Tuesday, September 28, 2010

Residential Market Update


RISING INTEREST RATES. Many financial and economic pundits expect interest rates to begin rising in the near future. A major problem with an increase in interest rates is that will force down the prices of houses even further and wipe out more equity. The main culprit in the run up in housing prices from 2002 to mid-2007 was low interest rates. Higher interest rates make qualifying for mortgage money more difficult, so something else in the home purchase equation has to give – home prices. This reduces the size of the mortgage needed, hence the size of the monthly payment for which the borrower has to qualify. Conversely, if the cost of money is low and qualification for larger mortgage sums is easier, the money otherwise left on the table is packaged into the cost of the house. See the following article. http://seekingalpha.com/article/227115-correlation-of-mortgage-rates-with-real-housing-price.
THE THREAT OF DEFLATION. A decline in housing prices may presage declines in prices of other goods and materials, which initiates a deflationary spiral. Among economists who responded to a recent WSJ poll, nearly two-thirds said that deflation poses a bigger risk to the economy than inflation over the next three years. 
AN INCREASING INVENTORY OF HOUSING UNITS. According to a WSJ blog yesterday, the “shadow inventory” of potential foreclosures and other distressed sales will rise to 4.7 million units this year, or a national average equal to a 10-month supply of homes. The shadow supply is as high as 26 months in some cities such as Miami and Orlando. But those numbers are dependent on how quickly banks move to foreclose on delinquent loans, according to a report released yesterday by John Burns Real Estate Consulting of Irvine, California. 
Foreclosures are conducted according to the laws of the state in which the real estate encumbered by the delinquent mortgage is located. Some states, such as Florida, have foreclosure laws that require lengthy court procedures, thus lengthening the clearing process.
In addition, the share of distressed sales will rise to around 40% of all home re-sales through 2012, and the shadow inventory of distressed loans will stay at elevated levels through 2016. This rising share of distressed sales could further escalate the decline in house prices because the owner-banks are motivated to clear the owned real estate off their books. John Burns Real Estate Consulting estimates that prices will fall by another 8% to 11% through 2012.
 ZipRealty, a brokerage firm, examined more than 1 million home listings and found that many home sellers are slashing prices by as much as 60%. 
THE SHRINKING NUMBER OF LENDERS. The WSJ online reported that 279 banks have collapsed since Sept. 25, 2008, and the Federal Deposit Insurance Corp. increased its number of problem banks by 6% to 829. Because of bank failures and consolidation of banks, the number of U.S. banks could fall to 5,000 over the next decade from the current 7,932. This is in addition to the more than 4,000 banks have gone out of existence in the past 15 years. The banks' disappearance means not only cutbacks in lending but also fewer banking choices, lower interest rates on time deposits, and lost jobs. Consolidation of banks also means the biggest are getting bigger: Bank of America, J.P. Morgan Chase & Co. and Wells Fargo hold 33% of all U.S. deposits, up from 21% in 2006, according to SNL Financial. That gives them more market power to squeeze out smaller competitors. 
THE EFFECT ON CREDIT SCORES. Also reported in a WSJ blog is a new report from the Pew Research Center on how Americans have fared during the recession. It that divided respondents into two groups:
·        A group that “held its own”, which was 45% of respondents and correlated to myFICO’s estimated 47% of Americans who have the best credit scores (over 720) during the recession, and
·        A group that “lost ground”, which represent the remaining 55%.
Demographically, the “held their own” group tended to be older people who already owned homes. According to the Pew report, 69% of people age 18-49 and 60% of those 30-49 “lost ground”. 
JOB GROWTH. Few doubt that the expansion of employment opportunities would have a salutary effect on the housing and credit markets. Currently, however, growth in employment hasn’t been strong enough to accommodate the number of jobs that must be created on a monthly basis to deal with the regular flow of new entrants to the labor force, let alone the previously employed.
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©2010 by The Falbey Institute for the Development of Real Estate


Tuesday, September 21, 2010

THE PENDING EXTINCTION OF COMMUNITY BANKS?




