But I have to disagree. Yes it will be different this time but not in the way you are proposing. This downturn will be worse than the one we faced in 1990 or 1981-2. I will back up my belief with the following facts.
1 Energy costs will be a huge factor for both individuals and corporations later this year.
2 How many strip malls and big box stores will we need if the pace of MEW is slowing a great deal.
3 The patterns you see in these charts exist for a very good reason and I believe it would take something extraordinary to break the pattern as you suggest.
4 What corporations will be hiring workers to fill the millions of square feet being built by developers? I would like to know which of these corporations will be expanding any time soon: Curcuit City, Sam's Club, GM, Chrysler, Ford, City Corp, Countrywide, WMC, Toll Brother's, Beazer, Pulte.
5 The type and variety of jobs being off-shored to China, and India continues to grow and now includes, legal, medical, teaching, diagnostic, middle management, tax preparation, and research/development.
6 If the pace of non-residential building remains constant or expands, how big will the overhang be in 2008. Will developers really follow the homebuilders over a cliff?
While your conclusion that a recession is possible is understandable, I respectfully disagree.
I believe that credit is tightening across the board, I believe that earnings quality at lending institutions is questionable, and that a day of reckoning is at hand. Rising deliquencies, decreasing net interest margins, the lack of adequate provisions for loan losses, and intense competition for deposits will exascerbate the credit crunch which is already underway.
This will run the full spectrum of the credit markets and will likely seem to take place "overnight" even though we are well aware that the tightening has already begun.
Speculation is at an extreme and valuations are high, the LBO & private equity bubble will soon burst, whether the catalyst is a tightening of margin requirements or the public blow-up of one of the deals is yet to be known, but, the fact is the credit bubble will burst in grand fashion.
Lax lending standards did not stop with subprime, they spread to ALT-A, prime, commercial, private equity, hedge funds, etc, etc
The asset coverage is poor and the ratings agencies are behind the curve.
The Fed induced inflation scare to hide the weakness in the economy worked for a short time, fact is we have deflation all around us, the loosening of margin requirements has created the speculation in commodities that has flowed through to the core, this was induced by the regulators to mask the facts.
Why haven't they tightened margin requirements yet? With so much speculation in the markets? Who would mop up the crap that Greenspan created?
For now, the leverage continues, there is absolutley nothing fundamentally supporting this market and the end game is quite near.
CR, why do you think we are in a technology fueled productivity boom? The year-over-year growth rate of productivity peaked in 2002 and has declined since. The big question is whether this decline is cyclical, structural or both. See this post and the comments:
I checked a few office vacancy reports and they do not seem particularly tight... slight decreases in 2006 is the general conclusion. I wonder if there is any correlation between residential investment and office vacancy? There would not seem to be... but since there is a correlation between residential investment and non-residential construction, there must at least be an implied correlation? And, if so, is there a lead or lag?
Let's not forget real wages as a factor as to whether or not consumption stays high and keeps us out of recession. I posted this a couple of times already, but always at the end of a comment thread. I'm skeptical about the conventional wisdom regarding real wages. From John Mauldin's April 13 newsletter:
The Bureau of Labor Statistics does a monthly survey of employment, calling roughly 50,000 businesses to get an estimate of the number of jobs created or lost over the preceding month. It is an estimate. They have a statistic to account for jobs they miss in the survey called the birth/death rate, based upon past trends. If you are going to have to make an estimate of employment, it is as good a method as any.
The BLS survey shows payroll growth at 1.8% and had wages growing at 4.3% last September. But then they come back and produce another report from hard data that comes out a few quarters later, which covers 98% of US jobs. They also go to state unemployment insurance programs which have reasonably accurate figures at to wages and taxes.
They just released the data for the third quarter of 2006. It looks like actual job growth was 1.5%, somewhat lower than the estimates. But the real eye opener was that wages grew an anemic 0.9% on a year over year basis. Given that inflation was in the 2.5% range, this means household income did not keep up with inflation.
I see the usual list of one-note-pony housing-centric lunatics have gathered here at the Alternate Reality Saloon to communicate with one another about the housing led recession and the tapped out consumer. A nice safe environment where they are not ridiculed by men, shunned by women, and untrusted by children.
The hysteria prone drama bears see an economic meltdown that will lead to Zimbabwe-style hyperinflation followed by martial law, soup kitchens, grapes of wrath, dust bowl, 1929, Tobacco Road, black lung, and nationwide Love Canal conditions.
What else is new?
The usual subculture of the food chain wont be participating in the coming profit-fest debauchery.
