Area Real Estate News & Market Trends

You’ll find our blog to be a wealth of information, covering everything from local market statistics and home values to community happenings. That’s because we care about the community and want to help you find your place in it. Please reach out if you have any questions at all. We’d love to talk with you!

Sept. 14, 2022

Blue Pebble Market Insights -- Sep 2022

 

Slowing Down

 

1) Mr. Powell Seems Angry

2) Rate Hikes Hitting Demand

3) Rate Hikes Hitting Supply

 

 

It’s officially the end of summer and time to get back to work. School is back in session, the leaves are starting to turn colors, and the Broncos are back to making questionable, game-ending play calls. As we were getting ready for our LDW BBQ’s, the Fed’s decision makers made some really interesting comments about their perspective on the economy and the path forward for interest rates. They told the market that "pain" is coming, and now the questions that remain are: (1) do you believe them and (2) are you ready for it?

 

1) Mr. Powell Seems Angry

 

The US Federal Reserve has a dual mandate to maximize employment levels while minimizing inflation. Unlike the ECB and BoJ, the lack of a formal "inflation mandate" in the US gives enough wiggle room for action that many “Fed Watchers” make their living predicting how the Fed will act. With unemployment levels below 4% and annualized inflation north of 8%, however, it’s no surprise the Fed is much more focused on stopping inflation at the moment. 

 

In fact, Jerome Powell, the Chair of the Federal Reserve even used the words “economic pain” in one of his recent statements to outline his expectations for the consequences of their projected rate increases. As someone who started reading Fed statements when Bernanke was Chair and doing everything in his power to settle markets at that time, hearing a Fed Chair use the word “pain” is something that can not be understated. Noise from politicians like Elizabeth Warren is a bit comical because the conditions for this recession have already been created, and there is literally no policy alternative for Mrs. Warren to legislate away this slowdown without making the inflation problem worse.

 

 

Back to the inflation game… The current stakes for solving this problem are much, much higher than most people realize because of the Baby Boomers. One of the problems with aging is that miscalculations in your retirement planning become magnified because you no longer have earnings potential to make up for deficiencies. Sure, you could go back to work to try to make up the gap, but then you wouldn’t be “retired” anymore, and you are probably not going back to the same wage earning as you previously enjoyed. If the Fed loses control of inflation, all of the purchasing power in Boomer savings goes away, and the government (read: Gen X, Millennial, and Gen Y) will be forced to pay for a whole generation’s retirement. For this reason, inflation *must* be stopped which increases the likelihood that the Fed will over-tighten.

 

The problem with over-tightening, however, is that the US government is still running at a $1 trillion annual deficit, and increasing interest rates will increase the cost of servicing our debt. (Don’t blame the Fed for this, though, because if they don’t do anything and inflation out of control, the countries who hold US debt will start charging more in a much, much more disorganized way…) Increased costs from servicing our debt only increase deficits with the absence of entitlement cuts. Additionally, the Federal government is adding fuel to the inflationary fire and just authorized a further $300 billion handout in the form of student loan forgiveness that will force the Fed to take even greater action.

 

It’s been called a game of kicking the can down the road since 2008 when the US chose to initiate quantitative easing instead of addressing its debt and entitlement problems like Europe. Until the US addresses these major issues, it’s really hard to be constructive on the macroeconomic picture.

 

 

2) Rate Hikes Hitting Demand

 

Let’s check in on our trust table summarizing the high-level statistics for the market within a 10-mile radius of Union Station in downtown Denver. All statistics are based on data taken from REColorado between September 10-13, 2022.

 

 

There are a few interesting trends to point out, and it’s pretty clear now that the broad market shift started in May. On the demand side, higher rates have impacted our market by slowing the pace of sales and starting in June, “pending” activity (or the number of units put under contract in the month) slowed down. There were actually more listings on the market at that time vs. the year prior, so the change in absorption can be directly attributed to the increase in mortgage rates.  

 

With a 10% downpayment, the median residential unit in our market area ($712,000) cost a buyer $3,400 per month in March or April; in order to qualify for this loan, the buyer would need to make approximately $116,500 per year without any allowance for car payments, student loan payments, or other debt services. Without any change in housing prices, the increase in rates from the spring to now would increase the cost of that home to $4,500 / month and that buyer would need to make at least $154,000 to qualify. (We've discussed this previously.)

 

Now, prices and days on market (DOM) are adjusting to the higher rate environment, and the question becomes: how far will this correction go? The price of an average sold unit is down 13% from June which is approximately 8% more than historical seasonal behavior would suggest. (June is always the peak in our market, and we do expect prices to come down about 5% from June to August.) The problem is that they probably haven’t adjusted all the way, yet. The average price of a sold unit is now $622,000 which makes the cost of carrying that unit $4,000/mo at prevailing interest rates. If you’re like me and don’t expect that there was much *wiggle room* in the market’s ability to service debt before the rate increases, then either prices are still a bit too high or the pace of the market is still a little too fast. The average price of a sold unit would need to go down approximately another 10% for the cash cost of that unit to be constant before or after the rate increase.

 

3) Rate Hikes Hitting Supply

 

One of the secondary effects of increasing rates is that supply is actually going down right now. Not everyone is a first-time home buyer, and many transactions are dependent on someone selling a property in order to purchase another one. With the increase in prices and rates, however, we are seeing a situation in which people who want to trade (move up, down, etc.) are unable to because they wouldn’t be able to afford to reset their mortgage at higher rates. Here’s a quick example… Let’s say your family is making $100,000 / year and that allowed you to afford our median home last year. The problem is that the cost of that home has increased 10 or 20% from where it was when you bought it, and you wouldn’t be able to afford that house now. So, if you want to take the equity from your current home and use it to trade up, you can’t unless you are making substantially more money (debt service coverage) or want to put fresh equity (higher downpayment) into the deal. As a result, many “normal” deals that would happen because of changes in situations, life, etc. are not happening in the same way they would have only a few months ago.

