🔎The Real Estate comeback will still be huge.
Capitulation in progress...
TLDR Summary
Homebuyers and real estate investors are capitulating. Not because they are forced to sell as part of a margin call, but because they are enviously looking at the stock market where returns are much higher. This sentiment is reminiscent of the late 1990s. A megabid into real estate followed when stock market returns started disappointing.
The poor housing sentiment is part of a larger trade, namely the capitulation on the US consumer. Investors don’t want to bet on Americans, whether for them to buy homes or sneakers. And Americans aren’t betting on themselves either. I believe it’s time for them to be proven wrong.
Falling mortgage rates are the most likely catalyst for a revival of the housing market. Economic growth expectations baked into the prices of US Treasuries are too high from a demographic perspective anyway.
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No comeback yet
In August, 2024, almost two years ago, I published the bull case on real estate below:
I argued that the asset class should in theory do well as part of the Debasement Trade. It’s difficult to make more supply of prime real estate just like it’s difficult to mine more gold or recreate iconic companies.
Few market segments are as AI-proof as real estate. It’s naturally scarce. In spite of that feature, it has fallen completely out of favor, in part for macro reasons (high interest rates), in part for industry specific reasons (office). Once a property doesn’t have a product/market fit anymore, it’s often challenging if not impossible to redevelop it without losing much of the equity.
This article has not aged well so far. The S&P Cotality Case-Shiller U.S. National Home Price Index is up just 3% over the 20 months that have passed and the annual rate of price appreciation is closing in on zero.
Depreciation and maintenance costs have exceeded price appreciation of many properties.
Rent growth is falling. The Zillow Observed Rent Index (ZORI) currently measures LTM rent growth at just 1.8%, significantly below the 4% average observed in the 2010s.
Other subsectors outside of the residential space aren’t doing well either. The Vanguard Real Estate Index Fund ETF VNQ 0.00%↑ , a large ETF that is primarily comprised of commercial real estate assets, is pretty much flat over the same period.
Most real estate investors have not enjoyed any appreciation over the last 20 months. At best they have earned 3-4% income yield annually. In many cases, they would lose more than that if they sold today. Over the same period, the S&P 500 is up 26%. Gold is up 90%. Even Bitcoin is up 17% despite its recent sell-off.
Had you bet on real estate when I published my article in August 2024, you would have underperformed significantly since then.
Investor capitulation
This underperformance has scarred investors. If sentiment is not at rock bottom yet, it has got to be close. Last week, the real estate investor Graham Stephan published his personal capitulation on Substack.
In case you don’t know him, he is a media personality who started out as a real estate agent and built a large social media following sharing his knowledge and investor journey. He declared that he will sell his entire rental property portfolio in the coming months, primarily out of frustration with local authorities in Los Angeles and with the weak financial performance of the properties. In his article, he compares the income yield on his properties of 4-5% with Treasuries. He feels that those pay similar income without the risks and hassles of owning rental properties.
While he doesn’t say it explicitly, it’s clear that he doesn’t expect any value appreciation or income growth from his properties. He has given up. He is framing that as a cool-headed decision. But the truth drips out of every line he wrote: He is driven by emotion. It’s a capitulation.
Today, he published a follow-up announcing that he intends to put the proceeds into bonds, stocks, most importantly international stocks, and Bitcoin. Can you think of a more consensus positioning? My confidence in US assets generally is even stronger than in real estate specifically.
The reader comments on both Substack and X are even more striking than the capitulation of such a high-profile investor. I’d estimate that about 90% of the replies echo his sentiment: Real estate is a garbage investment, not worth the effort. Stocks pay much more and they do so stress-free.
Hard data supports this anecdotal evidence. In a 2025 Gallup survey, only 26% of respondents currently think it’s a good time to buy a house. It’s still close to the lowest level since this survey was started 40 years ago. They will publish the 2026 survey results soon. I’m eager to see those.
Per the Bank of America Global Fund Manager survey, institutional investors are currently underweight real estate as much as during the aftermath of the GFC 15 years ago.
Interestingly, consumer discretionary and consumer staples are the only sectors they hate even more than real estate. To some extent that’s the same trade. Real estate could be viewed as a subsector of consumer discretionary. Buying a house is possibly the most discretionary purchase of all. You buy it when you can afford it just like you buy a new car or new branded clothing only if you can afford it.
Investors don’t expect anything from the American consumer. And homebuyers feel the same way. Existing home sales and new home sales are both significantly below historical averages.
There are 70 million more people living in the US today than 30 years ago. Even if 2005 and 2021 were excessive, current home sales feel way below sustainable levels.
It feels like there is significantly more reward than risk here. Consumer confidence is arguably very poor. But objective reality isn’t really that bad. Per the Fed’s distributional financial accounts of the US, the 50-90% wealth percentile (arguably most representative for the financial wellbeing of the US middle class and potential home buyers) has grown total wealth from $31tn in 2019 to $51tn in 2025. That’s a 65% gain, easily outperforming the cumulative inflation of 28% over the same period.
Even if reading the news doesn’t make it sound like it, the US middle class has been getting richer. The unemployment rate remains low. The delinquency rate on credit card loans is below the historical average and falling. The same is true for the delinquency rate on all consumer loans.
