Gray Report Market Summary and Highlights: Week of July 30, 2022

Along with negative GDP numbers for Q2, the second consecutive 0.75% rate increase from the Federal Reserve comes as reports on decreased home sales show the impact of previous rate hikes. In the multifamily market, higher cost of leverage is expected to continue to further impact cap rates and asset prices as more apartment buyers are unable to make their investment plans work in a higher interest rate environment.

SeekingAlpha: “There Is an Answer to Inflation” – https://seekingalpha.com/article/4526029-there-is-an-answer-to-inflation

• The author, Dr. John Mason, has that answer: The money supply.
• This focus on the money supply is called “monetarism,” and while Dr. Mason’s comment that “Wow! Monetarism is back!” suggests that noone cares about the money supply anymore, a quick Google search will put that idea to bed pretty quickly. But I agree with Dr. Mason’s need for a jumping off point, a foil with which to reflect his position.
• And it’s a pretty compelling position.
• The metric that Dr. Mason uses is the M2 money stock. This is the amount of “currency in circulation plus liquid bank and money-market funds balance.”
• Dr. Mason cites a recent WSJ article from Donald Luskin to say that this M2 money supply is a near-perfect leading indicator of inflation by 13 months.
  • In other words, M2 money stock goes up, wait 13 months, and inflation goes up.
  • This “near-perfect” rating, which, as far as I know, is not a technical term, applies to the pandemic-era economy rather than a more full timeline, but the chart he includes is pretty convincing.
  • The chart puts a 13-month lag on the M2 money stock, and the result is that it lines up very well with inflation.
• What does this mean, then? What is the real answer to, maybe not inflation, but the question “Has inflation peaked?”
• If Dr. Mason, Donald Luskin, and other monetarists are right, then the answer is yes.
• But that’s a small sample size, so maybe let’s ask a few more experts!

Barron’s: “When Will Inflation Peak? Experts Weigh In” – https://www.barrons.com/advisor/articles/when-will-inflation-peak-financial-advisors-51658856950

• Has inflation peaked? The answer is yes!
• Emily Rubin from UBS says yes, inflation has peaked. Robert Phipps at Per Stirling Capital Management says yes, Jennifer Cute of TD Wealth Private Client Group says yes, Eric Beiley at Steward Partners says yes, Samira Arikat from Wells Fargo says yes, and Randy Bruns at Model Wealth, well, he avoids the question entirely in a kind of politician-y way of answering a question that wasn’t really asked, BUT HE DOESN’T SAY NO!
• Pop the champagne cork, put the money BACK under the mattress, and put all your cares away, because inflation has peaked. It’s on the way down!
• Now, I may be having a little bit of fun in trying to suggest that anyone is in the mood to celebrate the economy at the moment, but discussions that we have hit peak inflation were circulating a couple of weeks ago when the CPI figures were released, and as economist Jennifer Cute notes, “[e]nergy, shelter, food, those big components are actually in a spectacular collapse over the past four to six weeks.”
• Now that last one, shelter, is not in the same kind of spectacular collapse as the others, and we’ll look into the recent Case-Schiller data that shows how home prices are still growing, just not as quickly.
• A more compelling argument comes from Emily Rubin, who notes that “categories like labor and housing are going to be stickier” when it comes to inflation, and Robert Phipps, who says that “the delayed way in which housing data are reflected in the inflation numbers [is] likely to make inflation look even worse than it actually is over at least the next three to six months.”
• Oil and energy prices can fluctuate very quickly, but not so for housing prices. And given the enormous housing supply deficit along with the difficulties in building more homes, we could see the shelter category of the CPI becoming a larger factor in the inflation story.

Axios: “Is This a Recession? Five Key Things to Know” – https://www.axios.com/2022/07/26/biden-recession-confusion

• There is a committee. That committee gets together, they think very hard, and they tell us if the economy is doing poorly and if we are in a recession.
• “Wait! What about 2 consecutive quarters of negative GDP growth!” Nonononono. See, worried exclamations like these are the reason why we have the committee. 
• Cooler heads will prevail when it comes to figuring out whether or not we are in a recession, and the National Bureau of Economic Research business cycle dating committee are the cooler heads that tell America what is happening.
• It’s just so reassuring: The Federal Reserve is pointing the economy where they want it to go, and the National Bureau of Economic Research business cycle dating committee tells us, officially, what is happening.
• Here’s a nice analogy: I may look outside and see that it’s raining. I may go outside and get wet from the rain. But was it actually a rainy day? I’ll never be sure until I check the National Weather Service. They’ll tell me what really happened.
• More seriously though, this article does a good job of highlighting the debate about the recession, even as it seems to over-amplify the sunnier predictions of the economy. The GDP could very well show positive growth for the second quarter, but even if it does, these numbers could also be revised downward in subsequent revisions.
• It seems like the suggestion here is that we’re too deep inside of things to get a good picture on how the economy is doing at the moment, which is just deeply unsatisfying. I’ll say this, I don’t think that the boiling frog metaphor works right now. I think that a lot of people are worried about the economy, and they’d jump right out of these overheated conditions if they could. Is this because we are mammals?

