State of the Real Estate Market Summer 2014

Mike Hambright: Welcome to the Flipnerd.com Podcast. This is your host, Mike Hambright, and on this show, I will introduce you to V.I.P.s in the real estate investment industry, as well as other interesting entrepreneurs, whose stories and experiences can help you take your businesses to the next level. We have three new shows each week, which are available in the iTunes store, or by visiting Flipnerd.com. So without further ado, let’s get started! Hey, it’s Mike Hambright, with Flipnerd.com, and welcome back for another exciting V.I.P. interview, where I interview some of the most successful real estate investing experts and entrepreneurs in the industry to help you learn and grow. Today, I’m joined by Dr. Christopher Thornberg. He’s a founding partner of Beacon Economics, and a wealth of knowledge on where the real estate market is going. Now, Chris is a regular commentator on CNN, NPR, The Wall Street Journal, The New York Times, but today, he’s sharing his insights with us here on Flipnerd.com. Before we get started with our interview with Chris Thornburg, let’s take a moment to recognize our featured sponsors.

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Mike Hambright: Hey, Chris, how are you? Dr. Christopher Thornberg: Doing great, thanks! How about yourself? Mike Hambright: Good, good. Welcome to the show. Dr. Christopher Thornberg: It’s nice to be here. Mike Hambright: Yeah, yeah. So, you’re the guy that’s got his pulse on where this crazy real estate market is heading, I guess? Dr. Christopher Thornberg: In theory, yeah. You know, it’s funny, I used to be an academic, worked in a variety of schools, including Clemson and UCLA. But in 2006, I kind of tossed all that away and started my own company. In part because of my beliefs about the housing bubble that was in the U.S. economy, and the damage it was going to create, on the way down. That forecast, unfortunately, turned out to be dead right, and of course today, we’re watching the other side of it, which is to say we’re in the midst of another sort of accelerating real estate market. Mike Hambright: Yeah. Yeah. It’s interesting, and I know, we’ll talk about this in a second, I know, if your real estate’s very local, and depends very heavily on where you’re at in the country, but it feels very much right now like 2005, 2006, in a lot of ways. Dr. Christopher Thornberg: Yeah, but you know, in a lot of ways it’s not. I’ll tell you that. I realize that people say, “Jeez! A lot of demand, prices are rising rapidly.” But on the other side of it, there’s a number of very important characteristics we’re seeing in the market today that make it completely different from what we were seeing in 2005. Probably, the two most important differences between now and 2005 have to do with construction and credit. On the construction front, we’ll just start there real quick, you know, back in 2005, we were in a peak of home building. Builders could not produce enough product because people were snapping them up, mainly to flip, to be honest with you. The net result of that, as a nation, was severely overbuilding the housing stock.

At one point and time, roughly in 2006, 2007, by our calculations, the U.S. was saddled with something of the order of three-and-a-half million excess single family homes. That’s an enormous excess number, and of course, that tells us a lot about why the construction market has been so weak over the last few years. The other side of it, of course, is people were doing all that flipping, they’re buying all those homes with crazy credit. Remember that 2005 was in the back end of the “financial revolution,” known as securitization. Mike Hambright: Right. Dr. Christopher Thornberg: Of course, securitization, as it turns out, was really just a way of taking a bunch of really bad loans, and making them look, at least in the short run, kind of good for investors. Mike Hambright: Right. Dr. Christopher Thornberg: That loose, loose credit meant, of course, that in the aftermath of that, sort of housing bubble, there was a record number of foreclosures. Foreclosures like we’ve never seen before in this nation, really extraordinary from a long-term perspective. Well, again, you think about today’s market, it’s not that market at all. Indeed, if anything, most folks would agree that the pendulum has gone too far in the other direction. That is to say, credit is still very difficult to get out there today, in this particular marketplace. So, the lack of overbuilding and candidly, the tight credit situation we’re in today, both suggest to me that what we’re seeing in the housing