Key to Real Estate Rebound...

By: NICK TIMIRAOS And ANTON TROIANOVSKI from Wall Street Journal

After dragging the U.S. economy into a severe recession, property markets across the country now are relying on an economic recovery to help cure their hangover in the new year.


The housing sector, weighed down by a glut of unsold homes, needs job growth to boost demand and curb the flow of delinquent loans into foreclosure. For commercial real-estate investors, lackluster hiring means fewer new jobs to fill empty office space and less consumer confidence to drive activity in stores and distribution warehouses.

"The No. 1 biggest risk is that, for whatever reason, the overall economy does not grow sufficiently to produce any meaningful rebound in jobs," said Thomas Lawler, a housing economist in Leesburg, Va.


For housing markets, the past year was another bumpy ride. Home prices stabilized in the first half of 2010 as the government offered tax credits to spur sales, but transactions plunged to 15-year lows after that stimulus expired. Sales have rebounded only modestly and at the current pace, it would take 9½ months to work through the volume of existing homes listed for sale.

The market dodged a bullet in March when the Federal Reserve ended its purchases of $1.25 trillion in mortgage-backed securities. Many analysts expected rates to rise, but they defied expectations by falling to 60-year lows, thanks first to the European debt crisis and later as the U.S. recovery faltered. (As the year ended, rates were rising but they remained historically low.)

Tail winds to spur a recovery are gathering. Large price declines have made housing more affordable than at any point in the last decade. New housing construction is stuck at its lowest levels in more than 40 years. "That will help absorb supply in ways that a lot of people underestimate," Mr. Lawler said.

But sellers also still will have to chop prices. Overall, prices are down 29.6% from their July 2006 peak to October 2010, according to the Standard & Poor's/Case-Shiller price index. Many analysts expect home prices to decline by an additional 5% before stabilizing later this year. "We're bouncing along a bottom," said Ivy Zelman, chief executive of housing research firm Zelman & Associates.

Moreover, credit standards are still tight. And while mortgage delinquencies peaked in February 2010, foreclosures could remain at an elevated level for years as banks work through a huge backlog. The most realistic "best case" scenario for 2011 would "simply be a year in which things do not get worse," wrote Morgan Stanley housing analysts in a research report.

One of the most stubborn problems is the 10.8 million homeowners who owe more than their homes are worth, or 22.5% of all mortgage borrowers, according to CoreLogic Inc. These so-called underwater borrowers can't easily sell their homes, and they are at risk of defaulting if they lose their jobs.

Housing faces additional uncertainty because the government is set to reconsider how aggressively to support homeownership. Deficit hawks have their sights set on scaling back the mortgage-interest deduction, and the Obama administration later this month will put forth a proposal on how to revamp Fannie Mae and Freddie Mac and the broader mortgage market.

"What goes on in Washington will be of critical importance to housing," said John Burns, an Irvine, Calif.-based home-building consultant.

Another wild card: Regulators and prosecutors could uncover sloppy practices from the heyday of the housing boom. In September, some of the nation's largest banks, including units of Bank of America Corp. and J.P. Morgan Chase & Co., were forced to suspend foreclosures due to potentially fraudulent document-handling procedures.

Banks say they haven't evicted anyone who hasn't defaulted, but the foreclosure machinery has been slow to restart nonetheless. Some real-estate lawyers warn that problems could be worse if it turns out that loans weren't properly recorded or transferred during the process of bundling mortgages and selling them as securities.

Banks already face rising costs as foreclosures become more time-consuming. Investors, meanwhile, are pursuing new efforts to force banks to buy back money-losing mortgage bonds.

In commercial real estate, last year saw some markets start to come back after a dreadful 2009. The biggest winner: Washington, where the federal government sustained demand for office space from contractors, lawyers and lobbyists.

More broadly, downtowns across the country have seen things start to turn around, while suburban areas are still reeling from excessive construction and the economic ripple effects of the housing bust.

Vacancy rates are near historic highs, from 10.9% in retail space to 17.6% for office buildings across the country, according to data firm Reis Inc. The pace of construction starts for hotels, office buildings and other kinds of commercial real estate is still falling, with the total of $47 billion in commercial construction starts from January to November 2010 more than 8% below the same period the previous year, according to Reed Business Information.

When the economy does start posting a stronger recovery, investors will be watching how commercial real estate responds. There is concern that companies are figuring out how to use less space per employee, reducing new office-space demand, while the growing popularity of online shopping could eat into demand for retail space.

But in the financial markets, things are looking up. The market for commercial mortgages sliced, diced and sold on Wall Street is widely expected to expand this year amid investor demand and more certainty about where the real-estate market is heading.

J.P. Morgan Chase predicts that some $45 billion in commercial-mortgage bonds will be issued for U.S. assets in 2011, well above last year's level of roughly $10 billion but still a pittance compared to the 2007 peak of $228 billion.

For both landlords and lenders, amid falling rents and rising vacancies, low interest rates were a saving grace in 2010. As long as rates stay low, many commercial-real-estate players should be able to ride it out this year, as well. "If all this cash is still searching for yield, where else will it go?" said Murray McCabe, J.P. Morgan's real-estate investment-banking co-head.