On Friday, October 16, the Norris Group proudly presents its 8th annual award-winning black-tie event I Survived Real Estate. An incredible lineup of industry experts will join Bruce Norris to discuss perplexing industry trends, head-scratching legislation, and opportunities emerging for real estate professionals. Proceeds from the event benefit Make a Wish and St. Jude Children’s Research Hospital. This event could not have been possible without the generous help of the following platinum partners: HousingWire, PropertyRadar, the Apartment Owners Association, the San Diego Creative Real Estate Investors Association, San Jose Real Estate Investors Association, InvestClub for Women, MVT Productions, First Lending Solutions, and White House Catering. For tickets and information, visit isurvivedrealestate.com.
Bruce Norris is joined this week by John Burns. John is the founder of John Burns Real Estate Consulting, which he opened in 2001. John and his team consult with executives all over the country, analyzing and summarizing the information they need to make housing industry decisions with more confidence. The company is on retainer with some of the largest companies in the housing and investment industries, producing regular monthly reports on housing market conditions and customizing specific studies to help with strategic and community-specific decisions.
Bruce has always found it amazing that when he looked at what he did in 2006, most of his type of businesses would have had a hard time surviving to 2009. However, John flourished against all odds. A lot of his growth happened after the downturn. John said volatility is good for his business; it’s when it is boring that they struggle. His team has expanded as well; right now they are up to 65 people and 17 offices. Most of them are 1-2 people, but the local presence really helps a lot to understand what is happening in the market. Bruce talked with somebody John had mentioned in Florida, and a few months later there was a report on Bruce’s exact question, which he found interesting. He had bought a track of lots in Florida, and this was the impetus for the question.
Bruce asked John when he has dealt with charts, had he ever dealt with one that disproved something he was sure was true. John said he probably has, but he was not sure. He said it is actually rare for him to be 100% certain about something since he is always wondering what he does not know. This is a really thing in the chart world since it is always a new twist or a new manipulation. This is part of what Bruce has had to deal with in years past. You are having to look at a delinquency list that is soaring in 2007 and 2008 when foreclosures are soaring. You are telling yourself these two do not go together and something is being tampered with there. John has definitely had charts teach him that what he thought was right was not. When you are consulting, you would probably interact with someone who is so sure that their basic premise true that you have to start disproving this so they can make a better decision. If that is the basis of what you think is going to happen, then that is going to be a problem.
John recently tried to prove the real separation of the classes with more people becoming affluent and others becoming poor. This is what he thinks is happening, but he has not found the stats to prove it. Bruce asked about the latest “Ah Ha” moment for them since they are always researching something. John said it would have been recently when he had his staff go look at what causes a recession. It started to dawn on him that they all seem to be preceded by a lot of debt. Sure enough, 11 out of the last 12 recession were preceded by too much debt in one way or another. When housing markets crash, they are usually preceded by too much lending. He started going into industry by industry asking them which ones had too much debt. This is where they should be the most concerned. Usually, what also happens when you have an easy time, like real estate did from 2000-2006, the debt becomes not only larger but unhealthier and more unsafe since the lenders keep on getting paid regularly on debt they never should have made in the first place. Good things happen, the industry looks great, people start investing and borrowing more, and all of a sudden when things slow down you cannot repay your debt.
Bruce asked John if he sees any inkling that we are going to experience that this cycle. John said yes, but not in real estate. You could see it in all kinds of government debts, both state and local, pensions and liabilities, and U.S. government. Some of these debts cannot even be repaid. John said he could not predict the timing of when this would all blow up, but it is certainly an issue. John once focused on the big publically traded companies down in Houston, but they were the small start-ups whose business plans made sense when it was $120 a barrel and do not make sense at $45. Those are blowing up right now as well as student loans. This is another industry where the debt has exploded. Most should be able to repay the debt, but 11% are already going delinquent. You are not just talking about a little bit of money, but rather money over $1 trillion. About $120 billion of this is delinquent.
