In this episode, Ryan Smith, John Chang, Hunter Thompson, and Neal Bawa have a lively debate about whether interest rates will rise over the coming year.
- Ryan Smith: http://elevationcapitalgroup.com/
- John Chang: www.marcusmillichap.com
- Hunter Thompson: https://asymcapital.com/
- Neal Bawa: https://grocapitus.com/
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TRANSCRIPTION
Joe Fairless: Welcome to another special episode of The Best Real Estate Investing Advice Ever Show, where we are sharing the top sessions from the best ever conference 2021. This year, the Best Ever Conference is back in-person, February 24th through 26th. Come join us in Denver, Colorado; you’ll hear all the new keynote speakers, you’ll meet some new business partners, you’ll learn some insights from the presentations and from the people you meet, that you can apply to your business today. Here is an example of a session from last year that is still relevant today, and will be beneficial for you.
Ben Lapidus: We are on to the most exciting part for me where I get to participate in the intellectual debate. This year, we’re talking about interest rates, which is a scintillating subject matter, because John Burns hinted that interest rates are going up to 1.8% in the next year, and others have hinted they could go down. There are negative interest rates and other countries around the world. Will US interest rates be higher 24 months from now? We’re going to find out. I’d like to introduce our speakers, one at a time.
First, I’d like to welcome back Mr. Neal Bawa from Grocapitus; he’s got an amazing Udemy course, he is a makeshift economist in his own right. And interestingly enough, he raises a million dollars a year just from the tomatoes in his backyard. Welcome, Neal. I asked him how, and he wouldn’t tell me. He said, “You have to ask after the show.” If you didn’t have a question for Neal, now you have one. Neal will be debating for interest rates being higher, he’s for the motion.
On the other side of the queue is Mr. Hunter Thompson. Welcome back from Asym Capital, this is going to be your second debate with the Best Ever conference as well. What’s awesome about Hunter is that he seems like he is a powerhouse. He’s always running a marathon in his work, but he does it in a slow, smooth way. How does he do it? Apparently, this mastermind can run a three-hour and 10-minute marathon, which just shows his endurance. He will be debating against the motion for interest rates either being at or lower, where they currently are today.
Joining Neal will be Mr. John Chang from Marcus and Millichap. Again, the chief economist of Marcus and Millichap. Interestingly about John – I know his life shifted drastically with COVID. He did 62 presentations last year that he otherwise would have had to travel to, but hasn’t stepped on a plane since COVID started. So good for you, John, welcome to the club. I also enjoy not traveling, which isn’t very good for acquisitions. But I suppose it’s why we’re growing teams.
Then joining Hunter, against the motion, is Ryan Smith from Elevation Capital. He’s been in the business for multiple economic cycles. He’s looked at mobile home parks, self-storage, and plenty of other asset classes, and he is keeping his pulse on the market. Like Neil, he eats a million dollars of tomatoes a month, but his interesting fact is that he is a size 18 shoe. So watch out Neal and John, he might step on you.
With that said, I’d love to get this debate started. Will US interest rates be higher in 24 months? We’re going to have three phases here. The first is going to be opening arguments from each of these gentlemen over the next two minutes apiece, then followed by some scintillating debate, followed by closing arguments, and we will see who has influenced the most minds. How are we going to measure the winners? You, as the audience members are going to vote. You’re going to vote once right now, and you’re going to vote a second time. The winner won’t be who gets the rawest percentage points of participants to agree with them, but rather who has influenced the most minds. Who has created the most spread between the starting and ending percentage rate.
So I’m going to open a poll right now. 60 seconds on the clock. It is now open. Will US interest rates be higher in 24 months? You can answer yes, no, or undecided. You have 60 seconds. And just maybe in that time frame, we can get Neal to fill the 60-second void with how he raises a million dollars a year with the tomatoes in his backyard. Can I get you there, Neal?
Neal Bawa: You want me to tell you now? Very simple.
Ben Lapidus: Yes, please.
Neal Bawa: I install LED lights in my backyard, and they’re very bright. They’re two different colors. My neighbors, as they’re walking past… It’s a very rich neighborhood, everyone has million-dollar mansions… So they’re walking and looking at what I’m doing with my tomatoes. I leave the lights on 24 hours a day, so my house has this Halloween-like glow all year. When the tomatoes are grown in the summer, I go with a bag to all of my friends, and they want to know everything about the tomatoes because they’re so curious, they’ve been walking past the entire year. So, of course, that call lasts about an hour, and during that hour they asked me what I do. Of course, the story starts, and before you know it, they’re asking to be investors. So each year my yield has been higher than a million on the tomatoes.
Ben Lapidus: I expected nothing less from that answer Neal, that’s amazing. It’s a great story for debates that are virtual in a world like this. Thank you for helping me fill the time. So we’re going to do five, four, get your answers in now, three, two, I see a couple more, one… And we are going to hit the right button this time and pull — oh, you snuck that last one in there. So the folks who are debating against the motion, will the US interest rates be higher in 24 months? The answer being no, at, or below, have their work cut out for them, with only 15.4% of respondents thinking that that will be the case. 74.4% of respondents believe that US interest rates will be higher in 24 months, leaving a very small slice of the audience who is undecided to have their mind shifted. Hunter, Ryan, you guys have your work cut out for you. 10.3% undecided. Let’s go. We’re going to start with Mr. Neal, with your opening remarks. Two minutes on the clock, and I am timing you.
