A weekend topic starting with Yahoo Finance. “At an event this week at a swanky restaurant atop the Equinox Hotel in Hudson Yards, New York City — the firm’s CIO Tony Roth opened evening discussions by arguing ‘3% is the new 2%,’ referring to the Fed’s inflation target. ‘As inflation comes down — and it’s going to come down, it’s already coming down — it’s going to get stuck,’ Roth said. ‘And it’s going to get stuck as a result of the real drop in labor participation and the impact that has on wages, it’s going to get stuck because of the lack of unlimited cheap supply of manufacturing from China, and it’s going to get stuck because energy prices are not going to back down to previous levels.’”
“Hedge fund manager Bill Ackman is among other Wall Street voices who have questioned the credibility of the Fed’s 2% inflation target in recent months. In December, Ackman tweeted the target was unattainable without a ‘deep, job-destroying recession.’ And during a call with investors the prior month, he said it was the firm’s view the central bank would not reach that goal.”
“Rising wages globally, the transition to alternative energy, de-globalization, and a shift to domestic sourcing and production will all weigh on the Fed’s ability to bring down inflation, in Ackman’s view, in addition to production risks ‘that have made nearly every U.S. CEO rethink outsourced or distant supply chains. A lot more of that is going to come closer to home, and it is more expensive to do business here,’ he said.”
From Bloomberg. “One of the most lucrative money-making machines in the world of finance is all clogged up, threatening a year of pain for Wall Street banks and private-equity barons as a decade-long deal boom goes bust. After driving a flurry of mega buyouts that contributed to a $1 trillion profit haul in the good times, some of the world’s largest banks have been forced to take big writedowns on debt-fueled mergers and acquisitions underwritten late in the cheap-money era.”
“The easy days aren’t coming back anytime soon for the fee-rich business of leveraged lending as a much-anticipated recession looms. Cue oncoming cuts to bonuses and jobs across the investment-banking industry. ‘The dislocation is more pronounced and longer lasting than anything since the Great Financial Crisis,’ said Richard Zogheb, global head of debt capital markets at Citigroup Inc. ‘Investors have no appetite for cyclical businesses.’”
“The most sophisticated players, paid to know when the music stops, were doling out risky corporate loans at what now looks like ludicrously generous terms as recently as last April — effectively betting that the easy-money days would live on even as inflation raged. Now the Federal Reserve’s resolve to tighten monetary policy at the fastest pace in the modern era has left them blindsided, cooling the M&A boom that’s enriched a generation of bankers and buyout executives over the past decade.”
“The freewheeling excesses of the low-rate years are no more. In that era, leverage soared to the highest since the global financial crisis, investor protections were stripped away, and ballooning debt burdens were masked by controversial accounting tricks to corporate earnings that downplayed leverage. The bottom line: the LBO machine is all jammed up, and as the Fed ramps up policy tightening it may take months to clear.”
From WPED. “Right now, prospective Myrtle Beach home buyers are facing a double-edged sword, high prices and high demand. The South Carolina House Price Index shows the current average home price in the Palmetto State is just under $390,000. In May of 2022, it was $350,000. On top of that, Myrtle Beach home buyers are also battling the loss of buying power, as interest rates are now doubled. For someone who is looking to buy a home at $250,00 in the Myrtle Beach area right now, with a 20% down payment, a 30-year loan would garner a price tag of more than $264,000 in interest because current rates are so high. Meaning, overall, you’d be paying over $566,000 for the home.”
From Vail Daily. “Chad Brasington, also an associate broker for Berkshire Hathaway HomeServices Colorado Properties, notes that for the local market, a dramatic shift back to the norm is something every local buyer and seller truly wants and needs. ‘We can’t sustain artificially inflated home prices when it comes to the most important thing to every family that lives here…their home,’ Brasington said.”
“‘If you are not under contract by the end of August, it is unlikely you will see anything until the second homeowners roll back into town in early December. When pricing a home, sellers need to flush out the memory of 2021 and early 2022 and shift their mindset to the more stable years of 2018 and 2019. It’s about market value not what you think your home is worth,’ he said.”
Nevada Public Radio. “Over the last few years, people have been paying a premium for homes in Nevada —many times bidding way more than the asking price; sometimes having to get into a lottery just for the chance to make a bid. Then the Federal Reserve raised interest rates as a way to fight inflation. The cost of getting a home mortgage rose, and home prices have fallen. Lee Barrett is the 2023 president of Las Vegas Realtors. He’s said that buyer confidence is going down, despite dropping home prices.”
“An average mortgage in Nevada today comes with a 30-year fixed rate of 6.27%. Jonathan Gedde with Simplifi Mortgage said he sees these rates as a return to normal. ‘And that includes the home price. We had a couple of years in a row of extremely high home appreciation, double digit 10, 20, 25% increases in home values per year. That’s not sustainable. And it’s not a normal market when things like that happen. So taking a little pause, coming back to earth a little bit on home prices, as we’ve seen since the peak in May, is a very healthy thing,’ he said.”
