America’s Path to “Renter Nation” as Prices Rise

Dave:
Hey, everyone. Welcome to the BiggerPockets Podcast. I’m your host today, Dave Meyer, joined by one of the OG original BiggerPockets members, podcast hosts, all sorts of things. Mr. J Scott, himself. J, thank you for joining us today.

J:
Thanks for having me back. I feel like it’s been a minute since I’ve talked to you guys.

Dave:
I know it’s been way too long. How far back do you go with BiggerPockets?

J:
2008. Six months before I flipped my first house, I found BiggerPockets ’cause I did a Google search for how to flip houses. So yeah, I think it was something like March or April of 2008.

Dave:
That’s incredible. I bet half of our listeners right now didn’t even know that BiggerPockets was around in 2008. Not to date you, J-

J:
Oh, I’m old.

Dave:
… but just to explain that we have a lot of experience at BiggerPockets. We’ve actually been around for about 20 years, which is incredible, and J has been one of the most influential investors and participants in our community. So we do have a great show that I’m very excited to have J on for because we’re going to be answering questions, some of our audience and some of the Internet’s biggest questions about the economy, about the real estate market-

J:
Hold on. Hold on, I thought we were talking about Taylor Swift and the football game that’s coming up. I’m not prepared for an economic discussion.

Dave:
Well, we could sneak one of those questions in there. Do you have strong opinions on what’s going to happen there?

J:
I don’t. I don’t. It just seems like that’s all anybody’s talking about these days. It doesn’t feel like anybody’s talking about economics or real estate anymore. All I hear about is football and Taylor Swift.

Dave:
Well, there’s some escapism going on where everyone’s just tired of talking about the economy or what’s going on, but it is so important, we have to be talking about what’s going on with the news and the housing market if we’re going to make good at investing decisions. So unfortunately, J, actually, I’m going to stick to the script and make you answer some real questions that are going to be useful to our audience. So let’s just jump right into our first question here: housing crash. This is the number one thing being searched right now on Google about housing, about the economy, and we want to know what you think, J. Are you on the housing crash side of things? When I say housing crash, let’s talk specifically about residential ’cause I know you invest both in residential and commercial real estate.

J:
So here’s the thing. First of all, when we talk about housing crash, too many people, I think, conflate this idea of the economy and the housing market, and they’re two very different things. So when I hear the question, “Are we going to have a housing crash?” Sometimes people actually are asking, “Are we going to see an economic market crash?” Because they assume it’s the same thing, but historically, they’re two very different things. Let me ask you a question, Dave. Going back to let’s say, 1900, how many housing crashes have we seen in this country?

Dave:
Crashes? I want to say just one, but maybe two, ’cause most of the data I look at is from the ’40s on. So I don’t know if there was one during the Depression, but I’m pretty confident since then there’s only been one.

J:
Yeah, there wasn’t one during the Depression, and the only housing crash we’ve seen in this country was in 2008. We saw a little blip in the late ’80s with this thing called the savings and loan crisis, which was another recession that was tied to real estate. But for the most part, every recession we’ve had in this country, and we’ve had 35 recessions over the last 160 years, every recession we’ve had has been non-real estate caused. Typically speaking, when you have a recession that’s not caused by some foundational issue with real estate, real estate’s not affected. Now, 2008 was obviously a big exception. 2008 was a real estate crisis, and it was a real estate-caused recession, and we saw a housing crash.
But the problem there is that I think there’s something called recency bias that where a lot of us are falling prey to. It’s the last big recession we remember, and so we assume that the next recession and the one after that and the one after that are going to be similar to the one we remember the best, which was the last one. But the reality is 2008 was very out of the ordinary. It was the only time we’ve seen housing crash in the last 120 years. So I think the likelihood of a housing crash anytime soon, and it’s not just because of historical reasons, and we can talk about other reasons, I think it’s very unlikely that regardless of what the economy does over the next couple of years, I think it’s very unlikely we see a housing crash or even a major housing softening.

