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Jason Hartman: This is Jason Hartman and welcome to another edition of Creating Wealth. We thank you so much for listening. This is our 71st show and it is mid-October 2008. We’ve got a lot of great events coming up I just want to remind you about before we get into our show today. Our Fall into Wealth party is on Thursday evening. You’re welcome to join us for that if you’re local. Register at www.jasonhartman.com/events.
And then, of course, we’ve got our Creating Wealth in Today’s Economy educational event this coming Saturday. Again, info and registration at www.jasonhartman.com/events. And also, we have got our twice-yearly event, a very important event, our Master’s Weekend, The Gathering of Experts. So check that out at www.jasonhartman.com/events as well and we’d love to see you at one, two, three, or all of those events, I guess I should say.
It’s my pleasure to have with us today on the show the chief economist for the National Association of Realtors, Lawrence Yun. Lawrence has a lot of fans and he has a lot of detractors out there. If you type his name into Google, you will see that. People are following his predictions and so forth.
Frankly, I think he made a very good interview. I was very happy to get him on the show and I do think he is a little more bullish than I am. I’m more bearish when it comes to the bubble markets. When it comes to the non-bubble, linear markets, the markets we recommend around the country, I am in agreement with him. I think those markets have a very good future and they’re actually doing quite well now.
We are in a period, of course, of monetary inflation, in fact, massive monetary inflation. I think Mr. Yun underestimates that dramatically. I believe that he is too much in agreement with the government statistics. I think they are vastly understated and you’ll kind of hear that come out on the interview.
However, I do believe that since we are in a period of asset deflation, we’re seeing land values deflate, but in the markets we recommend, there really is hardly any land component in that valuation of all. Say you buy an inexpensive property, say it’s a single-family home in Middle America or the mid-Atlantic, the Southeastern U.S., those markets, the land hardly constitutes any of the value, even though we’re calling the investment a real estate investment. It’s really an investment in packaged commodities, as you’ve heard me talk about on so many shows.
So again, I think Lawrence does do a pretty good job of parsing up the “housing market” or real estate market, as so many people in the United States call it. There’s really no such thing, of course. You’ve heard me talk about that many times if you are a regular listener. So let’s get into the interview. Again, I think you’ll learn a lot from this with those thoughts in mind. I don’t want to prejudice your opinion too much. Just hear it from the horse’s mouth. Lawrence Yun is a very famous national, if not international, figure.
And we’ve got many more of those coming up for you. We’ve got Harry Dent scheduled for an interview next week. Harry Dent, as you know, is the author of several books, a very, very renowned prognosticator on economics and demographics and how those two interplay together, so he’s coming up on a future show. But now, let’s get into the interview with Lawrence Yun, chief economist for the National Association of Realtors, which is the largest trade organization in the world with about 1.2 million members now. So, a very influential organization and here he comes from Washington, D.C. in the interview. Let’s listen in.
Interview with Dr. Lawrence Yun
Jason Hartman: It’s my pleasure to welcome Lawrence Yun, the chief economist for the National Association of Realtors. Mr. Yun, welcome to the show.
Dr. Lawrence Yun: Thanks for having me.
Jason Hartman: Well, it’s good to have you and we appreciate you spending a little time with us today. Obviously, people have a lot of questions about the real estate market and one of the things I’d like to explore in this interview is parsing up the market. The U.S. is such a large, diverse country. There’s really no such thing as a national housing market in my opinion, and your predecessor, David Lehrer, I wrote the book called All Real Estate is Local, and I just thought I would first start with getting your take on different markets around the country and maybe segmenting them or parsing them up a little bit, if you would.
Dr. Lawrence Yun: You are absolutely right. There is so much variation across the country. It will be very misleading to generalize the housing market as a one-national trend because what we are seeing today is that some localities, home sales are coming around very strongly. For example, markets that had been hard hit and prices have come down 20 percent, 30 percent, in the past few months, we have seen significant increase in number of buyers signing contracts. So, for example, Riverside, Sacramento, California, Fort Myers, Florida, Las Vegas, home sales activity is nearly doubling from one year ago.
At the same time, many middle parts of the country, Texas, Chicago, home sales are still down about 20 percent from the year before, so there is a large local market variation.
Jason Hartman: So let’s take the California market since it’s such a large market and we are based in Southern California, Orange County. What do you see as the future of the California market? In my opinion, we’re still declining and I predict we’re probably going to lose about another 10 percent in value. But you are more of an expert than I and have probably better information than I do, too.