I love reading meticulously reasoned and uber-graphed proof why the earth should be rotating the opposite direction. I believe the term is articulate incompetent, isnt it?
Im sorry to hear America isnt working out for you. I hear the weather in Havana is nice this time of year.
An interesting analysis of office vacancy rates here: ( http://www2.prudential.com/3dsj76/prei.nsf/14ef712a6b099d9d852566ef005111d0/bb33caa0f9248804852571cb004f4654/$FILE/The%20U.S.%20Office%20Market.pdf ).
The correlation to job growth would be the strongest indicator of office construction... but lead times and construction times lead to classic overshoots. If (and it is a real if) job numbers begin to fall then I suspect developers who are currently building will have once again overshot the market. In that sense they will have followed homebuilders over the cliff. If.
Countrywide Financial Corp. said on Friday in a regulatory filing that Chief Executive Angelo Mozilo in 2006 received a $42.98 million of compensation and had a $78.87 million gain from the exercise of options and vesting of stock awards, as shares of the largest U.S. mortgage lender rose 24 percent.
Compensation included a $2.87 million salary, $19.01 million of option awards, $20.46 million of non-equity incentive awards and $643,205 of other compensation.
Mozilo, 68, also had a $72.21 million gain from the exercise of 2,355,769 stock options, and a $6.66 million gain from the vesting of 170,002 shares.
Dan - yes, that's right. Real wage increases are much less for most of the population than most analysts believe.
To add to your quote, the Beige Book:
"Wage increases were reported in some industries of the New York, Philadelphia, Richmond, Atlanta, Chicago, Minneapolis, Kansas City, Dallas, and San Francisco Districts. These were generally modest. Specifically, the New York, Richmond, Atlanta, and Dallas Districts noted wage increases in some services sectors, and the Richmond District also noted faster wage growth in the retail sector. The Dallas District noted that continued layoffs reported by homebuilders and some manufacturers resulted in downward wage pressures. The San Francisco District indicated that wage pressures eased in the construction and agriculture sectors. Except for energy-related businesses, wage pressures in the Cleveland District were largely contained, but wage pressures edged higher in the Kansas City District. There were reports of wage pressures for skilled workers in the Dallas District and for in-store pharmacists in the Cleveland District. The Chicago, Dallas, and San Francisco Districts also noted faster growth in pay rates for some skilled positions."
I don't think this will last, but right now AFAIK most of the population is getting relatively moderate raises. The big jumps are concentrated. Once again it's a diffusion issue - stock market gains are certainly going to help out a segment of the population, but it's a much smaller segment than healthy home appreciation helps.
But what's actually driving the non-residential structures boom, which industries? The answer might be the key to projecting the growth of non-residential investment.
Though the linked article quotes an industry source as saying, "... regardless of what happens with vacancies, rents are likely to be higher in coming years because of the large number of office buildings in the suburbs being sold as investors worldwide flock to commercial real estate.
You have a lot of new owners coming to town that want to push rents, he says. They paid top dollar, so they cant do cheap deals.
Good thing for them there's absolutely no possibility of a recession ...
From what I've heard and read the current status of commercial real estate is that there are so many changes in locations and infrastructure that sometimes there is an illusion of tight space. There are many vacant offices and commercial floors, but they are usually in some new locations where nobody needs them. And best locations are packed.
Consumer spending counted for double the net GDP growth estimate...so ac has a strong argument IMO. Would business investment be a little more generous if owners foresaw a burgeoning consumer demand?
It's not as if they don't have record profits to pile back into their businesses...financing is only a problem for home buyers. No, they have no confidence in a growing market and seem to prefer survival strategies against/for M&A.
Ask the CEO of Target about the consumer's spending inclinations in April. Target has been the star in retail over the past few years and a bellweather. I would suspect the April retail numbers will be on the weak side, showing no or even negative growth.
A LOT of the multi family and commercial/retail construction underway right now is being done by REITs whose buyers heard the realtors spiel that "it never goes down" and "it will never be cheaper" and have jumped on the band wagon (perhaps a year or two late). In case you haven't noticed, REITs have become options in many 401K programs, with their recent high returns attracting investors to an apparently lucrative and risk free investment. Also big in projects right now are large institutional investors who felt that they were under-invested in real estate and missing out on big gains realized in the past few years. Because REITs have money pouring in they must buy or build. This pushes up valuations and costs. The problem gets manifested when the tenants never show up. Right now there is a lot of this development happening. The REITs are, to a large extent, the walking dead, with their zombie hands on the dead-man lever, "Full Speed Ahead". I, being in construction, benefit from this, but I don't know where the tenants will come from. The end may be closer than one might imagine because there is an ominous unusual spring lull occuring in the bidding market right now.
