Blackstone Group
is the world’s largest manager of alternative assets such as private equity and real estate. It is also a leader in one of the industry’s biggest initiatives—attracting retail investors.
By many measures, the company’s flagship retail product, Blackstone Real Estate Income Trust, is a success. Known as Breit, it has mushroomed in value to $116 billion since its inception in 2017 and become one of the largest buyers of real estate in the country.
Blackstone (ticker: BX) describes Breit as an “institutional-quality real estate platform that brings private real estate to income-focused investors.” Now one of the largest U.S. real estate investment trusts, Breit owns nearly 5,000 properties, mostly multifamily dwellings and warehouses, as well as the real estate assets of Las Vegas hotels/casinos including the Bellagio and MGM Grand.
Though not publicly traded, it’s sold by major brokerage firms and financial advisors, with a relatively low minimum investment of $2,500. In just five years, Breit has become a lucrative part of Blackstone’s industry-leading real estate franchise, generating $1.8 billion in fees last year and $1 billion in the first six months of 2022.
That rapid growth could have a downside. There has been concern recently about Breit’s outlook, including how it is valued and whether investor redemptions will increase from low levels. BofA Securities analyst Craig Siegenthaler estimated in July that net flows, or sales less redemptions, have essentially moved to “break-even” after inflows averaging $2 billion a month for the past 18 months.
In response to analysts’ questions about Breit on Blackstone’s earnings conference call in July, CEO Stephen Schwarzman said that Breit and other Blackstone offerings provide “enormous value” to investors, “who remember it and they appreciate the firm. That builds our brand. That helps us raise money.”
Recently, however, a cloudier outlook for Breit and other Blackstone retail products such as the Blackstone Private Credit Fund appears to be weighing on Blackstone stock, which at about $102, is down 30% from its November peak.
A Barron’s analysis of Breit suggests that investors should be cautious and instead consider publicly traded real estate investment trusts, or REITs, that look more attractive. Breit has gone up in price this year while public REITs have moved lower. Breit has relatively high fees, offers limited liquidity, and is more leveraged than comparable public companies.
| Company / Ticker | Total YTD | Return 52-Week | Since Breit Inception in 2017 |
|---|---|---|---|
| Blackstone Real Estate Income Trust / BREIT | 7.2% | 24.5% | 13.5% |
| Vanguard Real Estate / VNQ | -15.5 | -6.1 | 6.7 |
| Prologis / PLD | -22.2 | 2.8 | 20.4 |
| Mid-America Apartment Communities / MAA | -20.6 | -6.2 | 15.1 |
| Camden Property Trust / CPT | -22.3 | -6.6 | 12.5 |
Note: Returns since 2017 are annualized. Breit returns are for the Class I shares and through June 30.
Sources: Bloomberg; company reports
Blackstone says Breit has appreciated this year because strong financial performance has more than offset the impact of higher interest rates. It says Breit has “delivered exceptional performance” for investors and is “exceptionally well positioned,” given its focus on apartments and warehouses.
Apartments are benefiting from double-digit rent increases, and warehouse demand has been strong. “These are the best fundamentals that I have seen in these two sectors in my entire career,” said Blackstone President Jonathan Gray on a recent webinar.
Breit’s fees are comparable to its private institutional real estate funds, and Blackstone says Breit’s leverage is modest relative to many private real estate funds.
One of Breit’s big selling points, a distribution yield of roughly 4%, is above the REIT average of about 3%. But the distribution isn’t fully earned based on a key REIT cash-flow measure. The distribution yields differ somewhat among its four share classes.
| Total Value Including Debt | $116 B |
|---|---|
| Net Asset Value | $68 B |
| Share Price | $14.98 |
| Distribution Yield | 4.5% |
| 2021 Net Income | -$805 M |
| 2021 FAD | $1,290 M |
| 2021 Blackstone Management and Incentive Fees | $1,824 M |
| Shares outstanding | 4.6 billion |
FAD=funds available for distribution
Sources: Bloomberg; company reports
Breit differs from public REIT peers like
Prologis
(PLD),
Mid-America Apartment Communities
(
MAA
), and
AvalonBay Communities
(AVB), which can be bought and sold on public markets. Breit is the only buyer of its shares, and caps monthly redemptions at 2% of the fund’s net asset value and quarterly redemptions at 5%.
Breit says its shares should be considered to have “limited liquidity and at times may be illiquid.” Breit has met all redemption requests since its inception. With inflows that have totaled about $35 billion in the 18 months ending on June 30, the fund has been on a buying spree. For instance, Breit and another Blackstone fund have a $13 billion deal to acquire one of the largest owners of housing for college students,
American Campus Communities
(ACC), which is expected to close in the next few days.
Breit’s growth has been driven by excellent portfolio selection and ample returns. Nearly 80% of its assets are in rental apartments and industrial properties, including warehouses geared toward e-commerce, which have been the two strongest real estate sectors in recent years.
Breit’s total return has averaged 13.5% a year since inception, compared with 7% for the Vanguard Real Estate (VNQ) an exchange-traded fund whose holdings are dominated by the largest public REITs. “It has done a terrific job picking sectors,” says Dave Bragg, an analyst at Green Street, an independent real estate research firm.
