The Problems are the Path: The FED balks at lowering rates

the Problems are the Path: Foreclosures and Short Sales

The stock market was up over 300 points before the FED made their announcement on no interest rate cut.  Then the follow up by Chairman Powell put the icing on the cake.  The key comment to my evaluation is: "the decision to cut rates would be a consequential one because it could ignite substantial market rallies that boost spending and investments".  There in lies the crux!  The stock market is too high and is feeding spending in their belief.  Real estate is too high and is curbing affordability and fueling speculation in flipping....my comment not FED.  since then the stock market has lost steam and has had negative results.  UP for the week but rally stopped since Powell spoke.

The target levels of 5.1% for end of year 2024, 4.1% end of year 2025 and 3.1% for end of year 2026 are nothing more than target based upon hope....again my opinion!  If Trump wins all the targets are off the table!  Trump has stated he wants or is considering firing Powell.  That would mean a Stalin Purge at the FED to be replaced with Trump Economists.  Trump people want economic growth not manipulations of interest rates to play with the economy.  LET IT ROAR!

If Biden wins Powell and Crew hang on and the FED's target stays in place.

The target is a Recession target.  There is little doubt in my mind that Commercial Real Estate is in for a Purge.  Stalin lives again in Commercial real Estate. While most of you my readers, do not see the market of commercial property as I see daily, the Cap Rates that dictate property values all went up after Powell's speech.  Too many leverage loans in Commercial Real Estate were made during the 2020 era based upon low rates lasting longer that are in need of refinancing.  Property that once had 6% cap rates went to sub 7%, new properties popped out at 7-9%.  The property types are all those who are risk of losing tenants.  The 4-7 unit malls with an anchor tenant like Starbucks.  Retail sector is getting hit hard as the fear of retailers losing to Amazon and Costco; as well as, the eBusiness of Wall Mart and Target.  Banks are closing and consolidating as online banking takes over the need to walk in and see a teller.  Tellers are replaced with cash machines in 7/11 gas stations or small units in Safeway Stores.  Walgreens and CVS are closing and walking away owing lease payments rather than paying for money loosing stores where there greatest competitor is their own store too close to one another.  then add to that other similar competitors too close to one another.

As long as rates remain historically high the ability to refinance remains high when compared to the net operating income.  In most cases there is no" net operating income (NOI)", only a lose.  Banks and lenders do not want office buildings or empty banks and drug chains that are built solely for one type of tenant.  Convert office space to housing is a dream.  The conversion cost would further drive affordability as the building codes would make the cost escalate and another form of NOI negative.

The FED is repairing their balance sheet.  The balance of debt owned is being adjusted to the type of debt and maturity.  While at the same time the Balance sheet is slowly decining.  That mean money is being pulled out of the economy,  Less mone will keep interest rates high which will evenntually cause and collaspe soemwheres in the economy.  The FED knows that and needs to have the ability to bail out again, so the balance sheet repair is very necessary.  

The Governor's on the Federal Reserve Board do not have an enviable position. Damn if they do and damned if they don't.  They then need ot battle with a President and Congress on a SPEND SPEND SPEND budget. That ends up with an economy whose GNP declines and cannot keep up with debt. "What a revolting development", a quote from an old TV series "Life with Riley".

The economy can't start roaring again until real estate and the stock market looses some steam and corrects to a level of affordability and rational value levels.  There is nothing rational about Roarin Kitty and the price of GME stock!!!  Another error in government was to allow less regulation in the Securities industry and let in an open casino for investors without the regulation of prudent action.  

The Problems Are the Path: The Sky is Falling

The Problems are the Path: "Justice for Renters Act" Threatens Housing Market Balance

The potential of the passing of this act will have the following implications:

1.  The act could control properties presently exempt; such as, single family homes and new construction

2. More cities could expand rent control with the passage of this act.

3.  Removing Costa-Hawkins could lead to Vacancy Control in cities with rent control, limiting landlords ability to raise rents.

4.  The Act represents a broader shift of the California Legislature towards stricter housing regulations; thereby, creating uncertainty in real estate  investment analysis.

