Forecasting loan losses at banks is an inexact science. In fact, it’s not a science at all. It’s more like a game of chance, like craps or roulette. Even if you know the odds, you still have no idea about the outcome. Forecasting future cash flow from existing loans is also a game of chance. Both of these unknowable forecasts lie at the core of last week’s stress test.

The market’s reaction to the stress test — in the form of soaring bank stocks — tells me that the consensus is treating this stress test as if it has the ability to magically predict yearend 2010 capital levels with pinpoint accuracy.

Most of us do not have magic predictive powers — only the ability to make judgments based on knowledge and experience. In my judgment, the stress test was not stressful enough. For instance, it is not really accounting for borrower behavior in a scenario where they are underwater on their mortgage and under- or unemployed.

For example, the stress test’s estimated losses on second-lien mortgages in particular seem very low. In foreclosure, these are often total losses. With another big wave of Alt-A resets and foreclosures in the pipeline, the performance data on second lien mortgages should worsen. Several state-imposed and bank-imposed foreclosure moratoriums are ending.

The bulk of housing activity right now consists in foreclosure auctions and short sales. How much are second mortgage liens worth under this scenario? Not much.

Most big banks already have low levels of tangible capital relative to towering trillions in risky assets. The cash flow from their existing and new loans must exceed their loan losses in order to simply maintain existing capital levels (let alone increase capital).

Think of this situation as a bathtub. Bank capital is the amount of water in the bathtub, and the faucet pours new water into it (that’s cash flow from existing, paying loans and securities, plus new capital infusions) and the drain sucks it out (these are the loan losses). Pessimists claim that the drain of losses is sucking water out so fast that it will empty the bathtub within a year or two, depending on the bank. They tend to ignore or downplay the new water coming in. Optimists claim that if regulators prevent the water from falling to a very low level during this crisis (regulatory forbearance), in time, the water level will eventually rise back to normal levels. There’s a risk that if the optimists are wrong about the amount of new water coming in, we’ll be stuck with a Japanese-style “zombie bank” situation.

After last week, I think the risk of the zombie bank scenario is much higher. We’ll probably see this manifested in continued tight credit conditions. The banks under the most intense scrutiny will tend to reinvest cash flows into less risky assets like Treasuries and agency mortgage-back securities (another form of government guaranteed debt) — rather than write new commercial or consumer loans.

The big banks certainly will not be underwriting many commercial real estate loans (this is central to my thesis on buying the UltraShort Real Estate ETF (NYSE: SRS). Any commercial real estate lending that’s done will incorporate much lower loan-to-value ratios and higher interest rates. With property prices down 50%, the equity in levered deals done at the peak of the bubble has mostly vanished. REITs are a form of equity in leveraged commercial properties.

As you can see in the term sheet of the latest iteration of TALF lending for CMBS, the Fed is in no position to lower its lending standards (see link here). It is not willing to lend against commercial mortgage collateral that’s below investment grade or was created before July 2008 (“All mortgage loans must have been originated on or after July 1, 2008.”). These terms exclude virtually the entire pool of distressed commercial real estate assets. So even if the Fed lowers its collateral standards further, REIT equity will still not avoid massive dilution or elimination. Underwater commercial property owners (including REITs) are finding it nearly impossible to refinance maturing loans.

Certainly, the Federal Reserve will continue trying to cushion the deleveraging process underway in commercial real estate. The market’s expectation of Fed intervention in this sector has fueled much of the recent rally in REITs. But I think the market has it wrong here. The Fed may be able to slow the destruction of wealth in this sector, but it cannot preserve the equity value of overleveraged REITs, any more than the Fed’s 2007 lending programs could preserve equity value for Citigroup (NYSE:C) shareholders.

Source: Commercial Real Estate…The Crisis Begins

This from Investor’s Daily Edge:

A little over a week ago, in my Monday column, I correctly predicted that the December Housing Starts and Building Permits reports would miss the mark by a wide margin. I even correctly picked the actual number. This past Monday, my prediction was that the December Existing Home Sales report would also likely disappoint. I wasn’t such a good fortune teller the second time around.

The December Existing Home Sales report actually surprised to the upside, posting a gain of 6.5 percent versus November. This equates to roughly 290,000 units.