Breit’s value has held up amid the fallout in financial markets and in the public REIT sector this year. Breit’s total return this year through June has been about 7%.
On the other hand, the Vanguard ETF had a negative 13% total return through the end of July, while comparable public REITs like Prologis, AvalonBay, and
Camden Property Trust
(CPT) are off 15% or more based on total return. Breit has suffered just three down months since its inception in January 2017.
Breit can rise while comparable public companies are falling because it tracks private real estate markets, which can move more slowly than more volatile public markets. Blackstone prices the fund monthly based on its financial performance and other factors, including interest-rate changes.
Blackstone points to the strong performance of Breit’s portfolio—net operating income was up 16% in the first half of 2022—for the positive returns this year. Public REITs also have reported good results, but their stocks have dropped due to higher interest rates and concerns about a recession.
“When public REITs trade at discounts to underlying value of their assets, it’s a great buying opportunity,” says Bragg of Green Street. “We don’t think investors should be buying in the private markets when the public market opportunities are so great.”
He calculated that the big public REITs on average were trading recently at about a 15% discount to their net asset values.
As an alternative to Breit, investors could consider well-run public alternatives such as Prologis, a leading owner of warehouses, or multifamily REITs such as AvalonBay or Mid-America Apartment Communities. Barron’s wrote favorably on the apartment REIT sector recently.
Redemption requests by Breit investors appear to be picking up. Siegenthaler’s analysis showed that sales were roughly matching redemptions. “Given that Breit generated $9.8 billion in inflows in first-quarter 2022 ($3 billion plus per month), the fact that its flows may have slowed to break-even was surprising and occurred earlier than we expected,” he wrote. He nonetheless has a Buy rating on Blackstone and expects retail flows to Breit and other vehicles to reaccelerate in a recovery.
Blackstone noted on its recent earnings conference call that investors requested $2.9 billion of redemptions from its retail funds including Breit during the second quarter.
Blackstone says it isn’t worried. “In this period of extreme market volatility, a deceleration in fund-raising is unsurprising, but Breit net flows are still positive on the back of strong performance,” the company tells Barron’s.
Asked on the July conference call how it would handle a period of redemptions beyond redemption limits, Gray, who built the firm’s real estate empire, pointed to a “significant amount of a liquidity” at Breit. Gray himself recently invested $50 million in the fund.
Keefe, Bruyette & Woods analyst Robert Lee wrote earlier this year that alternative managers are eager to attract “locked-up capital” from individual investors. While that is not an issue when times are good, he said, “there is a risk that in times of stress, individual investors may realize they aren’t so happy with the lack of access to their capital.”
Breit levies a base annual fee of 1.25% of net assets and has an incentive fee of 12.5% of the annual total return if it achieves at least a 5% return. Bragg estimates that Breit’s fees are two to three times those of public REITs and funds, depending on the vehicle chosen by the investor.
Breit had a net asset value of $68 billion—equivalent to an equity market value—and a total value including debt of $116 billion at the end of June. Breit calculates its leverage ratio at 42%—debt divided by total value. Comparable public REITs are about half that level. The fund had $46 billion of debt outstanding at the end of the first quarter while a comparably sized Prologis had $18 billion.
No public REIT analysts follow Breit. It doesn’t issue earnings news releases or hold quarterly conference calls. It files quarterly 10-Qs and annual 10-Ks, but its financial statements, like those of public REITs, are complex.
REIT investors look at net income, but focus more on other measures such as funds from operations and funds available for distribution, which add back sizable depreciation expenses. The idea is that most of the depreciation is a phantom noncash expense since the underlying real estate isn’t falling in value.
Breit, unlike most big public REITs, has operated in the red based on net income. It lost more than $800 million in each of the past two years based on generally accepted accounting principles, or GAAP, and about $650 million in the first six months of 2022.
For 2021, it calculated its funds available for distribution at $1.3 billion, but that did not cover its distributions to shareholders of $1.6 billion. About half of Breit holders reinvested their distributions last year, reducing cash outlays.
Breit’s calculation of its funds available for distribution, a non-GAAP financial measure, excluded $1.8 billion of management and incentive fees paid to Blackstone in 2021. The reason is that the payments were made in Breit shares rather than in cash. But fees are fees regardless of whether they’re paid in stock or cash. Breit buys back stock paid to Blackstone, meaning Blackstone effectively gets cash. Breit includes management and incentive fees as an expense in its calculation of its GAAP net income.
The Breit distribution is nearly all a return of capital due to its losses. In contrast, most big REITs pay dividends at least partly from net income.
Blackstone says Breit’s net income is depressed by greater depreciation expense relative to public REITs. That high depreciation results in a tax-advantaged distribution, benefiting investors, it says. Breit says it has fully funded the distribution from cash flow from operations, a GAAP metric that excludes the management and incentive fees, since its inception.
Over its first five years, Breit has scored, thanks to smart sector allocations and a real estate bull market. But with a lofty price and high fees, it could be hard-pressed to repeat its historical returns and beat the public REITs. And it has yet to be tested in a sustained economic downturn or a period of net redemptions.
Write to Andrew Bary at andrew.bary@barrons.com
What will happen in the housing market this year?
