By: Thomas M. Brophy, Director of Research, ABI Multifamily
Let’s begin with a few quotes:
“There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know.” -Donald Rumsfeld
Risk assets are now supported by the new ”Keynesian Put”, the expectation that fiscal measures will be deployed to combat any renewed weakness in the economy/markets (independently of any larger political projects). But asset prices remain primarily supported by excess monetary abundance across the world:
- There have been 667 interest rate cuts by global central banks since Lehman;
2. G7 central bank governors Yellen, Kuroda, Draghi, Carney & Poloz have been in their current posts for a collective 17 years, yet only one (Yellen in Dec’15) has actually hiked interest rates during this time;
3. Central banks own $25tn of financial assets (a sum larger than GDP of US + Japan, and up $12tn since Lehman);
4. There are currently $12.3tn of negative yielding global bonds (28% of total);
5. There is currently $8tn of negative yielding sovereign debt (54% of total).
-Michael Hartnett, Bank of America, ‘The Liquidity Supernova & The ‘Keynesian Put.’
“There has been much tragedy in my life; at least half of it actually happened.” -Mark Twain
Introduction
Today’s multifamily market is one that I have truly never witnessed; perhaps this is the sentiment felt by all individuals in all market cycles. As a 4th Generation Arizonan, and yes, unlike unicorns, we do exist; I have seen, heard and felt more than a few boom-and-bust real estate cycles. Typically, Arizona leads the pack with mass speculation fueled on Western dreams and high profits which ends in Federal charges and vacant homes. This time it’s different (and yes it does pain me to use this battered cliche but if the shoe fits), and far from the over-built speculation nightmares of old, and a topic I’ve covered in a previous article, With All This Construction We’re Still Under-Supplied this fact still leaves me scratching my head. One could make the argument there’s a burgeoning over supply of high-end multifamily construction, and is cause for some concern, which I addressed in the previous article: Behind the Construction Report Numbers: Phoenix Rising from the Garden-Style Apartment Community but none of this points to systemic risk.
Before I digress further, my astonishment nay trepidation, lies not in the irrational exuberance in the lead up to the Great Recession where the proverbial, “build it and they will come” mentality reigned supreme across residential and commercial real estate. Rather my trepidation rests in the ever-growing possibility of an external shock, see quote 2 above. For the balance of this post, I will attempt to quantify what Rumsfeld called, ‘known knowns,’ jab at ‘known, unknowns,’ and leave you to predict ‘unknown, unknowns.’
Known Knowns
At the macro level and as BofA Analyst, Michael Hartnett, alluded to above, the developed world’s central bankers have embarked upon an unprecedented race to the zero bound and lower. Now, after a decade of quantitative easing and an amalgam of NIRP/ZIRP policies, over half of the developed market’s (DM) sovereign debt is negative yielding, central banks have accumulated a total of $25 trillion in financial assets, Brexit won and now Italy stands on the Mateo Renzi-inspired referendum precipice; the impacts of which should be categorized in the ‘known unknowns’ category. And all of this is just in financial markets and speaks nothing about rising global terrorist attacks, Turkish-PM Erdogan’s staged coup and purge fest, Venezuela’s Socialist collapse (looking at you Sean Penn), Syria, Ukraine and the general US election cycle.
So where does all this leave investors? In a word, skittish, and looking for safety. But where does one find safety, and for that matter, yield? In today’s current market there’s very few places. Speaking of previously safe places, according to Bloomberg, North American life insurers, stretched for yield (see chart below), piled into investment-grade energy bond positions in 2014/15 to fund the gap. By the end of 2Q 2016, companies including Prudential Financial, MetLife etc. held $1.32 billion of bonds that were in default, or close to it, their highest level since 2011.
This leads me to yet another group of investors feeling the bite of low yields, pension funds. In December 2014, and buried in the $1.1 trillion government spending bill, was a proposal which allowed multi-employer pension funds to cut pension benefits if the funds could prove they would run out of money in the next 10 to 20 years. This is an issue Mish Shedlock, SitkaPacific Capital Management, noted in a May 20, 2016 blog post, Rejected: Central States Fund (pension fund who handles Teamster’s Union pensions across several states) Proposes 60% Pension Cuts, Treasury Dept Says ‘Not Enough,’ 407,000 Affected and well worth the read.
