Keen's Response

Here.

When Life Gives You Lemons...

If you're me, you probably sulk a little bit before moving on to the lemonade stage.

For a bit of good news today, the pain that I was having in my leg, that had been going on for years and I always assumed to be shin splints, but it had gotten worse lately, was diagnosed as a stress reaction. For those without their medical dictionaries handy, it is apparently an indicator that a formal stress fracture might be coming. However, as I said, the discomfort in my shin had been around for years, so who knows whether that's really the case.

In any event, I like to run. It's not just exercise -- well, it is exercise -- but it settles me and keeps me mostly sane. I can work out and if I don't run, then it feels like I didn't do enough. And because of this injury, I might start to feel that way on a regular basis since I've been sidelined for 8 weeks. I can swim, ride a bike, lift weights, but nothing that resembles impact. It will be an adjustment.

So far I've done two things to battle the demons that I see coming. I got a pool membership and I bought a pair of those special clip shoes that fancy bicycle people wear. As fate would have it, my wife was a pretty good swimmer in her youth and will be responsible for helping me to set up a workout plan in the pool that keeps me fit. As for my gym, they seem to have regular spin classes. And before this injury was even recognized for what it truly was, I had two people tell me that the shoes make all the difference with spinning.

So, there you go. Lemonade.

Stay Curious, My Friends

I like to read. Sometimes investing, sometimes politics, sometimes economics, often sports, because you never know where the next good idea will come from. Today I was reading the website Stratfor, which mostly deals with geopolitical topics, and they made mention of the fact that the Panama Canal has been undergoing a widening project since 2007 that will allow it to accommodate much larger cargo ships coming from East Asia. By implication, the thought is that it will impact the business at port cities throughout the Caribbean and coastal United States. And, as a real estate investor, it seems to me that those are the places where one might want to consider purchasing properties ahead of the project's completion in 2014.

Tails

I have made the argument that I think real estate can be an interesting way to gain exposure to developing frontier markets. Well, we're nothing if not fair on this site, so here is the other side of that coin. The perils, as listed by a successful hedge fund manager whose focus is frontier markets and who rarely touches anything real estate-related:

-Requires a lot of local market knowledge about location, developers, competing projects, etc. that is not really available

-Takes far more effort to analyze real estate stocks than other stocks that are a play on local consumer economy

-Tends to be more problems in real estate stock investing -- valuations are suspect, transparency often not good, promoters sometimes suspect, etc.

-We don't like leverage, and leverage is often required for a real estate investment to work

-The real estate bubble that the U.S. experienced was truly global in scope, even affecting some (certainly not all) frontier countries

-Finally, from a time allocation perspective, real estate simply takes too much time

All considerations that are important. And all of them reasons that real estate is an investment class that requires on the ground research and investigation.

State of the Knicks

50 games in and hanging on to the 8th seed. They are a better team than that, but another recent batch of injuries could put their postseason life in peril.

It only seems appropriate that Amar'e would start to play well and then suffer a back injury that leaves him out indefinitely. His health was always the risk with that signing. And why I wish the Howard trade that I proposed some weeks back had come to pass.

I simply love Tyson Chandler. A fierce competitor, a defensive anchor, exactly what this team needs in the middle. Instead of Stoudemire, if he was paired with a power forward like Serge Ibaka, this team would be a really tough out in the playoffs. But, that is but a pipe dream.

The offensive weapons are there. The consistency is not (even after this 7-1 stretch). They have gutted out some wins (to my surprise), but I'm still not convinced. Should be interesting to see how it turns out.

Ahead of the Curve... :)

This could get interesting.

And my reaction is that I can't help but feel like Krugman is playing stupid in not understanding why Keen makes the argument that he does.