In December, President Obama met with bankers from small, community banks and instructed them to start making loans. Ten months later the banks are not making those loans. Why? Is this purposeful defiance of the administration by the grassroots of the financial sector?
The large banks such as Wells Fargo and Bank of America are deemed too large to be allowed to fail. These institutions engage in all manner of exotic transactions including swaps and derivatives that the community banks cannot. The small banks are in business primarily to loan money for mortgages and commercial purposes such as real estate development. But, for the most part they aren’t doing that.
The problem is tied to what are known as bank financial ratios. The following discussion regarding these ratios is somewhat technical, but follow along if you’re seeking financing from your community bank and not making much headway.
Banks are regulated by state and federal agencies created by legislatures, such as Congress, and operate under government-enacted regulations. These agencies also adopt their own rules and regulations as an expansion of power under the enabling legislation. Among these regulations are certain tests known as bank financial ratios. These ratios measure whether a specific bank is adequately capitalized as a means of surviving.
There are 3 main ratio measures that are used by regulators to assess the adequacy of a bank’s capital. The first is the total capital-to-weighted-risk assets ratio.
·        Total capital is the sum of Tier 1 and Tier 2 capital.
·        Tier 1 capital generally consists of the sum of the current book value of common stock plus surplus and retained earnings.
·        Tier 2 capital is loan-loss reserves plus subordinated debt. Subordinated debt is long-term debt that is secondary to the claims of depositors and secured creditors in the event of the bank’s insolvency.
·        Risk-weighted assets are the capital a bank must keep to cover its liabilities. They are calculated as follows: Government bonds, cash and equivalents have a risk weight of 0%; interbank loans 20 %; mortgages 50%; and most other assets have a risk weight of 100%. In other words, the total value of each category of assets is multiplied by its appropriate risk factor and the products are summed.
This sum is divided into the total of Tier 1 and Tier 2 capital. The resulting sum has to equal or exceed 8% for the bank to be deemed to have the minimum amount of capital in order to be deemed adequately capitalized.
The second measure of an adequately capitalized bank is the Tier 1 risk-based ratio. The minimum standard is 4% in order for a bank to be deemed to be adequately capitalized.
Third, the adequately capitalized bank also will have a minimum Tier 1 capital-to-average-total-assets ratio (aka leverage ratio) of 4%.
While these ratios originally were designated as guidelines, they now are deemed to be mandatory by banking regulators. Banks that are classified as undercapitalized are restrictively regulated, including replacement of senior executive officers and directors, thus making business efforts difficult at best. Banks labeled significantly or critically undercapitalized are placed in receivership.
There is another rule of thumb that also is used as a measure of a bank’s credit difficulties. It’s known as the Texas ratio, and is calculated by dividing the sum of the value of non-performing assets (including loans more than 90 days delinquent) and REO-Real Estate Owned (properties the bank has acquired by foreclosure or deed in lieu of foreclosure) by the amount the owners of common stock would receive in the event of the bank’s liquidation. History has shown that banks tend to fail when this ratio exceeds 1:1, or 100%.
So, what does all this techno-speak about financial ratios have to do with your community bank not lending to you? Just this: because most banks, large and small, made all the loans they could find and fund in the last decade – many of which now are delinquent, non-performing, underwater, or encumbered properties which the bank now has acquired through foreclosure or deed in lieu – they are experiencing capital adequacy issues when the above described ratios are applied.
Banks in this situation are not in a position to fund any additional loans until the ratios reset to the proper level. This reset can be achieved in a number of ways, but few of them ever are realistic. The larger banks were deemed too large to be allowed to fail, and received TARP funds to assist them. Not so for the community banks.
·        The smaller bank could try to raise equity through the sale of stock or subordinated debt. Because the stock in most small banks isn’t publicly traded, this chiefly works only for larger banks. Even if the smaller bank could float a new issue of stock, it has the effect of watering down the stock held by existing shareholders, who naturally oppose this avenue.
·        Reduction of assets also has the effect of improving the capital ratio, but also divests the bank of profit producing assets.
·        Finally, the troubled bank could allow itself to be merged into a larger bank. This has happened to community banks to a large extent in recent years. In fact, more than 4,000 banks have gone out of existence in the past 15 years.
The bottom line is that this raises the question whether community banks are going the way of the dinosaur. Speaking as a businessman and real estate developer, I believe that would be crippling to our industry. Most developers do not do projects that command the attention of the large banks. We rely on our community banks and the relationships we’ve established with them over the years.
If they disappear, it will make smaller scale development – under $50 million – very difficult to finance. The large banks prefer to put the same amount of time and effort into larger loan transactions, as do most equity funds. Additionally, equity typically coast much more than debt, so the numbers often don’t pencil out on projects heavily funded by equity.



