I know what you’re thinking: Is this guy serious?! Come on, McAlister, have you seen the Shiller Index? Have you heard about the insane bidding wars?
Have you looked at the underlying shakiness in the economy? Have you considered what happens when enhanced unemployment benefits go away, and lenders and landlords can pursue delinquencies?
My answer is yes to all of the above. And I still think housing markets may continue to grow in the coming months, and that strength may continue for years.
Before we get into the details, a brief reminder on critical thinking and generating an investment thesis: We don’t take one thought, one idea, one data point and lever our entire future on it. We think on the margin.
We think in terms of probabilities. Anyone who makes a call and claims they know exactly how the future will play out is more interested in fame, likes, or clicks than they are in being a good investor. If you ever read up on great investors like Ray Dalio, Howard Marks, Druckenmiller, and on down the line, one commonality you’ll see is that they forecast, but they don’t assume they’re always right and go all-in on one outcome. They understand thinking in terms of probabilities and adjusting mid-course.
What factors are in play today that might impact the future, and what potential outcomes carry what probabilities of occurring?
To be clear, I think the economy is in trouble long-term. We have a serious debt problem and some ugly demographic issues that point to weak GDP growth and productivity relative to our history. I also think inflation, though currently transitory, has a chance to become a serious problem.
Let’s focus specifically on single-family or one- to four-family “townhome/duplex” housing. Some important factors at play here may allow for further price increases before the party ends.
The biggest component is demographics. According to U.N. population data, in 2020, the largest age group in the U.S. was 25-29 years old. The next largest? Thirty- to 34-year-olds. Then 20-24.
Guess what the average age of a first-time homebuyer is? Thirty-four years old.
So what we’ve got is the three largest age groups in the country all teed up to hit prime first-time home-buying age.
Here’s the thing about being alive: It doesn’t stay that way forever. People are less price-sensitive when it comes to making certain purchases—like houses. You don’t wait around forever to find a deal. You hold your nose, borrow the money, and buy the house because your life is happening now. Kids are coming, careers are evolving, and homes are needed.
New federal policies
What else is happening on the demand side? How about a $15,000 first-time homebuyer credit? It’s not a done deal yet, but it’s easy to see something like this getting through to law.
Some form of student loan forgiveness or cancellation is also on the table.
Lastly, low interest rates are absolutely vital to the continued strong appreciation in home prices. Currently, there is no end in sight regarding Federal Reserve policy on low interest rates. Even with inflation picking up temporarily, it is unlikely the Fed will allow rates to rise meaningfully higher. They know it will end the party and turn everyone (including the government) insolvent.
You put all these demand factors together, and millennials will be plunking down cash for new homes faster than my little sister when Justin Timberlake tickets go on sale.
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We also need to look at the supply picture to better understand where housing may be going. In terms of existing homes, I don’t see a massive wave of supply arriving. The main places a supply wave of existing homes could come from would be economic distress or downsizing baby boomers.
Over the longer term, some economic weakness is on the horizon. I do not think, however, that the market is anywhere near what it looked like in 2006. Borrowers are more creditworthy and less over-leveraged. No one can know for sure, but I think the demographic and government support on the demand side will outweigh any pressure here, even with the eviction moratoriums burning off.
Some Boomers will absolutely downsize, and houses will hit the market. However, there are more millennials buying than there are boomers selling. Also, aging in place is becoming more common, where the elderly bring services to them instead of the other way around.
Grandparents also like to keep their homes to have a gathering place for their kids and grandkids. In some circumstances, they may continue to own their homes to house their kids and grandkids.
That leaves new construction supply as the main option.
I think we will see single-family and for-rent “horizontal” rental complex supply continually increase. However, rising construction costs and difficulty acquiring and developing land due to high prices, labor shortages, and zoning boards will limit the ability of the supply to meet the demand in the short term.
Let’s take a gander at single-family housing starts.
Since the bust, they’ve lagged considerably below historical averages. Single-family starts lagged significantly below the historical average of around 1 million starts per month up until 2020, where we got back to that level despite significantly higher populations now.
This tells me that the supply will still need to catch up for a while before prices moderate.
Home prices are skyrocketing, with the March Case-Shiller Index showing more than 13% price appreciation in the March year-over-year number. We last saw this level of growth as the last housing bubble was peaking between 2004 and 2006. Do I think that this will unwind over the long term? Yes. Do I think it will be a “crash?” Not necessarily. It could be a slow deflation.
More on the real estate market from BiggerPockets
Will prices continue to appreciate?
Even though housing prices seem insanely high (they are), and it feels like they should be much lower (they should), there is a strong case to be made that there is still a lot of runway due to the demographics, constrained supply, and government interventions into the housing market.
This doesn’t mean prices will continue this pace of appreciation. It also doesn’t mean that there won’t be cycles where prices moderate for a while and or that you can close your eyes and buy anything and expect to make money.
On the margin and in general terms, apartment outperformance may be sunsetting, and single-family/horizontal rental complexes may step into the limelight.
Some newer developments offer a pretty cool blend of single-family units with high-end apartment-like amenities, including pools, gyms, fitness centers, and dog parks. You’re going to start hearing the term “horizontal development” more and more.
Self-storage may also benefit here. Household formation tends to drive storage demand, as no one wants to get rid of their stuff when they move in with their partner or downsize.
Happy hunting out there!