The Breakdown - 'Housing Recession?' How the Beleaguered Real Estate Market Tells the Story of the Broader Economy

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.com, and FTCS, and produced and distributed by CoinDesk. What's going on, guys? It is Wednesday, September 21st. And today, we are talking all about the housing market. Before we get into that, however, a quick note. There are two ways to listen to the Breakdown podcast. You can hear us on the Coin Desk Podcast Network feed, which comes out every afternoon,

Starting point is 00:00:39 and also features other great Coin Desk shows, or you can listen on the breakdown-only feed, which comes out a little later in the evening. Wherever you listen, I would so appreciate it if you could take the time to leave a rating or a review. It makes a huge difference, and I really appreciate it. Also, a disclosure as always, in addition to them being a sponsor of the show, I also work with FTX. Finally, I want to tell you about CoinDesk's new event, the investing in digital enterprises

Starting point is 00:01:02 and Asset Summit or Ideas. Ideas is designed to facilitate capital flow and market growth by connecting the digital economy with traditional finance. Join CoinDesk October 18th and 19th in New York City for a 360-degree investment experience where you can source and invest in the next big deal in digital assets. Use code breakdown 20 for 20% off a general pass and register today at coindesk.com slash ideas. All right, folks, well today, as you well know, is FOMC Day. The market eagerly awaits what medicine the Fed will prescribe this time around. Although at this point, the 75 basis points is so priced in that getting that hike, which

Starting point is 00:01:41 would have been extraordinary in other contexts, could actually cause a small relief rally. Now, the opposite is also true. If we see 100 basis points later today, that could cause markets to take another leg down. In addition to this month's specific rate hike, investors are also looking to see what guidance the Fed gives about where they think the terminal interest rate will end up, and when they think they'll get there. Anyway, tomorrow's show will inevitably be about all of that, and the news comes out a little bit too late to cover today. So today, what I wanted to do is the show that I mentioned yesterday about an industry that I think is a fascinating microcosm of pretty much everything going on in the economy. That industry is, of course, housing.

Starting point is 00:02:19 This week has seen just a barrage of info on the housing market that gives us a perspective on how this key industry is behaving, reacting to changes in consumer demand, and reacting to changes in monetary policy. Let's start with U.S. Home Builder sentiment. U.S. Home Builder sentiment has continued to fall. It has slipped now for a ninth month in a row. The National Association of Homebuyers slash Wells Fargo gauge decreased by three points to 46, and this stretch of declines in which homebuilder sentiment has fallen every month this year is the longest stretch of declines in data going back to 1985. One of the big reasons for this is, of course, mortgage rates. The average on a 30-year fixed mortgage is up to over 6.3% as of this week. That's the highest level since 2008

Starting point is 00:03:06 and more than double the average rate a year ago. That represents the largest one-year change in data available back to 1975. The previous year-over-year change was around 45% in 1981, to give an idea of just how much of an outlier this rate adjustment is. Now, what this means in practice is that the average monthly price that homeowners on a mortgage are paying is way According to data from the National Association of Realtors and Bank Rate, the monthly mortgage payment using the median existing home price and assuming a 20% down payment is now over $2,000 nationwide. That's up from the pandemic low of $986 just two years ago, so more than double. Lance Lambert, the housing correspondent at Fortune, wrote,

Starting point is 00:03:50 Principal and interest payment on a 500K mortgage 30-year. At 2.65%, it'd be 2015, i.e. January 21. At 3.11%, it'd be 2,138, i.e. December 2021. At 6.42%, it'd be 3,134, i.e. today. And that's without factoring in home price appreciation. Joe Wisenthal also cataloged this data in a newsletter this week, showing that across 10 major metros, the monthly payment on new loans for the median property

Starting point is 00:04:19 had more than doubled since the pandemic. In Tucson, Arizona, the average monthly payment was 1891. In D.C., it was 3,113.13. In Los Angeles, it had reached 4,102, and in the San Jose area in Silicon Valley, it topped the list at 9,438 per month. Braden Gustafson, a real estate appraiser, wrote about the shift in what's called the Affordability Index. Based on a 6.35% mortgage, the affordability of homes is getting to obscene levels. The index is at 54.6%, meaning a typical home buyer only makes half the required income to buy a home. Charlie Belayo puts numbers on this as well.

