Omaha Apartment Market, Pockets of Oversupply but No Worries

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We continue to have positive views on apartment demand going forward. Occupancy has exceeded 95% for over two years. However, we view 2016 with some trepidation as a surplus of 500 units reaches the market in 2016. 

Market Breakdown

We believe the Omaha Metropolitan Area apartment market is heading towards an over-supply level of 500 apartments. However, this amount is fairly insignificant in light of the pace of job creation, population growth, and the overall amount of units in the market.

Three reasons support this idea.

  1. Supply is roughly in line with demand, but has slightly outpaced typical homeownership percentages.
  2. Multifamily supply has been in line with job growth, but has recently exhibited a ratio that signals some caution.
  3. The perceived amount of oversupply is not only a function of job growth. It is also a function of income growth. Construction costs have pushed rents to levels that many new entrants to the housing market will lack the means of stretching for rental payments in new projects.

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Supply and Demand Equilibrium Levels

The Omaha metropolitan area has grown beyond a population of 905,000 and has a consistent level of household formation around 4,000 per year. With about 70% of new housing demand typically attracted to homeownership, rental housing stays at rough equilibrium between supply and demand at 1,200 units per year. That number is roughly line with current supply numbers, but there are signs that new apartments have begun to outpace growth.

As a percentage of total housing supply, multifamily units have, in aggregate over the past three years, exceeded the typical homeownership ratio by 2%. There were 3,041 single family permits issued in 2013, 2,639 permits in 2014, and 2,830 for the trailing 12 months ending September 2015. Multifamily housing hit 1,370 units in 2013, 1,533 in 2014 and 1,114 through September 2015. The sum of the three years shows that multifamily has been approximately 32% of new housing. Meanwhile, historical averages for homeownership in the Omaha MSA have hovered at 70%. In this instance, the oversupply of 2% translates in 250 excess apartments.

As an aside, the peak single family construction occurred in 2005, when 5,877 units were permitted.

Total Units

Units         Single Family    Multifamily    Total      % Multifamily

2013             3,041              1,370            4,411              31%

2014             2,639              1,533            4,172              37%

2015 ttm       2,830              1,114            3,944              28%

Total             8,510              4,017            12,527            32%

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Job creation and Housing Demand

Apartment demand follows job creation levels in a fairly lock-step pattern. The Omaha employment market has been robust since 2012. Between the 2008 nadir of 437,000 jobs and the recent 2014 figure of 462,500 jobs, Omaha has created over 25,000 jobs. This level far outstrips the supply of housing by more than double. By comparison, the stock of housing increased increased by an astonishing 56,700 between 1999 and 2008, but jobs only grew by 26,200!

Typically market research firms such as Axiometrics use a ratio of 5 jobs per unit as a demand equilibrium ratio. In an ideal equilibrium, the 25,000 jobs created in Omaha since 2008 implies a maximum apartment supply of 5,000 units. In fact, over 6,000 multifamily units have been permitted between 2008 and the end of 2014. This implies a ratio of 4 jobs per unit. If one assumes a job growth rate for 2015 of just over 1%, it can be figured that 5,000 jobs have been added during the past year. The ratio for 2015 is, therefore, slightly better at 4.50.

The ratio of jobs to units at a sub-5 level implies an oversupply of about 750-1000 apartments in the metro area.

Year Employment Population Jobs/Population
1999 411,240 761,603 54%
2008 437,478 845,119 52%
2014 462,515 904,421 51%

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Income Concerns

So far, we’ve established that an oversupply of between 250 and 1000 apartments exists in the metro Omaha area. While this number is statistically insignificant out of Omaha’s 100,000 rental units, the direct peer group for new construction is much smaller. The peer group for these units really amounts to about 10,700 units built over the past ten years. These apartments have been built at the top end of rental rates. In this case, a 5-10% oversupply is a number that deserves watching.

Why do we say this? The new apartment math requires an annual income of $38,800 per year. This is towards the high range for single person households who have recently entered the workforce. With young people graduating with significant amounts of student debt, the ability to afford rents approaching $2 per square foot per month may be under pressure.

