All Things in Moderation

Vital Statistics:

Stocks are higher this morning as markets rallied overnight. Bonds and MBS are down.

Yesterday’s 7-year auction wasn’t a disaster, but it wasn’t great either, and that pushed 10 year yields up about 6 basis points or so.

Personal Incomes fell 7.1% in February, which was driven by stimulus check comparisons. Personal Consumption expenditures fell by a percent as well. The PCE Price Index rose 1.6% YOY and the core PCE Index rose 1.4% YOY. While we did see an uptick in inflation in the CPI numbers, the Fed prefers PCE, and so far it seems to be where it has been for the past year.

The homebuying market is competitive enough as it is, with homes sitting on the market for an average of only 20 days. Potential homebuyers have their hands full competing with each other, and now we have a new entrant. Homebuilder Lennar has partnered with Centerbridge Partners spend $4 billion on a build-to-rent strategy. Not sure if this also includes existing homes as well, but this have the effect of taking supply off the market, whichever way you look at it. Other SFR rental REITs like American Homes 4 Rent and Invitation Homes are also building up their inventory.

Separately, Lennar announced first quarter earnings of $3.20 per share, compared to $1.27 a year go. Not only were revenues up big, but margins exploded, with gross margins rising to 25% from 20.5% a year ago. Note Lennar is on a November fiscal, so last year’s quarter was entirely pre-COVID. New orders and backlog were up 31% and 32% respectively.

Homebuilder KB Home also announced earnings, however they saw more muted results, with revenues up only 6%. That said, KB’s earnings rose 62% driven by higher margins as well. Orders are up 23%.

The big jump in margins is surprising given that lumber prices have tripled over the past year and skilled labor is supposedly in short supply and expensive. We aren’t seeing the massive jumps in average selling prices though – KB’s ASP was up only 2%, and Lennar’s ASPs actually fell. IMO this is a product mix-driven change as starter homes are in especially short supply.

The rapid increase in home prices has people talking about a potential housing bubble, or at least the possibility of a correction. I think the talk of a bubble can be dismissed out of hand, since housing bubbles generally come around every third or fourth generation and the pieces simply aren’t in place for one.

Can we see a correction? That is certainly a possibility, however IMO the supply and demand dynamics simply aren’t there. Lennar’s new venture with Centerbridge is illustrative of why. Professionally managed money is flooding the sector, drawn to the high potential returns. Think about it: Resi real estate cap rates are in this high single digits, plus the entire sector is appreciating at close to double digits. Where else are you going to get that sort of return? Stonks? Even corporate high-yield debt is only mid single digits. Homes may be overpriced on a multiple-to-income basis, but so what? That won’t change until (a) rates rise and (b) supply increases. It will take years of housing starts above 2 million for that to happen.

There is one potential issue with investment properties and that is the government. Rumor has it that the eviction moratorium will be extended another year. That said, this issue will fade in importance as the economy recovers and leases expire. Note that with Fan and Fred’s changes on investment property loans that cap rates will probably fall a touch, although there will be a bid for these loans, especially on the mREIT side. Investor demand will still be high. Again, compare the potential returns on SFR rentals with the investment universe. The money has to go somewhere.Posted

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