Predicting the Next Real Estate Downturn - And Why We'll Survive This One
Today's Guests - Phil Anderson, Author, & Steven Kaufman, Founder, Zeus Lending
Today's episode is an absolute must-listen for every single real estate developer living in the shadow of the coronavirus. Why?
Because today's guest, Phil Anderson, has written a well documented historical book examining "The Secret Life of Real Estate and Banking" that concludes the real estate is always a 14 good year, 4 bad year cycle - which means that as dire as the current crisis feels, real estate still has another 4+ years of good times ahead - according to Phil's thesis.Â
Joining me in this fascinating conversation is co-host Steven Kaufman. This is one of those episodes that I fully expect will and should be remembered for providing a ray of hope in a very troubled time.
What You're Going to Learn
*Â How Real Estate Cycles Intertwine with Banking and Economic Cycles
*Â How to Assess the Risks of Cannabis Real Estate So You Can Reap the Rewards
*Â What Does Phil Anderson's Crystal Ball Say about the Future of Real Estate?
*Â How the Stock Market and Real Estate Cycle Patterns Differ
*Â What History Teaches Us about the Future of Real Estate
*Â How Big Events Always Trigger Changes in the Economy and Real Estate Cycle
*Â The Implications of the U.S. President Being a Real Estate Developer
*Â How Excess Liquidity and Credit Impact the Real Estate Cycle
*Â Why Opportunities in Real Estate Are Either Opportunities or Chaos
*Â What Are the Subtle Indicators of Shifting Economic Cycles
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Show Highlights
How Real Estate Cycles Intertwine with Banking and Economic Cycles
Adam: If you don't mind, please start off by telling us a brief synopsis of your thesis of real estate cycles and how they intertwine with banking.
Phil: Hi, Adam. Hi, Steve. The framework of the real estate cycle. and we're talking the American real estate cycle. is a really simple framework. 14 years up. 4 down.
And the book, with that simple premise, when I was putting a book together I thought nobody'd believe that unless I actually trace through the history. And so, I demonstrate that with a very clear pattern just going back to about 1792 with the first real banking and real estate panic that the United States saw on a nationwide basis. It's pretty simple.
Adam: 14 up and 4 down. Steven, you can chip in at any time you like.
Phil: Of course, we get 14 years up, 4 down and it's punctured, pretty much, in the middle with what I call a mid-cycle slow-down. A pause. You know, after the recovery from the prior recession, which was 2008 to 2012, 7 years up from there, which we're at, and then you get a mid-cycle slow-down. It's just started, if you haven't noticed.
What Does Phil Anderson's Crystal Ball Say about the Future of Real Estate?
Steve: I'm cutting right to the chase, so forgive me. Do you think if we're in the slowdown now that we have seven more years? I can't see in front of you. There might be a crystal ball on your table. I don't know if you were just rubbing it right there, looking for the answer to this question or one of those magic 8 balls. where it says yes, no, maybe not. What do you think?
Phil: The fine work of the real estate cycle, it gives you a basic crystal ball. If you go right back to 1800 It's been roughly 14 years up - 4 down, punctured in the middle by a bit of a slowdown. The slowdown in the middle usually some sort of, not always a recession they can be a bit more severe than it's not a regular type of slowdown. Some slowdowns in the past, have been worse than others. But, what you can say is that the slowdown which the United States is going to get over the next 12 months, doesn't involve a decline in land values. Or, aka, to date, same as house prices. But it is, in its land.  Doesn't involve a decline in real estate prices.
Often, the Central Bankers have the ability, mid-cycle to easily lower interest rates and a few other strategies that they can employ which will get a recovery started. And so, then you're left with the 2nd half of the cycle which usually runs 6 to 7 years. So, we've got, after this, we should have at least a 5, 5 to 7-year run, upwards. If you have a look at, if you read the history of my book, you can see clearly that the 2nd half of every
real estate cycle is way stronger than the first. The second half of the real estate cycle is when the speculation really gets underway. It's when the most credit is created, and it's when you see the biggest boom. And, all I'm saying is that if history repeats, there's no reason that it won't, we've got a big second half coming.
