All Forum Posts by: Andreas Mueller

To provide for our future and our families, we invest.

Investing is different than other moneymaking activities. It means each dollar we’ve allocated is working overtime on our behalf, not just sitting idle in an account as inflation saps it of its power. Investing means our dollars are like little worker bees, earning us $ when we’re at work, at the park, with our kids, on vacation and yes, even while we’re asleep.

This could mean buying stocks, bonds, real estate, contributing to one’s 401k, hiring a financial advisor (I hope not), fine art, crypto, collectables, classic cars, or investing in someone else’s fund, to name most.

I chose real estate (w/ some stocks and crypto too).

It’s used by the wealthy, the middle class, the young, the old and yes even the broke (I was both the latter, and I’ll tell you how).

It pays robust, consistent returns, but it’s more involved and time consuming than just clicking a buy button.

Real estate investors get paid for doing the work.

Real estate is a familiar to us but we may not know exactly how to do it. Roughly 65% of Americans own a home, while 60% own stocks. Heck, we’ve all likely had a nosey landlord at some point in our life. But owning a home where you live is not an investment. It’s not an asset; it’s a liability. You have to rent the property to others (aka put it into service) to reap the many gains of investing. And only 6.7% of Americans own rental property, according to IRS fillings. Moreover, while we’re on the topic, most all rental properties are owned by individuals or mom-and-pop businesses, not Wall Street. They own less than 3%. In this vein, real estate investors are really small business owners.

This is the Way These are the 5 Ways:

How Investors Make Money in Real Estate

Real estate pundits and online gurus often overly focus on one aspect of this business: cash flow. That’s a very limited view, and frankly, leaves out the juicy parts. After all, a roasted bird is so much more than just the white meat.

In fact, there are 5 primary ways investors make money in real estate. Cash flow is just one of them, and it begins as one of the smallest (keep reading).

To be clear, cash flow is important (or rather it becomes important), but it is not everything. Not even close. We don’t get into real estate for a dividend check. Returns from real estate are much more lucrative than that.

Hopefully, this article will reframe your perspective on wealth and why many investors choose to allocate a large portion of their wealth-building operation to real estate.

Let’s get into it.

(* Quick disclaimer, for the purposes of this article, this writer is referring to residential real estate: 1-4 unit residences. The scale / analysis does change for commercial real estate because of vastly different financing arrangements, and buyer/seller marketplace expectations etc... So we’ll save that for another day).

#1 - Natural Appreciation

“Buy low sell high,” I’m sure most of you have heard the well-known adage. We invest in something we are confident will be more valuable in the future.

That’s appreciation in a nutshell.

The savvy investor must hone their senses and utilize the data to take advantage of an asset’s natural value/price appreciation. Natural means you don’t directly control it, but you can guide it. For instance, I am currently concentrating my investments in Nashville, TN. A city I have witnessed growing its population, # of businesses and GDP faster than the national average, while also maintaining a low unemployment rate and robust job creation. Further, within this city, I have learned the desirable areas to live, researched future developments, paid attention to criminal activity and researched the % historic change in property valuations. I have polled the barista, waiter and entrepreneur. I understand now where the path of growth is for the city and where real estate is likely to appreciate more than others.

The path of growth guides property appreciation.

This is how I prime my investment for success. It’s not a blind bet; but, it’s also not guaranteed. That is why investors get paid. We have to take risk, calculated risk, but risk nonetheless. The difference is, investors act when the odds are in their favor and if so, statistically over time, they will be successful.

As the late great Charlie Munger put it:

“The wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.”

— Charlie Munger

Remember, life isn’t baseball. You don’t have to swing. Munger’s business partner, this guy named Warren Buffett, is fond of saying:

“The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot. And if people are yelling, ‘Swing, you bum!,’ ignore them.”

— Warren Buffett

The dichotomy illustrated above is that both patience and initiative are equally important qualities in the character of any successful investor.

Take heed.

To be clear, we don’t bet on appreciation per-say. Investors don’t gamble. We make decisions that will give us a high likelihood for success and take action. In a way, investors get paid for their shrewd judgement.

Real estate, like any investment, can decline in value. Munger emphasizes that if you can't tolerate a potential drop in your investment value, you're “likely to only achieve mediocre returns,” as great investments can experience significant short-term price fluctuations. Investors have to be able to stomach volatility. In fact, you should probably assume it will happen. Fortunately, real estate is known for being extremely consistent and declines in value are rare and short-lived. If an investor reacted to every little bump they would miss out on the tremendous long-term returns. Prices are like the weather (not the climate), they fluctuate.

