Landmark Links November 15th – Restraint

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Lead Story… To say that the past few days have been a shit storm in the fixed income market would be an understatement.  As I wrote last week, we’ve spent the past 6 or-so years becoming conditioned to believe that every major financial or geopolitical disruption would result in a flight to quality trade into US Treasuries, lowering borrowing costs for real estate.  Last week’s surprise election result obviously broke that trend and, even the few people out there that got the election result correct mostly got the bond market response incorrect.  As such, are now in a position where things could dramatically change in the lending market which would obviously have profound implications on real estate in general and housing in particular.  Interest rates are already up substantially as talk about potential tax cuts, a mountain of infrastructure spending and de-regulation of mortgage markets abounds.  What seemed to be a grindingly slow and somewhat boring market just a couple of weeks ago is now changing rapidly, leaving some worried and others excited.

But here’s the thing: no one really knows what this new administration is going to look like in terms of economic or housing policy or how it will interact with a congress that, although of the same party was often hostile towards the President-elect during the election.  Political campaigns have become little more than 2 years of mudslinging and bullshit and the one that mercifully just finished was far worse than most.  Markets appear to be jumping to the conclusion that it’s going to be easy for everyone on the right side of the isle to simply come together after all of their inter-squad fighting and slam through broad changes.  This line of thinking largely discounts that there is a very narrow majority in the Senate while disregarding the fact that there are major, major disagreements on key issues between the incoming administration and legislative branch.  Maybe they suddenly come together and do everything that market participants seem to believe they will, leading to higher inflation.  Maybe they don’t.  The fact is that we simply don’t know at this point.

Oaktree’s Howard Marks is one of the most brilliant and successful investors in the world.  His response to the election and policies that may or may not be enacted in the next 4 years is something that everyone should read.  From Financial Review (emphasis mine):

“I am in the ‘I don’t know camp’. We should not rush to conclusions,” the founder of $US100 billion ($131 billion) fund manager Oaktree told the audience at the Sohn Hearts & Minds Investment Leaders conference in Sydney on Friday.

“On paper he should be a pro-business president and objectively speaking he should be more pro-business than Hillary Clinton would have been,” Marks said, but added he will be watching to see which policies Trump will pursue and will be able to pursue and who he appoints.

“He said lots of things people didn’t like but he said some supportive things for the business environment such as cutting taxes. The negative is his view on trade.”

Another positive is Trump’s pledge to invest in America’s infrastructure.

“It will be a nice thing and put people to work but I don’t think it will redirect the trajectory of the economy, but it’s a plus and something people can agree on.”

The rise of populism would become a feature of the US political and economic environment.

“The Trump candidacy didn’t make people angry – it touched on an anger and a division.”

“Globalization and automation has cut into jobs and is going to cut in further.”

He feared that sustained lower growth will be a challenge for the nation.

That’s one of the world’s most successful investors freely admitting that he doesn’t know what’s going to happen with the economy from a policy standpoint.  If only all of the talking heads on the TV and internet could show such restraint….

The crux of the matter is this: infrastructure spending, tax cuts and financial de-regulation are all inflationary.  Protectionist trade policy and tarrifs are deflationary.  At this point, there is no way to tell whether the pro-growth or populist side will win out.  There is a fine balance to be struck here.  During the Bush administration, the regulatory pendulum swung too far towards de-regulation.  The result was banks gone wild and, eventually the Great Recession / housing crash.  Somewhat predictably it swung hard in the other direction during the Obama administration, leading to retulatory stagnation, a lack of bank credit and incredibly low interest rates.  My hope is that the new administration and Congress ease up on regulation enough to get banks lending again but not so much that we go back to the bad old days of 2005 which was basically the lending equivalent of the wild west.  IMO, we need policies that are more pro-growth but not at the expense of stability. To be sure, it’s a difficult tightrope to walk. We don’t know if it will happen or not but I’m remaining open minded until I know more.

