In this episode, Toby Mathis, Esq. of Anderson Business Advisors welcomes Neal Bawa back to the show for his third appearance. Neal is the founder and CEO of Grocapitus, a commercial real estate investment company, and CEO of MultifamilyU, an apartment investing education company.
Neal walks us through the realities we’re facing in the economy right now, discussing the Silicon Valley Bank failure, the Fed and interest rates, the bond and mortgage markets, and when and where to look for real estate bargains in the latter half of 2023.
- The Fed poisoned the banking system by flooding it with cheap money
- The bond problems are not the same as 2008
- Preventing bank runs that will domino other banks failing
- Reduction of bank liquidity reduces business activity
- Price stability and the banking system
- FDIC and the Fed dumping cash into banks
- Twitter creates bank runs in hours, not days
- Western states are down from peak in mid-2022
- One full percent cut in interest rates will start real estate price reductions
- Real estate sectors suffering post covid – offices, hotels
- Q3 is a good time to buy, with extensions
- The ‘spread’ and when mortgages might drop
- Big banks will get the deposits when smaller banks fail
- The next 6 months are a good time for bargains
Listen to Neal’s July 2020 appearance
Listen to Neal’s Oct 2022 “2023 Housing Market Forecast” appearance
Full Episode Transcript:
Toby: Hey, guys. Toby Mathis here with the Anderson Business Advisors Podcast. I have Neal Bawa on again, Neal, welcome back.... Read Full Transcript
Neal: Thanks for having me back on the podcast. We had such an incredible blast last time. People are still talking about the last time we did this podcast together, so I’m super excited to be back.
Toby: Yes, you had an absolutely great podcast here. It took off and lots and lots of eyeballs, over 100,000 people. So much of what we talked about was relevant then. Hopefully, people were able to utilize it and help themselves because we predicted what was going on. We didn’t predict the banking, but we did. I think we specifically talked about the Fed breaking things and what’s going to break first. Now we know.
The Fed broke the banking system, and then we’re going to gear up in focusing on real estate, whether your real estate’s safe. I really wanted to zero in on those topics. I’m going to hand this to you, Neal. I’m not going to poison you with my thoughts. What happened in your opinion? And what’s the long-term effect?
Neal: The honest answer is that the Fed poisoned the banking system. They did that by providing the banking system and the US consumer with such an extraordinary amount of money in late 2020, early 2021, all the way to the end of 2021 and into 2022. The flood of money meant that many people made wrong decisions.
Real estate, we see on the multifamily side, prices dropping because those people went and bought properties that were for $75 million, that were $45 million a year before. Why? Because they could do it, money was cheap. They could put in a higher amount of mortgage. They made those mistakes, and then we had banks. Banks were flooded with enormous amounts of deposits in the 2021-2022 timeframe.
Many banks, not all of them, luckily, but dozens, if not hundreds of them made the decisions to take that money and invest it into non liquid investments, for example, treasury bonds. You go in there, you take that money, hundreds of billions of dollars, and you buy treasury bonds. Those bonds don’t come due for a number of years, some of them for as much as 8–9 years from now.
The problem is after that, as the Fed started to raise interest, the Treasury rates also went up. The Treasury rates went up from 1%, to 2%, to 3%, to 4%. Today, when you buy a treasury bond, you’re getting 4% on a 10-year treasury bond, you’re getting 2½% on a two-year bond.
People want to buy those bonds. They don’t want to buy the bonds that the banks already bought, that they are holding. Technically, if the banks were forced to sell any of those bonds early, sell them well before they mature, then they will take a huge loss because the market doesn’t want to buy those bonds, so you have to discount them. We’ve ended up in this situation where the United States banking system now has over $600 billion of losses or potential losses on their balance sheets, that if they’re forced to get them off of their balance sheet, would be incredible losses.
Keep in mind, this is not like 2008. In 2008, when a bank gave you a loan on a 2000-square foot property, if you stop paying, the bank had to take the property back. Now the bank had to basically put that property on their balance sheet, so they had to go out and get an assessment of what that property was worth today. Maybe the loan was $500,000, but the property is only worth $300,000, but the bank immediately had to say, we’d lost $200,000.
With Treasury bonds, you don’t actually have to show any losses because there’s nothing wrong with the bond itself. There’s only a problem if you’re faced to sell early, which is why it’s very important for the Fed and the banking system now to control any kind of contagion, where people feel like their money is not safe, so they basically run towards a bank like First Republic and say, hey, we need to get all of our money out. If First Republic bought a bunch of those bonds, now it has to sell them immediately today to find people’s money, and that’s where the losses are.
This is one of those cases of there’s control. The Fed and the Treasury Department have to control negative buzz very closely. They don’t just have to do that for a matter of weeks. A lot of people are like, this could be over in two or three weeks if it calms down.
