by Calculated Risk on 3/11/2007 03:46:00 AM

First, here are two very different stories ...

From the LA Times: Businesses pinched as commercial rents soar in Southland

Sizzling demand for offices, warehouses and retail space is hitting Southern California and other major urban centers. ...Office rents have climbed more than 25% on average in the last three years in much of Los Angeles County.
...
Vacancies have plunged to well below 10% in many areas, making it harder for businesses to find space. Only 3% of the region's industrial space — used for warehouses and factories — is available, a level that is considered drastically low.

And from the Press-Enterprise: Office-space surplus plagues Coachella Valley

The Coachella Valley has too many offices for too few employers willing to rent them, but that hasn't stopped developers from planning projects with more than 1 million square feet of office space ...

Brokers said up to 23 percent of the offices in the Coachella Valley are seeking renters or buyers. A healthy office-building market occurs when vacancies are less than 10 percent.

In some areas, commercial space is clearly limited. But in most of Southern California, and in many parts of the U.S., there is a commercial building boom occuring right now.

This should be expected. Historically non-residential construction follows residential construction. In an earlier post, I graphed the investment lags for non-residential investment compared with residential investment. Here is the graph:

Click on graph for larger image.

The highest correlation for non-residential structures is a lag of 4 to 5 quarters. There is a positive correlation for other periods also. For non-residential structures, a lag of 5 quarters would suggest the YoY change would turn negative in Q3 2007. Update: The seasonally adjusted annualized change in structure investment was a negative -0.8 in Q4 2006.

This second graph shows the CRE delinquency rate vs. private non-residential construction spending. In the previous commercial real estate (CRE) slowdown, the delinquency rate started rising a couple of quarters before construction spending slowed.

The delinquency rate is rising again, although this time from a much lower level. This could be an indication that non-residential construction spending is about to peak.


And the third graph shows non-residential construction employment. Note: graph starts at 3 million to better show the change.

Non-residential construction employment has been flat for about four months, after a significant increase in employment in 2006. This might be another indicator that CRE investment is peaking.

This might be a story later this year: the start of a commercial real estate bust.

by Calculated Risk on 3/10/2007 11:54:00 PM

After reading the comments in the previous thread, I'd like to caution about generalizations. It's easy to pick out the mistakes, like this WSJ article at the peak in July 2005:

Neil Barsky writes in the WSJ "What Housing Bubble?"

If you want to be scared out of your wits these days, you basically have two choices: go watch Steven Spielberg's latest, or listen to the hysterical warnings of economists and journalists about the imminent popping of our so-called housing bubble.
...
The reality is this: There is no housing bubble in this country. Our strong housing market is a function of myriad factors with real economic underpinnings: low interest rates, local job growth, the emotional attachment one has for one's home, one's view of one's future earning- power, and parental contributions, all have done their part to contribute to rising home prices.

But at the same times there were journalists asking the right questions:

Caroline Baum: Enough About Loans. What About Lenders?

Forget the borrowers for a minute. Who's making these arguably risky loans? Why are lenders extending credit to seemingly bad credit risks?

Or Danielle DiMartino: Bubble's fallout? Two views

The inevitable pullback in construction speaks directly to housing's risks. A similar 40 percent decline in construction to that of the 1981-82 recession implies a decline of 2 percentage points in GDP.

And then there's the wealth effect. The housing bubble has added $5 trillion to household net worth, equating to about $70,000 for a family of four.

And it would be easy to blame the economists. Bernanke in July 2005: House Prices Unlikely to Decline

Top White House economic adviser Ben Bernanke said on Friday strong U.S. housing prices reflect a healthy economy and he doubts there will be a national decline in prices.

"House prices have gone up a lot," Bernanke said in an interview on CNBC television. "It seems pretty clear, though, that there are a lot of strong fundamentals underlying that.
...
"We've never had a decline in housing prices on a nationwide basis," he said, "What I think is more likely is that house prices will slow, maybe stabilize ... I don't think it's going to drive the economy too far from its full-employment path, though."

