Lead Story…. Landmark Links is back this week after a much needed break. I spent the week before last at the Pacific Coast Builders Conference (PCBC) in San Diego and wanted to share a few observations. PCBC is the premier residential home building and development conference on the west coast. Attendance appeared to be good and the mood was generally upbeat. That being said, I couldn’t help but notice a bit of a disconnect between developers/builders and capital providers. In general the developers and builders were more upbeat and bullish while capital seemed to be a bit more cautious.
One of my favorite parts of the conference was the annual Capital Markets Survey put together by Steve LaTerra and Jeff Myers of Meyers Research, LLC. In conducting the survey, they questioned multiple capital providers about their market outlook, targeted investment areas, deal structure, etc. They present the findings in one of the PCBC Land and Capital sessions. The presentation slide that I found most interesting was the question to investors about where we are in the cycle:
Source: Meyers Research, LLC
Clearly, a growing portion of capital providers believe that we are topping out. In fact, it’s nearly equal to the percentage that believe we are still “on the rise.” Here’s why I find this so interesting: typically in the so-called late innings of a real estate cycle, cash would be pouring in to ever-riskier sectors (mainly development, entitlement and higher risk construction plays) and development – measured in starts – would be booming. This is usually the time when contrarian investors typically begin to either sell or take short positions against companies that they believe are over-exposed when the cycle inevitably turns (think investors who went short mortgage bonds in 2005 and 2006 or builders who sold their companies or just stopped buying new land). Commercial real estate and multi-family have been on a tear and capital has been plentiful during the run-up. However, residential for-sale development has not participated up to this point. Investment terms are getting more difficult: co-invest amounts are higher, preferred returns are higher and investment horizons have been reduced. The reality is that in this strange, long duration cycle, there really is no contrarian position to be taken at the moment.
IMO, there are two factors at play here:
- Residential land development and home building is getting lumped in with commercial.
- We are in different points of the cycle across different parts of the residential spectrum.
First off, it has not been a secret that commercial real estate (excluding retail) has been booming for several years. Capital has been aggressive as rents have risen, vacancy has declined and cap rates have compressed. It makes sense that investors in that space would start to feel as if it is late in the cycle. However, residential land development and home building has not enjoyed anything close to the same availability of capital. I’ve previously written about why the “too much money chasing too few deals” phenomenon that has been a feature of the commercial real estate capital markets for years hasn’t translated to residential. Since commercial the commercial market is much larger, it makes sense that commercial cycle outlook would cast a shadow over residential.
If you live in a production market like California’s Inland Empire, you’d be forgiven for wondering how a cycle can be coming to an end if it’s just beginning. Areas like the Inland Empire (and Sacramento, for that matter) have seen little development during this cycle relative to the past, especially at the entry level. Development has just recently started to ramp up and sales are booming again. However, if you are in an high end market, especially along the coasts, home prices have been rising for years but there is still a substantial deficit in the number of units being produced versus demand.
It’s entirely possible that we could be in the late innings of the cycle at the high end but have a ways to go in entry level markets. What will be interesting is watching how capital responds. If investors continue to pull back in the belief that we are in the late stages and don’t invest in land development, the supply deficit could continue to grow, exacerbating the home affordability problem further. Either way, a very large portion of the for sale residential development spectrum has effectively sat out this cycle. Investors have remained incredibly disciplined in not chasing returns. The question is will they be able to maintain this disciple if the market continues to tighten while they are sitting on the sidelines.
No Problem? A lack of worry about the economy is worrisome unto itself according to Greg Ip of the Wall Street Journal:
If you drew up a list of preconditions for recession, it would include the following: a labor market at full strength, frothy asset prices, tightening central banks, and a pervasive sense of calm.
In other words, it would look a lot like the present.
See Also: Four problems looming over the historic US expansion.
Whipsaw: The yield curve had been flattening since early this year but reversed course last week amid a worldwide government debt selloff. See Also: Jeff Gundlach sees more pain for bond bulls as hedge funds make exit.
Uneven: Arizona, Connecticut, Mississippi, Nevada and Wyoming still haven’t regained their levels of gross domestic product from before the financial crisis.
Contrarian Opinion: How Amazon’s growth could spur a capex boom rather than widely anticipated disinflation.
Time to Get Busy: The US fertility rate just hit a historic low which has some demographers concerned.
Into the Abyss: The 1031 exchange could be on the chopping block and Congress’s lack of progress on tax reform could mean that there won’t be any offsetting provisions to help soften the blow.
On the Bright Side: How the retail apocalypse can lead to a suburban renaissance.
Opening the Floodgates? Credit rating agencies are dropping tax liens and civil judgements from some consumers’ profiles if information isn’t complete. At the same time, Fannie Mae and Freddie Mac are allowing borrowers to have higher levels of debt and still qualify for a home loan. In other words, mortgage lending conditions are easing as the market continues to get more expensive.
Disconnect: Federal housing policy focused on boosting demand (tax breaks, access to credit, 30-year mortgage, etc) but largely ignoring supply issues has no chance of solving the new housing crisis.
Rise of the Machines: Why two thirds of jobs in Las Vegas could be automated by 2035.
Pokemon No: A year after Pokemon go took the country by storm (for a few weeks anyway), popular so-called augmented reality games are still rare.
Chart of the Day
And here you thought that the US was expensive….
Source: The Economist
All that Glitters: A naked Arizona man who was covered in gold pain was found wandering through a Walmart parking lot and arrested. Shockingly, drugs were involved. (h/t Darren Fancher)
Why Did the Chicken Cross the Road? Probably to get away from this guy, who had to register as a sex offender after pleading guilty to sexually assaulting a live chicken in Oregon. Trust me, if you look at the mug shot, this will all make sense.
Meanwhile, In Florida: A Jacksonville man sat on a loaded gun on the drivers side of his car and shot himself in the junk.
Video of the Day: Chaos in Moscow as people flee flying porta potties during a massive storm. In Soviet Russia, porta potty poop on you.
Landmark Links – A candid look at the economy, real estate, and other things sometimes related.
Visit us at Landmarkcapitaladvisors.com