This Small Group is Driving the Entire Economy (and They’re About to Stop)

Dave:
These days with so much going on in the headlines and in the news, it is hard to keep track of what is going on. And that’s even for someone like me who spends all day obsessively updating the news and tracking these things. And sometimes I just need someone else who loves the economy and looking at data as much to bounce some things off of and to learn from myself. And today, we are bringing on the one and only J Scott to help us unpack what is going on at the economy, the housing market, and most importantly, what we’re all supposed to do with our investing portfolios based on all of the information we’re receiving each and every day. In this episode, we’re going to cover inflation, we’ll cover tariff, we’ll cover the Federal Reserve, and we’ll cover how the residential and the commercial real estate markets may react to everything going on right now. If you are nervous, if you are wondering what to do next, this is an episode you’re definitely going to want to listen to. Let’s bring on Jay. Jay Scott, welcome back to On the Market. Thanks for coming back once more. Hey, appreciate you having me. How you doing, Dave? Honestly, confused about the economy. Just trying to figure out what’s going on around here. So I’m happy you’re here.I’m not sure I can help, but I’ll doMy best. It at least helps to have someone to bounce some ideas off of to have a conversation about, because the reality is, as Jay said, no one really knows, but it is helpful to talk to someone else who I think follows this stuff as obsessively, if not more obsessively than I do.And I think it’s not just that nobody knows. I mean, I think it’s safe to say no matter when we’re having this discussion, whether it’s now a year ago, five years ago, 20 years ago, nobody really knows for certain, but there’s just so much that’s happened over the last, we can say the last couple years. But the reality is since 2008,
That
Has caused the economy to work in ways that aren’t necessarily historically accurate. The government has done a lot, the Federal Reserve has done a lot. Private industry has done a lot that has basically foundationally changed the way the economy works in some ways. I mean, in a lot of ways the economy is the economy, but there are just things that have happened over the last 20 years and especially the last five or six since COVID that have changed the way we can expect the economy to react. And because we don’t have any more than four or five years of data on this kind of new normal, it’s hard to say what’s going to happen. We don’t have much precedentAs an analyst. It’s frustrating because our whole job is to look at historical data and of course no two periods are the same, but you look at history to try and give you some idea of the direction that things are heading or say when conditions are like in the past it’s kind of gone this way, but we really haven’t seen a scenario like the one we’re in today. And so it really raises a lot of questions. And the best that we could do on this show is I think help people understand what are the main variables that are going to sort of dictate what happens next. What are the things that we should all be keeping an eye on over the next few months so that we can continuously updating our strategy, adjusting portfolio, adjusting resource allocations appropriately? Because we all kind of just have to follow this in real time. I don’t really know a better way to do it, do you?No, I don’t. And again, not only has the economy and the inputs changed over the last bunch of years, but without getting political, I think it’s safe to say, and I think everybody would agree that we’re kind of in uncharted territory in terms of what’s going on politically, both domestically and on a global stage. So lots of moving parts when it comes to things like tariffs, things like immigration, things like spending and tax bills, and we’re not really sure what a month or two or six from now is going to look like. And so it’s pretty hard to predict where the economy’s heading when we don’t know where the political and budgetary powers that be are headed.Maybe let’s just do a brief recap here, Jay, when you’re talking about the way that the economy and the housing market have changed since 2008, is that mostly talking about interest rate policy or what else are you getting at there?Yeah, a couple things. So interest rate policy is certainly one of them. Historically, we’ve had higher interest rates and people, they were just used to the fact that interest rates were 6, 7, 8, 9% historically speaking on a typical year and prices for everything from cars to houses to everything in between, just kind of normalized around those higher interest rates. Today, obviously interest rates are lower. Ever since 2008 when we faced the Great Recession, interest rates dropped to zero. They went up a little bit and then COVID came and they went back to zero, then they went up a good bit, what we considered to be a huge jump, the fastest jump in history from 0% to about five and a half percent, five and a quarter percent federal funds rate. But the reality is crazy as it seemed to raise rates 5% over about 18 months. The reality is rates were still lower than the historic average.
