Richard

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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Lawrence Yun, National Association of Realtors chief economist, joins ‘Squawk Box’ to discuss the state of the housing market, how mortgage rates impacted the housing market, and more.

Dave:
Hey everyone. Welcome to On the Market. I’m your host, Dave Meyer, and we are going to be ending the year with an absolutely incredible and very special show. Today we have one of my personal heroes and role models coming on the show. Her name is Liz Ann Sonders. She is the chief investment strategist at Charles Schwab and is one of the best analysts and economists in the entire world. And I promise you, you all are going to learn a ton from our very interesting conversation. Liz Ann and her team at Charles Schwab recently released a report called US Outlook: One Thing Leads to Another, it just came out in the last couple of weeks and presents information and their basic outline for what they think is going to happen in the economy next year. And during our conversation today, we are going to talk about the report. We get in all sorts of topics like the concept of a recession or a soft landing and where Liz Ann thinks we fall on that spectrum.
We also talk about mortgage rates and bond yields, consumer spending and sentiment. And of course we are going to talk about the Fed and what they’ve been up to. But I think in addition to just Liz Ann’s opinions about these things, there’s a lot to learn in this episode because Liz Ann does a great job explaining what data you should pay attention to and why, and which data is just kind of noise that isn’t as important for investors like us when we’re making our decisions about our portfolio.
So, while you’re listening to this, in addition to what she says, also pay attention to the things she’s talking about, why she looks at certain indicators, why she ignores other indicators, because it can really help you sort through all the noise out there and just focus on the things that are going to help you build your portfolio in 2024. With that, let’s bring on Liz Ann Sonders, the Chief Investment Strategist at Charles Schwab.
Liz Ann Sonders, welcome back to On the Market. Thanks so much for being here.

Liz Ann:
Oh, thanks for having me. Happy holidays.

Dave:
Thank you, you too. For those of our audience who didn’t catch your first appearance on this show, can you please just briefly introduce yourself and what you do at Charles Schwab?

Liz Ann:
Sure. So Liz Ann Sonders. I am the Chief Investment Strategist at Schwab, a role I have had, I’ve been at Schwab since 2000, so long time. And before that I was at a firm called Zweig Avatar.

Dave:
During our last episode, we ended on something that I’d love to just pick up on, which was your concept of a rolling recession. Can you tell us a little bit about what a rolling recession is in your mind?

Liz Ann:
Sure. So there’s no precise definition. It’s just a term that we’ve chosen to use to describe what is obviously a very unique cycle. And I’m not going to go back three and a half years and run through the litany of things that makes it unique. But I think it is important to go back to the stimulus era during the early part of the pandemic because at the time that stimulus kicked in, both on the monetary side and the fiscal side, and it boosted the, economy dramatically very quickly and took the economy out of what was, although painful, a very short-lived pandemic recession. That stimulus and the demand associated with it was all funneled into the goods side of the economy, because services weren’t accessible. And that’s also where the inflation problem began on the goods side of various inflation metrics. But since then, we’ve not only seen hyperinflation go to disinflation to deflation in many categories on the goods side, we actually have had recessions in a rolling sense in manufacturing, housing, housing-related, a lot of consumer-oriented products and goods that were big beneficiaries of the stay-at-home phase.
And we’ve had more recent offsetting strength on the services side. That’s also where you saw the more recent pickup and inflation on the services side. Inherently those metrics are a little bit stickier. So when we think about the recession versus soft landing debate, I think that’s a little too simplistic because we’ve already had hard landings in some of those areas. To me, best-case scenario is a continued roll-through. Whereby if and when services needs to take a breather that you’ve got offsetting stability and/or maybe even recovery in areas that are already had their hard landing. So that’s in essence what we’re talking about.

