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What Road to Take
When Real Estate Is Not a Sure Bet

PAUL J. LIM / New York Times 6aug2006


FOR most Americans, their home is their single biggest investment. So many investors are understandably worried now that the residential real estate market has turned decidedly cold.

Landscape of Housing Downturns - From Feb. 1972 to Jun. 2006, when monthly new-home sales declined 1 percent, investments in each of the following industries performed as shown. Correlations to 1% declines in housing market.

Landscape of Housing Downturns - From Feb. 1972 to Jun. 2006, when monthly new-home sales declined 1 percent, investments in each of the following industries performed as shown. Correlations to 1% declines in housing market.

Industries other than housing are S&P 500 sectors.

The question is, should they be?

Certainly, anyone who needs to sell their home today — to relocate for a job, for example, or simply to downsize — may need to be concerned about the growing glut of single-family homes for sale.

And investors who happen to hold a large stake of their financial portfolios in securities focused on real estate also need to worry about the growing risks in this sector. Since the start of the year, for instance, homebuilding stocks, which had been the market’s darlings in 2003 and 2004, have lost nearly a third of their value on average, according to Morningstar.

But for buy-and-hold investors who have the luxury of time, the answer isn’t so clear.

To be sure, all investors “need to pay attention to what’s going on in housing because two-thirds of the economy is consumer driven,” said Sam Stovall, chief investment strategist for Standard & Poor’s. And homes have been a major source of wealth that has bankrolled spending in recent years. Last year, for example, Americans pulled $595 billion out of their homes through sales, home equity loans and cash-out refinancing activity, according to estimates by UBS Securities.

But as long as the housing market continues to cool gradually, falling demand for single-family homes could turn out to be a slight positive for equities, said Jeffrey N. Kleintop, chief investment strategist at PNC Wealth Management in Philadelphia.

After all, a large chunk of the investment dollars that had been going into housing recently is likely to be redirected into equities, Mr. Kleintop said. He said that shortly after housing prices peaked in Britain and Australia in 2003, the stock markets in both those countries began to rally.

Still, equity investors need to be cautious and selective when it comes to investing during a housing slowdown. Should home values stagnate or fall while energy prices remain high, consumers are likely to pull back on their spending, said David R. Kotok, chairman and chief investment officer at Cumberland Advisors, an investment advisory firm in Vineland, N.J. This is why he recommends that investors underweight their exposure to the consumer discretionary sector.

This includes bets on retailers and manufacturers of consumer durable items like furniture and appliances. During the last three months, shares of furniture and appliance makers have tumbled around 26 percent.

History says avoiding consumer discretionary stocks during housing slowdowns is a smart move. Ned Davis Research recently studied how various sectors in the S.& P. 500-stock index have performed in past periods of declining home sales.

As one would expect, the sector most affected by declining home sales has been basic materials — since demand for commodities such as lumber, steel and copper tend to be affected by construction trends. From the end of February 1972 to June 2006, every 1 percent monthly decline in new-home sales coincided with a 1.7 percent fall among materials stocks in the S.& P. 500.

But the consumer discretionary sector has been nearly as vulnerable to housing declines. Since February 1972, a 1 percent drop in new-home sales has coincided with a 1.4 percent decline in the stock price of consumer discretionary companies.

Jack A. Ablin, chief investment officer for Harris Private Bank in Chicago, recently found similar results. Instead of looking at monthly changes in new-home sales, Mr. Ablin studied the correlations between various S.& P. 500 sectors and year-over-year changes in existing single-family home sales based on data starting in January 1999. In recent years, the sectors that have moved most closely with housing demand have been consumer discretionary and materials stocks. By comparison, since 2000, the sector with the lowest correlation to housing demand has been health care, Mr. Ablin found. This is one reason he recommends investors overweight health care stocks, as they are likely to be shielded from the weakening housing market.

To be sure, aggressive investors could take advantage of the softness in housing by short-selling housing-related equities. And the recent introduction by the Chicago Mercantile Exchange of real estate futures and options — which allow investors to bet on or against the housing market in 10 major cities, including New York, Los Angeles and Miami — has made it easier for investors to short real estate in general.

But Mr. Kotok cautions buy-and-hold investors from short-selling in general, given that this strategy requires you to pay close attention to day-to-day fluctuations in prices. He added that in the short term, the housing market could be just as unpredictable as equities.

What’s more, although the housing market is cooling, it’s not been a monolithic sell-off. While investor appetite for real estate is on the wane, there are still some segments of the market that are doing quite well.

Take real estate investment trusts that own multifamily apartment buildings. Thanks to high home prices and rising borrowing costs, renting has become more attractive as of late. “Two years ago, tenants were being scolded for being idiots because they weren’t buying homes,” said Joseph R. Betlej, vice president and portfolio manager for Advantus Capital Management. “Now it’s just the opposite.”

AS a result, rents in many markets are expected to climb more than 3 percent this year. And apartment REIT’s have been among the market’s best performers. From Jan. 1 to July 31, the average apartment REIT has generated a total return of 26.9 percent, according to SNL Financial, a financial services and research firm. Of course, since apartment REIT’s have posted double-digit returns in five of the last six years, some analysts think these investments are now trading at lofty valuations.

And apartment REIT’s aren’t a perfect hedge against the value of your single-family home. Ultimately, landlords are just as dependent on a healthy economy as is the single-family home market.

This is why many market strategists think now is a good time to invest defensively, rather than trying to make fresh bets on real estate.

There’s always a degree of risk in making tactical changes to your mix of stocks and bonds — and the types of stocks you hold. So if you plan to tweak your portfolio to position yourself better for the housing slowdown, it makes sense to err on the side of caution.

Paul J. Lim is a financial writer at U.S. News & World Report.

source: http://www.nytimes.com/2006/08/06/business/yourmoney/06fund.html?pagewanted=print 6aug2006

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