All Forum Posts by: George Gammon

@Shane Elias-Calles The advice I always give newbies is flip cars/trucks first.  It's not popular advice but it's the best I can give.  The process (buy low and remodel) is identical.  I've personally done both.  

Both you have to manage a remodel project with subs.  And you'll run into the same problems with both.  Not only will you have the advantage of learning "on the job" but you should make some good profit, while flipping cars/trucks, to apply to buying more rental properties once you start.  

Good luck,

 Hey Joe, great question. Before I answer let me remind everyone I speak, and think, in probabilities not possibilities or certainties.  That said, this scenario isn't certain, I only think it's most probable.

Referring back to my earlier post:

1.  Corporations have been the main buyer of equities in our current bull market via buy backs.

2.  Institutions (who invest most peoples retirement) divested themselves of equities in favor or the debt of the corporations that bought back all the shares that made the stock market go up.  Note:  These institutions, by law, can't own bonds below "investment grade" or BBB.  

3.  The more debt corporations take on to buy back their own shares, often, the lower credit rating they have.  But if the stock market goes down those same corporations exponentially suffer because so much of the asset side of their balance sheet is their own stock.  

4.  If the corporations balance sheets get worse, so does their credit rating.  So the a lower stock market would give the corporations a lower credit rating.  If this happens, the institutions will be forced to sell the debt they own if xyz corp is downgraded below BBB or investment grade.  Xyz corp's borrowing costs would increase dramatically making their share price go down further, making their credit rating go down further.  

You can see the negative feedback loop.  

Because of the fragility of the system the Fed has created by artificially low interest rates (solving the consumer credit bubble by replacing it with a corporate debt bubble) they've made matters far worse than 2007.  

The negative feedback loop outlined above will have several adverse effects.  Not least of which will freeze up credit markets.  This would devastate the economy because it's built on 1. debt 2. asset prices 3. confidence.  

But to get to your point, if stock prices go down, corps assets go down, increasing borrowing costs, the release valve would be jobs.  When ever a corporations are in trouble the first thing they usually do is cut workers.  see 2009.  This is how a lower stock market would most likely create higher unemployment and be potentially catastrophic to the economy.  

This is why you'll notice the Fed has desperately tried to keep the stock market high.  Every time the stock market shows signs of weakness the Powell will talk it back up with dovish fed speak or flat out cut rates and stop quantitative tightening, which was just done.  If the market continues going down, expect at least a 50 basis point cut next fed meeting or sooner.  

If we get to a point where the fed can no longer prop up the market by pulling financial rabbits out of their hat, that is when sh*t hits the fan.  But notice I said "IF", again, it's a game of probabilities.  It's up to us as astute investors to know and understand as much as possible so we can handicap the possible outcomes ourselves.  

But most on this thread are paying attention to what mattered in 2007 and ignoring what matters now.  Assuming the only way housing prices can crash, is if conditions mimic the past crisis, is very foolish and shows a lack of understanding of financial markets.  

The reason I post on BP is to give investors a greater understanding of macro economic conditions so they can make better informed decisions.  Hopefully I've done that by pointing out the risks in the corporate bond market.  

Good luck,

I'd love to Jay. I currently don't live there, I spend most of my time overseas, but I go back often to visit family.  Let me know when you're there and if our travel plans cross we'll make it happen.  

 Great points Jay.  It's why the Fed will never predict a recession because they know it'll be a self fulfilling prophecy.  And I want to emphasize what probably wasn't clear in my above post.  I'm not saying people should run into caves and buy canned goods.  

I'm saying it's very prudent to prioritize capital preservation, then yields, when you see a yield curve inversion and most investors would be wise to study macro as much as they study micro.

@Logan Causey I'd strongly encourage you to read @Calvin Lin post on this thread.  He obviously has a much more comprehensive understanding of the current macro environment than most.   

Anyone who tells you the RE market is insulated because lending standards are tighter doesn't know what they're talking about.  Ignore them.  Additionally ignore anyone who tells you anything along the lines of "don't wait to buy real estate, buy real estate and wait." 

Most RE investors just don't understand macro risk and rationalize it away because they're emotionally and financially invested.

Calvins outline of current conditions was excellent, I can't improve on what he said but I might be able to expand on it to give you an even clearer picture, and some actionable advice.  