There is a trend of "working from home" or even working from the road using WiFi and a hotspot .
1.\tHow is that trend going to reflect on the demands for office structures ?
There is all the credit-dependent industries: Real-Esate, Loan Brokers, mortgagee banks, Construction firms all the way to BMW and Hammer dealers and every biz that is created mostly on the "wealth effect"
How much of the demand for office space comes directly or in directly from the real-estate craze ?
You have a lot of new owners coming to town that want to push rents, he says. They paid top dollar, so they cant do cheap deals.
This is part of the world-wide Real-estate craze. Money is chasing a place to park. This amount of growth is really imposible.
People can only produce and consume so much the rest they have "to invest" and that has gone more and more into R/E in all sorts of shapes and forms.
R/E was the drain of the world-wide excess liquidity. In the process it created jobs so when the music does stop it will be very hard very sudden drop. In Spain it has already started. Who will be next ? US ? UK ? China ? East-Europe ?
Did anybody notice that Federal Funds Rate is now above the nominal GDP growth y-o-y? From Q1/2006 to Q1/2007 nominal GDP grew +4.8% ($13632.6/$13008.4 = 0.048 ~ 4.8%), while ffr is 5.25%? That means ffr is 45 basis points over nominal GDP growth y-o-y.
It is not very good news for leveraged investments. It should start to drag down investments on the marging. On the average, cost of capital now exceeds the return of the capital and should discourage investing on the marging.
FFR was above nominal GDP growth last 1989, followed by a recession, which took the rates down, then on 1995, followed by rate cuts also, but goldilocks that time, for a short period of time in 1998, problems with LTCM, rouble default, mini Dow Jones crash and then last in 2000/Q3, followed by a recession in 2001.
Not very bullish thing. Of course, this raises questions on the future movements in Federal Funds Rate, the lack of the actual effects and inflation. In the last GDP report inflation was up again, so I suppose it's not going to be extremely easy times for the Fed to do their policy.
How should we judge whether the commercial office market is undersupplied? Prices are a good place to check, and specifically rental yields, or the "cap rate" as it is known in CRE.
My understanding is that cap rates are running at record lows (below 4%). This implies that the rental yield is below funding costs, and that most of the return from the investment will come from capital gains. Of course, its possible that CRE investors are expecting rental yields to pick up in the future, but the condition of unemployment (near-record lows), the pace of job creation (solid relative to gdp growth but anenmic overall), and the prospecs for economic growth all point to at best a moderate increase in commercial rents.
Conclusion: if the CRE office market were undersupplied TODAY, rental yields would be more attractive. It is possible CRE investors think it will be undersupplied IN THE FUTURE, but where's the evidence to support that view?
Of course, the reality is that cap rates are low because of loose monetary conditions. When those conditions change, the odds are that CRE will turn down. So to close the loop, we'll have a recession when monetary conditions tighten, and that will happen when the Yen revalues. Since the Yen will not revalue on its own, then monetary conditions are entirely dependent on Yuan revaluation.
We'll have a recession when China says we should have a recession.
As to risk spreads, yes, there is some movement in high yield, nothing substantial as of yet, approximately 50 bps from what I have seen, there has been compression in high quality fixed (Corporate market).
Interesting that issuers are becoming more creative with what they are bringing to market, the demand for quality remains high and they are attempting to take advantage of it, to the detriment of those willing to purchase, the control rests with the issuer. Careful due diligence is required when examining the coverage.
Default rates were at historical lows for the last two years, this will change beginning this year in my opinion, rising defaults on the corporate level as the economy slows, the ability to roll the debt over decreases, and the debt service becomes too much of a burden.
More and more we are seeing stock buybacks financed with additional debt, this is troublesome, near-term this boost eps, long-term, in a slowing economy this adds to debt service and will pressure earnings, thus, the turn in corporate profits which is at hand will be magnified to the downside as revenues and margins come under pressure.
The biggest observation that I have seen is in the quality of earnings, many completely legal manuevers to prop eps. Many financials have seen NPL's increase, yet provisions for losses have decreased.
I have seen shifts from "loans held for investment" to "loans held for sale". Some say the secondary market has begun to show stabilization, my belief would be that more and more risk is being concentrated at home and not being dumped into the market, that this is a temporary blip up and will soon move in the opposite direction.
On the pension accounting front, I have seen disount rate assumptions which are unrealistic and not indicative of the current yield environment thus boosting the funded status of plans. Worthy of note is GM's decrease in equity exposure of more than 20% to "protect" the gains of 2006.
