August 2024
Here are some key takeaways from their conversation:
- There is a noticeable drop in real estate transaction volume due to high interest rates and sellers holding out for better prices.
- Many real estate loans are coming due soon, creating potential opportunities for buyers as sellers may be forced to refinance at higher rates.
- Potential interest rate cuts are anticipated but are not guaranteed. Fed Chair Jerome Powell is speaking this Friday, where he may release more information on rate cuts.
- Inventory for single-family homes in California is low, which could drive prices higher if interest rates drop and more buyers enter the market.
- Meghan and Chris agree investing in real estate independently allows for greater control and potentially higher returns but requires time and capacity to handle tenant issues. For those looking for an alternative option, investing through a fund can offer access to better expertise and opportunities but may involve fees and less control.
- It is important to properly evaluate real estate investments by calculating potential income, expenses, net operating income, and comparing it to other investment opportunities.
- People can have a lot of emotional ties to real estate. It’s important to understand what certain properties mean to you and how selling, renting, or other actions could potentially affect family dynamics, emotions, etc.
Watch previous episodes:
Ep. 98 How to Build Financial Confidence
Ep. 97 The Stock Market Selloff: Morton's Perspective
Hello, everyone. And thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by Chief Investment Officer Meghan Pinchuk. Meghan, thank you for joining us.
We're known for investing in stocks, bonds, alternative investments, things like real estate. And lately real estate as an investment opportunity or what's going on with it has been coming up quite a bit in client conversations. I think that here in California, we're a little bit spoiled compared to some of the other markets that are seeing some downturns or some fluctuations, which could potentially be good opportunities for investing.
But I wanted to start today by talking about the current real estate environment, maybe then followed up by how emotional people can get around investing. Maybe even how to properly evaluate a good versus potentially bad, real estate deal, and then how people can get in trouble with regards to putting on debt and making speculative bets around interest rates.
Let's do it. That sound good? So, Meghan, what are your thoughts around the current real estate environment?
High level we are getting the question a lot of okay, are there opportunities? And the answer is yes around the margins. And it's more about a broad based opportunity. We're not quite seeing it yet in terms of what's available out there in the market. You would expect there to be weakness in real estate related to just how quickly and how much interest rates rose.
Real estate is very sensitive to interest rates historically, but there's this interesting dynamic in the market now where sellers are holding on as long and as tight as they can because they don't want to sell at lower prices. And then buyers are sitting there waiting for a really good deal. So there's actually been a real drop in transaction volume, right?
The number of deals getting done in recent years. And that has somewhat put a pause on things where again, just the volume isn't there. So because of those prices, there's some, some opaqueness about where what our prices, how big, how much have they come down, you know, when will they recover those kinds of things. But the big opportunity that I think a lot of people are waiting for is related to the banks.
And you mentioned leverage and debt. There are a lot of loans that are scheduled to come due in the next year or two years, three years. And so then all of a sudden the sellers can't wait anymore, right? They have to go do something to essentially be able to refinance or sell properties. But they're going to need more capital.
And the main reason why that could potentially create opportunities is because they've got lower, cheaper debt right now on those properties. And when these loans mature, they're going to have to refinance. And rates are much higher today than they would where they were sort of like 2009 to 2022 ish. But rates by all means are not, you know, ridiculously high.
They're not. And so there's a lot of talk about the upcoming fed meetings. And will the fed lower rates and will it, very possible and probably I think the market's pricing in a very strong probability, the fed at least cuts rates by 25 basis points in September. That's not going to move the needle so much like we're talking you would need a big downward move to sort of save the values on some of these properties.
So we'll see what happens. But the people are going to need to come up with capital. They're either going to need to refinance, but the banks are going to look at it and say, oh, like values are somewhat down. So you need to come up with more capital. So does somebody raise new equity money to put into the deal?
Or if they can't do they just have to sell it? And at that point, if enough people have to sell, do you get distressed in the market? There's a lot of opportunities for buyers.
