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Yeah. Well, we're in an affordability crisis when it comes to uh to the residential housing market. Um many
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households are paying an extraordinary fraction of their income towards housing expenses, whether that's rents or or
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whether that's their their mortgage uh their mortgage payments. And um in a piece I wrote for the Aspen Economic
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Strategy Group with Vincent Raina um that came out in November, we outlined a list of potential solutions for dealing
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with affordability. Um, but ultimately it comes down to an imbalance in supply and demand. Uh, we simply don't have
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enough uh affordable housing units in the cities where people want to live. Welcome to the Ripple Effect, a podcast
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that takes you on a journey [music] through the minds of Wharton faculty. I'm your host, Dan Looney, and in each
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episode, we'll be diving deep into the inspiration behind the groundbreaking
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[music] research that Wharton professors have conducted and exploring how their findings resonate with the world today.
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We have seen the real estate market have quite the up and down ride the last few
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years. Home prices soared of course during the time of the pandemic and haven't lost a whole lot since.
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Meanwhile, the commercial market has had to deal with the work from home dynamic
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change how some companies think about their real estate footprint. So, what lies in the sector ahead? Pleasure to be
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joined [music] by Ben Keys, professor of real estate here at the Wharton School.
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Ben, great to catch up with you. How are you, sir? >> I'm doing well. Thanks for having me,
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Dan. Happy New Year. >> Happy New Year to you as well. It's interesting when you think about this
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industry right now, the word that seemingly comes up on so many different interviews in so many different places
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is seeing stability. Stability being that key word it seems like for 2026. Well, I think that's right. And and it's
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stable in the sense that we're not expecting big swings in in house prices, especially in the residential side of of
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the market. This is a market that is struggling on a number of different fronts. And I'm not sure if it's
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stability or or stasis or if it's stuck. Um, but all of those things uh ultimately lead to a similar pattern
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where we're going to expect national house prices to be relatively flat over
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the coming year. And those national house prices being flat are going to sort of hide a lot of interesting
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variation across the country. All right. So, we normally talk commercial and residential. Let me start with
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residential. Uh mortgage rates have come down a little bit. They're still higher
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than what we saw, you know, during the time of the pandemic. Uh we still have what's perceived to be a a fairly
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important shortage of properties. Uh these seem to be like two of the biggest issues out there right now. Yeah. Well,
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we're in an affordability crisis when it comes to uh to the residential housing
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market. Um, many households are paying an extraordinary fraction of their income towards housing expenses, whether
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that's rents or or whether that's their their mortgage uh their mortgage
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payments. And um in a piece I wrote for the Aspen Economic Strategy Group with Vincent Raina um that came out in
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November, we outlined a list of potential solutions for dealing with affordability. Um but ultimately it
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comes down to an imbalance in supply and demand. uh we simply don't have enough
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uh affordable housing units in the cities where people want to live. >> What are some of those ideas that you
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think are going to be important moving forward? >> Well, I think there are a lot of
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different proposals on the table. Some of those we're seeing from the administration just this week, sort of
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policy by tweet. Uh but if you if you think a little bit more substantively about about the challenges, it is really
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about supply. Um and uh and sometimes uh you know there are there are folks in the in the housing market that refuse to
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believe in the dynamics of supply and demand and the ways in which they play out. But ultimately affordability in the
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housing market is is is a function of supply and we need to make it easier to build. Um we need to ensure that
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construction financing is available um through the through the interest rate cycle and and broader business cycle. Um
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we need to do more to expand the the housing safety net. Um and I think we need to make home ownership a priority
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when it comes to um the challenges that um first-time buyers face in competing with uh with investors. So one of the
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things that has been a question in my mind for a long time is if you go back you know 60 70 years uh a lot of that
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affordability was assisted by the starter home. And it seems like we've done away with the starter home for the
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most part. you know that that property that you're just talking about that first property that somebody's looking
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to buy gets them indoor to home ownership and then they can live in that house for maybe 10 years whatever and
