Shadow Demand in 2022

Shadow Demand in 2022

In 2010, banks were sitting on a portfolio of foreclosed properties. Rather than sell them off immediately at the bottom of the housing market cycle, many chose to sit on the inventory, releasing foreclosures on a slow drip so as not to saturate an already weak market. This came to be called “shadow inventory” and banks released it into the market over the course of years following the housing crisis.

In 2022, there is no shadow inventory because the housing market is at historically low inventory levels with no relief in sight. Now, on this end of the cycle, we instead have shadow demand by many of the same institutional investors who controlled the shadow inventory a decade ago.

How Did It Start?

Over the past several years, there has been an unprecedented accumulation of capital by institutional investors. These institutional investors have billions of dollars to keep invested and never enough good investment options. Historically, their real estate investments have been directed at large commercial properties that could keep millions of dollars working in one development.

With the extraordinary appreciation of residential real estate since the beginning of the pandemic, it’s no surprise institutional investors have increased demand for residential housing. The strategy consists of buying up single family residences in strong markets and capturing the appreciation by deploying the single family inventory as a rental housing portfolio.

The aim of these institutional investors is not to achieve immediate positive cash flow so they can be aggressive in their purchasing. Instead, it is to invest their war chests and capture rapidly increasing appreciation. This began when institutional investors purchased distressed properties after the 2008 housing crisis and the trend accelerated during the pandemic. With 15-20% appreciation of these housing assets during and after the pandemic, the demand has become insatiable.

What’s Happening Now?

There is quite a bit of chatter in the media about a housing bubble. At the same time, there is historically low inventory and little lapse in demand even with increasing interest rates. This is due in part to millennials reaching a home buying point in their lives and increasing rents across the country as leases from during the pandemic are being renewed.

Ultimately, it’s about the resilience of the American dream of owning a home that ensures a demand for single family residences. On the supply side, increasing interest rates and increasing regulatory barriers make it more difficult to increase supply with new construction.

The increased interest rates also incentivize homeowners to stay in their homes with their low interest rate mortgages. This incentive to hold on to low rate mortgages reduces supply even further. In short, there is no cavalry coming on the supply side while demand for housing isn’t waning.

Where Is It Going?

What’s especially interesting about this market is the presence of those institutional investors who have become increasingly aggressive in acquiring single family properties and deploying them as rental properties. That constitutes a shadow demand that is waiting to buy any dip in the housing market. These are hedge funds with billions of dollars they must keep invested.

With the bubble popping in tech stocks and cryptocurrencies, single family housing is becoming an increasingly tantalizing investment opportunity.