Archive for the ‘Real Estate’ Category
Home-ownership vacancy rates
Regular readers will recall that we’ve linked continuous decline in home ownership rates to price instability. In short, prices won’t start rising again until home ownership rates stabilize. (They’re down from about a recent peak of 69.5% to about 66%, and we believe they will continue to fall to about 64%). One MORE piece of important data just hit our desks, in the form of the Census Bureau’s 1st quarter home ownership survey.
The report is full of useful data. For one, the number of owner-occupied units in the U.S. actually fell from 1st quarter 2010 to 1st quarter 2011 (as we would expect), while rental occupancies continue to increase. Rental market supply (in essence, construction of new apartments) is keeping pace with demand, and rental vacancy is just below 10%, slightly lower than the 10% -11% range we’ve seen in the past few years, but not so low as to put inflationary pressure on rental rates. (Of course, this varies from one part of the country to another.)
Among “owner-occupied” homes, though, the vacancy rate continues to rise. See the chart below for a vivid explanation —
If this was a classroom exercise, I’d ask the students to identify the pre-recession equilibrium level, which appears to be about 1.6% to 1.8%. We can then identify the point-of-inflection signalling the impending disequilibrium in the housing market (when vacancy rates increased significantly — 2005). This inflection point, of course, signaled a great time to start shorting mortgage-backed securities, since it signaled the beginning of an increase in default rates. Of course, once can point at this and say “hindsight is 20-20”, but we know that the folks inside many of the banks, who were hawking mortgage-backed securities to their customers, were reading those very tea leaves back mid-decade, and shorting the very same securities they were promoting as safe investments.
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Japan Earthquake
Just confirmed — I’m speaking at two big legal conferences on the Japan Earthquake, with focus on the insurance and re-insurance issues. I’ve been asked to address the valuation questions and the impacts on Japanese banking, finance, and housing.
The conferences will be held on May 17 in San Francisco and in June in Philadelphia. For more information, including an agenda, roster of speakers, and sign-up form, visit http://litigationconferences.com/?p=19825
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Musings of an expert witness
I JUST spent the entire week in booming, Towson, MD, testifying in a little-known, not-well-covered case called “Allison v. Exxon.” On the surface it seems like a fairly straight-forward case: In 2006, an Exxon station in rural Baltimore County spilled a lot of MTBE-laden gasoline (at least 26,000 gallons). The gasoline flowed into the drinking water aquifer, and contaminated the well water for a fairly large, up-scale neighborhood. Hundreds of houses and dozens of businesses are affected, and after 5+ years, the remediation is still ongoing. A small, preliminary case went to court a couple of years ago (we were not involved) and the significant jury award demonstrated that the subsequent cases, as they went forward, had the potential to be extremely expensive for Exxon and would potentially send a message about MTBE litigation.
The current trial, which has been ongoing for several months, will continue for at least another two months. Then it goes to a jury. As the stakes have gone sky-high, so have the players. Both Exxon and the plaintiffs up’d the ante on law firms. Exxon is now represented by DLA Piper, perhaps the largest corporate law firm in the world. The plaintiffs are represented by Peter Angelos, one of the most successful trial attorneys in America (and, coincidentally, the owner of the home-town Baltimore Orioles.) Naturally, we were called in as real estate valuation experts and economists to measure the monetary damages. I just testified this week, and of course my involvement behind the scenes is ongoing.
I actually testify in fewer cases than people might think. At Greenfield, we do a LOT of litigation support, but we’re glad that our work helps our clients settle the majority of cases outside of the courtroom. (For more on this, see a recent article on the website, LawyersandSettlements.com.) Success at the expert witness “business” requires thinking not only about what we do but more importantly thinking about HOW we do it. As such, the past week has caused me to focus a lot of attention on that “how” component, and I’m writing this blog entry more for my own memorialization than anything else.
As I think about the “how”, three things come to mind:
Experts have to be careful with their egos. The best experts have very strong egos — they have to, because in the run-up to trial, their opinions, expertise, and findings are challenged repeated. Good experts have very strong internal editorial systems within their organizations, and are constantly willing to put their own egos aside in favor of the pursuit of excellence. However, to get on the witness stand (and deposition, and meetings with clients, and inevitable reversals), the expert has to be able to withstand a withering intellectual assault. A strong enough ego, however, can be a two-edged sword. A clever opposing attorney can make mince-meat of an egotistical blow-hard on the witness stand. I’ve seen really fine testifying experts simply melt-down under that sort of pressure. It’s not pretty.
