The Causality is Backwards — It’s Housing That’s Holding Back Employment

Here’s what we know:

1) Over the past 6 years, we’ve built far fewer single family houses than we have since at least the 1940’s. We’re undersupplied.

2) The Millennial Generation is slightly bigger than the Baby Boomer generation, and the peak population cohorts of the Millennials are currently in their early 20s. The closer this cohort gets to its early 30s the more single family housing they’ll demand. The demographic demand story for housing over the next decade is the strongest it’s been in 20+ years.

3) The housing stock we have is old. The decade that produced the largest number of homes still standing is the 1970’s. In addition to adding new supply we’ll have to tear down and replace old supply (chart below h/t George Pearkes).

When you combine the undersupply from the past decade, the coming demand from the next decade, and the age/condition of the existing stock, it should be a no-brainer to expect housing construction activity to be picking up significantly right now, and it’s not. So what’s going on?

The problem, as Evan Soltas pointed out so clearly yesterday, is that housing is the weakest link in the economy right now, not employment. Households will only move out of their apartments and parents’ houses into homes of their own if they have [good] jobs. Builders will only build (and hire construction workers to build) when there are buyers with jobs looking to buy. But what do you do when the missing jobs are in the housing sector? It becomes a chicken and egg problem.

To get an idea of what I’m talking about, here’s a look at residential fixed investment as a % of GDP compared to the unemployment rate for when residential fixed investment as a % of GDP is less than 4%. You can see that 4% is historically very low:

As you’d expect, there’s generally a strong relationship between the unemployment rate and the employment-sensitive housing sector. I shaded past cycles different colors to highlight contrasts, and only included the past 6 quarters for this cycle.

I bolded 2 quarters in 1982 because those are the only two quarters prior to this cycle where RFI/GDP was as low as it is now. In those 2 quarters the unemployment rate was 9.6% and 10.1%. In the first half of 2014, with similar levels of residential fixed investment activity, the unemployment rate was 6.7% and 6.1%. Similar level of housing activity, much lower unemployment today.

A look at the 1974-95, 1981-83, and 1991-92 periods show housing activity levels higher than we’re seeing today, but also higher unemployment rates. Ex-housing, employment really is quite robust in 2014.

What about those first periods from 1966-1970? They, I believe, hold the key to our future. In 1966-67 the unemployment rate was very low, sub-4%, while housing activity was also low. That was also the period when the older Baby Boomers were in their early 20s. Demographers could’ve told you that we’d need to build a lot of houses in the 1970’s (and as mentioned above, they did). But where were they going to find the workers to do so when the unemployment rate was sub-4%?

All of a sudden the inflation in the 1970’s makes more sense — employers were in a vicious competition for workers to do all the work needed that decade.

At the moment, the job market isn’t strong enough to get builders off the sidelines and building. The rental market is tight, as is the homebuying market, especially at the low end. By the time the job market and wage growth are strong enough to induce builders to get back to mid-cycle levels of production — forget make-up production or an overshoot — it’ll be clear just how inadequate the labor supply is to meet this demand, and we’ll get wage growth that we haven’t seen in 20+ years.

How Hard Times and Tight Budgets Led to “Rich Only” Urban Planning

I’ll start with Atlanta because so much of what I think about starts with Atlanta.

Atlanta, like many cities, was hard hit by the financial crisis. Its economy historically has been more real estate-dependent than average, and additionally the shock to unemployment rates and credit access for blacks in particular had a devastating impact on a city that’s over half black.

The past 5+ years has been spent digging the city out of its financial hole, and with rainy day funds built up and property valuations and tax revenues recovering, Atlanta’s looking to plan for the future and address its infrastructure deficiencies.

Any vision for the future has to start with the constraints of the present. And cities know that when it comes to the federal government, “the cavalry is not coming.” While cities have an easier time raising taxes than states or the federal government, the middle class is still struggling and can’t afford the tax hikes, and governments at all level are reluctant to raise taxes for fear that it’ll hold back economic and job growth.

So if you’re a city looking to invest in infrastructure and can’t get money from the federal government or your own tax increases, the only answer is to do things to raise your tax base via gentrification and/or density. Imagine that mayors are like CEO’s and are looking to pad the bottom line without having the ability to increase prices for existing product lines.

