On October 14th, 2011, The Norris Group returns with its award-winning event I Survived Real Estate. An expert lineup of industry specialists join Bruce Norris to discuss current industry regulation, head-scratching legislation, and the opportunities emerging for savvy real estate professionals. 100% of the proceeds support the Orange County Affiliate of Susan G. Komen for the Cure. This event would not be possible without the generous help of the following platinum partners: Foreclosure Radar and Sean O’ Toole, Housing Wire, The San Diego Creative Real Estate Investors Association and President Bill Tan, Investors Workshops and President Shawn Watkins and Angel Bronsgeest, Invest Club for Women and Iris Veneracion and Bobbie Alexander, San Jose Real Estate Investors Association and Geraldine Berry, Real Wealth Networks, Frye Wiles Web and Branding, MVT Productions, and White House Catering, who will provide the 3-course meal for this black tie event. Visit iSurvived2011.com for more details.
Bruce is joined this week by Christopher Thornberg. Christopher is the founding partner of Beacon Economics and widely considered to be one of California’s leading economic forecasters. He is an expert in economic forecasting, regional development, real estate dynamics and labor markets. He is one of the earliest and most adamant predictors of the housing market crash and of the economic recession that followed. In 2008, he was appointed as chief economist for California State Controller John Chang as well as Chair of the Controllers Council of Economic Advisors. He also serves on the advisory board of Paulson and Company Inc, one of Wall Street’s most successful hedge funds. Dr. Thornberg holds a PHD in business economics the Anderson School at UCLA and a B.S. in business administration from the State University of New York at Buffalo. He has also been on the panel for I Survived Real Estate the past three years.
In one of Chrisopher’s reports, there was a quote that said, “Beacon Economics expects growth in the second half of the year to be 3 ½ to 4% range short of some unlikely turn of events.” Bruce wondered if we had any of these unlikely events, to which Christopher said they had toned down their forecast a bit as this was much earlier in the year. We’re looking at 2 1/2 – 3% growth now in the second half of the year. We have not had any unlikely events, but we know the market is in turmoil and a lot of his colleagues are running around drawing odds, whether it is a 30% or 50% chance of a recession. It doesn’t add up because, first of all, you have to separate slow growth from a recession. There are a lot of reasons why the U.S. economy is not growing fast enough to put people back to work in a meaningful way. There are also a lot of reasons why the U.S. economy continues to struggle in its recovery from the 2008 and 2009 recession. That’s a lot different than saying we are going to have another recession and another period of time where the U.S. economic output is contracting in a real sense and that we are producing less today than we were yesterday. For us to have another recession there has to be a shock and a hit to the system that can cause the type of turmoil that we call a recession. Christopher said if he looks across the U.S. economy today, he doesn’t see where that shock exists.
If you look outside the borders of our country and look at Greece; first of all, you see that Greece has not defaulted yet. You may link a Greek default to potential for a U.S. recession, but that is not what people are doing. They are saying that we are in a recession, but the default hasn’t even happened. The fact that their one-year T Bill is going for 130% interest gives Bruce an idea that it a default probably will happen. There are clearly problems in Greece. The question is whether Greece will default because they don’t need to. If they can continue to clean up their act, which is a big IF, make meaningful reforms, and continue to get the support from the European Union, they can work their way back to some kind of orderly workout over their existing debt situation. Christopher does not think they are ever going to pay all the debt back, but an orderly workout for a debt reduction is a lot different than a massive default. So Christopher is not worried about Greece contaminating other dominoes to fall in the area. People keep comparing Greece to Leman, saying Leman had $250 billion in debt and Greece had them outstanding across the European Union $400 billion. Therefore, it’s a Leman type episode.
It’s not a Leman type episode for a number of reasons. First of all, with Greece we’re talking about a straight debt default. With Leman, there were counter-parties and all sorts of transactions. They were intimately linked to other banks. When it comes to Greece, we know what is coming down the road at us. Leman was a total shock to the system; no one thought Leman was going to be allowed to fail. You have the surprise aspect; you have the counter-party aspect, the market maker-aspect. Leman and Greece are different situations. If Greece did go down, this would hurt some banks in Europe; but then, it’s not known how many people think the French government is going to allow one of their major banks to be pulled down by Greece. The lessons of Leman are clear. You don’t let your major banks default. The French government will step in with a program, recapitalize its banks, the central banks here and in Europe will work to provide the short-term funding necessary to calm investor jitters, and we’ll get through it. You have to have a lot of pieces in place for this thing to truly spiral out of control and start sinking the international banking system. If worse comes to worse and a lot of banks get hit hard, there is another way to deal with it which is simply basic short-term regulatory changes. The reason the banks are in trouble is because they have to maintain a certain capital ratio. If they start taking haircuts on the public debts, they are going to be in violation of the ratios and they are either going to have to raise capital on the fly or be closed down by the regulatory authorities.
