Welcome to April
…and welcome to Florida. I’ve been in the southeast corner of the U.S. for the past two weeks in a hearing. I happen to love Florida, and if I ever get around to retiring, I’ll probably end up here. Thanks to personal choice, some business, and just a little bit of kismet, I get to travel here at least 3 or 4 times a year. Indeed, by the end of April, I will have made 3 trips here in 2012, with at LEAST two more planned.
In many ways, Florida is the poster child for the current economic problems plaguing the U.S. It has all of the hotbutton issues in one place — overbuilt housing, lending practices to match, and huge demographic shifts. The latter is almost humorous — Florida is jokingly referred to as “God’s waiting room”, not withstanding the fact that suburban Las Vegas, Orange County, California, and Scottsdale, Arizona, are all fighting for that moniker. Indeed, about 15 years ago, I was relegated to represent my university at the annual meeting of the American Association of Retirement Communities. I learned (among other things) that the two Carolinas, when taken together, actually get as many retirees every year as does Florida. However — and here’s the funny part — the “source” of Florida’s retirees is primarily the New England and Mid-Atlantic region. The “source” of the Carolinas’ retirees is Florida — they’re called “half-backs” because they move to Florida, find the weather to be abysmal, and move half-way-back home.
Being that as it may, Florida is still the destination for seemingly millions of retirees, a large proportion of whom seem to be “snow-birds”. They live in Florida 6.01 months of the year (just enough to qualify for Florida citizenship, and thus preferential Florida taxes) and then head back up north on March 31 every year. (I was in Florida on March 31, and the out-migration seemed to clog the interstates).
Before the melt-down, the whole housing industry in Florida existed to provide half-year housing for these snow-birds. Pick what you want — condos, townhouses, detached homes, we’ve got it at every price-point, size, color, and configuration. It would be hard to imagine a housing solution that wasn’t available in Florida. Financing? No money down? No problem. Move right in. While a surprisingly large number of homes were paid for with cash, there was certainly lots of available financing for the retiree who didn’t want to tap his funds for a down payment. And why tap your funds? When the stock market is growing at 10% per year, and real estate is going up by 15% per year, who would avoid a 4% mortgage? And what bank wouldn’t make that mortgage? After all, Grandpa and Grandma are great credit risks, and if they die before the loan is paid off, certainly the property can be re-sold for a profit. It’s a win-win, right?
Yeah, we don’t need to re-visit the meltdown, but the aftermath is a fascinating war zone. First, a lot of cond0-dwellers simply walked away. A lot of single-family dwellers tried to hang on, but often to no avail. Nothing would re-sell, so the market just froze. But, remember that a LOT of the buyers paid cash or had very low LTV loans. Those folks are particularly harmed — they are sitting on nearly unsellable property, with no end of the pain in sight.
If you visit Sarasota or Naples or any of the dozens of “retirement” communities on the Florida coast, you’ll get two distinct pictures. The beaches are filled, the hotels are filling back up, and the neighborhoods look healthy. Visit the county government complex, though, and you get a distinctly different picture. Floridians are a distinctly tax-averse lot, and so many county and city governments thrived on fees paid by developers. With that market frozen, the local government finances are a mess. Couple with it an actual and meaningful decline in property tax collections, and you get a local finance problem that won’t get fixed anytime soon.
With that in mind, millions of Americans (and an increasing number of South Americans and Europeans) see Florida as the best of all retirement solutions. The weather is great most of the year, there is excellent infrastructure and health care, and plenty of recreational opportunities. The cost of living is among the lowest in the U.S., providing ample opportunity for “worker bees” who move here to care for the retirement cadre. However, the housing market continues in the doldrums. A good friend of mine, with excellent credit and not unsubstantial resources, recently bought a Florida condo. The BEST loan he could get was 40% LTV, and even that was a paperwork nightmare. There is plenty of demand for Florida housing, but the financing side of the equation continues to be an issue. Unless and until the financing problem gets fixed, the housing problem will still be with us.
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Gulf Coast Oil Spill Update
Separating fact from rumor can be challenging, particularly when there are complex competing issues that cloud the media. Even the Court’s own website disclaims any final details, and notes that further information will be available as the settlement progresses.
First, a few confirmed “facts” as we know them. On March 8, the Federal Court in New Orleans overseeing the mass tort issued an Order affirming that the Plaintiffs’ counsel and BP had reached a broad agreement on the terms of a proposed class settlement for remaining claimants. Notably, this does not affect all claimants against BP, but apparently creates a mechanism to settle the remaining private claims.
For those who haven’t been following the saga, about four months after the Gulf Coast Oil Spill, BP set up a fund (the “Gulf Coast Claims Facility”, or GCCF for short) to be administered by Washington, DC, attorney Ken Feinberg. BP agreed to provide up to $20 Billion, although only about $6.1 Billion has been distributed to date. Many claimants applied to the fund, were turned down, and pursued legal action. Other claimants elected to pursue legal action without applying to the fund at all.
Under the terms of the new settlement, the Court has appointed a new claims administrator, Patrick Juneau, an attorney from Lafayette, LA. A new claims center will soon replace the Gulf Coast Claims Facility. During the transition period, the GCCF will continue to pay out claims, and in fact has paid out about $26 million so far in March.
