1229: Economic Forecast by ITR Economics, Taylor St Germain

To give some other people who might be on the fence out there. It took me a while to buy into the concept of buying out of state and that's really one of the things that I really attribute to you guys. All the podcasts and then just kind of working through that and how the numbers worked and the comfort level of it. But you know, one of the things that I think did the best for me is after talking extensively with him, I think he might have paired me up with, you know, like almost like a match.com like he paired me up with the perfect local market specialist to fit my personality and my investment philosophy fee. And so I kind of attribute it to him. But I'm very, very happy with the way the transactions go and the way the interactions kind of all fluidly occur with me and local market specialist and it really has been a pretty seamless process.

Welcome to the Creating wealth show with Jason Hartman. You're about to learn a new slant on investing, some exciting techniques and fresh new approaches to the world's most historically proven asset class that will enable you to create more wealth and freedom than you ever thought possible. Jason is a genuine, self made multimillionaire who's actually been there and done it. He's a successful investor, lender, developer and entrepreneur who's owned properties in 11 states, had hundreds of tenants and been involved in thousands of real estate transactions. This program will help you follow in Jason's footsteps on the road to your financial independence day. You really can do it. And now here's your host, Jason Hartman with the complete solution for real estate investors.

Welcome to episode 1229. 1229. This is Jason Hartman and greetings from Helsinki, Finland. Great place, highly recommend coming here. We were in gdask, Poland. Carmen, what did you think of GDASK and Helsinki? Well, Helsinki so far. And what did you think of Berlin, I guess and Copenhagen? We've been all over the place, haven't we?

Yeah, this is. It's probably like speed dating, but of visiting towns here in Europe. You get off the boat, you go running, try to explore town, get as much as you can and then go run back to be ready for the next town. But they are so charming. Everything is just so beautiful. I'm loving it.

You know what I was surprised is when I was in Gdansk last time, I think it was two years ago. I really loved visiting the Lequilensa Museum and really seeing kind of firsthand about the revolution that he started, the Solidarity movement and so forth. That was part of making communism fall. But I Didn't know. There was that whole other charming area of Gdansk that we went to. That was so nice, wasn't it?

Yeah. The architecture is beautiful. And I think I read somewhere that it was the. The crown city of Poland at some point. I mean, all the money and royalty, everything was there. And it shows. It still shows. I mean, it's.

It's.

Is in great shape, and that main area just looked beautiful with the statues and just the facade of every building. It was just super charming.

Yeah. Really nice place. And a really nice kind of riverwalk area and. And so forth. So that's one of the things I love about visiting Europe is the cafe culture, if you will. Big fan of cafes and love eating in them. And, you know, we got the dog with us, so it's great. You can bring the dog around and everything. And sitting there and having an Americano, of course you have your cappuccino. I don't like cappuccinos.

That's your loss. I love him.

All right. And so that was good. And, gosh, what else was I just gonna say? Oh, yeah. You learned something new about me on this cruise, didn't you?

Well, I think I'm still learning it, but amazingly, you know, we have a few days that are just at sea. We stay in the boat, in the ship, and, Jason, all you do is just sleep pretty much entire day.

No, I do something else.

What do you do?

I eat.

I'm trying to forget about that part. This is a shame.

This is so unlike me. I know. You know, even I get to be a sloth sometimes. Just my personality. I'm a get up and go. I get up early. I kind of hate going to sleep, and I love waking up. I just want to take on the day and get out in the world and make things happen. But, you know, when you're. When you don't have good Internet connectivity, you have the sea motion, the motion of the sea and the waves. It feels good, kind of. It's like a lullaby. I like taking naps.

Well, it takes us back a little bit in time.

Right.

I mean, what do you do when you don't have Internet?

Yeah, that's true. Well, we used to not have Internet. It's kind of before your time a little bit, but not before my time, so. Hey, look, I can be a sloth too, sometimes.

Yeah, I think you're just recovering from maybe a few years of high energy.

A few decades.

Yes, yes. All in one week, so. It's okay. You deserve it.

All right, well, hey, let's get to our episode today and we will be back with more on location reporting on the next episode. Here we go. It's my pleasure to welcome a returning guest back to the show. That is Taylor St. Germain with ITR Economics. He's an economic analyst there. And Taylor, welcome. How you doing?

