Friday, July 29, 2011
Wednesday, July 27, 2011
Great article. The basic conclusion is that rental properties are and will continue to be great investment opportunities into the foreseeable future.
Demographics and destiny, US housing edition
Posted by Cardiff Garcia on Jul 26 22:07.
This morning’s miserable new home sales report gives us an excuse to write about a theme we’ve been distantly following for some time: the possibility that the housing downturn has overshot the pre-crisis boom and will eventually provide an economic boost when it corrects.
Whether this turns out to be the case depends on whether demographics can trump the recent adjustments in household behaviour, as a recent paper from RBC explains:
Some investors have expected that population growth would drive new home sales back to prior levels. We believe that this view intuitively makes sense and agree that demographic trends will ultimately drive demand in the long-term.
In our opinion, however, other factors including vacancy levels, declining homeownership rates and an increase in household size are temporarily exerting a disproportionate influence on housing demand. …
Historical Trends in New Home SalesMedian new home sales have dropped precipitously since the recession began in 2007. The United States experienced a median of ~675,000 new home sales from 1980 to 2006. Since 2006, however, median new home sales have been 430,000 annually.
And here’s a graph from Calculated Risk updated to include this morning’s figures (click to expand):
The bullish case — the argument that eventually we’ll see a burst of construction activity after a reversion to previous levels of housing demand — is partly based on straightforward population growth. Eventually more households will have to form and we’ll start to see prospective buyers of new homes emerge.
Here’s more detail from RBC…
The United States population has increased by ~3 million people on average since 1990. It is currently projected by the US Census to increase from ~310 million people today to ~340 million by 2020. This assumes a growth rate of ~1% or ~3 million people annually.
… and in graphical form:
Of course, what also matters here is whether or not there’s a lot of excess capacity already in the market. This is difficult to say, but if you look at the pace of homes built in the last few years relative to the population growth, we can at least start to get a sense of whether or not there’s currently a housing shortage in the making.
Helpfully, Dan Indiviglio did exactly this last month:
As you can see, the rate of population change per homes created declined over the last ten years from the previous decade. It’s higher than the decade before that, but not by much — suggesting that, as Indiviglio writes, “if there’s still some excess capacity in the market, there doesn’t appear to be much.”
Now back to RBC and the factors likely acting as countervailing forces to demographic trends: an increase in household size, declining homeownership rates, and vacancy levels.
To take each of these in order…
First, after decades of a declining population per household (one impetus for new home starts and sales during that time), we’ve seen an uptick in the last few years:
The trend driving this is the number of jobless college graduates and young adults moving in with their folks. RBC: “The Harvard Center for Joint Studies on Housing estimates that the number of young adults (age 20-29) living at home rose by 1.6 million from 2005 to 2010.” Newly jobless adults of all ages moving in with relatives and friends are also likely contributors.
Second, the national homeownership rate has dropped from a peak of about 69 per cent in 2004 to 66.4 per cent now. Even more worrying is that the biggest decline has come in the under-35 category, which “contains the largest proportion of potential first-time homebuyers”, according to RBC:
Third, high vacancy rates matter because prospective homebuyers could opt to buy cheaper existing homes, including those foreclosed on, rather than new homes. So higher vacancy rates now would imply a longer time before demand for newly built homes returns.
The estimates on vacancy rates tend to vary considerably by economist, making this the haziest of the three factors listed above.
The census bureau tracks that number. However, its month-by-month estimate was well out of whack with the preliminary data coming in from the formal 10-year Census. Still a credible guess is that there might be in the range of 1.5 million “excess” vacant homes. That number includes empty rentals as well as homes for sale. Even in the best of times some homes are vacant, but there are roughly 1.5 million more than there were in 1990, adjusted for population changes.
That 1.5 million number is less than our estimate of the number of missing households. Somewhere around 500,000 new homes are scheduled to be completed in 2011. However, typically around 200,000 to 300,000 homes are demolished each year as they become unlivable.
This suggests our total inventory of available homes is less than our total number of “shadow households” and is not about to catch up anytime soon.