It turns out that I just underestimated how bad the housing market is. These sales aren’t from eager buyers who got priced out of the market during the run up over the last few years. The buyers are vultures, swooping in and cleaning the carcass. Over 45 percent of the sales were “distressed” according to the report.

That is bad news for the market. It is just the beginning of a viscous cycle.

Foreclosures continue to drive down prices in all markets. As a result, more and more homeowners see their equity vanishing. Many more find themselves underwater. This leads many to simply throw in the towel and let their own home go into foreclosure, feeding the cycle.

Another item to consider is whether or not all the bank-owned foreclosures are even back on the market yet. There is growing evidence that banks are holding back properties from being re-listed to avoid flooding the market, which would result in prices being driven down below what they hope to get for the repossessed homes. This means there could be an additional backlog of properties that we aren’t even aware of yet. This will delay any recovery.

Finally, a major question that needs to be answered is how many people actually qualify to buy a home? Fannie and Freddie are said to be toughening up on standards, and banks are just flat out not lending. That means short of a huge down payment or an all-cash purchase, buying any home, foreclosure or not is going to be difficult. And the housing market needs buyers to move the inventory.

With all this gloom in the market, it is going to take quite some time for a recovery. That leaves you plenty of time to profit from the slide in the housing market. One way is shorting the iShares Real Estate Index (NYSE:IYR), another is shorting the Vanguard REIT ETF (NYSE:VNQ). Both have already seen a significant down leg, but with the housing market the way it is, there is still plenty of room to the down side.

A more speculative play could be the UltraShort Real Estate ProShares (NYSE:SRS). This ETF moves inverse to real estate, so it goes up as the market goes down. A quick look at the chart shows a huge spike in November and a drop since then. It is now trading at two-year lows, so you could view it as a more speculative play on the continuing decline of the housing market.

Source: There Is Still Money To Be Made In The Housing Market

This from Sovereign Society:

In a previous A-Letter, we talked about the three attributes necessary to make a portfolio successful in this kind of market. One of those attributes was yield…something that’s become easier to find as equity markets take more and more of a beating. But you have to be careful, because yield isn’t always the mark of a high-value investment. Sometimes it can be the siren’s song that lures you – and your portfolio – onto the rocks.

Doubting Those 16% Yields

On October 7th, Investment Director Eric Roseman wrote to you about Real Estate Investment Trusts (REITs), one of investors’ favorite asset classes, “One of the biggest casualties of the global financial crisis is the big bust now underway in REITs, or real estate investment trusts. Until mid-2007, U.S. REITs dominated global investment performance in the post-2000 tech stock “bubble” era with eye-popping 25% annualized returns.”

If they’re new to you, then think of a REIT as an index fund for real estate. Instead of holding a bucket of commodities or currencies, REITs – as their name implies – hold a variety of real estate titles and allow shareholders to profit from the appreciation of said real estate. And since 2008 was a bad year for real estate, you can imagine how these trusts are faring today.

Since peaking in 2008, Real Estate Investment Trusts have fallen in value by as much as 70%, and many investors are wondering whether it’s time to start picking up the pieces. And with distributions as high as 16% or more on some commercial-property-based REITs, it can be a pretty tempting proposition.

Having already declined 70%, wouldn’t you expect that a rebound might be in the works? Not necessarily…

Commercial Real Estate goes “Subprime”

Most Commercial Real Estate (CRE) in the U.S. is financed and developed by large REITs. And conversely, many REITs are dominated by CRE holdings, so one could say their fates were relatively intertwined. So what’s in store for CRE?

Close watchers of the mortgage market and insider experts have been warning about problems in CRE since before the subprime bubble gained critical mass. And as the subprime mess started to unfold, they continued to warn of the hazards in CRE loans.

To be sure, the underwriting standards weren’t as lax as they were for subprime paper, but there are different psychological factors at play here too. While a homeowner is likely to fight tooth and nail to keep a roof over their heads, small business owners are more likely to throw in the towel when they know they’re faced with a losing proposition. Some can set up shop at home, consolidate their operations, or even just sell off for fear of losing even more – like their house – in such a terrible marketplace.

That we’re already seeing a “terrible marketplace,” is painfully clear. In the words of one anonymous web-poster, Q4’s retail sales “jumped off a cliff, hit the ground and started digging.” The Baltic Dry-Shipping Index – an esoteric indicator of the levels of total demand, measuring the total number of containers shipped overseas – sustained a horrifying and unprecedented 93% drop this past autumn.

