Home builders have housing crisis playbook which has proven effective time and time again. They start by offering incentives like mortgage rate redemptions. If that doesn’t work, builders start lowering home prices until their unsold inventory has been moved.
Fast forward to 2022, and homebuilders are clearly back to their housing downturn playbook, but there’s a new wrinkle: institutional investors. In the years following the real estate crisis of the 2000s, institutional investors like Blackstone saw an opportunity to buy more directly from struggling builders. The expansion into this so-called “build-to-rent” category means builders this time around are already offering significant markdowns to Wall Street buyers.
Last week, Bloomberg reported this home building giant Lennar would start shopping 5,000 unsold properties – an amount greater than all total active inventory in Kansas City—institutional investors. In some of these southwestern and southeastern communities, investors would have the opportunity to purchase entire subdivisions at a discount.
“What’s an interesting dynamic with institutional investors is that a lot of them have been sitting on the sidelines waiting for that moment to strike… [they’re thinking] ‘Hey, I want to buy these houses from you [the builder]but I want to get a discount for doing so. “,” said Ali Wolf, chief economist at Zonda. Fortune.
These institutional investors don’t just want markdowns on the order of 10%, they’re hoping for price drops of “20% and 30%,” says Wolf.
Firstly, the current average 30-year fixed mortgage rate (6.28%) means the slowdown in the housing market is still very much alive. On the other hand, the drop in the average 30-year fixed mortgage (from 7.3% at the start of October) means that the trough in housing demand could be in the rear view mirror. That’s why, says Wolf, some institutional investors might be ready to pull the trigger.
“What we’re hearing now is that some investors, because mortgage rates have come down, are worried that prime buyers will come back into the market. So some of the institutional buyers are trying to rush in now because they’re worried that there’s an increase in demand from core buyers and they’re losing their chance,” Wolf says.
Why are homebuilders like Lennar going to investors now? There are two big reasons.
First, the current real estate correction has intensified These last months. As mortgage rates hovered around 7% in October, the homebuilder cancellation rate (i.e. the percentage of buyers who cancel their contract) tracked by John Burns Real Estate Consulting soared to 26%. This high vacancy rate, coupled with a weak spring 2023 housing market on the horizon, means builders are discounting faster and making better deals for investors who can buy in bulk.
Second, homebuilders still have a huge amount of inventory – both single-family and multi-family – in the pipeline. A pandemic housing demand boom associated with extensive supply chain issues the number of US homes under construction to a record high this year. Now, with cancellation rates skyrocketing, builders are eager to sell that backlog before they finish construction.
In the future, Wolf expects the historic pipeline of unfinished houses continue to drive down new home prices through the first half of 2023. But once permanent inventory is liquidated and the pipeline is brought under control, pressure on new home prices should ease.
How many of these homes will go to institutional investors? It’s hard to say.
While companies like black stone have made it clear that they want to continue to develop their real estate portfolios, some institutional buyers have also temporarily sidelined in the face of the ongoing housing correction. Look no further than Home Partners of America, owned by Blackstone, one of the nation’s largest private landlords, which announced in August that it halt purchases of single-family homes in 38 regional real estate markets in the United States.
There is also the fact that companies like black stone and Starwood announced plans earlier this month to limit withdrawals from their property funds. It is unclear how the continued increase in redemption requests from investors will affect their plans for future real estate investments.
Whereas the housing crisis certainly has home builders scrambling to move permanent inventory, that doesn’t mean we should write the builder apocalypse.
Just watch the stock market.
While the major homebuilders are all down from their 2022 highs, they are still well above their January 2020 price. This includes builders like DR Horton (+72.9% since January 1, 2020), Lennar (+67.4%), Toll Brothers (+30.2%), NVRs (+28.5%) and Pulte Group (+21.8%). During the same period, the S&P 500 index increased by 22.5%.
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