Consider Your Source
When you listen to any “Alleged” expert it is good to know that person’s bias. So here is a my quick bio and my economic leanings. I have a back ground in engineering and am very analytically based. I read a ton of financial information, around 2-3 hours per day. I know the biases of the experts I follow and take every bit of information in context and with a grain of salt. I was raised by depression era parents. My father was a smart man, a PHD, theoretical physicist / research scientist. They did not come from money. They instilled in me, the value of a dollar, to value education, to work hard, and how to save for a rainy day. I don’t believe in modern monetary theory or negative interest rates. In short, I believe in Austrian economic theory, not Keynesian economic theory. Politically, I lean towards Libertarian and believe both the Democrats and the Republicans are fiscally irresponsible. That should tell you most of what you need to know when digesting my analysis.
For further information of who I follow, here are my favorite financial pundits. https://lbre.com/my-favorite-alternative-investment-media/
What we know to date and where we left off since my last update
If we consider Friday 2/21 the start of this market meltdown, then we are a little over 3 months into this mess. In the first week we had a stock market melt down and interest rates plummeted. I suggested it was a good time to consider refinancing and I personally locked in on a 2.75% refinance. See YouTube Video (https://youtu.be/CDiO0ddxo58) Low rates are good for the real estate, right? Well yes they are! But after the initial excitement about low rates, people started dying and loosing their jobs and businesses. Loss of life and economic livelihood trumps low rates.
After several weeks it was clear that this was not a short term shock. How bad might things get? I left off about 1 month ago with two takeaways. One – we would not have a real estate market melt down like the stock market, but the real estate market was indeed slowing. I changed my beginning of year outlook from the market being flat to slightly up, to now flat and slightly down. However, as we come out of this 3 month hibernation it looks like I will indeed have to reverse course again to my more positive outlook from the beginning of the year.
Future assessment Summary (And this can change at anytime!)
Short term (the next 3 months), I am quite positive. Medium term (1-2 years) term I am neutral to slightly bearish? A question mark is inserted after bearish because Federal Reserve stimulus is so powerful and continued Fed stimulus may keep markets buoyant. Long Term (2+ years) I think owning real estate will be necessary to defend against potential inflation and currency debasement.
Real Estate’s Leading Indicators
Last month, I saw two leading indicators pointing to a slowing market. Both mortgage applications nationwide and new home sales in the City of Long Beach dropped by about 30%. This on it’s own was pretty negative. However, sellers were not putting their homes on the market either. Inventory was not building and was staying persistently low.
Just one month later, as we speak, the market seems to be popping a little bit. I have three bits of positive data. One, mortgage applications are now back to normal (https://www.cnbc.com/2020/05/20/weekly-mortgage-applications-point-to-remarkable-bounce-in-homebuying.html). Two, a very valuable data service that I pay “Big Bucks” for market analysis, Hedgeye.com, just removed the home builders ETF (ITB) from the “Short Side” plays they were recommending. Finally, on a local level, the number of home sales has returned to normal. There are about 2,200 SFR sales in Long Beach every year. Divided by 12 this would be about 182 sales per month and then divided by 4.3 weeks per month would be 42 sales per week. Below we can see a chart of weekly sales in Long Beach. In February we were headed into a strong selling season which dropped off aggressively in March. Today we are headed back to normal and inventory still remains persistently low at only 231 unsold homes. What is important is the ratio of homes selling per month relative to how may are on the market. If 180 homes sell every month and there are 230 homes on the market, then this is less than a 45 days supply of homes. This indicates that the market is NOT poised for a correction. If there were clouds on the horizon, inventory would be building and sales would be slowing. This is not the case.
Anecdotal Information – What’s Happening on the Front Lines
Just this week I put a home on the market. Within 24 hours I had 5 agents wanting to show the home and within 2 days I have a full price offer. I anticipate that by the end of the weekend, I will will have multiple offers and the home may be bid up in price. To confirm my hunch that the market may be hotter than one would think, I called several agents who have current active listings and or pending sales to see if they are experiencing the same surprisingly strong activity. The agents I spoke to said that if the property is in the right category, the market is hot. Low interest rates seem to be the fuel that is propelling the market. While many have lost their jobs, many of these jobs were in lower paid service sector job. The job loss didn’t affect the typical home buyer who’s job stability and income are usually stronger. Even if a buyer has not lost their job, sometimes general fear about the economic future can cause a buyer to postpone their purchase. However this doesn’t seem to be the case as current buyers seem unfazed by the overall job loss.
I think the greatest take away from speaking with other agents can be summed up by one agents response, “It’s almost like nothing ever happened”. Yet we all know that something has happened. Highlighting the economic issues going forward…. the economy has gone from the LOWEST unemployment in 50 years to the HIGHEST unemployment in 90 years! I question the narrative that we will ultimately be back to business as usual. Mortgage delinquencies, a good leading indicator of future foreclosures has more than doubled in the month of April from 3% to 6.5%. I spoke with a bank CEO yesterday. She mentioned that the are not allowed to consider people not paying their mortgage due to Covid-19 as delinquent. So there may be more mortgage delinquencies once a 90 day forbearance is up.