Case-Shiller National Home Price Index, Historical

And remember the above index is the average natural appreciation for the US. We endeavor to do better by picking a growth market/city, micro-targeting within that city and making sure we are in the path of growth.

Appreciation is how the majority of wealth/value is built in a real estate investment.

Not cash flow.

Remember this when calculating the total return on investment (ROI) in real estate.

The Leverage Effect

Real estate is often purchased with a loan to cover the majority of the asset’s cost. For example, the typical investor loan requires a down payment of 25% of the total property cost. This is called leverage. And in this case, the leverage is 4 to 1.

Using leverage enables you to drastically improve your ROI. Let's say you purchase a property for $500,000 and it appreciates to $700,000, the investment has made a 40% return.

Not bad.

But you used leverage in the form of a loan from a bank, not all cash. Since you put down just 25% of $500,000 - or $125,000 - and the property appreciated $200,000 - you made 62.5% on the dollars you invested.

Even better.

Real estate in the US is often purchased with leverage for this reason, and also because it’s one of the easiest assets to get a loan for (because of government incentives / regulation, which I won’t get into here). The lending terms and interest rates for leverage in US real estate are extraordinary. Real estate often has the lowest relative interest rate when compared to most other types of consumer-facing loans.

We often take this for granted as Americans. In fact, the 30-year mortgage with a fixed interest rate is a distinctly American benefit. Most other countries do not have this. Not Canada, not he UK, not Japan…

Take advantage.

#2 - Principle Paydown (aka Cash Later)

Another facet of using leverage, in addition to multiplying your investment’s return, is that you have to pay the mortgage back.

Crap!

But wait, this is actually a feature, not a flaw. Because it’s not the investor who is paying the mortgage, the debt is paid with the revenue the asset generates, in this case, the gross rents collected. Remember, a loan is broken into two parts: interest and principal, or the balance of the amount borrowed. Thus, every time the monthly mortgage is paid, the balance of the amount owed on that loan ticks down, and the equity value the investor owns ticks up (equity = assets - liabilities). And after 30-years (or whatever the term is on your loan) the balance is zero and the investor owns the entire asset outright.

Yay!

I think of principal paydown much as I do cash flow. But instead of that income being deposited into my checking account for immediate use, it is deposited in my property’s account for later use (or that I can borrow on now, more on that later).

Aka cash later. And it gets better.

At the start, the fraction of the mortgage that is principal is quite small. Typically just 1% annualized. The majority of the monthly payment goes towards the interest of the loan. So you aren’t putting much of a dent in the balance of the loan each month. But, in years 3, 5, 10… a larger, and larger, and larger portion goes towards paying down the principal and paying into your equity, particularly because of the way a loan is amortized, aka the process of writing down the value of a loan. This 1% quickly becomes 3%, then 5%, then 15%…

Cash later is very underrated in calculating real estate investment returns.

#3 - Forced Appreciation

Similar to natural appreciation, forced appreciation is increasing the value of an asset, but you control and can closely estimate it. We force appreciation when we add value to a property. In residential real estate, this is typically done via a renovation. But we can also improve the value of a property by fixing broken processes, removing bad management, working with the city to improve neighborhood blight, convincing a neighbor to stop parking their cars on the front lawn and clean up trash (yes, I’ve done this and wow what a difference in my property value :) etc…

Let’s focus on renovations, since it’s easiest to control and calculate. As a rule, I want a minimum 50% return on my construction dollar when I’m renovating a property. That means, if I spend $100,000 on renovations, I want the property to be worth at least $150,000 more afterward, if I were to put it on the market or want to refinance it. This means, typically, the larger the renovation the better, as long as I’m spending money judiciously. No gold bathtubs, we aren’t renovating the Taj Mahal. Deciding on a scope of work and what to spend money on is a skill that investors must hone.

Fortunately, we can calculate with high accuracy what our returns will be on a particular renovation. To do this we need to:

• Get quotes from contractors, and pick one;
• Add that cost to the price we paid for the property;
• Determine what price similarly renovated properties have recently sold for (we call this the ARV or after repair value). You can use Zillow to estimate this, or ask your real estate broker, which I recommend, as they likely have access to more data than you;
• Subtract the price of the home and renovation cost from the ARV to get our forced appreciation equity return. Voila!

For example: let's say we buy a home for $500,000 and put $100,000 into it. Based on the median ARV for sold comparable properties, we estimate it to be worth $675,000. Our total forced appreciation is $175,000, including $75,000 in equity returns. In other words, spending $100,000 to improve our asset made us $75,000 in equity or a 57.14% return on our construction dollars.

Nice.

