Why the Housing Market May Not Land Softly | Jim Righeimer

Interest rates are going up and it's impacting the home builders because they have a major carry cost. Will this have a big impact on housing prices as well? Today we sit down with Jim Rickheimer, who's a developer and prepares lots for home builders. He will tell us what's happening in the market right now. Listen, everybody always thinks it's a soft landing. It may not be a soft landing. It matters what the payment is to the buyer, not necessarily what the price is. The good news is those houses are going to come on the market. They're starting to come on now, But if you're saying, I'm going to buy a house for an Airbnb or for a rental or something like that, I would be very leery of it. What you don't want to do is have something go wrong in the middle where you can't service your debt. You don't want to have that. I'm Siamak. Welcome to Market Insider. Jim, it's great to have you back on. Welcome back. Great to be here. We want to talk to you about developers and what's happening right now. The interest rates are going up. Right. And at the same time, we have this housing shortage. It's impacting the developers. What are you seeing out there right now? Well, what's been going on for a while, I mean, the running joke is interest rates are going to be coming down for the last three years. And they went the opposite direction. They went up. So for new home builders, and many of the markets across the country, we're basically subsidizing interest. They would go ahead and what they call buy down the loan. And a buy down of a loan is a very expensive process. It's like where their rates are at 4.5% or 5% and you buy it down to 2.99% or 3.25% for 30 years. And to buy that loan down, that could be $25,000, $30,000, $40,000 in cost in closing. So if you're buying a house for, say, $500,000, they've got a loan for like $400,000, that project is penciled out to bring in like an 18% to 20% profit. That's what it's penciled out to do. So you've got about $100,000 in nominal profit per house you sell. And all of a sudden, you've got $30,000 or $40,000 in interest buy-down. That's big. The other thing that builders were doing is that all the extras that you could have, which had high margins in them, like finishing basements or doing nicer kitchen cabinets or just different things in the house that had high margins, they would give those to the buyer. They'd say, we'll put the basement in, we'll finish the basement for $20,000 or $30,000, whatever, for no cost to you. And so the value was added into the house by doing that. But again, that cost to builders in two ways. One is that high margin product they had of finishing a basement or doing some extra work inside the house, which is usually high margin, is gone. And then number two, the actual cost of doing it is a subsidy. so now with interest rates going up again and not just going up but looking to continue to go up for a while until this whole thing in the middle east gets straightened out oil and gas gets straightened out and everything kind of gets you know back on its feet again we're going to have all this upward pressure on interest rates and that's going to continue to make it hard for home builders to try to move their product so they're doing all sorts of different things to to get through they need to stay in you know they're in the home building business they can't just stop building homes but clearly upward interest rates is a lot of downward pressure do you think it's going to make them slow down in building or do you think they're going to continue for a while they've already slowed down in building i mean i can tell you in the projects that i'm building remember my company we we build the lots we you know uh buy the buy the farm put the streets in the roads in the schools whatever and then we sell the lots to the public home builders public meaning stock market you know major uh home builders like Lennar and yeah these companies sell you know 20,000 to 100,000 homes a year number maybe a little bit down uh than their say dr horton you know so when they go to do a takedown like we just had one of our projects had 117 lots um we built we built out all the sewer water and everything else for the 117 lots and the built then the home buyer said hey just put the curb and gutter in the street finish the lots the actual finishing for about a third of them like 30 now they're a multi-billion dollar company this is not like so they only commit like well they already own the land and they already put enough in but they're they're even not doing more they're not finishing a hundred lots like they would normally do. They're doing the, and they have a lot done. Like I said, the sewer and the water and all that stuff's in. So it's easy to finish by putting just a curb and gutter sidewalk and asphalt in, but they're watching their dollars and saying, we're not, you know, we're not going to put a hundred lots out here. We're going to put 37 and that 37 that, you know, what normally you'd, you'd sell that in eight, nine months, you may not sell 37 for, you know, 16, 18 months. so there's just slower absorption and so yes they're slowing down on how many lots they're buying and do you think because there's been discussion that there's a shortage of homes at the same time people can't afford the well it all depends on where you're at so if you if you go through the the