Rent Control

The article is from 2000, but turns out that there are certain topics where Mr. Krugman and I have no disagreement.

The Liar's Ball

The subtitle is The Extraordinary Saga of How One Building Broke the World's Toughest Tycoons and the author is Vicky Ward (2014).

Another happy marriage of New York City and real estate history, this time focused on Harry Macklowe's short tenure as owner of the GM Building.  As a bonus, it's a story in which the President-Elect also has a fairly major supporting role (largely to his detriment).  Lastly, it introduced me to a great quote from one of my investing heroes, Sam Zell:

"As good as [most] real estate guys are as transactionalists, that's how poor they are as conceptualists.  That's why they keep getting caught in oversupplies.  Because what they do requires such a micro focus, their ability to then go macro is limited."

Highly recommended.

Checking in on an old friend

Courtesy of The Real Deal:

“Jonathan Gray thinks people are getting too worked up about interest rates.

“There’s a (false) sense that owning real estate is the same as owning a bond,” Blackstone Group’s real estate head said in an interview on CNBC Tuesday. “Real estate, like stocks, can see earnings growth. And that’s what we’re seeing today because of favorable fundamentals.”

As the Federal Reserve readies itself to raise short-term rates later this year, many in the real estate industry worry that higher short-term rates could spill over into higher long-term rates, which could increase the cost of financing and put downward pressure on property prices.

But Gray argued that rising rates don’t have to be bad for the real estate market since they tend to coincide with improving fundamentals – such as employment and income. He pointed out that the real estate market “did OK” in previous eras of rising rates.

“We don’t expect to see the growth in value in the next couple years that we’ve seen in the last four or five years,” he admitted. “But we don’t expect to see some sort of sharp decline in the near term.””

It’s worth paying attention to the guys at Blackstone, as they are the biggest of the big in institutional real estate. And his logic about real estate having an ability to increase rents does distinguish it from bonds. BUT…we are dealing in unchartered territory when it comes to central bank policy, and part of what has driven recent pricing in real estate is the interest rate environment that we live in. As such, many folks have increased their allocation to the space because of its financialization and as an expression of an alternative to traditional fixed income. So, Gray may be right, but there is a lot more going on that muddies the waters in terms of what comes next.

Hello

In the great void that has been my absence from this site, I have read a grand total of two books.

The New York Nobody Knows: Walking 6,000 Miles in the City by William B. Helmreich (2013). An interesting idea put into practice by a sociology professor at CUNY – he attempted to walk every block in the city over 4 years. Some interesting encounters along the way and a description of how there is a real change in cultural dynamic and feel as you move from neighborhood to neighborhood. An interesting statistic is that the Jewish population in the five boroughs has decreased over time from 2 million to about 1.2 million.

Public Housing That Worked. The subtitle is New York in the Twentieth Century and the author is Nicholas Dagen Bloom (2008). As the title should suggest, the author believes that NYCHA’s version of public housing has been far more successful than in other cities because of the greater emphasis placed on implementing practices of competent property management. That is the case in spite of high-rise buildings (which are not ideal for a troubled and drug-addled population), political maneuvering by other city agencies that served to undermine the tenant selection process (and therefore the average tenant’s ability to pay rents), and the federal government’s decision over time to reduce support for public housing nationally. Far from perfect, but better than most.

Reimagining Midtown

I thought this article was a pretty cool look at the future skyline of midtown Manhattan.

Interesting Links

-I read John Mauldin regularly and his group holds an annual conference where a bunch of well-known investors give speeches. This year’s recent fete included Kyle Bass – and here is a good summary of what he had to say about China and Japan. In particular, short the Yen.

-I thought the title of this new Kuppy article was a play on “Cash Again”. In fact, he makes the bullish case for oil – a position that we at The Binary Trade share, especially in light of recent news about the Monterrey formation in California.

-I am bullish on NYC real estate. These short pieces (here and here) from The Real Deal over the weekend outline some of the reasons why.

Lessons

The deals that don’t happen still provide lessons to carry with you. And so with that as prelude, even as I haven’t yet done a first deal for my new venture, there is an education that I’ve received already.

(1) What institutional partners focus on when it comes to development projects is not the stuff of engineers and construction managers. If you can convey what the project will be, and a basic sense of what it cost, you’ll be able to check most of the boxes and sound professional.

(2) Lawyers are a terrific source of deal flow. With title guys and mortgage brokers also a useful contact.

(3) New York is its own world when it comes to deal process and the benefits of being a seller.

(4) Working for yourself means constantly thinking about your goals and how to achieve them.

(5) If you happen to be a bit reserved, you’ll have to find a way to get over it. Real estate is a relationships business. No way around it. If you don’t have (or alternatively go out and find) the relationships, you’ll never see anything worth buying.