From the point of view of a city’s financials, not all residents are created equal. The rich are more profitable than the poor. Employed adults are more profitable than “cost center” children. When you start thinking this way, current development trends make more sense.

Building a high end apartment complex with studio and 1-bedroom apartments is a lot more profitable than building housing for low income families. Land is scarce, especially in desirable and gentrifying parts of town, and when you’re scraping for every tax dollar you can get having an underutilized part of town can cost your city real money. And every tax dollar missed out on means fewer sidewalk improvements, fewer road repairs, fewer beautification projects.

The fact that good neighborhoods close to job centers and transportation infrastructure are so scarce, with two decades of Millennial demand on the horizon, means that for desirable cities and communities it’s a sellers’ market.

Struggling communities, like East Point here, don’t have that luxury. Desirable residents and businesses aren’t looking to move there, and the tax base hasn’t recovered in the wake of the financial crisis. They’re forced to greenlight any proposed development they can, and are making hard choices about what public services to cut. Meanwhile, the community’s infrastructure decays.

This all serves to reinforce trends that are increasing inequality at the local level, and until the federal government gets back in the game or the economy recovers it’s hard to see these trends reversing.

Why Black Neighborhoods Matter in the Context of Millennial Housing — We Need the Land

When we got past the era of Jim Crow, segregation, and red-lining, and into the era of white flight and the suburban/exurban boom, the unstated assumption in American real estate was to ignore black neighborhoods. In a race-uncomfortable society no right-thinking person would come out and say it, but you could see it in the actions and choices people made, and in many cases continue to make.

Young families looking for a place to plant their flag understandably place a high value on safe neighborhoods with good schools for their kids, but tens of millions of individual choices sum up to a reality that has led to unequal outcomes for black and non-black neighborhoods. It’s why Woodstock, Georgia, a place 30 miles from Midtown Atlanta, has grown from a city of 870 in 1970 to almost 27,000 in 2013, while the West End, a neighborhood near downtown Atlanta with many old, beautiful homes, has stagnated for two generations.

But conditions are changing. 85 million Millennials are approaching the years when they start to have families and need to start caring about single family housing and schools. The transportation infrastructure (highways) that led to the growth of cities like Woodstock was planned and completed decades ago, and without a new pipeline of transportation infrastructure we’re not going to create more Woodstocks. Despite stories to the contrary, there’s not a shortage of single-family housing out there, but much of the affordable housing is in neighborhoods that have a lot of non-whites, and more specifically, have a lot of blacks.

Unfortunately, both from a social and economic perspective, many of these neighborhoods are invisible to non-blacks. Whites have never been there, don’t have any friends there, and don’t have any businesses they want to frequent there. These neighborhoods were written off by their parents and grandparents, so it’s understandable if they’d feel like foreign countries to them.

Social change is more complicated than technological change. Because we interact with things like telephones and computers every day, we know how far they’ve come in 20 years. We don’t have as good of a framework for thinking about black on black homicides falling 67% in 20 years. Or about the collapse in the black teen birthrate. Or the surge in educational attainment. Blacks report higher levels of confidence in America’s future than whites, and young more than old, so it’s probable that young black Americans are the group most confident in America’s future. And they’re voting at record-high levels too.

Barring the invention and rollout of the hyperloop, becoming more familiar with and investing [socially and economically] in black neighborhoods is an important piece, perhaps the most important piece, of the Millennial housing puzzle. With Millennials and housing being as important to the next decade as the credit boom/bust was to the last, we can’t ignore it any longer.

Twitter and the New Era of Civil Unrest/Civil Rights

[If Ferguson happened before Twitter] In the aftermath of Michael Brown’s death there’s unrest in Ferguson on Saturday night and large scale protests on Sunday night. The scale of the protests and the forceful actions of the Ferguson police attracts the attention of the national media. Anderson Cooper flies in on Monday. The Ferguson police department and local government know the rules of television — keep cameras away from the bad stuff, let Anderson do his report with a police cruiser in the background. Anderson does some interviews, gets a segment on Monday night cable news, goes back and forth with a talking head, but you can only listen to two reporters go back and forth on TV for so long. Change the channel. The President makes a statement on Tuesday morning. The public loses interest, the cameras go away, the police secure the town [and we’re seeing just what “secure the town” can look like] and the story’s dead in 3 days.

