Real Estate: Down, but Not Out

The lifeblood of real estate is debt, and the Federal Reserve has made borrowing a lot more expensive by raising interest rates five full percentage points between March 2022 and July 2023.

- JAMES K. GLASSMAN

Households owe $12 trillion on their mortgages, and businesses owe $5 trillion in commercial real estate loans. Both sectors are being affected by higher rates and by fallout from COVID. Lately, shares have rallied, but in many cases I find prices attractively low.

First, consider residential property. It's no surprise that existing home sales are expected to fall 16% this year. What's surprising is that new-home sales have held up well, as have prices, which are up about 4%, on average, over the past year. The economy has continued to perk along despite higher rates, with unemployment near record lows. And the COVID experience gave buyers an incentive to own larger homes, with space for offices and recreation.

After sharp declines at the beginning of the COVID pandemic, home-building stocks have rallied. Meritage Homes (symbol MTH, $149) and NVR (NVR, $6,306), which I recommended previously ("Homebuilders Get a Pandemic Boost," Feb. 2022), have since hit all-time highs. My third recommendation, KB Home (KBH, $54), is up 31%. I still like all three as long-term investments, but they are no longer the bargains they were. (Stocks I like are in bold; returns are as of July 31.)

Commercial real estate has been hit by a double whammy: higher interest rates combined with new patterns of work and shopping as a result of COVID. For many businesses with little public contact, a schedule of three days in the office and two at home is becoming the norm. Whether remote work will persist is unknown, but I am a skeptic. Meanwhile, brick-and-mortar retailers are staging an impressive comeback. My guess is that America will continue to revert to the pre-COVID mean.

Investors and analysts who soured on commercial real estate over the past two years may have gone overboard in their negativity. Vornado Realty (VNO, $22)