle East, which is driving the stock market lower.]

New Life in the CMBS Market

The CMBS market has reawakened with more than $6.5 billion in new securitizations coming to market in just the past few weeks. February’s activity is about 60% of the $9.8 billion in CMBS offerings in 2010. While the resurgence is a positive sign, indicating that liquidity has returned to the commercial real estate markets, it raises concerns that the still struggling market is being propped up by over-eager lenders.

CoStar predicts 2011 CMBS volume will reach $25 billion. Citigroup’s head of CMBS research thinks volume will reach $30 to $40 billion. While this is a big improvement from last year, it’s a drop in the bucket when compared with the more than $1 trillion of commercial real estate loans set to mature in 2011-2013.

CMBS Buyers’ Faith Rewarded as U.S. Delinquency Numbers Level Off

CMBS delinquencies had one of their smallest increases in February since the beginning of the credit crisis, according to the March Trepp Delinquency Report.

The delinquency rate for U.S. commercial real estate loans in CMBS edged up five basis points in February to 9.39%. That is, once again, the highest percentage of loans 30+ days delinquent, in foreclosure or in bank real-estate owned departments (REO) in the history of the CMBS market. However, it is the smallest increase in two years. The monthly delinquency rate has increased an average of 23.8 basis points over the previous 12 months. Meanwhile, 8.75% of all CMBS loans are categorized as seriously delinquent (60+ days delinquent, in foreclosure, REO or non-performing balloons).

Home Prices: Are We Looking at a Double-Dip?

In early March, we learned that home prices had reached post-bust lows. Then, the government then reported that January saw a double-digit dip in the number of new homes sold. Then, Robert Shiller, the Yale economist and co-founder of the S&P/Case-Shiller home price indexes announced that “There’s a substantial risk of home prices falling another 15%, 20% or 25%.”

“There will be differences by market, but generally, you may get a big discount by waiting a year [to buy],” said Dean Baker, co-director of the Center for Economic and Policy Research, who thinks the price drop will be closer to 10% or 15%. Baker looks at the ratio between local home prices and annual rents to judge whether markets are overvalued. If the median-priced home sells for more than 15 times the median annual rent, there’s a good chance prices may come down.

 
Some stable areas, such as Texas and the Midwest, will probably not experience price plunges at all, but other markets, such as Seattle, Portland and inland California, could still fall substantially, according to Baker.
  

12 Cities: Where to Rent/Where to Buy

As the housing bust continues to be a disaster for the nation’s economy, how do you determine whether to rent or buy a home? The quarterly Rent vs. Buy index by real estate website Trulia says it’s about location; dividing median home prices by median annual rent to produce a Price-to-Rent ratio. If the ratio is over 15, renting is a better option. If the ratio is under 15, the market favors purchasing a home.

“Many former homeowners have flooded the rental market,” says Pete Flint, CEO of Trulia. “Following the principles of supply and demand, renting has become relatively more expensive than buying in most markets.” Below is a table detailing some of America’s largest cities and their Price-to-Rent Ratios.

Predictions for 2011 from JCR Capital

Thanks to Jay Rollins of JCR Capital (www.jcrcapital.com), a Denver-based distressed and opportunistic real estate finance company for allowing us to share a condensed version of his 2011 prognostications with our readers.

Major Economic/Financial Themes for 2011:

1. The resurgence of the conduit market, a steady flow of bank notes and an improving economy have sparked the beginning of the “new normal” era.

2. There are three markets now:
a. Trophy/core assets
b. Multifamily assets
c. Everything else

3. We’re still deleveraging – While “trophy” assets have increased in value due to investors chasing yield, non-trophy assets continue to go through a painful process of deleveraging that will take years to complete.

4. New capital is forming but it will not be able to compensate for the capital lost in the 2008 financial meltdown.

5. The economy is strengthening and double dip recession fears have subsided. Interest rate increases and lagging job growth are two big potential land mines.

Distressed Real Estate, Circa 2011

1. Note sales – 2011 will be the year of the discounted payoff and the year banks sell notes in volume.

2. Extend and pretend is over – Legacy lenders are tired of extending with no hope of repayment. The market has recovered and lenders are now pushing borrowers to resolve their problems. Recapitalizations will occur in earnest.

3. Distress is not going away – The government’s “Save the Banks” policy and the slow, methodical process of the CMBS special servicers have ensured a pipeline of distressed assets that should last at least 36 months.

Real Estate Overview, 2011

1. Cap rate compression – Cap rates have compressed on the best assets. This has occurred because investors have been chasing yields, not because of improving real estate fundamentals. Compressed cap rates are occurring on trophy assets in gateway cities (those with the best locations and rent rolls). Other real estate assets have wide variations in pricing, leverage, and structure.

2. Government-subsidized products – All paved roads lead back to the government. If there are government subsidies, capital will follow.

3. Where’s the bottom? – We have hit the bottom and we are standing on it. The question now is, how long will we stay at the bottom? Assets continue to trade below replacement costs, new construction is very limited and predicting occupancy and lease rates going forward will be challenging.

4. Banks – Bank closures are going slowly. Most banks serving the middle market continue to struggle with legacy assets on their balance sheets. Banks which serve the middle market will not be a capital factor in 2011.

Not all Markets are the Same

1. New York/D.C. – Class “A” properties have recovered. Lenders will drop rates and increase proceeds in order to be in these markets.

2. Other major markets – Pick your name, “gateway cities”, “coastal cities” or “24-hour cities”, they’re all a cut above in the eyes of the capital providers.

3. Everywhere else – Secondary and tertiary markets are not getting a lot of attention from capital providers. These are markets of opportunity for those with local expertise, capital and a sound business plan.

TRAILBLAZING: HEWITT STREET LOFTS