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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

‚ÄúWe are losing not only our 25 to 34 year-old workforce ‚Äď millennials ‚Äď but also losing K-12 and the college-age cohort as well,‚ÄĚ Walrod said.

The trend, he warned, ‚Äúcould devastate O.C.‚Äôs pool of workers, creating talent gaps as large swaths of the workforce retires, leaving open positions that will likely go unfilled.‚ÄĚ

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

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

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

As a result, he added, ‚Äúdomestic outmigration has been accelerating.‚ÄĚ

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

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

……

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

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

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

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

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

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

Economy

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

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

Commercial

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

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

Residential

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

Profiles

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

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

Chart of the Day

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

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

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

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

Visit us at Landmarkcapitaladvisors.com

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

Landmark Links October 21 – Dense Hypocrisy

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Lead Story…¬†There is little that I enjoy more than reading (or writing) about¬†the hypocrisy of self-important celebrities. ¬†However, one of my primary rules¬†for¬†writing this blog is to avoid politics – unless it’s land use politics (or water politics). ¬†As such, I haven’t had the opportunity to write much about celebrity hypocrisy, despite frequent gnawing temptation to do so. ¬†Today’s blog will be different.

At this point in his career, Leonardo DiCaprio is almost as well known for his environmental activism as he is for his acting, or, for that matter the number of supermodels that he’s slept with. ¬†This is despite the fact that his anti-fossil fuel stance is frequently juxtaposed against his high-rolling lifestyle of flying around the world on carbon-spewing¬†private jets and spending his vacations on yachts rented or borrowed from oil sheikhs, all of which is evidenced by his massive carbon footprint. ¬†¬†¬†However, the above examples may not even be his most egregious examples of hypocrisy since they only deal with his individual actions and lifestyle. ¬†His views on land use politics are far more disturbing and far more destructive from an environmental prospective.

So, now we come to the land use part of this story. ¬†It’s not a controversial notion that the best thing that a city can do to cut down on pollution is build more density in it’s core as higher density in urban centers leads to less automobile use, which leads to less carbon emissions. ¬†If residents are¬†located closer together, there is less need to transport people and goods over further distances. ¬†Therefore energy use is reduced, as well as water usage for that matter since higher density typically means less large lawns to water. ¬†This is roughly as objectionable as someone making an argument that water is wet or that orange juice tastes like oranges. ¬†So, imagine my surprise (end sarcasm here) when I recently read a story on Curbed LA about how self-styled environmental crusader Leonard DiCaprio (among other celebrity “activists”) had signed onto an anti-development¬†campaign known as the Neighborhood Integrity Initiative demanding the following: ¬†From Curbed LA¬† (emphasis mine):

(1) Direct officials to halt amendment of the City’s General Plan in small bits and pieces for individual real estate developer projects, and

(2) Require the City Planning Commission to systematically review and update the City’s community plans and make all zoning code provisions and projects consistent with the City’s General Plan, and

(3) Place City employees directly in charge of preparation of environmental review of major development projects, and

(4) For a limited time, impose a construction moratorium for projects approved by the City that increased some types of density until officials can complete review and update of community plans or 24 months, whichever occurs first.

This list of demands was presented to Mayor Eric Garcetti.  The group claims that they have enough signatures to get their measure on the ballot should Garcetti not submit to their demands.  This is NIMBYism, plain and simple.  There is just no other way to describe it  From Curbed LA (emphasis mine):

So, quite literally, the single best thing that a city can do for the planet is locate destinations‚ÄĒhouses, jobs, grocery stores, schools‚ÄĒcloser together so its residents expend less time, less money, and fewer fossil fuels traveling among them.

That‚Äôs how LA needs to think about density‚ÄĒas a long-term solution for climate change that will also deliver short-term social and economic benefits.

The problem with anti-density campaigns is that their boosters aren’t thinking about our city in a way that looks beyond what they see on their own block today.

Santa Monica’s anti-density measure, LV, is the most troubling, as it would require a citywide vote to approve any new structure over 32 feet. This would make it politically (and economically) difficult to erect buildings more than two stories tall in a prohibitively expensive city that already has limited room to grow, pushing workers farther and farther away from their jobs.

