Matrix Blog

Archive for July, 2007

[In The Media] The Real Deal Clip for 7-30-07

July 30, 2007 | 10:44 am | | TV, Videos |

The Real Deal Magazine which has experienced phenomenal growth and is a must-read reasource for the New York housing market, has made a real commitment to the videocast format and delivers new video content on their web site every week. Look for my regular new podcast feature, coming soon.

I just released my 2Q 2007 Long Island/Queens Market Overview for Prudential Douglas Elliman and this interview covers the results, with emphasis on Queens. You can download a copy of the report.

To watch the videocast.


[Matrix Vortex] Its Probably About Time, But Its Not All About Housing

July 30, 2007 | 12:01 am | |

The events of last week’s roil of the financial markets signified a brave new world for users of highly leveraged debt. The banks finally had enough. Of course, the word “housing” was thrown in after recent announcements of bank woes, weak housing prices, months of the subprime morass, a bad night’s sleep on my part and voila!, a vortex was born.

Here’s a list of links to put you in a tailspin, err…, a vortex:



Outstanding On Our Soapbox This Week: Wall Street’s Valuation Methodology. Is It Correct?

July 29, 2007 | 11:36 pm |

In this week’s Straight From MacCrate post in our other blog Soapbox called Wall Street’s Valuation Methodology. Is It Correct?, This week Jim MacCrate gets a bit DCF’ed about how Wall Street does not fully explain how it values real estate. He believes its a looming problem.


[Straight From MacCrate] Wall Street’s Valuation Methodology Is It Correct?

July 29, 2007 | 11:29 pm | |

Jim MacCrate, MAI, CRE, ASA, has worn many hats in his career. He taught a number of the appraisal classes I have taken through the Appraisal Institute and I think he is one of the few people who actually understands the “J-Factor.” His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

This week Jim gets a bit DCF’ed about how Wall Street does not fully explain how it values real estate. He believes its a looming problem.
…Jonathan Miller

The Global Equity Research Department of Lehman Brothers recently published the REIT NAV Handbook which summarizes the valuation methodology employed to estimate NAV which is defined as “an estimate of the private market value of a company’s assets.”

Anyone who understands real estate clearly sees the risks inherent in the valuation process that Lehman Brothers has used to estimate the private value of the companies assets. The process does not appear to conform to the Standards of the Appraisal Institute or the American Society of Appraisers. If they use the same procedures to value investments that they have made in real estate companies or real estate investment trusts, they may very well have to take some hits too when they have to “mark to market.”

Consider Lehman’s methodology, outlined as of June 2007:

“We first calculate a forward 12-month cash net operating income (NOI) based on annualized 1Q07 GAAP net operating income (real estate NOI plus joint venture NOI, adjusted for partial contributions, less lease termination fees where included in rental revenue), multiplied by an appropriate growth rate for the next 12 months, minus annualized straight-line rents. In cases in which joint venture NOI was not available, we used the equity in unconsolidated subsidiaries reported on the company’s income statement. (Please note that, for malls and outlets, a rolling four quarters of NOI is used to account for the quarterly fluctuations in revenue driven by percentage rents.)

The resultant cash NOI is then capitalized at an appropriate cap rate (adjusted for the quality of a company’s assets) to determine the implied value of owned properties. We next add capitalized management fee/service income (using between a 12% and 20% cap rate, in most cases), cash and cash equivalents, construction in progress at 110% of cost, any land being held for development, other assets, and, in some cases, the value of tax-exempt debt in order to arrive at the gross market value of a company’s assets.

To determine the net market value of assets, we then subtract all of the company’s liabilities and obligations, including preferred stock at liquidation value and the REIT’s share of joint venture debt.

Our NAV estimates make no adjustment for any mark-to-market on company debt.”

The blog format does not lend itself to an all-inclusive discussion of all the issues and standards. One must remember, however, that Wall Street is not subject to the Uniform Standards of Professional Appraisal Practice (USPAP). Perhaps they should be to protect the general public. For starters, are the individuals who prepared this analysis competent? According to USPAP, to be competent, the analyst must be familiar with the type of property, the subject market, the geographic area and the appropriate analytical methods for determining value for that type of property. Their qualifications have not been provided.

