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Finance and economics generally focused on real estate

Archive for the ‘Mortgage Lending’ Category

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

How many homes do we need?

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It is HARD to keep up with a blog when the news seems to move out from under you every day.  Now that the election is over, we can get back to normal stuff, like how’s the economy doing and where do we go from here.

Back on the campaign trail, ONE of the presidential candidates  (HE will remain nameless) complained about the level of home ownership, which hit the “lowest level” in 50 years or so.  Admittedly, that’s true, but also a bit misleading.  Since the peak — which led, by the way, to the recent mortgage melt-down, home ownership in America declined from 69.2% (June, 2004) to 62.9%% (June, 2016).  That’s not a huge decline, but indicative of just how sensitive our economy is to the level of home ownership.  I’ll be the first one to admit (and in my early days, I did more than a bit of research on this) that lots of good things eminate from new home construction and from the home brokerage business.  For one, there are a lot of good jobs at stake — from skilled carpentry to mortgage lending and everything in-between.  I’ll also note that there have been many studies thru the years focused on the social benefits of home ownership, which add to neighborhood quality, school quality, and even reduced crime levels.

That said, most good things come in “optimum” levels.  For example, eating a well balanced diet is superior to either starving or binge eating.  Human bodies are optimized for a temperature of 98.6F, and will die if internal temps are sustained even a few degrees on either side.  Not enough water and you die, and yet people drown each year from too much.  See the connection?

Home ownership would not have hit record levels without lending practices that were neither healthy nor sustainable.  We don’t know exactly what the optimum level of home ownership in the U.S. economy might be, since the economy is anything but static.  However, right now, the economy seems to be chugging along quite nicely with current home ownership levels.  Are we at a sustainable optimum?  Perhaps, but only time, and stable economic policies, will give us some empirical data.

Written by johnkilpatrick

December 7, 2016 at 3:53 pm

PWC’s Emerging Trends in Real Estate for 2016

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Ever since PWC acquired Peter Korpacz’s excellent quarterly commercial real estate survey, they have really leveraged that theme into a great regular read.  Along with my subscription, their annual Emerging Trends just landed in my in-box, and it’s a really excellent read.  (To access a copy, just click on the link above.)  The report is a must-read for anyone in real estate, particularly in the investment or finance side.  I’ll skip to two of the summaries — one they call “expected best bets” as well as the capital market summary, to give you a flavor of their report.

Expected Best Bets — PWC recommends, “Go to the secondary markets”.  They note that gateway markets have pricing problems, while the “18-hour cities” are “…emerging as great relative value propositions.”  They particularly cite Austin, Portland, Nashville, and Charlotte.

PWC also discusses “middle-income multifamily housing,” and notes the solid business opportunities providing creative answers for what they call the “excluded middle” households.  PWC also encourages planners to re-think parking needs, in light of the changing demands of “live/work/play downtowns.”

On the securities side, PWC notes that many REITs are priced well below net asset value, providing an interesting arbitrage opportunity in 2016.

Capital Markets — PWC opens by noting, “In many ways, it appears that worldwide capital accumulation has rebounded fully from the global financial crisis. The recovery of capital around the globe has been extremely uneven. And the sorting-out process has favored the United States and the real estate industry, affecting prices, yields, and risk management for all participants in the market.”

Whew…. I’m usually loathe to quote so much from another’s work, but I simply could not have said that any better.  PWC quotes one of their survey respondents, a Wall Street investment advisor, who says, “There is going to be a long wayve of continued capital allocation toward our business….”

Survey respondents largely were split on short-term inflation, with about 40% predicting modest increases and 60% looking for stability at current rates.  However, when they look down the road 5 years, 80% of respondents look for modest increases in inflation.  Coupled with that, over 60% of respondents think both short term interest rates and mortgage rates in specific will rise next year, and nearly 80% think such rises will occur over the next 5 years.  Intriguingly, a small but significant minority — about 20%, believe rates will rise substantially over the next 5 years.  Almost no one believes rates will fall, either in the short-term or the long-term.

To sum up the capital markets view, PWC says the general spirit of the industry is positive, albeit with an eye toward risk.  Many are calling for a “long top” to this recovery, but many are also taking defensive postures by shortening investment horizons, paying more attention to the income component of total return rather than the capital appreciation component, and moving down the leverage scale.

As always, I would stress that I am citing a 3rd party source here, and nothing in this review should be construed as investment advise.  That said, PWC’s Emerging Trends is an excellent read, and I highly recommend it.

“5 Economic Trends to be Thankful For”

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First, I hope everyone had a great Thanksgiving! For those of you who in countries that don’t share our festival of thanks, I hope you had a great Thursday!

Kuddos to Neil Irwin, writing in the Washington Post yesterday.  I agree 100% with his list, and wanted to reproduce it here:

1.  Household debt is way down.  Neil lists this as his first item, but I would suggest it has plusses and minuses to it.  On the plus column, we really WERE over-debted as a society.  On the minus side, changes household debt carries with it complex implications for the consumption side of GDP, as well as corporate investment (see my prior blog post) and even trade relationships.  Nonetheless, this is, on net, a good thing.

