Saturday, February 28, 2009

Retail, Co-Tenancy Clauses, and Ecological Cascade Effects

National Real Estate Investor has a story detailing the effect co-tenancy clauses are having on retail centers. An excerpt:

As retail chains close unprofitable stores across the country, remaining tenants at the shopping centers are increasingly invoking clauses in their leases that give them the right to pull out of a center without penalty, placing new financial strain on the property owner. At times the added burden of losing additional income is so great that it pushes the owner toward bankruptcy.

Called co-tenancy clauses, the legal passages in tenants’ contracts often say that if a major anchor such as Macy’s or Best Buy leaves the center, then they have the right to a remedy — from rent reduction to withdrawing from the center in order to seek a more profitable location. That is posing a widespread problem for shopping center owners, says real estate attorney Irwin Fayne, a partner at Holland & Knight in Fort Lauderdale, Fla.

This is a real estate variation of an ecological cascade effect:

An ecological cascade effect is a series of secondary extinctions that is triggered by the primary extinction of a key species in an ecosystem. Secondary extinctions are likely to occur when the threatened species are: dependent on a few specific food sources, mutualistic(dependent on the key species in some way), or forced to coexist with an invasive species that is introduced to the ecosystem.

Small retail tenants, of course, are dependent/mutualistic with draw retailers – they hope to capitalize on customer traffic created by the draw tenant. There is also a retail variation on being forced to coexist with an invasive species. From Surplus Real


Just think how happy a clothing retailer is when the K-Mart store turns into a lumber yard.

Friday, February 27, 2009

Too Much Retail Space in America

TWR had an interesting article this week titled Going Beyond Core Retail Sales Growth (note: free registration required). Here’s a chart of real retail sales per square foot of retail space:


There seems to me to be a clear link between this trend and the tremendous expansion of retail outlets See this link for visualizations of Target and Wal-Mart expansion. Do we really need all those stores?

Thursday, February 26, 2009

Abandoned Homes, Troubled Neighborhoods, and Foreclosures

This photo (hat tip Zillow) is the World Press Photo of 2008:

foreclosure world-photo

According to jury chair MaryAnne Golon:


The strength of the picture is in its opposites. It’s a double entendre. It looks like a classic conflict photograph, but it is simply the eviction of people from a house following foreclosure. Now war in its classic sense is coming into people’s houses because they can’t pay their mortgages.

That’s an interesting take, but it’s not what’s going on. The original caption for the photo says:

When Detective Cole finds a home that is already abandoned or vacant, he enters with his weapon drawn, to guard against squatters.

Squatters in abandoned homes are a much bigger risk than former owners and tenants, and abandoned homes are a major detriment to neighborhoods (more about that here). But, it’s not quite as dramatic as imagining warfare between the state and people who have lost their homes.

The photo is part of a great series you can see here.

Wednesday, February 25, 2009

A Modest Proposal to Reform Management Compensation

Nassim Nicholas Taleb has a post on incentive compensation in Financial Times which describes the problem with the typical bonus plan. Here’s an excerpt:

Take two bankers. The first is conservative. He produces one annual dollar of sound returns, with no risk of blow-up. The second looks no less conservative, but makes $2 by making complicated transactions that make a steady income, but are bound to blow up on occasion, losing everything made and more. So while the first banker might end up out of business, under competitive strains, the second is going to do a lot better for himself. Why? Because banking is not about true risks but perceived volatility of returns: you earn a stream of steady bonuses for seven or eight years, then when the losses take place, you are not asked to disburse anything. You might even start again, after blaming a “systemic crisis” or a “black swan” for your losses. As you do not disgorge previous compensation, the incentive is to engage in trades that explode rarely, after a period of steady gains.

Taleb’s solution is radical:

We trust military and homeland security people with our lives, yet they do not get a bonus. They get promotions, the honour of a job well done and the disincentive of shame if they fail. Roman soldiers signed a sacramentum accepting punishment in the event of failure. This is prompting me to call for the nationalisation of the utility part of banking as the only solution in which society does not grant individuals free options to look after its risks.

