Interview with Blanche Evans of Realty Times

We've predicted a 15 year correction in real estate in the U.S.  Blanche Evans sees a downturn, too, but not severe because of government supports and protections. 

May 18, 2006

Blanche EvansToday, iTulip.com’s President Eric Janszen interviews Real Estate market expert Blanche Evans, award-winning editor of Realty Times, the Internet's largest independent real estate news service.  Known for her keen insight on real estate industry issues, Blanche is the author of two best-selling real estate books: The Hottest e-Careers In Real Estate, an Internet marketing primer for real estate professionals, and Homesurfing.Net: The Insider's Guide To Buying And Selling Your Home Using The Internet, a comprehensive home buying and selling guide.  You may have seen Blanche’s expert opinions on CNN and in The Wall Street Journal and The Associated Press.  In 2006, Blanche will have three new books published, including Housing Bubbles, Booms and Busts, due to be published in mid-August by McGraw-Hill.

Janszen: Blanche, good to speak with you again. Last time we talked, you were writing a series for Realty Times called "The Perfect Real Estate Storm" in mid 2004.  The series begins: "Rising consumer debt, rising interest rates, inflation, low job and wage growth and many other factors are swirling together to form a housing slowdown. But there a few other factors that are adding to the winds that could create the perfect storm - the largest housing recession in modern history."

Do you still think we're headed into the largest housing recession in modern history?

Evans: We've encouraged nearly 70 percent of Americans to become homeowners, and many own multiple homes. Four out of ten buyers last year bought a second home. Yet these homeowners are highly leveraged compared to other generations. Lending rules have relaxed to accommodate rising prices, and that's dangerous for buyers who aren't good with their money, which most of us aren't. However, if they don't get in, even with a risky loan, they won't have their piece of the American dream. In California, many people are paying over 50 percent of their income to live there. That would have been unheard of 20 years ago.

Some areas of the country are already correcting. This will hurt owners with the least equity, but it shouldn't rock homeowners who want to stay where they are. That's why I'm not sure that the economic principal of reverting to the mean always holds true with real estate because of the desirability component. Each state, city, neighborhood and property is unique. Who's to say that your seaside or fairway-view home doesn't create its own mean?

Lack of affordability in the hottest markets is causing buyers to pull back, but they have to live somewhere, so they migrate. That means the real estate boom may not be over, but moving inland, or to areas that have been undervalued. In other words, Las Vegas benefited from the California migration. Now Las Vegas buyers may move their real estate money to Dallas or Baton Rouge or Atlanta - if they decide to stay in real estate.  

If you buy conservatively within your qualifying means, you should be okay no matter what the market does. But should you expect double digit annual returns on housing? Probably not, but there may be pockets of prosperity that will surprise all of us.

Janszen: The price of all assets have been rising for several years: real estate, stocks, bonds, commodities, hedge funds, private equity.  Everything's up!  Usually the prices of commodities and stocks are counter-cyclical, so the situation is anomalous.  Greenspan recently stated on one of his $110,000 per hour private seminars that the conditions that produced this are unusual and that he expects asset prices to decline... all of them.  It's been my thesis here at iTulip.com that asset prices may decline in real inflation-adjusted terms, but not in nominal terms.  In other words, we may see the DJIA to hold about where it has since 2000, but continue to decline in purchasing power due to inflation as it has to the tune of aboout 20% since 2000.  Do you agree we're in for a period of higher than normal inflation and, of so, do you see RE as a safer haven than other assets?

Evans: Yes, I do think we are in for a high level of inflation because we haven't been truthful to ourselves about the real costs of real goods. The bottom line is that oil, housing, precious metals and food are all more expensive. Anyone who thinks we haven't had inflation for the past three years hasn't been buying milk and eggs. That has to ignite inflation for other consumer goods and services. How long did we think we were going to be able to pay for increasingly expensive goods with stagnant wages?

The basics are food and shelter. Real estate is the only asset where vantage point matters. Your house may be declining in value because of market factors, but that never means that your house is worth the same as everyone else's. As long as people covet views, hilltops, corner lots, skylines, schools, and Starbucks, location will matter. So, you're talking about an asset that never declines to zero because it has useful life to someone - either to an owner, renter or a developer.

Today's slums are tomorrow's urban townhomes.

Since 1968, housing nationally has risen faster than the rate of inflation, but that doesn't mean inflation doesn't overtake housing in the short term or in certain markets. Despite a lot of support from the government and lenders, housing is still a big ticket item and you have to be qualified to buy a house. To keep houses selling, lenders will find new products - like the 40 and 50-year loan.

