Podcast Transcript: Ivy Zelman on the Coming US Housing Crisis

This is an edited transcript of our podcast episode with Ivy Zelman, published 22 July 2022. Ivy Zelman is CEO at Zelman & Associates. She co-founded Zelman & Associates in 2007 which is a leading housing research firm in the US. In 2005, Ivy called the top of the housing market. From there, she called the bottom of the housing market in January 2012. She helped best-selling writer, Michael Lewis, with research related to the mortgage crash which became a part of his best-selling book turned movie, ‘The Big Short.’ In the podcast, how COVID impacted housing, why housing demand is falling, the problem with rising mortgage rates, and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.

Introduction

Welcome to Macro Hive Conversations with Bilal Hafeez. Macro Hive helps educate investors and provide investment insights for all markets from crypto to equities, to bonds. For our latest views, visit macrohive.com.

These days, I often get asked about mortgages. With interest rates on the rise, should one lock into current rates or hold off as interest rates may eventually fall? To that end, I’ve written an article on the topic on the Macro Hive site. So, check it out. But more generally, the issue of housing could become a much bigger issue for investors in the coming few years, which is why this episode is dedicated to that topic.

But before we start, I wanted to flag that you can get your weekly dose of Macro Hive by signing up to our free weekly newsletter. It’s very popular and contains charts, explainers, and unlocked content, and it’s free. To get the letter, just go to macrohive.com/free and sign up for the newsletter.

And if you’re a professional or institutional investor, we have a much more high-octane product that features all of my, and the Macro Hive research team’s views, our model portfolio, trade ideas, and machine learning models, and much, much more. Many of the world’s top investors subscribe to this service. To get more details, email me on bilal@macrohive.com or hit me up on Bloomberg.

Now onto this episode’s guest, Ivy Zelman. Ivy is CEO at Zelman & Associates. She co-founded Zelman & Associates in 2007, which is a leading housing research firm in the US. In 2005, Ivy called the top of the housing market. From there, she called the bottom of the housing market in January 2012. She helped bestselling writer, Michael Lewis, with research related to the mortgage crash, which became part of his bestselling book turned movie, The Big Short. Michael wrote in the book, “all roads led to Ivy.” On top of all of that, Ivy was inducted into the Institutional Investors – America Research Team’s inaugural Hall of Fame in 2012 as a result of Ivy and her team earning 11 1st place rankings for her research. Now, onto our conversation.

So, greetings Ivy, it’s great to have you on the podcast show. I’ve been looking forward to this conversation for a while now.

Ivy Zelman (02:13):

Well, thank you for having me. I’m excited to be a part of your podcast.

Bilal Hafeez (02:17):

Great. Now, before we go into the meat of our conversation, I always do like to ask our guests something about their background. Our listeners love that. So, it’d be good to know about your origin story. What did you study at school? Was it inevitable that you would end up in real estate, research, analysis and so on that you’ve ended up becoming an expert in? What’s your story?

Ivy Zelman (02:34):

Well, I promise I’ll give the cliff note version. I started my career really backing into going to college. I was an undergrad in accounting, majoring in accounting, and I chose accounting because my father majored in accounting and he said, “You’ll always get a job. It’s a good foundation.” But I actually went to night school and put myself through college, financed my own education and was working full time at various jobs and wound up working in an administrative role at Arthur Young, now Ernst & Young. And I was inquisitive, and I’d ask a lot of the auditors and various professionals, “Do you like what you’re doing?” And they would honestly say, “Not really.” And I’m like, ugh.

So, as I started hearing all this negative feedback, I’m like, what should I do though? You’re not going to be okay in accounting. You have too high energy. Why don’t you go work on Wall Street? So then I had this idea that that would be the path I would choose, but I didn’t know the first thing about it. And at George Mason University that no one’s ever heard of until we made it to the final four, that Northern Virginia, which a great school, I started doing informational interviews from partners and various professionals at Arthur Young that helped set up things.

And so long story short, I got the job at Salomon Brothers, went into investment banking, thought my career was set, did a two-year financial analyst programme. And really didn’t like it. But fortunately for me, Salomon Brothers in the midst of the recession of 1991, they had a treasury scandal and John Gutfreund got let go. And there were a lot of people leaving. They thought the lights were going to go out. And there was an opening after my two years was up. 95% of the 70 people in my class, they actually went back to get an MBA. And I actually applied for an MBA at Harvard, Stanford in Northwestern. I said, “You know what, if I’m going to go get my MBA, it’s got to be the best school.” And I didn’t get accepted to any of those.

So, I was pretty devastated and deflated and I wound up looking for a job internally. And there was an opening in equity research working under the analyst that covered Bruce Hardy, that covered the GSCs and the SNLs. And he picked up the housing stocks as a favour because the analysts thinking that Salomon’s lights were going to go out left and he brought me in as associate and then I’ve been in the housing market since then for 30 years.

