Landmark Links November 4th – Who’s On First?

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Lead Story…. It seems like nearly everyone in the real estate industry likes to use the baseball analogy to describe the real estate cycle.  There’s a little known rule that every home builder/developer conference has to have a panel where participants are asked what inning the current cycle is in by a moderator.  I suppose that this was considered either novel or informative at some point but today it’s neither.  The problem is that it’s difficult to classify real estate, especially real estate development in such broad and generalized terms.   Whenever I’m asked such a question, I answer the same way: what asset class and what market?  Another important clarification is the time frame of the recovery that began the cycle in question.  Most people consider our current cycle to have begun in June of 2009 which was when the National Bureau of Economic Research (NBER) marked the end of the last recession.  However, when it comes to home building and by extension the economy as a whole, it’s not that simple as Bloomberg’s Conor Sen wrote this week (emphasis mine):

The National Bureau of Economic Research marked the end of the last recession at June 2009. Similarly, the stock market hit bottom in the first half of 2009. The four-week moving average of initial jobless claims peaked in April that year. And the unemployment rate peaked in October. All of these suggest a broad-based trough at some point during 2009, making the economic expansion at least seven years old by now.

But given the severity of the financial crisis and the shock to the economy, the beginning of the recovery was not like moving from recession to expansion. It was more like moving from depression to recession. Rather than a normal business cycle in which four steps forward are followed by two steps back, the Great Recession was more like five steps back. Should the ensuing first two or three steps count as part of the next expansion, or something else?

The growth in the early part of this recovery was abnormal. Part of it was caused by government fiscal stimulus, which proved to be inadequate and was then followed by federal, state and local austerity. Part of it was caused by a “dead cat bounce,” as output fell so hard, below consumption in industries like the auto sector, that a certain amount of recovery was inevitable as producers had to increase output merely to match consumption. And then some part of the recovery was caused by the energy sector and the boom in fracking, a localized boom that eventually went bust.

So what went missing in those first few years of “recovery”?  The answer is home building which is the reason that I think much of the current cycle’s math is a bit off.  More from Sen (emphasis mine):

The missing piece was housing, the bread and butter of the American economy. The Housing Market Index from the National Association of Home Builders didn’t begin to increase from depressed levels until October 2011. Similarly, single-family-building permits didn’t begin to increase from depressed levels until 2011. It’s here, in late 2011, that I would claim the current expansion began, making it barely five years old, quite young in the context of a downturn that lasted four or five years rather than just two.

Ultimately, housing is the driver of the U.S. economy, which is why any understanding of the recovery of the economy must factor in the recovery of housing. Single-family-building permits peaked in the second half of 2005. Subprime mortgage originators started going bankrupt in 2007, the same time that housing prices started falling significantly. Outside of globally attractive real estate markets like San Francisco, New York and Miami, housing prices and activity continued to fall well into 2011.

The early years of the housing recovery, from 2010 to 2012, were more driven by investors and institutions buying foreclosures and investment properties with cash than by owner-occupiers coming back to the market. In the past few years, housing demand has been soaking up inventory created during the bubble years and pushing home prices back toward their mid-2000s levels. First-time home-buying remains below normal.

Only now are we seeing tertiary markets like exurban areas start to expand again, and construction remains below the level of household formation. One of the metro areas that was a poster child of the housing bubble, the Riverside-San Bernardino metro area in Southern California, is still building 80 percent fewer single family homes than it was at the peak of the last cycle.

That last highlighted section is something that I’ve written about frequently.  Although LA, Orange County and San Diego get a lot of attention for their great weather, beautiful beaches and affluent communities, it’s actually the Inland Empire that is the engine of growth in Southern California.  Especially when it comes to creating new housing for first time buyers and blue-collar workers that can’t afford to live closer to the coast.  That this region is still building 80% fewer units than it was at the peak of the last cycle is nothing short of shocking.  IMHO, it can’t be classified as much of a recovery at all.  As Sen points out in his article, every economic sector doesn’t necessarily recover in unison.  Just because tech has boomed or energy has boomed then busted doesn’t mean that other sectors are doing the same.  When it comes to a traditional growth sector like housing, this can have a massive impact on a regional (or even national) economy.  For some traditional growth markets like the Inland Empire, perhaps the appropriate question isn’t what inning of the cycle we are in but rather when the recovery will actually begin in the first place.

