Happy New Year! I hope that you were able relax and enjoy time with your families over the holidays. As always, if you enjoy reading this, I would ask that you consider sending it to a friend or colleague to sign up that may find some value in it. I genuinely appreciate your time.

Macro Outlook.

2023 shaped up to be a much more economically productive year than most were anticipating. The S&P 500 increased by over 20% to reach all-time highs, the NH median home value increased approx. 8.0% [Redfin, Zillow] despite mortgage rates at 20+ year highs, unemployment remained low, and AI did not wipe out humanity (yet). This is a remarkable outcome given the fact that the Fed hiked rates at an unprecedented speed in 2022 and early 2023, several regional banks failed, inflation ripped in 2022 and early 2023, and geopolitical risks increased. Despite those headwinds, many investors had a good year and spent their holidays by the fireplace in their sub-3.0% rate mortgaged home, smoking their cob pipe, drinking a fine scotch, and tallying up their gains.

A significant amount of real estate equity is tied up in existing deals and therefore not being put to work in new investments. Owners of investment real estate (loosely defining as any real estate where the primary purpose is to generate returns for the owner) did not want to sell in 2022 and 2023 because interest rates were rising and the market was trying to reprice real estate. Although single family home values rose in 2022 and 2023 due to supply constraints, investment real estate felt a lot of downward pricing pressure. Why buy a risky asset like real estate at a 5% or 6% cap rate when you can make 5.00% risk free buying US Treasury Bonds? You don’t. Instead, you demand a higher return from the risky asset, which means a lower purchase price. So rather than sell into a market where buyers are demanding a lower price, owners largely held on to their properties. This dilemma is one of the key drivers for the wide gap between buyer and seller pricing expectations that we experienced in 2023, and why transaction volume was low.

If we experience several months of stability in the capital markets after a tumultuous 2022 and 2023, along with a potential decrease in interest rates, I would expect more capital to enter the market in 2024. All else equal, that should increase the value of investment real estate. I am keeping an eye on economic and job data though. If the economy does weaken, that will weaken tenant demand, which could temper valuation growth.

We know that there will be demand to acquire investment properties, but will there be supply? Will property owners with low-rate debt and good cashflow begin to sell their properties? For the right price, sure. But at what price is a seller willing to expend the energy to find new investments with higher interest rate debt. And if there are not many sellers in the market, those that do sell and want to redeploy capital have less options. It’s a chicken or the egg problem.

We need transaction velocity to increase which will naturally perpetuate more transactions. That’s why I think it will be important for buyers in 2024 to help sellers solve their issue of reallocating capital and minimizing or deferring capital gains taxes. It’s why I expect that values for quality real estate to increase as the market tries to reprice real estate based on lower and more stable interest rates. This process will take time, which is why it will be a slow process to see more supply / demand balance in the market.

While this segment was more macro in nature, I expect to have updated NH market data and anecdotes next month.

NH ADU House Bill Proposed.

House Bill 1291 was introduced this month, which is focused on Accessory Dwelling Units (ADUs). A similar bill was introduced last year and was unsuccessful. I am tracking this closely because there is an increasing problem with affordable housing in New Hampshire. I believe that there is increasing community support and growing political pressure to alleviate this issue, and one of the best free market solutions is to create more lenient zoning to allow for more density. Key highlights from this bill are:

· Increases the number of ADUs allowed for a single-family home from one to two, with one ADU being as of right, in any zoning district that allows a single-family home

· There shall be no additional requirements from what are required for a single-family home for an ADU, unless explicitly identified in the bill

· A municipality may require one additional parking stall per bedroom, if they impose parking requirements on the single-family home. This parking requirement may be satisfied off-site

· A municipality may require owner occupancy of one of the units, but may not require that the residents are related

· Allows for both attached and detached ADUs

There are several items of note here.

First, it would unlock a lot of value on single-family home lots if one ADU is as-of-right without any zoning requirements that differ from the single-family home. Today, many municipalities effectively don’t allow ADUs by creating zoning requirements that can rarely be met.

The requirement to have one unit owner-occupied puts a damper on the state’s effort to create more affordable housing. Investors have the most access to capital and discretionary income which makes them most capable of adding an ADU. If they its required that at least one unit be owner-occupied, the state will significantly slow the rate at which new ADUs are built.

That said, it does not require that the residents are related. This makes the bill a lot more commercial in nature rather than only providing a cost-effective way for families to grow into their homes.

Lastly, it is significant that an ADU would only be required to have one additional parking space per bedroom. This can be accomplished on many single family home lots. Municipalities often use prohibitive parking requirements as a tactic to limit ADU development.

