Altus Insight - March, 2013

The Altus Insight

Market news, commentary and relevant topics for today’s alternative asset investor


Date: March 31, 2013

FR: Forrest Jinks

RE: Real Estate and Cyprus

After two months of gearing up to do an article on free markets for this month’s edition, events have thrown a wrench into my plans by being, well…events. A discussion of free markets will wait for another day, and instead this article will discuss the current state of the residential real estate market and Cyprus.

Before jumping into the meat of the article I should mention that I have been asked to speak at the North San Diego County Real Estate Investors April meeting to be held on Tuesday April 16th in Oceanside, Ca. More information or instruction how to buy a ticket to the event can be found at

Real Estate Hysteria – Back in 2009 we started to preach the virtues of single family investment. These were the days of the despair among the real estate industry with much of California’s residential real estate having already dropped close to 50% in value and real estate values in the rest of the country gaining momentum in their slide. In the

June 2009  Altus Insight I said,

“To me, these factors add up to a market that has some rocky times ahead. How bad and for how long? I don’t have the crystal ball to answer that question, but my guess is we are close to the bottom and will bump along the bottom for the next couple years. The increase in available properties due to increasing foreclosures will be offset by buyers taking advantage of excellent intrinsic value in the markets either as home buyers or investors reaping strong rental returns.

I still believe we are going to see a strong recovery in the real estate market over the next several years (once the foreclosure inventory gets absorbed) due to population growth, green building initiatives adding substantial costs to new construction, loosening of the credit markets (it will happen at some point) and the coming inflation. This adds up to make me a buyer of property with strong fundamentals and good cash flow potential.”

In December of the same year I wrote,

“In taking a longer view on the real estate market, I continue to believe owning cash flow properties is an excellent strategy. In addition to the rent/price ratio being favorable, interest rates being historically low, and real estate being a hedge against inflation (all of which I have talked about in previous months), there is additional historical evidence that real estate prices will likely recover with gusto once the economy stabilizes. By going back over the past 40 years, reviewing the instances of greatest affordability, and tracking the increases of residential real estate prices forward from those points of highest affordability, we see that in every case residential prices have increase 2 to 3 times the price at the affordability peak. Our current affordability peak is the highest (meaning most affordable) that real estate has been since affordability began to be tracked in the early 1970s. This would indicate a recovery of at least comparable size, and maybe greater. The big question remains, however, of when recovery (and thus unadulterated market appreciation) will occur. There has never been a sustained economic recovery without job recovery. The employment situation is depressing (many measure true California unemployment over 17%) and recovery of any sort is difficult to predict.”

 We could be confident in our real estate investments knowing that we were investing in assets that provided a real life utility (a place to live), at below replacement costs (sometimes as low as ½), and with rents creating an investment return that far outweighed other investments on a risk adjusted basis. The idea wasn’t to predict when the market would come back, but to take comfort in knowing that it would. The 3/23/09 article (Click HERE to read it), breaks out the reasons in detail. In my mind, it wasn’t a question of IF the markets would recover, it was a question of WHEN. But even though I believed “real estate prices will likely recover with gusto” I didn’t foresee the ferocity of the market recovery once it truly turned the corner.

Anyone who was trying to buy residential market can think back to 2005 and to the ridiculousness of the market. Thankfully we had mostly exited residential real estate by then but we had enough exposure to get a feel for what was going on. Then came the crash, then came the banks, selling with requirements of full proof of funds up front, limited inspections, limited repairs, and more. New agents entered the markets, technology improved, and the face of the residential market changed. This, added to the shortage predicted several years ago (a growing population without corresponding home building), has created a buying frenzy even beyond the bubble days of the mid 2000s.

While antidotes can’t be depended on for accuracy of information, they can be useful in painting a picture of situations. And of antidotes, there are plenty.

Case #1. This past week we offered on a short sale that we thought would required $45,000 of repairs and be worth somewhere around $350,000 to $375,000 completed. The sellers ended up accepting an offer of $351,000, about where we thought the value of the property was AFTER the repairs.

Case #2. Omaha, Nebraska, has been the epitome of a stable market without the highs and lows experienced by the coasts or parts of the sun belt. Not anymore. Even boring Omaha is experiencing multiple offers over asking.

