Announcer: Please note disclaimers at end of show. Welcome to Creating Wealth with Jason Hartman. During this program, Jason is going to tell you some really exciting things that you probably haven’t thought of before and a new slant on investing, fresh new approaches to America’s best investment that will enable you to create more wealth and happiness than you ever thought possible.

Jason is a genuine self-made multimillionaire, who not only talks the talk, but walks the walk. He’s been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason’s footsteps on the road to financial freedom. You really can do it. And now, here’s your host, Jason Hartman, with the Complete Solution for Real Estate Investors™.

Jason Hartman: Welcome to Creating Wealth Show No. 125. This is your host, Jason Hartman. Thanks for joining me today. We have a great interview on today’s show, a senior economist with Moody’s John Stapleford will be joining us in just a moment here, and the interview was long, so we’re going to split it up on to two shows. The second part will not be the subsequent show. We will actually skip a show before we play Part 2 of this interview. I just wanted to let you know that for planning reasons, we needed to do it that way.

I think you’ll really enjoy the talk with him. Make sure you join us for our event on November 14. We have the Creating Wealth in Today’s Economy Bootcamp, and we have some guest speakers flying in for that. That’s going to be a fantastic event. We’re going to talk about investing in real estate with your IRA, so if you have a qualified plan, like an IRA, a 401k, a SEP IRA, you can convert that, self-direct it, and you can invest in real estate. You can finance properties within the plan. You can pay cash for them. You can produce a lot of income.

And there’s a big thing coming up next year, in 2010, that you are really going to want to know about. This is sort of a seismic shift in the way that’s working. If you have a pension plan, you need to talk to one of our investment counselors and also, join us on November 14 for our guest speaker, who’s going to be talking on that subject at Creating Wealth in Today’s Economy here in Costa Mesa, California.

I wanted to start off a little different today with a horror story. I hear about these stories a couple of times every single week. Not a week goes by where I don’t hear about some sort of problem, someone who went down the wrong path, someone who got themselves into trouble on a real estate deal. I hear about them all the time with stock deals and partnership type deals and we’ve talked about those.

But this one is on a real estate deal and it’s one of our clients, but they went and did something with someone else, another broker, and got themselves in a little bit of trouble, and Karam – you’ve heard him on the show before, one of our Senior Investment Counselors here – was telling me about it today. I said, “You know, Karam, why don’t we talk about this on the show so other people can avoid the same mistake.” There’s a famous old quote, “Experience is the best teacher.” The problem is that you have to have the experience before you get the lesson, and that experience is usually pretty expensive.

That’s what we want to do through education here on the show and with our other programs is educate you so you can learn from other people’s experiences and avoid mistakes. Karam, welcome.

Karam: Thank you, Jason.

Jason Hartman: Good to have you here today. It’s been a while since you’ve been on.

Karam: Yes.

Jason Hartman: Well, tell us what happened with this client.

Karam: Well, it’s not pleasant news. This client of mine, who had been with us for the last three years, had called me about a month ago and said, “I have this problem that I don’t know how to solve, and I went to a few people and nobody seems like they know how to solve it. So can you help me with it?” So I said, “Okay, let’s hear it.” And he was referred to one of the brokers in the business. The thing that is happening nowadays is there are so many crazy things happening in the market. Everybody is saying this is the best time to purchase. Yes, that is true.

Jason Hartman: It’s true depending on where and how.

Karam: Yes and what you do, and especially in real estate, once you make a mistake, to correct that mistake, it takes a few months and a few thousand dollars out of your pocket to correct that. And this client of mine, the broker recommended that he buy in Flint, Michigan. I said what made you think Flint, Michigan, is a good deal? And he said, “Well, I paid only $25,000.” I said, “Well, I can get your for $2,000, for that matter, in Michigan.”

Jason Hartman: Karam, I just have to comment on that because I was networking with one of the groups that I’m involved in on the internet, and they put up a post that said, “Michigan Foreclosures, $25,000, 22 houses.” And I said was that the price each or for all of the houses? She replied back, “That’s all of them.”

Karam: That’s like $1,000 apiece.

Jason Hartman: I know. Folks, sometimes, no matter how cheap it is, it’s still not a good deal. Some of these properties in some of these really blighted areas you can buy them for $1.00. They just want you to pay the property taxes and maintain them. So just because it’s low-priced doesn’t mean it’s a good deal.

Now occasionally, there’s a low-priced deal that is a good deal, but you really have to vet this stuff. There’s more to it than meets the eye, and that’s why you have us here at Platinum Properties Investor Network to help you do that. I’ve been doing this for 24 years and with our combined experienced with Karam, myself, and the other investment counselors here, and all of the experts we’re always talking to, we really bring you a wealth of knowledge that will help you avoid these mistakes. But go ahead with the story.