Dr. Lawrence Yun: One thing to be mindful of is that the current housing market cycle, both the boom and bust, was driven by the subprime loans. So the prevalence of the subprime loans brought in additional buyers into the market place and has a lot of multiple bidding processes drove up home prices. And of course, they’re in the bust as the subprime loan was defaulting. This is where we saw large numbers of foreclosures occurring. So, even within a locality like Orange County, what one sees is that, in neighborhoods with very little subprime lending, those neighborhoods’ price decline, I would say, is probably in the single digits. Or, if it’s in the double digits, low double digits, while the neighborhood with large subprime loan prevalence, this is where one would see 20 percent, 30 percent, 40 percent reduction in prices.
So, even within a locality, one sees a dramatic difference between the neighborhood with little subprime exposure versus large subprime exposure. And some of the prices measurement one sees, for example, Case-Shiller Price Index, which has become very prominent, they capture a lot of data points that are related to subprime distressed home sales, while the government data, which has much less subprime loan exposure, when one sees that price data, the price decline appears to be much more modest.
Jason Hartman: So which index do you think is the best? Do you think Case-Shiller is the best? What index do you like, and if so, why because I know they measure differently. One uses the same house, resold, and they’re just different methodologies. And also, I believe Case-Shiller does not do anything above conforming loan limits, if I’m not mistaken.
Dr. Lawrence Yun: I think all prices indexes provide their unique information, so it’s just a matter of digesting all of these different price measurements. Case-Shiller, what is includes is that it includes all the mortgage loan transactions. They get some data from the public records. So when Case-Shiller releases their data, because it includes subprime distressed properties, it generally tends to be more pessimistic in terms of the current downturn, the price declines.
Also, during the upturn, it was the Case-Shiller, which showed much dramatic run-up in home prices compared to other price measurements, again due to the subprime factor in their indices.
For the government data, specifically from an organization called OFHEO, they look at only the Fannie/Freddie loans. And it is capped at the conforming loans and not jumbo loans, and it excludes many subprime loans and it captures more of the middle market that doesn’t include a large segment of the subprime loans or Alt-A loans, and has the price trend has been much more left fluctuating.
So the increase has been more modest, decrease more modest, and at NAR, we also have our data, which is just straight from the multiple listing service and most timely because we have only one-month lag time as opposed to two-month lag time of other data series. It’s just measuring the median prices of homes that were transacted during the course of the month, and so all three measurements show general, similar underlying trends, except the magnitude tends to be different because of whether or not one includes the subprime loans into the transaction.
Jason Hartman: You know a few minutes ago, you were mentioning about California and I don’t know if I let you actually finish that thought. You said that areas with a large percentage of subprime loans, it seemed to be you were inferring they had a further decline coming their way. How do we know which areas have these? I know there are some websites and so forth that track the percentage of subprime loans in neighborhoods, but can it be done easier just by a price point, for example?
Dr. Lawrence Yun: The price points, one can just look at the latest neighborhood-by-neighborhood sort of price trends and when one notices a large price decline. I’m not an expert in the local area and certainly there are many professionals who will be able to better describe the neighborhood conditions, but generally, the neighborhood where one is seeing a large price reduction are generally lower price points. These are the area where now the buyers are coming back to the market. They are looking at the prices and they’re saying wow, this is just too good to give up or some people who may have been priced out during the boom years are now recognizing this is a second opportunity to get into the market at much better prices.
So we understand that there are many homeowners who are suffering as a result of price declines, but people who have been on the sidelines, for them, this is a great opportunity. They’re essentially entering the market at a low price point.
Jason Hartman: And still low interest rates. The challenge now is if they can qualify for a loan, which, suddenly, lenders are actually asking people to qualify for loans. It’s kind of refreshing, kind of refreshing and amazing. But yeah, I think you’re right. I think it’s a good opportunity especially for that first time buyer, that person just looking to break into homeownership.
What would you say about the outlook for investors? Where should they be focusing? Our firm here is based in Costa Mesa, California, and we work with investors in 37 markets around the U.S. Currently, at this moment, we’re not recommending California, Arizona, Nevada, but we do like Texas. We do like the Carolinas. Generally, Southeast, Mid-Atlantic, I’ll say. Any thoughts on your end as far as investing and buying rental property?
Dr. Lawrence Yun: For rental properties, one would generally look for the areas where jobs are growing, so in Texas, jobs are still being created, North Carolina, jobs are being created. In California, jobs are being cut and hence, there will be less demand for rental units.