I like the military analogy, but I think Taleb goes further than needed in eliminating bonuses entirely, and I think he doesn’t go far enough when he limits the proposal only to banking. Here is what I propose for all managers of public companies (or private ones which rely on public support, for example, a privately held bank).

1) Your base pay is limited to it’s military equivalent:


2) The rest of your compensation is in the form of whatever bonus your company thinks is appropriate – no mandated limits or performance criteria. However, the bonus must be paid in cash, and it gets paid into a federal trust fund.

3) After five years, the trustees compare the shareholder equity for the year the bonus was paid with current shareholder equity. If equity is the same or has increased, the bonus is paid. If shareholder equity has declined the bonus is forfeited and used to offset costs of administering the trust and then for some good purpose (education, or unemployment benefit funding). You don’t have to stay at the company to get the bonus.

This approach will cause managers to be thinking about values five years out, which should be a long enough horizon to avoid the problem Taleb describes. It also encourages managers to control employees engaging in risky actions (e.g., traders), and to move on if they think the company is taking excessive risks.

There are plenty of potential objections, but I think the most serious one is that some risk taking often produces real long term rewards, and this approach will dampen productive risk taking in public companies. That’s true, but I think it’s mitigated by the fact that private companies and partnerships will still be around to take big risks, and to provide opportunities for those who can’t wait five years for their reward.

Tuesday, February 24, 2009

Where Do Americans Want to Live?

The top five metro areas are Denver, San Diego, Seattle, Orlando, and Tampa, according to Pew research reported in this New York Times opinion piece.

The author, David Brooks, gives a number of reasons why, but this one caught my eye:

These are places (except for Orlando) where spectacular natural scenery is visible from medium-density residential neighborhoods…

One of my favorite themes is the link between natural amenities and market growth. Weather, water, and topographic diversity correlate highly with long term growth trends, and all these cities have very high natural amenity scores.

Monday, February 23, 2009

Recourse and Judicial versus Non-Judicial Foreclosure

Many are firmly fixed on the idea that making a loan recourse reduces default risk. Here is Greg Mankiw, for example:

How might the feds ensure repayment of these mortgages? One possibility is to make them recourse mortgages (that is, the lender would have recourse to the borrower's other assets, if the borrower defaults and the house value falls below the mortgage principal).

In my experience this is not the case; I've talked about why here. In a nutshell, there are factors far more influential than potential loss of other assets that drive borrower behavior (for example, ability to pay).

Another reason recourse is rarely pursued by lenders is because it is invariably a judicial process. Non-judicial foreclosures through trustee sales are just that – non-judicial, with a fixed time frames, no hearings, and precisely known fees. Once you get attorneys, judges, and even juries involved in a process, both costs and uncertainty escalate dramatically.

This is especially true when judges are on unfamiliar territory. Back in the early 1990’s while working for an income property lender we were in court many times every week getting receivers appointed. Ordinarily this kind of work is allocated within a county to one or two judges, and given any kind of volume the attorneys and judge quickly get on the same page as to what’s expected and what the results would be. However, when the judge normally handling receiverships was on vacation, results were all over the map, because the substitute judge was not familiar with receiverships.

Processes and results also vary wildly between jurisdictions. Receiverships were routine in California, but almost impossible to obtain in Florida. A bankruptcy case which would have been resolved in 6 months in San Diego took 4 years and an appeal to the U.S. Supreme Court to resolve because it started out in Shreveport, Louisiana.

Finally, it is often the case that a lender’s effort to strip the borrower of their assets in addition to seizing the collateral gets a cool reception from judges and juries. From a recent MBA Newslink article:

Terry Hutchens, president of Hutchens, Senter & Britton, Fayetteville, N.C., told participants yesterday at the Mortgage Bankers Association's National Mortgage Servicing Conference and Expo that while lenders or mortgage servicing firms in the past might be given the benefit of the doubt in the event a home foreclosure case went to court, juries and judges in the current unfriendly judicial environment do not feel as inclined to cut mortgage firms or their attorneys any slack whatsoever.