Karam: Well, Jason, this was like three or four years ago that you’ve been saying don’t take the California brain to all these markets. So $100,000 is cheap; $25,000 is even cheaper. How can you go wrong with $25,000? Well, if the house is purchased for $2,000 and sold to you for $25,000 in a not-so-good neighborhood, then you are in trouble.

So this client purchased a property for $25,000 and he had to pay property tax, some $1,400 – $1,800 property taxes, and come to find out, the seller went out of business and the seller had recommended a property management company who would find the tenant for this house, and they went out of business. Now he doesn’t know what to do. He doesn’t know anybody in Flint. And he calls around and nobody responds to him.

And so, I said, let’s do it this way. I’ll find you the property management company. He said, oh, I’ll be so glad to pay you. I said no. This is part of our service. You have been our client and once you are our client, we help you in any which way we can, even though you didn’t purchase from us. Even if a client brings us a deal that they have not purchased and they want us to evaluate, if they are going to purchase through somebody else, we are so glad to evaluate for you. You always want a second opinion, third opinion, third party. Even Platinum Property Investor Network, you want to check us out by talking to other people, how credible we are. You can talk to our past clients, who have purchased a number of properties. How are we in dealing?

Jason Hartman: I think, Karam, that’s the comfort level people get when they come to our events. They see our office. We have a real office. We’ve been in business 12 years. I’ve been in the business for 24 years now. By the way, folks, I just renewed my real estate license. What a joke. Do you know how easy the questions are on that test? I couldn’t believe it. I had to take the test every four years for continuing education, and I just have to mention this is why there are so many quacks out there in our business. This is one of the reasons.
One of the questions, Karam, I don’t even know if I told you this – one of the questions on the test – I had to take six little mini-tests to renew my license. One of the questions, I kid you not, were

“True or False: The IRS has their own website.” Can you imagine? That is a test question to renew your real estate license. Amazing.

Karam: You can ask that question of a Kindergartner.

Jason Hartman: I know. It’s amazing. But anyway, back to the point because I do digress. What I want to say about that is that when people come to our events, they meet a lot of our clients that are here, they’re coming to an event again, they’re in the process of purchasing properties. They may have purchased properties three years ago from us, four years ago from us, and you know, folks? We’re the real deal. We’re here for you. We stick with you. I think we don’t toot our own horn enough about that because we hear it on an individual basis all the time from our clients. And so we’re tooting our horn a little bit today, folks. Really, you have to understand that.

Karam: Today is Friday.

Jason Hartman: Anyway, go ahead.

Karam: So I called around to property management companies in Flint, Michigan, and started interviewing, and I found this one property management company that sounds very professional and they said we’ll check it out. While I was on the phone, they checked that particular address and they said, “This address is red-tagged.” I said what do you mean by that? They said either the property itself is in trouble or it is not maintained, so the city comes in and puts the red tag on it. So it shows on the internet that it is tagged.

So she said, “I’ll find out and I’ll call you and let you know.” So I called my client and the client is aware of it now. We have three-way calls, three-way emailing, and found out that the property was not maintained and that is the reason. And they went in; they checked it out. The property has to be brought to rent-ready, meaning $5,000 – $7,000 in repair work is needed.

Jason Hartman: Which is not necessarily a big deal, especially if the house has a market value. Say the investor is buying it for $60,000 or $80,000; $7,000 worth of work is a little less than 10 percent, but that would push the ARV, the after repair value possibly up to $110,000 – $120,000, so it’s well worth it. But in this case, these are just blighted areas. Nobody wants to live there. The population is declining. It’s a lost cause.

Karam: Exactly. After fixing it even, we don’t know if we’ll find a tenant who will pay you the rent. So two choices: fix it, find the tenant, put them in, and live with it; or sell the property, and selling the property, we don’t know what he will get. Maybe he will have to put some from his pocket. He will take a loss. And repair cost itself is uncertain. We’re dealing with so many uncertainties here, but he has no choice but to move forward with the repairs. So that’s why we are doing – this is the stage that we are at.

So folks, what we want to convey to you today is do your due diligence on anybody. Like I mentioned, even on us, check before you buy the property. Once you buy the properties in certain markets, especially markets that are losing population – population is not increasing.

Jason Hartman: Those markets pretty much don’t work. There might be an exception some day, but I haven’t found one of those markets that really work yet.

Karam: Our service is available to you if you’re buying, if you’re in the planning stage right now, buying through somebody. Check with us. We’ll give you our honest opinion and then you can proceed. You can have a third party opinion before you purchase.

Jason Hartman: That’s good. That’s a good point. Our Coaching clients, they bring deals to us. We evaluate them. If you are not a client yet, you are welcome to just talk to one of our investment counselors, email over a deal you’re working on, and we’ll give you an honest, objective opinion about it. It may be in one of our markets. It may be in another market. We like all of the markets we’re recommending at any given time; otherwise, we wouldn’t recommend them.

