Money Supply, Asset Bubble & iBuyers, Part 1: Lessons from the North

After my last VIP post about money supply and possible asset bubble (?) in housing, I got a couple of emails from people asking what if any impact there might be on iBuyers as a result. I hadn’t thought hard about that, but it’s an interesting question.

With some research, I’m leaning towards the idea that an asset bubble in real estate could be the best thing that ever happened to the real iBuyers in the industry: Opendoor and Zillow. In a weird way, it might *cough* open doors *cough* that appear closed today as a result of the insane market.

Or, it might not, and I’m just dead wrong.

Let’s explore the question together, out loud, to see which is which and why. I’ll argue that an asset bubble in real estate due to a massive influx of money means that Opendoor and Zillow should see amazing Q3 and Q4 results this year. You can think about why I’m right or wrong.

Again, keep in mind that I am not an economist and I’d be happy to learn from real economists talking about this topic. But lacking real economists, yours truly will have to serve for now… let’s do it.

Starting Point: Hottest Market Ever

As I mentioned in my last post, we are in and likely heading into a crazy housing market of persistently low inventory, rapidly accelerating home values, and lower transaction counts.

Inventory is at record lows, prices are at record highs, and given what’s happening in the macroeconomic picture, I don’t think we’re going to see the housing market slow down even a teensy bit in 2021. As I mentioned in that previous post, I don’t think we have inflation per se, but we might have a bit of an asset bubble in real estate, as we do in bitcoin, gold, stocks, jewelry, and luxury cars.

So let’s take it as a given that we are living through one of the hottest seller’s markets we have ever seen.

Could 2021 Be a Treacherous Year for iBuyers?

One of the motivations for writing this comes from an article a reader sent to me from an online magazine named Protocol. The basic idea is that we have a wave of foreclosures heading our way as the various moratoria against foreclosures, evictions, and the like expire once COVID is tamed,:

While the pandemic has made their upside more apparent than ever, iBuyers have struggled to capitalize on the opportunity due to the shortage of sellers in the U.S. market. But 2021 could prove to be a landmark year for iBuyers as the pandemic abates and real estate transaction volume rises. It may also prove to be a particularly treacherous year — home valuations are skyrocketing against the backdrop of significant economic hardship, and U.S. homeowners have deferred $1 trillion in mortgage payments during the pandemic through forbearance programs. iBuyers have yet to prove their resiliency against a market downturn, and they aren’t beholden to the same regulations institutional lenders have faced since the 2008 financial crisis. [Emphasis added]

Protocol goes on to note that there is a dark side to skyrocketing home values, and all of the money printed was to stave off an enormous economic depression from the virus:

But soaring home values and record-low interest rates only tell one side of the story. For millions of Americans — particularly those who were already struggling before the pandemic — 2021 is poised to usher in a full-blown housing crisis. The government programs that allowed many renters and mortgage holders to keep a roof overhead are set to expire in March. A short extension on the moratorium passed as part of Congress’s Dec. 21 stimulus bill will only act as a Band-Aid to a much larger problem: Of U.S. adults who weren’t up to date on their mortgage payments, 20% who responded said they were “somewhat likely” or “very likely” to be foreclosed on in the next two months, according to the Census Bureau’s recently Household Pulse Survey. And then there’s the fact that forbearance rates reached nearly 60 times the baseline rate in the U.S. this year, with a peak of $1 trillion in mortgage debt in forbearance during the pandemic.

“Fortunately, the government has put in place a ban on foreclosures and a ban on evictions,” Adena Hefets, the CEO of the rent-to-own startup Divvy told Protocol. “But at some point, when there’s a vaccine and it is expected that people go back to work, if payments don’t start coming in, those people are going to be at risk. It wasn’t forgiveness, it was a delay. And so now they’re going to have a ton of money due.” [Emphasis added]

Protocol ends by noting that if foreclosures outstrip demand, prices will plummet, and then iBuyer will be left holding the bag with a ton of inventory and lose their shirts:

However things pan out, 2021 promises to teach us a great deal about the long-term viability of iBuyers. If transaction volume soars to all-time highs, we will find out whether their business model can turn a healthy profit in near-ideal market conditions. Should housing prices plummet, we’ll see if iBuyers are resilient and sustainable.

