MARKET ANALYSIS REPORT

A detailed statistical analysis of the US property market for Investors and Financial Advisors by DGC Asset Management Limited.

US HOUSING MARKET ANALYSIS Q4 2012

Author: David Garner | Date: January, 2013 | Sector: Property | Market: United States Copyright DGC Asset Management Limited 2013. No part of this report may be duplicated without permission.

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CONTENTS
FOREWORD EXECUTIVE SUMMARY BACKGROUND CURRENT MARKET ANALYSIS Housing starts Building permits New home inventory Competitive market activity New home sales Existing home sales Property values Market confidence Affordability SUMMARY 16 4 5 6 7-15

FOREWORD
A report from DGC Asset Management designed to offer a factual insight into the current health of the US housing market. This report has been prepared by the Senior Management Team at DGC Asset Management, and is designed to provide Investors and Financial Advisors with a reliable source of factual references indicating the current state of the US housing market, and an overview of current investment opportunities. The report has been constructed utilising various credible data sources, and references a range of research sources which are all quoted in the content of the document. UK Investors should seek the advice of an authorised Independent Financial Advisor with experience of the asset class before committing to any financial investment. DGC work directly with both Investors and their Advisors, providing detailed information on the portfolio risks associated with various real-asset alternative investments, having participated in a range of transactions in the property and real-asset space. Under currently prevailing market conditions, many Investors and Financial Advisors are actively reducing their exposure to financial markets, and seeking alternative assets in an effort to boost returns and reduce beta (volatility risk). The current environment for Investors is defined largely by:
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Economic uncertainty (poor visibility) Price volatility in mainstream assets Concerns over inflation Poor returns on cash deposits

tangible assets that retain capital value and generate income, display a number of these characteristics, and whilst not without its own inherent risks, many Investors are now allocating greater proportions of their portfolios to the sector (mostly real estate and natural resources) in an effort to capture financial gains that are not derived from the performance of financial markets. A lack of credible, unbiased asset class analysis, and an inability for financial regulators to define realproperty as a regulated investment, has made investing in property-based alternatives risky, as a poor flow of realistic performance data and risk analysis has led many Investors to part with capital in exchange for over-priced assets, poor management and in some cases, outright fraud. We aim to position our consultancy service at DGC as a central, credible point of reference for Investors and Financial Advisors seeking reliable information on the portfolio characteristics and real risks/opportunities associated with a broad range of real-asset alternative investments.

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Consequently, Investors are seeking alternative assets that display the following characteristics:
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Tangible assets that retain capital value Simple, secure investments involving direct ownership of underlying tangible assets Productive assets that generate tax-efficient income Assets that share a Low, zero or negative correlation with financial market performance Capital growth supported by solid fundamental trends

Real estate assets i.e. physical,

David Garner, Partner Investments DGC Asset Management Limited

EXECUTIVE SUMMARY
interviews with a range of entities and individuals currently operating in the market including US-based Accredited Investors, US-based licenced Real Estate Agents, Mortgage Bankers, Investment Analysts and active Real Estate Investors. When assessing the current state of the market we found that the majority of indicators, including; Housing Starts; Building Permits; New Home Inventories; New Home Sales; Existing Home Sales; Property Values and Affordability Indices amongst others, displayed broadly positive trends, indicating that, in many markets, the beginnings of a slow and sustained recovery might indeed be underway. When speaking to Investors and Agents operating in the market, we found that the primary investment strategy has changed somewhat; with US Investors (both Institutional and Accredited Investors) aiming to acquire and hold significant volumes of single family homes for the rental market, aiming to dispose of the assets at market value sometime in the next 4 to 7 years. This differs from previous surveys conducted last year where US Investors were buying foreclosures to sell into the open market. We also found that US Investors found the majority of deals offered to UK Investors via Agents of poor value; with the majority of inherent equity already extracted and distributed across a range of Agents, Wholesalers and middle men. Considering our research, and building on our existing relationship s with professionals operating at the grass roots of the market, DGC Asset Management has structured and delivered investment strategies offering meaningful risk mitigation, allowing retail Investors to participate in the inherent profit at the very beginning of the investment cycle, alongside Local Investors and Selling Agents.