But there are some other markets that we actually like that we’re not in because we can’t be everywhere and we want to be only in markets that we have the capacity to service. So take advantage of that.

The other thing that I should say, take advantage of our rental coordination service if you are a client. It’s amazing to me. We have clients that don’t even use the service. It’s free, free for life. So if you need assistance at any time with properties that you purchased through us, if you need help with rental coordination, Sara, whom you’ve heard from on the show before, does our rental coordination, and she will help you by doing backup advertising and promotion online, working a little bit with your property manager, just to kind of back up the services they offer. It doesn’t hurt. There’s no charge for it. When we put ads on the internet, we pay for those ads. This is a free service. There’s no reason you shouldn’t take advantage of it.

Anyway, avoid the horror stories. Don’t have a bad experience. Check with us first. Get an evaluation of the deal. And sometimes, if it’s really cheap, there’s a reason for that. Thank you, Karam, for sharing that story.

Karam: Thank you. I want to say come meet with us one-on-one. Come attend our seminar. You will know what we do. Listen to our podcasts. And then go from there.

Jason Hartman: Yeah, we’ll look forward to hopefully seeing you listeners on the 14th of November here in Costa Mesa. And now let’s go to Part 1 of the interview with Moody’s senior economist from Moody’s I think you’ll find this very interesting. It was a fascinating discussion that lasted 75 minutes, so we’re going to cut this into two parts, and Part 2 will not be on the next show because we have another show we need to do first. But Part 2 will be on a future show real soon here. Let’s listen in.

Interview with John Stapleford of Moody’s

Jason Hartman: Let’s welcome John Stapleford to the show. He’s a senior economist at Moody’s, and comes to us from – are you from Pennsylvania today?

John Stapleford: Yes.

Jason Hartman: Fantastic. He is also a professor emeritus of economic development at Eastern University and former director of the University of Delaware’s Bureau of Economic Research. John holds a PhD in Urban and Regional Economics from the University of Delaware, and a Masters Degree from the University of Southern Illinois. John, welcome to the show.

John Stapleford: Thank you, Jason. Glad to be here.

Jason Hartman: It’s great to have you on. Talk to us a little bit about the outlook from Moody’s, if you would.

John Stapleford: Well, I think if you look at the most recent scenario from the President’s budget advisor in the Office of Management and Budget, we’re tracking along pretty similarly. We see the turning point – the turning point in absolutes will occur sometime before the end of this year, but the turning points in employment and income and some of the other areas of the economy won’t occur until next year.

And then, as they’re projecting, once you pass the turning point, because this has been such a long and steep recession, it’s going to take a good long while to get back up to the levels of activity that you had before the recession.

Jason Hartman: So many are hailing that we’re in a recovery mode now. If you turn on CNBC, they’re cheering the new comeback in the DOW and so forth in the different markets. What are your thoughts?

John Stapleford: I’m glad the DOW is coming back because it means if I did want to retire, I could. But yeah, there are some signs that little shoots of grass are breaking through the dry ground. I think it’s going to take longer than some people, some of the optimists, might think, but when you look at things like the unemployment rate, we think the unemployment rate is still going to go up and hit over 10 percent at the peak level in the United States.

In any of these economic indicators, for your listeners, just so they’re absolutely clear on this, all of the things that you read about the economy are based on sample data. That means that around any of these data points, whether it’s the unemployment rate or the growth rate in GDP or consumer confidence, it’s based on sample data and it has a confidence interval around it. So month-to-month changes don’t really mean much. You really need to look at change over three or four months, and then, in addition, if you’re looking at something like the unemployment rate, you need to look at four or five other labor market characteristics to really get the full picture, like what’s happening with initial claims unemployment insurance, what’s happening to the number of discouraged workers, what’s happening to the number of people who are working part time for economic reasons.

So it’s an important thing to keep in mind. The fact that the unemployment rate dropped from 9.5 percent to 9.4 percent between June and July in the United States, it really isn’t significant, and in fact, what had happened was the labor force declined because the discouraged workers, the population of discouraged workers increased, and so the total number of people who are unemployed fell, but not because they found jobs. It’s because they just dropped out of the labor force.

Jason Hartman: Right. And I know that the discouraged worker part of that plan that fell off, that was changed the way they count that statistic under Clinton, I believe, where if it’s over one year, you’re no longer counted. So someone could be very seriously unemployed, becoming absolutely destitute, and they’re not counted as unemployed. Is that how that works?

John Stapleford: That’s a really good observation and I’d have to go back and look at their current definition, but I would be aghast to think that politicians would manipulate data to make themselves look better. This takes me aback.

Jason Hartman: Of course, that’s a sarcastic comment, for sure.

John Stapleford: Oh, no, no, absolutely not. As you get older, you more and more realize how disposable politicians are.

