Archive for January 2009
1/30/09 — Stacking the Dominos Back Up
I’m a Member of the Faculty of Valuation of the Royal Institution of Chartered Surveyors, headquartered in Great Britain. The only reason I mention that is they do a great job — much better than their American counterparts — at tracking and reporting information on construction, valuation, etc.
I received a very insightful missive from them this morning about U.S. residential construction. (Please don’t miss the irony here — a Seattle-based real estate economist depends on Londoners to report on U.S. construction trends.) Employment in the residential construction sector has been falling for 18 straight months, with 100,000 jobs lost in December alone. Note that all job losses in the U.S. in November and December totalled about 1-million, so residential construction losses in December accounted for about 10% of the total job losses. As of the end of 2008, housing starts are about as low as they’ve been in the past 40 years, and show no signs of doing anything but getting lower.
The President, Congress, and… well… everyone is committed to getting employment back up. Simply throwing money at the housing sector isn’t even close to being enough. There are a whole series of dominos which have fallen down, and before the residential construction domino can be picked up, all the rest have to be picked up as well. Builders and developers won’t commit to the risk of starting houses without some promise that these homes will be bought. For that to happen, the housing demand equation has to get back up on its feet again. For THAT to happen, buyers have to have some promise that home prices will quit tanking AND they have to have savings for down payments AND the nation needs a healthy lending infrastructure in place.
I tend to be a “glass half full” kinda guy, but clearly the residential construction industry will remain moribund until the employment numbers turn around, until the foreclosure mess gets fixed, and until the banking industry is working and lending again. Here’s the good news — there are glimmers of light at the end of the tunnel. Congress and the White House seem to be speaking with one voice on fixing things and getting people back at work. In general, economists forecast that unemployment will get a little bit worse this year, but not by the sort of huge numbers we saw at the end of 2008. Brace yourself for a round of corporate bankruptcies, but most of those are already discounted by the markets and most of those have already suffered layoffs.
There is a substantial generic demand for housing in the U.S. — our population continues to grow, particularly on the two coasts. Some theorists suggest that over-wrought lending preciptated too much construction (our rate of home ownership briefly touched 70%, and there are theories that this number should be closer to 60%). The prolonged construction nadir will sop up any excess supply in the market. Remember — millions of homes per year are still being bought, even though we’re in a recession. In short, once our economy starts back up out of the recession, the residential construction sector should react quickly.
In the meantime, investors who are bottom-fishing for bargains might consider that the window of opportunity won’t be open forever.
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Busy week — and it’s only Wednesday
On Monday, I spoke on Low Income Housing Tax Credits at the Rainier Club’s Real Estate Roundtable here in Seattle. It was a tag-team event — my co-speaker was Paul Cummings, who heads up Enterprise Community Partners’ Western Region. His portion of the presentation more-or-less summarized how that market works (short answer: affordable housing developers get tax substantial credits which they can either use, sell, or syndicate). My portion was to discuss the state of the market (it stinks really bad because the usual buyers of tax credits are in disarray). We both then summarized the pending legislation to fix things (Congress knows it needs to act, but is loathe to provide more aid to financial institutions. Something will be done very soon, and we hope it’s enough.)
On Tuesday, I attended an economic briefing presented by Jack Albin, chief investment officer of of Harris Private Bank. His talk was mainly centered on securities, and only briefly touched on real estate (and at that, on REITs). He found REITs a bit hard to read, because so much of their current dividend yield is in stock dividends. Fundamentally, though, I thought most of what he said was pretty good.
Then this morning, I woke up to find myself quoted in an above-the-fold article on the lead page of the business section of the Seattle Times. The article concerned the recent release of the Case-Shiller index, which essentially says that residential real estate prices tanked from October to November. I added a couple of caveats to that. While Case-Shiller is an excellent index, and one of only two residential pricing indices which currently “work” (the other being the one from the Office of Federal Housing Enterprise Oversight), the C-S index month-to-month statistics have to be taken with a huge grain of salt. These indices are based on actual sales of homes, and they work wonderfully during “up” markets (I had an article about such repeat-sales indices in the Journal of Housing Research a couple of years ago). However, during periods of market disruption, such as we have now, these pricing indices are skewed downward due to a bias in the data. In short, since the data only reflects actual transactions, it’s generally picking up a huge percentage of distress sales, foreclosure sales, and other sales under duress. My quotes in the article picked that up.
I also pointed out — for local consumption — that the Seattle market is still pretty vibrant compared to the rest of the country. While we’ve had some noteworthy lay-offs (Microsoft’s first layoffs in history), and our other basic employers are troubled, we still have one of the best economies in the world here in the Pacific Northwest. I’d much rather own a home here than in most of the other top-20 cities in the Case Shiller index.
Well, that’s it for today.
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Low Income Housing Tax Credits
This coming Monday, I’m making a presentation at Seattle’s Rainier Club to the Real Estate Roundable about Low Income Housing Tax Credits. It’ll be more-or-less a tag-team event — another fellow from the not-for-profit community will talk about their focus, while I’ll present the for-profit perspective.
These two communities (for-profit, and not-for-profit) really aren’t in competition with one another, although it seems that way sometimes. Both are recipients of a fairly finite pool of tax credits. In some locales, they work in tandem since the two groups bring different strengths to the table. In the Seattle market, where we’re headquarted and do much of our business, the two groups tend to go it “alone”.
