GR: Thanks for spending time with us!  So how are things in the residential housing markets?  Good, bad or indifferent?

KL: Depends on who you are.  If you are a prospective first-time home buyer, you are pretty frustrated.  High real estate prices, spiking mortgage rates and soaring building costs have made home buying a heavy lift.  If you are an investor in or own housing, you are probably happy but concerned.  The value of your home probably went up a lot last year, and your carrying costs are probably low as you most likely have a sub 4% mortgage – thank you COVID.  However, spiking interest rates, tumbling equity markets, and a really hard to analyze mix of economic and geopolitical factors have you concerned that housing values are vulnerable.

GR: And if you are an investor in residential real estate?

KL: On balance, we think conditions are good, but with clear and material risks we are watching closely.  In the West Coast markets where we focus, you have to start with the housing crisis as perhaps the most important macro driver.  There is such a considerable shortfall of homes as a result of decades of underbuilding.  In California alone, most sources put the shortfall in the multiple millions of homes.  Certainly in our markets, there appears to be an on-going imbalance between supply versus demand that is favorable to investors.

GR: Hasn’t the “crisis” in California been around for a while?

KL: It has and, in our view, has contributed mightily to the high residential value growth rates in the State.  We track residential real estate in all the major US markets.  San Francisco and LA are well above the national averages.  We believe the San Jose/Silicon Valley market, our most important market of focus, has the highest 25-year appreciation rates of all the major US markets.  It has been in the 6% to 7% range annually, depending on what and how you measure.  Nationally, averages have been closer to 2% to 4%.  Pre rents, the benefits of leverage, value-added activity, this long-term rising tide has made for a relatively massive difference in California’s residential value growth rates compared to the other top US metro markets.

GR: So why isn’t everyone in California creating residential housing?

KL: Because it’s so hard.  In a great number of markets across the country, creating residential housing means you have to start by buying the underlying land.  A lot of land in areas where people want to live has become exceedingly expensive.  And then a lot of land is highly regulated – which creates restrictions to its use and adds a lot of costs for those who want to create housing.  Then in the current environment, building costs have risen dramatically.  Piling record building costs on top of high regulatory costs on top of record land costs is not conducive to creating residential housing, particularly at the scale needed.

GR: Not to digress, but isn’t this a huge societal problem?

KL: It is indeed.

GR: Is it getting better or worse?

KL: Depends on the market, but this is a long-term problem that is unlikely to be resolved quickly due to it scale.  In our California markets of focus, there has been a recognition of the problem for a long time.  For a variety of reasons, actions previously taken have not resulted in the outcomes needed.  The good news is the efforts of important parties to take stronger actions.  For example, last year the State of California enacted five-year legislation aimed at increasing the California housing stock and making it more affordable.  For those who follow these things, the implementation of SP 330, SP 10 and SP 9 could be important pieces of legislation that may facilitate the creation of more residential housing, particularly for middle-class families.

To be clear, this is a real US societal problem.  While homelessness gets a lot of publicity, the much deeper effects are the stresses it puts on a vast number of normal people, with normal jobs who want decent housing near good schools with reasonable commutes to work.  We are trying to be a part of the solution, but the challenges are considerable.

GR:  At a distance, Covid looks like it has been a great gift to residential real estate markets.  Would you agree with this?

KL:  For us, it was not a great gift when we were required to cease work at all of our site operations for a period of time.  Nor have the disruption to our supply chains – the access to building materials we need at anywhere near historic costs and the reduced availability of labor – been a great gift.  Having said this, for a lot of suburbs and secondary markets, COVID created at near-term renaissance.  The key questions are which effects caused or accelerated by COVID will prove to be durable?  Is office going to return to what it was pre-COVID?  COVID created a significant shift in demand to “work-from-home” and COVID-friendly living spaces.  Will this trend continue, or will there be major snapbacks towards the residential markets we knew them pre-COVID?

GR: So are you bullish or bearish, on residential real estate?

KL:  Bullish, except to the extent that current policy responses the major unwinds to the COVID policy responses cause deep economic harm.  The size of the current Fed balance sheet, the levels of the recent fiscal stimulus, the current levels of government debt, and the implementation of basically zero short-term interest rates is something that none of us have seen before in our lifetimes.  These represent nontrivial risks for our policy makers to manage.

GR:  And what of inflation risk that everyone is talking about?

KL:  Many an old-timer would tell you that inflation is the long-lost friends of real estate!  Certainly, the current economic actions – the deficit spending and the massive increases in government debt – look like they should diminish the value of dollar.  One would think this should make the traditional hard assets – real estate, gold, commodities and so forth – a relatively safer place to be than paper dollar exposures.  You can’t print real estate!

GR:  That was interesting!  Thanks!

KL:  Any time!