market today is completely sustainable and really nothing resembling what I would call a traditional bubble. Mike Hambright: Yeah, yeah. That’s great. And, what role do you think the real estate investor is having this time around? Because it feels like, while they’ve always been very active, it feels like it’s a little more managed, now. There’s obviously a lot of institutional players involved, but what… Dr. Christopher Thornberg: Yeah, it’s a different kind of investor. This is not the investor you saw in 2005. The 2005 investor was using crazy credit to buy and flip homes. The argument was, “Gee, I could hang on to this property for three months, and see a 20% increase in the value.” Kind of crazy stuff, if you will. This time around, most investors seem to be buying mainly to rent out. Mike Hambright: Right. Dr. Christopher Thornberg: There may be some movement around, maybe one investor buys, cleans it up, and sells it to another investor. But for the most part, most of the product is not being purchased to instantaneously flip. Quite the opposite, it’s more of a long-term investment. And again, going back to one of the features of today’s real estate market, compared to 2005, in 2005, because of the excess supply of units, because of the fact that there was so much demand to buy, the rental markets were actually comparatively weak. Mike Hambright: Right. Dr. Christopher Thornberg: Today, the fact behind us of these few million foreclosures, with credit still relatively tight, you have a situation where home ownership rates really aren’t that high right now. Indeed, they just now found bottom. And, most of the action in the market today is not what I would call the retail buyer or the flipper buyer, it’s the investor buyer. People are saying, “Wow, look. Rents are expensive. Loans are cheap. We ought to be taking advantage of that by buying this product and renting it out.” Mike Hambright: Absolutely. Absolutely. I guess on that note, with rental properties, where do you see rents heading? I know this is a loaded question because it’s very different across the country but, and I have a rental portfolio myself and, you know, where I’m at, it’s very different in different parts of the country. In fact, most of my rental properties here, we tend to be in them for somewhere around half of bill price. So, you know, on some level, you should be pretty safe at those levels. But just generally speaking, where do you see rents going over the next three to five years? Dr. Christopher Thornberg: Well, that’s a good question! So, there’s two things about the rental markets. They’ve been very hot, the last few years, for reasons already described; mainly a lack of credit combined with a lot of people on the back end of a foreclosure meant that most new demand for housing was on the rental side. And, you clearly saw that in everything from the ownership rate to the type of stock that was being built. Today, the recovery in the multi-family space is complete; that is to say we’re up to normal levels of construction in that market, whereas the single family market is still relatively depressed. Typically, we expect to see one to 1 to 1.2 million single-family units being produced per year. Today, it’s still 600,000, so half the normal rate.

Now, the question that you just asked is, “When does that shift? When do we start heading back into a market that is more dominated by, say, the owner-occupier than the rental space, and the answer is probably, believe it or not, we’re already in the midst of the beginning of that part of the cycle. That is to say, home ownership rates have just now hit bottom, credit’s starting to get a little easier to get, and candidly, people have a little bit more confidence in the economy today. As you know, unemployment continues to fall, the job market continues to increase, incomes are coming up just a bit. You add it all up, and that would suggest we’re going to see a shift to back towards the single-family owner-occupier market. And, that will take some of the umph out of the rental market. Mike Hambright: Yeah. Dr. Christopher Thornberg: Now, the good news is, for those people out there who are renting out, particularly the single family rental, right off the bat, single family properties tend to be a superior good than your typical multi-family property. That is to say, when the demand starts sliding away, you’re more likely to see those vacancies hit the multi-family space than the single-family rental space. That’s just how these markets work. They may not be able to command the same sort of rents on that single-family unit but you could keep it occupied.

