The Small Balance Intersection Update - November 3, 2024

Just in Case You Forgot:

Daylight Saving Time Ends in the U.S. — On the first Sunday in November (which often falls around November 3rd), clocks “fall back” one hour to standard time. This extra hour of sleep is appreciated by many and marks the start of shorter, cozier evenings as winter approaches.

Stat of the Day:

46%

The average price discount for 51 homes sold in auctions last year by Concierge Auctions, which calls itself the world's largest auction house for luxury real estate, according to the WSJ’s analysis of publicized U.S. sales that were recorded publicly. This year, closings through Sept. 18 had an average discount of 41% to their list price. Concierge said its competitive bidding process results in a “compelling value” for sellers of difficult-to-price properties. The increasing disconnect between what luxury homeowners think their properties are worth and what buyers will pay is driving interest in auctions. But aspirational sellers are finding that auctions don’t always yield their desired outcome—and aren’t without risks.

Supply Zone – Potential Slowdown

Home Builders Enjoy Boom Amid High Rates, But Declines May Loom

Despite typically adverse conditions, home-builder stocks have soared amidst high mortgage rates, benefiting from a stagnant resale market. Firms like D.R. Horton, Lennar, and PulteGroup have doubled in stock value since the Fed’s 2022 rate hikes due to a lack of existing homes for sale—still around 20% below pre-pandemic levels. Builders have continued constructing homes to fill the resale gap, maintaining an inventory of 7.6 months, above the typical 6.5-month threshold. To keep purchases feasible, builders have decreased home sizes by 5% and offered mortgage-rate buydowns, allowing buyers to secure rates around 4.5% to 5%, below prevailing market rates. However, these incentives are costly, significantly lowering gross profit margins; each rate buy-down point reduces gross margins by 3-4%. When mortgage rates do eventually drop, it could unlock supply from homeowners, 60% of whom hold mortgages below 4%, potentially marking the end of the builder-driven boom. In high-inventory states like Florida and Texas, builders are already struggling to sell new homes, and as resale prices continue to rise, home builders face rising challenges to stay competitive. With builder stocks currently trading well above historical valuations, a rate drop might increase supply from homeowners, potentially deflating builder stocks after this unusual high-rate boom.

Read the full article

Investor Lane

Wall Street Landlords Reshape Housing: Growth, Gains, and Trade-offs

Institutional landlords, led by firms like Blackstone and Invitation Homes, are rapidly expanding into U.S. residential markets, eyeing single-family homes as long-term assets. Since the 2008-09 financial crisis, Wall Street has acquired over 600,000 homes, constituting just 1% of America’s family homes but potentially growing tenfold by 2030, per MetLife Investment Management. These landlords concentrate investments in high-growth, affordable neighborhoods across states like Georgia and Texas, where they can benefit from lower purchase costs but competitive rental yields. In these areas, median home values sit at about $345,400, 20% below the national median, while rents remain just 3% lower. This disparity enables returns as high as 8%, compared to 6% for median-priced homes.

While landlords may benefit homeowners by boosting property values and, at times, improving neighborhood amenities, they can push up rents significantly; in fact, rents in highly invested zip codes have climbed 30% over five years, compared to the national 23% increase. This concentration of investor activity has led to mixed impacts, including increased competition for home buyers and heightened volatility when large-scale landlords offload assets, as seen when rising rates forced VineBrook Homes to liquidate properties at discounted prices in Milwaukee. Such trends mirror pressures in multifamily housing markets, where investor influence has driven apartment values down 20% since 2022. As investors move in, they bring benefits but add risks, impacting both tenants and home prices. Read more at WSJ.

Reentry Road

Office Market Shows Signs of Stabilization Amid Workforce Reentry

The U.S. office real estate market may be stabilizing as more companies recall employees to the office, reversing remote policies established during the pandemic. As of Q3, 33% of companies required full-time office attendance, a slight rise that ended a five-quarter trend toward remote flexibility. Major firms, including Amazon and Dell, are recommitting to in-person work, with notable expansions in office space by firms like Amazon in Manhattan. Yet challenges remain: vacancy rates hover near a historic high at 13.8%, with a significant portion of office spaces now considered obsolete and defaults on office loans continuing to climb, reaching 8.36% in September. As leases on about 40% of office spaces mature, more companies may consolidate, adding further pressure on office space demand.