the the south belt you know which is where people were moving to like florida Florida, Austin, Texas, Atlanta, Phoenix, you know, I can go through Tennessee, you know, the different states. You can see where there is already, I mean, there's downward pressure on pricing everywhere because interest rates are up, right? So remember, if you're a home buyer, you're going to make a payment of X, okay? And if they raise the price of that house, then your payment goes up, right? Well, they could have the price be the same and interest rates go up and your payment goes up. So it matters what the payment is to the buyer, not necessarily what the price is. And so when interest rates drop, it was the same thing. When interest rates dropped a ton, the prices shot up because people could afford to pay more for a house, not necessarily got a bigger or better house, they just paid more for a house. And that's after COVID or halfway through COVID when prices of housing shot up because everybody wanted to buy a house everybody want you know they were all stuck at home they want to have a little bigger house or more room to be in so remember in areas across the country there's over building already i mean you go into and other things that's kicked in insurance rates i mean insurance used to be a side number you never looked at when people were qualifying for a house i mean their insurance was you know way back in the day five six hundred dollars a year maybe twelve hundred dollars a year it's a hundred dollars a month now insurance on that same house is four or five thousand dollars that's four or five hundred dollars a month for nothing any different you know the house isn't any bigger you know the there's just you know there's no pool in the backyard it's just you know four hundred dollars more a month just for insurance um the other thing you have is different tax rates for houses you you the price of houses have gone up in the municipalities have their taxes based on what the house sold for. Now, whether the house sold for a lower price or a higher price, you don't need any more services. If it was a lower price house, you don't need more police or more schools or anything. If it's a higher price house, you don't need any more. Well, prices went up and the taxes went up with it also. So now the tax issues like, wow, the taxes are pretty high. So if you, in fact, if you had a low interest rate loan from the, you know, around the COVID time when rates were at 3%, people's taxes are higher than their interest payment on their house, literally, because the interest was two and a half percent and it's still locked in. So it's definitely causing everybody to have to look at what they have and what product's going through. On our product, the stuff that we have that's still moving is the move-up buyer that already has a house, probably has a low interest rate, if any interest rate alone. These are people closer to retirement. They don't need to sell a house to buy a house. And so when they go look at a house, especially a new home with a builder, they're going to hold out to kind of get everything. Everything that the builder was willing to do they're going to know about now and how does that happen you know just by saying no you like this house it's great they tell you the price and what you can get and you go no i'd like to have a low interest rate no i'd like you to finish the basement no i'd like whatever and you'll find out how far they could they'll actually go at some point they just say we're not going to sell the house for for less than it costs it doesn't make any sense until they have to i mean that's a different story but basically what builders will do is they'll slow down how many houses they're building so to keep in balance with how many they're selling and these type of buyers are they buying second homes are they planning to move uh is it you know these no i don't see it the second homes remember we had another big boom of buyers that came in that's starting to implode which is to the benefit to the benefit of home buyers remember you know the home buyers were the ones always getting hit prices were going up interest rates are going up and all that now we're seeing throughout different communities houses coming back on the market and they're coming back on people that bought quote-unquote second homes, but not really second homes. They bought houses that they had for Airbnb. Now, I don't have the numbers in front of me, but they're mega numbers of how many people own houses as a business, two or three houses, that they put it on Airbnb. It's treated like a hotel, you know, which is different than renting a house. And that was the business they were in. Well, now all of a sudden interest rates go up and they can't keep the house and they go to look to sell it and they realize they can't sell it what they paid for it. They can't keep on operating it. So they're losing money on their quote-unquote safe investment. I'm going to do an Airbnb. And that's kind of coming apart. So the good news is those houses are going to come on the market. They're starting to come on now and they're going to continue to come on. Remember we always talk about people with low interest rates don't want to sell their house. That's true. But if you have a second or a third house, that's a rental house, Airbnb, and now it's not getting rented out. And you've got all these communities, too, that