Friends of ResiShares:
It’s that time of the year again (rather, it’s almost 2 weeks past that time of year again, so we’re cheating a bit). Time to see if we got our desired 5/10 predictions right last year and make ten new ones for this year. Fewer than five we’re wrong. More than five we’re too conservative. And with that, last year’s predictions:
1) COVID-19 will exit the year considered an endemic nuisance disease rather than a globally disruptive pandemic in most of the world, as policymakers observe the continuing effectiveness of MRNA vaccines in preventing severe disease during the Omicron wave.
As an inhabitant of the developed world that has successfully provided most of its citizens with access to an ongoing series of effective vaccines (the most recent, bivalent version of which I received at a local Safeway with minimal inconvenience), I’d like to take the W here. It’s tough to argue, however, that we deserve a full point for this, when the world’s most populous country is dealing with unprecedented impacts. China’s combination of ham-fisted lockdown policies and inability to vaccinate its elderly population is creating a humanitarian crisis domestically while contributing to the stubborn persistence of inflation globally. Half a point.
2) (Most) people will return to the office
We’ll take the full point on this one. Even ResiShares, founded during the Pandemic as a remote-first organization, got itself a couple of office locations in 2022!
3) Someone will disrupt transaction management in a meaningful way
This did not happen. This was a bit of a stretch to pull this into 2022 already, and an environment in which venture funding and transaction volume simultaneously crashed is not conducive to this large-scale disruption.
4) The rich (boomtowns and zoomtowns) will get richer
We said last year that “Real estate trends create their own momentum, and typically need a reason to reverse.” Well, to say the least, that reason emerged, in the form of a massive reversal of money flows in the tech and finance sectors. The number of millionaires these sectors created in their executive ranks was not what primarily drove real estate prices in places like Truckee and Boise, as much as the number of young, mobile hundred-thousandaires sustained in the ranks of their engineering and sales organizations. In the words of Warner Wolf, let’s go to the videotape!
Below are the best performing MSAs amongst the top 200 in 2021. If you look at the 3 rightmost columns, we show the ranking in 2021, 2022, and the Jun/Nov ranking (of 2022), which acknowledges that the first half of 2022 included continued momentum from the boom, even as interest rates rose. There are approximately 900 MSAs on this list, so the fact that Austin was the top performing large city and #2 overall in 2021 and fell to one of the bottom 50 overall in 2022 is a remarkable reversal.
What trends do we see emerge when we look at the best performers of 2022?
Source: Zillow, ResiShares
Tech-destination Zoomtowns like Austin, Reno, Boise, and Salt Lake City disappear from the list. All of them saw meaningful price DECLINES in the back half of 2022. While they are all fast-growing cities, the hot tech money that came into these areas during the pandemic were never sustainable and prices outpaced growth.
The southeast, and particularly Florida, keeps on trucking. Our initial thesis at ResiShares was that the pandemic would both accelerate migration trends and generate “false positives” in areas that would never maintain the critical mass necessary for long term growth. This is what led us to focus our investments on the Southeastern US, which has proven prescient.
Notice the yellow highlight over Ocala, FL, which is the only MSA that performed near the top of the country in 2021, 2022, and the back half of 2022. This is an example of a second-tier community in a fast-growing state/region whose cost of living is still cheap on a national scale. This is the phenomenon around which we built ResiShares. Unfortunately, it’s also quite the opposite of what we predicted in last year’s “Top Ten” list for 2023, so I award us no points!
5) Inflation is here to stay
6) The real estate commission dam finally begins to show cracks
No points on this call. As with the momentum behind disrupting transaction management, the market became meaningfully less liquid in 2022, which is a challenging environment in which to pressure real estate commissions.
7) The federal government takes action on appraisal bias
I guess you can call this action? I can’t really figure out what they actually did here though, but at least they’re talking about it.
8) SFR average capitalization rates drop below 4% in some highly desirable investor markets
We heard about scattered SFR being bought down to 3.75% by some large institutions in Q1, when rates were still on the lows. We said that they’d DROP below 4, not that they’d STAY below 4. A nitpicky, technicality-earned point for us.
9) A large municipality will launch a massively extractive short term rental tax
I’m going to award us half a point on this and then remove it from future lists. New York just imposed a major regulatory burden on Airbnb hosts, but it does not include new taxes, though the state of NY is now considering a 3% “hotel” tax on all. In California, every major destination has piled on extractive taxes on short term rentals, though none have made national headlines. This continues to be a “boiling the frog slowly” story.
10) A reasonably well-organized attempt to move title onto the blockchain will be made
As with transaction management and real estate commission disruption, a low-liquidity environment is not one in which anyone’s biggest problem is efficiency. We will have to wait for another high-volume real estate environment for the drumbeat to begin again on streamlining the title and escrow process, and the recent events in the crypto sector will expose all blockchain-based innovations to greater scrutiny than before.
Total score: 5/10.
