Take Advantage of Exuberant Home Constructions and the CRE Crash

Hi and thank you so much for reading my very first blog. Well, here it is….

Many investors are sitting on the sideline at this moment due to high interest rates and higher home prices. The questions on top of every investors’ mind are: when is it a good time to buy, and whether prices will crash? This blog is the first of a three-part series where I’m going to share with you why the next couple of years will be THE OPPORTUNITY we’ve been looking for to invest in real estate. In this first part, I’ll talk about the current macro trends, and the home builders pipeline that will impact residential real estate in the next couple of years.

Each year, the US require about 1.5 million additional housing units to maintain balance. From 2000, lower interest rates and easier access to capital enabled home builders to increase the number of new housing starts. At its peak in 2005, the new housing starts numbers reached almost 2.1 Million units. This was much more than what we needed and subsequently caused the banks to stop lending new construction loans. The housing starts numbers started to crash in 2007 and it would take the industry 15 years to get back to the 1.5 Million annual housing units production number. The result of this pullback in new home construction was an aggregate shortage of about 6 million housing units from 2008 to 2020. This is why home prices and rent went up across the US during the same time frame. Home builders have gradually been adding more housing units as lending rules become more relaxed. But then COVID-19 happened and it accelerated the domestic migration patterns which caused tremendous demand pressure for housing in certain real estate markets. According to the U.S Census Bureau, the average median home value rose 17% from 2019 to 2021 nationwide. During the pandemic, my market in Florida saw home value increased 18.6% and was one of the 23 states where home value increased faster than the national average. There are local markets in states such as Florida where home value increased over 50% during the pandemic!

The housing starts numbers are expected to exceed 1.5 Million annual units from 2024 to 2030. Figure 1 shows the housing start trend. Challenges from the commercial estate market combining with housing starts surplus will create opportunities for residential real estate in the coming years. The current high interest rates environment, work from home trend, and consumers preference to shop online are causing a major blow to the commercial real estate (CRE) market. Some markets have reported losing 20% - 30% of their value. Lisa Shallet, Chief Investment Officer of Morgan Stanley, has issued a dire warning regarding CRE lending rates. Many CRE loans are becoming due from 2024 and CRE operators are facing a cash crunch when they need to refinance the loans. Even if interest rates remain stable, they are still considerably higher than the mortgage rates made for loans from 2019. Commercial property values will drop because income is expected to be stable but the mortgage payment (debt service) is going to be much higher. You might wonder what does CRE have to do with me as a residential real estate investor?

While residential real estate has not crashed yet, the banks are indifferent because a loan is a loan. Many banks have to take a loss on CRE loans they’ve made. To further reduce their risks, banks are now lowering the loan to value ratio. So a home builder or CRE operator need to bring in more down payment to get a loan. The home builders are really feeling the pain from all side. They need access to capital when their existing loans become due. They are also sitting on an increasing number of homes that have not been sold. High interest rates have prevented many consumers to move forward with their home purchases. The problem is going to get worse for home builders before it gets better. New housing starts data suggest more homes will finish construction in 2024 and 2025. Therefore, builders need to get these homes off their balance sheet quickly. The best way is to lower prices or offer more incentives.

So, in the next few years, I see builders continue to give out more concessions and discounts to sell their homes. This represent the perfect opportunity for the prudent investors to acquire properties at a discount. Currently, in my market of Central Florida, some home builders are giving $50K+ discounts on a $700K move-in ready homes. I expect this trend will continue and it will impact existing home prices. In order to compete, sellers of existing homes will need to bring down their prices. A home seller in one of my investment think tank shared that her Orlando home has been on the market for three months and she has reduced the price over 5% and still not a single offer. I anticipate it will take a couple of years for the industry to absorb the supply of new construction homes coming online starting in 2024. Investors hoping to get a value deal should start to look at markets where there’s an influx of new housing units.

In the second part of this blog series, I’ll go over the data I utilized to determine which markets will have an over supply issue as a base to make my investment decision.

Thanks for reading my blog.

Happy Investing.

Kevin