 

One of the most important lessons learned from my front-row seat of the 2008 Financial Crisis was that our financial system is way too complicated for any single person to understand all of it, and effects take much, much longer to work their way through the system. At the end of the day, we’re approximately 6-months removed from the *first* rate hike hitting the system, and that means we haven’t felt the full effects with the Fed suggesting more is coming down the pipeline. It’s our opinion that this is a time to stay relatively conservative on the risk curve – residential, main & main, fixed-rate financing. Everything will be fine. 




Posted in Market Insights
Aug. 18, 2022

Blue Pebble Market Insights -- Aug '22

The Shift is Here

 

 

1. Figuring Out the Macro Picture

2. Demand Slowing

3. Listings — No shift, yet.

 

There’s an amazing scene from the movie, “The Naked Gun,” in which Leslie Nielsen puts his hands above his head and declares, “Nothing to see here!” to a crowd of civilians after witnessing a sequence of car crashes involving an oil tanker, surface-to-air missile launcher, and finally, a fireworks shop. The driver who found himself in the unfortunate crash was hurtling uncontrollably at his impending doom to find that he survived the first two crashes — it all ended for him when he ran into the fireworks store riding the missile. (If you haven’t watched this movie, grab some popcorn and throw it on this weekend.)

 

While I’ve made references to this movie before, it’s hard not to again see the similarities between the movie and our economy. Even though the Fed started raising rates almost 6-months ago, on the surface, it seems that everything is “ok” right now. Just as the car driver was able to brush off crashing into an oil tanker, investors have so far brushed off huge, short-term rate hikes. Yet, cracks are starting to emerge in our economy that suggests the consolidation cycle might not be “over,” yet. Read on for a quick discussion of the macro environment as well as how Denver’s real estate market is reacting.

 

Figuring Out the Macro Picture

 

The actions being taken by the US Federal Reserve are the most important for our economy right now. This spring and summer, they announced a series of interest rate hikes and longer-dated bond sales to increase borrowing costs, slow the economy, and temper inflation. The equity markets reacted rather quickly (and violently) as companies issued guidance that earnings would take a hit. Since then, however, just as the driver in Naked Gun fended off the first obstacle, the S&P and global equity markets have rallied back and are within sight of levels we saw before these announcements. The question going forward is: did the Fed engineer a “soft landing” or is there more trouble ahead?

 

Right now, it’s hard for me to make a call that the Fed has raised rates enough to stop inflation which makes it harder for me to call a soft landing. The following image shows a screenshot of the components of CPI from the last report:

 

 

There are a few interesting points in this chart. The first is that the only component of inflation that improved from June to July was energy and this was the result of oil selling off 20-30% in a month. There are some really, really smart people in oil & gas who think we are more likely to see $120/bbl vs. $60 which means energy will likely contribute to further inflation in the future, not less. The second interesting thing is that food prices are continuing their trend of 10% annual increases and this is very concerning. Anecdotally, I was chatting with a friend (who reads this newsletter) about the report, and he acknowledged “yeah, grocery store eggs are getting really expensive!” Lastly, shelter and transportation prices have not been impacted by the interest rate increases, yet, and are still growing over 5% year-over-year. 

 

Energy, food, and shelter/transportation comprise a majority of the inputs for the index that the Fed uses to track inflation. If we assume that energy isn’t going down another 20-30% in the next month, then we have to assume inflation will be running very hot in the next report. This means the Fed is more inclined to continue raising rates instead of stopping. Until the Fed stops raising rates, it’s impossible to call for a “soft landing” as it will take several months for companies to feel the impact of these increasing borrowing costs.

 

Demand Slowing

 

Let’s check in on our trusty table summarizing the residential real estate market in the 10-mile radius surrounding Union Station in downtown Denver:

 

All data taken from REColorado from Aug 1 - Aug 14, 2022

 

Historically, July is the first month in the calendar year when the market is expected to “slow down.” Going back 10 years, the average sold prices in July are 1-2% lower than sold prices in June, and we typically start to see homes sit just a bit longer. While that hasn’t been a clear pattern since the start of COVID, higher mortgage rates are causing the housing market to shift from a seller’s market without per capita listing rates increasing.

 

As of the end of July, the average sold price of a housing unit (detached & attached) was $671,000. The increase in mortgage rates from 3% to 5.5% increases the expected monthly cost of that home from $2,800/mo this winter to $3,600/mo right now — and that assumes you’re putting 20% down, it gets worse if you’re doing less. 

 

While I don’t have the data that says “buyers were stretching their budgets as much as they could” before the increase in rates this spring, I feel relatively safe making that assumption based on the stressful conversations our team has had with respect to budgets, pricing, mortgage qualification, etc. over the last year. As a result, it’s easy to understand why pending units have fallen off a cliff (down over 25% YoY the last two months). There are simply fewer homebuyers who can afford homes at these prices and rates which is causing the market to shift. The shift is further shown in sold activity which was down nearly 30% in July, and it doesn't seem that trend will reverse next month.

 

Listings — No Shift, yet

 

Real estate is an asset class that involves a lot more “art” than most other financial disciplines. In that sense, we have a broad metric for defining the strength of the market and typically look to Days on Market (DOM) as a way of interpreting price stability. When DOM is less than 120 days, i.e. it takes less than 4 months for the median home to go under contract, we would say we’re in a “seller’s market” & prices are typically going up; when DOM is more than 180, we’d say it’s a “buyer’s market” when prices are more likely to go down. It follows that something in between would be more “balanced.”

 

The Denver real estate market had been showing 4-days as the median DOM (or a very, very strong seller's market) for months; this was the practical minimum number possible. When the market was in this regime several months ago, there was no differentiation among homes — if it was on the market, it was going to get into a crazy bidding war.

 

Now, the market is very different. While pricing has cooled off somewhat as a result of seasonal factors and fewer bidding wars, it is still relatively strong. Homes currently under contract or were closed in the last 90-days had a median DOM of 6 days. This data suggests homes that are properly priced are finding buyers relatively quickly. Even though the pace of the market has slowed down, on the whole, there are still less than 1.5-months of inventory on the market and the median DOM (by any metric) is still less than four months. I can explain this phenomenon by pointing to the left side of our table that shows new listings are still not hitting the market at a faster pace than last year. Without supply coming on to the market at a faster pace, it doesn’t appear that higher mortgage rates will be enough to cause a correction in the Denver market, yet.