Case #3. Another relatively stable market over the past couple decades has been Texas (I guess they learned their lesson in the 80s). Now? A friend just put a place in contract to buy and already has renters and buyers contacting him about the property, and he doesn't even own it yet.

Case #4. A property in Santa Rosa went into contract at $300,000 but the buyers backed out after less than a week in contract. The seller then put the property back on the market $20,000 higher than it was previously in contract for and ended up with multiple offers over asking, all in the course of a week.

I could go on and on with the stories but space is limited. Just understand that the old timers, and I can now almost include myself in that category, are consistent in saying they have never seen a market like this…ever. 20 offers? Cats play! 40 offers? No longer raising eyebrows. (Note: During the writing of this article I just received an email that I didn't get a property on which we made an offer and we were almost $75,000 over asking)

Here are some market statistics from two of the markets we focus on:

Sacramento Metro area (Thanks to Dan Lozano, Sellstate Realty): This is one of the hottest areas in the country right now. In January of 2012 the ratio of sold properties to listed properties was 38%. In January of this year it was 76%. This is caused nearly entirely by a 50% reduction in available inventory. Days on market has fallen to only 35 days. In the past year the median home price is up 27% and the average home price is up 28%, with the price increases seeming to gain momentum in the last few months. Certain towns/neighborhoods within the metro area are far more extreme. In east Rocklin 50% more properties sold last month than were put up for sale and over the past year both the median and mean home price have increased over 30%

Sonoma County (Thanks to Fermin Escutia, Keller Williams Santa Rosa): Over the last 12 months days on market (a measure of the amount of inventory available) has dropped by 25% while prices have gone up 20%. Between January and February the median home price went up 3% and the mean price went up 20% (in one month), though in the short term the mean can be adjusted by extremely high or low sales.

Southern Colorado: We were in the process of putting money together to move into markets in Southern Colorado when market turned suddenly, causing us to realize we were to late to the party for the strategy we want to employ (similar to our buy and hold fund). After houses sitting on the market for months, they suddenly had multiple offers over asking as people scrambled to get their hands on whatever they could find.

This activity has people starting to throw around the dreaded “bubble” word, but is it? Timing any market is difficult (see my self quote above) and my feeling is it is better to get out to early than too late. One of our funds recently had a long conversation discussing whether we should sell off our rental portfolio while the selling is good. Good arguments can be made for each case:

To Sell:

Prices are rising faster on a percentage basis than even 2005, indicating a hysteria. Hysteria is usually the stage before a crash.

An increase in inflation numbers could cause the Fed to raise rates, this would directly lower the current affordability of property (even as the appreciation is also lowering the affordability)

Wages have yet to show any signs of strength and employment is still high (far higher than released numbers even)

Europe has major fiscal issues. If those manifest themselves as a surprise, the shock waves through the US markets could be immediate

Taxes are going higher, much higher. This will reduce the amount of money people have to spend or invest on/in housing.

Long term demographics indicate a shift away from the home styles we have become accustom to over the past couple decades.

Or not to Sell:

There is a shortage of housing in many markets

Prices are still low enough that building new construction is prohibitive in most cases

Even after prices rise to where new homes can profitably be built, there is still a delay in land being rezoned and approved for building. In some areas, especially coastal areas, that delay can be several years.

Affordability is still very high and in many cases houses at or below the median home price have a lower monthly ownership cost than the monthly cost of renting the same house, and that is even before taking into account the tax benefits.

Institutional money is still flowing into the markets and buying everything in sight. Blackstone, as one of many (albeit the largest) of the institutional buyers, is buying roughly 50 houses in the Sac area each week. Not year, not month…week.

The large institutions won’t be able to unwind their positions quickly without creating large losses for themselves. Unlike stocks, rented properties take a while to unwind. Nimble investors can use the institutional sell decisions (or at least a reduction in buying) as an indicator changes may be coming to the market.

We are still way, way below the previous highs.

There is no yield available in the investment markets. When there is no yield, people chase appreciation. This speculations causes bubbles, generally bubbles are far larger than we think they can be. Of course, the pop of the bubble then turns out to be more painful than we imagined.