I'm doing very well. Thanks for having me.

So the housing market, cyclical markets, the high flying cyclical markets, definitely experiencing a correction and I think that's probably a few years overdue. So I think it's healthy. Interest rates were going up at the time that correction started to get pretty significant. But now rates have come back down again. Is that good news for these markets or is it not enough? Are they just overpriced and there needs to be a correction?

It is certainly good news for the markets. Our expectation, when we look at housing starts. So we look at single family and multifamily housing starts, those are the series that we forecast here. When we look at the year over year rate of change for those starts, starts, it is slowing in both single and multifamily starts. So even though we did get a back off of interest rate hikes from the Fed, of course we know mortgage rates correlate very well there, that'll help. But we're still expecting to see some weakness as we move further into the second half of this year and certainly in the first half of next year. And that's largely driven by the price of homes. So the average home price now is much higher than even the level we were at before 2008, 2009 occurred.

What I think you were alluding to there is that the Fed doesn't directly control mortgage rates, but obviously they influence them. So those are connected. And you know, Taylor, it's always been interesting to me how very few economists, prognosticators out there, very few of them talk about housing payments. They always talk about housing prices. And then they do mention mortgage rates as we did starting off this interview. But people buy a house on a payment, not a price. And that's what's interesting. You know, if you look back years ago and pick any period you want, you could pick a period where rates were high and prices were low, but the payment was the same as it is today. Right. Like I think really there's got to be a lot more focus on housing payments. You know, what is the median mortgage payment, you know, and is that the apples to apples house that you would buy years ago for that payment? So anyway, thoughts on that?

I certainly agree. And you know, we look at, we do boil it down to some similar metrics. So one metric we often look at here at ITR is household income needed to afford an average home in the region. So breaking it down and looking at some different statistics, and you can certainly see when you break it down to that level, why there are some pockets of the economy in terms of housing that are still doing very well. Because just the average income needed to afford a home is so much lower in places like the Midwest, some of those states like down in the Southeast, like the Carolinas and Missouri, compared to an area like California where you need just $135,000 in a household income to afford an average home, which is quite high.

Yeah, that's just absolutely ridiculous. And you know, it would be worth it if the quality of life were actually better. And I always have been puzzled by this dichotomy of, you know, you pay more, but you don't necessarily get more. You know, there's the old saying, you get what you pay for. Well, that's not really true all the time.

No, certainly not. Of course, taxes have an impact on that as well.

Yeah, no question. You know, I'm glad you brought up taxes because the SALT taxes, the state and local taxes, part of the new tax plan has that really affected these expensive higher end cyclical markets. And they really don't have to be that high end because if they're limited to $10,000 a year, you could have a property that's not even that expensive and it would still hurt you that you wouldn't be getting to take all your deduction as you did previously.

I think it's a contributing factor. I don't think it's the only thing, you know, we talked about just some of the general economic trends that are having some downside pressure on the market. But I do think it is making an impact. When I look at our luxury home data sets in the different data that's come in, in just a six month period of time, we've seen a complete trend reversal in US luxury housing home Sal. What I mean by a trend reversal is we went from an accelerating trend to a pretty sharp decelerating trend in the rate of change in just a six month period of time. So it was a pretty big swing and I think SALT is having an impact on that, but I don't think that's the only factor. I think housing prices and some of those general economic factors are having a bigger impact.

What about incomes? I mean, for the first time in really about 41 years, Americans have finally experienced a Real dollar raise in constant dollars. And that's pretty incredible. But again, that probably doesn't even make much difference for the higher end cyclical markets around the country. And when we talk about those, we're talking about South Florida, the expensive northeastern markets, and really most of the west coast.

Absolutely. And we have seen areas like the Southeast, you're still getting some very positive data coming out, housing market in some of those regions. So I think that is making an impact. But even though we've seen some of these salaries and median wages increasing finally, and we didn't get that wage inflation really through the first half of this decade, we're still going through this cycle as an overall economy and we still expect to slow down. So I think it helps to have a few extra dollars in our pocket. We certainly see that with the retail sales data at record highs, but I'm not seeing a large enough impact that would really change any type of trend or forecast that we have in place.

