Landmark Links November 4th – Who’s On First?

funny-baseball-player-falling-picture

Lead Story…. It seems like nearly everyone in the real estate industry likes to use the baseball analogy to describe the real estate cycle.  There’s a little known rule that every home builder/developer conference has to have a panel where participants are asked what inning the current cycle is in by a moderator.  I suppose that this was considered either novel or informative at some point but today it’s neither.  The problem is that it’s difficult to classify real estate, especially real estate development in such broad and generalized terms.   Whenever I’m asked such a question, I answer the same way: what asset class and what market?  Another important clarification is the time frame of the recovery that began the cycle in question.  Most people consider our current cycle to have begun in June of 2009 which was when the National Bureau of Economic Research (NBER) marked the end of the last recession.  However, when it comes to home building and by extension the economy as a whole, it’s not that simple as Bloomberg’s Conor Sen wrote this week (emphasis mine):

The National Bureau of Economic Research marked the end of the last recession at June 2009. Similarly, the stock market hit bottom in the first half of 2009. The four-week moving average of initial jobless claims peaked in April that year. And the unemployment rate peaked in October. All of these suggest a broad-based trough at some point during 2009, making the economic expansion at least seven years old by now.

But given the severity of the financial crisis and the shock to the economy, the beginning of the recovery was not like moving from recession to expansion. It was more like moving from depression to recession. Rather than a normal business cycle in which four steps forward are followed by two steps back, the Great Recession was more like five steps back. Should the ensuing first two or three steps count as part of the next expansion, or something else?

The growth in the early part of this recovery was abnormal. Part of it was caused by government fiscal stimulus, which proved to be inadequate and was then followed by federal, state and local austerity. Part of it was caused by a “dead cat bounce,” as output fell so hard, below consumption in industries like the auto sector, that a certain amount of recovery was inevitable as producers had to increase output merely to match consumption. And then some part of the recovery was caused by the energy sector and the boom in fracking, a localized boom that eventually went bust.

So what went missing in those first few years of “recovery”?  The answer is home building which is the reason that I think much of the current cycle’s math is a bit off.  More from Sen (emphasis mine):

The missing piece was housing, the bread and butter of the American economy. The Housing Market Index from the National Association of Home Builders didn’t begin to increase from depressed levels until October 2011. Similarly, single-family-building permits didn’t begin to increase from depressed levels until 2011. It’s here, in late 2011, that I would claim the current expansion began, making it barely five years old, quite young in the context of a downturn that lasted four or five years rather than just two.

Ultimately, housing is the driver of the U.S. economy, which is why any understanding of the recovery of the economy must factor in the recovery of housing. Single-family-building permits peaked in the second half of 2005. Subprime mortgage originators started going bankrupt in 2007, the same time that housing prices started falling significantly. Outside of globally attractive real estate markets like San Francisco, New York and Miami, housing prices and activity continued to fall well into 2011.

The early years of the housing recovery, from 2010 to 2012, were more driven by investors and institutions buying foreclosures and investment properties with cash than by owner-occupiers coming back to the market. In the past few years, housing demand has been soaking up inventory created during the bubble years and pushing home prices back toward their mid-2000s levels. First-time home-buying remains below normal.

Only now are we seeing tertiary markets like exurban areas start to expand again, and construction remains below the level of household formation. One of the metro areas that was a poster child of the housing bubble, the Riverside-San Bernardino metro area in Southern California, is still building 80 percent fewer single family homes than it was at the peak of the last cycle.

That last highlighted section is something that I’ve written about frequently.  Although LA, Orange County and San Diego get a lot of attention for their great weather, beautiful beaches and affluent communities, it’s actually the Inland Empire that is the engine of growth in Southern California.  Especially when it comes to creating new housing for first time buyers and blue-collar workers that can’t afford to live closer to the coast.  That this region is still building 80% fewer units than it was at the peak of the last cycle is nothing short of shocking.  IMHO, it can’t be classified as much of a recovery at all.  As Sen points out in his article, every economic sector doesn’t necessarily recover in unison.  Just because tech has boomed or energy has boomed then busted doesn’t mean that other sectors are doing the same.  When it comes to a traditional growth sector like housing, this can have a massive impact on a regional (or even national) economy.  For some traditional growth markets like the Inland Empire, perhaps the appropriate question isn’t what inning of the cycle we are in but rather when the recovery will actually begin in the first place.

Economy

Even Keeled: Calculated Risk’s Bill McBride is still not on recession watch.

Setting the Stage: The Fed didn’t raise rates at their November meeting but certainly indicated that they are open to doing so in December.  See Also: The Fed’s latest statement indicates that they are not going to target inflation rates above 2%.

Commercial

Going Strong: Chinese investment in US commercial real estate is still on the rise.

Residential

Put a Lid on It: Low FHA limits are killing home building in California’s secondary markets.

Imagine That: San Francisco home sales surged in September thanks to a large supply of newly-completed condos.

The Oracle of Home Building? Berkshire Hathaway just purchased the largest home builder in Kansas City.  It’s the just the latest purchase for Warren Buffett who has been buying up builders in the south and Midwest.

