It Isn't Just Location: Housing and the Economic Recovery

Includes: HON, TOL
by: Hard Assets Investor

Mike Norman, anchor, (Norman): Hello everybody, and welcome to I’m Mike Norman, your host. Well, talk about a hard asset, what about real estate? Here to talk about that, and somebody who has a very, very intimate knowledge of the real estate market is Tom Adkins of Tom Adkins Homes. Tom, thanks a lot; it’s great to see you.

Now you and I, we go back … because we spoke about this several years ago. We talked about the real estate market as maybe facing some period of softness. But things obviously played out, at least in some of the bigger markets, far worse than the forecasts or the expectations. How do see you things now? Let’s talk about now, because it seems to me, when you look at some of the data … little glimmers of hope popping up, obviously prices have come down a lot; you see the foreclosure activity. How do you see it now?

Tom Adkins, president, Tom Adkins Homes (Adkins): Real estate prices depend on three things: net income growth, interest rates ...

Norman: Net income growth has been going down.

Norman: ... Of course, when GDP shrinks, net income growth follows. Interest rates and confidence. Let’s not forget, people talk about the three ways we got here in the first place, which is critical to understand. The first thing we had was Fannie Mae getting involved with subprime and committing massive fraud to hide the losses, which became pretty dramatic. The second thing was the Federal Reserve’s incredibly stupid mistake of raising interest rates 525% inside of three years – never happened before.

Norman: Yeah, and you’re one of the few people whom I’ve heard mention that. I’ve said it before: This goes back to the old inflation-targeting strategy of central banks – doesn’t work. Higher interest rates don’t bring about suddenly more oil production, and nobody was counting on the 500% increase in rates.

Adkins: Straight from the real estate perspective, here’s Alan Greenspan, who’s telling you to get out and get adjustable mortgages, and then he raises the No. 1 index used to adjust mortgages 525% and wonders how come all these foreclosures started happening?

Norman: Are you saying people who got into these mortgages when rates were down at 1%, they were affordable? They went in there … let’s not talk about the ones that actually were fraudulent … but for the most part, the majority of people who locked in or got into the adjustable when rates were at 1%, because nobody knew that, suddenly the Fed was going to reverse course and jack the rates up by 500%, as you said.?

Adkins: Right, and keep in mind, you look historically, the Fed had never done that. The greatest change we ever saw was 2% or 3% over four or five years, and at that point your income can usually outpace the adjustment. This is the first time in history that it was impossible to do. Keep in mind, this is at a time when net income growth was going up 10% per year and the interest rate changes way outpaced that.

The third thing was, let’s face it, the subprime losses were contained somewhere early- to mid-2007; it stabilized. So what happened between mid-2007, when the economy is doing fantastic, and today? What happened was the media seized upon this – whether for political reasons or because they like to create good stories – exaggerated the foreclosure situation, which was really contained to three markets for a long time, which were Florida, Southern California and the Nevada Las Vegas area.

Norman: But we see this media effect very often. The media could latch onto it, they create the news, it’s the proverbial tail that wags the dog. They get the story, and whereas maybe investors in general might not be inclined to think that way, when they hear this story pounded over and over again on the news, they start to follow that.

Adkins: We call it the “alar effect.” Back in 1989, “60 Minutes” did that big exposé on alar. They had this fake scientist who came on and told everyone this chemical alar is used on apples, and when children eat it, they’ll get cancer and die. It was a complete lie, but within 60 days, every apple grower in America was bankrupt. Same thing happened this time in 2008 and 2009, when the media completely exaggerated the foreclosure situation, which was caused primarily because builders simply overbuilt. It had nothing to do with George Bush’s policies or the Fed, nothing to do with it whatsoever.

Norman: But aren’t we looking at the opposite situation? You talk about builders overbuilding. Back in 2006, I believe at the peak we put up about 2.6 million homes nationwide. Now we’re doing 400,000, 500,000. Even back when the population was 200 million in 1972, we put up more homes than that. Isn’t that fundamentally planting the seeds for a boom or a shortage at some point down the road?

Adkins: We still need to work off the inventory, which nationally is somewhere between 10 and 11 months’ worth of inventory. When that gets worked off, that’s when your boom starts, because as long as people have confidence, interest rates are reasonable, and they have net income to talk about. Keep in mind, you can have all the confidence in the world, you can talk up an economy very easily, but talking an economy up is almost impossible if people don’t have the money in their pocket. They can have all the confidence in the world, but when they open up their wallet and there’s like $11 there, they’re not going to go out and buy a brand new.

That’s one of the reasons why you see a problem with the auto industry as well. Not to go off on too much of a tangent here, but I think the auto industry and the automakers have really gotten an unfair smackdown by the media. The reason why they’re having big problems is because people have no money. If they have no money, every industry is in trouble.