Investor interest is rebounding for well-leased properties with attractive amenities like gyms and high-end dining, features that have proven effective at attracting employees back to the office. For instance, HSBC expanded its Manhattan office space after new amenities increased employee attendance to 80%. In October, Tishman Speyer’s $3.5 billion Rockefeller Center refinancing demonstrated growing investor appetite for select office properties, hinting at improved market sentiment. Nonetheless, the increase in distressed office property sales reflects ongoing caution, with prices falling but valuations potentially nearing a bottom. The office sector's outlook remains mixed, balancing renewed demand against high vacancies and loan defaults. Read more at WSJ.

Reduce Speed

Slow Recovery Anticipated in U.S. Commercial Real Estate for 2025

The 2025 Emerging Trends in Real Estate report, published by PwC and the Urban Land Institute, forecasts a cautiously optimistic outlook for U.S. commercial real estate, suggesting the start of a new, slow expansion cycle. In the annual survey, 65% of commercial real estate professionals expect their firm’s profits in 2025 to be “good” or “excellent,” a notable improvement from last year's 41%. Respondents are hopeful for a return to historical profit norms, although they do not expect the high returns seen in the 2010s. While acquisition and refinancing activity remains slower than desired, industry confidence is bolstered by the Fed’s recent interest rate cuts, with 80% of respondents expecting lower commercial mortgage rates in the coming year, which should stimulate refinancing and investment. Approximately 40% of respondents anticipate stable or slightly decreasing cap rates in 2025, though faltering property fundamentals and a potential economic slowdown may hinder income growth. Industrial properties, single-family homes, and multifamily units are expected to offer the best investment and development opportunities, with strong scores reflecting favorable market views for these asset types. This tempered optimism highlights an environment where gradual improvement is expected, and market fundamentals may shift as new tenant preferences stabilize. Surveying over 1,600 real estate professionals, the report’s findings underscore cautious optimism for 2025, with both potential and pitfalls in U.S. commercial real estate markets. Full report here

Cooling Market Road

US Home Prices Cool as Affordability Issues Stall Market Growth

In August 2024, the CoreLogic S&P Case-Shiller Index reported a 4.25% year-over-year increase in U.S. home prices, down from a 6.5% peak in early 2024 and marking a five-month slowdown. This cooling trend comes despite a temporary dip in mortgage rates, which briefly lifted buyer interest but not enough to overcome broader affordability constraints. The Midwest and Northeast continue to show stronger price resilience, supported by relatively affordable housing and lower cumulative price increases, while the West and South are seeing sharper slowdowns amid high costs and affordability pressures. Notably, price appreciation in Miami, San Diego, and Los Angeles decelerated the most, while Chicago saw a unique acceleration in gains. A monthly 0.13% decline in the non-seasonally adjusted index contrasts with historical seasonal trends and reflects affordability challenges, particularly in metros like San Francisco and Denver, which posted the largest price declines. On a city level, New York led with an annual gain of 8.1%, with Las Vegas and Chicago close behind, showcasing regional divergence in price growth. High-tier home prices fell by 0.4% nationwide, while low- and middle-tier prices also declined, with markets such as Los Angeles and San Francisco seeing declines across most segments. Analysts expect limited price movement into the fall, though spring 2025 may reveal diverging trends as regional market dynamics and the impact of non-fixed homeownership costs like taxes continue shaping the market. The evolving patterns suggest that while some regions may stabilize, others could face ongoing affordability issues into next year. Full report here.

