Motley Fool Hidden Gems Investing - Residential Real Estate is Cooling, Not Crashing

Episode Date: August 14, 2022

Build-to-rent housing is taking off and more home contracts are falling through. We’re probably not headed for another 2008 in the housing market, but it sure is weird out there. We’ve got two views on residential real estate, from renting and home lending. Rent CEO Jon Ziglar joined Motley Fool Contributor Matt Frankel for a discussion about: - The numbers behind rent increases. - The rise of build-to-rent housing. - How the rental landscape shifted over COVID. Brandon Snow, Executive Director, at Ally Bank caught up with Motley Fool Contributor Marc Rapport for a chat about the residential real estate market, and why more home contracts are falling through. Stocks mentioned: RDFN, HHC, ALLY Hosts: Matt Frankel, Marc Rapport Guests: Jon Ziglar, Brandon Snow Producer: Ricky Mulvey Engineers: Dan Boyd, Brandon Gentry, Spencer Daniel, Michael Schweitzer Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. Owning a home is still very much the American dream for many people. But in a lot of cases, it is no longer that. People actually prefer the flexibility, but they still want to live in a single family home. And so rental of single family homes is a huge growth driver in the industry. And there is a huge demand for that and a demand for a consistent product. I think that they're filling that need. I'm Dylan Lewis and that's John Ziegler,

CEO of Rent, a rental search platform that was acquired by Redfin for $600 million back in 2021. On today's show, we've got two views of the residential real estate landscape. We'll start with Matt Frankel's conversation with Ziegler, where they discussed where rents are cooling off and the areas that are staying hot, why this industry is begging to be disrupted, in the future of build-to-rent housing. Red Path of Rent now recently became a part of Redfin. Redfin acquired you, I think, earlier this year, if I'm not mistaken. How does rent fit into Redfin's ecosystem?

In other words, what's changed since the deal was closed, other than your name? Yeah, Redfin acquired the business in April of 2021, so just a little over a year ago. And the thesis behind it really is that Redfin, if you're familiar with it, is, in our opinion, the best certainly consumer experience brokerage site in the market. And what they want to be able to do is give people looking for a home, be able to be relevant in that in every part of the journey. So they already had one of the most visited brokerage websites on the web with over 50 million unique visitors a month.

They have a title business. They have a mortgage business. So really call it a one-stop shop of, I want to find, get a broker. They have, I believe, over 6,000 brokers around the US that can actually help me find and purchase my home. I can do that title. I can do the mortgage. But there's a huge segment of people that are either going to be renting and want to

buy, or rental is how they want to actually go forward. And so what Redfin want to do is be able to hit all of those consumers. And about 20% of people going to Redfin actually ultimately end up renting, whether it's because they can't afford to buy a new home or they ultimately choose not to. So this really fits in with that, within that ecosystem. Now we operate very separately as well, because we have a pure rental site, or we actually have a number of rental focused sites that just do rentals, but we also now power rentals on Redfin. So if you go to the Redfin web or app, you can look for homes to purchase, but you also can look for homes and, and apartments to, to rent.

So another way of saying it is that by just focusing on home buyers, Redfin was shutting out like 50% of the market, not exactly half and half, but it's somewhere in that ballpark. So it kind of brings them into the ecosystem and kind of creates more optionality on the platform, I guess you would say. Well, it does. And it also enables them to build a relationship with people that are renting now, but maybe in five years, they're not going to want to purchase, right? So now I've built that relationship.

I know more about them and I can put not just the right rental property in front of them when they want to rent, but the right home in front of them when they're ready to buy and even look at, and even look at their options between both. So I wanted to get into just general rental market and the housing market and stuff like that. But before we do, where do you see rent going from here? Cause obviously the past year or so has been very excited for, for rent. What is your kind of long-term vision for the company? Where do you see this going in, in five, 10 years? Along with this sort of relaunch of the business, we really see ourselves building more software and solutions to, as I say, eliminate friction and increased efficiency and convenience

along the renter journey. And that's both for the consumer, for the renter, as well as for the property manager. If you think about a rental, you know, transaction and even living, there are two parties involved at every point. Someone's looking to rent and ultimately becomes a renter. And then there's a property manager or landowner that is trying to fill a space and then manage that person and make sure that their experience is great, that they can have them stay longer and manage that experience for them. And so what we are really focused on is continuing to build out our software solution through that renter lifecycle so that the rent platform is the one that property managers are going to go to, to manage their business,

