From a small northwestern observatory…

Finance and economics generally focused on real estate

Posts Tagged ‘FED

Demand & Supply

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I just read a nice piece by Deloitte’s Robert T. O’Brien, their Global and U.S. Real Estate and Construction Leader, titled Commercial Real Estate Outlook 2017.  It’s far too interesting and too packed with info to summarize here, so have a glance for yourself.  However, I’ll point out a couple of things I believe stand out in his analysis.

First, homebuilders are under pressure due to what he calls the “demand-supply dichotomy.”  I’ve been concerned about this for a while.  During the recession — which admittedly was several years ago — big chunks of the housing infrastructure collapsed, including acquisition-development-construction (ADC) finance, skilled labor, permanent finance securitization, and local government permitting capabilities.  As such, we now actually have a bit of a housing shortage in hot areas (think “Seattle”).  Mr. O’Brien worries that homebuilders’ financial projections may be dampened.  I’m a bit more concerned with the upward price pressure on houses, which could put us back in a bubble situation.  Deloitte believes interest rates hikes by the FED may temper some of the demand side.

He believes private equity fundraising will decline this year, “…as managers focus on deploying existing funds.”  He believes managers will face increasing competition looking for good investments.  I would add that new managers or managers with a new story to tell will find 2017 a bit easier for fundraising than 2016.

O’Brien also sees slowing in the commercial construction arena, and so slugging financial performance for engineering and construction firms.  REITs should do well, though, albeit with continued portfolio repositioning.

Deloitte sees GDP growing about 2.5% this year and unemployment below 5%, which is in line with metrics we see here at Greenfield.  They also see several things disrupting the economy both this year and in out years.  The “collaborative economy” will certainly have implications for the way new start-ups use and lease commercial real estate.  The internet is rapidly disintermediating brokerage and leasing services, with implications for traditional brokers.  A shortage of talent in the STEM area and other shifts in the way millennials view the workplace have implications for location strategies.  Speed and mode of retail delivery — the “last mile” disruptions of Amazon — are still being sorted out.

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

FED raises rates — now what?

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from-tiaaThere is plenty of news about the FED bumping rates today — a whopping 0.25% (“yawn”) and only the 2nd time in a decade.  The argument is that the FED no longer sees low rates as a needed crutch for the economy.  Perhaps they’re right.  My interest is real estate — how will higher rates impact property returns?  More to the point, if the Trump administration goes ahead with infrastructure spending, as was promised, and the FED follows with further rate bumps, as has been projected, will real estate continue its upward climb?

Rather than answer that directly, there’s a great piece on that topic from TIAA — you can access it by clicking here.  Looking at data from back to 1980, TIAA finds that real estate appears to perform just as well during periods of rising rates as it does in other times.  Indeed, they find a 70% correlation between acquisition cap rates and long-term Treasury rates, suggesting that real estate buyers are agnostic on rates, within reason. Indeed, as the graphic above indicates, the most upsetting quarterly property returns came during periods of relatively stable, downward trending long-bond rates.  For the last half-decade, quarterly property returns have tracked the long-bond quite nicely.

So there ya have it, folks.

Written by johnkilpatrick

December 14, 2016 at 3:38 pm

Posted in Economy, Finance

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A Movie Review of Sorts

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I just saw HBO’s “Too Big To Fail”, staring a whole host of Hollywood “names” (James Woods, John Heard, William Hurt, Paul Giamatti, Cynthia Nixon, Topher Grace, Ed Asner etc.). Sadly, it’s a fairly boring movie, albeit about a terrifically exciting piece of near-term history. It focuses on the collapse of Lehman Brothers, mostly through the eyes of Treasury Secretary Hank Paulson (played spot-on by William Hurt). Asner does a wonderful Warren Buffett (who almost, albeit reluctantly, came to Lehman’s rescue) and Giamatti is a wonderful Ben Bernake. (As an aside — Bernake is the most dead-pan person I’ve ever met. Giamatti’s version of Bernake is even more deadpan than reality.)

The movie gets one thing right and one thing wrong. First, the wrong, and then the right.

