Despite growing evidence of an impending housing market crash, experts remain split on the matter. Chief economists and housing experts alike have largely stayed cautiously optimistic that a “crash” along the lines of the 2008 housing recession is more fantasy than reality. However, the bear case is quickly fleshing out. Some experts believe housing is headed towards a massive pullback.
One such bear is Sumit Handa, Managing Partner and co-head of the investment committee at Pennington Partners. In an exclusive interview with InvestorPlace, Handa went in depth into all of the forces pushing home prices down — and what that means for the greater economy.
“Our expectations are that over the next few months, the U.S. is likely to enter into recession and it’s going to be driven by this deteriorating housing market,” Handa said.
With further rate hikes on the way, the economic future of the United States has rarely been so uncertain. Let’s see what’s to come for a housing market on the fritz.
Investors Have Largely Abandoned the Housing Market
As interest rates hovered at rock-bottom levels for the better part of the last decade, institutional investors like BlackRock (NYSE:BLK), KKR (NYSE:KKR) and alike were on a virtual buying spree. Well, the party is over. With mortgage rates skyrocketing since the start of the year, many of the these institutional investors have backed out of the housing game entirely. Handa says:
“If you go back to 2000, the institutional buyer […] had about 6% of the market. Today, it’s close to the 14% […] If it goes back to sort of a median in between, let’s say it’s 9%, or even 10%, that marginal 2% difference between 10 and 12 and 10 and 13, that is going to put a damper on all of the buyers in the market. Who is the natural buyer of all of this supply that’s coming?”
This is an important point. Private equity firm Blackstone (NYSE:BX) is the country’s largest landlord. When homes go up for sale, frequently it’s not families purchasing these properties. Instead, it’s corporations. In 2021, investors accounted for a whopping 18% of residential home sales. With low borrowing rates, it’s easy for them to come up with the capital necessary to make a positive return on something as solid as real estate. However, the return on investment is simply no longer there.
As more waves of in-progress homes enter the market, sellers are quickly facing the unfortunate reality that demand isn’t what it once was. Homes are already starting to linger on the market for longer than in past years. And it may just be the beginning. According to Handa, this has no small part to do with the institutions exiting the market:
“When the cap rates have spiked, which is what [has] transpired this year, it becomes punitive and too expensive for these groups, the BlackRocks, the Opendoors, the Zillows, to generate a return that is attractive just from purchasing these single homes and then renting them out. That’s what they were doing. So that investor bid has disappeared for that reason. And I don’t think it’s coming back. I don’t think it’s coming back anytime soon.”
Housing Inventory Is Returning
It’s no surprise to see fewer players in real estate given current macroeconomic conditions. However, some may be interested to discover that the number of homes available for sale is notably elevated.
Places like Boise, Idaho and Tampa, Florida — which saw home prices skyrocket in the past few years — are currently seeing an inventory-fueled reversal. Properties are being listed en masse, except no one’s buying them.
As of July 2022, the U.S. has a 10.4 month supply of new houses for sale. That’s the highest level since the 2008 housing crash. As housing demand surged in the past few years, home builders did what they do best: build homes. They assumed prices would continue going up as low mortgage rates entice an ever-growing number of potential acquirers. In reality, these properties are going to enter, what is essentially, a buyer-less market.
The limited supply of houses for sale has long been one of the strongest points against a housing crash. After all, how can prices drop with so few homes available on the market? However, as the inventory of homes returns, with all the buyers having vanished, a correction in prices is all but a certainty. That’s especially the case in the most overpriced regions.
Housing starts are even beginning to strongly outpace household formations, meaning more homes are being built than there are families to occupy them. Supply is winning the race over demand. Home prices will likely only see the downside of this evolving relationship.
The U.S. Will Likely Enter a True Recession
A U.S. recession remains perhaps the single strongest argument in favor of a real estate crash. With inflation still trending over 8%, the Federal Reserve is all but forced to continue with its hawkish agenda despite desperate cries for a pivot. As interest rates go up, a pullback in aggregate demand may pave the way for a true recession.
By the technical definition, the U.S. is already in a recession by merit of the fact that GDP has fallen for two consecutive quarters. Relatively strong unemployment and consumer spending figures have weakened this argument. After all, the unemployment rate was only 3.5% as of September. But according to Handa, not only are these figures misleading, they’re also not going to last.
“At the end of the second quarter, Americans were at their highest levels with respect to their credit cards, payments. And so, what does that mean? It means that people are borrowing to live their lifestyle because inflation is so high, just to cut to the chase […] At some point, one is going to have to make those interest payments to Visa, MasterCard and et cetera […] And so, there’s going to be a contraction in the consumer.”
Consumer spending has largely been propped up by debt. Eventually, the well is going to dry up. When it does, Handa foresees a domino affect across the entire economy.
“Businesses were created at very low interest rates. And so, that resulted in jobs […] The problem is that now those businesses, they need access to capital. They’re not going to pay 3% or 4%. They’re going to wind up paying 8% or 9% on borrowing. That’s going to eat into their margins and it’s going to question the business itself. And I do believe a lot of businesses are going to shut down, which eventually means layoffs.”
Handa’s case for a recession is relatively simple: high interest rates and high inflation are going to push consumer spending down and, as corporate earnings drop, layoffs are a virtual inevitability.
At the end of the day, being able to afford your next meal ranks higher in priority than putting a down payment on a house. With mortgage rates likely to break 8%, housing affordability — which is already at one of its worst levels in nearly 40 years — may fall even further. This fall in demand could facilitate a dramatic drop in home prices.
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.