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10-14-05 Vol. 8: No. 5
RealtyStocks' Observer
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Monthly Feature:

The Impact of Hurricanes Katrina and Rita Upon Real Estate and the Attack on Housing

A. Hurricane Katrina's & Rita's Impact Upon Real Estate
B. Housing Under Attack
C. Housing's Potential Negative Influence Upon REMFs & REITs
D. Equity REIT Performance
E. Large Cap REIT Performance
F. Mortgage REIT Performance
G. Realty Corporations
G. Real Estate Mutual Funds (REMFs)

A. HURRICANE KATRINA's & RITA's IMPACT UPON REAL ESTATE
The toll of Katrina has been especially tragic for most residents of New Orleans and the coastal areas of Mississippi, as well as the eastern portion of Texas near the Gulf Coast. Katrina has displaced hundreds of thousands of people throughout other nearby states, and some throughout the U.S. The human suffering and death from Katrina stunned not only all Americans, but created sympathy worldwide.

Though it will take years to know the true impact of Katrina, and to a lesser extent Rita, there are already various indications of the recent impact these hurricanes have had upon real estate. Much of the impact is regional, causing home values and the population in places like Baton Rouge to surge. For those hotels/motels in the Gulf Coast not badly damaged and operational, vacancies are scarce and rates have risen. Commercial activities for the cities closest to the impacted areas have jumped for a variety of businesses from beauty parlors to restaurants. Office occupancies and rates in places as far away as Houston are showing improvement. However, the areas inland from the Gulf of Mexico are not only reaping various benefits, but are also feeling some strains. Student attendance in these other cities has increased dramatically, causing the need for more classroom space and teachers. Traffic has also increased, and the increased welfare and tax burden upon these other cities is causing concerns.

The affects of hurricanes Katrina and Rita are not only regional, but also national in scope. Post Katrina, unemployment rose, manufacturing declined and jobless claims jumped. The most obvious impact has been upon the increase in the price of oil, natural gas and gasoline. The CPI released last week showed a jump of 1.2% of which 90% was attributable to the surge in energy costs. Though oil prices have subsided recently, it may take a while for some major refineries and pipe lines to be fully operational. With the onset of winter and energy supply and delivery issues, DOE has indicated that the prices of natural gas in much of the country over the coming months are likely to escalate about 50%. Furthermore, an early and harsh winter, could cause even higher increases to occur. This will place an added cost burden upon homeowners and will also increase operating costs for commercial buildings, particularly in colder climates. Rising oil prices have also affected many construction products requiring petroleum derivatives. Not only are such products becoming more expensive, but the building needs in New Orleans and the Mississippi and Texas coast are creating a much greater demand for these items. Reportedly plywood has jumped about 25% in some areas of the country, which will cause home and commercial construction costs to increase. In particular, rising material costs could be most damaging among home builders who may have a difficult time of passing these increased costs on to consumers as home values appear to be stagnating in some areas.   Top

B. HOUSING UNDER ATTACK
Last week, the President's Tax Panel recommended a zinger that could have negative consequence upon residential real estate, especially in large coastal cities like L.A., San Francisco, New York, D.C., Boston - as well as resort and second home communities. This panel recommended reducing mortgage deductions from the current $1 million limit to about $300,000. They also may decide to recommend eliminating or reducing the mortgage limit applicable to second homes and/or home equity loans. Obviously, such a proposal is expected to meet much opposition from realtors, homeowners and other housing groups. However, with the Federal deficit reaching it's third highest amount this past month, the Federal Government needs to find ways to reduce deductions and increase revenues.

Besides the threat of lower mortgage deductions, it appears that even after an apparent slow down in the economy due to Hurricanes Katrina and Rita, that the Federal Reserve will continue to raise the discount rate. They may not stop until it reaches more than 5%, which was only 1% in June of last year. Though a 30-year fixed rate mortgage may still hover around 6% and has only increased about .5 percent in recent months, the short term interest only mortgage products and home equity loans that were over 2% lower than fixed rate loans, are now near the same cost. This is making it more difficult for people to qualify for home loans. Though Chairman Greenspan indicates the main reason for rate increases is due to the threat of inflation, possibly of equal importance is that higher rates are one of the few real powers the Fed has made to slow down what they believe is an overly speculative housing market.

