Thursday, December 29, 2011

Apartment Building Bubble

If your city is like mine, you see lots of cranes on the horizon building apartment buildings.

Five years ago, those same lots were destined for condo towers.  But today those very same buildings with very little interior modification are being put up as apartment towers.

Do you see the problem?

The same out-of-whack forces that drove condo prices into the ground are destined to do the same for apartment building owners.  Simply put, there are too many apartments being added to a supply of apartments that is already too large.

I know there's a bubble in apartment building valuations when I read that large NON-RESIDENTIAL developers are started to get the apartment itch.  In Seattle the bubble is obvious even to the lamestream media which usually can't find an pink neon elephant in a conference room.  When developers are chasing yields you know the bubble is in its last days.

I recently wrote about a sweet apartment building deal in Seattle where investors probably made 100%+ on their money in about a year flipping a building.  Returns like that are not possible outside of bubbles.

Apartment REIT valuations are high---and headed higher.  The industry currently reflects a P/E of 21, way too high for a real estate sector facing major headwinds.  That said, most of the individual REIT charts look less than stellar.  Here is EQR as an example.

What is the logic of apartment building ownership?  Simple.  People can no longer afford to buy homes or are unwilling to do so in previous numbers.  Since people have to live somewhere, the choice is either rent or buy.

Sounds good, right?  WRONG.

The first problem is that the number of households in the United States is shrinking.  The growth rate has been NEGATIVE for FORTY YEARS.

These figures are from the official U.S. Census Bureau Population Profile of the United States.

In the 1970s, on average 1.7 million new households were created each year.
In the 1980s, the number fell to 1.3 million per year.
In the 1990s, down to 940,000 per year.
In the 2000s, down again to a mere 716,000.

Remember the issue is not population growth but the number of people living together in households.

In downtown Seattle where I live, for example, it is common to see three or four people living in one apartment due to the high cost of rent in the city.  What does this mean?  Demand for SOLO apartment living is not as high as could be estimated.  Unless there are two, three, or four roommates/workers/employees available to fill each of those new and existing apartments you have a vacancy problem.

Guess what?  There aren't.  The city of Seattle itself says that just two of every five households in the city is made up of one person.  A full 15% of the city's households are made up of people who live together but are not related by marriage or family.  In other words, roommates.

So 60% of the new apartments you see being built better have more than one person supporting the lease or the rent is likely not to be paid.  NOT the way it is supposed to work for rental property investors.

I fully expect the apartment building bubble to grow and finally burst when either too much supply comes online (in late summer or fall 2012), when the economy dips again (in early 2013 after the U.S. Presidential election).

Of course, with historically low interest rates the moment condos are in demand those apartment buildings will begin languishing on the market.  Remember 2004 and 2005 and all those FREE RENT incentives?  The slightest loosening of underwriting standards will pop the apartment building bubble.

In the meantime, sell those buildings if you own them.

Saturday, December 17, 2011

59.4% Yield in One Year

The Marlborough Apartments is an 82-unit building in downtown Seattle. Built in 1927, this Gothic Revival architectural gem was purchased by a group on investors for $12.75 million in September 2010.

The new owners spent about $4 million on rehab costs and put the new Marlborough back on the rental roles in January 2011. By the middle of the summer, the building was fully leased.

The Marlborough just sold for $28.7 million or a sweet $321,000 per unit.

The cash-on-cash calculation is an approximately (less friction costs) profit of $11.95 million on an investment of $16.75 million over fourteen months.

Or about 59.4% for the year. Of course, using leverage the actual return for these investors is much, much higher, well into triple digits in less than a year and a half.

Still, I wanted to see how they pulled off this stellar accomplishment.  What lessons can be learned from their success?

I shot the video and photographs outside the Marlborough Apartments on very busy and noisy Boren Avenue in downtown Seattle. As you can see, the exterior of the building is gorgeous. Of particular note is the covered driveway which as far as I remember has been part of the building's original design. Here is an older picture of the Marlborough without all the shrubs and barriers setting off the street from the drive.

These investors made their money five ways and all real estate investors can apply the very same techniques whatever the size of the investments.

1.  Apartment buildings right now are hot commodities.  This investment group got out ahead of the trend by buying while others were still on the sidelines or selling.

2.  This was a foreclosure purchase.  The previous owner had tried to convert the building to condos but got burned when the bubble burst.  In other words, these investors bought cheap.

3.  The exterior improvements to this building are not expensive but impressive.  The dirty old Marlborough is clean and sharp again.  You expect to see Humphrey Bogart and Jimmy Cagney walking out the lobby.  The place has a museum feel.  The covered drive and the building's awning give this place a sense of class that others in the area lack.

4.  The bones of this building were solid and did not require much renovation.  You save money when you don't have to make major improvements.  Check out the interior detail of the building lobby and other tenant spaces in this photo gallery.

5.  They sold the building fully leased with a solid and growing cash flow statement.  All the above Steps #1-4 above are really designed to affect Step #5 which is to get tenants in every unit paying above market rents so the value of the property can be maximized to the extreme.