The movie keeps referring to Lehman’s “real estate”. No one will buy Lehman if they have to buy its real estate holdings, too. Lehman’s real estate “problem” is at first estimated at $40 Billion, then $70B, then “who knows”. The truth, of course, was “who knows”. Cynthia Nixon plays Paulson’s press secretary, who serve as an amiable foil to allow Paulson and his Chief-of-Staff Jim Wilkinson (Topher Grace) to explain the nature of the crisis to her (and thus to the viewer). Unfortunately, Lehman’s “real estate” isn’t “real estate” but “real estate mortgages”. More to the point, they have “tranches” of real estate mortgage pools, and to understand what a “tranche” is would be well beyond the capacity of a two-hour movie. Tranche, by the way, comes from the French word for “slice”. Imagine we pool $100 million or so in mortgages, then split up the ownership into three equal parts — an “A” tranche which will get paid in full, including interest, before anyone else gets paid; a “B” tranche which gets paid next, and a “Z” tranche which only gets paid after everyone else gets paid.

In theory, all three tranches should be good securities, since the underlying mortgages are pretty safe bets, and in practice the “A” and “B” tranches really were pretty good. However, the “Z” tranches will bear all the default risks. Banks (both mortgage and investment) made tons of money on these things, because the default risks could be “priced” as long as market continued to rise. Various investment banks then borrowed money to buy “Z” tranches, and coupled with credit-default swaps (essentially, a mutual insurance pact among investment banks), they were able to borrow huge amounts of money with very little capital.

The Paulson/Wilkinson explanation in the movie makes it sound like the whole problem came from mortgage defaults and foreclosures. In reality, mortgage defaults DO cycle up when a recession comes along, but these are usually predictable cycles. The REAL problem came from borrowing huge amounts of money — with almost no capital — to buy “Z” tranches that didn’t reasonably price the increased in defaults. A slight up-tick in defaults sent everyone to the emergency room, and when owners couldn’t sell or re-finance, the whole market went down the tubes. THAT was the “real estate” problem which plagued Bear Sterns, Lehman Brothers, Salomon Brothers, Morgan Stanley (my old alma-mater) and all the others. Sadly, the movie perpetuates the myth that the real estate down-turn was an exogenous event, and fails to discuss the sins of the secondary mortgage market which took a simple, cyclical downturn and turned it into a long-term, world-wide crisis.

But, even with that, the movie got one thing so very right that made up for the mistakes. In one pivotal scene, Paulson and his team are presenting the TARP idea to the leaders of Congress. (Central Casting found some excellent look-alikes for Pelosi, Dodd, Shelby, Frank, and the rest.) Note that this comes very late in the movie, well after Paulson (an almost billionaire, who really didn’t sign on for this level of stress) and his team have tried ever possible solution to stem the crisis. The movie does a great job of playing Paulson up as the unsung hero who really saved the world’s economic life, by the way. Anyway, the leaders of Congress don’t “get it” until Giamatti’s Bernake gives the most important 2-minute economic lecture in history. He notes that while the Great Depression started with a stock market crash, it was the failure of the credit markets which made the depression last so long. The current crisis, if left un-solved, would spin the world into a much worse, much longer economic depression. Giamatti really nails the tone of the reality which was facing the nation’s top economic thinkers at the time.

Anyway, I don’t watch very many movies. I saw Adam Sandler and Jennifer Anniston in “Just Go With It” on an airplane last week, and thought it was a hoot. As movies come-and-go, “Too Big To Fail” doesn’t even rise to the entertainment level of “Just Go With It”, but as an educational piece, it’s a must-see, even with its critical flaws.

Written by johnkilpatrick

June 7, 2011 at 4:54 pm

Housing Finance — Take 2

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Again, from the Wall Street Journal, we find reasons for concern. The “Ahead of the Tape” column in today’s Journal, we find an excellent — but troubling — article by Kelly Evans titled “Economy Needs a Borrower of Last Resort.” It really follows my theme from yesterday, and I couldn’t agree more.

Graph courtesy The Wall Street Journal

The first line of the article says it all: “A lack of funds isn’t hampering the U.S. Economy right now. It is a lack of demand for them.” The FED has been pumping billions into the money supply by buying bonds from banks. In a healthy economy, this should drive up the money supply by a multiple of the face amount bought. Why? An old equation from Econ 101 called the “Velocity of Money.” When I was teaching, I explained (or tried to, for the C students) that when the FED injects money into banks, the banks loan it out. The borrowers in turn buy stuff and the money goes back into the banks, minus a little. That happens several times over. Thus, a dollar of money “injection” by the FED should usually result in at least $2 of net M2 money creation.

Imagine a dollar (or a hundred thousand dollars) injected into the system which is loaned to a family buying a new home. They pay the builder, who deposits the money in the bank (actually, paying off the construction loan) and then that money can be loaned back into the system. Some of it bleeds off into taxes, exports, and such, with each iteration of the deposit-and-loan cycle, but still, the money cycles thru the system. Since each subsequent deposit and loan doesn’t happen instantly, there is a little bit of a lag. Nonetheless, over a short period of time, the system should work. The math behind this is called the “Cambridge Velocity Equation” and it’s been known to economists for hundreds of years.