You should also calculate this as a total leveraged return for the whole asset, like we did above, since we likely got a loan to purchase the property (and may have done so for the construction too, but i’ll assume not here). In this case, if we put 25% down ($125k) and paid for the renovation in cash ($100k) and the renovation returned $175k in forced appreciation, including a $75k equity return, this renovation brought us a 33% total return ($75k/$225k)!

I don't know where else you can confidently get a 50% value add return or a 33% total return. And the ROI is even better if you get the property for a great price, ie below market value, below comparable sales (aka comps). In our brokerage, we don't let our clients pay retail; I always aim to get them a property below the comps.

This is why a simple DIY / fixer-upper is so attractive to new investors. You can really hit the ground running and pay less for that renovation by doing some yourself. And when you start adding bedrooms, bathrooms, or overall square footage you should see even higher returns. Savvy investors look for properties where they can add value like this. The key is to look for properties with less than the ideal number of amenities (ie bathrooms etc…), and then add what they are lacking to create the most value.

#4 - Tax Depreciation

Yes, your property is appreciating, in value, but it is also slowly deteriorating, literally, which means you have to spend money to repair and maintain it. The government recognizes this, and much like equipment or durable goods a business owns, you can depreciate the value of the asset, thereby deducting a percentage of the property’s total cost from your taxes. For residential real estate, the IRS allows rental property investors to deduct 3.636% of the value of the structure of a property each year over 27.5 years. For example, if the value of my real estate is $500,000 and the land is assessed by the tax man at $100,000, the value of the structure is $400,000. Thus, you can deduct $400,000 * .03636 = $14,544.00 off my taxes every year. In practice, depreciation is used by the savvy investor to shield much of the cash flow earned from taxation. You can also accelerate this depreciation, but I’m not getting into that here. (* Required legal disclaimer: I’m not a CPA and this is not financial advice).

Your Primary Residence is Not an Asset, It’s a Liability

This is as good place as any to make this point. You can cannot depreciate a home you are living in (yes there are some nuanced exceptions but I’m not getting into that here). This is one of the fundamental reasons why owning your primary residence should not be considered an asset or investment, even if you happen to make a net profit selling it in the future.

Think of it this way: if you took that same money and bought a rental property instead, which you could depreciate, add value and raise rents on over time, while at the same renting your primary residence, you would make a significantly higher return, and have cash flow you could reinvest.

There is an old adage, “[rent where you live, rent-out what you own].”

Don’t get me wrong, it is amazing to own your own home. I do. But that is an emotional decision, not a financial one. I like owning my own home. I don’t want a landlord telling me what I can and cannot do (one reason I stay away from condos and HOAs too). I have a dog. I may get a few chickens. I have a garden. I park my car in any spot I want to. Tomorrow, I’ve actually got a pretty nice little Saturday planned, we’re going to go to Home Depot, buy some wallpaper, maybe get some flooring, stuff like that. Maybe Bed Bath and Beyond, I don’t know… I don’t know if we’ll have enough time!! (bonus points for getting that reference :).

So what have we learned?

Is owning where I live maximizing my returns?

No.

I would make more money if I moved out, rented-out my home and rented my primary residence. And even more money if I moved out my cars from the garage, finished the basement and added two more bedrooms, maybe a bathroom.

Now that’s adding value. :)

#5 - Cash Flow (aka Cash Now)

Lastly, we have cash flow, or Net Operating Income (NOI). This is how much cash is available each month after taking the difference between all money coming in and going out, including loan payments, maintenance, taxes, insurance, management fees, repairs, other expenses etc… (ok, technically NOI is not the exact same as cash flow, and is actually a more accurate definition as cash flow is actually a more broad calculation in business. But, in residential real estate parlance they are often used interchangeably, so I won’t go into the difference here. Just know there are technical differences).

Put simply, how much cash is in your property’s checking account each month after you pay for expenses? If you have more money in the account, congrats! You are in the black, as they say. You are cash flow positive.

Now, you don’t have to be cash flow positive to invest in real estate and make serious money, but it sure does help. I’ve had a few places where, in the beginning (first 2 years) I was not in the black. They “lost” money each month. But the areas were so hot, the properties appreciated 22%, or several hundred thousand dollars, which is why I bought them. It would literally take me decades to make a fraction of that return in cash flow. And, since I own a portfolio of properties, I could use the negative cash flow to offset cash flow gains from other properties I own, lowering my taxes.

Cash flow is key, I don’t recommend negatively cash flowing unless you deeply understand the risk. Cash flow de-risks your leveraged investments so you don’t get into trouble, can’t pay the mortgage and the bank forecloses on your home.

That would be no bueno.