5.  Uncertainty could upset housing market balance with unfortunate circumstances.

"The “Justice for Renters Act,” seeks to repeal Costa-Hawkins entirely, allowing for strict rent control on all types of housing, including single-family homes and newer apartments. It would also eliminate the ban on vacancy control, significantly impacting landlords’ ability to adjust rents when a tenant moves out and a new renter moves in. Compounding these concerns is the fact that several cities in California have already put triggers in their local rent control laws that would automatically adopt stricter policies if Costa-Hawkins were repealed. This means the repeal could instantly activate more severe rent control regulations in various jurisdictions. For rental property owners, the implications are severe. The potential for strict rent control across all housing types would deter investment in new housing construction, exacerbating California’s already dire housing shortage. This concern is heightened by the fact that about 25 local governments in California have adopted rent control ordinances, several over the past decade, and more potential targets for local rent control in the pipeline. Without Costa-Hawkins, tenant activists would be further motivated to bring more stringent rent control to more jurisdictions." (Mike Nemeth CAA Marketing Director)



This is just another nail in the coffin of single family rental landlords investment property in California.  Add to the the prior enactments of the California Legislature in this housing sector has caused an exodus out of single family rentals to investment real estate outside California, or a migration to Triple Net Leasing Properties within the State of California.



To summarize here are the Five Reasons to be Worried: (Nemeth and McKae comments)



1. Currently exempt properties, such as single-family homes and recent construction, could fall under rent control if the act passes, significantly altering the business expectations for many who believed their investments were safeguarded.



2. Tenant activists have brought rent control to several California cities in recent years. The act’s passage would further motivate them to pursue rent control in cities that currently have none. This would lead to new rent control measures in areas previously unaffected.



3. In cities with existing rent control, the removal of Costa-Hawkins would invite returns to vacancy control. This means that rents would be capped even when a tenant moves out and a new tenant moves in, leaving the owner unable to move rents to market. This would dramatically reduce the flexibility to adjust rents between tenancies. Imagine never being able to bring your rents to market rates.



4. The act would mark a broader shift toward more stringent housing regulations, bringing uncertainty to the rental housing market and affecting long-term investment decisions.



5. The act would lower property values and discourage new housing development, aggravating the housing shortage and leading to a stagnant rental market.



McKae Summary:



The most difficult job for investors and their advisors to comprehend is the slow change will make the value of their properties depreciate.  A good example is the action of East Palo Alto in the past 5+ years.  With the action of Tennant Activists  capped by the Pandemic, halting rent payments, landlords began a mass movement selling their properties at depreciated values to the Fix and Flipper.  The resultant outcome was even higher priced homes in an area that was once considered affordable for the "Blue Collar" workers, immigrants and hotel/motel and fast food worker group. 



The overall impact of this Act will create more unaffordable homes than increase the ability to create affordable housing in California!







The Problems are the Path: Recession, Unemployment, Asset Depreciation...Pick your Poison

My wife refuses to give up her Hair Dresser in Los Altos California.  So every month there is a 3 hour drive to Los Altos, listening to a Books on Tape Disc that make our drive pleasant. I then can drop her off see my doctors, or have lunch with a friend, or drop into a shop and spend about 3 hours relaxing.  This last trip was something of an eye opener. 

I drove past a former client's recently property on El Camino Real in Menlo Park. It was a bad move for him to build a mixed use multi-family unit with 4 commercial spaces.  Built at the same time that car lots were torn down all along El Camino next to the Rail Line with the same concept of multi-family commercial spaces.  He had some great ideas at the time of his venture.  He planned on renting fully furnished units to the hoard of business visitors and out of state employees then coming to the Face Book, Google and related technology firms.  Thereby capitalizing on the need for small start up places.  TIMING WAS BAD! 

A few apartments were rented out long term, no commercial spaces were rented and then finally all furniture was removed, prices cut and units were rented.  The Commercial Spaces are still open.  

As I drove by the signs of an economic pending collapse was evident to me.  Bed spreads covered the windows!  That reminded me of my college days when we students couldn't afford drapes and tacked up bedsheets to keep our apartments private.  

When my wife finished her appointment she noted that there were still 3 chairs open in the Salon.  That the owner had tried to fill the open chairs with no success and was financially struggling.  There were 80 other chairs open in Los Altos her hair dresser informed my wife.  Now for Los Altos the home of a strong housing market and Short DOM for lisitngs and over bids to have wives cutting back on their hair dresser is a bit of a warning shot across the bow!

We stopped at the Los Altos Grill for lunch.  This spot had usually been a busy restaurant.  Where waiting in line or "do you have a reservation was the "ordre du jour".  Easy walk in and get a nice booth.  Waiters and waitresses stood in the rear near the kitchen waiting for orders chatting with one another.  The customer's were spattered around the restaurant with more open spaces than full spaces.

While the Pandemic has been given as a reason for the change in hair habits of women and eating habits of most residents, this is some 2 years after the end.  So there must be more to the story of empty restaurants and open salon chairs in Los Altos.  

Could this be a precursor of a recession?  Damir Tokic a writer for Seeking Alpha, a financial website, recent contribution offer just that: S&P 500 Recession to Hit Just Before the Election.