Connect with us: visit facebooktwitterLinkedInYouTubethe Falbey Institute for the Development of Real Estate. There currently is a special on the real estate development videos available on the Institute's web site.
©2010 by The Falbey Institute for the Development of Real Estate

Friday, September 17, 2010

Did You Ever Think You'd Root For Inflation?

Data just released by the U.S. Labor Department show that inflation – ex energy and food – was flat in August. Core inflation has been running at an unusually low rate for several months. A review of comments and observations on this issue by a number of economists reflects a strong consensus that this trend will continue, perhaps dipping even lower.
This trend is one of the primary drivers behind the fears of a deflationary economy and double-dip recession in the U.S., and perhaps globally. Deflation is defined as a decrease in the general price level of goods and services, and occurs when the annual rate of inflation falls below zero percent. The inflation rate in the U.S. is trending troublingly close to zero.
As prices drop in a deflationary economy, consumers delay purchases and consumption in the expectation that prices will drop lower still. This actually does have the effect of driving prices lower (hence, the dreaded deflationary spiral), as vendors of goods and services lower prices in hopes of generating sales. To do this and maintain a profit margin, vendors must slow production and trim capacity. This results in a trickle-down effect of layoffs throughout the economy, stimulating a recession, which leads to further consumer conservatism. This essentially is what happened in Japan during its “Lost Decade”.
So, if deflation is bad, does that mean its opposite, inflation, is good? Yes and no. There is much disagreement as to what is a “healthy rate of inflation”. The pundits’ opinions vary in the 1% to 5% range, with 2% to 2.5% seemingly the norm. A healthy rate of inflation benefits productivity and wages, and encourages consumer activity.
Because the effect of inflation is to cheapen the currency, businesses and consumers aren’t reluctant to make long-term commitments. A two hundred thousand dollar home mortgage, for example, will be paid with cheaper and cheaper dollars over time in an inflationary environment. Inflation also has a market clearing effect in a situation such as the current one where deleveraging of underwater loans is greatly needed.
So, a little inflation is not such a bad thing after all. But, too much inflation is very bad. Unfortunately, the steroidal growth of the U.S. government and accompanying profligate spending by the current administration in Washington promises an inevitable surge in inflation – but it’s probably a couple of years away.

©2010 by The Falbey Institute for the Development of Real Estate

Thursday, September 16, 2010

A Random Stroll Through the 'Net


Sometimes a random crawl though the ‘Net, with a focus on a specific topic, can provide insight into the current state of that particular topic. Here are the results of a random stroll through the net this afternoon with an eye on data relative to real estate development news.

COMMERCIAL REAL ESTATE (CRE)
PricewaterhouseCoopers' Korpacz Real Estate Investor Survey® states that cap rates (i.e., first year’s net operating income divided by capital invested) are drifting downward because most current purchases involve Core assets – well constructed, well located (c.f., gateway cities), class A properties with high occupancy rates and credit worthy tenants on long-term leases. 

While this represents a flight to quality, which is not uncommon in these sort of uncertain financial times, it’s good to remember that aren’t that many sales from which to draw conclusions. This is because many properties remain overpriced in relation to their income production and leasing situations. Also, interest rates remain low, so money is still cheap which drives bond returns lower, and this affects most other investment returns.

In addition, investors continue to wait to take advantage of the underwater CRE properties, most of which have not hit the market because lenders are slow to force the issue with foreclosures. This particular behavior pattern may be driven to some extent by deflationary expectations. 

Although CoStar Group reports that foreign investment in the U.S. real estate has nearly doubled in the first half of 2010 over the dismal numbers from one year ago, the overall activity remains muted by the slowly recovering economy and a lack of high-quality property available in large U.S. metro markets. 

RESIDENTIAL REAL ESTATE:
PMI Mortgage Insurance Company's economic analysts forecast sales to reach an annualized rate of 5.6 million in the third quarter, and 5.75 million in the fourth. This still is very low in comparison to the years leading to the orgy in residential development and sales. 

