What will the new year bring for the housing market and real estate investors? Who will be buying and who will be renting? What changes will we see for single-family rentals and the build-to-rent market? What can investors expect from the economy in the coming year?
Today’s guest is real estate consultant John Burns. John and his team offer research and market analysis for building industry executives and their investors. They help clients make informed decisions based on homebuyer and renter demands. John is the co-founder and CEO of John Burns Real Estate Consulting and co-author of “Big Shifts Ahead: Demographic Clarity for Businesses.” He has a B.A. in economics from Stanford University and an MBA from UCLA.
If you’re interested in participating in John Burns Real Estate Consulting’s Single Family Rental or Investor Survey, send an email to firstname.lastname@example.org. They will email the survey results to you and as a bonus will send you some demand supply and risk metrics. Your participation will help them be smart about the housing market.
Kathy Fettke: Great to have you back, John.
John Burns: My pleasure, Kathy. Thanks for having me.
Kathy: It’s always so good to have you here. I love your updates. I follow whatever data you’ve got. I know your book has had a great impact on a lot of people trying to understand and track demographics. We’re moving into 2020. What should homebuilders be aware of moving forward? Is it still safe to build or should homebuilders be a little bit more cautious?
Builders Are Cautiously Optimistic
John: Well, compared to a year ago, they are a lot happier and more optimistic. The fourth quarter of 2018 was miserable. I know three of the large clients of mine did pretty significant layoffs in early 2019 preparing for a downturn and now they’re off buying land and hiring again. It’s been quite a reversal. I would say that they’re cautiously optimistic, and by that, I mean they’re optimistic. But nobody’s loading up on land, nobody’s doing anything crazy. They’re growing their businesses wisely. They’re pivoting down to lower price points in a number of ways. Some of them are just putting less back in the house, some are doing smaller homes, others are going to more exits down the freeway. In general, the industry is pivoting down in price and moving forward.
Kathy: What happened between the end of 2018 and the middle of 2019, and to now that would have builders feeling more optimistic?
John: Well, the end of 2018 was a triple whammy. Rates that were rising all year spiked in September all the way to almost 4.9% heading right into the slow season of the year, and then the stock market took a dump too. The fourth quarter was miserable, sales were down about 18% year over year. The homebuilders were actually discounting pretty heavily just to be down 18%. It was pretty tough. As we moved forward this year, rates came down substantially, the economy’s actually gotten better. Sales are quite strong right now. During that period, they didn’t buy a lot of land, so they’re not growing very quickly because there’s not a lot of finished lots on the ground for them to buy. They’re growing slowly and moving forward, optimistically, but not aggressively.
Kathy: Okay. I think it’s safe to say that the real estate market is pretty sensitive to rate hikes, because that seems to be the main thing that– Well, I take that back. If wages–
John: No, that’s exactly right. But let me add a little bit of color to that because at our conference in November, the CEO of Pulte said something that I think that was spot on. Is that, really, in his view, people that are going to become homeowners are going to become homeowners. A spike in mortgage rates may delay their decision. They may have to come to grips with, “Hey, we’re not going to get that nice new 2500 square foot home, we’re going to get a 2200 square foot home instead.” So things definitely slow, but most of the builders are pretty confident that over the long term, even if rates rose all the way to 5%, they would do fine. It’s just the short term that can be pretty painful.
Kathy: Yes, so I guess if wages are increasing at the same rate, then it might be okay. Perhaps that’s not what we were seeing. We’re seeing rates go up, but maybe not wages as much.
John: Right. Wages don’t grow really quickly. Almost all of my clients will tell you that they will take a growing economy and higher interest rates over a shrinking economy and lower interest rates. Right now, they have both low rates and a great economy, so things are fine.
Kathy: So they’re confident. I like that. Okay. Are you seeing a difference in what they’re building? Are they trying to downsize, lower square footage, more affordable homes, or are they going- continuing on the high end? Where’s the demand? I’m sure that varies from market to market.
Entry-Level Homes Getting Smaller
John: Yes, but the strategy really is not varying by builder. Almost all the builders have gone so far as to even come up with a new brand that is their entry-level brand. And even for a Toll Brothers, they have a new entry-level brand for a more affordable luxury home. They’re pivoting down in price. One of my clients, Meritage Homes, cut the number of floor plans they built from 3000 down to 700. Everybody’s getting more efficient. Instead of offering 100 options at the design center, they’re doing packages now, like the car companies do, just to get more efficient and all this is to get the price down.
