Thursday, July 10, 2014

"It Never Happened Before" - The Crazy World of Real Estate Markets

On the way into work this morning I caught an update to the "ghost city" situation in China. Hint: It's not getting better.

Consider some of the stats. Last month, prices fell in 79 of 100 cities surveyed by a regional real estate company. Land sales have dropped 30 percent. In Wuxi, subject of this morning's NPR story, has experienced a drop in prices of 15 to 20% this year.
"There's nothing you can do," says Huang Jiqiang, an agent with Central Plains Real Estate here. He says supply and demand are completely out of whack.
"Now all the new housing complexes are dropping their prices and doing promotions because there are just too many homes. There aren't that many buyers and the pool of buyers is getting smaller and smaller. Homes are still under construction out there."
 - www.npr.org 
One comment in the story especially caught my attention. A finance professor in Shanghai states matter-of-factly
"Since the beginning of this year there is a kind of switch of the mood. People have become more cautious. It never happened before."
That comment reminded me of our situation here in 2008-2010, when housing prices were falling all over the country. Much was made of the fact that people had invested in real estate, even at what seemed to be exorbitant prices, for the simple fact that home prices had never before fallen significantly in our history, certainly not on a national scale. It never happened before.

First of all, the statement is silly. Certainly, real estate prices have crashed, cities have dried up, all over the world, as the ebb and tide of history takes its toll. Sure, real estate prices have increased over the centuries, but I've never seen a definitive study that shows real estate outpacing natural inflation over long periods of time. And wherever people move away from, or where local economies have tanked, home prices have fallen. In some cases, dramatically. Here's an interesting story of six ghost towns in North America, including our own Pennsylvanian town of Centralia.

But the scale of, and the reason for, the people-less cities in China is unprecendented. That's what makes it an interesting story to continue to watch. It's not just the ghostly feeling of being in a deserted place...but the disquieting notion that perhaps, this greatest of all real estate booms is likely to be followed by the greatest of all financial crashes.

I began working with truss plants here in Pennsylvania at precisely that peak in the market, fall of 2007. (Hopefully that is ironic coincidence, and not cause/effect). I've watched and worked with truss and building component manufacturers as they've struggled with the realities of the downturn. This week, my visits to a few plants revealed a guarded optimism based on order files that have extended from a few days, to a few weeks.

But housing starts, both single-family and multi-family, took a significant downturn in May. The National Association of Homebuilders is still forecasting a sharp upturn in starts (which coincidentally, they have been doing for several years now) that will see a 50% increase in starts to over 1.5 million starts by 2016. This in spite of the fact that they also forecast a 1.5% increase in mortgage interest rates over that same time frame.

However, in stark contrast, noted financial market analyst Martin Armstrong, who has made a life's work of constructing an artificial intelligence (AI) model to forecast global economic trends with stunning accuracy, posits that the global real estate business cycle is a 78-year cyclical wave that peaked in the third quarter of 2007. From that peak, it fell into a trough that bottomed out in 2012, and the world is now experiencing a mild real estate recovery. But his data and models foresee the current recovery lasting only until the third quarter of 2015, after which the global real estate market will be in a free fall until the end of the 78-year cycle...in 2033. At that time, we will have been in a global real estate market contraction that will have lasted 26 years, and will take us back to the level of demand last experienced at the beginning of the 78-year cycle, that is, back in 1955.

Interestingly, my own analysis of housing starts potential back in 2009 forecasts a similar downturn scenario for precisely September of 2015. You may remember the following graph, which I've shared in the past.

Source: Penn State Wood Operations Lab, 2009-2014

The blue line is the number of actual, total housing starts. The purple line represents the "official" forecast in the summer of 2009. It was calling for a strong rebound, which would have normally happened in previous cycles. The pink line, which I labeled "worst case", is my own formulation of housing starts based on indicators as I read them at the time. The yellow line I calculated as a "moderate case"...in reality, a compromise between my own forecast and what mainstream economists were forecasting.

The actual housing starts have fallen between my own "worst case" scenario and the compromise model I calculated. In other words, much worse that the official forecast of the time, but not as bad as my own, thankfully. The interesting point, with respect to today's subject matter, is that these forecasts all contained a cooling-off period after the recovery. The official story was that we would have a strong run-up until fall of 2012, a one-year cool-off until fall of 2013, and then a more gradual but steady increase thereafter.

My own forecast, the pink line, was for a much more modest recovery until September 2015, to be followed by a two-year decline. At the time of my original work, I wasn't aware of Mr. Armstrong's long-cycle data, so my analysis then forecasted a modest recovery from late 2017 into the future. Much of that, I reckoned, was due to the fact that I believed we would probably be realizing the impact of policy changes brought about by the demands of the electorate in 2016.

However, Mr. Armstrong's analysis tells a story of a world in crisis, created by global government policies aimed at creating wealth out of thin air, or should I more correctly say, out of devalued money. Which is why the Chinese real estate market is so fascinating.

Consider this quote from a recent Business Insider story.
"...it's important to remember, too, that the ghost city phenomenon in China is partially due to how local governments are forced to finance themselves. Local governments in China are in a perpetual cash squeeze because they have to hand over a bulk of their tax revenue to the central government and because the central government often orders localities to build all sorts of infrastructure projects but Beijing often neglects to help with funding. Because the Party owns all of the land in China, local governments solve their funding problems by seizing land from their poorest residents, giving them a paltry sum in return, and then they sell the land to developers, essentially flipping real estate on a massive scale. Of course this has the added benefit of raising GDP figures, increasing the chance that local leaders will be promoted within the Party."
-Rob Schmitz, quoted in Business Insider, June 9, 2014 
Hmmm. This scenario which once might have been viewed as an oddity of China's version of party politics is starting to sound slightly not so unusual. Might the snowballing market backlash against this reality-blindered governance be a precursor of a global downturn so bad it will make 2010 look like the good old days?

Let's hope not. But just in case, I'll examine the issues, and logical actions wood businesses can take to prepare for the possible alternative futures, in upcoming posts.

1 comment:

PennwoodI3 said...

Great Article Dr. Chuck.

Thanks much!

In my family, my generation was the first to see home prices go the other way here in PA. My parents and grandparents always told me that you could never lose money long term by owning your own home. My home value dropped 25% but my property tax has remained the same. Funny how that works.

Why did we have to be the trend setters?

Consulting with truss builders causing the crash. Now I know who to blame.