All Forum Posts by: George Gammon

 Wow, great post J, thanks. You're rationale makes total sense.  The yield curve is one of those things I personally just can't draw conclusions from currently.  Not because it doesn't have merit, it undoubtably does.  It may have more merit than anything else.  The problem is I'm not smart enough to discount all of the variables that have no historical precedence.  Because of the massive manipulation of markets by central banks, price discover becomes almost impossible, therefore using a price to draw a conclusion becomes more difficult...too difficult for a guy who almost flunked out of high school (me) ;) 

As an example, the 10 year US bond is now not just a marker for the domestic economy it's almost become a marker for the world economy.  If you're european or japanese with some capital to allocate US treasuries look pretty damn good compared to the sovereign debt available in your home currency.  Therefore could QE by other central banks be creating artificial demand for US debt, artificially flattening the curve?  If so, by how much?  And even if its an artificial flattening of our curve at what point does the global weakness create the weakness in the US that would justify the flattening curve?  It's a bit of a self fulfilling prophecy.  These cause and effect scenarios seem limitless when interest rates are so heavily manipulated.  The chart below illustrates this expanding hall of mirrors.  

Let me go way off topic for a moment.  I was listening to some macro guys this morning and one of them brought up a great point that never crossed my mind.  If you believe in the deflation story obviously cash and assets like treasuries become attractive because they increase your purchasing power.  But look at these assets vs. gold.  Cash has been more attractive because gold has carrying costs and seen as inflation insurance so the value goes down unless there's fear of inflation.  But gold historically has also been a risk off asset.  Treasuries have been better than gold because gold doesn't have yield.  What I find interesting is if rates go negative it potentially takes away the positive yield of treasuries.  And what if they go so low that it becomes more expensive to hold cash and/or treasuries than own gold??  I'm not a gold bug at all but it's interesting to think about.  Also, if the cost of cash and bonds becomes that high it could be wildly bullish for RE.  

Back to topic...My view is my brain just isn't big enough to make all the necessary computations.  I need to defer to you, Minh, David, Gloria and Robert! ;) 

 Wow, great post J, thanks. You're rationale makes total sense.  The yield curve is one of those things I personally just can't draw conclusions from currently.  Not because it doesn't have merit, it undoubtably does.  It may have more merit than anything else.  The problem is I'm not smart enough to discount all of the variables that have no historical precedence.  Because of the massive manipulation of markets by central banks, price discover becomes almost impossible, therefore using a price to draw a conclusion becomes more difficult...too difficult for a guy who almost flunked out of high school (me) ;) 

As an example, the 10 year US bond is now not just a marker for the domestic economy it's almost become a marker for the world economy.  If you're european or japanese with some capital to allocate US treasuries look pretty damn good compared to the sovereign debt available in your home currency.  Therefore could QE by other central banks be creating artificial demand for US debt, artificially flattening the curve?  If so, by how much?  And even if its an artificial flattening of our curve at what point does the global weakness create the weakness in the US that would justify the flattening curve?  It's a bit of a self fulfilling prophecy.  These cause and effect scenarios seem limitless when interest rates are so heavily manipulated.  The chart below illustrates this expanding hall of mirrors.  

Let me go way off topic for a moment.  I was listening to some macro guys this morning and one of them brought up a great point that never crossed my mind.  If you believe in the deflation story obviously cash and assets like treasuries become attractive because they increase your purchasing power.  But look at these assets vs. gold.  Cash has been more attractive because gold has carrying costs and seen as inflation insurance so the value goes down unless there's fear of inflation.  But gold historically has also been a risk off asset.  Treasuries have been better than gold because gold doesn't have yield.  What I find interesting is if rates go negative it potentially takes away the positive yield of treasuries.  And what if they go so low that it becomes more expensive to hold cash and/or treasuries than own gold??  I'm not a gold bug at all but it's interesting to think about.  Also, if the cost of cash and bonds becomes that high it could be wildly bullish for RE.  

Back to topic...My view is my brain just isn't big enough to make all the necessary computations.  I need to defer to you, Minh, David, Gloria and Robert! ;) 

@J. Martin @Account Closed 

 Minh, 

Let me start by making it very clear I'm not arguing that we'll see inflation, deflation or stagflation.  I'm arguing that we as investors need to understand the economic environment we live in and maybe more importantly, the history of our economy.  As we all know, "those who do not learn history are doomed to repeat it."  