have come out and said, no Airbnb. I know a lot of my friends will look at that and say, oh, Jim, you know, it's your property. You can do what you want with it. You know what? There's a big distinction between living next to a house where it's not how many people live in that house, two or three people. It's how many different people live in that house over a year. and people are renting a house out every single week next door to your house, you don't even know who's coming or going anymore. That's not the neighborhood that you bought into. And unless you're in a community that is used to having weekly rentals, beach communities have it, a lot of areas have it, mountain areas have it, vacation areas, yeah. Palm Springs, something like that out here. If you don't have that, there's been a lot of pushback and a lot of city councils have said, no more Airbnbs. Now, in terms of the rental market, you know, rents are going down in certain areas. Even certain areas are slowing down. Is that impacting the new homes? And is that impacting, at the same time, we have multifamily issues with multifamily. We have a lot of multifamily buildings and the interest rates are impacting them. What are you seeing out there? Well, remember when COVID hit and everybody started working at home, nobody could believe how many people did not have to work in an office. and remember zoom came along and some other tools came along where you could put together a pretty good meeting which was about the same efficiency as all sitting in a boardroom and in some ways better because you didn't have to drive there and go do it and get other work done while you're not driving so nobody thought that would happen and at the time everybody was looking at the office market i remember going into office towers around here looking out the window and seeing three four floors of a building empty or going into the parking structure and realizing a six-story parking structure you know it was full up to the second story then fourth fifth and sixth wasn't there so that was a big hit uh to the market like four or five years ago when we all talked about it all the billions of dollars of of office that's just going to go away and the market in different areas has absorbed it figured out of the ways to convert it to other things slowly but surely but the price dramatically dropped. There's all these stories about, you know, a $500 million building that sold 10 years ago, just resold for, you know, a hundred million dollars. I mean, cause it's just simple math. It's how much rent can you bring in times, you know, the cost of money. And is that return makes sense or not? So that came down and that happened. Now the thing was, uh, was the apartments. Everybody said that was the great investment to make. Everybody go into the apartment Residential side. Residential side. But what it was is, I mean, commercial people can build apartments. I mean, developers develop, you know, it could be apartments, it could be retail, it can be, you know, single pad kind of investments, but builders will build. And like I always say, if the bank's going to give you the loan, the builder's going to go ahead and build it. But there was this big boom in the apartments and it takes, so COVID hits, there's a, interest rates are low and there's a boom to get apartments well remember it takes you know two and three years to get a project up and running so now you're 2002 2003 2022 they come on on the market now all of a sudden here we are 2006 last year so the apartments started coming on Wall Street Journal just had a story the other day talking about the i'm going to be wrong in this but like $1.7 trillion in debt coming due in the next 10 years for apartments, of which about $300 billion is coming due this year. So think about these loans. These are loans that were in 2% and 3%. The construction's done. They have to pay off their construction loan. And instead of paying 3% interest, they're paying 6% or 7% interest. That's a dramatic difference of what the building can afford. And a lender's going to look at that and say, you cannot make your payment. You literally cannot make the payment. So we're going to need to lower how much you owe us. And they'll basically say, it's a capital call where you have to bring cash in. Well, a developer can do that for a couple of projects. And then after a while, the money runs out because they can't, they don't have any more cash to pay down these loans that are coming due for the apartments so what you're seeing in is in all these again Sun Belt areas including um you know the same cities you know Denver and all in in Florida and all the different cities that overbuilt you're seeing all these deals and i and a friend of mine has there was in in Denver um a young kid in the family they were looking at apartments in Denver now in Southern California rents are ridiculous you know you're by the beach it's just crazy but there high rents were like you know 1900 for a nice one bedroom in a brand new building with all the amenities and everything else and that's you know pretty healthy rent depending where you are in the country and that was Denver Denver built about 40,000 units in the last three four years 40 000 apartment units in the Denver metro area based on the fact that we have to have all these apartments and they're all going to be rented out because the idea is there's a shortage of housing there's a