On Friday, September 22, the Norris Group proudly presents its 10th 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. All proceeds from the event benefit Make a Wish and St. Jude Children’s Research Hospital. This event would not be possible without the generous help of the following platinum partners: HousingWire, Coach Fullerton, Coldwell Banker Town and Country, PropertyRadar, the Apartment Owners Association, the San Diego Creative Real Estate Investors Association, InvestClub, Las Brisas Escrow, MVT Productions, Inland Empire Real Estate Investment Club, Realty411, and White House Catering. Visit www.isurvivedrealestate.com for event information and tickets.
- What does John Burns discuss in his newest book Big Shifts Ahead: Demographic Clarity for Businesses?
- Where could we see hedge funds going in the years ahead?
- Could those hedge funds be selling off the properties they accumulated over the years?
- What is the difference between private equity and constitutional investors?
- What is the current state of builders in California?
- Could we see a decline in homeownership, and what is the reason for this?
- What tax law changes could affect ownership interest?
Bruce Norris is joined this week by John Burns. John is the CEO of John Burns Consulting Firm for real estate in Orange County. He is the consultant for many types of businesses all over the country. He informs housing industry experts in how to make better decisions. Bruce has followed him for years, so he was surprised to hear that his business started in 2001. He thought he had been in the business much longer, although they met years prior to this.
John started his consulting business in 2001, although he has been working in the business itself since 1989. From 2001-2006, this was an interesting time for him to have his own business and deal with what was going on at that time. Bruce asked him who his clients were during this time, which he said they were primarily homebuilders. He started the company three months after 9/11, which was the worst time ever to start a company. Bruce asked John if builders think they need a consultant, which he said they ebb and flow the entire time. Back then, nobody really could figure out what was going on in the housing market and cycle except for Bruce. It was around this time he put out some good reports. John started his business to get this information for people and help them run their business from a risk standpoint.
Now, it has completely morphed to their being too much information out there. A lot of it is bad, and people want him to read through it and make sense of it for them. His clientele has clearly changed. If he was hanging out with homebuilders in 2010 and 2011, he would have been gone. It was interesting seeing his business morph because of something bad that happened by the end of the bull run. One of the things John mentioned to Bruce was the difficulty of telling a builder something bad was imminent when they were enjoying the present so much.
Bruce asked John how he imparts bad news to people when it is not there yet. John said this was the challenge and still is today. If you are going to be investing in real estate, you are generally optimistic in nature. If you are a pessimist, you are not willing to take the risk. John puts his clients into two camps: the optimists who are making bets with their own money and the optimists making bets with other people’s money. The ones making bets with their own money listen, really care, and know about the housing cycle. The challenge is the ones who work for a publicly traded company and want them to spend as much money as possible so they can build up a big company and have a big bonus. Those are the toughest people to talk to about the risks ahead.
Bruce said as competitors they run across them all the time when they buy at trustee sales. You are competing against a billion dollar fund, and they are buying things every day where you shake your head and say it makes no sense. You realize they are on commission. John said one of those funds was paying people per house purchased. They had 0 incentive not to outbid you, and Bruce said it felt like this. When you know the numbers, you look at it and wonder what the plan is going to be. Some of it was a different game plan. When the business of buying and holding came into play and they started buying hundreds and thousands of homes, that was a new toy for them completely. He imagined this started a whole new clientele for John. John said they actually stumbled into this accidentally.
In February 2009, he wrote a white paper targeted to people who knew nothing about housing and now needed to know. He ran around and met with HUD, Fannie, and the Treasury. One of the things that came out of the meeting was if you foreclose on all these homes and sell them at auction, you will drive prices down on yourself. You are in the business of helping people, especially HUD. If you are going to take the home away from them, take it away but let them rent. Don’t drive prices down. They thought it was a good idea, but they were bureaucrats and could not really execute on it. They wanted some capital to come in and play, so John went out and found a lot of capital clients and asked them if they would be interested in doing this. They told him absolutely.
These people ended up not doing anything, but this was got his name out there with the single-family rentals business. The smart money came in a few years later after home prices had already fallen. Bruce asked if they got in at the bottom since his sense was that they did not. John thought they actually created the bottom. Most of the companies were started in 2012. Way Point started a little earlier than that; but when Blackstone started buying, they had a lot of confidence that the flaw was created by them. They almost had enough money to create it themselves. Tom Barrack from Colony came along and started doing it as well as Barry Sternlicht from Starwood, and these guys can raise a lot of money. It became clear that the bottom was in not because of the economy was turning around, but because they were going to do exactly what they did with Bruce on the auction steps.