And ultimately, you know, I think that for most investors, and I think it’s probably a truism, that ultimately, 5, 6 years, you may find your best options just turn around and sell that unit. You’re going to make lots of great appreciation because home prices continue to rise even in today’s market. So, I’m not terribly worried about the single-family rental market, particularly with all the potential excess exit routes you have, but I would argue for small multi-family, older multi-family in some parts of the nation, particularly the Midwest, you may see a kind of excess supply situation start to occur. A lot of it’s going to depend on how long these investors hang on to those single-family properties. Mike Hambright: Yeah, and in terms of investors, what’s interesting to me is, you know, for as much talk as we’ve done about hedge-funds and institutional players coming in and buying, if you like at the top ten hedge funds, they bought less than 1% of the houses in America. It’s actually a very low percentage. Dr. Christopher Thornberg: Yeah, that’s true. Mike Hambright: And, the real estate investors tend to be a very fragmented group. Dr. Christopher Thornberg: Yeah. Mike Hambright: What’s interesting to me is, I think, Ma and Pa Landlord are finding it easier and easier to find properties that aren’t in their backyard. You know, there’s property management companies that are national franchises now that allow you to own a house anywhere. Technology allows you to buy and sell houses, and actually be somewhere without actually being there. It seems like there’s the, the opportunity is ripe, and it obviously is happening for people to buy rental properties all over the country where it used to feel much more like a local activity. Dr. Christopher Thornberg: Yes, but as always, you’ve got to be a little careful there. If you can’t see the property, you’re not there on the regular basis to make sure it’s being maintained properly, well, some things could happen. Obviously, if you’re going to be working outside of your local market, you want to make sure you have somebody you really trust, there on the ground level, managing the property for you. And keep in mind, when you have somebody manage your property, they often could cost quite a bit. Mike Hambright: Sure. Dr. Christopher Thornberg: That is to say, they could take a nice chunk off the top. So, while yes, on one level, in terms of portfolio diversification, it’s good to have properties in multiple markets. On the other hand, you do increase your underlying cost at a more-than-significant level, I would say. Mike Hambright: Yeah, yeah. I think probably where you see that more than anything is, maybe, investors on the coast, namely California . . . Dr. Christopher Thornberg: Yeah. Mike Hambright: . . . they want to buy in the Midwest, and in Texas, and areas where they can’t fathom that you can even purchase a house for that much money. Dr. Christopher Thornberg: Yeah. Mike Hambright: You can’t buy cash-flowing rentals in California so they look outside of California for cash-flowing rentals. Dr. Christopher Thornberg: Absolutely. Because, mainly because, as you already noted, when you tend to invest in California, you almost always start out in the negative position, that is to say, you’re losing money for the first couple years because prices are so expensive here. Mike Hambright: Yeah. Dr. Christopher Thornberg: One of the things about the coastal markets, particularly California, are complete lack of construction over the last twenty years, largely because of abuse, something known as a California Environmental Quality Act, the CEQA, has meant that our state is sort of perpetually under-supplied. Prices here are really hitting a very high level, and affordability gets worse and worse, but you know, in this case, it’s sheer supply-and-demand. So you’re right, a lot of west coast investors are looking towards the Midwest because, candidly, you just use too much capital investing out here, right now. Mike Hambright: Yeah. Yeah. And I know, for a lot of real estate investors across the country really, they’re feeling a lot of that pressure, that pinch of supply-and-demand. And, a lot of new investors that have come in, that want to get in on the game now, like you said, credit’s a little bit easier to come by, and there’s more activity like that happening. Specifically in California, a lot of investors that I know, are feeling a lot of pressure there to find deals. Dr. Christopher Thornberg: Yeah, absolutely! And it’s now becoming harder and harder because again, the lack of inventory is amazing. At the national level, right now, according to the National Association of Realtors, the housing market, the resale housing market, is looking at about six months supply. Mike Hambright: Yeah. Dr. Christopher Thornberg: That is to say, the overall number of units, divided by the pace of sales, here in California, looking at about two-and-a-half months supply. Mike Hambright: Wow. Dr. Christopher Thornberg: It’s a very, very tight market. And, it’s one of the reasons that some of the fastest pace of price growth is actually here in this state. Mike Hambright: Yeah. So, where does that, specifically in California, what does that mean? Where does that go from here? Does it start to peak out, or you think, just because it’s a supply-and-demand issue, it’ll continue to push up? Dr. Christopher Thornberg: Oh, I think it’s going to continue to rise. Again, this is not a credit-fueled increase in prices. You’re dealing with a true demand situation particularly in some of these inner city places. These are all cash offers that are driving the shows. A lot of foreign money moving into the area that’s driving the show. So yeah, I do consider that the area to expect ongoing price increases for probably the next two years. We will start to hit a cap, at some point and time. You will eventually reach “limits of affordability.” But, we’re not there yet.

