The Problems are the Path: Recession Part 2

Where do I start?  The layoffs continue in Silicon Valley.  According to Layoffs.fyi, 107,370 workers have been laid off to date in 2024 by 366 tech companies.  Foreclosures are popping up in Paradise as Zillow notes foreclosure on Oahu, the most expensive state in the US per cost of living index.  Locally Notice of Defaults are increasing in the Commercial Sector for the smaller projects where investment groups took too much leverage and now are faced with an expiring mortgage with vacancies, permit violations, red tags and inability to refinance without contributing extra equity for a new loan with rates doubling the previously expiring loan.

Commercial buyers are looking for 7-9% Cap Rates.  Sellers are wanting 5% or even sometimes lower.  Triple Net buildings for Pharmacies, banks, discount shops . That does not include the large Commercial Projects that line El Camino Real in Silicon Valley or the offices of San Francisco and San Jose who are a major subject matter for newspapers all over California.  Will the Dominoes Fall?  Tough question to answer, but with each month of the FED not cutting rates makes things far worst that one can see from the statistics the Federal Reserve follows.

The FED and Mr Powell and other Governors are all saying that a rate cut is imminen.  Wall Street is a 100% certain it is in September.  That make me willing to take a bet with great reward if Wall Street is wrong.  It is like buying a lotto ticket with all odds on my favor not the house.  Why?  July 9, 20024 comments from Chairman Powell....., "But he warned Powell on a pre-election rate cut, saying "perception matters, and so I would just submit to you ...any move to lower interest rates or move interest rates either direction before November 5th could certainly be a bad perception."

On July 17, 2024 GOP Candidate Trump stated...."It’s something that they know they shouldn’t be doing," 

Will a Quarter a point drop in interest rates from 5.5-5.25% to 5.25% to 5% really help?  Of course Wall Street strategist will win. It is take much more for in rate cuts to save the commercial market and help first time buyers qualify.

On world wide interest rates, the International Monetary Fund stated recently that.....The International Monetary Fund said Tuesday that global inflation is expected to come down more slowly in the second half of the year, raising the prospect of interest rates remaining "higher-for-even- longer."

The high end consumer is cutting back as the Wine Buyers are either drinking their inventory or have declared prices just too high.  Per Jeff Lander of SF Chrionicle .......

Limon-Valentine originally listed Cabernet Sauvignon grapes at $9,000 a ton, which many wineries would use for a roughly $90 bottle of wine, but has dropped it to $8,000 and anticipates having to lower it more. If the vineyards don’t get any buyers, she estimates it will be a half-million-dollar loss.

D’Ambrosio’s struggle is reflected in a report released last week from Wine Business, which revealed that June grape sale listings on its classifieds website jumped 93% from June 2023 and are up 113% year to date. For five months in 2024, grape listings have hit a five-year record high. Wineries aren’t renewing grape contracts, and it’s placing growers in a “pretty hairy situation,” said Jeff Bitter, president of Allied Grape Growers, a cooperative that represents 400 growers in California. Growers are forced to continue investing money into farming a crop that might end up on the ground.

This crisis comes with the entire wine industry in turmoil. Global wine consumption is declining, and growers are ripping out their vineyards en masse due to a yearslong oversupply. Bitter has urged the California wine industry to remove 50,000 acres of grapevines statewide to correct the oversupply issue; thus far, he estimates about 30,000 acres have been removed this year."

The most disturbing forecasts are coming from Zillow.  The service most buyers, sellers and even residential real estate agents look at.  Zillow's one year forecast is down! -3% for Redwood City CA, -3.3% Belmont CA, El Dorado Hills CA -1.3%, Cool CA -1.9%, Granite Bay CA -2.2%, Reno NV -1.5%.  Those are just a few as most of Silicon Valley from Woodside to Atherton Los Altos are all forecasted for negative returns in FACE Of a Sellers Market from Media and Real Estate Sponsored sites.  There are some bright spot as Scottsdale Arizona has a +4.4% forecast and a pop in Pinehurst North Carolina...golf any one?  That's if you can tolerate 125 degrees in the summer or 89% humidity while you play the famous Pinehurst course, home of the PGA.

I still believe rates will be cut after the election.  Cut aggressively to stave off further economic deterioration.  Don't expect it to last.  If Trump is elected and he gets the Red Wave taxes will be cut, tips will not be taxed and revenue needs a strong economic recovery to offset the loss in Government Revenue that will doubtfully be offset by higher tariffs.  I pray the GOP can accomplish it.  Otherwise; high interest rates will come from larger debt offerings to offset budget deficits that will require higher interest rates.  On the plus side Clinton did with the help of his predecessor the GOP states.

On a long term basis real estate will still be the best hedge as we watch as the Mighty Seven are sold off as investors shift to defensive stocks and Trump stocks of his commitment to MAGA.

BUY or SELL, and What?

A recession has a historic precedence of being the best time to buy asset that will appreciate.  The first question is what asset?

The are two basic asset types, Income and Appreciation.  The question is stocks, bonds, gold, Bitcoin....What do you buy?  

