There are many angles to this crisis, but to put it in simple terms, people are losing lots of money in various types of real estate investments.
It is a very serious issue. Thousands of people have collectively lost billions of dollars.
Thousands of people, meaning from the Orthodox Jewish community?
From the heimishe community.
Are we talking about the heimishe community around the world?
No. I’m focusing on America.
We are currently sitting in Ami’s Lakewood office. What percentage of that loss would you say is from Lakewood and its environs?
I don’t know. But Lakewood was probably the epicenter for this cycle.
Can you define this cycle? When did it start?
Real estate has always been very cyclical. A full cycle is either from peak to peak or from trough to trough. Real estate starts getting stronger and stronger, and then people come in and see that others are making money, so more money comes in and then more people come in, followed by more money. Eventually, the prices go up. That ties into construction as well, because when home prices are rising, it’s economical to build more office or apartment buildings. Then there’s a frenzy and everyone starts rushing in, but eventually the prices go too high and it moves back. This cycle can last for anywhere between ten and 20 years. The last cycle crashed in 2007 and 2008, and the prices fell for a good three years. The new cycle started in 2010 or 2011.
People don’t realize that down cycles wipe out people’s entire investments and turn people who thought they were rich into paupers.
It’s much more nuanced, as it depends on how well you diversify and how much money you made on the way up. If you made a lot of money on the way up and cashed out…
But a lot of people do get wiped out.
That’s because they continually double down on their investments. Meaning that they put in a million dollars and three years later it’s worth two million. They don’t take out the two million; they put it into a new deal that turns it into four. Then that four turns into eight.
And they borrow money to add to that as well.
Correct. So the borrowing grows and the paper gain and equity grow, but the shechitah tends to wipe out everything you put in before because the nature of the real estate investor and the whole system encourage you to keep rolling it over. So even people who made a ton of money on the way up end up losing everything when the crash comes.
Let’s try to understand that. If your cash portion of the transaction is 20% and the real estate market wipes out 25%, your equity is completely gone.
Exactly. This is the key point. In other investments, it’s more likely that people will take gains off the table. In real estate, however, that’s not the case. One of the main reasons people invest in real estate is that it offers tremendous tax benefits. If you keep kicking the can down the road and don’t take the profits out and put them into the next deal, you don’t pay any taxes. This is called a “1031 Exchange.” You don’t pay any taxes on the gains, and it can even have other tax benefit. Whereas if you do take money out, you’re going to be hit with a massive tax bill.
So the tax benefits tempt you to put it back in.
Correct. And if the cycle keeps getting better and better, you’re also going to add more money to your investment because it keeps getting more exciting.
And the banks are giving good interest rates, so you can buy a $20 million building for relatively little cash, but when the cycle starts to turn, you get wiped out and can’t afford the debt service, so the banks take back the building.
Correct. However, if you take a step back during the cycle, it changes things completely. There are people who took money out and diversified their investments.
But many more people lost a lot of money.
More money does tend to be lost than earned because more people join the market later in the cycle. That’s when it seems most exciting. There’s a counterintuitive aspect to investing that people struggle with: The more prices went up, the more likely you are to be facing a crash or a market correction. Warren Buffett said it best: “The more greedy people are in the market, the more fearful you should be. The more fearful people are in the market, the more greedy you should be.” You’re supposed to be countercyclical, which means buying low and selling high, but in reality managing that cycle is very challenging.
Let’s go back to the down cycle in 2010.
If you had cash and confidence, it was a great time to buy because prices kept falling, and because the crisis was so bad, the government lowered interest rates to a very low rate, so it reached a point where you were able to buy at a very low price and receive great financing terms.
And you were able to get a huge return because your debt service was being covered plus the profit.
Correct. But then, as the market started turning in 2013 and 2014, the prices started to go back up while the interest rates remained low, so you were able to consistently either refinance and take out a lot of money or roll over your profits to buy more properties.
Then Covid really shot up the market.
That was already ten years into the cycle, so the cycle was already looking long by then. Instead of crashing it, Covid supercharged it.
To the surprise of many.
Almost everyone.
It looked like Tishah B’Av initially; people thought the world was coming to an end.
That’s what it looked like for the first couple of months, but then things really changed. I’ve written hundreds of articles. One of the ones I’m most proud of is an article I wrote during that time. People kept calling me to ask if they should cancel their home purchase contracts, and I told them not to. I said, “Buy it. People are going to need houses. Aderaba, double down.” Baruch Hashem, they did very well. But after the market was supercharged, people were making so much money that it drew in tremendous sums of money even from people who wouldn’t necessarily have the confidence to invest.
I was getting calls from rabbanim, yungeleit, regular professionals—people were saying, “I have to mortgage my house because people are making crazy sums within two or three years; they’re doubling their money. The stock market is a joke; even in the best of times you can make 20%. It’s bal tashchis not to take every penny I have and put into real estate syndications.” The more excited people got, the worse the deals were getting, because the prices were rising to crazy heights. The only way you were able to make the deal work was to take very risky financing. Even at the very low interest rates, the numbers still didn’t work.
So people were taking floating mortgages, mortgages where the rates aren’t locked in. Such deals are extremely unlikely to succeed.
To clarify, you’re talking about investment properties, not buying a home to live in, correct?
Yes. I’m talking specifically about giving people your money to invest, which introduces many types of challenges.
And you’re not talking about the real estate maven or syndicator; you’re talking about the typical person who’s giving them money.
Yes.
What’s the difference between the two if everyone who went in at that point lost their money?
Let’s make a very clear distinction in three parts. You have the people who buy a house to live in or to rent it out. They’re benefiting from real estate that they control. That’s one category. I’m a huge fan of that; it’s relatively easy to get involved in that, because almost everyone buys a house, so you’re invested in real estate. If you can do it for one house, you can then buy another house and rent it out. Typically, it’s a market that you understand, and the mortgages available for that allow you to lock it in for 30 years. If you do a little bit of research you can do very well. What I’m talking about falls into two other categories. There are LPs, limited partners, who do deals with GPs, general partners. The general partners are also known as syndicators, and they do “deals.” They find a commercial piece of real estate…
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