(6) Brokers are generally a waste of time.

(7) Be constantly curious about the markets and asset types that you want to focus on.

(8) Know that doing a deal often takes time and a few iterations. You will look at plenty of stuff before the pieces finally come together.

(9) If you partner up with someone, being able to trust him is more important than anything else he might bring to the table.

(10) You never know who or where the next lead will come from, so always take the meeting or call when someone wants to meet you.

Around the Web (and other notes)

-This week’s edition of Asia Confidential highlights why South Korea is a stock market to watch. There is a current account surplus and an innovative population – but the part I’m focused on is the likely and eventual unification with the North, and all that brings with it.

-I feel this 2009 piece from George Friedman on Russia and Ukraine offers good insights into the current situation.

-As mentioned before, I am trying to build my own real estate firm, focusing on the markets and opportunities that I deem the most interesting and profitable. In a seller’s market, it is challenging to get stuff done. But, with each deal that we get close on, I’m learning something and continuing to build out my network.

Still Here

I have been focused on other things lately, leading to no new posts in quite a while. I am working towards a goal and it takes up a lot of time, but satisfying time at that. Nevertheless, I did want to mention a couple of things that I’ve read recently that were interesting:

-First up is a blog post that talks about the experiences of two entrepreneurs who started a real estate investment shop about 4 years ago while still in grad school. It has now grown to a $400M portfolio. I imagine there might be some lessons in there for someone like me.

-From The Real Deal, with the condo boom in the City and other conversions going on, the stock of Class B office in Manhattan has been on the decline. Which means such assets make for a compelling investment simply on the basis of supply and demand.

-John Mauldin takes time in his weekly piece to examine the recent CBO report about Obamacare, and how the legislation will likely lead to people working less, given the taxes that will function as a disincentive. So, for those concerned about wage stagnation relative to productivity, get ready for it to become even more pronounced. Which means a drop in GDP – which, by the way, means a drop in tax revenues to pay for the government. So much for smaller deficits.

Family Secrets

The subtitle is Secret Strategies for New York City Multifamily Investing and the author is Peter Von Der Ahe (2010).

As part of my professional transition, I am spending more time thinking about NYC real estate than I have in recent years.  And while this book doesn't offer a ton of new information if you have experience in the industry, it does spend some time on the rent regulation laws which comprise a large part of what makes this market both unique and tricky.  The insight, for lack of a better word, was not something terribly novel, although it was not something that I had thought about either.  Regulated apartments are arguably a hedge in bad times.  Given that they operate at below market rents, even if the economy were to suffer a downturn, cash flow for these units should be immune.  And while I'm not looking to get into the affordable apartment game, the presence of these apartments should not be a deal killer either.

2014

I had to go back and remind myself of the quick list of predictions that I made for 2013. Overall, not a stellar job. Gold is still in a bull market, but it also suffered horribly over the last 12 months. Japan showed the early signs of what I deem to be big problems, but there was no obvious combustion. There was a taper, despite my best guess, and the unemployment rate moved lower (even if everyone now knows it is a bad measure of success). But, shorting the yen was definitely a winner.

On to 2014…

I think the same themes that I focused on then are in play. We have just moved 12 months closer to the point when everyone else will start to realize it.

-Japan keeps approving more “stimulus” because Abenomics does not do anything except weaken the yen and create cost-push inflation. Wages are stagnant.

-Gold has tested the 2013 low a few times. We’ll know shortly, I think, whether that will hold or $1,000 to $1,100 is the landing spot. Either way, a good value exists in the metal and the better mining stocks. Still,  I anticipate that 2014 will be much more generous to the gold bulls than the past two years have been.

-The 10-year closed above 3.00%. That can’t make the Fed happy and is a clear measure of how the bond market is no longer cooperating. Higher rates are bad for housing prices, the stock market, budget deficits, profit margins and all the things that create a desired wealth effect.  So, with all of it, I don’t think the Taper is the thing.

-Finally, on a personal note, I expect my endeavors in real estate to evolve.

A happy and healthy new year to all.

Links

I think Alasdair Macleod provides an interesting take on the taper announcement. To wit:

-The reduction was a token amount and the fact that it sliced away at MBS and Treasuries equally suggests that the decision was one to “pluck a figure out of the air”

-Even if the QE policy was reduced in scope, the commitment to ZIRP remains. And, therefore, implicitly a commitment to providing as much liquidity as needed to keep rates suppressed. Doesn’t that make the two policy announcements a bit contradictory? Or, better yet, QE meaningless in the context of whether or not the Fed must continue to be out in the market buying and selling lots of securities?

Here’s another interesting link – the gold ain’t there.