There is also a third way, which happened in the U.S. It’s called the suspension of basic rules of asset valuation on bank balance sheets. You step in and say you’re going to suspend the rules for two years, so you better clean up. This way the bank is not undercapitalized and they have the leeway to go ahead and do what they need to do. In the meantime, you have to have the short-term lending from the various monetary authorities that will allow them to offset any kind of short runs that may occur on the banking systems. It can be handled and worked through. The idea that it is going to be allowed to spiral out of control and sink the worldwide financial system is a little far-fetched.
When looking at how things are going in the market and whether or not to be optimistic or pessimistic about it, Christopher will look at the data and know what it is showing him. He has some sense of the politics and what is going on in the regulatory authority’s minds. There is always the chance for a lot of boneheaded moves. Europe has shown us in the past that it can in extreme moments of crisis completely fail to do what needs to be done. This is a remote probability, but this is a lot different than people calling for a double-dip. One problem we have in our own country that may be extending over there is it seems to do something that is painful in the short term but most beneficial in the long-term rarely gets done. A lot of politicians, like most people on a two-year contract, have a “short-timers” syndrome. They are worried about getting re-elected, so everything is about now. It’s a problem, and what it means is we have to stumble from crisis to crisis. Right now, Christopher does not think we are in a situation right now that is going to send us into another hole.
Right now the ten-year T-Bill is 1.7%, which says that the Fed is not going to have much of an influence on the economy right now. You can’t lower the long run with long run rates much longer, and you surely can’t lower short-run rates anymore. Cheap debt is not really the solution for what ails the economy. If you think about the U.S. and ask yourself where the problem is and what the issue is that the nation is dealing with. About 1/3 of our problems stem directly from construction. We are not constructing homes or commercial real estate. That is the tyranny of the inventory. For several years we built too much retail and too many homes, so as a result of that those sectors are basically sitting in neutral until the inventories start getting worked out. The good news is they are getting worked out, and Christopher expects construction will start picking up again in 2012. This will go some distance towards reducing some of the stress on the U.S. economy. In the major markets, for example California, in the areas you have land to build on you have a price structure that would prevent it because is upside down.
In California, we actually have the second lowest housing vacancy rate in the nation according to the 2010 census. We also have the second lowest housing affordability here. It’s funny because you go to Sacramento, and what the regulators want to know is how they will push home prices up again in the state. All the time they are worrying about how to make California more business friendly: taxes, regulations, education, and infrastructure. We need to start with home prices. For example, in Texas the most expensive housing market is Austin, Texas. The median price of a house in Austin, Texas is $192,000. The most expensive housing market in Texas is cheaper than the California housing market over all. It’s on par with the Inland Empire housing market, which we consider to be an affordable housing market. If you think about businesses and think about the location in California locating in Texas, you have to know they are looking at Texas and thinking they don’t have to pay people as much there. Texas has more public employees than California does on the payroll. They have a larger public sector than we do in terms of bodies. They get away with that because they pay their people about 1/3 less than what we pay ours. This really boils down to the cost of housing; it’s better when the median price of a house is $100,000 in the whole state. We here in California need to stop thinking about home prices going up. In the long-run and for the good of the state, we would be benefited by seeing them go down more.
The construction could not possibly come back, but not because the cost of bricks and labor is so high. It’s because the cost permitting the properties is so high. It goes back to the problem of building in the state. You look at some of the cities in California, and up front you are going to pay anywhere between $40,000-$70,000 to permit a single lot, before you even put a single piece of concrete in the ground. This is ludicrous and not how you run a state. You’re much better taxing people on an on-going basis through property taxes than lumping all the costs up front on the builder who is making the property in the first place.
California is the second most unaffordable state in the country, yet it has to be at some of its highest affordability. It was more affordable back in the 80’s, but it is more affordable now that it has been in the last 15-20 years. You would be surprised how affordability has really not increased that much despite the drop in prices. In some places, they have not even fallen back to 2003 levels. As much as they came down, it is more because they have been driven to such unbelievable highs. It’s a little hard when you live in places such as Riverside, which is the epicenter of a lot of the damage. A lot of the Inland Empire is more extreme than most, but if you look in coastal areas like Orange County and San Mateo, prices have not come down much at all. There are a lot of people who owe more than a house is worth, which seems to be the biggest impediment for California. However, the biggest concern should be the overall lack of equity rather than the “underwater folks.” During the bubble, Americans picked up something on the order of $8 trillion in mortgage debt on the basis of what they thought was about $20 trillion in real estate wealth, maintaining about a 60% equity ratio in the housing market. The $20 trillion in housing wealth disappeared when the bubble broke, but the $8 trillion in debt more or less stayed in place. The result is we as a nation are carrying a level of equity in our housing market, which is about 45%. This is more acute in areas like Arizona, California, and Nevada where you had the bigger ups and downs in home prices. This is probably the single largest impediment to a housing recovery.
