Daily Dose of Optimism

Weekend Viewing: Glengarry Glen Ross

In the first ever DDO video clip, I've posted a short excerpt from one of the great business movies of all time, Glengarry Glen Ross.

Best known for the "ABC: Always Be Closing" scene with Alec Baldwin (a scene that was copied and modified for Boiler Room) Glengarry Glen Ross looks at real estate salesmen in high pressure situations, and the questionable tactics employed out of greed and desperation.

One of my favorite scenes from the movie (among many) is this clip of Al Pacino as the smooth talking Ricky Roma, selling a piece of property to Jonathan Pryce, as the timid James Link.

If you haven't seen the movie the whole way through, rent it today, or just go ahead and buy it on Amazon. You won't be disappointed. - Ed

Please note: if you are offended by crude language, don't watch this clip.

The complete opening phrase is cut off in this clip. Here's the text:

"All train compartments smell vaguely of sh*t. It gets so you don't mind it. That's the worst thing I can confess. You know how long it took me to get there? A long time."

Video enabled by a cool new blog tool, Videoegg.

My favorite quotes, which basically occur in sequence:

Ricky Roma: "Great meals fade in reflection. Everything else gains. You know why? 'Cause it's only food. Just shit we put in us." [...]

"The great f*cks you may have had, what do remember about them? I don't know. For me, I'm saying what it is, it's probably not the orgasm. Some broad's forearm on your neck, something her eyes did, there was this sound she made. Or it's me and the, uh, I'm telling you; I'm in bed the next day; she brought me cafe au lait, gives me a cigarette. My balls feel like con-crete." [...]

"What I'm saying, what is our life? It's looking forward or it's looking back. That's it. That's our life. Where's the moment? And what is it that we're afraid of? Loss. What else?  The bank closes, we get sick, my wife died on a plane, the stock market collapsed. What of these happen? None of 'em; we worry anyway, why?"

2006 Predictions: What To Expect When Real Estate Foreclosures Spike (in 2007-2008)

The NY Post had an article a while back that said that NYC foreclosures had risen 8% in the month of March.

I did a little extra research on this article to fill in the blanks, and found interesting, but perhaps expected, disparities in foreclosures amongst the five NYC boroughs. (Note: the overlap between "county" and "borough" may not be perfect.)

Basically, Staten Island has foreclosures on 1 in 700 properties. Manhattan has foreclosures on 1 in 15,000 properties.

I interpret this data to mean that when real estate foreclosures really start to spike, it will probably be a phenomenon disproportionately occurring in lower income neighborhoods. The 1980s gave us trickle down economics; the housing boom could give us trickle up recession. - Ed

NYC Foreclosure Rates - March 2006

• NYC Overall: 1 in 1,313
• Staten Island: 1 in 698
• Brooklyn: 1 in 1,230
• Bronx: 1 in 1,529
• Queens: 1 in 2,454
• Manhattan: 1 in 15,963

Thoughts on Real Estate Startups Inspired by Zillow.com (Update 1)

Update 1: Refined proposal for a "national real estate market"

Zillow.com is a TBA web startup in the real estate space, founded by former folks from Expedia. I came across this post this via Infectious Greed, and have since generated a few thoughts about the real estate market. Although I haven't yet purchased my first apartment/house, I nonetheless have spent a fair amount of time thinking about it in early 2005.

What I think frustrates everyone about real estate is simple:

• We gain comfort buying (and selling) in markets with experience. I am comfortable purchasing a round-trip ticket across the US because I have done it about 30 times in the past few years. I know when I'm getting a deal, when I'm getting hosed - and I always know why (usually, because I waited to buy). I, unfortunately, cannot say the same about real estate, and neither can just about everyone I know, except the one who is an NYC realtor and real estate goddess.
• Most people don't have the chance to build meaningful critical mass of experience in real estate transactions, because they only buy/sell a few times in their lives. For this reason, a realtor with high transaction volume can provide extremely valuable counsel on price and other terms to an inexperienced buyer/seller. "User dissatisfaction" arises when the realtor is inexperienced, because then the buyer/seller realizes one of the few transactions they will make in their lives will likely suffer due to an intermediary who is about as qualified as they are to facilitate the transaction.
• The real estate market only appears to be transparent, because listings of properties for sale are readily available. However, the price listed has nothing to do with what buyers really want to know - which is a history of prices paid. After all, we're talking about a negotiated, over-the-counter (OTC) market. If buyer/sellers know how the price they paid deviated from similar sales in similar neighborhoods, they would be able to rest easy at night, knowing the transaction was fair. In the words of Robert Chapman:

[Chapman] learned that bartering for oranges in China is "a classic example of a non-transparent market. If you don't want to get ripped off, you better make damn sure you saw the trade in front of you go down."

If I really wanted to cause trouble in the real estate market, I would take my cues from the evolution of the stock market:

1. With home ownership at about 75% percent of the population, it isn't a stretch to acknowledge that real estate is a large, national market that trades on something resembling a lot of small, local exchanges.
2. From the perspective of a national market trading locally, disclosure of transaction prices should be required by law to the locality where the sale was executed. Although houses aren't technically "securities", I'm not sure why this matters; a separate regulatory organization, as in the commodities market, should be created.
3. As price disclosure would only be a piece of the puzzle, and it would only be reported locally, private firms could "fill in the gaps" in delivering transaction data under this model as they do in the equities market. The business would be (1) collecting the price data from localities, and (2) adding to this data other relevant information such as zip codes, number of bed/baths, square footage of house and lot, etc.
4. By aggregating the details on these "trades," private firms could create competing "market data providers" in the real estate market, and make money by charging people to access the data, with prices to vary depending on depth of information required.
5. Buyers and sellers would then have the leverage they are looking for in making sure they received a fair price for the property they purchased, and hence feeling "satisfied" about the sale.

Think this is crazy?

Look at what the NASD recently did to the bond market with TRACE. (Perhaps, not so crazy.)

I'll take a wild guess and say that the reason something like this has not been yet done are:

• Realtors, as the primary profiteers in a fragmented real estate market, have a huge lobbying advantage here, and all the interest in maintaining the status quo
• Although Americans have an interest in transparency in the real estate market over the course of their lives, it's hard for people with jobs and families to get their head around what this would a require. However, a motivated, for-profit real estate "trade-printing" facility might have the motivation to see this through...
• Real estate folks don't like to invest in the stock market, so they are less apt to pay attention to the regulatory backstory to the madness that drives their Google shares to $450.

My assessment then, of any real estate startup that isn't a realtor, is that in the absence of increased transparency on purchase prices, there isn't a whole lot of room to increase "user satisfaction" with the process.

Ranging from $200,000 to several million dollars, and occurring only a few times in a person's life, it's hard to imagine what you can do to make people feel better about the largest deal of their lives other than letting them confirm for themselves, based on unambiguous third-party data, that they got a fair deal in their real estate transaction.

Consider me all ears! - Ed

2006 Resolution: Ignore Real Estate Bubble Articles Until 2007

I think 2005 was clearly the year where widespread fear of the real estate bubble came and went.

Someday, a scientist with some real talent will be able to systematically track the rise and fall of memes, where they start and where they end, and what their relation was to an underlying phenomenon (if any). The result would teach us a great deal about idea origination, diffusion and extinction, which could be of use to media types, bloggers, scholars and the like.

With regards to the "Real Estate Bubble" meme, a June 15, 2005 NYT article made this point:

This year [2005], only about $80 billion, or 1%, of mortgage debt will switch to an adjustable rate based largely on prevailing interest rates, according to an analysis by Deutsche Bank in New York. Next year, some $300 billion of mortgage debt will be similarly adjusted.

But in 2007, the portion will soar, with $1 trillion of the nation's mortgage debt - or about 12 percent of it - switching to adjustable payments, according to the analysis.

The 2007 adjustments will almost certainly be the largest such turnover that has ever occurred. Link

This means that even if we start to see some signs of trouble in 2006, the avalanche would not come until 2007 and beyond.