Maturity Wall Blvd

Extend-and-Pretend Lending Spurs CRE Risk

The New York Fed warns that U.S. banks’ “extend-and-pretend” practices in commercial real estate (CRE) lending could destabilize the financial system. Banks have frequently extended loan maturities rather than addressing rising defaults directly, creating a wave of debt that may not be repaid, according to a report titled “Extend-and-Pretend in the U.S. CRE Market.” Rising defaults or an “orderly” restructuring of these loans will significantly impact banks’ balance sheets, with the strategy already linked to three regional bank collapses in 2023, including Silicon Valley Bank. Since the Fed’s 2022 rate hikes, banks extended many distressed loans, which in turn limited their capacity to originate new CRE or business loans, with CRE originations dropping by up to 5.3% since Q1 2022. Analyst Rebel Cole from Florida Atlantic University notes that loan-to-value ratios have risen about 20%, increasing default risk as many properties have decreased in value. He estimates 25% of larger banks may close within a year, and up to 1,000 smaller banks could fail under similar pressures. S&P Global reports that the maturity wall for CRE loans could reach $1 trillion in 2025, peaking at $1.26 trillion in 2027, with borrowers facing “rate shocks” on refinancing at higher interest rates. While the Fed's recent rate cut may offer some relief, the growing maturity wall poses a substantial risk to financial stability. Read more.

Caution: Uncertain Terrain Ahead

Top Real Estate Issues in 2025: Key Challenges and Opportunities

The Counselors of Real Estate (CRE) identified ten critical factors likely to shape U.S. real estate in 2025, with broad implications across residential and commercial sectors. Political uncertainty, including upcoming elections in over 70 countries, could impact regulation, taxes, and trade, creating caution among real estate investors awaiting economic clarity. Financing costs remain high despite recent rate reductions, and CRE predicts cautious deal-making and the potential for more distressed asset sales as $1.8 trillion in commercial real estate loans mature by 2026. Global conflicts, notably in Ukraine and Gaza, are intensifying supply chain disruptions, inflation, and labor shortages, contributing to investors’ increased risk assessments. Insurance premiums are rising due to more frequent natural disasters, affecting especially high-risk sectors such as residential and hospitality real estate, with owners pivoting towards alternative risk management strategies. Housing affordability issues persist, driven by inventory shortages, while multifamily construction remains concentrated in major cities, pushing renters’ cost burdens higher. The rapid adoption of AI offers efficiencies but presents data challenges and demands extensive computing power, spurring new data center developments. Sustainability efforts are increasingly critical in real estate, particularly in response to climate-related risks, though U.S. regulatory actions lag behind Europe. Meanwhile, the high office vacancy rate is spurring efforts to repurpose office spaces into residential or other uses, potentially revitalizing urban centers. Finally, the gap between buyer and seller price expectations is narrowing as the real estate market moves toward stabilization. Read more.

Reform Road

Modernizing RESPA Section 8 for a Competitive Mortgage Market

The Mortgage Bankers Association (MBA) has published a white paper calling for major reforms to Section 8 of the Real Estate Settlement Procedures Act (RESPA) to better align the law with modern mortgage industry practices and consumer needs. The MBA’s report, titled “RESPA at 50: Key Reforms to RESPA Section 8 to Better Serve the Modern Mortgage Market,” critiques the law’s limited success in reducing settlement costs and highlights the administrative burden on lenders and settlement providers. MBA President Bob Broeksmit argued that outdated regulations limit competitive marketing opportunities and reduce consumer choice, advocating for a shift in how Marketing Services Agreements (MSAs), desk rentals, and digital marketing are regulated. Key proposals include re-evaluating MSA and desk rental guidelines based on fair market value rather than restricting compensation outright, enabling digital marketing that does not mislead consumers, and allowing greater flexibility in affiliated business arrangements (AfBAs). The white paper also recommends removing outdated requirements, like redundant disclosures and the inclusion of affiliate organizational charts, to enhance consumer understanding. Additionally, the MBA urges the CFPB to revisit certain regulatory interpretations to account for subsequent legal precedents, creating more precise compliance boundaries and liability limits for lenders and service providers. The association is prepared to collaborate with the CFPB, Congress, and industry stakeholders to implement these reforms.

For a detailed breakdown, access the full white paper here.