Dec 9, 2022
Brian Beaulieu is the CEO and Chief Economist of ITR Economics and the Returning Guest from the Episode 67
In this episode we talked about:
Useful links:
https://www.linkedin.com/in/brian-beaulieu-28481977/
https://workingcapitalpodcast.com/real-estate-inflation-and-government-policy-with-economist-brian-beaulieu-ep67/ - episode 67
Transcription:
Jesse (0s): Welcome to the Working Capital Real Estate Podcast. My name's Jessica Galley, and on this show we discuss all things real estate with investors and experts in a variety of industries that impact real estate. Whether you're looking at your first investment or raising your first fund, join me and let's build that portfolio one square foot at a time. Ladies and gentlemen, my name's Jess for Galley, and you're listening to Working Capital, the Real Estate Podcast. I have a returning guest, Brian Bolio. Brian is the c e o and chief economist of it, t r Economics.
He's also a returning guest from episode number 67. If you want to go check that out. Brian, how you doing today?
Brian (39s): I'm doing well, Jess. How are you
Jesse (40s): Doing? I'm doing great. Always good when I get to talk to a, get a talk real estate with an economist. So nothing's happened since we last spoke episode 67, so I'm thinking about a year and a probably about over, just over a year ago.
Brian (54s): Yeah, nothing's happened since then. You're absolutely right. Oh man. Yeah, long it's been, it's been, I don't know, life still isn't back to normal since the pandemic. We're going through all these covid echoes, this is what I call them. I mean, the, the inflation is a covid echo because it stems from the government's and federal reserve's response to the pandemic. And now we have higher interest rates as an echo because that's stemming from the inflation that stemmed from the pandemic. And those two factors are having other echoes, including through the real estate market.
I mean, we're gonna, we're still years away from being back into normal economics in, in my opinion, and that includes the current yield curve and the extreme extremeness of the yield curve, which can lay directly at the feet of the Federal Reserve. And that isn't going to do any of us any good either. So we're still living with the economic after effects of covid, even though we're running around without masks anymore. We we're bearing the scarves, the economic scarves.
Jesse (1m 58s): And how, if you were to grade the, if the fiscal policy, let's, let's focus on the US for now. How would you grade that? Fiscal re policy response and continued response to the economic environment that we're currently in?
Brian (2m 13s): I graded as C is fairly average, and that with each successive economic crisis, the fiscal policy response has grown disproportionately large at the point now where when we see a fly on the windshield, we don't even think about it. We just grab a sledgehammer to kill the thing. You know, there's no measured response anymore, it seems, and you know, it's, and it just occurred to me, it seems to be in direct response to the divisiveness of the two political extremes.
They seem to wanna do outdo each other in terms of, you know, bringing in favor and votes and getting reelected at ever extreme levels. It's very disturbing.
Jesse (3m 0s): So do you see on the monetary side, so we're, you know, since we last spoke, even we've, we've gone up on interest rates a number of times continued, you know, if anybody had construction loans or anybody was doing any variable type of debt, they definitely felt it over the last year. Did you, you know, playing Monday morning quarterback, your view of the interest rate increases, did they overdo it? Was it just enough? Not enough.
Brian (3m 25s): Oh, they get an F The Federal reserve gets an F They were too slow to start to push those interest rates up, and now they're going way too high. They've created this inverse yield curve, you know, it's, it's Federal Reserve 1 0 1. The Federal Reserve is supposed to be looking into long gone, taking some clues from that. And, and Chairman Powell in this Federal Reserve, they seem to be off the reservation. I don't know if I can even say that anymore. You probably have to edit that up.
They seem to be no longer playing by the playbook that we all have known through prior cycles. And they've, they're by now, they should have been saying not we're gonna increase rates by a smaller amount. They should have said, we're stopping because Disinflation is here, and let's see how far down it's going to come without us ruining the economy. And they should have come to their realization three or four months ago.
And they, and they failed to. And hence we're in this inverse yield curve situation, which is not pleasant. I just went through and looked at for all of our December client accounts, the, the data will be touching their company data. 43% of our clients in December will be able to tell 'em that they are not interest rate sensitive. The inverse yield curve is not gonna be adversely impacting them, but for all the others, they're clearly at risk because of the interest rate trends that have been forced upon us.
Really get, getting back to your, to your really, your concern. It, it is, you know, the unaffordability of the single-family houses now, it's not the fact that housing prices went up so much during covid because the market's already correcting for that, that, you know, we're seeing those bar markets and key measurable areas coming down. It's what I call the Peloton effect. You know, everybody going up, everybody's in quotes, I got a Peloton because you were stuck at home. Demand was screwy relative to supply, prices went up.
