How I'm Thinking About Passive Investing In A K-Shaped Economy | Ep 111

James: Since we published our economy podcast, people have been asking me more questions about the K Shape economy. Mm-hmm. So we're gonna dive into a little bit more of that. Yay. On the Furlo Capital Real Estate podcast. Yeah. Where we dive into the intricacies, intricacies

Jessi: of real

James: estate

Jessi: investing.

James: Yeah, yeah.

Keep going. You got this.

Jessi: So

James: real

Jessi: estate investing together we can improve housing and build wealth.

James: Sounds good.

Jessi: I think I missed a section

James: in there. Yeah, that's all right. Uh, I'm James, and

Jessi: we not memorized

James: that. This is my wife Jessi.

Jessi: Maybe we should spend some effort on that.

James: Eh,

Jessi: new Year's resolution.

Memorize the podcast intro.

James: No, we're fine.

Jessi: It's,

James: but yeah, so, um, hi. Hi. So a big day. So excited

Jessi: to talk

James: about econ for us, uh, because our son got braces.

Jessi: Talk about economics.

James: So exciting. Aw, dude. That's not economics. That's just straight up an expense. Oh,

Jessi: it's an

James: expense. It's crazy.

Jessi: Aw, he's so cute though.

James: Yeah. He doesn't like 'em. He hated, you know. That's okay. So, okay. And, um, yeah, I wanna talk about the K shape economy. Mm-hmm. Because again, uh, people have been. Uh, mentioning it, asking me questions about it, and so I thought it was worth just kind of doing a follow up. Yeah. And diving a little bit deeper into it.

So for those of you who, who don't know or don't remember, the idea is that it's a K shape. So the, the, the vertical line for the K would be now. Mm-hmm. Like, that's times zero.

Mm-hmm.

James: And, and then where the legs are of the, of the letter that's, you know, going out in the time. Mm-hmm. And there's two legs, right?

There's one that's going up. Up and into the right baby. Mm-hmm. And then you have another one that's going down. And so the idea being, for some people, the economy's fine. Mm-hmm. It's great. It's doing good for other people, not so much. Mm-hmm. It's headed down, so that's what they mean by K shape.

Jessi: Honestly, I feel like our two kids experiences with braces,

James: Ooh,

Jessi: explain this perfectly because it's.

It's virtually the same experience. They both got braces put on their teeth, but like literally watching our first one, she looked in the mirror, smiled at herself and was like, woo, cool. It's blingy. I like the colors. Yeah. And then our son looked at himself in the mirror and like it wasn't even a smile, he.

Furled his lips so he could see his teeth and was just instantly like, oh

James: well,

Jessi: like meltdown. He was just like, oh,

James: yes and no. Uh, you're talking about the perception of events.

Jessi: Sure.

James: And whether or not you think it's good or bad, and this is their

Jessi: experience, is definitely a good experience. There's the bad experience.

Well,

James: yes, but this is more of, um. One person, I, we'll stick with this analogy. I think there's better ones, but we'll stick with this one where one person gets on the braces and it hurts.

Jessi: Ooh.

James: Whereas the other person, they're like, everything feels fine. It's great. It's great. I got cool colors. My friends really loved it.

Jessi: So it actually is a bad experience,

James: correct? Yes.

Jessi: Mm.

James: Like and, and the idea being if you, and we'll, and we're gonna dive further into this.

Jessi: That's a good distinction.

James: We're like, if you are lower income

Jessi: mm-hmm.

James: And inflation is up for the core things that you buy.

Jessi: Yeah.

James: It's really hard.

Jessi: Yeah.

James: If you are, um, of the socioeconomic status where you're not worried about the price of gas and the price of food

Jessi: mm-hmm.

James: And, and you maybe own a business and are able to charge more and. And, you know, maybe off offset

Jessi: some of those costs.

James: Yeah. Yeah. You're like economies. That's fine. Great.

Jessi: Mm-hmm.

James: Things are wonderful. So I'm using AI all over the place. Mm. You know, that kind of thing. Mm-hmm. So that's like, so it's not just your perception though.

I, I admit that is a factor for it. Mm-hmm. But you're, they are genuinely different experiences. All right. Depending on where you're at.

