Housing Crisis?

I’ve been scratching my head for the past six months. Interest rates have skyrocketed upward resulting in everyone’s cost of capital increasing. Common sense would imply a downward reversion of housing prices. But we have seen the complete opposite. Housing prices across the board have increased despite the rather sharp increase in housing prices.

I have been thinking about this phenomenon for a few months now as it is a fascinating time for real estate investors alike. I am in no way a professional real estate investor. The only real estate I own is my personal residence with a sub 4.0% interest rate, termed out for 30-years.

Owning this personal residence has gotten me interested and vested in a market that only appears to be going up. And seeing the power of taking on significant cheap debt with a 30-year term, alongside leveraged equity appreciation makes me want to acquire even more personal debt and use it as an asset.

Consider this…

• I can rent out my current residence for a significant premium to my “all in” monthly payment. In fact, if I rented out my current place I could use the after mortgage cash flows from the rental stream to almost entirely pay for another personal residence (a much smaller place, but nonetheless “free” housing).

• That is two large debt tranches paid down by one rental stream, essentially cutting my largest expense (outside of taxes) to zero.

• My ultra-low mortgage payment will stay the same for 30-years while rents continue to increase every year — by whatever the rate of inflation is (my guess high single to low double digits).

• This ultra-low mortgage payment, combined with rising rents, gives me an incentive to never sell my property as this debt is essentially an asset.

• The Fed has announced a pause on rates. Money printer (quantitative easing) will be back on session in no time, resulting in lowered rates and asset pricing going much higher.

• TLDR: housing is going to go higher

If you don’t believe me that housing is going higher try to find one homebuilder stock that is not at a 52-week high. Too lazy to pull-up 15 different homebuilder stocks? Then just take a look at iShares U.S. Home Construction EFT (ITB) which is trading at almost an all-time high.

So why are homebuilders trading at 52-week highs? A few reasons.

1. The Federal Reserves strategy of zero percent interest rates allowed a significant amount of Americans to lock in historically low mortgage rates for a 30-year term. Anyone with a sub-4.0% rate will likely not sell their asset since they would have to trade-up for higher rates.

2. With higher rates came higher rental prices. Given the limited supply of homes available for purchase, there has been an increase in demand for rental units, resulting in higher rental rates.

3. Higher rental rates, combined with a lack of supply has resulted demand for new build homes. Prospective buyers are now turning to homebuilders to meet their needs, resulting in record profits for homebuilders.

The picture below explains it all, concisely and accurately.

New single family homes sold as a percentage of all single family homes sold is at an all time high.

If you are interested in the housing market you should definitely consider reading through D.R. Horton’s recent earnings call. Here are a few quotes from the call that stood out to me.

• Our average closing price for the quarter was $378,800, down 2% sequentially and essentially flat with the prior year quarter.

• The average sales price of net sales orders in the second quarter was $372,900, down 7% from the prior year quarter and up 1% sequentially. To adjust the change in market conditions and higher mortgage rates, we have continued offering incentives and reducing the prices and sizes of our homes where necessary to provide better affordability to homebuyers and to optimize the returns on our inventory investments. We expect to continue offering a similar level of incentives throughout 2023 and we are seeing indications that our average sales price and incentive levels are beginning to stabilize.

• So there are still places where we are seeing pricing still slightly decline, some places where we're seeing it stabilize, some places we're able to start pushing it up a little bit. So on a net basis, as we look forward, we expect our margins to stabilize around current levels. So that's why our guidance range anticipates perhaps slightly below this quarter, perhaps a little above this quarter. And it's too early to know for sure how that will play out over the remainder of the coming quarter.

• Yes, absolutely. We all see the same headlines there. And depending on what happens in the rate environment and across the spectrum of banks, so there could be further headlines, obviously. But today, no, we have not seen a significant impact. — this is in terms of not seeing any significant impact from the banking crisis and failures.

• And so we feel pretty good about market conditions right now. We've seen good stabilization in pricing and incentive levels and when we see that, we're hitting absorptions in the communities at a community-by-community level, we're looking to adjust incentive levels and pricing.

• We have seen good pace on our ability to rent up both our apartments and single-family for rent. We have seen stability in rent rates. They've been increasing quite a bit over the prior 12 months, and we've seen stability there.

Over the short-term I think we see housing and rental prices stabilize at the current levels. If the Fed lowers rates there could be a huge surge in demand for housing, alongside continued inflationary impacts on assets prices, like single family houses. Long-term, anyone who locked in an ultra-low interest rate will not be selling their residence and look for alternative methods — such as renting their unit — to hold this free debt.

There is nothing for me to do now. But over the next several years I wouldn’t mind taking on more debt in the form of a 30-year term. Used the right way, debt is an asset and can be powerful way to control a significant amount of real estate.

Goals:

• Take on as much debt as possible in a risk adjusted manner (non-recourse).

• Rent out my current residence and buy another place to have my renter at the first unit pay my current mortgage and also my second mortgage.

• Have an opportunity fund (cash invested in treasuries) ready to deploy in case of downturn in housing market.

• Network with more real estate investors to have the optionality to launch a real asset fund in the future when opportunities present themselves.

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