Businesses & consumers are already starting to gear up for the worst. Granted, you might not be able to call it “Depression Mentality” just yet, but “Bubble-based Optimism” is wearing off quickly. As a result, the CRE sector is rapidly deteriorating.

CoStar – one of the best sources for information on CRE – is reporting an alarming rise in the number of CRE loans being moved into “special servicing.” According to CoStar, this is “generally an indication of a delinquency or failure to pay off a mature loan.”

Looking at data like this, you can’t help but think CRE – and in turn, the REITs holding Commercial Real Estate – have still got a ways to go before putting in a bottom. Despite the fact that they’ve already taken a serious blow in the last year and some of the trusts are yielding double-digit dividends, it’s likely still too dangerous to go bottom-fishing.

But Eric believes there might be some handsome deals for individual investors on the way there, “The United States can expect more government auctioned foreclosures in 2009, and that means big bargains for speculators and investors alike. Banks are desperate to remove non-performing loans from their clogged portfolio of real estate deals.”

We’ll give all this a few months to unwind and then re-visit it mid-year. Eric believes that the U.S. REIT sector could lead the rest to recovery. It’s also possible that real estate could lead market recovery in general. If that’s the case, then REITs could offer a windfall opportunity to cash in on a recovery, or even just a short-term bounce. Just not yet.

Source: WARNING: The 16%-yielding Asset that You Should NOT Invest In

This from Investment U:

The U.S. housing market is walking the plank. Easy credit helped usher in an unprecedented period of rising home prices. But now those same lax credit standards have us caught in one of the worst slumps in recent memory.

According to the latest data, the inventory of unsold homes sits at 4.23 million, representing a 10.2-month supply at the current sales pace. For comparison’s sake, that’s as many homes as Delaware, North Dakota, South Dakota, Alaska, Vermont and Wyoming have people.

In other words, an eager buyer these days is about as hard to find as a living dinosaur.

But before you abandon the beleaguered real estate sector altogether, you should know that opportunities for safe and steady profits do exist.

In fact, I’ve found a handful that may well be the most attractive investments – given the abysmal state of the markets right now – this side of the credit crunch…

Investments That Pay Stock Dividends Like Clockwork

These investments all pay handsome stock dividends like clockwork. And they avoid the volatility swings that now define the stock market, too. What an enviable tandem to have in your portfolio as we embark on what could be another tumultuous year for stocks.

Even better, when the market rights itself – and the inevitable real estate recovery occurs – you’ll be perfectly positioned for a nice pop in the stock price, as well. (That’s right: You’ll own shares that trade on major stock exchanges, not the properties themselves.)

So as the credit crunch bites off more market capitalization nearly every day (we’ve already witnessed $28 trillion in wealth disintegrate before our eyes), the following REIT (real estate investment trusts) has enjoyed a bulletproof status of sorts.

One REIT That Works In the Face of the Credit Crisis

Let’s take a look and examine exactly why this REIT is working in the face of the credit crisis.

First Trust/FIDAC Mortgage Income Fund (NYSE:FMY) invests exclusively in mortgages. The fund holds $100 million in mortgage-backed securities, the income from which allows it to pay a handsome 8% dividend yield.

Now I realize that your instincts may be to skip to the next article after reading “mortgage-backed securities,” but before you do, understand that the fund didn’t lose a penny in 2008 and raised its dividend three times.

To understand how it pulled off this feat, you first have to know a little bit about the market for the securities the fund owns.

You see, the problem with mortgage-backed securities is that once it was discovered that many were backed by bad subprime mortgages, the market for trading them froze up. Thus, trading for the worst securities went “no bid,” which means there were no offers to buy. Using mark-to-market accounting methods, holders were forced to write down values to zero.

But First Trust’s net asset value declined only about 15% over the course of the year, which means the mortgage bonds it holds are the few still being actively traded through this credit crisis.

Dividend aside, there’s a capital appreciation component here, too.

When the day comes where mortgage-backed securities are in favor again (and it will happen), this fund’s share price will surge. So look past the bad apples and focus on the bulletproof.