Neal Bawa: Anyone that thinks that interest rates will not rise over the next 24 months is quite simply delusional. We’re going to hear phony arguments, like the Fed has promised to keep interest rates low, or that the underlying economy is too weak to raise rates, or that the Fed is afraid of a double-digit recession, so they will not raise. Our team, John and I, will prove to you that all of these arguments come from just one source. They come from our inner desire as syndicators and apartment owners to see ever lower interest rates so our cap rates keep going down. We love drinking the Kool-Aid, we love smoking the opium, and we end up looking at only one side of this argument. And then we use social media to spread that one-sided argument to the point that we actually think that everyone is saying it so it must be true nonsense. Nonsense. Throughout today’s debate, we will present tangible, fact-driven arguments that will prove that not only are interest rates going to rise, but that there is already evidence that they will need to go up, already.
Our esteemed colleagues are going to spend a lot of time pointing to a year-old statement from the Federal Reserve as proof that rates will stay low. What they will fail to tell you is that the Fed also mentioned in the same statement that there are a data-driven organization and they will change their stance as necessary. At the time the Fed made that statement in Q2 last year, that pandemic was the greatest threat that the world economy had ever faced, ever. And that statement did its job already. The stock market bounced back, interest rates went down, real estate when ballistic, the US economy came out of the recession much faster than anyone had thought; it did its job. Now the Fed has to do what’s right for the US economy. Stocks are at an all-time high, real estate is going insane, one Bitcoin costs more than a luxury car; asset bubbles are everywhere. The Fed’s watching carefully, patiently. But folks, 24 months is a long time. The Fed does not have 24 months. They will have no choice but to start raising rates a year from now, and we will prove this to you beyond any shadow of a doubt. Thank you.
Ben Lapidus: Perfect two minutes, with inflammatory language to get Hunter and Ryan all riled up. Hunter, I’d love to hear that response. Two minutes on the clock, sir. You are good to go.
Hunter Thompson: I’ll keep it as brief as possible. Just for context, in terms of how we anticipate this is going to go… We’ve got John Chang, who on my podcast mentioned they spend about five million dollars a year in terms of proprietary economic data. We’ve got Neal Bawa, who is literally known for his ability to analyze economic data. Three years ago, I was asked to be a debater at this stage, but I was shortly told after that I was not the first pick. In fact, I wasn’t the second pick, or third pick, or fourth pick. I was the 13th pick to be on the debate stage just a few years ago. They had me paired with Ryan Smith, who for my understanding is a previous baseball player. So I’m looking forward to understanding how this is going to play out. Now, I was told to throw bombs; maybe I shouldn’t throw bombs at my teammate. But alright, just so we’re just we’re on the same page, let’s get into this.
I think that this is an important discussion, because a lot of people think that real estate is a great bet, regardless of what interest rates do. That’s pretty much the totality of their understanding. It doesn’t matter if they’re low or high, real estate is so good we should be participating. But the decisions we make based on interest rates are very consequential. There are some very savvy fund managers that made incorrect decisions, specifically to exit multifamily, with the intention of thinking that interest rates would rise and cap rates may similarly expand. And hundreds of millions of dollars of managers refuse to take floating rate debt, because they anticipated that interest rates would rise. Going back to 2010, that was the same question everyone was asking. When are they going to rise? How quickly is it going to happen? Look at the debt to GDP ratio; eventually, there are going to be some headwinds. And this whole time, they’re asking the wrong question. Really what the question needed to be was, how low can they go, and how quickly are they going to go negative? That’s the question that I’m seeing more and more as being much more important for us to ask as real estate investors, and what does it look like, and what real estate investment should be pursuing if that’s the case.
So my goal for this is to paint a very clear picture. When we look at the macroeconomic picture, we see where interest rates are headed. If you look up the 100-year or 200-year interest rates of the United States, it’s a very clear picture down and to the right, especially the last 40 years, down into the right. I’m not going to get up here and tell you that this time it’s different, and that this next decade, or next two months, or anything like that is going to be anything other than that. Now, the 24-month period is a short timeline. But from my perspective, this is like pocket aces versus pocket kings. Pocket kings can win sometimes, but that down and to the right trajectory is not going anywhere.
I’m also going to talk about the Bank of Japan, European Central Banks, all industrialized countries that have moved to zero or negative rates, and how the US political system, the incentive alignment associated with that, and the Fed working hand in hand have painted themselves into a corner that even in the most robust economy of the last 50 years cannot substantiate rate increases. That’s what we’re going to talk about today.
Ben Lapidus: Thank you, Hunter. Just so everybody knows, Hunter was my first pick this year, because of his amazing contrarian views on his podcast over the last few years. Thank you for joining despite the amazing competition you have on the other side of the aisle. John, two minutes on the clock, your opening arguments debating for the motion, interest rates will rise in the US, 24 months from now.