shortage of housing and so we're going to have it and then these are the higher end stuff the nicer stuff right well what happens with the apartments well they're 1900 but if you do a 15 month lease they'll give you three months free so it's really 1600 it's really 1600 so what's happening there is they don't want to give up saying their rent is 1900 and the whole hope and you know hope is not you know a way to get things done it's not a strategy right exactly their whole hope is that you're going to move into these apartments and you're going to stay past the 15 months so they don't have to give this big discount so over the next 12 months you'll you'll pay the 1900 for that amount in there but talking to this one person that just moved into the area they said you know we really like it it's really neat it's the cool parts of town this is in Denver it's all the neat buildings that are here but i don't feel safe and you go what you're by the Rocky Stadium and all the different cool things you know and they go no there's homeless people hanging out all over the place. There's groups of people. I don't feel safe in the area. That's what the problem is in these downtown areas is that you've got, especially in the more blue cities, you'll have a situation where they won't do what it takes to clean up their downtown areas. So young people move in, college educated, making good money on their jobs. These are all the kind of people you want to have in your town are saying after their lease is up, I'm not staying here. I don't want to live here and these cities refuse to do what it takes to clean up their areas to get people off the streets they'll come back with all the drugs and the mental illness and all these things which are true but you need to solve those things when they're off the street you can't like try to solve them while they're on the street and so we're seeing a lot of areas spend you know billions of dollars in apartments redoing areas gentrifying everything else finding out that if these towns don't clean up their towns it's not going to get rented out i mean you you'll rent out your apartments when people stay but they're just going to leave after the first lease is up that's not you have to keep giving the incentives yeah and it just yeah and again it doesn't make any sense remember when from three percent to six percent these are these are problems and and you still see construction going on so tell us about that you still see construction going on should it slow down at least for the well it will so it's kind of how deals get structured and who the money comes from so if you have like a pension fund that's in the deal pension funds people you know if they're they're public employees that they they raise money out people's paychecks every single month and they've got billions of dollars they have to put out and so in some ways if you're a pension company you get your money at zero no cost because people just you know give it to you you got to put it out. You have to invest it and get some kind of return. Where in my world or in most people's world, I bring investors and I have to give them some kind of minimum return. And it's not zero. It's going to be three, four, 5%, whatever. It's going to be some kind of preferential rate. If you have a pension fund, they have the money to finish the building and go do it. And that's kind of how the structure was done. The developer who built that building may end up with zero they may get a development fee to do it but because of the cost of the money and they don't it takes longer to get their investment back it chews up more of the money like like the money the what's the profit in the project that you're going to split somehow with the investor all of a sudden there isn't any profit to split so at some point if things continue the way they continue construction will slow down more if it continues the way it does now we i'm not saying it's going to continue we don't know what's going to happen we always think we do like i said interest rates were coming down i remember i was talking about interest rates coming down and they just haven't and you know and and we could argue about why you've got the fed you know sitting there at you know two and a half percent inflation worried that inflation's too hot at two and a half and you're saying you know what when we're six seven or eight going up it was one thing but when you're stabilizing down in the twos everybody can just you know calm down for a little bit but if you continue to have the government keep on overspending spending money that they don't have whatever the bond market's going to go ahead and cause pain and the pain is raising interest rates when it comes to multifamily it seems like your industry has innovated in the way that you guys are building you're kind of building just in time you're paying attention to the market and you're not building a bunch. But when it comes to multifamily, the way that the commercial loans work is not like the residential ones where you get a 30-year mortgage. Every five years, the mortgage rates adjust, right? Yeah. It used to be until rates went up, it was pretty much 10. You'd lock in a 10-year loan, and the locking was both ways. I mean, you couldn't pay it off early either. I mean, the penalties- You're locked, 100%. You're locked in. I mean, you can pay it off- But the penalties don't- But you could have a $10 million loan