Speaking of Obamacare, one more requirement has been waved by fiat – namely, the deadline for people who had policies cancelled to sign up or else endure a penalty. This thing is becoming the disaster that keeps on giving. But, the best part is the closing line of a very snarky article: “And the punchline: With only days before the Monday deadline to sign up for coverage that starts Jan. 1, insurers are facing a much smaller, and sicker, pool of customers than hoped for. Like we said: anything that can go wrong... oh look, over there, the Stalingrad & Propaganda 500 just hit a new all time high!”

In Mark Hanson’s latest, he lays to waste the idea that housing is more affordable now than it was during the bubble years since rates are lower and prices are still beneath the highs. The reality is that the exotic financing of yesteryear that allowed people to buy with no money down and no income is gone. Today, the great majority are doing 30-year fixed terms, and the monthly payments are about as high as they have ever been. Factor in at least 20% down, and you should ignore the prior highs on Case-Schiller as to where things could go.

Be the Change You Wish to See

“Even if you’re on the right track,
You’ll get run over if you just sit there”

-Will Rogers

“If you can fill the unforgiving minute
With sixty seconds worth of distance run,
Yours is the Earth and everything that’s in it
And – which is more – you’ll be a Man, my son”

-Rudyard Kipling

Some time earlier this year, I expressed a bit of optimism that my career would change for the better. However, in the months that followed, despite the efforts that I was making, the doors that I tried to open were either locked or stuck. And confronted with the possibility of being somewhere that I did not want to be, I decided to try something different.

I recently teamed up with a friend to pursue a career in real estate on my own terms. Actually, that might be overstating it. There is always someone you have to answer to. And, for us, it will be potential investors as we try to get deals done. But, be that as it may, we are trying to be our own bosses, focusing on the markets that we want to focus on, and operating as entrepreneurs not bound by a rigorous mandate.

In other words, we’re trying to have fun.

Now, it is still very early days and far from clear that we will succeed. But, the tenor (at least for me) has changed. I feel re-invigorated and excited about the possibilities. That’s a good start. And it happened because I agreed to do something that seemed more risky than my straight and narrow demeanor typically goes for. I’m sure there’s some sort of moral in there – maybe that the only route to success is one where your nerves get a little frayed along the way. And no doubt that will be the case. But, that’s alright.

I guess these words are really meant to memorialize a turning point then. So, to bring it home with one more quote, here’s the incomparable Ellis Boyd Redding:

“I find I'm so excited that I can barely sit still or hold a thought in my head. I think it's the excitement only a free man can feel. A free man at the start of a long journey whose conclusion is uncertain…get busy living, or get busy dying. That’s goddamn right.”

Hanson on Housing

I think Mark Hanson is pretty good at explaining the trends in housing. His latest blog post is no different. Here’s the main takeaway:

“Unless exotic loans are reintroduced and widely accepted literally overnight, incomes surge, rates plunge to sub 3%, or all-cash buyers/investors substantially increase market share house prices are in store for period of retracement/mean reversion. And at present, all of these variables are going in the opposite direction.”

Passing Time

Lately, in spite of various frustrations, I have been trying to think through where the opportunities will be in real estate. We’ve discussed my Panama Canal thesis before – but, with that one, in a certain sense it depends of global trade increasing and a growing economy. Put differently, the Third Coast will perform relatively better, but relatively is not always absolutely.

Anyway, I tend to focus on macro trends, then trying to translate them down to specific, investable ideas. One area that has my attention is the direction of interest rates. Given that I believe money-printing will result in a more obvious level of inflation (at some point), it stands to reason that rates will rise. And, in doing so, there will be some opportunities in the debt space, suggesting that the term “distressed debt” could even mean something again. And so it is with great interest that I read the following in a recent WSJ piece about Sam Zell:

“Mr. Zell's breakthrough came when he and Merrill Lynch raised a fund to buy distressed assets just ahead of the early-1990s recession. That downturn differed from the latest partly because banks, thrifts and regulators capitulated quickly on pricing troubled assets, allowing investors like Mr. Zell to snap up enormous portfolios of loans and property at super-discounted prices. This time, lenders have been more inclined to hold distressed assets because interest rates are low.”

If low rates are what is holding this all together (we knew that), then there will be a play at some point. “When?” is the great question of our time.

NYC Housing

Perhaps out of boredom, I decided to research the particulars of rent control and rent stabilization in New York City. I am in no way representing accuracy – and please don’t ever use a blog (especially this one) as a legal reference tool – but these are the basics:

“Rent Control” units represent only about 2% of the total housing stock. It applies to apartments that were constructed prior to 1971, and the tenant has to be living there without interruption since July, 1971. It covers the stories that you hear about elderly folks paying $40 a month for something that could be updated and sold for $10 million. They can be passed down within a family from generation to generation. Once that chain is broken though, rent control disappears. But, breaking that chain can be pretty difficult.