Cash Flow Evolves

As you can tell, I am intentionally downplaying the importance of cash flow, at least in the beginning. Cash flow is like a house plant. It starts out small. You have to nurture it. But over time, it grows. You raise rents. Yet, your long-term debt stays fixed (thank you America). Yes, property taxes and insurance (especially in some parts of the country, watch out) will tick up, but rent increases should cover those costs.

Do you buy real estate with the intention of holding a property for only 1 year?

No. We are investors.

That’s not why we do this (unless you are flipping, which is not investing, thats a separate business / job and is taxed at a much higher rate to boot).

So as it grows, cash flow becomes much more important later. In fact, I would argue… it evolves.

Cash flow grows slowly over time until BAM!…something very powerful happens…The mortgage just…disappears.

It’s been 30 years, you now own the property free and clear. But….how many properties do you own now? If you have been slowly, conservatively acquiring and renting out properties you may own 5, 10, 30+ properties? Without any fancy tricks or schemes.

Now you have some serious cash flow. And each year another loan vanishes.

At this age in your life, cash flow is important. Cash flow is how you retire. Social Security is not reliable, and was not purpose build for retirement. Don’t rely on it.

But it does take time. Real estate is not a get rich quick scheme. Anyone who says otherwise is lying. Don’t listen to the gurus. Investments grow slowly and compound over time. And don’t forget our old friend depreciation. Again, we only pay taxes on our cash flow after we account for that depreciation / tax deduction (3.636% / yr). The result? Investors pay very little taxes on the cash flow income. Especially in the beginning.

So I recommend not chasing cash flow early. Allow it to grow and evolve into a big green monster. Of course, if you find a great deal that can net you higher returns early, by all means jump on it. But chasing cash flow as priority #1 will likely suck you into either one of two things: high risk D-class neighborhoods and underperforming markets that will under-appreciate. That’s how folks achieve mediocre results, or worse, lose their shirt.

In investing, Rule #1 is never lose money. Rule #2? See Rule #1.

Protecting your downside is more important than maximizing your upside.

Cash Flow Buys You More Real Estate

As your cash flow grows, you can use it to buy more real estate. As your rents tick up, you can choose to refinance: replace the mortgage with a larger one it can now support, and pull equity out of the property in the form of cash. The best part, the cash you pull out is debt, not profits, so you pay no taxes on it. Zero. You can then use those funds to purchase more real estate. I have properties I have owned for a long time in great areas that I have refinanced multiple times. Real estate mogul Barbara Corcoran has spoken about this same tactic. She has one property she has refinanced 9 times over the decades.

What did she do with that tax-free cash?…

“[I prefer to refinance and pull money out]. I’m talking about a lot of money back out. I’m not saying I had a mortgage of $200,000, I put 250 on it. I would wait five years. For the $200,000 I would then put an $850,000 mortgage on put in my pocket. Listen, refinancing is the way you really get rich in holding real estate that’s what I never like to sell. It’s just a bank that’s going to keep on giving. That’s how I look, I feel like I’m in the banking business, but I have real estate to back it up.”

— Barbara Corcoran

Growth Markets > Cash Flow Markets

The above is why savvy investors seek growth markets. The ability to add value, grow rents, and refinance an appreciating property. This is also called the BRRRR method, as coined by David Greene.

So, when I’m looking to invest I want an area where assets supply is low/constricted and/or demand is strong/growing, population is increasing, unemployment is low, job openings are attracting new workers, wages are growing, and the property is in the path of growth.

My Skeptical Take:

Real estate allows an investor to buy and control a large asset, while only paying for a small percentage of its cost. The asset pays for itself, the investor makes an ever-growing income each month, the asset’s value can be forcibly appreciated, they build immense wealth and pay little in tax.

Remind me why only 6.7% of the population does this?

Well, three is one catch, conventionally (no pun intended) you need money to buy real estate. Saving 25% for a down payment + closing costs is nothing to scoff at. And yes hold your responses, there are creating financing strategies to buying real estate such as owner financing, subject-to, raising capital, partnerships, syndications etc…but I’m not going to get into those here. I’m talking classic, tried-and-true - and yes potentially more conservative - real estate investing. To grow immense wealth it doesn’t need to be complicated or risky. You just need to Work, Save, Invest, Repeat…WSIR! (Not a cool acronym I'm afraid, let me workshop it)

To succeed you have to be, as Theodore Roosevelt put it, “In the Arena.”

We all want to grow our wealth for our us and families. The only question is, what are you going to do about it?

Until next time. Stay Curious. Stay Skeptical.

Herzliche Grüße,

Andreas Mueller

Welcome to TN, the water is warm. 

Highly recommend Nashville. Fun fact, we have the lowest unemployment rate in ant top 25 major city.

