Archive for the ‘Uncategorized’ Category
Dreams of GDP growth
Paul Krugman and I don’t necessarily agree on everything, either in politics or economics, but I respect his research (and yes, envy his Nobel Prize). That said, he has an insightful piece on his blog about The Donald’s economic projections, which both Paul and I find probably untenable. I encourage you to read it here.
In short, The Donald projects 3% to 3.5% GDP growth throughout his tenure in the White House. Under Reagan, it was at the lower end of this scale, and under Clinton it hit 3.7%. Remember that both of those presidents inherited crappy economies, and so a pendulum bounce in GDP would have been expected. The Donald is inheriting a healthy overall economy (admittedly, with pockets of problems). As such, growth in the 2+% range is more likely. So why are they projecting such glossy numbers? In short, they back into what they need to say in order to fit their rosy projections.
I would note that the Chair of the Council of Economic Advisors sits vacant as of this writing, with no nominee in the offing. This Council serves the president, among other ways, by putting a reasonableness test on just such projections. Truly excellent economists have served on this Council thru the years, from all sides of the economic spectrum (and yes, there are more than two). In the absence of trained, academic economists in this role, these projections are left up to whim.
Unlike Paul K, I have some hope that Paul Ryan may be a voice of sanity here. He seems to understand that balance sheets need to balance. Let’s see how that works out.
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The long lost shopping mall?
Common wisdom holds that the shopping mall is on life support. I venture into maybe one or two a year, and my most recent ventures weren’t very encouraging. Two recent Wall Street Journal articles illustrate the complexity of repurposing.
First, in a January 24th article by Ester Fung, “Mall Owners Rush to Get Out of the Mall Business”, the Journal notes that even the big-names in the biz are making use of strategic default to get rid of underwater properties. Citing data from Morningstar, the story detailed that from January to November 314 loans secured by retail property were liquidated, totaling about $3.5 billion. According to the story, these liquidations resulted in losses of $1.68 billion. Washington Prime, CBL and Simon have all sent properties back to lenders in recent months. Ironically, these big players have seen no dings to their credit ratings, and the equity market in fact views these put-backs as evidence of financial discipline. On the downside, surrounding properties, such as out-parcels and other nearby retailers, such as restaurants, that depend on spillover from the mall, are suffering from the loss of shopper attraction.
One alternative to strategic default is a revamping of the real estate itself. This often includes attracting a new or new type of anchor tenant or demolishing the mall entirely to make way for offices or apartments. Unfortunately, as detailed in a February 14 WSJ piece by Suzanne Kapner, existing tenants often have covenants or restrictions standing in the way of such revamping. In “Race to Revamp Shopping Malls Takes a Nasty Turn”, Ms. Kapner outlines how many department stores want to protect existing parking or existing exclusivity through “reciprocal easement agreements”. For example, large swaths of unused parking space have value for repositioning. However, as Gar Herring, chief executive of the MGHerring Group, a regional mall developer, put it, “But if you want to put a snow cone shack in a parking space furthest from the mall, you need the agreement of every department-store anchor.” Currently, for example, Sears is suing a mall developer in Florida to prevent it from adding a Dicks Sporting Goods as an anchor. Lord & Taylor filed suite in 2013 to stop a Maryland mall’s demolition to make way for offices, residential properties and a hotel. The retailer claimed violated an agreement signed in 1975 that prevents the landlord from making changes to the property without its consent.
The shopping mall is three different things. From a consumer perspective, it’s a place of gathering and consumption. Indeed, the loss of the shopping mall, which replaced Main Street, has sociological implications as well. Does Amazon.com now become a place of gathering as well as consumption? That’s an interesting subject for another day. Second, from a business perspective, the mall is a bundle of contracts, and sorting through those contracts will keep lawyers and real estate experts busy for some years to come. Finally, a shopping mall may be, in some circumstances, a valuable piece of real estate. Repositioning that real estate, either as retail with different tenants and focus, or as something other than retail, will be an interesting story in the coming years.
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Strong vs weak dollar
Ahem…. this may or may not be the truth, but in the words of my fellow Low-Country South Carolina expat, Stephen Colbert, it’s certainly “truthy”. Reportedly, according to Huffington Post, The Donald called his national security advisor, Flynn, at 3am, to ask whether a strong dollar or a weak dollar was good for the economy. Reportedly, Flynn told The Donald to ask an economist. Since then, economists of all stripes have offered advice, because, well, this is important stuff for a President to know, along with “war is bad” and “full employment is good” and stuff like that.
