Housing Market CRASH Predictions with Eric Basmajian: Part 1

The thing that kills everything on both sides of that equation, the rental yield side and the housing price side, is a reduction in population. And that's something we're really going to have to contend with. In about 30 years. We're going to start seeing that in the U.S. china, of course, and Japan and Russia and many other. And all of Western Europe is just like I always say, if you want to have a country, you have to have children. Okay? You just can't have a country without children. They're seeing that, that in a huge way. And their economies are just a disaster.

And now here's your host, Jason Hartman.

With the complete solution for real estate investors. Good day and welcome to episode 1894. 1894. Thanks for joining us today. We have a returning guest for you today who will be here with us today and again on Wednesday because we took a very deep dive into the housing market. Of course, that's mostly what we do here, as you know. And I want to reframe this issue. It is so important that we reframe this issue. Why is that? Because without the proper frame, you as an investor and all investors will experience massive, costly blind spots. And you cannot afford to have these blind spots. So many investors are operating from the wrong perspective, the wrong frame, and they need to be operating from the proper frame. Now, one great example of framing, right, when you're framing any issue, any thought process, any debate would be from. And you can look it up. I think I've played it before on the show, but it's such a good example. And it is the old, old, uh, 19, I guess it was. Was that 1986 maybe? Uh, I don't know. Anyway, 1984 something presidential election where Ronald Reagan was debating with Walter Mondale. And you, you probably know what I'm going to say here, right? Mondale made a remark about Reagan's age because at the time, now we've, we've vastly exceeded that now with the half asle we have today. But at the time, Reagan was the oldest person to ever run for president. And he turned out to be a pretty great president. Certainly not perfect. I have my complaints about Reagan, but he was overall quite good. And Mondale made an issue in the debate of Reagan's age. And Reagan reframed this beautifully. I mean, it was a masterstroke, saying something to the effect of, as the attention turned to Reagan to hear his response when Mondale brought up the issue of his age, or maybe the moderator brought it up, I don't know. I can't remember. Anyway, whatever. The point is, the issue was raised of Reagan's age and Reagan responds with, I will not exploit for political purposes my opponents youth and inexperience. That was just beautiful because what Reagan could have done, what most people might have done, is simply tried to rationalize, justify and defend themselves. But instead Reagan just completely threw a different frame on that issue of his age. And, you know, it was a correct frame. Right. And Mondale said later in an interview that he realized at that moment that he lost the election and Reagan won the election. And we all know the rest is history, as they say. Right? So when it comes to the housing market and when we're thinking about our investments and what we should do, and of course, I've talked about this last week. I did a pretty good spot on it last week, I think on Wednesday, you know, I've talked about it along the way. But so many people are agonizing over whether prices are going to go up or down. And okay, you know, fine. There are different opinions on this. Our guest today actually is fairly bearish. He thinks prices will go down a bit. And I think that's only really true in the cyclical markets, given where we are today. Right, but the point is that that is not the debate. That is not the frame, that is not the issue. The issue is, remember investors, for the 17 or 18 years that you've been following my work, what have I always said? I have been entirely consistent on this all along the way. No exceptions. Investing is a game of yield. It's all about yield. If appreciation comes, great, you know, I can spend it as well as the next guy, right? Fantastic. But we are not about capital appreciation as investors. The primary reason we invest, our main frame is yield. How much yield do we get off of our investments? Right. We don't need to see huge appreciation. You know, if we just get an average of 6% a year over time or even 4% a year overtime, we're going to do fantastic. We're going to be great. Okay, that is the frame. And the other part of this frame, maybe it's another frame. Maybe there's two frames, right? So the other frame is that if we see continued softening due to these higher rates and, you know, the general economy as a whole, we will see upward pressure on rents. Why is it that everybody out there is simply focused on one frame and I say it's the wrong frame? It's the frame of our prices going up or down. As yield oriented investors, as yield farmers, we don't really care of Course, we'd rather see prices going up and