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Real Estate Likely To Face Headwinds

The trend of increasing foreclosures and a weak housing market deals yet another blow to the real estate sector.

According to recent data from RealtyTrac Inc., U.S. home foreclosures hit record numbers marking the second consecutive record breaking month in a row.  The month of May saw foreclosures increase in every state.  To put it into perspective, bank repossessions climbed 44 percent from last May and one in every 400 households received a foreclosure notice. 

What is even more alarming is that a relief in the number of foreclosures to hit the market is nowhere in sight. In the first quarter of the year, nearly one in every four mortgage holder owes more than his house is worth.   With this in mind, a contagion effect could hit the markets as increasing number of homeowners are strategically walking away from their homes.  This could tremendously hinder the real estate markets as inventories will likely increase and fewer individuals will be credit-worthy to obtain a loan in the future. 

In fact, the number of foreclosures is expected to continue to increase throughout the year with foreclosure activity stabilizing sometime in late 2011.   

Another indicator that relief is not in sight is a step taking by two of the largest U.S. home lenders.  Bank of America (BAC) and Wells Fargo (WFC) have recently started to cut the principal on some mortgages in an attempt to keep homeowners who are upside down on their loans in their homes and paying a portion of what they owe.  More specifically, Bank of America started reducing the principal for borrowers who owe more than 120 percent of what their homes are worth.

To further put a strain on the real estate markets, “shadow” inventory is expected to grow at an exponential rate.  “Shadow” inventory is inventory that is being held by banks and homes that have been foreclosed on but haven’t hit the market.  With the alarming number of severely delinquent homeowners who haven’t entered foreclosure yet, but likely will, “shadow” inventory is likely to put a significant supply and demand constraint on the sector.

Lastly, high unemployment rates and a labor force that has not witnessed wage increases will make it very difficult for the real estate sector to see any sustainable spark or recovery. 

Some equities that are likely to feel the headwinds of the real estate sector include:

  • SPDR S&P Homebuilders (XHB), which closed at $16.13 on Thursday.
  • iShares Dow Jones US Home Construction (ITB), which closed at $12.49 on Thursday.
  • PowerShares Dynamic Building & Construct (PKB), which closed at $11.93 on Thursday.

If invested in these equities, the use of an exit strategy which identifies specific price points at which an upward trend is likely o come to an end could help preserve returns.

According to the latest data at www.SmartStops.net, these price points are XHB at $14.95; ITB at $11.54; PKB at $10.98.  These price points are reflective of market volatility and change on a daily basis.

Disclosure: No Positions

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