The Fallacy of the Real Estate Sales Pitch "Buy Land — They’re Not Making Any More"

Back in the pre Asian Crisis boom during the mid 90s when I was a practicing licensed real broker, the common sales pitch by my contemporaries had been “buy land, because land supply is limited”. Even when I wasn’t into economics, I didn’t buy into this simply because I sensed something wrong with it. 

And given today's climaxing Philippine property bubble, aside from G-R-O-W-T-H, such spiel could most likely be part of the bubble promotion.

Anyway, at the Mises.org, Peter St. Onge eloquently explains the economic reasons why “buy land because supply is fixed” is a myth. (bold mine)

“Buy land — they’re not making any more!” is an old investing chestnut, and a common sense one to boot. Economically, it’s also completely false.

As counterintuitive as it may seem, we make land all the time. It just doesn’t look like land.

Why? Because land’s value doesn’t come from its ability to cover up the naked earth. Land’s value comes from its economic usefulness.   From the value of things that can be done using that land (Rothbard’s “marginal revenue product” of the land). And that value is, indeed, changing all the time. Economically, from a price perspective, then, we make land all the time.

Step back a moment and ask why land has value anyway. Why do people want land? Well, obviously, because you can put stuff there — including yourself — plus buildings, swimming pools, and factories.

Now, anybody who’s visited West Texas knows there is plenty of building space in the world. You could drive for hours and meet nobody. There’s lots of space for that factory of yours. But it’s not really space itself that makes land valuable. It’s location. As in, there’s only so much room in Manhattan. Or Central London.

Once again, though, it’s not the actual space that matters. It’s the access. Put a strip mall on Manhattan surrounded by crocodile-filled moats and snipers and it will have low value. The value is in access. So Manhattan is valuable because it’s easy to get to other parts of Manhattan. And it’s easy for other people to get to you. Customers, partners, and friends can all easily visit you if your apartment or office is in Manhattan, moatless and sniperless.

So if it’s the access that matters, are they making new access? Of course. They’re doing it all the time.

New highways, new exits, new streets, mass transit, pedestrian malls are being regularly constructed. These all effectively “make new land” because they offer access to existing space. They turn relatively “dead zones” into "useful zones," or new land.

What are some of the meta-trends on land as investment, then?

First: roads. This was a bigger value-driver a generation ago in the US, as new roads made the suburbs more accessible, helping to drain many cities even as US population grew. Outside the US (Mexico, Thailand, Russia), new roads are still a big deal, and even in the US, new highways can reshape values — draining old neighborhoods and building value in new ones. The decline of cities like Baltimore or Detroit are partly thanks to those beautiful roads that redistribute access to the suburbs.

Second: population. In the US “rust belt” of declining manufacturing, many regions have dropped in price simply because people are leaving. Detroit homes for $100 is emblematic, although of course there are also political reasons some cities are so cheap — in particular, taxes and crime.

And that brings us to politics. Real estate can be cheapened shockingly quickly by taxes and crime, and those traditional drivers have been joined in recent decades by environmental politics.

Environmentalists, by taking land off the market, effectively squeeze the remaining accessible locations. Driving up the price. Regions like Seattle or San Francisco are poster children of this environmental squeeze, with modest homes even in remote suburbs costing upward of a million dollars. On the other extreme, cities like Dallas or Houston have kept prices down despite exploding populations by allowing farmland to be converted to residential, commercial, or industrial use.

Beyond the access and political angles, land is also vulnerable to “network effects.” In other words, the neighbors matter. Gentrification or urban decay can be hard to predict. Even in a compact city with rising population like Washington, DC, it can be hard to predict where the middle class or rich want to colonize, and where they want to flee.

There are clues, of course — in large US cities, gays moving into a neighborhood, new coffee shops or art galleries are some leading indicators that property prices might swing up. But gentrification has it’s own mind; even in a booming city it might go into some other neighborhood. New York’s Harlem or Silicon Valley’s East Palo Alto are two very accessible locations with low prices because of perceptions of the neighbors.

