Investors Cutting Exposure to Risk-on Assets

Hi, The Investor’s Podcast Network Community!

Hope you have a profitable Wednesday and welcome back to We Study Markets! 📖

Investors seemed to like yesterday’s earnings reports as the Dow rose 754 points to 31,827 and the S&P 500 gained 2.8%. 👍

We have a lot to cover, so we’ll keep it brief and concise!

Today, we’ll also be discussing interesting results from a fund manager survey, look at Netflix’s plans, do a deep dive into today’s real estate market compared to 2008, with much more, in just 5 minutes to read.

Read on 📖

IN THE NEWS

📺 Can Netflix Turn It Around? (CNN)

Explained:

• Netflix reported they had lost 970,000 subscribers in the second quarter after anticipating a loss of 2 million. Investors seem to be shrugging the continued decline in the subscriber base off as the stock is up 7.8% in after-market trading.
• With the stock price down 66% this year, the company has three planned initiatives to turn things around: 1. Crackdown on password-sharing, 2. Launch an ad-supported tier, and 3. Try to create more strong and profitable franchises like Stranger Things.

What to know:

• The average U.S. household was signed up for 4.7 streaming services this past quarter. This doesn’t provide Netflix with much of a moat or competitive advantage.
• Netflix will need to strike a delicate balance and reach enough viewers to attract advertisers while making sure not to lose too many full-price customers.

💰Bank of America Survey Shows Investor Capitulation (Bloomberg)

Explained:

• Bank of America conducted a monthly fund manager survey of 259 participants with $722 billion under management. The survey shows investors have cut their exposure to risk assets to levels not seen since the Great Financial Crisis of 2008 indicating a sign of full capitulation amid a “dire” economic outlook. Growth and profit expectations sank to an all-time low, while recession expectations are at levels last seen during the start of the pandemic.
• The survey showed that high inflation is the biggest tail risk, followed by a global recession, hawkish central bank policies, and systemic credit events.

What to know:

• 58% of fund managers say they are taking lower than normal risks and exposure to cash surged to levels not seen since 2001. Among equity regions, investors are most bearish on Europe and Japan. The most crowded trades are long the US dollar, long oil and commodities, long ESG assets, and short US treasuries.
• Fund managers said that any rally in stocks may be short-lived as a recession seems likely and inflation pressures continue to be problematic.

↘️ A Fake Recession? (Fortune)

Explained:

• Economic pessimism seems to be in the headlines as the alarms are sounding that a recession is looming. Chief economist at Jefferies, Aneta Markowska, says that while there are headwinds for the economy, a recession is not imminent.
• Households and businesses still hold a lot of cash, and while the Fed has been able to cool the housing market, a reduction in consumption and labor demand will take more time. A strong labor market, which she expects to bottom at 3.2% unemployment, also indicates a recession may not take hold.

What to know:

• The Great Recession lasted from the end of 2007 to June of 2009, saw unemployment peak at just above 10%. A recession occurs when the economy experiences two consecutive quarters of negative growth in GDP.
• With household income and unemployment rates still appearing to be in good shape, a 2022 recession would be “fake” in Markowska’s eyes. What are your thoughts? Do you agree, or do you lean towards the likes of Jamie Dimon, Carl Icahn, and Elon Musk, who feel a recession is on the horizon, if not already here?

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DIVE DEEPER: Is It 2008 Again for Real Estate?

There are pundits today concerned we are about to experience another major real estate market correction as we did in the 2008 Great Financial Crisis. Given the likelihood of a recession, some are worried we may see 2008-like corrections of up to 20% in home prices. While there are many signs of a slowing real estate market, it is unlikely we will experience the same kind of decline for several reasons we will explore. Of course, we could be wrong, but today’s market is very different from the real estate market of 2008. Instead, the real housing crisis may center around many potential buyers getting locked out of homeownership altogether.

There are some cracks in the housing market caused by rising interest rates and unprecedented inflation levels. We’ve seen an uptick in buyers backing out of purchase contracts recently and the sentiment from homebuilders dropping based on the National Association of Home Builders Index. The market seems to have stalled as sellers dropped the average asking price by 3% last month. In addition, mortgage applications have dropped by 25%. Despite this, the housing market remains relatively strong, although many buyers are getting priced out of homeownership. Here are some thoughts to consider why it is not 2008 all over again:

• For today’s housing market to crash, the U.S. would have to see a wave of sellers listing their homes. This could happen if we experience a serious recession that causes people to be unable to afford their mortgage payments. To date, however, homeowners are meeting their debt obligations, for the most part. In May, mortgage delinquency rates fell to a record low of 2.75%. Many buyers have also seen strong appreciation and have built up substantial equity. They would be able to sell their homes for a gain if forced to sell because of unfavorable economic conditions or hardship. In 2008, many buyers had negative equity and were foreclosed upon when the recession caused an inability to make mortgage payments. Today’s typical property owner has more skin in the game than in 2008.
• America is also facing a significant housing shortage. Some conservative estimates put the shortage at 1 million homes, while others believe it is closer to 3 million. Homebuilders have had difficulty keeping up with demand since the pandemic due to supply-chain issues, material shortages, and a lack of skilled labor. The labor market is still strong, and households still hold a lot of cash. While the Fed is attempting to thwart inflation with their rate hikes, the lack of supply in housing will likely prevent a major collapse in home prices.
• Covid-19 caused many homebuyers to upgrade their housing as they lived and worked from home with the entire family. Historically low interest rates fueled people to buy that typically would have rented, pushing demand up and often causing bidding wars. While demand is softening due to higher rates and rising inflation, 51% of homes sold above list price this past month. We’d need to see homes start selling far below list price if 2008 were to re-occur, and to date, that is not happening in most markets.
• The 2008 crisis originated in the unprecedented growth of the subprime mortgage market. Predatory lending and poor financial sector regulation were the main causes of the 2008 collapse. Loose lending practices put money into the hands of homeowners that truly didn’t qualify that would later default on their payments. Subprime mortgages, made to buyers with less than stellar credit, comprised 20% of the market in 2006. Some banks made subprime mortgages their entire business due to their initial profitability. In early 2008, these institutions began to see late payments and defaults in high numbers. Lending practices are much more stringent today, and more regulations are in place to protect the consumer from predatory lenders, which was designed to result in fewer defaults and foreclosures.
• There is less risky leverage in today’s market compared to 2008. $3 trillion went into mortgages that had never existed previously. Non-traditional loans, known as NINJA mortgages (No income, no job, no assets), became commonplace. Heavy subprime portfolios quickly brought down insurance companies, like AIG, that had insured these subprime loans. As defaults began, pools of mortgages used for investments in mortgage-backed securities (MBSs) that were underwritten, owned, and sold by the likes of Bear Sterns and Lehman Brothers saw drops in value so great they closed their doors and brought others down with them. Increased foreclosures brought property values down and caused home prices to fall throughout the country.
• Mortgages today are harder to obtain than in 2008. There is a barometer on the availability of credit called the Mortgage Credit Availability Index (MCAI). The higher the index, the easier borrowers can get loans, and vice versa. The MCAI peaked just shy of 900 in 2007, a historic all-time high. As mentioned, this was fueled by loose lending standards leading up to 2008 and included loans such as interest-only and adjustable-rate mortgages that came with a lot of risks because of the high potential for default. Today’s MCAI index is a modest 181.3. This indicates the health of today’s existing mortgages is much stronger than in 2008. Higher lending standards have led to stronger borrowers and a more robust real estate market.

The Takeaway

While we will likely see a continued slow down in the housing market, it’s unlikely we will experience 2008 again-at least for the real estate market (crypto lenders are another story…). Typically recessions see a 2%-4% decline in home values. This is more in line with what we expect to unfold in the coming months. The greater concern is more and more people are getting priced out of home ownership, primarily younger generations. What do you think is going to happen in the real estate markets? Respond to this email and let us know!

QUOTE OF THE DAY

“Risk is the ultimate differentiator. I’ve always had a deep and complex relationship with it. I am not a reckless person, but taking risks is really the only way to consistently achieve above-average returns-in life as well as in investments.”

— Sam Zell

Sam Zell is a billionaire and an American real estate icon who says, “I’ve spent my whole life testing my limits.” He is the author of Am I Being Too Subtle?, a book about his investing adventures.

Sam managed a 15-unit apartment building in exchange for free room and board during college. He continued to grow his property management business while taking classes and was netting $150,000 by graduation. He attended the University of Michigan’s Law School and, upon earning his law degree, was now managing 4,000 apartments and owned 100-200 outright in his portfolio.

One of his primary investing rules is to buy assets below replacement cost. Sound familiar? If Sam had sought his fortune in the equity markets, he likely would have been a follower of Ben Graham.

Instead, he pursued a career in real estate, founded Equity Group Investments, and amassed a fortune estimated at $6 billion. Zell’s companies have owned the Schwinn Bicycle Company, Revco, the mattress company Sealy, and the Chicago Tribune. Sam is now 80 years old and continues to be active in the business and real estate arenas. He has lived a life worth studying and learning from and has taken large gambles throughout his career. He seems to thrive off pushing his limits and continues to take risks when most men his age are enjoying the grandkids or are hitting the links.

