Author: californiaforecast

by Mark Schniepp
April 2018

In this part 2 of my monthly newsletter blog on robots, I’ll mention how our fully employed economy is rapidly accelerating investment in and implementation of a robot workforce.

Are We Actually Experiencing an AI Explosion?

The world of artificial intelligence is advancing so rapidly and in so many industries, countries, and applications, that to many it feels like the automated evolution is rising exponentially. Here is tech writer Tim Urban’s (waitbutwhy.com) illustration of just where we are on the timeline of human progress and the explosion that is allegedly right in front of us.

There is this notion that rapid growth in AI (or rather, explosive exponential growth) is here now or just in front of us. Tom Friedman’s best selling book, Thank You for Being Late, also supports this premise.

However, I don’t believe we are this far along the S-cure of progress, because implementation of robotic technologies is not evolving at light speed. AI trends such as virtual assistants, smart robots, and human voice adapting are still in their relative infancy and taking more time than initially thought to be really useful. While I think the future is soon, it’s not that soon.

Consequently there is time to prepare your company and your workforce for the robot economy. And it’s a good idea to start soon because there is no doubt that the robots are coming.

In last month’s newsletter I mentioned a couple of AI applications fully operational now. Aside from Flippy at Caliburger in Pasadena, there are many examples just in the past 18 months of robots successfully performing repetitive or mundane tasks in a variety of industries.

Robots are quickly expanding in the food industry mostly in China and Japan, but also here in California. The robot restaurants in China have replaced greeters, waiters and some cooks. They are growing more popular, even if only as a curiosity for visitors to experience being served by robot waiters.

For a number of years robots have largely worked in industrial capacities, bolted to an assembly line. Industrial robots are automated, programmable and capable of welding, painting, product inspection and testing, all with precision, consistency and speed. A study by MIT economists found that robots were responsible for the loss of up to 670,000 manufacturing jobs between 1990 and 2007 in the U.S.

Amazon and Walmart employ hundreds of thousands of machines within their warehouses and fulfillment centers that do much of the heavy lifting of goods, and filling and organizing shelves with the help of directing human workers.

The warehouse robots have replaced some humans and the growth of Amazon has created thousands of new human labor positions, but the massive growth of e-commerce including the numbers of new warehouse hires do not mitigate the overall retail jobs losses that have been the consequence of this growth.

Sea Change in the Use of Robots?

Now, a new generation of robots is here, capable of moving among people and therefore finding a wider range of work in stores, hospitals, hotels, and offices. And this has become a major cause of concern because the McKinsey Global Institute reported that 30 percent of the global workforce could be displaced by robots by 2030.

While robots employed now are not displacing too many workers, they will in the future as they become more dexterous and smarter, and as human workers performing repetitive tasks become too expensive. Robots don’t need to be paid the minimum wage (or any wage at all) and they don’t need healthcare, family leave, sick leave, “a change in perspective,” vacations, or worker’s compensation insurance.

There would likely not be massive unemployment because millions of new jobs would ultimately be created. Robots need repairmen, software programmers, circuit board designers, ergonomic specialists, etc. Consequently, robots do pose a disruptive force that will push us to seriously reevaluate our occupational training and skill set more carefully than ever.

This is a good thing because when human jobs are eliminated much of this can take place mainly through attrition, particularly as the baby boomer industry continues to progress into retirement.

Wages are now rising more rapidly in the fully employed economy, and this trend is likely to reverse as automation increases. Consequently, it is more important than ever before in human history to own skills that are deemed necessary for a rapidly evolving techno-economy.

Furthermore, companies must adopt coming trends in AI that can create competitive advantage and generate value. This is what Amazon has successfully done, (and not without major criticism for being one of the early and successful pioneers).

At a minimum, you can at least own assets that will rise in value as a result of AI growth. To me, this means owning shares of companies like IRobot, Nvidia, Google, Bosch, Ekso Bionics, Northrop Grumman, Honda, Boston Dynamics or Waymo. There are many others so now is a good time to conduct your own research.

by Mark Schniepp
March 2018

We’ve been reporting for years that the labor markets in California and the nation are as healthy as they can possibly get, that anyone who wants a job can get one, and that technology has been the engine of growth during this expansion.

The state just revised the jobs numbers for 2016 and 2017 that affirm all of this, and then some.

The unemployment rate in California is the lowest since reliable records have been kept. My data for the state go back 50 years to 1968.

Technology employment, though slowing down, is still the engine of growth in California and remains the fastest growing sector of the Bay Area economy.

California created another 333,000 jobs in 2017, about 40,000 more than previously reported. My continued question about this is how can the state and its regions continue to produce more jobs when the unemployment rate says that the labor force is fully employed?