So without further ado, The Top Ten Surprises of 2023. As always, the following is not the official view of ResiShares or the product of our research - just the fun pastime of your humble correspondent.
1) The Fed will engineer a “soft landing”... And we’ll hate it.
Consensus opinion is that the Fed will “overshoot” in its tightening, causing a short, sharp recession, to which they will need to respond with immediate rate cuts. While that is a compelling story, given the recent economic history of the US, I believe that the markets are underestimating the potential for a soft landing. A soft landing, in this definition, is a moderation of inflation (Core CPI) without causing a recession (2 consecutive quarters of negative GDP).
According to this consensus, the collapse in liquid asset prices and tech layoffs are the canary in the coal mine, and a similar mass layoff in the rest of the economy, eventually leading to a reset of housing prices that drives CPI deflation, will follow shortly thereafter. This will give those of us who have coasted comfortably on our circa-2010 long bets another bite at the apple, this time in large enough size to move our retirements forward by a decade, Inshallah.
While the above scenario is certainly quite possible, the devil on my left shoulder keeps whispering in my ear that any scenario the entire professional investor class wants to see so badly should probably be viewed with a questioning eye.
Let’s say that CPI moderates in the first half of the year, as brutal shelter and commodity cost comps come back down to earth simultaneously, consistent with the “Fed Overshoot” thesis. I contend that we will not likely see a recession, nor a true blowout bottom in asset prices, as long as this country faces a labor shortage. This labor shortage is structural, resulting from the rapid onshoring of American industry relative to the ability of American workers to adjust their skills accordingly. Why is this not just the “transient” reverberations of the COVID meteor strike?
Source: Customs and Border Patrol data, ResiShares
Tariffs are still relatively low in the US, compared with our industrial past. They are still running at double their level for the entirety of most current workers’ careers. Add to this the harder-to-quantify effects of subsidies and other non-tariff barriers, and one must come to the conclusion that we, as a society, have decided to value making stuff here instead of bringing it in from elsewhere. China has been making our stuff for decades. It will take far more than 6 months for us to build a domestic supply chain that can once again deliver cheap abundance, especially while adhering to American environmental and labor standards.
As long as we are engaging in a star-spangled version of Nehruvian import substitution, we are facing structurally higher inflation. While we will avoid both a sharp recession and runaway inflation in this scenario, those of us accustomed to sub 3%, 30-yr mortgages and getting groceries delivered free to our front door will not like this return to the economy of the early ‘90’s. I do think that we’ll get some relief from the return of inflation, eventually, mostly thanks to a positive 2022 emerging trend that the powers that be have kept quiet, probably on purpose:
Cosmo Kramer tried to avoid import restrictions on Cuban cigars by importing Cuban cigar rollers. It seems that we might be very quietly doing the same, which would eventually pressure inflation (and, therefore, interest rates) in a more favorable direction!
2) Rents will be higher on average nationwide by the end of the year, and housing prices will be up in certain markets.
Part of the “Fed Overshoot” thesis is that the shelter cost reversals we have seen in the Mountain West will deepen and spread nationwide. Consistent with the soft landing anti-thesis above, avoiding a recession would tend to indicate that rents and even prices are up year on year, though the latter would likely be most noticable in select areas of the country with secular job growth, in-migration, and housing costs that are cheap on an absolute scale.
3) Absolutely cheap will outperform relatively cheap.
Boise and Austin are cheap, relative to San Jose. Miami is cheap, relative to New York. Second-tier cities in the Southeast and Midwest are just absolutely cheap. Many are well off the radar of the incumbent SFR players and are seeing in-migration and job growth. They should outperform the US overall on resale prices and rents.
4) SFR cap rates stay below current (Jan, 2023) financing costs.
The “free money” era of borrowing in the 2’s to acquire 5-caps is over. The country is short housing, and the tens of billions of dry powder aimed at SFR is well aware. The money that will be made going forward will be from picking the right markets, neighborhoods, and assets, paying the right price for them, and operating them with higher margins than peers. There may well be periods of time when cap rates widen or spreads tighten to enough look extremely attractive, but each such period will be met with a flood of home buying and ABS issuance from institutions.
5) At least one modular building startup will attract an eye-watering Series B (or C or D) financing round
The mid-to-late-stage VC business has a problem. Mature-ish businesses that need money are facing severe financial uncertainty, while those who were lucky enough to raise a war chest before tech valuations collapsed have little incentive to raise more at today’s valuations. The housing industry has a problem - lack of supply, especially in single family.
The solution to both of these problems is for the VC business to start picking some winners from amongst the dozens of modular construction startups that launched around the globe in the past 5 years. I don’t follow the space enough to know which company has mixed up the secret sauce, but I predict that whomever it is will attract a bidding war for their B or C round in 2023.
6) A record-setting water year in California will move most of the state out of “severe” drought conditions. The complacency this engenders will lead to devastating fires.