It's Morning in Nashville, what a great time to witness this city growing up. At only -700k population, it has the lowest unemployment of any top 25 city, and those folks need homes. We just pass a transit referendum too, which will finally allow matching money to flow to the city for the first time. 

Zero tax state, no insurance or property tax issues like FL and TX. 

Couldn't agree more Luka and Tyler. 

Plus: TN is top 3 in net inflows too. COVID was not a fad, folks keep moving here. 

And here is the latest BLS report. 

On the election: Trump in the WH wont make a difference. I see no causation. Im hopeful we can get some housing supply policies, everything on the campaign trail was net boosting housing demand, which we have enough of.

My 2 centss:

Antioch is have some crime issues, I'd stay away till it gets better. It may be too early, which is the same as being wrong. Several clients had shooting issues lately. Im out.

LOVE Madison though, great call Luka. 

We have several land deals in Nashville. Contact me for more info. 

Quote from @Andrew Syrios:

I think the economy is going to soften and there will be a lot of pressure on the Fed to lower rates, which I think they'll do. Long term with baby boomers retiring (and passing away) I think we'll see rates go up, but I think they'll probably dip down a bit more in 2025. 

 Hopefully, they dont tick up too much, for all us investors' sake. 

Much appreciate you engaging in the comments!

Quote from @Bruce Lynn:

The Fed doesn't control mortgage rates, and I'm not even sure they influence inflation and unemployment any more.  I think they've lost control of most of their tools.  The most stubborn parts of inflation may start to increase again...food, fuel, rent.

 Bruce, I hope, for our sake, they can maintain some control. 

Much appreciate you engaging in the comments!

Welcome to the Skeptical Investor Blog, right here on BP! A frank, hopefully insightful, dive into real estate and financial markets. From one real estate investor to another.

Today We’re Talkin:

• - The Weekly 3 - News, Data and Education.
• - Interest Rates are Threatening Even Higher
• - It’s Inflation Stupid: Federal Debt Matters
• - None and Done? The Fed be Done Cutting Rates for the Year
• - My Skeptical Take

The Weekly 3: News, Data and Education to Keep You Informed

1. - Six major US metros have seen YoY home price declines. New Orleans (-4%), Austin (-4%), San Antonio (-2.7%), Tampa (-.5%), Jacksonville (-.3%) and Dallas (-.3%) (Nixon).
2. - The US government now spends just as much on interest payments as it does on defense expenses. The latter defends our country, the former destroys it (Pomp).
3. - Home Affordability is Difficult, and it’s Not Getting any Better. To return to pre-2020 housing affordability 1) incomes would have to spike 60%, or 2) home prices would have to fall 38%. Neither seems likely (Lambert).

Interest Rates are Threatening Even Higher

Well, what a difference 30 days makes.

The Fed cut interest rates by a larger than expected .5%, and after a few days of celebration (yay!), the market is now calling their bluff (boooo!).

Specifically, the bond market. It does not believe we are out of the recession/inflation woods yet.

So, it has grabbed the wheel and turned this car around, like a frustrated dad with 5 kids on the way to the amusement park!

Mortgage rates, which track the 10yr Treasury bond, have reacted in kind, up .73% from their September lows, following the Fed rate cut.

Mortgage Rates Sept-Oct, 2024

Why?

Investors have sold off Treasuries over resurgent inflation concerns and reckless fiscal spending (also inflationary). If you are a bond/debt investor, you hate inflation because it erodes your interest rate earnings.

The Fed Can’t Repair the Housing Market

As a reminder, the Fed does not control mortgage rates.

Mortgages are predominantly influenced by the market demand for 10yr Treasury bonds, not the Federal Reserve's adjustments to its short-term Fed-Funds rate (that’s actually what they do when they “cut interest rates.” The 10yr Treasury and 30yr mortgage are competing assets investors buy in the marketplace, expecting a return for their expected risk. If investors expect higher risk to the economy, they buy 10-yr Treasuries. If the future seems less risky, they buy 30-yr mortgages. Investors also sell Treasuries if they see inflation on the horizon, which would erode their returns (yes yes, this is all oversimplified, hold your comments angry-web).

The Housing market is a difficult issue, with many moving parts. The two primary drivers for a healthy market are the supply of homes and the cost of debt to purchase those homes. So, the Fed can’t unilaterally repair the housing market, but it can assist with cheaper debt (ie interest rates).

Last month Fed Chair Powell made some salient points on this topic precisely, saying:

“The real issue with housing is that we have had, and are on track to continue to have, not enough housing… and where are we going to get the supply? And this is not something the Fed can really fix.”

