Josh Barker Real Estate Podcast #23
Transcription of the Podcast Episode #23
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Josh: But yeah, we're looking at the future of real estate. We have to go. The biggest risk I see, and just to squeeze this into this conversation, is going to be more so on the commercial side. So on the residential side, banks right now are even remodeling homes and cleaning them up a little bit before they give them over to a realtor to sell, which is good for the first-time home buyer because then, they don't have to come out with additional funds, to fix the home up after they purchased it. They can just finance the whole thing. But the commercial side is really tough. You've got folks sitting on five-year fixed loans that are now coming due.
Joey: I didn't even know they did that anymore. I thought they stopped that.
Josh: No, on the commercial side, it's always like that. So.
Joey: I'm back.
Josh: You're back.
Joey: It's been a couple of months, man.
Josh: Yeah, it has.
Joey: Yeah. I was out of town and then something else. And I think you just got, you were like, dude, I need somebody else out there, I need some fresh blood, man, somebody who knows what they're talking about.
Josh: You're stealing the Show, dude. Everybody's like, where's Joey at? It's pretty cool.
Joey: Standing next to Waldo. So if you can find him, you know where Joey is, right?
Josh: That's right.
Joey: So it is October, man, that's crazy to say that. It's October of 2023.
Josh: I know. We've made it, man. We're almost to the finish line.
Joey: Oh my goodness. In real estate, the same news keeps trucking along. It's the same factors interest rates are where right now.
Josh: Right now they're, they're averaging about 7.5%. Yep. So it's still if you look back the three years ago when it was averaging probably 3%, we're up about 45% to the average buyers, purchasing power. That's how much it's decreased.
Joey: And that's a major headwind. It's been, what's it been? Was it? I'm trying to remember when interest rates start. Was it the beginning of 2022? The first quarter of 2022. They just started jumping fast.
Josh: Yeah. They started to move. And then.
Joey: So We've been a year and a half.
Josh: Oh Yeah.
Joey: Of high interest rates.
Josh: That's right.
Joey: Is there any news that this is going to change? I mean, nothing is coming out of this. It's not, is it? I mean, there's no like.
Josh: Oh man.
Joey: Light. We're not. There's no light at the end of the tunnel.
Josh: It's kind of hard to know. When I exercise in the mornings, I usually have Bloomberg on, so I'm just listening to some other reporting coming in there. It's a pretty good source. But no, it doesn't look good because, I mean, it's funny. It doesn't look good because it looks good. After all, the current reporting shows that the economy's still strong. We still have some inflation. We're projected at 3.7 year over year right now. It's likely.
Joey: This is a little high. That's a little higher than they want, but it's not like it was. What were we at 8% or something like that?
Josh: Yeah, yeah.
Josh: The year-over-year stuff was super high a couple of years ago. But people are beginning to realize that just because the inflation rate goes down, it doesn't mean wages are going down. And it doesn't mean the cost of products is going down. It means they'll freeze. Right? I had somebody asking me this last week. They said Hey, what's the chance of labor going down? I said, well, isolated to certain industries. The construction industry will likely see some labor reduction or the cost of labor going down slightly.
Josh: I do. Yeah. Because in order to be competitive, if fewer jobs are available to bid on, these builders will have to become more competitive in their bid price. Right? The last time, and I can't say what'll happen this time, but the last time I say that, I'm talking about 2007, 2008, 2009, the builders would return to their construction crews if they still had them. And were basically saying, Hey, look, we we're going to need to reduce our wages a little bit if we're going to be competitive against somebody else that just started a crew at a lower cost and this is the thing you got people don't understand about labor is that when you have labor, and wage increases like that, it's hard to get those to peel backwards. You know what I mean? If I went in right now and talked to my company and said, hey, I'm going to take my employees, and we're going to cut your wages. I'd have some of them quit, and some might silently quit, right?
Joey: Yeah. Check out.
Josh: Or check out or, and it certainly wouldn't be well received. And so you almost have to go through a massive recession where there's massive job loss to reset the labor or the cost of wages. Right? And nobody wants that either. So, these wages are here to stay.