Many reference news headlines over the past few years claiming we're in another housing bubble.  Their point is everyones been saying it and it hasn't happened so the yield curve inverting is just another doom and gloom predictor that will come and go.  

Comparing the yield curve inverting to other news headlines is like comparing advice given by a homeless person and advice given by Warren Buffett.  FYI, the yield curve is Warren.  Let's look at a chart to put things in perspective.   

Please note: the current yield on a 1 year is 1.72 and the current yield on a 10 year is 1.52.  This has literally predicted every recession since 1953.  

Nothing is ever certain, we have to look at probabilities.  Based on the chart above the probability of the US going into recession is extremely high.  But so what.  The US has been through recessions before w/o real estate prices being affected.  

We need to first understand what 3 things now drive the US economy:

1.  Debt

2.  Confidence 

3.  Asset prices

Just picture a US economy with half the debt.  What is the USD backed by other than confidence?  Consumer spending (70% of economy) driven by confidence.  How about asset prices?  What does the US economy look like if housing, stocks, bonds all take a 50% haircut?  

 So why are the risks so great? What are most investors missing as they whistle past the graveyard?  

First and foremost corporate debt.  

Artificially low interest rates create mal investment.  Everyone knows this.  After the dot com bust artificially low rates were vital to creating the housing bubble, which was a credit bubble (mal investment.)  

While it is true, we don't have a consumer debt bubble like we did in 2007, although there's a strong argument for auto/student loan debt being the next consumer shoe to drop.  But this isn't likely systemic like the housing debt bubble was in 2007.  

The big problem is, all that consumer debt we had in 07 has moved to corporate balance sheets.  see chart

So what's the big deal?  The reason this is such a problem is what the corporations used the debt to purchase.  see chart

Corporations didn't use the money to build more factories or become more competitive, they used the debt to buy back their own shares.  Also note: institutional buying, where did the institutions go?  Into the corporate bond market in search of yield because the Fed dropped rates to zero.  

Are you starting to see the iceberg in front of the titanic? ;) 

So corporations borrowed a ton of artificially cheap money (more debt) to buy back shares and artificially increase their share price (higher asset prices) making the stock market go up and give the illusion of prosperity (public confidence).

Remember, the economy is driven by 1. Debt 2. asset prices and 3. confidence.

What happens if stocks go down for more than 6 months?  

Step 1 - Corporate balance sheets deteriorate because so much of their balance sheets consist of their own stock.

Step 2 - The corporate debt gets downgraded because of deteriorating balance sheets.

Step 3 - Institutions have to sell the downgraded corp debt because by law they can't own "junk" or high yield debt.

Step 4 - No buyers for stocks or corporate debt.

Step 5 - A massive negative feedback loop where lower stock prices create lower debt prices and lower debt prices create lower stock prices.

Then debt seizes, stocks get cut in half (which is where they would likely be without the corp buy backs), and confidence goes to 2009 levels if not worse.  Also, think about what happens to retiree's pensions, if stocks and bonds go down by 50%...pensions go bust.  It gets ugly fast.

What are the likely side effects for RE investors?  

1.  Much higher interest rates on the 10 year, so mortgages.  If you can get a loan which will be tough because the credit markets will be near frozen.  That means lower home prices.  

2.  Unemployment will skyrocket putting downward pressure on rents.  Usually higher unemployment would mean more renters, but not if unemployment goes into double digits and people are struggling to find work.  

3.  Rolling debt over at much higher interest rates so positive cash flow props will go negative.  

I could go on but you can see how we don't need a consumer credit bust or housing centric problem to create a massive housing problem.  

Please note:  These are probable outcomes, not certain outcomes.  As an example, the Fed would possibly drop the fed funds rate into negative territory and do a massive round of QE 4 to bail out the corporate bond market.  An MMT democrat could take the white house and print trillions to bail out consumers.  But something has to give, there has to be some release valve.  That release valve would most likely be the USD.  Which in turn means 1970's 2.0, high inflation, high unemployment and high long term interest rates.  

I'd encourage everyone reading this to stress test your RE portfolio using the 1970's metrics... 9%+ unemployment, 10% inflation, and double digit interest rates on the 10 year. How would it do?  My guess is not well.  

My point is, anyone brushing off the yield curve doesn't know what they don't know.  Don't fall into this trap and ignore the fact if we have even a small recession the US has HUGE problems, far greater than 2007. 