In Conclusion

Apartment supply as a percentage of homebuilding implies a 2% level of oversupply – about 250 units. When a job ratio is applied as a benchmark, the oversupply level rises to between 750-1,000 apartments. Our best estimate is that the Omaha MSA is heading towards a 500 apartment surplus in 2016 that will cool the occupancy levels from the peaks enjoyed the past several quarters. Additionally, units being delivered to market must be cautious about the pressure of income levels. While employment growth has been robust, student debt is high and many new jobs are below $35,000 per year.

Are we concerned? Not yet. We believe that many of the areas receiving supply have been absorbed at a rate that has exceeded our own expectations. Meanwhile, some experts believe that the Midtown Omaha area is going to be pushing the limits of absorption by late 2016. Also, while supply may have been running ahead of demand recently, the level of occupancy has been in excess of 96% for a few years now. Anything above 95% implies a very tight market. In this regard, there is proof of continued high demand.

One final caveat: We are not in the camp that there has been a paradigm shift in home-buying attitudes. Millenials will eventually get married and have kids. This process may have been retarded by the recession, but it will continue.

Desert Island Discs

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This is more for my own enjoyment than anything else. This entire blog is for my own enjoyment, for that matter. If anyone derives any pleasure from these self-indulgent posts, then…well…that’s on you.

The Clash.

The Clash.

We used to play this game all the time when I worked at WBRU Fm in Providence, Rhode Island in the early 1990’s. It would start with some basic questions: “What’s the best concert you ever saw?”, “What’s the first album you ever bought?” After some rocket fuel had been ingested, we’d blast off into questions of an obscure nature:

Q: “What’s the best concert you saw from which you expected nothing?”

A: INXS after their arena days were over (post-Kick) at Paradise in Boston, 1993. There was maybe 500 people in the house.

Q: “Worst concert with the highest expectations?”

A:  Happy Mondays in Boston 1992. I think Shawn Ryder actually sat in front of the drums for 30 minutes before they drifted off. I paid $40 for that ticket. (note: If someone asked me this today the answer, hands down, would be Bob Dylan in Omaha, 2007. I walked out.)

“When did punk music start?”

A: Britain, 1976. Sorry fans of The Ramones, Jonathan Richman, and Velvet Underground. I would however, give an honorable mention to Iggy Pop.

And on and on it would go… If you saw High Fidelity with Jack Black and John Cusack, you know what I’m talking about.

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But the most important list of them all was the Desert Island Disc List. If you were washed up on a deserted island and only allowed 10 albums, what would you bring?

This leads to logistical questions, of course. Presumably, you would have no ability to leave this island or reach other humans, but you would have a portable stereo system with enough battery power to last long enough to listen to said collection. Perhaps these items, as well as your discs, would wash up on the beach in some FedEx boxes along with a volleyball.

Here is my self-indulgent list. Wait…wait…some rules first. We always had rules!

No greatest hits or compilation albums allowed. No soundtracks. No pretentious prog-rock bullshit that your friend, brother, cousin told you was mind blowing (read: Can, Captain Beefheart).

Dark Side of the Moon, Exile on Main Street, The White Album or Sgt. Pepper, Pet Sounds, any Zeppelin, any Steely Dan is/was banned for being cliché. And no, you can’t list some fucking Grateful Dead bootleg of a show in Cincinnati in 1974 or some wildcard like that.

Bowie was never allowed because one guy loved Bowie (in an almost unhealthy way) and we banned Bowie just to piss this guy off.

Now, rap presented a conundrum… Ah, yes, hip-hop albums were set as a bear-trap in the underbrush for the uninitiated parlor game player. You disagree and you are a racist. You emphatically agree and you look like you’re trying too hard. Invariably someone would throw in a Public Enemy reference or maybe NWA. I think they never actually loved the albums that much, but it made them sound culturally wise. Best to remain agnostic on the topic and move on.