With so many Agents offering property investment opportunities based on the acquisition of bank-foreclosed properties in the United States, there remains a dire need for useful, credible information allowing Investors and Financial Advisors to properly assess the risks and opportunities associated with acquiring and utilising physical real estate in the US housing market as a portfolio optimisation and diversification tool. The main aim of this Research Report which is updated and published on a quarterly basis; is to investigate and analyse the markers and indicators covering the key factors supporting the US property market, from house prices, affordability, builder confidence and new construction. In order to properly analyse the current state of the market, we have used a variety of credible data sources, all of which are referenced throughout this document. Furthermore; we conducted informal telephone

DGCs own investment strategy; the Secure Income Strategy (SiS), in partnership with Portland Funding LLC and the True Wholesale group of companies mirrors that of US Investors; acquiring high-yield single family homes for the rental market; with disposal planned within 4 to 5 years. At January 2013, the SiS portfolio comprised 232 properties owned and under management worth approximately $13 million. $129,736.14 in gross rents was collected in January, and of that, $51,164.03 was paid out to investors participating in the project. Investors currently hold an equity gain above their original investment of around $2,275,000.00 For more information on this project; contact DGC Asset Management Limited: info@ dgcassetmanagement.com.

2. BACKGROUND
After recovering from the Great Depression, America had a prosperous 40 years of economic growth. The internet bubble of the late 90s and subsequent progression made in technology led to an explosion of financial products known as derivatives. Many finance experts and advisers insisted that these made the market more stable, when in reality they did not. Warren Buffet referred to these new financial products as weapons of mass destruction. Along with this, many banks consolidated to create fewer but larger firms. Some would say that the larger the bank, the less chance the government would let it go down in a time of crisis (too big to fail), and as such this gave these institutions a disproportionate amount of power. As a result of this increased power, banks were able to force de-regulation even further. Over the last decade securitisation of CDOs (Collateralized Debt Obligation) took place. CDOs were amongst the most deadly of derivatives and within these financial instruments were mortgages. A high percentage of these mortgages were subprime however, they were still given AAA ratings. With no regulatory constraints, banks, lenders and brokers began making riskier mortgage loans. Between 2000 and 2003 mortgage loans in the U.S. nearly quadrupled. Although the sub-prime CDOs were higher in risk the interest rates were higher and investment banks preferred these as a result. This led to predatory lending on a massive scale. Brokers were incentivised to push the higher risk higher returning mortgages, placing borrowers in mortgages without the means to repay them. Because these CDOs were so attractive the Banks started borrowing more to lend more, some borrowing up to 33 times the collateral they actually held. The Aftermath Incentive structures which included paying bank bosses million dollar bonuses were generated to create short-term profits but which imposed no penalties for later losses. This encouragement for brokers to push these mortgages eventually led to massive consequences for the U.S. financial system. From 2001 to 2007, billions of dollars flowed through the securitisation chain. Since anyone could obtain a mortgage, this pushed the values of houses through the roof. The sub-prime mortgage industry had increased from 30 billion dollars to 600 billion dollars and house prices doubled. This was the biggest bubble in financial history, only it did not seem to be a bubble about to burst, after all the notion was you cant lose money from investing in bricks and mortar, can you? Many homeowners had borrowed up to 99.3% of the value of their homes. This meant that should anything go wrong, the homeowner had very little of their

own money in the deal, they simply walked away. 1/3 of mortgages defaulted, and foreclosures in the U.S. reached 6 million by 2010. As a result banks are now holding back from listing as much as 70% of their repossessed homes, in a likely bid to delay absorbing further losses on their balance sheets. Either banks are overwhelmed and cannot get the houses listed quickly, or they are deliberately slowing down so they do not have to take markdowns to actual home values on their books.