Bisnow Dallas Fort Worth in Texas. “Turmoil in the economy has the CRE industry coming to terms with the fate of beleaguered office buildings as fourth-quarter reports paint a grim picture heading into the new year. For some, that will mean giving up and handing over the keys. Ownership groups that need new debt on a maturing loan will have to decide whether sinking more money into a low-performing asset is worth the investment, said Ben Brewer, a senior managing director in Hines’ DFW office. ‘People may feel like, ‘Golly, I’ve been trying to lease this thing for two years and it’s not working, why would I throw good money after bad?’ he said.”
Bisnow New York. “New York landlord Chetrit Group is looking to sell more than 8,000 residential units it acquired across 10 states in 2019 as it faces default on a $481M loan it used to finance the acquisition, The Real Deal reports. The CMBS loan, originated by JPMorgan Chase, was used to acquire 8,671 units New York, Illinois, Indiana, Ohio and several Sun Belt states, but despite strong nationwide demand for apartments in nearly four years since the acquisition, the portfolio had an occupancy of just 76% in the year leading up to March 2022, per Trepp.”
“The occupancy rate hasn’t been high enough to pay the debt service on the floating-rate loan, which was pegged to Libor. The loan was originated at an 84% loan-to-value ratio, The Real Deal reported in 2019, and rising interest rates last year could have caused debt service payments to double. It’s not the first CMBS loan from 2019 Chetrit has struggled to stay current on. Jacob Chetrit and his sons, Michael and Simon, acquired 850 Third Ave. from Chinese conglomerate HNA Group in 2019 for $422M, and two years later, the $177M CMBS loan on the 617K SF building was sent to special servicing.”
“Multifamily properties bought in the low-interest rate environment before last summer are seen as some of the most prime buying opportunities for distress investors.”
Mortgage Introducer on the UK. “Disappointing December housing sales data may point to a buyer’s market in early 2023, along with pressure on those seeking refinancing. But there are differing views on whether prices are on the way to a serious drop, or a soft landing. Lewis Shaw, founder of Teesside-based mortgage broker Riverside Mortgages, said the slump in the Nationwide house price index was expected. And with 1.8 million mortgage holders needing to remortgage in 2023 and inflation still in double figures, Shaw believes the pain has not even started. ‘I expect to see forced sales, a massive increase in debt consolidation and adverse lending, along with a buy-to-let fire sale, all contributing to an Annus Horribilis,’ he added.”
“‘These are the snowflakes that started the avalanche,’ said Samuel Mather-Holgate of Swindon-based advisory firm, Mather & Murray Financial. Mather-Holgate said people will not be in a rush to buy properties at the top of the mountain in the new year. ‘There is plenty of room for prices to fall and I expect little activity in the market until we know where prices decide to settle and that will not be until late Spring,’ he said. Mather-Holgate added that there will be many distressed sellers needing to offload their properties when they cannot cope with cost-of-living increases.”
Stuff New Zealand. “If you’re buying a first home on a tight budget, the so-called bargains on offer include a clutch of houses not renovated since the middle of last century. The house price slump has seen median values in Wellington suburbs drop by as much as 21% over the past year, but new data suggests the housing affordability crisis continues to warp expectations.”
“This time last year there were just three suburbs with median house values under $700,000, and only 38 suburbs worth less than $1 million. In retrospect, those inflated values were the dying sparks of the housing boom. Now, according to CoreLogic figures, there are 19 suburbs worth less than $700,000. And the number of suburbs worth less than $1m has more than doubled: 79 in total. It’s a course-correction rather than a total reversal. In the Porirua suburb of Ascot Park, for instance, median house values are still up 44% on pre-pandemic levels, even with a 9% dip over the past year.”
“One of the cheapest houses for sale includes peeled-and-blistered interiors and the muted promise of possibility. ‘Yes, some serious work needs doing,’ the listing reads. ‘But a savvy buyer will recognise the amazing opportunity.’
On the market for the first time since the 1960s, homes.co.nz estimates the three-bedroom Wainuiomata house will sell for a cheapish $535,000. It’s a bargain hunter’s paradox: $107,000 cheaper than the median house value in the suburb, yet $115,000 more expensive than the RV three years ago.”
“For an extra $20,000 dollars, you could set your sights higher – an elevated three-bedroom house in Stokes Valley with a view over the valley. The $555,000 asking price is a 143% increase on when the Logie St house last sold in 2014.”
