All Forum Posts by: George Gammon

Think about macro and forget micro for a minute.  And yes, I am blue in the face... ;)  

Let's think about a loan.  Assuming the term of the loan is constant, payment is based on two things 1.  the loan amount 2.  the interest rate.  If interest rates go down the monthly payment decreases and purchasing power of the buyer increases.  If interest rates go up, monthly payments increase and the buyers purchasing power decreases.  

I know, this is obvious.  What's not obvious is the fact that as interest rates go down buyers can choose whether or not to use that purchasing power to make a purchase.  But as interest rates go up buyers don't have a choice, they can't buy any more because the monthly payments are no longer affordable (unless real wages increase, which they aren't).  So the increase in demand (higher real home prices) as interest rates go down is probable but not certain, whereas the decrease in demand (lower real home prices) as interest rates go up is much more probable.    Therefore, if you think home prices will increase you must also believe there's a far higher probability interest rates will decrease, and not rise, over the next 5 years.    

Let's also remember that the one of the main reasons these coastal markets are so hot is because investors can't get a yield on bonds.  Ask yourself how many of those 10 million dollar apartments in NYC, San Fran, LA etc would the Chinese of purchased if they could've gotten 5% from a gov bond?  

I have no way of knowing whether or not housing is going to dominate the US economy for the next 5 years.  Nor does anyone else.  But what I can say definitively is 1. interest rates matter... a lot.  2.  the probability of housing prices increasing or decreasing with interest rate moves is highly asymmetric.  

@J. Martin great thread.  

Unfortunately, I didn't have time to read every post so forgive me if I'm being redundant but there a couple things I never hear people talk about.

1.  Labor force participation.  It's lower than it's been since the mid 1970's.  That's crucial in any data involving unemployment rate.  If our labor force participation was at the level is was in 1990's our current unemployment rate would be close to 10%.  I'd be curious what the leading index would look like if you changed 4.9% to 10%?  

We know manufacturing is in recession so everyone hangs their hopes on consumer spending.  But instead of looking at an unemployment rate we should also look at the total amount of people working.  This seems like a better measurement of potential consumer spending.  And we currently have roughly the same amount of people working now as we did 10 years ago.  Said another way, we have about the same number of people in the labor force now as we did 10 years ago yet our population has increased by 20 million.  

So if real wages aren't really going up and the amount of people working hasn't really changed the amount consumers spend can't be that much different unless their spending credit.  If consumers aren't spending more and manufacturing is in a recession I'm not sure how we're not in recession unless the gap is being filled or exceeded by government spending?  

2.  I never hear people consider the effects of a 0% fed funds rate?  Saying were not in recession right now could be true.  But that's like saying a patient isn't sick right now ignoring the fact they're on life support.  Anyone who suggests the economy is healthy only has to look at the fed funds rate to be proven wrong.  

Lastly, no one seems to consider a higher amount of aggregate risk with a .25% fed funds rate.  Is there greater risk in the economy if we go into a recession with rates at 5% or at .25%?  Obviously the impact of a recession could be exponentially greater with interest rates already at the zero lower bound.  

George

 Just to clarify Brandon that's not exactly what I'm saying.  True, repeal of Glass Steagall could've been a factor, but the more stringent government policies, that came in the form of quotas given to the banks and FF, were the first steps in reducing lending standards.  This happened gradually through the 1990's and early 2000's.    

And the low interest rates I was referring to is the fed funds rate set by Greenspan then Bernanke.  It's hard to imagine a scenario where we could've had a housing bubble (regardless of political blunders or wall st. malfeasance) without Greenspan taking real rates negative.  

If anyone would like to know the story from start to finish in a format of well documented facts read the book suggested above, Thomas Sowell's "The Housing Boom and Bust"...

 Please include the catalyst...changing of government polices and artificially low interest rates.   

@Brandon G. 

Brandon thanks for starting a great thread and even bigger thanks for recommending a Thomas Sowell book @Brian Lacey.  If I could give one piece of advice to anyone in the world, real estate investor or not, it would be read every Thomas Sowell book.  It's basically like taking the red pill in the Matrix.  Start with "Basic Economics" and go from there.  

Regarding an accurate depiction of the causes that fuelled the housing bubble... I always like to point out the fact that the US had never had a prior housing bubble.  Many factors potentially went into creating it:

1.  greedy bankers?

2.  greedy mortgage brokers?

3.  CRA?

4.  no more Glass-Steagall?

5.  fed/interest rates?

6.  Fannie Freddie?

7.  ratings agencies?

Since we never had a previous housing bubble something had to of changed to cause this one?  Although it's popular for people and films to blame "greed" it's tough to argue that caused the bubble because that would mean people just all of a sudden became exponentially more greedy.  

So what did change? Glass-SteagalI and CRA.  I'm not saying low interest rates, ratings agencies, FF didn't play a role I'm saying they existed long before so I'm not sure they were the catalyst.

I'd say it started with the CRA, then was fuelled by the fed lowering interest rates.  Then FF, Glass-Steagall and the ratings agencies came on board to assist.  Finally the animal spirits kicked it into high gear.  

