“Things Are Going to Be Messed Up”

Dave:
Hey, everyone. Welcome to On the Market. We have a very special guest panel for you today. We have Scott Trench, the CEO of BiggerPockets joining us. Scott, thanks for being here.

Scott:
Thanks for having me.

Dave:
I am embarrassed that it took us 112 shows to invite you on, but thank you for coming. J, I think you’re our first three-time guest. We have J Scott. How would you introduce yourself, J? You do so many things.

J:
I’m A BiggerPockets OG, how about that?

Dave:
That is a good one, yes, and absolutely true.

J:
I’m excited to be here.

Dave:
And Kathy, you need no introduction on this show, but you can say hi as well.

Kathy:
I want to be a BiggerPockets NG.

Dave:
You’re a new gangster?

Kathy:
Yeah.

Dave:
That’s true. All right, well, we have this esteemed guest panel here to make some predictions about the second half of this year, and what’s going to happen in the broader economy and the housing market. We have gone through a really interesting first half of the year, and if you listen to the show, you probably know what has been going on. But the question on most people’s mind is is this hot market that we’ve seen over the summer going to continue? Are we going to enter a recession? And we’re going to get Kathy, Scott, and J’s takes in just a minute. But first we need to evaluate all of your respective credibility to make some predictions. So we’re going to do a quick trivia game to ask you about some of the things going on in the US right now, and see how well you’re keeping up with real estate trivia.
Scott, it’s your first time here, so we’re going to pick on you first. The first question is how many renter-occupied homes are there in the United States?

Scott:
Ooh, I’m going to go with 45 million, plus or minus 2 million, rented residences in this country.

Dave:
All right. J?

J:
So let’s see. There are about 125 million households in the US and the home-ownership rate is somewhere in the 64 to 66% rate. So that’s 35% of the households are renters, which 35% of 125 million, I’m right around 45 million also, plus or minus 2 million. I’m right where Scott is based on that.

Scott:
This is the only place in the show where J and I are going to agree.

Dave:
Yeah, this might be the only part where you’re going to agree, so let’s enjoy this comradery while it lasts. Because you’re both actually extremely accurate. It is 44 million, so with the plus or minus 2 million, Scott, you got it, J as well. So congratulations to both of you. That was very impressive.
I think they’re getting a little bit harder. So second question is which city was voted the best city to live in the US this past year? So the criteria were cost of living, housing prices, the weather, healthcare access, and also given inflation, the costs of goods and services. Anyone got an answer for that? J, I guess we’ll go with you first.

J:
I seem to recall hearing this and it being a city that I was surprised, like somewhere in the southeast, Alabama, or Tennessee, or something like that. I’m going with Memphis, Tennessee. I don’t know.

Scott:
I’m going to go with Charlotte, North Carolina.

Dave:
Okay. Both in the southeast, but both wrong. We are actually in a very different part of the country. It is Green Bay, Wisconsin, and as I was reading this thinking, “Man, they used weather to evaluate this.” Everything else must be very good in Green Bay if the weather didn’t drag it down. But as everyone on the show knows, I’m long on the Midwest and I think Wisconsin is a really good investing market.

J:
The mid-north north Midwest.

Dave:
Yeah, it’s growing pretty quickly over there. All right, for our last question, which is the fastest-growing US city in terms of population? Scott?

Scott:
Fastest-growing city in the US in terms of population? I’m going to go with Tampa Bay, Florida.

Dave:
J, that’s your neck of the woods.

J:
Yeah. I’m going to actually go a little bit north of there and say Ocala, Florida.

Dave:
Oh, I can never pronounce that place. Ocala is how it’s said? Okay.

J:
Yep.

Dave:
I always get that wrong. It is in Texas, which I mean I think you had a pretty good guess in either Texas or Florida. It is Georgetown, Texas, which I think is just north of Austin in that Round Rock area. And it apparently grew 14% in a single year, which is remarkable.

J:
From 20 to 22 people.

Dave:
Yes, exactly. But no, current population is 86,000, so it grew pretty significantly. Do we got Kathy back?

Kathy:
Yeah, you guys, Rich is a miracle man and got my hardwired working.

Dave:
You’re back. You just officially lose the game, so you’re starting in last place. You forfeit all of your answers.

Kathy:
I did that on purpose. Yeah. Thanks, guys.

Dave:
All right. If you all couldn’t tell, Kathy disappeared if you’re not watching on YouTube, because her internet went out, but she’s back and she’s ready for the actual part of the show. She just comes in last place for the trivia game. Scott and J, you tie, and so the amicable start to the show continues.

Kathy:
And I just want to say there was no way I was going to compete against these guys, so I played this one well.

Scott:
I’m sure you would’ve gotten a few of them, Kathy. We whiffed on all of them except for… Actually, can we ask you how many rented residences are there in the United States?

Kathy:
It’s not fair. Well, I would say I did a story on it a while ago and it was 44. I have no idea what it is today.