With Twitter the rules are different and we’re still not sure what they are. Everyone with a smartphone and a social media account can play the part of reporter. The police and local government can’t silence everyone. Get a scoop and your tweet or picture can go viral. With television people with good seats at sports games would tell their friends “Look for me on TV!” Being a viral part of a story that has captured the public’s imagination is much more intoxicating. Reporters can pick up 10s of thousands of followers in a few hours — there’s no more effective way to build a personal and professional brand. People on the ground can coordinate with each other and figure out who the de facto social media leaders are, which keeps protesters engaged and interested in a way they couldn’t have been in the TV era.

Television took off as a mass medium in the 1950’s but still tripped up Richard Nixon in the 1960 Presidential debate. He looked like a sweaty mess compared to the younger, more telegenic JFK. We see clips now of water cannons and police dogs in Alabama in the 1960’s and know that some in charge either didn’t appreciate or didn’t care about the power of this new mass medium.

We’re there again. Twitter is a decentralized, coordinated, viral communication medium. If the past is any guide it will change the power relationships between the powerful and some of the aggrieved over the next decade in ways we’re still coming to grips with. And it feels more like 1961 than 1968 out there.

On Social/Urban Matters, We Need Wonks like @ModeledBehavior to Pay More Attention to People like @petesaunders3

There’s a lot of inequality in 2014. Especially with regards to housing and public education. Wonks can show this to you In One Chart. That leads to "obvious" analysis/conclusions like this. It’s well-meaning “macro” social policy that doesn’t address many of the issues that impact our communities. It often comes from, and this isn’t their fault, but the reality, white males without kids who went through good school systems in the northeast, far away from the Black Belt and/or illegal immigration. My views on public education have been profoundly shaped by moving to Atlanta after spending the rest of my life in the northeast and in California.

The Atlanta public school system is 76% black. 14% non-Hispanic white. Here, race matters. If your school system or city had these demographics, it’d matter there too. That racial disparity isn’t evenly distributed throughout schools, of course. Elementary schools in the nicer parts of Atlanta are often mostly white (or high socioeconomic status). Middle school clusters tend to be more diverse and high schools even more so. Many progressive, well-meaning white parents start off in the public schools and then switch to private schools or move out of the city because it doesn’t work for their families. In the most recent school year APS had over 900 white kindergartners but just 163 white 12th graders.

The goals of eliminating neighborhood schools is to reduce inequality and especially to give low socioeconomic status students (who, in many Sun Belt and Rust Belt cities especially, are often more black than the general population) a better education. These are noble goals we should pursue. But part of the reality of the process is we need to keep upper class (often white) families invested in the system. It benefits no one if, after several decades of white flight finally being reversed, we have a new wave of people out of the cities as up-and-coming neighborhoods no longer have good schools.

I’m just learning about these issues and am going to get some things wrong. Pete Saunders has been living and working through them for his whole life, and as a black man his experience is much more different than mine. I’ve learned, and continue to learn, a lot from him. There are geographic limits to how far away kids can go to school — you’re not going to bus kids 30 miles each way. If you eliminate neighborhood schools then anxious parents will find new oases far away from poverty and build their lives there. As Pete pointed out today, from 1970-2010 Detroit’s non-Hispanic white population declined by 93%. Bad social policy can lead to those with means abandoning the city.

Eliminate neighborhood schools and cities will start finding ways to eliminate low-income housing (we’re seeing it already near where I live). You’ll see increased demand for private and/or charter schools. If restrictions get placed on those then you’ll see neighborhoods use technology to create crowdsourced home schools.

There are ways to reduce inequality in the schools, but we need to listen to people invested in communities, both rich and poor, and look to how and why cities have self-sorted, and not be naive that a snap of the fingers can get rich and poor to successfully integrate.