The only way to create new jobs is for the labor force to expand. Now the labor force is merely the population, 16 years or older, that wants to and is able to work. The labor force expands when seniors graduate from high school or college and enter the job market, and when graduates complete graduate school.

The labor force can also expand when people move to California from other states or countries, legally or illegally.

So 126,000 people that were previously unemployed found work last year and another 218,000 new people entered the labor force and were employed.

But this kind of scenario cannot continue much longer. At some point, the low unemployment rate will constrain employment growth and not just marginally like it has to date.

The Robots are Coming. No They’re Actually Here Now.

The tightness of California’s labor market is and will continue to manifest in onerous conditions for firms in recruiting new workers, higher wages and salaries, and more demands by workers for additional benefits, such as more paid time off, a better healthcare plan, or an office with a window.

Rare conditions like these accelerate the incentives by firms to pursue substitutions for human labor with more capital intensive investments. And with the new tax bill, there are additional incentives to explore labor saving automation. You see, there is full and immediate depreciation of capital spending, including investments in technology and equipment (like robots) that could soon or ultimately replace workers.

Consequently, with a fully employed and healthy economy in 2018, look for more news about the implementation of workplace robots, especially in the service industries.

Take Flippy for example, who just this month started working at CaliBurger in Pasadena. The robot combines thermal vision, 3D vision and computer vision. Flippy can cook 150 burgers an hour, flipping them at the right time and removing them from the grill perfectly cooked. CaliBurger says more “Flippies” will be flipping burgers at multiple locations this year.

In late January, the first Amazon Go opened in Seattle. The convenience food store allows shoppers to scan their phone upon entrance, grab whatever items they want off the store shelves, and automatically get charged after exiting the store without needing to stop at a register. In fact, there are no registers and the only employees in the store are those that prepare fresh food, check IDs for beer and wine, and stock the shelves with merchandise.

Not only does the new technology replace human cashiers, it eliminates the wait to check out which can often be as long or longer than the shopping time. Moreover, this new technology also renders shoplifting obsolete.

Another Amazon Go is apparently being planned for a location in the Grove in Los Angeles later this year, with another 5 stores to open elsewhere.

Since Amazon now owns Whole Foods, the “Go” technology might be headed that way in the not-to-distant future.

by Mark Schniepp
February 2018

GDP growth in the 4^th quarter was 2.6 percent, which is in line with expectations. This amount of economic growth is not too hot and not too cold, and at this point in the economic expansion, it’s actually a decent number. Though most of the GDP reports during the current expansion are considered disappointing, the economy continues to hum along producing new highs in many key indicators along the way.

I wrote about this last year and conditions have only improved since. We are at fuller employment, a much higher stock market, higher consumer confidence, higher industrial production, and a faster than expected pace of consumer spending.

Why? Everyone has a job, business confidence and investment are strong, and the world economies are growing including the troubled ones like Spain, Greece, Ireland and Italy.

Last year I called it another Golden Age of the American Economy. These don’t come around often so enjoy it while it lasts. But that begs the question: How long will these times last?

The financial markets sold off sharply on February 2, and again on February 5. What does this mean? Is this a timely omen? Are we now in the midst of an inevitable fall?

As an economic forecaster, I’m always on recession watch, but admittedly I’ve been able to nap a bit at my post because the economy shows no tell tale signs of weakness.

A 2,000 point contraction in the Dow Jones Industrial Average (or a 200 point decline in the S&P 500 index) is actually a healthy sign for this market. The indices have simply risen too far, too fast and for too long without a pull back. We have been expecting some sort of correction for quite some time. Profit taking is inevitable and arguably, the price-to-earnings ratio is on the higher side of history and needs some adjustment.

Fundamentally however, corporate profits are higher and should continue to rise this year because of the new tax policy and a growing world economy. I look for the financial markets to stabilize and resume their upward march this year, albeit with a little more volatility than we’ve seen the last two years.

The probability of recession is unbelievably low and business confidence around the world remains surprisingly strong. Just because the financial markets are going through a correction doesn’t mean that economic momentum has changed.

The recent fire and flood disasters in California will only act as a further economic stimulus providing more opportunities for business expansion this year and next.

So don’t let a few hundred points in the S&P get you down…. not just yet anyway. The economy remains fundamentally strong and economists are generally looking for a stronger growth year in 2018 than we experienced in 2017.

