A potentially big real estate story for 2019 …

While most Americans are fixated on the brouhaha surrounding the government shutdown, we’re thinking about something even MORE slimy …

Oil.

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 supplydemand, 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.

Not only were lots of jobs created, but wages grew at the best rate since 2008.

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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2/23/14: Clues In The News – Cloudy With a Chance of Sunshine

Have you heard?

There’s been some bad weather lately….and it seems to have sub-marined much of the U.S. economy.  At least that’s the official spin.Severe weather is being blamed for gloomy economic data

But is it all doom and gloom or is there a chance of sunshine?

Here to rise above the clouds of confusion to see what the latest economic stats mean to real estate investors…

  • Your sunny host, Robert Helms
  • His gloomy co-host, Russell Gray

You may have heard it said, “Figures lie and liars figure.”  And we’ve learned that 87.2% of all stats are made up.  Or is it 27.8%???

So when you hear about new housing starts, existing homes sales, mortgage applications and jobless claims, they’re all a bunch of stats that the tea leaf readers on TV and newspapers try to interpret.

The problem is those financial talking heads, as smart and attractive as they may be (at least when compared to the hosts of The Real Estate Guys™ Radio Show), aren’t real estate investors.  So the paradigm, spin, interpretation and context they have is all for paper asset investors and real estate owner-occupants.

So what do all these economic metrics mean to real estate investors?

First, home sales get divided into two categories.  The biggest chunk is EXISTING home sales and is reported by the National Association of Realtors. Existing home sales is an indicator of prosperity because new home buyers are entering the market and existing home owners are moving up. Presumably because they can afford to.

But take by themselves, existing home sales don’t tell the complete story.  And for investing purposes, you have to dig down into geographic regions, price categories and buyer demographics.  After all, who’s buying and who’s not, which area is hot and which is cooling, and whether prices are rising or falling, all begin to shine the light of opportunity or danger on specific places, price points and property types.

New and existing home sales are considered a leading indicator of economic recoveryFor example, if you knew that the fastest growing segment of price point was in the $1 million and up price range and the fastest declining segment was in the <$100,000 price range, would that affect where you might choose to flip versus where you might choose to invest in rental property?

The other component of housing sales is NEW home sales.  But it’s a much smaller chunk.  So why do so many talking heads care so much about housing starts?

Think about it.  People who watch financial shows are often trading stocks.  If housing starts are slow, it means home builder stocks are negatively impacted.  Whereas if existing home sales slow, it only means some real estate agents don’t make as much commission.  Sad for real estate agents, but meaningless to stock traders.

Another index that stock traders fixate on is home builder confidence.  The idea is that if home builders are optimistic they’ll build and sell new homes.  They means demand for labor and materials, plus all the goodies new homeowners spend money on when first moving in.

Sounds good.  But if more people are buying homes, does it mean less people are renting?  Which is better for landlords?

Again, the news is prepared for the audience it’s presenting to.  And if you’re a real estate investor, financial TV is NOT talking to you.

Before we leave the topic of housing, think about this:  Lots of people, including those who pull the levers of the macro-economy, think housing LEADS economic recovery.

Really?

Now, we’re just a couple of dudes on the radio, but it seems to us that housing REFLECTS economic recovery.  See the difference?

If someone is overweight and they stand in front of the mirror, they can see the reflection of their condition.  But the image in the mirror isn’t the person’s actual body. It’s only a reflection.  So if someone didn’t like the condition there body was in and they modified the mirror to make their reflection thinner, does it make their actual body thinner?  Of course not.

So, if people buy houses because they’re selling below replacement cost in the wake of a recession, and government subsidized interest rates and tax incentives make is easier to make a down payment and stretch the monthly payment into a bigger loan; or the down payment is coming from cashing in stocks whose value was inflated by easy monetary policy, does the activity reflect a healthy and robust economy?  Or is it just a funny mirror that makes you appear to be in better shape than you really are?

We think housing is strong when people have good jobs and incomes, living costs are low, and they’re able to save up enough for a down payment and qualify for a loan.  That is, the  housing sale is a reflection of their success, NOT the cause of it.

If that’s true for an individual, wouldn’t it be true for a collection of individuals like a country?

We think so.

So do people have good jobs and incomes?

The jobless claims and labor participation rate says no.  And with healthcare costs, food and energy costs rising, people are actually being pinched.  Are these the conditions we’d expect in a healthy economy and a sustainable housing recovery?

Probably not.

Does this mean we’re bearish on real estate?  Not at all.  In fact, we still think this is a good time to acquiring income producing property in the right markets and price points.  Though we do encourage caution in the aggressive use of leverage.  We still see downward pressure on wages and discretionary income for the working class.  So for long term buy and hold, cheaper markets with a good business climate and low costs of living are probably safest.  Along with fixed rate loans and good operating margins.

If you’re a fix and flipper, the higher priced markets actually look better.  At least according to the stats.

The point is, like any business, you must know your target market.  If you want to sell the use of your property to a long term tenant, that’s a different game than flipping a pretty property to an owner-occupant.  And the clues you need to make better decisions are in the news every day.

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