And he continued:

“But as we normalize rates, I think you’ll see the housing market normalize. Ultimately by getting inflation broadly down and rates normalized and getting the housing cycle normalized, that is the best thing we can do for householders. And the supply question will have to be dealt with by the market, and also by the government.”

So, in short, while they can’t repair the broken housing market, they are a major piece. This is likely a relatively short-term problem, but unfortunately homebuyers / sellers are caught right in the middle.

It’s Inflation Stupid: Federal Debt Matters

US federal debt is absolutely out of control. Unquelled, it will bring higher inflation and higher mortgage rates. The number is staggering: $35 trillion and growing, faster than our economy.

And as I am reminded daily on my news feeds, we are in a Presidential election cycle. Even without any additional spending, the next president is on track to spend an additional $10+ Trillion over 4 years. Add that number to the wild spending promises from both Presidential Candidates, which are stacking up under the Christmas Tree, and you have a recipe for inflation disaster.

Each of those nicely wrapped boxes is a future fiscal time bomb, ready to explode.

Why does Good Economic News Mean Bad Market News?

All this being said, for now, the overall US economy looks to be holding strong, especially when compared to the rest of the larger world economies.

But back in August, a doddery jobs report may have spooked the Fed after sending markets sharply downward. Yet, in the months since, most jobs and inflation reports have come up roses.

And we just had a very positive jobs report. Employers added 254,000 jobs in September and unemployment ticked down to 4.1%, both better than expected. Plus, this past month's employment was revised up. As was gross national income, personal income and the personal savings rate. September 2024 CPI inflation now sits at 2.4%, close to the Fed’s 2% target.

Now most folks would think: “yay, more jobs!,” but, again, the bond market interpreted this news as either: a potential return to inflation or an extended timeline for the Fed to cut rates. After all, why cut rates quickly if the economy is doing well and jobs are plentiful? This risk is driving the sale in 10yr Treasuries; and thus, mortgage rates.

Bonds are selling off again today.

We are still in a precarious economic time, so good economic news may be “too good,” and bad for debt markets. And mortgages are debt.

Muah! Now that’s some real economics charcuterie for ya.

None and Done? Is the Fed Done Cutting Rates for the Year?

The bond market’s concern with future inflation is likely shared by the Fed. Perhaps they even slightly regret cutting rates by a full .5% in September.

So, could the Fed decide to pause here for a while?

Economist Ed Yardeni (one of the talented ones :) ) believes the Fed is on a path for “none and done,” no more rate cut rates for the rest of 2024.

This is a seemingly bold prediction, but I would argue it is looking increasingly less so.

In a concise presentation, he asserts that the economy is performing better than expected and the sentiment amongst investors is positive. There is no impetus to cut rates.

My Skeptical Take:

Is a return to elevated inflation a real risk?

Yes. It’s not likely, but yes it’s a real risk. And a dramatically higher risk if the Federal Government doesn't stop the printing press. We will have a new President in 2025. It’s up to them, working with Congress, to determine our fiscal future.

For the Fed, a return to high inflation is a worst-case scenario; I think they will be measured over the next 12 months.

Does the Fed have regrets about being so aggressive? I don’t think they are regretful, per se, but they may adjust their posture. The Yardeni piece (above) swayed me. So, I’m changing my mind. I’m now a little more bullish on the economy, and thus bearish on the pace of rate cuts. I’m revising my prediction of two more cuts this year to just one (.25%), likely in December. I think the economy continues its on-trend growth, oil prices are still low (albeit threatened by geopolitical tensions), and the job market continues to surprise to the upside. There will be noise in the stock market and in the press, especially in the next 3 weeks of election season, but the trend will remain positive for the next 5-6 months.

Former Treasury Secretary Larry Summers is also cautiously skeptical on rate cuts. He sees the Fed taking the cautious/slow approach to rate cuts, even going so far by calling the larger .5% cut a “mistake,” while pointing out that wage growth is strong, above 2019 levels, which could risk inflation returning.

So What’s Next for Mortgage Rates?

My prediction for rates in 2025 has not changed. I think we hit hit 5.5%. I am more bullish on lower rates than most investment banks / economists, many of whom are calling for ~5.9% by Q4 2025. IMO, 5.5% is the “magic” mortgage rate, where folks are no longer sitting on the sidelines of homebuying using rates as a main reason for waiting. A recent survey of homeowners seems to agree.

With rates maintaining their elevated position, homebuyers and sellers are likely to hibernate for the Winter and Skip till’ Spring. Activity this late Fall and Winter will be suppressed and inventory should rise more.

BUT….If you are an investor, you can hack your way through all the noise and find that deal. Those selling a property today will be waiting 2x as long for a buyer. Sharpen your pencil and find that deal that is sitting on the market.

Be greedy when others are fearful.

