On Friday, September 27, the Norris Group proudly presented its 12th annual award-winning black tie event I Survived Real Estate. An incredible lineup of industry experts joined Bruce and Aaron Norris to discuss perplexing industry trends, head-scratching legislation, massive tech disruption, 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 is not possible without the generous help of the following platinum partners: the San Diego Creative Real Estate Investors Association, InvestClub, ThinkRealty, Coach Fullerton, Keller Williams Corona, PropertyRadar, the Apartment Owners Association, MVT Productions, and Realty411. Visit isurvivedrealestate.com for event information.
This week’s radio show is the final part of our series that will cover our recent event I Survived Real Estate. Today’s show will cover the ramifications the next recession could have on our industry, the benefit of long-term economic policies to asset holders and wage earners, the black swan event that everyone on the panel said keeps them up at night, Prop 13 and rent control, what they are most looking forward to, and Bruce’s biggest wish for every politician.
- What ramifications could the next recession have on our industry in terms of prices?
- Have the long-term economic policies benefited the asset holder or wage earner more?
- How could an impending recession affect foreclosures?
- What could happen if Prop 13 passes along with the rent control bill?
- What black swan event keeps them up at night?
- What are they most looking forward to for the year ahead?
- What is Bruce’s biggest wish for every politician?
Bruce talked about the next recession and the ramifications on our industry pricewise. Bruce asked if is there any consensus like that and if they thought we were going to have a recession in the next twelve months. Jim Park did not think so, but Simon Chen thought we were already seeing the early signs of it. It’s not going to be anything like 2007/2008, but he thinks one could happen in the next twelve months. Mark Lesswing believes there has to be a small correction, while Sean said we don’t have a market economy. With our current administration, we would throw anything at not having a recession.
John Burns built an index to predict recessions, and normally within the two years, there’s a twenty-seven percent chance. According to the data, it’s at seventy-five right now. He would say yes to a recession, but he will throw the kitchen sink at it if it’s coming. Doug said he doesn’t have the same numbers as John, but the risks are rising and we’re never able to predict exactly when they happen. But the 12-18 month time period seems legitimate. Bruce said if we have a recession, we want to prevent it from getting worse. The first thing the Fed does is lower interest rates by typically 4 to 5 percent. Right now we don’t have that, although we can go negative. It’s in a report Bruce read, and it’s not a big deal. Doug said it must be true if it was written in a report. If you look at sovereign debt around the globe and take the U.S. debt out of the picture, 50 percent of sovereign debt is paying negative yields. That’s $17 trillion. Sean said it’s like you paying them to have your money.
Bruce sent most of the people on the panel an e-mail because they were messing around with the idea of negative interest rates. He said if, hypothetically, you owe a trillion dollars and you’d be able to get a 50-year loan at minus 2 percent, you would never have to make a payment. It would resolve itself in 50 years just by taking your interest credit. That would be good. There are several countries that are not at the end of their negative cycle. They’re at the beginning of their negative cycle. Places like Germany are going negative, and Bruce wondered if it is going to get more negative. Doug said there’s no question that their economies have slowed. In fact, the Germans were, depending on how you define it, in a recession for a little bit. They’re heavily dependent on trade and on manufacturing, and both of those things have been slowing because of the trade debates that are underway. If you want to see Germany shudder, all you have to do is use the words “car tariffs.” There’ no question that around the globe things are slowing, which is part of the reason that the rates are where they are. Bruce asked if the Fed can only lower so far before it starts doing injecting money. Doug said one of the things that Paul did say in an answer to a question was that it put the damper on the idea of negative rates. The evidence that central banks around the world have seen it that it hasn’t really helped growth. They would ease, however, and expand the balance sheet. They would offer whatever liquidity services they could in the industry, but then the rest would have to be done by the fiscal policy. Tax cuts probably would come through too.
Bruce said they’re basically controlling the short end. You had negative rates that got into pretty negative territory. Bruce asked what would happen to our 10-year if something like that was to occur somewhere else. Would we have that invert to quite a low number? Doug Duncan said unlike those global institutions who do not have regulatory requirements to hold sovereign debt from their nation, we do as our banks have to hold Treasuries as part of their capitalization or asset classes for liquidity and safety issues. Some of the institutions hold those securities or that debt, even though it’s going to generate a negative yield over the course of life because of regulatory requirements. Part of the reason rates in the U.S. are low is because capital flows to the U.S. and it is a positive return. It would be positive, even if it was less negative than where it was originating. Doug said that’s where expanding the balance sheet, or increasing the size of that balance sheet, will come in to attempt to hold those rates up.