Getty Images
When will home price growth really slow down? Will mortgage rates continue their upward climb? What do I need to know if I’m trying to buy a house now? These are all questions we’re hearing from readers, peers and others, so we asked top economists and real estate pros to break down what exactly they think will happen in the housing market this year.
Mortgage rates could continue to rise — but it depends on the economy
Already this year, average 30-year fixed rates have climbed from a little over 3% in January to around 6%, data from Bankrate shows. And it’s possible the growth won’t stop there. (See the lowest mortgage rates you can get here.)
Realtor.com chief economist Danielle Hale says it depends on a lot of factors, including the jobs reports. “If the jobs report is too strong, it’s likely to spark a new uptick in mortgage rates in anticipation of bigger Fed action.
And until we see sustained evidence that inflation has peaked, there’s still risk mortgage rates will climb higher, says Greg McBride, chief financial analyst at Bankrate. But he adds that the prospect of the Fed front-loading their interest rate hikes and doing more sooner rather than later, may actually help keep a lid on mortgage rates or even bring them down. “More rate hikes now means fewer rate hikes later, it means the timetable to peak interest rates gets moved up and it means the eventual decline in rates due to a weak economy also happens sooner,” says McBride.
And here’s an interesting take: “Real mortgage rates, the mortgage rate less the inflation rate, are negative for the first time in 40 years, so mortgages are not as expensive as they look when controlling for inflation. Inflation itself tends to serve as a floor for house price growth, with most quarters over the last 40-50 years facing higher home price growth than consumer price growth,” says Mischa Fisher, chief economist at Angi, an internet services company that connects users with vetted pros for home projects and services.
Home price appreciation will cool …
“Due to the housing shortage, home prices will continue to rise in the following months. Although inventory is improving, it will remain tight as home builders have cut down on single-family home production,” says Nadia Evanhelou, senior economist and director of forecasting at National Association of Realtor (NAR). However, as many home buyers are priced out due to low affordability, home prices won’t rise as fast as they did in previous months. “There will be continuing home price deceleration. Nevertheless, home prices will likely continue to experience double-digit year-over-year appreciation in August,” says Evangelou.
For her part, Hale says housing prices, both median and sales prices, tend to slow down as we approach the end of summer. “I expect this year will be typical in that respect. On top of the usual seasonal slowing, housing price growth should continue to ease up as the housing market resets,” says Hale. (See the lowest mortgage rates you can get here.)
… But overall home prices will still rise
For his part, Bankrate’s McBride says asking prices are coming down from moonshot levels as prospective buyers pull back. “Selling prices will level out as the market cools but this cooling is just a return to the type of balanced market that has been absent the past couple of years,” says McBride.
“In August, I expect house prices to rise by mid-single digits year-over-year for four reasons,” says Angi’s Fisher. Among them, common repeat sales indices like Case-Schiller and the FHFA are lagged by a few months so they won’t pick up the latest day-to-day conditions. And even though affordability is at a 30-year low, there are still supply and demand imbalances in housing stock in a lot of desirable metros. What’s more, downward price pressure in housing is very common and unless economic conditions force people to sell, they prefer to wait. Moreover, inflation is a wild card, she adds.
Demand is cooling
Demand is pulling back at today’s prices, and home shoppers are fewer and farther between than they’ve been for much of the pandemic, says Zillow senior economist Jeff Tucker. “That’s cooling the market and pushing it toward the rebalancing it needs. Very expensive markets, where home buyers are already on the edge when it comes to affordability and therefore more sensitive to mortgage rate changes, in addition to pandemic superstar markets that saw red hot growth during the past 2 years, are most likely to slow,” says Tucker.
Meanwhile, uncertainty is growing over what the economy holds, therefore diminishing the willingness of buyers to go all-in and max out their housing budgets when widespread inflation means other important categories like gas, groceries and utilities are eating up larger shares of their paychecks, says Hale. “By region, we’re likely to see the biggest slowdown in home price growth in the West and South, where both listing and sales prices are highest and where inventory has had the biggest turnaround so far,” says Hale.
The advice, recommendations or rankings expressed in this article are those of MarketWatch Picks, and have not been reviewed or endorsed by our commercial partners.
The housing market is cooling off. After two years of red-hot sales, economic data paints a tale of a market that’s seeing weaker sales, plunging sentiment among homebuilders, and rising mortgage rates.
But economists are divided over whether the U.S. housing sector is in a recession.
Some economists say it is.
Given that the decline in housing activity is across the economy and has lasted for more than a few months, “many housing indicators do point to a recession in the U.S. housing market,” Selma Hepp, deputy economist at CoreLogic, told MarketWatch.
Just like how Freddie Mac’s Len Kiefer predicted in early June, the housing market has contracted significantly.
With the Federal Reserve hiking interest rates, housing starts and existing home sales have fallen by 20% this year compared to 2021, Hepp noted.
“‘All of this does point to a growth recession in housing, though outright recession … is still unlikely.’”
Sellers are adjusting list prices to reflect demand: About a third of homes listed for sale on Realtor.com in some markets like Reno, Nevada, and Austin, Texas, are having prices cut due to weakening demand.
And with home builder waning as well, “residential investment, the measure of housing-related activity included in GDP, declined at about 12% annual rate in the second quarter” and is likely to fall again in the third and fourth, Hepp said.