Until next time. Stay Curious. Stay Skeptical.

Herzliche Grüße,

Andreas Mueller

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What, did you think I was going to send you a Starbucks gift card? 😅

Welcome to my weekly Investor Newsletter. A frank, hopefully insightful, dive into real estate and financial markets. From one real estate investor to another.

Today We’re Talkin:

• - The Weekly 3 - News, Data and Education.
• - All the “whys” for High Home Prices
• - Home Prices, it’s more than just supply and demand.
• - Generation Toolbelt. LFG!
• - Bring Back Home Ec!
• - My Skeptical Take.

Fuel for the Day: Greens! I actually make my own greens smoothy / drink often but when I am on a writing heater and don’t want to pause, I grab some AG1. Good stuff, really good. Gets my brain firing.

The Weekly 3: News, Data and Education to Keep You Informed

1. - Folks are Skipping Till to Spring to Buy. Rates are coming down in a few months, and buyers know it (, ).
2. - Refinancing is starting back up again. But you ain’t seen nothing yet (ResiClub).
3. - Book Recommendation: Bubble in the Sun: The Florida Boom of the 1920s and How It Brought on the Great Depression. The 1920s in Florida was a time of excess, immense wealth, and precipitous collapse. It was the largest human migration in American history, far exceeding that of the West. And it was real estate speculation here that helped cause the Great Depression. This is a must for your library, something to re-read again and again (Knowlton).

Today’s Interest Rate: 6.25%

(☝️.06, from this time last week, 30-yr mortgage)

Guten Morgan investors. It’s a lovely day to talk real estate. Let’s get into it.

Last week was all about rate cuts. But it’s going to be a while for mortgage rates to come down (as I’ve written about), so for now let’s put that on the back burner and talk about something poignant.

Home Prices.

Why are Home Prices This High?

The primary reason for the price of anything is simple supply and demand. (And we will get into significant secondary reasons below, keep reading!)

In the case of housing: we have ample demand (and more on the sidelines waiting to jump in once rates tick down) and not enough supply. Not even close.

Supply is currently short 1.5 million housing units of what is needed to keep up with demand.

Increasing Supply Works!

Case in point, in 2017-2019 while facing a severe housing shortage, Minneapolis enacted its 2040 Plan, becoming, “the first major U.S. city to end single-family exclusive zoning, opening the door for developers to build multifamily buildings on lots where a single-family home used to be (NBC).”

The result? Supply UP!

A Pew Research report found that between 2017 and 2022 - the beginning of the Minneapolis 2040 plan - “housing stock grew by 12% in the city, compared to 4% statewide. An NBC News measure of home buying difficulty shows that Hennepin County, where Minneapolis is located, is the second-easiest county to buy a home in compared to the seven counties adjacent to it — even though Hennepin is the most populous county in the state.”

Great damn job Minneapolis!!!!

What Else is Contributing to Home Prices?

Supply and demand this is not the whole story. Home prices are higher than they normally would be even in these tight market conditions.

Tell me why!

Well, I don’t mind if I do.

Home prices have been amplified because of the increased costs for builders to actually build a home in the US, mainly:

1. Inflation (materials and labor).
2. Regulatory burdens.

Let’s look at both:

Inflation

Prices for everything necessary to build a home - including building materials and hourly labor - are much much more expensive. These higher prices are likely permanent, as prices rarely deflate (and that can cause a whole other set of economic problems).

I have written at length about the case and effects of inflation. In short, inflation is caused by policies and spending (not consumers or businesses). And over the last few years, we went on quite the money printing spree.

More than $10 Trillion!

You can read all about what the US did in my previous article on the subject here.

It’s a doozy.

For now, just know we had a few years of much higher than normal inflation and it caused permanent damage in the form of higher input prices to build a home.

Regulations

The second cost of a home is regulatory policy. Especially for large development (ie apartment and condo buildings), where many of our housing units come from.

Building housing is subject to a significant array of regulatory costs, including a broad range of fees, permits, reviews, and other requirements imposed at different stages of the development and the construction process, with both a direct cost and a time/delay cost.

In fact, according to a recent study, regulation “imposed by all levels of government accounts for an average of 40.6 % of development costs (NAHB, O’Leary).”

Apartment developers in particular are subject to a variety of regulations across all levels of government. They include: zoning requirements, building codes, impact fees, permitting requirements, design standards, public land requirements, and federal Occupational Safety and Health Administration regulations and other labor requirements. Unfortunately, many regulations, such as design standards, go far beyond important safety concerns, and impose costly mandates on developers that drive housing costs higher. Others are duplicative and require resources to confirm compliance with multiple regulators with overlapping jurisdictions.