Jason Hartman: Fair enough. I’m going to agree with you on that one for sure. So the other thing that I’ve always been very concerned about when you look at unemployment rates is the underemployed. And the joke in California, which is sort of the subprime mortgage capital of the country, is that the mortgage broker, who used to be making $40,000 a month, is now working at Starbucks and delivering your pizza. There’s no real way to tally the underemployed, is there?

John Stapleford: Well, there is, and the way I do it, when I look at metropolitan areas or states, I look at wages and personal income. And wages, of course, are a part of personal income. And this whole thing is complicated not only by the underemployment that you referred to, but by these furloughs. There are many people who are getting two-week furloughs, which amounts to like a 4 percent pay cut. So in the unemployment rate, they don’t show up because they’re still “employed,” but in fact, they show up in the wage bill, in other words, the wage component of personal income starts growing a lot more slowly than it has been in previous years, which affects disposable income, which affects consumption, which affects retail trade and automobile sales and so forth.

So, to me, a more accurate way of tracking things is wages. And the other part of it, Jason, that people don’t realize is if you’re working at Macy’s or a large retail store and you’re working 15 hours a week, in the unemployment date, you’re counted as employed. In other words, they don’t adjust jobs to full-time equivalent. That’s another reason I tend to lean towards wages, like retail, typically, is around 12 percent of employment, but it’s only about 7 percent or 6 percent of total wages in any particular area.

Jason Hartman: And not to harp on the unemployment statistic here, but the other one that’s always concerned me is the fact that people are comparing today to the Great Depression and they’re saying things like, “During the Great Depression, unemployment got up to 25 percent at the worst point, and today, it’s much lower, and so things really aren’t that bad.” I agree that in many ways, they’re not that bad.

However, I’d also like to just take a look at the concept of the independent contractor, the sort of free agent, the freelancer, whether it be in the real estate or mortgage business, big industries like that, or it be the graphic designer who works out of their house and is just doing contract work here and there, but they’d much rather have a real corporate job and have what I would consider full employment. Running a real estate business myself for the past 12 years, I’ve seen independent contractors that make very little or no money for long stretches of time on commission only, yet they’re not counted as unemployed.

John Stapleford: Sure. Now, the proportion of employed folks in the United States, who are self-employed, has actually been relatively stable over the last five years. It has shifted from agriculture over into lots of other things, into the services area. But you’re right. And then how much do you like paying the FICA for both yourself and for yourself as an employer?

Jason Hartman: Right, two times.

John Stapleford: How do you like giving up 13 percent of your money just right off the bat? Well, that’s pretty fair. No, no, you make a good point. And I guess I would say, as well, we have built into our economy today things that didn’t exist back in 1929 – 1930, like the unemployment insurance, that are countercyclical. Unemployment insurance is one, but there are food stamps, a whole series of things that help to stabilize the economy that weren’t around before.

And one other aspect of this, we had talked about wages and personal income – transfer payments, which is Social Security, Medicare, and then some other things, Medicaid, too, has gone from around 12 percent of personal income 15 years ago and is up close to 18 percent of personal income or a little bit over today across the United States. Well, one aspect of that is it smooths out the business cycle. That money, regardless of whether people are unemployed or employed, that money is still flowing out and it’s flowing out to all the states. The downside of it is I guess it’s reasonable to question how long can you just transfer money from one group to another without killing the economy.

Nevertheless, the whole transfer payment system wasn’t around 60 – 70 years ago.

Jason Hartman: Right and the takeaway I’d like listeners to get from my comment in the comparison of unemployment to the Great Depression is that back then, which you alluded to, but I just want to make it clear, we really didn’t have all the independent contractors. People had more traditional, industrial era jobs at that time, right?

John Stapleford: Right and I’m not an expert on the data, but I find it very hard to believe that the data that we have today is in any way comparable to what they had then. I’m sure they were just getting started on tracking all these things. Now, another factor in here, Jason – and there’s lots of factors you could talk about – is married women in the labor force, and married women in the labor force started accelerating in the 1970s and hit an all-time high a few years ago. That really wasn’t a major factor back in the 1930s. And so one of the questions is if somebody is unemployed, are they the primary wage earner in that household or are they a secondary wage earner? And if they’re a secondary wage earner, it still hurts, but it’s not as serious as a primary wage earner losing their income, their earnings, and their benefit package. So a lot of compounding factors that make it difficult, in my mind, to make a comparison.

Jason Hartman: Yeah, that’s a very good point. I remember looking through William Bennett’s book, The Leading Index of Cultural Indicators, and one of the interesting points in there, as I recall and this was years ago that I was looking at it, is that both the husband and wife have to be working to support the household as you got into the ’70s and ’80s because the tax burden increased so much, whereas before, the tax burden was much lower and other costs were lower, too. It’s sort of hard to make sense of that. You’re right. I don’t know what to think of that or take away from it.