Janszen: So one way to look at it is that we're in for a downturn in assets but that RE will do the least badly among asset classes largely due to government subsidies and protections.  What are the major subsidies and protections that the US government provides to US RE owners?

Evans: There are numerous subsidies the government offers from special buyer programs and incentives available at the local level through the Department of Urban Housing (HUD) to the Tax Relief Act of 1997, to state and federal
income tax deductions for property taxes, and finally the government sponsored entities such as Fannie Mae and Freddie Mac that create low-barrier loans to buy back from lenders.  That means you can borrow substantially to get into a home, stay in it for two years, sell it, and keep the capital gains up to $250,000 as a single, or $500,000 as a couple. No wonder we’ve been in a 14-year housing boom, but the afterburners were turned up post 1997.

Janszen: Here at iTulip.com we call the Tax Relief Act of 1997 the "Flipper's Bonus," part of the U.S. government's creation of the ideal conditions for a housing bubble.  You can argue whether these condition came about by intent or accident, but it's hard to argue that if the Federal government were TRYING to create the conditions for a housing bubble, they could not have done much better than the set of tax and other policies we have today.  How do these government protections and subsidies compare to other popular asset classes, such as stocks  and hedge funds, in terms of protecting value in the long term?

Evans: It’s almost can’t lose. Unlike stocks, you have two things with housing – the  use of the investment, plus control.  You don’t have to be a financial genius to do well. Just buy a nice home in a nice area, with nice
city management and  lots of jobs, and your house will pay your living expenses back over time in  most cases. Contrast that to investing in instruments that are managed by ridiculously overpaid or crooked CEOs that
siphon off the profits, protected by their buddies on the board and the SEC. The average Joe isn’t supposed to make any money, so it becomes a trust issue. Do you trust these suits who might be  lying to you about the viability of
their companies, or do you trust your own eyes?  With a house, you can see with your own eyes what needs to be fixed, and you can control how and when it's fixed.  The government doesn't want housing to decline and will do almost anything at the federal level to prevent it, but it has to have help at the municipal level too. That's why you have subsidies.
 
Janszen: Are government RE subsidies likely to continue? Have other income tax deductions of interest rate expenses been eliminated in the past?

Evans: The President appointed a tax reform panel in January 2005. Not surprisingly, the panel came back with the recommendation of a flat tax that eliminates the mortgage interest rate deduction. It was shouted down, but
that doesn’t mean it won’t come back for reconsideration. According to the National Association of Realtors, which spends a substantial amount of money on lobbyists, someone on Capital Hill tries to do away with the mortgage interest rate deduction every year. You may remember back in the 70s that interest rates were deductible on automobile purchases. When that was eliminated, it created some temporary outrage – but let me ask you – have you continued to buy cars? Probably. People forget, and I think that’s what they were hoping would happen with the mortgage interest rate deduction.

Janszen: Yes, I hate to admit that I’m old enough to remember that.  I also remember a time when interest on credit card purchases were deductible and that was repealed.  Won’t government protections of corporate shareholders, hedge fund share holders and the like improve ala Sarbanes-Oxley and other regulations on the way?
 
Evans: I’m not hopeful. The investment culture is about cronyism.  As long as you have boards voting outlandish pay and severance packages for their friends, regardless of performance, the system is still too heavily slanted against shareholders. I also blame the shareholders for their apathy.  That’s what’s allowing this situation to continue.  It’s really stupid – how can you expect a company to make money when upper management is doing everything possible to skim off every profit, if they are lucky enough to make one?

Janszen: There’s been a fair amount of abuse in the RE industry, such as appraisal fraud and mortgage lending abuses, and there have been some fairly dubious mortgage products sold as well such as Toxic Reverse Mortgage Gobbles up a 94-year-old Widow's Home Equity covered by Realty Times.  Doesn’t this make RE just as risky as stocks from a government oversight perspective?

Evans: It makes mortgages risky – not buying real estate. The risk with real estate is whether there are enough jobs to produce real estate buyers and therefore demand. We live in a culture that celebrates greed so you can assume that anyone who can make money off any transaction will do so.  However, unlike corporate governance where so much is done with sleight-of-hand accounting, you can see a copy of your loan papers called a Good Faith Estimate within three days of applying. If you aren’t sure the loan is on the up and up, you can show it to someone else, a financial advisor, attorney, or your Realtor for second opinions.

