Norris Bruce
Dec 14, 2018

A Year In Review Part 2 With Bruce and Aaron Norris #621

Bruce Norris radio

Aaron Norris is joined this week by his dad and president of The Norris Group, Bruce Norris. Aaron said this was their opportunity to take a break from all the many things they have been working on this busy year. Therefore, this broadcast focused on the “year in review.”

Episode Highlights

  • What models have different investors used with their real estate?
  • Can California, in the state they are in, continue with rental increases?
  • What will Prop 13 do for commercial real estate?
  • What did Proposition 5 do with tax transfers?
  • What is the attitude of California buyers when it comes to staying here or leaving?
  • What are some big things to look out for in the coming year when it comes to real estate?
  • What topics is he most excited about for the new report?

Episode Notes

Last week they ended by discussing rentals and whether they have done their job. In his new talk Bruce will be doing at the clubs is called 10 Decisions Real Estate Investors Need to Make In the Next 12 Months. This sounds pretty ominous, but the talks he has done over the last two years have been urging investors to upgrade, cash in, change seats, and think about what they own. Aaron asked Bruce if he feels he has gotten more conservative as he has gotten older. He said he has always been willing to let go of what he had to get to what he though was either safe ground or better inventory. This is something he has always contemplated.

There are different models investors have followed. Rick Solis has sold everything he owns in real estate right now, so it did its job. He bought it, worked his butt off with his partner, and did a great job. However, he got tired of managing because they were marginal rentals in a tough area. When the assignment was complete and when the properties doubled or tripled, he cashed out. Mike Cantu has spent 40 years getting to the inventory he wants. Not everybody has done that journey. For a lot of people who just got introduced to the business ten years ago; they had the opportunity to buy this discounted real estate, and it has matured in price. Bruce has met with several people who have amassed 50 rental properties in 14 different cities. The ages range from 80 years to 30 years, and they have all gone up tremendously in value.

The choice: keeping all of this stuff when you know the market will probably be flat for the next 8 years. You will have a rental portfolio that wins no tie breakers whatsoever since it is not new. As you have had properties that are older, you will have the new roof request, and the AC will break. The rental properties Bruce had in Moreno Valley were not in a great area, and only 25% of the people would say they would even live there. He had eliminated 75% of the world just by driving down the street and saying he did not want to stay there.

When you have a downturn, all of that is exaggerated. One of the things about the title of his talk is it is about the timeframe. We have a comfortable year ahead without having to pay a penalty. This is what it means by “on borrowed time.” You have this rental portfolio, and you have a choice. If you choose to stay in California, that’s great. But, you might want to get rid of those things that will drive you nuts or already is. When Bruce met with a couple people, he told them to write on the left-hand side how they felt. They loved 25% of their portfolio but hated the rest. However, it did its job since it went up, both in 29 Palms and Lancaster. To manage that in a downturn is a whole different story. You have to figure out how to get all your rentals on the “like it” page or look at a new location.

When he decided to keep some rental, he spoke with Mike Cantu. He asked him to give him the perfect rental and tell him what it has. From there, they built it. Aaron said after the election, there were a few things that surprised him. He was really glad Proposition 10, especially after his experience in New York City where he lived in the areas where rent control was big. In the last place he lived, he was on the fifth floor of a walkup. They would keep a plastic bowl in the shower since they may or may not have any water pressure on any given day. There would be drips they would collect in the bowl. There were families he would run into who would brag because they were paying so little in rent. He would talk to people who had lived there for 70 years, and the running joke was whether they had water or electricity or were still running gas lamps. When you are paying $300 a month in New York City, it is guaranteed the landlord has not made enough to justify infrastructure improvements.

