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Mike Simonsen

A true data geek, Mike founded Altos Research in 2006 to bring data and insight on the U.S. housing market to those who need it most. The company now serves the largest Wall Street investment firms, banks, and tens of thousands of real estate professionals around the country.

In this episode of the Top of Mind podcast, Mike Simonsen sits down with Rick Palacios Jr., Director of Research and a Managing Principal at John Burns Real Estate Consulting, to talk about what to expect in the real estate market in 2023. Rick discusses the company’s latest research on homebuilder sentiment, shares their latest forecast for home prices and the economy, and talks about some secret signals to watch for changes in the market.

About Rick Palacios Jr.

Rick Palacios Jr.

Rick Palacios Jr. is the Director of Research and a Managing Principal at John Burns Real Estate Consulting, where he oversees all research pertaining to the US economy, for-sale housing, and rental markets.

Rick has 15 years of experience in residential real estate and economic research, originally joining John Burns Real Estate Consulting in 2006 and then rejoining the company in 2014 after working as a home builder Equity Research Associate at Morgan Stanley in New York. He has also worked as an Analyst at the Milken Institute, an economic think tank.

Rick holds a BA from the University of California, Irvine, and an MS in real estate economics and finance from the London School of Economics.

 
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Here’s a glimpse of what you’ll learn: 

  • Why new home construction might accelerate the housing market slump
  • How much home prices are likely to decline in the next two years
  • The leading indicators (and secret signals!) to watch for changes in the market
  • What’s happening with the second home market now
  • The surprising impact of ARMs in this cycle

Resources mentioned in this episode:

About Altos Research

The Top of Mind Podcast is produced by Altos Research.

Each week, Altos tracks every home for sale in the country - all the pricing, and all the changes in pricing - and synthesizes those analytics to make them available before becoming visible through traditional channels.

Schedule a demo to see Altos in action. You can also get a copy of our free eBook: How To Use Market Data to Build Your Real Estate Business.

Episode Transcript

Intro 0:02

Welcome to Top of Mind, the show where we talk to real estate industry insiders and experts about the biggest trends impacting the market today. Enjoy the show.

Mike Simonsen 0:13

Mike Simonsen here. Thanks for joining me today. Welcome to the Top of Mind podcast. This is where I talk to the smartest leaders, thinkers and doers in the real estate industry. For a few years now, we've been sharing the latest market data every week in our weekly video series. With a new Top of Mind podcast, we're looking to add some more context to the discussion about what's happening in the market, from the leaders in the industry. And every week, Altos Research tracks every home for sale in the country, all the pricing the supply and demand all the changes in that data and we make it available to you before you see it in the traditional channels. People desperately need to know what's happening in the housing market right now, the market was so crazy and is now totally crazy in the opposite direction, the landscape has changed so dramatically. So they need you to communicate about this market. To them, they need you to be the expert. So go to altosresearch.com for a free consultation on how you can use the market data in your business. So without further ado, I am happy to introduce my guest today Rick Palacios Jr. Rick is the Director of Research and managing principal at John Burns Real Estate Consulting, where he oversees all the research pertaining to the US economy, for sale housing and the rental market. He's also had stints at Morgan Stanley and the Milken Institute. Milken is such a cool organization. I'm interested in maybe hearing a little bit about that today. It's got a ton of expertise in residential real estate, Economic Research, and is actually a prolific publisher of data on the housing market, which many people rely on including me. So I'm thrilled to get a chance to talk to you today, Rick, welcome.

Rick Palacios Jr. 2:02

Thanks, Mike, I will reciprocate that big fan of the content you put out there. I tried to catch your weekly updates. So it's nice to join you nice to join a fellow housing geek because we were both label ourselves housing geeks,

Mike Simonsen 2:16

that is true. And it's also it's a really great place to start the conversation. How did you find yourself here as a housing geek? How did you get here?

Rick Palacios Jr. 2:24

Yeah, it was a bit of a long and winding path. You mentioned Milken, and I'll give you a little bit of kind of some backdrop there. So try to frame what I've been doing over the last 20 years or so in kind of a backdrop of things that are going on in the world too. Because I think for me, there were some pretty pivotal points in time where you kind of just like a fork in the road or dividing the road, you're like, oh, wait, I'm not gonna do that. Now I'm gonna go do this. And so, for me, I mean, rewind the clock all the way back to undergrad I went to undergrad, early 2000s. So I graduated into a recession. Lucky me, I did the same thing later after graduate school, which I went to, but in undergrad, it was you had the.com recession, you had 9/11. That was my I think that was my junior year. And so for me, I was kind of on the political science, international relations, macro track, and I was gonna, I was gonna go to law school, and I was I was planning on doing and 9/11 happened. And for me, it was very mean, I remember I had a professor coming in the next day. And he had somebody that was very close to him that was on the flight from LA that went to one of the towers. And it was just, it was very much for me this kind of turning point where I said, Okay, I've got this background in international affairs, maybe I don't go to law school, maybe I focus more on policy. And so when I got to my senior year, that was actually the path that I was gonna go on. And so I said yes to UCLA, they had a good policy program, and I was gonna go that path, focus on foreign policy, and then kind of venture out to DC, and see if I could get my foot in the door with some sort of something related to the intelligence industry. And that was kind of the path. But at the same time, I've always been kind of a fan of creating optionality in your life, no matter what you're doing. And so same time I was applying to grad school, I was applying to different jobs. So I'm like, you know, I wanted to be able to weigh this ended up getting a job at a local kind of boutique investment bank. And I said, Okay, well, I can always go back to grad school. This would be my first real job other than like, you know, paper out Blockbuster Video best by working in construction, because these are all things I did like in high school, junior high. And so I went down that path. And so that's like, Oh, 405. And as you know, peak time for housing, residential, just getting hot. And we did a lot of work across a lot of sectors. But it was interesting because housing and real estate always tended to find its way into the lot of deals that we're working on. And so I said, this is really a really interesting industry that I had never really spent a tonne of time on. So it's like I wonder if there's a way for me to do this as a living So long Behold, John Burns firm I met, he started his firm in 2000. And it was right in my backyard. So I said, Oh, let me apply there, end up getting an analyst role there. And so I'm loving it. I'm doing that it is like peak froth times with subprime and countrywide and everything. And I'm doing that up until about I think it's like 2008. And I knew I always wanted to go back to grad school. But now I was on the path of Gosh, I really love economics, a real love real estate and finance. And so I went, I ended up going to grad school out in London, do my masters in real estate, econ and finance, and love that graduated, like I said, I had a grad school into the GFC. And fortunate enough, I actually had a job lined up before I graduated at the Milken Institute, like we just said. So I came back to the States went to Milliken fantastic experience. And the group that I was in, there was all housing, all mortgage. And we were basically trying to figure out, Hey, what the hell's going to happen here with the GSEs, with with the structure of the mortgage market. So it was a great experience ended up actually participating in, we ended up publishing a book. And I worked a lot on that book, and kind of the outline for it on the history of housing, finance, I mean, going back like centuries and centuries. So all housing did that for about a couple of years, ended up talking to at that point in time, our Director of Research here, John Burns, found my way back to the firm, did that for a couple of years, and then always wanted to be in New York at some point in my career. And so you have these kinds of random moments in your day where you're like, Oh, let me see if there's anything out there. And just on a whim, I applied to a job at Morgan Stanley because they were not covering homebuilders at the time. And from the first point, I started talking to him, until when I had an offer, it was probably like three weeks. And so then I moved to New York, there for about a year, just about to launch our coverage on home builders. And John calls me, John Burns. And he's like, Hey, I'd really like for you to come back and be our director research. And that was, again, the kind of point in time dividing the road. It was like, Man, do I stay in New York? Or do I go back? Obviously, I ended up coming back. And here we are today. And I love it. And we're doing tonnes of amazing things that I think we can get into but kind of an interesting arc over the last 20 years or so from what I've been doing. 