But some economists were warning about housing. From Bloomberg: Greenspan Housing View Seen Hazardous by Wall Street Economists

Worry, say Wall Street economists including David Rosenberg of Merrill Lynch & Co. and Stephen Roach of Morgan Stanley.

The economists say the Fed must act, for a simple reason: The U.S. has become so dependent on real estate and construction to fuel growth and jobs that an eventual, wrenching correction has the potential to sink the entire economy.

"Act now and cut off the pinky, or wait till later and risk slicing off the entire hand," Rosenberg said in an interview last week. "Either way it hurts, but you can still type with nine fingers."

Economics Professor and former Dean of the UCI Graduate School of Management Dennis Aigner wrote in the OC Register: Trouble in housing market no game, Region's house of cards ready to topple as prices reach unsustainable levels.

Over the past four years, 90 percent of the growth in U.S. GDP was accounted for by consumer spending and residential construction. Declines in the nation's biggest housing markets are likely to trigger a major economic slowdown.

It is not a question of whether this will happen but when, how dire will be the consequences on economic growth, and how long it will take to restack the blocks and begin again.

It is easy to focus on the negatives in Tanta's post, but remember Tanta also wrote:

Let us say that we cherish those reporters who are regular readers of ours and insightful commenters on the blog, enthusiastic participants in a new medium, interlocutors rather than overlords.

And we do cherish them. Blogs are a complementary good to other media outlets, not a substitute.

by Calculated Risk on 3/10/2007 05:18:00 PM

From CR: Regular readers will immediately recognize that the following piece was written by Tanta. I'd like to add that I have an excellent relationship with several prominent reporters (you know who you are), and I look forward to continuing our offline discussions via email and phone calls. I've never sought any personal publicity, although I'd be happy if you quoted from the blog (with a reference). For those reporters hoping to have a similar relationship with Tanta, please think of Tanta as the Man in Black from the "Princess Bride":

INIGO: Who are you?!

MAN IN BLACK: No one of consequence.

INIGO: I must know.

MAN IN BLACK: Get used to disappointment.

Dear Inquiring Minds:

Calculated Risk is a hobby blog, created and maintained by a retired executive, with occasional assistance from a former bank officer and mortgage lending specialist who is currently on extended medical leave. Both of these people get endless questions, answers, hat tips, links, analysis, and overall inspiration from a very diverse group of commenters, regulars and occasional de-lurkers, all of whom are beloved except some of them.

CR regularly gets emails and comments from paid reporters who wish to know if CR or Tanta would like to be interviewed, or would simply like to answer one or several questions that the reporter has about economic or housing or mortgage issues. Because, so far, the answer has always been something on the order of “no,” we would like to explain to you why this is the case. (CR Note: I have no problem discussing general economic and housing issues offline).

Calculated Risk is a blog. That means that it is a medium on which CR, Tanta, and the commenters are free to publish the things they want to say about subjects in which they are interested and to which their expertise is relevant. It is possible that there are bloggers out there who are publishing blogs with the secret hope that they will be discovered by the Big Paid Media and get interview requests, so that they may see their names next to a short, context-free, undetailed, possibly memorable or pithy but usually just crudely-edited quote in the newspaper. Some people may have ambitions that go beyond that, such as becoming a freelancer for Big Media companies, in order that they may get paid in the high two figures to produce short, simple-minded articles that Big Media won’t fact-check any more than they fact-check anything else. There may even be bloggers so delusional innovative that they still have hopes that the Big Media, print or online, will quote directly from their blog postings and provide links (text or hypertext, as the format allows) so that Big Media’s readers can be directed to the blog for further information. It’s a big internet, we’re not all alike, and neither CR nor Tanta intends to be speaking for any bloggers other than themselves here. Suffice it to say we are not in the above categories.

Dear reporters, we quote your stuff periodically, giving credit both to the reporter and the publication, under fair use terms. We have no objection to your returning the favor. If you have an editor who will not allow that, and you think that the problem can be solved by getting one of us to drop our online personas, give you our real names, and say the same thing to you over the phone, so that you can get your editor to accept it as something other than just blogging, which everybody knows is untrustworthy ranting by anonymous nuts, you are making a faulty assumption about the relationship among us, our birthdays, and yesterday. Neither CR nor Tanta wishes to play into a set of assumptions that render what we say on the blog as unworthy of coverage by the Big Media, but what we might say on the phone to Intrepid Reporter as good dirt and straight skinny.

