413: How the Current Rental Market Is Affecting Real Estate Investors & Where to Go From Here with Steven Thomas

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It is my pleasure to welcome Stephen Thomas. He is the founder and chief economist for Reports on Housing and you may have seen them in the news media. They are all over the place and he's got some really interesting insights for us today. One of the trends that he's been studying is something that I talked about, but not calling it by this name a couple of years ago in predicting how this poison pill the Fed has put into the market with these artificially low interest rates is going to cause people to not want to give up those incredible mortgages. And you know what? Millions, well, tens of millions of people have 28 years left on those loans. So we're going to talk about that today when we talk about hunkering down. Stephen, welcome. It's great to have you.

Thanks. Appreciate being here. Thank you.

And you're coming to us from my old stomping grounds. You're in Orange county, specifically Ledera Ranch, and I know it well, so it's great to have you. But tell us about your view on the hunkering downtrend. People not wanting to relinquish their properties, right?

Yeah. It's a trend that we knew once interest rates really started to rise.

What seems to be exponentially is such a gigantic sea change that everybody had locked into, or not everybody, but most everybody had locked into these really incredible rates. The people that had higher rates, of course, are probably nearing the end of their term. So if anybody had purchased over the last 10 years, many of them refinanced.

After we hit record low interest rates during the COVID year of 2020 and then all the way to January of 2021. And then we enjoyed those rates throughout 2021. So many refinances took place. So everybody's locked into these really incredibly low rates. And with rates as high as they are, it's such a big gap that's preventing a lot of people from placing their homes on the market.

Yeah. So it's a pretty tough decision for a homeowner to say, hey, look, you know, we Want a bigger house or a different house, or move to another city. And, you know, we don't want to trade our 3% mortgage in which, by the way, 25% of the country has a mortgage sub 3%. I mean, that's incredible. We don't want to trade our 3% mortgage in for a 6% mortgage. Imagine that.

Yeah, exactly. Exactly. And it's not necessarily many people are ready to make a move, but. But they just don't want to because it's so cost prohibitive. And when it gets this cost prohibitive, they might not be in love with their home, but they're definitely in love with their loan. They're in love with their incredible payment. And that's what's preventing people from contacting a professional place. That sign in the yard.

Yeah. And you know.

The thing I think this will spark is it will keep inventory low, possibly for decades to come, but it will also spark more interest in home improvement, remodeling, home additions, because instead of moving, people are going to put that second story on. They're going to add a room, they're going to remodel the kitchen, the bathroom, you know, maybe, you know, make the house nicer because they can't move that mortgage with them. And I don't know that we've ever really been in this situation before. I mean, the famous last words of every investor is this time it's different. But it really is quite different, isn't it?

Yeah, the playing field is extremely different. I used to say that when rates go up a little bit, it's not really going to be. It's going to create a hunkering down effect. But I proved myself wrong. And that's what economics is always about, is seeing the evolution of looking at the data. And the data is definitely showing that when you go up this fast at such a great clip that it just keeps everybody frozen and still people are transacting. It's just we're dealing with far lower numbers than what everybody's been accustomed to.

Yeah. So do you see this as being a real problem with housing inventory for years to come? As do I. I do.

I have a slide that shows it. I'll go ahead and share my screen and show you kind of what I'm referring to. Just so you can understand, these statistics come out on a monthly basis across the United States. 40% of everybody out there owns their home free and clear, but the other 60% has a mortgage. And of those people that have a mortgage, you're looking at 65% that have an interest rate of 4% or lower and 24% have an interest rate of 3% or lower. And the average interest rate out there across the United States is actually three and a quarter. So three and a quarter when we're now pushing up towards and beyond 7% interest rates, that's such a giant chasm. And we're not going to be coming down towards these low interest rates anytime soon because this inflation battle that we're dealing with is going to be something we talk about for this decade. And also inflation is going to be a problem for this century because we're having an issue with our population, a big population of baby boomers that are aging out and they will be leaving the market as far as being employed in their jobs, jobs. And there aren't enough people to backfill these jobs.

Right.

So put more pressure on wages, which puts pressure on inflation.

Right, right. So let's just be clear, make sure people understand that. Stephen. So baby boomers leaving the workplace means we've got my generation, Gen X behind them. And we're a much smaller generation, only about 46 million versus baby boomers, about 76 million. And that means there's going to be a continuing worker shortage, which puts upward pressure on wages. And when you have wage inflation, you have inflation period, because people simply have more money to spend. It's going to go out into the economy and buy more stuff, right?

Yeah, absolutely. And you have to understand that.

