In spite of rising rates and concerns about bubbles … real estate is looking pretty good right now.  At least the right real estate in the right markets.

Of course, “real estate” can mean a lot of different things.  In this case, we’re talking about good ol’ fashioned single-family residences.   Houses.

Yes, we know mortgage rates are rising.  But that just means it’s harder for renters to buy a home … which keeps them renting … from YOU.

And if you proceed with caution, there are some reasons to pursue single-family homes even though prices have recovered substantially from the 2008 lows.

Consider this Yahoo Finance headline:

Small business earnings hit all-time high, NFIB declares

“Small business earnings rose to the highest levels in at least 45 years last month, according to the results of a survey from the National Federation of Independent Businesses (NFIB) …” 

“ …  the 17th consecutive month of ‘historically high readings.’”

That’s good news for small business owners … and for the U.S. economy.  It’s commonly believed that small business drives a majority of job creation.

So perhaps this CNBC headline isn’t a big surprise …

Job openings hit record high of 6.6 million

Of course, job creation is good for landlords.  It’s a lot easier for tenants to pay rent when they actually have jobs.

But there’s the issue of wages.  Even though the unemployment rate fell below 4% … which is considered “tight” … wages still haven’t risen substantially … yet.

Meanwhile, life is getting more expensive as rising interest rates, gas prices and healthcare premiums are among several factors squeezing household budgets.

While jobs are good, it’s hard to save up for a down payment when living costs are going up faster than paychecks … which keeps people renting.

And if all that isn’t a big enough challenge, there’s the problem of high housing prices.  Obviously, higher prices also make it harder for renters to become homeowners.

So all that’s not horrible news for landlords … especially those who are investing in more affordable markets and property types.

But there are two more parts to the story …

First has to do with a deeper dive into the jobs market.  The April jobs report didn’t seem great at first blush.

But in the past, the reports looked great at first, then you’d drill down and discover the jobs created were low-wage service industry jobs.

Notably, recent jobs reports reflect a subtle but important shift in the composition of jobs.

So while the quantity of jobs created might be not bad … the quality is actually looking pretty good.

According to this Wall Street Journal article, manufacturing added 24,000 workers in April … after adding 22,000 and 31,000 in the last two months.

“While manufacturing employment has been generally declining for decades, hiring picked up in the sector over the past year.” 

Way back our 2011 blog, What Washington Could Learn from Real Estate Investors, we argued that not all jobs are equal. We like what’s happening.

Seems to us if the American economy can keep this up, it’s a tailwind for housing … in spite of rising rates, inflation, and high debt levels.

And speaking of wind …

As we discussed at length during Future of Money and Wealth, the entire financial system is based on debt.  So to grow the economy, debt MUST grow.

The why and how of all that is too big a topic for today’s discussion, but if you take it at face value, it really explains a lot.  It also has some big ramifications for real estate.

After 2008, lenders ran away from real estate … but debt still needed to expand.  So new debt-slaves borrowers were needed.

Student debt soared.  Sub-prime auto loans spiked.  Credit cards hit record highs. Corporations borrowed heavily to bid up their own stock.

But today, students are reconsidering the value of a financed college education.  Auto sales are slowing.  Credit card losses are mounting.

Corporations are slowing down their borrowing … with nearly 14% of the largest companies unable to pay their interest payments from earnings.

In fact, a recent Bloomberg article quotes Gregg Lippman of “Big Short” fame as saying corporate debt will trigger the next financial crisis.

“ … corporate debt and equities will face the biggest pain when the next downturn comes. Investments linked to consumer debt, unlike the last crisis, will be relatively safe …”

“The consumer is in much better shape than corporates. Consumers are less levered than they were pre-crisis. Corporates are more levered than they were pre-crisis …”

So let’s wrap this all up and put a bow on it …

If it’s true debt MUST expand, lenders will be looking for where they can make loans.  Remember, your debt is their “investment”.

There are already tremors in the debt markets.  Lenders will be looking for quality.

Similarly, there are tremors in the stock markets.  Investors and consumers will be looking for an alternative for their wealth building (remember, consumers consider their home an investment).

So we think there’s a good chance the focus will shift to real estate again.  Just like it did in the early 2000s.

Yes, we know the run-up from 2000 – 2008 ended badly.  But not for everyone.

If you buy the right markets, use sustainable financing structures, and pay attention to cash flow, there’s an argument to be made that single-family homes still have solid potential for long-term wealth building.

Shhh … do you hear it?  It’s the margin calling …

“Margin” is a term we hear all the time but can be a little confusing … because it means different things depending on the context.

But margin comes up often in financial conversations because it’s an important concept … and worth taking a look at.

In stock trading, margin is debt secured by the stocks you’re buying.  It’s like the way real estate investors use mortgages to acquire property.

Typical margin leverage with stocks is fifty percent.  So you put in half and borrow the rest.  If the stock goes up, you get to keep ALL the gain … just like real estate.

