Webcast transcript
WW: Thank you Susan and good morning everybody. Welcome to another Walker Webcast. If it’s Wednesday, it’s the Walker Webcast. It’s wonderful to have Ivy Zelman joining me today to dive into the insightful data that Ivy and her team at Zelman & Associates collect, analyze and distribute on a regular basis. If you do not subscribe to Ivy’s research and you are in the housing industry, I would strongly suggest you visit the Zelman website where you can not only subscribe but also purchase individual research reports.
I’m not going to provide my normal introductory remarks today about what we see happening in the markets at Walker & Dunlop because this discussion with Ivy is going to dive into the data and perspectives in a big way.
I will mention that next week my guest on the Walker Webcast will be Zoom founder and CEO Eric Yuan. It is truly amazing what Eric and his team at Zoom have done to connect the world during this pandemic and I’m really looking forward to discussing how Eric founded Zoom, built the platform to be so scalable and how the Zoom team has managed its exponential growth since the onset of the pandemic. And then in mid-September I’ll have Barry Sternlicht back on the Walker Webcast to discuss his outlook on the real estate markets and where he sees Starwood investing their enormous new fund which they have just closed.
So Ivy, first of all it is wonderful to have you with me. Before I wind back the clock a little bit to your story and how you came to be such an insightful and influential voice in the housing industry, I have a two-part question. If you had a million dollars to invest today, first what housing asset class - single-family, single-family rental or multifamily - would you invest it in? And then second, what city or suburb would that asset be located?
IZ: Good question. I would actually invest in single-family rental. I think having a cash flowing asset is the most beneficiary, long-term wealth creation. If you look at the fastest growing markets, there’s a lot of competition in those markets so I think I would take a hybrid approach. I think I would start in my hometown here in Cleveland, Ohio. Many of the institutional investors have actually not wanted to come to the Midwest which are slow growth markets, but the yields are incredible here. I'd probably allocate money to the Midwest and Cleveland and other markets in the Midwest. But I'd also look at probably only one or two, a million dollars doesn’t go too far in Cleveland, it goes pretty far but I’d actually look at Boise, Idaho is one of the fastest growing states and Boise’s on fire and I don’t think the single-family rental institutional guys have really focused there so I would choose a little bit of a hybrid approach.
WW: So I know all of our listeners want to hear more on all of that but I’m going to back the clock up for a moment and then we’ll get back to that conversation. So you grew up on Long Island and went to Ward Melville High School. Your father had his own business. Can you tell me a little bit of what you learned from watching your dad run his business?
IZ: Sure. Let me first say that my father actually was an executive for an international bank for over twenty years before he took the entrepreneurial plunge and started his own business. My dad was like God to me, I just wanted to be just like my father in every way. I was a tomboy, one of three daughters, the middle daughter and when he started his own business, I was I think in the 11th grade, and he wanted to get into home health care. So he bought a franchise in Queens and he later bought another franchise in Westchester. I actually graduated high school early in January of 84 and I went to work for him in Queens at the home health care called Health Force and what I really learned in watching him is that he didn’t have a background in healthcare, he didn’t really have a management team that was experienced. He levered up to buy the second franchise and eventually unfortunately it was not successful and as a result of that I think what I’ve learned is that you need to do a significant amount of due diligence and you have to have experienced management and I am definitely fearful of leverage. Maybe too conservative in fact but fortunately my husband David is a risk-on investor and we balance each other out pretty good. So that’s what I’ve learned.
WW: So you went to George Mason and you had a full-time job at what is now Ernst & Young and took your classes at night. First of all, that’s a rigorous schedule for college. Did you have any time to relax and enjoy being in college and then, second, did you ever seriously consider becoming an accountant because those of us who read your research on a consistent basis are very happy that you’re not doing our tax returns today.
IZ: Well thanks for that. Well first I would say I started my college career actually when I was working full-time for my father at Baruch College in New York City and after being there for two semesters I actually met a guy from Virginia and fell in love and despite everyone telling me I was nuts I decided to move to Virginia and live with my boyfriend Ian and I actually transferred quickly to a community college, NOVA, out in Reston, Virginia and we were together. Fortunately for me, my very best friend I met in London when my father was overseas for three years, my friend Yvette, lived in Virginia. I’ve known her since I’m 12 so I had friends there and I did have some fun, but it was like playing house like everyone used to tease me. But I did transfer eventually to George Mason while working at Arthur Young, now Ernst & Young. It took me six years in total to finish school and some student debt. But when I worked at Arthur Young I was like crazy ambitious and I would ask all the accountants all the time do you like your job, I’m majoring in accounting because that’s what my dad did, and they would be like you don’t want to be an accountant, you’re crazy ambitious, you should go work on Wall Street, and I had no idea what Wall Street was. No one recruited, none of the firms recruited at George Mason, so I went to the library, I started networking and it led me to investment banking at Solomon Brothers.
WW: So there couldn’t have been many other George Mason graduates in your entry analyst class at Solomon Brothers and you went into investment banking not investment research. How’d that go?