Try, Try Again

I finally finished The Economics of Inflation A Study of Currency Depreciation in Postwar Germany by Constantino Bresciani-Turroni (first published in 1931). After putting it down for a bit to read something else, I found it much more interesting in my second attempt. As the title gives away, it examines the post-war period in Germany and the hyperinflation that ensued. Bresciani-Turroni identifies the increase of money in circulation as the main culprit (prompted by huge deficits from the war, the armistice, the unemployed, etc.), undercutting the then widely held position that it was a balance of payments issue. Like today, the increased money printing did not immediately cause a huge surge in inflation, nor were the effects felt uniformly. In fact, there was initially a divergence between the internal and external values of the German mark which delayed the inevitable. But, eventually, the large amounts of money began to slosh around and (1) precipitated huge speculations in foreign exchange and equities; (2) caused certain industries to thrive at the expense of others (particularly producer goods over consumer goods); (3) temporarily caused unemployment to go down as the industries that "thrived" needed lots of additional labor (although it proved unsustainable and the average wage was not increasing - when it finally did, unemployment started to shoot up); (4) increased the concentration of wealth into fewer hands, and in great measure that wealth was derived from less productive activities; and (5) simply punished anyone living off a fixed income and savers. Essentially, the ideas from economics and investing that live on the fringe today manifested themselves about 90 years ago across the pond. One last point that interested me as an investor -- interest rates actually rose throughout the period, but they did not dampen the impact of the hyperinflation because that rate was even higher (only after the currency stabilization did things normalize).

Ice Water

One more observation about the Knicks-Sixers game. Previously, I have not been shy about questioning whether Jeremy Lin is for real. Last night he impressed me. Arguably, he had a lousy game. But, in the fourth quarter he stepped up, going 10-10 from the line. That's the sort of way that you get in my good graces.

Dee-Fense

That game in Philly was a grind. And they won. Keep proving me wrong.

"Faaascinating!"

I am reading through a new paper by Steve Keen and was struck by the following data points:

"The downturn in GDP was relatively minor -- from $14.4 trillion at its peak to $13.9 trillion at its lowpoint, a fall of just over half a trillion or 4% of nominal GDP...

The downturn in private aggregate demand was much more severe; from $18,4 trillion at its peak in November 2007 to $11.4 trillion in February 2010, a fall of $6.9 trillion or 38% over 2.3 years."

Now, had I followed through on my promised review of important concepts from Keen's book, your reaction might have been the same as mine. However, as I have been lazy, Irving Fisher's debt deflation theory did not automatically trigger, within the context of Hyman Minsky's financial instability hypothesis. And so here we are.

Oh well, I'll get around to it I guess.

Studying the Market

I want to dig in a little more on what you need to think about when surveying a market as a real estate investor. Clearly, the most important part is getting a read on the direction and speed of expansion. And whether it exists at all.

Last week, I was on the road performing such a task. I will leave out names in order to ensure my continued anonymity, but let's just say I was in the periphery of a large U.S. market that has some unconstrained features and a below-trend growth forecast overall. Sounds like a bad start, but it doesn't mean pockets might not exist, and I was there to find out.

The niche in this case was an area that represents the next node out from the already well-developed suburban sub-markets for the city. My read was that the particular location in question has some possibilities, but at the end of the day it would come down to pricing. In other words, while the market seemed to have some interesting retail popping up, the particular property in question was not in the ideal location within the submarket (meaning that its rents should probably be a little bit lower than its competitors, which they were) and the plan of attack, if purchased, should not be to dump money into a "value-add" with expectations of huge rent bumps. Simply put, it was a property in a potentially overlooked area that could be had on a good price per unit basis, and the focus upon taking ownership would be to deal with deferred maintenance issues over anything else. The spread in rents with its competitors would shrink somewhat, and then you could hold the property with the belief that downside risk was mitigated by a good entry point.

So, let's circle back to my original focus. The market is okay with some positive pressure points showing up. But, as we don't expect the larger MSA to have huge upside, caution and restraint must be exercised. Again, the strategy for the deal is different than one where population and job growth is expected to be outsized. And you can only figure these things out on the ground.

Enough for now.

Post Mortem

As I was away when it happened, this post is one more opinion, just later to the party.

D'Antoni deserved to be fired. He is a great offensive coach, but defense is his downfall. Which is why his Suns teams were fun to watch but never really a threat (save for the one year when a little scrum and a couple of suspensions ruined their best shot). Which is not to say all the blame should be laid at his feet. The more I watch them this season (after initially getting blacked-out), it's clear the team is imbalanced and lacks enough guys who make the effort on the defensive end. Basically, when the offense isn't clicking, chances of grinding one out 75-73 are low.

