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Residential Resurgence?

Market analysis
Residential Resurgence?
A recovering housing market may lift all boats — including commercial real estate.
by Sara Drummond

“When Warren Buffett and Sam Zell comment about distressed single-family homes being one of the best investment opportunities in the market, people tend to listen,” says Ken Wimberly, CCIM, managing director of Noble Crest Property Group/KW Commercial in Arlington, Texas. “We are seeing strong sales as a result of investor purchases for single-family residential homes.”

Like most CCIMs, Wimberly doesn’t work in the residential market, but as a KW Commercial affiliate, he has a strong relationship with its residential division and keeps abreast of housing trends and how they affect the commercial market.

One of the strongest trends to come out of the residential market this year is the investor interest in single-family homes. Home sales are up 6 percent this year, and about 30 percent of all sales are cash, says Kevin J. Thorpe, chief economist for Cassidy Turley, meaning that some investors are parking their money in residential.

“Investors have been very active in the Twin Cities buying single-family homes as investments,” says Herb Tousley, CCIM, director of the Shenehon Real Estate Center at the University of St. Thomas in Minneapolis. “Many of these sales have been distressed properties that are renovated and converted into rental properties. Low prices have made these properties very attractive as investments and many of these sales have been cash sales. The rental market is very strong and these investors are achieving favorable rents.”

From local mom-and-pop investors to private equity funds such as Colony Capital, which owns about 3,600 single-family homes, investors have turned to residential and for those who got in early, it’s beginning to pay off: In September, existing home sale prices rose for the seventh consecutive month year over year, according to the National Association of Realtors. That number of back-to-back monthly increases hasn’t happened since the height of the housing boom from November 2005 to May 2006, says Lawrence Yun, NAR’s chief economist.

Even Las Vegas, hit very hard by the housing collapse in 2007, has seen a dramatic turnaround, according to Soozi Jones Walker, CCIM, SIOR, with Commercial Executives. This is a very strong market,” she says. “Investors from all over the world have been purchasing homes for long- and short-term investments. The buy-and-flip market is strong and due to short inventory, multiple offers are back.”

Walker says the housing inventory has gone from 24,000 to 4,000, due in part to Nevada’s anti-foreclosure laws that restrict banks from foreclosing on properties. The limited inventory has pushed up housing prices, according to the Greater Las Vegas Association of Realtors. In September, the price of Las Vegas single-family homes was up 13.5 percent from a year ago, and condo and townhome prices rose 24.3 percent YOY.

Like many CCIMs, Walker has her roots in residential, and although her firm is strictly commercial now, she understands the relationship between the two markets. “The two go together like a hand and glove. Without jobs we don’t need residents, and without the residents we will not have the job force,” she says. “Las Vegas has many small businesses that rely on the local residents to support them. Everything from clothing stores, to pet grooming shops and restaurants are affected. As hiring has slowly stepped up so has our commercial real estate market.”

How Strong Is Residential?

Unlike the commercial market, the improving residential market is not restricted to major gateway cities and core markets. In September, 99 metros in 33 states saw improving residential conditions, up from 80 metros in August, according to the National Association of Home Builders, which defines improving as six consecutive months of rising housing permits, employment, and home prices. Markets added to the list in September include smaller cities such as Tucson, Ariz.; Jacksonville, Fla.; Springfield, Ill.; Greenville, N.C.; and Bend, Ore.   

“While economic and political head winds remain, it is obvious that the residential market has turned the corner,” says George Ratiu, NAR’s manager of quantitative and commercial research. “Sales have recorded moderate growth, prices have advanced throughout the year, and the share of distress has been in decline.” 

Many CCIMs note that the number of distressed properties for sale is declining in their markets, tightening supply. While some of that decline is due to foreclosure slowdowns, NAR reports that, nationally, distressed property sales — both foreclosures and short sales — accounted for 24 percent of total sales in September, down from 30 percent in September 2011.

But we’re not out of the woods yet, Tousley notes. “Historically high levels of foreclosures will still be with us for the next two years, but the percentage of distressed sales has been moderating during 2012 and I expect that to continue through 2013. The shadow market of properties that are in the foreclosure process is probably not going to overwhelm the market in 2013.”

Lower inventory and strong demand have builders moving forward on projects, giving rise to the thought that housing is ready to reclaim its spot as the recovery’s economic engine. Housing starts — up 20 percent this year — should rise an additional 15 percent for both 2013 and 2014, according to Mark Vitner of Wells Fargo Securities. He adds that the Federal Reserve’s recent decision to pump $40 billion a month into mortgage-backed securities should ease financing troubles for both buyers and builders. “The added liquidity … should also bolster builder and lender confidence, which should provide a real boost to sales and construction activity during the key 2013 spring selling season…,” he says. “This spring could very well see the pace of the housing recovery ratchet up in a significant way.”

As residential builders gear up, land brokers have been busy, says Bill Eshenbaugh, CCIM, ALC, of Eshenbaugh Land Co. in Tampa, Fla., but buyers remain particular about location. National builders have been very active, he says, bidding up the price on the finished available lots in class A locations.

“But there’s a big fall off from A sites,” Eshenbaugh adds. “Builders are ready to buy entitled but undeveloped land in good locations rather than buy existing lots in inferior locations.”

He adds that the activity for residential lots has included a lot of bigger players: “We had a lot of private equity and hedge funds buy residential land from builders, failing developers, banks, and CDD bond districts; now these investors are developers and/or sellers.”

