How to fix the housing market

0:09Aidan, you're a young man who recently moved to New York City. Indeed. How's it going finding a place to stay? Well, I'm now on my third sublet, essentially hopping around the apartment, hopping around the city, sleeping in friends' beds who are on vacation. So I can't say it's easy. No. What's your long-term plan? What are you going to do? I'm not going to couch there forever, I wouldn't think. In a sense, yes. Waiting to move in with some family. But that's not a great solution as a 26-year-old either. Well, Aidan, while your experience is probably different from many Americans and that New York City is a place of its own kind, the general theme here will resonate with a lot of people because we don't have enough houses in this country.

0:54House prices are up. Housing starts are down. Ladies and gentlemen, this market is broken. Today on the show, can we fix it? This is Unhedged. the markets and finance podcast from the Financial Times and Pushkin. I am proud homeowner Rob Armstrong, coming to you from Unhedged World headquarters in New York City, joined by couch surfer Aidan Reiter, who is my partner in crime on the Unhedged newsletter. Aidan, I'm not making fun of you. I was a young couch surfer once myself. I remember those years fondly, as it happens. now live nine months in a row living out of one suitcase. And honestly, you know, there's something lovely and minimal.

1:41You will look back on that with nostalgia one day, I promise. Aiden, in a functioning market, if the price of something is extraordinarily historically high, somebody shows up and makes more of it. That in a thumbnail sketch is the genius of capitalism that is not happening with American housing. No, it is not. The median price of an American house is$430 ,000 or something, which doesn't sound like a lot of money to New Yorker, but sure does to everyone else. I think even inflation adjusted, we're near highs here. Yeah. The Case-Shiller Index, which is a typical index of broad housing affordability, is at its highest ever.

2:25Yeah. It's never been more expensive to buy a house in America relative to the amount of money that Americans are earning. Exactly. So the Atlanta Fed helps us measure this. They have this measure of the relationship of prices to incomes. And the old rule of thumb, our listeners will remember, is 30 % of your income going to housing. And the Atlanta Fed has this tracker, a numerical tracker, where 100 stands for the median income. 30 % of it is the median cost of owning a house. Right now, we're at 68.5, which is lower than it was even in 2007 during the housing bubble. So houses are more expensive relative to incomes even than during the housing bubble.

3:15It's not a pretty picture. No. So we've talked about this before, but just to review, what has gone wrong in this market? There's a couple things. Well, there's been a long time building gap. What's the opposite of a glut? Yeah. A dearth. A dearth. A dearth. That's it. There's been a dearth in home building the past five to 10 years. Yes. American home builders, Americans have not been building enough houses relative to population growth, relative to household formation. And part of that is the whole industry got scared to death in the great financial crisis. There was a huge amount of building very briefly before the financial crisis.

3:54Building is a leveraged industry. It got completely wiped out. And the industry's, to some degree, never gotten over it. Never gotten over it. And also, you know, it started looking into new areas to build, right? High-end condominiums, commercial real estate. There's plenty of things that have been built over the past 15 years, but they're not necessarily what we need to build to actually address the housing shortage. Of course, part of the problem here is high interest rates. If you look at a chart of housing starts, how many new houses are being started every month, it's like a 1.2 million a year or something number now.

4:27It was going up. And then the instant the Fed starts in 2022, builders start pulling back. Yeah. And interestingly, over the past, I believe, couple of quarters, there's been a gap between permits and starts, which means builders are actually applying to local zoning councils, to states to build things and getting the permits to do so, and then not even starting construction. So this is the area we've talked a lot in both in the newsletter and on the show about how higher interest rates have had less of an effect on the economy than we expected. Not here. Not at all. Construction. But, you know, as a country, we should be able to build houses when interest rates are at 5%.

5:07And what drives me slightly crazy and makes me think I don't understand something that's going on in this market is that the big home builders, the big publicly traded home builders are doing great. Their stocks have crushed the S &P 500 during the pandemic and everything after. They're making loads of money as reflected in the stock prices. Why don't they just jam the pedal to the metal and build more houses? Well, potentially they're now having the ability to only cater to pricier customers, people who are really willing to spend money, maybe paying cash. Pay a big premium. Not to be, oh, they're an evil corporation, but if they don't actually address all the outstanding demand, they have a lot of pricing power.

5:48True. I'm suggesting. I don't know what it is. Maybe listeners know, but it does suggest there's something wrong with the market that somebody doesn't come in and say, and we'll talk about some reasons why this might be. Somebody doesn't come in and say, well, look, the big home builders are focusing on the high end of the market where they have the highest margins. Let me come in and build some mini homes, some affordable homes, some efficient homes. Yeah, but the cost of materials, the cost of getting whatever loans they need for the bank are going up because of interest rates. So maybe those low end producers are who, if they do exist, are just being priced out of the market as well.

