From a small northwestern observatory…

Finance and economics generally focused on real estate

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

Why I’m not that worried about Greece

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Pundits (and yes, to a degree, I’m one) have taken every position possible over the Greek debt crisis.  I’ll toss in my 2 cents, and hopefully I’ll add a bit to the debate.

First, I’ve never been to Greece, but one of my colleagues from Greenfield just came back and brought me a bottle of Ouzo (than you, U.S. Customs Service).  Also, I had a nice lunch at a Greek restaurant a few days ago.  As economists go, that must count for something.

Here is Greece’s problem in a nutshell — as a stand-alone economy they suck.  Their people are old, the bright young folks go somewhere more productive as soon as they are old enough to read a map, other than feta cheese they don’t export much of anything, and there simply isn’t enough austerity to balance the budget.  Hence, they’ve hocked everything worth hocking right down to the scrap value of the Parthenon to pay for social services and little things like food and medicine.  Additional austerity (demanded from what passes for the right in Europe) will salve the wounds for a while, and additional high living (essentially a non-starter, but none-the-less demanded from the left) simply isn’t in the cards.  The credit cards are maxed out and the repo man is backing up into the driveway.

By the way,  Greece has roughly the same population as Ohio.  Greece’s most important industry is tourism, which accounts for 20% of Greece’s GDP and employs one out of five people who actually have jobs.  In 2014, tourism was an estimated $12 Billion slice of the economy.  However, to put that in perspective, Ohio’s tourism is estimated at $40 Billion per year.  You see?  The most important thing in Greece is about a 4th the size of one of the least important things in Ohio.

We don’t really think about it here in America, but if the 50 states tried to exist as separate nations, some would die on the vine and others would prosper very nicely.  (Although, to be fare, the worst unemployment in America, West Virginia at 7.2%, sits right in the middle between the two healthiest economies in Europe, France and Germany.)   We don’t think about that because of the crucible of the Civil War, which you may have read about in your history books.  Not withstanding some of the news from South Carolina lately, the Civil War was about several things.  Slavery was at the top of the list, for sure, but southern “heritage” types (and yes, I was born and reared in the South) would posit that it was all about states rights versus the central authority of Washington.  Let’s go with that for a minute, just for the sake of argument.  Let’s assume that was the central theme of the war.  How did that turn out?  Huh?  Turns out, the north won.  America was one nation, undivided, period, exclamation point.  Along the way, we’ve made numerous economic decisions which would not be rational if we were 50 separate nations, but make perfectly good sense in the long shadow of the Civil War.  Hence, some states don’t pull their own weight, economically, but we drag them along, sometimes kicking and screaming, as the rest of us march forward into the economic future.

Europe also had a recent crucible.  Indeed, one might think of the 20th Century as one long, amazingly painful period.  It essentially started with the “War to End All Wars”, and then a massively painful depression, followed by, “War, the Sequel”, and then followed by, “Let’s all count down to nuclear Armageddon” as the superpowers stared each other down across Germany’s Fulda Gap.  By the time the Eurozone was created, thinking people in Europe were willing to do whatever it took to unite the continent and make sure that the casus belli of the past no longer existed.

So, that takes us to Greece.  One might not think of Greece as being a focal point, but that would be short-sighted in the extreme.  Of course, anyone who has studied anything about western civilization thinks of Greece as the fountain of democracy.  That said, it is right at the crossroad of Europe and Asia, and has been central to pretty much every argument in that part of the world in the past two or three thousand years.  More to the point, the reasonably solid economies of Europe look at the laggards with pity but also with fear, because a splintering of the Eurozone removes the warm blanket of unity that staves off the kinds of wars that Europe is all too familiar with.

So, like it or not, Europe will hold their noses and cut a check to help pay for Grandma Greece’s hospice bills.  They will probably make her move to from a private room to a semi-private one, and she’ll have to settle for generic medicines from now on, and eat in the cafeteria like all the other folks, but she won’t be allowed to starve, and she’ll get a card every Christmas, as long as anyone remembers the 20th century.

