2102: 5x Your Real Estate Returns; Housing Market Insights from a 53-Year Spreadsheet Analysis

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Welcome to episode 2102-1102 and thank you for joining us today. We've got a great show for you, a returning guest, the author of One Rental at a Time, who is one of the people who seems to agree with me on the direction of the market. We'll see how this conversation goes in just a moment. But first I do want to share some demographic trends with you that I thought would be very interesting. And this is related to something called shadow demand. Now during the Great Recession, which now is 15 years ago, really 16 years ago, even 17 years ago, depending on how you look at it, right when it really started. But we heard a lot about shadow supply, the supply of properties that will eventually hit the market but aren't hitting the market yet because the lenders hadn't done their foreclosures and they hadn't put the properties on the market and so on and so forth. So that is what was called shadow supply. I want to talk to you about the other side of the equation today and that is shadow demand. And we have discussed this before, but I really did some work on this last week and I looked at some real hardcore firm, undisputable, unassailable demographic data that I think will be very interesting to you. So when we look at shadow demand, this is the one component of the number of people that need to form a household, the people that haven't formed a household yet, meaning they didn't demand a rental property or they didn't demand a for sale property that they needed to buy because they have not yet formed a household. Now, the typical household in the United States includes 1.8 people. 1.8 people, right. Some have three people, some have one person, some have 2.2, whatever it is, but 1.8, that's the typical number. So I did a little math here for you and I looked at this. Now, you've all seen, and if you're watching on video, you see on the screen the demographic pyramid or the population pyramid. I've shown these to you many times over the years because the US out of all developed countries, countries, has a really healthy demographic pyramid, as opposed to China, Japan, Russia, Western Europe, et cetera, et cetera, have very unhealthy demographic pyramids, meaning they have a severe demographic crisis that they are already experiencing that will only get dramatically worse as we approach next year, the year after the year after that, and certainly the next decade. So the US In a very good position compared to these other countries. All right, so this is our demographic pyramid and this is how it looks overall. But let's zoom in on this nice fat demographic pyramid. This is exactly what we want. This is a good demographic pyramid because it shows that there are a lot of young people coming up, forming households and supporting the older people who are retiring. This is what we want to see for a healthy population pyramid. Now, it won't always be this way, by the way, because if you look at the bottom of this demographic pyramid for the really, really young people, there aren't enough of them being born. So this ultimately, you know, fast forward a few decades, this is going to become a problem, and we've talked about that before, too. But you really don't have to worry about this until the mid-2040s or maybe even the late 2000s. And it's subject, of course, to immigration and various factors that are complex. And we'll talk about those in 20. How's that? Set your calendar for episode number 19,000, 336. We'll talk about those in 2035. I'm not sure how the math works out on that, by the way, but. Well, we do, what, 156 episodes per year? Right? So, yeah, I don't know. Do the math. Get back to me. Comment below. If you did the math for what episode number we'll be on in, I don't know, 2035. Right. Okay, so let's zoom in on this demographic pyramid, though. This is the important thing. We want to zoom in on a certain age group. And this is the people who. Some of them are a little young to consider, but because of this one statistic, I was able to get a hold of, this is what we're talking about today. And these are 18 to 29 year olds. 18 to 29 year olds. And there are a lot of these people. There are a lot of these people adding to our very healthy demographic pyramid in the United States. Okay, so let's take a look at that. This is this big part of the pyramid, right? And we see this is kind of an upside down version of it, right? Resident population of the United States by sex and age as of July of 2022. Okay? So as we look at this chart and we look at this demographic cohort, we see this is a pretty big group of people. And we are looking at what, over 40 million of these people that are part of the shadow demand equation. So let's zoom in on this a little bit. And here we've got 45 million people in this demographic cohort. Now, this is the startling and amazing thing. Do you know that half of these people are living at home with their parents? Yes. Folks, this is a new era, Right? It didn't used to be this way in my Gen X generation, little older than this