Bilal Hafeez (04:40):

Oh, wow. Okay. Okay. That’s a great story.

Ivy Zelman (04:43):

It was a good fit.

How COVID Impacted Housing

Bilal Hafeez (04:44):

Yeah. And obviously you’ve done incredibly well since then. I guess one of the big questions is, obviously the state of the housing right now, but before we go into that, it’ll be useful to know what’s your sense of what happened to housing during the COVID period and the immediate aftermath of it? Because obviously we had this lockdown, there was an absence of construction workers and so on. There’s all these anecdotes and stories we hear, but what’s your sense as an expert on what did COVID do to the housing sector?

Ivy Zelman (05:08):

Well, I think that when the initial shutdown occurred in 2Q of ’20 and we were dealing with the world imploding, we would’ve expected that housing would roll over pretty sharply. We were looking for like a 25, 30% decline in pretty most of our volume metrics, but we still had home prices that we thought would at least stay on a relative basis up about 3% really due to inventories, being very tight. And in May through our proprietary survey work that we do, which we really are differentiated in the market by aggregating at the C-suite level, hundreds and thousands of companies that are providing us insights, we started hearing about the market is really starting to accelerate.

And so we were as most people, very surprised on the reaction that the housing market had while you have 11 million people unemployed or everything that’s happening. So people were really looking for safety and less dense places to live. On top of that, the remote aspect of working, they can work anywhere. And so you had this explosive response in housing and that continued really starting May as the inflexion in ’20 to just ramp at a euphoric pace. And that continued really until May of call it ’22, where we started seeing little bit of seasonal weakness earlier in the year, but May was a big inflexion point where we have home prices and markets that have doubled in some cases over that two-year timeframe and inventories while they remain tight are rising at pretty significant levels right now. We’re seeing the market dynamics, the Mach speed of how quickly it’s changing varies by market.

But the COVID setup had the benefits of substantial stimulus that obviously the federal government provided. Marry that with Fed policy that created interest rates that were provided, free money, and then you layered in the primary buyer or the person who wanted a co-primary home, that they could leave the New York market and they can go out to Connecticut or Westchester, or then I’m going to go to Florida and I’m going to work there. A lot of co-dual property, co-primary dual property owners. And then you started seeing investors starting to take advantage of the free money, private investors, institutional money, which had already been prevalent, but just accelerating.

So right now, we’re getting a backlash of the change in direction from free money to now rising rates, inflation. And so, the market is poised for a fairly significant correction and we’re already seeing signs of that in the last several months at, again, a pretty significant severe deceleration.

Inventory Trends and Why They Are Not Supportive of Prices, Why Housing Demand is Falling, and the Problem with Rising Mortgage Rates

Bilal Hafeez (07:51):

And you mentioned inventories and that’s often the thing that seems a bit different about this housing cycle compared to previous ones and many people point to that as a reason why you’re going to still see a strong housing market. People are saying inventory is very low, even going back to pre-COVID, the post-GFC period, there just wasn’t much invested in the residential sector. You did mention that you think inventory picture’s turning. So could you talk a bit more about inventory? Is it a regional story, a national story, and just how we should understand the influence of inventory?

Ivy Zelman (08:20):

No, it’s a great question. And if you go back to pre-COVID, inventories were… When we look at inventories, we like to look at it from a historical perspective to have some kind of trend line, as opposed to realtors talk about inventories and month supply. And that’s really predicated on the current sales pace, which can change dramatically. So we don’t like to look at inventory from that perspective. We look at inventories and marry that with velocity, which I’ll speak to in a moment. But if you just take all single-family inventory, majority of which is existing plus new, and you look at it as a ratio of households, you can look at 40 years of data and pre-COVID, we were pretty much in this close to record low levels.

However, home prices were ranging in ’19, call it 4, 5%. And there were questions prior to even ’19, starting in ’16, ’17, ’18, why is housing so benign when inventories are so tight? And so, we used to have to explain, well, people are locked in at low rates, they’ve refied, so they don’t want to move. We also have what has been a combination of single-family rental investors that have not wanted to sell these great cash flowing assets. And we were just kind of going through mobility of people that are ageing, the population tend to move less. When you’re in your 20s, the cohort between 20 and 24 will move over 50% in a given year. But when you’re an old dog like myself, that gets in the single digits. So, you have a demographic headwind.

And then what we saw with COVID is this explosion and people talked about it, the Great American Shuffle. That Great American Shuffle has been going on for decades where people are leaving high-cost states, going to low-cost states. But admittedly it started going on steroids relative to where it had been, doubling in terms of the pace of migration. And inventories are really what the narrative has been. Inventories are at record tight levels through 1Q ’22. In the same ratio I provided, inventories divided by households. And that trend line, if you look at it historically, call it a little over 2% would be a trend line. And in absolute numbers, the inventory has peaked in 2007, I think at 4 million. And currently, a normalised level might be closer to a little over 2 million just in terms of absolutes. And we’re currently running at a little over 1,200,000 in that range. And the NAR just came out with the numbers and I didn’t even review the number yet, because I’ve been jammed.