Therefore, I resolve to ignore effectively all articles about the "real estate bubble" for twelve months.

Although I wish the time elapsed between idea and action was instantaneous, in reality, things can take their sweet time. - Ed

PS: The Rude Awakening (on June 16, 2005) reminded us:

The notion of a housing bubble is no secret to the masses. Therefore, could anything as widely anticipated as the end of the housing boom ever come to pass? Our contrarian instincts rebel at the thought. Perhaps, therefore, we have not yet reached the terminal stage of the bubble, but are merely drawing closer to it.  Link 

Amen.

Barron's: There is No Real Estate Bubble

Perhaps the most interesting article in this weekend's Barron's was an article by two contrarian investors. They argue (among other things) that there is no real estate bubble. They make this poinut by saying that if you use a non-governmental inflation measure - such as the increase in the value of precious metals - and adjust property values for that increase, then property values are declining in real terms.

Now, I have to say I love the idea of ditching a government indicator, particularly for a market-based one, although the idea of whether precious metals really reflect inflation is tough for me to grasp (I'm working on it).

But, if one thought that inflation could be a serious problem, then real estate - any hard asset - would provide protection, and their argument is a logical one. - Ed

Link: Barron's Online - Extreme Contrarianism.

We don't see a bubble in the housing market. It's true that homebuilding, real-estate transactions and mortgage credit are industries that have boomed thanks to low interest rates. We also agree it's about time for them to contract with the next phase of the business cycle. However, we find that housing prices have very little to do with interest rates.

On a national-average basis, U.S. house prices rose 29% between the end of 2001 and the end of 2004, and 20% when deflated by the CPI.

But this is a mismeasurement of the "real" increase, since housing and other assets trade in fluid and fast-moving markets, while the CPI is one of the tardiest imaginable measures of inflation.

When the price of housing is deflated instead by the best benchmark we know for expressing the dollar's falling value -- an index of gold, silver and platinum prices -- we find that it has actually been declining in real terms since the end of 2001.

With precious-metals markets continuing to advance, we anticipate that housing prices, measured in nominal dollars and on a national basis, are more likely to accelerate than decline as inflation takes hold.

DDO is not Making This Up

A friend of mine received this in the mail (California market):

Dear Friends, Clients, and Neighbors,

We sure hope all is going well for you and your family. The purpose of this letter is to let you know we are continuously watching the changes in the Real Estate Market. If our market continues to soften, we want you to know as always we will work as hard as possible to maintain your neighborhood values at the highest level. We know we cannot control economic factors, but we sure can expose every home we sell to more buyers and ensure the highest price possible on every home. If we can help you or anyone you know with any Real Estate needs call us anytime. We will keep you informed of any future market changes.

Talk about stating it in plain English! How quickly things change... - Ed

The Real Estate Bubble Rabbit Hole (Update 1)

Update: Fixed link at end of article

As part of my reading about the real estate bubble, I have been curious to find other dimensions to the discussion other than the argument that is conventionally stated, which is:

"cheap credit combined with fear of stocks has turned houses into the preferred investment vehicles of average Americans" (my writing).

This statement is part-truth - about cheap credit - but part-falsehood; that is, the claim it makes that average Americans view their homes principally as investment vehicles.

I am starting to think the "investment" dimension to the housing bubble is actually cynical talk by higher-IQ Americans, who were either grandfathered into the $1 million dollar home regime or are fortunate to make enough money that it doesn't really affect them.

The excerpt below, from Kausfiles, was first published on July 1, 2005, and has been a bit of a "rabbit hole" for me (in that the ramifications and details behind it are almost endless) in trying to understand why home prices are rising - because they aren't rising everywhere equally:

[E]very state (and the District of Columbia) that voted for John Kerry last year, without exception, was among the top 24 states in the country in terms of the increase in residential property values since 1980.