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build up to that next house. Now it seems like everything is $400 $500,000 and above and that's hard for a lot of
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people to consider to be a starter home. >> Absolutely. That first rung on on the
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housing ladder uh that you know gets your foot in the door to home ownership. It gives you an opportunity to build
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some equity and it also gives you a chance to access a neighborhood that you might not otherwise have been able to
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access. When it comes to school quality, when it comes to safety, when it comes to some other amenities, those are
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harder and harder to find. We are seeing a small decline in the size of new homes
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being built. So, new homes are shrinking just a little bit on average. But that said, I think your point is is a good
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one, which is um that the that most affordable tier of of housing is not what's being built. And a lot of that is
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a function of the high fixed costs of construction. It's difficult for builders to get uh approved. Um so to
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get permits um and zoning challenges, something we've discussed for a long time is a big barrier. When you raise
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those fixed costs, it means there's a higher hurdle to construction. We've
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also seen construction costs rise sharply um really over the last 10 years. um you know house uh con house
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housing construction costs are up about 60%. Over the last 10 years and that's a
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function of both materials, labor, land and everything in between. And now you add financing costs with high interest
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rates. And all of those things point to developers choosing to build at the high
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end rather than the low end. Well, you mentioned uh the uh policy by tweet. Uh there are obviously a couple of things
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in the most recent period that we heard from the administration. uh one being uh
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that you know people that are connected to the president buying uh mortgage back
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securities to maybe help uh lower rates, but the other thing was that President Trump brought up was corporate ownership
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in single family homes and trying to maybe ease that out a little bit. I I don't know where both of those
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components live. I don't know if you wanted to speak about either one of those, but the government seemingly is
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going to play a role in trying to alleviate some of these issues, isn't it? >> I I think that's right. What's clear is
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that the the problem has been diagnosed by the administration that we have an affordability problem. You know, maybe
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maybe the administration read my op-ed in the Hill this past week uh with my colleague Vincent Raina on on improving
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housing affordability. Um but they are throwing some ideas uh at the wall and seeing what sticks. The worry I is that
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a number of these these ideas are going to stimulate demand rather than supply. And what that means in the housing
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market is that's going to bid up prices. And so if we think about things like the
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the 50-year mortgage or um you know buying mortgage back securities to try to drive down the mortgage interest rate
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that is going to make um you know housing purchasing more accessible for those people on the margin who are you
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know feeling crowded out because of high interest rates. But at the same time there's going to be more of them bidding
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bidding for a scarce number of houses. And so there's going to be a portion of
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that that's going to be captured by the existing owners in the form of higher
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prices. It's hard to know exactly how how that all plays out, but I think, you
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know, if we're looking at the the spectrum of potential policy responses, I think doing things that are largely on
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the demand side are probably going to have unintended consequences. I'm much
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more excited with with policies that are going to stimulate supply. And some of those are really uh when it comes down
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to it about building new uh new housing, new construction, new units. >> But the the administration's proposal to
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to squeeze uh institutional investors out of the market is another you know potentially very controversial and you
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know potentially illegal uh proposal uh when it comes to thinking about um about
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solutions to get people into home ownership. If you think about the large institutional investors in the US, those
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that own, you know, a thousand uh homes or more, they represent only 1% of the US housing stock. And so on the margin
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at that scale, it's just not going to move the needle for the affordability issues in the country. But as we go
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further down and we think about the overall investor share in the market, it is on the order of 10% of all single
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family homes in the country are owned by investors. And so, you know, I think there are things that can be done
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through the tax code, um, through credit markets that that could, um, reduce the
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benefits of ownership for investors and and steer those more towards, um, owner occupied residences. But I think, you
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know, you know, fiat by tweet is certainly not going to get it done. >> And and we need to do something that
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that's far more um, thoughtful and um, and resilient to um, to to potential challenges in the court.
