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Joshua Anderson, Emmanuel S. Sharef
Key economic trends suggest the worst of the housing crisis may be past: Home prices appear to be stabilizing or increasing in some of the hardest-hit markets, mortgage delinquencies have declined, loan modifications are showing greater success rates, and new construction is gradually recovering. Many institutional investors are entering the distressed property market, and the Federal Reserve continues to be strongly committed to supporting housing and the economy.
In light of these developments, PIMCO believes many housing-related assets are positioned to outperform the assumptions currently embedded in their pricing and offer attractive return potential over the secular horizon.
Among the many opportunities available, some of the most compelling are those that offer the highest return potential in a housing recovery, while hedging against downside risks, as housing would not be spared if the broader economy enters a double-dip recession.
Housing uncertainty is waningThe severity of the housing crisis made previously existing models and forecasting methods obsolete. With no historical model to reference, housing forecasts were often based on short-term trends, extrapolating recent weak borrower behavior into the long term. Risk premiums in housing-related assets have been, and remain, high.
However, as the bulk of the turbulence from mass-default risk and ever-changing government programs passes, housing is becoming a more quantifiable risk factor. Improved clarity likely will help reduce the risk premium even before the housing market heals fully. While PIMCO’s base-case forecast is for national home prices to decline somewhat further before stabilizing, we believe the market is embedding too great a risk premium into housing-related investments, making them attractive portfolio additions.
The market is reaching several turning pointsFour key themes that we believe many market participants do not appreciate fully are likely to drive returns on housing-related investments over the longer term.
While housing would not be spared in a broad-based economic downturn, market shocks likely would be met with coordinated action from agencies, regulators and other participants. In sum, we believe the collection of potential market outcomes is now skewed to the upside, rather than to the downside.
Classification of housing-related investmentsApart from purchasing houses directly, there are a number of indirect ways to position for a housing recovery, offering various levels of exposure and leverage. These include buy-to-rent strategies, vacant residential land purchases, nonperforming residential loans, non-agency residential mortgage-backed securities (RMBS – either senior or mezzanine tranches), mortgage servicing rights, new mortgage origination, multifamily commercial real estate, homebuilder equity or debt, apartment REIT (real estate investment trust) equity or debt, commodities futures such as lumber or copper, and many others.
We see three investment strategies as particularly attractive:
In conclusion, the potential to earn attractive real returns, even before benefiting from house price appreciation, makes housing-related assets desirable additions to many portfolios. As in every recovery, we expect the market to begin pricing in new scenarios well before housing has returned to full equilibrium, allowing for potential investment gains to be realized sooner. At PIMCO, we are continuing to position for an eventual housing recovery, while being mindful of its foundations. We are patiently seeking diverse opportunities that offer substantial upside exposure while remaining resilient to occasional tremors.
For more information, please see “In Depth: Positioning for a Housing Recovery.”
Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. REITs are subject to risk, such as poor performance by the manager, adverse changes to tax laws or failure to qualify for tax-free pass-through of income. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. Investing in distressed loans are speculative and the repayment of default obligations contains significant uncertainties. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors.
There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their financial advisor prior to making an investment decision.
This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. ©2012, PIMCO.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2014, PIMCO.
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