Dave:
Well, see, J, this is why we bring you on here. You have so many good stats and an excellent opinion on this, and I completely agree with you about this. I was calling it a year or two ago this housing market trauma that I think my generation, I’m a millennial, had and a lot of people around my age grew up during this era when the housing market was a disaster for most people, and they feel like that that might happen again. Of course, there’s always a chance. But as J has provided us with some really helpful context, that is not the normal situation in a broader economic downturn. I am curious what you think about this, ’cause part of me thinks there’s this recency bias, but there’s also this desire for the housing market to crash by a lot of people. For people who might not be investors are own property currently, I think a lot of people look at prices now and the relative unaffordability and are hoping or rooting for a housing market crash, even though it sounds like you think that might not be likely.

J:
Yeah. There are a lot of people in this country that are really unhappy with the direction of the economy and their personal finances. I think inflation at 9% a year-and-a-half ago really threw people and put people in a pretty bad situation. We talk a lot about the wealth gap in this country. There’s a big gap between those who have money, those who have hard assets, real estate and stocks. 10% of this country are millionaires, but the other 90% are struggling, and there’s a big gap between the two. Those who are struggling, they don’t want to be struggling. They remember 10 years ago when there was a crash after 2008, and all the people that had lots of money started buying up houses and buying up stocks and buying up all the hard assets, and they want to go back to that time.
They want to have a chance to participate in that. Unfortunately, I don’t think we’re going to see that type of opportunity again anytime soon. Yeah, there’s a lot of frustration out there. It’s also, I’ve talked a lot about this over the last couple of weeks, there’s a big disconnect between economic data. The economy is looking really good purely from a data standpoint, but economic sentiment or public sentiment is just the opposite. There are a lot of people who don’t feel like things are good. People don’t feel like the economy’s moving in the right direction. They don’t feel like their personal finances are moving in the right direction. So there’s this big disconnect between what the data’s telling us and how people are feeling. So yeah, it’s a tough time out there right now.

Dave:
Okay, so I do want to dig into that disconnect that you just mentioned a second ago, and we’re going to get right into that after the break, along with some of the other hottest questions in real estate like, when will mortgage rates come down? Will affordability ever improve, and what is the single biggest economic risk right now? Stay tuned. Welcome back to BiggerNews. I’m here with J Scott hashing out some of the most debated economic questions in real estate right now. If you remember, right before the break, J pointed out that there’s a big disconnect between what the economic data is telling us versus how people, the American people actually feel. So let’s dig into that. That’s a great topic. Let’s jump into that a little bit because I see the same thing.
When you look at traditional measures of the economy, things like GDP, it grew in Q4, and it actually started to accelerate at the end of Q4. We also see labor market has been up and down a little bit the last few months, but generally, it’s just unemployment rate is very low in a historical context. There are many different ways to measure the labor market, but many of them point to strength. So when you look at these old school or traditional ways of looking at the economy, it looks great, but you see people are frustrated. They have a lot of pessimism about the economy. I’m curious, do you think it’s because that gap in wealth that you mentioned? Because when you look at GDP, that’s basically a measurement of how big the pie is growing, but it doesn’t really tell you anything about how that pie is being divided up between people in the United States.

J:
Well, this is a weird thing because yes, we have really poor public sentiment right now. People feeling stressed and strapped and not happy with their personal finances, but at the same time, they’re spending money. You look at holiday shopping, we were up 14% year-over-year for holiday shopping this year. People are spending money. Despite the fact that college loan repayments restarted, so people you would think would be more strapped there. The cost to rent right now, 52% more expensive to rent than own right now, so you would think people are feeling strapped paying their rent. Food costs have obviously gone through the roof. Even though inflation has come down, we’re still seeing higher than typical food inflation. So that thing, when people go to the grocery store once or twice a week, they’re getting hit pretty hard.
So you would think it would impact people’s spending habits, but the fact that we saw GDP grow at 3.9%, the fact that we saw year-over-year holiday spending up 14%, that tells me that people aren’t really feeling it. I’m thinking that part of the issue, or part of the reason for that is number one, we are seeing that credit cards are getting maxed out. Savings is at the lowest rate in history right now, so people are running out of money. But at the same time, the average homeowner has $200,000 worth of equity in their home that they can tap, not even including that 20% that the lender requires them to keep in. So people can tap home equity if they need to.
The stock market is at all time highs. So anybody that owns stock has the ability to cash out some of their stock holdings, and they have access to cash. Anybody that holds Bitcoin or gold or other hard assets, those things are going through the roof, so people can sell their assets. They have access to cash and they can just keep this gravy train rolling. So I think as long as the economy is moving along and asset prices are going up, people are going to find access to cash one way or the other, and they’re going to keep spending. So it’s just a question of is this musical chairs as the music going to stop at some point, and we’re going to see everything come crashing down?

