Pouring Gasoline on Three Colliding Problems
When hedge funds buy up detached houses and town houses, those houses are not likely to come back on the market. They are gone for now and likely for the long term, because they won’t be coming back.
Hedge funds may hold a portfolio of homes for 5-10 years, but when they decide to sell, I seriously doubt those homes are not going to show up on your local MLS. Now that the homes have been bundled, funds will sell to other funds. Houses have been transformed into an asset class to be traded among institutional investors and funds. Once homes get bundled into a fungible asset, people are not going to be able to buy individual homes to live in. Those homes become part of the rental market. For prospective home buyers, they are going to be unavailable.
This will exasperate the shortage of new and existing homes for sale. We cannot build quickly enough and we cannot build inexpensively enough to make up for the gap between housing supply and housing demand.
The worst part of this structural issue is that funds can over-pay for a home on the front end, now that a market for bundled homes has been established, since they are looking at appreciation of a scarce asset that generates tax sheltered cash flow from rents and depreciation expense while they hold it. This gives a hedge fund a competitive advantage in a hot housing market. Not only are they cash buyers who will raise an inspection, but they can pay more than individual homebuyers.
You might think this is like the financial meringue of credit default swap and the bundling sub-par mortgages into securities which led to the real estate crash of 2008, but I think that is not the case. I don’t think funds crowding individual home buyers out of the market is going to lead to some 2008 scale disaster or even a serious correction in the next 10 years. The annual demand for housing does not go away on December 31st. Unmet demand Carrie’s over into the following year. People are still forming new households. The demographics that drive demand for housing are like gravity.
In my view there are three colliding problems at the heart of the supply problem:
1. Lots of people are not paid enough to afford rent and cannot save up a down payment to buy a home. Except for some recent increases, wages have been stagnant for the last 20 years while housing costs have increased steadily.
2. The pain is not spread equitably around the US. Even with double digit annual increases in home prices and rents, folks keep moving to dynamic metropolitan areas for jobs, education, and health care. The housing crisis can be observed all over the US, but we are still a country of regional real estate markets. Some aces are seeing greater increases in costs than others.
3. Productivity in the housing construction sector is really low due to a prolonged endemic shortage of skilled construction labor. Skill construction labor is what folks in the project management trade call the “critical resource “. Production will not increase until there is more of this resource. Local small developers and builders may find ways to be more productive with the people they can find or train, but they will be doing this out or raw necessity. For them, it is a time to innovate or close their enterprise.
These three colliding problems are going to hang around for the next ten years. The activities of hedge funds will just be gasoline thrown on a well-established fire.
Thankfully, the Federal Reserve's decision to raise interest rates has cooled the overheated market to a large extent. That said, the fundamentals of low inventories and a shortage of construction labor will still be in play for the foreseeable future. Homes that were selling in a week before the Fed stepped up are now taking a whopping 4-5 weeks to sell. You could call that a _relative_ improvement, from off-the-charts insane to garden variety crazy.