Wanted to hear your thoughts whether you believe Residential Real Estate prices will ever come down.
My thesis is that they might never come down as mortgage lenders learned from their mistakes during the GFC. In ‘08-‘09, lenders foreclosed on consumers that defaulted on their loans, leading to a large number of houses flooding the market simultaneously. As a result, house prices rapidly declined putting further pressure on the housing market and LTV ratios.
During the COVID pandemic, I noticed that a lot of lenders supported the homeowners with mortgage holidays / interest-only payments.
With higher mortgage rates slowly creeping into the mortgages of existing homeowners as their fixed rates run out, I am now wondering whether you think prices will come down or whether liquidity / transaction volume just dries up given there are no “forced sellers” on the market given the banks support them. At the same time, buyers can’t pay the high prices anymore given the higher mortgage rates.
Given this is a CRE forum, would be great to also get your views on how the institutional investors might influence this market.
I heard from a friend who is investing in European 1-2 bedroom apartments professionally that most professional investors are on floating rates, putting pressure on the housing market in the European city where he is most active.
This has not yet spilled over to 3+ bedroom properties given there are little institutional investors in his market.
All in all they still don't own much of the housing stock and I don't think they'll keep the whole US afloat...it'll depend by region and how quickly absorption happens when Boomers trickle out and how fast constructions starts contract in this rate environment to close the unit deficit gap.
Institutional buys with a strict underwriting box, cap rate target, and specific MSAs to achieve economies of scale (before 2011 investors didn't think it was possible to achieve the latter with residential RE). That being said there's a significant amount of the US where they just don't buy because it doesn't make sense. The blow up for this sector becoming a household with Blackstone buying HPA was pretty laughable because the alarm bells didn't make sense, HPA already owned those 40-50k homes and their business model actually promotes homeownership through what's called an RTP agreement (right to purchase). They also target a much higher home price point than the US median.
You'll see these guys in the Sun Belt the most where they bought all the shadow inventory as they became available post crisis. Some firms started getting a bit riskier chasing cap rates into third tier cities in the tail of covid, but not many really... the big boys will do BFR. If you got big players buying out all local landlords in Arkansas, lets say, the exit strategy is much more constrained vs. Atlanta or Tampa.
To me the inflection point hits when the cap rates are too tight (they already are in some places), but coupled with rents slow down, and cost of funds (floating rate) increases, making the levered returns a lot weaker vs. securitizations at an 80% LTV had all in economics of like 100 bps pre-hikes. Typical hedges through caps are ofc getting more expensive to cover financial covenants, as well. Regulation might affect them at a state and local level. We've already seen big portfolios trade, early investors cashing out on the equity gains and pivoting strategy.
Europe's institutional firms depend a lot on what country and what I've found is that the risks are just different and its apples to oranges comparison. Something that is a huge barrier in terms of supply is the length of leases (can be 5-7 years vs. the US average of 1) and strong tenant protections/squatters rights (honestly kind of insane). The countries I deal with haven't yet seen a meaningful slowdown in all home price cohorts, and its really ripe for opportunities with an average apartment decently aged and non-updated. How much of that is fluff, its hard to know immediately because data privacy is so significant, even appraisals are done with listings and not sales comps in some areas. There have been pressures on the lowest priced apartments as of recent, and thats where a large chunk of institutional rental firms bought. I'd be surprised if the larger guys spilled into the higher end category because the target renter at that point would have enough capital to buy (and you start competing with foreign buyers, too in most cities).
For revolving capacity from banks its probably floating, but most retail mortgages have historically been fixed, after concessions/add-on services the increase is like 50 bps? A lot of the banks now for retail are pushing for floating rate mortgages, but the margin is much lower compared to the US - the transitions away from LIBOR are interesting, too. Away from housing reading through the current situation in England, for example, is quite different in the US because they have a decent size of their government debt that isn't floating per-se, but tied to inflation instead
Couple things:
- Banks did not necessarily flood the market with foreclosures all at once in 2008/2009. They purposely tried to stagger it which avoided a likely even more severe downtown. That said, I do not believe we are heading towards a 2008-like housing crash.
- As far as coming down, it really depends on how far the Fed goes. We're absolutely going to see a pull back from all-time highs, but it will vary in a given market -- hotspots like Boise are likely in for some pain. I personally think the Fed is targeting housing (Rent/Shelter are 1/3 of CPI) and we therefore likely will continue to see rate hikes until housing cools meaningfully (~10% or more from all-time highs). Many are going to point to the fact that we're already past peak inflation and the Fed has already pivoted - I do not buy the notion that the Fed has pivoted nor do I think the market is correct in pricing in rate cuts next year. As long as we stay above 5%+ 30-year fixed rates, housing will slowly come down (again, some more than others depending on market).