Mike Simonsen 7:31

For sure. That's really great. That's that is, has to to be confessed that it's more intentional than I was getting here to this point. But that's great. That's a great arc. And you kept getting pulled back to John Burns to talk to us about John Burns. And I think a fair number of people know, John Burns, but maybe not you know, about, like about the organization and who your major clients are?

Rick Palacios Jr. 7:53

Yeah, so we like I mentioned, we've been around for now about 20 years or so. And the way I like to describe the firm is, our client base is really anyone and everyone, both on the industry side, as well as on the investment side, that is trying to figure out what the heck is going on the housing market. And so it is it really touches the whole ecosystem. And I think about it from the ground up. It's land developers, it's homebuilders, clearly, all the groups that manufacture, distribute, sell retail, all the products that go into the home, think about foundation up to the roof, a lot of those groups are clients of ours. You think about the rental space, single family rental operators built around operators, apartment developers, all the groups that are now trying to change the way that housing is purchased finance transacted I buyers, I think that probably hits most of the groups. So that's really the industry side fix and flippers I'd put in there too. And then you flip over to the investment side of that conversation. And it's traditional banks, lenders across the board, private equity, so that you kind of get into now institutional investors, private equity, pension funds, sovereign wealth funds, hedge funds. So my day is fun, because it changes every single day, every single day. But one of my the bet, one of the best directional signals for me, as an analyst is what are the questions in my inbox? And if I start to get this kind of consistent theme of things that I'm getting asked, it's usually a pretty good signal that okay, this is something that if we're not already trying to dig here, we got to go and figure this out. So that's one of my, I love the diversity of clients that we have

Mike Simonsen 9:38

Got it. So in your case, it's really about like solving specific questions as they come up.

Rick Palacios Jr. 9:46

Yes, so there's the custom stuff, and hey, let's go figure that out. That happens all the time. And then the way that we engage with our clients is it's really on two fronts. There's the research side, which is the side that I had Uh, and so for all those different client types, we have reports that the cadence can be monthly, it can be quarterly. During the peak spring selling season for home builders, which is critical time, we do a twice a month check in, and survey builders across the country to kind of give our clients like, hey, really important time, you got to know what's going on even more frequent than usual. So that's the research side tonne of survey work, which that's probably my favourite part of it to picking up the signal you're getting through all the comments. And then on the consulting side, for all those same type of clients. We've got consultants scattered across the country doing bespoke assignments for all of them. And the firm as a whole is about 130 people all together, scattered all across the US

Mike Simonsen 10:43

got oh, well, I didn't realise that many. That's, that's terrific. Yeah. And the survey, the survey stuff is actually something I'm interested in. Because at Altos, you know, we're doing a bunch of data, but we don't do it via survey. Right? So you get a different perspective when you're serving. And in fact, you guys just did you just do a an October survey? Is that a builder survey that you've just done?

Rick Palacios Jr. 11:04

Yeah, so I should say all the surveys are my favorite survey. But honestly, the builder survey is my favorite because I really just love the conversations, the data. And it's super, super topical, too, for consumers. And so that that survey we've been doing for 14 years or so it's a really good sample size of about 20% of all new home sales. It's about 400 Home Builders of large scale across the country we're serving every single month. And so the month ends, and within two or three business days, we turn around a report telling our clients exactly hey, here's what just happened. And so I think what Yeah, so what you're referring to is our most recent version of that, which was for October. So we told our clients, I think it was like probably the third or fourth of October of November. What happened in October? And it wasn't all that great. Not a shocker. 

Mike Simonsen 11:56

Yeah, so So the like, everything is nuts. What did we learn from about the homebuilders from the homebuilders in October, like, was like one of the big takeaways?

Rick Palacios Jr. 12:06

Yeah, I think everyone expected it to be bad. But this was really the first month of 7% ish mortgage rates for the duration of the month almost. But I don't think and I like to always say that the commentary that color ends up leading the data, the data was bad, the color, the commentary was even worse. And I think that what that signals to us is that it's going to be a pretty rough winter, as we start to get into 2023. And some of the stats, I mean, we track pricing, cancellation rates, sales starts, expectations, all the things that really you go through and you check off the list. Yeah, that's important. That's important. That's important. Cancellation rates shot up to 26%. Nationally, that is the highest that we have seen this cycle. They were 20% in September. So that was the meaningful pop in cancellation rates. And if you follow the builders, Dr. Horton just reported today, as we're talking on the ninth, and they said their cancellation rate for the quarter was 32%. That didn't even factor in October yet. So this is October data. So the October data was pretty rough. 

