From a small northwestern observatory…

Finance and economics generally focused on real estate

Archive for February 2012

Latest from S&P Case Shiller

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The always excellent S&P Case Shiller report came out this morning, followed by a teleconference with Professors Carl Case and Bob Shiller.  First, some highlights from the report, then some blurbs from the teleconference.

The average home prices in the U.S. are hovering around record lows as measured from their peaks in December, 2006, and have been bounding around 2003 prices for about 3 years.  Overall in 2011,  prices were down about 4% nationwide, and in the 20 leading cities in the U.S., the yearly price trends ranged from a low of -12.8% in Atlanta to a high (if you can call it that) of 0.5% in (amazingly enough) Detroit, which was the only major city to record positive numbers last year.  In December, only Phoenix and Miami were on up-tics.

One thing struck me as a bit foreboding in the report.  While housing doesn’t behave like securitized assets, housing markets are, in fact, influenced by many of the same forces.  Historically, one of the big differences was that house prices were always believed to trend positively in the long run, so “bear” markets didn’t really exist in housing.  (More on that in a minute).  With that in mind, though, w-a-a-y back in my Wall Street days (a LONG time ago!), technical traders — as they were known back then — would have recognized the pricing behavior over the past few quarters as a “head-and-shoulders” pattern.  It was the mark of a stock price that kept trying to burst through a resistance level, but couldn’t sustain the momentum.  After three such tries, it would collapse due to lack of buyers.  I look at the house price performance, and… well… one has to wonder…

As for the teleconference, the catch-phrase was “nervous but hopeful”.  There was much ado about recent positive news from the NAHB/Wells Fargo Housing Market Index (refer to my comments about this on February 15 by clicking here.)  The HMI tracks buyer interest, among other things, but the folks at S&P C-S were a bit cautious, noting that sales data doesn’t seem to be responding yet.

There are important macro-economic implications for all of this.  The housing market is the primary tool for the FED to exert economic pressure via interest rates.  Historically (and C-S goes back 60 or so years for this), housing starts in America hover around 1 million to 1.5 million per year.  If the economy gets overheated, then interest rates can be allowed to rise, and this number would drop BRIEFLY to around 800,000, then bounce back up.  However, housing starts have now hovered below 700,000/year every month for the past 40 months, with little let-up in sight.

Existing home sales are, in fact, trending up a bit, but part of this comes from the fact that in California and Florida, two of the hardest-hit states, we find fully 1/3 of the entire nation’s aggregate home values.  The demographics in these two states are very different from the rest of the nation — mainly older homeowners who can afford now to trade up.

An additional concern comes from the Census Bureau.  Note that for most of recent history, household formation in the U.S. rose from 1 million to 1.5 million per year (note the parallel to housing starts?).  However, from March, 2010, to March, 2011, households actually SHRANK.  Fortunately, this number seems to be correcting itself, and about 2 million new households were formed between March, 2011, and the end of the year.   C-S note that this is a VERY “noisy” number and subject to correction.  However, the arrows may be pointed in the right direction again.

Pricing still reflects the huge shadow inventory, but NAR reports that the actual “For Sale” inventory is around normal levels again (about a 6-month supply).  So, what’s holding the housing market back?  Getting a mortgage is very difficult today without perfect credit — the private mortgage insurance market has completely disappeared.  Unemployment is still a problem, and particularly the contagious fear that permeates the populus.  Finally, some economists fear that there may actually be a permanent shift in the U.S. market attitude toward housing.  Historically, Americans thought that home prices would continuously rise, and hence a home investment was a secure store of value.  That attitude may have permanently been damaged.

“Nervous, but hopeful”


Retail and the Internet

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First, if you can only read ONE magazine every week, it must be The Economist.  If I were to go into hibernation for a year (or 20, for that matter), a cover-to-cover read of the current issue would bring me up-to-date on pretty much every topic of major importance, both in the U.S. and globally.  And no, I don’t get a kick-back from them on subscriptions.