I'm not saying US RE prices won't go up.  US could be the next Japan and have ZIRP for years.  What I am saying is it's less probable.  Use the info in this post and a few other very astute posts on this thread to make a decision based on facts and economic reality, not emotion and ignorance.  

Actionable takeaways:

1.  If you buy now, use 30 year fixed rate debt <60% LTV. If the USD is the release valve you'll make a fortune. If it's not you can refi at lower rates, there's almost no downside.

2.  Buy starter homes under the cost of construction with 1% R/V ratios in great neighborhoods.  It's the most you can do to limit your downside.  

3.  5%-10% of your portfolio in gold

4.  Consider investing in RE outside the US in markets where theres very little debt in the RE market.  The world is drowning in debt, this will have to be written off or inflated away.  Both scenarios favor non leveraged RE markets.

Hope that helps,

Contrary to popular belief mentors can't help you become successful.  

At the very best they can help someone who was already going to be successful make a few less mistakes.  But that's much much different than what most newbies believe.

We as humans are always looking for a fast track or silver bullet to get us to where we want to be immediately.  There seems to be a universal belief that if you can just find the right "mentor" he/she will give you all the secrets and give you the tools required to be successful from their vast experience. 

Another wild misconception is...the reason people fail who've worked with a mentor is they quit, or didn't have the work ethic, or they did't "take action."  While this maybe in part to blame it's not the main culprit for failure. 

I think the root cause of the problem is an industry accepted narrative that knowledge is power.  Armed with the right knowledge you can achieve anything.  This is complete nonsense.  

Let me quickly give you the knowledge required to be a successful real estate investor.

1.  Buy a property for less than what it's worth 

2.  Fix it up

3.  Sell it or rent it out 

That was literally the extent of my knowledge when I started REI in 2012. I'd never even owned a house before, let along an investment property. I didn't know what tax liens were, no clue how to get a mortgage, barely had an idea of what a property manager did.

But I was immediately successful. 

Why?  I definitely wasn't smarter than anyone else,  didn't work harder, wasn't lucky.  So what was my secret?  The reason it was easy for me is because of two things.

1.  I knew how to manage people 

2.  I knew how to problem solve 

Prior to getting into REI I was an entrepreneur, in fact, I've never had a 9-5 gig. In the 15 years prior to REI I started/ran several companies and thousands of employee's. This was my edge.

My point is, regardless of how much you learn from a "mentor" about real estate investing, if you can't problem solve and manage people you won't succeed.  And if you know how to problem solve and manage people you'll most likely succeed with or without a mentor.  

You can get all the info you need to start REI with about an hour of research on google. But unfortunately you can't get what you need to be a successful REI on google or from a mentor. It comes from doing.

Don't get me wrong, a mentor has value, just not to newbies.  If you've already successfully invested, or have the personal skills required, someone with more experience can definitely give you useful knowledge on how to improve and scale.  But they'll never be the difference between success and failure.  

The best advice I can give newbies is to start small and learn the skills required (manage people/problem solve). Once you've learned these skills then start REI where the stakes are bigger.

It sounds crazy but start flipping cars.  It's literally the exact same process minus the leverage.  Buy an ugly car that has potential, fix up the interior/exterior, fix any mechanical issues (just like you would a house) and flip it.  You'll learn everything you need to know, while risking $5,000, not $50,000.  

Good luck, and I look forward to vigorous debate. ;) 

George 

 So what are the actual returns from the S&P 500 over the last 100 years?  

The returns normal people care about...how much did my investment actually grow...are measured by CAGR (compound annual growth rate).  Let's explore this and try to discover which approach yields the highest CAGR over the long haul.

Then let's see where RE fit's into the equation in my opinion.

To analyze this I compared several approaches.

1.  Interest rate cycles.  My hypothesis was returns in bull interest rate markets would outperform.  As we all know, interest rates are cyclical, and the run in very long cycles of 20 -30 years.  I found data for interest rates going back to 1790 but could only find CAGR for the market going back to 1871 so that's where I started.  

Here's the chart of interest rates I used.

I took each time frame of bear and bull market in rates and plugged those into the CAGR calculator (I included dividends and adjusted for inflation).  Here's a screen shot of the calculator (below).

And here are the results.

