The Problems are the Path: Statistics and Probability

One of the most enjoyable classes I had in college were in the Statistics and probability classes.  I must admit my greatest source of successes from these classes in my formative days was Black Jack.  A colleague of mine named Tony, who looked like Tony Soprano and was from New Jersey, and I were so successful at in that in the mid 70's we were told not to come back to Las Vegas.  So it became a rather humorous endeavor when I listened to Economists talk about the various forecasts they had on the economy and where the future was going.

Another  benefit  was in viewing the FED and their attempts to use interest rates to solve and economic situations.  The Federal Reserve of St, Louis published an economic report which detailed the past actions of the FED with interest rates.  I can say, that my interpretation was the FED was alway Behind the Ball.  They either failed to cease their interest rates cuts until inflation started and ceased to act fast enough to stop inflation without aggressive interest rate rises that eventually affect the economy and employment.  They always had the rhetoric that it was being done to stop inflation and its affect on the economy.  Of course, I saw the economy as my neighbors, my parents, my relatives and those I knew who needed to work to earn a living and support a family.  I could never see how some overly educated members of a Federal Reserve, appointed by politicians, who were wealthy and in no need of earning money to support their families.   If they were laid off or unemployed.  They either went back to Wall Street, or an endowment their family established or the academia to write books.  

When the failure of their actions resulted they went back on an Economic term that bailed them out.  We simply know it as "the past is no guarantee of the future".

Through all my years on this planet I too looked at the various formula's and computer devices to forecast the economic future and profit from the forecasts.  "Too Soon Alt and Too Late Smart" is a Milwaukee German emigrant saying.  

The brain we have been given with is far more able to quickly adapt than any computer, silicon chip or formula.  

As we started 2020 the forecasts were for a advance in home prices, then as interest rates rose no growth.  By the time we were into the 4th quarter a negative performance after athe first 6 months had a double digit return.  We ended up with double digit decline.  Some areas in the peninsula had 11% decline in the last two months; while others had no decline for the entire year.  As I look at the Fidelity reports on various towns and cities in the Peninsula I see 25% declines, year on year.

So where does that put us for 2023?  One thing to remember is that stocks, bonds and real estate are not in the same bucket.  Again, going back to college and "Money and Investing", Real Estate is called that because it is your "real estate".  It is the estate you leave in your will.  Stocks and bonds are store of value assets.  Real estate is purchased not for a store of value.  It is shelter, a home, a source of income; something we can see and feel.  We don't need to sell it because interest rates went up because our mortgage is fixed, if we have one.  The rise in interest rates is matched with a rise in income from the  income producing real estate owned.  We use it to grow flowers, vegetables, food products. maybe even entertain ourselves, family and friends.  Shares of companies and bonds pay dividends, interest and are there when we need money for emergencies or planned expenses as retirement, household emergencies and our children's education.  Inflation is great for real estate as it creates increased value from inflation and the income rises due to inflation.  So why is it so BAD?

So where are home values going?  First, I do not see the supply and demand changing since last letter.  I watch the MLS statistics on "new listings". "contingent", "pending" and "sold" on a daily basis.  We started out a week ago at 37 new listings went to 51 and dropped back to 46 as of Sunday  February 26th.  

Homes that were taken off the market in November and December have not come back on the market.  Once we get past St Patrick's Day we may know where we will be heading.  Right now home prices will not be a run away.  More homes will be over priced as owners refuse to admit or realize and or real estate agents are more interested in getting a listing; than being honest with there clients on the real market value of the owner's property.  Home prices are less now than they were last year.  What is useful is that with each decline, no matter how minuscule, the level of prices bring in another level of buyers.  Irrespective of what interest rates are.  Buyers will see the lower price of a home as a good entry point to buy their life time shelter.  Unlike stocks lower prices do not breed lower prices, they breed new buyers!

For those of you who think that I will wait until a bottom occurs you live in a fantasy land of denial.  Homes are unique, they fit individual likes and dislikes. Neighborhoods are also likes and dislikes.  Some neighborhoods are listed very seldom have a limited supply.  The neighborhoods are so enjoyed by owners that the sales are only from divorce, death and relocation.  All three are rare in occurrence.

Yes, there are those who would like to move to another "neighborhood".  They are cautious as the extra money needed to move up are in cash accounts with substantially higher returns than anything in the past 15 years.  Then they need to rationalize to themselves the capital gain taxes, the higher mortgage rate and higher property taxes.  To make that move there must be a very advantageous situation.  The additional consideration is amount needed to make the exterior and interior to the buyer's liking.