The current issue has not one but TWO thoughtful pieces on the impact of the internet on retailing.  From a real estate perspective, this is of vital importance for three reasons.  First, internet retailers actually DO occupy space, but it’s a very different kind of space than most-bricks-and-mortar retailers occupy.  (For more on my perspective on this, read my interview about Amazon in Seattle’s Daily Journal of Commerce this past week.)  Second (as the Economist articles point out), many retailers “get it” but many don’t (more on this in a minute).  As a result, some retailers thrive (Apple and Disney are two cited examples, but I’d also note Seattle’s Nordstrom as a firm that grasps how to thrive in both markets).

The third reason is a bit more subtle.  The Economist quotes Roy Amara, the American futurologist, who says, “We tend to overestimate the effect of technology in the short run, and underestimate the effect in the long run.”  As a small-e economist, I would note that in the long run, internet retailing has the very real impact of making American business more productive, in terms of “unit of output” per “unit of cost” (or “unit of labor”), which is a very good thing indeed.  Why?  Simply put, the developed economies (U.S., Europe, and Japan, for starters) are fighting a demographic battle.  Japan and Europe are more-or-less losing.  Their populations are becoming increasingly older, and their population growth is basically flat.  The U.S. is barely winning the demographic battle, ironically thanks in no small part to immigration (both legal and otherwise).  Why is this important?  Simply put, increases in GDP are necessary in order to create jobs and to support the increasing costs of an increasingly aging population.  There are only two real ways to accomplish this (note the word “real”, as in without inflation):  either grow the working-age segment of the population (we’ve already thrown in the towel on that one) or make equal strides in productivity.  Hence, the information age allows fewer workers to generate greater productivity in order to support a population in which increasingly large segments are not part of the productive landscape.

As noted, some bricks-and-mortar retailers “get it”.  For many segments of the shopping landscape, an on-line substitute just won’t do.  Apple figured this out with the Apple Stores, which are slick looking, very efficient, and a far better solution when need instant answers or want to buy something “Apple”.  By the way, I have an Iphone which I acquired from an ATT store.  I have to go back into that store occasionally for upgrades or accessories — it’s near my house and thus very convenient.  I can’t help but notice that they’ve re-done the store in much more of an Apple-esque image.  Accident?  I don’t think so, plus the shopping experience is much more efficient and enjoyable now.

Borders didn’t make it, but Barnes and Noble seems to be hanging on, in no small part because of the adaptation to the internet.  Interestingly enough, many “mom-and-pop” booksellers were predicted to go out of business due to Amazon, yet many of them have thrived by partnering with Amazon and doing what entrepreneurs do best (catering to “niche” needs).  Last time I bought a “new” book it was a Christmas present, and I got it at a deep discount at Costco.  The last 10 books to come into the Kilpatrick house, though, came from small-town retailers who had partnered with Amazon, and to whom we paid full-retail.

Interesting side note — ONE of these retailers was Seattle’s Goodwill store, who have cataloged their bookshelves and partnered with Amazon to sell used books.  (My congratulations to my good friend, Ken Colling, the CEO of Seattle Goodwill, and no, I didn’t get a penny’s worth of discount.)  Also, by the way, it was cheaper for me to go on-line to Seattle Goodwill, buy the book, and have them mail it to us, than for us to drive to downtown Seattle and buy the book the old fashion way.  Is Goodwill going out of business because of Amazon?  Far from it — this is a windfall for them.

As The Economist notes, and I concur, retailers are struggling to figure out this new paradigm.  They are also coping with an explosive growth in shopping space — between 1999 and 2009, shopping space in the U.S. ballooned from 18 square feet per person to 23 square feet.

A final note:  The Economist deals primarily with the experience in the U.S..  Clearly in Europe and Japan, this is also a struggle and perhaps an even worse one.  However, this information-age paradigm shift is occurring right as many developing nations (China in particular) are seeing an emerging middle class, and the retail-therapy that permeates middle-classes everywhere.  Retail real estate developers who look at the Chinese economic trends and think that China may need as many square feet of shopping experience as Americans have come to enjoy over our cultural history may need to think again.  The simultaneity of the emergence of the information age with the emergence of a Chinese middle class (not to mention the cultural history, which in China may favor small, entrepreneur-driven businesses) may portend a very different retail future.

U.S. housing market — good news and bad

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The good news, such that it is — home sales are inching up — a 0.7% rise in January from the previous January.