The Need to Tear Down 1970’s-’80s Suburbia: Another Short-Term Housing Headwind

Let’s talk about Roswell, Georgia. It’s near the fringe of what I’d call core Atlanta suburbia. Here’s its population growth historically:

It was essentially a small town until 1970, when it began to explode thanks to the Sun Belt suburban boom. Its population has grown by 15x since, and is now almost as dense as a place like Palo Alto. Driving through yesterday, you couldn’t help but notice how old and dated the landscape felt. Aging strip malls and low rise commercial buildings. A housing stock that was built primarily in the 1970’s and 1980’s. Think about that when you look at this chart:

The Roswell boom was happening during that late 1970’s spike. Let’s think about that buyer. Someone who bought in 1978 — median age of a first time buyer might’ve been 28. So it was a young, presumably white, Baby Boomer family. Born in 1950ish. If they’re still there, and many of them are, they’re in their 60s. They’re now empty nesters.

And indeed, when you look at Roswell’s change in population from 2000-2010, that’s what you see — a lot of white Baby Boomers aging in place (red on the chart is whites, green is blacks, blue is Asians, yellow is some other race — Hispanics are lumped in with whites).

Roswell is well-situated — it’s got a cute, walkable downtown, fairly close to job centers, is a stable community, and for metro Atlanta standards has a reasonable amount of history. It’s the kind of place upper-middle class college-educated Millennials will want to raise their families.

But much of the landscape and housing stock will be unacceptable for future residents. Somebody needs to pay for that capital stock improvement — it’s probably not going to be the vacating 70-somethings, and it’s probably not going to be 32-year old first time buyers with student loans who have to scrape for a downpayment. It’s a “cap structure issue” at the municipal level that we need pools of capital to solve.

Demographics and 2020

2020ish is gonna be pretty wild and crazy. Political nerds have been focused on it because of the Census and Congressional redistricting, but there are a lot of demographic trends lined up.

1) The Census/Presidential election year/redistricting: this has been written about a lot.

2) Economic leadership handover from Baby Boomers to Gen-X: Last night I was hacking around with data on the age of CEO’s of Dow Jones Industrial companies, how long they’ve been CEO, the age at which they became CEO, and they age they are now. Table here:

The median has been CEO for 6 years, was 53 when they got the job and is 59 now. So, using the Dow as a proxy for big time corporate America, in 2020 we’ll have companies increasingly run by Gen-X’ers born in the mid-late 1960’s who took over 5+ years after the financial crisis. More Nadella/Google guys/Bezos, less Immelt. The Baby Boomer retirement theme has been going on for several years now, but change at the top tends to be more disruptive than change in the ranks.

3) National political leadership handover from Baby Boomers to Gen-X: The median age of US Senators right now is 63. Median age upon taking office is 50-51. Less than 20% of Senators first take office above age 60. Just about every new Senator being elected in 2020 will be a Gen-X’er, and Baby Boomers will be rapidly exiting the Senate. The House is younger, with the median age currently 58. Median age upon taking office is 48. Less than 10% take office above age 60. Following the 2020 elections the House will be a solidly Gen-X-led body, with increasing numbers of Millennials filling the ranks.

4) State governance dominated by Gen-X, Millennials on the verge of taking over cities: Only a handful of governors are currently Gen-X’ers, and they get headlines — Haley, Jindal, Walker, O’Malley, Christie. The age skew of governors is very low — about half get elected between age 50-60. Following the 2020 elections, more than half of governors will be Gen-X’ers, and of those with national ambitions, all will be. Mayors skew even younger — it’s not uncommon for big city mayors to get elected in their 30’s or early 40’s, which gets you into Millennial territory. Outside of Mark Zuckerberg it’ll be the first time you’ll start hearing about individual Millennials with real economic and political power.

5) The most powerful demographic tailwind for homeownership in 70 years. This isn’t hyperbole. Gen-X is currently punching way below its weight when it comes to homeownership. The biggest increase in homeownership rates happens between 30-35. The largest group of Millennials was born in the early 1990’s, and by 2020 they’ll be approaching 30. Older Millennials will be approaching 40 and serving on city councils and getting involved in schools and neighborhood committees. Millennials will be putting major strains on the economic and political systems to have their housing demands met.