Now the interior and exterior liking is the next step in a healthy housing market.  Most buyers DO NOT WANT to remodel, paint and landscape.  This is the opportunistic investor/contractor known as the Fix and Flipper.  As long as the Fix and Flipper are active in the real estate market there is a "Seller's Market".  So far, that has not changed since interest rates have risen. It does not appear it will end soon.

To summarize, do not believe in the statistics and probability of real estate professionals.  Use your intuition, if you like it buy it.  If you want to sell, do not let taxes influence you.  I have too may times found in my life time in investing when a client did not want to sell due to taxes and lost as a result.

I recall a client I had as a stock broker who bought Warrants in Atlantic Richfield at the time of the Alaska Oil discovery.  About a $100,000 in warrants which were the right to buy shares at a set price by a set date.  Any time between now and then they were tradable on the New York Stock Exchange.  Within months his return was over 50%.  I advised to sell as the warrants had only a few month to last.  He refused due to sort term capital gain's taxes.  The warrants expired worthless!  

As stated in my last letter, if you have questions, need help buying or selling property.  Do not hesitate to call, email or text me.

Thank you

Gary McKae

The Problems are the Path: Affordability

 The National Association of Realtors, NAR, creates and Affordability Index on a regular basis.  It really defines how the FED uses certain tools to determine inflation. It also gives insight on how various real estate markets will perform.  I see the CPI as being 30% home prices and rents.

The index is simple, the higher the number the greater the affordability.  The lower the number  the more unaffordable the area.  

Last letter I took a swipe at our state legislature and those who support multiple housing units in all the state towns.  I spent too many years in local politics not to realize that politicians want to get elected.  It is not logic of the laws they pass.  They capitalize on voter ignorance more than voter intelligence.  If the voter based elections on their representatives intelligent work there would be a 99% turnover in all political posts!  In my opinion and experience.

Woodside, as an example, is to put in multiple housing they would need a very large septic system.  The present sewer systems is limited in Woodside by capacity of the sewer project servicing Woodside.  Woodside septic systems are plagued with high water tables which flood septic drain fields.  Woodside has  impermeable soils, that makes the drain field unable to filter out the septic water.  Next is the cost of construction.  An acre of land in Woodside per San Mateo County Health will only tolerate a 3 bedroom 3 bath home's septic system.  5 acres may take five three bedroom/bath homes of 2000 square feet.  Woodside also has a limit on the size of a house to about 6000 SF; therefore, only three houses.  Cost of construction is about $500/ sf for a Home Depot house.  The cost of the land $5 million, if you can find a level one without slope to handle a large septic system, and if the town laws allow the building of more than total 6000 sf of covered area.  The rough total cost is $10.25 million, or $2.05 million per unit.  Is that affordability?

Now we get to Affordability, a score of 100 equals income to needed to qualify.  The Least affordable homes in our area are 1. San Jose, Sunnyvale, Santa Clara with a rating of 38.5 with a medium income of $159K and Income of $414K to qualify for a home.  2. San Francisco, Oakland, Hayward with a rating of 44.3 and median income of $141K and qualifying income of $319K.  

It comes to affordability not on supply to create affordable homes!

Now when it comes to affordability, let's look at those areas that Californians have migrated to.  A score of 100 equals income to needed to qualify: Boise ID @ 114.3, Boulder CO @ 101.3, Charlotte NC @ 153.1, Dallas @ 167.4, Austin @ 137, Houston the new home of HP @ 169.9, Memphis @ 175, Phoenix @ 139, Portland @ 117, Tucson @ 142 all show why Californians have moved out.  In fact; over the past 2 years 700,000 have moved out of California.  

Next to consider is "market vulnerability".  Sorry to the doomsday folks, there is no recession that will collapse our local economy.  Buyers and sellers are in a stand off. Buyers have cash and can pay all cash.  Sellers can hold until economics make them adjust their home price.  That leaves unfordable housing to exodus to areas in California that is affordable or a move out of the State.  Many of my low income buyers are looking at new housing projects of east bay and central valley

The recent 7 days is a clear example of that to me.  Each week this year there have been increasingly less new listings. Sales are eating up inventory.  This will happen until demand out distances supply and price will move up not down with interest rates increasing.  Again this past week I have seen homes that have hung on the market 20-30 days plus and BOOM 15 offers!  Boom; multiple over bids after a price cut or several price cuts. Fidelity Title weekly reports keep all our area in a sellers market based upon homes for sale, inventory and days on the market.

