January 2024

Michael Shvo, CEO at SHVO, joins ‘The Exchange’ to discuss the future of San Francisco’s offices, the impact of AI on the city, and more.

Dave:
Hey everyone, welcome to On The Market, I’m your host, Dave Meyer. And listen everyone, after you hear today’s episode, I don’t ever want to hear again that data or economics or finance is not interesting because we have an amazing conversation and an amazing guest today, Mark Zandi, who is a very well-known American economist. He’s the chief economist of Moody’s Analytics, and I look forward to talking to Mark every time we have the great opportunity to have him on the show. He makes really complicated topics very easy to understand, and I really love just how humble he is about his remarkable success as an economist. But he also gives it to you straight. He tells you which data points are important, which ones are unreliable, which should be ignored altogether, and it really helps you cut through a lot of the clutter and make sense of what’s going on in the complicated economy.
Today, we talk a lot about the labor market and I learned several things that I never knew from Mark. We also get into immigration, what happens in the economy in an election year, and we also talk about the housing shortage and some of Mark’s ideas on how we could restore some affordability to the housing market. So we have a great show for you, and with no further ado, let’s bring on Mark Zandi from Moody’s Analytics.
Mark Zandi, welcome back to the podcast. Thanks for being here.

Mark:
Thanks, Dave. It’s good to be with you.

Dave:
For those of our listeners who are new or didn’t hear your last episode, can you just tell us a little bit about yourself and your career at Moody’s?

Mark:
Sure, I’m the chief economist of Moody’s. I joined Moody’s a while ago now, 15, 16 years ago. I sold a company that I had formed in 1990 to them, and I’ve been with them ever since. So I’ve been a professional economist for, hard to believe, but over 30 years. I’ve seen a lot of ups and downs and all arounds.

Dave:
When you were here on the show last time, we ended with this term that you had coined, the slow session, that you had been using to describe the economy. Can you remind us what a slow session is and if your thoughts about it came to fruition?

Mark:
Yeah, slow session, and you can look it up in Google. You can Google it. There’s a URL there that one of my colleagues purchased. Yeah, for nine bucks a year apparently so not bad. Slow session, not a recession. So the economy isn’t contracting, going backwards, but an economy that’s not going anywhere quickly, a slow session. I’ll have to say, 2023, of course not over yet, but pretty darn close is going to turn out to be a lot better than a slow session. Not only did we avoid a recession like we thought, but it was a really good year in terms of growth.
GDP is what economists use to gauge the broader health of the economy, that’s the value of all the things that we produce. That’s going to grow 2.5% on a real after-inflation basis in the year, and that’s a good year. I mean typically think of 2% as the benchmark. You get 2%, you’re doing just fine, especially when unemployment’s so low, when sub 4%. 2.5%’s great. So it turned out to be a much, much better year than certainly most people feared and even better than I had expected.

Dave:
What do you attribute that resilience to?

Mark:
A bunch of stuff, but there’s a list, but I put at the top of the list the supply side of the economy really surprised, meaning we got a lot more productivity growth during the year. We can peel that onion back too if you want, but productivity came back to life. One thing that might be going on is all those people who quit their jobs back a couple, three years ago, they’ve now taken on jobs that they think better of, they’re more suited to their talents and skills and they’re better paid and they’re happier. And we can see that in surveys and that probably translates through to higher productivity, but remote work might be playing a bit of a role. I think it’s way too early for AI, but that may play a role down the road.
The other big thing is labor force growth. A number of people out there working and looking for work. That has been very strong surprisingly, and part of that’s just more participation, more people are coming back into the workforce. Participation rates aren’t quite back to pre-pandemic, but they’re higher than I would’ve thought they would’ve been if there had been no pandemic, just because the retiring baby boom generation and then immigration has been boom-like, and of course that poses a whole slew of questions and challenges. But one of the benefits of that is you’ve got more folks out there working and looking for work, and that adds to growth. So because the supply side of the economy grew more quickly, surprisingly so, that allowed the GDP the amount of stuff that we produce to grow more quickly without any inflation, with inflation coming back in. So I can wax on, but that’s I think a high level the most important factor resulting in the surprisingly good economy.

Dave:
Great. Let’s dig into that a little bit more because you mentioned a couple things I think that are going to be really interesting for our audience. One of them was about labor force growth. During the pandemic, we saw a lot of people leave the workforce, and as you said, it’s starting to come back. You also mentioned that immigration is fueling a lot of the labor force growth. Is that legal migration, illegal migration, a combination of both?

Mark:
It’s got to be a combination of both. Certainly the former, legal immigration is up. I mean, that got crushed during the pandemic for lots of obvious reasons and that’s made its way back. That’s certainly adding to a number of folks out there working. But I do think we’ve seen, it’s clear we’ve seen a surge in undocumented workers now and I’m sure that’s adding to jobs and payroll and labor force. But here’s a technical point. These estimates, these numbers are based on surveys and if the Bureau of Labor Statistics, the keeper of the survey goes to someone who’s undocumented and say, “Are you working?” I’m pretty sure that undocumented worker may not want to respond to the survey. So I’m sure undocumented workers are finding their way into the workforce and adding to labor force, but I’m not so sure how much of that is behind these really good numbers that we’re observing.

Dave:
Got it. So in the numbers and the data that you provide in your report, which comes from the Bureau of Labor Statistics, that is mostly reflecting legal migration, but there might be even more labor force growth it sounds like that is not measured by traditional methods.

Mark:
Got it, exactly. The data is imprecise representation of reality and all data is an imprecise representation of reality. In this case, it’s quite imprecise. And my guess is my sense is that we’ve seen very strong labor force growth of strong immigration, but it’s probably been even stronger than we think it is in the data that we’re observing.

Dave:
That’s super interesting. I mean, one of the questions I’m constantly wondering about is when you look at the total number of job openings in the United States right now, it’s come down a little bit over the last couple of months, but it’s still I think eight and a half million, somewhere around there, pretty high. And even if, from my understanding, correct me if I’m wrong, even if we got back to pre-pandemic levels of labor force participation, it still wouldn’t fill the need or fill all of those jobs. Is that correct?

Mark:
Yeah, that’s the arithmetic, but I’m not sure that’s reality. I’m not sure I believe in those unfilled positions. Okay, now I’m going to speak to you as an employer. I hire lots of people, I employ lots of people.

Dave:
Yeah.

Mark:
I’ve got a couple hundred economists around the world in my world reporting up to me. And what’s happened is it’s costless to open up a position and you just leave it there, it doesn’t mean you’re going to hire anybody. You could slow walk that forever, and that’s what I think is going on here. I think it’s not like you’re getting dinged for having that open position. And here’s the other thing, if you work in a big company, a multinational like I do, the human resource function is a machine. It’s a very complex machine and apparatus. You really don’t want to shut that thing down, because once you shut it down, to get it back up and running is going to be incredibly painful. So you keep it running, but less than full force and that’s what’s going on here I think in a lot of companies.
So those open positions don’t mean what I think people think they mean, which is interesting because the economics profession, if you go back a couple, three years ago, there was this whole, even sooner, more recently than that, smart folks were saying, “Oh, we’ve got to have a recession. We’ve got all these open positions. That means the labor market was really tight. The only way we’re going to get cool the labor market off and get inflation back down is by jacking up interest rates and pushing the economy into recession.” So they pinned a lot of that view on all these open positions, but without actually, I think understanding. And I guess you wouldn’t really understand unless you’re actually a business person doing this, doing it actually that there isn’t as many open positions out there as people think there are.

Dave:
That is a great take and one I haven’t heard before, but makes total sense because you hear a lot right now about the concept of labor hoarding where people basically businesses don’t want to lay off employees or more hesitant to lay off employees than they were in the past because how the labor market was especially two years ago or whatever. And this seems like an extension of that almost where people might be opportunistic. You post a job and if someone fantastic comes along that you would love to have a couple years from now, you would take advantage of that, but you’re not necessarily eager to fill any of these positions with any sort of urgency.

Mark:
You nailed it, that’s exactly right. And you just want to keep those resumes coming in, you want to take a look, you might have a conversation or two, but it doesn’t mean you’re actually going to hire that person sign on the dotted line and I think that’s a lot of what’s going on here. And in times past that was less the case. Before online job matching and searching companies, if they had an open position, they had to go to the newspaper and put a help wanted ad, and now it’s expensive. Probably people don’t realize this, but if you go back in the day, probably 25 years ago, New York Times was a big client of mine, and they made a fortune on help wanted advertising. It was like, I don’t know, crack cocaine margins. I mean, it was incredible business.
The newspapers were the single most profitable industry on the planet. The pharmaceuticals were a close second, but the newspapers were number one, and that’s because the cost of doing that. But for the business person, that was costly. So if you weren’t actually going to hire somebody in any reasonable timeframe, you wouldn’t keep posting online. I mean, excuse me, you wouldn’t keep posting help wanted, right? You wouldn’t put it in the newspaper, but online costs are, if there is any costs, there’s some if you go LinkedIn I guess, or some other job searching sites, but it’s relatively modest in the grand scheme of things.