Do you, can you, understand the implicit insult in that? You want to talk to us because of what we have written on this blog, instead of simply engaging with what we have written on this blog. You are saying that blog entries we have written, at our own inspiration, on our own time, for our own intellectual purposes, backed up by our own research, are not good enough for you to use as source material (properly credited). It only “counts” if you get to ask the questions, form the story angle, edit the material, and put names on it. This is the message we’re getting from you, and the only reason that our answer to many of your inquiries is “no” is that we are—CR at least, is—too polite to make it “no, and go take a hike with the horse you rode in on.”

Some of you are also, if we may say so, operating out of a sense of entitlement that takes our breath away. Here is the entirety of an actual email we received from an actual reporter of a print publication (names omitted to protect the egregious):

I am working on a story about Wells Fargo and subprime lending. I am trying to determine if Wells Fargo bears any sort of risk to the subprime shakeout. You covered this topic on Feb. 16 after John Stumpf presented to the CFSB conference.

I have the same questions many of your bloggers did. What is co-issuing and does that really remove WFC from any risk from these loans?

That is the entire message except for the name and newspaper of the sender. CR and Tanta, who have both worked in large corporations for non-trivial amounts of time, can testify that we have rarely gotten emails like that even from our bosses, who were paying us in dollar-denominated instruments and therefore reserved the right to ask us to do some work. Tanta has herself received email requests for research and information from the CEO of her company that managed to include “please” somewhere near the beginning and “thank you” somewhere before the end. She has also received email requests from business associates who were not actually providing her paychecks, but who were sources of business for her company and thus part of what made her employer profitable, that included not only “please” and “thank you” but such phrases as “if you have the time” and “I realize you aren’t paid to do this, but” and “please let me know what I can do for you in return.” Stuff like that.

Let us say that we cherish those reporters who are regular readers of ours and insightful commenters on the blog, enthusiastic participants in a new medium, interlocutors rather than overlords. We hope any representative of the Big Paid Media will join us in our journey of discovery—just click on the “comment” link at the bottom of a post, make up a handle for yourself, and type away! Feel free to make suggestions for future posts; everyone else does. Feel free to share your own information; everyone else does. Feel free to get flamed if you get uppity; everyone else does.

At the end of the day, please try to understand that we’re doing this for fun. We are not being compensated except for the modest ad revenue that covers the costs of hosting the blog and doing some subscription research that pays salaries for Real Reporters. Insofar as you are sending us inquiries because you think we sound like professionals and have brains in our heads, we’re flattered. However, like you, we just want people to read what we have written. We are not here to hawk our services as comment-bots for some reporter on deadline, nor are we interested in anyone’s investment strategies. This blog is not about helping anyone else make money in the stock or bond or real estate market. Commenters are free to discuss such issues, although they are subject to being banned or having their comments edited if they appear to be disseminating insider information, or trolling for suckers to buy some product or service, or just hijacking threads to endlessly request investment advice that will not be given, unless such comments are sufficiently entertaining to the rest of us and provide useful opportunities for clever snark. The definition of “appropriate comments” is at the whim of the blog host, and there is no avenue of appeal. This guideline extends to emails sent to the blog host, which may or may not be read or answered as the blog host’s time, energy, and idiosyncratically fluctuating level of enthusiasm for reading emails allow. (CR Note: I try to read and respond to most emails) If you do not receive an answer to your email, it may be that we are simply without the time to get to it. It may be, as in the example above, that we do not trust ourselves to answer without blowing our cool in ways that are not conducive to a pleasant retirement or tranquil recuperation. Yes, this means that you are dealing with some hobbyists who really don’t care if this sounds “professional” or not. That is what we have been trying to tell you all along by our choice to be bloggers instead of professional research organizations. We apologize if our strategy was insufficiently transparent.