Norman: If you get the economy back, then cars are sold, homes are sold – you alleviate, you eliminate the problem.

Adkins: Find me an industry that’s not suffering right now. All of a sudden, all the management was bad, the unions were bad, blah, blah.

Norman: If Toyota is losing money, you don’t hear the Japanese saying they’re not viable and they’re about to force them into bankruptcy.

Adkins: You don’t hear them complaining about the Toyota unions – there are none. The Toyota management … they’ve been making zillions of dollars over these years. All of a sudden today they’re stupid? The same guys who had the best car company for 10 years in a row, now they’re awful? Come on.

Norman: Let’s give an outlook now. So you’re saying some things are looking more positive, but we still need to get the confidence coming back, we still need to get the net income growth. Essentially what you’re saying is the economy needs to start growing again. Once we see that happening, you get the other two elements coming back.

Adkins: People have been hit really hard. People are not just going to take Barack Obama’s word for it, Timothy Geithner’s word for it. They’re going to want to see money in the pocket, and just writing a check from the government ... what are people getting now, $13, $14 a month from the federal government? That’s not going to spur them to buy a house. They need to see serious money.

Norman: What about the $8,000 tax credit for first-time home buyers?

Adkins: Well, it’s great, but it only lasts one year. It doesn’t go forward. Look at this thing, you’re looking at a $200,000 or $300,000 house or more. In New York City, if you live in an OK suburb, you’re spending $700,000 or $800,000 to buy a decent three-bedroom house; that’s nothing up here. So before people spend that kind of money, they need to know they’re going to have money in their pocket going forward. They need to say, oh, I’m making more money than I was last year. Right now they’re not seeing that, and frankly there’s no prospect for that.

Norman: On this site we talk about assets, we talk about quality assets, about diversification. Real estate has always been the bedrock, the foundation, the biggest asset of household savings.

Adkins: By far.

Norman: Well, that and stocks, but real estate has been the biggest. Is that going to stay that way or have we seen a major change yet?

Adkins: We always talk about that. In the moment that you find yourself living in, it’s like, oh my God, everything is going to change? As soon as the economy recovers, it’s going to go back to the way it was, because look, real estate is leveraged and there’s nothing wrong with that; it’s just the way it is. So if you put 10% down on a house and it rises 10% in value, you just doubled your money.

You can’t find that in almost anything else, and if you have net income growth that’s coming in, let’s just say you’re making $10,000 more next year than you made the year before, that $10,000 converts to about, I don’t know, about $200,000 or $300,000 more in buying power. So if rates were at 5% or 6% or 7%, you’re buying at $200,000 more than you could the year before. So if a house were selling for $200,000 or $300,000, it will now sell for $300,000 or $400,000. When the recovery happens, Michael, it will be strong and hard.

Things have pulled quite a bit; you’re looking still now for an improvement. We need to see that confidence come back; hopefully it’s going to start. We’ve seen a nice recovery in the stock market since last March. We need to see net income growth, which, essentially, what you’re saying is we need to see the economy start growing again.

As an investor – now I know you do this professionally – you’re involved in the home building yourself. For an investor, for somebody who thinks as you do right now – that there could be a good opportunity given the price decline. Given the fact that we may be starting to stabilize – what are some ideas, ways to go about it?

Adkins: If you’re going to be a real estate investor, you have a couple of options. The first one is actually physically buying real estate, buying a house.

Norman: Foreclosure?

Adkins: Sure; a thousand ways to do it. The other way, of course, is you can get involved in the stock market. If you’re afraid to be an industrial investor, and the reason why is because if you own a home … look any knucklehead can go out and buy a house; the hard part about making that house work is management. The advantage of going into the markets where they provide ETFs or whatever is you go into the market, somebody manages it for you. You sacrifice something, you have less control; the only control you have is to sell it, and, of course, if you bought it at 50 and it’s down to 30, you’re losing.

So that’s the downside of going through the market: You don’t have the control over it. You’re weighing these two things out, and for some people, they don’t want to get involved with calling the plumber or fixing the roof; it’s just a pain in the neck.

Norman: You don’t have to do that with a stock.

Adkins: Yeah.

Norman: What areas of the country … now, the ones that were hardest hit obviously were California, Miami, Las Vegas, Phoenix, these places. Are those the places you want to get back into?

Adkins: Not yet, no. I’ll tell you why. They were the first places to suffer, and there’s a huge inventory there. There are in some places they are thinking of, four, five years’ worth of inventory.

Norman: But aren't those places the real desirable places, don’t they have the demographics backing it up that’ll say, long term, that’s where the growth is going to stay?