“All of this does point to a growth recession in housing, though outright recession … is still unlikely,” she added.
Chris Low, chief economist at FHN Financial, felt more strongly that housing was in a recession.
“Housing is a leading indicator of the broad economy. I would say housing is in a recession, and that likely means the rest of the economy will be in a recession soon,” he said in an email to MarketWatch.
But deciding that the housing market is in a recession is not common practice, Nancy Vanden Houten, lead U.S. economist at Oxford Economics, said.
“We are seeing weakness right now in the major housing indicators and we expect the residential sector to be a drag on GDP growth over the next several quarters,” she said, “but we don’t declare on the basis of that, that the housing market in isolation is in recession.”
Richard Moody, SVP and chief economist at Regions Financial Corporation, agreed with her assessment.
“I’m not really sure what it means to say ‘the housing market is in a recession’,” he said.
Normalizing vs. collapsing
While the data has been weaker, demand hasn’t dissipated, he pointed out. So it could be that the “market is simply normalizing,” Moody said, “rather than collapsing.”
Besides, the housing market is undersupplied.
For instance, existing homes listed remained on the market for 14 days, according to the National Association of Realtors. That’s a record low, according to the realtors, since they began tracking it in 2011. That may mean that there are buyers on the sidelines who may be waiting for opportunities now, despite higher borrowing costs.
These data points suggest that rather than the housing market collapsing, Moody stressed, the market is more likely normalizing. Unless that re-stabilization overshoots.
Recession or no recession, that doesn’t reflect on how home prices will grow (or not) over the next few months, one economist said.
“I wouldn’t say we’re in a housing market recession,” Sam Hall, assistant property economist at Oxford Economics, said.
But the data adds “to the evidence that house-price growth has peaked,” he added. “We are forecasting a small fall in prices, with house-price growth bottoming out at -5% [year-over-year] by mid-2023.”
Given that home prices in the 20 biggest cities in America grew 20.5% year-over-year in May, according to the Case-Shiller index, which despite slowing is still a big increase, a drop of 5% is a big reversal.
Write to MarketWatch reporter Aarthi Swaminathan at aarthi@marketwatch.com
Text size
The downturn in China’s property market is unlikely to lead to a meltdown that triggers a financial crisis.
STR/AFP via Getty Images
China’s property slump and suffering economy is leading some to wonder if China could be on the brink of its own Lehman-style crisis. While the troubles facing China’s economy are substantial, it’s unlikely to push China into the type of meltdown that sends the country’s financial system into a tailspin.
The debt that has fueled China’s property boom—and as a result its economic growth—has long been a source of concern for long-term investors. They aren’t alone: Chinese policy makers had been trying to tackle the debt in its economy—a reason they were much more restrained in providing Covid-related stimulus in 2020 and the reason for the property crackdown that sparked the current slump.
But policy makers face a bind as boycotts on mortgage payments spread to roughly 300 unfinished projects in 90 cities. Authorities are trying to balance two contradictory goals: keeping a lid—or even lowering—the amount of debt in its property sector while also supporting property developers to finish projects and avert further social unrest, Pavilion Global strategists write in a note to clients. Property developers’ debt is piling up rapidly, while net income falls.
Mortgage suspensions is a different feature than during past bumps in the housing market, and Eswar Prasad, former head of China for the International Monetary Fund and currently an economics professor at Cornell University, worries it could constrain developers of even viable projects that end up getting stalled because of the lack of financing. That could create further ripples in a market where housing prices are already slumping and economic uncertainty is high after Covid-related lockdowns led to anemic second quarter economic growth.
There is no denying the economic risk given that the property market is a major engine of growth. Defaults could rise as tighter liquidity stresses developers and some banks could also suffer, though Prasad notes that many are state-owned and the government can easily infuse liquidity, limiting the risk of a systemic financial crisis.
Plus, unlike the U.S. global financial crisis, the amount of leverage propping up speculative investments is much more limited and households’ balance sheets and high savings rates act as a buffer, Prasad says. Down payment requirements are also so large that even a significant further decline in prices wouldn’t put a lot of mortgages underwater, he adds.
“A Lehman moment may come some day, but I have come to appreciate how many policy levers they have,” Prasad says. “We will see lots of stumbles and accidents because of unbalanced policy responses, but is there going to be a real Lehman moment where the financial system comes apart? I think not.”
The bigger concern is the hit to the economy. Economists are keeping close watch on how the troubles in the property market seep into consumer sentiment because real estate is a major source of Chinese wealth.
A survey by the People’s Bank of China of urban depositors three years ago found roughly three times as many people expected prices to rise as expected prices to fall, but last month 16% expected prices to rise and 16% expected prices to fall. Though volatile, the survey offers a gauge of sentiment among urban Chinese—and it’s clear there has been a major change among how they think about the property market, writes Michael Pettis, Peking University finance professor, in a recent note.
The troubles in the property market and economy more broadly could weigh on Chinese stocks. Domestic A-shares are trading at a premium to H-shares in Hong Kong, and leverage as measured by net debt to earnings ratios is two to three times higher in mainland China versus the U.S. or even emerging markets outside of China, according to Pavilion Global strategists. In a note to clients, they said the domestic A-shares market offers a better short than long opportunity for investors.