Now, for the bad news — the median home price in America, measured on a January-to-January basis, just hit its lowest point in 10 years, according to a recent announcement from the National Association of Realtors.  Indeed, 35% of home sales were “distress sales”, driving the median home price down to $154,000.

graphic courtesy CNN-Money

This represents a 6.9% price decline from 2011, and a drop of 29.4% since the peak in 2007.

Why would anyone buy a house during this free-fall?  Actually, even in a falling market, buying a home makes some sense.  For one, interest rates are at amazingly low levels, and if you have great credit, loans are available.  On the other hand, rental rates are on a sharp increase, due in no small part to the lack of apartment construction in recent years.  Putting the two together (and if you buy into rational expectations), then buyers who look at an alternative of renting would find that buying a house, even in a declining market, may make some economic sense.
Second, a LOT of the distress-sale buyers are investors who plan to convert former “owner-occupied” stock into rental homes.  Indeed, we will probably see a significant increase in the stock of rental homes in America in the coming years.  Again, the rapidly rising rental rates induces investors to want to get on that bandwagon quicker rather than later.  Since investor-buyers are usually in for the long-run, eventual re-sale prices are inconsequential to the decision.
The real challenge is for appraisers.  They are typically backward-looking in forming sales adjustment grids, and assume both linearity and continuity in market conditions adjustments.  Neither of these assumptions are valid today.  PLUS, when appraisers “get it wrong” in a declining market, they are often held to blame.  In short, appraising a $100,000 house today which turns out to only be worth $92,000 a year from now can get you in hot water, even though, following good appraisal practice, the house legitimately pencils out for $100,000 today.
Oh, and let’s not forget the challenge faced by tax assessors.  In some jurisdictions (like the one I live in), tax rates can rise when assessment rates fall, so that county and city budgets remain constant.  In other jurisdictions, however, either legal constraints or public opinion keeps tax rates flat, and thus a 30% decline in property values translates into a 30% decline in local budgets.  Since property taxes fund police, fire protection, and schools in most jurisdictions, this translates into some real pain for local officials.

Written by johnkilpatrick

February 22, 2012 at 10:26 am

A few thoughts about the stock market

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As the Dow Jones Industrial Average creeps ever so slowly toward 13,000, I’m reminded of the words of William Shakespeare, from the famed “Seven Ages of Man” soliloquy in the comedy, As You Like It:

…and then the whining school-boy, with his satchel and shining morning face, creeping like snail, unwillingly to school…

Now of course this blog is primarily focused on real estate and the various economic forces that affect it.  However, since so much of real estate is securitized, particularly in the U.S., and so many of the players in the real estate market are publicly traded companies, an occasional glance at the ticker-tape is in order.

With that in mind, I have a small idea.  It’s not a huge one, but just a little observation, if you will, about why the market is creeping so slowly, even though so many pundits claim that it’s underpriced right now.  (I neither agree nor disagree with that sentiment — I’m in a wait and see mode.)

However….. I serve on the board of a small Trust which is VERY conservative.  Our sole manager also manages a lot of high-tech money (remember — Microsoft is headquartered here… duh…).  We have a lot of liquidity, and even our bond investments have a very short average duration.

As one money manager put it to me, “Our clients aren’t interested in MAKING money in the stock market.  They just don’t want to LOSE any more money in the stock market.”

Thus, there MAY BE some upside potential to this market.  However, it may take a long time to realize it, because so many money managers got singed in the flames of the market burn-out a few years ago.

Written by johnkilpatrick

February 21, 2012 at 9:32 am

Retail — on the mend?

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The Marcus and Millichap 2012 Annual Retail Report just hit my desk.  It’s a great compendium — one of the best retail forecasts in the industry — and not only looks at the national overview but also breaks down the forecast by 44 major markets.

