Home Is Where the Alpha Is: Busting the NIMBY Cartel (HomebaseDAO)
Why our Redfin browsing is doomed and how fractionalizing real estate can help.
(A special collaboration with Domingo Valadez of HomebaseDAO)
Why you can’t buy a home
By the time you reach adulthood, you think that you’ve passed most of the milestone birthdays. That enthusiasm that marks your childhood fades and each new year seems to bring more of the same. When you’re 16, you get to drive. When you’re 18, you vote or buy that first cigar (just kidding, Mom). When you’re 21, you take your first (legal) shot.
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But there’s this milestone that happens around the time you turn 30 that no one tells you about. All of a sudden, you feel compelled to start browsing houses on Redfin and Zillow. I swear - it happens like clockwork. It’s got to be something deep in our biology.
So over the last couple years, I’ve watched as my once-youthful friends have been taken in by the siren song of Redfin. I've looked on with horror as they start spending weekend afternoons at open houses. And this behavior is self-destructive because, here's the thing:
The American housing market is fucking terrifying right now.
Already, the pandemic had driven the median housing price up by 46% in the last three years:
And then the Fed raised interest rates to, y’know, stop hyper-inflation or whatever. The Harvard Joint Center for Housing estimated that these rate hikes raised median monthly mortgage payments by $600.
And so, those of us reaching our 30s and hoping to live that Great American Dream of Homeownership are … well.. screwed. Even if we skimped on lattes and avocado toast.
It turns out that this is pretty bad for the typical millennial’s financial health. You see, homeownership remains one of the primary routes to building wealth in the United States.
A 2018 analysis by Laurie Goodman and Christopher Meyer calculated the relative financial returns of buying a house compared to renting in 2002. They found that, over the last 20 years, home ownership was a better performing asset than bonds, the S&P500 and even investing in a public apartment ownership REIT.
And this return is even government subsidized!
The US Tax Code has a large set of incentives to encourage homeownership. There’s the “tax break” on imputed rent – or, roughly, the taxes you would pay on income as a landlord if you rented out the home you live in. It’s not taxed everywhere, but many countries in Europe do tax it. It totaled 121B in savings for homeowners in 2019. There’s the tax deduction for mortgage interest – that one totaled 25.1B. There’s property tax deductions - $6B. There’s the tax break for selling your primary residence - that’s a $43.6B gain in 2019.
That’s roughly ~$200B in tax savings accrued by the American homeowner every year. Or roughly 13% of the total federal income tax paid in 2019.
Why does the US government provide such favorable terms for homeowners? There's the narrative piece: The American Dream(TM) always meant owning your own home. But there's also the fact that home ownership is the primary way Americans built wealth.
In 2019, home ownership accounted for 26% of all American household wealth. Business ownership was second and reflected 20%. Retirement accounts reflected only 15%. And other stocks/bonds reflected just 7%.
And this asset investment is also critical leverage for accessing other financial tools. It's a way to build credit. And it's a tool for accessing securitized loans with lower interest rates.
So – here we’ve got this asset that appreciates in value, has preferential tax treatment and opens up new financial opportunities. Plus, it feels pretty cool (I imagine) to own your own home. King/Queen of the Castle and all that jazz.
So if prices are going up like crazy, why wouldn’t we see a boom in new houses that would restore prices to equilibrium? Is our Invisible Hand asleep on the wheel?
It turns out there are two factors to blame here. I don’t want to get all technical but we can call them: Supply and Demand.
The Demand Spike
Some of the growth in demand over the last ten years has been natural. After all, the US population has been growing (albeit, at a slower rate).
But some of the surging demand for home-ownership is attributable to the rise of private equity investors. In the low-days after the bubble burst in 2008, speculators began to buy up homes for pennies on the dollar. Today that spending spree continues. Investors buy out properties then rent them out to the same people who would have bought them.
In the first quarter of 2022, the Harvard JCHS estimates that investors bought 28% of single-family homes on the market. In fast-growing markets like Atlanta or San Jose, that number is closer to 40%. Redfin, whose analysis looked at all homes (not just single-family ones) found that investors bought 20% of all homes on the market in Q1. That’s 30% more (in relative terms) than they bought one year ago.
And this bet makes a lot of sense for these investors!
They are able to out-compete residential home-buyers because they have large amounts of capital on hand and can deploy it quickly. They are also willing to pay above market rates, if they see potential for long-term returns. And usually, they can find a way to make higher numbers work. Real estate is a phenomenal asset class. Investors can make money on short-term or long-term rentals. This guarantees a liquid cash stream. At the same time, they get preferential tax treatment and have an appreciating illiquid asset.
And you really can’t blame these investors for what they’re doing. The market makes their actions so logical that it would be malpractice for them not to invest. That's why speculators -- and surging demand -- are really just a symptom of a broader disease. The United States does not build enough housing.
The Supply Crunch
In 2021, Freddie Mac estimated that the US had a housing shortage of 3.8M homes. Considering the US has ~126M households, that’s a supply gap of ~3%.
As we can see, this shortage starts way back in the Global Financial Crisis…. And then just kind of lingers:
As the Recession hit the housing market, construction workers moved into other fields. 81% of General Contractors polled in a 2020 survey said they had issues with hiring their workforce and this led to lower housing construction.
But there are other culprits, too. As Freddie Mac notes, even during the halcyon days of the housing bubble, entry-level home construction was falling off a cliff:
And this points to the other major culprit in the housing shortfall: zoning regulations.
In the 70s and 80s, environmentalists pushed back against overdevelopment. They used environmental reviews and restrictive zoning to keep communities in-tact. Today, those same tactics are used to stop construction of new, smaller, cheaper housing. The existing homeowners have the political power to create and enforce these new zoning restrictions. They also have a powerful financial incentive to do so. The less housing is built, the more valuable their home.
