1217: Housing Shortages, Affordability & Inventory in the US & Canada

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Welcome to episode 1217. 1217. Thank you for joining us today. I have Doug here with me today and we are going to talk about quite a bit critique and add our opinions to some, just some of the litany of prognosticators and economists and forecasters and hey, everybody's got an opinion, don't they? They've got an opinion about what is going on with the economy, what's going on with the stock market, but most importantly what is going on with the housing market and what does that mean to you as a good prudent income property investor? And what we want to do today is just kind of go over some of these predictions and see what you think of them. Doug, welcome back.

Great to be back, Jason.

Okay, so let's dive in here and let's play some clips. This one is from realtor.com and of course realtor.com at least last I checked was owned by the national association of Realtors. That could have changed. I'm not exactly up to date on what NAR is doing all the time nowadays. But anyway, let's see what they're saying. Usually their feel about the housing market is pretty promotional. They're usually putting a positive spin on everything. So let's see what they say.

Hello everyone and welcome to Economic Insights with Audrey Whittington and Danielle Hale, Chief economists@realtor.com so today we're going to be talking about the housing Market and sort of the trends of 2019. I think this is a really hot topic. I think people are wondering, where are we headed? Know where we've been, where are we going?

Yeah, absolutely. What's going on right now?

Exactly.

So the way that we track this is by looking at our inventory data. It's the most current read on what's going on in the housing market. And what's going on right now is in some ways a continuation of what we saw at the end of 2018. So the biggest trend is more. More homes are available for sale. That's good news for buyers who have been grappling with years of not enough homes available for sale. But what's interesting, we're seeing those new homes for sale concentrated in higher price points and pricey markets.

So that's interesting. So it really isn't across the whole pricing spectrum. So really it could be good for buyers sort of in. And where would you see that price cut? Maybe half a million and up or 2, 300. I'm not sure where the cut is.

Yeah.

So if we look at homes that are priced at 750,000 and above, for instance, those are increasing at a double digit pace, like 11 gain year.

In terms of inventory. Yeah.

In terms of number of homes available for sale.

See, Doug, that's one of the things that's so confusing. They talk about these numbers and they never say what they are. Are they housing starts? Are they housing sales volume? Are they sales volume of resale homes? Are they sales volume of new homes? Or are they housing prices? And then in which category, of course, they did bother to segment by price, which was good. And what they didn't tell you is that most of those more expensive homes above 750,000 are of course in the cyclical markets, the coastal markets and the markets that we wouldn't touch as a prudent long term income property real estate investor, right?

Well, absolutely. And what I'm actually doing right now is looking at my notebook where I was taking notes and as we were listening to the interview in real time and when they said, when I wrote more homes available for sale, I annotated and wrote at what price question mark? Because the big shortage that we have is not in McMansions. Right. There is no national shortage of $900,000 houses. There is a national shortage of $100,000 houses that are reasonably livable.

Right.

And I think that's actually the place where we have a double built in advantage is that we are intentionally sourcing our INV inventory in affordable Markets at affordable price points. So that when the inevitable correction comes at the high priced markets and high priced houses, that there will still be sufficient demand, as you said, from both directions, from people who are moving up and from people who are moving down because they were moving, they were living in something they couldn't otherwise afford.

Right, absolutely. Good point. And I think your inevitable correction is already here. I wouldn't say it's quite to the point of an inevitable crash yet in the higher end cyclical markets, but it is. We are at correction point. I think we could both agree on that. It's pretty interesting how few people really understand how to segment the market and how to divide it up. But you're right, you know, we want to catch people moving up on the spectrum. In other words, you know, people that are wanting to move from an apartment to renting a single family home. And of course, we're, we're really not that concerned overall with housing prices anyway because we're concerned about income yield, rents, return on investment for investments that we buy and hold. But since everyone talks about housing prices all the time and some people think they're going to time the market and, you know, wait for a better deal, and usually those people never win, but they keep trying, you know, that it does apply to them. So it's interesting to look at. You know.