They had a different formula. Their formula was whether or not it made sense if they held it and collected rent, not if they had to resell it tomorrow. Their formula at the time was buying below replacement cost. They were clients of his. Distressed real estate buyers were purchasing, and buying homes below replacement cost as his game. They never really got on the same page, but that was his investment thesis.
John has private equity and constitutional investors. Bruce asked what the difference is between the two and if they have different end games. John uses the term “institutional investors” to refer to people who are trading securities and the private equity people making less liquid investments. There are companies who do both, but they are different buckets of capital. Now that some of the private equity funds are publicly traded companies, they have essentially cashed out all their private equity investors and are now trading on the stock markets as a different kind of owner.
Bruce gets a lot of questions on whether people are afraid of all these large holding companies selling everything at one time. Bruce does not think this is their end game, and they have already changed their position. However, John said they cannot and are publicly traded companies who have loans secured by the income on those assets. They are prohibited from selling off more than a certain percentage of those, and they are all REITs. He does not know the exact REIT laws, but if you sell more than a certain percentage of your assets every year, you lose the REIT tax benefit. John said it is the non-publicly traded people you need to worry about, not the publicly traded ones. Bruce said it made sense to him that they would be holding these.
Bruce asked if they have switched their emphasis from ownership of rentals to doing loans. John said not for them, but there are some affiliated groups making loans. It is a different bucket of capital, although probably raised by the same people.
In general, this is their first big investment in rental real estate. Bruce had never seen that before, so he wondered if this was a new toy that will at some point discontinue. John said he thinks it is actually a permanent piece of the landscape. They are publicly traded companies who have rated bonds. You can look at their financials and see they are making money. They are only 4-5 years old, so there is a lot of fine-tuning of operations, and there is a lot of low-hanging fruit inside their own business just to get more efficient. They do ancillary services just like the apartment people where they will sell landscaping services and cable packages.
Bruce said areas like Palmdale, Lancaster, Victorville, Menifee, and Hemet would be cranking out new homes during the boom cycles. When he looked at the charts recently, this just hasn’t happened yet. He asked John what he believed was next for these areas. John thought they were going to have their day, it will just take a long time. The recession we just went through was massive, and the recovery has been slow. John wrote a book about the demographics and how big the millennial generation is. They are getting started much later because of the economy and other factors.
Another thing John does not really think people have focused on is how in the last 20 years there has been virtually no infrastructure investment in improving freeways. The only investment they have really done recently was on the I-15. The traffic has gotten horrendous, and society has shifted away from the importance of owning something really cool and commuting to value their time and experiences more. People just want to live closer in, and he still thinks the outlying areas will eventually come back. He has seen this happen in economies that have recovered stronger than ours. In areas like Texas, Denver, and Atlanta, people are driving and the freeways are packed.
Bruce said there is a mental shift that happens when you have aggressive price increases. If a lender is willing to lend money, people will say yes to ridiculous payments, but they will also say yes to exaggerated categories like driving time. When they built the 93 houses in Rosamond, which is nine miles out of Lancaster, 90% of the buyers worked in L.A. That was a drive that was acceptable to them since they had a chance to get their name on a grant deed.
In his book Big Shifts Ahead, which he read in a day and marked up more than any other book, he talked about a decline in ownership coming. This is a really interesting thing to Bruce because there are other things that will happen if this occurs. Bruce asked if there is current group of young adults that are capable but not interested, or are they not capable of getting a yes answer in the current lending environment. John said they are far more capable of receiving a yes answer than most people think, including the media. There is so much media running around saying the mortgage industry is too tight. John said the documentation is tight; but if you have a job with a W2 and can scrape together a 3 ½% down payment with your median-priced home in the market, you are in. If you go back decades, this is historically loose.
The issue most people miss is the very high homeownership rate amongst people born in the 1930s-1950s who are starting to pass away. We are going to lose 16 million homeowners over the next ten years, and it will take a lot to replace this. You would almost need something like a G.I. bill to prevent the math that John figured from happening. Homeownership will trend down unless we make it really easy for people. The math is inevitable since you have people going from 65 to 85 who will not be here, and this is the group that owns 80-85% of the time. They will be replaced by a group that owns much less than this.
