Big REIT Opportunities in the U.S. Housing Market Recovery

By: Money_Morning

Martin Hutchinson writes: If you listen to most pundits, you would think housing is on its way back.

But I don't listen to people. I do my own research and make up my mind.

And what I've found is that this housing rally is a double-edged sword. But if you're smart you take advantage of its potential while eliminating much of its real risks.

The one edge: A more active market is undoubtedly good for the economy, since it leaves less money trapped in houses people no longer want. But rising prices are not good news, as I explain below.

The other: There are still some excellent opportunities in the real estate sector through real estate investment trusts (REITs), but you need to be very selective (also below).

And as usual, it's all about 3 things: location, location, location.

Except this time around, it's not the locations you would think.

A Cautionary Tale

Let me explain by example...

I have just returned from Britain and the trajectory of that economy shows very clearly: High real estate prices are a major competitive disadvantage.

House prices in Britain are much higher than in the United States. The average house price in June 2013, according to Rightmove's house price index, was 253,000 pounds, about $382,000 at today's exchange rates.

That compares with about $266,000 in the U.S., taking a weighted average of new and existing home sales prices. However, you have to add into this calculation the reality that British incomes are only around 80% of U.S. incomes, when converted at market exchange rates (about 75% at purchasing power parity).

So in terms of earning power, U.K. house prices average about 80% higher than U.S. house prices.

That doesn't take into account the fact that British houses are on average substantially smaller than U.S. houses, or the exorbitant additional costs of trying to live in London, Britain's bloated capital, where house prices have been pushed up by the advent of wealthy Russians.

This isn't just bad luck for Brits, it imposes huge additional costs on the economy. When the Bank of England wanted to attract the Canadian Mark Carney as its new Governor, it had to pay him a housing allowance of 250,000 pounds annually, tax-free, on top of his already substantial salary.

The same premium applies in a hidden way at all levels of the income spectrum. Ordinary blue-collar and white-collar workers must be paid extra to cover the cost of their expensive homes, especially in southeast England.

The more mobile of them are tempted by job offers paying similar wages, but in locations where real estate is much cheaper. For example, to duplicate my Poughkeepsie, NY house near my hometown of Cheltenham would run me 4x more - so in practice, if I returned to England I would have to accept a substantial reduction in lifestyle.

And the same is true for office, commercial and industrial space. It was headline news in 1984 when London became more expensive than New York for prime office rents.

Today the differential with New York is almost 2 to 1; according to CB Richard Ellis's latest survey total occupancy costs in London's West End are $222.58 per square foot compared to New York's $120.65.

Of course, a similar or even larger differential for retail space adds substantially to the U.K. cost of living and makes British retailing very inefficient compared to the U.S.

Buying Smart

The same competitive factors apply within the U.S. market.
Based on 2011 figures (prices have increased since) New York state's average house price was $329,000 and California's $299,000, while Nevada's was $138,000 and Indiana's $130,000.

Of course, there are network advantages to locating your business in or near a major city such as New York or a tech hub such as Silicon Valley. Still, at some point the real estate cost differential outweighs these advantages, especially for businesses for which such network effects are not crucial.

Indiana's cheap real estate prices (and other cost savings, such as its relatively new right-to-work law and lower state income taxes) make it a very tempting alternative for businesses not subject to major network effects.

Even Detroit, if it is able to provide adequate policing, decent government and keep property and other taxes down, may find recovery is remarkably quick because of its immense advantage of extremely cheap housing.

For investors in real estate, whether directly or through real estate investment trusts, the message is clear.

Ultra-low interest rates have given an artificial advantage to regions with very high real estate prices, while artificially depressing rents. The wise investor will thus buy property or REITS in areas of the U.S. where prices are low - Indiana is a fine example.

In those areas, rental yields will generally be better. Furthermore a rise in interest rates, which will suppress house prices in high-cost areas such as California and the New York, Boston and Washington suburbs, will increase Indiana's relative cost advantage, as the annual savings from its lower house prices will increase.

Indiana-based REITS such as Duke Realty Corporation (NYSE:DRE), Simon Property Group (NYSE:SPG) and Kite Realty Group Trust (NYSE:KRG), each of which specializes in a varied mix of office, industrial and commercial properties, are all worth a look.

The operating costs of their head office staff will be relatively low and the growth prospects for their Indiana properties relatively good.

Money Morning takes a look at other ways to profit from the housing market recovery here.

Source :http://moneymorning.com/2013/07/17/big-reit-opportunities-in-the-housing-market-recovery/

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