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Three Things I Think I Think – Housing Risks

Here are some things I think I am thinking about:

Housing, housing, housing. If I had to distill my current macro outlook down into a sentence or two it would be “watch everything housing related”. Housing is going to steer the US economy and inflation in the coming 24 months and the current high mortgage rates create an unusually high level of risk to both house prices and consumer demand. But let’s dig into this a little deeper.

1) Shelter and inflation.

Today’s CPI report was much better than expected. And although it’s better to focus on core PCE (because it’s a broader index with less housing skew) the CPI is still widely followed and influences policy perspectives.

The interesting thing about CPI is that it uses Owners Equivalent Rent for shelter prices. And this index is well known to lag. So, when housing booms you’ll tend to get overstated inflation and when housing crashes you’ll get overstated disinflation or deflation. And it typically lags with about a 6-12 month pace.

This is important at present because it’s becoming increasingly clear that inflation has peaked. But Core CPI has a 40% weighting in rent. And all the real-time rent indicators show that rents are falling. But the CPI is still showing rents rising. So this is about to become a big drag on CPI in the coming year. In fact, I think it could become a much bigger drag than some expect.

But the more interesting thing here is that even with the high probability of disinflation in 2023 the Fed is virtually guaranteed to remain tight all year because inflation is still way too high relative to their target. And that’s part of why real estate worries me so much – if the Fed keeps policy tight then 6%+ mortgage rates are here for years and housing is dead in the water with 6%+ mortgage rates.

2) Is Housing on the verge of a “Collapse”?

These comments by Restoration Hardware weirdly flew under the radar last week. On the quarterly conference call their CEO said:

“The housing market has collapsed, and it’s gone down pretty viciously as interest rates went up….I haven’t seen this kind of drop since 2008.”

This one is interesting. On the one hand RH is a high end furniture company that you might be inclined to shrug off. On the other hand, their CEO has been pretty bang on about housing all year. So this is a warning I am inclined not to ignore. “Collapse” might be an overstatement, but again, as I said last week, it’s interesting to think about the 40%+ surge in house prices in the last two years because a 25% “collapse” in prices would only take us back to where we were in 2020. In that context it doesn’t seem so crazy.

But there’s something even more interesting at work here. As the economy has become more financialized housing has been increasingly used as a speculative asset. So it’s interesting to wonder if this is the new normal? Is housing just becoming a more volatile asset class because people are treating it more and more like a trading instrument instead of just shelter? I don’t know, but it’s sure interesting to think about.

3) Private REITs are in the crosshairs.

I loved this Twitter thread by my friend Phil Bak about private REITs. Phil specifically talks about the difference between private REITs and publicly traded REITs and how their performance and prices can vary. The long story short is that private REITs don’t mark to market at a true daily NAV. Their prices are based on much longer and lagging appraisals. This can make their performance appear more stable when the reality is that you just don’t have as much transparency into prices.

It’s not dissimilar to the way that publicly traded stocks work relative to private stock. You don’t really know the value of a private company because it’s not marked to market. But that doesn’t mean it’s not super volatile. It just means you can’t really see the volatility.

The private REIT story is interesting in the same way that the lagging CPI rental data is interesting. Except in this case you know housing is potentially collapsing and you can still redeem shares at a very elevated price. BlackRock has apparently started to limit withdrawals, but this is a question I have been getting far too often lately – should I buy private REITs? I personally would be very cautious with these products at present. The next 24 months have the potential to be very rocky in real estate and I’m inclined to let that dust settle before buying in after such a large jump in prices.