IZ: Well I was one of 70 in a financial analyst program that’s a two-year program and I actually was one of three women and I was very intimidated because I was one of the only ones that wasn’t from the best of the schools out there, the Ivy league schools. We were grunts. We worked 80 plus, 100-hour weeks, you’re building spreadsheets, you’re going to the printer all night, you’re working on pitches for your team, I was on the transportation team. You’d be lucky if, like we were doing a pitch to win business from Delta Airlines. I was on the transportation team, you’d been working all night, even if I got to go to the meeting to make the pitch I would be quietly sitting in the room, in the conference room, and not a peep out of me and just being happy to attend. So given that I’m very much a people person it just wasn’t a good fit and after two years everybody goes to business school, that’s sort of the normal track, so I thought I needed an Ivy League MBA and I applied to Harvard, Stanford and Northwestern and unfortunately, very deflated, I was rejected from all three. So at that point I had student loan debt and I decided that I would just find a job to pay my rent and forget about the MBA. So I started looking internally and for those of you who remember the big Solomon Brothers treasury scandal coming out of the 1991 recession there was a lot of openings in various parts of the firm and there was an opening in Equity Research as an associate. So I actually got the job and everyone in investment banking told me I’d be crazy to go work in equity research because their just monkeys and they just write what management tells them to write. So, despite all those warnings I wound up in equity research and started my now almost 30-year career being an equity analyst.
WW: So you went into equity research at Solomon Brothers and crushed it and then you moved over to Credit Suisse and had an incredible run at Credit Suisse. The number of accolades that you got from Institutional Investor, from the Wall Street Journal, you were the top, top, top on all of their rankings as it relates to research. Beyond just working exceptionally hard what do you think differentiated you from other analysts on Wall Street?
IZ: Well Solomon Brothers actually took me out of the role as Associate and gave me a chance to join the MBA program as a full analyst myself and they assigned me an institutional salesperson as a buddy and I had a year to learn my industry and during that interaction my buddy told me whatever you do don’t rely on publicly traded management teams to tell you what’s going on, you’ve got to go dig in the channel and talk to private companies. So I started calling private companies, I’d go to trade shows, I’d meet any private companies I could, home builders, building products and the good news was that my industries were really highly fragmented. So at the time the home builders only had the public company going at eight percent market share so it was easy to build a rolodex. And fast forward that rolodex today, which you’re a part of, is nearly a thousand companies that are C-suite executives that are participating in monthly surveys that we do. It’s funny just thinking about all of what we’ve done from the scratch pad, writing notes down, we have now an automated platform, we have surveys, we produce nine monthly and quarterly, and these surveys are really very extensive and detailed and highly correlated to the publicly traded companies that report quarterly at over a 95 percent R-squared and these results allow for clients and industry executives that purchase the research to stay ahead of the curve and really that’s enabled us to actually make really bold calls and stick to our guns and is helping the guys with the boots on the ground. And the other thing I was known for and probably still, I’m a little bit more mature now, but I was quite bold and never afraid to ask tough questions and would get into it with management teams sometimes on public conference calls. I try not to do that anymore, I try to keep that offline, but I’m not afraid to ask tough questions.
WW: That I’ve seen and that is highlighted, if you go on YouTube and look at Ivy on various video clips you will hear CEOs being asked a cruel question. I now clearly understand why you don’t really listen to what I say because I am in that category of public company CEOs who don’t tell you the real truth. Anyway, so you and your husband and your colleague at Credit Suisse, Dennis McGill, jumped out to start Zelman in 2007. If I look back to your questions to leaders in the housing industry in 2006 you knew things were getting ugly, you knew that there was overbuilding, you knew that there was a mortgage crisis coming out and in Michael Lewis’ book The Big Short you’re in there and you’re cited by Michael. So you knew something was coming. I can’t think that if you knew it was going to get as bad as it did get that you’d kind of make the move to go out in 2007. And looking back at that what made you and your husband and Dennis decide that at that moment it was the time to strike out on your own and create your own firm?
IZ: Well as the housing bubble was brewing, and in 2005 we actually were early in calling the top and saying that this wasn’t sustainable, we became the bomb, everybody wanted us in every capacity at the bank. I was being paid by what home building stocks traded and every part of Credit Suisse wanted access to Ivy Zelman and what our research was doing - capital markets, the asset-backed securitization area, the fixed income, so we were really sought after. And while we were contrarian, I always make the analogy that we were the sober ones when everybody else was getting ripped at the party and getting wasted, we were definitely very much hot and in demand. And because we had this unbelievable proprietary rolodex, which now is exponentially bigger, we knew that we could go on our own, and really hang our own shingle, and were confident we could do well. But we did our due diligence. We built a 10-year model. We spent a lot of time, about a year and a half, planning and circling very quietly institutional investors and asking if they’d come and they’d use our services and so we left the firm in May of 07 and it was with David who was experienced and really more the business acumen that I felt confident that joining me and helping us get started I could focus on the research. At the time I had no idea that the housing market would cause the great financial worldwide bust that it did, but I knew Willy frankly if it didn’t work out, I’d probably find a job, so I was willing to take a risk. My husband and I did sell our home in Florida which he still regrets but we needed the capital to start it and fortunately we’re still the only owner, so we’ve done well.
WW: So housing tanks in '08, '09, 1'0 and then in 2011 you start to get bullish on housing again and you start to come out and say now is a really good time to get back into the housing space. And then in 2013 you follow that up basically saying from an investment standpoint sort of the housing market is as good to nirvana as an investor can find right now. Talk for a moment about, I mean if you look back hindsight is 20/20 vision, was that the time for people to be as bullish on housing as you said? And when you say housing let’s segment for a moment between single-family housing and multi-family housing because that was sort of the advent of the great running multi and we’re going to run through the 2010 to 2020 and then we’re going to talk about where we’re going from here, but talk for a moment about '11 and '13 and what you saw then in the single-family world that made you so bullish on housing vis-a-vis multifamily?