As to margin requirements, late last year, the requirements were loosened for hedge funds, in my opinion, this should be addressed now, this is a bubble which has propped up the averages and led to massive speculation, exposure to illiquid assets (remember how long it took to unwind Amaranth), and money created entirely through excessive leverage in search of alpha which is far more difficult to get due to these money pools chasing the same trade.
If I were to venture a guess, one to two quarters max before the unwind goes full swing, the key here in regard to PE and LBO's is that the end-tickets are yet to be seen, the accumulation phase has been full tilt, valuations are extreme, and high yield spreads have widened, and will further widen. The money flows to the speculative pools will slow dramatically and soon. This is the story, in my view, the fee revenue bonanza that wall street has cherished from the M&A boom is in its very late stages, the appetite for these over-priced buy
I think a good sized chunk of this CRE build out is driven by activity in private equity buyouts - it seems every time I turn around I hear of another public company going private. I work with two now - they are a complete pain in the ass but are expanding aggressively.
The strategy seems to be pretty much the same...
(1) pool a bunch of private money, borrow even more from hedgies & commercial banks (GE Capital, Citi, etc.)... Big highly leveraged pool.
(2) buy a company - borrow even more using the company as collateral.
(3) use the cash to 'dress the company up'... new offices, upgrade systems, expand markets, etc.
(4) sell for big capital gain or (if the market stays strong) float IPO.
In effect it is 'flip this company'.
The improvements aren't all 'cosmetic' either. The companies I know did a lot of work on quality & mfg systems & logistics & completely overhauled their marketing channels. Very necessary changes.
But they also added to & built a number of newer buildings - very showy & expensive additions primarily to impress future buyers in a walk through.
I don't know how much of the current build out is REIT speculation & PE activity vs. more 'tradition' demand. But I'd guess recent PE money & REITs are both fairly significant additional sources of current build demand. How long they hold up, who knows?
Regardless this activity has been one more factor helping to stave off any recession - CRE is a big source of good paying jobs.
Thanks Neal for this bit: "The end may be closer than one might imagine because there is an ominous unusual spring lull occuring in the bidding market right now."
Maybe the negative savings rate that HELOCs facilitated have brought demand forward...that will leave a bit of a hole in those CRE developments as consumers wait for their house or wages to fill their purses.
The commercial build-out should have a smaller dimension than the residential on this account (having the present picture of residential vacancies in front of them, and having a better feedback loop than the scattered and less organized residential builders). And in general, what we see from business is hesitation, not confidence.
Notice that at the beginning of this cycle the dropoff in nonresidential investment was steeper than in previous recessions, and the recovery was slower. Ergo: we never really recovered from the recession of 2001.
Let ne explain that. When we start to recover from a recession businesses first add hours for existing workers, then add workers, then build factories. But the downshift in investment this cycle reflects American business doing its investment in low wage countries outside the US. Business is not going to bail us out of this cycle because they have simply shifted priorities away from investing in the United States. Unemployment has stayed low because higher waged manufacturing workers have gotten jobs as burger flippers when they were downsized, but the damage to our industrial base was not mitigated.
Finally: consumption in this situation because lower and middle incom homeowners hit up the housing ATM rather than cut back when their income was reduced.
Small problem: both charts are the same after clicking. The link points to the same image.
Great news! Spend, spend, spend: There's just no stopping the US consumer:
Spend, spend, spend: There's no stopping the U.S. consumer - MarketWatch
As long as people have jobs, and the confidence that they will get one if they don't, they will spend -- and usually above their means.
Gee, that's swell!
Calculated Risk
Great Charts!
But I have to disagree. Yes it will be different this time but not in the way you are proposing. This downturn will be worse than the one we faced in 1990 or 1981-2. I will back up my belief with the following facts.
1 Energy costs will be a huge factor for both individuals and corporations later this year.
2 How many strip malls and big box stores will we need if the pace of MEW is slowing a great deal.
3 The patterns you see in these charts exist for a very good reason and I believe it would take something extraordinary to break the pattern as you suggest.
4 What corporations will be hiring workers to fill the millions of square feet being built by developers? I would like to know which of these corporations will be expanding any time soon: Curcuit City, Sam's Club, GM, Chrysler, Ford, City Corp, Countrywide, WMC, Toll Brother's, Beazer, Pulte.
5 The type and variety of jobs being off-shored to China, and India continues to grow and now includes, legal, medical, teaching, diagnostic, middle management, tax preparation, and research/development.
6 If the pace of non-residential building remains constant or expands, how big will the overhang be in 2008. Will developers really follow the homebuilders over a cliff?