No, it’s just going to come up again because whenever there’s contagion or talk about the next bank, then the issue comes up again because now, that bank could still have losses. If that bank has to declare losses, that bank goes down, the Fed bails it out, now the cycle starts over again.
Now you have dozens or hundreds of banks that they need to figure out how to de-leverage, and it’s not an easy process to do that. I’ll have some speculation on that, but that’s what’s happening.
Normally, when there’s a run on a bank, one bank goes out of business, tough luck for the stockholders of that bank, the FDIC makes most people whole up to a $250,000 limit, and you move on. You can’t do that right now because that first bank tripping could lead to the next one tripping, which could lead to the next one tripping.
We are in a very unusual environment. It’s a very problematic environment, and the Fed has to figure out what to do. I believe that what the Fed is going to be forced to do—they don’t want to do it—is that they will be forced to cut interest rates much sooner than they had planned.
Toby: I’m with you 100% by the way. The way you laid that out is exactly how I understand it. If you’re sitting on a 10-year bond at 2% that you bought two years ago—so there’s eight years to mature—and nobody wants it because you can go out and get a 4% bond right now. Why would you get the 2%? There’s no market for it, but that’s what the bank has as an asset.
They could have done some hedging and they could have done something, but most of these folks were asleep at the wheel and they didn’t. You have somewhere around 200 banks or thereabouts that are susceptible. Really, it’s all banks because the banks, it’s not your money. You give it to them, they put it on their asset, and they put it on their balance sheet. People don’t realize that it’s not yours, it’s the bank’s.
You might be entitled to your deposit and hopefully you have some FDIC insurance, but they didn’t put an account that says, Neal Bawa, his money, and it’s earmarked. No, your money went in with everybody else’s. The banks are different from brokerage houses. I’ve done videos on custodial and all that, but that’s not what today is about. Today is, oh, Jiminy Christmas, this is what they did. What’s it going to do to real estate?
I think you’re right. I think the Fed is going to be forced to backtrack. They created this mess because they said inflation was transitory, ignoring the fact that they dumped an extra $4–$5 trillion into the market. It’s transitory. What, you’re going to pull that cash back out? Because otherwise, you just devalued everybody’s dollars. How are you going to fix this? They started raising interest rates, it seems crazy. What’s going to happen, Neal? What are we going to do?
Neal: I think the first piece of this is it will become obvious in the next 30-60 days, how much leverage and how much leeway the Fed has, and I’ll explain why. In 1987, there was an event like this, the savings and loan crisis. If you look at the 1997 events where in Asia there was a liquidity crisis. We call it the Asian currency crunch in seven or eight countries, and Asia went through that in 1997. Of course, we’ve learned from 2008 as well. What we find is that these kinds of events are self-fulfilling prophecies.
Think about one week ago or 10 days ago. There may have been a bunch of Fortune 500 CEOs that were like, the economy has created 800,000 jobs in the last two months. That’s a really awesome number. I’m going to keep investing. I’m going to keep hiring. I’m going to keep moving forward rather than pulling back. Now, none of those Fortune 500 CEOs are thinking that.
The events of the last 10 days are a self-fulfilling prophecy because they force all of those CEOs to say, you know what? I may not have funding available if I want to launch a new billion dollar factory or a $5 billion project. I might not have funding available. There could be significant liquidity issues in the marketplace because the banks have to step back.
I’ll explain why the banks have to step back at this point. They have to remove the liquidity from marketplace. Now, every CEO is aware of that because we were getting all this education from Goldman Sachs and Merrill Lynch saying, hey, we were saying that there was a 35% chance of a US recession in the second half of this year, now we’re saying it’s 45%. One Bank is saying it’s 50%, one saying 65%.
What the banks are saying is, because of what happened in the last week, the chances of a recession have increased because banks have to pull back, that reduces liquidity. When banks reduce liquidity, then that gives less options for businesses to grow. Now we’re moving towards a recession.
Guess what happens? When you start moving towards a recession, business activity reduces because there’s less liquidity available. By itself, that reduces inflation. In an odd way, the Fed has done something that’s really good for the Fed and really bad for the Fed. They’ve done something really good because now, finally, the Fed has broken something, and they’ve broken something very big. Not only have they broken it in the US, they’ve actually now got cascade effects with Credit Suisse being sold at a ridiculously discounted price to UBS.
The European bank that was weak and had similar problems didn’t even have direct problems. They weren’t buying US Treasuries, but they were buying European Union Treasuries. They were buying their treasuries, so the same situation that they were in. That bank has now been sold for a discounted price of $3 billion to a bigger competitor called UBS.
This is a contagion. It’s spreading. The European zone, their administrators are calling the Fed today saying, we need to calm down. We can’t keep raising interest rates at the same rate because what we’re doing is we’re actually actively increasing the amount of contagion in the market. We’re not just clamping down, we’re doing the exact reverse. We’re actually making it worse because with every quarter point that we raise, and every half point that we raise, the $600 billion that’s at risk becomes $650 billion, then becomes $750 billion, then becomes $800 billion.