"There has been a climate change," Hutchens said. "The pendulum has swung too far and we are not being treated fairly."

Recourse lending is not a panacea.

Sunday, February 22, 2009

Economic and Real Estate Post Picks: Week of February 16, 2009

Deflation Risk Down but not Out: The declining risk of deflation

Six Retailers that are Thriving: Some obvious (Wal-Mart), some not (Best Buy?)

Sales Tax Collections Plunging: Bad news for state and local governments

Is There a Treasury Bubble?: Lots of supply coming, but also lots of demand

Tracking the Household Balance Sheet: Income and debt flat, but net worth down substantially

Saturday, February 21, 2009

Why Loan Modifications Don’t Happen: The Kubler-Ross Model Effect

It takes two to modify a loan; the borrower, and the servicer. The presumption is the servicer is the obstacle; why wouldn’t a borrower want a modification? The reality, however, is that often borrowers default and make no effort to reach an agreement, or they start negotiations for a modification but don’t pursue them. Why does this occur?

I think part of the answer is explained by the Kubler-Ross model. When someone loses something significant, the person goes through five stages to come to grips with the loss:

1. Denial - “This house is still a good investment!”

2. Anger - “How could this have happened?!”

3. Bargaining - “With a little help I can make this work.”

4. Depression - “This is going to wipe me out.”

5. Acceptance - “I’m moving on.”

Stage 3 is the stage at which a modification might happen – the rest of the time, a borrower’s mental state is not conducive to reaching an agreement. What are the odds of a borrower at that stage of the process connecting with someone at the servicer and working something out? Pretty small.

Thursday, February 19, 2009

We Worry Too Much About Moral Hazard

James Surowiecki has a good post on how we overemphasize the risk of moral hazard. Even the classic case of moral hazard turns out to be unsupported; people who are insured often have fewer accidents, not more.

Surowiecki identifies three reasons why this is so. The first is it’s often unclear if a bailout will occur and on what terms. It’s unlikely people rely on a safety net if it may not be there.

Secondly, when we’re talking about the actions by companies like banks, it’s more likely that the risks they take are driven by individual decisions, and not the interests of the institution itself. Trader and banker incentives, not moral hazard, is the issue.

Here’s Surowiecki on the final reason:

Finally, the biggest reason that moral hazard matters less than it might is that it can operate only if people actively countenance the possibility that their decisions could lead to complete disaster. But it’s well documented that people generally, and investors particularly, are overconfident and significantly underestimate the chances of being wiped out. The moral-hazard fundamentalists argue that banks and other financial institutions will act recklessly if they think they’ll be rescued in the event of failure. But Wall Street was reckless because it never believed that failure was even a possibility.

Best Article Yet on the Residential Housing Collapse

George Packer has written a great article, The Ponzi State, in the February 9 New Yorker (the link is to the abstract but the full article requires a payment if you’re not a New Yorker subscriber). Here is an excerpt:

Driving around Florida’s ghost subdivisions, if feel not just that their influence is waning but that they are physically hollowing out. In a place like Lehigh Acres, near Fort Myers, where half the driveways are sprouting weeds, and where garbage piles up in the bushes along the outer streets, it’s already possible to see the slums of the future. More and more of the residents in Hamilton Park will be renters like Lee Gaither. The vacant houses in Country Walk will be boarded up. The St. Augustine grass in the front yards of Tanglewood Preserve will grow three feet high. The open fields with street lights but no houses will become dumps.

Wednesday, February 18, 2009

Are Lending Standards Really Loosening?

Of course not, but Zero Hedge seems to think so. Here is an excerpt from the post:image

(Click on the image for a larger version in a new page)

The fallacy, of course, is that a decline in the percentage of banks tightening standards does not mean that any banks are loosening them. Think of a faucet – once you’ve shut it off, you stop tightening, right?