It seems that much of the weakness in consumer spending is sentiment driven rather than due to actual hardship. People are scared of inflation, interest rates, geopolitics and AI. If the outlook on any of those factors improves, consumer sentiment will improve as well. Demand for homes and housing in general will then benefit.
Affordability
It’s easy to form a bearish view on home prices by pointing to where they stand relative to incomes. The data on that differs based on the source. But overall, it’s safe to conclude that home prices have greatly outperformed incomes over the last decades.
The chart below indicates that the average home price to income ratio is currently 7 in the US, about the level shortly before the GFC and about 30-40% higher than for most of the post WWII period.
In this context, it’s important to understand that affordability alone is not a sufficient condition for poor prospective performance. Would you say that one Bitcoin is unaffordable at $75,000? Or would you say its price simply reflects the preferences and financial resources of its buyers?
One must understand where the lack of affordability comes from and whether the driver is sustainable or not. There are several reasons to support home prices being structurally higher vs. incomes. Two of them stand out for me.
Firstly, labor force participation. The labor force participation of the 25-54Y age group has risen from under 60% in 1950 to almost 85% today. Many women have joined their men at work.
That trend is structural. The consolidation in the 2000s and 2010s in the chart below is primarily driven by the age structure within the labor force. As baby boomers aged, they first went into prime employment age and then graduated into retirement. Labor force participation naturally starts declining way before official retirement age. If you lose your job at 30, you are more likely to look for a new one than when you lose it at 50.
As a result, many double income households are now competing for the same homes that were previously financed with single incomes. This puts upward pressure on home prices. The activation of women in the labor force has raised living standards for goods and services where a supply response is possible. Basically anything you can buy in a store. But it has made it more difficult to acquire products or assets that are naturally scarce. Sure, you can theoretically build more homes by converting cow pastures into neighborhoods. But desirable locations are hard to replicate.
Secondly, consumer preferences. Today, consumers prefer larger homes than they preferred (or were able to afford) in the past. New single family homes in the US are today about twice as large as they were in 1970s.
The chart below is a bit dated, but it tells the story quite clearly. At the same time, household sizes are shrinking. In the 1970s, there were 3 people on average per home. By 2015 this had dropped to 2.5.
Bigger homes and more home per capita. It’s unsurprising that the cost of housing has risen faster than incomes, isn’t it? Both are factors that can’t be expected to reverse anytime soon. Housing is part of people’s personal brand similar to where, how they travel and what car they drive.
Mortgage rates
Mortgage rates drive the performance of real estate assets like barely any other variable. They determine levered returns and valuation multiples. Whether you actually use a mortgage or not, buying real estate is a bet on falling mortgage rates.
Mortgage rates consist of two components, the risk-free rate aka as the Treasury yield, and the spread of mortgage rates above that risk-free rate.
Treasury yield
The 30Y Treasury Yield currently stands at 4.9%, the highest it has been in 20 years.
Treasury yields compensate investors for opportunity costs and inflation. The stronger the (expected) returns in risk(ier) assets, the higher the Treasury yield. The higher the expected inflation, the higher the Treasury yield. That’s why the 30Y Treasury yield typically trades close to nominal GDP growth as observed in recent history.
And that GDP growth closely correlates with productive age population growth (defined by me as 20-54; one could extend to 64 and get the same story, but correlation coefficient would be weaker). People in productive ages don’t just provide goods and services. They also have the incomes to create the demand for them.
2022 to 2025 have been outlier years. Nominal GDP growth has been more than 2% higher per year than predicted by the historical correlation with productive age population growth. The inflation caused by the surge in fiscal deficit spending is obviously the most plausible explanation.
US productive age population growth is expected to accelerate moderately until the early 2030s and will then fall again. The acceleration is a temporary effect as the aftermath of the baby boomer retirement wave. Overall, I see the fair level of the 30Y Treasury yield at 4% maximum in this environment. Unless the US government goes full Argentina of course. But that should boost rents and home prices as well.
Spread
The 30Y mortgage rate currently stands at 6.3%, 140bps above the 30Y Treasury yield of 4.9%. The average spread over the last 40 years has been 1.4% as well. It seems close to a fair level, not just in the historical context, but also considering the most relevant spread determinants.
In fact, I see downside potential for the spread. It’s primarily determined by three factors:
Credit risk: Investors deem mortgage borrowers less creditworthy than the US government which is why they require a higher yield. This yield premium will surge during times where US households are financially under pressure, for example during recessions. Right now there is very little risk in US household balance sheets in my opinion. The Treasury is still pampering them with huge deficit spending.
Interest rate volatility: The more volatile interest rates are expected to be, the higher the mortgage rate vs. the Treasury yield. Mortgages typically come with prepayment options. When interest rates fall, borrowers will accelerate payments and investors miss out on the return they thought they had locked in. The more investors expect falling/volatile rates, the less attractive they deem mortgage lending. Only a small minority of investors expect falling long-term rates right now. I don’t think MBS investors consider prepayment risk elevated.
Lender balance sheet and preferences: Commercial banks and MBS investors are the primary lenders in US real estate. The more liquidity and appetite they have vs. overall appetite for Treasury securities, the lower the mortgage spread will be. I believe US residential real estate will be a very attractive asset class for fixed income investors in the near to medium term, esp. if private credit continues to struggle. Home buyers have a better creditworthiness than software companies the lunch of which is eaten by AI.
Sincerely,
Rene