Blitz Report On Real Estate Markets

Pa n g e a M a r k e t A d v i s o r y June 15, 2009 Blitz Report On Real Estate Markets Inside This Report • Baseline Forecast Data • RPX Home Price Leading Index • RPX Forward Market Pricing • Capital Market Pricing — Equity & Fixed-Income • Contact Info Economic Overview The economy will manage just enough positive growth through the second half of 2009 to allow for home prices to appreciate between now and year-end. The argument as to whether the economic landscape shows “green shoots” or is still a brownfield is, to my thinking, beside the point. Many indicators lead, many lag, and their timing relationship with the economy changes some with each cycle. To be clear, consumption and production data have yet to turn up broadly enough or even narrowly enough for that matter to suggest recovery. A slower pace of decline is a positive development but it isn’t positive growth and changes in economic activity during a recovery have a plus sign in front of them. My view on most economic forecasts is that the bias is to look for growth in all the usual places, especially where the collapse had occurred, and look forward from there. In truth, it is impossible to tell in advance where the drivers of growth are going to be – no one would B aselin e R 25-M C posite Index PX SA om 20 6 20 4 20 2 20 0 10 8 10 6 20 8 0 2 9 00 21 00 21 01 21 02 10 0 6 ,00 10 0 4 ,00 10 0 2 ,00 10 0 0 ,00 8 ,00 0 0 6 ,00 0 0 4 ,00 0 0 2 ,00 0 0 20 08 20 09 21 00 20 1 1 2 12 0 R X 25-M ATransactions P S This inaugural issue of Blitz Report on Real Estate Markets is more introductory in nature than not. Ensuing monthly issues will explore more specific economic trends and activities with a focus on recognizing real estate related opportunities in the capital markets. If you have any comments or suggestions, please feel free to email Steve Blitz — sblitz@econmkts.com have forecast hi-tech in 1992 or single-family homes in 2002. The model that Pangea has developed is driven by interest rates, yield curves and credit spreads. Markets signal first the economy’s direction — fundamental data naturally lag. If Chairman Bernanke et al had understood credit markets a bit better in August 2007 the extent of the negative spasm in the economy might very well have been mitigated. Monetary and fiscal policy, yield curves, credit spreads, inventories, and the price of oil suggest that the worst is behind us and an upside is about to begin. The recent rise in oil prices is particularly telling. As the chart on the next page illustrates oil price spikes precede recessions and recoveries begin when falling oil prices stabilize and start rising. Delays and revisions in fundamental data consequently turn current market oil prices a leading indicator. There will not, however, be a “V” shaped recovery. If there has been one constant since the 1980-82 recession it is that it takes longer than expected for recoveries to ramp up employment growth. As for what drives the coming recovery, now that the historic twin engines of expansion — autos and Blitz Report On Real Estate Markets Page 2 Economic Overview cont’d homebuilding — are sidelined, look for a cheaper dollar. It is hoped that a cheaper dollar will generate growth through import substitution as well as growing the export sector. This potential source of growth becomes all the more important because consumption will grow more slowly with households frightened into saving and the collapse of asset prices keeping debt onerous and avenues for new credit closed.. The critical dollar relationship that needs to change is with the Chinese Yuan. Think of it not so much as dollar depreciation but East Asian currencies revaluing to the dollar to the extent that their trade surpluses would indicate. Keeping their currencies too cheap to the dollar is how China and the rest of East Asia ended up holding too many dollar assets in the first place. Baseline Forecast 2008 Personal Income (After-tax) Consumption Consumer Prices (x food & energy) Employment Fed Funds 2-Year Treasury 10-Year Treasury Mortgage Rate* RPX 25-Msa Composite 2.2% -1.1% 1.7% -2.8% 2009 5.0% -3.8% 1.5% -3.6% 0.3% 1.5% 4.3% 6.0% -10.4% 2010 3.9% 1.4% 1.6% 1.0% 1.5% 2.6% 4.8% 6.4% 11.7% 2011 3.8% 2.0% 1.7% 1.6% 3.0% 3.7% 5.2% 7.0% 13.8% 2012 3.7% 2.6% 2.1% 2.0% 3.8% 4.5% 5.5% 7.3% 4.1% YearEnd-Over-YearEnd Percent Change Year End Levels 0.2% 0.8% 2.4% 5.3% -21.6% YearEnd-Over-YearEnd Percent Change Real GDP Growth Vs Oil Real GDP QOQ SAAR (right scale) 12 8 4 200 150 100 -8 50 0 -50 -100 1980 1985 1990 Brent Oil USD YOY %ch (left scale) 1995 2000 2005 Vertical Lines Mark Recession End 0 -4 Blitz Report On Real Estate Markets Page 3 Leading Indicators For RPX The proprietary leading indicators that Pangea has developed are, like the fundamental model, pointing to higher prices – especially in those markets that have been hit the hardest. The major exception is the New York market, where the downturn has been less severe relative to Miami, Phoenix, and Los Angeles. The result is none too surprising considering that NYC has less possible recovery in price and still potential downfall from the losses in employment and income in the financial related industries that drive much of the New York area economy. 