The Unaffordable Housing Market

Welcome all new subscribers to Alpha Letter. Every week I write about interesting opportunities in the public market. I focus on stocks off the beaten path. Broken businesses. Assets trading under liquidation value. Macroeconomics and where the economy is heading. I don’t like investing in large, popular companies and find a fascination with assets no one else is looking at.

Today’s piece will be focused on the housing market and why I think housing prices could go up even further.

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The Housing Market

In early 2022 I was scrambling to purchase my first home. I have rented my entire adult life and was ready to make the move to homeownership. Since moving to the city six years ago my rent has continued to go up. I wanted a three bedroom apartment. A place big enough for an office, a nice master bedroom and another room to do whatever else I wanted in it. Renting a three bedroom place in the city costs a ridiculous amount of money and on a absolute basis it was cheaper to throw down the chips and buy my own place.

I placed bids on multiple homes and was outbid every time. The city I was living in was just beginning to reopen from the multiyear pandemic and the flood gates of individuals who wanted to buy a home was incredible. There was limited supply on the market, making the process of purchasing a home even more challenging.

Buying a home at the beginning of the pandemic was attune to buying an asset at the absolute top. We had basement level interest rates, which pushed the price of a home to sky high levels. Also given the lack of supply on the market, people were going to bidding wars and taking out a house $100k over asking. It was insane. But I wanted in. My rational for buying at the top was strictly based on the thought that this would likely be the last time in my lifetime that I can secure a 30-year term for under 4.0%. Interest rate under 4.0% is free money. And I wanted it.

I’ve also been a huge believer that we would see hyperinflation during our lifetimes. I’ve spent many hours pouring over old textbooks from the Weimar hyperinflationary period to know what happens when a country’s currency fails. One of the best ways to protect oneself from a currency collapse is through the ownership of a primary residence. As rents skyrocket from a hyperinflationary event, the cost of your mortgage stays the same. A fixed cost mortgage payment is an arbitrary trade and inflation hedge. Moreover, when the costs of raw materials and labor skyrockets, the replacement cost of your primary residence also increases in value.

I’ve been thinking about an inflationary period and housing for years now. A few years back it seemed like it was only me and a handful of other random guys who were yelling about the money printing and debt. But now it seems like everyone has woken up to this bizarre economic event. And while having my early morning coffee before the gym I stumbled upon this tweet when doom scrolling…

John F. Carter @johnfcarter

Housing supply question - is anyone who locked in a sub 3% mortgage going to sell their home so they can get a new house with a 6% mortgage?

Which led me to question the entire housing market and where it could go from here. Are we going to see housing prices crash back down as interest rates rise, or will home prices continue to go up as the replacement value to build a new home is now much higher?

From a personal standpoint, I don’t think I will ever sell the house I bought given my ultralow interest rate that I locked in for 30-years. Sub-four percent rates, the money is cheap and basically free. A bank essentially gave me extremely cheap debt that will only get cheaper as time goes on. I don’t think I will even try to pay this mortgage off early. There is just no point.

Which begs to question, what do I plan to do with this home for the next thirty years? On average a person lives in their home for seven years and moves on. There is no way I am staying in this place for seven years. I’ll probably live here for two at the most. Since I want to keep the place the only logical next move is to rent it out.

I’ve talked previously about the dynamics on how higher interest rates lead to higher rents. Basically, as interest rates go up, the cost of homeownership also increases. This prices out individuals given their monthly payment increases as interest rates increase. This leads to higher rents as there is more demand for rental units as a homeowner with an entrepreneurial mindset, this is an opportunity.  

I’m of the view the market is wholly rational unless you are investing in the most illiquid and obscure securities out there. Housing by definition is illiquid as you can’t buy and sell houses on a daily basis like a day trader plays the stock market. But obscure, tiny and unheard of? Definitely not. Real estate is one of the largest markets in the game. And by no means irrational.

Which begs to question, what will happen to home prices if interest rates stay at these six percent levels, or even increase from here, going forward? This is a question I have been struggling with and I’m sure anyone following the overall macroeconomic market has also pondered.

In the traditional sense, as interest rates rise, asset prices should fall. We are seeing this happen in the stock market. Interest rates are up so investors are forced to increase their discount rates, leading to lower implied free cash flows in out years. We can see this happen in the stock market in real time as stocks are illiquid and investors can re-price securities on a daily basis to adjust for any future macroeconomic impact. Given the illiquidity of the housing market, it is a little harder to see any price drops from higher interest rates in real time.

Bearish investors on housing will say prices will drop. Bulls will say prices will remain elevated as the replacement cost to build a new home is up 25%. In addition, there is the argument that anyone holding a mortgage with a sub-four percent interest rate will not be inclined to sell their home as they will never get an interest rate this low again. And who in their right mind would sell a home with a sub four percent rate to buy a smaller home with a 6-7% rate? Market rationality would suggest almost no one would.

I’m not an expert on housing. I invest in the most illiquid microcaps out there. Beaten down securities that no one will touch. My niche. Housing is a huge market that many institutions and guys much smarter than me focus all of their time on. I’ll probably never allocate more than 10% of my wealth to the real estate market. But I can have a high level view of the housing market and where I think it will go.

If you have been following Alpha Letter you probably know I have a strong view that fiat currencies will eventually collapse under mounds of debt and outrageous money printing. The Fed will do all it can to prevent a hyperinflationary period. When a society loses faith in the money system, that society will fall. I think the Fed will continue to raise rates until we go into a deep recession. Prices of commodities, labor and everything else should fall in a recession. But interest rates will remain high and the cost of anyone who has floating rate debt will increase substantially. Who is one of the biggest holders of floating rate debt? The U.S. Government.

Imagine the interest rate cost on $30 trillion in debt with rates at 7%. Imagine it at 10%. Last year I wrote up an article in Alpha Letter highlighting how raising interest rates on $30 trillion in debt would effect interest payments. We effectively went from paying annual interest payments of under $18.9 billion. With a 6% rate our annual interest rate is now $1.62 trillion. This interest payment is only increasing.

• 1% - $270 billion

• 2% - $540 billion

• 3% - $810 billion

• 4% - $1.08 trillion

• 5% - $1.35 trillion

• 6% - $1.62 trillion

• 7% - $1.89 trillion

• 8% - $2.16 trillion

• 9% - $2.43 trillion

• 10% - $2.70 trillion

• 15% - $4.05 trillion

• 20% - $5.40 trillion

Eventually the Fed will have to lower rates again because there is no way in hell we can afford $30 trillion in debt with 6-7% rates. The math just doesn’t work. Money printing will resume and asset prices will elevate.

This is a long drawn out post to really just say one thing. Owning your own home in a period like this will be a powerful asset. The Fed is playing dangerous games with the money supply. Higher interest rates will price new homeowners out of the market. Lower interest rates will increase asset prices. Anyone with ultra low rates on their primary residence will likely not be selling into this market to buy another house with rates double or triple what they have already locked in.

I have a strong view that housing only goes higher from here on out. Prices might come down in the short-run. But over the next few years, asset prices will go ballistic as money continues to be printed. Fixed assets like a home will only increase in value. Individuals who locked in ultra-low rates got a sweet deal. Keep those rates and let hyperinflation take out your debt for you.