Landmark Links -July 22nd – On the Sidelines

Tebow-Sideline-600x340

Lead Story… CNBC posted a Bankrate.com study this week which found that more Americans prefer cash to stocks or real estate as a means of investment for money they don’t need for 10 years or more.  In other words, a somewhat shocking 54 million American’s are embracing a zero-risk, zero return mentality.  The most troubling finding was this (highlights are mine):

Younger millennials, or those at ages 18 to 25, overwhelmingly chose cash as their preferred investment for they money they would not need for at least 10 years. That was by more than a 2-to-1 margin over the next highest category, real estate. (Millennials are also less likely to own a home because they simply can’t afford one, according to a separate report from the U.K.’s office of National Statistics.)

Older generations were more likely to cite real estate as their top choice for a long-term investment.

What I find so disturbing is that the typical investment paradigm has been turned on it’s head – normally, young people in an asset growth stage should be investing long term assets more aggressively and becoming less aggressive as they age into a wealth preservation stage of life.  When people, young or old start holding long term investable assets in cash, it’s deflationary. This level of risk aversion is also frequently a characteristic of those who have experienced a dramatic financial crisis like the Great Recession or Great Depression.  I wrote about this back in April as it pertained to Millennials not buying homes due to experiences during the housing crash.  However, the bank rate study shows that the risk averse, deflationary mentality extends far beyond the housing sector when it comes to young people and investing.  This brings us to an article by Conor Sen, one of Bloomber View’s excellent new columnists that makes an interesting argument about Millennials and housing.  Sen makes a case that Millennials almost need a housing bubble to come off the sidelines and create demand for new housing, using oil production as an analogy:

To understand the slow-motion trends in single-family housing, start by looking at the oil market: It took years of oil priced around $100 a barrel to spur the investments that drove higher production, leading to the current supply-driven glut and prices closer to $50 a barrel. The levers of supply and demand worked, but they worked slowly — as is happening in the housing market.

Every year since 2009 we’ve been running a housing deficit: More housing for sale has been absorbed than built. With a glut of housing left over from the housing bubble and the great recession, it’s logical that construction of new supply was subdued for a few years. But vacant inventory for sale normalized in 2012, and currently stands at a 12-year low. So why aren’t builders building more? The pace of construction remains far below the rate of household creation.

IMO, it’s an imperfect analogy as it’s likely a bit easier to drill for oil in barren portions of  North Dakota or West Texas than it would be to build a large development with reasonably priced homes (the reasonably priced part is key) in places that they are needed like San Francisco or Los Angeles where discretionary entitlements, environmental regulations and NIMBY activists could tie approvals up for a decade or more.  That being said, a lot of Sen’s thesis is based around economic stagnation due to the lack of wage growth in the construction industry despite a near-record-low unemployment rate  coupled with incredibly low housing inventory:

In response to a nearly generational low in housing inventory and construction worker shortage, one might expect that there would be booming wage growth for construction workers, drawing labor away from other industries. Yet we don’t have conclusive signs of that. Year-over-year wage growth for construction workers is currently 2.7 percent, nearly a full point lower than it was at the same time in the year 2000.

The lack of growth in new construction jobs is sobering. Despite a need for more housing, and despite the labor shortage and the wage growth, construction industry employment fell 6,000 in April and 16,000 in May and showed no growth in June. This is the first time in more than five years that construction employment has shown no growth for three months.

This is all the more perplexing because the cyclical conditions for real estate have rarely been better. In addition to the low level of inventory and rising secular demand as millennials are ready to buy homes, the economy has rising wage growth and historically low levels of interest rates, as I wrote about last week.