6:23Yeah. Our colleague Stephen Gandel had a good article this week in the FT about U.S. banks lending to home construction is falling. It's not even flat. It's going backwards. Five straight quarters of falling home loan contraction. So the markets, I don't think it's too much to say the market's in a bit of a crisis. Lucky for us, Aidan, we have politicians. We do. Well, we should, before we jump into politics, and maybe it's worth noting that part of the issue here is that a lot of people also get new houses because people sell old houses. Yeah. But right now you're totally frozen, right? Yeah, yeah.

7:00It's good you mentioned this. If you have a 30-year mortgage and you finance it way back in the day when it was a lower cost to fix mortgage, why would you give that up to then get a new mortgage on a new house at a much higher rate? I am that person. I got my mortgage in like 2018. I'm going to die in that house, Aiden. I don't know much about my future, but I know you're going to pry that mortgage out of my cold, dead hands. Yeah, mortgages right now are, at least for 30 years, are north of 7%, which is much higher than they had been in the era of free money after the recession. So we all acknowledge this is a problem, and it's become an issue in the election.

7:37So what is Vice President Harris and former President Trump? What are they proposing? Yeah. So Vice President Harris and former President Trump have both brought up housing on the campaign trail. Harris has made an actual pledge. She wants to build 3 million new homes in one term if she were to be elected. So that's 3 million homes in four years. We should note that - Can we just pause on that number for a second? 3 million homes is a damn city. It's a city. And also, it's less than the current shortage. So most people put our shortage around 4.5 to 7.2 million homes. There's a range of estimates.

8:13So yes, 3 million is a great goal and something we haven't been able to do. And ambitious goals. What I'm saying is like 3 million houses is like, I don't know what city is 3 million. So that's a city of 6.2 million people or something that we're just going to invent. Not all in one place. It'll be scattered all over the place. Scattered or it could be rehabilitations. And the idea is bringing new homes to market. Very good. But that's in excess of what otherwise would be built. And on top of that, that's still not enough to make the market. So how are we going to build three? What gets that done?

8:46Well, we should note that President Trump has also said things about housing. He said he wants to protect the suburbs. He said he wants to bring down hot prices. He has not been so explicit in giving goals. But I don't even want to ask what protecting the suburbs means. It's a kind of chilling phrase. Also, I'm a snobby city dweller, so I'm quite snotty about the suburbs, but still protecting the suburbs. Well, that and everything kind of comes down to zoning. So Harris and theoretically Trump want to pull on the levers available to them. But the thing that we have to keep in mind is housing is principally governed at the local level.

9:23Yes. Local zoning boards of people who live in a place get elected or get on the zoning board, and they determine the laws of what can be built in their area, right? There are some federal affordable housing and state quotas they have to abide by, but for the most part, they can kind of do whatever they want. So your vice president Harris, what can you do? Are you just powerless? Yeah. So I think there's four things that a federal government or an ex-presidential administration could do to boost supply. And as we noted, zoning is always going to come into play. So the first thing they can do is trying to incentivize zoning changes.

9:56The Biden administration actually unleashed a program, I believe it was last year, called Pathways to Removing Obstacles to Housing or Pro Housing, which is essentially a broad-based carrot to anybody who wants to change their zoning laws to allow for the building of more homes. So like we will give your town a tax credit if you - We'll give your town up to$10 million if you came up with some interesting zoning change that'll allow there to be more homes built in your town. If you change your zoning laws, you can apply and get this money from the government to be used on housing, to be used on schooling, whatever it is.

10:29Essentially, it's a broad-based general carrot. So pay people to weaken zoning laws. Yeah. So there's a couple of issues with that though. The first is the federal government is relatively new to changing local zoning, right? This is a relatively recent phenomenon. And arguably, we don't actually know that much about the broad-based zoning of different counties. and what works to get people to change their zoning laws to allow for more housing, but also allow them to keep their property values and the things that they think are important. We're relatively new to this world. So right now, as we said, that Biden administration program is very broad.

11:03Do something and here's some money. We haven't gotten to a point where we're really targeted and saying, this is what you need to do. Yeah. And I can imagine a kind of warren of different laws in a single state or a single metropolitan area and then multiply that by all the metropolitan areas in all the states. And you're like trying to reform a zillion different laws all at once. Yeah. It's really complicated. I mean, states have tackled this, right? Multiple states. And there's been a huge issue in California of people trying to provide incentive to build more homes. So states will try to get local governments to change their zoning laws, either by legal mandate because they have some jurisdiction or by some other carrot to, for example, allow there to be accessible dwelling units on a property, right?

