Building a Fortress in Real Estate
Scenario planning put to the test.
Let’s rewind a few weeks.. about a month ago I shared this in-depth post explaining my rationale behind an inflation-induced rise in home prices and real estate in general.
Generally speaking, as the US dollar continues to crumble, the price of real assets will increase as investors (and individuals) fly to safety.
A Deteriorating Macroeconomic Backdrop
As Hannah from Salary Transparent Street shared in her email newsletter just a few days ago — we’ve begun to see a massive halt in hiring, as well as layoffs across Big Tech.
On May 23rd, Snapchat (SNAP) shared an 8-K filing that stated the following:
“Since we issued guidance on April 21, 2022, the macroeconomic environment has deteriorated further and faster than anticipated. As a result, we believe it is likely that we will report revenue and adjusted EBITDA below the low end of our Q2 2022 guidance range.”
As we check this website, we can see an up-to-date tracker of how many tech companies are freezing their hiring process and laying off staff.
One of the largest venture capital firms in the world, Sequoia Capital, issued a 52-page presentation to their founders warning of a ‘crucible moment’ and a ‘longer recovery’ ahead.
For the first time in 12-months, we’re beginning to see the Seasonally Adjusted Initial Jobless Claims bottom-out and turn back up around the other way — suggesting more and more people are claiming unemployment.
The Bear Market Cycle
As shared in this post, we continue to look at the market from a lens of uncertainty. And when I say “we” I’m not just talking about myself, but money managers as well — according to this tweet.
Cash positions are at the highest since 2001 — we’re dealing with 40-year high inflation, quantitative tightening, rising rates, and a potential recession — having a high cash position makes sense to me.
With that being said, it’s important to be conscious of both sides of the aisle here. One side is our “best case scenario” of inflation subsiding, rates rising only moderately, and no recession — the soft landing as described here.
The other side we see a “worse case scenario” of inflation remaining elevated, interest rates rising above 5% as the Fed is unable to remain in control, stagflation begins settling in, and a global recession causing company earnings to be slashed in half.
As explained above, the market is very much risk-off at the moment.
Cash on hand is higher than ever and the trading volume of speculative tech stocks on green days in the market is steadily decreasing (alluding to a bear market rally).
So that begs the question: where are the best risk-adjusted returns located, today?
According to Fundrise, and myself, it’s real estate.
A mix between multifamily residential, single-family rental, and last-mile industrial — owned at or below replacement cost in desired markets (the Sunbelt).
We explained in this post the historical information that supports rising real estate prices in times of high inflation. Not only are we experiencing exceptionally high inflation, but also a major housing shortage around the country.
According to this report, we’re more than -3 million homes short of demand, especially starter homes. A complete lack of supply is a major reason why we’ve seen the median home price rise so dramatically since the pandemic started in 2020. Especially when paired with Covid-induced supply chain constraints as warned about in this post.
I’ve found two important graphs online and tried to line them up as well as possible on their X-axis below — one shows the number of new “starter homes” being built and another shows the median sales price of a home in America.
“The main driver of the housing shortfall has been the long-term decline in the construction of single-family homes and that decline has been exacerbated by an even larger decrease in the supply of entry-level single-family homes, or starter homes.”
As I mentioned above, when you pair this with supply chain constraints — it only gets worse.
I recently had to buy a new oven for my home — it took more than two months for the appliance to be delivered after ordering. Clogs in the supply chain cause the delivery of non-negotiable items (like refrigerators and ovens) to be delayed by months at a time — leaving the newly built homes unlivable and more importantly unsellable.
The Essentials in Times of Need
From the perspective of diversification, real estate makes the most sense to me right now. We’re not betting on a tech company to sell a product or a retailer to maintain their margins.
We’re making a bet that in a time of macro economic slowdown (when you tighten your belts), people will forgo discretionary spending — but not essential spending.
This categorization of essential spending includes housing.
As we look below on a longer time horizon, there’s only been one clear recessionary event that caused the median sales price of homes to drop dramatically — the Great Recession. As I shared in this post, I don’t think things will get that bad this go around.
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Disclaimer: This is not financial advice or recommendation for any investment. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.