2.  The cost of servicing that debt is way down — as Neil points out, from 14% of disposable income in 2007 to 10.7% today.   Of course, remember that one person’s interest EXPENSE is another person’s interest INCOME.  Nonetheless, this constitutes a significant wealth transfer from people who HAVE money back to people who NEED TO BORROW money.

3.  Electricity and natural gas prices are falling.  It’s hard to find a downside to this one.  From last year, consumer natural gas prices are down 8.4%, and electric rates are down 1.2%.  I would add to Neil’s analysis that more of this money is staying at home — the U.S. is well on its way to being import-neutral on energy.  Of course, this has some geopolitical implications, which we’ll deal with on another day.

4.  Businesses aren’t firing people.  While unemployment remains high at 7.9%, at least the arrows are pointed in the right direction.

5.  Housing is dramatically more affordable.  Neil points out that in 2006, the typical homebuyer faced a payment equal to 41% of the average wage of a private-sector worker.  Today that’s 26%.  This is a combination of both lower house prices (which proportionally lowers down payment requirements) and lower mortgage interest rates.

Congrats to Neil Irwin and the Washington Post for an insightful and timely article!

Written by johnkilpatrick

November 23, 2012 at 9:33 am

Sustainability — Follow the Money

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Sustainability seems to be the real estate buzz word du jour.  A “google” of “sustainable real estate” brings me slightly over 56 million hits.  Number two on the list is the Journal of Sustainable Real Estate, (a more-or-less joint presentation of the American Real Estate Society and CoStar) of which I’m apparently on the editorial committee.  Go figure.

I don’t want to sound too cynical here, but as a “finance guy” in the real estate field, I tend to follow the money.  A lot of what’s going on in real estate, particularly at the individual building-level, has a lot to do with sustainable energy (e.g. — LEED Certification, Energy Star) or sustainable architecture.  There was a nice paper out of Clemson University by David Heuber and Elaine Worzala recently on sustainable golf course development (click here for a link) which begins with the irony that no one is building golf courses today.  Scott Muldavin has a great book on underwriting and evaluation sustainable financing (reviewed here) which gets close to the heart of the matter.

However, Ben Johnson, writing for the current issue of Real Estate Forum, seems to have caught the scent, to use a hunting dog analogy.  In his article, “When CalPERS Talks, People Listen”, he notes that this mega-pension fund n($228 billion) has about 8% of its total invested in real estate.  (My own estimate is a bit higher and more current than that — see here for details.) The noteworthy thing, however, is that CalPERS just made a $100 million stake in Bentall Kennedy outt of Toronto.  B-K is one of North America’s largest real estate investment advisors, resulting from the 2010 merger of the Canadian firm Bentall with Seattle’s own Kennedy Associates.

Two things make this all very interesting.  First, B-K earned the top spot this year on the Global Real Estate Sustainability Benchmark Foundation’s ranking of fund managers in the Americas.  This ranking, covering 340 of the world’s largest funds, measures social and environmental performance.  (Given B-K’s Pacific Northwest and Canadian pedegrees, this doesn’t surprise me at all.)

Second — and this may be the biggie — as CalPERS goes, so goes the industry.  The focus of Mr. Johnson’s article was to note that now every pension fund in the known universe will need to consider using an advisor like B-K.  Johnson notes that this deal “gives the largest public institutional player in the US a deeper investment in understanding real estate as an asset class and a unique insider’s view of the industry’s dynamics.”  More interestingly, I would posit, it puts a leader in sustainable real estate front-and-center in the view of the sorts of pension managers who, until now, have very little cross-pollination with the real estate industry.  In short, as institutions look to find good real estate partners, sustainability will be a key element of consideration.

The right number of new homes?

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Much has been said in recent days about the Census Bureau’s August 23rd announcement about new residential home sales in July.  To summarize, 372,000 new homes were sold last month, which is 25.3% above the July, 2011.  This is good news for a lot of reasons — construction workers get jobs, banks get new loans, etc., etc.

Naturally, it begs the question, “what’s the right number of homes?”.  Here at Greenfield, we’ve posited that the U.S. housing price “bubble” was really a demand bubble, fueled by easy money, which led to an artificial inflation of the nation’s home ownership rate.  (Housing bubbles in other countries were fueled by similar problems.)  We’ve also suggested that the market won’t get healthy again until several things happen, including a stabilization of the homeownership rate at long-term equilibrium levels, a restoration of “normal” conventional lending (both for home mortgages as well as for development financing) and a restoration of the housing infrastructure (development lots in the pipeline, local regulatory department staffing, hiring & training skilled construction workers, etc.) .  It is highly doubtful that we’ll see housing starts and new home sales “bounce back” to normal levels anytime soon, and our own projections suggest several years before we get back to “normal”.

But this begs the question:  What’s normal?  (A great t-shirt from the Broadway play, “Adams Family” simply said, “Define Normal”.)  Anyway, as new home sales go, it’s helpful to glance at the experience over time.  It may surprise you.