But I would tell you that the level of acceleration in inventories is not so much that inventories in themselves are changing, we’ll get to that in a moment, but it’s the demand that’s plummeting. So when you marry the narrative with the inventories or record lows, we have so much confidence that the housing market is going to withstand a severe correction. It’s predicated on the fact that demand is going to still be prevalent and what you look through COVID to see another stat that will help supplement the inventory, I think of the inventory number that I provided sort of a balance sheet item. It’s a point in time.

And so, what we look at is really understanding how quickly that inventory is turning. And if you just looked at new listings from 2013, through 2022’s first quarter, the trajectory of new listings was pretty consistently on an upper trajectory with the exception of 2Q of ’20. That’s where you saw that plunge. And then it just kind of came back up. So, the listings were sort of normally rising, but what really changed is how quickly they were being absorbed. So, we look at a stat called velocity and velocity really shows you that turnover. So, if you go and take inventory at the end of the month, how many units are available for sale? And then over the next 30 days, how much of it was sold? Historically, pre COVID, that was running in the low 20% to mid-20% range, historically. That got to over 55%. I think it peaked at nearly 60%, was like 56%. The new listings never sat there long enough to be within that balance sheet item showing inventory was there.

So, what we’re seeing right now, we just published our Broker Survey today. So, we aggregate data that is a sample size of north of 10% of existing home sales through C-suite executives that are independent brokers and franchised owners that we’re getting as part of our survey platform, which we do for all of the various silos. And today’s Broker Survey showed that inventories in certain markets, mostly within the West Coast and Southwest and mountain states are rising at Mach speed. Like we have markets that are up more than 100%, markets that are up almost 200% just in inventories. As that demand should be the narrative, the velocity is plummeting and it’s a combination of rates, a lack of affordability, people getting sort of, I want to run for the exits because I know now which I didn’t back in the last downturn, that home prices can actually go down.

So, if you look at the severity of the rate of change, this is so much faster than the last recession, because there was a lot of complacency. We look back in 2005 when we published our piece at Credit Suisse called Investors Gone Wild, because we were seeing inventories were starting to build. But there was just this view, that house prices aren’t going to go down. So, there wasn’t this stampede of people trying to take advantage of all the money they made because there were trillions made during that cycle in terms of HPA.

So now we’re seeing it like, wow, I need to lock in today. And you have people cancelling for their concern they’re buying at the peak, or you have people, deals falling out because they now recognise there’s a lot more alternatives. You have investors that are sitting in some cases, private investors on portfolios that might be 10, 15 houses and the costs are up with inflation. They want to take some of that and monetize it. Maybe they only need two homes out of 15. And then you have institutional investors that have been extremely active that with the deepest pockets are also running for the exits in some cases. So, it’s really been just kind of eye-opening shocking at the rate of change.

Now in some of the markets, elasticity still exists where you’re seeing traffic down in the Florida markets or the Southeast call it 30 to 50%. But if you incentivize or do rate buydowns or you are giving good deals on good product in locations that are preferable, then you’re seeing still demand respond. In some markets it doesn’t matter, rate buydown. It doesn’t matter what discounts you provide and incentives. You’re just seeing the market is arrested and the velocity is just fallen to levels that are shocking, frankly, in some of the markets in the country.

And lastly, I know I’m blabbing, but the last point I’d make to let you ask a question is that there are many markets where take Phoenix for example, which is sort of the epicentre of boom bust markets and certainly we’re seeing Phoenix probably deteriorate the fastest. I think today, the risk that inventories as fast as they’re rising and demand again, plummeting that we could see pretty substantial price corrections, but it’s going to vary by market. And I don’t think it’s just going to end quickly. I think this is going to be a very pressured market nationally ’23, ’24, but it’s going to vary considerably on where that pressure is more significant than other areas.

The Role of Investors in US Residential Housing

Bilal Hafeez (15:35):

And you mentioned investors. I mean, how much of the market is owned by investors? I mean, how big a player are they? I mean, has it increased since COVID or is it about the same and they’re just acting faster? I mean, how does that dynamic work?

Ivy Zelman (15:46):

We like to call the category non-primary and when we think about non-primary, that’s inclusive of second home ownership, as well as private investors, institutional investors and what we call sort of liquidity providers, which would include bridge financiers or iBuyers. So that equates to between 24, 25% based on the data aggregation that we have nationally. And we think that that’s up from call it 19, 20% pre COVID on a national basis. It may also be understated because we have a lot of cash buyers that say they’re primary. So it’s difficult to really determine exact numbers. There’s been the explosion of supplementing your income through Airbnb short-term rentals. The numbers that have been thrown out that could be as high as 2 to 3 million are Airbnb units. That’s been a great opportunity for people to, again, supplement incomes and even not have to work anymore.

