Bruce Norris is joined this week by Bill Armstrong. Bill was the 2013 Treasurer of the National Association of Realtors, the largest trade organization of its type with about 1 million agents who are involved in both residential and commercial real estate. Bill has been a broker for over 30 years and is vice president of Macintosh Realtors in Frederick, Maryland. He is also involved in fundraising and has raised over $300,000 for adults and children with disabilities. He is also a father of three.
Taking a look at how the future unfolds in 2014, Bruce asked if there was anything we thought was going to happen that has been a surprise that it hasn’t. Bill said he would not say there are many surprises out there. He knew we had a bit of inventory that had to be absorbed before you would start to see construction start to commence. The good news is in some markets we are experiencing that and seeing an uptick in new construction. In Bill’s market, in Washington D.C. and the Maryland suburbs, he has a project that has had sight plan approval for some time and they have not been able to get going on it due to people shrinking their operations and space. There are places where it is going good, but they still have some inventory. It is hard to kick off new construction when this is the case. In this case, we are specifically talking about commercial real estate.
Bruce said the residential mix in California was dominated five years ago by lender-owned properties. Afterwards, we shifted to lender-owned properties and short sales. Now we are dominated by 90% plus of normal sellers. This is a much healthier market. Bruce asked if commercial real estate went through this same process or if it somehow did things and did not have the REO domination we thought it would have. Bill said he does not know if we have experienced the REO domination that residential real estate did. There is more consideration, and he does not know if the underwriting standards were thrown out for commercial loans. Therefore, Bill said this has not really been the case. There are a lot of institutional monuments out there, so it has to go to work somewhere. The stock market has been healthy enough that nobody will be rushing into the commercial market. On the other hand, residential had been and remains a pretty viable option for folks since they have been so undervalued.
Bruce asked if a healthy stock market hurt real estate development, or does it add lots of money to where people start looking and spreading their money in other places. Bill said a healthy stock market is not necessarily creating jobs. Rather, it is a place where investors have some of their money, and you can’t put it all in one basket as we saw what happened. While it is a healthy market, it may take a little more impetus to get you to make a move towards some commercial investment. On the other hand, if it is not creating jobs and you are not selling the office space then more and more businesses are downsizing when they consider moving their operations. Therefore, we have to figure in where we are going.
Bruce asked what part uncertainty plays in commercial real estate’s decision. Bill said it plays a great deal since there are so many outstanding legislative issues that make investors nervous. This year is the expiration of TRIA, the Terrorism Reauthorization Insurance Act, and we have struck a deal to go forward with this. The Congress will go on recess, and we need to know that certain things are done. For example, with TRIA alone if you have some significant holdings, not necessarily in New York, LA, Chicago, or San Francisco, because it has happened in Oklahoma City as well. If something happens and a building goes down, if terrorism insurance is not available then the insurers are not going to provide for these properties. What follows is the lenders will not lend on these properties. You then have real problems. The government is the best equipped body entity to keep track of this. They were listening to the chatter, and it is just not something we can have private insurers deal with or the rates will go through the roof.
In the residential side, especially in California in 2012 and 2013, hedge funds were very significant with participants as buyers. Bruce asked if this has also happened in the commercial side, and in what segments. Bill said there are so many institutional buyers, and as properties became really a bargain and could not be duplicated anywhere near the asking prices, opportunities have come up. Now, multifamily pretty well corrected itself. Hotel vacancies are down, so we have more people using hotel rooms. Some of the REITs are doing very well. Industrial is an area where we have seen a slight uptick, as well as retail. Retail had been suffering, but all these markets are doing a little better. He is looking at across the board numbers, which has shown a slight uptick from the fourth quarter of 2013 to this year. Year-over-year it was a modest increase from 2012. It is going in the right direction, but slowly. This seems to be the case in almost every sector. It is getting mildly better, but not at a pace that has a very positive effect on the unemployment rate or employment.
Bruce asked what the thought was going into 2014 as far as employment. Bruce asked if we are where we thought we would be, and if that is good enough. Bill said there is still a lot of uncertainty out there. His daughter is in human resources in one of the biggest firms in New York, and they have 70% employees and 30% contract employees. They are transitioning towards 30% employees and 70% contract employees for a number of reasons. This is across the board with several companies, including Google, Twitter, and other big employers. The reason for that is everybody is necessarily on probation. A year later, they are up for an extension of their contract. If they get it, great. However, they do not have to comply with certain Affordable Care Act requirements. They can be let go without any problems, but it also creates a double-edged sword since these people do not have job security and cannot apply for and get a residential loan. This is because they have an annual contract, nothing more.