Profiles

Ain’t No Free Lunch (Or Shipping): Why the free shipping that you love so much from online retailers is mostly a lie.

Shocker: This years Black Friday deals will probably be exactly the same as last year’s Black Friday deals.

Subprime Redux: Rising automobile repossessions show the dark side of the car buying boom.

SMH: The University of California at Irvine, which is in Landmark’s back yard wants to be the Duke basketball of online gaming (aka video games).  Ok, fine but can they please stop calling it a “sport”?

Chart of the Day

ie-permits

WTF

Hero: A woman sustained burns after causing a fire by farting during a surgery, igniting a laser.  Pain is temporary but glory lasts forever.  See Also: Ten people who were arrested for farting.

Guaranteed Contract: Former NBA star and certified crazy person Gilbert Arenas just received the final check from the $111MM contract that he signed in 2008. If you’re not familiar with Arenas, he once got into a locker room altercation with a teammate that involved a firearm and hadn’t played in the NBA in nearly 5 years. Great investment. (h/t Tom Farrell)

That’s Going to Leave a Mark: A drunk 28-year old Florida man fell out of his pickup truck on the way home from a strip club and immediately ran his leg over before it crashed into a house.  He’s apparently still at large.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarkcapitaladvisors.com

Landmark Links November 4th – Who’s On First?

Landmark Links October 25th – When Will The Empire Strike Back?

darth-vader

Retraction: Before we get to today’s post, Leonardo DiCaprio’s rep announced that he doesn’t support the anti-density initiative that I spoke about on Friday, despite his name being all over it’s literature.  Maybe he is a regular Landmark Links reader and didn’t like getting called out 😉

Lead Story…. Since I began writing this blog last year, one of my main areas of focus has been how the historical relationship between primary and secondary markets has broken down in this cycle, especially in CA.  In the past, the inland production markets would heat up when prices rose along the coast.  This lead to a virtuous cycle where housing starts beget jobs which beget more employment, wage growth and ultimately more household creation and home buyers.  This cycle has been different for several reasons:

  1. Difficulty of inland builders to develop affordable homes profitably due to low FHA caps and high impact fees
  2. Growth in preference for urban living among wealthier adults
  3. Declining home ownership percentage impacts the marginal entry level buyer more than the affluent one and historically, the marginal buyer is more likely to look inland for housing.

It’s become fairly common in our industry to look to increases in FHA limits as the salvation of the secondary markets.  However, for that to occur in any substantial magnitude (all indicators point to a small increase next year),  Congress would have to revise the statutory formulas that they set back in 2008 to govern FHA limits.  As my colleague Larry Roberts wrote in OC Housing News, that is far easier said than done:

Through the lobbying efforts by the National Association of Homebuilders or the National Association of Realtors, Congress knows exactly how the conforming loan limit impacts home sales and new home development.I recently spoke with Scott Meyer and Michelle Hamecs of the NAHB. They provided me their NAHB Issues Update that detailed the FHA loan limit issue (click here for that document). It isn’t ignorance to the problems the prevents Congress from raising the limit.

The conforming loan limit demonstrates the tug-of-war between two conflicting desires of policymakers.  On one side, advocates for the housing industry and advocates for expanded housing opportunities to all Americans want to push the loan limit higher. On the other side, the more fiscally conservative lawmakers want to lower the limit to restore the prior mandate of insuring loans only for lower- and middle-income Americans. Further, they want to reduce the potential liability for the US taxpayer, who would currently cover all the losses if the market crashes again.

If the conforming loan limit were reduced, it would decrease the potential liability for taxpayers and reduce the size of the GSE operations and make it easier to someday dismantle them; however, the last time the conforming limit was dropped, Irvine, CA witnessed an 84% decline in sales volume in the price range no longer financeable with GSE loans. Ouch!

There is no doubt that increasing FHA limits would help.  There is nothing particularly healthy about having a market that is 100% reliant on government-backed loans to function but unfortunately that’s the hand that we have been dealt.  Raising FHA limits attacks the problem from the bottom of the prospective home owner pool by allowing buyers at lower price points to purchase homes with much lower down payments than what’s available using a conventional mortgage.  Today, I want to look at a different scenario that could play out in the next few years.  It’s more from the upper end of the pool where coastal renters could find themselves once again looking inland if prices continue to rise.  Today, I’m going to focus on Orange County and the Inland Empire but the demographic dynamics that I’m going to focus on could apply to many affluent coastal regions and their less-affluent inland neighbors.