Stay at the cutting edge of your body of knowledge, but not beyond it. There is a “safety zone” right at the front edge of the body of knowledge. Whatever the field, there is always a “current body of thought” concerning methods and standards. In real estate valuation, it’s obvious that the older methods have been severely called into question during the current real estate melt-down. As it happens, there are great new methods that have been tested and found superior (hedonic modeling, time-series indices, contingent valuation, etc.). These are well tested and established methods. Ironically, many “old-hands” at testifying in court are too busy playing “witness” and spend very little time maintaining themselves as “experts”. They fail to keep up with the current literature. They may publish, but it’s usually about things that were old-hat 20 years ago. When faced with newer methods from the other side of the courtroom, they have no foundation to comment, and as such do a poor job for their clients.
Keep it simple Ironically, most “expert” work is highly technical. However, every testifying expert should be able to describe and discuss what he or she did in a very short “elevator pitch”. It has to be simple. In my experience, jury members are usually pretty bright, and typically want to be engaged in the “show”. However, they want to know that there is a simple theme to the expert’s work. If it’s too convoluted, even though it may be true, it doesn’t “seem” true, and hence won’t be compelling to the jury.
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Second quickie from the WSJ
On the same page (C-1), Nick Timiraos contributes “Critical Signs in Foreclosure Talks”. This is the followup to issues I discussed a few months ago regarding the botched foreclosure processes at many banks. Regulators had hoped to put in place a far-reaching settlement, to forestall many state Attorneys General from filing state suits which would put all of this in a variety of courtrooms (probably ultimately in a multi-district litigation in the Federal Courts, and from there… no one knows…). The regulators and the AG’s are on opposite sides, although both seem to agree that the banks need to be taken out back of the woodshed and given a good spanking.
I have zero sympathy for the banks — it’s one thing to create a high-speed mortgage assembly line, but even the auto makers have figured out how to keep track of the documentation on each car they make. Bankers (and the thousands of lawyers they employ) are supposed to be good at this stuff. If they can’t keep track of a $100,000 mortgage, how exactly do they keep track of a $100 checking account balance? (They do seem to be great at keeping track of every $1 I owe on my visa card.)
However, from a market perspective, this all has extremely serious implications. As I discussed some weeks ago, if the foreclosure log-jam isn’t fixed, the home credit market won’t get fixed either. Housing starts, existing home sales, and millions of jobs depend on straightening out this problem. Hence, this is not just a trivial argument about who gets to spank the bankers.
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Two quickies from the WSJ
Page C1 today has two important articles that caught our eyes. I’ll write about the first right now, and follow up with the other one later today. First, Kelly Evans contributes “Overlooked Inflation Cue: Follow the Money.” It shouldn’t come as a surprise to anyone that money supply growth in the western economies was rampant during the run-up to the current recession. In the U.S. and the U.K., M-2 growth peaked in late ’07 to early ’08 (you don’t have to be a monetarist to figure that out). The Eurozone kept pumping money at faster rates right up to mid ’09
Where money supply growth went from there, though, was a bit of a mixed bag. In the U.S., the annual growth in M-2 fell from a peak of about 12% right before the recession to a low of about 1.5% in early ’10, and has stayed below 3% since. (This basically supports my contention that the sturm-and-drang over QE-2 was all politics.) The U.K.’s growth rate peaked at about 9%, fell earlier than ours, and hit its bottom (about 2%) in mid ’09. Intriguingly, the U.K. money supply growth rate bounced back immediately, with the virtual money presses running full-speed to get the money supply growth rate back up to about 6% in early ’10, but then falling off to about 4% today.
In the Eurozone, the money supply growth tracked very closely with the U.S., bottoming with ours in mid ’10, but since then, the European bankers have started pumping money back into the system, with their M-2 growth rate headed continuously back upwards (at about 4% today).
There are two important implications for all of this (plus my afore-mentioned observation about QE-2). First, the three big western currencies are on decidedly different tacks. The idea of opposing viewpoints among the big western central bankers is not well explored in today’s decidedly multi-polar world economy. (Back when western banking was a closed system, everyone else in the world could only sit back and watch. Now that the Chinese — and even the Japanese with all their other troubles — are more than sidelines spectators, one can only wonder how disagreements among the western bankers will play out.)
Second, though, the really significant point is that despite all of the different paths of M-2 since 2009, all of the growth rates are decidedly down from the earlier peaks. From a real estate perspective, this has major implications. As investors diversify away from stocks, real estate and bonds have a certain equivalency. In a no- or low-inflation scenario, bonds are viewed as the more secure investment. In a higher-inflation world, real estate is viewed as a bond with a built-in inflation hedge. Hence, lower inflation portends well for bonds but poorly for real estate.
One might argue that healthy bonds means low interest rates for real estate, but this ignores the fact that interest rates are already at historic lows. Hence, what real estate needs today is a nice raison d’être, which a tiny bit of inflation would give it. I’m NOT pro-hyper-inflation, mind you, and inflation flat-lines are overall healthy for the economy. However, if real estate investors are hoping for an inflation kick, it doesn’t look like they’re going to get it.
