May '23 Market Update - Recession Alert! +Future of Affordable Housing

The wait is over -- it's time for another market update! I'll jump right in.

It's been an eventful ten months since my last update, both personally and for the housing market.

Personally, we bought three houses. Two were flips (which netted $150k+ total profit for the investors) and one is now a long-term rental in Tallahassee.

As for the housing market…where do I begin. I’ve been tracking a LOT of weekly and monthly data points, and they all tell me (with a couple notable exceptions) that we’re on the verge of a recession. Some of you may be thinking, No duh Sherlock, while others may counter, But jobs and consumer spending are as strong as ever! And those two sentiments pretty much sum up the two opinions you can find on the internet right now.

So what’s the crystal ball say?? Here’s the TLDR: Even though interest rates are so high, the historically low housing inventory continues to prop up values. But a recession is coming.

• --At some point (probably this year), consumers will slow down their spending,
• --Which will cause more layoffs,
• --Which will cause more people to list their houses out of necessity,
• --Which will cause the housing supply to finally normalize (or 3D-printed homes will take over the world and solve the affordable housing crisis),
• --Which will cause home prices to go down (but probably not by too much on average, since this wasn't a bubble).

So, yes, I’m being much more conservative in my underwriting right now. I want to make sure I have as much capital available as possible in a year or two when more deals start hitting the market. If you want to talk more about how to become a passive investor, you know where to find me.

Now for you nerds, some charts and graphs to prove my point (or maybe no charts just graphs, I don’t really know the difference, not sure anyone does):

1. The Inverted Curve

You’ve probably heard of this in the news. Whenever the spread between the long-term and short-term Treasury yields has gone negative, a recession has followed every time. And the spread is now wayyy negative:

This isn’t magic. There are good reasons for the correlation.* But there are, as usual, plenty of people saying Yeah but it’s different this time, for reasons I can sort of understand. But I sort of don’t buy it.

2. The Leading Economic Index

This one might be new to you. It measures a wide variety of factors and spits out a number — up is good, down is bad. And it’s been tanking for six months — full-on recession signal.

3. Mortgage Purchase Applications Index

This is one of my favorites to track. Some people say it is the single best real-time indicator of housing demand. And it is as low as it’s been in 25 years. It’s clear the Fed’s interest rate hikes are doing their job.

4. Labor Market Finally Softening

If you don’t follow Axios, I don’t know what you’re doing with your life. There are two key takeaways from this article:

• --Job openings declined for the third straight month.
• --Construction saw one of the sharpest jumps in layoffs — up 112k in March.

I guess that's what happens when no one is buying houses. (Side note, crazy how volatile this measure has been since Covid — I don’t know what that’s about.)

5. The M2 Money Supply

As I’ve said before, housing prices pretty much follow the M2 money supply. Notice how the two graphs below are basically the same, with one notable exception: see that, uh, bubbly-shaped period around 2004-2008? Home prices went off the rails, but eventually made their way back down to the M2 trendline.

This also proves the price jump of 2021-22 was not a bubble, since it was simply following the M2.

But here’s where it gets very interesting, because the M2 has now taken a swift and unprecedented turn lower — and, shocker, so have home prices. I believe the Fed’s tightening will continue to bring the M2 down at least through the end of this year, which will continue to weigh on home prices.

The X-Factor — Inventory

BUT! Home prices continue to be propped up by the historically low inventory:

Why is inventory so low?? Two simple reasons:

1. 1. The “lock-in effect.” The period of historically low interest rates, followed by the rapid rise, trapped everyone in their current mortgage and now there is no incentive to move.
2. 2. There aren’t enough houses being built. Home builders are way, way off the pace of new homes needed for our growing population. 
3. 
   
4. On the plus side, I’m pretty sure that with the rise in 3D-printing, advances in factory-built homes, and the large-but-aging Baby Boomer population**, the affordable housing crisis will be ancient history 20 years from now.

Conclusion

Recession is coming. The fed will make sure of it. But that just means there will be opportunities to buy, if you're prepared. So be prepared!

Peace,

jake

*Here is an explanation, courtesy of generative AI:

**There is an outsized portion of the population aged 50-70 -- maybe 10 million more than would normally be expected. That means an above-average amount of housing supply will become available over the next 20 years or so as that generation...how to say this delicately...no longer needs their homes.