On Friday, October 19, the Norris Group proudly presents its fifth annual award-winning event I Survived Real Estate. An incredible line-up of industry experts joins Bruce Norris to discuss perplexing industry trends, head-scratching legislation, and opportunities emerging for real estate professionals. Proceeds for the event benefit Make a Wish and St. Jude’s Children’s Research Hospital. This event would not be possible without the generous help of the following platinum partners: ForeclosureRadar and Sean O’Toole, 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 Bobi Alexander, San Jose Real Estate Investors Association and Geraldine Berry, Frye Wiles, MVT Productions, and White House Catering. Learn more about the panel and how to attend at isurvivedrealestate.com.
Bruce Norris is joined this week by Eric Janszen. Eric is an economic analyst with more than two decades of experience as a technology industry executive and venture capitalist. In 1998 he founded itulip.com, a financial analysis company with an amazingly accurate forecasting record. Eric is also the author of the post “Catastrophe Economy.” Eric Janszen will be featured on the panel for I Survived Real Estate 2012. Bruce described how the panel is going to include a whole new demographic. One of the speakers is vice-president of Carrington, which is one of the billion dollar piles of money interested in residential real estate in California. In the last six months, it has been obvious that California real estate is considered a smart bet. People have been buying everything in sight because of this. What is interesting is that we have never really had a market-maker in the real estate world who is such a dominant player that they could almost create their own outcome. Since they have shown up, inventory has gone from six months to one month. All of a sudden, every time you have something for sale there has to be twenty offers that show up inside of two days. We are having price increases because of this.
Eric said this is not surprising. The way that the hedge fund works is it is a relatively small community, and they do tend to operate in the herd. The last couple years have seen a lack of yield, and there is a very small number of opportunities to go after. One of the funds Eric invested in did not invest in real estate, but actually multifamily properties and the theory of rising rents. Eric has also been in contact with a fair number of mangers who have all decided that housing has pretty much bottomed. With mortgage rates at 3%, you can do a simple calculation where it is very unlikely that home prices will appreciate at an average rate of 3% over 30 years. You are likely to make money in capital gains on real estate if you can lock in those fixed rates and buy at what appears to be a market bottom.
What is interesting is that in many areas in California the price of the home is actually less than the cost to build by considerable. It would seem the math would catch up with it, and eventually we will have enough demand to where we will have to build something. That should then be a very profitable day to those people who have bought it and held some of it. This seems to be true, and the latest Case-Shiller data showed home prices are up considerably in twenty major cities year-over-year. In early 2010 prices went up as well, so it is not absolutely clear if we are at the bottom with prices, if they will continue to rise from here, or if we are having another bounce on the way down. Eric said back when he was first writing about the housing bubble in 2002, what he identified was the loss of the normal correlation between regional income and home prices. This is generally an indication of a bubble in real estate. What appears to be happening is prices are re-correlating incomes. You have some areas of the country where prices are going up, and there are other areas where they are still not doing well. It really depends on how well the regional job market is doing and whether incomes are rising.
Bruce said he does not know if he is typical of most buyers of real estate, but his wife and he started out buying a $20,000 home that turned into a $30,000 home. They bought a new one at $39,000 and took the net proceeds to use as a down payment. Their payment really did not change, and then the $39 grand went to $85 grand. They took the $50 grand from this and put it down on a $120. Their payment did not change very much. Using this money, they built a custom home, which they had the same payment for as the first home. The progression of price was astonishing with what they were living in, but their payment never changed. When you look at a ratio saying what are the people’s incomes and if it supports the price, you see that sometimes it is supported by the fact that they brought an awful lot of cash from the former ownership.
Eric said you have to keep in mind that we have been living in a very unusual period of time since the early 1980s. This was right after we had a big inflation. The problem was it felt like the prices were going up, but that was the period of time when housing was only keeping up with the rate of inflation, so it may have felt to people like they were making money. What felt good for Bruce was that he had three piles of money going up instead of one. You had to keep your money at the time; anybody who was in cash lost their money. That was the right thing to do. However, subsequent to that the economy was hammered into the ground to stop the inflation spiral. Interest rates were quite high in double digits, so it is hard to imagine that a 30-year treasury bond is creating anything like 13 of 14%. These are only now maturing. Everybody at the time was convinced that inflation was going to go on forever. Now everyone is convinced that inflation will never appear ever again. Eric’s theory is everyone is wrong again, but in the other direction.