Do Democrats produce rising home values or do rising home values make people Democrats? (The latter seems implausible.) Are both phenomena related to high education levels and/or a large concentration of universities? And how does this correlation jibe with the much advertised GOP dominance in the fastest-growing states, which you'd think would be states with rapidly appreciating real estate?  Link

This blurb above led me to this quote, talking about how families with both mother and father working still have less disposable income available than did families with a "single breadwinner" a generation ago:

"Even as millions of mothers marched into the workforce [since the 1980s], savings declined, and not ... because families were frittering away their paychecks on toys for themselves or their children.

Instead, families were swept up in a bidding war, competing furiously with one another for their most important possession: a house in a decent school district.

A study conducted in Fresno … found that, for similar homes, school quality was the single most important determinant of neighborhood prices ...

[The corollary to the result of this study is the reality that bad American public] schools impose indirect—but huge—costs on millions of middle-class families. In their desperate rush to save their children from failing schools, families are literally spending themselves into bankruptcy." Source: The Two-Income Trap, by Elizabeth Warren and Amelia Warren Tyagi. 

I'm still trying to piece it all together, but I now basically think that observed home price increases are driven by the fact that cheaper credit makes it easier to compete to purchase a home in states where "good" public schools are harder to come by. States where good public schools are easier to come by are less subject to so-called manic real estate appreciation.

As credit becomes more expensive, housing prices will likely no longer increase, and may experience some "softness", but the underlying dynamic driving higher prices in (say) California  - access to good schools for children - won't go away.

If you want to know what creates "good" public schools...well, that's a topic for this article. - Ed

Cause and Effect in the "Real Estate Bubble" (Update 1)

Reader comments have inspired me to be a little more clear about what I meant in this post. To recap, I was inspired by Jeff Matthews to crystallize my thoughts on the "real estate bubble".

Jeff said that while signs from the mortgage market indicate the appreciation in real estate prices is being driven by unsustainable speculative financings, bubble-events are undone due to unanticipated events, where we forget about the "bubble" while it is undone.

First I'll survey some of the main ideas I've heard over the past six months on this topic:

Evidence of a bubble:

• 2+ standard deviation increase in home prices (Grantham)
• ARM, neg-am, and low-documentation mortgages account for increasing percentage of new home purchases; makes it easier to buy more house than could otherwise be afforded

Factors understood to be able to pop it:

• Higher interest rates:
  • Increases in Fed Funds rate to 4-5% range, pushes up interest rate on ARMs in 2006-2007. $1 trillion in ARMs begin to float in 2007, which would be the first opportunity for mass-defaults.  Flat-to-inverted yield curve creates further disincentive to make new loans
  • Diversification of international investors away from US long-bond holdings, causing fixed rates to rise
• If rates stayed relatively stable: increased unemployment or declines in average US wages makes it harder for average worker to meet mortgage payments

Factors that argue the increase is sustainable (these are not widely discussed):

• Regionalized increase - the "blue" Democrat states - not a clear nation-wide increase
• Quality of life factors are key - good schools for children - people may give up a lot before they sell
• Real estate is a real asset - could afford protection against loss of dollar purchasing power due to US or international monetary policies

The argument as to why this won't end the way people think it will:

• No real bubble was ever widely anticipated (Fisher)
• Events that cause bubbles to deflate are not the ones we expect (Matthews)

Expected outcome: Fed Funds increase makes home purchases unaffordable for the marginal buyer. Removal of liquidity from market creates a long period of moderate downward drift in prices that could last up to 12 years. Prolonged period of higher rates (through 2007) leads to higher mortgage default rates.

To be revised as my thinking evolves. I'll close with a few more thoughts:

• There doesn't need to be a "crash" and there probably won't be. It is as simple as: once the virtues of an investment are widely known and widely acted upon, the conditions that made the decision sound can become no longer so.

• In the last two months, I had a bellhop at a Miami hotel give me advice to invest in local real estate, and I heard the doorman at my girlfriend's building tell the gardener that it is much better to own than rent.

