About two years ago, I had a training program for top-tier real estate professionals who wanted to make the leap into real estate syndication. These were A-level players who wanted to become A-level players in real estate syndication and real estate funds. I put together this video as part of our rapid implementation calls. It walks you through market analysis, discussing market cycles rather than individual markets themselves. I talk about some of the thought processes and what was happening at the macro level at that time.
You’ll see some of my predictions were completely true, while others didn’t come quite as true as I had thought. However, the information remains valid. What’s important here is not the specific information from that time, but the thought process that went into analyzing the market cycle and where we were in it.
When we’re making predictions about the future, which is what we’re doing in securities and when we put together an investment vehicle, we’re trying to predict what’s going to happen to create gains for our investors and ultimately for us as well. This video demonstrates how I think about what’s important when it comes to money and where we’re at in any sort of market cycle. I hope you’ll find it useful.
There are four stages in any market cycle. They can be drawn as a circle or linearly, but for our purposes, I’m going to draw it as a circle because that’s how I’m used to it. We have a market cycle with four distinct phases:
- Recovery
- Expansion
- Hyper Supply
- Recession
After the Great Recession, things were stable for a while at a low level, then slowly rebuilding up. This was the recovery phase. Then we went into the expansion stage, where it expands and expands until it can’t expand anymore. This leads to hyper supply, like blowing up a balloon too much. Finally, it starts going down, and we enter a recession.
I’m not using the technical definition of a recession here. By the technical definition (where GDP does not match inflation), we’ve probably been in a recession for a while. We’re in this weird sort of recessionary, expansionary phase right now.
During the expansion stage, rents rise and construction levels go up. We start getting high rent in a tight market. New construction takes place from the recovery phase all the way through to hyper supply because the cycle of building takes so long.
In the hyper supply period, we see positive rent growth but declining occupancy. During a recession, vacancy increases significantly and competition goes up. It becomes a tenants’ or buyers’ market, as opposed to the landlord’s or seller’s market in the expansion stage.
In the recovery phase, we have declining vacancy and no new construction. Rents stay fairly stable until vacancy drops to a level where there’s enough demand to charge higher rents.
This market cycle is currently on my mind because my wife and I recently decided not to move to North Carolina. We’re in this strange period where there’s definitely some recession going on, but also this weird kind of expansion. It’s a weird interaction point between the two, and that middle space is inflation.
If we look at the pure definition of recession (where GDP minus inflation is less than zero), we are in a recession. One of the main expenditures for most families, between 30% and 50% of their annual income, is housing. Right now, rents and new home prices are extremely high, as is the cost of goods.
Goods costs are really, really high. They’re way higher than they were before. Just a silly example: A candle – a very boring candle that was available last year, that I bought and liked, was $19. The same candle is now $29. Does that make sense?
On the cost of a new home – a home that is comparable to what we are looking at. Wood was going for $174 a square foot in March. This was when we were last in Raleigh. It sold in March for $174. Unfortunately, we weren’t the ones that bought it. Because it was a great house and we should have bought it. But that $174 in March is now completely shot. Now the market is over $350 a square foot. I mean, it’s doubled the cost.
Now, when you’ve got something that looks like a spike, you’ve got this arrow right here. So you’ve got this graph here and here you’ve got price per square foot, and you’re taking into account 2% rent growth annually. We’re taking into account 2%, nothing crazy. If you look at the trendline, it looks like boom. Now, does that make any sense at all? Or does that look like an unstable market? I would posit that it is so irrational that we have long since left this expansionary period. Even though we’ve got high rents still, we’re in that tight market. I think that this cannot last. That means that we’ve got this declining period coming really, really soon. Because there’s also this inflation that’s pulling everything down. There’s nothing that we mortals can do about it. Inflation is pulling everything down, and the bottom is going to fall out.
Now, why is it possible that this can happen? I don’t, as you have probably noticed, make political comments here. But I can make a political comment about both major parties. As a side note, when people ask me what my political affiliation is, I typically say whatever my client’s affiliation is. That’s typically my answer. So I keep that private and to myself.
But we’ve got the Fed, who clearly cannot be scoffing at the value of what inflation currently is. They are seeing – they’ve got excellent data sources – they see this inflation that’s happening in the country, and their mandate isn’t neutral unemployment. The United States neutral unemployment is not relevant to what the Fed is trying to do. The Fed’s only job, its mandate by how it was called out, was to have stable growth and decrease with minimal inflation.
Instead, what is the Fed doing? The Fed points out the fact that we’ve got this COVID situation that’s going on for some time. And so we really need to just keep pumping money and money and money into the system. I mean, the loan on our house right now is 3.5% on a 30-year fixed. A building that I know of that’s owned is now at a seven-year commercial building, seven years on it, and its rent is 3.75%, which is way below the cost of inflation. It’s below the value of inflation, and it’s below the predicted growth of our economy.
So yet, the Fed is encouraging banks to keep pumping money into the economy to keep this rent low, to keep these mortgages low, but it isn’t working because rents are sky high, because the money is low, so landlords drive them as high as they can. And then home prices are sky high. Because the Fed keeps pumping money into the system and keeping prices low, which is driving up inflation. It doesn’t make any sense where things are at.
