Financial Ideas and Notes
for 2009
What’s in Your
Economic Future?
As we look forward to the coming year the same question is on all of our minds. Will the economy improve and if so when will we start to see the beneficial effects? We have all seen the tremendous drop in stock prices, as the country goes through a time of economic hardship. Here are some ideas about the coming year, free of political comment, but rooted nevertheless in pure guess work. While we rely upon economic statistics, it should be remembered (as stated by a prominent economist) “If one tortures statistics long enough they will confess to anything.” With that disclosure aside, we must declare: “There has never been a better time to be heavy in rental housing and light on cash and stocks.” Our 2009 will be a surprisingly good year. Not a great year, but a good year. Will it be a year of tremendous change as we have been promised by our politicians? Of course as Voltaire stated so long ago: “The more things change, the more they are the same.” Thus it may not matter whether the politicians deliver on their promises or not. Despite this set back, the economic doom and gloom that has been so pervasive in the mainstream press will brighten, and things will get better. I call the current state of affairs the Faux Recession. The promised lowering of interest rates (already partly established) by the Fed will have its beneficial effect. Indeed, had the down ward adjustment started a year earlier than it did, we would not be feeling the pinch so much now. The Fed is always slow to move its interest rates downward, but once it gets going the reduction does improve the economy. There is talk that the fed interest rate could go to zero! That is low indeed. Right now it is at 1.0%. The trick is for the fed not to over load our economic recovery with too much regulation. The problem of course is that the Democrats feel that the time for heavy regulation and taxation has come, and it is their time to shine with each politician out doing the other, calling for more and more regulation, and more and more control of every aspect of our society. Rental Income Market 2009 The Four Horsemen of the Apocalypse (Death, Famine, Pestilence, and War) The First Horseman (Death) is coming disguised as Taxes. It seems from all political indications that this coming year will be a year of increases in government taxes. Even the Governator has stated that he will have to bow to the pressure of the spenders, and argue for increased state taxes. (Government spending of course never goes down, no matter what the promises). However, remember real estate property taxes are controlled by Prop 13, so housing providers will not see a rise in their property taxes. Rather, the tax burden will be placed the consumer, heavily weighted on the poorer economic level of our citizens. The real problem with increased taxes is that it will effect the renters net income, and reduce the renters’ spendable income. However, as we see it, the first cut backs will be restaurants, clothing and jewelry stores, and other types of extravaganzas; whereas living (rents) will be the top priority on the list. As Santa Monica is considered the safest, more desirable location among renters, the demand will keep rents at their current level, with some upward demand (depending on other factors discussed below). The Second Horseman (Famine) is coming disguised as monetary inflation. The way the current federal government is printing new money, it is no surprise that the value of the American dollar will be falling dramatically. The cash in circulation has increased dramatically over even one year’s time. It is not as bad as it could be, since other countries are staying in the printing run, step for step. However, it is clear, that a dollar earned this coming year will be worth less than a dollar earned last year. What effect does this monetary printing inflationary policy have on the little apartment building owners in Santa Monica (and the greater Los Angeles area)? What this means for them is that long on dollars is not where to be. As the dollar goes down in value, the price of real estate goes up. Thus real estate is a great hedge against inflation, not only because it keep up with the sinking dollar, but because it produces income as well (as opposed to gold, which is nothing but a liability). Thus 2009 is not the year to sell your rental property, unless you are going to reinvest in other real estate somewhere else. However, beware, for many seemingly safe and secure investments in other parts of the country or the state have turned out to be losers. Never buy a property you cannot drive to at least one time a week. Foreign markets and foreign properties are too hard to manage and understand. Many people investing in the Midwest properties have learned that their investments are too expensive to manage, and the appreciation in value has been negative. There are few areas so safe and full of upside as Santa Monica. So before you decide to sell and get away from it all, be sure that you know where you are going to arrive. On the positive side, this printing of new money is accompanied by a drop in interest rates. It is no secret that interest rates are going lower this coming year on real estate financing. Of course lower interest rates do not automatically mean better loans. It is clear that we are in the middle of a credit crunch. For without the ability to borrow money, we will starve. Will the banks open up their lending vaults? Clearly, the immediate financial problem we have been facing is that the banks are not lending base on that rate or any other rate. However, word within the industry is that they will start to lend again come next year. It has been a scary time for banks as well as everyone else. Banks need to figure out where they are, which banks are solvent, and which must be avoided by all the rest. It takes time to process out all this information, before banks will start making real estate loans. The current government thinks healthy banks are the key to our recovery. Secretary Paulson in remarks on the U.S. Economy in November 2008, stated that the government’s plant involved a consistent effort to strengthen our financial institutions so they can support our economy. Such action is critical to our progress through the current economic downturn. Strong financial institutions and a stable financial system will smooth the path to recovery and an eventual return to prosperity. Paulson stated that he devoted $250 billion to increasing the capital of our banks. A stronger capital base enables banks to take losses as they write down or sell troubled assets. Stronger capitalization is also essential to increasing lending which, although difficult to achieve during times like this, is essential to economic recovery. We expect banks to increase their lending as a result of these efforts and it is important that they do so. As Paulson stated then, “the root of this financial turmoil is the housing correction that began and accelerated throughout 2007.