And now for some good news

Some readers have emailed to periodically to ask whether I plan to be perpetually bearish, or if it's just a phase. Let me assure you that I am as bearish as I am only because the fundamental AND macro pictures are lining up against financial assets.Viewing the remainder of this article requires a Subscription

PrimeX – The Time For The Next “Subprime Trade” Has Come

The following article came out on ZeroHedge.com early Friday morning. The article is a bit technical so here's a bit, and then some thoughts:

. . . What happened a day prior is that Fitch came out with an eagerly anticipated report titled, "U.S.

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Real Estate

It's been a while since we looked at the real estate statistics.Viewing the remainder of this article requires a Subscription

IYR Outside Day

I’m not a technician, but I also don’t like to turn a blind eye. I’ve said it before, so my apologies for repeating: real estate is the beneficiary of excess profits. Fundamentally, it is still sick. Contrary to reports of rising rents, we are still at elevated pricing, ownership rates, etc. not to mention the fact that any asset class supported by massive debt is in a dangerous position given the current environment for jobs.

All that being said, it’s interesting to note that the charts might be confirming some trouble ahead. Looking at today’s formation, you can see that IYR is having an outside day, namely, the high is higher than yesterdays and the low is lower. This can often signal a move in the direction of the close. I’m not calling the close, but it’s interesting to watch and keep an eye on.

Relevant ETFs: IYR, VNQ

Real estate woes continue

CalculatedRisk pointed out an article in the Washington Post about housing affordability. From the article:

About 26 percent of renters — or 10.1 million people — spent more than half their pre-tax household income on rent and utilities in 2009. That’s because incomes slipped dramatically from their peak at the start of the decade even as rents kept rising.

Read the full article here. The implications are that housing affordability is not yet improving, although pundits might point to the price/income ratio falling. And while, that is true, a few points: 1. it’s not falling evenly (obvious to anyone not in the top 5% of income earners) and 2. it’s still high. Check out these charts from The Big Picture:

What are the implications? Well, for starters, the recent run-up in REITS, justified by increasing rents, might be prove ephemeral. Secondly, with real estate still not recovering, the financial health of the banking sector and just as importantly, the GSE, is in question. As the GSE’s are now the biggest real estate financiers in the world, risk to rent can prove dangerous, especially since the GSE’s will have a politically hard time foreclosing on US citizens if it comes to that. This is a fragile situation.

Relevant ETFs: VNQ, SRS

New Home Sales

I’ll spare you all the details which you can find at CalculatedRisk organized in always-useful charts, such as this:

What you should know is that not only are we making new lows in new home sales, inventory is also up (not at new highs, but still up), meaning that expecting a recovery, or even a stabilization in real estate might be premature. We’ve discussed previously, that without a growing population, jobs, and new household formation, real estate will not find a bottom until the price to own is significantly more enticing than the price to rent, which it’s not at this time.

And by the way, without a global real estate boom, there will probably be less pressure on lumber, copper, and other building supplies. Rebuilding Japan might give materials a short term bump, but the global real estate deflation is continuing. That also continues to put pressure on the financials, without which, I don’t think the market can have a sustainable rally.

Relevant ETFs: VNQ, RWR, REK, SRS, XLF

S&P Case Shiller – this just makes it more official

The S&P Case Shiller index reports came out today and not surprisingly they show new lows in multiple markets, and more importantly a resumption of the decline in real estate prices. I don’t want to spend too long on the numbers, but you can see a quick summary on CalculatedRisk. I have some issues with the index composition and the fact that it ends up being a lagging indicator for the real estate market; yet, it’s the most widely followed index and should at least provide confirmation for what we’ve been discussing.

Real estate is regional – or at least that’s what everyone says. That is true to the extent that lending and credit are regional. However, when GSE’s are providing the funding on 95% of mortgages, tax credits are provided nationally, and credit deflation is felt across the board, correlated moves should be expected to some extent. I think we will continue to see pressure on real estate, which in turn means that the US markets will have a tough time finding solid footing.