rents going up and our interest rates be super low. That would be great. And our expenses below. But it's not, not always that way. Right? We just invest for yield. So you go to Jason hartman.com, you click on the properties page, you look at the projected yield on these properties of 15, 20, even 25% in this market with very conservative projections, very conservative assumptions. And by the way, a lot of other people, you might be listening, who don't put in all of the legitimate, accurate assumptions like they assume your property will never be vacant and it will have no expenses to run and there will be no repairs and no maintenance. Yeah, these are not credible people. We have credible, realistic projections. Okay, so go to jasonartman.com, take a look. Right? You invest for yield. And remember, if you wait and don't invest, you're going to lose to inflation. So whatever the inflation loss projection is, take that and add it to the yield projection and then you'll know how much. That's your opportunity cost. That's your frame. That's your opportunity cost by waiting. Right? That is critically, critically important. So that's the frame. And I'm going to kind of talk about that with Eric today. So when we get to Eric in just a moment here, I think you'll benefit from that a lot. But look at the second frame I talked about. Okay? So, and if you're watching on video, this is on the screen five. This is a CNBC meme that they posted or a infographic, I don't know what you call it. Five cities where at least half of millennials can't afford to rent a one bedroom apartment. Just a one bedroom. I mean, this is not a two bedroom, not a nice place, just a little cracker box place to sleep. Right. Los Angeles, Long beach and Anaheim, California. Right. Annual income needed to rent a one bedroom is $73,000 a year. Median income of millennial renters is $37,000 a year. Look at the massive disparity there. Okay, right near me, Miami, Fort Lauderdale, West Palm Beach, Florida. Annual income needed to rent a one bedroom apartment, $52,000. Median annual income of millennial renters, $31,000. So these gaps are ginormous. This whole huge generation, the biggest demographic cohort in American history, the millennial generation, simply cannot afford this. Let's go to number three, San Diego, California. And you know what's interesting? I've lived in a lot of these places, so I know what they're like I grew up in la. I currently live in South Florida and I lived in San Diego, as you know. Okay, so annual income needed to rent a one bedroom apartment in San Diego, 70 grand, you gotta have $70,000 a year. Median annual income of millennial renters, $42,000. Okay, right near me, Orlando Kissimmee, Sanford, Florida. Right. Disney World area. Right. That metro income needed for a one bedroom, $49,000. Income of millennial renters, median income, $30,000. Now let's look at San Francisco. You know, of course, very out of whack San Francisco, Oakland, Hayward, California. See, they include Oakland and Hay. Not the super expensive San Francisco. It's the outlying sprawl in the suburbia as well. Annual income needed to rent a one bedroom cracker box, $100,000. Actual median annual income of millennial renters, $63,000. So there's a huge disparity there. And part of this frame I'm talking about, the second frame I talked about, is the rents. You've got to understand that these rents in the markets we're in, that we're recommending, which are, by the way, not these markets at all, these are the cyclical markets that are overpriced and, well, except for Orlando, that's the one I would make an exception of, that will see declines in prices. Right? These rents. There is so much upward pressure on rents. It is just phenomenal. The demographics for the rental market over the next decade are absolutely phenomenal. Okay, now I want to talk about my two value drivers for anything, scarcity and utility. And you know, this came up because after winning my trial and putting my life on hold for four years to litigate that case, and, you know, having this great win and, you know, now the lawyers on both sides are trying to chop up the jury award that, you know, my latest calculation is the jury awarded us $51 million plus attorney's fees, plus back interest of about $12 million. Right? So this is over $60 million. Now they're fighting and they're, they're probably going to hack it up a little bit and it's not going to be as high as we thought. Right. So we're dealing with that. But it's still, hey, it's a lot of money either way, right? So that's good. It was great. You know, happy with the result. After four years of just very difficult time for me, I won. And it's great news. Right? But not everything is great in life, I must admit. I got a little case of what they call oneitis And I'm suffering from a bit of a broken heart. And so it made me think over the weekend as I was, you know, trying to process my emotions, right? And you know, nothing springs a person into action, or at least nothing should like a heartbreak, because then you really sort of