The real estate market like all other asset classes is subject to the laws of supply and demand. When supply outstrips demand, inventory rises, prices fall and it takes longer for sellers to sell their homes. The longer it takes for a seller to offload his or her property the more likely they are to drop prices. Real estate unlike many other investments usually involves a significant cash outlay to purchase and sell; as a result there is a sizable carrying cost for holding real estate as an investment. Forget the flippers and the no document, no down payment sales, they are not investments in the traditional sense of an investment, they fall more into the class of so called investments called ponzi schemes.
No investor is capable of accurately predicting the bottom in any market on a consistent basis, if it was possible to consistently predict a bottom in any market, then it would be possible to make unusual profits from this knowledge. One of the first rules of investing is not assuming that we can predict when the market has hit a bottom. However, there are other macroeconomic indicators that can be utilized in making an intelligent predication of where things stand and how much more turmoil exists in the market.
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Inventory of homes on the market in April 2008 jumped by 10.5% to 4.5 million as compared to the same period in 2007. At the current pace of home sales, it will take approximately 11.2 months to clear out this backlog. Most real estate experts are predicting a bottom at the end of 2008 or by the end of the second quarter in 2009. Both the Federal Reserve and the U.S. Treasury have pumped significant amounts of liquidity into the market, so why haven’t things eased up yet? Well unfortunately, the situation is not quite that simple, apart from the existing real estate fiasco, there is also a slowing economy to contend with as measured by the GDP and the increase in unemployment (5.5% in May).
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As consumers, we are all aware of the increase in inflation, the consumer price index (CPI) currently stands at approximately 3.9% and is increasing. Food, energy and transportation contribute the most to the increase in the CPI. The average price per gallon for regular gasoline is now above $4.00 and is predicted to continue to climb in the short-term. To compound all of these issues, the dollar has been weak and hence inflationary, since a significant number of goods are purchased from countries oversees.
The consumer confidence index is also reflecting diminished hopes amongst consumers, to date, consumers have held up quite well. With consumers losing confidence and joining business in their recessionary mode, there is little hope for a recovery in the real estate sector in the short-term.
A bottom should be established first before investors step back into the real estate market. Some indications of a recovery would be a sustained increasing in housing starts, a sustained decrease in residential inventory, an easing in mortgage lending and an overall economic recovery, specifically a reduction in inflationary pressure from both food and energy prices. All of these factor combined will set the stage for a decent return in the real estate market. Investments to keep an eye on are the real estate investment trust (REIT), the home improvement retailers, Home Depot (HD) and Loews (LOW), and the big residential builders.
For investors wanting to jump back into real estate but wanting to have some protection, covered call investing is worth considering. For example, the iShares DJ US Real Estate ETF (IYR) has several covered call investing positions to choose from for expiration in July of 2008. A covered call investing position for the 08 Jul 67 call option currently has a potential unchanged return of 3%. So even if the price of the IYR ETF remains unchanged, the position will return 3% – in only 33 days. Best of all, the position has 2.9% downside protection, so even if the price of IYR drops in price less than 2.9% at option expiration, the position will be profitable.
As was the case with the stock market crash in 2000, the real estate market will bottom and return, as soon as the current inventory levels decline. Keep in mind the fact that in any market there are always opportunities, this is true in the current real estate market. Parts of the U.S – Florida, California and Nevada have been hit hard whereas North Dakota and parts of New York State for example are doing just fine. As always, time heals all wounds, and this one will not be any different.
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[tags] real estate, supply and demand, Federal Reserve, U.S. Treasury, GDP, CPI, consumer confidence index, stock market, U.S, Florida, California, Nevada, North Dakota, New York, HD, Home Depot Inc., IYR, iShares DJ US Real Estate ETF, LOW, Lowes Cos Inc., covered call investing, covered call investment strategy, investment strategy, iron condor, poweroptions, stock option trading, stock options [/tags]