Jason, I want to challenge that assumption just a second.

Sure.

Even if I was going to buy and hold a property forever, and even if I never wanted to extract a nickel of equity out of it, I would still want the price to go up so that I can get better terms on refinancing.

Fair enough. Well, that's long term. And long term we know it will go up. I'm just talking about little dips here and there and little sides of the market. Exactly. Not big long term dips. But you know, you're a fan of Warren Buffett. You didn't pay $4 million to have lunch with him like the cryptocurrency guy just did. But you know, you and I both agree, even though neither of us love the stock market, we agree with the concept of value investing, the Benjamin Graham kind of mentality, if you will. And I know that's not completely attributed to him, but just broadly speaking. And you know, it's about just buying good value, holding on to it, rather than trying to pick up every little dip and not being in the game and not getting the tax benefits, not getting the income, not getting the return on investment. Because here's a faulty belief. A lot of investors have say that there is a person sitting out there now. And I don't hear this often, but I did hear it from one person last week, so I thought I'd bring it up who says, well, hey, you know, I missed the last cycle. Yes, I should have bought lots of properties a few years back. I didn't. I missed it. And I'm going to just keep my powder dry, keep my money in the bank, and wait for the next recession. And funny thing is, is that first off, the recession is usually caused by, obviously a slowdown in the economy. But the housing recession, if you will, is usually caused by higher interest rates. And so you're going to have to pay more every month to own the property, even if the price does decline and even if you can time it right, which is a miracle in the first place. But here's the big thing people miss, Doug, and I'd love for you to comment on this. They miss that if you have to wait three years for that cycle for that dip, if you have to wait for it to come, and you could have earned 20% annually on that investment as the overall return on investment, everything included, you missed all that return while you're waiting and keeping your powder dry, so to speak. What do you think of that?

Yeah, I think the opportunity cost is very, very real. And it's something that people frequently ignore because you're just. People's brains are naturally attuned to think about, think in terms of accounting profits and losses. But one thing that you were that you touched on, that I wanted to unpack a little more, which is where you were saying that nobody can time the bottom. And that's actually even more true than a lot of people think. Because if you say, okay, I'm gonna wait till the next recession, then I'm gonna buy. Prices go down 5%. Hey, we're in the next recession. Time to buy. They go down another 5%. Oh, well, whatever. I'm gonna buy again. They go down another 5%. The thing you just bought at the very beginning is now down 10%. And if you had to liquidate it, you'd probably. All of your equity's gone where you say, okay, now I'm in. I'm all in. It's down 15%. I'm going to buy some more. Then it goes down another 5%. Is that right? You know, if you're trying to buy on the downside, you have no idea where the market's going to bottom, and so can be almost guaranteed that you're either going to buy while it's still going down. You might catch it on the other side, but then you're not going to know whether you bought at the top again.

Right.

And so it's way more important to understand the value of what you're buying as opposed to trying to time the price. Because if you're trying to play that price timing game and you're disconnected from value, then there's no time when what you're buying is gonna make sense from a value perspective. Case in point, let's say you're talking about a townhome in San Francisco. I think like about 15 years ago, those were like about, you know, 400,000 bucks. Now they're like $3 million. And say they go down to like 900 grand. Well, it didn't make sense at 400,000. What means it's going to make sense at any other price?

And I don't know about your prices. I think you plucked those out of thin air a little bit because. Okay, well, you admitted it. Good. Because I don't think it went from 400,000 to 3 million that quickly, but it certainly went up. So it might be 1.5 million or, you know, whatever the number is, it doesn't matter. But when it was 400,000, it only rented for maybe $2,000 a month. Okay. And if it's rent controlled, and we have a real case study on this, one of our listeners who was on the show, he lives in a rent controlled apartment in San Francisco, came on the show, talked all about it, is paying, like I think he said, $2,400 a month or something, and the place is worth 1.5 million. Yeah, right. Yeah.

That's ridiculously low.

