From a small northwestern observatory…

Finance and economics generally focused on real estate

Trump’s Tax “Reform”

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Mark Twain is usually — and incorrectly — quoted with the phrase “No man and his money are safe while Congress is in session.  (The actually quote goes to 19th century NY politico Gideon Tucker, but I digress.)  There’s little to be said, in general, about TheDonald’s proposals yesterday, simply because there’s little substance to analyze.  However, I’m old enough to remember the last tax overhaul, in the early stages of the Reagan administration, and perhaps I can offer a few observations.  I’ll limit my mental meanderings to real estate for now.

First, the Reagan tax re-hab (the 1986 Tax Act) was a disaster for real estate investing, particularly at the individual, atomistic investor level.  One of the “loopholes” to be cured was the elimination of deductibility of passive losses on real estate investments.  The real estate community reluctantly supported the tax act, in trade for increases in the deductibility of home mortgage interest and a guarantee that passive losses on then-existing real estate deals would be grandfathered.  Indeed, in the run-up to passage, there was a flurry of investing (by Main Street USA folks — the kind of folks who still, amazingly, support Trump) in just such “grandfathered” investments.  At the last minute, the grandfathering was removed, costing Main Street USA investors tons of alternative minimum tax payments on now-sour investments.  Some pundits suggest that this grandfathering-revocation, alone, led to the downfall of the Savings and Loan industry, but that excuse is a bit to simplistic.  It did, however, shut down the time share industry for a while.

Today, according to news reports, single family residences are enjoying record demand (which may or may not be good news).  The hottest market is among first-time buyers, and the demand is greatest among starter homes.  The Trump proposals would double the standard deduction for a married couple filing jointly.  While, on the surface this seems like a good idea, it will drastically shrink the number of tax payers who itemize mortgage interest and property taxes.  In short, for the biggest tranche of homebuyers, the biggest differentiation between ownership and renting would be effectively removed.  As a guy who invests in rental property, that’s nice, but the home building industry won’t react well.

Otherwise, I don’t see lowering the marginal tax rate on corporations as having much of an effect on real estate investing.  For one, most of those projects are either done thru tax-advantaged REITs or thru other pass-thru entities, like partnerships and LLCs.  Even if it did, the demand / supply of investment grade real estate depends on other factors, and slight changes in the tax rate may have an impact on the debt/equity mix, but not on the aggregate output of new commercial construction.  The ONE area most affected will be low income housing, which is funding in no small part by tax credits.  The value of those credits will be slashed, requiring a complete re-thinking in the finance side of low income housing.  The last time such a tax cut went into effect, it was a real mess for low income housing.

If I was the government, and I wanted to create good paying construction jobs, I’d embark on a long-term infrastructure redevelopment plan.  That would probably require actually raising tax rates a bit, but would have marvelous returns on investment for middle America.  But that’s just me….

A word about “health care”

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The debate in America seems to be split between two warring factions — the “I’ve got mine so screw you” group, and the “Basic healthcare is a basic right” faction.  Admittedly, constitutional strict constructionists could see it both ways.  The Preamble clearly states that it’s the role of the Federal government to ensure the general welfare, and that has usually been held by the Courts to mean some level of equality.   The Constitution says nothing about education, but once states began providing education to some citizens, Brown v. Board of Education held that it had to provide essentially equal education to all.  The commerce clause says nothing about running a lunch counter in a Woolworth Store, but once Woolworth started serving anyone, it had to serve everyone.  (By the way — why doesn’t this apply to people who make wedding cakes?  But, I digress….)

The reality is we HAVE very broad access to basic health care.  Admittedly, for complex procedures such as cancer or transplants, this generalization falls apart.  (Remember the old adage — all generalizations are false, including this one.) However, a child suffering a 104 degree fever, or a car wreck victim, or someone suffering from a stroke will generally not be denied basic health care in America, albeit admittedly it may not come as immediately or as nicely as it comes to TheDonald or…. me.

I’ll digress again.  Quite a few years ago, we lived in a major city with one big public hospital and a couple of private ones.  For a variety of reasons, our health care plan required we use the public hospital.  As the father of four small (at the time) children, one can guess I made more than one visit to the emergency room.  It was not the nicest place in the world.  Patients with open wounds were stacked up in the waiting room, having been triaged by a nurse and now waiting patiently to see a physician.  Often, treatment waits were hours, but everyone got treated.  Later, I had a much more liberal health plan that allowed us to use one of the private hospitals.  Guess what?  Completely different emergency room.  Subdued lighting.  Music.  Comfie chairs.  Almost immediate service.  Almost no wait.  Felt like a 5-star hotel.  I was shocked they didn’t have a wine list.