And so the American public consumers have not quite adjusted to this new normal of, hey, rates are going to be a little bit higher than they’ve been for the last 20 years, but again, they’re still lower than they have been historically. Then there’s all the money printing. I mean, we all know that since 2008, the government’s just been a runaway train when it comes to printing debt over the last six years alone, and again, not political, this crosses the current administration, the last administration, the end of the first Trump administration. We’ve printed half the debt that we currently have in this country, so 250 years of this country, and half the debt that we have, about 19 trillion out of 37, 30 8 trillion has come in the last five or six years, which is just absolutely astounding. What’s more astounding is that it doesn’t look like either party has the will to do what’s necessary to change that, and we’re likely to be running huge deficits, which means we’re likely to be increasing the debt and the money supply considerably more over the next several years. And with more money flowing through the system with higher debt, we have a whole bunch of different considerations when it comes to how the economy works, how the Fed handles rates, and how we deal with things like inflation than we did before, all of this crazy money printing.Totally. Yeah. I’m glad you brought up the concept of debt because this to me has probably the biggest implications for the long-term trajectory of the housing market and just and commercial real estate too, just generally the real estate market and in a way that I don’t think a lot of people are thinking about. I don’t know about you, but everyone I talk to is very focused on mortgage rates in the next year or two, and I don’t know where mortgage rates are going in the next two years. I have my idea, but I personally have a lot of fear about long-term interest rates, which I think brings up a lot of questions and is pretty critical to figuring out your strategy for how you’re going to invest right now. So given all of that, how would you summarize the state of the economy where it stands today? Some people say we’re on the precipice of a recession. Some people say we’re about to see explosive growth. Where do you fall on that spectrum?Yeah, I mean the funny thing is if we had this conversation a year ago, I think we did have this conversation a year ago.Yeah, we probably do. AndSome people were saying we were on the verge of recession and some people were saying we’re on the verge of explosive growth. They would’ve said that two years ago. They would’ve said that four or five years ago. And the crazy thing is both sides have been right every time because what we really have these days is kind of a bifurcated economy.That’s right.We see certain people, the top 5%, 10%, even 20% of Americans in terms of wealth and socioeconomic status, who are actually faring very, very well
Because a lot of their assets are in hard assets. They’re in the stock market, they’re in crypto, they’re in gold, they own real estate and hard assets have been going crazy the last few years. And so the folks that have invested in hard assets have made a lot of money over the last few years. The other 80%, 90% of people who don’t have much money in hard assets, they might have a retirement plan or a 401k, but other than that, they don’t own stocks. They don’t own real estate, they don’t own gold or crypto. They’re living paycheck to paycheck because for the most part, inflation has outpaced wage growth. And so they have not seen wages on an inflation adjusted basis go up for the last five or six years. And so they’re struggling. And there’s been a lot of data that’s come out over the last few months that basically says the entire economy right now is being driven by the top 20% of wage earners. The bottom 80% are basically only buying the things they absolutely need to buy to continue to live. They’re buying clothes, they’re buying food, they’re paying their rent, but not much more, very little discretionary spending. And so as the top 20% rack up more debt and start to slow down, that’s going to have a tremendous impact on the economy. It’s really scary that 20% of the Americans right now are controlling the economy for the most part.So you said when they slow down, do you think that’s imminent, that there’s going to be a slowdown in spending among the top 20%?Well, remember, the economy works in cycles. We have expansions, we have recessions, and those cycles are driven by debt. As consumers and businesses build up more debt, we basically start to see more inflation because everybody’s spending more money and we get to this peak where it’s not sustainable. All this debt, people can’t pay it, businesses can’t pay it. There’s more debt than there is the ability to pay that debt. And that’s when we start to see defaults. We start to see businesses go into bankruptcy. We start to see houses going to foreclosure. We see cars get repossessed, we see credit cards defaulted on, and that’s what leads us kind of down into the recession, this de-leveraging this shedding of debt. And so at some point, I know we’ve put it off now for 17 years since the Great Recession. Yeah,It’s crazy,But at some point, all of this debt is going to get to some critical point where it simply can’t be serviced any longer by consumers and businesses, and we’re going to start to see massive defaults. We’re going to start to see bankruptcies, we’re going to start to see foreclosures. We’ve actually already started to see it to some degree. If you look at the data for the first eight months of 2025, we’ve had more corporate bankruptcies in the first eight months of this year than in any year since 2010.Really?I didn’t realize that. And so businesses are already starting to struggle and consumers are already starting to struggle. So I suspect that it’s going to happen at some point soon. But here’s the crazy thing. I mean, if you’ve been paying attention since 2008, you know that the government doesn’t like recession,