Dave:
Oh, Kathy came back and wins.

Kathy:
Is it still?

Dave:
Kathy just disappeared and she was just googling the answer and then she came back and was like, “Oh, it’s 44 million.”

Kathy:
Well, I know it was last year, but I would think it would’ve increased, but…

Dave:
All right. Well Kathy, I think you still have to lose, but that was a major flex. You’re definitely a BiggerPockets NG now. All right, now we’re going to take a quick break and we’ll be right back.
Welcome back to On the Market. We have Scott Trench, J Scott and Kathy Fettke here to make some predictions about the second half of the year here in 2023. Our first question is going to be about interest rates because, obviously, so much of the direction of the housing market and real estate prices right now are being impacted by interest rates. And so Scott, we’re going to start with you. Where do you think interest rates, and we’re going to specifically talk about mortgage rates. I assume you’ll get to the federal funds rate as part of that, but let’s talk about mortgage rates and where you think they are heading throughout the rest of 2023.

Scott:
I think that mortgage rates are going to be volatile, but on a steady march upward from where they are now, to get to in the high sevens, low eights by the first quarter of 2024 in a nutshell.

Dave:
And what are the major drivers of that opinion?

Scott:
Yeah, so I think that first the Fed is saying that they’re going to raise rates another one or two times, quarter rate hikes, and I think that that’s what they’re going to do. I think that they messed up in 2021 and they’ve been correcting that, and been very clear about what they’re going to do. And I take them at their word at this point. I think a lot of people don’t like the Fed. I think that we have the least bad central bankers on planet Earth in the United States, which I think perhaps some people would agree with at least that phrasing. And I think they’re going to do exactly what they say and they’re going to likely get the outcomes that they’re looking for.
Now, what that means is that the treasury and short-term debt that’s tied to the federal funds rate are very close to that, is going to continue to march up a few ticks. And unless there’s an economic disaster, which I am not seeing the… I’m less bearish than perhaps some other folks, and I think that we’re going to get, relatively speaking, more of that soft landing that the Fed is looking for. That’s going to result in the yield curve, which results the 10-year treasury for example, continuing to march up. So I think your 10 year is going to march up and up and up and up and up, and that’s going to put upward pressure on mortgage rates. Complicating this is there’s a spread between the 10 year and the 30-year mortgage rate. That is going to decrease, but I think that the overall upward pressure from rising federal funds rate and a normalizing yield curve is going to offset a normalized spread in the mortgage. How’s that for a very complicated rationale for why I think that the 30-year mortgage rates are going to march slowly upward, but again, be volatile?

Dave:
I think it’s a very good rationale. Those are the two real major variables right now it seems, is the yield on the 10 year and the spread between the 10 year and mortgage rates. But I got to tap J in here and hear what he has to say because I think he’s going to disagree.

J:
I do disagree. So I personally think the 10 year is not going to keep marching upwards. I do think that the yield curve will righten itself out, but I think we’ll see short term treasuries drop before we see long-term treasuries or midterm treasuries spike. So I think we’re going to see the 10 year… Right now, it’s at 3.7375 as of a day or two ago. I think it’s going to substantially stay the same, maybe even drop a little. Because I do think that we’re going to run into some headwinds in the economy. I think that we’re going to see some issues with jobs and employment, and I think that’s going to cause things to soften. I think that’s going to cause the 10 year to hold steady at that mid to high threes.
And I do agree with Scott that delta between the 10-year treasury rate and mortgage rates is historically smaller than it is today. So I think we’re going to see mortgage rates come down a little bit closer to that 10 year. And so if I had to predict, I’d say… And I said 6% mortgage rates last December at the end of last year, I was pretty close there. I got lucky. But I’m going to say somewhere around the same at the end of this year, somewhere around 6% mortgage rates at the end of this year.

Dave:
So it sounds like the major point of disagreement is the general state of the economy. Scott, you think that a soft landing is possible. That would reduce demand for 10-year treasuries, which would push the yield upward and bring mortgage rates up. Where J, it sounds like you’re a little bit more pessimistic about the general economy. Traditionally, in recessionary times there’s a lot of demand for US treasuries, and that pushes yields down. And so that seems like the linchpin between what you two are disagreeing about.
Kathy, are you going to come in and just blow both of these guys out of the water here with a perfect answer again?

Kathy:
Well, maybe. It’s just so hard to predict anything these days. I think that’s one thing we’ve definitely learned and many have tried, and so I will try. But I will say that there’s a lot of different pressures, and it’s not that simple. One thing we know is that the Fed has had an experiment with quantitative easing, buying mortgage-backed securities and that’s artificial. So we haven’t had a natural market for a while. But when the Fed says that they’re going to unload that and basically sell those mortgage-backed securities, that kind of floods the market. So it’s an environment we haven’t really been in before. I think without all that manipulation, we would see mortgage rates coming down, but because of that, we may not.
So to sum it up, in a natural market, I think we’d see mortgage rates come down because inflation’s coming down, and I don’t think the 10 year is going to go up. It would normally come down under the circumstances of a looming recession. But again, because the Fed had artificially bought all of these mortgage-backed securities and is now selling them, they’ll be more on the market and that would cause rates to go up. So I just kind of think they’re going to stay steady and that would be somewhere in the low sixes, mid sixes is where I think we’ll see it rates over this fall.