So when we had originally thought, okay, perfect, we can go from a place that I would rather like to leave called California, where we’ve got what’s going to be fairly soon a 16% state income tax. And we’ve got a standard of living that is less than good. We can talk about that offline if anyone wants to. So we got a less than great standard of living, and we have earthquakes, all for what? And we have really high prices. Our price per square foot is somewhere around $750 a square foot right now in residential.
I’m sorry, this has turned into a discussion on residential real estate. But it’s what’s on my mind right now. And it all relates to exactly what you’re doing. Because you got to find opportunities. And if you don’t know why the market is, and aren’t paying attention to where the market is, it’s going to be difficult to find opportunities.
So we’ve got North Carolina here, which has about a 5% income tax, in some ways, a better standard of living. But we’ve got real estate here that’s two times where it was just six months ago. Versus here where it’s a ridiculous steal 10% where it was six months ago? Well, let’s think about what’s going to happen when the bottom falls out. This is a lot more stable, because our house really isn’t that much more. It’s not two times what we bought it for, at this point. And that’s over a period, we’ve lived in that house for about seven years today.
So in seven years, it’s gone up a fair amount. But in six months, this has gone up 2%. So the market kind of adjusts that the fair market value of California real estate right now. It’s not too far off. So if you look at it like whether it’s stable or not, it kind of looks like this. Not too top heavy. But if we look at Raleigh right now, it’s like this, it’s incredibly top heavy. And it just needs something to try and push that off.
So I just am so concerned if we were to move right now, that that market, what happens when it goes underwater? Say we bought this house at $350 a square foot and then the market corrects and let’s say it goes down to $250 a square foot, well, then we suddenly got this gap here that we’re underwater, not necessarily underwater in terms of the loan cost depending on how much we put down. But we just lost $100 a square foot, much bigger number in value.
So what to do? I think the only logical thing is hunker down, hold tight on this kind of real estate. So now where are the opportunities then given this? The opportunities are here, they’re in real estate that is going to hold its value. Still is good value, good properties out there, there’s properties below the replacement costs that are able to get, there are properties that have a fairly long trajectory that you’re planning out, they’re going to be fine. But if you’re planning on a quick flip, it’s just not going to hold.
The people who are flipping are already getting in trouble. Because the flippers are right here at the point where they’re paying the maximum number of dollars that they can pay for a unit. And their margins are so narrow right now, it’s just a little tiny switch. And suddenly, every one of them is losing money. I mean, a lot of them have been losing money anyway, we saw this dip that took place, actually, this year for flippers, where if you looked at time and margin, they were doing really, really good. And then it sunk. It just became terrible, terrible margins. And a lot of them went out of business and lost a lot of money.
And now it’s back up where the margins are back high, where they can do it. Actually, it’s not that high, because the other thing that drives the flipper market is their renovation costs. So their expenses have gone sky high, because not only are they having to buy into the property very high, but fortunately, growth is making it so it’ll still kind of work. But the value of the labor and the materials is just killing any sort of long-term prospect in that business.
So while I’m still hot on the markets that we talked about before – Atlanta, Phoenix, Seattle – I wouldn’t be going in for a short term. I’d be looking for something where its price per square foot is relatively low compared to the market, that is something that’s going to be desirable for a very long time. And that’s what I would be mostly focused on.
Let’s go ahead and turn a little bit to financial analysis. I could get on my soapbox about the state of the market right now and how frustrating it is. But I think you all know what that market is, so don’t let my procrastinations about the market dissuade you.
Again, there are great opportunities out there. It takes some work. I subscribe to a bunch of other syndicators and I’m watching every deal they do. I’m seeing deal after deal come out of these guys. So there are deals out there, and they’re not bad deals. I’ve looked at the numbers, and they all look pretty good. They look believable, and they’re not making outrageous claims.
There is great opportunity out there, plus you’ve got a huge amount of cash that still hasn’t been put back into the market yet. You’ve got cash sitting on both sides – in the form of people who tend to save a lot and have saved a ton, but also regular people have just saved a lot of money. We’ve also seen Wall Street putting in more and more money into buying out companies, which creates liquidity events for investors, which means they’ve got money to invest into your real estate.
So there’s plenty of opportunity right now. That said, would I want to put all of my eggs in one particular basket? No. But that’s why syndication is so great, because I can not only buy something in California and Raleigh, I can buy something in Ohio and Atlanta, and Charlotte and Texas and Florida and around. Colorado is a great market. I can put that money to use, which would be much, much smarter and better.
There’s tons of upside on syndication. There’s a lot of opportunity still to find great deals, and there’s going to always be opportunity. Because no matter what’s going on, I’m just talking right now about the big picture, the macrocosm of what’s going on in the economy. But really, real estate is a micro game. Every property is a little bit different. Some properties do really well all the time. Some do great in recession, some do great in big markets. It’s just finding the right thing, something that matches your fit, getting it done and syndicated.
So that’s how I look at a general market cycle and where we’re at at any given point. Again, this video is two years old, but the information is still valid and you can see a very methodical thought process.
If I can help you put together your syndication, whether it’s for real estate, for your business, private equity, anything like that, we’d be happy to help. My name is Tilden Moschetti. I focus exclusively on Regulation D, Rule 506b and 506c syndications. My name again is Tilden Moschetti of the Moschetti Syndication Law Group.