Janszen: Research by Asha Bangalore, economist with Northern Trust Co, shows that housing- and real estate-related jobs accounted for 36 percent of private sector job growth over the last four years.  If jobs produce real estate buyers and real estate is producing more than a third of all jobs, doesn't it hold that if housing prices soften as they have that housing related employment will decline and with it real estate buyers?  Is there a danger of a self reinforcing dynamic here?

Evans: That depends. The National Association of Realtors grew from 750,000 in 2001 to over 1.2 million members in 2005. All that means is that these people came from other industries to try the gold rush of real estate, mortgage banking, etc.  If it doesn't work out, they'll leave and be absorbed into other professions. People who aren't making money don't buy houses. Unless you're paying cash, you need an income.

Janszen: Before there were bonds there was real estate. Rent is the yield on the principle.  So, in a way, bonds compete with RE.  With bond prices falling and interest rates rising, won’t that create competition from bonds?

Evans: Only if you see bonds and real estate as the same kind of investment, which they aren’t. An owner may have a number of goals in mind when purchasing a home to use it as a homestead, vacation home, rental, or retirement home. Real estate provides a home for someone – either the owner or a renter.  The transaction costs are steep, about 14 percent to buy and sell the same home, so you’re not going to view a home the same way that bonds hedge stocks. You're going to think long term, unless you're a speculator.

Janszen: Where do you see the rental market going over the next few years? Rents have lagged mortgage costs for a while, hurting profits in the rental property business.  Do you see that changing?
 
Evans: Yes, as interest rates and property values rise, that will knock out some buyers, including the speculators. That will stimulate the rental market and that means rents will rise, too. It’s already happening in some markets. The bull housing run has depressed rents, but that hasn’t stopped many investors from buying rental properties because they are counting on the appreciation, not the yield. It’s interesting, but there’s a kind of subsidy there, too, which allows investors to essentially lose money on a house and collect tax breaks. It’s a sweet deal.

Janszen: Are there some RE markets that you recommend over others?

Evans: It’s very clear that the coasts have been red-hot, and they will be again. People are not going to want to stop living in San Diego, California or Naples, Florida, although buyers may pull back for a time because of affordability.  What makes these areas so desirable is restrictions – either man-made or natural. If you have government that restricts growth (no more units) or refuses to invest in infrastructure (roads) or a seashore or mountains that wall off growth, you are artificially creating density.  Density is what drives up prices – a mass of people wanting to live in one location.  If that weren’t the case, Las Vegas - in the middle of the desert - would be the most expensive real estate in America.

So, look at cities that are supporting urban growth in a positive way – subsidies to employers, revitalization of downtown and inner city amenities.  What you don’t want is a city that subsidizes suburban growth because you reach a point where your tax base is larger in the suburbs than in the urban rings. That creates decline, and that’s what most cities are living with.  The smart cities are trying to bring taxpayers back with attractions like Portland, Dallas, Houston and Oklahoma City.  However, you won’t experience the double-digit gains with some of these urban pioneers because there is still too much land to buy cheaply nearby. The only thing you can hope for is that the suburbanites will get sick of commuting on congested roads that can’t be built fast enough.

Janszen: Makes sense that you'd want to invest in real estate where the local government is investing in infrastructure.  Are there any places where the investment in infrastructure has been made but real estate prices remain depressed for various reasons?

Evans: At the risk of sounding self-serving, I would seriously look at the major cities of Texas – Houston, Dallas, Austin, San Antonio, Galveston and El Paso.  Texas has been under the national average of housing appreciation for over 15 years. That’s a long time to be undervalued.

Dallas, for example, is one of the largest cities in the U.S., yet its homes are among the lowest in costs in the Southwest. The reason is sprawl (no mountains, so seashore) but that’s coming back to bite the area. To get away from Dallas' dysfunctional city government, poorly performing schools, and high crime, wage earners moved to nearby suburbs. Now, the commutes are outrageous and home appreciations have been fairly modest to stagnant, even if you can live like royalty 60 miles from your employer.  So the fed-up factor is coming into play.  People are finding the grass isn't greener in suburbia, and they're returning to the inner city. Dallas has about 28 high-rise housing projects either under construction or planned. The entertainment area adjoining downtown has a public improvement district when enables it to operate like a little fiefdom Uptown has extra police, flower beds, and other things that aren’t in the city budget. It's exploding with growth. We still have dysfunctional city government, but now they're handing out subsidies, so they look like geniuses.  

Janszen: So, as with other financial assets, one can’t follow the herd and expect to make money in real estate, especially after the big run-up in prices -- it takes experience and expert advice.  I very much appreciate yours, Blanche, and look forward to reading your book later this year.

Evans: Thanks, Eric.  My pleasure.


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