The housing market has been red hot, with surging prices and bidding wars as far as the eye can see. But now mortgage rates are hitting 5%. So will that slow things down? On this episode of the Odd Lots podcast, we speak with Conor Sen, a Bloomberg Opinion contributor and the founder of Peachtree Creek Investments as well as Dustin Jalbert a senior economist at Fastmarkets, with a specialty in the lumber market. We examine housing from both the macro perspective as well as the supply chain. Transcripts have been lightly edited for clarity.
Points of interest in the the pod:
What 5% mortgage rates mean for affordability — 5:47
Is there any good news on the supply chain front? — 7:10
The difference between this housing boom and the last one — 12:58
Demographics and pent up demand — 14:28
How many more homes do we need to build? — 25:00
In defense of Baby Boomer homeowners — 31:00
Where we’re seeing shortages and supply chain stress — 42:00
Joe Weisenthal: (01:10)
Hello, and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway: (01:16)
And I'm Tracy Alloway.
Joe: (01:17)
So Tracy, you bought a house recently. That's kind of like winning the lottery in this economy.
Tracy: (01:22)
I know. Well, okay. So first of all, we put in three offers for different houses and we got gazumped on all of them. We got outbid. And then finally we found a house that we really liked and it happened to be a probate sale. So the owner had actually died and it was going through, you know, this probate process. So no one else wanted it, because no one else wanted to deal with that. So we actually got that house and it's been really amazing.
Joe: (01:47)
It's kind of like an odd lots of housing, right? I mean like a literal, like here's like this asset that didn't go through, it’s not the normal thing. And you have to like put it a little extra work to move it. And you took advantage of that.
Tracy: (01:57)
That's right. We did our due diligence and we were very patient at a time when a lot of people kind kind of are worried about losing out.
Joe: (02:05)
No, it really has been an extraordinary, I mean the last two years have been extraordinary for all kinds of reasons, [but] particularly with housing, we've done a handful of housing episodes before, but it feels like maybe we're at some sort of turning point because rates have just seen one of the biggest upward moves. Mortgage rates just hit 5%. Maybe something's changing here.
Tracy: (02:25)
Is this the peak housing market episode that we're doing right after I bought a house?
Joe: (02:31)
Right, so we've jinxed your home purchase. Now you're gonna be underwater for 10 years. But it does feel like something's changing.
Tracy: (02:37)
That's right. So we saw the 30-year more mortgage rate hit almost 5% quite recently, which is, you know, a very big increase from what it has been over the past couple of years. And there's this wider macro discussion going on right now about financial conditions as interest rates rise. How much of an effect is that going to have on financial conditions and the overall health of the U.S. economy? Are homeowners going to start feeling the pinch of these higher rates or have most people at this point actually refinance their mortgage at very, very little rates?
Joe: (03:13)
You know, I was thinking about this. The other interesting thing about housing is it's such an important part of the economy, obviously. It's a huge source of wealth, housing assets. It's a huge source of consumption. People need to pay rent or have a place to live. And as we've sort of been reminded in the last six months or year, it's a manufactured asset. It has a supply chain like everything else. And for 20 or so years we did not think much about that aspect of housing. You just take it for granted, you get the wood, you get the workers and so forth.
The labor part had been stressed for a little while pre-Covid. But I think that we're all sort of being reminded that homes have like tons of parts, like a car has tons of parts. And if you're missing one thing or a part, or wood, for example, it gets really expensive and that makes building the new house difficult.
Tracy: (04:02)
Right. So it feels like we have all these different push/pull factors. So on the one hand housing finance, the cost of a house is very, very expensive at the moment. And with rates going up, you would expect it to get even costlier. But on the other hand, you're not necessarily seeing the [expected] supply response because of all these supply chain and logistics issues that we've been talking about.
Joe: (04:25)
Well, I'm very excited. We're gonna have a big housing conversation because as you mentioned, mortgage rates are nearing 5%, macro things — what's going on there, micro things, supply chain, commodities, all kinds of questions we had to bring on two guests this time to help us bring it down. We're gonna be speaking with Dustin Jalbert. He is the senior economist at Fastmarkets in the wood products area. Great on the sort of supply chain costs, lumber, all those things, what's going on there.
And we're also gonna be speaking with Conor Sen, columnist for Bloomberg Opinion, founder of Peachtree Creek Investments. He’s a longtime friend of the podcast but amazingly I think this is his first time actually coming on. So I'm really excited about this conversation. Dustin and Conor, thank you so much for coming on Odd Lots.
Dustin Jalbert: (05:15)
Thanks Joe. Thanks Tracy. It's a real pleasure to be here.
Conor Sen: (05:18)
Yeah. Likewise. I'm excited to be having this conversation.
Joe: (05:21)
So Conor, actually, let's start with you and, you know, let's just start really big picture. Okay, we've seen this huge rate shock. Rates nominally are still not that high, but the size of the move is absolutely historic over the last few months. What are the immediate first order implications for the housing market from this big move to basically 5% 30-year mortgage rates?
