In this podcast, Motley Fool analyst Matt Argersinger and host Deidre Woollard discuss:
- The current situation for home sales and what could change it.
- Why homebuilders are in a good position right now.
- If renting will become permanent for more Americans and which companies might benefit.
To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
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This video was recorded on Sep. 02, 2023
Matt Argersinger: You don’t want to let go of that mortgage and you can’t blame people for that. It’s an amazing thing that’s happened, and it’s just perpetuated this massive supply demand imbalance that we’ve been dealing with for, like you mentioned, over a decade or since the global financial crisis. But homebuilders are filling the vacuum. So while there’s no activity happening on the existing home sales side, they are coming in and building new homes. Here’s a situation where it is possible to sell home.
Deidre Woollard: I’m Deidre Woollard, and that’s Matt Argersinger, Motley Fool analyst, and my fellow housing nerd. There are two things we know about the current housing market. Mortgage rates are high and inventory is low. That’s bad news if you’re looking to buy. But there are opportunities if you are an investor. Matt and I talked about whether or not we’re going to become a nation of renters. How homebuilders are making hay while the sun shines, and where to invest in the future of housing.
Every month, I look at the National Association of Realtors existing-home data and I worry because it’s a down year for sales. It’s down 17% in July. But the number I watch is inventory, which they measured by month supplies. Normal month supply equal buyers and sellers, six-months supply. We haven’t had a normal market, I think, since the great financial crisis. We’re at 3.3 months based on the July numbers. What does this mean for the market though?
Matt Argersinger: Well, first of all, Deidre, thanks so much for having me. It’s always a pleasure to get together with you and talk real estate. I think they’re really low inventory means it’s just highly unlikely we’re going to get any meaningful drop in home prices. I think that’s unfortunately, well, a lot of people, including a lot of would be homebuyers have been waiting for it, but it’s just hard to see that happening when there’s such limited inventory. As you mentioned, we’ve been dealing with this situation for well over a decade now.
What’s remarkable to me is that we’re in a situation now where 30-year mortgage rates are above 7%. You have to go back to the late ’90s for mortgage rates to be at this level. If you had told someone five-years ago that mortgage rates are going to rise more than four percentage points, we’d go through this pandemic, this downturn, everyone I think in the world would have said, well, the home prices are probably going to fall, but they haven’t, they’ve held up and it’s because of this low inventory situation. It’s just become really, really hard. If you’re a first-time home buyer.
Bill McBride, I think who you know, he writes the Calculated Risk blog, post grade data on housing market and he’s written about the effect that this rise in rates has had on the cost of finance the purchase of a home. If you use July 2021, going back to a little over two years ago, the payment on a $500,000 house with a 20% downpayment and a mortgage rate of around 3% would have been about 1,700 a month principal and interest. That same monthly payment for the same $500,000 house, with house prices up 20% over the last two years, and mortgage rates now at around 7%, it’s a $3,200 monthly payment. That’s an increase of 87%. Yes, it’s a double whammy if you’re trying to finance a home. Think about what it’s like right now to be a person you’re in your late ’20s or maybe early to mid thirty’s, you’re looking to buy home, you probably don’t have a ton of savings for down-payment. You might have a student loan that you have to start repaying pretty soon. Your rent is high, and I know we’ll talk about rents in a bit. You probably have a car payment, and now just when you think home prices might finally be reversing, mortgage rates are through the roof and there’s still no inventory out there to buy, Deidre. Wow, tough going.
Deidre Woollard: There was talk about home prices are going to drop, and they did for maybe a month or so.
Matt Argersinger: A little bit in certain markets.
Deidre Woollard: A little bit but nothing like what some people were hoping for. The reason for that, and this is a stat that is stuck in my head lately is 91% of people with a mortgage have a mortgage that is under 5%. Nobody wants to move. Everyone I talked to with the mortgage says they’re not leaving and it doesn’t look like that’s going to change. The mortgage rates aren’t going to shift to for what, maybe a year maybe two. We can count that out. Then I’m thinking about who or what is going to pick up the slack. I think a lot about homebuilders, they aren’t quite building as much as we’d like to see. But the homebuilder stocks, it went from last year being not a great time to own homebuilder stocks to this year being a much better time. What’s happening here?
