80% of US Housing Is Overvalued

Dave:
Hey, what’s going on everyone? Welcome to On The Market. I’m your host, Dave Meyer, joined today by James Dainard. James, what is going on, man?

James:
Oh, doing well. Just grinding through this market right now. We are in rapid wrap things up. It has definitely been transitioning pretty aggressively in the last four to six weeks.

Dave:
Well, as we’re going to hear from our guest today who is incredible, the guest today is Cris deRitis, who is the Deputy Chief Economist at Moody’s Analytics. He specializes in assessing the economy’s impact on household financing, housing credit markets, and public policy. He’s incredible guest. We had an amazing discussion. He talked about, spoiler alert, he thinks markets are going down over the next couple years and he’s going to explain that in more detail, but with that information, maybe, do you have a quick tip for anyone listening to this on how to keep investing and keep improving your financial position in a market that is potentially declining in the next year?

James:
Yeah. It’s all about just proper underwriting and buying right now and just mitigating risk. I think the biggest thing that we’ve been doing and we’ve been talking to our clients about is just not rushing into that deal, really running your core metrics numbers, putting some padding in your proforma, putting some padding in whatever your exit plan is. Like what we’re doing or my favorite strategy in 2008 to ’12 was I just ran everything so worst case. As long as I knew I would break even no matter what on the deal, we would buy it. So just be super conservative on the numbers.
We are seeing extremely good buys right now in the multifamily sector, though. I mean, we are getting pricing I haven’t seen in a while. So just really look for where the actual opportunities are, and if you were doing something in the last 24 months, you might want to switch it up and look at in a different investment platform at this time.

Dave:
Awesome. That’s great advice. Yeah. Everyone listening to this, I mean, it’s what this show is about, right? There’s always opportunity. You just have to adjust your strategy to the market conditions. I think you’re going to learn a lot from this episode. I loved this episode. This was really helpful. Finally, we’re talking to someone who really does economic forecasting and modeling and has, I think, a very sound understanding of what’s going to happen in the housing market, not just in the next two years, which is important, but over the next 10 or 20 years, which is perhaps even more important for real estate investors who are trying to build a long-term strategy, trying to find that financial freedom. So definitely stick around for this. We’re going to take a quick break, but then we’ll be back with Cris deRitis from Moody’s Analytics.
All right. Let’s welcome Chris deRitis, who is the Deputy Chief Economist at Moody’s Analytics to On The Market. Cris, thank you so much for being here.

Cris:
Oh, thanks for having me. Looking forward to it.

Dave:
Well, James and I have been nerding out about some of your economic studies and we will get into some of the Moody’s forecasts for the next few years, but first, can you just tell us a little bit about yourself and your role at Moody’s?

Cris:
Sure. So I am the Deputy Chief Economist at Moody’s Analytics. That’s distinct from the rating agency that most people think of when they think Moody’s. We have a different division that focuses just on risk analysis. Particularly, my group focuses on economics and economic scenarios. So we do a lot of forecasting across the United States. We’ve got a lot of local markets, as well as international forecasting as well. So we’re constantly looking at the data, trying to figure out where economies are headed, and hopefully providing some guidance that leads to better or more useful decision making.

Dave:
Well, we’re super excited to have you. We do a lot of speculating on this show where we read a lot and I think we’re all pretty informed about what’s going on in the housing market, but none of us actually maintain for economic models or do our own forecasting. So we’re really excited to have you on and talk about what you all see happening in the short-term and, perhaps more importantly as we were just discussing before we started, the long term trends in the housing market.
So before we pin you down and ask you what you think will happen next year, can you just tell us a little bit about the variables? What are the factors that you’re looking at that impact the forecasting you’re doing for the housing market at least over the next few years?

Cris:
So forecasting housing is like forecasting any other asset. We look at both supply and demand. On the supply side, we’re looking at the factors that impact builders’ ability to build homes, so construction costs, how much are building materials. Lumber prices had been a big issue throughout the pandemic, for example. Wages of construction workers and even availability of construction workers is an issue when it comes to building homes. Perhaps more than anything right now, the builders tell us that it’s zoning restrictions and other regulations that they face, which really limits their ability to find buildable lots and put up housing.
Then on the demand side, we’re certainly looking at the cost to borrow. That’s the major factor impacting home buyers. Most homes are still financed in the US. So as interest rates go up, demand comes down, and we’re seeing demand come way down, of course, as affordability gets impacted. So those are just some of the factors that we’re looking at, household formations, right? So how many households are actually being added to the population? Well, that’s a direct corollary or highly correlated with demand, right? You have more households coming in, you have more immigration or higher birth rates. That’s going to impact the demand for housing that we need in the country.
Aging of the population might impact how many second homes or vacation homes people want as well. So there are a number of factors that we’re looking at, but it helps to really break it down into that supply and demand side of the equation. Then from there, we can try to estimate what an equilibrium level of housing might be and where we are today relative to that equilibrium.