Rick Newman, writing online for the Thach Real Estate Group notes that: “Home prices have been falling since 2006, and in many areas they still haven’t hit bottom. With foreclosures and short sales still on the rise, prices will probably keep falling into next year. Once prices stop falling for good, homeowners will adjust to their new, lower net worth, and potential buyers will stop worrying about investing in an asset that’s falling in value. But a significant pickup in sales depends largely on the job market, since buyers need to feel confident about their job security before committing to such a large purchase. Since housing varies greatly by region, some areas will recover sooner than others. When it might happen: Second half of 2011.” 

Alejandro Lazo, writing for the Los Angeles Times cites a recent RealtyTrac report to the effect that “The continued convergence of the two trends — fewer notices of default filed on homes but more properties sold at courthouse steps — indicates that major lenders are meting out foreclosures in a systematic way so as not to flood the housing market with a wave of steeply discounted properties.” This suggests that the foreclosure/short sale dilemma will continue for some time. In fact, Lender Processing Services Inc. finds more delinquent loans entering the foreclosure process "first look" at August month-end mortgage performance statistics derived from its loan-level database of nearly 40 million mortgage loans. 

On the other hand, CoreLogic reports that “distressed sales - real estate owned (REO) and short sale transactions - are at a seven-month low. It attributs the low levels primarily to tax-credit-induced sales increases. With the expiration of the tax credit, the share of distressed sales is expected to rise in the fall”. 

Finally, the Wall Street Journal’s online news offers this: Allure of Home Ownership Dims: The number of people who say they consider housing a safe investment continues to decline, falling to 67% in July from 70% in January and 83% in 2003, according to a new Fannie Mae survey.  

The WSJ also notes: “Home sellers continued cutting prices in August, real-estate website Trulia.com reports. As of Sept. 1, 26% of homes on the market saw their prices cut–accounting for more than $29 billion in reductions. Price cuts on average were about 10%, or about $34,000.”

CONCLUSION:
Things remain slow in the CRE and residential markets, and probably will continue to be so for awhile. Recovery in the employment market and ultimate disposition of the mortgage dilemmas encumbering both CRE and residential markets remain necessities.

©2010 by The Falbey Institute for the Development of Real Estate

Tuesday, September 14, 2010

Want to Know More About Real Estate Development?

The Falbey Institute for the Development of Real Estate (FIDRE) is an organization that promotes the creation and enhancement of careers in the real estate development industry.

It does this through a number of programs offered online with unlimited 24/7 access. Each program is taught by an experienced real estate developer and is accompanied by downloadable materials in PDF format. Certificates of completion and quizzes also are available at no additional charge.

Several complimentary videos with PDF materials are available for viewing at the FIDRE website.

Currently, there is a Fall Special being offered. For a limited time, all real estate development courses are available for $19.95 with no limits on viewing time or access. Certificates of completion and optional quizzes are included too. New programs covering Real Estate Finance and Financial Analysis have been added. Plus there are new complimentary videos and pdf files available for your review.


Experienced real estate developers present all programs, and more programs are scheduled to be added.


If you or someone you know is interested in becoming involved in real estate development, or if you're in the industry and desire to enhance your knowledge base and career opportunities, please take advantage of this offer.

Monday, September 13, 2010

What Does the Road to Recovery Involve?

It seems clear now that monetary policy isn’t able to shake the economy out of recession. Fiscal policy, on the other hand, probably could.  Monetary policy, the province of the Federal Reserve, primarily stimulates a flagging economy by driving interest rates down. This entices businesses and individuals to borrow funds to invest in expanding their operations, thus creating more employment opportunities. The more the ranks of the employed expand, the greater the amount of consumer spending, which in turn greens the economy. Unfortunately, interest rates are at historic lows (0-.25%) yet the economy is not in a recovery mode.
The Fed has other monetary tricks, such as its open market activities, but these have made very little difference so far.
Fiscal policy is controlled by the Congress and takes the form of raising or lowering federal spending and/or taxes. Here’s the dilemma. The administration, with the Democrat-controlled Congress, certainly has raised spending to unheard of levels, but failed to aim those dollars at targets that would directly and positively impact the economy. This in turn has caused a great deal of concern over the negative impact the burgeoning debt ultimately will have on the economy.
In addition, until very recently the administration and Congress have been clear in the intention to raise taxes in a variety of ways: let the Bush tax cuts lapse; raise taxes on certain individuals and businesses; impose a value-added or VAT tax; etc.
The record-breaking debt, out-of-control spending, and imminent tax burdens have created acute uncertainty about the future of the economy and the well being of the businesses and individuals in it. This is an anti-recovery recipe and exactly opposite of what the government should be doing to stimulate confidence: slashing spending, shrinking government, and lowering taxes. The individual consumer is conserving cash out of a sense of fear of the unknown. U.S. businesses are sitting on almost $2 trillion in cash because of this curtain of uncertainty hanging over the economy. Turned loose, this is quite sufficient to stimulate a strong upward surge in the U.S. and global economies.
For an interesting review of the three most likely economic scenarios, read the Wall Street Journal at the link provided.