IZ: Right, well in late 2011 inventories had really troughed at record high levels and we started doing analysis that there were a tremendous amount of institutional investors, mom and pop investors, primary buyers that were in the market. if you look at Google searches for homes, it was a lot of indications, rates were at record lows, that it was just a ripe time so we called the bottom in January 2012 and housing started ripping. Starts were up for single family 25 percent, home prices were up double digits and that continued into the first half of 2013. I was on CNBC in March of '13 and I said this is nirvana and that was the end because within two months Bernanke decided that they would stop doing quantitative easing, rates spiked 100 basis points and housing stalled out all the way through the end of '13 and into '14 and then to make it worse, to pile on, FHA lowered their loan limit in the early part of &rsquo14 so housing really stalled out and it wasn’t until really 2015-2016 it picked back up.
And with multifamily frankly we really missed it because we weren’t bearish, we had some buy recommendations but we just weren’t anywhere near as bullish as we should have been and we really under appreciated the hangover that millennials would have in terms of delaying marriage and family formation and the negative sentiment that people were afraid to invest in and buy because of what their parents went through, so we were definitely not bullish enough clearly on multifamily.
WW: I want to dive into that for two seconds. What makes you think that post COVID we don’t get back to a similar type of pattern? Because we’re going to be talking in a moment about what’s happened in the housing market over the summer and what’s happened in this pandemic that has sort of made everyone’s head spin around. But just going back to sort of your frame on 2011, 2013, being bullish on housing but that people were still having that hangover effect from the Great Financial Crisis. Why do you think or not think that it’s going to be either similar or dissimilar this time around?
IZ: Well I think right now there’s no question that the demographics are extremely favorable. During the great bust and really for the last 15, starting in 2001 all the way through 2014, the number of 35 to 44 year old was actually declining and that was a headwind that we really didn’t fully appreciate when we early on in 2012 called the bottom. And in 2015 we started seeing growth so the trough of the age cohort 35 to 44 was 40 million and by the end of 2030 it will be 48 million. So there’s been a nice tailwind that has really been benefiting since 2015 the single-family asset class. Couple that with record low mortgage rates that, obviously they can move higher and that would change the game, but rates are very very low and they’ve dropped since they were record low in 2011-12, but now they’re at a new record low and they’re down 85 basis points from where they were a year ago. But I think the real key underpinning, is that the inventory in the United States is at an all-time record low and it’s fallen another 25 to 30 percent since COVID and so there’s a lot of elements that, and we won’t get into it if you want or we can talk about it now, but the pandemic has created, housing has taken center stage as people are just stuck at home. So we can get more into it but I think that the risk for the housing market is really around rates and the robust home price inflation we’re seeing right now that could at some point negatively impact affordability. But I think there’s a lot of bullish underpinnings that can keep the market on a relative basis outperforming.
WW: So as I’ve read through your research, you go back to the sort of 2010 to 2015 timeframe and all the things that you just pointed out as it relates to demographics, some real concerns about single-family homeowners diving in, where rates went because of what Bernanke did, made it so it was sort of a period of time where everyone was going multi. And then you mentioned in 2016 that single-family home builders kind of finally got the memo that they needed to start building entry-level single-family housing and in your latest research report there’s a fantastic graph which shows that the average square footage of a single-family home being developed in the United States has gone from 2,630 square feet in 2015 down to 2,225 square feet in Q1 of 2020. And in that period of time as the size or the footprint has come down also the number of homes that are qualifying for an FHA financed loan has gone from 43 percent in 2015 up to 68 percent in Q1 of 2020. All of that needs FHA financing if you will to meet that entry-level borrower’s needs, FICO scores lower than what Fannie and Freddie are on. Should those people I guess be homeowners? I know that FHA will give them a loan but we kind of saw in the 2000s what happened when the subprime really grew. What’s your take on the financing will be able to meet that product because the home builders have clearly started to build it?
IZ: Well just to put some perspective around it. FHA accounts are roughly 13 percent of purchased mortgages. For the home builders it’s probably 20 percent, even though they’re obviously focused on entry-level that’s growing. But I think what we recognize is that it’s not a subprime loan, certainly the down payment is less at 3.5 percent for the 580 FICO score. If you look at 90-day delinquencies the book has actually been performing very well, it’s roughly at, prior to COVID I should say in June of 2019, 90-day delinquencies were almost near record lows at 1.9 percent. And when you think about it Willy, the way people create wealth over long periods of times, many create wealth only through their homes. My best friend in Utah, my friend Lisa, who I’ve known since middle school, three kids, single mother, if she hadn’t bought her home using an FHA loan, she now doesn’t even have a mortgage, she’s created a legacy for her children and her grandchildren, and she actually has been able at times to borrow against that home to fund things that she’s needed. So I think there’s a place for FHA. I do obviously think it’s a higher risk from the perspective of having that down payment so minimal but at the same time we’re looking at inventories of the United States. So today when we look at delinquencies, 90-day delinquencies with COVID, we’re at eight percent for FHA and that’s concerning obviously if people don’t get jobs, and the vaccination doesn’t come to fruition, and people wind up losing their homes. They could sell their home and probably wind up getting enough equity to not only pay the bank back but actually even have some equity given the strength that we’re seeing in home price appreciation right now. So just to give some perspective around it I think there’s a place for it, but we do monitor the credit box and right now I’d say they’re fully underwritten loans, not like we had in the boom-boom days.
WW: And clearly Fannie and Freddie have made, I mean their certification on single-family lending since COVID started has actually gone up to make it so that it’s even harder to get a Fannie or Freddie loan at this point. Does credit availability given that rates are driving so much of what’s going on right now, does what FHA and FHFA do for Fannie and Freddie concern you at all as it relates to the single-family market?