Right now, though, these two groups are working together to try to get some sort of LIHTC relief out of Congress. In short (and this is a very truncated overview), tax credits are awarded for projects and can be used to offset other income for Federal tax purposes. The credits have to be used straight-line over a multi-year period, with no carry-backs or carry-forwards. Thus, the recipient of the tax credits (usually a developer of an affordable housing project) will sell or syndicate the tax credits to corporate buyers. Individuals can’t use the tax credits due to the passive loss rules, and corporate buyers need to be able to look down the road and predict a steady stream of taxable income in future years against which the credits can apply.
In recent years, the most likely buyers have been financial services firms — banks and insurance companies. In fact, some of these companies have subsidiaries set up just to buy the tax credits and help finance the projects. With the current roilling in the financial services sector, these industries have basically shut down buying, so the affordable rental housing development business is on the skids right now. This is a huge problem — something like half of the total apartment construction in America in the past 10 years has been in the affordable housing sector. With the collapse of home buying, the demand for affordable rental housing is soaring. In addition, this construction activity provides jobs, buys building material, and generates urban redevelopment.
You would THINK that such a win-win business would have Congress jumping to provide very modest support — ad actually the dollars needed to get this sector back on its feet are trivial compared to what’s being spent for the rest of the bailout. The problem is, it’s difficult to come up with a quick solution to this problem that DOESN’T use the financial sector as the conduit. Simply put, the financial sector is so heavily intertwined with the afforable housing sector, that the solution will either have to be channeled thru the banks and insurance companies OR we have to invesnt a new and costly conduit from scratch.
The first solution (using the financial sector as a conduit) is repugnant to Congress right now, since they’ve already sent the financial sector to the woodshed. The latter solution (re-invent the wheel) is both silly and probably un-do-able. So where does that leave us? With a gaping hole in our nation’s housing strategy and no quick fix in sight.
The good news is that there is widespread agreement that SOMETHING has to be done. Unlike the auto industry, there aren’t any nay-sayers complaining that affordable housing should be allowed to collapse. However — and this is terribly ironic — affordable housing woes affect all 435 Congressional districts approximately equally (OK, urban ones a little worse than others, but you get the picture). As such, we don’t have the Congressional delegation from one state (say, Michigan) championing this bail-out above all others.
Now it’s just a matter of finding a solution that Congress can stomach.
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January 20, 2009
I’d planned to start this on January 1, but that didn’t happen. (Actually, January 1, I was in Charleston, SC, at Renaissance Weekend, recovering from the parties the night before.) Given all that, it’s probably not a bad idea to start on the first day of Barack Obama’s presidency.
First, by the way, my congratulations to our new President. I’m available for ambassadorships to smaller, peaceful countries located on or near the tropics with good, indigenous rum and liberal attitudes toward Norte Americanos. Barbados comes to mind. Do we have an embassy in St. Barts?
Seriously, though, as I write this (4:30pm EST), the Dow Jones Industrial Average is closing down 332 points at below 8000. It naturally begs two questions — what impact does all this have on real estate, and what can be done about it?
To the first question, the markets generally realize that the Obama presidency does not imply a quick fix to anything. We’ll be lucky — extremely lucky — if the markets don’t get any worse before they get better. Consensus opinions — and I like the Livingston Survey from the Philadelphia FED — are that 2009 will be a muddled mess and 2010 will be the recovery year.
The biggest problem right now is in the credit markets. The government is simultaneously telling banks to tighten down on credit (so as not to make anymore “liar loans”) and to make more loans. Great. The banks need to find their most credit-worthy clients and give them unlimited lines of credit. It sounds good, but even at zero percent interest, money won’t get borrowed if the transactional costs exceed the returns. Imagine a homebuilder with a great line of credit (none of those exist today, so we have to imagine). If s/he built houses and no one could buy them, then “free” money from the bank is still w-a-y overpriced.
What do we do about it? Our economy is a series of cogs/wheels which interact with one another. If one or a few clog up, then it’s like a very small bird flying into a very big jet engine. (Readers of this blog a dozen years from now will miss the analogy — google USAIR 1549 and see what you get.)
Assuming “google” still means something a dozen years from now.
Anway, what do we do about it? The system really needs some support from the ground-up. The recent $700B or so (I’m losing count) was spent in a top-down effort to shore up the institutional structure. It wasn’t badly spent money, on the contrary. If we hadn’t spent that money, or at least something like it, then we’d be spending several times that in the first quarter of ’09 to re-create a financial system. Now, comes phase two — individual market participants have got to feel some safety and security in their jobs and homes before they’ll become market participants again. The stimulus package being discussed in DC is heartening — it spends a lot of money locally which has the promise of creating jobs, rather than just directly dumping money into consumption. Don’t get me wrong — consumption is good, but only if there is a fundamental jobs-based economy to back it up. We could put everyone on welfare and print enough money for everyone to shop to their hearts content, and our economy would grind to a halt pretty quickly — that’s basically what third-world dictators do with THEIR money. Hyper-inflation and total economic collapse generally follow that sort of strategy.
I think we’re moving in the right direction, but it will be a slow walk rather than a fast sprint.
Is there anything individuals can/should do now? I have a few ideas, but I”ll leave those until tomorrow.
From a small northwestern observatory... 