On the surface, things look great in Orange County.  Economic growth is strong as is employment and home prices are now above their prior peak.  Development is humming along and occupancy levels are extremely high in commercial and multi-family projects.  In addition, OC has diversified it’s economy quite a bit as finance and tech have taken a large role as the County has become less dependent on real estate.  However, as the OC Register detailed last week, Orange County has a growing demographics problem and I think that the Inland Empire just might be the prime beneficiary.  The problem isn’t that Orange County isn’t creating jobs.  It is and we actually have the lowest unemployment rate in Southern California.  It’s that the jobs being created often don’t come with wages that would allow someone to live here.  Combine that with relatively few new housing units being built and the cost of existing units rising quicker than inflation and you have a recipe for what economists predict will be a declining population of prime workforce age population (25-64 year olds) from 2010 – 2060.  From the OC Register (emphasis mine):

“They say demographics are destiny,” Wallace Walrod, the Orange County Business Council’s Chief Economist told the conference. “It is imperative that everyone in this room understand the consequences of pending demographic shifts.”

The national trend of aging baby boomers moving into retirement, he said, is “magnified and exacerbated” in Orange County, where the over-65 population is on track to nearly double by 2060 to “a staggering 26.2 percent.”

Unlike California as a whole, every age cohort other than seniors is shrinking in Orange County, where the median age has risen from 33 to 38 since 2000.

Most worrying, the prime working-age population – 25-to 64-year-olds – is expected to dip by 1 percent by 2060, even as overall population grows by 15 percent.

By contrast, working-age groups in Riverside and San Bernardino counties are on track to grow by 61 percent and 47 percent, respectively.

“We are losing not only our 25 to 34 year-old workforce – millennials – but also losing K-12 and the college-age cohort as well,” Walrod said.

The trend, he warned, “could devastate O.C.’s pool of workers, creating talent gaps as large swaths of the workforce retires, leaving open positions that will likely go unfilled.”

The Register went of to identify the the obvious culprit: housing.  I frequently hear friends, neighbors and co-workers and neighbors who live in Orange County complain that the area is being over-developed.  The stark reality of simple math shows that view couldn’t be more wrong.  Again, from The OC Register (emphasis mine):

A severe housing shortage has turned Orange County into one of the most expensive markets in the nation, with median home prices exceeding $650,000 and average monthly rents at about $1,900. Higher-density developments that could alleviate the shortfall are often opposed by current homeowners.

Rising values are “good news for current homeowners, but bad news for those looking to afford to relocate to O.C. or to buy a house and stay here, especially millennials,” Walrod said.

As a result, he added, “domestic outmigration has been accelerating.”

The report projects that “new job creation will significantly outpace projected new housing units over the next two and half decades, resulting in a housing shortfall that will grow from a current reading of 50,000-62,000 units to a staggering 100,000 units by 2040.

Many workers are being forced into neighboring counties to find more affordable housing, increasing their commute and complicating their work-life balance.”

……

According to the report, it takes an hourly wage of $32.15 to afford a two-bedroom apartment in Orange County, putting it out of reach for minimum-wage workers in the county’s fast-growing service sector, given the current California wage floor of $10 an hour.

The story goes into much more detail about a developing skill gap and low wage job boom.  However, I want to keep the focus on housing for this post.  Note the above projections about working age populations in Riverside and San Bernardino Counties (growth of 61% and 47% respectively from today until 2060).  Those are massive numbers that will create a strong demand for housing and not all of it will be entry level.  If you take the median income required to buy and rent a median-priced home in Orange County today, it is around $100k (assuming you can put down 20%) and $70k, respectively, so there are a lot of people with well-paying jobs that fall below that amount.  Given the fierce opposition to density in the OC, it is likely that those numbers will only increase.  Also, keep in mind that the averages above are for the entire county.  The most desirable areas with the best school districts can easily be double those amounts which is incredible when you consider that median income to afford an apartment in the neighboring IE is around $55k.  At some point, something has to give.  My guess is that it’s a move towards more relatively affordable housing markets, in this case the Inland Empire.

I want to make an important caveat about what I wrote above: I haven’t a clue as to when this change will actually take place and more affluent workers will start to look inland to buy or rent.  However, one thing that I’ve learned witnessing our current market is that things change incredibly quickly once they hit a critical mass.  Just a few short years ago we were subject to an endless barrage of “renting is superior to buying” articles in the mainstream and business press.  Just this week, Bloomberg ran a piece that argued that it’s almost always better to buy.  Such an article would have never seen the light of day in 2011.  Both types of articles are virtually assured to be wrong since they argue in absolutes. In reality it’s sometimes better to buy and sometimes better to rent but that level of nuance doesn’t lead to many page views.

My comment about how quickly things change goes for regional and local trends as well.  For example, 15 years ago, pretty much no one with a college education wanted to live anywhere near downtown LA.  Within the past 10 years that has changed rapidly and an area which was once in the grips of urban decay has become one of the most desirable locations for young, affluent home owners and renters in the US.  Some of the same conditions that created the LA gentrification/urban renewal boom have caused the Inland Empire to lag: delayed household formation by Millennials, preference for urbanization among high earners and a downward trend in the percentage of Americans who own a home.  However, I have serious doubts that these are permanent trends and there are other factors at play already that could begin to create more inland demand:

  1. Addition of urban elements and amenities to existing CBD and downtown regions.  This is already happening in downtown Riverside as more density and foodie oriented retail are on their way.  There are other urban areas out in the IE that could experience the same thing over time, downtown San Bernardino for example.  It’s probably difficult to imagine right now but that’s ok.  Downtown LA as it currently exists was didn’t seem feasible back in 2001 either and I doubt that many of us foresaw luxury condos and apartments going up next to Skid Row.
  2. Self driving cars could help to ease commute stress in markets without mass transit infrastructure.  The technology is advancing rapidly and the Inland Empire will arguably be the region that will benefit the most in the US.
  3. Bank lenders are starting to compete with the FHA for low down-payment loans to entry level buyers.  Bank of America has been so successful with their 3% down program that they are doubling it.  These lending programs are still tiny by comparison but it wasn’t long ago that they didn’t exist at all.
  4. Millennials are getting older.  Many of the oldest Millennials are now entering their mid to late 30s which are the prime household creation years.  Once people start families, studies show that they are more likely to favor the stability of owning over the mobility of renting and the family-friendly single family home over an apartment.

The Inland Empire is down but I wouldn’t count it out over the long term.  The current trends that have hurt the housing market there aren’t likely to last forever and the region is adjacent to too many incredibly expensive areas to not experience some spillover as even relatively high earning families eventually get priced out of the coastal regions. Conventional wisdom is that only an increase in the FHA loan limit can revitalize the IE housing market.  In the short term, that may very well be the case but a sustainable recovery just might come from higher earners moving into the region.

Economy

The Walking Dead: How bankrupt oil companies that are continuing to pump could keep a lid on oil prices.

Stay In: It’s getting more expensive to eat out even as grocery prices are falling.

Commercial

The Spigot: Pension funds have been steadily increasing commercial real estate allocations for the past few years and that isn’t likely to change in 2017 despite signs of a maturing market.  See Also: REITS have become a more attractive target for activist investors.

High Times: A San Diego based medical marijuana landlord just filed for an IPO.

Residential

Further Afield: High prices and low yields near the coast have investors looking for rental homes in cheaper locations through management and investment services like Home Union, Investability and Roofstock.  However, a lack of local knowledge can lead to out of area investors paying the dumb tax by thinking that they are getting a good deal when they aren’t.

Profiles

Pull the Lever: How smart phones and app developers create digital addiction by mimicking slot machines.

Paradise: The Cubs paved the way for the Dodgers to come to LA by hosting their spring training on Catalina Island. See Also: For the Cubs oldest fans, this year could be their last chance. And: There are people trying to get 6 figure ticket prices for a single seat at World Series games at Wrigley Field.

Chart of the Day

WTF

Hard at Work: Meet the TV weatherman who got bored with his job after 23 years and decided to become a porn star.

Not a Detail Person: Russian oligarch has giant hideous boat built at a German port on the Baltic Sea. Ship draws too much to get out of the straits at the entrance to the Baltic. Epic FAIL ensues.

Lawsuit of the Year Nominee: A woman is suing KFC for $20MM because she felt that her bucket of chicken wasn’t full enough.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarkcapitaladvisors.com

Landmark Links October 25th – When Will The Empire Strike Back?

Landmark Links October 11th – Put Your Money Where Your Mouth Is

USP NFL: CLEVELAND BROWNS AT BUFFALO BILLS S FBN USA NY

Lead Story… As I wrote a couple of weeks ago, the Obama Administration took the unprecedented action of calling on cities and counties to re-think their zoning laws.   This was a concerted effort to increase affordability and fight back against NIMBY’s who have successfully stopped development in some of America’s most productive cities.  The proposal is bold in that governors don’t often involve themselves in land use issues, let alone a sitting president.  However, the toolkit presented by the Administration is somewhat toothless because cities are ultimately still ultimately free to do as they please and they ultimately have control over local land use policy.

An additional way to achieve more density is actually quite straight forward: cash.  If the Federal Government really wants denser, more walkable mixed use development then they need to incentivize it by amending FHA rules that currently make it very difficult to build product that fits that description.  From The Washington Post (emphasis mine):

Main Street-style development — the “storefront on the first floor, apartments rented out above” style that forms the core of any older town’s historic center — is a residential building form that uses first-floor commercial space to serve community members and enliven a neighborhood. This low-rise density helps prop up the balance sheets of towns responsible for running utilities all the way out to suburban developments, as former city planner and engineer Charles Marohn has repeatedly demonstrated. It also keeps a constant set of the “eyes on the street” that Jane Jacobs identified as necessary for safe streets; renters keep an ear out for burglars after business hours and shopkeepers keep the same at bay during the day. It is, in other words, the core of any successful town-building.

Yet for 80 years, Main Street development has been effectively driven from the market by the growth of federal housing policy hostile to mixed use. Ever since Herbert Hoover’s Commerce Department helped promote the spread of model zoning codes that physically separated people and their community institutions, the federal government has poured its energy and resources into encouraging the growth of widely dispersed single-family homes and large, centralized tower blocks. To this day, FHA standards for loans, which set the market for the entire private banking sector, prohibit any but the most minimal commercial property from being included in residential development. As a groundbreaking report by New York City’s Regional Plan Association found, these standards are “effectively disallowing most buildings with six stories or less.” And depending on the program, a building could have to reach to 17 stories before it is eligible for participation in the normal housing markets. Without the FHA’s blessing, projects are granted the “nonconforming” kiss of death unless their developers can persuade a local bank to write an entirely customized loan for them, one whose risk the bank would have to keep entirely on its own books.