Source: Bulletproof REIT Bargains: How to Profit From the Inevitable Real Estate Recovery

This is cause for celebration. But poking under rocks to find the losers is interesting. Every industrial group and sector has a smattering of stragglers. And one industry is doing much worse than any other. If you are feeling contrarian, this is where to look for bargains among the unloved–in real estate investment trusts.

Known as REITs, pronounced “reets,” these trusts pass most of their profits through to investors as generous dividends. Among the REIT losers so far this year, the current yields range from 4% to 22%.

The problem with REITs is that to pay out a portion of profits, the company has to make a profit in the first place. So this is not an automatic gimme. But it is an exceptional place to look for companies that are undervalued. The stronger companies in this group will come out of the recession and reward investors well for getting in early while the shares are cheap. My estimate at this point is that this group of stocks will look very smart about 18-months from now. But the best gains will go to investors who get in within the next six months.

Just a hint to those who know what to do next.

Source: January Blues for Some – Opportunity for Others

This from Money Morning:

The U.S. housing market is already being pounded by the “perfect storm.” And the outlook for the New Year is for the stormy weather to continue – and probably to get worse.

As if a locked-up credit market and tidal waves of foreclosures weren’t already enough, we’re now watching unemployment climb and consumer confidence plunge.

But even when the housing market is taking on water, there are ways to stay afloat. Indeed, investors nimble enough to maneuver can even make money.

The watchword on this market, though, is caution.  If an investor decides to test the waters, beware of the extraordinary financial undertow.

Here’s a look at what’s happening now, and what the implications there are for investors in the New Year.

Rising Unemployment Feeds into Sinking Demand

The grim reality is that skyrocketing unemployment is a major threat to the recovery of the U.S. housing market.  And consumers shackled with record levels of debt are unlikely to ride to the rescue this time.

Since this recession is expected to be long and deep, economists are projecting high rates of unemployment. And the latest statistics released by the U.S. Labor Department show the crucial jobs market deteriorating at an alarmingly rapid pace.

The U.S. unemployment rate jumped to a 14-year high of 6.5% in October as another 240,000 jobs were cut – an uptick from 6.1% in September and the 10th month in a row the jobless rate has risen. Most forecasts are calling for unemployment to spike as high as 8.5%, which would be the worst showing since 1980.

So far this year, a staggering 1.2 million jobs have disappeared. More than half the decrease occurred in the past three months alone, Money Morning reported in its “Outlook 2009” series economic forecast story. Even worse: A year ago, job cuts were concentrated in the financial-services and homebuilding sectors. Now they’re rising across the board; virtually every part of the economy is feeling the squeeze.

For instance:

• U.S. automaker Chrysler Corp., one of Detroit’s wheezing “Big Three,” is laying off 25% of its white-collar work force of 18,500.
• Appliance maker Whirlpool Corp. (WHR) recently announced it would cut 5,000 jobs to cope with declining sales.
• Worldwide shipping giant DHL, a subsidiary of Deutsche Post AG, is laying off 9,500 people, and threatening to close its U.S. distribution center.
• Onetime Internet search giant Yahoo! Inc. (YHOO) plans to let 1,100 workers go – on top of the 1,000 already jettisoned in January – the result of several botched merger attempts.
• Ailing banking giant Citigroup Inc. (C) heaped more bad news on the financial sector, announcing whopping 50,000 layoffs in the next 12 months.

Layoffs of this magnitude are more than a mere shot across the bow of the housing market – they’re actually a direct hit amid ship. People who are unemployed cannot buy homes. Period. But even consumers who are afraid that they might be joining the jobless ranks are loath to take on the added risk – making them unlikely candidates to buy a new home.

Foreclosures Still Rising

As unemployment climbs, foreclosures will continue to multiply. That only exacerbates an already unappealing combination – more houses being dumped onto the market even as the pool of potential buyers grows increasingly smaller.

RealtyTrac Inc. reported that more than 81,000 homes were foreclosed on in September – 71% increase from the same period just a year ago. For 2008, foreclosures rose to a record 765,558.

“I wouldn’t be surprised to see foreclosures increase as the economy slows down,” said Rick Sharga, RealtyTrac’s vice president of marketing. “The people living paycheck to paycheck are at risk if they lose their jobs. It will cause more people to lose their homes.”