Starting point is 00:04:56 Two years ago, 30-year mortgage rate was 2.87%, an average new home price in the U.S. was 405,000. Today, 30-year mortgage rate is 6.02% and average new home prices 547,000. Result? $28,000 increase in down payment, assuming 20% down, and 96% increase in monthly payment. Note, this cost comparison does not include property taxes, insurance, utilities, and repairs, or maintenance, which have all seen significant increases as well. Putting an even more human note on this, he continues, Canadian-American household would need to spend 44.5% of their income to afford payments on a medium-priced home in the U.S., the highest percentage on record with data going back to 2006. Despite this, and all other evidence to the contrary, there are still many saying there won't

Starting point is 00:05:40 be a nationwide decline in home prices. If that sounds familiar, it's because exactly the same thing was said during the last housing bubble, including comments by the Federal Reserve. Now, in terms of this sector's connection to larger macroeconomic policy and things going on, in the last CPI print, one of the big drivers was owner's equivalent rent, which is basically what you'd pay if you were renting your own house. 24% of the CPI index comes from that number. Now, theoretically, increasing mortgage rates could force the prices of housing down in the long run.

Starting point is 00:06:09 We are seeing home sellers start to cut prices a bit. Mike Simmons from Alto Research writes, price reductions inched up this week to 40.6%. 40% of the homes on the market have taken a price cut in the last few months from the original list price. That's higher than recent years, but not super bear. Basically, what you're seeing here is if fewer people can afford the mortgage and the down payment, they take themselves out of the market. In August, sales of new homes hit their lowest monthly level since 2008. New purchase applications have dropped by 20% year over year. This slowdown

Starting point is 00:06:39 has caused a backlog in supply with 4.1 months' worth of homes available for sale compared to only 2.1 months in January. This sort of increase in supply is typically associated with falling prices in the year ahead. Morgan Stanley analysts say this predicts for cheaper prices in a year. When more than one month of additional supply was brought on, prices were lower in the following year 88% of the time. This is historically speaking. There have been only nine instances in the last 30 years where two months' worth of housing supply have been added within a six-month period. In each case, house prices were lower a year later. Now, of course, the problem with a lot of these assumptions is that we've still got an inventory problem that is more structural than short-term.

Starting point is 00:07:17 While inventory growing by a few months suggests a shift in current conditions, it doesn't solve the problem we've been dealing with for a decade. which is the fundamental underbuilding coming out of the global financial crisis. To put a point on this again, Mike Simmons tweets, A little bounce in inventory up to 552,000 single-family homes unsold on the market. 26% more homes than last year, 43% fewer than 2019. Nexo is a security-first platform built for the long run with everything you need for your crypto. Five key fundamentals, including real-time auditing and insurance on custodial assets,

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Starting point is 00:09:14 When you trade NFTs on FTCS, you pay no gas fees. Download the FTCS app today and use referral code breakdown to support the show. Getting back to the Home Builder Sentiment Survey, remember that that is a forward-looking survey as well. It's not just about what's happening right now, it's about what people believe will happen in the future. I think all you need to know about that forward-looking sentiment comes from a phrase that I believe was likely carefully considered. The National Association of Home Builders' Chief Economist Robert Dietz said,

Starting point is 00:09:48 The Housing Recession shows no signs of abating, as builders continue to grapple with elevated construction costs and an aggressive monetary policy from the Federal Reserve. Now, one weird byproduct of all of this is that some sellers have given up on selling and have shifted to renting instead. The Wall Street Journal wrote about this a couple days ago. Basically, the squeeze on affordability and slowing sales have led some number of prospective sellers to give up on achieving a sale and instead focused on renting out their former home. This was a strategy that some had speculated about during the pandemic, but now we have some more firm data showing that in key markets, homeowners were choosing to switch their listing from sale to rental in large numbers. 10% of the listings in Southern California went from