While your conclusion that a recession is possible is understandable, I respectfully disagree.
I believe that credit is tightening across the board, I believe that earnings quality at lending institutions is questionable, and that a day of reckoning is at hand. Rising deliquencies, decreasing net interest margins, the lack of adequate provisions for loan losses, and intense competition for deposits will exascerbate the credit crunch which is already underway.
This will run the full spectrum of the credit markets and will likely seem to take place "overnight" even though we are well aware that the tightening has already begun.
Speculation is at an extreme and valuations are high, the LBO & private equity bubble will soon burst, whether the catalyst is a tightening of margin requirements or the public blow-up of one of the deals is yet to be known, but, the fact is the credit bubble will burst in grand fashion.
Lax lending standards did not stop with subprime, they spread to ALT-A, prime, commercial, private equity, hedge funds, etc, etc
The asset coverage is poor and the ratings agencies are behind the curve.
The Fed induced inflation scare to hide the weakness in the economy worked for a short time, fact is we have deflation all around us, the loosening of margin requirements has created the speculation in commodities that has flowed through to the core, this was induced by the regulators to mask the facts.
Why haven't they tightened margin requirements yet? With so much speculation in the markets? Who would mop up the crap that Greenspan created?
For now, the leverage continues, there is absolutley nothing fundamentally supporting this market and the end game is quite near.
check the titles on the graphs...
CR, why do you think we are in a technology fueled productivity boom? The year-over-year growth rate of productivity peaked in 2002 and has declined since. The big question is whether this decline is cyclical, structural or both. See this post and the comments:
Econbrowser: A New Era for the Dollar?
I checked a few office vacancy reports and they do not seem particularly tight... slight decreases in 2006 is the general conclusion. I wonder if there is any correlation between residential investment and office vacancy? There would not seem to be... but since there is a correlation between residential investment and non-residential construction, there must at least be an implied correlation? And, if so, is there a lead or lag?
Let's not forget real wages as a factor as to whether or not consumption stays high and keeps us out of recession. I posted this a couple of times already, but always at the end of a comment thread. I'm skeptical about the conventional wisdom regarding real wages. From John Mauldin's April 13 newsletter:
The Bureau of Labor Statistics does a monthly survey of employment, calling roughly 50,000 businesses to get an estimate of the number of jobs created or lost over the preceding month. It is an estimate. They have a statistic to account for jobs they miss in the survey called the birth/death rate, based upon past trends. If you are going to have to make an estimate of employment, it is as good a method as any.
The BLS survey shows payroll growth at 1.8% and had wages growing at 4.3% last September. But then they come back and produce another report from hard data that comes out a few quarters later, which covers 98% of US jobs. They also go to state unemployment insurance programs which have reasonably accurate figures at to wages and taxes.
They just released the data for the third quarter of 2006. It looks like actual job growth was 1.5%, somewhat lower than the estimates. But the real eye opener was that wages grew an anemic 0.9% on a year over year basis. Given that inflation was in the 2.5% range, this means household income did not keep up with inflation.
I see the usual list of one-note-pony housing-centric lunatics have gathered here at the Alternate Reality Saloon to communicate with one another about the housing led recession and the tapped out consumer. A nice safe environment where they are not ridiculed by men, shunned by women, and untrusted by children.
The hysteria prone drama bears see an economic meltdown that will lead to Zimbabwe-style hyperinflation followed by martial law, soup kitchens, grapes of wrath, dust bowl, 1929, Tobacco Road, black lung, and nationwide Love Canal conditions.
What else is new?
The usual subculture of the food chain wont be participating in the coming profit-fest debauchery.
I love reading meticulously reasoned and uber-graphed proof why the earth should be rotating the opposite direction. I believe the term is articulate incompetent, isnt it?
Im sorry to hear America isnt working out for you. I hear the weather in Havana is nice this time of year.
An interesting analysis of office vacancy rates here: ( http://www2.prudential.com/3dsj76/prei.nsf/14ef712a6b099d9d852566ef005111d0/bb33caa0f9248804852571cb004f4654/$FILE/The%20U.S.%20Office%20Market.pdf ).
The correlation to job growth would be the strongest indicator of office construction... but lead times and construction times lead to classic overshoots. If (and it is a real if) job numbers begin to fall then I suspect developers who are currently building will have once again overshot the market. In that sense they will have followed homebuilders over the cliff. If.
Countrywide CEO gets $43 mln pay, $79 mln gain
Countrywide CEO gets $43 mln pay, $79 mln gain
| Reuters
Countrywide Financial Corp. said on Friday in a regulatory filing that Chief Executive Angelo Mozilo in 2006 received a $42.98 million of compensation and had a $78.87 million gain from the exercise of options and vesting of stock awards, as shares of the largest U.S. mortgage lender rose 24 percent.