Jessi: That makes sense.

James: Yeah. Uh, but no good, um, clarification too. So, um, what's interesting is from a passive investor standpoint mm-hmm. The like. You're not in charge of the day-to-day operations.

Mm-hmm. And so a lot of those, the macro forces just play a bigger role in, in how investments go, define

Jessi: macro force,

James: uh, like those are the economy at large. Right. How GDP unemployment population. Inflation, some of those bigger pieces have a bigger influence on your investment than if you were just running it yourself.

'cause if you're running it yourself, you just have a lot more options and choices.

Jessi: Okay.

James: So it's not now it's a hundred percent on this, it's just the, it matters a little bit more. Mm-hmm. Which is part of the reason why people are asking me about it. So, um, what I wanna talk about. So, um. I want to talk about where the K is showing up in Oregon.

Mm-hmm. Specifically.

Jessi: Okay.

James: Dive a little bit deeper into this.

Jessi: Oh, k.

James: Alright, so you have, um. Uh, you have like workforce rentals mm-hmm. Versus say, luxury rentals.

Jessi: Okay.

James: So you got your studios to one, maybe two. Mm-hmm. Two your three bedrooms. Yeah. You know, with all the amenities. Yeah, exactly. So what's interesting for the workforce h housing is that there's a lot stronger demand for that than there's for the luxury right now.

Jessi: Makes sense.

James: Which I would say if you went back a year, that wasn't necessarily true. Really. There was a lot of demand for that higher end.

Jessi: Okay.

James: Uh, class A. Brand new type of stuff.

Jessi: Interesting.

James: It's a lot less now. Um, historically workforce housing rents have been growing more just 'cause they were smaller and there was, when you have just overall increased demand.

Jessi: Yeah.

James: It just, it increases everything everywhere. That, for the last six months has not been the case.

Jessi: Hmm.

James: It's actually been pretty flat. It's been kind of flat across the board. I mean, even in like the, the higher end homes I've noticed rents decreasing, um, significantly, which has been really hard conversations I've had with owners because like, Hey, is that

Jessi: just because tenants can't afford

James: to

Jessi: pay certain numbers?

James: Yeah, that's, yeah.

Jessi: So they just choose something different.

James: Yeah. They, they move down market mm-hmm. To stuff. Um, which in theory should increase the demand for the down market properties.

Jessi: Right.

James: But again, you're still running into like, hey, like. Yeah, but I can only afford so much.

Jessi: Mm.

James: Right. Like, who cares if you have an infinite demand, if everyone only has a hundred bucks, like dude, that's what you get to charge.

Mm-hmm.

James: And so we're kind of running into that problem right now, which is fascinating. It means you could be Hoosier on the screen side. Interesting. Which is kinda nice. Um, there's typically, um, lower volatility as well because when on the workforce, 'cause when someone needs to move in, like they're there, they can't just up and move to go somewhere else.

Um, yeah. And as opposed to on the luxury side, they're just more sensitive, like job placement and Hmm. And migration type of stuff.

Jessi: Okay.

James: Which was kind of surprised me when I was researching it. I was like, huh, that's kinda opposite of what I would've thought. But

Jessi: yeah, I

James: don't know. I've,

Jessi: I guess it depends on the market that you're working in.

James: Yeah.

Jessi: Maybe.

James: Yeah, there's other, um, so, so I guess what's important here is that supply and demand isn't the only story to this, right. The ability to pay matters just as much. Mm-hmm. Because if you've got people, if you are primarily renting to people on that, who are on that lower sloped curve mm-hmm. It can cause issues.

Mm-hmm. Because again, you just can't charge a whole lot more. Yeah. Um, this doesn't matter at all to people on the podcast, but it. I can't tell if our kids are having a party or in a massive argument right now. Um, they were,

Jessi: I assumed they were playing with the dog and it was happy screams.

James: Let's hope that's the case.

But it's screams nonetheless screaming. We can hear it. You cannot, uh, I'm focused

Jessi: Okay.

James: At not letting it, um, distract me, which is hard 'cause the parent in me's like, what is going on there? It's

Jessi: fine.