In fact, not a single bank in any lending category reports easing standards. Here is the data for CRE, for example:


(Click on the image for a larger version in a new page)

Here is a link to the survey.

Tuesday, February 17, 2009

Marking CRE to Market

Marking assets to their current market value is an important aspect of the current crisis. Even if you agree CRE debt should be marked to market, it’s very difficult to do because the assets are not homogenous and because the market is thinly traded in the best of times and almost completely frozen now. CoStar has an excellent article describing these difficulties here.

For a good summary of the mark to market debate in general, see this Naked Capitalism post.

Economic and Real Estate Post Picks: Week of February 9, 2009

How Bad is the Employment Picture, Really? Recession comparisons using Payroll Employment versus Household Employment data (hint: payroll employment is a better data source)

How This Recession is Different: Consumer, bank, and business balance sheets are much more leveraged then previous recessions

Real Disposable Income Up: The savings rate also improved in December

Significant Fall in Domestic Demand: The worst decline post-WWII

Retail Store Opening and Closings: Good information on trends in openings and closings by retail sector

Sunday, February 15, 2009

Underwater Homes, Exurbs, and Income

Paul Kedrosky’s Infectious Greed picks up on a story in the San Diego Union Tribune which has an interesting graphic of the percentage of underwater homes in San Diego County by zip code:


(Click on image for a larger version in a new window)

I agree with Paul that the full map tells the story as an exurb phenomenon (I’ve posted on that in more detail here) and relates to vintage (more on that here).

I also think the inset has something interesting to say about household income and underwater homes. The inset area is not an exurb, but there is big variation in the percentage of underwater homes across a relatively small swath of San Diego. Here’s a blowup of a piece of the inset:


Best to worst performance is light grey, yellow, orange, red, dark grey.

Now, here’s a UUorld map of average household income (2000) for the same swath:


(Click on image for a larger version in a new window)

Note how the higher income neighborhoods have fared better. I’ve written more about that here.

Saturday, February 14, 2009

Economic and Real Estate Post Picks: Week of February 2, 2009

Sharp Contraction in Trade: Both imports and exports have gone off  a cliff

Jobs Forecast by State and Sector: Interactive map and charts of a Moody's forecast of job loss/gain by sector and state through 2012

The Housing Market: 1982 versus 2009: A comparison of our current situation with the situation in 1982

The Behavior of LIBOR in This Economic Crisis: Very detailed discussion of LIBOR and its recent movements

Upcoming Economic Indicator Releases: A useful calendar of upcoming economic indicator releases, with links directly to the data sites.

Thursday, February 12, 2009

Lumpers, Splitters, and Decisionmaking

There are two kinds of people; lumpers, and splitters. Lumpers look for commonalities, and lump things into groups. Splitters look for differences between things, and treat each individually.

For example, you, Ernst, and Ralph are looking at a toy poodle, a labrador, a newfoundland, a sharpei, and a mastiff playing in a dog park. You ask them each to break the dogs into groups.

Ernst says there is just one group – they’re all dogs. Ernst is a lumper. You press him, and he comes up with this group:

Color Dogs
White Toy Poodle
Black Labrador
Brown Mastiff

You press him some more, and Ernst identifies this group:

Size Dogs
Large Newfoundland
Medium Labrador
Small Toy Poodle

Now it’s Ralph’s turn. Ralph says there are no groups, all the dogs are different. You press him, and Ralph comes up with this:

Color, Size Dogs
White, Small Toy Poodle
Black, Medium Labrador
Black, Large Newfoundland
Brown, Small Sharpei
Brown, Large Mastiff

Note that, although Ralph has identified categories, each dog has his own.

Neither of these approaches is wrong – you need both approaches to make effective decisions. For example, an extreme lumper will not be effective at working out loans, because he or she will offer the same modification to every borrower, and the same modification will not work for every borrower. An extreme splitter will also be ineffective, because every modification will be customized for each borrower, and the time that takes will result in few modifications being completed.