As you can plainly see, with one exception, my list is stuck in the late 80’s to mid 90’s. These were years during my impressionable youth, and naturally when my brain had been most pliable. Neurons had been programmed towards the north of England. As a teenager, I must have identified with the post-industrial cynicism of Thatcherite Britain. This is an obvious choice for a middle class boy from Omaha. The parallels are uncanny.

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Metal Box

Here we go then…

  1. Public Image Limited – Metal Box.
  2. The Fall – Wonderful and Frightening World
  3. Elvis Costello – Imperial Bedroom
  4. Joy Division – Unknown Pleasures
  5. The Jesus and Mary Chain – Psychocandy
  6. Radiohead – OK Computer
  7. Arctic Monkeys – Favourite Worst Nightmare
  8. Massive Attack – Mezzanine
  9. The Clash – Sandinista
  10. Wire -154

Whoa, you say. Sandinista? Not London Calling? Yes, my friends. London Calling is pretty polished for all the talk of how innovative they were  in 1979 (sorry, ripping velcro to sound like fire is not really experimental it’s just screwing around in the studio). Sandinista is full of dub experiments, reggae, occasional pop, and biting sarcasm. The Clash had discovered New York City and some of the hip hop elements started trickling in.

No Smiths? Nay. Meat is Murder gets an honorable mention. Hatful of Hollow is one of the first albums that blew my mind. But I never got the “Best Smiths Album Ever” title bestowed on The Queen Is Dead. Vicar In a Tutu? Please.

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Albums that slipped off the list from earlier times: Happy Mondays, Pills and Thrills sounds slightly comedic upon today’s listens. The Mondays’ “Madchester” peers Inspial Carpets’ album Life aged much more nicely.

New Order’s Love Vigilantes fell off the list. The frog sounds on Perfect Kiss are a little too gimmicky in hindsight. What about Power, Corruption, and Lies? No argument there…should be on the list.

REM’s Reckoning was and is a masterpiece. It fell off the list by sheer association with their later efforts. Shiny Happy People sullies the catalog beyond repair.

No Jam? Not even Modern World? Sorry, as much as I like the Jam, none of their albums can sustain 45 minutes of ecstasy. Paul Weller’s first solo album, however, now that’s a solid record from top to bottom.  

What’s on your playlist?

Omaha 2015 Multifamily Permits Below Trend… For Now

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Through September 2015, there have been 667 multifamily housing units permitted in the Omaha-Council Bluffs metropolitan area. This is well below the 2014 level of 1,533.

When asked about housing supply in Omaha, Def Leppard responded through their agent

When asked about housing supply in Omaha, Def Leppard responded through their agent “We played two bloody nights at the Civic back in 1983. It was brilliant.”

The equilibrium level which keeps supply and demand in balance is roughly 1,000 to 1,200 units per year.

If you track the previous 12 months and include the last three months of 2014, permits totaled 1,164.

I suspect that 2015 permits will come in at roughly 1,200 as a few projects sneak in at year-end. Despite this fairly moderate number, experienced lenders have expressed concerns of over-supply.

Affordability will be a much bigger issue as rising costs force developers to ask for rents that are pushing the outer limits of income levels.

Recently, lumber prices have started stirring again.

Lumber_Composite October 2015

What the world’s richest man can tell us about Omaha – and, no, I’m not talking about Warren Buffett

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Aside from the occasional plague and peasant uprising, Europe during the early 1500’s was an exciting and prosperous place to be. New worlds were being discovered, art and technology flourished in the Renaissance, nations emerged from fiefdoms, and religion was undergoing a massive reformation.

medieval-peasants

In spite of growing wealth in the 1500’s, peasants could still prove to be an unruly bunch.

The strongest financier during this period was a German by the name of Jacob Fugger (rhymes with cougar) who hailed from Augsburg, in present day Austria. He transformed his family’s textile business into a massive empire of banking, mining, and trade. Fugger was wealthier than the famous Medici clan who received much more historical attention. As a percentage of GDP, his wealth would dwarf Rockefeller, Gates and Buffett.