 

What I can say for sure is that you don’t want to list your house at a price that’s too high. Of all the homes that are currently on the market, the median DOM is 29 (up from 6!) and if you look at the data conditional upon the home not selling in the first weekend, you can expect that listing to sit for more than a month. Homes that sit on the market for a month are expected to sell at a price that’s at least 5% below their list price… so, if you want to avoid chasing the market down to low-ball offers, make sure to be realistic about the value of your home and work with a real estate professional who understands what’s happening in the market right now.








Posted in Market Insights
July 13, 2022

Blue Pebble Market Insights -- July '22

Peaking Over the Edge

 

1) Taking Stock

2) Demand is Cooling.

3) Supply Building (slowly).

 

Taking Stock

The effects of the Fed's aggressive rate hikes are starting to show, and the real estate market is beginning to slow down. Corporate earnings season in the US begins on July 20th and the expectation is that companies are going to have some pretty lackluster results. In addition to reporting their most recent results, the next two months will be an opportunity for companies to update year-end '22 and also FY23 guidance, so it's more likely stocks move on future expectations vs. second-quarter results. (It seems as though the market is still a little skittish after sniffing 3,600 (S&P 500) and the consolidation pattern forming now will break into a new trend right around when earnings kick-off.)

 

On the debt side, 10-year interest rates in the US appear to have settled into a level around 3.0% which is now leading to average 30-year mortgage rates on the order of 6-6.5%. There are growing concerns that the Fed has acted too quickly in raising interest rates, and we do expect volatility to persist in the interest rate markets while inflation pressures mitigate and the impact of the short-term increases continue to propagate throughout the system.

 

Demand is Cooling.

As always, let’s check in on our table summarizing the performance of the residential market within a 10-mile radius of Union Station in Downtown Denver.

 

All Data taken from REColorado in July 2022.

 

Mortgage rates started accelerating higher in April, so June is the last month of data that doesn’t fully capture the impact of prevailing interest rates higher than 5%. When a typical buyer goes under contract, he/she typically “locks” their rate for the duration of the 30-60 day contract period, so it takes 2-3 months for the data to reflect the behavior of buyers operating in the current interest rate regime. Even though we're not at the end of the time period, yet, you can already start to see the shift in the market. Simply, there is more red forming at the very bottom of our chart. (As a reminder, the chart is shaded so that data wish is "good" for prices is green and "bad" is red.)

 

June is historically the month in which prices hit their maximum during the annual cycle because it's normally the month with the highest transaction pace: more buyers means more demand and higher prices. Shockingly, this behavior did not happen this year. Instead, preliminary indicators suggest only 1,976 units were put under contract in the month which is the lowest number for that month in our market going back to 2012. June 2020 and June 2021 saw pending units hit 2,800 & 2,600, respectively, so a drop below 2,000 is a HUGE move. We expect this trend to continue as the impact of higher mortgage rates continues to be felt. 

 

Supply Building (slowly)

The nominal number of new listings per month is relatively unchanged over the last two years. As a result, this past month saw a 38% increase in active listings versus a year prior which can be solely attributed to the slowdown in demand mentioned above.

 

There is probably more shock value than actual value in the normalized increases; because the results are starting from such a low denominator, any increase will seem large right now.  There was an increase of approximately 900 units on the market at the end of June which made the total tally 2,369 units on the market. Even with the slower pace, we are still under 1.5 months of supply which means homes will sell if they are priced properly. There is still only 60% of the inventory available on the market right now as there was during the summer of 2019, so we still have a very long way to go until the market is saturated and prices are at risk of coming down.

 

 

Posted in Market Insights
June 13, 2022

Blue Pebble Market Insights -- June '22

 

Here We Go!

 

(1) The Shift

(2) Demand Shifting in 2-Months

(3) It Only *Looks* Like a Supply Shift

 

Summer is officially here which means you’ve probably got better stuff on your schedule than checking your email and reading about Denver’s crazy housing market. For those of you who made it to this point, I promise to keep my comments brief as things will be very dynamic over the next few months. In short, the themes we've been tracking since the beginning of the year are playing out in the economy & capital markets, and it seems that we’re at the very beginning stages of a recession. As opposed to the last cycle, housing will outperform other sectors as this asset class will enter this recession under-supplied and supported by construction costs which. are unlikely to go down materially.

 

The Shift

 

The economic slowdown will be the result of increased costs related to interest rates and labor. The Federal Reserve has an inflation problem, and the market is concerned that interest rates will have to go up very quickly in order to cool things down. The Fed has also announced their intent to reduce their balance sheet which means that they will also be putting pressure on longer-term sections of the interest-rate curve as well. With all the government support provided through the bond market to the economy over the last decade (along with direct payments to companies during the pandemic), many companies rely on cheap funding and low interest rates in order to fund their businesses. We expect there will be significant discomfort for many businesses over the next two or three years with modest spillover on the housing market.

 

The real estate market is more similar to a commodity market like oil than the venture capital market; there is economic value to improving land and it’s just a question of determining the best use. So, it’s a *bit* easier to predict what will happen durng an economic slowdown as the value of land and structures is rooted in real cash flow vs. an unproven business model. For example, when prices are skyrocketing faster than replacement costs, builders can step in to create supply and bring things back to equilibrium; the opposite is true when costs go beyond prices and construction slows down until it becomes profitable again.

 

We will enter this recession already in a multi-million housing unit shortage across the country which includes a shortage on the order of 10,000-15,000 units in the Denver metro area. Higher interest rates will decrease the size of the buyer pool at every price point and create longer marketing times before homes get sold. The cost of new construction is still extremely high, so we don’t think new supply is going to get turned on anytime soon. Therefore, we expect the “high plateau” to start forming over the next few months.