Recessions have an effect of depreciating an asset, until the Recession is cured.  When you look at depreciating assets the first thought is commercial real estate and the losses due to the Work From Home Movement as a result of the Pandemic.  It goes further in that regard.  When interest rates collapsed and a mini depression was rapping on our economy's door, interest rate were dropped to near Zero.  The sector of a market that prospers on low interest rates is Growth.  Now let's look at what is growth and was is income.  It is easy to see stocks that are considered growth.  The first thought my reader may have is Nvidia.  Correct?  What a run along with all the AI stocks.  A run that was in the face of higher interest rates and a plateau of high interest rates.  By all standards in Fundamental Analysis high interest rates are the death Knell of Growth Stocks, especially technology stocks.  Yes, yes I know, there is a New Normal.  Or is there?

Let's walk away from stocks and think about real estate.  Growth is Single Family Residential, Income is Commercial Real Estate.  Like Nvidia single family real estate has skyrocketed in value in face of higher interest rates, higher mortgage rates and suitability and debt coverage ratios.  But like Nvidia and the other AI and Growth Stocks that have dominated CNBC and other financial medias interest rates will sooner or later make holders re-examine their portfolios take profits and readjust portfolios into the lure of safe and secure high yielding cash instruments.  Another set will look at dividend and value stocks.  Then too the real estate investor will look at selling growth and buying income properties.

This is where investors should look for their investment portfolios.  Income Producing Real Estate. The choices are numerous from Multi-Family properties to  office buildings (small and large) shopping malls, Properties leased to well known highly regarding and investment grade companies like Tesla, Starbuck, JP Morgan/Chase, 7 Eleven.  The returns are varied from 7-9% to 5-5 % and in between.  All of which have the ability to increase rents, thus increasing Net operating income and increasing return on investment which in turn increases the value of the underlying property.  Not much different than Apple which increases its dividend buys back stock and creates value from their product and their allocation of profits to shareholders.  Your choice is Apple in Real Estate or Nvidia?

Recession is the time to buy long term assets that have stability and potential to appreciate due to their inherent growth.  There may be an opportunity with President Biden dropping out of the 2024 Election.  The democrat agenda is a universal Rent Control Amendment.  How many Single Family institutional and individual owners of rentals will give that as a sign to sell? 

A final comment on residential real estate.  Price is not the issue, mortgage rates are the issue. My former home in Woodside sold at $1.8 million went to $3.5 million during the interest rate decline.  Interest rates at $1.8 million was just over 7%. The interest cost on the home then was over $10,000 a month.  At $3,500,000 the interest cast was about 3% or $8,750 a month.  It was over priced at $1,800,000 and under priced at $3,500,000.  More people could afford it.  Today at 7% the cost is still $3,500,000 with a 7% mortgage rate or over $20,000 a month in interest.  Get the point.  It is the cost of money than create affordability not price!  That is also why the owner who has a 3% mortgage rate at $3,500,000 will not sell.  All those who have 3% mortgages will not sell.  The price of their home would have to depreciate by 2/3 just for them to be able to buy an equivalent house at high interest rates of today.

Now let me give you the difference in Commercial rates and why I think they are a buy.  I can get a 7% return on equity, cash on cash for a non residential commercial property.   Say and storage facility or Car Wash.  I can get a 6.5% loan with a 35% down payment over a 5 or at max 10 year term.I can make 7% on my 35% down payment and .5% return on the debt.  I 2will make 9% on the borrowed money and 7% on my investment for a 7.9% rate of return.  I will still have ability to earn more from car washes and storage facility because there is no risk of Rent Control!

Interest Rates will take a long time to come down in the future.  go to the FED history on line at the Federal Reserve of St Louis website to see my rational.

As before, call or write for any question you may have and think of me of your "in the know real estate professional".

The Problems are the Path: Recession!

Recession: " ...a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarter", from a 17th century definition it is, "...a temporary suspension of work or activity".  The Present Day standard needs measuring devices or formulas, the 17th century is simply put and to know that there has been a decline in business is easy to experience without a Economist declaration.

I have found that the best place to see the beginning of a recession is the reduction of spending by the "Nouveau riche".  There is no better place to determine a recession other than to look at Bordeaux Future Sales.  The premise on Future Sales is from the en primers of the Bordeaux region who sell futures in spring after a harvest.  They get cash up front to finance the next crop and the consumers get a discount on wines that will be bottled two years later.  China was booming the World was booming and then the Pandemic, Then President Xi became Chairman Xi and the demand collapsed.  Futures prices were higher than the bottled wine from years 2022, 2021, 2020, 2018, 2017.  I imagine you can add Ukraine, Iran and its subordinate groups to the problems the issues of evolving nations in Africa battling Islamic groups.  2023 futures are down 12%-49% depending on which of the chateaux you favor.    

In real estate the evacuation of office buildings from the Pandemic was followed with open apartments from the movement of employees who could work from home to more enjoyable and less expensive locations.  This in turn created growth in areas once affordable and out of the way: within our state South Lake Tahoe became an ideal location to ski and enjoy the lake but still be able to commute when absolutely necessary to the Bay Area.  Texas, Florida, Utah, North Carolina, Arizona, Nevada and even the shores of a island in the State of Hawaii became destination points for the new economy.

