Inflation proving to be stickier than the Fed bargained for

The December Federal Open Market Committee policy statement and news conference were not the news markets were hoping for. While raising the terminal rate higher than expected, the Powell Fed also poured cold water on the hopes of a Fed pivot. Sorry, but no rate cuts coming in 2023. Absent a severe recession and financial instability, the Federal Reserve is still sticking to its guns when it comes to taming inflation.

This has important implications for the housing market. The housing reset of 2022 will continue. Many speculators and levered market participants were hoping for a quick return to free money. That scenario is not in the cards with headline inflation still running at 7.1%.

Goods inflation in various sectors of the economy has come down recently. Unfortunately for the Fed, services inflation is still running very hot. It appears the much-feared wage-price spiral that gives central bankers nightmares is still a real risk.

Housing inflation is still a major problem despite some industry players talking up month-over-month declines in rents. Big landlords would like you think prices have come back down. You can be the judge for yourself. The Justice Department has opened an investigation into Richardson-based RealPage and several of the country's largest apartment owners. The DOJ will examine whether RealPage helped landlords coordinate rent increases. It will also be looking at the 2017 merger where RealPage absorbed one of its primary competitors.

Official Consumer Price Index figures for housing inflation hit their highest numbers for the cycle in November. The November readings for official year-over-year shelter inflation look like this:

Shelter up 7.1%

Rent of primary residence up 7.9%

Owners' equivalent rent up 7.1%

As I have explained previously, the shelter components of CPI are extremely lagged. While real prices and rents have already started turning lower, the Bureau of Labor Statistics is playing catchup with this sector of the economy. The problem for the Fed is that home prices and rents are still high — higher than they were a year ago. That's a big problem for a central bank trying to get back to a 2% inflation target.

Actual single-family rent inflation in Denton County was running at 6.6% in November. Median rents were up 8.1% in the city of Denton compared with November of last year. Rents for local apartments are still up double digits for many local residents as property owners look to squeeze tenants for even more profit.

Median home prices in the city of Denton are still up 11.9% from a year ago. The median price for November came in at $375,000. That's still $100,000 higher than January 2020 home prices for Denton. Local home prices are still 36% higher than where they stood before the pandemic. This is why November home sales in Denton were down 34%.

Other metrics for the Denton housing market point at continued demand destruction. Average percent of list price in Denton fell to 96.1% in November. Available home supply in Denton was the highest in three years, rising to 2.8 months of supply. Remember that big construction backlog I have been talking about? The supply of new homes in Denton hit six months of inventory in November.

Some of that inventory is getting purchased with typical year-end December demand. The inventory build should resume again toward the end of January as seasonal trends return. The first quarter of 2023 will be interesting to watch in terms of inventory levels. More sellers will be looking to cash in on spectacular pandemic home price appreciation. Builders will be looking to work through that huge backlog.

Builders are talking up marginal price cuts

I have seen some interesting discussion of late on the price cuts from new home builders. Housing industry participants are no strangers to financialization. They feasted on the Fed's massive liquidity injections during the pandemic and took advantage of the opportunity to ramp up home prices while padding gross margins. Publicly traded builders also bought a ton of their own stock.

The latest quarterly earnings for the country's two largest homebuilders provide some context on what prospective buyers are dealing with. D.R. Horton and Lennar both posted positive sales numbers and declining orders for the latest fiscal quarter. The spike in mortgage rates to 6% and 7% put a huge dent in affordability and demand. Despite the recent softness in their business, Horton and Lennar have spent over $2 billion combined in share repurchases.

That's over $2 billion thrown at propping up stock prices and padding executive compensation. At the same time, the building industry has been lobbying Congress for more handouts to aid the now-foundering housing market. Lennar has taken the financialization game to another level recently. Bloomberg reported that Lennar has been marketing 5,000 homes to investor landlords. With first-time home buyers struggling to afford new homes, Lennar has responded by offering discounts on entire neighborhoods to wealthy investors.

Stay with me. It gets better. Lennar's average new home order price dropped $50,000 (10.6%) in the latest quarter, falling from $469,900 to $419,000. Lennar's average sales order price for the Texas division collapsed by $65,000, or 19.9%!

This is interesting because owner-occupant homebuyers aren't the only ones getting snubbed by Lennar. Lennar has also been acting like Ebenezer Scrooge to agents. While most builders have been offering beefed-up incentives to buyers and increased commissions to agents, Lennar has basically told local agents to go fly a kite with comically stingy commission co-ops.

REITs get slammed with redemptions

Big real estate investment trusts are now getting slammed with redemptions as investors look to pull their money out. Quantitative tightening and the recent housing downturn are exposing speculation and irrational exuberance on Wall Street, too. Both Blackstone and Starwood Capital have gated redemptions on their funds recently. "Blackstone and Starwood, which are nontraded REITs, have capped investor redemptions while paying out $3.7 billion in withdrawals in the third quarter."

While many of the big institutional predators in the housing space are waiting for a recession to buy up even more homes, some investors are already unloading inventory. American Homes 4 Rent, one of the country's largest single-family landlords, has been selling some of its inventory in Denton County. Other landlords are also trying to cash in on the recent bout of housing inflation.

For now, it's just a few homes hitting the market. These are not what you would call prime real estate in many cases. The stuff that AH4R is selling appears to be of 2014-15 vintage, homes that have basically doubled in value from when they purchased them. Some recent housing investors are just trying to get out of the market without getting skinned alive. As iBuyers have learned this year, the home-flipping business is ripe with risk when the Fed is actively working to crush demand and tame inflation.