Every time we raise interest rates, we’re increasing the amount of money that banks have to now write off of their balance sheets by doing a process called mark-to-market. From that perspective, the Fed did something good. They broke the market and because of that, inflation is going to come down. It’s going to slow down because every CEO is saying, I’m not going to move forward with my $1 billion or $10 billion project in this marketplace. We’ll just go defensive. That’s what the market was not doing.
The Fed was trying to get the market to move on to the defensive so our GDP growth would slow down to maybe half a percent or 1%. It’s still at 2%. Now, the Fed got what it wanted. On the downside, though, the Fed got what it wanted by hitting the one sector that the Fed cares about the most. It’s not real estate, it’s not stocks.
The sector that the Fed cares about the most is the banking system because the Fed has two mandates. Most people think the Fed has one mandate, that’s wrong. The Fed has two mandates. One of the mandates is well-known, price stability. They call it price stability, we call it inflation, same thing. Their primary mandate is the stability of the banking system. They always have to have the stability of the banking system first, and then price stability.
Now, because the banking system was completely stable in the last nine months that they were doing all this crazy stuff, they didn’t have to look at mandate number one. They were simply focused on mandate number two. Now the Fed is going to be forced to switch to mandate number one because the banking system is not going to be stable until they bring interest rates down. Luckily, they don’t have to bring them down to Covid levels or things like that. Right now, they’re at 4.75%. I think the system stabilizes when they get back to maybe 3%–3½%.
The speed at which they’re going to cut interest rates is likely to accelerate. Even though I’m expecting that later this week, when the Fed meets, they will still raise interest rates by a quarter point because they have to make sure that they’re not sending contradictory signals to the marketplace. But beyond that quarter point, I see it’s extremely, extremely difficult for the Fed to raise rates.
Toby: I look at this and I’m frustrated because I think that there was some supply chain stuff, but I really think it follows the M1 money supply. If you get a chart out and you look at the real estate, it’s almost identical. For me, pulling back, yeah, they raised interest rates. It didn’t seem to do what they thought was going to happen with real estate, though.
They seemed shocked that real estate wasn’t going into this downward spiral. Guys like me are like, well, it’s because there’s so much demand. There are 5–7 million units underbuilt. You still need supply, and you have excess demand, so I don’t care what you do to it.
If you’re starving, you’re going to find a way to get fed. That’s what they were doing in the real estate world, but this is because they dumped so much cash in. I thought, wow, they’re doing quantitative tightening. This is going to work. They’ll actually take some of that liquidity out. Even though they’re raising interest rates and trying to break things, I was hopeful.
Now I’m dashed because not only are they no longer tightening, but I think they went on a big old dumping spree. I think they just dumped a whole bunch more cash into the market, which is going to cause inflationary concerns. But the good news is, like you said, I think they broke the banking system because they killed their own bond market.
Neal: They did. Though, I have to say, I’m very curious. The FDIC basically pumped $143 billion into the market in the last 10 days, and the Fed pumped in $165 billion through the discount window, so the total is about $310 billion of brand new money. I’m very curious to see if any of this money is actually going to reach the market, because right now the banks are simply asking for money so that they have more liquidity. They’re not doing anything with it, they’re not buying anything. They’re borrowing to keep.
Obviously, you can’t do that for the long term because you’re not borrowing money for free, you’re borrowing it at interest. Right now, interest rates are high, so the Fed is giving you $143 billion. Now you need to pay at 4%, $6 or $7 billion of interest. The banks don’t want to keep that money for a long time. I’m curious to see, will they lend it out, or will they give it back?
Toby: It’s interesting because it’s not like they were losing money. When you have a 10-year bond, you’re going to get your money back. It’s not like the stock market’s work is just crashing you. It’s just today, nobody wants it. There’s no market for it. Since nobody wants it, it’s like when you were selling real estate during the Great Recession.
It wasn’t that your real estate wasn’t worth anything, it’s just that there was nobody that could buy it. Nobody wanted it because there was so much other stuff out there that was better, or they didn’t have access to it. They’re basically loaning on that bond. They’re saying, hey, you have a 2% coupon, we’ll loan it at 4%, so your loss is really that 2% for as long as you need to take it. Who knows how long they’ll need the loan for? But that’s a lot better than what they were doing. The Silicon Valley Bank, didn’t they sell a whole bunch of their bonds to JP Morgan and just get torpedoed on it?
Neal: They lost $2 billion that way because they needed liquidity, they needed their depositors. There was a run on the bank, their depositors wanted money, and they had 24 hours. They called the biggest bank in America, JP Morgan Chase. Chase says, we’re not buying these bonds at face value, we’re going to buy them at a discount, here’s our price. If you want it, we can give you that money immediately.
