On October 18, 2013, The Norris Group proudly presented I Survived Real Estate 2013. An expert line-up of industry experts joined Bruce Norris to discuss perplexing industry trends, head-scratching legislation, and the outlook for real estate in the coming year. Over $90,000 was raised to benefit Make a Wish and St. Jude Children’s Research Hospital. This event would not have been possible without the generous help of the following platinum partners: This event would not be possible without the generous help of the following platinum partners: PropertyRadar and Sean O’Toole, HousingWire, the Apartment Owners Association, the San Diego Creative Real Estate Investors Association and President Bill Tan, Investors Workshops, InvestClub for Women and Iris Veneracion and Bobi Alexander, San Jose Real Estate Investors Association and Geraldine Barry, MVT Productions, Wilson Investment Properties, RODA Construction, and White House Catering. For event video and information, visit isurvivedrealestate.com.
Bruce Norris began the night with the fist panelist, Christopher Thornberg. Dr. Thornberg is an expert in the study of regional economies, real estate dynamics, labor markets, and business forecasting. He has been involved in a number of special studies measuring the impact of important events in the economy. This included the NASDA treaty, California power prices, and full security. Christopher is the first person who Bruce remembers thinking, “I can ask him anything, and I don’t have to know the answer.” This was quite a relief for him. Joining Christopher on the panel was John Burns. John and his 40-person team advise executives on major residential real estate industry decisions all over the county. The company is on the retainer with many of the largest companies in real estate and investment industries that produce ongoing research and advice.
Bruce said he witnessed something very important. He watched a presentation John did where he was the moderator and had several people on his panel. What he witnessed was something he has only rarely seen, which was complete trust of the people he was asking questions of from their point of view. This man has a lot of credibility. Bruce was glad to have him there since there was a piece of the puzzle he was confused by which he though John could answer. If you think about where your business model came from, it was mostly talking with builders. You then have a completely different or growing set of clients. John said if he was hanging out with homebuilders, he would not have his business today.
Bruce started with Christopher Thornberg by asking him what he saw as 2014’s GDP growth as far as the country. Bruce wanted to tie this into the question if interest rates are going to be radically different or very much the same. Christopher said there are two questions here that don’t actually relate as well as you may think. Fundamentals for the economy today have substantially improved. Corporations make a lot of money, labor markets are starting to tighten up, and incomes are rising at a better pace. In addition, real estate is starting to turn the corner and banks are healthier in terms of profits and losses. The biggest problem you have is the elected leaders in Washington D.C. who seem to have desperately upset the apple cart. Christopher said he just ran into this nonsense over the debt ceiling, both about it being not over and extended 90 days. Some folks claim that they will not shut the government down again, but we will see about that.
Even pushing aside the budget debates, we don’t even have a full set of regulations about the banking industry. They cannot even agree about what a conventional mortgage looks like. We live in this period of policy uncertainty that is having an influence on things. The fundamentals will keep us going, but they are optimistic about next year being at 2 ½-3%. If we could actually get somebody in D.C. who could get some of these things resolved as well as focus on things that are important, it could probably be a much better year. Bruce wondered why Christopher thinks this does not relate to them saying they will pull funds due to Fed fund buying. Christopher said in this case you are talking about tapering, and the presumption here is that in one way or another, quantitative easing is having this huge impact on long-term interest rates. In reality, it is kind of a psychological game, as it always has been. They were pushed to abnormally low levels, and when tapering occurred they were bumped back up to what would be a realistic place. They may go up 40 bits, but that is about it.
Ultimately, we live in a world awash with capital. Our central bank is being loose as well as other banks. We have large economies in Asia that are growing rapidly, and they have a lot of savings they are trying to move out of their country. Ultimately what this means is that rates are going to remain low. Some Chinese rating agency just downgraded U.S. government debt, and at the same time they announced their treasury now holds the most amount of U.S. government bonds they ever have, which is at $3 trillion. Talk about talking out of both sides of your mouth.
Bruce went on to talk next with John Burns. He told him that usually the builders have a bigger piece of GDP than they do right now. Bruce asked John what he sees for 2014 both on a national basis and in California. John said the builders have been pretty optimistic, as Bruce pointed out back in June. The problem is that they cannot grow their business because there were zero dollars devoted to land entitlement during the downturn. They are trying to get some of this kick-started again, and it is taking them forever. There really are two kinds of builders out there. There are the public homebuilders who have had insane access to cash. One of them raised $250 million at a 0.5% interest rate. Another one got it at a 4 ½-5% interest rate for thirty years. With interest rates being so low, if you are running a bond fund then to get any kind of yield you have to be desperate. There is a huge archetype for mortgages in today’s market, so John does not know why people are buying any mortgages.
There is also the private builder world who is trying to get loans from the construction lenders who want to see a lot of equity and are trying to buy land. Some guy with a really low borrowing cost of 4% can buy all the land and develop it at a 4% interest rate. A private builder can’t pay that price and just cannot get it done. Bruce wondered why the national builders are not really busy in California. John said they are trying to be, and the number one complaint he hears is the shortage of land. Bruce said this is something that likely will not change. There is a stigma associated with being in some of the sub-markets where they wrote off 90-100% of what they paid in the premium. There is definitely a stigma to going to Victorville and some of these other places. If you bring a deal back to corporate, it better look smoking good. These guys have not been bringing deals to corporate for that reason. However, if it is in Ontario or Rancho Cucamonga, they are paying close to peak land prices now for some finished lots in the good locations.