group, no way you would be living with your parents. Right. If you were a baby boomer, no way you'd be living with your parents at this age. Right. I mean, maybe when you're 18, you would. Usually when you're 18, maybe you'd go off to college. But nowadays we have the boomerang. I don't even want to say generation, because it's really two generations now. It's the millennials and the zoomers, the gen zers. Right? So two generations of people who are living with their parents much, much longer. But in this particular cohort we're talking, it's 45 million people, and half of them are living at home with their parents. So we've got 22,500,000 people. Almost 23 million people. Folks, if your mouth is not watering yet, if you are a real estate investor, it should be. You should be very, very excited about this. Check it out. 1.8 adults per household. That's the number. So we Simply take our 22,500,000 people, and we take 1.8 as the average household size, and that leaves us with 12,500,000 actual housing units needed. Okay. It's a big country. There's a lot of Houses. In fact, there's almost 140 million housing units in the United States. That's true. But wait, look at how many are for sale. Currently only 499,000 are for sale. Now, this takes a few years to play out. Of course, we all understand that these 12.5 million people aren't going to suddenly form a household tomorrow. It may take three years, five years, it might take the next 10 years. But we know it's coming. That we can be sure of. We know the household formation and the demand is coming. We know it's coming. And we know that the supply will not be relinquished, meaning people dying off soon enough to satisfy this demand. And that's another equation. Right, the supply side. Right. But we know that There are currently 499,000 housing units for sale, about 0.3% of all of the housing inventory in the United States. Again, we're in a very inventory constricted market. And so what do we have here? We have normal inventory of about 1.2 million homes. We have urgently low inventory now of over 499,000 homes for sale. And how does that compare? Because the right question is always compared to what? Well, inventory is down by 10.3% year over year. So last year at this time, we had 10.3% more inventory. And if you look at the Pre pandemic era, 20, 19, at this time, inventory is down by 49.3%. We literally have half of the inventory we had pre pandemic. And we have a shortage of 700,000 homes below normal. And the shadow demand is 12.5 million. You do the math. This is the kind of stuff demographers and economists look at to understand the future need for housing and the future demand. So there you go. I hope that's helpful. Having a big shadow demand in a low supply world equals rising rents and rising prices. It just can't do anything else. And then people will say, well, housing affordability is so much lower than it used to be. And to that I say, you're right, but so what? Housing affordability is better in the United States than it is in a whole bunch of places around the world. It's certainly better than it is in the uk. It's better than it is in Hong Kong. It's better than it is in a lot of places. There are a lot of places around the world where the compared to what? Question would tell you that homes in the United States are actually quite affordable. So just because of this comparison to how it used to be here, right. How it used to be here a few years ago, yes, housing affordability was dramatically better, but that doesn't mean it can't get a lot worse. That's the thing. People have to understand the compared to what? You've got to compare it to the right thing. Right. And just because something was one way a few years ago doesn't mean it has to go back to that way. I mean, nothing really goes back to the way it was, does it? Look at all of the things in life that just will never, ever return. I know people love to be nostalgic. I do, too, about the old days and about the way things used to be. But that's just not the way the world works. Okay. So I hope that's helpful to you if you want to learn more about these issues and many more things. Join us on our Empowered Investor cruise. We're going to have last call for this real soon, folks, because we've got to make another deposit to Celebrity Cruises for all of these rooms. And it is really important that you book your ticket now. If you want to go, go to empoweredinvestor live.com empoweredinvestorlive.com hang out with us on the beautiful brand new Celebrity Apex. I believe this is the most stunning cruise ship in the world, actually, because I went on the sister ship several months ago in Europe and it was phenomenal. The celebrity Edge. This is the apex. This is the brand new sister ship of that. And it's just going to be a phenomenal time. We've got two days of education at sea, three days in port, networking, learning, having fun, having a great time. So join us for our Empowered Investor Cruise. Go to empoweredinvestorlive.com and get your tickets today. We're going to have last call for that real soon. And without further ado, let's get to our guest and talk about One Rental at a Time.