Conor: (05:47)
The most obvious one is that affordability has certainly taken a huge hit. I've seen things like the average mortgage cost if you were buying a house now versus a year ago is up around 30%. So that's certainly going to impact demand to some extent, although at the same time, rents are up 17% year over year. So it's not like this is happening in a vacuum. But I think just that affordability shock is the first thing we're trying to figure out.
Tracy: (06:10)
Yeah. This is something that came up recently. This idea of homeowners actually purchasing houses as basically inflation insurance, as a way to get away from increasing rents.
Conor: (06:20)
Right. So in 2006, when everyone's worried about is this another housing bubble, housing crash thing going on? That was really more about home price appreciation, speculation, people putting down very little hoping that homes would go up a lot over the next two to three years. Whereas now arguably, it's more of like my rent is going up a ton and I'm worried about inflation, maybe it's more of rent inflation speculation than home price appreciation speculation.
Joe: (06:42)
My impression is that overall in the economy right now, there may be some softening, I don't know, logistics, may be goods. What are you seeing on your side? Because a huge question that, you know this issue is like, yeah, there's tons of demand for housing. We just can't get, 'em built. You have all these permits, but it takes forever. Is there any easing going on in any aspect of sort of the construction of new homes yet?
Dustin: (07:10)
I mean, you know, right now it doesn't seem like there's a lot of good news. If there are some kind of silver linings here, certainly in the wood product space that I cover, you know, specifically with Fastmarkets, we're seeing lumber prices come off kind of the peak levels that we saw sort of about a month ago. You know, the cash market that we report based on, you know, our random lengths editorial team, what they report, the market's down probably almost $300 per thousand. You know, a lot of people follow the futures market and it's fallen a lot more. So you know, there has been some loosening on the framing side, but everything we hear on the ground, trucking, you know, especially flatbeds are still incredibly tight.
I know there's been some talk recently on the van inside of the trucking market, things loosening substantially, but flatbeds, you know, it's a different animal. That's really how a lot of building materials go to market. And that is still incredibly tight. Part of it is seasonally. You know, demand is strong right now we're entering the prime building season. And so that is, you know, still a challenge in the marketplace. Another maybe kind of green shoot here. Some positive, the rail side is starting to loosen a little bit. There's a lot of framing lumber as you've talked about with, you know, previous guests, Stinson Dean, on this, a lot of framing lumber comes from Canada and a lot of that is delivered via rail. We've had huge rail challenges for several months now. We're starting to see some improvement there and that's helping deliver some of that framing material to market, but it's still very, very tight, even as prices come off these really hot levels, so.
Tracy: (08:52)
Can you just remind me, what is the relationship between lumber prices and new housing inventory? So when lumber prices are going down, is that bullish for new houses? Because everyone's like “oh, it's cheaper to build them, let's get started,” or does it suggest that construction is already coming down and so, you know, there's less demand and more supply.
Dustin: (09:12)
This is probably something that some would debate here. I would argue that the situation with lumber right now is more a function of what we're seeing in the transportation markets, this sort of loosening, right? And what you're seeing on the housing side, sort of the inventory effect, you know, there's still a lot of construction, actual physical construction, going out in the marketplace.
So you think about the actual wood put in place or other building materials put in place, right? There's still, a borderline historic amount of homes currently under construction, right? There's this sort of huge unfinished inventory that's in progress. So there's still good demand, especially on the new construction side, and some parts of the remodeling space. So at least in the short term, you know, the demand picture for us the next three to six months looks, you know, hasn't really changed all that much. So again, a lot of what we see on the pricing side right now is more a logistics and transportation issue, as opposed to the building cycle, you know, sort of actual starts slowing down or something like that. Does that kinda make sense?
Joe: (10:19)
Yeah, you know, it's something that I've been thinking about a lot, obviously we've done quite a number of logistics episodes, but it's something more broader that I've been thinking about, which is that in a downturn or in a crash, like we saw in March/April, 2020, you can sort of build up these big stockpiles of goods, right? Lumber sits there. Other goods sit there. But you can't really build up an inventory of logistics capacity. That's just gone forever. And then when the economy picks back up again and starts growing really hot, it's not like there's a bunch you can draw down. It just immediately gets, you can see how it immediately gets squeezed.
Dustin: (10:54)
Yeah, for sure. Yeah and actually, you know, it's a good point, Joe, because one thing we see right now, it's kind of skewing more to what I see on a daily basis, this being lumber and wood products. But what's interesting right now is when you look back say 12 to 18 months ago, you know, we had this big sort of positive demand shock of home construction and this renovation boom, so positive demand shock. Some of it was sort of underlying demographics and demand, but certainly Covid has contributed to that. And the supply side was constrained for a lot of reasons. Some of it was actual plant capacity issues, but a lot of it too was workers were furloughed, you know, sort of sent home and it's taken a lot of time for sawmills, wood products mills and other sort of building material producers to get those workers back and be able to sort of add shifts, add overtime, things like that.