One last comment on interest rates and inflation. I have stated in past newsletters that the FED is looking at Asset inflation more that real inflation.  While many of the media reports focus on prices of eggs, gas, and consumer items, the real issue is asset value.  They are like politician's selling their services not reality.  Nothing to me means more than AFFORDABILTY in housing.  

My additional comment is on the Stock Market. Interest rates increases are a death knell for growth stocks!  Growth stocks pay no dividends.  Go back to the Schwab money market account.  Do you want the volatility on FAANG or a steady 4% return that could go higher?  The FED will continue to raise interest rates in the near future, in my opinion.  I don't think higher mortgage rates will affect buyers, except the potential affordable stressed buyers will move out of state to affordable areas.

There are opportunities here in our area.  Investors continue to look for a home to fix and flip.  Buyers do not want to fix a home and will pay for an up to date interior with new paint and landscaping.  The difference between "what was and what is",  is a handsome profit for the investor.  

As long as those factors remain the same we have a healthy real estate market!

Need Help?  Let's talk!

The Problems are the Path: Clearing the Road Part II

Interest rates rise.  No end in site, YET!  CPI rises, the best Valentines gift for your Lady Faire is a Dozen Eggs.  Price cuts are beginning to tumble out in the Ultra High End and Luxury Markets.   Spec Builders in the Luxury Markets are trying to sell projects on a "To be completed basis".  Once in demand "medium priced homes" are beginning to see price cuts.  The Medium Price of an Oahu Home has now broke below $1 million to $986,000, inventory doubles.  Locally, the real estate forecasts bounce like a drop of water on a hot skillet.  The latest forecast is a rise for 2023 of 1.5%, from a slight decline.  We will not know what the future will bring until 30 days from now. Then, the inventory of homes once taken off the market at the end of 2022 may come piling back on the market.  Real Estate Markets across the Nation are all seeing price cuts.  The once "hot markets" that the "Work From Home" group flooded to are weak.  Slowly there appears to be a dribble back to San Francisco and the Bay Area as the mobile work place returns to the office.  The Commercial Market is in the worst condition I can remember since the Great Recession of the 70's.  Google and Meta are reconsidering their Real Estate Projects in the Bay Area.  Affordable housing is a joke as the homes built cannot be afforded by the income of those on the street.  Progressives seem to think by making Atherton and The Curry Family build an apartment building will solve the inability to pay for housing.  Something wrong with the Economics I was taught here!  That is all we need here is for Atherton, Hillsborough, Portola Valley and Woodside to have "The Projects" to end the Camelot of Silicon Valley.  Good Job to all the Progressive Politicians in Sacramento!  Where Khrushchev failed, you Won!

Keep the faith, you will not have a bell ringing when the bottom occurs.  So buy what you can afford and wish to live in for the next 20 years.  Sellers get off the idea "it always comes back".  Tell that to the fellow who bought Nvidia at $330 per share!

Bond Traders and Junk Bond Investors say...NO RECESSION, as highly indebted companies, the first to go into bankruptcy during a recession, have seen loan prices rally and defaults remain low.

BTW: Happy Valentines!

No greater gift than wife, daughters and granddaughters wishing Happy Valentines!

The Problems are the Path: Clearing in the Road

The problems we have seen in the real estate market started with the aggressive push in values due to cheap money by the FED and the expansion Money Supply of over $9 Trillion to the FED's Balance Sheet.  Today the FED's Balance Sheet is $8.58 Trillion.  FED rates have went from below 1% to 5.25-5.75.  That relates to Morgage rates of less than 3% to a high of 7.3% in 9 months!  Or; $2,500 per month Interest Only mortgage on $1 million to $6,083 per month.  A rather large jump in a period from roughly March 2022 to November 2022.  

In my past commentaries of early 2022, I had forecasted a decline in the average price of homes in the Bay Area which occurred. What did also occur was a decline across the US in home values.  The largest declines where in areas where the "work from home gang" went to live.  San Francisco saw the biggest drop in home values in the Bay area and Rents.  

I was amazed on how well the Santa Clara valley, aka  Silicon Valley, held up and more surprised in the areas that stood firm against price declines.