Okay, so a general slowdown, not hugely significant, not a crash. But tell us about the slowdown. Why is the economy slowing?

Yeah, absolutely. And first I just want to unpack that a little more. We look at two different data sets when we talk about benchmarking overall economy. So of course we look at US GDP and we're seeing retail sales slowing, we're starting to see some of our consumer driven indicators slowing and certainly global activity in our, some of our major trading partners are slowing down. So we expect that all to contribute to the GDP slowdown later this year. But no recession expected in our forecast for GDP at this time. Of course we'll put an asterisk there because we got to certainly watch this tariff situation that we have going on. But at this point we're not expecting a GDP recession. So that's the first expectation expect GDP to slow into the first half of next year. But we're not expecting any real period, 2/4 of contraction to get us a recession. However, on the industrial side of the economy, we look at US industrial production, which is an another major benchmark for us. And that looks more at the utilities, mining and manufacturing section of the economy. And we are expecting to see a little more weakness in the manufacturing side of the economy than what we're expecting for overall gdp. So for those of you out there that are in the non residential construction, in the manufacturing sectors, we do expect to see a slowdown as we move into that 2020 timeframe that's more pronounced than what we're seeing in overall gdp.

Yeah, yeah. And when that relates to the housing market. Can you, Taylor, have a slowdown in housing volume that doesn't mean a decline in prices or do those two always go together?

No, I wouldn't say they always go together. And we might get a short period of price decline. But our expectation is that generally as we move through the first half of this decade that housing prices are going to continue on the trajectory they're on right now. We expect both from a business and personal investment side that the housing market is pretty positive place to be. Even though we're expecting a mild slowdown this year. The slowdown. So mild. Just to put it in perspective for you, our year end expectation is about 2% contraction year over year for single family housing. That was almost 50% in 08 09.

So just 2% price contraction?

No, that's overall housing starts. Okay, so we don't forecast. Yeah, okay, yeah, we don't forecast housing prices specifically. We have tracked that course, certainly something we track. And right now we're at about 270,000 on average home prices. And we would expect that to continue as we move into the next half of the 2020s.

Tell me you've mentioned housing starts quite a few times and maybe it was off air as we talked for just a couple minutes before we started. But why are housing starts so significant? Tell us about that.

As in why do we look at housing starts?

Yeah, I mean, I know it's a barometer of the overall economy, developer optimism, of bankers financing deals, investors financing deals, whether it be debt or equity. So talk to us about housing starts. I mean, of course, you know, it means a bunch of construction jobs, a bunch of material pulled through the supply chain. So obviously building is a huge stimulative.

Effect to the economy just from a high level. The first reason we look at housing starts is of course as a benchmark of activity for the overall economy. So the activity in the housing market tends to lead the general economy in terms of GDP and industrial production. That lead time can vary, but it's always a lead time rather than a lag time. When we look at non residential construction, that tends to lag the overall economy. So that's the first reason. Just knowing where residential construction activities headed is a good indication of where we're headed as an overall economy. And of course we saw that in 0809 certainly. So that's the first reason. The second reason is by looking at housing starts, the way that data comes to us, we can look at a lot of different areas. We can look at that housing start Data regionally we can look at multi versus single family. So there's a lot of different ways we can break out that data and really get at what markets our clients are interested in. And those are large data series that we have a high degree of accuracy forecasting. So that's another main reason we leverage housing starts.

Yeah, sure, sure. When you see a decline in housing starts, does that mean that if you project that out a few years later you're going to have a shortage of inventory?

You know, I think that's a case that we saw in 2008, 2009, of course, where of course that was in before 0809. That was a level that just unsustainable now how single family housing inventory. Even though we're slowing down, we still don't have enough single family housing. So we're still working to get back to some higher levels of single family homes. On the multifamily side though, that is a very high inventory levels right now. So those apartment buildings, those multi family spaces, we expect to experience a more significant period of contraction rather than the 2% that we were expecting for single family. We're expecting below 9% contraction. When you look at multifamily. And that is because of those high inventory levels and rising vacancy rates in these apartments.

Yeah, the class A apartments have really been overbuilt, haven't they?

Absolutely. Yeah. And there are areas like the Southeast where that's proved to be okay because of the population growth those states are seeing. But for much of the Midwest, some of the states out west, they don't have that same supporting population to drive those multifamily startups charge higher. So sort of a, a tale of the different regions. When you look at the multifamily market.