Matt Argersinger: Yes, the homebuilders are definitely filling a vacuum. But before we talk of homebuilders, I just have to say that stat that you brought up about 91% of people having a mortgage that’s under 5%, it’s such a paradox if you think about it, because we have a situation where the Fed has raised the Fed funds rate what is a dozen times now over the past 16 months. The whole idea was to try to slow the economy a little bit, slow down the pace of home prices and rents. But it’s had the effect of locking in people, as you mentioned, to their homes, so there’s really no existing sales transactions or velocity in the market. You can’t blame people. If you’re sitting on a 30-year fixed mortgage right now of say 3%, even if you wanted to move, even if you saw a house since you want it out in the market that fits your life better, it might be bigger or in a different location, you don’t want to let go of that mortgage and you can’t blame people for that. It’s an amazing thing that’s happened. It’s just perpetuated this massive supply demand imbalance that we’ve been dealing with for, like you mentioned, over a decade or since the global financial crisis. But homebuilders are filling the vacuum. While there’s no activity happening on the existing home sales side, they are coming in and building new homes. Here’s a situation where it is possible to sell homes because there can be different financing fee the homebuilders, or they’re able to discount certain parts of their inventory to meet demand. They’re doing gangbusters right now. If you look at their margins, for example, the homebuilders are putting up the best gross margins, best net income margins they’ve ever done in their history. For them, it’s almost a perfect situation because they’re really the only game in town. There’s no activity on the existing home side, they can build houses, build-to-suit, and also build to rent, which I know we’re going to talk about. There’s just a lot of avenues for them right now to fill this big hole in the market that’s not being filled by the existing home side.
Deidre Woollard: Yeah. Usually homebuilders, new homes is about 10% of total homes for sale. It’s now around 30% depending on the market, which is just this massive shift.
Matt Argersinger: Total game changer.
Deidre Woollard: We don’t have that. Well, and I’ve been hearing from the homebuilders listening to some of their earnings calls, cancellation rates are going down and the homebuilders are trying to be strategic here and trying to be a little cautious. But I was listening to the call for Toll Brothers recently and they play at the higher end of the new home market. One of the things the CEO talked about was wealth transfer. They’re seeing first-time homebuyers getting down payments from their parents. I’m thinking about these baby boomers, the ones who have that massive amount of equity in their homes, I wonder if they’re not going to transfer the homes to the children because the children they don’t want the older homes and they don’t want homes in certain areas. Will they sell those homes eventually to fund the down payment for the children? I’m wondering if we’re going to see the wealth transfer turned into a location transfer.
Matt Argersinger: Before you had mentioned this before the show, it’s not something that I had thought a lot about or seen but it makes a ton of sense. We should do a whole show at some point on just the overall massive amounts of wealth transfer that’s happening now between baby boomers and generation-X. Since baby boomers, millennials are eventually generation X, the millennials. But there is just a massive amount of equity and that’s because who has the equity in this country of ours and it’s the older professional established population.
Matt Argersinger: Those people that have those lucky 3% mortgage rates and who have lots of savings. By the way, this is a little bit of a tangent, but bear with me talking about wealth transfer. Think about what happened with rates going up to the Fed funds rate going up to 5.5%. Now they can invest in a 5% CD or get a 5% high-yield savings account, 5% money market account via their broker maybe who has that amount of money to take advantage of that. People with savings, generally the older populations, and that itself is a massive wealth transfer. The first time in over a decade that people actually are earning interests on their savings and people who have these savings are doing really well. So again, all the wealth is held up here on the Boomer class or the older generations and I see a ton of opportunity for that. Equity be transferred down not just from parents to children, but a lot of cases, grandparents to children or grandchildren. The equity is there so why not do that and enable your son and daughter to actually invest in home when they otherwise probably couldn’t.
Deidre Woollard: So if you’re trying to decide between the various home-builders, I know you and I are both fans of NVR, but and you mentioned margins earlier. What else are you looking at and are there any other home-builders on your radar?
