Stock Traders Daily has issued a sell rating on Real Estate. Our analysis suggests that a combination of three factors has contributed to what now appears to be excessive valuation in wealthier real estate markets, and although the same irrational exuberance does not seem to exist in lower income areas, the trickle up impact of these recent pro-real estate policies will eventually trickle-down to those areas as well as they are unwound.
The perfect conditions that existed for real estate started with stimulus, ultra low interest rates, and finally low supply. Let's address each one.
Stimulus flooded the economy with money that would not have otherwise been there and that money eventually found its way into asset classes like the stock market and real estate. Wealthier investors benefited most, but in every case you, had to be in it to win it given the wealth effect that followed.
However, this demand was fabricated, unnatural, and not in line with the natural growth rates I have defined in my macroeconomic model (The Investment rate). The natural question though is what will happen now that this fabricated demand is over, and my answer is that the demand levels will revert to their more natural conditions, which are much lower. This could remove the bid from real estate.
Also, estimates show that lower interest rates have increased the buying power of the average consumer by about 20%, suggesting that they are able to buy a home that is 20% more in value today than they were when interest rates were higher. Now that the direction of rates is turning the probability of pricing pressure is also likely.
The inverse relationship between price and yield boosted real estate prices as rates declined, but they will have the opposite impact if rates rise.
That brings us to the supply question. Hedge funds have purchased tens of thousands of properties from the banks during the credit crisis. They sold a small amount, rented most of the rest, and since then they have been reaping the rewards by realizing performance fees on their real estate holdings during these perfect conditions.
The interesting part is that these hedge funds are in large part some of the smartest investors on the street, and if they think pricing pressures are going to come if interest rates begin to increase, which would be logical given the inverse relationship, they may just open the floodgates and start to sell their real estate holdings. That would change the supply picture for real estate dramatically.
Everything considered, the perfect conditions that helped boost real estate prices in recent years are reversing themselves, this has started already, and as a result we advise people to sell the general real estate market and we would even go so far as to recommend shorting the ProShares Ultra Real Estate ETF (NYSEARCA:URE) for the next year or so.
It is important to note that we do not currently have a stop loss set for this trade but we will monitor it and provide recommendations to clients as our opinion changes over time.
In addition, this is a 2x ETF and it carries with it a degree of risk that requires additional attention. Significant losses can occur, and everyone should consult with their own personal advisors before making any decisions to buy or sell any stock, much less a leveraged ETF. The article above does not constitute a recommendation to buy or sell and should not be construed as such.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: By Thomas H. Kee Jr. for Stock Traders Daily and neither receives compensation from the publicly traded companies listed herein for writing this article.
Additional disclosure: Clients of Stock Traders Daily may already be short real estate.