to attract and find and manage renters. And that renters similarly look at the rent platform and that rent brand as saying, well, I know that that's going to be an easy experience. I'm going to find the right place. It's going to be easy for me to apply. I'll be screened and I can get in. And that's a platform that if they're using the rent platform, that's a place that it's be easier for me to go. There are a few industries in the world more in need of disruption than real estate, which is kind of why Redfin and rent both exist. I mean, I I'm a rental property owner and literally every part of buying, finding a property manager, finding tenants, managing maintenance, things like that. Literally every part of the process is clunky at best. So there's

definitely a lot of room for disruption and i'm i'm personally excited to see where you guys take it over the next five ten years which is you know why i asked that question one thing i'll say is there there's a lot of technology adoption in the industry right now a huge amount uh as you see in in every industry that goes at the stage i think right now where we are in the in the particularly the rental industry in terms of technology adoption is there a ton of of sort of point solutions that have been coming up. And so people are sort of getting, you know, this solution does this thing and this solution does this thing, because I don't want to be on spreadsheets anymore. And where, where we're really focused on is now that we're in that adoption cycle,

actually having a single purpose-built platform that does it all versus having to stitch all of those technologies together. And we think we've seen that analog in a lot of other industries. My previous company, that's exactly what we did. And we see the similar opportunity here. And real estate's also one of the biggest markets in the world, in addition to being one of the most disruptables. And speaking of being a big market, it's getting bigger in terms of dollar value very quickly in the past year or two. In the rental market, just looking at your own recent report, in the average U.S. market, rent on a two-bedroom apartment is up 26.8% year-over-year in the United States. Some markets are growing even faster than that.

Why has rent gone up so dramatically? I read that inflation is, you know, eight or 9% in that ballpark. Why is rent rising so much faster than overall inflation? So first of all, the real rent increases occurred in 2020 and 2021. And that's when the vast majority of them happened, which had was a perfect storm, right? I had, I had a, an increase in demand because suddenly not everybody wanted to have a roommate. Okay. So that started, you had a lot of liquidity going into the market through stimulus checks. So I had actually a very healthy consumer. And we had historically low interest rates as well.

And so I had a very healthy consumer, a lot of demand, and people wanted bigger places and wanted to live alone. And so that really enabled rents to increase along with the demand and go there. We actually have seen since January of 2022, rents overall across the U.S. have only increased about 2% to 3%. So actually not even keeping up with inflation as inflation has come on. The other thing I will mention that the story is great to talk about the markets like Austin and others where it's up 100% year over year and the overall increases.

But if you look behind the numbers, the vast majority of the increases in rents have also been in call it the high end and more expensive apartments and single family homes. If you look at the lower, call it more affordable apartments, it's actually only increased between 5% and 8% in the last two years, or year over year. It's not as much as you'd see, as you'd think, if you start to take out those really higher-end places. But it is continuing to go up. There's no question. You mentioned the perfect storm. Now that the perfect storm is starting to pass, if you will, do you see rent prices coming down? Because historically speaking, in both rentals and just home prices, things rarely move backwards. It's happened once in my lifetime where

home prices have moved down. And that was in the aftermath of the 2008-2009 mortgage meltdown. So do you think higher rent is here to stay, or is it a temporary supply-demand issue? So we've actually seen rental prices over the past month have actually come down about 0.3% to 0.4% nationwide. What I think we probably will see is that you will see rental prices, on average, in the upper tiers stabilize where they are, maybe continue to move up just along with inflation. And I think in the lower tiers, which also have not moved up all that appreciably over the past year anyway, I think that's a place where we may actually begin to see pressure because you just don't have as healthy of a consumer. And with the inflation where it is,

gas prices where they are, that's a consumer that just cannot afford to absorb a price increase and increasingly may not be able to afford the existing rents where they are. So it really remains to be seen, but we think that there may be some risk there. The one thing I think that will moderate this is that if you look at most of the inventory coming into the market, it's really in the higher end. There have not been nearly as many incentives coming forward for apartment builders to be building lower end properties and units. And so you are probably going to see a crunch in demand on that lower end where all your supply is coming in the higher end. It's been true in this new home market as well. The biggest supply gap is at the lower end in

entry-level homes. When I was looking at your data where I quoted that figure, rent's up 26.8% on a two-bedroom, what really stood out to me is the wide range of rent increases, and particularly the fact that rent has actually declined in a few metro areas across the country. That seems like a bigger gap between the highest-performing and lowest-performing markets than the, than even the home home prices. Why, why do you think we've seen such a kind of disparity between different areas of the country? I think a lot of it has to do with, with a, you've got a new work from home environment or work from anywhere environment. So people are able to actually move wherever they want to move. And what you've seen is people really moving to

