Lead Story… CNBC posted a Bankrate.com study recently that found that more Americans prefer cash to stocks or real estate as a means of investment for money they don’t need for 10 years or more. In other words, a somewhat shocking 54 million American’s are embracing a zero-risk, zero return mentality. The most troubling finding was this (highlights are mine):
Younger millennials, or those at ages 18 to 25, overwhelmingly chose cash as their preferred investment for the money they would not need for at least 10 years. That was by more than a 2-to-1 margin over the next highest category, real estate. (Millennials are also less likely to own a home because they simply can’t afford one, according to a separate report from the U.K.’s office of National Statistics.)
Older generations were more likely to cite real estate as their top choice for a long-term investment.
What I find so disturbing is that the typical investment paradigm has been turned on its head – normally, young people in an asset growth stage should be investing long term assets more aggressively and becoming less aggressive as they age into a wealth preservation stage of life. When people, young or old start holding long term investable assets in cash, it’s deflationary. This level of risk aversion is also frequently a characteristic of those who have experienced a dramatic financial crisis like the Great Recession or Great Depression. However, the Bankrate study shows that the risk averse, deflationary mentality extends far beyond the housing sector when it comes to young people and investing. This brings us to an article by Conor Sen, one of Bloomberg View’s excellent new columnists that makes an interesting argument about Millennials and housing. Sen makes a case that Millennials almost need a housing bubble to come off the sidelines and create demand for new housing, using oil production as an analogy:
“To understand the slow-motion trends in single-family housing, start by looking at the oil market: It took years of oil priced around $100 a barrel to spur the investments that drove higher production, leading to the current supply-driven glut and prices closer to $50 a barrel. The levers of supply and demand worked, but they worked slowly — as is happening in the housing market.
Every year since 2009 we’ve been running a housing deficit: More housing for sale has been absorbed than built. With a glut of housing left over from the housing bubble and the great recession, it’s logical that construction of new supply was subdued for a few years. But vacant inventory for sale normalized in 2012, and currently stands at a 12-year low. So why aren’t builders building more? The pace of construction remains far below the rate of household creation.”
IMO, it’s an imperfect analogy as it’s likely a bit easier to drill for oil in barren portions of North Dakota or West Texas than it would be to build a large development with reasonably priced homes (the reasonably priced part is key) in places that they are needed like San Francisco or Los Angeles where discretionary entitlements, environmental regulations and NIMBY activists could tie approvals up for a decade or more. That being said, a lot of Sen’s thesis is based around economic stagnation due to the lack of wage growth in the construction industry despite a near-record-low unemployment rate coupled with incredibly low housing inventory:
“In response to a nearly generational low in housing inventory and construction worker shortage, one might expect that there would be booming wage growth for construction workers, drawing labor away from other industries. Yet we don’t have conclusive signs of that. Year-over-year wage growth for construction workers is currently 2.7 percent, nearly a full point lower than it was at the same time in the year 2000.”
The lack of growth in new construction jobs is sobering. Despite a need for more housing, and despite the labor shortage and the wage growth, construction industry employment fell 6,000 in April and 16,000 in May and showed no growth in June. This is the first time in more than five years that construction employment has shown no growth for three months.
This is all the more perplexing because the cyclical conditions for real estate have rarely been better. In addition to the low level of inventory and rising secular demand as millennials are ready to buy homes, the economy has rising wage growth and historically low levels of interest rates, as I wrote about last week.”
Sen concludes that it might take substantial increase in both housing prices and construction wage growth in order to push housing starts to a level where construction adds substantially to GDP and adds enough supply to eventually meet the marketplace demand. It’s an interesting thought, but I doubt that it’s possible (or even desirable) under in our current situation for a few reasons:
1. The construction needs to take place where it is actually needed and that is more restricted by zoning and local opposition than it is by a labor shortage. In the oil market, it matters little where the oil comes from so long as there is a way to get it to a refinery and then the end user. In housing, location is everything. Unless real demand shifts into outlying suburbs, this will continue to be a problem.
2. In order to work, substantial credit expansion both to develop/build units and also for purchase mortgages would be needed. This seems unlikely given current economic conditions, political climate (anti-GSE sentiment) and diminishing affordability.
3. As seen in the oil industry, there is a fine line between adding enough supply and creating a glut. When oil prices go down, oil companies, employees, owner of land with reserves and providers of services lose money. If the housing market were to become too oversupplied and tank again, millions of home owners lose a tremendous amount of equity. In one case, the loss is felt by a (relative) few. In the other its impact adversely affects many.
4. Any significant decrease in prices brought on by a large surge in housing production would typically hurt the people who Sen is saying need help the most: young people and first time buyers since housing credit availability typically contracts when prices fall and lender assets become impaired. This means that those with stronger credit and more cash (often not entry level buyers) fare better in times when credit becomes restricted.
Again, the concept that housing and the construction industry can respond to surging prices in a similar manner to the oil industry is desirable from an economic perspective. However, I’m not sure how well it plays out in the real world when the regions where housing is needed most are those where it is least likely to be built. I sincerely hope to be proven wrong in the next few years.
Since co-founding Land Advisors Capital of California, the predecessor to Landmark Capital Advisors in 2011, Adam Deermount, along with Steve Sims led a team that originated over $500 million in equity and debt commitments for commercial, residential and entitlement projects in the Western US. Prior to Land Advisors Capital of California, Adam served as a full-time consultant on high-profile restructuring and workout projects. Mr. Deermount was an advisor to State Street Bank on the restructuring of a $550 million land and development loan. Prior to that, he served as a bankruptcy consultant to Hogan-Webb, LLC, the Chief Restructuring Officers of LandSource Holding Company, a $2.6 billion land development company owned by Lennar Homes, LNR Partners, and CalPERS.