Dave:
Now, I’ve seen there’s been a lot in the media coverage of Moody’s forecasts and it seems, I’ll just summarize and let you do the detailed analysis, but I’ve seen that on a national scale, Moody’s is predicting year over year price declines in 2023. Can you tell us a little bit more of the details about those predictions?

Cris:
Sure. So we run models, as I mentioned, that look at those supply and demand factors, and we are estimating what the equilibrium or trend housing values should be. What should house prices be if we just considered incomes or rents and look at historic ratios between prices and incomes? So that is a core or fundamental basis of our model. That then defines what the fundamental value is, and we compare that to what values we are currently observing in the housing market.
Right now or during the pandemic, we saw tremendous run up in home prices, about 40% increase from the beginning of 2020 till today. That far outstrips what incomes did during that time. Although we’ve had some nice income growth, it’s nowhere near 40%. So as a result, our calculation leads to the conclusion that most housing markets across the country are indeed overvalued. So of the 400 plus metropolitan areas that we have in the country, we stated that about 80% of them are above their fundamental value.
Now, there’s some measurement error in the models as we know, and you said you’re a data nerds, so you know there’s a lot of volatility in the data. So you don’t want to get overly excited by a market that’s only one or two percent overvalued, right? So you want some threshold or some cutoff that really sticks out. So we tend to look at those markets that are more than 20% overvalued as being once that we might be particularly concerned with, and then we rank order the markets to see which of these metropolitan areas we particularly want to be focused on.
When we do that, what we find is that many of the markets in the South, and particularly in the Mountain West did experience very sharp rises in home prices relative to their incomes, and those would be the ones that are most vulnerable to a double digit type of correction here. So we’re thinking about Boise, Idaho, Phoenix, Arizona, Austin, Texas, some of the major markets, but then particularly concerning to me are some of the second tier or third tier markets as well that might be sitting next to major metropolitan areas that also saw a big run up in prices, and my concern there is that as things turn, they might start to weaken.

James:
So Cris, you were just talking about and I was reading online as well, so Moody has predicted some decline in the market about five to 10 percent over the next 12 to 24 months, but what you were just describing to me is the perfect mixture of what also could be a disaster where cost of housing going up by 40%, cost of money now up about 40% on the mortgage cost and then salaries just haven’t quite kept up with that pace. I know even in the expensive markets like our tech buyers or our tech markets, we saw salaries increase 15 to 20 percent. They made a lot more money on their stock growth than they did anything else, which is now also down.
So it is looking like this perfect mixture of what also could be a disaster as well, not just a five to 10 percent pullback, but it could rapidly bring pricing down. Why are you guys predicting more of a conservative drop rather than a rapid with all these things going on?

Cris:
Yeah, great question. Parallels to the housing crash in the late 2000s are obvious. So what’s different this time are really two key factors. One is demographics, right? So back in the housing crash of 2006, 2009, we had a small Gen X population turning 30 or in their earlier 30s, prime age for home buying. At the same time, we were building over two million units, new housing units per year. So we had the supply-demand imbalance there. We had a lot of flipping and speculation going on.
Today, we don’t have that. We have actually the reverse. We have a very large millennial population that is looking for housing. We have a housing deficit in this country because we haven’t been building over the last decade. By our calculations, we’re about 1.5 million housing units short of where we should be. That’s on top of just what we should be building each year to keep up with population growth.
So you have that underlying demand out there. You have the lack of supply. So the demographics are actually more favorable today. So even as prices start to come down, our expectation is you will have buyers stepping up as prices come back into a more reasonable zone. You’re right that the interest rates are a big weight in terms of affordability, right? So that is the reason why we do expect to see house prices come down, housing demand coming down over the next couple of years to begin with, but to really cause more of that snowball effect you’re referring to, you’d really need to have labor market declines, so higher unemployment, people actually losing jobs, losing their incomes, and unable to make their mortgage payments.
The other key difference, of course, today is that the lending standards for mortgages have been much, much stronger than they were back in ’06 and ’09, right? Back then, we had very loose lending. People didn’t have to put a whole lot of money down on their properties. Today, home buyers are much more qualified. They don’t have these crazy option ARMs or negatively amort using ARMs or adjustable rate mortgages, and they have much more equity in their homes.
So even as prices coming down, most home buyers are still going to be in a positive equity situation, and the fact that they have been able to lock in very low interest rates, record low interest rates over the last couple of years means that they are more likely to fight for their homes, right? They’re not going to let those homes go quite so easily into foreclosure, right? They’re going to do what they can to avoid a default because the consequence is going back into the market and then facing a much higher interest rate, facing much higher rent prices as well. So for those reasons, expect to see the market cooling here. We allow time for the market to catch up in terms of incomes and rebalance the price to rent or price to income ratios.