Relevant ETFs: IYR, SRS

A Study of Real Estate Markets in Declining Cities

From the Rockefeller Institute:

The “Great Recession” of 2007 to 2009 has taken a great toll on housing markets in most cities and metropolitan areas in all parts of the country. Though the pace and extent of the overall economic recovery of these markets is still far from certain, many places will likely resume growth and fully recover within the next decade or so. This is almost certainly not to be the case for all metropolitan areas. In fact, a number of large metropolitan statistical areas (MSAs) experienced severe recessions during the latter half of the 20th century and prior to the Great Recession and never fully recovered or took many years to do so. Even among those metro areas with relatively bright long-run prospects for growth, certain submarkets within them may remain well below recent house price peaks for many years to come.

Read the full report here.

Farmland of the future

We have discussed the appeal of arable farmland on different levels (inflation risk, geopolitical risk, etc.). Throughout my research, my focus has been on measures of efficiency, yield, crop rotations, size of land, etc. We’ve also discussed Detroit, experiments in neighborhood destruction, and urban farming (most initiatives bound to fail).

So it was with great interest that I started reading the work of Dickson Despommier, a professor at Columbia University. Despommier has recently written a new book called The Vertical Farm, but he’s been working on the idea for years. He’s been contacted by everyone from urban planners to Dubai. His ideas center on the same idea behind highrises to house people.

In the olden days, creating a new house for a family required space, read land. With the inventions of steel foundations, elevators, etc. highrises allowed space to be “created” vertically as opposed to horizontally. There’s some loss (think of all the common spaces in apartment buildings, hallways, elevators, lobbies), but there’s a gain by allowing more people to live closer to work and other resources. Despommier contends that farmland can also be built vertically. Instead of needing endless acreage, technology can help manage a vertical farm, complete with rotation, harvest seasons, watering systems, etc. Food would be closer to the end markets. Land, a big cost component, would be virtually endless (you could always build another floor). Weather could be controlled (rains will always come on time, and thermostats can be changed)…and more (e.g. no need to drive around in a pollution producing tractor).

I’m not promoting it, but just bringing it to your attention as an area worth watching.

Back to ag

Last week I highlighted some inflation stories that were beginning to surface and readers sent me more – everything from gold and silver hitting new highs to anecdotal evidence of Malawi land prices. You are preaching to the choir – there are global imbalances on the one hand, and power-shifting demographic changes on the other that are supporting the underlying strength in certain commodities (not all). One of the areas that we’ve mentioned in the past as a source of stability in volatile periods, a hedge against inflation, and a hedge against worst-case scenarios for those prone to hyberbole is direct investment in agricultural land. I’ve been discussing it for a few years, mentioning the potential and also the difficulty (both in implementation and in management).

We are not alone, as money continues to flow to arable land: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7997910/The-backlash-begins-against-the-world-landgrab.html. This article points out another trend that I’ve been discussing, which is the backlash against globalization as protectionist measures increase globally. In a best case scenario, I expect that countries will move to build up strategic supplies of food-stuffs, and perhaps place loose limits on foreign ownership – troubling, but manageable. In the worst case scenario, I think we could have actual land seizures, elimination of certain property rights – in the name of national security, ideology, or what have you, and nationalizations similar to previous decades in various parts. Egypt, which is enjoying a certain renaissance these days, comes immediately to mind, as do various South American countries.

Given some of the challenges of implementation, I continue to focus on diversified baskets of commodities, commodity-related companies, and second-degree beneficiaries for active investment opportunities. In terms of direct investment in agricultural land, there has been a mad rush to Africa, which I am currently avoiding (at the risk of missing significant returns), and sticking to areas that have ample water supply (north/midwest US and Canada). I don’t expect significant returns there – yields should hover in the 3-6% range unless inflation picks up, but in this environment, that’s not a bad place to wait.

For a succinct article with a few different options mentioned, click here.

New York City Real Estate – follow up

As a follow up to my previous article on New York City real estate, the WSJ had an article this morning about the falling euro impacting European hunger for NYC apartments. Sure, they might be attracted to the relative stability of the US and the dollar, but Europeans now have to pay around 25% more for that luxury. It must knock at least some of the demand down. By the way, I anticipate that the euro’s decline will continue, thereby adding to the pressure:

The euro’s 25% depreciation against the dollar, to less than $1.20 earlier this month means that Europeans are paying a quarter more for New York property in dollar terms than they did two years ago when one euro was exchanged into $1.60. The British pound, valued at $2 in March 2008 but recently trading below $1.45, has taken a similar plunge.