Starting point is 00:10:27 sale to rental, and 9% in Texas. Anthony Lamakia, owner of Waltham, a Massachusetts real estate broker, said, people are hearing that rents are going up, so they're saying, well, if I can't sell it for what I want, I'll just rent it, because I'll get a really good rent. David Freeman, CEO of Knox Financial in Boston said, In a market that's flattered down, you're going to have a lot of people who probably don't want to sell right now. We certainly expect people to decouple when they buy from when they sell, and part of the way to do that is rent. A huge factor enabling this trend was the availability of 30-year mortgages which were refinanced at an all-time low during the pandemic.

Starting point is 00:10:59 For many people, the property that they owned in 2020 is attached to some of the cheapest debt that they're ever likely to see, so giving that up is a difficult choice. What's more, the recent surge in rents has helped make this choice to retain additional property easier. In June, the national average rent for a single-family home was up 13.4% from a year prior. A John Burns' real estate consulting survey found that 11% of prospective home buyers switched to renting in July nationally, with as much as 24% of buyers switching in hotspots like Texas. Builders seem to be following these trends as well. Bradley Hunter, a real estate consultant, tweets, 24% of builders reduced prices.

Starting point is 00:11:34 Cancellation rates are spiking in many markets. More builders are pivoting harder into build for rent. There's also been some discussion around the last week around big institutional investors pausing plans to purchase more residential homes or even looking to unwind some positions. Commentators noted that with one-and-two-year treasuries approaching 4%, the premium for collecting residential rents was beginning to get really thin compared to just buying bonds.

Starting point is 00:11:57 If you think about what we're going through right now was an unwind of some of the things that characterized the last decade, this kind of makes sense. The whole paradigm of institutions looking for alternative investments was all about the search for yield. If there isn't a search for yield right now, because the U.S. Treasury is handing out that yield happily, that becomes less important. Now, whenever we talk about housing, one of the questions that it brings up for people is, will this be another great recession scenario where a crashing housing market brings down the rest of the market as well? Obviously, one of the major problems with the 2008 collapse was the economic turmoil that happened throughout the housing sector. According to Fred data,

Starting point is 00:12:31 1.5 million jobs were lost throughout the construction industry during the span of the GFC. Bankruptcies also rippled through the housing finance sector, with more than 25 subprime lenders going under in February and March 2007 alone. This ultimately led to the collapse and nationalization of the two largest mortgage lenders in the U.S., Fannie Mae and Freddie Mac, in the summer of 2008. However, there are a number of things different this time, with perhaps the chief being that in the post-Great Recession world, U.S. homeowners have a lot more equity in their homes than they did before. Real estate agent Hank Bailey tweeted this. Another reason why this time it's different. In the Great Recession, there was no equity or reason for many not to walk away. Today,

Starting point is 00:13:10 U.S. homeowners have a lot of equity on their hands. Underscoring that, according to the Federal Reserve, home equity hit an all-time record level of 27.8 trillion in Q1 of this year. Basically, there just isn't the same category of low home equity mortgage holders that there were 2010. Another interesting dimension of this conversation is whether the resilience of the housing sector and U.S. homeowners in particular in the wake of changes post-GFC could actually be hampering Fed policy now. Lisa Abramowitz, a host at Bloomberg, wrote, about half of U.S. income is earned by households making more than $100,000 per year, with most owning their own homes. So the largest expense for these households isn't rising even with tighter Fed policy, but wages are going up, perhaps

Starting point is 00:13:52 explaining why core inflation is so sticky. Problem is that for lower-income Americans, their bills including rents are going up at a rapid clip. So Fed tightening affects them more directly and painfully than higher-income households, which are still able to spend rapidly, fueling more inflation. Bloomberg columnist Conor Sen responded, It's not so much that inflation is entrenched as the fact that the pass-through between higher interest rates and slower economic growth is more limited than in the past. Fixed rate debt, less systematic leverage, etc. Dodd-Frank reduced the effectiveness of the Fed. He then makes a joke, the entire financial regulatory apparatus said, we want banks, homeowners in the U.S. economy to be more resilient in the face of rising