Mike Simonsen 13:10

So that's, that is 26% of the contracts that they have followed a contract. Is that what

Rick Palacios Jr. 13:17

percentage of gross orders? Yeah, yeah, is a way to think about it. And so those are the figures that a lot of builders are reporting right now, me we're getting close to levels that we saw during the height of Oh, 607, which obviously, was not all that great for housing. And so that's a national number that 26%. And if you it's different across the country, if you go to the southwest, if you go to Texas, think Southwest was like a 45% cancellation rate, and Texas was 39%. So those are really rough Southwest is like Vegas, and Phoenix is Vegas, and Phoenix is magazines. Yeah,

Mike Simonsen 13:54

so 45% of the orders are being canceled. And so that is, so if it's 45% to two months in a row, is that like, we've got 1000 orders, and now we've got 550 and now we've got 260. Is that like the

Rick Palacios Jr. 14:16

Eh, Well, it's the denominator is that month's orders

Mike Simonsen 14:21

that month's orders. So it didn't make it didn't make it a month or like it went in. We're negotiating. We have an order. And then.

Rick Palacios Jr. 14:27

So it's important too because, again, as housing data geeks, you see the census numbers that will come out for new home sales, and they don't really reflect that. Right? They don't really reflect those cancellations rolling through and so in a lot of ways when you see those numbers do you almost have to go in haircut immediately because we know what's happening with cancellation rates and it was across the board you had links sales were down about 50% starts were down 50% They were basically matching each other traffic, which is a great leading indicator lowest that we've seen since called the march freeze in 2020, when everyone thought the world was going to end and nobody else saw house so traffic's already down to those levels, and the pricing stats are moving really fast to the downside, right. And so there's a couple of ways of thinking about that. So there's the year over year number, so we asked builders will, what are prices up here? And so if you rewind the clock, back to February through May, they were up 20%, year over year, this is nationally, October, they were only up 8%, year over year. And I say that because it's important not to get lost in the year over year numbers, well, they're still up. Because when the rate of change drops like that, it tells you that prices are actually falling sequentially, and pretty rapidly. And so then we asked that same question in a different form, where we say, alright, on a monthly basis, what percentage of builders are having to cut prices? And it was 60. And it was like 68%, of builders in October said, Yeah, we had to cut prices on a month over month basis.

Mike Simonsen 16:02

And when you so a few questions, one is when you ask these types of questions to the builders, are you getting? Are you like going to the CFO? And like getting real numbers? Or are you going to somebody who's like, Yeah, we had to cut prices? or No, we're fine. Like, how is how do you?

Rick Palacios Jr. 16:17

It's, it's so these are relationships that are like a labor of love is what I would say. And so there's, we've got a great survey team that our builder survey team is run by Jody Khan, who has been in the industry for many decades knows the builders that are answering these questions like they're her friends. Yeah. Devin Bachman, is another one that participates in that survey. And so and these are the people that are answering the questions. For a smaller builder, it could go up to that level in terms of season, but these are generally division presidents, regional presidents, so they're people that know what the heck's going on their business.

Mike Simonsen 16:50

Yeah, yeah. That's great. Okay, that makes a lot of sense. And then my, my, my next question is, okay, so we know that you have some orders, but 45% of them are canceling in Phoenix in Vegas, and we know that traffic is down, and we know that pricing is down, we also know that those builders are coming off, you know, mega years. And so in 2000 678, we had builders who were stuck with too much land inventory, and they were add, they got upside down, and they had to liquidate, and they basically created the whole invitation homes, like these entire industries of Wall Street would picked up 1000s of homes. Because the builders were so screwed, they got behind, and they had to liquidate quickly. Yep. What does it look like for 2023?

Rick Palacios Jr. 17:44

Yeah, so there's some interesting things today versus prior cycle that you're talking about, from just a builder standpoint, and a balance sheet and how they've positioned themselves. I think one of the big lessons learned there was as the market starts to pivot, and you can kind of see the writing on the wall, try to de risk as much as you can, because a lot of builders did not do that. In Oh, 607. And we saw what happened. And so one of the ways that they've de risked this cycle in a way, and I'm not saying there's no risk, because clearly there is, is in terms of like the process for buying land. So rather than going out and buying it, and controlling it on your own, and you're on your own balance sheet, a lot of builders this cycle have pivoted to, well, hey, let's option more of this. And it goes back to my comment on structuring optionality in your life makes sense to do in your business. And so what you're seeing right now is, a lot of builders are walking away from the options that they've engaged that they've entered into, for 1000s of lots, I mean, 1000s, this, and this is this public information. If you just read what the builders are telling you on their earnings calls, they're walking away, because it makes sense. And while it's a small boy say small, it's a financial hit. But it's not as big of a hit if they were to have bought that land completely on their own and then controlling it. Because then you're stuck with it, you build through it, you're going to have to impair it, because you're not going to make what you thought you were going to make in basically you bought it in a 3% mortgage rate backdrop. And then you're having to monetize that land into a 7% mortgage rate backdrop. So that doesn't work. It just doesn't work. So that's what's happening with a lot of builders right now. And I think what is going to happen is it's in our forecasts, you're gonna see a really sharp, sudden, pullback and pretty much everything and I think builders realize we got to clear the decks right now. There's a lot of like picking the Python analogy. There's a lot of stuff coming to market and if we've already poured a slab on it and our vertical, rang a stop that's going to come but if we can get in front of anything that isn't yet at that stage We can dial back our landline, we'll walk away from land options, because I think what they're kind of seeing is let's clear the deck drop supply as much as we can. Let's get to 2023. And prices will have come down by that time, is I think it's clearly in our forecast. And I think it's in a lot of other people's forecasts, too. And this is a really critical part of it to not only will home prices have come down, but there's a lag on the construction cost side, so they need the input cost side of it, to come down to because until that happens, you can't really model your business. And so I think that is really the, this this kind of air pocket that we're in right now. But we get out to 2023 all the trades, see it happening right now, every builders going to their trade base and saying, hey, the market is not what it was six months ago. And I think everyone across housing that participates realizes that, okay, we're gonna have to come to the table here and figure out how we can all have a business, we're not gonna have a business at the margins that we had in 2020 2021, though, it's gonna mean, materially lower, but we're still going to have a business. And so I think that is the conversation is kind of price discovery conversations happening right now.