Aaron does not think California can continue with the rental increases like they have. We have a homeless problem and are not building enough inventory. It is unfortunate that politicians have tried to put that on the back of real estate investors and landlords because it is expedient to do so when they don’t actually solve the problem. The statement “politically expedient” is scary. California ownership is lower than the U.S. average, so Bruce was surprised the legislation got defeated so soundly. It was the 59.6 said no, but it is still uncomfortable that about 40% said OK. This does not mean there will always be that margin, and you also have other considerations in California.

Prop 13 will be up for grabs for commercial real estate. When he speaks in front of the Apartment Owners Association, he is not an apartment expert, but there is rolling laughter when people asked if they would own their own building. Bruce wonders why they are keeping everything. Maybe they have the apartment building they want just like Mike Cantu has a pile of rentals he wants and it does not matter whether it goes up or down. This is perfect. However, if you bought that apartment building six years ago with the assignment for it to go up, it has. To camp out there just for it to go down and then get legislation passed on the Prop 13 change, that could be damaging.

Now that we have a Democratic super majority in California, some things could be pushed through pretty easily. Bruce said one of the things he wants to do for the audience is interview what that means. If you have a super majority, what cannot be stopped now legislatively. He really wants to know this. Aaron suggested getting CAR on for this since this would be good to understand. Aaron had just called LA County, and they said December 20 is the deadline for raising rents more than 3%. In unincorporated areas of LA County, there is a temporary moratorium where you cannot raise rates more than 3% a year. Bruce asked where they got the right to do this, which confused about since it came out a week after Prop 10 was defeated.

Aaron said the articles he saw in September, so they may have been thinking they were going to do it anyway even if it did not pass. He called LA County to make certain, and they confirmed it. Bruce asked if every city has the opportunity to do this, and Aaron did not think they did. He thought this was the whole point behind Costa Hawkins. California is becoming a less friendly landlord state. As you are talking about the 10 decisions you will have to make, you really have to look at a lot of different factors. Aaron has rentals he cannot imaging getting rid of since he bought them next to nothing. He has a rental in his ROTH. Because he bought it at the bottom of the market, his tax bill is lower than his neighbor’s.

If Prop 13 changed for residential, you would not want to be here. That would be a tough day since you would have a lot of people not be able to stay in their home. You could have someone who is 80 years old living in a $2 million house she bought for $200 grand. Her tax bill was a tenth of her neighbor’s. This is a difficult thing but true. She and many others who were living on social security and a pension were not going to stay there on a $25-$30,0000 property tax bill. However, it is a heck of a subsidy when you start thinking about that.

Aaron said with Proposition 5, where you can transfer your taxes, he was surprised it did not pass. 59.7% said no to that, and Bruce did not understand why that was the case. Aaron said there are already some counties where you can do that, and the people for it said they could downsize it to something more affordable and free up the property. Aaron saw the goal was keeping people in the state. However, he has a lot of friends who were not benefitted by the Trump tax law changes, particularly the wealthy. He is afraid the wrong people will be leaving the state since a lot of things are less friendly.

Bruce said the attitude in California is concerning. If you make a lot of money and do not write off your state taxes anymore, it is not deductible against the Federal. If you add both the numbers up, there is a significant penalty for staying here. You will have some migration from people saying the $50-$60 grand a year is not worth it. On a 5% interest rate, you can buy a $1 million house in Florida for that. Aaron and Bruce even met someone at a Sacramento airport who sold everything and went on a worldwide cruise because it is cheaper to live on a cruise ship than it is in California.

If you go onto the calendar on the Norris Group’s website, the 10 Decisions for real estate investors to make in the next 12 months will be done all through next year. They launched it in San Diego at the Creative Investors Association, then they will pick up again in January. The last report done in 2017 was 2% Interest, $40 Trillion in Debt, and Other Surprise Endings. He really thought this would be the last report he ever did. In the very beginning of that report, he described the characteristics of a market timer and that when you are wrong, you say you are wrong. You should be able to defend any decision. The 2% interest rates was very carefully calculated by looking at past recessions. He thought we would have one by the end of 2018, and the said in his report that we would need this by 2018 for what he discussed to occur. What he did not calculate was the benefit to the GDP of the tax law changes. That is what has bolstered this economy and driven the GDP.