The error lumpers make is the failure to identify relevant differences. The error splitters make is to identify differences which are not salient, encumbering the decisionmaking process.

Ideally, what you want is to identify the salient differences between borrowers (a splitter skill), and group the borrowers according to their salient differences (a lumper skill) so similar modifications can be offered to the each group.

Obviously, people can put on different hats and function as a splitter some of the time and as a lumper on other occasions. I do believe, however, that people have a preferred mode.

These ideas are drawn from Scott Page’s excellent book, The Difference, which I highly recommend.

Wednesday, February 11, 2009

Borrower Optimism Bias

Lansner reports on a Zillow survey which finds that, although homeowners are aware home market values have declined, they underestimate the extent the decline applies to their own home:


What’s most interesting to me is the future outlook:

Most homeowners seem to believe the worst is over. Seventy percent think their home’s value will either increase or stay the same in the first six months of 2009. Zillow researchers call that “a curious optimism” and say the year will not play out that way.

I’ve previously posted on why borrowers continue to support properties which currently have no equity. I think this “curious optimism” is a big part of the explanation.

Tuesday, February 10, 2009

Why Do Lenders Take Excessive Risks? Certainty and Feedback Issues

Out of all the potential deals to be done, some are more risky than others. Ideally, a lender’s underwriting model screens out the risky deals, so the lender only makes loans that do not default. By definition, this means some deals don’t get done.

This creates two problems for lenders. The first relates to certainty. If a deal is screened out, the lender certainly knows it did not collect the income attributable to that deal, but it doesn’t know for sure that the loan would have defaulted. This creates a bias towards screening out fewer deals.

The second issue relates to feedback. If a lender does a deal, there is immediate positive feedback; fee income and interest or servicing income is realized immediately. However, it could be years before a default occurs. The positive feedback occurs immediately, while negative feedback is delayed. Also, except in rare occasions a lender is not aware if a deal it screened out is done by another lender and subsequently defaults, so there is no positive feedback to a successful screening. Again, this creates a bias towards screening out fewer deals.

These issues are outlined in James Reason’s classic Human Error:

All organizations have to allocate resources to two distinct goals: production and safety. In the long term, these are clearly compatible goals. But, given that resources are finite, there are likely to be many occasions on which there are short-term conflicts of interest. Resources allocated to the pursuit of production could diminish those available for safety; the converse is also true. These dilemmas are exacerbated by two factors:

(a) Certainty of outcome. Resources directed at improving productivity have relatively certain outcomes; those aimed at enhancing safety do not, at least in the short term. This is due in large part to the large stochastic elements in accident causation.

(b) Nature of feedback. The feedback generated by the pursuit of production goals is generally unambiguous, rapid, compelling and (when the news is good) highly reinforcing. That associated with safety goals is largely negative, intermittent, often deceptive and perhaps only compelling after a major accident or string of incidents. Production feedback will, except on these rare occasions, always speak louder than safety feedback. This makes the managerial control of safety extremely difficult.

Monday, February 9, 2009

“We’re Going to Make a Fortune!” – Why CRE Borrowers Hang On

A reoccurring theme here is that borrowers tend to hang on even though the economics of the deal suggest it would be better to walk away (see, for example, this post). Via Deal Junkie, a MarketWatch interview with a real estate investor explains why better than I could. The money quote is at 2:18 in the interview:

People that take a long term perspective and have a reasonable expectation on their capital are going to make a fortune. Simply, it’s historical. They did it the last time, and they did the last time, and they did it the time before that.

It’s true, the investors who bought distressed assets during previous real estate recessions have ended up making a lot of money. Borrowers hang on until they can’t because the market has come back from previous downturns, and if they can ride out the storm they will be the ones with the fortune. The idea of someone else making money on an asset you used to own is a powerful motivator to persevere.

