This September, we hosted nearly 300 investors at our 2022 Investor Symposium in New York City. Leading experts in real estate, residential debt, and credit discussed industry trends as well as the global economic landscape. The headline: there are a number of forces at play in the global real estate and credit markets that are relevant to investors now and as we head into 2023.
A Rising Rate Environment
Perhaps the most salient of these forces is rising interest rates. The scale and speed of the Federal Reserve’s rate increases have pushed up U.S. mortgage rates, leading to an expected deceleration in home prices, with prices in some markets already flattening or beginning to fall. Apart from the impact of rate increases, housing market fundamentals in the U.S. remain strong, with persistent outsized demand, limited supply, strong credit quality, rental growth, and record levels of home equity.
In fact, the $28 trillion in existing home equity in the U.S. is the largest such buildup in the last 40 years. This is expected to mitigate the risk of forced selling and thus support stable home values, unlike what was experienced during the global financial crisis of 2008.
Disruption is also occurring at the mortgage company operating level. During this period of dislocation, mortgage-company stocks are significantly down, and spreads on loans have widened. Once the Fed-induced volatility in rates markets subsides, however, mortgage spreads and lending conditions should normalize.
The Ongoing Growth of Rentals
Opportunities are likely to emerge in real estate and specifically single-family rentals (SFR) as the housing market adjusts to the rising rate environment. SFR yields should rise as rent growth outpaces home price appreciation, which is more affected by Fed tightening. This would represent a reversal of cycle-to-date trends. Build-to-rent (BTR) is also likely to see compelling opportunities emerge as US homebuilders act to reduce unsold inventory backlogs that grew at a faster than normal pace due to pandemic supply-chain disruptions. Even with higher-than-normal builder inventories, single-family housing’s overall supply-demand imbalance persists and should remain an important dynamic in the post-pandemic housing market. Single-family construction has once again fallen below long-term averages; meanwhile, the pandemic has unleashed a long-term structural increase in demand for single-family housing driven by phenomenon such as work-from-home and increased migration. These factors point to SFR as an investment opportunity—and at an attractive entry point.
The Residential Credit Investing Landscape
Strong fundamental loan performance driven by substantial home equity and strong lending standards continues to provide good support for the Residential Credit market. Investment opportunities remain strong in nonperforming loans, subordinate bonds, nonagency origination, and mortgage servicing rights. Disruption from higher rates and wider spreads is reducing competition in the nonagency mortgage origination space and will reward vertically integrated platforms. The aging housing stock will continue to drive the need for residential credit transition loans to sophisticated operators.
Opportunities in Structured Credit
Investors continue to see opportunities in structured credit, as the market has transitioned from a niche to a strategic/core asset class capable of generating double-digit returns. As panelists emphasized, collateralized loan obligations (CLOs) now represent a trillion-dollar market that represents 40% of high-yield corporate debt markets. CLO issuance is set to experience the second-highest issuance year on record despite a worsening arbitrage environment as investors seek leveraged exposure to a recovery scenario.
During periods of volatility and price dislocation, participants increasingly pivot to secondary markets. The volatility and dislocation are expected to continue, which broadens the opportunity set for credit investment in the next 12 months. Many are relying on defensively positioned portfolios with longer reinvestment periods to maintain dividends through a recession while providing freedom to opportunistically build par and excess spread when market conditions allow.
A Boost from Technology
Technology was another key theme of the symposium. Not only does it allow managers to make more informed, data-driven decisions, but it also is enabling change at the operational level. Technology helps attract and retain residents while fostering transparency in vendor services. A customer-first mindset and continuous tech improvements in SFR, for example, are mobilizing resources in real-time, giving a boost to resident experiences and ultimately investor returns. As smart homes and home services become more accessible, panelists predicted that innovations, such as “homes as software,” will provide more predictable and controlled living experiences. Meanwhile, as the digital economy expands and the value of technology appreciates, intellectual property (IP) assets have grown in importance, creating investment opportunities in the data and privacy litigation space.
Don’t Wait for Market Clarity
Though the markets are currently volatile, participants are not waiting around for them to calm. Instead, they’re staying nimble and seizing opportunities in the market disruption. As the symposium revealed, there are many investment opportunities to be uncovered, but working with a well-established, vertically integrated asset manager is key to accessing value.
As we celebrate our 10th Anniversary, the valuable insights gained within the context of our global market trajectory make it clear that Pretium is well positioned for the future across all our strategies.