While some New York brokers say that affluent buyers from abroad will be attracted to a stronger dollar and the relative stability of property in the city, others say Europe’s debt crisis has already made some jittery about indulging in a Manhattan pied–à–terre or tying up cash anywhere outside their home countries.

The article goes on to state:

While there are no official records of foreign owners of city property, appraiser Jonathan Miller estimates that overseas buyers typically account for 15% to 20% of the Manhattan condo market. But when the dollar declined against other currencies a few years ago, demand from foreign buyers picked up. During the boom, Mr. Miller estimates that foreigners represented about 30% of condo buyers, with Europeans representing most of those sales.

For the full article, click here.

New York Real Estate

As a resident of New York City, this topic is near and dear to my heart, and I am obviously a biased observer; however, today we’ll just focus on the numbers.

Bloomberg recently had an article about New York real estate prices and new condo development. Within the article, was this:

The relationship between home prices and rents typically remains steady within a market, Miller said. In Manhattan, the average apartment, adjusted for inflation, cost 8.1 times annual rent from 1991 to 1997, according to Miller Samuel data. That means that in those years, buyers in Manhattan concluded that the long term benefits of owning an apartment — tax savings and property appreciation — were worth an initial investment of eight times the cost of renting.

Then in 1998, Manhattan prices began a decade-long climb, with year-over-year values rising by 10 percent or more in most quarters. By the second quarter of 2008 apartment prices peaked at 22.4 times annual rent, according to Miller Samuel data.

For the full article, click here.

I went to look at some apartment listing around the different neighborhoods. Here are some of my assumptions:

Assume you bought a 2 bedroom for roughly $900,000 (we’re talking about $750 sq ft) – a good deal, not the top building and a discount for the fact that many buildings in New York are co-ops that face a discount for a host of reasons (annoying boards, lack of liquidity, rental limitations, etc.). The rent on the apartment would be roughly $4,500/month at current rates.

At a rent multiplier of 15 (average of 8 and 22), we’re looking at a “fair value” of roughly $810,000 – a 10% drop in real estate prices. But rents have been falling – the article suggests by 6% from last years levels. Let’s assume a conservative 6% drop going forward to $4,230. If that’s the case, we’re facing a 15% decline in real estate prices.

Those are some serious assumptions – so let’s take a closer look.

1. Rents might stay stable, but with financial services continuing to be a big loser in the most recent unemployment figures (over the last 5 months, financial services lost 58,000 jobs) and those being the drivers of high rents in the city, it’s tough to see rents staying stable. A 6% decrease is just based on the rent decrease last year, however, rents could certainly drop by more. With a lot of the new developments mentioned in the article as shadow inventory for either sale or rent, one or the other will be pressured, probably both.
2. Rent multiplier: I used the average of the high to low mentioned in the article. It’s probably a fine long term assumption, but the trend has been for the multiplier to come down and it could certainly overshoot to the downside. At stable rents (not likely) and a multiplier of 10, we’re looking at a 40% decrease in prices.
3. Range of prices: I used a conservative $750 per square ft. assumption. Many listings are at $1,000 per square ft. or higher, and while the rents in those buildings might be higher, there were plenty available at lower ranges. That would translate into very different rates of change for the higher level and new construction apartments.
4. Condo vs. Co-op: New York is a quirky market. Co-ops are more restrictive, and most apartments are owner-occupied. Additionally, co-op boards have much stricter entry requirements for down payments than banks, so their conservatism means that their owners will face less pressure to sell. In turn this may actually result in MORE selling pressure in the condo market as investors and real estate owners who own both will have more liquidity in the condo market than co-op.
5. External buyers have always been attracted to New York. Pied-a-terre’s for retirees or international owners are relatively more common than most other  cities. In 2004 to 2008, it was common to hear about European buyers coming in as strong bidders. Except, at the time, the euro was strong and getting stronger. These days, real estate in the US looks a lot more expensive and many investors don’t want to lock up their money. Not that there won’t be foreign buyers looking to lower their exposure to their home currencies, just that it will be more of a hurdle.

All of that leads me to be quite concerned about New York City real estate prices.

