- Sean Bill believes the real estate market will remain strong due to tight supply.
- The American homeowner is also in a strong position due to low debt and 30-year fixed mortgages.
- He says high interest rates will keep homeowners from selling their homes to buy new ones.
As the Fed continues to put heat on borrowing rates to help fight inflation, the intended effect of cooling down the housing market appears to be well underway.
In September, mortgage rates reached peaks not seen in the last 15 to 20 years. The average 30-year fixed mortgage now has a 6.29% interest rate, and the 15-year term hit 5.44%, according to data from Freddie Mac.
Existing-home sales were down 0.4% in August from the previous month, and 19.9% from one year ago, according to the National Association of Realtors. The near-decade high construction levels seen over the past two years and plummeting demand has some experts bracing for a 2008-style crash. Buyers are also apprehensive. June saw 14.9% of homes under contract fall through, according to a report from Redfin, a real estate brokerage.
But Sean Bill, the chief investment officer at Prime Meridian Capital Management, says that recent mortgage and sales data suggests that the housing market is still going strong.
“We feel like the niche that we’re in, in terms of the value add properties, is pretty strong, pretty stable”, Bill said. “And there could be a bit of a correction there. But I’d say we have a relatively contrarian view that we are not super beared up on the housing market.”
His firm, which operates out of the San Francisco Bay area, is a private credit investment management firm that’s active in the real estate market. They purchase fractional shares or whole loans and finance credit warehouses to the sector. From his perspective, housing supply will remain tight, regardless of a drop in demand. Additionally, the American consumer is in a much stronger position than they were in 2008, he added.
When his firm underwrites loans, they look at key data points, including the supply and demand of the marketplace. Their focus is primarily on regions that don’t have very much new construction but where micro developers are flipping houses.
He acknowledges that there’s definitely room for a correction.
“No question everything’s gotten frothy”, Bill said. “We’re coming out of a zero interest rate policy environment for a decade, there’s going to be froth that gets taken off these markets, but I don’t expect it to be anything like 2008 or 2009, where it’s down 30% to 40%. The consumers are in much better shape than they were then.”
For one, homeowners are less leveraged. In fact, they’re at historic lows, he added. They also have a tremendous amount of equity in their homes, thanks to the housing boom during the pandemic which saw home values skyrocket. However, property owners in areas that saw some of the highest demand in the last two years may also witness a more drastic correction, thus, continued volatility in home sale prices and actual equity.
The following chart provided by Prime Meridian Capital demonstrates that the consumer is under leveraged relative to corporate America and relative to the 2008 financial crisis.
AlphaCentric Funds
Additionally, most mortgages are currently fixed rate. There are almost no variable rate loans, which was a huge problem in the financial crisis, Bill noted. This will also lend itself to a tight supply because most homeowners won’t find it easy to sell and buy during a period of high interest rates.
“They’re kind of trapped in their current homes,” Bill said. If their home value has increased or even doubled in value over the last six years and they want to make a parallel move, it would double their cost basis, he noted. The mortgage rate on the previous home could have been 3%. Now, it will be closer to 6%. This also means a significant increase in their tax basis. So the buyer’s affordability goes down, he added.
The chart below demonstrates the significant difference between the period surrounding 2008 and 2022. In 2006, 50% of mortgages had adjustable rates. In 2022, it’s only 2%.
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Mortgage scores are quite strong at 776, which is above the long term average of 750.
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“A lot of homeowners are sitting on a lot of equity,” Bill said. “We think that combined with them having fixed rate mortgages at very low rates makes it unlikely that they will be looking to move or list those homes. So we see that as a factor that could keep supply quite tight.”
The average debt to value of home owners is only 27%. The chart below demonstrates historically low mortgage rates on outstanding debt since 1979.
AlphaCentric Funds
