The Housing Bubble

A weekend topic starting with Bloomberg. “A decade after the U.S. housing market collapsed, Federal Reserve officials are watching rising apartment towers as the next potential asset-price bubble, which could add to the debate about the pace of interest-rate hikes this year. Fed Chair Janet Yellen cited commercial real estate prices as ‘high’ in a speech at Stanford University on Jan. 19. That message has been echoed by Governor Jerome Powell, who warned ‘low rates may lead to a reach for yield,’ as well as Boston Fed President Eric Rosengren, who cited luxury housing in his city.

“While single-family housing prices have had a gradual recovery from the mortgage bust, commercial real estate is showing signs of being overheated in markets such as New York, San Francisco and Boston. Fed officials have mostly said they plan to address potential asset price bubbles with financial supervision, rather than by raising interest rates at a faster pace than they currently expect. But such hot-spots are testing their patience.”

“The Moody’s/RCA Commercial Property Prices Indices, which cover apartment, retail, office and industrial sectors, dropped 40 percent from the start of the last recession in 2007 to the end of 2009. They’ve since more than doubled and now stand 23 percent above the pre-crisis peak. The Fed’s Beige Book of anecdotal reports, while noting healthy markets mostly, cited some worries including that New York City’s rental market has ‘weakened noticeably’ and ‘rents of larger units have declined.’”

“‘I continue to be concerned about the commercial real estate market,’ Rosengren said in response to questions on Jan. 9 in Hartford, Connecticut. ‘If you look at prices of commercial real estate, particularly multifamily properties, they have been going up very rapidly in many parts of the country.’ All around Boston luxury apartment or condos have sprung up, he said. ‘They are all very expensive properties,’ he said. ‘It varies depending where you are in the country, but I think it is certainly something we should be watching.’”

“The Fed’s concern has been building for a while. In September, Yellen pointed to Rosengren as a point person monitoring of the market. ‘Of course, we are worried that bubbles could form in the economy,’ she said at a press conference. While it’s difficult to determine a bubble in real time, ‘We are monitoring these measures of valuation and commercial real estate valuations are high.’”

“Yellen and other officials say supervision should be the first line of defense for preventing bubbles, while leaving open the possibility of using monetary policy, because it gets into all the cracks in financial markets that may be missed by regulation. ‘CRE prices have objectively gone up, and even anecdotal reports suggest some froth in that market,’ said Roberto Perli, a former senior Fed economist. Yet the repeated warnings may not have much of a policy signal. ‘Most people at the Fed still think the funds rate is not the appropriate tool to address potential financial instability issues,’ he said.”

The first of two reports from The Real Deal. “Equity Residential’s outlook on its New York rental market continues to look gloomy, with the real estate company on Wednesday bemoaning falling rents and rising concessions in the Big Apple. The real estate investment trust expects its revenues in New York to fall by 1.8 percentage points in 2017. Same-store profits had fallen by 3.1 percent in 2016. The culprit: growing supply thanks to new construction, and mediocre growth in high-paying jobs.”

“‘Financial services are contracting and tech job growth has stalled,’ the company’s COO David Santee said in the fourth-quarter 2016 earnings call, adding that most new jobs in New York are in low-paying sectors like retail and hospitality. That drives rents down and concessions up.”

“The company has budgeted $4 million for concessions in 2017 in New York – a figure no other market comes close to (it budgeted around $90,000 for Washington, D.C. and $80,000 for Seattle). ‘We are already hearing some crazy stuff like three and four months free on 12-month leases,’ Santee said, speaking of the market more broadly.”

“If you asked a real estate executive to rank property types by bubble risk, odds are they’d start with condos. Then, probably retail with its precariously high vacancy rates. Third might be the office market, where supply has surged. Way down in the bubble-risk ranking would likely be multifamily: the asset class in which, conventional wisdom goes, rents tend to rise and never crash (not even during the depths of the 2009 recession).”

“With that in mind, you’ll forgive this reporter for almost falling out of his chair when Mark Zandi, chief economist at Moody’s Analytics, picked multifamily lending as one of the two greatest near-term risks to U.S. financial institutions (along with automobile loans). And Zandi isn’t alone.”

“As early as December 2015, federal banking regulators issued a joint statement warning that banks’ increased commercial real estate and multifamily lending poses a threat to financial stability. In April 2016, Madison Realty Capital’s Michael Stoler wrote an op-ed warning that ‘trouble might be coming’ for loans backed by rental apartment buildings.”

“But lenders haven’t slowed down. Between the first and second quarter of 2016, the volume of outstanding multifamily debt in the U.S. grew by $27.6 billion to $1.09 trillion, according to the Mortgage Bankers Association. Since 2007, the dollar volume of multifamily debt held by banks, thrifts and bond investors has more than doubled. And in the trade group’s year-end survey, 92 percent of lenders said they had a ’strong or very strong appetite’ to issue new commercial and multifamily loans.”

“Banking regulations accelerate this trend. Banks doing multifamily loans need to hold less capital as an insurance against losses, making such mortgages more attractive compared to office or construction loans. Are we at risk of a multifamily mortgage bubble?”

“Bubbles can form in any asset class, but they are particularly dangerous in those perceived as unsinkable. It is precisely the multifamily market’s perceived stability and crash-resistance that should give investors pause. But just because an asset class has strong underlying demand and a track record of stability doesn’t mean it’s immune to a crisis. ‘Like all markets that get overdone, they start with good fundamentals — good logical reasons why you would invest there,’ Zandi said.”

“As of May 2016, more than 500,000 apartment units were under construction in the U.S. — almost twice the historical average and the highest total since 1985, according to CoStar. In some southeastern cities like Nashville, Charleston and Fort Myers, new construction as a share of existing inventory is precariously high. In New York, new supply is still widely regarded as lagging behind demand and nobody expects the market to hit a prolonged downturn amid strong fundamentals. But the risk is that investors overestimate the potential for future rent increases and overpay for properties.”

“Earlier this week, Madison Realty Capital filed to foreclose on an East Village apartment building after its owner, Raphael Toledano, defaulted on a $34 million loan — offering a taste of how multifamily investing can go wrong.”

“‘Many people all over the world seem to have thought that since we are running out of land in a rapidly growing world economy, the prices of houses and apartments should increase at huge rates,’ Yale economist and Nobel laureate Robert Shiller wrote in 2009, analyzing the subprime mortgage crisis. ‘That misunderstanding encouraged people to buy homes for their investment value – and thus was a major cause of the real estate bubbles around the world whose collapse fueled the current economic crisis. This misunderstanding may also contribute to an increase in home prices again, after the crisis ends.’”