Joey: So, okay. So I was thinking about that because there was a huge construction boom a couple of years ago. So that meant labor was brought in. There's lots, we, and the big news then was we don't have enough labor. We don't have enough labor. We can't get supplies—that gluts kind of passed.
Josh: Yes. It has.
Joey: Jobs, work has gone down. The supply chain's caught up. So now.
Josh: That's right.
Joey: Everyone's not paying 4x.
Joey: For faucet.
Josh: No. No.
Joey: Right. And you have all this labor that moved in the market.
Josh: Lumber's come down. Most of the products associated with their home haven't dropped like lumber has, but they've plateaued out in some cases. Come back a little bit. Labor has yet to fall, although I'm talking to contractors. I've also been expanding out of the Shasta County market in terms of conversations around this. And I'm being told up and down the state that they're slowing down new construction-wise. I know that's happening across the United States right now. I had some friends up in Bend, Oregon, and recently, I was talking to a contractor who used to be really busy up there, saying the same thing, that everybody's slowed down. So, now you've got this skill in the marketplace that needs to be utilized at a higher volume than it was. And any reasonable person could conclude that they're either going to change their job or they're going to reduce their fees in order to be more competitive, to stay busy. And we'll just have to kind of wait to see, how it unfolds. But right now, as long as interest rates are at the level they are right now, it's very challenging on the new construction market just like it is for the resale market. And we're going to continue to see, slower volumes.
Joey: Do you have any numbers on the big contractors, the big companies that come in? The ones that build subdivisions all across the United States? Are they, how are they bringing inventory? Is it at a certain pace? Are they done just showing what they have? Do you know anything about that?
Josh: Yeah, we talked with, our local one here. DR Horton came in. We spoke with one of their representatives recently. And, they were estimating it was pretty high, but they were saying that they were pending about 10 properties a month. And I haven't been able to personally verify that, but, they may have had a month like that. It was certainly a shock to me when I heard that number, because it sounded to be more optimistic than what I had thought was going on. But there's a lot of resources being put on that. I mean, if you think about it with builders right now, they're not, most of them are just finishing up existing projects. There's very few people that are excited about the prospect of developing land, bringing in the curb gutter sidewalks and streetlights and all those things. Only to have a volume be so low that, you're really going to burden through cash. So a lot of folks are just focused on buttoning up existing projects they're working on right now. And it's slowed down the market.
Joey: I would think that these larger contractors, because they have the economies of scale and they're probably sitting on quite a bit of capital, they have an advantage over the more local contractor who has to take money out. Interest rates are high. So now that eats up into his profits. And with somebody like DR Horton, I mean, they're national. They've Got.
Josh: Yeah. Well, and.
Joey: They've Got huge economies of scale and product, right? I mean.
Josh: Yeah. They're not even semi-custom though. They are literally quality, arguably a quality track home builders. So, they're going to do things other than the things that many of the local builders will do. A lot of local builders will accommodate some of the necessary or, some of the desired, modifications to a floor plan or to, a type of improvement to the interior, whether it be cabinets and countertops and painting and those things like that. And with DR Horton, I mean, they lock it down. This lot has this home with these amenities. Like it or don't like it.
Joey: You could Have any color you want, as long as it's black.
Josh: That's right.
Joey: Henry Ford Style.
Josh: That's right. And it's been a very well received model and it's a proven model, and it's kept their prices competitive. So, I'm not knocking that process, but that's different than a semi-custom home builder who will walk somebody thoughtfully through the selection process and help them make good decisions on what they want their home to look like when they move in.
Joey: I Was thinking more along the lines of that they might be a barometer of sorts, where if they said, Hey, look, we're not building any new homes. You'd be like, Ooh, that's because they have that advantage. Because they have the supply chain. Because they have the finance, because they have, I mean, they've got investors and stuff. And so their money has it's.
Josh: Well, and to your point, they haven't done that.
Joey: That's my, that's a good Sign.
Josh: That's a good sign. Yeah.
Joey: Because If they're like, Hey, we're cutting and running, we're done. We have no, then you're like, Ooh, that's a really bad sign.
