Wednesday, December 14, 2011

Aftermath of Housing Bubble: Stat Review


Updated thoughts to accompany the updated housing numbers from JPM:

Top Left
  • A 28% national “correction” from peak to trough.
  • Implied 56% total housing appreciation through the 90’s – or 4.5% per year.
  • Implied 25% total housing appreciation through the 00’s – or 2.2% per year.
  • Index growth from 1990 through 12/2011 is 90 --> 160 = 78% total housing appreciation – an annual return of 2.7% per year – the long term average.
  • This exemplified the hyperbolic appreciation that took place from the late 90’s through 2007; do not anchor yourself to the high-point (as is human nature), but to the fact that despite the volatility, there was housing appreciation in the past two decades in accordance with long-term averages.

Top Right
  • Matter of hedonics, preference changes, subjective interpretation.
  • The San Francisco rental market has skyrocketed as of late, which is a historically sound indicator that property values will follow and also increase materially as home ownership proves more financially fruitful in the long-term.

Bottom Left
  • Notice that inventories are a lagging indicator—why a secular trend must be established before developers / contractors see pickup in activity.
  • High correlation between housing sales (turnover) with prices in the above-left graph.
  • The bouncing sales line came as a result of federal intervention—first time home buyer credits, quantitative easing & operating twist in an effort to lower mortgage rates—which is still met with resistance of the capital markets naturally “correcting” prices further.

Bottom Right
  • This graph needs to be considered in context of wages, demographic shifts in age and location, and so forth.
  • This is an example of a catch-22 statistic.
  • My opinion is that this chart pairs well with the upper-right graph… that we are entering a period where home buyers are at a net advantage. For how long? We will wait for the numbers…

Have a great day.  

Wednesday, December 7, 2011

Short Sales (not so short) + REOs

Short sales - REOs (Real Estate Owned) - Foreclosures: all speak to distressed sales and what home sellers may be facing today.  The silver lining within the various stages of distressed property sales is the opportunity to walk out from being “under water” and regain positive financial footing.  An opportunity exists for both buyers and investors, as they are able to purchase property at a discounted price and reap the benefits of higher yield potential or sentimental bang-for-the-buck!
                                                                   
Deals and bargains are all about the price!  The main benefit of purchasing a property as a short sale, foreclosure or REO is one’s ability to get it at a discounted price from the market comparables.  The cons, however, are the following:

Short Sale cons:
-          Takes at least three months to close, depending on the lender
-          The sale may not even go through because foreclosure proceedings are imminent
-          Competition: prices rebound to comparable market sales
-          Buyer is left to pay any liens, property taxes and closing cost fees if Seller is not able

Foreclosure (at courthouse steps) cons:
-          Title insurance, which indemnifies a Buyer against any pre-existing liens or encumbrances attached to the property, usually always comes with the purchase of a home.  When buying at the courthouse steps, however, title insurance is not made available to the Buyer and you assume the risks of inheriting any defects in Title; such as, mortgage liens, mechanics liens and encumbrances. 
-          Must buy ALL CASH – forgo opportunity to finance and leverage banks at the onset
-          Competitive arena with many savvy investors present

REO cons:
-          Institutional owners and banks may not have all disclosures and material information on property
-          This is the final resting place for bank foreclosures that have been picked over by short sale purchases and auctions earlier in the foreclosure process.  So, quality is likely lackluster and heightened in distress
-          Bank may require you to obtain financing through them given they own the property, and may not offer most competitive interest rate

Though the aforementioned Cons may be disenchanting, purchasing a distressed property is still worth considering on a property-by-property basis.  At the end of the day, purchasing a home boils down to the emotional tie you may have to it, long-term goals, affordability and value proposition. 

Wednesday, November 30, 2011

King-Kong Cap Rate

The Property Report in today’s Journal features the “King Kong,” Empire State building. The disclosed facts are that the building was appraised this summer at $1.65 billion, and secondly, that the net annual income is $63 million.

$63 million of revenue, relative to a property valued at $1.65B is a yield dancing around 3.82%. Not exactly the best way to define the ‘cap rate,’ because “net income” implies that interest deductions and various credits are netted out, but close enough! 

3.82%… (Yawn). Unless you don’t travel or eat food… this will barely outpace inflation.

However, this figure is actually within range of an edifice to most major metros: it is acknowledged that cap rates of 2-3% are really ‘the norm’.