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>> What about the rate lock component? And that's something that we've talked about
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for several years now. I mean, when you, you know, got into the early days of the
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pandemic, so many people refinanced at 2 and 3/4, 3%, three and and a quarter% on
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their existing home. That allowed them to open up and and do home projects. And there's just not a want or a need for
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many people to move because of that. And that's the component that I I'm you know
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from a historical perspective I don't think we had prior to the pandemic. You
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can correct me if I'm wrong in that, but it it's a dynamic we're going to have in
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this mix for quite some time. It it is and and it's something we've we've been
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talking about for years now and will continue to talk about for years because over 50% of all outstanding mortgages in
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the US have interest rates below 4%. And so when we're talking about doing things
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to the mortgage back securities market that might move interest rates by 25 basis points, you know, from a little
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bit above 6% to a little bit below 6%. The majority of mortgages are below four and and most of those people are going
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to sit on those mortgages. um that is a you know one of the the the strongest performing um assets in their portfolio
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is is a below market mortgage and that induces people to stay in their homes longer than they otherwise would. I
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don't think we've seen this dynamic uh play out in really modern mortgage
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history in the US with this degree of lock in and I and I think what that ultimately leads to is many fewer homes
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on the market. it leads to to many fewer transactions and and it leads to these frictions when it comes to um people
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finding where they want to live. I think one more underappreciated piece of this
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is you know co really acted as a type of musical chairs in the housing market. There was a big opportunity where the
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music was playing interest rates were low and people reoptimized and a lot of that reoptimization was accelerated
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retirement or it was accelerated suburbanization. So people with young families moving to the suburbs, well the
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music stopped, interest rates uh shot back up and now those people are happy where they are. And so, you know, I
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think that that pulled a lot of transactions forward uh in time as well. And all of that leads to a more
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depressed housing market when it comes to transaction volume and when it comes to the availability of properties. I I
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mentioned the the uh the commercial real estate sector and let's spend some time
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on that right now. Uh this obviously an industry that has been impacted by the pandemic as well because of the dynamics
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of how companies have thought about their footprint. Uh employees working from home more often. Uh companies
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reassessing just how much real estate they want to have in the mix and that's
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leaving a lot of uh you know main street shops in some cases open and not being used. Yeah. I mean the just like with
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with the residential side of the market, this has been a gradual process. I think
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in some ways the financial crisis in 2008 sort of warped our brains into thinking that housing and real estate
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markets respond very rapidly um to changing conditions and in fact they usually respond very slowly. Mo most
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office uh leases are 10 years or longer. Um and so firms are only very gradually
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reassessing uh how much space they want to use. Um but we are seeing a big uptick in in office um to residential
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conversions and uh you know this year um we're going to see the Flat Iron Building in New York City um probably
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finish their conversion process um into into residential units and that's kind
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of the um you know the the the the leading uh I would say the leading example of a very famous building uh
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where this conversion is happening. And I think we are seeing it um play out in cities across the country where
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downtowns um emptied out of many of their office workers and now um there's a desperate effort to to bring foot
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traffic back to the city and some buildings are much more easy to to repurpose than than others. I think that
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it also as you alluded to has these knock-on effects for retail u depending on the foot traffic in some of these
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downtowns and some of the corridors have bounced back very quickly and others continue to struggle and that's really a
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function of the the industries and the dynamics city by city. One of the other hopes I guess was the fact that uh the
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ad current administration talked a lot about uh the repatriation of uh companies coming into the US uh taking
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over facilities, taking over factories and building out property from there. Uh that will probably happen to a degree,
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but would it happen enough where you're going to have a significant impact on
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the commercial real estate market as a whole? I I wouldn't think so given the
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the dynamics of work from home across industries, right? The industries that that I think they have in mind are much
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more about manufacturing and um and really about controlling supply chains. I think the the kinds of work from home
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dynamics is much more about um about office workers. Um and it's not office jobs that are that are in the discussion
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when it comes to to repatriation. So so I think those are you know slightly uh on two different tracks. I think you
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know office jobs you know we have seen firms kind of settling into a work from home that's uh that's some sort of in
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between uh model where you're in the office two three maybe four days a week.