All in all, I’d say Protocol’s take on iBuyers is skeptical. That’s par for the course for most of Wall Street, I find.

I think there’s a lot of truth to what Protocol is saying here, but I have a radically different take on this. I know, shocking, right?

I believe that there is no reasonable scenario under which home prices fall anytime soon. Yes, open civil war would change that analysis, but I don’t think it is reasonable to expect Mad Max scenarios. It could happen, Black Swan, etc. etc. and that’s why I’m advocating antifragile as a strategy… but “say we have open civil war” is not a reasonable starting point for analysis of any kind.

So assuming we don’t turn into former Yugoslavia in 2021, I think the basic premise of Protocol’s article means we are headed for boom times for Opendoor and Zillow.

Let me explain.

Anybody Remember Shadow Flipping?

Back in 2016, there was a bit of a shockwave throughout the Canadian real estate industry when the government of British Columbia went on a regulatory and legislative rampage because of a practice known as “shadow flipping.” I wrote about that in this post with various links and to the Report of the Independent Advisory Group.

The basic problem then was that home prices in BC were rising so fast that agents (some agents, as you’ll see below) were going into contract with the seller, then selling that contract (i.e., the right to purchase the house) for more than what the sale price was.

This article from Global News does a decent job of explaining what the problem and the controversy were:

What is the issue?

The assignment clause allows real estate agents to sell a contract for a single property multiple times at increasingly higher prices as they make a commission on each transfer. Buyers in the middle also benefit by pocketing the difference between what they paid and the resale value. They also don’t pay any land-transfer taxes because the entire transaction happens before the deal officially closes, so the property is never technically in their possession.

What is the end result?

The original seller receives less than what the property ends up being worth and the last buyer may be paying an inflated price, with the difference in value going to the real estate agent and the buyers in the middle.

Because it takes so long to close on a house (90 days used to be kind of the average, and still might be in parts of the country), in the lag between signing the sales contract and the closing date, the home could have appreciated significantly.

I recently spoke with Lynette Keyowski, a friend of mine who was the CEO of the Okanagan Mainline Real Estate Board, who lived through all of that even though she wasn’t at ground zero in Vancouver.

She did point out that shadow flipping wasn’t actually widespread, and it wasn’t a common practice within the BC REALTOR community. It was something that only two firms, neither of which were actually all that involved with REALTORS, engaged in and that some of the agents likely had connections to international organized crime… which is why Canada put serious anti-money laundering laws into place. This report from some experts to the government of BC is an interesting read.

Because it was perceived (and may actually have been the case) that the cause of the insane run-up on prices in Vancouver in 2014-2016 timeframe was due to foreign investors, BC put a number of measures into place to stop that, most notably a 20% tax on foreign buyers and a vacancy/speculation tax.

Thing is…

It Doesn’t Matter Where the Money Comes From…

What Lynette and I agreed on, because it is just logical, is that it actually doesn’t matter if the money is coming from Chinese billionaires, or Russian oligarchs or from Canadian millionaires. The issue is the injection of money into the housing market.

More money into the housing market = rise in home prices. The source of the money doesn’t matter, but the amount and the speed with which that money was injected into the market does.

The expert panel that released that money laundering report above estimated that BC saw $6.3 billion in 2015, and $7.4 billion in 2018 being laundered through BC real estate. That’s a lot of money, and in a short period of time, and that’s only dealing with actual money laundering, as opposed to legitimate foreign buyers bringing cash to the table.

So the short version of what is likely a very long story is that BC experienced a massive increase in the supply of money into the housing market, which drove the prices up rapidly.

This article from Global News shows just how insane the market was:

The average price of a sold detached home was $1.4 million in September last year – but climbed to $1.6 million in October, $1.7 million in December, and $1.8 million last month – overall, an increase of $420,000.

By contrast, it took five years (from March 2010 to March 2015) for the average to rise from $1 million to $1.4 million, another five years (August 2005 to March 2010) for the average to go from $600,000 to $1 million – and 24 years (from February 1981 to August 2005) for prices to go from $180,000 to $600,000.