Dave:
Yeah. Cris, I saw something the other day, just to reiterate one of your points and all those are very helpful, thank you, but just about the adjustable rate mortgages and how that got us into a big part of the mass in 2008, that back then 40% of mortgages were adjustable rate and now it’s less than 2%. So that just shows you the scale and difference of how lending standards have changed.

Cris:
Yeah, and even the adjustable rates we have today, the adjustable rate mortgages are quite different than what we had back then, right? Today, we do have adjustable rate mortgages. You can get a five one ARM or 10 one ARM, but even those have very limited or more limited risk than the adjustable rate mortgages we had back then, which may have been adjusting every month or every six months, may have had negative equity. So very different situation.

Dave:
Okay. So I have this question I’ve been longing to ask someone and it seems like you’re the person for the job. So you said that the basis of your model is that you derive this intrinsic value in home prices based off income and home prices, and traditionally what people pay. That makes sense, but in other countries, like if you look at Canada or Australia or New Zealand over the last couple of years, that dynamic has just fundamentally changed, right? The proportion that people are paying for their home out of their total income has gone up and up and up, and we’re probably seeing corrections in those markets too, but I’m just curious, is there risk of that happening? Is there maybe a chance that the United States is heading in this way where people are just going to have to pay way more for housing than they have historically?

Cris:
Yeah. I think it goes to certainly the demographics and the demand side of the issue, right? So from my viewpoint, we do have this housing deficit. We have much more underlying demand than we have supply. So you obviously see the homeowners and you see the renters out there and you get a sense of housing market from those populations, and you can look at the home ownership rate to see what that looks like in terms of are people able to buy homes, are we seeing home ownership rates increase.
What gets unnoticed is that whole population of young adults in particular who are unable to access the housing market in any way, they’re not able to rent because the rents are too high relative to their income, they’re not able to buy because of the affordability issues, and so they’re living with parents or they’re living with roommates. So they fall out of our housing statistics. We don’t really have visibility into them.
So at the moment, given the demographics, yes, I would agree with you that there’s so much demand out there that is forcing individuals who want to join the game, want to start their own households to face even higher house prices because of the supply issues. If you look ahead, and I think we’ll get to this a little bit later, the demographics are forecasted to change here, right? We have falling birth rates, immigration rates remain low. So this dynamic could change very rapidly as you go 10, 15 or 20 years out.
So I don’t expect to see these types of constraints in terms of how much households are spending on their housing costs to persist forever. I don’t think they can. I don’t think that’s sustainable. So over time, it will adjust as those other demographics adjust, but in the meantime, you certainly can have a bit of a pressure on those households and see that they’re spending a lot on housing.

James:
Well, yeah, because there’s no other logic behind this that you can come up with. If you look at certain parts like Vancouver, Canada, it’s just very expensive real estate, very expensive housing. Right now, even with what we’ve seen in the market pullback, we’ve seen about a 20% drop off of the peak, peak pricing, not medium home, but the highest comparables that we were seeing. I was even talking to Dave about this earlier is that you would think it would have more impact with the cost of money. If the cost of money’s up 40% and we’ve just seen this, I would almost think that the housing price would come back even further, almost drop as fast as it appreciated over the last 24 months. We’re seeing a pullback, we’re not seeing that free fall, and that’s where I’m like, “Yeah, we might just be in an expensive housing, but housing might just be a privilege going down the road.” You’re going to have to expend a lot of money and that’s going to go into a lot of your earned income. It’s going to be going towards housing costs, but that’s obviously not the healthiest housing economy in general. So how do you even fix that before it just goes off? I think once it water falls over, it’s going to be stuck there for a while.