Mike Simonsen 21:12

That's okay, that's a lot of information. So one of the things that brings up is that we have record numbers of homes under can that was because of, obviously pandemic demand, but also the supply chain delays and those are now starting to get finished. Yeah, and so are there some in that I don't really know how they calculate under construction, but are there some in that under construction that are like, you know, not slabs poured that they can walk away or those further along that those all got to come to market?

Rick Palacios Jr. 21:46

Authorized but not started would be the component that is hasn't hit the the because, you know, typically the trigger for a start is when the foundation has been poured. And so if it's authorized but not started, in a way, you can try to mothball that, slow it down, and maybe wait until you get out into 2023. And the markets kind of reset. Maybe, hopefully, maybe rates have even come down. And then you go back at it. But beyond that it's beyond that stage, you kind of got to ride that way is how I think the system is going to work right now. And it brings up an interesting conversation to that new we might get into on the Home Price side. Because you mentioned that wave of supply, and we don't have a lot of supply on the resale side right now. Yet home prices are falling really fast. And so what is factoring into this is if you look at the percentage of total for sale inventory on the market right now, so the denominator there would be what builders have what's in the resale market. Historically, builders account for I think it's like 13% of that that's historical average going back 3040 years. Today, it's right around 30%. So we know what builders, they meet the market, they're gonna do what they have to do on price to sell these homes versus a resale owner. It's a much different psychological process for the most part. And that's a lot. That's a big reason why home prices are historically sticky to the downside. But if you have the price setters right now, and a higher percentage of them, weighting wise is coming from home builders. If it's coming from high buyers, we all know that's happening right now, if it's coming from fix and flip investors have busted flips, and we track overall investor sales really closely across the country. And so I think what's really important right now, and it fed into our view on Hey, the price correction is going to happen faster than probably what you were expecting is who are the sellers? That's kind of like the billion dollar question right now to dig in on and figure out, Okay, in this market, what percentage of sellers are those different categories that we just talked about? Because if it's 30 40% 50% of those groups, and the emotional hang up of selling a home and cutting prices isn't their prices are going to move faster? I mean, that's what we're seeing right now. There's a chart that that I did in, we do this client webinar every month and one of the charts that really stood out to me, and it's supported our view on prices coming down faster. And the magnitude being probably worse. If you look at the month over month, rate of change on home prices, and this is our national index, we track it across the country. You go back to oh eight, and you had to wait until almost the Lehman moment it was summer oh eight when home prices were falling at a 1% monthly clip. So it took a good year and a half of kind of subprime and the slowdown to get to that rate of change. We've seen home prices nationally falling 1% month over month, August September and we just Our October data. So we're already there. So it's happening pretty quickly.

Mike Simonsen 25:03

Yeah. Wow. So, so much to hit. So first of all, let me follow that up with a question of, of that record number in construction right now that we have a record number that are under construction. Does that mean you? And so how much should I worry about that? In terms of exacerbating our crisis, a huge challenge our new crisis.

Rick Palacios Jr. 25:31

I think how it I think the worry manifests in home price declines. And, and it happens right now. And it happens into next year, because it all feeds off of our conversation where builders are slowing down construction, because they know supplies come in, they don't want to start anything right now that they don't have to, let's get to 2023 Hoefer, lower rate environment Hoefer costs coming down, and then we'll kind of come back into the market, but in between, prices are going to fall on the stuff that they do have to move. And that's kind of a shock to the system right now. That mean, we got pretty negative on home prices. I would say back in April of May, is where we that's where we went through took a big swing in our forecasts and said, Okay, wait a second. Rates are moving a lot faster than what anyone anticipated. We were expecting a moderation from the nuttiness of 2021, but not what is actually happening right now. And so I remember in May, we, that's where we came out with our view. And this is when mortgage rates did just touch 5%. And we said, we now think peak to trough home prices nationally are going to fall I think was like 10 to 12% through 2024. And I remember at the time when we came out with that view, we also made a recession call, which was super non consensus, then I think now it's becoming more consensus and clients. I mean, it was like immediate, how could this happen? How could home price, how can home prices fall? And so for you and I, we've been in the industry since last time around, and we're like, Well, that happens. And so that was in May, then you go to October, and I did the same webinar a few weeks ago for our clients, and it was a forecast when materially lower, and it was walking them through a lot of the things that you and I are talking about right now. And so when we roll it all up, we think, again, our view is and this is now a 7% mortgage rates and core assumption in here is that mortgage rates stay relatively, relatively close to about 6% through next year. So that's a foundational assumption, we think that home prices nationally, will correct to late 2020 levels, by the time we get to 2024. And so when you invest 30%, or something, what it's not 30, it's not 30%. So but when you unpack that, it's and again, the lens on it is important to because home prices nationally went up 40%, spring of 20, to spring of 2020 to like unprecedented home price appreciation. So we squeezed a decade of home price appreciation into two years. And so now with 7% rates, the demand destruction that we're seeing across the market. And I think how quickly people are going to try to move stuff are it's it was 40%, up spring of 22, spring of 2022. And the downside will be right around 20 22% is

