Houston Southard
a name that looks so fake you'll care just as little to learn it's not
recession-proof real estate investing
J. Scott
Chapter 1- Introduction
Nationwide, foreclosure filings increased by more than 81 percent in 2008, with more than 800,000 families losing their homes. And that trend continued for the next two years. From 2009 through 2010, about 45 percent of existing home sales in the United States were REOs (real estate owned) or short sales.
short sales, where lenders were giving sellers permission to sell their properties for less than what they owed on their loans.
After the crash => flipping => short sales => builders selling excess lot inventory for spec homes (building new construction spec homes) or buying older homes on "infill" lots.
As of January 2019, we’re in the middle of the second longest business cycle expansion in U.S. history. Whether this current expansion will outlast the one we saw during the 1990s tech boom remains to be seen. This will be our 34th economic downturn.
Buyers give money to sellers in exchange for a good/service = transaction
The aggregation of a specific good/service = market
Market = all the transactions for a certain good/service
Put all the markets together = economy
Strong economy - a lot of transactions and a lot of cash flowing.
Weak economy - smaller and fewer transactions.
Pattern of size/number of transactions in a market in an economy changing over time (strong => weak => strong again = cycle
Chapter 2 - What Drives Cycles
many interrelated cycles, and the interaction of these cycles is what drives the length and magnitude of the uptrends and downtrends we see in our economy.
Post-Recession Business Cycle
Unemployment goes down.
Employed people spend more money.
Companies increase production to sell more stuff.
Higher company profit trickles to employees, who will buy even more.
Demand begins to outpace business ability to produce products.
Wages go up as businesses need more people but don't have any unemployed to hire.
Businesses offset production increases (equipment/factories) by increasing prices.
When the economy inflates, consumers spend less and finance more.
The Federal Reserve combats inflation by controlling interest rates.
Low interest = cheap to borrow/low savings interest. High Interest = expensive to borrow/high savings interest.
Inflation = Fed raises interest rate = consumers spend less/save more.
High interest rates = slowing inflation/slowing economy (and layoffs) = economic contraction (unemployment rises = mortgage and credit card defaults, bankruptcies, downsizing) = maybe recession.
Fed steps in again to lower interest rates = consumer spending up and easier for businesses to borrow.
Strong economy = inflation.
Inflation = Fed raising interest rates.
Increased interest rates = slowing economy (recession).
Recession = Fed lowers interest rates.
Unfortunately, business cycle isn't cyclical the same way. It's a smaller facet in a long-term debt cycle, which exists because of a quirk in the business cycle, because each cycle has a bit more economic growth than contraction.
More economic growth = ability to accumulate more debt
As economy expands from business cycle to business cycle, so does the debt.
After decades of short-term business cycles, the debt pushes us into a bigger downturn called a deleveraging.
Deleveraging = maybe depression = 20-30 year recovery before debt is back to sustainable levels.
Chapter 3 - The Business Cycle
NBER - 33 business cycles since 1854. Pre 1945, cycle length = 51 months. Post 1945, cycle length = 69 months.
Expansion is roughly 5 times as long as contraction.
Four Phases:
Expansion -
Peak - With excess inventory on the market, rising interest rates, and the first signs that the economy is starting to crack, we start to see real estate prices decline, and the downturn begins.
Recession - As occupancy rates fall below the long-term average, reduced market rents are often seen (landlords drop rent).
Recovery - Government lowers interest rates to spur economic growth. Demand increases and the whole thing starts over again.
Chapter 4 - Knowing Where We Are In The Cycle
We can't use localized real estate health to measure where we're at on the national economic cycle.
We're currently thought to be in a peak phase since most consider 2009 to not be a deleveraging point (based on how quickly we've recovered).
Fed is expected to keep raising interest rates
Observation
Real estate values increasing
Confidence is extremely high
We're closer to the top of the market than we've been in a while
If we look back to the first decade of this century, home values were rising. In fact, the average sale price of a new home in the United States increased by almost 40 percent from April 2003 ($237,000) to March 2007 ($329,000). Not only were we in an upswing, we were in the middle of the one of the hottest real estate and equity markets in history
135 Months - longest business cycle in history
Data
Two types of indicators to help determine where we're at in the cycle
Leading indicators- shift before major changes in a specific market or the general economy.
Big company says it's moving its headquarters to your city.
Trailing indicators - results of shits in a market or economy.
Large HQ moves in and creates more jobs, traffic, relocations, high home values.
Buy property when you know an HQ is going in somewhere.
Non-Real Estate Indicators
Yield Curve - the change in interest rates for government bonds of different expiration dates.