 

Economy

Glass Half Full: Higher interest rates mean long term gain at the expense of short term pain.

Positive Trend: The prime working age population (ages 25 – 54) is finally growing again which should help to provide a positive economic tailwind.  See Also: 40-somethings are the prime drivers of US productivity but no one really understands why.

Breaking Away? As you can imagine, a large portion of Silicon Valley was not happy with the results of last week’s election.  Several tech titans got together and are now working on an initiative to put a referendum for California secession on the 2018 ballot.  Here’s why that would be an incredibly dumb idea from an economic standpoint.

A New Direction?  As I previously wrote, last week’s Election results have traders betting on more inflation in the near future.

Commercial

Giving Away the Farm: Manhattan landlords are offering more concessions than ever due to an oversupply of available apartment units.

Virtual Reality: Some online retailers are turning to physical locations in an effort to connect with consumers better.

Residential

Paying Up: A post-election Treasury sell-off that resulted in higher mortgage rates has home affordability in the United States waning.

Bullish: While the nation as a whole may be divided, construction firms are quite bullish on the result of the presidential election.

New Direction?  Silicon Valley is the poster child for the housing affordability crisis in the US.  However, the election of several pro-development candidates in local city council races should be a positive for a region that has become so expensive that it’s not uncommon to see Tesla’s in trailer park driveways.

Chart of the Day

More sensitive than an America college student.

Here’s what happens to values when rates rise 1%

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And here’s what happens to values when they fall 1%

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WTF

Good Boy: A town in Minnesota re-elected a dog as mayor for a third term.  In related news, if anyone asks me what leaders I admire I’m going to direct them to Duke the Great Pyrenees.

Cat Lady: A woman in Texas was arrested last week after police discovered three tigers, a cougar, a skunk and a fox in her house along with her and her 14 year old daughter.

Bottoms Up: A new study found that drinking a beer a day helps prevent stroke and heart disease.  You’re welcome.

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links November 15th – Restraint

Landmark Links November 8th – Size Matters

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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 September 23rd – What’s the Point?

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Lead Story… Former Federal Reserve Chairman Paul Volker once said that the only useful modern financial innovation was the ATM.  While that’s a rather harsh assessment, there is a bit of truth to it.  Too often, financial products ranging from subprime loans, to derivatives to leveraged ETFs are created more as profit and marketing opportunities for those selling them than they are to fill an actual need of the people that they are being sold to.  That being said, I’m still somewhat fascinated by the FinTech industry because there are segments of the market that are not covered by traditional sources where FinTech companies can provide real value to consumers.  There have been several such products from online mortgage lenders to crowd funding platforms for real estate deals that fill a need.  I’m especially interested when a FinTech startup is aimed at our beleaguered national housing market.  Last week, top tier Venture Capital investor Andreessen Horowitz announced a new venture called Point which was created to invest in a portion of the equity in a home in exchange for a portion of the return when you sell or refinance.  Point lowers a homeowner’s monthly payment because you don’t pay current on Point’s equity investment and that all of their profit is realized upon sale or refinance of the home. Although this reduces a homeowner’s current pay, it could cost a lot more in the long term depending on whether your house appreciates and by how much.  When Point was announced via press release, the financial blogosphere when into a bit of a tizzy which was somewhat predictable given that: 1) The concept of offloading equity in a home, typically a family’s largest asset, has been around for some time but this seems to be the first time someone has attempted to do it in scale; and 2) Andreessen Horowitz is known for making smart investments – so people naturally assume that their involvement validates Point’s business plan.  I wanted to hold off on offering my opinion until I had time to do a bit of reading and research on the product.  There is still  a lot of information that hasn’t been released on how the product works but I’ve been able to piece together enough to get a decent ideal.

First off, let’s explain how the product works.  The best way to do that is probably the example from their own website:

 

Check if you qualify

Enter your address and answer a few questions. The process is free and takes less than 5 minutes.