James: Yeah. Yeah. Which I think a lot of, um, investors are having out, like what is going on there? What is going on?

Yeah. Everything's calm over here. What's wrong with you guys over there? Uh, let's see here. Um, oh, and just some, there's some other things in Oregon that just further muddy the waters. Like there's the whole rent cap issue. Mm-hmm. So you can't increase it more than 9.9% sure this year. And so you get little things like that, which really get it.

Uh, there's new construction slowdown.

Jessi: Hmm.

James: Which is fascinating. 'cause that again, increases the demand. Mm-hmm. Because when you don't have newer units coming in, that just pushes just, and we have people coming in. Mm-hmm. Just put pressure on it. But again, it's not quite that straightforward of mm-hmm. Oh, well we'll just keep increasing prices.

'cause again, there's this ability, there's a

Jessi: cap on the ability to pay.

James: Yeah. Yeah. Exactly. The other thing that I thought would be interesting to talk about would be the differences between, say like rentals mm-hmm. Versus flips. In the K shape economy, 'cause that we do that kind of investing as well.

Jessi: Mm-hmm.

James: And um, so I was kinda like, what is the, yeah, what is the data and influence on this? So in general, rentals behave better than flips, which I was like, Hmm. Okay. All right. Um, it's not to say you shouldn't do a flip, but I'll go into why it can be a little bit scarier. I

Jessi: work this the opposite.

James: Well, so here's the deal with rentals.

There's multiple ways to win. Right. So you can get cashflow. You do have the inflation protection to a degree, especially if you have a mortgage on it. The mortgage stays the same. So as inflation goes up, your mortgage, relatively speaking mm-hmm. Becomes worth less. And you just got time. Right. You can, you can wait it out.

You're not trying to get all of your money up front. Mm-hmm. Um, which is nice, and you can, and related to that. Is you can choose when to exit or not. 'cause you have a rental.

Jessi: Yep.

James: Right. You're like, oh, I'll just, I'll just hold onto it for a couple more years. Wait until interest rates do their thing.

Jessi: Yeah.

You don't have to sell whatever. Mm-hmm.

James: Exactly. Exactly. Um, talked about that. Debt advantage, I think especially fixed debt is, is hugely, I just in general it's better. Yeah. Whoa. Excuse me. Um. Yeah. And then, um, why flips are a little bit riskier right now is they require confident buyers.

Jessi: Mm-hmm.

James: It does require some liquidity.

You gotta have investors who can come in and can do it. You gotta have people who

work

Jessi: can

James: buy, and the timelines are often a lot tighter. Mm. So you don't have that, ah, we'll just hold onto it for another year or so.

Jessi: Mm.

James: And so when you get a split economy like this, um, it can create, it can thin out the buyer pool pretty quick.

'cause you just have less people who are able to look especially on that lower end

Jessi: mm-hmm.

James: Which could be an issue. And you just, you start doing discounts on stuff instead of, a couple years ago it was all bidding wars. Mm. Right. It was, it was insane. Yep. What you could do. And that's just not the case anymore.

Hmm. And so, um, it's just not, and yeah. The big outcome is like you sell it, that's what you're trying to do. You have short-term debt on this thing. You can't just hold onto it for a couple of years.

Jessi: Yep.

James: And so could cause a problem.

Jessi: Yeah. You need to get your money back.

James: Yeah. So it's not that flips are bad necessarily, it's just you really gotta pay attention to the assumptions and the timing going in on them and um, yeah.

Yeah.

Jessi: This kind an issue, particular economy, it may be better to buy and hold. Rent something out.

James: Yeah, yeah, exactly.

Jessi: Fix it along the way with smaller amounts of money versus put it all in now. 'cause the demand's not there to buy it.

James: Right. Yeah.

Jessi: Makes sense.

James: Cause an issue.

Jessi: Yep.

James: Yeah. It sit for a long time.

Get stuck, you lose money, it's not a good,

Jessi: yeah.

James: Yeah. Um, so I also wanna talk about just affordability as a hard ceiling. So I just wanna talk a little bit more about that. So again, even if supply tightens

Jessi: mm-hmm.

James: Which we've talked about it, it is. 'cause they're building less. And because construction slows more people move in, just rents can't just go up forever.