The
iShares MSCI China
A-shares exchange-traded fund (CNYA) is down 17% so far this year, a bit worse than the
iShares MSCI China
ETF (MCHI), which is down 15% year-to-date.
China’s housing rout isn’t like the one suffered in the U.S. during the global financial crisis, and Beijing has a vast toolbox to avoid a Lehman-like crisis, but that doesn’t mean it won’t be messy.
Write to Reshma Kapadia at reshma.kapadia@barrons.com
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Home prices have fallen in China, developers have defaulted on their debt, and many housing units are still uncompleted.
Wang Zhao/AFP via Getty Images
With Beijing stepping in to help China’s beleaguered property market, many believed the sector’s crisis may be averted. New situations are causing reconsideration of that optimism.
After years of boom times, property prices are experiencing near-unprecedented declines. New home prices in June fell for the 10th straight month, even as the government is enacting measures to support the sector.
More than 30 Chinese developers have defaulted on their dollar debt or pushed out bond maturities because they can’t sell new offshore debt,
Deutsche Bank
’s
Owen Gallimore told The Wall Street Journal.
Various Chinese analysts Barron’s spoke to gave varying reasons why the property market at best needs further reform, at worst is headed into a deeper crisis.
Huang Qifan, vice chairman of the Financial and Economic Affairs Committee of China’s National People’s Congress, told Chinese media that continued construction should essentially just cease.
“China has no need for new construction,” he said. Many units are unoccupied investment properties for citizens who already have primary residences, yet China’s population has peaked and will begin to quickly decline. Construction and renovation on public facilities like schools and hospitals have essentially been completed, he said.
Chinese media last week quoted other analysts as saying that China’s property demand has peaked for the next decade, due mainly to the aging population, as happened in Korea and Japan. Repeated demographic studies have concluded that China is headed toward a demographic crisis, with too many older citizens, a dwindling pension system, and not enough new births to support near-future taxation and social-related revenue.
For Ting Lu, chief China economist for
Nomura
,
there is a vicious cycle happening in China’s property sector.
The primary problem is a simple confidence crisis among would-be buyers because they don’t trust that units will even be finished. A widespread mortgage boycott among home buyers recently deepened the crisis. Depending on the breadth and duration of the boycott, refusals to pay could devastate the sector, as new home purchases account for more than 80% of China’s property industry.
This adds insult to injury, as private developers fund new projects using 50% of their income from new home sales, Lu said. “The continued contraction in new home sales will further squeeze the funding for developers and make it even harder for developers to build homes,” he told Barron’s.
But the problem does not end there. In China, 30% of local government revenues come from land transfers. As home sales fall, developers purchase less land, and this can crush municipalities’ income. This translates into governments downsizing or reducing staff pay—“a social class with relatively stable income and housing demand, leading to even weaker new home sales in those cities,” Lu said.
Developers and local governments aren’t the only ones to suffer.
“If this sales and funding recovery doesn’t play out, developers could impose on investors steep haircuts on their bondholdings and long extensions to tenors, to manage their high debt burden,” S&P Global analysts wrote in a note Monday.
“The end of the beginning is at hand for China developer defaults. In the first stage, firms asked investors to exchange or extend defaulted bonds, to buy some time until the property market recovers. In the next stage, we assume investors will lose patience for such deferrals, especially if home sales do not soon recover,” they added.
National authorities have stepped in with credit easing and less strict mortgage and other homeownership requirements. Localities have cut mortgage interest rates and lowered down payments.
But these seem to be losing the battle against the myriad forces depressing the sector.
For
Morningstar
’s
senior China real estate analyst Cheng Wee Tan, “The effectiveness of mortgage lending rate cuts is limited by lockdowns, with limited impact on consumer sentiment; reopening and buyer sentiment recovery are more key in our view,” he told Barron’s.
For Nomura’s Lu: “We still don’t see a swift and strong recovery of the property sector in 2022 due to the highly infectious new variants of Covid-19, the reduced confidence of Chinese households, the frontloaded demand of new homes in 2015-2018 in low-tier cities, and the vicious cycle mentioned above.”
As for stock implications, Morningstar analysts were bearish about the sector and the effects of government measures, but said the current situation offered small buying windows. They prefer state-owned developers in China, “which have strong balance sheets to take market share away from private developers,” they said in a note Wednesday, citing
China Overseas Land & Investment
(688.Hong Kong) as one example.
“Worsening affordability appears to be having an impact on demand, which could lead to prices plateauing or even correcting modestly in some markets,” one pro told MarketWatch Picks.
Getty Images/iStockphoto
Rising home prices and mortgage rates have made homeownership unaffordable across much of the United States. Indeed, home prices have jumped 20% over the past year, and mortgage rates have risen from around 3% to about 6% this year, with some pros saying they will go higher (see the lowest mortgage rates here you may qualify for here). And now, the vast majority of counties in America are less affordable than they’ve been in the past, though there are some major exceptions.