And while foreclosure volumes are outpacing projections, the cumulative losses by banks on bad mortgages may have yet to hit their books.  Since loan losses don’t get recorded until the property is sold, it’s likely there’s a lot of bank-owned inventory that hasn’t been unloaded – meaning there may be more foreclosures out there investors don’t yet know about.

“We are in uncharted waters,” said Brian Bethune, an economist at research firm Global Insight (IHS).

Making the waters even rougher was the decision by Standard & Poor’s Inc. (MHP) to cut the ratings on $34.1 billion of “Alt-A” residential loan packages that had been issued in 2006 and 2007.  Alt-A mortgages are those written with little or no documentation, i.e., without proof of income or assets. Even worse, S&P put an additional $351.7 billion of Alt-A securities up for possible review reflecting the rating company’s “belief that further declines in home sales will depress prices further and push loss severities higher than we had previously assumed.”

On top of all that, record numbers of borrowers are already “underwater,” or “upside down” on their mortgages, making it more attractive for them to default by simply walking away, than to hang around and drown.

About 18% of homes nationwide are now “upside down,” according to a report from First American CoreLogic.  Almost two-thirds of those homes are in just seven states: Arizona, California, Florida, Georgia, Michigan, Nevada and Ohio. In Mountain House, Calif., an unincorporated planned housing community located in the foothills of the Diablo mountain range, the housing crisis right now has nearly 90% of the homeowners owing more on their houses than they are worth – the highest percentage in the country, The New York Times reported on Nov. 10. The average homeowner is underwater by $122,000, the newspaper said.

Other areas are suffering almost as much: In Nevada, alone, borrowers owed a whopping 89% of the value of their homes.

Despite such dramatic anecdotes, this housing slump is nationwide in nature. It’s more severe than any other such downturn since World War II, mostly because of the risky lending practices that inflated the real-estate bubble in the first place.

The Downdraft in Housing Prices

Meanwhile, while unemployment rises, the downward spiral in housing prices is gaining momentum.

“The No.1 thing that drives housing values is incomes,” said Todd Sinai, an associate professor of real estate at the Wharton School at the University of Pennsylvania. “When incomes fall, demand for housing falls.”

The S&P/Case-Shiller Index of home prices plunged 16.6% in August from the year before, following a 16.3% drop in July. The index has fallen every month since January 2007 (See accompanying chart, “Plummeting Prices.”).

Prices were lower in all 20 of the major cities the index covers, with Phoenix and Las Vegas down nearly 31% from last year.

Nationwide home prices have fallen 20.3% since peaking in June 2006.

And the skid isn’t over.

According to Fitch Ratings Inc., U.S. home prices will fall another 8% to 10% before they show signs of stabilizing.  According to a Fitch forecast, the peak-to-trough price decline will be 30%.
And still one other reliable indicator of housing prices seems to confirm that, in many cities, home prices still have further to fall.

According to analysis by Moody’s Investors Service (MCO), Miami houses are right now priced at about 22 times annual rental income – versus an average of just 15 over the past two decades. This suggests that a home currently priced at $350,000 is actually worth only $238,600 – meaning the price would have to drop 32% to reach the fair-value point.

Congressional Missteps

In an effort to help more than 400,000 homeowners avoid foreclosure, Congress came up with the “Hope for Homeowners” program.  Unfortunately, in their infinite wisdom, federal lawmakers designed a program that is almost certain to fail.

The program supposedly makes as much as $300 billion available to at-risk borrowers, enabling them to refinance into a 30-year, fixed-rate loan insured by the Federal Housing Administration (FHA).

The biggest mistake Congress made was to make this program strictly voluntary for participating banks, experts say.

Just as bad: In an effort to make the program more affordable for beleaguered homeowners, it also requires the lenders to write the value of the home down to 90% of its current market value. So in a downtrodden market like Phoenix, if a lender holds a $400,000 mortgage on a home currently appraised at $300,000, the bank would have to settle for a new mortgage worth only $270,000.

Needless to say, the response has been underwhelming.  After four weeks, a whopping 79 people had applied for the program.

Not to be deterred, the Federal Deposit Insurance Corp. (FDIC) is proposing another package, which would extend the terms of at-risk loans from 30 years to 40 years, with interest rates as low as 3.0%.  Housing payments for delinquent borrowers could not exceed 38% of gross monthly income.