People say, why is the participation rate so low in the United States? Well, between the wealth creation and equities and crypto and through supplementing income with rental income, it’s been a very nice position for these investors to have, which is quickly changing. That’s a part of the market that we’re most focused on to try to understand what is the mindset of these investors and do they plan on sticking around. Institutional investors, I think are more likely to look at this on a longterm basis, but the private investors are getting out big time. That’s easy, but there are some institutional investors that are also starting to recognise it’s probably a good idea to take some money off the table.

The Airbnb Effect

Bilal Hafeez (17:19):

And the Airbnb effect, I mean, it’s noticeable, is it? It’s something that you’ve observed since the creation or the popularity of Airbnb?

Ivy Zelman (17:25):

I think that we don’t have very good data on that. I think you could probably publish data, but I would say that we have seen from an availability perspective, it’s been a very tight market and now you’re hearing more anecdotally where there’s a lot of vacation rentals that are empty and that has something to do too with the fact that people can travel again. So, let’s say, for example, in Palm Springs where it was great to own short-term rentals and profit from people that are not going anywhere but driving from LA to go to Palm Springs, now they can get an aeroplane. And so, you’re seeing a lot more empty homes and then you have to ask, what is that investor who owns that property, seeing an inflation in their overall costs and what’s their capital structure look like? Are they financed at the short end of the curve? Are they sitting on long-term money or are they at risk of seeing pressure on what their overall returns are? And they start to contemplate, maybe I should take profits.

Housing just finally, it’s really so much driven by sentiment. When you go back in 2008, when the economy was peaking in terms of the severity of the downturn, and then you kind of have the stimulus from the government, first-time buyer tax credit, Obama stepping in and really providing support to the economy, it wasn’t until 2012, that housing started accelerating, even though affordability was at all-time record levels in ’09, ’10, ’11, because rates had fallen so much, but the consumer was concerned that they didn’t want to be buying at peak prices. And a lot of inventory needed to be cleared.

In a similar vein, here we are. Inventories are rising, a lot of complacency that that will be a result in pricing pressure, which we believe nationally home prices are going to go down in ’23 and ’24 in that 4 to 5% range right now in existing homes. And we’re going to see that pressure. And when you think about where the sentiment is, I call it, the bloom is off the rose and that’s like this massive ocean tanker. So, once it changes direction and you’re at a barbecue event or you’re out to dinner with friends and, “Yeah, we sold.” People are like, “Oh, goodness.” They start to think about it and that takes a lot to change direction. And that’s why it’s so important to look at the elasticity of demand. And people say, “Well, millennials are in the market buying.” They’ve been in the market buying. So, affordability is at the tightest level it’s been really since the last cycle, even in excess of that for the first-time buyer market.

Why House Prices Will Fall in 2023 and 2024

Bilal Hafeez (19:51):

And you mentioned, you think there’s going to be price declines in ’23, ’24, 4 to 5%. I mean, how does that compare to previous periods or price declines, say, in 1990 or after the Global Financial Crisis?

Ivy Zelman (20:03):

In nominal terms, prior to the Global Financial Crisis we never had national home prices go down in nominal terms. So, in real terms, we had modest declines nationally and regionally, you had severe declines in nominal and inflation adjusted in real terms in places like in the late ’80s and early ’90s in California and the Northeast. And I think we’re going to see more of a similar pattern because we don’t have the mortgage exotic products that drove nationally so much of the excesses given there are guardrails in place because of Dodd-Frank, that was legislated for the ability to repay.

So, there are some mortgage guidelines or guardrails that could mitigate nationally, a severe downturn. And yet the magnitude of the decline for us, the 4% that we’re expecting in 2023 and 5% in 2024, I feel like it’s a starting point, honestly, that three months ago we finished our forecast, we do a quarterly macro forecast on every metric that is available in housing. And it’s just the speed of the declines makes us feel like maybe that could be conservative, but we could see double-digit price corrections in markets that are in those, the hot markets, like the Phoenix and Austins and Boises, and areas in Montana that are really seeing a stampede of people trying to get out. And yet it is summer. It is over 100 degrees in most parts of the country, but seasonally it’s way worse than normal. But we think this is going to last longer than people are anticipating.

Changes in Mortgage Products Since 2008

Bilal Hafeez (21:29):

And you mentioned the exotics of mortgage products. I mean, that’s something obviously we saw during the subprime period in the 2000s. So that’s a difference to today, but are there parallels to that period or not?