Cris:
Yeah, I’d agree with that. So again, our forecast does have the prices coming in, but basically going flat for the foreseeable future until incomes can approach the type of house price to income ratio that we’ve had historically. Supply, though, is the real barrier here, right? Obviously, rates matter and higher costs do restrict the opportunities for folks to actually purchase homes, but without more supply of housing, this is going to persist, right? You’re still going to have too few homes and too many people looking for housing. So that involves changing zoning laws. That involves changing other regulations, things that are very difficult to do because of the NIMBYism or the other trends that we’ve seen.
Another fact I can throw out there in terms of a Vancouver mark is also the reduction now of foreign home buyers given the strength that the dollar, in particular you are seeing that foreign home buyers no longer find the US or Canada particularly attractive for them to invest in. So that actually could have some beneficial effect for the home buyer, the domestic home buyers who might be looking to buy. So that could have some offsetting impact, but, yeah, that is a delicate equation there in terms of how that dynamic plays out over time.

Dave:
Yeah. Cris, I really want to get into that supply issue and some of the long-term things, but before we get off the short-term forecast, you had mentioned Mountain West markets, Boise, Phoenix, you named a few. What is the downside forecast for that? How bad do you think it could get in some of those markets? Then on the other side, are there any markets that you think will keep growing even in this environment?

Cris:
Yeah, great question. So I think 15, 20 percent down from the peak. So peak was probably second quarter of 2022 for most markets or maybe a little bit of variation there, but if you tell me Boise is going to be down 15, 20 percent over the next couple of years, I wouldn’t debate that, but that’s off of a 40, 50 percent increase, right? So for the homeowner who’s been there a while or the homeowner who tends to stay there a while, this isn’t catastrophe, right? This is something they, to a large extent, could ride out. It’s the buyer who bought recently, bought at the peak, that’s the one, of course, that’s most at risk. So there is the chance that things could snowball a bit, but by and large, there’s a lot of equity that folks have that we have to burn through until we really start to do damage to those markets.

Dave:
So the second question there, are there markets that are going to grow? I think we saw some in maybe the Midwest or Northeast. Do you think, maybe not even grow, but at least be a little bit insulated from downside risk?

Cris:
Yeah. There certainly are markets that didn’t experience quite the run up that others did in the Northeast and the Midwest. There was a lot of migration out of those areas into the South and to the Mountain West states that drove the prices up. So there are values there and certainly, again, for these millennials or younger home owners or home buyers looking for a place that there are more opportunities perhaps in some of those areas than what they face in those more competitive markets, and with remote work being an option for more and more people that I would expect to see some stabilization in those markets, even potentially some growth for the ones that really didn’t experience much of a rise during the pandemic.

James:
So is that how you guys came up with most of those metrics was … I saw Albany, Georgia, Columbus, Georgia, where areas that you guys predicted would it actually have 5% growth in those markets. The basis behind that is based on housing prices and income, right? Those are the two main factors that they’re looking at, and because those markets didn’t skyrocket in the second quarter, that’s why you’re predicting more steady growth. The ones that basically didn’t hockey stick up in that second quarter are the ones that are going to be the healthiest.

Cris:
Yeah, for the most part. There are some markets that actually did experience a lot of price appreciation that we don’t have as being at high risk because they maybe were dominated by individuals who brought a lot of wealth with them, right? So you did have folks moving out of the Northeast accelerating the retirement from wealthier individuals moving to Naples, Florida, for example, and prices in Naples really did go up or Miami. They went up a lot, but they also brought a lot of income with them or a lot of other wealth that might offset the risk that they would have to or be forced to sell in any type of downturn. So you want to be a little cautious to just jump on the markets that saw a lot of house price increase and assume that they’re going to reverse. There are some other factors out there that might offset those risks.

Dave:
All right. Well, that’s super helpful, Cris. Hopefully, everyone listening to this appreciates that. It’s really, really good, informed analysis of what might happen in the market over the next couple year or two, but real estate investing is a long-term game for most people and we’d love to pick your brain about what’s going on long term. I mean, you said it very succinctly and I loved it. You just basically said we need more supply. That’s the problem with affordability in the United States. That seems to be causing a higher, maybe I’m wrong here, but it seems like there’s a higher degree in pricing variance than we’ve seen traditionally in the housing market. Can you just tell us a little bit more about the nature of the housing supply shortage in the US and then James and I will ask you a hundred more questions?

