The Breakdown - Why the Housing Market Is so F%#@ing Insane Right Now

Starting point is 00:00:04 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.io, Arculus, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Friday, April 22nd, and I am incredibly excited for today's show. It's something that is deeply personal for a ton of people, and I wanted to do a show on this for a while. Before we get into that, however, a few housekeeping notes. There are two ways to enjoy the breakdown podcast. You can either listen on the Coin Desk Crypto Podcast Network feed, which features both

Starting point is 00:00:46 the breakdown as well as other CoinDesk shows, or you can listen on the breakdown-only feed, which has just this show. Both come out the same day with CoinDest coming out in the afternoon and the breakdown-only feed in the evening. Whichever feed you are enjoying this show on, please go subscribe to it, give it a rating, give it a review. Believe it or not, those things actually do help the show. get discovered. And if you want to dig deeper into the conversation, come join us on the Breakers Discord.

Starting point is 00:01:11 You can find a link in the show notes or go to bit.com slash breakdown pod. Finally, a disclosure as always, in addition to them being a sponsor of the show, I also work with FTX. All right, so real estate is fascinating for a lot of different reasons. It's something that tons of people interact with and something that becomes very personal when you do. Real estate and particularly homeownership is tied up in the American narrative of the American dream. And even beyond that, given how many people make money elsewhere and then get into some version or some form of real estate as well, there's clearly something intrinsic about our desire to be connected to land and connected to property. It has become a part of a new aspiration in the fire movement, financial independence retire early,

Starting point is 00:01:56 which is something you see all over Instagram and TikTok and basically any social channel, and is largely driven by people who are using real estate among the money. other strategies to try to become financially independent and get out of the normal rat race. And of course, on the negative side, real estate was an important part of the great financial crisis, the most significant defining economic event of our times. And if you've been paying attention even a little bit, you also probably know that real estate right now is absolutely crazy. The S&P Core Logic K-Shiller Index puts house prices up 19.2% on average over the last year, and 31% since the start of the pandemic.

Starting point is 00:02:36 The increase is even higher in what they call desirable cities, with, for example, Phoenix up 50.9% and San Diego up 42.5% in two years. The same index considers 65% of U.S. markets to be overvalued, with only 26% of markets as normally valued and only 9% as undervalued. And just to be clear that this isn't just the norm of things, the long-term average of annual price increases in the U.S. was 4.9% over the three decades prior to 2020. Like I said, if you spend any time on any of these social channels, you've probably seen videos of people lined up around the block for an open house for a seemingly crappy little house in the suburbs in any one of dozens of major American markets. There's an increasingly desperate tone around it.

Starting point is 00:03:24 This is a post from Reddit that was shared on Twitter. I'm so done with home prices and crazy price bidding by rich assholes. The house across the street from my parents was built in 2014 and sold for 185K at the time. I went to college aspiring to own a simple home like that. At the time, going through college 2014 to 2018, I thought, I will work really hard until I'm 30, save up for a down payment, and then it will be able to afford a starter home like this with a spouse. Four days ago, the house was listed for sale for $540,000.

Starting point is 00:03:53 Today it sold for $935,000. Literally what the f***? I have lost hope in everything. I'm stuck living with my parents because I can't afford anything. My apartment that I rented in 2018 to 2019 was $800 a month. Right now, it's $2,800 a month, and in order to qualify your income must be $3.X the monthly rate. I feel so defeated. Everything I worked so hard for in the past 10 years is officially out of reach. This is hardly a unique post. You see things like this every single day. Now, the questions swirling around this are how can this go on? Is this another housing bubble like before the great financial crisis? How are interest rate increases likely to impact this market? So those are the questions we're going to dive into today. But before we do, I just want to caveat this even more than usual that obviously I am not a real estate expert. This is an interest, but unlike crypto is not something I spend every day looking at. Still, I think you guys will find this useful at least if you're trying to wrap your head around what the is going on? So let's start by going back. Given how much the current discussion is, is a question of whether this is the great financial crisis all over again, we probably need to

Starting point is 00:05:02 go back and actually explain it. And to do so, we have to travel back farther to the bursting of the dot-com bubble in the recession that followed. Interest rates went from 6.5% in December of 2000, quickly down to 1.75% in December of 2001, and then bottomed at 1% in June 2003. rates were held at 1% for a little under a year. At that time, there was a major push to get people who had previously had a hard time buying into houses. In October 2002, George W. Bush said, We can put light where there's darkness and hope where there's despondency in this country. And part of it is working together as a nation to encourage folks to own their home.