25 MSAs -- Home Price Leading Index 280 240 Radar Price Sq. Ft. (right scale) 200 160 Buy 120 80 Leading Indicator Sell 00 01 02 03 04 05 06 07 08 60 40 20 Leading Indicator 0 -20 -40 00 01 02 03 04 05 Sell 06 07 08 Radar Price Sq. Ft. (right scale) Buy Los Angeles -- Home Price Leading Index 450 400 350 300 250 200 150 100 30 20 10 0 -10 -20 -30 Miami -- Home Price Leading Indicator 240 200 160 Phoenix -- Home Price Leading Indicator 180 160 140 120 40 Radar Price Sq. Ft. (right scale) 20 Leading Indicator 0 -20 -40 00 01 02 03 04 05 06 07 08 Buy 120 80 40 300 200 100 Radar Price Sq. Ft. (right scale) 100 80 Leading Indicator Buy Sell 0 -100 00 320 280 240 Sell 01 02 03 04 05 06 07 08 NYC - Home Price Leading Indicator Radar Price Sq. Ft. (right scale) 40 20 0 -20 -40 00 01 02 03 04 Sell 05 06 07 08 Buy Leading Indicator 200 160 120 Blitz Report On Real Estate Markets Page 4 RPX and Capital Market Pricing Capital markets continue to price for lower home prices thereby creating investment and trading opportunities. Outright long positions could be taken in RPX forwards, ABS/ABX HEL or in various equity indexes tied to the residential housing market (see charts below). If less certain about HPA recovery but more certain that house price increases will be evident in RPX data before capital markets prices adjust then a long position in RPX forwards against short positions in any of these asset classes is an attractive opportunity worth looking into. Forward Contract Implied HPA For MSA Composite* vs Model Forecast (Cumulative %Ch from Initial Index Value of $207.49) Forward Market* Model Forecast *Fixing date: 06/09/2009 Dec-09 -22.89% -15.31% Dec-10 -31.56% -5.26% Dec-11 -31.08% 7.86% Dec-12 -26.74% 12.69% Dec-13 -23.85% RPX vs. Select Equity Indexes 1,600 RPX 25-MSA Composite Price (right scale) Forecast 280 300 RPX 25-MSA Composite Price (right scale) 250 Forecast 280 240 1,200 200 800 160 150 240 200 200 160 Capital markets continue to price for lower home prices, thereby creating opportunities … 400 S&P Homebuilding Index (left scale) 0 00 01 02 03 04 05 06 07 08 09 10 11 12 120 120 100 PHLX Housing Sector Index (left scale) 00 01 02 03 04 05 06 07 08 09 10 11 12 80 80 50 140 RPX 25-MSA Composite Price (right scale) 120 Forecast 280 RPX 25-MSA Composite Price (right scale) Forecast 280 240 200 160 240 100 200 520 480 440 400 360 320 280 240 S&P Home Improvement Retail Index (left scale) 120 80 80 S&P Homefurnishing Retail Index (left scale) 160 60 120 40 00 01 02 03 04 05 06 07 08 09 10 11 12 80 00 01 02 03 04 05 06 07 08 09 10 11 12 B l i t z R e p or t O n R e a l E s t a t e M a r k e t s Page 5 RPX vs. Select Equity Indexes cont’d RPX 25-MSA Composite Price (right scale) Forecast 280 240 200 120 160 100 120 80 60 40 20 00 01 02 03 04 05 06 07 08 09 10 11 12 50 00 01 02 03 04 05 06 07 08 09 10 11 12 KBW Bank Sector Index (left scale) 80 100 S&P Construction Materials Index (left scale) 120 150 200 200 250 240 300 RPX 25-MSA Composite Price (right scale) Forecast 280 160 80 RPX 25-MSA Composite Price (right scale) 160 280 Forecast 240 120 200 The strong correlation between the price behavior of these Equity Indexes and the RPX 25-MSA Composite creates opportunities to construct any number of attractive positions, hedged and not, that profit from the direction of home prices. 160 80 120 40 S&P Thrifts & Mtg. Fin. Index (left scale) 0 00 01 02 03 04 05 06 07 08 09 10 11 12 80 RPX and Fixed-Income Spreads 280 240 200 160 1.2 0.8 0.4 0.0 00 01 02 03 04 05 06 07 08 09 10 11 12 OAS spreads are from Barclays Fixed-Income Indexes RPX 25-MSA Composite (right scale) Forecast RPX 25-MSA Composite (right scale) Forecast 280 240 200 20 160 16 120 12 80 8 OAS: ABS Floating Rate Home Equity Excldng NR (Moody's) 4 (left scale) 0 00 01 02 03 04 05 06 07 08 09 10 11 12 OAS: Agency Conventional MBS 30 Year Priced btwn 100 and 102 (left scale) 120 80 Quantitative easing collapsed the OAS between Agency RMBS and Treasurys. When house prices do increase the OAS might actually widen as the Fed then chooses to reduce purchases or become an outright seller. There will be more opportunity in the OAS of related ABS when home price appreciation turns positive. Because our Model and leading indicators point to higher home prices, they suggest being long ABS and/ or ABX against Agency RMBS. Pangea Market Advisory Steve Blitz, Pres. & CEO 445 Park Avenue Floor 2 New York, N.Y. 10022 Email: sblitz@econmkts.com Phone: 646 747 6509 The securities/instruments discussed in this report may not be suitable for all investors. This report has been prepared and issued by Pangea Market Advisory primarily for distribution to market professionals and institutional investor clients. Recipients who are not market professionals or institutional investors should seek independent financial advice prior to making any investment decision based on this report or for any necessary explanation of its contents. This report does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. 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