So, while they’re not “making” land, they are constantly making things that affect land price. Access, regulations, changing neighbors. These are the kinds of factors that make land valuable, not it’s ability to cover the earth.

And so land comes back to earth, joining boring old commodities like wheat or copper. Just as vulnerable to changing supply and demand factors.

And if you are looking for something they’re not “making more of?” Well, gold does come close. Hence its appeal. They do mine new gold all the time, but the costs are high enough that gold is a very “inelastic” commodity. It comes close to “they’re not making more.”

Beyond that? Develop your ultimate resource: yourself.

Of course, land prices can also be influenced by central bank's cheap money policies.

 

Oh besides, technically speaking, it isn’t true that land is not being made.

United Arab Emirates looks like a "factory" of land through various land reclamation projects

A few notable examples…

UAE’s the Palm Island

UAE’s The World Islands

In short, technology allows people to expand or “make” land out from its economic usefulness.

The Philippines has its own land reclamation area the Bay City. 

It's not just economics, many controversial land reclamations have been completed or in near completion for political purposes. 

The above pictures are ‘before and after’ aerial shots of the contested Fiery Cross Reef at South China Seas (photos courtesy of Zero Hedge)

These have become tinderboxes for war.

Perhaps one day these islands will be sold and transformed as tourist destination…

“Buy land because they’re not making any more”?

World's Priciest Emerging Market Properties

The Real Estate Business Intelligence Services (REDIN) showcases the most expensive properties in the emerging market world as categorized by...

Residential
Office

Retail

Industrial

and Land

(HT: Paul Kedrosky)

Evidences of Monetary Forces Gaining Upper Hand in Hong Kong

In our previous post, Monetary Forces Appear To Be Gaining An Upper Hand, we argued that the tsunami of monetary programs applied by global governments have been distorting financial markets relative to the real economy. This has prompted for glaring disconnections which has caused quite a confusion between the bears and the bulls looking for justification for their causes.

We find further proof of these phenomenon evolving in Hong Kong.

We excerpt an article from the Wall Street Journal, (bold emphasis mine)

``A wave of money flooding into Hong Kong from mainland China and the rest of the world has propelled property and stock prices even as the economy falters.

chart from tradingeconomics.com

``Hong Kong's government predicts the economy will shrink up to 6.5% this year and unemployment is at a three-year high. Yet home prices are up about 13% this year, while the benchmark Hang Seng Index has gained 18% in the same period.

chart from stockcharts.com

``The strong inflows of capital from abroad have kept Hong Kong's de facto central bank busy. Since January, it has pumped more than US$22 billion of Hong Kong dollars into the market to keep the pegged currency within its mandated trading band against the U.S. dollar. The result is a wave of liquidity washing into asset prices.

``Hong Kong's real-estate market may be one of the more pronounced beneficiaries of a global effort by governments to print money and stimulate lending. Quantitative easings by central banks in the U.S., Europe and Asia have created "booming capital flows" that are "swamping" some markets, Sean Darby, a Hong Kong-based strategist for Nomura International, wrote in a recent report.

From Wall Street Journal

``Hong Kong's situation, however, is unusual. In other places, a net inflow of foreign funds can lead to both a rise in asset prices and a rise in the value of the local currency. But thanks to Hong Kong's link to the dollar, only the asset prices can rise -- and because the currency can't, the gains are more pronounced.

``The peg also makes Hong Kong attractive to investors during a period of currency instability. And Hong Kong's stock market is one of the most accessible and liquid places for foreign money to bet on a recovery in mainland China, where currency controls make direct investment trickier.

``Andrew Fung, head of investment and insurance for Hang Seng Bank in Hong Kong, believes that, with Western markets still sputtering, Hong Kong investment dollars that have long flowed overseas may now be coming back home.

``Anecdotal evidence also suggests some of the money is coming from mainland China, where Beijing's efforts to hurriedly channel four trillion yuan ($586 billion) in stimulus measures into the domestic economy have energized bank lending and unleashed a flood of liquidity."