Again, as stated previously, the fact that increasing density in urban cores is good for the environment is not particularly controversial, nor is it an issue opposed by those on either the right or the left….until it happens near when they live. ¬†In this case, it’s a matter of wealthy¬†hypocrites who claim to be environmentalists trying to stop development because it happens to inconvenience their lifestyle a bit, despite the fact that the development would have a substantial positive impact on the environment that they claim to care so much about. ¬†Again, from Curbed LA¬†(emphasis mine):

Restricting building height and planning for cars goes against everything that environmental leaders and sustainability experts have been saying for decades: If you’re erecting a multi-use structure in a dense, transit-accessible neighborhood with centralized freight delivery systems, the environmental impact of that structure is lessened significantly over time.

Building a two-story building surrounded by a city-mandated parking lot on an extra wide street is not the worst thing you could do for the planet. The worst thing you could do for the planet is codify this kind of development into the land use and planning policies of your city to make building anything else impossible.

That’s why many cities and states are incentivizing dense, transit-accessible development as part of a larger climate-friendly mandate to not only decrease emissions, but also improve public health, clean the air, and slash energy costs.

My broader point here is that you can’t have it both ways. ¬†This isn’t an issue where there is a credible case that increasing density in urban cores isn’t better for the environment than doing the opposite: incentivizing¬†sprawl by making it impossible to build in urban areas. ¬†You can’t be an environmental advocate only when it suits your personal interests and expect not to get called out on your hypocrisy, especially when you stake out as hard-line of a position as DiCaprio has.

Economy

Watching the Horizon: According to Bloomberg, odds are that the next financial crisis will come from depressed lenders, shadow banks or China.

Conscientious Uncoupling: How a massive surge in divorce rates in couples over 50 years old is forcing people to work longer and putting retirements at risk.

Commercial

Rise of the Machines: Industrial robots are driving some major changes in both warehouse design and workforce composition.

Residential

History Lesson: The New York Times published a fairly balanced history of the story behind the prop 13 tax revolt and it’s consequences.

Bad Rap: Luxury condos and apartments get a bad rap when it comes to the increasing cost of housing when restrictive zoning is more often the real culprit.

The Missing Middle: By continuing to focus primarily on housing prices in San Francisco and NY, the media is missing a bigger story – rentals are becoming un-affordable nation-wide for middle class families.

Profiles

What’s the Story? ¬†HGTV has achieved something incredible: a bunch of hit shows with no¬†serialized narrative drama that is the hallmark of the modern successful series.

Video Of the Day:¬†Meet Rox Zee, the Boise State football team’s kickoff tee fetching Labrador Retriever. ¬†In related¬†news, I think that I just became a Boise State fan.

Troll So Hard: Twitter’s infamous army of anonymous trolls played a roll in Salesforce passing on offering to acquire the troubled social media platform.

Farm to Cart: Target is experimenting with so-called vertical farms where produce is grown in-store.

Chart of the Day

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Political Metaphor:¬†A Hillary Clinton tour bus was busted dumping human waste down a storm drain in an Atlanta suburb, resulting in a hazmat team getting dispatched to the site. ¬†If you’ve ever seen National Lampoon’s Christmas Vacation, you are aware that this¬†can end really, really terribly. ¬†On a personal note, I can’t wait for this election season to end.

Revealing Protest: Porn actors (I never understood why they are all called stars) are picketing on the streets in Hollywood to protest a ballot proposition which would impose mandatory condom use for any adult video filmed in the state.  Los Angeles passed a similar law in 2012 that decimated the adult industry, causing permits to plunge from 480 in the year it was passed to just 25 last year.

Pack a Day:¬†Meet Azalea, the chain smoking chimp who has become the¬†star of North Korea’s new national zoo in Pyongyang.

