Fed Tapering May Curb The U.S. Housing Market's Impressive Rebound

Includes: BX, FMCC, FNMA, KKR, OAK
by: Andrea Lafleche

Despite the financial crisis that has affected the United States since 2008, housing markets are showing signs of a sustainable rebound, however Federal tapering may inhibit the natural upswing of the rebound.

Since 2011, even though U.S. economic growth has been struggling against recession due to the financial crisis of 2008, the housing market is showing impressive signs of a blossoming rebound. Home prices are rising up gradually, while new home sales and building permit activities are on the road to recovery, as well. Quantitative Easing (QE) is an effective monetary policy introduced by the Federal Reserve to stimulate households' consumption, where low interest rates plus massive amounts of money from the Federal bond-buying program will likely fuel liquidity to the equity markets and inevitably push the asset prices higher. This will not only work to help the economy's growth rates, but will also stimulate employment, especially within the real estate sector where the asset prices have been lying at the bottom.

Impressive Data Showing the U.S. Housing Market is Finally Recovering

The indicators of a housing recovery are both plentiful and nationwide. According to the survey from the National Association of Home Builders (NAHB), the real estate market during the spring and summer of this year were the strongest they have been since the height of the housing bubble in 2005. There are very favorable results in the housing markets in recent studies and experts say all signs point to the real estate market finally being in the green.

According to data taken from November 2011 to September 2013, existing home sales have increased by approximately 24.47% and new home sales, an astonishing 35%. New housing starts and building permit activities generated about 41.26% and 43.75% respectively in the same survey period. The market value of U.S. real estate made an impressive statement when it surpassed $20,000 billion USD in value for the first time since the financial crisis in 2008.

The housing services and residential fixed investments have consistently kept the annual median rate of between 15-16% of GDP's contributions, totaling over 0.4 percentage points per year to real GDP growth.

Blackstone Group LP (NYSE:BX), the largest real estate private equity firm in the world today, invested $69 billion USD of assets under management when it recognized that the "bottom out" of the real estate market would produce more attractive opportunities. Blackstone spends $100 million USD weekly on properties in states such as California, Arizona, Florida, and Nevada. This has been the trend for Blackstone since the beginning of 2013, with a large focus on individual properties, including foreclosure auctions and short sales.

"You know how hard it is for you to buy a house? I mean, you have got to negotiate with somebody, you have got all kinds of stuff, and you have got the title. We did it for 40,000 houses," said Stephen Allen Schwarzman, Chairman of Blackstone Group LP.

A few weeks ago, Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC), the country's largest provider of funds for home mortgages, announced second quarter profits after sending $10.2 billion USD and $4.4 billion USD respectively to the Treasury. Both companies have stated that their businesses have done well since their takeover by the Federal government in September 2008. Long term, they expect to be more profitable than previous years due to the high credit quality of new loans and declining losses on its existing mortgages.

"Be fearful when others are greedy and greedy when others are fearful" is a famous quote from Warren Buffett, and has proven to be a very successful strategy when the financial market is in crisis. Oaktree Capital Group LLC (NYSE:OAK), the world's largest distressed debt investor, is a pioneer in its field. It has been steadily investing money into the real estate market following the housing crash. With many homes selling for half of their peak value and the demand for properties still within average range. Oaktree was earning an annual 15% return on its capital and expected to raise $2.2 billion USD for strategic credit and $700 million USD in real estate debt by year end if the housing rebound continues its current upswings.

Following the lead of the larger competitors in the rush for real estate investment, KKR & Co. LP (NYSE:KKR) began to invest seriously in the real estate market in early 2011. It sought to expand the business beyond its traditional leveraged buyouts by fueling $650 million USD into 10 property deals.

"We have got a real sense of urgency around scaling in these businesses and grabbing as much land as we can." Said Scott Nuttall, KKR's head of global capital and asset management.

Potential Risk of Federal Tapering and the Outcome of this Prospect in the Long Term

Despite the positive data on U.S. housing markets, I am still quite doubtful about the long-term sustainable growth in the real estate sector. The upswing in housing is unusual because the liquidity is largely being fueled not by consumers purchasing a first or even a second dwelling; but by the many hedge funds, private equity firms, and other foreign investors, that are looking for a better rate of return on their equity by shifting their portfolios to massive home assets. This is one of the reasons that the Federal Reserve kept its interest rate at the lowest level allowing mortgage rates to do the same.

U.S. residents are worried that news of Federal tapering will cause an increase in the interest rate, especially the mortgage rate, which will follow suit over the long term. Presently, there is no doubt that Federal tapering will be risky for those investors who are going to be extremely vulnerable if they continue their investment in real estate properties.

Releasing housing data that showed a better prognosis than in previous years, following the crisis of 2008, may be convincing people to ignore Federal tapering plans. I expect the housing market to extend its rebound and contribute an average 0.6 percentage points annually to real GDP over the next quarter. Consumers will continue to increase their purchases of durable goods such as cars and furniture, and indicate a willingness to purchase a new home. The housing recovery is also underpinned by rising household formations and the growing population that lies within the age group for establishing a prime household formation. Nevertheless, there is still a level of cynicism for this proposed recovery as housing markets may face several obstacles before it can level off, such as, tight mortgage credit conditions, high labor costs faced by builders, a shortage of lots, elevated materials costs, and lower appraisals.

This being said, investors will need to approach the situation with caution and look past the favorable data to the real issues and challenges facing the housing market. If Federal tapering comes to an end, real estate investors are now pushed into an extremely volatile market, with potentially low liquidity opportunities.

There is no debate, the U.S. housing market is definitely making a rebound, however how long can we expect this to last? Is it time for investors to get out while the going is good or should they ride it out and see what happens? These questions are weighing heavily on all real estate investors, and by the end of December when the Feds announce their plans for QE3, it may be too late to get a solid return. Of course, only time will tell if the U.S. housing market can withstand Federal tapering and the aftermath that ensues.

Investors should tread carefully in this market, especially until the final word is out on QE3. After December, there should be a better long-term plan set into motion from the Fed's, which will likely decrease market volatility, making it easier to plan strategic investments within the real estate market.

Now is the time for investors to take a "watch and wait" approach to real estate investments until early in 2014, when the results of tapering talks have taken effect, investors can take a look at the long-term stability of the U.S. housing market and form their own opinion on whether the U.S. real estate market is truly far enough out of the woods to start making investments again.

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.