 

Demand Shifting in 2-Months

 

Let's check in on our trusty table summarizing market activity in the 10-mile circle centered on Union Station in Downtown Denver: (All data taken from REColorado on June 13, 2022.)

 

 

From a demand perspective, not that much changed last month. The pace of homes put under contract was still consistent with the trends we've seen since the start of the pandemic and Days on Market (DOM) is still stuck at 4 days in the median. As far as this table is concerned, everything is peachy keen.

 

Here is an interesting piece from Barron's that outlines their argument for why the housing market has peaked. They note that mortgage applications have fallen precipitously which means that fewer buyers are going to be entering the pool over the next few months. This will probably only get worse as interest rates are up another 0.5% - 0.75% since that article was published just a week ago. It's too early for our systems to show the shifting demand curve, and we are confident that data will show up in the next few months as higher rates make homes less affordable.

 

It Only *Looks* Like a Supply Shift

 

You might notice how last month showed the first "red" cell for Active Listings going back to 2019... If you did, that's really impressive as it’s been so long, we’ve almost stopped lookin or it. This past month was the FIRST month going back almost THREE YEARS when there was more supply on the market this year vs. the same time last year -- that's pretty crazy. As you can see from the far left column, though, the shifting supply picture is not the result of new homes hitting the market but buyer's slowing down the pace of purchases. You can see in the Pending column that activity has been trending lower for the last year.

 

As higher interest rates take hold, we are expecting the Pending data to drop even further which should start leading to more homes staying on the market for longer periods of time. We're still another 10,000 units short on supply before prices would start to move lower and we still expect buyers to have a few more choices when they're shopping for homes later this year.  

 

 

 

 

 

 

 

 

 

 

Posted in Market Insights
May 11, 2022

Blue Pebble Market Insights -- May '22

Turning the Ship

 

(1) The Government’s Pickle.

(2) So far, no change in demand.

(3) No sharp supply changes, either.

 

No one starts taking drugs with the intent to become an addict. Over time, habitual use of a stimulant leads to diminishing marginal returns for the user which encourages further abuse to get the same high. If that drug is abused for a long enough duration, the body will develop a chemical dependency that requires continual abuse just to feel “normal.” When the drug is removed from the system, the body goes through extremely uncomfortable withdrawal. If you think our economy is going to go through anything dissimilar, you are mistaken.

 

The Government’s Pickle

 

When an economy is recessing (read: sick), there are certain amounts of cheap money (read: drugs) that are good for the system. Problems develop when drugs are still administered even after the patients have recovered and that’s exactly how our economy got to this point in time. There’s no way President Trump could have predicted the COVID-19 pandemic when he passed his tax cuts, and it doesn’t matter — this legislation (in my opinion) was one of the worst things that happened to our economy in recent history and it’s finally playing out. Here’s why:

 

1) Passing tax cuts that benefit wealthy individuals (estate taxes, QBI, lower marginal rates, etc.) creates a lot of cash.

2) When interest rates are <2% and inflation is >2% (negative real interest rates), unlike less fortunate people who use tax cuts to fund their lives, rich people invest it.

3) No matter the channel (public or private), increased investment increases prices and return requirements.

4) Higher prices leads to higher return requirements which, in turn, forces investment managers and corporate executives to invest in more projects.

5) New investments require new resources (people & goods). Keep in mind the goods also require people for production.

6) At the time these tax cuts were passed, unemployment was only ______% which is effectively “maximum employment” for the US economy.

7) When you’re already at full employment and there’s a huge slug of new demand for labor as a result of increased investment, you get wage inflation. (Have you seen salaries in the tech space lately…?)

8) Wage inflation increases discretionary spending…

9) Which leads to more demand for goods…

10) Which leads to more demand for labor to make those goods…

11) And the inflation cycle continues until it can’t anymore.

 

The pandemic only exacerbated economic issues that were already brewing. Both the Trump and Biden administrations share blame for taking the path of printing money first and asking questions later. Replacing income for workers while everything was shut down led to higher free cash flows for the American consumer and created an increase in spending. At the same time, many companies that should have gone bankrupt were given exceptional accommodation which kept labor from recycling into the market to satisfy increased demand in other sectors. As a result, supply-chain issues were exacerbated which only increased inflation pressures on consumer goods. Simultaneously, low-interest rates for an extended period as a result of Fed accommodation further incentivized investment in long-term capital projects and an already sizzling real estate market which resulted in dramatically higher real estate costs across the board -- both for construction and existing products across all asset classes.

 

With the Fed’s new course of increasing rates, companies are now facing a new triple-threat: (1) costs of labor have skyrocketed (salaries, benefits, turnover, etc.), (2) costs of financing are materially higher, and (3) buildings that manufacturers need to make goods are significantly more expensive. While a company can try to increase prices to cover these higher costs, that is not always an option. Additionally, if the cost of commodities continues to increase, it will only increase the pressure on the Fed to act more aggressively which makes (2) and (3) a bigger problem than it already is today. 

 

The acknowledgment of inflationary pressures by the Fed is a good thing in the long run and it will cause significant pain in the short & medium term as the second and third-order effects of Quantitative Tightening (or QT) are untested. Here’s just one thought experiment… Before QT was recently announced, Quantitative Easing (or QE) was one of the “exceptional tools” the Fed deployed during the financial crisis in order to help encourage long-term investment; it’s also become the drug on which we’ve depended to fund our lives.

 

Since the concept was introduced in 2008/2009, the US Fed has accumulated nearly 40% of all outstanding US government debt onto its balance sheet. The Fed isn’t legally allowed to lose money, so think of this arrangement as a short-term loan between the Fed and Congress that effectively “prints money” but only for a period of time. The Fed bought bonds from the US treasury and at some point, the US treasury will have to make the Fed whole. The benefit of this series of transactions, at the time, is that it provided a ceiling on long-term interest rates that facilitated long-term investment by companies and lowered the debt service costs of the US government; we borrow money to cover annual budget deficits which increases the amount of interest the government has to pay on its debt. This was all fine until inflation started to rear its ugly head and caused the Fed to change course.