Federal and state governments and corporate America doing a generational handoff, and Millennials taking over cities and the housing market…the past 5 years have been a period of technological fluidity and disruption while the economy and government have felt stagnant. ~5 years from now my guess is Apple/Google/Amazon/Facebook will be consolidating their grip on the tech economy, which will feel boring compared to what we’ve been used to, while government and corporate America will feel as disrupted as they’ve felt since the late 1970’s/early 1980’s.

Building a Sustainable Hedge Fund Model

I had some thoughts on this a couple years ago when I said the traditional hedge fund model was antiquated. I want to revisit the thread in light of a couple stories today.

First is here (WSJ paywall) — Goldman Sachs is pulling back on less-profitable clients and charging existing clients more for services.

And the second is here — an ex-Bridgewater analyst a few years younger than me is starting a management fee-only hedge fund. Having gone through the experience myself, in a post-2008 world it’s incredibly difficult to get your start in portfolio management, and the obvious way to make it easier is undercutting existing managers on fees (leaving aside the #signaling question of what charging less implies about your product).

So if you’re running a hedge fund, costs are going up, and fees are going down. Looking out 5 years, it’s not going out on too much of a limb to think that equity multiple expansion will be minimal, and interest rates could rise, making performance much more challenging than it’s been over the past 5 years.

What this says to me is the cost structure of the industry will have to go down significantly unless clients are willing to pay 3%+ of AUM a year in fees in exchange for low to mid single digit returns. I think more highly of clients than that to expect the latter to be the outcome.

Some thoughts on what could happen…

Major industry consolidation: We don’t need 8,000 firms with their own compliance, legal, finance/back office, client communications, IT, and trading/ops groups. Most of the time portfolio managers start hedge funds because they want control over the investment process and the business upside if the firm succeeds. They don’t want to deal with actually “running the business of a hedge fund.” With industry profit margins likely to fall, PM’s will have to choose between lower pay and giving up control in exchange for a lower cost structure.

Prospective hedge fund managers thinking of themselves like aspiring musicians do: Taylor Swift is the music industry’s equivalent of SAC in its heyday. She can charge whatever she wants. You, however, are not Taylor Swift. You probably need to put your music on YouTube, Spotify, iTunes, and hustle for gigs at dive bars to grow your business and raise assets. What does that mean for aspiring PM’s? If you’re not bringing the weight of an established firm and/or $100mm+ and a 3-year track record to the table, you’re going to have to do everything possible to make the sale with early clients — low fees, full transparency, and anything else that’s necessary. You may have to live out of your house or split office space. Once, or if, you’ve raised significant assets and built a track record, then you can start charging clients more, if you can find some willing to pay a higher price.

Vested incubators that offer true partnership and infrastructure in exchange for a piece of the firm: Compared to the tech/venture capital industry, the hedge fund industry is an embarrassment when it comes to an ecosystem that looks for emerging managers. Any yokel with an idea for an app can raise money on a platform like Kickstarter or AngelList. Nothing like this exists in investment management. 10 years from now the Buffetts and Grosses and Icahns of the world will be gone, and who will take their place? Right now, nobody’s being groomed and there’s no established training grounds for aspiring managers in their 20s and 30s. Many of the best and brightest have gone to work in tech or other industries. When the old guard retires there’s going to be a dire shortage of managers.

Even as Wealthfront-type models gain share, there is always going to be a place for active management. We’re still in the shakeout of active managers who made their names in the ’90s and ’00s, but eventually the industry will be grasping for a solution to these problems.

Social Capital, Debt, and Stages of Growth

I finally read this Pettis piece from last month. This point struck my interest:

Developed countries are rich because they have higher levels of social capital than backward countries, and not, as is sometimes believed, because they have abundant capital stock. On the contrary, rather than the cause of wealth, abundant capital stock should be, but isn’t always (China may be an example), a consequence of abundant social capital. The resulting higher level of worker productivity makes it easier to justify additional infrastructure that saves the time and labor of productive workers. A high level of capital stock is a “symptom” of wealth, not a cause.

It got me thinking about the types of things I like to think about, in this case neighborhood/community/economic revitalization.

A caricature of neighborhood gentrification would be, “Gays and hipsters move in, start fixing up the neighborhood, cool bars/coffee shops follow, and then entrepreneurs and wealth/yuppies enter the scene.”