Yeah, that makes sense. I mean, I got an email from a real estate agent, just this last week saying that because of the move in volatility in the stock and bond market over the last week, even though the fed has not come out and said that they're going to lower interest rates or they've not actually lowered interest rates, they may... you never really know, that nonjumbo loans, the interest rate on borrowing has actually come down by close to a percent from the mid to high sixes to that to the high fives.
Yeah. And that's something people need to keep in mind when you think about the fed cuts the market. The fed controls the short term borrowing rates. Right. But the market, the broader interest rate market, it's priced off of what the fed does. But it moves oftentimes in anticipation. So rates have already come down somewhat. Right. Not obviously to where they were but they've already come down.
And so it would actually be the reverse. Now if the fed doesn't do that cut, is that a bad shock to the market? And rates kind of spike back up at that point. So to some degree it's already happened at least for the short term. And we'll see actually now if it transpires in the market and backs up what happens.
Another challenge with that too is like there's a lot of cash and buyers and people with money on the sidelines. So if you're waiting for just rates to come down that when that happens, there's going to be a lot more buyers out there. And so inventory, at least in single family homes in California, is very low. So that could be a situation where prices even go higher from there.
We've seen a really interesting situation in Southern California in particular. That's the one that I'm most familiar with where there's just no supply because you have people who normally would have sold to downsized ups at whatever it is. So they would naturally have some turnover in, in residential real estate, and they can't do it because their mortgage rates are so good.
So for them to move, even if they downsize, right, they would end up paying more because rates are so much about their current mortgages. So some of that's also going to be floating rate. And so will that reset and force people to start moving and transacting? Or do they just have life events that force them to do it.
And it's a non financial decision. But every market in real estate, it's very important to keep in mind how local it is because you can't really paint things with a broad brush, even property type like right now people hate office. But certain office markets, even where we are, are very strong and solid with really good occupancy. So it's definitely very location specific.
Yeah. Location specific for sure. I mean, the big boom of some cities during the pandemic, I'm thinking of places like Austin and Nashville and Atlanta. Those prices have come down north of 2,025% in some areas because of the oversupply and the increase in rates and what's going on there. Very different story than what we're seeing.
Yeah, yeah. So one of my favorite topics to talk about, especially as it relates to real estate, is how personally tied we can become to it and what it means to us. And emotions are very much involved.
Yeah. There's people who inherit properties. Maybe that means something to their families. There's something where they own it a long time and, you know, it becomes real estate's a real asset.
You're touching and feeling it like... it feels a lot more personal in a lot of ways. You know, if you're managing it yourself. And so it is challenging sometimes to take the emotion out of it and just go by the numbers. and emotion should be factored into. But the pure financial decision, you want to at least make sure that you're thinking through kind of the risks, the returns, the ups and the downs.
We see this especially prevalent in, in residential. So if people are dealing with their homes or what used to be their home, we actually had a herself event recently and talked about real estate. And one of our clients had a really interesting example where she talked about renting out her home, and it was the right decision financially.
In that case, the numbers really worked out. But the emotional hit of having somebody, basically a renter, come in there and mess it up, it is was traumatic and I understand it, I get it. And so it might not be the right thing for you. You know, financially you run the numbers. It made a lot of sense.
That's funny. I've got a client who they've got a long-term family property. This property's been in the family since, like the 1930s, and they set it up to be like an LLC type structure a long time ago. So that way it could get passed down to future generations. And at the onset, it made a lot of sense.
Right. You've got, you know, the parents that owned it. The family got to enjoy it. Their kids got older. And when the parents passed, now these three kids own it. And then when something happens to them, it goes to their kids. And so all of a sudden it went from two people owning it to eventually probably like 15 people owning it.
It's a lot of owners. And just the thought about like, who do you how do you determine what percentage gets the weeks and the maintenance? And what if somebody wants to fix a bathroom? I mean, it creates a long-term mess, even though this property is a beautiful property, has been in the family a long time.
That's a lot of opinions and a lot of their family related emotions that are going to get interesting. But I get real estate- you can look at it purely by the numbers financially, but it tends to be a more emotional asset than others.
So what are some of the pros and cons investing in real estate? And let's just say doing it yourself.
