Richard Florida has had some success helping urban economics and urban geography (and related fields) shed their dull and boring images. Researchers now try to identify the places that the young, cool, hip, creative types prefer. But every so often, Joel Kotkin comes along to show us that it's not all that simple.

But even though the research is potentially trendier than ever, the researchers are still trying to pin labels on areas (counties or metro areas) that are much too big to be so easily characterized. Metro area average population density, for example, can be misleading. In previous blogs, I have noted that I am late-to-the-party in discovering the smaller PUMAs (Public Use Micro Sample Areas).

It's easy to take a leaf out of the playbook of the Creative Class researchers and study the link between "hip" in-migrants and PUMA population density. Occupation code 2600 is "Arts, design, entertainment, sports, and media occupations". Correlate arrivals of these people with small area (metro PUMAs) population density and do it for the nine Census Divisions. The results are all over the map (sorry!). They range from 0.06 (Mountain States) to 0.41 (Mid-Atlantic). In five of the Divisons, the correlation between all arrivals and PUMA population density is higher than for creative arrivals.

Our field is probably stuck with dull and boring.

My favorite LA novel is The Tortilla Curtain by TC Boyle. Another great guide to today's LA is "The Scavenger: Pig's ear, octopus, and fish-kidney curry with LA's most adventurous eater" in the Nov 9 New Yorker.

The report follows the adventures of Jonathan Gold, "the high-low priest of the Los Angeles food scene." Gold describes LA as the "anti-melting pot". And "... unlike in New York, where immigrants quickly broaden and assimilate their cooking styles to reflect the city's collective idea of 'Chinese food,' the insular nature of Los Angeles allows imported regional cuisine to remain intact, traceable almost to the restaurant owners' villages of origin. 'The difference is that in New York they're cooking for us ... Here they're cooking for themselves' [Gold tells writer Dana Goodyear]."

Gold could have mentioned that LA also has plenty of the New York-style "they're cooking for us" options.

Urbanists keep writing about density, but neither explain what they mean or fall short with meanignless measures such as metro area or countywide density averages. The real fabric and the real nature is far too complex to capture with such vagaries. Interestingy, LA is melting pot and anti-melting pot. One can find the "cooking for us" dishes one day and the "cooking themselves" dishes the next. Whatever "the density" of LA is, it is, both "insular" and not-so-insular as to make both cuisines possible.

Perhaps urbanists can take the hint. Let a thousand densities bloom.

Even if there is an inflationary spike, real estate could be a beneficiary. It will favor owners of properties with short-term leases and properties with large near-term rental rollovers. It will also benefit those with long-term fixed-rate debt, as they could repay their debt with a devalued currency, but don't forget there could be another side to this with higher interest rates.

People always ask me where are the opportunities in today's marketplace and how do you find them? In the first quarter of this year, 20,251 businesses sought either Chapter 7 or Chapter 11 protection. With all these filings, there will be distressed asset sales. General Growth filed with 158 regional centers - 200 million square feet of retail representing $27 billion in debt.

But the real action is still with the banks. So far this year, 106 federally insured banks and thrifts have already failed -- the most since 1993 which was around the end of the savings-and-loan crisis -- and more than 400 banks are on the FDIC's "problem" list.
More than half of the $3.4 trillion in outstanding commercial real-estate debt is held by banks. A separate report at the Fed meeting predicted that commercial real-estate losses would reach roughly 45% next year. Bank examiners are stepping up their scrutiny of commercial real estate portfolios at U.S. banks.

Citicorp was getting beat up in a court battle on construction financing. A New York state court this summer ordered Citigroup to keep making payments on its $155 million construction loan on the first phase of a project called Destiny, which had been on track for completion by the end of this year. NY Supreme Court Justice John Cherundolo ruled that the borrower provided "unrebuttable and undeniable" evidence that Citigroup's claim was erroneous. He also suggested that Citigroup might have tried to get out of its funding commitments because it needs to preserve capital. The order has been stayed, however, while Citigroup appeals the ruling.

While each case is different, banks demand that developers put in more equity because of lower real-estate values or cost overruns.

Developers argue that lenders are using the falling values as an excuse to stop their funding. They are calling them "contrived defaults."

For pictures, go here. Thanks to Matt Moore for research assistance.

(1) Family of four median income in California ranks 15th among the states. Regardless of how income is measured, in California it is somewhat above average, but not extraordinarily so.

(2) Among the 50 states, California ranks 4th in per capita spending; add DC, and it ranks 5th.

(3) Per capita spending on K-12 education is about average.

(4) California's high school graduation rate is 10th from the bottom.

(5) This can be explained partially by the fact that California leads the nation in foreign born population.

(6) But even after controlling for foreign born population, educational attainment in California is average.

(7) California's incarceration rate is a bit above average, but not extraordinary by US standards.