In order to sweeten the pot for lenders, the government would share as much as 50% of the losses if a borrower ended up in default anyway.  In addition, the FDIC would pay servicers who process these new mortgages a fee of $1,000 for each re-worked loan.

FDIC officials estimate that this anti-foreclosure program would cost $24.4 billion, and would prevent 1.5 million of the 2.2 million at-risk homes from falling into foreclosure.

But that also means the taxpayer will be on the hook for half the value of 700,000 mortgages that do fail.

Can you say “fuzzy math?”

Homebuilders on the Ropes

You can probably guess where this leaves the nation’s homebuilders – gasping for air.

D.R. Horton Inc. (DHI), one of the nation’s biggest homebuilders, just wrote down $1.1 billion in land, deposits and inventory in the third quarter, as sales fell by half. The Ft. Worth, Tex.-based company expects to post a fourth-quarter net loss of between $800 million and $900 million, 18 times more than it lost in the fourth quarter a year ago.

Other builders are in similar shape. Pulte Homes Inc. (PHM) and The Ryland Group Inc. (RYL) just reported quarterly losses of $280.4 million and $65.7 million, respectively.

Even Toll Bros. Inc. (TOL), which caters to the high-end buyer, said fourth-quarter revenue fell 41% from the same period last year.

The Forecast for 2009: More Pain Before Any Gain

No matter what happens in the U.S. housing market, until a large inventory reduction takes place, housing prices will not stabilize.

In a recent Forbes magazine column, A. Gary Shilling, president of an economic consulting firm of the same name, said the worst is yet to come. Says Schilling: “Excess inventory, the mortal enemy of prices, now amounts to 1.8 million homes, which is a huge number relative to the net demand (new families minus departures due to deaths and moves to nursing homes) which is only 1.5 million a year.”

And one of the architects of the U.S. housing debacle – former U.S. Federal Reserve Chairman Alan Greenspan – is also downbeat: “At a minimum, stabilization of home prices is still many months in the future,” Greenspan said in an October speech.

The question that needs to be answered, then, is this: In the current atmosphere, does anyone believe we actually need homebuilders to add even one new home to the market?

Some pundits claim this may be a golden opportunity to short U.S. homebuilders. Even though they’re already down 80% from their highs, the deadly combination of skyrocketing unemployment, deflating prices and tight credit continue to spell further pain for the industry.

Short sellers would obviously look at any of the companies mentioned above. They might also consider iShares US Home Construction (ITB), the prominent exchange traded fund (ETF) for the group. However, any such move would have to be made with extreme caution.

The reason: All bets are off if the new Barack Obama Administration implements a moratorium on mortgage foreclosures. There’s also the possibility that Obama will be able to shepherd through any one or more of the proposed mortgage guarantee programs now on the table.

Those kinds of moves could provide a boost to homebuilders and leave short sellers in the grips of an uncomfortable squeeze – just like the millions of homeowners saddled with mortgages they can no longer pay.

Source: New Year U.S. Housing Market Forecast: No Gain, More Pain

This from Today’s Financial News:

It is a great time to be buying a house, but an absolutely horrible time to be selling one. Potential buyers are scared off by the financial crisis. Mortgages are tough to come by. And buyers that do get qualified for a loan cannot sign a contract because they have no buyer for their own house.

That is why smart homeowners are not selling, they are renting. Instead of selling their houses today, when they are worth a pittance of what they were just a year ago or a fraction of what they will be in a year or two, savvy would-be sellers are renting.

By renting a house, homeowners with no mortgages receive enough cash flow to keep them afloat until the market rebounds. They can take advantage of a once-in-a-generation buyer’s market, purchase a home at a fantastic price and collect enough income from rent to help them get by until the crisis weakens.

Money may be tight over the next few years for these folks, but pulling a few extra hundred dollars out of a monthly budget to meet mortgage costs for a year or two is certainly better than locking in a huge loss by selling your home at today’s prices.

****** Oil at $70 a Barrel — Gold at $500 by Christmas? ******

With stocks as volatile as nitroglycerin, gold should be trading above $2,000 an ounce! But the dollar insurrection has shaken up the commodities markets. Some experts now put gold’s downside at $500… even $400.

What if they’re right?