and the payment to lock it off is another million dollars. I mean, it's real money you have to pay to pay it off. So they'd have some sort of defeasance or some situation to do it. But it used to be a 10. Now, and even in the debt that we're refinancing, again, debt that was at 3%. Now, we keep very low leverage, so we don't like paying the higher interest rates, but it's not going to change. It's not going to put you out of business. It's not going to change my life. Yeah. It's like, okay, I guess we're going to pay more interest than we were paying before. But I do look at it and say, hey, I'm not looking at building another commercial center or whatever if I don't have the tenants already in place. Where before when interest rates were lower, you might take a little more risk. You might say, hey, I'm going to start construction on that. I've got it half leased up. I'll get the rest leased up. Once you're under construction, you actually do get more activity. People go, oh, that's a good place. And I want to put, you know, X, Y, Z restaurant here or nail shop or whatever it is. So they'll go ahead and you'll, you'll do that. But now I look at stuff and if it's not, you know, I mean, 50% solid with a bunch of leads to get it up to 70%, I'm just like, eh, I'm not going to take on additional risk. It's not worth the return. It's just not. The other thing is that we'll borrow less. We'll take more equity. We'll go to partners and say, we want to have more cash in the deal and borrow less. And maybe we have to give them a better return, but we'd rather have less risk in the project, have the project borrow less money. Because when everything, and everything's in cycles, right? So when everything get straightened out six months from now or four years from now whatever it's going to be fine you know when rates come back down okay we'll stabilize we'll refinance then everything will be fine but what you don't want to do is have something go wrong in the middle where you can't you know service your debt you don't want to have that do you think there's going to be a lot of foreclosures coming for for like multi-family well um because these loans are coming due and from what it sounds When people are going and getting these loans, they are predicting a 3% payment, and then they will sell the bank the idea that this 3% interest rate matches the rents. They're going to have some returns, but now that the interest rates are a lot higher. Well, the interest rates are higher, and it's not full. They were expecting to be 95% full at a certain rent, and it's 70% full. So that delta is everything. It's not just interest. It costs the same thing to operate a building that's, you know, 95% full and then one that's, you know, 80% full. The light's still got to be turned on. You know, the person at the front desk, the elevator, the maintenance, it's all going to stay the same. So you're pretty much, your fixed costs are going to stay the same. So they do have that problem. It's a little bit more sophisticated now. We don't, you don't see the foreclosures. You see a lot of lenders and borrowers more sophisticated in how they did deals. So it's kind of like the lender finally says, you know, this isn't going to work. We're going to need to do whatever. And both parties kind of agree that, you know, give us the building, write us a check for X amount. Any other kind of guarantees you did, we'll wipe it off. People negotiate the settlement. So you don't necessarily, on large apartment projects and all that, I'm not saying on individual single-family houses. Because there's not that much, because the loans are 30-year loans, and a lot of people have a lot of equity. So they're fine. But on other stuff, so I don't see it. You just see more of the $500 million towers sold for $150 million. Well, you know the buyer had $300 million in that, and probably a loan of $200 million. And everybody kind of got wiped out. So everybody is, it's just more orderly how things handled. How do you think all of this will impact the housing market? It seems like, from what you're seeing, it seems like we're going to have less development. Right. Prices are coming down, like the interest rates have gone up, so prices have to come down. But there's going to be, at the same time, maybe less inventory in the market. Or does that not matter? What happens is that, listen, everybody always thinks it's a soft landing. It may not be a soft landing. It may be a situation where, you know, there's not many houses on the market and people can stay in there for a while. But after a while, you know, people that say they were never going to sell, things in life happen. You know, you lose your job. If you're older, you might pass away. There's all sorts of things in those houses at some point come on the market. If there's a bunch of houses over time that artificially stay off the market, at some time there's going to be a rebound and more will come on. The areas that I'm more concerned about are your higher priced areas, your suburban areas where there's nothing available. So when a buyer goes to move there, let's say they have to come into a certain area. They've got a job transfer or something. They go, well, what's available? Well, this is available. And that's, God, these prices are really high. Well, if you want to buy a house, that's what they go for. And so they're paying it and they can afford it, you know, but it's like