Ivy Zelman (21:38):

Well, as it relates to the mortgage availability, today, I’d say that we’re in a much better position, that we don’t have 100% financing with the exception of VA with the FHA, VA being very, very, very high LTVs. FHA is 96.5% and VA is 100% LTV. In most cases, you’ve got people putting down 10%, 20%, a lot of cash purchases. You don’t know what they’re doing after the fact, whether they’re getting a refi and pulling cash out. But we’ve seen more of, I think a benefit from the fact that mortgage exotic products are just not as prevalent. There had been for a while product being introduced, what we call non-QM, which therefore don’t fit within the framework that Fannie and Freddie have provided that you have to prove that you have the ability to repay, but it’s a really negligible part of the market. So, it does create some cushion.

The Large Backlog of Housing Supply

Bilal Hafeez (22:31):

Okay. And on the supply side, something we did see in the 2000s where there was a big building frenzy in the end, which kind of helped bring down the housing bubble, what’s the supply side looking today?

Ivy Zelman (22:42):

So today in the United States, from a new construction perspective, we’re seeing declines in volumes in the 25, 30% range from the peak levels. And yet when we look at backlogs for both multi and single families, the levels are at the highest levels ever. In multis, we’ve got the highest level since the early ’70s and we’re sitting at, call it 1,600,000 in backlog in total. So those numbers in single family are not as significant as multi, but at their highest level since ’06.

So, a lot of that backlog, if we just look at single family, it will get completed and the completions have been delayed because of all the supply chain difficulties, whether we’re talking about at the top of the funnel with development delays, municipality delays, labour shortages, all the way through to getting the right product, whether it be windows or doors. So, the completions have really lagged, but that backlog, it’s kind of like those that love Game of Thrones, it’s the winter’s coming and we’re going to see that supply and builders and developers will monetize. They will not sit on that product.

Understanding the Build to Rent Market

Ivy Zelman (23:49):

But one thing that’s been interesting and really a big part of what we’re observing is the appetite from, call it the newest entrant, the build for rent institutional investors. Because we track that market, which is not a new market, because there’s always been product that’s been new construction that’s been developed that gets rented out. A lot of times when a builder can’t sell it, they’ll decide they’ll hold it and they’ll be a landlord. But today that market has exploded with institutional capital, and we’ve been tracking it. Like the movie All the President’s Men, we’ve been watching the money and we have nearly, I think today, and it’s been a moving target, but there’s been 95 billion in aggregate that’s at least publicly announced, that’s trying to get allocated much of which I’d say has not been allocated yet but been raised and have been announced. And that appetite doesn’t seem to be waning.

So, when you talk to the builders that have been predominantly building for the for sale primary buyer, many of them have been programmatically selling to build for rent operators, whether it be 10% of their production or as high as 25% of their production. Now you’re hearing them say, given the slowdown, I’m repositioning a lot of my product that I’m going to sell to the build for rent market, which is great countercyclical for me, but will the build for rent demand still be as strong or will that appetite wane? And right now, I’d say that they want a little discounts when they’re working with the builders, but they’re still in the market and they’re still buying. And so that could help mitigate this backlog that’s going to get delivered.

And don’t forget that backlog, we think anywhere from a third to 40% is speculative within the single-family market. Multifamily is all speculative, because they’re building multifamily, whether it’s high-rise, podium, they’re speculating on the entire project because they have to get to a certain level before they can start lease up. Most of the new construction for single family, people sign a contract, then they wait for their home to be completed.

But builders have always speculated in some cases, but during COVID because the difficulties of trying to ascertain what are my costs going to look like by the time this house finally gets completed, which is running, call it two plus months, it had been running two months longer than normal, let’s say, on a typical entry level home rather than put myself at risk that I have a consumer sign this contract. And now, eight months later, my costs are up 20, 30% and my margins are going to get crushed. I’m going to speculate and release that home later in the construction process and maybe I’ll release it framing, maybe I’ll release when the cabinets are getting installed, because I have a better understanding of my cost basis.

And as a result of that, there’s an elevated level in backlog of spec homes that are being constructed and then builders want to sell those homes. So, their incentives have spiked. Cancellation rates are spiking as we’re starting to see again, those that do have contracts that they signed, most of which is coming from those that purchased in the last six to 12 months. Because the ones prior to, let’s say, six plus months have so much embedded equity that they are feeling pretty good still if they haven’t yet closed. But the cans are rising at a pretty significant pace due to affordability constraints where they no longer could be approved for the underwriting at the new rate level, but there are also people getting again, cold feet or there’s just people that are recognising that the market is, for them, their investors, it just doesn’t make sense anymore because their returns won’t pencil.

So just thinking through the dynamics of how the market is changing so rapidly, I think the build for rent is a big part of the dynamics that we have to watch what they do. And will we flood the market with just a lot of homes available for rent? Because the dialogue in the media is, well, people can’t afford to buy now, they’re just going to rent. And there’s this massive shortage of homes available for the demographics of this country. And we just frankly disagree with that.

