Landmark Links November 8th – Size Matters

funniest-urinals-around-the-world-5

Lead Story…. CIO Magazine posted a thought provoking piece last week about how first time private equity investment managers consistently outperformed established managers from 2000-2012.  Many of our investor clients are private equity funds and I worked for a commercial real estate pension fund advisor in a prior life.  Needless to say, this is a topic that fascinates me.  From CIO on how newer has been better when it comes to performance:

First-time private capital funds have consistently outperformed more experienced managers in recent vintage years, according to Preqin.

Newly launched private equity, private debt, real estate, infrastructure, and natural resources funds achieved a higher median net internal rate of return than established counterparts in every vintage year but one between 2000 and 2012, the report stated.

Private markets investors who took a chance on a brand new fund were rewarded with “strong (and in some cases, exceptional) fund performance, increased portfolio diversification, and experience with niche strategies,” said Leopold Peavy, Preqin’s head of investor products.

Overall, investors have grown more likely to invest with first-time managers, with more than half of surveyed investors saying they would at least consider committing to a brand new private capital fund, compared to 39% in 2013.

CIO didn’t give a reason for this outperformance but I have a theory as to why this happens, at least in the real estate world: Size matters.  A lot.  Most first-time funds are substantially smaller than established funds as they tend to attract less capital due mostly to a lack of investment track record.  Most managers aspire to grow their AUM because it means that they make more money.  Larger asset base = larger fees in dollar (if not percenage) terms.  However, while this growth in AUM might be a great deal for the manager, it isn’t such a great deal for their investors.  To illustrate why, lets look at the typcial life cycle of a fund:

  1. Fast Out of the Gate: In the early years, a typical real estate fund starts with a relatively small amount of capital.  Let’s say $200MM.  The young fund is running lean and can be extremely picky in choosing the deals that they enter into.  Why?  Because they don’t have a large amount of capital to place so they can do it on a highly selective basis.  This typically means off market deals and value-add opportunities that the big boys might consider too be a waste of time and difficult to scale.
  2. Asset Aggregation: By the time that our fund goes out to raise another investment vehicle they have done well.  Really well.  Their ability to be nimble and pick up smaller deals has led to outperformance of market benchmarks.  Large institutional investors take note and jump in, throwing money at the growing manager and allowing them to increase their AUM substantially.  The problem is that this comes at a price: once you take on the capital you have to place it.  This means no more small deals and less off market opportunities.  They just aren’t efficient enough to place a large amount of capital.  Our once-nimble manager now needs to target more capital intensive but often underperformign segments like class A office and large portfolios in order to get money out.  Their performance suffers accordingly and falls back to the pack.
  3. Maturity: The fund is now a steady market performer – maybe beating benchmarks by a little bit.  However, in a market where AUM begets more AUM, they are a focused fundraising machine and able to raise capital well into the billions.  Their old 2,000sf class B office space is now a full floor headquarters in a class A building and they are staffed up accordingly, running a high G&A budget.  The only way to pay for all of the extra expense is to keep the fundraising gravy train going.  However, the returns aren’t what they used to be and top performers from within begin to go out on their own, only to re-start the cycle again.

The irony here is that the very thing that a manager wants – a lot of AUM is often responsible for suppressing returns as they grow.  It’s nearly impossible to have it both ways.  You can either beat the market by being relatively small and nimble or you can become a huge AUM machine.  It’s rare to have both.  Size matters a lot when it comes to real estate investment funds and it often correlates closely with how long they’ve been in existence.  It’s a lot harder to steer the Titanic than a Boston Whaler.

Economy

All About the Benjamins: Friday’s jobs report was pretty good despite the headline number coming in a little below consensus.  The big story: wages are rising.  See Also: What we know about the 92 million Americans who aren’t in the labor force.

Counter Intuitive: Will the rising number of retirees cause more inflation rather than less?  It’s not as far-fetched an idea as you may think.  See Also: Rising bond yields are telling us that inflation is returning.