The increase cost of new construction and remodeling, as previously mentioned, is expected to rise. This could further deter home purchases, especially if home prices flatten or begin to decline. As the winter holidays approach, the home sales activity traditionally slows. Thus, we are beginning to catch a seasonal downturn. The cost to maintain a home could also increase dramatically this winter with rising natural gas and oil costs. Consumer sentiment has dropped dramatically over the past two months, which could further dampen not only consumer sales, but also home sales.

Though past predictions of a demise in home prices have been incorrect, and the housing market has proven resilient, more negative housing influences are occurring. Combined, the factors noted above are expected to significantly challenge the housing industry for the coming year. We believe the main factor that will start home prices to stagnate and fall, is when fixed rate mortgages pull away from 6% and become a half-point higher or more. As we stated before, should there be a rapid change in interest rate movement, and especially if long term rates rise over 7%, we believe housing's golden goose will be cooked. What is especially bothersome, is that by some accounts, over 40% of recent home purchases have a down payment of less than 5%, and over 30% of all recent home mortgages will be due within 5 years, or will have floating rates vulnerable to significant increases. Though we still don't see an immediate "housing bubble" bust, as long as any rate increases occurring in the next year or two are modest, we do foresee a more stagnant housing market. Also, if rate increases return to the levels that persisted throughout most of the 1990's, significant value declines will occur and a troubled housing market could last for several years or more.   Top

C. THE HOUSING MARKET'S NEGATIVE INFLUENCE UPON REMFs and REITs.
Should the outlook for housing flatten or turn negative, there is some concern that it may affect the performance of real estate mutual funds (REMFs) and even public real estate investment trusts (REITs). Though a few REMFs have positions in Home Builders, most REMFs are required to hold mostly REITs and have little or no housing holdings. Most REITs invest in equities involving commercial real estate (CRE), which has dynamics that are quite different than those for residential real estate. Though these property groups are influenced by different factors, both are very sensitive to sudden changes in interest rates and both are subject to higher construction and energy costs. However, most CRE markets have not been subject to overbuilding and the improving economy, in general, has reduced vacancies and helped increase rental rates. That said, the improving occupancy and rental situation with most CRE properties have been modest and any lingering affects of the noted hurricanes, such as a slowdown in the economy reducing the demand for CRE, could reduce the profitability of commercial properties.

Another negative issue affecting REITs is that there is becoming less disparity between the dividends they pay (many are now under 5%) and the yields on very secure short-term instruments. As the yields for short term rates begin to equal or even pass some REIT yields, there will be less incentive for investors to hold REITs for yields - after factoring in risk due to potential prices declines. Also, equity markets continue to feel pressure from large bankruptcy filings like Delta and Delphi as well as reporting improprieties - most recently involving Refco. The immediate performance of the market will likely be influenced by the overall results of quarterly earnings now being released. However, the major concern involves the threat of inflation and how increased raw material costs will affect the earnings across a broad spectrum of industries.   Top

D. EQUITY REIT PERFORMANCE
After a negative first quarter drop of -8.16% and a second quarter gain of 11.46%, REITs have been challenged to become positive in the third quarter. Up 4.89% in July, the past two months have seen small REIT declines for August and September. Year to date (YTD), REITs have only managed to edge out an increase of about 3%. The lone positive property group in August was MH Parks, up 1.05%. In September, all but 4 groups were negative, with Industrial being the best performer, posting a 2.17% increase. Retail was the worst performer for both August and September, though the different sub-groups have widely different YTD results with Malls and Center down -20% and Regional Malls up 12%. However, the best performing group YTD is Self-Storage, up 20.04%. Besides the noted retail group, only Retail Center and Specialty are negative YTD, with loses of -1.47% and -3.83%. (Please see Equity Gainers and Losers.)

