What’s next for the Property Market? - Holdun

To Buy or Not To Buy?

This weekend, I spent much of my time scrolling various property websites, virtually searching through houses both at home and abroad. To be honest, I do this quite a bit, but typically, I’m doing it out of curiosity more than intent.

Generally, my wife sends me a link to a house, I have a nose at the pictures, and then I carry on living my life, the end.

This time it’s different.

The fact that we might actually buy one of the homes behind the link this time around adds a whole new and altogether stressful layer to a previously beloved pastime.

Take me back to the good old days. Monologues about everything that’s wrong with a $15 million Hamptons home that I could never afford in the first place are far more satisfying than searching for a ‘fixer-upper’ on a budget….Trust me.

Like many, the idea of investing in property is something I have toyed with for a while. From a financial standpoint, I have never been overly drawn to the idea of real estate as an asset class. At least not real estate I have to actively manage myself.

Despite our cultural obsession with homeownership, there are multiple downsides.

Blasphemy, I know, but bear with me.

  • Mortgage fees
  • Property taxes
  • Insurance
  • Maintenance costs
  • Realtor fees
  • Lack of mobility
  • Landlord duties

To name just a few.

All of these seem to be conveniently forgotten when the back of the envelope property performance calc is being done.

While real estate has performed relatively well over time, much of this performance is simply a result of holding a leveraged asset for an extended period of time. Once you strip out the leverage, the returns become less compelling.

Since 1940, the median home value in the United States, adjusted for home size, has increased at an annualized rate of 4.6%. After accounting for inflation, the average home value has risen by just 1.5% per year.

Stocks have generated roughly 7% per year over the long run after accounting for inflation. In other words, the stock market has generated returns at more than four times the rate of real estate appreciation.

With that being said, I do have some gripes with the stats above. Firstly, it ignores the excess volatility you get from the stock market.

Secondly, and more importantly, you can’t just strip out the leverage effect. If you have purchased a property and it doubles in value, a cash buyer makes a 100% profit. A buyer who has purchased the home using just a 10% down payment has made a 900% profit (excluding fees) on their original investment. Of course, leverage creates issues in the opposite direction but still needs to be factored in.

One final unique upside. If the capital appreciation isn’t what you expect, you can still live in it. The stock market doesn’t offer you a roof over your head.

Like most things in life, nothing is ever as good, or as bad, as it seems.

There are pros and cons to everything. Property is no different.

With the background out of the way, let’s get into the important stuff.

It’s easy to look back and wish you bought that property 20 years ago or bought Apple stock when it went public. Hindsight is 20/20. But essentially, it’s irrelevant.

Given the lack of advancements in time travel as of late, focusing on missed buying opportunities is redundant. The only question that needs to be answered is – Where do prices go from here?

My Opinion

Do I think house prices are cripplingly high for first-time buyers? Yes.

Do I think they can go higher? Absolutely.

There is this unsupported opinion that what goes up must come down, but unfortunately, the economics is a bit more nuanced.

While I don’t think that property can continue to grow at the same clip into a rising interest rate environment, there are too many supportive variables at play to justify any significant move lower.

5 factors stick out here.

Supply vs. Demand

Simply put, the recent increase in property prices has been driven by the fact that we have record-high demand and record-low supply.

Population growth has outpaced home construction for the last 20 years.

Since the Great Recession, home construction has been increasing but is still down 55% from 2006.

Home construction over the past two decades

Number of single-family homes built yearly per 100,000 people

Source: US Census Bureau/ USA Facts

While 2006 supply metrics flipped the supply/demand dynamic too far in the other direction, two decades of underbuilding has left us with a considerable housing shortfall. Our fear of repeating the same mistakes following the last crash left us gun shy, creating an altogether different but equally concerning issue—unaffordable housing.

The current inventory levels in the U.S. are the lowest on record. If you’re wondering why the house you bid on went for 25% more than the asking price, here’s your answer.

Total Inventory  Homes for Sale US – Single-Family 

U.S. housing starts and permits, monthly

Source: Altos Research

With that said, there has been a pick-up in new U.S. housing starts but we have years of underbuilding to make up for.

US Housing Starts and Permits, Monthly

Millions, SAAR

Source: Census Bureau RSM, US

Government regulations, supply chain issues and higher labour costs will ensure this housing shortage is not resolved overnight.

It’s a seller’s market for the foreseeable.

Money Supply

Between December 2019 and August 2021, the U.S. money supply measured by M2, grew by $5.5 trillion, a stunning 35.7% increase in only a year and a half, driven primarily by the Fed’s purchases of Treasuries.

YOY change (by %) in money supply, M2 and TMS/Rothbard-Salerno Measure

TMS & M2 chart

Source: Mises Institute

This increase in money supply pushed savings accounts, household net worth and consumer demand to record highs in 2021.

“Whereas the Great Financial Crisis (GFC) saw the destruction of household net worth (the bursting of a housing bubble) of about 70% of GDP in the 3 years through mid-2009, laying the ground for liquidity trap-like conditions, the Great Pandemic has seen household net worth increase about 120% of GDP in about half the time.” Chris Marsh – Money: Inside and Out

Household net worth is now over twice what it was in 2007.

Household Net Worth – USD Billions 

Household Net Worth – USD Billions

Source: JP Morgan

What you are left with is an ever-growing supply of money chasing a finite number of financial assets.

The money must go somewhere.

Inflows into equities over 2021 were higher than the prior 19 years combined.