However, having said that, the longer term outlook, the people who have a longer time horizon or holding period, the prices that some of the properties are going for – I mean if people can hold onto the property, one would see a – I would say some good rebound in home prices in California market because I believe that price decline that has been experienced – there’s somewhat of an overshooting downward. And now, when homes reach the marketplace, we are often hearing of a multiple bidding process. So this is after 30 percent price reduction, 40 percent price reduction, but once it comes onto the market, there appears to be multiple bidding, which means that the bottom in home prices may have already reached or be very close to reaching that point in California market.
Now, in the price measurement, because the way it is measured is compared to 12 months ago, you will likely show continuing price decline in California market. But if one was to look at month-to-month change, I think one will see that the price declines are not really occurring or are very modest at this point because most of the price drops have already occurred in California market.
Jason Hartman: Well, I’m a little more bearish than you are, but I do appreciate what you’re saying in terms of the data that NAR uses versus the other indices because you’re looking at a more front-end data. You’re looking at when properties sell and you have a pending sale index, I believe. I can’t remember what you call that, but you’re seeing it more quickly than the others that are really looking at a lag time of about three months in that data. Any comments on that?
Dr. Lawrence Yun: That’s right. There is a lag time in other data series, but NAR, we just pick the data from multiple listing service and we just look at the most recent months. And not only do we look at the closed sale activity, but we also look at the contract signing, which is the pending home sales. And the latest pending home sales, which was as of August, showed a nice bump increase. It was a roughly 30 percent increase in the west region from one year before, which implies that the September closing activity was also notably higher. We are in the middle of October and then we will get a reading of the September pending home sales very soon, but I anticipate that the momentum appears to be strong.
So, it’s not a one-month fluke, but we are looking at consistent for the past three to five months. Riverside, Sacramento, and also San Diego and Orange County coming into the picture, while the sales increases appears to be consistent year over year, and with the higher loan limit, which means that now more previously called “jumbo loans” qualify for Fannie and Freddie purchases, so the mortgage rates for some people are falling because of the higher loan limit.
Jason Hartman: Right, that’s true. So, that opens up the market to a lot of people. Let’s just talk about NAR for a moment. NAR, I think, sort of topped out at about 1.4 million members if I’m not mistaken. How many members now? Are you seeing some people get out of the business due to the market?
Dr. Lawrence Yun: We topped roughly at 1.4 million, so you are right on that figure. Currently, we have 1.25 million roughly, right around that range, so we lost 150,000 members. Now, at the start of the housing market boom, which was back in 2000, 2001, the total membership figure was about 750,000 – 800,000. So the current figure is considerably higher than what it was back in 2000 and interestingly, home sales, even with some recovery in certain markets, are below the 2000 level, so back to the 1998 level.
So we may see further shake out in some of the membership figures, but the way I view it is, let the market decide how many members there are and we are here to serve membership, whether it’s a half million, one million, 1.5 million. We serve the members that are out in the marketplace. But I think for the members, because the declining membership has not been as short as home sales, that we may see further tapering off in some of the membership.
Jason Hartman: I agree. There’s a lag time there between when they have to renew and pay their dues again, and that’s sort of when they make the big decision – you know, are they making enough money or do they want to pursue another career. How many licensees are there in the country? I’m not even sure you’ll know that number, but I’m curious to compare it to NAR membership.
Dr. Lawrence Yun: The licensee figures are generally about twice as high as the NAR membership. Now, having said that, other third-party information and our internal calculation generally says that the realtor members, the people who are that 1.2 million, generally do the bulk of the real estate business out in the marketplace. But in terms of the licensees, because people tend to hold onto the licenses longer than the membership, it’s generally about twice as high as the membership.
Jason Hartman: Good. Do you see any statistics in terms of investors purchasing properties now versus people purchasing for principle residence or a vacation home? I’m sort of curious about what the delta is with those two numbers and how it’s moving along as we go through time. Are investors starting to get more interested? Is that business picking up now again? Or is it about even?
The problem is the investor financing. And I know it’s a loaded, sort of long statement question here, but what has always amazed me – and maybe you can address it, Mr. Yun – why is it that a bank will make it easier to qualify for a loan on a primary residence, where you receive no income, and that is a total liability, versus a property that produces income and is less of a liability than a primary residence or a vacation home? That has never in the 23 years I’ve been in the business made any sense to me. Long question.