kind of two general areas. One is the Sunbelt, which is typically with, with a number of exceptions, much was much more affordable. So they could get more, uh, they could live in a place that had lower crime, better quality of life. And then we've also seen the large cities that are always going to have a real draw for people like New York. I mean, New York City is back above where it was when we went into the pandemic. And so what you see is people sort of voting with their feet because they don't need to be in a certain place for their job. And so some markets where they were there, they can leave and they can go elsewhere. And so you're really going to see a real difference based upon the livability of the city, the affordability of the

city, the resources around it, because people are living where they want to live versus where they have to work. I know you can't really talk too much about home sales and home prices and things like that, because obviously, you're the rental company. But home affordability has gone down, and that has played into the rental market. It costs people a lot more to buy a home, both on price and on mortgage rates, the average mortgage payment on the same home to a year ago is up about 70% when you figured the higher cost of the house and the fact that mortgage rates have essentially doubled. So it does play into the rental market a little bit because it's creating people who are priced out of the housing market. Where do you see the housing market going? Not

just for the rest of 2022, but you can answer that from a more kind of broad perspective. Obviously you don't have a crystal ball. At least I don't see one on the shelf behind you, but take a crack at it, I guess. First of all, it's anyone's guess. I think there's some basic assumptions or thesis that we can go with though. We've already seen an increased number. I don't have the number off hand. I think it's 15% or 20% of home listings have actually put through a price decrease in the past month. So we're already seeing asking prices coming down. We do see mortgage applications coming down as well. So the demand has come off as well as sellers are starting to realize that they're not going to get 120% of ask as they were before. Prices are

already starting to moderate. And as you point out, a lot of that has to do with two things. A, we have a huge amount of inflation. So people are just not able to afford as much just because everything else is costing more. And at the same time, correlated directly to it, mortgage rates are up significantly. I would say if it's just me betting with a crystal ball, that home prices, particularly in the, in the, in the middle and lower ends are going to, are going to moderate and may even, we'll probably be coming down by the way they had a historic increase over the course of the past year. So, you know, whether that's saying the homes are cheap is a whole different, whole different conversation. Right. But I do think you're going to see home prices

coming down at the very least moderating as they go. It's probably fair to expect a lot of geographic diversions with that as well. And it depends what mortgage rates are going to do too. if mortgage rates went back to 3% overnight, not that that would happen, but if it did, then we'd be having a different conversation. Well, you know, the thing is too, is that cycles go so much faster nowadays, you know, by the time we think we're, we decide we're in a recession, we may be coming out of it. You know, I just, that's one of the things is, yeah, we probably are going to see them come down. The question is going to be for how long. Speaking of the housing market, I mentioned earlier a little bit that there's a real supply gap at the lower end

of the housing market. Yeah. It's, it's generally not that economical for builders to build, starter homes, I guess you would say. There's a big supply problem in housing. Housing starts since the financial crisis have been at a historically low level, and it's created a lot more people who want to buy a house than actually own houses. Do you see a housing crisis in the making in the U.S.? We have a gap in housing overall. The primary reason being, in 2008, when the Great Recession began, you saw housing starts. This is multifamily and single family dropped to historic lows. It didn't really recover to pre-recession levels until around about 2015. So you've got a six-year gap there of just not building enough housing to

even keep up. And then in 2020, 2021, we actually got back to where now the housing starts, at least as of six months ago, we're at levels we haven't seen since the mid-80s, right? But you've got a lot of catch-up that we're going to need to have. So I do think we're going to have a housing shortage just as we have an increasing population and increasing needs, and we're just not keeping up with the demand. It's going to take a while for that issue to work itself out, I think. It's not an overnight fix. Absolutely. And then you have the current rates and the current economic instability. You're also going to, whether the builders are going to be willing to extend themselves that much further with an uncertain future is another question. We may see housing

starts, a multi-family and single-family begin to moderate as well, which will exasperate the problem two years down the road. Speaking of housing starts, one of the biggest trends I've seen is this built-to-rent housing phenomenon in the market. I could just name one company I follow closely, it's the Howard Hughes Corporation. They're historically a land developer, and they just announced their first ever built-to-rent housing community. I think it's 260 homes or something like that. I can name a few other companies that have done the same thing. A lot of private equities going into these built-to-rent housing communities. It's a big trend. It seems like there's just a lot of cash on the sideline wanting to invest

in real estate at a time when private buyers can't afford mortgages right now and things like that. So why has that become such an attractive business model? And is it part of the solution to the housing crisis or is it part of the problem, do you think? I think it is both part of that, you know, it's both the poison and the cure. The reason that there's been such an interest in it is the past few years, you've seen historic rises in rents, right? You've had effectively free money, very low cost of capital.