Compensation included a $2.87 million salary, $19.01 million of option awards, $20.46 million of non-equity incentive awards and $643,205 of other compensation.
Mozilo, 68, also had a $72.21 million gain from the exercise of 2,355,769 stock options, and a $6.66 million gain from the vesting of 170,002 shares.
Dan - yes, that's right. Real wage increases are much less for most of the population than most analysts believe.
To add to your quote, the Beige Book:
"Wage increases were reported in some industries of the New York, Philadelphia, Richmond, Atlanta, Chicago, Minneapolis, Kansas City, Dallas, and San Francisco Districts. These were generally modest. Specifically, the New York, Richmond, Atlanta, and Dallas Districts noted wage increases in some services sectors, and the Richmond District also noted faster wage growth in the retail sector. The Dallas District noted that continued layoffs reported by homebuilders and some manufacturers resulted in downward wage pressures. The San Francisco District indicated that wage pressures eased in the construction and agriculture sectors. Except for energy-related businesses, wage pressures in the Cleveland District were largely contained, but wage pressures edged higher in the Kansas City District. There were reports of wage pressures for skilled workers in the Dallas District and for in-store pharmacists in the Cleveland District. The Chicago, Dallas, and San Francisco Districts also noted faster growth in pay rates for some skilled positions."
I don't think this will last, but right now AFAIK most of the population is getting relatively moderate raises. The big jumps are concentrated. Once again it's a diffusion issue - stock market gains are certainly going to help out a segment of the population, but it's a much smaller segment than healthy home appreciation helps.
But what's actually driving the non-residential structures boom, which industries? The answer might be the key to projecting the growth of non-residential investment.
Chicago office market vacancy rates certainly aren't low.
Though the linked article quotes an industry source as saying,
"... regardless of what happens with vacancies, rents are likely to be higher in coming years because of the large number of office buildings in the suburbs being sold as investors worldwide flock to commercial real estate.
You have a lot of new owners coming to town that want to push rents, he says. They paid top dollar, so they cant do cheap deals.
Good thing for them there's absolutely no possibility of a recession ...
From what I've heard and read the current status of commercial real estate is that there are so many changes in locations and infrastructure that sometimes there is an illusion of tight space. There are many vacant offices and commercial floors, but they are usually in some new locations where nobody needs them. And best locations are packed.
Non-Residential Investment: The Key?
No... I think it's clear from today's GDP report that consumer spending is the key.
If consumer spending falls because of declining MEW and higher gas prices, I think it's all over.
Consumer spending counted for double the net GDP growth estimate...so ac has a strong argument IMO. Would business investment be a little more generous if owners foresaw a burgeoning consumer demand?
It's not as if they don't have record profits to pile back into their businesses...financing is only a problem for home buyers. No, they have no confidence in a growing market and seem to prefer survival strategies against/for M&A.
Ask the CEO of Target about the consumer's spending inclinations in April. Target has been the star in retail over the past few years and a bellweather. I would suspect the April retail numbers will be on the weak side, showing no or even negative growth.
Business owners, they do read GDP report, too. They are almost like bloggers, just balder...
This stuff is self-reinforcing, f.e. when meeting a delegation demanding pay rises, the mob can be disbanded with folded newspaper with GDP report.
A LOT of the multi family and commercial/retail construction underway right now is being done by REITs whose buyers heard the realtors spiel that "it never goes down" and "it will never be cheaper" and have jumped on the band wagon (perhaps a year or two late). In case you haven't noticed, REITs have become options in many 401K programs, with their recent high returns attracting investors to an apparently lucrative and risk free investment. Also big in projects right now are large institutional investors who felt that they were under-invested in real estate and missing out on big gains realized in the past few years. Because REITs have money pouring in they must buy or build. This pushes up valuations and costs. The problem gets manifested when the tenants never show up. Right now there is a lot of this development happening. The REITs are, to a large extent, the walking dead, with their zombie hands on the dead-man lever, "Full Speed Ahead". I, being in construction, benefit from this, but I don't know where the tenants will come from. The end may be closer than one might imagine because there is an ominous unusual spring lull occuring in the bidding market right now.
If consumer spending falls because of declining MEW and higher gas prices, I think it's all over.
Correction, delete "I think."
CR: Great analysis - even better than usual.
2 questions about fundementals:
There is a trend of "working from home" or even working from the road using WiFi and a hotspot .