Mm-hmm. That really is an issue, and I think that's especially true for the workforce housing. Um, or like those entry level tenants. I'm, I've, I'm pretty certain it feels like just based on my experience, what I've seen, like they're the ones who are hurting the most

Jessi: interesting,

James: um, on it. So it's one of those where it's like, man, you would think like workforce, housing, long-term rentals, that's the way to go.

Yeah. It's like, eh, you know, there's still just, there's risk there. Because if I would say don't invest in a property that's like, and we're gonna increase the rent, it's 10% every year. Yeah. Like, I would not, uh, I would not get super excited about that particular assumption at this moment,

Jessi: because in reality, they're not.

You could increase them that much, but you really can't because your tenants can't pay it.

James: Yeah. Yeah. You just have zero people apply.

Jessi: Interesting.

James: Which has been what I've been noticing.

Jessi: So it sits vacant.

James: Yeah. Is we've lowered the, our asking rents on a few places because we just don't have people

Jessi: mm-hmm.

James: Applying. I'm like, oh geez. Well right. Well, okay, let's get it rented. And even like six months ago, it wasn't quite as bad as it was now. Now weather also plays into everything. People just don't move during the winter, but. Whatever,

Jessi: if there's more people still coming in and they can't afford rent, so they're not renting places, are they just finding other solutions for housing?

Like living with friends? Yeah. Moving it with family

James: or, mm-hmm. Yeah. Yeah. That kind of thing. Reconsolidating

Jessi: put in their car.

James: Well, it was kind of interesting because of COVID. People spread out a lot more. Mm-hmm. Where you might've moved in with friends. Mm-hmm. You didn't do that anymore.

Jessi: Mm-hmm.

James: And so that lower end, like the studios one bedrooms, oh my gosh, those were so popular.

A one bedroom was almost the same price as a two bedroom.

Jessi: Whoa.

James: Because like

Jessi: there was a ton of people wanting to live by themselves,

James: all by themselves. Yeah. Interesting. And so, and then that created, now it's

Jessi: kind of

James: consolidated, and you had families who were like, yeah, we're gonna go buy our own place, we're gonna move out.

Mm-hmm. And so the demand just skyrocketed in addition to everyone getting all these checks. Mm-hmm. And you're no longer traveling, spending money on doing some other stuff. Mm-hmm. So you just, you had extra money in it and banks were like, let's go. Interest rates are super low. Mm-hmm. And that was what caused that massive explosion of demand and then housing prices and, and everything just went through the roof.

Jessi: Mm-hmm.

James: Now that's not quite the same anymore. Now you're like, eh, if I'm struggling, nah, I'm moving in with friends, it's fine. Mm-hmm. Like, I think those days are, are gone. Yeah. And so you're seeing a slight retraction there, but it's still, still an issue. And, um, yeah. So that's what they're doing. They're just not, they're not just figuring it out and we're not, the stimulus checks aren't a thing anymore.

Jessi: Right.

James: Inflation is a lot higher in, or Yeah, people, inflation actually

Jessi: making lists.

James: Not higher. I wanna say inflation did its thing last year. Right. Two years ago, right? Mm-hmm. It went way up and now we're living in this new, more expensive world.

Jessi: Mm-hmm.

James: And, um, and wages though technically on average have kept pace.

That's not true. Mm-hmm. On the lower end side of things. Yeah. Yeah. It's kind of a, I know. Welcome to the Grim Economic Show.

Jessi: Wha

James: wa Indeed. Um, so. What do seasoned smart investors do in a K shaped economy? Um, I think they do a couple things. They need to segment risk more precisely. Right. It's not just, is this a good market?

Jessi: Mm-hmm.

James: Because that's not, it's a complicated answer.

Jessi: Yeah.

James: Because again, if you're doing high end stuff, it's a great market. Mm-hmm. Things are wonderful. So instead what they ask is like, well, what economic cohort. Does this deal rely on? Is it that lower income or is it the higher income?

Jessi: Oh, okay. Sure.

James: Yeah.

Jessi: Because you have a totally different approach based on the clientele who you're grading

James: it for. Yeah. Or you're gonna ask about the elasticity of the demand. Mm-hmm. Right. Is this thing inelastic where even if prices go up, the demand still gonna be there like gas?