(8) California relies less on property tax revenue to finance its government than the average state. Economists generally find the property tax to be less distortionary and unstable than other types of taxes.

(9) in 2005-06 (the last year for which I have data), California had more net business creation than any other state. After scaling for size, California's business creation was comparable to Texas'.

(10) California relies disproportionately on Information Technology and Professional and Technical Services for employment. These are high paying jobs that require a well educated labor force.

CNBC reports that houses in Las Vegas are falling apart, and that at least one buyer went to a homebuilder for a new house because she couldn't find any existing home that was acceptable.

This is actually a good example of what Ed Olsen was writing about in his seminal paper, "A Competitive Theory of the Housing Market." When prices fall below replacement cost, housing deteriorates until its depreciated cost equals price. Once this happens, housing markets are in equilibrium. The fact that the inventory of houses available for sale in Las Vegas has dropped to four months suggests that it is near its equilibrium level.

We could just be happy that the market in Vegas had returned to normalcy where it not for the fact that the deodorization of houses has almost certainly produced negative externalities--i.e., blight. (I was last in Vegas late last spring, and it looks pretty awful). But it is amazing how quickly markets adjust.

He concludes:

WHAT should we conclude? Given the abnormality of the economic environment, the sudden turn in the housing market probably reflects a new home-buyer emphasis on market timing. For years, people have been bulls for the long term. The change has been in their short-term thinking. The latest answers suggest that people think the price slide is over, so there is no longer such a good reason to wait to buy. And so they cause an upward blip in prices.

At the moment, it appears that the extreme ups and downs of the housing market have turned many Americans into housing speculators. Many people are still playing a leverage game, watching various economic indicators as well as the state of federal bailout programs -- including the $8,000 first-time home-buyer tax credit that is currently scheduled to expire before Dec. 1 -- in an effort to time their home-buying decisions. The sudden turn could signal a new housing boom, but is more likely just a sign of a period of higher short-run price volatility.

My take is different: I wonder if we have actually seen a sudden turn. The mix of sales has recently included fewer distressed sales. If distressed sales are fundamentally different from others, changes in the mix will influence the index. I suspected before that prices for non-distressed transactions before fell somewhat less than CSI; for the same reason, they may not be rising quite as quickly as CSI now.

The financial markets have been anticipating major defaults in the commercial mortgage sector for some time now. We are all aware that there is close to $300 million of CMBS -- commercial mortgage backed securities -- coming due by the end of 2009 and almost a similar amount in 2010. But that market has been illiquid - the holders of these bonds are not able to sell their shares that have fallen in value and the real estate backed by these bonds can't find anyone to refinance their properties to pay off the bondholders.

The question is, will the investor (lenders) let these bonds go into default or are we going to see some other strategies and options surface? My own view is that we've already seen a few new structures work. A number of the big REITs have gone out and raised new equity capital and that equity capital is being used to pay off or replace some of this CMBS debt. More importantly, we've had a real hurdle for some time with tax issues relating to any restructuring done with the servicers of these mortgage-backed bonds.

We now have a new proposal that came from the Treasury which would allow discussions on negotiations for modifications including lowering the interest rate or extensions on troubled loans without having to worry about the tax results. You could do that whether the debt is delinquent, in default or whether or not they are at their maturity dates. With that kind of a release from a tax trigger, I think we are going to see many more modifications.

In addition, I've been observing that a number of the institutions that are holders of these bonds are able to enter into a structured transaction where they sell a portfolio of the assets purchased with these securities, and then provide the financing for that sale in return for getting back an equity component from the buyer. I've seen this on some real estate transactions. Just recently, Barclays PLC sold off a $12.3 billion portfolio of securities backed by subprime mortgages in the U.S. and provided the new owners with a loan to finance the deal.

I don't see a pending disaster here so while I think we'll have delinquencies, some defaults and some covenant defaults, I think we're going to work our way out of this. For the long term, I'm hoping that the government's Public Private Investment Program (PPIP) will also help to reduce problems in the CMBS sector.

While all this activity is going on, the commercial developers are taking a lot of steps in order to survive and they are doing it a lot earlier. They are doing whatever it takes to protect their company and their asset base.

Primarily, they are taking a hard look at their entire asset base: looking at their strategies and business plans, evaluating their assets on a more realistic basis, doing sensitivity analysis, looking at the options in financing, but most important, being current, transparent and increasing the communication with their lenders so that hopefully they are not caught in any last minute surprises. I think all these steps will be very positive and help if a loan modification is needed.

July 7th, 2009

Abstract

We analyze the impact of lender recourse on mortgage defaults theoretically and
empirically across U.S. states. We study the effect of state laws regarding deficiency
judgments in a model where lenders can use the threat of a deficiency judgment to deter default or to shorten the default process. Empirically, we found that recourse decreases the probability of default when there is a substantial likelihood that a borrower has negative home equity. We also found that, in states that allow deficiency judgments, defaults are more likely to occur through a lender-friendly procedure, such as a deed in lieu of foreclosure.