Dave:
Just to make sure I understand and to explain to everyone, traditionally a recession, at least as it’s defined by the National Bureau of Economic Research, states that there needs to be significant declines in economic activity through a broad portion of the economy. And as Liz Ann is explaining here, what’s going on now is more like a whack-a-mole situation if you will, where one section of the economy might start to see a decline as Liz Ann said that was mostly in the goods area, and then services, a different sector of the economy might be strong and might in the future start to decline. So that’s why it’s rolling through the economy one industry at a time. And Liz Ann, you mentioned that some industries have had hard landings. Are there any that come to mind that have been particularly painful?

Liz Ann:
Well, housing, depending on what metric you’re looking at, you didn’t see epic-level declines in prices, at least not in existing homes. And I think that just has to do with the supply-demand imbalance, the fact that even though mortgage rates accelerated quite dramatically over the last year or so for the existing home market, so many homeowners are locked in at much lower mortgage rates and therefore they’re locked into their homes. But we did see pretty epic declines akin to the bursting of the housing bubble type declines in sales. Now we started to see a bit of recovery there, but that’s one area that saw compression. You certainly saw it in manufacturing broadly in certain components of manufacturing. And by the way, the weakness in manufacturing without the attendant weakness, we’ve had a little bit of weakness in services, but nowhere near the extreme helps to explain why an index like the LEI, the Leading Economic Index, which has 10 subcomponents has been flashing recession.
Now that index is more manufacturing-biased, not because the conference board that created the index is missing something. They know that services is a larger portion of the US economy, but manufacturing does tend to lead, and that’s why there’s more of a manufacturing bias in the leading indicators. But that helps to explain a disconnect too, given that we’ve seen recession in manufacturing, it’s picked up in something like the LEI, but it hasn’t manifested itself in this big decline in the economy because of the resilience in services, which is a larger, by the way, services is also a larger employer, helping to explain why the labor market has been so resilient.

Dave:
I’d love to talk a little bit more in a minute about the services and what might happen in 2024, but I’m just curious your opinion on the implications of this rolling recession, because in my mind, parts of it seemed to be positive, right? Rather than having this one deep recession, different sectors of the economy are performing at different levels, but it also feels like it’s sort of dragged out the economic pain and people are still sort of waiting for some definitive event to happen to declare a recession or to declare that the economy’s better and it feels like we’re sort of in this economic purgatory right now. Do you think this is having a psychological effect on businesses and American consumers?

Liz Ann:
I do. In fact, I think that that’s an important question because it brings up another unique facet to this cycle, and that is that the psychological ways we measure growth in the economy, whether it’s things like consumer confidence or consumer sentiment, they’re very similar monthly readings, they’re put out by two different organizations. Consumer confidence tends to be a little bit more biased to what’s going on in the labor market where consumer sentiment tends to be a little bit more biased to what’s going on with inflation. So you can see divergences there. You can also look at other surveys like CEO Confidence, well, that’s considered soft economic data, survey-based data. What are people saying? What’s their mood? What’s been interesting is the hard data does not corroborate the much weaker soft data. In other words, you’ve had this very dour backdrop of consumer confidence/sentiment, but you haven’t seen the equivalent in consumer spending.
You’ve seen this very dour recessionary-like backdrop in CEO confidence, but as a proxy maybe for what would make them confident or not would be corporate earnings. And although corporate earnings were slightly negative in the last year or so, nowhere near to the degree that you would expect given the weakness in CEO confidence. So that’s another unique aspect to this cycle is a pretty wide gap between the sort of attitudinal or soft economic data and the actual hard activity-based data. So that’s good news in the sense that yes, we’re seeing it psychologically, but it’s not manifesting itself in behavior that’s commensurate with the weakness in confidence.

Dave:
That makes a lot of sense, and I just experience that almost every day. When you talk to someone about the economy, almost always you hear negativity or pessimism or fear, but when you look at these macro indicators, you see pretty strong reports coming out of multiple different sectors of the economy. So it does just feel like there’s this sort of strange disconnect and that’s why I really appreciate your analysis and terming of the rolling recession because it does explain, at least in my mind, a lot of what’s driving that psychological element.