Now, head counts have more or less normalized in a lot of parts of the supply chain. What we're seeing now is yeah, it's that throughput via trucking, via rail that are causing bottlenecks. And one thing we've seen in lumber specifically, mills are actually having to curtail production right now — not because they're not profitable. You know, prices are still close to record levels and their margins are swelling, but the issue is they're over producing what they can actually ship. You know, specifically in British Columbia. You know, there's, again, there's a lot of sawmill output and a lot of lumber that comes to the domestic market here in the U.S. Some of that is sort of captive because of these rail bottleneck issues, which again, from a builder perspective, if you're a wholesaler is just incredibly frustrating, you know, that the hits just keep on coming, even as we're seeing at least the plant level some improvements in supply chains.
Tracy: (12:36)
Conor, could you come in on that demographics point that Dustin just mentioned? And you know, we hear a lot about this idea that millennials are finally getting into the housing market. People wanted to buy houses and move away from cities during the pandemic. What exactly is going on here and are there any historical analogies we can look at for this particular era?
Conor: (12:58)
So sure. This is the main difference between the current cycle and the mid-2000s, because the average age of the first time home buyer tends to be in the early thirties. And so what was strange about the housing bubble was that the the people born in the early 1970s, that was actually like the smallest generation of people in a long time in U.S. history — only about 3.1 million Americans were born every year during that time. And so as they were in their early thirties, that was the sort of peak of the housing bubble. So the demand that we had at that point was really unnatural, driven by speculation rather than demographics. Whereas now it's the opposite. There were 4 million people born per year around 1990, they’re the ones who are in their early thirties now. And so that's why the demand picture is so much different now than it was then.
Joe: (13:39)
That's really fascinating. I don't think I'd ever realized that aspect. I mean, I knew that in the mid 2000s, there was a lot of unhealthy speculative activity, but I had never thought previously about how just there wasn't really a very large base of, I guess you would say natural buyers during that period. That's really interesting, but I guess, what about the bigger question? So for people who aren't in the housing market, or for people who didn't win the lottery like Tracy did and actually get a house, the other question besides mortgages is like, well will housing ever go down, will it ever get cheaper or will it at least slow down in prices such that it's not a big risk to wait a couple of years? Is that a possibility? Could we see the nominal price of a house come down? And what are the factors that would drive this? Maybe both of you could sort of come in on this question.
Conor: (14:29)
Yeah. My view on this is there's sort of two ways in which that could happen over the next five to 10 years. One is that you have millions and millions of people losing their jobs because ultimately if you don't have a job, you can't pay a mortgage. Maybe you're a forced seller. And then the other is that we do know at some point, baby boomers will transition out of their current homes, whether it's voluntarily or involuntarily. That's probably more of a later part of the decade story. But once that happens, particularly in places that don't have great demographics, maybe rural parts of the Northeast and Midwest, places like that, then you just don't have people to step in to buy those homes and they go down in price.
Dustin: (15:01)
Yeah. I generally agree with Conor. I mean, I think, you know, when you look at the dynamics in terms of demographics over the next 5 to 10 years, it's a very positive story. And again, barring some sort of unexpected recession where yes, employment goes down and aggregate demand of the economy goes down, you know, we’re kind of having a steady sort of business cycle expansion. It seems hard to imagine a situation where you're gonna have broad-based downward moves in home prices. And you know another, and again, we look at this from the building side of the equation here. You know, one thing that we think is gonna be really challenging is just for construction activity to be able to ramp up sufficiently, to build the number of homes that we need to meet not only existing demand, you know, year-to-year demand in the marketplace.
If you're a believer in this idea of pent up demand, sort of suppressed headship rates, where people are not forming households and some of the key demographics we've talked about here at more kind of traditional rates, we've seen over history, it's gonna be really problematic for the industry to ramp up. Labor is gonna continue to be an issue. You know, we've heard a lot about the zoning and, you know, issues on the multifamily side. Think about that in a hot, tight labor market. How are we gonna ramp up, you know, say half a million residential construction workers? If we wanna ramp up to say, you know, 1.8 million starts or completions consistently, and we're seeing that right now too, you know, completion rates, we're starting homes at a 1.6, 1.7 million pace, but completions are pretty flat around 1.3 million completions. And that is, some of that is supply chain oriented in terms of actual building materials. But some of that is also labor. Some of that is land availability. All those factors are gonna also on the supply side, make construction constrained and kind of underpin home price appreciation.
Joe: (16:58)
This is really striking. And I'm just looking at this chart on my terminal right now because I just wanna drive home for listeners what you said, which is that we have had housing starts pick up. You know, homebuilders like get a plot of land and start putting down a frame and all that. But completions, like actually turning the housing start into a home that someone can then move into, has clearly not kept up. So currently just looking at the February [starts] numbers, it's like close to 1.8 million homes and the actual completions are 1.3 million. And so, yeah, I mean, there's this huge gap that's emerged between, okay, you wanna start a house, but actually should get a house completed.
Conor: (17:35)
Yeah. Something that Dustin and I have talked about over the past few weeks in response to this rate shock is that homebuilders have had this, you know, to the point of that data, they've been starting a lot more homes than they've been completing. And so their inventories of homes under construction, that backlog has been growing. And we wonder if that's gonna be something that management teams think about over the next couple months where they say we have a lot of homes under construction that are at risk if you know, maybe they’re supposed to be delivered in the first half of next year. And if market conditions really change, that could be the kind of thing where they might have to take losses or write downs. And I believe, I mean, home builder stocks are down 30 to 35% year to date. So I think investors are worried about that as well. And that would just be really bad news if they start fewer homes and just focused on finishing their backlog. Cause then you create more supply issues next year,
Tracy: (18:22)
I was about to ask about the home builder stocks. So if you look at something like KBH, I think it's trading below its book value at the moment. What is that telling us about the future direction of housing construction and profitability, I guess?