Who doesn't want their number to go up?
Let Them Own Shares!
Broadly speaking, there are three ways to level the playing field for homebuyers.
We could prevent private equity buyers from purchasing homes. That would drive down prices. It just might also collapse the housing market. Which would, y'know, discourage new building (lower price, lower incentive to build). So… let’s put a pin in that one for now.
We could change policies to remove local zoning impediments to construction and launch a housing boom. We should do that! But right now we lack the political will.
Or, we could make housing more accessible as an asset class. We could let younger and middle-income Americans get some skin in the game. We can do this by enabling investing in fractional shares of real estate.
This approach might seem like fighting fire with fire. After all, if speculation is responsible for driving up asset prices, how is increasing the number of speculators going to help?
But there’s an important nuance here.
The problem isn’t that speculators are driving up prices. It’s that after purchasing a home they then use their political and financial power to constrain the housing supply. This leads to a negative feedback loop.
Only people with money buy homes in single-family zoned areas. The politicians in these areas then only serve these home owners. Homeowners have a massive financial incentive to keep housing scarce in their area. So they only elect anti-housing officials. This locks in a low supply in a given area as Marc Andreessen well knows.
The solution to this feedback loop is part political, part market-driven. First, we need to broaden housing policy from local jurisdictions to state targets. In San Francisco, for example, the city is being pressured by the state to hit housing construction targets. This ensures that all Californians — not just home-owners in, say, Atherton, get a say in housing policy.
But housing policy also struggles from a collective action problem. Homeowners are heavily incentivized to care about policy. We need to get more Americans invested in the housing market.
If we can lower the barriers to real estate investment through fractional shares, we can create a new real estate focused voting bloc. As these investors see returns on their real estate shares, they will seek more investment opportunities. Because their wealth is not tied to a single property, they are likely to be more promiscuous in investing in any yield-generating real estate project. This, in turn, will create a race to extract profits. Investors will increase financing for new housing construction until the actual point of market saturation. Y’know — how an actually healthy market operates.
And this is where moving real estate on-chain can play a role.
Web 3.0’s ethos, of course, is about giving ownership and power back to the people. Think of a collective facilitating profitable real estate investments. Think of a group of friends coming together to buy a shared home. Imagine a world where investors -- irrespective of wealth -- have the opportunity to benefit from residential real estate investment.
One of the biggest superpowers of web3 is giving liquidity to a historically illiquid asset. Imagine that the ownership of a physical property was able to be fractionalized and represented online via tokens.
You could have a $420k home split into 100 tokens, with each token being worth $4.2k. Instead of relying on a broker to sell your 420k property to a single interested buyer, you could decide to sell 60 of your 100 property tokens, and keep the remaining 40. Those 60 tokens could be sold in the open market to not just 1 buyer, but to 60 different buyers. Suddenly, you have a property owned by you (you hold 40% of the tokens) and 60 other individuals who each own 1 token, or 1% of the property.
This is a model that works well for the homeowner who is able to keep as much of the equity in their home as they want. These “master tenants” would then be able to live in the home, paying prorated market rent to shareholders. Meanwhile, their investors can benefit both from rent and appreciation in the underlying asset.
At first glance this type of approach might seem unattractive to existing homeowners. But it actually could benefit these traditional buyers. Mortgage payments, especially those at a 5-7% rate, are typically 20-40% higher than rental payments for a property. By owning shares of the property, you stand to pay less in rent, and to save on imputed rent taxing.
This is the future that Homebase (Domingo’s startup) is currently building. They are working towards democratizing access to real estate investing.
Of course – this particular notion is not limited to blockchain. There are a number of real estate start-ups that are working on fractionalizing home equity. But what is unique about blockchain is how its open-protocols and decentralized data can provide transparency, liquidity and efficiencies in the opaque and clunky real estate market.
Efficiency gains are not hard to come by in the real-estate space. By transitioning lien data on chain, we could abolish the need for title insurance. That’s a $22B industry that could be liquidated in favor of buyers savings.
Then there’s the potential abolition of lender gain-on-sale. As Packy wrote this past week in Not Boring, “Fannie Mae estimates that 6% of the total cost of U.S. homeownership is a result of lender gain-on-sale, which compensates lenders for the 1) time lag between origination and loan sale, 2) uncertainty of execution, and 3) embedded process inefficiencies. Originating loans on-chain, with smart contracts executing securitizations for de minimis additional cost, could materially reduce gain-on-sale while increasing lender profits by reducing the time-and-cost-to-securitize (freeing up expensive working capital).”
But this type of sea change will take time and lobbying energy to realize. Housing is a highly regulated industry. As 2008 showed, that’s for good reason. But regulation can also seize a market in favor of rent-seeking incumbents. The project of America's regulators must be to find a middle path.
Realizing the future outlined here will take some big changes. Among them, we will:
1. Need to encourage local governments to move real estate data on-chain, allowing them to be represented as “mirror assets.”
2. We will need increased regulatory clarity on how to consider house-tokens. Ideally, we would move away from treating these fractionalization as full, public equities.
3. Finally, we will need a stronger regulatory regime for tying NFT ownership to asset ownership.
This process is already in-flight for commercial assets in Delaware and Wyoming.
That’s a lot of “ifs.”
But if America is going to reinvigorate the engine that drove former generations' prosperity, we need big ideas. Fortunately, there's a large class of entrepreneurs up to taking on the regulatory risks. For the sake of our economy and for the sake of 30 year old Zillow addicts everywhere – we should hope they find a way to succeed.
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