Short The Market

Short The Market

Short The Market

There are many reasons that I’m worse at my job than I otherwise could be. One reason is that I really don’t like working on the weekends. It’s a pretty terrible trade, I tell anyone thinking of getting into this business, to be able to take some random Tuesday afternoon “off” in exchange for membership in a business where weekends are expected workdays. Christmas Eve? Game. Fourth of July? Don’t even be silly by suggesting that’s a Holiday. Do I like working weekends? No. Do I do it? Yes. Do I plan to do it forever? No. Oh, and the other reason I’m bad at my job is because I think the primary housing market is massively overbought and should be facing a serious reckoning this year and next.

I’d also short the western mountain markets, especially after I just spent a week in Aspen. Living there feels like living on a tiny island. How many times can you walk to the White House Tavern and proclaim the chicken sandwich to be the best in Aspen? I ran out of enthusiasm after the first time. Aspen, like Saint Barths, is a nice place to visit but you sure wouldn’t want to actually live there. Cheap money, covid lockdowns, and a roaring stock market fueled the ski town markets, but in a year, or two, or three, those Chicagoans and New Yorkers that fueled these markets are going to start to do some real math. It’s the sort of math that Lake Geneva excels at and almost all other vacation home markets absolutely flunk. It’s called the Cost Per Night (your annual ownership cost divided by the nights you actually slept in that property). When you live in Manhattan and own a rather terrible $8M condo in Aspen, your CPN is bound to be frightening. But factor in a return to work and the return of your favorite restaurant and the return of sports and concerts and, well, your CPN is going to be downright dastardly. When markets are accelerating it’s easy to overlook your CPN, but when markets pause you just might take out that pencil and open your calculator and realize that your pretty awful condo in Aspen just cost you $26k per night last year. The Jerome would be 95% cheaper, and they clean up after you.

But this isn’t about the mountain markets that will be facing declining valuations in the coming years, this is about the primary housing market. It’s about the primary market in Lake Geneva and the primary market in Barrington. It’s about the primary market in Williams Bay and the primary market in Arlington Heights. To be clear, I’m talking about the meaty part of the market, which in the Lake Geneva area would have historically been $250k-550k. Today, that meaty part is wildly higher, and we’ll call it a $450k-$1M market now. The $600k homes were $380k homes four year ago. The $1M homes were $600k homes. The $1.4M homes were $800k. This is what happened over the past few years, and I’m here to remind you how unsustainable this is for a market segment that relies on leverage.

Luxury markets operate on the whims of the wealthy. If you’re Jim Rich Guy and you want an $8M lake house, AND you have some attachment, be it nostalgic or geographic, to Lake Geneva, well then you’re going to buy a home here. Your desires and subsequent real estate maneuvers have nothing to do with the sort of real estate maneuvering that takes place in the primary market. Jim Rich Guy isn’t happy that a gallon of milk costs $7, but it doesn’t matter. He doesn’t care that gas is $5 a gallon. He doesn’t like any of it, but it doesn’t impact him on any meaningful level. The Turbo in his garage is worth 30% more than it was three years ago, his boat is worth the same price he paid for it in 2017, and his stock portfolios have been gaining momentum to such a degree that a 10-20% haircut is not going to significantly alter his lifestyle.

But this isn’t how it is to be in a $600k home with an 80% mortgage, even if that mortgage is at 2.75% and fixed for 30 years. That’s an important aspect of this housing situation, which is why I don’t see a crash coming for the primary market, but I do see a meaningful softening. In 2008, mortgages exploded largely because of ARM products and aggressive lending practices. There is no similarity to the lending practices of the past five years when compared to the five year run up to 2008. But the inflationary pressures are squeezing the wallets of the primary home market participants, and interest rates are nearly double what they were last summer. The primary home consumer is being pinched in every possible place, with everything from the price of a used car to the cost of redoing their backyard deck to the cost of that gallon of milk causing uncomfortable pressure. I mean, it’s only one banana, what could it cost? $10?

I’ve written previously about the concern I maintain due to the amount of FHA and USDA loans that have been written inside our primary housing market. These loan products involve limited down payments, and a we know, small down payments make a borrower more sensitive to swings in valuations. If we take a look at the primary housing market in Williams Bay last year, we’d find 41 home sales priced between $400k and $700k. Some of those home sales were of vacation homes, but we’ll just look at the market segment as a whole. Of those sales, 66% closed with some sort of financing involved (MLS). I could dig deeper and come up with the down payments for these notes, but I’m going to assume a significant percentage of these loans featured less than 10% down payments. If we contrast that to the upper bracket on Geneva, those lakefront home sales that printed last year over $5M, we’d find that just 15% of those sales were completed with some variety of financing. Which market should be more insulated from interest rate increases?

Even so, interest rates are going to impact the lakefront home market here. The increase over last year is too significant to ignore. Perhaps this increase knocks out 15% of our lakefront buyers. What are we left with? A market where buyers outnumber sellers by at least 10 to 1. That’s a healthy market, albeit one that should see appreciation stall this year. I worry far more about the primary home market, and these neighborhoods where vinyl ranches rocketed from $380k to $550k. This momentum was largely on the back of low interest rates and liquidity in all price segments and all geographic regions. This momentum will slow rapidly, and if inventory starts to rise, you’re going to see modest pricing reversal in our primary markets. While interest rates will deter new buyers, it’ll also deter sellers that own these 30 year fixed rates in the 2.5-3.5% range. And that will be the only hope this primary market has for hanging onto their gains of the past three years. Sadly, I’m still a net pessimist on the meaty parts of the primary market, and if Aspen thinks their one bedroom condos are always going to be $3M+, they’re in for a surprise.

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