Dr. Lawrence Yun: Well, in hindsight, certainly some of the loans that came into the marketplace during the boom, zero down payment, no income documentation, it was clearly unsafe and people are recognizing that and today, the underwriting standard has tightened a bit, perhaps overly tightened. But even under healthy conditions, one would generally expect some level of down payment so that the homebuyer has some skin in the game because if people have no equity in their home and as soon as they have an opportunity to skip and just default on the loan, they will do so. So I think it’s always good to have some level of equity into the game.
And the investors always have that. They are coming with 10 percent down payment, 20 percent down payment. But the market condition currently does because, right now, the credit crunch situation is really hampering any type of loans, whether it’s small business loans, loans to buy a car, and loans to get a second home or investor home because the public policy mission currently seems to be we have a credit crunch. But let’s assure that mortgages still flow to people who want to buy a home to live in and hands the direction by the treasury, which now oversees the Fannie and Freddie. They are pushing Fannie and Freddie to be more active in the marketplace. But being more active is only related to primary ownership and not for the investor loans.
And without Fannie and Freddie, there are very little mortgages out there. I mean one can look at the super jumbo loans. Those are non-conforming, million dollar loans in a very high interest rate, and one is seeing very similar conditions for investor loans, even though as you rightly point out, investors are putting down larger down payments and many times, investors have shown that they have a good credit history. They repay their loans because they generate income from their rental property.
Jason Hartman: How about the mix between investor and primary residence purchasers?
Dr. Lawrence Yun: So during the boom years, roughly 40 percent of home sales were either vacation or investor property. Currently, that figure is down to about 25 percent, which is slightly on the lower end of the historical average. So there is no investor speculative activity currently because we’re now just back to the historical norm or one may say even below historical normal levels.
So, for the loans, again, if it’s not for primary ownership where one considers it as a vacation and partly rented out, it’s still much tighter now than before. And we know that, even for the primary ownership mortgages, it’s tighter than before. But there’s more push on the part of government to get Fannie and Freddie to purchase those loans, and hopefully, it is flowing back into the primary mortgage market so that more people can become homeowners. I mean we don’t want people just to become homeowners just for homeowners’ sake. I mean they should be emotionally ready, financially ready because it’s not in anyone’s interest to buy a home and be foreclosed upon.
Jason Hartman: I couldn’t agree more. So, in terms of the statistical analysis, does NAR lump secondary and vacation homes in with rental property purchases? Is that the same number? You did combine the two. I’m wondering is it always lumped together.
Dr. Lawrence Yun: The 40 percent second home purchases are both the vacation and the investor property, and then one can subdivide that figure and then one generally finds that among these second home purchases, by a ratio of 2:1, that the investor purchases are roughly twice as high as vacation home purchases.
Jason Hartman: Okay. Talk to us a little bit about the stimulus bills and the bailouts and so forth. This is an issue, obviously, that has much, much disagreement. What’s going on there and has the money started to flow? If not, when? Your take on the whole thing.
Dr. Lawrence Yun: The $700 billion package, that’s quite a sum, a large amount of sum, and many people are asking why should people who were not involved in subprime loans have to bail out all these Wall Street firms. But I think the bigger picture during the $700 billion discussion is essentially the following. The capital in the word capitalism stopped flowing because of the very high leverage ratio among many financial institutions. Even a small decline in some of the long performers or say the rising default rate and what one would consider to be manageable, but if they’re highly leveraged, that small increase in default rate can quickly wipe away the capital.
So, what has happened was the financial institution overleveraged. A small decline in asset value led to this huge freezing of the credit. So the $700 billion plan was not really a bailout of the Wall Street, but it was to invest in the capitalism, invest in the financial institution to ensure that we do have a system where people are able to lend, people are able to save, allocate resources, in the most efficient way. So, for that reason, NAR supported the measure.
Having said that, we also say that government will be using that $700 billion on behalf of taxpayers to buy these troubled mortgages on banks’ balance sheets. If they are able to purchase at a good, decent price, and once the housing market recovers, it’s possible that the taxpayers may, in the end, get return off this $700 billion investment.
Jason Hartman: That one, just on its face, kind of concerns me because it seems as though a lot of these firms will be selling bad assets to the government. I don’t think the government has much of an incentive to bargain very hard and I’m just concerned about the massive lack of efficiency and extreme government waste because whenever it’s the government, it’s nobody’s money really. And it just seems like the government do much well financially.
Dr. Lawrence Yun: I share your concern. I share your concern that many elements of government activity I think that there is a natural bureaucratic inefficiency that gets introduced into the system. But the current $700 billion – I mean is the question of whether or not credit stopped flowing in the market-based economies of the world because what we saw during the Great Depression, there was an involuntary contraction of credit. In many deep recessions since then, we also saw involuntary contraction in credit.