- Ed

Links to relevant resources:

• Jeremy Grantham (4/05) "Bubble Watch"  Link
• Ken Fisher (7/05)  "Bubblenomics"  Link
• Jeff Matthews (7/05) "When 11 of 56 Leading Economists Agree, Something’s Wrong"  Link

Real Estate Sector Impact on Job Creation (Update, With Graph)

There is a misleading statistic floating around about the disproportionate impact of real estate on US job growth from 2001 to 2005. It has been said in many places, not the least of which in the esteemed magazine The Economist, which goes to show that you can't trust anyone, even Brits:

The Economist (June 18, 2005): "Two-fifths [40%] of all American jobs created since 2001 have been in housing-related sectors such as construction, real-estate lending and broking.  If housing prices actually fall, this boost will turn into a substantial drag."

This statistic is usually employed by people who profess to be themselves skeptical of statistics, but is a misleading figure nonetheless. I looked into this one myself, getting the actual data from a sell-side economist using FactSet:

The facts:

Since 2001, about 400k jobs in real estate and related industries have been created.  Let's call 2001 a "trough" year for real estate, which was flat until 2002, when it began its growth.

Real-estate and related industries compromise "40% of the jobs created" only if you use the relatively small peak-to-peak change in total non-farm employment (2001 peak to new 2005 peak).  Between the peaks, total non-farm employment only increased about 900k. Hence, the 400k is about 44% of that.

Why is this incorrect?

Non-farm employment did not bottom until late 2002 / early 2003. Any stat that overlooks the massive post-dot-com job-loss in this period also overlooks the massive job-creation in non-real estate sectors from 2002-2004. Here's what I mean:

* From 2001 to early 2003, the economy lost 2.3 million jobs (ex real estate)

* From early 2003 to present, 2.9 million jobs were created (ex real estate)

So, the 40% figure isn't the right way to think about this.

Let's be generous to both sides, and use their trough to peak job stats. For real estate, this is all jobs created from the 2001 trough to the 2005 peak. For total non-farm employment, we'll look at job creation in the "recovery" from the 2002 trough to the 2005 peak.

If you take trough-to-peak real estate jobs and divide them by trough-to-peak total non-farm jobs, then you will get, depending on your starting dates, a figure attributing 8-13% of new non-farm jobs created in the recovery from real estate. 

Now, 8-13% is not 40%, certainly, but it is a substantial figure when you consider that real-estate and related industries only accounted for 2.8% of non-farm jobs in 2001, and 3.0% in 2005.

Said another way: ~3% of our non-farm workforce accounted for ~10% of its growth. This is an interesting, and true, stat you can circulate. Let me know if you think differently. - Ed

(Note: My figures may differ from other sources or calculations due to rounding.)

Condo Flip

Hmmm...a website designated to facilitate real estate "flipping", including pre-construction (ie, unbuilt) properties. Well, if you can flip stocks online, why not apartment buildings? 

(Don't really have an answer for that one, other than it just 'doesn't feel right.' I guess this is because real estate, particularly real estate you live in, is sort of the investment opportunity that also doubles as a place of refuge. Can't say that about paper investments. But the fact that most people who "own" real estate do so for security purposes (protect them from the vicissitudes of renting), it rubs us the wrong way to see them become short term vehicles for wealth. But I digress.)

Condo Flip allows us to "flip" Miami real estate. I guess, I'm young and don't know the "enduring value" of Miami property, but I'd say this about it:

I spent five days in Miami recently, and the market didn't seem that "hot" to me. In fact, crusing around in my rented Mustang convertible, I found that most of the areas were pretty dodgy. South Beach had about 8 vacant buildings in what I would have assumed was prime real estate for retailers and/or apartment buildings (on Collins). And the Arts District / Biscayne Corridor area (downtown Miami) was pretty run down, apart from new office building and apartment buildings that were somewhat incongruous with the rest of the area. They do have a nifty "monorail", which is basically a bus that drives on a special elevated track. Kewl!

To top it all off, Miami is subject to atrocious weather and hurricanes from June through September. So, that basically rules out about 1/3 of the year as a good time to be there. - Ed

http://condoflip.com/