They
Don’t like foreclosures and bankruptcies and credit card defaults, and they’ll spend as much money as it takes to try and keep us out of a recession. And so I suspect as we get closer and closer, the government’s going to do what they’ve done the last two or three times that this has happened and they’re just going to start spending a ridiculous amount of money. And the question is, will that work? And for how long?All right. We’ve got to take a quick break, but with Jay Scott right after this. Welcome back to On the Market. I’m Dave Meyer here with Jay Scott. Let’s jump back in. I know whenever you talk about a recession these days, it becomes political. People are always get up in arms, whoever’s in power at that point. But as you said, so much of it is just cyclical. These are long-term things that have been going on and sort of transcend individual presidencies or political power, and there’s just an inevitable point where things need to reset, at least in the current iteration of our economy. This is just sort of how it works, but like you said, whoever’s in power at that point obviously doesn’t want that to happen, and so they’re going to try and figure that out. I guess my question is what is the catalyst? Because people have been saying there’s going to be a recession for years, but what is the tipping point? Is it consumer spending goes down? Is it unemployment rate goes up? Do you have any sense of what can actually go from this feeling like it’s going to happen at some point to actually manifesting?Yeah, I think it’s going to be jobs. I think it’s going to be the employment sector. Consumers are still spending, that’s the crazy thing.Oh yeah.Despite all of these hardships that a lot of people around us are experiencing and that we’re hearing about and that the data is indicating is out there, despite all of that consumer spending has been tremendously resilient. Americans are still spending a lot of money, and as long as they continue to spend money, I think we can kind of buoy the economy to a degree. But at some point, businesses are going to run into issues. So one thing to keep in mind is that just like Americans live off of debt businesses for the most part live off of debt as well, and a lot of business debt is short term, three to five years. And during COVID, a lot of businesses took out debt at very, very low rates. You remember federal funds rate was at zero. So businesses were taking out loans at 2%, 3% interest. A lot of those loans are coming due. They’ve been pushed out as far as they can, and businesses now need to refinance that debt and they now need to refinance that debt at rates that are closer to seven or 8%. Big difference between two and 3% and seven and 8% in terms of interest payments. Even large companies, companies like Walmart, companies like Target, they generate a lot of their debt through issuing bonds
And they were able to issue bonds at three, four, 5% a few years ago. Well, now they need to issue those same bonds at seven, eight, 9%. And again, paying 9% versus 5% is going to impact the profitability of those businesses. And at the end of the day, the businesses are going to have to run leaner, which means they’re going to have to start laying people off. And as I think we see unemployment rise, that’s going to be the catalyst that kind of pushes the economy down once and for all into the next recession.Do you see the labor market data that we’ve been seeing recently as evidence of that? Because I’ve done a couple shows on this recently. There is no perfect way to measure the labor market. I agree with that, but in my opinion, when you look at the total universe of labor market data that we have access to, it all shows a weakening labor market in my opinion. And so do you see that as evidence of this move towards a new phase of the cycle starting?I think the labor market data is very well aligned with what I think a lot of us are seeing with our own eyes.
Let me start with the labor market. The way the Bureau of Labor statistics collects labor data is outdated. It’s not a very good mechanism. We’ve seen the issues with revisions like really big revisions. Last year we saw 900,000 job revision downwards. This year we saw 800,000 job revisions downward. We’ve seen big monthly revisions downward. A lot of people think that that’s evidence of manipulation or fake data. I personally don’t believe that we tend to see certain types of revisions during certain periods of the economic cycle. So typically as the economy is softening, we tend to see revisions downward because revisions are basically data that’s coming in later. And if the economy is softening, then the data that comes in later is data that’s coming in further down the softening pipeline. And so it’s not surprising that we’re seeing downward revisions. So do I trust the data? I trust that the data is as good as they can make it. I trust that the data is not being faked or manipulated, but I don’t necessarily think that it’s accurate without future revisions.
That
Said, there’s clearly a softening trend. We’re clearly seeing unemployment rise. We’re clearly seeing layoffs increase and that comports with the headlines.
