The State of Real Estate in 2023

David:
This is the BiggerPockets podcast show 718.

Dave:
If you’re in a market where wages are not going up, there is just a psychological limit to what people are going to pay for rent. It can only be X percentage. Usually, it’s 30% of their income can go for rent, and so I totally agree that in a hybrid or an appreciating city, rent growth will go up. I don’t know if that necessarily means they’ll ever reach the cash flow that these cash flowing cities tend to support, but personally, I think that that’s the better bet because you’re not betting on just cash flow or just appreciation or just rent growth.
You’re getting a little bit of everything. You don’t know which of the three might perform the best, but whatever happens, you benefit.

David:
What’s going on, everyone? This is David Greene, your host of the BiggerPockets Real Estate podcast here today with one of my favorite co-hosts, none other than Biggerpockets’ own VP of analytics, Dave Meyer with a fantastic show for you. First off, Dave, how are you today?

Dave:
I’m doing great. I had a real fun time recording this episode. I think people have a lot to look forward to.

David:
You are doing great, because if you guys listen all the way to the end of the show, you’re going to see exactly why this was a fantastic show about a very difficult topic that all of our competition is avoiding, because they don’t want to talk about what’s going to happen in 2023 other than screaming. The sky is falling, or pretend like nothing’s happening, and just give me your money so I can teach you how to invest in real estate. Here, we’re not about that life.

Dave:
Absolutely not, and maybe we should have talked about this at the show, but I think people are avoiding the concept of risk. They see there is risk in the market, and that’s true. I believe there is risk in the market, but risk is the counterbalance to reward. So, you have to understand risks so that you can reap the reward and opportunities that are out there. I think at the show, we really talked about that. We talked very specifically about what the risks are and some of the ways that you can mitigate risks and take advantage of opportunities that might present themselves over the coming year.

David:
That’s exactly right. So if you’ve been curious, if you’ve been frustrated, if you’ve been just wanting to understand what the heck is going on in the housing market right now, this is a show that will bring a ton of clarity to you. If you listen all the way to the end, we’re actually going to get into three strategies that we both believe will work regardless of what the market does in these uncertain times in 2023. Before we get into today’s show, I have a quick tip for you. Go to biggerpockets.com/report, and download the report Dave ROE.
A lot of the information from today’s show was coming out of that, and you can get it for free if you’re a BiggerPockets member. Dave, anything you want to say before we jump in?

Dave:
No, go check out the report. I spent a lot of time on it.

David:
Go support Dave, and leave us a comment in the YouTube video telling us what you thought of this report. Show him some love. If you like this show, please leave us a five-star review wherever you’re listening to podcasts. Guys, honestly, this is very, very important. We are currently the top real estate show in the entire world. We want to stay that way, but we cannot do it without your help. So whether it’s Apple Podcast, Spotify, Stitcher, wherever you listen to podcast, please take a quick second, and let the world know how much you like this podcast so we can stay number one. All right, let’s get into the interview.
Dave, you wrote a report about the real estate market. Tell us a little bit about that.

Dave:
I did. It’s a full comprehensive state of real estate investing for 2023. I wrote it because there’s just so much going on right now. We’re not and haven’t been in a normal housing market for the last several years. I start the report by going through all the different factors and variables that are going to impact the housing market right now, and then talk about some of the best strategies that you can use in 2023 to take advantage of what I personally think are going to be opportunities in the coming year, and just pose some questions about the 2023 market because we all obviously like to make forecasts, and guess what’s going to happen, but there are some just unanswered questions that I think are going to be the X factor for the 2023 housing market that we just don’t really know how it’s going to play out just yet.

David:
I’d say in my short career investing in real estate… Well, I say short. Compared to some people, it’s long, but I’m not an old man yet. This is the most complicated market I would say that I’ve ever seen. It’s got a lot more competing factors that influence what we’re seeing. Is that similar to what you’ve noticed, and is some of that covered in the report?

Dave:
Absolutely. When you look at the housing market back in time for the last 80 years or wherever we have pretty good reliable data for, the housing market is usually fairly predictable. It moves in cycles, but for, let’s say, seven or eight out of every 10 years, it goes up 2% to 4%, somewhat just above the pace of inflation. It’s pretty steady state and not that exciting. For the last 15 years or so, things have gotten a little more interesting, and it’s been a little bit more boomer bust over the last couple of years.
For the last three years in particular, as everyone listening to this probably knows, it’s become insane. It doesn’t mean that people are necessarily acting irrationally, or that we’re totally unhinged from fundamentals. In my mind, what’s happened over the last couple years is the variables and the factors that always impact the housing market have all aligned in this perfect storm to push housing prices up. Now, we’re sort of starting to see that unwind and go back to a more balanced and honestly more normal housing market.

David:
That seems crazy. It seems really negative. We’re having this overcorrection, but I think when you consider the insanity we had over the last eight years in how hot the market was, and you put it within context of that, I don’t think this is as big of an overcorrection as people are saying, but it certainly feels like it when you compare it to 20% increases in price being the norm in certain cities. Now, you mentioned that there are some levers of the housing market that affect the way that it performs. Can you tell me what you mean by that?

Dave:
Sure. I think generally, there are different variables, and these are mostly macroeconomic indicators that impact housing prices more than others. There’s thousands of things, and every individual housing market does perform differently. But when you talk about the national level housing market, it really all comes down to a few things. People often want to honestly even oversimplify it, and say, “Mortgage rates are going up, so prices go down.” Fortunately, it’s not that simple. There are more indicators. There are more things that really matter, and it shouldn’t be surprising.
These levers are things like supply and demand. Obviously, pricing always in an economic sense come down to supply and demand, but if you extrapolate that out a little bit more, we need to really look at things like affordability, inventory, the housing shortage in the United States, inflation of course, and things like mortgage rates. Those to me were the major things that were impacting the market in ’22, and will continue to impact in ’23, but just in a slightly different way because the way these variables are interacting with each other has changed.

David:
Now, we came out of one of the biggest recessions in our country’s history right before we had this explosion. So from your take, what impact did that great recession play in the home builder space over the last 10 years?