Dave:
Scott or J, you want to respond to that or any other thoughts on mortgage rates?

Scott:
I think it’s a who-knows situation. So I love how you opened up with these trivia games to show just wrong we’re going to be on any of these guesses about just current realities and the past. No one knows all this stuff. So yeah, I think that it’s anybody’s guess there. And I just would slightly weight the probability of, at least in the definitions of a recession and employment numbers and those types of things that we track officially, more of a soft landing than perhaps Kathy and J are forecasting here, for reasons I’m sure we’ll get into later.

Dave:
Well, let’s get into that because that is one of the questions we were going to talk about. Do you think we are currently in a recession or will we enter one? Scott, we got a brief preview of your opinion there. J, can you take that one first?

J:
Yeah. So I hate this question of are we in a recession? Because as far as I’m concerned, there’s really no good definition. And I know a lot of people talk about that if you have two negative consecutive quarters of GDP, that’s a recession. And a lot of people like that definition, but I will point out that even over just the last 20 years, there have been two situations where… 2001, we didn’t see two negative consecutive quarters of GDP in 2001, but I don’t think anybody that lived through that would disagree that we saw a recession in 2001. And then in 2008, we didn’t see two negative quarters of GDP until the end of 2008. So technically, by that definition, the 2008 recession didn’t start until the beginning of 2009, and I think most people would disagree with that as well.
So when you look at the data that two negative consecutive quarters of GDP, I don’t like that definition. I think it’s a little bit more amorphous and vague and you kind of look at the economy and you say, “Hey, are things bad? Yeah. No.” At some point you transition from a good economy to a bad economy and if you want to draw the line for recession somewhere in there, you can. But for me, I’d rather just say one to 10, how good or bad is the economy?
And if we look back about a year or two years, we saw what a lot of people would deem a technical recession back in 2021 when we saw those two negative quarters of GDP. Now, we’ve had positive quarters of GDP ever since. So does that mean we’re no longer in a recession? I would argue that now is actually worse than things were a year ago when we saw those two negative quarters of GDP. And so if anything, I would say if you thought we were in a recession before when we had that technical definition, I think we’re still at least in the same situation now when that technical definition no longer applies.

Dave:
Yeah, we’ve talked about this a lot on the show before. And just for everyone to know, the way that we officially figure out if we’re in a recession is retroactive. There is a government bureaucracy, the National Bureau of Economic Research, and they decide years later. So that’s why this is up for debate. Is that, as J said, there is a textbook definition that a lot of people use that is not the official way and there is no official way to know whether we are in a recession or not. So, even though you hate this question, J, we’re going to make you debate it. So Kathy, why are you a little bit pessimistic about the economy?

Kathy:
Well, I’m not so pessimistic. We are technically not in one now because GDP has not been negative, it’s been positive. We have over 10 million job openings. Jobless claims are rising, but still pretty low when you look at it historically. So generally, you don’t have a recession when there’s job openings. People may be losing their jobs, but they can turn around and get another one. On the government website, they’re calling it the great American reshuffling where there is a lot of people leaving their jobs and getting another one. And again, that’s not generally something that happens in a recession. If you lose your job, you have a harder time finding one.
So until we see the labor market break, I just don’t think we’re going to see a recession. But unfortunately, that’s what the Fed is focused on is breaking the labor market. So I don’t think it’ll happen this year, but it all depends on what the Fed does. I mean if they, they’ve said they plan to keep hiking rates. We all thought they were done and then they don’t think they’re done because they’re still going after that inflation number of 2% that they’re just fixated on for some reason. And the only way they know how to get there and to lower inflation to what they want, which is still twice what they want, 4% is much lower, but still not where they want, they are going to go after the job market and that could bring in a recession.
So if they went crazy and hiked rates a lot, I think we’d see it this year. But if they go gentle, I don’t see it this year. And all the reshoring that’s happening as well. There’s a big push to bring business back to the US and that’s bringing more jobs. And it’s so bizarre because the government is actually promoting that, right? More jobs when the Fed is trying to kill those jobs. So again, it’s like all these forces coming in and conflicting that makes it feel, to me, like we’re going to just stay steady for a while.