When you read about real estate investment successes in your area, visit the locations and see for yourself what you can learn.  Little details mean a great deal.  For example, on the Marlborough there are two banners hung on the corners of the front facade.  On many buildings these advertisements look cheesy and detract from the beauty of the building.  In this case, the banners highlight the architecture of the Marlborough.  Even the colors used on the banner is consistent with all the building's signage.  Notice in the old picture of the Marlborough above the banners on the building are an awful garish green!

This is an impressive achievement and I'm sure there were lots of celebrations when the contract was signed.  Super nice job.

Tuesday, December 6, 2011

Seattle Plastic Bag Ban Scam

For the second time in just two years, the Seattle City Council is getting ready to pass a ban on nearly all plastic grocery bags the kind used at supermarkets and convenience stores.

Despite this provision being overwhelmingly rejected by the voters of Seattle by referendum in 2009, the City Council last night held hearings on the idea---which, of course, makes little real sense since most of the members of the Council have already said they will vote for the ban.

The bill's sponsor, council member Mike O'Brien, has publicly stated that a report called "Keeping Plastic out of Puget Sound" by a group called Environment Washington has helped him understand the importance of this issue.  This report supposedly makes the case that banning plastic bags is the right thing to do for Puget Sound.

The only problem with this report is that it is a sham.  

NO ONE could read this report, including Mr. O'Brien, and conclude that any rational case has been made for a plastic bag ban in Seattle or anywhere else.  This entire document is a series of non-sequitors written by someone without a clue how to do research, statistical correlation, or anything else except make political statements in favor of unproven science.


Given the fact I could raise about 250 objections to this piece of sloppy investigation, let's take three at random.

There is plastic in Puget Sound.

Yes, there is.  BIG DEAL.  Given the fact that plastics are and have been one of the most common substances on earth for nearly the past hundred years, you will find TRACE AMOUNTS of plastic everywhere.  You find trace amounts in every human body.  The Environment Washington report mentions plastic in Puget Sound but in no statistically significant amounts.  The report wants to make the presence of plastic in the water as ominous and threatening but it's not.  NOWHERE does this report mention any significant level of plastic in Puget Sound that would endanger human or animal life.

The proportions of plastic in Puget Sound water is microscopic, in parts per billion.  No person or animal is harmed at such concentrations, nor does the report suggest a threshold of toxicity for plastic.

The plastic in Puget Sound comes from supermarket garbage bags.

This is the biggest lie in the report of all.  There is no link proven or even attempted in the report between supermarket garbage bag plastic and plastic residue found in Puget Sound.

The author's of this report want you to believe Gil Grissom and his CSI team have conclusively linked through intensive chemical analysis like "Plastic DNA" supermarket bags to the plastic found in Puget Sound.

There is NO ANALYSIS in this report making such a claim.  The idea that millions of plastic bags are migrating from landfills miles away into Puget Sound is ludicrous.  Has any member of the Seattle City Council ever visited a landfill?

The almost certain causes of the plastic residue in the Sound are:

1.  Decades of industrial production and manufacturing on the shores of the Sound now rotting.
2.  Thousands of tons of plastic debris sunk and decaying at the bottom of the Sound.
3.  Hundreds of tons of plastic debris added by boaters and consumers every year, things like soda bottles, food wrappers, etc.

Can the authors of the Environment Washington report please explain how tens of millions of plastic bags get into the Sound each year?  HOW?

Plastic bag bans are accepted by the public.

There is no a single fact in the report that proves efficacy of a plastic bag ban beyond one year.  NONE. The report even goes so far as to say this:

Fee programs and taxes can have multiple purposes. First, by establishing a price on disposable bags, governments can send a price signal to citizens to mo- tivate different behaviors. For example, in 2002 the Republic of Ireland established a15 Euro cent tax on plastic bags (roughly equivalent to about 28 U.S. cents per bag today), applied to consumers at the point of sale. In the first year of this policy, consumers used 90 percent fewer plastic bags. The tax grew relatively less effective over time, so the nation increased the tax in 2007. Overall, plastic bags have gone from 5 percent to less than 0.25 percent of the waste stream.60

It is clear that even the proponents of these bans admit that their effect fades over time.  Consumers will just begin buying paper bags and paying the "tax" unless it is constantly boosted.  Nowhere does this report make the case that these bag bans are wanted anywhere,  Seattle residents sure do not want it.  So why is the assumption made that people will meekly go along with the social direction suggested by the ban?

Also, notice how the Irish call the bag fee a "tax" but the Seattle City Council refuses to label the same mandatory fee as such.  The bag fee is "voluntarily"unless you need a bag.  Right now the bags are free to customers but what should that fee paid by consumers to retailers and then forwarded to the government really be called?

This Environment Washington report on Puget Sound is one of the most pathetic documents I have ever read in my life, filled with at least a dozen intentional attempts to mislead on nearly every page.

For example, the report coins the term "single use plastic bags" when describing supermarket bags but each of us knows that term is false.  Many plastic bags are recycled, including reused by consumers for all sorts of purposes such as lining kitty litter boxes and kitchen wastebaskets, and even "Pooper Scooper" duty on the street.