Jessi: Mm-hmm.

James: Or is this more elastic where prices go up, demand's gonna drop off.

Jessi: Mm-hmm.

James: Significantly, like, I don't know,

Jessi: like cookies.

James: Cookies or vacations, I guess. Um, yeah. And then they just ask a lot of questions. You gotta stress test it, right? What does flat rente look like? And I think that's actually like. Borderline. That should be the assumption for, for most things especially, um, longer wins.

What happens if we do have to hold onto this thing longer? Mm. Um, or related if the exit is a lot slower. Um, you just, you really wanna make sure that your assumption, I mean, in general you want your assumptions to be conservative, but an economy like this,

Jessi: even more so,

James: especially depending on who you're focusing on.

Mm-hmm. Like, you really wanna pay attention to that. And, um. And then you also just wanna pay attention to how the sponsor people like myself, how they, um, how they respond mm-hmm. In this situation. Right. Do their, do their deals slow down, which ours definitely did. Mm-hmm. Um, do our returns compress, uh, because of the way we structured the deals that did not for my investors.

It did for me, um, but not for my investors. Mm-hmm. And, um, and then yeah, do the markets just like, they just stop cooperating with the types of deals that you're trying to do?

Jessi: Yeah.

James: Um, so all sorts of questions. Yeah. It's kind of interesting. I, I was looking back at last year and the types of deals that I did, I did three short term deals.

Kind of, yeah. And, but then I did three longer term deals, um, which was interesting. Whereas the year prior, I think I did, what was it? I think I did like all five short-term deals.

Jessi: Mm-hmm.

James: And so I think that just also speaks to what numbers are, what makes sense here? What's working, yeah. Right now.

Jessi: So you think this year you'll actually pursue more, longer hold deals?

James: I don't know. Depends on the deal, to be honest. Depends on, yeah. The numbers. At the end of the day, the numbers just have the pencil.

Jessi: Mm-hmm.

James: I think one of the things we're gonna do is we're gonna double down looking for the short term deals. 'cause I, we didn't, we did like quarter of what we thought we were gonna do.

Mm-hmm. And, but part of it. There were other factors, like my property management company starting up.

Jessi: Right.

James: That played into it. Yeah. And so we're gonna look for more of 'em, but the number's gotta make sense. Like we're looking at a deal right now that's in Phil that like, man, I love the deal. It's like it's perfect for what we wanna do.

We actually like, if we got it, we already have buyers for it. Like it's that kind of,

Jessi: that's awesome.

James: Like, yeah. Yeah. And. Turns out they're in the upper half of the K, but yet they want to go find a fixer upper and fix it up and make it awesome, and like this is exactly what they're looking for, but they need to do conventional financing.

This house doesn't qualify for it, so it needs someone to come in and get it too Conventional. Make it

Jessi: conventional. Yeah.

James: Yes. We ran the numbers. So it's interesting about this one is it's actually another flipper who owns it. And he bought it for a screaming deal, which we're just like, oh, okay, we gotta do more lead sourcing.

'cause that's an amazing deal, but he can't get to it. He's got too many of the projects and stuff going on, so he just wants to sell it. Mm-hmm. But he's been a little greedy on the, like, he, he still wants to make his $60,000 and we're like, dude, you just held onto this thing, didn't do the

Jessi: work.

James: So, um, and which is the difference, but honestly what he bought it for is pretty close to what is the right number.

Jessi: Mm-hmm.

James: Which is hard. 'cause again, he's trying to

Jessi: make profit,

James: make big profit, but. It's not financeable. Mm-hmm. And for me, I'm just like, oh dude, just do our strategy.

Jessi: Mm-hmm.

James: Just go do the minor repairs and move on, but whatever. Um, that would be our goal is we would go in, fix it up, hold it for a month, and then sell it.

Mm-hmm.

Jessi: Be

kinda

James: the idea. Um, probably two months with all the closing time. Hmm. Um, but yeah, but those are things you gotta pay attention to for the sponsors. Like how are they talking about the economy and, you know, what are

Jessi: they? Yeah. Are they paying attention?

