Christopher Thornberg Joins Bruce Norris on the Real Estate Radio Show #405

Christopher Thornberg

On Friday, October 24, the Norris Group proudly presents its 7th 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 and President Bill Tan, InvestClub for Women and Iris Veneracion, MVT Productions, and White House Catering. For event information, visit

Bruce Norris is joined this week by Christopher Thornberg. Christopher is the founding partner of Beacon Economics and widely considered to be one of California’s leading economists. He is an expert in economic forecasting, regional economies, labor markets, economic policy, and industry and real estate analysis. He was one of the earliest and most adamant predictors of the subprime mortgage market collapse and of the global economic recession that followed in 2008. Dr. Thornberg serves on the advisory boards of Paulson and Company Inc., one of Wall Street’s leading hedge funds, and of the Los Angeles area Chamber of Commerce. In Southern California’s largest not-for-profit business federation between 2008 and 2012, he served as Chief Economic Advisor to the California State Controller’s Office and was chair of controller John Chang’s Council of Economic Advisors. Dr. Thornberg holds a PhD in business economics from the Anderson School of UCLA and a B.S. in Business Administration from the state university of New York, Buffalo.

Bruce wanted to ask Christopher what he made of $84 oil since he did not get the chance. This time he asked him about $82 oil and if this signaled anything. Christopher said we know that the global economy is having some issues. China has been slowing down, Europe is having trouble getting out of doldrums in which they have been. There was some political turmoil, and lo and behold some of these commodity markets have really floundered. It is important to keep in mind that commodity markets tend to overreact to everything on both the high and low end. His guess is some of the numbers out there are frustrating, and ultimately the selloff is probably going to come to an end in the near future. The numbers will start bouncing towards the hundreds again, and we know this big swing producer in Saudi Arabia aims for that number. The worst case scenario is they will start turning off pumps in order to push that number a little higher. Ultimately he tends to not look at any of the commodity markets or the stock market and pretend these week-to-week fluctuations mean much from an economic standpoint. They are volatile given how these markets work.

Bruce asked if the global economy really affects what happens in the United States and if this affects the specific market of real estate. Bruce said yes and no would be the answer to this, although being an economist this is how he is supposed to answer everything. Bruce is correct in saying the U.S. is fairly isolated from all this. The U.S. is over 20% of the global economy, and our two neighbors, Mexico and Canada, are also fairly large economies. In North America we are kind of our own little block that is somewhat isolated from the broader global trends because we merely trade with each other. We hear about Japan and China all the time, but you have to keep in mind that our biggest trading partners are Canada and Mexico.

Putting it to the side, it does have a couple bits of influence. One of the ways is we are seeing a little bit of diminishment in the demand for U.S. products. Exports have more or less flattened even though imports continue to rise. This is definitely a weakness for the U.S. economy at some level. If you wanted to consider the slowdown in the U.S. economy in the first half of the year compared to what was happening last year, it almost exclusively is due to the widening of the trade deficit. This in turn can be linked to trends.

The second part of it has to do with interest rates and money as well as the exchange rate, as the case may be. A lot of people are now expecting the Federal Reserve to be tightening way before the other major central banks. The dollar is starting to come up as a result of that, and at some level this means you may start to see slightly less money coming into the United States in terms of investment since we are not as good of a deal anymore. On the other hand, with the U.S. economy growing and other places not so much, you may see more money pouring into the U.S. economy. This is because we are starting to look like one of the safe havens. If you think about what we are seeing here in California, particularly in Southern California over the last couple years, has been a massive wave of money from China. Whether this is looking for better returns or people looking to hide their ill-begotten earnings, the numbers are across the board from an unofficial to official investments to even unofficial home purchase investments, the money is flooding here. The slowdown in China does not seem to be slowing down to move on capital.

Bruce asked if this type of flow of money is reminiscent of the Japanese real estate boom since they were flooding their market with our money towards the end of the late 80s. Bruce asked if it is reminiscent of this, to which Christopher said yes and no. It is a lot of money flowing on shore very quickly. You look at some of the prices being paid and deals being done, and you almost might question if they are really good investments. One example is the $2 billion hotel purchase that came out the other day and that most people look at and are shocked. This is a lot of money to be putting into a relatively old hotel. There are some nuances that have been coming out since, but nevertheless this seems like stupid cash. However, it is different in as much as the money coming out of Japan in the late 80s was due to that massive financial bubble in Japan at the time that gave them all this funny money.

In the late 80s at the height of the boom at one point in time, things had gotten so out of hand that there were estimates that suggested Tokyo was worth as much as all the land in the United States combined. It was so far off the charts as to be ridiculous. The money coming out of China was not based off some ridiculous financial bubble going on over there. It is the actual creation of real wealth being generated by the second largest economy in the world growing at a 7-9% pace. It is not going to come to a halt when the Shanghai industry collapses or property prices collapse since candidly there is no evidence that those numbers are terribly overvalued right now. Christopher said it is different on this front as it is more sustainable. He did not feel like China had a real estate bubble.