Sen concludes that it might take substantial increase in both housing prices and construction wage growth in order to push housing starts to a level where construction adds substantially to GDP and adds enough supply to eventually meet the marketplace demand.  It’s an interesting thought but I doubt that it’s possible (or even desirable) under in our current situation for a few reasons:

  1. The construction needs to take place where it is actually needed and that is more restricted by zoning and local opposition than it is by a labor shortage.  In the oil market, it matters little where the oil comes from so long as there is a way to get it to a refinery and then the end user.  In housing, location is everything.  Unless real demand shifts into outlying suburbs, this will continue to be a problem.
  2. In order to work, substantial credit expansion both to develop/build units and also for purchase mortgages would be needed.  This seems unlikely given current economic conditions, political climate (anti-GSE sentiment) and diminishing affordability.
  3. As seen in the oil industry, there is a fine line between adding enough supply and creating a glut.  When oil prices go down, oil companies, employees, owner of land with reserves and providers of services lose money.  If the housing market were to become too oversupplied and tank again, millions of home owners lose a tremendous amount of equity.  In one case, the loss is felt by a (relative) few.  In the other  it’s impact adversely affects many.
  4. Any significant decrease in prices brought on by a large surge in housing production would typically hurt the people who Sen is saying need help the most: young people and first time buyers since housing credit availability typically contracts when prices fall and lender assets become impaired.  This means that those with stronger credit and more cash (often not entry level buyers) fare better in times when credit becomes restricted.

Again, the concept that housing and the construction industry can respond to surging prices in a similar manner to the oil industry is desirable from an economic perspective. However, I’m not sure how well it plays out in the real world when the regions where housing is needed most are those where it is least likely to be built.  I sincerely hope to be proven wrong in the next few years.

Economy

Interest Rate Roulette: Now that the Brexit vote happened we can revert to normal economic journalism where writers try to predict when/if the Federal Reserve will raise interest rates.  This week, there is disagreement between two of the most astute Fed watchers out there.  John Hilsenrath of the WSJ says that the Fed could raise rates as early as September.  Tim Duy says “no chance” so long as the yield curve continues to compress.

Commercial

Game Changer: Pokemon Go has accomplished something that brick and mortar retailers have dreamed about for years: turning location-aware smart phones into drivers of foot traffic.  The implications for commercial real estate and retail in particular are yuge as Nintendo plans to allow companies to pay up in order to be featured prominently on the game’s virtual map. (h/t Tad Springer)

Residential

Crystal Ball: The Terner Center for Innovative Housing at UC Berkley has come up with an app that allows a developer to input variables for sites and give an indication of whether or not a project will be approved and built. It’s still in beta but the concept is fascinating. (h/t Ingrid Vallon)

Profiles

QOTD: “‘I was collecting Pokémon’ is not a legal defense against a charge of trespass, so be sure that you have permission to enter an area or building.”   – Wyoming, MN police department Twitter account warning Pokémon Go players not to trespass onto others’ property.

Worker’s Paradise: Venezuela has become the poster child for “it can always get worse.” Hugo Chavez’s worker’s paradise has inflation set to top 1,600% next year as well as an epic food shortage crisis.

Success From Scratch: Dollar Shave Club, which just sold to Unilever for $1 billion in cash is the ultimate modern American success story.

Chart of the Day

WTF

A Monkey Walks Into a Bar: A new study found that monkeys are basically furry little drunks. First off I hope this wasn’t funded by tax dollars. Second, if someone wants to buy drinks for me, I can prove that I like to get drunk as well.

Money Well Spent: A woman got stuck in a tree in a NJ cemetery while trying to capture a Pokemon and had to call 911 to have the fire department get her out.  Your tax dollars at work. (h/t Ryland Weber)

Citizen of the Year: A woman in Tennessee witnessed a car crash outside her (likely trailer park) home where the 67-year old driver died on impact.  Rather than calling 911, the woman stole the man’s wallet and used his credit card to buy beer and cigarettes.  People are wonderful.

Video of the Week: Some hipster figured out a backpack that you can carry a cat around in complete with a round submarine window.  Then we wonder why studies say that cats hate their owners.

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links -July 22nd – On the Sidelines

Landmark Links July 19th – One Size Fits All?

one-size-fits-all-rubber-duck

Lead Story…. Nobel Laureate Robert Shiller wrote a piece in the NY Times this weekend titled: Why Land and Homes Actually Tend to Be Disappointing Investments that caught my eye.  In the article, Professor Shiller discusses both farmland and residential land and makes a case they are both subpar investments over time (highlights are mine):

Over the century from 1915 to 2015, though, the real value of American farmland (deflated by the Consumer Price Index) increased only 3.1 times, according to the Department of Agriculture. That comes to an average increase of only 1.1 percent a year — and with a growing population, that’s barely enough to keep per capita real land value unchanged.