Taking a cue from Tom Sowell, I try to disuade students from talking about "solutions". There are only trade-offs. Second on the list of offenders is the easy use of "success". Today's NY Times includes "In Phoenix, Weekend Users Make Light Rail a Success".

Well, no. Just use the data in the article. $1.4 billion of capital costs, 33,000 riders per day and fares of $1.75 suggest $109.5 million of annual losses. Use 365 days (the story cites the many weekend users), 5 percent opportunity cost of capital, depreciate over 30 years. Add lowest-in-the-U.S. operating costs, San Diego's $1.15 per boarding. Fiddle with any of these and "success" is still far fetched.

Boosters love to cite non-rider benefits. $109.5 million a year is a very high hurdle.

When markets don't deliver what we think they should deliver, we can test our suspicions via cost-benefit analysis. This is what the Copenhagen Consensus does for some of our biggest challenges and concerns. They typically involve Nobel laureates and other world class experts. Here they list their top-thirty policy recommendations based on their cost-benefit studies. Note that global warming mitigation ranks last.

Nevertheless, global warming policy proposals are everywhere. The National Academy of Sciences has just published Driving and the Built Environment. Whereas the writing includes numerous hedges and caveats, the authors clearly want to prescribe "compact development" as an antidote to global warming. They never bother with the sort of CBA that the Copenhagen Consensus practices.

The "Costs of Sprawl" assertion is almost as old as antipathy to suburban development. (Enter the phrase in quotes on Google and you get over 400,000 hits.) But there are some problems. First, most people (here and abroad) prefer suburban living. Second, we are not cost-minimizers, but weigh trade-offs (mentioned only for times in the 180-page NAS report). Do any of the NAS authors drive any of these ten new cars priced below $15,000? The ones who don't should go straight to the chalk board and write "I am not a cost-minimizer" 500 times before going times.

At this point, the careful reader says: "But what about externalities not considered by individual households?" For the careful reader, we have the Copenhagen Consensus.

Leaving the price of raw land out of it, the cost of a 1600 square foot house seems to be around $250,000. One cost estimator puts the cost of building the house at about $200,000. Developers tell me that cost of turning dirt into a finished lot is about $50,000 (this includes impact and other fees). I also understand that construction costs and fees are much higher in West LA than in other parts of the region.

Median prices in San Bernardino and Riverside County are now well below $250,000, as are several zip codes in the San Gabriel Valley and a few in the San Fernando Valley.

If anyone has data that shows materially different estimates of cost, I would be very interested to hear about it.

According to the Commerce Department, seasonally adjusted retail sales in August were 2.7 percent higher than in July - a larger than expected increase (although still off by about 6% from August last year). So what could this mean for the retail portion of real estate markets?

How well an individual retailer (or retail segment) will perform depends in large part on how much the demand for those particular goods is affected by changes in household income. Traditionally, two categories of goods that are highly sensitive to income fluctuation are luxury items and durable goods: it's easier to forego buying a fur coat or replacing a washing machine than it is to avoid buying groceries. That premise is largely supported by the Commerce Department's data, which shows increases in non-durable or semi-durable necessities -- food and beverage, health and personal care items, clothing -- while sales are still declining in categories such as building supplies, garden equipment, furniture and home goods. (Note: normally consumers would also put off buying cars in a recession, unless of course the federal government decides to subsidize car purchases with the Cash for Clunkers deal). 

Changes in income can cause households to shift consumption towards lower-priced goods within the same category. For instance, as a recent NY Times article reports, consumers are shifting away from top-shelf liquor brands. The increasing popularity of "recession specials" at restaurants (including ones where getting a table used to require a bold-face name or a 6-month wait) suggests a substitution towards the cheaper option of food prepared and eaten at home. Within grocery stores, more consumers are purchasing store brands rather than name brands.

How will these trends translate into impacts on retail real estate? One implication is that shopping centers with greater diversification, both of product types and price points, should be less vulnerable than retail centers with highly specialized stores or ones that cater primarily to the top end of the market. In circumstances when the tenant mix is fixed in the short term, there may be an opportunity for landlords to suggest alterations of product lines for existing tenants. Much of the substitution towards cheaper items already happens within a single store, and inventory changes are quicker and cheaper than tenant turnover.

A final thought: two segments of retail and consumer services that are holding up well in the recession are movie theaters and liquor sales. Perhaps therein lies a new marketing strategy: how many happy-hour gimlets after a matinee of Julie & Julia would it take to persuade otherwise frugal customers to buy a pair of Manolos?

The Daily Show last night featured the sale-leaseback deal that Arizona is trying to get for its capitol. Sales price of $735 million, lease payments of $60 million for 20 years, property reverts to state at end of the 20 years.

The IRR for the investor: 5.2 percent. Hmmm.