Liz Ann:
And by the way, I agree it is arguably a better backdrop than a recession where the bottom falls out all at once, particularly in an extreme way like was the case in 2008. I mean that was a protracted recession, but certainly that acute ’08 part was the bottom falls out all at once, and I think probably anybody would choose more of a roll through than that. But you’re right, it does leave I think a lot of people in this state of limbo and uncertainty for maybe a more extended period of time.

Dave:
You mentioned that the best case scenario in your mind heading forward is a continued roll through. So presumably some sectors recover, others go into an economic decline, and you mentioned services as being potentially one of the areas that might get hit. Why do you think services are one of the big things to watch in 2024?

Liz Ann:
Particularly in areas where the strength has been a bit more recent, where the job growth has been more recent, reflecting the revenge spending on things like travel and leisure and hospitality. I think that the key ingredient to keeping that afloat, and we have started to see some cracks, ISM services index, which is a proxy for the broader services category, that has weakened from recent peaks. You’re seeing it in a smattering of ways where we may be not at the exhaustion point, but at some point you’ve met that pent-up demand. But I think the real key is the labor market. I think if the labor market can remain resilient, I think that’s been a thing that consumers are hanging onto to maintain that consumption, which again, in more recent periods has been more sort of services-oriented or experiences-oriented as opposed to things, stuff, goods.
I think if we start to see more cracks in the labor market, given that metrics like the savings rate, the diminution of the so-called excess savings, the fact that delinquencies for auto loans, for credit card loans are really picking up particularly down the income spectrum into the subprime categories, the increased use of credit cards for those that are turned off by the high fees or high interest rates, the increased use of buy now pay later, those are signs that there’s at least some pocket of the consumer that is starting to get a little bit tapped out. But I think there’s been this reliance on the health of the labor market as a buffer, and I think if we were to start to see more than just the cracks we have seen, I think that that would have a feeder on the services consumption side that might occur a bit more quickly.

Dave:
So in your outlook for 2024, are you forecasting breaking the labor market or at least an uptick in the unemployment rate?

Liz Ann:
So we had gotten obviously an uptick in the unemployment rate from 3.4 at the low to 4%, and then that came back down to 3.7%. What’s interesting about the unemployment rate is you don’t historically see a lot of jump around volatility. It tends to be trending in one direction and then there’s the inflection and then it tends to trend in the other direction. It’s not like a metric initial unemployment claims where you can see an incredible amount of volatility. So it was a bit of a surprise. I think in general, the unemployment rate is probably going to be trending higher. That’s just the nature of being later in an economic cycle. But there is also truth to this notion of labor hoarding and the fact that for a lot of companies, the skills gap, the labor shortages were so acute that I think they’re more hesitant to use that, laying off people as a cost-cutting mechanism.
So there is that sort of hanging on of labor. You’ve seen it picked up in other metrics like hours worked having come down. You’re also seeing cracks under the surface. For instance, with initial unemployment claims, which continue to be very low, that’s a weekly reading, but there’s attendant report or a metric that comes out every Thursday morning with initial claims, which is continuing claims measures, not people who have just initially filed for unemployment insurance in the prior week, but people who continue to be on unemployment insurance. And the fact that that has accelerated to a much more significant degree than initial unemployment claims tells you that it’s taking a bit longer for people to find jobs. So it really just is peeling a layer or two of the onion back to see where we’re starting to see some cracks. I don’t anticipate some major move up in the unemployment rate.
I think that there is resilience in the labor market. There is truth to that notion of labor hoarding, but it’s what happens when you’re later in the cycle. And by the way, one mistake that a lot of economic watchers or market watchers, investors, whatever term you want to use make is they think of the unemployment rate almost as a leading indicator and it manifests itself in questions I get all the time. Why is anyone talking about a recession when the unemployment rate is so low? Wouldn’t that, I’m paraphrasing different forms of the question, wouldn’t that have to go up a lot to bring on a recession? Well, it’s actually the opposite that happens. Recessions happen for lots of reasons, and eventually the recession causes the unemployment rate to go up. It’s not the other way around. So that’s why it’s important to look at things like unemployment claims and even more leading than that, layoff announcements and job openings because those are where you pick up in a leading way signs that eventually will work their way into a rising unemployment rate.