think, evaluate your life and think, oh, I got to do this and that. And I took a bunch of action on a bunch of things I've been putting off for four years as I've been putting my life off, right? But it reminded me of what I've taught you about over the years, that my two primary value drivers for anything are scarcity and utility. So why is it when we suffer from a broken heart, that it is so difficult and so devastating, right? Because it's one person. Talk about scarcity, right? You know, you view the world possibly very myopically. My up. It's early. I'm not pronouncing anything. Well, say that again. Myopically. You view the world myopically as if there is only this one person, right? And of course, there's 7.8 billion people and half of them are either gender, Right? And nowadays, you know, there's like 64 genders, but you know what I mean, biologically speaking, right? Well, actually, people would even argue with that. I know, but this scarcity, now, of course they have utility because they're the object of your affection, right? And they're scarce because they're only one person. She's only one person. And maybe it's not really anything more than just the disappointment of being lied to, right? You know, we hate it when people lie to us and deceive us because not only is it it selfish and insulting, right? But it's also the implicit message when someone lies to you is that you're too dumb to figure it out, that you're so gullible you're going to believe it, right? And that is really. Well, it's upsetting. But we go to the famous words, the immortal words of none other than philosopher Billy Joel, and he said, she can kill with a smile, she can wound with her eyes, and she can ruin your faith with her casual lies. And she only reveals what she wants you to see. She hides like a child, but she's always a woman to me. You know, song lyrics, memes and quotes sum up big, giant ideas in very small spaces, very succinctly because we have all experienced in life what is written about so beautifully in so many songs. And that's why music is the most powerful force in the world. Which by the way, last week I did a great interview with the author of a fantastic essay on music and its impact on culture and it was about an hour long. We're going to have that coming up on the show and you're going to love that interview. So that'll be coming up soon. But do not forget, if you haven't done so already, to register for our recession proof Investing Summit. We just booked a speaker and I'll formally announce him on maybe the next episode. But he's been on the show before. He's got some fantastic ideas and he's going to be speaking at our Friday evening reception where we're, we're kicking things off, talking about the importance of mindset, how to get rid of head trash. We have a lot of trash in our heads, folks. So this will be a personal growth event. But of course we will drill down on the important aspects of investing and the state of the market, the state of the economy, what you should do. It's entitled the Recession Proof Investing Summit and we're here and that event is specifically geared to help you not only strive, but thrive and arrive and learn the secrets to achieve financial freedom through income property investing in this current time. It's a virtual event so it's very easy to attend. We start Friday evening and it's right at the beginning of October, or I guess that's the second weekend of October actually. Then we go Saturday for about five hours. We'll have several speakers. We'll have local market specialists. They'll be talking about their properties. You'll absolutely love this event, so do not miss it. Go to jasonhartman.com and get your ticket. And remember, with a virtual event, one ticket's good for the whole household because you can all watch and participate. The nice thing about these events is you can actually participate. It's a two way thing. You can ask questions, share feedback, whatever, network with other investors right over zoom. So it's just real, real easy. And of course, many people have already purchased the recordings of the event that have yet to take place. You've got a special offer also when you buy your event ticket for the recordings at a good discounted price as well. So go to jasonhartman.com it's right at the top of the page. And register for our recession Proof Investing Summit right now. And without further ado, let's get to our guest, Eric Basmajian. Let's take a deep dive into the housing market and the overall economy and let's see where things are going here we go. It is my pleasure to welcome Eric Basmajian back to the show. As you know, a lot of you made great comments last time he was on about his view on the economy. He's got some great charts and data. If you're listening only on audio on the podcast, Please refer to YouTube or several other video platforms that are censorship free, by the way, as you wish to see the visuals of this presentation. But we'll try and explain it for you too, if you're just listening on audio as well. Eric, welcome. How are you doing?

