Macroeconomics Outlook 2015 Q3
Sree Annavarapu slept in a tent all night on September 28th. Despite being six months pregnant with her first child, Sree camped out so that she could snag a corner lot in the Prestwyck development in McKinney, a booming town 35 miles north of Dallas. She was not the only one. All 83 lots in the development sold within 12hrs.
We don’t have tents outside of our offices (yet), but our long waiting list of tenants confirms our long held thesis that residential property shortage, in the US and especially the Dallas-Fort Worth Metroplex (DFW), is worsening. DFW median home prices increased 8% in August (year over year) while rent surveys by Zillow, RentRange and Zumper showed that rents soared between 5-14% in the same period, far above the roughly 2% inflation rate in the US. We expect that the residential property shortage in DFW, caused by insufficient new home construction in the past decade, will persist until at least 2018.
Macroeconomics Outlook
The most anticipated Fed meeting in the last two years ended with a whimper in September. The Fed, as we expected, kept rates at zero. Fed Chair Yellen cited recent global economic and financial turmoil and subdued US inflation as the twin forces that pushed back the rate increase.
Taking Yellen’s logic further, we expect the Fed to raise rates in the next 12 months, but will keep rates below 1% until the end of 2016. We are predicting minimal impact on the economy and the markets, with the high-likelihood of a short-term correction, but nothing more.
Globally, China’s economic slowdown has claimed numerous victims, from Canada and Australia, to Chile and the rest of Latin America. Europe and Japan are no help, drowning in their own demographic and debt-fueled crisis. US will continue to muddle along at 2% GDP growth.
Despite the uncertainties, we are actually quite optimistic here at Bridge Tower. The US economy is adding jobs. The price of gas at $2.25 per gallon is giving consumers extra spending power. Low interest rates are keeping homes affordable in large parts of the country. Combined, these factors are contributing to an uptick in new household formation. Yes, millennials, armed with new jobs and a car, are finally venturing out from their parents’ basement.
Taken together, we continue to see mortgage rates hovering below 4.5% in the next 12 months and home price appreciation outpacing inflation nationwide.
Outlook for the Dallas-Fort Worth Market
DFW homebuilders went into overdrive in the third quarter, trying valiantly to catch up from construction delays caused by this spring’s record-breaking rain. Even with an almost rain-free third quarter, home builders closed only ≈6,800 homes (24,000 homes in the past 12 months) in the Metroplex.
During the process, homebuilders discovered that they could not find enough skilled construction labor to increase their pace of building. After the last downturn, 2 million construction workers were laid off. 570,000 of those workers, emigrants from Mexico during the last housing boom, have now left the US for good. Domestically, young workers never took up craftsmen trades due to the lack of construction jobs in the past decade. Now, carpenters, electricians and plumbers are hard to come by, and those that are available for work come at a huge premium. In Texas, many workers chose work in the oil fields over work in the construction industry. The labor shortage is exacerbating the supply shortage of residential properties. Single family home inventory sold in 38 days or fewer in August, faster than anywhere else in the country. Available homes for sale in DFW remain near all-time lows at around 2.5 month’s inventory, compared to 6-7 months historically.
Rental demand in DFW remains robust. By our own survey, DFW class A rental properties have a vacancy rate of just under 2%. Even as crashing oil prices finally slowed down job growth in Texas, DFW continues to create around 100,000 net new jobs per year, while the rest of Texas will add only around 100,000 new jobs in the next year. Demographics have contributed to the pressure on the rental supply. Millennials, when venturing out on their own for the first time, are more likely to rent than to purchase a home.
The latest rent versus buy study by Trulia showed that DFW median rent has risen to $1,550 per month while DFW homeowners pay only around $1,100 per month (about 40% less). Thus, while homes prices are rising faster than we would like, DFW homes, compared to rents, are cheaper than 90% of US metros and arguably as cheap as it was three years ago. Indeed, home price gains are simply reflecting a multi-year supply-demand imbalance, current rental and mortgage rates, and low median home prices at the start of this multi-year run. According to the latest Zillow estimate, DFW median home price is $168,000, still 6.8% below the national average of $180,100 and less than 3X median income.
Our Framework for Selecting Property
We continue to be disciplined in our acquisitions, rehabs and new construction. Our four criteria for selecting property for the Fund are 1) desirable location (good schools, safe neighborhood, quiet street); 2) appealing home for the location (size, number of rooms, amenities; 3) gross rental yield of 12% or more; and 4) a purchase price significantly below replacement and market value.
By only purchasing homes that fit our strict criteria, the Fund expects to achieve a minimum net rental yield of 8%. Combining the rental yield with our projected 3-6% annual increase in home prices, the Fund can provide investors with good current income and total return of around 12% annually.
We look forward to giving you an update next quarter. In the meantime, please don’t hesitate to contact us should you have any questions, comments or concerns. We always welcome the opportunity to speak with our partners.
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