IZ: Well actually we survey roughly 20 percent of the mortgage market and we do every month. We look at the strength of underwriting on a scale of 0 to 100 and 100 is you can’t get a mortgage and 0 you can fog a mirror and get a mortgage, 50 is normal. And so right now I’d say that we’re at kind of in a 63 score. Back in early 2012 it was almost 80 and it really hasn’t gone, it got close to 50 but with COVID it’s tightened. And one thing I’d mention is the builders actually, if you look at their average credit score for FHA borrowers, their average FICO score is about 700 to 720 so you have a much higher quality borrower that’s coming in and buying that new home than over overall in the total market.
The other point to make is that when you just think about FHA and the number of people that are borrowing today what we’re seeing is the lenders have so limited capacity, they’re hiring like crazy but because of refis are going gangbusters they’re actually tightening because they can because they have more and more better quality applicants they have more than they can service which is one of the reasons why spreads are wider than normal. If you look at the 10-year treasury which is hovering at 0.7, typically the 30-year fixed rate is roughly 170 basis points over the 10-year, and right now it’s about 230, 240 over the 10-year and that’s just because they’re so busy and they’re so capacity constrained so they’re looking for even better credit than they had been.
WW: So let’s dive into the crisis and then we’ll get to where we are today and then we’re going to look going forward. So the pandemic hits and the world really turned upside down yet a little more than a month after most investors and analysts said that things were going to get super ugly, green shoots started to sort of appear in many sectors, most specifically in housing. Your home building stock index was down 39 percent in the month of March and then it turned around and jumped 31 percent in April, marking the group’s strongest one-month gain since October 1982. You can sort of see things flipping quick for an Amazon or a Home Depot but given that buying a home is the largest purchase that one makes in their lifetime typically, what caused it to flip so quick?
IZ: Well when you think about the pandemic and people’s focus on their wellness and safety, the first thing that we saw was that people were leaving densely populated cities, they were fleeing for distance and space, and as people started in late April recognizing that they could be stuck in their homes and really not able to do the typical things they normally did, going out to dinner, going to concerts and sporting events, everybody starts looking at the space they have and recognizing that it’s either not good enough, it’s not enough, when you think about at home you’ve got kids working or learning online, you’ve got people working remotely so they want home offices, they want bigger kitchens because you’re dining at home more and they want more outdoor space. So, these are really the initial things that we were hearing.
And as you fast forward, so our proprietary surveys, interestingly in April we had a tale of two halves. The first half of April was down about 45-50 percent. The second half was down about 20 to 25 percent so we saw that inflection. And remember our surveys again is about 15 percent of new home sales, over 95 percent correlated to the publics, so we wound up seeing in May up 33 percent and in June and July up 60 and 61 percent. And these surveys are just remarkable strength. And if you remember prior to COVID, the housing market in January and February was for the first time single-family actually hit a million starts. So it was like for the first time in the cycle it’s even stronger from the underlying fundamentals right now than it was back then and has gotten higher, 20 percent higher than pre-pandemic levels at least from quarter activity. So people are nesting, your home is your castle, and so they’re really focused with rates at three percent and looking at what they can buy today, they can buy more home but they’re also not spending on all those other areas, the share of wallet is all being geared to being focused on their homes.
WW: So I want to talk about the sustainability of that but before I do that let’s just stay on kind of these eye-popping numbers as it relates to sales. Sales of previously owned homes jumped 25 percent in July from June, that’s the strongest monthly increase since 1968. Sixty-eight percent of homes sold in July were on the market for less than a month, and first-time buyers accounted for 34 percent of sales in July. But in the process of all that Ivy the median home price in America rose 8.5 percent from a year earlier to $304,100 which is a record high anomaly. Isn’t this appreciation putting the American dream further away from that entry-level home buyer because you’re not getting enough inventory of new homes and the existing stock is inflating up so much that at some point yeah we’ve got a lot of people who have the money who’ve jumped into the market in the past two to three months but at some point as prices continue to inflate the people who can actually put down that deposit and actually buy that entry-level home get smaller and smaller?
IZ: Well first I would just clarify that 8.5 percent increase, that median home price, is actually reflective of mixed, a benefit because the entry-level inventories are down over 60 percent so it’s just skewed to higher priced homes. If you look at what’s happening in the overall market and you look at like-for-like housing, Case-Shiller, CoreLogic, you’re really looking at, call it about a 4.3 percent increase. We’re actually, for full year 2020 we’re forecasting three percent with an upward bias, but the builders are building affordable homes in the tertiary markets, we call it the excerpts, and that’s one of the benefits of the builders because the inventories again at record tight levels they’re desperate. I remember back in 2015 being on a stage at an industry conference saying, if you build it, they will come and now they are and they’re building it as fast as they can but it’s not fast enough. So they are providing affordable homes you’re just not seeing it in the existing home sales because it’s at the new home level. But the velocity you pointed out, the way we look at it, a home that’s listed in the same month that it sold was at an all-time record velocity so you might not see it in the numbers but if it comes on the market and it’s priced in the twos it’s gotten multiple bids, and there’s bidding wars all across the market now in many markets not just the entry level, so I do think there’s affordability there. But to your point, if home prices keep going up the only reason right now they’re able to overcome that is because of where rates are so rates solve a lot of problems right now without them being down so much but at some point if rates go up and home prices continue to go up we will have more challenges related to affordability.
WW: What’s your outlook on rates? What do you think is going to happen to rates over the next year?
IZ: I’m not a rate guru but I can tell you in this battered economy and not the likelihood for 10 percent unemployment going down very soon I’m not really seeing a lot of inflationary concerns other than lumber and some of the building materials that we’re seeing going nuts but without that I’m guessing rates are going to stay pretty low.
