After a two-year period of substantial growth, demand for real estate is slowing amidst more investor caution. With mortgage rates now north of 5%, and inflation expectations feeding into a potential further increase in 10-year Treasury yields, the slowing in demand is physiological.
According to a builder survey conducted by John Burns, “traffic, pricing, sales expectations, cancellations, and finished inventory metrics all deteriorated materially in May.” Builder commentary – which is considered to be an accurate leading indicator – also suggests potential sales softening and pricing challenges ahead.
Perhaps more tellingly, less than 40% of the builders raised prices month-over-month in May, compared to 71% in April 2022 and 92% in May 2021. Some builders even started lowering prices, which is a substantial change from April when none of the surveyed parties had done so. And home buyer traffic, a leading indicator for future sales, is also considerably down.
In particular, in the built-for-rent category, real yields are just barely enough to offset inflation, and potential gains are limited capital appreciation. In addition, investors using debt to fund transactions are unlikely to be upbeat on the asset class’s outlook, given the higher cost of funding.
Some geographies – namely the Northeast and Texas – also saw a robust increase in inventory, which is the indication that demand and supply are closer to finding a balance.
Invest In Real Estate
Within the real estate space, the multi-family market has seen record transaction volume and value appreciation post-COVID, fueled by the availability of attractive leverage due to quantitative easing and unprecedented flow of investor capital. Demand in this segment often resulted in bidding wars and sales closing above broker guidance, setting a market standard for extremely low cap rates compared to historical measures.
Throughout the past year, Yieldstreet has seen rent growth and net income outpace the projections at close, with value-add properties achieving rents that were expected only post renovation.
While recent quantitative tightening has resulted in an increase in debt service cost and put downward pressure on ongoing cash distributions, rent growth in high growth markets, especially the Sun Belt, saw double digit percentage rent increases due to wage growth, record low unemployment, and renters seeking higher quality housing as a result of work-from-home lifestyle.
In other words, the thesis behind most multi-family trades was that future rental growth would justify the low entry cap rate, and that thesis is still alive and well.
We expect rates to edge higher as the Federal Reserve continues tightening, but the negative effect on our portfolio is likely to be mitigated by the continuing rent growth. We are also witnessing a major housing shortage in the nation and people getting priced out of home ownership, which is further supporting the rise in rents.
We do expect rent growth to slow down eventually over the next year or two, but the previously realized rent and net income growth is likely to keep the segment attractive.
In addition, the projected dislocation – which has not materialized yet – creates potential opportunities. And as real estate is likely to eventually reprice, we remain patient and on the lookout for potential new investment opportunities.
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