So one thing that we don’t want is because the credit market has seized up and frozen, that we don’t want to have another similar deep recession or even something resembling a Great Depression while the policymakers had a tool to fight this. So, I do share your concern that, any time government gets involved, it introduces some level of bureaucratic inefficiencies, so I think it’s really up to the administration. I mean, Hank Paulson – I will be surprised if he has got a good night’s sleep for the past two months. But Hank Paulson I hope he utilizes more of the private sector in trying to invest the $700 billion. Maybe what he could do is possibly bring in private sector partnerships to invest so it’s really the private sector who is investing along with the government.
Now, Warren Buffet has made a comment saying that there’s a possibility to make good money for taxpayers on this plan. Bill Gross, the big bond investor, also made a similar comment. So certainly, some people see it as an opportunity that it could be a good return for taxpayers, but I do share your concern and I think what needs to happen is that government should not overpay for these troubled assets. They need to buy it at a fairly decent price and, of course, they cannot buy it at the fire sale price because if they do so, then the credit market will cease up again.
Jason Hartman: When do you really think we’ll start to see in the marketplace the effects of the bailout of Fannie and Freddie and the stimulus package or the big $700 billion bailout? When do you think we’re really going to see that in the marketplace?
Dr. Lawrence Yun: So now, the government has the tool. Now it’s a matter of whether or not implementing it. Concerning Fannie and Freddie, since the takeover, the mortgage rates have actually come down, and the underwriting standards have been loosened somewhat because prior to the takeover, Fannie and Freddie, they were just concerned with their survival and they wanted to preserve their capital.
But their mission is to provide mortgages in times of crisis, but they were not doing that, so Treasury took them over and as a result, they said go out. Treasury told Fannie and Freddie to be more active in the marketplace and we saw roughly a 50 basis point drop in mortgage rates since the takeover. So at least over the short term, there seems to be more mortgage availability since the takeover by the Treasury.
On the $700 billion plan, it’s now being implemented and the tools are now available, and another possibility is that they may never really use the $700 billion total. They may only utilize $50 billion or $100 billion. They will only do so to the degree that it will unclog the financial system. So if they can unclog the financial system with very little money, I think they will just use that amount. But the $700 billion, that large sum, was just part of the toolkit to say that, in the worst case, let’s have all the weapons available to fight it off.
Jason Hartman: Well, I sure hope you’re right. I don’t share your optimistic view, but I hope you’re right about that. If they can use just $100 billion of that, that would be great for all of us rather than the full amount or even more than the full amount. Mr. Yun, you have been quoted as saying the credit market will start to unfreeze once home prices have past bottom and I believe that’s an exact quote. When do you think this will occur?
Dr. Lawrence Yun: First, going back to all real estate is local. I think that some markets they are seeing some nice price gains, Denver and Houston markets, based up on the fundamentals where they have cut back on some of the home construction, while at the same time, they have a very decent job growth. And the home prices never accelerated out of the normal range. So, in places like Denver, Houston, I see a very decent price gain. I would not be surprised if there is even a 10 percent price gain this time next year in those two markets.
California, Florida markets, still pressure on the foreclosures, but yet at the same time, buyers are trying to take advantage of these bargain prices, so there is a fight between increased foreclosures, yet the buyers are jumping in. So, we may have reached the low point in prices in this market. I’m worried about areas where inventory has been rising and sales falling, and this would be the Pacific Northwest, where home sales have fallen, and as a result, the inventory has been rising. So we may get some price correction in the Seattle market, Portland market, much more modest than what California underwent because the price increases were not that dramatic.
So there are large local market variations, but broadly speaking for the mortgage security industry in terms of the $700 billion plan, in that perspective, one would look at the national median price and I believe that national home prices could begin to show neutral trend, meaning no longer in decline, probably from the spring of 2009. And once that happens, I think the mortgage-backed security evaluation will be clear and with the price increases, I think people will begin to see some valuation increases in those mortgage-backed securities, and hence, one can say the worst in the housing market cycle has passed.
Jason Hartman: That’s an interesting point because I was talking with one of our clients yesterday. He had purchased – I own several properties in Houston. I’m very bullish on that market, and he had purchased one property from us in Houston and was saying – we were talking about inflation versus deflation, and I believe we’re in an environment of asset deflation and largely. By asset, I mean land values, so in areas with expensive land will continue to see deflation. Overall, stocks will continue to see deflation in my opinion. Yet, we have a lot of monetary inflation with the government pumping so much money into the system. What do you think of as the true inflation rate and then I’d also like to ask you about rental prices and NAR’s tracking of them, if any?