WW: That’s a good segue to housing starts. So, housing starts sort of almost 23 percent in July from June. Can you help me unpack a little bit Ivy that start number because first of all, is that number just single-family or is that single as well as multi as far as what’s accounted for in that starts number? Can you answer that first and then I’m going to go into some of your projections as it relates to what you’re seeing from starts going forward.
IZ: Sure, actually that’s a combined number. So single-family was actually only up 7 percent, multifamily was the lion’s share up 58 percent.
WW: Okay, so on that then you have as it relates to housing starts in your current projections, on the single-family starts you have growth of one percent this year, two percent in 2021 and seven percent in 2022, while you have multi starts shrinking 10 percent this year, seven percent in 2021 and nine percent in 2022. So give me a little bit of the context of what you and your team are thinking is going to happen here because that’s a pretty dramatic shift from kind of all in single and moving out of multi.
IZ: Well multifamily has a multi-decade high backlog of nearly 700 units that are not yet completed and in the multi-family market today the demographics are actually more of a headwind than a tailwind. So we talked about the 35 to 44 year olds, and I forgot to mention by the way, the reason why that number is so important for single-family is that our data shows that those aged between 30 to 39, that are married with two or more children, 82 percent live in a single-family home. I always like to joke that if you’re living in an apartment thats900 square feet and you’re married and it’s hard enough to stay married imagine adding a few kids. So people go and they find more space when they’re married and that data really is what’s the benefit of lifestyle decisions that push people to single-family. On multifamily, 20 to 34 year olds really from the period of 2001 through 2014 were on a massive upward trajectory but the growth rate started decelerating and between now and the end of 2030 we’re going to see that decelerating growth rate continue and by the end of the decade it actually turns negative. So you’ll go from 2020, call it 67 million, to the end of the decade you’ll be at 67 million. So you just don’t have the same tailwind on the demographics.
Secondly, when we look at the urban core which the multi-decade high of supply is actually more concentrated in the urban core, that’s where the wall of capital really chased significant development and that’s an area where we not only are seeing people flee, we’re seeing the risk of remote work and what that will mean for the market, as well as soaring crime rates that are really making people reconsider living in cities for today. I’m not saying longer term that won’t necessarily change back when we get a vaccination, but I think right now multifamily is really feeling a perfect storm, you’ve got eviction moratoriums, you’ve got collection rates under pressure. So I think that the suburban markets, by the way, are really not at multi-decade highs. There is definitely a lot of supply coming, more in the suburban Class-A than in Class-B, but I think that our view is that underwriting today and trying to develop needs to shrink so the market can get rebalanced to then resume growth. But when we see a 58 increase in starts that’s not good for multifamily, they need to work through that supply because you know Willy when developers have a lot of capital and they’re shovel ready they’re not going to turn back, they’ve got too much invested. So we know from surveying over one and a half multi-family developer-operators, which again you could buy our surveys, you’ll see they’re telling us they’re not going to stop, they’re moving forward. And so I think that supply while it overall pressures lease rates, it’s a great asset class, but it’s going to be a problem, we feel like it’s going to be problematic for the industry to see the ability come through this thing in the next year or two and needs to shrink the new starts.
WW: What we’re seeing a lot on our end Ivy is buyers, not necessarily developers, because to your point developers who have shovels in the ground they’re going to continue forward and complete their projects. But on the buy side there are many people saying to us that at current cap rates and current interest rates to make a buy that there might be some noise in the rent rolls over the next year or two, but that with the limited supply coming in in 2022, 2023, 2024 that instead of having 650,000 units delivered in 2023, like there will be delivered in 2020, that they’re going to have 300,000 units delivered and therefore that’s going to allow them to have full properties and push rents. Do you buy that as it relates to an investment thesis right now on the multi side?
IZ: Let me just clarify, there won’t be 675,000 delivered in 2020, that’s what’s in backlog so what we’re expecting and with the numbers recently going higher I think that you need to work through that backlog in order to get the market position to suggest to their point that you’ll have you more of a normalized level. So I think that the pressure is not going to necessarily be gone by 2022, it really depends on how quickly that backlog unwinds and how much development actually comes to fruition. So our forecast for declining development, new starts, is actually a good thing to reposition the market to not be so overwhelmed with so much supply. So I’d probably be looking more like maybe three to five years rather than two to three years for a market to really resume and be at a healthy level. And don’t forget about that headwind from deteriorating growth rates and seeing the number of young people with Generation Z that’s actually behind that millennial generation it’s just not going to be growing and having the same magnitude that the millennials did for the industry.
WW: You mentioned the eviction moratorium being a headwind for multi. Both multi and single-family loans that are backed by the federal government have the ability to go into forbearance. The forbearance numbers on the signal-family side are dramatically higher than multi which makes sense, you’re getting sort of economies of scale if you will as it relates to a property that has two or three tenants or 10 percent of their tenant base not paying, if you get one person not able to pay on their single family mortgage that’s coming in. But right now, we’re about eight percent, between seven and eight percent of Fannie and Freddie outstanding single-family looking at forbearance and less than one percent on the multi-side. Does that elevated level of forbearance in the single-family side cause you pause and make you wonder about what we’re going to see from a foreclosure standpoint in single-family housing?