James: Yeah. Yeah. Yeah. Um, so I got some more questions that you should ask.

So, again, similar like, it's not, is this a good market, but what side of the K does this deal depend on? And both are okay. You can definitely prop it off of both. You just wanna know what it is. Walking into it,

Jessi: it's a different strategy.

James: Yep. You wanna know if an investment still works, if appreciation stalls, because that definitely can be a thing.

There's a lot of people out there who are like, this is it like we're gonna get a correction. Yeah. Maybe we'll see. Economy is so different now than when it was even just five years ago with how automated all computers and everything is. Hmm. Uh, you wanna know, is this cashflow durable or is it just projected?

Which works a lot better for Multifamilies. 'cause you can say this is what it is for flips or even single family homes. That's a lot harder to say 'cause they are projections.

Jessi: Mm-hmm.

James: You do wanna know what's the backup plan if this thing,

if

Jessi: it doesn't

James: sell, doesn't rent, it goes 24 months from now.

Jessi: Yeah.

James: Um, it's like we're building a house and that's like, that's our backup plan. Like, yeah, we'll just rent it out.

Jessi: Mm.

James: It's fine. Turns out I have a property management company, we can just get someone in there and then we can sell it in a year or two when it makes sense. If there's some conversation we'll have to have, well, here's what's cool about it.

Because of the way we structure the lending of it, we have that kind of flexibility.

Jessi: Mm-hmm.

James: Um, 'cause we're not using a hard money lender on it. Yeah. And so, um, we can talk to our, in individual investors and be like, would you like to just continue earning interest? Mm-hmm. We'll take a bath or we'll probably break even is my guess.

Not my guess. I'm, if I remembering the. The spreadsheet, right. If we have to rent it. So we will, we won't make any money, but hopefully we won't lose any money. And then we're just like, yeah, we'll just, so whatever we make, we'll give to investors, take it, guys, take it, uh, will be kind of the, the plan there.

And then again, you just always, you wanna be asking about like, how exposed is this deal to the, to those affordability limits? Mm. Like that's something important. Yeah. That, um, yeah. Those are good questions to ask.

Jessi: Yeah. If you're making super nice places that people can't afford, you're gonna lose some money.

James: Yeah. Yeah. So, you know, at the end of the day, what this means is that the deals that probably make the most sense are the ones that are just boring and ordinary.

Jessi: Come on.

James: They're just,

Jessi: I mean, that's kind of life.

James: Yeah. Yeah. It is true.

Jessi: Brushing your teeth every day turns out is a good idea.

James: Yeah, yeah. No, it's true.

Jessi: Looping back to prices.

James: Yeah. So, um, so again, I, or final thoughts I should say is the economy's just weird. The K economy means that it's split and there's just really two different experiences. And so as an investor you just really wanna pay attention to where this investment lies in there. Yeah. And what.

Figure out what they're doing to mitigate

Jessi: mm-hmm.

James: Um, against it. So there you go. There you go. That's a little bit deeper. Dive into the k, what it means for investors and, um, how long do I think it will last this way? Dude, I don't know. No one knows. Yeah. Um, it, this could be a multi-year thing. My guess honestly is that it will last until the economy crashes.

And then you'll watch the upper part. Just go will just

Jessi: wonk w

James: right. And then, um, yeah, and then, and then we'll all bounce back and

Jessi: then everybody will

James: together. Hopefully. That's my guess when that'll happen. I don't know. Again, there's some weird because of computers and how fast information speed travels through things.

I've, I just, I don't know, I don't necessarily see like the way these cycles used to work working anymore, but

Jessi: it could be interesting. Anyways.

James: Yeah,

Jessi: that's another episode.

James: There you go. Yeah. Right.

Jessi: What does the future hold?

James: Uh, nah, that was a few weeks ago. We're good. We're good. Um, that's where I totally prognosticate all of it, but yeah.

So hopefully that was helpful. Dive in a little bit deeper into that K shape and just kinda explaining what it is and if you did find it helpful and are interested in learning more about the types of investments we do, you can check us out at furlo.com where you can see our investment thesis and what we do and mm-hmm.

What we're all about. So with that, thanks for listening. Have a great day.

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