THE UNSETTLING ECONOMIC HISTORY BEHIND OUR BAD NEIGHBORHOODS

I’ve done my fair share of traveling around this country. Indiana, Florida, Hawaii, Oregon, Nevada, Virginia, Arizona, Washington, Ohio, California, Texas, etc… And one of the things I’ve noticed is that financially challenged communities are prevalent in nearly every major metropolitan area.  In fact, I can say with confidence that practically every big city has a “rough” part of town.  In the more extreme cases, drugs and gangs emerge, which can often lead to violent crimes.  It’s really quite tragic, and I know we’ve all seen it.

What accompanies these struggling parts of American cities is an equally disturbing economic history with roots stretching back to the Great Depression.

AN IMPORTANT (AND CONTROVERSIAL) ECONOMIC HISTORY

At the peak of the Great Depression nearly 100 years ago, financial firms were in a panic as investment capital fled the mortgage market due to spiking levels of unemployment.  At the height of the economy’s dislocation in the 1930s, over 24% of eligible workers couldn’t find a job (and you thought today’s employment market was tough!).  Investors were convinced that the increasing pool of unemployed Americans would result in a wave of mortgage defaults, and available mortgage capital dried up at a dramatic pace.

In response to this, the government formed the Federal Housing Administration (FHA), which was responsible for standardizing lending criteria and instilling confidence back into the mortgage markets.

Now, here’s where it gets interesting.  On top of the normal lending criteria, the FHA underwriters were also given specific parameters for loans that included demographic information such as religious affiliation and ethnicity.  This would be illegal today as it constitutes discrimination, but back in that era of American history, our social views weren’t exactly “enlightened”.

At the time, 20% of a mortgage’s approval was based on a neighborhood’s racial profile, religious composition, and social class.  Restrictive deeds and provisions were introduced that were designed to reduce the likelihood of minorities owning homes in certain neighborhoods (brutal, I know).

On the other hand, if the underwriters determined that there was NOT a large number of minorities or “targeted” social groups in the neighborhood surrounding a mortgage applicant’s property, it was considered a good investment and mortgage capital would rapidly fund the loan.

This policy was responsible for the simultaneous co-creation of the suburbs and the ghettos in many parts of the country that we still have to this day.  Mortgage capital flooded into the suburbs, while urban regions were generally neglected.  As a result, areas with substantial minority populations had a much harder time receiving mortgage loans.  Over the course of several decades, those markets and communities often deteriorated in terms of quality.

Mortgage Capital Diagram for Post-Depresson America

Lower home ownership rates meant lower property values and lower property taxes.  And lower property taxes led to less area and school funding, which of course created its own unique set of issues.  When you compound these financial shortcomings over the decades and couple that with some cultural conditioning, you can end up with neighborhoods that have been challenged and distressed for generations.

Now, I’m not saying that government policies from the 1930s are entirely to blame for the rough parts of your city; there are many factors that contribute to that.  Nevertheless, this is the unfortunate economic history of how some neighborhoods in your town evolved into ghettos.  The genesis can be traced back to antiquated financial policies that are no longer enforced or even legal.

WHY THIS MATTERS TO US AS INVESTORS

As investors, this historical background is important because it explains a lot of the demand for rental housing in certain areas of the country today.  And that rental demand metric can play a role in helping us identify good markets and opportunities.

Additionally, understanding this economic history can help us forge our mission as investors in residential real estate.  For example, I pride myself on being an outstanding landlord that services working-class Americans by providing a quality rental property at a good price.

In the end, not all of America’s financial and economic history is something we should be proud of, but that doesn’t mean we can’t learn from it.  History can be a phenomenal educator.  Both as a country and as independent investors, we’re not destined to repeat the mistakes of the past as long as we can take a step back and objectively assess the events that have led us to where we are today.  Ultimately, that’s the foundation for sustainable progress.

Those are my thoughts. Feel free to share some of yours below. Thanks for reading and as always, make it a great day.

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Gerald Larue thumbnail pictureThis post is by Gerald Larue, the founder of DEMOS Financial, an investment training, education, and financial research company. DEMOS Financial is a California limited liability company that specializes in helping novice and intermediate investors with strategies, approaches, and techniques for generating investment income and putting their money to work for them. The Pay Me Plan home study course was created and produced by DEMOS Financial.


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