Eq: Total Market
The US commercial and residential real estate markets have been headed in opposite directions for a little while now, with the former looking weak and the latter looking strong. However, new data suggests that US residential real estate now looks headed for its worst downturn in years. The market is suffering from heavy prices and rising rates, which are constraining buyers. Those realities are now starting to play out in the data, as the latest US market info shows that existing home sales dropped in June (for the third straight month), new home purchases are at their slowest pace in eight months, and inventory is finally starting to increase. Annual price gains in May were also their slowest in almost a year and a half.
FINSUM: It is still early days to predict a big downturn, but these three data points are a big warning sign. We are especially paying attention to rising inventory, as really tight supply has been the hallmark of the market for at least five years.
The US property market is a complex and bifurcated sector right now. On the commercial side, prices look set to weaken on huge supply of property and financing. On the residential side, inventory is tight and prices are rising. On the latter market, new data out shows that home sales and inventory are plummeting, and prices are rising quickly. Home sales have fallen for a third straight month, and according to the National Association of Realtors, “The root cause is, without a doubt, the severe housing shortage that is not releasing its grip on the nation’s housing market. What is for sale in most areas is going under contract very fast, and in many cases has multiple offers”. US median home prices are up 5.2% year on year and have set a new high of $276,900.
FINSUM: So the market is seeing rising prices and rising rates. What gives? At some point fairly soon the market almost has to stall by default.
In a highly unusual break from presidential tradition, President Trump weighed in yesterday on the Fed’s current policy approach, and he was not happy. Speaking in regard to recent rate hikes and plans to continue doing so, Trump said “I’m not thrilled … Because we go up and every time you go up they want to raise rates again ... I am not happy about it. But at the same time I’m letting them do what they feel is best.” Speaking plainly, Trump continued “I’m just saying the same thing that I would have said as a private citizen … So somebody would say, ‘Oh, maybe you shouldn’t say that as president. I couldn’t care less what they say, because my views haven’t changed. I don’t like all of this work that we’re putting into the economy and then I see rates going up”.
FINSUM: The media is trying to make a very big deal out of this, but in our view, these are pretty benign comments, especially coming from Trump.
All of the worries in the real estate market have been focused on commercial property. While commercial real estate is supposed to be overvalued and over-supplied (a dangerous combo), US residential real estate is supposed to be healthy, with manageable price rises and tight supply. However, the residential market has just gotten some bleak news. US Housing starts plunged by over 12% in June, and new building permits dropped over 2%. The reasons cited for the drop are a lack of skilled workers to build and a higher cost for materials.
FINSUM: The question is whether this is a demand-led problem (new buyers pulling away) or a supply-led one (meaning the supply of everything is too tight). The first would indicate falling prices, the second the opposite.
Three of the foremost experts on Financial Crises—proven by their experience in 2008—have just weighed in on the threat of another Crisis. Ben Bernanke, Tim Geithner, and Hank Paulson have just commented in a joint press conference that while the US financial system has better barriers in place to prevent a crisis, its tool kit should one come is considerably weaker than in 2009. The main weaknesses cited were the massive increase in debt the government has experienced since the Crisis, giving it less room to bail out the market; and secondly, the deep political divisions which could more easily block any bipartisan action that may be necessary to save the financial system. Geithner summed it up this way, saying “Better defenses, weaker arsenal”.
FINSUM: This is some very good insight from the most experienced Crisis fighters out there. All their points sound quite reasonable to us.
When big US banks are worried about lending to the commercial property market, one knows things must be getting bad. Big bank executives say they are unwilling to sign off on a number of deals in commercial real estate as the sector looks overheated. For instance, the CFO of JP Morgan Chase said spreads, a proxy for returns, were “under a lot of pressure”. Big banks like JPM and Wells Fargo have been shrinking their exposure to the sector for some time. Market participants say competition in the space is so high that deals no longer provide good risk-return metrics.
FINSUM: It sounds like commercial real estate is maybe just past its peak and headed for a downturn. All of which appears in direct contrast to the residential property market.