John Chang: Alright. Hunter actually ran off into left field for a little while and then he came back and argued that it’s down and to the right over the long term. But I want to pull some different context and some different data into the conversation. When the pandemic hit the US, our economy shut down like someone hit a light switch. We’ve only partially recovered from that. And when vaccinations reach a critical mass, likely in the second half of this year, economists are forecasting the economy is going to come roaring back. A new roaring ’20s, if you will. So the governments already injected 3.1 trillion dollars of stimulus into the economy, it looks like another 1.9 trillion is on tap; that’s five trillion dollars of stimulus, which is basically the equivalent of the entire economy of Japan being injected into our economy in cash. That is a lot of money. On top of that, the US money supply is over 19 trillion dollars; that’s up 25% in the last year to the highest level ever. As I mentioned this morning in my presentation, economists are forecasting growth in the 5% to 7% range in 2021, the strongest growth in more than 35 years. When the global economy reignites, it’s going to spur a surge in commodity prices, like oil. We’re also going to see growth in consumer good pricing, and that means inflation.
Part of the Fed’s mandate is to control inflation, so they cannot allow it to take off. They’ll need to do two things – raise the federal funds rate, and mop up liquidity. Now I’ve got to point out – back in 2013 after the financial crisis, when the Fed just mentioned the idea of reducing liquidity, Fed Chairman Bernanke’s remarks sparked the taper tantrum. That drove the 10-year Treasury up by about 100 basis points in about 100 days. So even a hint that the Fed plans to walk back into an accommodative stance could spark a flood of capital coming out of the bond market, which will push up interest rates. As my partner Neal pointed out, the Fed is a data-driven organization. Back in 2018, Chairman Jay Powell demonstrated that he has the backbone to go up against popular opinion and raise rates. So the Fed will not stand by, risk runaway inflation, and let the economy overheat at a record pace. So there you go, there’s my two cents.
Ben Lapidus: Thank you, John. Thank you for those nuggets of wisdom. To close out our opening arguments, debating against the motion that US interest rates will be higher in 24 months, Mr. Ryan Smith from Elevation Capital. Two minutes on the clock.
Ryan Smith: Awesome. Well, since nobody’s used a movie quote… When Neal was talking, I was disappointed. I was hoping he would end by saying “sexual chocolate” and just drop the mic, because that was just pretty thematic. Second, there’s going to be a lot of facts, figures, and numbers shared; I’ll just remind the audience that about 87.32% of all statistics are made up on the spot. With that in mind, I will also remind, to start, that the burden of proof really isn’t ours, meaning Hunter in mine. If all prevailing trends continue as is, unabated, we’win the argument. Their side will have to prove that if this, if that, and sequential ifs happen, then they’ll be correct. To that end, I’d have anybody go back and watch the debate last year in Neal’s position around cap rates, and should I buy or should I sell. I think there’ll be a similar outcome this year. But with all that being said, I remember back to 2014, talking to a number of limited partners that were interested in certain things, and the general thought was interest rates have to go up. In 2014, interest rates have to go up. Inflation is right around the corner. I heard talk of hyperinflation and the question I would ask is why. And there’s a sense that, well, it has to. But why? Well, it has to. And they were wrong, to Hunter’s Point.
Similarly, in about 2017, there was a lot of discussion around cap rates. Cap rates are at historic lows, they can’t go lower. Again, why? Because they can’t. Well, why? Because they can’t. Those folks, to Hunter’s Point, were wrong. So there’s a sense of nostalgia that I detect in the market, where there’s this sense that equilibrium… We’re going to go back, return to this point of equilibrium where everything’s just hunky-dory. But when you look at the data, things move in long-term trends; it’s either moving up or down. The trends that we’re going to be talking about, which is supportive of our motion, which is supportive of our position against the motion, is that since the year of my birth, 41 years, interest rates have been declining. For the last more than 10 years, the Fed funds rate has been declining. The Fed is actively and currently growing its balance sheet through Treasury purchases, which puts downward pressure on treasuries.
Similarly, the money supply has increased 250% since 2010, and 20% in the last year. There’s a flood of liquidity, which John alluded to, and his “if they mop it up” – that’s a pretty big if; there’s a lot of liquidity in the marketplace.
And lastly, when you look at transaction volumes, they are flat and declining over the last several years. So you have downward pressure that will likely remain. On the Treasuries you have thinning spreads that lenders are charging over the Treasuries, as there’s more supply of capital than there is demand for it, due to declining transaction volume.
So the last point, just to speak quickly to Neal, I’m actually in favor of inflation. I like inflation. We have members of our team that were operating in the real estate sector in the ’70s, when interest rates were 16% and things generally performed pretty well at that time. So I’m not in the camp of lower interest rates are better. That being said, I think it is a reality that will happen.
Ben Lapidus: Amazing. Thank you, Ryan. I wonder how many people got the movie reference. Thank you for that. Nobody got to see me laugh behind stage.
Break: [00:17:17] – [00:18:56]
Ben Lapidus: John, I want to start with you. And folks, because of our time, I know that we’re virtual so it’s a little bit weirder to kind of corral everybody… Do please keep your preambles to a minimum in answering these questions. Do feel free to answer each other, but I will intervene if I think we’re going off course.