kind of a stretch to do it. And, but at some point, enough come on, now all of a sudden, the house that you bought for X dollars is now X minus 10%. And you got a loan of so much, and then you got to sell. And it can, it can be a very bumpy, you know, you know, hit going down. That, you know, that's what happens a lot. It's not as soft of a landing as we think. Right now, you know, the thinking is it'll be kind of soft, it'll figure itself out. But, you know, right now, rates are supposed to be down for the last three years and they haven't been and the other side of this is do you think we have a mismatch in housing because of this rate lockdown meaning like some people have more housing than they need yeah i mean you know clearly the whole concept of that people would buy down on their houses depending on where you live that happens or doesn't happen so in California, you have a thing called Prop 13, which keeps people's, um, um, interest, not interest, property taxes, property taxes, very low, very low. And if I say, you know, my friends out there, you know, if I say keep some artificially low, they'll say, Oh my God, you're just, you know, you want to raise people's taxes. I don't want to raise anybody's taxes. But when a neighborhood that kind of everybody's the same, one person spending $2,700 a year on taxes and one person spending $27,000 a year on taxes, three doors down from each other. Something's off. Something's off in there. But what happens in government is that if the elected officials won't solve a problem, people will. And elected officials wouldn't do anything. Prices were taking off. Property taxes were taking off back in the 70s. Prop 13 came in to protect people so they wouldn't lose their house. But having the rates, you know, the house taxes be down now for, you know, 40 years, it's just, it's kind of unbalanced. I mean, it's just unbalanced. Is this a good time to invest in housing? Do you think the prices are coming down? Interest rates are going up? Well, I don't know that I would look at investing in housing right now. I would say that if you're moving to an area or you need to be in a certain area and you want to be stable and you find a house that works for you, that you can afford, and it's in a neighborhood that you can send your kids to school and all those things kind of come together. I do it over a long-term. When I say long-term, seven to 10 years, because whatever up and down dip we have, that usually will get itself worked out at that time. But if you're saying I'm going to buy a house for an Airbnb or for a rental or something like that, I would be very leery of it because I don't think prices have um have changed dramatically yet in southern california northern california now in other parts of the country where there's over building and new houses i would start to look at that and figure out you know what made sense because builders are really giving away a lot of interest buy downs additions to houses all sorts of stuff that they're doing um and giving discounts that i think there's some really good buys and then you know when interest rates come down someday you can refinance whatever but again I would look at large down payments I would look at not a lot of negative cash flow you know one of the things I tell people they talk to me about doing investments or whatever and in in the real estate business we kind of have people that have equity cash to do things and we have people that have sweat equity and so people that get in the real estate development business or the you know buying and fixing up houses that kind of that's kind of the sweat equity person who kind of finds a deal, whatever. And then they find somebody with money and they kind of come together. That's basic real estate one-on-one of how you get in the development business or the flipping business or whatever. You got to find your equity. What I would tell anybody right now is make sure you don't go on a string, a shoestring budget to get something done. Make sure that if you put together a transaction, you put enough cash equity in there to pay all the bills to make sure things are done so everybody expects it. The return will be lower, or you may have to give a higher return to the investor and a lower return to yourself. There's nothing wrong with that. You can make money a dollar at a time. What you don't want to do is lose money. Losing money is where you overpay for the house, the construction costs cost too much, and you say it'll rent for a certain number and it doesn't. You'd rather set expectations and find that an investor is somebody you know already. It's a friends and family type of thing where they see it. They don't want to do the work. You're willing to do the work to fix up the house, whatever, and get it rented out or get it sold, whatever. I would look at those. But again, I would make sure you didn't do it. I see too much of people doing those deals, borrowing against their house to go buy another house. I wouldn't do that. I wouldn't be doing that. Jim Riekheimer it was great to have you back on please come back and give us an update in the near future it was great to have you on Market Insider. Thanks for having me. Tell us what you think about this conversation with Jim and are you seeing a change in the housing market in your area? Make sure to tell us in the comments. I'm Siamak Korami this is Market Insider we'll see you next time.