Have We Hit The Top?

[Red Lion]

On 10/20/2023 at 5:19 AM, Spekulatius said:

I would be careful betting on anything house related now. Buying a house at 3.5% Cap rates when mortgages are at 8% seems like a loser proposition. Housing prices are auction driven (just like anything else) but value is affordability and we are at a 25 year + low on that metric.

I’ve been thinking about this a lot, and I’ve bought over $2 million of real estate this year which is a significant chunk of my net worth. Most of these deals are value add, so obviously even if real estate crashes I’m happy to hold these. 
 

But I disagree that real estate is a bad play just because we have unsustainable 8% mortgages. 
 

There’s a huge difference between today and the 1970s and 1980s, and that’s that the cost of replacement is far more. For example it costs the median household income of about 10 years to build a meh new construction house in my California city, and it’s not even one of the crazy expensive cities. 
 

I just saw a statistic that in 2022 40% of homes bought by millennials. In 2023 the number was below 10%. This is where your interest rate unaffordability is going. It’s delaying demand from millennials and gen z buyers. I also read that for every 1% drop in mortgage rates there will be 3 million more eligible buyers to qualify. 
 

Either we continue to have higher inflation and rates, which will continue to increase replacement cost and exacerbate the shortage, or else we have recession, lower rates, and likely higher housing prices as a result. 
 

I’m not saying housing is a slam dunk, and obviously it’s not possible to do 75% ltv on a 4 cap rate at 8% mortgage, but it’s totally possibly at 30% ltv. I’m actually only at about 15-20% ltv and still looking for more properties. 
 

I think you’re almost certainly a smarter and better analyst than I am, so this gives me pause to take the opposite stance here, but I really do think 8% mortgages only last for a bit, and if not it’s because of a lot of inflationary pressures that have historically been good for housing. 

Edited October 22, 2023 by RedLion

[SharperDingaan]

19 minutes ago, RedLion said:

I’m not saying housing is a slam dunk, and obviously it’s not possible to do 75% ltv on a 4 cap rate at 8% mortgage, but it’s totally possibly at 30% ltv. I’m actually only at about 15-20% ltv and still looking for more properties. 

 

Keep in mind that housing is local, and price paid is the 'market cap' PLUS a premium (location, scarcity, utility, etc.). You own a boat on the market tide, and premiums change. We hold our London (UK) RE primarily as a luxury good; the better the 1% do, the more our neighbourhood gentrifies, and the better we do.

 

The economic/political solution to millennial's deferring house purchases, are fiscal programs financing post WWII quantities (after servicemen returned) of affordable new builds for the masses. Today's mansions become tough sells at current prices, when buyers have viable alternatives.

 

Millennial's are also increasingly viewing housing as just shelter, NOT an investment. Buy just what you need (house poor vs house rich), stay in it for some time, and buy it to live in. Sell/move only as your needs change (work, more/older kids, etc.). Not that a dissimilar view to those who lived through the 1930's depression. 

 

SD

[Spekulatius]

@RedLion I do not think that replacement  cost protects your downside as much as you think. There is plenty of commercial real estate valued below replacement cost. It all depends on the supply versus demand situation.

 

Obviously if you do value add deals then it’s a totally different story and very much project dependent.

 

I do not know housing demand, but I think it’s way more eslasric than people think. Maybe the millennials will just rent instead of buying. There is plenty of new multi family housing supply  

coming online in 2023 and 2024 before it will tail off in 2025, especially in growth markets like the Southwest and Texas.

 

I do not think I have any crystal ball on housing ,others are way better. I just don’t think it’s a good bet because I think the value metric is affordability and we are at a 25+ year low on this metric.

[dealraker]

Although I did buy some tracks of land, one as a half owner the other as 20% owner, I have only watched (instead of participating) a lot of people I know very well - all my first cousins or their children - participate in both commercial and residential real estate.  These aren't small players.  Here's my summary:

 

The guys - all family to me - putting the deals together whether commercial or residential are fabulously well off, but the residential dealmakers have done better by a significant amount.

 

The people - all family to me - investing in the endless number of deals the above have orchestrated have varied results.  The commercial investors have had some successes but some blowout losses too.  Overall nowhere as good as an index fund.  The residential investors have far better results with only a couple of wipe outs.