John, I want to start with you, and I want to refer back to Ryan’s point. Ryan is saying that the burden of proof is not on Hunter and Ryan’s side. Interest rates have been declining for decades. And you’re mentioning a 7% growth rate, but Hamad Khan on our chat is suggesting he’s concerned with GDP and unemployment. Isn’t a 5% to 7% growth rate just recovering from a massive drop? Is hyperinflation something to be concerned about? Or is Ryan’s point valid?
John Chang: Okay, so you covered a lot of territory… There is that long-term movement. It’s been coming down, interest rates have been coming down for a long time. But we can’t count on that trend. If you look at the last 10 years, it’s been hovering right around 2%, and that seems to have been the balance. But you can only push things so far. The money supply is almost 30%, the Fed balance sheet is off the rails; it’s up 80% since the beginning of the year. So you see all these numbers and you say, “Okay, we can continue to do this. We can continue to stack it up. We can continue to pile into our debt and our overload.” But eventually, you start to hit a point where it breaks down. And if you look at the liquidity and the bubbles that have been forming… The stock market’s up 21% in the last year, and we went through a pandemic; it doesn’t make sense.
The problem is there’s too much money pursuing everything, there’s too much cash in the marketplace, there’s too much debt, and the interest rates are so low, it’s fueling that. That’s why there’s so much fear of an uprising of the interest rates, is that it’s going to create a contraction in the liquidity and cause some companies a lot of brain damage.
So I just really don’t think that the idea of long-term growth is going to hold out with regard to hyperinflation. It’s possible, but that’s exactly what the Fed wants to avoid. They’re going to let it run hot. If it gets into the two-and-a-half percent inflation rate, they’re okay with that. If it gets up to 4% and 5%, they’re going to hit the brakes; they’re going to hit them hard. And then they’re playing catch up, and that’s when you really start to run into some problems.
Ben Lapidus: Awesome. The against team, do you have a counterpoint to that?
Ryan Smith:
A couple of things. Again, it’s the if, if, if, if, if scenario. Again, it’s things can’t go lower. Why? Because they can’t. Why? Because that reaches a breaking point. Well, that breaking point wasn’t just described, it wasn’t articulated as “Here is the set of factors.” It’s this comment, which I agree with John, there’s likely going to be, some call it a number of names, call it inflation this year, for a number of reasons. I would at least submit that maybe a proper term would be reflation, not inflation, as the economy kind of comes back to its natural life, I think, to the gentleman who made a remark in the online interface.
But again, when you go back to the historic measures, when you look at inflation, John just said 4% and 5%. Well, there are two things that are problematic with that. One, there’s been only one time in the last 12 years that inflation hit 3%. That’s the peak over the last 12 years. It hit 3% one time, for less than half a year, and that’s the peak. That’s the highest inflation that has hit roughly in the last 12 years. Then the second, seen in advance of what I believe we’re talking about, which is this inflation/reflation argument, the Fed has modified their policy stance, which I find personally intriguing, for reasons we can discuss at another time. But the point is, late summer, I think early fall, the Fed announced a policy shift where their target is 2% inflation. However, they’re now considering it in the aggregate. And that simple little shift is a pretty big departure. And what that says is, simply put, that they will let inflation or reflation run without moving the Fed funds rate at all.
And to put one last data point on that, when you look at the trailing two years, which if you add that two years to now, you’ll find that we’re right. But if you go back for the last 24 months, the moving average for inflation has been 1.14%. If inflation, to John’s point, or reflation, does come and tick up to 3% for a year or more, the average would be barely more than 2%. Again, it’s a nonsensical argument, because I don’t think the possibility of that would even occur by the time the two years happens, which would, again, give us the victory in this debate.
Ben Lapidus: I appreciate that, Ryan. So Neal, Ryan is saying that the Fed has shifted their monetary policy, Hunter is suggesting that there is precedent globally in more developed countries… Not more developed, but more socialized countries, for interest rates to go to zero or negative. President Trump, during his time in office, exuded jealousy over that fact. So you suggested in your opening arguments that there is, “evidence that the Fed needs to increase those rates.” Given those arguments, what is that evidence?
Neal Bawa: Well, I want to start out by saying that Ryan is completely wrong when he mentioned that the burden of proof is on our team. All Ryan has to go out and look at is past recessions. The Fed raised interest rates after the 2008 recession. In fact, the Fed has raised interest rates after all recessions end. There is actually no proof of the Fed not raising interest rates after a recession ends. Show me that proof, Ryan; show me that proof.
And by the way, Ryan’s been reading stuff from a year old. He needs to actually go hit the newspapers, because on January 27 this year, the Associated Press reported that the Federal Reserve removed certain statements from their December statement that had said that the pandemic was pressuring the economy in the near term and posed risks over the near term. Why did they remove that phrase? Well, according to Jerome Powell, the most powerful man in America… It’s not the president that’s the most powerful man in America, it is Jerome Powell. According to Jerome Powell, the Fed now, today, sees the pandemic increasingly as a short-term risk, that will likely fade as vaccines are distributed more widely.