Demographic Issues

Ivy Zelman (27:52):

We published a piece that’s available for purchase on our website called Cradle to Grave last summer in August. And it wasn’t very well received because it’s quite sobering, the US demographic outlook as is the globe. I mean the demographics are definitely a headwind and we think that we’re more imbalanced right now in terms of the normalised level of what should be built and what’s completed. But given the backlog, if we complete all this backlog, then we’re going to be overbuilt in both multis and in singles. And so, our view has been much more pragmatic and cautious relative to those that are saying, there’s this massive deficit and the capital that’s been chasing RESI, which RESI’s like the prettiest girl at the dance, I call it, they see that deficit as a way to really benefit long term and have not deviated at all at this point, from that view. So, we’re watching that very closely.

Bilal Hafeez (28:48):

And so, this backlog measure sounds interesting. I mean it seems almost like the better indicator to look at rather than inventory. So, in essence, we’re seeing at a time when demand is starting to fall because of all the reasons you mentioned earlier, where we’re going to get a lot of new supply coming into the market as this backlog completes. And then you have this build to rent where you could flood the market with rentals, assuming that completes as well.

Ivy Zelman (29:09):

Well, the build for rent portion is embedded in that backlog. If the builders, when you look at the builders in total, so when you see housing starts reported, there’s two numbers. There are the production builders that are building to sell those homes, and then the non-production, which tend to be viewed as custom where people might buy a lot and then they’ll build on their own lot. And therefore, they’re different categories. In the non-production starts, that includes build for rent.

So, when we look at our forecast right now, we forecast housing starts, we’re looking for a 5% decline in single-family starts for ’23, but that includes a 16% reduction in production starts offset by a 10% increase in non-production, starts predominantly due to build for rent. So, that piece of it is very critical to understanding what the volumes are going to do. And as builders are shifting and reconfiguring product to go to the rental market and people’s perception is that, well, the rental market’s going to benefit, I think it’s just a question of recognising that this is not affordable product that they’re providing to consumers that can’t afford to buy. I mean, you’re looking at homogeneous product that’s monthly payment, in some cases, as a rental is more expensive on a per square footage basis than it is to actually buy if you could afford the down payment, or you don’t have too much debt and you get approved.

So, it’s just a question of how much competitive product will be in the market within the rental market. And you’ve got this class A, let’s say, luxury multifamily that’s massive backlog that is, again, delayed and completions have been under pressure. It’s coming. Once you put the shovel on the ground and you put sewage, roads, pipe, you’re going to move forward. There’s no way you’re going to stop that project in very little cases, maybe 5% of the time. So, whether they’re distressed deals, broken deals. So, that is that backlog in multi-families coming. It starts competing in luxury class A with the build for rent product that might be further out, that the consumer has to drive to live there because they build out in the tertiary markets.

So, one thing I didn’t know that you should recognise is that not only has the capital chased the RESI asset class, but they’ve also all gone to the same markets because that’s where the growth has been. So, we think about, we call it the smile states, the sand states, no surprise you get boom bust in Arizona or you get boom bust in the mountain states and the capitals’ been flowing into the same markets, call a dozen markets and they’re all going out to the tertiary part of the market.

And I say tertiary, which we just define as extremely suburban. I joke where even the cows don’t want to live. It’s so far out there and typically people drive to qualify. That’s where the build for rent product is most prevalent, right alongside the for-sale product. But if you don’t have to drive that far for a rental and you have a luxury suburban apartment now, that could be a two bedroom and is a better deal, and now you’re not working remote because your employer’s asking you to come in three days a week, there’s a lot of dynamics that might create pressure on lease rates, which we’re expecting, but the build for rent guys aren’t expecting that.

Affordability in Properties

Bilal Hafeez (32:16):

Okay. Understood. And you mentioned affordability a few times. Obviously, mortgage rates have gone up. How do you look at mortgage rates? Is there some threshold that is important? Is it just the rate of change?

Ivy Zelman (32:26):

We think about rate of change, but if you think about a brand-new home and think about the monthly payment for the consumer on an entry level home, right now, it’s up about 50%. Combining the pressure from higher rates, couple that with the higher home prices, income’s inclusive of rising incomes that are just not rising fast enough, affordability in an index that we measure it is at like amongst the highest levels that we’ve seen even exceeding the prior stretch levels that we saw in the last cycle.

So that’s really a function of how does the Fed orchestrate improved affordability while trying to fight inflation without pushing rates higher? I’m outside of my expertise on trying, I don’t forecast long rates, but right now we need to see a pretty substantial decline in rates and/or home prices to see affordability more attractive. And keep in mind, one of the things that I’ve been trying to appreciate over the course of the last five years of watching the refinance market, even prior to COVID, continuing to benefit from just the tailwind of rates, just headed 30 years lower. And how many people in the United States that have a mortgage, roughly 65% of homeowners in the United States have a mortgage, what percent of them actually are locked in below, let’s say, 5% or locked in below 3.5%? So those two numbers are to give you some perspective. Below 5%, the last time we measured it, it was 92%. And those that are locked in below three and a half was 50%.