Starting point is 00:05:40 Bush wanted to, quote, use the mighty muscle of the federal government, which are his words, to achieve something that he called the Ownership Society. Congress passed the American Dream Down Payment Act in 2003, which provided $200 million per year spread across 40,000 families to assist with down payments and closing costs. The biggest change, however, was relaxing regulation in the mortgage sector, and in that context, a set of new products were created.

Starting point is 00:06:05 Major mortgage brokers reduced underwriting standards and began writing mortgages like the infamous Fannie Mae and Freddie Mac Affordable Gold 100 mortgages, which required no down payment and no closing costs from the borrower. The assumption was that as long as the price, price of housing continued to rise, the loan couldn't go bad and cause a loss to the underwriter. This culture of lax underwriting and high commissions paid to mortgage brokers led to a huge increase in what were called ninja loans. No income, no job, no asset loans. These were loans

Starting point is 00:06:33 written under a simplified documentation process designed to help people with hard-approved incomes like wait staff and gig workers. These loans were based mainly on credit score, so basically if you could keep up with credit card payments, there was a good chance you could qualify for a mortgage. Many of these types of mortgages came to be known as subprime. Of the top 25 non-bank subprime lenders in 2006, only one was subject to the usual mortgage laws and regulations. And these non-bank underwriters made more than 12 million subprime mortgages with a value of nearly $2 trillion, representing over 10% of the U.S. housing market. When all was said and done, however, by September 2010, after the crisis,

Starting point is 00:07:10 23% of all U.S. homes would be worth less than the mortgage loan. If you've tried to get a mortgage recently, you're probably just shaking your head in disbelief about how different this was. In 2006, the minimum proof of income requirement was satisfied by a phone call to an employer with very little verification of legitimacy. The median credit score for purchasing a home is today 455 points higher than it was before the 07 crash. The 10th percentile credit score, which is deemed the lower bound of creditworthiness to qualify for a mortgage, is now 657. Before the great financial crisis, it was below 600. But it wasn't just how easy it was to get a mortgage, it was also the types of financial instruments themselves. If you've gotten a mortgage since the Great Financial Crisis, it's highly likely that it's

Starting point is 00:07:53 a 30-year fixed interest rate loan. Currently around 99% of mortgages in the U.S. have that 30 rate fixed. That means, for example, that as the Fed increases interest rates, existing homeowners will not have to increase mortgage payments. In 2006, this wasn't nearly as common. Many of the loans out there were adjustable rate or balloon payments. These loans would have a discounted short-term interest rate called the teaser rate, which would then adjust up to market rates or in some case need to be refinanced at the end of the discounted period. These teaser rate discounts were often five or six percentage points below the rate that would apply for the rest of the loan. Approximately 90% of subprime mortgages issued in 2006 were this type of adjustable rate mortgage.

Starting point is 00:08:35 This would become a problem. After those low 1% interest rates in 2003, the Fed started increasing rates. That started in June 2004 and reached a peak of 5.25% in June 2006. Because so many of these variable rate mortgages were still in their fixed rate period, there was little to no effect on the housing market. But then, the teaser rates on subprime loans began to expire, adjusting mortgage payments back to market rates. These rate resets reached their peak mid-2007. Because of this, foreclosures started to increase. 1% of households were foreclosed upon in 2007, which was double the number in 2006. Foreclosures were heavily localized to subprime loans, with 8.5% of all subprime borrowers being foreclosed compared to only 1% of prime borrowers.