Friday, September 10, 2010

Developing & Marketing Master Planned Communities


I attended a ULI forum on developing and marketing master-planned communities (MPCs) yesterday. Here are the notes I took. The comments were made somewhat randomly, so you may see subjects revisited later in the discourse. Also, much of the social media comments are old news to marketing people and Gen Y members.
·        A presence on FaceBook is mandatory for development product, and Twitter, YouTube, LinkedIn, and Digg also are important marketing devices for driving prospects to your website.
o   Stress product differentiation and value
o   Give timely information that drives prospects to return to your website
o   Use feedback (positive and negative) to adjust the pitch and content of your marketing efforts
·        In this economy, shore up your existing customers and prospects as opposed to trying to develop new markets.
·        It’s very tough to find a happy medium between costs and amenities offered – for example, golf course expenses (@$2 million/year) are killing MPC developers and there currently is an oversupply of golf in the Florida market.
·        The focus should be on creating “lifestyle” and “sense of community” with emphasis on family-oriented activities. BUT you can’t be all things to all people, so pick your target market carefully.
o   Value is the key in marketing product in today’s marketplace.
o   You have to compete on value AND price, so offer some amenities, not a stripped, bare bones community. Think about the public’s feeling about airlines – passengers are nickel-dimed to death after they purchase a seat
o   The buyers’ mantra today is “show me the value”, so building the amenities early in the project life cycle is almost mandatory
o   Fitness centers and a full calendar of activities are critical
o   Buyers today are not willing to pay for a lot of options and upgrades (think pools) like they used to do
o   Be prepared to “sweeten” the deal by throwing in some options/upgrades
·        It’s still important to create a lifestyle, a core neighborhood feel, so incorporate online as well as onsite social facilities.
·        Prospective buyers are very sensitive to costs – both current and ongoing (c.f., HOA fees, CCD costs, etc.). They want to know that they have an exit strategy if the costs go too high.
·        Multifamily is very capital intensive and represents a small part of the demand for housing market, so single family has to be affordable AND offer value.
·        Be flexible so that you can reinvent your project or product if necessary
·        If you have to reposition your product or project, use focus groups consisting of existing and prospective residents.
·        In MPC purchasing decisions, women drive 91% of those decisions – that should impact everything you do in the development design and marketing processes.
·        Buyers today are educated, have access to information as never before, and have lots of options to choose from
o   Offer value (not necessarily the cheapest price – value is the “intersection of price and location”)
o   Differentiate 

Tuesday, September 7, 2010

The Economic Shell Game


Is it any wonder that Americans are struggling through a blizzard of economic uncertainty? The type of uncertainty, incidentally, that stifles consumerism, which in turn further shackles recovery in the broader economy.
For example, in its Real Time Economics blog on Friday, the Wall Street Journal cited a very recent Labor Department report to the effect that “the share of workers who were out of a job for six months or longer fell for the third straight month”. Although, it should be noted that many economists cited in a companion article opined that the news should not be interpreted as a sign of a rapid recovery under way.
On the other hand, this morning the same blog cited the August employment trends index issued by the Conference Board, which suggests there will be a slowing in hiring in the coming months, even slower than it has been recently. Seven of the eight labor-market indicator components of the index were negative.
So, the Labor Department report seems to indicate that the job market situation may be improving. However, the Conference Board’s index suggests the opposite. And the American consumer, the backbone of a vibrant economy, is supposed to make sense of this, and even more, feel comfortable about spending money? As Al Borland famously and frequently said: “I don’t think so, Tim”.
©2010 by The Falbey Institute for the Development of Real Estate