I know what you’re thinking: is this guy serious?! Come on, McAlister, have you seen the Shiller Index? Have you heard of the frenzied bidding wars?
Have you looked at the underlying shakyness in the economy? Have you thought about what happens when increased unemployment benefits disappear and lenders and landlords can pursue arrears?
My answer is yes to all of the above. And I still think housing markets could continue to grow in the coming months, and that strength could continue for years to come.
Before we get into the details, a quick reminder about critical thinking and generating an investment thesis: we don’t take one thought, one idea, one data point and bet our whole future on it. We think in the margins.
We think in opportunities. Anyone who calls and claims to know exactly what the future will look like is more interested in fame, likes, or clicks than in being a good investor. If you ever read about big investors like Ray Dalio, Howard Marks, Druckenmiller and many more you will see that they predict but they don’t assume they are always right and go all in. on one outcome. They understand thinking in terms of opportunities and interim adjustments.
Which factors are at play today that can influence the future, and which possible outcomes have which chance of occurring?
Just to be clear, I think the economy is in trouble for a long time. We have a serious debt problem and some ugly demographic problems that indicate weak GDP growth and productivity compared to our history. I also think that inflation, although transient at the moment, has a chance to become a serious problem.
Let’s focus specifically on single-family or one-to-four-family “townhome/duplex” homes. Some key factors at play here could allow for further price increases before the party ends.
The biggest part is demographics. According to UN population data, in 2020 the largest age group in the US was 25-29 years old. The next biggest? Thirty to 34 year olds. Then 20-24.
Guess the average age of a first-time homebuyer? Thirty-four years old.
So what we have are the top three age groups in the country that have all started to reach prime age for buying a home.
Here’s the thing about life: it doesn’t last forever. People are less price sensitive when it comes to certain purchases, such as houses. You don’t wait forever to find a deal. You shut up, borrow the money and buy the house because your life is happening now. Children are coming, careers are developing and homes are needed.
New Federal Policy
What else is happening on the demand side? How about a $15,000 credit for the first time you buy a home? It’s not a foregone conclusion yet, but it’s easy to see something like that getting through to the law.
There is also a form of remission or cancellation of student loans on the table.
Finally, low interest rates are absolutely essential for the continued strong rise in house prices. Currently, there is no end in sight to the Federal Reserve’s low interest rate policy. Even if inflation picks up temporarily, the Fed is unlikely to allow interest rates to rise significantly higher. They know it will end the party and make everyone (including the government) insolvent.
When you add up all these demand factors, millennials will spend more money on new homes faster than my little sister when Justin Timberlake tickets go on sale.
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We also need to look at the supply picture to better understand where the housing is going. As for existing homes, I don’t see a massive supply wave coming. The main places that a supply wave of existing homes could come from are economic problems or the downsizing of baby boomers.
In the longer term, some economic weakness is looming. However, I don’t think the market is close to what it looked like in 2006. Borrowers are more creditworthy and have less debt. No one can know for sure, but I think the demographic and government support on the demand side will outweigh the pressure here, even as the eviction moratoriums burn down.
Some Boomers will definitely downsize and houses will come on the market. However, there are more millennials buying than boomers selling. Also, aging is becoming more common, with older people bringing services to them rather than the other way around.
Grandparents also love to keep their home to have a meeting place for their children and grandchildren. In some circumstances, they can continue to own their home to house their children and grandchildren.
New-build supply remains the most important option.
I think we will see the supply of single-family homes and for rent ‘horizontal’ rental complexes continuously increase. However, rising construction costs and difficulties in acquiring and developing land due to high prices, labor shortages and zoning will limit supply to meet demand in the short term.
Let’s look at the start of single-family homes.
Since the bust, they have lagged significantly below the historical average. Single-family homes lagged significantly behind the historical average of about 1 million first-time buyers per month through 2020, where we have now returned to that level despite significantly higher populations.
This tells me that supply will have to catch up for a while before prices start to moderate.
House prices are skyrocketing, with the March Case-Shiller Index showing a price increase of more than 13% in the March year-over-year figure. We last saw this level of growth when the last housing bubble peaked between 2004 and 2006. Do I think this will settle in the long run? Yes. Do I think it’s going to be a “crash”? Not necessary. It could be a slow deflation.
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Will prices continue to rise?
While housing prices seem insanely high (they are), and it feels like they should be much lower (they should), there’s a strong argument that there’s still a lot of runway out there because of demographics, limited supply, and government intervention on the runway. The housing market.
This does not mean that prices will continue at this rate of appreciation. It also doesn’t mean that there won’t be cycles where prices moderate for a while or that you can close your eyes and buy everything and expect to make money.
In the margins and in general, apartment outperformance may disappear and single-family/horizontal rental complexes may be in the spotlight.
Some newer developments offer a pretty cool mix of single-family homes with high-end apartment-like amenities, including swimming pools, gyms, fitness centers and dog parks. You will hear the term ‘horizontal development’ more and more.
Self-storage can also benefit from this. Family building tends to drive demand for storage space because no one wants to lose their belongings if they move in or downsize with their partner.
Have fun hunting there!