Dave:
I mean, from pretty much everyone’s estimation, the U.S. has a huge shortage in housing units. The predictions vary significantly somewhere between three and a half and seven million housing units. When you talk about economics, this just means a shortage of supply, right? There isn’t enough housing units in the United States for people, and this is largely attributed to what happened during and in the aftermath of the great financial recession. Basically, tons of builders just went out of business in 2008. It was rough out there, and people were looking for jobs. Businesses closed.
People who worked in construction wound up going into other industries, and so we see, if you look at the graph, and I put this in the report, it’s pretty startling the graph. You could just see that construction just fell off a cliff from 2008 to 2010. We’ve slowly been building our way back up, and it’s now at a pretty good level. But that eight years, or, like you said, from 2010 to 2018, we were well below the building rates that we should be at. So, that created these conditions where there weren’t enough homes.
That coincided with the time starting around 2020 when millennials, which are now the biggest demographic group in the entire United States, hit their peak home-buying age. We have these confluence of factors where there’s a ton of people who want homes, and millennials who are starting families, starting to have kids, and not enough homes. That is a perfect scenario for prices to go up. That’s just an example of how these different macroeconomic forces work together or did through the pandemic work together to push prices up.

David:
Now, if you want to hear more about the stuff Dave’s talking about, and the nitty gritty details that make this so exciting, you can download the report for free at biggerpockets.com/report, and see this data for yourself. Now, we’re going to continue talking about what’s in the report, but if you actually want to stop the podcast, and check this out or get it after the podcast is over, please head over to biggerpockets.com/report. Now, I think what you’re mentioning about supply and the issues in supply plays, in my opinion, maybe it’s the biggest lever in this whole drama of real estate prices and trying to understand them.
I was just talking about this yesterday when someone said like, “Well, David, if rates keep going up, do you see prices plummeting?” I said, “I don’t see them plummeting, because they’re such a constricted supply.” If you’re a homeowner and you’ve got a 3% interest rate, and you could sell your house and get a 7% interest rate, unless you have to move, you’re probably not going to do it, especially with your house being worth less now than what it was before. You’re going to wait. So because we’re not seeing a bunch of supply flood the market, we’re not seeing this crash in prices, and that’s what we saw during the last time we had a crash.
There was so much supply. There was way more properties than people could afford to buy or even wanted to buy, which is what led to the big decrease in prices. That’s, I think, what’s confusing to people that are like, “What? We’re going in a recession. Shouldn’t prices be dropping like they did last time?” What’s your take on comparing the environment we’re in now to the last time we saw real estate crashed?

Dave:
That’s a great point, and there’s a lot to that. I’ll just say about supply first that there are two good indicators of supply. One is this long-term indicator, and it’s what I mentioned before, that there just aren’t enough housing units in the U.S. To me, I am biased, because I’m a real estate investor. That’s the thing that points to long-term appreciation for real estate. Regardless of what happens in 2023 or 2024, because we don’t know what’s going to happen, to me, the fact that there are a lot of people who want houses, and there aren’t a lot of houses, that bodes well for real estate pricing over the next five to 10 years.
When you’re talking about what’s happening in the short term, I like to look at a metric called inventory, which is basically how many homes are on the market right now. To your point, it’s not exploding. It’s definitely up from where we were in 2020 and 2021, but not in the way where it’s signaling a crash. Just to explain this to everyone listening, inventory, I think, is one of if not the best indicator of the short-term performance of the housing market, because it measures supply and demand. It’s not just how many houses are put up for sale. That’s something known as new listings.
Inventory is a measure of how many homes are put up for sale, and how quickly they’re coming off the market. So when you see inventories start to spike, that signals a significant shift towards a buyer’s market, where prices are probably going to go down. We have seen that in the last six months that inventory is going up. But actually, David, I was just looking this week. I don’t know if you know this guy, Mike Simonson. He’s from Altos Research. He’s a big real estate guy. Inventory fell last week. It’s going down now, so it’s not like inventory is skyrocketing, and all of a sudden, we’re seeing things stay on market way longer than they were pre-pandemic.
They’re just going back to pre-pandemic levels. As of right now, things could change over the next six months. But as of right now, we’re recording this in January of 2023. Things are pretty stable in terms of inventory, and that is a big difference from what happened in 2008. I’ll also mention that the main biggest difference between now and 2008 is credit standards. This is not my area of expertise, but I read a lot about this. Basically, banks are not allowed to give out the crazy risky loans that they did back in 2008.
People are not defaulting right now. People are paying their mortgages on time, and that really puts a backstop in prices, because what really causes a market to just bottom out like crazy is forced selling. When people are forced to sell, because they cannot make their payments, that’s what sends the market into a tailspin. Right now, there is no sign that that is happening.

David:
That’s important to note. I was using the analogy yesterday when I was talking to my sales leaders that were asking the same questions. My take on it is we’re a semi-truck coming down a hill. Now, everyone knows you’re not supposed to just use your brakes when you’re driving down a hill, because your brake pads get worn out. You’re supposed to shift to a lower gear. But if this was a real recession, we wouldn’t be going downhill. We would be going flat. If the economy was struggling, people could not buy houses. They could not make their payments. They were suffering. With the job market, you’d see for selling.
We’re in a market where we are artificially slowing things down by raising rates. It’s like using your brakes when you’re going down this hill. If we take our foot off of that brake, you’d see home prices go up. You’d see transactions happening in greater numbers. You’d see days on market start to go back down. It is important to note this is not a recession based on fundamental problems in our economy right now, at least. Who knows if ChatGPT changes all that. We all lose our jobs, but I’ve said something crazy. This is absolutely something that the government has chosen to do for the sake of trying to slow down the inflation and rising home prices.
Now, that is something that real estate investors need to be aware of, the decision the Fed makes, the decision the government makes. These macroeconomic factors play a huge role in what your investment is worth or what the cash flow numbers are going to look like when you buy it. Tell me a little bit about what types of markets are created as a result of the swings of low or high inventory that you mentioned.