Dave:
So given that, and we talk about this on the show quite a lot, there’s a lot of different labor market data, none of it perfect as you pointed out, but when you look at the big picture, the aggregate of all the information you look at, Mark, what are your feelings about the strength of the labor market right now?

Mark:
I feel great about the labor market. I mean, it’s rip-roaring. It’s sub 4% unemployment for two straight years. Last time that happened was in the 1960s, and that’s the only other time in history I think that that’s been the case. Lots of jobs, job growth is moderating, but that’s by design because the Fed’s trying to cool things off and get inflation back in the bottle. Wage growth is good. There’s lots of different measures, but if you look at the plethora of the data, it says 4% wage growth and that now is higher than the rate of inflation. If you look at wage growth across all wage tiers across the wage distribution, low wage workers, high wage workers, everyone is getting wages that are increasing at a rate that’s faster than the rate of inflation. That’s been the case now for all of 2023, so that’s all really good.
Probably the best thing, quit rates have come in, which is I think consistent with the moderation and wage growth and that’s probably good because that was things were getting heated. Hiring has come in, it’s more consistent with pre-pandemic, but really, and you mentioned this in the context of labor hoarding, really important thing is layoffs remain very, very low. I mean, we’re talking today on a Thursday in December, we get the unemployment insurance claims data, which is a read on the number of people that lost their job and say, “Hey, can you help me out?” And get a check. That remains extraordinarily low, close to 200,000 per week, which that’s consistent with a rip-roaring labor market. So if you wanted to pick one part of the economy to highlight how well things are going, it is the job market. It is very good. And it’s across industry, it’s coast to coast. It’s not like one part of the country’s doing great, another part’s not. It’s uniformly the case across the country.

Dave:
I think that’s really important because there are a lot of high profile or when a big tech company lays people off that makes the news and I think that distorts a lot of the underlying data about what’s going on with the labor market that although some of the big companies were laying off maybe six months or a year ago, that overall that is not really the case. Initial claims, as you said, Mark, are extremely low. Continuing claims I think are going up a little bit but are still low in historical context, so it shows a lot of strength. Mark, given what you said about the labor market, can you tell us a little bit more about your outlook for this year, 2024?

Mark:
I’m positive, I’m upbeat. We may not get the same kind of growth in ’24 that we got in ’23, but that’s okay. Get GDP growth around two, that’s very consistent with a good solid year, help create a lot of jobs and at least certainly enough jobs to keep unemployment at or around 4%. So it should be a good year. I mean the key to the economy obviously is you and I is consumers, Dave, if we keep spending, particularly if you keep spending, it’s key that you keep spending.

Dave:
Me personally, I’m doing a very good job of it.

Mark:
Although you’re in Amsterdam, you’re not going to help out the US economy from Amsterdam.

Dave:
Oh, I come in hot every time I come visit though. I’m going skiing, I’m doing fun stuff, don’t worry about it.

Mark:
We need those dollars. But as long as the consumer hangs tough and does their thing and spend, not with abandon but just enough, we’re good. We’re golden because they drive the economy, and all the forces that influence consumer spending look pretty good. We talked about jobs, we talked about wage growth higher than the rate of inflation. We talked about unemployment. The stock market’s at a near record high. Housing values, they’ve gone flattish, but they’re way up from where they were just a few years ago. Lower income households are under more financial pressure and they have taken a bigger hit from the previously higher inflation, and so they have borrowed against their credit cards and taken on consumer finance loans and are now paying a lot more in interest because of the higher rates.
But middle income and high income households, they have not borrowed, and they have done a really good job of locking in the previously low record interest rates through various refinancing waves. The average rate on an existing mortgage is 3.5% so that gives you a sense of, it’s amazing. So people are really insulated from the higher rates, and then there’s still a fair amount of excess saving that got built up during the pandemic. Again, high income, high middle income households have most of that, and households are sitting in their deposit account as cash and they call on it when they need it and have used it to supplement their income.
So if you add up all the things that drive consumers and their spending behavior, it all looks pretty good. Certainly consistent with the idea that they’ll hang tough, stay in the game and allow the economy to move forward without suffering a recession. Now, obviously a lot of risk, a lot of things to worry about. There always is. The thing that makes ’24 unique is because we have an election coming, and we could talk about that if you want, but that does pose some potential threat given just how fractured our politics are. But abstracting from the things that are low probability, the most likely scenario is that we have another reasonably good year.

Dave:
I do want to get into the political question, but before we do it, I just would love your opinion, given your belief that there is remaining strength in the US economy, how do you feel about the Fed’s recent, I don’t know if you really call it a pivot, but their more dovish approach in the last couple of weeks?

Mark:
I’m all for it, I think it makes a lot of sense. I was perplexed back previously when they still thought they’d raise rates in 2023. I thought that made a lot less sense to me in the context of fading inflation, everything suggested that they could pause, and now they’re forecasting three-quarter point rate cuts in 2024. That makes sense in the context of inflation moderating and all the trend lines there look really good. It feels like by this time next year we’ll be within spitting distance of the Fed’s target without any rate hikes and some rate cuts. The only thing that’s keeping inflation from its 2% target, the Federal Reserve has a target of 2% on one measure of inflation, is the growth in the cost of housing services.
And that goes back to rents. And as you know, Dave, rents have gone flat to down for the past year, and so that’s going to translate through in the slower growth and the cost of housing services over the next year. And as that happens, overall inflation is going to get back in the bottle so to speak. So I forecast lots of stuff, some things I’m confident in, some not so much. Inflation coming back to target by this time next year, if we have this conversation next year, and I’m on the record here now, I feel confident in that. I think that’s very likely to happen. Stuff could occur, but that’s very likely to happen. And if so, that would be consistent with rate cuts so I’m all on board with that.

Dave:
I certainly hope you’re right. And I do just want to take a minute to explain something that Mark just said, which is rents have been one of the main things that have been keeping one of the main headline inflation indicators that you hear about, the Consumer Price Index, up over the last couple of year or so. But the way that it’s collected for the CPI lags quite a bit. And so that is why we see inflation numbers reflecting higher rent. Whereas if we look at some of the data I look at or a lot of the private sector data into rents, you see as Mark said, they have been flat or even fallen in some markets. And so the Fed, even though the CPI uses this older historical data, they can see from private and other data sources that the rent pushing up inflation is likely to end. So that is, I believe, Mark a big basis of your hypothesis about inflation coming down.

Mark:
Yeah, you explained that very well, Dave. That’s exactly right. Yep, exactly right.

Dave:
Thank you. You mentioned.

Mark:
A, A+.

Dave:
I appreciate that, I’ll take it.

Mark:
I’ll put my professor hat on.

Dave:
You mentioned that an election year could influence the economy. Can you tell us a little more about your thinking on that subject?

Mark:
Well, I do worry about our fractured politics, they are a mess. I think it’s likely that the election is going to be close. Feels like it’s going to be former President Trump against current President Biden again. Obviously, a lot of script to be written over the course of the next few months and the year, but that feels like the most likely scenario and that argues that it’s going to be a very close election. And if it’s a close election, when I say close, it’s going to boil down to 5, 6, 7 states. It probably boils down to one county, two counties in each of those states because at the end of the day, it’s really about, I live in Pennsylvania. That’s a swing state, and the swing county is Chester County, the county I live in because it’s a suburban county, it’s a purplish county.
In fact, I joke my wife is going to determine who’s going to be the next president because we live on a circle. The circle is a mile in length in Chester County, and it’s some legacy farmers and folks you think are Republican. And then you’ve got a bunch of newbies, Vanguard employees because we live very close to Vanguard and got less Vanguard executives coming in and they are more progressive Democrat. In fact, I could go on and on about my neighborhood. It’s a story in and of itself.

Dave:
But the way the elections have gone recently, it really could come down probably not to one vote, but you do see these hugely impactful counties or states coming down to fractions of a percent of the total population. So I agree that, obviously we’re a long way away. We’re still 11 months away, but it does seem like it will be a close election.

Mark:
The point is it’s going to be close, and if it’s close, it’s going to be for sure going to be contested. If it’s contested, well, that could be messy, and I think that’s a threat to sentiment which is already pretty fragile. And at the end of the day, a recession is a loss of faith with sentiment. As fragile as it is, if it takes another knock, people could pack it in. The consumer doesn’t do what I expect and we don’t have the year I expect.

Dave:
I got it, okay. So it’s not necessarily that there’s historical precedent that during an election year.

Mark:
No.

Dave:
The economy behaves one way or another. It’s more just given the political realities right now there’s just more chance for, yeah. There’s just more chance for a surprise I guess, or a loss of faith like you said.

Mark:
Maybe it won’t be a surprise because we’re all talking about it already.

Dave:
Fair.

Mark:
But one of the fundamental strengths of the American economy is the stability of government, the political process, the rule of law. And if that’s shaken, challenged, then that goes to the core of what makes the US economy exceptional, and it is exceptional. And so that poses a threat to economic growth in the coming year. And of course even after that longer run.

