Editor’s Note: Dennis Fassett is a former corporate finance executive turned real estate investing “Cash Flow Mercenary.” Dennis specializes in single-family and multi-family cash flow properties and thoroughly enjoys assisting his fellow investors with their own strategies, including how to buy your first apartment building.
As an ongoing contributor to Mogul’s “Market News Updates,” Mr. Fassett provides us with his own unique, lively, and thought-provoking commentary on the timely industry news and events of today that are impacting our industry. And be sure to check out his other super-helpful Market News Updates. For now, enjoy...
From Dennis Fassett, Cash Flow Mercenary...
As you know, I’m a big proponent of reading up on the economy to try to figure out what it’s doing, and by doing that, get some idea what may happen to real estate.
Lately, though, it’s been about as effective as reading tea leaves or consulting astrology. There doesn’t seem to be any consensus whatsoever about what’s happening.
I found a piece on theStreet.com though that did a decent job of laying out both sides of the issue.
I have a couple of issues with their analysis, though.
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They ignored the Fed’s threat of increasing interest rates at the end of the year.
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They ignored the worsening labor force participation rate, which means that more folks are opting for government “help.”
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They ignored the “contract economy,” where a large percentage of the jobs being offered are contract rather than permanent.
That being said, they did describe the situation perfectly in their opening statement:
“The state of the U.S. economy is almost Dickensian: It's the best of times and the worst of times. There are reasons to be bullish as well as reasons to be bearish.”
They offered 3 reasons to be bullish on the economy…
1. The housing market continues to recover, although at a moderate pace. Of particular note is the positive trend in home-construction permits. The number issued has grown year-over-year each month since May 2011, with the exception of a slight pullback in March of 2015. Housing stats followed a similar pattern.
Permits are a particularly useful metric because they point to likely future economic activity, since houses require lots of materials such as copper wire, lumber, concrete and glass, as well as appliances. Plus, you need labor to build everything. So when you see a permit issued, it tends to be good news for the economy. In general, the more permits the better.
2. For big business, getting a loan is easier. Banks reported having eased some loan terms, such as spreads and covenants, especially for larger firms. There was also stronger demand for such loans from some banks.
Why does this matter? Loans taken out by businesses are typically used to invest in capital and equipment. They only purchase such equipment when the managers feel optimistic about future economic activity. If they are taking out more loans, they are likely optimistic, and that's good news for the economy.
What they failed to mention in their analysis, though, is that debt is a big part of why we got into so much trouble back in 2007-08. So this is not necessarily a reason to be bullish.
3. The labor market continues to improve, and the outlook is good. The number of private companies intending to hire over the next 12 months is at a post-recession high, which bodes well for the nation's payroll increases overall.
The data has historically tracked well with what happens in the real economy. In this case, consistent hiring would push the economy into a so-called virtuous circle: New employees spend more, thus boosting the economy further so that more people get hired.
BUT, as I mentioned, a large percentage of the jobs aren’t permanent or salaried jobs. So while the trend may look the same at a high level, the details undermine the argument that the labor market is really improving. As an owner of a portfolio of rental houses, I’m seeing this more and more from applicants.
Then they discussed 3 factors that show signs that all is not well…
1. The Business Conditions Index, reported by the Philadelphia Fed, shows a slowing economy for most of 2015. The index is a real-time gauge of the economy, more timely than some other measures, like GDP growth, which can take weeks to produce.
Its read on the economy is echoed by The Economic Cycle Research Institute, which notes that the U.S. Economic Index has been declining all year. Slow growth isn't negative growth, but if you slow down enough, you can fall below zero, so it's worth watching closely.
2. The risk appetite of investors has declined dramatically. The amount that bond investors need to be paid to lend money to reasonably creditworthy corporate borrowers, versus what they'd be paid by the government, has increased a lot lately. It's known as the credit spread. For those investment-grade bonds rated BBB, the spread has steadily marched higher since mid-May this year, according to Merrill Lynch and the St. Louis Fed.
The credit spread was 1.8 percentage points in the spring, and now it's 2.2. Historically, wider spreads augur slower growth.
3. The manufacturing sector isn't doing well. The Philadelphia Fed's Business Outlook Survey, which examines the manufacturing sector near Philadelphia, dropped into negative territory recently. The latest reading for the New York Fed's Empire State survey spent a second month below zero as well, indicating contraction.
While manufacturing is typically much more cyclical than the services sector, there are two issues to be concerned about here: First is that supply chains for factories are often intertwined across the globe, so the slowdown in China may crimp manufacturing in the U.S. Second, a stronger dollar may crush sales for some manufacturers as it makes their products more expensive to foreign buyers.
The net worry is that the manufacturing sector pulls the rest of the economy into recession. What happens over the next few months will determine exactly whether the U.S. tilts to faster growth or falls back to a more anemic pace.
And here’s what I think is going on…
My takeaway is that there is still a ton of risk in the economy.
Two of the “positives” they state aren’t necessarily positive, and the “negatives” reflect how business is doing and what people are doing with their money. As such, the negatives, plus the impending interest rate increase, tip the scale to the negative, in my book.
The important thing to keep in mind, though, is that whether the economy is going up or down, there’s still a lot of money to be made in real estate. As investors, we need to be ready to pivot quickly when things change.
You don’t want to be the last one standing in the game.
So now it’s your turn…
I’d love to hear what you think about all this in the comments section below.