The Housing Market: Home Sales and Housing Prices

Reuters: “U.S. new home sales drop to two-year low in June” – https://www.reuters.com/markets/us/us-new-home-sales-drop-two-year-low-june-2022-07-26/

• The measure of new home sales is a rare figure in housing statistics that indicates an actual, linear decline.
• They are down 8.1% since last month and down 17.4% since last year.
• The expectation was that we’d get 660,000 new home sales last month, but the reality was 590,000. They even revised last month’s numbers down, from 696,000 to 642,000.
• What does this mean? Well, it means that people aren’t buying as many new homes, lol. Now, Reuters does mention that new home sales are just a fraction of total home sales, but even so, they are clearly down.
  • What I think this means is that we’ve got super high mortgage rates scaring buyers away, and we’ve got the inflation and labor issues that make it hard to build new homes in the first place.
  • The article pushes hard on the mortgage rate factor, which I think is the chief determinant of declining new home sales, noting that the average 30-year fixed rate mortgage, as reported by Freddie Mac, is at 5.54%, more than 2% higher than it was in January.
• If less homes are being purchased, where are people going to live? (this question is rhetorical).

CNBC: “Home price growth slowed for the second straight month in May, S&P Case-Shiller says” – https://www.cnbc.com/2022/07/26/home-price-growth-slowed-in-may-sp-case-shiller-says.html

• So, new home sales are down. That’s clear. There are less new homes that sold in June than there were in May.
• What about home prices? If you were to Google “Case-Schiller home price index,” you’ll find a lot of headlines like this one from CNBC, with words like “slowing” and even a particularly juicy one like this New York Post headline: “US home prices to plunge ‘substantially’ on ‘cratering’ demand: economist”
• Slowing growth is still growth, but yes, this slowdown is a trend worth watching, but the numbers don’t illustrate the drama that the headlines are projecting. Now, the New York Post article cites economist Ian Shepherdson at Pantheon Macroeconomics, who says that “US home prices are likely “about 15 to 20% overvalued” compared to incomes,” but the implication here of a dramatic implosion in housing prices is very far from the consensus.
• I’ll admit I’m in my own media bubble when it comes to home prices and things like that, it’s like… a kind of “housing” bubble. But we’ve looked at housing prices and income levels on the renter side just last week, and the picture is starkly different from the one that’s being reported in the New York Post. 
• I very much doubt that we will see the cratering home prices that they predict in that article because of the very tangible difficulties in building new home supply.
• We’ve covered this story for the past few months: The Case-Schiller index shows a declining rate of growth, but the year-over-year rate of growth is still quite incredible. Headlines that lean heavy on the word “slowdown” will become a lot more meaningful when the year-over-year home price growth dips below historical averages. Will that be too late as we slide into another another housing crisis? Will history be that cruel?
• This is something that, above all, we should see coming. Keep watching these home prices, especially since the numbers here are for home prices in May, two months ago.

GlobeSt: “Blackstone: Slowdown of New Construction to Keep Lifting Rents” – https://www.globest.com/2022/07/25/blackstone-slowdown-of-new-construction-to-keep-lifting-rents/

• I included this because it supports my conception of the market forces shaping apartment rents and housing more generally:
  • It was hard to build new housing units at the start of this year, and the pandemic-related supply chain and labor issues had not abated.
  • Inflation has been increasing since the beginning of 2022, which makes wages and building material prices higher.
  • The supply chain and labor issues have NOT gone away since the beginning of 2022, so when you add that to the inflationary forces, how would anyone think that the result is going to be better for bring more housing units into the market?
• When inflation spiraled into double-digits 40 years ago, Gray noted, apartment rents grew as new construction plunged by 50%. “I think investors haven’t fully appreciated the value of hard assets in this kind of climate,” he said.
  • Totally agree with Blackstone COO Jon Gray here.
  • What do I not agree with? Vague, unsourced statements describing “SFR and multifamily rents exceeding the standard metric of affordability—monthly housing payments should not exceed 30% of monthly income—in most of the markets in the US.”
  • The average rent for market-rate apartments in the United States is 23.2%, and I can source that number! It’s from a really great research report that the RealPage team worked very hard to produce. We talked about it last week, and it’s fresh enough in my mind to make me a little piqued when I read things that, jeeze, I don’t even know where to track down.
  • My problem is that when you write that rents are unaffordable and you don’t cite your sources, you make it seem like common knowledge, and that seems wrong to me.