The new facility will settle with about 100,000 lawsuits which have been filed. The rough estimate is that a total of about $7.8 Billion will be paid on all of these claims. Two separate settlement processes will be followed — an economic damages fund and a medical fund. Currently pending claimants can get a “quick payment” of 60% of their claim without signing a release (less legal fees of about 6%). They may then wait for final adjucation to receive either the remaining 40% or, potentially, a higher figure in a later “settlement class”.
If that sounds complicated, note that the final terms of the settlement are still up in the air, but essentially, it’s recognized that there may be further appeals or claims to be adjudicated. This settlement covers property damages, economic losses, and medical claims, and also provides for BP funding $100 million in enhanced health care throughout the region. Included within the estimated $7.8 Billion is a $2.3 Billion “seafood fund”. Other than the seafood fund, the actual maximum settlement isn’t capped, so $7.8 Billion is simply a best-estimate going forward.
Of course, BP still has various state and Federal claims to face. The U.S. Government has yet to start proceedings under the Clean Water Act or the Migratory Bird Act, and some estimates put BP’s exposure under that alone at potentially $20 Billion. BP also faces exposure on state and local government claims, which could prove significant.
Attorneys for both sides are expected to propose final terms to the Court on April 16. One interesting squabble which has emerged is over fees. As noted, many claimants filed suit while others filed with the GCCF. Of the latter group, many were represented by counsel and many others weren’t. The current settlement plan calls for a 6% set-aside to reimburse plaintiff attorneys who have funded and managed the litigation. Since 6% of $7.8 Billion is nearly a half billion dollars in legal fees, there is naturally some push-back from attorneys who were not part of the litigation group but have been representing claimants through the fund. This promises to be an interesting fireworks show as Spring turns into Summer in New Orleans.
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Real Estate Marketing Focus
I’ve observed over the years that real estate investors, developers, and such try to aim for the “middle”. It’s a defensive strategy. Lots of community shopping centers got built before the recession hit, not because they were hot or trendy or even hugely profitable, but because they were generally considered to be “safe”. The same was true with single family subdivisions, all of which looked pretty much alike by 2006. Lots of “average” apartments were built, Class B to B+ office buildings (some of which marketed themselves at Class A, but could get away with that only because of demand), and plain, vanilla warehouses were added to the real estate stock.
Now that we’re (hopefully!) coming out of a recession, it may be a good time to dust off some basic truths about business in general as it applies to real estate. Sure, there’s a very strong temptation to rush to the middle again, and in the case of apartments (for which there is a demonstrably strong demand right now), that may not be a bad idea. Nonetheless, I recall one of the great pieces of advice from Peters and Waterman’s In Search of Excellence: “average” firms achieve mediocre results. The same is frequently true in real estate.
Case in point — there was a great article on page B1 of the Wall Street Journal yesterday titled “The Malaise Afflicting America’s Malls”. by WSJ’s Kris Hudson. (There’s a link to the on-line version of the article on the WSJ Blog.) Using Denver, Colorado, as an example, they note how the “high end” mall (Cherry Creek Shopping Center), with such tenants as Tiffany and Neiman Marcus is enjoying sales of $760/SF. At the other end of the spectrum, Belmar and the Town Center at Aurora are suffering with $300/SF sales from lower-end tenants. Other malls in Denver are shut-down or being demolished and redeveloped. For SOME consumers and SOME kinds of products, in-person shopping is still the normal. It’s hard to imagine buying a truck load of lumber from Home Depot on-line (and Home Depot has done very well the past few years), although even they have a well-functioning web presence for a variety of non-urgent, easily shipped items.
I noted recently that some private book sellers are actually doing well in this market, and have partnered with Amazon to have a global presence. (We buy a LOT of books at Casa d’Kilpatrick, and nearly all of them come from private booksellers VIA Amazon’s web site.) On the other hand, it’s hard to imagine buying couture fashion over the web. Intriguingly, Blue Nile, the internet-based jeweler, notes that their web-sales sales last year (leading up to Christmas) were great at the both ends of the spectrum, but lousy in the middle. Stores like Dollar General, who aim for a segment of the market below Wal Mart, have done quite well in this recession (the stock has nearly doubled in price in the past two years). Ironically, Wal Mart, which is increasingly being viewed as a middle-market generalist retailer, hasn’t fared as well. Target, which seems to aim for the middle of the middle of the middle, has seen it’s stock price flat as a pancake for the past two years, and Sears, the butt of so many Tim Allen jokes, is trading at about half of where it was two years ago. These lessons are being lost on some retail developers, but being heeded by others. Guess who will come out on top?
So, who needs offices, warehouses, and other commercial real estate? Businesses at the top, middle, or bottom? If we follow the adages of Peters and Waterman, we’ll expect the best growth — and hence the most sustained rents — at the top and bottom of the spectrum. (Indeed, even in apartments, one might build a great case that the best demand today is at the low end and high end). However, we’re willing to bet that developers will aim for the middle, as always.
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Latest from S&P Case Shiller
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”
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Retail and the Internet
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.
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U.S. housing market — good news and bad
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.
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A few thoughts about the stock market
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.
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Retail — on the mend?
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.
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Canada looking more like the US and UK?
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
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Housing News
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.
From a small northwestern observatory... 