By Brian Blackstone

From The Wall Street Journal Online

U.S. housing prices may decline "a little" within the next year, but any such drop is likely to be mild and inconsistent with a bursting housing bubble, according to a paper written by a Federal Reserve economist.

Based on an analysis of housing futures and options and derivatives of housing-related company shares, "market participants expect home prices to decelerate sharply or actually decline a little within the next year," wrote J. Benson Durham, an economist with the Fed’s monetary affairs division. However, the anticipated drop in prices "is mild compared to some estimates of the purported overvaluation of the housing market," he added. The paper, dated September, was posted on the Fed’s Web site Thursday.

Mr. Durham cautioned that deep and liquid markets needed to signal future home-price trends don’t fully exist and that housing futures and options have only been trading on the Chicago Mercantile Exchange since May 22. Still, implied volatility on CME housing options are greater than the historical average, "which suggests that investors see more risks to home prices going forward," he wrote. That higher uncertainty, however, is "generally inconsistent with the perception of a "bubble,’" he added.

Mr. Durham also examined options on shares of certain homebuilders to gauge whether investors see upside or downside risks to home prices. Those options "are only marginally negatively skewed at the present time," he wrote. "This suggests that market participants do not, in fact, view the risks to home prices or, perhaps more accurately, to the broader housing sector as especially tilted to the downside," Mr. Durham concluded.

The paper’s conclusions seem in line with the thinking of Fed officials that the sector will slow substantially through the rest of 2006 and into 2007 but is unlikely to derail the economic expansion.

In the minutes of the Sept. 20 Federal Open Market Committee meeting, the Fed said housing "seemed to be cooling considerably" but that the overall economy should strengthen next year "as the housing correction abated." Officials also continue to remark that higher inflation poses a greater risk than a slower economy.

Housing data had declined markedly in recent months, raising fears of a housing-induced slowdown severe enough that it would eventually require Fed rate cuts. But there have been tentative signs of stabilization of late. The National Association of Home Builders index rose in October, albeit by only one point, but nevertheless breaking a string of eight straight declines. And housing starts unexpectedly rose in September, breaking a string of three straight declines.

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By Ryan Chittum

From The Wall Street Journal Online

The commercial real-estate cycle appears to have reached its peak and will begin pulling back in 2007, according to a new survey of industry executives.

The Urban Land Institute, a Washington-based nonprofit planning and research group, and PricewaterhouseCoopers surveyed more than 600 developers, investors, brokers, consultants and lenders this summer for an annual report on the industry, dubbed Emerging Trends in Real Estate 2007.

The survey suggests commercial real estate is beginning a return to its norm as an income-producing investment rather than the wildly appreciating asset class it has been this decade. The easy lending of the past several years will tighten next year in part because of worries about the economy, surveyed executives said. Investors will have to turn to asset management and operating performance to raise returns as investment inflows slow because of lower return expectations, respondents added.

"I think it’s a clear mandate from people that you’re going to have to make money the old-fashioned way," says Stephen Blank, an Urban Land Institute senior fellow who specializes in real-estate capital markets. "You’re going to have to earn it" through leasing, cost control and other asset management.

The report also says real-estate investment trust stock prices "appear to have more downside risk than upside potential over the short term."

Still, those surveyed expect commercial real-estate cash flow to continue to grow as factors such as reduced vacancies and higher rents keep improving across most property types. One reason: High construction costs are putting a damper on new construction.

While the commercial real-estate market has exhibited some signs of a bubble in recent years — driven by low interest rates and an influx of investment — it has differed from the residential market. A key difference is that supply and demand have been more tied to vacancies and rents and not as closely linked to the rising interest rates that have cooled the housing market.

The report advises investors to sell marginal properties and hold on to well-performing ones, with an eye to improving their performance in advance of a potential economic downturn. It advises developers to "hunker down," saying most property markets don’t need much new space.

