This is Why You Should Stop Gambling and Start Investing

So today, let's talk about something from 20 to 21 years ago. And that is none other than the Hartman Risk Evaluator. With current data looking at the producer prices of construction materials and what this means to all of us. Now look, I have long said that as a real estate investor, that's not really the best thing in the world. The best thing is to be a commodities investor. More specifically, a packaged commodities investor. Well, what do I mean by that? Here I am in my house and all around me there are commodities. In front of me I see glass behind me and on the side we see drywall or gypsum, right? And below me concrete and of course, other materials. I'm just naming some of them. In the walls we have lots of copper wire for electrical, we have lots of petroleum products for all sorts of things in a house. And these are all commodities that have intrinsic value. And everybody in the world needs them. Everybody needs these commodities. So rather than going to the commodities exchange, rather than doing that, because if we went to the commodities exchange and we bought copper, for example, or we bought lumber or any one of a zillion other commodities, we would not get 30 year fixed rate financing, we would not get special tax benefits. We would not be able to leverage those commodities the way we get to leverage them with real estate. See, as soon as you stick the real estate label on something, suddenly you get all of these different benefits. But what you're really investing in largely is these commodities. And that's why with the Hartman Risk evaluator, and I'll get to that in a moment if you're new and what that really means, this is a way of dramatically limiting downside risk on a real estate deal. That's the Hartman Risk Evaluator. But back to these commodities. So we want to invest in these commodities that have intrinsic value. Look, if I pull out this thing, right? What do you call this? Well, this is a $5 bill and today it's called a $5 bill. But guess what it was called 30 years ago. It was still called a $5 bill. And the value of it has dramatically changed. And it's just made of paper. And now if I pull out these, these are Zimbabwe dollars. So this one is a 100 trillion Zimbabwe dollar and it's basically almost worthless. And the five dollar bill, the US five dollars is not worth as much as it used to be. And all of these paper currencies have gone down in value. Now the US Dollar has been incredibly resilient and it has lasted so much longer than other Currencies have. And it has held its value so much longer because it is the reserve currency of the world and it's likely to stay that way. But the history is littered with paper currencies that have zero value. It's a race to the bottom, folks. Every fiat currency ultimately goes to zero. But what has intrinsic value? Well, these commodities, right, the commodities, they have intrinsic value because, look, drywall, gypsum, concrete, lumber, petroleum products, copper wire, glass, steel, all of these things are needed because every human being needs shelter. And they are traded globally and denominated in many, many different currencies. So they have intrinsic value. So as a real estate investor, we get to be commodities investors in the best way. We get to invest in packaged commodities. I also refer to this sometime time as assembled commodities testing, because that's what it is. When you buy a house or an apartment complex, they have the land, that's one component. But then they come to the land, they bring all these commodities and they assemble them and you buy them in a big package. And that dramatically limits your downside risk as a real estate investor by being a packaged commodities investor. All right, well, let's look at the packaged commodities and let's see what they're doing. Now. This is a brand new report that just came out. I got it in my NAHB newsletter, National association of Home Builders. Because what are those home builders very, very concerned about? They're concerned about input prices, right? All of these ingredients, these commodities, these ingredients that they need to build houses. If they go up in price, they have to do one of two things. Either cut into their profit margins and decide, hey, we're going to make less money. And then they have to go to their shareholders and they have to do an earnings call and Dr. Horton, Lennar, whatever, Toll Brothers, whatever builder, right? They have to say, hey, we've decided to earn less money because the prices of all these commodities have gone up. And the executives have all decided to take a pay cut because the prices of the commodities go up. Now, how likely is any of that? Very unlikely, right? They are going to simply pass the cost through to the buyers of their products, their homes, so they will raise prices. And this is one of many reasons that real estate is the world's best hedge against inflation. It's the best one because these commodities have intrinsic value and they tend to go up in value, or at least they will hold their value because a piece of wood will always be worth a piece of wood. Now, this is one of the other reasons I created the Hartman Comparison Index. We haven't talked about that that much lately on the show. We gotta get back to the Hartman comparison index a little bit. We have been working on that behind the scenes, making it better, adding more commodities. But that's what the HCI does. It compares the value of these commodities trading against the dollar and against each other and against other currencies, because that's what really counts. It's not the nominal value of something. The name of it. This is a $5 bill. It's called a $5 bill today. It was called a $5 bill 30 years ago. But the value is obviously lower than it used to be due to inflation. So let's look at some of these prices for the ingredients, the commodities, the packaged commodities that have to be assembled or packaged into a complete home. So overall producer prices in