Dave:
Basically, inventory, I think, is really good to look at in your local market, because it’s behaving really different in different markets. Often and in the report, I use different examples, but I think generally speaking, places in the Midwest and in the Northeast are doing relatively “well.” Everyone has a definition of well. Some people want to see the housing market crash. I’ll just say that prices are stable in the Chicago, Philadelphia, Boston, Indianapolis. If you look at them, and you want to understand what’s happening in your market, if inventory is staying flat and is still below pre-pandemic levels, you could probably expect that the housing market in that area is going to either be relatively flat or maybe modestly even grow over the next year.
When you start to see inventory levels spike above pre-pandemic levels, that, to me, is a signal that prices are probably going to go down in that market. You see this frankly in a lot of the boom towns from the pandemic like Boise, Reno, Austin, Denver, where I invest. These markets are seeing more of a correction, because they just went up too high. They’ve just reached a level, and this is another important indicator of affordability that is just not sustainable, people who their salaries, their wages cannot sustain the prices that we’ve seen in some of these boom towns.
I really recommend if people want to look at their individual markets, and figure out what’s happening, looking at inventory and days on market are two really easy ways that you can start to understand like, “Are you in a seller’s market? Are you in a buyer’s market?” Just for clarity, because I think people actually confuse this a lot, buyer’s market means often that it’s a good time to buy. I know that’s confusing because people see prices going down, but that means you have more leverage traditionally. Buyers’ market means buyers have the power. Seller’s market means sellers have the power.
So, we are leaving a time on a national scale where sellers had all the power, right?we sell this every… I mean, you’d probably deal with this every day, David. Sellers could basically be like, “I want everything, no concessions, your firstborn child. Give me your car and your wedding ring,” and people were doing it. Now, it’s a different scenario where buyers can be a little bit more selective and negotiate. Again, days on market inventory, good ways to tell where if your market’s in a balanced market, a seller’s market or a buyer’s market.

David:
That is a great point. I think something that sets our podcasts apart from other ones is we don’t just rely on the fear factor to get clicks. Now, it’s easy to tell people, “During a seller’s market, you shouldn’t buy because the seller has all the power. Just don’t buy.” But the reason it’s a seller’s market is usually because prices are increasing so fast, or rents are increasing so fast, or your alternative options to real estate are so bleak that this is clearly the best option. So, more of your competition floods there. That creates the seller’s market.
Then conversely, it’s easy to jump in and say, “Well, it’s a buyer’s market, or sorry, prices are dropping, so you shouldn’t be buying. You should wait for the bottom, even though it’s a buyer’s market. This could be a better time to buy, and so you have to be aware of both markets. There’s a strategy that works in either one, and there’s pros and cons. Buying in a seller’s market is very difficult. You’re going to give up a lot of things that you nor… Sometimes an inspection you have to give up. However, you’re getting the upside of the asset exploding in price.
In a buyer’s market, you may be buying into a time where prices could go lower. Theoretically, we never know where the bottom is, but you’re gaining due diligence periods, sellers paying a lot of closing costs, getting cream of the crop inventory that you couldn’t even get your hands on before unless you had 1.2 million in cash to go compete. There are pluses and minuses to both, and we really are trying to bring the full picture here rather than just making some title that says, “Buy now or wait. The crash of the century is coming.” Then we’ve seen that stuff for eight years. It never came.

Dave:
They’ll be right one day if they keep saying it. They’ll be right one day.

David:
That’s a good point. A broken clock is right twice a day. Isn’t that how it goes?

Dave:
Exactly.

David:
Your take on this is what I think people should be looking at as opposed to just, “Tell me what to do. Is this buy, or is this sell?” It’s understand the factors that are influencing price, and then the right decision will usually make itself known. We’ve covered the supply side talking about inventory, monitoring inventory, understanding this is why prices aren’t plummeting right now is there isn’t a lot of supply, but the demand side’s important too. Real estate is interesting, because the demand is a little more complicated than it would be in something else like maybe Pokemon cards.
Can you tell me a little bit about demand and how that works within real estate specifically?

Dave:
Demand in real estate is composed of two things. I think people often think demand is just how many people want to buy a home. It’s not. It’s how many people want to buy a home, and how many people can afford to buy a home. Those are two… They both influence demand, but they behave in different ways. I think the biggest example, David, we are both millennials. I think for years, you see these pundits on TV being like, “Millennials don’t want to buy homes. They’re not buying homes.” It’s like their data doesn’t show that. It shows that they couldn’t afford to buy homes, and then the second they could afford to buy homes brought on by low interest rates in the pandemic, they jumped into the housing market like crazy.
So, demand is not as simple as people don’t want to buy homes. I think that the major things that are driving demand and will, I said it already, is that millennials are reaching peak family formation years. This is a strong thing. People really underestimate, I think, the impact of demographics, but it’s super, super important. We’re seeing the largest generation in the country enter their peak home-buying age, so that is going to increase demand. Like I just said, with low interest rates from 2020 to mid 2022, people are going crazy into this market.
Now, that demographic demand will probably last another three to five years if you just look at the demographics of the U.S., but what has changed and the biggest factor that has changed from mid 2022 until now is that affordability factor. The second half of demand is how many people can afford to buy a home. With mortgage rates going up as quickly as they have, that is just completely eroded affordability. We have seen basically the housing market react to this single factor more than anything else, because if people can’t afford to buy a home, that pulls all the demand out of the market, and that really tempers prices, or can even send prices going down backwards.
That’s really what’s happened with demand. Frankly, maybe I’m getting ahead here, my opinion about what’s going to happen in the housing market over the next year, two years, three years, is all about affordability and if it recovers. It really comes down to, in my opinion, will affordability improve? That’s when the housing market will bottom and start to grow again.