Understanding How the Stock Market and Real Estate Cycle Patterns Differ
Adam: Â First of all, the 14-4.
Phil:Â Yes.
Adam: Starts at the depths of the last recession. Is that correct? That's where you measure it from?
Phil: Well, we have to differentiate between the two asset classes, really. Real estate and stock market. Of course, they work, sort of, together but we need to, you know. They operate a little different at both ends of the extreme, at the lows and the highs. So taking the lows. The stock market recovers first, which it did. We had the lows in the stock market, well, the Nasdaq bottomed in October 2008. The Dow bottomed in March of 2009. I'm not measuring the 14 up - 4 down from there. We've gotta talk about, then real estate comes in. Real estate is the last to recover. US real estate pretty much, in figures I've seen, roughly, and of course, you know, United States is 52 states. You know, it's states right? It is a combination of states. I'm talking, homogeneously the United States, the whole United States. You can't talk about that picture, really, you know every state is a little bit different. The real estate lows were round about 2012.
I just add 14 years up from there, as a general framework. You know, individual states can differ a little bit, and of course, regions and towns and localities. I don't get into the fine print. We're just doing the framework. So 2012 plus 14 gives you 2026. I know some people are going to have trouble with that. It's too simple. But, if you look at the history, this is what the history demonstrates. So we've got a few years left up yet.
Adam: Â Right, and so, and then what you also talk about is these mid-cycle downturns, right, and that's not a real estate downturn is it? So is that what we're hitting right now and is that naturally triggered by this "black swan" events of COVID-19 or is there something else going on, do you think?
Phil:Â All right. Now there's two things in that. The mid-cycle is usually just stock market driven. After seven years going up and the 70s bull market, it's just time for a pause. It doesn't usually involve real estate or land values and that's because interest rates are usually lowered fairly quickly. The second thing is on that, you know, you mentioned what they call a "black swan" event. That's named, of course, for the black swans that turned up in Perth, in Australia, when the settlers discovered there was such a thing as a black swan. I don't think there are black swans in economics. I say that for the very simple premise that after seven years of asset price rises and credit creation, it just so happens that if you get an event that sort of tends to come out of the blue, because we've had so much credit, it's just that the economy is on a weaker footing. If this same event had happened at the lows, you know, it's probably not seen as so dramatic and it's not going to turn the economy like it normally would.
So I'm not a believer in black swan events. It was just time. It was time for some sort of event to take place that would turn the crowd from greed to fear. And if you have a look, mid-cycle, you'll see there are always events that take place mid-cycle. You can go back to the year 2000, 2001, where you'd had a huge boom take place before that. And of course, you got the events of 9/11 that turned greed to fear. If you go back to 1981, 1982, it was very high interest rates. And then you've got Paul Volcker at the Fed having to introduce some dramatic strategies that again, turned greed to fear. Adam, I can tell you and Steve as well, this is a very regular pattern. You can see this. It goes back to 1800 in the United States. I'm staggered that other people don't see this, it really does.
What History Teaches Us about the Future of Real Estate
Steve:Â Â I know that the phrase "black swans" been used since Nicholas Taleb introduced it a lot and your philosophy on the greed turns to fear and there's just a pivot of weak, a weak economic system that's occurring at that time. Do you think 2000 was the 2001? Was that a recession? So you would categorize that actually as the mid-cycle correction, right?
Phil: Â Â Yes, it is.
Steve:Â OK, because that's where everyone, I think, gets a little bit off when they're thinking about the 14-year timeline.
Phil: Â Â Yes. Well, let me let me say that, let me give you another example. I think, based on history repeating, that we'll get a fairly decent recovery after the next twelve months. We've got all the fear to go through first. But once you get to 2022 and thereabouts, a bit longer, everybody, bankers, as I mentioned before, will congratulate themselves for getting out of the recovery. By the time we get to 2026, after we've had 14 years up, very few people in the system have got any memory of the real serious land price led recession back in 2008, 2009. And memory will just stretch back to, that's how we're 2026 looking backwards, memory will just stretch to what all the resources that people were able to combine in lowering interest rates and the Fed action that's going to take place over the next six months or so.
