Wall Street Gets Housing Wrong Too Often

July 22, 2016

After the exhaustive first hand research into Pokemon Go last week, I want to share what people do in Manhattan when a rare Pokemon character is seen at 11pm at night. This serves as an analogy of what consumers and mortgage lenders do during a housing bubble. No one wants to miss the opportunity that presents itself.

Vaporeon stampede Central Park, NYC from Woodzys on Vimeo.

My firm is based in Manhattan where Wall Street is largely headquartered and remains a core industry – providing about one quarter of the total wages but only 5% of the jobs. Every Wall Street job supports about 2.5 private sector jobs so city has highly leveraged its health to Wall Street. In recent years we have seen the rise of “Silicon Alley” which is a higher wage sector than most industries, but Wall Street remains very important to the New York City economy. So whenever layoffs, weak profits and bonuses are announced it can have a more highly levered impact on the economy. However this isn’t an auto industry-Detroit scenario but it is a concern. The Brexit aftermath may shine more of the world’s financial industry focus on New York City, away from London so there is a potential net positive.

Wall Street’s relationship with New York City

I wrote a magazine article for Douglas Elliman five years ago heavily relying on the New York Times archives for notices about rental and sales prices. I remember reading an article that was written during the early 1920s (sorry, lost the link) with the pronouncement made (paraphrased) that “Wall Street will continue to be an important force behind New York City real estate.” That could have been written today and it would still be relevant.

decenturyinfographic

Wall Street’s Relationship with Housing And Mortgages

But from my perspective Wall Street has gotten housing wrong a lot more than it should. They have some of the smartest people on the planet running and working in these firms, with a slew of freshly minted MBAs from Ivy League Schools crunching spreadsheets and wearing out the batteries on their HP12Cs. I’m not saying they haven’t made a lot of money or good bets – think Blackstone’s single family foreclosure purchase frenzy – but the Housing Bubble and the recent overbuilding of super luxury condo and rentals should have been seen in advance. I’ll run through some scenarios I have observed over the past decade or so.

– Federal Reserve under Alan Greenspan They relied on NAR housing statistics and commentary when NAR was the defacto housing information source back in the old “Gatekeeper” days. Leading up to the bubble bursting, their chief economist was hard at work spinning that it was a good time to buy. The Fed remained extremely pro-Wall Street. Eventually NAR was overtaken by Robert Shiller’s Case Shiller Index within the Fed as an alternative reference given its underpinnings in academia, despite its 6 month lag and well chronicled flaws. Eventually the Fed came to rely on CoreLogic data and insights which is a better, less biased, more robust housing resource.

– The Housing Bubble This was a systemic event but the key problem came from allowing Wall Street investment banks being able to play in the sandbox of commercial banks via the signing of Gramm-Leach-Bliley. Wall Street was able to massively over leverage and package mortgage securities into tranches and sell them to uninformed, not-interested-in-being-informed and not-interested-enough-to-not-invest-despite-concerns investors all over the world including the Icelandic banking system and modest sized U.S. school districts. We literally remain, a decade after U.S. housing peaked, in the hangover phase of the Housing Bubble.

– Arbitraging Appraisals Circa 2007 our firm did very little consulting for Wall Street firms despite the housing boom and massive appraisal volume. We were warned by colleagues who had moved there from the appraisal industry to stay away saying “be careful what you wish for” so we headed their advice. One of the big investment banks came to me (unnamed to protect the guilty), requesting a gross retail value on a potential new condo conversion from rental on Manhattan’s Upper West Side. I performed the assignment and was discussing the results with them. They trusted my work and eventually decided to use it to “arbitrage” their risk. In other words, they hired one of the commercial appraiser “hit the number” hacks to do an appraisal and if their value was more than 30% higher than mine, they wouldn’t do the deal because it was deemed high risk. They didn’t see me as a “low baller” but rather a place holder within the insanity that allowed them to measure their exposure and 30% was at then of their tolerance range. After all, they could easily securitize exposure and ship it off to hungry investors. Kind of mind bloggling now when you look back at it. This was one of a series of interactions with Wall Street during this era that enlightened me to the forthcoming collapse.

