Tale of Two Residential Real Estate Markets

"...it was a tale of two cities" wrote Charles Dickens about Paris prior to the revolution. Today in the United States, it is a tale of two very different residential real estate worlds and the wide disparity in supply and demand should not surprise any one. It is all about jobs (and job quality) and supply. At one end of the spectrum is a market with negative job growth and plenty of buildable land (pockets of Michigan). On the other end you have markets with growth in both jobs and wages and no meaningful increase in housing supply (Manhattan, San Francisco, Atherton, Ca). In between you have things like Fort Meyers (no jobs, but it is nice a couple months a year), and markets like Las Vegas and Phoenix. In these markets you have momentum on job growth but lots of space and little restriction on building.

Main stream media will continue to sell dramatic headlines to us. The reality is that any one who is awake can not be surprised at the numbers in their local markets. At the same time we have 400 properties auctioned in Orlando, we have record prices in premium neighborhoods in San Francisco and New York City.

Prosper company income data weak

This guy in Austin is doing some good work.
$100K in revenue for the month of September 2007?
http://prosperousland.blogspot.com/2007/10/prospers-september-revenue.html

How many employees here?
Let's think about the growth assumptions required just to get over the liquidation preference in this deal (Prosper Marketplace, Inc.) ...I think it is $39.5 million at this point.
http://www.rateladder.com/2007/06/20/prospers-20mm-series-c-venture-capital-details-press-release/

Good luck to the prosper stock option holders!
Will they borrow on prosper to finance their option exercises?
Would artificially created some volume but not sure any one has the faith yet to go after than long term gain treatment.

Dotcom bubble back. Yahoo throwing money away?

Good article by the International Herald Tribune. Focus is on Yahoo's (YHOO) acquisition of Right Media and fact that Yahoo initially invested at a $200 million valuation and then 6 months later paid $850 million for entire company. Are you valuation services companies paying attention to this? That is either quite a control premium, a really discounted prior deal, or as the article suggests, another sign that these public companies - Yahoo, Google, eBay have currencies (their stock) that needs to be used to go out and try to buy growth. As we saw recently with eBay/Skype the deals are probably too generous and there probably needs to be more carrot with management as part of the deal.

The Right Media founder offers a surprisingly candid quote:
"I have to say I giggled," O'Kelley, 30, said of Yahoo's acquisition, which earned him $25 million. "There is no way we quadrupled the value of the company in six months."

http://www.iht.com/articles/2007/10/16/business/bubble.php

Bay area housing bubble bloggers still frustrated

Folks who understand just a little about economics and can read through the "news" could see a few things in developing in residential real estate in this decade:
1. Individuals investors looking for investment alternatives outside of stocks and bonds.
2. A very liquid mortgage market and an appraisal system that has been, let's just say, imperfect.
3. Homebuilders with capital and available land (or space) in certain markets like Las Vegas, Phoenix, Florida, San Diego, etc.
4. Employment and wage data, while noisy quarter to quarter and carrying significant variances from region to region, that has been overall quite stable and relatively strong. Certainly in the major job center markets, labor has been tight.
5. Relative to jobs and wages, there has not been an oversupply of residential real estate (whether for rent or for sale) in major employment centers like San Francisco, Silicon Valley, and Manhattan.

The most famed bloggers focused on housing, are hosted and "led" by Mr. Patrick Killelea who, according to an article by the San Francisco Chronical reportedly rents a 3 bedroom in Menlo Park. The article says that Killelea works as a contractor and takes a substantial time away from work which, all else equal, must make it difficult for Mr. Killelea to obtain the same type of mortgage financing available to comparably skilled workers who collect a W2. Mr. Killelea and the other bubble watchers do not view consuming housing the same as they view consuming a car or a cup of coffee, which is fair enough. Housing is a big investment for most people and it is absolutely fine to attempt to quantify and separate consumption features from opportunity cost features for housing.