 

I've been typing for years that Bruce Flatt's skill is marketing and fees, not buying assets, without success of persuasion.  I've enjoyed my failure some...and glad not to ever be a Brookfield investor ever again, win or lose...I could care less.  

Edited October 22, 2023 by dealraker

[Red Lion]

2 hours ago, Spekulatius said:

@RedLion I do not think that replacement  cost protects your downside as much as you think. There is plenty of commercial real estate valued below replacement cost. It all depends on the supply versus demand situation.

 

Obviously if you do value add deals then it’s a totally different story and very much project dependent.

 

I do not know housing demand, but I think it’s way more eslasric than people think. Maybe the millennials will just rent instead of buying. There is plenty of new multi family housing supply  

coming online in 2023 and 2024 before it will tail off in 2025, especially in growth markets like the Southwest and Texas.

 

I do not think I have any crystal ball on housing ,others are way better. I just don’t think it’s a good bet because I think the value metric is affordability and we are at a 25+ year low on this metric.

I think you’re right about replacement cost not protecting downside at least in the short term, but it keeps supply limited and I think still makes the setup favorable once interest rates normalize, or gdp/rent normalize to the upside. 
 

I think value add is 100% the way to go. 
 

I also see that there’s a ton of apartments being constructed, but I wonder how much demand there will be for apartment living versus sfh. The new construction apartments in my area rent for similar amounts to sfh which doesn’t seem sustainable, but maybe other people are way more into that than I am. 
 

In the early 80s I know housing wasn’t very affordable, but it’s been a home run since, just due to falling interest rates. 
 

I’m just a lowly amateur, but it doesn’t seem like interest rates can possibly get as high as before due to the much higher levels of government/business/household debt.
 

And if they did, wouldn’t the interest on government debt create its own inflation since it’s just going to result in further deficit spending? 
 

I’m protecting my downside by taking low leverage, value add, supply constrained markets wirh demand drivers and real estate at a healthy discount to replacement cost. 
 

I think short term bonds or longer duration tips could be a good alternative right now, but I feel like equities have just as much or more risk than residential real estate and have acted accordingly in my portfolio allocation. 
 

I’ve been thinking I’d trying to get into the credit side on some private real estate deals. Hard money lending or something. But it’s very tax inefficient, and I feel like you really would want to setup a c corp in a tax friendly state to get started. I’ve been seriously considering it. 

[Red Lion]

3 hours ago, SharperDingaan said:

 

Keep in mind that housing is local, and price paid is the 'market cap' PLUS a premium (location, scarcity, utility, etc.). You own a boat on the market tide, and premiums change. We hold our London (UK) RE primarily as a luxury good; the better the 1% do, the more our neighbourhood gentrifies, and the better we do.

 

The economic/political solution to millennial's deferring house purchases, are fiscal programs financing post WWII quantities (after servicemen returned) of affordable new builds for the masses. Today's mansions become tough sells at current prices, when buyers have viable alternatives.

 

Millennial's are also increasingly viewing housing as just shelter, NOT an investment. Buy just what you need (house poor vs house rich), stay in it for some time, and buy it to live in. Sell/move only as your needs change (work, more/older kids, etc.). Not that a dissimilar view to those who lived through the 1930's depression. 

 

SD

SD

 

Half of my real estate investments by value and all of my debt are in Maui which obviously has some of the same characteristics as your London investment re: a play on 1%. Also very high replacement cost especially with demand surge from the fires. 

As far as millennials, I think they all want to buy and mostly can’t qualify. It seems like they were buying a relatively outsized percent of the overall volume over the last couple years and now that rates are higher they’re buying a far lower percentage of the overall volume. My deduction is that millennials want to buy but can’t qualify for anything at these rates. The ones who can are relocating to the same cheaper states where new construction is barely more expensive than existing housing stock. 
 

For example I think Huntsville Alabama is interesting. They have a great median household income. Super low property taxes. Fantastic employment/tech scene. Investor friendly laws. But you can also build a brand new house for basically the same cost as the existing stock. It’s definitely more affordable, tons of demand drivers, but also all the supply in the world. 

[Spekulatius]

4.9% annualized GDP growth...I guess most of it is caused by Federal spending which means more borrowing which is the reason why LT interest rates are up.

https://finance.yahoo.com/news/gdp-us-economy-grows-at-fastest-pace-in-nearly-two-years-123246049.html

 

We are probably growing faster than China at this point.

