This post first appeared in: Cirios Trends – Special Edition: The Year Ahead

It often gets thrown around that owning real estate is a good “hedge” against inflation. That is, real estate prices will inherently rise under inflationary pressures. As far as conventional wisdom goes, this seems to be the case. But does this rising inflation = rising real estate prices relationship actually hold true? To investigate this idea further, we looked at three separate data time series: National Median Home Price, Dow Jones Industrial Average (DJIA) and Consumer Price Index (CPI, a measure of inflation).

As you can see in the graph below (all lines are expressed as the percent change starting from January 1963), home prices have consistently outpaced inflation by a wide margin. Even the recent real estate market meltdown hasn’t brought prices back down to inflationary levels. By contrast, the stock market had been growing at below inflation levels until the early 90’s when it exploded, even surpassing home price growth.

As you can see, during the heavy inflationary periods of the early and late 70’s, real estate did indeed provide an excellent hedge against inflation. Home prices essentially kept pace or outpaced CPI growth during these periods while the stock market stagnated. From a basic perspective, therefore, a dollar would have been smartly invested in real estate during this time.

Interestingly, looking at a more recent time period, the late 80’s, real estate again outpaced inflation (much more modest inflation this time than the 70’s). However, over the time period shown here (1986-91), the stock market more than outpaced home price growth at almost all times (the exception being the ‘87 market crash). So in this case, in hindsight, a dollar would have been more smartly invested in the stock market than in real estate.

To conclude, historically speaking, real estate investment has been a good inflation hedge, particularly during periods of high inflation when other market growth stagnates. Of course, this is a vast over-simplification of the picture, as evidenced by the stock market growth of the late 1980’s. Furthermore, individual real estate markets can behave wildly different from national trends. It is also important to note that on smaller time scales, fluctuations in both inflation and home price trends do not correlate exactly, meaning that inflation is not as significant a price driver for real estate than some might have you believe.

In general however, it is safe to say that real estate values are not likely to be pushed down in any material way by inflationary pressures. As diversity is the key to any long term success in investment, real estate has to be included in any portfolio.

This post first appeared in: Cirios Trends – Special Edition: 2010 Real Estate Roundup

In February of this year, we wrote:

“while many risks still remain for the housing market, we believe the time for being pessimistic about real estate is finished. That’s not to say there won’t be more price declines, more foreclosures, more defaults – to be sure, there will be more of all of those things; housing is far from out of the woods. But we have reached a point where Price Discovery is far enough along in certain markets that it’s time to start looking for opportunities, rather than sitting on the sidelines.”

Since that time, the homebuyer tax credit expired and in many markets, demand all but disappeared; interest rates have risen materially from historic lows and mortgage guidelines continue to tighten; Greece effectively went bankrupt; Ireland effectively went bankrupt; we experienced the worst off shore oil spill in United States history; a “Flash Crash” in the stock market erased $1 trillion in value in a matter of minutes and still remains largely a mystery; unemployment remains stubbornly high; jobs remain stubbornly scarce and shadow housing inventory remains at historic highs … to name but a few of the headwinds our economy faced this year.

And despite all this, we are sticking with our statement from February, licking our chops at the opportunities that ongoing turbulence in the housing market is busy creating. To be sure, not every listed property is a deal and there are myriad pitfalls if a buyer doesn’t exercise caution, but we are still of the belief that now is a time to be opportunistic, rather than pessimistic. Certain segments of the housing market are extremely compelling at today’s prices, as fundamental changes within communities are ongoing.

The key of course, is knowing what those segments are and what to do about it.

In this month’s Cirios Trends, we examine the key events of 2010 and how they shaped the housing market. We saw ups, downs and just about everything in between. But through it all, buyers who bought in the right markets did well, while others are stuck holding depreciating inventory because they didn’t understand the market.

