Economic Update (Sept 28 - Oct 3, 2020)

[Lloyd Segal]

Economic Update
(Yom Kippur Edition)

The second quarter of 2020 (April, May & June) was the mother of all economic contractions. Real GDP shrank at a 31.7% annual rate, the largest drop for any quarter since the Great Depression. However, based on the economic reports so far, it looks like the third quarter (July, August & September) will be the mother of all economic rebounds. It's going to be the fastest real GDP growth for any quarter since World War II and that is truly amazing. But in reality, you and I both know, this growth can’t be sustained. Although growth should continue after the third quarter, it's not going to be nearly as fast. Further, a full economic recovery in the US is still multiple years away. The bottom line is that the pace of our recovery in 2021-22 will depend not only on the course of COVID-19, as well as development of vaccines and therapies, but also government policy. With this in mind, let’s wash our hands, put on our facemasks, social distance, and get under the hood…

Existing Home Sales. Existing home sales continued to climb in August, marking three consecutive months of positive sales gains, according to the ever-optimistic National Association of Realtors. Total existing home sales (completed transactions that include single-family homes, townhomes, condominiums and co-ops), rose 2.4% from July to a seasonally-adjusted annual rate of 6.00 million in August. Sales as a whole rose year-over-year, up 10.5% from a year ago (5.43 million in August 2019). The median existing-home price for all housing types in August was $310,600, up 11.4% from August 2019 ($278,800), as prices rose in every region. August's national price increase marks 102 straight months of year-over-year gains! But here's the rub; total housing inventory at the end of August totaled only 1.49 million units, down 0.7% from July and down 18.6% from one year ago (1.83 million). Unsold inventory sits at a dangerously low 3.0-month supply at the current sales pace, down from 3.1 months in July and down from the 4.0-month figure recorded in August 2019. (Ideally you want at least six months of inventory to balance between sellers and buyers.) Scarce inventory has been problematic for the past few years, an issue that has only worsened in the past month due to the dramatic surge in lumber prices and the dearth of lumber resulting from our California wildfires. The need for housing will grow even further in the months ahead, especially in suburban areas that are attractive to those who can now work from home. As highlighted in NAR's August study, remote work opportunities are likely to become a growing part of the nation's workforce culture. And this reality will likely endure, even after a coronavirus vaccine is available. Properties typically remained on the market for 22 days in August, down from 31 days in August 2019. Sixty-nine percent of homes sold in August 2020 were on the market for less than a month! Isn't that crazy? First-time buyers were responsible for 33% of sales in August, up from 31% in August 2019. Individual investors, yes you and me, who account for most cash sales, purchased 14% of homes in August, a small change from July's figure of 15% and equal to the August 2019 rate of 14%. Overall, all-cash sales accounted for 18% of all transactions in August, up from 16% in July 2020. Distressed sales – foreclosures and short sales – represented less than 1% of sales in August (equal to July's percentage). So, if you're an investor, obviously don't focus your energies right now on foreclosures or short sales. Existing-home sales in the West inched up 0.8% to an annual rate of 1,250,000 in August, a 9.6% increase from a year ago.

SoCal Home Prices. Although we’re suffering through an historic pandemic, Southern California home prices continue setting records. The six-county region’s median price just reached $600,000, up 12.1% from a year earlier, according to data released by DQNews. That was the largest percentage increase since 2014 and the third consecutive month during which prices set a new all-time high! Sales rose 2.4% from a year earlier. Although the price leap seems unlikely amid double-digit unemployment, you can plainly see that this trend reflects the uneven effects of the coronavirus and its economic fallout. Compared with low-wage workers, people who have the financial ability to buy homes have been far less likely to lose their jobs, and in some ways, their ability to purchase homes has only expanded. Interest rates have plunged, with the average rate on a 30-year fixed-rate mortgage now below 3%. But only certain families are able to take advantage of historically low interest rates. And many typical entertainment and recreational activities are still closed or operating at reduced capacity, leading some households to save more at the very time they realize they could use much more money. For example, the desire for larger homes with bigger backyards is causing people to increasingly come to the San Fernando Valley from central L.A and for those already in the Valley to trade up in size. Though many low-wage workers probably couldn’t have bought a home before the crisis, our county’s economic pain has been felt on a sliding scale, with middle-income households hit less than low-income households, but harder than the wealthy. Those factors are causing a shift toward the luxury segment of the market. For example, homes that sold for $1 million or more accounted for 22% of all homes sold in California last month, up from 16% in August 2019. In stark contrast, the share of homes that sold for less than $500,000 fell to 38% of all sales in August, down from 46% a year earlier. But how long the upswing will continue is unclear. Part of the increase in sales and prices reflects pent-up demand from the spring, when stay-at-home orders and fears of the virus all but froze the real estate market during what is typically its busiest season. But now, prices are shooting up across the region. In Los Angeles County, the median home price rose 12.2% from a year earlier to $692,750 in August. In Ventura County, the median home price rose 8.1% to $647,250.