These caps on commercial space and income should be raised to level the playing field for housing development and let small developers invest as much in their home towns as huge corporations will in big cities. Caps currently limited to 15 and 25 percent should be raised to more than 35 percent to legalize even just three- and four-story buildings. As small towns and secondary cities across the country seek to revitalize their downtowns to become more competitive job markets, unreformed financing restrictions act as an invisible barrier, suffocating local efforts to invest in smaller communities. And while the housing affordability crisis has reached the most acute levels in a handful of coastal cities like New York, San Francisco and Washington, the White House admits that “this problem is now being felt in smaller cities and non-coastal locations.”

The current financing restrictions make it so that the tail frequently wags the dog in mixed use residential construction.  Cities often want ground floor retail to be included to add to their tax base and  increase walkability but it’s incredibly difficult to finance.  Instead what happens, is the developer gets stuck trying to thread the needle between building just enough retail to appease the city but keeping it at a low enough percentage of the total project square footage to avoid the dreaded non-conforming label.  The end result is that functional retail space is sacrificed in order to comply with FHA rules.  So, rather than having a well-designed retail concept, you end up with small, non-functional retail components in all but the largest projects.  The space has little actual economic value except as a means to obtain financing.  By way of example, a project one block from our office was recently denied by Newport Beach’s city council due to a lack of ground floor retail.  No doubt that the developer was designing to the financing constraints but didn’t include enough retail to get the City on board.  The federal government took a step in the right direction earlier in the year by making it easier to finance condos.  This is the next logical step if they are serious about increasing density and making housing more affordable.  Time to put your money where your mouth is.

Economy

Meh: The September Jobs Report was sort of a dud.

Here to Stay?  I love this explanation from Bloomberg’s Noah Smith on why low interest rates don’t necessarily cause excessive risk taking:

What is it that allows rates to hover around zero indefinitely without causing investors to do bad things with cheap money? It depends on why rates are low in the first place. If money is cheap because central banks are using their powers to keep rates lower than what the market would bear on its own, it stands to reason that investors will take cheap money and invest it in riskier things than they otherwise would. But if rates are low because of natural forces in the economy, and central banks actually have little to do with it, then there’s no reason business people would be taking extra risk.

Crude Math: An agreed OPEC production cut has oil back above $50/barrel but large, recently discovered reserves are likely to create yet another glut in the not-too-distant future.

Commercial

Over the Hump?  Apartment rents fell for the first time in a very long time in the 3rd quarter.

Dumpster Fire: Bottom tier retailers Kmart and Sears are technically still in business but both stores are utter disasters.  Rating agencies just put Sears Holdings, the company that owns both on death watch and the only way that it’s keeping the lights on is by selling the best assets that it owns.  Part of the problem is that Sears Holdings still own or lease approximately 2,500 properties so this mess will be very difficult and time consuming to wind down.

Sears-map

Residential

Beneficiaries: Vancouver’s home sales are down 33% after they introduced a foreign buyer tax.  Seattle is likely to benefit.  See Also: New York is overtaking London as the #1 destination for international property investment thanks to Brexit.

White Knight?  Tech firms, often considered villains when it comes to housing issues in the Bay Area are now throwing their weight behind pro-development groups to push for more housing construction.  See Also: The housing shortage is going to start negatively impacting economic growth in California more seriously if something isn’t done.

NIMBY Awards: The Bay Area Metropolitan Observer put together a list of their top 10 Bay Area NIMBY moments of 2016.  It would be funnier if it wasn’t so sad.

Profiles

Payday: Everyone’s favorite sexting app, also known as Snapchat is working on an IPO rumored to value the tech firm at $25 billion.

GTL is Cancelled: Tougher regulations and taxes are hitting tanning salons hard and there are 30% less of them than there were in 2008.

Chart of the Day

NIMBYs gone wild: LA Edition

Greg Morrow Capacity Graph

Source: Greg Morrow of UCLA

WTF

Best Excuse Ever: A Canadian pole vaulter who tested positive for cocaine just days before the Rio Olympics and nearly didn’t get to attend claimed that it happened because he made out with a girl that he met on Craigslist.

Wings (and Heads), Beer, Sports: Green Bay Packers tight end Jared Cook ordered some food at Buffalo Wild Wings and received a deep fried chicken head on his plate.

People of Walmart: Walmart was selling a shirt on it’s website that said: “I’d Rather Be Snorting Cocaine off a Hooker’s Ass.”  Sadly, it was taken down once management realized what was going on.