David:
This is such a powerful nuance point that you’re making. Demand has two heads when it comes to real estate. You got to be willing, and you have to be able. Conventionally, able has been the problem. Even if you wanted to buy a house, you just couldn’t because the prices were going up faster than you could keep up, or you didn’t want to be competing with 11 other offers, or waving your contingencies, so you just said, “Hey, I’m out. I’m not going to do this.” When you’re in a really, really bad market is when the willing side is gone.
People don’t want to buy a house. That was what we saw in 2010. A lot of people were unable to buy a house, but many of them could. They just didn’t want to. I remember in 2010, no one actually looked at real estate like buying an asset. This is hard if someone wasn’t around back then. They looked at it like tying themselves to a 30-year anchor called a mortgage. If you said, “I bought a house,” I’d be like, “Oh my God, you have to make that payment for the next 30 years. Why would you do that?” This is funny, Dave, because my first house, my mortgage was $900. That was still considered a death sentence. Why would you ever want to just tie yourself to $900?
Nobody was willing to buy homes, and there was so much supply that caused that plummet in prices. This is what we’re monitoring when we’re looking at what’s the market doing is how much supply is out there, which we’ve covered, and then how much demand is out there. There’s two components to it. It’s you got to be willing to buy a house, and you got to be able to buy a house as opposed to many other things that don’t involve financing, like the Pokemon card example I gave. It’s just, “Are you willing to buy it, right?” Most people can afford to pay $30.
I don’t really know much about Pokémon cards. Then I bought my nephew some for Christmas, and he was super excited about it. It’s not a thing where you have to be able to buy them with real estate.

Dave:
So much of being able to buy real estate is out of our control, because most people use leverage, use debt to finance real estate. So, the rate on a mortgage really impacts what you can afford, and that was positively impacting people during the pandemic, because people could all of a sudden afford way more. Now that we’re back to… Actually, it’s high compared to where we were, but we’re right about the historical average of mortgage rates. Now that we’re back to a more normal mortgage rate in historical terms, that’s negatively impacted affordability.
When you talk about buying a Pokémon card or fine wine or whatever else, you’re just using equity. You’re not usually leveraging those purchases, so it’s really up to you like, “Do you have that money in your bank account? Then you can go buy it.” There are other examples of leveraged assets, but real estate is probably the biggest example of a leveraged asset, and it really is. That’s why real estate is really sensitive to interest rates is because it really, really impacts how able you are to buy investment properties or primary residents.

David:
Now, when it comes to rates and the Fed, can you tell us a little bit about how these decisions are made, and then how that ultimately ends up affecting affordability?

Dave:
Oh boy, my favorite topic. Basically, as we all know, inflation is really high. That is a huge problem for the economy. It erodes our spending power. Everyone hates it. Real estate investors hate it a little bit less, because real estate is a fantastic hedge against inflation, but it still sucks for everyone. The Fed is basically making decisions to try and combat inflation. They do that by increasing the federal funds rate. That’s the only thing that they can control. It’s wonky, but it’s basically the rate at which banks lend to each other.
The idea behind raising the federal funds rate is that if it becomes more expensive to borrow money, less people do it. When there’s less people borrowing money, less money is circulating around the economy. That’s also known as the monetary supply, and so they’re trying to reduce the monetary supply because we’ve seen it go crazy. Over the last couple years, there’s a measure of monetary supply called the M2. Basically, we’ve seen that explode, and that happened for a few reasons. One was because of low interest rates, but the other was because of money printing. We have introduced a lot of new money into the system, and so they’re not able to pull that money out of the system.
What they can do is raise interest rates, and try and get it from circulating around the economy less. If less people are borrowing money, the money stays in the bank, or it stays in your savings account, or you do less with it. That helps cool down inflation at least in traditional terms. That’s what the Fed is trying to do. Obviously, as of early January 2023, inflation is still super high, but the trend looks like it’s starting to come down. Now, the federal funds rate does not directly control mortgage rates, but it does influence mortgage rates. So, we’ve seen mortgage rates go from…
The beginning of 2022, they’re, I think, below or right around 3%. Now as of this recording, they’re at about 6.2%, so they’ve more than doubled. That significantly increases the amount of… That significantly decreases affordability, I should say. We’ve seen a time when at the beginning of the pandemic, affordability was at almost record highs. People could afford anything to a point where now, affordability is at a 40-year low. This is the least affordable real estate has been since the 1980s, and the implications of that are obvious. If you can’t afford it, you’re not going to buy it, so there’s less demand in the market.

David:
That is really, really good. Now, to recap here, so far, we have covered the housing market levers, what makes prices go up or down, supply and inventory and how you can be tracking those, demand and ability, the nuance of what affects demand as well as mortgage rates and inflation, which are all ingredients in the cake of the real estate market, I should say, that you monitor. You add more flour. You add more eggs. You add more sugar. You’re going to get a different tasting cake. This is what we’re all trying to understand when we’re trying to predict how things are going.
Now, before we move on to what works in an uncertain market like this one, my last question for you is that what needs to happen for affordability to become rebalanced again to where investing in real estate is something that people can be excited about and actually possible?

Dave:
First of all, I still think real estate investing is possible and excited. You have to be a little creative, which we’ll talk about in just a second. I think what’s happened is basically for two years, every single variable, all the levers that we’ve talked about were just pointing in one direction for prices, and that was up. Now, we’re at a point where we’ve need to rebalance, and things have changed. Affordability has declined to the point where prices are likely, in my opinion, going to go down a little bit in 2023. What needs to change for affordability is one of three things.
Affordability is a factor of three different things. One is housing prices of course, and so if prices go down, that improves affordability. The second thing is wage growth. If people make more money, things start to become more affordable. We’re already seeing wage growth start to decline, and I don’t think that’s going to be a major factor in the housing market. The third is mortgage rates, rights? If mortgage rates go down, affordability will go back up. Those are the major factors at least I’m going to be looking at for the next couple of months.
Mortgage rates already come down off their peak. They could go back up again, but back in October, November, they’re in the low sevens. Now they’re in the low sixes. Affordability is already starting to improve a little bit. That’s probably the thing. If you’re going to look at one thing to understand the housing market in 2023, affordability is the thing I would recommend.

David:
affordability is, as you mentioned, a combination of the price versus the mortgage payment. It’s not as simple as just one or the other.

Dave:
Exactly.