As you can see, there was a difference, during interest rate bull markets the S&P performed better.  

Unfortunately it wasn't a significant enough difference to suggest waiting for the start of another bull market in rates to start investing, your cash would be idol for too long eliminating the edge, creating a lower total compounded growth rate.  

At best I think this is a broad predictor of future expected returns based on current P/E multiples and where we are in the cycle.  This makes sense because a stock is a claim on future cash flows and interest rates are a discount mechanism for future cash flows.  Here's Warren Buffet commenting on this.

Again, the simple takeaway is, bull market in rates creates tail wind for stock prices, bear market in rates creates head wind for stock prices.  A quick observation of where we are in an interest rate cycle can assist in predicting if future returns will be higher or lower than the historic norm (going back to 1871).  

FYI, we're 40 years into an interest rate bull market...

2.  Back test strategy using lows in Shiller P/E ratios.  My hypothesis was investing only when P/E ratios where at their low would give enough of an edge to make it a useful strategy.  

To test this I used two dates as starting points, 1920 (an absolute low in P/E' ratios) and 1929 (a high in P/E's close enough to do decades long tests).  Heres the chart 

Please not the difference in P/E's between 1920 and 1929 (above).  Here my results assuming a starting investment of $10,000, adding dividends and adjusting for inflation (below). 

After each 10 year time frame buying from a low starting point massively out performed.

But is it realistic for most, who only have roughly 35 years to save, to wait for the next time P/E's go to 5?  Obviously not.  Although this didn't give us an investable strategy it did show that, if possible to deploy, "buy low" works.  

You maybe saying "Duh George."  But remember, the collective ethos of BP (real estate) and DR (mutual funds) is "buy always."  What's the saying real estate agents have?  "Don't wait to buy real estate, buy real estate and wait?"  I'm sure financial planners have a similar saying. ;) 

More on this later...

3. Only buy when P/E's are low, not necessarily at their all time lows.  My next hypothesis was narrowing the wait time to buy.  I wanted to buy when P/E's were below 10 and sell when P/E's were above 20.  In the interim, sit on the cash.  This is very consistent with my RE strategy, which is buy when it's historically cheap, and sell when it's historically high.  

Let's check out the results, again starting with $10,000, adding dividends and adjusting for inflation.  

   The time frames coincide with the points on the Shiller P/E ratio chart above.  Remember, buy when P/E's dip below 10 and sell when the go above 20.  (I accidentally left out 1878 - 1898 it was 9.8%)

It worked very well in the sense it gave us multiple entry points.  But did it work better than just buying in 1916 and leaving your money in until 2018?  No.  

It performed significantly worse (3.2 million compared with 7.1 million), because the strategy of buy under a P/E of 10 and sell at a P/E above 20 has been sitting on cash since 1993.  

The big problem is the time between when you sell and when you buy...Maybe the numbers do favor those who "don't wait to buy, buy and wait?"

4.  Buy low, sell high, and but the cash in 6 month treasuries between high and low points.  For my last hypothesis I wanted to see what would happen if we used my buy under 10 and sell over 20 approach combined with putting the cash in 6 month treasuries (to lower inflation risk and provide liquidity without relying on market value of the tbill).  

I couldn't find data going back to 1916 for 6 month tbills, but what I found showed a rough average of 3% in rate bull markets and 6% in rate bear markets.  I plugged those values into the times the strategy was in cash.  The results are on the spread sheet above.  

Using this method, starting with $10,000 in 1916, including dividends, adjusted for inflation, at the end of 2018 you'd have $17,426,905.  Compared to $7,112,261 with the traditional buy and hold method.  

If we're strictly measuring long periods of time, as Dave Ramsey does, the buy low, sell high, and keep your cash in short term treasuries vastly outperforms.  More importantly it's something any average Joe can do.  

So what about REAL ESTATE?? 

Bad news fellow real estate investors.  Going back 100 years, comparing decade to decade, if you keep your money in the market 20-30-40 years, the market outperforms (including dividends, adjusted for inflation, NOT including leverage or taxes).  Why?  The same reason the all the strategies above, except the last, underperformed.  Cash, or in this case cash and equity, sit idol too long without the effects of being compounded.  

Additionally, rents and prices don't really go up, they only keep pace with inflation.  True, both have periods of time when they wildly exceed inflation (like right now) but going back to 1890 they've always mean reverted.  Which makes sense because they're a direct function of real wages...stocks are not.  