Cris:
Yeah, absolutely. So there’s definitely a shortage, particularly at the lower end of the market, and we do break out home prices in these different markets by tier, right? So we’ll group each market into low, medium, high tiers by price in that market. What we’ve seen is that prices have risen the fastest at the lower tier. There’s lots of demand in that lower tier. People are looking for starter homes, looking for homes that they can then maybe live in for a while and turn into investment properties, right? So there’s a lot of demand in that particular segment, much more than the available supply.
So prices have gone up across the board. I want to say that high tier markets or high tier homes aren’t rising as well. They just haven’t risen as fast as the lower tier, and that’s very much a consequence of the fact that you do have so many people looking to enter the housing market.
You do have regional variation as well when we think about the affordability of housing where people are wanting to live or choosing to live, right? So there is quite a variation in terms of affordable housing in terms of the demand. Then on the supply side, there are certainly land constraints that will drive up home prices as well and limit the amount of affordable housing that you might be able to build in a San Francisco or in the Bay area versus areas like a Dallas, which until recently at least have a lot of land to build on, but now are actually facing constraints in terms of travel time and other considerations that buyers may have. If you have to commute to work still and you’re living two, three hours away, that’s not going to work either.

Dave:
It’s not commuting, that’s traveling. Yeah. So that’s fascinating. So you mentioned at the top of the show some of the issues that are contributing to this, but I’d love to talk about a few of them. One of them is this idea of NIMBYism, which is not in my backyard, what it stands for and is this phenomenon where people always speculate that they want more housing but they don’t want it built near them because that would add more supply in their neighborhood or maybe they don’t want multifamily units in a single family neighborhood, something like that. Can you just talk about that phenomenon and how that specific issue is contributing to the housing shortage?

Cris:
Yeah, it’s pretty interesting, right? What I find particularly interesting is that it seems to cut across the political divide, right? You ask folks on the left, “You want more housing?” “Of course, we want more housing. Housing is right and everyone needs a place to live. We want more housing.”
“Okay. How about we build it? There’s a nice lot not too far away from you. We’d like to put a multifamily complex there. We need to achieve density. That’s one of the ways we can lower housing costs as well or build up a lot of housing units in a short period of time.”
“Oh, well, well, wait. Wait, well, no, there’s traffic congestion issues or there’s a million different reasons why we want more housing but we don’t want it near us.”
The same talk does apply on the right as well. The argument typically given over on that side are, “Well, everyone should have a right to do with their property what they wish then.” So there’s property rights issues, and yet then there’s still this concern about traffic and congestion, “oh, well, maybe we do need some zoning and restricting things.” So it’s very difficult when we have local control of communities that are deciding on their own zoning laws to then impose or change the system, right? There are ingrained interests, right?
If you’re already in the club, if you’re already a homeowner, it is in your interest in some sense to keep restricting the supply that does drive the price of your individual property upward. So it’s a very difficult situation to get around. There are a few states now that are challenging or have introduced some relaxation on zoning and that will help, but even those will take some time, and even though you might have the right to build multiple units on your property today in some jurisdictions, it’s still maybe difficult to actually execute on that option in a cost effective way. So it’s not a short-term solution. It is part of the solution, but it’s not something that gets us there rapidly.

James:
Yeah, and that’s actually been a struggle for us in the local Seattle market is we had a lot of upzoning over the last 24 to 36 months, where they actually allow you to expedite your permits to put in affordable housing or detach ADUs and DADUs, and what they’ve gone with the zoning, they want no more McMansions. They actually shrunk the FAR ratio, the floor air ratio coverage or floor area ration coverage, and they’ve done that because they don’t want these big houses getting built and they want a bunch of smaller properties and more affordable housing, but the main issue is the cost to build is extremely expensive because the units are so small and you still have kitchens, you still have bathrooms, and the core costs.
So there was this big fad of these things getting built throughout all of Seattle for 18 month period, and now the brakes have been hit because the cost. That’s the problem is they’ve upzoned it, but they haven’t thought of it all the way through because the replacement cost is still so high you can’t really make it work right now in today’s markets with the current rates and the current pricing.
So we actually did see this oversupply and we have seen a little bit of pushback. A lot of the people in Seattle, they wanted the affordable housing, but now with all these little detached ADUs throughout, it does affect the neighborhood profile. It affects how the neighborhood feels in the character, and then the parking and the traffic is an issue. These are things that I think it was working well in some markets for a two-year period. Now, it’s like, “Here, here’s this pause. We need to rethink a couple things through.”
Mostly, I think that inventory’s going to stay lower though just because the cost to build is too high. It was costing us. We build town homes in Seattle for around $300 a foot start to finish, and the ADUs and the DADUs or the cottages that you could build were costing us nearly $400 a foot because they’re just so small. So why would you build them at that point? It just didn’t make any mathematical sense, and then that’s caused the dirt to come down quite a bit over the last two months.
It’s like they’ve started to figure out the affordable housing, but it’s like they haven’t figured out how to make it affordable. So it’s just the pricing is so high on these things. It didn’t fix the issue. I think the only way to really fix it is, to be honest, the government’s probably going to have to subsidize building costs a little bit on those. If they really want affordable housing, they’re going to have to keep that number down because it’s causing pricing to be up 20% across the board.