David:
Just funny because when rates were going down, everyone was complaining about how homes were unaffordable, because people could afford to pay more for them, so prices kept going. Then when prices finally came down, people complained that interest rates are too high, but they’re both two sides of the same coin. You can’t usually have one without the other, just like supply and demand. All right, let’s move on to three things that work in an uncertain market like this one. What’s your first piece of advice for strategies that people can take advantage, or where they can make money even when we’re not sure what’s going to happen with the market?

Dave:
Well, one of the things I’m most excited about, and I’m actually looking to make an investment in the next couple weeks here on, is private lending. When you’re in a high-interest rate environment, that’s the bank who is charging those high interest rates. So, if you can become the bank, that is a pretty exciting proposition. There are probably a lot of flippers out there who want money. There’s probably syndicators who need bridge loans. There’s people who need mortgages, and so there are opportunities to be a private lender. I am not an expert in this. David, I don’t know if Dave Van Horn, the third Dave. Maybe we should have him on one time.

David:
Three D.

Dave:
He’s a real expert in this. I forget what his book’s called, Note Investing. BiggerPockets has a book. Check that out. I think private lending is a really interesting option right now, because if debt is expensive, that’s bad for the borrower, but it’s sometimes good for the lender. That’s something I’m at least looking into at 2023. Have you ever done private lending?

David:
I have a couple notes through Dave’s company actually, the PPR Note Company I believe it’s called. It’s a similar concept like what you’re saying. That principle applies for private lending, but it also goes into just saving. You got punished for saving the last eight years or so. Inflation was way higher than what you could get on your money in the bank. That helps fuel the rise in asset prices because you’re like, “Well, I got $100,000 sitting in the bank, earning me half a percent while inflation’s at God knows what it is, probably realistically 20% to 30% if you look at food prices and gas and real estate and stuff like that.”
I got to put it somewhere. Where am I going to put it? Well, I’m probably going to put it into real estate, because that’s what’s going up the most, right? But when we see rates go higher, even though it does slow down, the asset prices going up. Man, there was a time, I remember, when I was working in restaurants where I was making 6.5% of my money that I would put in the bank, and that wasn’t even in a CD. So, strategies like private lending, just saving your money at a certain point become possible when we finally get rates up to healthier levels.

Dave:
I actually just wrote a blog about this in BiggerPockets that I think we’re reaching a point where savings rates are attractive again. In my high-yield savings account, I can get almost 4% right now. I know inflation, it comes out tomorrow, but as of last month, I think it was at 7.1%, right? People are like, “The 7.1% is higher than 4%.” Yes, that’s true, but 7.1% is backward looking. That’s what happened last year. If you look at the monthly rate, it’s averaging about 0.2% over the last five months. So, if you extrapolate that out, and no one knows what’s going to happen, but if you just extrapolate that out, you can imagine inflation a year from now might be somewhere between 2% and 3%.
So if you’re earning 4% on your money for the first time in years, your savings rate can actually earn you not a great return, but at least more money than inflation is eating away. Personally, at least I’m putting the money… I’m looking for opportunities in real estate, but I’m taking the money I have, putting them in either a money market or a high-yield savings account, because at least you can earn 1% to 2% real returns on your money as opposed to the last few years where if you put your money in a savings account, you were losing 6% or 7% at the minimum.

David:
You didn’t even have this as an option when rates were super low, and it was fueling this big run that we had. Now, with no investing specifically, you do make a profit on the interest that comes in from the note, but it’s negligible compared to how much money you make when the note pays off early. Typically, what you’re doing is you’re buying a discounted note in these cases. I bought a note. Let’s say maybe I paid $50,000, and the note balance was $75,000 or $80,000, and I get my $300, $400 a month coming in from that note, so there’s a return on the money that I paid.
It’s amortized, so you’re going to get more than what you put out, but you really win when that person sells or refinances their property, and you get paid back the $80,000 when you only had spent a smaller percentage for the note. The hard part is unlike real estate, you don’t have control. It’s not like an asset. I can go in there, and I can buy, and I can fix it up to make it worth more. I choose at what point in the market I’m going to sell it. You’re at the mercy of the other person, so the strategy is just to have all of these little notes that are out there. Unlike a jack in the box, you don’t know when it’s going to pop, but at a certain point, it’s going to.
Then boom, you have a note pop off. You make a profit. You either go buy a bigger note that gets more cash flow, or you go invest into something different, which is something that I had planned on doing a lot more of when I bought it. Then we saw what happened with the housing market. It was like, “Oh no, all steam ahead, get me irons in the fire as I can as this market is increasing.” I think that’s great advice, different strategies surrounding real estate, but not necessarily just owning it. The second thing I see that you mentioned are hybrid cities. Let’s start with what do you mean by hybrid?

Dave:
If you look back historically, different housing markets perform really differently. Traditionally, pre-pandemic, what you saw is that certain markets were great for cash flow, but they didn’t really appreciate much. Other markets were great for appreciation, but they didn’t cash flow that much. Those are the two ends of the spectrum, but there are some that get modest appreciation and modest cash flow, which personally I am really just interested. I think that’s the best conser… It’s conservative in a way that you have good cash flow, solid cash flow, not amazing cash flow, but solid cash flow so that you can always pay your mortgage.
There’s no risk of default. You can hold on. There’s nothing. No risk there. But at the same time, it’s appreciation, so you still get some of the upside opportunity that you get in markets like California or Seattle. It’s not quite that much, but you get a little bit of each. I think those markets are going to do particularly well, because a lot of these hybrid markets tend to be more affordable cities. My theme in a lot of what I’m talking about today is affordability is dominating the housing market. I think, markets that are more affordable are going to perform well relative to other markets over the next couple of years.
I think some of these hybrid cities are really interesting. I just want to caution people who have gotten into real estate in the last few years that what we’ve seen over the last few years is so atypical in so many ways, but what I’m talking about right now is appreciation. We’ve seen every market appreciation, big markets, small markets, rural markets, urban markets, suburban markets, everything. Why not? That is not normal. Normally, some markets go up. Other markets stay flat. Some markets go down.
I personally believe we’re going to return to that dynamic over the long run. I don’t know if it’s going to be this month or next year, but I think that is normal for the housing market. I think we’re going to get back to that. So, I would look at markets that we’re seeing some cash show and some appreciation pre pandemic. These are tertiary cities like Birmingham, Alabama or Madison, Wisconsin or places like this that have strong demand population growth, but still offer cash flow. I think they’re going to outperform other markets for the next couple years. That’s just my opinion, but that’s what I’m looking at.