But not everyone is convinced that single-family residential has turned the corner, and local markets may not always reflect national trends, Tousley says. Although Twin Cities housing prices are up almost 6 percent YOY, “June and July have been the first two months since February 2011 that the median price of a traditional (non-
distressed) home sale has been higher than the previous year’s levels,” he says. “I will be a believer that this housing market recovery is for real if the median price of a traditional home remains above last year’s levels for the remainder of the year.”

Commercial Spillover?

Tousley adds that the residential meltdown had a serious effect on the Twin Cities commercial markets, but that the improving housing market bodes well for everyone. After the large drop in home prices, “this ‘negative wealth’ effect changed the way people felt about their financial security,” he explains. “Consumer confidence declined and the retail and office markets were among the first to be impacted. We are just beginning to see signs of recovery. Home prices are a leading indicator, and if they continue to increase, commercial real estate will follow the trend.”

On a business level, some CCIMs have benefited from the strong residential market — at least those with ties to residential agents. “We readily share leads and referrals back and forth,” Wimberly says of the arrangement between KW Commercial and Keller Williams. “Just this year I have received over 20 referrals from our residential division.”

The commercial deals resulting from residential leads run the gamut for Wimberly’s company, including industrial and restaurant tenant rep assignments, a medical office purchase, two multifamily listings, and four other buyer rep assignments.

Of course Wimberly has the good fortune to be located in the Dallas/Fort Worth market, where the strong local economy is turning out jobs and attracting transplants.

But the uptick in residential came over the summer, he says. “The past three months have quickly transitioned from a buyer’s market to a seller’s market,” he says. “My land developer clients are getting back in the market and searching for 20- to 50-acre tracts to start the process of putting lots on the ground again.”

Jones Walker in Las Vegas is also benefiting from residential referrals. “We have completed over 16 transactions in the past 12 months with referring agents,” she says. “They were all residential agents who were selling homes to clients moving to the area to open their businesses or, in the case of three referrals, local residents wanting to purchase buildings knowing that prices had declined from 40 percent to 60 percent from the top of the market.” 

Two of the strongest housing markets are Florida and the West Coast, where shortages are actually occurring. “Sales have picked up dramatically to the point that there is two to four months’ inventory,” says Janet K. Robinson, CCIM, with Coldwell Banker Commercial NRT in Sarasota, Fla., who has been getting two to four referrals a week from residential agents. “Rental property is also seeing strong activity including limited inventory. New home development is picking up, but is still limited primarily to the under $200,000 market.”

On the West Coast, Juan Huizar, CCIM, a broker with Accrued Financial Services in Signal Hill, Calif., who does both residential and commercial, says the Long Beach, Calif., residential market “is hot, bottom line. Inventory is down by over 40 percent YOY. There are fewer foreclosed homes on the market and currently more buyers than sellers. People are having to overbid in order to win the deal.”

Huizar is also seeing cash investors gravitate to residential, picking up bank-owned houses and condos. “A condo under $150,000 provides owners a great cash-on-cash yield, with minimal risk,” he says. “Vacancy is extremely low and rents are forecasted to increase, so these condos rent fast. From a broker’s standpoint, if you don’t have a cash buyer for these condos, you simply don’t stand a chance.”

Huizar says the residential uptick has not translated into commercial activity in his market, and many CCIMs report a similar situation. But, says NAR economist Ratiu, residential’s return is still a good sign for the commercial market: “With rising sales, property values also tend to increase, … appreciating values should lift consumer confidence and, over time, consumer spending.”

In addition, the residential market provides an indication of where consumers are going, he says: “Demand for housing relates to consumers’ appetite for spending and their medium- to long-term outlook. Upward trends in both would indicate a strong economy.”

And, when people buy houses, they buy lots of other stuff to fill them such as furniture and appliances. Today’s home buyers have exceedingly low mortgage interest rates, which translates into more disposable income. “A lower cost of financing leaves more money for spending in retail stores, which drives demand for consumer goods, increases trade, and directly impacts demand for industrial space,” Ratiu adds.

The apartment market has also been influenced by the residential market, he says. “The level of inventory and supply of residential space are other important indicators, directly tied to the apartment market,” he says. “In an environment of high supply and high inventory of homes, along with low interest rates, such as the first half of the 2000s, demand for apartments may be low. On the other hand, in the post-2009 period, low levels of new construction, low supply and tight lending standards, in addition to the fallout from the foreclosure crisis, have elevated demand for apartments.”

But will the demand for single-family housing eat away at multifamily demand? Hardly a chance, says Cassidy Turley economist Thorpe. The pent-up demand for household formation stands at about 1.3 million units, enough for both multifamily and single-family residential to sustain healthy markets for several years.

In fact, NAR economist Yun predicts single-housing shortages — and price appreciation — in the near future, as supplies dwindle and homes sell more quickly. “Ironically, if housing construction doesn’t pick up to normal levels within two years, supply shortages could be sustained for an extended period and lead to above-average appreciation,” he says.

No one sees a return to the wildly inflated home prices of the housing bubble, but a little appreciation would go a long way toward increasing consumer confidence, which, in a low interest rate environment, would lead to more demand, more sales, more new construction, and more jobs, setting in motion the wheels of a true recovery.

Sara Drummond is executive editor of Commercial Investment Real Estate.

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