We’re seeing a lot of layoffs in the tech space. We’re seeing a lot of layoffs in the transportation space. So ever since tariffs, we’ve seen a big downsizing in freight and transportation and warehousing. We’ve seen a lot of layoffs in the agricultural industry just with immigration. And we could have a whole separate debate on whether illegal immigration is good for the labor market or bad for the labor market, good for the economy, bad for the economy. But the reality is that we’ve seen a lot of people who were employed, whether legal or illegal in the agriculture industry that are no longer employed in that industry. And so with all of these layoffs with the changing landscape with respect to immigration and tariffs, there’s no way around the fact that we’re going to see a softening labor market over the next six to 12 months. It’s just a question of again, can the government spend their way out of it?Yeah. So does that, you think the Fed is already too late on lowering rates to impact the labor market? I mean, I know there’s the whole inflation side of this that they have to balance, but do you think fed just cut rates 25 basis points? They are projecting another two. Is that enough to offset the declining trends in the labor market?So you mentioned inflation. If labor market were the only consideration, the fed is way behind. I do think we’re behind the curve on cutting rates to deal with the economic softening.
That said, the reason the Fed has been hesitant to cut rates and they haven’t cut rates more steeply than they have is because there’s the other side of the coin, which is inflation. And it’s the Fed’s job not just to control the economy from an employment standpoint, but to control the economy from a pricing and inflation standpoint. And typically when you cut rates that leads to more inflation. We’ve already seen inflation tick up over the last four months and the Fed I think is very concerned that any rate cuts could lead to a larger spike in inflation. And so they need to kind of play both sides right now. In a perfect world, they could cut rates just to help the labor market and raise rates just to push down inflation, but you can’t do both of those at the same time. And so I think the Fed has more been in a wait and see mode as opposed to being behind the curve. They want to see what’s the bigger risk to our economy right now? Is it inflation or is it jobs? And once they see what that bigger risk is, they’ll do with rates, whatever it takes to address that particular risk.Yeah, I agree with you. I don’t think a 25 basis point cut’s going to do anything for the labor market to be perfectly honest.I personally think that was political. I think that was to appease the president. I think that was to appease corporations that have been demanding a cut. Do I think it’s a bad thing? I don’t think it’s a bad thing. I think a 25 basis point cut, it wasn’t going to impact things one way or the other tremendously. And I think it gives people a little bit more faith that the Fed isn’t just trying to push back against the administration, that they are willing to cut when the data indicates that they should. And we have seen some softening in the labor market over the last couple months. And so I don’t think it was a bad time to cut, but I also think not cutting a couple weeks ago would’ve been just as reasonable.Yeah, I guess my feeling is I don’t think a 25 basis point cut is going to change behavior very much either for businesses, they’re not going to all of a sudden start hiring way more. And I also don’t really think 25 basis point is necessarily going to impact inflation, especially when there’s all these other inflationary pressures that we need to be thinking about. This is probably not the biggest risk. Now if we cut it another 75, that could change things a little bit. So we’ll have to wait and see. To your point, we have two things going on with the labor market. One is it’s just that part of the cycle. This is just how this works. The other thing that we haven’t even talked about that I think is going to complicate this, another thing that falls under the bucket of like we just don’t know is how AI is impacting the labor market too.
And I don’t know if I’ve seen to the point where people are like, okay, we’re going to fire all these people and then just use robots. But I do think if someone leaves a company these days, people are saying, do we need to replace them or can we empower our existing employees with AI to augment their skillsets? And maybe we don’t hire as many people. And I just think that question is probably not getting resolved very soon. And I think we’re going to see that ripple through the labor market because my guess is that at this point in the cycle, businesses are going to err on the side of trying to automate things even if they don’t have a good reason to do it, even if they don’t know if it’s going to work. I think they’re going to overcorrect on automation and be slow to hire right now just because they think AI can do everything and maybe one day it can right now it certainly can’t.