 

Just as the QE drug was helpful when we were sick, the problem is two-fold for the US government now that we are experiencing significant side effects (inflation). The first problem for the government is that Treasury now needs to find a new buyer for its debt at a time when that debt is starting to become less valuable. (They could solve this problem by increasing Tier One capital requirements at banks/insurance companies but this will also decrease the velocity of money and slow down the economy.) The problem will become even bigger over the next several months given the Fed’s recent announcement that they will start selling $60 billion/month of their portfolio and then accelerate that figure to $90 billion/month this summer. Now, instead of the Fed acting as a stabilizing force for the bond market, it will become destabilizing when it starts to compete with Treasury in the bond markets.

 

THE FOLLOWING is what keeps me awake at night... The US had a decade to get its fiscal house in order, but instead, we chose to borrow more money to fund deficits because the Fed made money so cheap. Now, we have a very, very limited amount of time to resolve our budget issues before the market will force the US government to divert funds away from entitlement programs/defense and into debt service. If we want to avoid cutting programs, then taxes will have to go up, but neither of those options are going to be pleasant, especially for a Baby Boomer generation on the verge of retirement with a disproportionate amount of voting power. What makes this scenario potentially worse is that all of this will happen even if the economy doesn’t enter a recession!! If the economy recesses, then it will only exacerbate the need to increase taxes which will further hurt prospects for growth.

 

Nice rant, Jared. So what?

 

First, wages will not go down anytime soon. Boomers are leaving the workforce and will need to be replaced by someone or something; additionally, their increased longevity will increase demand for goods and labor which will maintain demand for human capital well into the future -- and also keep inflation running hot. Real estate is going to stay expensive and probably become less affordable in the future. Without new tradesmen entering the labor market, replacement costs for real estate will stay exceptionally high and provide support for pricing no matter how expensive financing*** becomes. Companies are going to have to make the choice to increase prices for their goods or lower expenses to stay profitable. If they can’t increase prices and need to cut costs, jobs will be lost***** in favor of software or robots. Whether it happens now or later, the government will need to increase tax revenues to cover higher debt service costs and maintenance of Boomer entitlement programs -- this will definitely hit aggregate consumer spending.

 

This all won’t play out over the summer. First, no politician wants to talk about raising taxes on the campaign trail and this isn’t an important enough issue in the face of Roe and other social issues. Additionally, China’s Communist Party is having its elections this fall and that is a HUGE incentive for Xi Jinping to maintain a feeling of normalcy even while you’re starting to hear about their commercial property bubble bursting and revolt against their COVID policies. So, go out and enjoy your summer. Play a lot of golf, take a vacation, buy a house if you can, but don’t deploy a ton of investment capital. I think you’re going to have a much better entry point in 6-12 months.

 

_____

Footnotes:

*** Unless something drastic happens, the trend is reverting back to what we saw before WWII when you had to be upper-middle-class to be wealthy enough to afford real estate... How many “middle class” Denverites make enough (~$150,000) to afford the median home in Denver right now? By the way, you can break the student loan cycle and simultaneously solve the affordable housing crisis by incentivizing a lot of young men and women to go to a trade school for secondary education.

 

***** That’s not a joke. If you’re looking for long-term equity investments, I think companies specializing in robotics and automation are going to be a no-brainer for the next 10-20 years after we cycle through the next 12-24 months of volatility.

 

_____

 

 

 

So far, No Change in Demand

 

Let’s check in on our table summarizing what’s happening in Denver’s real estate market right now.

 

Data taken from REColorado on May 6, 2022.

 

Over the last year, we’ve seen the pace of the market slow down less than the pace of new listings which is why prices for homes skyrocketed in Denver. Last month was no exception. In the first four months of 2022, approximately 8,000 units (detached and attached single-family) went under contract. That number is in between what the market displayed in 2020/2021 but right in line with the 8,200 units that went under contract in 2019.

 

What we’ve experienced so far this year is extremely impressive when you factor that the average price of a sold unit in our market area in 2019 was $490,000 and interest rates were around 3-3.5%; now, the average price of a sold unit is $700,000 and the cost of financing is much closer to 5%. I recognize a lot of “cash” has moved to Colorado over the last few years and that’s helped provide a significant lift to prices; anecdotally, it’s not unusual anymore to meet a client moving to Denver from NY, FL, TX, IL, or CA that is looking to purchase a million-dollar home for cash. I’m struggling with who the next buyer will be, though… If you assume that a majority of those who could relocate to a new area already did so during the pandemic, then I’m not sure from where the new influx of buyers will come who can afford these higher prices once we cycle through the existing demand in town.

 

No Sharp Supply Changes, Either.

 

Just as we continue to see similar market behaviors on the demand side, they continue on the supply side. And, the more that I’ve given it thought, I’m not sure it’s going to change anytime soon. Even with everyone moving here and all the new units that have been built over the last three years, we are still seeing drastically lower per capita listing rates. In 2019, 9,800 new listings hit our market area in the first four months of the year, and this year that number was 8,900 (down ~10%).

 

There are A LOT of Coloradans who are now “stuck” in their homes — a confluence of factors including rising home prices, higher interest rates vs. existing debt, and less workforce mobility (why leave CO if you can work remote?) means fewer homes will go on the market in general. Assume you bought your home in 2019 for $500,000 and are paying 3% interest on a $400,000 mortgage. Even if there weren’t transaction costs and you were able to roll all your equity into your next deal, you’d start out paying an additional $8,000 in interest every year just based on the interest rate moves this year. If you’re still working, maybe you got a raise that would allow you to qualify for another loan, but the odds are that you’re already spending a chunk of that money on other aspects of your life. Additionally, many older homeowners on fixed incomes can’t absorb the increased mortgage costs and can’t put additional equity into a new home given their retirement needs. Furthermore, they are taking advantage of equity positions through reverse mortgages so they can stay in their homes rather than cash the equity out at once.

 

It seems we are already in the “new normal” for Denver’s real estate market.