Mike Simonsen 28:32

so you know, and this was an assumption. So you I do remember you guys make that call very early, but we're going to have home prices down enough. There you go. And so for me, the blind spot that I had, and still have is that I don't have any capacity to predict where rates are gonna go. And so, you know, we when we started the year at three, I could see four and a half, I could see five, I could imagine that I couldn't imagine seven, and seven and a quarter it was and so you know, and we can see I could watch in the data at win rates in August fell back under five and a half towards like five, we could see people buying inventory declining. And then September one rates jumped again, from five to six to seven. And that's when the breaks head on. And that's when I was like I didn't see like have seven in fact that there have been there a lot of people who've like been calling a housing bubble for a decade, and I haven't heard any of them that said 77% interest rates are going to be the factor. They said well, we're gonna have a big recession and people borrowed too much money or whatever, but nobody said 7% interest like No, I, you know, that would have been nuts and that would have been the real call. So So you made the call when rates were about five to six and that time and you know, earlier in the year when they went from five and a half to six. It slowed and then they drifted back down and things picked up a little bit again, and we could see it week to weak. And so, so So now you're

Rick Palacios Jr. 30:03

on your seven, no one predicted it's in every conversation I have with clients, as we're talking through these similar similar items, I always ask them, Do you know anyone that was forecasting? Six 7% mortgage rates? Because if you do, I would love to talk them. Yeah. And nobody has said, oh, yeah, it was this person. Yeah, go talk. I mean, no one knows of anybody. So I think we all miss that. And I think the 2022 has been, I mean, kind of rewind the clock and things that happen. I mean, we really started to see, if you just look at 10 year Treasury rates when Russia invaded Ukraine, and in February, it was kind of just an another, okay, gasoline on the fire inflation. You saw 10 year rates start to come up. It also synced up to, and this is where I think where what we missed. And I think a lot of people miss to the significance of what the pivot from quantitative easing to quantitative tightening was going to do to not only the Treasury market, but the mortgage backed security space, because I think we all kind of knew, alright, feds are gonna hike short term rates, that's baked in, it's going to happen, but we were kind of in uncharted territory in terms of now fed, stepping back with Qt. And that's synced up right around spring summer, which is when mortgage rates started to blow out. And we track this, if you look at it, you can see it crystal clear, there's a direct correlation between the Fed backing up the truck loading up on 10 year treasuries, and then when it kind of crests and starts to flatten out, they're still buying there, but not as much, it syncs up almost perfectly when mortgage rates started to really blow out. And then the second part of that too, and perhaps even more important is their activity in the mortgage backed security space. Same exact story, you can see it that backs up the truck spring of 20 loaded up on MBS trying to save the day, and then they start slow that down. And then it stops in September. And you can go to the New York Feds website, and it says no, no further plan for now purchase activity. When did rates blowout? It was August, September. And so you kind of go through that exercise. And it also for us, gave us some confidence and saying, Look, this is probably going to last a little bit longer, we gotta go down on our forecast, because there's the structural drivers of why mortgage rates are doing what they're doing. And we can't really get some conviction around around another pivot back to QE, that would come in and reverse that. And so because I mean, look, what the Feds having to fight, they're gonna fight inflation, so they can't move back to QE. So those were things that I think none of us really knew what would be the impact on mortgage rates. And there's this the spread between 30 year fixed rate mortgage and 10 year treasury. That's that is really kind of the benchmark for how we think about mortgage rates. So historically, it's 170 basis points, going back to like 67 years, 300 plus basis points right now. And I was talking to a client of ours, about this. And I said, this is probably the most important chart of the 1000s of charts that we publish every month. And he said, where the spread is right now. It's a three standard deviation event. And I said, Okay, well, what does that mean? What does that mean for humans to think about that? And he said, Well, what it means is 99% of the time, all past instances of this data point, the spreads have been lower. So that tells you like we're in this world that we haven't really had to experience. And we kind of always were, it was always going to be a bit of wild times when the Fed finally started to say, hey, no more QE, let's go to QT. And now we're all witnessing what that looks like.

Mike Simonsen 34:00

Yeah, there's a really great ocelots podcast with Joe Weisenthal on Bloomberg odd lots about that mortgage market and the parts that are broken and why the spread is so big right now. It's really great couple of weeks ago, super, super cool. Okay, so here's a question. You had obviously, some calls that were early and strong, like I don't make things we don't do things like recession calls.

Rick Palacios Jr. 34:25

So I wish we didn't have to either. It's like, 

Mike Simonsen 34:28

All I do is I go man, this is how many houses there are. And here's where they're priced. Like we're gonna give you the date. But were there things you know, in January or something calls that you made, that you've gotten wrong? Recently?

Rick Palacios Jr. 34:41

Absolutely.

Mike Simonsen 34:42

What did you get wrong?

Rick Palacios Jr. 34:43

We got the inflection in home prices wrong. We were forecasting that the rate of growth with moderate we were not forecasting that home prices were going to flatten and or fall this year. That's in our forecast. Now. I think we've got home prices, and we forecast December, December. So when I tell you what our 2022 forecast is, it's December 21 versus December 22. We've got home prices nationally down 1%. On the resale side, and this year down 1%. Yep. Worse than that on the new home side, and it goes back to the conversation on builders. Just what do we got at what price do we have to hit? Let's hit it. Let's move it. We're gonna sell this. And so Oh, yeah, totally missed that. The there was a piece that I remember writing back in. It's almost a year, the date November of last year called Bubblicious, I don't know if you saw that piece. But that was kind of me. He has gone out on a whim and saying, Look, none of this makes sense right now. And namely, on crypto. And I mean, gosh, look at today, what's going on. But it was also a, hey, when you have rates this low for this long, and the stimulus that got thrown on everything, weird stuff happens, and asset prices just explode everywhere. And so rational brain, don't assume that in perpetuity. And so we started communicating how we do have the growth coming down considerably next year, next year being 2022. But again, I think the rate of change on how quickly things slowed given what rates did totally missed that. Yeah.

Mike Simonsen 36:20

Yeah. That's it's a fascinating space being having to put a stake in the ground for the future.

Rick Palacios Jr. 36:27

Yes. And man, people challenge you when I like, Well, we made that recession call who? Yeah. Yeah. And still, because you're clearly we're not in a recession right now. But I think if you study history, and you study cycles, fed moves on rates, recession doesn't hit tomorrow. I mean, it takes there is a big lag there. And it takes time. And but eventually, especially if rates need to keep going up up and stay elevated those higher rates, I mean, they permeate the cracks of every asset across the economy. And we're I mean, you're seeing that right now. Housing, tech, especially. 