Dave:
I’ve been surprised personally, J, with some of the things that you mentioned. Back in September when student loans resumed, I was like, “Okay, things have to start slowing down,” or you periodically get these reports from the Fed or other sources that say that all the excess savings from the pandemic from stimulus checks, that has all been depleted, but it keeps going. Obviously the credit card stuff is concerning, but I personally felt like the writing was on the wall six months ago. But it continues to go on, and I continue to be surprised.
So I think that is one of the things I’m going to keep a close eye on throughout this year is just what is going on with consumer spending, because that makes up 70% of the U.S. economy. So as long as people keep spending, as J said, that bodes well, at least for the traditional ways of measuring the economy like GDP. Now, I do want to get back to the housing market a little bit. You mentioned that you don’t think the housing market is going to crash. Can you just talk to us a little bit about some of the fundamentals of the housing market and why you think the housing market is poised to at least remain relatively stable in the coming years?

J:
Yeah. So it all boils down to supply and demand. Just like everything else in the economy, if you look at supply and demand trends and supply and demand pressures, you get an idea of where prices are likely to head. It shouldn’t surprise anybody that we in the single-family world are seeing high demand and low supply right now. Anytime you have high demand and low supply, prices tend to go up or at least they stabilize. So historically, we generally see about 1.6 million properties on the market at any given time in this country. We’re at about half that right now, so there aren’t a lot of properties out there to buy. Supply is low. At the same time, heading out of the Great Recession, 10 years ago we were at about 5 million units underserved. There was demand for about 5 million more housing units than we had.
Well, we’ve been building units at about the same rate as demand has been increasing for units. So based on that, we can assume that we’re still about 5 million units short in this country on housing. New homes, we completed what, 700,000 last year I think it was, or maybe we sold 700,000? So that’s still like seven years worth of inventory that we need to sell to catch up to the demand in new housing. So long story short, low supply, high demand, not enough building basically means that prices are going to be propped up. Case-Shiller data for November just came out a couple of days ago, and that data is always a few months behind. But data for November basically indicated that we saw a 5% year-over-year increase in housing prices, and housing prices are once again at all time highs. So things aren’t slowing down yet.
I suspect they will at some point, but again, I don’t think there’s going to be a crash because I think that this low supply and what’s driving low supply, people might ask. Well, it’s the fact that millions of homeowners, 85% of homeowners or something like that, maybe it was 87% have fixed-rate mortgages at under 5%. Something like seventy-something percent have under 4%. So homeowners aren’t going to sell their houses right now and get rid of these great mortgages just to go out and buy something else that’s overpriced and have to get a mortgage at 6 or 7%. So I think this low supply is likely to persist. I think the demand both from people who are paying 50% more to rent and now want to buy, investors who want to buy more property, large institutions like BlackRock and others, hedge funds that want to buy, there’s going to be a lot of demand out there. So I don’t see prices coming down anytime soon, even if we do see a softening economy.

Dave:
That’s a great way of framing it. I think for our listeners, it’s really important to remember that housing crashes don’t happen in a bubble. It really does come down to supply and demand, and you can analyze each side of those. As J said, when you talk about supply, it’s very, very low right now. So if you think that there’s going to be a housing crash or you want to know if there’s going to be a housing crash, you have to ask yourself where would supply come from? Where is it going to materialize from? And I don’t see it. Construction is actually doing decently right now, but it would take years at this decent clip to eliminate the shortage you talked about.
You mentioned the lock-in effect, and that’s constraining supply. It’s also worth mentioning that inventory was already going down even before the pandemic because people have been staying in their homes longer. Lastly, I know a lot of people, especially on YouTube, talk about foreclosures coming in and starting to add supply, but there’s just no evidence of that. You might see a headline that it’s up double from where it was in 2021, great. It’s still about 1/3 of where it was before the pandemic and it’s at 1/9 of what it was during the great financial crisis. So I don’t see it. I hope I’m wrong because I do think it would help the housing market if there was more inventory, but I just don’t see where it’s coming from.