When someone tells him that the trend is that huge employers are transitioning away from full-time employee status, this is of great concern to him. Bruce said he does not know if everybody is familiar with the term “contract employment.” Somebody who is working for Google has a job, and their 70% is what we think of them as where they work. Bruce asked if the 30% are hired annually, or if it is by the job or demand like an independent contractor. Bill said it is like an independent contractor, and some of them make the transition to become a full-time employee. At the time they are like a probationary, but at this point they are transitioning away from this for a number of reasons. They have come about partially because of how the government has treated employers. They are trying to save a lot of money on things that would be overhead.
Now if people are self-employed and come to provide service only, then this is a very different ballgame. These young people right now are thrilled to land that job and hopeful that they get renewed and re-upped. We have issues with this, and there is a great deal of uncertainty here. Bill does not even know if we are going to change it since a lot of people have multiple part-time jobs. This is a result of government intervention.
Bruce said it is interesting that they have set up a game to where they have to get tight on lending, and at the same time they are going to make a job market less and less likely to provide the stability that gets a yes answer from a lender. A lot of people don’t realize the unintended consequences from their actions. Bruce said when he hears the unemployment rate, it sounds like we are really headed in a positive direction. There are all kinds of caveats in here, so people who have stopped looking have grown at the same rate as job creation. Bill said this number is something he would never believe in a million years. There are so many people who are not a part of this statistic any longer. It is discouraging when you start hearing statistics and feel you cannot buy them.
Bill said he thinks it has been under represented. If this were accurate, then why would we have every bit of available office space sitting empty. It is being absorbed slowly, but nothing new is really being built. There is a certain amount of growth that is inevitable and has to happen. They are also downsizing their space and going with more cubicles and telecommuting. However, Yahoo actually went the other way and don’t want to have people telecommuting. One way or another, they have some real property issues that are very telling when we are not filling up office space with these new jobs that are being reported.
Bruce also asked about the income when you are a full-time employee compared with when you are a contract employee. Bruce wondered if it is more when you are a contract employee. Bill said as a contract employee it is a pretty healthy number. This is the misnomer. It is a pretty significant number, and at the end of the day a full benefited employee does get more. Some people do not know the difference and do not know that they don’t have a 401k being created on their behalf and what the real value of what health care benefits are. If they are not getting them there, they may or may not be getting them still. If they do, some are still discouraged when they try to sign up.
Bruce said what is interesting to him is that there has really been no volatility of interest rates for a very long time since about 2009. When Bruce got into the business in 1981, the Fed fund rate changed 21 times that year. It has not changed in 5 or 6 years, yet there is very little confidence and you feel uncertain. Bruce said how this has played out in California is Riverside and San Bernardino Counties are bedroom counties to Orange County and LA and still have land. Normally construction drives the migration in the economy. They have the lowest interest rates, despite being at 4%, since they are lower than the 17% when he saw it in 1981. There are developers in Riverside and San Bernardino sitting on their hands creating 10% of sub divisions that they used to in any good year. We are sitting here because they are so uncertain about the rules of engagement for lending, and lenders are looking at the same rules and saying they are not sure if they will have to buy a loan back.
There are definitely things that are challenges on the residential side. A statement was made that they did not go as crazy on the commercial side as they did on the residential side, which is probably true. However, they did stated income loans in the sense that they projected income for the structure. This was where they were incorrect since this did not happen, and it is still vacant in California. It used to be you could have 50% preleased, or if you have great credit and history as a developer then somewhat less than this is a pre-leased portion for you to commence. Now you really have to have strong support in advance of any construction project. Something else that has happened is the cost of materials has gone up as well as the cost of transporting anything has gone up. The cost of everything has gone up except for income. Interest rates have stayed relatively low, but commercial loans are hard to come by. You have to show great equity and great leasing activity as well as having a good relationship with you lenders.