There are short-term risks that happen in the US economy all the time. We don’t even need to go into recessions; with the Fed changing its stance to the pandemic being a short-term risk – Jerome Powell’s words, not mine – there is now clear evidence that the Fed has changed its stance. Now, the Fed, when it changes its stance, takes time to move people from A to B, because they don’t want markets to crash. But if you simply read what the Fed is saying, look at what the Atlanta Fed is saying, look at what the St. Louis Fed is saying, it’s clear over the last two months that they’re changing their tune. And keep in mind, to win this argument — this argument is not whether interest rates will change in the next six months. In fact, John and I are not arguing that at all. We are saying that it’s impossible for the Fed to keep the rates this low for 24 months. If they raise rates 23 months from today, we would win the argument. What is the chance of that happening when the Fed is already talking about it, already backing away from its arguments? There is abundant evidence, Ben, that this is already happening. We just need to read the articles that are out there.
Ben Lapidus: So Neal, you invoked Ryan’s name. Ryan, I want to give you a chance to respond to that. Then I’ve got a question for you, Hunter, from the audience.
Ryan Smith: Neal, I’m a big fan of yours, by the way. I love the banter. But I would say similar to the fact that Neal grows tomatoes and ends up convincing people to invest in securities at the same time, it’s similar trickery. He just conflated two facts that are not to be interposed. So I’m familiar with what he’s saying, and I read generally publications with words that are longer than four characters… But in short, the conflation that he just made is the difference between the Fed’s shift in recognizing that the pandemic is a short-term impact, which I 100% agree with him, and recognize that with my point, which is still actually enforced… And the point I’m making is the Fed has made a policy shift and still maintains that policy shift. And what that shift is – it’s fundamental and it’s pretty seismic, in that they’re saying that, yes, inflation may kick up in the short run; they’re acknowledging that. Again, we can call it reflation, inflation, we have a debate on that. But the point is, they are fundamentally — and historically, if inflation was to kick up at all, they would run in advance of it, raise rates, to Neal and John’s point, they would get ahead of it, try to pool in inflating situation by raising rates and kind of cooling things down as quickly as they can. Realizing some of the policy missteps in the past and some of the fundamentals in the economy currently, they have modified their policy stance saying “We’re actually going to let it run and consider inflation in the aggregate.” This is a really big shift, because now they’re not considering it at present value as it’s ticking up, they’re considering it to a degree a moving average of what it might be. So the point is, they’re going to likely let it run above 2%, and they have clearly stated and have not modified their stance that they will keep the Fed funds rate at zero until 2024, and also let inflation run, if it were to pass or come to fruition. So I would say, I’m not disagreeing with Neal’s point, but Neal had made a different point than I was making.
Ben Lapidus: Understood. I appreciate it, Ryan. We have a question from the audience for Hunter. You talked about the precedent of 0% or negative interest rates in other countries, particularly in Europe, I imagine. Can you reference those and try to draw a line for us as to why that might be a bellwether for the future of the US?
Hunter Thompson: Oh, it’s not just Europe, it’s all over the world. We’ve got Norway, Denmark, Sweden… Look it up. Industrial countries all over the world have zero or negative interest rates. So what I think people make the mistake of thinking is that how low can they go? That window is drastically different than what most people believe. It’s the same thing with how high can the debt to GDP ratio go before people are unwilling to purchase our bonds? Well, we have a tremendous amount of historical context and economic data to kind of discuss this. The the topic that I’ve talked about frequently, and I definitely want to talk about during this debate, is Japan. They have none of the advantages that we have in terms of the dollar being the reserve currency; they have about a 266 debt to GDP ratio. For those that aren’t familiar, they experienced basically an 80% collapse of real estate and stock market, it initiated a multi-decade-long, endless money printing. That’s the model that the United States is going after, that’s the model that Europe is going after; it will never end. The quantitative easing will never end. And because the debt burden becomes higher and higher and higher, the implications of actually raising rates become so burdensome that it’s absolutely crippling.
So when you look at the way the political system is set up to basically incentivize people to work on a four-year type of basis, and the Fed is certainly not set up to blow up the global economic picture… You just see this prolonged low interest rate environment. Now, the conversation about inflation is interesting, but I’m just not seeing it. So the question is, how much money printing can we have before this starts to happen? Again, look at Japan. Over the last three years, they’ve had half a percent inflation, -0.1% inflation, most recently and heading into 2021, 0.3% inflation.
So with all this money printing – and I’m interested to get both Neal and John’s perspectives on this – this does not result in CPI shooting through the roof. This results in the financial sector basically getting it and people purchasing bonds. So the negative interest rate bond market is about 16 trillion or 17 trillion dollars. That number is just going to go more and more and more.
The question about — and I’m assuming you’re talking about Europe… It’s much more widespread, and the reason it’s taking place doesn’t really make sense to me. These countries are buying their own debt, which suppresses their own interest rates. But I think people look at this and say, “Hey, Japan lost 80% of its stock market, 80% of its real estate market, and they’ve figured it out. They unlocked the ultimate key, which is that if you print enough money and keep interest rates lower, you never touch 10% unemployment.” Imagine that. Imagine the United States if you had an 80% collapse in the stock market and unemployment peaked out at 5.5%, which is what happened in Japan. People who are proponents of this theory view Japan as “We’ve unlocked it.” It’s like taking the power source and plugging it back into the power source. We got unlimited money now, and it’s never going to end.