IZ: No because like I said earlier the inventories are so tight that if we had all those people, eight percent, seven percent were to wind up having to leave and vacate their homes they could arguably sell those homes today if the scenario was still the same as it is right now and even maybe have more left over after they pay off the bank. What worries me about the renters is that you have the opposite, there’s too much inventory and so as we see today rent collections are under pressure but we’re still in an environment where there’s stimulus and whether the unemployment benefits are not as high or people are at risk if that band-aid gets ripped off it could be worse and we might really start seeing a lot more vacancies. In New York City, as an example, inventory is up nearly 30 percent which is like an all-time record increase so there’s a lot more supply risk that would then pressure more on lease rates and we’re seeing concessions are rising so I think there’s more of a protection. Because don’t forget forbearance for the consumer they have up to 12 months, assuming it’s a Fannie-Freddie FHA loan, that they don’t have to pay for up to 12 months and even when they get to the 12 months they can tack those missed payments onto the loan to extend the duration of the loan and not change their monthly payments. So I think the government is giving the owners much greater support and the renters are really unfortunately not getting the same type of support that homeowners are getting.
WW: So you talked about core versus suburban. Let’s talk about two sort of shifts that you talk about in your research - first remote working and the second sort of blue state-red state. On the remote working side of things clearly we’re still in sort of a dispersed model today and who knows when we’re going to get back into offices. I have been a big believer, and still am, that culture and creativity happen in offices and the moment that Walker & Dunlop can get back into offices we will be back in our offices but as of today we’ve said no one has to be back in the office until January 1st and we’ll see where we are come then. But you’re making some pretty strong assumptions that remote working sticks around for quite some time. Talk for a moment about what you and your team are seeing and why you have such conviction that this remote work environment makes it so that people can live further and further out, to the suburbs and even further out, and really grow as it relates to overall housing.
IZ: Sure, so if you look at the data Brookings Institution shows that as of 2017 roughly five percent of people work remote and recognizing that today whether it’s technology companies, mortgage companies where it’s a very competitive industry, people are offering their employees flexibility, giving them optionality if they want to come to work one or two days a week or even work permanently from home. It’s allowing for the expectation that we go from five percent, whether we go to 10, 15, 20 percent I don’t know where the number is going to go, but we’re going to have more people that have shown they could be productive. For example, one of my buddies who lives in Chicago his wife would never leave the city and with the crime rate soaring there they bought land in Austin and his employer is going to let him work from Austin, and not only is he moving there but he’s moving his in-laws and his parents and they bought land and they’re actually going to spend less on all of their land and what they build their homes at than they are spending in Chicago. So I think that you’re going to see that it’s not a, it’s C-change but it’s on the margin the incremental growth that we’re going to find that’s going to really benefit the housing market as opposed to thinking that everyone’s going to be remote.
WW: And so that then goes into blue state-red state because your friend is moving from a blue state to a red state by moving from Illinois down to Texas. Tax rates, job growth, you go into quite some detail as it relates to the fastest growing economies versus those that are really slowing down. Talk for a moment about, my first question to you was where would you invest and it didn’t surprise me that behind Ohio you went to Idaho, not that tax rates in either Ohio or Idaho are the lowest in the country and clearly they’re not income tax-free states like Florida and Texas, but clearly Idaho is a high growth area right now, in Boise particularly. But talk a little bit about red state-blue state and what you see happening over the next five years particularly as we recover from this pandemic.
IZ: Sure. So first just to give you guys a little bit of data, if you look at 2010 to 2020, and its estimates because the census has not finished the decennial survey for 2020, but if you just look at the growth rate for population and household growth by state, the red states have been growing at double-digit rates in many parts of the country versus barely any growth in many blue states. So, for example, Utah, Idaho, you’ve got Texas, Arizona, the Carolinas growing at double-digit rates compared to New York, Connecticut, Illinois, Pennsylvania barely growing two to three percent so we call it the great shuffle. This migration is not new and we think about the northeast for example and taxes now where if you own a home you can’t deduct more than $10,000, I mean that’s across the board for the nation, but just overall increases in taxes through SALT. You’re seeing that people are able to not only move to more affordable places but that might have more favorable taxes and also nicer climates than the cold northeast. So, I think that right now with the migration that we’re seeing, whether it’s sustainable, we thought there would be some urgency pull forward because of school, people are wanting to get in before school starts. Also people were saying that it’s likely that once school starts and winter comes then housing might start to temper and fade, which could be true, but a lot of people might want to get out of the northeast in the cold markets like Chicago and go to Florida or go to the Carolinas and markets like Nashville and Birmingham, I mean these markets are just flying, the southeast is the strongest in the country of all the regions. Everywhere is strong and it’s strong across all price points from the entry level all the way up to the move-up. And interestingly before the pandemic we actually wrote, as you may remember Willy, the Tale of Two Markets, that the move up market was actually languishing and that had a lot to do with people that just didn’t want to move with a low rate that they were locked in at and upgrade for a discretionary purpose as well as the aging of the boomers. So the mobility rate in the United States if you go back and look at 1998 to 2002 on average was 14.9 percent. If you then fast forward to 2013 to 2018 on average it was 11.9 percent. So it’s declined over that period, call it 400 basis points, 300 basis points, and what you’re seeing it’s the aging boomer in place who tends to move less. If you’re in my cohort between 50 to 54, nine percent of people move versus those that are age 20 to 24, 53 percent move, so we have these boomers, 75 million, that are a much bigger cohort compared to the prior generation that increased 53 percent versus millennials they increased 14 percent. So what the boomers do, believe or not, are much more important than what even the millennials do and they were aging in place. But now we’re seeing people, again because rates have fallen, that they want those discretionary purchases so the move-up market in Greenwich, Connecticut where you couldn’t sell a mansion, brokers are having multiple bids on homes that have been sitting for years priced at 3 to 5 million dollars. So those fleeing urban core markets like New York are really breathing life back into these suburbs that were dead, almost six feet under. So that’s been a big part of what we’re seeing and the question is how long will we see the growth rates that we’re currently seeing in our surveys sustain why we’re modeling, that we actually right now are modeling that we do stay expected to fade and have a more flattish outlook. We’re going to be updating our forecast which we do quarterly, because the market has definitely been much more favorable than we had been initially expecting.