The second problem deals with scope of work which, according to USPAP, should be clearly delineated so that investors can ascertain the risks associated with this type of analysis. This includes but is not limited too:

* “the extent to which the properties are identified;
* the extent to which tangible properties are inspected;
* the type and extent of data researched; and
* the type and extent of analyses applied to arrive at opinions or conclusions.”

I presume that the information was provided by the individual companies which would tend to be biased, as history and common sense have indicated. The credibility of the results is always measured in the context of the intended use. I will let the individual judge whether the scope of work is adequate to make an investment decision in any of the REITs discussed. In fact, the term “private market value” is not even defined.

While there are many criticisms that will be left unresolved, I would like focus on the second paragraph and specifically the following statement:

“We next add capitalized management fee/service income (using between a 12% and 20% cap rate, in most cases), cash and cash equivalents, construction in progress at 110% of cost, any land being held for development, other assets, and, in some cases, the value of tax-exempt debt in order to arrive at the gross market value of a company’s assets.”

No justification or support has been provided for the 12% to 20% capitalization rates selected for the management fee/service income. They have also added construction in progress at 110% of cost. That could be overstated. Some developers are having trouble selling properties; therefore, the value of construction in progress may be falling and is certainly well below cost. Land values are dropping as construction costs rise, capitalization rates and mortgage interest rates are increasing, thereby reducing the potential value of the finished product. I doubt that the big four accounting firms are making the appropriate adjustments that are required to properly mark the assets and liabilities to market value.

The final sentence is also quite interesting in that Lehman Brothers is not adjusting the debt to market. Many real estate companies have short-term debt and other obligations that will have to be refinanced within the next five years. The cost of the refinancings will most likely be higher over this period, which means the cost of borrowing will increase.

Clearly, anyone involved with real estate knows that real estate investing requires a long term commitment to minimize the cyclical variations occurring in the market place. DCF analysis takes the long term into account, and is regarded as one of the best methods of replicating steps taken to reach investor buy/sell/hold decisions, and is often a part of the exercise of due diligence in the evaluation of an investment.”

Moreover, USPAP states that “DCF (discounted cash flow) analysis is becoming a requirement of advisors, asset managers, fiduciaries, portfolio managers, syndicators, underwriters, and others dealing in investment-grade real estate. These users of appraisal services favor the inclusion of DCF analysis as a management tool in projecting cash flow and return expectations, capital requirements, refinancing opportunities, and timing of future property dispositions. If pension funds and investors apply a discounted cash flow analysis to truly reflect the actions of buyers and sellers in the market place, then, why does Wall Street ignore the same? They too have a fiduciary responsibility, as well as an ethical obligation, to provide investors with meaningful conclusions that are explained, justified and supported by market evidence.

If other Wall Street firms are following similar procedures, expect further hits to some of the REIT shares as interest rates rise, construction costs increase and profits decline as indicated in my previous posting, “Is The Stock Market Signaling A Warning Sign To The Private Commercial Real Estate Market Or Was The Reverse True?Wall Street appears to have forgotten many lessons that were learned in the 1970’s.

Thanks to Noreen Whysel who provided some input and assistance.

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State Of New Jersey: Otteau Contract Report 2005-2007

July 29, 2007 | 12:01 am |

This report is provided by Jeffrey Otteau of the Otteau Appraisal Group who also authors a series of widely followed quarterly market reports on the New Jersey real estate market. This information is collected from various sources including Boards of Realtors and Multiple Listing Systems in New Jersey.

I have known Jeff for many years and consider him one of the leaders in the real estate appraisal profession. He has taught me a lot about quantitative real estate market analysis.
…Jonathan Miller


The results of our latest analysis indicate that contract-sales activity declined by 5% in June, continuing a pattern of inconsistent sales pace. Following 3 consecutive months of increasing sales activity in January, February and March, sales declined in April, then increased in May, only to decline again in June. This uneven performance is evidence that the market has yet to regain its balance and continues to struggle with the effects of diminished affordability following the unprecedented home price increases that occurred between 1992 and 2005.