Starting in 1983, interest rates had been declining continuously. The reason that Bruce was able to move into one house after another without paying more is because interest expense keeps falling. The monthly cost of owning keeps falling even if the sticker price on the house is going up. Bruce said at this point he does not owe anything, but it was the progression of what happened when he was in that mode.
Bruce said Eric’s book is the toughest book he has ever read. He was on vacation on a cruise where he brought about four or five books with him. He read each of the other books inside of half a day, and took him eight days to read Eric’s. Eric’s was the kind of document where you would have to reread it to completely grasp it. It is not just technical, but it is dense in what it brings. On the cover he has America looking like it is getting a tune-up. The subtitle is “Rebuilding America and Avoiding the Next Bubble.”
Eric had hoped we would head in a certain direction and get the ship righted. Bruce wondered if we have made strides in getting there. Eric said we have to a certain degree, but not nearly as much as we could have. We have spent a great deal of the nation’s limited credit trying to re-inflate the housing market. We have not really addressed the biggest area of the economy that is really laying down on households, which is the expense of health care. It is the one thing that really stands out like a sore thumb in the personal consumption expenditure of households. It keeps growing and growing and consuming people’s incomes more and more. You can do more to stimulate the economy by reducing the costs of doing anything else. Looking forward to the future, the book did not focus on this as much as issues around energy costs as we go through the peak-cheap oil era that began back in 1998. This has really changed the dynamics of the way of the energy market, which is driven entirely by oil prices. What he was hoping for was we would take some of that money we spent on trying to rebuild our economy and focus it on productive businesses that specifically are aimed at solving our energy problems. Most of the things that are really practical that we can do are related to conservation.
Eric spoke at a conference last year to the Building Owners and Managers Association, and he suggested to them that one of the ways they could make money was to spend some time electric fitting buildings to reduce energy expenses. This falls right into the cap rates and improves the return, both on a cash-flow basis and a capital valuation basis of commercial buildings. Someone went out and actually did it. There are a lot of ways to actually make a lot of money off of solving this problem, the problem being the amount of energy it takes to generate a dollar of VP growth is still too high. We will continue to grow as oil prices rise.
Regarding the upcoming presidential election, Bruce wondered if Eric had a feeling about how it was going to go and what the ramifications would be of either candidate. Eric said it is a really close race, and last time he checked Romney was slightly ahead. He thought the first day of the convention recently went well for the GOP, and there could be a chance that Romney could win the election. On balance, it might be better for the economy and real estate industry, although it is actually a bit of a loss either way.
Bruce wondered if the health care bill that has been passed solves anything. Eric said the political third rail that you cannot touch no matter what is the fact that insurance companies are adding an incredible amount of inefficiency to the health care system. No other country does it this way, and the thing that has to be done has to be taken out of the loop somehow. We have to get back to a system where the individual consumer is making decisions on costs and the market can operate again and set prices for health care.
One thing we have been ignoring in 2012 due to it being an election year is the fiscal cliff. Bruce wondered what Eric sees in 2013 that could happen and if we are going to make some hard decisions to get the fiscal house in order. Eric said the problem with the whole framework of debate regarding the fiscal problem is that all of the foreseeable problems we are having now with our fiscal position are the result of excessive leverage in the private sector and there being too much debt. Eric attended a recent meeting where Janet Yellen was giving a speech, and he spoke to her after the conference. He asked her how it would be possible to address the fiscal problems we’re having that the Fed is continuously warning Congress being a predecessor of some pretty painful increases in debt costs and interest rates in the future. He wondered how this will be addressed if the economy is currently dependent on $ ½ of debt creation for every dollar of GDP growth. Every time that ratio becomes a problem, as it did in 2008, the government has to step in and fill the gap. If the private sector is not lending all the money, the government has to. If the government handles it, then its fallacy gets worse and worse. What it comes down to is what we are going to do to reduce this dependence on credit to grow the real and productive economy. She did not have an answer; and really nobody has a good answer because it is one of those things where once you get on the treadmill, it’s tough to get off.