3. CURRENT MARKET ANALYSIS

3.1 HOUSING STARTS The term Housing Starts refers to the number of privately owned new houses on which construction has been started in a given period. As any market requires new entrants in order to support the market; housing starts are seen as the base foundation of a property market, and consistent growth in housing starts is a relatively reliable indicator of growth in the market as Constructors are prepared to invest in new projects if they are confident of achieving sales. In February 2012, US housing starts were up almost 15 per cent year on year, almost 19 per cent from 2010 levels, and 26 per cent from the lows of 2009. Whilst encouraging and definitely the start of an upward trend, the actual numbers show a long recovery ahead (good news) as February starts hit 698,000, still much more room to grow in order to reach 2005 highs of over 2 million. On May 16, the Commerce Department reported new housing starts rose 2.6 per cent to an annual rate of 717,000 units in April. And Marchs figures were revised upward from an annual rate of 654,000 to 699,000. In August, housing starts rose again by 2.3 per cent to an annual rate of 750,000, around middle-range of a Bloomberg survey of 85 Economists which had predicted an annual rate of between 740,000 and 800,000. Construction on new U.S. homes jumped up 12.1% in December 2012 to a seasonally adjusted annual rate of 954,000 - the highest level since June 2008 - with gains across the country, as well as in single-family homes and buildings

US Housing Starts February 2009 to December 2012

1200000 1000000 800000 600000 400000 200000 0 2009 2010 2011 2012

3.2 BUILDING PERMITS Because receiving a Building Permit is the first step in the construction process, the figure is used as the earliest indicator for developments in the housing market alongside housing starts. Additionally, because of the high outlays required for construction projects; an increase in Building Permits implies an increase in investment and corporate optimism. Finally, the figure offers some limited insight into consumer activity since new home purchases are associated with an increase in sales of "big ticket" durable goods. Given such connections to consumer and corporate sentiment, real estate generally leads economic developments thriving at the start of a boom and waning at the onset of recession. In 2009, there were 583,000 permits issued, in 2010 there were 604,600, and by 2011 the number of permits issued had risen again to 624,100. This demonstrates a simple annualised rate of growth of 3.52% since 2009, and the latest figures published in December 2012 a seasonally adjusted annual rate of 903,000, a growth of 28.8 per cent year on year. The chart (right) clearly shows the impact of the run up to the subprime mortgage crisis on the number of building permits issued. At that time, Constructors were less confident in selling new homes and so were not seeking permits for new projects; also finance for development had virtually dried up. From 2009, we see a point of capitulation followed by steady growth in the number of permits issued, again indicating that House Builders are gaining confidence in the market.

US Building Permits Issued 2004 to 2012 (in thousands)

2,500.0 2,000.0 1,500.0 1,000.0 500.0 0 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: United States Census Bureau Building Permit Survey

3.3 NEW HOME INVENTORY New home inventory is the number of new homes available for sale at any point in time. Because the housing market is seasonal by nature, most Analysts report seasonally adjusted information. Seasonally adjusted inventory figures allow Investors, House Builders and other interested parties such as Financiers to compare inventory levels for all months of the year. New home inventory figures are closely watched by homebuilders and lenders. Slow sales and/or increases in construction can cause

the months of inventory indicator to rise. A rise of only one month, from 4.0 to 5.0 months of supply for instance can be very damaging to builders given the sensitivity of the construction industry to interest payments on builder profit margins. A rise in inventory is also an early warning indicator that sales are slowing, competition is increasing, and price wars could begin. At the time of writing, new home inventories are comparatively low. In January this year, new home inventories dived to their lowest level on record at 150,000 units, and fell further to 143,000 in March, levelling off to 146,000 in April.

According to Analyst Ken Lee at Hanley Wood Market Intelligence; Months of new home inventory remain at levels that are typical in a healthy housing market. (source: Hanley Wood | May 2012 | www.hwmarketintelligence.com) The latest figures published in December 2012 show new home inventories remained at 150,000 units, or 4.9 months of seasonally adjusted supply. This compares favourably with 5.4 months of seasonally adjusted supply as at the same time last year indicating a 9.3% improvement.