Matt Argersinger: Just one more thing on margins, I would say that’s the one way I like to look at homebuilders. What gross margins that are getting that clues Eunice as to how well they’re managing their inventories over time. Then you can look at their net margins as well, make sure those are consistent over time and companies like NVR or Toll brothers have done a fantastic job. The cautionary tale there though is that their margins have never been better right now. So there is a time when those margins are going to come down but what you want to look at is, how stable can they be? How far would they fall and you want to make sure those are staying high if you’re investing homebuilders. I’d also just look at the total return track record for a lot of these companies. Homebuilding is very much a capital allocation business. In other words deciding what land to buy or what land to option, when to build homes, when to then take cashflows and either buy more land or return value to shareholders, whether that’s buybacks or dividends. Of course, you and I know NVR has done an incredible job of add the track record for the shareholders has been just astounding. Toll Brothers is also another one, KB Homes, I think, has a pretty good track record and so, six to the ones that have delivered value to shareholders over time and you’ll probably do well.
Deidre Woollard: I think that the thing with margins that I also think about is you and I have talked before about the three hours. The land, lumber, and lumber. The lumber part has been pretty good for a while, but I don’t expect that that’s going to last.
Matt Argersinger: No.
Deidre Woollard: It’s a factor as well.
Matt Argersinger: Commodity costs or can jump around, but you’re right. But the labor one has been the sticky one, and it’s not just the cost of labor, but it’s the availability of labor that has really been. It hasn’t affected the homebuilders so much in terms of their businesses right now but is it being in other parts of the economy?
Deidre Woollard: Well, let’s switch to the other side of thinking about mortgages. Not everybody can buy a home, not everybody wants to own a home. It’s interesting because the homeownership rate has stayed pretty steady. It’s been between 60 and 65% for decades. But I’m wondering, is renting going to shift as renting going to become more attractive over time?
Matt Argersinger: I loved it, lower to know what you think about this as well. I think it almost has to. First for some of the reasons we’ve already talked about, which is home-buying right now is so cost-prohibitive, especially if you’re in that late ’20s, early to mid ’30s. Generally, the first time people tend to buy a home at those ages. It’s so hard to do at the moment with a low inventory, high mortgage rates. But I also think there’s just other things going on, especially since the pandemic, I think people are more mobile than ever. Remote work flexibility is enabling that to a certain extent and I know we’ve seen companies try to claw that back a little bit, but I think the dice has been cast and a lot of ways with a lot of corporations and businesses where at the very least employees have more flexibility today than never had, especially white-collar employees. I also get the sense that with younger generations there’s less of a need to put down roots and the town the grew up into the city that they’ve lived in the past. I just think people are chasing opportunities and we’re willing to go different places not having so much stuff. Maybe that’s another topic which I think people just desire less things, which is also keeps them mobile. So for those reasons, I think renting, I feel like that proportion has to change. I feel like we might get to a situation. We won’t go as far as Europe where I know countries like Germany, you look at the home-owning populations like 20% and the renting populations is 80%. It’s a total flip of what we have in United States, but I do think the trend toward renting will go higher. What do you what do you think?
Deidre Woollard: It’s a maybe for me, I think we’re absolutely already seeing it more on the coastal markets but I think in the middle of the country you still see more people that are buying at what would be more traditional age. So I think we’re going to see really two trends shaking out. But the other part of this that you and I have been following too is the single-family rentals. Because if you’re in a single-family rental, you tend to stay in that rental so much longer than an apartment. So for some people, they get into that house and they just stay and I think that they don’t necessarily think about the monetary aspect as long as their rent remains relatively stable.
Matt Argersinger: Yes. I think that the single-family rental it’s almost a perfect environment [laughs] for single-family rentals because you mentioned the low turnover rate, that’s a big part of it because if you think about once a family moves into a house, two parents and two kids, you’re renting, but it’s harder to move, especially if kids are going to school and it’s the largest space, you have your furniture for all those reasons. But I also think it’s because of this lock-in effect that we’ve talked about that’s keeping so much of the existing home inventory away from what would be home homebuyers. That’s creating this environment where people want a larger space. Again, especially since COVID. People want the yard. They want the separate home office. They want the no shared walls, no shared ceilings and that makes single-family homes much more appealing than say, your average apartment, condo, or town home. At the same time, they want the flexibility of an annual lease.