From an inventory perspective, while the number of unsold homes continued to rise in June, that increase occurred at a slower pace than in the 4 preceding months. Unsold Inventory increased in June by only 1% suggesting that inventory growth may be approaching the high-water mark. Statewide Unsold Inventory now represents an 8.5 month supply, as compared to 8.1 months in May and 7.7 months one year ago.

Despite this uneven performance, there are emerging signs that the housing market may be nearing the bottom of its current recession which began in September 2005. The most compelling evidence is based upon submarket trends in northeastern New Jersey that are within commuting range of Manhattan. In these markets, which include the counties of Bergen, Essex, Hudson, Middlesex, Monmouth, Morris, Somerset and Union, contract sales declined by only 1.7% from May to June (as compared to 5% statewide) and actually ran higher than the June 2006 level. Most notable in this group is Hudson County where year-to-date sales activity is running 12% ahead of last year. The stronger market conditions in northeastern New Jersey serve as a reminder that the strength of the Manhattan real estate market, which continues to experience strong demand levels, is generating overflow demand to nearby suburban locations. Expect this to be a long term trend as communities near to direct Manhattan rail access will see the strongest price increases once the market recovers.

Looking ahead the housing market still faces significant challenges as sales pace will likely slow during the approaching fall and winter seasons. Given this probability, home prices will be challenged to hold at current levels considering there are presently more than 72,000 homes for sale in New Jersey as compared to only 39,000 in June 2005.

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But Buyer Psychology Is Part Of Market Value

July 27, 2007 | 12:01 am | |

The NAR says consumer psychology is to blame.

“Homebuyers have been getting mixed signals about the housing market, which is causing some of them to hesitate”

Lawrence Yun, NAR senior economist, who has taken torch from controversial former chief economist David Lereah, said some consumers are uncertain (yes, 1/3 fewer sales):

“Home buyers have been getting mixed signals about the housing market, which is causing some of them to hesitate,” he said. “Mortgage interest rates have risen recently, and tightening lending standards are continuing to hamper sales, but fewer risky loans will put the market on a healthier path. Although general buying conditions remain favorable for long-term home buyers, it appears some buyers are looking for more signs of stability before they have enough confidence to make an offer.”

Ok. Lun has moved beyond blaming the weather to blaming buyers. This strikes me as odd.

Lets look at the use of the word value.

The most probable price (in terms of money) which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: the buyer and seller are typically motivated; both parties are well informed or well advised, and acting in what they consider their best interests; a reasonable time is allowed for exposure in the open market; payment is made in terms of cash in United States dollars or in terms of financial arrangements comparable thereto; and the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

Value is steeped in consumer psychology. Its about perception about a future benefit.

Consumer psychology is the study of how people relate to the products and services that they purchase or use.

So the measurement of how people relate to the housing market, is the value they place on it. So value is part psychology. When someone makes an offer on a house, its the amount they feel is justified and correlated to their perception of the benefit of ownership in the future (phew!).

In other words, Lun is blaming the value buyers place on the housing market as keeping them from buying them. Actually, its also a tired reference to blaming the media for housings’ troubles.

So a buyer won’t buy because the value they see in the property isn’t enough to make them want to buy. Isn’t this a circular reference?

or to put it another way…huh?

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The State of The States Of The Market: Party Like Its 2009

July 26, 2007 | 10:26 pm | | Radio |

Click here for interactive table (and to see straight)

James Hagerty and Ruth Simon performed their quarterly survey of the US residential housing market in 28 metro areas.

While the general state of the majority of the 28 residential markets were weak, the stats showed some light at the end of the proverbial tunnel, although I suspect that means 2009. The big wild card now is the state of consumer credit. Restrictions placed on the sale of properties overlay more difficulty in obtaining mortgages and thereby restrict the odds of recovery anytime soon.

Tighter credit is prolonging a deep slump in home sales, but a quarterly Wall Street Journal survey of 28 major metro areas shows that the surge in inventories of unsold homes is slowing. In two of those markets — Boston and Denver — the number listed for sale has actually declined from a year ago.