Rents Are Falling. While Southern California home prices are rising, rental units in some of L.A.’s most expensive and luxurious buildings are bearing the brunt of what economists call “downward pressure.” The result? The cost of leasing so-called Class A rental properties—sleek apartments with amenities including Spin gyms, poolside cabanas, and dog spas—is headed down as vacancies increase. Meanwhile, rents for the city’s most affordable Class C and Class D multifamily units remain largely unchanged. After all, there are only a limited number of renter households that can afford luxury apartments in L.A., so competition is more intense at the top of the market. On top of that, virtually every new project that is built in L.A. is a Class A luxury project. In downtown L.A., which saw the largest number of new luxury developments in the past decade (with thousands of more units still under construction), rents declined 3.1 percent from January to March. That’s a lot! And since the onset of the pandemic, they’ve dropped an additional 4.5 percent, bringing the decrease to nearly 8 percent! The remedy – free rent. As an example, DTLA’s “Circa L.A.” development is offering two months free as an incentive to prospective tenants. A few blocks away, “Hope + Flower,” another newly completed luxury high-rise is offering up to ten weeks rent free for a 24-month lease. So, if you play your cards right, you could live rent free for over 4 and half months in Downtown LA. Experts say the pandemic is less the cause of the decline in luxury rents and more an accelerant of forces already in motion in L.A.’s economy. Pre-COVID, we were already seeing the exit of both jobs and employees (with those jobs), often in tech, from the most expensive markets to secondary tech hubs. For example, people from Los Angeles were already moving to high-amenity, high-millennial-friendly cities like Portland, Austin, and Boulder. The difference is that now that no one is asking you to come into the office, so destinations are even more dispersed.

Women in Commercial Real Estate. Although women dominate residential real estate, the same cannot be said for commercial real estate. There are far fewer women in commercial real estate than men, especially in high-ranking roles. The latest data from the Commercial Real Estate Womens Network (“CREWN”) shows that in 2020 women account for only 36.7% of the workforce in the nation’s commercial real estate industry, a percentage that has not changed much in the last 15 years. Worse, according to the report, women in the industry earn 10.2% less than their male colleagues. And when commissions are taken into account, the average earnings gap increases to 34%. And the gap is even wider for women of color. That is never acceptable! In Los Angeles, women leaders in the field say there have been improvements, and they have started to see more women with seats at the table. Pam Westhoff, a real estate attorney and Southern California president of NAIOP Inc., the Commercial Real Estate Development Association, launched a diversity task force when she took the reins at the organization. “When women see that you have women in influential roles, they want to go there.” And to keep women in the organization, CREWN has educational programs, impact programs and an executive development program for women to “make sure they have the training and support to be successful.” In the commercial real estate industry, women are far less likely than men to hold top roles. According to a recent study by CREWN, women hold 9% of C-suite positions in 2020, the same percentage as in 2015. The number of women in mid-level roles, however, has increased 5% during that time. In brokerages, reaching the top has been particularly difficult for women. Pay is often commission-based, and titles are set according to sales numbers, which are hard to keep high if a broker takes a few months off for maternity leave. The CREWN program has helped women want to stay with the company because they don’t feel like they are falling behind. In the long run, CREWN wants to see an increasing number of women in high-profile roles and even ownership. Bottom line, we all need to see more women in prominent positions in commercial real estate.

RoomKey Project Evicted. It’s the beginning of the end for L.A. County’s “Project Roomkey,” the $100 million-plus program to repurpose hotels and motels (emptied by the coronavirus) as safe havens for homeless people. After peaking at just over 4,300 “guests” — about 30% of its ambitious goal — the project will shed several hundred beds monthly until it closes down early next year, says the Los Angeles Homeless Services Authority. The program is being squeezed by lack of funding from the Federal Emergency Management Agency (which pays about 75% of its cost), raising the possibility of a sudden cutoff that would force the county to abruptly shut down hotels. The program, part of a statewide effort launched by Gov. Gavin Newsom, began in March with a goal of providing temporary housing for the 15,000 people in LAHSA’s records who were 65 or older or had chronic health conditions, most susceptible to Covid-19. Its legacy will be mixed. By moving thousands of people off the street in record time, it was a stunning demonstration of what can be done, officials say. But it also highlights the limitations of both funding and human capital to solve LA county’s burgeoning homeless crisis. As the initial surge of leases with hotel owners tapered off, it quickly became clear the program would fall well short of its goal and make no more than a small dent in the roughly 66,000 people estimated to be living on our county’s streets. Besides funding, the other limiting factor was the number of hotel and motel owners willing to participate. Although the owners of more than 20,000 properties expressed interest, differences over price, qualms by insurance carriers and lenders, and concerns about branding turned out to be major obstacles. Data from Project Roomkey shows that a third of the roughly 6,600 people who checked into the 38 hotels and motels have already moved out. The city and county, which have both negotiated leases, are working with LAHSA to make the withdrawals orderly. But all of this illustrates the sad fact that we simply do not have enough permanent housing available for homeless people in need. Isn’t it ironic that I can write in earlier stories above about increasing sales and prices of SoCal homes, and yet 66,000 Los Angelenos continue to be homeless…