But what does this mean for you? Sub-districts and managed personal-properties can find yields in the vicinity of 8-10%, and even higher if managed the right way! Sure, people most often anchor themselves to the nominal figure…$x-dollars…but a yield is the most objective, apples-to-apples comparison people can make when evaluating an actual investment. So, focus on the yield of an investment when determining its capital investment worthiness.  

Cheers.

Tuesday, November 22, 2011

Mortgage Mechanics

The value of mortgage paper is a function of how a product is structured around the cash flows. I want to take the time today to explain what a mortgage is, theoretically. In the future, I will look to explain how the mortgage transfers into structured bond-type products in the capital markets.

Examples are great ways to explain a concept. A $500,000 listed home purchased with 10% down results in a $450,000 loan. We will assume that the purchaser qualifies for terms of a “fixed” 4.5% APR loan, with a duration of 30 years. An amortization calculator will confirm that the annual payment for such a loan will be around $27,600 per year, or the equivalent of $2,300 per month. For the sake of explanation, let’s ignore taxes, fees, and any other overhead costs.

The result of paying $27,600/yr over 30 years comes out to an actual liability outlay of $828,000. This assumes, further, that there will be no refinancing or any modification to the terms of the loan. The topic quickly becomes controversial and a bit of a catch-22. The accounting number says that we bought a $500,000 value home, while the “economic” cost is, in this case, $828,000, a significantly higher sum. The market listed price really doesn’t reconcile with the real cost.

You better trust whomever it is you work with to explain concepts like this.

Back to the example. The $328,000 difference represents the total interest cost—compensation for the lender who is assuming the risk. Much more can be said on the topic of ‘risk'. Important to recognize is how increasing the time horizon or the interest rate can have a dramatic magnifying effect. In our example, if we increased the APR to 5%, a mere 50 basis point increase, the total interest outlay raises from $328k all the way to $379k, a difference of $51,000! Put another way, one-half of one-percent on a $450,000 loan is the equivalent of a 11% total increase in price ($51k / $450k) or a 6% increase in total cost ($51k / $828k) over thirty years!

More to come…

Monday, November 14, 2011

Importance of Agency & Client Representation

Every agency relationship has a principal, an agent and a third party.  In a real estate transaction, the principal (Buyer or Seller), agent (real estate broker) and third party (customer) are bound together in a legal relationship, with all the duties and rights that go with that connection.  Most frequently, the principal is a Seller who employs an agent to find a Buyer for his property.  Sometimes the principal is a Buyer who employs an agent to locate a property. 

Given the premise of agency, it is very important as a Buyer or Seller to identify an agent that you know has your best interests at heart.  Specifically, it is the agent’s fiduciary duty to place your objectives at the forefront and not compromise them in the slightest.  Buying and selling a home can be a very emotional and complex matter, which begs the employment of an agent who embraces confidentiality, loyalty and your utmost trust. 

As a Buyer looking to purchase a property, you need to identify an agent that upholds the following traits:
  • LISTENS and pays careful attention to you and your needs and wants
  • Gives advice and guidance with FACTS
  • Educates you along the home buying process (i.e. prepares comparable market analysis)
  • Has a strong rolodex of resources (i.e. painter, plumber, interior designer, lenders)
  • Strong negotiator & market savvy
  • Is ‘ahead of the curve’ on available property
  • Is respected professionally by other agents in the field
  • Strong problem solver and commitment to you after the deal closes – lifelong Realtor

As a Seller looking to sell your property, you need to identify an agent that upholds the following traits:
  • Cutting edge marketing platform with use of Internet and print mediums
  • Intimate market knowledge of value and future outlook
  • LISTENS to your goals and objectives in selling – caters accordingly
  • Strong negotiator in maximizing sale proceeds
  • Creates an over-arching allure of the property and what is has to offer to prospective buyers

The aforementioned outlines the high-level points to be mindful of when interviewing agents and finding someone who you feel most comfortable with. 

Lastly, there are cases where a real estate agent may represent both the Buyer and Seller, which is called Dual Agency.  In such a case the agent must act with extreme care because the agent owes fiduciary duties to both principals.  The cumbersome nature of working on behalf of both principals can be challenging; however, depending on the overall interest level of the property and market timing, it could work in everyone’s favor – so, such an option is worth investigating.  In the end, identifying an agent that you are comfortable with and listens to your objectives will prove most beneficial to getting the best deal possible. 

