NMHC Recap, SFR Gridlock, & More

release edition [005]

read time [8 minutes]

Welcome to The Multifamily Download, a weekly newsletter where I provide institutional insights to help you build an exceptional career in Real Estate.

Today at a Glance:

FOMC: Fed Pauses, Finally
SFR: 'Lock In' = Gridlock
NMHC: Key Observations
Weekly Listen: Passive Pockets

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FOMC

The Federal Reserve Open Market Committee announced no change to the Fed Funds Rate (FFR) on Wednesday afternoon, and this came as no surprise to most.

As I wrote about two weeks ago, I believe the Fed made a mistake, and now they're paying the price for it.

The below excerpt from Wednesday's FOMC statement reads almost identically to the Fed's September 2024 statement, but the only difference is that the Fed cut by 0.50% in September.

"The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate."

Let's hope that the Fed can do it's part to help the U.S. avoid a stagflation economy.

SFR

The single family residential (SFR) market is currently experiencing gridlock.

Why? Because as estimated 80% of mortgagees have interest rates of 5% or lower.

For example, one of my best friends owns a house in Boise, Idaho with a 2.5% fixed 30-year mortgage. Rather than selling and buying a home here in Southern California, it's better economically to AirBnb the Boise home and rent where he lives in SoCal.

And I know he's not alone.

The unintended consequences of cheap debt: The 'lock in' effect.

Total U.S. single family home sales transactions in 2024 were the same as 1995, despite there being 70 million fewer people in 1995 than today.

This 'lock in' effect is not going away anytime soon, and it's stifling the SFR market.

The math to buy a single family home today simply doesn't make sense for most leveraged buyers relative to renting. As I've shared recently, the delta between median monthly rents and PITI is historically wide.

Additionally, there's a myth that the 'lock in' effect is being caused by large institutions that snapped up thousands of homes when rates were low.

The graph below shows that just 0.3% of homeowners are investors with greater than 1,000 properties as of July 2024.

So now what?

Well, now we wait.

As I've written about recently, recession indicators are going off despite what the Fed or mainstream media might be reporting. 'Higher for longer' is here to stay, and eventually things in the economy will begin to break.

Where, how bad, and when they break are largely a guessing game, but things eventually break in a 'higher for longer' economy that has become intoxicated with cheap debt and extreme asset bubbles.

Then, and only then, will the 'locked in' pool of mortgagees be willing to part ways with their historically low interest rates; when they can sell, buy more home, and maintain a relatively similar monthly payment.

As shown below, mortgage payments have shown a propensity to revert to the mean, and I'm not convinced that this time will be any different.

Until something breaks, single family home sales will generally continue to be muted on the average, while inventory will begin grow in select markets with tax and/or insurance issues, or those with higher supply at higher price points.

The graph below shows the results of Fannie Mae's housing survey from the Fall of 2024. A near-record 81% of respondents said that now is a bad time to buy a home.

The survey data is backed up by the dramatic rise in builder inventory, shown below.

The current level of inventory is the 5th highest level ever, and the long-term average monthly supply since 1964 is 6.0.

In aggregate, the current number of homes for sale by builders in the U.S. is the 2nd highest level ever, trailing only the GFC era of the mid-2000s.

Why does this matter?

Because SFR sales, like every good or service in capitalism, is based on supply and demand.

Rates and prices have both gone up due to the violent combination of feverish demand in 2021-2022 followed by artificially low supply in 2023-2024 (due to the 'lock in' effect).

Now, rates are still elevated and buyers are fed up (no pun intended) with this combination of higher rates and prices.

If rates continue to remain elevated, then prices will inevitably fall until an equilibrium is reached. It's just math.

For example, very few people will buy a home today with a monthly PITI of $10,000 when an equivalent home can be rented for $5,000.

Shown below, nearly one-third of all homeowners surveyed by Redfin say that they'll never sell their home.

This certainly doesn't bode well for eliminating the 'lock in' effect that I mentioned above.

Are we in a single family residential housing bubble?

Only time will tell, but the data certainly tells a story of inflated SFR values.

Look at the below home price-to-income ratio graphic. What stands out to you?

The national average is 4.7, and anything above 3.0 may create a scenario in which the monthly PITI exceeds the 36% front-end DTI ratio if we assume a 20% down payment and a 30-year fixed mortgage at 7.00%.

Until rates or prices come down, would-be home buyers will continue to rent where they live.

For prospective buyers, the unfortunate reality of SFR properties compared to Multifamily is that SFR loans are coterminous, which means that the loan's amortization schedule and term are matched such that the final payment of the term takes the principal balance down to $0 owed.

This means that home owners will never be forced to refinance, recapitalize, or sell at the wrong time if they can financially avoid having to do so.

By comparison, commercial Multifamily loans balloon, forcing an owner to refinance, recapitalize, or sell over a shorter period of time, and in many cases, at inopportune times like today when rates are materially higher than they were just a few years ago.

In summary, the SFR market gridlock will remain until either interest rates / prices retrace to levels that align with affordability, or once real wages catch up to the current prices and rates that can make purchasing a home economically justifiable.