Posted in Market Insights
April 13, 2022

Blue Pebble Market Insights -- Apr. '22

 

 

The 8th Inning

By: Jared Frost, 14 Apr 2022

 

 

The Skim:

1. The Top of a Rollercoaster

2. Denver Demand: Spring Begins

3. Denver Supply: Still Nada.

 

Think about the last time you were approaching the very top of a roller coaster ride... Before you hit that moment when the last chain link releases and the coaster feels as if it will creep to a halt before going over the top, everything feels the exact same as it did in the prior moment -- until it's too late. Once those first cars go over the apex, physics takes over; if you're in the back, you might still feel as if the coaster is at the top, but you know something is about to change very quickly. That's a corollary to what's happening in the real estate market right now. The Fed is acutely aware of the risks that inflation poses and has signaled an end to loose monetary policy. We're already seeing the initial impacts of this move on Denver's market and expect more secondary effects later this year. This summer buying season will be the 9th inning in our residential cycle, so expect some interesting times ahead.

 

The Top of a Rollercoaster

Economic cycles are often described in baseball terms. You might hear something like "we're in the fourth inning" or something like that to imply the commentator doesn't know exactly how much longer the economy will stay on track and it feels like it's a bit less than halfway through (there are nine innings in a baseball game). This isn't a bad way to describe things, but I prefer the rollercoaster analogy better. Think about the different asset classes in an economy as the individual cars (or rows of people) on the rollercoaster. Different cars will experience the track in different ways but all of the cars move together through the ups and downs.

 

In my humble opinion, financial markets are no different than a rollercoaster. You will always hear people say "this time is different" or "XYZ is going to withstand a downturn" and they rarely tell the truth. Evolutions of financial technology and quantitative finance along with the globalization of financial markets have not decreased correlations among markets but increased them instead. As a result, when you see flare-ups like the current inflation problem along with global central banks moving concurrently to tighten monetary policy very quickly, the odds of something going wrong increase exponentially.

 

As a result, for those baseball fans out there, I'm calling our current inning at the 8th with an expectation that this summer will be the 9th inning of this cycle. If you want to go with my rollercoaster analogy, the residential real estate market is in the middle of the train and the first car just went over the top. In Denver's real estate market, everything is set up just as it was over the last several years: bidding wars, no supply, and summer buying season around the corner. Those who have been desperate to purchase over the last few months only to be beaten in bidding wars over will keep prices stable or going higher for a few months, even though they probably won't need to be as aggressive. Prices are at a point where a material number of buyers have to reevaluate their budgets and we're starting to see transactions fall through when the expiration of rate locks gives way to significantly higher costs.

 

The extension of the student loan payment moratorium will continue to provide some support to the housing market even with borrowing costs skyrocketing, but you can't expect that to continue past January of next year. Additionally, the average consumer will be under a lot of pressure over the next 12-months from inflation and a slower economy, so the risks to our market finally look more symmetric to the potential rewards. The good news is that if you've had trouble buying a home recently, that will likely change for you by the end of the year. And if you've got one to sell, now is the time.

 

Denver Demand: Spring Begins

Let's check in on our trusty table summarizing the residential market's activity in the area surrounding Union Station (10-mile radius) in Downtown Denver as of the end of March:

 

Data taken from REColorado on April 13, 2022

 

Pending activity, sold units, and Avg DOM (days on market) are the best indicators of demand but they're not quite telling the full story right now. At first glance, one might think the market is slower since both pending and sales activity is down year-over-year (YoY) but we're finally starting to see the pace of sales affected by the lack of supply. Even though aggregate supply has been down more than 40-50% in YoY comparisons, our sales pace held resilient through December of last year, and now it's changing. It feels like the market is now just trying to find a price at which people will finally sell their homes, and we haven't found that price level, yet.

 

There will be a price regime at which things start to slow down and homes stay on the market for more than four days; we think it's going to happen by the end of the year based on the following. Assuming a 10% downpayment with interest rates where they were at the end of last year, the median home in Denver would have cost $3,029/month. As a result of price and rate increases through March, the cost of that median home is now $4,296 -- that's a 42% increase in just 12-weeks. Based on my crude calculations, the income a buyer needs to afford that medium home at current levels jumped from $103,851 to $147,291, which assumes no other long-term debt is being carried. I don't have data on what portion of the buyer pool just got priced out of the market, but... If the median wage earner in Denver is still able to afford the median home right now, then I'll be applying for a "real job" soon.

 

Denver Supply: Still Nada.

We're going to stick with the longer-term historical comparisons this month because the recent comps are losing impact. Active supply down 20% from last year hasn't been a surprise in the last six years. The shocking statistic is that supply is down SEVENTY FOUR PERCENT (74%) since 2019. That's right. Three years ago, there were 2,900 homes on the market at the end of March, and this year, there were only 931. To make matters worse, this is statistic is not normalized for population growth. Once you factor in that lots of people have moved to Denver in the last two years, the number of active listings per capita is likely down over 80%.

 

The supply side of our market explains the crazy bidding wars and material price increases that we've experienced recently. Unfortunately, it's even more expensive to build homes right now, so there is no hope of increasing supply through new construction, which leads to an expectation that the undersupplied condition will exist for a long, long time. As rates go up and affordability decreases, we do expect the market to balance at a "high plateau" that merely becomes a function of interest rates and local incomes. When interest rates go down (incomes higher), buyers can afford higher prices and make offers that sellers will accept; when rates go up, buyers will be unable to afford homes and sellers will have to adjust expectations lower. The future of this high plateau will feature fewer listings at higher prices and persist until new construction becomes economically viable.

 

Posted in Market Insights
March 16, 2022

Blue Pebble Market Insights -- March '22

 
 

While The Goin' is Good...