Your List for 2018

• Learn the basics about the new tax reform act and take advantage of it. Speak to a seasoned accountant this year because tax reform rules now apply. Part of this may ultimately be investing in your business with new capital and equipment.
• Technology is changing at an accelerating pace so have your IT up to date and ready to change going forward.
• Automate what you can. Hiring is more expensive and it’s so tough to recruit.
• Business conditions are unlikely to change much this year. There will be more income and more spending because more people are working and earning a higher salary.
• Interest rates will go higher. All forecasts have the 30 year mortgage rate moving higher through the year.
• Nevertheless, home prices will still move higher. If you are waiting for a pullback in prices, it won’t be this year.

by Mark Schniepp
January 2018

The Expansion Continues Through the Year

We are now in month 102 of the economic expansion, eclipsed only in recent times by the March 1991 to March 2001 expansion lasting 120 months. From what we can see at this vantage point in early 2018, the current expansion will at least challenge that record.

The Tax reform bill will result in a net gain in economic growth in 2018, despite all the wrangling commentary you’ve heard over the last 30 days. Tax reform will certainly have a positive effect on corporate profitability. And higher expected profits will drive stock market valuations.

So while it’s hard to see the 2017 stock market returns eclipsed in 2018, barring any episodic change in the world’s economy, the stock market advance is likely to continue. An expanding economy supported by low interest rates, low inflation and improving corporate profits all provide a favorable environment for stocks. The second half of 2018 is less certain, and cracks in the economy that are invisible now may begin to show. Hence more volatility in the market is likely.

Admittedly, tax reform could be modestly negative for housing, especially as the mortgage-interest and property-tax deductions will be scaled back some.

However, real estate is more highly dependent on local factors. Creation of higher paying jobs, for example, are lacking in certain parts of the nation. And though homes are much less affordable in California and other coastal hotbeds, there remains strong demand for higher paying positions, particularly in the technology sectors. The state continues to attract population from other states and abroad. Furthermore, there’s all those millennials living with parents. Are they ready to move out yet?

And incidentally, whichever city lands Amazon’s coveted second headquarters this year could become a sizzling housing market practically overnight, for better or worse.

The global economic outlook continues to improve. The expansion has been underway since 2010 but now almost all affluent nations are growing again. World GDP is forecast to rise 4 percent this year. Global growth will only heighten the demand for U.S. products and services.

What You Should Expect in 2018

Increased profitability and continued job creation

• Due to lower corporate tax rates and a rising global economy

Rising interest rates

• The fed is committed to higher rates, especially in an expanding economy

Rising wages

• We are at full employment and rising wages are a natural outfall of this
• If you need workers this year, recruiting will be difficult

More stock market volatility

• Valuations are high and we are overdue for a correction

An increase in consumer spending

• This is a no-brainer based on higher wages in a fully employed economy. Furthermore, stock market valuations are at record levels, household net worth is at record levels, and average real estate equity per household is just shy of the 2005 record level

A modest increase in inflation

• A symptom of an expanding economy at full employment
• The rate of inflation will be higher in California due to housing

More new homebuilding

• Especially more affordable homes

A Note on Bitcoin

I mentioned it last month but said little. Why? Because there’s really not much to say. The meteoric rise in price has corrected some in recent weeks. Valuations for Bitcoin and other cryptos will ultimately head further south. The question is not if but when because the digital asset has no protection, no intrinsic value, plenty of substitutes, and its price behavior is indicative of a textbook bubble, driven by speculation. If you own bitcoin, you’d better be thinking carefully about an exit strategy. However, I do believe that the general class of cryptocurrencies is here to stay as a modern method of asset exchange.

by Mark Schniepp
December 2017

Well the title should actually read: “It’s the Economy Stupid.” I hope that got your attention because you’re gonna want to read this final feel good edition of the newsletter for 2017.

If you will recall, that was the old campaign slogan of Bill Clinton in 1992. And it’s still true today because it’s the answer to the question of why American households feel so optimistic about their economic futures. Except this time, conditions are stellar rather than lackluster as they were for much of 1992, prompting the regime change from Bush to Clinton.

Despite record numbers of retail closures this year, horrific fires, hurricanes, Kim Jong Un and an ugly World Series game 7 (for the Dodgers), the consumer confidence index rose another 3.3 points in November to the highest monthly reading in a generation, or since December 2000. Americans view their current and future job prospects very favorably; ditto their income growth and their spending levels. Consumers have been the strongest and most consistent source of growth in the current economic expansion.

The increase in household wealth has been stunning as wages are rising and stock and house prices have surged.

Last week’s Gallup U.S. Economic Confidence Index rose sharply, at more than twice the rate as the average weekly gain observed over the past year. Like the Consumer Confidence Index, the Gallup pole measures American sentiment regarding both current and future economic conditions. The Gallup current condition component of the index rose to its highest level since Gallup began tracking economic confidence in 2008.