Home sales and prices generally should bottom out around mid-2008, says Mark Zandi, chief economist at Moody’s, a research firm in West Chester, Pa. “The market will not revive quickly, however,” he says. “It won’t be until the turn of the decade before housing activity returns to more normal conditions.”

I agree. Zandi is really saying 2009-2010 before things return to normal (whatever normal really means).

The NAR released their monthly existing home sale stats yesterday indicating more weakness as the number of existing sales fell 3.8% below the same period last year. Since these are the numbers for June, which is one of the most active months of the year for residential real estate, the decline suggests more weakness on the way.

The day before, Countrywide reported a 33% drop in net income, which triggered a 200 point drop in the stock market on Tuesday. Angelo Mozilo, CEO and cofounder blamed housing. It was surprising that Countrywide reported weak earnings since Mozilo has always been direct about the housing market so it would seem that they would have anticpated the current state of affairs (He also has the best sun tan of any Fortune 500 CEO).

Today, the DJIA dropped 311.50 on lending and credit worries. Take a listen to the mp3 in the article. Its worth listening too, plus the interface is very slick (NYT Radio?) Home builders reported lower earnings, combined with $77 dollar a barrel oil and several days of bad housing news caused some jitters.

However, relative to 14,000, a 311.50 drop doesn’t seem that catastrophic as the housing hyperventilating suggests.

This week has been a heck of a housing party.


Color Housing Any Way You Want, As Long As Its Beige

July 26, 2007 | 11:23 am | |

The Federal Reserve released its Beige Book yesterday, an anecdotal look at the economies in the regions of its 12 member banks. Its a good overview of the economy performed by their in-house economists who interview their contacts in each region to get a “ground level” sense of the major sectors, including: Consumer Spending and Tourism, Business Spending and Hiring, Construction and Real Estate, Manufacturing, Banking and Finance, Prices and Labor Costs, Energy and Natural Resources, Agriculture.

Five regions indicated that retail sales of items related to housing–such as furniture and home repair materials–were weak or declining.

Most Districts said that residential construction and real estate activity continued to decline on balance. Many Districts, however, noted increased activity in some individual market locales or segments. Atlanta, Chicago, St. Louis, and Minneapolis said construction decreased. Boston and Kansas City said housing markets remained “soft” and “weak,” respectively, while San Francisco indicated that residential markets were weak and had slowed further in some areas. New York said markets were mixed but stable. Two notable exceptions were the Cleveland and Richmond regions, which experienced slight increases in sales. Atlanta said home inventories remained high, as did Dallas (even after a slight decline in the recent period). Inventories increased in Kansas City, but they declined in New York, and contacts in Boston and Cleveland described the number of homes for sale as “normal” and “acceptable,” respectively. District reports on home price appreciation were mixed: Boston noted a return to price appreciation and Kansas City indicated slower rates of decline. But Richmond and Chicago reported slower rates of increase or the beginning of declines, and in the Dallas District, some contacts projected a correction in entry-level home prices. Looking ahead, contacts in the Cleveland District were uncertain about how long it would be until the market turned, and analysts in Dallas had revised their housing outlook down. Contacts in Atlanta expected further declines overall, though they anticipated the market in Florida would be flat.

…manufacturers of housing-related products (lumber, stone, glass, cement, appliances, and furniture) typically reported declines.

My take-aways were:

  • Demand for products designed for use in the housing sector is generally weak. No surprise there. Beside employment, this is one of the key influences housing has over the economy.
  • Sales levels and new development are down, which is consistent with national housing stats. I thought it was important to appreciate (no pun intended) that there was disparity between various markets, in terms of their performance, although the general picture was generally negative.

The Beige Book was originally red.


2Q 2007 Long Island/Queens Market Overview Available For Download

July 25, 2007 | 2:50 pm | | Radio |

The 2Q 2007 Long Island/Queens Market Overview [pdf] that I write for Prudential Douglas Elliman [PDE] is available for download. We created this market area study in 2006.

You can see the methodology that went into the report.

You can also build your own custom data tables using the aggregate report data (from 2Q 2003 through 2Q 2007 [2Q 2007 – to be uploaded shortly]). I have created a series of quarterly market charts that may also be of interest.