They took that money, gave it to depositors, didn’t help them because they still went out of business, but they basically took a $2 billion loss in a single day because of that. That’s where the Fed is going to be forced to act. I have absolutely zero belief that this is the last domino to fall because with so many banks having so many issues, it becomes much easier for there to be a bank run.
I want to talk about that, Toby, because we are in a weird environment, where Twitter can create bank runs within minutes. How did this happen? Silicon Valley Bank basically was the banker for everyone in Silicon Valley. I live here. I’ve had accounts with them before. Every dot-com, big and small, had accounts there.
There’s a granddaddy in Silicon Valley. His name is Peter Thiel. He’s part of the PayPal Mafia. He’s a big VC investor. What he did was he figured out that these people were at risk, and he didn’t tweet. He actually wrote a document, and he sent it out to his own investors and all of the startups that he was responding to. Obviously, five minutes later, that information was on Twitter.
It only took hours for billions to be withdrawn. That’s something that the Fed now fully understands. The Fed understands that a single tweet, which has its origin back to Peter Thiel, can completely destroy a bank. Silicon Valley was doing some really bad stuff. I think that sooner or later, they would have been sold at a discount price, maybe not a bank run, but they would have been sold at a discount price for the mistakes that they made.
We wouldn’t have had the third largest bank failure in US history if we didn’t have this tweet. Here’s the problem—the next one’s going to have a tweet, the one after that is going to have a tweet. Because of the existence of Twitter, the speed at which bank runs now happening is massive, so the Fed is going to be forced to take actions that they didn’t have to take 10 years ago, they didn’t have to take 20 years ago, because it still took many, many days for a bank run to form. Now it takes hours for a bank run to form.
The bank has basically one or two days at most. It’s extremely, extremely problematic in the next 12 months for the Fed to get us through this timeframe. Here’s what I’m going to predict is going to happen. They’re going to basically stabilize it, and then a bank will go under. When that second bank goes under, now there’s going to be a cascade and three, four, five, six are going to go out of business in a day, and then the Fed in the middle of all of this will actually cut interest rates on that day. They’ll be forced to cut interest rates by 50 or 100 basis points.
None of this is really good for the economy. None of this is really good for the banking system as well because they were making record profits. Keep in mind, maximum and making huge amounts of profit because interest rates were high. Bank of America is still only giving me a quarter of a point, but they’re able to buy a treasury bond at 2½%. The arbitrage was pretty massive, so bank profits were very high.
This is not good for the bank. I don’t see how the banking system survives the next 12–18 months for the Fed to gradually bring rates down. We’re now going to see aggressive step downs of rates every time one of these banks goes under.
Toby: I tend to agree with you. I look at it saying the Fed definitely brought this about by raising the interest rates so aggressively. I don’t think we’d ever seen this type of raising as quickly as they raise the interest rates.
Neal: This is absolutely the fastest in history.
Toby: This is why you don’t do that. Maybe the federal use this as a learning, like, hey, maybe we won’t overreact in the other direction too. Maybe we won’t do it like in 2008, where they just raced to the bottom, then they just stayed there forever, and you could get this free money. The banks were getting it at about 25 basis points, so basically free money.
You created that environment where if they hadn’t raised the interest rates, we’d be fine, but we’d have runaway inflation. Again, I still think it’s that they dumped so much cash into the economy that they could have done that first and then slowly raised interest rates, but who am I? I’m not an economist.
Here’s the most important thing, Neal. What’s this going to do to real estate? If we’re talking about lowering interest rates, correct me if I’m wrong, but that’s not a bad thing for real estate. That’s a good thing for real estate, right?
Neal: I’ll say it in a different way. I don’t completely agree and I’ll say why. I’m going to give you two scenarios. In scenario number one, Silicon Valley never happened. SVB didn’t fail. The world went on as usual. No subsequent bank failed either.
This is an alternate universe. We’re in the metaverse now. This is an alternate universe where SBB didn’t fail. I have 100% confidence that we would have seen significant reductions over the next 12 months in single family and multifamily prices, because I think that we were beginning to see discount prices in Western markets. Especially the five or six Western states that are hit the hardest, we were beginning to see significant discounts there. We haven’t seen much in the Midwest at all.
Toby: How much is a significant discount, though?
Neal: California is now at 11% from peak. For most markets, the peak was either May or June of 2022, so we’re seven or eight months from peak. Some markets peaked earlier, they peaked in April last year. But pretty much all of them peaked between April and June of last year, and now were on their way down.
The US has now lost 6% from its peak in about 8 months. Western markets have lost 11%, California being the highest, but other markets like Seattle as a market. But in general, Washington state, Oregon State, Utah, Nevada, and Arizona, are other states that have lost maybe 5%, 6%, 7%.
