While most Americans are fixated on the brouhaha surrounding the government shutdown, we’re thinking about something even MORE slimy …
Long time followers know we’ve been watching oil for quite a while … and for a variety of reasons over and above the amazing tax breaks.
Oil and energy have a substantial impact on the economy, inflation, geo-politics … even the health of the financial system.
We’ve observed that as oil prices rise and fall, the specific area of their impact shifts. There are important clues and opportunities to be gleaned from watching these dynamics.
When oil prices rise, it’s a drag on economic growth and can also be a sign of inflation. It’s no secret President Trump wants to lower cost inputs to help fuel economic growth.
The Trump formula is lower taxes, lower oil, lower interest rates, a weaker dollar, and less regulation. Labor is the only input he wants to see rise.
You may agree or disagree, but that’s what Trump wants. Of course, there are some conflicting goals in the Trump recipe …
Specifically, low interest rates and a weaker dollar generally mean rising prices (inflation) … and oil is one of the first places it shows up.
Also, more economic activity leads to more energy consumption, which means higher demand … and rising prices.
So … the only way to keep oil prices low in an environment like this is to increase oil production to where supply overwhelms both higher demand and a weaker dollar … and pushes oil prices down anyway.
Perhaps obviously, a domestic agenda which needs lower energy costs will affect U.S. relations with oil rich nations.
We think Trump’s stance towards Saudi Arabia … in spite of denials … makes it clear low oil prices are a high priority for the White House.
It’s consistent with what Trump told us when we asked him about his vision for housing and real estate. He said, “Jobs”.
Remember, oil and energy were the largest drivers of job growth in the United States coming out of the 2008 financial crisis.
Many real estate investors who recognized this trend and got involved in Texas real estate in 2009 …and have done very well over the last 10 years.
We think that party’s probably not even close to over.
One less obvious, but very important connection between oil and real estate is in the financial system … specifically, the debt markets.
As we’ve discussed several times over the years, LOTS of loans were made to oil companies when oil prices were over $100 per barrel.
But when interest rates rise and oil prices fall … it’s the worst of both worlds for heavily indebted domestic oil producers.
MANY billions of oil-related debt has the potential to go bad … and crater the financial system just like bad mortgage debt did in 2008.
And when credit markets seize for whatever reason, liberal users of debt, such as real estate investors … are directly affected.
We don’t think it will happen.
First, there’s too much upward pressure on oil prices.
Second, as we’re about to discuss, there’s BIG motivation to stimulate domestic production … which provides a lot of cash flow to service debt.
Of course, we could be wrong … as Ben Bernanke was about the dangers of sub-prime … so real estate investors should pay attention to oil.
Using the gas pump as an indicator, you probably already know oil prices have been a little soft.
Of course, businesses and consumers (including your tenants) LOVE this because it makes everything more affordable.
U.S. car manufacturers love it because it means they can sell more gas guzzling SUVs and trucks.
But bigger picture … oil and energy are major cost inputs on virtually all products.
After all, it takes energy to manufacture and transport everything.
And many products are made from petroleum derivatives, such as plastic, roof shingles, and asphalt.
So even though energy is left out of the “core inflation” index, the effects of changes to oil pricing are still reflected in it.
And so partly due to subdued oil prices, concerns about excessive inflation have been muted … even in the midst of a red-hot economy.
Obviously, sellers of oil would prefer higher prices.
But you can only charge what the market will bear … which is a factor of supply, demand, and capacity to pay.
It’s also important to note that energy, like real estate and food, isn’t a discretionary purchase.
People MUST have energy to survive and thrive. Therefore, demand for energy is ever-present.
So when it comes to oil … the thing to watch is supply and capacity to pay.
Breaking out capacity to pay from the traditional supply and demand model is something we started doing a long time ago … because there’s no effective demand without it.
Just because you want something, doesn’t mean you can afford it. Think of it like debt-to-income ratios and interest rates in real estate.
Just because someone makes an offer on a house (demand), if they can’t quality for the loan (capacity to pay), there’s no sale.
And when mortgage rates rise, but wages don’t, the dynamic negatively impacts qualifying ratios … thereby decreasing capacity to pay and ultimately, effective demand.
That’s why observers often expect rising interest rates to lead to decreased housing demand.
It’s similar with oil.
When oil prices rise and wages don’t, then lack of “real” wage growth (incomes outpacing inflation) makes it hard for the market to bear price increases.
That’s why the recent blowout jobs report was notable.
That means capacity to pay improved.
As you may recall, Saudi Arabia (the leader of the middle-eastern oil cartel OPEC and one of the largest oil producers in the world) INCREASED production …
… which meant MORE supply and LOWER prices (and thanks from President Trump).
But just recently, Saudi Arabia reversed course, calling for a target price of $80 per barrel … and a REDUCTION in production to make it happen.
Now before your A.D.D. kicks in … remember, this ALL has ramifications for real estate investors …
The point is there’s some real pressure on oil prices to rise … and a lot of motivation by President Trump to take steps to push prices down.
We think BOTH will happen and lead to interesting opportunities for real estate investors … in spite of the pressure higher oil prices puts on your paycheck-to-paycheck tenants.
If you invest in oil for the tax breaks and oil prices go up … there’s big potential for a double dip … tax breaks and profits.
Nice. You can use both for your next down payment.
Higher oil prices reduce the risk of oil debt imploding credit markets. Healthy credit markets are essential to vibrant real estate markets.
If oil prices rise on the international stage, we’d bet President Trump will do whatever he can to further stimulate domestic production to counteract it.
And that means more U.S. jobs and robust regional economies … with increased demand for real estate to in those areas.
All this to say, we think it’s smart to pay attention to oil … as an investment, as an economic gauge, and as a treasure map to potentially hot markets.
Oil will be a big topic of discussion on our upcoming Investor Summit at Sea™.
Until next time … good investing!
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