And they'll say that having worked. So you again, get into that false sense of security and, you know, you will get the same thing happening again in 2026 and 2027 if there's a bit of a hiccup, you know, that the Fed will come out and say, we've got it all under control. We'll be at low interest rates again. We'll be out of this procedure. But it won't work because the next one, not this one we're in currently, but the next one, will involve, we'll head 14 years up and it will involve land price coming down. And if the land prices go below the value of the credit outstanding, the world then has a systemic problem and lowering interest rates doesn't fix that problem like they discovered in 2008, 2009.
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Big Events Always Trigger Changes in the Economy and Real Estate Cycle
Steve: Why do you think we have a long wait for the U.S. to drop rates? That's number one. Number two, because they can move very quickly when they can move aggressively down and then I guess maybe because you only think it’s 12 months to make the correction. I'm answering the question maybe there. But the other question is, what do you think about negative interest rates and the impact?
Phil: Yeah, that's a that's a good question because even though I'm suggesting a reasonably simple premise of 14 years up, 4 down, clearly there are things happening today that didn't happen in 1810 and 1910 and 1950. We've got, so for example, that you know the cycle just gone, we introduced exchange rates and then exchange rates went floating, that sort of thing had never been, that hadn't been done before in any of the prior cycles. If we had the introduction now of, as you suggested, the possibility of interest rates going negative, and indeed some places have. That of course is a first as well. That's not going, happening before.
So, the cycle can never repeat exactly. If it did, everybody would see it and we'd all make our actions to develop strategies and things. So that's the first part on that Real estate's often going forward can never repeat exactly. There has to be stuff happen. There has to be things happen that's going to make people confused and everything else. The reason I mentioned that is because what I discovered when writing my book and this might be a little bit hard for people to believe in. It was a bit hard for myself.
But what I noticed when I was, when I did all the history and, you know, you know, you've read the book, there's a lot of history data that demonstrates the repeats. I found that events happen in the United States that will ensure and that will definitely make the real estate cycle repeat. Now, I can't always know what that will be to make the repeat happen. And we're going to get different events take place. That will be a little bit different all the time. All I know is events will take place to ensure the repeat of the cycle. And so far, in my opinion, it will happen at the right time.
So, let me give you, let me give you an example of what I mean by that. As we went from 2009, 2010, 11, 12 and 13, we got to 2013 and the United States stock market, the Dow Jones and other indices broke into all-time new highs. Yet when it did, it was very subdued and there was still an enormous amount of people in the United States that just simply thought the recession would go on forever and that there'd always be another problem around the corner.
We got to 2015 and then 2016 and we had market hiccups there and all the bears came out and said this was another repeat of the Great Depression and that we'd all have to hunker down and buy a gun and bury your cash in the backyard.
And then Mr. Trump came along, you know, a real estate guy at the top of the White House. And he spent several years trying to convince everybody that the that things were on the up. That, you know, he added to it of course that he was creating all this stuff.
And, you know, we got into 2019 and I think, I think with a few people, it started to resonate. And did you notice that a good deal of greed started coming back? So, that was the catalyst that put people started forgetting about what happened in 2008 and started looking forward. And so, by the time we got to 2019, just about everybody in the United States was looking forward.
And of course, as I also show in my book, when you get, when you get seven years up, of the real estate market, and a very big bull market, you know the history shows that years ended in 9 And you go back a long way, years ended used in 9 usually come in is a type of peak in the stock market. All we needed was for somebody to stand up towards the end of 2019, early 2020 and give a big rah rah and say that the business had conquered the real estate cycle. And we had Mr. Trump himself come out and say that it was the greatest economy on the earth that had ever been created.
