Economic Update (Monday, January 18, 2021)

[Lloyd Segal]

Economic Update
(Happy Martin Luther King Day)

Predictions for 2021? As 2020 has shown us, the world can throw so many curveballs at you that predictions can be about as useful as new year’s resolutions. In that spirit, instead of trying to forecast the future, let’s talk about a real estate trend that was accelerated by the pandemic over the past year — and ask you as an investor (who buys and more importantly sells) to consider what you think will happen in 2021? Will it fade or flourish? I’m referring to the increasing emotional value of “home.” The pandemic shined a bright spotlight on housing. Specifically, residential real estate has become both more functional and more emotional. Consumers aren’t just searching for a house anymore; they’re seeking “home.” While the pandemic confined us to our homes to the point where we’ll do almost anything for a change of scenery, it has also pointed out Home is shelter. Home is safety. Home is family. Home is our school, the gym, the movie theater, the best local restaurant. Consumers appreciate “home” more than ever, and they have a more three-dimensional view of what they want their homes to be. Like so many other elements of our lives that have changed during the pandemic, it’ll be interesting to see if we go back to the status quo or have indeed entered a “new normal” with respect to housing. While you consider the fate of housing, let’s wash our hands, put on our facemasks (yes, you), social distance, and get under the hood…

Consumer Price Index. The Consumer Price Index advanced 0.4% last month, the government says. Which means the prices of consumer goods and services — the cost of living — rose in December at the fastest clip since last summer. Yet the pace of inflation over the past year was still quite low at 1.4%. The yearly rate increased from 1.2% in the prior month. Before the pandemic began last spring, inflation was running at a much higher 2.3% pace. About 60% of the increase in consumer inflation last month was tied to higher gasoline prices. The cost of gasoline jumped a seasonally adjusted 8.4% in December, though the actual increase to consumers was much smaller. In any case, gasoline prices are still 15% below year-ago levels. Why? Because obviously people are staying home and driving less during the pandemic and so there’s not as much demand for fuel. On the other hand, the cost of food — groceries and supermarkets — increased 0.4% last month. Prices of other important consumer goods and services were mixed. Rents rose and the cost of clothing increased sharply, but prices for used vehicles, medical care, drugs and recreation all declined. Restaurants eliminated another 372,000 jobs in December. Investors are worried about inflation again, but it’s likely to hover below 2% through the early spring and probably won’t pose a threat to our economy this year or next. The bigger question though is whether it will exceed the Federal Reserve’s 2% target — and stay there. The Fed said it’s willing to let inflation run above 2% for a while until our economy has returned to normal.

Retail Sales. Sales at U.S. retailers fell in December for the third month in a row as the record deluge of coronavirus cases opened fresh wounds in our economy. Specifically, retail sales dropped 0.7 % last month, the U.S. Census said Friday. If auto dealers and gasoline stations are excluded, retail sales sank a sharper 2.1% in December. Auto and gas purchases often swing up and down and can mask underlying trends in retail sales. Sales fell sharply at Internet retailers, bars and restaurants, and electronic stores, accounting for most of the decline last month. Bars and restaurants suffered a 4.5% drop in sales, marking the third decline in a row. They are among the businesses bearing the brunt of new government restrictions after the resurgence in coronavirus cases late last year. Customers were also more wary of going out for fear of catching the virus. Internet retailers posted a surprising 5.8% plunge in sales. They’ve been one of the standout performers during the pandemic. Hard to explain the decline really, except maybe you had nothing left to spend on Amazon? Nevertheless, internet sales are still up 19% from a year earlier. Sales also slid nearly 5% at big-box stores such as Best Buy that sell appliances and electronics. These declines more than offset a nearly 2% increase in sales at auto dealers. Sales also increased 6.6% at gas stations, mostly due to higher prices (not higher consumption). But higher gasoline prices don’t help consumers. The spate of weakness in retail sales toward the end of 2020 underscores the ongoing drag on economic growth from the coronavirus pandemic. Consumer spending accounts for 70% of U.S. economic activity and retail sales are one-third of that. The rollout of vaccines and promise of more financial help from the incoming Biden administration will certainly help. The president-elect is proposing $1.9 trillion in additional spending to boost our economy. Nevertheless, retail sales and broader U.S. economic growth are likely to be uneven until the pandemic fades.

