The Declining Market

Today’s guest post by Living Off Dividends & Passive Income who shares our views on the US economy and real estate markets.

According to Bloomberg.com;

Billionaire Sam Zell said the housing market could start recovering as early as next year and he’s focusing on investing in debt rather than equity.

“We believe that the opportunities, particularly in difficult situations, are in the debt,” said Zell, who made his fortune building the largest publicly traded office and apartment companies in the U.S. “We have been focused on, not only in real estate but in corporate, identifying debt situations where it is trading at a discount.”

Early next year the U.S. may see the bottom of the single- family housing market, Zell, 66, said in an interview today with Bloomberg Television. “I think it will be relatively fragile as confidence builds and it will take probably another year for confidence to be completely returned.”

Zell is focusing on debt as the real estate recession deepens. Existing U.S. home sales fell to a 10-year low in the second quarter and the median price for a single-family house dropped 7.6 percent. Record foreclosures have brought on more than $505 billion in capital losses and asset writedowns worldwide and companies that lent money to homeowners and repackaged the debt into securities saw those businesses falter.

Zell says he’s not buying property at the moment.

“I think the real estate market as a whole is fairly priced,” Zell said. “I think from a yield point of view, it might be attractive. But I am a capital investor and an entrepreneur, and I need to be able to invest in situations that by virtue of changing them, I can dramatically change value.”

Zell also said the U.S. government must be willing to step in to protect the debt of Fannie Mae and Freddie Mac’s, the two biggest suppliers of cash to the U.S. housing market.

“I think there is no question that the government’s responsibility must include protecting Fannie and Freddie debt,” Zell said. “It is extraordinarily important. They today represent 70 percent of the mortgage market in this country, and I think that percentage is growing as other lenders are moving away.”

If he really thought that real estate was on the upturn, don’t you think he would be buying property or at least getting ready to buy? The fact that he said he’s buying debt and in the same breadth mentions that the government should protect Fannie Mae & Freddie Mac’s debt indicates that he’s actually buying their bonds. Bonds issued by Fannie and Freddie should be just about as secure as U.S. Treasuries, which have the “full faith and credit” of the U.S. government behind them. But their yields remain far higher than Treasuries bonds, with the highest spread in two decades.

A 30-year Fannie Mae mortgage-backed security now yields around 6.5% which is 44% higher than a comparable 30-year Treasury at 4.5%. Incidentally, Standard & Poor’s recently cut the rating of Fannie and Freddie’s subordinated debt and preferred stock three notches to “A-” from “AA-.” However, the rating agency also confirmed they are maintaining the “AAA” rating of their bonds.

So I’m reasonably convinced that Zell, one of the smartest real estate investors ever, is buying Fannie Mae bonds as an alternative to Treasuries. For Bloomberg to claim that he thinks housing will turn a corner next year seems disingenuous.

If you’d like to invest like Zell, you can buy the First Trust/FIDAC Mortgage Income Fund (NYSE: FMY). Its entire portfolio is invested in “AAA” rated Freddie Mac debt and it currently yields around 7.6%. Note that this isn’t a recommendation to buy this Fund and I do not have a position in it.

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