If I had to formalize/abstract this a bit, I’d say that first the cost of real estate has to fall to a level such that there’s a market opportunity in buying access to physical infrastructure (however dilapidated it might be) for less than its market value. This allows “social capital formers” who may lack financial capital to come in and build community/social capital.

As the level of social capital rises it attracts financial capital and status seekers. I’d define a status seeker as roughly someone who’s risk averse in nature but often hard-working and looking for social/financial capital trends to follow.

As a neighborhood becomes more and more rich in social capital the demand for physical infrastructure improvements rises, as does financial capital and economic activity. Now the neighborhood is booming. The boom goes on for awhile.

In the latter stages of the trend social capital begins to decline (through some combination of the aging/death of the high social capital population, and/or high social capital young people being unable to afford the neighborhood), and often debt levels rise as status seekers/entrepreneurs stretch to enter the neighborhood/community.

A decline in social capital coinciding with a rise in debt levels then becomes the most dangerous possible state for a community — an economic shock makes the debt unserviceable, unemployment and vacancies increase, the price shock creates vacancies for less desirable community members to enter, which creates further downward shocks to social capital, and so on. And the natural state of physical infrastructure, as with everything, moves in one direction — decline/decay.

But the bottom line is social capital is everything.

Housing, Race, and the Politics of Scarcity

The little Elizabeth Warren bubblet this week reminded me of when I first heard of her, when I was watching the indie documentary “Maxed Out" in the dingy Opera Plaza Cinema in San Francisco back in 2007. Never did I imagine that 7 years later she’d become the heart and soul of the party most likely to win the presidency in 2016.

Inequality and hence Warrenism has become all the rage, and while after 3-4 decades I believe inequality has begun to reverse over the past 1-2 years, its political impact will be felt for many years to come.

That being said, there are growing economic and social pressures for a new political movement that being at the vanguard of the Millennial generation makes one acutely aware of.

Those pressures involve housing, which always involves race, and leads into a broader discussion about scarcities for the things that Millennial families need and some amount of political action is necessary to provide.

As the employment market continues to tighten, wage growth accelerates, as does household formation, brought about by the largest vintages of Millennials (currently age 21-23). This will put more and more pressure on the housing and rental markets.

The housing market is ill-equipped to provide the things that Millennials want. In global megacities it’s too expensive, there’s not nearly enough single-family housing, existing residents are uncomfortable with more construction, and in many cases the school systems are poor. In maturing Sunbelt metropolises the cheap/available single-family housing has a combination of awful commutes and/or exists in “socioeconomically undesirable neighborhoods,” and large scale transportation infrastructure improvements in a best case are a decade or more away. In Rust Belt and/or somewhat-forgotten mid-sized cities the housing stock is generally poor, and the job market is still transitioning from the manufacturing age into the global age. And in all cases construction workers are in short supply even at the present level of single-family construction.

I didn’t mention how race fits in. With job centers increasingly in urban cores, commutes become more and more important. Most urban cores are built out, so the only way to build new urban core housing tends to involve tearing something down. In many cases, this means low income housing mostly occupied by black and Hispanic families, and/or older neighborhoods that have been predominantly black for decades. After enough low income black and Hispanic families get displaced by young, wealthy, predominantly white families, it would be easy to see how this could become a bigger political issue in the future as non-whites become a growing part of the electorate. Additionally, as these wealthier families move into traditionally non-white neighborhoods, school quality becomes of more importance, and in many cases creating new charter schools to fit the needs of these families becomes easier than reforming existing schools, another friction point between new and existing residents.

Housing availability (build vs NIMBY), commutes (highways vs transit/bike lanes/walkability), schools (public reform vs charter), and neighborhood conflict (wealthy Millennials vs older blacks/Hispanics) — these are the issues that cities and metros are currently wrestling with, and will bubble up into national politics over the next decade.

Watch those Millennials born between 1991-93 (currently 21-23) — as they exited their college years we finally hit mainstream (some would say peak) walkable, mixed-use, apartment-led construction and development. As they approach age 30 their needs and wants will put more and more pressure on the political system.