Lead Story… I was talking with a client earlier this week about how long projects seem to be taking in the development world lately. Across the board, we have found things moving a lot slower than they were just a couple of short years ago. Lenders and capital partners are generally less aggressive than they use to be which means that the process of getting a commitment – let alone closing, takes a substantially longer time. There are plenty of culprits here: in addition to the aforementioned tepid capital market, stifling bank regulations, the construction labor shortage, city issues, etc are all playing a role in dragging things out. Our discussion focused on trying to identify the primary cause of all of the delays. While there is a confluence of factors, I’m becoming more convinced by the day that this is an issue that starts in the city planning department.
Several years ago, builders were buying a fairly large number of projects at Tentative Tract Map and taking it from there, assuming that the hard work had been done once a project had run the gauntlet of discretionary approvals. However, this assumption was proven false once the builders began to process non-discretionary approvals needed for grading and building permits to get physical construction underway. The problem was that many planning departments were (and still are) woefully understaffed. Today’s staffing levels may have been fine during the recession but are nowhere near adequate for a healthy, functioning market. As a result, projects have taken much longer than anticipated to start, hitting returns hard and causing both capital partners and builders to pull back from buying earlier in the process and insist on only buying “shovel ready” sites. This puts a higher degree of scrutiny and stress on the process. Developers who could count on selling a site with a Tentative Tract Map in 24 months now have to underwrite 36 months or more to account for taking the project through final engineering in order to maximize value and ensure a capital event. This means that carry costs are substantially higher and IRRs are lower, leading to a general desire to delay closing as long as possible. Add in the fact that banks now do much more detailed underwriting before even issuing a non-binding term sheet and a crippling labor shortage and you have a recipe for major return-killing delays.
So, what is the culprit behind understaffed planning departments? Conor Sen addressed the issue in a Bloomberg View column earlier this week about how low unemployment and tight state and local budgets have led to a shortage of public servants. The story primarily dealt with police officers and teachers but could just as easily be applied to planning departments (emphasis mine):
Tax revenue from ordinary economic activity is volatile as is, but the unusual nature of the nationwide housing downturn in the 2008 recession had a profound impact on local tax streams. The run-up in housing prices during the boom years led to higher appraised values and increased property tax revenue for municipalities to spend. The bust led to lower appraised values and budget deficits that had to be closed, in many cases via spending cuts and layoffs, as the private sector was going through the worst recession in 80 years. While home prices have recovered to varying degrees around the country, appraisals often occur with a multiyear lag, which has constrained local budgets during the economic recovery.
The financial accounting of when tax revenue is earned and can be spent is one thing, but the governing philosophies of politicians during this economic cycle are another. Elected officials who came into office in the aftermath of the great recession were mostly focused on shoring up budgets. In part this was because the electoral wave in 2010 following the recession was dominated by austerity-focused Republicans, but it affected Democrats as well. Big city mayors, who tend to be Democrats, had to balance their budgets, and it’s hard to get people to agree to tax hikes to fund services when unemployment is high. Rainy day funds needed to be built up, and in some cases, pension costs needed to be addressed.
Look, it’s easy to bag on government employees and not all of the criticism is unfounded – there is quite a bit of waste in the sector, especially when it comes to guaranteed pensions. However, it is absolutely necessary to have properly staffed government services. Fire, police and teachers come to mind. A competent and functioning planning department falls into that category as well, especially in the midst of a housing crisis brought about by too few units being built. The results of under-staffing are the now-common developer/builder tales of projects stalling out for months at the plan check phase. Sen makes a great point about this being an incredibly difficult situation to remedy (emphasis mine):
In the same way that over-hiring during the boom years came back to bite governments, under-hiring now is going to increasingly lead to pain when governments are inevitably forced to catch up. Government payrolls didn’t hit bottom until January 2014, nearly five years after the technical end of the recession. They are back to their level from December 2007, when the recession began. By comparison, over that same time frame, private sector payrolls have increased by 8 million workers.