After reading my last post I must apologize.  In my concluding couple of paragraphs I used the word "you" a lot.  I didn't mean you (Minh) directly, I meant "you" in broad, general terms, meaning the average investor.  I think that came off as me being condescending and that wasn't the intention.  Writing is in no way a strength of mine and I haven't yet figured out how to edit these posts... ;)  

1.  Regarding zero hedge.  I've heard of it but never read any of their posts...maybe I should? And I respect your decision to make bets based on the interpretation of data.  The point I'd like to make to the general reader is be smart about interpreting data.  Most investors read book after book on real estate investing that focus on the micro.  While this is extremely important, macro, at times, can be equally as important (i.e. 2009 crash).  Minh, I think we'd both agree on this.  Therefore, I'd encourage the general investor to read a macro book for every micro book you read.  If you read a Gary Keller book make the next book Keynes, if you read a Robert Kiyosaki book make the next book Hayek.  You, the general investor, will be no worse off as a result.  

2.  If you can get whatever terms you want I need to switch banks or hire you as my negotiator! ;)  When you say your portfolio can handle a max of 500 basis point increase it confuses me.  Maybe I'm just not understanding something, and if I am please help me understand, but I can't imagine risking my entire portfolio, if rates go back to their historic norms, to gain a couple extra points of interest per year?  Why wouldn't you fix the rate and eliminate the risk of totally loss?  The risk/reward just doesn't make sense to me? Again, maybe I'm not fully understanding your capital structure? 

3.  Charts are subjective to a degree.  Here's another chart that might illustrate my point better.  Please notice the time frames the chartist for CNBC pointed out.  

4.  To answer your questions on where I think interest rates will be at the end of the year...I have no clue.  I can give you a compelling argument for both higher and lower.  But what I can say with 100% confidence is there's more credit in the system than there was in 2007 relative to GDP.  Therefore my personal priority is capital preservation/reducing as much risk as possible.  

5.  I'm not sure I follow your logic on home prices never going down as interest rates have gone up?  It's obvious, based on the crash in 2009 that home prices go down as a result of interest rates rising.  If you're saying interest rates rise after or during home prices going up I'd agree, but then you're left guessing at what point will the fed funds rates get high enough to prick the bubble? .5%? 1.5%? 5%? To me that's a game of musical chairs that I'm too risk averse to play.  

6.  That's why the average Joe makes money only based on his degree of luck...not skill.  You could very well be right on the 120 prediction.  The only thing I'd predict with any degree of confidence is we'll go lower than 175.  I'm happy to buy if I'm invited ;) 

7.  Great point on the smaller lot size.  I'm not sure where to draw the line?  Although I firmly believe it must include real and nominal prices.  How many indicators do I use to buy or sell or to determine how much leverage to use?  Now this is a good question and one that I've never thought about.  Let me write down the detailed process I actually used and then analyze it to try to answer your question and hopefully give the general investors some ideas.  

I started real estate investing in 2012 after retiring from a career as an entrepreneur, I knew nothing about RE.  In 2010 I started to study economics as a hobby, as I had more free time I studied it more.  The more I studied macro the more I realized I didn't want my all my money in a bank.  I studied all asset classes and RE was a no brainer.  Once I decided I needed to diversify with some RE I started to study current prices (remember this was 2012), I noticed that they were getting very close to the historic inflation adjusted trend line.  I saw that RE prices always seemed to revert to a mean which made sense to me because if people spend a consistent percentage of their income on a mortgage payment, home prices should stay consistent with real wage growth and population.  And if home prices go up based on another factor that's unsustainable, such as credit growth, the prices will at some point revert back to the mean.  All of these data made me come to the conclusion that now (2012) was potentially a prudent time to buy.  

I then took it a step further.  Because the extreme nature of the US credit crisis I wanted to juxtapose my US data with Japans data going back to their credit crisis in 1989.  I was trying to get a rough idea as the max probable downside for US home prices.  I found that Japans market, at it's worse, had declined 10% more than ours had currently declined (from their respective high water marks).  Based on the fact that prices were at their historic mean and Japan had only declined 10% more, I made the decision that 2012 was good time to buy considering the risk/reward. 

Next, I started to focus on the micro that most investors are familiar with. I wanted to buy distressed properties and rehab them A. to build equity B. cushion my principle from the market declining further C. be all in for 70% of the ARV so I could extract 100% of my principle D. be all in under the replacement cost of construction.

I started looking at markets in the US.  I wanted a linear market because through my research I came to the conclusion that the way you invest in RE is cash flow and building equity by adding value.  The way you speculate is betting on appreciation.  To me speculating is gambling dressed up in a nice suit.  I have no desire to gamble with my money.  

