US Real Estate Investment Trusts (REITs) Bubble Rolling Over! Foreign Financials Flying!
Housing-Market / Global Stock Markets Jun 22, 2007 - 09:30 AM
Mike Larson writes : Just a couple weeks ago, I told you that the bond market had suffered a critical break. Now, we're seeing Real Estate Investment Trusts (REITs) roll over, too.
The benchmark exchange-traded fund for this sector, the iShares Dow Jones U.S. Real Estate Index Fund (IYR) , just broke through critical technical support. In other words, investors are voting with their feet and saying the bubble in commercial real estate is finito.
Just look at the chart!
This should come as absolutely no surprise to you …
In September 2006, I first started warning about how overvalued many REITs were. I suggested you exercise caution, saying, "If you're hip-deep in commercial real estate holdings, this may be a good time to step away from the table and call it a day."
Then, earlier this year, I singled out apartment REITs as being in particular trouble. My take was that many of the flippers and speculators who snapped up homes and condos during the boom wouldn't be able to sell them. Instead, they would dump their units onto the rental market. And that would hurt traditional apartment landlords.
By early May, I ratcheted my warnings up a notch . I said takeover mania in the sector had gone too far. I pointed out that commercial mortgage lenders had gone bonkers, just like their residential counterparts did during the housing bubble.
Lastly, I highlighted the underperformance of REIT shares, and said it was time to "jump off the REIT bandwagon."
Look what's happened since: The IYR is already down 16% from its early February high.
And I'm expecting even deeper losses in the months ahead. What will fuel such a move? Tighter debt and financing markets, that's what.
As I've said before, commercial lenders lost their marbles during the commercial real estate boom …
They financed anyone and everyone who wanted to buy an office building, shopping mall, or industrial park, using aggressive assumptions about rent growth and valuations in the process …
And they were aided and abetted by a dramatic influx of liquidity from the "secondary market" for commercial mortgages. That's where bundles of commercial loans are sold off, or "securitized," as a form of bond to investors.
In the past few weeks, however, lenders and investors have started finding religion. They're scrutinizing borrowers more closely and getting skittish about the performance of commercial mortgage bonds. That's draining liquidity from the system, and lowering valuations for commercial property.
As a great Wall Street Journal story, "Skyscraper Prices Might Start Returning to Earth," put it on June 2:
"Driving the boom were low interest rates and easy loan terms — similar to the home-buying boom — that allowed buyers to borrow as much as 95% of the value of the building, compared with roughly 75% historically.
"In recent weeks, lenders have become worried that prices have gotten so high that buyers wouldn't be able to raise rents high enough to pay off their loans. In response, the interest rates that buyers have to pay have risen, and banks have demanded that buyers put up bigger portions of the purchase price."
Bottom line: Yet another real estate bubble appears to be starting to deflate here in the U.S. If you jumped off these high-flyers when I told you to, congratulations! You dodged this carnage, and you're in great shape to ride the profit waves that are unfolding in other sectors, industries, and countries.
Let me tell you about one area that I like right now …
Plenty of Opportunities in Foreign Financial Firms
The real estate industry and overall economy is suffering here in the U.S. But it's an entirely different story overseas.
Think about it: Who gives credit cards and consumer loans to upwardly mobile citizens in India? Who lends funds to the Brazilian companies that are building telecommunications networks and hydroelectric plants, or extends credit to citizens in emerging markets like Eastern Europe and Turkey? Who provides the money to build all those Chinese office towers and factories?
The banks, that's who! And as long as the underlying economies where they operate continue to boom — like they are — they're the ones who are going to mint money.
Heck, I've been seeing juicy opportunities everywhere I look …
India: A few weeks ago, for instance, I recommended that my Interest Rate & Currency Trader subscribers target one of the titans of the Indian financial industry.
The stock recently shot up to a fresh all-time high, before pulling back to consolidate those gains. I think even more upside lies dead ahead!
Reason: Indian economic growth is off the charts. Gross domestic product in the $854-billion economy surged 9.2% last fiscal year. And we're likely to see another 8% or 9% rise in the current fiscal year.
That growth stems from the country's rapid industrialization and the emergence of a vibrant consumer class, one that's spending like never before. We're also seeing a massive surge in development projects designed to modernize the entire country.
One prominent banking official expects India to spend $500 billion on infrastructure and manufacturing projects over the next three years. Longer-term, Prime Minister Manmohan Singh recently estimated that India will shell out $320 billion just on roads, airports, and ports through 2012.
Again, the important question to ask is: "Who's funding all those improvements?" And the answer is, India's leading banks. Loan volume for these guys is on track to rise 25% or more annually for the next few years.
Europe: Safe Money Report subscribers hit paydirt earlier this year when Dutch financial giant ABN Amro got swept up in a takeover battle with multiple suitors. But I think there's more money to be made in European financial shares. Why?
For one thing, more intra-Europe takeovers are likely. The region's banks and insurers there are trying to cut costs, boost efficiency, and gain scale. Combining with each other allows them to do these things quickly.
Plus, these companies are riding a wave of international expansion into higher-growth markets. That's boosting their earnings potential.
One European giant I like just announced a $2.7 billion takeover deal in Turkey. It's snapping up a bank there because economic growth in Turkey has been averaging more than 7% for the past few years. Consumer bank loans are surging, up more than 20-fold since 2003!
China: It's the same story. Insurance companies and banks are seeing business boom along with the economy. Chinese bank loans are growing by more than 15% and Chinese insurance premiums surged 24% year-over-year in the first four months of 2007.
I just recommended call options on one of my favorite plays in that market. Yesterday, they soared in value after the insurance company struck a partnership deal with a U.S. private equity firm. The two companies are going to explore ways for the insurance firm to participate in the boom in Chinese real estate, a move that should boost returns.
How You Can Ride the Global Financing Wave
Investing in overseas financials isn't risk-free. We're still talking about stocks, after all. And foreign markets can be volatile, trading wildly on the latest news in the currency, bond, and stock markets — even while you sleep!
But for a portion of your more speculative funds, I think investing in foreign financial firms can really pay off. And you have at least three ways to play this trend …
Choice #1: You can buy a global financial mutual fund or exchange-traded fund. One ETF that comes to mind is the WisdomTree International Financial Sector Fund (DRF) . It holds more than 200 of the world's top financial firms, with companies based in the U.K., France, and Austria topping the list.
One caveat, though: Interest rates are rising in many countries right now, which means this kind of "shotgun approach" to buying global financial firms may not be the best way to go.
Choice #2: You can try zeroing in on individual global financial stocks. For example, you could look into the American Depository Receipts (ADRs) of foreign firms.
A great place to get started is the NYSE Euronext exchange's search tool , which allows you to research foreign companies that trade on the U.S. exchange. Many banks and insurers are represented there.
Choice #3: If you're looking for even bigger gains and strictly limited risk, consider trading options on interest rates and global financial firms. Again, this is something you can research on your own.
Or, for more guidance and specific names, give my Interest Rate & Currency Trader a try. I'll tell you exactly what options on interest rate instruments and leading global financial firms look best poised for gains. Not all positions will be winners, of course. But as I mentioned, we've had some nice successes in global financial stocks already, and I'm expecting even more in the months ahead.
Until next time,
Mike Larson
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