– Opening The Blinds To See 7 Competing Buildings Next Door New luxury development of the past 5 years depended nearly exclusively on alternative financing since traditional commercial banks remained in the fetal position on construction lending after the legacy of bad decisions made during the housing bubble era. New development financial exploded world wide with investors chasing higher returns in a low interest rate world. Wall Street firms, hedge funds, sovereign wealth funds and private capital flooded the markets and luxury residential development exploded, pressing land prices to record levels. However on January 1st of this year I noticed almost an overnight panic as financing began to dry up. Wall Street led financing sources began to push back after financially seeing the oversupply of product skewed to the super luxury space and the luxury rental market.

– Looking for someone to believe you are worth $1.3B In my 30 year view of Manhattan real estate, there have been many real estate brokerage firms that came and went. In this Wall Street driven development boom, real estate brokerage Compass (formerly Urban Compass) has gotten a lot of attention. I’ve been following their rise in public view through lots of press releases and full page NYT advertising. Their last touted valuation was $800m but they only have 1,000 agents nationwide. In my understanding, the “traditional” real estate brokerage industry valuation has multiples in the low 1’s. so I’m quite confused. There was a recent Business Insider piece on their quest for more capital in what looks to be the result of a high burn rate. The Real Deal just published an amazing investigative piece on the firm. I have nothing against Compass and love the idea of starting up a new disruptive firm, but the messaging coming out of this Wall Street backed firm doesn’t make sense to me. They also tout that they have 50 engineers to create all kinds of efficiencies for their agents. At 1,000 agents, that’s 1 engineer for every 20 agents which seems like a stretch as a model of efficiency. This reminds of something that happened during the last housing bubble. A star real estate broker actually used 3 Blackberries to conduct business. I know this to be true because I observed it firsthand. When this was touted in a real estate article, another top broker and rival claimed they used 13 Blackberries to run their business, not realizing how inefficient that made them sound.

Luxury Real Estate ‘Takes a Breather’

Here are a few thoughts on the current luxury real estate slow down. But first, here’s a great Hamptons chart from Bloomberg.

bb7-21-16hamptons

And many Wall Streeters seemed concerned about the Hamptons since the Bloomberg article that covered our market results was the top most emailed article all day world wide until stocks started to slide.

Image 7-22-16 at 8.18 AM

But I digress

– Luxury or high end housing was the first segment of the market to recover after the 2008 financial crisis. They were not impaired by credit constraints to the same degree as entry and mid markets. Perhaps the cycle ran its course although though I contend that much of the pricing was aspirational, i.e. based on “nothing empirical.”
– The high end was hyper exaggerated and could not be maintained. The conventional wisdom that the market was infinitely wide and deep was based on nothing empirical.
– Overbuilding was a key component to the end of the luxury party. You could make a lot more money creating luxury product than entry and mid level product but when everyone has the same idea, it ends badly.
– There was a global luxury phenomenon that began around 2012 and ran through early 2015. I dubbed it “Luxury Real Estate is the New Global Currency.” The excess construction currently underway was a product of the global investment frenzy of several years ago. Here is the article I wrote for Douglas Elliman in 2012:

denewglobalcurrency

What is being overlooked in what many would characterize as weak results across many of these markets is the robust activity in the “bread and butter” markets of entry and mid level housing. Most of the markets we cover are showing very active markets below the “luxury” level.

The Last of the Second Quarter Market Report Gauntlet

Yesterday Douglas Elliman Real Estate published the last 7 reports that I authored covering the second quarter: Hamptons, North Fork & Long Island, New York; Fairfield County, CT including Greenwich; Aspen, CO; Los Angeles, CA. It’s been a whirlwind and we are even expanding our coverage for the third quarter. From the Hamptons to Los Angeles there were a number of new insights that were extracted and I will share over the coming weeks. One of the most apparent patterns seen in my research was that housing markets remain “soft at the top.”