BUT … if the stock goes DOWN … you get a “margin call” … which means you need to bring in cash to restore the loan-to-value ratio.  No fun.

We’re sure glad that doesn’t happen in real estate!

The term “margin” has another important meaning.  It’s the “edge” or “fringe” … things that are farthest from the center of the target.

So when you think about your personal budget, you have things at the core … food, clothing, shelter, medical care, etc.

Out at the far edges … the margin … are highly discretionary, non-essential expenditures.  These are things you can easily live without, but you enjoy when you’re flush.

These are the first things to get cut when you’re squeezed.

Households, corporations, even governments all have “core” expenses and activities … and “marginal” expenses and activities.

Again, when prosperity recedes … things at the margin fall off the target.

Our point in all this is you can learn a lot about the direction of the economy simply by watching what happens at the margin.

Make sense?

That’s why this headline caught our attention …

Rising Home Prices Push Borrowers Deeper Into Debt

– Wall Street Journal, April 10, 2018

“ … higher mortgage rates make homeownership out of reach for many,

pressuring lenders to ease credit standards.”

“ … rising debt levels are a symptom of a market in which home prices are rising sharply in relation to incomes, driven in part by ahistoric lack of supply that is forcing prices higher.”

Hmmm … some of that doesn’t make sense to us.  But before we go there, consider this headline …

Home builder confidence slides for fourth straight month

– MarketWatch, April 16, 2018

“The 69 reading is still quite strong. In the go-go days of the housing bubble, between 2004 and 2005, sentiment averaged 68. Still, the fact that confidence is declining so steadily is notable. When NAHB’s index started to fall in late 2005, it was one of the signals that foreshadowed the coming housing bust.”

“ … builders are keeping the pace of construction slow and steady. And they’re worried about their costs.”

And then there’s this one …

US home building rose slightly in March, led by apartments

– Associated Press via ABC News, April 17, 2018

“… driven by a big 16 percent gain in apartment buildings. Single-family home construction slipped 3.7 percent.”

“There is a severe shortage of existing homes, which has pushed up

prices in cities around the country … That’s lifting demand for new homes.”

Again, a few things here that don’t make sense to us.  And we could probably write a book just on the excerpts from these three news articles.

But let’s see if we can unpack all this briefly …

First, rising mortgage rates and prices are causing people at the margin of prospective home-ownership to remain tenants. Not great for them, but not bad for landlords.

Usually when prices rise based on DEMAND, builders ramp UP production to profit by selling into the increased demand.

So it seems to us home-builder confidence should be growing.  But it’s not.

That makes us think the number of people who can afford to buy isn’t growing either … it’s shrinking.

That’s because when prices rise faster than incomes, the ability to borrow eventually peaks.  Falling interest rates can delay the problem by getting more mortgage for the same payment.

But now that rates are rising, it seems people at the margin are getting pushed off the back of the affordability bus.

That may also explain why apartment building is growing, but single-family home building is declining.

It may also explain why Freddie Mac is lowering lending standards.

They can’t create jobs or increase incomes, but they can make it easier to borrow in spite of rising rates … and they are.

Freddie’s making it easier for first-time home buyers to get in and push up the market from the bottom.  It’s like the air inlet in an inflatable jump house.

The concern is when lower lending standards act as the air pump trying to compensate for higher interest rates and insufficient income … how long can the debt inflation go before it tapers off … or worse?

Don’t get us wrong.  We LOVE passive equity.  It’s fun to buy a property and just watch the equity grow.

But the market giveth and the market taketh away … unless you’re smart enough to get your equity off the table with cheap long-term debt while both are still available.

As John F. Kennedy said, “The best time to repair the roof is when the sun is shining.”

The sun is shining on real estate right now.  Enjoy it. But be sure you’re preparing your portfolio for stormy weather.

It’s probably smart to have some cash on hand … to be prepared for credit markets to tighten unexpectedly … and to lock in long-term rates where you can.

It’s also wise to pay close attention to cash-flow and avoid dependence on market factors to increase rents or values.

Make sure your deals pencil TODAY … based primarily on things you can reasonably control.

Sure, you might have to walk on some marginal deals … even though they’d be “winners” as long as the tide is high and the sun is shining.

But if the tide goes out and the storm comes, then marginal boats sink.  And if they’re tethered to your best boats, they ALL sink.

Now if you just can’t resist taking a chance on a marginal deal … consider structuring it so it can’t take down the rest of your portfolio if things don’t go as planned.

We’re just two weeks removed from our incredible Future of Money and Wealth conference … an it was an EYE-OPENER.

(If you missed it, you’ll be glad to know we video-taped the ENTIRE event and it’s in postproduction right now.   Click here to pre-order at a really great price.)

Meanwhile, now that we’re getting back to our normal routine, we noticed some real estate related news that looked interesting …

Home prices surge to a near four-year high, Case-Shiller shows 
– MarketWatch, April 24, 2018

“Rather than moderating, as many economists expected, home prices are accelerating.  The 6.8 percent annual gain … was the strongest since mid-2014.”