Josh: No, well, I'm sure they're not. They're not cutting major profit margins right now by any means. But I think that they're understanding that real estate is to cycle. We are on the downward side of that cycle right now. I think their goal is to probably keep all of their crews working, keep their supply chains established, maintain their sales and marketing efforts, and then as this market transitions over the next couple of years, they'll be in a position to flourish. And I think that most long-term established, well-managed companies are doing the same thing.
Joey: Do You know of any local builders that have any projects going right now?
Josh: Yeah, there's been a few. I'm not going to just mention names right now, out of respect for what they're up to. But, they're, honestly, they're hurting. They're just and maybe not personally financially, but actually staying productive and busy with their business. It's not great, they recognize that this is a season for them to slow down, button up existing projects, be good, and thoughtful about how they manage their money right now, and get ready for things to turn where I think someone like DR Horton is going to, continue to just push them out as much as they possibly can through this season and maybe even burn a little bit of cash in the process. Some of our more local builders won't do that. They just need to have a different depth of pockets to do that.
Joey: Exactly. Yeah. That adds on the other side of what we talked about, the interest rates, is that we're not going to see inventory replenishment. We won't see new inventory in the coming years build up.
Josh: It's going to take a while, right now we have a standing inventory. I got the report right here, actually, but I think the standing inventory is around 750. Yeah. 756 as of the end of last month. We had 250 or so units come to market last month. That's new listings coming to market. Which was down, from the previous year down from the year before that, down from the year before that. And I've talked about this on our monthly market updates but when a homeowner is sitting on an interest rate at 3%, let's say and they probably literally couldn't afford to purchase the home they're currently living in at today's interest rates. You know what I'm saying? And so it's really, it doesn't, it's just a de-incentive for them to go, Hey, let's relinquish this 3% interest rate.
Josh: Where I have seen a few things though, is that let's say, over the last few years, your wages have gone up. You bought a home that's a little bit smaller than what you really want, but you have an interest rate at 3%. I've seen those kind of turn into a, to a rental situation, and then they're purchasing the next home, and keep that nice low mortgage and keep the houses a rental and then moving on to another property.
Joey: I Wondered.
Josh: And we're seeing a little bit of that right now.
Joey: I wondered if people would, with the stock market's still doing fairly good if people would start to, I don't know how, like a volume of this, but, people would pull their money out of other investments and say, you know what? I wanna buy a house for cash right now and I'll rent my house out. And the reason why is my cash is pretty strong right now in the market. I think it would definitely be strong in places like Austin and Boise where they've overbuilt.
Josh: Yeah. But it's but tough though, man.
Joey: But it's still.
Josh: Yeah, but if you look at stocks and bonds, I mean, if you look at the bond market and see market, I mean, I don't do financial advising. I don't pretend to do that. But my understanding is you're probably getting a rate around 5% for a longer term, which is outperforming some of the returns on real estate right now.
Joey: You Had some projections on what, you have a, I can't remember the report you used, but it said a projection for the next five years, and it was right in the 5% for a year range.
Josh: Yeah. There's a collection of four or five of what they call a home price economist that anticipates how valuations will be over the next five years. And the average of that trend right now is a compound of about 5% a year, just over 5% a year starting next year. And then, so it's going to be up over 25%, in five years. Which is a lot.
Joey: It is.
Josh: I mean, that's a.
Joey: What did Einstein say the greatest invention of man is compounded interest. Right?
Joey: There you go.
Josh: Well, and if you think about it, if interest rates are more likely to be lower in five years than they are now, it doesn't really surprise me that we could see home valuations going up 25% over five. And I think that's where the folks that are deciding to buy right now versus sitting it out, I think they're looking at it going, look, as soon as interest rates start to come down, they recognize that with the tightness of the real estate market, that their home values are likely going to go up with that. So buy now, and like you've said before, you marry the home, but you only have to date the interest rates. So you have a higher rate now, but, a few years from now when the rates are a little lower, hopefully you were able to just go and refinance it.
Joey: I've watched enough of Tony Soprano and like Mafia movies, I know that in that scenario, our house would be our wife and our interest rate would be our Kumar so that's the proper terminology. That's a soprano reference.