According to my own data (relying on the S&P/Case-Shiller U.S. National Home Price Index, which I helped create), real home prices rose even more slowly over the same period — a total increase of 1.8 times, which comes to an average of only 0.6 percent a year.What all that amounts to is that neither farmland nor housing has been a great place to invest money over the long term.

To put this in perspective, note that the real gross domestic product in the United States grew 15.5 times — or, on average, 3.2 percent a year — from 1929, the year official G.D.P. numbers began to be kept, to 2015. That’s a much higher growth rate than for real estate. But why?  For home prices, a good part of the answer comes from supply and demand. As prices rise, companies build more houses and the supply floods the market, keeping prices down.  

The supply response to increasing demand may help explain why real home prices nationwide fell 35 percent from 2006 to 2012 (and even more in some cities). Investment in residential structures in the United States was at near-record levels as a percentage of G.D.P. just before the price declines. Prices have been rebounding since then — and so has construction of new houses.

 

While the idea of supply and demand balancing out the housing market makes perfect sense from a textbook economic perspective, it quickly falls apart when you take into account the most local of all factors that has quite possibly the largest impact on both land and home prices: politics.  Essentially, there are two primary restrictions to developing more residential units.  The first is geographical.  This includes mountains, bodies of water and scarcity of available water resources for new units.  The second is political.  This includes restrictive zoning, discretionary approval rights, etc.

Shiller’s analysis is perfect for markets with little to no geographical restrictions and even fewer political restrictions.  For example, land and home prices are incredibly stable in a place like Houston, Texas where new homes can be added quickly.  However, it fits poorly in coastal California which is hemmed in by mountains and the pacific ocean, has incredibly restrictive zoning and a populace with political leanings typically hostile to new development.  I was a bit surprised that Shiller wrote this piece as he knows what I just wrote better than anyone.  In fact, the Case Shiller Index that bears his name tracks housing prices in individual cities and backs up what I just wrote.  For example, look no further than the difference between the Case Shiller Chicago Index (the don’t track Houston) and the Case Shiller San Francisco Index to see how land use restrictions can lead to explosive moves in asset pricing when coupled with real economic growth.

Shiller goes on to explain how adding density keeps land and housing prices stable over time (highlights are mine):

Of course, underneath every home is a piece of land. Although that is typically only a bit of former farmland, it is often in an urban or suburban area, where a plot of land tends to cost much more than in the country.

Sometimes that little piece of land dominates the value of the home, particularly in dense urban areas. But if we are to understand long-term trends, we need to realize what land represents, even in Manhattan or Silicon Valley or any booming area. People in such places usually aren’t buying land for its own sake but for the myriad services that housing provides. A home is not just a place to sleep and store clothing and keepsakes. It can be a place that is convenient to a stimulating place of work, good schools and entertainment and, indeed, part of an entire human community.

These services have developed enormously over the last 100 years, changing the spatial and geographic dimensions of housing. There are vastly more highways and automobiles, telephones and various electronic connections, enabling people to leave center cities and still obtain the housing services they want. Thus, from a long-term perspective, these developments relieved a great deal of the upward pressure on home prices in cities.

Right now, there are some interesting developments in the supply of housing services that economize even further on urban land. We have recently seen interest in “micro-apartments,” which may be little more than 200 square feet but manage to squeeze in a kitchen, a bathroom and an entertainment center. For many people, this tiny space, with its proximity to like-minded people, interesting neighborhoods and restaurants, is preferable to living in a house in a far-flung suburb. Carrying this idea further, keepsakes can be kept in remote storage, maybe deliverable someday, on demand, with driverless cars. Already, rules are being changed in many cities, including New York, allowing the little apartments to be built and to accommodate many more people per acre of city land. These factors could lead to near-zero future demands on valuable urban land.