11:47Build the shed in the backyard that grandma can live in. So there are things that have been done at the state level. But again, to your point, it's a big, big, giant country with so many different laws. It's hard for the federal government to really pinpoint what they need to do. Okay. What's the next thing? The second thing they could do is arguably what they are most poised to do, which is provide tax credits to build new things. So historically, there is the low-income housing tax credit, which is an effort to get private developers to make affordable homes. It's a tax credit. If you are a private real estate developer, you make affordable homes, you get a tax credit on building those homes.

12:21And that's what Harris kind of gestured at. I know she's been very vague, but she said, we will work with the industry. Exactly. And LIHTC, which is that program, is very popular. It's been around since 1986. It's kind of never going to go anywhere. It's touched the third rails of American politics. It hasn't been enough so far. It has built about 3.5 million homes in the past 30 years, which is a lot, but again, not enough and not at the clip that they need. She's also mentioned something about affordable starter homes for families. It's unclear if that would be different from LIHTC and different from those types of tax credits.

12:55So yeah, that's the second thing. Give some money to developers. Make it more appealing to build more homes in certain areas. Work with the industry. The third thing they could do is start to incentivize conversions and rehabilitations. Right. So currently there's a lot of old homes in America, old buildings that are really expensive to rehabilitate to allow people to move in, right? The math doesn't math, right? The math doesn't math for a developer. Huge cost. You're not going to get a lot of money on the flip side, especially if it's a place that has old funky sewage systems that are hard to rehabilitate.

13:27There's an old joke that an empty house ages like half a head of cabbage. If you don't have people living in the house, it becomes uninhabitable really quickly. The plumbing rusts out, the electricity, the walls come down, you get mold. And so there are, and you see a lot of these in sort of small towns where the industrial base is left a little bit. The earth kind of reclaims housing very quickly if there's nobody in it. It's expensive to fix those houses. Yeah. So the idea here, and there's actually proposals in Congress to do this right now, is the neighborhood homes tax credit. It's a Senate proposal.

14:05It's a House proposal to give a tax credit to developers who would want to rehabilitate old homes. The Harris administration, in the little that it's actually given us, has very explicitly said they want to support that bill. Have you ever been to Detroit? I have not been to Detroit, no. There is some amazing, like the parts of old Detroit that have kind of been abandoned, whole blocks that have been bulldozed. But a couple of years ago, they were like, you know, we'll sell you this house for a dollar if you'll take it on, if you'll take on the issue. Yeah, it's expensive. Yeah. So the idea is get people to take on the issue.

14:36Yeah, yeah. So it's expensive. That has been something explicitly they want to do. There's nothing yet on the books, but it's a Senate proposal. Sure. The other thing you could do is incentivize the conversion of commercial real estate into housing units. Yes. You know, we've had this commercial real estate crisis. People built a lot of buildings. People didn't go back to the office. The Biden administration has flicked at doing this, right? They have an action plan that includes converting commercial real estate. There's no explicit thing on the book that would theoretically incentivize it. There are some other federal housing taxing credits that it could incentivize, right?

15:10There are credits to build clean homes. There are credits to build more affordable homes. If you could make a commercial building into something that qualifies for other tax credits at the federal level, then it is incentivized. But right now, there's no explicit commercial real estate conversion tax credit. Big issue in New York City. Big issue in New York City. But again, it might also be politically hard to do because it could be seen as a bailout of these large commercial real estate developers that played their hands very poorly pre or post-COVID. There's been a fair amount of writing in the FT about commercial real estate conversion.

15:43Our excellent colleague, Josh Chafin, has written quite a bit about this. It's tough, man. And like these office buildings are not laid out. Yeah. One bathroom per floor. So, I mean, I think they'll figure it out. You know, these big buildings in the middle of Manhattan that there's not really the office demand. They'll figure it out, but it's going to take some time. It's hard to imagine that happening within one administration, right? One term, one four-year term. And the final thing you could do at the federal level is to incentivize more sales. So, right, we've talked a lot about building new homes.

16:17Yes. Currently, 20 % of homes sold are net additive to the market, meaning that either investors were holding a bunch of homes at the same time or a family had a vacation house and an apartment and a bunch of places. Pied à terre. Exactly. 20 % of the homes that are sold. I just wanted to say that word. It makes me sound sophisticated. It is a lovely word. It doesn't mean like put your feet up, pied. Yeah, I don't know. My French is no good. So 20 % of homes sold typically in a typical time. Right now, we're not in typical time. are net additive. Somebody died or somebody got rid of their excess supply.