1.\tHow is that trend going to reflect on the demands for office structures ?
There is all the credit-dependent industries: Real-Esate, Loan Brokers, mortgagee banks, Construction firms all the way to BMW and Hammer dealers and every biz that is created mostly on the "wealth effect"
I think this woman simply didn't understand the Bull case.
Stories from the Front Lines - Credit Slips
Charlie Stromeyer :
There were 3 waves of productivity gains:
2 and #3 have also caused workers to work longer hours (from work and home)
will there be a #4 ? I think good things come in quants of 3.
risk capital - when do you think it will all ake place ?
when China raise banks margin requirements ?
will they wait after the olimpics ? or would they rather do it now to allow for some recovery prior to summer of 2008 ?
Dan: This means household income did not keep up with inflation.
This is almost the only inflation factor the Fed really looks at. As long as wages are not rising they can continue to pump money and keep rates low.
If consumer spending falls because of declining MEW and higher gas prices, I think it's all over.
Correction, delete "I think."
Banker | 04.28.07 - 1:12 am
Wow, going out on a limb, eh, Banker?
I kinda figured you were a risk taker.
risk capital :
Do you see any real evidence to higher risk-spreads ?
seems like ABX, CDX and others are not moving much these days there was some higher spreads on the CMBX but they are off from the weekly highs.
Neal,
Do you have specific names in REITs that you think are "walking dead" ?
You have a lot of new owners coming to town that want to push rents, he says. They paid top dollar, so they cant do cheap deals.
This is part of the world-wide Real-estate craze. Money is chasing a place to park. This amount of growth is really imposible.
People can only produce and consume so much the rest they have "to invest" and that has gone more and more into R/E in all sorts of shapes and forms.
R/E was the drain of the world-wide excess liquidity. In the process it created jobs so when the music does stop it will be very hard very sudden drop. In Spain it has already started. Who will be next ? US ? UK ? China ? East-Europe ?
Did anybody notice that Federal Funds Rate is now above the nominal GDP growth y-o-y? From Q1/2006 to Q1/2007 nominal GDP grew +4.8% ($13632.6/$13008.4 = 0.048 ~ 4.8%), while ffr is 5.25%? That means ffr is 45 basis points over nominal GDP growth y-o-y.
It is not very good news for leveraged investments. It should start to drag down investments on the marging. On the average, cost of capital now exceeds the return of the capital and should discourage investing on the marging.
FFR was above nominal GDP growth last 1989, followed by a recession, which took the rates down, then on 1995, followed by rate cuts also, but goldilocks that time, for a short period of time in 1998, problems with LTCM, rouble default, mini Dow Jones crash and then last in 2000/Q3, followed by a recession in 2001.
Not very bullish thing. Of course, this raises questions on the future movements in Federal Funds Rate, the lack of the actual effects and inflation. In the last GDP report inflation was up again, so I suppose it's not going to be extremely easy times for the Fed to do their policy.
See this article from Bill Gross at Pimco:
PIMCO - Investment Outlook- January 2007 "The 5% Solution"
How should we judge whether the commercial office market is undersupplied? Prices are a good place to check, and specifically rental yields, or the "cap rate" as it is known in CRE.
My understanding is that cap rates are running at record lows (below 4%). This implies that the rental yield is below funding costs, and that most of the return from the investment will come from capital gains. Of course, its possible that CRE investors are expecting rental yields to pick up in the future, but the condition of unemployment (near-record lows), the pace of job creation (solid relative to gdp growth but anenmic overall), and the prospecs for economic growth all point to at best a moderate increase in commercial rents.
Conclusion: if the CRE office market were undersupplied TODAY, rental yields would be more attractive. It is possible CRE investors think it will be undersupplied IN THE FUTURE, but where's the evidence to support that view?
Of course, the reality is that cap rates are low because of loose monetary conditions. When those conditions change, the odds are that CRE will turn down. So to close the loop, we'll have a recession when monetary conditions tighten, and that will happen when the Yen revalues. Since the Yen will not revalue on its own, then monetary conditions are entirely dependent on Yuan revaluation.
We'll have a recession when China says we should have a recession.
Yal,
As to risk spreads, yes, there is some movement in high yield, nothing substantial as of yet, approximately 50 bps from what I have seen, there has been compression in high quality fixed (Corporate market).
Interesting that issuers are becoming more creative with what they are bringing to market, the demand for quality remains high and they are attempting to take advantage of it, to the detriment of those willing to purchase, the control rests with the issuer. Careful due diligence is required when examining the coverage.