Now the Pelotons sitting in the closet after being used for all the six or eight weeks, something like that, prices in those key metro areas are coming down, but the rates aren't going to come down enough to offset the damage that has been done. And the builders at the same time, at least the ones that I've been talking to, are saying, look, I don't, I don't need to be pulling all these permits. I'm not gonna hold the land. I'm not gonna gonna pay those co carrying costs. I, I'm, my backlog's good for 23. So, you know, I'll think about pulling those permits further on down the line.
When I'm, when I'm back out there, I'm constantly telling people when they, not strangers, but when they ask me, this isn't 2006, 7, 8, 9 again though, because the homeowners out there actually qualified for their mortgages and this go round, homeowner vacancy rates are, are very, very low. And the consumer is in really good shape financially speaking, despite what the headlines may be saying, when you look at loan delinquencies, whether it's auto or housing, you look at on the corporate side of the street, businesses are still in reasonably good financial shape.
Very, very different scenario than what we saw in 2006, 2007 in particular. So we're not, the paradigm I think that we should be looking at is more like 2000, 2001 or 19 90, 91. And Jess, I, I mean you may have read about the early 1990s, but
Jesse (7m 8s): Survived till 95.
Brian (7m 12s): Well,
Jesse (7m 13s): Y I mean that, so that, that's a great point. So interest rates have gone kind of crazy compared to the last 10 years. Inflation is where it's at. But you know, for those that do remember oh eight, and you know, prior to my time 1991, you're saying that the paradigm we should be looking through is the early nineties or the.com era. What, why is that? Why, why is that paradigm make more sense than say oh eight?
Brian (7m 39s): At least for the real estate market? It makes more sense because of the inventory levels, buyer qualifications. I even remember in, in 1987, we had another, another housing crisis. And through that period, and again, it was people who were way over extended and you could see it in their balance sheets. And we're not seeing that in consumer's balance sheets today, real incomes are going up that by real, I mean after adjusting for inflation, which is incredibly important because that means our incomes are still rising.
It will match these market levels eventually, it's just take some time to readjust the market. But what I've been doing is, and it's for housing for our clients, for just about anything that I can trend, I actually look to see the deviation upside deviation from the long term trend. And that helps me identify the Peloton effect and housing clearly experienced the Peloton effect. So we have to go through this, I think it's going to be two to three more quarters of lackluster single family market activity before it starts to turn around.
And we start that recovery process. Then we run the risk of that getting short circuited that recovery process, getting short circuited in 2024 because of the inverse yield curve. So it, it's the intermediate outlook with, and we, for me that includes 2024, doesn't look all that great for single family housing units. Now, multi-family to me looks fantastic because you're looking at affordability problem for single family homes, and we're still looking at low vacancy levels for those multi-family homes.
And the affordability quotient is gonna work there where it doesn't work on the single family home. So they're both residential market, right. But one's gonna be much more resilient to these economic circumstances than the other is. And since the last time we talked, Jess, the I've, I did this analysis and it was fascinating to me. Single family new homes, those prices experienced quite a bit of beta on the way up and on the way down.
Whereas the multi-family is very resistant to decline in price. The, those prices went down in 2008, the great recession of that through that period. But in other recessions, they just flattened out. They don't really go down and they become a much better store of value. If you want, you know, you'll strike it rich if you strike the single family market correctly. But if you wanna play the long game, then you've better off in the multi-family market.
And I correlated multi-family home pricing to existing to stock market. It's oblivious to the stock market. I correlated it to the general business cycle. G or US industrial production has not correlated to that either. In other words, it's a wonderfully safe place to be for the next 10 years with all this craziness going on around us.
Jesse (10m 59s): So Brian, you know that I'm a student of economics, but I only play a smart guy on TV here. So if you could educate us on you, we see, we see good job numbers, I see all the anti data, we look at, we see businesses hiring. We see that there isn't a credit crisis like there was a oh eight, but we still look around and there's this, there's this talk of recession in the next year, the next two years. What is the driver for the layperson of, of that outlook of that outlook into, into the next year or two?
Brian (11m 33s): Well, the first driver is that's what the headlines are screaming at us day after day after day. So it becomes part of our emotional makeup when you hear that sort of thing. And it, because some sectors, like we've seen the housing market pricing come down, we, we know household furniture is doing poorly. We know that home exercise equipment's doing poorly. All those peloton factors, it's not hard to spot them.
30% of the customers, the, our client data that I looked at for December had some peloton effects. So they're feeling this air underneath them after they're running so hard in 21 and 22. So that impacts the thinking also. But it, you have to separate the 30% from the other 70% that aren't feeling that. And that's what keeps it from being the great recession redux. Hmm.
