From a small northwestern observatory…

Finance and economics generally focused on real estate

A great little September

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Following up on Renaissance Weekend at Aspen, Lynnda and I took off with some friends for Europe for a couple of weeks.  It was wonderfully relaxing (albeit my office found out I had wifi most days) and a great way to dip into the culture and economies of some countries I’d either never visited (Hungary, Slovenia, Austria) or hadn’t visited in a few years (Germany, The Netherlands).

First, it’s interesting that the river valleys we visited (Rhine, Main, and Danube) appear to enjoy a tremendous economy off of tourism.  The proliferation of river cruise ships (we were on Viking) means that a lot of cities and towns can make money selling low-capital, high-profit items (beer, wine, food, and tourist paraphernalia) without investing in high-capital, low-profit infrastructure (parking lots, hotels).  They seem to have focused their attention on fixing up cathedrals and castles, all of which are quite lovely.

I was also terrifically impressed with how much commercial vessel traffic uses the Rhine River.  I didn’t try a head count, but I’m guessing commercial vessels outnumbered tourists by 10-1.  The Main and Danube weren’t quite so busy, but the traffic was still there.  Unlike the U.S., where our very few locks are frequently public infrastructure, the vessels we were on paid an average of 1,000 Euros per lock (times 68 locks between Amsterdam and Budapest!).  I presume the commercial cargo haulers paid something similar.  That said, the cargo haulers generally transported low-value, time-insensitive cargo (grain, aggregate, scrap metal) and each cargo hauler was able to replace quite a few trucks.  Thus, the benefit of these 10-knot, fairly efficient cargo vessels, was not only in cost but also in using a natural infrastructure (the river) to replace one that would have to be built (highways and bridges).  Add to this the environmental concerns (I’m told that the cargo vessels are significantly more environmentally friendly on a “per ton of cargo” basis) and it all seems to add up quite nicely.

One of the biggest economic problems facing Europe is the aging population.  Indigenous populations (e.g. — native Germans) are living long and not breeding very much.  To put it in simple terms, if Germany makes money selling Mercedes to other people, then how are they going to build them when all the Germans retire?  Many industries — not only in Europe but elsewhere — deal with this problem thru advanced automation.  Indeed, the advances in productivity in Europe, North America, Japan, etc., can be tied directly to automation.  However, there is a limit to replacing people, particularly in the service industry.   Up to this point, “First and Second World” countries (that is, us and them) have partially staved off the problem by importing labor.  That, of course, has its own problem, not just the crowding out effect (immigrants allegedly taking jobs from natives) but also results in a shortage of labor in some skill areas in the countries which source the immigrants.  For example, nurses are flooding into Europe and the U.S. from India, leaving a shortage of nurses in India.  The opposition argument to the crowding out effect is that natives are often unwilling or untrained to take certain jobs.  One German engineer pointed out to me that it’s impossible to get a German to collect garbage.  Here in the U.S., there is a huge demand for nurses, computer programmers, etc.  Sadly, we seem to churn out an excess of poets.

Sigh…. you’d think I could tour the Danube and the Rhine without thinking about such things, but here we are….

Written by johnkilpatrick

October 15, 2016 at 12:46 pm

Posted in Economy, Finance

Renaissance at the Aspen Institute

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Other than a few of the permanent pages (over on the right of your screen), I’ve let this blog die on the vine this year.   It’s actually been a surprisingly busy year, so busy that I’ve not had the time to write much!  My lack of intellectual output on this blog is mirrored in my other writings, and all of that needs to change.

Lynnda and I spent this past weekend at the Aspen Institute, which hosted one of the regional Renaissance Weekends.  I spoke on a couple of topics, most notably on real estate (of course).  I wanted to share with you a bit of what I had to say.