We'Re getting a, a group of people that will be retiring and not enough people that are coming into these jobs. And this is going to be, and we've also locked down borders. There's not enough people that are coming in to replace, replace, like I said, backfill these jobs. So there, there's going to be less spending from the baby boomers, but then we're going to have more, you know, this inflation is going to be pretty hot in the lower end and it's going to continue to feed on itself for quite some time. And we've seen how the Fed fights this. The Fed does not like to see wages get out, out of hand. So how do they fight this? Higher rates. So which, which begs the question of how long are these, how long are we going to be at higher, this higher rate environment? And it's seemingly going to be for quite some time, like what you were alluding to earlier, Jason.

So what are we going to do? I mean, there's already a terrible housing shortage. Is it just going to persist for, for decades to come?

I mean, yeah, it is.

Yeah. Before you answer, I'm sorry, let's just go back to that chart. Keep that up for just a. Yeah, yeah. Let's just parse that up a little bit more. Okay, but that's the overlying question, the one I just asked. Okay.

Yeah.

And we've got.

285,000 people in the country have mortgages below 2%. Boy, those lucky people. They must be like Greek gods, you know, two to two and a half percent. 4.7 million households. Do you think those people are ever selling? And between 2 and a half and 3%, 13.1 million homes have that mortgage. Another 11 million under 3 and a half percent.

Wow.

Another 9 million under 4%. This is incredible.

Yeah, yeah. So this really does. So we were. I was seeing this in the numbers, and then we started to. To see how it looked within the marketplace. And in looking at what's happening in the marketplace, we are definitely getting fewer homes coming to the market. And as rates have come up since about September 1, once the Fed came out of Jackson Hole, Wyoming, their economic conference, oh, all of a sudden they came out swinging and they came out hot and heavy. They're like, people say they're hawkish. They're like hawkish with MK47s.

They have messed this up badly. They should have raised rates much sooner and much more gradually and we would never be in this problem. But Powell believe the transitory myth and we're all going to suffer from his. His mistaken belief.

Yeah, so he had egg on his face and now they're going to fix it. And they're not. They're going to make us take our medicine and they are not going to back down until they see that it comes down there. No problem with overshooting it. They don't want to undershoot it because they'd have egg on their face again. So they're more inclined to overshoot this, which definitely looks like the direction that they're going to be going. I wouldn't be surprised by the end of the year if we don't see interest rates close to Mid/7 to 8%.

Wow. Wow. Okay. So these people aren't selling their houses. If you want to pull the chart down now, feel free. But what's next? I mean, what do we do? You know, we're going to have inflation and a low housing affordability and people that just won't give up their houses all at the same time. I mean, you know, years ago I heard someone talking about the idea of a mobile mortgage that you could Move from one house to another. I don't know how that could possibly work, but it's an interesting idea. I mean, is there any solution hanging out here in the, in the future?

Well, knocking on doors of people that have FHA or VA loans, those are assumable right now. Seeing if there's any assumable loans that are out there. There's not a whole heck of a lot. But there are FHA and VA.

Loans.

That were done and we do know that those are assumable. That's a direction we went in 1980s. Everyone got really creative and that's what everybody has to get back to, getting creative in order to make things happen, in order to move from point A to point B, if that's what you really want to do. But yeah, you have to do a lot of homework, a lot of legwork.

Okay, so what else? The hunkering down thing is hugely significant in my opinion. I know you have some other stuff you want to show us. Yeah.

So I kind of want to talk about the CPI and how sticky it's going to be. And it's going to be sticky for quite some time.

We just need to get used to this new idea of having to battle inflation. And every time they're going to back off, the inflation could rise again. And the only way to battle it is of course one of their biggest tools in their arsenal is increasing the short term rates, which is credit card debt, automobile loans, equity line of credit. But it also investors, investors take a look at this and they start pricing in these short term rates, these rates in the system. And that's why we get the long term rate goes up pretty much prematurely prior to them even making these changes. And the Fed has changed their tune from the beginning of this year all the way to where we are today. And every time they talk it's like they get more aggressive. It's like they push down the gas pedal a little bit harder. And if you see this, this is the cpi. This is just going to make it even worse. Worse because they. This just came out last week. Fed meets next, next month. Looks like we're going to get a three quarter bump in November. We could possibly be looking at based upon the next CPI read if it's also too hot and heavy, which I think it's going to be, we're going to, we're going to see a three quarter point bump in December and that is going faster than the market expected, which is why we can see interest rates go up because. Oops, that was kind of There's Jerome Powell.

I love that one.