I also think Jeremy Lin is a liability at the point - a turnover waiting to happen. He was fun for awhile, but now he is a marketing ploy more than the player who can run this team. I feel more comfortable with Baron Davis. And to repeat what I wrote some time back, Stoudemire is nothing like the player of last year. Which means his contract could go down as one of the worst in franchise history (Allan Houston's will never be outdone) if he can't turn it around. All of which is why I was willing to trade those two with Tyson Chandler (who I think is simply one of the best signings in recent memory) to get Dwight Howard.

Anyway, they are fighting for the 8th seed and have looked impressive in the last two games. I hope it continues.

Radio Silence

I will be away for the next few days and unable to post until the end of the week. Meaning the NBA trade deadline will have come and gone. My suggestion to the team at 33rd and 7th: offer Chandler and Stoudemire for Howard and Turkoglu. If you have to throw in Lin, do it.

How To Invest In Real Estate

I put this analysis together as much for myself as for my scant readership. Consider it my list of major considerations that need to go into any decision about allocating money towards real estate (primarily large commercial, not single family homes, in spite of some overlap).

Typically, I like to start with a macro perspective, consistent with the cycle I outlined recently. I prefer the larger, more established markets, but the analysis can be applied anywhere. In the particular market in question, focus on whether population is growing and whether employers are creating jobs. That means going there and looking around, identifying the particular sub-markets that have the positive trends developing. For example, Charlotte, NC may interest you, but there are better parts of town than others. And even if company XYZ is opening up a new plant that will create 2,000 jobs there, the positive effects will not be felt equally across the metropolis. So you need to be able to make that distinction. Again, go there, take a map, drive around and mark it up with your comments about the different neighborhoods. You can start to focus your time more efficiently afterwards.

Some of the other data points to factor in:

-Demographics, both locationally and over time. Claritas provides a service that gives you exactly that information. I like to look at population changes and median household income data.
-Economic and rental trends. I usually turn to Reis and PPR for that sort of stuff. You can learn about unemployment, rental growth rates, a hodge-podge.

After doing the above, you probably have developed a point of view on whether you like the market. And now you can start to hammer in on the micro that is more deal specific. (Note: Any deal in any market could seem cheap enough that you potentially skip the macro and head right to the micro, but then it becomes a much more speculative play. Kind of like the guy who buys a stock before earnings, expecting good news and a quick profit.) At this level, you want comfort about prevailing cap rates, recent sales and the type of product that will be attractive to your renters.

-Real Capital Analytics can give you information about recent sales.
-You'll need to shop the competitors to the property you're considering, to see how rents compare and what type of spread may exist or not.
-Is the property in question a value-add play? A mistake often made is confusing deferred maintenance with the need for a major overhaul. Depending on the market in question, and particular clientele, the wrong interpretation can be deadly for your future returns.
-Sometimes the cap rate might be expensive, but the price per unit is very cheap. And if you think the market has good growth prospects, you can still justify the purchase.

I will add to this outline as new thoughts pop into my head. But, generally, this covers a large part of my approach.

On My Mind

-The yield on the long bond has been moving up all week, meaning that I have not yet initiated my short position. Still, it is fast approaching the upper band of the trading range that started last summer, so a drop in yields could be coming. Especially if Bernanke and co. don't announce more easing measures next week. Equally telling, though, will be if there is no further measure announced, the market starts to slide, but bond yields don't drop.

-The yen keeps going down.

-The guy who I work with that has boatloads of experience (I think an appropriate nickname might be the "The Guru") estimates that the multifamily space has about 12 to 18 months before the jig is up, due to the perfect storm of new supply coming online, an actual bottom in the housing market and stagnating income levels that will prevent much more in the way of rent hikes. I don't disagree, but I also know that markets can be highly irrational for far longer than you might expect.

Africa's Resource Curse

I just finished up the Douglas Yates book about African oil that I mentioned a few weeks back. Fair to say that I enjoyed it. The driving objective is an examination of why a continent so rich in resources remains so mired in poverty and corruption. Using each chapter to cover a different angle, and a country-specific case study to extrapolate therein, he lays out a compelling case for why change must come from below and not above. The topics covered include neocolonialism in the aftermath of "independence", failed attempts to implement better governance by outside entities, evolution of rentier states that ultimately create a class of elites that have no interest in sharing oil revenues with their countrymen, and the simple reality that the countries of Africa are artificial constructs of colonial times. He makes a surprisingly strong case for why African states might try to follow the lead of Hugo Chavez in Venezuela, but also recognizes the inherent differences between Africa and Latin America that complicate such a possibility. In any event, I liked it and it provided the necessary relief from my previous read.