Mike Simonsen 37:04

Yeah, yeah. For you, every day in San Francisco. Okay, so. So next question is, are there underappreciated data points, leading indicators, that that you like that we that don't get enough play in the headlines? Like you guys do some surveys, which are right, right. That's original data by coming up with those are their signals. And you talked about, for example, the language they use in your surveys? Yeah. Tell me about how you parse that. So that's, do you trust them? Like, like, you go like, Oh, yeah. Like, they always have an optimistic bias. And then they're like, is it a procyclical bias or like, Tell me about it.

Rick Palacios Jr. 37:49

It depends on the constituents that are participating in the survey. So the skew towards by positive bias, I would say, the resell agents we survey. That's true. Yeah. But at the same time, I'll tell you, they also got negative fairly early in the survey we do we serve 1000 Plus resale agents every single month, the builders, I think, and this goes back to the builders meeting the market on price, they know what they have to do, and the market pulls back. So I think the commentary we get there is probably more candid and honest, I love what told you one of my favorite directional signals is kind of a wisdom of the crowds exercise on my inbox. Like, what are all these different clients asking me about as I Okay, that's a good signal. That's one of them. Another one of them is I personally love almost an obsession reading through earnings calls across all types of different sectors, because you never know. It's almost like, like, I wake up, and like, Okay, I'm gonna go on a treasure hunt, what am I going to find today, and when it's earnings season, there's a lot of treasure out there to find. So I love that. But what beyond reading the calls, sometimes I think it's even more important to and I've suggested to some of my, my and our analysts, when the markets at an inflection point, or you think it's at an inflection point, listen to the call. Because when you listen to the audio of the call, you can pick up nuance in everything, namely in voice inflection, patience, or lack of, and you can tell that as people are going through questions, and so in good times, you know, you're boisterous and rosy, but as the market starting to shift, the patient's goes away, and it's next question, but then they go to the next question. And so I mean, those are very little things that you kind of start taking notes you're like, Okay, wow, this person sounds very different right now.

Mike Simonsen 39:42

That would be an amazing thing to to automate or to least instrument measure over time. My I don't know if you know, Paul Kedrosky is he's a venture capitalist and analyst has big Twitter following and he has an automated car. An earnings call script processor, where he looks for F bomb and so he could track profanity, E and the earnings calls as like, I think he mostly does it because there's a turns into a there's a story there and there's more interesting story there. But like, that's, that would be a fascinating thing to process and

Rick Palacios Jr. 40:21

I would love that, right? Yeah, but it's true. It's like, you know, information is everywhere. There's information when and when people don't want to answer a question, there's information in the way they answer the question how they're moving, what they're saying the inflection. So these are all things that I love, just trying to figure out and like, Okay, I'm gonna, I'm gonna I'm gonna triangulate a view now, based off of all these different things like to me, that's a fun, fun exercise. 

Mike Simonsen 40:45

and then in this earnings call season, is there. Has there been signal in any of that is different or maybe adds to your?

Rick Palacios Jr. 40:52

Yeah, I would say it's giving us more conviction in that on the cost side, I think things are going to come in pretty quickly here, because it's not only on the builder side, it's on the apartment, multifamily side, where and this goes back to my comment on higher rates permeate through all asset classes, all industries, residential real estate is Case in point there, multifamily is have, there's been a huge ramp into construction, they have a lot of supply coming. Now the market shifting. And so things are going to pull back really fast there from what people are saying right now heading into next year. So if you've got multifamily pulling back quickly, you got single family pulling back quickly. And then you think about the rest of the world, which we haven't talked about. I mean, the entire developed world had a housing bubble, you could probably say that, I think now in hindsight, now it's going to flip to the other side. And then you've also have China too, which is basically slowing down still. So if you kind of work through that thought exercise and go okay, if most of the world is pulling back really quickly on the construction side, input costs should get better, faster. So that that's one my favorite. There was always always like a favorite Zinger, I think in earnings as I'm going through. And so I love it where I'm reading through. And it's usually really early in the morning because earnings season all rotate. Like I usually I try to do a physical book in the morning, but an earnings season, I'll just like alright, transcripts, I'm just gonna read your transcripts. And so I'm it's early morning, I'm reading through this apartment REIT earnings call and I won't mention who it was. But the CEO says, and I'm always looking for read throughs into other sectors, namely for sale. And he says, you know, I'm on the board of the largest private homebuilder in the country. And our sales are down 50% Since June, and then not come and they're not coming back. I'm reading through this. I'm like, I can't believe that you just said that. Like for me that's so that's the kind of stuff that when I uncover it, it's it. I love that process.

Mike Simonsen 42:58

That was real. I saw you tweet that out. That was really remarkable. Yeah, those are real signals. That's, that's, that's super exciting. So it actually brings up another point, we have real geographic differences going on in the country. And if especially new construction is driving this down, correction, more prices hitting deeper on new construction, inventory supply coming harder on new construction, like the new build is leading the burst of this bubble. Does that. Like does that mean that Cleveland is spared compared to Austin I was on. And let me just finish with a little anecdote I was in Nashville a couple of weeks ago. And Nashville has three dozen high rise cranes in the sky looks like Miami in the early 90s. It's nuts. And it's super exciting, right town is growing. It is it's you know, it's flashy and new. And like it's really neat. But you know, who's gonna buy a million and a half dollar condo in Nashville at 7% What happens with all where we stayed in an Airbnb and it was a, you know, an entire neighborhood, and you can tell they were all Airbnbs because they all had the $30 Costco, Nashville sign on the side. And like the whole neighborhood, you know, it build the short term rent those so so. So the question is about geography like, do the these are also the same markets where the eye buyers are focused and where the investor dollars are focused? What does do the other markets escape that escape this time?