• ISM Services for April shows contraction in the U.S. service sector, a key driver of the economy, while the U.S. economy added fewer jobs than expected.
• Based on this data, the U.S. economy is likely slipping into a recession in Q3 2024.
• Thus, S&P 500 is facing a recessionary bear market, which could be brutal as the mega-cap tech bubble burst.

The labor market report for April showed that the U.S. economy added only 175K new jobs, which was well below the expectations of 245K. This data, on the surface, points to a slowing U.S. economy.

But more importantly, the ISM Services for April came at 49.4, which indicates that the U.S. service sector is contracting. This was completely unexpected by the market, as the consensus expectation was 52.

This is important because the service sector remained resilient due to the strong consumption, which accounts for 70% of the U.S. economy.

Thus, it appears that the U.S. economy is slipping into a recession.

The recent forecast by ING, which is dated April 25th, predicts that the U.S. Q3 GDP growth rate would be at 0% in Q3 and 0.6% in Q4. This forecast was published before the recent unexpected weak data, and, thus, it's likely to be revised to a negative number.

Based on a normal business cycle, once high inflation becomes unsustainable, the Fed is forced to increase the short-term interest rates above the long-term interest rates to invert the yield curve.

An inverted yield curve creates a restrictive macro environment where credit availability is reduced, particularly to more financially vulnerable firms, which eventually results in less investment and higher unemployment. In addition, higher credit costs reduce credit consumption, which also reduces investment and causes a higher unemployment rate.

Thus, an inverted yield curve generally precedes a recession. However, the effect of the inverted yield curve on the economy has "long and variable lags". This means that it takes time for the yield curve to actually affect the real economy. Generally, a recession occurs 12–18 months after the yield curve initially inverts.

However, the findings show that a deeper and longer inversion of the yield curve produces a deeper and longer recession. The chart below shows the difference between the 10Y Treasury yield (US10Y) and the 3-month Treasury Bill yield (US3M) - that's the yield curve. During the current cycle, we have a record deep inversion, and a record long inversion. Based on this observation, an inevitable recession should be deeper and longer than usual.

So, that's the macro reason behind the expectations of an imminent recession.

The April labor report also came much weaker than expected. The market consensus was for 245K new jobs created, while the actual number came at 175K new jobs created, with an increase in the unemployment rate from 3.8% to 3.9%.

Obviously, the key implication for the stock market is that a recession usually produces a recessionary bear market, which could be a very deep 50%+ drawdown like in 2001 and 2008, or a minor 20% correction like in 1991.

With the correction in the stock market and especially in Technology that drives California there will be weakness in housing price from the resultant loss of jobs and net worth.  Then too, there will be rents declining.  Those units along the Rail Road Track are still looking for renters!

The latest from the FED is that Quantitative Tightening will diminish a bit to about $35 billion a month.  That still means money is being taken out of money supply and rates will still remain high.. High interest rates are like Holy Water to Vampires when one considers Technology stocks.  Even Warren Buffet took some profits in Apple, won't other investors do the same for recent run ups in technology and AI issues?

Expect a Summer Sell Off in the Technology Market and the S&P in general.  Real Estate will see that in reality the Buyers are the Kings.  It may look like a Sellers Market when the inventory is taken into consideration.  When one looks at price cuts it is really the Buyers who are calling the market.. Then we must consider the July ruling in the Real Estate Industry Settlement and how buyers and sellers will handle the market place.  It may be chaotic at first before order comes into play.

Add to that another Kent State, a missile into Moscow, an incident at the 38th Parallel, Tehran miscalculation.  Things could get messy REAL FAST!  Not to forget Politics of Donald and Joe and their supporters and another contentious election and result.

It all sounds like Doom and Gloom, but in reality more a case for an interest rate cut after the election and a number of others thereafter.  

Plan your Summer Accordingly!

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

Where Forth Art Thou Goeth Interest Rates

The Problems Are The Path: Interest Rates and Money Supply

The commentary and forecasting of interest rates have taken a Pivot from confidence that rates would be cut in 2024 to a point that there will not be a cut or the cuts forecasted will be late or slow in occurring.

All attention has been on interest rate commentary and very little if any attention on total FED actions in slowing down the economy.

Of the FED's tools the tightening beyond interest rates can occur in contracting Money Supply. Money Supply takes many forms if one looks at the Federal Reserve's Balance Sheet.  The most visible part the the Balance Sheet are the Assets.  

To save the US economy and the world economy during the Pandemic the Federal Reserve began a policy of Qualitative Easing.  A policy of lowering interest rates and simultaneously buying Treasury Bonds, Mortgage Backed Securities and debt instruments to feed liquidity into the monetary system to help business and the population in general survive the economy that was shut down by the Pandemic.  