A last minute edit — Later in the day, I noticed that yesterday’s USA Today had a “snapshot” (a little graphic in the lower left corner of the front page) titled “Which Investment Will Perform the Best”, taken from a survey recently conducted by Edward Jones. Topping the list was Technology (33%), follwed by Gold (31%), Blue-chip stocks (10%), Real Estate (9%) and International stocks (9%). Given that gold and real estate are both thought to be inflation hedges, it appears that the market still worries in that direction.
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Nevada
Just came back from a day in Reno. (Hard to type that without hearing Johnny Cash in my head.) Sitting in the airport, I struck up a conversation with a young man sitting next to me. He asked what I did for a living, and as soon as I told him, he wanted to know my “economic prognosis” for Nevada. Whether I had a good one or not, I gave him my two cents worth.
Nevada — and Florida, for that matter — primarily make their living from three things: tourists, retirees, and people who care and feed the first two categories. (One might be tempted to add Arizona into the mix, but that would be a bit of a mistake. Arizona’s economy is a bit more complex. One might argue that Florida and Nevada’s are, too, but let’s go with it for a while.)
One immediate “hit” to the economies of both Florida and Nevada was tourism, as families (and in the case of Las Vegas, conventioneers) had to tighten their belts. However, this segment is actually coming back a bit, albeit not totally to pre-recession numbers. For example, Florida’s Gulf Coast Panhandle (the nine counties in western Florida) were actually seeing a resurgence of tourism until the Gulf Oil Spill. Occupancies in the Gulf Coast region on Memorial Day, 2009, were quite good, but then the oil spill hit, and occupancies were dismal on that same weekend, 2010.
Las Vegas is certainly in trouble, but some of that came from overbuilding. The Saraha just closed — it had been slated for a makeover, but the owners have decided to “go dark” for a while instead, waiting for the economy to turn. The Las Vegas City Center continues to be a prime example of speculative overbuilding, both rooms and casino space.
But, Reno isn’t Las Vegas. Sure, Reno has casinos and some gambling, but it’s more of a retiree area. This segment of the population has been hurt in two ways. First, they can’t sell their houses. Moving to Reno (or Ft. Lauderdale) generally requires selling a house in Los Angeles or Groton. As I’ve noted previously, the supply of existing homes is pretty stable, and even though new construction has tanked, the demand for owner-occupied homes is actually shrinking from its pre-recession peak of about 69.5%. Thus, retirees may WANT to move to Reno, but no one will buy their home in Los Angeles.
Second, POTENTIAL retirees look at their 401-K’s and start thinking, “wow, I guess I’ll need to work a few more years.” This has some long-term issues for the economy. First, every retiree who “stays” on the job means one applicant at the beginning of the work-force pipeline who can’t “get” that job (or at least the job that leads to it.) Second, early retirement is more care-free (both personally and financially) than late retirement. Thus, early-retirees generally spent financial assets into the system without making many demands ON the system (health care being the biggie). Now, many retirees will defer retirement until the fateful day when they start demanding more of the system than they are able to put into it. If we think medicare and social security are problematic NOW, wait until that reality takes hold.
From a housing perspective, large parts of the U.S. (Nevada, Florida, and, yes, big swaths of Arizona) have been built to accommodate retirees in between the time they “sell the big house” and the time they move into assisted living. A prolonged “work-life” means a significant lowering of demand for this segment of the housing market.
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sushi or dead fish?
I’m at the semi-annual meetings of the Real Estate Counseling Group of America (RECGA), a small (capped at 30), invitation-only group of real estate experts founded by the esteemed Dr. Bill Kinnard back in the 1970’s. Over the years, RECGA members have included editors of major journals, presidents of various real estate academic and professional organizations, and advisors to major investment groups. We’ve nearly lost track of how many text books have been written by the members — well over several dozen, plus many hundreds of journal articles, book chapters, and scholarly papers.
A few somewhat random observations:
Investment activity is up, but the major impediments are lack of capital and excess inventory
Apartment “cap” rates are falling again, with lots of activity
The credit markets are still a mess, with no consensus on when they will be “fixed”
Wonderful presentations (patting myself on the back for one of them), with great interaction on complex issues in real estate analysis and valuation.
Why the title to this post? Simple — one real estate investor was quoted as saying, “The market today is like a platter of seafood. I have to figure out which are sushi and which are just dead fish.”