Indeed, median home prices in 560 of the 575 counties analyzed in the Q2 2022 US Home Affordability Report conducted by real estate data company ATTOM are now less affordable compared to averages starting in 2005. The report determined affordability by calculating the amount of income a person living in the area needed to meet major monthly home ownership expenses like mortgage, property taxes and insurance on a median-priced single-family home, assuming a 20% down payment and a 28% maximum debt-to-income (DTI) ratio. (To calculate your DTI, add up your monthly expenses including mortgage payments and insurance, and divide the total by your gross monthly income, the result of which will be in the form of a percentage which reflects your DTI.)
“Very few local markets have been able to escape the dramatic home price increases of the past few years. When prices rise and compensation fails to keep up, things become less affordable,” says Elizabeth Renter, data analyst at NerdWallet. So just where are these places that people can supposedly afford to live?
10 counties that are now more affordable than in the past
| County, State | % of annualized wages needed to buy a home |
| Hennepin, Minnesota | 27.8 |
| Fulton, Georgia | 27.6 |
| Harris, Texas | 27.4 |
| Franklin, Ohio | 27.4 |
| Oakland, Michigan | 25.7 |
| Cook, Illinois | 25.3 |
| St. Louis, Missouri | 21.4 |
| Philadelphia, Pennsylvania | 19.1 |
| Cuyahoga, Ohio | 18.4 |
| Allegheny, Pennsylvania | 17.4 |
See the lowest mortgage rates here you may qualify for here.
Jeff Ostrowski, Bankrate.com analyst, says affordability is mostly a function of supply and demand and the most affordable counties are often in Rust Belt localities that have low levels of population and job growth, and therefore relatively little new demand for housing.
Still, it’s important to remember that these counties are the exception to the rule. In general, housing affordability is worse in most counties: “Affordability is a nationwide problem for a variety of reasons,” says Ostrowski. Reasons include an inventory shortage, rising mortgage rates and more, he adds. And “property prices have been soaring just about everywhere and home values have outpaced wage growth during the past two years,” says Ostrowski. Some of the most unaffordable large counties include Los Angeles County, California; Maricopa County, Arizona; San Diego County, California; Orange County, California; and Kings County, New York.
That said, “worsening affordability appears to be having an impact on demand, which could lead to prices plateauing or even correcting modestly in some markets. Many potential buyers may elect to continue renting until market conditions improve. Others might adjust their sights and look for smaller properties or homes that are further away from major metro areas,” says Rick Sharga, executive vice president of marketing at ATTOM.
The most recent headline CPI came in at 9.1% so it might seem odd to think that the risk of disinflation and deflation is rising.
But while the CPI is a rearview-looking indicator, many forward-looking indicators are starting to tell a very different story – a story of falling demand and falling prices.
The economic and inflation story of the last 36 months is simple:
- We had a global pandemic that we responded to by printing $7 trillion while we also shutdown huge portions of the global economy.
- This created a mix of demand-side inflation and supply-side inflation.
- While many people thought the inflation would be “transitory,” it has persisted longer than many expected because of the waves of COVID, shutdowns and then the surprising war in the Ukraine.
I am on record having predicted the high-ish inflation in 2020 and 2021, but I was shocked by the persistence of COVID and the War in Ukraine, so inflation has overshot my original upside prediction by a bit. I guess I need to get my crystal ball fixed so it can predict wars and pandemics.
Read: Wholesale prices jump again and signal still-intense inflation in U.S. economy
That said, this doesn’t change my view from a few months back: I still expect inflation to moderate in the coming years, and in fact I think the risk of outright deflation is rising.
As for historical precedents, I think a repeat of the 1970s and the risk of a prolonged period of high inflation is overstated. In fact, I’d argue that the risk of deflation is becoming more and more apparent. This environment looks more like, gulp, 2008 than 1978.
I hesitate to compare anything to the 2008 financial crisis because that was such a unique crisis, but the current period has more similarities than many people want to admit. This includes:
- Booming stock and real-estate markets that have only just started to cool off in recent months.
- Booming commodity prices and uncomfortably high inflation.
- An aggressive Fed that is more worried about runaway inflation than the risk of deflation.
Some people have argued that inflation will be persistent because of wage-price spirals, surging rental rates or a continuation of the COVID supply constraints. And while a worsening war in Ukraine or a war in Taiwan would certainly cause continued high inflation, the baseline at this point appears to be dominated by other higher probability outcomes:
- COVID and its related shutdowns are ending or at least moderating substantially.
- A war in Taiwan looks like an extreme outlier risk.
- Supply chains are improving.
- Demand is slowing across the economy, especially as rate hikes cool the real-estate market.
- Fiscal headwinds will continue well into 2023.
Most importantly, something potentially nefarious is brewing under the surface here and we’re only just starting to see it in the real-estate market.
In short, the Fed’s aggressive reaction to inflation has stalled the housing market at the worst possible time because prices had surged so much. So we have a nasty combination of very high prices combined with suddenly unaffordable mortgage rates.
Federal Reserve Economid Data
The only way this resolves itself is in one of three ways:
- House prices fall substantially.
- Mortgage rates revert to their old rates.
- Some combo of 1 & 2.
As we learned in 2008, housing IS the U.S. economy. So when U.S. housing slows, it will drag down everything with it.
While some are worried that inflation has to continue to surge because price-to-rent ratios are still wide, I believe the risk of deflating home prices will pose a meaningful downside risk to inflation in the coming years.