Monday, November 7, 2011

Tech and its Role in SF Real Estate

Forty technology companies are looking for two million square feet of office space in San Francisco, most of it South of Market, according to a report by Colliers International.  Most concede that the technology sector has been the culprit for property appreciation in San Francisco. But have you considered why that is exactly?  The industry’s boom-and-bust cycles has given its players a robust ability to earn large sums of income, which has a correlation with affordability and home prices.  Specifically, economists and laymen alike recognize that one of the main drivers in home ownership is having the financial bandwidth and confidence in making such a large purchase, which the Tech industry clearly affords its workers given the compensation packages offered.    

The Bay has experienced an influx of new ‘Techies’ entering the work force for companies such as Twitter, Facebook and LinkedIn.  One can internalize this phenomenon by merely observing the surge in rents.  Specifically, the occupancy rate in the City rose six percent between 2010 and 2011, while the average cost of all rentals went up from $2,214 to $2,422, a 9.3% increase, according to RealFacts data. A 3.3% differential multiplied by the population of SF (approximately 809,000) is a total of nearly 26,700 people that are scrapping to find a place to live, per year.  Increased hiring at tech companies indicates confidence by both niche and conglomerate companies.

With the Tech market heating-up again, and rents sky-rocketing – what are the implications for the prospects of out-right home ownership?  Historically, a swell in the rental market tends to spill over into a greater demand and thus increase in values for home ownership.  People vying for rentals quickly come to the realization that instead of ‘throwing money away’ via renting that it is better to make an investment in owning a piece of San Francisco real estate.  Real estate values are arguably at 2002 levels given the sales activity I am experiencing today; plus, interest rates are within a range not seen in the past 50 years. This is what I dub: the perfect storm for first time homebuyers and investors alike.  These sound indicators’ reminds me of an old adage, “It’s better to buy Bay Area real estate and wait, than to wait to buy Bay Area real estate” – this cannot be more true today. 

The takeaway: San Francisco remains and will continue to be the epicenter for the Tech Hub of the world.  Innovative people want to live here despite the concrete evidence that there is little remaining land to develop, (thus limited housing stock available) and in turn, continuous demand as evidenced by the data above.

Tuesday, October 11, 2011

Real Estate: a Local Market

Since most of us have become numb to the high volatility that has situated itself in most markets these days, I want to spend time studying the data that is most pertinent to the readers of this blog: San Francisco Real Estate. The following points stem from the S&P/Case-Shiller Indices:

  • The 20-City Composite Index measured from the June/July 2006 peaks through July 2011, showed a peak-to-trough decline of -33%.
  • San Francisco specific experienced a peak-to-trough decline of -46% - much of which can be attributed to the lower price ranges (lower for the City) and in the less affluent neighborhoods (i.e. Bayview / Hunters Point).
  • San Francisco’s recovery from recent lows is up nearly 15% vs. the 20-City Composite Index of only 4%.
  • San Francisco is #1 on the 20-City Composite Index for recovery from recent lows, followed by Washington DC at 13%.

The takeaway: real estate is a local market and it is too difficult to draw conclusions on a national level.  Real estate is fragmented, which means that real-estate specialists have to properly evaluate the local economy. Here are my opinions as to why I have strategically positioned myself in San Francisco: SF is a world-class City, with limited land to further develop and build, a climate that’s arguably ‘perfect’ and with an economy driven by innovation and progressive minds, as Silicon Valley is steps away. Such dynamics present a real estate market where demand has shown resiliency and supply is limited – a formula that most businesses salivate over.

This evidence, albeit a matter of perspective, is valid and is why real estate in San Francisco is not commensurate to the macro variables we continually hear about via the media and other outlets. What I will be paying attention to are the underlying qualities continuing to be present in San Francisco. This is how I will determine how the demand-side of the equation will change… and where prices have to reflect that change.

In sum: I maintain an optimistic outlook on the SF marketplace. Stay tuned for a more in-depth look at how various sub-districts within San Francisco have fared since the market’s peak…

Saturday, October 1, 2011

Implications buried within Housing News


Much to think about these days, especially towards the housing market…

Lots of implications within the pages of the daily news: government intervention has turned the housing market into a serious political affair. The best way I can summarize “Operation Twist” is by saying:

1.      The Federal Reserve has become more fiscal than monetary in purpose, promoting economic growth and employment more than fighting inflation and maintaining price stability, and

2.      Net selling of short term rates, and buying more long-term rates, is an effort to flatten the yield curve (though I fear an inverted YC – which is a bad thing).