There are a couple ways of thinking about this. One way is are property prices in China really overvalued? For the most part the answer to this does not seem to be yes. Property prices have come up, but so have rental prices as well as incomes. When you consider some of the basic fundamentals to look at in California, such as price-to-income ratios, the numbers do not seem terribly troubling. Equivalently, they do not use a lot of mortgage debt. Most debt in China is either industry debt or equivalently local government debt. The local government situation right now is a little weird. It is not so much with household debt since it is fairly small. It is not like here in the U.S. where we have all this funny money pouring into the U.S. and blowing things out of proportion. While it is true that they have overbuilt in many cities, the cities that are overbuilt are not the cities that are terribly overvalued. The cities that have seen the biggest increase in values tend to be the ones that do not have empty property. These are usually cities like Beijing and Shanghai, places that really don’t have this giant excess supply with which people were worried.

Christopher said he is not pretending to be an expert on the Chinese markets, but the reports he has read that are fairly middle ground are taking a very data-oriented approach. Information Christopher has been given suggests to him that the situation is not dire and there will not be an eminent meltdown over there. This is good news, but China still has a lot of other problems with which they have to deal. It seems clear to him that some of those problems are very likely to be widening in the slowdown. It is not the cheapest place in the world to do business anymore. It is a nation that does not have very good institutions, nor does it have a very clear rule of law. They have terrible corruption problems at many different levels. There is no doubt that they have challenges ahead, but this may not be one about which they really have to worry.

Bruce said we are winding down the QE efforts, and we land today at below 2.2% for a ten-year T-bill. Christopher remembered telling Bruce last year to not worry about quantitative easing. Everybody was thinking it was going to stay way over 3, but there has to be other reasons why it is still at 2.2%. Quantitative easing never had a dramatic impact on interest rates coming down. Therefore, why would the end of quantitative easing have a big impact on them going up again? Interest rates were on a strong downward trajectory for years before Ben Bernanke got into office and years before quantitative easing was even a gleam in his eye. They have been falling because of what he termed at the beginning of his term as the global savings glut.

We live in a world that is awash with capital relative to the demand for capital. Under those kinds of circumstances, you expect a lower interest rate, low return type of environment. We are still there in deed of anything, and we are even more awash with capital today than we were at the beginning of Ben Bernanke’s term. Because of some of those global issues, there still is not much demand for it, and this is the low interest rate environment. After quantitative easing, the most important statistic here is while the headline numbers look pretty scary, there is another side. Of all the trillions of dollars created, 87% of that cash never made it into the economy. It is sitting in the banks in the forms of excess reserves, and these reserves are officially held by the Federal Reserve. This is not real money; it is numbers on a spreadsheet somewhere in the center of the Central Bank. It is not real cash and has no real influence on the economy.

Bruce asked how you have borrowed money be reserved capital for banks. First of all, the excess reserves you are talking about are not capital. It is not counting toward their balance sheet, and it is another form of asset. Banks can hold onto loans, securities, or cash, and in this case it is just another asset hanging onto cash.

Regarding retirement pension plans, you have this low interest rate environment just about when you really need a high yield return for keeping your promises. Bruce asked if we are going to stay in this low interest rate environment for a while, and how would this play out when we have to pay people? Christopher said we are going to see an influence-free environment for a while for all the reasons he said. What is going to change the low interest rate environment is when we manage to get the Chinese from being the ultimate savers they are, since the savings rate runs in the 40-45% range, and turn them into consumers. By turning them into consumers, there is suddenly a little less of that capital floating around which would in turn mean higher interest rates. Christopher does not think this will change anytime in the near future.

Christopher had given a talk the other day to an Asian business group in Southern California called the Asian Business League. They had a number of Chinese nationals in the room, and he made the idea that they had to start consuming. They asked if they should build more homes as opposed to buying securities. They go to building homes as an investment when he was talking about consumption. They could not even fathom what he was talking about. For this population, they have had such terrible times economically over the past 100 years. For them it has always been about savings, and this is hard to break. We have the opposite problem here in the U.S. People have to have enough for retirement, so what are they going to do? They have to be a little bit more Chinese; it does not say that they have to start saving. They need to consume more, and we need to save more. Hopefully somewhere in between we will all end up in a better place.

