From a small northwestern observatory…

Finance and economics generally focused on real estate

Posts Tagged ‘housing

Trump’s Tax “Reform”

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Mark Twain is usually — and incorrectly — quoted with the phrase “No man and his money are safe while Congress is in session.  (The actually quote goes to 19th century NY politico Gideon Tucker, but I digress.)  There’s little to be said, in general, about TheDonald’s proposals yesterday, simply because there’s little substance to analyze.  However, I’m old enough to remember the last tax overhaul, in the early stages of the Reagan administration, and perhaps I can offer a few observations.  I’ll limit my mental meanderings to real estate for now.

First, the Reagan tax re-hab (the 1986 Tax Act) was a disaster for real estate investing, particularly at the individual, atomistic investor level.  One of the “loopholes” to be cured was the elimination of deductibility of passive losses on real estate investments.  The real estate community reluctantly supported the tax act, in trade for increases in the deductibility of home mortgage interest and a guarantee that passive losses on then-existing real estate deals would be grandfathered.  Indeed, in the run-up to passage, there was a flurry of investing (by Main Street USA folks — the kind of folks who still, amazingly, support Trump) in just such “grandfathered” investments.  At the last minute, the grandfathering was removed, costing Main Street USA investors tons of alternative minimum tax payments on now-sour investments.  Some pundits suggest that this grandfathering-revocation, alone, led to the downfall of the Savings and Loan industry, but that excuse is a bit to simplistic.  It did, however, shut down the time share industry for a while.

Today, according to news reports, single family residences are enjoying record demand (which may or may not be good news).  The hottest market is among first-time buyers, and the demand is greatest among starter homes.  The Trump proposals would double the standard deduction for a married couple filing jointly.  While, on the surface this seems like a good idea, it will drastically shrink the number of tax payers who itemize mortgage interest and property taxes.  In short, for the biggest tranche of homebuyers, the biggest differentiation between ownership and renting would be effectively removed.  As a guy who invests in rental property, that’s nice, but the home building industry won’t react well.

Otherwise, I don’t see lowering the marginal tax rate on corporations as having much of an effect on real estate investing.  For one, most of those projects are either done thru tax-advantaged REITs or thru other pass-thru entities, like partnerships and LLCs.  Even if it did, the demand / supply of investment grade real estate depends on other factors, and slight changes in the tax rate may have an impact on the debt/equity mix, but not on the aggregate output of new commercial construction.  The ONE area most affected will be low income housing, which is funding in no small part by tax credits.  The value of those credits will be slashed, requiring a complete re-thinking in the finance side of low income housing.  The last time such a tax cut went into effect, it was a real mess for low income housing.

If I was the government, and I wanted to create good paying construction jobs, I’d embark on a long-term infrastructure redevelopment plan.  That would probably require actually raising tax rates a bit, but would have marvelous returns on investment for middle America.  But that’s just me….

And yet another post about housing

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With all the negative news about housing, the market may have a tendency to grasp at any straw that floats along. In today’s news, that straw is a report from the census bureau that home ownership rates — which have been declining steadily for two years, and are now at a 13-year low — seemed to reverse trend in the 3rd quarter and rise by 0.4% to 66.3%.

courtesy U.S. Census Bureau, 11/9/11

Of course, a quick read of the footnotes belies the problem with this pronouncement. First, as you can see, there’s a fair amount of cycling around long-term trends, and that’s probably what this is. Second, on a seasonally adjusted basis (which is really where the truth can be found), the increase was only 0.2%, which is statistically insignificant. Further, on a year-to-year basis, we’re still lower than where we were a year ago, which really underscores the long-term trend. I continue to believe that ownership rates will stabilize somewhere above 64%, but probably pretty close to it. At the current trend, that may take 3 – 5 years.

More importantly, though, an increase in housing demand (and prices) led us out of prior recessions, but housing is continuing to be a drag on the market following this most recent one. Unless and until the housing market doldrums stabilize, solid economic growth will elude us.

courtesy U.S. Census Bureau, 11/9/11

Written by johnkilpatrick

November 9, 2011 at 8:24 am

Home Prices Decline — Why?