Reading the Tea Leaves: How big data mining operations are combing social media and review sites to create a more detailed picture of US earnings.

Commercial

A Different Type of Farm: How vertical farming technology could lead to higher demand for warehouse space and more efficient food production.

Residential

Easier Said Than Done: The McKinsey Global Institute thinks that they can “fix” housing in CA by targeting vacant land tracts in urban infill areas for high density development. Conor Dougherty and Karl Russell of the NY Times lay out why this is largely doomed to fail (and in some cases already has).

Rise of the Machines: This homebuilding robot being developed in Australia could lower construction costs substantially….but could eliminate some construction jobs.

Off the Grid: Tesla’s new solar roof tiles and battery packs could completely alter the way that America generates and uses home electricity.

Getting Out of Dodge: Tech workers and startups are getting out of Silicon Valley and moving to new markets with a much lower cost of living.  This isn’t going to have any impact on the Apples and Googles of the world but the next generation of small startups could come from much more diverse locations.

Profiles

Tear Jerker: Meet the Cubs fan who drove 600 miles to sit in a cemetery and listen to the Cubs win the World Series with his father at his grave, keeping a promise he made decades ago.

Skimmed: Great profile from Bloomberg on how The Skimm (the first thing that I read most mornings) became a must-read for Millennials.

Nip and Tuck: More Americans 65 and older are getting plastic surgery than ever before….and not only in Newport Beach.

Charts of the Day

WTF

Innuendo: I found something that both Hillary and Trump voters can agree on – Anti-Prop 60 (for those not from CA, that’s the one where they are trying to make condoms mandatory in pornos) ads are the best political ads ever.

Squirrels Gone Wild: A squirrel went on a rampage in a retirement community resulting in a resident calling 911. Once again, because Florida.

Seems Reasonable: A drunk Russian man murdered and dismembered a friend for insulting his accordian skills because, Russia.

A Little Wired: A man was caught driving through a family neighborhood with wires attached to his genitals because, Florida.

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links November 8th – Size Matters

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 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 October 7th – Urban Legend

urban-legend

Lead Story…  Chances are that you’ve heard tales about alligators living in the NY sewers, Coca Cola’s magical ability to dissolve teeth overnight, that Elvis Presley is still alive and in witness protection, or even the old  Weekly World News standby of a bat child found living in a cave. These urban legends and others like them have spawned a virtual cottage industry of cable TV shows and websites seeking to either prove or debunk their claims.  Likewise, if you’ve attended development industry conferences in the past 4 years or so, you’ve probably heard some variation of the following on a capital panel: “There is too much money chasing too few deals.”   It’s been repeated so frequently through the past few years that the concept of “too much money chasing too few deals” is almost universally accepted as truth in the residential development industry.  However, just like tooth-dissolving cola, it falls apart under further scrutiny when discussing for-sale residential real estate development.  When viewed from 30,000 feet, the previous sentences probably looks crazy.  Many private equity funds, hedge funds, etc have raised money to invest into housing development.  However, it’s not the amount of money raised that’s been problematic in recent years.  Instead it’s that the type of money available is often a poor fit for projects in need of financing in today’s relatively stable housing market.

In the years before the housing bubble and subsequent bust, private home builders typically utilized bank debt and pension fund capital to build subdivisions and master-planned communities.  The debt component was readily available and attractively structured and pension fund capital had relatively long investment horizons and reasonable return expectations when compared to opportunity fund money which was typically used for entitlement projects and other, more risky ventures.  It wasn’t unusual back then to have decent sized private builders in California build and sell several hundred homes a year or more.  With a couple of notable exceptions, they were not going to compete with public home builders when it came to cost of funds.  However, they were still substantial players in the market and were able to build at decent levels of production while often delivering higher quality homes than their public competitors.  This all changed when the housing market crashed.  Banks reduced exposure to the home building and development space by a substantial amount, as did pension funds.  Some left the space entirely.