RBC, for its part, pegs the number a little higher…
… and is less optimistic:
Based on anecdotal evidence from the National Association of Realtors (NAR), we believe that remarketed foreclosures are being priced on average at a 20% discount to new homes. The large size of this discount suggests to us that many consumers will elect to purchase foreclosed properties as opposed to investing in a new home even if homeownership rates remain constant. We expect that the level of vacancies will remain stable at ~2 million homes which is meaningfully above the long-term average.
There’s a chance that vacancy rates could be high very high now and remain high if homebuyers were to simply express their choice for new rather than existing homes. But this is certainly not what’s happened lately, as the percentage of total sales that new home sales has accounted for continues to decline:
On these points, it would seem that RBC economists are right to be pessimistic — to think that too many current trends will continue to overwhelm natural demographic pressures for more housing construction. And if you really want to pile on, check outScott Sumner’s recent post on why previous household formation trends won’t return anytime soon.
Sumner notes that along with young people moving in with their parents, another problem is something that we previously worried about in this space: less immigration, caused both by recent crackdowns and by less incentive to move here because of the stalled economic recovery.
But as ever, the whole story is actually a bit more complicated.
As both Smith and Indiviglio have noted, the pre-2006 boom in housing took place almost entirely in single-family homes, while new construction of multi-family residential buildings stayed flat (chart from Indiviglio):
Multi-family structures, of course, are those that typically rent out their units. We’ve seen a significant climb in rents inflation in the past year or so, which makes perfect sense: increased demand for rental units coincides with the lower homeownership rate. Indiviglio adds that once young people finally do decide to move out, it will likely be to rentals, given their limited credit histories and tighter standards for buying homes. The same would apply to the jobless who have stayed with friends and, especially, to those previously foreclosed on — given their damaged credit histories. So there’s a good chance this pattern will remain.
All this has obvious implications for the possibility of new construction activity. Given that there never was a boom in multi-family buildings, this is precisely where the shortage would be (Smith’s case all along) — and if demand for rentals continues, at some point you can expect to see a supply-side reaction, ie more construction. In addition, existing single-family homes might be turned into rentals, which would (helpfully) reduce the amount of shadow inventory. All of this would also be entirely consistent with a more fundamental shift among Americans in the perception of the value of owning homes versus renting, if there’s been one.
At any rate, we find the case persuasive, so we’re not ready rule out the possibility of a meaningful increase in housing activity just yet. It’s too early to know what will happen, and as Ryan Avent explains, construction cycle operates with a big lag on increased demand, so we wouldn’t see much progress for a while, maybe a year or two.
What everyone writing on the matter seems to agree on is that a higher level of economic growth would be needed to launch the construction takeoff. Growth — and jobs in particular — is needed to rejuvenate household formation, get young people to strike out on their own, reduce vacancy rates, and attract immigrants. Once this happens, the demographic trends will do the rest of the work.
But that’s an awfully big “once”, as the prospects for higher growth in the next few quarters remain uncertain. So although we tend to agree with the idea that there’s a burgeoning housing shortage, we remain agnostic on when the eventual correction will begin.
China, and Overdone Green Energy Hysteria
This strikes me as a tremendous investment opportunity if you can find a firm that is a pure peaker power play. If there is no such thing I could see a REIT type structure that purchases, builds and operates these plants. All signs point to continued political manipulation of energy markets so that the consumer/regulated utility is forced rely on unreliable renewable energy sources. This to me logically means that there will be more of these so called peak moments where demand exceeds supply because supply will be less stable and less available. Since this is the case holding an assets that is highly profitable at peak usage/demand moments could be an excellent investment/business. Now if I only had several hundred million to play with :>)..
China, and Overdone Green Energy HysteriaBy Steven Hayward
Of all the verses in the "China-is-Awesome" hallelujah chorus, none is chanted louder than the fact that China is leaving everyone in the dust in "green" energy, especially wind and solar power. The latest Clean Energy Report from the Pew Charitable Trust gushes, "Private investment in China's clean energy sector increased by 39 percent in 2010 to a world record $54.4 billion. China also is the world's leading producer of wind turbines and solar modules. In 2009, it surpassed the United States as the country with the most installed clean energy capacity."