Cris:
Yeah. Well, one problem in housing in general is just the haphazard nature of the rules and regulations, right? It’s not that we plan these things in a very systematic or well-thought out way. It’s reacting, right? We make a change here. We don’t fully think through all the consequences. Maybe we can get there is a fad or a trend that starts in one area, but now all of a sudden we do have congestion and all these concerns of the NIMBYs do have some legitimacy. So how do we think through those in a more constructive manner?
You’re right. The builders, they have a profit motive, obviously. So even to the extent that they want to build more affordable and they’re onboard with building more affordable housing, they face challenges, and when it comes to building costs, availability of labor, so it’s a shifting market from that perspective as well.

James:
Yeah, and going to your point, the inefficiencies of the city, the debt cost is actually one of the worst costs of the whole thing because it takes so long to get permits with the pandemic and supply chain. I mean, labor shortages, plans, permits, everything take 30% longer than it used to. So the debt cost too, so unless they can figure out how to build that faster and cheaper, it’s not a solution that’s really working in today’s market.

Cris:
Yeah. I would think that a shorter term play could be to focus a bit more on all the vacant housing that is out there. Now, there are millions of vacant homes that are not used even seasonally or occasionally. They’re just in need of repair. They need some attention to be brought into active use, but they do tend to be scattered, right? So along the same lines of, “Okay. It’s great we can build accessory dwelling units,” but that’s not the same as open tracked development, right? The costs are much higher because they’re one-offs, right? It’s one unit here, one unit there. So there is an opportunity, I think, to rehabilitate vacant homes and bring them online a bit faster because they don’t have all those permitting restrictions. The home already exists, right? Just needs to be fixed up, but I think that only happens with some type of support to kickstart the process as well.
An individual is going to face a lot of challenges. If they want to fix up their home, bring it back in the market, they may not be able to capture the full value in terms of the market rent until all the other properties around them are also reaching the same level of amenities or building quality. So I think you do need to see some government support out there to provide the incentives for the builders to either fix homes or build new homes and provide that additional housing. So I think there are other solutions that we can come up with here beyond just trying to find another place to build and facing all the permitting and regulations that you mentioned.

Dave:
Are there any other solutions? I know you’re not a politician or a policy firm necessarily, but are there any other proposals or ideas that you think could help alleviate building costs and bring more supply online?

Cris:
Well, now, there’s this whole idea of office conversions, right? So now, we have another imbalance caused by the pandemic, retail and office. We have too much retail space, too much office space. Should be converting that. That’s, I think, a lot of analysts say, “Oh, it’s obvious, right? It seems like a coincidence of wants, right? You have these empty office buildings that are getting underutilized and you still have a lot of need for housing, right? Why not just convert them over?” That’s a promising solution, but as we know when we talk to builders, it’s not that easy, right? The footprints of buildings are quite different. The location of office buildings may not be zoned for residential. So you have, again, some regulatory or zoning issues.
So I think there is opportunity there to do some of these conversions, but that, again, is going to be a slow process. It probably needs to happen, right? We don’t want empty billings sitting vacant all over the place. So there is economic value to them, but no, I don’t see any quick fix. A lot of the proposals that have been put forward really are focused on the demand side, right? They’re looking to bring down the cost of financing, and that’s all good, provide more opportunity, open up the credit box. That’s good. We need to focus on those opportunities as well, but until we fix the supply issue, I don’t see that we’ll really address the needs of all the people who want to start homes or start households and buy homes.

Dave:
Yes. I’m so glad you said that because I agree. Short-term demand side alleviation can help and people need housing. We need short-term stuff, but the only solution is more supply. I just don’t understand how. It seems like not even in the either side, political discourse, people are talking about long-term housing issues and how it’s going to be addressed over 10 or 20 years.

Cris:
Well, so that gets to long term if you look beyond the next 10. So next 10 years are going to continue to be a struggle because you do have this millennial population that is the largest generation, in their early 30s, looking to buy homes. They’re delaying those home purchases because they can’t afford it, but they’re going to continue to want to purchase homes over this period. At some point, they will start to age out, right? At the same time, we have baby boomers, their parents, who at the moment are choosing to age in place and they even have two, three properties, a vacational, maybe investment property as well. So they’re actually soaking up some of the demand for housing as well.
Well, eventually, they’re going to be downsizing as well, either by choice or as they move on, right? Then you’re going to have more supply coming online from them. So there is a potential here for the verse problem to occur in terms of oversupply of housing, I should say, 20 years from now. So as the population ages, as the birth rates come down, if we don’t change our immigration policies, we could be in a position at some point where actually you have too many houses, not too many houses. It’s likely that we have houses in places that people won’t want to live. So I always look to Europe as my guidepost or I look to Italy as a good idea of where the future is. You have this aging population.