So, here we go. I’ll take a stab at it. Whenever the world roils, investors of all stripes look for stable currencies in which to invest, and the dollar is the “mother of all stable currencies”. Until Brexit, the same could be said of the Euro and the Pound. Now, not so much. Anyway, paradoxically, the election of The Donald roiled the world’s zeitgeist, causing investors to seek the dollar, and thus strengthening our currency. Now, what’s the impact? Well, a strong dollar makes it tough to export stuff, but it makes it easy to import stuff. That wrecks the trade imbalance, and costs jobs in exportive industries. Conversely, a weak dollar suggests lack of faith in the American economy, but helps with American jobs, albeit makes American consumption more expensive.
ALSO, a strong dollar makes it easy to borrow. As America runs deficits (both fiscal and trade), we have to borrow and much of this borrowing occurs in foreign markets. Conversely, a weak dollar drives up the cost of borrowing.
In short, if The Donald wants to bring American jobs home, he’ll opt for a weak dollar, but that will inevitably drive up the cost of consumption as well as the cost of borrowing. Ironically, the way to achieve a weak (or lets say, “less strong”) dollar is to achieve some sort of stability in the world, and that doesn’t seem to be in the offing.
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Low Income Housing Threatened
OK, folks, this gets complicated, so follow along with me. The Reagan era tax cuts, and specifically the U.S. Tax Reform Act of 1986, adversely affected many of the incentives for investing in low income rental housing. To provide some balance, the Low Income Housing Tax Credit (LIHTC) program was added to the Act. This program provides a tax credit which can either be used or sold by the developer.
Usually, the tax credits are sold or syndicated, and corporations that anticipate that they’ll have taxable income over the next 15 years will buy the credits, which can be used to offset future tax bills. The developer uses the proceeds from the tax credit sales as the equity for the low income housing development. Coupled with the program is a substantial emphasis on fiscal discipline (audited financial statements, regular reporting, etc.) and as such, these low income multi-family developments have had a foreclosure rate of less than 0.1%, which is far better than comparable market-rate properties.
Typically, a developer will cobble together several programs, such as FNMA debt financing, Section 8 vouchers, and state and local incentives. The LIHTC program is administered by State Housing Authorities, and of course has oversight from the IRS.
Here’s where it gets both interesting and complicated. The selling price for the credits is a function of two things — the discount rate (which is very low now-a-days) and a company’s forward-looking tax burden. Let’s say, just as an example, I believe my company will have $1 million per year in net income in the coming fifteen years. My tax rate is 40%, so I’ll end up paying $400,000 in annual federal income taxes, and I’d be willing to pay for credits which would erase that tax burden. In short, I’m agnostic as to whether I send the money to the IRS or to a developer who wants to use the money to build an apartment complex. (Actually, it’s w-a-a-a-a-y more complicated than this, but bear with me.) Now, my tax burden over the coming 15 years will be $6 million ($400,000 per year times 15), but the present value of that cash flow is what I’d pay today instead of the $6 million. If my cost of capital is 5%, the present value of that 15 year tax bill is actually closer to $4.15 million. So, I’d be willing to pay $4.15 million to avoid paying $6 million in taxes in the next 15 years. A given developer is awarded a certain level of tax credits based on the overall value of the project being proposed.
So, what’s the problem? Ahhh…. “problem” depends a bit on your perspective. As it happens, the new administration, and Congress for that matter, are bent on cutting corporate tax rates. Good for them. I own a couple of corporations. I’d like to save some money. However, if a corporation envisions that their tax bills over the next 15 years will be much lower than previously anticipated, then the amount they’re willing to pay TODAY to avoid those tax bills is much lower. How much, you say? Well, let’s assume our company had it’s effective tax rate lowered from 40% to 15%. The tax bill over the next 15 years would only be $2.25 million, and the present value of THAT is only $1.56 million. Ahem…..
I’m not knocking tax cuts, but everything has a cost, and building low income housing employs a lot of people, provides a much-needed private sector solution to a public problem, and creates investment. We’re already seeing this market dry up. An article in today’s Pittsburgh Post-Gazette, by Kate Giammarise, outlines the problems that developers are already facing. One solution may be for Congress to increase the level of available tax credits, so that developers can be left whole even with the tax cuts. This will, by its nature, be a nationwide problem.