Default rates were at historical lows for the last two years, this will change beginning this year in my opinion, rising defaults on the corporate level as the economy slows, the ability to roll the debt over decreases, and the debt service becomes too much of a burden.
More and more we are seeing stock buybacks financed with additional debt, this is troublesome, near-term this boost eps, long-term, in a slowing economy this adds to debt service and will pressure earnings, thus, the turn in corporate profits which is at hand will be magnified to the downside as revenues and margins come under pressure.
The biggest observation that I have seen is in the quality of earnings, many completely legal manuevers to prop eps. Many financials have seen NPL's increase, yet provisions for losses have decreased.
I have seen shifts from "loans held for investment" to "loans held for sale". Some say the secondary market has begun to show stabilization, my belief would be that more and more risk is being concentrated at home and not being dumped into the market, that this is a temporary blip up and will soon move in the opposite direction.
On the pension accounting front, I have seen disount rate assumptions which are unrealistic and not indicative of the current yield environment thus boosting the funded status of plans. Worthy of note is GM's decrease in equity exposure of more than 20% to "protect" the gains of 2006.
As to margin requirements, late last year, the requirements were loosened for hedge funds, in my opinion, this should be addressed now, this is a bubble which has propped up the averages and led to massive speculation, exposure to illiquid assets (remember how long it took to unwind Amaranth), and money created entirely through excessive leverage in search of alpha which is far more difficult to get due to these money pools chasing the same trade.
If I were to venture a guess, one to two quarters max before the unwind goes full swing, the key here in regard to PE and LBO's is that the end-tickets are yet to be seen, the accumulation phase has been full tilt, valuations are extreme, and high yield spreads have widened, and will further widen. The money flows to the speculative pools will slow dramatically and soon. This is the story, in my view, the fee revenue bonanza that wall street has cherished from the M&A boom is in its very late stages, the appetite for these over-priced buy
I think a good sized chunk of this CRE build out is driven by activity in private equity buyouts - it seems every time I turn around I hear of another public company going private. I work with two now - they are a complete pain in the ass but are expanding aggressively.
The strategy seems to be pretty much the same...
(1) pool a bunch of private money, borrow even more from hedgies & commercial banks (GE Capital, Citi, etc.)... Big highly leveraged pool.
(2) buy a company - borrow even more using the company as collateral.
(3) use the cash to 'dress the company up'... new offices, upgrade systems, expand markets, etc.
(4) sell for big capital gain or (if the market stays strong) float IPO.
In effect it is 'flip this company'.
The improvements aren't all 'cosmetic' either. The companies I know did a lot of work on quality & mfg systems & logistics & completely overhauled their marketing channels. Very necessary changes.
But they also added to & built a number of newer buildings - very showy & expensive additions primarily to impress future buyers in a walk through.
I don't know how much of the current build out is REIT speculation & PE activity vs. more 'tradition' demand. But I'd guess recent PE money & REITs are both fairly significant additional sources of current build demand. How long they hold up, who knows?
Regardless this activity has been one more factor helping to stave off any recession - CRE is a big source of good paying jobs.
Risk Capital,
Thanks. Yes I agree with you.
I just don't know how long before it unwinds. somehow I have the feeling it will be sooner rather than later....
Thanks Neal for this bit:
"The end may be closer than one might imagine because there is an ominous unusual spring lull occuring in the bidding market right now."
Maybe the negative savings rate that HELOCs facilitated have brought demand forward...that will leave a bit of a hole in those CRE developments as consumers wait for their house or wages to fill their purses.
The commercial build-out should have a smaller dimension than the residential on this account (having the present picture of residential vacancies in front of them, and having a better feedback loop than the scattered and less organized residential builders). And in general, what we see from business is hesitation, not confidence.
The Big Picture
90 days ???
Thoughts from the Frontline
Neal-
In the business. Ditto that.
Agree Private Equity & REITS.
+
Foreign Cos. warehouses, offices etc. to expand even more in U.S. and Mexico.
Notice that at the beginning of this cycle the dropoff in nonresidential investment was steeper than in previous recessions, and the recovery was slower. Ergo: we never really recovered from the recession of 2001.
Let ne explain that. When we start to recover from a recession businesses first add hours for existing workers, then add workers, then build factories. But the downshift in investment this cycle reflects American business doing its investment in low wage countries outside the US. Business is not going to bail us out of this cycle because they have simply shifted priorities away from investing in the United States. Unemployment has stayed low because higher waged manufacturing workers have gotten jobs as burger flippers when they were downsized, but the damage to our industrial base was not mitigated.
Finally: consumption in this situation because lower and middle incom homeowners hit up the housing ATM rather than cut back when their income was reduced.