Bruce asked about the recession and if it will cascade into lots of foreclosures this time, therefore having a negative impact on prices. Sean said no. The whole regulatory framework changed in 2009. The regulators, pre-2009, required the banks to get rid of bad assets as fast as possible at any price. As soon as they change that, the course of the foreclosure crisis changed. In previous ones, we let the savings and loans fail, and hopefully they learned their lesson. He thinks we learned something each time. We’ll make a new mistake next time, but it won’t be the same one.
John Burns agreed with Sean, but with a different twist on it. He thinks if there’s a recession and people stop paying their mortgages, the servicing companies are required to foreclose on them. He thinks we are going to see the foreclosure process get started, and the lesson learned this cycle, unlike last cycle, was there’s gonna be a huge amount of money raised to do non-performing loans. You can sell the pool to non-performing loans. Now you have all these rental companies who will be asking for a thousand homes with somebody in them that they can restructure as a tenant. They had conversations in ’09 with Doug, Fannie, Freddie, and FHA about FHA becoming the landlord in this situation. They just couldn’t do it. He thinks they are going to find a solution next time. The other thing is that they really do hit the market. He has asked American Homes, Invitation Homes, and others how soon they are going to start gobbling them up. Their answer is as soon as the yields make sense. The odds of a 40% price decline or even a 20% are pretty low in his view, and he thinks those guys would see a lot of new money come in and compete with them.
Doug Duncan said the other thing that is out there is, given the shortage of supply relative to the level of demand, if the recession is mild and unemployment runs to 7 1/2 percent, you still have 92 1/2 percent of households working. Interest rates come down because the Fed eases. The demand curve backs off because of unemployment. But for those that are still employed, that means price appreciation is slower or maybe at zero and interest rates are great. It’s a pretty good time to buy a house, especially if there’s a foreclosure that they’re aware of.
Bruce said from the lending side, he has witnessed an unbelievable effort to not foreclose on houses in the last years. Jim said it was like drinking out of a fire hydrant for these institutions. They had never seen that kind of volume coming through of delinquent notes and foreclosures. At one point he had an asset management firm that operated out of all 50 states, and one of his clients was Bank of America. They had one point two million delinquent notes, and he thought the contract was going to last forever. Lo and behold, they started selling off their notes left and right, and literally over about a six month period it went from 1.2 to less than half that. He thinks there’s a huge appetite to buy, but he is not sure whether people will be able to buy 30 cents on the dollar or 40 cents on the dollar like they used to last time around. That certainly isn’t going to happen, and there’s a situation right now with the average down payment with Fannie Mae. He asked Doug what the LTV is on their typical book of business right now. Jim jokingly said you could just make something up and nobody would know, to which Doug said eighty-four percent of statistics are made up anyway.
Jim said the downpayment cushion is quite substantial, even for FHA right now. So, it would require a pretty big hit in terms of price depreciation for the big flow of foreclosures and all that to happen. From a lending institution point of view, a lot of the community banks that hold the notes would get hit as well as people that are selling into the market. A lot of independent mortgage banks, unless they’ve done something wrong in terms that were originating that loan, they probably don’t have any repurchase risk related to it. It depends on who you are, and he thinks we will not see what we experienced in ’08, ’09, and ’10.
Bruce Norris doesn’t think we’ll deal with anything like that quantity, but he was thinking that the consumer had been taught that they were going to get a hug, a recast, and a 2 percent mortgage, and they’re going to put it on the back end or they’re going to forgive it and stay for four years without a payment. That’s what they just experienced. Jim said they experienced that, but you also had about 5 million people who actually lost their home. That was the first round, and that’s when they said they better not do that. Jim thinks the pain of those five million people is still alive and well. Obviously they’re people who got the pass. They didn’t have to pay a mortgage for three years or whatever it was, and you certainly had those situations. But he thinks the general perception in the market is people got hit pretty hard. A lot of people literally lost their home and really lost their trajectory in their life. People are just recovering from all of that now, and he doesn’t know if it will be viewed as this kind of positive experience that somehow they’ll get saved through the process.
Bruce asked if the economic policies that have been in place for a while have benefited the asset holder versus the wage earner? If so, what are some of the ramifications of that? John Burns said he answered this himself. Bruce said we are seeing these things almost on a daily basis. He had just read about a new net worth tax, up to eight percent of your net worth if it’s over $100 billion per year. What used to seem completely ridiculous is now being considered reasonable. That’s scary because now you have a list of things like college debt forgiveness and free medical. He wondered if this is going to ultimately change some policies that are going to be really expensive for the U.S. economy.