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America’s calling Harry Truman..
Harry Truman, written by Robert Lamm, recorded by Chicago:
America needs you
Harry Truman
Harry could you please come home
Things are looking bad
I know you would be mad
To see what kind of men
Prevail upon the land you love
America’s wondering
How we got here
Harry all we get is lies
We’re gettin’ safer cars
Rocket ships to mars
From men who’d sell us out
To get themselves a piece of power
We’d love to hear you speak your mind
In plain and simple ways
Call a spade a spade
Like you did back in the day
You would play piano
Each morning walk a mile
Speak of what was going down
Each honesty and style
America’s calling
Harry Truman
Harry you know what to do
The world is turnin’ round and losin’ lots of ground
Oh Harry is there something we can do to save the land we love
Oh woah woah woah
America’s calling
Harry Truman
Harry you know what to do
The world is turnin’ round
And losin’ lots of ground
So Harry is there something we can do to save the land we love
Oh
Harry is there something we can do to save the land we love
Harry
Harry is there something we can do to save the land we love
Written by Robert Lamm, Robert William Lamm • Copyright © Warner/Chappell Music, Inc, Spirit Music Group, BMG Rights Management US, LLC
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Unilateral tariffs
It occurs to me that a few people might not understand why unilateral tariffs against Mexico might be a suicidially bad idea, the global equivalent of “Hey, hold my beer while I try this!”
Here are a few random reasons, just off the top of my head, why this is an amazingly stupid idea… in no particular order…
- Any tariffs on imports from Mexico will be born, 100%, by American consumers, and generally those at the bottom tier of the consumption curve.
- It pisses off our one of our two nearest trading partners, and will undermine our relations with the other one.
- It opens the door for China to create and expand a hedgemony in the Pacific Rim….
- …which, in effect, nullifies the Monroe Doctrine (3 & 4 being the most devastating problem — no one in the Pacific Rim will trust us ever again).
- Since the left coast of our country is vitally dependent on Pacific Rim trade, it’s…. well… I’ve already used the word suicide. Given that Washington, Oregon, Hawaii, and California didn’t vote for Trump, why does he care???
- We export zillions of things (trucks, airplanes, software, indie movies, timber, building products, video games, wine — just to name the things that come from MY ZIP CODE) to the Pacific Rim. Kiss those asses goodbye.
- Google “Smoot Hawley Tariff Act of 1939” and see what you get.
- Unilateral shifts in complex demand curves are theoretically unsupported (OK, that one requires a bit of graduate level econ, but bear with me here.)
- On a practical level, I can now import anything I want from El Salvador at a price 1% higher than I previously received from Mexico. Thus, I’ve simply baked in a 1% consumer inflation to be borne entirely by folks who shop at Wal Mart (see #1 above).
- Oh Christ it’s such a stupid idea….
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Vinyl record sales
First, a big caveat — this post is NOT going where you think it’s going. It’s only peripherally about vinyl record sales.
Second, I’ve made my peace with digital music. Thanks to somewhat degraded hearing (not deaf, but you know…) I don’t pick up the subtleties of vinyl records. Don’t get me wrong, I’m absolutely in love with rock music, particularly some of the new stuff that’s better than we give it credit, but my ears are not dexterous enough to appreciate vinyl. That said, vinyl record sales in 2017 are expected to top $1 Billion. I’ll let that sink in for a minute, because back in the day, my expenses on turntables, speakers, headphones, etc, dwarfed my actual expenditures on vinyl records. Add it all up, and this is a huge business. There continues to be a huge amount of money in this world, and inventive people who figure out ways to market to the demands of folks who have that money, or who have needs in the 21st century, will prosper.
Which leads me inexorably to entrepreneurism. The story 0f the internet revolution has been one of entrepreneurism. I won’t belabor it, only to note that a bunch of college-age kids (often drop-outs — I’m looking at you, Bill Gates) took IBM, DEC, Wang, Amdall, and a bunch of others out back of the barn. I was in the supercomputer biz in 1990-1994 (as an academic, running a scholarly program) and I can tell you NONE of the big-ass suit-and-tie companies I was working with then are still in biz, save for Intel that saw the writing on the wall and got out of supercomputers and back into chips where they belonged. In short, great strides foward in our economy have been made — indeed, have always been made — by entrepreneurs, usually working tirelessly in the shadows.