First off, micro-units are wonderful as a means to drive housing prices down for those wishing to live in a high-priced urban area IF AND ONLY IF YOU ARE ACTUALLY ABLE TO GET APPROVALS TO BUILD THEM.  Clearly Professor Shiller has not attempted to get such a micro-unit development approved in a wealthy, coastal region of California – say Orange County, for example.  If a developer were to propose such a thing in a high-priced neighborhood, he’d be run out of town on a rail or worse for even daring to bring it up.  This type of concept that works great in some places (cities without restrictive zoning and economics text books) and not at all in others (pretty much every major city on the west coast and a few on the east coast as well).  In addition, adding density typically results in INCREASING underlying land values rather than causing them to fall. Please note that I’m not disagreeing with Shiller as to the premise of his article from a strictly economic perspective (at least when it comes to homes – not necessarily land) only noting that politics MUST BE taken into account because they play such an out-sized role in some regions.

I am far from an uber-bull when it comes to housing prices.  Trees don’t grow to the sky and asset values can go up in a straight line for an extended period of time.  That line of thinking has been fully debunked by the debacle that was the housing crash and Great Recession.  IMO, one buys a house for stability and as a hedge against future rising rents, especially in supply constrained regions.  If you are looking at a house soley as a means of making a large return on investment, you are doing it wrong.  Unlike say tech stocks, housing is a necessity.  Therefore the only way to properly judge it as an investment is versus the alternative: renting.  You either do better over time as a renter or an owner depending largely on economic and political factors where you live.  All real estate is local and making broad generalizations about housing supply being able to meet demand regardless of location and political climate is next to impossible even for an economist as accomplished as Shiller.

Economy

Bass Ackwards: How negative interest rates have turned the world’s economy upside down.

Delay: Britain has now pushed the projected date of the Brexit back to 2019.  The odds of this thing actually occurring are falling by the day.

Reaching: Someone published a research note on Seeking Alpha theorizing that the Pokemon Go app will lead to higher oil prices.  Color me skeptical.

Commercial 

That Didn’t Take Long: WeWork is cutting it’s revenue forecast and its CEO is asking employees to change it’s “spending culture.”

Residential

Over the Falls: London luxury home sales are plunging post-Brexit.

Profiles

Class Act: Tim Duncan was the greatest basketball player of his generation – sorry Lakers fans but deep down you know its true and not all that close.  True to Duncan’s persona, he left quietly, shunning the typically season-long distraction/going away party that players of his caliber so often demand in the modern era.

Fading Away: Why golf is going the way to the three martini business lunch.

Chart of the Day

The condo development capital stack is becoming a convoluted mess as banks pull back (h/t Tom Farrell).

(Click to enlarge)

WTF

Such a Bummer: McDonalds has stopped allowing customers to stream porn on their free in-store wifi.  It will be interesting to watch how this impacts the bottom line as I’m pretty sure that the free porn was the only reason anyone still went to McDonalds.

Headline of the Year Contender: Woman Decapitated By Passing Train During Sex will be a difficult one to beat.  In a twist that should surprise no-one, this happened in Russia and she was drunk at the time.

Inevitable: Someone shot a gun at a couple of teenagers playing Pokemon Go. Did it happen in Florida? Of course it did.

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links July 19th – One Size Fits All?

Landmark Links July 15th – Proceeding with Caution

Squirtle

Last Tuesday, I was sitting in a hospital room with a somewhat-drugged-up Mrs. Links just after baby Hayden was born when I read an article about a new video game that had just been released. That game was just beginning to become a phenomenon like nothing I had ever seen.  I remarked to Mrs. Links that this was going to end up being the tech story of the summer.  She rolled her eyes at me in a painkiller-induced haze and told me that I had to be kidding.  I wasn’t.  If I were smart, I would have dropped everything and bought Nintendo stock.  I’m’ not.  Since then the Pokemon phenomenon has taken on a life of it’s own and not just among kids.  Twenty and thirty somethings are playing the augmented reality game which now has more users than Twitter and more engagement than Facebook.  It’s led to car crashes and muggings but has also helped to boost traffic at zoos and museums and is being utilized as a dating app by some.  I’m not a gamer and I personally find the whole thing rather lame (not for kids – for 30 year olds).  I also haven’t downloaded the app and don’t plan to although it has been a regular topic of conversation at Landmark World Headquarters.  However, there is no denying that that this game is dominating the news cycle and having an economic impact on everything from local businesses to real estate (yes, seriously).  As such, today’s blog has decidedly Pokemon Go theme…..and yes, I acknowledge that makes me almost as nerdy as the 30-somethings crowded onto Santa Monica or Newport Piers in search of imaginary cartoon characters that show up on their phones.