First, let me lay the groundwork.  Renaissance Weekend is now in it’s 35th year, and has held about 125 such gatherings.  It is a non-partisan, invitation-only gathering of thought leaders from a variety of fields (government, science, business, show business, astronauts, authors, Nobel Laureates, etc.).  All discussions are strictly off the record (although a speaker, like myself, is free to share what I personally said).  The first one was held at the home of Phil and Linda Lader.  At the time, he was the developer of Sea Pines Plantation on Hilton Head and went on to be the U.S. Ambassador to England during the Clinton Administration.  They wanted a gathering of families over the New Years weekend to talk about important issues of the day — the sort of informal chats we all used to have in college outside of the pure classroom setting.  Over the years, Renaissance has grown, and is now held in Charleston every new years.  The Charleston event draws 1,100 or so, and over the years, many of the participants wanted smaller, more intimate gatherings. Hence, Renaissance also meets on major holidays (July 4, Labor Day, President’s Day) in places like Napa Valley, Santa Monica, Jackson Hole, and Banff, British Columbia.  The Clintons were regulars at Renaissance back when he was Governor and President, and President and Mrs. Ford were also regulars.  All in all, about 20 presidential candidates, countless Senators, Representatives, Governors, and elected officials from every level and both parties have attended over the years.

Labor day was hosted by the Aspen Institute, which is a non-partisan forum for values-based leadership and the exchange of ideas.  It has earned a reputation for gathering diverse thought leaders, scholars, and members of the public to address some of the world’s most complex problems. It was founded in 1949 by Walter Paepcke, then the Chairman of Container Corporation of America.  His first gathering drew such luminaries as Albert Schweitzer, Jose Ortega y Gasset, Thornton Wilder, and Arthur Rubinstein, along with members of the international press and more than 2,000 other attendees. Through reading and discussing selections from the works of classic and modern writers, leaders better understand the human challenges facing the organizations and communities they serve. “The Executive Seminar was not intended to make a corporate treasurer a more skilled corporate treasurer,” said Paepcke, “but to help a leader gain access to his or her own humanity by becoming more self-aware, more self-correcting, and more self-fulfilling.”

One of my talks was about housing, and specifically addressing an accusatory issue being tossed around in political circles that “homeownership in America is at its lowest level in 50 years.”  Like so much in politics, that is technically true, but may not be a bad thing.  Home ownership in the U.S. hit record levels during the bubble — slightly over 69%.  Today, the homeownership rate is about 64%.  If you look back at periods when home ownership in America was stable and healthy, the ownership rate hovered around 64%.  Thus, from an ownership rate perspective, we may be at a very good level.

The bigger problem we have is home ownership equity.  For many years, the aggregate equity enjoyed by homeowners was about 60% of the aggregate value of the homes in America.  That means that on average an American homeowner had about 60% equity and about 40% debt.  From an equilibrium perspective, that appeared to be pretty good.  At the trough of the recession, roughly early 2008, that level got down to about 35%, which everyone would agree was a terrible number.   Today, we stand at about 55%.  By the way, this is a LOT of money — the aggregate value of all residences in America today is slightly over $20 TRILLION.  That means the aggregate equity in America is close to $11 TRILLION.  Getting from where we are to where we used to be means we need to create about another $1 Trillion in equity.

So yes, the housing market is still a bit in disequilibrium, but not from the decline in the home ownership rate, but rather from the decline in home equity.  The good news is that we’re headed in the right direction.  Recent projections from the National Association of Realtors suggest we may get back to “normal” in the 2018-ish period.

P.S. — Not everything at Renaissance is as boring as I’ve made it sound!  Lynnda and I had several great chats and dinner with Jay  Sandrich and his wife Linda.  He directed two-thirds of the episodes of the Mary Tyler Moore Show, the first three seasons of the Cosby Show, and many other iconic productions.  The behind-the-scenes tales were awesome!

Written by johnkilpatrick

September 6, 2016 at 10:07 am

Posted in Uncategorized

PWC Surveys Investors

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PriceWaterhouse Coopers does a great job with they’re quarterly survey of commercial real estate investors.  Previously known as the Korpacz Survey, after it’s founder, Peter Korpacz, the lengthy but highly readable review gives investors, brokers, appraisers, and others a snapshot of anticipated market performance both by property type (retail, office, etc.) and market (regional, and in some cases by metro area).  The most recent issue just hit my desk, and as usual it’s terrifically informative.

The headline this quarter is, “Investors Scrutinize Cash Flow Assumptions”.  As it turns out, the assumptions and resultant aggressiveness (or lack thereof) varies significantly by property type and geographic market.  For example, strip shopping centers (nationally), apartments (also nationally), and regional warehouses in the pacific and east-north-central regions are enjoying increased optimism, measured by very significant declines in overall capitalization rates.  On the other hand, 20% of investors surveyed expect regional mall cap rates to increase over the next six months, and 40% of investors felt the same about the overall Denver market.