This bill impacts both single-family home investors and multifamily investors. While single-family home investors have typically been able to outbid primary residence buyers, this would start to level the playing field by giving primary residence buyer’s an opportunity to unlock value that investors do not have. It would also have an indirect impact on multifamily rental demand over time by introducing an alternative affordable living option for prospective residents.

If I were a lender, I would make sure to have a user-friendly financing option for single-family owners looking to add an ADU. It’s an opportunity to lend more capital to your best borrowers and lend at higher rates. From the borrower’s perspective, a higher rate on a small ADU loan blended with the lower rate on their larger primary mortgage is a cost-effective way to expand living space for their family(ies). Win-win.

New Hampshire does have an unhealthy rental market with vacancy rates in many cities sub-3%. It has benefited many landlords in recent years as rents have risen 5-10% per year. But over time it can freeze up a leasing market and make it a less attractive place to live. I think steps to update zoning to allow increased density, where appropriate within the context of a city, will ultimately benefit the state.

The bill can be found here. I will keep you updated if this bill picks up momentum.

The Importance of Patience.

The Global Financial Crisis (GFC) was a real estate led recession. Due to bad lending practices, property values increased at a rapid clip. Almost nobody saw it coming until it was too late. The bubble burst, and a horrible correction ensued. Eventually, we clawed our way out of the aftermath of the GFC and experienced a strong bull run in the mid to late 2010s. Then COVID hit. As a result, the Fed Funds rate was slashed to effectively zero and a tremendous amount of money was printed and released into the economy. Assets, including real estate, went wild. As you can see below, the median home sales price increased more in two years following the onset of COVID than in the strong bull market of the 2010s. We’ve now seen a cooling nationally, as seen below, although property values in the Northeast remain strong. [link]

Yawn. Ok, here me out on why I am sharing this. See the Ownership History below from a property I recently analyzed. I blacked out the names to avoid shaming the poor guy. Billy Buy-at-the-Top acquired the property in 2005 for $390,000 (ignore the $4,000 a year later, this was a transfer between two entities with the same ownership). 2005 was near peak pricing in the previous cycle. We enter the GFC, property values crash, and the bank takes ownership in February 2009. Peter Profits then acquires the property from the bank in May 2009 for a 42% discount from what Billy paid in 2005.

I bring this up because it’s a sobering reminder that property values do decline. And it can be unexpected. I don’t think we’re at risk of a GFC-caliber crash, or any crash for that matter. I actually think that the market in New Hampshire is poised for further growth due to low supply and expectations for lower interest rates in 2024. But that’s the point. These crashes are difficult to predict.

It’s tempting to make aggressive offers today as interest rates improve. These deals may start to pencil again even at top-of-market pricing. And if cap rates do come in and property values rise, you may actually squeak out a nice little return. But it’s critically important to protect yourself when you buy, and the best way to do that is to buy at below-market pricing. This provides cushion for unforeseen declines. Don’t forget that we got to current market values due to mortgage rates in the 2- 4% range, and today mortgages are in the 6 – 8% range. If we didn’t have such a supply and demand imbalance, partially driven by owners not wanting to sell due to their low rate in-place debt, we would have seen more significant price declines over the past 12 months.

This isn’t rocket science; for that click here. But it’s a good reminder as we enter a new year where market sentiment is cautiously optimistic. The difference between a successful outcome and handing the keys back to your lender is using patience and being conservative when you buy.

As I mentioned above, if you found any value in this, it would mean a lot if you would consider sending this to at least one friend or colleague that may also benefit from this information. Please feel free to reach out if you would like to discuss any of these topics or have recommendations for future topics.

Articles and Podcasts that I Enjoyed.

A collections of business, real estate, personal development, and technology news and media that I found interesting this month.

Sam Altman: What I Wish Someone Had Told Me

Sam is the CEO of OpenAI, so his thoughts and writings lean towards tech. However, I found this really inciteful and applicable to all pursuits in life.

What I Wish Someone Had Told Me

Brad Jacobs to Enter Building Products Distribution Industry

Brad Jacobs is a baller. He has built several billion dollar businesses around logistics and home services. He is making a big bet on home building. That is worth paying attention to.

Brad Jacobs to Enter Building Products Distribution Industry

Emerging Trends in Real Estate 2024

Big picture, institutional real estate-focused trend predictions for 2024. Admittedly a little boring to read, but it’s good perspective to gain.

Emerging Trends in Real Estate 2024

All-In Podcast 2024 Predictions

Tech, politics, and business predictions for 2024.

All-In Podcast 2024 Predictions