Archive for August 2018
REITs vs Open Ended Funds
There is a great article in the current edition of REIT Magazine, by Michele Chandler, celebrating the 25th anniversary of the creation of REITs in Canada. Ms. Chandler does a great job explaining why Canada has a REIT system in the first place, and why Canada’s REITs came into being in 1993.
In short, Canada’s commercial real estate market collapsed in 1993, and open-ended funds were flooded with investors redeeming shares. The funds quickly appealed to the government which allowed them to suspend redemption. This, of course, led to liquidity problems for investors. The solution was to turn those funds into close-end REITs which would then be listed on the Toronto Stock Exchange. Investors could sell their shares on the exchange to gain liquidity. Today, the exchange has 38 Canadian REITs with total capitalization of about C$57.7 Billion as of the end of 2017.
This article illustrates one of the subtle but important benefits of REITs as opposed to a private equity fund or an open-ended fund — liquidity without having to sell off the underlying assets in a down market.
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Yield Curve Inverting
There has been a good bit said lately about the yield curve inverting. Historically, so they say, an inverted yield curve forecasts a recession. I decided to explore that concept a bit. Like all generalizations, this may have a grain of truth in it, but there is more than meets the eye.
By the way, this topic has been explored in greater depth, and with more granular data, by economists who actually focus on this topic. (Just as a reminder, my area is Real Estate Securities). If you are reading this with an eye to fleshing out some masters thesis somewhere, I’d suggest you keep looking for authorities. That said, the FED leadership is meeting in Jackson Hole this weekend, and you can bet this is on the agenda.
Speaking of the FED, I grabbed a bit of data from them — monthly 10 year treasuries and 6 month bills back to December, 1958. I actually explored some other time periods and even daily data, but this was the best pairing I could get in short order. Anyway, the “shape” of the yield curve is essentially the gap between these longer term rates and the shorter term ones. For a normal yield curve, the long bonds (10 year) should be about 2 to 4 percentage points above the short term yields. That makes some intuitive sense — in “good times”, borrowers are willing to pay more to borrow longer term, and investors are willing to accept less return for shorter term loans. When borrowers sense that there may be trouble ahead, they are less willing to borrow long-term, and hence the demand for long term money falls relative to short-term stuff. When things go really topsy-turvy, the short-term money is actually more expensive than the longer term, because borrowers simply don’t want to borrow long-term at all. The topic is w-a-a-a-a-y more complex than this, but hopefully you get the picture.
Speaking of pictures, I then took the difference between these two yields and graphed it. Along with that, I graphed the incidence of all of the recessions since 1958. Here’s what I got:
Data courtesy Federal Reserve, graphic (c) Greenfield Advisors, Inc.
Not EVERY inversion was followed immediately by a recession. although almost all were. The only exception was in 1966. That one is generally considered a “false positive” because it was triggered not by general economic trends but by a short-term reduction in Federal spending.
More interestingly, though, is the long-term bull market of the 1980’s, which was followed by the recession of 1991. That long-term market followed the double-dip recessions of 1980 and 81, which are often considered one long recession. (I know — I was there.) More to the point, the recession of 1991 was not following a yield curve inversion. Indeed, the yield curve spread, measured on a monthly basis, never got below 0.38%, in November, 1989. Also, notably, the behavior of the yield curve over the course of the 1980’s mimics what we’ve been seeing of late.
There is also an argument that rates are behaving more like the 1992-2000 period, and there is some rationale for that. If that’s the case, then the question is whether the yield curve recovers from here or takes a swan dive below zero. If the former, then we may have 2 years or so of continued positive GDP. If the latter, then we’re headed for a rough patch.
The yield curve spread ended July at 0.78%, and closed yesterday down at 0.59%. Again, this is the data the FED leadership is discussing in Jackson Hole. We’ll keep you posted.
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WSJ Property Report
Three things caught my eye in the Wall Street Journal’s Property Report this morning. The first two were a positive note about Home Depot — which is doing a land-office business — and a related note about the aging of American homes. Let’s start with the second point first.
The National Association of Homebuilders reports that the median age of a home in America is now 37 years, up from 31 years just a decade ago. Mathematically, that’s an extraordinary increase. It basically means that very few new homes have entered the housing stock in the past 10 years, and almost no homes have been torn down or in some way converted to some other use. That’s the point NAHB is trying to make. Our aging housing stock is a drag on the economy. People who might have been employed in higher wage construction jobs are now serving coffee at Starbucks. This ultimately means that our flat-line inflation in America has, to at least some degree, been achieved on the backs of stagnating wages.