Saturday, February 7, 2009

Pittsburgh versus Phoenix, Football and Growth

Although Pittsburgh had the better football team (at least this year), Edward Glaeser picks Phoenix as the long term growth winner:

The Super Bowl was a reversal of fortune because Phoenix is one of the country’s biggest boom cities and Pittsburgh continues to lose population. Since the last census, Phoenix’s population has grown by 927,551, more than any metropolitan area except Atlanta and Dallas. Over that time, the Pittsburgh area has lost more than 75,000 people, more than any city other than Katrina-beset New Orleans.


The great boom areas of the 21st century — Atlanta, Dallas, Houston and Phoenix — are expanding because of a combination of warmth and willingness to build. While geography made Pittsburgh’s rise inevitable, Phoenix has few innate natural advantages, other than sunshine. Instead, it has mile after mile of desert, which it is covering with thousands of attractive, affordable homes.

Warm temperatures don’t count for everything, for example, Denver and Boise, for example, both have strong long term growth trends and are not particularly warm places. When you account for a few other natural amenities like mountains and water you get a better picture of which areas grow and which don’t. David McGranahan of the U.S. Department of Agriculture has studied the effect of natural amenities on growth for many years. I’ve previously posted on his work here.

Friday, February 6, 2009

Did Homeowners Really Lose $3.3 Trillion in 2009?

Zillow, via The Big Picture, says so:

The U.S. housing market lost $3.3 trillion in value last year and almost one in six owners with mortgages owed more than their homes were worth as the economy went into recession, said.

I have previously posted about how illiquid the residential market is; only about 5% of homes trade in a year. In the current environment, distressed sales are a very significant percentage of the sales occurring. This post says 45% of sales in December were distressed, but I suspect the number of people selling because they have to is much higher than this – why would anyone voluntarily sell in this environment?

So, you take an inactively traded market, base your current value on distressed sales, extrapolate back to the entire market, and report a huge value loss. That approach is one way of looking at things, but the only owners who actually lost money are the 5% of owners who actually traded. Further, the amount they lost is limited to their investment, so a good share of the actual loss was picked up by their lenders (in some cases, all of it; remember those 0% down loans?).

Actual homeowner losses are much, much smaller than this number.

Thursday, February 5, 2009

CMBS Loan Deterioration

Via Zero Hedge, Deal Junkie, and Calculated Risk, Moody’s is in the process of reviewing more than $300B in outstanding CMBS debt (more than half of all outstanding CMBS) with downgrades inevitable.

Separately, the MBA’s Commercial/Multifamily Newslink summarizes a REIS forecast that CMBS defaults for loans made in 2006-07 will in excess of 12%. Some markets will be hit particularly hard:

Reis expects this year's default rates to reach 20.8 percent in Sacramento, 18.4 percent in San Bernardino, Calif., 16.6 percent in Phoenix, 15.8 percent in Oakland, Calif. and 14.5 percent in Detroit.

It pays to be somewhat skeptical of forecasts, but the increase in loans now on servicer watch lists is alarming:

CMBS loans on servicer watch lists increased from 0.72 percent of total balance in January 2008 to 15.6 percent last month, and Reis said more than 20 percent of CMBS loans secured by office properties are on the watch list compared to 15.2 percent of all retail loans and 15 percent of all apartment loans.

I’ve previously posted on why income property loan performance tends to deteriorate rapidly, and why some vintage years are hit especially hard.

Wednesday, February 4, 2009

Will We have a Commercial Real Estate Crisis?

Casey Mulligan thinks probably not. From his New York Times piece:

For months now, experts have been predicting that commercial real estate will be “the other shoe to drop.” But in fact, non-residential building fell far behind housing construction during the housing boom. This shortage of commercial buildings relative to housing suggests that a commercial real estate crisis will not occur, or that at worst it will occur with much less severity than did the housing crash.

Here is the chart purporting to support this argument:


(Click on image for a larger version in a new window)

The error Dr. Mulligan makes is the belief that the housing bubble and future CRE performance was/is primarily a function of inventory. The chart suggests housing prices have collapsed because too many residential structures were built. That’s like saying Citibank’s stock price has collapsed because too many shares have been issued. Home prices have dropped because the financing that people used to buy homes at an inflated price is no longer available, not because there are more homes than people are willing to occupy. To the extent CRE inventories were tight, values were inflated, which won’t help us now if the deals were leveraged based on the higher values.