Now, look at this graph of the Canadian M1 money supply:

I know it’s a bit hard to see but Canadian M1 went from $415 billion in Dec 2007 to $832 billion in Dec 2015. (Source)

And at one point in early 2016, before the government acted, the YOY increase in home prices in Vancouver reached 40%:

New figures from the Real Estate Board of Metro Vancouver are showing a mind-boggling increase in home prices when you compare this January to last. Experts say policy makers need to take action now to stop homes from becoming any less affordable.

The average selling price of a single-detached home in Metro Vancouver (excluding Surrey) was $1.83 million in January, according to the Real Estate Board of Greater Vancouver. That’s a year over year increase of 40 per cent. The adjusted industry benchmark price now sits at about $1.3-million.

40% YOY translates to roughly 3.3% per month. If a closing takes 90 days, that’s a 10% increase in the value of the home between contract signing and closing.

Maybe shadow flipping was limited to just a couple of bad actors doing shady things, but that kind of inflation does lead to crazy buyer behavior, right?

Real Estate Mania

Here’s an article from 2017 from Canadian Business, after the housing craze moved somewhat from Vancouver to Toronto:

But signs of real estate mania are everywhere in the city. Open houses can attract lineups, even in sub-zero temperatures. On a -10° C day in March, Stephanie Fusco queued up with her husband and around 15 other interested buyers to view a house listed at $1.2 million. “They had us waiting outside like it was a nightclub,” she says. The 1,200-sq.-foot property couldn’t accommodate all the people who turned out, and the listing agent kept the crowd moving swiftly through the house.

Pre-construction developments can be even more popular. The sale event for a block of 28 townhomes in an upscale part of Toronto recently drew more than 750 real estate agents; some were so eager to buy they offered more than the list price, neglecting the fact the units would be parceled out through a lottery system.

List prices these days are largely meaningless and properties routinely sell for over asking—which agents happily promote by affixing a “Sold for over asking!” plaque to the sold sign on the front lawn. Take a recent semi-detached listed in the city’s west end for $699,000. To step inside was to travel back in time to the 1970s. The house was festooned with brown rugs, brown linoleum floor tiles and, in the basement, wall-to-wall wood panelling. After just five days on the market, it sold for $1.03 million in March—$331,000 more than the list price. Under-listing is a well-worn strategy to stoke bidding wars, which have become the norm.

I imagine a number of my U.S. readers who lived through, and are living through, crazy low inventory markets are going, “Huh, seems familiar.”

And as the article notes, it doesn’t take a genius to make money flipping houses in that kind of a market:

In this frenzied market, a shrewd speculator barely has to work to see a return. Scott Ingram, a Toronto real estate agent, took note when a house in his neighborhood sold recently for $1.04 million—a $102,000 increase from the last time it was sold, which was only nine months prior. Zero renovations had been done in the meantime.

Why Do We Care, Again?

I figure most of you are thinking, “That’s all very interesting, Rob… but why oh why do we care about what happened in Canada years ago?”

The answer is this chart, from Bank of Canada:

During the time of M1 more than doubling, inflation was kept mostly between the target band of 1.0% to 3.0%. So there was, for all practical purposes, no real inflation in Canada from 2010 to 2016. But home prices nearly doubled… which neatly tracks what the M1 supply was doing.

What Vancouver and Toronto experienced, then, is not inflation as a result of money supply going up dramatically but an asset bubble in housing as all this money (from foreign investors, money laundering, whatever) went into real estate.

That is my thesis for what will happen to the U.S. as a result of our money printing in 2020, because the source of the money doesn’t matter; the amount and speed of increase does.

Foreclosures, Crazy Seller’s Market, and Hyperinflation of Houses

So let’s turn back to Protocol’s thesis that once the various deferment programs and eviction moratoria and whatever expire after COVID crisis passes, there will be a flood of inventory. $1 trillion in mortgage debt is in forbearance, and some 20% of people behind on their payments say they’re looking at being foreclosed on in the next couple of months.