Ben Lapidus: Hunter, I want to interrupt that, because I’ve got a fantastic question from the audience… And time flies when we’re having fun. So we are going to move to closing arguments after this. The question from Matt is if the US interest rates go negative –Mr. Matt Mopin, excuse me if I’m saying your name incorrectly– the dollar would be dethroned from the world currency… This is important to the point that you just made, Hunter, because the only reason we were able to execute quantitative easing is that we were the global currency of the world. So this is an open question for anybody. If the US interest rates go negative, the dollar would be dethroned from the world currency. True or false, and how does that impact your argument?
Neal Bawa: I’d like to take that on because, I’ve talked about this in the past. When Hunter tells this scary story to compare our interest rates with Europe, he makes what is known as a false equivalence. Then he compares us with Japan, which is an even more false equivalence. He fails to point out that the eurozone and Japan’s negative rate policies are in fact creating a massive, unprecedented flow of money into the United States. The Germans are sending us money, the Swiss are sending us money… When this money flows into our economy, it creates inflation, because it’s money that comes in here, and we have a fixed number of assets. When that fixed number of assets is presented with this money, it causes asset inflation. Because Ryan is confusing the Fed policy with saying rates stay lower for longer, with the Fed saying they will not raise at all. In fact, the Fed raises rates regardless of whether inflation is rising or not. Go back and look at when the Fed raised rates the last five times. They have raised rates when inflation is low. The biggest reason that the Fed raises rates is that interest rates are their weapon against a bad [unintelligible [00:32:55].22] They will raise rates whenever they can. They want to raise interest rates, because they lose this weapon if they simply never raise interest rates. Go back and look at the history of the last three or four recessions and you’re immediately going to notice that the US does not follow the world, and that is what gives us the privilege as a reserve currency of the world.
Ben Lapidus: Amazing. Hunter, he invoked your name, so I’m going to give you the last word here before we move on to phase three of this debate. Do you have a response?
Hunter Thompson: Sure. I’ll quote two of my favorite economists. This is from Larry Summers. “We are one recession away from joining Europe and Japan in the monetary black hole of zero interest rates and no prospect of escape.” Here’s another one. “It’s a good thing that we’re at positive yields. But our politicians want to go Germany’s route. Why? Because they can lend and basically borrow more money. The Treasury is financing our ridiculous trillion-dollar deficits with these kinds of Treasury bonds. So if you have a 10-year treasury bond that goes from 2% to 0%, now we can borrow so much more money. That’s the way the politicians are always thinking.” That’s from my favorite economist, Neal Bawa
Ben Lapidus: [laughs] Amazing final words. Ben Andrews, [unintelligible [00:34:10].13] I am going to get your question. I think it’s an important question, but it’s not substantial for the direction of this debate.
Break: [00:34:17] – [00:37:13]
Ben Lapidus: We’re going to move into closing arguments. Neal, I’m going to give you the last word. Ryan, I’m going to give you the first word in closing arguments here. Two minutes on the clock. Let’s try to get to that time folks.
Ryan Smith: First, let me say thank you, Neal, John, Hunter, and Ben. This has been lot of fun. I have a lot of respect for you. I’ve made my points in that, the trend is your friend. There’s a statement, “The trend is your friend, and don’t fight the Fed.” Both of those statements have us winning this debate, in that interest rates and both of those things happen, interest rates will be equal or lower two years from now.
Again, to my opening comment, I actually am rooting for inflation, against Neal’s assertion, because inflation can be incredibly positive in the asset classes that I play in. So for me, I’m actually a fan of inflation, but do not expect it. I actually think our position will be true in spite of my hopes.
And lastly, this whole debate that’s taking place – and if I may, I parked on the if’s. Let me interject my first if, which should tell you something about my stance. My first if – this is all presuming no global conflicts, which would cause central banks to seek flight to safety, which again wouldn’t create bond-buying of US Treasuries, depressed yields, and everything else.
We are in one of the greatest periods of peace in US history. And if you referred to a great book called The Fourth Turning, which is a regressive study of the market cycles for every industrialized population – it’s about 450 pages, and if you struggle with sleep, you should read it, it’ll cure what ails you… But in short, there’s a significant chance of global conflicts in the period of time that we’re in. So my position is interest rates will be lower, the same if not lower two years from now; I’ve made my case. All of that presumes no conflicts with China, Iran, Russia, or any of their surrogates, which I think is seemingly likely in the coming year. Anyway, I think we’ve got a good position, I feel good about it, and I’ve got a great teammate in Hunter.
Ben Lapidus: Awesome. Thank you, Ryan. The Fourth Turning, now on the reading list. John, final words.
John Chang: Alright. I want to tie up a couple of loose ends here. First of all, Japan has had negative treasury rates, but they’ve also had no economic growth. Their average economic growth over the last five years or so has been under 1%. So we’re not in that kind of a situation.
When you look at a willingness to raise interest rates – first of all, the 10-year treasury has gone up 30 basis points so far this year, and it’s already trending upwards, so there’s a basis going on right there. We also know that Jay Powell will raise rates. In fact, there wasn’t even that much pressure for him to raise rates. But when he took over as the chairman, he came in and just kept swinging. So in 2018, Jay Powell was raising rates, and he actually had to reverse course as the pandemic hit. So he’s one of the few chairmen of the Federal Reserve that I think would actually just go in there and just start hitting it.