Jesse (12m 32s): So if, if from the practical standpoint for investors or even homeowners that are getting into real estate or recently purchased real estate where interest rates are where they are, what, what is the conventional wisdom's suggestion or, or advice in terms of longer term fixed rates versus shorter term, you know, refinance in a couple years? Is, are you seeing, are you seeing a trend in one way or the other
Brian (12m 58s): When it comes to those long term rates? My preference would, and what I would personally do is go fixed either for seven or 10 years, get a fixed rate. They may come down some, and I know the, the street is loading in some assumptions about interest rate decline. I wouldn't bet on that we're not gonna see an inflation correct as much as we have in the past, and therefore we're not likely to see the interest rates back down as much as we have in the past.
And while waiting home home prices two, three years from now could very well be up considerably from where they are today. So you'll pay about the same rate mortgage for a higher priced home. So if you like it both the trigger now,
Jesse (13m 44s): So we're also seeing rental prices in most of the major, major markets that we're in go up quite substantially. And you know, the idea of, of real estate investing for us has always been this idea where you can pass on some of that inflation to your customers or renters. Do, do you see a correlation between the, the valuation of where homes are now start starting to get priced in, I guess quotations properly and the, the rate that we're able to increase rents?
Because what I've noticed is that the, especially multi-family, most of the, the people in our market here in Toronto, and I was just in New York this week, you know, they are very, very sensitive to dropping any valuation because they've seen their prices, you know, at a certain high. So I, I feel like there's a bit of a lag there, but on at the same time we're seeing intra, we're seeing rental increases that we've, we haven't been able to get in years over the last year or two. So what do you make of that, the interplay there between valuation and the recent ability to increase rent quite substantially?
Brian (14m 53s): Well, you gonna help me out here a little bit? The valuation of which asset? Single family or multi-family?
Jesse (14m 59s): Yeah, so in this case I'm thinking more on the commercial end, but we can choose multi-family as, as that commercial asset.
Brian (15m 6s): Okay. Because co commercial to me is a very broad bucket.
Jesse (15m 11s): Yeah, yeah. I mean the commercial multi-family as in five units are greater. So apartment buildings,
Brian (15m 17s): Yeah, it becomes a positive feedback loop in that the external single family competition is difficult to afford, which means you can raise rates and because you can raise rates and because of the historical tendency for those valuations to be sticky in that particular market becomes even more valuable. But there is that lag obviously between the cause and the effect.
But I think that's a trend that we are going to see go on in a positive way from an investment standpoint in a positive way through the rest of this decade and maybe a couple years into the 2030s. So this is just the beginning of that ride from our perspective.
Jesse (16m 7s): So in the business cycle, where do you see us in, you know, are we, are we headed towards the trough? Are we, are we in it? Yeah,
Brian (16m 18s): We're not in it yet. Not from a macroeconomic perspective. You know, you're in Toronto, so the circumstances are somewhat different because the US dollar is so strong right now that it is distorting the economics between north and south of that border.
Jesse (16m 42s): Yeah, I did, I did a crazy thing last year. I bought, I bought my first US property pre-construction, so I got hit with the interest rate increases and I got hit with the dollar. I was like, what could happen in a year? Turns out a lot.
Brian (17m 1s): Yeah. Sometimes you just get lucky, sometimes you guess just get unlucky. That's the way it works.
Jesse (17m 7s): Yeah, yeah. It's, it's, there was a Danny Kahneman and Traversy where it's, it's that loss aversion, right? I'll remember about this one, but you know, 10 years ago when I hit it out of the park, I won't remember that. So you have to think, it kind of evens out in the end, you know, we're in it for the long haul in real estate.
Brian (17m 24s): Oh yeah. You absolutely have to be. Which state did you buy in, in the
Jesse (17m 29s): States? So I bought in Orlando a townhouse.
Brian (17m 32s): Oh
Jesse (17m 33s): Yeah. But what I still amazing, or what was amazing to me was that the, the actual yield, you know, was a 9% yield and like cap rates in Toronto at the time, even now they're starting to come up. But three 4% was like your typical cap rate in Toronto. So even with the interest rate increases as a foreign national, the lowest I was gonna be able to get was in the low fours. It turned out to be somewhere in the sevens. I didn't even wanna, I don't even wanna think about it now, but the, you know, the, the good headline or the, you know, the thing that you know, was the silver lining I guess I should say was the fact that it still was gonna coverage in cash flow, which most of our major markets and in us major markets, finding cash flow is, is not the easiest thing to do.