Conor: (18:35)
Right. So the book value for a lot of these home building stocks is really based on inventories, which is homes under construction and land that they own. And so to me, if home building stocks are trading below book value, that's saying not only are investors thinking they're gonna miss earnings over the next few quarters, they're saying they're gonna take actual write downs on the land and the homes under construction that they have, which is to me a pretty severe forecast. But if that were to happen, that just shows that the economy I think is much, much worse than appreciated, or it could just be an overreaction.
Joe: (19:06)
But this is pretty wild. We're in a market in which demand for housing even seems to still be red hot. 5% mortgage rates, despite that, it still sounds like there's huge lines and bidding wars. It doesn't seem like that's gone away yet. And yet you have these home builders, which, you know, are well off their recent highs and investors saying they might take a loss on some of these plots. They might just completely write them down. It feels like a pretty extraordinary disconnect.
Conor: (19:39)
I think the sort of sell side view of what's going on with homebuilding stocks is that the valuations are cheap, but when mortgage rates are rising, you don't own them. And it's sort of, you just kind of wait until rates turn and see where things are and then reassess.
Dustin: (19:53)
You know, it's interesting that I think the home builders have had a lot of confidence that demand was gonna be there, right? Even as cycle times for particularly on the single family side of the market. The cycle times have gone from say, you know, six to seven months on average pre-pandemic. And now we're somewhere probably around eight, nine, maybe even approaching 10 months in some cases. You know, I think while you saw this growing delta between completions and starts go up, I think the home builders had some confidence that demand was gonna be there months out, particularly given how low rates have been. But now as this affordability question has come into play, I think there's just generally less confidence what the home buying market will look like in 2023, even though we have all these underlying sort of demographic tailwinds.
But you know, one thing that we often remind clients is that just because there's pent up demand out there, it doesn't necessarily dictate that it has to be realized in the marketplace and affordability does still matter. So I think, you know, you're seeing it in some of the home builder sentiment data recently that, you know, maybe they're getting a little bit skittish and, you know, I think completions are gonna continue to move higher here. Those start numbers could start to kind of flatline a little bit as they try to sort of focus on those backlogs.
Tracy: (23:23)
Can we talk a little bit more about what happens to affordability when rates go up? So, I mean, clearly you would expect higher interest rates to knock demand a little bit. But what's your expectation for exactly what happens here and how much of it depends on how high the Fed actually raises rates?
Conor: (23:41)
Something that interests me is that Redfin, they do housing analytics and help home buyers and home sellers, put out a piece last week I believe, talking about softening that they see or signs of potential softening. And it was really focused on high-cost markets like San Francisco, Los Angeles, New York, just because that affordability is really, really challenged. It was challenged to begin with. And it’s even more so now.
And they hadn't seen that to the same extent in the destination markets that people have been moving to during Covid with remote work and migration. And so something I wonder is that arguably the Austin, Texas housing market has been driven more by the buyer profile of people moving there than local market conditions. And so could we start to see something where the high cost markets start to stagnate a little bit, but as long as people are still moving to those destination markets and bringing their bigger budgets with them, that doesn't impact their affordability issues.
Joe: (24:30)
Well so this raises another question. And of course, when Covid initially hit and suddenly everyone wanted to move, or it seemed to catalyze some big shifts and we saw, okay, a bunch of people left the Bay area. We're gonna move to, Austin or somewhere else in Texas. Or maybe they went down to Florida or something like that. I can't live in a city. I want to live in a suburb, but it doesn't feel like the other places cooled down. Are we seeing other areas where prices are falling because everyone is moving out of them? It seems like some places got really hot, obviously places in Texas, etc., but it doesn't seem like the other places actually cooled or really got that cheap, or at least in New York here, you know, nothing seems to be particularly cheap.
Conor: (25:16)
I think that gets to Dustin's point about the headship rate going up where, and this could be a strong economy, strong job market thing as well, that in the 2010s, we spent all this time talking about people still living in their parents’ basements when the job market and wage growth was weak. And now that those things are strong, you have that pent up demand for new household formation and things like that.
Dustin: (25:34)
And I was just gonna say too, I think that last point Conor on household formations, you know, you look at the official census data, you know, 2020, and you have to take it with a grain of salt to some degree because the data can be quite choppy, but you know, at least looking at 2020 data, you know, when you look at sort of the number of households, it was sort of flat year over year. But again, to Conor's point, you have to think that there's a lot of people returning to the shelter market, both on the ownership side, but also the rental side of the market too. And so, you know, they kind of move hand in hand, you know, you're not seeing any relief on the ownership side of the market, but it's the same story in some cases, if not worse on the rental side of the market.
