Nearing The End of a Cycle – by Bruce Norris

It’s hard to believe a decade has passed since the great boom in real estate prices ended around 2007. The California Crash started in earnest in 2008 and continued until 2012. Prices went from about $600,000 to $250,000 in just a couple of years. It was devastating to anyone who did not see it coming. Since 2012, California has enjoyed a 100% gain in median price, going from about $250,000 to $500,000.

The healthy increase in real estate prices have been accompanied by some very unusual charts.

For the past seven years, the United States has enjoyed a growing economy. The GDP gains have been less than during a normal recovery, but things have been gradually improving.

GDP

GDP1

California Unemployment

Unemployment has gone from nearly 10% to below 5%. Anything below 5% unemployment is generally considered “full employment.”

Unemployment

As the economy improves, it’s normal for interest rates to gradually rise. That did not happen. The United States has had the lowest interest rates in more than a century. Despite near zero interest rates for the past 10 years, the economy has grown slowly. Finally, in 2016 and now in 2017, it seems interest rates will begin to rise. 

History of Federal Funds Rate and GDP Growth
(GDP percent change based on current dollars)

GDP-Growth

It will be very interesting to see how fast the FED raises rates this year and what affect the rate hikes will have on the economy. My feeling is that the FED is raising interest rates, not so much to combat impending inflation concerns, but to have something to take back when the next recession hits.

The Fed has raised interest rates three times in the past two years after seven years of no changes at all. Every change in interest rates has become a “media event”. We have become so used to no volatility that any rate hike seems to create quite a stir. The year I got into the real estate business, the FED changed rates 21 times in 12 months!

So, in 2017, with technically full employment in place, we are finally ready to raise rates. It will be very interesting to see the pace of the rate increases in 2017. The most aggressive estimate has the Fed Fund rate at 2% by the first quarter of 2018.

Job Creation Under Presidents

Here’s a chart of past presidents and job creation or job loss that leads to a recession. We have had seven consecutive years of job growth.

Job-Creation

 

Fed Fund Rate and 30-Year Mortgage with Recession Date

If we do have a recession in 2018, what’s likely to happen to interest rates?

Fed-Fund

 

I think we will have a recession in 2018. If we do, the Fed will take back all of the rate hikes and, if past history is followed, dip into negative rates in the last half of 2018.

That will be a very interesting development for the real estate industry! Normally, real estate suffers when we have a recession. This time, I’m not so sure that will happen. There are three reasons:

1.  During a recession, we normally have a large increase in the number of foreclosed properties and the MLS gets flooded with REO listings. That won’t happen this time. Lending policies have been very strict since the crash. Nearly 100% of the loans have fixed interest rates. Unlike the last boom in prices, owners have not taken out equity lines. The owners of real estate are sitting with a lot of equity and a payment based on a loan of either a 3 or 4% interest rate. My bet is that foreclosures will go up but nowhere near enough to impact prices

2.  Builders usually build like crazy during price booms and then have huge unsold inventories they have to get rid of when recessions occur. That won’t happen this time either.

California Housing Units Built

Single family construction never took off during the real estate comeback, so there will be a very mild amount of unsold inventory to deal with in the event of a recession.

Housing1

3.  Reacting to a recession, the FED usually lowers the FED fund rate by 4% points. If history repeats itself, the industry that will benefit the most is real estate. For a short period of time, you will have the chance to refinance your home mortgage with a rate that starts with a 2! You’ll be able to refinance your rentals with a rate in the 3s.

Bruce Norris is an active investor, hard-money lender and real estate educator. A talk show host in his hometown of Riverside, Calif., Norris is a frequently quoted in financial publications and a speaker at investor club meetings throughout California. His latest study, The California Comeback 2, was released in July 2013 and provides the statistics that substantiate his predictions. More information about Bruce Norris, his research and his investment seminars are available at www.thenorrisgroup.com

Reprinted with permission of AOA (Apartment Owners Association)

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