Bad Idea: Entering a Florida Walmart is a bad idea in the best of times.  Doing it before a major hurricane when people are stocking up is just asking for trouble as you’ll see in the video of the day.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarkcapitaladvisors.com

Landmark Links October 11th – Put Your Money Where Your Mouth Is

Landmark Links September 27th – Unusual Trend

manliest photos on the internet, funny manly images, leather mullet midget

Lead Story… “When Orange County catches a cold, the Inland Empire gets the flu.”  If you’ve spent any time in the real estate industry in Southern California, you’ve probably heard some variation of this truism.  The relationship has held up over the years because the two regions are closely linked in terms of geography and economy: OC has white collar jobs and executive housing, whereas the IE traditionally has more blue collar jobs and more plentiful affordable housing.  In a typical cycle, OC home prices rise first, followed by IE prices.  When the cycle turns, the IE pricing and volume typically falls off first when entry level financing disappears and blue-collar employment falls off.  The price movements in the Inland Empire are typically greater in percentage terms (although substantially less in nominal dollar terms) to both the upside and the downside since values there are lower.  This cycle, that historical relationship has broken down, as I detailed in a blog post titled Mind the Gap back in May.  Last week, JBREC’s Rick Palacios JR posted a research piece about the disjointed nature of the recovery across housing markets in the US, summed up neatly in the chart below:

jbrec_housingcycle-marketbymarket_q32016_black3

The first thing that I noted on the chart is that, aside from Houston, every market on here is still on the positive side of the slope.  Larry Roberts at OC Housing News wrote a follow-up post that helps put the above chart in context about how Dodd Frank’s crackdown on so-called affordability products will dampen volatility in future housing cycles.

The second thing that I noticed is more local and that is that JBREC classifies both OC and LA as late Phase 2 to early Phase 3 while the Inland Empire has barely made it out of Phase 1 and is plagued by relatively low levels of housing construction.  Orange County prices exceed the prior cycle peak while Inland Empire prices are still 20% – 30% below.  IMO, there are several reasons for this:

  1. While development impact fees are very high in both Orange County and the Inland Empire, they are far higher as a percentage of new home price in the Inland Empire.  Housing prices crashed in the late aughts but impact fees didn’t, making it very difficult to build homes profitably in further out locations that haven’t experienced the coastal recovery.
  2. The Inland Empire is a less diverse economy than Orange County and is more reliant on real estate development to power it’s economy, which has struggled in light of the low number of housing starts the region is experiencing from what we would typically see at this point of the cycle.
  3. There was a far higher level of distress in the Inland Empire markets during the housing crash which took longer to work off than it did in Orange County.
  4. Perhaps most importantly, the Inland Empire is an affordability-driven market.  Orange County is not.  Riverside and San Bernardino Counties are both highly reliant on FHA financing that allows for much lower down-payments than conventional financing options.  San Bernardino and Riverside Counties are constrained by the FHA limit of $356,500 which is absurd given the massive geography of these two counties – if they were their own state it would be the 11th largest in the US by land mass.  At or below this loan amount a borrower can put up a down-payment as low as 3%. That down-payment goes up substantially for loan amounts above $356,500.  That is a huge problem for builders in the IE since they are essentially sandwiched between rising impact fees / regulatory costs and an FHA price ceiling.  If a builder wants to sell homes priced at or below FHA, he has to find cheap land and it’s still tough to make a profit.  Price above it and his absorption dries up due to a lack of a buyer pool with substantial down payment capacity.  Orange County has an FHA limit of $625,500.  Even still, Orange County just isn’t that beholden to FHA limits because home prices are so high here.  Perhaps the only silver lining is that it’s highly unlikely that the FHA will reduce loan limits for Riverside and San Bernardino Counties next year and increasingly likely that they will raise it a bit.  Still, being constrained by a completely arbitrary government loan cap on a huge and diverse area is hardly a healthy situation, even if you can get some relief when that cap increases.

Perhaps I’m incorrect and the historical relationship will remain in tact when the market eventually turns.  However, it seems unlikely given that the Inland Empire really hasn’t experienced much of a real estate recovery while Orange County has.  It’s a lot more painful to fall off of a ladder than off of a curb.

Economy

Happy Losers: So much of what’s wrong with the US economy is summed up in this paragraph from the Washington Post:

Most of the blame for the struggle of male workers has been attributed to lingering weakness in the economy, particularly in male-dominated industries such as manufacturing. Yet in the new research, economists from Princeton, the University of Rochester and the University of Chicago say that an additional reason many young men are rejecting work is that they have a better alternative: living at home and enjoying video games. The decision may not even be completely conscious, but surveys suggest that young men are happier for it.

Quick to Jump Ship: Why decreasing employee tenure could be a positive sign for the economy.

Paycheck to Paycheck: Small businesses are now surviving but still not thriving. A new JP Morgan study found that the average small business has less than a month of cash operating reserves.

Residential

Movin’ Out: KB Homes is seeing more young people entering the first time home buyer market.  Apparently, there are a few more vacancies in mom’s basement now.

Slim Pickin: Home sales fell in August as inventory fell over 10% from this time last year.

Super Sized Incentives: Builders are constructing super sized homes because they are highly economically incentivized to do so.