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Our neighbors down the street, zillow.com, just released a report showing that home prices nationally fell by 3% in the first quarter, or a total of 8.2% from March, 2010. The cumulative national average decline from the market peak (June, 2006) is 29.5%, and this quarter’s decline was the worst since 2008.

By the way — and this may seem totally obvious — but one of the biggest reasons people buy homes is because they are expected to go up in value, not down. Hence, a home is expected to be a storer of value and a hedge against inflation, not a dissipating asset. A buyer in June, 2006, would have reasonably expected his or her home to increase in value by 5% or so per year. For example, as Zillow’s chart shows, even back in the 1990’s, a home bought in 1996 (where their chart begins) went up by a total of about 20% by 1999 — slightly over 5% per year compounded. In five years, 5% compounded annually totals about 28%. Hence, not only are homes going down, they are totally contra to expectations by a total (28% plus 29%) of nearly 60%.

It sounds trivially obvious, but bankers also expected that. It’s one of the reasons why they fearlessly (and yes, foolishly) made loans to anyone who could sign their name (or make a “X”) back in the bygone days, because if the loan went sour (and they KNEW some of them would), they could always dump the collateral for more than they had in it. “Heads, we win. Tails, we don’t lose.”

CNBC had a nice piece on this topic this morning, featuring (among others), Dr. Susan Wachter, of U. Penn, who we’ve had the pleasure of knowing for many years. All of the talking heads agreed that banks won’t loan money today unless they’re absolutely sure of creditworthiness of the borrower. Hence, fewer people can borrow today, so fewer homes can get sold. Values decline due to lack of demand (pretty simple ECON 101 stuff happening here) and, as Prof. Wachter put it, the spiral will continue downward until an equilibrium is reached.

I’ve opined about that equilibrium in this column for quite some time. There is some significant albeit anecdotal evidence to suggest that the equilibrium home ownership rate will constitute the floor in all of this — probably somewhere around 64%, which is where we were back in “normal” times of the late 1980’s to mid-1990’s. I wish we had more data, but systemically declining housing markets don’t happen very often.

Written by johnkilpatrick

May 9, 2011 at 9:20 am

Housing equilibrium — part 1

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This is going to be a bit convoluted, so bear with me.

This week, I’ve been at Renaissance Weekend, an annual gathering of top minds in a variety of fields (Nobel laureates, authors, actors, CEOs, etc) and I’ve been asked to make several presentations on real estate finance and economics. It’s a pretty heady experience, but more on that later.

One of the principle questions thrown my directions is, ‘When will real estate bottom?’ One might argue that commercial real estate has already bottomed, and there’s a fair amount of data to support that. (A weak “bottom”, I’ll grant you, but a bottom, none-the-less.) Apartments are coming back particularly strong, but even hotels and industrial are showing positive gains this year.

Owner-occupied residential is a completely different story. We’ve really never had a phenomenon like this, and according to both the Federal Housing Finance Authority and Case-Shiller, housing prices continue to collapse all across the country. Indeed, C-S just released a report two days ago indicating that new lows were hit in 6 out of 20 top markets. Overall, housing prices have been downtrending every quarter since mid-2007.

When will this bottom? I’m toying with a set of models which suggest that the pricing market won’t bottom until the ownership rate reaches an equilibrium. Heuristically, that optimal rate appears to be around 64%. Why? I’m looking at the last time ownership rates ballooned, which was at the end of the hyper-inflation period of the late 1970’s. Pricing markets stabilized after the ownership rates stabilized.

This posting is a deviation from my normal routine — My thinking on this topic is evolving, and I’m hoping to trace that evolution here on the blog until I reach something that I can actually flesh out into a paper. I’d appreciate any comments you have, either added as a comment here on the blog or, if you’d like privacy, e-mail them directly to me (john@greenfieldadvisors.com)

Written by johnkilpatrick

December 30, 2010 at 7:38 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