And so I think that’s just another thing that we’re contending with. And another thing that the Fed, I think is going to have to think about. So Jay, we talked about the labor market in isolation, which obviously doesn’t make sense. We need to talk about inflation too. We’ve talked a little bit about the potential for rate cuts contributing to that, but study after study, basically what I’m seeing is that economists are generally surprised that inflation hasn’t gone up more just yet because of the tariffs, but that it’s still coming and that it’s trickling through the economy a little bit slower, partially because of the way the gradual rollout nature of the tariffs and how they were implemented over the course of four months. And because there was just this flurry of trade before tariffs went into place, and we have this backlog of goods at lower prices that are still wicking its way through the economy. Do you buy that read on inflation and do you think we’re going to see it continue to tick up? And just for everyone’s reference, it’s gone up a little bit over the last couple of months. I think we’ve gone from about 2.6 to 2.9, but that reverses a trend that had been in place for a couple of years of gradual declines. Now we’re gradually climbingAnd the hiccups been a little bit more than that. I think it’s 2.4 to 2.9. Okay, thanks. But I mean depending on, you can read that a couple ways. It’s a 25% increase, 2.4 to 2.9, but 2.9 relative to where it was a couple years ago when we were over 9% is actually not too bad. And here’s the other thing, the fed targets a 2% inflation rate. Realistically, historically speaking, the last a hundred or so years, inflation in the US has been closer to 3.1%. So my barometer is if we’re in the 3% range, it’s actually not too bad.Okay,That’sA good way to look at it.But just like the labor market trend has been in a certain direction, it’s been down, the inflation trend has been in a certain direction that’s been up, and I think I’m not overly concerned with that 2.9% CPI inflation number. I am more concerned that it’s going up month after month, four out of the last six months, and it’s heading in the wrong direction. Like you said. There are a couple of things at play. One is that terrorists were actually rolled out a lot more slowly than it may have seemed. There’s so much news flying around on a daily basis that it’s often easy to overlook the fact that we did have a 90 day pause in tariffs and we basically just restarted them a month or two ago. The other point that you brought up was that we warehoused a lot of inventory earlier in the year when there was the expectation for tariffs.
And so these companies had a ridiculous amount of inventory sitting on shelves that they were able to purchase at lower prices six, eight months ago that they’re just finally working through now. And then there’s a third thing that we have to consider, and that’s that not all price increases are going to be passed along to the consumer. So generally there are three places that price increases can be absorbed. Number one, the manufacturer. So if we’re buying stuff from overseas, we’re buying a widget from China that last year cost a dollar and now costs a dollar 50 because of tariffs, the manufacturer might say, well, I’m going to eat 20% of that and so I’ll sell you that dollar 50 widget for a dollar 20. So now the manufacturer’s losing 30 cents, then it comes over to the US and the retailer here in the US who would be selling it instead of for $1, now a dollar 20.
Well, they say, well, I’m going to eat 10% of that cost. So now they’re taking another 12 cents off of that, and then the consumer’s eating the last 8 cents. And so basically tariffs are being absorbed in three places in the economy. And it’s unclear at this point, the breakdown of how much is being absorbed by the manufacturer overseas, the domestic wholesaler, and how much is being eaten by the consumer in terms of actual end product inflation. And so if you look at some studies that Goldman Sachs has done, they say that businesses and consumers in the US are eating about 80% of it. Foreign manufacturers are eating about 20% of it. The administration is saying that’s not true. The foreign manufacturers are eating more of it, we don’t really know. But the reality is that businesses and consumers are eating some of it, but it’s not all being passed on to consumers. And so when we say that we’re not seeing that much inflation, I think what we’re saying is that consumers aren’t necessarily seeing that much inflation, but there are other places in the supply chain where other businesses are getting hurt and we have to consider that as well.And do you think that will maybe then leak into corporate profits essentially?Yeah, and I think that’s where we’re going to get a much truer picture as we move into Q3 earnings reports next month and then Q4 earnings reports at the beginning of next year. We’re going to see the real impact of tariffs not just on consumers, but on American businesses as well, and that’ll give us a much bigger picture of how much prices have gone up and how much is being eaten by businesses before they pass it on to consumers.One thing I keep thinking about is if you’re a business, you’re an importer, you’re immediate thought is, I’m going to pass this on to my consumer, but as you said, 80% of us consumers are struggling, so they can’t absorb it. So maybe the businesses just do have to absorb it, at least for certain products and services. It’s just something we’re going to have to see. We’ll be right back, but when we return more insights from Jay Scott and what he recommends investors do in the market heading into 2026. Thanks for sticking with us. We’re back with Jay Scott. Well, you’ve painted a very intriguing picture of the economy here, Jay, very accurate. Look at what’s going on. What do you do about this? This is such a confusing thing as an investor, not just a real estate investor, big picture, resource allocation, risk mitigation, opportunity pursuing. What are you doing?Yeah, so a couple of things to keep in mind, and we talk about this every time I’m on, but it’s worth it to reiterate, we’ve had 36 recessions in this country over the last 160 years. Two of them have had a significant impact on real estate, the Great Depression back in the 1930s and the Great Recession back in 2000 8, 9, 10. Those were really the only two economic events that had a significant downward impact on real estate.Residential, right,Residential, thankYou. Yes,Absolutely. We can talk about commercial separately.