The supply demand curve from ECON 101 would have indicated that a rise in interest rates would correlate to demand to decrease homes; along with,  price decrease.  Not so in all cities in the Santa Clara Valley.  Of course the outer areas of California that benefited from migration out of SF and surrounding Bay Area Cities, and areas out of the State of California had some substantial declines as the desire to move was negated by costs and job security.

It was my belief, if you are constant reader, is to remember the FED was not really after inflation per se, but after Asset Inflation.  Asset Inflation in terms of Stocks, Bonds, Commodities and Esoteric Investments outside the realm of the Securities Exchange Commission or the Federal Reserve oversight.  The result of the rise in rates was to correct the Risk Free Rate of Return when investors consider investing.  When investors then look at investing they look at what if I did noting.  What would i get in T-Bills and Bonds? Today using the Bond Curve, the yield on 1 month Bills are 4.56%, 3 month are 4.66%, 6 month are 4.88%, 1 year are 4.86, 2 year are 4.45%, 10 year 3.63% and 30 year are 3.67.  What is that yield curve telling you about the bond market's forecast on inflation and interest rates?  To me it is saying that the FED will raise rates  for most of this year.  Thereafter the FED will let the rates alone. within 2 years rates will be lower and 10 years plus no inflation and possibly rate cuts.

Blood letting in high tech growth names have been shattering.  From any of the FAANG stocks to other Techies, they all went to declines have been in high double digits. We started out the year with Media forecasts of lower home prices of 10% or more and negative forecasts on Tech names.  What happened?  The tech stock rallied.  Home prices did not decline measurably in Santa Clara Valley.  The Bond market is forecasting what is reasonable for rates which should be a good indication of mortgages.  Tech stocks were, in my opinion, Short Cover Rallies. That rally maybe short lived as President Biden plans to attack Silicon Valley that has a universal support of a divided Congress.  This is music to the ears of Investment Bankers as they envision Mergers, Take Overs, Spin Offs and restructuring.  The Asset Managers that will be in vogue will be Risk Arbitrage.  For better information on that subject look up Risk Arbitrage on Google and seek out Ivan Boesky's, Risk Arbitrage, a book I contributed to.  Ivan was very clever.  Inside information made him the darling of Wall Street and time in a Federal Prison.

In home prices:

• Rates down: since November, 30-year-mortgage rates fell from 7.3% to 5.99%, lowering the typical U.S.  mortgage payment by $260 per month.
• Sales are up: from November to December, pending home sales increased 2.5%, the first month-over-month increase since May.
• Competition is stronger: in January, 37% of newly listed homes had accepted an offer within two weeks of their debut, faster than at any point since last July.

Supply/Demand has given me a reason for the stability of prices in our area.  78%, per US Census, home ownership in the U.S. is in Baby Boomers.  Baby Boomers are not selling!  They will not pay higher property taxes to downsize or move.  They will not pay high Capital Gains Taxes on sales.  They will wait until they die, or at least one of the spouses die.  At that point there will be a step up in valuations to current market appraisals.  Sales will then create "0" Capital Gains taxes.  What is left is property taxes.  At death proceeds go to heirs and no property taxes.  The end result is home buyers will still be faced with low inventory.  Inventory will increase only subject to Baby Boomer death rates.  Compared to their parents Baby Boomers are in better health.  They have better health care.  They diet and are aware of what they eat and the conditions that are detrimental to their health.

There is one measurement of real estate health that is difficult to follow.   It is the Fix & Flip market.  This is a very difficult market to trace and measure.  F&F buyers directly solicit the Baby Boomer+ market with no commissions, no disclosures, immediate cash payment, no repairs, and move in a time schedule that fits both our calendars and no Real Estae Brokers or Agents.  With that the homes that come on the market on the MLS are once they are repaired and updated.  There is no prior sale in MLS records.  The only method to find out the history is to search County Title Records to discover sales and change of ownership.  This is the most interesting part.  The sale are well below list.  The repairs are noted in the improvements for tax basis and the ownership is not in individual name but LLC or Cooperate entities.  Sales are Cash and there are no mortgages.  As long as this market remains strong Bay Area Real Estate will remain strong.

Buyers will find there is less competition, there will be less over bids, seller's are more realistic in sales prices than the "Pie in the Sky" attitude that dominated in the prior years.  Sellers still have a slight advance  from the sales of homes in and around list price as inventory will remain low!