Archive for the 'real estate' Category

What’s Down With Real Estate?

Kurt Brouwer September 23rd, 2009

Home prices are way down, but an uptick may be underway.  However, commercial real estate — office buildings, malls, warehouses, hotels, theaters — is still heading south.

Let’s start with home prices.  This chart shows the decline in home prices as shown by the S&P / Case-Shiller home price data versus the owners’ equivalent rent line (OER), tracked by the Federal government.

Owners’ equivalent rent attempts to measure the market value of homes in terms of rental income.  Without going into the details, I believe OER constitutes a good benchmark for evaluating whether or not homes are overvalued, undervalued or fairly-priced.

As you can see, we are getting back to a reasonable valuation level for homes.  However, markets typically overshoot on the downside of fair valuation just as they often overshoot on the upside.  If that’s the case, more trouble is ahead.


Source: Calculated Risk 

According to this data, home prices peaked in early 2006 and have slid ever since, except for a modest uptick in prices recently.  We do not know whether or not the bottom has been reached, but we believe we are quite close.  However, even if a bottom has been reached, real estate activity - sales of existing homes, new construction, remodeling - will remain at low levels for some time to come.

Commercial Real Estate:  Commercial real estate has also fallen hard although the downturn started later than that of residential.  Unfortunately, the decline and fall of commercial property has been very quick indeed. This chart compares the decline in residential with that of commercial. The blue-gray bars denote periods of recession.  The blue is residential and the red line is commercial.

Source: Calculated Risk

As you can see, commercial real estate took longer to begin falling, but the downturn has been steeper.   Now, both real estate markets are off considerably from the highs.

With falling prices for homes, those who provided residential mortgages have been the big losers.  And, unfortunately, the government is the ultimate deep pocket when it comes to home mortgages through takeovers of Fannie Mae, Freddie Mac and the possible takeover of FHA.

With falling prices for commercial real estate, those mortgages are under extreme pressure also.  But, commercial mortgages are typically held by regional and local banks.  Those institutions are now struggling and we have seen a rash of bank failures as a result. In a way though, the Federal government is the ultimate guarantor for banks too through FDIC guarantees.

For more on bank loans, see Bank Problem Loans Keep Growing.

Household Net Worth Gains $2 Trillion

Kurt Brouwer September 21st, 2009


Source: Bespoke Investment Group

I like this chart because it shows the growth in our net worth over a long period.  Net worth grew along with the equity market and when stocks began to falter in 2000, net worth kept going because home prices boomed.  When stocks fell again in 2008, real estate was also tumbling and net worth fell with it.  This chart illustrates how closely tied we are to the world of investments.

This piece from MarketWatch spells out the turnaround after a steady string of declines for our collective net worth [emphasis added]:

Household net worth rises for first time in two years (MarketWatch, September 17, 2020, Rex Nutting)

American households were $2 trillion richer on June 30 than they were three months earlier, the first time in two years that household net worth has increased, the Federal Reserve reported Thursday in its quarterly flow of funds report.

Household wealth rose in the second quarter at a 17% annual rate, or $2 trillion, to $53.1 trillion after falling at a 13% rate in the first quarter, the Fed said. It was the first time since the second quarter of 2007 that wealth had increased. Net worth is down $12.2 trillion from the peak in 2007, an indication of how much the collapse in stock prices and home prices have hurt. Read the full report.

…The rally on Wall Street was the main reason for the increase in household wealth, but rising home prices contributed as well. Wealth in corporate equities rose by $1.04 trillion, while real estate wealth rose by $139 billion. Assets held in mutual funds, life insurance and pension funds rose by $1.06 trillion…

It has been a long, hard slog for investors in stocks and in real estate.  No doubt there will be more trials ahead, but this is nice news.

Bank Problem Loans Keep Growing

Kurt Brouwer August 14th, 2009

Bloomberg reports on the growing trend in non-performing loans at U.S. banks [emphasis added below].  Non-performing loans are those that are not making payments of interest and/or principal.