At the same time that pension funds and banks were pulling back, opportunity funds ramped up their fundraising in order to capitalize on the carnage that the Great Recession wrought on land values.  They offered their prospective investors high-octane returns that would be realized when they bought trophy properties at bargain-basement prices in a distressed environment, to develop or sell as the market began to recover.  This capital was and is well suited for opportunistic investments brought on by a market crash – thus the label opportunity fund.  What it isn’t a great fit for is investing in home builder and land development deals in a stable market.  In reality, the window to buy distressed assets wasn’t quite as long as many had anticipated and the doldrums of 2010-2011 quickly gave way to a run-up in transactions and land values in late 2012 into early 2014.  All of which brings us to where we are today: a stable market with tight inventories where there is a ton of capital that has been raised – but very little of that capital has a return profile that fits where it is needed most: lot manufacturing and production home building.  There are several reasons that this is happening:

  1. Unrealistic Investor Returns in a Stable Market – As stated above, much of the capital that has been raised to deploy for home building and land development in the market today is much better suited for a distressed market than a stable one.  However, there is something bigger at play: equity funds are targeting the same mid-20% IRR returns with the 10-year Treasury yielding 1.75% that they were when the 10-year was yielding 5%.  All returns are relative, meaning that, in real terms, today’s targeted returns are actually substantially richer than they were when the 10-year was substantially higher.  This has more to do with fundraising and marketing than anything else.  Funds are reluctant to pitch investors at the returns they are likely to achieve (mid to high teens) since their competitors will still promise mid-20%s, meaning that they won’t be able to raise capital, even if the underwriting that they are using to get to those returns is aggressive BS.
  2. Private Builders Get Squeezed Leading to Less Competition – In order to offer high returns to investors in a lower return environment, funds need to grab a bigger piece of a smaller pie, leaving less for builders and developers.  Typically, this means putting steep minimum multiple hurdles in their waterfalls.  Ironically, minimum equity multiples are incredibly short sighted as it encourages builders to push prices rather than absorption since the multiple hurdle is almost always substantially higher than the IRR hurdle, leading to longer sell out periods.  As if that isn’t enough, the few bank lenders left in the space are typically quite conservative and require a full persona guarantee.  So if you are a builder, you now have to put up 10% of the equity or more in order to get a deal done and put your balance sheet on the line to finance it and you’re getting a smaller piece of the returns.  Eventually, you have to wonder what the point is.  This is a huge reason that there are very few decent sized private builders left – in many cases the reward simply isn’t worth the risk.
  3. Lack of Debt Capital Resulting in Broken Deal Structures – Many land deals purchased during the aforementioned 2012-2014 run-up were bought under the assumption that either debt would be available to improve lots or public builders would purchase paper lots.  Fast forward to 2016 and the public builders still don’t have much of an appetite for paper lots nor is there debt readily available for horizontal development.  That means that the owner is either going to need to sell for a substantially lower number than they had in their proforma (sometimes even a loss), or improve the lots themselves by raising additional equity.  As a result, many of the sites that were bought in 2013 with a business plan to entitle and flip are effectively underwater.  Mind you that home prices have almost universally INCREASED during this time frame but a lack of reasonably-priced development debt or public home builders with an appetite for paper lots has caused a stealth land correction of sorts that has been playing out for months.
  4. No Investor Appetite for Long Duration Deals – Ask an opportunity fund investor what they fear most and you will probably hear something about getting stuck in a multi-cycle development project.  High octane capital needs to get in and out relatively quickly in order to make the out-sized returns promised to investors.  Many opportunity funds are of the mindset that we are getting late in the cycle since prices have risen so substantially from the bottom despite the fact that housing starts in key production markets haven’t picked up much and inventory is still bumping along near record lows.  Many funds have been looking to trim project duration in an effort to ensure that they are out when the cycle inevitably turns.  As a result, there are some incredible opportunities out there that require capital to execute a 5-7 year business plan that no one will touch due to duration.  We have seen several of these sort of projects where sponsorship is strong and land basis is very attractive due to a lack of bidders.  However, it’s incredibly challenging to find capital that is willing to go out that far, even if the returns are exceptional.  This short-term mentality has left a large hole in the market for anything but bite-sized infill deals.