P.S.: If you are a Nigerian Prince, or anyone else, in need of a bridge loan in order to secure Endless Riches that you would like to share with us, please provide us with your SSN/TIN, checking account number, ABA/routing information, home address, and photographs. We promise not to share that information with anyone other than one or two acquaintances of ours at the DOJ. TIA, as we say on the blogs!

by Calculated Risk on 3/10/2007 04:53:00 PM

Gretchen Morgenson writes in the NY Times: Crisis Looms in Mortgages. This article is a must read. A couple of quotes:

"I think there is no doubt that home sales are going to be weaker than most anybody who was forecasting the market just two months ago thought."
Thomas A. Lawler, founder of Lawler Economic and Housing Consulting, March 10, 2007

I think I was more bearish than most, and even I am considering revising my forecast downwards.

“There are delayed triggers in many of these investment vehicles and that is delaying the recognition of losses. I do think the unwind is just starting. The moment of truth is not yet here.”
Charles Peabody, founder of Portales Partners, an independent research boutique in New York, March 10, 2007

by Calculated Risk on 3/10/2007 02:12:00 PM

From Annette Haddad and E. Scott Reckard at the LA Times: Loan turmoil closes doors for buyers

Many would-be home buyers, and homeowners who want to refinance, are finding that virtually overnight their status has changed: They no longer are eligible for the kind of easy-credit loans that helped millions of people join the ranks of property owners during the housing boom.

This is an excellent summary article of the events of the last few weeks. It does seem like an "overnight change"!

A key concern: whether the problems of sub-prime lenders and borrowers could drag the economy into recession by causing a broader credit crunch.

Many economists, as well as Fed officials, say they don't believe that sub-prime borrowers account for a big enough share of the housing market to have a dramatic effect on the economy.

First, the problems in the sub-prime segment alone could be large enough to significantly impact the economy. As the LA Times article noted, 21.5% of all mortgages in 2006 were sub-prime. Some estimates are that about one fourth of all sub-prime borrowers will be locked out the market in 2007. That would represent 300K or more potential home buyers.

And the problem is much worse because of the dynamics of the housing market. Each first time home buyer (and many sub-prime borrowers are first time buyers) is the start of a mini-chain reaction in the housing market. As an example, when a first time buyer buys a home, the seller buys a move-up home, then that seller buys a larger home, and that seller buys a Toll Brothers' McMansion. The loss of one sub-prime borrower may result in the loss of several sales. The loss of 300K buyers will be in, the words of Bear Stearns' Dale Westhoff, "non-trivial".

And second, the problem is already spreading to Alt-A and will probably impact many prime borrowers - especially the borrowers that used non-traditional mortgages, like option ARMs, as "affordability products".

by Calculated Risk on 3/09/2007 08:15:00 PM

From Reuters (hat tip: Cal): Stricter lending seen barring 1 mln US home buyers

Tougher lending standards stemming from the shakeout in the beleaguered subprime mortgage industry could prevent up to 1.1 million U.S. homebuyers from getting mortgages this year, a Bear Stearns analyst told investors on Friday.

Banks and mortgage companies would sharply scale back lending to two groups: subprime and "Alt-A" borrowers, said Dale Westhoff, Bear Stearns' head of mortgage-backed research.
...
Westhoff estimated a 30 percent, or $180 billion, contraction in the subprime sector in 2007 from 2006, and forecast a 25 percent, or $100 billion, decline in Alt-A loan production from last year.

"This implies a purchase contraction of 1.1 million borrowers," said Westhoff who was speaking at Bear Stearns mortgage conference here. "That's a non-trivial number."

As I've been writing, Wall Street's 2007 housing forecasts are "No longer operative". I'd like to welcome Westhoff to the fold, and I'll write more about this later.

by Calculated Risk on 3/09/2007 08:13:00 PM

From Reuters (hat tip: realist): Countrywide Financial ends no down-payment lending

Countrywide Financial Corp. ... on Friday told its brokers to stop offering borrowers the option of no-money-down home loans ...

by Calculated Risk on 3/09/2007 06:59:00 PM

So far BLS reported residential construction employment has only fallen 4% from the peak in 2006. Meanwhile housing starts have fallen about 35%. What gives?