From Better Dwelling. “Canada’s overleveraged mortgage borrowers are still a big share of the real estate market. Highly indebted households represented 32.1% of mortgage originations in Q3 2022, down 6.0 points from the previous quarter. Yes, nearly 1 in 3 mortgages were still going to overleveraged borrowers—even as interest rates ripped higher. The share peaked at 40.2% of new mortgages in Q1 2022, a new record for at least 10 years, and possibly an all-time high. It remains elevated compared to historical volumes, which were already too high.”
“It’s also worth noting the distribution of smaller lenders saw a surge in highly leveraged borrowers. The first surge was in 2017, when BC and Ontario had a mini-speculative bubble. The second was during the pandemic, when record home price growth was sparked by low rates, and investors piled into the market.”
The Telegraph. “From February 2020 to February 2022, average home prices in Canada increased by 46pc, according to the CREA. This was the biggest rise among advanced economies during this period. Low interest rates were a key factor. The Bank of Canada, the central bank, cut rates from 2pc to 0.5pc in 2020. This was a steeper drop than in Britain, where interest rates fell from 0.75pc to 0.1pc. Canada’s market was further frothed up by domestic and foreign investors, said Sal Guatieri, a senior economist at the Bank of Montreal.”
“‘When prices were going up as much as they were, there’s an incentive to invest…and as you’re doing that you’re pushing prices higher,’ he said. ‘It was just a massive asset bubble,’ he continued. ‘It wasn’t just in the housing market. Asset prices exploded higher globally across most categories.’”
The Globe and Mail. “Plenty of homes, too few homeowners. That’s the paradox of Canada’s housing crisis – there may not be an actual housing shortage. Any first-time homebuyers who ever got trapped in a bidding war, or tenants wrestling with escalating rents because they can’t put together the money for a down payment on their own home, will find that idea outrageous. But it may actually be there’s enough accommodation to go around.”
“Those years of bidding wars, on the other hand: they’ve been all too real. But it’s also possible we’ve misinterpreted them. We’ve generally surmised that they resulted from a growing pool of homebuyers chasing a limited stock. However, it may just be something else is going on – namely, an increase in activity by property investors. In some parts of Canada, up to two-fifths of the housing stock is now owned by multiple-property investors, one in six owners owns more than one property, and the figure seems to be rising. In short, there are a lot more houses than there are homeowners.”
“Over the past few years, anyone with money to invest would have been drawn to property, because the Bank of Canada’s monetary policy made it a money-mill. Despite the apparent anomaly that property prices were surging in an economy that was all but stagnant, the bank persisted in its loose monetary policy on the grounds it wasn’t affecting consumer prices.”
“Now I know it’s all too easy to blame the Bank of Canada, but still, it blew this call. Meanwhile its defence, that nobody saw an inflationary surge coming, rings rather hollow. Long before the Ukraine invasion the bank says triggered the price spiral, critics warned that trouble was brewing (I humbly place myself in those ranks, having published a piece in these pages four years ago).”
“Economic growth had been driven up by the ‘wealth effect’ of rising asset prices, particularly house prices. Investors who saw their wealth growing in leaps and bounds felt free to spend some of it, taking advantage of ultracheap credit to both buy more property and spend some of the gains. But with so much money going into housing, investment elsewhere in the economy fell, limiting productivity growth, and Canada now has one of the worst levels in the Group of Seven.”
“The Bank of Canada is now atoning for its past sins and has slammed the monetary brakes on hard. So far, this hasn’t caused a recession, which is the conventional way of crushing inflation. But it’s already knocked house prices down, and that alone has started taking steam out of the inflation rate. That’s to be expected: A recent study of the American economy found that the recent inflation surge was caused not by excessive fiscal stimulus, as economists like Larry Summers have been saying, but by the excessive monetary stimulus that inflated asset-values, putting the wealth effect on steroids. The same is likely true for Canada.”
“We’ll soon know if investors distorted the property market. By early last year, when interest rates were still in the basement, variable-rate mortgages accounted for a third of new issuance. If those were mostly employed homeowners, whose earnings are following inflation upward, they’ll probably be able to take the hit to rising rates by pulling in their horns. But if they were disproportionately investors looking to flip the properties or cashing in on its rising equity, they may be forced to liquidate some of their portfolio. The added supply could then drive house prices sharply downward.”
“We’re thus probably now at the moment of truth. Given the final surge of the housing bubble last year, a lot of those mortgages are coming up for renegotiation. If a disproportionate number of them were indeed investors looking to cash in, the rush to liquidate could come soon. But funnily enough, falling house prices will probably give the economy a breath of fresh air. In addition to the decline in inflation and the fact that homes will become affordable again, the economy will allocate capital more productively. Instead of chasing bubbles, investors will have to look for new opportunities. And with labour costs likely to keep rising, that will provide strong incentives to invest in the new technologies and processes that raise worker output.”
“That would be a big plus for the Canadian economy, which has long been a laggard in these respects. So while we may feel like we’re now sheltering from a storm, come the spring, we could be planting a new garden.”