Yeah, well, it's rent controlled and it's worth 1.5 million. That's my point.

If you were, boy, I'd vote for Democrats too, if they, if I had that good of a deal.

That's an incredible deal. So if you were the owner of that property, though, and you were subject to rent control, you'd just be losing your shirt. It's a terrible deal.

Oh, absolutely.

Yeah. Yeah. But okay, so buy value. Market timing is usually. It just fails. I mean, it's almost always fails. The thing to do is the old saying, don't wait to buy real estate. Buy real estate and then wait. But you got to buy real estate. And follow my commandment number five, thou shalt not gamble. The property must make sense the day you buy it or you don't buy it. That's absolutely got to be the case. Let's go back and play a little more of this audio because they were getting into something good here.

If we're looking at homes under $200,000, those are still declining. So there are still fewer of those homes available for sale this year than last year.

So this.

So see the dangerous perception there? She says if we look at homes under 200,000, those are still declining. People would think she meant the price. What she was talking about was the inventory. The inventory has declined, which means upward price pressure on those lower priced homes. Let's continue.

Kind of all the data then really keeps pointing to what you keep talking about, which is affordability.

Right.

So more people are sort of orienting themselves to houses they can afford and at the sort of upper echelons, maybe they're kind of pausing and holding a bit.

Yeah, sure.

They're taking a little bit of a break as far as like assessing what they can afford, assessing where they want to be. There's not the same frenzy that there was before because we're starting to see more homes come available for sale. But I do think sales will continue in those price points. We've got mortgage rates that have, you know, approached the 5% by the end, at the end of 2018, and they're now down under 4 and a half percent.

Wow.

So it's a nice boost to the.

Spring market, especially actually at the higher end home price homes because every quarter of a percent makes a huge difference. So let's talk about the rest of the year and I know you're going to look into your crystal ball and you're going to tell us exactly what we can expect.

Yeah. What does this mean? So we are. One thing, I'll tell you one thing we're definitely looking at to see whether home sellers continue to be interested in listing their homes for sale because it's a different market for sellers this spring, for the first time in many years, they've got to think about their competition.

Right.

So last year it seemed like homes are selling so quickly you were probably the only home listed for sale because your neighbor that listed for sale a week before you, you know.

Exactly.

But this year they'll have to think a little bit about competition, especially if they're listing in those higher price points. So above that 750, 000 mark, or even maybe at a slightly lower price point in some markets. On the flip side, if you're selling an entry level home, one that's priced under $200,000, it'll go like that. Like that. Absolutely. So Depending on your.

Yeah, so I would agree with that. I don't know why they put that stupid music track, you know, that music bed in the video. That's just super annoying.

But anyway, there was one thing that that kind of stuck with me. They said people are orienting around what they can afford. And my thought was, has that ever not been the case? Well, I mean, maybe it wasn't in 2007.

Yeah.

Isn't that like how people buy houses?

Right. Yeah.

Normally what people do.

Well, it's what the lender will let them afford. They don't necessarily do what they can afford. It's what the lender will let them. As we saw, you know, as to what brought on the Great Recession. But let's take a look at another video. Okay. Or not a look at it, but a listen to it. And this one is a CNBC video. And I think this will be kind of interesting to you.

Even if you can get credit at a low interest rate, if you can't find the house that fits your financial profile, there's not much you can do. And it is at the low end of the market usually.

By the way, this is Doug Duncan, the chief economist for Fannie Mae.

Existing home part of the market where people are moving up.

Yeah.

And people are just not moving up. The boomers are aging in place. That part of the market is at 30 year lows in terms of supply.

We also mentioned that there might be.

Some kind of floor under rates that.

The banks would put into place.

Doug, can you elaborate at all on that?