What we have in America is a health care FINANCE problem.  Quite frankly, I pay top dollar and expect the best health care.  However, I don’t deny that my less-fortunate neighbors should also get good, basic health care.  I drive a nice car.  I don’t deny my neighbor the right to drive on the same road as me, albeit in a less-nice car.

We recognize that some form of transportation access is a basic right, and indeed an economic necessity if everyone is going to get to work.  However, not everyone gets to ride in a limo.  Some folks ride the bus.  From an economists perspective, we need to figure out how to provide FINANCING for everyone, so that the folks with no insurance don’t just randomly pass off the cost of their health care to me.

That said, I don’t mind the fact that there should be some personal mandates, but perhaps not the way you think.  If my neighbor, who drives a crappy car, wants to share the highway with me, then he also needs to have a drivers license and insurance and tags on his car.  If he repeatedly refuses to do these things, he’s not denied transportation, he’ll just have to get his transportation via the city bus.  Similarly, there is a shockingly large number of folks who only go to the physician when they have chest pains.  These folks should be required to see a doctor regularly and get regular check-ups and inoculations and vitamins and such.  If this sounds totalitarian, it’s no more onerous than what we require for you to drive a car.

I thought Article 1 of the health care plan that went down to defeat last evening was fair and reasonable — leaving kids on their parents policies until age 26, and not denying insurance for pre-existing conditions.  The system has to accomodate the kids and the pre-existing conditions one way or another, and so providing for these within the health care finance system is reasonable.  The roster of basic rights (maternity care, screenings, portability, etc.) were also economically reasonable.  The bill went down to defeat for two reasons.  First, the White House was comically amateurish.  I believe Jed Bartlett’s west wing staff would have handled this much better, and provided Paul Ryan with the tools he needed to twist arms.  That said, this White House has zero clout on Capitol Hill, and that basically means we have no government for the next 3.75 years.  While that may sound to some of you like a good thing, wait until some random crap hits the fan, as it always does.

Second, the very deep conservatives in the GOP don’t want ANY sort of government involvement in health care.  They really do believe that health care is not a universal right.  It has nothing to do with finance – it has to do with the fact that when they go to the emergency room, they don’t want to be sitting next to a poor person.  They really do have the view that if you can’t afford food, you can starve.  (Remember — this government denies — with a straight face — the linkage between a good breakfast and school performance.)  If you can’t personally afford health insurance, under their theories then the door to the hospital is barred.  Pence was, reportedly, giving a talk recently and was asked what does a person have to do to get the same level of health care as he gets.  Pence replied, “join the Air Force.”  Ahem…. that pretty much says it, doesn’t it?



Written by johnkilpatrick

March 25, 2017 at 12:48 pm

Posted in Economy

Tagged with , , , ,

Sears on life support

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I write mainly about real estate, and while the glass has been more than half full these past few years, the recent announcements from Sears are troubling, to say the least.   For those not keeping up with such things,  In their most recent annual report, Sears made a “going concern” announcement, which essentially said that there is a reasonable chance they will not survive as a going concern for another year.

This is a massive problem, and the real estate issued will take years to sort out.  Sears has announced some steps to try to address this, including selling off real estate, selling key brands (Kenmore, Craftsman) and shutting badly performing stores.  However, they’ve already been doing this for years.  Craftsman is now owned by Black and Decker, they’ve been shutting stores for over a decade, and they formed Seritage REIT several years ago (in no small part owned by Warren Buffett) to monetize their real estate holdings.

As of the most recent reports, Sears runs about 1500 stores in the U.S., mostly under the mastheads “Sears” and “K-Mart”.  They employ 178,000 people, and had revenue of $22 Billion in 2016.  They’re bleeding cash, losing about $1.2 Billion in cash in the past 2 years.  Their net equity now stands at negative $3.8 Billion, according to recent reports.  At an average store size of about 100,000 square feet, they operate about 150 million square feet of retail space, which will be a real problem to deal with.  (I’m writing this while sitting in my office in Key West.  There are 5 big “anchor tenants” of shopping centers in Key West.  Three are groceries, and the other two are owned by Sears.)