It is my pleasure to welcome Michael Zuber back to the show. He is the author of One Rental at a Time, which I think just the title of that book alone speaks to the right idea about real estate investing. You know, just this sort of progressive thing that you just do on and on and on just very consistently. I really like Michael's philosophy on that and he's got some insights on the market. So we're going to do a little myth busting today as well, I think. Michael, welcome back. How are you?

Jason, thank you very much. I love what you do. Being on your show is such an honor. It was always a goal of mine. So thank you for the opportunity and the opportunity to come back.

You know, you have a very good handle on the market. You cover it a lot with your audience. What do you think is going on? I mean, they're just, just so many opinions that I. It's overwhelming. Yeah.

So I think there's a couple of things. So, again, like yourself, I've been buying real estate, specifically rental properties, for 20 years, which means I started before the last crash. I happened to be lucky enough to sell all of my houses in 06 and 1031 into apartments because I saw pain coming. I saw it coming. So I sold. Right. I took action. I didn't know it was going to be that bad. It was twice as bad as I thought. And then I've been buying ever since. So a lot of people have come back to me and say, well, hey, you sold last time, you've got to be selling this time because the affordability numbers are horrible, if not worse today. Yeah, but I'm a data guy, I'm not a feeling guy. So something we're going to look at here was something I've now called the 53 year spreadsheet. I've gone back all the way to 1970, which is just before I was born.

Which, by the way, since we're speaking of years and age and stuff, I do have to correct you because you sort of made the casual statement like you, I've been investing for 20 years. I bought my first rental when I was 20 and that was more than 20 years ago.

There you go. So we got, we got, we got 50 years of experience plus combined. There you go. But the key is, I wanted to know because again, I took action last time. I saw the affordability, I saw the horrible underwriting, I saw the bidding wards. So I sold, I got out, I moved my money to apartments. I'm like, should I do that again? And I have a lot more now, so getting to apartments might have been the right idea. So I went back to 1970 and I collected a whole bunch of metrics and we're going to show everybody the metrics. We're going to highlight some columns.

This is good stuff. Yeah, I think.

But the key was, is have we ever seen a time where interest rates went up 500 basis points in a relatively short time? And if the answer is yes, what happened to real estate? Now, most people only focus on price. Most people only focus on nominal price, let alone real.

Right.

So that's where most people's heads are.

Yeah. In other words, nominal meaning in name only versus Adjusted for inflation, what is the real price? The other thing though, because There's a big YouTuber friend of mine who constantly talks about if you adjust real estate for inflation, it really hasn't done nearly as well as most people think. And that's sort of true. But here's the flaw and what he's not telling you, which is critically important. Most people and certainly all investors pretty much are leveraging their real estate so they are multiplying their returns. So it would be a false comparison. And I know I'm on a little bit of a tangent here, but since I'm thinking of it, I want to say it, to say that real estate prices vis a vis inflation haven't done as well as we think. But once you consider that they multiply Those returns typically by 5x with leverage, it's done way better than inflation. I mean, just dramatically better. It's so outperformed the market. But yeah, go ahead.

Yeah, I mean it's funny how people, again, there's a lot of negativity around housing and people preaching crash. A lot of people bring up this nominal versus real. But the debt also gets adjusted. Right. So let's not get it twisted. You're getting a 30 year loan and I would argue that if you have an interest rate sub 3, it's going to be the best asset you have because you've basically borrowed below the rate of inflation. So all of that. But back to my stated goal is I want to know what happened last time rates went up. I wanted to look at price. But there's also this little sneaky thing called transactions. Because as an economist I understand the supply and demand curve can both lines can move.

Transaction volume.