Edited October 26, 2023 by Spekulatius

[gfp]

44 minutes ago, Spekulatius said:

4.9% annualized GDP growth...I guess most of it is caused by Federal spending which means more borrowing which is the reason why LT interest rates are up.

https://finance.yahoo.com/news/gdp-us-economy-grows-at-fastest-pace-in-nearly-two-years-123246049.html

 

We are probably growing faster than China at this point.

 

This print was primarily a reflection of the still-strong employment situation and the strength of the consumer.  I guess you can try to trace that back to government spending somehow but this quarter was the consumer and the inventory cycle -

[Gregmal]

22 minutes ago, gfp said:

 

This print was primarily a reflection of the still-strong employment situation and the strength of the consumer.  I guess you can try to trace that back to government spending somehow but this quarter was the consumer and the inventory cycle -

Whenever the recessionistas are wrong they just make up another excuse or find someone to blame and then kick the “call” down the road another Q or two. 

[changegonnacome]

Growing at the fastest in two years.....like there's an election or something coming up soon  

 

Ideally as politician you'd like this Q's GDP headlines to have landed sometime in mid-2024......will be interesting to see if Grandpa Biden has prematurely stimulated.....which is what I hear can happen as you get older 

[Red Lion]

1 hour ago, changegonnacome said:

Growing at the fastest in two years.....like there's an election or something coming up soon  

 

Ideally as politician you'd like this Q's GDP headlines to have landed sometime in mid-2024......will be interesting to see if Grandpa Biden has prematurely stimulated.....which is what I hear can happen as you get older 

 

What's funny is that no one is happy about the GDP growth because they all have apoplexy about high rates and inflation. Maybe I'm just talking to the wrong folks.

 

It seems to me like maybe we are entering a new era of higher higher wage inflation, higher GDP growth, and perhaps as a result higher rates. The wage inflation seems almost guaranteed in the USA unless somehow AI keeps it at bay.

 

We have an aging retirement age population that's richer, healthier, and wants to spend; a working population that doesn't want to work and is sick of their low quality of life; an immigrant population that's barely growing and seemingly demanding higher wages than previously; onshoring; (hopefully not) World War III.

 

Edited October 26, 2023 by RedLion

[Gmthebeau]

On 10/22/2023 at 10:02 AM, RedLion said:

I’ve been thinking about this a lot, and I’ve bought over $2 million of real estate this year which is a significant chunk of my net worth. Most of these deals are value add, so obviously even if real estate crashes I’m happy to hold these. 
 

But I disagree that real estate is a bad play just because we have unsustainable 8% mortgages. 
 

There’s a huge difference between today and the 1970s and 1980s, and that’s that the cost of replacement is far more. For example it costs the median household income of about 10 years to build a meh new construction house in my California city, and it’s not even one of the crazy expensive cities. 
 

I just saw a statistic that in 2022 40% of homes bought by millennials. In 2023 the number was below 10%. This is where your interest rate unaffordability is going. It’s delaying demand from millennials and gen z buyers. I also read that for every 1% drop in mortgage rates there will be 3 million more eligible buyers to qualify. 
 

Either we continue to have higher inflation and rates, which will continue to increase replacement cost and exacerbate the shortage, or else we have recession, lower rates, and likely higher housing prices as a result. 
 

I’m not saying housing is a slam dunk, and obviously it’s not possible to do 75% ltv on a 4 cap rate at 8% mortgage, but it’s totally possibly at 30% ltv. I’m actually only at about 15-20% ltv and still looking for more properties. 
 

I think you’re almost certainly a smarter and better analyst than I am, so this gives me pause to take the opposite stance here, but I really do think 8% mortgages only last for a bit, and if not it’s because of a lot of inflationary pressures that have historically been good for housing. 

 

Housing is definitely an inflation hedge, due to what you cited the replacement costs.  If we have persistent inflation which seems likely you will continue to have pressure on commodity prices, labor costs, all of which goes into the replacement cost.  The FED itself does not expect to hit a 2% inflation target until 2026!  With the massive debt the government has they have no choice but to try to inflate away the debt.   Many people believe they intentionally let inflation get out of control and have been intentionally slow to deal with it because they don't intend to get to 2% even by 2026.  I mean their projections are notoriously way off!

[gfp]

I don't know why everybody seems convinced that inflation is still a big deal.  The difference between the current inflation rate and the Fed's target is basically going to be determined by OPEC+.  Mission accomplished.  The new wage inflation is getting to keep your job / hours.