Bruce asked Christopher if anything surprised him about the lack of volume of sales in California real estate sales. Christopher said first of all the numbers are starting to come back up again. If you look at the recent data, it is already starting at about 4. Putting it to one side, you have to understand that the numbers you are looking at are not directly comparable today to a year ago. We are in a trough between the investor and the retail buyer. A few years ago investors such as Bruce Norris figured out something important. They realized rents are expensive, homes are cheap, and people can’t get capital. The idea is that since they can get capital, they will go out and buy properties, then turn around and rent them out. The investors were the ones who drove the first wave of the real estate recovery.

This explains a strange phenomenon. A couple years ago the homebuilders were excited because prices and sales were up, and this meant more demand for new homes. This did not happen this time, which was a big shock to a lot of people. The homebuilders really haven’t seen the kind of gain they expected to see. This wave is pretty much done. Foreclosures in the “crisis” are gone, and people have cleared a lot of the bad debt. As a result of this, the market has started to cool for the investor because there are not many cheap units to pick up anymore.

What we are waiting for is the next wave, which is going to be the retail/move-up/buyer. This is the person who owns the house they live in, will sell it, buy another unit that is bigger, better, smaller, more convenient, and closer to their job. This jump in the market has just now started to occur because of two things. For one, credit is now starting to get easier to obtain. With the price increases that have occurred as driven by this first wave of investors into the market, this is a situation where a lot of new equity is out there for the owners. When the market bottomed-out, we went from $16 trillion in equity in the U.S. to about $8 trillion. Americans lost $8 trillion dollars in real estate in two years. Since then, it has gone back up to about $14 trillion.
You have a lot of new money, and it is suddenly easier to get credit. The banks are making it easier, but if you look at the numbers bank holdings of mortgages are suddenly starting to rise. The average FICO score for a Fannie Mae 30-year fixed-rate mortgage has dropped from 760 to about 735. You have all kinds of signs that suggest that credit is easier to obtain, people have more money to play with, banks are willing to play along, and this means there is a whole second wave in the market that will be coming from the move-up buyers. This time it will have the impact of driving new home demand, which should get the construction markets moving again.

If you look at charts by the California Association of Realtors and take a look at the absence of volume, a lot of it is coming in the first-time buyer category. This goes back to the credit situation. If their capacity is diminished, Bruce wondered about their willingness. You have a whole country that is used to hard times, and they do not spend. Bruce’s dad lived through the Great Depression, and it affected him his whole life. Bruce asked if a Great Recession taints somebody’s willingness, even if they have the capacity. Christopher said what Bruce’s dad went through in the Great Depression was really tough. What we just went through compared to that was nothing. You are talking about a ten-year period of time with unemployment at the 25-30% rate and massive problems across the board, including deflation and humongous migrations of impoverished populations. Economic output went down by 5%, and the unemployment rate reached about 10%.

We are already bouncing back well above where we were pre-Recession. While there are still a lot of people on the outside looking in, for the vast majority of Americans things are better today than they were in 2005. Nothing happened over the last decade that should traumatize anybody. To pretend otherwise would almost be an insult to Bruce’s dad and his generation. Be that as it may, Bruce wondered why the millennials are not buying. He wondered if they are not forming households as early as other generations. Christopher said this is not actually happening. What you are dealing with here is a decline in ownership rates for all age groups, not just for millennials. It is not exclusive to that group alone, and Christopher does not know why people keep thinking it is.

The ownership rate has stayed the same for people 65 and above, while for everyone else it has dropped. As for millennials, it looks like they may be spending a little more time with their parents or roommates. The millennials are getting married later, and it is a different kind of generation. They are putting off some of the big life decisions because they can. He does not think this represents anything but an ongoing continuation of a long-term trend. Christopher jokingly blamed Bruce and the baby boomers on this. They coddled their children so much that they want to live at home forever. Christopher was a gen-xer who could not wait to get out of the house. Boomers have spoiled kids, and it is a very different thing.

Christopher Thornberg will be featured on the panel for the upcoming I Survived Real Estate 2014, where they will discuss things with peers from all different walks from the real estate world. The Norris Group would like to thank its gold sponsors for supporting I Survived Real Estate: Adrenaline Athletics, Coldwell Banker Town and Country, Elite Auctions, In A Day Development, Inland Valley Association of Realtors, Investor Experts, Jennifer Buys Houses, Keystone CPA, Las Brisas Escrow, LA South REIA, Leivas Associates, Pilot Limousine, Primary Residential Mortgage, Northern California Real Estate Investors Association, North San Diego Real Estate Investors, Real Wealth Network, Realty 411 Magazine, Resonant Lens Photography, Rick and LeAnne Rossiter, Personal Real Estate Magazine, San Jose Real Estate Investors Association and Geraldine Barry, SONOCA Corporation, Southpointe Companies, Spinnaker Loans, Tony Alvarez, uDirect IRA Services, and the Council of Multiple Listing Services. See for video of the live event and more on our sponsors.

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