So there you have it; quantitative easing, China's stimulus program and repatriated capital driving the Hong Kong Financial Markets where inflationary programs have indeed been buoying the marketplace.

Welcome to the new bubble.

China Slashes Rates, Shanghai Composite At Critical Juncture

Faced with grim prospects of dramatically decelerating economic growth (World Bank Projections have cut growth forecast from 9.2% to 7.5% for 2009), an alarmed China has opted to aggressively use its monetary policy.

According to a report from Bloomberg (highlight mine), ``China lowered its key lending rate by the most in 11 years, extending efforts to prevent an economic slump less than three weeks after unveiling a 4 trillion yuan ($586 billion) stimulus plan.

``The key one-year lending rate will drop 108 basis points to 5.58 percent, the People's Bank of China said on its Web site today. The deposit rate will fall by the same amount to 2.52 percent. The changes are effective tomorrow…

``The bank lowered the reserve requirement for the biggest banks to 16 percent from 17 percent, effective Dec. 5. The requirement for smaller banks will fall to 14 percent from 16 percent. The central bank also reduced the interest rate that it pays on reserves deposited by commercial banks to encourage lending.

chart courtesy of Dankse Bank: Lending and deposit rate (left), reserve requirement (right)

Yet additional measures are being considered, from the same Bloomberg report,

``Two hours after the rate cut, China's cabinet said it was studying extra measures to help struggling companies in the steel, auto, petrochemical and textile industries; to increase key commodity reserves; and to expand insurance for the jobless.

``The government will also push ahead with fuel-price and tax reforms to help boost consumption, the cabinet said. A fuel-price cut would be the first in two almost years. The government regulates energy prices to contain inflation, which fell to a 17- month low in October.”

Fundamentally, the global contagion is expected to impact China via the export channel (and via portfolio flows), albeit exports still managed to grow robustly by 19.2% last October, but down from last September’s 21% with trade surplus swelling to a record $35.2 billion on declining import growth. A CLSA survey recently showed that export orders have dropped to its lowest since 2004, which possibly indicates that exports have yet to reflect on the substantial decline with a time lag.

But the continuing slump in the real estate industry seems likely a bigger concern considering that many loans from the informal sector could surface or find its way into the balance sheets of the formal banking sector, and increase incidences of Non Performing Loans. This should translate to a significant weakening domestic investment as we previously discussed in China’s Bailout Package; Shanghai Index At Possible Bottom?, which the Chinese government aims to offset with a massive stimulus package.

But, it is our hunch that perhaps China’s markets have already priced in or have discounted much of these somber expectations considering the harrowing bear market losses of 72% (from peak to trough).

Unless, the world will yield to a depression, the recent lows could possibly mark a cyclical transition from a declining phase to a “bottom” phase.

China’s Shanghai index appears to be testing the 50-day ma resistance.

A successful breakout from this resistance level could serve as one of our confirmation metrics. Otherwise a failed breakout means a test of the recent lows.

Relative Economic Growth, Lack of Access to Capital and Global Depression

``With greater wealth comes greater responsibility. This is inescapable. Wealth has a social function. If you own something, you must make decisions about how to use it. Consumers are always bidding for either ownership or the use of your assets. Ownership therefore has a price. If you do not respond to the offer, you are paying this price. You are paying the price in the form of forfeited opportunities. Whatever you do with the wealth, you could be doing something else with it. You cannot escape the responsibility of not doing something else with whatever you own.”-Professor Gary North, Honeymooner Politics

It can’t be an argument from the economic growth perspective too…

Figure 6: IMF: WEO Presentation: Economic growth decelerates Around the Globe

Even as global economic growth has moderated to 4 ½ in the first quarter of 2008 down from 5%, such growth clip is expected to decline further to 4.1% in 2008 and 3.9% in 2009, according to the IMF.

From the IMF’s World Economic Outlook update (emphasis mine),

``Growth for the United States in 2008 would moderate to 1.3 percent on an annual-average basis, an upward revision to reflect incoming data for the first half of the year. Nevertheless, the economy is projected to contract moderately during the second half of the year, as consumption would be dampened by rising oil and food prices and tight credit conditions, before starting to gradually recover in 2009. Growth projections for the euro area and Japan also show a slowdown in activity in the second half of 2008.