Correct. Total transactions correct. Because again, what I saw and called now two years ago was ultimately what we were going to have based on history is a transaction crash. We're down 40 and going lower, but prices would be stubbornly high, if not flat. And that's exactly what's transpired. So I'm going to show you the data that led to my opinion. We're going to go through some highlighted columns and I'm sure we'll dig into some others. You ready for this?

Yeah, go for it.

So again, just kind of level set what we're looking at here. This again is a 53 year spreadsheet, goes back to 1970. All of the metrics are down the left side. The year is at the top. Just so you know, it's not me. I sourced all the data from St. Louis Fed. So you can go Check all these numbers. So every, every metric has a source, unless it's math, like some subtraction or whatnot. So all the data is there. This is not just made up. But here's the deal. We're going back to interest rate environments because again, that was the question, right? Have we been in an environment where interest rates skyrocketed? So if you start in 1978, you will see an interest rate of 9.64%. Now that comes from December 31, because when you put a spreadsheet together, you have to, you have to make like for like. So all of these numbers were the interest rate on December 31st at the year. But what, at the year end, what you will see is from 1978 to 1982, interest rates went up 700 basis points. There's 16. Actually, if you go back to 1981, there's 16.64%.

And just to give it some context, this is the end of the Jimmy Carter presidency, the beginning of the Reagan presidency, and Paul Volcker as our Federal Reserve chair, who was the guy that is credited the late Paul Volcker for breaking the back of inflation, definitely causing us all to experience some pain, but also ending the inflation spiral. And I don't think Jerome Powell is going to be able to do that. But that's another discussion. Go ahead.

But here's the key. So we have had another environment where rates went up, in this case exactly 700 basis points. So when I saw that, I'm like, great, what happened to housing? Because again, a lot of people says if rates go up, housing has to crash, right? That's what people say. So if you look at row 8, nominal home appreciation, and let me highlight this in a slightly different way, keep.

In mind though, the difference is because we've said it a lot on this show, and I'm sure you've said it before too, Michael, that this is the fastest historical increase in interest rates. What you're talking about is a four year period versus ours is a one year period. But you know, again, our increase hasn't been quite this much yet. Hopefully it's not going to be, but yeah, go ahead.

Yeah. So again, when you go back to history, you can only use the data that was there, right? And again, we did see a bump of 300 basis points in a calendar year. But in the end we have seen 700 basis points. And if everybody's right about housing, housing should have crashed in prices. That's what everybody thinks. So I wanted to know what happened. Well, if you start looking at 1978, 1978 was last boom year was up 14%, nominally, 1979, up 12%, 1980 up 3%, 1981, up six and a half percent. Now, if you adjust for inflation, you will see the numbers below that. They're not quite as rosy, but in the end, we had rates go up 700 basis points, and price was not negative, at least nominally speaking.

Yep. Interesting. You know what? I'd love it. I think you need to add one more row to your spreadsheet and do the leveraged appreciation.

Oh, yeah, I could do.

So in other words, what you would do here, folks, this is the thing that everybody's missing. Okay, folks, is. I mean, everybody's missing a lot of things, but one of the things they're missing, okay? When these clickbait people talk about the housing market, they just don't understand the multidimensional nature of the investment, Right? And so what you do is you take an under row eight, you put leveraged nominal appreciation leveraged. And so you just multiply all those numbers times five. We're literally doing this now, folks. For those of you listening on audio, we're doing this right now. I can use Excel, assuming 20% down. Okay. Yeah.

So let's. Let's go back and let's go do all of these.

Yeah, this is going to blow your mind, folks.

So this is a percentage. So this should probably be. Would it just be five, or would it be 500%? Let's see. There we go. And now we just drag this across.

Look at this. This is incredible. And then you subtract inflation, because, remember, everybody, your real estate is leveraged, but inflation is not leveraged.

Correct.

So inflation only gets the rate of inflation. You know, it doesn't get to multiply itself times five.

Okay, so you would do that in the same row, or would you want to do that in a separate row?