David:
If somebody wants to identify cities like this, what data should they be looking for?

Dave:
I think the number one thing is if you want to look at cash flow, you can look at a metric called the rent to price ratio. You just divide monthly rent by the purchase price. If it’s anywhere near 1%, you’re doing really well. You’ve probably heard of the 1% rule. I think it’s a little outdated personally, and that expecting a deal that meets the 1% rule is probably going to cause you more harm than good, because you’re going to wait around forever looking for a mythical unicorn. Not that it can’t exist, but like I was just talking about, those 1% deals often occur in markets that don’t appreciate. I think to me, that’s not worth it.
I would rather see something that’s a rent to price ratio of 0.7 or 0.8, but is an appreciating market. That’s what I mean by a hybrid city. Rent to price ratio is good. Then for appreciation, it’s difficult to predict, but the most important things are very simple, population growth. Is there going to be demand, or more people moving there than leaving? Two, economic growth, you can look at this in terms of wage growth or job growth, but if people are moving there, and they’re getting paid more and more, asset prices are going to go up.

David:
We often talk about appreciation and cash flow as if they’re opposing forces like Yin and Yang. Are you a appreciation investor, or are you a cash flow investor? But in practical terms, for those of us that own real estate, we realize that they’re not actually mutually exclusive, that many times, you see cash flow appreciates as rents go up. What are your thoughts on the idea that certain markets will have rent increases, just like the value of the asset will increase?

Dave:
I personally… I agree. There are great markets that have 1% cash flow. I wouldn’t invest in them, because personally, I work full-time. I’m not reliant on my cash flow for my lifestyle entirely. But also, it’s just too risky to me, because those markets tend to have declining populations or not great economic growth. That’s, to me, risky. I know people say cash flow is a good hedge against risk, but I think some… But if your vast value is going down, then I don’t think cash flow is going to make up for that. I think that’s super important.
I personally would caution people against assuming rents are going to go up at least this year or the next year. I just think that we had what they call in finance or economics a bit of a pull forward, where it’s like rent prices usually go up a couple percentage points a year. They went crazy the last few years, and that might have just taken all the rent growth for the next two or three years, and just pulled it forward into 2021 or 2022, for example.

David:
Very possible.

Dave:
My recommendation is to underwrite a deal assuming that cash flow is not going to go up for the next year or two. If it happens, which it might, that’s just gravy on top, but I think the conservative thing to do is to presume that cash flow is probably going to be pretty mellow… I mean, rent growth, excuse me, is probably going to be pretty mellow for the next couple of years. But if you’re holding onto it for five years, seven years, then I would probably forecast some rent growth for sure.

David:
Well, when you’re making a decision on where to buy, do you think it’s reasonable to expect a hybrid city’s rents to increase more than a cash flow market, Midwest non-appreciating market?

Dave:
Oh yeah, 100%. I mean, if you’re seeing a city that has economic growth, I mean just look at wage growth. If wages are going up, if good jobs are coming to that city, those are some of the best indicators.

David:
People are able to pay more because there’s demand within the rental market, just like there is within the home ownership market. Same idea.

Dave:
Exactly. If you’re in a market where wages are not going up, there’s no legal limit, but there is just a psychological limit to what people are going to pay for rent. It can only be X percentage. Usually, it’s 30% of their income can go for rent. If you’re way above that, and if wages aren’t growing, then it doesn’t support rent growth. So, I totally agree that in a hybrid or an appreciating city, rent growth will go up. I don’t know if that necessarily means you’ll ever reach the cash flow that these cash flowing cities tend to support.
But personally, I think that that’s the better bet because you’re not betting on just cash flow or just appreciation or just rent growth. You’re getting a little bit of everything, and you don’t know which of the three might perform the best. But whatever happens, you benefit from it.

David:
Well, that’s what I wanted to highlight for the people who are maybe newer investors, that are inexperienced in some of these cash flow markets where turnkey companies tend to operate, and the gurus that are selling you a course, they’re usually, “Cash flow, quit your job. Get a girlfriend. Don’t be a loser. You need cash flow, and they’ll fix all your problems.” Then they push you into some of those markets that rents hardly ever go up. For the last 10 years, they’ve been the same. Versus if you had invested in maybe Denver 10 years ago, it might have been modest cash flow when you bought it, but 10 years of rent growth, and it’s doing really, really well.
We don’t want to say assume it’s going to go up, but you can absolutely put yourself in a position where it is more likely to go up by going into one of these markets that is having wage growth, companies moving in, population growth without completely betting the whole farm on investing in some wild appreciating market that you’re bleeding money. There is a responsible way to do it. I think that’s a really good sound advice that you’re giving here.

Dave:
I mean, this is probably a whole other show, but God, man, you know how many rentals it takes to become financially free? I know a lot of real estate investors are like, “Oh yeah, just quit your job. Buy three rentals, and be financially free.” It’s just absolute nonsense. The way to think about it is the way you earn money and cash flow in investing is you need X dollars invested at Y rate of return to equal Z cash flow.

David:
Just like we look at every other financial investment vehicle when we’re like, “How much do you need in your 401k at what return to retire?”

Dave:
Exactly, and so you can choose to be a cash flow investor and say, “I’m going to have $100,000 invested at 11% cash on cash return.” Great, that’s making you $11,000 a year. I can’t live on that. If you want to build for the long term, and you say, “I’m going to make a 6% cash on cash return, but through appreciation and working at a good job, I’m going to have $2 million invested at a 6% cash on cash return,” then you’re making $120,000 a year. I think people just get obsessed with this cash on cash return idea without thinking about the amount of principal you put into your investments is equally if not more important than the cash on cash return. That’s just my rant.