The Emperor

I came across an interesting post on Paul Krugman's blog presenting a recent speech that he gave in Europe. I have always found him very intelligent and thoughtful, yet able to raise my ire in the blink of any eye. And in this speech, he pulls off the feat again, in the span of two paragraphs. First, the good:

"It's also normal to think of economics as a morality play, a tale of sin and redemption, in which countries must suffer for their past excesses. Again, this normal reaction is wrong, or at least mostly wrong -- mass unemployment does nothing to help pay off debt. But absent clear guidance from the people who are supposed to explain that economics is not, in fact, a morality play, moralizing became the core of economic policy thinking in Germany, and hence played a huge role in European policy more generally."

I think he's right in his indictment of most economists and politicians who are johnny-come-latelys to austerity as policy. It is a political ploy and it's not based on sound arguments. I think for those who take an objective approach (or try to think like investors, to repeat a theme I've referenced before) it is not about morality so much as simple truth. And therefore disagreement exists over whether Krugman offers as alternative a solution that is really viable and sustainable.

Now, for the other stuff:

"Finally, government officials who hang out with businessman -- and almost all of them do -- naturally tend to be attracted to views that put business confidence at the heart of economic problems. Sure enough, belief that one should slash spending even in a depressed economy, and that this would actually promote growth because it would have positive effects on confidence, spread like wildfire in 2010. There were some economic studies used to justify the doctrine of expansionary austerity -- studies that quickly collapsed under scrutiny. But really, the studies became popular because they suited the prejudices of politicians, prejudices that would have been totally familiar to Herbert Hoover and Heinrich Bruning."

For those who are not from the ranks of the politicized, is that really the case for austerity? I think Krugman is arguing against a straw man, in order to avoid dealing genuinely with the line of reasoning which says that there is no easy and clear path out of this. That perhaps time (and unfortunately some pain) is the only cure. In other words, the argument is not that austerity is expansionary, but simply what we must face. That to try easy money and fiscal planning is likely to lead to more of the same problems eventually. (Yes, Minsky says capitalism is inherently unstable, but I have already raised my concerns about what his theory seems to take for granted and ignore.) And, to make matters worse, Krugman totally misrepresents Hoover. He may not have been hugely expansionary, but his policy response to the crash of 1929 and subsequent depressionary times was to increases federal deficits. Now, Krugman may not think the size of deficits was sufficient, but it is entirely misleading to present the narrative in the way that he does. So, good Krugman, bad Krugman. As usual.

Interesting Day

The market was down. So was gold. But, so were treasuries.

More on Real Estate

I think it should be clear, but with respect to my post yesterday about the sequence of real estate cycles, the precursor to step one could be the existence of lots of resources in the ground. Sound familiar?

Odd and Ends

-I have not yet initiated the previously discussed treasury short. I think that will change next week. My target is the 30-year and I am looking for yields to move down to about 3%. At that point, game on.

-The chart for FXY (Japanese Yen proxy) looks heinous. It has now fallen below the long term trend line that I pointed out a little while back. Which begs the question of whether a bounce is due. Regardless, that short trade has the appearance of picking up steam.

-I am always amused when I see economists try to explain the daily noise in the markets. It's noise. Trying to explain it is a fool's errand. Which brings me to a great quote in the most recent quarterly missive from Jeremy Grantham of GMO:

"Ignore especially short-term news: the ebb and flow of economic and political news is irrelevant. Stock values are based on their entire future value of dividends and earnings going out many decades into the future. Shorter-term economic dips have no appreciable long-term effect on individual companies, let alone the broad asset classes that you should concentrate on. Leave those complexities to the professionals, who will on average lose money trying to decipher them."

Quick and Dirty

My quick little progression chart for real estate investing:

Population growth --> Job creation --> Higher Incomes and demand --> Higher rents

I see an argument for why the first two inputs are perhaps circular and more simultaneous then sequential. Nevertheless, the takeaway is really that if you can identify this cycle and catch it early on, you stand to profit.