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>> Yeah. >> And in that case if you're using you know your same offices three or four
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days a week you probably don't need to downsize all that much on on your office
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space. But there may be some ways in which you can use that space more flexibly or more creatively. and we're
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seeing firms uh making agreements that that allow them to do that with with more flexible agreements. Two final
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things I wanted to bring up. First one, rents. I know you have followed rents closely. It's been an important topic
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for you. Uh we've seen rents come down. That's obviously going to be a good
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thing whether it is uh residential or commercial moving forward. Where are we in terms of rents right now?
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Yeah, I think um good thing for the renters uh to see the rents coming down. I I think we're seeing um continue to
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increase supply uh of uh rental units in in many markets and and that's delivering on lower rents. We're seeing
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increases in concessions from landlords. So that means like uh offering free rent
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or um or some other kinds of perks to try to get people in the door. We're seeing big gaps between um the existing
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rents that that are being paid and the rents for for new renters in in a lot of markets. There's a big wedge between
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those. This is an opportunity where if you're a renter right now, it pays to
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shop around >> and see what's out there because if you've been in the same place for three
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or four years, >> um chances are that that the new renters in your building might be paying quite a
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bit less than than you are. So in the cities where where we've seen an uptick
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in construction especially since co we are seeing rents soften that in other places like in in Manhattan you know
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rents remain astronomical. So it it is a tale of of different markets for sure. What about the insurance industry and
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some of the concerns that they have had you know about some of the building areas about uh uh climate change a
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variety of different concerns. Insurance costs have obviously been a big problem
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for many people. >> Yeah. Insurance has been a big focus of my research over the last couple of
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years. We're seeing large increases in homeowners insurance over the last few
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years. And if anything in the commercial side, insurance has increased dramatically faster. It's just a much
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less regulated market. And and what we're seeing in this latest wave of research is that this is having an
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effect on house prices. is that the areas that have seen the sharpest increases in insurance, which tend to be
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those that are most prone to disaster risk, whether that's wildfires, hurricanes, or severe storms and and
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hail. Um those are areas where we are seeing house prices respond. Now, these are areas that have in general already
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seen house prices rise quite dramatically uh over the co housing boom, but we estimate that they would
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have risen, you know, maybe $20,000 more had it not been for uh for rising insurance costs. So, these insurance
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costs are are really a pocketbook issue for for households uh at the moment and it is affecting asset values in a very
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direct way. Let me finally touch on this. It's seemingly the topic that everybody talks about these days. Uh,
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are you seeing a a significant impact from AI in the real estate market right now?
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>> I think we're still in the early innings when it comes to AI in real estate and
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some of that is uh a question of of organizing often uh messy and complicated data sets whether that comes
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from um you know if you think about a multifamily uh owner who has information on rents and vacancies also information
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on expenses also interacts with their with their tenants. I think we're seeing
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AI at the sort of entering in where you'd expect to the lowest hanging fruit. So things like chat bots to to
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manage maintenance requests. I think that's kind of the early stages of this.
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But when it comes to really building out the functionality of AI for real estate
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investing, whether that comes to making portfolio decisions, um you know, purchase decisions, um or renovation
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decisions or or um or exit decisions, I don't think we're there quite yet. Um, I
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think there are some firms that are leading the charge, but it it's still very early stages when it comes to the
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interplay between uh between AI and real estate. But, you know, I'm teaching a
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course this this spring, starting next week, on real estate data analytics, uh, which which I think of as the, you know,
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the the the precursor to um to really embedding AI into the systems when it comes to real estate investing.
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>> Going to going to drag you kicking and screaming down that path, isn't it, Ben?
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>> Far far from it. We love we love data over here. There you go, Ben. Great to
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catch up with you again. Thanks very much. All the best. Look forward to talking to you throughout the year.
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>> Yeah, absolutely, Dan. It's always fun to be here. Thanks. >> You You got it. Ben Keys, professor of
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real estate here at the [music] Wharton School. Thank you for listening to The Ripple Effect. We hope you found this
00:19:29
episode informative and engaging. Don't forget to subscribe and [music] leave us
00:19:33
a review so that we can continue to bring you the best insight from the Warden School.