Lead Story… Property values in the US have recovered dramatically since housing bottom, leading to an additional $260 billion in home equity.  However, this hasn’t led to additional borrowing.  According to CNBC, this is why:

During the last housing boom, homeowners used their properties like cash machines, pulling out more equity than the house or the market could support. Arguably, no one wants to see that again, and so far, it is not happening.

“During the mid-2000s, as house prices went up, borrowing went up almost dollar for dollar. In the last few years, when house prices have again been increasing more rapidly than the long-term average, mortgage borrowing has not increased at all. In fact it has decreased,” said Sean Becketti, Freddie Mac’s chief economist.

Much of that may be due to more careful lending. The equity may be there, but lenders are far more strict about letting borrowers pull it out, especially if their incomes don’t support the higher debt.

“We are hoping that people continue to be prudent about cashing out, but part of it is, lenders are more cautious. One of our frustrations at Freddie Mac is we think we’ve set a very prudent credit box, but we find that lenders won’t go all the way out to the edge of our credit box. They are more restrictive than we would allow them to be. They just are super cautious,” added Becketti.

Mortgage refinances will likely rise on lower rates, but the same volatile global economic conditions pushing rates down are making borrowers even more cautious. The cash-out share is not expected to change, as lenders keep standards high and homeowners keep their personal leverage in check.

Economy

Vortex: How the black hole of negative rates is dragging down yields across asset classes and around the globe.  See Also: Germany just sold 10-year bunds at a negative yield.

Ancillary Benefits: How to drive insane amounts of traffic to your local business using Pokemon Go. Contra: Pokemon Go is actually terrible for the economy.  Here’s why.

Commercial

Bargain Shopping: Brexit could lead to foreigners buying up even more of London as UK real estate funds look to sell assets in order to meet redemptions as the pound continues to weaken.

No Moat: WeWork is the largest player in the co-working space, leading to a much scrutinized, sky-high valuation of $16 Billion for a real estate company.  However, the business is growing and, with very few barriers to entry, competitors are popping up everywhere.  I found this excerpt from the WSJ about valuations vs. barriers to entry particularly interesting (highlights are mine):

Some WeWork investors have compared WeWork with taxi-service provider Uber Technologies Inc. and overnight home-rental provider Airbnb Inc., saying WeWork will transform the office-space market.

But Airbnb and Uber enjoy high barriers to competition. The more drivers and hosts in their networks, the harder it is for an upstart to challenge them.

WeWork, by contrast, leases all its office space itself and then rents it out, making it more like a large hotel operator than a network that connects a buyer and seller—and potentially more susceptible to competition.

If the above is true, and scale isn’t as important as barriers to entry, that $16 billion valuation is looking awfully rich.

Residential

Millennials, They’re Just Like You and Me: Realtors marketing to Millennials are driving traffic to their open houses by advertising that Pokemon characters are present in said houses.

Profiles

Deal of the Century: I used to think that George Steinbrenner’s purchase of the Yankees for $8.8MM (now valued at $1.6 billion) or Al Davis’ purchase of 10% of the Raiders for $18,500 (worth around $800MM today) were the best investments in the history of sports. However, the UFC just surpassed both.  This past week, the Fertitta family and Dana White sold UFC for a whopping $4 billion after having bought it for a mere $2MM a mere 15 years ago.

LOL: Leadership at struggling online lender Sofi has long been highly critical of banks. However, a major slump could force the upstart company to become what it despises the most: a bank.

Podcast of the Day: The Big Man Can’t Shoot from Malcolm Gladwell’s Revisionist History series is 35 minutes long and absolutely worth the listen.  It’s about how Wilt Chamberlain (a historically terrible free throw shooter) started shooting his foul shots underhanded, was incredibly successful at it but then stopped because he was embarrassed.  The episode is much more about human behavior than basketball. I found it fascinating.

Chart of the Day

Remember this chart the next time you read an economic report referencing low productivity:

WTF – Pokemon Go Edition

Everybody’s Searching for Something: Searches for Pokemon porn are up 136% since the launch of Pokemon Go on July 6th.  The more that I learn about people, the more I like my dog.

