Property Valuations & the Pandemic - 3 Fundamental Observations for (would-be) Buyers

WOULD BE BUYERS AWAIT THE 'PULLBACK'

It’s generally accepted knowledge that property is today, more expensive than it has ever been. In just about every city in America, that desirable home or condo is listed for more than it ever has, and it feels like 3 years ago would have been the perfect time to buy.

EXCEPTIONS - NOT THE RULE

Now there are some exceptions, like the glut of luxury condos that flooded the high-density downtown areas of Los Angeles and Midtown. Then there's deceivingly serene parts of the country where natural disasters have ravaged the land, rendering it no longer habitable nor insurable (Paradise, CA). You might have stumbled upon a city rich in history but where various economic factors have led to severe localized changes for the worse, and have thus suffered long-term depopulation (Natchez, MS)

THE REAL ISSUE...

The point is this - if you are one of the millions of Americans looking to buy your first home or even your second investment property, you've probably heard all the talk about an upcoming 'pullback' and you're curious if waiting 6-8 months to buy is better than buying in the next 6-8 months. Let’s not forget that asset prices of all types are at an all-time high, business cycles have proven themselves to exist (thus far), and interest rates have set record lows during the longest bull run in history, and Joe Biden has won the presidency. Chances are that you know somebody who has already sold their property in anticipation of the next housing crisis… If you are waiting for a 'pullback' in prices before you buy, consider these 3 thoughtful observations

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OBSERVATION #1

ASSETS OF ALL TYPES ARE AT RECORD LEVELS - REAL ASSETS WILL OUTLAST PAPER ONES

Residential risk profiles across the country are much more conservative that what was in place leading up to the global financial crisis of 2007-2009. Prices may reflect record levels, but the growth path we took to arrive here has been organic, slow, and natural. Long gone are the subprime mortgages, negative equity loans, and toxic MBSs that crept into every working Americans retirement account. As a result, the risk profile of the mortgage industry is lower today than it was in 2007 when prices were lower than today.

The last global recession was born from real estate so naturally this was the hardest hit sector, and naturally received the most scrutiny when it came to regulatory changes. Real Estate was actually designated the 11th and newest sector of the S&P500 as a result of the asset's collapse and its global fallout, and as a result, the mortgage industry saw sweeping changes that have been effective in reducing the systemic risk that can shock the industry into collapse as was the case in 2007-2009. It's pretty clear at this point that the the next recession will have to start somewhere else, and when it does, real residential assets on Main Street won't be sinking nearly as fast or as deep as the paper assets on Wall Street. So if you are waiting for a deep dip in prices before you buy, consider that the risk profile of the entire mortgage industry is much more robust this time around... and you just might be disappointed.

OBSERVATION #2

REAL ASSETS ARE THE STRONGEST PERFORMERS, AND IT'S NOT A SECRET ANYMORE

Demand for real estate started growing as soon as the housing crisis began to recover, and it will continue to gain momentum over the next 10 years. A LOT of momentum. From BIG money sources with the deepest pockets you can imagine. It all starts with the graph below

Industry leaders and think tanks like Brookfield and PwC all see Real Estate as the prime alternative investment being targeted by big institutional money managers going forward and for all the right reasons: good cash on cash yield that generally adjust with inflation, reduced volatility, and its superior returns over any other asset class. Pension funds, private equity, and other institutional investors are accelerating their organic growth into real estate, a trend that is expected to continue and is evidenced by Blackstone's newest $20B fund - the largest real estate fund raise in history.

Even more important than the organic growth I just mentioned, is the trending allocation of institutional investment portfolios into the real asset sector. Commercial real estate allocations began to grow from around 5% in the 2000s to around 25% today, and this is expected to grow to around 40% by 2030.

This combination of organic growth and future allocation means that an estimated $45T (Trillion!) of capital deployment into Real Estate is estimated to occur by 2030. That is A LOT of future demand! Even single family homes are seen as institutional investments when you consider the growth of investment firms like American Homes 4 Rent (AMH) and Colony Capital (CLNY) coming out of the global financial crisis. The reality is that BIG money has figured out how to own this asset class and are diving in head first. Institutional money now crowds the space once dominated by Retail investors, and they have PLENTY of dry powder, and unlike you they wont have the same patience for waiting to buy. It appears they are moving into real estate assets since they are the best hedge against a recession, second only to gold. The secret is out, and institutional valuations, AKA high property prices, might be here to stay.

OBSERVATION #3

REAL ASSETS FACE LONG TERM SUPPLY PRESSURE

Follow me on a stroll down Logic Lane... Land parcels are finite and can't be moved. They're a unique resources that can't be manufactured or otherwise produced to fill a supply shortage. We live ON land. Still not convinced about long term supply pressure? Then consider the global population grew from 1.6 billion in 1900 to 7.7 billion in November 2019. These billions of people tend to concentrate in desirable areas. As they do. desirable areas become overpopulated which leads to regulations that limit the population density in the overpopulated areas. So housing inevitably becomes increasingly difficult to deliver in areas with the most people living there. Thus, we are stuck with long term supply pressure. It's sounds so simple because it is.

Still not convinced? Plenty of evidence can be found by looking at the mountains of data available. Trends like shrinking house size and the increase of single person households point to a strong need for new housing units. So if a lot of new units are needed, then logically speaking, apartments will be much more effective at delivering units to the market in terms of buyer affordability versus single family homes. But when we examine the national pipeline we find that the forecast calls for a net housing shortage of about 1.5 million units by 2030! That is a huge shortfall and the only permanent solution is if politicians quickly and drastically change zoning regulations in densely populated job centers to allow more housing units, or, you need to be on the winning side of property ownership. This is definitely something for would-be buyers to consider.

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So lets take in what all this means. The risk profile of the mortgage industry is much less susceptible to shock and collapse, despite higher valuations than before the Global Financial Crisis. Demand for real estate assets has been growing and will continue to grow by leaps and bounds in the next 10 years. Supply for housing stock - the most reliable asset class - is facing a massive shortage over next 10 years. Tying all in is the fundamental law of supply and demand. We all remember this one, right? It states that price is ultimately just a result of supply and demand. And since its a law and not just a theory, it should make you wonder where you think prices might just be headed, or how deep an upcoming dip might actually be. Since nobody really knows for sure, it sure helps to stay in the know.