Well, Jason, thanks for having me back on. Quite a bit has changed since we spoke last. Couple hundred more in mortgage rates. There's been quite a lot going on. So glad to catch up.

Absolutely, yeah, it's great to catch up. You know, I'm wondering, do you think Jerome Powell thinks he's the new Paul Volcker?

Well, he certainly took a step in that direction in Jackson Hole. You know, it's funny. So in June we had mortgage rates hit 625. And there were a couple of stories that hit the financial media about the MBS market freezing mortgage backed securities, by the way. Yeah, exactly. And the market started to really fall apart. And then he had his following press conference in July and he really softened his tone. It's almost like he felt like there was an accident waiting. And the market really took that and ran with it. Financial conditions eased a lot. Mortgage rates came all the way back down to 5 from 625. Equity market rallied like 20%. And I think he sat there and said, you know what, I made a big mistake there. I really got to get this inflation under control. So he took that Jackson Hole speech to really reassert his view and sort of correct that mistake. And here we are. Mortgage rates are back to 625 today. So we've had this unbelievable move in the market from 625 to 5, back to 6. And he's definitely feeling like Volcker today. We'll see how long he sticks with this stance.

Yeah, yeah, absolutely. So before we dive in and look at some of the great charts you prepared for us, and we really appreciate that I want to try and reframe some of the housing debate. Look, I've been doing this a long, long time, longer than I care to admit. And everybody frames the housing market as a price market. Are prices going up? Are prices going down? Is it a seller's market? Is it a buyer's market? And that's the wrong question, right? The right question is what kind of yield can I get as an investor? And the housing price side is a reduction in population. And that's something we're really going to have to contend with in about 30 years. We're going to start seeing that in the U.S. china, of course, and Japan and Russia and many other. In all of Western Europe is just like I always say, if you want to have a country, you have to have children. Okay? You just can't have a country without children. They're seeing that in a huge way, and their economies are just a disaster. But in the U.S. you know, we have slightly growing population overall. You gotta lag that by about 30 years for household formation. It used to be 22 years, maybe.

Right, right.

Millennials and gen zers wait a lot longer. And so, you know, I really just want to reframe that debate because the important thing here is yield. It's not prices, and it's the lost opportunity investors have if they lose yield during the waiting time trying to time the market. So, for example, if people go to jason hartman.com they click on the Properties page, they look at any of these very conservative performers we have, they'll see that with very moderate appreciation and, you know, moderate cash flow, you can get 15 to 20% yield all in on a rental property every year. So if you wait a year and lose that yield by staying in cash, inflation eats up 9.1% of your cash, if not 15 to 17% in reality, because the CPI is understated. And then you have to be right and the market has to decline for you to offset the loss of lost return on investment plus loss of principal value due to inflation. So there's just more to this stuff than most people think, isn't there?

Yeah, there really is. It's a very complicated market. And it's also, you know, a big difference. Whenever we talk about the housing market, you always get questions of people saying like, you know, I'm looking to buy a home. Should I delay the purchase of a home? And I always really like to caveat these things by saying, you know, if you're going to buy a home, you have to buy a home that's within your budget when it's right for you and your family. You're not trying to time the market and pick the tops and the bottoms to play to find a home. Right. We're talking about, or at least I'm talking about the housing market as it impacts the broader economy, as it impacts the business cycle. And even in the work that I do, we have to separate the volume cycle in the housing market versus the price cycle. You can have a decline in volumes and almost no decline in price, or you could have a decline of volumes and very slight decline in price. So whenever you talk about the real estate market, you got to get very specific as, as what is it that you're focusing on. For me, prices come second to the impact that volumes have. Because what I'm really trying to, to gather is I'm not a real estate investor like, like yourself. I'm just trying to use the real estate market as a clue or a leading indicator about what's going to happen in the broader economy. You know, six months from now, what's going to happen in the employment market. And you know, you could have big declines in volume like we've seen. Prices can be very sticky like we're seeing now. So it, you really have to get specific as to what it is you're, you're trying to solve for when you discuss the real estate market.

Very good points. And you also have to segment for price range and for geography. Higher priced homes, I think are really going to continue to soften. Cyclical markets, I think are going to continue to soften. But little cheap entry level houses that they're simply not building anymore that make good rental properties, there's just a huge shortage. It's like people watch this stuff on YouTube and in the media and they come to us and say, well, can I get a deal? No, there's nothing for sale.