While we’re at it, let’s remember how consumers behaved in Vancouver and Toronto when the asset bubbles were inflating there. (Again, neither of those were necessarily “bubbles” driven by investors; they were asset bubbles driven by consumers who wanted/needed a house.) Facing 40% YOY price increases, consumers are going to behave in odd ways.

The question I find myself asking in either of those situations is, “Who the hell would sell in that market?”

I mean, we already know that most people don’t sell their family homes for the hell of it. They only do so because of some life event, or because they have to (e.g., foreclosure, unemployment, medical bills, etc.). And in every case, in a hot seller’s market, you can sell your crappy home in five days and get $300K over asking as happened above… but then you have to find some new place to live, don’t you?

Imagine the 40% YOY market.

You have to sell your house, because like Protocol said, the COVID moratoria come to an end, and you lost your job as a hotel manager during COVID times. So you gotta sell your $500K house and downsize to a $300K house, because the new job you managed to land at an Amazon warehouse isn’t paying what you were making before. At least you have some equity in your home, right?

The problem is, you could get the asking price of $500K in five days of listing the house. But it’ll take 90 days to close the transaction. The $300K house you want to buy will be $330K by the time you close on the sale of your house. Maybe you can qualify, or maybe you can’t. (Assume any “I got over asking” applies to you as the seller and as the buyer.) And if you lose out on that house, you might be waiting six months before you find another one… and homes prices will have gone up 20% by then.

You can try to buy the $300K house with a sale contingency… but your agent reminds you that you have next to zero chance of buying any house with a contingency in this crazy market. Cash is king in a market like this one.

You know what’s an amazing service in an insane market like this?

That’s right: a market maker.

Shadow Flipping Without Legal or Ethical Problems

In an insane market like what Vancouver and Toronto experienced, shadow flipping becomes extremely attractive. A 10% increase between the sale price and home value in 90 days?

But shadow flipping is potentially unethical and possibly illegal. Certainly, it’s very difficult without an assignment clause in the sale contract.

Market making, however, is almost like shadow flipping without those problems.

Seller wants to sell his $500K house to buy a $300k house. He doesn’t want 90 days to pass in between, and he doesn’t want to lose out to an all-cash buyer or whatever.

Well, the Opendoor Trade-In program sounds like a perfect fit, no?

You get an offer, then go shopping on Opendoor’s inventory, then line things up so you do a double close on the same date:

Once you’ve found your next home, you can line up your Opendoor sale close date with the date you’ll buy your new home, and skip the double-moves, double-mortgages, and storage units. Our trade-in program comes with a three-day complimentary Late Checkout to give you extra time to move your belongings into your new home.

Zillow doesn’t offer a Trade-In program as of this writing, but I can’t imagine they’ll be far behind.

This is ethical and legal shadow flipping.

The seller got what he wanted: $500K. That contract is not being assigned; he’s being paid cash, exactly what he asked for. There’s no WTF moment at closing.

Opendoor is buying the home at $500K. It will do its typical sprucing up, light renovation thing, and then put that home on the market. My research to date shows that the typical Opendoor home takes roughly 90 days from purchase to sale. In a 40% YOY hyperinflation environment, that $500K home is now worth $550K.

If someone wants to buy that $550K home, he’s either paying cash, or part of a Trade-In program… because he’s not particularly competitive otherwise. Even a 30 day close means the home will be $569K and Opendoor would be foolish not to negotiate accordingly.

Which means that the buyer would be encouraged to do a Trade-In, starting the virtuous cycle all over again.

Perhaps most importantly, buying at $500K and selling at $550K is what Opendoor’s business is. It might have the same economic endpoint as shadow flipping, but it feels emotionally different to the seller. This is something that came out of the Canada experience.

I can’t find the link right now, but I know I saw reports of at least one seller suing his former agent during the shadow flipping madness. The agent had listed the home and got asking price for it. But immediately upon closing a few weeks later, that same agent listed that same house for something like $200K more. There was nothing illegal about this, or even unethical (arguably). But I suspect the homeowner felt somehow betrayed by the agent he trusted to look out for his interests.