I’m talking about single family residential at this point. So it’s reasonable to assume that single family residential real estate is pretty well insulated from most bumps in the economy, a standard recession. And if you look at the data a little bit more closely, what you find is that pricing or values in single family residential is most closely tied to inflation. When we have high inflation, values tend to go up when we have low inflation, values tend to go up more slowly. And so if you want a good idea in a normal market, a normal economy where housing values are headed, you’re going to look at inflation and the higher the inflation, most likely the higher you’re going to see values continue to go up. The two examples I gave though of where we didn’t see housing values go up were when we saw big recessions. So again, 1930s, 2008, those two really big negative economic events. So question I want to ask myself now is are we likely to see a 1930s or a 2008 type event which could have a significant impact on real estate, or are we likely to see a standard recession if we see any recession,
Which likely wouldn’t have a big impact on real estate? So my general thesis is that real estate’s pretty well insulated. It’s unlikely we’re going to have a big drop in prices unless we see a significant recession or a significant economic event like we did in again the thirties or 2008.I agree with you. I was actually working on my BP presentation and just talking about different scenarios and I see three scenarios that could really play out in the housing market. One of them is a crash, but I think the probability of that, I probably put that as my third most likely outcome out of the things that could happen in the next couple of years. But it’s obviously possible we’ve seen it before, but do you think that’s the most likely scenario?I actually think that’s the least likely scenario.Okay. We’re on the same on that, yeah.Yeah. I’m not going to say it’s a 0% chance. I think we’re in a economic place right now. Again, it’s been 17 years of debt building up and at some point that debt’s going to have to go away and it could be some major economic downturn that leads to it or causes it, but I think more likely we’re going to see one of two things. We’re either going to see a continued softening in the economy and the government starts to spend lots of money like they’ve done in 2020 and they did after 2008, and that’s going to cause one of two things to happen. Either they’re going to be successful at kind of staving off the recession for a couple of years longer, in which case we’re going to continue to see what we’ve seen for the last few years. We’re going to continue to see housing prices kind of either flat or go up a small amount. We’re going to continue to see this wealth gap build.
We’re going to see people on the higher end of the socioeconomic spectrum do very well, make a lot of money in hard assets. People lower on the socioeconomic spectrum suffer probably even more, but the economy will keep moving along or the government will spend a lot of money to try and keep us out of that recession and they won’t be as successful as they have been the last couple times simply because we’ve built up too much debt. In which case I think there’s a reasonable chance that we do see a downturn. Again, I don’t think it’s going to be a 2008 style downturn, but we do see a downturn where we see jobs go away, where we see inflation start to come down. We normally see in a recession where we see businesses go to business and foreclosures go up and bankruptcies go up, and it won’t be a fun time. But again, real estate tends to be pretty insulated under those scenarios. It’s only the scenario where we see a major, major downturn that single family residential tends to hit. And again, I’m not discounting the possibility for that, but I put that at my third most likely.Okay. Well, I see things fairly similarly. I’ll tell everyone else my exact predictions there at BP Con, but I think Jay, you and I are on somewhat of the same page, but I guess the question is given three reasonably likely scenarios in normal times, my third most likely scenario is probably like a 5% chance or less. I think they all have somewhat decent chances. So how do you invest given this very confusing, uncertain economic landscape?Yeah, so let’s say if I had to assign probabilities, I think there’s a 40% chance that things just keep bumping along the way they have been for the last few years and there’s a 40% chance that we do see a standard type recession, and I’ll reserve the last 20% for we see a significant recession or maybe we even see the economy boom. Again, I don’t think that’s likely, but I’m not going to, you can’t say never these days. So let’s say 80% chance that we see continued bumping along or we see just a mild recession in either of those cases, it’s a great time to buy real estate.Yeah, that’s right.Because remember, real estate only goes up over time. There’s been no 10 year period in this country where single family real estate hasn’t gone up in value. So if you’re buying, right, and when I say buy, right, I mean you’re buying properties that can cover the bills that are generating a little bit of income or at least breaking even when you consider all expenses that go into them. If you’re being conservative on things like your rent growth, even maybe assuming rents might go down a little bit because while we don’t necessarily see housing values go down during recessions, we do see rents go down sometimes.