J:
At this point, it looks like there’s only one thing that’s going to drive more supply, more inventory, and that’s mortgage rates coming down, interest rates coming down, because at that point, people feel more comfortable selling their houses and buying something else because they know they can trade their 4% mortgage for a 5% mortgage or a 5 1/2% or a 4 1/2% mortgage. So people are going to be more comfortable doing that. But what’s the other thing that happens, if interest rates come down?

Dave:
Demand goes up.

J:
Demand’s going to go up. So even if we fix the supply problem, the way we fix it is likely going to create more demand. So I’m not saying that nothing could impact the market, but I think it would take some major economic shock. It would take a black swan event or it would take some major economic softening, the labor market imploding and unemployment spiking, something like that before we really saw any major increase in supply. There’s no indication that we’re anywhere near that. So I think we’re going to see prices about where they are for the next several years.

Dave:
That’s really important to note that there’s always a possibility of what’s, quote, unquote called, “black swan events.” Basically, it’s something J and I and no one out there can really predict. These are things like the Russian invasion of Ukraine or COVID, things that just come out of nowhere and no pundits or people who are informed about the economy can really forecast those types of things, so of course, those are always there. But just reading the data on the supply side, I totally agree with you. Just to play devil’s advocate for a minute here, even if you couldn’t increase supply, you could change supply and dynamics in the market if demand really fell, if people just didn’t want to buy homes in the same way. I do feel like you hear these things that if housing affordability is at 40-year lows, and so do you have any fear or thoughts that maybe we see a real drop-off in the number of people who want to buy homes, and maybe that would change the dynamics of the market a bit?

J:
I suspect that we will see that trend, but I think that’s a 5, 10, 15-year trend. I don’t think that’s something that’s going to hit us in the next year or two or three because, again, really, it’s pretty simple. Right now, it costs 50% more to rent than to own, and nobody in their right mind is going to trade their 3% mortgage to pay rent at 50% more. So I do see this becoming a, quote, unquote, “renter nation” over the next 10 years, but again, I don’t see that being a short-term thing. I think that’s going to be a consequence of the market fixing itself. I don’t think that’s going to be a driver of the market fixing itself.

Dave:
So the one thing you mentioned that could change the market, and I think it’s really important to mention that when we say, quote, unquote, “the market,” most people think we’re only talking about prices, and that is a very important part of any market. But when you look at an economic market, there’s also quantity, the amount of homes that are sold. That’s super low right now, just so everyone knows, we’re at, I think, 40, 50% below where we were during the peak during COVID, so that’s come down a lot. One of the things that you mentioned could potentially change, in my mind at least, both sides of the market, both the number of sales and where prices go is if mortgage rates come down. So J, I can’t let you get out of here without a forecast or at least some prognosticating on what is going to happen with mortgage rates in the next year. So what are your thoughts?

J:
So I think they’ll come down. It doesn’t take a genius to make that prediction. I think most people are predicting that. The reason for that is as of December, the Federal Reserve, the Fed basically reverse course said, “We are done, our hiking cycle for interest rates for the federal funds rate.” At this point, the next move will probably be down. When the government starts to lower that federal funds rate, that core short-term interest rate, that’s going to have an impact on other markets like the mortgage market and mortgage interest rates. So the market is pricing in that core federal funds rate could likely drop from where is it? It’s at like 5 to 5 1/4 right now to somewhere between 3.75 and 4% by December.
So 40% of investors are betting their money that the federal fund rate’s going to be down around 4% by the end of this year. So that’s about a point-and-a-half less than where it is now. Does that mean we’re going to see a point-and-a-half less in mortgage rates? Probably not, because that’s spread between the federal funds rate and mortgage rates right now is smaller than normal, so that spread will probably expand a little bit. But I think a point-and-a quarter drop in federal funds rate will likely translate to about 3/4 of a point in a drop in mortgage rates. So if we’re right now at about 6.6, 6.7, 6.8%, 3/4 of a point puts us around 6%.
So if I had to bet, I would guess that by the end of this year we’re somewhere between 5 3/4 and 6% mortgage rates, which is a decent drop, but it still doesn’t put us anywhere close to that 2, 3, 4% that we were seeing a couple of years ago. It will open up the market a little bit. There will be some people selling. You mentioned foreclosures increasing. It turns out that the bulk of the foreclosures that we’re seeing are houses that were bought in the last two years. So there’ll be an opportunity for people that bought in the last couple of years who are struggling to get out. So yeah, I do see mortgage rates coming down, but if I had to bet, I would say 5 3/4 to 6% by the end of the year.