The confidence indices are now at some of the highest levels ever recorded. Why? Because economic growth is accelerating, everyone has a job, incomes are rising, homes are selling, and the new Star Wars movie is about to be released.

Speaking strictly in terms of the economy, 2017 has been a good year and perhaps the best year during this up phase in the economic cycle, which began in July of 2009.

We are now in year 8 of the economic expansion and by next summer, we will be in year 9. Economic expansions rarely go for 9 years but this one is clearly headed that way. We have no indications at this time that the economy is vulnerable. And fortunately, there are no bubbles, except for Bitcoin.

The economic expansion continues to power forward. Recent economic data have exceeded expectations and in some cases by a wide margin. Along with strong confidence in the economy, the unemployment rate is the lowest since 2001 and October existing home sales rose to their highest level since 2007.

Furthermore, third quarter 2017 gross domestic product growth was revised higher, from 3.0 percent to 3.3 percent. The nation is now growing at the fastest pace since 2014. We are likely to see approximately 2.7 percent growth in the current quarter of 2017 with consumer spending leading the charge. Remember, hundreds of thousands of vehicles need to be replaced in Texas and Florida. And tens of thousands of homes need major repair.

The likelihood of recession over the next six months is now at the lowest level since the risk of recession index was invented, back in 1996. If there is a chance that the economy will change over the next six months, it’s likely going to be faster growth because of impending tax cuts, fire and hurricane rebuilds, infrastructure spending, and a rising stock market which is already at record levels.

The Senate Finance Committee passed its tax reform plan. The full Senate will now consider the bill. The potential for tax reform is a further contributing factor for high consumer confidence and record stock valuations.

OK, Conditions Appear Safe for Now but What are the Seeds for the Next Recession?

A myriad of conditions can produce a recession, but the ones that we can identify in the current environment are these:

• Overly tight monetary policy
• A supply shock
• Another financial crisis

The Federal Reserve is expected to hike interest rates in December and several times in 2018. Despite low inflation of 1.3 percent in the core consumer price index, the Fed will decide that GDP growth is strong enough to boost the short-term federal funds rate to 3 percent by 2020 from 1.25 percent today.

Long-term rates that affect mortgages are likely to stay low if inflation remains contained, which we expect to be the case for a while.

So while the fed is trying to tighten monetary policy, their prescription for raising (normalizing) interest rates is very conservative and cannot be interpreted as “overly” in any sense of the word.

A supply shock is just that, a jolt to the domestic or world economy that is a shock, or unanticipated. We can’t predict one and it’s unlikely to happen. We do see that geopolitical risks are rising especially between North Korea and the U.S., so we are watching this with particular interest. But we can’t otherwise predict a random event.

Another financial crisis is also very unlikely because of regulations put in place since the last financial crisis. Banks are quite healthy today. Nevertheless, international incidents including defaults by entire countries (like Greece or Spain) might always occur, especially in the very slow growth environment of Europe. We don’t see this as a major risk, nor even a minor one. The European economy is actually strengthening, as is much of the rest of the world.

At this writing (December 2017), it appears that we will avert recession for another year. So plan accordingly.

by Mark Schniepp
November 3, 2017

Key Elements of the New Tax Reform Plan

So as of November 3, here are the key components of the House Ways and Means Committee’s tax reform proposal, before any further revisionist intervention from the full House or Senate:

The maximum corporate tax rate would be cut from 35 to 20 percent. Many business expenses would no longer be deductible, except expenses on R&D, low income housing, and some other miscellaneous expenses. Depreciable asset expenses can be deducted entirely.

There are 3 proposed tax brackets for individuals: 12, 25 and 35 percent instead of the seven that now exist.

The AMT (alternative minimum tax) would be eliminated. The standard deduction for middle class families would be doubled.

The estate tax would be gradually reduced and entirely repealed in 6 years.

The inherited wealth exemption would double from $5.5 million to $11 million.

Tax credits for children will increase from $1,000 to $1,600.

Itemized deductions would be eliminated, except for charitable expenses and the mortgage interest deduction which would be capped for newly purchased homes up to $500K.

Also property tax deductions would be retained but only up to a maximum of $10,000.

State and local taxes would no longer be deductible.

There would be no changes to pre-tax 401(k) contributions.

There is a new 25 percent tax rate for sole proprietorships, partnerships, and S corporations that currently pay taxes at the individual rate of their owners. These type of businesses represent about 95 percent of all businesses in the U.S. and produce most of the corporate tax revenue for the U.S. government.

How Will this Impact You?

If you own a home in coastal California and you’ve purchased it in the last 4 years or so, your property taxes are likely in excess of $10,000 annually. So you will not receive the full benefit of the property tax deduction. However, the standard deduction roughly doubles from $6,350 to $12,000 for individuals and $12,700 to $24,000 for married couples.