Which leads me to Robert Henlein. If you haven’t read him, he’s one of the deepest of the deep thinking science fiction authors. Among the top four or five on everyone’s list. Naval Academy (which is where I met him, as a 19-year-old midshipman, 40+ years ago), then a masters in engineering, washed up by 30 with tuberculosis, he dragged himself up to become a masterful writer. Stranger in a Strange Land alone has spawned an untold number of PH.Ds. In creating his fictional worlds, he noted that new colonies always thrived quicker and better than the monther planet. Why, you say? Because it takes a certain gumption, a certain spirit, a certain amount of energy, to jump on a boat on the high seas (or, in his case, in outer space) and take a risk on a new place. The western U.S. thrived because disillusioned Civil War vets — blue and grey — struck out for a new land with new opportunities. Heinlein, an early 20th century Coloradan, saw that first hand.
Which leads me to the wet-foot-dry-foot rule, and all that accompanies it. I note that the Obama administration, for reasons I don’t fully grasp, suddenly suspended the rule this past week. I had the opportunity to go to Cuba last January, and was amazed and overwhelmed buy the entrepreneurship of the people. It’s tough to eek out a living in a totalitarian, centrally-planned dictatorship, but many people seem to do it in a style we can only hope to emulate. As a west-coaster, I’ve seen how the influx of Asian immigrants have fueled the entrepreneurship of the internet age. As a native of the south, steeped in east-coast-ness, I know how our country has been fueled by wave after wave of immigrants from every corner of our planet. In every one of our major cities there is a jewish tailor, there’s a mid-easterner with a falafel stand, an Indian with a hotel, a Chinese merchant, an Italian eatery, a Nisei left with nothing at the end of WW II who started a business and built a fortune. These may seem like stereotypes, but these stereotypes built the nation I call home, and swore to defend w-a-a-a-ay back when. I spend a bunch of my time in Key West, where eastern Europeans have built some nice homes by setting up janitorial businesses and t-shirt shops, doing work I wouldn’t do.
I agree — the laws should be followed, and illegal immigration should be dealt with. But how? Arguably, the deck has been stacked terrifically against brown skinned folks and in favor of people who look and sound like me. The folks who we endeavor to keep out are often the most inventive, figuring out how to make markets out of janitorial services, falafel stands, and yes, selling vinyl records to music afficianados. I’d like to keep America great, and I would argue that only with a constant influx of new, inventive, aggressive, creative blood, that may be a problem.
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Mueller’s Market Cycle Monitor
I was giving a brief presentation on real estate two weeks ago, and mentioned Glenn Mueller’s great Market Cycle Monitor, which is actually owned and produced by Dividend Capital Research in Denver. Dr. Mueller is a professor at Denver U, and the Market Cycle Monitor stems from a paper he wrote back in the 1990’s. The Monitor basically examines commercial real estate across four phases — recovery, expansion, hypersupply, and recession. It then examines real estate subsectors across these phases (suburban offices, downtown offices, factory outlet retail, etc.) and then examines the top markets in the top 55 geographic markets. If all of this seems massively complicated, Dr. Mueller makes it relatively easy to understand, with great explanations of his graphical presentations.
By the way, the four phases are determined in the context of rising and falling occupancy, rents, and new construction. Thus, a property type or market in recovery evidences declining vacancy rates and no new construction, which leads to rising rents and values. The expansion phase is marked when the market or property type occupancy rises above the long term occupancy average, and that phase evidences continued declining vacancy and some new construction. After occupancy peaks, and begins to decline, the market or property type enters the hypersupply phase, marked by increasing vacancy yet continued new construction. A property type or market enters the recession phase when occupancy falls below long term averages, and yet increasing vacancy rates are met with increased completions of new properties. The report goes on to explain the impacts on rents, rent changes, and how rental rates interact with construction feasibility at different levels of the cycle. Simply reading the Market Cycle Monitor is a great primer on how commercial real estate markets work.