On the surface the numbers sound very impressive: "With a staggering $45 billion invested in wind, China was able to drive installation of 17 GW of additional wind energy generating capacity. Another $4.7 billion was invested in the solar sector, as China begins reaching for its new goal of 20 GW of installed solar energy by 2020. It also has a target of installing 150 GW of wind power by 2020." And if you look at the numbers compiled in BP's recently released Statistical Review of World Energy, it sounds even more eye-popping.
China's wind, solar, and biofuel energy output increased 1,545 percent between 200 and 2010, while their coal-fired energy output only grew by 132 percent. Green energy is obviously rocking the Middle Kingdom. (Never mind that there are reports that many of China's new windmills aren't even connected up to their electricity grid; like their ghost cities with empty high rises, office buildings and malls, China apparently is putting up windmills just for practice.)
Anyone with a single wit of statistical sense will smell the obvious rat in these numbers, as they are the simple tricks of radically different baselines. If someone with ten units of something increases to 11 units, they've had a 10 percent increase, while someone with 100 units of something who goes to 102 units only has a 2 percent increase. But who has the larger real increase in output? The person who went from 100 to 102.
In the case of China, the real action is revealed when the absolute numbers are posted up. Buried in the data tables of BP's energy report is the staggering fact that new energy supply from coal alone was 85 times larger than new energy from wind, solar, and biofuel. Add China's growth in oil consumption, and old-fashioned energy accounted for more than 100 times as much new energy as the "green" sources.
Here are the actual numbers, as measured in the common unit of Million Tons of Oil Equivalent (MTOE) in BP's report: Between 2000 and 2010, China's total non-hydro-renewable energy increased 11.4 MTOE, while their coal energy output increased 976.4 MTOE, and oil increased by 204 MTOE.
Figures for how much China spent for new coal and oil energy are hard to come by, but one suspects that $45 billion spent for wind power looks like a poor return on the investment compared to coal. Pew and other China cheerleaders trumpet the fact that China added about 50 terawatts of new renewable electricity production over the last decade, but they leave out that China's new coal-fired electricity built over the last decade amounted to 4,200 terawatts - 84 times as much as renewable electricity. China now accounts for 48 percent of the world's total coal consumption. Does this sound like an authentic "green" energy juggernaut?
The right term to apply to the whole green energy scene, whether in China or in the U.S., is ironically the favorite green term of art: unsustainable. Right now the green energy cheerleaders trumpet falling costs for renewable energy, wind power especially, with figures showing that some onshore wind power is almost competitive with coal and natural gas electricity the basis of what the trade calls "levelized cost," that is, the total lifecycle capital cost of equipment and fuel cost over a 20-year time horizon. Wind (and solar) power is more expensive to build than coal or natural gas, but has no fuel cost once built, which would seem to be in its favor.
However, this assumes a chalkboard world of uniform electricity demand and pricing, like the market for gasoline or diesel fuel, which varies little from producer to producer or time of day. While wind power might compete with coal and gas at the average price of electricity, the actual market price for electricity varies widely by time of year and time of day, with huge spikes in demand occurring in circumstances like last week's heat wave. At such times of peak demand, spot electricity prices are often ten to fifteen times the average price. This is why "peaker" gas power plants can be profitable even if they only operate a few days per year.
And it is exactly under these circumstances where intermittent wind and solar cannot compete with coal or gas, because they are not reliable sources of dispatchable, peak-demand power, and never will be unless someone invents a magic battery. For investors, this is why a gas power plant promises higher returns than a wind or solar facility, even allowing for the subsidies wind and solar power enjoy. And this is why China is going to continue to build fossil fuel energy over renewable energy at a ratio of better than 50 to one for the foreseeable future, even as they create a new export industry to sell wind turbines and solar panels to politically driven markets like ours.
This crucial distinction between average and peak period prices and the need for dispatchable baseload power is lost on most of the public, let alone politicians who want to meddle endlessly to "level" the playing field between renewables and fossil fuel energy with subsidies and mandates. But investors and analysts who want to understand where the real energy action is in China should look at where they're really getting their new energy supply from, rather than getting excited about the hype about "green" energy.