Well, they do have to make money. So their mortgage rates are a spread over their cost of funds. Now, the cost of funds, if used the treasury rate as a proxy suggests that mortgage rates should get down around the 4% range given their spread over the 10 year treasury, which is at about 2.2 today. But banks don't make money unless they have some spread. That said, their cost of funds has fallen as well. But consumers need to be confident of a couple things. One is house prices have been slowing. So they don't want to step in if they think there might be actually an outright decline. So you don't want to catch a falling knife, so to speak. But if they think rates are going to be down for a while, they may say, well, I'm just going to wait until the house that actually fits my profile is available because rates don't look to be going anywhere. That's sort of what our survey data say is they expect actually rates to fall a bit more.

And Diana, that's what's so interesting is that it's not like rates are down.

Here and people are figuring it out.

For the first time.

This is almost becoming the new expected normal.

Yeah. I mean, if you talk to a millennial and you tell them that you got a mortgage rate at 9% back in the 90s, and you thought that was great, they looked you like you're.

In or a mortgage rate at 20% in the late 70s. I mean. Oh, millennials. There you go. Okay, go ahead.

When I was a kid, the cul de sac where we grew up, for the longest time, we were the only house there. And I didn't understand it. Of course, when I got a little older, I figured out that my dad bought that house in 1979, but he bought it with a VA loan. So he was able to get the loan at, I think, about 9%. And all the other loans were going off at, you know, 12 to 15%. And so there was just, you know, our house, another house a little down the way, and then another house the other direction. And for about five years, there's nothing else built. You know, all of us kids, we just ran around in the fields and ran back and forth to each other's backyards because there's no point in putting a fence in because there's nobody else around.

You know, what's interesting about that, too, is there's this mythology that exists that says, well, the construction will stop if the buyers stop. And that is true, ultimately, but it doesn't happen right away. Remember, I've talked to you many times over the years about the lag time that occurs. And when I say you, I mean you listeners, right? We talk a lot about this. There's this lag time, and that's the disconnect. And that's why this stuff is so hard to figure out and so hard to forecast, because the buyers could have gone on strike, yet the builders still have bank financing and letters of credit and commitments, and they're just going to keep their machine going right into the recession sometimes. And we certainly saw that happen into the Great Recession. The buyers were going on strike, but they kept building for a while. Right? So there's this. This disconnect in time where it doesn't, you know, you don't notice it right away. And that's what happens. There are all these, like, overlapping factors. But, yeah, let's go back to this. You know, tell a millennial the rates are 9%. Well, what about when they were 20%? Go ahead, Doug.

I was going to Say if I could just unpack that a little bit. Because the reason why there's that lag is because the builders who do the most volume, which is the people like your Dr. Horton, Toll brothers, you know, the Lennar big builders. Yeah. What they do is they buy big tracts of land for usually very high premiums and then they put a whole bunch of money into prepping the land, into putting those retaining wal, at least where I'm at, they put in retaining walls, you have to put in the drainage ponds for storm runoff, you have to put in the infrastructure, you have to put in the streets. Right. There's a ton of money that goes into prep. And then they start building and selling houses. Well, the first few houses haven't even come close to covering their costs. They probably don't cover costs until they're two thirds of the way sold out onto the development. And so if the bottom falls out of the market when they're halfway through development, they have to keep the train moving, even if they have to cut the prices on the houses because they gotta make some fricking money.

No question about that. Yeah. You didn't even mention all the governmental approvals, the environmental impact reports, the regulatory compliance and to create, you know, what we call finished lots. Right. Where you know, the utilities come up to the lot, but all the infrastructure is built.

So there's no small amount of effort that goes into this.

No, no. No small amount of effort or money. Okay, let's continue.

Doug, I'd be interested also, and I don't want to get too wonky on this question, but I've been hearing a little bit also that while we do say that mortgage rates follow the Yield on the 10 year treasury loosely, they are mortgage backed securities, that is bonds that investors have to buy that also dictate rates. And we're hearing that this talk that Fannie and Freddie might come out of conservatorship. And Mark Calabria, the head of the fhfa hasn't actually said specifically that there would be any kind of government, government guarantee in the new world that investors are pulling back from mortgage backed bonds and that's keeping rates higher than they keep could actually be. Is that true?