By: Jared Frost, 15 Mar 2022

 

 

The Skim:

1. The Fed is Changing Course

2. Denver Demand: The Usual Insanity

3. Denver Supply: Some Hope? Maybe...? Haha, Nah.

 


Welp, it's been quite a month since we last checked in with each other. War broke out in Europe, crude oil went to $130 and back, the S&P 500 is extremely volatile, and real estate prices are going berserk. The recent change in tone of negotiations between Russia & Ukraine is encouraging because the literal nuclear option is coming off the table. Regardless of how that war is resolved, major enemies still remain at the gates of domestic monetary policy-makers and those are the issues with which we now need to contend. The Fed is putting everyone on notice that rates are going up, so get your easy money while the goin' is still good...

 

The Fed is Changing Course

The war in Ukraine is obviously distracting investors right now. Further escalation presents additional geopolitical risks forcing massive realignments of global trade, supply chains, banking, etc; the best thing for all markets is a quick resolution that maintains the pre-war status quo as much as possible. Even so, this war forced everyone to pick a side that is accelerating the rise of new diplomatic tensions. How would you feel about trading oil in yuan instead of US Dollars? As an American in finance, that's a pretty scary thought, and now it's something that has a material probability of occurring.  But, we can worry about those worries another day... The Fed is talking, and we need to pay attention.

 

The Fed does not take shifting lightly -- there's even an adage within investment circles that the Fed will go further and longer than you expect. That means when the Fed loosens (prints money, lowers rates, etc.), things are actually probably worse than you think and rates need to be lower or more money printed than you think is necessary based on the information available to you. Conversely, whenever the Fed ever tightens, they will likely go further and longer in that direction. This is a double-edged sword -- things are so great the Fed expects we can tolerate way more intense treatment for our inflation problem... And, they just started the tightening cycle this week.

 

Leading up to the Russia-Ukraine War, markets had been expecting a short-term rate hike from the Fed on the order of 50-75 basis points (0.5-0.75%), and those expectations came down heading into the meeting this week. So, it wasn't a big surprise when the Fed raised rates by 0.25% at this meeting. The important language in their announcement had to relate to their balance sheet, which has now grown to nearly $9 TRILLION DOLLARS. That's right, the Fed has monetized 30% of our total national debt. The most important language from their statement regarding their balance sheet is the following:

 

".. the Committee expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming meeting."

 

While not entirely unexpected, it's an earth-shattering sentence. If you're curious why that's such a big deal, I submit the following chart:

 

Image taken from: https://www.currentmarketvaluation.com/posts/2021/07/Fed-Balance-Sheet-vs-SP500.php

 

Since the Fed started buying assets in 2008, they've expanded their balance sheet by $9 trillion. Over that time, the total market cap for the S&P 500 has grown by approximately $25 trillion. The picture above shows in the pictorial form how important monetization of debt has been to the equity markets. The relationship between Fed asset purchases and higher equity prices is even more obvious once put in context with data suggesting 40% of the market's growth can be attributed to printing money. It's a big problem for equity market investors when the Fed stops buying assets and it's an even bigger problem when the Fed says they are going to start reducing the balance sheet. The physics of money doesn't change so quickly as to assume these relationships will all of a sudden reverse. If the Fed is going to be raising rates on the short-end of the curve as well as decreasing balance sheet, the capital markets are going to be in for a wild ride. (Here's a fun little article on what happened when the Fed tried to decrease the balance sheet the first time...)

 

The Fed is telling us that rates are going up and things are going to get a little choppy. If you can get long-term, fixed-rate financing right now, do it.

 

Denver Demand: The Usual Insanity

Let's check in on our trusty table summarizing the residential market's activity in the area surrounding Union Station (10-mile radius) in Downtown Denver as of the end of February:

 

Data taken from REColorado on March 10, 2022

 

We look at demand primarily through pending and sold activity. As you can see from those two columns, the data has been extremely volatile over the last couple of years. Even though both metrics are down slightly in the past month, they are not down nearly as much as the supply metrics. The fact that the number of sold units has stayed relatively constant over the last few years is incredible. So many people have moved here with cash that the local demand curve is as close to "perfectly inelastic" (buyers are totally insensitive to price) as the real world will allow.

 

The price of a median unit in Denver, or the weighted average of home and condo prices, was around $625,000 last month. That means that the median Denver household is just barely not able to afford the monthly mortgage payments on a 20% downpayment loan if they even had the $125k to start. Given the lack of supply, the only thing that will put guardrails on the housing market is affordability (@Megan_Aller, where you at?) When rates go up and buyers have to offer lower prices to maintain debt-service ratios, that's the only thing that will get demand to go down, and we're not even close to that, yet.

 

Denver Supply: Some Hope? Maybe...? Haha, Nah.

I'm trying to move to Parker right now and one of our amazing brokers is helping me out, so I'm in the same boat as many of our clients. (Hey, if you know anyone in Parker looking to sell a house, give me a call.) Over the weekend, I got one of the email listing updates and saw about a dozen homes hit the market when I'm used to seeing one if I'm lucky. It was so exciting and I was convinced the market was shifting to finally get homes on the market. Yeah, that didn't happen, at all.

 

You might be seeing more homes come on the market and that's not unusual. Denver and the Front Range are extremely seasonal markets in that a majority of people want to move in the summer and not deal with real estate during ski season. The market typically starts to "wake up" around the end of March or the beginning of April, so it's not uncommon to see more listings come through right now than what you've seen recently. The problem is that we are seeing more than 40% fewer listings on the market from last year and that was a huge down year, too!

 

Here's some perspective for you... A comparison of supply metrics for 2022 vs. 2019 at the end of February:

 

Active Listings: 729 vs. 2,789 (-74%)

New Listings: 1,862 vs. 2,152 (-13%)

 

There are 74% fewer homes on the market now than there were three years ago!! That's crazy! If you want to take the data back to 2013, there are now 87% fewer listings on the market. On the demand side, sold activity is only down 2% from 2019 levels.

 

That's the ball game: demand is "down" 2% while supply is down 74%. Prices go up. And they'll go up until rates cool everything down.