“ … finally broke above the peak it last touched in 2006.”

Hmmm …. is that good?

It kind of feels good.  Then again …

Subprime mortgages make a comeback—with a new name and soaring demand
–CNBC, April 12, 2018

“The subprime mortgage industry vanished after the Great Recession but is now being reinvented as the nonprime market.”

A rose by any other name?

“allow … borrowers to have FICO credit scores as low as 500 … can take out loans of up to $1.5 million … can also do cash-out refinances … up to $500,000. Recent credit events, like a foreclosure, bankruptcy or a history of late payments are acceptable.”

“ … will also securitize them for sale to investors.”

Uh oh.  We’re having flashbacks …

“Big banks are also getting in the game, both investing in the securities and funding the lenders …”

Like “too big to jail fail” banks?

“It’s large financial institutions. A lot of people with private capital sitting on the sidelines …” 

Okay.  Let’s take a deep breath and try to figure out what’s really happening, and how it might impact all us lowly Main Street real estate investors …

First, does this mean another grandiose sub-prime implosion that drags the global economy into yet another Greater Recession?

Not sure we’d bet on that happening again.  At least not the same way.

Peter Schiff tells us he thinks the real crash will be the dollar.  He thinks when the debt markets implode, central banks will destroy the dollar in a vain attempt to reflate asset prices and save banks.

Wow.  That’s pretty apocalyptic.  But hey, it’s Peter Schiff.

James Rickards thinks the stage has been set to replace the dollar on the world stage with the IMF’s SDR.  Not sure what that means?  Read Currency Wars and The Death of Money.

But no one we’ve talked to think it’s all going to happen in a day. It’s a process.  And if you’re paying attention, you can see it coming and take pre-emptive action.

Of course, that’s a big topic and too much to dissect in this missive.  That’s why we hosted Future of Money and Wealth … and video-taped the whole thing.

Some of what we learned is that as the dollar begins to fail, dollar denominated bonds would fall out of favor.  After all, who wants to loan “strong” dollars today and get paid back late with weaker dollars?

Foreigners buy fewer U.S. longer-dated Treasuries at auction 
– Reuters, April 23, 2018

Well, THAT’S interesting.

Less bidders on bonds usually means interest rates rise …

Mortgages, other loans get pricier as 10-year Treasury rate tops 3% 
– USA Today, April 24, 2018

Okay, that’s getting closer to home … literally.

But usually when the world isn’t buying bonds (and yields rise) … the money goes into stocks and stocks go UP.  But they went DOWN.

Hmmmm…. it seems the paper players of the world aren’t wild about bonds or stocks.

Since stock investors aren’t piling into bonds for safety, where are they going?

Could be cash … for now.  That would explain the aforementioned, “… a lot of people with private capital sitting on the sidelines.”

We can’t claim to be paper asset experts … far from it.  But it seems to us if there’s cash on the sidelines, the issue isn’t liquidity as we’ve heard some say.

And if there’s plenty of cash … and plenty of stocks and bonds to buy … then maybe the issue isn’t liquidity or inventory, but quality.

Think about Detroit real estate at it’s worst.  There was PLENTY of properties.  And they were cheap.

You could buy a whole house for $2500.

But few did.  In fact, they bull-dozed lots of properties because on one wanted them.

The problem wasn’t price or availability, it was quality … or lack thereof.  No sale.

So MAYBE paper asset investors are a little afraid of stocks and bonds right now.  Maybe they’re starting to look for more real alternatives.

That’s what happened at the turn of the century.  Stock and bond investors poured into real estate and mortgages.  From their perspective, they’re safe.

Real estate is like that loyal, sometimes boring best friend in high school.  When things are free and easy, you hang out with your party pals … but when life gets hard, it’s that old faithful best buddy you lean on.

There’s a LOT of debt in the world right now.  More than ever before.  Much of it created in the last 10 years … providing the jet fuel for some pretty powerful paper pricing runs.

Of course, some of the cheap money has also made its way into real estate.  So real estate’s been good too.

But it’s quite possible the party is coming to an end.  Rising rates and declining stock prices could be warning signs.

And yes, a slowdown will probably impact real estate PRICES … especially for homes, which get overbid in good times.

However, incomes and rents are often less affected by downturns, making income producing properties much more stable in slowdowns.

And if you’re smart enough to lock in low cost long term financing, you’ve got a real competitive edge in a rising interest rate environment.

Meanwhile, if history is any indicator, when the paper party ends … it usually means an increased interest in real assets … especially real estate.

At least for now, it seems to us the volatility caused by rising interest rates is a MUCH bigger deal to the paper crowd than for real estate investors.

BUT … even Main Street investors should be paying attention to Treasuries, interest rates, the dollar, gold, and energy.  They’ll provide early warnings for bigger concerns real estate investors should be aware of.