Simply collecting the data is a bear, so there is usually a 2 month delay producing the report. The most recent report covers the 3rd quarter, 2016, and was produced in late November. While the report covers 55 markets and 12 different property type sub-markets, the data generally spans five major property types — office, industrial, apartments, retail, and hotels. Three of the five sectors (office, industrial, and retail) had improving occupancy in 3Q16 and improving rents. Hotel occupancy was flat, but room rates actually increased, albeit at only 2.2% annually. Apartment occupancy actually declined 0.1% in 3Q16, but room rates increased at an annual rate of 3.2%.
The remainder of the report is packed with great information, and extremely readable. Check with Dividend Capital for a copy, or send me an e-mail.
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Renaissance at the Aspen Institute
Other than a few of the permanent pages (over on the right of your screen), I’ve let this blog die on the vine this year. It’s actually been a surprisingly busy year, so busy that I’ve not had the time to write much! My lack of intellectual output on this blog is mirrored in my other writings, and all of that needs to change.
Lynnda and I spent this past weekend at the Aspen Institute, which hosted one of the regional Renaissance Weekends. I spoke on a couple of topics, most notably on real estate (of course). I wanted to share with you a bit of what I had to say.
First, let me lay the groundwork. Renaissance Weekend is now in it’s 35th year, and has held about 125 such gatherings. It is a non-partisan, invitation-only gathering of thought leaders from a variety of fields (government, science, business, show business, astronauts, authors, Nobel Laureates, etc.). All discussions are strictly off the record (although a speaker, like myself, is free to share what I personally said). The first one was held at the home of Phil and Linda Lader. At the time, he was the developer of Sea Pines Plantation on Hilton Head and went on to be the U.S. Ambassador to England during the Clinton Administration. They wanted a gathering of families over the New Years weekend to talk about important issues of the day — the sort of informal chats we all used to have in college outside of the pure classroom setting. Over the years, Renaissance has grown, and is now held in Charleston every new years. The Charleston event draws 1,100 or so, and over the years, many of the participants wanted smaller, more intimate gatherings. Hence, Renaissance also meets on major holidays (July 4, Labor Day, President’s Day) in places like Napa Valley, Santa Monica, Jackson Hole, and Banff, British Columbia. The Clintons were regulars at Renaissance back when he was Governor and President, and President and Mrs. Ford were also regulars. All in all, about 20 presidential candidates, countless Senators, Representatives, Governors, and elected officials from every level and both parties have attended over the years.
Labor day was hosted by the Aspen Institute, which is a non-partisan forum for values-based leadership and the exchange of ideas. It has earned a reputation for gathering diverse thought leaders, scholars, and members of the public to address some of the world’s most complex problems. It was founded in 1949 by Walter Paepcke, then the Chairman of Container Corporation of America. His first gathering drew such luminaries as Albert Schweitzer, Jose Ortega y Gasset, Thornton Wilder, and Arthur Rubinstein, along with members of the international press and more than 2,000 other attendees. Through reading and discussing selections from the works of classic and modern writers, leaders better understand the human challenges facing the organizations and communities they serve. “The Executive Seminar was not intended to make a corporate treasurer a more skilled corporate treasurer,” said Paepcke, “but to help a leader gain access to his or her own humanity by becoming more self-aware, more self-correcting, and more self-fulfilling.”
One of my talks was about housing, and specifically addressing an accusatory issue being tossed around in political circles that “homeownership in America is at its lowest level in 50 years.” Like so much in politics, that is technically true, but may not be a bad thing. Home ownership in the U.S. hit record levels during the bubble — slightly over 69%. Today, the homeownership rate is about 64%. If you look back at periods when home ownership in America was stable and healthy, the ownership rate hovered around 64%. Thus, from an ownership rate perspective, we may be at a very good level.
The bigger problem we have is home ownership equity. For many years, the aggregate equity enjoyed by homeowners was about 60% of the aggregate value of the homes in America. That means that on average an American homeowner had about 60% equity and about 40% debt. From an equilibrium perspective, that appeared to be pretty good. At the trough of the recession, roughly early 2008, that level got down to about 35%, which everyone would agree was a terrible number. Today, we stand at about 55%. By the way, this is a LOT of money — the aggregate value of all residences in America today is slightly over $20 TRILLION. That means the aggregate equity in America is close to $11 TRILLION. Getting from where we are to where we used to be means we need to create about another $1 Trillion in equity.