The Multifamily Lending Environment

Multifamily Dive: “Will increased borrowing costs dent sky-high apartment valuations?” – https://www.multifamilydive.com/news/will-increased-borrowing-costs-dent-sky-high-apartment-valuations/628028/

• There seems to be a slight verb tense issue in the headline of this article. The headline asks “will,” as if the article is about something that is going to happen in the future, when really, the article should be in the past tense, as in “Have increased borrowing costs dented sky-high apartment valuations?” and the answer, when you put it that way seems a little bit easier to find. (Yes)
• “The Real Capital Analytics Commercial Property Price Indices (CPPI), a gauge of apartment prices, jumped 23.7% year over year in June, according to MSCI.”
• From 2017 to 2021, year-over-year price increases were around 10%. Then we’ve got the huge jump to 23.7%.
• The article cites one firm that saw prices falling 10% below the broker’s opinions of value. Over the next six months, he expects values to drop between 20% and 30%.”
• This is a little bit like seeing the monetarist perspective in action. When there is less money available for these transactions, then the prices should go down. But there still may be money available, according to this article, as foreign investors and new investors are drawn to the multifamily market. According to Real Clear Analytics, “the number of unique buyers in the market was 13% larger in the second quarter of 2022 compared to the same period in 2021.”
• Ultimately, the fundamentals of the apartment market are very solid, which would preserve multifamily assets from seeing a huge price drop, but we have seen and there has been some price reduction of apartment assets.
• At this point, it seems like a pretty clear cause and effect situation here with interest rates and apartment valuations and cap rates. With that in mind, it is a worthwhile reminder that multifamily investment projects have a longer time horizon that could easily extend longer than the current interest rate environment.
• This really grants some security to owners of cash-flowing apartments more than those who are looking to achieve their returns after the sale of the property.

The Wall Street Journal: “Real-Estate Deal Making Slows as Bank Lending Tumbles” – https://www.wsj.com/articles/real-estate-deal-making-slows-as-bank-lending-tumbles-11658836800

• This is an article-length answer to the question from Multifamily Dive, but it also covers all of commercial real estate and is not limited to the apartment market alone, which is doing better and has higher sales volumes than other commercial real estate property types.
• “Higher rates are putting a squeeze on values as well as deal volume. Real-estate analytics firm Green Street says that commercial-property prices have fallen an average of 5% from the peak they hit in March.”
• This time the market may be adjusting faster than usual, according to Jeff Scott, a managing director of Eastdil Secured. He said one sign of this is “widespread” repricing. That is when sellers who signed contracts with buyers before the sharp increase in interest rates agree to renegotiate prices lower.
• “Think about it: Before, you were borrowing in the low 2% [range.] Now you’re borrowing in the low 5% range,” he said. “It’s just math. It’s not someone trying to take advantage.”

Our Suburban Future

Vox: “The Covid-Era Trends Taking Shape in America’s Suburbs” – https://www.vox.com/the-highlight/23178774/suburbs-return-planning-urban-flight

• Read this Vox article for a fleshed-out perspective of something that we have talked about on the Gray Report for more than a year: There’s a pull to the suburbs, and the suburbs are changing.
• I was just talking to a friend about the suburbs around Indianapolis, and look, I don’t want to live in a society where people living close to downtown don’t have some kind of rivalry with people who live farther from downtown. There’s no clear line that defines the suburbs and the downtown, even though Unigov made it technically Marion county.
• Twenty years ago, we would say, “Carmel, Indiana” and roll our eyes, but nowadays, I’m talking to my friend and he says “you know, it is kind of cool” and I have to agree. The suburbs are getting cooler. They are building up the kinds of entertainment, dining, and retail options that at the very least approximate what you find downtown.
• “This desire to be near things is as likely to lure millennials leaving the city to seek less expensive housing as it is immigrants coming from countries with more traditional urbanism, and remote workers looking for amenities they used to find near their urban offices. What makes suburbs desirable for many people today is not what Americans traditionally associate with “the suburbs.” It’s vibrant dining scenes — according to the New York Times, some of the best in the country — nightclubs, taller buildings, and walkable developments.”
• So one of the undercurrents of this article is the idea that Millennials want the same things they had downtown to be there when they move to the suburbs. More accurately, there’s a big enough population in the suburbs that can support some of the downtown amenities.
• I think you’re not really getting to that level unless you plan on a little more density than typical suburban neighborhoods. There’s an expectation of a walkable neighborhood, and on a simple level, it’s more walkable to walk past one apartment building than a dozen or more single family lots, which kindof goes against my whole conception of the suburbs as a place where you sacrifice walkability for more space at home.
• The article gestures at public transit and does a good job of describing the kinds of features that are popping up in these new suburbs, but I think it’s worth emphasizing that housing density, at least in certain sections of these suburbs, is what you really need to create a population base that can enjoy and be patrons of the new businesses and amenities of a transformed suburbs.

Marcus & Millichap: “Has CRE Momentum Shifted to the Suburbs?” – https://www.marcusmillichap.com/research/videos/has-cre-momentum-shifted-to-the-suburbs

• John Chang starts the video by reminding us of some of the movement patterns that we actually tracked on the Gray Report oh-so-long ago: Everyone was thinking that the pandemic and remote work were going to be sending people all across the country, but instead they just moved to the suburbs.
• The downtown is recovering but “the big picture leans towards the suburbs”