The goal is to improve long-term financing of major assets (like homes) and simultaneously shift the liability obligations of the government on future generations. This is unsettling, and I fear that some degree of manipulation is in place. Well, obviously there is meddling going on…politicians and Wall Street, the like, have been meddling for a long-time now! Why else do people vote for pro-intervention policies – we tend to believe that people know what they are doing...

Furthermore, the new limits of government risk-backing have now been capped at $625,500 for a residence (with exceptions in NYC, LA, and Washington). I tend to ask the question: which underwriting agency will be pooling the mortgages of homes that are over this target price? That is a real implication. I am also thinking about the implications on supply-demand dynamics…

No solutions coming from me on these problems. I would only suggest, as I already have, that you align yourself with professionals whom you can trust to offer you fair and objective opinions.

Saturday, September 24, 2011

More Productive Thinking than the Normal Complaining


Rather than pledging up to $400 billion to protect the off-balance-sheet Government Sponsored Agencies (GSEs) Freddie Mac and Fannie Mae…

…why didn’t / doesn’t the government just set up a public REIT and take out-right ownership in the houses???

Put another way, there is ‘closet’ socialized risk in backing the validity of the mortgages in the first place, where the spurious belief is that free markets are therein left alone to work. Yet moral hazard has already taken its toll. That’s why I pose the question: why not just claim the ownership (and risk); protect the nation from future liability matching schemes; keep the national balance sheet in some kind of order (that is actually on the balance sheet); and technically improve the supply-demand dynamics? Keynesian’s would love that policy because that is as direct as federal intervention gets! Plus the government would effectively be able to regulate and administer the benefits to society with genuine accountability.

According to JPMAM, homes make up 25% of the total national assets of $71.9 Trillion…so that is roughly ~$72Trillion x 25% = $18 Trillion. $400 billion is only 2.2% of the aggregate value…a meager and insignificant insurance policy in my opinion. Buying 2% of the worst segments of the market might provide a better ROIC than pulling the rug over an otherwise mess...

I will spare you from graphs here today. Just a thought to ponder, but an even better conversation topic! Be well...  

Monday, September 19, 2011

Bid-ask spreads and rational markets respective to Real Estate


Efficient markets are “rational.” The Efficient Market Hypothesis (EMH) is a concept that most can nod their head in agreement towards regardless of a genuine understanding of the phenomenon. So I have recently been pondering: is the housing market today a rational one? I tend to think negatively, and here is why…

The bid-ask spreads are most revealing: what a willing buyer and seller come to terms on with prices, ignoring all commissions. Generally speaking, narrow(ing) spreads equate to efficient, liquid market environments. Liquid and efficient markets foster trust, faith and stability. Today’s housing market has spreads that easily exceed 10-20-30%! It is not uncommon to purchase a home at discount prices of…well you know what I mean.

So, let’s think about the concept here—a buyer’s market is not a seller’s market, and vice-versa. That is just another way of saying which of the two parties is facing more of the pressure to compress the bid-ask spread: will bids come down or asking prices go up? Today is more on the irrational side because of the psychological bias that sellers more notably are dealing with – denying what willing buyers are willing to pay. 

This is significant because as far as I see it, if spreads continue to remain as wide as they are…it justifies that the housing market needs more time to stabilize itself. Unfortunately, prices tend to stabilize in the downward direction more than upward (funny thought). Much of the dislocation comes as a function of the price-appreciation component of Total Return concept. If homes are perceived to no longer offer greater appreciation than the long-term rate of inflation, 3 percent per year, then that will definitely prove that the pressure should continue to be on sellers to narrow the spread.

Friday, September 16, 2011

Fragmented Housing Market


The above chart is a state-by-state breakdown of home-equity ownership, courtesy of Deutsche Bank research. I think that this graph is powerful; it offers some flavor on the fragmented national housing market. This speaks volumes to the point of tangency which the housing market has arguably reached…

Some observations:
  • It is difficult to talk about housing from a national perspective given the dramatic differences in state demographics and sub-stratified marketplaces.
  • There is no clear trend or difference between states within the 50-99% home equity range; only a small (but still insignificant trend) with the 25-50% equity makeup.
  • What your eyes want to gravitate towards is the penetrating blue ‘negative equity’ slice. Alarming, no? This goes back to the point I made in an earlier blog where I challenged the reader to think whether we are riding a trend or at a transitioning point…
  • These statistics are like when political persons have to reveal their own net worth: very subjective still. How does this graph account for refinancing and in cases where home equity is tapped? Can’t tell from this, too many moving pieces-parts.
Still, this is pretty interesting. More to come, stick around…