 Profiles

Acquisition Target: Suitors are beginning to line up to acquire beleaguered Twitter. Google and Salesforce are the among the latest rumored to be interested as is Disney.  See Also: Why is Salesforce interested in Twitter?  It’s all about the data.

Fashion Statement: Snapchat is entering the hardware business with a line of camera-equipped sunglasses.  This is great news as is it will instantly ID people who deserve to get punched in the face.

Gross: Hampton Creek is a San Francisco startup that wanted to become “the first sustainable-food unicorn” in part by selling a vegan concoction called “Just Mayo.”  The problem was that it apparently tasted like crap and the company was busted buying gallons of their own disgusting concoction from Whole Foods and other stores in an effort to boost it’s sales. (h/t Mike Deermount)

Chart of the Day

REITs get their own sector in major S&P 500 makeover

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WTF

No Regrets: A 27 year old man from Boston attempted to create something he called a “scuba bong” by filling a scuba tank with marijuana smoke. He failed miserably and lost both of his testicles when the tank exploded. The gene pool has been chlorinated once again.

Stupid Is As Stupid Does: As many of you probably know, Apple got rid of headphone jacks on the iPhone 7 leading to angst among many loyal Apple users. A prankster posted a video purporting to show owners of the new phone how to “add” the headphone jack by drilling a hole in the phone. The video went viral and idiots are now breaking their phones by drilling them out. Imagine a person of average intelligence. Now consider that half of the world’s population is dumber than that person.

Florida Has Jumped the Shark: A tweaker on a 5-day methamphetamine binge cut off a certain part of his anatomy and fed it to an alligator because, Florida.  A friend first sent me this story and I thought it was a fake.  It appears to be legit.  When it comes to Florida weirdos, reality is often stranger than fiction. (h/t Andrew Shugart)

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarkcapitaladvisors.com

Landmark Links September 27th – Unusual Trend

Landmark Links September 13th – Falling Behind

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Lead Story…. It’s incredible how quickly things change.  Just a few short years ago, conventional wisdom was that it would take an eternity to work through all of the excess inventory created by the housing bust and foreclosure crisis.  However, in reality banks were incredibly adept at managing their REO inventory, effectively preventing the massive  glut that so many expected.  In the meantime, very little in the way of new housing was built as financing dried up and builders pulled back in fear of competing with the looming bank REO inventory liquidation that never really materialized.  Fast forward to 2016 and the stark reality of a new sort of housing crisis: there simply aren’t enough residential units being built to satisfy household creation.  The pivot has been as pronounced as it has been swift and it doesn’t look like things are about to change anytime soon.  The Federal Government’s bi-annual report on housing inventory provides a rather bleak outlook, especially for entry level buyers and renters.  From ULI (emphasis mine):

Newly released data and analysis from several sources illustrate a major obstacle to a fully healthy housing market in the United States: the nation is not building nearly enough new residential units. The serious shortage of new supply is bottling up housing demand and pushing home prices and apartment rents well beyond what a growing number of households can afford.

A biennial report from the federal government titled The Components of Inventory Change found that the nation’s housing stock increased by a net 270,000 units between 2011 and 2013—the slowest growth measured by the survey over the past decade, which included the worst years of the Great Recession. The report concluded: “Despite the gradually improving economy, there were large declines in both new construction and net additions to the housing stock during the 2011–2013 period compared to the 2007–2009 period.”

A recent Freddie Mac market commentary noted that the total number of housing starts (single family plus multifamily) in 2015 was 30 percent below the historical average between 1970 and 2007. The National Association of Realtors estimates that the country’s supply of for-sale and rental units combined is 3 million units short of current demand.

The most substantial issue here isn’t even the massive shortfall in raw numbers, it’s the distribution of where what limited construction that we do have is occurring: at the high end.  Not only are we not producing enough units across the board but nearly nothing is being produced at the entry level in either for-sale or for-rent properties where units are most in need.  Again, from ULI (emphasis mine):

Not surprisingly, millions of Americans cannot find an affordable home to buy or an apartment to rent. A survey conducted by the National Association of Home Builders (NAHB) found that 59 percent of respondents said they could and would spend no more than $249,000 on a new home, but only 35 percent of new homes started in 2015 were at or below that limit. The online real estate service Trulia recently reported that the number of starter and trade-up homes available in the 100 largest U.S. metropolitan areas has plunged by more than 40 percent since 2012.

Yes, apartment development has experienced a historic boom: multifamily construction volume nearly doubled in 2012 compared with that seen in 2010, and increased another one-third from 2012 to 2014, according to a new study by the Research Institute for Housing America. New multifamily completions topped 310,000 units last year, the most in at least 25 years, according to the National Multifamily Housing Council. And 1 million more apartments could come on line in the United States in the next three years, according to projections by the market research firm Axiometrics.

But most new apartments and single-family homes are aimed at the top of the market. The median asking rent for a new apartment today exceeds $1,300, which is unaffordable for roughly half the renter households in the United States (based on a rent standard of affordability of 30 percent of income). The average price of new homes for sale in 2015 was $351,000—a 40 percent increase from 2009.