Individual homebuyers, while not always as economically motivated as investors, have experienced a mixed bag of opportunities and frustrations. Sellers in certain areas are reticent to accept realistic pricing, and a slew of properties have languished, unsold on the market. Patience and opportunism remain central to finding a great home at a great price.

So, sit back and enjoy a turbulent journey through 2010 as we eagerly await what 2011 has in store for real estate markets here in Bay Area and beyond.

This post first appeared in: Cirios Trends – Special Edition: 2010 Real Estate Roundup

A 2010 housing market recap would be incomplete without a rundown of what has become known as “Foreclosure-Gate,” a foray into the procedural minutiae of distressed mortgage servicing.

In September of this year – in the midst of the crucial mid-term elections – several large banks, including Ally Bank (formerly GMAC), Bank of America, and JPMorgan Chase, acknowledged problems with their foreclosure procedures. Bank employees, in addition to third party mortgage servicers and legal vendors, were found to have signed as many as several thousand documents a day, at times without personal knowledge of the facts they were attesting to in courts.

The practice became popularly known as “robo-signing” and sparked fresh political wrangling over the process by which Americans are forcibly removed from their homes.

In the wake of press reports and political backlash, lenders froze foreclosures and initiated internal reviews in the hopes of swiftly (and correctly) resuming foreclosures. The review process, however, has been anything but swift.

All 50 state attorney generals filed suit against transgressing lenders, in no small part because many were up for reelection at the time. By late November it was rumored that both sides were working towards a settlement. Some reports speculated the settlement could include: 1) a fund that banks pay into to compensate borrowers whose mortgages were wrongfully foreclosed; 2) banks eliminating the dual track of simultaneously reviewing modification requests and advancing the foreclosure process; and 3) a third party mediator review of cases where borrowers claim a foreclosure was in error.

As of publication, no actual settlement has been announced and repossession proceedings in many states remain delayed.

As reported in the Washington Post, mortgage industry representatives, including executives at Fannie Mae and Freddie Mac, have testified in front of Congress that mortgage servicers and the law firms filing foreclosure actions are to blame. Vendors, for their part, argue that Fannie and Freddie set policies and procedures that encouraged the sort of cost cutting automation now blamed for the errors.

In the rush to provide competitively priced services and reduce overhead, mortgage servicing companies and foreclosure filing law firms introduced high levels of automation to the document-intensive foreclosure process. The rub, however, was that human
reviewers would have to handle more and more files, with less and less time dedicated to each one.

For example, the ABA Journal reported on December 3, that a Pennsylvania law firm, Goldbeck McCafferty & McKeever, was accused of the unauthorized practice of law for non-attorneys routinely preparing and filing foreclosure suits without direct attorney oversight, including signing the purported attorney’s name themselves. In other instances, it has been learned that reams of documents were signed via stamps and that the signers had not actually read the documents they were signing.

Further revelations as to the mechanical foreclosure processes in place are likely to increase, which could continue to cause undesirable consequences to the entire housing market.

First, foreclosure freezes have resulted in delays in the healthy clearing of housing inventory via foreclosure. According to ForeclosureRadar, in Arizona, California and Nevada, the number of properties hitting the auction blocks has dropped more than 30%.

Second, investors that were buying distressed loans and foreclosed homes at auctions have become more cautious. For vulture investors buying defaulted loans and flippers buying REOs at auction, speed is essential to their investment return models. If more homeowners are successful in delaying foreclosures due to shoddy paperwork by servicers and law firms, what is to stop homeowners from attempting further delays even after an auction sale? This notion of continued delays has investors tweaking their pricing models to the downside.

Third, individuals buying REO properties on the open market have been more hesitant to purchase foreclosures due to the media’s regular coverage of the Foreclosure-Gate debacle. Many would-be buyers have begun to believe that if they purchase an REO, they could later lose the home to a former owner filing a lawsuit claiming they were incorrectly foreclosed upon. If fewer investors and homebuyers are interested in purchasing REOs, more REOs will languish unsold on the market, further eroding prices.