Yeah. And that's always the way it is. Look, all real estate is local. That's the thing everybody needs to understand. It's a pretty localized type of thing. I do think you can really categorize it by type if you don't want to be overly local. You can look all around the planet and use three broad categories, linear, cyclical and hybrid. And you know that's going to tell you a lot. But of course there's more to it than that. Of course as well. What I was getting at when I asked you about housing sale volume and then you talked about housing starts and prices not being directly correlated, I wanted to dive into the. And I'm not gonna call it what everybody calls it, the trade war. I'm gonna call it the trade negotiation. Okay. Because that's really what it is. But in the trade negotiation, you know, when you have tariffs on imported products coming into the U.S. that means everybody's got to pay more for those products. And maybe they onshore their orders again, and instead of ordering locks and fixtures and materials, building materials from overseas, they're ordering American products, which are more expensive. So either way, if you're a home builder, you gotta pay more for your raw materials, right?

Absolutely. And we saw that certainly with that first round of tariffs that was put in place, focusing on steel and aluminum, of course, those are two very important input costs for the construction manufacturing industries. And as a result, we did get some inflation, which we were expecting to see. But we saw a lot of price increases that were a little higher than what you would expect out of a typical price increase for the year. And that was to offset some of the costs that were coming from tariffs. So we saw it in two areas. Either you eat that cost of the higher interest put and take that against your margins, or we're going to pass those along to our customers. And we saw a lot of businesses choosing to pass along those price increases to their customers. So that's something that we should expect, especially if we see more tariffs putting in place those price increases passed along.

Yeah. I mean, how significant is that? You know, it begs the question, when a builder builds a new home, how much of that home is imported? Right. And how much of it is subject to tariffs? Is it half? Is it 25%? And then what's the tariff amount? And then, you know, what's going to happen to housing prices from that perspective? You don't know overall, because that depends on interest rates and the market and the economy in general. But you know, for pure construction cost, that's a big deal, right?

Certainly is. And that's where our concern comes in with the tariffs. We certainly don't get political as a firm here. That's just not our space to play into. But there's winners and losers in this tariff situation. And I think people really need to understand that this isn't a one size fits all. It sort of depends where you fall into this equation. For some people that are manufacturing the stainless steel, these tariffs are great. And you know, there's a lot of people out there that believe that we need to continue to renegotiate these deals. But if you're on the flip side and some of these products that are having tariffs placed on them are inputs for you, that's going to increase your costs and you need to pass that along to your customers in order to protect your margins. And as that works down to the US Consumer, that's really where the concern among economists comes in. How far can we push before we start negatively hurting all of our businesses and consumers here in the United States?

Okay, so what's the answer to that? And do you have any data or, you know, to answer that other question of how much of a home is subject to tariffs? Like. Like here's maybe a good way to look at it. If everything stays the same, in other words, the interest rates don't change, the economy doesn't change, and you simply have in isolation tariffs, and builders have to pay more for the raw materials, how much does that increase the price of a home?

It's a great question, and I'm not sure what the exact number is. I guess the best example I could give you is just when I have a construction client, and this is a real example from one of my clients, typically they would increase their prices about 3%, and those price increases would come twice a year. Last year, due to the tariff and aluminum tariffs, we saw three price increases rather than two. So we saw an extra price increase, and those price increases were up in the range of 5% instead of 3%.

Are you talking about for the whole year? Are you talking about 3 times 5? 15%. I mean, roughly, obviously.

Right? That was certainly the case in some situations where we had between 10 and 15% increases in prices. If you were to compound them over.

The year, wow, that's pretty significant.

The one thing I want to mention is that's not all. I think a couple of price increases could have offset the tariffs. But that's the other thing these tariffs have given us. The avenue to do is increase our prices and fall back and use those tariffs as an excuse, even if we've already had those costs covered. We're also seeing businesses sort of take advantage of this tariff situation to benefit their margins as well.

You mean are they using as an excuse to raise prices? Is that what you mean?

They certainly are, yeah.