Yeah. So this is where rates are right now. Today, Core is super. You can see how it goes back in time. We're about 1983 levels. People think it can continue to go up, but they're fighting so hard that eventually we're going to get this lid and it's going to come down because we're already seeing it in many different metrics that have not been absorbed yet in cpi. But this is the way I look at it. Once inflation gets out of hand, it's like putting toothpaste back.

Into the toothpaste bottle. And it's very, very difficult to do. It's a slow process. It's a grind. And they're doing it at the expense of the housing market, because the housing market is where it's truly affected by these higher rates. As we've seen, we've seen demand come down and when they got more aggressive back in, back in the end of August, start in September, we saw an inflection point in all the data. Inventories were peaking out and they were starting to come down across the country and demand. But then it, all of a sudden it flattened, right? Demand fell quite a bit. Demand is falling at. Normally falls during this time of the year. So does the inventory. It's seasonal. Starts to. Starts to fall. However, demand is falling at a greater rate than it normally does, about twice as fast. So we're getting fewer buyers in the marketplace. But this is now the inventory. The only reason why it's not. There's not a whole bunch of sellers that are accumulating and the inventory is growing is because we have fewer homeowners coming. So it's exactly what we've been talking about. So we're just going to have fewer participants on the buy side and on the sell side. And this is. I made this slide because this definitely shows how incredibly hot the gutter reserve has come out. And they've come out pounding and they've said that they're going to cause a lot of pain in the marketplace.

This is unbelievable. I mean, I never thought Jerome Powell would become the next Paul Volcker. I mean, I just never thought he had the guts to do it and neither did I. Yeah, but now he's overdoing it.

Well, you know what book is sitting on his desk, right?

What book? Oh, which I do, and I can't remember.

Paul Volcker's book.

Oh, yeah, okay. God.

Paul Volcker's book is sitting on his desk, which he's. Who wants to be that Next, Paul Volcker and definitely going down that pathway. So this is the way I see the Federal Reserve, like I said, a hawk with the, with a firepower job. And what they're looking for is kind of something to crack. And that's the job openings. They want to see job openings come down way too hot. Job market is way too hot. And I already explained it's going to be hot because we don't have these replacement workers. So this is going to be really hard to bring down because we're still seeing help wanted signs all over the place. But yeah, they definitely slow the economy enough. And then unemployment actually went from 3.6% to 3.5%. Going the wrong direction once again giving fuel to the, to the idea of having two more three quarter point bumps this year, November and December. And then consumer spending. We've got to stop getting on airplanes, going and traveling and stop going to restaurants. It's been way too busy. That's what they want to see. These are the things that they're following. And until we see these metrics start to change, we're not going to really see it translate into the cpi. And it's taking time, a lot more time than I thought. So that's why I actually don't see a recession until like second quarter of 2023. But who knows? It's anybody's guess. Once again we'll just have beers and figure out where rates are going to go and when this recession is really going to start.

You know, I know how to solve the inflation problem without it being very painful. But sadly, the way the government is going, it's going the complete opposite way of the way I would solve it. I would solve it through deregulation and you know, trying to exploit more cheap foreign labor markets and letting people build stuff, including developers building more housing through deregulation and just making it easier to manufacture and you know, less. Fewer labor laws just take out the friction. The system has become so top heavy with just regulation that it's, it's just so expensive to comply with all that regulation. The cost of compliance translates into consumer prices, you know, and that's what's got to be done. And that's the much less painful way to get out of the inflation problem. But we're going the opposite way. They want to introduce all sorts of green, new green rules and I mean it's just, it's just the complete opposite. And that's going to make everything more expensive. It's going to make for more inflation. And yeah, this is a Tough. The Fed is in a tough spot, aren't they?

Yeah, Fed's in a really tough spot. And then you throw into that. Now we have opec.

They want a monkey with oil. They want to take advantage of this. If you see what GDP estimates for next year for countries around the world, the ones that are going to go positive are all oil producing countries.

We're supposed to go negative, they're going to go in the positive and that's because they have control over oil. With the war between Russia and Ukraine, they see this as a really good pivotal point for them to jack up prices a little bit more and take it to the United States.

Yeah, that's true. And you know, our current administration has really made a point of lessening our oil production, so that's even more inflationary. Where do you see housing prices and inventory going over the next year or so?

Yeah, that's interesting that you ask that because the model that we follow for, with supply and demand is actually broken. And the reason it is broken is because of where rates are at today. There's so much.