Dave:
I hope you’re right, and I do think that’s general consensus. I think for most of the year, it will probably be in the sixes, and it will trend to downwards over time. I do think personally that it’s not going to be a linear thing. You see that it’s relatively volatile right now. It went down in December, it’s back up in January, but I think the long-term trend is going to be downward, and that is beneficial. You mentioned it’s going to open things up a little bit. How do you see this playing out in the residential housing market throughout 2024, just given your belief that rates will come down relatively slowly?

J:
I think it’s going to have probably pretty close to the same effect on demand as it does on supply. So I think rates coming down is going to encourage some people to sell, and it’s going to encourage some people to buy, and I think those forces will pretty much even each other out. In some markets, we may see prices continue to rise a little bit. In some markets we may see prices start to fall a little bit. But I think across the country we’re going to see that same average, what’s 3% per year is the average of home price appreciation over the last 100 and something years. So I think we’ll be in that 3 to 5% appreciation range for much of the country if I had to guess. Here’s the other thing to keep in mind. You mentioned that this isn’t going to be linear. This is going to be an interesting year.
We have an election coming up in November, and historically the Fed does not like to make moves right around the election. They don’t want to be perceived as being partisan and trying to help one candidate or another, and so I think it’s very unlikely. In fact, I think there’s only two times in modern history where the Fed has moved interest rates within a couple of months of the election. So I think it’s very unlikely that we’ll see any interest rate movement between July and November, which is a significant portion of the year when you consider that we’re unlikely to see any movement between now and March. So that basically gives us March, April, May, June, and then December. So we have about half the year where we could see interest rate movements. So if we do see any movements, it’ll probably be big movements in that small period of time as opposed to linearly over the entire year.

Dave:
That’s really interesting. I had not heard that before. It makes sense that the Fed doesn’t want to be perceived as partisan, so that’s definitely something to keep an eye out for. It makes you wonder if there’s going to be a frenzy of… it’s already the busy time for home buying, what did you say, April through June, basically? So that’s the busiest peak of home buying activity and might be the most significant movement in interest rates. So we might see a frenzy in Q2 then.

J:
Yeah, and we can take that one step further. While the Fed doesn’t like to seem partisan leading up to an election, there is evidence that they tend to be in favor of supporting the incumbent, regardless of whether it’s a Democrat or a Republican. They like to see that the economy is doing well in an election year. So what we’ve seen historically, again, not right before the election, but typically, the few months prior to an election or the few months prior to prior to the election, we see the Fed make moves that tend to favor the economy and to favor the incumbent.
So I wouldn’t be surprised if we see a drop in rates in the March, April, May timeframe, even if the economy isn’t necessarily indicating that’s necessary. I think that’s something that Jerome Powell was preparing us for in December when he came out and said, “Hey, we’re open to dropping interest rates if we need to.” After two years of basically saying, “We’re going to keep rates higher for longer,” he suddenly reversed course and prepared everybody for us to start considering dropping rates. So I think that that just could be just a signal that they’re going to be a little bit more dovish in the first half of this year than they otherwise would be.

Dave:
Okay. So we are getting into some of the good stuff here, and we are about to cover a recent economic change that will impact lending and the biggest economic risk to investors right after the break. Welcome back, everyone. J Scott and I are in the thick of it talking about the most pressing issues in real estate right now. Before the break, we got J’s predictions on interest rates and what we can expect from the Fed in 2024. While we’re on the topic of the Fed, and man, I pray for the day we don’t follow the Fed as closely as we’ve had to the last couple of years, but they recently made an announcement in a different part of their directive here and announced that the Bank Term Funding Program is ending on March 11th. J, can you just tell us a little bit about what this program is and what this means for the financial system?