Another thing that is happening is you have a lot of people who have come out of the construction workforce, and this is why construction costs have gone up. It used to be that construction costs worked for a huge builder for a year or two, then all of a sudden they get their pickup truck and start their own construction company. Many of these kinds of businesses have gone away, and these people are either employed by someone else who let enough people go that they have not re-hired a lot of them. Bruce said one of the things he remembers is migration shifts in California.
We had some volatility where we lost a lot of people, and reports said there is a line of demarcation. If people are out of the state for longer than four years, they no longer think of California as their home. If you leave the construction industry because it is dead as a doornail over four years, there is a good chance you have found something else to do. You think you can call somebody back to work, but they are not coming back to work. Now you have a shortage to where you can’t do the volume or you can’t do it well enough for a while to where you cannot play catch up again. There has been quite a transition here.
Bruce asked about foreign investors. They had talked about hedge funds, but with residential real estate in California they literally have some wealthy people coming in from China. Bruce spoke with a group of Chinese investors, and their idea of a deal could be very different. If you look at the median price in Beijing, it is 24 times their gross income. You cannot land too many places in California where it is anywhere close to 10. They think it is a bargain. For example, if they go into an area of $800,000 houses, there may be a client who says he will buy them all. We are sitting here as Americans on our hands, and other people say America is still much more stable than their own country. Whether this is China, India, or Brazil, South Florida, for example, has been bought up a lot by Brazilians.
Bill said he was down there a year and a half to two years ago, and several investors were buying up South Florida. Bill asked them about other cities up and down the coast, and he found out their money is cheap and they still consider America much more stable. This is actually the scary thing because we know better. We have seen what happened when a lot of people lost a lot of money here. They have governments and regimes who go by the wayside and can lose a lot. For this reason they are still much more comfortable with our system. One thing that is a little uncomfortable is when you are relying on people from out of the country investing here to sustain whatever it is. Japan did this for a while in the 80s. They took money out of Japan and brought it here, but when their market crashed and stayed crashed for twenty years Japan as a big buyer disappeared as well.
One thing you have to be careful of is if one country has their domino fall, it will change the dynamic here. You can imagine what happened in other countries when our economy tanked. There was an awful lot of their money here, and we really impacted adversely a lot of people throughout the world. Bruce said he has been pretty stubborn on the next point regarding the demographic shift and what this generation is going to want to in the way of housing and jobs. Bruce has really fought the idea that they don’t mind not owning a home and want to stay flexible to where they can go wherever the jobs are. Bruce thought when you turn 30, this is not going to happen. Bill raised some points about the job market to where it may add to their vulnerability and they may want to pack up and go. There is something to be said for this, but on the other hand Bill has actually heard that what has happened residentially is people who were reluctant to get into the housing market were coming in, and it is not as bad as it seems. It might be that it was delayed a little, but there are a lot of people who still remember their parents, grandparents, and a home in which they grew up.
Just moving around is okay, but the other side of this is if you don’t own a home and you pay rent, you may pay a little bit less but it will keep going up. You move around or stay somewhere for a long time, it will go up and you will help somebody else own real property. You are going to look at them and envy them because they are the rich person who owns this building. If you do own a piece of real estate and maintain some advantage and incentive to become a property owner by interest deductions, then in the long term it is a great way for people to create some wealth and retirement they can lean on later. We are not a saving society anymore, so as long as this is happening we will see people still buying. It was the fish in a barrel thing that was going on with housing a few years ago when underwriting standards went by the wayside. This was a big problem, so hopefully this will correct. Bill said he sees so much value in owning his own home and owns a lot of properties.
Bruce said he looked into the future in about 2006 and wrote a report for California saying that prices could go down by half. However, he did not sell his residence because he realized why he owned his own house and did not want to ask anybody if he could do anything. This is how important homeownership is to him. When you do own a property versus renting, you are not going to finish the basement, build a deck, or do much of anything with it. The whole community is better and people are more involved because they care a little more. If it is not yours, you care a little bit less. For the person who is there, it is the reason more people own since they want those choices.
Bruce was married at 17, and when he was 20 he finally got to own his first house. He literally remembered mowing his grass for the first time that Saturday, and he really felt like a man. He had a grant deed to a property with no equity, but it was still his. This had an impact on Bruce, so they bought more and more. Their whole clientele buys houses, and they own 50 free and clear houses in California. This has been the path to wealth and has been a very gradual process. People buy and hold and pay it off. He still very much likes real estate as a ticket to wealth.
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