Now for doing it on your own. One is you have control, right? Unless you've got 14 partners in it. But in theory, if you're doing it yourself or with someone that you trust and work with, you're the one who's making all the decisions about buy, sell, hold, how to rent it out, or when to renovate or make improvements.
So that's a big advantage. and usually it's more cost effective to do it yourself versus going through a professional manager and, having that extra layer of fees, but now an extra layer of expertise or even people to take some of the work load off your shoulders.
And so even though you might have a better net return because you're not outsourcing those costs, you still have to factor in your time and your emotion.
And people don't usually do that, especially at the time. Right. What it's what's their time worth? But we have one of our advisors who owns a property and, you know, got really sick of getting calls in the middle of the night about the toilet being, you know, stuffed up and needing to call the plumber and fix this and that.
And, you know, again, if that's your zone of genius and you enjoy that, like, it can be rewarding and it can even be more cost-effective in a smart and financial return. But it's not for everybody having to be that hands-on at all times. I mean, even then, there's not fun stuff to it.
It's not that it's fun, but, do you want to have to go evict the tenant who stops paying, you know, and be the one that sets all that up and deals with the sheriff and things like that. There's a lot that goes on to efficiently manage real estate property. So it's, it can be complicated and you need a certain level of expertise and a certain level of time and patience.
So if somebody wants to invest in real estate, I mean, it's very popular here on the West Coast for people to be excited about building well through real estate, because they've seen what prices have done over the last 20 plus years, what are some other avenues, like they can go into a fund type structure. They obviously give up a little bit of control or decision making, but there's some pros and cons to that as well.
You give up control, you pay that extra layer of fees. You know that we talked about to a professional out there. I think one of the big advantages, though, is if you're looking to invest in real estate, the opportunities that these professional groups are seeing is huge. Like this is literally all they do every day is that they're looking at deals and they have big networks of people sending them deals and, and it's not quite as easy to sort of just go, oh, I'm going to go find like a really interesting property but good value, especially today because again, it's tough.
It's not like it's if real estate were just probably, you know, attractive. Everything's falling apart. Like honestly, after 2008, a lot of people have been efforts to just pick it off. You know, anybody could do it. But right now I think you have to be a lot more selective. And finding the right deal situation, I think, is harder than in other environments.
So a professional that's going to go in there and be real opportunistic and thoughtful and be able to crunch the numbers and, and see it makes sense. Factor in the downside. Big thing right now some people are thinking about it as like cost insurance cost in particular.
Yeah. I think people understanding how to calculate whether something is a good or bad real estate investment is important. And it really comes down to what's that? What's the income that you're going to receive from the property. What are all the expenses? What could those expenses look like down the road? And then you calculate sort of a net operating income, the income minus expenses to determine a proper value.
I've got a client I was actually just talking on the phone with the other day. They've got a place near the ocean in Santa Monica, Mar Vista. And they said, oh, you know what? Maybe we should just keep this, property long term. We could probably rent it out for like $10,000 a month, and that'd be a lot of income.
And I said, well, hang on here real quick. You guys don't have any debt on the property, so it's paid off. That's a plus. So not a lot of risk from leverage or refinancing or interest rates standpoint. But let's just run the numbers just for fun. So let's pretend that, you know, you get $10,000 a month, that's $120,000 a year.
And your property tax and insurance, let's just call it round numbers, $20,000 a year. So your net operating income is $100,000. And then you look at the value of the home. It's about 3.5 million. And when you factor in, if they were to sell it and pay the taxes on it, they would net $3 million from those proceeds.
So when you look at it from that perspective, the $10,000 a month doesn't look nearly as attractive because it's only a 3% yield. It's hard to factor in what appreciation is going to be, but it's really only a 3% yield. And today, you can put your money in a money market and earn, you know, 5%.
Sure. And like you said, you don't now. And there's I think a lot of confidence for people who have been in real estate for decades that ultimately it will keep going up and long term, especially in the right markets. That probably is true. But when how much? there's a lot of questions related to that. So if you're not in it for truly long term, in that example, would it be better to have liquidity redeployed elsewhere?