Dragnet: A woman in Queens, NY used the Pokemon Go app to catch her boyfriend cheating on here when she noticed that he caught a Pokemon at his ex’s house.

Attempted Darwin Award: Two men fell off of a cliff in San Diego on Wednesday while trying to catch a Pokemon.  They both lived, despite their best efforts.  I can’t think of a good way to go but, when it’s my time, I don’t want a video game mentioned as the cause in my obituary.  See Also: Three people, at least one of whom was an adult were locked in a cemetery while playing Pokemon.

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links July 15th – Proceeding with Caution

Landmark Links July 12th – We Know Nothing

sgt-schultz

Lead Story….  There is an old investment joke about Albert Einstein going to heaven that goes like this:

Einstein dies and goes to heaven only to be informed that his room is not yet ready. “I hope you will not mind waiting in a dormitory. We are very sorry, but it’s the best we can do and you will have to share the room with others” he is told by the doorman.

Einstein says that this is no problem at all and that there is no need to make such a great fuss. So the doorman leads him to the dorm. They enter and Albert is introduced to all of the present inhabitants. “See, Here is your first room mate. He has an IQ of 180!”
“Why that’s wonderful!” Says Albert. “We can discuss mathematics!”

“And here is your second room mate. His IQ is 150!”
“Why that’s wonderful!” Says Albert. “We can discuss physics!”

“And here is your third room mate. His IQ is 100!”
“That Wonderful! We can discuss the latest plays at the theater!”

Just then another man moves out to capture Albert’s hand and shake it. “I’m your last room mate and I’m sorry, but my IQ is only 80.”
Albert smiles back at him and says, “So, where do you think interest rates are headed?”

Believe it or not, there was a time that it was considered foolish to speculate as to the future direction of interest rates.  For better or worse, that time has clearly passed.  On a personal level I try to avoid interest rate projections whenever possible and nothing loses my attention quicker than a one sided statement like “interest rates have nowhere to go but up,”  which we’ve been inundated with for several years.  Why?  Simple: I HAVE NO IDEA WHERE INTEREST RATES ARE HEADED AND NEITHER DO YOU, so let’s not waste time on  something that’s complex to the level of being unknowable.  My preference is to look at interest rates (especially at the long end of the yield curve) as an indicator that tells us about the economy as opposed to something that fluctuates based on the whims of where economists, consultants, finance bloggers or even the Federal Reserve think that they ought to go.

Two weeks ago, I read a post on John Burns Real Estate Consulting’s typically-excellent Building Market Intelligence blog that suggested that finished lots could be substantially overvalued – as much as 26%!  The post is relatively short so I’ll post the entire thing here:

In 2013, finished lot values (shown in navy blue below) spiked back to mid-2005 values. Since then they have climbed modestly. Today’s low mortgage rates support the high lot values, but lots are 26% overpriced if rates were to rise back to a long-term norm of 6.0%.

BFLVI2

Methodology

To help our clients assess housing cycle risk, we calculate intrinsic finished lot values in 24 markets around the country and intrinsic home values in approximately 100 additional markets. Intrinsic values are those one would expect over a very long period. We assume that 6% is the normal mortgage rate over a long period like this. (6.45% is the median rate over the last 25 years.)

Valuation

Today’s finished lot values make sense in the current 4% mortgage rate environment (red line above) but won’t make sense if rates rise to 6% (green line above). Most home buyers are highly sensitive to mortgage rates, which is why the difference is so dramatic. The intrinsic valuations vary widely by market, too, with Dallas’s finished lots the most overvalued market in the country and Charlotte’s the most undervalued.

Conclusions

Our analysis, which includes interviewing brokers and running cash flows, concludes that finished lots are 3% underpriced nationally as long as rates remain where they are. If rates rise to 6%, finished lots would be overpriced by 26%. Our research subscribers get the detail for each market and the methodology.