But what is wrong with the bubble bloggers? With all this blood in the streets, why are they still blogging? Reportedly, Killelea spends most of his time on his blog and it generates about $1,000 per month in advertising - this seems like a relatively low return on investment if we are to believe that the man earns $100 per hour. Maybe these bloggers are still blogging because they live in the bay area. By their arguments, these bloggers imply a personal conflict between not being able to afford the properties that they really aspire to live in and the simultaneous refusal to live in a community where houses are so cheap that it costs less to own them then to rent.

Do Prosper.com lenders quantify adverse selection in their pricing models?

Jenny R. studied all the loan performance data made available from Prosper.com and read other people's analysis as well. Still, she says, "there is something missing". "Something does not feel right." she says to me when explaining her interest but apprehension in lending to strangers over the internet. Her dad had told her to ask me whether I thought she should invest $25,000 through an online lending site. I first asked her a bunch of questions about her financial objectives and constraints. Turns out $25,000 is money she can afford to lose, but the time commitment required to actually lend online is not a good fit for Jenny. Anyway, I asked Jenny how she could quantify the adverse selection in the borrower population. She asked me to describe adverse selection. Some of you have asked me about peer lending before so I figured a post was deserved.

What is adverse selection?:
1. Think of a credit worthy person. May be you are a great credit - you have terrific excess cash flow and liquidity - that is what a great credit is - someone or some company that does not need credit. This person uses a credit card for purchases and does not revolve balances - at least not for long. This person has stopped opening credit card offers. He/she has no time for it. The last thing this person is going to do is go online and go through a bunch of hoops to borrow $25,000 or less at prime or prime plus. Why would they?

2. Imagine a peer lending site that has originated a really meaningful size portfolio - like say $400 million in a twelve to eighteen month period. With that number of borrowers, think about the type of people who have learned about peer lending and decided to take all the steps necessary to borrow. Stop there and pause for a moment. Are FICO, profile and "community" adequate inputs to price unsecured 3 year debt? How could and how should you distinguish between (loss adjusted) expected returns between two individuals. Let's say one of the individuals is you and you only have two facts about the other person. The first is that you know their FICO score is identical to yours. Second, you know that they are seeking to borrow money from you through an online forum. Do you think the individuals deserve identical pricing? Do you think the market should price the individuals identically?

Bigger picture:
There are very valid arguments for individuals to consider alternative investments including lending or participating in debt securities. Disintermediation is highly seductive and makes for a great pitch. No one wants to piss on the idea and neither do I. I do wonder through whether a FICO score and profile are sufficient inputs to a credit decision. I also wonder if the majority of individuals who are moonlighting as consumer credit officers understand adverse selection. If you are drawn to think of the NextCard portfolios as I am you will recall that much of NextCard's growth was from transferring balances from other lenders. As I am writing this I am thinking that in these term loans you don't even have that explicit debt replacement that credit issuers do when they send money to pay off balances on other credit accounts. With Prosper, Zopa, and LendingClub.com you have incremental debt with a person who is willing to go through all these hoops to get a term loan.

In sum, I say good luck lenders, borrowers, and good luck Chris Larsen. Benchmark is just doing what they told Calpers they would do with the money. FT's associates probably wanted to call but their limited partners (Bank of America, Wells Fargo, HSBC, etc) would not have been quite so giddy. None of these guys (ELoan, Mortgage.com, NextCard, etc.) were able to lever the internet to really change the economics of consumer credit. I am not a hater (quite the opposite), but I will bet against the idea that peer lending is going to change the entire economics of the industry. Hope I am wrong. You have my profile here and my FICO is top decile. Is your money cheaper than Bank of America's or CapitalOne's? Do Prosper.com lenders quantify adverse selection in their pricing models?

Is this the top for Venture Debt?