John Stapleford: One factor in there, because I’ve looked in pretty close detail at the black family and the black family, the labor force participation rate for black males used to be equal to the white males, and the black family up to 1950 was still mostly married couple families. And the black out of wedlock birth rate is now up around 70 percent of all births are out of wedlock, which doesn’t bode well for the portion of black children who are going to grow up in married couple families. And there are two factors that are driving that. One is the Great Society programs, which really took the steam out of the role of the black male and the importance of being in the labor markets, so the black male labor force participation rate has plummeted with that.

And then, in addition, over this last at least 30 years, as we talked about, black males have been competing against married white females coming into the labor market, so they’ve been hit from two sides. There is a third factor, which, of course, is that the pool of marriageable black males is very low compared to marriageable white males, in other words, single and employed full time because more black men have been killed. They have a higher mortality rate. But in addition, they have a lower labor force participation rate. There are more discouraged workers that you had mentioned previously, and there’s more that are incarcerated.

So you take all those things together and you end up with not a complete breakdown, but a really rapid loss of the proportion of black children in married couple families. And all the research literature, whether it’s liberals or conservatives doing the research, says growing up in a single-parent family is not the greatest thing for children.

Jason Hartman: Yeah, I would certainly agree with that. One of the things that’s interesting about that, even cutting across racial lines, is the Aid to Families with Dependent Children, and you just have to wonder if the government and the Great Society programs you mentioned have incentivized the breakup of the nuclear family. Have they done that through the tax program, through fiscal policy?

John Stapleford: Well, you always look at incentives at the margin and you have to assume that people are rational. And initially, the Great Society programs and AFDC in the early 1970s, then when you took the whole package with Medicaid and Food Stamps and Section 8 Housing and go down the list, you actually would have needed at that time a $13 – $14 an hour job to be equal to that package. Then it got slowly cut back over time, and of course, they had the temporary welfare reform. When you say, well, was this providing an incentive to people, the welfare reform – and these numbers are close; they may not be right on target – but before welfare reform, I think we had around 14 million people in the welfare system, the AFDC. Afterwards, we were down to around 3 million.

When you have that kind of drop in the population of folks on welfare just because you’re putting requirements on, like, you have to stay in school or you have to work, it must mean there were people who were taking advantage of that system.

Jason Hartman: Well, that’s the problem with government programs is that everybody starts looking for the loopholes and the ways to exploit the system. We just got through this Cash for Clunkers thing, and on both sides of the aisle, the car dealerships are complaining.

John Stapleford: Jason, if you look at Congressional Budget Office reports on things like the current income tax benefit report or food stamps, typically, about a third of the payments given are fraud. I’m sure Medicare is the same way. I think that applies across the income distribution. In other words, I think of high income people, about a third of them are ripping the government off and I think middle income probably about a third. I think there’s probably a relatively constant corruption factor and it just comes from the fact that we live in a fallen world and that’s human nature. So you have to expect it, and the only thing you can do is to design the programs as carefully as you can to try to minimize the fraud. You’ll never get rid of it.
There’s a huge black market for food stamps, for example. You can’t buy liquor with your food stamps. Well, they sell the food stamps, get the money, and buy liquor or drugs.

Jason Hartman: And the same is true, since we kind of focus on the housing angle of you look at rent control programs that have been done in various cities in California and New York and so forth, and it always gives rise to this gray market or totally black market, where people are doing deals under the table. There was even a Seinfeld episode about it, where Jerry’s neighbor died, this older lady that lived in his apartment, and Elaine wanted to rent the place. They were doing payoffs.

John Stapleford: And the other thing, too, is that in cities where they have rent control or extensive rent control, homelessness increases because the incentives of rent control are No. 1, if you’re the landlord, you don’t maintain your unit; No. 2, if you’re a developer, you don’t put up new rental units because you can’t get the market price. And so the supply of housing actually goes down over time and homelessness increases. Adam Smith’s contention was that people are self-interested. He didn’t say self-interest is good. He just said that’s the way people are, and from a Judeo-Christian perspective, that’s the same position that the Bible takes. It says, well, people are fallen and find a way to deal with it. Don’t expect people to act like saints. There are a few exceptions, like probably you.

Jason Hartman: There you go. Sure. So that’s the invisible hand as Smith described it, right? Talk to us a little bit about the housing market, if you would, knowing that all real estate is local and that markets differ greatly across the nation. And your thoughts on Case-Schiller – I noticed that on Moody’s website, you have a very prominent link talking about Case-Schiller. There’s been some debate about the accuracy, and nothing is perfect of course. I remember listening to one DVC program where there was a person representing Case-Schiller and someone representing another index and they were kind of debating the merits of each. Both had an argument really, I thought.