So, you know, the real estate market across the board is having this massive adjustment as you know, a lot of, especially young people who maybe lived with parents during the pandemic are stepping back into rental market, right. You know, job growth and income growth is driving people to separate away from roommates, right? So, you know, now you don't need to share an apartment, maybe you're going out and getting your own place. I mean, all this is impacting the shelter market across the board here. So everything is really tight and even in the high cost cities where people are migrating out of.
Joe: (26:50)
So that actually is a good sort of stepback. And I wanna go back to this question of pent up demand. And this was obviously something that we talked about a lot even prior to Covid, which is just like, okay, there's this huge wave of potential millennial home buyers. Post-great financial crisis, we know that housing starts were very slow. So the story of the under-housed economy was a thing that we were talking about prior to Covid hitting and then it really seemed to accelerate, but what are the numbers like? What are we actually talking about in terms of how big that pent up demand is and what we need to see on a sustained basis to do something about getting back in equilibrium. Like, okay, is 1.8 million annualized housing starts enough. Does it need to go to 2 million? Like what what seems a reasonable number here to bring it to balance ? What's the shortfall?
Conor: (27:42)
I think there are two way of looking at this. First is looking at the vacancy rate of homes that are like sort of owned homes and rental homes and looking at what a normalized level was over time. And that maybe tells you something about what the current shortfall is and that number's around 2 million housing units and then sort of for pent up demand, that gets a little tougher because again, you're making assumptions about what home ownership rates might be in an ideal environment. Should the home ownership rate in 2025 look like it did in 1995? But you're seeing that both say millennial households, but also households in their forties and fifties, that home ownership rate is much lower than it was pre-2008. And so if that were to normalize, that's several million more and to Dustin's point, it's unclear whether we can meet that demand on the construction side over the next several years.
Dustin: (28:29)
Yeah. And just to extend on Conor's point, it's something that we at Fastmarkets when we do our kind of long-term housing forecast,it's really a demographic story. And this is always a big point of debate is what is this pent up demand idea. And you know, when you look other people who forecast the market, you know, the range is anywhere from there's zero pent up demand — we're already overbuilding — to we're 6 million units short. So, I mean, there's a massive range out there, you know, just to kind of attach more numbers to it. First of all, you need to think about what existing demand is for shelter. And that number is when you think about what household formations could be trending at to just meet, you know, again, existing demand, you're probably talking about anywhere between 1.1 and 1.2 million units, then you tack on every year there's shelter loss. That is either because of natural disasters, wildfires, infills. So, you know, homes that are torn down and then built on, you know, a new home built on that lot. That averages, you know, 200 to 300,000 units a year. And then you tack on second and third home ownership, you know, that puts us between somewhere around 1.4 and 1.5 million units of demand annually, just existing demand.
And then you have to build on top of that, right, to deal with the pent-up demand that Conor talked about, let's say you think there's 3 million units of pent up demand because of the vacancy rate issues, plus these forgone households. So if you complete at a 1.8 million unit rate, that's gonna take you 10 years, you know, that extra 300,000 units you're getting a year, that's gonna take you 10 years to fill that pent up demand gap. So that's just, that's a huge number that you're dealing with there.
Tracy: (30:24)
Dustin, you mentioned this very wide range of expectations. Is that historically unusual? Have we been in a situation like this before where people can't really agree on that number or is this the result of just being in a very, very weird post-Covid time, where there are a lot of different things going on and we're just not sure how they're all gonna play out.
Dustin: (30:48)
You know, I think it goes back to Conor's point is that this idea of pent up demand is a little bit nebulous and some of it is a function of what you think, ‘normal headship’ and household formation or age should be, you know, looking at the key demographics as they kind of come of age in home buying years. And that is a difficult thing because it's somewhat arbitrary in terms of what that should be, determining that. And to some extent, it's also a function of where you start calculating, like what year you start calculating pent-up demand, right? So if you start in 2000 versus 1990, that starting point matters in terms of what that cumulative buildup of pent-up demand is. So you can arrive to very different answers there. That's kind of where we see it when we kind of do this type of analysis internally ourselves. So we keep kind of a range, you know, I don't think anybody know what that exact number is.
Conor: (31:45)
So I've got a theory related to this pent-up demand thing that's sort of in defense of baby boomers in the housing market.
Joe: (31:50)
Oh good.
Conor: (31:51)
I think when people our age think about baby boomers, the sort of stereotype is they all got to buy a house in Los Angeles in 1984 and made a gazillion dollars over the next 30 years. But it's sort of like, when did the baby boomer pent-up demand in the housing market get met? And we know that mortgage rates in the 1980s were still in the double digits. And you can imagine how we would feel today if mortgage rates were 10%, how many people would be locked out of home ownership? And as rates kept declining, that allowed more and more people to get into homes. And I would argue in a sense that some of the early least mid-2000s housing construction boom lagged pent up demand from 30 years of people who finally could buy a home based on 4 to 5% mortgage rates. So this could go on for quite a long time.