68%
Number of homes sales receiving competing bids across 6 States 3.4 COMPETITIVE MARKET ACTIVITY A good sign of a recovering market is the occurrence of counter bids between prospective buyers of specific properties. Whilst this evidence is purely anecdotal, it is more than interesting to see the reemergence of this kind of competitive activity which may indicate a healthy sellers market. Redfin, an internet based real estate broker with offices in 14 states reports that agents encountered multiple bids on about 50% of offers in Seattle, Boston, Washington D.C. and Oregon in the year to date up until March, and

March 2012
Lowest new home inventory level on record nearly 83% of offers that Redfin agents have made on behalf of clients in the San Francisco Bay area this year and 71% in Southern California have had competing bids. Elsewhere, stories of bidding wars are emerging across multiple US States. BusinessWeek recently reported that Matthew and Carina Hensley offered $10,000 more than the asking price for a threebedroom house in suburban Seattle, then lost out to one of seven other bidders. The Wall Street Journal recently reported the story of Andy Aley, a 31-year-old attorney from Seattle who offered up to $23,000 above the $357,000 listing price and agreed to waive inspections and other closing conditions.(Source: Wall Street Journal | April 2012 | http://online.wsj.com) In June 2012; the number of houses listed for sale nationwide dropped 24% compared with the year prior, sending the supply of homes relative to buying activity down to levels not seen since 2006. That's led to some stiff competition among buyers, says Sin-Yi Chao Lambertson, a broker in Glendora, Calif.: "I've had listings get 45 offers."

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3.5 NEW HOME SALES Many Analysts consider that it is altogether likely that new home sales have declined to a bottom, leaving ample room for growth and recovery. In 2011, new home sales fell to 302,000 units the worst reading on record. For comparisons sake, in 2005, 1.28 million new homes were sold. In February however, new home sales were recorded at an annualised rate of 313,000 units, an uplift of over 11% year on year and in May; the Commerce

Department reported that new home sales had risen 3.3% to an annual rate of 343,000. The latest figures for December 2012 show that new home sales were recorded to a seasonally adjusted 369,000-unit annual rate. It was a notable monthly decline with sales falling 7.3% since November, but rising 8.8% above the level seen in December 2011. Most Analysts and the general media have put the monthly decline seen in December down as a temporary blip, with the general

consensus being that sales are steady and growing, fuelled by cheap mortgage finance and bargain property prices.

Monthly New Home Sales August 2011 to November 2012 (000s)

390 380 370 360 350 340 330 320 310 300 1-Nov 1-Dec 1-Jan 1-Feb 1-Mar 1-Apr 1-May 1-Jun 1-Jul 1-Aug 1-Sep 1-Oct 1-Nov 1-Dec

Source: U.S. Department of Housing and Urban Development

8.8%
Growth in new home sales Dec 2011 to Dec 2012

11.2%
Annual growth in new home sales to November 2012

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November sales were revised down to 4.39 million from an initially reported 4.42 million. The preliminary annual total for existinghome sales in 2012 was 4.65 million, up 9.2 per cent from 4.26 million in 2011. It was the highest volume since 2007 when it reached 5.03 million and the strongest increase since 2004. Mark Zandi, chief economist for Moodys Analytics Inc. in West Chester, Pennsylvania said, The housing crash is finally giving way to recovery in an increasing number of markets across the country, and the decline in unsold listings and vacant homes and the increase in rents presage better times ahead for single- family housing. According to Trulia Inc, Low values and interest rates have made buying a better deal than renting in 98 of the largest 100 metropolitan areas. Total housing inventory at the end of December fell 8.5 per cent to M-o-M Change 3.2% -5.9% -3% 5.1% Y-o-Y Change 10.3% 15.5% 14.7% 8.8%

1.82 million existing homes available for sale, which represents a 4.4-month supply at the current sales pace, down from 4.8 months in November, and is the lowest housing supply since May of 2005 when it was 4.3 months, which was near the peak of the housing boom. The median time on market for all homes was 73 days in December, up from 70 days in November, but is 26.3 per cent below 99 days in December 2011. Distressed homes - foreclosures and short sales - accounted for 24 per cent of December sales (12 per cent were foreclosures and 12 per cent were short sales), up from 22 per cent in November but below the 32 per cent share in December 2011. Foreclosures sold for an average discount of 17 per cent below market value in December, while short sales were discounted 16 per cent.