Other Categories of Real Estate may suffer even though Long Beach SFR stays strong
You may hear news that real estate is going to suffer. This may be true. There are many types of real estate. Office space, retail space, and income properties are a few that may suffer during this downturn. It is very likely as companies learn to work virtually they realize their fixed office space requirements can be reduced. I can see companies either going out of business or cutting the amount of office space they use, putting pressure on commercial office space. The same trend is likely to happen with retail space as restaurants and shops either go out of business or reduce their footprint.
Income property faces a unique set of circumstances. Long term, income property looks great. Investment rates of return are low making apartment cash flow desirable. In addition, I believe several years out inflation may be a real concern, making income property a great place to hide out. Immediately however, there is the concern of tenant job stability and their ability to pay rent. While many home buyers were unaffected by layoffs, many tenants are likely the ones with less stable incomes and our Governor Gavin Newsom has put evictions temporarily on hold. This may put a temporary cloud over income property purchases.
There is one category of housing that I have read about that may be affected. They are the homes operated by Air BnB superhosts. These are hosts with many homes under management. In recent years there has been a trend for Air BnB hosts to acquire many homes that may not rent out conventionally for a positive cash flow and turn them into money making machines through short term rentals. With a sudden slow down in recreational and business travel many of these superhosts have been unable to makes their mortgage payments. These short term rentals are not a significant factor in any of the housing I see in Long Beach.
So if you are listening to the talking heads on TV and they say that real estate is down, they might be correct, but not right now in Long Beach.
The Outlook – Short Term (next 3 months), Medium Term (1-2 years) and Long Term (2 + years out)
As I mentioned mortgage rates are at all time lows. This certainly is propelling the market forward as we speak. Based upon the stock market’s recovery, it appears that the current narrative is for a “V” shaped recovery. This is keeping buyer confidence high, as long as you didn’t loose “your” job. Interest rates are low and housing inventory is low. Plus most buyers only know a “buy the dips” model. There may also be pent up demand from a buying public that has essentially been on hold for three months. These are all factors that bode well for the Long Beach real estate in the near term.
But what about the medium term? What might 2021 look like? Trillions of dollars in stimulus can certainly put temporary bandage on the economy. The Federal Reserve can print money, but they can not print jobs. The “V” shaped recovery narrative has the economy back to normal, like a switch that can be turned on and off. Real estate in Long Beach appears back to normal. However, I believe there may be aftershocks to this initial quake, here is why. I have read that over half of the 40 million in job losses will become permanent. We are also just starting to see the first wave of “white collar” layoffs with IBM announcing layoffs this week and Boeing announcing layoffs of 10% last month. I recession is defined as 3 months of negative economic growth as defined by the GDP. A depression is defined as a decline of GDP growth of 10% or more.
The Congressional Budget office estimates real GDP to be down 12% during this second quarter of 2020. This is a depressionary statistic. Will the economy just bounce back to positive GDP growth next quarter and next year? I think the current shock wave the the economy is experiencing is too large that the economy will just bounce back to positive growth. We are recovering, but from a potential depression to just a serious recession, and only with the help of trillions of economic stimulus. The US GDP is about 21 trillion. If the GDP takes a hit of 10% for the year and the government just steps in to fill in the gap, it isn’t a recovery. It is borrowing money to stay afloat. Will the money printing resuscitate the patient or will the government have to keep printing just to fill the gap. My best guess is that the money printing will work “kind off”. At first we will have a recession and deflation in some prices, while at the same time inflationary forces will be building in the background. This is my best guess.
So 1-2 years out, the economy may not be any better than today. Maybe even worse. The extent to which the Fed prints money and artificially suppresses interest rates, the housing market will remain robust. If the housing market takes a dip 1-2 years out, it will be because the economy does not come roaring back. I believe this is likely to happen. If the economy is weak and we are still in recession I believe the Fed will continue to print money and significantly increase their balance sheet.
Then in 2 years or more, it will be clear to the markets that inflation is a reality and owning hard assets is the name of the game. I really truly believe that we are headed into a radical shift in our economy. It may be a time that once again returns us to the values my parents tried to instill. Value education and hard work, learn how to save for a rainy day and understand the value of a dollar. However the last part “understand the value of a dollar”, may get flipped on its head. and become something more like know the value of an ounce of gold, or the value of being debt free.
Far into the Future – How will we know if the Fed money printing / counterfeiting is working or if it is failing?
Simple, just track the value of an ounce of gold in dollar terms. Gold has broken out to new highs in all currencies but the dollar. Today it stands at $1,735 per ounce, close to its all time high of $1,900. Will it retreat of will it power above $1,900 on its way to $2,500 or $3,000? If it retreats, then Greenspan and his predecessors will still go down as heroes. If gold hits $5,000 an ounce, history won’t be so kind.
We certainly live in interesting times. However, when this phrase is said in Chinese, it is said as a curse. Me on the other hand, I find these times terribly exciting. I can’t wait to see what happens next. It’s better than the best TV series as long as you plan for contingencies, stay educated, work hard and save for a rainy day. Oh yeah and know the value of a dollar. Opps, I mean know the value of an ounce of gold and the value of owning real estate.