Intriguingly, cap rates in CBDs trend lower than in the suburbs of those same cities, driven mainly by higher barriers to entry and a lack of available land downtown.  Additionally, most downtown cores in major markets provide the sort of 24/7 lifestyle and transportation alternatives that appeal to younger workers, and hence the firms that employ them.  As such, the downtown locations are viewed as less risky, overall.

Overall, vacancy rate assumptions have remained steady over the past year.  Coupled with that, tenant retention rates have also remained steady across markets.

In general, office markets remain fundamentally strong, and PWC survey respondents project falling vacancy and rising rental rates over the next few years.  Retail market conditions are improving, with no major markets currently in recession and an increasing number in expansion.  In the industrial sector, the expansion of the past few years is likely to abate, according to the survey, and a few metros may find themselves in the overbuilt state (Austin, Jacksonville, Las Vegas, Portland, and DC).  Apartments will continue in expansion in many markets, but the peak may be near, and an increasing number of markets are reported to be in contraction as 2015 turns into 2016.

As noted, the report is detailed, and this issue also features their less frequent surveys of medical office markets, development land, and student housing.  For your own copy (they come at a subscription cost, by the way) visit

December’s Livingston Survey

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The late columnist Joseph A Livingston started surveying economists about their forecasts back in 1946. It’s the oldest continuing survey of its kind, and is continued twice a year under the auspices of the Philadelphia Federal Reserve Bank. One of the neat things about this semi-annual report is that it compares the current central tendency of projections to the projections which were being made six months ago. In short, we can directly compare how economic forecasts are changing over time.

One of the biggest shifts is in the GDP growth rate for the 2nd half of 2015.  Six months ago, economists were projecting that we’d end the year with a modestly healthy 3.1% annual rate of growth.  Now, economists are forecasting we’ll end the year at about 2.1% — a fairly significant shift in sentiment.  Similar declines in GDP growth are projected for 2016.  Check my prior blog post about the 12th District report on the western economy, and particularly the impact a stronger dollar is having on the export market.

The good news — and it’s slight — is an improvement in the projections about unemployment.  Six months ago, economists were forecasting we’d end the year with an unemployment rate of 5.1%.  This has now been revised downward, ever so slightly, to 4.9%.  Also, inflation continues to be dead-on-arrival.  From the end of 2014 to the end of 2015, the consumer price index is projected to rise only 0.1%, in line with prior forecasts, and the producer price index is actually projected to fall by 3.2%.  Both indices are expected to swell in the coming year, but only slightly.  The current CPI forecast for the coming year is 1.8%, and PPI is 0.7%.  I’ll leave it up to the reader to pick a reason for this, but can you say “energy costs”?

Six months ago, interest rates were forecasted to rise.  Actual increases are somewhat lower than previously forecasted.  Six months ago, forecasters predicted we’d end the year with 3-month T-bill rates at 0.59%.  In reality, the November 23 auction was at 0.14%, although rates are trending up in December (0.28% as of Monday) in anticipation of Fed rate increases.  The current forecast is for 3-month rates to end the year around 0.23%, and for 1-year rates to end around 2.3% (down from the previously forecasted 2.5%).  Forecasters currently predict 3-month T-bills will hit 1.12% by the end of 2016, and 10-year notes will end next year around 2.75%.

Finally, forecasters are asked to predict the S&P 500 index for the end of the year as well as the end of next year.  Six months ago, the consensus forecast was an S&P level of 2158 for the end of the year, and this has now softened to 2090.  (It’s helpful to note that the S&P opened just under 2048 this morning.)  Forecasters currently project the S&P will hit about 2185 by the end of next year, which is an anemic growth of 4.5% over the coming 12 months.

If you’d like your own copy, which includes much more detail on these forecasts, you can download it for free here.

12th Fed District issues 3q report

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Greenfield is a global firm (albeit mostly in the U.S.), and even though we’re headquartered in Seattle, we try to focus our attention broadly rather than locally.  That said, the 12th Federal Reserve District just released First Glance 12L (3Q15) which takes an early cut at the data from the nine western states.   It’s very telling data — the “left coast” as I like to call it tends to suffer worse when times are bad and boom better when times are good.  Thus, there are some interesting facts and figures to be gleaned from this well-written report.