_An excerpt_

…Both average sales price and median sales price indicators approached stabilization, after two years of decline. However, changes in price levels varied by price strata and market area. The most notable price changes occurred in a weaker North Shore market and a stronger Queens condo market. Despite stabilizing prices, the overall number of sales fell across the entire region with the North Shore market being the only market to show a gain as compared to the same period last year. As a result of diminished demand, inventory levels have continued to rise, causing other market indicators like days on market and listing discount to expand. A decline in the overall number of sales in one of the most active quarters of the year suggests that the housing market may experience continued weakness in the near future…..

Download report: 2Q 2007 Long Island/Queens Market Overview [pdf]

Here’s a brief summary of the media coverage for the study. Its interesting to place the coverage side-by-side because its based on the same data.

Here’s the recap:

Queens-Long Island Home Prices Little Changed in Second Quarter [Bloomberg]
LI, Queens housing sales still cool [Newsday]
LI, Queens housing sales still cool [amNew York]
Queens prices down in 2nd quarter [The Real Deal]
Queens Residential Market Drops, Except for the Pricey Stuff [Curbed]
Queens-Long Island Home Prices [Bloomberg Radio (no clip yet)]


Another Way To Lose Your House

July 24, 2007 | 12:15 am |

Last week the White House issued an executive order:

Blocking Property of Certain Persons Who Threaten Stabilization Efforts in Iraq

…all property and interests in property of the following persons, that are in the United States, that hereafter come within the United States, or that are or hereafter come within the possession or control of United States persons, are blocked and may not be transferred, paid, exported, withdrawn, or otherwise dealt in…

When I came across this order, I wondered what would the US government do with the property? If a consumer bought a property that was formerly owned by someone that the government deemed a threat to national security, would anyone really want to live in it if they were fully informed about the prior owner? Does the buyer second guess the government to determine whether the threat is real and its worth the risk to take possession?

If this prior ownership was clearly disclosed at sale, presumeably in an auction, I would think this stigma could have an adverse impact on market value. However, on a more macro level, Dan Green debunked the relationship between recent terrorist threats and mortgage rates over at The Mortgage Reports.

Crains New York Business Economic Spotlight Chart – July 2007

July 23, 2007 | 12:01 am | | Charts |

Since 2003 I have provided a chart that appears once a month in the Economic Spotlight section of Crain’s New York Business magazine. Here is this month’s chart appearing in the current issue of Crain’s New York Business.

Source: Crain’s New York Business

Go here for a complete archive of all my Crains’s New York Economic Spotlight charts. They are organized by year.


[Getting Graphic] Remake, Remodel: Slow but Steady

July 23, 2007 | 12:01 am |

Getting Graphic is a semi-sort-of-irregular collection of our favorite BIG real estate-related chart(s).

Harvard’s Joint Center for Housing Studies just released their quarterly Homeowner Remodeling Activity Report which forecasts low but steady growth over the coming year.

Source: JCHS

Click here for full sized graphic [pdf].

I expanded their chart back to 1995 using their historical data [XL]. It shows 2-3 year cycles of robust activity followed by a sharp drop in activity.

Source: JCHS, Presented by: Miller Samuel

Click here for full sized graphic.

I always assumed their was a fairly close correlation between housing activity and remodeling activity over the past decade. As prices rise, activity increases due to either upgrading the home after purchase, or expanding and re-configuring homes as an alternative to buying a new one. I know in my home town, it seemed as though there were more homes being extensively renovated and expanded, than there were sales of new homes. However, my expanded chart shows a different pattern as far as I can tell.

The whole topic of remodeling brings to mind one of my pet peeve with repeat sales indexes. Advocates of this methodology say it is clearly better than looking at aggregate differences in prices since the index plots patterns of the same asset over time. However, in reality, repeat sales indexes rely on a false sense of continuity because tend to miss a significant characteristic of a changing housing market: Houses change a great deal. Houses get larger or their interiors are significantly improved upon in a large number of the transactions. The subsequent sale gets distorted because it may essentially be a different house.

but I need to digress…

While writing this post, I thought of Remake/Remodel. Did I dress like that in the early 70’s? (age check: I was 13) I must have remodeled since then.

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