So yes, the housing market is still a bit in disequilibrium, but not from the decline in the home ownership rate, but rather from the decline in home equity. The good news is that we’re headed in the right direction. Recent projections from the National Association of Realtors suggest we may get back to “normal” in the 2018-ish period.
P.S. — Not everything at Renaissance is as boring as I’ve made it sound! Lynnda and I had several great chats and dinner with Jay Sandrich and his wife Linda. He directed two-thirds of the episodes of the Mary Tyler Moore Show, the first three seasons of the Cosby Show, and many other iconic productions. The behind-the-scenes tales were awesome!
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12th Fed District issues 3q report
Greenfield is a global firm (albeit mostly in the U.S.), and even though we’re headquartered in Seattle, we try to focus our attention broadly rather than locally. That said, the 12th Federal Reserve District just released First Glance 12L (3Q15) which takes an early cut at the data from the nine western states. It’s very telling data — the “left coast” as I like to call it tends to suffer worse when times are bad and boom better when times are good. Thus, there are some interesting facts and figures to be gleaned from this well-written report.
Naturally, the report is focused on the health of the member banks in the region, but the macro-econ factors driving that health are of much broader importance. Nationally, unemployment stood at 5.1% at the end of the 3rd quarter. Western states tended to be a bit worse off, with 3 states (Idaho, Utah, and Hawaii) recording lower unemployment rates and the rest showing higher numbers, ranging from Washington’s 5.2% up to Nevada’s 6.7%. California, always the thousand pound gorilla in the room, came in at 5.9%.
However, job growth in the western states is well above the national average — 3% annually for the region versus 2% for the U.S. as a whole. However, the west is digging out of a deeper hole — while job growth nationally hit a trough of -4.9% at the peak of the recession, it bottomed out at -6.7% in the west. Generally, job growth in the west over the past 20 years had held steady at about one percentage point above the national trend during “boom” years.
Housing starts in the west are well below the pre-recession peaks. As of September, 2015, the seasonally adjusted annual rate (SAAR) of housing starts stood at 161,000, with 107,000 of that in 2+ family units. This compares with a peak of 449,000 SAAR in the 2005-2006 period, at a time when 2+ unit housing only made up 85,000 of the starts. Arguably, the market in the west is still absorbing the huge shadow inventory built up during the boom days.
Commercial vacancy rates in the west have been drifting down for the past few years in the office, industrial, and retail sectors. Apartments, however, seem to have plateaued around 4.3% at the end of the 3rd quarter, and are forecast to rise a bit to 4.7% a year from now. I might posit that historically, profit-maximizing apartment vacancy rates have been found to be somewhat higher than these numbers, so apartment managers and owners may have some lee-way to continue building.
The 5 western maritime states are very export-driven, and the strength of the U.S. dollar (up about 18% against major currencies since 2014) has been rough news for those markets. While western state exports rebounded nicely from the trough of the recession (up about 17% from 2009 to 2010), export growth has flat-lined since 2012. Regionally, exports declined about 2.5% since last year, with positive growth reported in only four states (Arizona, Hawaii, Nevada, and Utah). Bellweather California saw exports decline 3.6%. Note that in Washington, my semi-home state, exports make up 21.2% of the gross state product. (We export things like big trucks, big airplanes, software, and agricultural products.) Hence, this is critically important stuff.
The remainder of the report focuses on the health of the regions banks. I’ll leave that up to the reader if you care to download your own copy. Short answer, though, is that the region has seen loan growth accelerate even while the nation as a whole has flattened. Further, the regions banks tend to be a bit more efficient in terms of expenses and staff, both compared to the nation as a whole and compared to the “boom days” pre-recession. Both small and large commercial borrowers generally reported tightening credit standards at the end of the 3rd quarter, which is a change from previous reports. However, consumer borrowers (residential mortgage, credit cards, and auto loans) generally reported easier standards. The bulk of loan growth for small banks (under $10B) came from non-farm non-residential, while for large banks the biggest growth sector was in consumer lending. The percentage non-performing assets (the “Texas Ratio”) in the region, which peaked at 38.9% in 2009, is now down to 5.4%, although still higher than in the 2004-2007 period. By comparison, the national peak hit in 2010 at 19%, and is now standing at 7%, also higher than pre-recession levels.
From a small northwestern observatory... 