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".

Soon to be added: Consultant Services, Commercial Loan Services

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