This chart shows the level of bank loans that are not performing.  As usual during a recession, the percentage is going up.  The left scale shows the percentage and the right scale indicates the number of banks with serious issues.

The 1990-91 recession also had significant real estate problems and the non-performing loan percentage peaked north of 3% back then.  We’re at 2.6% or so now and we are probably headed higher this time around.

Source: Bloomberg / Big Picture

Toxic Loans Topping 5% May Push 150 Banks to Point of No Return (Bloomberg, August 14, 2020, Ari Levy)

More than 150 publicly traded U.S. lenders own nonperforming loans that equal 5 percent or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival.

The number of banks exceeding the threshold more than doubled in the year through June, according to data compiled by Bloomberg, as real estate and credit-card defaults surged. Almost 300 reported 3 percent or more of their loans were nonperforming, a term for commercial and consumer debt that has stopped collecting interest or will no longer be paid in full.

… “At a 3 percent level, I’d be concerned that there’s some underlying issue, and if they’re at 5 percent, chances are regulators have them classified as being in unsafe and unsound condition,” said Walter Mix, former commissioner of the California Department of Financial Institutions, and now a managing director of consulting firm LECG in Los Angeles. He wasn’t commenting on any specific banks.

…While 5 percent can be “fatal” for home lenders, commercial real estate lenders may be able to withstand higher rates, said William K. Black, former lawyer at the Federal Home Loan Bank of San Francisco and the OTS. Commercial loans carry higher interest rates because they’re riskier, he said.

“At the 5 percent range, you’re probably hurting,” said Black, an associate professor of economics and law at the University of Missouri-Kansas City. “Once it gets around 10 percent, you’re likely toast.”…

One important additional point is how much of a loan loss reserve a given bank has.  That is, if non-performing loans are 3% and there is a fully-funded loan loss reserve of 3%, then the problem is manageable.  Conversely, if a bank has non-performing loans of 3% and a reserve of only 1.5%, that’s a problem.

Update:  Floyd Norris, at the New York Times, reports that a big bank failure is likely:

…Colonial BancGroup…may soon become the largest bank failure of 2009, with more than $25 billion in assets. Alabama regulators have raised the possibility the Federal Deposit Insurance Corporation may take over Colonial.Even worse, the bank’s attempt to obtain a federal bailout has prompted a criminal investigation. After a raid requested by the inspector general for the government’s Troubled Asset Relief Program, Colonial said it was being investigated on suspicion of accounting fraud...

See also:

Banks Use Bailout Bucks to Lobby Congress

U.S. Treasury’s Plan C For Banks

Federal Deficit Hits $1.3 Trillion…and Counting

Kurt Brouwer August 8th, 2009

The Congressional Budget Office (CBO) put out its estimate of the Federal budget deficit for the current year (10 months) through July [emphasis added]:

Monthly Budget Review (Congressional Budget Office, August 6, 2020)

The federal budget deficit for the first 10 months of fiscal year 2009 reached $1.3 trillion, CBO estimates, close to $880 billion greater than the deficit recorded through July 2008. Outlays rose by almost $530 billion (or 21 percent) and revenues fell by more than $350 billion (or 17 percent) compared with the amounts recorded during the same period last year. The estimated deficit reflects outlays of $169 billion for the Troubled Asset Relief Program (TARP), recorded on a net-present-value basis adjusted for market risk…

The budget deficit last year was high, but we are beating it by $880 billion.  Oh joy.

The CBO suggests that this estimate understates things because it just includes payments to Fannie Mae and Freddie Mac and does not include their total operations, which are horrendous money sinks.

For example,  Zero Hedge has been reading Fannie Mae’s Second Quarter Supplement, which provides a breakdown of troubled loans suggesting that Fannie Mae loan has nearly $1 trillion in troubled loans.  Who knows how much more Freddie Mac would add? Zero Hedge reports [emphasis added]:

…The report describes FNM’s exposure to problematic classes of mortgages on their book. That total comes to a whopping .9 Trillion. The total book of business is $2.7 Trillion, fully 32% of their book is troubled...

