Fear the taper: What's really behind the REIT decline

Tough slog for REITs, and other interest rate flapdoodle. Photo: Wikimedia.

WASHINGTON, May 5, 2013 – We knew that sooner or later, the fun we have been having with mortgage REITs would eventually come to an end. Since buying them at their last market bottom in December 2012, we’ve enjoyed repeated capital gains each time we traded them while reveling in the huge yields—often as high as 18 percent—we’ve been getting from some of them.

But on Wall Street, like everywhere else, if something looks to good to be true, it probably is. In the case of our favorite REITs, the problem wasn’t in the REITs themselves. Most mortgage REITs’ balance sheets seem solid even if they’re highly leveraged. The problem instead has existed in the underlying dynamic of what’s been going on in the housing market for roughly the past three years.

After the real estate crash and subsequent foreclosure crisis, whose peaks occurred between late 2007 and the beginning months of 2010, small and medium-sized investors who held a lot of cash began to buy foreclosures as fast as they could get Stone Age bank REOs (Real Estate Owned) properties through the system and to a lawyer’s desk for closing.

But, more importantly, given the Fed’s increasingly easy money policies, the big fish in the pond—holding companies, megabanks, private capital, and some REITs—came up with an even better idea. They decided to use their still substantial leverage to buy up city blocks of the more attractive REOs and rent them out for an almost guaranteed profit, given low foreclosure purchase prices. Eventually, the idea went, they’d do mega-flipping at a later point in time for substantial capital gains.

The beauty of this approach is that larger institutions could still qualify for leveraged loans while the average little guy in the market for a bargain house could not and still cannot. As cash buyers began to dry up, the rich guys who still had access to capital stepped up to the plate, big time.

The buying eventually became so fierce that institutions and existing REITs began to spin off other REITs solely devoted to this burgeoning market—one, effectively, that they had all to themselves. Unfortunately for everyone concerned, gravy trains as good as this one were bound to run into trouble, and now this one has.


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The fear of future consequences—especially the potential for rising interest rates should the Fed really start to “taper” its QE bond-buying program—has severely affected the performance of all REITs over the past few weeks. In short, as related in an article in today’s ZeroHedge, “the recent pounding all related housing REITs have experienced [is based] on nothing more than the mere concern that rates may, at some point rise.”

Zero’s basic argument is this: with cash real estate purchases drying up, with REIT and/or vulture capitalist purchases gobbling up remaining REO-type housing inventory, and with re-fi action rapidly disappearing—mainly due to the fact that many normally qualified property owners (like the Maven) with excellent credit ratings simply cannot get a re-fi even now—the current housing price recovery has a substantial element of phoniness buried within it. If interest rates begin to rise again, which they will when the “tapering” actually commences, we could be in for another real estate bubble collapse, this time engulfing mortgage REITs and buy-rent REITs. And you know how that game ends already.

ZeroHedge again: “After 5 years of interest rates being forced incrementally lower each year—and everybody that qualifies refinancing over and over again allowing the banks to originate and earn several points off of each gov’t loan churn— the jig is up for a while at least.  The mortgage market is now so efficient—and rates have been at historic lows for so long—there is simply nobody on the proverbial ‘fence.’” 

Noting increasing but largely underreported layoffs in re-fi employment levels, Zero further observes that the “’refi capital conveyor belt’ is a quiet, yet powerful economic driver. Not only do refi’s grease homeowners balance sheets and have been responsible for the lions’ share of mortgage-centric US banks’ earnings over the past few years but they are huge for the labor market. 


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“With respect to jobs, well over 100 individuals touch one refi from loan application printing/shipping, up-front processing (appraisal, credit, bank/job verifications, title, escrow etc.), to lender underwriting, document drawing, and funding, and through post-closing including securitization and trustee services. So when the refi door slams shut it’s a macro headwind for which few account. In fact, many model the exact opposite…that rising rates is great for banks and the economy.” 

So, with the refi conveyor belt drying up and with the newer REITs becoming fearful that the buy/rent scenario they’d anticipated could actually become an overleveraged disaster, “it is only a matter of time before we get yet another ‘capital reallocation’ catalyst event, which forces speculators out of stocks and right back into the ‘safety’ of bonds where they can hibernate until 2014, when the ‘Great Rotation’ charade that has repeated itself every year for the past four, can resume once more even as the even greater charade, Quantitative Easing, which is merely a wealth transfer mechanism from the middle to the upper class, is here to stay

(Bold, above, is ZeroHedge. Italics are the Maven’s.) 

Sobering thoughts, perhaps adding to the fear that Wall Street will soon go into full tilt boogie mode to the downside. 

Further, ZeroHedge, who seems a good bit farther to the left than the Maven ever could be, nonetheless sound the same alarm that the Maven has been trumpeting now for years: the middle class continues to be raped from above by the fat cats and from below by the Obama “taker” contingent. As the erosion of the markets and housing continues, largely hidden from sight, the whole idea of the middle class in America is becoming a thing of the past. South America is the model for what happens next. 

Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate.

Positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.

Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.

References to other reporters, analysts, pundits, or commentators are illustrative only and do not necessarily represent an endorsement of such individuals’ points of view. If specific investment vehicles are mentioned in any article under this column heading, the author will always fully disclose any active or contemplated investments in said vehicles.

Read more of Terry’s news and reviews at Curtain Up! in the Entertain Us neighborhood of the Washington Times Communities. For Terry’s investing and political insights, visit his Communities columns, The Prudent Man and Morning Market Maven, in Business.

Follow Terry on Twitter @terryp17

 


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Terry Ponick

Now writing on investing, politics, music, movies and theater for the Washington Times Communities, Terry was formerly the longtime music and culture critic for the Washington Times print edition (1994-2009) before moving online with Communities in 2010.  

 

 

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