It has been kind of fun watching this subprime mortgage meltdown and finding out who the guys were that were actually behind the funny money. Me and my cohorts are all for free money when our companies are taking advantage of it. Should we have some concern for endowments, pension plans and for ourselves to the degree that we have some financial exposure to banks who are giddy about lending to startups? Rather than post a diatribe, let me just put a few questions down here:
1. Does anyone remember Comdisco? They were the first ones and the last ones to price venture debt at 1 or 2 over prime with 2% or 3% warrant coverage. For the rest of the market, even going to 5% warrant coverage was too thin and a bad path to go down.
2. Are any financial sponsors questioning the pricing and underwriting that is going on at venture debt firms?
3. Is any one thinking about the pricing and the mortality rate of startups? If 3% warrant coverage is sufficient, why not 2%? How about 1%.

Who are the players and how can you profit from a downturn in venture debt portfolios? Study Comerica, Silicon Valley Bank, Western Technology, Hercules Growth, Lighthouse Capital and Eastward Capital to name a few. First get a term sheet from a venture capitalist, then call a few of these firms and look at their terms sheets. This money is easy and we know the fate of easy money.

Peter Thiel of Facebook to CNBC: "People are one of the most important things in the world."

Video clip link:

CNBC asks Peter Thiel is explain the end game for social networking.

Here is the story: CNBC had been hyping having Peter Thiel on as a guest in San Francisco. I have never met Peter. I do have some common friends and was naturally interested to see and listen about why he had been invited to one of my friend's party and why CNBC wanted to interview him. With all due respect for Peter, I was disappointed. Aside from the fact that his answers were peppered with "umms" and pauses, there really was little to no substance. There is nothing that I know now that I did not know before watching the interview except that Peter thinks that "People are one of the most important things in the world." This was his answer to the question "Is social networking a fad?"

Another comment I might tag as "curious" if not "questionable" was Peter Thiel's assertion that valuations for companies that produce "social networking" services are, in the aggregate, not too high to provide an attractive risk adjusted payoff for investors. Bill Griffith asked Peter Thiel if there is a bubble in the market for web 2.0 and social networking companies. Notes, his line of questioning was: ‘is social networking a fad?’ and ‘what is the next Google?’. In response, Peter Thiel uttered “Facebook” although Griffith had not asked about any specific companies, then he offered four reasons why there is not a bubble as it relates to [private venture equity capital] investments companies that offer web 2.0 and social networking services. Peter Thiel said [this is not from a transcript, just my notes from the interview and my sarcastic comments are in [bracktets]]:

1) There are "no IPOs" for these companies. [Did you know bubbles are defined by whether or not the public can invest directly instead of indirectly? I did not.]

2. MBAs are going to private equity not coming to Silicon Valley [Mr. Thiel added, and I am not making this up, that ‘this was what was going on a year ago’. So his reasons are not even forward looking, they are backward looking, and at least a year old. This one is too easy. No, MBAs are not coming to Silicon Valley, they are dropping out of undergrad and moving to Silicon Valley - they don't have time for an MBA when there is also this tagging and networking and mashing up to do! : ) ]

3. And this was perhaps the most interesting reason why valuations are supposedly not too high: "...it takes far less cash to get these companies off the ground". [Peter Thiel is such a genius that people like you and me can not even follow his logic.]

4. People in the late 90s were swapping out old economy investments for new economy investments. [Well, that was true...therefore your little widget code must be worth $5M pre, right?]

I have an economic interest in the web content economy as do many people that I care about. Peter made a reference to the importance of enabling human communication globally and that was appropriate. Much of the rest sounded like cheerleading and the explanations were not exactly what I would expect from someone who is probably Mensa material. Facebook is obviously thinking IPO. If publishers like Anthony Noto or Mary Meeker are going to explain Facebook to the likes of Bill Miller or Will Danoff, I guarantee that these will not be the four bullet points they use to justify the valuation. Fidelity is a "build it" shop, so they probably won't let Noto or Meeker "poke" or "nudge" or "wink" at Danoff or the other managers using Facebook when the initiation report is ready.