Rolling 12m Flows to Equities

Rolling 12m flows to equities

Source: BofA Global Investment Strategy, EPFR

The real estate market was no different. The U.S. housing market gained $6 trillion of value in just one year.

Total Value of U.S Homes, in Trillions

Total Value of U.S Homes, in Trillions

Source: Redfin Housing Value Index

While higher yields and a reduction in federal spending will likely see the rate of these effects fall away as we move forward, the unprecedented money flow in the system will have a prolonged effect on asset prices.

Credit facilities

In recent times, historically low-interest rates have pushed debt payments as a percentage of disposable personal income to all-time lows. These lower debt service ratios have helped justify increased spending and facilitate higher asset prices.

Debt payments as a % of disposable income

Debt payments as a % of disposable income

Source: JP Morgan

Looking specifically at mortgages rates, monthly payments are as affordable as they’ve ever been.

US Household Mortgage Debt Service as Percentage of Disposable Income

US Household Mortgage Debt Service as Percentage of Disposable Income

Source: Ritholtz Wealth

You have lenders borrowing at fixed rates of 3% in a 6% inflationary environment. Credit scores are stronger than they have ever been, lending standards are high, and we have more money in the economy than ever before. This is far from a repeat bubble.

It’s not just lower mortgage rates that have pulled forward demand.

Readily available and elaborate credit lines certainly haven’t helped matters. Thanks to some banking wizardry, we can stretch way beyond our means.

It’s not our financial robustness that allows us to afford these astronomical house prices. Our sudden ability to afford million-dollar homes perfectly correlates with more ‘affordable’ 40-year mortgage options.

Yes, $1,00,000 is a sizeable mortgage, but if you spread it out over 40 years, suddenly, it seems justifiable, manageable even. The bidder most willing to shackle themselves to this life sentence, ‘wins’.

These never-ending mortgages are pitched as supportive consumer products, but the reality is they facilitate higher housing prices. Without the advancements in mortgage products over the years, properties simply wouldn’t have had the capacity to reach the levels they have.

Interest rates

Conventional wisdom suggests that rising rates should slow things a bit as borrowing costs increase, making previously justifiable loans unaffordable, dampening demand as a result. Makes sense, right?

Bizarrely, the opposite has been shown to be true in the past.

Housing Index Vs. Interest Rates

Housing Index vs. Interest Rates

Source: Rob Viglione

Post-WWII to early 80s, home prices climbed higher despite 30 years of rising rates.

Contrary to that, from the early ’80s to 2008, interest rates precipitously declined as house prices exploded.

The correlation isn’t as obvious as you would expect.

In the post-world-war instances above, my view is interest rates didn’t matter as much as other prevailing factors such as personal income, general economic conditions, supply vs. demand, and population growth. The supportive forces of demographics and economic activity outweighed the move in interest rates.

Maybe, if all other factors were held constant, we’d see a negative relationship to validate conventional wisdom.

Just another iteration of the unpredictability of markets. Always remember, there are multiple factors at play.

While rising interest rates will likely have a cooling effect on markets, other factors will drive housing prices in the other direction.

The strongest factor wins.

Private equity ownership

This one is somewhat exaggerated but worth mentioning.

Always a crowd-pleaser when you blame surging housing prices on the big bad investment banks. After all, who doesn’t love to rally behind a ‘Vultures out’ campaign. As much as I would love to burden them with most of the blame, the stats simply don’t back it up.

The share of total home sales that come from investor purchases has actually been in decline. In 2020, estimates showed that investors make up about 20 percent of housing sales.

Investor Purchases as a Share of Total Home Sales

Investor Purchases as a Share of Total Home Sales

Source: John burns real estate consulting

Bear in mind that number is not just the share of institutional investors but anyone who isn’t just buying a house as their primary residence. This 20% includes people purchasing second homes, vacation rentals, individual investment properties, and small investors flipping homes for profit.

Since 2011, the cumulative acquisitions from institutional investors has approached 400,000 single-family homes across the U.S. This may seem like a lot, but with 83 million homes in the U.S., this represents less than half a percent of the market. If we narrow our focus solely to the 16 million homes on the rental market, institutionally backed firms only own 2.5% of the market.

In reality, large investors make up just 1 to 2 percent of all single-family purchases, while other investors make up 18 to 19 percent.

The numbers show that most rentals are owned by small investors. Your neighbours, your friends.

To be clear, I agree that levies should be in place to prohibit bulk buying of properties, but simply using private equity firms as the scapegoat ignores the crux of the problem.

As masters of the dark arts of deflection, politicians are quick to point the finger. In reality, money supply, over-regulation, a distinct lack of planning, inadequate funding, and extended periods of undersupply post the GFC are the driving forces behind the current housing crisis. But I guess it’s easier to fix the blame than fix the problem.

Final Word

I expect home prices to grow more moderately in the coming years as more supply reaches the market, but those waiting for a considerable pullback could be left wanting.

Don’t expect housing to become affordable any time soon.

If I had to guess, it’s going to be years until we see anything approaching a “normal” housing market.
We simply didn’t build enough homes following the last housing crash to meet the demand
coming from millennials reaching their household formation years

Ben Carlson – A wealth of Common Sense

Looking ahead, rising rates could slow things a bit if mortgage rates get high enough. With that said, the central banks are relatively boxed in. Interest rates are unlikely to skyrocket given the effect this would have on the service level of government debt, but that’s for another day.

Remember, just because you think house prices should fall, doesn’t mean they will. The distinction is vital.

The waiting game hasn’t always paid off.

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