Dr. Lawrence Yun: In terms of the inflation, one turns towards the consumer price inflation and now, I don’t have any good reason why that measure is not good, but even based upon that measure, I know there are some economists who say that measurement is understating the true inflation. But even by that measurement, the general consumer price inflation is running around 5 percent. That’s double what the Federal Reserve would consider to be comfortable. The Producer Price Index, so these are actual materials –
Jason Hartman: The PPI.
Dr. Lawrence Yun: – and not the service related, like medical service, but actual material. Producer Price Index are rising 7, 8, 9 percent, so much stronger. Now, one thing about real estate is it’s a tangible asset, so one looks at a home and one says, well, there’s brick, there’s aluminum, there’s copper, so it’s embedded with all these commodities and we have this commodity price boom, aside from recent – some declines –
Jason Hartman: The overall trend is up.
Dr. Lawrence Yun: – so, we can say that the real estate is real tangible asset that should reflect overall price conditions, yet real estate has not been following the commodity price, for instance.
Jason Hartman: Well, see, I think the key to that is when you’re investing in real estate with very cheap land in a market like Houston, for example, where a typical single-family home, your lot value might be only $25,000.00 and the whole package is $175,000.00. So, the largest percentage of it is commodity prices. It’s the structure sitting on the land. So I’d like to parse that up into two separate value drivers, one being land, which is a concern for asset devaluation, but commodities, which the overall trend I think we would both agree is up, up, up. Any thoughts on that?
Dr. Lawrence Yun: The land value in, interestingly, the sort of middle of America, generally the agricultural land of Nebraska, Iowa, the prices have been rising in terms of the farmland. Now, it has not carried into the suburbs because from the suburbs point of view, there was building massively by the builders and there was a bidding up on the prices, and now with the building construction coming to a halt, there’s a lot of land availability and as the price of land is coming down. California market always has been expensive and will continue to be so just because people like to be near the coast, so there will be a demand for land in the coastal regions.
So, it is right to subdivide the price of a home into the land value, which is really just an immovable object – well, versus other commodities, which is part of the construction, and the construction costs have been rising. But the land value, at least temporarily, because the builders are just dumping their land on the markets, it’s coming in at lower prices.
Jason Hartman: Can you talk to us a little bit about rental rates? Does NAR track rental rates much?
Dr. Lawrence Yun: No, we don’t track the rental rates directly. We do monitor third-party sources and the rents for multi-family apartment rents that is still running at a decent pace, broadly speaking about 3 – 4 percent annualized growth rate. But in terms of the single-family rentals, people buy a property and try to find the renter to live in, we don’t have good information on this, other than in those markets with large inventory, Tampa, Miami, the Washington, D.C. suburbs. All indications point to lower rent currently in those single-family rental units.
Jason Hartman: Do you attribute that in those markets – those are largely bubble markets that you mentioned – do you attribute that to excessive foreclosure inventory softening the rental market, or just excess inventory of investors who thought they could flip the house, make some money, and turned out to start renting it instead?
Dr. Lawrence Yun: There is a combination of oversupply, partly on the builders building too much, and also investors purchasing those properties. So there was an oversupply. At the same time, I would say there is also abnormally low demand, meaning that generally we have a population growth in the U.S., so given a three-million population growth in the U.S., which is a given, one would anticipate about 1.2, 1.5 million household formations, family formation, or people who want to live on their own.
But that number has really stalled, which means that many people are not trying to form their own households, but remaining in the existing household, so one can visualize young adults moving in with their parents or young adults finding additional roommates, third roommate, fourth roommate, and as long as they’re living in a crowded area, there’s less housing demand.
So, what is happening is despite the population growth we have in the U.S., household formation has surprisingly slowed greatly, but I think once there is some sign of economic recovery – now, we’re just heading into a recession, but once there’s a sign of economic recovery, we may begin to see some pent up demand releasing into the marketplace. People who have been doubling up want to separate and go on their own. Young adults want to move away from their parents. So there could be some demand releasing into the rental market once there is some clear sign the economy will be recovering.