Unsavory as it may seem to be profiting from foreclosures, these players are vital to the process by which over-leveraged housing stock is flushed through the system. This price discovery is the only way a sustainable bottom in home prices will be found.

These consequences point towards further downward price pressure in the broad housing market. Until banks are able to legally move forward with the clearing of the large inventory of foreclosures, a true recovery in the housing market will not take root.

This post first appeared in: Cirios Trends – Special Edition: 2010 Real Estate Roundup

Spring 2010: Financial Crisis Goes Greek
Believe it or not, Greece’s national debt is larger than its economy. Sound implausible? The United States’ national debt is also larger than its economy (but that’s another story). Years of uncontrolled spending, cheap debt and an utter lack of financial reforms left Greece vulnerable when the global economy fell sick. The European Union stepped in with an aid package to the tune of $61 billion and within weeks Greece had announced austerity measures aimed at cutting public spending. Greeks went crazy. Rioting and picketing ensued, as average citizens decried what they believed to be unreasonable demands by the global financial community. In recent weeks, Ireland suffered a similar fate and many believe Spain, Portugal and even Italy may be the next European nations to come hat in hand for an EU bailout.

April 20, 2010: Deepwater Horizon Blows Its Top
The largest offshore oil spill in United States history left an indelible mark on the country, and indeed the world, in the spring and summer of 2010. The effects of this catastrophic event will not be fully realized for decades. As if the current economic woes and lingering effects of Hurricane Katrina were not enough for Gulf Coast residents, lax procedures on the part of British Petroleum and a handful of other industrial firms, not to mention haphazard at best oversight by regulators, have left potentially irreversible scars on one of our nation’s precious coastlines. Ecologic, economic and social ramifications were heavy during the crisis, but now that the news media has moved on to other items, it remains to be seen whether lasting, effective change can be put in place to avoid future catastrophes of this kind.

April 23: Arizona Passes Controversial Immigration Law
In one of the more widely debated legislative moves in recent memory, the state of Arizona passed a highly controversial law aimed at cracking down on illegal immigration. State lawmakers argue that new rules give police the power to pursue and prosecute illegal immigrants, while opponents counter that the law is simply a legalization of racial profiling. Protests spread across the country, including a San Francisco Giants game against the Arizona Diamondbacks, where demonstrators marched in front of AT&T Park. At the least, the law highlights the federal government’s continued failure to address the issue of immigration in this country. As long as Washington ignores the swelling ranks of illegal immigrants, states are likely to continue to take matters into their own hands.

April 30, 2010: Homebuyer Tax Credit Expires
After more than a year of helping prop up the ailing house market, the homebuyer tax credit expired this summer. In the months following, data began to show slackening demand in almost all housing markets. And while some argue that weakness should be more directly attributed to general economic sluggishness, the effect of the tax credit expiration was material in many areas. The chorus for another round of credits is now barely a whimper, as anti-deficit sentiment in Washington has supplanted the desire for increased government intervention into the housing market. Now even the mortgage interest deduction is under assault, as economists begin to question the wisdom of such aggressive policies aimed at promoting homeownership in this country.

July 2010: Hunters Point Redevelopment Gets Green Light
After years of political wrangling, the San Francisco Supervisors gave the final approval to redevelop the city’s most chronically depressed area at Bayview-Hunters Point. The proposed development, spearheaded by residential developer Lennar Corp., would create 10,500 new residential units (a third of which would be for low-income residents), a swath of new commercial space and over 320 acres of parkland and open space. Mayor Gavin Newsom claims the project would create 13,000 new jobs. Many local groups oppose the development, arguing it will push out longtime residents in favor of the wealthy, further reducing the already limited supply of housing that any rational person would consider affordable.
(for more coverage on the Hunters Point development, see previous Cirios Trends.)

