Landmark Links December 2nd – Moment of Truth


Lead Story… So it finally happened.  Just like a proverbial broken clock, the “interest rates have nowhere to go but up crowd” was finally right, albeit for all of the wrong reasons.  Ironically it wasn’t QE, a soverign debt downgrade, bailouts or the Fed holding short term rates at low levels that ultimately caused rates to soar.  Instead the culprit was an unexpected election result and subsequent expectations of growth-spurring infrastructure investment, tax cuts and financial de-regulation that sent 10-year US Treasury Bond yields on a moonshot from 1.79% at the end of October to 2.44% today – a whopping 36 percent increase (although starting from a very low level).  Mortgage rates have followed suit as one would expect. Whether this move is sustainable or merely a market over reaction to an unexpected outcome won’t be known for a while.    However, the fact that rates responded to uncertainty by going up – rather falling as they have over the past 6 years or so is telling.  At the same time, housing prices are now back above their pre-bust levels, at least in nominal terms.  From Laura Kusisto at the Wall Street Journal (emphasis mine):

U.S. home prices have climbed back above the record reached more than a decade ago, bringing to a close the worst period for the housing market since the Great Depression and stoking optimism for a more sustainable expansion.

The average home price for September was 0.1% above the July 2006 peak, according to the S&P CoreLogic Case-Shiller U.S. National Home Price index released Tuesday. As of the previous month’s reading of the Case-Shiller index, a widely used benchmark for U.S. housing, prices remained 0.1% below the July 2006 record.

Adjusted for inflation, the index still is about 16% below the 2006 high. Home prices jumped 5.5% over the past year.

The record caps a four-year recovery from the trough of 2012, when prices sat 27% below the peak after a crash that caused more than nine million American families to lose their homes.

Admittedly, this recovery has been far from even across the country.  However, the fact that values are back above water is generally good news if you were either able to hang onto your home (assuming that you didn’t buy right at the peak) or were able to purchase a home when prices were at distressed levels.  If you don’t fall into either of those two categories, not so much.  Kusisto goes on to explain why (emphasis mine):

While prices have recovered, the market is flashing caution signs. The country is building far fewer homes than normal, the home ownership rate is near a five-decade low, and mortgages remain difficult to come by, especially for less-affluent buyers. Rising mortgage rates could also begin to pose headwinds to further price growth.

Home-price growth has also outpaced income gains, making it more likely that the current rate of appreciation is unsustainable. Home prices have grown at an inflation-adjusted annual rate of 5.9% since 2012, while incomes have grown by just 1.3%, according to Case-Shiller. By contrast, from 1975 until the present, prices grew at a rate of 1.1% a year, while per-capita incomes grew 1.9%.

When it comes to housing, price has recovered, but in terms of sales volume this has been a meh recovery at best.  Home sale volumes are generally trending up, albeit slowly and the percentage of first time buyers in the market has risen to 33% (it was 31% a year ago and still has a long way to go to get to the historical average of 40%).  Perhaps the most important factor in the still-tepid volume recovery is that wage growth is finally starting to increase solidly after being essentially flat for years.  In addition, the FHFA increased conforming loan limits for the first time since 2006 and the FHA followed suit.  Both of these moves will make mortgages more available and the new administration’s stated desire to lessen banking regulatory burdens will likely do the same.  Demographics are positive as well with an increasingly large percentage of the massive Millennial generation moving into the key household formation years of their mid-to late 30s.

As you can see the conditions are ripe for higher sales volume in the housing market but for one very important question: Can home prices be sustained and sales volumes increased through a period of rising interest rates?  A recent Wall Street Journal article by Steven Russolillo cites a study by John Burns Real Estate Consulting that suggests that they can:

A study by John Burns Real Estate Consulting Inc. examined 10 instances over the past four decades in which mortgage rates rose by at least 1 percentage point. It found prices weren’t especially sensitive to rising rates, particularly in the presence of other positive economic factors, such as strong job growth, rising wages and improving consumer confidence.