John Stapleford: I have to say, Jason, I don’t think the problem today is the lack of data. I think the problem is the lack of conceptual frameworks. The reason the housing bust occurred and the bubble occurred and the reason for this housing correction is the complete absence of the application of a very basic housing market economic framework to what was going on. So is the Case-Schiller right? All of them have their limitations issue. The multi-listing, for example, you’re only picking up the houses that are moving, and right now, at least a third of those houses are foreclosures. So what does that do to your data? What does that do to the average price that you have in data that’s based on the multi-list?

If your listeners are familiar to Zillow, do you really believe that down at the zip code level or the neighborhood level or the census block level, whatever, that we have accurate data on what’s happening with the housing market? I mean if we did, why do we pay people to do assessments? Why do we pay realtors to go out and tell us what the market value of our house is?
I think the more important thing is the conceptual framework that allows you to figure out the big picture. And when I say that, I mean what are the four or five factors that drive the demand for housing and what are the four or five factors that drive the supply of housing, and what’s happening to those things? And it’s absolutely clear. When you look at those factors back in 2004 – 2005, and we were talking about this on, demographics weren’t there for the tremendous run-up in house prices. I mean they weren’t there. You didn’t have a baby boom coming into the housing market. It was all based on easy money.

Jason Hartman: I would call it a mortgage-induced housing boom or a Federal Reserve-induced housing boom.

John Stapleford: Let’s say MIHP. But you’re exactly right. Not many people stood back from it. Even some of the “experts” said, “Oh, well, it’s just how people really value their housing and there’s a huge federal subsidy of housing,” and of course, you can write off your mortgage interest and so forth, and real income is rising. But really, real income wasn’t rising that rapidly and interest rates weren’t that low underneath the whole thing.

Yeah, the factors weren’t there, and the rate of withdrawal from the housing spot because of deterioration or whatever is very, very steady over time. The rate of renovation/rehabilitation is very steady. And so in the demographics, if you don’t have net in-migration – and from coastal California, you actually had net out-migration, particularly of older people.

Jason Hartman: You have it Florida now, too, by the way. I just saw a report about that.

John Stapleford: Yeah, in Florida now, too. But even before the bubble burst in California, that was going on as people were looking for lower cost of living areas, like in Bakersfield or wherever.

Jason Hartman: Well, they were going to Arizona, Nevada as well.

John Stapleford: They were going to Arizona, yeah. Rather than get into hemming and hawing over what’s the best most representative housing data, step back and look at it comprehensively through a sound conceptual framework. That will get people who are in the real estate industry much further down the line.

Jason Hartman: So give us the points. You said four or five sort of key factors that made up that conceptual framework. Of course, you talked about employment, in and out-migration. What are the other ones?

John Stapleford: Real income, household formation, and of course, the whole demographics thing, which net in-migration is part of and housing formation is part of. And looking at the overall labor market because young people, who – a person like me, we’ve been in our house now 20 years and it’s unlikely that we’ll move until we downsize to a condo or a coffin. But young people who are the ones who are mobile, 18 – 29, and they move to dynamic labor markets. They don’t move for amenities. Amenities may be a factor in there, but elderly people will be more aware of amenities when they move as retirees. But young people, they’re looking for places where if they lose the job, they can find another job quickly.

So what’s the level, what’s the rate of net in-migration, and does the labor market say that this level of in-migration is going to sustain itself or continue, and then what’s the income distribution of the people coming in because more educated people are more mobile than less educated people, and more educated people move to metropolitan areas where there’s already a high level of education, which says that those that have will get more and those that don’t have won’t get it. And the metropolitan areas in the country that have highly educated labor forces are the areas that are the healthiest.

All I’m saying is it’s a very simple micro-economic demand model. What are the factors that cause the shift in demand? Change in population, and that’s the household formation and the in-migration, income, prices, the substitutes, the compliments. Of course, we keep track of rent in a metropolitan area, and if the rents are going up rapidly, that would encourage people to think about shifting over to ownership. Inflation; can you buy a house and will it appreciate? And then the regulations of the government – one of the largest subsidies the federal government gives out is for owner-occupied housing, and will that sooner or later come under attack?

Jason Hartman: And that’s the home mortgage interest deduction you’re referring to, right?

John Stapleford: Home mortgage interest and property tax deduction. The two of them together is huge. The last time I looked, it might have been $130 billion, and it would be very hard to touch it, but they may say any mortgage amount up to $100,000, the interest is deductible, and above that, it’s not. Or they may fiddle with it.

Jason Hartman: I don’t think they’re going to get to that point. I remember years ago, in California – well, it wasn’t California per se, but it applied particularly to California and other expensive areas – they limited it at $1 million in mortgage amount. And so if you’re in the high, high upper end and you’re looking at a $4 million property, you can’t deduct that whole mortgage anymore. But that’s such a sacred cow. There are just too many voters that own homes.

John Stapleford: You’re right, Jason, but also, you’d have the National Association of Homebuilders coming after you. You’d have all –

Jason Hartman: The National Association of Realtors.