November 1, 2010: Salesforce.com Snaps up 14 Acres for New HQ at Mission Bay
Cloud computing juggernaut Salesforce.com announced the purchase of 14 acres of real estate in San Francisco’s Mission Bay district, the sprawling development area formerly owned by the Southern Pacific Railroad. Notably, UCSF is building a medical center in the area as a host of other development projects have been fighting to thrive against the broader housing market’s downturn. Salesforce shelled out $278 million for what will become its 2 million square foot headquarters, which will no doubt change the landscape of neighboring SOMA and Potrero Hill in the years and decades to come. Despite macroeconomic weakness, pockets of real estate development continue and savvy investors are looking beyond near-term uncertainty to profit from these fundamental changes that are already afoot.

November 1, 2010: Giants End World Series Drought
For the first time since moving West 52 years ago, the San Francisco Giants paraded down Market Street as (baseball) Champions of the World. Not only was this the first championship for the Orange and Black, but no Bay Area sports franchise has won a title since the 49ers beat the San Diego Chargers in Super Bow XXIX back in 1995. For a group of misfits no one gave much of a shot to earlier in the year, the Giants overcame doubters throughout the post season. The city of San Francisco rallied behind its team, culminating in a 5-game victory over the Texas Rangers, a group of misfits in their own right, that knocked off the New York Yankees in the American League Championship series. Already, and in typical fashion, the sports media establishment is discounting the Giants chances of repeating in 2011.

November 2, 2010: Whitman Spends How Much to Lose?
Meg Whitman spent $160 million in her attempt to become governor of California, only to lose the election in a landslide to Jerry Brown. Despite a budget some six times greater than Brown, who most recently held the governor’s post from 1975-1983, Whitman was trounced by almost 13%. Most experts point to a late-race revelation that the former eBay CEO knowingly employed an illegal immigrant housekeeper. A political outsider, Whitman ultimately could not overcome her spotty personal voting record, the housekeeper fiasco and a general lack of confidence in her ability to lead the state out of its fiscal quagmire. Californians asserted their belief that for as incompetent as Sacramento is, the governor’s seat cannot be bought … at least not by this powerful former Silicon Valley executive.

This post first appeared in the September edition of: Cirios Trends: In Search of Real Estate Opportunities

In a financial landscape marred with uncertainty, there is one constant, one thing that “everyone” knows: Housing is in trouble. And while the bears certainly have ammunition to support their pessimistic case, history tells us that when everyone is looking one way, smart investors should be looking the other.

The federal government’s determination to prop up housing at all costs is creating pockets of opportunity, even as data point to an increasingly bleak picture. We’ve heard the story for months: Tax credit expiration, weak employment outlook, looming shadow inventory, tight lending environment, etc. And it’s all true.

Meanwhile, billions of dollars continue to be thrown at the housing market, in the desperate hope that home prices can be kept from falling (again).

This flood of money is keeping mortgage rates low, which benefits not just hard hit markets, but all markets, including those poised for fundamental growth. Buyers in markets that don’t need government support, those that are strengthening because they are becoming more popular with wealthier buyers, are benefiting from stimulus pouring in to help distressed markets.

Recently, on the same day the financial media was obsessed with existing home sales data that painted a stark picture for the future of housing, we checked on a house in Bernal Heights, a neighborhood on the outskirts of San Francisco, that had gone under contract in just a few days. The transaction had closed, well above list, with a note that there had been 13 offers.

Apparently, Bernal Heights didn’t get the memo that housing is dead.

Bernal Heights isn’t unique, despite being one of the strongest real estate markets in the Bay Area. It is one of the last affordable neighborhoods in San Francisco (on a relative basis of course), it has a growing main drag and is well-poised to benefit from large scale redevelopment plans already underway (see last month’s Cirios Trends that discussed the Hunters Point redevelopment project).