So that really stops mobility as it disincentivizes consumers to move and they’re locked in, so you start to see turnover really slowing. But then on the other hand, you’ve got these non-primary owners that might be, you know what, I don’t need this many properties. And then you just have the typical, what we in real estate refer to as the 3 D’s, which might be more notable in a recession: death, divorce, default. And you start to see that those transactions are going to happen and the discretionary kind of goes away, but it’s not going to mitigate price decline. But those are the dynamics that we’re watching, and we would really need to see a sizable decline in affordability. And even now, I see offers because our analysts and my team, we’re tracking in the market through every data point available, what we’re seeing on public builder websites, what we’re seeing with Google alerts and various markets, where we’re seeing offers of rate buydowns that are pretty substantial or a teaser rate 3.75 adjust to 4.78, lock in now, a great deal and still no buyers at that in certain markets.

So, there’s inelastic response, even though they’re giving you this nice rate buydown or lower rate. Whereas it could be that that starts to work because it’s working in certain markets, but in other markets, it’s not to give people more affordable offerings. But when the consumer starts getting nervous that they’re buying and home prices can go down, that arrests their demand. And so that’s the dynamics that we’re looking at. And while discretionary spending, obviously with non-discretionary with shelter, healthcare, utilities, property taxes, where you’re dealing with higher costs, you now have all your food, your energy, all those costs are going up to. So even without affordability, necessarily a stretch it is, the availability of discretionary spending is shrinking and they’re allocating more to their home.

So, we’re seeing consolidation in households. Whereas this idea that we’re having, this massive pent-up demand, because all these young adults that are living at home are now, we’re unlocking that, we believe household consolidation is starting to accelerate. And you read about people are renting out rooms in their home to supplement their income or you’re seeing people having to double up and have roommates and that’s not positive for the need for more supply. So, it’s a headwind as opposed to a tailwind, which is how I think the market views it today, that there’s more of a tailwind as it relates to the demographics than we do.

Regional Outlook, Including New York

Bilal Hafeez (36:33):

And in some of the regions, say for example, like New York, I mean, lots of our listeners live in New York, do you have a more localised view?

Ivy Zelman (36:41):

We see New York really at a MSA level and sort of looking at just the political backdrop and high cost from a tax perspective. When you look at just the blue states, New York being one and think about the migration from high cost to low cost, New York City actually saw a peak in real estate prices by 2014 when there was just this massive run up from investor demand and really suffered from ’14 through really up until probably about a year and a half ago. And really, even maybe a year ago, lagged the rest of the nation’s surge. New York took a while to come back in the city as compared to the suburbs who were on fire initially.

I mean, Connecticut was left for dead, Greenwich, and all of a sudden, every mansion was being sold at multiple bids and kind of market outside the greater New York area exploded. But the New York City market took longer to kind of join the party. And right now, I’d say the New York market is a little bit more resilient depending on the price point. But we’re definitely seeing a lack of foreign investors and we are seeing more competition now and more listings, not to the magnitude that we’re seeing in other markets in terms of the surge of listings. But I do think that the market is in a headwind situation. As a New Yorker, I’m not happy about that.

Bilal Hafeez (37:55):

I can imagine. I could carry on asking you questions, but I think you’ve laid out a very compelling case for the outlook for the next few years.

Ivy Zelman (38:02):

I wish it was more favourable.

Bilal Hafeez (38:04):

Yeah. Yeah. Unfortunately, it’s not as favourable, but it’s better for people to have complete information than not. So, it’s been very helpful. I did want to ask you a few non-market questions and this is something I ask all my guests. One is, what’s the best investment advice you’ve ever received from anybody?

Ivy Zelman (38:20):

Oh, goodness. Well, I actually would say that I’ve read a book a few years ago called The Psychology of Money by Morgan Housel. And that really changed my views of how to invest. So, I wouldn’t say Morgan gave me personal advice, but that book had an impact on how I think about investing. And, for me, I’m really more in conservation mode as opposed to being interested in just kind of trying to make a quick buck. So, I’m more of a conservative person as it relates to my personal investing, but that book had an impact on how I think about investing more so than trying to buy individual stocks and be smarter than people that are paid professionally to do it. I’m in my little housing world. So, I look for more of the risk off and more longer term, where do I have consistent returns rather than trying to get grand slams. And that was really the message from The Psychology of Money, that book, I thought it was really impactful.

Bilal Hafeez (39:17):

Okay. That’s great. Another question is many students are graduating university. It’s been a horrible few years for them being stuck at home and so on, but what advice would you give to people leaving university as they enter the world?