The question is, in this alternate universe, if SVB didn’t happen, what happens to real estate? My answer is, it goes down by another 5% or 6% nationwide. Certain markets, especially bubbly markets in the southeast, in the Sunbelt, go down by 10%. That’s what is going to happen.
To me, Silicon Valley going down is not necessarily that the price of real estate is going to go up. I don’t believe that. I would not say that on air, that the price of real estate is going to “recover.” We have a massive gain, and that gain is that 5%–10% decline that we would have seen in the next 12 months.
Now you’re unlikely to see that because what you’re going to notice in the next 60 days is that the market will start to absorb this data from the Fed about potential rate cuts in the second half of the year. Once everyone understands that, then people are like, let’s just hold off, let’s not sell our property because it may be possible that prices are going up. I don’t think they go up, but I don’t think they go down.
I think that’s a very, very big deal because 10% in the market would have been massive in terms of declines in real estate. I don’t think real estate starts to go back up until the Fed cuts interest rates by at least one full percent. You need it to be cut by one full percent for it to become more affordable, and then we have the ability for it to stabilize and start going up, hopefully not like 2021 because that was scary, and it just scared the hell out of me how quickly prices were going up. Hopefully, it rises in a more reasonable way, tracking inflation 4%–5% a year because inflation is not going to come back down to 2%. That’s what we’re likely to see.
Our big gain is that this hole that we were about to fall into, we’re unlikely to fall into. I don’t believe that you’re going to see real estate prices go up for single family or multifamily this year. I think you’re going to see prices go up for both sometime in 2024.
Toby: I think you’re right. I also think that the Fed may end up cutting interest rates significantly depending on how badly this thing snowballs before the end of the year. There are market predictions I think that we’re going to be at 3% at the end of the year, which is quite a bit different, I believe. It seems different than what they were saying before. I think we were looking at topping out at 4.75% or thereabouts, close to 5%.
Neal: 4.75%-5% is still the official dot plot. Every time the Fed meets, there are a bunch of people that get into a room. They give them a sheet. Each person, each fed governor says, this is where I think we are going to be in the next 12 months. They put their dots in, then they aggregate those dots together, and then they publish that information.
The feds official dot plot is that at the end of the year, we’ll be at 5%, the 4.75%–5%. Of course, that dot plot was before SVB collapsed. I’m curious to see what the Fed’s dot plot is later this week when the Fed meets again. I’m positive it’s going to be different.
Toby: Whatever it may be because I don’t like dating these types of videos and looking at it saying, hey, we can grab good information, apply at any timeline. But as we’re sitting here today, I think you’re right. I think it’s going to be lower, which just says for real estate. Again, that’s a very good thing for real estate if the affordability is better, if at the end of the year, we’re sitting at a much lower rate. Right now, it seems like rates have already accepted what the Fed has done, where it was going to be, and they started to go down anyway.
Neal: Yes, we’re beginning to see some decline. One of the key things that most people don’t understand is that the 30-year mortgage, which is what we use for single family, is simply tied to the Fed funds rate. It’s not direct. It’s very common for the Fed to raise the Fed funds rate and over the next 30 days, the 30-year fixed declines.
The Fed goes up by half a point, and the 30-year goes down by half a point. That’s pretty common because they’re trying to speculate. They’re trying to say, where do we think the Fed is going to be in the next 90 days, in the next 180 days? They come up with rates on the basis of that.
Today will be actually very interesting because last week, the mortgage markets simply didn’t know what to think. I believe that this week—this is the week that the Fed’s meeting in March—we’re going to see a marked-decline in the 30-year fixed rate for single family. It could go down as much as 0.5%, which is a huge swing in a week, an absolutely massive swing, especially given the fact that the Fed is actually likely to raise rates this week.
Toby: You’re not saying, hey, real estate is going to go boom. What you’re saying is it’s been going down at a trajectory and they might level off.
Neal: It might level off and have a chance of coming back in 2024. To me, real estate was going down simply because of the rates, no other reason. We see extraordinary demand in single family and multifamily, especially post Covid on the multifamily side, because the retail and hotel asset class did not do well during Covid. The office asset class is absolutely being slaughtered. I can’t think of any word, and I’m still sugarcoating when I say slaughtered.
Toby: It should continue to get beat up because all the five-year leases are expiring. I know so many people that run companies, their offices are empty, and they’re just waiting for the expiration of their lease. They’re just keeping a zombie office, and then they’re losing the space when it comes due.
Neal: Yup. I think that if there is going to be a real estate crisis, it may not occur this year, it might occur two years from now in the commercial space, when we get to the point where offices are at 80% occupancy because I think most properties can break even. I think that it’s extraordinarily likely that at some point over the next two or three years, we’ll hit under 80% occupancy. That’s for another podcast because we have time there.