So, since November, the FED has purchased $684 Billion in bonds, which SHOULD have resulted in trillions of dollars in new money creation. Instead, M2 (the abbreviation for the money supply, defined as all of the cash, bank deposits, and money market funds in the system) has only increased by $326 Billion, suggesting that the velocity of money is about 0.5. Note that it SHOULD be 2 or 3 or more in a vibrant economy. This means that for every dollar injected into the system by the FED, half of it has dissipated.

As the article points out, this is why the recovery has remained so anemic. I would posit that a big problem is in the home loan business, which is far weaker than merely “anemic” — it’s on life support with the undertaker waiting in the lobby.

Kelly Evans posits that the market needs a lender of last resort, which is exactly what I was saying yesterday. Unless and until the system starts turning into the skid, by fixing the totally busted mortgage market, a double-dip recession seems inevitable.

Written by johnkilpatrick

June 2, 2011 at 4:05 pm

Tis the season….

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Intriguing mixed messages from the economy. Employment continues to lag, but holiday shopping was up. Go figure?

Two or three things may be in store. First, I’m sure that some of the more profitable businesses, fearing future tax increases, were holding off spending tax-deductable money until 2011 rather than 2010. The key lesson for lawmakers — get some stability and predictability into the tax system.

Second, while “on-line” shopping went up, the unmeasured impact of on-line was the ability to target shopping. Lots of holiday shopping went at bargain prices, and I’m interested to see how much sustainability there will be in the increases. It’s very difficult to imagine, with the underlying instability in economic fundamentals, just how long the shopping bubble can be sustained.

But, on to real estate. What looks good right about now? What looks bad? We continue to be doom-sayers on housing construction into 2011. Normally, in a recession, there’s a build-up of excess supply (construction in the pipeline pre-recession get unsold DURING the recession). However, past recessions rarely have a contemporaneous melt-down in homeownership rates (see the following).

Note that since we began keeping records in 1960, ownership rates have inexorably trended upward but for two instances — this one and the 1980-84 period. After 1984, it took until the mid-1990’s for rates to start trending upward again, and many would suggest that this up-trend was only the result of Greenspan’s “easy money” policies. In a more cautious lending environment, it’s hard to say where the true equilibrium might lie. However, it’s intriguing that the run-up in the 1970’s is often blamed on the high levels of inflation (making home ownership the favored “inflation hedge” for families) and that in the post-recession, low-inflation period of the late 80’s and early 90’s, rates seemed to hover around 64%.

If in fact that’s where the equilibrium lies, then the U.S. has about three more percentage points in owner-occupied homes to absorb. This absorption occurs in one of three ways — growth in the population, conversion of homes to other uses (usually rental in lower-end or transitional neighborhoods), or demolition. Whatever the reason, with the current slope of the trend-line (which, intriguingly, matches the slope of the 1980-84 period), we see that it took about 5 years (2004 through 2009) to get from about 69% to about 67%. At this rate, getting to 64% will take another 7 – 8 years, suggesting a best case scenario of stability in the 2016 range.

This scenario, interestingly enough, matches some of the employment-growth scenarios I’ve seen, which suggest we’re looking at the mid-to-late teens for unemployment to get back down to pre-recession levels.

So, if owner-occupied housing stinks, what looks good on the menu? Apartments. In very rough numbers, we WERE building about 1.5 million homes per year prior to the recession (year-in, year-out, with a HUGE amount of variance from year to year). Now-a-days, we’re building about a third of that or less, suggesting an un-met demand for housing of about a million units per year, more or less. Apartment construction also flat-lined during the recession, primarily because banks simply didn’t have the money to lend for construction financing. (Permanent money comes from other sources, and it’s available, but the construction financing problem is still with us.)

As credit continues to ease — particularly with the recent announcements by the FED in that regard — we can see some strong lights at the end of that tunnel. Good news for construction workers — their unemployment rates have been huge lately, but the same folks who drive nails for owner-occupied homes can also drive nails in apartment complexes. Easing credit in this area will thus fuel job growth, which also fuels consumption, home purchases, etc. Thus, addressing the housing demand/supply problem may be the most important single thing policy makers can do to restore the economy to good health.

Written by johnkilpatrick

December 16, 2010 at 9:57 am