That led me to Kansas City where I happened to have some friends in the construction business.  I went there for a few months and did all the typical micro stuff.  Looking at school districts, neighborhoods, population migration, local preference of house layouts etc.  High yielding C and D areas had no appeal whatsoever because through time the home prices tend to lag inflation and I wanted a good store of value.  I limited my selection to A and B areas. 

Finally, I took all the capital that I'd allocated to RE and bought your typical foreclosure props, tax deed props and a couple short sales (paid cash). I rehabbed them, rented them out and flipped a few. In total I bought about 15 SFH's and an office building.

So how many indicators did I use?  probably about a thousand...;) 

How many indicators did I use to determine leverage? 1...inflation/deflation.  I had no clue back then and I have no clue now, so if I use debt, I make sure I have an equivalent amount of cash (or highly liquid, non-correlated assets).  It gives me a portfolio thats inflation/deflation net neutral.  Please keep in mind this is a long term buy and hold strategy.  

8.  Those people shouldn't be so surprised.  Seven years of zero percent interest rates can make the impossible possible in any asset class.  

Regarding your chart...those are nominal prices.  If you adjust for inflation CA prices (based on the chart) have had a compounded annual appreciation of 1.75% per annum.  Like so many Zimbabweans, I base my degree of wealth on purchasing power not the number on my bank statement, so I'm going to stick with inflation adjusted data... ;)   

Thanks again for the dialogue Minh, I think there's a lot of value in this thread for the average investor...

George 

@Chai Jonn

@Mike D'ArrigoI agree the best time to buy was 3-4 years ago.  I'd say that about most US markets.  But when looking at a bench mark for prices I prefer to look at the inflation adjusted historic norm.  I'm in no way trying to be critical of your post.  I'm only trying to offer a different type of analysis that I prefer.  Hopefully I can add a little value to the thread...  

The reason I like to go back in time and look at inflation adjusted prices is it takes us back to a time in our country when the things that affected prices were real wage growth or population growth.  Said another way, fundamentals that made an increase in prices sustainable.  

Some newer investors may not realize this but throughout our history most banks required a 20%+ down payment, solid credit score, and income sufficient to pay back the home loan.  These were rules that stayed consistent for decades, and magically, we never had a massive housing crash.  At a national level housing prices went up and down slightly, in real terms, but would always revert back to a mean.  

Then in early 2000's prices skyrocketed.  Why? Did real wage growth skyrocket?...no.  Did our population skyrocket?...no.  So if people were spending the same percentage of income on housing and income didn't increase how did prices go up so dramatically?  Obviously with increased credit via lowering lending standards and artificially low interest rates (below what the market would set).    

The reason I mention this is a rise in prices based on credit expansion is only sustainable if real wages increase (more income means higher mortgage payments are affordable) or interest rates go down (although amount of credit increases the monthly payment is not increased therefore an increase in income is unnecessary).   

So what's my point?  We haven't had a significant rise in real wages or population, therefore if prices go significantly above their historic inflation adjusted trend line, those prices are most likely unsustainable and will revert to the mean.  This is why I prefer this metric when analyzing prices for xyz area instead of an absolute high water mark.  

Here's an inflation adjusted chart of Orlando that illustrates my point.  Notice where prices are now compared to the 2005/06 high water mark and the historical mean.  

What becomes obvious from the chart is the historic norm is about $175,000 inflation adjusted.  This gives you the data I would use to determine if prices are high or low.  Example: If real prices were at $250,000 I'd say they're high.  Another person that looked at the absolute high water mark of $340,000 would say they're low.  I'll let the reader determine which camp they fall into but hopefully it provides food for thought.  

So, having said all that, it would seem based on my analysis prices are close to their historic inflation adjusted norm (please note prices could be different now, this chart only goes to 2014),  therefore now is a reasonably prudent time to buy in Orlando.  

Hope that helps,

George 

@Nathan W.I'm not sure it's been mentioned, but if it hasn't, I'd suggest factoring rising interest rates into your decision making. I'm assuming the 75% will be fixed but I doubt the HELOC will be. In my experience they adjust monthly.

Granted, it likely won't happen in the short term.  But not too far back most people said interest rates will go higher.  That didn't happen.  Now, I hear most people saying interest rates won't go higher.  In my experience "most" people are most often wrong.  

If interest rates rose, an extra 20 or 30 dollars a month wouldn't be the end of the world, but I think it's wise for investors to get in the habit of analyzing deals using all interest rate scenarios.  

Good luck,

George 

 J. 

