Technology

In The Thrall Of The Fed, Operators Tap Tech To Harden Against Risk

As higher and higher finance costs upend pro forma margins and depress land valuations, we'll see a culling of the weak vs. strong players in the BTR space over the next six to 18 months.

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Mosaic

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Technology

In The Thrall Of The Fed, Operators Tap Tech To Harden Against Risk

As higher and higher finance costs upend pro forma margins and depress land valuations, we'll see a culling of the weak vs. strong players in the BTR space over the next six to 18 months.

Together with
September 15th, 2022
In The Thrall Of The Fed, Operators Tap Tech To Harden Against Risk
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Setting aside for a moment whether the people at the helm of the Federal Reserve are villains, or inept, or susceptible to the risk of bad and lagging data sets, or any number of other causes for blame, what they do at their FOMC meeting next week will be what they do.

A New York Times piece this morning from Federal Reserve beat correspondent Jenna Smialek notes:

Central bankers have been hoping to slow the economy enough to decrease job openings without harming it so much that unemployment jumps. Some economists still think that is possible, given how unusual labor market conditions are right now.
Yet, a faster, more drastic series of rate increases would heighten the chance of a sharp pullback in growth that pushes up unemployment.

How the action they take impacts and reverberates -- through not just for-sale but also rental housing, Wall Street, and Main Street – will set the terms and conditions for reality. Right or wrong, good, bad, ugly, or indifferent, that reality is upon us. The dynamics and unknowns of inflation and the kinds of squeezing it will take to ratchet it down to the 2% levels considered tolerable and healthy have us all guessing on two crucial measures of misery and opportunity: Trajectory and Duration.

  • How high will interest rates go and for how long?
  • How sticky will 4% inflation – once supply chain whiplash imbalances regain equilibrium and the "low-hanging-fruit" inflation drivers roll back rates from current 40-year-high levels over 6% – remain, and how long and how hard will it be to get it to 2%?
  • How far will home prices fall, and for how long will they decline?

Barry Sternlicht, chairman and ceo of Starwood Capital Group is unambiguous about what he thinks of the Fed and its inflation-killing tactics right now:

“The CPI, the data they [the Fed] are looking at is old data. All they have to do is call Doug McMillon at Walmart, call any of the real estate fellas and ask what is happening to our apartment rents,” he said, pointing out that the rate of rent growth is now slowing.
The continuation of rate hikes will also cause a “major crash” in the housing market, Sternlicht predicted. The once-hot real estate market is swiftly slowing down, with mortgage rates for a 30-year fixed loan over 6% — up from 3.29% at the start of the year, according to Mortgage News Daily.

If Fed chair Jerome Powell were taking Barry Sternlicht's call right now, we probably would not be quoting a Sternlicht interview on Squawk Box. Like as not, however, the terms and conditions of reality – hidden until at least next week's glimpse at the Fed's next move – mean this:

A property valuation famine period will now follow the feast that took place between March 2020 and Spring 2022.

And, mind you, while owner-occupied property values and transactions will no doubt be feeling that famine, don't imagine that rental communities will be immune from misery.

For the hyperbolic single-family build-to-rent space, higher borrowing and financing costs exert pressure both on present and future land valuations, as well as on the pro formas of projects in the pre-development, development, and early construction stages preceding the cash-flow they'll produce when they're leased up and running.

What's more, residential investment's "the-only-game-in-town" halcyon days immediately following Covid's initial crisis, now seems to have run its full course as other safe-haven investment classes, some of them in other areas of real estate have emerged as alternative channels to pursue investment yields.

In a sweeping property valuation famine – whether or not it actually crashes into bear market 20% declines – equity takes a hit, deals go upside down, and they break, some of them, historically, to cents on the dollar resets. Pain spreads.

Expect that property valuation famine to cull weaker, less strategically and operationally sound projects and players from the herd in the months ahead. Ones that get snagged on local entitlement risk, or who founder on unforeseen pre-development challenges that delay vertical construction, or stall-out on ongoing supply chain-labor constraint chokeholds and snafus that wreak havoc with schedules and project milestones. They're the ones at greatest risk of having their deals break down due to failures to mesh their models with reality.

Stronger operators with reliable on the ground relationships, powered by reality-tested single-source-of-truth data, process, decision-chain, and management platforms stand far better odds of making a go of the near- and median term potential of consumer-driven single-family built-to-rent neighborhoods.

Gravitational pressure on property valuations – the extent and impact of which we may not yet fully recognize – will domino, and it will squeeze money, time, and opportunity, breaking deals that aren't grounded solidly in operational realities, while others reach their pro forma goal lines despite a shifting, volatile, and turbulent economy.

Resilient operators will work that compressed and stingier broader context to their advantage. They'll know how to do more with less and thrive.

Salman Ahmad, co-founder and ceo of Mosaic, talks about a "flexible technology stack" that allows both builder operators and skilled frontline workers to function and do what they're best at in synch with one another. As Ahmad puts it, it's a technology solution that enables operators in construction to do and be their best, without pulling a rug out from under them:

How are we doing this? We analyze construction drawings before construction starts to clarify exactly what needs to be done. We generate lot-specific construction worksheets (“mini” versions of the full plans) that highlight the essential information with additional data to eliminate ambiguity. This normally would be a huge lift to generate for every house in even modest-sized housing developments, but we leverage a programming system that automates the lift for us.
"Right now, we have been doing this for framing. The data and automation has not only made the process clearer for workers, it has reduced waste and costs. We plan to build on this success and apply the technology to other trades, like HVAC, electrical and plumbing.
"In addition to making each trade more efficient, we also want to solve the logistics issue of getting everyone to show up at the same place at the same time. Trying to coordinate each piece of the house for delivery and assembly on site is a logistical nightmare, with ample opportunity for components and labor to be delayed. We are building predictive models and other data logging solutions to make this process more reliable and efficient."

In January – even before the Ukraine war – we wrote:

The claim comes from a mid-field, front-row seat witness to the some $60 billion in investments experts estimate began flowing from financial investors into the residential real estate market in 2021 and will continue to underwrite deals through the current year, powered by an asset class that's taken real estate development by storm in the past two to three years – single-family rental communities.
"90% of the residential land deals underwritten by these financial investors between mid-2021 and the end of 2022, that are pegged to begin executing starting in late 2022 and into 2023 will miss pro-forma business projections – by a mile," says an executive active in the land, development, and home construction space in multiple U.S. markets, with direct knowledge of when many of the Wall Street-fueled investments began changing the rules of the land game last year and now sees more than a few of them showing signs of wear and tear as messy realities of zoning, permitting, development, and construction play out. This executive sees a reckoning."

The culling has begun. Right or wrong, the Fed will do what it's going to do. The markets will react, respond. Only those who are fit for more adverse conditions, and enabled by a "flexible technology stack" will come out of this time entirely intact.

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ABOUT THE AUTHOR

John McManus

John McManus

President and Founder

John McManus, founder and president of The Builder’s Daily, is an award-winning editorial, programming, and digital content strategist. TBD's purpose is a community capable of constant improvement.

ABOUT

Residential construction made easy. As a tech-enabled general contractor for the residential development industry, Mosaic focuses on production-scale projects of all types, from single-family homes to horizontal apartments to other build-to-rent product types.

Website

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John McManus, founder and president of The Builder’s Daily, is an award-winning editorial, programming, and digital content strategist. TBD's purpose is a community capable of constant improvement.

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Residential construction made easy. As a tech-enabled general contractor for the residential development industry, Mosaic focuses on production-scale projects of all types, from single-family homes to horizontal apartments to other build-to-rent product types.

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