Initial Jobless Claims. Some 870,000 people filed for state unemployment benefits in the week ending September 19, the Labor Department reports. That amounts to an increase of 4,000 from the week before, and is still four times the typical weekly level before the coronavirus pandemic struck in March. (Another 630,000 workers applied for Pandemic Unemployment Assistance, a program for the self-employed and gig workers.) Job growth has slowed in recent months, and worse, employers in most industries appear reluctant to hire new workers in the face of deep uncertainty about the course of the virus. The new unemployment data coincides with evidence that some newly laid-off Americans are facing delays in receiving unemployment benefits, with state agencies intensifying efforts to combat fraud. California, for example, has said it will stop processing new applications for two weeks as it seeks to reduce backlogs and prevent fraudulent claims. The new federal program, created as part of the Coronavirus Aid, Relief and Economic Security Act in March, made self-employed people, gig workers and contractors eligible for jobless aid for the first time. Though roughly 14 million people are still classified as receiving aid under that program, economists increasingly regard that figure as unreliable and likely inflated by both fraudulent applications and inaccurate counts. Nevertheless, roughly half of the 22 million payroll jobs that were lost in March and April have been regained as people slowly return to work. But the prospects for this trend to continue are mixed and high unemployment will remain a problem for at least a couple of years. In addition, the inability of Congress to pass another spending package is expected to lengthen the recovery process.

Avoid Disasters When Flipping. As the author of “Flipping Houses,” I must caution new investors that flipping a house is a difficult process filled with a rollercoaster of emotions along the way. As many of my past students will tell you, if you’re a buyer of a potential flip, you need to ensure that you do a meticulous inspection when previewing the property BEFORE you buy (not after). When an investor does the initial walk-through in a house, there are red flags that will pop up, and all you have to do is look around to spot them! Here are some warning signs that a house may not in a good candidate to flip. Roof. You will probably not be able to get a thorough visual inspection of the roof, so you will need a professional house inspector to let you know it’s condition. Structural Flaws. During the initial walk-around of the outside of the house, be sure to check if there are any cracks in the foundation. This can be a sign of trouble to come. If structural issues are not taken care of properly, it can prohibit you from reselling the property. A slanting floor can also be a telltale sign of foundational issues. Some slants, if not major, can be remedied easily and won't take up a big chunk of your budget. Plumbing and Water Damage Issues. Most plumbing and water issues are easily overlooked. However, if repairs are needed, these can easily eat up a significant portion of your rehab budget. To avoid plumbing and water damage, check for spots on the walls and floors that look discolored or warped and feel to see if they’re soft or mushy. If you discover any of these issues, have your inspector immediately check if there is any invisible further damage. These projects are not only expensive to fix, but can also be extremely time-consuming. Recurring Toxin Issues. Upon the initial walkthrough, you may see signs of toxins. Toxin issues can be anything from old houses with asbestos in the walls, to mold from water damage, to vermin issues. All of these pose serious threats to an investor because correcting them is expensive. Vermin issues can be extremely destructive both externally and internally. Vermin include mice, rats or termites. Be sure to look long and hard at a property before investing. If any of these warning signs pop up, you know to be extra cautious.