Economy

Even Keeled: Calculated Risk’s Bill McBride is still not on recession watch.

Setting the Stage: The Fed didn’t raise rates at their November meeting but certainly indicated that they are open to doing so in December.  See Also: The Fed’s latest statement indicates that they are not going to target inflation rates above 2%.

Commercial

Going Strong: Chinese investment in US commercial real estate is still on the rise.

Residential

Put a Lid on It: Low FHA limits are killing home building in California’s secondary markets.

Imagine That: San Francisco home sales surged in September thanks to a large supply of newly-completed condos.

The Oracle of Home Building? Berkshire Hathaway just purchased the largest home builder in Kansas City.  It’s the just the latest purchase for Warren Buffett who has been buying up builders in the south and Midwest.

Profiles

Ain’t No Free Lunch (Or Shipping): Why the free shipping that you love so much from online retailers is mostly a lie.

Shocker: This years Black Friday deals will probably be exactly the same as last year’s Black Friday deals.

Subprime Redux: Rising automobile repossessions show the dark side of the car buying boom.

SMH: The University of California at Irvine, which is in Landmark’s back yard wants to be the Duke basketball of online gaming (aka video games).  Ok, fine but can they please stop calling it a “sport”?

Chart of the Day

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WTF

Hero: A woman sustained burns after causing a fire by farting during a surgery, igniting a laser.  Pain is temporary but glory lasts forever.  See Also: Ten people who were arrested for farting.

Guaranteed Contract: Former NBA star and certified crazy person Gilbert Arenas just received the final check from the $111MM contract that he signed in 2008. If you’re not familiar with Arenas, he once got into a locker room altercation with a teammate that involved a firearm and hadn’t played in the NBA in nearly 5 years. Great investment. (h/t Tom Farrell)

That’s Going to Leave a Mark: A drunk 28-year old Florida man fell out of his pickup truck on the way home from a strip club and immediately ran his leg over before it crashed into a house.  He’s apparently still at large.

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links November 4th – Who’s On First?

Landmark Links September 27th – Unusual Trend

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Lead Story… “When Orange County catches a cold, the Inland Empire gets the flu.”  If you’ve spent any time in the real estate industry in Southern California, you’ve probably heard some variation of this truism.  The relationship has held up over the years because the two regions are closely linked in terms of geography and economy: OC has white collar jobs and executive housing, whereas the IE traditionally has more blue collar jobs and more plentiful affordable housing.  In a typical cycle, OC home prices rise first, followed by IE prices.  When the cycle turns, the IE pricing and volume typically falls off first when entry level financing disappears and blue-collar employment falls off.  The price movements in the Inland Empire are typically greater in percentage terms (although substantially less in nominal dollar terms) to both the upside and the downside since values there are lower.  This cycle, that historical relationship has broken down, as I detailed in a blog post titled Mind the Gap back in May.  Last week, JBREC’s Rick Palacios JR posted a research piece about the disjointed nature of the recovery across housing markets in the US, summed up neatly in the chart below:

jbrec_housingcycle-marketbymarket_q32016_black3

The first thing that I noted on the chart is that, aside from Houston, every market on here is still on the positive side of the slope.  Larry Roberts at OC Housing News wrote a follow-up post that helps put the above chart in context about how Dodd Frank’s crackdown on so-called affordability products will dampen volatility in future housing cycles.

The second thing that I noticed is more local and that is that JBREC classifies both OC and LA as late Phase 2 to early Phase 3 while the Inland Empire has barely made it out of Phase 1 and is plagued by relatively low levels of housing construction.  Orange County prices exceed the prior cycle peak while Inland Empire prices are still 20% – 30% below.  IMO, there are several reasons for this:

  1. While development impact fees are very high in both Orange County and the Inland Empire, they are far higher as a percentage of new home price in the Inland Empire.  Housing prices crashed in the late aughts but impact fees didn’t, making it very difficult to build homes profitably in further out locations that haven’t experienced the coastal recovery.
  2. The Inland Empire is a less diverse economy than Orange County and is more reliant on real estate development to power it’s economy, which has struggled in light of the low number of housing starts the region is experiencing from what we would typically see at this point of the cycle.
  3. There was a far higher level of distress in the Inland Empire markets during the housing crash which took longer to work off than it did in Orange County.
  4. Perhaps most importantly, the Inland Empire is an affordability-driven market.  Orange County is not.  Riverside and San Bernardino Counties are both highly reliant on FHA financing that allows for much lower down-payments than conventional financing options.  San Bernardino and Riverside Counties are constrained by the FHA limit of $356,500 which is absurd given the massive geography of these two counties – if they were their own state it would be the 11th largest in the US by land mass.  At or below this loan amount a borrower can put up a down-payment as low as 3%. That down-payment goes up substantially for loan amounts above $356,500.  That is a huge problem for builders in the IE since they are essentially sandwiched between rising impact fees / regulatory costs and an FHA price ceiling.  If a builder wants to sell homes priced at or below FHA, he has to find cheap land and it’s still tough to make a profit.  Price above it and his absorption dries up due to a lack of a buyer pool with substantial down payment capacity.  Orange County has an FHA limit of $625,500.  Even still, Orange County just isn’t that beholden to FHA limits because home prices are so high here.  Perhaps the only silver lining is that it’s highly unlikely that the FHA will reduce loan limits for Riverside and San Bernardino Counties next year and increasingly likely that they will raise it a bit.  Still, being constrained by a completely arbitrary government loan cap on a huge and diverse area is hardly a healthy situation, even if you can get some relief when that cap increases.

Perhaps I’m incorrect and the historical relationship will remain in tact when the market eventually turns.  However, it seems unlikely given that the Inland Empire really hasn’t experienced much of a real estate recovery while Orange County has.  It’s a lot more painful to fall off of a ladder than off of a curb.

Economy

Happy Losers: So much of what’s wrong with the US economy is summed up in this paragraph from the Washington Post:

Most of the blame for the struggle of male workers has been attributed to lingering weakness in the economy, particularly in male-dominated industries such as manufacturing. Yet in the new research, economists from Princeton, the University of Rochester and the University of Chicago say that an additional reason many young men are rejecting work is that they have a better alternative: living at home and enjoying video games. The decision may not even be completely conscious, but surveys suggest that young men are happier for it.

Quick to Jump Ship: Why decreasing employee tenure could be a positive sign for the economy.

Paycheck to Paycheck: Small businesses are now surviving but still not thriving. A new JP Morgan study found that the average small business has less than a month of cash operating reserves.

Residential

Movin’ Out: KB Homes is seeing more young people entering the first time home buyer market.  Apparently, there are a few more vacancies in mom’s basement now.

Slim Pickin: Home sales fell in August as inventory fell over 10% from this time last year.

Super Sized Incentives: Builders are constructing super sized homes because they are highly economically incentivized to do so.

 Profiles

Acquisition Target: Suitors are beginning to line up to acquire beleaguered Twitter. Google and Salesforce are the among the latest rumored to be interested as is Disney.  See Also: Why is Salesforce interested in Twitter?  It’s all about the data.

Fashion Statement: Snapchat is entering the hardware business with a line of camera-equipped sunglasses.  This is great news as is it will instantly ID people who deserve to get punched in the face.

Gross: Hampton Creek is a San Francisco startup that wanted to become “the first sustainable-food unicorn” in part by selling a vegan concoction called “Just Mayo.”  The problem was that it apparently tasted like crap and the company was busted buying gallons of their own disgusting concoction from Whole Foods and other stores in an effort to boost it’s sales. (h/t Mike Deermount)

Chart of the Day

REITs get their own sector in major S&P 500 makeover

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WTF

No Regrets: A 27 year old man from Boston attempted to create something he called a “scuba bong” by filling a scuba tank with marijuana smoke. He failed miserably and lost both of his testicles when the tank exploded. The gene pool has been chlorinated once again.

Stupid Is As Stupid Does: As many of you probably know, Apple got rid of headphone jacks on the iPhone 7 leading to angst among many loyal Apple users. A prankster posted a video purporting to show owners of the new phone how to “add” the headphone jack by drilling a hole in the phone. The video went viral and idiots are now breaking their phones by drilling them out. Imagine a person of average intelligence. Now consider that half of the world’s population is dumber than that person.

Florida Has Jumped the Shark: A tweaker on a 5-day methamphetamine binge cut off a certain part of his anatomy and fed it to an alligator because, Florida.  A friend first sent me this story and I thought it was a fake.  It appears to be legit.  When it comes to Florida weirdos, reality is often stranger than fiction. (h/t Andrew Shugart)

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

Visit us at Landmarkcapitaladvisors.com

Landmark Links September 27th – Unusual Trend