16:52And the great problem in the market right now, of course, is because people are holding onto their old mortgages or whatever, people aren't selling. There's not enough inventory on the market from people who are willing to sell. Yeah. So this is an area where the easing of financial conditions, the lowering of rates will help, but you could also give it a little extra juice by starting to tax the sale of real estate differently. Currently, real estate sales are taxed at capital gains rates. You could lower that. But again, politically, that would be very sensitive. It's hard to imagine a government that has been populist positioned as both the Trump campaign and the Harris campaign had been to say, we're going to start taxing the - Tax break for the rich.

17:31Tax break for the rich who own multiple homes or tax break for investors that have bought up all these properties that are probably contributing to the housing issue. Yeah, that ain't going to sell. Not going to sell. No. So yeah, but that's essentially what the government can do. Okay. So we have this list of options. Most of them come down to subsidizing or incentivizing construction, renovation, resale, release of existing homes, all of this stuff. And we have this goal that the Harris campaign has articulated, three million incremental new units. Is any of this stuff going to work in your judgment, Aiden?

18:07I think it's a really good thing we're focused on supply. Past administrations have not looked at the supply side of the issue. Usually it's spurring demand by giving you more money to buy something. So I'm heartened by the change. And I think a lot of the housing experts we spoke with were really excited that there is a focus on supply. But as we said before, everything comes down to local zoning laws. And until we get a little more targeted and really figure out how to incentivize local zoning laws to change to allow for more housing, it's hard to imagine that 3 million additional units on top of the building that was already going to happen will happen in four years.

18:40It's almost like we have to do a bunch of experiments and see what works to kind of crack the zoning and the nimbyism that is doing so much to make US housing sclerotic. Which is a good thing. I mean, I think we should have policies that are meant to be experimental. I think it's great when the federal government and state governments work together to find things that work. But in terms of actually hitting the goal and addressing the housing market issues we have right now. Easing financial conditions will help, but really building new homes is going to be a long haul. Yeah. This is a seriously broken market and seriously broken markets take a long time to fix.

19:15On that pessimistic note, we will be back shortly with Long and Short.

19:31Welcome back, listeners. This is Long and Short, that portion of the show in which we go long things we like and short things we do not like. Aidan, do you have a long or a short for us? I do. Well, it's something I like. I think it's really interesting, but I am short Turkish equities. Short. We wrote an article about this the other day and I thought they sounded pretty good. It's interesting that your takeaway from all the things we learned was different from mine. Well, I thought they sounded good in the sense that it was really fun and really interesting to write. But I'm short Turkish equities because essentially the Turkish market has been in complete disarray for a couple of years.

20:10Inflation has hit 90%. But stocks have been on a rip. Stocks have been on a rip, but now they're starting to fall for two reasons. The two groups that piled into stocks, one was Turkish households were looking for an inflation hedge, and two was foreign investors, are now starting to sell off the equities. Turkish households are getting way better returns by putting their money in really high bank accounts. And then the foreign investors have also polled because they've seen that change of local investors and for a couple other macroeconomic and local reasons. So the great support, the supports are coming out from under, you think?

20:42The supports are coming out from under. I think there is a case to be long Turkish equities. There are some things that are going well for the Turkish economy going forward. But in terms of the recent market rise and the recent rut, I think right now it makes sense to not be buying. The bears have the upper hand. The bears have the upper hand. That's two animals in one market sentence. I, for my part, I'm going to be short something too. I'm short the yield curve. The yield curve has everybody excited right now because it uninverted. For those listeners who are not super huge nerds, the yield curve is the difference in interest rates at different time periods.

21:23An inverted yield curve means that short-term interest rates are higher than long-term interest rates, which is the reverse of the normal relationship. And for a long time, they were reversed. And that was supposed to be a recession indicator. And now they're back in there. They've just gotten back into their normal relationship. And people are speculating about what that might mean for the economy. And I'm here to say it means nothing. The pandemic and the policy actions that were taken after it have rendered this indicator useless for economic prediction. And we should all just ignore it. With those two pieces of advice, listeners, we will be back in your feed next week.

22:10Stay sharp out there. Build some homes. Until then, build a damn house. Unhedged is produced by Jake Harper and edited by Bryant Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler FT Premium subscribers can get the Unhedged newsletter for free A 30-day free trial is available to everyone else Just go to ft.com slash unhedged offer I'm Rob Armstrong, thanks for listening

23:02We'll be right back.