Dumping 150 million feet of retail floor space into the market is a pain any way you look at it.  Currently, new retail construction in America is about half that.  However, this “new retail construction” includes a lot of stuff that doesn’t look like an old Sears or K-Mart store.  Indeed, repositioning big-box and anchor tenants can be a daunting challenge, and often the best use is demolition of the structure and repurposing of the vacant site.  Losing a big anchor retailer can blight an entire shopping center and need an entire large neighborhood.

One might suggest that a leaner, meaner Sears could be in the offing.  In someone’s dream world, Sears and K-Mart might retrench to half their current size — say 700 or 800 stores.  This is still a big problem, but at least kicks some of the cans down the road.  I’m a real estate guy, not a retail guy, but I think the problems of running a small chain of big, diversified retailers is pretty obvious.  Distribution, financing, and brand management will all die on the vine.  No, Sears and K-mart have bigger problems.  Sears tries to sell to a slice of the market that doesn’t shop much anymore (your grandmother) and K-Mart tried to be Wal-Marts scruffy little brother.  Neither of these retail strategies work very well.

We’ll see how this turns out, but the complexity of a Sears bankruptcy will keep real estate consultants busy for years to come.

Written by johnkilpatrick

March 24, 2017 at 8:20 am

Thus Spoke Janet

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Yeah, who else tried to slug their way thru Thus Spoke Zarathustra back in their halcyon days?  Now that the storms of autumn breath over my career, I find the pronouncements of Janet Yellen every bit as obtuse as Nietzsche.

I’ll try to make it simple. CNBC had an excellent piece this afternoon.  If you borrow money, you’re going to pay more.  If you invest in debt instruments, you’re not going to get paid more.  Simple?

So what does this mean for real estate?  I’ll posit a few axioms.

  1.  If you have a home equity loan and a first mortgage, and you have positive equity, you need to rush to your friendly banker and refinance all that into a fixed rate loan before happy hour this evening.
  2. If you’ve been planning to buy a house with a loan (as most people do) then yesterday was the day.  Today maybe.  Tomorrow… eh…..
  3. If you can invest in rental property, look for “equity positive” locations.  These are cities with solid economics, but the cost of construction is disconnected to the local rental rates.  Existing rental houses sell for a discount to new construction.  Buy all you can grab.
  4. There are three different explanations for the shape of the yield curve — rational expectations, debt stratification, and liquidity preference.  Today, liquidity preference trumps the other three.

Written by johnkilpatrick

March 15, 2017 at 1:08 pm

Economics of Climate Change

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To give credit right up front where credit is due, today’s post was stimulated in no small part by an excellent piece written for NPR last month by Angus Chen titled 1,000 Years Ago, Corn Made This Society Big.  Then, A Changing Climate Destroyed It.

In “all my spare time”, I’ve wondered a bit about the dichotomy of North American natives versus Europeans.  The latter developed a relatively advanced society by the time of Columbus, while the former seemed to be living in the bronze age.  I’ve really not had the time, effort, or inclination to study it much, and the few pieces I’ve read didn’t seem to be very robust, from a scholarship perspective.  One stream of research notes that pre-Columbian Europe, in the crossroads of trade among three continents, had more complex influences.  However, North American tribes traded among themselves, and before the Europeans brought gifts of small pox and syphilis, the population of this continent was certainly at a critical mass.

One of the less convincing arguments stemmed from lack of wheat.  In short, a population needs a robust agriculture in order to sustain modern civilization.  One farmer needs to be able to feed more than him or herself.  To me, this was also suspect — I’d been taught as a grade schooler that east coast natives actually demonstrated advanced cultivation techniques to European immigrants.  Chen’s article turns all this on its head by noting the Mississippian American Indian culture, a group of farming societies ranging from north of St. Louis down to present day Louisiana and Georgia.  The most prominent of these was the city of Cahokia, about 15 miles east of present-day St. Louis.  Around the 9th and 10th centuries AD, this society was fairly robust and successful, with large cities, complex agriculture, and trade.  In the absence of wheat, their principle row crop was corn, and apparently this contributed their diets in the same way wheat contributed to Europeans.

However, by the time Europeans came in the 15th century, these cities had already been abandoned.  Modern research now pins the failure of this civilized society on climate change.  The rains which sustained the corn crops for hundreds of years dried up, and by 1350 AD the region faced profound drought that lasted up to 500 years.