CBO writes this about the hit we are taking from Fannie Mae and Freddie Mac.  The budget deficit estimate:

…includes net cash payments of $83 billion in support of Fannie Mae and Freddie Mac, although CBO believes that those two entities should be considered federal operations and that the full scope of their activities should be incorporated in the budget in a manner similar to the TARP. CBO estimates that spending increases and revenue reductions stemming from the American Recovery and Reinvestment Act of 2009 (ARRA) have totaled more than $125 billion so far this year (excluding the impact on the budget from the effects that the legislation has had on the economy)…

So, this budget deficit estimate probably underestimates the actual deficit we are incurring.  Additional problem areas exist too.  For example, the Federal government has taken on an increasing role in funding unemployment benefits (which are up sharply) and Medicaid spending (also up sharply) that normally would be picked up by the states.

CBO continues:

…Outlays topped $3.0 trillion for the first 10 months of the fiscal year, growing by 21 percent compared with outlays through July of last year-or if the estimate is adjusted to reflect the shifts in payment dates, by 20 percent. Payments for the TARP and net cash disbursements for Fannie Mae and Freddie Mac account for nearly half (or $252 billion) of the increase over last year.

Spending for unemployment benefits is more than 2½ times what was spent in the first 10 months of 2008 because of higher unemployment and legislation that increased the amount and duration of benefits. Federal spending for health care has also grown rapidly. Medicaid spending grew by 24 percent, largely because of a provision in ARRA that temporarily increases the share of Medicaid costs paid for by the federal government…

So, we are in record territory here, both in terms of budget deficits and in terms of total spending.  For example, spending has already topped $3 trillion and there are still two months to go. The higher spending tab for unemployment and Medicaid is currently a subject of dispute with governors of many states.  The Feds are picking up the tab now, but they want states to begin doing so.  Unfortunately, the states are generally broke also, with California, Michigan, New York leading the way.

See also:

Tax Revenues Plummet…Again

Crackpot Economics & Cash For Clunkers

California Pension Plan: Betting the house

Kurt Brouwer July 25th, 2009

From the New York Times [registration may be required] we get this report on the California Public Employees Retirement System (CalPERS), which is the largest pension plan in the nation.  CalPERS has struggled of late due to investment losses and funding issues.  It also has a credibility problem after helping bring about the current crisis in California public pensions.

Now, the investment chief for CalPERS is doing something that is quite unusual in that he is calling for the system to essentially bet billions on risky assets in the hopes of making a big gain [emphasis added below]:

CalPers Hopes Riskier Bet Will Restore Its Health (New York Times, July 23, 2020, Leslie Wayne)

Big as California’s budget woes are today, so are the problems lurking in its biggest pension fund.

The fund, known as Calpers, lost nearly $60 billion in the financial markets last year. Though it has more than enough money to make its payments to retirees for many years, it has a serious long-term shortfall. Meanwhile, local governments in the state are pleading poverty and saying they cannot make the contributions that would be needed to shore it up.

California’s public pension funding problem is one of the thorniest financial issues facing the state. The state made an unwise and almost certainly unsustainable deal to substantially raise public pension payouts approximately 10 years ago.  CalPERS played an important role in that disastrous decision (see Budget Busting Pensions).

The New York Times continues:

Those problems now rest largely on the slim shoulders of Joseph A. Dear, the fund’s new head of investments. He is not an investment seer by training, but he thinks he has the cure for what ails Calpers, or the California Public Employees’ Retirement System, the largest in the nation with $180 billion in assets.

Mr. Dear wants to embrace some potentially high-risk investments in hopes of higher returns. He aims to pour billions more into beaten-down private equity and hedge funds. Junk bonds and California real estate also ride high on his list. And then there are timber, commodities and infrastructure.