While it would be nice to think that government has gotten dramatically more efficient over the past decade, the combination of tight budgets and recession-scarred governing mentalities means that public sector employment is short of where it needs to be to return to pre-recession levels of service.
Reality is that there are certain tasks that the private sector can’t accomplish without well-functioning government agencies. Your local planning department is one of these roles. In an ideal world, the development process in California would be a lot simpler than it is. However, we need to deal with the way the world is, not the way that we think it ought to be. It seems a bit ironic for someone with largely libertarian political leanings like me to be writing this but we need more government hiring in planning departments to get things moving again. Until that happens, the delays will continue.
Catching Up: Low income earners are seeing weekly pay gain faster than other groups.
Standing By: The Federal reserve has indicated that they may pause their planned rate hikes if inflation continues to come in weak.
Tidal Wave Investors are piling in to alternative investments in general and commercial real estate in particular in a desperate search for yield.
Exodus: As companies re-locate to big cities, suburban towns are left scrambling.
Make it a Double: Retail developers are lobbying cities to allow walking around with open beverage containers to generate buzz in retail spots. (h/t Stone James)
Fire Hose: Foreign buyers are buying US homes at a record rate, boosting prices in supply-constrained coastal markets, as the dollar plunges.
Severe Impediment: Increased Student debt is responsible for as much as 35 percent of the decline in young American home ownership from 2007 to 2015 according to a new study done by the NY Fed.
Headed In the Wrong Direction: Venice Beach is one of the most desirable places to live in the US, yet it’s housing supply has been shrinking.
Can’t Beat ‘Em, Join ‘Em: Sears announced that they are going to start selling Alexa-enabled Kenmore appliances on Amazon, sending shares soaring. See Also: Amazon can now crush a company (in this case home meal kit company Blue Apron) just by filing a trademark. And: How Amazon has become a problem for re-flationary monetary policy in Japan.
Dinosaurs? How technology could lead to banks facing Kodak-style obsolescence over the next 15 years.
Rise of the Machines: Walmart is increasingly replacing retail employees with robots. In addition, they area working on facial recognition software to detect customer dissatisfaction and adjust staffing accordingly. How this will play out in practice will be fascinating since apparently, Walmart management is unaware of this website that sheds some light on what Walmart shoppers actually look like.
Zero Point Zero: In an extremely rare circumstance, a private equity fund that made highly leveraged plays on oil and gas back in 2013 is now worth essentially nothing. The Orange County Employees Retirement System was an investor and has now marked their position to zero.
Chart of the Day
Courtesy of the WSJ Daily Shot
Mortgage debt service ratio is way down by the non-mortgage consumer ratio is way up:
The share of Americans who rent is at it’s highest level in decades:
Source: @MatthewPhillips, @FactTank
The ratio of home prices to incomes in Canada is insane:
Source: Capital Economics
Here’s who is buying US real estate:
Source: Wall Street Journal
Seems Reasonable: A man who was upset with AT&T trucks parked outside of his house took matters into his own hands and shot their tires out because, Florida.
Not the Sharpest Tool in the Shed: A man who “identified himself as a drug dealer” called police early Sunday to report the theft of cash and a small bag of cocaine from his vehicle because, Florida.
Can’t Catch a Break: In the latest round of terrible PR, rats fell from the ceiling at a Dallas-area Chipotle. For those keeping score at home, they have now had issues with E coli and norovirus, as well as rats falling from the ceiling – in addition, I’m fairly certain that they put laxatives in their burritos. Other than that, things are great.
When You Gotta Go: A bear wandered into a house in Wyoming, took two poops in the living room while several people were at home and then ran away. I guess he just wanted some privacy.
Landmark Links – A candid look at the economy, real estate, and other things sometimes related.
Visit us at Landmarkcapitaladvisors.com