Bottoms Up

Posted By: Tadd Jones ICOR Blog & News,

As you follow the headlines, or maybe the ‘advice’ of your ‘helpful friends’ from outside the industry, it would seem things are pretty convoluted.  To help make a bit more sense of it, let’s look at our market in two different ways: ‘top-down’ and ‘bottom up’.  These two ways are obviously related, but there are some important distinctions.

As far as ‘top-down,’ the single-family residential market continues to moderate and return closer to normal.  And yes: things aren’t all peachy with what seems to be a lot of angst among prognosticators seemingly trying to out-do each other in dire predictions in fringe scenarios, but those seem increasingly unlikely and do not bear scrutiny.  Moody’s is frequently quoted in hyperbolic terms, but their forecasts are far from scary.  Looking at the actual forecast[1]: “Nationally, moderate depreciation in house prices is coming. Prices will continue to rise through the end of 2022, but at much slower rate than in 2021. There will be modest price declines in 2023, and then prices will mostly flatten. If there is a recession, prices will likely drop farther.”  Moody’s also provides an indication of magnitude and timing:

Fitch sees things similarly: “Fitch Ratings estimates that national home price sales were overvalued by 11.0% in 1Q22”[2].  Fannie Mae expects home prices to decrease 1.5% in 2023[3]; Freddie Mac (as of July) was still forecasting a slight increase in prices through the fourth quarter of 2023[4]. Goldman Sachs expects a 5-10% decline from the peak[5] and Morgan Stanley is predicting a 7% decline from the peak[6].  One of the best ways to keep track on an ongoing basis is the CME Case-Shiller futures, which also broadly agrees, expecting a 12.9% lower price in February of 2024 when comparing to the expected price of November 2022[7]

It's not all rosy and moderate in the SFR market, which is the source of some of the angst.  Low inventory means sales volumes are off, meaning realtors (who are paid per transaction) aren’t happy.  With the rise in rates, anyone in the mortgage business, which has become very dependent on refis, is likewise unhappy.  And new home builders have been having a rough go that started with supply chain issues last year and then has just kept going this year with their premium homes less in demand. This means there are some unhappy people in the space. 

But the macro picture for home prices is broadly consistent: house prices cooling, by about 10% or so, over the next 3 years or so, with the normal season effects. That environment is important to the ‘bottoms up’ of what we do, which is not dependent on housing prices per se, but rather dependent on our borrowers being able to find good properties that can have value-added and sell in a reasonable time.  To address this question, David Nielson, who heads up lending, considers new originations and the state of the loans we currently have.

“Investors continue to find good deals in this market. A couple of months ago the homes that were most in demand and getting the top prices needed a rehab taken to the next level, with brand new cabinets, new windows, new fixtures, etc. Today investors can do a more cosmetic rehab such as re-finishing cabinets, leaving old dual pane windows, using existing fixtures, etc. The end buyer today is looking for a finished home at the most affordable cost.  This helps our investors not only reduce the cost of the rehab, but it’s also faster to complete.  We are also seeing a consistent flow of loans paying off, which means people are hitting their numbers and timing expectations.  And, usually, they are coming back with a new project in a week or two.”

The ’top-down’ (macro or big picture or overall averages) indicates a market that is continuing to cool after an very hot period.  It is expected to come off 10% or so over the next 3 years.  The ‘bottoms up’ (what our investors are seeing) remains optimistic and busy with plenty of opportunities. 






Note that I try to use source links that do not require subscriptions.  If you can get hold of it, Morgan Stanley wrote a great article on the anomalies piling up in the housing market.  Here’s the Bloomberg recap  - unfortunately, also behind a paywall:

[7] Using 13 October 2022 settlement prices.