Real Estate Equilibrium

The aftermath of the COVID-19 pandemic on real estate diverged in to two opposite paths: residential real estate demand soared while commercial real estate, particularly in the office space, plummeted. According to S&P Market intelligence, the U.S. office real estate sector faces a higher risk of loan defaults and delinquencies as increasing vacancies, declining property valuations and tougher refinancing hound office landlords. Vacancies in U.S. office real estate are currently estimated to be at 20%, undergoing a slow recovery in stark contrast with class A and other property types.  

The affordability and availability of residential real estate has been a long-running issue. Housing faced an acute shortage during COVID, and it is a persistent cause of elevated inflation even today. Within OECD nations, home prices have increased 40% in the last decade, while wages only grew an average of 10%. 

Although increasing housing stock can help relieve the affordability crisis, many builders have left the industry since financial crisis of 2008, soon after the peak of new construction in 2005. Another major factor constraining new building is local governments' zoning and land use regulations that mandate how land can be developed and often actively prevent much-needed housing construction. 

Although increasing housing stock can help relieve the affordability crisis, many builders have left the industry since financial crisis of 2008, soon after the peak of new construction in 2005. Another major factor constraining new building is local governments' zoning and land use regulations that mandate how land can be developed and often actively prevent much-needed housing construction. 

Like new housing, the resale market has been constrained by a lack of inventory, exacerbated by institutional investors buying up housing inventory. Large investors have reportedly have purchased 14% of homes as recently as the first quarter of 2024. 

Interestingly, the contrasting demand and supply issues of residential and commercial real estate could solve each other’s problem. Many cities are actively attempting to convert office buildings to residential housing or mixed-use spaces. However, these types of conversions require gut-rehab, which is costly. In my city, Washington, D.C., the mayor recently announced three commercial-to-residential projects incentivized through a conditional 20-year tax abatement. 

As with many large issues, the solution to the housing crisis is multipronged – one that requires policy support, urban planning that conforms to modern small families, and public-private partnership in investments like we saw in the Washington, D.C., project. Hopefully we see many such projects. 

Opportunities

Housing Sector 

In the housing sector, many builders, such as DR Horton and Lennor, are overvalued at this point. One area I highlighted in the last newsletter was the demand for senior housing, and Ventas (VTR) owns a portfolio of high-quality assets in the senior housing, medical office buildings, life science, and hospital segments. 

Macerich owns several Class A malls, and over the last several years has sold off many lower-quality malls. It is a good opportunity to capture the evolving trends in the commercial real estate market. 

AI Companies 

It seems like AI companies are carrying the market through all uncertainties. Although many AI-focused companies seem overvalued, a few pockets of opportunity occasionally open up. Among them are Adobe and Autodesk, which I mentioned in the last newsletter. Adobe is still trading below its fair value.  

Photolithography 

Photolithography is the process by which a light source creates circuit patterns on a semiconductor wafer. Smaller gate lengths — indicated in nanometers (nm) — allow more transistors to be packed on a chip, and chipmakers are continually increasing the number of transistors on the same area of silicon. 

There have been staggering advances in this technology: In 1997, leading semiconductors were 250nm. The latest iPhone uses a 3nm node.  

ASML is the leader in photolithography, offering the latest technological advances in this segment. Due to a selloff in the recent quarter, ASML has turned into a great investment opportunity.