Since mid-2004, Ken Rosen has been saying the housing market has been bound to correct itself. The economist and hedge fund manager in turn has been shorting homebuilders and mortgage lenders and making long bets on apartment and office REITs.
It took some time, but his strategy is finally starting to pan out. In recent weeks, homebuilders have been getting hammered as several companies reported disappointing new order numbers. On the flipside, apartment REITs have been soaring as fundamentals in the sector rebound and
M&A activity heats up.
Rosen's $120 million hedge fund, Rosen Real Estate Securities, is currently 30% short homebuilders, 11% short residential mortgage REITs, and 9% short other equity REITs. The fund is 50% long apartment and office REITs.
Rosen's central thesis is that the runaway residential housing boom has to reverse at some point. At the same time, he's betting on the improving economy and lack of new supply to help office and apartment owners fill space, raise rents and post solid operating fundamentals.
"Since 9/11, we've had one of the most unusual periods in American history," says Rosen, who is also a professor of real estate and urban economics at UC Berkeley's Haas School of Business.
Whereas some people say there's been a change in demographics and housing demand, Rosen believes the vast majority of the housing explosion was instead due to easy money and cheap credit, which make the boom unsustainable.
He expects housing starts to drop from 1.7 million in 2005 to between 1.3 million to 1.4 million in 2006 and 2007. He says home sales will fall to 5.5 million to 6 million in 2006 and 2007, down from 7 million in 2005.
"It's not a perpetual motion machine," he says. "We borrowed all that demand from the future."
Although Rosen says he can't mention his specific holdings or talk about individual companies, borrowing demand from the future clearly applies to
. The builder's recent 29%
drop in new orders spooked the market and can be blamed on difficult year-over-year comparisons and a tough sales market. Some analysts now think Toll will be hard-pressed to achieve earnings growth over the next two years after the company doubled earnings in 2005.
Rosen projects sales will only get worse for builders, and he expects the 10-year note could yield 5.5% by the end of 2006. That will put "pressure on these guys to make their volumes. Volumes will be down in both the mortgage lending business and home building industries," he says.
While Rosen has taken some money of the table recently and rebalanced his homebuilder portfolio, he still thinks the sector could be in for another 30% decline as "earnings will be lowered dramatically for 2006 and especially for 2007" and housing remains weak for the next three years.
In the meantime, he admits that many REITs are getting pricey. But he likes the improving fundamentals of the office and apartment sectors.
Both property owners are benefiting from a lack of new supply and an improving economy. Apartment REITs are also being helped by the fact that owning a home has become a lot more costly.
In the office sector, Rosen particularly likes companies focused on New York, Los Angeles, and Washington, D.C. -- areas with strong job growth, increased leasing, and improving rents. While he declines to give names, companies that fall into this group could include
Although his overall long/short strategy didn't pan out too well over the past two years, Rosen says his fund has been able to post annual gains by making money even when he was wrong. His fund has long and short positions in every sector he trades (with apartments being predominantly long). Trading at the right time allowed him to book gains.
Rosen says his fund was up 7.1% in 2005 and 14% in 2004. Year-to-date, the fund is up about 1% but has been performing well of late, as homebuilders have tumbled and apartment REITs have soared.