Jason Hartman: I totally agree with you about that and I think there’s a lot of pent up demand that it’s very tough to count out there. Obviously, these rental stats for single-family homes and kids living with their parents, staying longer than they want to stay, these are very fragmented and hard to evaluate. But I think we all know it’s going on and I think when that pent up demand releases into the market, it’s going to consume a lot of rental housing inventory and it’s also going to consume a fair amount of for-sale housing inventory as well right now and maybe for the next year or two during tougher economic times. I think it’s sort of almost a status symbol if you’re a single person to have a home of your own.
Dr. Lawrence Yun: Yeah, with people marrying at a later age, I think having a home – I think that’s a sign to say one has made it. Of course, people should not buy a home if they are not financially or emotionally ready, but people who are making it, at the right time, with the financial resources, this is part of the American dream to say one has made it in this world.
Jason Hartman: Good point. You have been quoted as saying the economy will not recover without housing market recovery. Fairly bold statement, although I can definitely see with real estate stimulating so many ancillary industries, very true. When do you think the economy will start to recover and at the same time, that’s the housing market recovering? Are you saying middle of next year, I think you alluded to earlier?
Dr. Lawrence Yun: Some markets we are seeing a turnaround and the question is whether this turnaround will be broadened over to other areas. Right now, my forecast projection is that by the early part of next year that we will begin to see some measureable rise in home sales compared to similar times the year before. So, we will get to see some rising existing home sales.
But in terms of economic impact, it’s the new home sales that will be a bigger impact on the economy because the builders need to hire people – the construction related purchases. So, there is bigger economic impact from new home sales and for new home sales, right now, baseline forecast is that that will not recover until middle of next year. But there’s a lot of things being done in Washington in trying to stimulate the housing and once, assuming that there is additional housing market stimulus, then I think we could see even a faster recovery. There’s a discussion by Nancy Pelosi. There’s discussion by John McCain of possibly removing capital gains tax, which will help the housing market. Senator Obama is mentioning possible mortgage interest credit. Not mortgage interest deduction, but credit for people who don’t itemize their returns. Again, that would be helpful for the housing market.
So I think there’s a large policy discussion in Washington. If some of that gets actually passed, I think we could see a quicker recovery than my baseline forecast.
Jason Hartman: On the legislative side, you mentioned capital gains in there and I wanted to just bring up a point on that. You think that lowering or eliminating the capital gains on sale of a home or investment property? I mean I know you have the exclusion obviously, $250,000.00 or $500,000.00, but what are you referring to as far as the capital gains?
Dr. Lawrence Yun: There is some discussion from the McCain camp where they are trying to just, broadly speaking, not only for home sales, but even for stock purchases, where their general philosophy is, “Well, this tax should not have been in there in the first place.” So now, there is some internal discussion where they want to either reduce or even eliminate capital gains tax, and obviously, that would apply to home sales. And if that was the case, particularly for the investor home sales, where currently they would pay capital gains tax, removal of that would certainly raise the rate of return on those investor home purchases. So, if that was the case, then you say certainly a stimulus for the housing market.
Now, from the government’s overall point of view, they need to look at the offset of loss revenue from capital gains tax revenue and possibly trying to find other sources.
Jason Hartman: Yeah, I think that another part of the legislative side is the “due on sale” clause. Back when that went into effect a long time ago, I think that that really – if they were to suspend the “due on sale” clause for a time or eliminate it altogether, of course, lenders wouldn’t like it very much, especially if rates were much higher in the future. But initially, I think that would bring a lot more investors into the market. Any thoughts on the “due on sale” clause? It’s not talked about very much.
Dr. Lawrence Yun: No, that’s not been talked about. I think the primary focus right now is more on the primary homeowners, but things like capital gains, even though it may not be the intent, but the indirect impact will be stimulating the investor home purchases. But one thing that we need to be cautious of is, again, from the hindsight of the housing market boom and housing market bust was that many people into the market using a system were permitted no income documentation and also, as a result of that, many people got into the investor market. So, the investor home purchases really skyrocketed from normal 25 percent market share to 40 percent market share.
So, we don’t want a condition where there’s too much investor activity. Normally, there’s always people that need to rent, but if there’s too much investor purchases, then one can visualize too many vacant homes on the market. And any time there’s too much vacant homes, it always, eventually, leads to some nasty, bad events.
Jason Hartman: Right. Two final questions in closing. We sure appreciate your time with us today. One is what is your prediction on the national inflation level for the next three or four years and how will this play out in the world of mortgage rates because I really want to get your prediction on mortgage rates and I know that’s a tough question.
