Over 350 investors attended the Old Capital Speaker Series event April 26th in Grapevine with Mark Dotzour. Here are my takeaways from his presentation:
1) Interest rates are driven by 10 year treasury not the Federal Reserve
Fannie and Freddie loans, which are both forecasted to do over $50B in loan originations this year, are based on the 10 year treasury. When the Federal Reserve raises their 24 hour lending rate to other banks by 25bps or 50bps it does not directly impact the 10 year treasury.
So what would cause an increase in the 10 year treasury? If the expected rate of inflation increases, the 10 year treasury will go up. When Trump promised infrastructure spending and lower taxes that was a signal of increased inflation and the 10 year treasury went up 70 bps to 2.60%. Now 100 days into office, Trump has not been able to pass any of these programs and the 10 year treasury has stabilized at 2.30%, which translates to Fannie/Freddie multifamily loans around 4.50%-5.00% depending on loan term.
2) Oil – Not going above $60/barrel for a while
At $40/barrel, Midland and Odessa can drill for oil. At $60/barrel, more US sites like the North Dakota bakkan shale start to come on line. Saudi Arabia and Russia need $80/barrel oil to subsidize all of their state run programs. Early in 2017, US production in oil completely offset drop in supply from overseas which kept gas prices low. Oil and Gas firms in Houston have stabilized, but have not started hiring again. Construction lending has been off for a few years in Houston, once the metro absorbs 2017 deliveries, Houston should be in much better shape for 2018/2019.
3) Single Family Affordability- Supply constrained as costs continue to increase
Materials, labor, and lack of financing continue to increase costs for single family home builders. Along with more regulation and requirements from cities, it is becoming unaffordable for builders to build starter homes. A risk to DFW’s economic growth is home affordability, and if prices continue to increase 5-10% annually then companies might stop coming to DFW because their workers cannot afford a home.
4) Why Invest in Class B & C Multifamily? Only property type with negative supply and inflation adjusted
Builders are not building B and C class multifamily, they are actually being torn down which is tightening the supply of inventory thus giving owners the ability to raise rents. The cost of construction today is so high, the rents needed to justify construction are anywhere from $1.50/sf-$2.50/sf per month. Most B and C rents in DFW are $0.90/sf-$1.25/sf, which leaves a significant gap between new construction and workforce housing.
If inflation does occur due to increased government spending or a decrease in tax revenues, multifamily has only 12 month leases which gives owners the ability to move rents upward to account for higher inflation. Most other commercial properties have tenants locked into 5-10 year leases, which gives the owner no upside if inflation increases significantly.