What to expect going forward

So much news, but let’s simplify:

1. Bankruptcies will continue to rise.
2. Rents will go down, causing owners equivalent rent to go down in the CPI, deflationary pressures continue.
3. Europe falls apart: Hungary needs a bailout. How much more will the German taxpayer take on? What about Austria? Remember Spain and Portugal and Ireland? Yikes. Additional deflationary pressures on the USD (devaluation vs. euro).
4. Europe is big problem for China. Net negative for UST, but we are early on our call to short the 10 year, but the end of the bond bull market is upon us.
5. Unemployment doesn’t look good. Weeks searching going up. Temp is the only work out there. Lots of people giving up makes the numbers look good, but watch out for credit card defaults going up. Negative for the big card issuers (C, BAC, COF, Mastercard/Visa/AMEX) and retailers.
6. Politicians will downplay all of it, talk about stability and strength. Increased stimulus? From where?
7. Look for additional municipal cuts in budgets, employees, etc. Again, negative for jobs outlook, real estate, etc.
8. Geopolitical risk remains high. Forget North and South Korea. Look for something like the conficker virus making big headlines. We are always fighting the previous war, in this case small-group, armed guerrillas, terrorists, etc. Cyberwars will make the big headlines soon.
9. Yen is toast. Again, I’m probably early, but the demographics make their debt load unbearable. Some serious restructuring will need to occur – and someone will have to lose.
10. BP is in so many pension funds, the month end and quarter end numbers will be painful.

These are not black swans. They are just a matter of timing.

The equity markets were down today…

…is one of the bigger understatements I heard in the news. Not only did the DOW drop 376 point, the S&P fall through key technical levels, and the Nasdaq fall off a small cliff, everything else was down too – except the euro and the yen? What is going on here?

It will take years for the current cover-ups to be revealed, and I am not much of a conspiracy theorist, but the move by the Swiss yesterday and today was out in the open, while the moves by some unknown buyer (rumor has it that it might be Uncle Sam) was top-secret. Well, as governments start to believe that they can control currency levels, rates, money flows, etc. inefficiencies will only increase. Check out this article about China’s recent resource hoarding.

The international trading system is about to encounter an entirely new challenge. The global hunger for natural resources is inspiring a surge in restrictions on exports of crucial raw materials. As with so much else in trade nowadays, the focus of this emerging conflict is on China. The Chinese stand accused by some trading partners of hoarding rare elements and other raw materials that are essential to many globally traded products.

But China is hardly the only country considering export restrictions as the race for natural resources heats up in the wake of the recession. The sharp increase in restraints is happening world-wide, and raises fundamental questions about the rules and the resiliency of the World Trade Organization…

But you can’t fool all of the people all of the time. I am not a technician by nature, so I have to go back to valuations. I’ve said it before: equity markets continue to be 30% or more overvalued. Real estate across the board is overvalued. There were a round of recent speculators that were probably able to make some money, but commercial real estate is going to continue to be a drag on regional banks, and ripple through the economy.

What is surprising is the continued inhuman strength of the yen. I’ll be looking for opportunities to increase short exposure to it. While I expect yields on 10-year to be bid as a safe haven, they are in a precarious position and I don’t think they’ll go below the 2.5% range, so I’ll be looking to increase short exposure there as well. In the meantime, we wait. The opportunities to buy will be there in the future, but for now, capital preservation is the order of the day.

As a sidebet: how long before we hear about a large hedge fund liquidation?

And for those who say real estate is stable…

Morgan Stanley has told investors in its $8.8 billion real-estate fund that it may lose nearly two-thirds of its money from bum property investments, according to fund documents reviewed by The Wall Street Journal. That would likely make it the biggest dollar loss—$5.4 billion—in the history of private-equity real-estate investing.

Not much more to say, but there was an additional nugget in the article:

When times were good, the fund generated fat fees for various segments of the bank. In 2007 alone, Morgan Stanley earned $104 million in acquisition fees, $22 million in fund-management fees, $13 million in financing fees, $36 million in real-estate-management fees, and $21 million in financial-advisory fees, according to fund documents reviewed by the Journal.

To read the full article, click here.

Not much more too say (now for real). Illiquid, no transparency, too much risk, conflicts of interest, etc. The story is old.