CDC Commercial Inc

February 2014 Monthly Letter

“The quality of a person’s life is in direct proportion to their commitment to excellence regardless of their chosen field of endeavor.”

– Vince Lombardi

Great words to live by and to think about as your favorite football team hoists the Lombardi trophy over their heads this Sunday. We all know that to get to that level of excellence you have to execute on the fundamentals. In real estate, we always hear that the fundamentals are; “location, location, location.” Well that might be true but more importantly you want to own real estate where more people are moving in than moving out. If we were to believe the press you would think that all of California is moving to Texas. Though there is an outward  migration, I welcome that you look at the following map of  “How money walks.”

This shows you what you read in the media. However, please click on the State of California and then on San Diego County and you will see why I am still bullish on real estate in San Diego and Riverside County.

The second fundamental is employment. You must have jobs to make real estate work. Well the good news is that San Diego County unemployment dropped to 6.4% in December, down from 6.9% in November and down from  8.2% a year ago. Job growth occurred in healthcare and social assistance (70% of growth). Other significant growth was in construction and leisure and hospitality. This downward trend in unemployment and rise in construction jobs is a very bullish indicator.

Despite what you might read we are creating jobs at the low end of the income spectrum — 58% of jobs created since 2007 pay less than $13.33/hour. Earners at the top have done well too — top 1% of earners took home 19.3% of household income. The top 10% of earners took home a record 48%. While the media is focused on the top 1%, what they are missing is that the middle income job is disappearing and the cost of a middle-class lifestyle is becoming more expensive (college, healthcare, housing). One of the biggest reasons behind the middle class squeeze is automation — and it is only going to get worse, much worse. Think of driverless cars and trucks replacing truckers and drivers and computer pattern recognition screening piles of documents eliminating paralegals and patent lawyers, or fast food workers and medical transcriptionists.

The third fundamental is inflation. Although the media and government portray consumer price inflation as low it doesn’t take much exploring to see that lots of prices are rising. Unfortunately, excessive money creation  shows up as asset bubbles, where new money flow into “hot asset classes.” Think 1990’s dot coms and the 2000’s housing and mortgage boom/bust. In recent years (5 years), hard tangible assets have sky rocketed; classic cars (+115%), coins (+93%), Art (+92%).

Precious metals and commercial real estate have not participated in this recent bubble (except at Class A Trophy properties). There is lots of talk about manipulation in the precious  metals market, but this is not my field to speculate. Real estate is controlled by the sheer fact that banks are unable or unwilling to make many  loans (though that is changing). Although lots of money has technically been created, much of it is so far unused (sitting on account at the Federal Reserve). This lack of “velocity” is why the money supply has exploded but we see relatively little inflation. Now we are faced with the challenge of getting the economy to grow (lend the money) and the Fed pulling back all the excessive liquidity (raising rates and getting rid of excess reserves) without plunging us into another recession. Like a great athlete, this will require superior timing. As I heard said, “We are in a bubble waiting for a pin prick.” My take is quite simple, this is a great time to buy real estate and borrow long at these historically low (and artificially low) rates  if you can borrow. It is an equally great time to  refinance  and pull money out to go buy more property. Lastly, this is an opportune time to trade up by way of a 1031 tax deferred exchange.

There aren’t many great tax avoidance opportunities left out there. However, the ‘1031’ is a way to defer tax indefinitely, use pre-tax dollars to earn money and hold the property until the investor passes away, at which time there is a step up in basis. This stepped up basis eliminates the tax liability on the deferred gain (there could still be estate taxes). I refer to this strategy as; “Defer till you die, refi to live.”

If you haven’t already signed up for the 18th Annual Burnham Moores Real Estate Conference with Sam Zell as the Keynote speaker, I highly recommend that you consider doing so. I have never been disappointed with the networking and education that I get from the half day.

I used to think the hardest thing in sports was to hit a baseball or a golf ball but I know believe it is being the losing coach at half time in the Super Bowl and realize you have to change  a winning game plan that got you to the Super Bowl! So as we move into the future and make whatever adjustments we must, let’s prepare for that future by remembering the game plan of one of our great presidents whose birthday we celebrate this month.

You cannot help the poor by destroying the rich.
You cannot strengthen the weak by weakening the strong.
You cannot bring about prosperity by encouraging thrift.
You cannot lift the wage earner up by pulling the wage earner down.
You cannot further the brotherhood of man by inciting class hatred.
You cannot build character and courage by taking away people’s initiative and independence.
You cannot help people permanently for doing for them what they could and should be doing for themselves.

Abraham Lincoln

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