The housing market looks like it may be entering a period of rapid consolidation. Following a post-COVID boom, mortgage rates are on the rise, listing prices are getting reduced, and inventories are on the rise. Phil Bak is the CEO of Armada ETF Advisors, the issuer that oversees the Home Appreciation U.S. REIT ETF. He joins the ETF Think Tank to offer his thoughts on the state of the real estate market, where he sees opportunities today, and the challenges of launching an ETF.
Goldman recently came out with a forecast that predicted a housing crisis that wouldn’t end until 2024. Bak agrees with the assessment. He believes that high rates should persist and remain higher than they’ve been in years. There’s certainly a supply/demand imbalance already and the market could be in real trouble when adjustables kick in. Bak notes that it is important, however, for Investors to differentiate between REITs and real estate/homes. Vanguard’s real estate ETF, for example, is not all that correlated to home prices. With residential REITs, you’re talking about rental income. Those are much slower to move than home prices. As long as rental rates are at 94-95%, it’s going to be difficult for rent prices to come down. Bak expects home prices to come down with greater velocity, but there’s more of a cushion on rental incomes than most may think. It is more stable and less volatile.
There is not a lot of data out there for how real estate can be expected to react in a high inflation environment. Bak says that if we get to hyperinflation, you probably want to be in home ownership. Rental incomes tend to be more stable and are more correlated to wages and incomes. There is going to be a big dispersion of inflation rates by region. As a result, we are going to see more of a dispersion of returns and incomes by region. That means investors will likely need to spend more time thinking about their REIT allocations. There are going to be opportunities to generate alpha by being more selective. Office buildings, for example, do not look attractive right now.
The conversation switches to entrepreneurship in ETFs, which Bak thinks is the Silicon Valley of financial services. You can come to market with a great idea and make it unique, but you need to tell your story and succeed. Cathie Wood is a good example of this with the disruptive innovation story. The success rate of new ETFs is not high, but the scalability can make the upside high. Being more targeted, especially in real estate, can offer a greater chance of success.
Bak notes that you launch with a 35% chance of failing. There are parts of the entrepreneurial experience that are hard. The ones that say it’s great are the ones that have survived. There is a difference between the founders and the managers that came later. Founders think there is a way around every obstacle. Managers think about efficiencies and such, but the point of view is different. The house cat and street cat are different. The experience makes us the street cat and you can’t shortcut it.
Other key takeaways:
- Most funds launch after a trend has become popular and end up systematically underperforming. You need a product that you believe in, and you think adds value. If you don’t have conviction, your investors won’t.
- ETFs have a great deal of transparency, but hedge funds won’t tell you who is coming and going. Bak said it would be nice if fund managers were rewarded for that. In some cases, they are looked down on.
- The panel talked about why more family offices aren’t considering launching ETFs of their own? The feeling is that transparency is what keeps them out. Their biggest concern is taxes. Couldn’t they benefit from a tax standpoint? Absolutely. It would be a great way of achieving structural alpha for clients.
- Closure risk is more of a problem for the smaller entrepreneur despite their grit or passion. A lot of times the idea comes too late. If the style stays out of favor long enough, even the best ideas can fail. The best thing you can do to succeed is survive. The timing also needs to be right. If you’re too early, a good idea can fail.
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