1.  Good point.  It all depends on the rate of deflation.  If it out paces the interest rate drops you've still got positive real rates.  How far below the zero lower bound can the fed go before people start trying to withdraw all the cash that the banks don't have?  And we wonder why Larry Summers wants to ban 100 dollar bills...;)  

2.  I'm sure Minh is a lot smarter than I am but there's a few things that concern me (referring to the thread about refi/ballon payments).  And when I say concern, I mean frighten me like an 8 year old watching one of the SAW movies. lol ;)  I'm sure if you read his post you know what I mean.  

My point is just because you make money on an investment or because of a business decision it doesn't mean it was a good investment or decision.  A lot of people made money owning dot com stocks from 98-99 did that make it a good investment?  

I'm sure this will sound crazy but I'd rather lose money making a good decision than make money on a bad decision.  Why?  Because I know over the long term, with proper money management, I'll win. 

I was an entrepreneur for 15 years and there was one thing I did that made all the difference in the world.  I learned to play blackjack.  In 2004 I read Ed Thorpe's "Beat the Dealer" and it totally changed the way I conducted business.  I went from making 6 figures to 7 figures very quickly because I took the principles of black jack and incorporated them obsessively in business.  The main principles being A. don't measure success or failure based on making money, base it on making the mathematically correct decision  B. know the numbers and probabilities, there's no such thing as certainty and C.  systematically structure money management to never go bust.    

Speaking of WB I'd encourage you to think of one of his quotes when considering emulating any investment strategy that's currently hot..."never risk what you need for something you don't need"  

@J. Martinhousing chart is from case schiller, I think that's where I got the 10 year chart too?  You're absolutely correct real home prices and nominal interest rates.  Here's a chart of real rates...same take aways, but fed funds seems to have some correlation?  

 Nick, so true what your saying about behavioral economics...equally if not more important than everything else we're discussing.

I read a study the other day that shows people actually save more when interest rates go down.  They don't get the return on savings so they have to save more to retire.  I also heard David Einhorn point this out several years ago.  

One thing I was thinking about that no one seems to discuss is the deflationary pressure lower interest rates could cause.  Not saying they'd cause deflation but could produce downward pressure?  Here's my hypothesis...Fed lowers interest rates which reduces corporate/biz borrowing cost.  That reduces total cost of doing biz.  Wouldn't a rational response be to lower prices to try to increase market share?  If I had lower nut every month the first thing I'd do is lower prices to try to undercut my competitors.  Everybody has lowering borrowing costs, so everyone starts to undercut.  Lower and lower prices.  Deflation as a result of lower interest rates...

Again, just thinking out loud.

George

@Lesley Resnickthanks for your opinion, I'd like to respectfully point out a couple things...and please understand I'm not arguing for inflation/deflation, only offering food for thought.  

1. Deflation is temporary and can't last an extended period of time. There are no long term examples? I think the 1930's may disagree...;) Joking aside, the dollar had more purchasing power in the year 1900 than it did in the year 1800...said another way, the entire century was net deflationary. In fact, the dollar doubled it's purchasing power. That means over that 100 year span we had 50% deflation. It may be a different world of fiat currency now but I'd submit Japan. 25 years of deflation while the population increased. And what would've happened 2009 if the fed would've done nothing? Most economists including Ben Bernanke thought we'd go into the worst deflationary depression since the 1930's.

But now we have far more debt in the system than 2009 and interest rates are already at the zero. It's a statement of fact that QE has diminishing returns and the returns on QE3 were negligible. The fed is out of bullets. What happens if we go into a recession with far more debt in the system and an impotent fed. If we faced something that looked like the 1930's in 2009, what are we facing now?

2. As long as US has high levels of debt the fed funds rate will remain well below inflation? To your point, the feds trying to create inflation to decrease real value of debt. What happens if they succeed? What happens if they can increase the velocity of money? Historically inflation is very hard to tame, and as we all know thanks to Paul Volcker, the only cure is interest rates above the rate of inflation. see chart

3.  Interest only loans?  does the reward justify the risk?  

Thanks,

George 

@Gloria Mirza@David Faulkner

Regarding silicon valley:  I have no knowledge of the tech business capital structure but it seems any business that isn't cash flow positive would struggle if the cost of debt went up or what they could sell equity for went down?  Maybe some additional risk to the local RE market?   

David I recall that WB interview well.  What worries me most about deflation is most investors are totally unprepared for it.  At least with inflation, although not cognizant of it, their portfolios are inadvertently set up for it.  On a positive note, I was looking at a chart of historic rents and it looks like they hold up well even when real prices decline, which makes sense because fewer people buying.  Knowing housing price declines are a far cry from CPI deflation, I tried to find rent data that went back to the 1930's but didn't have any luck.  I'm very curious to see what rents did then.  If you happen to find any rent data going back that far please let me know.