Our Firm
Resi Wrap - The Big Bang
March 2024

Friends of ResiShares -

Today is Good Friday, a day that the entire securities trading industry has off, and nearly no one else does.

The securities business, where I spent the first 15 years of my career, has often marched to its own tune. Its ritualistic respect for the past, its dictionary of esoteric jargon and acronyms, and its often outsized profits makes it seem a vestige of the medeival guilds.

Traders don’t buy and sell shares, they “lift offers” and “hit bids.” They don’t like or dislike things, but instead are “bullish,” or “bid only,” or “bearish,” or think that a bad idea is “yours in size.” They are regulated by government agencies like the SEC and CFTC, not to mention the Fed and the OCC (Which OCC? Both, of course!), DTC, and FINRA, which is an SRO (meta-acronyms are the best acronyms).

Sort of like real estate brokers.

Like stock brokers and traders, real estate brokers’ value to customers as a trusted intermediary increases the more complex, inpenetrable, and gated the market is. This is why the last 45 years of securities market structure history is instructive for the future of real estate brokerage, now that NAR and various large brokerage companies are settling lawsuits around fixed commissions.

Mayday! Mayday! Mayday!

May 1, 1975 would be known as “Black Thursday,” predicted traders. The SEC mandated the end of fixed trading commissions on the New York Stock Exchange (NYSE), which market participants claimed would “bring about the downfall of our free enterprise system.” They claimed that SEC must stand for “Soviet Economic Committee” (I still like that acronym better than what Elon thinks it stands for).

Why were brokers predicting doom? Because they made eye-watering commissions and bid-ask spreads were wide enough to pass through a sideways-skidding Cybertruck, ensconsed as they were within a cozy monopoly since 1792. Brokers were concerned that unfettered competition would drive their fees down to marginal cost, putting many of them out of business.

And they were right! Commissions fell BEYOND ZERO, with institutions like Citadel willing to actually pay for the chance to interract with retail order flow. Bid-ask spreads collapsed to 1 cent wide across the vast majority of stocks. Many firms did go out of business, and many brokers earning outsized economic rents from positions of privilege were displaced by hungrier and cleverer competitors.

But the naysayers missed the big picture. The innovation sparked by competition led not just to lower costs per transaction, but to a far greater volume of transactions and technology-powered cost-compression. The trading firms that innovated and survived are wildly more profitable in 2024 than they were in 1974, despite the loss of monopolistic pricing protection.

The market participants also missed how long it would take for the full implications of the rule change to be realized. Eleven years later, in 1986, their counterparts overseas in London experienced “The Big Bang,” so named for PM Thatcher’s instant implementation of a broad, multi-pronged de-regulation package. It would not be until 2001 that the US would mandate “decimalization,” which allowed spreads to narrow past their previous minimum increment, 1/16th of a dollar, thereby not only shrinking spreads but putting paid to the practice of brokers charging “an eighth” or “a teeny” commission, instead converting it to cents per share.

Much like the actual Big Bang, theorized to have set the universe in motion, the regulatory Big Bang would spin off fractals of business model innovation that compounded unpredictably over a sufficiently long time frame.

It will be thus for real estate.

What Might Winning Look Like?

First, the obvious differences.

An individual investor will do hundreds or thousands of securities trades during their lifetime. An institution may do millions. These transactions are purely financial and largely frictionless. Selling Exxon stock to buy Pfizer stock does not require moving barrels of oil or safely storing medicine, nor is there much utility the investor obtains from the transaction other than whatever money they make (ESG considerations notwithstanding).

By contrast, most residential real estate is purchased and sold by owner-occupants who will, on average, own 3 homes in their lifetime. These are very large, very infrequent transactions, which makes it more likely that the home buyer will need to rely on the expertise of their agent to get it right. Furthermore, these are high-friction transactions. Even if the bid-ask spread and commission rates were narrowed to stock-like levels, the vast majority of home-buyers will need to physically move in order to take possession of a new home. This is all without mentioning the administrative burden associated with financing.

These differences are significant, and drive many of the internet hot takes (mostly from real estate agents and brokers) that “the NAR deal changes nothing, because you still can’t do real estate transactions at scale without a buyer’s agent.” They’re right, in the sense that going from today’s market paradigm to one not requiring a well-compensated buyer’s agent is indeed an insurmountable hill to climb, if done immediately. If the examples of May Day and The Big Bang are parallel, however, it suggests that the path to a new market structure will be gradual, but persistent in the same direction, and eventually compound into enormous changes.

