“Housing Reset” Becoming Widespread

“Housing Reset” Becoming Widespread

The Fed’s plan—in the words of Chair Powell—to create a “housing reset” is working in more ways than many realize. While much has been written about declining home sales due to higher mortgage rates, much less has been written about declines throughout other areas of the housing industry. As we called out in our client webinar 4 months ago, the Fed is throwing the housing market “under the bus” in its attempt to rein in inflationary pressures.

Rising borrowing costs have driven many investors, including fix and flippers, out of the market.

For those of you that think flipping is a small part of the market, think again. For starters, the real estate investor website BiggerPockets has almost 1 million subscribers to their Youtube channel. Higher rates are hurting the fix-and-flip market from both ends by shrinking pool the pool of available home buyers as well as the pool of feasible home acquisitions. Our 2Q22 survey of fix-and-flip investors across the country, which was fielded in mid-July, revealed that 35% of flippers saw at least half of their deals fall through due to the rise in financing costs. These two comments we received from flippers succinctly sum up current market conditions:

  • Atlanta, GA flipper: “This is a much higher risk environment due to rising rates. Sellers still have not reset expectations from earlier this year, so acquisitions have essentially come to a halt.”
  • Charlotte, NC flipper: “Higher prices for purchases and rising interest rates are hurting our ability to acquire homes. We are seeing weaker after-repair-value (ARV) for flips and tighter profit margins.

Rising borrowing costs have also slowed the single-family rental market.

This is a theme that the SFR REITs echoed in their 2Q22 earnings commentary over the last few weeks, and was reiterated by attendees at two of John Burns’ recent capital markets presentations. As capital markets recalibrate, we will likely see a slower pace of acquisitions from all institutional investors. CEOs of two of the largest rental home companies say it best:

  • “Capital cost for us as well as for the individual homeowner has changed, and that’s got to get reflected in the marketplace. It’s getting there, but it’s not there yet.” American Homes for Rent (2Q22 Earnings Call)
  • “We don’t love where our cost of capital is today on our balance sheet. But we’ve done a nice job of building out our investment management business over the last couple of years, so we think that will lend itself to additional opportunities in the future.” Invitation Homes (2Q22 Earnings Call)

It isn’t just homebuilders who are feeling the pain of higher rates.

Top land brokers around the country told us in our most recent Land Survey that some homebuilders are dropping land deals or renegotiating terms and price to better reflect today’s market fundamentals, negatively impacting the current and future businesses of everyone involved in land and home development.

  • “We evaluate each land deal through our portfolio investment committee to determine the optimal financing vehicle by weighing cost of capital, duration, and underwriting assumptions to maximize our long-term risk-adjusted expected returns. Going forward, further expansion in our controlled share will be dependent on market dynamics as we are pleased with the current balanced mix of our portfolio.” Taylor Morrison (2Q22 Earnings Call)

Apartment operators feel the pain as well.

While rising mortgage rates create increased rental demand, rising interest costs have cut into their profits, causing asset buyers to pause and cap rates to rise as market uncertainty proliferates. John Burns recently met with a large apartment company who told him they would be selling most of their holdings at a loss these days, so they will continue holding.

  • “The transaction market has slowed down substantially given everything that’s going on with the Fed. The cost of capital has gone up for everyone, and for buyers that were using 60% to 80% leverage—that game has changed and their return on equities have gone down. We think that values have probably gone down anywhere from -10% to -15%.” Camden Property Trust (2Q22 Earnings Call)

Remodeling is also slowing as higher rates limit HELOCs (home equity lines of credit) and cash-out refis.

Customers taking out loans for large remodeling projects now face stricter lending criteria and may delay their projects until they save up cash or interest rates fall. Both our US Remodeling Index, in partnership with Qualified Remodeler, and our National Kitchen and Bath Index, in partnership with the National Kitchen and Bath Association, forecast slower times ahead.

  • “Residential remodeling is softening as consumers postpone upgrading their homes.” Mohawk Industries (2Q22 Earnings Call)

And we could go on and on, starting with the mortgage and real estate agent industries who have been announcing significant layoffs, and ending with home furnishings and other businesses that are impacted in a much less obvious way.

Rising rates hurt most housing industry businesses across the board, from rental homes to homeownership to every business involved in the home.

The extent of the impact on the broader economy remains to be seen, though the Fed’s reference to a “softish” landing for the economy suggests that there may be more pain on the way. What is clear, though, is that the boom times associated with cheap debt have come to an end.

Alex Thomas If you have any questions, please contact Alex at (408) 506-1828 or by email.
Devyn Bachman If you have any questions, please contact Devyn at (303) 956-9881 or by email.