Blue Pebble Market Insights - October 2022

Coming Around (The Wrong Way)

1) The Macro

2) Active Buyers but Fewer

3) Supply Sitting Longer

I hope you've had plenty of Tums around your office if you've been checking on your 401k balances the last few weeks. There was a slew of economic data published recently suggesting the Fed has much further to go with their rate increases than previously thought. Even though the tightening cycle started 6-months ago and some non-core markets are starting to turn, the Fed continues to be concerned with inflation (still high) and unemployment (still low) -- this combination is giving the Fed the "green light" to further increase interest rates which increases the likelihood of overshooting. Price volatility in the public capital markets will stay elevated until there is more clarity on the Fed's terminal interest rate while things are starting to come around (the wrong way) in the real estate markets.

1) The Macro

Last week was actually a lot of fun for economy watchers while it might have been a little stressful for the casual observer. On Wednesday, the Producer's Price Index, a leading indicator to the Consumer Price Index (CPI), came out at 8.5% year-over-year (YoY). Following that data was the release of the official Core-CPI data for September which registered its highest level ever at 6.6%. Initial jobless claims did not move up materially and the strength of the job market will continue to add inflationary pressures (Note: inflation happens when there is more demand for goods than supply. In the absence of increasing supply due to supply chain issues, the only way to limit inflation is to lower demand. The best way to lower demand is to decrease the amount of money a consumer has to spend which typically only happens when they lose a job).

The combination of this data in the US, along with some stress at the Bank of England, contributed to some very large price swings, and we should expect those price swings to continue. Based on the feedback that I've received, it feels as though the "smart, macro institutions" are all getting out of equities while individual, bottoms-up investors, and analysts are scooping up long-term purchases. We are able to enter the thick of earnings season in the US, and equity market returns will be most dependent on company guidance for 4Q22 vs. previous earnings results.

But you're reading this for real estate updates, right?

Things are changing very quickly under the surface while it might not be that obvious to only casual market participants. We will go into further detail in the following sections, and it seems our hypothesis that home prices will stay sticky while fewer transactions happen in a low-supply environment is starting to come true. New listings are still down YoY which suggests absolutely no panic selling of homes and prices are still staying within sight of seasonal patterns. This makes sense based on previous comments re: the labor market -- until unemployment ticks up, there will likely be no forced selling of homes.

Under the surface, the Fed is starting to have the desired impact on real estate prices. Food & housing have been two of the biggest pain points for inflation right now. While the food question is something that will get worse (in my opinion), the real estate side seems to be getting better. If interest rates are higher and prices aren't coming down quickly, the only way to get cheaper housing is to build more units. And the only way to build more units right now is to wait for construction to be economically viable again. Let me point you to the chart of lumber prices over the last five years (Source: NASDAQ Market Data).

The price spikes in lumber correspond with the spring/summer buying season along with COVID free money. Anecdotally, getting a quote from a GC last summer was almost laughable. The change isn't just with lumber, either. Copper is down 30% from its earlier highs and many of the major construction inputs are also down materially. Raw material inputs into the building process are getting hit across the board as cancelation rates with public home builders increase and the cost of construction financing has skyrocketed. Prices quoted to consumers have not changed much, yet, because subcontractors have been busy for years now, and they are still showing higher prices to manage their schedules. We would expect construction prices to start coming down next year as contractors need to start competing for jobs again.

At the end of the day, demand for these inputs is showing that something is coming down the pipeline with respect to a real estate market slowdown. The question will be how much prices are affected and at which point new supply is brought onto the market.

2) Active Buyers but Fewer

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 October 13-17, 2022.

September was a continuation of the new trends that started when the Fed initiated raising rates several months ago. First, Active Listings (second column from the left) have steadily been increasing relative to last year's supply. In conjunction with this slow build of inventory, we are also seeing an increase in Days on Market (third from right) -- the median home in Denver is now staying on the market for two weeks instead of just the weekend before going under contract. While that move from one weekend to two weeks *is* material, we are not anywhere near the inventory levels one would expect before prices start coming down relative to seasonal comps. The housing market would need to see homes staying on the market for 4-6 MONTHS before that happens.

In addition to incrementally more homes on the market for a slightly longer period of time, we are also seeing demand wane. Pending transactions started the year slightly off the pace from last year and that lag has increased material in the last few months with the spike in mortgage rates. This is translating to over 20% fewer closings every month which is already down from extremely low levels during the pandemic. We do expect these trends to continue as rates will more likely go higher than lower.

3) Supply Sitting Longer

There's no doubt that higher interest rates will slow the market, so higher DOM is not unexpected. Without a material increase in wages or incomes, the home price one can finance goes down when the cost of interest goes up. As a result, fewer buyers will be present in every single pricing level of the market, and the expected time it takes for a seller to find a buyer goes up.

What's interesting is that the divide between buyers and sellers seems to be increasing. Going back to 2017, the average premium of the average list price in the market normalized by the average sale price was 3.2%. There is some noise in that time series and moves within 7% of that number aren't extremely significant. As of the end of September, however, that premium stood at 14.8% which is one of the highest deviations in recent history. The average sales price in the market has been down over 10% since the peak in July while the average list price is now 2-3% OVER the PEAK list price.

It remains to be seen how this divide will resolve itself. Either sellers are wrong and buyers will be able to raise their budgets to afford significantly higher costs of ownership, or there are going to be a lot of price reductions coming this fall... Stay tuned.