Landmark Links August 12th – Why We Can’t Have Nice Things

kids making a mess

Lead Story… In a profoundly disappointing but not remotely surprising story, labor, environmental and tenant advocacy groups have effectively nuked CA Governor Jerry Brown’s plan to streamline approvals for housing developments, imperiling it’s chances of passing through the legislature this year.  Brown’s plan essentially would have allowed development “as of right” so long as it conformed with underlying zoning and allowed for a certain number of affordable units.  This would have effectively subverted the veritable maze of discretionary approvals currently required in some municipalities.  First, construction union leaders threw a hissy fit because the plan didn’t include enough goodies and hand outs for union labor to buy – I mean win – their support.  Next, environmental groups (Side Note: in California, the term “environmental group” is nothing more than a euphemism for  NIMBY) opposed the plan because they don’t want anything built under any circumstances ever if it’s anywhere near the expensive – and often developer-hostile neighborhoods where they reside and Brown’s plan would effectively take away a major lever of control – discretionary approval – that they have held in the development approval process.  Third, some renter advocacy groups joined in with the construction unions and environmentalists because they apparently aren’t all that sharp and don’t realize that they are being bamboozled into opposing something that would ultimately lead to lower rents which would benefit them the most.  i guess that no good deed goes unpunished.  From the LA Times:

Labor and environmental groups say they are done negotiating over Gov. Jerry Brown’s housing plan – LA Times

“After several meetings without an agreement on a variety of requested changes, we believe it is time to focus on real affordable housing solutions that don’t directly undermine local voices and place communities and our environment at risk,” said a statement from the State Building and Construction Trades Council, Sierra Club and Tenants Together, who are among a coalition of more than 60 groups who joined to oppose the governor’s housing proposal.

Cesar Diaz, the legislative director for the State Building and Construction Trades Council, confirmed that the coalition would not participate in further discussions over the plan.

“This needs much more time and a policy-vetting process,” Diaz said.

Yes, this is depressing but it isn’t at all surprising to anyone who has spent any time in a field related to development in CA.  Any time that someone makes a proposal that attempts to fix out badly broken housing system, existing stake holders dig in their heels and do anything in their power to stop it.  This, as today’s headline suggests is why we can’t have nice things in California – namely an affordable and moderately functional housing market.

Today I’d like to present a counter example to illustrate what a functional housing market looks like.  There is a major global city that is fully built out with a population of over 13 million (far larger than any city in CA).  This city is a major global finance and trade hub.  It is land constrained and effectively fully built out, yet housing prices haven’t budged in nearly 20 years.  The city that I’m referring to is Tokyo and Robin Harding of the Finacial Times published a very important story about how regulation impacts housing cost called Why Tokyo is the land of rising home construction but not prices last week.  First off, I want make something clear.  The Japanese respect property rights to a level that’s almost inconceivable in California.  According to Takahiko Noguchi, a regional planning head in Tokyo:

“There is no legal restraint on demolishing a building.  People have the right to use their land so basically neighbouring people have no right to stop development.”

In other words, Tokyo has become the anti-coastal California where housing supply is created to meet demand without mountains of red tape and shrieking NIMBY obstructionists.  The outcome has been so dramatic that it’s a bit shocking to those that don’t live there.  From the FT (highlights are mine):

Here is a startling fact: in 2014 there were 142,417 housing starts in the city of Tokyo (population 13.3m, no empty land), more than the 83,657 housing permits issued in the state of California (population 38.7m), or the 137,010 houses started in the entire country of England (population 54.3m).

Tokyo’s steady construction is linked to a still more startling fact. In contrast to the enormous house price booms that have distorted western cities — setting young against old, redistributing wealth to the already wealthy, and denying others the chance to move to where the good jobs are — the cost of property in Japan’s capital has hardly budged.

This is not the result of a falling population. Japan has experienced the same “return to the city” wave as other nations. In Minato ward — a desirable 20 sq km slice of central Tokyo — the population is up 66 per cent over the past 20 years, from 145,000 to 241,000, an increase of about 100,000 residents.

In the 121 sq km of San Francisco, the population grew by about the same number over 20 years, from 746,000 to 865,000 — a rise of 16 per cent. Yet whereas the price of a home in San Francisco and London has increased 231 per cent and 441 per cent respectively, Minato ward has absorbed its population boom with price rises of just 45 per cent, much of which came after the Bank of Japan launched its big monetary stimulus in 2013.