They’re looking for opportunities where there’s more homes per acre, so be a smaller house, but the deal still works because there’s an extra house on the acre. Some are moving a little bit further out. It’s interesting that the two big builders that have been moved further out, Dr. Horton and LGI Homes, have really been doing fantastic. The rest of the industry is a little reticent to compete with them in the outlying areas because if there is a recession, those homes tend to be really hard to sell.
Kathy: I read a report that really high-end homes, like hundred million dollar homes, way up there, are on the rise. I don’t know if you would even be in that world or notice what’s happening there. But are you seeing some more high, high, high-end luxury builders out there?
John: Well, that’s high– I spent five weeks in New York in the Fall. There’s a lot of stories there, because that’s where a lot of those homes are. I actually hear that that market is extremely soft, very soft.
Kathy: I would think so.
John: The housing market above 10 million, there’s some pretty heavy discounting going on.
Kathy: Yes, that makes sense. Alright. Well, as you know, you have been consulting one of the projects that Real Wealth Network Investors are equity investors in. It’s called the Mirada outside of Tampa, north of Tampa, where there’s that crystal lagoon. We got a great deal in the land over 10 years ago, got it for 10 cents on the dollar, but it’s taken– it’s going to be about 10 years before we’re out of it.
It’s interesting how large developments– it’s hard to plan when it takes so long, and you really don’t know what’s going to happen next decade. Are we seeing builders taking on huge projects like that? Well, that’s 4200 lots, or are they going with smaller subdivisions that they can get in and out of faster?
Smaller Projects, Smaller Subdivisions
John: Smaller subdivisions. We’re 10 years into an economic expansion, seven, eight years into a strong housing market. Really, for the last three years, long term investments in land like you’re talking about, have been almost non-existent, in terms of buying raw land and getting it built. There’s been a few exceptions, a couple companies with really strong balance sheets, like Minto, of the latitude Margaritaville deal with Jimmy Buffett. That’s just been a wild success. But they didn’t pay a lot for the land either. And the price points that they’re offering are $240,000 for an amazing retirement home. They felt pretty confident doing that.
But generally, one of the reasons we don’t think construction is going to grow really quickly is exactly what you’re alluding to, is there’s not a lot of money being invested in long term land development right now. I’ll just add my clients who got in at the right time and made some great investments on long term land have only done okay. That’s part of this is like, “Shoot if I timed it right, and I’ve only done okay,” because the cost increases on land development, I believe, have been worse than the cost increases on home building, and a lot of that is at the city level, who’s just layering one more regulation on top of another– It’s just making that a less desirable thing to do.
In fact, I will add, at our conferences every year, we ask what’s the best risk-adjusted return and the worst risk-adjusted return. Land development has come back as the worst risk-adjusted return. I think at the last six conferences that we have asked that question.
Kathy: Yes. One of the things that we’re doing because Real Wealth is partnering with developers, and we are equity investors in building homes, but we’re not taking on any commercial debt at all, we’re just raising enough money to buy the land, the land has to be already entitled, and then we just raised enough money, again, to buy the land and build the first phase. Sell that first phase, to fund the next phase because we just don’t want to have any debt if things slow down. Are you seeing that kind of thing out there?
John: Well, let me differentiate between the publicly traded builders and the private builders. The publicly-traded builders have had the opportunity to go to the bond market and get long term debt and pay– MDC Holdings, Richmond American got a 30-year bond. [laughs] Some of them have gotten a fair amount of debt because it doesn’t mature for a very long time. And I don’t think Wall Street differentiates between the debt on homebuilding and the debt on land development, even though they should. They just give it to the company based on their balance sheet. I think that the public builders have hit the debt markets pretty hard but their balance sheets are still in great shape.
This entire cycle though, the private builders who’ve relied on bank financing– The banks have been really cautious and conservative. The loan to values and loan to costs have been pretty low. Because of that the interest rates have been pretty low. But we’re not seeing anybody take on a lot of debt frankly because the lenders aren’t giving it to them. That being said, there are some hard money lenders and others out there who can seize on that and start making… debt and other things like that. I’m sure some of the people listening to your podcast actually do that for a living.