Josh: Well, then I'm seeing that right now. I mean, those are the interesting things about it. I mean, the economy, I think there's buyers right now that are a bit nervous in the market, especially with like, the war that's going on right now, it's so sad what obviously would happen with Israel. But there's, anything like that that's on a larger scale, I think it brings fear. And with that fear, people tend to, when when they're fearful, they tend to not do as much. And that's something that we have to watch too. I mean, if this thing that's going on in the Middle East turns into a bigger issue, that could certainly compound the fear, if you will, of people here in our country and their desire to do something.
Joey: Yeah. Warren Buffett has some kind of, quote about when the market's fearful, he's aggressive, and when the market's aggressive, he's fearful, or something like that. You know what I mean? Like, he's always, the opposite of the market, you know what I mean?
Josh: Well, it's rationale, right? So when the market's doing terrible, let's just, we'll just get away from real estate for now. Let's just say that for example, the stock market's doing terrible. The majority of people will say, I don't wanna be in the stock market right now. It's horrible. Right? But people like Warren Buffet will be like, I'm all in. This is a good time to buy. Right?
Josh: And it's the opposite, right? So when the stock market's going extremely well, everybody's like, oh, man, I have to find a way to get into the stock market And people like Warren Buffet are like, you know what? It might be time to sell. And so I think that people, maybe their view of investing, in those types of assets, I think it's a little misguided, if you will, but there's very little education going on in stay away from the politics of this, but there's very little education that takes place in a controlled, education environment around economics and finances and stuff like that. And so people behave in weird ways. Housing is different because housing is a shelter, cost that you're going to have either way anyway and I'm not talking about speculation, I'm not talking about investing. I'm just talking about owning a home. You have to have a place to live anyway. You're either going to be renting or you're going to be purchasing, and.
Joey: If you're renting, you're paying a 100% interest.
Josh: Absolutely. And it's already been proven that the largest amounts of wealth that have been accumulated in this country, predominantly are in the housing market. Meaning that if you purchased a home and you held your home for a period of years, you receive the benefit of a for savings account, appreciation over time, paying down a mortgage balance if you started with one. And it's kind of a staple of home ownership.
Joey: Yeah. So also, the thing that we talk about all the time is the national, the state, and the local and we come back to this, is that there are a lot of, they all get mixed together. And so, earlier I was saying, I brought up Austin and Boise too, examples of major markets that have expanded dramatically in the last decade. And they built, and everybody's moving there and they overbuilt. And so they're seeing, the prices come down dramatically. And then you take a place like Redding where it's like, we have no inventory. And even though we have this major headwind of interest rates. Prices have more than stabilized. I've seen one of the reports are showing that they, we had that little dip when interest rates first hit, but it's like, it's slowly creeping up the median and the mean home sales they keep creeping even when we face this.
Josh: Well, it's the lower end that's been blowing up. The lower end of our market isn't really exist anymore. I mean, here's a little report on this. It shows us our active inventory, for pendings. So, I'm sorry, for close last month. So from 150,000 to 200,000, eight homes sold last month.
Joey: I didn't know you could get a home. I didn't know that.
Josh: Apparently you could, you could get eight last month.
Joey: I didn't know that.
Josh: If you were to go back a couple of years ago, that number would've been in the 30s, and now it's eight. If you take two to 250 there was 11 last month. If I were to go back a couple of years ago, that would've been in the 30s to 40. This is the price point that's essentially gone. People are, it's going to be very difficult and challenging now with higher interest rates for those types of homes and those price points to get purchased and sold. So that's why you're seeing the median sales price climbing like it has is because the lower end just isn't there anymore. It's truly has moved up and there's, I think that's the challenge I think for us going forward is what kind of homes are we really going to build in the state of California, and how are we going to be able to build them in a way that's affordable? Because right now you've got I have a stack of papers right here. But this is a new regulation for 2024. And by the way, we need to find a way to get less expensive homes out there to the marketplace. It's like, well, you just gave me 25 pages of new regulation I have to meet to build a home. How am I supposed to do both? And so it's.
Joey: California's a model for the nation, Josh anybody will tell you that anybody you wanna listen to will tell you that we're a model for the nation. If you can't do the math, I mean, I don't know what to tell you.
Josh: Well, and.
Joey: We can Tour downtown San Francisco. I mean, it's pretty obvious.