It's like this big anvil from the Bugs Bunny cartoon with mortgage rates. It got so big that it is pushing down on the housing market. And as a result, we're seeing prices, Tom, start to come down regardless of where the market lines up. Because for the most part, the market's still lining up slightly in favor of sellers. If you look at just the sheer number of homes that are available and the buyers, the marketplace, but there's so few homes on the market, it's matched with so few buyers in the marketplace. And the buyers that are in the marketplace today do not want to stretch, they do not want to overpay, they do not want to be a part participant of that first froth that we had earlier this year. So we're seeing prices already come down in many, many markets. And I see prices coming down next year. It's only slightly that they'll slowly come down because the homeowner is really strong. This is not the Great Recession.

Yeah, so. So there's no distressed homeowners out there? Well, I mean, there's like three of them, I like to say. But you know, all the mortgage underwriting has been so strict that, you know, the, the homeowners have good credit scores, they have low interest rates, they. 40% of the loans in the country are paid off. I just, you know, the, the new home inventory that is coming on the market as the developers tried to catch up, a lot of that is going to the build to rent companies and it's just turning into the rental market with institutional landlords and then it's just higher priced properties, you know, and the areas you said like you see some softening in prices but most of that is in the expensive markets, you know.

Yeah.

And those are the markets you profile, you really specialize in. Southern California, you're adding Northern California. I know. And then you do some Phoenix and Las Vegas, also somewhat expensive, but yeah, to comment on that.

Yeah, you know, Phoenix and Vegas and some of these other areas that have Boise, Austin, they're right now seeing inventory that's already caught back up to pre Covid levels. I'm seeing it in Vegas right now. They're already lined up in buyer's market area. They have over a four month supply of homes. That's right.

But they gotta have six months supply just to be considered normal. They're not even a normal yet.

Yeah, but at four months now the metrics show that right now we're getting values coming down and we have market times of, of less than three months. And when you get up towards four months there's more weight on values coming down because there is more competition. So we're going to see values coming down in those areas just like we're seeing in SoCal too. And in SoCal we're seeing a little bit more because the sticker shock is gigantic. When you're looking at for an example, Orange county is at $1.2 million as a median detached home right now. And, and if you put in the interest rates where they're at today, you're looking at seven grand per month for, for the middle, middle house. There's not that many people that can afford that.

So are we just going to see a lot more wage inflation? Are wages just going to catch up with that or what's going to happen?

Well, it's got to stop. There's two things that can happen. Inflation and as well as values come down slowly and then they'll meet to where the Fed wants to see more balance and they said that they want. Somebody asked them what they meant by a reset. One of the things that he answered this was just back in September, he said that what they're looking for is a correction in the housing market. And what he meant by that is 10 to 20% down in value and not nominal. Probably real is what he's looking at. So if we get that coming down, we'll see more balance in the marketplace. They didn't like to see what we all didn't like to see. And that's because they kept rates down so low that it was just fueling this unneeded extra demand. We didn't need the extra, have enough homes to begin with. And when you throw in this incredible demand with not enough homes, we get what happened to values. But values unhealthily skyrocketed northward. So it's time to just give back a little bit of that value because it was just, it was, it was absurd.

It's totally absurd. And I mean, you know it all too well. In Ladera Ranch, I'm sure it's, you know, that was one of the markets that went crazy like that. Yeah, good stuff. Well, is there anything else you want to share with our listeners as we wrap it up?

Yeah, it's just, I wouldn't, I wouldn't expect this market kind of what you see is what you get in this marketplace. There's so many people that are rooting for so many different things given their different vantage point. Everybody's rooting for what they, what they want in the marketplace. I listen to people that do BPOs or follow foreclosures and I talk about that no foreclosure wave coming and they get all bent out of shape. They tell me all the BPOs they've done within the last week and they tell me all the asset managers they've been talking to, it just doesn't exist. That's just not going to exist. Just like the buyer.

Let me just explain, just explain that for the listeners. A BPO is a broker price and what that is is like a cheap version, a cheap, quick version of an appraisal. And banks order these BPOs en masse usually to sort of assess their portfolios. And if they're considering, you know, foreclosures and like there are certain brokers who specialize in selling foreclosure properties for lenders. And so they want to ramp up and do more BPOs because that probably means more businesses coming. But like you said, Stephen, it's just not really there, is it?

No, it's not. As a matter of fact, the delinquency rate right now, which includes even people that are currently in forbearance, it's at decades lows. So we're going to have a, we're going to, it's going to take some work even to get to pre Covid levels, let alone even close to great recession levels, which some of these people are arguing is going to happen. So that is something that I think that everybody should be concerned or if you hear people talk about this wave, you've got to discount it. Another thing is that this market's going to be like the Great Recession. You just need to understand, even if we go, we're going into this recession, it's not going to be the Great Recession. The reason for that is billion reasons and tight lending qualifications. No teaser rate loans, no BK's, no glut of homes on the market. There's so many, there's dead people, dogs that got, that got property. So and true story, two dogs got loans. So we don't have that kind of fraud in the system or anything. Every single downturn is different. Do not compare it to the Great Recession. This is going to be much more mild compared to that. But are we going down? Well currently, yes, in many, many markets. And the rest of the country will catch up just given how.