Starting point is 00:09:22 Now, this could have caused a huge amount of misery all on its own, but it wouldn't, on its own, have caused the great financial crisis. In fact, it didn't cause the great financial crisis, because there is a whole separate part to the story, which is not the consumer lending products themselves, but the financialization of those products. When a lender rights a mortgage, they don't hold the loan on their own books. They sell the asset into the market as a mortgage-backed security or MBS. There was a problem during this era with subprime mortgages in that they were too risky to sell on their own. So lenders mixed a small part of a subprime mortgage with other MBS into a financial derivative known as a collateralized debt obligation.

Starting point is 00:09:57 These instruments would spread the default risk of mortgages across hundreds or even thousands of households, so that individual mortgages could default without causing the CDO to significantly devalue. The underlying assumption was that most people don't default on their mortgage and most property increases in price over time, making the CDOs very safe. The structure was seen as so safe that the bond ratings agency gave them a AAA rating, the same as U.S. Treasury bonds. Because of this high rating, financial institutions began using them in the same way they would treasury bonds, posting CDOs as collateral to obtain leverage in the market. This leverage collateral would typically be valued on a daily basis, with leverage in financial markets being

Starting point is 00:10:32 super short term, renewing every day in what's known as the repo market. So as we know, this didn't end well. And maybe the best way to describe it, at least in the depth of this show, is through analogy. One way to think about this chain of events is to imagine what would happen if you had to renew the loan on a car every day. You turn up and every day your car, the collateral of the loan is worth about the same amount, so your loan gets renewed. Then one day, someone smashes your car overnight. You show up to the loan office the next day to renew your lease. They look at your smashed up car and demand immediate repayment, because your collateral is no longer worth what it once was. When the value of CDOs started falling in value, they didn't drop

Starting point is 00:11:08 slowly like treasury bonds do. They dropped like a rock. So thousands of financial institutions showed up to renew their loans with their suddenly devalued collateral and were refused loans on the same terms they were used to. Because they weren't able to make the same level of loan funds, they had to close leverage positions across the financial markets. It's not a problem if one financial institution is forced to close positions. This is something that happens every day. It is, on the other hand, a gigantic problem if the entire network of financial institutions are all forced to close positions all at the same time, which is what happened in 2008. Now, the specific combination of causes of the great financial crisis is and will continue to be debated. But the key takeaway for our purposes is that

Starting point is 00:11:48 while, yes, there was a housing crisis, it was not exactly the housing crisis that caused the GFC. It was a housing crisis that caused a banking crisis that caused the GFC. Looking for ways to step up your crypto game? Then go with Nexo. For starters, you get free crypto for each purchase or swap. How about earning? guaranteed yields, up to 17% paid out daily. Ideal for you hardcore hodlers. You don't even need to sell. Instead, borrow instant cash against your assets. Get the most out of your crypto with nexo at nexo.io. That's nexo.io. Meet Arculus, the next generation cold storage wallet. Arculus secures your crypto using three-factor authentication, providing a simpler, safer, and smarter

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Starting point is 00:13:16 with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCX, you pay no gas fees. Download the FTCX app today and use referral code breakdown to support the show. Now, the next part of the story that bridges to today is what happened in the wake of the GFC, and it's arguable that this, more than anything else, is what's causing the dislocation in the

Starting point is 00:13:51 housing market today. In short, new housing construction tanked. And in many ways, this was just simple economics. The economy craters driven by a housing bubble bursting. Some constructions are halted midway, and other areas, demand completely falls out. The people working in those industries are left scrambling. And remember, recovery from the great financial crisis took years. By the time things started to pick back up, much of the construction labor supply had left the workforce got jobs elsewhere, trained in other skills. By the end of the great financial crisis, 2.1 million construction workers were out of a job. Construction jobs were down by more than a third. And while the general U.S. unemployment rate got up to 10%, unemployment in the construction sector