… As I have said for some time, the housing correction is at the root of our economic and market difficulties. The most important thing we can do to mitigate foreclosures and progress through the housing correction is to reduce the cost of mortgage finance, so more families can afford to buy a home, and so homeowners can refinance into more affordable mortgages. Thus the coming year will be lower interest rates, government sponsored reduced interest rates. With these rates falling, we can expect a jump in real estate sales and an improved economy. The reinvigoration could start with real estate loans to the residential rental industry. Banks and news commentators have been talking about transparency and openness. No where is there more transparency than in the residential rental market. Years of rental history, the current tenants’ financial history, building repairs, comparable sales, costs of maintenance are all on record for the lender’s review. It will be a good place for banks to start. Once banks get their feet wet with the residential rental market they can branch out into other forms of real estate lending. If indeed banks do start their re-lending within the rental industry, apartment owners will be on the front curve of the return to prosperity, able to take advantage of reduced interest refinances and increases in property values. The government is fight back, trying to revive the economy. The U.S. Treasure is such a good investment nowadays, that they are only paying 1% on 2 year Treasury notes. One wonders why investors would not rather buy apartment buildings which bring a 5% to 6% yield. Could it be that government regulation has reduced the attractiveness of owning such property? What this means of course, is that those who know how to manage rental housing income properties, will be the new gurus for investors seeking a larger return on their money. So while the economy is in a downturn, it is not without potential for knowledgeable owners of residential rental property. Stay put in other words and hang on. Of course the goal is to keep rents constant and costs down to keep the repairs made and the mortgage paid. All the talk about helping out the home owners with their mortgages has not filtered down to the HP. The HP’s must make do on their own. The other worry which comes with the credit crunch is the way the current federal government is printing new money, it is no surprise that the value of the American dollar will be falling dramatically. The cash in circulation has increased dramatically over even one year’s time. It is not as bad as it could be, since other countries are staying in the printing run, step for step. However, it is clear, that a dollar earned this coming year will be worth less than a dollar earned last year. What effect does this monetary printing inflationary policy have on the little apartment building owners in Santa Monica (and the greater Los Angeles area)? What this means for them is that long on dollars is not where to be. As the dollar goes down in value, the price of real estate goes up. Thus real estate is a great hedge against inflation, not only because it keep up with the sinking dollar, but because it produces income as well (as opposed to gold, which is nothing but a liability). Thus 2009 is not the year to sell your rental property, unless you are going to reinvest in other real estate somewhere else. However, beware, for many seemingly safe and secure investments in other parts of the country or the state have turned out to be losers. Never buy a property you cannot drive to at least one time a week. Foreign markets and foreign properties are too hard to manage and understand. Many people investing in the Midwest properties have learned that their investments are too expensive to manage, and the appreciation in value has been negative. There are few areas so safe and full of upside as Santa Monica. So before you decide to sell and get away from it all, be sure that you know where you are going to arrive. The Third Horseman (Pestilence) is coming to Santa Monica disguised as the Green Movement/Save the Planet. With all its hype and type it brings unnecessary additional costs of retrofitting, new construction, and increased utility costs. It includes solar energy installations on your buildings (hopefully government subsidized) all the way to water heater retrofits, and increased insulation. Obama has re-pledged to bring alternative energy to the forefront. This means more money spent on solar, wind, and other exotic forms of energy generation techniques. It might be that the government wants to grow itself into a make works project somewhat similar to FDR’s Fair Deal (“Brave New Deal?”) with high levels of regulation. And what form could it take in our housing industry? Are we about to witness federal rent control? Will Obama and his government announce that the cost of housing is too high, and we need federal control? It would give him an opportunity to hire thousands of federal governmental workers to oversee the program. Or perhaps he could nationalize the building of apartments, and take away local control. There could be a uniform building code, height limit, and density laws, that would impose the needed apartment units on a city. Santa Monica has downzoned its properties to 4 units per lot. The Federal G could rezone that