A pullback in the galloping commercial real-estate market will raise capitalization rates — the initial return on investment in the first year — by as much as 0.7 percentage point in some property types and restrain the increase in property values, the report says. Falling cap rates mean investors are willing to take a lower return for their money. Cap rates are already rising in some areas, especially in lower-quality properties, after dropping between 2.5 and three percentage points to record lows over the past five years. Cap rates vary by property type, but high-income apartments, for instance, averaged a 5.66% cap rate in July, while limited-service hotels brought a 7.93% cap rate.

The property sectors with a "buy" in the report are warehouse, which the executives interviewed said will boom on the East and Gulf Coasts because of overflow import traffic from the West Coast, and moderate-income apartments, especially on the coasts. Retail property fared worse, with executives suggesting consumer spending will be "middling" and advising investors to sell weak properties while holding strong ones.

Those surveyed said Seattle is the best office market to invest in right now, with office rents set to rise and supply tight. The city is also sitting in a prime position to benefit from explosive growth in Asia and has the best potential of any American city to become the next "24-hour" hub like New York or San Francisco, according to the report. The report lists five U.S. cities as "global pathways" with bright futures for real-estate investment: New York, Seattle, San Francisco, Los Angeles and Washington.

Philadelphia and Chicago are ranked among the worst markets for investment in all property types in the survey. Chicago is being dragged down by economic problems, the "Midwest malaise," the report says, while investors question Philadelphia’s future as a global city since it lies between New York and Washington.

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By Ian Salisbury

From The Wall Street Journal Online

Many people would like to own real-estate abroad — and while buying a pied-à-terre in Biarritz may be difficult, investing in international real estate could soon get easier.

State Street Corp.’s State Street Global Advisors recently filed with the Securities and Exchange Commission to launch an exchange-traded fund based on real-estate securities in 23 countries. Exchange-traded funds resemble index-oriented mutual funds, but trade on an exchange like a stock.

While there are a number of traditional mutual funds to track international real estate, so far all the real-estate ETFs on the U.S. market follow domestic stocks.

In the past few years, real estate has been a hot investment and, importantly, one that promises not to rise and fall in correlation with U.S. stocks and bonds. That has many brokers saying an international ETF would be welcome.

"It would help us span markets" overseas, says Louis Kokernak of Haven Financial Advisors in Austin, Texas. Mr. Kokernak allocates about 5% of his clients’ portfolios to real estate.

He says he already uses State Street’s domestic real-estate ETF and, if an international version became available, he would consider switching a quarter to a third of his clients’ real-estate exposure to it.

Mark Willoughby of Greenbaum & Orecchio Inc. in Old Tappan, N.J., is also interested. "We’ve looked at international real estate for the past two years," he says. His firm recently started using two institutional funds for its high net-worth clients, but also would like to see an ETF, because ETFs typically have lower annual expenses than other funds.

"The expense ratios are not that bad, about 100" basis points, or 1%, he says. "We’re used to something cheaper, but we haven’t been able to get it."

The State Street filing doesn’t say what the annual fees will be for the proposed ETF, but a number of advisers say they would be surprised if it were much more than 60 basis points, or 0.6% of assets.

One possible rival, the Northern Global Real Estate Index Fund, boasts an expense ratio of 65 basis points. That product is "global" rather than international, meaning it includes some U.S. stocks, but still, an ETF that wasn’t priced in this range could find it hard to compete.

The State Street fund will be based on the Dow Jones Wilshire exUS Real Estate Securities Index. The "exUS" means there are no U.S. stocks.

The index has posted some eye-popping returns, but because it was introduced only in March, those numbers are based on hypothetical back tests and don’t reflect actual results.

According to the tests, the index has returned 33% over the past three years, 23% over the past five years and 9% over the past 10 years.