One of the things that you’ll have to keep in mind is, with these low interest rates we’re seeing in today’s market, overall levels of affordability are actually still pretty good even from a long-term perspective. The nation, overall, could see about another 10% to 12% increase in prices just to get us back to what are called “historic norms of affordability,” given what these interest rates are right now. I hear, in California, it’s the same sort of picture. From a long-term perspective, yeah, we’re actually affordable in our own, very own affordable sort of way. Mike Hambright: Yeah, I think I saw something the other day that said that the median price point maybe, in San Fransisco, just hit a million bucks, or something like that. Dr. Christopher Thornberg: Maybe the city itself, possibly. Mike Hambright: Yeah. Dr. Christopher Thornberg: I know San Jose is the most expensive market in the nation as an MSA, which, of course, is a broader definition. The city of San Fransisco is different than the San Fransisco MSA. Mike Hambright: Right. Dr. Christopher Thornberg: But, the San Jose MSA recently saw a median prices hit over 800,000. Mike Hambright: Okay. Dr. Christopher Thornberg: And, that’s just off the charts. But again, this is tech money driving the show. What you have here is a lot of these kind of rich entrepreneurs who want to live close to their Apple campus or their Google campus, and they’re spending the money to live there. Mike Hambright: Yeah. So, nationally, can you share any insights on where some of the, I guess, more, bigger opportunities are for real estate investors? I’d like to kind of boil that down, ultimately, to kind of even a local level here in a second. Are there regions of the country where you’re seeing more opportunities than others? Dr. Christopher Thornberg: Well, again, it really depends. There’s a market by market basis, as you noted. Each market tends to be a little bit different. Mike Hambright: Yeah. Dr. Christopher Thornberg: Florida, I think, is becoming a hot market again, particularly towards the Miami area. Sure, they have lots of excess supply still but demand is off the charts, largely because of foreign money coming in, primarily from Latin America. Mike Hambright: Yeah. Dr. Christopher Thornberg: That’s one of the big markets that I think is seeing a nice bounce back at this point in time. Vegas, believe it or not, is starting to bounce back, as well. You look at the economy there, the jobs are back, employment’s back, hotels are busy again, and suddenly you start to see that housing market finally start to recover. Dr. Christopher Thornberg: Are you going to edit this? Mike Hambright: Uh, we can. Dr. Christopher Thornberg: Okay. Hey, I’m doing an interview here. No, because it’s ringing, and I’m on Skype, and it’s just like ringing and making all this noise. Okay, bye. That’s my business partner, believe it or not, I apologize for that. Mike Hambright: Nah, that’s all right. Dr. Christopher Thornberg: Let’s back up. Ask the question again? Mike Hambright: Umm… Dr. Christopher Thornberg: So, yeah, about different markets. Mike Hambright: Yeah. So maybe, could you share some insights for individual investors in their markets? Some of the things they should look for to know whether the market is getting overheated or not. Dr. Christopher Thornberg: Well, some of the things I like to look for, obviously, is you want to look at what I call “rent-to-price ratios.” You want to look at the price at a home, consider what the mortgage cost would be. Sit down and use your typical Excel spreadsheet, calculate what a monthly cost would be. Just a 100% loan-to-value, make it easy. Don’t even worry about, you know, “Well, gee, how much are you going to put down,” or any of that kind of stuff. Take that payment and compare it to local rental prices. It’s a great metric for how well the real estate market is being priced because remember, if you buy a house, you buy a condo, and you’re going to rent it out, it’s like buying a stock, and you get the dividend, right? And, that’s the flow you need to be paying attention to.