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links October 21 – Dense Hypocrisy

Landmark Links April 22nd – The Rise of BARF

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Lead Story…. We’ve been spending a lot of time lately talking about what’s going on in the high priced/high barrier to markets.  Of particular interest is San Francisco since it’s a market that Landmark is quite active in and it also has the most stringent land use restrictions (and the arguably worst affordability crisis) in the US.  Recently Tyler Cowan of Marginal Revolution posted a piece summarizing a new book that urbanist Joel Kotkin published and made the following head-scratching statement:

Lots of high-density, vertical building doesn‚Äôt really make cities cheaper.  In fact it sucks more talent in, and more business activity, and in the longer run makes cities more expensive.  Just look at Seoul and Singapore, which have built plenty but are nonetheless considered some of the most expensive cities to live in.  After all, isn‚Äôt that the increasing returns to scale story?

This in spite of overwhelming evidence that cities that add units are more affordable than those that don’t.  Let’s try a quick thought experiment: San Francisco currently has around 382,000 housing units.  Hypothetically, let’s assume that SF suddenly becomes Houston overnight and decide to build like crazy, sending that number up to 1.5 million units in a few years.  Raise your hand if you think this will have no impact on prices and rents.  Now take that same hand and slap yourself in the face until you realize that San Francisco is not magically immune to the laws of economics.  Kevin Erdmann penned a strong retort to this, pointing out that first off, it’s not accurate and, even if it were, building more density would still have a highly desirable outcome:

Even if it is true, it would be an even better reason to build, because it means that the value of density is practically limitless….On careful reading, I don’t think Tyler is saying this is a problem, per se.  He’s just saying building won’t lower costs.  But, even here, I think it would be quite a jump to argue that greatly expanded building in the Closed Access cities would not benefit the current residents who are being stressed by rising rents.  Even if expansion only led to more rising incomes and rising rents, the increased local market for non-tradable services would surely raise the incomes of current residents, too.  They would likely get some relief from rising incomes, even if rents didn’t relent.

We mentioned a few months ago that restrictive zoning as a driver of income inequality was an issue that would start getting more national attention once it started showing up in papers from economists employed by the Federal Government and across the political spectrum.  It is now indeed happening.  That brings us to BARF.  Last weekend the NY Times published a profile piece on a new political advocacy group called the Bay Area Renters Federation or BARF.  There are plenty of left leaning renter advocacy groups out there so what’s so special about BARF (aside from a great acronym) that garnered them a large profile in the weekend edition of the NY Times? Unlike most renters advocacy groups that focus on subsidized housing, BARF is very, very pro development.

Sonia Trauss is a self-described anarchist and the head of the SF Bay Area Renters‚Äô Federation, an upstart political group that is pushing for more development. Its platform is simple: Members want San Francisco and its suburbs to build more of every kind of housing. More subsidized affordable housing, more market-rate rentals, more high-end condominiums.

Ms. Trauss supports all of it so long as it is built tall, and soon. ‚ÄúYou have to support building, even when it‚Äôs a type of building you hate,‚ÄĚ she said. ‚ÄúIs it ugly? Get over yourself. Is it low-income housing? Get over yourself. Is it luxury housing? Get over yourself. We really need everything right now.‚ÄĚ

Her group consists of a 500-person mailing list and a few dozen hard-core members ‚ÄĒ most of them young professionals who work in the technology industry ‚ÄĒ who speak out at government meetings and protest against the protesters who fight new development. While only two years old, Ms. Trauss‚Äôs Renters‚Äô Federation has blazed onto the political scene with youth and bombast and by employing guerrilla tactics that others are too polite to try. In January, for instance, she hired a lawyer to go around suing suburbs for not building enough.

As you can probably imagine the San Francisco old timers and aging hippies are not fond of BARF:

Ms. Trauss is the result: a new generation of activist whose pro-market bent is the opposite of the San Francisco stereotypes ‚ÄĒ the lefties, the aging hippies and tolerance all around.

Ms. Trauss’s cause, more or less, is to make life easier for real estate developers by rolling back zoning regulations and environmental rules. Her opponents are a generally older group of progressives who worry that an influx of corporate techies is turning a city that nurtured the Beat Generation into a gilded resort for the rich.

Those groups oppose almost every new development except those reserved for subsidized affordable housing. But for many young professionals who are too rich to qualify for affordable housing, but not rich enough to afford $5,000-a-month rents, this is the problem.