The Fed is pressing on that gas pedal as hard as they possibly can to break things. And when they do that, they're going to break things like employment. We can see unemployment go up. We could see job openings go down. We could see people spending less and we could see you. There'd be some unemployment to this recession which would cause more housing transition. So. But it's going to be different.

Yeah, it is going to be different and I think it's going to, you know, if people are waiting for some big crash, I think they're just going to be sadly mistaken. Don't hold your breath. It just, there's just no indicator that that's happening. I mean there's no reason for all of the sellers, the potential sellers who own homes now to sell them. There's just, there's lots of reasons for them to keep them and almost no reason for them to sell them. Like when you talk about distressed homeowners and foreclosure activity. Yeah, it's, you know, like there's three people in the country in foreclosure obviously, but, but maybe there's four or five. Okay. But it's nothing. It's a drop in the bucket. And everybody who's, who's, I mean, you look at those studies of credit scores of current mortgage holders. I mean these excellent credit, these are golden borrowers.

Yeah.

You know, there'll be a little more unemployment eventually and some people will lose their job and you know, it'll peel off just a very small number of houses, but just nothing close to fixing the inventory shortage. Not even close.

No, not at all.

So Steven, everybody's talking about housing prices, but what about rents? You know, real investors? I mean, most of our audience is interested in investing. They don't invest for capital appreciation, they invest for yield return on investment. It's all about the yield investment. That's the way, you know, Warren Buffett thinks, that's the way value investors think. What is going on in terms of housing rents?

Yeah, so of course now we're seeing they were spiking, they were going up at extremely rapid pace. But you're everybody's, it's hunkering down. Renters are hunkering down too. They're not going to, they're not as inclined to move when, when there's a lot of fear in the system. So we're not seeing a lot of movement. We're also seeing, not seeing rates continue to, rents continue to go up at a, at a, at a really fast rate. What we're seeing is more, it's going to move more towards a flat line. During the Great Recession, people said rents are going to come down. They did not. So that's something that we all have to keep in mind. It would be very, very hard for rents to come down. There are some markets that are vulnerable and those are the markets that have, that are building a ton of multifamily units. You know, those skyrise apartment buildings.

There are certain segments around the nation because that is what is being built right now. Way more multifamily units than we have of brand new homes. So you've got to know your marketplace and know what you're competing against when you're pulling the trigger on where to invest next.

Yeah, sure, makes sense. But overall rents make the deal work. And people I really think need to be focused much more on that rental income than the housing prices because our people are not flipping these houses. Right. They're buying them and holding them for long term income. And the other thing they have to look at is what is the alternative. You know, there's an acronym in the investing world, Tina T I N A there is no alternative. I know you know this well, right. And if you keep your money in the bank, you're going to lose 9% per year for sure. I think the real number's more like 17% if you look at real inflation versus the CP lie, the CPI.

But you know, believe whichever number, it's 9% or 15 or 17%, you know, whatever you want to believe. And you know, if it's in the stock market, who knows if it's in crypto, definitely, who knows. But you know, the income properties are pretty darn stable and that income component is Quite reliable. Like you said, during the Great Recession, rents really weren't that affected. I mean, they, it depends where they were a little bit affected, but by and large not an issue.

Right, right, agreed. And just know that we went up in value too fast. We should have done what we should have done in five years. We did in two.

Right.

But like you said, it doesn't matter. You're going to be holding it long term. So if you're going to be holding it for longer than the next three years, you know where values are going to, can continue to go and where it goes over time, it's just a really good investment is real estate, period. So you're looking at cash flows down the road. That home's going to be worth more.

And you're going to be able to refinance it. When we have another, once we go into the recession, the Fed will start cutting rates to ease the recession and then you'll refinance then.

Yeah, they're talking an extremely.

Big game and they're putting on their big game face right now. But it's really easy to do. It's really easy to talk about pain when there is no pain. But once there is pain and constituents, everybody start to, to start to point the fingers at the Fed and there's a lot of political pressure. We'll see if there isn't that pivot.

That we're talking about, they won't be able to withstand too much pressure. So, yeah, that's, that's a good thing. So it's a different time, folks. Listen to experts like Steven. Steven, Give out your website.

Yeah, you can go to Reports R E P O r t s reportsonhousing.com.

Reportsonhousing.Com Stephen Thomas, thank you so much for joining us. Absolutely.

Thank you.

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