Mortgage Rates Surge Higher. Fasten your seat belts, mortgage rates are rising. Rates moved sharply higher last week, erasing months of declines and putting pressure on you (and other investors) to move hastily to lock in cheap financing. The 30-year fixed-rate mortgage averaged 2.79% for the week ending January 14, up 14 basis points from the record low set last week, Freddie Mac reports. (A year ago, the 30-year fixed-rate mortgage was a much higher 3.65%.) The 15-year fixed-rate mortgage, meanwhile, only increased seven basis points to an average of 2.23%. The 5-year Treasury-indexed hybrid adjustable-rate mortgage averaged 3.12%, up 37 basis points from the week prior. Historically, mortgage rates roughly follow the direction of long-term bond yields, specifically the yield on the 10-year Treasury. And as Treasury yields are rising, it is putting pressure on mortgage rates to likewise move up. Over the past week, the 10-year Treasury notched its longest streak of daily increases in yields since 2017. Yields have risen as bond investors expect President-elect Biden and a Democrat-controlled Congress to pass additional stimulus amid the COVID-19 pandemic. This expectation of more borrowing by the U.S. government, economic growth, and possibly inflation in the future lowers the price of bonds, thereby increasing the yields. The incoming administration (with the support of Congress) seems likely to issue sizable additional stimulus, which will help offset ongoing virus-related income and spending disruption, which will likely increase yields. For example, the yield on the 10-year Treasury briefly hit 1.18% last Tuesday before easing back to 1.12%, but still more than 0.90% at the start of the year.

Foreclosure Activity Drops to 16-Year Low. ATTOM Data Solutions released its Year-End 2020 “U.S. Foreclosure Market Report," which shows foreclosure filings— default notices, scheduled auctions and bank repossessions — were reported on only 214,323 properties in the United States in 2020, down 57 percent from 2019, to the lowest level since tracking began in 2005. Fortunately, those 214,323 properties represent less than 0.16 percent of all U.S. housing units, down from a peak of 2.23 percent in 2010. The government's moratoriums have effectively stopped foreclosure activity on everything but vacant and abandoned properties. But no question about it, there is now a backlog of foreclosures building up – loans that were in foreclosure prior to the moratoriums; loans that would have defaulted under normal circumstances; and loans whose borrowers are in financial distress due to the pandemic. We really won't know how big that backlog is until after the government programs expire. In the interim, lenders repossessed only 50,238 properties through foreclosure (REO) in 2020, down 65 percent from 2019 to the lowest level as far back as data is available (2006). Further, lenders started the foreclosure process on only 131,372 U.S. properties in 2020, to a new low also going back to 2006. The good news in all of this is that the government and the mortgage industry are working together preventing any unnecessary foreclosures. The question now is how many homeowners (whose finances have been affected by the pandemic) will ultimately default on their loans, and whether the strength of the housing market will help cushion the fallout? By the way, among metro areas with a population greater than 1 million that had the highest foreclosure rate is our neighbor, Riverside, California (0.28 percent).

Home Flipping is Down but Profits are Up. ATTOM also reports that home flipping fizzled in the tail end of 2020, representing only 5.1% of all home sales (57,155 total single-family homes and condominiums). Fix and flips declined from 6.7% in Q2 to 5.1% in Q3, which is typical as the cold-weather season approaches. However, 2020’s rate also fell short of Q3 2019, where flips accounted for 5.5% of sales. All year long, we’ve seen one of the most fast-paced real estate markets in recent history. Sales moved quickly, as buyers fleeing big cities searched for larger homes (and better standards of living) now that most people can work remotely. These factors led to low inventory levels in the majority of large markets, forcing higher prices, competitive offers, and shorter days on market. Of course, this all happened in the context of the pandemic, which has created unusual circumstances for the housing market to thrive. Yet the data shows there was still money to be made. Profits skyrocketed last year thanks to low inventory, heavy buyer competition, and record-low interest rates. As a result, home-flipping generated higher profits on less transactions across the United States in the third quarter of 2020 as investors continued to make more money on a declining number of deals. So even though flips declined, investors (that sold properties) had a lot to be happy about. The median profit from a flip was $73,766 in Q3, a massive gain year-over-year. In Q3 2019, the average gross profit was $61,000, meaning investors are making an average of $12,000 more this year! Metro areas with a population of at least 1 million that had the biggest annual increases in flipping profit margins in Q3 include Phoenix, Arizona (up 69.8%); Kansas City, Missouri (up 55.9%); and Las Vegas, Nevada (up 54.4%). Los Angeles and Ventura counties are low on the list. As always, investing strategies differ from investor to investor, but as you know, the core idea is to buy low and sell high. This means that for investors, if you have a house to sell, sell it now! But buying might NOT be in your best interest at the moment, considering we don’t know what will happen in 2021 with the pandemic or how the new presidential administration will respond to current policies.

