All real estate is local
The real estate recovery has been uneven. Some parts of the country are outperforming others.
As you can see from the chart above, the Pacific and Mountain states have outperformed the rest of the country over the past two years. The Middle Atlantic and New England states have underperformed.
The FHFA House Price Index breaks down home price appreciation by region and by state. There has been quite a bit of divergence as the West Coast has rallied and the Northeast has grown more slowly.
While economic differences between the states explain some of this, another important consideration is that some states have very borrower-friendly—or creditor-unfriendly—policies. These policies slow down price appreciation. For example, some states require a judge to approve all foreclosures.
As a result, New York, New Jersey, and Connecticut haven’t made much of a dent in foreclosed homes’ shadow inventory. Meanwhile, states like California dealt with the pipeline years ago. This explains why prices are rising in California real estate but are lagging in the Northeast.
Real estate companies must watch their geographic exposure
Real estate companies like Colony Financial (CLNY) and Northstar Realty Finance (NRF) invest in non-guaranteed MBS (or mortgage-backed securities), which means that these companies take credit risk. This separates them from agency REITs like Annaly Capital (NLY). While being underwater does not necessarily mean a borrower will stop paying—in fact, the vast majority of underwater homeowners are current on their mortgages—it does mean that the severities (or losses) go up if the lender has to foreclose.
As an investor, you should examine these companies and determine what sort of geographical concentration they have. Diversification can certainly help.
Investors who would like to trade the real estate sector through an ETF should look at the iShares Mortgage Real Estate ETF (REM). Those who are wishing to make interest rate bets should consider the iShares 20+ Year Treasury Bond Fund (TLT).