One of the things John’s company just came out with was the spread between the price of inventory when it is a way’s away. This was significant. About 8 months ago they did a report, and one of the things they looked at were homes in Moreno Valley that were bought at $60-$70,000 that were now worth $240. 25 miles down the road, he could buy a 3,000 square foot home in Hemet and San Jacinto for $220. Bruce wondered why this exists, which John said this has always happened in the past with outlying areas recovering last since they crashed first and hardest. This one seems to be taking longer than normal. One of the things he did a couple years ago was take one of their top researchers offline and made him their top demographer. They studied the whole urban versus suburban versus rural living issues.
John was not a huge believer in urban growth the way it was being shown where they said the whole world would go urban. The more research he has done, the more he has concluded we will be living a more urban lifestyle moving forward than in the past. A couple things that surprised him was for decades we would invest in freeways to get out to the next big city. Over the last couple decades, we have really stopped doing that. Instead, the money has been invested in re-developing a lot of urban areas, even in small cities. A lot of cities and urban areas around the country are much nicer places to be and live than they used to be. We are down to a point where 29% of households have kids in them, which means 71% do not. Some shifting demographics have pushed people to go urban. He still thinks the majority of growth will be suburban, but there is less pushing out to Victorville, Hemet, and San Jacinto.
Bruce asked if part of the reason is the difficulty in applying for a loan, which John does not believe is the case. It is very difficult to get a down payment together however. John said he has several clients who will tell him if they have a 640 FICO, get together a 5% down payment, and document their income, then John can get them a loan. It is not from the big four banks that the Wall Street Journal covers and are shedding some of that business because it is a higher risk business. If that loan blows up and you made a mistake in the documentation, you will eat the whole loan. They recognize that, but non-banks are taking a huge market share by making those loans.
Bruce said his business buys and sells houses. They have an easy time selling a 1980 house that is $240. If we are $320 in a superior area, they have a harder time. John asked if we are still below the FHA limit, which Bruce said we are not. In Riverside it is at 350. Any time they pass this it is a problem. Bringing this down hurt the builder in Riverside since most of the new homes were right between 500 and 350, which was where the FHA limit came down. What John just articulated was an FHA loan, which is 115% of the median price. More than half the homes on the market qualify for FHA. You can get a high LTV above the loan limit, but you need a much better credit record than John articulated.
We have hedge fund participation, and the attitude went from wanting to buy a lot of homes to lending to a lot of investors. Bruce asked John if he sees any appetite for them wanting to loan to a group of occupant owners that are not getting serviced and likely won’t be serviced. This could include someone who owns a business or the person with less down payment than FHA. John said he does not deal with this on a day-to-day basis and is not sure. While he was in New York he met with a couple hedge fund clients who talked about that business and shared something very surprising. If you have been following crowdfunding, hard money lending has now gone to the internet. To John this is an early precursor to somebody eventually being able to buy a home through a non-bank or lending club.
The hedge funds will take a lot of risk. If you are running a bond fund in the hedge fund environment, then the question is how you get a 7 or 8% yield. The answer is you would have to take a lot of risk. John said he could see them headed that direction, but he could not say who is doing it. One thing that John’s company may want to pursue is to read a crowdfunding document. Bruce was going to be on a panel with somebody in Washington D.C, and he had read their document. With this particular company, when he read the document, he found out that what he would own would not really be a trust deed and he would be making an unsecured loan to the company. Bruce did not know this and does not know whether many people are aware of this. People who supposedly have good credit are taking out $30,000 loans to remodel their house or pay off their credit cards with a 12-15% interest rate.
John wondered why somebody with good credit would have that kind of an interest rate. What is also fishy is the investor in the $30,000 note is supposed to be accredited. Bruce and John deal with enough people with funds that you just think none of the clients would even think of participating in a partial note like that. The next bad news we have in our world will be the crowdfunding crowd having problems.