Adkins: You need someone to rent that thing from you, unless you want to buy and let it sit there. You need someone to rent that thing to get some income coming in, and right now they’re just not there. There’s a market stabilization where there’s just about enough renters as there are houses available; that’s when you get back into the market in those places.

Now let me give you an example of a place to look at. I do a lot of investment in Texas; Texas is a spectacular state. You look for the following things: a state that has low taxes, a great growth environment, great business environment, and other factors that might increase its desirability. For instance, Washington, the Seattle area, is actually not that bad of a place to go; they have not been hit that hard. Why? Because imports are doing great; it’s still a place to buy. Also, when exports happen, all these exporting areas …

Norman: Exports have been doing great.

Adkins: Imports and exports, both. If you bring something in, it goes through Seattle, it goes through San Diego, and it goes through the ports of Houston. So you look at places where there’s a lot of commerce going in and out of the country, because regardless of what the country’s doing, whether imports are happening or exports are happening, either way, they’ve got to go through that port, and that’s where you want to do a lot of business.

So if you look at places like … anywhere there’s a decent port city, there’s typically a decent business environment, especially with Asia right now. So anything on the West Coast that has a decent business environment, I like it – take out California.

Norman: I think what tripped up a lot of people is this speculative fever. I’ve spoken about it here concerning other markets as well, like oil last year when it ran up to $150. How do you as a professional investor maintain a discipline when you stay away – when things are floppy, but you don’t plunge in … really become aggressive like now when things look very opportune?

Adkins: There are two things to consider when you’re an investor. One is when you see that overexcited, overexuberance in any kind of market whatsoever, you can understand when the peak’s going to come and when to get out, or, if you’re in it for the long term, you don’t worry about that. The other side is you have to worry about what government policies might do that completely obliterates any of these peaks-and-valleys investment strategies you’ve got, because the government could come in at any point and just screw everything all up.

Norman: But isn’t government on your side as a real estate investor? We’ve had 70, 80 years of history where real estate has been a favored asset class, and there’s been, either in the tax code or otherwise, support from the public sector, from the government, for home ownership.

Adkins: Yeah, when you buy real estate, there’s a couple of things to keep in mind. One is always take a look at your tax breaks and understand how they work. Make sure that a tax break that existed three years ago still exists today. For instance, during the savings and loan crisis, that was primarily created when the government changed the depreciation schedule from like 30-something percent down to 3 percent, and all these shopping malls that were worth $10 million are suddenly worth $2 million because depreciation wasn’t there anymore as something you compute into your valuation. So always make sure you understand all that stuff.

But when you look at buying real estate, there are a couple strategies: You can either go short term or long term. Some people buy houses, fix them up and sell them, make a profit that way; some people buy a house, wait for the market to peak out and try to play the market.

Norman: Isn’t it better to accumulate and just build a portfolio, hold on to it?

Adkins: The downside to buying real estate and holding it … and I’ll tell you, I do it and I believe in it. If you buy a house, don’t sell it, keep it. If you have a house and you want to go buy another house and sell your old house, don’t sell that house, keep that thing. Twenty, 30, 40 years later, it’s worth an incredible amount of money.

Norman: It’s like a great company with great quality stock, like any great asset.

Adkins: If today it’s worth $200,000, 30 years from now it’s going to be worth $400,000 or $500,000. Yeah, you’d be a fool to sell your real estate, plus the closing costs going in and out will kill you anyway, so you might as well hang on to the thing.

So what I tell people is, first of all, if you’re just a single person going out to buy a house yourself for the first time, always buy your second house first. Don’t buy that little house and sell it and buy a bigger house and sell it; you lose tons on commission, and the house that used to cost $300,000 now costs $700,000 seven years later. Why did you do that? You could have bought that. By the way, that’s why I jump on mortgages; they’re actually great things to use.

Norman: It’s this flipping mentality and I think it does people in.

Adkins: Michael, I’m not afraid of the flipping mentality. The flipping mentality is not what got us in this mess. What got in this mess was having all these people who are doing short-term adjustables who were not qualified to do short-term adjustables. There’s nothing wrong with adjustables; it’s like any other tool in your shed.

Norman: I think you hit on it on the first one. I think what got us into this mess is the notion – and I think it’s a false notion – that the Fed could somehow target inflation, and that we’re going to discover oil, what, if they put interest rates up to 5¼%.

Adkins: Michael, don’t forget, the people who got hurt the worst in this thing were not the rich people who were flipping, it was the poor people in the ‘hood who were trying to get their first house and the government said sure, just sign right here and we’ll give you any stinking thing you want; they’re the people who got crossed.

Norman: There you have it folks: real estate. There’s no hard asset any bigger than that and that’s what we’re all about here on This is Mike Norman signing off for now. Take care, have a good one.