Dave:
I’d love to turn a little bit towards our focus here of the show on the housing market. In your report, you detail some interesting information about the housing shortage. We’ve talked about this, but probably not for a while on the show. Can you just tell us a little bit about the nature of the housing shortage in the United States?

Mark:
Yeah, we don’t have enough homes. Particularly affordable homes, both for rent and for homeownership, and this happened in the wake of the financial crisis, the bust. I mean, housing seems to be always at the center of our economic problems, I don’t know why. But before, the financial crisis 15 years ago, the problem was overbuilding. Builders put up too many homes, vacancy rates soared, and that was the basis for the collapse in the housing market that occurred in the crisis, 2008, 2009 into 2010, house prices fell 2020 5% peak to trough depending on the index. The bottom really wasn’t until 2011.
That wiped out a lot of builders. It was such a wipe out crash, it wiped out builders, it wiped out a lot of infrastructure for building. It also raised the cost of building because a lot of local governments that rely on property tax revenue got nailed by the fall in housing values and so then they jacked up fees on permits in construction. And so the fixed cost for building rose very sharply in that period. And so that’s really made it difficult to ramp up homebuilding, particularly for lower priced homes that have lower margins, again, the builder has to cover those higher fixed costs. And it really wasn’t until right before the Fed started raising interest rates that homebuilding seemed to have gotten back to where it needs to be, not to solve the shortage, just simply to ensure that it wasn’t going to get any worse, that we were putting on enough homes to meet the underlying demand.
And by the way, going back to the point about immigration, underlying demand may even be stronger than we anticipate because we’ve got all these immigrants coming into the country, and we probably much more than we think, and it’s adding to the problems at the affordable part of the market and then adding to our homelessness issues and that kind of thing. But if you do the arithmetic, and so right now we have a vast shortage. The vacancy rates are low, the homeowner vacancy rate is at a record low, and we’ve got data back until just after World War II. By my calculation, we’re short by about 1.7 million homes both for rent and for homeownership. Increasingly, it’s less of an issue on the rental side, more of an issue on the homeownership side.
So this just exacerbates the problems potential first-time home buyers have getting into the market. They have this shortage of homes, lots of other things going on, high mortgage rates, high house prices, soft income growth and that just adds up to a world of I can’t afford anything, I’m just locked out of this market. I think it’s one of the key reasons why even though the economy’s good, people don’t think it is, many people don’t because they’re paying more for lots of stuff and one thing that younger people in their thirties and forties know is it’s going to be, unless something changes here, unless mortgage rates come in and the house prices weaken a bit, they’re not going to be able to afford to become a first-time home buyer anytime soon.

Dave:
Yeah, it definitely impacts sentiment for sure. And like you said, it doesn’t seem like there’s an immediate fix. I did have a couple of questions for you to follow up. One of the things I look at quite a lot is that there’s been a lot of multifamily housing for rent, rental units being built in the US over the last couple years. And there’s some evidence that in certain markets there is an oversupply. If you look at absorption rates, they’re turning negative. So how do you square those two things? On one hand, we don’t have enough housing. On the other hand, we’re a little bit oversupplied. Can you help make sense of that?

Mark:
Yeah, the oversupply you talk about is entirely at the high end of the multifamily market. It’s these big apartment complexes that are going up in big urban centers. I live in Philly. If you go down to downtown Philly, massive projects, luxury apartments that are going in. That part of the market is oversupplied. Vacancy rates are rising and rents are flattening out there coming down in many. I say Philly, but that’s symptomatic of what’s going on in DC, New York, Boston, Chicago, Seattle, San Francisco, LA, lots of markets around the country.

Dave:
Oh, yeah.

Mark:
So they’re no problem. It’s really in the affordable rental for people that have lower income. It’s not lifestyle rental. Some people want to rent, it’s a lifestyle. I want to live in an urban center and I have that lifestyle and therefore I’m going to rent. This is rental because of necessity. I have no choice. I can’t afford to own a home, I have to rent. And it’s that part of the market where the shortages are more severe. And by the way, if I exclude the high-end rental, the shortage is even greater than 1.7 million units obviously. That 1.7 million is for the entire market. If I exclude that, the shortage is probably two and a half million, something along those lines, even much worse.

Dave:
So it’s similar to something we see with the purchase market, which there’s just seems to be a mismatch between the product available and what demand is. We don’t build a lot of small homes or first-time home buyers anymore that are affordable and seems like a similar thing happens in the rental market as well.

Mark:
Yeah, exactly. Exactly, it’s the same dynamic playing out. The entry level, builders focus on high-priced homes because that’s where the margins are. They can make a lot more money. They’re not as focused. That was changing right up until when the feds started raising interest rates. You could feel like D. H. Horton for example, the biggest home builder in the country really was increasingly focused on entry-level housing. So that was changing, and I assume that’s going to be the case on the other side of all this mess. But that was very recent. You’re right, builders had been focused on the high end of the market.

Dave:
Mark, do you know what level of construction we need to get to start making a dent in this deficit?

Mark:
Well, I think the underlying level of construction, single-family multifamily starts that we need just to maintain the current vacancy rate for the shortage not to become even worse is probably around 1.6, 1.7 million units. And right now, we’re a little bit shy of that. We just got one more data point though that was somewhat encouraging, but it’s only one data point. For the month of November, housing starts single-family multifamily got to 1.55 million, something like that. So that’s pretty good, I’m pretty encouraged by that. We’ve got to see better than that, but that’s helpful.
The one area where I think it would be good if policymakers could focus is for manufactured housing because the other source of supply on the homeownership side is manufactured homes. That’s about 100,000 units per annum. And of course that’s affordable and that’s where you can get some really good productivity gains through improved manufacturing processes. And so if I were king for the day, I might need a week or a month, but if I were king, I would focus on that market and how to get that going and produce a couple hundred thousand, 250,000 a year. We’ve done it in the past, I mean at the heyday of the manufactured home building.

Dave:
Oh, really?

Mark:
Yeah, it was a bit of a bubble. But if you go back into, I think it was the ’80s, there was a period when we were producing a quarter million manufactured homes a year, yeah.

Dave:
That’s fascinating. I didn’t realize that. It just seems like such an obvious solution. I appreciate all the other things that people are doing, but correct me if you disagree, but to me, the only way to fix the housing market is more supply. We just need a lot more supply.

Mark:
Yeah, absolutely.

Dave:
Everything else is a stop gap. And not that stop gaps shouldn’t be attempted, but we just dramatically need more homes and that seems like a good option.

Mark:
And some things where the intuition is, oh, if I could only help people with their down payment, or if I could only lower the mortgage rate somehow, or make mortgages assumable or portable, that’ll solve the problem. No. I get the intuition.

Dave:
Yeah.

Mark:
I get it. But all you’re doing is juicing up demand if there’s no supply, all that happens is you just jack up rents and prices and not helping anybody and it’s obviously very costly. So I really focus on the supply side. I mean, there’s some demand side things that I think we could do, but there are things that would kick in later once we get more supply coming into the market.

Dave:
All right, thank you. Well, Mark, this has been super helpful, but before we get out of here, I got to know what’s your outlook for housing prices for 2024?

Mark:
Yeah, you remember, Dave, I said I forecast lots of stuff. Some I’m confident, some not so much. This is one of those not so much.

Dave:
Good. Me neither.

Mark:
One of the surprises for me in 2023 because prices started falling when the Fed jacked up rates in ’22 and coming into ’23, it looked like we were going to see more price declines and I expected it to help store affordability. But instead, no, prices have firmed and actually are up a little bit. And the actual prices today are, I think they’re at an all-time record high, not by a lot. Prices really haven’t gone anywhere for a year and a half, but nonetheless, I mean they haven’t fallen to a significant degree. I still believe that we will see some price weakness here over the next couple, 1, 2, 3 years and that goes to restoring affordability. You can only restore affordability if mortgage rates decline, expect that. Incomes to rise, I expect that, but I also think we need some decline in house prices for that arithmetic to work for people to get mortgage payments to a place where they can afford them.
And I think what happens is, I may have talked about this when we met last time, but I think when happens is life happens. Events, life events, divorce, death, children, job change. Those things can happen and you can put off a move for a while, but after a period of time, the helm you’re living in doesn’t make any sense given your demographic need, you’re going to move. And my thesis is that when these folks start moving, then they’re going to have to cut the price at least a little bit to make the arithmetic work for the buyer, to get a buyer for the home. But that doesn’t play out in a month or a quarter, that plays out over two, three years, something like that. Or the other scenario could be that I feel as likely could happen, prices just stay flat for three, four years because there’s a so-called reservation house price. I know this myself, I believe my home is worth what the highest price Zillow ever posted.

Dave:
Everyone does, right?

Mark:
And I’m going to be very reluctant to sell at a price below that so I might just wait, wait, wait until rates are down, incomes are up enough that I can sell my home at the price I think it’s worth, which is the highest I’ve ever saw in Zillow.