The bottom line is, multifamily became much more powerful post-Covid when offices stopped doing well, hotels had their issues, and retail had their issues. There’s a lot of money sitting on the sidelines, and that money is smart money. They’re not investing. They’re simply saying, you know what? I’m not going to buy a property when interest rates are this high. That money is just sitting on the sidelines. I know a lot of single family people are sitting on the sidelines as well.
We’ve seen a very dramatic decline in investor purchases of single family rentals, somewhere around 77%–78% compared to 12 months ago. That money is sitting on the sidelines, they want to buy, but investors want cash flow. Right now, properties are not cash flowing, and that’s why they’re very slowly declining. We’re seeing about a half percent or 1% price decline per month because properties are not cash flowing. Now we might start to see that pickup again, but I still think we’re six months, seven months out from that.
Toby: So you’re telling an investor, keep your powder dry or keep available. Eventually, this thing’s going to turn around. Or are you saying, if you can, you’re still going to do great in real estate, but understand that it’s going to be over a longer time horizon, and there are no quick hits. We’re not going to get in and out of a project in the next year. These are going to be long-term projects. What do you tell them folks?
Neal: I am going to tell you, don’t buy until Q3 because I think that there’s a very good chance that you will still see a lower price by Q3. Before I was telling people, I think that the single family bottom is going to be Q1 or Q2 of next year, I think now I’m saying the bottom might be as quick as Q4 this year, so by one quarter before that because you never really time the bottom.
Whether it’s real estate or stock markets, timing the bottom is a foolish exercise. Nobody’s actually managed to do it. People think they’d time it, sometimes they’re just lucky. But I think Q3 would be a tremendous time to buy real estate because you can actually get a twofer, and I’m going to actually provide specific advice.
Q3 is a good time to buy real estate. But when you’re buying a single family home, get yourself lots of extensions, even if you have to pay up for those extensions. I think that as the Fed cuts prices, you can have a property in contract at Q3 values based on Q3 mortgage rates, then drag it along for three, four, or five months, and then actually lock in your rate based on Q1 rates, which are likely to be much lower than Q3.
Fundamentally, you created value by simply keeping the property in contract without actually purchasing it. With multifamily, I’m saying the same thing to people. I’m saying, get nine months worth of extensions, even if you have to pay for it. I want to keep dragging that multifamily property in contract for six, seven, eight, nine months as long as I possibly can because I’m actually making money by keeping the property in contract, and that’s a very rare scenario.
Toby: If you’re a seller, be aware that they’re going to try to drag you because obviously, you buy on cash flow. When you look at debt, debt is more expensive. You have less cash flow that’s coming to your bottom line. If that debt gets less expensive, there’s more cash flow, which means the value just went up. If you got nine months of getting dragged out by Neal there, you’re going to be kicking yourself when the value of your property is going up and you’re giving it to somebody, and now it’s a discount. I’m just teasing on that.
I see people that do get in that situation, where they’re forced to sell it. Somebody’s dragging them along. When the market is going down, it’s like, yeah, I would do it too. They’re looking for cheaper money. If it’s dropping every flipping month, if they can get you to delay two or three months, the value of their property just went up because you buy properties on cash flow. Just be aware. Be big boys and big girls, and be aware that these things are going on.
That’s obviously not just going to be Neal. That’s going to be anybody who’s looking at these things saying, hey, the Fed, especially like you said, the Fed governors, when they meet and they start estimating, if they and the markets are saying 3% end of the year—I believe it’s what they were doing today—if the Fed backs that up, then I think 100% that in Q3 and Q4, you’re going to have people that are looking at it the same way you’re looking at it saying, hey, the longer time that I can delay, the better off it is for me and my investors, so just be aware.
Neal: One item I wanted to add on there is something known as spread. I think very few investors understand this critical concept. If you look at what the Fed funds rate is today, it’s 4.75%, basically, roughly. 4.75%–5% is the range, but 4.75% is the discount window or close to the discount window.
The banks are actually getting the funds from the Fed, even slightly lower than that. You might say, why are mortgage rates at 6.7% or 6.8%? That’s a big number from the 4.75% swing to the 6.75% swing. That’s because, normally, banks will add on 1% or 1¼%. But right now, the banks are adding on 2%. They’re basically playing the worst case scenario.
The moment the Fed even says we’ve stopped, we are not going to raise rates further, that gap (called the spread) collapses. It collapses back to what it always has been. Without the Fed dropping rates, without the Fed doing anything to rates, if they simply indicate that they’re at a plateau, you should immediately see 30-year mortgages go down because now, no one’s using the worst case scenario. They can use the normal scenario.
Toby: That makes sense. What’s the normal amount?
Neal: Between 1¼% and 1½% is what we typically tend to see.
Toby: If what you’re saying is accurate, then you could see an immediate drop in mortgage rates by ½%–¾% just because the Fed raising interest rates. What if they did that this time?