Naturally, the report is focused on the health of the member banks in the region, but the macro-econ factors driving that health are of much broader importance.  Nationally, unemployment stood at 5.1% at the end of the 3rd quarter.  Western states tended to be a bit worse off, with 3 states (Idaho, Utah, and Hawaii) recording lower unemployment rates and the rest showing higher numbers, ranging from Washington’s 5.2% up to Nevada’s 6.7%.  California, always the thousand pound gorilla in the room, came in at 5.9%.

However, job growth in the western states is well above the national average — 3% annually for the region versus 2% for the U.S. as a whole.  However, the west is digging out of a deeper hole — while job growth nationally hit a trough of -4.9% at the peak of the recession, it bottomed out at -6.7% in the west.  Generally, job growth in the west over the past 20 years had held steady at about one percentage point above the national trend during “boom” years.

Housing starts in the west are well below the pre-recession peaks.  As of September, 2015, the seasonally adjusted annual rate (SAAR) of housing starts stood at 161,000, with 107,000 of that in 2+ family units.  This compares with a peak of 449,000 SAAR in the 2005-2006 period, at a time when 2+ unit housing only made up 85,000 of the starts.  Arguably, the market in the west is still absorbing the huge shadow inventory built up during the boom days.

Commercial vacancy rates in the west have been drifting down for the past few years in the office, industrial, and retail sectors.   Apartments, however, seem to have plateaued around 4.3% at the end of the 3rd quarter, and are forecast to rise a bit to 4.7% a year from now.  I might posit that historically, profit-maximizing apartment vacancy rates have been found to be somewhat higher than these numbers, so apartment managers and owners may have some lee-way to continue building.

The 5 western maritime states are very export-driven, and the strength of the U.S. dollar (up about 18% against major currencies since 2014) has been rough news for those markets.   While western state exports rebounded nicely from the trough of the recession (up about 17% from 2009 to 2010), export growth has flat-lined since 2012.   Regionally, exports declined about 2.5% since last year, with positive growth reported in only four states (Arizona, Hawaii, Nevada, and Utah).  Bellweather California saw exports decline 3.6%.  Note that in Washington, my semi-home state, exports make up 21.2% of the gross state product.  (We export things like big trucks, big airplanes, software, and agricultural products.)  Hence, this is critically important stuff.

The remainder of the report focuses on the health of the regions banks.  I’ll leave that up to the reader if you care to download your own copy.  Short answer, though, is that the region has seen loan growth accelerate even while the nation as a whole has flattened.  Further, the regions banks tend to be a bit more efficient in terms of expenses and staff, both compared to the nation as a whole and compared to the “boom days” pre-recession.  Both small and large commercial borrowers generally reported tightening credit standards at the end of the 3rd quarter, which is a change from previous reports.  However, consumer borrowers (residential mortgage, credit cards, and auto loans) generally reported easier standards.  The bulk of loan growth for small banks (under $10B) came from non-farm non-residential, while for large banks the biggest growth sector was in consumer lending.  The percentage non-performing assets (the “Texas Ratio”) in the region, which peaked at 38.9% in 2009, is now down to 5.4%, although still higher than in the 2004-2007 period.  By comparison, the national peak hit in 2010 at 19%, and is now standing at 7%, also higher than pre-recession levels.


PWC’s Emerging Trends in Real Estate for 2016

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Ever since PWC acquired Peter Korpacz’s excellent quarterly commercial real estate survey, they have really leveraged that theme into a great regular read.  Along with my subscription, their annual Emerging Trends just landed in my in-box, and it’s a really excellent read.  (To access a copy, just click on the link above.)  The report is a must-read for anyone in real estate, particularly in the investment or finance side.  I’ll skip to two of the summaries — one they call “expected best bets” as well as the capital market summary, to give you a flavor of their report.

Expected Best Bets — PWC recommends, “Go to the secondary markets”.  They note that gateway markets have pricing problems, while the “18-hour cities” are “…emerging as great relative value propositions.”  They particularly cite Austin, Portland, Nashville, and Charlotte.