J:
Yeah, so last March, there was this big regional bank called Silicon Valley Bank. Anybody that wasn’t paying attention, basically-

Dave:
It feels so long ago-

J:
Right.

Dave:
… there’s so much has happened since then. I can’t believe that was only a year ago.

J:
It was less than a year ago. Crazy.

Dave:
Yeah.

J:
But basically, this bank, they bought a whole lot of Treasury bonds and based on the movement of those Treasury bonds, the value of those bonds fell considerably. The bank was in a bad financial situation or it was looking like they could be. So a lot of, not investors, but depositors in that bank started to take their money out. A lot of those depositors were venture capitalists and startup tech firms that had literally millions of dollars in the bank. So some ridiculous amount of money closer to $50 billion was at risk of flowing out of that bank over a couple of days, and the bank essentially became insolvent.
The state of California basically took the bank into receivership, and the federal government said, “We need to make sure that this isn’t a broader issue that contaminates other parts of the banking sector.” So they set up this thing called the Bank Term Funding Program, where they told banks, “If you’re in this situation where you bought too many Treasury bonds and movement in bonds has caused you to lose a lot of money, come to us and we’ll give you a loan against those bonds to ensure that you have lots of cash on hand, and you’re not facing this crisis.” They set up this thing called the Bank Term Funding Program, which was a way of loaning money to these banks that said they needed it. Between March of last year and June of last year, banks basically went to the fund and said, “We need a $100 billion.”

Dave:
Oh, just that?

J:
Yep, 100 billion. A lot of it was in the first couple weeks, but over the first three months, 100 billion was borrowed from this fund. For the next six months through November, December, essentially nothing was borrowed. Basically, banks indicated that they were in a pretty good position, they didn’t need to borrow money from the government, and they were very favorable loan terms, by the way. But banks basically indicated, “We don’t need to borrow.” Then in December, the Fed started talking about, or the Treasury started talking about getting rid of this program. It was supposed to be a one-year term, which means the program would end in March. Right around the time they started talking about getting rid of the program, suddenly banks started borrowing again. Banks went back to the program and said, “I need money. I need money, I need money,” and it went from 100 billion borrowed to 170 billion over the course of about a month.
The most likely scenario here was that banks realized that they were getting near the end of having the ability to borrow cheap money from the government, and so not because they needed the money. If they needed the money, they probably would’ve gone and gotten it sooner, but because they saw an opportunity to get this cheap money, they went and they took another 70 billion. So a lot of people are looking and saying, “Well, obviously this program is still needed because another 70 billion was borrowed over the last two months. Banks are still in need.” But the more likely scenario is that banks were just taking advantage of this cheap money, and that’s the reason they borrowed, and there haven’t really been any banks that have needed the money since last June.
So I don’t see them phasing out this program as of March to be a big deal. The Fed has also said that anybody that’s borrowed money doesn’t need to pay it back right away, they can pay it back over years, so there’s no risk to the banks that have already borrowed. More importantly, even if they were to get rid of this program on March 11th, I think the date is, if on March 12th there was a bank that was in trouble, I have a feeling the Fed would step in and say, “Okay, we’re going to bail you out.” So I don’t think there’s a lot of risk here. I think it’s something that’s going to be talked about over the next two months a good bit. But I think at the end of the day, it’s going to be a non-event. The government’s already indicated they’re going to bail out anybody that’s in trouble, so anybody big enough that’s in trouble. So I don’t see this being any real issue anywhere.

Dave:
In a way, you can see it as a sign of strength. If the Fed is feeling confident enough, as you said, they’ll bail out people who need it. If they’re saying basically people don’t need it, hopefully, that means that the acute issues with the financial system last year with Silicon Valley Bank and a couple of the follow-ons after that is alleviated, and now there’s a little bit more confidence in the banking system. So that’s great news.