Dave:
The $1 houses?

Cris:
Yeah. So very possible that you will have some areas of the US where people will no longer want to live. It won’t be cost effective for them to live there, so you could have that phenomena, and perhaps even more importantly, you might have housing structures that are incompatible with the demand, right? So we have these five-bedroom, six-bedroom homes, but in the future we’re going to have even more single person households or one child, two child households. So we might not need those types of structures. So how do we then redesign or redeploy that housing as well? So when you think about how does this housing deficit get resolved, well, it will resolve itself to some extent because of the demographics, but it still might not be efficient use of all the housing stock we have once we get there.

James:
There’s going to be a lot of house hacking going on where people are just renting out these big mansions room by room.

Dave:
Where you’re just living in by yourself, just partying, staying in a different bedroom every other week. Well, to your point, Cris, I was joking, but in Italy, there is a dollar, they do offer these incentives to people to move where there’s housing supply and no one wants to live. Obviously, it feels like we’re very far away from that in the US, but to your point, with a declining population, that does seem like where we’re heading unless something changes in terms of population or lower construction rates or something like that.

Cris:
Yeah. So I would assume that the construction rates will adjust if that plays out. So it’s really the demographic story, the immigration. If birth rates all of a sudden start to pick up, then that’s maybe a different story, but we don’t see those trends, right? Even on the immigration front, either from domestic policies, it doesn’t look like we’re changing anything, but then we may even miss the boat. Other countries are experiencing the same type of population slow downs or declines. So there may not be as many immigrants globally that are available or they may choose to go to other countries, go to Canada. Other countries may soak up some of that immigration as well. So I do see a slow down certainly as we start to look at 2040 or 2050, start to go out aways. In our forecast, we have construction coming down as household formations are coming down as well.

James:
If you guys are predicting that, as demographics population shrinks, that there’s going to be oversupply of housing or affordable housing for people to actually purchase, there’s still going to be … What about the rental market and the apartment market? Do you feel like there’s going to … We’ve seen a rapid amount of rent growth too over the last 24 months. Do you guys feel that there’s going to be oversupply in that space too or because of the need for smaller households, that’s going to be in high demand and there could be higher rent growth on those areas because they don’t need the three-bedroom house, they just want a one-bedroom apartment, is that going to be where you think there still could be a lot of growth over the next 10 to 20 years because that’s just where the demand is, small living, affordable costs instead of buying? Is that something that you guys have forecasted out or looked at on the smaller apartment scale? Is that where the major growth’s going to be?

Cris:
Yeah, I think so.

James:
Because there has to be growth somewhere.

Cris:
Right, right, no, and the other thing is these demographic trends, right? they play out over decades, right? It’s not something that you’ll see very obviously, right? You’ll see things slowing perhaps, but you also have the cyclical volatility in the economy. So you might not actually recognize it year to year if you’re looking at things. Next year, it could very well be an up year when it comes to construction if things were to turn around, right? There is still this housing deficit that I mentioned. So I think short-term, multifamily apartments, clearly, there’s a lot of demand. So the lack of affordability and home buying does mean that you will have more households renting, looking for rentals, but even there at some point, as you mentioned, you do have these double digit rent increases over the last couple of years and affordability is being hit hard there too as well.
So I don’t expect to see those rent trends continue at this pace, but I do expect to see the demand for rentals hold up better than the demand for purchases in this current environment, but there will be demand destruction, right? You have households that would’ve been formed if they could that just won’t because it’s just too expensive to either buy or rent. So I do expect to see that rental market hold up reasonably well. I don’t think we should count on those double digit type of rent growth rates coming back anytime soon. I think that was a unique situation when it comes to the pandemic, but going forward, I would expect to see that demand, certainly in those particular markets where people want to live, continuing for the foreseeable future versus building those larger luxury single family homes.

James:
The McMansions are over.

Dave:
Yeah, and maybe so. We’ll see. People really like them, so we’ll see.

James:
I’ve seen about the affordable housing that actually, this is a sidebar, but in California, they outlawed the big mansions in some areas. So now, they’re doing McMansion basements-

Cris:
I saw that as well.