Your PE ratio, if you will, for a house, is that rental value, relative to the cost of the house, using those interest rates as that swing item. That’s a great place to look, and what you’re going to find in most markets in the U.S. is that rents are still relatively high compared to the cost of a home which suggests, yet again, that homes remain a good place to put your cash at this point in time, even with the big increase in prices we’ve seen over the past couple of years. Mike Hambright: Yup, yup. And for, kind of the lay-person, who doesn’t have the kind of economics background of you, or anywhere close to that, what should they look for in terms of long-term opportunities from a job standpoint? I know a lot of large multi-family investors are kind of following job bubbles. Where are the jobs being created at? Obviously, there’s a lot of places where those are being created. Texas and the Southeast are pretty hot right now; California, maybe not so much. Let’s talk about… Dr. Christopher Thornberg: Ah, ah, ah, ah, ah! Mike Hambright: Maybe, I’m wrong! Dr. Christopher Thornberg: That’s the attitude I see. For the record, last year and over the course of this year, California has actually added more jobs than Texas, in absolute terms. Mike Hambright: Oh, okay! Dr. Christopher Thornberg: So, yeah, we’re well over 300,000 jobs at this point in time. Mike Hambright: Okay. Dr. Christopher Thornberg: California, while it has its issues, there’s no doubt about it, on the other side of the equation, it has some enormously important job clusters including, of course, technology. Mike Hambright: Yes. Dr. Christopher Thornberg: And really, this state’s booming back. Last year, for example, the inland empire, which was very hard hit and it kind of hits the downturn, added about 4% to the labor force. Mike Hambright: Okay. Dr. Christopher Thornberg: So, you’re watching a lot of parts of California exploding right now. This is going to be one of the hottest economies out here. As already noted, the problem with California is the context of, “Can you build,” or “Can you buy,” because everything’s so expensive and so hard to do. That’s one of our biggest issues. Texas, as you already noted, clearly continues to be a hot state. Mike Hambright: Yeah. Dr. Christopher Thornberg: Several of the smaller states… Anybody who’s kind of oil-producing right now, tends to be a hot commodity. I’m sure you’ve heard about North Dakota, how well they’re doing. Mike Hambright: Yeah. Dr. Christopher Thornberg: There’s some pockets of Wyoming, for example, same sort of thing, energy boom really pushing things forward. Those markets are doing pretty well at this point in time. A lot of the Rocky Mountain states are doing very good. Colorado’s been bouncing back very nicely at this point and time. Pacific Northwest, believe it or not, also doing pretty well at this point and time; both Seattle and Oregon seem to be seeing fairly positive signs. And, as you already noted, obviously, the Southeast; Florida has been a very good market lately, coming back nicely. Probably the coolest part of the U.S. right now, in economic growth and home price perspective, is the Northeast. And ultimately, that shouldn’t be much of a surprise to us. Remember, those kind of global long-term trends of population movement within the United States are reasserting themselves. That is to say, people are moving south and they’re moving west. And, as you see those migrant flows begin to move yet again, that means kind of those traditional places or people moving to Nevada, Arizona. These places start to heat up and, of course, implies good medium-term investment opportunities for people like yourself. Mike Hambright: Sure, sure. And, let’s talk a little about inflation and interest rates. I think a lot of people believe that most of the government statistics that come out are baloney in terms of both of those things specifically, in terms of inflation. But… Dr. Christopher Thornberg: Yeah, I hear that all the time. And, what makes me laugh is a couple of things. First of all, one what basis do people make this determination that somehow these people in D.C. don’t know what they’re talking about? It actually, honestly, I know some people who have gone and worked for the Bureau of Labor Statistics, Bureau of Economic Analysis, who crank these numbers out. These people aren’t corrupt. Mike Hambright: Yeah, I think the biggest thing is that, you know, typically . . . [crosstalk 00:21:42] Dr. Christopher Thornberg: . . . make the number. Mike Hambright: Sure, sure. Dr. Christopher Thornberg: The inflation rate is exactly what they’re telling you. Yes, in some parts, they’re a little higher than normal. But, look at the price of gasoline. In real terms, it’s cheaper now than it was in the 1970s. You look at the price of automobiles, how they’ve come down; stereos, computers, all this sort of stuff. Yes, some parts are going up in price, other parts are going down. I believe the inflation statistics. Period. Mike Hambright: Okay. Dr. Christopher Thornberg: And, so do investors. I mean, look, remember, 10 year bottom ranks are not set by the Federal Reserve. There’s this idea, this argument, that somehow, the Federal Reserve has this incredible control over long term interest rates and mortgage rates. They don’t! They have a small swing power when it comes to the federal funds, right, and the ability to purchase and sell bonds. But, these are marginal effects. Interest rates are low today because inflation is low, and because there’s a whole bunch of new money floating around the global economy. What determines interest rates in the long term is the supply and demand for capital. And, we live in a world today that is awash with capital.