Dave:
I think that from my completely observational and anecdotal consensus analysis of economists, I think that’s what a lot of people think is that prices are going to remain relatively flat and you can restore affordability over time by, like you said, by mortgage rates coming down slowly, by wages going up slowly if housing prices just stay flat, affordability will improve. But like you said, it could also be a combination of all three. So appreciate you giving us your outlook. We know it’s very tricky to forecast this right now, but had to get your opinion. Mark, if people want to check out the great reports you’ve put together or follow your work, where should they do that?

Mark:
There’s a website called Economic View, and there’s a lot of free content there. It’s a paid site as well, but there’s a lot of free content. And I put a lot of the work I do write, I post it on the free side of the paywall, so you can take a look at that. I also tweet @MarkZandi, so feel free. I actually, I got my handle @MarkZandi gazillion years ago. Never used it because I, “Well, what’s this Twitter thing? Why would I do that?” And so I entered in right before all this recent turmoil on Twitter, which I still don’t quite understand or get. But anyway, I actually enjoyed the Twitter. This is going to sound weird, but when I was a kid, we had a teacher who taught us haiku, you know haiku poetry?

Dave:
Yeah.

Mark:
Japanese poetry, and it was very rigid in terms of the syllables and the lines and everything.

Dave:
Yeah, it’s 14 syllables or something like that.

Mark:
I don’t even remember but I loved writing haiku and I love writing tweets. I love it because it’s so therapeutic because you have to get into 280 characters and that really hones what you’re saying. And that really, I think really is quite useful.

Dave:
Honestly, I think the economic conversation on Twitter is something you can’t get anywhere else.

Mark:
I think you’re right.

Dave:
I follow so many different economists and analysts on Twitter for something about the format of Twitter just works really well for this economics financial conversation that doesn’t work on any other social media platform in my mind. So I follow you there, and a lot of the guests that we have here, they’re primarily on Twitter. So if you want to follow Mark.

Mark:
We should start a social media for economics. What do you think?

Dave:
It would be 20 of us, but I don’t know if we’d get the ad revenue from Twitter, but.

Mark:
I don’t know. I like that idea somehow.

Dave:
I don’t know. We get a lot of downloads here, so maybe we’ll get our audience over too.

Mark:
Yeah, I like that idea. Of course, I’m going to be dead wrong, but I still like the idea.

Dave:
Well, you’ve got one follower already from me.

Mark:
There you go.

Dave:
All right, Mark, thanks so much for joining us. We appreciate it and hope to have you back again soon.

Mark:
It was really a pleasure, I really enjoyed the conversation. Thank you so much.

Dave:
On The Market was created by me, Dave Meyer, and Kaitlin Bennett. The show is produced by Kaitlin Bennett, with editing by Exodus Media. Copywriting is by Calico Content, and we want to extend a big thank you to everyone at Bigger Pockets for making this show possible.

For all the recent talk about a possible interest rate easing in 2024 and the low likelihood of a severe recession, people are still feeling pessimistic. The Fannie Mae Home Purchase Sentiment Index for November is out, and it paints a general picture of low confidence among both homebuyers and home sellers. 

As interest rates began to climb in 2022, consumer confidence in the housing market began to plummet, reaching their lowest levels by late 2022. Confidence stabilized somewhat in 2023 but quickly reached what Fannie Mae is calling a ‘‘low-level plateau.’’

Fannie Mae measures home purchase sentiment by collecting data from its questionnaire. The questionnaire, which uses responses from 1,000 adults (aged 18-plus) who are household decision-makers, has several components, including people’s perceptions of whether right now is a good time to buy or sell, concerns about the job market, and expectations about interest rates.

Economic Uncertainty Means a Muted Outlook

The November result is not encouraging for real estate investors. While the mood is not quite as gloomy as it was last year—the overall index is up 7 points year over year—there clearly is a long way to go before consumer confidence in the housing market is restored in any meaningful way. 

The most stark figure in the index is the meager 14% of respondents who believe that now is a good time to buy a home, which is a new survey low. This incredibly low number is, of course, tied in with respondents’ increasingly downbeat expectations about the interest rate trajectory, as well as their own purchasing power, as unemployment continues to climb and the economic outlook remains uncertain.

Doug Duncan, Fannie Mae senior vice president and chief economist, points out in a news release that at the end of last year, as interest rates reached 7%, ‘‘a rate level not seen in over a decade, a plurality of consumers said they expected home prices to decrease; however, that optimism faded over the course of 2023.’’

Currently, 22% of survey respondents think that mortgage rates will go down in 2024. That’s an increase of 8% from the month before, but this optimistic outlook is still seen in the minority of respondents, with the majority thinking that rates will either go up further (44%) or stay the same (34%).

Add to this the fact that 24% of those surveyed believe home prices will go down, while the majority again believe that home prices will continue going up or will stay the same, and the overall picture becomes clear: Right now, consumers simply don’t believe that affordability will improve. 

To top it off, most consumers are experiencing stagnating or declining household incomes, with 68% saying their income has stayed about the same and 12% reporting it was significantly lower than before. Only 19% said their income significantly increased.  

What People on the Ground Are Saying   

No one should be surprised that people who are losing confidence in their financial stability while witnessing continually increasing home prices and interest rates don’t have much faith in their ability to buy a home—or are reluctant to put their current home on the market. 

We spoke to licensed real estate agent Erin Hybart, who says that in her experience, sellers “are hesitant to list if they do not have to sell because they know buyers are stretched thin financially with higher interest rates. There’s also worry about affording the mortgage on their next house and the interest rates at the current level.‘’

However, Hybart is noticing a somewhat different attitude among buyers who are ‘‘still in the game, often grabbing deals from motivated sellers or on outdated houses.’’ Those who really want a home of their own are still trying to get one—they’re just smarter about it, and they’re prepared to compromise on size.

This is actually good news for real estate investors and house flippers. Hybart points out: ‘‘Now’s a good time to buy smaller, fixer-upper homes, as there’s a growing demand for move-in ready, smaller houses as housing affordability declines.’’

Realtor and chief lending officer at New Jersey-based Approved Funding Shmuel Shayowitz also tells BiggerPockets that his on-the-ground experience isn’t as bad as the report makes out, adding, ‘‘My clients are starting to get more active in the market with the recent rate drop.” 

Whether the Fed will drop rates next year, as is widely speculated, remains to be seen. If rates do begin to come down next year and the U.S. avoids the much-talked-about recession, consumer confidence in the housing market is very likely to bounce back. 

And if rates don’t go down? LA-based Ashby & Graff Real Estate CEO John Graff offers BiggerPockets readers a word of tough wisdom: ‘‘Buyers and sellers will have to get used to our new normal.’’

The Bottom Line

Has the housing market been increasingly difficult to navigate? Without a doubt, both buyers and sellers know this. However, the desire to own a home is likely to eventually override all misgivings for many people. Investors who can offer a value-for-money, ready-to-move deal in local markets where demand for single-family homes is high may still be in luck despite the current pessimism. 

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Bess Freedman, Brown Harris Stevens CEO, joins ‘Squawk Box’ to discuss the luxury real estate market, what to expect in 2024, and more.

Inflation broadly impacts the overall economy, causing the prices of goods and services to rise. This can have rippling effects across various sectors, including the real estate market. 

Real estate investors, homebuyers, and home sellers need to understand how inflation impacts the real estate market. This can help them make the best decisions when buying and selling real estate. 

We’re here to explain what causes inflation, its impact on real estate, and how real estate investors can benefit even when inflation is high.

Understanding Inflation and Its Causes

When your dollars don’t buy as much as they did in the past, it’s because of inflation. An increase in the money supply and debt is the ultimate culprit of high inflation. 

Over the years, the central bank has significantly increased the money supply. Because of this, there are more dollars to go around. Ultimately, this means companies selling goods and services can charge more for them, as people technically have more money to spend, although incomes usually stagnate for inflation to happen.

An economy that isn’t growing, or at least isn’t keeping pace with the growth in the money supply, results in inflation. Companies can’t necessarily produce enough goods to keep up with demand, allowing them to charge more for what they can produce. 

To keep inflation in check, the Federal Reserve often increases interest rates. This can help reduce consumer spending and lower rampant inflation. 

As people spend and borrow less, companies can replenish and build up supplies. However, it can take several years for the economy to neutralize or grow after a period of high inflation.

What Happens to Real Estate During Inflation?

For real estate, inflation typically means you’ll pay more for a home. Your dollars aren’t worth the same amount today as they were last year. So a house that cost $400,000 a year ago could cost $450,000 today. If interest rates are also high, this means a significant increase in what you pay for a property. 

On the other hand, if you already own property, you could see higher equity during periods of high inflation. While equity is good for your bottom line, inflation can be challenging if you want to add assets to your real estate portfolio.

Real estate as an inflation hedge

Many real estate investors will tell you real estate is a good hedge against inflation. The reason for this is often because of rising interest rates.

Let’s say you buy a home when interest rates are at 5%, and two years later, interest rates go up to 7% because of inflation. In this case, the mortgage you got with a 5% fixed interest rate is going to have a lower payment than if you get a mortgage with a 7% fixed interest rate. A higher interest rate, combined with a higher purchase price, makes real estate less affordable.

You might have to hold real estate long term if you want to use it as a hedge against inflation. Often, a volatile real estate market can create short-term corrections that affect the price of real estate. This may quickly change the value of a property. 