Dave:
That’s an excellent analysis and detailed opinion about the labor market and underscore something we talk about on the show that I want to remind everyone that there are lots of ways to look at the labor market. No one is perfect and as Liz and clearly stated, you sort of have to look at the whole picture by understanding the unemployment rate, how many people are filing for claims, how many hours are work, the labor participation rate. There’s a lot to understand. So if you want to use this type of data and information in your own investing, you should, but make sure to get a holistic picture and not just cherry-pick one sort of metric and use that as your barometer for the labor market. Liz Ann, you mentioned that we’re late in this cycle and your report discusses this at length and talks about how rate hikes have a quote long and variable lag associated with them. Can you explain this concept to our audience?

Liz Ann:
The terminology of long and variable lags dates back to the late great Milton Friedman who wrote about that in one of his books. And it’s really just this idea that changes in monetary policy. In other words, the Fed raising interest rates or lowering interest rates, the impact that that has on the economy from a time perspective is very variable. We know the lags are long, meaning the Fed raises rates, it doesn’t have an immediate and in the moment impact on the economy. It takes a little while, but the time it takes and the magnitude of that impact is very variable over time. And that’s really what we just wanted to point out. It’s also justification, and the Fed has stated as such for the Fed being what we believe to be in pause mode right now, we do think that the July 2023 rate hike was the final one in the cycle because they feel that they’ve done enough tightening.
It was the most aggressive tightening cycle in more than 40 years. And this is the time now to assess the impact given those long and variable lags. And the other point we made in the report looking at things like the decline in the leading indicators, which we touched on, the inversion of the yield curve, any number of measurements that in the past have been pretty good recession indicators that were still within the range of time spans historically that have incorporated when you finally see the impact. So that was why one of our conclusions was we’re not really past the expiration date, maybe not a recession per se, but we’re not past the expiration date of continuing to worry about this. There’s not some point where we can say every metric that has been calling for a recession, we’re way past the historical range of impact, therefore nothing to see here, nothing to worry about. Let’s celebrate. So we’re still within the variable range associated with the past, even including the unique characteristics of this cycle.

Dave:
That’s super important and your report does a great job pointing out that all of these indicators that market watchers point to that there should be a recession or is likely to be a recession. Even historically there is a long lag. Some of them take 24 months or 18 months, meaning that even though the Fed is in pause mode, the economy is very possibly still feeling the impact of rate hikes that happened, not just the most recent one, but ones that happened 12 months ago or perhaps even 18 months ago.
I’m curious if the recent Fed news, and as a reminder we are recording this towards the end of December, we just heard from the Fed that they’re continuing to pause and the most recent dot plot, which is a projection of where the Fed thinks that their federal funds rate will be in coming years, shows a potential for three rate cuts next year. Do you think that Fed’s signaling that they might bring down rates might blunt sort of this lag effect? There’s always this lag effect and part of me always thinks about how that’s psychological, that if rates stay high, people are a little less willing to invest money, they’re a little more timid, and now, perhaps the Fed is trying to blunt the impact of some of their more recent rate hikes and get people to start spending and feeling a bit more confident again.