J:
See, I don’t feel like they’re likely to be many more rate hikes, and we can talk about that separately. But independent of that, I feel like the Fed’s already overcorrected. I feel like raising 500 basis points over the past year and a half has put us in a situation where we haven’t yet seen the ramifications of our actions. And we talk about the labor market. The problem I think with the labor market is everybody focuses on the headline numbers. So you look at the May jobs report, and we haven’t seen the July jobs report, we will by the time this comes out, but we haven’t as of the recording, but if you look at the May jobs report and the headline is, “339,000 jobs were created.” But it’s not a very good number because there’s two jobs surveys that the government uses to determine what’s going on in the jobs market.
They have this thing called the establishment report, which is basically the government polls companies and they say, “How many people have you added to your payroll?” And last month or May, that was 339,000. So jobs companies have said, “We added 339,000 jobs to our payroll,” so that’s the number that gets reported. 339,000 jobs were created last month. Everything’s great. But there’s actually a secondary survey that the government carries out and that’s called the household survey. And that’s where the government calls up regular people, like you and me, on our cell phone or our landline and says, “Hey, how’s your job going? Are you employed? Are you unemployed? Are you looking for a job?” And the household survey last month basically showed that 400,000 people lost their jobs. 400,000 people said to the government when they picked up the phone, “I was employed last month, I’m not employed this month.”
And so there’s a big difference between what companies are reporting and what households are reporting. Why is that? Well, the big difference between those two surveys is self-employment. The company, the establishment survey doesn’t capture people that are self-employed. They don’t capture mom-and-pop businesses, they don’t capture gig workers, people that do Uber, and DoorDash, and Etsy. And so while companies are saying that their payroll ranks are growing, people are saying, “We’re losing jobs.” And so it turns out about 400,000 people, back in May, lost their self-employment or said, “I’m no longer employed as a self-employed person.” Not to mention, when somebody goes and takes a second job, that adds a number to the payroll survey. That companies say, “Hey, we added somebody on the payroll,” but it doesn’t take somebody off of unemployment. They still say they’re employed. So when somebody says they’re employed, we don’t know if they have 1, 2, 3, 4 jobs. So it’s possible that back in May, a lot of people just added a second, a third or a fourth job, which doesn’t bode well for the economy and for the employment sector.
So overall, I think employment is a lot worse than what the headline numbers indicate. Secondarily, I read an article yesterday that basically said that with interest rates where they are, there are a lot of businesses that are struggling. Think about this, how do businesses capitalize themselves? A lot of businesses are self-sufficient and they make money and they live off their profits. But a whole lot of businesses don’t do that. They capitalize by getting money from investors, venture capitalists, or angel investors, or by borrowing money from banks, or by issuing bonds. And rates for all of these things, whether it’s bonds that you’re issuing or borrowing money from banks or what you have to pay to investors, as interest rates go up, companies have to pay more for all these forms of financing. And companies can’t afford…
Walmart last year was able to sell bonds at 7%. They could raise money at 7%. Now they have to raise money at 12%. Walmart might be able to handle that, but there are a whole lot of businesses that can’t. And so what I read yesterday was that 37% of businesses are facing significant headwinds from this credit crunch because they’re having trouble borrowing money at costs that they can afford. 37% of businesses. Imagine if even a quarter of those businesses went out of business. We’re talking 9-10% of businesses. That’s tens of millions of people that are going to lose their jobs when those businesses go out of business, even if they don’t go out of business, even if they just have to cut employees, even if they have to cut back to save money, we’re going to see potentially millions of people out of jobs because interest rates were higher, and that affects businesses.

Dave:
That’s some great data, and I totally agree with you about the labor market data. There is very confusing and often conflicting data. So if you are interested in that, definitely dig into it a little more than just seeing the top-line number. But Scott, I’d love to hear your opinion because you’ve been saying that you’re thinking that a soft landing is possible.

Scott:
So first of all, when I say soft landing, I’m talking about in terms of the definitions of employment as we officially compute it. I think J’s diagnosis is spot on. And so the question is, these academic questions, are we in a recession? Will unemployment go up? These types of things. We can debate those all day in terms of these definitions. What’s going to happen over the next several quarters is pain is going to hit the economy. People are going to make less money, however you want to phrase that in terms of unemployment or loss of gig worker jobs, and asset values are going to march downwards most likely in a lot of cases, especially these small businesses that J just described here.
The challenge is what’s the Fed going to do about it? That’s what we’re trying to get at here. And if you put on your Jay Powell hat, right, this guy blew it in 2021, right? Inflation went way too high. He knows it. Everyone knows it. Well, how are we thinking about our legacy here if we’re Jay Powell and the Fed at this point in time? We’re going to combat inflation. The central bankers going to be remembered for, did inflation spike during their tenure or was there a horrible economic recession or depression that they put in place? And if you can avoid those two things, that’s the only marching order here. And the Fed, at this point in time, has a clear run of sight to stop inflation because of what J just described here and the unemployment numbers being so masked by these other underlying factors. The gig economy exploding by 20 to 30 million jobs over the last decade, 30 million gig jobs. Those don’t count in unemployment stats, right?
Self-employment, I don’t know the numbers there, but I’m sure that that self-employment has increased to a large degree by many of these folks in a similar capacity. That doesn’t count in some of these unemployment or jobless claims to a large degree. There’s 11 million illegal immigrants in this country, probably many of them are employed. They won’t show up on those statistics. So I think the Fed has a very long run ahead of them where they can create a lot of pain in the economy without undermining their charter of keeping unemployment low, in addition to keeping inflation low. And I think that’s the real risk factor here that we’ve got to be kind of aware of.
And to me, that gives them a clear line of sight to not just raise them one or two more times like they say they’re going to do, but keep them high, long past the point where pain begins to come into the economy because it won’t be counted in an official capacity. And so that’s where I am kind of worrying about this, right? That’s not good news. This is not a very fun prediction when I say that’s my soft landing that we’re going to get here, is the Fed’s going to beat inflation by crushing all of these unofficial employment statistics that aren’t going to show up on their scorecard.