This leads me to the last crushing ‘known known’ and that is demographics. The chart comes from Chris Hamilton’s Econimica blog and can pretty much stand on its own. If out of control debt, negative yields, corporate investment grade bond implosion and pension cuts weren’t enough……enter demographics. As the chart below suggests the US is entering the rapid explosion of an aging population.
As Hamilton highlights, “91% of all US home buying is done by those aged 20-69yrs/old, according to NAR data. In 2015, Millennials (20-35yrs/old) made up 35% of home purchases, Gen X (36-50yr/olds) bought 26%, Boomers (51-70yr/olds) 31%, and the Silent Generation (70+yrs/old) 9%. I’m no great fan of the NAR, but this makes basic sense as most homebuyers need an income to be homebuyers and most 70+yr/olds are retired and have the lowest average incomes of all the above groups.”
Although Hamilton’s point is to say the single-family home market will unlikely recover due to a rapidly aging population, it also shows the demographic torpedo headed directly toward the US economy, i.e. Social Security benefit explosion (already insolvent) and will exacerbate the financial fiasco known as the Affordable Care Act. And so it goes, older people need more healthcare from an industry unable to keep up with current demand. With history as our guide, and our government’s love of bailouts, I’d assume the Nationalization of healthcare to be just around the corner which leads me to the axiom, think healthcare is expensive now….just wait till it’s free.
Known Unknowns = Opportunity
At the beginning of this article I referenced negative interest rates impacting just over half of DM economies in some form or another. At first, central bankers assured the public that negative rates would only impact excess reserves other banks held in central bank coffers and not spread to various business or personal accounts. That all changed on August 11, 2016, as Bloomberg notes in its article, “Negative Rates for the People Arrive as German Bank Gives In.” That was just the first as several other banks, including RBS (Royal Bank of Scotland) and Bank of Ireland, began charging depositors a premium to keep their money in the banks coffers. How does this all play out?
Negative rates are seen, by central bankers, as the elixir needed to arrest deflation which has been the bogeyman hiding under central bankers’ beds since the Great Depression. Furthermore, use of negative rates is thought to stimulate personal/business investment because, it is assumed, people and businesses would rather spend their money, aka stimulate the economy, then be charged for keeping it in the bank. What this model fails to address, nor could it, what will investors do with their money if they want to protect it? Enter the US commercial real estate market, specifically the Southwest and Arizona.
Conclusion
As I’ve stated in numerous articles, referenced above and, including: Where Does the Market Go from Here? and Phoenix Metro Rental Housing Boom Explained in One Chart, Phoenix, and the general Southwest, is still positioned for growth. In fact, average rents in Phoenix (City) are anywhere from $500 to $1,500+ below those of its closest equals in the region, i.e. Denver, Portland, Los Angeles, Seattle etc. As referenced from data found on RentJungle.com:
Current Average Monthly Rents (all unit types)
Phoenix (City): $1,051
Denver (City): $1,588
Portland (City): $1,644
San Diego (City): $2,072
Seattle (City): $2,179
Los Angeles (City): $2,603
San Francisco (City): $3,907
In addition, Arizona as a whole, have been attracting employers looking for more affordable housing, better quality of life for its employees and access to new, highly qualified college graduates.
Since the end of 2015, and accelerating in 2016, Arizona has witnessed an increase of both direct and indirect foreign investment in multifamily properties. Additionally, domestic investors have focused on the Phoenix Metro looking to harbor profits made in other markets, most notably from California and Colorado. As a result, Phoenix is experiencing robust year-over-year total sales volume increases rising over 80%, just north of $2bn, this year alone. Phoenix Metro economic development officials, I must admit, have done an incredible job courting new industries (primarily tech, pharma and manufacturing) and employers to the region which has gradually transitioned us off our dependence on construction jobs to fuel the economy.
I do not know what the future holds and if, or when or how, a market correction will take shape. Nonetheless, I expect ceteris paribus, in the near term, the Fed will not raise rates, central bankers the world over will continue to push rates more negative, investors will continue to vie for stable assets and occupancy/rents will continue their upward trend.
For full article click here. For additional information, Brophy can be reached 602.714.1400.