In fact, investors worried about the exact same thing in 2006-2007 when the price-to-rent ratio was far smaller. This is part of why the Fed overreacted in 2005-2006 and raised rates so much. But what they were really doing was crushing housing demand and creating dysfunction in the credit markets.
That same risk is playing out today.
The kicker here is that the driving force is house prices and house prices are the volatile factor here. Rents lag substantially due to contractual agreements and wage lags. Real and nominal wages are actually deflating thereby putting an upward limit on how much rents can rise. And the softening housing market is going to put downward pressure on house prices.
This means the price-to-rent ratio is likely to converge in the coming years primarily because house prices have downside risk, not because rents have upside risk.
I want to emphasize that I don’t think this is a repeat of the 2008 financial crisis. The underlying housing dynamics are much healthier today than they were back then, but my baseline case continues to be slowing growth and disinflation with a rising risk of deflation if housing weakens more than I expect.
On the flip side, the obvious risk to this forecast is a return to COVID shutdowns, large fiscal stimulus, worsening war in Ukraine and/or a war in Taiwan. But I would argue that disinflation and a rising risk of deflation is more likely than prolonged high inflation.
Cullen Roche is founder and chief investment officer of Discipline Funds, a financial-advisory firm. He is the author of the Pragmatic Capitalism blog, where this column first appeared. Follow him on Twitter @cullenroche.
More from Cullen Roche: It’s now clear that the Federal Reserve has made a huge monetary-policy error
Home builders are feeling jittery.
That’s according to a June survey of home builder sentiment by John Burns Real Estate Consulting. Demand for new homes is cooling as buyers cancel orders, and builders are slashing prices to offload homes, the survey found.
“Scary times,” a home builder in Nashville, Tenn. told the company. “Hoard cash and hang on for the ride!”
Sales of new homes fell 31% this June as compared to last year. Cancelation rates jumped in June to 14.5% nationally, up from 6.5% a year ago, as seen in the tweet below.
The monthly survey was based on 320 participants in 84 metro areas.
Texas saw the highest rate of cancelations (when buyers terminate a contract for a new home), followed by the broader Southwest, and Northern California.
A quarter of home builders are reducing their prices, according to the John Burns Real Estate Consulting survey.
There are couple of reasons that homebuyers are pulling back: Mortgage rates have risen considerably since last year, which has made borrowing expensive, on top of rising inventory levels.
Other surveys have suggested that home builder morale is sinking. Builder confidence fell for the sixth straight month in June, according to the NAHB/Wells Fargo U.S. Housing Market Index. This month’s numbers will be released on Monday.
Home builders surveyed by John Burns expressed frustration over the slowdown.
“Someone turned out the lights on our sales in June!” one builder in Atlanta, Ga. told the company.
“Sales have fallen off a cliff,” an Austin, Texas builder said. “We’re selling 1/3 of what we sold in March and April.”
A Boise, Idaho builder said that builders are slashing new home prices by 15% to 20%.
Write to MarketWatch housing reporter Aarthi Swaminathan at: aarthi@marketwatch.com
Mark Fleming
Housing has become increasingly unaffordable to millions of Americans — with home prices and mortgage rates continuing to rise (see the lowest rates you may qualify for now here). So – as part of our series where we ask prominent economists and real estate pros their take on the housing market now – we talked to Mark Fleming. Fleming – the chief economist for title, settlement, real estate data and risk solutions company First American Financial Corporation – has analyzed and forecast the real estate and mortgage markets for 20 years. Before becoming the chief economist at First American, Fleming developed insights and analytical products for CoreLogic as well as valuation models at Fannie Mae and today his research expertise includes real estate and urban economics and mortgage risk. So we asked Fleming: What do today’s buyers and sellers need to know about the housing market?
Mortgage rates are higher, but they’re still not high
Though they’re significantly higher than three months ago, which reduces house-buying power, they’re around 6% for a 30-year fixed-rate mortgage, which Fleming says is a far cry from high. “Mortgage rates are higher but by historical standards are not high,” says Fleming. He has a point: This chart from the St. Louis Fed shows the curve of mortgage rates since 1975. (See the lowest rates you may qualify for here.)
Affordability is increasingly a challenge for buyers
Home price appreciation has been rapid in the last two years. Indeed, according to data from the National Association of Realtors, the median sales price for an existing home was up 17% from last year. “That’s important because it’s been practically impossible for house-buying power to keep up, and consequently, affordability has been declining,” says Fleming.
Fleming says house price appreciation, as measured by many of the house price indices reported in the media, have a significant lag, sometimes as much as six months. “It’ll be a few more months before the house price indices reflect how prices have reacted to the rapid increase in mortgage rates in the second quarter,” says Fleming.
Prepare for slower home price growth
But just because affordability is a challenge, doesn’t mean home prices are going to fall. Fleming says his research shows that during rising mortgage rate eras like we’re experiencing now, the number of home sales does tend to decline but house prices generally don’t. “Fewer sales and less price appreciation is the expectation,” says Fleming.