Josh: They've got it figured out. And this is where I've got a responsibility. You do. And all of us who have kids that will be buying homes in the future is how do we ensure that they have options? And we do need to figure this out. And I'm encouraged a little bit. I think the state has done some things like where they increased density for existing lots and inside of.
Josh: Yeah. ADUs has been, not that it's a one solution thing, but it's a step in the right direction. And then they've also been leaning into cities and saying, Hey, we understand you have a general plan, but we're willing to allow you to waive all of those things. When somebody proposes a project that includes multifamily which gives the, actually it helps our county because our county, if you adopt a general plan in a county you can't just easily move, change that plan, because sometimes it might even require a vote. But if the state of California comes down and says, this is now the law of the land, you must comply that gives them the cover they need, to be able to accommodate some of this multifamily that's coming online.
Joey: Yeah. I think technology, we talked about this before. I mean, anytime this is a great, innovation in technology, that's where it thrives, is when there's some kind of constraint that stops everything that's usually what steps in, I mean, it's either going to be legislation where you say, Hey, they go, you know what, we're going to pull back the requirements, which probably isn't going to happen.
Joey: Or they're going to do, like you said, Hey yeah, let's increase the density, let's do some ADUs. And then I've just seen a ton of prefab homes all like the entire spectrum, 3D-printed homes, just different where they take Conex box, not, they literally take Conex boxes, but Conex box type homes where they build them and they're getting really, really nice.
Josh: If I had to guess all the different options that are available, I think all of those are valid. 3D printing is going to be valid. And there's a different couple of different ways that that gets done. And then what we control with modular types of homes.
Josh: I think is what you're speaking to.
Josh: I see. Of all of them, the winning horse in this is modular homes. The most economical way to do this is for these block boxes to be built in factories, and then they'd be placed on a lot, which will decrease the construction time dramatically. A lot of the inspections can take place inside of the factory. So now you have trained people in the factory fully certified to sign off on this, which reduces some of the burden on the city or the county to do that.
Josh: And then, you'll have this ability to piece together your two or three or four-bedroom home, and you could do it modularly at a much lower cost. There's some. This is a tricky thing because historically, financing from banks and appraisers has been resistant to those types of methods having an impact on value and appreciation and those types of things. And so we will have to have lenders and appraisers, and the construction industry will work hard to get on the same page on some of these things. But if I had to guess, I'd say that's the future.
Joey: Well, I think they'll be forced to because they won't have an alternative, know what I mean?
Joey: So it's back to how are you going to solve the problem, like you said, the ability to reduce the costs, by reducing labor costs, reducing time to market, things like that. And the technology. It's, I was thinking about it the other day. I know growing up, electric cars were always 20 years out. Always.
Joey: It was always going to be couldn't be done.
Joey: Elon does it now. Everybody has an electric car. You drive. Every company has an electric car there. Push, there are many new car manufacturers I have yet to hear of. I was watching a commercial during the football game. It was like Polestar, or somebody was like, what brand is that? A bunch of manufacturers only existed five, six, or seven years ago. They're all electric. And so it's just got, it's like the four-minute mile. Somebody just has to break it, and then once they do it, everybody breaks it.
Josh: Well, I think the motor itself is a much more challenging instrument to build than a battery-operated car. And so there's more participation just because of the required technology. It's more, but it's less, way less. What I see with it going back to the modular is that we build homes predominantly like somebody that builds their car in their garage. Right? Let's take that technology and do what Ford did with the Model T and how it expanded. Let's build homes and factories so that you can get the cost down. Let's build these homes in a factory. Let's build out these modular units in a factory. Let's streamline the process. Let's get it so you can pump out more property. And I see that being something that, again, is why it will go in that direction.
Joey: And I also think this, we have a generation or maybe even a generation and a half, how they do it is that their ideas are changing, their expectations are changing. And so, you know what I hear all the time? I hear I have teenage daughters and they weren't super thrilled about getting a car. Like, I remember them getting like me when I got my license.
