Home prices to drop 2% to 3% in 2020... Seriously?

Zillow Research recently published its forecast, a baseline "2%-3% drop in (home) prices through the end of 2020, followed by a slow recovery throughout 2021. Prices will return to 4Q19 levels by 3Q21." Its pessimistic case calls for a 3%-4% drop.

While this prognostication may seem exceedingly rose-tinted given the likely double-digit percentage economic contraction of this year, there are reasons for optimism and why we may not in fact be in "Housing Bubble 2.0" territory.

Several factors may "flatten the curve" that will keep housing supply from overwhelming the softening demand.

1. Mortgages in forbearance plans made up 7.54% of mortgage servicing portfolios last week according to the Mortgage Bankers Association. These home owners will be gaining a 90-180 day payment holiday, dampening the impact of the double-digit levels of unemployment.
2. Home owners are also in better equity position in aggregate, sitting on $6.2 trillion of untapped home equity, or 1.65x the amount at the end of 2007, right before the last housing crisis. If the home is an ATM, it's a well-stocked one.
3. Moreover, since the Great Recession, housing production has been well under historical levels. Freddie Mac estimates that "2.5 million additional housing units will be needed to make up this shortage."

Even if all these factors help attenuate the drop in housing prices to the levels estimated by Zillow, it will not be smooth sailing ahead for all. There will, in all likelihood, be significant local disparities driven by, for example, industries and uses.

1. Areas reliant on the hospitality industry will be hard hit. Some predict it will take "the U.S. hotel industry approximately five years to achieve pre-COVID-19 occupancy, revenue and profitability."
2. Similarly areas with exposure to the sharing economy, like Airbnb or VRBO holdings, may see distressed selling as overstretched owners capitulate as their "bargain with the devil" turns south.
3. This pandemic will also influence our housing and living behavior. The Atlantic's recent piece on epidemiological-driven retail change has a clear second-order impact - our housing priorities.

Extra credit (for now): How will the fintechs/proptechs of the recent wave find ways of surviving in this new normal? Some initial considerations...

1. Will iBuyers like Opendoor become tech-enabled, social-distancing acceptable front ends for institutions seeking to roll up distressed housing stock?
2. Will fractional equity plays like Point be able to pivot to help consumers access tappable equity rendered untappable due to financial distress?

Opendoor resumes operations

Opendoor resumes operations in Phoenix.

“the #iBuyer has released three fully-digital, contact-free experiences to help their customers purchase homes while coinciding with social distancing guidelines.”

While digital innovations receive the headlines, I can’t wait to hear about innovations on the take-outs since these platforms are perfect to opportunistic acquisitions at-scale

Zillow’s coronavirus playbook

"On the call, Rich_Barton revealed that Zillow will slash expenses by 25% this year; freeze hiring across the company; cut nearly all marketing spend; and suspend home-buying through its Zillow Offers business."

Non-QM and iBuying as canaries in the coalmine

Further sign of a liquidity crisis in the housing finance market - a system-wide retrenchment in Non-Qualified Mortgage originations with major originators in the segment shutting down production.

Those considering Non-QM loans risky and are saying "good riddance," are missing the forest for the trees as non-banks dominating housing finance rely on interim funding as working capital since they lack access to the permanent capital available to banks.

Together with iBuyers, which have suspended their purchases en masse, these two are the veritable tide pools of the housing finance ecosystem, teaming with innovation, yet most exposed when the tides turn. While it's comforting that the Federal Reserve Board is now deploying an unlimited checkbook towards quantitative easing, the administration's erratic actions and Trump's deep antagonism towards Powell is depriving the market of something just as critical - confidence.

This recalls the book "The Confidence Game" written 25 years ago at the zenith of the independent central banker with the author positing that "central banks are the sole institutions capable of maintaining a global system of checks and balances."

Something fishy with Zillow's revenues

Great analysis by Mike DelPrete.  It’s as if an investment bank reported revenues based on the gross value of securities sold through its brokering business.  Another sleight of hand relates to ‘holding cost’ since the reported amount ‘excludes expenses incurred during the period that are not related to homes sold during the period.’  The good news is that Zillow sold 115 more homes than it bought in 4Q19; the bad news that ended 2019 having bought 2,198 more homes than it sold.  What’s clear is that the company’s balance sheet has changed dramatically, with Inventory ending the year at 13.6% of assets, up from 3.8% at 2018 year-end.  Since the $1.5B of credit facilities is already at 46% utilization, I’d keep a close eye on the velocity of homes inventory in 2020.  Zillow may discover that what they thought was a ‘shipping’ business was, in fact, a ‘storage’ business.

Is Zillow in the shipping or storage business?

Much ink has already been spilled about the losses racked up by Zillow as it aggressively grows  revenues from its Homes segment.  Mike DelPrete further points to how the reported revenues are misleading because its basis is that of the home sale price.  It’s as if an investment bank reported revenues based on the gross value of securities sold through its brokering business.

Another sleight of hand relates to ‘holding cost’ since the reported amount ‘excludes expenses incurred during the period that are not related to homes sold during the period.’  The good news is that Zillow sold 115 more homes than it bought in 4Q19; the bad news that ended 2019 having bought 2,198 more homes than it sold.

What’s clear is that the company’s balance sheet has changed dramatically, with Inventory ending the year at 13.6% of assets, up from 3.8% at 2018 year-end.  Since the $1.5B of credit facilities is already at 46% utilization, I’d keep a close eye on the velocity of homes inventory in 2020.  Zillow may discover that what they thought was a ‘shipping’ business was, in fact, a ‘storage’ business.

Will iBuyers love LA?

Leading iBuyers Opendoor, Redfin and Zillow are all entering Los Angeles, the second-largest housing market in the US.  Will their valuation algorithms be up to the challenges of this significantly more heterogenous and expensive real estate market?  Tune in...

Fighting the last war are we?

Bret Stephens's recent piece about the "fighting the last war" effect being played out as the American military continue to navigate a path that had made it wildly successful in the past while insurgent powers chart an asymmetric, potentially disruptive, course.  His recounting of Agincourt clearly indicates that it's happened before.  And it will keep happening if the continued evolution of ISIS after being shorn of its territorial holdings is any indication.

This brings up the state of play in my own backyard, residential housing, where incumbent mortgage companies are scratching their heads about the disruptive potential of the iBuyer segment.  Their infinitesimal 0.2% share of total 2018 home transactions belie substantial scale gains in select geographies.  As highlighted in a recent report, the segment accounted for nearly 6% of the Phoenix market in Feb 2019.  Just as importantly, well funded and generously valued, the iBuyer presence will increasingly be felt broadly as they re-shape  expectations around the velocity and level of certainty in home sales and purchases.

Moreover, to remedy the low margins of the core transaction, iBuyers have been rapidly expanding the basket of constituent services, most recently discussed in a panel with folks from Knock, Opendoor and Offerpad at LendIt Fintech orchestrated by my friend Geoff Green of Salesforce.  Not all of these ideas will work, but these actions will further strain the traditional retail real estate models, starting with the realtors.  In the face of the billions raised and being deployed by these insurgents, the nearly $73 million spent by the National Association of Realtor in 2018 to further the status quo, second only to the US Chamber of Commerce, no longer seems so daunting.

The impact, however, expands beyond realtors.  By stirring the realtor pot, these insurgents are messing with what's traditionally the main purchase lead source for retail-centric mortgage companies.  As the realtors' role is usurped, their ability to drive transactions to mortgage loan officers will be impeded.

The question will be how to respond...