Rick Palacios Jr. 44:40

Well, I don't think any market will escape a price correction. But I think for like a relative basis because I mean, we do these forecasts market by market and you can we have a couple of heat maps that show this where you can see the run up every metro from Spring 20 just to call it spring 2022, which was Pete for a lot of markets, and even in markets that were kind of on their back, like San Francisco, compresses, were up 20%, I think was a stat we had during that time period. And then you kind of go across the Midwest and Northeast, you had solid home price appreciation. But it wasn't the 6070 80% that you saw in South Florida, in Austin, in the Southwest in Boise. And so I think on a relative basis, we have the Midwest northeast, weathering this better. But every market has to have some sort of a correction when the purchasing power impact that we've seen when rates go from sub three to seven happens so quickly passed to happen. And it's it brings up an interesting thing too, because what like when I think about cycles, what's the same, what's different is always thought exercise I like to go through. And one of the things that is different this time around as it relates to affordability is if you think about post Dodd Frank, the Dodd Frank Act 2010, a lot of rules kind of came into place to try to prevent things like massive waves of foreclosures and payment shock. And one of those was around adjustable rate mortgages. And it became much, much more difficult to qualify for an arm. Namely, if you're doing a five, one arm, you got to now qualify at the reset rate. So arms have almost become more of a product for the affluent. And you can see this, just look at the median mortgage on an arm versus a GSE. Loan. It's massive, massively different. So go back to the mid 90s. And every affordability squeeze cycle that we've seen arms were 30 35% of all mortgages, in those time periods. And so arms in my mind are kind of like this white knight that have always come in and save the day for some people that still want to get in, we'll take that rate risk. But you're not seeing that now I know arms have come up a little bit, but they're still not even half of what we saw. So.

Mike Simonsen 46:57

So the lack of arms is actually a negative in this cycle.

Rick Palacios Jr. 47:02

So this is a it's a thesis that I think is something that we've worked in, because that's

Mike Simonsen 47:09

the opposite direction where I thought you were going. So that's really an interesting

Rick Palacios Jr. 47:12

while. So that's so there is a piece. So there's a piece that I wrote back in September, that Fortune featured was which was about this where I think the knee jerk response from people is Oh, no arms, no distressed supply. Totally true. Not none, but you probably will have less, but then flip that on its head and go okay, well, you're trying to convince me buyers either. So you don't have as many tools in the toolbox for buyers, you can't assume the same number of transactions that are going to happen in a rising rate environment. And I do think that there's some validity to that. And we're seeing that right now.

Mike Simonsen 47:46

That's fascinating. I didn't like I was going the other direction with it. I was going fewer arms, therefore fewer. The affordability resets and fewer distressed supply, but it actually because arms are harder to get. Therefore they are less likely to help us get out of this downturn as well.

Rick Palacios Jr. 48:05

Yeah. And I think you can flip the lock in effect, too. on its head. That was also part of the piece. Yeah. Because if you have, and it goes back to my earlier comments on probably the most important thing to identify right now is well, who are the sellers. We know that average homeowner that locked in, and that's 85% of existing mortgages are sub, I think it's like sub five is the stat they're not selling right now. So if they're not selling, who is the marginal seller, it is a marginal seller that has to sell, fix and flip investors, high buyers, builders. And so you think about that, and it's like, okay, now you just flipped the arm narrative on its head, you flip the lock in narrative on its head. And so the dynamics of housing right now are that prices are falling pretty quickly.

Mike Simonsen 48:54

Yeah, that's really interesting. I love that. Let's talk investors for a second. There are a couple of things, one that that you and I have talked about in the past, that is, I think, important for our audience to hear and hear again, and that is the percentage like how impactful is on the Wall Street, the big Wall Street money, you know, and compared to individual investors, and you know, right, the headlines are big Wall Street investors buying everything. Yep. And so, so talk to us about what you know about that. And then the implications for where they are and what that means for 2023.

Rick Palacios Jr. 49:35

Yeah, so there's a variety of ways to unpack that. I think what we've seen is and when you label Wall Street, the majority of the activity there has been on the rental side, it's been buying homes to rent them out. And so one of the ways that we can kind of proxy for that is okay, well, of the single family rental ownership in metros across the country. How much of it is A mom and pop, how much of it is an institution and the threshold we use for an institution is I believe they've got to own 100 Plus homes in aggregate across the country. And there's only I think, one market in Charlotte, I believe 9am centre there, Charlotte, where institutions are more than Mom and Pop, this is specifically around around single family rental ownership, every other market across the country, it is mom and pop that really dominate this. And so I think our view on the narrative of Oh, Wall Street is destroying housing. It's an easy, it's an easy narrative. But then when you kind of dig in the data, you're like, well, it's not really true for most markets. So that's kind of where we are on that. I think when we say investors, it's kind of an overarching umbrella of fix and flip rental investors, buyers. And then we also will lump in there, because the litmus test that we've used on this, although we're starting to maybe change the methodology around it has been property tax records go to a different address than the home in question. And so you will get some second home vacation in there. And so there was kind of some pushback from people like, well, that's not an investment property. But then I said, Okay, well, do you think that buyer buys that property, when rates go up, market slows down stock market goes down the perception, when they buy that property is more of a it is an investment property? And so that's why we included there. And like, oh, by the way, second home vacation market, I think we track weekly loan lock data on this, it's down for purchases down like 70%, year over year, it's the worst of all segments right now. So that tells me, it probably makes sense to think of that as kind of a investor component as we go through that exercise.

Mike Simonsen 51:44

Yeah. So then as we look forward, there are I have two competing hypotheses about investors in the next year. And I'm interested in your take on which one wins the hypothesis. One is that investors are they have to pull back, they pull their demand out of the market that exacerbates the downturn, especially in the Texas in the Phoenix and all those places. Yep. And hypothesis two, is that there's a lot of cash in the world, still, and a lot of investors with a lot of cash, I was talking with a friend recently who got a million bucks in stimulus, you know, for with his company, and then he's doing hard money loans to you know, people doing real estate because, you know, you borrow it three and you lend it 12, right. Like it's, it is in so like so. So the how Yeah, exactly. It turns out not for me, that's,

Rick Palacios Jr. 52:46

I have no interest in doing.