In Tokyo there are no boring conversations about house prices because they have not changed much. Whether to buy or rent is not a life-changing decision. Rather, Japan delivers to its people a steadily improving standard, location and volume of house.

So how, exactly did this come about?  Some of us remember tales of the runaway Tokyo real estate market and subsequent crash in the 80s during the great Japanese boom and subsequent bust.  It may seem odd that a place that produced such an epic real estate boom and subsequent bust would be home to a stable, efficient real estate market.  Again, from the FT:
“During the 1980s Japan had a spectacular speculative house price bubble that was even worse than in London and New York during the same period, and various Japanese economists were decrying the planning and zoning systems as having been a major contributor by reducing supply,” says André Sorensen, a geography professor at the University of Toronto, who has written extensively on planning in Japan.
But, indirectly, it was the bubble that laid foundations for future housing across the centre of Tokyo, says Hiro Ichikawa, who advises developer Mori Building. When it burst, developers were left with expensively assembled office sites for which there was no longer any demand.
As bad loans to developers brought Japan’s financial system to the brink of collapse in the 1990s, the government relaxed development rules, culminating in the Urban Renaissance Law of 2002, which made it easier to rezone land. Office sites were repurposed for new housing. “To help the economy recover from the bubble, the country eased regulation on urban development,” says Ichikawa. “If it hadn’t been for the bubble, Tokyo would be in the same situation as London or San Francisco.”
Hallways and public areas were excluded from the calculated size of apartment buildings, letting them grow much higher within existing zoning, while a proposal now under debate would allow owners to rebuild bigger if they knock down blocks built to old earthquake standards.
All of this law flows from the national government, and freedom to demolish and rebuild means landowners can quickly take advantage. “The city planning law and the building law are set nationally — even small details are written in national law,” says Okata. “Local government has almost no power over development.”
Note that this is not all that dissimilar from the proposal that Gov Brown made where the State of CA would set policy from the top down since cities have shown absolutely no inclination to get their shit together when it comes to housing policy.  When the Japanese crisis hit, policy makers did something that those in the US have been unable and unwilling to do: liberalize development regulation to spur economic growth – which also led to a subsequent dramatic slowing in housing costs due to a pickup in efficiency.  Remember the Tokyo example next time someone makes an economically illiterate statement that building more market rate won’t make housing more affordable.  Albert Einstein once said that the definition of insanity is doing the same thing over and over again and expecting different results.  Japanese policy makers understand this, Californians apparently don’t.  The simple fact is that coastal CA cities will not get housing costs under control until they start doing things differently, much like Japan did in the midst of their economic crisis.


Debt Decision: Plunging interest rates have lowered the cost of borrowing over long time periods, making it appealing for the government to roll short term debt into longer term maturities.  See Also: It’s never been cheaper for cities and states to borrow money so why are they so reluctant?

Opposite Result: There is early evidence that negative interest rates are actually encouraging savings, rather than discouraging it as central bankers had hoped.

Pendulum Swing: In the never-ending tug of war between labor and capital, labor is gaining an upper hand as the job market tightens.


Landmark in the News: Landmark’s own Tom Farrell had a prominent quote in a feature Wall Street Journal article entitled  Lopsided Housing Rebound Leaves Millions of People Out in the Cold.  : The whole piece is well worth a read:

Tom Farrell, director of business development for Landmark Capital Advisors, which counsels investors on real-estate projects, said risk appetite is low, particularly outside core markets.

“We’re often saying ’You all want to be in the same spot, and you’re tripping over each other,” he said. “It’s just difficult to get people out to those secondary markets.”


Early Exit: Startups are opting to sell rather than IPO as investors look to cash out early.

The Rise and Fall: How Yahoo went from tech powerhouse to also-ran and why Verizon bought it.

Chart of the Day


Headline of the Week: It’s hard to beat Subway rider smokes crack and strips naked before shocked witnesses on No. 3 train when it comes to news headlines.  Especially when said headline includes pictures (before the guy took his clothes off, thankfully).

Swipe Right: Judging by usage numbers and the 450,000 condoms provided to athletes, Tinder and the Olympic Village are a perfect match.

FAIL: Man tries to light house on fire in broad daylight but lights self on fire instead.  To make matters worse, the whole thing was caught on a security camera including the hysterical part where he tries to put it out.

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

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Landmark Links August 12th – Why We Can’t Have Nice Things

Landmark Links July 12th – We Know Nothing


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%.



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.)


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.


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):


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


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


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.

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

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Landmark Links July 12th – We Know Nothing