So factor in a 10% rent decrease just in case factor in 10% higher vacancy just in case factor in mortgage rates, maybe going up a little bit from here. So we’re currently in the low sixes. I don’t think we’re going to go much higher than that, but who knows? Things are crazy these days. We could see rates go back up to 7%. So factor that in, factor in all of these conservative assumptions into your underwriting and if the deal still makes sense, if you can break even make a little bit of money, you’re going to be happy you made that purchase in 10 years.Jay, there’s a reason we wrote a book together. I completely agree with everything you just said. I totally agree. It’s just be conservative. This is real estate investing 1 0 1 in the broader investing world. If you talk to someone who’s a stock investor, private equity hedge fund investor, they have this concept of risk on risk off. I think we’re in a risk off era of real estate investing, which means not that you shouldn’t invest, it just means that you got to be super patient and super diligent about your three years ago, five years ago, you could have messed up and been fine. That might still be true, but it’s not definitely true. It was in 2021, it was like you could be kind of loose with your underwriting in 2021 and have a fairly high degree of confidence you’d be fine for residential. Now, I just think it’s the complete opposite. I think you need to just be really diligent and if you’re wrong and things are fine or go well even better, this is just a mentality of not taking on too much risk because that way you’re going to be okay and maybe you do great and either way you benefit, but you’re not going to be putting yourself in a situation where you’re taking on a lot of risk in an uncertain time. To me, that’s just never really worth it.And the other thing you have to remember is that everybody thinks that we’re heading into uncharted territory with real estate with higher interest rates. It’s hard to generate cash flow and it just feels very different than it has for the last decade or so. It is different, but the thing is it’s back to where it was for the 30 years before 2000 10, 11, 12. It’s back to the normal state of the market. Everybody seems to think that low interest rates, high cash flow, fast appreciation, get rich quick is the normal in real estate. It’s not the normal. It was an aberration that we were lucky enough to experience if we were investing from 2014 to 2021, but it’s not the normal. The normal is higher interest rates, lower cash flow, slow and steady wins the race. You build equity over time, you get the tax benefits and you leverage the tax benefits. You get the principal pay down, you let your tenants pay down your mortgage, and in five or 10 or 20 or 30 years you get wealthy.I completely agree. I called it on the other show, the Goldilocks era from 2013 to 2022 just because everything was perfect. It was just this very unique, unusual time and just sort of coincidentally that time aligned with the explosion of social media. And so people got really used to and expecting unusual results, but real estate investing was good in the seventies, even though there was inflation and there was high mortgage rates, real estate was good in the eighties, it was good in the nineties. You don’t need perfect conditions. You need to adjust your strategy and your tactics to a more normal era. But that’s fine. You can absolutely do that. And it’s not all negative. There are positives to these types of things too. Maybe not in terms of cashflow as Jay said, or appreciation, but lower competition. You’re not going to have all these people jumping in on the bandwagon in this next era as you did in the previous one because the benefits of real estate are going to be a little less obvious than they were during 2019 and 2020 when everyone just looked at how their neighbor was getting rich and wanted to jump in on this as well.