They're hiding behind it. Even if you're a business and say you're a home builder in the example we've been using, and you have a ton of raw material inventory in a storage warehouse, so the tariffs don't even affect you. I mean, we saw this years ago with, with Southwest Airlines when oil prices went through the roof. And of course that affects jet fuel prices. Ultimately, they bought futures, and so they locked in cheap fuel, and all the other airlines had to pay more. It was like a Brilliant move by Southwest. And so their margins just totally increased because all their competitors were increasing prices and they were keeping their costs the same as everybody else had to increase due to the rising fuel cost. So that was really good treasury management. Right. On their part. And so say you're a home builder and you either have futures contracts on the commodities, the raw materials, or you just have a bunch of them in storage and in physical form. So the tariffs actually don't affect you. So you've got a one year supply, but you can raise your prices as an excuse. Right. And use the tariffs. That's the tariffs we got to raise prices, right?

It is. Or you can do what many of the other end of the spectrum was doing, which is, is keep your prices low and go after that market share.

Right? Yeah. You can increase market share or raise margins either way. So either way. Exactly, you're gonna win the game. But it's a pretty interesting thing. So, you know, what's your overall outlook and are there any questions? I didn't ask you that. You just, you know, things you want to share with our audience.

Just to piggyback on the end of our tariff conversation, our overall view is that the, if we see more tariffs being put in place, that's a downside risk to our forecast. So I just want to reiterate for that to everyone out there who's there's a lot of uncertainty due to tariffs. I don't know what the current administration is going to do. If I did, I'd be a very wealthy man. But just look at those more tariffs as a downside risk, maybe hinting at a recession coming our way in 2020. If we see a very large dollar amount, we'll certainly keep you updated and evaluate then. But just plan for a slower economy later this year. That's CapEx, that's industrial production, that's GDP. The indicators we look at, they're slowing down, they've already turned over. So start to think about your cash position. Start to just get ready for a lower level of activity compared to what we've seen in years prior.

You know, I mean, the economy's been on a tear for years. Things have been booming. You know, how much of an adjustment are we talking about?

Yeah, when we look at US Industrial production, we're only expecting about a very mild period of contraction. Really. The first two quarters of 2020 is where we expect that weak point to be. But by the second half of the year, we're going to be accelerating in the pace of rise once again. So it's really just the next four to five quarters. We expect to feel that weakness. But we'll recover quickly and expect 2021 especially to be another great time to be in business here in the U.S.

Yeah, yeah, that's interesting. And obviously it'll be an election year in 2020, so that'll be make it even more interesting, won't it?

Oh, there's just more fun to be had. That's for sure.

That is for sure. One interesting thing about this, just as we wrap it up here, is something has to give. And a lot of people ask, well, okay, so if the economy cools off a bit and these tariffs cause prices of homes to increase. And by the way, real estate investors, if new home prices increase and you already own existing properties, that puts upward pressure on your prices too. Because it's just a competitive market. Buyers look at new homes, they look at resale homes, they look at continuing to be renters as maybe they're priced out of the market and they've got to stay in the rental pool. So overall, investors win. Any which way you slice it. There's. But, but the interesting thing is, is that a lot of people don't understand that ultimately lifestyle is where, you know, that's the thing that, where you take a bite out of it. Right. The lifestyle has to contract. If you have higher cost for home builders, if you have a higher interest rates or a slowing economy, people just don't get to live in the same house they might have lived in previously or been able to afford to live in. So, you know, the square footage declines, the density increases, the quality declines, the neighborhood declines. Something has to happen. Something has to give. And usually it's just overall standard of living.

Yeah, yeah, absolutely. It's in this downturn, we're not expecting to see something that's going to really alter the way of life. It's so mild and no return so quick. But that's certainly true when we look at previous recessions. It's. It not only has an impact on prices and what goes on in the market, but also just the way people are living, their personal expenses and how much money they're willing to throw at a new home and might keep them in their existing home for a little while longer.

Yeah, yeah. So if they're already renting, they might just keep on renting or they'll be buying a smaller house. Taylor, give out your website. Tell people where they can find out more about ITR.

Go to ITREconomics.com great website, give you some more information about our consulting services, the different forecasts and tools that we can help you all out with out there. So Please check out ITREconomics.com and contact us with any economic questions you may have. More than happy to help.

Thanks for joining us.

Thanks for having me. I appreciate it.

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