If this actually were a  market with the aforementioned “too much capital for too few deals” we would expect to be seeing increasing transaction volume and increasing land prices as the supply of capital led to a seller’s market. However, neither of these are occurring in all but a select few markets (at least on the west coast).  Instead, we are seeing light (at best) land transaction volume.  In order for the land market to turn the corner, either  the public builders need to regain their appetite for buying paper lots and developing them or we need more sources of capital that are properly aligned with the projects that they are financing under normal market conditions.

Home building and land development can both provide great returns in a healthy market. However, trying to finance these ventures with little-to-no debt and opportunistic capital raised to buy distressed assets is like trying to fit a square peg in a round hole.  Does this sound like a market with too much capital to you?  Better keep searching for those sewer-dwelling gators.

Economy

Pay Up: A look at who pays the most for housing, healthcare, energy and groceries by state.

Lag Time: How the psychology of the Housing Bubble helps to explain today’s odd labor shortage.

Commercial

Office Space: Open office concepts are becoming a bit less open as many tenants build out more private space.

Residential

Delusional Narcissism: Celebrities really suck at selling homes, mostly because they dramatically overestimate the value of their fame on the house they are trying to sell.

Flattening Out: Residential construction spending was down again in August despite strong gains in multi-family.

The Pendulum: There is a fairly strong demographic argument that we are approaching “peak renter.”

Profiles

Clowning: The clown industry (yes, there is such a thing) is not happy about all of the creepy clown sightings occurring across the US. See Also: Penn State students lose their minds after creepy clown sighting.  And: Someone even started a Clown Lives Matter movement, complete with organized protests.

Useless: Robo-callers and internet scammers have turned the National Do Not Call List into one big joke.

Soul Crushing: The average white collar worker will spend 47,000 hours on work email over his or her career.

Scapegoat? Meet the whiz kid behind the sketchy Russian mirror trades that are causing Deutsche Banks whole bunch of trouble that it really doesn’t need right now.

Chart of the Day

slide1

WTF

Bite to Eat: Some lunatic threw an alligator through a Wendy’s drive thru window. Because, Florida.

Incestuous: A 68 year old man unwittingly married his 24 year old biological granddaughter. They don’t plan on getting divorced. Once again, because, Florida.

Crimes Against Humanity: Today’s video of the day is a bunch of adults beating the crap out each other in a massive brawl at a Chuck E Cheese in, you guessed it: Florida.  Kudos to the guy in the Eli Manning jersey who appears to have a much better arm than the real Eli Manning.  (h/t Ethan Schelin).

P.S.  I know that we spend a lot of time laughing at Florida’s expense on here. However, please keep Florida residents (including my parents) in your thoughts and prayers as they batten down the hatches to deal with Hurricane Matthew. Hopefully everyone will be ok so that they can get back to their goofy antics ASAP. 

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links October 7th – Urban Legend

Landmark Links September 30th – Careful What You Ask For

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Lead Story… Anyone who has ever dealt with addiction will tell you that the first step towards recovery is admitting that a problem exists as opposed to sticking ones head in the sand an denying it’s presence.  Ever since the end of the Great Recession, we’ve faced a different sort of housing crisis: one defined by an inadequate amount of residential development taking place in our most productive cities.  This has led to skyrocketing rents and home prices and resulted in an affordability crisis.  The primary reason, as outlined here numerous times is that restrictive zoning and a grueling discretionary approval process in our most productive cities make it incredibly hard to develop more density which is desperately needed to accommodate an ever-growing population.  When demand exceeds supply prices go up.  Despite the contentions of some anti-growth city dwellers, housing is not immune to the basic laws of economics.

Nearly all land use politics is local in nature and it’s incredibly difficult amend restrictive zoning.  The reason is simple: existing owners benefit from scarcity of new housing units since it leads to increased values.  They also tend to prefer less traffic and crowding. Existing owners will always be a more powerful and well-organized constituency than aspiring owners or renters which is why NIMBY’s wield so much power and influence over local government.