Any regular reader of this blog knows that I have nothing but the utmost respect for the JBREC team and link to their posts regularly but I have some real issues with this analysis, not because they chose to apply a higher interest rate to stress land values but rather because I believe the methodology that they used to be flawed for several reasons:

  1. Flawed Scenario Analysis: I have absolutely no issue with scenario analysis and actually favor it as a means of establishing a range of values where variables can not be pinpointed.  We use it in almost every underwriting that we do.  However, they only ran one scenario here: rates rising.  What if rates fall?  Brexit, anyone?  Then what happens?  I would assume that finish lots would be undervalued if they did fall?
  2. Counterfactual: The Burns Intrinsic Finished Lot Value Index is based on a conterfactual.  In that regard, they are trying to take a condition that currently doesn’t exist in the market, change one variable and reach a conclusion based solely on that variable.  This may work great in a laboratory environment but doesn’t work so well when interest rates are completely intertwined with all other facets of the economy.  When it comes to finance, counterfacutals are challenging because they are garbage-in-garbage-out and you can make them say almost anything.  Want to make something look overpriced?  Just change an input and voila, you’ve just come up with a bear thesis.  Same thing goes for showing that an asset is undervalued.  In this case, the index is using a historic average that isn’t applicable to today’s economic conditions and then applying it across the board. Which leads us to my biggest beef:
  3. Oversimplification: The entire analysis is an exercise in oversimplification.  In their index, JBREC is implying that, since rates have averaged 6%+ over the past 25 years that they will return to that level.  At the time that the JBREC post was written, the 30-year mortgage rate was 3.56% (it’s substantially lower today).  That means that mortgage rates would need to rise 69% to get back to 6%, which, while steep is clearly not outside the realm of possibility – IF we have substantial economic growth. The problem that I have is that the index doesn’t take into account the economic conditions over the past 25 years that allowed for mortgage interest rates to average 6%.  The economy drives long-term rates, not the other way around.  Income and GDP growth would both need to be substantially higher as would the labor force participation rate (which is largely driven by demographics).  If these conditions were present, it would lead to the long end of the yield curve (upon which mortgages are typically priced) to rise – which could lead to 6% (or greater) mortgage rates due to inflation, which is currently nowhere to be found.  However, rising incomes would help to blunt the impact of rising interest rates when it comes to home, and by extension land affordability.  In other words, it’s fine to increase the assumed mortgage rate but only if you adjust the other complex economic variables necessary to achieve that rate, which constitute a far more complex analysis.  Otherwise you end up with a scenario that won’t happen because it can’t happen: interest rates do not function in a vacuum.  They don’t typically rise 69% without a substantial increase in inflation, meaning that 6% mortgage rates would not result in lots that are 26% overpriced because incomes would be rising as well.  It doesn’t appear from the JBREC post that they took income growth commensurate with that type of increase in long term rates into account.

Are lots overpriced today?  Perhaps they are but it has more to do with increased regulatory and development/construction costs and fees outpacing the rate of home price inflation than it does about mortgages being hypothetically 69% higher.  The reality of the current world economy is that deflation is everywhere, a VERY different dynamic from previous periods of economic expansion.  Negative interest rates are no longer a text book hypothetical and are becoming more prevalent around the world. For example, Switzerland’s bonds now yield negative all of the way out to 50-years. Former Treasury Secretary Larry Summers wrote an excellent op-ed in the Washington Post last week outlining four take-aways from today’s incredibly low interest rates that provide a bit more background as to why I have issues with JBREC’s index (highlights are mine):

First, with differences between countries, neutral real interest rates are likely close to zero going forward. Think about the U.S., where growth has been relatively robust by recent standards. Growth has averaged little more than potential for the last one, three or five years while the real Federal funds rate has been about -1 percent.  There is no good reason to think given sluggish investment expectations that the neutral rate will rise to be significantly positive in the foreseeable future. The situation is worse in other countries with more structural issues and slower labor-force growth. Substantial continued reductions in Fed estimates of the real neutral rate lie ahead.

Second, as counterintuitive as it is to central bankers who came of age when the inflation of the 1970s defined the central banking challenge, our problem today is insufficient inflation. In the U.S., Europe and Japan, markets are now expecting inflation that is below target even with full employment over the next 10 years. This is despite a 70 percent rise in the price of oil. Evidence from markets and some surveys suggests that inflation expectations are becoming unhinged to the downside. The policy challenge with respect to credibility is exactly the opposite of what it has been historically — it is to convince people that prices will rise at target rates in the future.  This is likely to require some combination of very tight markets and mechanisms that give confidence that during the best times, inflation will be allowed to exceed target levels so that over the long term, they can average target levels.