Bruce said the fiscal cliff seems like the end of the road, and he wondered if this end of the road is a mathematical number or a loss of faith that we are capable of making hard and correct decisions. Eric said our problem as a country is that we not only owe a lot of money to ourselves, but we owe a lot of foreign governments, private institutions, and individuals a great deal of money as well. The problem with that is normally when a country gets into trouble in repaying its debts, it pays itself back to its foreign creditors that leads them to tend to move first in anticipation of that order of precedence. The concern has always been that someday we will not be able to issue enough new treasury debt to cover what is already out there that is maturing. Otherwise, we will have to raise interest rates in order to attract enough foreign capital to finance all the debt. This is ultimately what the Fed is doing by buying Treasury bonds. There is a risk the U.S. will have to raise interest rates in order to attract foreign investment in Treasury bonds because the minute we have to do this, it is game over. We simply cannot finance and refinance all this debt at higher interest rates because then we could immediately fall into a cycle where we have to issue ever more debt in order to cover the expenses that we were trying to cover before interest rates went up. Our expenses are going up faster than we can issue new debt. Ultimately, the question is what will trigger this event; and it will most likely be some oil or price shock that would perturb the system and get the cycle started.
Bruce wondered about the fact that we have a 1.6 ten-year T-Bill rate and what it tells Eric in regards to deflation and inflation. Eric said we don’t have inflation because we still have a gap left over from the Great Recession. This means the economy is operating well under its capacity. This explains why Japan has been drifting in and out of inflation and deflation. They have had very low inflation and deflation rates out there for twenty years and have continuously been in that epic gap. We are in one too; and while we are here, inflation will probably not be a problem. We will probably be here for quite a while. This explains why we are not seeing demand push inflation, but it does not mean we are not getting some cost push inflation from rising oil prices. It just does not tend to feed into the rest of the economy since there is nothing to re-enforce it. However, Eric said he does not think the interest rates are connected very much to inflation risk because the market debt is always driven by government debt. Interest rates of all kinds of mortgages and corporate bonds are all driven by government interest rates. The government interest rates are being driven by the government buying the debt itself and in its political arrangements of trade partners, particularly Japan and China, to purchase at a rate necessary to maintain low rates.
Bruce wondered if Eric sees what is going on in the Euro zone as playing out poorly for our economy at some point. Eric said it is such a mess as the Euro was badly structured from the very beginning. He has always referred to it as half a currency because it is a central bank to manage inflation and provide liquidity, but there is not centralized Treasury Department, IRS, or tax authority. Out of all the things that make a real currency, like the dollar, only one of four components of a real currency is there. Because things are so mis-structured, it is always ready to be tipped over. What tipped it over was the U.S. financial crisis. Before that it was doing okay. Now they are in the situation involving the political stresses with Germany. This started way before the Euro happened back in the early 90s and late 80s when the structure of the Euro was being debated. At that time, the big concern was that if a European currency was ever devised, Germany would become the milk cow to the rest of Europe because only Germany would be in a position as a major goods and capital exporter to support the system. This turned out to be exactly the case. For political reasons, they have to do nonsensical economic things like forcing Greece to go into a deep recession as if it is going to be able to pay its debts back if its economy is shrinking. From an economic standpoint, it does not make standpoint. It does make perfect sense, however, from a political standpoint.
Eric Janszen can be heard again on the panel for I Survived Real Estate 2012, which will take place Friday, October 19.
The Norris Group would like to thank its Gold Sponsors for supporting I Survived Real Estate: Adrenaline Athletics, Coldwell Banker Pioneer Real Estate, Elite Auctions, FIBI, Inland Empire Investors Forum, Inland Valley Association of Realtors, Investor Experts Incorporated, Keller Williams of Corona, Keystone CPA, Las Brisas Escrow, Mike Cantu, Northern California Real Estate Investors Association, Northern San Diego Real Estate Investors Association, Personal Real Estate Magazine, Realty 411 Magazine, Rick and LeAnne Rossiter, Southwest Riverside County Board of Realtors, Starz Photography, uDirect IRA, Wilson Investment Properties, Tony Alvarez, Westin South Coast Plaza. See isurvivedrealestate.com for more on the event and all of the I Survived Real Estate sponsors.
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Tags: bruce norris, Building Owners and Managers Association, California, Catastrophe Economy, economic analyst, Eric Janszen, Euro zone, financial analyst, fiscal cliff, hedge funds, i survived real estate 2012, iTulip, Janet Yellen, The Norris Group Real Estate Radio Show, venture capitalist