If you are a business owner, you are very likely to see a smaller tax obligation. And if a large part of your business expenditure is for research and development of the business, or equipment, software or the purchase of a building, then your tax liability will go even lower because those expenditures will be deductible on top of the low 20 percent maximum rate.

Do We Need Tax Reform?

The hieroglyphical tax code that we all have to navigate through each year to determine both our personal and our business’ tax obligation is constantly changing and seemingly growing more complex. For anyone that has filed a tax return beyond the standard 1040 form, their answer is a very likely yes. We desperately need tax code simplification.

Does the economy need a tax cut? Well, growth has remained strong even as the administration and the Republican-led Congress have struggled to enact economic programs. And despite all the campaign rhetoric about jobs and businesses going overseas because of high corporate taxes, the economy has remained ruggedly resilient, the unemployment rate is the lowest in 17 years, real wages are rising, and GDP growth is accelerating.

Tax reform is always welcome, but do we need a tax cut to stimulate economic growth? No, not right now.

Conclusion

For me, any tax reform that is an actual reduction in my taxes is a good thing. I would much rather control the expenditure of my own income than I trust the federal or state government to do. So any tax cut is welcomed, providing it actually does reduce my taxes.

As Californians, some of us will face a higher tax bill due to the fact that we won’t be able to deduct all our property tax payments. This is especially true if you purchased a home recently in the Bay Area, or coastal Southern California. Moreover, the state income tax payment is non-deductible and California income taxes are higher than anywhere else.

Also, the home mortgage deduction on new purchases will be capped for many new home owners in the higher housing cost areas of the state. This includes Santa Barbara and Goleta, coastal Ventura and Oxnard, the Conejo Valley, most of LA and Orange County, and coastal San Luis Obispo County. A reduced mortgage rate deduction will impact the decision to buy a home in California, so fewer home sales next year are likely. Realtors are naturally against this.

If you already own your home, you’re not going to be affected by the limits on the mortgage deduction. If your household income is above $250,000, then the elimination of the state income tax deduction will hurt you, but as an offset, you’re likely to benefit from the business tax reforms.

The Tax Foundation in Washington D.C. has evaluated the plan and according to them, households from the full range of incomes would benefit with at least a modest tax reduction.

Critics say this plan will hurt the poor. This is nonsense simply because the poor do not pay any state or federal income taxes. The bottom 35 percent of Americans will not get any extra benefits, because they already have a $0 federal tax liability.

Might this plan increase the deficit? Yes, it likely will. But I see the deficit as it’s own issue which does not have to be addressed when discussing tax reform. Why? Because there is always expenditure reform which many people erroneously assume is unreformable. The Senate must consider expenditure reform if they hope to pass tax reform with a 51 vote majority. Otherwise, the plan is dead.

Upcoming Presentation:

Santa Barbara Executive Roundtable
“Anticipating and Bracing for the Next Recession…”
Panel discussion with Mark Schniepp, Brian Johnson, Keith Berry, and Justin Anderson
November 9, 2017
University Club, Santa Barbara, 8 AM

Register Now

by Mark Schniepp
October 2017

First Half GDP Growth

Second quarter real GDP rose 3.1% at an annual rate, up from 1.2% in the first quarter. That’s a decent economic growth rate for the U.S. at this stage in the expansion, but not a great one. The third quarter of 2017 is now in the books. How did the economy do and what does that mean for the final quarter of the year?

We can’t forget that Irma and Harvey struck in the third quarter of the year. They destroyed nearly 1 million cars and damaged over 200,000 homes in Texas, and nearly every home in the Florida Keys. More than 20,000 homes were completely destroyed by both hurricanes.

Damage Valuation

The carnage is still being assessed and will change with more information, but at the end of September, the latest estimates for the cost of Hurricane Harvey’s damage range from $65 billion to $190 billion. In the event the actual cost falls on the higher end of that range, it could become the most expensive disaster in the history of the U.S.

Meanwhile, Hurricane Irma damage could end up costing between $50 billion and $100 billion. Irma was the bigger storm but the property damage due to flooding was much greater with Harvey.

The storm and floods have interrupted 20% to 40% of U.S. refining capacity. The damage to refineries was serious and caused gasoline inventories to sharply decline, affecting gasoline prices. Consequently, the Department of Energy released 5 million barrels of oil from the Strategic Petroleum Reserve to bolster supply.