Well, that's a poss.

That's a really interesting question. And over the years we've discussed the possible privatization of Fannie Mae and Freddie Mac. And now that is on the table again. It sort of went away for a few years. But Doug, you might remember it. Meet the masters in maybe 2011. I'm guessing we were on Stage together. We were talking about this and the possibility of, of Fannie and Freddie becoming privatized and what that might mean. So it's interesting that, you know, history does repeat itself, so we'll see if it happens. But the talk is, is really becoming louder again. Let's listen to Doug Duncan's answer though, because I don't want to make too much lag time in the momentum of that and then we'll talk more.

I suppose. However, it's also the case that the Fed continues to run off its portfolio of mortgage backed securities even though they've slowed the overall portfolio runoff. They are running off mortgage backed securities. So that would put some pressure on spreads as well.

Your comment, Doug, the thing that I.

Think is really interesting is that if you're talking about privatizing Fannie or Freddie, is that the proof in the pudding is going to be the next time that they lose a lot of money, what's going to happen? Because I think a lot of people would be, would like the idea of some kind of, you know, quasi or full privatization. They might not like what it means because chances are it means higher mortgage rates and you won't be able to get 30 year loans because if you talk to people from other countries, their interest rates are usually two to six points higher and their loan amortization is, you know, say 15, maybe 20 years. Yeah, 20 year loans, a long loan.

Some are literally five year loans that force you to refinance after five years. Yeah, exactly. You know, again folks, and we've talked about this many times, but the United States has a very special housing market. It's very unique in all the world in so many ways. And that's why foreign direct investment here is very high because we have a very special housing market here.

The impact of privatizing would be a dramatic shift in the terms which over the long term, I don't necessarily think it's a bad thing because it'll help prevent the market from getting overheated. Just because if people have to pay 2 to 3 more points for a mortgage, so instead of being 4.5%, it's 7.5% and they have to amortize that loan over 20 years, affordability goes in the tank, but now all of a sudden the prices don't escalate quite as high and so it's going to lean out that boom and bust cycle.

I agree with you completely. I think Fannie and Freddie should not have anything to do with the government. They should be private and everything should run by the free market as much as possible. Okay, let's talk a little bit now about the Case Shiller index, which is rather misleading.

Again, I was going to say your favorite index ever.

Yeah, yeah, exactly. Because it overweights the cyclical markets. About 75% of that index is in the high flying cyclical markets and only a quarter of it in the prudent linear markets. But let's listen to this FOX Business clip and talk about that.

Well, depends on what side of the door you might be on as the latest Case Shiller report shows mixed results for the housing market. Homeowners on the whole still seeing their home values increase. That survey showed that housing prices rose in the 20 largest markets on an average at 2.7% year over year. However, that was the slowest pace since August 2012.

Yeah, and that's pretty slow really. But let's continue.

This is in New York City, for example, even dropped 0.1% from February into March. It's another data point for those who.

As they should, as they should. New York City was it's time long overdue for a correction about growth moving forward.

Strong growth is partly what President Trump and his team are relying on for re election in 2020. A New York Times op ed over the weekend noting that three reliable models suggest that President Trump will win once again. Joining me now, the CEO of Bach Enterprises, Ernie Bach, Jr. Ernie, thanks for joining us. Appreciate it. Thank you. So want to start with the housing market Case Shiller, what do you make of it? Because it seems like housing prices are starting to move in that direction, at least the pace of sales and home prices. I think that the prices are high, extremely high. So they're, they're coming down, they're leveling off. I think they're adjusting. I don't think it's too much to worry about. The interest rates are low and it's okay. Shouldn't though, with interest rates this low, shouldn't the housing market be in a much better spot than it is right now, though? Well, in some case in some places in the United States it is. But in a lot of other places, especially in New York, prices were so high they could not go up anymore. They had to come down. Want to get to these models? They are three models which are pretty good at predicting who will win presidential races. One of them, especially from a Yale University professor.