Written by johnkilpatrick

July 10, 2015 at 4:38 pm

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Wow… where was I?

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I have a habit of not mentioning my travels until I get back — it helps to dissuade burglars if they don’t know I’m out of town.

That said, I just returned to the good old US of A from 3 weeks in Spain and France.  I was the lead testifying expert this past Spring in FHFA v. Nomura (more on that eventually), and headed to the land of good wine and cheese for some much needed R&R.  Of course, it’s impossible for me to travel through two of the great countries in Europe and not think about real estate.  Following are some relatively off-hand thoughts about two countries that share a lot of history with the U.S., and considerable high-level political and economic thinking, but surprisingly little else at a granular level.

First stop was Barcelona.  There is a saying in Barcelona — “it’s a great town if your pockets jingle.”  Unfortunately, I have no basis to disagree.  We were in Barcelona for 4 days, mainly touring the great architectural works of Gaudi.  It’s hard not to like Barcelona if you’re able to stay at the beach — and by the way, Barcelona has one of the best beaches in the world.  However, Spain as a whole is suffering 20+% unemployment (remember that during the great depression, U.S. industrial unemployment never really got higher than 35%) and its no surprise that in last months regional elections, the far-left parties captured control from the center-right parties.  Spain is a spectacularly beautiful country, with terrifically friendly people.  However, their government has never really been able to come to grips with the central problem in Europe, which is how to be relevant in a 21st century economic world.  The leftist view sounds good on paper, but there simply aren’t enough industries and raw materials in Spain to nationalize and gain any sort of short-term traction.  (Of course, in the long-term, such nationalization and confiscatory taxation is self-defeating.)

Next, we headed for Toulouse and tour of western France, Normandy, and eventually Paris.  From a purely tourist perspective, one cannot pick a better part of the world to unwind.  I will note, however, that all too many tourists head for “Paris” when they want to go to France.  Don’t get me wrong — I like Paris.  However, all too much of Paris is geared to the tourist trade, and it’s hard to figure out what to do and what not to do.  For example, the Louvre is perhaps the greatest museum in the world, but it’s packed to the gills most days (although I’m told if you are REALLY an art aficionado, head there in January).  On the other hand,  Musee de l’Orangerie right down the road has perhaps the greatest collection of impressionist art in the world (including Monet’s Water Lilies, around which the museum was built).

For a really terrific tour of France, head for the small towns.  We started in Toulouse, which is actually a fairly major city — the 4th largest city in France and the home to Airbus and significant military and space assets.  However, Toulouse was also the capital of the Visigoths in the 5th century and a center of the heretical Christian movement called Caharism in the 12th to 14th centuries.  The architecture and history of the regions is spectacular.  On top of that, the wine and food cannot be beat.

From there, we headed up to the Loire Valley (again, history, architecture, food, and wine) and then headed over to Normandy to tour Mont Saint-Michel Abbey, Omaha and Gold beaches, as well as Point du Hoc.  If you try to duplicate this trip (and I highly encourage it), be sure to wear comfortable walking shoes.  Between Normandy and Paris you hit the town of Giverny and Claude Monet’s home and gardens. Carve out a couple of hours, even if you are not a fan if impressionism, and plan to have lunch (and yes, French wine) in one of the delightful little cafes in town.

France has figured out the trick to monetizing tourism.  They have a massive infrastructure, at a very local level, devoted to attracting, feeding (and yes, watering), and entertaining tourists from all over the world.  The cathedrals, caves, abbeys, castles, and colorful towns are in first-rate order, and every small town in the country is prepped to handle tourists in season.  The bed-and-breakfasts are first-rate, and the amenities meet or exceed anything you would expect in the U.S.  At the worst, a b&b is small and un-air conditioned, but the food and wine will be better than expected.  At best, a b&b will have a room and service to compete with a top-tier U.S. hotel.

Well, enough about that.  More on the more interesting FHFA v Nomura later.  Oh, and by the way — a tip of the hat to Air France.  What a great airline!

Written by johnkilpatrick

June 13, 2015 at 6:05 pm


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