J:
Can we talk about inflation?

Dave:
Let’s do it.

J:
So I think to a large degree we’ve beaten inflation in the short term, and I know a lot of people disagree with me there, but here’s what I think the data is going to indicate over the next couple of months. Right now, as we’re recording this, the trailing 12 months of inflation is at 4.0%. The June numbers come out on July 12th, which will be week and a half, I think, before this gets released. And I think what we’re going to look back when this is released and we’re going to see is that inflation in that one month, the annual number is going to have dropped from 4.0% to under 3.5%. And then in August, we’re going to see the July number. And I’d be willing to bet that that 3.5% annual number drops below 3%.
So come August, we’re going to be hearing a headline that inflation is now under 3%. Is it really under 3%? No, but the trailing 12 months, the average of the last 12 months is probably going to be under 3% as of August because the two numbers that get replaced over the next two months were numbers from last year that were super, super high. And anytime you do an average and you take out a big number and you replace it with a small number, the average is going to drop. And so we’re going to see inflation drop from 4 to 3.5, to under 3 in two months. And I think the media is going to latch onto that, even though it’s not meaningful, even though somebody as dumb as me can sit here and predict that’s going to happen because that’s just math. The media is going to latch onto that and they’re going to say, “Look at this. Inflation’s finally under control,” even though it really hasn’t changed. The monthly numbers are going to be the same, but the annual number is going to drop.
And so I think come July, come August, the Fed’s going to meet and they’re going to say, “Okay. Inflation’s okay. Jobs haven’t changed that much. Everything’s good. We don’t need to hike.” But then you go to September and you look at the August number. Well, last August was a really, really low number, so come September we’re likely to see inflation number go up. And so that’s when the Fed’s going to have to basically say, “Okay.” Now, the media’s reporting that inflation’s going up again, the same thing’s going to happen in October. September and October we’re going to see that number go up again. And that’s when the Fed’s going to have to make a difficult decision. Do they hike again? Not necessarily because inflation’s bad, but because again, that headline number that everybody looks at is going to look worse.
And so if I had to make a prediction on inflation, I’m going to say by the time this comes out, we’re under 3.5%. Come August, we’re under 3%, come September and October, we’re back over 3%. Everybody starts to panic a little bit, and the Fed has a tough decision to make in September and October, and I think that’s when it’s possible that we see another 25 basis point hike from the Fed come September, October.

Kathy:
Yeah, J, I mean what it really comes down to is the Fed is looking and driving the economy looking through the rear-view mirror. And the tools that they’ve been using are outdated. It needs to be updated, but that’s not going to happen this year, sadly. I couldn’t agree with you more that we probably are where we need to be, but the data that they’re using is old data. So one example of that is rent and owner’s equivalent rent when they take the average of the last 12 months. Well, we know that rents were insane a year ago, but they really have come down in terms of growth. The growth rate is way down, but when you average the last year, it’s going to look higher. So they’re just not looking at the current data, unfortunately, and that will affect the decisions that they make.
It’s the same with… I mean, we’ve been fighting deflation actually for a decade until this past year. It was 2021 that Janet Yellen was saying, “Oh, we need more inflation.” And boy, did they get it. So deflation has really been more the trend until the last few years. And due to of course, the manipulation of the Fed. So sadly, J, I think you’re right. I think that they’ve fixed it, but the data’s not going to tell them that because they’re using outdated data. And unfortunately, that could mean that they raise rates and really cause a mess. So hopefully, somebody on the team is going to wake them up. But based on the last Fed meetings, it was kind of unanimous. I think there were two that were not in agreement, but the rest of them were very bullish on raising rates further this year.

Scott:
So let me ask a question here and be that guy there. Okay, so we all agree that the rates are going to go up and we think it’s likely that the Fed’s going to increase rates. We’re all maybe differing opinions there. Some of us think that the Fed are not very smart. I think the Fed is probably… We’re probably giving a little too little credit to the Fed, and they’re probably pretty smart guys there to some degree. But we all think that they’re going to raise it. Why do we think the 10 year is going to stay down and not continue to rise in that context?