The next piece is that we already have inflation. Just one thing for the real estate industry – construction costs for materials have gone through the roof. Lumber is already at a peak level, it’s up about 15% for materials on a year over year basis right now, and overall construction costs are up about 11%. So I wanna toss that out there to start… And the only circumstance that I can think of where interest rates don’t rise is if something bad happens to the economy.
If the vaccine doesn’t work, or if the vaccine actually starts the zombie apocalypse, or if we have a major economic setback – something like that could cause the Fed to ease off. My fingers are crossed that that doesn’t happen. The good news is that rising interest rates mean the economy is accelerating and doing very well, and that’s good for real estate. As Ryan was pointing out, a little bit of inflation is a good thing, and growth is a good thing. So we want those things, and we want the Fed to actually raise rates as we go forward, because that means things are going well.
The last piece I wanted to say is – pull it back to real estate. Look, take action. If you’re looking at refinancing, get it done. Yeah, rates can possibly come down in a short blip, but if you’re refinancing, refinance now. If you are buying an asset, lock in your rates. And if rates go down and you miss it a little bit, you’re probably okay. I don’t know anyone ever who complained that they locked in an interest rate at three and a half percent. So ultimately, we’re in a good place right now, it’s a great time to invest, and the opportunities are out there. But I still think interest rates are going to rise.
Ben Lapidus: Amazing. Thank you, John. Hunter, I will give you two minutes on the clock for your final words.
Hunter Thompson: Sure. I’ll try to keep it brief. I can’t see the clock, so give me the yank.
Ben Lapidus: You’re good.
Hunter Thompson: Agreed, interest rates rise when things are going well, and… Things are not going well. I think the metaphor is that we’re on morphine, so it feels like it. That’s not the right thing. I was injured, I had to get surgery on my shoulder; morphine doesn’t make you feel like this. This is adrenaline. This is adrenaline, but we’re just sitting at the desk, working like it’s normal. It’s not like being super productive, it’s just that we’re at the desk, we’re working, we’ll be able to keep our head off the desk because of the amount of stimulus.
There was a $1 trillion deficit in 2018, which was about 4.8% of GDP. That was the highest percentage deficit in GDP not in war times, in 2018, while we have the lowest unemployment rate of 50 years. That’s the type of situation that we’re in, where we have peak, peak, peak, peak debt, peak, peak, peak, peak deficits, all-time low-interest rates; if you sneeze, you create a massive economic collapse, and no one’s going to be on the front of that. Don’t bet against politicians acting within their best interest. Don’t bet against Janet Yellen being Paul Volcker all of a sudden; don’t make that mistake. I anticipate a similar to Japan low-interest rate, low growth, low inflation, kind of stagflation type of environment that continues on and on. That’s the way that I’m going to be investing.
Ben Lapidus: Thoughtful words.
Hunter Thompson: By the way, it can be quite lucrative for the real estate investor.
Ben Lapidus: Thoughtful words from Hunter. See, Hunter, that’s why you’re debating here for the second time with Best Ever. Thoughtful words that we can wrap our heads around. I appreciate the metaphor. And the king of metaphors and strong language, Neal – two minutes on the clock to make the most influence on our audience and this debate. Take us home, sir.
Neal Bawa: Ryan Smith said to Neal Bawa, “Show me the money.” And I said “Ryan, take a look. This is the greatest, the most super-heated stock market ever.” Ryan said, “I don’t see it.” So I said, “Take a look at the real estate market. This is by far the greatest, most mega-heated real estate market of all time.” Ryan said, “I don’t see it.” I said “Look at Bitcoin. One and a half-trillion dollars produced just in the last few months.” Ryan Smith says, “I don’t see it.” I showed him John Chang’s number of five trillion dollars injected into the US economy in the last 12 months, and Ryan Smith says “I don’t see it.”
The truth is, if you choose to ignore everything massive in the economy and base it on some old argument that has worked in the past, you’re not data-driven, you’re simply saying “It didn’t happen in the past so it’s not going to happen in the future.” Hunter says, “We see where interest rates are headed over 100 years.” We are not debating that, Hunter, we’re talking about the next 24 months. In the last 100 years, rates have gone up, rates have gone down half a dozen times. It takes our listeners less than five seconds in a Google search to prove you wrong.
I asked Hunter and Ryan, “When has anyone injected five trillion dollars into the US economy? When has anyone injected one third of that amount?” We are creating an asset boom the likes of which have not been seen since the roaring ’20s. The truth is our friends are confused. They think that because millions are hungry in America, we cannot have a booming economy. They think because half a million are dead, that we cannot overheat. This is an emotional approach, it’s an empathetic approach, it’s a good person approach, and I sympathize with them. But the truth is, folks, when the Fed makes decisions, it does not count the dead; it does not feel the hunger. It’s going to look at cold, hard facts. And our friends are choosing to ignore a mountain of evidence, and that is why they can see that interest rates must rise in the next 24 months. They absolutely must.
Ben Lapidus: There you have it, folks. Neal, your punditry is always a pleasure. So is the feature of interest rates based off of the adrenaline of the stimulus, as Hunter has suggested? Or have we over-compensated with the stimulus and interest rates need to go up to bring it back down to Earth?