For example, look at Miami, a residential bubble market. The graph below shows the number residential permits issued in relation to the number of new jobs created on a rolling 12 month basis. The secondary axis is the OFHEO Housing Price Index year over year change.


(Click on image for a larger version in a new window)

Home price increases began decelerating in late 2005, but at the time Miami was creating twice as many jobs as new units, so if anything the market was undersupplied. Something else was clearly dragging prices down, and in retrospect we know it was the withdrawal of aggressive lending parameters.

Now, of course, most markets are losing jobs, and most markets are still adding units (and commercial real estate) as projects work there way through the development pipeline. We won’t see a recovery until the employment situation turns around.

What does this mean for CRE? We don’t know for sure how many deals were done with aggressive underwriting during the peak years, but we know there were quite a few and so we can expect some decline in values related to the withdrawal of aggressive leverage similar to what’s happened in the residential market. We also know that CRE is sensitive to employment trends, and those are very negative. The CRE situation may not become as bad as residential, but if it doesn’t it will be because the underwriting was better and employment improves. It won’t be because there was a lack of inventory.

Tuesday, February 3, 2009

Are Corporate Jets Necessary?

Via Marginal Revolution, there is a defense of business jets in the New York Times opinion page. There’s only one argument I find compelling: there is a very long tail of places which are not served by airlines, and  if your business is in many locations not served by them, private aircraft make sense.

For example, if you’re at Walmart’s headquarters, here are your direct flight options:

NW Arkansas Places

And here are your store locations:


The graphic is a still shot from Flowing Data: check out the version which shows the expansion over time:


There’s one for Target too:


Monday, February 2, 2009

Why CRE Goes So Bad So Fast: Vintage

During times of peak rents and occupancy levels there are a lot of loans done using aggressive underwriting parameters, and when market conditions soften those loans all go upside down at once (see a discussion of this and other factors in this post).

Here is an illustration from the New York Times, via Calculated Risk:

[M]any landlords find themselves in a bind because they paid stiff prices for property in recent years and need to cover hefty mortgage payments. On average, Manhattan landlords paid $3,348 per square foot for retail properties in 2008, compared with $538 per square foot in 2004, according to the brokerage Cushman & Wakefield.

Loans underwritten in 2004 based on the lower value will fare much better than loans underwritten in 2008.

Sunday, February 1, 2009

The Housing Market is not Like the Stock Market

If you own some shares of Microsoft, you won’t have any trouble selling it - on average, more than 80 million shares of Microsoft trade every day the market is open. If you own a home, the situation is completely different.

Here are the Microsoft numbers:

Trading Days in 2008


Microsoft Avg Daily Volume (1)


Annual Volume 20,101,731,250
Shares Outstanding


Annual Volume/Outstanding Shares


(1) 50 day average as of 1/30/09  

The market for Microsoft stock is thick. The housing market, to understate, is thin. Here are the equivalent numbers:

Existing Single Family Home Sales


Existing Single Family Homes




Everyone learns in Investing 101 that thinly traded markets are relatively illiquid. The homes being sold now are overwhelming not voluntary sales. They are being sold out of foreclosure, are forced sales as a consequence of the owners situation, and are new homes working their way through the development pipeline. It is no surprise these homes are subject to dramatic markdowns given the lack of buyers in a market that is thin to begin with.

Fortunately, the vast majority of homeowners do not view their housing investment like a stock; homes are first and foremost places to live. Those unfortunate enough to have to sell in this market or who are overleveraged and can’t service the debt will experience losses. The rest of us are just like long term investors with a dividend stream, but in this case the dividend is living in a home we like paying an amount we can afford.

The sales estimate is from the National Association of Realtors as of December, 2008, and the number of homes is from the Census.