Again, by the time this video goes out, they may have already met. It’d be fun just putting us in a time capsule, but what if they don’t raise interest rates? What if the Fed takes the drastic action of saying, whoa. We broke this. Maybe it’s a little bit worse than we thought. Again, I’ve seen anywhere from 180–200 banks being on the line of having just massive uninsured deposits and not being able to meet liquidity requirements. What does that look like?
Neal: I think it’s a bad idea, and I don’t think the Fed’s going to do it. Because if they do it, they’re going to reignite rallies in the stock market. If they reignite rallies, the inflation which is coming down fairly is lower than we like, but it’s coming down nicely, you’re going to reignite inflation. I think that is a very big risk for the Fed to take.
The Fed right now has to take risks. All of their decisions are very risky. But I think that if they take the decision of just holding, you’ll see a big, huge stock market rally. Everyone will be saying, oh, you know what? Rates are about to go down. No recession, blah-blah-blah. The moment we do that, inflation turns right back around and starts screaming upwards.
Toby: What do you think about the 2% mark where they’re saying, inflation should be at 2%? What do you think about this? Is that an arbitrary rule? Do you think that we could be okay at 4%, 6%, or something higher?
Neal: I think it’s very problematic, and I’ll explain why. The US government has $30 trillion of debt, but the Fed funds rate actually sets the standard, not just for the US, but for the world. The euro zone’s debt is higher than ours, so we have $30 trillion of debt there. The euro zone’s larger than the US, so they’ve got more than $30 trillion of debt. The Japanese have huge amounts of debts, so do the Chinese.
The world banking system is based on the Fed funds rate of their respective banks being around that 2.5%, which is where inflation tends to be. That is the Goldilocks zone because at that point of time, most governments can pay the interest on their debt. No one can pay debts back. There’s no way to pay most sovereign debt back. But I think that as long as people keep paying interest, then they can kick the can down the road.
Inflation is one of those things where you need just enough of it. Too much inflation is bad because think about it, the US government, $30 trillion. At some point, if the inflation is at 4%, and the Fed funds rate is at 4%, that’s $1.2 trillion of interest in a year. You’d have to cut Social Security to half, the Pentagon to half, and Medicare to half, to pay that.
I don’t think the world functions properly when the Fed funds rate is significantly above 2%. Eventually, they have to figure out how to bring it back down. Having said that, I think we can have a Fed funds rate at 2%–2.5%, and inflation closer to 3%. I don’t think that there is a possibility of inflation coming back to 2% for a very long time because of energy costs.
The world is running out of energy. We’re in an expensive one-time transition to electric vehicles and to basically everything being low carbon. That is an expensive transition. It’s very, very expensive, it costs tens of trillions of dollars, and makes the world economy less efficient as we go through that process. All of that is going to show up inflation.
Remember, if food is expensive, it’s energy. If transportation is expensive, it’s energy. Everything in our society is all based on oil. It’s all based on energy and the cost of that energy, including food.
I think you’re going to see inflation running hot in that 3%-plus range for developed economies and then running even hotter than that for China, India, and some of the developing world. I don’t think there’s any way to put the inflation genie completely back in the bottle. We’re going to have to live with it.
Toby: Yeah, I agree. Again, we could all play armchair cat quarterback on Monday morning or whatever they call that, Monday morning quarterback and say, oh, the Fed raised too fast and they overreacted. At the end of the day, it seems like a little patience might play out.
I think that what you’re telling folks is dead-on accurate. I never tell somebody not to be investing, so I know that in the multifamily, you’re probably dealing with bigger projects. I’d look and say, if something’s cash flowing and you get it for cash, I’m not a big debt guy. I’m so averse to debt. I hate debt.
I know that there’s a use for it, but I’ve never seen somebody get foreclosed on that didn’t have debt, so I tend to be on that side. I say, hey, you’ll still be buying. But for the most part, there’s been a lot of money on the sidelines. When the whistle goes off, or the green light gets played, boy, this thing’s going to take off again. What I’m saying is that you don’t want to miss that out.
Neal: I do have a tip for your viewers. I was speaking at a conference called the Best Ever Conference a couple of weeks ago. It was in Utah. One of the other speakers buys a lot of single family homes. Her name is Kathy Fettke. I think you know her well.
Toby: I know Kathy. She’s great.
Neal: Yeah. What Kathy was saying was very interesting. Because she does a lot of single family purchases, and I tend to buy large multifamilies, she has some data that I want to share with your users that I think is very beneficial. She said, this is an incredible time to be making cash buys. The market has gone down, so you’re paying less than you were 12 months ago. But the cash buyer market, she says it’s gone, where if there were 20 cash offers on a property, now there’s one.