Over the past few years, there has been a growing consensus from economists on both the left and right that restrictive zoning and so-called slow growth development restrictions are a leading cause of income inequality and cause a drag on economic growth.  State and even the Federal Government are finally taking notice and acknowledging that this is a big problem that cities aren’t likely to solve on their own because they don’t have the stomach to push back against the NIMBYs.  It’s very rare that governors opine on local land use decisions.  However, CA Governor Jerry Brown did just that earlier this year when he attempted to make it easier to build apartments and condos – and was ultimately unsuccessful.  As rare as it is for governors to get involved in local land use issues, it’s pretty much unprecedented for a president to do it.  However, earlier this week, President Obama did just that.  From Politico (emphasis mine):

The Obama administration Monday is calling on cities and counties to rethink their zoning laws, saying that antiquated rules on construction, housing and land use are contributing to high rents and income inequality, and dragging down the U.S. economy as a whole.

City zoning battles usually are fought block by block, and the president’s involvement will create friction, particularly among environmental groups and the not-in-my-backyard crowd. But the White House jawboning is welcome news to many others, including mayors and builders increasingly foiled by community opposition to development.

The White House published a “toolkit” of economic evidence and policy fixes to help local political leaders fight back against the NIMBYs that tend to hold sway over municipal zoning meetings.

“In more and more regions across the country, local and neighborhood leaders have said yes in our backyard,” the paper states. “We need to break down the rules that stand in the way of building new housing.”

The prescriptions call for more density, speedier permitting and fewer restrictions on accessory dwelling units such as basement and garage apartments. The plan rejects some of the arguments made by environmentalists, labor unions and other liberal constituencies that have stood in the way of development and endorses changes long sought by builders and the business community.

“When unnecessary barriers restrict the supply of housing and costs increase, then workers, particularly lower-income workers who would benefit the most, are less able to move to high-productivity cities,” said Jason Furman, chairman of the Council of Economic Advisers. “All told, this means slower economic growth.”

Ultimately, there really isn’t much that the Federal Government can do directly to tackle this issue.  However, the administration’s 2017 budget request includes $300 million in grants to help mayors update zoning rules, and the Department of Transportation has begun considering plans for housing growth and affordability before approving funding for some transit projects.  Both of those measures are amount to little more than a drop in the bucket but it’s now clear that both State and Federal Governments are increasingly less reluctant to tackle this issue.

The aspect of this that I find most interesting is that we now have the president and the governor of the nation’s most populous state, both of whom are Democrats taking a public position on an issue that opposes strong Democratic constituencies.  Most every city in the US with a housing affordability problem has a strong Democratic majority – the only one that I was able to find with a Republican majority was San Diego and only by a very slim margin.  Aside from the NIMBY’s, development has frequently been opposed by constituencies that lean hard left: primarily environmentalists and labor unions – who want everything built with expensive union labor.  I’m highly skeptical that anything will actually come from this effort as it’s incredibly difficult and not exactly a desirable outcome for the State or Federal Government to start influencing local land use politics since it’s an area where one size typically does not fit all.  However, it’s a sign of just how serious this problem has become when politicians such as Governor Brown and President Obama both were compelled to take positions that run counter to some of their core constituencies.

Economy

Getting Out: Foreign central banks are selling US Treasuries at an unprecedented pace.

One Size Doesn’t Fit All:  Median income in Los Angeles County is $45,000.  However, new research by economist Ross DeVol of the Milken Institute found that a resident would need to make $145,000 in order to spend 30 percent of earned after-tax income on rent for a two-bedroom apartment in Los Angeles County.  There is no one size fits all solution when it comes to determining what constitutes middle income in a country with increasingly stratified regional cost of living.

Giving Away the Farm: Stanford will give you $160k towards your MBA…if you agree to work in the Midwest for a couple of years after graduating.