You know, put it in something more opportunistic that does have the potential to appreciate more quickly. But in that case, you know, if it's a home again, are you emotionally tied to it? And is that what's driving the decision versus purely just kind of what are the numbers and does it make sense?
Yeah, those memories really play a large role in decision making.
One of the reasons why I'm so glad that you're our chief investment officer is because you don't like people that come here with just a deck of BS and sort of speculation. Right. And so one of the ways that people can get into real trouble with investing in real estate is over speculating on where they think interest rates might go.
Yeah, that's my favorite. First of all, I've never seen a deck or like a presentation on a potential deal that didn't look good right now. And no one's going to come and be like, this is kind of mediocre, but everything looks good. And the reason it's easy, especially in real estate, to make it all look good, is because it's very easy to play with some of the numbers, some of your back end assumptions to be like, oh, we're assuming that rent growth is, you know, some high number where vacancy is very low.
We're assuming that cap rates are basically set prices go up by a certain amount. And again, to to show someone what the return might be, you have to come up with some level of assumptions. But that's why it's really important. And I think we see a lot of individual deals too. Clients will send us and say, my friend wants to do this.
What do you think all of those parts and components are really important to look at? Because what we like to see and what managers we like to go with, they often do the same thing, right? If they have to look at and say, what's it going to grow by? What could we sell it for? But they're using pretty conservative numbers and they're actually usually going out, call it close to ten years and saying at the end of this, if you've had modest rent growth, if you haven't had a lot of appreciation, all these different things is it's still a good deal in return.
And then if something's going your way, you know, you're going to have some additional upside from there. So that's how we like to they see things modeled.
And where you see people get into a lot of trouble around speculating on interest rates are saying, hey, look, this deal, if I did it today, if interest rates were to fall from 7% to 5%, it's a great deal. So I'm just going to go ahead and buy it even though it's a 7% interest. So dangerous hope is not a strategy.
Right. And so that's one of the ways that you see people get into trouble is just speculating on where interest rates might go and then potentially putting on too much debt.
And, it's very... you see a lot of that of people where it's going to work if A, B and C. And so I think we like to see the reverse. Right. We like to see like if, if things don't go our way it's going to work. Maybe it won't be amazing. But like if things kind of go against us even it's going to be okay.
And then if things actually go in our favor, like it's going to be great. So I prefer that level of risk reward dynamic, that level of hope of like, I'm okay if it doesn't happen, but hopefully it's good versus the whole like, well, it needs to come down or else. Basically we're losing the property. You know, that's what's good.
I feel like investors have been spoiled over the last 16 years because the Fed has stepped in and printed money and sent out stimulus, and they might.
Do it again. It's that's the tough thing too, is like you have we started a billion opportunities and it is you mentioned the idea that there's money on the sidelines. It is very possible that some of this transpires, right. There's issues, problems in the market. There are opportunities, but it's brief. And so basically cash flows in the fed steps up to the backstop stays.
And then it's all back to the races. And we miss it right. We miss it because we weren't sitting there ready to pounce. I just don't think you can live or invest like that where it's like there's there's truly a teeny tiny window, like, you know, catching the exact spot is going to be pretty much impossible. And so you want to be with people who are thinking more long term, not like short term speculate, get the exact window.
They better be doing deals that are going to work again. What are those? The kind of which direction the fed decides to go.
Megan, thank you so much for joining us. I know that real estate is a very common topic for us to talk to people about and people, something that people are very interested in investing in. hopefully you guys found some value out of the conversation today and can better assess the emotions that you have tied to investing in it and maybe, maybe how to calculate whether or not it is a good investment return.
Disclosure: The information presented herein is foreducational purposes only and is not intended to constitute financial advice.Morton makes no representations as to the actual composition or performance ofany asset class. The views and opinions expressed by the speakers are as of thedate of the recording and are subject to change. It should not be assumed thatMorton will make recommendations in the future that are consistent with theviews expressed herein. Past performance is no guarantee of future results. Youare encouraged to seek tax and/or financial advice from your financial advisorand/or tax professional to thoroughly review all information beforeimplementing any transactions and/or strategies concerning your finances