WW: So on that, everything you just said makes perfect sense as it relates to people wanting to move to the Southeast, people moving out of New York to go to Greenwich to buy the house and stop living in the high-end apartment downtown, what have you. But we do still have 14 million Americans unemployed. What’s your thought as it relates to, you just said the kind of a flattening of this growth curve as it relates to housing, how do we, I mean that’s more people that are unemployed than were totally unemployed during the Great Financial Crisis and it took fully three years for you to sort of get bullish on housing after we began the Great Financial Crisis so talk for a moment about, you know we are sort of in this euphoric moment where the American consumer has surprised us because we’ve gotten $3 trillion of stimulus payments out of the federal government, we’ve got basically free money going everywhere out of the federal government and we might have another stimulus payment coming now, the stock market is at an all-time high and we’re kind of in this rebound, what’s your thought as it relates to sustainability of this and then also kind of the, just how do you soak up 14 million people who are unemployed when airlines are unlikely to be flying anything close to what they were, Las Vegas is not going to be back to where it was, Marriott hotels isn’t going to be hiring the same number of people it was before. I mean, just, we can see Amazon and Target and others starting to employ many more people, but we’ve got whole sectors that are still sort of on their knees so how long does it take us to get through all this Ivy?
IZ: Well when you think about the number of people that are unemployed, which is tragic and this whole thing is tragic, think about the people that are employed. Your employment base is 160 million so you’ve got a substantial number of people that are gainfully employed, are feeling confident, have the income, and remember they’ve shifted their attention to their home, their home is their castle, so they’re not spending elsewhere. So I think that it’s a question of, in this case those that are employed are overwhelming those that are unemployed.
But if you go back historically housing has been, the majority of downturns if you go back to the early 80s, was really the cause of our recession, led us into recession like in 1980-1981 and then 1990-1991, all of those recessions including the great bust was housing. When you go back and look at the tech wreck, call it late 1999 through 2001, housing actually fared very well during that period because interest rates were falling and even though unemployment never got close to what you’re referring to unemployment was rising and housing was outperforming and home prices actually over that time frame actually increased over 6.5 percent. So is it possible that interest rates basically trump COVID and keep people in the market buying as we are dealing with this pandemic and I think this is a once in a lifetime experience, we hope, that we never have to go through again but while people are focused that are gainfully employed I think their home is really all that matters to them right now.
WW: You mentioned your home is your castle and we’ve seen record sales at Home Depot and Kohl’s as people have been investing in their home. I was talking to a pool builder here in Denver and I said how’s your business and he said look it’s off the charts. And I said are you building new pools, are you renovating old pools and are you putting pools into places that there shouldn’t be pools and he jumped right on that last one and said to me we are putting pools into backyards that never ever should have a pool, it’s like every single piece of ground. So when someone’s gone and built their pool, built their deck, gone in and bought their can of paint to redo their home and they’ve also refinanced their home now at historically low interest rates, is there a risk that all these single family builders are out building inventory and a year or two from now when all that inventory gets delivered everyone says I’ve just invested in my home, I’ve just refinanced my mortgage at a rate I’ll never get again and I can’t port that rate with me, I’m not a buyer.
IZ: Right, well I think your points, we first have to clarify that the new home market is less than 12 percent of the total market so you’re dealing with 88 percent of the market is resale and resales are at an all-time record low so there has been such a deficit of new construction that’s been plaguing the market. Because remember the builders didn’t get the memo to build affordable houses, they were scared that people wouldn’t drive to qualify so while the recovery really began in 2012 the true entry-level didn’t really start in earnest until really three or four years ago. So I think there’s still a large gap, we estimate it to be about 20 to 25 percent of what is needed based on the number of homes that have been completed versus the number of households that have actually been formed and so I think that gap as long as it’s not even back to normal I think the inventory is desperately needed from what we analyzed. And I would also point out that as the builders continue to build, they have an incredible opportunity to capture more share. Historic rate for new homes was 16 percent pre-housing bust of the financial crisis so there’s still a long way from gaining back enough share that would even put them at a normal level, so we really need that supply Willy.
WW: And so as you think about the various home builders and their inventories, their entitled land, because land entitlement has been a real hindrance if you will, since the Great Financial Crisis. Getting land entitled for single-family development has been one of those big issues that developers have had to work through. It’s my assumption that that’s better today but I would assume that a dispersed work model where a lot of county courthouses are closed and things of that nature trying to get new land entitled is causing some issues. If you’d answer that in this broader question which is just who as far as the home builders is positioned really well to take advantage of this given the type of inventory they’re building? Because you’ve segmented the market nicely, you talked about existing home sales, you talk about new home sales, but who’s going to reap the rewards of this right now over the next year to two years?
IZ: Well the public builders represent 40 percent of the market. So I mentioned they were eight percent when I started my career, now they’re 40 percent and they are really a significant advantage to the small builder. We survey builders that build anywhere from a few hundred homes to a few thousand homes, so scale really matters. We see it right now whether they’re trying to obtain lumber, forget about skyrocketing prices even getting lumber, so the builders that actually are best positioned, builders that have long-land pipelines that are professionally equipped to get land entitled. The biggest publics that we follow are really the ones like a Lennar or a D.R. Horton, thinking about Meritage. Meritage is one of the builders that back in 2015 literally completely shifted to entry-level. And we also have builders that are building not only for-sale homes but there are builders like Lennar and Horton that are now doing single family for rent, build-to-rent, and so that’s actually an advantage that gives consumers more flexibility for those that don’t have the ability to buy.