Climate change and crop failures led to destabilization of society and government.  Current archeology points to construction of palisades, burned villages, and skeletal injuries consistent with warfare beginning around 1250 AD.  Scientists are reluctant to blame the  entire collapse on climate change, but rather that climate change was probably one of a series of problems that brought down this remarkable American civilization.

The vast majority of scientists today concur that climate change is real.  Something on the order of 97% of recently published peer-reviewed empirical studies support this.  Admittedly, there is less concurrence regarding the impact of human factors, such as CO2 emissions, but the majority of scientists still seem to agree that at the very least, human intervention has probably accelerated existing trends.  That said, speaking as an economist, this all has implications for societal change which must be addressed in an organized, cogent manner.

Written by johnkilpatrick

March 9, 2017 at 1:37 pm

So, how’s Real Estate?

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OK, OK, OK — we get it.  The stock market has been the “place to be” the past few months.  Actually, it’s been a great place the past few years.  You may not realize it, but 2016 was the first year in the past 6 that the S&P 500 did NOT turn in a double-digit return.  That said, the S&P came in at 9.4% for the year, and that’s nothing to sneeze at.  The Nasdaq turned in 7.5%, also a decent number.

So, comparatively speaking, how were the returns in Real Estate?  Two of the best markers for that are indices produced by the National Association of Real Estate Investment Trusts (NAREIT) and the National Council of Real Estate Investment Fiduciaries (NCREIF).  NAREIT is made up of 167 publicly traded equity REITs and 34 mortgage REITs (for our purposes, we’re only interested in the equity side).  These have a total market capitalization of slightly over $1 Trillion.  NCREIF is an index of non-securitized commercial properties, generally owned by tax-exempt institutions, and totals slightly over $500 Billion in value.  Both indices do a pretty good job of benchmarking commercial real estate returns.

For 2016, the NAREIT index came in at 8.63%, or slightly above the NASDAQ and slightly below the S&P.  The NCREIF index came in at 7.97%, also not a shabby number.  Because of the nature of the NCREIF index, it’s not quite as granular as the NAREIT index, and only reports quarterly.

However, NAREIT reports monthly, and also gives us some return numbers on a sector basis.  This can be very telling, because it reminds that an equally weighted REIT portfolio may be inferior to one more carefully chosen.  Year to date, the NAREIT index has come in at 4.19%, which is somewhat below the S&P’s 6.68%.  However, some sectors such as timber, specialty, and single family homes have turned in double-digit returns already this year, and data centers, infrastructure, and manufactured homes have also bested the S&P.  On the other hand, shopping are actually turning in negative returns thus-far this year (notably, regional malls came in negative for 2016).  The industrial sector has turned negative in 2017, but enjoyed the top returns of all sectors in 2016, at 30.72% for the year.  Lodging/resorts is also negative thus-far in 2017, and also turned in significant positive returns in 2016 at 24.34%.

As always, this is not a recommendation or solicitation to purchase any particular investment, and prior returns are not indicative of what may happen tomorrow.  This is just a blog — nothing more than that.

Written by johnkilpatrick

March 2, 2017 at 8:32 am

Dreams of GDP growth

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Paul Krugman and I don’t necessarily agree on everything, either in politics or economics, but I respect his research (and yes, envy his Nobel Prize).  That said, he has an insightful piece on his blog about The Donald’s economic projections, which both Paul and I find probably untenable.  I encourage you to read it here.

In short, The Donald projects 3% to 3.5% GDP growth throughout his tenure in the White House.  Under Reagan, it was at the lower end of this scale, and under Clinton it hit 3.7%.  Remember that both of those presidents inherited crappy economies, and so  a pendulum bounce in GDP would have been expected.  The Donald is inheriting a healthy overall economy (admittedly, with pockets of problems).  As such, growth in the 2+% range is more likely. So why are they projecting such glossy numbers?  In short, they back into what they need to say in order to fit their rosy projections.

I would note that the Chair of the Council of Economic Advisors sits vacant as of this writing, with no nominee in the offing.  This Council serves the president, among other ways, by putting a reasonableness test on just such projections.  Truly excellent economists have served on this Council thru the years, from all sides of the economic spectrum (and yes, there are more than two).  In the absence of trained, academic economists in this role, these projections are left up to whim.

Unlike Paul K, I have some hope that Paul Ryan may be a voice of sanity here.  He seems to understand that balance sheets need to balance.  Let’s see how that works out.

Written by johnkilpatrick

February 21, 2017 at 12:00 pm