Liz Ann:
That may be indirectly a part of it. To be perfectly honest, we were a little surprised at the telegraphing of a pivot. It’s been generally deemed to have been a more dovish meeting, particularly once the press conference started and Jerome Powell was taking questions. Now, that said, there is still a pretty wide gap between, to your point, what the dots plot, what is suggested by the expectations of Fed members for three rate cuts in 2024 versus now. The market’s expectation of six rate cuts in 2024. I think at this point, all else equal, given what we know now, and the rub is that the Fed is data-dependent, so the data will define when they start to cut and how aggressively, but given what we know now, to me it looks like the Fed is probably more right than the market. But in terms of blunting the impact, yeah, I mean the Fed looked at what in November was the most amount of financial conditions easing in a single month in the history of these multiple indexes that measure financial conditions.
And that was one of the reasons why there was an assumption that Powell at the meeting would a bit more hawkish and say, “Look, the loosening of financial conditions has done some of the job for us. We can stay in pause mode maybe longer.” But he did kind of do that more dovish kind of pivot to an expectation of rate cuts. But there is still a fairly yawning gap between what the Fed is telegraphing and via its dots. It’s not telegraphing anything, it’s data dependent. So they’re not on some predetermined path, but I think six seems fairly aggressive given that inflation is not anywhere near the fed’s target, and they claim that that’s what they want to see. So I wouldn’t be surprised if as we get into the beginning of 2024 if we don’t see continued significant disinflation and/or if the economy continues to behave quite well and we don’t see any further cracks in the labor market or maybe even strengthening in the labor market. It wouldn’t surprise me for the Fed to have to push back again against rate cuts starting as soon as three months into the next year.

Dave:
For what it’s worth, I was also very surprised. It’s not like we saw these amazing inflation numbers and as you said, financial conditions were already loosening. So it is a bit of surprise and I just want to remind everyone who’s mostly real estate investors here that although for those of us who are looking forward to lower mortgage rates, this may be encouraging, but certainly not guaranteed. We’ve seen mortgage rates move down about 100 basis points in the last couple of weeks, but as Liz Ann just pointed out, we don’t know what the Fed is going to do. They’re going to wait and see more economic data. And we also don’t know how the bond market and mortgage-backed security markets are going to react to further economic data.

Liz Ann:
And that’s a key point because it’s the 10-year yield that’s most directly correlated to mortgage rates, not the Fed Funds rate, which is what the Fed has direct control over. So that’s why it’s the market forces associated with the bond market and longer term yields that will influence mortgage rates.

Dave:
Well, that brings me to my final subject here that I want to talk about, which is the yield curve. Because bond yields are so pivotal in setting mortgage rates, as a real estate investor, I am very curious for your take on the yield curve, but for those who aren’t familiar, can you just explain what the yield curve is?

Liz Ann:
There’s different yield spreads that are measured to then declare an inversion, which would in general just be when short-term interest rates are higher than long-term interest rates. It’s probably the two most popular yield spreads that are analyzed when looking for an inversion, how deep the inversion is would be the 10-year versus the three-month treasury or the 10-year versus the two-year. And it reflects an environment where early and even in advance of a tightening cycle, you’ve got still elevated short-term interest rates, but the bond market is starting to anticipate weaker economic growth and an eventual easing cycle by the Fed. So those longer term yields will come down and once they go below the shorter term yields, that’s when the yield curve inverts, which occurred now more than a year ago. And it was a very deep inversion. What’s interesting is recently when the yield curve started to steepen again, I heard a lot of comments saying, “Well, an inversion of the yield curve has been a pretty perfect historical precursor to a recession, and now that it’s un-inverting, which that was fairly short-lived, we don’t have to worry about recession anymore.”
But what’s interesting is that if you look at the long history of this, the inversion, if you want to use a weather analogy, inversions are the warning, and steepenings are actually the watch, because recessions have actually typically started after a steepening. And in many cases where the yield curve is actually un-inverted, and that’s because the long end starts to come down in anticipation of Fed easing to come. And so that’s another, I think misperception much like the relationship between the unemployment rate and recessions, inversions and recessions, it’s actually the steepening that is the watch, it’s the inversion that’s the warning. But it also reflects problems in the financial system given that most financial institutions, they borrow on the short end and they lend out at the long end and they make that spread. And that’s what then provides juice to the economy. It gives them the ability to lend and keep the credit markets open, and an inversion really stunts that. And so it works its way through the financial system and through lending standards. And that’s ultimately how it impacts the economy.