Because people have less disposable income, investors might have to drop the price of their properties to make them more affordable. Being able to hold a property longer means you won’t have to sell if the market takes a downturn. 

Having real estate in your investment portfolio can help mitigate losses from other assets that inflation affects more drastically, such as stocks and bonds. Because home prices usually outpace inflation, they tend to rise even when the economy is experiencing a rough patch. Rental income from real estate investments keeps up with inflation historically. This means investors can continue to receive passive income regardless of inflation.

Real estate construction costs and inflation

Construction materials cost more when inflation is high. This results in higher costs to build new homes and remodel or rehab existing homes. 

Builders are less inclined to start new construction projects during periods of high inflation. Investors could see an increase in the price of their properties because of this. A property becomes more valuable when there’s less inventory available.

However, builders may have to reduce prices for new homes in their inventory if high interest rates keep them on the market too long. When prices for new homes fall, it affects other real estate in the area. If comparable homes in a neighborhood where you own property drop in price, it makes your home worth less to potential buyers. 

New construction often requires builders to borrow money to complete the project. High interest rates can deter construction companies from building new homes. While this may drive up prices on existing homes, low housing inventory can fuel inflation. This may not affect the real estate you currently own, but it could make buying new properties more challenging.

Real estate investments and the effects of inflation

Rental property isn’t the only type of real estate inflation affects. 

Commercial real estate is another area for investors to consider during times of high inflation. Business owners who rent or lease commercial space face an increase in operating costs. There’s also a higher potential for their rents to go up when inflation is on the rise. Those who own commercial buildings may see more vacant space if businesses have to downsize or close because they can’t afford to pay these higher costs. 

It’s also important to consider the increased costs of materials for making repairs to a commercial building. If you put off making repairs while you wait for inflation to come down, you risk allowing your building to fall into disrepair, lowering its value. On the other hand, there may be a reduction in new construction for commercial buildings, which can increase the value of buildings that already exist. 

Benefits of Real Estate Investing During Inflation

Despite higher interest rates and tighter lending requirements, investing in real estate during inflation has some benefits. For instance, you can build equity in an investment property soon after buying it. While the price of real estate varies, overall, it only goes up. So, in terms of real estate, buying sooner is always better, especially when you plan to hold it long term. 

Another reason to invest in real estate is that interest rates could continue to rise. The higher interest rates climb, the less affordable housing gets. You can refinance your high-interest mortgage if interest rates come back down in the future. And you’ll have been building equity with each mortgage payment you make.

Rent often rises when inflation does, so you can increase your passive income by investing in real estate during inflation. Additionally, the demand for rental property tends to increase during times of inflation because borrowers have a harder time getting a loan or don’t want to pay the higher interest rate on their mortgage. This creates an excellent opportunity for investors who have the capital to buy property when inflation is high.

Final Thoughts

Inflation means the costs for goods and services are up compared to previous months, and incomes aren’t keeping up. What happens to real estate during inflation can have a big impact on investors. Increases in interest rates can make mortgages less accessible. A decrease in supply means fewer options when looking for investment opportunities. 

But there’s a bright side. Real estate investors can take advantage of higher rents that result in an increase in cash flow. Plus, having a diversified portfolio that includes real estate can help mitigate losses, as real estate prices typically go up during inflation.

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Dave:
Hey everyone. Welcome to the BiggerPockets podcast. My name is Dave Meyer and I’d like to start by just wishing you all a very happy New Year. This is going to be a very fun episode of the podcast where we’re going to be talking about some of the best markets to invest in in the United States. And in order to do that, I have brought my friends and co-hosts from the On The Market podcast to join us. First we have Kathy Fettke joining us. Kathy, tell me one of your New Year’s resolutions this year.

Kathy:
Oh man. I would say it’s to watch less Outlander before bed.

Dave:
What is Outlander?

Kathy:
I started watching it because my mother-in-law’s dream was to go to Scotland and so Rich and I are taking her to Scotland and I heard there’s a whole tour in Scotland for Outlander. It’s a show on, I don’t know, Scotland. So now I’m addicted, but then what happens is I stay up too late watching it and then I don’t get up early enough and I love getting up early, so I just need to limit it. I just need to back off a little bit of Outlander.

Dave:
I’ll be honest, I was expecting a real estate related New Year’s resolution but each of us have to have our own goals. So if you are trying to watch less Outlander, we are all here to support you in that resolution, Kathy.

Kathy:
Well, it is real estate related because then I’ll get to bed earlier and get up earlier and be able to focus more on real estate.

Dave:
I like it, better mindset. All right. Henry Washington is also joining us from Northwest Arkansas. Henry, what’s one real estate resolution you’re working towards this year?

Henry:
Oh, Kathy, Outlander is such a weird show.

Kathy:
It is weird.

Henry:
My wife watches it and maybe I just catch it at the weirdest parts but I’m like, “This is a little too much for me, a little too much for me.” My New Year’s resolution is to finish my resolution from last year. So last year I made a goal to lose a hundred pounds and I got 65% of the way there, and so I’ve got another 35 pounds that I need to lose in 2024.

Dave:
Damn, man. You should be very proud of yourself. 65 pounds, that is very, very impressive.

Kathy:
That is.

Dave:
You look great. Last time I saw you-

Kathy:
You look great.

Dave:
… you do look great and we’re very proud of you.

Henry:
You can keep saying that actually. It’s fine.

Dave:
Again, you’re both are just sort of failing on the real estate goals, but I really support you in your resolution. Maybe James Dainard, our last co-host from Seattle. What is your resolution? You got to give me something about real estate.

James:
Well, I will say the last New Year’s resolution we talked about on our podcast, I didn’t even make it one day. It was to quit Rockstar. I think I just kept going, so I failed. I failed at that. I’m not putting that back on the agenda. Well, my New Year’s resolution is always to just do more deals. My goal is to get our volume back to 2021 levels because they were just a… We were just running hot and obviously 2023 was a lot flatter. We’re probably down 30%. So I want to get it back up to that magical 2021 volume of sales.

Kathy:
And yet I spoke with you yesterday and you said you also wanted to slow down a little.

James:
I know.

Dave:
I don’t believe it. That’s like his Rockstar resolution. It’s just complete nonsense. He’s just completely lying.

James:
Yeah, Kathy caught me on a moment. I was in between two different things at the moment, but then you just keep going. You chug a Rockstar and you’re back on it.

Dave:
So these things are related. Okay, I get it.

James:
Yeah, peaks and valleys.

Dave:
For me, my resolution is if you follow the On The Market podcast or know anything about me, I live in Europe and I’ve invested almost entirely passively over the last four years and my resolution is to start a buying again directly single-family, small multifamily deals in the US. I’m going to tour a couple of markets in the first couple of weeks of January to pick where I’m going to do it and I’m very excited to jump back into that part of my real estate portfolio. And with that is a good transition I guess to what we’re talking about today, which is some of the best markets to invest in in the United States. And we thought a really fun way to present information about good markets is to follow the four teams that are in the NCAA college playoffs right now. So each one of us here on the show is going to represent one of the towns and colleges in the playoffs.
So James is going to be representing Seattle and the University of Washington. Kathy’s going to be representing Texas at Austin and the Longhorns. Henry, the Crimson Tide for Tuscaloosa, Alabama and I will represent Ann Arbor, Michigan for the University of Michigan. And I want you guys… We’re doing this because it’s a fun way to talk about markets and to debate about which different metrics are the best and the most important.
But as we’re talking about these things, think about the different metrics and the ones that are most important to you and your strategy. The thing that I think we would all agree on despite the debate we’re about to have is that different markets work for different people. There is no such thing as the best market in the United States. It’s really about which market works for you. So as we talk about these things, just take notes of which metrics, which points that each one of us make that are applicable to your situation and then go use them when you do market research and make decisions about your deals. So with no further ado, let’s get into our first market. Let’s start with James because he gets the easy layup and we’ll just let him roll off some stats and talk about his own backyard first. So James, first tell us a little bit about the Huskies. What do we got to look for in the games today about the Huskies and then tell us a little bit about Seattle as an investing market?

James:
Well, not only is Seattle the best investing market, the Huskies are the best team this year. They’re the number two ranked 13 and 0 and this is the final year of the Pac-12, which is kind of sad to me because I grew up watching Pac-10, Pac-12 football, and now it just got obliterated and this is its last year, so we’re hoping we win the final championship game and they’re going to smash Texas on Jan. 1 and I do plan on going to the championship game in Texas, so I’m excited to go.

Dave:
James, do you have a ritual for watching the game? This episode comes out on the first. We’re obviously recording it beforehand, but you will be watching the game while everyone is listening to this. What do you do to support your Huskies?

James:
Well, I mean, as soon as you put your underwear on, you got to put your gear on too. So it’s hats and jerseys right away. I will say my Seahawk rituals are a lot more aggressive, but you just got to rep them. And so I’m actually going to be in Australia randomly, but I will be repping the W throughout on all continents.

