Is The Phoenix Housing Market Getting Too Hot?

Includes: BX, KBH, LEN
by: Zoomie Brokers

Phoenix has been leading the charge in residential home price increases for many months now. And by leading, I mean like Michael Phelps in the 200 meter butterfly in Beijing (not London) - pretty much trouncing the other 19 major metros that make up the Case-Shiller index. But have prices in Phoenix gone up too much and/or too quickly? Before attempting to answer that question, let's look at the current numbers according to Arizona State University's Center for Real Estate Theory and Practice as of February 4, 2013 (here's the full report):

• Single family home prices rose yet again between November and December and are dramatically higher than a year ago:

o The median sales price is up 33.9% from $122,500 to $164,000

o Average price per square foot is up 27.2% from $83.88 to $106.72

• Townhouse/condo prices were stable between November and December 2012 but are still showing very substantial increases over December 2011:

o The median sales price is up 42.7% from $70,000 to $99,900

o Average price per square foot is up 23.6% from $85.19 to $105.30

• Overall supply (excluding homes already under contract) was down 6% at the start of January 2013 compared with January 2012, and distressed supply was down 42% over the same time frame. However, overall supply increased by 13% during the fourth quarter of 2012.

• Recorded trustee deeds (completed foreclosures) on single family and condo homes fell 16% between November and December 2012, and were down 51% from December 2011.

• Sales of single family homes were 12% lower than in December 2011 while sales of townhouse/condos dropped by 13%.

Those are some pretty explosive numbers, especially for real estate. The Arizona State University report is very insightful and when it comes to the question as to whether or not this rebound in prices can continue, it's a simple economics question of supply and demand. When in equilibrium, let's say that real estate is worth "X" amount. As supply became excessive, coupled with weak demand during the Great Recession, prices retreated significantly below "X" as basic economics would dictate. As supply has tightened and demand has picked up, especially over the last year, prices have been pushed up significantly. Investors' appetite for distressed real estate absorbed a significant amount of supply and now with the number of foreclosures drastically reduced, the pipeline of distressed property is now but a trickle. The supply / demand picture still shows that demand far outpaces supply. So as simple economics would dictate, one would expect prices to continue to push up until equilibrium has been met, which at this point still appears distant. And when one factors in all of the boomerang buyers that are likely to buy back into the real estate market in the coming years, that has the potential to really juice the demand side of the equation. So put on your sunglasses and sunblock, this market is just getting warmed up!

So how can an investor profit from the Phoenix real estate market? One could directly acquire and manage real estate in Phoenix, one could invest in various homebuilders that have been active during the downturn and are quickly assembling new subdivisions in Phoenix - some prime examples being Lennar (NYSE:LEN) and KB Homes (NYSE:KBH), or one could invest in companies acquiring distressed residential assets in Phoenix, such as Blackstone Group (NYSE:BX).

With the recent surge in prices, many real estate investors in Phoenix are realizing internal rates of return (IRR) in excess of 50% on short term projects and IRRs in excess of 20% on longer term projects. A prime example would be the following investment:

A single family home in Scottsdale, AZ sold for $165,000 on 7/8/2011 (for more details, click here). The owner spent approximately $15,000 on improvements and leased the home for $1,550 per month. Even with 80% loan to value (LTV) financing on the property, the investment yields a positive cash flow of approximately $600 per month. Last, but not least, recent comps show the property valued at approximately $285,000 in today's market. If the owner were to sell this summer at the comparable price, the investment would return a before tax IRR of approximately 88% and an after tax IRR of approximately 79% (with some basic assumptions).

These types of numbers are exactly what has been driving Blackstone to be the largest buyer of residential real estate in Phoenix since they entered the marketplace in 2012. CNBC did a piece with them yesterday regarding their $3 billion portfolio of residential real estate that they've recently acquired (see full article here).

Even with a nice run up in prices, opportunities still abound to capitalize on the continued strength of the Phoenix real estate market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.