Dave:
Given the importance of the steepening, what is happening with the yield curve of late? You mentioned that it inverted I think over a year ago, but has there been any recent movement of note?

Liz Ann:
Well, yeah. So the 10-year as a perfect example, went from a 5% where it hit for a fairly short period of time all the way down to when I looked before coming on here, it was sub-3.9. So that’s an extraordinary swing in the 10-year yield. And by the way, has had direct implications for the equity market, which was one of the themes in our report that really the bond market has been in the driver’s seat of the equity market. And the period from mid-July or so until the end of October when the 10-year yield was surging on the upside, ultimately hitting that 5% peak, that was the period when the US equity market had its correction. S&P down 10%, NASDAQ down 12 or 13%.
And then since then, the peak in the 10-year yield at 5% all the way back down to below 4% has been very much what’s behind the incredible move off the lows at the end of October for the equity market. So there has been a very, very direct relationship between what’s going on in the bond market with an inverse relationship between yields and stock prices, higher yields met lower stock prices and vice versa more recently.

Dave:
Thank you for explaining that. That’s super helpful for all of us who are so interested and watch the bond markets pretty carefully. Liz Ann, before we get out of here, I’d just love to hear from you what you would recommend to our audience, if there’s a couple of indicators that you think they should be watching heading into 2024 to understand the health of the US economy.

Liz Ann:
Well, one thing that’s always important to understand is which economic indicators, and we’re barraged with them on a daily, weekly, monthly basis, but what bucket they fall into, are they a leading indicator? Are they a coincident indicator? Are they a lagging indicator? And that applies to not just labor market data. I mentioned initial unemployment claims, a key leading indicator, payrolls, a coincident indicator. The unemployment rate, not only a lagging indicator, one of the most lagging of indicators. So that’s really important is understanding which fall in which buckets. Understanding that at times there can be a big difference between the soft and the hard economic data, which we touched on. So survey-based data versus actual hard activity-based data, kind of like you’ve got to look at what they’re doing, not just what they’re saying, whether it’s consumers or CEOs. But I think at this point, I happen to believe that what the Fed will key off of when it comes time to start to cut rates, actually pivoting to rate cuts, not just staying in pause mode, will be the combination of their dual mandate, inflation and the labor market.
So on the tightening part of the cycle, they were almost solely focused on their inflation mandate. That was what was triggering the rate hikes in this very aggressive cycle. I don’t think, they don’t not care about inflation anymore, but I think the labor market, the employment half of their dual mandate, I think will sit alongside the inflation data and it’s the combination of the two that will send the message to the Fed. Okay, you can feel somewhat confident that not only has inflation come down to or close to the target, but conditions in the labor market are not such that it’s likely to reignite inflation again if we start to ease policy. So we always pay attention to labor market data, but the point is that I think the Fed is going to have a more keen eye on that than was the case during the tightening part of the cycle.

Dave:
All right, well thank you so much, Liz Ann. We’ll of course link to your report in the show notes. Is there anywhere else people can find you if they want to follow your work?

Liz Ann:
Sure. So all of our work is actually on the public site of Schwab.com. That’s one thing a lot of people don’t realize. You don’t have to be a client, you don’t need to log in. There’s a learn section on Schwab.com. That’s where all of our written, what we heard is. That said, probably the most efficient way to get everything, not just written reports and videos and links to our new podcast, but the daily massive production of charts and reactions to economic data on either Twitter, X, formerly known as Twitter, or LinkedIn. So that’s probably the easiest sort of one-stop shopping way to get everything.

Dave:
Absolutely. And we’ll make sure to link to Liz Ann’s Twitter or X profile as well as her LinkedIn profile below, if you want to check that out. Liz Ann, thanks again for joining us. We really appreciate it. Have a happy New Year.

Liz Ann:
You too. Thank you.

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 BiggerPockets for making this show possible.