Third, in a world where interest rates over horizons of more than a generation are far lower than even pessimistic projections of growth, traditional thinking about debt sustainability needs to be discarded.  In the U.S., the U.K., the Euro area and Japan, the real cost of even 30-year debt will be negative or negligible if inflation targets are achieved. Indeed, the conditions Brad DeLong and I setout in 2012 for expansionary fiscal policy to pay for itself are much more easily satisfied today than they were at that time.

Fourth, the traditional suite of structural policies to promote flexibility are not especially likely to be successful in the current environment, though some structural policy approaches such as removal of restrictions on investment are still desirable.  Indeed, in the presence of chronic excess supply, structural reform has the risk of spurring disinflation rather than contributing to a necessary increase in inflation.  There is, in fact, a case for strengthening entitlement benefits so as to promote current demand. The key point is that the traditional OECD-type recommendations cannot be right as both a response to inflationary pressures and deflationary pressures. They were more right historically than they are today.

What I like about the Summers analysis is that it looks as interest rates as a barometer of the economy and inflation (or disinflation in this case) rather than try to predict their future trajectory.  So when will we see inflation (leading to an increase in long-term rates)?  At risk of sounding like I’m making a projection – after trashing the practice for several paragraphs – it will be when we stop hearing the constant refrain of investors “searching for yield.”  In an environment where there is strong real economic growth, fixed income investments are less attractive because inflation eats away at returns and investors turn to growth strategies as a way to benefit from said inflation.  I have no clue when/if this will occur but you can be certain that it will coincide with robust real economic growth that could make the JBREC index assumption of 6% mortgage rates a reality once again.

Economy: Recent non-farm payroll reports have looked as if they were pulled from a random number generator. Barry Ritholtz of The Big Picture is spot on in explaining why no one individual NFP report should be taken too seriously (but the trend should be):

The month’s data for June 2016 was a very robust 287,000 following last month’s very punk 38,000 for May 2016. The unemployment rate ticked up 0.2 to 4.9 percent in June — offsetting the drop last month by the same amount. The phrase “Assume its noise” should be foremost in your thoughts as you read the BLS release.

Also, those 35,000 striking Verizon workers muddied the water both months, but if you have the a PhD. in applied mathematics, you might be able to perform the arithmetic functions of ADD 35,000 to MAY and SUBTRACT 35,000 to June — it should not throw you too much.

Let me remind readers (again) that the monthly employment situation report has a margin of error of 100,000 jobs. So last month could very likely have been as high as 173k (38 + 35 + 100) and this months could very likely be as low as 152k (287 – 35 – 100). If you understand this simple math, you should be able to understand why I insist on noting the actual BLS official monthly number ain’t all that.

Everything Old is New Again: Forget about the Brexit.  Graphic Detail, The Economist’s excellent infographic blog gives us a closer look at the Amexit (h/t Elizabeth DeWitt):

Commercial 

Ejected: Mall owners are pushing out department stores in favor of specialty retailers.  See Also: How malls can survive in the age of Amazon.

Profiles

Fad: Hipsters with nothing better to do are obsessed with new “augmented reality” game Pokemon Go where they search for Pokemon characters in the real  world. Nintendo, which created the game saw it’s stock surge nearly 25% on Monday adding a cool $7.5 BILLION to it’s market capitalization on a day when there was virtually no other news that would have moved the stock.  However criminals are taking advantage of players as easy marks and one player in Wyoming found a human corpse while searching for a Pokemon.  IMO, this is the lamest thing since adults were collecting Beanie Babies for hundreds of dollars.  That being said, anything that led to this meme can’t be all that bad:

Chart of the Day

WTF

Assault with Extra Pepperoni : A North Carolina couple is facing charges after assaulting each other with pizza rolls.  Whoever said a picture is worth a thousand words clearly had the two mug shots in this article in mind (h/t Bhavani Vajrakarur).

Walk of Shame: An intoxicated thief in Tennessee was caught in bed with a scantily clad mannequin that he stole from a Hustler store.  He claimed that he thought it was a Pokemon.

LOL: Women are using Tinder to con desperate men into doing chores because guys are complete suckers if we think there is even a slight chance of getting laid.

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Landmark Links July 12th – We Know Nothing