TFN’s options strategist Andrew Snyder has developed a gold hedge strategy that could make you money on your gold position either way. Find his Special Report on the Members Only Reports section of HotStockConfidential.com. To become an instant member, click here…

———–

When the market rebounds in a few years, renters can once again put their homes on the market, hopefully selling them for $30,000, $50,000 or even $100,000 more than they could have today. Pinching pennies for a couple of years does not seem all that bad when those kinds of profits are available.

Forget the open house

There is a house just down the road from mine that is a perfect example of how profitable this strategy could be. Earlier this fall, the quaint rancher was listed for $209,000. In a normal market, the house is worth every penny of that price. At the peak of the market, it was likely worth closer to $275,000.

I talked with a realtor friend and she said, right now, the owner would be lucky to get $175,000 for it. So it was no surprise when she said the house was taken off the market. Instead, the owner rented it for $1,100 a month.

Now, I have no idea what the owner originally paid for the house, but I do know in just a few years it will be worth significantly more than what he could get today. If he gets his original $209,000 for it, he will receive $34,000 more than what he could get today, plus he would have received $1,100 in cash every month in between.

Obviously, this situation does not work for everybody and renting comes with its own set of hassles, but for a lot of folks forced to move during this crisis, or for those that simply want to take advantage of a fantastic buyers market, this is a money-making strategy.

The economy may have handed us a bushel full of lemons, but there is always an opportunity to make some great-tasting lemonade. Instead of putting up a “for sale” sign, look for a good set of renters. In an economy like this, there are plenty to choose from.

Source: Moneymaking Strategy: Don’t Sell, Rent

This from Today’s Financial News:

Should a retail chain be severely and directly impacted by the fall of the nation’s real estate market? Should retailers divert from their core strategic mission and invest directly in the nation’s real estate market? Those are the questions Target Corp. (NYSE:TGT) investors are asking the company today.

According to William Ackman, the boss at Pershing Square Capital Management, the answer in Target’s case is no. He is pushing the company’s management to spin off its nearly $20 billion in real estate holdings into an independent real-estate investment trust (REIT).

Sure, almost every retailer’s revenues will be negatively impacted by an economy that is slowing because homeowners can no longer use their houses as built-in ATM machines. But that is something retail investors must expect. What they may not expect is the value of their positions to drop because of fluctuations in the value of the land their stores are sitting on.

By unloading its land investments, Target is free to focus solely on its retail mission without the threat of fluctuations in the real estate market dramatically altering its earnings potential.

For example, shares of Target have dropped by nearly 50% in the last year. While it is impossible to accurately determine how much of that drop can be attributed to lower retail sales growth and how much can be blamed on the decline in its real estate holdings, we can be certain that the fall would be dramatically smaller without the burden of real estate losses.

But we must remember the real estate pendulum swings both ways. Right now, real estate prices are depressed and share price is down. When the momentum swings the other direction, Target shareholders would see their holdings appreciate at a higher rate thanks to real estate gains.

Even with this risk, Ackman is right. It is not Target’s responsibility to hedge against real estate fluctuations. All it does is distract the firm from its core goals. By selling off its holdings and leasing its properties, investors are given a much more pure revenue stream to analyze and predict.

After the spinoff, if investors want to remain invested in the land holdings, they can use their proceeds of the sale to invest directly in the newly created REIT.

When investing, it is extremely important to compare apples to apples and oranges to oranges. When a company’s balance sheet is compromised by non-strategic irregularities, it makes forecasting difficult and smart investing nearly impossible. It is impossible to tell what is an apple and what is an orange.

Keep a close eye on Target over the next few months. Share price jumped on the notion this morning and has since leveled off. If Ackman’s demands find momentum, share price will continue to climb.

Source:Target (TGT) investors call for real estate sale

This from Today’s Financial News:

It is a fact that the real estate industry has historically been a leading indicator of the American economy. When it falls, Wall Street falls. When home prices rise, so does the Street. If that continues to be the case, the American economy is on the rebound.

For proof, look at today’s new-home sales figures released by the Commerce Department. Compared to sales in August, the amount of new homes that sold in September rose by an unexpectedly high figure of 2.7%.

Over 464,000 freshly built houses traded hands across the country. Three years ago, that number was nearly three times higher. But that is all in the past. What matters is that this month’s figure marked an end to the real-estate landslide.