The math is there unless this new group can own at a really brisk pace. If you want that happen, some special circumstance with financing will have to be created. Bruce asked John if there is any willingness to do this. John thinks there could be and that there is not any administration that wants to see falling homeownership on their watch. There could be, but he thinks the young folks will achieve a 5% lower homeownership rate than their parents did. By the age of 65, they will still get to 75% homeownership, which is quite high. However, it is not the 80% of their parents, and this is the shift. Even 75% is aggressive, and this prior generation had the G.I. bill to help them. The G.I. bill still exists, only in the previous generation many more of them were veterans.
Bruce asked if he is against a nothing-down loan program that has nothing to do with being a veteran but how the VA qualifies people. John said they have a successful program and underwrite very tightly, dot every I and cross every T. More people in the military seem to honor their mortgage payment than others. It is amazing how much more the VA loan program faired during the downturn than other programs. It is more who they lend to than the process. If that person was in the military right now, they did not lose their job. The biggest reason for foreclosures is job loss.
Bruce asked what tax law changes could affect ownership interest. John said this has already become far less important. You rarely hear that the mortgage interest deduction is the reason people are buying now. This is different from 20-30 years ago. The standard deduction for a couple now is around $12,600. This means you need to get to $12,600 in itemized deductions before you see any tax benefit at all. In coastal California, somebody buying an $800,000 home will get this, but in most of the country there is very little interest to be deducted. A piece in the LA Times showed how the mortgage interest deduction went from $1 million down to $500,000. The cap could only impact 2.4% of households in California and impact a far lower percentage nationally.
It is not the sacred deduction, or Holy Grail, that it used to be. Nobody is deducting interest because you need a $400-$500,000 mortgage to do that. Unfortunately, they are not getting that big of a mortgage. One of the tax law changes that could be implemented is to raise the standard deduction, and that would take out most people. They are talking about raising it to $24,000, and there would be no mortgage deduction.
Considering other unintended consequences, when you retire there is a very big difference financially from owning a home versus not owning one. One of the things that will occur with your math is you are going to have closing in on 40% of people not owning a home or building one. Bruce asked if John considered this and talked with people about the outcome not being pleasant. John said the math on the 60% would be about 75% amongst the retirement age and 40% amongst people in the early 30s and 40s. It is not 40% of retirees renting. However, it is a higher percentage than today. The whole argument is that homeownership has been a great savings account for retirees.
The other thing it does is fix a payment to where overtime as people make money, they have more spendable income. If you rent and are a landlord, they check the number every year and bump it to where it is always taking a bigger and bigger chunk of their money. It is a bill they never get away from nor diminishes in percentage if you do not own. The number of single-parent households now is very high, and it is really hard for people to save the down payment. Most of his homebuilder clients tell him that is the issue these days. It is not the mortgage payment or FICO score, but rather the down payment. Even the 3 ½% is really hard for people. This is why it seems to be a no-brainer. Take the risk and do a nothing-down loan program with two caveats.
Why not do a loan program that is a Fannie Mae, nothing-down with two additional features. The loan can be taken over subject to a simple assumption as it used to be. If anybody makes a payment current and it actually goes to a trustee sale, the opening bid is the payment. The payment is missed and has nothing to do with the loan balance. He imagines you would have virtually no foreclosures in that program that would end up being an REO that would lose the bank money. John proposed the assumable loan 15 years ago. E-Trade had a mortgage program that was assumable, so the bond market assumed it was not a 10-year maturity but rather 30-year. This has a 50 basis-point higher interest rate associated with it, and nobody opted for it. Nobody wanted to pay 50 basis points higher, even with the great program just outlined. Consumers just said they would take the lower interest rate, and they need to understand it better.
John Burns will be one of our featured panelists at I Survived Real Estate 2017. The Norris Group would like to thank its gold sponsors for supporting I Survived Real Estate: First Lending Solutions, Guaranteed Rate and Nathan Chabolla, In A Day Development, Inland Valley Association of Realtors, Jennifer Buys Houses, Keller Williams Corona, Keystone CPA, LA South REIA, Michael Ryan, New Western, North San Diego Real Estate Investors, Northern California Real Estate Investors Association, Orange County Investment Club, Pacific Premiere Bank, Pasadena FIBI, Pilot Limousine, RealWealth Network, Rick and LeeAnne Rossiter, the San Jose Real Estate Investors Association, San Francisco Bay Real Estate Networking Summit, Sonoca Corporation, South Orange County Real Estate Club, Spinnaker Loans, Think Realty, uDirect IRA Services, Westin South Coast Plaza, Wilson Investment Properties, Inc. See www.isurvivedrealestate.com for event information.
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