That’s right, he wants to load up on many of the very assets that have been responsible for the fund’s recent plunge. Calpers’s real estate portfolio has tumbled 35 percent, and its private equity holdings are down 31 percent. What is more, under Mr. Dear’s predecessor, Calpers had to sell stocks in a falling market last year to fulfill calls for cash from its private equity and real estate partnerships. That led to bigger losses in its stock portfolio.

CalPERS has made very significant investments in illiquid real estate and private equity partnerships.  Selling stocks last Fall to help keep those partnerships going may or may not have been a huge mistake, but it is certainly unusual behavior.

From the Sacramento Bee, here is a report on a billion dollar bust in CalPERS’ real estate portfolio.  The details do not sound encouraging:

…CalPERS made aggressive investments in real estate at the worst possible time, when inflated property values had peaked and were already beginning to decline.

As The Sacramento Bee’s Dale Kasler detailed in a recent article, one CalPERS real estate misstep stands out in particular. In February 2007, CalPERS invested $922 million in a deal with LandSource Communities Development LLC that involved thousands of homes and lots in seven states including Florida, Arizona and California.

A month before the investment was finalized, Lennar Homes, a principal partner in the LandSource deal, announced it was writing off $500 million in real estate assets because of deteriorating market conditions. That should have served as a clear warning to CalPERS, but it did not.

Sixteen months later, LandSource filed for Chapter 11 bankruptcy. Depending on what assets the partnership sells to pay off creditors, CalPERS could lose its entire investment, nearly $1 billion...

In fairness, CalPERS made lots of money from its real estate investments over the years, so a billion dollar writeoff won’t break the bank.  However, the bankruptcy of a private real estate deal like this one should be a warning light that the partnership investments the plan already holds may have other unwelcome surprises.

Joseph Dear, CalPERS’ new investment head seems to be a smart guy and he is certainly well connected in a political sense.  He also seems to be a gutsy guy in that he is definitely making a bet — in effect, betting the retirement future of many Californians  — that the private partnerships he likes will outperform more traditional investments.

…He [Joseph A. Dear] was hired in large part for his management skills and political savvy - honed in Washington, where headed the Occupational Safety and Health Administration in the Clinton years. He does not have an M.B.A. or any other advanced degree in finance. Harvard, Yale or Wharton is not on his résumé. Instead, his lone degree, in political economy, is from Evergreen State College in Olympia, Wash.

Most recently, Mr. Dear headed the Washington State public pension fund, which gained a reputation as a daring investor under his oversight. It risked more of its portfolio - 25 percent - on private equity than any other public fund. The bet pushed the Washington State Investment Board, which now has $67 billion in assets, into the top 1 percent of its peer group in performance during the boom years, according to Wilshire Associates. But in the fiscal year that ended last month, the fund lost 27 percent of its value, or $18 billion.

Calpers has a lot riding on Mr. Dear’s effort to achieve above-market performance. The fund just posted a loss of 23 percent, the worst in its history. That leaves it 66 percent funded, the lowest level in two decades, meaning it has only $66 on hand for every $100 in benefits promised to 1.6 million California public employees and their families.

… “Calpers is significantly underfunded, and they have decided that they will roll the dice,” said Edward A. H. Siedle, president of Benchmark Financial Services, which audits pension plans. “Is that appropriate if you have just lost 25 percent of your portfolio? These are high-risk, illiquid, unregistered products where there is tremendous valuation uncertainty. I would bet you any amount that five years from now, this plan will not have outperformed the market.”…

On one hand, I applaud CalPERS and its new head of investments for taking a bold and contrarian stand.  It may work and, if so, I will be very happy.  On the other hand, I question the motivation behind this move.  Is it the desire to follow a sound investment principle of adding to solid holdings when they have fallen in value? Or, is it a move like that of a gambler who suddenly decides to double down in order to erase a series of losing hands?

Via: Calculated Risk

See also:

Budget Busting Pensions

10 Rules for Investing

Oakland ‘Mulls’ Bankruptcy

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