Matt Argersinger: They don’t want to worry about maintenance. They want a far more affordable monthly payment. I just feel like it’s just as perfect backdrop for the single-family rental industry. Here’s a stat that’s always jumps out to me. If you look at data from John Burns, the housing research firm, it’s cheaper to rent. one of Invitation Homes. Invitation Homes is one of the larger single-family rental SFR rates out there. They own and operate over 80,000 homes. It’s cheaper to rent one of Invitations Homes than buy a home in all 16 of the company’s markets that the operated by an average of $900 or 30% per month. The average rent of an Invitation Homes single-family rental is paying $900 less than it otherwise would buying a home in those markets. That is a huge value proposition. I mean, that’s over $10,000 a year in savings by renting instead of buying, and you don’t have to deal with the same responsibilities you have is a homeowner to taxes and maintenance and all those other things.
Deidre Woollard: Yeah. I think the ease of living is definitely higher. Now, you mentioned invitation. There’s a Tricon Residential, there’s American Homes 4 Rent, those are all in the single-family side. You’ve got multi-family as Mid-America Apartments, MAA and AvalonBay. Are you thinking about multi-family different from single-family in terms of the investment potential.
Matt Argersinger: Right now I am. I think the tailwinds are much more favorable for the SFR versus the traditional multi-family. But that isn’t to say a multi family is experiencing weakness. They’re not. I mean, it’s just I think the near-term picture is a bit cloudier. There’s a lot of supply coming into the market on the multi-family side. There was recent data from the St. Louis Fed FRED database, which really has some great data on the housing market. New apartment units that are currently under construction are at the highest level. They’ve been going back to the early ’70s. Gosh, more than 50 years. There’s just a ton of supply of new apartments coming online over the next six to 18 months, especially in a lot of those hot markets. I think your Sunbelt, your Texas or Florida, maybe Arizona. I think that’s going to put pressure on rents. You’re already seeing that even Mid-America and AvalonBay, the two you mentioned that there’s still generating rent growth on new and renewal leases, but it’s in the low single-digits coming way off the double-digit growth that they were seeing in 2021 and 2022. It’s flattening out. It’s not a dire situation at all. In fact, I think MAA in particular looks really compelling from an investment standpoint right now. But I do think as in the near-term, you might do better with the SFR side looking at Invitation Homes or American Homes 4 Rent. I just think the momentum there is so much stronger. The rent that those companies are putting up are still in the high single digit in terms of growth.
Deidre Woollard: What do you think about location? You and I have been following the Sunbelt trend for like four or five years now. There is that little bit of overbuilding in Austin and in Dallas, certainly on the multi-family side and certainly on the office side, but that’s another story. Is the Sunbelt thesis is it still strong? Is it maybe shifting a little bit?
Matt Argersinger: I think shifting might be the right verb to use. I mean, it was so strong and it was always bound to face a slowdown, and now it’s a situation where there has been some amount of overbuilding. Like I mentioned, all the new supply that’s coming available now. I do think you’re going to see rents probably flatten out even decline a little bit. You might see landlords have to put larger discounts or offer months of free rent. But gosh, in the long run, it’s still the place you want to be. It’s still where the population is trending, where the demographics are strongest, where corporations are tending to move people and to set up shop. I think it’s still the place you want to invest. But I would say the traditional markets that we poo-pooed [laughs] for the last five-years as well, your New York’s, your San Francisco’s, Chicago’s, Washington DC, there wasn’t just a ton of overbuilding and rents didn’t really go crazy, and yet now you’re seeing New York city’s having a nice bounce back. I know San Francisco still has some challenges. Boston is seeing loss strength Philadelphia. It never got too hot and it’s never got too cold in those markets. Those are areas to where I think Multifamily is going to hold up pretty well. It’s just not going be as volatile as it is in Sunbelt. But I think, long run, some part of the country is where you want to be.