Fugger financed the Habsburg dynasty and the expansion of the Holy Roman Empire – an empire that ruled the core of Europe for four hundred years until World War I swept aside Austria-Hungary. He was a shrewd operative who financed the Vatican (indulgences aren’t free, you know), and obtained the ownership of entire villages when debtors defaulted on their loans.

fugger

Fugger did not mince words with the Habsburgs. In one undocumented incident, he threw his gold cap at Maximilain and told him to “Fugg off”.

Greg Steinmetz’s book “The Richest Man Who Ever Lived” is the latest book to revive the legend of Jacob Fugger.     The book is a business biography, but it is also a geographical instruction manual.

The story of Jacob Fugger illuminates the importance of cities in the development of commerce. Augsburg, Rome, Venice, Antwerp, and Mombasa are the supporting cast of characters in the book. The evolution of these cities provides insights into our own urban areas. For me, the book provides a lens through which to look at he challenges faced by Omaha as it tries to surge past 1 million people and reach the second tier of US cities.

Fugger maintained his home in Augsburg, but he located important business centers in Venice and, later, Antwerp. He chose to locate in Venice early in his career because the Venetians were the leaders in big business at the turn of the century. Their fleets traded goods from all over the world and their management skills were second to none. Most importantly, the Venetians mastered the system of accounting. Double-entry book-keeping was a new science, and Fugger used his mastery of accounts to centralize his far-flung empire. Later, Antwerp became popular as shipments from the New World increased. It’s massive port and access to the European heartland drew Fugger.

Charles_V

Charles V borrowed heavily from Fugger and took it on the chin.

This process of city and regional emergence is on display today as ConAgra considers moving its executives to Chicago. Omaha has a strong infrastructure in place to serve the agricultural industry, but Chicago has what it takes to reach consumers: It has a core group of companies like McDonalds, Kraft, Mondelez, ADM, and Ingredion all sharing resources. Chicago has thousands of well-educated people, young folks who can identify with a growing millenial target market, and dozens of advertising and marketing firms. Chicago, with its high cost of living and pension problems, trumps Omaha when it comes to innovation and sales. Like Silicon Valley, the costs of living are far outweighed by the opportunity to rapidly gain from networks of people. Omaha lacks the talent needed to reach rapidly-evolving consumer tastes.

Omaha also suffers from its peripheral location on the Great Plains.

One of the most fascinating stories in the Fugger biography is the rise of Portugal. Once a European backwater, the Portuguese decided to punch above their weight. They spotted their opportunity in pepper.

Portuguese_galleon

The Portuguese galleon. A badass to be reckoned with. Shut up and dance with me.

Pepper was essential for the bland European diet. Spoiled meat was a frequent entree and it needed a little, ahem, flavor. At the time, the Venetians controlled the pepper trade from India. They had a direct route but it required an overland trans-shipment at Suez. The Portuguese made the bold move of sending ships around the Horn of Africa to the Indian Ocean. While the route was dangerous, it was much faster than the Venetians could manage.

augsburg

Augsburg. It’s no Frankfurt, but Pope Leo X said it was “pretty darn good.”

One of the most exciting chapters in the book is the siege of Mombasa in present day Kenya. Only a few cannon blasts allowed the Portuguese to take over the trade hub. From there, it was a direct route to India. The galleons returned to Portugal loaded with pepper. They reaped a fortune from the trade. Fugger, as their investor, took his handsome share as well. Steinmetz argues that the loss of the pepper trade is what directly led to the demise of the Venetians.

The story illuminates the role of trading hubs and transportation centers to the growth of an economy. It seems fairly obvious, but it is remarkable that a city or region can grow exponentially without having a local industry. Singapore and Hong Kong are certainly modern examples of this phenomenon. Closer to home, Louisville and Memphis show how modern transport hubs have emerged in the jet travel era as the hosts of UPS and FedEx respectively.

“I’ve already bought my Cubs season tickets. Last one to leave Omaha, turn out the lights.”
– ConAgra Executive O. Redenbacher

Omaha may have lost it’s stockyards, but it remains an important commodities trader with firms like Scoular and Gavilon. Trucking is big here. But at the periphery, Omaha will probably never emerge as a transportation and market hub. Alas, it does not have a fleet of galleons to lay siege to The Loop.