On a World Wide Level, the process was copied by most, if not all, of the World's Central Banks.  The Qualitative Easing by some Central Banks went as far as mortgages were negative. Home owners did not pay a mortgage but were paid to have a mortgage. Government Bonds had a negative return.  Buyers of such bonds did not receive the full amount of their purchase. Thus a NEGATIVE RETURN!

All through these times the United States Federal Reserve accumulated over $9 Trillion in assets.  The money supply expanded.  Corporations borrowed heavily at ultra low rates, individuals refinanced mortgages at ultra low rates.

Now we are experiencing the reverse.  Quantitative Tightening. things are going too well, prices are escalating and inflation is or has increased.  The result is lowering rates to stop the economy rolling into a recession.

So far, there is little to indicate a recession.  

There is one item that has not been addressed, the Balance Sheet of the Federal Reserve. While raising interest rates in concept slows an economy down and reduces inflation.  There is one tool the FED has in slowing down an economy that media and Wall Street Economists and Investment Analysts fail to mention.....MONEY SUPPLY.

From over $9 Trillion to the present balance to March 2024 to $7.74 Trillion, the FEDis reducing Money Supply.  Interest rates have remained at the present level since Mid 2023.  During that time the FED has been taking money out of the supply of funds necessary to grease the economy's gears. Since the end of April 2023 the FED has shed $1.53 Trillion through the maturation of debt and sale of debt in the FED's Balance Sheet.  See Details Here

"By going slower we are going farther" said Chairman Powell in one of his recent comments.  Which means that as long as the economy keeps a positive trend and the inflation slowly comes down the FED can control inflation by reducing the Money Supply.  Thus investments in the economic growth will be evaluated on Risk Free Rates of Return as exemplified by the Yield Curve in Bonds.  SEE RATES

By going slower the risk level of speculation comes down.  The demand for higher wages comes down, with the exception of governmental interference.  Conceptually the price of goods come down and inflation comes down.

Frankly, the concepts do not work well when extraneous forces make conceptual theory fail.

We are at such a point.  Commodity prices are increasing.  The price of Oil is increasing.  These are all supply side economics.  Interest rates cannot help supply side economics and neither can money supply.  When Supply Side issues arise money supply reduction only accelerates commodity inflation as lack of supply of money must fight for limited supply.  Then the only alternative is a flip to increasing money supply and lowering interest rates again.  Until supply is corrected and then begin the cycle all over again.

Where are we today?  Far from the FLIP.  We are at the PIVOT.  The Pivot from lowering interest rates to lowering Money Supply.  The next phase is asset inflation decline.  The Dow industrial Averages, the speculation over Artificial Intelligence will eventually lead to profit taking and the placement of proceeds of sales in T-Bills at 5%+ will certainly be warranted.

Now the Big Question for a Real Estate Blog is what happens to Real Estate?  LOWER prices on residential housing is slowly occurring, but in most cases, hidden by the inability to have a look back.  Look back at your specific neighborhood, town or city and you will note the decline that has occurred month to month year to date year to year.  SEE HOME PRICES

As mortgage rates have increased it has diminished the number of those who can afford to purchase a home.  Lenders have seen money supply decreasing affecting the ability to have funds for mortgages.  Cash buyers have depleted savings.  Baby Boomers who own 25% of the housing market are getting older and getting ill or dying adding slowly to the housing inventory for sale. On top of all that, the equation of how to purchase a single family home has been upset by the recent NAR settlement.  Will buyers submit to a Broker Buyer Agreement that commits the buyer to a set $/% to the buyer agent?  Will the buyer attempt to represent themself?  Will sellers try to represent themselves?  Will the cost of selling a home be unbundled between seller and agent to lessen the commission fee?  All of this is unknown. When unknown my bet is the supply of homes increase because buyers back away from the market.  Sellers attempt to use online sources to sell a home to buyers who have no idea of the legal implications in doing so.  It all sounds like a Train Wreck waiting to happen.  SEE MORTGAGES

Based on the history of the FED, the wreck will occur and the FED will then try to stop it from happening....JUST TOO LATE....as usual!

My recommendation is to pay off your mortgage, wait, continue to rent and wait.  investors sell your single family home rentals in California and look for a states more friendly to single family rental market owners.  Buy multi-family rental projects, Triple Net Lease corporate guaranteed properties, Storage facilities and gas stations with marts and car washes attached.  Stay away from Bank buildings as they are closing. Car washes are intriguing but their competition is hard to battle and too many older washes needing upgrades are coming on the market.  Take your profits in the growth sectors of the stock market, especially technology where the Federal Trade Commission is taking on monopolistic tendencies of the Tech industry especially in Search Engines and Social Media. SEE REAL ESTATE COMMISSIONS. SEE FB. SEE OPENDOOR. SEE AMAZON. SEE AI.  

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