Will the real estate bubble burst? Here are 3 reasons why not

I know what you’re thinking: is this guy serious ?! Come on McAlister, did you see the Shiller Index? Have you heard of the insane bidding wars?

Have you looked at the underlying shakiness of the economy? Have you considered what happens when the increased unemployment benefits cease and lenders and landlords can track payment defaults?

My answer is yes to all of the above. And I still think real estate markets will continue to grow in the months ahead, and that strength could last for years.

Before we get into the details, a quick reminder about critical thinking and creating an investment thesis: We don’t take a thought, an idea, a data point and leverage our entire future on it. We think on the edge.

We think in terms of probabilities. Anyone who calls and claims they know exactly what the future will be like is more interested in fame, likes or clicks than in being a good investor. If you ever find out about great investors like Ray Dalio, Howard Marks, Druckermiller, and others down the line, you will find that they make predictions, but don’t assume that they will always be right and go all-in on an outcome . They understand thinking in terms of probabilities and adapt in the middle of the course.

Which factors play a role today that could influence the future, and which potential outcomes have which probability of occurrence?

To be clear, I think the economy is in trouble in the long run. We have a serious debt problem and some ugly demographic issues which point to poor GDP growth and productivity compared to our history. I also think that while inflation is temporary at the moment, there is a chance that it will become a serious problem.

Let us concentrate specifically on single-family or one to four-family houses “town house / duplex”. A few key factors at play here may allow prices to increase further before the party ends.

Housing demographics

The biggest component is demographics. According to UN population data, the largest age group in the US was 25-29 years old in 2020. The next bigger one? Thirty to 34 year olds. Then 20-24.

Guess how old the first time home buyer is? Thirty-four years old.

So what we have are the three largest age groups in the country, all of which are the prime ages to buy a home for the first time.

That’s the thing about life: it doesn’t stay that way forever. People are less price sensitive when it comes to certain purchases – such as houses. You don’t wait forever to find a deal. You hold your nose, borrow the money, and buy the house because your life is happening now. Children come, careers develop, and a home is needed.

New federal policy

What else is happening on the demand side? How about a $ 15,000 loan for first time buyers? It’s not finalized yet, but it’s easy to see that something like this is being legally enforced.

Some form of student loan issuance or cancellation is also on the table.

After all, low interest rates are essential for the sustained strong appreciation in home prices. There is currently no end in sight to the US Federal Reserve’s low interest rate policy. Even if inflation picks up temporarily, the Fed is unlikely to allow interest rates to rise significantly. They know this will end the party and bankrupt everyone (including the government).

When you put all of these demand factors together, when the Justin Timberlake tickets go on sale, millennials will be able to raise money for a new home faster than my little sister.


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Housing supply

We also need to look at the supply picture to better understand where the living space could go. In terms of existing homes, I don’t see a massive wave of supply. The most important places from which a wave of supply of existing homes could emanate would be economic hardship or the dismantling of baby boomers.

In the longer term, there are signs of some economic weakness. However, I believe the market is nowhere near what it was in 2006. Borrowers are more creditworthy and less over-indebted. Nobody can know for sure, but I think demographic and government support on the demand side will outweigh any pressure here, even if eviction moratoriums burn down.

Some boomers will absolutely downsize and houses will hit the market. However, there are more millennials buying than there are boomers selling. Local aging is also becoming more common where older people bring services to them rather than the other way around.

Grandparents also like to keep their homes to have a meeting place for their children and grandchildren. Under certain circumstances, they can still own their homes to house their children and grandchildren.

The new building offer thus remains the main option.

I assume that the supply of single-family homes and “horizontal” rental complexes will continue to grow. However, rising construction costs and difficulties in acquiring and developing land due to high prices, labor shortages and zoning plans will limit the ability of supply to meet demand in the short term.

FRED data

Let’s take a look at the beginnings of the single-family home.

Since the bankruptcy, they have been well below the historical average. Single-family house start-ups remained well below the historical average of around 1 million new start-ups per month until 2020, when we returned to this level despite a significantly higher population.

That tells me that supply has to catch up for a while before prices moderate.

Home prices are skyrocketing, with the March Case-Shiller Index seeing prices jump more than 13% in March year over year. We last saw this growth when the last real estate bubble peaked between 2004 and 2006. Do I think this will resolve in the long run? Yes. Do I think it will be a “crash”? Not necessarily. It could be slow deflation.


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Will prices continue to rise?

Even though property prices seem insanely high (they are) and it feels like they should (they should) be a lot lower, there are strong arguments that due to demographics, limited supply, and government interference in the housing market.

This does not mean that prices will continue at this rate of appreciation. Nor does it mean that there won’t be cycles where prices are moderate for a while and or that you can close your eyes and buy anything and expect to make money.

On the fringes and in general, the outperformance of apartments can go under and single-family houses / horizontal rental complexes come into the spotlight.

Some newer developments offer a pretty cool mix of single-family homes with quality home-like amenities, including pools, gyms, fitness centers, and dog parks. You will hear the term “horizontal development” more and more often.

Self-storage can also benefit here. Household education tends to drive storage demand, as no one wants to get rid of their belongings when they move in with their partner or shrink.

Have fun hunting out there!

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