A market maker is fundamentally different, emotionally speaking. Opendoor and Zillow are more like Carmax to the homeowner: they pay him what he wants, and the homeowner knows that they plan on selling that house for more money as quickly as they can. There is no deep relationship involved here; just a business transaction. It feels very different.

I have a bit of insight into that, because Sunny recently sold her car to Carvana. We were buying a new car for her from out of state, so a trade-in wasn’t going to work. Here’s the thing: Sunny got a quote, she shopped that around, and accepted what Carvana offered her. She knew for a fact, because Carvana made it perfectly clear, that they were going to resell her car for more. It was all right there out in the open. Sunny knew she could have gotten more money if she went and tried to do a private sale on some website somewhere. She didn’t want to bother, and timing was an issue.

When it’s all right out in the open, Sunny didn’t care what Carvana was going to resell her car for. It could have been double what they paid her. What she cared about was that they agreed on a price, and they paid her in cash and on time with little hassle.

I know that cars and homes are different. They’re emotionally different, financially different, the complexity is different. I get that. But the point is that emotionally, selling to a Carvana who is very open about their business being reselling that, is different from having an agent who promises to get you the most money possible… then to see it up for resale at a far higher price.

New Doors Open

I think this is the new door that opens for iBuyers in an asset hyperinflation market.

As described above, a “trade-in” makes the most sense for consumers if the market is appreciating 10-20-40% a year. A market maker who can pay cash, have homes in its own inventory, and can easily synchronize closing dates is the ideal and most efficient solution in that environment.

Traditional real estate can try to do the same, but it’s just more difficult to pull off, even if they can do the “instant offer” thing as many companies have rolled out. (Let’s ignore the fact that most of these “instant offer” programs are working for investors and flippers who demand significant discounts from market price.) Because they still have to find the next home for their sellers, secure that home at a price, then coordinate the closings. And they have to somehow secure that next home without a sale contingency, make sure their clients can secure the financing, etc.

It’s not that it can’t be done; it’s that it is just more difficult and complicated. It’s near impossible if there is relocation involved, with the seller moving from California to Arizona for example.

Since the only people who are likely selling in a crazy market are those who have some kind of a real need to sell (life events, impending foreclosure, etc.), market makers should find massive opportunities. Real investors who are hoping to make the most money should just hold on to the asset, and try to time the market. They won’t be selling. Only people who need to sell for reasons beyond just money will be selling in a market like this, and those people are likely to be buyers on the other end.

Sellers who today are resistant to just taking a cash offer, believing that they can get more money through traditional list-and-sell methods, will come to realize that every day of waiting means their next house will be that much more expensive. Sure, they might net more, but they’ll also be paying a ton more… and sales contingencies just makes them uncompetitive.

New doors open.

Not a Black Swan, But a Grey Goose

This is getting long and I think there are at least two other important aspects of this to cover. I think there will be a Part 2, maybe a Part 3 to this topic.

Let’s wrap up with some speculative predictions.

I think we see this really start to come to the fore in the second half of 2021. The various legal moratoria on evictions and foreclosures will likely have expired by then. The impact of the flood of money on housing prices should be fully felt by July or so.

I fully expect both Zillow and Opendoor to set some eye-popping records in Q3 and Q4 of 2021. There’s a part of me that thinks Redfin might come back to the iBuyer fold and abandon their flipper/investor mentality for Redfin Now in order to reap the rewards that will come from being an actual market maker, rather than a fake one. Offerpad… might? Might not? Who knows.

The bridge loan models like Flyhomes and Knock should see a healthy increase as well… but they’ll capture less of the economic benefits of the asset bubble since they don’t own the underlying asset. (If value goes up by 10%, the bridge loan guys only get 3% of that 10% increase.)

Traditional real estate might notice, but then again, every productive agent is going to operating on four hours of sleep a night for the foreseeable future as both volume and transactions should see record highs. Plus, working with buyers is about to get extremely difficult. So I suspect that most of the industry just won’t have time to focus on what’s happening. I mean, you will… because you’re here… but others? I don’t know.

And this whole scenario feels like a grey goose: entirely predictable known unknowns. We don’t know what’s going to happen and when and how, but we can make predictions and think about things.

More to come! Watch this space.

-rsh