Deidre Woollard: Well, we’re talking about the single-family rentals, but I want to talk a little bit used mentioned earlier, build-to-rent because that’s the idea of building at times whole communities of single-family and town home for rent rather than sale. It’s hard to figure out because it’s this emerging class within housing. It’s started during the pandemic when the homebuilders couldn’t sell and then they sold a whole communities off. Now it’s becoming more purpose-built. You mentioned zoning earlier. I’m seeing already some moratoriums on build-to-rent. Some towns are starting to notice this because for a town it’s one thing to have a community come in, and there’s the concerns about that. But when it’s a rental community, it seems like there’s an additional concern which I feel like it’s a stigma against renters, which I don’t like. But how can investors think about build-rent? I haven’t seen like a pure play. I know some of the homebuilders are doing it. What do you think about build-to-rent as it starts to grow?
Matt Argersinger: Again, we’ve talked about so many trends that feels so undeniable on this show, and I think build-to-rent is another one where it was always done in a very small scale, but here we are, it’s at a point now where, like you mentioned there’s these whole communities now that are being built that are purely designed for rent or the rental market. That’s creating some obvious concerns from communities where maybe there’s preponderance of homeowners and all of a sudden now you’re introducing another subset of the population that is maybe there for different economic reasons. But I think it’s an undeniable trend and I think there aren’t any pure ways to play it. But one way is the SFRs, the invitation homes of the world because they are in a way the customer for a lot of the build-to-rent. They’re making big moves. Invitation homes just recently in July, bought a huge 1,900 home portfolio. I think a lot of it came from a one of their build to rent partners. You’re seeing that happen and that’s just a way for them to really goose their inventory in one big slug. I want to say that Blackstone and Starwood are still involved in this quite a bit. Even a smaller company like Boston Omaha, which I think a lot of listeners might be familiar with. They’ve got their own build-to-rent vehicle as well. There are some ways to play it right now, not a really a direct way, but you can get a little bit of it indirectly through the homebuilders and the single-family rental rates.
Deidre Woollard: Well, to wrap up. We’ve talked about the current situation with inventory. We’ve talked about rentals and what we’re seeing there. Is anything going to make this shift over time other than, we know rates they’ll go down. Maybe inventory will loosen up. But is there anything if I’m investing in homebuilders which I am, add up investing in rates which I am. Is there anything I should be looking for?
Matt Argersinger: Well, this is going to be too simplistic, but I do think a change in the interest rate picture would have the most meaningful impact. In other words, when the Fed stops raising the rates or when the Fed starts cutting rates, I mean, that’s something that a lot of analysts are looking at, maybe toward the second half of 2024. I think if you’re a rate investor, a homebuilder investor, that’s going to be a pretty big catalyst. Because especially on the right side, rate valuations have just really been beaten down. A lot of it is because they’re locked into a situation where they have debt maturing over the next few years. Especially on the office side, which we don’t need to get into, but it’s a really mismatch between liabilities and leases right now. But overall, the whole housing picture, real estate picture is going to change dramatically, I think on rates because right now there’s this feeling like, well the Fed’s maybe stopped but could go one more, and maybe we’re at this new may five-and-a-half or 6% range on the Fed funds rate. That’s going to cause yields to go up probably again, but at some point it will flatten out. Then we get to a situation where if rates start coming down next year because inflation is tame and maybe we get a little bit of a slowdown in the economy, that would be a little bit of a game changer on the rate side and the housing side. I think that could affect, at least especially on these existing home side, which we’ve talked a lot about, that could help loosen that up a little bit finally. But we’ll have to see. It’s not something that’s going to happen over the next six months. It might be more of a second-half 2024 scenario.
Deidre Woollard: l have to have another conversation then. Thanks as always, for breaking this down with me.
Matt Argersinger: Absolutely, Deidre. Thanks so much for having me.
Deidre Woollard: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. I’m Deidre Woollard. Thanks for listening. We’ll see you tomorrow.