Construction Nightmare. New York City has problems Los Angeles never even thinks about! For example, how do you chop 20 stories off a too-tall skyscraper? Now that the 52-story tower at 200 Amsterdam Avenue in Manhattan is finally done, it may soon have to be partly undone (like a construction project running in reverse). If the appeals court that will hear the case starting this Wednesday upholds a judge's ruling that the building is illegally tall, crews will have to start unraveling the top 20 floors. Yikes, 20 floors! That’s taller than most LA buildings! The decapitation will involve breaking freshly installed glass, slicing through new steel beams, and grinding down recently poured concrete. If the never-used bathroom fixtures can’t be salvaged, they may have to be smashed, at considerable risk to workers. Smashed fixtures are like razor blades! Toilet bowls, not so much. All that wastage has to be expelled and carted away. If the whole shebang were coming down, workers could run a rubble chute through the shaft to the basement. But here there are actual working elevators in the way, so the chutes will have to be fastened to the still un-scuffed exterior. As you can imagine, taking down a building is more surgical than erecting one. It’s art and science combined. For example, yanking out a length of steel without the proper preparation is clearly a unique balancing act. “As you’re deconstructing the building, you’re also bracing it, so you don’t leave something freestanding that can topple over,” says New York Department of Buildings deputy commissioner Gus Sirakis. It’s an elaborate puzzle that can involve as much building as breakage: shoring up floors, supporting steel skeletons, erecting scaffolding, installing chutes, and positioning cranes. Too technical for me, but what goes up must come down. If the Court ruling stands, Upper West Siders will witness a slow-motion decapitation from the inside out, which is about as gruesome as it sounds.

Nobody Wants to Buy Trump’s D.C. Hotel. Who could have guessed that inciting an insurrection against the United States government would be bad for one’s personal brand? And now the listing broker has quit, too! JLL, the real-estate brokerage that has been marketing the sale of the Trump D.C. hotel, says it is no longer involved in the effort, according to the Washington Post. It’s unclear exactly when JLL backed out or what role last week’s insurrection played in the decision. The Trump Organization has been shopping its lease on the 263-room hotel for the past year, hoping to fetch $500 million for a hotel that, according to one potential buyer, has underperformed since Donald Trump took office in 2017. There were already clear signs that the hotel was becoming a liability when the Trump Organization received bids at less than half the asking price. And its requirement that the new owners retain the Trump name as part of any deal is a sticking point that has likely become untenable now that the name is synonymous with the mob that stormed the Capitol last week. The hotel saga is emblematic of the challenges the Trump Organization will face after Trump leaves office this week. Trump hotels worldwide have suffered since his fateful trip down the Trump Tower escalator in 2015, which transformed his brand during his presidency. Apparently, businesses and conferences don’t want to deal with the potential blowback from booking a Trump hotel, and the president’s business partners are already cutting ties with his properties left and right. The PGA announced over the weekend that the 2022 PGA Championship, one of the tour’s four major tournaments, will no longer be played at Trump’s golf course in Bedminster, New Jersey. Deutsche Bank, Signature Bank, City of New York, and Cushman & Wakefield have also jumped ship. They likely won’t be the last businesses to cut ties.

Ryan Seacrest Selling Beverly Hills Estate. Ryan Seacrest is one of America's most recognizable faces. From his days hosting American Idol to his iHeartRadio morning show and most recent stint on Live With Kelly and Ryan, his smiling personality has won him lots of fame and plenty of fortune - a fortune he hopes to add to by selling his Beverly Hills house for $85 million. According to TMZ (always reliable?), Seacrest decided to move as he's spending so much more time in New York filming Live With Kelly and Ryan. He originally bought the four-bedroom, six-bath home from fellow TV host superstar Ellen DeGeneres in 2012. He got the mansion for $39 million, and if he sells for market price, he'll make a cool $44 Million dollar profit. The price increase might strike you as steep, but it should be noted that, aside from its lavish neighborhood, it has a history of high-profile ownership. Originally owned by Will & Grace star Max Mutchnick, it's been home to some of America’s most influential television figures. The glorious property is a resort-like oasis in the heart of busy Los Angeles. Composed of five structures in between garden water installations, the main house spreads across 9,000 square feet with a chef-curated kitchen that transitions into an outdoor patio (with pizza oven). In addition, the estate is equipped with a modern lounge, with 22-foot ceilings, a movie theatre, a spa, a top-tier gym and a peaceful meditation garden. The house, and especially the pool and teak pool house, gives sunbathers a jetliner view of L.A.

Quote of the Week: “Does anyone know if we can take showers yet or should we just keep washing our hands?”

This Week. Looking ahead, investors will continue watching Covid case counts and vaccine distribution. Beyond that, it will be a busy week for economic data featuring our housing sector. The National Association of Home Builders’ NAHB/Wells Fargo housing market index will be release on Wednesday (1/20), the Census Bureau’s new residential construction data on housing starts on Thursday (1/21), and the National Association of Realtors’ existing-home sales for December on Friday (1/22).

Weekly Changes:
10-year Treas:        Fell 0.02 points
Dow Jones Avg:      Fell 300 points
NASDAQ:                Fell 150 points

Calendar:
Wednesday, 1/20:   NAHB Index
Thursday, 1/21:      Housing Starts
Friday, 1/22:           Existing Home Sales

For further information, comments, and questions:

Lloyd Segal
President