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Facebook, Pharma, And Foreign Investors Bolster NorCal Real Estate

With over 25 years in the financial advisory and investment management business, I have no doubt seen the market's highest highs and lowest lows. Over the last decade in particular, our Bay Area-based firm has closely monitored the local real estate market, making bold statements and predictions about where it is headed and what this means for investors.

In 2003 we published "Potential Banking Crisis, " an article predicting that the U.S. banking system would become over extended and would experience a financial calamity. In July 2004, Dick Davis Digest reprinted an article from Valentine Capital Asset Management's newsletter entitled "Where is the Real Estate Market Headed?" The article predicted a real estate bust noting "a seven year real estate cycle should hit its peak the summer of 2006 and end in 2007. Once the market hits its peak, investors should expect a market bust." Our office received a backlash for our opinions when they were originally published - both of these forecasts came to fruition.

Another Bold Statement

If you are still waiting for real estate in Northern California to hit rock bottom, get comfortable. If you were considering when it might be the right time to buy, consider this: hordes of foreign investors are swooping in and purchasing houses and apartment buildings on the cheap in prominent areas like Silicon Valley. Facebook is about to launch perhaps the biggest IPO in history and looks to anchor the social network presence firmly. A biotech campus in Emeryville called QB3 is poised to be a stronghold for biotech firms and other innovators.

After several years of stagnation, the California residential real estate market is poised for recovery--triggered by banks, home developers and mortgage lenders who have collectively set the stage for growth in this sector. Although U.S. investors are understandably hesitant to buy-in, and seize such deals, high-net-worth investors willing to get in on the current level and buy distressed properties today stand to handsomely profit over the long haul. Right now, it is cheaper to pay a mortgage than it is to rent, if you do an apples to apples comparison of properties. As the for-sale housing market continues its slowing trend, the Bay Area rental market will remain a "landlord's market" according to experts. Rents have increased an average of 7% in each of the past two years with occupancy at over 97% (compared to an average of 90% nationwide).

As you may have gathered, I'm bullish in my stance on California residential real estate, mainly due to the supply and demand imbalance caused by overzealous bank lending, coupled with a modest growth in per capita income. This results in hyper-valued homes-many of which are vacant and have succumbed to foreclosure. But this phenomenon would not have happened if not for the relatively recent influx of new businesses to the area, igniting a new home construction boom that peaked just prior to the 2008 economic meltdown. When Chevron Corp. moved its national headquarters Northern California's East Bay, for example, their thousands of new employees prompted the construction of thousands of new homes, predicated on population growth projections that failed to materialize. Today, the vast majority of those homes remain unoccupied, while new home construction has dropped off precipitously. With a high percentage of major developers either out of business or under-employed, sidelined Caterpillar tractors are common sights, and big-name contractors once in high demand now flood Craigslist with ads while workers stand outside Home Depot to solicit jobs they're willing to do for fifty cents on the dollar.

That's a pretty bleak picture - so where's the silver lining? With California real estate likely already having hit rock bottom in my opinion, there is nowhere to go but up. I believe that interest rates will bottom out later this year, before the pendulum swings the other way, and rates begin rising again. While it's true that rates have generally fallen during the last 30 years, for the decades prior to 1980, rates were on the climb, and we are likely to find ourselves in a similar cycle sooner than later. This is important because in addition to stimulating downward pressure on bond prices, this occurrence is likely to foster an atmosphere where investors fear "missing out" on lower interest rates and begin to buy properties suddenly, quickly driving up values. Guess what - it has already begun.

Why now, why at all? With market volatility presently in full swing, California real estate offers a way to diversify away from equities and fixed income, and into hard assets. And most modern investment portfolios could benefit from radical asset allocation overhaul right about now. As a wealth transfer strategy, we look at relations of about 15 different ratio metrics, including the measurement of hard assets to paper assets. Hence, for each investor, stock to bond to real estate holdings will vary, depending on years to go until retirement and other factors. But in general, the time horizon for return on investment in real estate will fall in the five to ten year range.

In the meantime, as the economy slowly improves, investors who buy units in high-end apartment buildings are likely to immediately see secondary income streams in the form of rental income. One reason for this is the legions of first-time business professionals who are making a decent income for the first time, but who none-the-less fail to qualify for new homes and are loathe to move in with their parents - they make excellent tenants.

Surfin', Surfin' U.S.A

The California residential real estate market has admittedly battled an image crisis, because U.S families are skeptical about the prospect of buying foreclosed real estate properties that sell at a discount of 25% or more. Thankfully, this worry is slowly beginning to diminish, thanks in part to the influence of Asian investors from Pakistan, India and China, who have been riding the wave in, gobbling up these properties. Tour buses regularly transport Asian investors all throughout Northern California, so they can participate in foreclosed property auctions in Bay Area places of interest, like Palo Alto or Fremont, which has seen such an influx of Asian residents and investors, it has earned the nickname "Little Kabul".

Facebook is about to launch an IPO, and is here to stay. This IPO is expected to be perhaps the biggest in history. This is social money, cloud money. In other words, this money talks, and the sky's the limit. In Emeryville, a 43 acre campus for bio-tech companies is nearing completion. Genentech, Bayer, Glaxo all call this area home and it is being configured attractively for new businesses to get started as well as veteran multi-nationals. Without question, the housing market is overdeveloped. And forecasting the sweet spot where freefalling housing prices definitively bottom out considers many factors. But it is profoundly telling, when on a daily basis, County Courthouse auctioneers are calling out million dollar properties as if they're yelling out bingo numbers at the retirement home. And although acquiring property in this manner may seem unconventional, it is a method that can work well. I don't know about you, but I like to be ahead of the wave myself - so if the surf's up, its time to carve it up. Another way of putting that might be: I never recommend anything I do not or would not do myself. Get your board, jump in and start paddling - CA real estate will come back, and the waves haven't looked this good in a long time.


By John Valentine - John Valentine is Founder and Chief Investment Strategist of Valentine Capital Asset Management, Inc. John is well-established in the field of portfolio management and has been independent since 1989. Prior...  

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