Joe: (32:36)
This also of course, gets to the challenge of like, what is a cheap house, right? Or when is housing affordable? Because okay. We could look back at the early eighties, [and say] houses were so cheap, but mortgages were of course much higher, or we can look back at 2010 out of the great financial crisis when houses were cheap and mortgages were cheap and yet unemployment was close to 10%. So there were not a lot of people at the time who had the income to get a mortgage. It kind of feels like there are very rarely sweet spots, maybe, you know, 2021 with rapidly improving job growth and yet mortgage rates really low, was like that sort of brief extreme, sweet spot. But then again, I guess that was like a year of huge housing bidding wars. So it doesn't feel like there's ever like the perfect time.
Conor: (33:29)
I mean, I've been out of college for 20 years now and I've never once heard people say housing so cheap, it's time to buy. And so right. Maybe the late 1990s were okay because as the job market was strong, the real home price boom hadn't happened yet mortgage rates were coming down, but if it's only a few years out of a multi-decade period, then maybe housing just never gets cheap.
Joe: (33:49)
Is there any prospect for something meaningfully different on the supply side, like a different kind of construction? Is it something regulatory that could open up a lot of space? You know on Twitter all the time it’s like “build, build, build” and it doesn't feel like that's a very controversial stance. Everyone likes the idea of more housing stock in general, but there're all kinds of constraints. There's the physical ones, then there's regulatory ones, whether that means cities where it's difficult to build etc. Is there anything that could happen that would actually meaningfully just change the supply side of the supply-demand equation?
Dustin: (34:28)
You know, Joe, it's interesting because I think, you know, the last decade we've been so worried about affordability on the demand side, right. It seems like we haven't really prepared ourselves for what we're gonna do when we get there. And now the supply side is constrained. Right. You know, and I'll kind of break it down between single family and multifamily because I think, you know, there are definitely crossover issues, but you know, to me, when I look at this, you know, on the multifamily side, certainly the permitting and zoning issues seem like major challenges that are kind kind of stalling the ability to ramp up apartment construction and smaller, more affordable sort of units out in the marketplace. And so that is gonna continue to be a challenge, right.
For political reasons, I think, you know, maybe Conor, you could probably talk about this better than I, but I think that's gonna remain challenging. I think the advantage is with multifamily, right. When you look at history in terms of productivity of construction, multifamily actually has a lot better track record of increasing productivity growth. So I think even in a labor-constrained environment, you know, we are seeing technology like wall panelization, offsite construction that are being implemented, component manufacturing, you know, more quickly adopted in the multifamily space. So I think even if we're in a labor-constrained environment, we probably have the ability to ramp up multifamily given those factors. Single family is very labor intensive. You know, you're building on site, you're stick framing in a lot of cases, most of our homes are built with wood.
Historically it's been a cheap way to build, but it's kind of been contingent on a well-supplied labor market. In that context, you know, on the single family side, I mean certainly zoning and things like that can help. But again, I come back to really issues on the labor side. Can we pull in more migrant workers in key building markets like in Texas and California, you're talking about the residential construction employment is dependent on, you know, anywhere 30 to 40% of the labor market there in residential construction are foreign born workers. So in an immigration constrained environment, you know, it's gonna be tough to ramp up. If that loosens up, maybe we get some quick burst of production, but beyond, you know, kind of really pivoting to offsite construction, manufactured home construction, it looks like a challenging road ahead for single family in particular.
Conor: (36:55)
So I look at it sort of in two ways, I follow what the homebuilders do and say really closely. And they've really, in my opinion, kind of optimized their businesses where they're really trying to be cautious about how many homes they build. They don't wanna get caught with too much inventory. They're really focused on high profit margins, returning cash to investors. And that to me isn't gonna be enough to meet the housing demand. I have this line that I like to use that “the future is a policy choice.” And I think ultimately that really is what it comes down to. And you can sort of look at in the response to the return of soldiers from World War II, and there was this sort of, ‘we're all in this together.’ We have to build enough homes to meet the demand for GIs and people like that. And we met the challenge with zoning changes and giveaways to home builders and things like that. And I don't see that same political will right now. And you know, ultimately that's what we need. Otherwise I think this is just gonna be the reality for at least this decade.
Tracy: (37:47)
Can I just ask, going back to the baby boomer point and your well-intentioned defense of baby boomers, Conor, but one of the things we hear a lot is this idea of either large financial institutions like private equity coming in and buying up a bunch of single-family homes or sometimes multifamily. And this idea that you have a lot of baby boomers who have built up wealth over the years and there are very low mortgage rates, and so what they do is they go out and buy second homes and then rent those out for additional income. How much does that constrain supply and how much additional inventory would you expect to come on stream when baby boomers, uh, how do I put this? I guess when they die.
Conor: (38:36)
So even though the numbers from institutional investors buying homes are large, like tens of billions of dollars, it sounds like a lot. When you're talking about tens of trillions of dollars of real estate value in the United States, that's not a very large percentage. And so it gets a lot of headlines, but to your point, that's not really where that sort of soaking up of inventory’s coming from and earlier, yes, Mike Simonsen spoke to that. When Boomers die, I think the question is, I mean, maybe they just give their homes and their real estate to their kids and it stays in the family and it doesn't get released onto the market. So I think that will help to some extent, but sort of magnitude wise, I don't know.
