The amplified correction in the housing market has homebuilders offering sweet deals to Wall Street
Builders have a playbook for real estate downturns that has proven effective time and time again. They start offering incentives like mortgage interest buybacks. When that doesn’t work, homebuilders start lowering home prices in communities until their unsold inventory has been moved.
Fast-forward to 2022, and homebuilders have clearly returned to their housing downturn playbook, only there’s a new wrinkle: institutional investors. In the years after the housing crisis of the 2000s, institutional investors like Blackstone saw an opportunity to buy more directly from distressed developers. The extension a this so-called “build-to-rent” category means the builders are already handing out big discounts to Wall Street buyers this time around.
Last week, Bloomberg reported that housing giant Lennar would begin buying 5,000 unsold properties — a lot larger than all of it entire active inventory in Kansas City—to institutional investors. In some of these southwest and southeast communities, investors would have the opportunity to purchase entire subdivisions at a discount.
“One interesting dynamic among institutional investors is that many of them have been sitting on the sidelines waiting for this moment to strike… [they’re thinking] “Hey, I want to buy these houses from you [the builder]but I want a discount for it.’” says Ali Wolf, chief economist at Zonda wealth.
These institutional investors don’t just want discounts on the order of 10%, they’re hoping for “20% and 30%” price cuts, Wolf says.
On the one hand, the current average 30-year fixed-rate mortgage rate (6.28%) means that the housing market downturn is still very much alive. On the other hand, the fall in the average 30-year fixed-rate mortgage (down 7.3% in early October) means the bottom for housing demand could be in the rear-view mirror. That’s why, says Wolf, some institutional investors might be willing to pull the trigger.
“What we are hearing now is that because mortgage rates have fallen, some investors are afraid that the main buyers will come back into the market. Some of the institutional buyers are now trying to crowd in, fearing that demand from primary buyers will fall sharply and they will miss their opportunity,” says Wolf.
Why are house builders like Lennar going to investors now? There are two big reasons.
First, the ongoing real estate correction has intensified in recent months. When mortgage rates fluctuated 7% in October, the homebuilder churn rate (ie, the percentage of buyers who walk away from their contract) as tracked by John Burns Real Estate Consulting rose to 26%. That increased cancellation rate — coupled with a weak housing market on the horizon in spring 2023 — means builders are discounting faster and investors who can buy in bulk are getting better deals.
Second, builders still have a tremendous amount of inventory — both single-family and multi-family homes — in the pipeline. A pandemic demand boom coupled with supply chain issues has pushed the number of US housing units under construction to a record high this year. Now that cancellation rates are skyrocketing, builders are desperate to sell that backlog before they finish construction.
Looking ahead, Wolf expects the historic pipeline of unfinished homes to continue depressing new home prices into the first half of 2023. But once inventory is cleared and the pipeline is under control, pressure on new home prices should ease.
How many of these houses go to institutional investors? It’s difficult to say.
While firms like Blackstone have made it clear that they want to continue expanding their real estate portfolios, some institutional buyers have been temporarily marginalized in the face of the ongoing real estate correction. Look no further than Blackstone-owned Home Partners of America, one of the nation’s largest private landlords, which announced in August it would halt single-family home buying in 38 regional US housing markets.
There’s also the fact that earlier this month firms like Blackstone and Starwood announced plans to cap withdrawals from their real estate funds. It’s unclear how the continued surge in investor redemption requests will affect their plans for future real estate investments.
While the housing downturn is certainly causing home builders to shift inventory, it doesn’t mean we should mark doomsday for builders.
Just look at the stock market.
While the major homebuilders are all below their 2022 highs, they are still well above their January 2020 share price. These include builders such as DR Horton (+72.9% since January 1, 2020), Lennar (+67.4 %), Toll Brothers (+30.2%), NVR (+28.5%) and PulteGroup (+21.8%). During the same period, the S&P 500 index rose 22.5%.
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