Well, I would do the. The real home appreciation is now a new formula, because I was thinking, yeah, it is the leverage return minus the rate of inflation.

And just so people know where inflation is, that is row 26. And we'll just add this. We'll drag this over.

So, Michael, this is fascinating. Now that your spreadsheet shows the real appreciation with leverage. In other words, the formula for that is you take the appreciation rate and then you multiply it times five, assuming there's 20% down or 20% equity, either way. Right. And then you subtract the rate of inflation.

Right.

And then you get the real home price appreciation. And it was phenomenal. But in 1982, it did go negative. So why don't you just go through these numbers with us a bit?

Yeah, so if we focus on the spreadsheet, row 8, that is nominal home price appreciation, and that again, comes from the St. Louis Fed. But that's just a single number. What we then do to your point is most investors will buy with 20% down. So again, if you want to get the benefit of leverage, we have to multiply that by five. But when we're really looking at real appreciation with leverage, we also need to know that there's this stealth tax called inflation. And for this scenario, we took the cpi inflation, it's the most reported, and we've kind of put that together so folks really can get an appreciation for what was going on in the housing market with leverage and the inflation rate. And it's really shocking, both on the good side, right. The big positive numbers and on the negative numbers. Because there are some negative years.

Yeah, right. But the negative is pretty minimal and the positive is insanely positive. I mean, for example, who would have thought? Because they don't know how to do the math. Okay? But if you're doing the math right, in 1979, the last, you know, year. Well, not really the last year, but almost the last year of the Carter presidency, okay? Which you see that nominal home price appreciation, even with Paul Volcker increasing rates, is 12.4%, but inflation is out of control at 11.25%. Okay? Now look, nobody here is under the delusion that the government, the cpi, is giving us the real rate of inflation, okay? So even if we adjust for that, still these appreciation rates are phenomenal. And we're not even talking about return on investment from rents and so forth. But then in 1979, your real appreciation rate with the leverage minus the inflation rate is 50.5%. So if you're rounding properly, it's 51% appreciation. But look at how radical it shifts. One year later, 1980, it goes down to only 2.4%. But then the next year it goes way up again to 22.1%. And the next year it goes down to negative. And this is the only negative year, negative 4.1%. And then the following year, it basically 11 x's that and goes positive 41.2%. Now, again, this doesn't tell you everything because if you had a property with negative cash flow, you're paying to sustain that property, and you would have to subtract whatever you paid from those returns. Okay? Correct. But you know, we're assuming you're breaking even here. If you have positive cash flow, you did better. Okay, so this doesn't tell the whole picture. It doesn't talk about the tax benefits, which is a positive thing, of course, or anything else. But, you know, this is really, really enlightening. What do you think?

No, it absolutely is. And again, at the end of the day, I go back to why I put this together. I put this together because I had to make decisions about my portfolio. Last time I decided to sell. This time I was looking at the environment. I was seeing historical evidence of significant interest rate rises, and I wasn't seeing the deterioration in price. So then I asked myself, well, if price isn't deteriorated and affordability is undoubtedly horrible, what else could be adjusted? And that is supply, AKA transactions. So what I would ask you to look at here is look at total transaction. We've highlighted the row in pink. It's row seven. We see a total transactions. This is new home sales and existing home sales total. We'll round it to 4.8 million. Now, you won't be able to see it on the screen.

What year are we looking at?

1978.

Okay, so 1978, there were 4.8 million housing sales. That was the sales volume.

Correct. Transactions, Correct.

Okay.

New and existing. So new homes and existing. And again, my whole question was, what happened last time? Rates went up.

And by the way, we are below that number now.

Oh, no question.

But it's. But it's actually, and let me, I'll just say it now so I don't forget, it's actually dramatically worse now because we have as a comparison, like on a per capita basis. Right. As a comparison to the population, which is much larger now, and the number of housing units, which is also much larger now. The market in terms of sales volume right now is dramatically worse than that. So we are in this frozen, weird market.