You now have a different ending. However, one of the problems with that is the ending ten years from the beginning of that report was not that exciting of an upside. It becomes more dangerous because he thought we would stop at 5 ¼ or 550, and we got to 600 quicker than he expected. The closer you get to this ending number, you have a much bigger change of having a downturn in between and a gradual going back. That is like the 90s. This period was really benign when you look at a chart and see the average took 7 years to go down 12%. If you were part of it, it did not feel like that. You were in the wrong inventory, and most of the people who experienced that were buying properties left and right at auctions. At the same time, lenders were taking 50% hits.

It was not as bad as the 2008-2010 deal, it was bad. If you had the wrong inventory, it was devastating. At the time, Mike Cantu had land, and it was completely worthless. He had to trade it for airplane or motor home, and he figured out how to do it. Aaron remembered the Palm Springs home very vividly because he was planting the plants outside and swimming in the 90 degree pools to “cool off.” When that was happening, he remembered some of the trading items Bruce traded the homes for inside his garage, including artwork. He thought it must be special since it was wrapped in plastic and on a palette. Of course, the art was worthless and the house was not, so it solved something. They had a 60 foot yacht that they traded for the art and a home they could actually use. Bruce ended up never going on that yacht since he did not want to get seasick. If you take the 2500 gallon diesel tank and multiply it by how many dollars it takes to fill it, it was never going to get started.

Bruce built some home over a period of 6-8 months when the whole world changed. He wished someone had told him about the time factor there. He was on borrowed time and did not know it because he was so confident that because things were good, they would stay this way. He remembered a very vivid day when he was speaking to a potential buyer at the Palm Springs homes. Two years before, he had bought 50 building lots on lease land. The comments was that they were not going to be around long enough to be at the end of the lease anyway. They rationalized this to where it was a no factor in their decision. He was talking with a couple along with his son Greg. When he said leased land, the couple was shocked because it was such a huge change. He did not have the instruction manual to know that when you went from a good market to just barely starting in a bad market, they didn’t really have anything to go on. This was in 1990 when they did not have a bunch of foreclosures. He just owned the wrong things.

If you think about the negatives, he had leased land and the most expensive real estate in a second home area. However, a positive was he had a brand new custom home in a gated area. It got trumped. Bruce expects us to have another one of these rounds where everything matters. It matters on your rentals and flips, so you have to start thinking. You have to clean up what you have and say if you will flip something, you don’t want to end up with that property where 80% of the world drives by and says “no way.”

Aaron has people calling him weekly asking him what month they should sell. They want an exact day, and it is interesting seeing people who have been in it a while. Rick Solis is already out, for example. Even Bruce has been out of California buy and large for two years because he got to accomplish what he wanted to accomplish. He did not sell it because he thought it was the peak price. He sold it because he had an opportunity to double a cash flow and end up with different inventory.

Tony Alvarez almost told Bruce in 2005 to wait. He had about 50 houses and asked what month he should sell them in, and Bruce couldn’t believe it. He was going to become his own worst enemy. People don’t realize it takes time, and you want to be thoughtful. Imaging having to do that many 1031 exchanges at one time and trying to find a home. This is why one of the topics in the talk is to think about taking a year. You have a year, but during this time it will be a methodical process where you have to make intelligent decisions and have time to do them. You do not want to cram it all in just in that month. It does not work.

