272: Current Real Estate Market: Rental Challenges, Institutional Landlords and Homeownership Trends with Jay Parsons Part 2

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Your average mom and pop rental and your average affordable housing unit is not actually listed online where someone's surveying that rent, including it in a rent index. And so it's apples and oranges. And so I think what you have to be able to do is you don't track incomes, the time of renewal, but you can look at two things. One, you can actually, this is what we do. I think a lot of larger property managers, you want to look in small ones, you want to look at what's the rent income for actual households in your communities that for the time of lease signing and, and then you want to look at your rent collection people still able to pay the rent. And on a national level and in most markets we're still seeing rent to income ratios for new leases in the low to mid 20% range and we're seeing rent collections in the upper 90% range. And so that's for the market rate side, it's more challenging, the affordable space. And so overall it's a good story. Again, my concern though is people who are not even in those numbers because they don't qualify to live in the units that are, that are available.

That's, that's a good point. You said a lot of stuff there. And a survey like that that's comparing rent to income ratios is almost doing it sort of the way the housing affordability index does it. Right. And there's a lot of flaws in that because you know, it, it doesn't survey who's buying what house and it also doesn't count foreign money moving into a market. And it, of course, what it really doesn't count is people in a market that are already there buying a house, moving up and trading their equity. You know, it just looks at median income, median mortgage payment. And that's, that's very misleading.

Yeah.

Although it's a decent index other than that. But you know, it does have a.

Few big, all of these things are challenging. That's why I think it's I think you're right, but I'm very skeptical. I see these crazy numbers because I mean, the reality is no one's leasing to someone paying half their income on rent and it just doesn't happen. And so to say it's the median, it's like it's mathematically just very improbable to even get there unless it's an area like maybe, you know, maybe Miami where it's so much retirement income, retirement money and foreign money, where it's not even a W2. It's just they've got a lot of wealth and it makes look like the rent income ratio is a little out of whack.

Fair enough. You know, that's interesting because I just had a guy who wanted to rent one of my houses who's retired, doesn't have an income. Okay. Or you know, a big income and you know, the rent for this property was fairly high. And I said, well, you know, what's your income like? And he says, well, I'll just pay you a year in advance. Okay. You know.

Yeah. Savings, Right.

Yeah. So. So income wise he is basically was telling me he wasn't going to qualify. Right. But, but he, he has money, it's not a problem. So. Yeah, interesting.

He'll take the year up front. Why not?

Yeah, right, right, right. Yeah. What about the institutional landlords owning sing I'm talking about most of our listeners and audience are buying single family homes. Some apartments too, but mostly single family. And this has really been a change coming out of the Great Recession, how we've seen just a huge level of interest from the big money, the smart money in single family homes buying entire neighborhoods, huge portfolios, tens of thousands of single family homes. Overall though, compared to the rental market size, it's still a drop in the bucket, but it is bigger than it's ever been that I know of. Talk to us about that market, what's going on there, what your thoughts are for the future of it.

Yeah, well, I mean single family rental market is really saying, I think in some ways, I mean, just go back a little bit. You know, great financial crisis, you know, everyone's struggling with, you know, foreclosures and whatnot. End up, you know, obviously, as everybody knows, we start to see some institutional groups move in and buy single family rental homes. And then since then, you know, they've continued to be a presence in this market. But you know, even now, Freddie Mac did study, I think a year ago showing that institutional landlords were, I think it was less than 5%, maybe a 6. I forget it's low single digit, low mid single digit percentage of the market. But they tend to be sort of an outsized face of the market. And certainly, I think what we've really seen and now though is that they've gone to the sidelines too. I mean, rates are high, they're using debt also. And also home prices are still high. Now if only one of those things were true, I think they'd still be active buyers. But the combination of the two has certainly, I think, pushed a lot of folks to the sidelines at the moment.