Despite all the carnage and tragedy, the hurricanes hardly affected consumer optimism; the assessment of present economic conditions hiccupped in September, while expectations of future business conditions moved higher. Consumers still believe jobs are plentiful and they expect their incomes to increase over the next 6 months. Their buying plans have slightly declined for homes and cars but have increased for major appliances.

It does appear that Harvey impacted new home sales in August because that metric was off 3.4 percent during the month. We know that the September numbers will be more negative when they come in next week. However, new home sales have slackened elsewhere as well and not just in Texas and Florida. So the hurricanes are only partially responsible for tepid U.S. home sales.

Spending during August was also affected slightly, with less retail sales of general merchandise and less consumption of utilities (because of power outages). Nearly 6.9 million homes were left without power in Florida, Georgia, North Carolina, South Carolina and Alabama.

The damage and closure of Gulf located refineries notably pushed gasoline prices higher following Harvey in Texas. However, average U.S. prices are now falling precipitously again. In California, the price spike was much less significant.

Who Loses and Who Wins

An estimated $20 to $30 billion in economic losses are the immediate impacts resulting from business interruptions, such as idle hotels, closed stores, shutdown refineries, workplaces closed and people unable to go to work, Disneyland, SeaWorld, and Universal Studios—all closed. Spending was therefore curtailed on energy, home buying, car buying, and tourism. There is an estimated 50% to 70% loss of Florida’s citrus crop, valued at $1 billion. The estimate for third quarter GDP is predicted to be ½ percent lower because of the hurricanes. So perhaps a rate of between 1.8% and 2.3% is anticipated.

But we fully expect that total economic activity linked to rebuilding and replacement spending will compensate for any short-term economic losses. Already, Congress has allocated more than $15.3 billion in hurricane relief funds to the more than 1 million applicants for federal aid so far.

This means the economy, as a whole, will not only be okay, but will likely see a surge in GDP growth during the first half of 2018. Stay tuned for more updates in future newsletters.

by Mark Schniepp
September 2017

The current environment for housing in California is being routinely referred to as a crisis. Many consider it a bubble and anticipate the possibility of another crash.

For California, the “housing crisis” is a direct consequence of the state’s economic boom. And 30 years of resistance to housing development has resulted in an onerous environment for the creation of new housing today. California has always been a desirable place to live and over the decades has gone through periodic spasms of high housing costs. However, a booming economy and the lack of construction of homes and apartments have conspired to produce the current housing crisis.

The Heart of the Problem

The economic recovery and expansion have not occurred without consequences.

The technology revolution, epicentered in California and in particular the Bay Area,

has resulted in the creation of thousands of higher paying jobs. The record levels of foreign and domestic visitors vacationing in California has also pushed job creation in the visitor serving industries to all time record levels. The aging of the baby boomers and the Affordable Care Act are responsible for pushing employment in healthcare jobs to all time record levels.

The tech boom, the visitor boom, the healthcare boom, and the professional services boom have employed every California resident that wants a job and encouraged an estimated 512,000 net migrants into the state from 2011 to 2016.

The strong demand for and consequent creation of millions of new jobs since 2010 has encouraged extensive office development in San Francisco, Los Angeles, Orange County, and Santa Clara Counties.

But these counties have failed to build a commensurate amount of housing, for new workers and new in-migrating populations.

Cities have built high tech research parks and innovation campuses but have failed to build housing. Consequently, a major imbalance has resulted and this imbalance has manifested in sharply rising home prices and apartment rents since 2011.

The high cost of housing is principally a failure to build.

Proposition 13

And then there is Proposition 13 which caps property taxes, discouraging owners to sell their properties and face a major tax reset. And in recent years with property values escalating to all time record highs in the state, the disincentive to sell is too great so there is far less for-sale inventory of existing homes that would typically provide for a lot more inventory.

Furthermore, cities receive very little in property taxes from homes whose value has not reset in the last 10 or 20 years. Consequently, this fiscal disincentive which grows larger over time gives communities little reason to permit more housing, especially when the neighbors already oppose it for all the usual reasons.

Supply Limitations

Cities and Counties use zoning, environmental laws and procedural laws to oppose, discourage, and/or deny residential projects deemed too large or out of character.

There are also growth restrictions put in place by voter referendums that directly or indirectly limit housing development. Examples of these are density and height restrictions, or an actual limit on housing unit development.

Cities that deny housing are a principal and direct cause of the housing crisis.

The lack of housing supply, together with the demand for housing encouraged by a strong economy and record creation of jobs and income, has created a political environment where prospects for a state housing intervention appear more likely than ever.

Housing Elements

Since 1969, California has required that all local governments (cities and counties) adequately plan to meet the housing needs of everyone in the community. California’s local governments meet this requirement by adopting housing plans as part of their “general plan.” The law mandating that housing be included as an element of each jurisdiction’s general plan is known as “housing-element law.”