J:
Yeah, and those banks that had trouble last year, they were in a very specific sector. They were in the tech sector. Their profile of borrower and depositor was very different than the typical bank, and that led to a lot of the issues, not so much an issue with the underlying banking system.

Dave:
All right, J, last question before we let you get out of here. Is there one economic issue or risk that’s keeping you up at night, or what are you most worried about are going to be following the most closely this year?

J:
I’ve been saying this for a good six or nine months now, but I think the biggest risk to our economy is the cost of debt for small and medium-sized businesses. There are a lot of businesses out there that need debt to run. They rely on bank loans or SBA loans, or maybe they need equity. They get money from venture capitalists if they’re in the tech space, and a lot of businesses are running negative. They don’t make a profit. They rely on this debt to grow and get them to the point where they become profitable, but they aren’t profitable yet. A few years ago, they were able to borrow this money at 3%, 4%. In the case of venture capital, they were able to get investment money whenever they needed it. Typically, these loans or these investments are on a two to three year runway, meaning that in two to three years, they either need to be refinanced or recapitalized or companies need to go out and get new investment because they’re going to run out of money.
Here we are two to three years after interest rates started to go up, and a lot of these small and medium-sized businesses are now facing a situation where they need to refinance their debt or they need to get new debt, or they need to get new investment. It turns out the cost of capital right now, for obvious reasons, because interest rates have gone up 5%, the cost of that debt has gone up tremendously. So small businesses that were borrowing at 3 or 4% three years ago now need to borrow at 6 or 7%, and business owners can’t afford this. So to borrow at those rates, they need to cut costs, they need to lay people off, they need to scale down their operations. What we’ve seen is that bankruptcies have gone through the roof over the last year, and on the horizon, there are a whole lot more bankruptcies looming. So I think this risk to small businesses is probably the biggest risk to the economy over the next 12 to 24 months until interest rates start to come down.

Dave:
This is a really under reported issue it feels like, ’cause you hear these huge things where it’s like, “Oh, tech, UPS yesterday laid off 12,000 people.” That’s a huge deal. But when you look at who is employed and where, most people work for small businesses, you see these high-profile things. But the American economy in so many ways is based off of small business. So if as you say, a lot of these companies are facing bankruptcy or challenges that is maybe going to keep me up more at night than it has been over the last couple of months.

J:
Yeah, and it’s not just the small and medium-sized businesses, I think they’re the ones that are most at risk. But even companies like Target and Walmart, they finance their operations by issuing bonds. They raise money by issuing bonds. A couple of years ago, they could raise a billion dollars by issuing bonds at 3%. Well, nobody’s going to buy bonds at 3% anymore because you can get U.S. bonds at four and 5% these days. So if Walmart or Target wanted to go out and raise a bunch of money to finance their operations and to continue to grow, they’re going to have to issue bonds at 6 or 7%. That’s a huge difference in their bottom line how much they’re paying an interest.
So if they can’t expand operations as quickly as they were, as much as they were, that’s going to impact their business. That’s going to impact GDP. That’s going to impact their hiring. That’s going to impact how much they can pay in additional wages, and that’s going to reverberate through the economy. So it’s not just small and medium-sized businesses that are going to struggle. I think they’re the ones at biggest risk, but I think even big businesses, we’re going to start to see wage growth slowing. I think we’re going to start to see more layoffs. I think we’re going to see less growth over the next year or two, again, until interest rates start to come down.

Dave:
Well, J, thank you so much for being here. I really appreciate your time. If you guys didn’t know this, J and I actually wrote a book together. It’s called Real Estate By the Numbers. It teaches you how to be an expert at deal analysis. If you want to learn more from J and myself, you can check that out on the BiggerPockets website. Otherwise, J, where can people connect with you?

J:
Yeah, jscott.com. So go there and that links out to everything you might want to know about me.

Dave:
All right. Well, thank you all so much for listening to this episode of BiggerNews. We hope this discussion and insight into what’s going on in the housing market and the economy helps you make informed decisions about your real estate investing portfolio and really what you do with your money generally speaking. If this is helpful to you, we appreciate your feedback and a positive review. We always love knowing what types of episodes you like most here on the BiggerPockets Podcast. Thanks again for listening, and we will see you very soon for the next episode of the podcast.