IMO you've got to put the majority of the blame on the GSA/CRA and the fed.  New laws were the only variables that didn't exist before and at the end of the day, it's an issue of excessive credit, and you can't have excessive credit without artificially low interest rates.    

I don't know the secondary debt markets like @Jay Hinrichs and @Chris Mason so I'd be curious to hear their opinion on the roll Glass Steagall and Fannie/Freddie played.

George

 Sounds like a great plan Jason.  It seems you're a conservative, long term, investor.  If so, one more piece of advice...cash flow is always you're best hedge.  If your property is in a good area, cash flows from day one and you've got a fixed rate loan, your exposure to risk is greatly reduced.  

Hey Brian, great post.  I tried to respond above using bold print (open the quote).  Hopefully it works.  One thing I wanted to suggest... if you haven't seen it, the rap battle on youtube between Hayek and Keynes is something I think you'd get a kick out of.  ;)  https://youtu.be/d0nERTFo-Sk

 Jason no need for apology.  I'm happy to answer any questions to the best of my ability.  That's one of the main reasons I allocate time to BP.

I'm not familiar with citydata? It sounds like they give you the nominal median home prices for xyz area?  If that's the case it'll require some math to get the inflation adjusted prices.  You'd need to go as far back as they provide data (ideally pre 1970) and then figure out the annual rate of inflation and adjust each annual price accordingly.  Once you have your points plotted draw the line and the historic mean should become clear.  It may seem like splitting hairs but I like to adjust for the increase in home size too.  Many times the average price has gone up in an area solely because the homes in that area have grown in size.  Without factoring that into the equation one could easily confuse that with apples to apples price appreciation.  

Another place to find the info fast is google.  Just make sure prices are at minimum inflation adjusted.

Finally, if you can't find the data (or don't want to spend all the time using the method above) simply look at home prices in that area in 2012.  That was the bottom of most markets and most markets bottomed close to their inflation adjusted mean.  

As far as interrupting the data to determine if you're over paying...  Let me take you through my thought process for buying a house today in a market like Kansas City (I'll use this area because I have several properties here and I know prices well).  

I only buy in A and B areas, having said that a 3 bed 2 bath in an area I buy had an ARV of about 110k in 2012. Now that same home has an ARV of around 130k-135k. What that tells me is if we have another decline, prices have a high probability of recovering to at least the 110k mark because that mark is most likely based on real wages (because it's the historic inflation adjusted mean) and not credit expansion. The price spread between the 110k and 130k, to me, is credit expansion, so would prices recover to that mark after a decline? maybe, maybe not?

Armed with these data you can apply them to your investment strategy and risk management. That's different for every person. Someone extremely risk averse would only buy a deal where he/she was in it 70% of 110k. Others, may be comfortable buying a deal where they're in it for no more than 110k total. An easy way to think about it is the historic inflation adjusted mean ARV for a 3 bed 2 bath property in that area is 110k.

As credit expands and prices rise it becomes increasingly difficult to find a deal based on this metric.  I've heard Florida had much longer foreclosure times so they're still clearing inventory from 2009?  I know when I looked a recent chart of Orlando prices seemed reasonable.  You might want to look there...

Please remember though this is only the macro analysis.  The street by street micro is just as important if not more important.  If you buy a house in a C or D area there's no telling what prices will do.  Although there's always risk in A and B areas the probability of prices keeping up with inflation  and/or recovering is far greater.  

Hope that answer your question.  If you'd like further clarification please don't hesitate to ask.

Good luck,

George

If you're a buy and hold investor you may be getting scammed...

The federal reserve has kept interest rates at near zero for the past 7 years.  This has created an artificial increase in purchasing power and therefore higher RE prices.

What's the problem with that?  

Nothing as far as you're equity, but these higher prices may increase your expenses faster than you can raise rents.  The main expense I'm referring to is property taxes.  And that's the scam.  The value of your rental property doubles and so do the property taxes.  A higher portion of your gross rent will go to the government...they just picked your pocket! 

I know we all love equity gains but my point with this post is don't forget your property taxes.  If you bought a foreclosure at far below market value don't forget to call the county and get the property reassessed.  

I did that with several of my properties when I bought them because the county had them assessed based on the neighborhood not what I paid for them.  I wasn't able to get the assessed value down to what I paid, but I got it down, which lowered my overall property tax burden significantly.  

Remember the county will always tell you when you're not paying enough but the never tell you when you're paying too much.  You've got to stay on top of that.  Especially now when housing prices in your area may be rising faster than rents. 

I'd love to hear other people strategies...

George

 Jason, one thing I'd add about housing prices always recovering.  

I can say with a great degree of confidence if prices go below their inflation adjusted historic mean they'll recover.  Why?  The historic mean is tied to real wages not credit growth.  Prices based on real wages are sustainable.  If prices go below that they'll recover because people have more purchasing power than prices reflect.  

Will prices always recover to an absolute high water mark? maybe but maybe not...it depends on credit expansion.  

So my advice is if you can buy under the price of historic mean inflation adjusted, whether it's because of a drop in the market or you just get a smokin deal, your risk of the price not reverting to that mean or "recovering" is low.  

* please note: this is referring to general prices and may not be applicable to street by street RE prices.  

Good luck,

George