Investors should note that, despite the large number of countries in the index, nearly 60% of the holdings are concentrated in just three: Australia with 20%, the United Kingdom with 19%, and Japan with 18%. The top nine countries comprise just more than 90% of the weightings. Also, many of the stocks in the index are "real-estate operating companies" instead of real-estate investment trusts.

Ronnee Ades, senior director of institutional markets at Dow Jones & Co.’s indexing unit, says a REIT-only index wouldn’t be as diverse, because many countries have yet to adopt that special tax structure.

REITs, which were introduced in the U.S. in the 1960s as a way to invest in income-producing real estate, are largely exempt from tax on profit at the corporate level, and distribute nearly all of their net income as dividends.

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Asbury Park Press  10/25/06

BY David P. Willis

The bankruptcy of Kara Homes, one of the largest home builders at the Jersey Shore, has more than enough victims: customers, employees and scores of creditors owed millions of dollars.

It has also placed a cloud over the New Jersey home building industry as potential customers wonder just how strong other builders are and if more may be following Kara into bankruptcy court.

"People are skittish," said Carolyn Villani, vice president of sales and marketing at Paramount Homes of Jackson. "People are waiting to see what happens to Kara and what happens to other builders. They are concerned about everyone right now."

On Oct. 5, East Brunswick-based Kara Homes filed for Chapter 11 bankruptcy, saying the real estate market’s slowdown hurt sales and scared off lenders.

Builders are trying to distance themselves from the Kara controversy.

Representatives of Hovnanian Enterprises mention the differences between Hovnanian, a large, publicly traded Fortune 500 company based in Red Bank, and Kara Homes when the topic comes up. The company has a strong cash position and $1.5 billion in bank credit it has not touched, a spokesman said.

"We are very financially stable, and that usually reassures people," Hovnanian spokesman Douglas Fenichel said.

Likewise, Paramount representatives tell prospective customers about their own company and its reputation, Villani said.

Offer to Kara customers

Paramount Homes officials have also decided to go on the offensive, reaching out to help Kara buyers worried about their down payments and deposits and, at the same time, drive some sales their way.

"A lot of us, the majority of builders and the builders’ association, are very reputable people," Villani said. "We want to do our part if possible."

Paramount’s Villani said the company has started a marketing program meant to get Kara customers into new homes. Here is how it would work:

A customer who has put a down payment on a Kara home would receive a credit of an equal amount, up to $150,000, on a Paramount home, depending on the development. Paramount would then have the right to the homeowner’s down payment, or any part of it, if it were to be recovered.

"We would take the buyer’s position in bankruptcy court," Villani said.

Alternately, Paramount would complete construction of the customer’s Kara home if the customer were able to obtain clear title to the property.

Paramount would help a customer obtain a construction loan to finish the house and a mortgage if the person has a clear title to the property.

If they qualify financially, customers could finance 100 percent of their new Paramount homes.

"We can’t say that any of these are absolutely 100 percent going to work," Villani said. "We may be the right builder for some of the people out there. There is a good faith here."

Robert Kenney of Staten Island put $126,000 down as a deposit for a Kara home in Monroe. He signed a contract in March 2005, sold his old home, and has lived in an apartment for a year.

"We are in limbo. There is no end in sight," said Kenney, 49, a construction project superintendent in New York City. "I have no idea when or if I can ever get a house."

Paramount’s offer might be an option, but it would depend on the home’s location, he said. "Being in the bankruptcy, there (are) no guarantees," he said. "We could absolutely lose our money."

Court to hear Kara plan

Kara Homes has said it has lined up $5 million in financing to resume building the homes it has already sold and to reimburse buyers who canceled their contracts before the home builder filed for bankruptcy protection. The company has about 300 contracts for homes in New Jersey that it did not complete or start to build.

A hearing on Kara’s plan is scheduled for Monday in U.S. Bankruptcy Court.

David Bruck, a lawyer for Kara, said in court papers that the plan would help remove the "aura of distrust" surrounding the embattled developer, something that is "critical," he said, if the company is to reorganize successfully.

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