Americans Love Pickup Trucks. Americans’ love affair with pickup trucks shows no sign of braking. There were 13.2 million new pickups sold from 2013 to 2019 in the U.S. It’s no surprise so many Ford F-Series trucks on the road. It’s been the best-selling vehicle in the United States for 39 straight years. (And it looks like 2020 will make it 40 in a row.) In fact, the top three vehicles in the U.S. over the past seven years are all pickup trucks. That’s more than 13.2 million new pickups sold from 2013-2019, and these are only the most popular models. It’s easy to see why people love pickups, given their utility, flatbed in the back, the higher profile while driving, and the convenient rifle holder attached to the rear window. I’m sure there are people in certain professions who need a truck, but I’m not sure how so many millions of people afford the payments on them? If you get all of the bells and whistles such as four-wheel drive, extended cab and such, these trucks can run anywhere from $50,000 to $70,000. For a 60-month loan at 4%, that’s a monthly payment in the $800-$1,300 range, depending on your down payment. And these numbers don’t include extras like gas or insurance. That’s a lot of money for a truck if you’re not regularly using it on the job. But there are certainly people out there who spend far more than they should in their vehicle(s). It’s also true that the “good feelings” you get from buying a more expensive vehicle are fleeting. Researchers from the University of Michigan studied drivers of a BMW, Honda Accord and Ford Escort. During a short trip such as a test drive, people reported positive feelings for a luxury brand like a BMW. This is because you’re hyper-aware about all of the bells and whistles that come in a more expensive ride during that initial drive. But once people began taking the cars for longer trips, those feelings all but evaporate. The correlation of positive feelings to the price of the car was essentially zero. Once you get behind the wheel enough times, the novelty wears off and it becomes more about traffic, other drivers on the road, and getting from point A to point B. In other words, a more expensive pickup truck isn’t going to make you any happier, or get you there any sooner.

California City [Part 3]. [If you recall in Part 2, we learned that Nat Mendelsohn and his company Great Western Cities eventually settled with the Federal Trade Commission, at the time the largest consumer fraud case in the history of the FTC. Shortly thereafter, Great Western filed bankruptcy and Mendelsohn died.]In the 1970s, a man named Tom Maney began working for Great Western Cities. In fact, Maney helped negotiate the settlement with the FTC. After Great Western Cities declared bankruptcy in 1984, Maney acquired some of the assets, including thousands of worthless acres of vacant California City land and a small deserted resort called Silver Saddle Ranch. Maney continued selling vacant desert land, using the resort as an attraction to draw potential buyers. Maney maintained that he and Silver Saddle had nothing in common with Nat Mendelsohn or Great Western Cities. In 2011, Silver Saddle transitioned from selling vacant desert lots to selling shares of a confusing real estate investment called “land-banking.” Land-banking is where a group of people jointly own a huge chunk of raw land. In Silver Saddle's case, approximately 1,000 acres of empty desert on the outskirts of California City, were divided into 4,000 shares and sold to susceptible investors. The pitch was that the land would inevitably appreciate in value, and when it did, all the co-owners could sell it to a developer and make a ton of money. Silver Saddle targeted a very specific type of customer: Latino, Filipino and Chinese families, most of whom lived in California, but spoke English as a second language. During the sales pitch, potential customers were divided up by ethnicity and paired with a salesperson who spoke their primary language. They watched a presentation about the area's potential. According to court documents, sales agents suggested that wealthy businessmen like Elon Musk and Bill Gates were already investing nearby. They compared California City to Las Vegas and other large cities in the Southwest that began as tiny desert outposts. And their sales pitch was very, VERY successful! Since 2011, Silver Saddle's sales agents sold "shares" of the land-banking project to more than 2,000 people, for up to $30,000 each. Between 2011 and 2019, Silver Saddle made more than $56 million. It made Tom Maney a very wealthy man (while the land remained worthless). But it didn’t stop there. [Continued next week in in Part 4.]

Witch’s House. Every Halloween, people ask who built that spooky-looking witch’s house in Beverly Hills? People like to call it the “Witch’s House.” But in reality, it was originally built as a movie studio in Culver City for 28-year-old mogul Irvin Willat. Willat ordered a fantasy mash-up of 18th century Swiss, Belgian, and English cottages that could also be used as a logo for his production company. Five years, four films, and a movie star wife later—and with a lucrative offer to direct at Paramount—he sold the house to producer Ward Lascelle, who loaded it onto a truck and relocated it to 516 Walden Drive, near Carmelita Avenue in Beverly Hills. Be sure to visit it on Halloween, when hundreds of trick-or-treaters line up for big candy and a bigger show (even during a pandemic!).

This Week. Looking ahead, investors will remain focused on medical advances to fight the coronavirus. The core PCE price index, the inflation indicator favored by the Fed, will come out on Thursday (10/1). The ISM national manufacturing index will also be released on Thursday (10/1). Beyond that, the monthly employment report will be released on Friday (10/2), and these figures on the number of jobs, the unemployment rate, and the wage inflation will be the most highly anticipated economic data of the month.

Los Angeles County Data (August):
Total house sold: 6,341 (down 5% from last year)
Median days on market: 22 days (down 15% from last year)
Median sales price: $692,750 (up 12% from last year)
Supply of Inventory: 3.0 months (down 17% from last year)
Sold above listing: 47% of all sales (up 8% from last year)
New listings: 8,280 (down 2% from last year)