Find me a person who can talk and you’ll find someone with an opinion on the housing market or real estate investment. And most of those opinions—even from happily settled homeowners—bear the tones of suspicion at best and downright defeat at worst.
Housing prices have skyrocketed a staggering 34% nationwide over the past two years. This rate is essentially an order of magnitude higher than historical home price appreciation. Certain markets are arguably out of hand (to use a technical term). Take Boise, Idaho, where prices are considered 73% overvalued.
Is the booming real estate investment trend at least partially to blame?
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Supply and Demand is Still a Thing
No one denies that the fundamentals hold strong: when demand is high and supply is low, prices increase. It’s simple, and the basic principles of economics still hold true in the US housing market. Nothing is broken.
But how has this grand mismatch between supply and demand been allowed to fester? Well, like with almost anything regarding the economy since early 2020: it’s the pandemic, stupid*.
*Click the link for the reference. I’m not calling you stupid. I love you, actually.
The Pandemic and the Housing Market
As lockdowns were enacted, a number of factors conspired to create a mismatch between supply and demand. New housing starts, already behind and timid after getting belt whipped by Big Poppa 2008 Financial Crisis, nearly halted in early to mid 2020. White collar workers were pent up in condominiums and cities. Consequently, they took their laptops and their remote work elsewhere. En masse, they decided to move to the suburb or the mountain town of their downtown office daydreams.
The problem is that those suburbs and mountain towns were built for a pre-pandemic world. In such a world, city people lived in cities and mountain people lived in the mountains. So, when this grand and sudden migration began, markets did what markets do. Prices skyrocketed to buffer the increasingly mismatched supply and demand scenario. According to this study, remote work accounts for up to 50% of home price growth since 2019.
Low Interest Rates Spur Investment Opportunity
But that’s not only what happened. When the Fed dropped interest rates to keep the country from an economic free-fall in early 2020, mortgage rates also dropped to historic lows. When one can obtain a mortgage for sub-3%, that’s damn-near free money! Despite the surging prices, savvy investors seized the opportunity to enter markets and purchase additional properties at these historically low mortgage rates. Meanwhile, investors simultaneously posted higher rents to hedge against what would become a period of high inflationary pressure.
The Rise of Real Estate Investing
But let’s back up for a second. Let’s talk about real estate investing. The concept of real estate shares roots with our sweaty, boar-clubbing Neolithic ancestors, where a type of currency exchange may have existed for ancient shelters. Modern real estate investing, however, really took off in earnest after the recession of the 1980s (source). The tiny spark became a wildfire in the housing bubble run-up of the early 2000s*.
*Check out this nifty analysis of Google traffic for the term “real estate investing.”
The Major Real Estate Investing Crash
Well, the end of that story kind of sucks. A lot of people, drunk on the pina colada nectar of a booming market, bought into an increasingly mismatched supply and demand environment. Many of them lost their respective shirts in the subsequent subprime mortgage crisis and the 2008 financial crisis.
The Perfect Habitat for a Post-Crash Real Estate Investment Environment
Once the dust settled in the early 2010s, housing prices, as well as stocks, were largely undervalued. The blogosphere was also beginning to blossom. The nascent roots of the FIRE movement took shape as markets of all kinds were ripe and plump for future growth.
Methods of real estate investing once only shared among elite investors or this or that random dude were now being shared across websites and podcasts. Us millennials, with our noise-canceling headphones, a firm command of computers and smartphones, and an increasingly draining work email inbox, embraced ways to increase wealth beyond the standard paycheck.
Voila! A new army of investors is born.
Real Estate Investment Accounts for Nearly 30% of 2021 Purchases
Now, let’s fast-track back to Q3 and Q4 of 2021, examining some comprehensive data and analysis from CoreLogic. Let’s get ourselves a peach and head on down south through the sultry night air of those north Georgia woods, on down to Atlanta. In Q3 of 2021, 43% of Atlanta area home purchases were made by investors, followed closely by San Jose-Sunnyvale-Santa Clara, CA (42.4%), and Phoenix, AZ (38.8%).
Investors have increasingly focused on high return potential properties in the south, mountain west, and perhaps surprisingly, California (again). All told, 27% of all single-family home purchases (nationwide) were made by investors in the first three quarters of 2021. The rate in 2019 rate was 17%.
In an environment where supply is already tight, one can quickly imagine how an investor share of nearly 1/3 of the market will have ramifications in affordability. This is particularly true for prospective first-time home buyers without equity from previous homes. But don’t take my word for it: Moody’s Analytics reports that prices increased more than 20%, on average, as a result of the investor market share in 2021 (source).
The Real Estate Investment Demographic
And who are these investors? Are these large firms swiping up huge swaths of American single-family homes? Not really. CoreLogic reports that small investors—those with nine properties or less—were responsible for 43% of all investor purchases in 2021.