There is high yield debt out there not from traditional financing sources and there’s not a lot of great data on it for that reason. It’s a good question. I don’t know the answer to how much high-risk debt people are taking on. I don’t think it’s significant for homebuilding, I hear it’s pretty significant for activities like fixing and flipping houses.
Kathy: And apartments. Seems like a lot of lenders are doing pretty high LTV and LCCs on apartments.
Kathy: Okay, now, you’ve been mostly focused on consulting for home builders, but you’re doing something a little different, you’re taking some time to understand the rental market. Tell me a little bit more about that and why.
John: Yes, we’re best known for our home builder work but we actually have a strong apartment practice too. What has happened over the last four years, I’ll say, there’s this new type of development or new name called “build for rent,” purpose-built homes, which basically– Purpose-built for rent, which fall into two categories. They’re either detached homes or they’re what we are calling horizontal apartments which are single story townhomes, some two story townhomes.
What changed is when Invitation Homes and American Homes 4 Rent proved that you can manage a portfolio of rental homes all over the metro are, now people are saying, well, why haven’t we been building these with the homes right next to each other? So we’re seeing a lot of that. In fact, the capital flooding in for that is so insane that we’re already having conversations about potentially getting overbuilt. They just had some… journal reporter on that this morning.
Let me give you some perspective on that because I learned a lot from our keynote speaker at our conference, Bruce Flat, who’s the CEO of Brookfield Asset Management. His view, which is going to make a lot of sense when I say this, is that he raises money from six to 700 of the largest institutions in the world, the big pension funds and insurance companies and they need to get about a 7% yield. They’ve always allocated a pretty significant percentage of their portfolio to bond investments. You just can’t get a seven in bonds anymore. So a lot of the money is rotating into alternative investments including real estate and that would include equity investments in rental communities, which frankly I think they’ll go out and lever to get the yield. Maybe if something is at the four or five cap, if they can borrow 50% of it at a 3% interest rate or something along those lines, they can get their 7% yield. The fundraising has been pretty easy, I believe, for the private equity to do this, and that’s what’s driving all this activity.
Kathy: Interesting. You’ve moved into studying the dynamics of the rental market. That’s the first time I’ve heard that there could be overbuilding in the build to rent. Do you think that would affect rents across the board or just in that niche?
John: Well, my analogy is, it’s like luxury apartments, and there’s always room for one or two luxury apartments in every single area. And so there’s plenty of demand for build for rent, these type of communities, right now because there’s really never been anything built– product like this built that’s new. But in some areas like Phoenix, I think there’s 70 communities on the drawing boards. If we get 70, let’s call it luxury apartment complexes, horizontal apartments, built in Phoenix and five of them are right across the street from each other, when recession hits, that’s not going to be pretty. That’s the conversation people are having. The industry is definitely not overbuilt right now, though.
Kathy: Yes. Are you seeing more rental demand in the future or more home buying demand or a mix of both?
Rental Demand Growth
John: We’re seeing more rental demand. In the book that you mentioned Big Shifts Ahead, we really dove into the demographics deeply, and you have to make a number of assumptions about the economy and other things. Over a 10 year period, we thought we’d see about 12-and-half-million households formed. That’s the need, for about 14 to 15 million housing units. We thought of that 12-and-a-half-million households a little more than seven million will be rental a little more than 5 million will be own, that means homeownership rates should fall. Now, that’s not some horrendous situation, falling homeownership rate, if the demand for sale goes up by 5 million and the demand for rent goes up by 7 million, everybody is winning. It’s just the rental guys are having more demand.
Kathy: That is a study from a couple of years ago. Are you seeing it play out that way?
John: Yes, a few things are different. It is playing out that way. Actually, our chief demographers got under the hood on the homeownership rate data, and it really, honestly, is pretty miserable. We think the Census Bureau showed a massive overcorrection and is now fixing it. Some of the headlines lately have been rising homeownership but we think they’re fixing a mistake, basically, because they had two surveys that weren’t agreeing with each other.
Kathy: That’s funny.