David:
We won’t go too far down that road, but I will tease people, which is this little idea. This is one of the reasons that I encourage people into things like the BRRRR method or buying and appreciating markets, because your property can create capital for you much like you earned at your job that you were working. You can have two sources of capital being created. We just call it equity when it’s within a property. We call it capital when it’s in our bank account, but it’s the same energy. You start your career off using methods like that, and then later in your career, you transition into higher cash flowing markets that are a little bit more stable, and then you do exactly what you just described.
This is some pretty deep cool stuff that we’re getting into when we just plan on talking about the market.

Dave:
I like this conversation. This is fun.

David:
All right, last topic I want to ask you about is buying deep. What do you mean by buying deep?

Dave:
I mean, buying deep just means buying below market value. I don’t know about you, David, but for the first eight years of my real estate investing career, I never even offered at the asking price. I would always offer less than the asking price. Only in recent years did it become normal for you to offer above asking price, and still pray.

David:
So true. You hear agents say things like they paid full ask, and I laugh like, “That’s a deal out here.” Full ask doesn’t mean anything, but they’re operating from the old paradigm where nobody pay the asking price.

Dave:
Totally. In the beginning, you would always try and nickel and dime the seller a little bit, see whatever you can get. I think we’re back to an environment where that’s possible. Not in every market, not every asset class, but we are in a market where you can buy below asking. I think it’s just a good way to hedge. If you think your market might go down 5%, try and find a property that’s 5% below. I invest in Denver, and it’s already gone down almost 10% in Denver. It’s one of those leaders of the market in terms of price declines.
I think it might go down another 5%. So when I make an offer right now, I’m going to offer 5% below asking. That way if it goes down, I’m okay. It gives me a little bit of cushion. That’s what I mean by buying deep. It’s just going below asking price to give yourself a little bit of cushion. I’ll also say I really think timing the market is hard, and if it’s between 1% and 2%, don’t worry about it too much. I bought my first property in 2010. The housing market bottomed in 2011, 18 months after I bought or something like that.
Do you think I’ve ever once thought about that, that my property went down 1% before it started to come back up? Not once. People tell me how jealous they are that I bought in 2010. What they don’t see is that my property value actually went down 1% or 2% before it started growing like it did over the last couple months. I think buying deep is really important, but I wouldn’t obsess about trying to get it exactly to the bottom of the market. It’s literally impossible to do. But if you think the market’s going to go down 5% or 10%, try and get some concessions out of the seller to make yourself more comfortable.

David:
That is incredibly sound advice. When I bought my first property, it was the end of 2009, so I wasn’t even at 2010. Then it went down more. I was like, “I’m so dumb. I should have waited.” Everyone was like, “Why’d you buy real estate?” In my head, I pictured it going all the way down to zero. Then a year later, it started going up, and then it exploded. It’s funny. I paid 195 for that house that probably dropped to 185, and I was kicking myself. Now, it’s worth 525 or so. It just doesn’t matter.

Dave:
Exactly.

David:
This doesn’t matter, right? It’s your ego trying to be smarter than you are, and you’re making it. That was a property that I was under contract at 215, and I went in there to get some seller concessions, and got it at 195. That is exactly what people should be doing in this buyer’s market. If the house has been on the market three days, it’s getting tons of interest. Maybe you don’t get to use the strategy, but I look for houses with high days on market, poor listing photos. I literally teach people how to target stuff in the MLS that’s been passed up by other people, write very aggressive offers, and then gauge based on the counter offer how serious that seller is and how we can put a deal together.
In the 1031 exchange that I wrapped up a couple months ago, I think I bought 17 or 18 properties, but only 12 or 13 of them were through the exchange. From those 12 or 13, I made over a million dollars in equity based on the appraise price versus what I paid. It was just this strategy of, “I’m on the MLS. I’m not doing anything crazy,” but I’m not going after the house with the beautiful listing photos professionally taken by a really good realtor. I’m looking for the people that paid a 1% commission to their realtor. They took some pictures with their iPhone seven.
It looks terrible. It’s been sitting there for a long time. I mean, literally, Dave, some of them had upside down uploads. The bathroom pictures were uploaded upside down that you can tell Zillow’s, “Four people have looked at this, and no one has saved it.”

Dave:
Those are the ones you want.

David:
That’s exactly right. So buying deep, I refer to as buying equity. Same idea. Don’t just think you have to pay asking price like you used to. Explore. Write a really low offer, and wait and see. I tell people, “An offer should be like a jab. If they accept your first offer in this market, you probably wrote too high.” You shouldn’t be knocking people out with an offer. It’s a jab, and you wait and see how did you defend? Are you weak? I won’t go too deep into it, but one of the deals in particular was listed for 1.6 million, had dropped its price all the way down to 1.2 million.
I went in and wrote an offer at $1 million 50 with about $50,000 in closing costs. It was about 1 million even. He countered me accepting my deal, but just he didn’t agree to the $50,000 closing cost difference. I knew if he countered me that hard, he wants to sell this house. I’ve got all the leverage here. I’m going to get this deal. I ended up holding out, and he still came back and said, “Fine, I’ll give you the closing cost too.” Now, if he had countered me at maybe $10,000 off of his 1.2, I would just let it go. That’s not a motivated buyer.
You could never use strategies like this the last eight years. They just did not exist. That’s a great point. If you’re worried the market’s going to keep dropping, just go in there and write a more aggressive offer than you normally would have, and cover yourself that way.

Dave:
You got nothing to lose. I think people are like, “Oh my God, they’re going to reject it.” It’s like, “So what?” Obviously, you don’t want to just be doing stuff that makes no sense, but if you think your offer is fair and reasonable, might as well try. See if they agree.

David:
Then the other thing, the piece of advice I’ll give people is don’t assume that one punch is going to knock someone out. Many of these properties we’re talking about, I wrote an offer. They said no. I had my realtor go back a week or two later, and it was maybe. A week or two later after that, it was like, “Let’s play ball.” Then that started the actual negotiation. Sellers are freaking out just like buyers are freaking out. Everybody’s freaking out in this market, and you just want to find the right kind of freak to match up with your interests.
Dave, I’m going to lead us to wrapping this thing up by asking you for the one thing that we’re always hesitant to do, but everybody wants to know, what are your predictions for 2023?