Joe: (39:13)
I saw there's a new start up that Andreesen Horowitz is funding that allows people to basically do what commercial real estate investors do, which is if they don't wanna be a landlord and they don't wanna sell their home so they can like swap it in for this portfolio of like a quasi-Reit And so they retain ownership, retain housing equity. And so, you know, I feel like they're gonna find a way to prevent these houses... Capitalism will find a way to prevent these houses from coming out to the market.
Tracy: (39:43)
Capitalism finds a way.
Dustin: (39:45)
You know, the other thing, going back to Conor's point to, you know, one question, about, you know, even if this sort of baby boomer supply is released into the market, it's a question of also the geography. Where are these homes located? So, you know, if you have lots of migration to the Sunbelt, you know, if these are sort of whatever vacation homes or second homes in, I don't know, Midwest or Northeastern United States, you know, sort of Cape Cod, like are those places that we really need the housing supply to be released from, right? So I think that's what also makes it quite uncertain, even if that supply side release occurs, is it geographically gonna be in the locations that you need?
Joe: (40:25)
Housing, the original non-fungible token, right? A house in like Southern Illinois is not a house in central Texas between Austin and San Antonio. So just because it exists doesn't mean it's going to solve an acute housing shortage that people immediately need.
Conor: (40:44)
I think something we haven't talked about yet too, is that if hybrid remote work becomes a thing, tens of millions of workers now need an extra bedroom as a home office. That's sort of tens of millions of bedrooms from the national housing stock that aren't gonna be there because maybe now instead of needing a three or four bedroom home, you need four or five bedrooms or what have you. And so I do think that's sort of a subtle factor that hasn't been discussed enough in terms of why the shortage is existing.
Dustin: (41:09)
Yeah. You think about the amount of floor space that's pivoted from the commercial space and the office space to the home for that exact reason, people needing extra space for a home office, maybe two, that's a lot of demand in terms of floor space, going to the residential side all of a sudden. And I know that the numbers are kind of squishy on the percentage of the population that was pre-Covid remote work and where we are now. But if that number doubles, let's say, just for just a thought exercise, that's incredibly bullish for real estate demand in general, not only new construction, but also renovation demand, where we're seeing, particularly for lumber and structural panels, that's a huge category, a channel of demand that we're seeing being driven by this work from home movement. And by the way, you have soaring home equity, that's helping fund that.
Joe: (42:06)
That's really interesting. How much are you seeing on that? So, like we talk, we've been talking about all the housing starts etc., but how important for lumber wood products is either renovation or someone wanting to add a deck to their home? Like how big of a contributor is that to overall demand?
Dustin: (42:24)
I'll speak to lumber mainly, it's probably different by building, you know, the type of building material. But certainly or softwood lumber demand, remodeling is actually the largest single-end use market in terms of volume it's larger than new residential construction. And that always surprises people because…
Joe: (42:43)
Yeah, I would not have guessed that.
Dustin: (42:45)
Lumber's a little bit different than say even plywood or OSB. You know, OSB tends to skew a little bit more towards the construction space, but you know, you mentioned it, Joe, you think about all the renovation that happens, you know, new decks, putting in fences, people putting in, you know, those, you know, flower beds, things like that.
There's a lot of sort of home improvement that happens on the renovation side that is substantial and probably the best number to kind of size up the market is from the Harvard Joint Center on Housing Studies. And that market based on their estimates, including both improvements — so home renovation and maintenance — is around a $430 billion market. So that's substantial. And to put some context to it, total construction spending is probably about over $800 billion in total, that excludes sort of the maintenance portion. So if you tacked on maintenance, it's probably more like a trillion dollar market. So that's a pretty big chunk of total residential construction that goes into that renovation space. It's incredibly important. And I think it's gonna remain outsized because of how, you know, we have such a shortage of both new and existing home inventory. People are pivoting to renovations to enhance their shelter space.
Tracy: (45:47)
Can I just ask in terms of supply shortages, I mean, we've had lumber, truss plates, kitchen sinks, garage doors. What's the next thing on your radar? What is your pricing data telling you will be a future crunch point?
Dustin: (46:06)
It feels like we've covered everything, right? It feels like every component of a house. I'm not sure what the next thing is Tracy, because I mean, I think when you think about it, the way that the shortages have progressed, it's almost been in tandem with what the building cycle looks like. Right. First it started with lumber and structural panels and engineered wood products. And now it seems like more of the shortages are stemming from, you know, how you finish a home. Again, you mentioned the windows. The HVAC systems. I was kind of joking at the beginning of the question, but it does feel like we've really touched a lot, you know, all points of the building cycle. So, you know, it seems like, again, those parts to finish a home are really gonna be continued to be the critical determinant of us being able to complete homes, especially considering a lot of that material, either the components or the actual building materials themselves are sourced from offshore.
I think why you're seeing maybe a little bit of relief on sort of the framing materials. A lot of it is sourced domestically, you know, the vast majority of it. And so it's a lot more a function of the domestic transportation constraints, which are still tight, but probably improving a bit on the margin while, you know, containerships and port throughput, you know, it continues to be a constant challenge with complex items like that. So, you know, I don't know what's the next thing, but it seems like that area's still gonna be problematic.