Remaining a lower tier City is not all bad. Cost of living does matter when it comes to location selections. Nice people and good education systems do add value. By all accounts, Augsburg remains a pretty nice place to live even though the banking capital of Germany moved to Frankfurt centuries ago.

Omaha Economy Running Like a Deere?

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Don’t kid yourself Omaha, for all the hype about tech jobs and the evolution of youth culture in our fine hamlet, we are seriously dependent on the farm economy. And the trajectory of the commodities markets should have us looking over our shoulders.

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Below is a chart showing the six month performance of John Deere, September corn futures, and September cattle futures. Even if its hard to see this chart I copied from Yahoo! Finance (damn screenshot button), the trend is easy to identify.

Farm commodity prices are dropping. That means fewer trips to Omaha stores for back-to-school shopping, fewer trucks purchased at local dealers, a drop in irrigation system orders at Valmont and Lindsay, fewer combines rolling off the assembly lines at Claas, and a pull-back in rural lending.

Deere

Back in January, some of the warning signs emerged when Marubeni took a massive writedown on its purchase of Omaha commodities firm Gavilon. Although the writedown included crude oil assets, the entire amount approached $1 billion.

Union Pacific has made moves to lay off 200 Omaha managers due to declines in coal shipments and oil transportation. The rumors swirling around the future of ConAgra haven’t been positive.

irrigation

I recall a lunch I was invited to at a major regional bank back in 2010. The founder sang the praises of the farm economy and how important it had been for Omaha. The local economy had fared much better than most during the 2008 collapse.

Could the reverse become true? Rural banks could face headwinds and land prices could decline sharply. Indeed, Fed Governor Esther George argued that farm land prices had reached a bubble in 2013.

If Omaha is a big city now, it has to play by big city rules: the world economy does impact the prospects for local growth.

Pension Fund Fantasy: Omaha’s 8% Return Projection

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Omaha is not unique among municipalities across the country – deals cut with workers many years ago have left pension funds well short of money needed for retirement benefits. The shortage has cost Omaha it’s top municipal bond rating and has driven Chicago – the nation’s most egregious offender – to the brink of bankruptcy.

It’s time for the City of Omaha to level with unions and citizens and admit that it’s 8% return projection for the future is a mathematical impossibility.

Today’s World-Herald:

The city expects a return of about 8 percent each year. In 2014, the fire and police pension fund returned 4.9 percent and the civilian fund 5.5 percent, according to annual performance appraisal reports for the funds.

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Let’s start out with how the pension fund managers performed over the past two years, because frankly, its hard to fathom. If you try to “back in” to the portfolio allocation, some weird numbers emerge:

First of all, let’s assume that the City of Omaha is smart enough to follow John Bogle’s advice and put its money in low-cost funds that track the indexes. If the City is paying anything more than 1% to have someone manage the portfolio, it is an outlandish fee and further detracts from the struggling performance. That’s an argument for another day. Let’s stick with the passive formula assumption for now…

In order to have generated a 16.2% return in 2013, the fund would have allocated roughly 33.7% of its money in bonds. Let’s say they went with the biggest option and chose the PIMCO total return bond fund. It was a bad year for Bill Gross and prompted his departure to Janus as the fund returned -1.92%. But don’t fret Omahans, the remaining 66.3% of the portfolio invested in the S&P 500 index would have returned 26.39% in 2013. Thus, for the year, the fund still generated an outstanding 16.2% return in 2013.

But if you apply the same asset allocation assumption to 2014’s numbers, the performance breaks down. PIMCO’s broad based bond fund bounced back and delivered a 4.69% return. Meanwhile, the S&P 500 continued its bull run and advanced by 12.39%. Based on the same allocation weighting at 34/66, the pension fund should have easily turned in a gain of 9.8%, not 5.5%. The only way this 5.5% performance could have occurred is if the managers shifted almost 90% to bonds or made the even-worse decision of holding straight cash in a large portion of the portfolio. The pension manager should be called on the carpet.