Click on graph for larger image.

The most important reason employment hasn't decreased significantly - yet - is that employment tracks completions, and completions are still near record levels. This graph shows starts and completions since 1968. Clearly starts have "fallen off a cliff", yet completions are still near record levels. But completions will follow starts off the cliff soon ... and so will residential construction employment.

As a techinical note: historically, on average, completions have followed starts by about 6 months for single family homes according to the Census Bureau, and by about 9 months for buildings with 2 units or more. However because of the increase in building size in recent years, the multi-family buildings are now taking an average of over 11 months from start to completion. Because of the longer period from start to completion, it has taken a little longer this time for completions to follow starts off the cliff.

There are other possible reasons too: In the construction industry there are many cash workers and illegal immigrants. These workers were probably the first to be let go, and they don't show up in the BLS statistics. See this WaPo article: Immigrants' Jobs Vanish With Housing Slowdown

"There's no work here anymore."
Amilcar Guzman, immigrant construction worker from El Salvador, Dec 27, 2006

Another possible reason BLS reported jobs haven't fallen significantly is because some employers might be hoping for a spring rebound in the housing market, and they don't want to lay off valued employees only to have to search for skilled employees in a few months. At my company, we would avoid layoffs during slow periods if we thought a turnaround was only a few months away. So this is another possible explanation.


And finally a possible technical reason based on how the BLS reports employment.

Residential construction employment is very seasonal. This graph shows both the Not Seasonally Adjusted (NSA) and Seasonally Adjusted (SA) residential construction employment from the BLS. Note: the residential specialty series starts in January 2001, so earlier totals were estimated from the residential building series.

This graph shows a key point: the next four months (March through June) are the main months for hiring construction workers. If NSA construction stays flat through the summer, the BLS will report approximately 300K lost residential construction jobs over the next four months. With the excess inventory in the housing market, it is very possible that NSA residential construction employment will actually fall during the peak hiring months!

So I'm sticking with my forecast of 400K to 600K residential construction jobs lost over the first 6 months of 2007.

by Calculated Risk on 3/09/2007 04:50:00 PM

From Bloomberg (hat tip: Brian): Subprime Defaults Are `Beginning of Wave,' Bies Says

Banks' losses from risky home loans made at low introductory rates are just beginning, U.S. Federal Reserve Governor Susan Bies said.

Bies, who has been Fed's top banking policy official in her tenure at the U.S. central bank, said today banks are likely to see more missed payments and foreclosures as consumers with weak credit histories begin to face higher monthly mortgage payments.

"What's happening is the front end of this wave of teaser- rate loans that are coming into full pricing," Bies said at a risk-management forum in Charlotte, North Carolina. "So what we're seeing in this narrow segment is the beginning of the wave -- this is not the end, this is the beginning."

by Calculated Risk on 3/09/2007 09:16:00 AM

From Bloomberg: Rising Subprime Mortgage Defaults Add to Unsold Homes Inventory

Rising mortgage defaults by subprime borrowers may add more than 500,000 homes to a residential real estate market already beset by slumping prices, according to CreditSights Inc.

In January, 4.09 million new and existing homes were offered for sale, down from 4.43 million in July 2006, the National Association of Realtors and the U.S. Commerce Department said. New homes accounted for 536,000 of the January total, down from a record 573,000 in July.
...
"We estimate that the effect of looser lending standards could translate into another 533,000 homes coming onto the market as borrowers default -- an unwelcome phenomenon given the existing supply surplus," Sarah Rowin and Frank Lee of bond research firm CreditSights wrote in a March 1 report.

The article makes the point that New Home inventories are probably understated because of how the Census Bureau treats cancellations. But the comparison to July 2006 could also mention seasonal factors. It is common for inventory levels to fall during the holiday season, and then to rise again in the spring. A better comparison might be January 2007 to January 2006, and that shows existing home inventories are up 23% YoY from January 2006.