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Gulf Oil Spill — Lessons Learned conference
I’ve just been confirmed as a speaker at the big one-year “Lessons Learned” conference on the Gulf Oil Spill, sponsored by Tulane University Law Center, American Lawyer magazine, and the Brickel and Brewer Law firm. The conference will be held at the Weston Canal Street in New Orleans on April 28th. I’ll be one of the “wrap up” speakers that afternoon, focusing on the impact of the oil spill on the value of bank collateral portfolios.
For more info on the conference, click here. Hope to see you there!
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Japan — take 2
A correspondent on one of the news shows seemed almost apologetic this week in discussing investment opportunities following the crisis in Japan. I concur with the sentiment — the focus today must be on humanitarian and environmental concerns.
Nonetheless, Japan will fix the immediate problems, and then must move rapidly toward the economic issues. People need to be fed, housed, clothed, provided jobs, and treated medically. To accomplish this, they need energy (over 10% of their nuclear generating capacity has been wiped out) and capital.
It’s too early to get good facts on the housing disruption, but it is safe to say that the housing shortage will be north of a million units. The final tally will depend on whether or not large swaths of “buffer” zone will be created around the melted-down nuclear plants (probably so, but we don’t know for sure or how big yet). In a typical year, Japan builds less than 1 million housing units (788,000 in 2009), down from about 1.3-ish million a decade ago. Thus, the housing shortage will likely exceed a year’s typical output for their housing industry.
Further, even though Japan is a heavily forested country, they are the least-self-sufficient in terms of lumber of any developed nation in the world. By the last statistics I’ve seen (and these are estimates — Japan itself isn’t very forthcoming with this stuff) they import about 44% of their lumber needs. Canada has historically been their biggest supplier, followed by Russia, Indonesia, Malaysia, and the U.S.
From a global-trade perspective, this is problematic in the extreme. Ironically, the U.S.-Japan lumber trade has declined dramatically in recent years, due to foresting limitations here. China has become a big importer of lumber in recent years, principally from the same markets as Japan. Both China and Japan have faced the same commodity-price increases of late, mainly driven up by increasing demand in emerging markets.
Lumber is not the sort of thing that can be spun-up quickly. Here at Greenfield, world lumber supplies are not our expertise, and we would note that demand in the U.S. is down (due to the housing crisis) by an annual amount roughly equal to the potential housing disruption in Japan. Thus, there may be some offsetting world-supply equilibrium, albeit with prices (and transport costs) going through the roof.
None of this portends good things for prices of new homes in the U.S. One of the saving graces of the construction industry has been that costs of construction have fallen sufficiently so that builders can construct homes at prices which match the overall price decline. If lumber prices soar, as is quite possible, then it may very well be that homebuilders won’t be able to deliver homes at market prices. Since home builders are very much economic “price takers” right now, this could really be a short-term death knell for that industry and many of its smaller — and even larger — players.
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Appraisal and Financial Reporting
Real estate appraisers are, by and large, behind the curve as far as International Financial Reporting Standards are concerned. IFRS is already the norm in most of the world, and will integrate in the U.S. with our accounting rules in the very near future. The Appraisal Foundation recognizes that many (most?) appraisers lack the knowledge and training to compete in the this new realm, and is taking proactive steps to address the problem.
The “ying and the yang” of this — implementation of the IFRS, particularly following the real estate meltdown, will focus considerable attention on asset values rather than asset costs. This has become known as the “mark to market” phenomenon. In an era when everyone basically THOUGHT that asset values gallopped upward non-stop, reporting historical costs-less-depreciation was the norm, and a conservative one at that. However, in an era when real asset values have actually declined, the conservative approach is to mark these values to market. This necessitates regular appraisals. All well and good for appraisers, right?
Not so fast, bucko. There’s nothing in the IFRS that requires an appraiser, per se, and in fact appraisers are so out-of-touch with financial reporting standards that CPAs (who are ultimately responsible for the reporting) may be loathe to use appraisers for these assignments. At best, CPAs are described as “skeptical” on the contribributions to be made by appraisers.
One change will be the migration from “market value” (as is commonly preached to and by appraisers) to “fair value” which is enculcated in Statement of Financial Accounting Standards NO. 157. IFRS will converge Fair Value guidance with US Generally Accepted Accounting Principals with the pending issuance of IFRS 13.
Other changes include new thinging about “market participants”, “highest and best use”, and a concept totally foreign to appraisers, “levels of valuation input.” This latter creates a hierarchy: Level 1, Level 2, and Level 3.
Yesterday, the Appraisal Foundation sponsored a webinar featuring some great thinkers on this subject. Rather than get “down in the weeds”, they were good enough to keep the topic at 20,000 feet and thus cover a wide array of implications in a very short time. Clearly, there’s a lot of education and re-education needed if appraisers are going to have a role to play in this. In the meantime, appraisers can begin familiarizing themselves with the salient information at the IFRS web site, www.ifrs.org.
From a small northwestern observatory... 