Yeah, yeah, it sure has. So they're on the sidelines. So we've got this very weird market in real estate. I've been doing this an awfully long time and it's just really, I still can't help but comment on it because we have very low inventory yet demand has been, there's been a lot of demand destruction with the interest rate increases. So we've got sales activity down by, you know, depending on who you ask and where it is. They're Talking about about 23%, maybe decline in, in sales volume. Yeah, but still we have only about one third of the inventory of single family homes. We need to be normal. You know, most people would say somewhere around there. Normally with these massive interest rate increases we've seen, you'd expect to see a flood of inventory coming on the market and you'd expect to see a crash. Now we're not seeing that at all. I mean, still, what I call the crash. Bros are out there hoping for a crash because they've mostly missed the market the last 10 years and they want to get in and they tend to be rather jealous people about that. But what do you think about that? I mean, what do you make of this type of market?

Yeah, you're right. No, it's, you know, it's always kind of weirdly sick to me how many people, especially on social media, seem to be cheerleading a crash in the housing market and grand misery for half the population. I find that to be exceedingly bizarre.

But it's sick, it's a sickness.

Yeah, I'm glad they consistently are wrong, not just for the rest of us, but also for the sake of our, of our country's health, the fact that these people continue to be wrong. But I digress. No, no, I think, I think what's happening is that you read all the headlines and home prices and incomes and inflation and everything's really negative. And certainly consumer sentiment has even been weak the last couple of Years. But the reality though is that by and large, always there's exceptions, that by and large the people have fared pretty well over these last few years in terms of incomes and jobs. Unemployment the lowest level in multiple decades. Wage growth been consistently the strongest in multiple decades. Wage growth is part of inflation too. And oddly enough, the Fed, obviously there's reason for this, but ironically enough, the Fed even wants to see wage growth levels come down. So there's been a lot of people have more money and there's very little distress in the homeownership market right now. Most homeowners are in good shape, they locked in at low rates, they're sitting pretty. Why are they going to sell? Their mortgages are affordable. They aren't paying 8%, you know, they're paying 3 and 4%. So you have this kind of unique dynamic where homeowners are fine for now, you know, and hopefully that remains the case. But they're not incentivized to sell in many cases unless they have to.

Yeah, they're protecting part of their asset which is the mortgage.

Yeah.

You know, 25% of the country has a mortgage add or below 3%, 65% of the country has a mortgage Add or below 4% and 42% of the country has no mortgage at all. How do you get distress out of that? Like, I just don't see it happening. I mean, even if we see unemployment spike quite a bit, these people, number one, they could probably afford their mortgage with much lower income than they have now. And if they couldn't, I think they would still just beg borrower, steal to protect that mortgage and take on a roommate Airbnb their house. Now that market's in distress too, but you know, it's still there. Right? They would just do whatever they could to make it work somehow.

Yeah. And also too, it's, it's, you know, we learned a lot of lessons from the, from the GFC period. Obviously it's like we don't see the same issue with arms. And ironically that's more of an issue now in not all of it, but some niche of commercial real estate, the equivalent of that with short term floating rate debt. But it's really not an issue in the single family market this time around. It's not like everyone's resetting to higher rates. And so, you know, I think again, barring some big shock, I mean, I think we're in pretty good shape. And even a big increase in unemployment. We were at double digit unemployment in 2020 and still didn't see the crash that people expected to see.

Yeah, well you know, people are going to take issue with that. They're going to say, well they put moratoriums, you know, all that kind of stuff.

But even that I'd be curious to look at the number. And the stimulus money helped too. Don't be wrong. But you know, again the point being is is unless you have a sustained shock, I think we'll be able to weather through. And I guess the other part of that too is most of these, you know, banks are now set up to work with consumers much more than they did in 2008.

I agree. Yeah. So they're going to do workouts, loan mods and I think they're going to be more inclined to this time not only because they're set up for it and they're mentally prepared for it, but also because you know, they're simply going to see that that borrower has a good chance of making that loan perform if it becomes a non performing loan. Which now there's like almost none of those in the entire country. So yeah, pretty much the only part.

Of real estate seeing nonperforming loans is the office sector. So. But most real estate is, and obviously residential is in good shape.