3.6 EXISTING HOME SALES Sales of existing homes are clearly a strong indicator of the health of a property market. The National Association of Realtors reports that the total existing-home sales, which are completed transactions that include single-family homes, town homes, condominiums and co-ops, rose 5 per cent to a seasonally adjusted annual rate of 4.61 million in December 2012. Region Northeast Midwest South West Annual Sales 640,000 1.12m 1.95m 1.23m

Median Price $231,600 $144,800 $161,100 $239,900

Y-o-Y Change 5.3% 12.3% 11% 17.3%

Source: National Association of Realtors

14.5%
Year on year growth in existing home sales to December 2012
Source: National Association of Realtors

5%
Monthly rise in existing home sales in December 2012

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3.7 PROPERTY VALUES There are two broad measures of home prices at the national level in the United States; the S&P/CaseShiller National Home Price Index (10 and 20 city composites); and the Federal Housing Finance Agency House Price Index. The S&P/Case-Shiller 20-City Composite Home Price Index measures the value of residential real estate in 20 metropolitan areas of the U.S. which seeks to measure changes in the total value of all existing singlefamily housing stock.

As of December 2012; the index was at 146.08 (October 2012), and posted returns of 4.3 per cent over 12 months and 0.9 per cent annualised over 10 years. The housing crash was evident in the 5year and 3-year annualised returns at -5.42 per cent and -0.9 per cent respectively. Source: S&P Case Shiller National Home Price Index 20 City Composite. The Federal Housing Finance Agency House Price Index provides a more detailed analysis of homes prices on a national and regional basis.

In the latest figures to November 2012; the FHFA Index showed that house prices had risen by 0.6 per cent for the month and 5.6 per cent year on year on a seasonally adjusted basis, and the index is 15.2 per cent below its April 2007 peak and is roughly the same as the August 2004 index level. Furthermore, national home prices have not declined on a monthly basis since January 2012. Source: Federal Housing Finance Agency

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4.3%
Year to date rise in S&P 20-city composite index

5.6%
Rise in home prices year to date November 2012, FHFA

Figure1: Seasonally adjusted and unadjusted monthly appreciation rates - Purchase only index - USA
2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% Aug 11 Oct 11 Dec 11 Mar 12 Apr 12 May 12 Aug 12 Sep 11 Nov 11 Feb 12 Sep 12 Oct 12 Jun 11 Jul 11 Jan 12 Jun 12 Jul 12 Nov 12 -2.0

Unadjusted Index Seasonally Adjusted Index

Source: Standard and Poors

Four-Quarter Appreciation 2012Q3 (Purchase-Only Index, Seasonally Adjusted)

-2.6% to 1.5% 1.6% to 3.5% 3.6% to 6.0% 6.1% to 21.1%

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3.8 MARKET CONFIDENCE Whilst hard to quantify with data, market confidence is seen as the best anecdotal indicator of a housing recovery. A number of large institutional investors are now moving forward with plans to acquire single family homes enmasse. Colony Capital in Los Angles, which previously invested in over $4 billion of defaulted mortgage loans with the Federal Deposit Insurance Scheme has raised $750 million from institutional clients for a new Real Estate Investment trust (REIT) investing in single family homes for the rental market, and a number of pension funds are also setting up investment vehicles in order to participate in the high yield opportunities that abound. Another such Investor - the Blackstone Group; the largest private equity Investor in the world, has acquired more than $100 million of discounted real estate assets every week, intending to either rent or sell for profit. Builder confidence in the market for newly built, single-family homes was unchanged in January 2013 according to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index, remaining at a level

of 47. This means that following eight consecutive monthly gains, the index continues to hold at its highest level since April of 2006. Derived from a monthly survey that NAHB has been conducting for 25 years, the Index gauges builder perceptions of current single-family home sales and sales expectations for the next six months as good, fair or poor. The survey also asks builders to rate traffic of prospective buyers as high to very high, average or low to very low. Scores from each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view conditions as good than poor. According to Barry Rutenberg, chairman of the National Association of Home Builders (NAHB) and a home builder from Gainesville, Fla; Conditions in the housing market look much better now than at the beginning of 2012 and an increasing number of housing markets are showing signs of recovery, which should bode well for future home sales later this year. However, uncertainties stemming from last months fiscal cliff negotiations contributed to the pause in builder confidence and continuing discussions among policymakers related to spending

cuts and the future of the mortgage interest deduction could put a damper on housing demand in the coming months. The Indexs components were mixed in January. The component gauging current sales conditions remained unchanged at 51. Meanwhile, the component gauging sales expectations in the next six months fell one point to 49 and the component gauging traffic of prospective buyers gained one point to 37.