Commercial

Filling the Gap: Private equity funds offering bridge and mezzanine financing are increasing taking share in the commercial real estate industry as traditional lending sources dry up.

Follow Up: As a follow up to a story that we posted a few weeks ago, it’s really difficult to sell an office building that looks like a picnic basket.  Newark Ohio’s famous Longaberger Basket Building is heading to foreclosure due to a large delinquent property tax bill. (h/t Tom Farrell)

Residential

Widening Gap: Bay area wages are soaring, having risen by approximately 30 percent in the past five years.  However, they still can’t keep pace with Bay Area home prices which are up 87% over that same time period.  But See: Some of America’s hottest housing markets are showing signs of cooling off and incomes are now rising quicker than home prices.

Back to the Stone Age: Communal living is a hot new trend with young people in urban areas.  However, it’s really not new at all and is actually a repeat of the way that people lived during the middle ages.

Double Wide: As the US faces a building home affordability crisis, it would make sense that mobile home sales would be taking off.  However, mobile home deliveries are actually soft and the reasons likely have a lot to do with expensive financing and social stigma.  Looks like a market segment desperately in need of a re-brand.

Profiles

Scam: Ever wonder why get rich quick schemes cause otherwise intelligent people to let their guard down?  It’s all in the messaging.  As an aside, if you ever come across someone touting their IQ in marketing material or any sort (including their CV), RUN. (h/t Stone James)

GOAT: Vin Scully, the voice of the LA Dodgers (and arguably all of baseball) for the past 67 years is retiring this weekend at the age of 89.  Los Angeles fans were incredibly fortunate to have both Vin and the late Chick Hearn of Lakers broadcast fame on the radio for decades (if you want to appreciate just how great Scully is, have a listen to some of the dreck that they put on the radio in NY).  This oral history of Scully’s career from ESPN is a great read.

Deflated: The collectible car market is headed in reverse and is well off of it’s highs from just a few years ago.

Christmas Idea: If any of you feel the need to buy your favorite blogger a Christmas present, this motorized, ride-able suitcase called the Modobag is near the top of my list.

Chart of the Day

This is not cyclical

WTF

Repent, the End is Near: Toilet frogs are becoming a problem in parts of Florida.  You read that correctly, frogs are coming up through the plumbing and showing up in toilets in Florida homes.  I think there is a biblical plague reference in there somewhere….

He Who Smelt It…: A new study finds that couples who fart in front of each other have healthier relationships and stay together longer.  I’ve been telling this to Mrs. Links for years.  She’s not impressed.

Product Review of the Week: Sugarless Haribo Gummy Bears sound delicious and healthy too:

“OMG. Everything previously written is true. It’s all true. Don’t eat more than 15 in a sitting unless you are trying to power wash your intestines.”

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links September 30th – Careful What You Ask For

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 20th – Young Man’s Best Friend

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Lead Story… If you follow the news even casually, you probably know that Millennials are less likely to own cars and homes or be parents than prior generations.  However, there is one area where Millennials are out ahead: Pets.  The Washington Post published the results of a study of pet ownership among young people and the results were somewhat stunning (emphasis mine):

Three-fourths of Americans in their 30s have dogs, while 51 percent have cats, according to a survey released by research firm Mintel. That compares to 50 percent of the overall population with dogs, and 35 percent with cats.

The findings come at a time when millennials, roughly defined as the generation born between 1980 and 2000, are half as likely to be married or living with a partner than they were 50 years ago. They are also delaying parenthood and demanding flexible work arrangements — all of which, researchers say, has translated to higher rates of pet ownership.

“Pets are becoming a replacement for children,” said Jean Twenge, a psychology professor at San Diego State University and author of “Generation Me.” “They’re less expensive. You can get one even if you’re not ready to live with someone or get married, and they can still provide companionship.”

