While we deal with the fallout from Covid, political divides, the Ukraine invasion, supply chain issues, inflation and monetary policy changes, innovation and progress still manage to find a way to push forward. Bad news elicits strong emotional reactions, which drives more advertising revenue, and progress rarely gets the attention it deserves. The following is a positive story on energy innovation which, over the long run, dramatically impacts the economy and geopolitics.
Global energy production currently comes from three primary sources:
- Burning fossil fuels like coal, natural gas and gasoline.
- Renewable energy like solar, wind, hydroelectric and burning biomass.
- Nuclear power generated by uranium-based fuel.
In December 2021, Commonwealth Fusion Systems raised a massive $1.8B series B round based on their breakthrough magnet technology. The fusion community agrees that these magnets were the last step in creating commercially relevant fusion power sources. The timeline to the first working fusion reactor is a realistic estimated 3-4 years away, which is extremely short considering the previous timeline to a commercially viable reactor was measured in decades.
Tiger Global led the round. While Tiger Global’s performance has been awful during this downturn (total losses greater than 50% YTD), owning revolutionary fusion patents will likely work out well for them in the long run. Small teams of capable people can produce meaningful innovations that often change the world for the better in surprising ways. While we are collectively distracted by the many apparent challenges of the moment, progress marches on. What do climate change and energy independence look like in 10 years when working fusion reactors enter the equation?
In 1972 the book “The Limits to Growth” was published based on computer models and research concluding that civilization growth was heading towards a sudden and uncontrollable decline due to population, resource production, industrial production, natural resources and pollution constraints. The book sold millions of copies. Fifty years later, a new retrospective book titled “Limits and Beyond” reviewed those perspectives from 1972.
Over the past 100 years, whenever we’ve been forced to innovate, we’ve been remarkably good at solving our most complex challenges. For example, synthetic ammonia production and the introduction of short-stalked wheat allowed wheat yields to triple over the last 50 years while the population grew by 2.3x. Without these agricultural changes, population growth would have outpaced wheat production. Doomsday forecasts made before those wheat production innovations would have been incorrect.
We are naturally wired to be attracted to doomsday prophecies, possibly because they seem more intellectual than hope and optimism. In reality, innovations typically don’t make it to market until their economic benefits outweigh the cost of implementation. In other words, a certain degree of financial pain is required to push innovation forward. One conclusion from these two books is that innovating our way out of trouble appears to be a choice available to us when needed.
With 30-year fixed mortgage rates up to nearly 6%, many are forecasting (hoping for) a dramatic drop in real estate prices. Unfortunately for would-be buyers looking for a deal, the numbers behind residential real estate do not point towards an imminent price correction. Here are some considerations:
- 40% of US homes are owned outright, without a mortgage. Unlike ‘08/’09 when investors were allowed to buy multiple homes with 0% down payments, fewer homeowners will be forced to liquidate today, even during a downturn.
- Low-rate lock-in. Over the past few years, homeowners were able to refinance mortgages at a 2% to 3% rate. With mortgage rates at 6% today, very few can afford to lose their mortgage rate by selling to buy a different home. If you own a property with a 2.5% mortgage, you’re likely better off renting it than selling. To the renter, renting from you is probably more economical than buying the equivalent home. All of this puts downward pressure on available supply.
- New homeowners typically buy their first home based on their stage of life. More millennials are entering their peak earning years and starting new families than new housing is being built. Demand continues to outpace supply.
- Real mortgage rates are negative and at the lowest in 40 years. A 5.3% 30 year mortgage less 9.1% inflation = -3.8% real mortgage rate. This is a purely academic way of looking at mortgage rates, and it’s not entirely representative. The cash flow required to service a 5.3% mortgage is less affordable than a 3% mortgage. It’s not like inflation results in improved cash flows, but if you’re working on a larger scale, your debt is inflated away faster. Inflation is also a variable rate.
- More people are forced to rent. Lack of affordability (down payment + mortgage payment) has created more renters, making it attractive for real estate investors to buy existing supply.
In short, I wouldn’t recommend holding your breath while waiting for a real estate price correction.
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