Dave:
All right. Well, that’s an image for everyone to think about during the game today, James. But why don’t you tell us about Seattle as a market. Obviously, this is your backyard where you have built your entire career. So tell us a little bit about why Seattle is such a great market for you and what strategies people listening to this might want to consider.

James:
Yeah, I mean, Seattle… Not only the Huskies the best team, Seattle is probably the best market that I know to invest in. And I know they go… I hear a lot. They’re like, “Oh, it’s expensive. The landlord laws can be tough,” and those are all true things, but it is an amazing city to invest in in general. To give you a quick background what it is, there’s over four million people and the unemployment rate is 3.9%. What makes Seattle so good to invest in is the median income is 97,000 and in the tech space it’s more like I think around 120,000 and we have a lot of condensed, very well paid, very well employed workers, and the median home price is only at 699, 750. So for the income that’s being brought in, it’s actually somewhat affordable. But the reason it’s such a great market, we have built an amazing portfolio. We can cash flow it at 10 to 11% cash on cash returns every year.
We do this and the reason that it’s such a great market to invest in, it’s a heavy value add because what we have is we have a booming city where the tech is expanding. The reason the tech is expanding is because we have no income tax in our state. And as these tech companies in San Francisco have to start competing with Amazon, right? Our two big anchors are Microsoft and Amazon, our big tech hubs. What’s happened is Google, Apple and everybody else had to come to our city because they can’t compete with the wages because anytime you’re making over 13% more than California, people’s quality of life automatically goes up. So it’s a booming city and we’ve seen a lot of growth and the growth is going to continue.
The tech expansion throughout the market is massive. Microsoft is building a 10-year campus build-out. Apple’s investing in their campuses, Google’s expanding their campuses. That tech money is real money that’s coming in and building infrastructure. But not only can you make high cash on cash returns if you are into value add, we also make an average of 35 to 40% on our flip properties and dev deals. So it’s a high, high return business.

Henry:
Well, James, one thing I can’t agree with you on is I also wore Husky underwear, but that’s because it was the Fat Kid brand and that’s what I wore when I was a kid. Other than that, I think what you meant to say was that Seattle is a great investment market for people who already have money. I mean, the prices are expensive and that means you’re going to have to put a down payment down and 20% of $200,000 in the Midwest somewhere is a whole lot easier than 20% of $550,000 for a fixer-upper. So I think you have to get pretty creative if you’re a new investor who doesn’t have a lot of money to be able to jump into a market like Seattle and take advantage. I agree. The margins you have, man, I get jealous when I see your profits and your proceeds on a flip because you’ll make on one flip what takes me like four or five to make, but it seems a little riskier as well. So Seattle scares me.

Kathy:
Yeah, I agree. I mean, Seattle’s a great place to invest 20 years ago. I wouldn’t invest there unless I were James Dainard and really knew how to do it or if there were little pockets outside that are growing or yet to be discovered, perhaps that could work. But the people I know, Tarl Yarber for example, he’s not doing the buy and hold, and I’m a buy and hold investor, so I don’t think it would work for me.

Dave:
James, what do you say to that? Do you think regular people can jump in?

James:
Regular people can jump in. We work with clients all day long that are regular. It works for any types of price point just because certain pockets of Seattle are expensive, that is for sure, but there’s also very affordable pockets too. You can flip a house and buy it for 350,000, sell it for 499. You can buy rental properties in the 350,000 and they just need a little bit more work. The beautiful thing is about being in an expensive market though or more expensive market with the big equity positions, it allows you to leverage more, so you don’t need this… Even though the pricing’s bigger, you can get deeper discounts with bigger equity positions and so you can stack your leverage if you want. And as an investor, it’s about figuring out that market. The first deal I ever did, I had to take a hundred percent financing on and pay for it, but it gave me so much equity, it gave me the gunpowder. I could start rolling it from there. So that first deal can give you that cash to grow very quickly.

Henry:
You heard it here folks. James Dainard is going to give you the cash for your first deal in Seattle, Washington to get you started.

James:
And remember what I said, I paid a lot of money for that money. You vary the rates.

Dave:
All right, James, you’ve done a decent job defending yourself, but I think all of James’s problems, James’s opinions are a little biased given that he’s only ever invested in Seattle. So let’s go to a different part of the country, one that has been really in the center of a lot of news over the last couple of years. Kathy, you’ve got the University of Texas at Austin, Texas. Tell us a little bit about the team. I’d love to hear your recounting of what the team is like and then tell us about the market.

Kathy:
Well, listen, if I were 17 years old, I would definitely consider going here. The team is the Longhorns of course, record 12 to one, win probability of college football playoffs at 25%. James is shaking his head.

Henry:
James has no chance.

Kathy:
Austin is cool, Austin is weird. That’s what they say. It’s a great place to invest for the long term. It’s been the darling of real estate investors for years and right now it’s a buyer’s market. And realtor.com just came out and forecast that for 2024 actually prices will… Their forecasting will continue to decline. They said 12%. So is it a good time to buy right now? Well, if you can get a great discount better than 12%, probably. But I think Austin will be a great place to get to know and understand because prices appear to be coming down. They have in the city and in the Red Rock area come down about 10%. As I understand it, some markets probably even more. So this is a city that is growing. It’s the new Seattle. Sorry, James, but you’ve got Google, Tesla, Amazon, Apple. You’ve got SpaceX, Meta expanding billions and billions of dollars coming in there.
Just Elon Musk alone with Tesla’s bringing in 10,000 jobs and if you heard him on his other recent podcast, he says that brings in six X that or whatever because then there’s all the services needed. So Austin’s not slowing down in growth, it’s just that prices went up so dramatically over the last few years that it’s tapering off coming down, and that to me says there could be a buying opportunity in 2024 and would be a good time to really get to know the neighborhoods. Now if you’re going to go and move there and hold, great. Especially if you can get a duplex or a fourplex, rent those other units out and hold it for the longterm, I do believe that Austin… Right now, the median home price is $459,000 compared that to Seattle, which was 699,000. I really believe Austin is the new Seattle. Again, sorry, but I think there’s room for growth just not next year, not in 2024.
But when prices are down, it’s a buyer’s market. You want to buy in a buyer’s market. So many times people get this confused and want to buy in a seller’s market when everybody’s buying and the seller has the power. Right now you have the power. So I would keep an eye on Austin. You’re still not going to cash flow as well as some of the other cities that are also growing in Texas. That’s why we focus on Dallas where the median home price is lower. We’re looking at San Antonio. The market, that whole area between San Antonio and Austin is going to be one metro area like San Jose and San Francisco where that just all grew in. I think that’s going to happen there between San Antonio and Austin. So lots of opportunity if you buy right and can hold it maybe good for flipping if you know the market well and not maybe this year but in the years to come.

Dave:
Poor, poor, Kathy. We’re giving her the number one biggest correction market in the entire country to try and defend right now and you’re doing a very admirable job of it. I will give you that. But-

Kathy:
Thank you.

Dave:
… I’m just joking because there is this kind of weird dynamic right now where with many of the markets that are seeing the biggest corrections also have some of the long-term best fundamentals, like the best population growth, the best economic growth, the best job growth. So it is actually an opportunity, I’m just kind of teasing you, but I do think it’s one of those markets that you have to be pretty careful with.

Kathy:
Yes.

Dave:
Kathy, if you were moving to this market, you said flipping. Are there any other strategies you think people should consider?

Kathy:
If you’re in California and you’re moving to Austin, it’s still super cheap. So I see people doing that and I have friends doing that and they’re buying homes that they can fix up and they’re going to live in for a while and I think they’re going to do really well, especially if you’re buying in some of these areas where all that growth is happening, which is kind of everywhere honestly.
So yeah, if you’re looking to live there, I think you’re going to do well over the long term if you’re looking to build something potentially. Honestly, I wouldn’t do it in 2024. I would do towards the end because like I said, realtor.com came out with their 2024 housing forecast and it’s not looking good for Austin in terms of prices. It looks like it’s still coming down, but we also saw mortgage rates come down, so who knows? Who knows? You got to know. It’s just like James said. He’s making it work in Seattle. If James can make it work in Seattle and you know Austin well enough, I tell you right now, there’s listeners and I’d love to hear it in the comments. I want to hear from you guys. There’s listeners who are making a ton of money in Austin. They just know it well enough to be able to make that work.

Henry:
I agree. I think it’s a different investment mindset with a market like Austin because what Austin’s going to be good for is like real wealth accumulation. If you can get in now and negotiate a really good deal because of the rates are high and there’s not a lot of competition, people who are selling now need to sell or else why else would they be doing it? And so if you could get in, find yourself something now and maybe it doesn’t make you a ton of money over the next one to three years, maybe it doesn’t make you much at all, but if it’s going to increase in value by 50, 70, a hundred thousand dollars over the next five years because as rates drop and demand goes up, people want to live in Austin because it’s cool and it’s fun and there’s huge amenities and for all that cool and fun, you get it at a more affordable price than living in a coastal city.
And so there’s any place that’s got a reputation like that people are going to want to move to and they’re going to want to own homes. And so if you’ve bought some of these properties now when you can get in at a good price and capture that appreciation, real wealth is built through appreciation and debt pay down over time. So it’s more of a long-term play. You’re not going to get month over month phenomenal cashflow in that market unless you are a market expert and know where exactly what pockets you can go do that in. So it’s just a different strategy, but that doesn’t mean you can’t make money there.