February, they were up. And what we're seeing here is we're seeing very high increases in these prices during the COVID era. But there was a lot of supply shock back then because of the supply chain problems. And we reported on that frequently on many, many prior episodes. But if you look at the prices right around our time now, you see that prices are way, way up. And if you take out the COVID era, they are historically up at the highest increases on this chart. So these commodity prices are getting a lot more expensive. And what that means is that the end product, the packaged commodities, the assembled commodities, will be higher priced in the future because the builders will simply pass these prices along to home buyers. Now, what have builders done because of the housing affordability problem? Well, they have, of course, downscaled the size of their houses. They've made them smaller and they've made them cheaper. So they are now putting inferior finishes into these homes and they are making smaller homes to try and make the packaged commodities or the assembled commodities more affordable to the end. Homebuyer. Right. So again, that's going to skew the data a bit. Get ready for that. Because it's coming, right? It's coming. When you see some survey in the future and it says new home prices only went up by 5% last year, for example, what it won't tell you is it won't tell you that the size of the home got smaller and the quality of the home got lesser because the builders are doing shrinkflation, right? They are providing less. Just like that bag of potato chips keeps getting smaller, that candy bar keeps getting smaller. In fact, the bag of the chips might be the same size, but it's filled with air and there are fewer ounces of potato chips in the bag. We've reported on shrinkflation many, many times. Okay, so this is the overall ppi, the producer price index. That's what we're talking about and looking at now. But let's look at some specifics. Let's look at softwood lumber. Now we all know the insane lumber price problems we had during the pandemic era. And they went through the roof. I remember one time during the COVID era on the show, I took a picture as I was out walking the dog one day, I took a picture with my phone of a lumber delivery truck, right? With, you know, with a bunch of two by fours on it. And I thought, forget about armored cars. If someone hijacked this truck and stole it with that lumber on the back, that was incredibly valuable. That now since the supply chain problems have largely cured themselves and the ships are shipping and the lumber mills are running, and we don't have the COVID era insanity we used to have lumber prices have adjusted to a more normal level, but not really. Look at the difference between the pre Covid era and lumber prices now. I mean, if you look at 2019 to today and we take out these radical price increases during the COVID era, we see that lumber prices are what, in terms of the index, they are dramatically higher than they used to be, right? So lumber prices much, much higher. Taking out the COVID era. Now this one is absolutely shocking. This is wallboard gypsum, right? Drywall. And we look right here and as I'm knocking on my wall here, on my house, we see that these prices have absolutely skyrocketed. And they really haven't come down. They have just gone straight, straight up. They don't look like the other charts with the COVID supply shock type of problem. Okay, so here we see that this ingredient is, has become a lot more expensive. All right, we've got ready mix concrete, same kind of chart, incredibly, incredibly expensive in terms of the price increases. And then we've got steel mill products, right? So steel, definitely an ingredient of your houses. And there, when we take out the COVID era supply shocks, we see prices dramatically, dramatically higher than they were in the pre covet era. So all of these prices go into the Hartman risk evaluator. Now let's talk about the risk evaluator for just a moment. And if you'd like the full episodes on that and a full explanation on it, just go back, go to Jason hartman.com, type in hartman risk evaluator or just risk evaluator on the search engine. There. And it will serve up to you all of the prior episodes where we have talked about that. But why is the risk evaluator been so valuable to so many investors over the last 20 years? Well, it really came about when I purchased my first out of state property. And this was about 21 years ago, I guess. I was living in California, and I was buying this property across the country, which I had never seen. And I was buying a personal residence in California. And the personal residence at the time was $815,000. Now, that property is well over $2 million, by the way, and the property across the country was $159,000. And I was using the same insurance broker, Jennifer, for both properties. And she called me up one day and she said, jason, I've got your insurance quotes on both properties, the rental property you're buying and your personal residence. And I said, okay, great, fire away. What are the quotes? She tells me the prices of the insurance. But the key thing that Jennifer told me is she told me the amount of insurance, in other words, the amount of coverage they were offering. And here's what I discovered. On the personal residence, that was mostly land value. Why? Because the insurance company only insures the house sitting on the land. It could burn down. So that's what they're going to replace and insure. And on that one, they said, we're going to give you $156,000 worth of insurance. I couldn't believe that this $815,000 property was only 156,000 of it was improvement value, the house sitting on the land, whereas the property out of state, that was 159 total price. And they said the improvement value was 135,000. So on that one, the land value was $24,000. Whereas if you do the math, on the Southern California property, the land value there was 6, $160,000. Just rounding off. So if you want to lower your risk as a