5 minutes

  • You provide us with basic information about your home and your household finances.
  • To be eligible for Point, you’ll need to retain at least 20% of the equity in your home after Point’s investment.
  • We can instantly give you pre-approval or denial based on the information you provide.

Point Makes you an offer

Point makes a provisional offer to purchase a fraction of your home. We will provide you with an offer based on the value of your home today.

1-3 days

  • If pre-approved, we provide a provisional offer based on the data you provide.
  • The offer is typically for between 5% and 10% of your home’s current value.
  • We’ll ask you to complete a full application and provide documentation for our underwriting team.
  • If possible, we will improve on our pre-approval offer.

Schedule an in-person home visit

Pick a time for a licensed appraiser to visit you. We want to ensure the price is correct by checking the place out — no cleaning necessary 🙂

5-8 days

  • We will schedule time for a home valuation visit.
  • You will be charged for the cost of the appraisal, which is typically between $500 – $700.
  • The appraiser will visit and inspect your home.
  • We will share the appraiser’s report with you once it’s complete. The appraiser’s value is an important component of the final offer.

Point pays you

We usually send the money within 4 business days of closing.

3-5 days

  • We finalize the offer following the appraisal and receipt of all supporting application documents.
  • You will meet with a notary to sign the Point Homeowner Agreement.
  • Point files a Deed of Trust and Memorandum of Option on your property in your county recorder’s office.
  • Once the filings have been confirmed, we transfer the offer funds (less Point’s processing fee of 3% and the escrow fee) electronically to your bank account.

Sell the home or buy back from Point when the time is right for you

Point is paid when you i) sell your home, or ii) at the end of the term, or iii) during the term, when you choose to buy back. Regardless of the timing, there’s no early buyback penalty.

1 to 10 years

  • If you sell your home within the term then Point is automatically paid from escrow.
  • If you don’t sell, you can buy back Point’s stake at any time during the term at the then current appraised property value.
  • Point is paid a fraction of the home’s value. If the home has declined significantly in value, Point may be due less than its original investment.
 Sounds simple enough but as usual, the devil is in the details.  A few caveats:
  1. Point collects a processing fee of 3% upfront in addition to appraisal and escrow fees
  2. You need at least 20% equity in your home to qualify
  3. You are guaranteeing repayment in 10 years
  4. Point is in a preferred position, meaning that they get paid first in the event that your home loses value
  5. When Point first went live last week, they gave an example of their pricing on their website (they have since taken it down for some reason).  In this example, Point put up 10% of the value of the home and received 20% of the appreciation (net of any improvements done by the home buyer in return.
One of the primary issue holding back the market is a lack of capacity for down payments by first time home buyers.  Low interest rates may be great for monthly payment affordability but they do nothing when it comes to a buyer’s ability to save a 20% down payment for a conforming loan.  There is a real need for investors in this space and some platforms have tried to tackle it.  For example, FirstRex which was profiled by Bloomberg back in 2013 will put down up to 50% of a homebuyer’s downpayment in exchange for a portion of the profit.  However, I am not aware of there being a substantial need for people who already have a large amount of equity in their homes to be able to extract that equity, especially when cheap HELOCs or reverse mortgages ( for seniors) are readily available.  Both HELOCs and reverse mortgages allow an owner to extract their equity WITHOUT giving up 20% of the upside in their home.  In order to illustrate this I ran a scenario outlined in Point’s press release.  For the sake of simplicity, I didn’t include property taxes, insurance or maintenance as these would be the same with or without Point.  I also didn’t include any loan fees in an effort to keep things simple.  This analysis has 2 scenarios:
Scenario 1: Borrower buys a home for $500k.  Borrower takes out a $400k with a down payment of $100k.  The mortgage has a 4% coupon.
Scenario 2: Borrower sells $50k in equity (10% of the total value of the home to Point, reducing the loan size to $350k, again with a 4% coupon.  Under this scenario, Point gets 20% of the home price appreciation.
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As you can see, it’s substantially less expensive to use a traditional mortgage if you experience any home price inflation – and Point’s website and press release both imply that it will be targeting higher priced markets that will likely experience more inflation.  If a borrower lives in a market that experiences home price inflation of less than 2%, Point makes some sense.  Above that, it doesn’t appear to.
So what’s the Point (Pun fully intended)?  IMO, this would be a great investment program if it were structured as some form of down payment assistance (like the FirstRex example above) – I’m even willing to bet that they could get more aggressive splits if it were designed to fill that substantial need in the market.  However, as currently offered, it’s an expensive preferred position that sits in front of a substantial amount of equity (again, assuming that there is any home price inflation).  I’m just not sure that there is much of a need for a product that allows people with a lot of equity to extract it from their homes when HELOCs are available, cheap and flexible and reverse mortgages are an option for seniors.  Borrowers that need something like this (and would be willing to pay for it) to defray their down payment can’t qualify and those who would qualify have better options if they want to extract equity from their homes or finance a purchase.  As such, I just can’t see how this is something that will be very scalable in it’s current form.