Dave:
All right. So James, has Kathy convinced you that Austin is the new Seattle and are you going to pick up shop and start flipping homes in Austin?

James:
Hey, I do like Austin and part of the reason I like Austin too is it was a little bit more of a bubbly market and so it’s getting more overcorrection. So I do think that the market’s in a little bit of a panic still there. So you can get some good buys and the market’s scared. There is some goodbyes there. I agree with Kathy on that, but that’s the reason why Seattle is actually better than Austin. It’s less bubbly, it is less… I’ll be honest, it’s a less cooler place to live. And so during the pandemic they saw way more surge in population than Seattle saw because it was a cool, swanky place to live.
And I get it, Austin is a really cool city. I like going there. I would invest there but Seattle’s a lot more stable. We didn’t get the surge because Seattle’s just a little bit rainier. It doesn’t have that same coolness of it, but the stability is why I like Seattle a lot better than Austin. And speaking of which though on the football, how did Texas be 12 and one and they’re favored to win? Everyone’s always hedging against Seattle. They gave us a 12 1/2% chance and Texas has a 24% chance. We’re going to see how this goes, but I guarantee you that the Huskies will win and I also guarantee you that Seattle will make you more money.

Dave:
You’re going to guarantee it with your own money, James? If someone loses money, you’ll reimburse them?

James:
Actually, I don’t want to ever guarantee a return. So come find us and we’ll help you out through the process.

Henry:
SCC has entered the chat.

James:
Yes, that is not a guarantee.

Dave:
We’ll add a disclaimer at the end of the show.

James:
Stability is key and Seattle has proven over the last 18 months it’s a much more stable market.

Dave:
All right. Well, Kathy, thank you for bringing that information for us. So far, James has represented Seattle and his hometown favorite and his alma mater, the Huskies. Kathy represented the University of Texas and the Longhorns. Now Henry, we’re moving to your neck of the woods with the University of Alabama. Tell us about the Crimson Tide and Tuscaloosa.

James:
Alabama. Yeah, man, this is right in my… I live in essentially a market that’s pretty similar to Alabama being Fayetteville, Arkansas. Mostly a college town but what’s cool about Alabama is there’s a lot more market dynamics than just the college. When you look at the economy in Tuscaloosa, Alabama, not only do you have the University of Alabama there providing tons and tons of jobs, but you’ve also got the healthcare system in Alabama, and Mercedes has a manufacturing plant where they manufacture a lot of the SUVs from Mercedes in Alabama. So there’s lots of jobs to go around. You’ve got a fairly affordable median home price of just over $200,000, but what’s cool is you’ve got a median rent of $1,600. So that’s a pretty good rent to purchase ratio and it’s got some of the lowest… It’s got lower vacancy rates than the national average.
I’m sure a lot of that has to do with college or student housing, but when you couple the average salary, well, the average salary is just under 55,000 a year. So when you couple an average salary on top of good jobs, population growth that’s growing year over year with a pretty decent median rent price and a pretty low average home price, it’s a great place where you can actually buy properties that not only are going to cashflow, but they’re going to stay rented with lower vacancy rates, meaning… And with lower vacancy rates, that just means there’s less competition. If something’s on the market for rent, it’s typically going to get rented. And so you’re able to know that I’m going to have tenants consistently that are going to pay a good rent that’s going to cover my mortgage plus my expenses. I’m going to have great people with great jobs in more than just one industry.
And so yes, it is not a sexy place like… Excuse me, yes, it is not a sexy place like Seattle or Austin, but there are still plenty of fun things to do. It’s a college town. Trust me, I’ve been to an Alabama football game. Them people are not short of having a good time out there. There’s plenty of good times to be had out in Tuscaloosa, Alabama. So I think it’s a great place to invest your money. It’s got great fundamentals and market dynamics.

Kathy:
Yeah, that sounds like my kind of market. Look at that, median home price, 208,000, median rent, 1,600. Those numbers work, especially if you’ve got student housing and could rent per the room. I haven’t done that, but boy I bet it could be lucrative. So I’m going to thumbs up.

Dave:
I like this one because it’s actually a college town. Obviously, there’s giant universities in Washington and Seattle and in Austin, but I’ve never been to Tuscaloosa but we did another show where we were representing markets and I did some research into Tuscaloosa and it does really feel like sort of the engine of that city. Henry mentioned there’s car manufacturing, there are other industries, but it does really seem centered around the town and that there’s a lot of attractions around the university. They’re building arts facilities there. And given the spirit of the show talking about what the best college town is, I do like the idea of a place that is really sort of fueled by the university itself. Henry, tell us a little bit more about the game. How much fun did you have?

Henry:
Well, I mean, it was a good time had by all. We did some partying before the game and then we went to the game and I don’t know if you know much about Alabama as a football team and Arkansas as a football team, but we don’t really do well when we play them. So we weren’t at the game the whole time because we were having more fun at the places we were at prior to the game. So we hung around, we cheered, the game was over by halftime and we went back out and drowned our sorrows.

Dave:
That sounds about right. Well, I’m glad you at least enjoyed yourself. All right. Well, so now we’ve gone through Seattle, Austin and Tuscaloosa, Alabama. So we’ve sort of had two more expensive markets but great strong fundamentals, a lot of economic growth. Then Henry brought us Tuscaloosa, which is more of a college town, a big city. It’s almost got 278,000 people, so a big city but a much more affordable city.
And the last market that we’re going to be talking about today, I will be bringing you, which is Ann Arbor, Michigan and the University of Michigan with the Wolverines. And I got to tell you guys, I am very excited that Kailyn, our producer assigned me the University of Michigan because I have been to a grand total of one college football game in my entire life. And while I went to some D-III games at my college, but a D-I college game and it was at the University of Michigan. I was a sophomore in college and I drove to see some friends and using Henry’s evaluation technique of how much fun you had at the party, I’m convinced that Ann Arbor is the single best real estate market in the entire country because we had a very good time at that college football game.
But really Ann Arbor is actually a very interesting market. Sort of similar to Tuscaloosa, it’s really centered around the university but has a pretty big population. It’s 366,000 and it’s actually one of the biggest universities in the entire country and has pretty good fundamentals. So it’s a high income place. The median income is nearly 80,000, but the median home price is only 381,000. So if you compare that to just absolute garbage markets like Seattle where their median income is higher, it’s, yeah, 97,000 but their median home price is 700,000. So the rent to price ratio in Michigan is a lot better. It’s actually growing this year. We’ve had price growth of 3%, which is certainly better than Austin, which is just crashing right now. And we also have a solid rent growth. So from where I’m sitting, not only is the University of Michigan the best investing town, but it also is the favorite to win the college football playoffs with a 38.5% chance of winning. So I’m feeling pretty good about Ann Arbor right now.

James:
Michigan is my second favorite college football team and I will rep them. One of those cherished items I have in my house is a signed national championship hat by Charles Woodson. And so I do rep the blue, but as far as investing goes, I think the big point that Henry and Dave are missing on their affordable markets, I get it, they’re really good for cash flow. There’s great rental metrics. You can do well on cash flow if that is your plan and goal.
But even if you’re getting your cash flow and you’re making $500 a month on a unit on a single family house, that’s great cash flow, that’s six grand for the year, on one deal in Seattle, I can create a hundred thousand dollar equity position. Once I’m done renovating it, it’s going to take 18 years for both of your markets to catch up after 12 months with the equity position we’re going to gain. And that’s why I like Seattle over Ann Arbor and over Alabama. You can get 20 years of cash flow in nine months by just strategically adding value to that building.

Kathy:
Yeah, I would agree with that.

James:
Get the juice.

Kathy:
They’re just two different worlds, right? If you are trying to grow wealth, you’re not going to do it in markets that don’t grow in equity, but you will get cash flow. So it just depends on where you are. If you are wanting cash flow now and some people do, some people have already made their equity. They want to invest it and just live off the cash flow. And if that’s you, that could work or if you just don’t have a lot of money. At $200,000 property is going to be a little easier to get into than a higher priced one. So again, it just depends on where you are in life, but if you’re trying to make equity, be in equity markets, not in cash flow markets.

Henry:
Dave, I’m not going to argue too much with you here about Michigan. I think Michigan as a state in general is a pretty slept on real estate market that has great fundamentals outside of even Ann Arbor. It’s a place where you can really, really get some cash flow and then in markets like Ann Arbor and some of the other more popular areas in Michigan, you can get cash flow and depreciation. And a lot of people just don’t think about Michigan as a state to invest in because it just seems to be one of those states people forget that’s a state, but it’s also you’ve got… It’s the weather. I think people see it as this cold weather place and they don’t want to live there and so they don’t think about it from an investment standpoint. But Michigan in general, I think, is super slept on. Great market fundamentals. If I didn’t have such a good real estate market, I would be looking at markets like Michigan and Ohio, these cold weather states that have great dynamics.

