Bruce Norris is joined again this week by Peter Schiff. Peter is the CEO of Euro Pacific Capital and bestselling author of The Real Crash: America’s Coming Bankruptcy – How to Save Yourself and Your Country. He is also the host of the nationally syndicated Peter Schiff show, heard daily from 1-3 Pacific Time at schiffradio.com.
Bruce asked a question very near and dear to most of his clients’ hearts. Bruce asked about Riverside where the prices are so low that a builder could not possibly create a building lot or build a house for a profit. He wondered if this makes it underpriced or if it is still over-priced. Peter said that California is certainly not one market, but there are many local markets within the state. To the extent that property prices are below the construction cost, it is an indication that the market in that area may not be as overvalued as it is in other areas. In many cases, this depends on what the land is being valued. The land may actually be worthless in that respect, and the only value is the improvement. The improved property does depreciate over time, so if it is there to be used then it is also wearing out. If you cannot really sell it, then you have to factor in the depreciation until there is a point where you can factor it.
A lot of people who were in California during the Bubble were getting priced out of the market and started to stretch into distant Inland Empire type markets. Here they had about an hour commute, but they thought it was worth it because it was the only way they could get into the real estate game. They wanted to get rich, so they figured they would endure the long commute. Now that the bubble is burst, there is really no reason to live so far away from where you work, especially with the higher cost of gasoline now making it so expensive to get to work. This is assuming you still have a job. Peter said he thinks more people would rather rent something closer to work than buy something an hour away, even if it is a bargain based on what it may cost to build it. There could be no reason to build it. You could build a house in the desert and say it is selling for a lot less than it cost you to build it. However, there was no reason to have that house out in the middle of the desert.
In some respects you cannot say a property is selling below construction cost because it maybe should not have been constructed in the first place. It may have to go down a lot more before it makes sense for people to buy it. Usually when you think about California you think about the San Francisco Bay area, Los Angeles, and Orange County. Even here prices are still way out of whack with people’s ability to pay. The only reason that people are still able to afford these high prices is because of massive government subsidies. Right now we have the lowest mortgage interest rates ever in the history of the country. This is what it is taking to pop up real estate markets. In addition, interest rates should not only be at record lows, but the Federal Reserve is buying $45 billion worth of mortgages a month.
Without the Fed buying up the market, mortgage rates would be rising. The only reason they are not rising is because the Fed is buying them all. The government is directly loaning money to people to buy houses at the lowest mortgage rates in history. This is the only thing holding onto the market. Eventually, the Fed has to take away the punch bowl; interest rates have to go up. This means mortgage rates have to go up and real estate prices have to plunge. Once interest rates go up, people cannot afford to buy these houses at these inflated prices. The other problem with California is the fact that the jobs are going to go. No entrepreneur in his right mind is going to move a business to California since plenty of entrepreneurs are planning to escape from California. Peter talks to people all the time who are planning to move to Nevada or someplace else and get out of California. You have governors, such as Rick Perry from Texas, who almost lives in California now recruiting California businesses to move from California to Texas. With a 13% income tax versus 0% along with work the California Labor Board is doing, the tax base will most likely be eroded. It is very expensive and risky to hire people in the state of California. People will most likely be leaving the state, not coming into the state. This means more houses will be up for sale and not as many people up to buy them. It is a disaster in the making for California real estate.
Peter is not opposed to signing up for a thirty-year payment at this level. If you own a house, you have to take advantage of the money. The worst way to own real estate right now is to own it free and clear and own it all-cash. The only way that you make money as a homeowner is by being a debtor. You are not really making money on the value of your house going up, but rather on the value of the debt being wiped clean. If you can buy a property with a 3 ½% down payment, which you can with an FHA loan, then you get a lot of leverage and can take advantage of the chief financing. When inflation wipes out all the savers and debtors, they also wipe out your mortgage debt. Therefore, Peter definitely thinks if you are going to own a house, then it should be done this way. However, if you are looking at an investing in property, he would not be buying in California.
There might be places where the economies are likely to be better, such as Texas, but the national economy is still going to suffer. This is because of the policies that come out of Washington and the Federal Reserve that affect everybody, even if you are living in a state that is getting it right. You are still living in a country that is getting it very wrong. In general, real estate is not a preferred asset almost anywhere. Peter said if he is right about the US economy headed for a major collapse, the financial crisis, the sovereign debt crisis, the dollar crisis, then it is not a good market for real estate. People are losing their jobs and will be spending more money on food and energy. They will not have as much money left over for rent or mortgage payments. Peter said he also thinks that households will be destroyed.
In the late 1990s, people were graduating from college, were getting good jobs, and they immediately bought a house. This is not going to happen anymore. People are graduating from college, cannot get jobs, and are drowning in student loans. There is no way they can afford a house, so there would be no reason for them to want one. There is no compelling reason to buy since the reason to buy before was that you could get rich since the prices were increasing. Now, people start to appreciate the cost of owning a house. There is a money pit, and you have to pay taxes, insurance, maintenance, and everything that costs money. People forgot about the cost of owning a house when prices were rising since it cost them nothing. The appreciation offset all those costs and caused money to be left over. Houses are not appreciating if they are just keeping pace with inflation. It costs you a lot of money to own them, so a lot of people cannot afford it.