J:
I personally don’t think the Fed is likely to raise rates. I think that they’ve spent the last, as long as I’ve been an adult, talking very aggressively about how they’re going to take action and they’re going to quash inflation if it happens, and they’re willing to be bold and take chances and do what’s right. And despite all that talk, what we’ve seen over again the last 20, 25 years that I’ve been paying attention is that they typically are pretty dovish. They don’t want to take bold action because they’re scared of breaking things. And I personally think that once inflation comes down over the next two months, and again, the math indicates that it almost certainly will, I think they’ll use that as cover not to raise rates. Like I said, I think they’re going to have a hard decision to make in September or October, but I think it’s unlikely that we see more than one more hike, and I’d be willing to even make a reasonable bet that we see no more hikes this year. So I don’t necessarily think we’re going to see additional rate hikes.

Dave:
It’s so interesting to hear everyone predicting the Fed because, J, I get that argument that the Fed will use inflation coming down as an excuse to raise rates-

J:
Not raise rates.

Dave:
Not raise rates. But I’ve also heard the opposite opinion that the Fed is intentionally using lagging data as cover to keep raising rates. I mean, Kathy and I interviewed someone just the other day who was saying that, so it’s very interesting. We’re all just trying to predict what they’re really trying to get at.

J:
Here’s a trivia question for you, Dave. So we’re talking about inflation here, and we know that shelter costs and the term Kathy used, owner-equivalent rent, basically all these things that involve housing is a component of inflation data, of CPI. What percentage of CPI do you think is made up of housing data?

Dave:
Oh, I used to know this. Of the headline CPI?

J:
Yeah.

Dave:
It’s like 20 or 30%.

J:
Yeah, 33%. And of core CPI, it’s over 40%. So basically, more than a third and up to 40% of the inflation number is housing. And Kathy hit the nail on the head when she said, “Especially with housing, you can’t trust the number because it’s so lagging.” We’re looking six, nine months in the past when it comes to housing data. And yet, that is by far the single biggest component of this inflation number. And so Kathy’s right on the mark when she said, “The tools we have to look at this are just meaningless.” And so we’re looking at these numbers and we’re making… Or not we, the Fed. And I agree with Scott that I think the Fed is a lot smarter than a lot of people give them credit for. I like the Fed. I think they’re the best of a bad group of central banks out there in the world.

Scott:
Least bad central bank in the world.

J:
Yes, the best bad central bank in the world. But like Kathy said, yeah, the tools that they’re using. Hopefully, they have internal tools that are a whole lot better than the stuff that we’re seeing because I don’t think the actual data we’re seeing is meaningful, even if the trends might be.

Kathy:
Well, And Jay Powell is an attorney, not an economist, and that says something right there. Nothing we can do about it. We’ve got to just be able to react and be able to operate in a time when we’re not in control of it, and we don’t know what’s coming. And it’s so funny that the three of us, I thought would be maybe more in the same camp, but it’s really wild to have so many different opinions right here from BiggerPockets, from the OGs and then NGs.

Dave:
Well, J, to your point, if you’ve heard of core inflation, which just strips out food and energy costs, now there’s core-core inflation, which also strips out shelter costs, and that’s been dropping pretty significantly because I think a lot of people are trying to get at what J is saying, which is if you strip out this lagging indicator in the core, which is really bad, then you get a better idea.

J:
We need just one CPI number that only factors in is the cost of Skittles. Strip everything out else out.

Dave:
That’s what the people care about.

J:
Yeah, exactly.

Kathy:
I mean, a concern is that the Fed is so fixated on this 2% inflation rate, which nobody really wants inflation, except if you own assets that inflate, it’s good for you. But nobody wants to pay more for things. But this 2%, where did that come from? And to get there, doesn’t that mean if you’re averaging over the past year and you’re looking behind, you would have to have really, really, really low, under 2% inflation numbers to average to get to 2%. So it’s really impossible, as I see it, and you’re the numbers guys, but how do you get to 2% when you have higher inflation in the past and you’re looking at the past and you’re averaging… You’re not going to get there unless you change that target somehow and admit, we can’t get there because we don’t have low inflation numbers to average into this equation.

Scott:
Americans do not like high inflation. And why did they pick 2%? Literally, I think it was something to the effect of, well, if there’s deflation, people hoard too much money and they don’t spend and that lags your economy. So a little bit of inflation encourages people to consume, and I think it’s literally as simple and as complex as that kind of line of thinking. Go ahead, Dave.

Dave:
No, I was going to say we had Nick Timiraos on the show. He follows the Fed for the Wall Street Journal, and he told us the whole story. Basically, some economists in New Zealand had that exact line of thought that you were talking about. And they were like, “2%.” And then basically every other central bank in the world was like, “Okay, 2%.” New Zealand did it first.