Quick expiration dates have lower returns and a healthy economy has a big difference in the return of short term bonds vs the return of long-term bonds. People should be able to expect a higher return when they are willing to invest their money for longer.
The amount of demand from investors also plays a part in bond yields—the more demand there is for a specific bond, the lower the price; the lower the demand for a specific bond, the higher the price.
When investors get wary about the economy they move their money into long-term bonds, and the demand lowers the price of long-term bonds.
At the same time investors want to move money out of short-term bonds, and the low demand for short term bonds increases its return.
This long-high, short-low wariness flattens the yield curve.
The yield curve if one of the best predictors of an impending top inflection point in the economic curve.
Unemployment - percentage of us workers in work vs not
Most Common is the U3 unemployment rate (out of work and looking for previous 4 weeks)
Healthy U3 at 4-5 points
Higher unemployment speaks to a weakening economy, but lower U3 under 3% indicates full employment.
Full employment is good but a precursor to inflation.
Stock Market - prices reflect predicted future strength of a company.
Buffet Indicator - the value of all companies in the united states should increase linearly over time. If we can determine where that line indicates the correct stock market price should be today, we can see if the market is higher than that (and likely to drop) or lower than that (and likely to rise).
Total value of the stock market is directly tied to US GDP. Compare one to the other to see if the equities market is correctly valued, undervalued or overvalued.
If the ratio between the two is 75-100%, market is valued right.
GDP - total value of economic activity within a country and is an indicator of overall economic health. When GDP is increasing, the economy is growing. When GDP is decreasing, the economy is contracting. It's ideal growth rate is 3-4%.
Above = above average inflation (Fed may increase interest rates to slow inflation)
Below = If GDP growth is negative for two or more quarters, we're in a recession
Interest Rates - rates are low during recovery and expansion (Fed tries to fuel economic growth)
Typically interest rates will level off and start to rise a year or two before a recession.
Wages - strong economy = strong wages
Weak economy = stagnate, decreased wages preceding layoffs, unemployment, mortgage default, cue downward economic spiral.
Wage growth indicates if people will spend their money, or saving because merit increases aren't matching inflation rates.
Currently, most employees aren't earning more these days than they were 10 years ago.
Real-estate indicators
Housing Supply/Housing Inventory/DaysOnMarket - average amount of time it takes to sell a house in a particular market. The average is 6 months.
Housing Starts and Building Permits - number of new residential units developers are starting to build. You can get this by looking at the number of permits that have recently been issued to indicate what phase of the real estate cycle you're in.
There tends to be a dramatic drop in housing starts preceding each recession.
Foreclosures - number and percentage indicate economic health
Chapter 5 - Investing Factors (17 pages)
Sellers market - when demand outpaces supply and the sellers control the market.
Buyer's market - more than a six month supply of houses, putting the buyer's in control.
Margins are simply the percentage amount that a business’s profits exceed its expenses
Chapter 6 - The Financing Factor
When ability to borrow reduces, so does ability to acquire inventory.
Conventional Lenders -
As we get toward the top of cycle and over the hump, things change quickly. Unlike conventional lenders who start to require larger down payments and better credit, portfolio lenders just stop lending altogether. The first to go are flip loans
Chapter 7 - Investing Strategies
Chapter 8 - Peak Phase
We know we're in a peak phase when:
Gurus are out in force
Many new naïve investors
Hard to find good deals
Appraisals are coming in lower
What to do:
Assume 10% lower market rents
Assume 10% higher vacancy
Focus on C-class properties
Consider student housing
Lend to landlords before flippers
Wholesale instead of flip
How to prepare for the next phase:
Build your credit
Apply for lines of credit
Chapter 9 - Recession Phase
We know we're in a recession phase when:
Desperation selling increases
Two successive quarters of negative GDP
Increase in foreclosures, home prices are falling
Appraisals are coming in low
Oversupply of new construction
What to do:
Take advantage of seller financing
Focus on creative deals
How to prepare for the next phase:
Hoard cash
Get familiar with public auction process
Build relationships with people with cash
Build your credit
Chapter 10 - Recovery Phase
We know we're in a recovery phase when:
Gdp is increasing
Housing inventory is starting to drop
What to do:
Buy on courthouse steps
How to prepare for the next phase:
Get good at analyzing
Chapter 11 - Expansion Phase
We know we're in an expansion phase when:
Economic optimism
Easy deals are gone
You're competing with cash offers
What to do:
Consider a live-in flip
Get last of buy-and-hold deal
How to prepare for the next phase:
Be a badass