Of course, this means good things for home re-hab shops like Home Depot. If you’re house is getting older, you have two choices. You can sell it and buy a new one (making the NAHB happy) or you can buy a can of paint or some new kitchen cabinets at Home Depot. (Full disclosure — the folks at my local Home Depot know me by name.)
As for the third point, while wage stagnation is decidedly affecting the middle class, there is no such problem in the luxury class. Belmond Hotels, owners of some of the world’s premier hotels, are considering buy-out offers. Financially, this suggests they think we may be at the top of a cycle, and it’s hard to imagine that they could wring any more profits out of their properties than they do already. Ergo, it may be time for them to cash in, and rumor has it some sovereign wealth funds are offering top dollar. (Full disclosure — Belmond owns the Charleston Place in Charleston, SC, where I spend every New Years. It is one of my favorite hotels in the world.)
By the way, Belmond is one of those fascinating stories that underscores the globalization of commerce. Belmond was actually founded with the acquisition of the Hotel Cipriani in Venice, Italy. It owns the Orient Express, which is run out of its Paris Office. Corporate offices are in London, and today owns properties in 22 countries, including the historic 21 Club in New York and the Copacabana in Rio. The legal headquarters, however, are in Hamilton, Bermuda, and the stock trades on the NYSE. Go figure….
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Phily Fed Survey: More of the Same
The quarterly survey of forecasters, produced by the Philadelphia FED, is one of my regular touchstones for where the economy is headed. One caveat — in “steady” times, they tend to be pretty accurate. They miss black swan events, but so do everyone.
That said, they are look at annualized GDP growth of about 3% in the coming quarter and about 2.6% in the following quarter. Job growth will decline into 2019, adding about 195,000 jobs per month this year, declining to about 165,000 next year. However, unemployment will remain pretty much where it is. Inflation continues to be a non-event. These numbers pretty much make sense, if you consider there is a pretty strong tail wind. We’ve been on a positive trend since about 2010, and in the absense of systemic shocks to the system, why worry?
I’ve noted in the past that this group of forecasters tend to be fairly… ahhh, I hate to use the word lazy, but what the heck. They mostly work for banks and such, and so have a bit of a bias in favor of good times ahead. That’s one of the reasons they tend to miss negative signals. I’ve noted here in past posts that the yield curve is approaching a dangerous inverted shape (for the uninitiated, this isn’t just reading tea leaves — it tells us a lot about the expectations of borrowers and lenders). The trade war only gets worse, and we’re seeing increasing disruptions in agriculture and manufacturing here in the U.S. as a result. I’m not trying to be Chicken Little, but this is certainly influencing my thinking.
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Need a job?
I pulled up behind another car at a stop light yesterday and couldn’t help but notice a license plate surround for the local construction laborers union, plus a labor bumper sticker in the back window. This attracted my attention because the vehicle in question was a late-model Cadillac Escalade.
Admittedly this may have been an outlier, but all across the U.S. there is a huge demand for entry level construction trainees. Here in Seattle (a high-wage, high cost-of-living area) entry level “no experience, no education” wages are in the high-teens per hour, rising rapidly to $50k per year with a modicum of experience. Take some winter months to go get trained in plumbing, electrical, or HVAC and the annual income gets into the high 5 to low 6 figures pretty quickly. (The average plumber in Seattle makes $95,000 per year, according to Salarylist.com.) Some sources put this number somewhat lower, but you get the point.
Ironically, these jobs are going begging, and the reasons are varied. Many young people are scared off from a job that evidently requires a lot of outdoor work and physical stamina. Yet, as one young woman in a carpenter training program noted, “If you work hard and you put in your effort, they’ll take you over somebody else who is muscle…” Baby boomers seem to think that if their children don’t go to college, they’ve failed as parents, and so the percentage of construction workers under age 24 has declined in 48 states since the peak of the housing boom.
Wall Street Journal has a great article this morning called “Young people don’t want construction jobs. That’s a problem for the housing market.” It is indeed. It is one reason why home construction per household in America is at its lowest level in 60 years of keeping records, according to the article. The reasons include lack of vocational programs in high schools, although many of these are coming back. The Home Builders Institute, affiliated with the National Association of Homebuilders, has as many as 6,000 young people in their training pipeline at any given time.
I’m not suggesting — nor is the WSJ, that flooding young people into construction jobs will change the housing affordability metric overnight. The homebuilding industry is still replete with problems such as a trade war with our principle material suppliers, a lack of housing infrastructure, and short-term financing issues. Nonetheless, young people might want to be reminded that a surprisingly large number of CEOs in the construction field got started with a hammer in their hands.
From a small northwestern observatory... 