John Stapleford: You’d have the realtors and that’s the associations you’d have. And like it or not, this subsidy has made residential construction a very significant part of our economy in the United States, so you’d also be messing with the underpinnings of it. And I was looking at the DuPont Company, for example. When the housing industry goes bust and the automobile industry goes bust, the DuPont Company really hurts because they sell a lot of fiber for carpeting and they sell TyVek, and you could go down the list of things.

Jason Hartman: There are so many ancillary businesses that are affected, and that’s why housing is so important obviously.

John Stapleford: Yeah, there would be a lot of people who would be feeling the pain.

Jason Hartman: And I just wanted to mention on your earlier comment in this salvo, when you talk about those dynamic cities, those employment cities, Richard Florida wrote a book called, The Rise of the Creative Class, and we kind of refer to those around here as the creative class cities, Denver, Austin – those are two examples of markets that we think are pretty interesting for investors right now. And they’re creative class cities, very educated.

John Stapleford: His two books are very interesting, of course, but it’s never been proven empirically, and it’s been tested three or four times. And if you look at his books, the data is a bunch of scattered diagrams. It’s not statistical tests of relationships. It’s more the real – and I think it appeals to some people because they say kind of nerdy, oddball people, who do strange things, boy, we really need them. They’re a source of innovation and growth. Well, what you need is people with human capital, and this is confirmed again and again in the economic literature. Human capital is not just formal education, the Bachelor’s degree, but it’s also the years that you spent in a particular occupation, and the demand has to be there for this type of work.
So you look at, as you mentioned, Austin. You have a lot of high-tech, biochemical, computer, and the areas of the country that are doing well are loaded up on human capital. In the United States, about 26 percent of the adults have a college degree. San Francisco has up around 41 percent.

Jason Hartman: Right, but let me interrupt you for a moment, if I may. So my question is there, though, when you’re looking at investing and you’re looking at a renter population and you’re looking at in-migration, you also have to look at a place that’s affordable to live. And San Francisco is not affordable. And it has rent control on top of that. So it has two really bad things. Taxes are high in California. So when you sort of cut San Francisco and New York, obviously those are world-class cities, out of it, where do you get that highly educated workforce and that kind of dynamics and human capital element you mentioned for a low price?

John Stapleford: Yeah, let me come back to that question and just jump on, “Is housing in San Francisco affordable?” What the research literature says is when you look at wage levels, if you adjust for the amenities that are in a metropolitan area, if you adjust for the industrial structure, if you adjust for the characteristics of the workers, the cost of living in that metropolitan area will be picked up in the wages. In other words, a high cost area like San Francisco – and you’re absolutely right it’s high cost – in fact, you get some inflation and wages to compensate for the cost of living. The markets work.

Jason Hartman: Before you go into the next point, can I just ask you a question on that? The question is, though, not how does the typical San Franciscan afford their $800,000 little, tiny condo versus the typical Austonian – I just made up a word, Austonian – how do they afford their $400,000 4,000 square-foot house on a half acre of land? See that’s a different life, in my opinion. You know what I mean? It’s not really the same comparison because you get a different life for that relative cost of living, right?

John Stapleford: Well, see, that’s your preferences. You think living in –

Jason Hartman: No, it’s not my preference. I live in an urban area.

John Stapleford: I know, but what I’m saying is somehow you’re saying living in a 3,000 – 4,000 square-foot house is more attractive than living in a 1,000 square-foot condo, when in fact, in the 1,000 square-foot condo, you have four 5-star restaurants within two blocks. And people, at least the Housing Demand literature shows that people recognize these tradeoffs. And remember, housing consumption is a bundle of amenities and goods and services, not just the sticks and stones. It’s not just the size of the lot. It’s the quality of schools, it’s access to medical services, it’s crime rate.

Jason Hartman: Oh, sure. It’s a whole lifestyle.

John Stapleford: They have hedonic price indexes where they try to adjust for all of the things that we’ve mentioned and they work okay. But people definitely trade off among the components in the housing bundle. So it’s apples and oranges, to some extent, to say the 1,000 square-foot unit in San Francisco versus the 3,000 square-foot home in Austin.

Jason Hartman: Right, but that’s $100 a square foot versus $800 a square foot.

John Stapleford: Yeah, but you’re not just buying square feet.

Jason Hartman: I agree with you completely.

John Stapleford: In Philadelphia, Jason, there are two kosher vegetarian Chinese restaurants. They don’t have that in Austin.

Jason Hartman: Well, in Austin, they actually do. Well, they don’t have kosher, but they have vegetarian for sure.

John Stapleford: But I’m sure in San Francisco there are things – and would that make me move somewhere? No, but it could have an influence on some people. They could really value that.