I hope this is the case.  However, one of the unique aspects of this cycle has been that low rates have made up for flat to falling incomes for an incredibly long period of time allowing home prices to increase in an era of long term wage stagnation.  As such, today’s housing market conditions are likely considerably tighter and more credit reliant than they were in many of the instances in the Burns Study (I was unable to find the raw data so I can’t say for sure).  If that is indeed the case, wage growth will have to be substantial if rates keep going up, otherwise affordability is going to become a yuge issue.

So, what happens when the positive variables of tight inventory, wage growth, increasing credit availability and strong demographics run into the negative variable of increasing interest rates?  We haven’t had to deal with a scenario like that in a very long time but I suspect that we are about to find out.


Good Investment: It’s been well-chronicled that the US has a ton of infrastructure that needs repairs and upgrades.  The problem is that most of it is simple (think dams, railway bridges/tunnels and freight railway lines) rather than sexy (think high-speed rail) which makes it less likely to get attention and funding.

The Long Game: Incoming Treasury Secretary Steven Mnuchin says that he’ll consider longer treasury maturities as a vehicle to finance the national debt.  With low interest rates, this is a common sense idea and should have been done years ago.  Definitely a step in the right direction.  See Also: Could the US start issuing 100-year debt like European countries?

Too Damn High: A new study by Denise DiPasquale and Michael Murray published in the Journal of Regional Science blames rising rents (and stagnant wage growth) as a substantial contributing factor to America’s recent economic stagnation since renters have less excess capital to consume.


Changes Coming?  There may be some reforms on the way for the Low Income Housing Tax Credit program which has become inefficient and bogged down with inflated labor prices.

TIC Tock: There are few real estate transactions more complex than re-capitalizing a busted Tenants in Common or TIC deal.  My Landmark colleague Ethan Schelin has been killing it in this space lately.  Ethan recently served as an advisor on a $42 million ($32MM in bridge debt and $10 MM in equity) TIC deal for the recapitalization of a large office complex in Connecticut and sat down with Globe Street to discuss the transaction.


Staying Put: American’s are moving far less than they used to, both in percentage and number terms and everything from tight mortgage credit to dual income families to working remotely are partially to blame.  See Also: Buying a house can be a very lucrative investment IF you buy in the right area and stay put for a long time.

Not From The Onion: House flipping startup Opendoor just raised $210MM of venture capital and is now Silicon Valley’s latest $1 billion unicorn.


Unintended Consequences: Fast food workers have been pushing for a $15/hour minimum wage for a while now.  In related news, McDonalds recently announced the nationwide roll-out of touchscreen self service kiosks.  As it turns out, $15/hour doesn’t fit that well for jobs that can easily be replaced by a computer or robot.

Painful: Some big name investors are taking a massive hit from their investment in fraudulent blood testing start-up Theranos.

Horse Already Left the Barn: IMO, one of the more ill-advised things that the incoming presidential administration has floated is the idea of scrapping the Department of Labor’s Fiduciary Standard rule for brokers and financial advisors.  However, according to Josh Brown, the financial industry has already changed so much that the impact will be muted, at least in the long run.

Chart of the Day



Brilliant: A police department in the Canadian town of Kensington has publicly advertised that, in addition to fines, criminal charges and license suspension,  those arrested for drunk driving will have to listen to Nickelback in the police cruiser on the way to jail.  This constitutes cruel and unusual punishment under the Geneva Convention (I Googled that).  It’s also brilliant.

Hero: Meet the Las Vegas man who got frustrated with package theft took matters into his own hands by filling boxes with dog poop and leaving them on his front porch.

Bro…. A South Carolina man sprayed AXE Body Spray into his mouth during a traffic stop in an effort to mask his breath and avoid a drunk driving arrest.  Needless to say it didn’t work and the aftertaste was terrible.

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