New economies have their price.  For lease signs became more prevalent in the Bay Area.  Newly built apartment complexes in the Bay Area were offering free months rent, their benefits included pools, exercise room, conference rooms, patios with grills and picnic tables, wifi and satellite communication to mention a few.

CVS and Walgreens, along with some discount stores began to shutter up.  Banks closed branches and consolidated.  With the closure of the former small business closed from the lack of patrons: restaurants and family stores were among them.  Bank of America has announced plans to close numerous branches nationwide in 2024 as part of its ongoing efforts to consolidate its physical locations due to the rise of online banking.  In 2024, Citibank plans to close approximately 60 branches across the United States, with the majority of these closures occurring in California. This is part of Citigroup's broader strategy to consolidate its physical footprint due to shifts in customer behavior towards digital banking and declining foot traffic at physical locations.  JPMorgan Chase has closed several branches in California recently. Following the acquisition of First Republic Bank, Chase closed 14 First Republic branches in September 2023. Additionally, Chase announced further closures of 22 First Republic branches, mostly in the Bay Area, in late 2023 and early 2024​.  Overall, Chase has been reducing its branch network in response to changes in customer behavior and the rise of digital banking. This trend is not unique to Chase, as other major banks, including Bank of America and Wells Fargo, have also been closing branches nationwide​.

While economist point to the inverted yield curve as an indicator of a portending recession, they fail to look beyond the books to the streets of the city or town they are in.  We are in a recession, a rolling recession.

This type of recession will be harder to view from a text book analysis.  It is a common man analysis.  The stock market chugs on to new highs, bond have done very well.  Underneath those indicators we have problems that will lead to the path of recovery.

The commercial Real Estate market is the best measure.  A recent sale of an office building in Silicon Valley for $17 million was compared to the cost not more than 3 years ago of $37 million.  

The smaller commercial market of offices and malls, banks and restaurant buildings, CVS and Walgreen buildings, Bargain Centers are overwhelming the inventory of smaller commercial properties for sale, nationwide.  An inventory that the common man does not see.  No MLS.  

The residential housing market continues to evolve higher in price as Baby Boomers and those fortunate enough to refinance their home when mortgage rates were in the 3% level will not sell. The question is, are home overvalued?  Greg Ip of the Wall Street Journal, Friday June 28, 2024 puts that same question to the reader.

• Homes are as overvalued as they were near the peak of the 2000's bubble, according to a variety of metrics, including the Federal Reserve model
• Homes are assets, and overvaluation is a predictor of stagnant, even negative, real returns in coming years, a headwind to anyone counting on real estate as a source of wealth.
• Valuations are stretched by S&P CoreLogic Case-Shiller U.S. National home price index.  Up 51% since the end of 2019.
• The stream(s) of income generated from an asset are: living there which can be measured by the cost of rent of a similar property home.  Since the end of 2019 rent is is up 24%. That is a lot but far from the increase in home prices and the cost of the monthly mortgage payment which is up 114%.
• Since 2019, 10 year interest rates have moved from 2% to 4% a factor in the higher cost of mortgage payments.

A model in the Federal Reserve's semiannual financial stability report shows homes are 25% over valued.  That is just below the 28% peak in 2007. 

John Burns Research and consulting says relative to history over valuation is from 24% in Northern California to 37% in Southern Florida.

Over valuation in Homes are the same as stocks.  Over valuation can continue for some time more than when first discovered or commented by writers like Mr. Ip.  

Demand exceeds supply by 2.1 million units today.  In 2009 demand exceed supply by 1.9 million units.

Burns Research goes on to state 74% of Metropolitan markets are high risk for investors right now.

High Stock Prices can be justified by earnings, home prices are justified by rents.  If rent growth stops or stabilizes; home prices like stock and earnings will be subject to adjustment. 

DON'T EXPECT REAL ESTATE PRICES TO COLLAPSE AS THEY DID FROM 2009-2011.  Since then income and appraisal standards have become more stringent, credit scores are higher, especially at the bottom end.  Foreclosure prevention is more effective.  90% of mortgage backed securities are Federally Insured.  Leslie Goodan a housing finance scholar at the Urban Institute has stated, "You will not have the big price declines because you've taken out the contagion effect that caused them"

To substantiate that thought Goldman Sach, Blackstone and similar monied organizations have created and solicited multi-billion dollar funds to lend to those owner's of real estate who need help and are financially stressed due to old loan due with cash flow from vacancies.

We are not in a crisis market as we once were.  Opportunity will present itself to investors who are willing to search and investigate.  Buyers of residential properties will find opportunity by working diligently under new Buyer Broker Agreements and Retainers with experienced career agents.  For every listing either commercial or residential that sell, there at least 3-4 others that are overpriced and will find price cuts.  The rest will sit and wait until they too either cut or run of market.  In the Bay Area Price Cuts have averaged double digits in the 20% level with the greatest cut of +40% in Woodside!

As before, call or write for any question you may have and think of me of your "in the know real estate professional".

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