“Rent Stabilization” is far more prevalent and impacts over 1 million apartments in the City (but not co-ops or condos). It applies to buildings with 6 or more units. If you’re a landlord and you make improvements, you can only realize a rent increase that captures 1/60 of your cost. But, once the apartment hits $2,500 per month (based on annual increases subject to regulated guidelines) it becomes deregulated upon vacancy – or, once it hits $2,500 per month and household income is in excess of $200,000 for two consecutive calendar years, it can become deregulated even without vacancy.

Those threshold numbers are based on recent increases – in other words, the politicos are not looking to end the program. And, during the recent election season, the sense one might have gotten is that the candidates would like to make the laws more stringent and onerous. Shocking.

On the other hand...

After my somewhat bearish post earlier today on housing, I figured that the economist in me should come out. So I quote Chris Mayer, who captures a sentiment that I share very well:

“The consensus is that higher rates are bad for real estate. They raise borrowing costs, for sure, and the idea is this will push prices lower. And it may happen that way. On the other hand, higher rates deter new construction and raise the replacement costs of real estate assets. Growing rents can also blunt the effect of higher rates. So it's not a given that higher rates equal lower real estate prices long term.”

Housing

Over the weekend, Mark Hanson came out with his updated views on housing. Obviously, he talks about “housing” as if it is one monolith, yet there is always nuance depending on the market. Nevertheless, I think his overall bearish tone holds merit.

His basic view is that the recent spike in rates is like other moments over the past half dozen years when leverage and stimulus were withdrawn – when high leverage programs disappeared in 2007/2008 and when the Homebuyer Tax Credit wound down in 2010. In the aftermath, there was a crash and a double dip, respectively. Currently, the surge in rates has immediately reduced “purchasing power” by 15% to 20%. The manner in which those low rates allowed housing to become a speculative market again has been ignored by those (the majority) that want to believe in a durable recovery. When you couple those rates with government and big banks trying to suppress supply, through the avoidance of foreclosures, one can imagine why it will take people by surprise again when/if housing stumbles.

His takeaway is that we are likely to see the convergence of “panic sellers” due to higher rates, fewer organic buyers because of lower affordability, and the all-cash PE element continuing to back out of the market.

“What do you want it to be?”

I have been around real estate long enough to know that the process of underwriting a property is about 99 parts art to one part science. In fact, the title refers to the old joke about what to say if someone asks you what the cap rate is on a deal. In any event, in the process of looking at something at work, I came across a situation where total return was going down as the hold period got longer. And there are really only a handful of explanations for why it should happen:

-Expenses are growing at a faster rate than revenues (i.e., shrinking margins)

-Debt is floating rate

-Debt transitions from interest only at the beginning of the hold period to amortizing later on

-There is capex as the hold period gets longer in the tooth that causes the denominator to increase

That’s it. No real reason for the post other than to memorialize a thought process.

Modern New York

The subtitle is The Life and Economics of a City and the author is Greg David (2012). An interesting read about the City, since the mid ‘60s, when John Lindsay became mayor. The takeaway is that the City is at its best when Wall Street is thriving. Therein, though, the author (who was the editor of Crane’s New York Business for over 20 years) tries to note distinctions in the administrations that encouraged growing incomes, versus those who emphasized the role of government to lift everybody up. Again, where the mayor (Koch, Giuliani, Bloomberg) seemed to be supportive of the financial industry, the economy grew. In every case, though, each of the mayors seemed to revert eventually to growing government in order to pay back constituents (whether from the beginning, like Dinkins, or later on, like Giuliani).

The book also touches on rent control. It has become a political third rail and the chances that it is ever eliminated are slim – even though it still operates as a disincentive to development and forces up the rents of market-rate apartments, making the City prohibitively expensive for many. In fact, the chances of the system becoming even stronger are high with the election of a new mayor in 2013.

The other interesting discussion is about the sectors that drive New York’s economy now. Obviously, the list includes finance (which in 2007 represented 28% of all income in the City). But, of great import is also tourism. And, more recently, higher education, the television and film industry, and technology have all become key engines with regards to income and workers. As one anecdote, the 110 institutions in New York have about 600,000 students – roughly the population of Boston, which is itself known as the college town. All of which is to say that manufacturing is not nearly as important as it once was – so, the argument from community groups when a new development is proposed in their backyard, that includes reference to the loss of manufacturing jobs when industrial space is converted, is not really valid given the data.

As a born and bred New Yorker, it got me nostalgic at times, reminded of my childhood when certain pivotal moments in the City’s recent history were mentioned. I enjoyed the book.