All over the country, there are similar pockets of fundamental growth. Neighborhoods are changing, jobs are being created, people are moving who need places to live. Meanwhile, the vast majority of
housing markets remain weak, plagued by oversupply, anemic job markets and a limited pool of prospective buyers.

These struggling communities are the focus of the trillions of dollars in housing stimulus that have driven interest rates to historic lows and kept distressed inventory off the market. These unsustainable policies have, unwittingly, doomed most distressed markets to stagnation for years, if not decades, by preventing the legitimate price discovery required to find a sustainable bottom. On the flip side, this massive injection of cheap funding is accelerating demographic shifts already underway.

So while housing bears look at national data and proudly remind us how right they have been about the double dip in housing, they risk throwing the baby out with the proverbial bathwater. There continue to be opportunities out there, as long as you know where to look.

This post first appeared in the September edition of: Cirios Trends: In Search of Real Estate Opportunities

Every couple months, the trials and tribulations of Fannie Mae and Freddie Mac (collectively known as the Government Sponsored Enterprises, or GSEs), appear on the national radar. This typically happens around earnings season, when staggering loss numbers are announced.

Once hailed as critical components to a robust housing market and easy access to mortgages for low income Americans, the growing sentiment of many inside housing finance is that the two mortgage giants should be fitted with toe tags.

Maybe its because policy makers aren’t sure what to do with the troubled companies, whether they should be publicly or privately owned. Perhaps its due to the staggering amount of money they’re losing: the GSEs are beyond broke, burning through $150 billion in taxpayer money to remain solvent. Last month, Freddie requested billions more after reporting its 12th straight quarterly loss.

Before delving into the quagmire that is “what to do about the GSEs?” a brief history lesson is in order. Fannie Mae was established by the federal government in 1938 to create a liquid secondary mortgage market that would allow loan originators to focus on creating more loans. Essentially, Fannie bought mortgages from lenders so that lenders could use the cash for new loans (sounds like the foundation of a bubble, or at least inflation, doesn’t it?).

By 1968, the federal government released Fannie into the wild when it morphed into a private, shareholder-owned corporation. By 1970, Fannie was authorized to purchase private mortgages in addition to federally insured mortgages, such as FHA and VA mortgages. That same year, Freddie Mac was created to provide some “free market” competition for Fannie. Importantly, while they were technically outside the government umbrella, the GSEs carried an implicit guarantee from the US government. That is, investors in Fannie and Freddie debt were led to believe that any repayment problems would be cleaned up by the federal government.

Though both were publicly traded companies, the federal government routinely passed regulations specifically directing their actions. In 1989 the government passed the Financial Institutions Reform, Recovery and Enforcement Act, subjecting both to oversight by HUD (the U.S. Department of Housing and Urban Development).

In 1995, more than ten years prior to the peak of the housing bubble, Congress granted the GSEs
affordable housing credits to encourage the purchase of subprime mortgage securities.

By September of 2008, as the housing market was in the throes of collapse, the GSEs were placed into conservatorship under the Federal Housing Finance Agency and have since been kept alive by regular injections of taxpayer money. So why are the GSEs even necessary? Why not just shut them down? Perhaps its because of how important a role they currently play in the financing (read: propping up of) the US housing market: Fannie and Freddie were the buyers of more than 70% of mortgages issued last year.

Essentially, the GSEs buy loans from mortgage originators, paying in cash or exchanging the mortgage for a mortgage-backed security comprising those mortgages. By doing this, Fannie and Freddie enable lenders to quickly sell their loans and use the money to make new loans.

The GSEs will also issue guarantees that mortgages will be repaid, which act as insurance against borrower defaults. Both companies also issue mortgage backed securities that come with a guarantee that the principal and interest payments will be paid on time to the investor.

The GSEs earn income from the interest rate spreads between what they pay investors to buy their securities and the interest collected on mortgages underlying them, as well as from fees for guaranteeing loans and assuming the aforementioned risks related to defaults.