Joey: It was, yeah. It was a countdown, man. It was, and to them, they're like, okay, maybe, I don't know. What do you mean? Like. They live in a different time. And so that's similar to growing up, it was like, you want this huge expansive house, and it's spread out, and you had tons of land, and it's just, that's going by the wayside. And they're more like these tighter amenities, smaller spaces, the tiny home movement. I think all these, and the financial pressure of it, merge together to say, you know what? We're going to go with more of these smaller technical modular homes. You could put it on the back of the lot. We just pull up. It's just like a perfect storm to just, that's the way to release the pressure.
Josh: Yeah. And it's changing. People are changing. Kids are changing. When you just said that, I was like, we didn't have social media, we didn't have anything. So, we were stuck at home unless we had a car.
Joey: I'm so old that I remember when call waiting was revolutionary because you used to call people, and it would be busy. And you know what you'd have to do? You'd have to call back. You wouldn't be able to leave a message or anything. Like, you're just like, dude, get off the phone. I've called like six. Can you imagine calling them? I remember calling the movie theater and listening through. To like, when the time was. Yeah. And, like, somebody talks to you, right? When they're like, they're like, Indiana Jones will be playing at. Hey Joey, what are you doing? Hey, I'm, listen. Wait, what? You'd have to hang up and call back. Oh, my goodness. Now, they don't have any of that. They're just like, ah, let me just Google Siri.
Josh: No. And the kids today, I mean, the world comes to them. I think they're more focused on experiences than they are material where I think we valued homes and white picket fences, and we had a, we were told of a certain thing, and as kids about what success looked like and what life looked like. And ours included a house with a white picket fence. Theirs is way different. They have a whole different viewpoint on that. And Elon Musk probably said it best, that the planet is just a big timeshare, and like a timeshare, some of us have to leave for others to come. Right. And some of the best, some of the ideas and the innovation and some of the ways that the world is going to change, it won't be all that flattering to us because we have our way of seeing the world. Still, it will be very flattering to the next generation behind us. So I might think about a modular and go, thanks, but no thanks. But for these kids coming up, they might be like, this is the greatest thing ever.
Joey: I completely agree. Even I, coming from that generation of bigger, see some of these I love, there's just, when you get on YouTube, once you watch one video, it's like, oh, you watch that, you're going to watch all these. But I went down that path of all these smaller homes, very technologically advanced smart homes.
Joey: Very small. But lavish. Like, this is all bamboo, and this is a faux mahogany. You're just like, whoa. And this, faux granite, but it looked fantastic. Tight. We're talking 600 square feet, 400 square feet, and nice. And the idea is, no, I eat and sleep here. But I go live out there. I go out there to live.
Josh: Their experiences, right? Where we have our home, and it's got all kinds of, I got stuff in there from 20 years ago. I don't have to get rid of it. My house is big enough to accommodate it.
Joey: Many stories. What's the saying? A man's home is his castle. We were finishing each other's sandwiches. No sentences. But the castle's big and protective and everything. Like a man's home. Is his porta John? Like what?
Josh: Well, to segue from that. Yeah. I do think that we have a challenge here for sure in the housing side of it, but it's, and I think people are asking a little, I wouldn't say too much, but it's like, well, what's going to happen? What's going to happen? I'm like, it's going to take time. I mean, this whole thing takes time. We have to slow down the inflation, which they've done. We need to stabilize the market, which will likely be another year on top of that. And we have to hope that there's no black herring. We have to hope there's no black swan. We have to hope there's no big war.
Josh: Because those all will definitely have a big impact on housing, but for people who are trying to figure out, and I think this is a point we probably do need to address, is what, how do people feel about, is it a good idea or not a good idea, to purchase a home right now? And one of the things we have to bring up is just what I talked about earlier: that you're going to be paying for a home either way. You're either going to rent, or you're going to own. And so if you plan on staying in a home, like I gave you from the examples, for the next five years, you're probably glad you bought. If you purchased a home right now and you plan on selling in the next 12 months, you may not have purchased it. So, I think you need to evaluate from everybody's individual perspective. There's no right answer. There's just the answer that's right for you.
Joey: I was thinking about like, yeah, the home flipping is over. This is not the market for that. This is not the time, the cost of money, what have you. That said, there will be cash-heavy individuals, and they're like, are you kidding me? I will buy all the things the banks won't touch and flip. But that's the outlier.