It is true, real estate provides a much better cash on cash return, I'm sure most on BP can get at least 7% cash flow without leverage.  The problem is the amount of time you have to save up that cash flow, or build equity via mortgage payments, to make another investment and start compounding the money.  

Did I do a spreadsheet for RE?  No.  I didn't need to because doing the homework for the other strategies I knew a 10% yield would never outperform a 7% CAGR unless the money from the yield was constantly being reinvested with the same yield.  Not reinvested once every 2-10 years pending on inflation or real appreciation etc. (to extract and reinvest equity/cash flow).  

NOTE: I did not factor in leverage and taxes to keep a more apples to apples comparison.  We all know those 2 factors are huge.  

But wait, I have good news!

There is one area where real estate will almost always outperform stocks.  

In 2019, when there's 15 trillion in negative yielding debt in the world, the USD is losing it's grip on world hegemony, US 23 trillion in debt with 100 trillion in unfunded liabilities, the largest debtor nation in world history...I could go on and on.  What's more important CAGR or capital preservation?  

I'd argue capital preservation.  And in that arena, RE is the champ.  

As we all know, prior to 2006 the RE market had never gone down in nominal terms.  Even when the bubble burst prices went down by 60% to the market 50%.  Not a big enough difference to make up for the countless times over the last 100 years the market has dropped massively.  

Bottom line is RE is far less volatile.  And in a world with macro economic conditions as they are today that should take precedence.  

If you've read this far I sincerely thank you.  I know this is a ridiculously long post but I strongly believe the information is of value because it's so rare to see details and actual data.  I think in depth analysis is the cornerstone to good investment decision making.  

That said, let me leave you with a chart from Japans Nikkei index as a further counter balance for stocks having a higher CAGR over the long haul.  Notice where the Nikkei was in 1989 and where it is today, 30 years later...lower.  In fact it never got close to the 1989 level again.  Why couldn't the US be the next Japan?  If you give me 3 reasons their economy is worse, I can give you 3 reasons it's better.  And remember, Japan is the largest creditor in the world, the US is the largest debtor in the history of the world.  

All the results I've given you in this post are from the past, as we all know, the past isn't necessarily a predictor of future events.  If we all lived in Japan in 1989, and made investment decisions based on the last 40 years how well would we of done in the future?  

I know for a fact, somewhere in Japan in 1989, there was a personal finance talk show host telling all his listeners to buy the Nikkei because you can't go wrong...  ;) 

I'm not sure Joe, my family lives in Las Vegas, but I've been traveling to different countries since I retired in 2012, my residence is in Puerto Rico...currently I'm spending time in Colombia.  

I started investing in real estate in August of 2012, in the Midwest, I've never invested anywhere else in the US.  On those properties I'm up 100% (nominal) in appreciation, additionally 12% per year in cash flow.  Outside the US I've invested in South America where I've made about 30% compounded annually since 2015.  

Hope that answers your question,

@JD Martin 

Russell, you bring up an interesting point.  Correct me if I'm wrong, but the premise of your statement is actual RE returns are higher than the inflation adjusted RE returns would lead one to believe because housing is 42% (majority component) of CPI?  

Although it isn't a pure measurement, because the number used as a deflator contains what you're attempting to deflate, but I think it's more accurate than not.  Here's my thought process.  

1.  I read an article on seeking alpha this morning claiming we're mid cycle in US housing.  One of the main reasons given was the expansion of home prices 1976-1989 was much higher than the nominal compounded annual growth of the most recent expansion starting in 2012.  In other words, the market hasn't gone up as much as other times in the past, therefore we've got a long way to go in the current cycle.  

But when you adjust for inflation it goes from 15%+ annual growth to 0% annual growth...a massive delta.  If housing and the CPI were rather similar due to the housing over weight, this type of extreme delta wouldn't exist.  

*Also, not sure how long ago they switched, but now they're using a rent equivalent metric.  IMO so they can run inflation hot to mange real value of the national debt.  

@JD Martin @Steve B. 

If someone invested $100 in the market, and the market had an annual rate of return of 10% over the next 100 years, how much would they have at the end of those 100 years?  (excluding taxes, excluding dividends, and excluding inflation) 

A) Unknowable

B) approx $1,378,061.23