The latter is why the GSEs were crushed when the housing market fell apart. When borrowers default on loans guaranteed by Fannie or Freddie, the GSEs owe the entire balance of the loan or guaranteed security. Now, explicitly not just implicitly, US taxpayers are on the hook for GSE losses resulting from mortgage defaults and home price declines.

Calls for reforming Fannie and Freddie are growing ever louder. However, despite these calls no right solution seems to exist. Moreover, it seems unlikely that any real resolution to problems with Fannie and Freddie will take place before November. Treasury Secretary Timothy Geithner has promised to deliver a proposal for housing finance reform to Congress by January 2011. Conveniently after the midterm elections in November.

As long as it is politically unacceptable to tackle this gaping hole in housing reform, the only thing that can save the GSEs is the return of private securitization. Which, as it turns out, may not be as far off as most “experts” think.

This article first appeared on Minyanville.

A piece in this weekend’s New York Times contends that the golden era of real estate is over. The author, David Streitfeld, argues that for the foreseeable future (and possibly forever), a home will simply be four walls and a roof, ceasing to be the lucrative financial investment it’s been since the end of World War II. The premise is mildly compelling, particularly given the dour housing data of the past couple months. But to argue that real estate as an asset class is dead is to grossly misunderstand not only housing, but the nature of human progress itself.

After five years of a housing depression that brought the entire global financial system to its knees, it’s easy to get behind the argument that housing is dead: Shadow inventory is looming, government incentives are running their course, the employment outlook is cloudy at best, and people are thinking twice about plunking down a life’s savings for the privilege of 30-years of indebtedness.

Moreover, according to Streitfeld and the housing economists he quotes, a shockingly large portion of Americans’ disposable income over the past several decades was generated through real estate appreciation. Not only did banks like Wells Fargo (WFC) and JPMorgan Chase (JPM) get rich off originating, packaging, and selling mortgages, but cruise operators like Carnival Corp (CCL) and Royal Caribbean (RCL) and gadget-makers like Apple (AAPL) and Research in Motion (RIMM) cashed in as homeowners cashed out.

And while all this is true, to say that “real estate’s gold rush seems gone for good,” is to lump Silicon Valley in with the Wasatch Mountains, Daytona Beach with Huntington Beach. Articles like Streitfeld’s make for interesting chatter at the water cooler and cocktail parties where being bearish on housing is all the rage, but they miss the larger point that progress and development are ongoing, and there are good long-term real estate investments out there if you know where to look — even if you’re just looking for a place to raise your family.

The bearish thesis breaks down when you look at what it means to actually buy a house, and what factors effect the future price of that particular home. Buying a house isn’t the same as investing in the “housing market.” Not even close. The argument relies on the naive, yet now-popular belief that the same factors that make taking a flier on a Vegas condo risky must, by extension, also make buying a starter home in Austin, Texas, a dicey proposition.

Rather, buying a home is investing in a neighborhood, a community which may or may not be squarely in the path of demographic patterns that were set in motion well before our country had ever heard the term “subprime.” If done right, a happy medium can be found between finding a place you want to live and settling down in what may even turn out to be a good investment.

Population shifts evolve over decades, not years, and are based on fundamental factors that run deeper than short-term blips in the national, or even regional economy. Demographic movements, not short-sighted speculation, are behind the creation of real estate wealth in the long run. These shifts explain why rural towns with stagnant populations won’t see appreciation for decades (if ever), while regions with expanding job markets and a growing population are ripe for smart investment (yes, such areas exist, even now).

At the same time, established, snobbish communities of aging baby boomers may see home prices flatline for years, while buyers in many gritty, neighborhoods on the fringe currently far outweigh sellers. In these markets, prices are creeping back up based on fundamentals, not government crutches.

So as stubborn housing bears drone on, spouting their frail generalities, the precious few of us with vision to see beyond next quarter’s GDP data will be the landlords of the future.