Implications of the U.S. President Being a Real Estate Developer
Adam:Â Â Is it different this time? Right? The four most dangerous words you can say, "it's different this time". Is that four? It's actually five. It's different this time. Right? But in the sense that, for the first time in history, we do actually have, correct me if I'm wrong, but in the United States, a real estate developer running the country, right? So he sees the world through this same lens, in some regards. Actually, why don't we just start with that and then I want to come back to the question of liquidity. So what do you think about that?
Phil: Â You go back to the first president of the United States, George Washington. He was, at the time, America's largest landowner. I mean, we've just gone back, talk about back to the future. So, you know, normal, I think really, I don't see anything different from that point of view.
Adam:Â Â In terms of the way that the economy is being managed, interest rates and tax breaks, et cetera?
Phil:   Again, I see it as the same thing. There's very little change there, especially with banking. Banking is all about the credit and banks have to have that small margin where they're lending out money greater than what they are paying out. That process has been going on for a long time. And certainly since 1800, in the United States, when the federal government there began selling off their real estate in large chunks, 160 acre lots, really, you know. You went to the frontier, you staked out your 160 acres. You went to the titles office to get title and you went to the bank to get some credit. Prices are not really so different today, is it, that much. And it's so, you know, sorry, my book, it's all based on the enclosure of the rent. So, you know, it goes from there.
How Excess Liquidity and Credit Impact the Real Estate Cycle
Adam:Â Â The connection between banking and real estate and the cycle is the connection between, is liquidity. That's what connects the dots. Can you talk about that a little bit and how that inflates and impacts the cycle?
Phil:Â Â Yes. Well, that's it in a nutshell, really, and I don't think that's changed greatly in history, you know. I can't see it stopping either and you know we all need the credit and now I think banks, they tried to do a reasonable job. It's not anybody in the system, that causes the system, it's just all of us acting together. Everybody tries to do the decent job that they can so I'm not trying to lay fault or blame on anybody. It's just history just seems to show that 14 years up, 4 down and it's just a collective action, I think.
Adam:Â Â And that's brought about by excessive liquidity though, towards the end, right?
Steve:Â Â Â Do you mean excessive liquidity or excessive credit?
Phil:Â Â Credit. Excessive credit. Yes. Credit. The creation of credit. Yes. And the crash is basically on the land value.
Steve:Â Â Â I guess I knew what he meant, I was just clarifying.
Adam: Â Â But it does also refer to equity as well, right? Credit is borrowing but as credit goes up, by banks, as banks inject more into the system, people tend to pursue that with greater amounts of equity. So there is generally more liquidity. It's just more money in the economy, right? The real estate economy chasing what there is out there and that's what creates this price inflation.
Phil: Â Â Yes, it is, though, at its core, It's the creation of credit backed by what I would call land value but basically a mortgage. So it's the creation of credit on the mortgage. That's the system.
Why Opportunities in Real Estate Are Either Opportunities or Chaos
Steve: I have a friend who is very experienced or seasoned, meaning he's very old. And I asked him once, advice about investing in the market, during a recession or during a major, you know, borderline depression/recession. He said, all you have to do is remember these words, which is: "it's never been this bad before". And when you hear those words, start investing, because then, you know, everybody's so afraid that that they're not going to take any action and that's when the opportunity will come. So, to your point, I guess I feel Adam saying paraphrase what he said, I'd love to know the answer to this, how can every time it be worse than the last one?
Phil: Well, of course, you know, I'd like to put a bit of perspective on that.
It depends from whose perspective, depends from whose point of view you're talking. You know, for me, 2008, 2009, 2010, I can genuinely tell you, I knew that was coming. Now, I know, you know, we're sitting here in 2020 and now it's very easy in hindsight to look back. But, I can genuinely tell you, after having the book come out in 2008, I was ready for that downturn. I've often told the story, you know, I had my cash ready to go. You know, it wasn't, you know, we're not talking hundreds of millions a year, but we're talking a reasonable amount for an individual investor, and I was able to buy up. I had my office in both France and London at the time. Indeed, I'd already retired to France to write the book. I bought several properties in central London at that time in 2009 and 2010. They were bargains. But it was, you know, it wasn't easy to do. But I had the strength of the book behind me. So, you know, it depends from whose perspective you're looking at these crashes and things. You know, if you're going to be buying. Let's just assume. Economists like to make assumptions, but if we suggest history to repeat 2025, say, it's not going to be a great year if you go highly leveraged in that year and we've had 13 years up of rising real estate prices. History suggests, now, I could be wrong.
