Invest Properly Today to Sleep Well Tomorrow
Dramatic Changes in the Economy Have Had a Major Impact on Our Industry by Adam Whitmire What is happening to the real estate market? Homeowners are finding it easy to sell their homes. They are also sharply realizing that they are not able to find another one due to low inventory. Is this a bubble, or something more? Since the last recession in 2008, new home starts have been below 50% of pre-recession levels, up until recently, 2019 to be exact. New home starts dropped again significantly during the pandemic. It is what happened next that was so unexpected. After sheltering in place for several months and working from home, homeowners and renters decided to stretch their legs and expand the home front. This meant bigger yards, a home office, and room for social distancing. The shelter in place ended during the summer with lower interest rates and pent-up demand for housing. Not to mention that social distancing does not mix well with high density housing in high density cities. This began the race to the suburbs. Coinciding with the anti-density movement, millennials were already getting older and looking to buy or rent a home. In fact, the moment an apartment renter bought a pet, they began looking for a yard. Add this excitement to the extremely low home production over the last decade, and the many new home sellers that were created from skyrocketing home prices, and you have a mass buying frenzy. Where are we going to get all these new homes? There are many builders anxious to build and sell homes. But they cannot build without materials or lots. During the full force of the COVID-19 pandemic, there was a lot of new home inventory available. We were helping investors purchase new homes as rentals at that time. We tried to get investors excited about the additional selection of homes that would not be available during normal circumstances. However, to no avail, most investors were too afraid of the economic shut down to purchase rental homes. A few months later, all the homes were gone and there was nothing to replace them with, but much higher priced pre-sales. Today, construction materials have skyrocketed. Lumber has increased over 300% and no one can find windows. We have plenty of land. Let’s just develop more lots. Sounds simple, right? Well, if you think waiting 5-6 months for a home to be built is a challenge to your patience, try waiting 18 months to develop a lot. You see, in the olden days, prior to 2008, a local developer could go down to the bank and take out an A&D (Acquisition and Development) loan, buy some land, develop it into lots, and sell the lots to a builder group or a national or regional builder. The problem with that model today is that since the financial crisis, banks stopped loaning money to develop lots. Not to mention, most of the developers went bankrupt or were forced into retirement. And since builders do not like to develop their own lots, here we are with no lots to build on and more housing demand than ever before. Home buyers have noticed that for the last few years as the homebuilding industry has been trying to shake off the dust and ramp production back up, the majority of the homes were priced from $300K – $500K, the price of a typical move up home. Building for less than that just did not make sense financially. The cost of development was too expensive. This left workforce housing and starter homes in short supply. To solve this problem, the industry began building rental subdivisions, commonly termed build-to-rent or build-for-rent. These are communities of single-family homes and townhomes that are only for rent and not for sale. The income valuation of these homes was enough to justify building them. And with the growing demand for rentals, a new asset has emerged. Today, these types of developments have become increasingly popular due to its mitigated risk profile and ability to fill a large gap in the market. These dramatic changes in our economy have had a major impact. One year ago, you could still buy land at a reasonable price. In fact, you could buy homes at a reasonable price. The capital markets were flush with cash and underwriting was still disciplined. Today, equity and debt are being flooded into the market as sensible underwriting has become somewhat hazy. Don’t get me wrong, there is legitimate demand in the real estate market, just below the smoke screen of “everything is a good deal” and “you can charge whatever you want in rent”. I like a growth market as good as the next developer, but this is off the chart. So, are we buying for deals, supplying the gap in the market, or just trying to place debt because we are expecting hyper-inflation? No matter what the future holds, if we invest properly today, we will sleep well tomorrow. Keeping our feet on the ground when the market is flying will only lead to better decisions.
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