G
ary Yeowell The residential real estate industry has undergone significant changes due to economic shifts, industry-specific activity, and consumer behavior. We believe there's a disconnect between market perception and forward fundamentals. Publicly traded REITs are priced for tepid earnings growth rates, while we see an inflection point ahead.
The housing shortage in the US is often discussed, but rarely is it explored how free market forces can correct it. The key data underlying the shortage is the high cost of construction and its interaction with microeconomic forces to drive up rental rates over time. Based on supply and demand data, we believe housing is structurally undersupplied while the high cost of construction economically prohibits sufficient supply from being delivered.
New supply of residential real estate has declined materially since 2021. Construction costs have increased due to inflation, labor costs, and regulatory burdens. The cost of capital has also become expensive, making it difficult for developments to pass underwriting standards. As a result, the supply curve has shifted to the left, with fewer apartments being built at any given rent level.
Demand growth remains robust, driven by population growth and GDP per capita growth stimulating household formation. However, demand is outpacing new supply, leading to an imbalance in the market. We anticipate significant asset value and rental rate growth as the market clears and equilibrium is restored.
The distribution of NOI increase across residential real estate verticals will be influenced by factors such as savings rates, wage growth, and mortgage rates. We expect a mix shift from homeownership to renting due to declining personal savings rates and high mortgage rates.
Valuations across the residential supply chain are attractive, with apartment REITs trading at 19.7X forward AFFO and timber/lumber REITs trading at 81% and 74% of NAV, respectively. Even homebuilders remain at reasonable valuations despite strong market price performance.
We own a Residential Infrastructure Basket that captures growth in demand for housing across various forms. The basket includes apartment REITs, homebuilders, timber REITs, manufactured housing communities/developers, and manufactured housing manufacturers.
Risk factors for the inflection point thesis include negative population growth or a material decline in construction costs. Historically, population and construction cost have largely gone up over time, but investors should be aware of policy or economic shifts that could change this pattern.