Joe: (47:34)
What's the next thing you're thinking about right now? Or what should people be watching? And it can be anything, but sort of like, what's the next thing on your mind.
Conor: (47:42)
I think for me, since again, we talked about how home building stocks are down so much this year and builders have been still saying, they're trying to meet construction backlogs and growing community counts by 10% this year is that when they report earnings over the next couple months, what will they be pivoting at all in their business models, in response to changing market conditions?
Because as an investor, I'm looking at them trading in some cases three to four times estimated this year's earnings saying, okay, what's going on? Like the market’s straight valuing you, like, you're going outta business. Prove to me that you're not having an issue a year from now.
Dustin: (48:14)
Yeah. And I mean, I think on our side at Fastmarkets, we're obviously thinking a lot about what, you know the building picture looks like in 2023, right. It feels like 2022, the market is kind of set here in terms of the construction activity we're gonna see, except with maybe the exception of the DIY side of the renovation market. We're seeing some softening there, but I think when you think about new construction and pro-driven renovation, you know, a lot of that activity is already booked out for much of the year.
We're wondering now, okay, what does 2023 look like with rates going up close to 5% now may be going higher building material costs, continuing to remain elevated, you know, is that gonna cool? Housing starts to some degree, is that gonna cool the renovation market between, you know, a combination of demand destruction, and also thinking about this pivot back to the service side of the economy, right? If people are less inclined to renovate at their homes, because they're going on vacation again. And on top of that, you know, just demand destruction from elevated price levels, you know, will we see some cooling in 2023, both on the new construction and maybe on that R&R piece too.
Joe: (49:26)
All right, well guys, Dustin and Conor, that was fantastic. We covered a lot. I learned a ton and great having you both on Odd Lots for the first time.
Conor: (49:35)
Thanks for having me.
Dustin: (49:37)
Yeah. It's been a pleasure. Thanks Tracy, thanks Joe.
Joe: (49:48)
It's almost like you don't even know where to begin to think about it. I had not thought previously about just like how much adding decks and fences and flower beds added to the lumber market.
Tracy: (50:00)
I guess that's true. I mean, I thought the point about how the supply shortages are sort of following the trajectory of actually building a home was very interesting. I do feel a little bit better about buying over the past few months right before interest rates go up. I'm sure…
Joe (51:00)
You were really worried but everyone does. I think that's like a thing people buy a house and are like, “oh, I definitely bought the top.”
Tracy: (50:20)
Yeah. I mean, I think everyone inevitably feels like that and I suspect, you know, maybe that will turn out to be true, but I feel a little bit better. I have to say.
Joe: (50:30)
Your feeling better is someone else’s feeling worse. I does not feel from this conversation that you bought the top. And I guess this is probably one of my big takeaways that even with 5% mortgage rates, that there's gonna be like some major softening. There's too much structural demand. There's too much pent-up demand. The demographics are too good. The supply is too constrained for there to be like some sort of shift. Quality. We didn't really get into it, but like, I know like loan quality, I believe is very high these days — nothing like it was in the mid 2000s. So it does not feel like there's gonna be like some like wave of relief or a bunch of new homes that get really cheap all of a sudden.
Tracy: (51:12)
Well, you mentioned loan quality, and this is the other big thing that is emerging. And we just discussed it. But this idea that people who are buying houses now are not necessarily buying them as speculative assets and thinking that that price is just going to keep going up and, and up. Rather, a lot of people seem to be buying these as logical investments or a logical choice and inflation protection. So rents are going up enormously. I might as well own my own house in the current situation.
Joe: (51:42)
Yeah. We had the CEO, I forget which homeowner, it might have been KB Homes, maybe Toll Brothers.
Tracy: (51:48)
Yeah, I knew you wrote about this.
Joe: (51:49)
I wrote it and he said, look, you know, he said housing is shelter and it's also shelter from rising rents. And I thought that was just like really fascinating. Like people want a predictable monthly check that they pay out and to not have to worry that their cost of rent is gonna jump 20% next to year when the landlord ups it. And so in an environment in which there's a high degree of anxiety about rents going up every year, you could pay extra and buy a house, but then you could theoretically lock in a monthly cost that's stable for 30 years out.
Tracy: (52:22)
Right. And so even if mortgage rates are going up, at least they're relatively and predictable.
Joe: (52:28)
And Conor made that point like, yes, the all-in affordability for homes is like up 30%, but rents are up 17% and you have to have shelter that makes it such that the price of, you know, it has gone up the ost of buying, but not, it makes it sort of relativistically not as much. Anyway, so many, so many different angles.
Tracy: (52:48)
Yeah. But you're entirely right there. There is just so much to digest in the housing market at the moment. It does kind of feel overwhelming.
Joe: (52:56)
We'll come back in six months. We'll see how far underwater you are or whether you're already…
Tracy: (53:02)
Oh yeah, another episode based on my personal misfortunes. Excellent. All right. Shall we leave it there?
Joe:
Let's leave it there.
You can follow Conor Sen on Twitter at @conorsen and Dustin Jalbert at @2x4caster.