Jason Hartman: I’m a single guy. I like urban environments. I don’t like suburbia personally. I’m just saying, though, if I had a wife and three kids, I couldn’t live in that 1,000 square foot in San Francisco. And so, do you pay an eight times multiple to have more swanky dining near your house? I think there’s a point of diminishing return there, where people stop paying for it. And then you look at the climate of the government in a place like San Francisco – and I don’t know why we’re picking on San Francisco in particular, but we sort of led there – and sort of that anti-business climate. Yes, there’s a lot of innovation, of course, with the tech stuff. But businesses are being pushed out. I see these smart, educated people – I’m in Southern California – I see smart, educated people leaving here constantly. It’s been going on for years, even during the housing boom.

John Stapleford: Yeah, but in the case of San Francisco – and I haven’t looked at this exhaustively – in the case of San Francisco, the only reason it’s not growing is because you’re out of land. And that’s it. People love it there. The people who come there and stay there, they love it, and the amenities are super. It’s a beautiful place. There all kinds of interesting things, and if you want to be a complete whacko, nobody will look at you twice.

But the people who have been leaving California, I’m sure there are some young people who are then moving to areas like Denver and other areas where there are some high tech growing. But for the most part, it’s people who are in their 50’s and older, who are looking for a lower cost of living. They may want to continue working for a while, but they – remember, we said the cost of living is reflected in your wages. As you get to the point where either your wages have peaked or you’re going to get out of the labor market, if you can’t sustain the cost of living in San Francisco, you have to get out of there. Your Social Security isn’t going to keep up with it.

So I would say, you may know some very smart young people that have moved out, but I’d say for the most part, the out-migration is the people who are moving on their way to get out of the labor market eventually.

Jason Hartman: Yeah. I know that during, I think it was 2005, when the California economy was theoretically booming – it was a housing-based economy largely – but we had an out-migration for the first time, I think, since the early ’90s, of a very small number for a big huge state like California. It was only about 69,000 people as I recall. That’s just a drop in the bucket. But the fact that it happened at all was amazing and I don’t know how they do those out-migration stats, if they take into account just the net.

John Stapleford: IRS.

Jason Hartman: Okay, IRS.

John Stapleford: And the Post Office. Those are the two main sources.

Jason Hartman: Okay, so it doesn’t do – like if there’s a lot of illegal immigration into the state –

John Stapleford: It doesn’t pick it up.

Jason Hartman: Right, good. So that’s better. I trust the statistic more now that you said that because I thought if they’re just looking at a net number and you have a million that came across the border, and then you have a million and a half that moved out, that’s a completely different dynamic, of course, than we just mentioned. So that’s good.

John Stapleford: They do have people with counters based on all the major roads. I’m kidding.

Jason Hartman: I’ve seen those a few times.

John Stapleford: See, what they do with the IRS data is they can actually tell you of the people who move out of California, where did they go, and of the people who moved into California, where did they come from, and that’s some of the data at we give to clients because they find that really important because it’s very interesting, Jason. Some metropolitan areas have a reach that is only regional. It’s only very close to the metropolitan area in terms of who’s moving in and who’s moving out. And then other metropolitan areas, like places in Florida, they’re getting people from New York City and Chicago, and so it’s a different kind of ball game.

What do you think, into California, which state is sending the most people, in absolute in-migration to California?

Jason Hartman: Into California? I want to say sarcastically say Mexico, but that’s not a state.

John Stapleford: Well, actually, now that I look at it, you might be right because Texas is No. 1 and Arizona is No. 2 and Nevada is No. 3. But that may be that you may be picking up Latinos. But over the last year, the data that we have in our system, the net migration for California, there was an out-migration of 191,000 folks.

Jason Hartman: And I remember I was reading an article some time last year talking about how the number of millionaires up in the Bay Area, since we’re picking on San Francisco, has declined fairly substantially. And it wasn’t because of the stock market. It wasn’t because of anything, except the fact that they’re moving to Nevada, or at least establishing residency there, whatever that means, so that they don’t have to pay the state income tax. So there again, you see government screwing things up, in my opinion.

John Stapleford: Well, you know what they say – and you know this because you work with these people – why does the government think they can outwit really bright professionals in finance and the law when it comes to getting tax money out of rich people? Why does it think it can outwit the folks who go into the private sector and are working for these types of clients? They can’t.

Jason Hartman: I don’t know if they really think they can. I think a lot of it is campaign platitudes, or just bureaucrats that have never had a real job, run a business, made payroll. Sorry to talk about the president that way, but that’s the reality of our situation. We have people that just buy votes, and that’s all they’re doing. They look at things as a zero sum game. It just doesn’t make any sense.

John Stapleford: But eventually, when they implement things, eventually, the results come home to roost and they realize, oh, I actually created more harm than I did good.

Jason Hartman: Yeah, well, that’s why so many of these well-intentioned programs just don’t work in real life. They just don’t.

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Duration: 49 minutes