Construction costs are way down, and they are relying on a lot of home price appreciation. There is a little bit of a ramp-up period when you decide we can build something and ask what the ramp-up period is. If you look at the 90s downturn, it was a 4-5 year ramp-up period. Construction hit bottom in 1993; and through 1996 there was not a lot of construction happening. It really only started to trickle up in 1997-1999. John sees the same scenario playing out from a lot supply this time around as much as last time around. Bruce wondered if there is a thought that since they are not creating sub-division it must be because they are just sitting on unfinished building lots. However, John said this is totally false because if they had finished lots on which they could build, they would be building on them like crazy. The question why they were not in the last year since they could have made a lot of money selling homes.
Bruce was baffled, but he does not understand the no sub-division creation. There is a data company that calculates a number of finished lots, and it is at an all-time low right now. Christopher Thornberg jumped in to say that at the national level you are not seeing these kinds of huge numbers. You know there has been a softening in new single-family home sales over the course of the summer, and it has not really bumped back at all. There is growing inventory, and the inventories of existing single-family homes are up about 50% over the course of the last eight months. At least on a national level you are not seeing this same kind of trend.
The census has an estimate of the number of single-family homes for sale, which is at about 50% over the course of the last year. Supply is still relatively low, but we are still talking about $180,000 nationally. Chris thinks the new home market is being stymied in large by the lack of credit. You are really dealing with a situation where the thing people are looking for with a Fannie/Freddie loan is $750, originally $710. This knocks off 15% of the buying public.
Bruce asked John who the buyer of a new home is, whether it is a move-up buyer or a new buyer. John said it is somebody who got their last mortgage 15 years ago. They are either moving up or they are moving down. It is heavily skewed to that group, and other data showed the entry-level buyers have really been missing in this recovery. It’s just stunning to him. The entry-level buyer cannot even buy the builder’s home. Why would a builder build a small home when he can build a big home? John said the math is such where if you have to pay a silly price for land, then you have to build a big home on it. Because of the supply dynamic and the land market, it is forcing them to build bigger homes than they would normally choose.
When one says builders have confidence, they receive that feedback from somebody who they trust. The public builders look at the stock price every day, and when they are way up they think people love them. They say their shareholders are buying more and want them to grow their business. The stocks rallied a lot this year and have given almost all of it back at this point. You would think the lessons would have really been learned, but usually we start drinking the same kool-aide every time it gets good. The lesson for them is to manage your balance sheet right, and they have. They have gotten very little debt due in the next 3-4 years; so for the first time in their careers they have gotten long-term capital to really low interest rates to play around with for now.
Some are concerned that we have debt levels that are not so good. Bruce asked Christopher what he thought, on a scale of 1 to 10, what his level of concern is of the total national debt. Christopher said for national he is at a 3, while for California he puts himself at a 3 also. In this case we are talking about financing and outstanding debt. The national debt right now is at $12 trillion, and a lot of it is sitting in the government’s own hands. The social security administration has been buying debt to pay off future obligations and have some modest degree of basic accounting skills.
Regarding student debt, Christopher still put himself at a 3 on the scale. This was also the same for the national deficit. He pretty much put himself at a 3 all the way around. Bruce knew this would happen, and John jokingly said he must be running of office. Bruce then asked him about the shortfall in retirement accounts, or people with defined benefit plans who think they will be paid in full, which he put at about an 8 ½. Oddly enough, certain pensions are bad, and California is actually one of the bad states. If you look at other states, Texas has a worse pension problem than we do. This puts him at a 6 ½ for California and an 8 ½ for the nation overall.
There are court cases right now regarding some of the cities declaring bankruptcy. Normally what happens is that kind of debt is considered senior debt. This is probably going to be challenged, although he does not know if it is going to change. Christopher said it is already being challenged. When you think about senior debt, according to the Michigan Constitution and the California Constitution, you are going to declare bankruptcy when there are certain pensions that cannot be touched. The debt is being challenged and will almost certainly be overthrown because when the city goes bankrupt, it ends up in a Federal Bankruptcy Court.
Federal law trumps state law, so if the bankruptcy judge says you are on the hook, then you are on the hook. It is as simple as that, and CALPERS has already made the statement that if they indeed lose this particular legal issue, they will indeed garnish those pension payments for those in the San Bernardino system. Those who will be garnished will be those receiving the defined benefit, in this case the retirees. Those in the system today will lose a portion of their payments. This is a serious problem because the question is really about who made the promise. If you said that about social security, we would all have a problem with it because there was a promise made.
Bruce asked if either of them feel better about short-term than long-term. They said yes, and this is actually the problem. You listen to the screaming going in in D.C, and you see the gerrymandering of districts of a complete collapse of any control of campaign finance laws. You end up with two groups of zealots, one left and the other on the right. One is making a huge amount of noise about something not important, and the other is completely ignoring the things that are important. It is no wonder anything is getting done.