Aaron asked what new topics he is most excited about for this new report. He said he has one on his desk that is about 500 pages to read while he is in Florida. It has to do with topics he thinks are coming up that he needs to know. He does not think the damage will come from real estate, but other directions. One of the things he is trying to become more familiar with is corporate debt. If you look at the chart, it has exploded since 2008. That can be a big problem, especially when there is a leverage ratio that has never been higher. They are at record leverage and have been able to access very cheap money. They have rolled the dice and probably bought back tons of their stock. The market has done nothing but go up, and all of a sudden it is not doing that. It is having gyrations, and there are ramifications to that. He said he hopes to interview somebody at the top of the heap of the hedge fund world. He wants to ask him about how just like the residential market we had the paper that went bad, could there be bets against the paper that could crash the system. They were many times bigger than the loans themselves. Bruce wondered if there were bets against the corporate debt failing and who is holding the bag. This could be really major, and he really wants to understand this.

He also wants to understand the unravelling of quantitative easing. We have the Fed having $4 trillion plus of assets they are releasing gradually into the marketplace, and he does not completely understand the ramifications. However, there is a blueprint for this. It has been done before, and there have been ramifications that looked then like what we are starting to get now. This is no joke and things are repeating themselves. This was in the book Bruce just printed for himself to read. This is an important chapter on how this works and how that category effects the real estate owned and the impact it has on the next recession.

Aaron asked if he were a realtor in the current market whether he would still believe in homeownership and selling real estate. Bruce said he would since he does not want to not call his own shots. If you asked him in 2006 when he wrote The California Crash whether someone would have been devastated by the events, he said it would be a wise thing if it were a monetary decision at all. When he wrote this report, he did not sell Piedmont, which was worth $1 million. Later, it sold for $5 million, so it cost him half a million dollars to own his own home. If asked if he would do it again, he said yes. It was an intentional decision, and he did not go into it blindly. He did not want to have a pet. One guy he talked to had a really nice house to rent, but he asked Bruce if he had a pet. He was thinking this was why he owned instead of rented.

Fortunately, for a lot of his properties the debt was fixed or was free and clear. We still have a pretty good rate also. The other part of the title On Borrowed Time is a play on words regarding debt. We are on borrowed time in the sense that as the cost of credit goes up, it starts taking down the price that you are capable of reaching. In the short-run it is painful, but in the long-run it is more healthy. If we were going to sit there at 3% and have 3 ½% mortgage rates until we peaked out in price, they would have been in trouble. Now if you have a 5% mortgage rate and had already reached the affordability lows, you have nowhere to go.

We are actually aggressively getting to this now. There is a big difference between having a 3 ½% and 5 ½% mortgage rate. If you are getting an FHA loan with PMI, you are really at 6 already. When you start calculating that, that is why we are on borrowed time in the short run. As interest rates rise, we will have an ending quicker than we would have if it was at 4. It is after that we might see the other idea of borrowed time, which is the debt we have. Some of that debt is going to start looking pretty unpayable. For instance, GE has gone down from $35 to $7. This is an 80% hit. Rick Solis was on Facebook saying you could get paid 6% interest for GE bonds. Ge has a gazillion people who are retired and getting retirement checks. They have been getting them reliably, but what if they went BK. He does not know what that would do to people who have been retired. If they hand the bill to the entity responsible, they do not have any money either. This is where the $40 trillion comes into play. He is still comfortable to this and not saying that we will not reach a low interest rate at some point. It is just not the point he thought, and it becomes less likely.

Now what is happening is they are building up interest rates they can take back. What is interesting is the 10-year T-Bill is hovering around 3%. It had gotten to 3.3% today, and now it is back down to 3%. The Fed is changing its stance a little bit. They were saying a month ago they would be raising rates past neutral, and they were nowhere near close to neutral. The Stock Market really liked that and went down 2,000 points in two weeks. Shortly after, they modified this and said they were close to neutral now. Following this, there was a 600 point up day. That will be part of the story. If they are afraid of a recession, you cannot take 4 ½ or 5 percentage points from a 2 ½% Fed fund rate. You would have to do a quantitative easing way quicker than you could even get out of the position you are in, or you will lower interest rates to negative rates if you have a recession. That title is not wrong, it just may be delayed.

For more information, check out the newsletter that was released yesterday and the live update Bruce will be giving on Tuesday, December 18.

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