A Deep Freeze Followed By Equilibrium

Generally, I am a fan of old country music; Hank Williams, Lefty Frizzell, Kitty Wells, Loretta Lynn, and of course, the best of them all, George Jones. I am also a fan of Real Estate Investment Trusts (REIT) as a way to invest in real estate without having to actually having to buy dirt. Non sequitur? New country has artists I admire as well, and one is Jordan Davis, whose song, Buy Dirt is iconic country. It’s the story of a grandfather advising his grandson that “the truth about it is, it all goes by real quick, you can’t buy happiness, but you can buy dirt.” In other words, buy land, they’re not making more of it.

But how does a working person that is earning median income, about $57,200 per year invest in real estate? One answer is a different approach to the idea behind a REIT – aggregating capital by selling shares in investments, allowing smaller investors the benefits of appreciation and liquidity – selling very small shares working people can afford. Happy Nest is an app-based REIT founded by Jesse Prince, who wanted to make real estate investing and the REIT model accessible to everyone. I asked Prince what he thought of today’s housing market.

Before I get into Prince’s responses to my questions and my thoughts, I have a history with the REIT concept. Years ago, while on plane, I found an article in a discarded copy of the Financial Times about the Ethical Property Company, now known as Ethical Property, an innovative take on the idea of essentially crowd funding real estate investment before that term emerged. Rather than depend on government subsidies or philanthropy, Ethical Property treated the acquisition of property that benefited purpose driven uses like non-profits and cultural uses as an investment.

Buy shares in the acquisition of an older building housing environmental advocacy groups, a gallery, a dance studio, and incubator space for startups, and you’ll get a return. It demonstrated confidence in these uses as financially viable as well as socially important. I wrote a post back in 2012, We Loved Our Neighborhood So Much We Bought It, about how this approach could stem community frustration over change from the development of new housing. I wanted to get Prince’s take on the housing economy at the midpoint of 2023. His answers are below the bold questions and my thoughts are in italics.

Is it correct to say that there was something of a bubble in 2021-2022, with many people jumping into purchasing a home because of low rates, especially in cities like Boise with very low prices? That seemed to have ended last year. Are we seeing some kind of reset and if so, what is it?

We’re entering into a hibernation period before a potential reset. This “deep freeze” in the housing market could be prolonged for an extended time because of the Fed signaling a potential pause on increasing interest rates. Moreover, today’s homeowners, many of whom saved up during the pandemic and jumped in when prices were sky-high and interest rates were rock-bottom, are putting a pin in any moving plans for the time being. This kitchen-table decision-making while logical, is also putting a squeeze on housing supply, slowing the usual give-and-take between high mortgage rates and home prices.

My biggest concern, articulated last year, is that the “deep freeze” Prince is describing will discourage new housing development. If people are unwilling to move from existing housing into new units, who is going to build those? This is why I worry about supply dwindling, then when things settle down sometime in the next 18 months, demand comes back pushing up prices. It’s why the answer, I think, is for local governments to stoke new housing production with fewer regulations and subsidies if needed.

Would you describe the single-family market as volatile? Have rising rates and economic uncertainty caused people to stay out of the market?

I wouldn’t say it’s volatile, but I would say the factors – higher rates, inflation, construction and labor shortage – are not conducive to a healthy housing market. Furthermore, we cannot overlook the role of institutional investors. With their obligations to safeguard shareholder value, they have little motivation to exchange assets locked in at low mortgage rates for deals involving higher interest rates. This reluctance further exacerbates the issue at hand.

If I was advising someone or something like a large REIT or investor, I’d suggest now is the time to buy up as much as possible – this might be counter to what is suggesting larger investors might do. Those with cash in this market can absorb lots of distressed assets at a discount and when demand returns, make a killing. It’s why, again, state and local governments need to get in front of this now with incentives but also banking land where they can. This could help shelter many households from price shocks when demand returns. Buying up land now could mean passing on the savings to families later.

Longer term, if there is a slowdown in housing production and since lowering interest rates is no longer on the table to spark production, will there be a long term fall off in supply that means higher prices in the future when the economy booms?

In places where house prices have been really high for a while, thanks to cheap loans, we’re now seeing prices start to drop because it’s getting more expensive to get a mortgage. On the other hand, in areas where houses are more affordable and there aren’t as many on the market, prices are still going up.

In the future, I expect to see mortgages keep getting more expensive because of these higher interest rates and the potential Fed-induced pause. This could make houses less affordable for most people, which might slow down the number of houses being sold and could lower prices everywhere, not just in the pricier areas.

Bottom line upfront: I expect inflation to eventually cool and interest rates to stay elevated. This should lead to a more balanced, normalized housing market, finding a new equilibrium between supply and demand.

People shopping for houses are really shopping for money. Measures to curb inflation, essentially reducing supply of money, mean it gets more expensive (higher interest rates). This is the first time I’ve observed a disconnect between the two, the price of money and the price of housing. This is a global phenomenon as one can see from this chart from the Organization for Economic Cooperation and Development.

Prince sees housing prices falling with money staying expensive, which he suggests would lead to equilibrium. That’s possible. But we could also see both fall after a job killing recession. That’s called a recovery, and when that happens, today’s “deep freeze” means fewer homes when that recovery comes. However, slower housing production now, and a recovery later, means a housing shortage, and higher prices even with lower rates. That’s not equilibrium.