People talk about foreclosures, but this is not really the issue. They also talk about a lack of credit, which is harder to get out than it was in 2005 due to the markets being broke. For Christopher, the biggest single problem in fact the lack of equity, which is preventing move-up buyers from moving up the food-chain in the housing market. One of the biggest problems with the construction market right now is that you typically build homes for move-up buyers. Unfortunately, this is not going to be the market to work in over the next few years. Rather, you want to be working in entry-level housing. The fixed costs are such that there is very little incentive to build entry-level housing. It’s $50,000 whether you put a 4,000 square foot house or a 1,000 square foot house on the lot. This makes it very tough to build a small house, which is a big problem for the state. You have to go back to the fee structures and how the state pays for infrastructure. We have to get away from the builders’ inactive property taxes, which mean getting rid of Prop 13. This was one of the biggest fiscal disasters ever perpetuated out of the state’s budget.
For people who are elderly, have a house free and clear and have their taxes raised, you would use reverse mortgages. Mortgage your house and pay your taxes. We use the same roads, the same fire services, the same police services. It doesn’t mean that just because you happened to be 80, you shouldn’t have to pay your fair share. We want to be business friendly, giving businesses that have been located here for 20 years a massive cost advantage over a new business trying to start operations is reasonable. You have to level the playing field, and people have to pay their fair share. When you think of California, people think California is a high-tax state, but it’s not. We’re an average tax state. We feel like a high tax state because we have given these ridiculous protections to certain portions of the population and economy that we’re not all entitled to, and those folks are completely under taxed. As a result of that, we have to overtax everybody else to make up the difference. Texas makes their senior citizens pay property taxes the same way everyone else does, as does every other state in the U.S. except for California.
Foreclosure is not the reason for California’s problems, but one thing it does do is it does not replicate a buyer for the next transaction; those people are not buying. 70% of Riverside’s sales is either a short sale or an REO; so every time you have 1,000 houses moved, about 65-70% of people are not buying because they just lost their credit. This sounds good on paper; but if you go back to 2000 and look at the housing market in Riverside, you will see that close to 40% of single family units were actually rented out to other families. They were investor-owned rented out. It is pretty clear that there is a flourishing investor market in the Inland Empire. People buy single-family homes; they rent them out to people who need them, and there is no reason in the world why that process cannot do the job of absorbing some of the excess supply out there. In many ways, right now the administration course has been talking about how we get investors to move into the market to scoop up more units. Christopher’s answer is you don’t have to do anything except get out of the way and let investors have the same rights as individual buyers when it comes to securing financing. This would probably be the end of the problem in a very short period of time, particularly in California because there is not enough housing with it being the second-lowest vacancy rate in the nation. It is not going to fix the problems in Arizona, Florida, or Nevada because the problem there is the vast excess of supply. It doesn’t matter how many investors you pull into the market, it’s just not enough households to absorb all the stock.
What is interesting about this downturn is that as severe as it has been, we have not lost a lot of migration out of California. This is because migration is driven by two things: relative unemployment and relative home prices. As bad as things are here in California, they are bad pretty much everywhere, unlike the mid-90s where things were bad here but the rest of the country was doing okay. At the same time, we had a lot of people leaving in 2005 and 2006 because of the skyrocketing cost of housing. This goes back to the idea that affordability is a good thing and something we should strive for and not fight against. A lot of folks were simply leaving because they could not find a house. With affordability being so much better in California and them providing one of the best standards of living in the nation and many other factors, there is a lot of reason to be in the state. People want to be here. To see more, go to www.beaconecom.com.
Doug Duncan will be on the panel for I Survived Real Estate 2011, taking place on October 14th. The Norris Group would like to thank their gold sponsors for the event: Adrenaline Athletics, Coldwell Banker Pioneer Real Estate, Conaway and Conaway, Delmae Properties, Elite Auctions, Inland Empire Investors Forum, Keller Williams of Corona, Keystone CPA, Kucan & Clark Partners, LLC, Las Brisas Escrow, Leivas Associates, Mike Cantu, Northern California Real Estate Investors Association, Northern San Diego Real Estate Investors Association, Pacific Sunrise Mortgage, Personal Real Estate Magazine, Realty 411 Magazine, Rick and LeaAnne Rossiter, Southwest Riverside County Board of Realtors, Starz Photography, uDirect IRA, Wilson Investment Properties, Tony Alvarez, Tri-Emerald Financial Group, and Westin South Coast Plaza. Visit isurvived2011.com for more details.
For more information about The Norris Group’s California hard money loans or our California Trust Deed investments, visit the website or call our office at 951-780-5856 for more information. For upcoming California real estate investor training and events, visit The Norris Group website and our California investor calendar. You’ll also find our award-winning real estate radio show on KTIE 590am at 6pm on Saturdays or you can listen to over 170 podcasts in our free investor radio archive.