So poll is going to be opened, we have two minutes to answer. Will the US interest rates be higher in 24 months? You get to decide what the answer is. Are you going to be voting for a future that hundreds to thousands of people will be seeing, predicting the future interest rates going up? Or will they be staying the same or going down in the next 24 months? You get to decide. The poll is now open. Yes, no, or undecided.
While we are doing that poll, John, I do have a question for you. This whole conversation is fantastic. I appreciate all of you guys. But what’s the “so what” here? We have a question from Ben Andrews. What are the implications for real estate investors just starting out if rates go up? Same question for if they’re going down. I’m going to couple that with a comment from Ryan [unintelligible [00:46:27].21] “John Chang showed the spread between a cap and US Treasury rates. at which point spread will investing in real estate not be worth it? Are interest rates and cap rates uniformly tied together? How much does this conversation matter for real estate investors?” If we have time for a second answer, I’ll let you guys jump in, but I want to direct this to John first.
John Chang: Okay, so I’m going to take the last part first. If you look at the trends on the cap rates and the Treasury rates, both have been going down to the right for a long time. But when you look at the short-term movements, it widens and it comes together, it widens and it comes together. Right now, it’s very wide, and that is good. We anticipate and I expect personally that interest rates will be rising. But I will also quote Mark Zandi, the head economist of Moody’s who said, “Forecasting interest rates is a fool’s errand and nobody ever gets it right.” So we have this window, and this is the “so what?” The window that we have right now is that the cap rates have been stable for the last two years or so. The interest rates have come way down, and the spreads from the bankers have tightened up over the last six months or so. So you can get financing on assets today. There’s a lot of liquidity, you can borrow money on just about anything, except for maybe a hotel or a big shopping mall. Outside of that, you probably get financing and it’s going to cost you less than it ever has. So the window is here; looking forward, those things can tighten. But I’ll tell you, even when they’re super-tight, investors make lots of money. People who bought real estate in 2007, when that spread was the narrowest ever, and held it, if they held it all the way until today, made a fortune on that real estate. So there is opportunity, and it’s just a question of how long it takes to get their perspective.
Ben Lapidus: Perspective appreciated. We’re going to close the poll in 20 seconds. Does anybody want to fill the space answering that question, with 20 seconds? Ryan.
Ryan Smith: Quickly, on the first part of the question, with is it good or is it bad? The answer is yes, unfortunately. There are two sides to the coin. You have cash flow, you have the value of cash flow, or the capitalized value of the cash flow. Generally speaking, there are trends like the one we’ve been in, where cash flow has been reduced on assets, but the value of that cash flow has been inflated on those assets. The opposite trend is increasing in cap rate, a decline in multiple, with increasing cash flow. There’s a lot of opportunity around market pivots, to my point earlier about inflation, if we’re able to lock-in. We did this rate lock two weeks ago on a mobile home park we’re buying in the Washington DC Metro next month, at 2.77%, 30-year in, 10-year fix, one-year IOO, non-recourse, fully assumable yada, yada, yada. The point being is if inflation does run and I can pass inflation on to the customer, then that means I have tremendous cash flow growth in the near term. So there are two sides to the coin, and you’re always deficient in one. You have too much here, not enough here, but over the long run, it’s kind of a ratchet system, if you’re on for the long run. It’s really, to John’s point, [unintelligible [00:49:20].13] get in the game.
Ben Lapidus: Thank you, Ryan, for the perspective and ownership. Sorry, Neal, I’m going to have to cut you off. We are going to go to close the poll, three, two, one… Poll ended. And what is amazing – let’s go over what the results were from the beginning. Will US interest rates be higher in 24 months? 74.4% of you answered Yes, not leaving a lot of room for Neal and John. This is what their answers were at the beginning, Hunter. They’re not leaving a lot of room for Neal and John to move a lot of minds, with 74% in agreement with them. 15.4% said no, they will be the same or lower in 24 months, and 10.3% were undecided. Not a lot of folks to bring home into your basecamp. What’s interesting is that the undecideds went up to 11.1%, almost a full point of people being more confused…
John Chang: We did such a terrible job. [laughter]
Ben Lapidus: Congratulation’s gentlemen, that’s a singular takeaway.
John Chang: Hey, that’s what you pay for.
Ben Lapidus: And those that believe that US interest rates will be higher in 24 months moved from 74.4% down to 66.7%. Seven points were gained by the team that suggested rates will be at or below where they are currently in 24 months. So Hunter, Ryan, congratulations. You have 12 months of bragging rights until the next Best Ever Conference. All four of you, congratulations on participating. This was a heated debate. I appreciate the spunk that all he brought to it, and I can’t wait to see y’all next year. Thank you. I’ll bid you adieu so we can keep this moving. I appreciate you guys. Thank you, gentlemen.
Joe Fairless: I hope you’ve gained some useful insights and actionable advice from this previous Best Ever Conference session. Remember, if you’re looking to scale your investing in 2022, we look forward to seeing you in Denver. Get 15% off right now with code BEC15 at besteverconference.com That is code BEC15 for 15% off at besteverconference.com.
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