Ivy Zelman (39:29):

I have three of them. So, two of them in university and a rising senior. My view is that these four kids have been through the ringer. My son didn’t get to graduate high school in a normal ceremony and obviously in the heart of COVID, he was graduating in May. So, I think that most people, the intensity of what the demands on students today from every aspect is I would never get in university right now, probably, if I tried. It’s just so much more challenging and I always tell them, “Your first job won’t be your last job.” And just recognising that today in the challenges that we have, there’s opportunities and a lot of millennials really want a more balanced life. And that’s something that in my generation…

There’s a great book by Scott Galloway called The Algebra of Happiness that should be required reading for young adults. But you really have to put in the blood, sweat and tears in order to be successful, whether it’s from your 20s to your 40s. And then you can kind of enjoy on the downward slope. But I think young people need to recognise that they really have to work hard and be committed and have the work ethic that will allow them to be successful. And many are like, “You know what, my weekends…” It’s just a different philosophy. So, I think if you really are interested in being successful, then you have to put the work in and recognise that you can change direction in careers. One of my good friend’s sons was in property management and at 30, he went to learn how to code and took a loan and now he’s shifted.

And so, it’s never too late to change. And if you’re in a major and you don’t really like it, you can reinvent yourself and don’t be afraid to take that risk. Because when you’re young, you don’t have kids, not married and all the responsibilities that we have, it’s harder. So, when you’re young and you can experiment, but you’ve got to be willing to put in the time and the work and the effort. I talk to kids today and I ask them, “Do you read the Journal? What are you reading?” And sometimes, “Well, I don’t really. I have it on my newsfeed.” It just feels like paying attention and asking questions, that’s the biggest thing.

So, I wrote a book called Give Me Shelter and it was really a memoir about, for me, how to pay it forward. And it was really geared towards students and women and people that are interested in finance. But I always asked for help. I always was doing my best to meet people and ask them about their careers and do they like what they’re doing and just constantly digging to help me ascertain what I wanted. And so that’s my best advice is ask for help, whether it’s your parents’ friends, your relatives, your professors, and email them. People want to help. And it’s funny, when you talk and you’re the one that is on the other end as students asking questions, all of a sudden, they’re asking questions, you’re like hanging up. You’re like, oh my god, that young person is brilliant, and they barely say anything because you talk so much as the person they’re requiring from. So, I do think it’s really important that people take advantage of relationships or try to create them.

Bilal Hafeez (42:28):

Yeah. No, that’s great advice. Another question I had was, I mean, you obviously digest a huge amount of information and there’s so many information sources. Do you have a system or some way of keeping on top of everything?

Ivy Zelman (42:39):

Absolutely. Organizationally, we wouldn’t be successful, and we really rely upon our own data aggregation machine, again, having the ability to have relationships with C-suite executives across our entire housing ecosystem and doing a systematic monthly aggregation of that. Marrying that with all the public data that’s available, we can synthesise and triangulate and really collaborate with each other on what we’re seeing month to month. And intramonth, we’re in many cases, especially right now, given the severe changes in the market, we’re on the phone talking with the owners and operators because you can have the best models in the world that’s already proven they didn’t work. So, mine is the boots on the ground, having the ability to aggregate on a monthly basis, on a quarterly basis, what we’re learning from these great partners of ours and then tracking all the public available data from the publicly traded companies. It definitely is a lot of information that comes into the funnel and then working very hard to utilise what we can into our programmatic foundational systems that we’ve created.

So, I would just say that we’re fortunate that we have this business model because it’s unique and differentiated, but we also do a lot of deep dive thematic work that creates a foundation like the demographic work we’ve done to help us understand where we are in the cycle. But we’re always testing ourselves, never complacent. I always call myself, I’m like a paid warrior. I’m just always looking and sceptical about whether it’s good or bad, the sustainability of that. But our work, if you check out our website, we do offer the research a la carte or in various silos that could be purchased for investors to check out. And I think that our consistency, we’re not a one hit wonder. We’ve been consistently providing; I think research that has been helpful to our predominantly institutional investors to help them with what investment strategies they might be employing. So, that’s our business model.

Bilal Hafeez (44:40):

That sounds great. And I’ll include a link to your site so people can click straight through to it. So, with that, I just wanted to say a big thank you for participating in the podcast show. I’ve learned a lot, both in terms of housing and also from a personal level as well. And it’s great having you on.

Ivy Zelman (44:56):

Thank you for having me. Thank you.

Bilal Hafeez (45:01):

I also wanted to add that Ivy will be hosting the Zelman 2022 Virtual Housing Summit on September 19th to 23rd. It’s got a great speaker list and we’ll cover all you need to know on US housing. Ivy said she will kindly give a 25% discount to the Macro Hive community. Just mention Macro Hive when you sign up on the Zelman & Associates website. Thanks for listening to this episode. Please subscribe to the podcast show on Apple, Spotify, or wherever you listen to podcasts. Leave a five-star rating, a nice comment, and let other people know about the show. We’d be really grateful. Finally, sign up for our free newsletter at macrohive.com/free. We’ll be back soon, so tune in then.

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)