``Expansions in emerging and developing economies are also expected to lose steam. Growth in these economies is projected to ease to around 7 percent in 2008–09, from 8 percent in 2007. In China, growth is now projected to moderate from near 12 percent in 2007 to around 10 percent in 2008–09.”

In short, despite the moderating pace, the economic growth differentials are still tilted towards in favor of emerging market economies (see left pane in Figure 6).

Moreover, we can hardly buy the arguments from the deflationist proponents of a world depression or near depression see figure 7.

Figure 7: ADB: Asia’s Household Indebtedness

ADB’s data shows of the dearth of leverage or indebtedness of the household sector, which reinforces our supposition of the insufficient access to the banking system by a large segment of the Philippine economy. Similarly this represents both as a shortcoming and as an opportunity (huge growth area).

If the banking system, the main conduit for finance intermediation, has relatively low exposure, it explains why the Philippine capital market likewise lags the region or for most of the world.

It also gives credence to the outlook that a large section of the economy is levered to informal financing channels.

Basically Indonesia and the Philippines could be deemed as primeval cash based society. It also demonstrates why both countries have lagged in the aspects of developments simply because of the lack of access to capital and to paucity of sophistication to lever and recycle capital.

Figure 8: ADB: Public Sector and External Debt as % of GDP

External and Public sector Debt for most of Asia has likewise been materially improving. But the Philippines has the worst position among the peers but has likewise shown significant progress.

Of course past performance may not repeat in the future given the deteriorating conditions abroad, but given the composite framework of the Philippine economy or financials, we need to be substantially convinced of how a depression in the US will result to a depression in the Philippine economy or in Asia. We have discussed in details such linkages in ‘Is the Philippines Resilient Enough to Withstand A US Recession?’.

We also don’t share the view that advanced economies will RECOVER first given the so-called belated effects of an economic growth slowdown contagion to Asia or to emerging markets.

The reason is that the US or UK or countries presently scourged with the deleveraging process is a systemic impairment which will take a longer period for convalescence or for market clearing. Whereas Asia or emerging market’s bear market comes about from the trade and financial nexus with these economies and has not yet been a structural problem (YET).

As a reminder, from every cycle emerges a new market leader, e.g. in the US, the technology sector 1990s-2000 and financials and housing in 2003-2007 (today the energy sector appears to be at the helm) and it is likely that once a recovery phases there will likewise be a new market leader (perhaps the next bubble). And our likely candidate emanates from Asia or emerging markets.

To elaborate further, monetary inflation has been a process INTRINSIC to the fiat paper money/currency standard. Since the impact of inflation is always never equal, it gets to be absorbed in different points of the economy at different times.

For instance in 2003-2007, most of the inflationary actions by global monetary authorities got absorbed in the real estate sector backed by financial securities (structured finance, derivatives, mortgages backed securities, etc…).

Aside, the spillover from these actions led to global arbitrages which spurred a phenomenon of price values of stocks, emerging market debts and commodities.

But since the advent of the global credit crunch, much of the real estate financed securities have been deflating, thus, the inflation absorption has shifted towards hard assets. Hence, the accentuated surges in food, energy and commodity prices (which is why it gets political mileage). Now that commodity and oil prices are in a respite, our suspicion is that some asset classes are likely to takeover or benefit from these relative price adjustments or the rotating inflation.

Remember, these processes won’t come to a halt, especially under political imperatives to save the system or the poor or the society or the economy. There will always be some justifications (cloaked by technical jargons-or ‘intelligent nonsense’ as Black Swan savant Mr. Nassim Taleb would say) for such politically based actions.

Overall, if the popularly held inflation menace will be less of a threat to the global economy, aside from global markets having priced in MOST of the decline in economic growth aspects as reflected in the financial markets (markets indeed serve as great discounting mechanism) then it is likely that we should see the rotation of this inflationary assimilation into new conduits; let me guess-Asia.