James:
… because you’re not going above ground, so you’re allowed to do that. People have pools and gyms and they’re like, “All right. Well, you won’t let us do it above ground, so we’ll just do it below ground,” and these things are massive. It’s like a whole city underground. So I think no matter what, there’s always going to be a demand for McMansions as well.

Dave:
The amount of people will find a way around any rule never ceases to amaze me. It’s just like they will figure out the way to do it if they want to do it and still stick to this letter of the law.

James:
I mean, it is pretty cool.

Dave:
Yeah, a basement pool, it just sounds weird. All right. Well, Cris, thank you so much for being here. This has been super helpful. I have a whole line of questioning. Maybe you can come back sometime. I’d love to talk more about not even just housing, but the economic implications of declining population because I think that is a big juicy topic we’d love to talk about again, but this was phenomenal. Super helpful for myself and I’m sure James and for all of our listeners. So thank you so much for being here. If anyone wants to connect with you or follow up, where can they do that?

Cris:
They can follow up with an email, [email protected] or I’m on LinkedIn or Twitter. MiddleWayEcon is my Twitter handle.

Dave:
All right. Thanks again, Cris.

Cris:
Thank you. Thank you.

Dave:
All right. We got to debrief about that, but did your lights go out during the middle of that recording?

James:
It did. All of a sudden, it got into mood lighting. All of a sudden I’m like, “There we go.”

Dave:
Yeah. It looks like there’s like a spotlight on you right now if you’re not-

James:
I’m looking pretty oily right now, actually, but-

Dave:
Well, you got a beam right in your face. I mean, yeah, if you’re not watching this on YouTube, right in the middle we had a little snake bit recording here. We were having a lot of technical issues and we finally resorted them and then James’s light went out. I was like, “What the hell is going on? Why is everything breaking right now?”

James:
It just auto turned off. As we’re doing the recording, I was like, “Did anybody notice that?” Obviously-

Dave:
I was messaging Kailyn about it. It must be a full moon or something today. I don’t know what’s going on.

James:
Yeah. That is a first.

Dave:
Anyway, that was awesome. I mean, that was super interesting. I’m curious what your main takeaways were.

James:
My main takeaway was I’ve always thought real estate is this super safe investment over a 20-year period and it’s really actually making me double fit, not that I do believe in real estate and it’s always an asset you want to own, but going forward, just with the demographics and how we ended it, and I definitely want more information about this because where you buy and how you buy today can make a big, big difference down the road for you. Now, I am glad we’ve transitioned out a lot of a single family into apartments over the last five years because the demand’s going to be there.

Dave:
Yeah. It was really interesting just the timeline and it makes sense, right? We’re probably going to see a pullback over the next year or two, but the 10-year horizon, just based on demographics alone, pretty encouraging for the housing market as a whole, but beyond that remains a question, right? Once the millennial demand is done and we get to Gen Z, which is a smaller generation and with declining birth rates and declining immigration rates, that could potentially lead to less demand, but like we said, that doesn’t necessarily mean there won’t be demand because we’re at a shortage right now. So it’s something I think we need to look at more, right? Is the declining demand just going to reach equilibrium and then we’ll actually be in a better place or is there a potential that prices or demand could fall so much that we actually get in the opposite where we have too much housing? We’ll have to look more into that over the next couple of years, but luckily, we’ve got five to 10 years to figure that out.

James:
Yeah. We got some breathing room, and that’s why it’s so important to really watch these trends over into the next. We just came out of the craziest two-year run and I think the data’s all messed up everywhere, to be honest. It’s really paying attention over the next 24 months of what’s trending is going to make a big difference in how you’re going to invest down the road.

Dave:
Absolutely. Well, thank you for joining us, James. For anyone listening, we appreciate it. Just a couple of things. First and foremost, if you like this show, I think you will because this show was awesome, I love talking to Cris, share this. We would really appreciate if you share these episodes with your friends or if you have people who are freaking out about the housing market, want to know what’s going on. This is a great episode. Share it with them. Help inform other people in the investing or home buying communities about what’s going on in the market, and give us a review if you liked it. If you have any feedback about this show or thoughts, you can message me. I’m on Instagram, @TheDataDeli. James, where can people find you?

James:
Best way to get ahold of me is on Instagram, @JDainFlips.

Dave:
All right. Sweet. James. Thank you so much. Appreciate your time today, and thank you all for listening. We’ll see you next time for On The Market.
On The Market is created by me, Dave Meyer and Kailyn Bennett, produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, copywriting by Nate Weintraub, and a very special thanks to the entire BiggerPockets team. The content on the show On The Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.