And so the ability to build and finance these large, and a huge demand, by the way, increase in demand for single family homes, as well as rental of single family homes. So the ability to put capital to work, create a very strong cashflow generating model with a large builder rent single family home community is very, very attractive. Probably becomes less attractive as the cost of capital increases, but at the same time that the investors have a lower cost of capital than the consumer does. I do believe that actually there's a real benefit and there's a place that, uh, that the built to rent industry, uh, provides, uh, two things. One is, uh, they're able to build homes, you know, build homes fast and at a lower cost of capital. They also can

provide, you know, a really good product, a consistent product. If you're talking about an entire community, whereas, you know, single and double home landlords, you know, that are not necessarily able to keep the level of quality, the service, you know, the plumbers getting there, all that kind of stuff, I think that these professional communities can provide a higher level of service in a lot of cases. And I think they're also filling a need. Renting used to be the thing you did before you bought a home. And owning a home is still very much the American dream for many people. But in a lot of cases, it is no longer that. People actually prefer the flexibility, but they still want to live in a single family home. And so rental of single

family homes is a huge growth driver in the industry. And there's a huge demand for that and a demand for a consistent product. And so I think that they're filling that need. And for a look from the home lending side, we have Brandon Snow. He's an executive director at Ally Financial. Motley Fool contributor Mark Rapport interviewed Snow about the cooling housing market and home builder confidence. Black Knight says that home price growth fell by a full percentage point year over year in May. And I think we're going to see more of that going forward, but that I'm not in a business. I just read about it. What signs of cooling are you seeing in the housing market and any specifics? Yeah. Everybody's got a view of where prices go and

listen, they're up somewhere between 40 and 50 percent in most, you know, call it key metropolitan areas across the country since the start of the pandemic. So that's I mean, that's a massive number. You know, it's great if you have been a homeowner and you've been able to take advantage of low rates and increasing equity position. Obviously, it puts the potential homeowner in a spot where they need to kind of digest all that and figure out what that means for them. we are seeing not a downturn in home prices, but a deceleration of the pace of growth, right? So we kind of look at things in two ways, year over year, and then month over month. So from, say, April or May or May to June, the pace at which home prices are going up is definitely cooling off.

They are absolutely still up versus this time last year. So that does have, obviously, an impact on affordability and monthly payment. I think what you're seeing, honestly, Mark, and this is our view of the world, is you're seeing a normalization of what has been really historical home price growth. I think you are seeing some early signs. And I think too early to react one way or the other, that market is cooling. And this concept of a seller's market versus a buyer's market, which is something we all love to talk about, maybe is normalizing a little bit away from the seller to the buyer. We've seen things like more activity in sellers having to drop prices. We've seen things like more activity in the amount of contracts that

were canceled, say, in the month of June relative to where that number has been sitting earlier in the year. I think we saw something like 15 or so percent of executed sales contracts to purchase a home were canceled in the month of June. That's a number that has not been anywhere close to that really over the course of the last few years. And then when you couple that with things like consumer sentiment, so the University of Michigan's Consumer Sentiment Index is something we kind of all watch and have access to via the news cycle. That touched some lows, telling you that we all as consumers are mindful of everything we talked about, the inflationary environment, the global political environment and that kind of effect on our day-to-day lives in terms of finances and

budgeting. And when you roll all that together, it does suggest that doom is not near, but that the market is softening a little bit relative to where it's been historically. Yeah. You mentioned the University of Michigan. That's a widely watched, their consumer sentiment measure. And I was just looking at the National Association of Home Builders, which is also kind of a forward indicator, I guess, that they just recorded the biggest drop in home builder sentiment in the 35 years they've been doing that survey. I mean, is that a sign of panic or is that just a sign of these buildings? What does that tell us? Yeah, listen, and I think some great quotes from the president of the NAHB around kind of what that means, I think it's prudence. I think if you also

So can I monitor any of the home builder stocks and some of their forward-looking guidance and quarterly earnings that they're being mindful of some of the things I just mentioned? I think maybe they're faced with something that us as a lender or a real estate agent maybe isn't faced with, which is rising materials costs. And I know some of that is moderating too, but it's gotten more expensive to build a home. Obviously, they have to be mindful of building homes that people can afford so that they can balance supply and demand. I think no builder would want to find themselves in a similar

scenario that they may have seen back in the mid 2000s as part of that, you know, particular home crisis. And so, and I think they're seeing the same trend lines in terms of canceled contracts. And obviously that could leave them in a precarious position. So it's a sentiment index and it's a measure of the way they're feeling. I think some of it is absolutely grounded in some data points we've talked about, but I just would expect them to be more measured as we navigate what is uncertainty. I think no one can prognosticate for sure which direction we go, but I think we all have a view that is generally aligned, and I think they're just trying to be prudent business operators. As always, people on the program may have interests in the stocks they talk about,

and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll see you tomorrow.