California’s housing-element law acknowledges that, in order for the private market to adequately address the housing needs and demand of Californians, local governments must adopt plans and regulatory systems that provide opportunities for (and do not unduly constrain), housing development. Consequently, housing policy in California rests largely on the effective implementation of local general plans and, in particular, local housing elements.

However, providing opportunities under the housing element law and actually approving and permitting housing units are not the same. Getting the homes built is largely ignored by most jurisdictions in California today. Why? Because there is no real penalty for denying housing, even if there is adequate zoning for it.

The myriad of association of government agencies in California help to develop a RHNA for each county and city to follow for their zoning of housing. RHNA stands for Regional Housing Needs Allocation.

RHNA is supposed to enable cities and counties to anticipate their growth so that their quality of life is enhanced. And this includes producing a fair share of regional housing to accommodate anticipated growth.

However, too frequently, cities and counties use their planning processes as complex and complicated systems that confuse and frustrate prospective developers who must navigated through a labyrinth of requirements. It is often a highly discretionary process that effectively obstructs housing and therefore anticipated growth.

The most recently completed RHNA planning period is January 1, 2006 to June 30, 2014 for most Southern California counties. For this time period, housing estimates were developed based on population, employment and household growth projections. In Southern California, a total of 821,000 housing units were allocated. Only 404,500—less than half—were built. In the Bay Area, 215,000 housing units were planned for. Only 116,000 were built.

For the 2014 to 2021 planning period, the RHNA allocation for Southern California is 412,000 housing units, of which 180,000 are in Los Angeles County and 19,000 are in Ventura County. Permitted housing in L.A. County is currently on a pace that could meet the RHNA allocation. However, Ventura County is way behind.

Bills in Sacramento to Help Resolve the Housing Crisis

The general notion prevailing today is that the state needs to do more to penalize cities and counties that are blocking development before agreeing to spend more dollars subsidizing projects.

There is currently one law on the books from 1982, the Housing accountability act, which requires cities to approve housing projects if they meet 3 fundamental criteria. Cities often interpret the criteria with discretion, and projects are downsized or denied. Predictably, there has been a spate of lawsuits over the years between developers and cities arguing whether the criteria have been met.

There are now three more bills in Sacramento looking to move forward this Fall:

SB35 Affordable Housing: streamlining the approval process

This bill essentially forces housing recalcitrant cities to eliminate impediments to new housing development and accept a streamlined entitlement process from HCD for approving new housing developments.

HCD is the California Department of Housing and Community Development that promotes policies and programs to expand affordable housing.

SB 3 The Affordable Housing Bond Act of 2018

This effort would place a $3 billion bond for low-income apartment housing on the November 2018 ballot.

AB 1505 Inclusionary Housing

This potential law would require that any new development of rental housing include a certain percentage of affordable rental units.

Rent Control Initiatives by Tenant Coalitions

Momentum is now building again for the implementation of rent control to cap rental rates on housing in California. Currently about 15 cities have some form of rent control, including San Francisco, Oakland, and Los Angeles.

A bill has also been submitted in the California Assembly to repeal a 1995 state law—the Costa-Hawkins Rental Housing Act—that limits the scope of local rent control laws. AB 1506 seeks to eliminate rent control exemptions for duplexes, condos, and single family homes to enable rents to be capped on newer housing stock built after 1995.

And in the November 2016 election, rent and eviction control ordinances passed in Richmond and Mountain View.

Rent control was strengthened in Berkeley, Oakland, and East Palo Alto.

Voters passed Measure U1 in Berkeley, which increases the business license tax on landlords with five or more residential units. The tax increased from 1.1 percent to 2.9 percent of gross receipts. The tax may not be passed onto tenants.

In East Palo Alto, this same business license tax is 1.5 percent of the gross receipts of landlords.

Rent control was defeated in Burlingame and San Mateo and Alameda. But a rent review and stabilization ordinance was passed by voters in Alameda.

The Santa Barbara City council considered it in March 2017 but rejected pursuing it as a policy and will consider issues associated with rental mediations and inspections.

by Mark Schniepp
August 2017

Ho Hum

A year ago I made the assessment that the economy was boring, growing at a lackluster pace but growing steadily nonetheless and generating higher asset values, more jobs, more spending and rising confidence by consumers in the U.S. economy.

Just recently, Moody’s economist Mark Zandi picked up on this idea and wrote about it in his monthly U.S. Macroeconomic Outlook at economy.com, noting:

It’s almost boring. Regardless of what’s happening around the globe—and a lot seems to be happening—the U.S. economy continues to plug away. The U.S. economic expansion is 8 years old and counting, and growth remains remarkably stable.