Meaning

What is your own relationship with risk? Are you playing in an arena that maximizes your talents, skills, and abilities? Have you been playing it safe or pushing your limits? Have you been burned by taking on too much risk? What’s one risk you could take today that would push you outside of your comfort zone?

Let us know your experiences! We’d love to hear from you and hear your stories.

13 Steps for Your First Rental

Maybe you don’t have the appetite for risk as Sam Zell does, but owning real estate has been used for generations to diversify portfolios, generate cash flow, and obtain wealth. The beauty of preparing to own your first rental is you can take it slow, gather information, save cash, and make offers on deals that are attractive to you. For younger investors, or for those looking to get started with training wheels, you may even consider House Hacking. Before you can do that, you need to gather a fair amount of knowledge. Taking your time on the following 13 points will prepare you for your first offer and profitable rental.

1. Begin with the end in mind – Understanding your financial goals is the first step towards purchasing your first piece of real estate. Work backward and consider when you plan to retire and how much you will need to cover your lifestyle. Where does real estate fit within your goals, and do you intend to grow your real estate holdings? If so, how?

2. Pick the brains of successful real estate investors – Speaking to someone who is doing what you’d like to do will save you time and money. Clone what others are doing and implement their strategies.

3. Save for the downpayment – You’ll want to save up roughly 20% for a downpayment. While not easy, there are steps to help with this, including paying off high-interest debt, setting up an automatic savings plan, reducing your expenses, and taking on a second job or starting a side hustle.

4. Get pre-qualified and explore funding options – Getting pre-qualified for a mortgage will help you understand what types of investment properties you can afford. The initial steps to prepare for pre-approval are to get your credit score above 680, have a solid work/income history, and show a bank balance that can fund a downpayment.

5. Know your expenses – Determine the overall expenses on the property, including property taxes, insurance, and estimated repairs. You’ll want to build up a rainy day fund for unexpected maintenance expenses that will arise. Ideally before the property is acquired, but if not, as soon as possible thereafter. Take the time and sit down and make some cash flow projections. Once again, the numbers must make sense. Now is the time to see if this potential rental will be cash flow positive.

6. Research your market – You cannot do too much research to understand and know the market you’re investing in. Research the city’s job and population growth, look at city plans for revitalization. “Farm” a particular area and develop contacts there. Study average rents and know what range homes are selling in your target area. Know what the quality of the schools, the crime rates, household incomes, and the number of rentals in the area. You cannot do too much research to understand your market.

7. Speak with property managers – If you don’t plan on managing the rental yourself, begin to interview several property managers. Ask for references. Determine their level of knowledge in your area. Most important, assess their level of honesty and competency.

8. Get an inspection – Property inspections typically cost between $300 and $500 for single-family houses, and it is well worth the money and time to learn all you can about your potential investment. You may uncover issues with the house that can become a bargaining tool during this phase. If there are too many issues and you don’t have construction experience, it may be best to move on. You may consider putting an inspection contingency in your offer, as it gives you the option to back out of the deal if there are too many red flags.

9. Have the property appraised – If you intend to finance the property, the lender will order the required appraisal. The lender wants to ensure that the purchase and appraisal prices are similar, or at least that the purchase price is below the appraisal. It also will give you peace of mind that you aren’t overpaying. It may also be a good idea to put an appraisal contingency in an offer in case the appraisal comes in too low and affects your financing.

10. Be properly insured – Ask around to find a good insurance agent that handles rental properties. You want to ensure you have coverage in case damage occurs to your property. You may also want to consider an umbrella policy, another laying of protection that protects you against an unexpected accident or lawsuit.

11. Avoid a major fixer-upper – Unless you have considerable construction experience or contact with someone who does, it is best to avoid a first rental that requires major repairs.

12. Choose the right financing – Find a lender you’re comfortable with who will take the time to explain the different financing options available. Mortgage loan products change all the time, and you want to ensure you obtain a loan that allows you to stay cash flow positive every month.

13. Making an offer – This is the fun and exciting part! Once you have made an offer and it is accepted, the clock starts ticking. Stick to the closing date and ensure you do the home inspection and appraisal within the specified time. Start lining up real estate experts to schedule any needed repairs or improvements. The faster you can get your rental occupied with a great tenant, the faster you’ll start making a return on your investment. But you don’t want to rush it – you want the right tenant!

Following these 13 steps, you’ll be ready to make an offer on your first rental. Take some inspiration from Sam Zell, get out there, and make it happen!

If you want to get started with real estate investing, but aren’t ready for some of the laboriousness of it, check out PassiveInvesting.com.

SEE YOU NEXT TIME!

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