Dave:
Well, thank you, Henry, for supporting me. I really appreciate that. Now that we have the information for all four college markets, I want us all to vote. I know we are representing the city that we were assigned, but I’d like your honest opinion. We all know what James is going to say. He’s going to say Seattle but-

Kathy:
That’s easy.

Dave:
… let’s just give him the opportunity to say the obvious. James, go ahead.

James:
Go Huskies, Seattle. I know what I know and I’ve lived what I’ve lived and I can tell you, it makes huge impacts to be in this major metro city.

Dave:
All right. So we’ve got one vote for Seattle. Kathy, are you sticking with Austin or where would you vote?

Kathy:
I really am. This is one place I might even be okay with negative cash flow. Not really but Austin is booming and the real estate prices aren’t right now, but they will, they will over time. So if I had to choose between the four, it would be Austin. If I didn’t, I’d be right outside of Austin and maybe some of the other Texas cities.

Dave:
All right. Wow, two homers so far. Henry, what do you got?

Henry:
I’m going to give two answers and neither one of them is the market that I represented. So if I was thinking now in my current investment journey where I’ve already built a portfolio, I have income coming in from not just real estate but other parts of businesses that I own, it’s not just about cash flow anymore for me. It’s more about true wealth creation, equity, appreciation, and tax benefits. And so I would look at Austin and get in and start buying really good deals even if they negatively cash owed for me. If I got to feed a deal a hundred dollars a month but that deal is going to increase in value by 20, 30, 40, $50,000 a year and that deal is going to offset my tax bill by 40 to $50,000 a year, I mean, I’m going to get way better appreciation there than I am in my current market.
And so if I had to choose one of the four as an investor that the place that I’m at right now, I’m going to look at Austin. If I was a new investor and I was getting in the game and wanted to get my feet wet, wanted to get some cash flow, wanted it to be more affordable, less risky, I’m probably going to look at the Michigan market. I just think the fundamentals are great with the population, the economy, the average rents and the entry price for the homes. I think you’re going to get a little bit of… You got to a little bit of everything, a little cash flow, a little appreciation. It’s not a ton of risk, much safer play.

Dave:
All right. Well, I’m voting for my own, which is Michigan, and this is actually genuine as well because of what Henry just said. The way where I am in my investing career, I do still want to get appreciation, but I’m looking for at least modest breakeven cash flow so that I don’t have to feed any money into it ideally. And so when I’m looking at Michigan, I really like that. I like Alabama too because I like those cities that they’re really have consistent demand due to the college atmosphere. You’re always going to have professors, you’re always going to have students. There’s always going to be a little bit of tourism, people coming into these types of places. So I really like that. So I don’t really know where this puts us because Henry voted twice.

Kathy:
No, Henry said Austin first. Austin wins.

Dave:
You’re just more convincing than I am, Kathy, so we’re going to let Austin win. I think that’s a good market.

Henry:
You’re a smart man, Dave.

James:
You know what, good for Austin.

Dave:
It also has excellent food and I like hanging out in Austin, so I’m willing to give it to you.
Hopefully this information helps you understand these four particular markets, but I think more importantly, we do these types of shows to help you understand how to think about different markets. Most markets in the United States can make money for investors really in any type of conditions. Just look at James, right? He is investing in a very expensive market and doing it very, very well. You look at other people who are investing in less expensive markets like Tuscaloosa and are probably also doing really well given their personal situation. And so we hope that these types of shows help you understand where you are and trying to align the right types of markets, the right types of strategies for where you are in your investing career. If you like this show, please share it with a friend or give us a good review on either Spotify or Apple. Thank you all so much for listening and we’ll see you for the next episode of On The Market.

Kevin Maloney, Property Markets Group CEO, joins ‘The Exchange’ to discuss real estate, top housing markets and outlook.

Low-cost properties are appealing because you can acquire and generate income with less initial capital. However, they are actually the most expensive way to achieve and maintain financial freedom. Here’s why.

What Determines Prices and Rents?

Real estate prices and rents are driven by supply and demand. When the number of sellers equals or exceeds the number of buyers consistently, property prices remain low. If prices do increase, the rise will be gradual. Furthermore, when prices are low, more people can afford to buy, leading to fewer renters. This results in stagnant or slowly increasing rents.

Where there are consistently more buyers than sellers, property prices are higher, and rents and prices rise. In the right locations, rents outpace inflation.

Here are two (of many) indicators of a location where rents and prices are likely to keep pace with inflation:

• Significant, sustained metro population growth: Only when the population increases rapidly will demand for housing be enough to raise prices and rents at a rate that outpaces inflation. 
• Low crime: On average, a corporation lasts for 10 years, while an S&P 500 company typically survives for 18 years. This means most nongovernment jobs your tenants currently have may disappear in the foreseeable future. In order for your tenants to sustain their current rent level, new companies must set up operations in the city, offering jobs with similar wages and requiring similar skills. High-crime cities are not typically chosen for new business operations. Without these replacement jobs, your tenants may be forced to accept lower-paying service sector jobs. This could lead to a decrease in rent or, at best, limit potential rent increases. 

Capital Required to Reach Financial Security

To replace your current income, you will likely need multiple properties. The capital required to purchase the properties depends on the appreciation rate.

Low appreciation cities

Cities with a low appreciation rate have low prices due to limited long-term housing demand. With a low appreciation rate, you can’t use a cash-out refinance to buy additional properties. Therefore, all the funds required to purchase multiple properties would have to come from your savings. 

An example will help. Suppose each property costs $200,000, and you need 20 properties to match your current income. Assuming a 25% down payment, how much must come from your savings just for the down payments?

Total capital from savings: 20 x $200,000 x 25% = $1,000,000.

High appreciation cities

Suppose you purchase property in a city with high appreciation. You could then use cash-out refinancing on existing properties to fund the down payments on future properties. 

Another example: Suppose each property costs $400,000 and you can use a cash-out refinance for the down payment on the next property. In this case, the total capital required from savings to purchase 20 properties will be:

Total capital from savings:  $400,000 x 25% = $100,000

The question then is how long you need to wait in order to accumulate sufficient equity for a $100,000 down payment. In the following calculation, I will assume a 7% appreciation rate.

The formula for future value:

Future Value = Present Value x (1 + Annual Appreciation %)^Number of Years Into the Future

Here is the net investable capital after years one to five:

• After year 1: $400,000 x (1 + 7%)^1 x 75% — $300,000 (pay off existing loan) = $21,000
• After year 2: $400,000 x (1 + 7%)^2 x 75% — $300,000 = $43,470
• After year 3: $400,000 x (1 + 7%)^3 x 75% — $300,000 = $67,513
• After year 4: $400,000 x (1 + 7%)^4 x 75% — $300,000 = $93,239
• After year 5: $400,000 x (1 + 7%)^5 x 75% — $300,000 = $120,766

After four or five years, you can use the net proceeds from a 75% cash-out refinance as the down payment for your next property without dipping into your savings.

This diagram shows the almost geometric progression of acquiring properties this way.

Many of our clients have successfully used this method to grow their portfolios.

Capital Required to Maintain Financial Security

According to the government, inflation is currently at about 3.5%. In low-cost cities, rents appear to increase by 1% to 2% a year.

To show the impact of rents not outpacing inflation, suppose you own a property that rents for $1,000 a month. What will be the rent’s present value (purchasing power) at five, 10, 15, and 20 years?

In this example, I will assume an annual rent growth of 1.5% and use the following formula.

FV = PV x (1 + r)^n / (1 + R)^n

• R: Annual inflation rate (%)
• r: Annual appreciation or rent growth rate (%)
• n: The number of years into the future
• PV: The rent or price today
• FV: The future value after “n” years.

The calculations:

• Year 5: $1,000 x (1 + 1.5%)^5 / (1 + 3.5%)^5 = $907 in today’s dollars.
• Year 10: $1,000 x (1 + 1.5%)^10 / (1 + 3.5%)^10 = $823 in today’s dollars.
• Year 15: $1,000 x (1 + 1.5%)^15 / (1 + 3.5%)^15 = $746 in today’s dollars.
• Year 20: $1,000 x (1 + 1.5%)^20 / (1 + 3.5%)^20 = $677 in today’s dollars.

As you can see, buying power declines every month, so it is only a matter of time before you will be forced to return to the daily worker treadmill or invest more capital to acquire more properties.

In cities with high appreciation, rents typically outpace inflation. This means the purchasing power of your rental income remains the same or increases over time, leading to true financial freedom.

Final Thoughts

Low-cost properties are the most expensive because cities with low property prices have limited appreciation. With limited appreciation, you cannot grow your portfolio through cash-out refinancing. Therefore, every dollar invested must come from savings.

If rents do not keep pace with inflation, you must constantly buy more properties to maintain your standard of living or return to work.

Higher-cost properties are the least expensive because in cities with high housing demand, prices and rents rise rapidly. This enables the use of cash-out refinancing to purchase additional properties. This significantly reduces the total capital from savings needed to purchase the number of properties required to replace your current income.

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