to 30 units a lot, with no environmental controls allowed. Just build it with federal money. We could indeed be in for a change. We should investigate the cost of solar installation on the roofs of our buildings. If Obama makes good on his promise to develop solar energy, then all the federal governmental regulation which go along with it, will be in place; preempting the City of Santa Monica’s tied response. Thus, we will probably see exemptions from having to comply with expensive planning commission and architectural review board hearings and design mitigation features. We will be able to slap up the panels and be done with it. Furthermore, there should be great federal financial incentives to buy and install the panels. Finally, with the cost of utilities skyrocketing, having solar electricity available to your tenants would be a fabulous selling point to get those vacant units rented. Remember Obama has just recently stated at the Governors’ Global Climate Summit, his strong support for federal action to reduce greenhouse gas emissions. He stated: “The science is beyond dispute and the facts are clear. Sea levels are rising. Coastlines are shrinking. We’ve seen record drought, spreading famine, and storms that are growing stronger with each passing hurricane season.” He then went on to reaffirm his support for his cap-and-trade policy, which, he said, “will establish strong annual targets that set us on a course to reduce emissions to their 1990 levels by 2020 and reduce them an additional 80 percent by 2050.” What this means is that there will be a tax on the production of electricity from coal and gas. These are the disfavored energy sources. Thus, Edison will have to pay a premium tax to use coal or gas to make electricity (and will have to pass on that tax to you the user). The people lucky enough to have installed solar photovoltaic panels will be getting their electricity cheaper. Indeed, tenants who have electric cars, will be able to fuel up at your apartment buildings for free. What will that mean for rent? It is not just the Feds that intend to step up the attack on coal and oil. The State of California has long announced plans to do so as well, under the guise of reducing carbon emissions by 20% or so. See Global Warning Solutions Act, Health and Safety Code Section 38500 et. Seq. The State’s law call for implementation of plans starting January 1, 2009 (yes this January). The state’s plans call for restrictions not only on using coal and oil to produce electricity, but also changes to the current building codes, to institute “green” building practices for new construction and retrofitting for existing apartment houses as well. These green building codes are being promulgated by the U.S. Green Building Council and locally in California, by the California Air Resources Board, which has established a subcommittee to review and recommend green building criteria. Some of these green building requirements are set to go into law for existing buildings in 2010. The state has its own cap-and-trade plans (not to be outdone by the federal government). The state’s goal is to have by 2020 at least 33% of its energy produced from renewable sources. To accomplish this goal, use of oil and gas to produce electricity will be heavily taxed. As the State’s plan is quoted: “drive investment and fuel use choices toward more efficient and lower carbon options.” I.e., tax the stuffing out of coal and oil. The state is considering expanding the state solar incentive programs, including the Million Solar Roofs Program which will require building owners to meet certain efficiency requirements to obtain these incentives. The law currently anticipates that the state will institute incentives for up to 200,000 solar water systems in the next few years. The thing to remember is that the “green” building standards, and the new required use of renewable energy all cost great deals of money. It is not in our state’s budget, nor the federal budget, to pay for these things. Probably, the bulk of the cost of providing these programs will rest on the property owners themselves. The efficiency and efficacy of our public bureaucracy is unsurpassed in new rules and regulations. Except they have long ago figured out how to require the workers to shoulder the burdens of their folly. Our goal is to push the costs of these burdens onto the populous who voted these wonderlings into office. On the bright side of the regulations, maybe Green Buildings will be the best way to market our buildings, reduce our utility costs, and stay ahead of the competition. Clearly the local renter has great support for solar implementation. This would encourage tenants to rent “green,” in other words rent from HP who have solar on their buildings. Don’t forget a governmental rent increase for the cost of solar installation as well. Maybe the Feds will pass a short form rent increase for rent controlled buildings. Solar will also save tenants money. With the skyrocketing cost of electricity, solar energy will be a savings (when government subsidies are added into the mix). Maybe such solar installations will enable the tenants to electrically charge their cars for free. This security alert also spills over into the school system. The old proverb “What is good for the Santa Monica Schools is good for business” has never been more correct. Santa Monica is spending more on schools than they can vote into policy. All this moves the Santa Monica rental market higher and higher. Well, what about school costs, the worried tax payer asks? Santa Monica is known for its great schools. SMRR has kept the tax rate so high that our schools have money to burn. This brings parents who cannot afford private schools, to want to rent in Santa Monica. This of course, increases the demand for Santa Monica apartment units. A typical private school (K through 8 grade) costs $2,000 per month per child. A family with 2 children will save $4,000 a month being able to keep their children in SM public schools, rather than putting them in public schools. That $4,000 a month can be used to rent a much better apartment than one in West Los Angeles.
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