real estate investor, how do you do it? What do you do? Well, if you want to lower your risk, you simply do this. You invest in mostly commodities, ingredients, packaged commodities, the things that make up the house, the walls around me, the ceiling above me, the floor below me, the big window in front of me, all of those packaged commodities, the glass, the steel, the concrete, the lumber, the petroleum products, and the labor, by the way, labor is also a commodity. All of those things are much more insulated from market fluctuations than land. When the money printer goes on and the money gets easy, land values skyrocket. Now, you've heard me talk over the last 20 years, many times about three major types of markets. Linear markets, cyclical markets and hybrid markets. Just a little review here. Linear markets, if you're looking at a graph of appreciation over time, they just kind of chug along and they're kind of boring. Right? There are small ups and small downs, but again, not very pronounced. Whereas cyclical markets, that chart looks like a roller coaster. Glorious highs, really ugly lows and then highs and then lows and highs and lows through history. Right? That's a cyclical market. Hybrid market, somewhere in between. Where are the cyclical markets? They are anywhere in the country and anywhere in the world that you have high land values. Now, another thing I invented to help understand this is what I call the LTI ratio, the land to improvement ratio. You've all heard of the LTV ratio. That's the loan to value ratio. Well, this one is the land land to improvement ratio. And what it shows you is how much are you paying when you buy a property, you're not buying one thing, you're really buying two things. You're buying land and you're buying improvement. The house sitting on the land and the land below it. So what is the ratio of lti? Well, in a good solid linear market with lower risk, better cash flow, better return on investment, and usually landlord friendly laws, okay. And usually more conservative government, not always, but most of the time, leading to landlord and business friendly regulations, this land to improvement ratio will typically be somewhere around 80, 20. It'll be 20% land value and 80% improvement value. Whereas in the cyclical market it will be the opposite of this. It'll be. The vast majority will be land value with very little improvement value leading to much higher fluctuations. Now, in a cyclical market, you can make more money on appreciation, being a speculator during the good times, when the money printer is printing and the money is just flooding the markets, you will make big home runs. In cyclical markets, however, you will have to support that property with negative cash flow or dramatically higher down payments, which means you have an opportunity cost because you can't use the money for something else. So we don't like cyclical markets. Okay. Although, you know, occasionally you dabble in them a little bit. You just don't make that your main thing because it's very risky. And we want to be prudent investors, investing for the long term, not gambling, not speculating. We are investors, not gamblers and speculators. 10% of your net worth, okay? Gamble a little bit. Speculate a Little bit, if you want. Occasionally you'll hit a home run and that'll be great. But most of the time, you're going to do better in the boring linear market where prudent investors invest. That's where you're going to make your real money. That's reliable and dependable in the linear markets. All right, so you want to invest mostly in commodities because commodities are more stable. Land. Yes, it's fair to say land is commodity. That is true. But land prices fluctuate like crazy, so it is a much riskier investment. And you want to monitor the cost of these commodities, of these inputs, of these ingredients that builders need to build houses, because it sets something of a floor as to how far things can decline in a declining market. And when we look at the linear markets, no matter what cycle you're in, those have a much lower decline. Why is that? Because the commodities, they could get cheaper during a recession, no question about it. But they won't get that much cheaper. And the prices of those commodities are influenced by natural disasters and by development all over the world, not just in your market area and not just in the U.S. so when there is a catastrophe in some other part of the world or a war and they need to rebuild these areas, that increases the prices of all of those ingredients of a house globally, not just locally. So you know the old saying that I always talk about, all real estate is local, right? Definitely true. That is true. But when you invest in the boring linear markets, the sensible markets, you get the best of all worlds. You get that local linear market that's conservative and prudent, but you're investing mostly in commodities, packaged commodities, assembled commodities. So you get the benefit of all of the consumption of those commodities worldwide because they're traded worldwide. So when you get these prices of these builder inputs, whether they be steel, and I'm just going backwards now, Steel or ready mix, concrete or gypsum or wallboard or softwood lumber or overall producer prices, you see that as a good linear market, conservative, prudent investor, you are going to win the game. Much better than keeping your money in this stuff, and definitely much better than keeping it in this stuff. It's absolutely shocking how fiat currency always goes to zero. That's its ultimate destination with the US Dollar. Since the US has got such hegemony, it's going to take a very long time to get there. I'm not worried about the US Dollar losing its reserve currency status anytime soon, folks, but it will happen eventually. It has to. That's the direction of all fiat currencies. So you are much better off investing in commodities, things that have intrinsic value, like all these great ingredients of our single family home investments.