The 'lock in' effect, if it continues over the mid-term (2-3 years), should bode well for Multifamily and Build-to-rent (BTR) properties across high-demand markets with diminishing supply and relatively inflated home prices where PITI is 2x or more than an equivalent housing unit's rent.

NMHC

The largest annual Multifamily conference was held this past week in Las Vegas, and it was a good one.

Below are more details about the six key observations that I shared on LinkedIn after my 25+ meetings and conversations. I hope you find them helpful, and I would certainly enjoy hearing your NMHC key observations or takeaways.

1. Brokers are optimistic again

Real Estate brokerage is tough, and it's impossible to be successful without a healthy dose of optimism. That said, the brokers that showed up this week were enthusiastically optimistic for a few reasons: (a) They 'survived until 2025', which a lot of their competition cannot say. This means more market share for the survivors. (b) "How much worse can it get?" 2023 and 2024 were both significantly lower sales volume years than recent historical averages. Many are betting on a rebound year. (c) Technology is enabling the best brokers to be even better. Opportunity cost is expensive in brokerage. It feels like brokers that lean into AI and other technologies will grow their market share and production in the near future.

2. Sponsors are cautiously optimistic

The days of buying widely-marketed deals and generating 50%+ IRRs are over. The toxic combination of cheap debt, yield-starved equity, and inflation created the perfect storm of rent growth and easy wins for Sponsors that sold assets in 2021-2022. Unfortunately, many of these Sponsors didn't realize that their success was not a product of their own doing (see: attribution bias), so they learned the wrong lesson and have now become victims of their own success because it's always easiest to do more of what has previously been rewarded.

But great investors don't do what's easy -- they do what's necessary. Sponsors that are prepared to grow in 2025 and beyond must be extremely disciplined: Capital Markets are volatile, equity is gun shy or skittish, and business plans are largely reliant on the return of rent growth. (footnote: please be weary of Sponsors that continue to acquire assets using just one primary investment strategy in a market landscape that has shifted dramatically over the past 24 months).

3. Equity groups are itching to deploy capital

Two words that we've all heard plenty of times the past few years: 'Dry powder'. The uncomfortable reality of the Real Estate business is that people get paid when deals get done. This means that when deals don't get done, people don't get paid, and job losses begin to occur.

After record levels of Equity capital were raised, many investors have mandates to deploy capital in 2025 and 2026 before their investment period comes to an end and they have to return the capital or negotiate an extension with inferior economics. With this in mind, it feels like Equity investors will be aggressively seeking to deploy capital this year.

As an example, I spoke to an institutional Fund manager that has a current value-add IRR target of 16% gross and 14% net. This is a material adjustment from the 18% gross and 16% net target of many over the past 12 to 18 months.

4. Are we there yet?

Price discovery and distress were top of mind for everyone in attendance. Everyone that I spoke to realizes that 2022 peak pricing in markets delivering high-supply (Phoenix, Austin, etc.) will retrace to new price levels, but those exact prices remain to be seen en masse.

If there's a sampling of sales at reset pricing levels (aka 50% of 2022 peak prices), will the market's expectations be reset for that specific vintage or location? If so, how will the market respond? Will sale velocity increase as values race to the bottom?

5. Buying Real Estate is Local & Hyper Local

Economies change. Presidents change. Trends change. Employers change. Legislation changes. Location doesn't. Yes, economic growth can occur in a property's immediate surrounding areas, but hope is not a strategy.

The investors and Sponsors that are getting burned the worst today purchased assets in tough locations with a challenging resident demographic and elevated crime levels.

Successful investing is about making sound and strategic one-time, irreversible decisions: "Where do I buy? What price do I pay? How much leverage do I use? What is my CapEx budget?". Answer these questions correctly and it's tough to lose money when investing in Multifamily real estate.

6. Brand + Relationships = Deal Flow

The best known professionals will win in 2025. While Commercial Real Estate has historically been an industry that's resistant to change, there are an increasing number of high-level executives that are leaning into their personal brand. Jon Grey of Blackstone, Jay Parsons of Madera Residential, John Drachman of Waterford, Brandon Sedloff of Juniper Square, myself, and countless others are leveraging organic Social Media to reach more people, cultivate deeper trust, and build a stronger personal brand.

For example, I received a call today from a broker that I've spoken to a handful of times but have never met in person. His first question, because he follows me on LinkedIn, was "How was NMHC?". Then, the second half of our conversation was spent discussing four off-market deals that he brought to me first before calling anyone else.

I share this story to drive home the following point: Building a personal brand matters today, and it will matter even more tomorrow.

LinkedIn Posts About NMHC

NMHC Recap: Tuesday

NMHC Recap: Wednesday

(left) Carl Whitaker, Chief Economist at RealPage, myself, and Greg Willet, Chief Economist at LeaseLock

Weekly Listen

This week's listen is Passive Pockets Episode 205 featuring Jay Parsons with co-hosts Paul Shannon and Jim Pfeifer.

Jay is an exceptional housing economist, and in this podcast he discusses several topics including Multifamily's surprising demand, the potential for upcoming distress, changes in supply, policy, and interest rates, as well as the return of risk-adjusted returns, and more.

This is an excellent episode to listen to on the heels of NMHC.

You can listen to the full episode here.