Thankfully (in my opinion), the outcome of the discussion referenced above was that we would not sell the properties as of yet. I really believe this to be the best decision for a couple reason (in addition to all the ones listed above): 1. Our possible upside in holding on to the properties is massive. Even a reduction in the speed of increase could still earn the fund hundreds of thousand, if not millions, of additional gains each year. Meanwhile, our downside is limited because we own a rental portfolio that is producing yields higher than are available in any other markets. 2. Generally, asset bubbles occur in multiple stages. An early stage is people expressing concern about a bubble. A later stage is those same skeptics jumping into the market so they don’t get left behind. This usually happens after some “guru” proclaims that market is different this time around and can justify the run up in prices.

That isn't to say there won’t be something to cause a sudden decline in prices in the short term, but I am of the belief if this happens it will be due to macroeconomic shock, not the dynamics of the market themselves. So how long until there truly is a bubble in danger or popping? I have no idea. I can’t predict the future any better than anyone else (although we did call the last one, just not the severity). I just try to understand the possible outcomes and try to position myself to do well regardless of the outcome.

In terms of future opportunity, yield still looks difficult to find. Development and redevelopment is still hard to justify using today’s numbers but the value of such projects will change drastically in very short order as residential prices continue to increase. This is also true with commercial properties. Prices have started to creep up, but finding value is still hard to do. Expect a boon in commercial property prices soon as well (again, assuming the residential market stays strong).

Little Tiny Cyprus: Cyprus is a small country by any measure with roughly only $1.1 million citizens. There are 9 US cities larger and several more knocking on the door. In the scheme of the world economy, how can such a small country even matter? Cyprus is one of the wealthiest of all the Eurozone nations per capita with a GDP nearing $25 Billion. However, the banking industry is 9 times the size of the economy, and so obviously an important part of the Cyprus economy and also other European and Asian (mostly Russian) economies.

Up until a few years ago Cyprus ran an annual fiscal surplus. The economy was strong, the banking industry was strong. However, the banks of Cyprus invested heavily in Greek bonds (which, based on falsified information given to the heads of the EU resulted in strong bond ratings). When Greece hit the skids, it turned good banks into bad banks. Those banks then needed a bailout, which the government couldn't afford to do.

Fast forward to March 2013 when it was announced that the banks based in Cyprus were being temporarily closed in anticipation for a one time “cash tax” equivalent to 10% of cash balances. Obviously the uproar was massive. After manipulation, tweakings, and pleadings (over the course of a week with no banks being opened) the cash taxes was changed to only hit those accounts with over 100,000 Euros. The hope was that most of the money would be taken from large Russian depositors of which there exists in large numbers. Additionally, even after the banks opened on Thursday, capital controls were put into place restricting the flow of money out of the country and invalidating the entire purpose of the monetary union that is the EU. To show the ridiculousness:

Somewhere along the line they forgot about businesses, for whom 100,000 Euros might just be next week’s payroll. The same employee that was “spared” the cash tax can’t get to their money in any decent quantities due to the capital controls and also many of them won’t be getting paid due to the reduction in company cash balances

The banks of Cyprus are all getting hit. Greek (and other) banks based in Cyprus or with major Cyprus presence? Not getting touched.

One purpose of structuring the money grab tax they way they did was to get as much skin from the Russian depositors as possible. But, according to Rueters, no one was smart enough to realize the banks of Cyprus had branches in other countries (specifically England) so the branches outside of Cyprus didn't get shut down and depositors had free access to their money the entire period of the bank holiday in Cyprus. How much money flowed out the back door? Those rich people aren't dumb, so I am going to be the money raised by this fiasco will turn out to be a lot less than originally anticipated (as so it goes with nearly every tax is seems).

ECB officials warned (before later back tracking) that what happened in Cyprus could happen in other countries with trouble banks. There are no reported numbers on it yet (that I have seen), but if you were a depositor in Spain or Italy, how likely are you to leave your money there versus moving it to Germany or Finland? It still spends the same; it is just backed by a viable government. Here is the rub. Deposits are necessary for the bank to prove it meets its liquidity and reserve requirements. As deposits flee it increases the likelihood of bank default. Bank default increases the likelihood of government default. This is why spreads on Italian and Spanish debt has risen over the past few days. Cyprus is tiny. Italy and Spain (and France)? Not so much.

We will keep our eye on Europe, real estate prices, and more, hopefully to be able to report items of relevancy in the future.

Until next month,


Forrest Jinks

Altus Equity Group, LP