Starting point is 00:14:29 got up to 25%. Even when the economy recovered, construction never did. At the start of 2006, Newhouse starts, which refers to new houses starting to be built, reached a peak of around 2.3 million. By 2009, this rate had dropped to below half a million. New House Builds stayed depressed for an entire decade, never since the end of the great financial crisis, reaching even the low rate in the middle of the 2001 recession. Now, things have now started to pick up. The Commerce Department reported this week that housing starts reached $1.79 million in March, which is the highest rate since June 2006. But the net effect of a decade of underbuilding is that there is massively more demand for new houses than there is supply. Freddie Mac's chief economist Sam Cotter estimated that the

Starting point is 00:15:16 housing supply was short 3.8 million units based on numbers for Q4 2020. He stated that between 2018 and 2020, remember, this is before COVID, the housing stock deficit increased by approximately 52%. However, that was before COVID, and that's the next dimension of this story. This is something that we and basically everyone else has discussed a lot, so we don't need to belabor the point. But even before COVID, there was a distinct shift in work habits with more people choosing to leave cities and work remotely. There are a lot of reasons for this. First, it was possible. Thanks, internet. Second, work from home is sort of a positive feedback loop trend, in that the more people that do it, the more normal it seems, the more work organizations adapt to that type of

Starting point is 00:15:59 behavior, the more creates that possibility for other employees. Third, the cost of living in cities has been on an upward trajectory forever. And fourth, millennials were simply coming into home buying age. Millennials are the largest American generation ever, even bigger than the baby boomers. There's 83 million of us. Generations see their peak apartment demand in their mid-20s as they leave home and peak home ownership in their mid-30s. This is when they form families and begin to have children. What we're experiencing right now is the largest generation in American history hitting its peak homeownership demand after a decade of underbuilding. That could have been enough to cause huge strain on the housing market already, but of course, then-coversing.

Starting point is 00:16:40 it hit and with it came a radical transformation of work habits. It wasn't just an acceleration of the work from home trend. It was a total transformation. Ten plus years of change around work and living habits compressed into two. The number of counties in America that experienced net increases in internal migration increased from around half before the pandemic to around two-thirds during the pandemic. So at this point, it's probably starting to get clear, right? If you're into Bitcoin, you probably have a pretty strong idea of what happens when growing demand meets limited supply. That's the story as COVID hits, and of course it is totally exacerbated by city wealth hitting rural markets that have much lower costs. But that wasn't the only COVID

Starting point is 00:17:22 impact. It wasn't just that mass increase in demand. There were also issues around supply chains, personnel, and so much more. In October 2021, there were 402,000 construction positions unfilled, the second highest level recorded since data collection began in December of 2000. The cost of construction is way up and completely unstable due to supply chain issues in building materials and fixtures. For example, lumber prices have nearly tripled in recent months, causing prices to increase for both single-family and multifamily construction. The average single-family home-build cost increased by more than 18,000. And at the peak of lumber prices, they were causing an additional cost of 30,000.

Starting point is 00:18:00 And that's on average. Even the most basic contracting becomes challenging with such wildly fluctuating materials and labor costs. Now, this show's already getting long, but I think it's still worth referencing a few other complicating factors that could be exacerbating the situation. One clear one is local policies in Nimbism. Nimbism stands for Not in My Backyard. This is where people who own houses in a particular market fight tooth and nail to not allow for more construction because they worry that it will either decrease the value of

Starting point is 00:18:30 their property or just change the texture of the place that they live. Nimbism tends to be particularly acute in the context of multifamily units. People hate it if they have nice houses with picket fences, and all of a sudden a big apartment complex wants to build right next door. Brent Todarian, the former chief planner of Vancouver, said the toughest part about city planning isn't the planning, the design, the economics, the public engagement, or the challenging, exciting complexity of cities. The toughest part is the politics of self-interest.