66%
Growth in builder confidence April 2012 to January 2013

18.6%
Growth in 6-month sales prospects in September

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per cent in the last year. 30 year fixed rate borrowing costs hit an all-time low of 3.87 per cent in February down from 4.95 per cent a year ago. NAR's National Housing Affordability Index stood at 198.2 in November, based on the relationship between median home price, median family income and average mortgage interest rate. The higher the index, the greater the household purchasing power; recordkeeping began in 1970. With 11 months of data reported, 2012 will clearly go down as a record year for favourable housing affordability conditions, and a great year for buyers who could get a mortgage, according to the National Association of Realtors. 3.9 AFFORDABILITY As previously mentioned within this document, house prices are sitting around 30 per cent below previous peaks, and at the same time rentals prices are increasing. In fact, the National Association of Realtors Housing Affordability Index hit a record high of 206.1 in January. (A value of 100 means a family earning the national median income can afford a median-priced property at current mortgage rates.) A separate study undertaken by Deutsche Bank reports that the average rent is now 15 per cent more than the average home loan payment up from just over 8 per cent in the previous quarter. This creates an ideal buying environment, encouraging new entrants to re-enter the housing market. Its worth noting, too, that borrowing costs are down about 20 An index of 100 is defined as the point where a median-income household has exactly enough income to qualify for the purchase of a median-priced existing single-

family home, assuming a 20 per cent down-payment and 25 per cent of gross income devoted to mortgage principal and interest payments. For first-time buyers making small down payments, the affordability levels are relatively lower. For all of 2012, NAR projects the housing affordability index to be a record high 194, up from 186 in 2011, which was the previous record. November's reading was 2.5 index points below October, but up 1.5 index points from a year earlier. Source: National Association of Realtors The National Association of Home builders also produces an Affordability index in association with Well Fargo Bank; the Housing Opportunity Index (HOI). Figures to Q3 2013 show the national Median Home Price at $189,000 and the weighted interest rate for a fixed rate mortgage at 3.8 per cent, putting the HOI at 74.1 per cent.

90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: NAHB Wells Fargo Housing Opportunity Index

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SUMMARY
The general tone of this Report has been largely positive, and the majority of datasets, indices, anecdotal evidence and interviews conducted with active Investors and Realtors, would all lead one to believe that a sustained recovery in the US real estate market is underway, however a note of caution is advised. Readers must take into account that broad figures such as national house prices and the like are not an entirely accurate indicator of the real goings on at the grass roots of a property market as they are comprised of ever changing variables, and one must remember that it is in fact purely facilitated demand that drives growth i.e. demand for property that turns into sales of property due to the availability of mortgage finance and an abundance of creditworthy buyers. Therefore for a sustained recovery to take place it would require consistent increases in wages and a consistent decrease in unemployment, whilst also ensuring a constant flow of affordable finance, and as the current low mortgage rates are set more by political policy rather than by the market, they will at some point begin to increase, making it more expensive for new entrants to buy homes. It is fact that house prices are about 10 per cent above 1990 levels, and the cost of a mortgage in 1990 was about two and a half times higher than it is today, and real disposable incomes have increased over 70% since 1990, housing prices are best thought of as being incredibly cheap. This certainly presents opportunities for Investors, but household debt is much higher than in 1990, and many homeowners are still holding considerable negative equity, although these households are generally not participating in the resale market at present. From an Investors perspective, there are opportunities to profit from the US housing market, however acquiring long-term exposure to real estate assets might be a little pre-emptive, and ultimately end up as a negative cash flow investment that is difficult to sell. If another recession ensues then tenants are less likely to meet rental payments, yet the on-going costs will continue. Entering into joint ventures with Local Investors who are prepared to share both the inherent capital gains and ongoing risk offer a solution for those seeking low risk exposure to the market and who might be satisfied with lower yields in exchange for risk mitigation and the selling agent retaining a vested interest in the property. DGC Asset Management Limited offer two direct property investment products designed to mitigate the risks associated with the US real estate market and property investing in general. For more information on our current range of products and services, please contact your Advisor, or email for a no obligation consultation on: info@dgcassetmanagement.com or call 0044 (0) 207 043 2592.

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