 

https://fred.stlouisfed.org/series/T10YIE

Edited October 26, 2023 by gfp

[Gmthebeau]

9 minutes ago, gfp said:

I don't know why everybody seems convinced that inflation is still a big deal.  The difference between the current inflation rate and the Fed's target is basically going to be determined by OPEC+.  Mission accomplished.  The new wage inflation is getting to keep your job / hours.

 

https://fred.stlouisfed.org/series/T10YIE

 

lol, the government numbers are 3.7% which is almost double their target, and everyone knows the government numbers under report actual inflation.

[gfp]

41 minutes ago, Gmthebeau said:

 

lol, the government numbers are 3.7% which is almost double their target, and everyone knows the government numbers under report actual inflation.

Everybody knows the government numbers under report actual inflation huh?

 

Sounds like you got it all buttoned down Mr Thebeau

Edited October 26, 2023 by gfp

[Red Lion]

@gfp I'm not saying that per se inflation is a big deal. I think a lot of people are worried about the effect of 5% long treasuries and 8% mortgages on asset valuations.

 

So inflation might very well come down, and then so will the 5% treasuries and 8% mortgages, and real estate and bonds will do fine, and probably lots of stocks too. 

 

But the only reason for mortgage rates to stay at 8% for several years is if inflation does not come down. 

[Gmthebeau]

17 minutes ago, gfp said:

Everybody knows the government numbers under report actual inflation huh?

 

Sounds like you got it all buttoned down Mr Thebeau

 

Even if it doesn't under report it is still nearly double the target.

 

However, yes most believe it under reports.  Congress has essentially directed the BLS to change the calculations in the past so that it reduces social security payments.

[ValueArb]

6 hours ago, Spekulatius said:

4.9% annualized GDP growth...I guess most of it is caused by Federal spending which means more borrowing which is the reason why LT interest rates are up.

https://finance.yahoo.com/news/gdp-us-economy-grows-at-fastest-pace-in-nearly-two-years-123246049.html

 

We are probably growing faster than China at this point.

Building fresh Abrams tanks may or may not be necessary, but it isn’t economic growth even if measured that way. 

[mattee2264]

Amazing how Big Tech earnings are so good but they are still selling off. Goes to show just how high expectations are from these market darlings and that sentiment has shifted from "AI is the future, the sky is the limit" to "Is this as good as it gets and concern about forward guidance for the core non-AI businesses". 

[Spekulatius]

I think the "problem" with the better than expected GDP growth that it caused the much better than expected earnings growth last quarter. The market is forward looking and the 4.9% of course is unsustainable. That is probably why the current earning season is tough - the market expected a continuation of the recent trends and now the economy is slowing down and earnings go in reverse.

 

Someone smarter than me all figured this out before it happened probably.

Edited October 27, 2023 by Spekulatius

[mattee2264]

What is interesting is that because policy operates with lags you are still seeing the benefits from the unprecedented easing during COVID while the full impact of the rate hikes/QT and less effective fiscal policy (still trillion dollar deficits but not helicopter money the way it was during the pandemic) is yet to be felt but will weight on the economy in 2024 and 2025. 

 

All bets off of course if the Fed does a shock-and-awe pivot but monetary policy is so reactive that it will only do that when a recession is confirmed by which point the market will already be down considerably. As for the US government they will come under more and more pressure to reign in spending and even if the Democrats stay in they will probably cut back post-election. 

[UK]

Read somewhere recently: “Far more money has been lost by investors in preparing for corrections or anticipating corrections than has been lost in the corrections themselves.”

[Spooky]

Why is everyone so pessimistic. The US prints an impressive GDP figure and it's all doom and gloom.

[gfp]

20 minutes ago, Spooky said:

Why is everyone so pessimistic. The US prints an impressive GDP figure and it's all doom and gloom.

 

You know how people get when the S&P goes down...  Don't neglect your daily dose of Wabuffo

https://twitter.com/wabuffo

 

Edited October 27, 2023 by gfp

[Gregmal]

Yea in a lot of ways this is all actually really similar to what occurred last year, even down to the monthly timing or it all. More or less nothing changed but people started screaming and guaranteeing recessions are imminent and those looking at “the market” can only seem to stare at Fang stocks. It’s all rather stupid and boring. Waiting for something real to happen.