Further, the study noted that “[Three quarters (74.5%) of housing developers said they encountered “Not In My Backyard” (NIMBY) opposition to a proposed development, adding ~ 5.6% to total development costs and an additional 7.4 month delay.]”

Wow.

This is why both presidential candidates are talking about the need to reform housing regulations on the campaign trail.

Construction Innovation: A Call to Action

It seems that innovation in the construction technology space, and thus labor productivity, is an area for significant improvement.

Productivity in virtually all industries is accelerating over time, leaving construction in the stone ages.

Logan Mohtashami

We don't really build homes that differently than we did 100 years ago.

Why?

We need investment in construction technology and government needs to green-light it asap.

It’s just too expensive to build a home!

Gen Z is Gettin Handy

One glimmer of hope is the new Generation Z folks are getting interested in the trades. Gen Z is becoming known as Generation Toolbelt.

Love it!

A fantastic Wall Street Journal article reviews the renewed interest in vocational training, manufacturing and hands-on labor fields.

From the article:

“Demand for trade apprenticeships, which let students combine work experience with a course of study often paid for by employers, has boomed. In a survey of high school and college-age people by software firm Jobber last year, 75 percent said they would be interested in vocational schools offering paid, on-the-job training (WSJ).”

And this idea of blue collar career interest was recently discussed on the All In Podcast, which includes a group of prominent Venture Capitalists. They make a great point about the “premium of human service.” This is something that won’t be disrupted by AI; in fact, it could be a catalyst.

There is a role for government and investors here. We need more startups, funding and pro-business policies in traditionally blue-collar industries!

And I’ll go a step further.

What Happened to Home Ec?

Frankly, it’s a shame we don’t have Home Ec anymore. Teaching personal finance, woodshop, home repair, car repair (the mechanical part) and cooking should be required at every high school. A full yearlong class. And it often is not on the top of lists for parents to pass on to their kids anymore. Young folks just aren’t handy anymore. I took apart my TV (a few times, and the toaster) when I was 11 and after a little parental lecture, they encouraged it (this time with Goodwill appliances). We should all be teaching our kids (and other little family members aka nieces and nephews) this stuff too. It’s about thinking through problems, being resourceful, critical thinking etc… not necessarily that you will be a contractor (but it could be).

So I say, bring back Home EC!

My Skeptical Take:

The US economy seems to be chugging along well, at least for now. GDP is up 3% YOY, unemployment is historically low at 4% (and even better here in Nashville at 2.9%). Inflation is ticking down and is likely at the Fed’s 2% target, which we will see in hindsight. Prices for staples are down a bit from their high and their inflation has slowed considerably, particularly in gas and many groceries. It is true that home prices have never been higher, but this also means most homeowners have more equity in their homes than ever. An average of $300,000 in equity in fact.

Rates are on the way down, meaning Spring will likely bring a new wave of demand to the market and folks will look to refinance their home, taking cash out to pay for life needs, and also likely to splurge on new toys. This point should be emphasized. Fortunate homeowners will very much be flush with future cash. Equity in homes is multiple Trillions that people will tap in the next 12-18 months. This money will be spent throughout the economy.

I am Skeptical that the US economy will have a Goldilocks recovery in the next 18 months. Specifically, I am concerned that the relatively positive state of the current economy may be a lingering result of the stimulative drugs Uncle Sam slipped in our martini. Consumer spending is 2/3 of the economy and it’s hard to ignore the sheer volume of free dollars the federal government pumped, and is continuing to pump, into the economy. $10 Trillion dollars worth. Folks will spend those dollars. In addition to my point above on tapping trillions in home equity.

When the drugs stop, or at least abate, it will be time for the come-down.

Keep a Skeptical eye out. And it could be something international that sparks it. It is unfortunately a tumultuous time in many parts of the world.

Until next time. Stay Curious. Stay Skeptical.

Herzliche Grüße,

-Andreas

Please Share this Article!

It takes several hours to write this weekly article, and they will always remain free. All I ask is that you share it with 1 friend. Just 1. If you do, you will get two gifts: free education for one of your friends, and good karma for helping to grow a community of folks trying to figure out a way to create wealth for their family.

* I write this myself and get it out for you all on the same day. Apologize in advance for the likely errata. Don’t have a team of editors, yet.

** The preceding has been my opinion only, the views are my own, and are intended for educational and entertainment purposes only and do not constitute financial advice.

Michael, we represent buyer investors here in Nashville. Happy to chat anytime!

And, if it's helpful, our we put out a weekly financial real estate column here on BP. Check it out! (Always free of course). 

https://www.biggerpockets.com/member-blogs/15226/103921-home...

-Andreas