You also have older people now who are retiring, but they do not have any income since they are getting 0% interest on their savings. They cannot afford to stay in their homes, so they are putting their homes on the market for sale. They have to downsize because they do not have the income to sustain themselves. You have a lot of people leaving the workforce now, so you have people who want to downsize, young people who cannot afford to buy, and the old people who have to sell. The supply and demand imbalance is going to be enormous, and you have all the backup in foreclosures. The whole process has been dumbed up for years, and there is a huge shadow inventory of property that is not on the market right now because people don’t think they can sell. The minute people see some kind of uptick in prices, you are going to see a lot of properties come right back on the market. Most of it will not be able to sell since there are not enough buyers. It is not going to be good if you are really worried about inflation and want to buy gold, commodities, or foreign stocks. If you want to buy real estate, buy it in Asia, Australia, or anywhere the economy is going to improve.
Peter lives in and owns a home in Connecticut. His home is way underwater even though he just bought it a couple years ago. He did not buy it as an investment, but rather because he was tired of moving. He rented it before he bought it. However, he bought the property for about 60% below what the guy who sold it to him paid, and he is still losing in it. It is still down because he spent money fixing it up, and he probably lost about 70% of the money he improved. Whatever he spent improving the house, he got back on the appraisal about 30%. The house went down anyway even though he bought it in December 2009. He bought it for half of what the price was in 2002. The person who sold it to him spent a lot of money on it and fixed it up. He really took a hit since he owned it for several years. Peter did not buy it because he thought he was picking out of the bottom. He bought it because he had enough money that he did not care how much money he lost on the house.
Peter owns a boat, which he said is not a smart financial decision since he only uses it about three or four times a year. At what it cost him to maintain the boat, he could rent a much better boat and save a lot of money. However, he does not own the boat as an investment. It is a lifestyle and something that he wanted to have, just like his cars. He buy cars he knows will go down in value every year, but he buys them anyway. This is the same attitude he has about a house. This is why you should not buy a house if you are not prepared to lose money. Otherwise it is rent. For most people, renting is cheaper. Brokers always try to con you into thinking you are throwing away money when you are renting. You’re not because you are getting a place to live out of it. For years he was renting houses and paying his landlord such a low rate of rent that they were in negative cash flow.
Peter was getting a great deal renting because he was avoiding all the headaches of owning a home. Now he owns a home, which he enjoys. However, it costs him a fortune. Things are breaking in his house all the time. Even though the house was built in 2002, things are still going wrong in it. There are workers at the house fixing something every week. Part of the problem is a lot of hot money has moved into the real estate market. There are a lot of private equity people who have borrowed a lot of cheap money and bought all these single-family homes. A lot of the home sales that have taken place recently are not legitimate buyers. They are flippers and speculators who have bought these houses up, are putting them up for rent, but they are hoping to sell them when the market comes up. It’s like a war because when interest rates go up, the prices are going to come down and they are going to start losing money on these houses.
With interest rates going up, if they take just the money they borrowed to buy them, they are not going to collect enough in rents to cover the interest on the borrowed money. As the economy worsens, some of the tenants may lose their jobs. Peter thinks you will see a lot of these speck homes coming down in the market. These guys are levered up, but when the investors want their money, they are just going to sell. They are just going to hit the bids, so you can see a big drop in prices because of all the speck money that is trapped in residential housing right now. Single families, for example, did not just buy an apartment, but rather huge blocks of single-family homes in Nevada, Arizona, Florida, and even Riverside, California. They think they are going to make money and are trying to catch a falling knife. However, they are going to end up catching it right in their stomach.
Peter has a son named Spencer who is ten years old and another on the way. Right now Spencer is too young to have an opinion on what he will have to deal with, but it probably starts early in the Schiff household. Peter does have one book he wrote that young people can really read, understand, and enjoy. It is called How an Economy Grows and Why it Crashes, which a lot of ten and eleven year olds have read. Peter recommended if you have a young child to buy the book for them, and when they are done to read it yourself.
Peter uses the term decoupling to describe a situation where, using the analogy of the global economy as a train, all the trains are attached to one another. If one moves, they all move. In that analogy, most people think of the U.S. as the engine with all the other trains. However, the idea of decoupling is that a train can decouple from that engine and keep on going. This means the U.S. might can stumble, but emerging markets can still do well. Peter’s idea about decoupling is that the U.S. is not the engine, but rather the caboose. Decoupling will actually benefit all the other cars because America is not pulling the train, but rather the train is dragging America’s dead weight. The reason Peter says America represents a dead weight is because we are net importers. We consume more than we produce, which means we are living off the global economy. If America just disappeared, then the world would have more, be able to work less, and enjoy more consumption from the work they are currently doing. They would have more. This kind of decoupling is going to be very positive.
A lot of people think if the US economy crashes, we will take the whole world down with it. Peter thinks it is the opposite and that it is actually popping the US economy up that is holding the whole world back. If the world lets the dollar collapse and stops subsidizing our economy, then their economies will take off.