Posted in Market Insights
Jan. 28, 2022

Blue Pebble Market Insights -- Feb '22

The Skim:

1. A Crack in Risk's Armor

1b. A Warning For New Construction Buyers

2. Demand Limited by Supply

3. It's official: Zero homes on the market.


You might want to check your retirement accounts because it's been a pretty wild ride in the capital markets since the start of the year, and I don't see any reason why that will slow down in the next few months. The market is telling you that the "Pandemic Trade" is OVER and you need to reevaluate your portfolio positioning. This month, I'm going to take you through my thesis on what's happening in the stock & debt markets and how that will impact Colorado's housing market.

 

A Crack in Risk's Armor

One of the best and worst books written about investing is "A Random Walk Down Wall Street." In his book, Malkiel argues that retail investors should focus on low-cost index investing because there is no way for the average investor to "beat the market." He makes some valid arguments for someone who is totally disinterested in investing, and I firmly believe is dead wrong for the self-selected group that reads this note. In my opinion, if you can catch big, secular shifts in the financial system, then you can position yourself to avoid big losses and capture the right long-term trends. I believe this is one of those times when the stock market is screaming at you to be concerned.

 

** Please, note: the following thoughts are musings of a washed-up derivatives trader from the financial crisis. Before taking any action on your investments, please, consult with a trained financial professional who can consider the risks of a strategy as it relates to your personal situation. (If you don't have someone with whom to speak about financial advice, we'd be more than happy to refer you to someone awesome -- give us a call.) **

 

A. The Background -- Before I discuss the shift in market trends, let's summarize the trends from the last two years. At the onset of the pandemic, the government had *no* idea how mandatory shutdowns and quarantines would impact our economy. As a result, the US government (and many others around the world) responded with insanely huge liquidity injections through a variety of different channels; for the finance nerds in the back of the room, this is referred to as "MP3" or the coordination of fiscal & monetary policy. On the monetary side, the US Federal Reserve dropped its overnight target rate from 1.75% to 0.25% in the span of a week and also injected $3 TRILLION dollars through quantitative easing into the market over the first three months of the pandemic. Additionally, the Fed will add another $2 trillion in total QE by the time they stop the program this quarter. In addition to the monetary stimulus, the federal government provided fiscal stimulus through a holiday on student loan payments, $300/child/month tax credits, expanded unemployment benefits, and payroll support via multiple rounds of PPP financing.

 

The end result of all this stimulus is that the government did too much and the effects are now starting to show. First, and most easily reported by media outlets, headline CPI is registering the largest annual gains in over 30-years. (Just today, CPI for Jan '22 was more than 7% year-over-year.) Supply chain issues are the primary driver of inflation and show that prices are going up because demand is outpacing supply for goods across the country through a recession. An additional report that supports the thesis that the government did too much was written by Vanguard and titled "Quantifying the Health of the US Consumer." They don't expressly argue that the government put too much gas on the fire; instead, the author discusses a series of metrics showing that, on the whole, consumers have saved more, paid down debt, and shored up delinquencies over the last two years. The fact that the average American consumer is better off financially now after two years of a recession means too much was put into the system.

 

** If you want to read a report written by someone who is way smarter than me and says a lot of these things in a much more eloquent way, I would highly suggest you read Bridgewater Associate's Global Outlook for 2022. **

 

B. The Setup -- In addition to paying down debt and increasing savings, it's quite obvious the market was happy with the health of the US consumer during the pandemic. Here are some of the most popular consumer discretionary stocks and how they've behaved recently. For the most part, these stocks peaked in November even while the S&P continued to rally into the end of the year and through the first half of January. (All stock charts were developed on TradingView.com around Feb. 1st)

 

Before the pandemic, LULU (Lululemon) was a $200 stock that hit $460 at its highs, and is now off 30% from November:

 

Nike (NKE) gained 80% through the pandemic and has given away half its gains. Be careful with this one as there does appear to be further downside when it "fills the gap" down to $136.

 

You can also see how XLY (the ETF tracking consumer discretionary stocks) created a triple top with its peak back in November and failed to make a new high when the broader market rallied in Dec/Jan. This is generally a very bearish pattern and the stock fell materially:

 

C. What's Happening Now? The US consumer is the name of the game in the global economy. US consumer spending drives revenues worldwide, and if that spending starts to pull back, revenues across the market should fall. Consumer discretionary stocks including LULU, NKE, etc. were sounding the alarm bells into the end of last year that the consumer might be faltering. In addition to the consumer discretionary stocks, the tech leaders through the pandemic were also sounding alarm bells. Zoom, Moderna, and Peleton (to name a few) all peaked last year and were steadily on their declines before year-end. (As I make an edit this note on Feb. 3rd, Facebook/Meta/Whatever is down 25% after reporting earnings.)

 

But why won't the consumer be as well off now as before and how long might this be an issue? Isn't everything opening up? Yes, and that's kind of the problem. As the economy opens up and COVID becomes less of a concern, the government needs to unwind loose monetary & fiscal policies in order to prevent runaway inflation.

 

Fluctuations for prices of financial assets are based on the difference between expectations and reality, so when things change suddenly, there tends to be some chop. The first thing that's changing is that low rates are over. Below is a chart of the 10Y US gov't bond. From the depth's of the market reaction at the onset of the pandemic, you can see how interest rates have made higher lows consistently over the last two years. This shows as time goes on there is progressively less and less appetite to clear bonds at lower interest rates. The increase in rates both on the short-end (as controlled by the Fed) and long-end (below, as dependent on the market's expectation for US inflation) will cause an increase in borrowing costs across the economy. These borrowing costs will negatively impact consumer spending as the costs of housing rise (both mortgages and rents).

 

In addition to the monetary tightening with increased short-term rates and inflation expectations, the federal government is adding its own fiscal tightening (and it's not being advertised as much because it's not super popular). Fiscal tightening caused by the resumption of student loan payments, the elimination of the child care tax credit, and the ending of expanded unemployment programs will take a lot of the extra "froth" out of the system. Without that froth of money coming into US companies, it's hard to see from where the driver of earnings growth will come. This explains the equity market sell-off and also the volatility we've seen over the last several weeks -- as shown below.