Josh: Well, the banks are fixing some of this stuff up right now.
Joey: I was going to say iBuyers are moving in. Why are they long-held?
Josh: No, no. I think what they're looking at right now is they're thinking that probably the worst is behind them. You had the chair of the Federal Reserve come out and say the real estate market already bought him down. And that was like six months ago. Well, it hasn't. He has yet to prove wrong because the market has yet to go down—the median sales price. The average sales prices are both up. So.
Joey: Nationally as well. Oh, I didn't know that.
Josh: Yeah. Well, again, it's because the volume of homelessness drops down. The lower end of the market is essentially evaporated. So, the median average sales price is bumped up. And that's a national trend. But yeah, we're looking at the future of real estate, and we have to go. Well, the biggest risk I see, and just to squeeze this into this conversation, is going to be more so on the commercial side.
Josh: So, on the residential side, banks right now are even remodeling homes and cleaning them up a little bit before they give them over to a realtor to sell. This is good for first-time home buyers because they don't have to come up with additional funds to fix the home after purchasing it. They can just finance the whole thing. But the commercial side is really tough. You've got folks sitting on five-year fixed loans that are now coming due.
Joey: I didn't even know they did that anymore. I thought they stopped that.
Josh: No, on the commercial side, it's always like that. So, normally, on the commercial side, it's a 25-year modernization with a five-year balloon. And that's a very common loan and a lot of folks right now have buildings that they've purchased, and they had a debt service on it that they could afford. But now the fifth year's coming up in the next year or so, and as that year comes up, they have a choice to make. Do I sell property number one, refinance property number two, or, in the worst-case scenario, you have to let it go? If they refinance, they have to prove that the rent they're receiving is about 50% higher than the mortgage debt or the monthly mortgage service fee. So they're using a fraction of 1.5, meaning it's about a 50% difference. Let's say I'm renting my place for $1000 a month. My mortgage or my debt service can be at most 500.
Josh: And so the difference is that they'll have to go in and pay down the mortgage balance and their refinance. The rate will likely go up because what they had four years ago for the rate is lower than it is today. And when they go to refinance, it's a higher rate, and they will have to put money into the deal to get that monthly payment down to about half of the rent. Does that make sense?
Joey: Yeah. And the same, not the same, but a very similar issue that helped cause all the problems with residential mortgages a little over a decade ago. They didn't, they, oh, we got rid of that in residential, but that idea of that five-year balloon, you're kind of setting people up. Like if it just, if the market just doesn't go wild. You're going to be in a bad situation.
Josh: I haven't seen that to be a big issue. Honestly, because the commercial side of things is a lot different, you would assume that many of them are qualified investors. They probably have a net worth of, you know, let's say, a million dollars or something with all their assets pulled together. So they have some resources, you know, they can sell the property, refinance it, or if the worst case scenario, they'd have to let it go. But it's not their home. I don't have as much concern about its commercial side when it comes to financing in terms of regulation and things like that. I don't like it all on the homeowner's side.
Josh: And the reason why is because, as I said, people need a place to live. So it's either you're going to rent, or you're going to own. Let's make sure that our loans are in a way where they're not risking the farm to buy a house. You know what I'm saying? But when it comes to buying or developing a piece of commercial real estate, that's only for some. And so they should be educated on the instruments that are available to them.
Joey: Well, Josh, we talked about a lot, but we left some on the table. We hit our 30-minute mark.
Josh: Oh, did we already?
Joey: We hit our 30-minute mark, so we're going to have to save a little bit for November. But, in closing, it's like the local market, residentially speaking, is still very, very strong.
Joey: It's, there's very low inventory, and although interest rates are low, buy now and refinance in a few years. Right? If interest rates go down, and that's have to be long term wise, that's have to be the projection that we're not going to go up to 10, 12% interest. That it should, at some point, start coming down. When it does, the residential market will start to take off because that pressure, it's, you're relieving that pressure of that headwind. It's going to shoot.
Josh: Yeah. I don't see the rates going much higher than they already are.
Joey: Thanks, Josh. I appreciate it, man. I'll see you next month a lot.
Josh: Sounds good. Thanks a lot.