John: What is playing out more favorably for homeownership is, we didn’t think mortgage rates would be this low, and we definitely did not think mortgage terms would be this easy. I mean, Dodd Frank said, you should not make a loan to somebody that’s more than 43% of– all their debt is more than 43% of their income, but they exempted Fannie, Freddie and FHA because it was 2010, and Fannie and Freddie are still exempt and still making a lot of those loans right now. I just don’t see the mortgage industry getting even looser. It’s actually looser than we thought it would be, or easier to get a mortgage.
Kathy: Well, if that’s the case, and interest rates are low, why would we see more rental demand than home buyer demand?
John: Well, we’re seeing it. The millennial generation, if you will, associates recessions with losing your house, and I think they all want to become homeowners. Our surveys and other surveys say the same thing, going, “Push comes to shove, do I have any savings in the bank? And what is this going to feel like if I lose my job?” A portion of them are choosing to rent. This is actually a good debate we recently had it at our conference. They’re choosing to rent, they’re choosing urban, more of them are coming into homeownership but there is as a percentage– Their parents and grandparents got to 80% homeownership rates. We just don’t think this generation is going to choose to get there. And that’s the basic reason why homeownership is going to fall.
Kathy: Interesting. I was wondering how many of those people are going to inherit homes and then suddenly be in a position– or inherit just money in general– and have that change fairly rapidly? With baby boomers being the wealthiest generation. At least that’s what I’ve heard.
John: Yes. Well, you’ve got to remember, people live till they’re 80 so you don’t make an inheritance until your 50s or 60s.
John: The affluent folks are getting help from their parents. I think that’s maybe a third of America. Certainly not 70% or 80% of retired people are in a position to help their kids and grandkids buy a home. No, that’s definitely not the case. Their biggest fear is running out of money before they die, and they may live another 20 years.
Kathy: There may be no inheritance for many people.
Kathy: Okay. Good stuff. Alright. So then, the big whopping question. I heard you say that we’ve got a pretty good economy out there, do you think that will continue or should we be prepared for a slowdown?
Preparing for a Slowdown
John: Everybody I know is preparing for a slowdown, not betting on it, but what they’re doing is they’re keeping their balance sheet conservative, just, exactly as you said, not taking on a lot of debt. Our view is the economy has been growing a little faster than we thought it could because we’re running out of people to employ, basically. And we’re continuing to recruit more people back into the labor force, but we’re at a near-record high participation rate in the labor force. And unless they start opening up the floodgates to immigrants, which I’m not going to bet on that anytime soon. I don’t know how we’re going to grow the economy because we just don’t have the people. And the drag is people entering their retirement years. We’re seeing more and more people that, particularly the more affluent ones, retire and spend less in retirement, so we’re viewing more continued modest growth for the forseeabe future.
Kathy: No major crash but no major growth.
John: Well, there’s a lot of risks out there, they’re things that can cause a crash and it’s not in housing. And the level of government debt is unbelievable. I mentioned corporations borrowing– we talked about the homebuilders borrowing from the bond market. We actually did a study on this, though. They’ve borrowed the least. Other industries have borrowed like crazy. All of that is being securitized, just like subprime mortgage debt was securitized. I’m hearing plenty of stories of really named companies that have too much debt. You know how that ends, when their business slows down? Their ratings will drop and their interest rates will go up, and it’ll get ugly.
So I think there’s lots of good reasons to be scared, and I think a lot of CEOs are scared. What I’m concerned about, and I mentioned this to you the other day, is that I’m seeing a lot of, call them millennials if you will, but people that were still in school during the last recession, all balled up on housing investment as the way to get rich. We’re starting an investor survey. We started a single-family rental landlord survey about a month ago and developed an index on single-family rentals. We’re going to do the same thing on investors because I really want to monitor investor activity, because that was one of the problems in the last cycle as we had a lot of non-professionals getting into investment. I’m starting to get concerned that we’re going to see more of that.
Kathy: Yes, so be cautious. Be cautious. Look at how people were able to ride through the last recession even, and that was a bad one. There are ways to prepare for that. So be cautious out there. John, we really do want to support you on that survey. I’ll let our listeners know how to do that in the show notes. Okay? Wonderful. Well, thank you so much for being here on the Real Wealth Show, and look forward to having you back in the future.
John: Thanks, Kathy. Take care.