Economy

Surprise, Surprise: The Fed chose not to raise rates at their meeting this week but signaled that 2016 rate increases are still likely.  For those keeping track at home, they did exactly the same thing that they’ve done at pretty much ever meeting this year.

You Want Cream or Sugar with That? Yes, there is a Millennial underemployment crisis but it only extends to those with liberal arts degrees.

Commercial

Bottom of the Barrel: The ongoing dumpster fire that is K-Mart announced that it’s closing 64 stores and laying off thousands of employees.  I honestly had no idea that there were 64 K-Marts still open to begin with.

Going Long: Blackstone jumped back into the logistics business after selling IndCor Properties in 2015 by purchasing a $1.5 billion mostly-west-coast portfolio from Irvine-based LBA.  See Also: How Amazon is eating the department store, one department at a time.

Residential

Flipper’s Back: Home flipping continues to make a comeback and is now at it’s highest level since 2010.  A lot of the activity has been taking place in secondary markets like Fresno which could be a good sign that things are getting better.

Soaring: According to the Federal Reserve Bank of St. Louis, urban rents in US cities are rising quicker than they have in any time in recorded history.

Kicked to the Curb: Cities are starting to follow New York’s example by allowing developers to eliminate or reduce parking requirements for condos and apartments in order to provide more density and cheaper prices.  However, there is a lot of concern over the impact of this move with regards to on-street parking in cities where mass transit infrastructure hasn’t kept up.

Profiles

Talking Your Book: One of Lyft’s co-founders believes that private car ownership will go the way of Johnny Manziel’s NFL career by 2025.

Grudge Match: Tesla’s battle with car dealers has the potential to reshape the way that cars are sold in the US.

The Paradox of Leisure: The rich were meant to have the most leisure time. The working poor were meant to have the least. The opposite is happening.  Here’s why.

Chart of the Day

Rise of the regional banks

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WTF

Terrifying: A crazy woman from New Zealand made a handbag out of a dead cat and is trying to sell it for $1,400.

Broken Clocks: Brangelina broke up this week, meaning that those tabloid headlines that you’ve seen every time that you go to the grocery store for the last 10 years were finally correct.  If you believe Us Weekly, they broke up at least 31 times in the last decade.

Hero: Meet the 110 year old British woman who attributes her longevity to drinking whiskey on a daily basis.  See Also: New study suggests that people who don’t drink alcohol are more likely to die young.

Hell NO: South Carolina residents warned about clown trying to lure children into woods.

Video of the Day: Watch a diver catch video of great white shark attack on his GoPro off the coast of Santa Barbara (don’t worry, no blood).

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links September 23rd – What’s the Point?