And, you want to know why? Look on the other side of the ocean, Pacific Ocean. There’s a little country there called China. China, of course, growing gangbusters, 7% to 8% per year, lots of new income, lots of new wealth being created. Oh, by the way, China has a 41% savings rate. These people are not far out of abject poverty. They still have the mindset that, “You have to save. You have to save.” Powerful amounts of cash just being generated and flowing out of that economy; you see it across the West Coast. You see tons of foreign investors coming and buying all sorts of stuff, both officially and unofficially.

I’m talking everything about people buying a home when they’re in Orange County to send their kids to, to major investment funds pouring billions of dollars into buying land in downtown Dallas or downtown Los Angeles. Tons of new supply, not a lot of demand, not a lot of inflation; this says low interest rates not only are here, but they’re here for us for a while. And so, ultimately, from an investor’s standpoint, that makes the housing market even that much more sustainable because really, I can’t see ten-year. But, ten-year rates got above 3½% in two years, I’d be shocked. Mike Hambright: Wow. Wow. I think not everybody has the same view. There’s a lot of folks that believe we’re going to see some rapid inflation here over the next few years to come. Dr. Christopher Thornberg: Well, you know, there are also people who told me, in 2005, it wasn’t a housing bubble and credit was fine. Mike Hambright: Sure, sure. Dr. Christopher Thornberg: And, the big banks were completely insulated because of the new securitization process. So . . . Mike Hambright: Yeah… Dr. Christopher Thornberg: . . . there’s all sorts of people out there, fear mongers or deniers, as the case may be. Don’t believe me. Go out and look at the numbers. One of the beautiful things is that you can go the Bureau of Labor Statistics, you can download everything they’re using in order to come up with these numbers they come up with. You can go bit-by-bit and step-by-step, and you can see for yourself that the numbers actually work out. So . . . Mike Hambright: Yeah. Dr. Christopher Thornberg: . . . I’m always a big believer in not listening but learning. Mike Hambright: Yeah. Dr. Christopher Thornberg: Get your head out there, play with the data, and see what’s out there. Mike Hambright: Yeah. For individual real estate investors, Chris, what do you recommend are some of the key metrics they keep an eye on in their markets? Dr. Christopher Thornberg: Well, again, I think I already mentioned the price-to-rent ratio. I think that’s an important thing to keep an eye on. That’s one thing to consider. Another thing is to pay attention to what is going on in terms of pace of construction. You know, there’s all sorts of data. You can go to the Census website. You can get monthly tracking of residential building permits. You can see what’s happening in your particular market. If you start to see a big surge in permits, a lot of new inventory come online, that should be a warning sign for you that the market may end up being over-supplied. That’s not an issue at this point and time, but it may end up being in the next year or two, depending on how rapidly the home-building market bounces back. That’s something you want to keep in mind.

And of course, as always, you really want to track just demand, just overall job-growth in the area. Ultimately, the more people that have jobs, there’s going to be more demand for housing, whether they’re rental or single-family. And again, ultimately, that’s something investors need to know about. Mike Hambright: Yup, yup. Absolutely. Hey, Chris, thanks so much for sharing your insights today. Very good information. Dr. Christopher Thornberg: My pleasure. Mike Hambright: Appreciate your time. We’ll talk to you again soon, okay? Dr. Christopher Thornberg: Sounds good. Thanks so much! Mike Hambright: All right. Thanks for joining us for today’s Flipnerd.com podcast. To listen to more of our shows, and to hear from incredible guests, please access all of our podcasts on the iTunes store. You can also watch the video versions of our shows by…