One of the questions Peter asks in his book is if we will default in order to avoid a crisis, or will we react to one. Peter said he does not think we are going to avert a crisis. The only hope we have of eventually doing the right thing is doing it in the aftermath of a crisis. This goes to the nature of politics. Politicians follow their own self-interests, their own need for preservation, and their need to be re-elected. They are never going to deliberately do something to bring on short-term pain, even if it is exactly what is needed. They are never going to ask them to swallow medicine that is bitter, even if it will cure us. They would rather give us some sugar or something that tastes good just so they can get re-elected, even if in the process the disease gets worse since we are not treating it. Once it comes to the point where it is so bad they cannot do it anymore, then they may finally be forced to do the right thing. However, they will try everything else first.
Bruce said it seems like the one suggestion of just giving a one-time tax of the wealthy certainly seems like the sentiment is leaning toward people who have done well and have savings. They want to tap that spigot and tax it as hard as they can. Bruce said this feels like a pretty dangerous trend to him. Simply confiscating wealth through a confiscatory tax plan is not going to solve any of our problems. First of all, whatever money the government confiscates is just going to spend it. It is not like it is going to help the economy. However, you also create a very dangerous precedence that what you own is not yours and the government can steal it. People will not be trying to accumulate more wealth, but rather trying to hide whatever wealth they have out of the county. Once you start this, you are pretty much finished. What we need to do is restructure the debt by simply not paying back what we borrowed. This is not confiscating anything; this is simply defaulting.
Individuals declare bankruptcy all the time, but it does not mean we are no longer a nation of laws and that we no longer have a market. The market allows for bankruptcy. Stockton, California just declared bankruptcy. Cities can declare bankruptcy if they are broke. The US government is broke, and there is no way to pay its bills. All we can do now is keep interest rates at 0 so that we do not have to pay our bills. $1 trillion is being printed a year so we don’t have to pay our bills. This is damaging the economy much more than if we just defaulted. What we are doing now is far more dangerous to the economy than a legitimate restructuring of our debt where we tell our creditors we cannot pay them back. If we were to immediately default on our debt, nobody would want to loan us anymore money. This is a good thing. The best thing that can happen to America is that nobody wants to loan the US government any money because then the government has to stop spending. If they cannot borrow, they cannot spend.
In addition, we have to tie the Fed’s hands and make sure they cannot print. Right now the Fed is monetizing all this debt. They have to stop doing this. They have to stop giving the government an easy way out. We need a better Fed sharing with some backbone to let interest rates increase and to refuse to monetize any of this debt. This would force the government to cut spending. However, because the Fed gives them an easy way out they do not have to cut spending because there is no immediate negative consequence to the budget deficit because the Federal Reserve modifies them. However, this is creating grave long-term consequences. Peter said he is not talking about 10-20 years from now, but rather we are going to face these long-term consequences in the next few years.
Peter mentioned Stockton, California earlier. This is a real test cast for a lot of people who have debt who are in line, Calipers being one of them. There was another event with Cypress recently that probably makes people feel uncomfortable with large deposits. This could even be true with small deposits since initially they talked about giving everybody a haircut, including the accounts that were insured. If you have a bank account in the United States, you are going to lose. One way or another, you are going to lose. Your bank is going to fail, the government is not going to bail you out, and you are going to lose some of your deposits even if your account is insured. We have $8-$10 trillion of insured deposits, and the FDIC has about $20 billion worth of treasuries to back them up.
One scenario is that your bank fails, there is no bailout, and you lose and don’t get back your money. The other scenario is the bank does not fail because the government bailed them out and you get back all your money, but your money is not worth anything because the government had to print trillions in order to bail everybody out. Either you lose to inflation, or you lose to default. The lesson is don’t maintain a large bank account. You just need to keep enough money to clear your rent check or your mortgage check, and don’t keep any significant amount of money in the bank. You have to do something else with it, whether it is to invest it, buy gold, silver, stocks. Even buying real estate is better than leaving your money in the bank. Peter said he likes buying foreign stock or dividend-paying stock. Do something with your money. You have to buy something that the Federal Reserve cannot print.
One of the hardest things about investing now is because of the manipulation and interference, it is hard to say how it is going to play out in the short term since it is so volatile due to the interference. There is a lot of noise and a lot of things happening to manipulate the market. We also have foreign central banks, including the Bank of Japan, the Bank of China, the European Central Bank. We have banks all around the world and emerging markets in Latin America and Southeast Asia that are all interfering to prop up the dollar. All of this is delaying the day of reckoning, and it is impossible to know when this day will arrive. The only thing we know for sure is that it will arrive. The longer we have to wait, the worse it is going to be.
If you are interested in learning about how to build a globally diversified portfolio of foreign stocks and bonds, you can talk to one of the brokers at Euro Pacific Capital. The website is www.europac.net. If you want to buy physical precious metals, he also has his own metal company. You can visit him here at schiffgold.com. If you also want to listen to more of what Peter has to say, he also has his daily radio show he does on weekdays 7 am to 9 am California time Monday through Friday at schiffradio.com. He repeats the show every two hours in case you missed it the first time.
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.