Ask yourself this simple question.  If you currently use the plastic bags you get at the store for your cat or for the trash pail in your home, what happens when these bags are banned and you can only buy PAPER bags at your local store?

Yes, you will use fewer SUPERMARKET plastic bags.
BUT you will use MORE non-supermarket plastic bags.

In other words, you won't be bringing home free plastic bags any more.  You will have to buy the same number of bags.  Same number of bags, just a different label given to them.

The efficacy and effectiveness of the bag ban is wildly overstated by the report, on purpose of course.  The subject of forcing consumers to buy new plastic bags for non-grocery purposes is never addressed once in the report.

Aside from being a policy boondoggle, the plastic bag ban is anti-environmental according the City of Seattle's own analysis.  Paper bags are far more costly to produce and recycle.  Paper requires the cutting of trees, while plastic can be made out of virtually any natural product including waste corn husks.  Paper production involves the use of dangerous chemicals like caustic lye and hydrogen peroxide.

Has any member of the Seattle City Council ever been to a paper mill?  I will gladly take anyone who wants to go.

This bag ban is politically offensive.  No member of the City Council ran on this agenda despite being elected back into office just a month ago.  Seattle voters have rejected this idea once already.  Does the city really need another contentious referendum and lawsuits on this issue?

PAPER BAGS in SEATTLE make no sense.  Mr. O'Brien, it rains in Seattle.  The other day when I bought a magazine at Walgreen's, the clerk asked me if I wanted a plastic bag because of the pouring rain.  I guess under the new regime I could buy a paper bag---but why?

This foolish idea needs to immediately tabled and an investigation launched by the Seattle media over how such a worthless report could be given such high regard by politicians when anyone with an open mind who reads it can instantly conclude the report is bogus and a sham.

The Seattle City Council needs to stop catering to the elitist whims of a tiny sliver of the city's residents and start addressing REAL concerns that people who live in Seattle have, like the deteriorating infrastructure, rampant homelessness, rising street crime, and the declining business base.

Saturday, December 3, 2011

Bogus Unemployment Numbers

The mainstream media is once again in full pom-pom mode relentlessly cheerleading the latest unemployment rate released this week by the Bureau of Labor Statistics.

Here's one typical headline from Bloomberg Business Week:

Unemployment Rate Falls to Lowest Since March 2009

But few of the journalists writing these headlines are actually looking at the raw numbers they themselves report and ask "How can the unemployment rate REALLY be falling when the numbers do not add up that way?"

You do the math yourself.

Here are the official numbers from the November 2011 BLS unemployment report:
  • Unemployment rate falls to 8.6%, down 0.4% from 9% last month
  • The private sector added 140,000 new jobs in October 2011.
  • The public sector cut 20,000 jobs in October 2011.  (A net of 120,000 new jobs created.)
  • But 190,000 people LEFT THE LABOR FORCE IN OCTOBER because (a) their unemployment benefits had run out and they no longer can file claims for compensation; and (b) they gave up looking for work since no jobs in their area are available, so-called "discouraged workers."
So ask yourself this simple question using the U.S. Government's own numbers.

If 120,000 new workers joined the U.S. labor force in October but 190,000 workers also left the very same labor force in the same month because they could not find jobs, how can the unemployment rate go down?

How?  The BLS assumes you can be unemployed, not have a job of any kind, but still not be "officially unemployed" for their calculations.  This is not how I learned to do math.  This video explains how you REALLY calculate an unemployment rate.

The fact the government does not count unemployed workers who are so discouraged they can't find work as "not unemployed" is indicative of what is really going on here.  According to you, me, and common sense, someone who is "not unemployed" is employed.  According to the U.S. Department of Labor Statistics, your brother-in-law or your daughter who has exhausted their 99-weeks of unemployment and has given up trying to find a job is unemployed---but they aren't "officially" unemployed for government accounting purposes.  To be blunt, they and the millions like them just don't count.  Here is the BLS' official definition of discouraged workers.  You read it.  If you are not in the labor force, aren't you unemployed?  No, you are merely discouraged....

This is statistical madness.  Kafka and Orwell would be proud of such reasoning.  Some unemployed are more equal than others???

I do applaud some news outlets like the Christian Science Monitor that have run critical pieces on the BLS and how these phony numbers are calculated.

The real reason the BLS and all government agencies play games with official numbers like inflation, unemployment, GDP, and the rest is obvious.

For example, when President Nixon in 1971 was battling a wave of inflation that ultimately led him to initiate a disastrous policy of wage and price controls, his administration changed the way CPI adjustments were made to Social Security and the Medicare program.  The lower the CPI increase, the better the inflation picture looked from a political perspective.  Plus the government saved hundreds of billions by shortchanging beneficiaries on the real rate of inflation increases in the economy.

By the way, President Clinton changed the CPI numbers once again to make his administration look better too.  Both parties play these games.

The lamestream media is in full cheerleader mode on the economy since the actual economic numbers are grim and not radically improving.  With their candidate Mr. Obama languishing in the polls, someone in New York and Los Angeles needed to turn the economic lemons received from the BLS into lemonade.