Adding to the strangeness is that the typical San Francisco progressive and the typical mid-20s-to-early-30s member of Ms. Trauss’s group are likely to have identical positions on every liberal touchstone, like same-sex marriage and climate change, and yet they have become bitter enemies on one very big issue: housing.

If the affordability/restrictive zoning issue is going to improve, there are going to need to be a grass roots movements like this to combat the entrenched NIMBYs.  IMO, we are likely to see more of these groups popping up in closed access cities as prices and rents continue to rise.  The California Legislative Analyst’s Office has taken notice and published a report in February stating that underdevelopment with the main cause of high prices in coastal cities.  However, there is only so much that state government can do (or frankly that we would want them to do).  The locals in these cities are going to have to start making as much noise supporting projects as the NIMBYs are opposing them so hats off to BARF for taking up the fight in San Francisco.

Residential

Upside Down: In Denmark and Sweden, negative interest rates have led to a real estate boom and have even resulted in negative interest rate mortgages in some instances.

Lifestyles of the Rich and Famous: While entry level sales struggle, high end realtors are providing helicopter real estate tours for wealthy clients and luxury developers are throwing in memberships in private jet charter programs for buyers of premium condo units.

Profiles

Growing Pains:  Several years ago, online lending companies like Sofi, Lender Club and Prosper were the darlings of the banking world.  They rolled out a peer-to-peer model that was touted as faster and more reliable than heavily regulated plodding banks and sure to turn the conservative lending industry on it’s head.  Last week Fitch released a report highlighting concerns about the online lenders and their business models which was picked up by Fortune:

The problem, according to Fitch, is that online lenders are taking on riskier borrowers than they originally suggested they would. And they have perhaps been relying too much on credit scores, which the fintech lenders appear to be recognizing. ‚ÄúPockets of recent credit underperformance beyond initial expectations have likely contributed to the ongoing refinement of underwriting models, including further de-emphasizing of the use of traditional FICO scores in certain instances,‚ÄĚ Fitch said in its note. In other words, traditional banks may actually be able to assess borrowers with more accuracy, then the data-driven fintech lenders.

So they are taking on riskier borrowers than they initially said they would AND their underwriting models are proving to be weak.  They also have high loan delinquencies and, perhaps most importantly: this model hasn’t yet been tested through a full interest rate or credit cycle. Sounds great so far, huh?

Fitch made another very important point – the online lenders aren’t really lenders at all:

Online marketplace platforms aren‚Äôt actually lending, rather they typically match up potential borrowers with the source willing to fund the money‚ÄĒsuch as hedge funds, institutional investors, or even traditional banks. As a result, the ‚Äúlack of alignment of interest due to separation of lenders and originators . . . present additional challenges,‚ÄĚ according to Fitch.

This arms length relationship enables companies like Lending Club to earn oodles on fees for a while, and not actually have to be responsible if the loans go bad.

That can work for a while. The trouble is that if quality is bad, the actual lenders, that is the hedge funds and others that fund the loans are going to stop coming back for more. And that‚Äôs exactly what‚Äôs going on. ‚ÄúAs institutional demand waned in recent months, marketplace lenders began to seek alternative funding sources to sustain loan originations,‚ÄĚ Fitch says.

If that sounds familiar to you, it’s because it’s pretty much exactly what happened in mortgage lending before the bust when banks got stuck with a bunch of crappy paper after investors balked.  The online lending business is minuscule compared to  the mortgage market so I don’t expect much to come from this.  However, it bears mentioning.  As Mark Twain once said “History doesn’t repeat but it rhymes.”

 

Chart of the Day

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Banned: The California State Senate voted earlier this week to ban Palcohol or powdered alcohol.  If the concept of consuming alcohol in powdered form sounds at all appealing to you, please stop reading this blog immediately and check into your nearest rehab because you have a problem.

What Happens in Vegas: Las Vegas hotels are about to start offering virtual reality porn in your room for $20.  No word on how the Vegas hookers are taking this news.

Smart Move: China has made the brilliant move of banning rich kids from appearing on reality TV shows that make them look like rich douche bags.  It’s a shame that the Kardashians don’t live there.

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links April 22nd – The Rise of BARF