Dr. Lawrence Yun: The mortgage rates, many people look at what Federal Reserve will be doing, but that’s the wrong way to view it because mortgage rates are more dependent upon inflationary expectations. And right now, mortgage rates are at about 6 percent, maybe a little higher. This will be considered historically favorable. Despite the high inflation we have, we have low mortgage rates – historically favorable rates – because there is an expectation in the marketplace that Federal Reserve will fight inflation.
And furthermore, we have seen some recent decline in oil prices and the global economic slowdown that will tamper inflations, so next year, inflation I would say it will be under 3 percent, which will be very close to normal. And then subsequent inflation will depend on what happens to the commodity prices. But right now, mortgage rates are behaving because there is an anticipation that inflation will not get out of control.
But if it does get out of control, I think it is very important because it is going to hurt mortgage rates. It’s going to go very high. The Federal Reserve really needs to fight inflation. So given that, again, the baseline, I mean there’s a lot of unpredictability on the future, but the baseline forecast is for the mortgage rate, 30-year mortgage rate to bounce around from 6 – 7 percent for the next 3 – 5 years.
Jason Hartman: Wow, see I think inflation is much more of a concern than the Federal Reserve seems to think it is. I think at the very least, an honest measure for inflation would be to do an average of the CPI and the PPI, blending the two of those, which would probably leave you somewhere around 5 percent higher than CPI. But that’s kind of a different discussion, if you have a quick comment.
Dr. Lawrence Yun: Consumer price inflation because consumer price inflation looks at the service component, things like getting a haircut, while the produce prices actually looks at actual tangible items. In the U.S. economy, many people get service items, whether college tuition, medical service, education service, so one is looking at the consumer price inflation and the market, the bond market, has said well, we believe the inflation will be contained and as currently the mortgage rates are historically favorable rates.
Jason Hartman: I think we’re in an era of negative interest rates, where the true inflation rate is a little bit higher than interest rates, so I think it’s just a dynamite buying opportunity for investors, which leads me to another point on that and then one final question after this. Inflation benefits real estate investors in two substantial ways. No. 1, the asset is indexed for inflation. Historically, it seems to appreciate faster than the rate of inflation. And No. 2, inflation really has a way of destroying debt because we’re paying our mortgages back in cheaper future dollars. Do you see inflation as a benefit for the investor, who is they buy-and-hold investor who wants to buy a rental property, hold onto it for the next 10 – 15 years?
Dr. Lawrence Yun: You are absolutely correct in your assessment. For people who buy now, and let’s say inflation suddenly, unexpectedly increases. People who are current homeowners or investors, they will benefit because of the rising asset value and the lower declining mortgage debt service obligation. So the people who already own property, they will be big beneficiaries. But what will be on the opposite side is that if inflation kicks in, mortgage rates will be higher, so that will deter future home buying activity. So even though the people who already bought, they will benefit, people who have not bought, I mean they will be hurting or having very difficulty entering the market.
Jason Hartman: Yeah, I think it’s just a huge opportunity right now to lock in on 30-year, fixed-rate loans. These rates are so cheap. I just can’t see anything, but higher rates. Even if they’re only a little bit higher in the future, they’re definitely going to be higher in my opinion. Okay, so final question for you. Do home prices falling in many parts of the country and mortgage rates still near historic lows – affordability conditions have improved for sure – what is your advice to the hesitant real estate investor? Is this a buyer’s market, and I know all real estate is local, so you might want to parse that up into geographical areas.
Dr. Lawrence Yun: To make it short, I believe there’s a sizeable number of people sitting on the fence, based upon population growth, home sales activity. Things don’t match up. Things clearly suggest there’s a sizeable pent up demand. People are hesitant to enter the market. In the meantime, people who are entering the market today obviously they believe the bottom has already reached and many times, people who are trying to perfectly market time, they realize they have really missed the bottom.
So I think people with a longer time horizon, whether they enter today, six months from now, one year from now, it may not make so much of a difference and many indications suggest that, right now, the buyers have the clear advantage in terms of inventory selection. The mortgage rates are lower. The mortgage rates will probably inch up over the next 12 months. So given these conditions, people who are financially ready, financially capable, it could not be a better time.
Jason Hartman: Well, thank you very much. Lawrence Yun, chief economist of the National Association of Realtors, we so much appreciate you being on the show today. Any final words in closing?
Dr. Lawrence Yun: It was my pleasure to be on the show and perhaps I look forward to join you at a later time.
Jason Hartman: We’d love to have you again. Thanks so much for your time today.
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Duration: 58 minutes