Starting point is 00:14:31 interest rates, financial market volatility, and declines in asset prices. To which the market responds, okay, done. To which the regulatory apparatus says, wait, why haven't six months of rate hikes been enough? Joe Wisenthal responded, tongue-in-cheek, time to ban 30-year mortgages and make everyone get five-year ARM so that monetary policy actually has some teeth. joking aside, I do think it's interesting that there's this tension between resilience and the effectiveness of interest rates as a vehicle for monetary policy transmission. A last topic that shows the way in which the housing and real estate market are exemplary of changes in the larger economy comes from Open Door.

Starting point is 00:15:07 TLDR, the struggles of Open Door right now, are part and parcel not just of housing market changes, but also of a shift in the high-growth, no-profitability mindset of venture capitalists that characterized the last decade. So to go back just a bit, online housing marketplaces like Zillow and Open Door controversially turned their pricing algorithms into market participants late last year. Basically, they were attempting to capture more upside in a hot housing market by operating a house flipping venture alongside their core services. Open Door was the most aggressive in offering this service known as iBying, where the company would offer to purchase homes from sellers who are asking for evaluation, make minor repairs and presentation modifications,

Starting point is 00:15:42 and then later list the home for resale. The value proposition was that this took the hassle out of listing and selling a home. Throughout 2021, Open Door sold more than 21,000 homes, and additionally sold 12,600 in Q1 of this year. The service operated across 48 major metro areas in the U.S., and generally had been running at a loss for several years. While simple measures of house sale profitability, considering prices at which they bought and sold property were generally positive last year, market analysts estimated that Open Door were reselling at an average loss of 8.3% when indirect expenses like overall corporate marketing and operations costs were taken into consideration. The company booked its first profitable quarter in Q1 this year,

Starting point is 00:16:19 making $28 million. That followed a loss of $662 million in 2021. In Q3, during the start of the housing downturn, the wheels seemed to have fallen off Open Door's eye-buying model. According to research from YipData, Open Door lost money on 42% of its transactions in August. It was even worse in key markets like Los Angeles, where 55% of sales were at a loss, or Phoenix where a full 76% of sales happened at a loss. What happened is that markets turned quickly, and because of the nature of the I-buyer model, they were simply stuck with too much overpriced inventory that they needed to liquidate. Adding to their Q3 woes, in August, the Federal Trade Commission fined Open Door $62 million for, quote, cheating potential home sellers by tricking them into thinking that they

Starting point is 00:17:01 could make more money selling their home to Open Door than on the open market using the traditional sales process. Overall, Open Door stock price is down over 88% from the top in February 2021, from 3459 to 388 yesterday. Summing this up better than I ever could, Nipsey Housel, who, by the way, has just a tremendous Twitter handle, wrote, J-Pow literally told you he was going to reset your Zestimate, but you chose not to believe him. So there you have it, a very different outlook on the housing market than the last time we talked about it in depth about six months ago.

Starting point is 00:17:33 The breakdown isn't all of a sudden going to become a real estate or housing show, but I think that it's clear that it does reflect some of these big changes in monetary policy and consumer demand that are finally starting to work their way through the system. What's more, it shows that there are long-term implications of all of those changes. For now, I want to say thanks again to my sponsors, nexus.com.i.o. Chainalysis and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. I want to tell you about CoinDesk's new event, the investing in digital enterprises and asset summit or ideas. The event facilitates capital flow

Starting point is 00:18:10 and market growth by connecting the digital economy with traditional finance. Join CoinDesk October 18th and 19th in New York City for a 360-degree investment experience, where you can source, invest, and secure the next big deal in digital assets. Use code breakdown 20 for 20% off a general pass. You can register today at coindesk.com slash ideas.

The Breakdown - 'Housing Recession?' How the Beleaguered Real Estate Market Tells the Story of the Broader Economy

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