California has gradually improving unemployment. Bruce asked John if we are going to fix unemployment without the participation of the builder, or are we just going to stay unusually high? John said when the builders are doing their best, the other complaint he hears besides finished lots is lack of labor. People do not want to come back to the industry. They have found jobs elsewhere that are not as hard work. Labor rates also fell 30% and up during the downturn, so the rates are going to have to come back up to attract people back again. John thinks this will happen but the skilled labor is gone.
Bruce asked what percentage of California is usually new homes versus existent homes. John said he does not remember, but he does have one good stat. In the last twelve months, they have built as many homes in Houston as they did in the entire state of California. This will tell you what it is like to try to get home construction done in California since they are trying just as hard here as they are in Texas. The government is getting in the way. Bruce asked if California has a lot more restrictions in the way that Texas would. John said that basically, your permits in Carlsbad cost more than the construction costs in San Antonio. Bruce jokingly asked if it would be a good idea for them to lower these costs. John said they are raising them because of everything going on with the deficit. Christopher jumped in to say a lot of it has to do with Prop 13, which will be discussed in a later segment.
One of the things that Bruce really wanted to know is in regards to those who buy and sell homes that are usually done by a competitor with a fair amount of volume. Bruce said he does not see the new lot creation to making that a factor. John said there is no risk to competing with the new home supply in the next three years. Bruce asked if it is possible we had price aggression that mimicked 2013. The builders would completely miss the subside in California because they did not have product ready. John said he thinks there is a case for that. They look back at 2013 and are surprised since they expected to see the kind of appreciation they saw over the next 4-5 years, and they had it in twelve months. Now we are having to pay near-peak prices for land, and it is outrageous. They are looking at the future of the business right now, and it is very risky because of the cost of entry, in this case land, being extremely high.
Bruce asked why they did not buy with both hands in 2008 and 2009. John said they called every single bank in California 1,000 times. What was surprising to him was that a lot of the landowners took the land back, kept the deposit, and had no urgency to sell. They did not want to sell during the downturn or sell it at the price they wanted, and they held onto it. They were wise to be holding onto it, but at the same time it held construction back.
Bruce asked Christopher if he was concerned about inflation. Christopher said he was not at that a lot of it goes back to the quantitative easing issue. One thing you have to keep in mind is that 85% of all cash pumped into the economy through quantitative easing is not in the economy, but rather it is sitting in the banks as reserves. As for bank lending, it has not accelerated but rather decelerated. Right now it is up about 1% over the course of last year. Banks are not lending again because of the regulatory uncertainty. The money is sitting there completely neutered, and inflation has a 0% chance anytime in the next two years.
Bruce asked John if the builders are surprised by the product that their customer wants. Bruce asked if the customer ever said they thought one thing was being built, but they really wanted something else. John said they are not really surprised so much since they are building different homes. During the downturn, they built a box with a roof on top since they were trying to compete with the foreclosures. Right now the consumer has said when you buy something new, you expect the latest and greatest technology. They want extreme energy efficiency and great rooms. They want a different type of design, but they are willing to leave the dining room out altogether. They are building some new product, which he thinks is a competitive advantage.
Bruce asked about the senior group who is retiring. Are they really wanting to downsize? We have been kind of spoiled the whole time, so that’s why Bruce wanted to ask. John said it is not necessarily a smaller home as much it is a lower maintenance home. It is also a different home. When you have little children, you want to be upstairs near them. When you have teenagers, you want them on the other side of the house. When they are older, you want a master bedroom downstairs. They are picking a different product that is lower maintenance. Some of the homes they are buying are pretty good sizes because they want the kids and the grandkids to come back.
Bruce also asked both of them about demographics inside of the next ten years. He wondered if it will be a different story in the second ten years when real estate when the baby boom generation is really tossing out a lot more homes than be absorbed. He wondered if there is a difference in those two decades. Christopher said he does not think so and as time goes on the boomers will be reluctant to leave.
To find out more, tune in next week for I Survived Real Estate 2013, part 3. The Norris Group would like to thank their gold sponsors for supporting the event: Adrenaline Athletics, REIExpo.com, Coldwell Banker Town and Country, Claudia Buys Houses, Elite Auctions, FIBI (For Investors By Investors), In a Day Development, Inland Empire Investors Forum, Inland Valley Association of Realtors, Investor Experts Inc, Keystone CPA, Las Brisas Escrow, Leivas Associates, Homevestors, Bottomfeeders, Northern California Real Estate Investors Association, Northern San Diego Real Estate Investors Association, Orange County Real Estate Investors Association, Orange County Investment Club FIBI, Personal Real Estate Magazine, Pilot Limo, Primary Residential Mortgage, Realty 411 Magazine, Rick and LeaAnne Rossiter, Southwest Riverside County Association of Realtors, Sonoca Corporation, Spinnaker Loans, uDirect IRA, Tony Alvarez, and Westin South Coast Plaza. See isurvivedrealestate.com for the video from the live event.
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