So it’s really just to me a matter of, like you said, being conservative, having appropriate expectations of what you can achieve and then just having the confidence that you know how to underwrite and that you can actually buy good deals. That’s how I say it. Absolutely. The one thing that keeps me up at night, Jay, I’ll just be honest, is long-term interest rates. I am curious about this because I look at the national debt, and again, as Jay pointed out, this has been a problem that both parties contribute to. You can Google this and look at it. You can just see the debt has been exploding for a long time. It just seems like the most likely way that we deal with that debt is by printing money. I don’t know if you agree with that, but that just seems like the way, the direction that we’re heading, and if that is true, aren’t interest rates going to go up in the long run?Interest rates will absolutely have to go up. A lot of people think that the Federal Reserve is the one that decides where interest rates head. If the Federal Reserve wants lower mortgage rates, they can lower the interest rate and we get lower mortgage rates. But the reality is the Federal Reserve controls one very specific interest rate, and that’s the rate at which banks lend to each other. All the other interest rates, your car loan interest rate, your business loan interest rate, your mortgage rate, your insurance rates, all of those are controlled by this other thing called the US bond market. And the US bond market is driven by not the Fed, but by investor sentiment. When investors think certain things are going to happen, it drives rates up and down. And specifically the thing that drives rates up is investors’ concern about inflation.Yes.When investors think there’s going to be inflation that forces the bond yields up and bond yields higher means that interest rates are higher. And without going into any more detail there, it’s as simple as inflation equals higher rates. And unfortunately, there’s not much the Fed can do about that. So if we want to lower rates, keep rates from going up, what we need to do is we need to keep inflation under control. And inflation isn’t only coming from tariffs or supply chain issues or anything else. Inflation comes from money printing. And the more money we print, the more inflation we’re going to have long-term, the more inflation we have long-term, the higher rates are going to be, and that is going to end up being in a snowball type cycle that’s really going to bankrupt this country.That is my number one fear. And I wonder how you incorporate that into your investing then, Jay? Because to me, the way I am reacting to that is fixed rate debt. How do I get stuff primarily residential real estate? If I can buy commercial with fixed rate, I would consider doing that, but I want to lock in my mortgage rates even at 6%. I would rather lock them in now because I don’t know if I got an arm or a variable rate mortgage now in five years, maybe it won’t happen in five. I don’t know. That’s the thing. It’s like you don’t know the timeline for this. It could be five years from now, it could be 20 years from now.Well, here’s the thing. A lot of people listen to me and they say, so what you think rates are never going to come down again. And the reality is rates will probably come down at some point, but they’re not going to come down for good reasons. They’re not going to come down because everything is moving along happily, and the markets are doing well, rates are going to come down when we have a big recession and investors are no longer concerned about inflation. When you have a recession, you tend not to be concerned about inflation, and that drives rates down. And so typically low rates means a bad economy. We saw this in 2008, we saw this in 2020. We’ve seen this in every recession going back 160 years. Recession means lower rates because we tend to see lower inflation. And so yeah, we may see lower rates again, but if we do or when we do, it’s going to be because there’s a lot of bad stuff going on in the economy.Right? Yeah. Because how I think is maybe we’re going to see sometime in the next two or three years a little bit lower rates because of the labor market, but I’m worried about 10 years from now where are rates going to beAnd there’s so many unknowns. So yeah, so there’s definitely the debt issue that could drive rates up. We also have ai, you mentioned AI earlier. If AI makes things much more efficient, if it makes businesses much more efficient and productivity much more efficient, we could see deflation and that could actually drive rates down.That’s a good point.And so to be honest, your biggest concern over the long term, and when I say long term, I’m talking 10 to 20 years, your biggest concern is high interest rates. My biggest concern is just the opposite. My biggest concern is deflation due to economic efficiencies from automation and ai. And I think the biggest risk to real estate is if AI is as successful as it could be, well, wages could get cut in half
Because
Businesses don’t need as many employees. And when wages go down, what goes down, housing prices go down, rents go down. And so for me, my biggest concern over 10 or 20 years is just the opposite of yours.Yeah. Okay. Well, now you’ve just unlocked a new fear for me. Thanks, Jay. Hopefully neither of us are right now. I could lose more sleep over what to do about things, but I think that just proves we don’t know. You buy deals that work today and you hope for the best and you adjust as you go along. Anything else you want to add before we get out of here, Jay?No, I just want to remind everybody, look, historically there’s never been a bad time to buy real estate. We don’t know what’s going to happen six months from now, a year from now, three years from now, but we have a pretty good idea of what’s going to happen 5, 7, 10 years from now, and that housing is going to go up in value. So don’t let anything we’re talking about today stop you from going out and looking at deals and buying them when you find them, because you will regret not getting started today a whole lot more than you would ever regret getting started today.Well said. Well, Jay, thank you so much for being here.Absolutely. Thanks Dave,And thank you all so much for listening to this episode of On The Market. We’ll see you next time.