Climate change is becoming more a reality than some distant fear. However, one of the challenges is forecasting how it will play out and impact different asset classes, many of which come as a surprise (e.g. cruise ships being significantly impacted). One of the aspects that everyone expects is that climate change is going to have a negative impact on commercial real estate, especially because so much debt exists in CRE on the coasts. However, the situation is not as grave as many think. If you analyze the performance of the mortgage market following the 2017 Hurricane Harvey disaster in Houston, one finds that the mortgage market was barely hurt. The reason has multiple causes, but one of the key points is that almost all lenders now require borrowers to have full flood insurance, mitigating risks.
FINSUM: Climate change is going to raise costs in the form of insurance premiums, but it doesn’t seem likely to do catastrophic damage. Even residential real estate, while hurt by Harvey, was not nearly as badly wounded as many expected.
In what may come as a worrying sing for older Americans, anecdotal evidence is showing that it may be luxury real estate that is hit hardest as the property market slows. The reason why is that there is a glut of huge houses that no longer suit buyers. In particular, Sun Belt areas are replete with years worth of high end inventory that just isn’t moving. In the early 2000s, Baby Boomers built many large five and six bedroom homes where they planned to live out their golden years, yet tastes have changed, as have living conditions, and few want those kind of homes now.
FINSUM: It is not just the size and expense of upkeep that are problems, but many of these are built 15-20 minutes outside of town, which is not nearly as appealing to buyers as it was 15 years ago.
Another day, another round of bad news for US real estate. New data on housing starts in February was just released and the results aren’t pretty. The number of new homes under construction fell 8.7% last month, a steep drop. The northeast was hit the hardest, with new starts dropping nearly 30% (thanks SALT limit). The only real gains in the country were in the Midwest, and only in apartments.
FINSUM: Not only did starts fall but new permits also declined, which means the bad run is likely to continue. We are curious how falling yields may boost mortgage issuance.
There are many in the market who think that real estate, and perhaps particularly commercial real estate, is in for a real headache. The real estate market tends to slump in recessions and there are special fears that the commercial real estate markets looks inflated. However, Barron’s argues the opposite, saying the three fundamental pillars of the CRE market are solid—overbuilding, overheating, over-indebtedness. The article uses a number of points to show that the market is not as overbuilt as many say it is, that price rises have been modest, and that borrowers and lenders have been restrained.
FINSUM: We don’t think it is as simple as just saying CRE looks fine. There are a lot of different areas of CRE. For instance, we are a lot less worried about new warehouses/logistics centers than simple office space.
The high end of the real estate market is faltering, and banks are feeling it acutely. So-called jumbo mortgages, or those outside of Fannie and Freddie backing, have been shrinking recently. In a sign of caution from rich home buyers, issuance of jumbo mortgages fell 12% last year and were off 27% from their post-Crisis peak a couple of years ago. That compares to just a 7% decline in normal mortgages last year. Jumbo mortgages dominate some cities. For instance, 61% of mortgages in Manhattan qualify as such. Banks are feeling the sting as jumbo mortgages have been a big profit center for them in recent years.
FINSUM: The housing market is slowing in all areas. The big question is whether this is a leading indicator of a recession, or just an isolated asset-level downturn.
The real estate market has been heading south for almost a year. Disappointing numbers keep coming in, but there has not been major urgency or alarm. In fact, homebuilders are having a stellar year, up almost 20% and well above the S&P 500’s gain. However, Stephen Kim at Evercore is warning that investors should be wary of hosuing stocks. Citing the most risky names as DR Horton, PulteGroup, Toll Brothers, and KBHome, Kim says about the group that “Hope is not a strategy”. Kim was bullish on the shares in the Fall before their big move higher, but now believes they are fully valued.
FINSUM: The trend may be your friend, but given the direction of the housing market and the big recent price rises, we wouldn’t want to be long the homebuilders index right now.