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Five Things You Need to Know: Real Estate Woes Contained to Congress; But Congress Woes Spreading to All Areas of American Life; Why Investors Should Consider Real Estate; How to Invest in Real Estate; How Not to Invest in Real Estate


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Real Estate Woes Contained to Congress

According to an article on Bloomberg this morning, it appears the housing woes are going to be successfully contained to Congress... which will then ensure the woes are magnified and ultimately spread out evenly to infect all areas of our lives.

  • Although it has yet to get much play in the media for what it really means, an important housing-related article was on Bloomberg this morning.
  • U.S. lawmakers want to stem the rising number of mortgage delinquencies (good for votes) by targeting investors who finance mortgage lending through mortgage backed securities.
  • Bloomberg says the top Republican and Democrat (God help us when bipartisanship rears its ugly head) want to write new laws making investors who buy mortgage bonds liable for deceptive or bad loans.
  • That all sounds well and good on the surface; place the burden for bad loans on the investors who are responsible for facilitating the lending practices in the first place.
  • And check out this vote-winning sound bite:
    - "More money was being lent than should have been lent," said Committee Chairman Barney Frank (D- MA), who added that growth in the market for mortgage bonds "provided liquidity without responsibility."
  • Ho ho ho! "Liquidity without responsibility!"
  • That's a real kick in the crotch coming from a congressman of either party.

2. But Congress Woes Spreading to All Areas of American Life

So, while Congress is busy "containing housing woes," we'we'll tell you what this rush to legislate really means.

  • It means that ultimately Congress is going to "save" the current crop of "homeowners" from themselves by raising the cost of borrowing for everybody else.
  • Mortgages are going to be far more difficult to obtain for everyone.
  • And because the new laws are going to make it far more risky for investors to facilitate lenders through mortgage-backed securities, the existing pool of money available for mortgages will be reduced, which will also raise the costs to subsequent mortgage borrowers.
  • The irony is that in the long run the greatest beneficiary of these new laws won't be either homeowners or mortgage borrowers, but the government-sponsored enterprises, Fannie Mae and Freddie Mac.
  • See, by the time Congress realizes that the net result of the legislation is a full blown mortgage availability crisis it will be time for lawmakers to step back in and expand the role of the GSE's.
  • Honestly, you can't make this stuff up!

3. Why Investors Should Consider Real Estate

For an alternate take on real estate, take a look at this article in the Wall Street Journal this morning, "Why Investors Should Consider Real Estate."

  • While acknowledging that "residential real estate is struggling," the article notes that some sectors of the real estate market such as commercial real estate are still "relatively healthy."
  • But the underpinnings of the view that real estate is "OK" for investors still comes down to asset allocation and long-term performance, according to the article.
  • "From a financial-planning perspective, real estate is an asset that investors should have in their portfolios over the long term. That is because real estate serves as a counterweight to inflation, while REITs, according to data from research firm Ibbotson Associates, have a low to moderate correlation with stocks."
  • Investment pros routinely agree that a portfolio should have between 5% and 20% invested in real estate that is not a primary residence.
  • Since for the overwhelming majority of people in America their home makes up almost 65% of their total net worth, this is clearly problematic.
  • It implies that the average investing homeowner who follows this advice would end up with a real estate weighting of, what, 70-80%?

4. How to Invest in Real Estate

The WSJ article mentioned above helpfully notes that investing directly in real estate isn't always practical for the individual investor.

  • Why not Real Estate Investment Trusts? Or real estate mutual funds?
  • Two of the REITs mentioned in the article are Vornado Realty Trust (VNO), and Boston Properties (BXP).
  • Check out the charts below showing VNO (Blue) and BXP (Red) versus the S&P 500 (Green) between 1998 and 2002.
  • You don't have to back of the envelope the math to see that there's not a lot of correlation there.
  • Now, check out the chart showing the same three instruments since 2003.
  • You want to invest in real estate? Buy an S&P 500 index fund.

5. How Not to Invest in Real Estate

Meanwhile, for a quick lesson in how not to invest in real estate consider the case of the nation's largest homebuilder, D.R. Horton (DHI).

  • D.R. Horton says fiscal second-quarter home orders fell 37%, far weaker than even housing perma-bears expected.
  • The company said it had orders for 9,983 homes, compared to 15,771 a year ago.
  • Meanwhile, the dollar value of those orders was $2.6 billion from $4.4 billion a year ago, a decline of 41%.
  • So prices are falling slightly faster than orders.
  • And that dollar figure doesn't even include incentives.
  • And then there's the 32% cancellation rate.
  • And what about the fact that, like other builders, D.R. Horton will continue to discount homes aggressively to move inventories?
  • And what if the company is later this year forced to write down the value of its land holdings?
  • Bah! Questions!
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