Scott:
Yeah. So look, if that’s your rationale, and how can you argue that? I mean millions of people will with this, but it’s just a pointless debate. That’s their target right there. And they have real pressures that are going to prevent them, Kathy, to your point, from getting to that 2% target and one of the big ones there that I think is underlying all of this is an aging population in this country and not enough immigration to replace those workers. So a lot of people are just retiring. That’s great news for people like us. We’re going to have a lot of wage optionality over the course of the next couple of years, the next couple of decades, as demand for workers grows and there’s not enough pool of supply. And the Fed is keying in on that as a core metric that they’re looking to attack. That’s one of their leading indicators that they’re trying to attack here.
And there are huge problems with that. I mean, we’ve got, again, the aging population. Lots of people retiring. 10,000 boomers are leaving the workforce every single day, and that will continue for the next several years. And we’ve got this new remote work world. Yes, there’s some pullbacks from that, but by and large, you can get a job anywhere. You can work many of these jobs anywhere in the country, and that continues to put upward pressure on wages here.
So I think that they’re going to have the work cut out for them. And that brings me back to this point of I can’t see the path to some of these leading indicators and core inflation metrics going below 2%. I can’t see the fed stopping raising rates altogether in the near future, or if I can, I can’t see them bringing them back down. And that bodes very ill for investors in certain asset classes because if rates stay high for years in a row, which is where I think I would be leaning at this point in my sentiments, that creates compounding pressures for certain people in certain asset classes, like the small business owners J just talked about.

Kathy:
That’s why there is a solution. Bring on the robots. I don’t know if you remember, five years ago or whatever, people were like, “Oh my gosh, all these robots are going to take our jobs.” It’s like, yeah, bring them on.

Dave:
I’ve been saying the same thing, Kathy. We need the robots, they’re our friends.

Kathy:
They’re our friends.

Dave:
This is how we all get killed by the robots, we invite them in.

Scott:
Well, ChatGPT will be making the predictions here soon.

Dave:
Yeah, exactly. We’re all out of a job soon. Well, before we get out of here, I do want to get to the housing market. We’ve talked a lot about the macro indicators and factors that impact the housing market, but would love to hear where you think things are going. Kathy, let’s start with you. If you could sum up all of your feelings about the economy, how do you think it’s going to impact the housing market?

Kathy:
Well, as I’ve said before, Dave, there is no housing market, so it can’t affect it. No, every market will be affected differently. Being born and raised in San Francisco, 2001 was a really, really hard time during the tech recession, it hit San Francisco hard. Other areas might not have felt it. So fast-forward to today, some areas are bringing in jobs like crazy, and many of those areas are doing that on purpose. They’re giving tax credits and making it a really job-friendly place. Of course, Texas and Florida come to mind when I say that. There’s other areas that are absolutely repelling jobs. So no matter what’s happening, whether we’re in a recession or not, those areas are going to feel the pain if they’re not friendly to businesses. So it’s just going to be different wherever you are.
I think what we’re seeing as a bifurcated market. You’ve got more affordable markets that aren’t feeling the pain because a rise in interest rates doesn’t make that big a difference in the payment on a $200,000 house. So in areas that are affordable, where there are jobs and it’s just steady markets, not as much pain. You go into an area where a million five is the average home price, they’re feeling it more. I mean, I could tell you that just anecdotally. In Park City, there’s more inventory than in other areas. Those are higher-priced properties and people maybe just getting rid of their second homes. So again, it’s going to just completely depend on the market. But as always, if you follow the jobs and the jobs that are here to stay, the jobs of the future, housing’s going to be propped up. In areas where jobs are leaving and people are leaving, it’s going to be harder.

Dave:
All right, J, what are your thoughts?

J:
I don’t think we’re going to see a normal housing market for at least a year or two, maybe several years. So I think things are going to be messed up for the next couple of years, at least relative to what we’ve seen the last however many years, decades. Historically, I mean, if you look at the data, between 1900 and 2013, if you track inflation and you track the increase in housing prices, what you’ll find is that those two numbers have pretty much gone hand in hand. Now, inflation kind of goes up nice and slowly and consistently in a straight line. Housing kind of goes up and down, and up and down, and up and down. But between 1900 and 2013, where those two things started and where they ended were right about the same place. So you can realistically say, or you can reasonably say that housing prices over the last 100 and something years have tracked inflation.
Now since 2013, we’ve seen a big disconnect. Inflation’s kind of kept going up in that straight line, and housing prices have just gone through the roof. So there are two things that can happen at this point if you believe that that long-term trend of housing tracking inflation is true. One, housing can come crashing back down to meet that inflation line. And in which case, we have a 2008 type event, where we see prices crash. Or two, housing kind of hangs out where it is, and inflation just catches up over the next 3, 5, 7 years, which one of those it’s going to be… And it could be a combination. Maybe housing will come down a little bit and inflation will go up. But I tend to believe that we’re not going to see that crash. I tend to believe that it’s more likely that we see housing prices stagnate where they are, maybe drop a little bit over the next three or four or five or even more years while inflation catches up, and those two lines intersect again.
So if I were a betting man, I would say that we’re going to see stagnant prices probably for the better part of the next five years.