The housing market is cooling
Watch inventory levels and the amount of seller price reductions on listings. “These are the leading indicators of where prices will go and how the increase in mortgage rates have affected demand. More inventory and more seller price reductions signal a cooling market,” says Fleming. For sellers, this means a reset on the expectation of how quickly their home will sell. “Mere days on the market were never normal. In fact, the old adage used to be that sellers should typically expect their home may take up to 3 months on the market to sell. Of course, we’re a long way from that yet, but sellers should expect it to take longer to sell their home. For buyers, expect less fierce competition to buy a home,” says Fleming. (See the lowest rates you may qualify for here.)
Consider an ARM, and be a smart shopper
Given the current market, Fleming says it’s easy to lose focus amid shifts in mortgage rates and other housing dynamics. “The reality is some basic steps remain important and are not much different than any market. Shop around for the best mortgage and in a rising-rate market, investigate adjustable-rate mortgages for the lower rate benefit. Make your choices based on home as shelter, rather than an investment return opportunity and have patience,” says Fleming.
Will Housing Prices Fall as Mortgage Rates Rise? History Says No.
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Rising home prices and mortgage rates imply a 30% increase in payments for the average borrower.
Frederic J. Brown/AFP via Getty Images
About the authors: Laurie Goodman is an Institute fellow at the Urban Institute. She founded and was previously director of the Housing Finance Policy Center at Urban. Michael Neal is a principal research associate in the Housing Finance Policy Center at the Urban Institute.
Housing prices have risen rapidly this year. Unfortunately for those hoping for a break in their rent or an opportunity to buy a more affordable home, a close reading of the market and the historical record suggests that prices aren’t likely to fall soon.
Mortgage rates are up substantially in 2022, with the 30-year fixed rate mortgage jumping from 3.11% at year end 2021 to 5.3% on Thursday, courtesy of aggressive Federal Reserve interest rate increases. This would suggest the mortgage interest payment on a $300,000 home rose from $1,283 to $1,666, a 30% increase in payments, challenging the affordability for many borrowers. While existing home sales have fallen from just over six million units at an annualized rate in December 2021 to 5.1 million units in June 2022, home prices continue to rise. Zillow estimates of the typical U.S. home price show an increase from $324,000 to $354,000 over the past 6 months, equivalent to an over 18% annualized increase. However, the past few months the rate of price increases has decelerated.
Some have looked simply at the affordability challenges in combination with the slowdown in existing home sales and concluded that home prices will fall. However, history has proven time and time again that by themselves, higher mortgage interest rates do not lead to home price declines. We look at the historical evidence and conclude that, in the absence of a major recession, home prices nationwide are likely to decelerate sharply, but are unlikely to fall.
The evidence, please!
Historically, the relationship between increases in home prices and increases in mortgage rates has been very weak, albeit positive. That’s right; increases in mortgage rates have been associated with increases in home prices. There are two important offsetting effects at work. One effect is that rapidly rising interest rates challenges affordability, which should weaken home prices. The other effect is that the increases in interest rates are not occurring in a vacuum; they are associated with periods of Federal Reserve tightening, in response to an economy in which growth or inflation is higher than desired. The positive relationship between changes in home prices and changes in interest rates indicates that historically, the effect of stronger economic growth, lower unemployment and inflation, factors that should strengthen home prices, have dominated the challenges to affordability.
However, this does not address the issue of what happens when mortgage rates rise very rapidly. There have actually been very few of those periods, as interest rates have been in a secular decline since the early 1980s. Nonetheless, we identify two periods where mortgage rates rose more than 1½ percentage points year over year: September 1979 to March 1982 and September 1994 to February 1995.
During these periods, the rate of home price appreciation decelerated rapidly. For September 1979 to March 1982, home price appreciation decelerated from 12.9% to 1.1%. And from September 1994 to February 1995, it decelerated from 3.2% to 2.6%. For each period, real home price appreciation (home price appreciation corrected for inflation) was negative for some part of the period.
In fact, since 1976, there were only two periods in which nominal home prices were negative nationwide: the early 1990s and the Great Financial Crisis. House prices don’t fall with every recession, but in both these periods, the U.S. was in a recession, and rates were declining, not rising.
Bottom line: there has been a lot of speculation about what rising mortgage rates mean for home prices, with little regard for the evidence. Our close look at the data shows that the state of the economy rather than housing affordability is a larger driver of home price changes. A solid economy reflected in low unemployment and rising wages boosts housing demand by helping buyers ultimately absorb interest rate shocks. In addition, inflation drives up rental prices, and creates expectations of future rent hikes, making it attractive to lock in the payment on a 30-year fixed rate mortgage. As a result, interest rate increases are correlated with home price increases.
While an official recession has not been called, economic activity has shrunk over the first half of the year. However, amid continued Fed tightening, we have an additional tailwind—a housing supply shortage. This shortage was created by years of underbuilding in the wake of the great financial crisis. That underbuilding was a reflection of increasingly stringent zoning and higher regulatory burdens driving up land costs, higher costs for raw material and labor, and more financing constraints. Today’s housing supply shortage had not been present in previous periods of rapidly rising interest rates, and makes a decline in nominal home prices unlikely even as the economy mildly weakened. In response to these conditions, affordability challenges are likely to persist for quite some time. Absent a deeper contraction, these conditions will also result in continued, albeit more moderate, house price growth.
Guest commentaries like this one are written by authors outside the Barron’s and MarketWatch newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to ideas@barrons.com.
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