How Are Real Estate Investment Properties Used?
How these properties are being used varies widely, from long-term stable tenants to short-term Airbnb models. What is the effect on local housing markets? Arguably the most damaging from a broad economic standpoint is the (non-owner-occupied) single-family home that is exclusively used for short-term rentals. While the return for the investor can be fantastic, the downstream effects to local housing affordability are real.
A 2019 study by the Economic Policy Institute found that Airbnb rentals are resulting in US housing shortages, increasing both the price of rents and home values. Those who benefit are disproportionately white and already high-wealth. Similarly, in a 2021 study, researchers in Cologne, Germany outlined how Airbnb rentals have contributed to a 14.2% overall increase in rent in that city. Of note, the researchers shared that, “While a large proportion of hosts can be considered home sharers, we find an increasing proportion of providers who have developed a professional business model from short-term rentals.” In other words, hosts are increasingly moving away from renting a space in the home they already own. They are instead renting entire separate properties.
Six states, Florida, Idaho, Arizona, Indiana, Tennessee, and Wisconsin have all enacted bans on local regulation of short-term rentals. In these states, investors are largely free to own and rent out separate properties exclusively as short-term rentals. This action reduces the market share for traditional rentals or new home purchases for local residents. The result still follows the basic laws of supply and demand: higher prices, increased competition, and reduced affordability as the available market shrinks.
Where Do We Go from Here?
It’s clear that this latest housing boom is starting to wane. The combination of high prices and quickly soaring mortgage interest rates are significantly dampening demand. Builders are building, which is slowly increasing supply.
No one predicts a Great Recession-flavored housing collapse. The job market is strong, lending standards are greatly improved, and demand still greatly outweighs supply. But most experts agree that prices will begin to level off and fall slightly in some overvalued markets. These price declines are expected to be moderate, 5-10% when adjusted for inflation (maybe up to 20% if a recession occurs), but these people own no such crystal balls.
It’s important to note that this slowdown in the housing boom is both intended and necessary. As we’ve discussed many times on this website and podcast, periods of rapid growth are not sustainable.
As Jimmy Cliff would say, “the bigger they come, the harder they fall.”
The interest rate knob is a powerful and highly sensitive knob tool available to the Federal Reserve. One can certainly debate, however, whether that knob has been turned too hard and/or too late.
Real Estate Investment and the Future of Housing Supply and Demand
I find this Time article about the future of housing supply/demand to be fascinating. In this article, author Alena Semuals notes two increasing downward pressures on future demand:
(1) A reduction in remote work as employers call workers back to the office.
(2) An aging and diminishing population due to lower native birth rates and increasingly restrictive immigration policy since 2016.
In essence, boomers are getting older, millennials and Gen Zers are having fewer children, and immigration is lower than previous decades.
This article, citing Dennis McGill of Zelman & Associates, whose CEO predicted that housing prices would peak in 2005, claims that the US is already overbuilt. Builders and developers are planning construction based on previous expectations of population growth that no longer reflect current expectations.
What’s the solution to avoiding a larger drop in housing prices or preserving sustained economic growth? According to McGill the solution is simple: support immigration. He goes on to say, “if you want your economy to grow, you need population growth. It’s that simple.”
Conclusion
I’m far from discouraging real estate investment as a sound means toward generating wealth. However, we must be cognizant of the adverse effects on both our neighbors and our broader economy.
The least impactful, and also the easiest solution, is to pursue a form of “house hacking.” With this approach, the owner simply rents out a room or section of the property that is currently owner-occupied. House hacking is mutually beneficial, putting money in the homeowner’s pocket and providing an affordable living situation for renters or travelers.
Other forms of real estate investment have wildly different impacts. These impacts depend strongly on location and the degree to which the landlord is willing to charge. Price-gouging is very real in tight markets.
I’ll admit that my wife and I have strongly considered owning more than one property and engaging in some sort of rental situation. I’ve personally never felt completely warm and fuzzy about this situation, but what do you think? I realize if one person passes on an investment opportunity, the next investor will pounce on the opportunity. Humans are opportunistic, and I don’t believe most (any?) are intentionally trying to impact housing affordability.
So, let me know in the comments below why you have or have not chosen to pursue real estate investment. What is the future for this form of investment? What else?
With you 100 percent on this Chad. Sure, it’s a form of passive income, but what does it do to our communities and long term stability? I don’t think I will find neighbors who prefer an AirBnB next door. The best neighborhoods where safety and a sense of community thrive are those that are owner-occupied. I could easily buy a few rentals, but decided the headache isn’t worth it and I’d rather focus on truly passive investments. I honestly wish there was some kind of law that requires owner-occupied homes to be given priority over an investor.
Surprising that there small investors were such a large portion of investment buyers! Wall Street firms were getting bashed for it, however both are there to play.
Agree with the house hacking definitely mutually beneficial providing housing as well as income.