The questionable 2014 results notwithstanding, reaching an 8% return assumption will be a virtual impossibility going forward:

First, you have the problem of rolling bond maturities. Assuming the pension fund bought some 30 year treasuries back when rates were north of 10% means that as those bonds reach maturity, those funds have no place to go but lowly 2-4% yields.

Second, if bonds are 34% of the portfolio and a PIMCO-esque fund runs at a typical 100 basis points over treasuries, 3.5% is a good year. What would the 66% of the stocck portfolio have to generate to reach an overall return of 8%?

10.35%

Nobel Laureate Robert Shiller has tracked stock market data from 1871 to the present and has shown an average return of about 8.2%.

Aswath Damoradan at NYU has a data series leading back to the late 1800’s showing that stocks have returned approximately 5.74% over the treasury bond. Based on these data points, one will do well to expect a stock return of more than 8% going forward with a Ten Year Treasury yield of 2.15%.

Using the same portfolio weighting noted above, the Omaha’s pension fund expected return should be adjusted to 7% (if not 6.5%!). Denial and compound interest don’t mix well.

If Omaha is looking for a dose of reality, it should look to California where unfunded liabilities are at 50%.  Calpers, the largest pension fund in the US, reduced it’s target rate to 7.5% in 2012. Its own actuary argued for 7.25%. 

The Discipline to Say NO

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You want to follow the herd. It’s natural. Do you remember the 1999 internet bubble? I got so frustrated hearing about my neighbors investing in Level 3 Communications, I thought I was the dumbest person on the block. I bought some Level 3. I made a little money, but I was too chicken to ride it out. I’m glad I didn’t.

Yes, some people escaped that bubble with fortunes intact, but most were swept away. The same can be said of house flippers and land developers in Las Vegas during the middle of the 2000’s. I remember feeling so envious of all these people making quick bucks left and right. What did I do? I went to Baltimore. I flipped a house and lost my ass. Thankfully I got out before the meltdown and I didn’t lose my entire net worth.

So, now, I look at my industry: apartments. Everybody loves apartments as an investment right now. The yield, the safety, the myth that people can’t afford houses anymore. I remember fretting about Omaha surpassing $1.00 per square foot rents in the late 2000’s. We’ve blown through that number.

Downtown is hot. Midtown is hot. But someone is going to be the last one in and they’re going to be late to the party. They will overpay for land, underestimate costs, and underestimate the depth of the market at an affluent level of rent.

It’s frustrating. You know people are making a lot of money right now. But you also have a sick feeling in your gut that everything is being propped up with artificially low interest rates. I went to a conference and heard they are paying 4.82% cap rates in Dallas.

Are we there? Is this Japan with a perpetual zero interest rate policy?

Everybody repeats the same cliche that real estate is about location, location, location. Here’s what they don’t say: real estate is also about price. You can have the best corner in the world, but if you pay too much for it you will dig yourself a hole that will take a generation to extricate yourself from.

We have to take risks as developers. You can’t make money without taking a risk. But you can’t follow the herd. Sheep get slaughtered as the saying goes. Lemmings head blindly over the cliff.

Farnam Street blog has an outstanding transcript of a television interview in India featuring Warren Buffett and Ajit Jain. Everyone needs to read it and watch the interview. It is pure gold.

Ajit: The discipline to say no, if you have that and you’re not willing to let people steamroll you into saying yes. If you have that discipline, that’s more than 50 percent of the battle.

Warren: Don’t do anything in life where, if somebody asks you the reason why you are doing it, the answer is “Everybody else is doing it.” I mean, if you cancel that as a rationale for doing an activity in life, you’ll live a better life whether it’s in the stock market or any place else.

I’ve seen more dumb things, and sometimes even illegal things, justified (rationalized) on the basis of “Everybody else is doing it.” You don’t need to do what everybody else is doing. It’s maddening, during the Internet craze when the bubble was going on.

You have to forget about all those things. You have to do what works, what you understand, and if you don’t understand it and somebody else is doing it, don’t get envious or anything of the sort. Just go on and wait until you find something you understand.”