Jim Park said when you look at the whole rent control thing, it’s going to have a detrimental impact on the investment side and the property. But, because of the pain people are feeling, they are willing to go down this path. There’s no real good answer. There has to be a solution for the consumer and the renter when they’re paying 40-50 percent of their income to rent. You also have people making irrational decisions to support something that’s going to, over the long haul, hurt the industry and the consumers. That’s why you’re having this kind of wild swing in political debates right now. Bruce found the issue with rent control interesting because he did not remember voting on it. When he had voted on it the year prior, it was a no. However, when he did not get a chance to vote on this one, it was a yes. It made him wonder what else he did not have a say in, or if he did, they could trump it.
Prop 13 is coming up on the ballot, not for the house portion of it, but for everything over four units. Is this something else where they could overturn the decision if it does not pass? Sean O’Toole said if it passes together with rent control, it’s going to be a margin squeeze since your taxes are going up every year but you’re being capped on your rents. Bruce asked if this is exactly what they would like. Sean said yes, clearly. The less supply, the less being built. Sanders has his proposal of a 25 percent tax on flips, which should be of interest to everybody. Every flip would get taxed at 25 percent. You can thank ATTOM Data Solutions out there because they keep talking about how much money everybody’s making on flips. What they’re doing is they’re taking the purchase price and the sale price, and they’re taking the gross number. Not many have achieved that with zero expenses, but that’s what all these folks believe. They think everybody who’s flipping a property is making all this profit. We get to tax 25 percent of it. With all that talk about dangerous statistics, everybody needs to call ATTOM and tell them to knock it off.
Bruce was challenged by this on the radio show. He thought it was the most ridiculous formula. Last time, there was a big pile of residential debt that caused problems. He wondered if there are big corporate debt bonds that could tilt over and be downgraded and if that could cause a liquidity problem. He then asked if there are side bets against the outcome of those bonds that are enormous in size.
Sean said the WeWork thing right is really interesting. You have WeWork, OpenDoor, Compass Real Estate, and Katara on the construction side. These are half-billion-dollar or larger investments in each of these things, and as a thesis, it’s a good thesis. Real estate is ripe for disruption, and we’re all hearing and talking a lot about that, but there’s a lot of money just in those. If you take that and go out wider, like how these iBuyers are working, they’re raising a lot of capital. Sean asked himself if they are doing it to make really great investments and if it could go wrong. Could it go wrong in a big bad way, and how broad or wide is that? He thinks there’s a lot of risks.
Doug Duncan said if you look at non-financial corporate debt, the share of it that is rated high yield or triple B is the highest it’s ever been. In the triple Bs are some companies that have regulatory requirements where they can hold securities lower-rated than that. One of the potentials is if there is a shock in capital markets that downgrades those triple Bs. There’s a bunch of companies that would have to make an adjustment; and there’s a question, given the liquidity discussion, whether that liquidity exists in the market for them to make that shift. It’s one of the consequences of a long-term, low-interest-rate environment where the low cost of credit keeps firms in business that would naturally have exited the business at a higher cost of credit. That is a risk.
Bruce said there was a discussion in a movie about the ratings and how they were not accurate. They had these tranches of triple-A rated garbage, and that’s what these guys were betting against. When you have corporate debt that has a rating, he wondered if that rating system now been cleaned up to where we feel that’s really telling the truth or if it is a competitive business where if you don’t give a rating you don’t get business. Sean O’Toole thinks the problem there is we’re always looking in the rearview mirror. We are saying these loans made last year were really good, and they haven’t gone bad, so we can loosen a little bit. We keep loosening up because we’re looking in this rearview mirror, and that is absolutely the issue until you reach a point where there is some sort of little thing that happens, and then suddenly there’s no market for that debt and it becomes a big thing.
Bruce asked if there are bets against the outcome of other people’s investments to a big extent. Doug said not to the degree that it was during the crisis. But, there are still derivatives, significant numbers of derivatives out there, and the worry in the derivatives space today is how many of those are tied to LIBOR, which they’re trying to replace. For an index, he said the Federal Home Loan Banks were just given some guidance to be moving off of LIBOR by the FHFA. So there’s some risk in that space. Sean O’Toole said Glass-Steagall and the Commodity Futures Modernization Act had more to do with the last crisis than anything else. We didn’t fix either of those.
Bruce began wrapping up the night by repeating what he had asked at the beginning. He wondered if anything is keeping them up at night, like a black swan event, as well as what the one thing is they are most excited for in 2020. Jim Park gave the same answer to both: the elections. These both keep him up at night, and he is looking forward to it for 2020.
Simon Chen said what keeps him up at night is that the Realogy stock lately is, unfortunately, a bit lower than their profitability and operating expertise would show. But, he also thinks that as some of this hype boils over in the marketplace, sound operating margins and discipline will prevail in the next year. It’s the same idea, just two edges of the swo