This was posted on Reddit a ~month ago and I agree with most of the points:
Higher Interest Rates. Many people try to buy “as much house as the bank will approve”. Buyers who can afford 700K at 2% can only afford 500K at 6%. Don’t fight the fed. Demand 📉
Volatility. What goes up, must come down. Homes doubled in value in many places in just 2 years. We just saw the most rapid rise in prices ever, but wage/population growth doesn't support it. In fact, median sales price was on a slight decline in 2018/19. What changed? The pandemic caused an unnatural supply shortage along with weird migration patterns. It’s rare for a stable commodity to skyrocket in price and then flatten. It almost always corrects downward. Supply 📈
No Mo’ FOMO. The fomo buyer is endangered. A record 80% of people on the Fannie Mae NHS survey say it’s a bad time to buy. Demand 📉
Price to Earnings. Home values are not staying aligned with incomes. Price to earnings ratio is at an all time high. Last time it got this bad, prices crashed. https://www.longtermtrends.net/home-price-median-annual-income-ratio/ Demand 📉
Prices can only go up. They have to. Without rising prices, flippers can’t flip, landlords can’t leverage infinite units to purchase, regular people can’t cash out equity to buy SUVs. In the last crash, the majority of foreclosures were well-qualified prime borrowers that ended up underwater and just gave up. If prices go down, even by 10% or 15%, the bottom will fall out and take down the entire house of cards with it. Supply 📈
Tech Slowdown. Tech provides many of the high-paying remote jobs that allow people to drive up prices in remote places like Prescott, AZ. Almost all tech stocks are way down from Feb highs and many have started hiring freezes and layoffs - some of these companies will not survive. I work in tech, VCs are telling cash burning startups to cut costs now or they’ll fail to raise in the future. Demand 📉
Shadow Inventory. Holding an empty home is expensive. Even with renters, profit margins are thin and many operate in the red. It’s all good though because prices go up 20% every year. If prices start going down, investors will not be able to hold these properties indefinitely. Supply 📈
Back to the Office. Managers are desperate to get workers back to the office. This could take some pressure off mini boom towns, i.e. Coeur d'Alene. Demand 📉
AirBnB Oversaturation. Consumer savings are eroding quickly. Gas is up [have since come down quite a bit but still elevated]. Travel is one of the first expenses people cut. People are starting to hate AirBnBs for the high pricing and ridiculous cleaning fees. These will become money pits for many in a recession. Supply 📈
Race for the Exits. Sellers sense a change. Price cuts have increased dramatically, yet many houses continue to sit. Prices will have to be cut further if inventory keeps rising. Supply 📈
Supply Chain. Some of the supply chain shortages are turning into supply gluts. Lumber prices have collapsed back to “almost normal” levels and houses are getting built. Homebuilders are dropping prices. Supply 📈
The Everything Bubble. Historically, stock declines precede housing declines. Crypto and retail traders have been getting crushed and more downward pressure is expected. It’s reasonable to assume that all bubbly assets will decrease together, with jobs and housing falling last. Demand 📉
Stimulus Hangover. No more mortgage forbearance, eviction moratoriums, PPP, etc. to bailout borrowers who would normally be delinquent. Delinquencies are just now starting to rise. Supply 📈
Don’t want to hit any counterpoints?
Go for it. Always open to hearing what the otherwise has to side to balance my view
Thanks, extremely helpful post and I tend to agree with most points you mentioned creating a imbalance between supply / demand at current prices.
My thesis outlined above was that the current imbalance just leads to a lower number of transactions in the market as everyone who is not forced to sell will just sit it out. As a result, there is no broad sell-off in the market as there are only very few transactions being done until the demand side picks up again.
RE: your point on DSCR loans - the AirBnB/short-term rental risk has historically been capped on warehouse LoCs, and is limited in securitizations, too (maybe like 5-15%) because of the risks. While DSCR loans have been originated even at a 0.8x, last securitization took a look at had an average of 1.4x. That's a major difference from 08, as originators aren't just pumping out mortgages and aggregators/purchasers with forward flow agreements who take any loan. The origination and securitization volume so much smaller it won't be making the same impact.
They (all investor purchases) don't make up a majority of the housing sales nationally and MLS data can't sort through the different types of LLCs. The volume of competition for homes came from the retail side much, much more (nationally; regionally there is different levels, but they all depend on home price cohort). leads to see more risk in those that the more recent securitizations with cash-out refi's were above 60%.
Which subreddit was this posted in?
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