Real Estate Foundations Look a Little Wobbly | Katonah Real Estate

Is it too late to catch the real-estate rebound?

Just a few years after suffering its worst downturn since the Great Depression, housing has seen a remarkable recovery. Skimpy interest rates, pent-up demand and lower prices have sparked gains of about 20% in the median price of new and existing homes over the past two years.

The Dow Jones U.S. Select REIT Index—which covers a number of investment vehicles—has climbed about 150% since the beginning of 2009, roughly matching the Standard & Poor’s 500, including dividends.

But the market’s foundation is starting to wobble. In June, home prices fell 0.2% compared with May’s levels, according to the seasonally adjusted S&P/Case-Shiller Home Price Index tracking the 20 largest cities. It marked the second consecutive monthly decline. The dip the month before marked the first time in about three years that prices fell on a monthly basis.

True, prices for June rose 8.1% compared with last year, and data tracking the sentiment of home builders has improved. But every city in the U.S. has seen home prices rise at a slower annual rate lately. Mortgage applications to buy a home recently fell to their lowest levels since February, refinance applications were the weakest since 2008, and housing starts dropped in August.

“The pace of slowing…has been somewhat more abrupt than we had expected entering the year,” says Michael Gapen, a senior economist at Barclays, who says there’s “downside risk” to his bank’s expectation that home prices will rise as much as 8% this year.

What’s going on? In part, the soaring prices of the past couple years have started scaring off first-time buyers. Those higher prices have also encouraged homeowners to put homes up for sale, adding new inventory. Meanwhile, investors, who played a key role in stabilizing the market by buying bargain properties, have become more cautious.

The slowdown is good news for home buyers, of course. And recent weakness in real-estate investments, including home builders, has created opportunities for bargain hunters, some analysts say. But if the Federal Reserve begins raising interest rates next year, as expected, the cost of financing will increase—making things tougher for buyers and investors alike.

Below is a look at the new real-estate game and the best ways to play it.

REITS: Beware Rising Rates

One of the attractions of REITs is that they pay at least 90% of taxable income to shareholders as dividends, about 4% on average lately. But analysts say many real-estate investment trusts are trading at expensive levels. And rising rates could undercut REITs by making their dividends look less compelling compared with bonds.

Expensive valuations don’t mean avoiding REITs, analysts say—just shifting to larger, high-quality REITs with lower borrowing, such as Sam Zell‘s Equity Residential and AvalonBay Communities Inc., each of which pays dividends of more than 3%. Because of their size and balance sheets, these are seen as safer bets if rates rise