Dave:
Well, you are a betting man. You’re like a professional poker player.

J:
Okay, I’m a betting man. There’s my bet.

Dave:
All right. Scott, what’s the last word on the housing market here?

Scott:
I think I completely agree with that take. I think that it’s going to be very regional. Local supply and demand forces are going to trump the macro forces in some cases around the country. But I think where the jobs and people are flowing is generally going to be the right tend and those markets are going to perform well or less bad than markets where people are leaving. And I think that the higher-priced markets, to Kathy’s point, are at much more risk because that’s a huge change in your payment on a million dollar loan, for example. That’s going to be a dramatic shift.
I think that a fundamental thing that we’ve acknowledged, I think, many times or you’ve acknowledged Dave on this podcast is the lock-in effect. 80 million American homeowners potentially are just locked in to their mortgages that they took out in the last couple of years or own their properties free and clear. So there’s not going to be a pressure on the supply front that I think drives a crash downward. Unless interest rates come down, I don’t think you’re going to see people moving unless they have a really good reason to do it and it’s going to keep transaction volume down.
So my most confident prediction is transaction volume cratered between the first part of 2022 and today, and I think it will stay low for five, 10 years, slowly creeping back up as the reasons people have to move, forcing more of that, and there’ll be very few voluntary moves during that period. So again, keeping transaction volume down. But I don’t think prices are going to crater, I think they’re going to stagnate, I think is the right word there.
Now, I do have one caveat. When you consider real estate as an income stream instead of as a personal residence, I think that the value of those income streams has just declined dramatically. When you can go and lend to Walmart on the public debt market at 12% interest, that makes the 4% cap rate on a multifamily project much less attractive and so much less valuable. And so you’re going to want to pay 6% or a 7% cap rate or something like that. So I think that while rents still have room to go up, even in spite of the onslaught of supply that we’re going to see in the next year in the multifamily space, a lot of units are under construction, I think the value of cashflow streams from that asset class is going to be impaired, and that’s going to be bad news for some investors in that particular space.

Dave:
Uh-oh, Scott’s picking a fight that we need to have on our next… We’re going to have you all back because we were running out of time, but that is a very good debate. Maybe Kailyn, maybe we should have a part two to this conversation where we talk about the commercial market. Kathy, did you want to say something there?

Kathy:
I just wanted to say that if mortgage rates come down and if they come down to the low sixes or even into the high fives, which some mortgage brokers think it should be already, just because the margin is so wide right now, that if it were a normal world and if the Fed actually paused and the banking system could take a breather, then rates would most likely come down. And if that happened, you’d have another five to 10 million people who are able to qualify for a loan again. And in that scenario, they don’t care what the interest rate is, they just want a place to live.
There’s millions of people. There’s seven… Oh, I’m going to get it wrong, but 72 or 82 million millennials. Do you guys know the number? I can’t…

Scott:
There’s a lot of us..

Kathy:
There’s a lot, millions. And the largest of them are at family formation age, they’re having babies. There’s like a baby boom, in my opinion. It’s you’ve got the largest group of millennials who are now getting married, having babies, and wanting a place to live. So I think we would have a huge housing boom. Boom, boom, boom, prices going up massively if mortgage rates come down. So that is kind of what I am actually predicting.

Scott:
I agree with that. If we get interest rates in the high fives, I think I would agree with Kathy.

J:
I mean the last numbers I heard, and I believe they were from March or April, 99% of mortgages are below 6%, 72% are below 4%, which means that’s 27% of mortgages are somewhere between 4 and 6%. And so yeah, we get below 6% or down in the mid 5s or even the low 5s over the next year, and that’s a quarter of the people that have mortgages that are now in a position where they can trade out their mortgages without losing money.

Dave:
All right. Well, unfortunately we have to get out of here. This was very fun. I really enjoyed this episode a lot. And maybe we will steal some more of all of your time to do this again. But in the meantime, thank you all again for being here. J, if people want to connect with you, where should they do that?

J:
Jscott.com. The letter J, scott.com.

Dave:
All right. And Scott?

Scott:
You can find me on BiggerPockets or follow me on Instagram at @scott_trench.

Dave:
And Kathy?

Kathy:
Well, I’m on Instagram, @kathyfettke. And also, you can find me at realwealth.com.

Dave:
All right. Well, thank you all for being here, and thank you all for listening. If you enjoyed the show, please remember to give us a review on either Apple or Spotify. We really appreciate it. And we’ll see you next time for On the Market.
On The Market is created by me, Dave Meyer and Kailyn Bennett. Produced by Kailyn Bennett, editing by Joel Esparza and OnyxMedia. Research by Puja Gendal. Copywriting by Nate Weintraub. And a very special thanks to the entire BiggerPockets team. The content on the show On The Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.