PWC also discusses “middle-income multifamily housing,” and notes the solid business opportunities providing creative answers for what they call the “excluded middle” households.  PWC also encourages planners to re-think parking needs, in light of the changing demands of “live/work/play downtowns.”

On the securities side, PWC notes that many REITs are priced well below net asset value, providing an interesting arbitrage opportunity in 2016.

Capital Markets — PWC opens by noting, “In many ways, it appears that worldwide capital accumulation has rebounded fully from the global financial crisis. The recovery of capital around the globe has been extremely uneven. And the sorting-out process has favored the United States and the real estate industry, affecting prices, yields, and risk management for all participants in the market.”

Whew…. I’m usually loathe to quote so much from another’s work, but I simply could not have said that any better.  PWC quotes one of their survey respondents, a Wall Street investment advisor, who says, “There is going to be a long wayve of continued capital allocation toward our business….”

Survey respondents largely were split on short-term inflation, with about 40% predicting modest increases and 60% looking for stability at current rates.  However, when they look down the road 5 years, 80% of respondents look for modest increases in inflation.  Coupled with that, over 60% of respondents think both short term interest rates and mortgage rates in specific will rise next year, and nearly 80% think such rises will occur over the next 5 years.  Intriguingly, a small but significant minority — about 20%, believe rates will rise substantially over the next 5 years.  Almost no one believes rates will fall, either in the short-term or the long-term.

To sum up the capital markets view, PWC says the general spirit of the industry is positive, albeit with an eye toward risk.  Many are calling for a “long top” to this recovery, but many are also taking defensive postures by shortening investment horizons, paying more attention to the income component of total return rather than the capital appreciation component, and moving down the leverage scale.

As always, I would stress that I am citing a 3rd party source here, and nothing in this review should be construed as investment advise.  That said, PWC’s Emerging Trends is an excellent read, and I highly recommend it.

Have I written about Thomas Bayes yet?

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I had the very real pleasure of speaking at the Appraisal Institute’s annual meeting this past July in Dallas, and indeed I’ve been asked to speak there 3 of the past 4 years — a great group and a very well-done conference.  My topic this year was on “Practical Statistics for Practicing Appraisers”, and given the need for continuing education credit, my talk was scheduled for two hours.  Unfortunately, two hours is either w-a-a-a-a-a-y too much time, or not nearly enough, depending on what you want to do with it.

About the only thing I could do was touch base on a dozen or so different useful topics, talk about the highs and lows of each, and point the audience in the right direction to get more information.  One topic I wish I’d spent more time on was Bayesian Statistics, a little-known and under-appreciated branch of statistical inference which, in fact, has significant every-day impacts on how we analyze (or at least SHOULD analyze) data.  For example, let’s say that I want to determine the house price trend in a particular town, and have no idea what that trend looks like.  I’ll want to construct some sort of “best linear unbiased estimator” (such as a time-series regression) to help me sort all that out.

However, what if afterwards, in that same town, I’ve already measured the overall property trends, but now I’m told that half of the town is known to be contaminated.  Do I still want to use the same estimators, or should my methodology be informed by what is now “prior knowledge” about both the existence of the contamination and the overall price trend in the town?

This use of prior knowledge falls into the category of “Bayesian Statistics”, or “Bayesian Inference”, developed by early-18th century theologian and mathematician Sir Thomas Bayes.  In short, Bayes noted that our inferences could be improved by the existence of prior knowledge.  What’s more, when we’re conducting a Bayesian investigation, our data gathering is anything but random, since we’re seeking data based on our prior knowledge of the situation.  In the contamination matter, I may want to look at price trends for homes in the contaminated neighborhood versus price trends for homes in the non-contaminated neighborhood.  Naturally, I’ll only focus my attention on properties that have actually transacted, which leads to a common problem in this sort of analysis where properties that have not transacted (which may contain different information) are not part of the data set.

Unfortunately, a lot of practical appraisal — particularly in the residential setting — is heuristic, and over-reliance on “prior knowledge” can lead to a level of sloppiness.  That said, a rigorous application of Bayes’ principles, and careful analytical techniques, can allow appraisers to actually develop statistical measures for their valuation work.

Written by johnkilpatrick

August 20, 2015 at 11:26 am