Yeah. So the office sector is seeing that. And you know retail's been under a lot of pressure for quite a while with the amazonification of the retail apocalypse. But how about the apartment market though? I'm hearing some pretty decent amount of stress with a lot of apartment syndicators being willing to sell general partnership shares just to get funding. They took short term bridge loans, kind of expected appreciation. What are you seeing there?

Yeah, well it's interesting because I think what's going to happen if it's first of all it's not really showing up yet, meaning that like distress is not really bubbling up. Bank loans are getting paid, you know also, you know, Fannie Freddie life insurance companies like there's no sign yet of non performance other than a handful of deals that have been national news.

And yeah, there was a big foreclosure in Texas, I Think in Houston. 430 units.

Yeah, big one one in San Francisco and then there was one for a portfolio based in New York. Had the assets and all over the place but you know it's, it's very limited. In fact MSCI RealCap analytics had a report recently showing that distressed sales on a trailing twelve month basis are actually down. It's just the ones that are, are making a lot of noise now that being said, here's what happened so most of those, the peak was 2021, early 22 pricing rates. And so deals that happened then using short term floating rate debt and with value add plans. So the equivalent basically if you're not familiar those listening, not familiar with multifamily, the value add short term players are kind of like flippers in the single family market. They buy a house, fix it up and sell it at a higher price or in this or they refinance and cash out of it. So what's happened is that you're going to see some of these syndication groups especially who bought at those peak prices and aren't able to do the value add work and also too are going to struggle at the higher rate when the two or three year term starts to mature and so or the rate cap expires. And so that timing really gets us to second half of this year and into next year we will see more of that. But you know, I've sliced this day a lot of different ways. I mean you're looking at, you know, a lot of this is, you know, CMBS or CDOs and that's, that's a single digit percentage of the market. You know, most Fannie and Freddie loans, that's half the market for multifamily and most of those are long term mortgages that with very few maturing on the next couple of years. And so by and large the market's in strong shape. But there's going to be a lot of noise coming from a small segment of the market.

Do you see a lot more distress in the multifamily market or pretty well.

There'S going to be some second half this year, next year. But again it's not going to be systematic. There's going to be pockets of distress among some segment of the market that bought at peak prices with short term floating rate debt. But again we're looking at a single digit, it's a relatively small piece of the market. And furthermore, I'll tell you what, there's a lot of what's so called rescue capital lining up for these deals. And so a lot of that's going to get worked out behind the scenes with preferred equity and mezz loans and may never even, you know, you never even see it officially default. So there's going to be some of that. But you look at the overall health, you know, the balance of multifamily debt in our country, it's just again it's just there's not enough of it maturing next couple of years to be a systematic Problem, barring a much bigger shock.

Yeah, yeah, that's a good point. And we still have a housing shortage regardless, you know, even with a big supply of new multifamily hitting the market, you know, over I guess the past year or so, we've certainly all witnessed them being built in every city in America. So, you know, but, but that'll get absorbed. I mean, how bad are those vacancies for the multifamily landlords?

I mean, we're, it's, it's so bad that we're back to normal, you know.

It'S so bad that we're back to normal. I love it. That's a great.

We were at 2 and a half percent vacancy this time, you know, basically this time a year ago, and now we're at five and a half percent vacancy, you know, and even the great thing about, about having a real estate or a rental housing portfolio, whether you own single family, assuming you have a bunch of them, or multifamily, is like you always have cash flow. It's not like office or retail where you have one company move out, you're at zero, you know, sometimes or 20. Right. You know, a bad apartment complex can be 90% occupied. And so, you know, I think it's really important to point out is again, barring a big shock, the issue for multifamily, even for the syndicares you mentioned, it's not occupancy and rents. Like everyone has some tolerance built in there to see, you know, some movement. Even rents can go negative. But the issue is entirely related to the expense side of the ledger and especially the cost of debt. And so that's why those with short interface shorting short term debt are facing some challenges. And especially in places like Florida where the cost of insurance is doubled or tripled as well. And that adds another layer of challenge to the expense side, Right?