No Surprises

The stability of the economy and the lack of any drama has made monitoring the economy a boring task. The boring economy is why the stock market continues to set new records, seemingly every month. Stock markets hate surprises typically created by chaotic events in the U.S. or World economies. They like steady growth, little inflation, low unemployment and modest wage pressures, exactly what we have now.

Yes, the economy is both stable and boring. There is no drama. No inflation, no runaway interest rates or even rising interest rates, no scarcity of job openings or new hirings, no consumer meltdowns, no financial crises, no bubbles (that we can detect), and gasoline prices that have remained relatively constant for the last 2 years………

There is a disruption in the retail sector, which was the subject of the July newsletter. But nevertheless, despite retailer closings all over the country, there is no diminishment of economic growth and no threat of recession. The index of leading indicators continues to rise month after month. The risk of recession fell to its lowest level ever in April and it remains low today.

GDP growth came in at 2.6 percent for the 2^nd quarter of 2017. That’s neither too hot nor too cold. The unemployment rate is now at 4.4 percent, indicative of an economy in which everyone who wants a job can get one. Inflation is running at less than 2.0 percent again, even the core rate.

Internationally, European growth has improved and even the Chinese economy has rebounded. Furthermore, we haven’t heard about Greece in some time.

There’s just not much to get worried about or for me to warn you about. It’s just plain boring out there. So continue to enjoy your full time job, your rising salary, your summer vacation, your new car, your new or remodeled home and your new IPHONE 8, due out this fall.

by Mark Schniepp
July 2017

Stores are Closing in Mass

Macy’s closed 68 stores this year. An estimated 4,000 employees have been impacted. Another 34 stores are planned to close in the next 4 years. At the end of this month, JC Penny will begin to close 138 stores, and liquidation sales are underway at many of these stores now on the chopping block.

Sears and Kmart are closing 72 more stores after already announcing that more than 180 stores will close. Most of the closures will occur in September. The total Sears store count will fall to about 1,200, from nearly 2,100 five years ago. Very few closures will affect California and there are none in Southern California.

Here are other stores on the list of closures that have either occurred or will occur this year:

Approximately 49 million square feet of retail space has closed year to date. Should this pace persist by the end of the year, total reductions could reach 147,000,000 square feet, which would be an all time record high.

Closer to home, we’ve seen a number of retail fatalities in California. The Gap, JC Penny, Kitson’s, Sears, 9 Walmarts, 19 final store closings of Sports Authority, and 30 Payless shoes stores will shutter this year in Southern California alone. Macy’s has already closed stores in Sacramento, Los Angeles, Irvine, Simi Valley, and Santa Barbara.

And speaking of Santa Barbara, there have been a spate of recent retail and restaurant closures on State Street, resulting in the highest level of downtown retail vacancy since the mid 1990s, according to the Radius Group.

What is Driving Retail Liquidation?

There are too many stores and too many shopping malls. The U.S. has more retail space per person than Canada, Australia, the UK, France, China and Germany.

Rents have also become alarmingly expensive for retailers. CBRE reports that rents have moved up faster than the growth of retail sales, and the rising level of rents cannot often be justified by tenants.

The Baby Boom generation is buying a lot less “stuff” these days, opting more for experiential purchases such as education and travel. And the Millennial generation doesn’t seem to want a bunch of stuff either, other than phones, food, and craft beer. Since Millennials are not buying many homes, they are not having to furnish those homes with carpets, refrigerators, lawn mowers, or new furniture.

But the biggest factor is the widespread and pervasive migration to online stores for many goods, even clothing.

Despite the view that shoppers prefer to try on clothing in physical stores, apparel and accessories are expected this year to overtake computers and consumer electronics as the largest e-commerce category as a percentage of total online sales, according to research firm eMarketer.

And though total online sales account for only 9 percent of total retail sales in the U.S, the growth of online purchasing is rising geometrically.

You can purchase just about anything online and just about everything from Amazon. The Amazon stock price has soared over the past year and is up 40 percent year-to-date over the first 6 months of 2016.

What’s Ahead for Retail?

The Internet and the growth of the online retail experience continues to evolve as one of the most disruptive forces in today’s economy.

The transition from the current retail environment to a steady state retail economy where rising rents for retail space do not exceed the growth in retail sales is ahead of us. This transition could span years however. Furthermore, to the extent that online shopping for goods and services becomes more mainstream among consumers (as it threatens to be), more store closures are likely until the supply of stores is compatible with the demand for stores.

Sales in stores still comprise 90+ percent of all retail sales. Consequently, making the retail experience more compelling will be the challenge to retailers.