As we reported in our last newsletter, with investors concerned over the high valuations of REITs compared to their asset values, and the discrepancy in yields between yields and short term rates narrowing noted above, the current environment is making it difficult for REITs to advance. Also, if and when housing prices begin to fall, this could create a more negative stigma towards REITs.   Top

E. LARGE CAP REIT PERFORMANCE
Large Caps faired slightly worse than the broader universe of Equity REITs in August with a loss of -5.6% in August, but had an increase of slightly over 2% in September. Large Caps outperformed this average for the first three quarters of the year. The only two positive performers in August were Trizec (TRZ) and Crescent (CEI). Duke (DRE) and Crescent topped this group in September with gains of 4.1% and 3.4%, respectively, even though more than half the Large Caps were negative last month. YTD, Large Caps are up over 6%, but about a third of the issues are in negative territory. For the year, the best performers are General Growth (GGP) and Public Storage (PSA), both up slightly more than 20%. The worst performer YTD is i-Star Finical, with a drop of -10.7%. (Please see Large Cap REITs.)   Top

F. MORTGAGE REIT PERFORMANCE
All Mortgage REIT subgroups were negative for August and September, with the worst performer for both months being the Mixed group. Overall, Mortgage REITs declined -5.84% and -5.62% for August and September, respectively. YTD, this group is down -10.68%. Though Mortgage REITs have outperformed Equity REITs for three straight years beginning in 2001, with rates expected to rise in the near term, it appears REITs involved with mortgages will underperform those in equity this year. (Please see Mortgage Gainers and Losers.)   Top

G. REALTY CORPORATIONS
Realty Co's. modestly outperformed REITs each of the past three months with price changes for July, August and September of 5.36%, -1.53% and -0.87%. YTD, Realty Co's are up 10.65% and ahead of the price appreciation for REITs. After Katrina, the need for alternative housing in the Gulf Coast helped push Manufactured Housing stocks up 16.7% in August and made it the best performer of only 2 other positive groups for that month. For September, the groups were fairly equally divided between those rising and falling. The best group last month was Timberland, up 2.7%. The worst group for two consecutive months, with drops of -15.2% in August and -4.3% in September, was HomeBuilders. For the year, the best performer is Lodging, up 40.74%, followed by a 23.8% increase by Const. & Engineering. YTD, the weakest and only negative Realty Corp. group is HomeBuilders with a drop of -9%. The steep downward correction to Home Builders over the past couple of months may cause some investors to look for a slight rebound in the immediate term. However, due to higher material costs and higher rates, as previously noted, the earnings for HomeBuilders may become more disappointing in the coming months.(Please see Realty Corp. Gainers and Losers.)   Top

H. REAL ESTATE MUTUAL FUNDS (REMFs)
For the first quarter, REMFs have lost -6.65% compared to the broader REIT market decline of -7.54%. REITs more than offset this loss in the second quarter and have posted overall gains of a few percent in the third quarter. The respective overall returns for REMFs for July, August and September are 5.75%, 0.88% and -1.44%. An important issue to keep in mind when comparing the RealtyStocks performance to REMFs and other indices, however, is that we only show price changes; dividends are excluded. YTD and through the third quarter, the average overall return for a REMF is 7.3%. The best performing REMF for the year is CGM Realty, up 21.64%, followed by EII Int'l and Alpine Int'l, both up nearly 15%. Out of over 200 REMFs, CGM Realty was also had the best return in September of 3%. (Please see REMFs.)   Top

Stock Changes. Kimco (KIM) and Drew Industry (DW)had 2 for 1 stock splits in late August and early September, respectively.

Note: In reporting group percentage changes, if a stock is under $2 for more than two months, it is subject to removal from our coverage. All gains or losses regarding Realty Stocks are price changes only; dividends are excluded, and are calculated as of the end of each month.

Disclaimer: The material provided herein should not be taken as endorsements or recommendations to invest in a stock, fund, a group of stocks or other securities. No guarantee can be made as to the expected performance of such investments. Investors should consult all available information, including data external to RealtyStocks and associated Web sites, and exercise own best judgment before making any investment decisions. The author may have equity positions in some of the companies covered in RealtyStocks, which may change from time to time, and will divulge such information upon request.   Top

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