One might actually expect the graph to be less erratic, but there are good explanations for the “bobbing and weaving” you see from year to year.  During recessions, new home sales decline, and then bounce-back afterwards.  During periods of economic overheating, the FED tightens the money supply, thus causing home starts/sales to decline.  (In practice, this is a major tool in the FED’s toolkit, simply because it has a great multiplier effect on the economy.)  Of course, the bubble is quite apparent, and following it the inevitable decline.

With all that in mind, though, we can see that there is a decided upward trend in the chart — that makes sense, since a growing population, coupled with a fairly consistent homeownership rate, will generally demand more new homes each year than it did the year before.

The second graphic adds a simple linear trend line for simplicity sake, which is not far removed from the actual household formation trend line during that same period.  Note that from the beginning of the chart until about 2001, we had a nice cycle going, and in fact around 2001, the blue line should have turned negative to account for the recessionary impacts.  However, money got very loose during the early part of the last decade, and rather than housing starts serving its normal “pressure relief” role, it was driven into a counter-cyclical path.  This created the oversupply we are now trying to work through (often referred to as the “shadow inventory”) and we won’t see a healthy market until this inventory is mopped up.

Good news, though — if you glance quickly at the second chart, it becomes clear — albeit from a very simple visual perspective — that we must be close to a spot where an up-turn in the chart would give us as much negative area red line as we had during the previous cycle above the red line.  In short, we’re not at the end of the tunnel yet, but this simple way of looking at things suggests we may be able to SEE the end of the tunnel in the not-too-distant future.

Written by johnkilpatrick

August 27, 2012 at 11:00 am

New Home Sales — “Much Ado About Not Enough”

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Big news today — new home sales hit an annualized rate of 369,000 in May, compared to 343,000 in April.  That’s 20% higher than a year ago.  It also beat economists collective prognostications of 350,000.

Wow…. and only about 63% less than the 1,000,000 per year we would consider health.

And about 74% below the peak of 1.4 million during the boom years.

Obviously, there’s a problem here, and unless and until we get back to “normal”, the portion of the economy which is driven by home development, construction, financing, and sales will continue to suffer.  Three things are currently terribly broken, and fixing them is no easy task.

1.  The lending market is utterly disfunctional.  There was a great headline in one of the papers the other day — if you don’t NEED money, there’s plenty of it.  Unquestionably, one of the contributing factors (not a major one — but one, none the less) to the market meltdown was the sale and financing of homes to folks who had utterly no idea how they were going to meet their mortgage payments.  However, even in good times, we know that a certain percentage of loans will go sour — call it about 2%.  The straw that broke the camel’s back was when the recession hit, that “sour loan” percentage went up to about 4% – 6%.  Unfortunately, the secondary market had “priced” these loan pools with the notion that only 2% or so would go bad.  The loan pools themselves were so badly over-leveraged (at Lehman, apparently, the pools were leveraged something like 35-to-1 or more) that an increase into the 4% range completely destroyed the secondary mortgage market.  Today, the pendulum has swung too-far in the other direction, and first-time homebuyers, who often have good jobs but little in the way of demonstrable credit, are completely shut out.  If they can’t buy “starter” homes, then the “move-up” market suffers, and the retirees (who want to buy in places like Reno and Ft. Lauderdale) can’t sell their homes to “move down”.  Fixing this lending crisis is the first order of business.

2.  The land development business is broken.  Even if we magically “fixed” the lending problem tomorrow, there is a real shortage of land in the development pipeline.  It takes years to turn a vacant field into a subdivision full of lots (or a condo site), with extensive engineering, planning, financing, and entrepreneurship efforts.  Even in good years, there is a fair amount of risk-taking and capital expenditure.  We can’t just pick up where we left off a few years ago, because many (most?  nearly all?) of these development projects burst like soap bubbles during the recession.  Thus, we have to completely hit the “re-start” button on subdivision development in America.  Unfortunately, there is absolutely no appetite for financing these projects, and many of the players have gone out of business.  After World War II, the country was able to kick-start the housing market with extraordinarly favorable financing (remember VA and FHA loans?).  None of that exists today, and the secondary market to sustain all of that has gone away.  In the absense of a Federal mandate to kick-start housing, comparable to the GI Bill of 1944, this aspect of the market will continue to be flat-lined.

3.  Local community infrastructure development is broken.  Housing development requires a substantial public-private partnership.  In many communities, much of this is paid for as a “public good”, while in others there is the expectation of significant developer contribution.  Nevertheless, local planning agencies, transportation and utility departments, and even school districts and fire departments have to stand ready to provide infrastructure for housing.  Local government fiscal crises have frequently broken the back of these agencies.  Nationally, we’ve laid off something like 50,000 teachers in the past few years, yet new housing development and household formation will require increasing numbers of schools.  The same is true for fire fighters, EMTs, police, road maintenance, and utilities.  Until our cities, counties, and states are back on their financial feet, this segment of the equation will continue broken

Sadly, these are interactive parts of the same equation.  For example, local governments fund planning departments with fees paid by developers.  Hence, the city or county reviews tomorrow’s building permits with fees paid by yesterday’s developers.  Restarting the system will take talent, money, and some significant leadership, none of which is currently apparent.

Written by johnkilpatrick

June 25, 2012 at 9:11 am