Right.

You know, it's slightly better than it was several months ago, but not much. There's still very little inventory. And like these little cheap rental properties.

The regional disparities are huge. You know, I'm really focused on the national data because again, I'm not a real estate investor. I'm trying to want to focus on the broader economic picture. That's, that's, that's the work that I do.

Right.

You probably know the regional disparities way better than I do. But off the top of my head, you have some of these more speculative markets like maybe Phoenix, that have a lot of new construction and a lot of speculative building that, that are seeing inventories rise a little bit. But, but where I live in the Northeast, there's nothing in terms of inventory. So the national statistics could say one thing. But then, and real estate's one of those things that you could say inventories are rising. And you could be correct if you live in Phoenix, but you could be wrong if you live in New York.

Let'S say, yeah, you're absolutely right. This geography. And then if you want to buy a entry level $250,000 to $350,000 home in Florida or Alabama, good luck. There's just so little to choose from. The inventory is just very scarce. But I want bring it back to one point you just mentioned before we go into some visuals and really dive into your data. And you mentioned something very important. You said you really follow the real estate market because your clients, who are many hedge funds or clients of yours and so forth, they want to know what's going to happen to the broader economy. And I want you to tell the listeners why the real estate market's so important for the broader economy. Economy. It's a big part of the economy, right?

Oh yeah. Oh yeah. So the, the actual residential construction, actually hammering in nails into new structures is only about 5 to 6% of economic activity. But it's extremely important for a couple of reasons. One is that it's super sensitive to changes in interest rates or monetary policy. So whenever the Fed decides to step on the brakes or hit the gas, the real estate market's one of the first to respond because of how sensitive it is to those changes in interest rates. The second thing is that it's a very big ticket item. So whether you're buying a new home or you're thinking about maintaining your home, the housing bucket of your budget tends to be quite large. So whenever there's softening in the economy, people would delay moving up in a new house. That'd be one of the first things that they put on hold. Or maybe you would delay putting in a new kitchen or something like that. So these bigger expenditures tend to be very cyclical. And then the third thing is that even though it only makes up about 5%, 6% of the economy, the actual physical hammering of the nails, the knock on effects of the real estate market are infinite. So it may only be 5% of the economy to bang in the nails to build a home, but then you got to furnish the home. Then you have to maintain the home. You know, you need your furniture, your.

Home appliances, all those appliance companies.

I mean, that feeds the whole manufacturing cycle. That and those goods aren't made in the United States that feed the whole global supply story. So that's reason why I'm so heavily focused on the volumes more specifically in the housing market. Because a slowdown in housing volumes today would quite accurately foreshadow a decline in retail sales maybe six months from now because you'd have a lot less home appliances. A lot less furniture. And then you can see that in manufacturers, they start to feel a slowdown. So there's this beautiful ripple that happens off of the back of real estate, which makes it such an important industry for anyone that's looking to get ahead of the business cycle to focus on.

Absolutely. Well, let's dive in, Eric. Let's take a look at some of your data and just take a deep dive into this.

Okay, so what I just outlined, or what I started to outline was a sequence of events that takes place. And the housing market really is one of the, one of the first movers. But we have to go even further beyond that. Say what's going to move the housing market? Right. And what moves the housing market initially, or at least on the demand side, is changes in interest rates.

Rates.

So this is a chart and it's a, it's called a longer leading indicator because it gives you a very advanced warning of what's going to happen and it's a little bit involved. So just give me a second to explain it. What this chart shows is the 18 month rolling change in a composite basket of interest rates. So I'm looking at mortgage rates, corporate rates and treasury rates. But if you're thinking about the real estate market, you can just, just think about mortgage rates. The chart would look almost the same because these rates tend to all move together and the line is inverted. So what this means is that right now, this last data point on My chart here, 2.75, means that interest rates across the economy are 275 basis points higher than they were 18 months ago. Now, it's not a, a huge leap to suggest that if rates are almost 300 basis points higher than 18 months ago, economic activity is going to have to cool. There's just going to be less demand for new mortgages because the cost of them has gone up. There's going to be less demand maybe for automobiles if it's increasing the financing. Anything that comes with a financing component is significantly more expensive today than it was 18 months ago. So that's what sort of sets the tone or sets the stage of what's going to happen. And what we see next is that is in fact what's happening. This chart shows the last 18 months of the Mortgage Bankers Association's purchase only index. So I take out the refinances. I'm not worried about the refinances. This is just an index of mortgage purchase applications. And as you might expect, if rates go up 300 basis points, you have a slowdown in the volume of new mortgage applications.