Okay, let's forget the political stuff and focus on the economic stuff. Doug, any comments on that one?

Well, the thing that I keep thinking whenever people talk about, you know, prices are growing to X or Y or whatever. And they talk about the average price of houses as though it's kind of this sterile thing. But you have to understand that any house that gets sold, somebody's got to buy it. And they need to hit debt to income ratios. They need to have some kind of down payment or they need to have some kind of goofy financing. And so people say, oh well, you know, prices are only going to grow another 2%. Well, yeah, it's because people have to buy this stuff and they have to be able to afford it. And if prices escalate to the point where none of the people in the market can afford it, they're going to stop buying it. I mean, that used to be called common sense, but that's not how people think anymore.

Yeah, very good point. Okay, let's do one final video and then we'll wrap it up.

Well, the housing market in Canada is cooling off.

But despite that, a new report says.

Most cities will be less affordable in 2019. Now the royal bank says higher interest rates will drive up the cost of carrying a mortgage.

In fact, it says the cost of.

Owning a home in the biggest city, Toronto will hit 79% of median household income.

What's interesting about this is that you look at these Canadian cities on both coasts. I mean, we've profiled Vancouver a lot is one of the most overpriced housing markets on the planet. It was absolutely insane. And I mean, think about what they're saying about Toronto, right, Which is just north of New York. Right. It's not too far at all.

Just on the other side of the border.

Exactly. I've actually driven that before. When I was a, when I was a kid, I wasn't driving, I was a passenger, but grandma was driving. My grandparents are from upstate New York. So we went to Niagara Falls, drove up to Toronto, and they're saying 79% of median income would be required for housing costs.

Are you kidding me?

That's insanity beyond all insanity. Doug, can you spell bubble exactly?

Because this is just getting back to our prior point, which is that somebody has to buy these dang houses. And you know, the thing is, right, you know, median's the middle. And even if you have a heavy upward skew on your incomes, which I'm sure Toronto does, at some point you run out of millionaires. There's only so many friggin houses a millionaire billionaire needs. And they say, hey, I'm good, you know, peace, I'm good, guys, I don't need any more.

And listen, even though they've got lots of money. It doesn't mean they want to lose money. How'd they get there? Their mentality was prudent, right? And so, yeah, this is the greater fool theory in action. These Canadian markets are absolutely beyond ridiculous. And the greater fool theory says, no matter how much I pay, some greater fool will come and pay more. But just like the game of musical chairs you played when you were a kid, the music eventually stops and someone is left standing.

In fact, I was almost thinking about, you know, the old airline joke, right? You know, they say, how do you become a millionaire? You know, start as a billionaire, then buy an airline? Well, we'd say, how do you become a millionaire, start as a billionaire, then buy a bunch of houses in Toronto.

Yeah, absolutely. And with that, I think we can probably wrap it up. I think people get the point. We don't need to listen to that.

We don't need to beat that over. We don't need to beat it up anymore.

We don't. But anyway. Hey, Doug. Thanks for joining me today, listeners. Happy investing to you all. Thank you for sending Happy investing. And thank you for sending your spam to reviewsasonhartman.com we love your real estate spam. So as you receive this spam, which you did not subscribe to from other players out there in the real estate industry, forward it to us. We will be your trash can for your spam. Just Forward it to reviewsasonhartman.com and we'd love to see it. Doug. Thanks for joining me, everybody. Happy investing. We'll talk to you tomorrow. Thank you so much for listening. Please be sure to subscribe so that you don't miss any episodes. Be sure to check out the show's specific website and our general website, hartmanmedia.com for appropriate disclaimers and terms of service. Remember that guest opinions are their own and if you require specific legal or tax advice or advice in any other specialized area, please consult an appropriate professional. And we also very much appreciate you reviewing the show. Please go to itunes or Stitcher radio or whatever platform you're using and write a review for the show. We would very much appreciate that. And be sure to make it official and subscribe so you do not miss any episodes. We look forward to seeing you on the next episode.