Macroeconomics Outlook 2014 Q4
Macroeconomics Outlook 2014 Q4
Macroeconomics Outlook
Deflation fears have swept the market after growth slowed globally. Europe is barely growing. Russian economy is imploding from the sanctions. Japan is in recession. China is slowing dramatically. The only bright spot – the US – is plodding along at around 2% growth.
The 60% collapse in oil prices, caused by a combination of increased production from the US Shale Oil and a lack of demand in the global economy, adds to deflationary pressures.
To spur growth and stave off deflation, central banks around the world are doing the only thing they know how – print more money. European Central Bank will start quantitative easing (QE) next month. That has led to the Euro dropping to $1.10 per dollar and falling. In addition, Spanish and Italian bonds are now yielding less than US Treasuries and the German 5-year yields have turned negative! The impending European QE forced the Swiss National Bank to take off its peg to the Euro, causing Swiss Franc to appreciate 20% against the Euro in a single day and pushing Swiss 10-year yields negative. To fight the recession, Japanese central bank is threatening to print money at ever faster speeds, sending Japanese 10-year yield to 0.27%! Canada, India and Singapore have all slashed interest rate and weakened their currencies in the past few weeks to support their economies.
Here are the investment implications for 2015:
1. US long-term rates will stay low. Yield-hungry investors are piling into US Treasuries and mortgage bonds, driving up their prices and lowering their yield. Why would you buy German 10yr yielding at 0.35% when you can buy US 10-year bonds yielding 1.75%? This relative value dynamic has driven down 30yr mortgage rate in the US to around ~3.75%.
2. The Fed will not be able raise rates much in 2015. The Fed wants to raise short-term rates to 1.25% by the end of 2015, but we see very little chance of that happening. US corporate earnings are already hurting from the strong dollar.
Anything beyond a symbolic 0.25% raise will likely cause the dollar to soar and send US growth plummeting below 1%.
3. US home prices will increase in 2015. As the employment picture improves further in the US, the low mortgage rates will lure more buyers back to the market and send US home prices moderately higher. We project home prices in the US to rise about 3-4% in 2015.
Outlook for the Dallas Market
Dallas home values increased around 7% in 2014. Housing inventory remains tight at around 2 months (compared to historical average of 6 months) and demand remains strong from increased employment in the city and surrounding suburbs.
Toyota just moved its North American headquarters from California to Dallas, bringing with it 5,000 jobs to the city. State Farm, the insurance giant, is expanding its presence in Dallas, hiring more than 1,000 workers in the past year. Active Networks and Omnitracs, two technology companies, are also moving to Dallas, bringing 1,500 jobs with them from California. Overall, Dallas added around 110,000 jobs in 2014, pushing the unemployment rate to 4.6%, significantly below the 5.5% rate in the US.
Oil and gas production drives only about 11% of the Texas economy. On the local level, oil and gas related jobs make up less than 5% of total employment in Dallas compared to around 15% or more in Houston. Overall, in Dallas, we expect the small job losses in oil and gas industries will be offset by the jobs created in other industries, leading to moderate job growth and little impact on the real estate market.
With Dallas adding 100,000 jobs annually in the last few years, home builders have only built around 22,000 single family homes per year, far short of the 35,000 homes needed to satisfy demand. In addition, Dallas homes remain extremely undervalued even after the recent surge in price. According to the latest Zillow estimate, Dallas median home price is $152,600, less than 3X median income. Compared to other large metros either in the US or abroad, where home prices are typically 5-10X median income, Dallas is cheap. We project Dallas homes to appreciate another 5-7% in 2015 and remain hugely bullish on Dallas housing for the next 3 years.
Q&A Section: How do we (Bridge Tower) select our properties?
Our Framework for Selecting Property
Our four criteria for selecting property for the Fund are:
- Desirable location (good schools, safe neighborhood, quiet street)
- Appealing home for the location (size, number of rooms, amenities
- Gross rental yield of 12% or more
- A purchase price significantly below replacement and market value
In Dallas, homes that satisfy all 4 criteria typically sell for $180,000 or below and rent for $1,800. Homebuilders, in addition to building less than market demand in the last 4 years, have decided to only build new homes for affluent customers. In 2014, out of the approximately 25,000 new homes built in 2014, less than 4000 homes (~15% total) are priced below $180,000. Since a significant portion of potential homeowners cannot afford these higher priced new homes, they have continued to rent, pushing Dallas vacancies to all-time lows.
By only purchasing homes that fit our strict criteria, the Fund expects to achieve a minimum net rental yield of 8%. Combined with our projected 3-6% annual increase in home prices, the Fund can provide investors with good current income and total return of around 12% annually.
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