The value of a cash purchase has dramatically increased, especially in the last three or four months. She says, you should be throwing all kinds of really stupid cash offers at people. If you throw enough of them, somebody will accept it, and now you’re getting the same price that people would have gotten four months, five months, six months down the line. You’re basically getting six months of additional cash flow, and you’re getting the price that you would have gotten at whatever the bottom might have been. This is a great time to be making cash offers.
Toby: Kathy is really, really smart, has been doing this a long time, and knows her stuff. I happen to agree with her. I’m going to say she’s really smart. I’m a dumb lawyer who does lots of tax stuff, but I’m an avid investor. I’m still looking at it going, when I buy cash, all I care about is cash flow.
Somebody could tell me all day long about this interest rate, that interest rate, but it means nothing to me other than my competition is getting aced out. I look at it saying, hey, I’m the only guy that some of these folks have given up offers to. We’ve been doing just fine, but then again, I’m a cash guy. I’m one of those dudes.
The big stuff, all that multifamily, I love it, Neal, but I’m smart enough to know that that’s not my lane. That’s why I go to guys like you. If you like crappy little houses that people love to live in, that’s my thing. I love little single family houses. I love it when I get tenants that have been in there for 10–20 years. I love those folks.
I’ll do anything I can for them, but I look at them as like, you’re my friend. It’s almost like they’re my employees. They’re paying me to be there. I’m going to look at it like, this is just the greatest thing ever. I’m going to do everything I can for them, and I love that area.
Kathy’s really, really bright. That’s real wealth. We’ve known those guys for years, they’re fantastic. Any parting comments, Neal? We’ve gone way over, but I always like talking to you. Twenty minutes becomes 40 minutes, becomes an hour.
Neal: This, in my mind, may be a great time to buy bank stocks. I’m not talking about something like First Republic, which is challenging, but I don’t understand at this point why the big five banks are at discount. They all made $20-plus billion in deposits in the last week. Chase got easily $40 billion. Bank of America said they got $18 billion. Wells Fargo said they got $17 billion. I’m sure Citi got their own chunk of money.
Their stock price has all gone down, but the deposits have all gone up by tens of billions of dollars. If you’re a too-big-to-fail bank, this is phenomenal news for you because as I said, I don’t believe this is the end. I believe another bank is going to fail a week from now and then another one.
Every time a bank fails, guess where the deposits go. They go to the too-big-to-fail banks. Every single time a bank fails over the next six months, the big banks are the ones that are going to be benefiting from this. It’s a tremendous time in my mind to get a huge discount off of the price from, let’s say, four weeks ago on one of the big banks.
Obviously, the big banks are not going to go out of business because if they do, then the entire economy is out of business. I’d say Citi, Chase, Wells Fargo, who else? I’m forgetting one of the big banks. Basically the big four banks, this may be a great time to buy their stock.
Toby: I agree with you, and people liked them before this was going on at a higher price, and now they’re on sale. You have to channel your inner Warren Buffett. You got to be greedy when everybody else is fearful. It is a little bit freaky to stick yourself out there, but do your homework. I look at it the same way.
I remember when the casinos are all getting beat down here and everybody’s like, oh my gosh. It’s during the recession. It’s just a matter of time. They print money. They’re money-making machines.
You might want to go buy some of those real cheap and you’re like, is it really this cheap? There must be something wrong with it. Nobody else wants it, so why do I want it? You might want to be doing that with some of your bank stocks, I think is what you’re saying. I tend to think that’s wise as well.
All right, anything else or are we good, Neal?
Neal: I just want to say, this is actually a good time to be that Warren Buffett person. Bargain time is coming up in the next six months. Be very active. Be reading a lot of news because normally, news really doesn’t have as much value as being attached to it. But right now, I keep Barron’s, MarketWatch, and Wall Street Journal, continuously open.
I’m one of those people that, firstly, don’t have any social media apps. I don’t connect with social media. I’m not on Twitter. But right now, I’m paying attention because I think the opportunity to make money right now is significantly greater than it normally is.
Toby: I agree with you. If somebody wants to follow you, speaking of, how do they get a hold of you?
Neal: It’s easy. Actually, I’m the only Neil Bawa on the World Wide Web. Simply type in Neal Bawa and hit enter. We do offer about 20 data-driven webinars on our website, multifamilyu.com. Last year, we had 26,000 people register for our webinars. As you can imagine, there’s a webinar about the banking system coming up in a few days here, so check out multifamilyu.com.
Toby: Perfect. We’ll send them your way. We’ll put you in the show notes. We’ll make sure that anybody can find you real easy. You’re always a fantastic guest to have on. Thanks again, Neal. We’ll have you again.
We’ll continue to watch what’s going on. I’m sure that there’ll be some more breaking that the Fed causes. We’ll get on and see what the opportunities are, but it certainly sounds like. For those that have the backbone and the skill, this is a great opportunity.
Neal: Sounds good. Thanks for having me on again.