But history suggests that's not going to be a great year to go really highly leveraged. But some people will and that'll create the opportunity in the downturn. After that, it'll either be the worst thing in the world that's ever happened. It'll be calamity and chaos and woe is me and it's just gonna be a disaster. Or you can at least try and have some sort of understanding of history and you could do better than read my book to have a bit of an idea of what might be coming next and try and at least reasonably position yourself for that, you know, so I don't know. I'm a bit circumspect on what you'd call these things, you know, their opportunities or chaos.
Subtle Indicators of Shifting Economic Cycles
Steve: I think I read this in your book, so I don't want to put words in your book, or in your mouth, but I thought I got the impression from the book that as we hit the mid-cycle correction, I thought it was a really an equity market correction. Adam and I know communicated a little bit.
Phil: Yes.
Steve: And you've clarified a part of my assertion on today's podcast, which is amazing. But one of things I thought I read from your book and again, I might have misinterpreted this, is that the people, who, the individual speculators in the market and there are a lot of them. I think it's even different now that people are in the market and I'm saying the market I mean, the public equities market, because of the availability and the advertising and marketing to what I'll just call the average American family or the average Joe or a non-accredited investor. The amount of families, you know, investing in the stock market today has got to be dramatically higher than it's ever been in the past. And what I eluded from your book, I think, and I'll want you to correct me if I'm wrong, is that. What ends up happening with a lot of those families and a lot of the speculators is they end up losing money in this mid-cycle correction and I have lots of friends who in the last two to three weeks have lost a, you know, a ton of money. They get scared and you know, like you said, greed turns to fear.
They pull their money out and they say they're never gonna do that again because it was gambling, or they can't resist the temptation not to pull their money out because they're really concerned. Is it going to get worse, and they then look for another asset class, which what's the one that never disappears in their mind is real estate. And then they then go and put their money in real estate. Thus, over the next phase of the cycle, we'll call it the second half of the game, like you're calling it. They drive up prices because now there's all this new liquidity in the market and all this new speculation because where else are they going to put their money. They've had this great run now they want to put their money somewhere else. So, I may have made that up. It just seems like in my career that's been how it's gone.
Phil: Now that's fair. I would also watch for some more repeats again as we go into the second half of the cycle. I would stay alert for technology companies turning to real estate, so it wouldn't surprise me. Well, I think it's already happening now, but it might come out of China first. Tencent and Alibaba and other sorts of companies, former real estate or former tech companies particularly. They still are tech companies, of course. They start to get into banking. They start to get into lending money. They start to get into, what usually happens, a new type of finance comes out, so I don't know how that will develop, but it could be, you know, it could be all sorts of digital coins and everything else.
And so, you may have picked up, in the book as well, in the banking chapters. New technology comes out that allows new startups and new tech companies to take advantage of the new forms of banking. That's particularly relevant because the workers and the creators of those companies, they don't have a long history in real estate. They don't have any memory of past downturns. Indeed, the past downturns, they won't have lived through because they're either too young or at university, and so they've never seen the past downturn. I'll have 14 years up of real estate. I think that real estate prices have never collapsed.
They always go one way. You'll get the tech companies going into firstly banking, and then by default, if I ever start lending credit and even lending funds or creating credit based on some sort of mortgage or things you've got to offer as credit as the security. You get all the setup for the second half of the cycle coming. Those type of activities, that the tech companies that go into banking, and other things, they bring with them a crowd of young people that, you know, they are devoted to the new technology and that's the second half of the cycle, you know, it just creates a lack of memory in stuff.
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