News

Landmark Links March 27th – Headed in the Wrong Direction

 

Lead Story….  One topic that I’ve written about from time to time since starting this blog is the growing stratification in the US housing market between entry level and premium housing stock.  The bubble of the mid 2000s represented a major turning point for the US housing market.  The entry level segment of the market experienced far more distress than other higher priced segments and was riddled with underwater borrowers and foreclosures.  The initial market response was a plunge in pricing that drove ownership costs well below rental parity.  In a functional market, this would have resulted in a great buying opportunity for aspiring home owners.  However, high unemployment and low earnings during the Great Recession, coupled with a severely restrictive mortgage market meant that few were actually able to capitalize on the deep discount.

Prospective home buyers’ loss of ability to buy presented an opportunity for investors.  Large and small landlords began buying up entry level homes in record numbers with the intent to lease them out to those who could not longer save up a down payment or qualify for a mortgage.  They purchased many tens of thousands of units, often at the court house steps using cash rather than individual mortgages.

At the same time that existing entry level homes were being taken out of the potential purchase pool by investors, rising construction costs – among other factors – made it very difficult for home builders to profitably construct entry level product.  As such, they shifted much of their production to the high end where borrowers had substantially better means to save for a down payment, mortgage credit was generally more available and profit margins were substantially larger, serving to dry up entry level inventory even further.

Initially, the lack of new construction of entry level homes coupled with large scale investor purchases of existing homes helped stabilize the market by drying up excess supply and slowing or reversing the falling prices that had plagued many cities since 2008.  While this initial elimination of so much distressed inventory was arguably a good thing, the long term consequences have not been.

Fast forward to the present day.  On the surface, the inventory situation in the US appears to finally be turning the corner after years of extremely low supply have led to ever-increasing prices.  Indeed, the supply of homes in the US increased by 3.3% in the 4th quarter of 2017.  However, a closer look reveals that the increase is due to a large 13.3% increase in the supply of premium homes while the supply of starter homes continues to decline (see Chart of the Day below).  Bloomberg’s Noah Buhayar highlighted the impact of this ever-declining entry level inventory citing a recent Trulia study (emphasis mine):

“Starter homes have become scarcer, pricier, smaller, older and more likely in need of some TLC” than they were six years ago, the real estate website Trulia reported Wednesday after analyzing housing stock across the country. Trulia began tracking prices and inventory in 2012.

It’s grim all over. American homes are at their least affordable in the report’s history. But the median listing price of available starter homes has risen 9.6 percent in the past year, easily beating out the trade-up and premium categories, while starter-home supply has fallen to a new low this quarter, Trulia reported.

Perhaps the most striking finding is that the very buyers who are typically least able to plunk down a lot of money are confronted with the least affordable homes. The share of income needed by those in the market for a premium home was 15 percent, and for a trade-up home 27 percent. For a starter it was 41 percent.

Adding insult to injury, the homes aimed at first-time buyers are less likely to be ready for human habitation than others, with fixer-uppers accounting for 11.2 percent of the category. They’re about nine years older than they were in 2012, and 2 percent smaller.

All of this begs the question: at what point is a starter home no longer a starter home?  If prices continue to rise like this, eventually much of what is considered stater home inventory today will be re-classified as move up.  Eventually, there isn’t much left other than serious fixer-uppers, tiny homes or units in remote or highly undesirable areas.  I’ve seen this happen up close in coastal Southern California over the past 17+ years and the results aren’t pretty.  Unfortunately, as construction costs continue to rise, it’s not going to become more economical to build new entry level homes anytime soon short of a major technological breakthrough.  In addition, rising rates make it less likely that existing starter home owners will move or that landlords will sell parts of their portfolios, meaning that there is little to suspect that a change in this trend is on the horizon.  Downward trending starter home supply appears to be the new normal – at least until the next recession.

 Economy

Jumping In: Investors poured $804 billion into private equity investments in 2017 in an effort beat a low-yield bond market and richly priced equity market.  However, the supply of capital is outstripping the number of good deals which could lead to disappointing returns.

Muddy Waters: Nobel Laureate Robert Shiller says that recent shifts in tax policy and deregulation may make it difficult to see the next recession but rest assured, that it will still happen in a way that few see coming, as it always does.

Shot in the Dark: The Fed is trying to manage inflation but really doesn’t know what causes it, how to measure it, or how to move it up and down.  This is why history shows that once central banks start tightening, they almost always go too far.

Commercial

Incentivized Behavior: A provision in the new tax law that limits the interest write off for leveraged buy outs will likely lead to less Toys ‘R’ Us-like over-leveraged debacles.  However, an interest cap exemption for real estate investment could lead to more private equity pouring into the space.

Residential

Technically Problematic: Housing costs in technology centric markets have soared since the last housing crisis.  That’s great news for long-time home owners but not so great for everyone else.

In the Drivers Seat: Americans are increasingly relocating to retirement hot spots and returning to suburbia according to Census Bureau figures released last week.

Opportunity Knocks: Housing speculators are making a lot of money flipping waterlogged homes in Houston, much to the chagrin of long term residents who can’t afford to rebuild.

Profiles

What’s the Point? For the life of me, I will never understand why several top VCs just dumped $12MM into something called CryptoKitties:

The game lets users create and breed virtual cats, storing the digital genetic material on the blockchain as new generations of kitties are created. Then, in turn, users can buy and sell the cats using the cryptocurrency Ethereum, which means users have to buy Ethereum in order to play.

Why Didn’t I Think of That?  The economic geniuses in Venezuela are tackling their raging inflation problem by deleting zeros from their currency.

In the Cross Hairs: The cryptocoin market may have met its match in the Securities and Exchange Commission as increased scrutiny leads to a plunge in ICOs.

Chart of the Day

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WTF

Fitting:Berkeley vegan activist covered herself in poop and laid down on a sidewalk outside of a Bay Area Trader Joe’s to protest the treatment of chickens because vegans, also because Berkeley. (h/t Dave Clarke)

Out on a Limb: A woman married a ficus tree in order to avoid having it cut down because Florida.  In fact the most incredible part about this story is that it didn’t happen in Berkeley.

Flying High: An Fly Jamaica Airways crew member was busted at John F. Kennedy International Airport with a whopping 9 lbs of cocaine inside his pants.  Either that, or he was very happy to see someone.

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

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