And some of the, you know,
Brian (18m 23s): Oh yeah, absolutely. You know, and thanks for telling me the specific market. I mean, you're not gonna go wrong in that market. You played the long game. I know you do. And you're gonna be smiling at and patting yourself on the back down the road. So,
Jesse (18m 39s): So Brian, for listeners that, I don't know if they've, if they haven't listened to the previous episode, they, you know, your background as an economist, what does this look like from kind of an economics 1 0 1 standpoint of how we go into the next phase of the business cycle and then what are the clues or indicators that show that we're coming out of a, out of a cycle and maybe even using a historical perspective to kind of outline it?
Brian (19m 6s): Well, the big glaring clue right now is that we've had an inverse yield curve in the states sustained for two consecutive months. And that's statistically significant. And that means we are definitely heading toward turbulent waters compared to what we've been going through over the last couple of years with more downside pressures and more weaknesses. Fortunately though, as I mentioned before, the consumer is not in bad shape and as you mentioned, the job situation is still 10.6 million unfilled jobs in the United States.
So those argue, well for this not turning into a, a significant or appreciably bad difficult downturn, but we're going be peeling that downside pressure into deep into 2024. How are we gonna know when we're coming out on the other side of it, our leading indicators will begin to go up and they are not close to doing that right now. We'll also know, because I, I expect the stock market is gonna be leading the way out of this also. I'm not at all confidence. The market isn't gonna show us some more downside before it finally reaches Its slow.
We'll know that we're, we're near and low because it's been at least three quarters since the Federal Reserve has stopped raising interest rates. That'll be a good sign. That's a rear view leading indicator, if you will. But we'll pick that up through corporate bond prices. When the bond prices start moving in the right direction, that'll be a good sign that we're coming out of the hole. There's some things though that can, that can well can hurt more than they can help.
China's still a mess. China's going backwards. Their current political regime is taking them back into the eighties in terms of the politics and that isn't healthy. And they are the world's second largest economy. Now the good thing for the US not so much Canada, is that we do more trade with Europe now than we do with China. So they we're not as tied to them. But for Chi Canada, China is still very, very important, particularly from a raw material standpoint.
And they're not looking very healthy right now. So there's this, there's that underlying weakness that has to be factored in. And then we have the Russian invasion of Ukraine and all of those ripple effects all occurring at a wrong time in terms of trying to come up with a, a positive outlook for the, for the economy as a whole. It, it's difficult to contrive one. And that's when I, and I tell my audiences, look, remember this serenity prayer, okay, you and I aren't going to change the interest rate environment.
You and I aren't going to change these macroeconomic forces, but you and I can decide what assets we are going to invest in, where we're going to invest in them. We can control all the microeconomic variables. And if you do that well enough, then those macro things aren't going to hurt you in the long run. They're just going to really, why did I do that in the short run? But in the long run, you know, they, those macro variables swing around and because you made the right micro variable calls, they're a very happy camper.
Jesse (22m 25s): There you go. So manage the, manage the manageables.
Brian (22m 30s): Exactly.
Jesse (22m 30s): Perfect.
Brian (22m 31s): Well, and I'm gonna say stop reading the newspaper. This is why we invented sports so you don't have to read the
Jesse (22m 37s): News. That's, that's exactly what I was gonna say. Be mindful of the time here. But that was, you know, this aspect of in economics where it's expected, you know, expected inflation, expect a lot of this, you know, does rely on what the, what the sentiment is out there in the economy. So in terms of where we go from here, I guess that's probably a good suggestion to, you know, consume, consume less, less news. Cuz the headlines are usually dire. But yeah,
Brian (23m 7s): I think there's a correlation between news consumption and drinking and they're positively correlated, so
Jesse (23m 13s): Yeah. Yeah, it's weird. You go to the gym and you see CNN on and it's like, why, why is this on in the gym? Throw a ballgame on or something.
Brian (23m 19s): Yeah, exactly.
Jesse (23m 20s): Okay. Well Brian, you were, you mentioned prior to the show that you, you have a speaking event coming up.
Brian (23m 26s): Alan and I are doing an i T R webinar on December 15th. It is on inflation interest rates and the US dollar, and if people go to our website, itr economics.com, they can see it advertised there, if you will, and they can lo sign up to be part of the, the audience.
Jesse (23m 49s): Perfect. And for those that wanna reach out is the, the website ITR is itr economics.com com Okay. We'll put a link in the show notes. Okay, Brian, well I appreciate you coming back on the show. If anybody wants to connect with the you, I'll, we'll put some notes in the, put some links in the show notes. But thanks for being part of Working Capital. Thank you so much for listening to Working Capital, the Real Estate podcast. I'm your host, Jesse for Galley. If you like the episode, head on to iTunes and leave us a five star review and share on social media.
It really helps us out. If you have any questions, feel free to reach out to me on Instagram. Jesse for galley, F R A G A L E. Have a good one. Take care.