A few key points:

  • What they call “sub-trend” employment growth will prevail until GDP growth surpasses 2.1% (we would add:  “…sustainably passes….”)  Increased business confidence will continue to transition temporary jobs to permanent ones.
  • Most retail indicators performed surprisingly well in 2011, defying a mid-year plunge, a slide in consumer confidence, and a modest contraction in per-capita disposable income.
  • The Eurozone financial crisis could undermine the U.S. recovery, but fixed investment will remain a pillar of growth, with capital flowing to equipment and non-residential real estate.
  • All 44 markets tracked by M&M are forecasted to post job growth, vacancy declines, and effective rent growth in 2012.
  • A rise in net absorption to 77 million square feet in 2012 will dwarf the projected 32 million SF in new supply, with overall vacancy rates tightening to 9.2%.
  • However, some major retailers, most notably Sears and Macy’s, will continue to downsize or close stores that fail to meet operational hurdles.
  • CMBS retail loans totalling $1.5 Billion will mature in 2012, but many may fail to refinance — about 81% have LTV’s exceeding acceptable levels.
  • The limited number of really premier properties in the “right” markets will hit what M&M calls “high-high” price levels, moving some investors into secondary markets as risk tolerance expands and capital conditions become more fluid.

For your own copy of this research report, or to get on M&M’s mailing list, click here.

Written by johnkilpatrick

February 17, 2012 at 9:57 am

Canada looking more like the US and UK?

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The books are still being written on the causes and effects of the recent recession, but one wide-spread agreement is that aggregate household debt, and particularly the ratio of debt to household income, has been a real problem for developed nations.  In the U.S., this ratio hit between 1.6 and 1.7 at the onset of the recession, and then fell to about 1.4 today.  In the U.K., the ratio topped out at just under 1.6 in late 2007, and is now down under 1.5.  Given the flat-lining of household incomes in the two countries, this constitutes a very significant pay-down in household debt.  Note that for most of the 1990’s, this ratio hovered between 1.0 and 1.1 in the U.S., and between 0.9 and 1.0 in the U.K.  It wasn’t until the easy money period of the late 1990’s that these ratios started soaring.  (In the U.S., this was a gradual rise, really starting about 1990.  In the U.K., the rise was more abrupt, beginning about 2001.)

Now we har that our neighbors to the north are trying to copy our bad behaviors.  In 1990, the typical Canadian household had a debt/income ratio of about 0.9.  This gradually rose to about 1.1 by the late 1990’s, then hovered there for a few years.  Over the past 10 years, the Canadian debt ratio has continuously grown, with no “peak” in the early days of the recession, and now sits at about 1.5.

courtesy RICS Global Real Estate Weekly

Canada, interestingly enough, did not have the great depth and breadth of recession that roiled the U.S. and Europe.  While they had a brief period of negative GDP growth in early to mid 2009 (remember — two consecutive quarters of negative GDP growth defines a recession), their recession was both brief and shallow, and was followed by very positive numbers — their 2010 GDP growth rate got as high as 3.6% on an annualized basis, and continues strong today.
That having been said, Canada hasn’t been a powerhouse of economic growth since the early 1960’s, and many pundits suggest that Canada’s relative health during the past few years is a direct result of the fiscal conservatism of both their institutions as well as their citizens.  However, there are some faint storm clouds on the northern horizon.  Vancouver, BC, housing prices have been booming and some analysts suggest they’re in for either a fall or at least a fizzle.  Watching the Canadian household debt ratio get up to levels that the U.S. and the U.K. have found to be unsustainable and unhealthy isn’t very comforting.

Written by johnkilpatrick

February 16, 2012 at 10:02 am

Posted in Economy, Finance, Real Estate

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Housing News

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I was just at a luncheon (sponsored by the local chapter of the Appraisal Institute) on apartments.  One of the speakers noted that a real problem in doing adequate analysis was getting a handle on the single-family housing market — the data simply stinks due to the foreclosure mess, the number of homes being turned into rentals, etc.  Thus, as we try to ALSO project the future of the homebuilding industry (really down for the count the last few years), that same dirty-data problem is a real issue.

That aside, the National Association of Homebuilders released a report today noting that the NAHB/Wells Fargo Housing Market Index rose in February for the fifth consecutive month.  As I discussed back in November (click here for a link) this index attempt to project home sales based on model home traffic, customer inquiries, and such.  Even though the over all stock market was down today, this news sent homebuilder prices higher — indeed, Beazer Homes (BZH) rose by 3.1%, albeit to just over $3/share.

NAHB’s Chief Economist David Crowe said, “this is the longest period of sustained improvement we have seen in the HMI since 2007.”  Great news for homebuilders — we hope it stays this way.  For a full copy of the article, on Fox Business News, click here.

Written by johnkilpatrick

February 15, 2012 at 4:54 pm