Starting point is 00:19:00 Another complicating factor is the presence of a new type of buyer. corporate investors like BlackRock have bought around 15% of the total homes for sale in Q1 of this year. The type of home they're purchasing is noteworthy. They're generally not buying high-end and new property. They're mostly buying existing homes built in the 70s. They're also not buying in a wide range of locations, with purchases concentrated in the suburbs of growing cities like Atlanta, Charlotte, and Phoenix, where they bought 20% of all listings. This is about buying suitable rental properties in regions with growing demand for rentals. It isn't exactly a new phenomenon. In 2019, it was estimated that professional investors owned 300,000 single-family homes out of the

Starting point is 00:19:38 total rental market of 15 million homes and the total market of 80 million homes. The change has been in property selection. Prior to the pandemic, professional investor purchases were mostly in neighborhoods where few residents would qualify for a mortgage. Recent trends in growth in cities have moved this demand to more desirable properties in areas with tight rental supply due to population growth rather than bad credit. What that amounts to is that we're seeing an uptick in reporting of professional investors outbidding hopeful first-time buyers because they're now competing over the same properties.

Starting point is 00:20:08 So what's my take with all of this? First of all, I do think that this housing moment is different than what happened before the great financial crisis. As we discussed, the GFC wasn't part of housing crisis, but it was more a banking crisis. It was a crisis of collateral, a crisis of the specific types of mortgage instruments used. I don't believe that we're going to see 8.5% foreclosures like we did with subprime loans. Indeed, the great challenge to me is that I think we have an increasingly stark divide. For the people who own houses, this price appreciation is good in a way. The house that we bought in January of 21 has appreciated 30% in a little over a year. I could turn that into more credit

Starting point is 00:20:50 that I could go use to buy another overpriced house. But at the same time, I also have a massive disincentive to sell. Who wants to go from the catbird seat to having to go fight in this market? To me, it feels like the rise in interest rates makes that worse. I was considering funding a home improvement project with a refi based on that increase in value, but taking out a new mortgage about 5% now would just be insane. So for those arguing that interest rate increases will slow down the overheating in the market, they might be right, but it's not really for wonderful reasons. People will be priced out of the market in new ways because they can't afford the new high interest payments. Existing owners will be even less likely to want to sell. Where this leaves things, I think, is that the only way our

Starting point is 00:21:32 is building. We basically can't build fast enough. At the same time, I think that local politics and regulation in the form of what types of units can and can't be built is going to have to be a part of it. When it comes to the Black Rock buying home side of things, I candidly don't know exactly how to feel. I haven't spent enough time with it to really make a call. I'm torn between, on the one hand, my deeply held belief in free markets and the opportunity for people and companies to go look for and find this type of market opportunity. Going even farther, there was a big part of my life where I desperately wanted to rent a house in the country, and that wasn't really a thing that existed. So it does feel like there's a market opening there. On the other hand, there feels to me

Starting point is 00:22:12 to be something fundamentally unfair about a system where a comparatively price insensitive corporation can always outbid a private citizen. It just feels sort of devastating, and I wouldn't be surprised if I ended up thinking that this was an area where there needs to be way more, not less regulation. All of this brings me back to that Reddit post where I started. I feel so defeated, everything I worked so hard for the past 10 years is officially out of reach. This is a post on Reddit. We don't know if it's a true story or a dramatization, but I think that that doesn't really matter. What's telling is that 175,000 people have liked it on Twitter, and that tells you that it's resonating. It wouldn't be resonating if it didn't contain some truth. Anyways, that is my 101

Starting point is 00:22:57 level summary on why the housing market is so crazy right now. If you liked this type of show on a totally different sector, let me know. It's something that I'm interested in doing occasionally. For now, I want to say thanks again to my sponsors, nexus.io, Arculus and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. Hey, breakdown listeners, come join CoinDesks Consensus 2020, the festival for the decentralized world this June 9th through the 12th in Austin, Texas. This is the only festival showcasing and celebrating all sides of blockchain, crypto ecosystems, Web 3, and the Metaverse,

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The Breakdown - Why the Housing Market Is so F%#@ing Insane Right Now

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