Yeah, Most people would call that turnover. Turnover is much worse today than it was in 1970.

Lower turnover.

Correct. Lower velocity. So, but back to my question is what happened? So if I were to ask the audience, just a guess, in 1978, we did 4.8 million transactions. We've just highlighted that interest rates went up 700 basis points in four years. What year or how many years, depending on how you want to answer it, did it take for us to take out the 1978? 4.8? Like, how long did it take for us to do total transactions above 4.8 million?

Okay. And the answer is.

So the answer is a lot longer than Most people think so. Again, you can see the transactions, they come off 4.8 to go to 4, 5 down to 3 5. But we don't actually get back to 1978 numbers until 1996. Wow, 18 years.

So the, the real estate industry, not, we're not talking about the market, we're not talking about investors, how much money investors made or didn't make. We're talking about the industry side size, the brokerage industry, the title company industry, the mortgage industry. Well, you know, mortgage industry, you know, you don't have to have a transaction to do a refinance. So that's really actually different. And rates went down so much. There were probably, you know, plenty of refi, refi businesses. So. Yeah, very interesting. Okay, so, so tell us what does that mean to you?

When I put together, and again I made this real decision, I put this together about 18 months ago, I decided that I wasn't going to sell any of my single family homes. And again, I'm somebody who sold in 06. So this was a different decision because I saw what was going to happen and that was there was going to be a marketably drop in transactions. I estimated 40 to 50% which has now happened and values would be stubbornly high if not go up. Because what's going to happen and now is being reported by everyone is people are going to treat their mortgage like an asset. You're going to hear people called lock in, you're going to hear all these things and we're going to have luxury properties sit on the market. But the entry level stuff, the Fed broke the housing market market and this spreadsheet told me is the Fed could break the housing market for more than a decade. So I'm prepared for transactions to be right around 4 million for the next five or six years.

Yeah. So it's like throwing a stone in a pond, right. That generates a lower income for everybody in the real estate industry with the exception of the mortgage people, which now it's terrible for them and a lot of them have washed out. So you can, you know, if you have your pizza delivered, it might be from a former mortgage broker, sorry, mortgage people, I, you know, your business is very volatile, but you, you make tons of money when it's good. So that will have a, a little bit of a shrinking effect on the economy. But that's just the transaction industry, right, the home renovation industry. My thesis has always been, since the beginning of COVID that that industry is going to actually boom quite well with lower transaction volume. I think more people do home improvements. It's just my theory. I haven't really researched it, but it just sort of seems obvious to me.

I think there's a couple of things there. I think. I think we clearly. I think evidence is on your side. 20, 20, 21, 22. I think we're creating probably an air pocket right now where people are just trying to figure out everybody's already done their backyard, They've done the fence, they've done the patio. But again, consumers are very predictable that in a year's time, they'll be like, oh, time to update it. We've, you know, we've got to do this, we got to do that.

We got to remodel the kitchen now.

Yeah, yeah, exactly. We got to do the master bath. We got to do that. So. So I think your thesis, you know, minus this little air pocket is right on, because people are going to age in place. Historically, people have stayed in their homes for about 8.1 years. I have a sneaky suspicion in a decade that's going to average 12 or 13 years, we're actually going to have people pay off their mortgage. Jason, that's going to happen.

42% of the country has no mortgage already.

And we'll be back with a lot more on this topic with this guest on our next episode. Thank you so much for listening. Please be sure to subscribe so that you don't miss any episodes. Be sure to check out the show's specific website and our general website, hartmanmedia.com for appropriate disclaimers and terms of service. Remember that guest opinions are their own, and if you require specific legal or tax advice or advice in any other special specialized area, please consult an appropriate professional. And we also very much appreciate you reviewing the show. Please go to itunes or stitcher radio or whatever platform you're using and write a review for the show. We would very much appreciate that. And be sure to make it official and subscribe so you do not miss any episodes. We look forward to seeing you on the next episode.