It also suggests that the innovation will come from the pool of housing market participants not facing the same information asymmetry and frictional cost that require most homeowners to make use of an agent’s expertise.

Trickle-Down Market Structure

The thing about changes to market structure is that someone has to go first. The chicken-and-egg problem inherent in any market paradigm shift is that no one works for free. If buyers’ agents are accustomed to being paid by sellers’ agents, they will not (and SHOULD not) be willing to show houses that are not offering them a commission split, until a business model emerges to compensate them for their effort.

The last 15 years have seen the emergence of a class of single family home owners that does not suffer from the same constraints. Institutional SFR investors still hold less than 1% of the US housing stock. The approximately 500k homes they (we?) do collectively own, however, may be enough to incubate the business models that will come, over time, to change the way real estate gets transacted.

Institutional SFR investors routinely trade packages of stabilized, tenant-occupied homes with one another, working through brokers like Roofstock, SVN, and Entera. The industry is nascent and transaction volume infrequent. It runs primarily on non-standardized spreadsheets (as does the commercial real estate industry writ large), with market participants expected to bear most of the due diligence burden to price and inspect assets. Furthermore, with the current state of cap rates and interest rates, a seller’s best execution is nearly always with an owner-occupant, which requires non-renewing tenants, one at a time.

Having said that, one can easily picture a cap rate/interest rate environment in the future in which firms are actively buying and selling SFR homes both to each other and to homeowners, based on their unique views of price and rent growth and their return mandates. With sufficient liquidity and transaction volume, it would make sense for a central clearinghouse to emerge, either in the form of an exchange or even something akin to an equity dark pool, that forces participants to organize their property and operating data into a standard scheme. This, in turn, drives down explicit and implicit transaction costs. If we want to get really ahead of ourselves, we can propose that firms such as Opendoor and Offerpad (or, with the proper separation between ownership and asset management, Goldman Sachs and Citigroup) could act as market makers, holding homes on balance sheet from weeks to months for motivated sellers. None of these ideas require unilateral changes from a large number of buyer or seller agents. All they require is a few large institutions feeling that such a setup would be in their best interest.

Whether the innovation moves in the direction described above or something completely different, my base case is that the institutional investor community and the vendor and broker ecosystem that supports them find ways over time to standardize and consolidate home data and management processes. While institutional SFR is and likely always will be a small part of the US housing stock, a more liquid version thereof would represent a meaningful portion of US transaction volume, meaning an owner-occupant homebuyer will be increasingly likely to interract with a professional “home dealer,” not tethered to the traditional business model.

Standardization of data and process can power a wide-ranging bloom of business models. Flat fee brokerage models are just the beginning. What about an arrangement in which the buyer pays nothing on the transaction, but a fixed percentage of equity value per year (like a financial advisor), with the expectation that the Real Estate Advisor (new job title!) optimize their mortgage (and HEI!) financing, remind them to pay their property taxes, and interface with home repair contractors and tradesmen?

No matter the path forward for real estate, the experience of the securities industry indicates that a lower cost, higher-competition world will mean larger profits for the winners, and greater utility and choice for consumers.

Rest Of Resi

  • In case anyone had forgotten, China’s housing market is still a slow-motion trainwreck.

  • Modular housing is also struggling. Unlike Chinese real estate, I have high hopes for this business in the long run.

  • This self-described “Squatter Hunter” learned how to deal with illegal occupants and now helps others do likewise.

  • AOC and Bernie Sanders propose Green New Deal for public housing, remain bad at math.

  • LA home flippers are making money again in a tight market.

  • Over-optimism at the market peak is proven correlated to non-payment of mortgages after the market peak. Authors of study are good at math, bad at applying their talents to questions that actually require math to answer.

  • Jensen Huang of Nvidia has many nice houses.

T-RECS Of The Month: Beaumont-Port Arthur, TX

T-RECS is getting into the oil business (pronounced awwwl business), which makes sense, given that he and his prehistoric brethren have been decomposing into oil for the last few hundred million years. With the US now the world’s largest producer of crude oil and already a leader in natural gas, the strategically located Port Arthur refineries and waterways serve as vital processing and trading capacity for inbound oil and gas and outbound gasoline, diesel, and LNG. With an average home price of only $208k, T-RECS likes the upside.