Do you have this chart back further? Because this comparison is not great. I mean, if we go to 2021, I mean, the market was nuts then. That was like one of the busiest mortgage markets in history. History. You know, the rates were so low, everybody was trying to get a mortgage back then.

Right, right. Yeah, I have the data. Not. Not in this slide deck that I brought with you. But you bring up an interesting point.

Okay, so question is always compared to what?

Compared to what? Right. Okay, so you make a good point that the housing market may be cooling from very extreme levels. But when we're looking at the economy or the business cycle, it's all about the rate of change. So the level of activity today is going to be slower than the level of activity 18 months ago. Now, that may have been a crazy high level of activity, and we may only be slowing to what some may consider more normal levels of activity, but it's still going to have that same ripple effect. So because the housing market was at insane levels of activity, retail sales were at insane levels of activity, and employment was at insane levels of activity. So the fact that the housing market is slowing directionally, maybe it's only to more normal levels. We still would therefore have to expect all of those ancillary industries that were getting the benefit to also cool to those more normal levels of activity. So directionally is what we're focused on here, or at least in my view, for what's going to happen to the broader economy, the employment market, it. And again, you make the point which you'll point out in this chart. This is the volume of new home sales. And I want to specify that I'm only looking at new construction here. I'm not looking at existing homes. And viewers may be correct to point out that existing homes are about 85 to 90% of the market. New homes are only about 10 to 15% of the market. So you say, why, Eric, are you only focused on new homes? Well, most of the economic activity, those ancillary benefits of the real estate industry are concentrated in new construction. Right? Building the homes, furnishing the new homes. There's some benefit to the existing home market, but it's less so than the single family home. That's why I'm focused here. And what we see is that the volume of transactions is down about 51% from its peak. And the peak was for this cycle was in August of 2020. And you can see that in the 2008 scenario, volumes declined 70%. So when, when you see A slowdown in the volume of transactions. But home building companies are continuing to build, slow as it may be. What you end up seeing is a rise in the metric called month supply. And your viewers may be familiar with the term, but month supply basically means how many months will it take to clear the existing pool of inventory at the current pace of sales. And because the volumes have slowed down so much because of these higher rates, inventories may still be low if you look at them just on an inventory basis. But if you relate them to the level of sales volume, we're starting to see a pretty dramatic rise. But this is just in the new home market. There's a whole nother factor that we can get into in a little bit. But just rounding out this sequence, when home building companies are experiencing this slowdown in sales, but this continuing of building new homes, their sentiment about the market has been falling. So this index is the NAHB Housing Market Index and it's a sentiment survey of homebuilding companies. Above 50 means they have a positive outlook. Below 50 means they have a negative outlook. And we've been seeing this cool in conjunction with, with the volume of new home sales.

I want to ask you about this one for a moment if I can, Eric. Sure, yeah. Because I am not very interested in the stock market. However, when this index really started to turn down, I looked at the stocks of the low end home builders like Dr. Horton and KB Homes and I thought, you know, these stocks have been improperly punished, I think. And I, I was right. And I asked a bunch of my friends who know more about the stock market than I do about it, because I know firsthand, dealing with it every day in personal experience in my own business, that there is a giant shortage of entry level housing. But they're lumping the builders together with builders like Toll Brothers that build high end housing and builders like Lennar that build middle. And you know, all of these get lumped together as home builders. But there's huge difference between entry level and higher price homes.

And your commentary is why you're in the chair that you are.

I'm was right. I should have bought their stuff.