The immediate-term correlation between prior season weather and fire damage, contrary to popular opinion, is rather weak. A simple Google search turns up an R-squared of 23% between fire damage and rainfall and a measly 6% with April 1 snowpack depth since ‘05. In fact, our most damaging fire seasons have often followed periods of drought relieving precipitation, exemplified by 2017.
Source: CA Dept of Water Resources, Cal Fire, ResiShares
The drought will eventually end. That does not mean we should get complacent about fire safety. The western US forests have been burning since the dawn of time, in wet years and dry.
7) The Republican-controlled Congress will block an increase to the debt ceiling later this year, forcing the Treasury to mint high-denomination coins (or issue ultra-high-coupon bonds at a premium) to prevent a US sovereign debt default.
This move solves two problems for the embattled micro-majority. First, it provides evidence to their increasingly radical constituents that they are willing to take radical action, rather than just say radical words. Second, it allows them to create a narrative to blame slower-than-expected disinflation as the fault of the Biden Administration and the Fed.
Admittedly, this is one of the stretchier predictions for 2023, but I also think it’s more possible with the current political backdrop than it has been in the past. “May you live in interesting times,” eh?
8) A wave of CMBS maturations in distressed office and retail assets will force a repricing of CRE assets market-wide, resulting in robust transaction volume in the back half of 2023.
Just when you thought things couldn’t get any worse for embattled Class B and C downtown office and retail assets, it appears that quite a few of them need to roll their debt in 2023 (see here and here). This will not only force sales in the assets themselves, but drive marks lower on comparable assets not facing loan maturities. This, in turn, will save the job of many an analyst at CRE equity investment firms, who have been patiently waiting for deals that “pencil out” since Q1 of 2022.
9) Open AI will emerge as the single most disruptive business in history. By late 2023, new businesses will raise billions in seed capital to compete with it, build on top of it, exploit it, and educate people on using it.
The release of Chat GPT and Dalle in 2022 by Open AI will very quickly be retrospectively viewed as the Big Bang of the AI era. What the Apple Macintosh did for personal computing, what Microsoft did for productivity software, what Netscape did for the internet, what Google did for search, what Tesla did for electric cars, what Amazon did for ecommerce….Open AI is all of those combined.
I had intended to have Chat GPT write one of these Top Ten list items and make readers guess which one it was. Unfortunately, I could not, because the site’s server capacity has been maxed out for the last two days.
I’ll repeat that.
The demand for this service is so great, that its computers cannot keep up with the individual requests of the humans who want to use it (tech nerds: yes, I’m aware that it has an API and theoretically programmatic requests could flood it at computer scale).
We at ResiShares have more experience than most using machine learning and AI to answer very specific, well-described questions. Practitioners tend to harbor innate skepticism against the claims by the lay media about how a new technology is going to change the world, familiar as we are with its limitations. As I’m typing this, Sam Altman, of Open AI, is on Twitter hedging against how trustworthy his company’s tools appear to be. Having said all that, Open AI’s completely no-code interface and limitless breadth of application makes AI tools accessible and useful to literally everyone on earth with a computer.
In a few short years, the ability to efficiently program AIs will be looked upon as a skill equivalent to being able to execute a Google search. Our kids will not be able to get a white collar job without this expertise.
10) The luxury real estate downturn will spread from the ultra-high-net-worth to the merely rich.
While I believe that we will avoid a nationwide recession, the recession of the wealthy has already begun, and the conditions for its recovery are unlikely to emerge in 2023. While Bill Gross’s ex-wife may have had to hit a low bid to sell her house in 2022, 2023 will be a reckoning for those assets purchased on the highs using tech stocks and crypto as currency.
Rather than the $25 MM beachfront estate, we’re talking here about the $5 MM ski cabin in Sun Valley that used to cost $2 million before COVID. Even though many of these assets were purchased with cash, property taxes and maintenance costs begin to look daunting when the Silicon Valley gravy train is stuck on the tracks. Many recent buyers will sell at a small loss, secure in the knowledge that their losses would have been deeper had they held onto the stock shares and cryptocurrencies that funded their purchase instead.
Rest of Resi
I am perpetually a sucker for all stories about the elusive adaptive reuse deal.
Low taxes and hot weather: Texas and Florida again top the list of one-way Uhaul destinations. As usual, high tax states are supplying the demand.
Apartment buildings are going through their “Supertall, Superslim” phase, like fashion models in the ‘90’s.
The WSJ manages to write a few hundred words on the looming global demographic shift to older, smaller populations, while only devoting the bare minimum of attention to the real estate implications of this shift, arguably the most economically impactful result of an aging population of all!
Work from home creates implicit real estate supply, which will be deflationary over time.
Last month, we talked about home prices versus inequality (they are correlated). Continuing in this vein, these researchers found a tipping point for homelessness as a function of affordability.
The entropy of the street map in the city in which a person grows up is linked to their navigation ability as an adult. This proves, yet again, that those of us who learn to drive on New Jersey’s jughandle highway onramps are simply superior humans.
Looks like the A16Z guys are personally long some fancy homes in Palo Alto and talking their book.