So I think that the big builders are going to just keep getting bigger and there’s a long list. We have 11 companies or more that we follow. So there, between the ones that we like and the ones that we don’t, I’d say right now you can’t kiss all the boys, but we do like most of the builders. We actually just downgraded D. R. Horton even though it’s a great builder. And by the way the builders not only are they generating cash flow right now but many of them have de-levered substantially so they are in a way better position than they’ve ever been because they got so spooked by the great bust that I think that the industry has changed tremendously for the better. But we downgraded it because it traded at 2.6 times book and that was the peak multiple and so we try to remain disciplined because we don’t think it’s necessarily different this time, we’re not willing to say that, we still think there’s cyclicality and there’s risk with a battered economy, and if you tell me that Ivy the vaccine is here, we are all back to normal, I think that wallet and that focus on the home would shift back to what we normally spend our money on. So, I think housing could still be good but maybe not as strong as it is right now.
WW: And you started by saying single-family rental, that that’s if you had your million dollars and you put it into an asset class right now SFR would be where you’d put it. So just talking about the SFR owner-operators, who do you like as it relates to SFR today?
IZ: Well we only have two publicly traded companies, Invitation Homes and American Homes 4 Rent. The difference between the two is that American Homes 4 Rent is developing their own lots and taking on a little bit more risk to provide a built-to-rent product. Invitation Homes buys here and there 10 to 15 brand new homes but it’s not a big percent of their portfolio nor is it part of their strategy. But there’s a lot of institutional private companies that we interact with. It’s interesting because most of the institutional capital has gone to the “Smile States”, it’s gone to where the population growth is the greatest and there are now portfolios out there that are pretty sizable, eight to ten thousand type sizeable portfolios that are still privately held that are more focused on the Midwest. And that’s when I’m like oh my God finally somebody is taking advantage of these unbelievable double-digit unlevered yields. So, I think that there’s a tremendous opportunity for the business to continue to be institutionalized. We actually wrote a report back in the early days, Leasing the American Dream. We did another one called The New Old Thing. And more recently History Repeated where we talked about the parallels between when the multi-family market, it was still in the late 90s, 1997, it was a mom-and-pop business, it was fragmented, it wasn’t yet institutionalized and how the single-family rental market which is really very small institutional capital today in terms of the few hundred thousand units, 200,000-300,000, versus 15 million and the amazing parallels that we see for this opportunity for scale and really giving the consumer a much better experience 24-hour, seven days a week call centers, the service better, more CapEx in these homes. That’s one of the reasons I like Cleveland because there’s no good product, it’s a horrible experience for the consumer here if they want to rent.
WW: Is the play on SFR today to build it or is it to buy and, if you will, convert it? Because as you mentioned previously only 14 percent of the market is new inventory. The 86 percent that has not been that heavily invested in other than now where everyone’s putting new cans of paint on, all that stuff, is the play right now, and it’s all replacement cost, has the cost of existing inventory inflated so much that you can’t go and buy and make the SFR model work so you’ve got to build new or is it the opposite and you can actually go out, buy, convert and hit that market today?
IZ: I think it’s both. I think the returns are attractive for both it’s just if you actually retain the collateral as opposed to sell it and just operate and you are a manager of the operations, it’s just taking more risk because you have to retain the collateral when you’re building as opposed to just going in. If you think about the operations versus owning, I think both provide developing and resale, good attractive returns. The new development piece just is more risk because you have to develop the land and not every builder, and a build-to-rent strategy is doing that, they might be buying directly from builders. But the returns we’re told are even higher for build-to-rent than for the single-family rental market in general, but that really depends on the market. If you go to look at HPA in Phoenix right now, I’m sure that the significant increase in home prices there would make the single-family rental strategy there less attractive on a yield basis versus build-to-rent, but if you go into again a market in the Midwest it might be much more attractive to actually buy it versus build it.
WW: And finally on multi, what strategy do you like, because I don’t think your coverage universe has many multi, and the big multi REITS are out there and people know there’s EQR and others, but what do you see from a strategy on multi right now that plays out well over the next couple years?
IZ: Well post pandemic and really thinking about where we need better quality and just a level of stock that is more attractive is workforce housing. I think that is the area that is most attractive and the least sought after by institutional capital. So I think that has been performing despite the pandemic, it’s actually been performing very well and so looking at Class C, Class B - because Class A right now I think has just got way too much pending supply and I think that you are seeing again those people that are aging into single-family assets are going to be able to afford to buy and there’s going to be a lot of people in workforce housing that just will never be able to come up with the down payment and live paycheck to paycheck.
WW: All super insightful and helpful. I would reiterate two things. One, to any of you listening, if you want to go to the Zelman website and look for their research, I would strongly recommend that. Any of you who have not attended Ivy’s housing conference, you can look for information on her website for that as well, it is an absolutely fantastic gathering of many of the leading voices in the housing industry on an annual basis and hopefully we can get back to doing that in person Ivy rather than remote as we are doing it today.
And the final thing is, thank you very much for taking the time. I did notice in my research for you that you have three kids and all their names start with Z so they are double Z’s and as a double W, I would just say I love the ZZs and at some point I hope to meet all three of them.
Thank you for joining me today Ivy and thanks to everyone on the webcast. We’ll see you again next week with Eric Yuan of Zoom.
