What Inning Are We in? – Real Estate Fundamentals

If you’re not a baseball fan, that may be an odd question, but we’re really not talking about baseball here. Where is the real estate market in terms of innings? Is the real estate market on the warm up field? Is it in the 4th inning or in the 9th inning? This is probably one of the most persistent questions that I hear at real estate conferences.  We can make an educated prediction on the future of real estate if we look closely at the numbers and the trends. 

What inning are we in also depends on what game you are referring too. I believe we are in the late innings of the stock market. The election of President Trump may have extended the game into extra innings; however, real estate and the stock market do not tend to correlate. I suspect we are in the middle innings of the real estate cycle - maybe 5th inning - if I have to be specific. Let me explain why we are still solidly in a growth cycle for real estate. 

Massive undersupply of inventory: This goes to the basic supply and demand principle we all learn in Econ 101. If there is a lack of supply, there will be a steady growth to pricing equilibrium. The US has traditionally needed 1M to 1.2M new homes annually. This is to accommodate new birth rates and a net increase in immigration. But, for the last decade, we have failed to get anywhere close to those levels. Obviously, in 2007 through 2010 we had to absorb the oversupply from the previous housing bubble. However, as of last year we are still seeing US homebuilders being much more cautious with only 600,000 new homes sold in 2016. 

As you can see from the chart above the amount of new home sales has been below the 1M line for a long time, but home prices continue to push up. The increase in price mostly has to do with inflation but also higher cost to build and increased regulations and quality of builds. As a result of the new homes failing to relieve demand for housing, we also see historic rent price increases. 

Combining these factors into a tight credit market driven by the regulations of Dodd-Frank, you can understand why homebuilders are not interested in overextending themselves with too much inventory given the fact that it will be slow to sell with new higher price points and a limited number of qualified buyers.

The next factor attributing to a healthy growth cycle in housing is the fact that traditionally most homeowners need to sell their existing house to afford a new or larger home. But, with the historic rent price increases, a high number of these owners can rent out their current house for a positive cash flow which helps them afford a new/larger home. Of course, this benefits the individuals but it also prevents that home from entering the resell market. Owners holding onto homes for rentals are another significant factor in pushing down the housing supply to meet the demand needs. 

The final reason why I see us in a growth cycle is the upcoming deregulation of Dodd-Frank. Currently, it has passed the House and is gaining support in the Senate (I believe the banks will be able to buy this support). Deregulating Dodd-Frank will allow more homebuyers to qualify for loans and start to push up new home building purchases and positively increase the prices of the resell market. In short, I believe the deregulation of Dodd-Frank is a necessary evil to try and allow more builders to build houses, apartments, office and supply in general. But, like everything this also has some negative and most likely will be the lighting of the fuse to the next housing collapse as too many people get overextended and the market corrects in the opposite manner. 

In conclusion, I do not have a crystal ball to predict the future, but we are at historic lows of supply, and currently a very tight credit market. As a result, I don’t see the economic factors that would cause the real estate market to move downward. A potential risk to continued growth would be a sudden oversupply or systemic job loss. Love or hate President Trump, his policies appear to stimulate increased employment. This could only add to the support for the growth of real estate. 

Enjoy the Memorial Day weekend and be safe out there.