What is driving the trend towards builders constructing a smaller number of higher priced units versus a larger number of lower priced ones?  A few factors to consider:

  1. Post financial crisis, there wasn’t much of any mortgage financing available at the lower end of the market.  It doesn’t make sense to build homes for people who can’t obtain financing so builders focused on more expensive price points where buyers were willing and able to obtain financing or buy with cash.  Combine this with the higher margins often achieved on luxury units and you have a recipe for builders gravitating towards more expensive units.  Availability of financing is improving but it has left certain markets 100% beholden to FHA limits.
  2. Regulatory burden is soaring.  A study that the NAHB released earlier this year found that regulatory fees for new construction jumped nearly 30% (80k per home) over the past 5 years.  It’s incredibly difficult to make any profit on lower priced product in that type of environment meaning that builders need more expensive product to absorb the regulatory burden.
  3. People are staying put longer in their entry level homes since less move up houses are being constructed.  The result is less infill inventory which drives up prices.  Yesterday’s entry level home becomes too expensive to be classified as entry level if supply does not materialize to meet demand.
  4. While the development financing market has shown some marginal signs of improvement, it still pretty much sucks for all but the most credit worthy of developers in the best locations.
  5. Land owners aren’t selling, at least not when it comes to their best lots.  One would think that rising home prices would make this a great time to be a land seller.  However, that isn’t currently the case as Bloomberg detailed last week.  When asked for investment advice, Mark Twain once said: “Buy land, they’re not making it anymore.”  Right now, owners of well-located property are taking a similar stance in expectation (or, in some cases hope) of higher prices: don’t sell your well located land because you can’t sell it a second time and it’s likely to be more valuable in the near future.  In other words, there is substantial gap between what builders are willing to pay and what landowners are willing to sell for, particularly in the best markets.  Landowners will sell today but only if builders are willing to pay them for possible future inflation that may or may not happen.  To complicate matters further, a lot of landowners bought during a brief run-up in 2013 thinking that the market was about to take off.  It didn’t and now they are holding out in hope of larger profits down the road.

At some point, the laws of economics pretty much dictate that this has to change.  We aren’t going to stop creating households and people can’t continue to pay an ever-larger percentage of their incomes towards housing costs without the result being major adverse economic consequences.  In reality, demographics are actually improving for household creation through at least 2024, meaning that the housing shortage will get worse as the deficit continues to widen unless we ramp up production in short order.  Unfortunately, as you can see it’s not a problem that’s easily solved.

Economy

Christmas is Cancelled: The bankruptcy of South Korea’s largest shipper has a lot of cargo stranded at sea just as retailers are stocking up for the holidays. See Also: The shipping industry has a major problem – there are simply far too many ships for current demand.

Tougher Road Ahead: Economists are predicting a tougher road ahead for the labor market. But See: Short term optimism as wages expected to rise amidst the scramble for seasonal holiday workers.

Commercial

Yogi Bear, Architect: Brokers are having a difficult time selling a seven story office building in Columbus, Ohio designed to exactly resemble a picnic basket. 

Back Up the Truck: investors are bidding up REIT shares prior to real estate getting its own sector in the S&P500.

Residential

Good Riddance: Gaudy Mediterranean style McMansions that were all the rage in the 1990s have fallen out of favor and are not rising as quickly in value as other types of houses.

Sound Familiar? Norway’s economy is historically based on oil, which has had a rough go of it lately.  Norwegian interest rates have plunged along with the price of oil, leading to soaring housing prices and housing sector investment.  This sounds eerily similar to the post-tech bust era in the US to me.

Don’t Call it a Comeback: Cities in California’s Central Valley that were largely left for dead in the wake of the housing crash are making a comeback.

Profiles

Those Who Fail to Learn From the 90’s Are Doomed to Repeat Them: People are buying minivans again and trying desperately to convince themselves that the soccer mom mobiles are somehow “cool.” Newsflash: minivans will NEVER be cool

Viva Socialism: Venezuelians are turning to black magic and animal sacrifices to heal their sick due to a lack of basic medical services.

You Should Already Know This: Cheese triggers the same parts of the brain as hard drugs.

Chart of the Day

Super Size Me, urban home edition.

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WTF

FAIL: There are still 4 months left in 2016.  However, I think that we can safely call this year’s Darwin Award for a Florida man (of course) who found an old bulletproof vest in his garage.  He wanted to know if it still worked so he put the vest on and had his cousin shoot him.  It didn’t work and now he’s dead and the cousin is in jail.

Cultural Literacy 101: Apple’s iPhone 7 launch slogan: “This is Seven” translates to something sort of vulgar in Cantonese.

When You Gotta Go: How NFL players hide it when they have to pee during a game. Spoiler: there’s often more going on in the huddle than you think.

Sort of Impressive: A man was arrested for stealing $3,000….. in pennies.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarkcapitaladvisors.com

Landmark Links September 13th – Falling Behind