You read that correctly, 75% of American’s in their 30s have dogs!  That is a yuge percentage and makes this self-proclaimed crazy dog person quite happy.  As with most publications though, WAPO seems to be implying that Millennials’ penchant for animal companionship makes them somehow different from the rest of “us.”  Indeed, if Millennials were going to forego family life permanently in favor of living with only dogs or cats it would have dire demographic implications.  Instead, I would suggest the pet ownership trend fits nicely with my theory about Millennials: they aren’t any different from prior generations, they are just taking longer to hit certain milestones than previous generations did.  Human beings need companionship and pets fill that gap before young people are ready to start families.  The increase in pet ownership is a good thing.  There are a ton of healthy benefits to having a pet as a family member, not the least of which is reducing stress.

Why am I so certain that dramatically increasing pet ownership among young people isn’t a harbinger of demographic doom? Well, for one, I’ve lived it.  I was born in 1979 so I’m not technically a Millennial but I didn’t get married until later in life.  I rescued a Black Labrador named Shadow when I was 24 who was my best friend for 10 years.  Despite my attachment to my dog, I ended up getting married in my mid-30s and had kids soon after. Shadow passed away several years ago and Pepper, a 2 year old Golden Retriever is now an important member of our family.  Also, I can’t imagine a scenario under-which we wouldn’t have a dog.

All that being said, there was one segment of the article that really frightened me (emphasis mine):

Millenials were also twice as likely than Baby Boomers to buy clothing for their pets, a phenomenon Richter chalks up to the prevalence of social media.

“The clothing is, for them, an opportunity for performance — they put it on their dog or cat, take them for a walk, post a picture on Facebook,” Richter said. “It’s increasingly about getting a digital stamp of approval.”

On second thought, I take back everything that I just wrote.  Maybe Millennials are the hipster weirdos that the press makes them out to be after all.

Economy

Nada: The reason why the stimulus from low oil prices never boosted the economy – it was 100% offset by the reduction in energy investment.  Mea Culpa on this one.  I was dead wrong.

Crossroads: The Fed is basically in the dark when it comes to the relationship between “full employment” and inflation in today’s economy.  As we approach what was traditionally considered “full employment,” they have a decision to make.

Commercial

Out of the Shadows: Shadow lenders are stepping up to fund development deals as regulators force banks to pull back on commercial real estate exposure.

See Ya: Mall owners are totally over department stores and not sad to see them go as retail tenant mix remains in flux.  But See: Nervous bond investors are hedging their exposure to malls with mortgage derivatives.

Residential

Building Up or Building Out: Awesome time-lapse graphics from the Washington Post this past weekend on density in major urban areas over time and the conundrum that cities face when it comes to keeping housing affordable: do you build up or do you build out?  See Also: Some suburbs are trying to add urban-style development projects to attract young workers and the employers who covet them.

Profiles

Always Be Closing: How Wells Fargo’s high pressure sales culture spiraled out of control and led to a massive checking account scandal.

Fleeced: Back in 1999 former recalled CA governor Gray Davis gave away the farm to public employee unions that had supported his election bid in the form of increased pension benefits based on the bullshit assumption that  CalPERS’ annual returns would average 8.5% forever. Davis sold benefits increase to taxpayers by claiming it would cost them nothing since all of the increase would be borne by CalPERS’ return on investment.  Needless to say, things didn’t go as planned.  Today the unfunded liabilities total $241 billion.

Battle of the Buzz: How the alcohol and pharmaceutical industries are bankrolling the fight against marijuana legalization.  See Also: There is a land rush going on in some of California’s worst real estate markets and commercial pot is the reason.

Chart of the Day

Europeans are not as happy with big-city living as commonly believed.

WTF

Florida Grudge Match: Nothing says Florida quite like an octogenarian brawl on the shuffleboard courts. (h/t Steve Sims)

Buy Gold: A notorious runaway Russian robot that has escaped it’s lab twice has been was arrested by police at a political rally.  And so it begins…

Somebody Walks in LA: Meet LA’s first “People Walker,” a bearded hipster and wannabe actor who will go on a walk with you for $7/mile. (h/t Ingrid Vallon)

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links September 20th – Young Man’s Best Friend