Mike Simonsen 52:49

But but so that so there's two, right? So in that sense, there's a lot of money, who has been waiting a long time for good opportunities to buy houses. And so that so one, one says investors pullback Prices, prices and transactions decline accelerates. One is investors choose to go for the opportunities as soon as they pick up, therefore the arbitrage disappears quickly, investors keep a floor on price correction. Where do you see it playing out?

Rick Palacios Jr. 53:20

I I think it's more of the latter. And I think this also kind of to put a bow on our whole conversation where I think what the conclusions from this conversation are that the price correction will probably happen. And it is happening faster than what we all anticipated in a way. But at the same time, yes, that is going to happen. But the industry of single family rental and built around. I mean, that really got started during, oh, 809 and 10. And it was a wild west, they were figuring it out cashier's checks in the bag at Bank steps. It's now an established, massive global industry. And so our view and you're already seeing this with some of the larger groups that are out there and kind of rumored to be raising JV funds, because they realise there has not been an opportunity to buy homes at decent yields. For I mean, you gotta go back to like 2010. So talking a decade plus. And I think that money is in it for the long haul. And so that, you know, they can ride this out. And I do think that right, right now, there's not a lot of that happening, because this is really peak price discovery time. And I think the capitulation on price hasn't happened to the extent that we all know and feel it's going to happen, but I do think that they're going to be coming in and buying once home prices come down 15% 20% And there are a lot of builders already and they're saying this publicly that yeah, peak to now we're down high teens in a lot of markets. So I mean, and that's happened in three months, four months. So, I do think that your thesis does have merit to it, that those groups are going to come in, they've got mandates to grow. And you know, hopefully knock on wood, they will come in and put a floor under this. And it's funny, you bring that up too, because I haven't thought about this in a while. But those groups were have continued to be, you know, clients of ours, going back to Oh, eight and nine and 10. And I remember that time, then company come in and say, Hey, we know you guys know housing. We want to do this now, how can you help us? Can you help us figure it out. And when we started to see 56789 10, big groups starting to come in and concentrate in certain markets. For us, that was a signal going back to the kind of things that we pick up that signal to say, hey, home prices is going to have a floor here, because there's now money coming in pretty quickly. So that's definitely something we're watching for.

Mike Simonsen 55:52

Yeah, you could really see recovery in Phoenix, for example, where you could see it 18 months before you started, for example, in New Jersey. And I think I attributed that often to at that time, the judicial versus non judicial foreclosure states, like if it's 90 days, and you sell the house, like those markets recovered much more quickly.

Rick Palacios Jr. 56:15

I haven't thought about that. And so long Mike that just so you're, like, bring him back. You're triggering me back to those times. Yeah, cuz that's stuff that we haven't really had to think about.

Mike Simonsen 56:24

We haven't. And it's really wild, because like, we're having this correction. And meanwhile, nobody's there's no short sales in the country, because nobody's short on their house. Almost nobody, there's probably a few people in Boise, but even those folks still have 3% mortgages. And so they they bought a payment that they could afford. And so even if they're upside down, even if they they've now lost, you know, that premium that overbed premium they paid, they're still, you know, they're still not upside down on that, or they're still you know, have cheap payments that they can afford forever. Possibly.

Rick Palacios Jr. 57:00

You bring up something that I think it's kind of brushed under the rug in all this conversation on foreclosures evictions. When you really take a step back and you think about 2022, kind of peak nuttiness. Earlier this year, you had a once in a lifetime demand stimulus thrown on the housing market with crazy low rates, COVID work from home, go work anywhere go by home anywhere. So that was on the for sale, side migration on steroids. You had very similar thing on the rental side, too. So we had these once in a lifetime demand stimulus. But at the same time you had once in a lifetime supply suppression. Were no foreclosures, no evictions. I mean, in California, which you know, both of us call home I believe. It won't be until January February next year where they will start to allow rental evictions and start going through that process. And so if you have those two things combined, structurally crazy demand seamless, but you don't allow the market clearing process to happen like it usually does. Lo and behold, you get rental rates going through the roof. You get home prices going through the roof, and now all that stuff is like record everything. Now we're normalizing down probably overcorrecting.

Mike Simonsen 58:18

Yeah, yeah. Okay. Well, so much we've powered through an hour really quickly, so much to hit any big calls. Do you want to leave us with beyond 2024? What do you think? What do you think at mid part of the decade?

Rick Palacios Jr. 58:31

Please don't ask me that question.

Mike Simonsen 58:34

I you know, I put a stick in a stake in the ground now.

Rick Palacios Jr. 58:37

Yeah. I mean, honestly, right now. It's hard forecasting three months from now. Yeah, that's kind of the backdrop we're in so people that have to forecast. 5 10 years out. Oh, my gosh, I'd feel for you. Right.

Mike Simonsen 58:51

Okay. Well, that's a great place to end it. Rick, thank you so much. Really enjoyed it. So everybody, this is the Top of Mind podcast. I'm Mike Simonsen from Altos Research. And you know, we do the market data. And if you're sitting here listening to the conversation and saying, Gee, I wonder what's happening in my local market, and how we explain that to my clients, my buyers and sellers or anybody who's participating in the market right now. That's where you go to altosresearch.com, book, free counsel with our team, and we can talk to you about how we use you can use market data in your business. You can also reach Rick at John Burns Real Estate Consulting. And Rick, where else should they follow Twitter, you posted to do LinkedIn stuff? Where should we reach?

Rick Palacios Jr. 59:33

We? Yeah, so we've got people, we've got a master account for the firm. You can follow me on Twitter, we've got a lot of other great people posting content. So seek us out if you email me or message me. I can point you in the right direction. Yeah, that's great.

Mike Simonsen 59:47

That is so much valuable insight coming out of Rick and John Burns all the time. So really terrific stuff. Rick, thank you so much.

Rick Palacios Jr. 59:55

Yeah. Thanks, Mike. 

Outro 59:58

Thanks for listening to Top of Mind. See you again next time and be sure to click Subscribe to get future episodes.

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