Bruce said when he looks at charts this year, he looks at foreclosures at a point that it is not a significant part of the market and affordability is not very strong. Unemployment is headed down, and all those charts usually mean we are booming in construction and are going up in price. Bruce asked John what he thinks is going on in California since he has never seen this happen in years past. John said we are having strong job growth, but in most markets in California we are not back to peak employment levels yet. Riverside is about 3% above prior peak, but you do not have construction jobs. There is about 5% more people today age 20-64 than there was in 2007. His rule of thumb is you need to go 5% above peak employment to have fully recovered and gotten rid of your vacancies from all your prior foreclosures. The vacancy data is not very good at the local level, so he used job growth as a proxy. He has an interesting chart he created that ranks the major markets by total employment today as a percentage of prior peak. The ones at the top of the list are often Houston, Dallas, Raleigh, Seattle, Orlando. They are the ones off to the races, while the ones at the bottom are Las Vegas, Chicago, and Phoenix. It varies a lot by market. John thinks we are still recovering, and the job growth with low construction is very good. Once we get to 105% of the higher peak employment, we will see a serious housing shortage.
What is interesting about this is there is a very big spread between new and existing homes regarding prices. John said it is a separate issue, but there is. If you are building a new home and have to compete with a home built in 2005 and is 3,000 square feet, you have to consider you cannot sell your home for $500k. It is really the land prices that have driven up the home prices rather than other factors. Whether or not this changes will probably not be until you have a downturn. Land prices are sticky on the way down unless banks are owning the land, and we do not have a lot of these. The new home market is asking for a larger than usual premium over the resale market since they had to overpay for some land. What will solve this is the resale market having appreciation so that things get back to normal.
Bruce asked John if he sees all this happening in time for a building boom for California. John said this will require cities that approve buildings. He thinks California is becoming increasingly supply constrained, so a building boom is probably pushing it. If you told all the builders you would make more money by doubling production, John does not really know many who could. This is due to lack of entitlements and a labor shortage. This makes sense because of the lack of construction. If you are going to be in this industry, you migrate to a place that is having it or you migrate to another industry like oil. John’s clients have not seen the oil people come back yet since there have not been as many layoffs as you might think.
The bigger issue is there are 570,000 fewer Mexican-born construction workers in the U.S. today than there were at the peak. A good chunk of them went back to Mexico, and it is much harder to get across the border today than it was ten years ago. The Hispanic population has more than doubled in the county of San Bernardino in the last 15 years. This brings some unique opportunities as well as unique challenges.
Bruce asked if the millennial generation is interested in getting married, forming households, and owning real estate. John said all the surveys say they do, although John thinks they will do it a lot later than their parents did. A lower percentage of them will make it to homeownership. Bruce wondered if there is some damage to the psyche at the thought of owning a home or they want to be free wherever the next thing is. John thinks it is both. If you chart the GDP growth by decade going back to the 1930s, you will see the growth in 2000 was more similar to the 1930s than any decade since that time. It really shows they have had little economic opportunity during their 20s. This is preventing them from getting them ahead. They went to college but have a lot of student debt, so it is hard for them to save for a down payment. The importance of owning a house is less important than it was for their parents.
The Norris Group would like to thank its gold sponsors for supporting I Survived Real Estate: Adrenaline Athletics, Capital City Wealth Builders, Coachella Valley Real Estate Investors Association, Coldwell Banker Town and Country, Elite Auctions, iMortgage, In a Day Development, Inland Valley Association of Realtors, Jennifer Buys Houses, Keller Williams Corona, Keystone CPA, Las Brisas Escrow, LA SouthReia, Leivas Tax Wealth Management, North California Real Estate Investors Association, North San Diego Real Estate Investors, Pilot Limousine, Orange County FIBI, Real Wealth Network, Realty411 Magazine, Rick and LeeAnne Rossiter, Southern California Chapter of the Appraisal Institute, Sonoca Corporation, Spinnaker Loans, Tri-Counties Association of Realtors, uDirect IRA Services, Westin South Coast Plaza, FIBI Pasadena, Scott Whaley, Wilson Investment Properties, and SDIC FIBI.
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