Dave:
It’s really hard, but the thing I feel confident about is that we’re probably going to see a continuation of the current market conditions through at least the first half of 2023. I just think right now, there’s just still so much uncertainty. Are we going to see a recession? How bad is it going to get? Is unemployment going to go up? What’s the Fed going to do? There’s just too many questions right now, and until there’s some confidence about those big economic questions, I think we’re going to see, like you said, people freaking out a little bit and not really having stability enough for the market to find its footing.
The second half of the year, I think, is really the X factor. I think there are different scenarios that can play out. I’ll give you three different scenarios. The first is if there’s a global recession, which most economists believe there will be people… I won’t get into the details of this, but if there’s a global recession that tends to put downward pressure on mortgage rates, people flock to U.S. government bonds that pushes down yields, mortgage rates track yields, and so you see a scenario where mortgage rates could go down more than they are now. If mortgage rates go down even more than they are now, I personally believe the housing market is probably going to bottom a year from now, the end of 2023, beginning of 2024, and start to grow again.
The other scenario is the Fed miraculously achieves a soft landing, and mortgage rates could go down. That’s another scenario where I see the market bottoming towards the end of 2023, early ’24, or inflation keeps going up, unemployment goes crazy, but the mortgage rates for some reason don’t go down. Then in that scenario, if mortgage rates stay above 6.5%, above 7% for a long time, I think we’re probably in for a two-year correction. All of ’23 and ’24 will be like this. In that case, we might see double digit declines in the national housing market, but it’s still hard to say.
I think, two of the three scenarios in my mind point to a one-year correction where we’re going to see single digit price declines. I’ve said I think it’s going to be somewhere between 3% and 8% negative on a national level if mortgage rates stay high. I’ve said this. It’s all about affordability. So if affordability doesn’t improve, the mortgage rates stay high. Through the second half of this year, that’s when I think we’ll see 10%, 15% national declines, and not bottoming to the end of ’24, maybe even early ’25.

David:
That is a remarkably well thought-out and articulated answer for someone who did not want to give a prediction, so thank you. Thank you for that. I like how you’re providing the information you’re basing it off of rather than just throwing something out there. Because as the information changes, so will the prediction. Something people have to remember, these things are not set in stone.

Dave:
Totally. People are like, “You said this, and you didn’t factor in this.” It’s like, “I’m not a fortune teller.” I’m just like, “I’m looking at this information. Here’s how I’m interpreting it.” I don’t know what’s going to happen, but I think those three scenarios, I don’t know the probability of each of them, but I think that it really will come down to mortgage rates and affordability, and when we see it bottom. I will just say… Can I just say one more thing about it is that traditionally in recessions, they say that housing is the first in and the first out, where because mortgage rates go up, and real estate is a leveraged asset, prices tend to decline first. That’s what creates the recession.
We’re seeing that right now, right? Rates went up. Housing is in a recession, and so we’re starting to see that start to ripple throughout the rest of the economy. But like I said, when mortgage… When we enter official recession or whatever, mortgage rates tend to come down. That gets people to jump back into the housing market. That creates a huge amount of economic activity, and it pulls us out of a recession. It’s just interesting to see that recession’s not good for anyone. I’m not rooting for that, but if you see it, it often is the first step, and the housing markets start to recover. So, it’s another thing to just look that.

David:
It’s why you can’t time the bottom, because you don’t know when that’s going to happen. By the time you see that show up in the data, it’s already started, and the bottom’s already on the way up.

Dave:
It’s already happened.

David:
Great point. All right, so we’ve got a pretty good market prediction for 2023. We have a very solid understanding of the things that affect real estate prices. That would be the levers that people pull on to make prices go up and down, supply, and you can measure that by inventory, and then demand, which is a double-headed monster of both being willing to buy a property and able to buy a property. We’ve talked about mortgage rates and inflation and all of the complexity that that’s created in this insane but beautiful market that we like to invest in. We’ve also talked about ways that you can make money in 2023 regardless of what the market does.
Private lending and buying notes is one way that people can expect to make money in real estate. Looking for these hybrid cities where you’re not… You don’t have asymmetric risk in either direction of a cash flowing property that never increases in rent or in value, as well as a speculative market that you’re just hoping goes up and lose control over, and buying deep, understanding that this is a buyer’s market, and that means you have the control. So, you’re a fool if you don’t use it. Use the control to try to go out there, and get the very best deal that you can rather than just worrying about things you cannot control like when the market is going to bottom out.
Dave, thank you very much for joining me. I love it when you come for these things, and we can help make some sense out of the emotional insanity that we typically feel when people don’t know what to expect. Is there any last words you’d like to leave our listeners with before I let you get out of here?

Dave:
No, this has been a lot of fun. But if you want other recommendations about how to make money in 2023, or to understand this in full detail, I encourage everyone to download the report I wrote. It’s free. You could just do that at biggerpockets.com/report.

David:
All right, biggerpockets.com/report. Check it out. If you thought Dave sounded smart, wait till you read them. He looks even smarter when you’re reading there. Then you wrote a book with J Scott on a similar topic to this. Can you plug that real quick before we go?

Dave:
Sure. J and I, if you don’t know, J is a prolific excellent investor. He and I wrote a book called Real Estate by the Numbers. It is all about the math and numbers and formulas that you need to become an excellent real estate investor. I know if people think that sounds intimidating, it’s not. The math behind real estate investing is not super hard. You just need to understand some simple frameworks, and that’s what we outlined it. The whole point of it is to help you analyze deals like an expert. So, if you want to be able to analyze deals conservatively, especially in 2023, and understand what assumptions to make, that stuff, you should check it out.

David:
Yes, go check that out as well. If you’re a nerd, or you want to be as smart as a nerd without being a nerd, this is the book for you. All right, Dave, thank you very much for joining me today. I’m going to let you get out of here, and get about doing some more research to help the BiggerPockets community understanding what’s going on in the market. This is David Greene for Dave, the gentleman’s renegade, Meyer signing off.
I’m a professional. Just watch. Watch how good I am at saying things.

Dave:
He’s Ron Burgundy. He’ll read anything you put on the teleprompter.