One Big Thing
Yesterday, I wrote about multifamily development getting more speculative because of uncertainty about cost inflation. Today, let’s take a look at the for sale housing market. If you want to get an insider’s view of housing, Bloomberg’s Odd Lots Podcast with Zonda’s Chief Economist Ali Wolf from earlier this week is about as good as it gets. There were two parts that really stood out to me:
- The discussion about how much relocation buyers are driving the market around the 15 minute mark.
- An absolute banger of a quote from an anonymous homebuilder employee about purchasing land at values that don’t make any sense in today’s market:
“You can do the deal now and get fired 2 years from now or you can pass and get fired now”
I can’t think of a better way to highlight the crossover between career risk and FOMO in an industry where participants are like sharks – they need to keep moving (by buying land) to survive.
All real estate development is speculative in nature. However, not all speculation is created equally. Its one thing to pay market value for land that pencils today (with reasonable assumptions) and assume that conditions over a 2-3 year development window will stay roughly the same or improve. Its very different to overpay for land and hope that market conditions improve substantially during the 2-3 year development window in order to be profitable.
The first type of speculation is healthy. The second is risky business. Why? because the developer in the second type is effectively giving the seller credit for an increase in value that may or may not happen in the future, substantially reducing his own profit (or downside cushion) in the process. The land seller has effectively captured the upside without having to take any development risk. Great deal for the seller. Not so much for the buyer.
There is enough inherent risk in real estate development without needing to make market directional bets in order to for projects to work. However, in a soaring market when FOMO meets career risk, things can quickly get crazy AF.
The Odd Lots quote reminds me of something that I’ve heard from homebuilders, who tend to be optimists by nature over the past few years: if cost inflation is underwritten correctly, land is worth a lot less than the value at which sellers are willing to transact. In other words, land is a finite resource and sellers typically decide when to transact (so long as they aren’t leveraged). Builders cease to be a going concern when they run out of supply (lots on which to build). As a result, overpaying for land is often the price of entry into a hot market. Homebuilding is such a lovely business.
What I’m Reading
Cutting Edge: Commercial real estate as in industry is notoriously slow to adopt technology. However, data analysis is getting close to hitting critical mass and those who don’t employ it to catch trends early will start falling behind. The American Reporter
Self Fulfilling: Private equity has a massive and still growing hoard of cash reserves targeting commercial real estate that’s yet to be deployed. Paradoxically, the larger this capital stash gets, the less of a chance that we will see any real distressed opportunities.
Even 2008-2010 was classified as an “opportunity-less recession” by some investors because commercial values didn’t fall nearly as much as they thought. However, we look back at that period as one that was brimming with opportunity (although it certainly didn’t feel that way at the time). I wonder how we will look at the COVID era in ten years. Commercial Observer
Round Trip: Foreign investor demand has helped push US investment grade bond spreads to an all time low versus Treasuries. Yes, our rates are low but in a place like Japan, where long rates are zero and short rates are negative, they look like a bargain so long as hedging costs are reasonable. Axios
Gone Like the Wind: Venture capital subsidized urban millennial staples like Uber, AirBnb, WeWork, Bird and MoviePass. Now those companies are either public (or bankrupt in the case of MoviePass) and need to achieve profitability and the adjustment is going to be painful. New York Times
Fire Hose: Debt funds continue to take share in the commercial real estate debt market as a tidal wave of liquidity seeks yield, compressing spreads. Globe Street
Chart of the Day
Follow up from yesterday’s chart. Note all of the big gateway markets clustered on the right and the booming Sunbelt on the left. Negative or flat growth in large markets like LA, SF, NYC, etc has largely kept a lid on national rent inflation stats over the past year but that is changing quickly.
Source: RealPage
WTF
Tunnel of Love: A couple was caught having sex in the crawling tunnel of a playground in broad daylight because Florida. (h/t Steve Sims) The Smoking Gun
If At First You Don’t Succeed: A woman who went missing for several weeks before being discovered naked in a storm drain has been rescued underground for a second time because Florida. Click Orlando
Basis Points – A candid look at the economy, real estate, and other things sometimes related.
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