So what has caused buyers to return to the markets? Two things, falling prices and fear of the stock market.

As for falling prices, take a look at these figures. One year ago, the average new home sold for $240,300.  Right now, that figure is just $218,400.  Buyers smart enough to realize home prices are not going to drop any further are getting an instant 10% discount on their homes.

Next, there are plenty of folks unwilling to take a leap into the stock market right now. With the nation facing a deep recession, the equities market is a scary beast for the uninitiated. They figure if they invest in real estate, their investment will always hold at least some value. After all, a piece of land cannot go bankrupt and disappear overnight. Smart idea. Instead of burying their money in their backyard, they are making it work for them.

News you can use

Even with the strong selling last month, inventory levels are still near record-high territory. Over 390,000 new homes remain unsold across the country. According to the experts that calculate such things, that is a 10.4-month supply. Inventories dropped by over 7%.

With prices falling and such a high inventory of homes still on the market, few builders are willing to raise a new house unless it is already sold. That simply means the market is correcting itself and the free economy is working.

As long as the government stays out of the industry, it should recover in short order.

So where is the investment potential? It depends on how much you have to invest.

If you have plenty of cash and have access to the markets along the western coast, buy all the deeply discounted properties you can afford. Rent them now and sell them in a few years. Your investment will pay off handsomely.

If you don’t have a few hundred thousand dollars lying around, you can reap equally large gains by investing in a few choice real estate investment trusts (REITs). Trusts like Post Properties (NYSE:PPS), which is involved in apartment rentals and condo sales, and American Campus Associates (NYSE:ACC), which is taking advantage of the shortage in student housing and a real-estate industry bottom, will do well. And just as almost all REITs do, they both pay nice dividends of 9.7% and 5.5%, respectively.

The facts are obvious. The real estate market is turning around, proving the American economy will be on the rebound fairly soon. We have seen the worst of this crisis.

Now is the time to re-allocate your portfolio and ensure you are properly positioned to take advantage of the bull that lies just over the horizon.

Source: Last Chance for Deep Discounts In Post Properties (PPS) and American Campus (ACC)

This from Today’s Financial News:

Just a few days ago, I wrote about how the housing slowdown has reached its lowest point. I told readers that some real-estate investment trusts (REITs) look downright promising. I also warned that others were in extremely dangerous territories.

Yesterday’s consumer spending figures proved my theory was right on track. The report showed that while consumer spending dropped 1.2%, healthcare spending was up by a similar amount.

In other words, REITs that specialize in healthcare properties, like National Health Investors (NYSE:NHI), will beat the markets. And their counterparts that focus on retail-related properties, like Simon Property Group (NYSE:SPG), are going to under-perform.

Going out of business sale

Mall owners saw their share prices get slashed yesterday. As a whole, retail-based REITs dropped over 14%, while the rest of the markets dropped by just 8%. Stocks with those kinds correlations to consumer spending are not the kind of stocks you want to be investing in during a recession.

The pain is only going to get worse for REITs like Simon Property. Right now, out of the more than 380 malls the company owns, 91.8% of them are occupied. This time last year, that figure was only slightly higher, reading at 92% occupancy. Only a few less stores are rented now than last year.

Those two figures should scream to potential investors that the worse is yet to come. Because store closures significantly lag behind dwindling retail stores, we are going to see occupancy rates drop for several more quarters, if not years, to come.

Going belly-up

Companies like Circuit City (NYSE:CC) and Linens ‘n’ Things are in serious trouble. The electronics retailer is within grasp of bankruptcy. And the home furnishings chain is closing its door for good, with some stores shutting down as soon as tomorrow.

It is the same picture all over the industry. Mall occupancy rates will soon start to plummet.

Needless to say, the retail REIT sector is in serious trouble. As a value investor, it may be tempting to grab these stocks at current prices (they have fallen more than 40%) thinking they have reached their bottom. Do not do it. It is a trap.

The retail industry’s woes have just begun. The problems will get much worse before they even think of getting better.

If you are looking to play the real estate industry and take advantage of its sizeable dividends, look at the healthcare industry and its lucrative REITs. There are only two sectors of consumer spending that are actually expanding. Take advantage of them.

Source: Retail figures slump: Simon Property Group (SPG) feels the pain