Elliman Report: Hamptons Sales 2Q 2016 The Hamptons market shifted to a lower number of sales for the fourth consecutive quarter. The number of sales fell 20.5% to 561 from the same period last year, but remained 25% higher than the 450 quarterly sales average of the past decade. Listing inventory declined 9.9% to 1,527 from the prior year quarter, nearly in sync with the 1,522 quarterly average for the decade. As a result of a larger decline in sales than supply, the pace of the market cooled. The absorption rate, the number of months to sell all inventory at the current rate of sales, rose to 8.2 months from 7.2 months in the year ago quarter…
2q16Hmatrix

Elliman Report: North Fork Sales 2Q 2016 The North Fork housing market showed higher prices and more sales in the second quarter. Median sales price rose 2.9% to $535,000 from the year ago quarter, the ninth consecutive year over year quarterly increase. Average sales price showed the same pattern, rising 8.3% to $694,387 from the prior year quarter. Unlike the South Fork, the North Fork luxury market, representing the top 10% of all sales, saw larger price growth than the overall market. Luxury median sales price surged 33.4% to $1,797,500 and luxury average sales price jumped 15.3% to $2,018,347 respectively from the prior year quarter…
2q16NFmatrix

Elliman Report: Long Island Sales 2Q 2016 The Long Island second quarter sales tally was the most in a decade, a recurring suburban theme in the metro area. The number of closed sales jumped 20.8% to 6,324 from the same quarter last year. Signed contracts surged 28.8% to 9,610 over the same period suggesting heavy closing volume over the next quarter. Listing inventory fell to its lowest level for a second quarter in eleven years. There were 15,992 listings available at the end of the second quarter, down 6.3% from the year ago quarter. As a result, the pace of the market was at its fastest rate since 2005…
2q16LImatrix

Elliman Report: Fairfield County Sales 2Q 2016 The sales surge across Fairfield County continued much like the rise in activity observed in adjacent counties that surround New York City. The number of sales jumped 30.9% to 3,944 from the year ago quarter and was the highest second quarter sales total in more than a decade. Single family sales increased 34.9% to 3,082 and condo sales rose 18.4% to 862 respectively from the prior year quarter. Renters and homeowners priced out of New York City have been seeking more affordability in the outlying suburbs in high numbers over the past year. However the surge in sales has not caused housing prices to rise, given the amount of slack that remains in the market…
2q16FFmatrix

Elliman Report: Greenwich Sales 2Q 2016
• Single family price trend indicators continued to slide
• Single family sales declined as inventory expanded
• Condo price indicators fell consistently with sharp drop in sales size
• Condo inventory expanded as sales slowed
2q16GRmatrix

Elliman Report: Aspen Sales 2Q 2016 The Aspen market showed mixed housing price trends, with fewer sales but faster marketing times. After the previous quarter drop, the average sales size of a single family and condo sale returned to more typical levels, rising 4.3% to 2,551 square feet from the year ago level. Aspen did not experience the sharp rise in average sales size that Snowmass Village did this quarter. Median sales price declined 14.7% to $1,407,500 from the year ago quarter yet the remaining price trend indicators moved higher…
2q16ASPENmatrix

Elliman Report: Los Angeles 2Q 2016 Housing prices in Westside and Downtown Los Angeles moved higher, pulling more inventory onto the market. Average price per square foot for single family and condo sales rose 3.9% to $774 and a new record for the 12 years of this data series. Average sales price increased 5.9% and median sales price rose 7.7% respectively from the prior year quarter. Price trends in the luxury market, representing the top 10% of sales, did not keep up with the overall market…
2q16LAmatrix

Flashback to the 1980s Lower East Side, Manhattan

You’d never recognize it now that gentrification has rebuilt it. I remember how scary some of my appraisal inspections were there in the 1980s. I’m all for waxing poetic about the days of yore but seriously, it was not New York’s finest moment.

A Brilliant Idea

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See you next week.

Jonathan Miller, CRP, CRE
President/CEO
Miller Samuel Inc.
Real Estate Appraisers & Consultants

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