Yeah, it's definitely an issue. But you know, overall those expenses pass through to tenants because there's just no supply if the landlords can't pass it through. And that's ultimately what happens. The thing that hurts though is that two year adjustment period. There's always an adjustment period in every market and every type of market and every asset. And that's the part that really gets people.

And you can't pass it all down at the same time. Yeah, again, especially for those that are in that situation I mentioned earlier, is if you are seeing increased vacancies, you can't pass all that down to the resident in a one year period.

Oh, of course not.

Yeah, it's going to be challenging for pockets of the market in the short term, but I think again, long term we need more supply. So it'll be. The demand will be there.

That's the nice thing. At least every investor knows that we need more supply. And if you have supply, the world is somehow going to want to rent it from you. So. Or buy it from you. So. So that's good. You mentioned, of course, the office market is in major distress. Covid just changed the game as far as office and hybrid work schedules or completely remote work and so forth and the move away from cities to suburbia. What do you think about the reuse? I watch a lot of YouTube channels about the reuse of shopping malls, converting them to housing, converting office buildings to housing. These conversions are expensive. I mean, I even wonder if they're practical at all or it's just better to start over from scratch. But do you think we're going to see a significant supply of residential units come from conversions of offices, shopping malls? Anything else?

Well, I very. I wish I can say yes because I think it's. Those projects are always so cool. It's such a great adaptive reuse is such a great concept for many, many reasons. But unfortunately, as you allude to, it's just not practical. And these deals are expensive. Conversions are oftentimes more expensive than just starting, demolishing, starting new. But also too, a lot of these buildings, especially office buildings, are not. The building plates are not conducive to residential meaning like they're so deep that you can't build, you know, apartments or residential units. Inside these places you have really long, awkward floor plans with a lot of windowless bedrooms and no plumbing. Yeah, you have to redo all building, plumbing, electrical, all that kind of stuff. So it's a lot of drilling through concrete and building in new things. So it's just not easy. And the ones that do happen tends to have, you know, usually like a lot of times they're so everyone pictures these in their minds. But the cool ones that we've all seen are usually associated with some sort of historic building tax credit. And you know, again, there's only so many deals that really going to fit that profile. So we'll see more of it. But it's not going to move the needle in terms of overall housing stock.

Unfortunately it's not going to solve the shortage problem. And is anything else a disruptive technology like 3D printed houses? I know the answer. It's not. But you know, I'm just curious.

No, it's not. But I will say like I think the answer is more the all the above as opposed to you know, one thing I will say it's like you know, Greystar recently the biggest property manager the country they're, they're working on, they have now built a factory to build modular apartments. And you know, I mean it's great. I think the more we try different things and try to combat the cost of construction for new housing is worth trying. So I'm hoping that we can come up with some different ways that collectively help move the needle.

Yeah, that's a good point. It's not one thing, it's a whole bunch of things. Doing this, that and the other thing, you know, it's great having you on Jay. What else do you want people to know? What do you want to share as we wrap it up?

Well, I guess the one last thing I would share is that as you introduced me and I'm a big believer that rental housing is essential. It's important, it's misunderstood and I think especially now and you know all the so called as you mentioned like the crash pros and the housing bubble people and you starting to hear the same thing now for the apartment stock people. Everyone's excited to watch a crash of some sort. But at the long term as you alluded to, you said it several times is we still need housing. And I think that for housing investors, especially if you have the ability to be longer term investors and you're not as sensitive to what happens in the next year or two, given all the noise in the economy and whatnot, then you're going to be fine by and large for the most part. And housing is essential and I think Covid remind us of that. You could work from anywhere, you can shop from anywhere but you can order food from anywhere. But at the end of the day need a place to live and I think that's a big tailwind for housing.

Of all types and that place to live has actually become more important if it becomes your place to work too.

Yeah.

So it's like doubly important now. So. Yeah, yeah. Very interesting points, Jay. Give out your website or Twitter or whatever you want.

Yeah, well you could find me on Twitter just a Parsons and Also I'm on LinkedIn. I post there a lot and our website is realpage.com analytics, the blog there. Our team posts a lot of articles there as well.

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