Talladega Rates

Malt Liquidity 85

Carry the One

One of the oldest trades in finance is collecting a rates spread. From ancient times itself, people have been offering a rate for you to give them their assets, utilizing those assets to secure themselves a better rate, and profiting in the amount of the spread between the two. Generally, we think of two main businesses as primarily rates-spread driven companies — retail banks and brokers like Schwab, whose primary income is, well, rates on deposits,

In the first six months of 2018, Charles Schwab generated $4.8 billion in revenue. Over half of Schwab’s revenue, 54%, is its Net Interest.

which is why zero-commission trading stuck — the increase in balances and concurrently the potential interest income offset the commission revenue, if not surpassed it. As such, these operations make more money as interest rates rise — the overall ability to make a spread is higher when the rate is 5% as opposed to .5%.

These benefits extend to any business with a “treasury” of sorts that is able to deploy it. (This ties into a core flaw of any crypto rates product — while they were offering higher rates, this directly implies that they have to take higher risks to outpace the rates they’re giving you, and the general inability of most crypto yield products to access regular capital markets severely limited the volatility they had access to, resulting in a hot potato game where everyone was trying to pay everyone else off with the rates being offered, and, naturally, yield products collapsed across the board.) So it’s particularly amusing to see how much companies who hold capital seem to be relying on the classic “net interest” playbook:

Airbnb Inc. and Expedia Group Inc. invest billions of dollars of their customers’ money for their own profit. Thanks to rising interest rates, returns on these investments are higher than ever.

The travel sites typically collect money from guests the moment they book. But they only pass it on to hosts or hotels after the guest stay starts, which can be several months later. 

Meanwhile, the money is under their control. Airbnb said it processes around $80 billion in payments from guests to hosts annually. The company parks it in bank accounts, money-market funds and short-term bonds, which are considered safe and are easy to sell on short notice.

The sign of any “mature” tech startup that doesn’t have a stranglehold on some monopoly is when they start playing the financialization game, like when Uber made a foray into financialization through credit cards and leases on rental cars. Every move to boost the margins comes into play, and man it’s cute when this kind of stuff happens. Airbnb as a treasury management company and a liquidity provider between single stays and short-term leases is a pretty unique positioning. As I like to say, everything revolves around interest rates.

Stay Fluid

Something I’ve written about in the past is how people underestimate the edge that small sizing is in and of itself:

When you do not have to get off a block every time you transact, your price impact is virtually zero (and in fact, you can transact at prices better than your limit orders thanks to price improvement). Remember that old adage, “don’t trade against the size”? Well, there is a benefit to this - much like a bike at the back of a peloton, you can benefit from drifting along the price impact as size legs in to a position.

We can further extend this to any market, such as housing. If I have $100 million in capital to deploy, buying and selling a few houses to make $40k a pop doesn’t have any impact on my total return. A return on investment necessitates buying swathes of houses as a whole, and housing as an asset is extremely correlated with other portfolio holdings. While one house may fluctuate due to build quality and neighborhood positioning, a tranche of houses in Austin are going to get hit similarly from overall market turmoil as, say, a tranche in Phoenix. As such, seeing OpenDoor’s struggles are no surprise, as it seems they didn’t really think in terms of portfolio theory as much as scalping the top of the market:

In Phoenix, Opendoor lost money on 89% of the homes it sold in the fourth quarter, an average of $58,000 apiece, before accounting for fees and expenses, according to Tom Ruff, an analyst with Arizona data firm Information Market. The company in that same quarter on average flipped homes for 12% less than it had originally paid, he found. In November, Opendoor wrote down its real estate portfolio by $573 million. As of Friday, its shares had fallen 94% since their high in February 2021.

What particularly twists the knife are the quotes in the story of, well, individuals who successfully used “big liquidity” to exit and scalped their own profits on the market. I always love a good story of “dumb money” taking one over on “smart money”:

While Opendoor is nursing losses, local flippers sold homes for 20% above their purchase price. They tended to buy distressed properties, though they also generally put more into renovations. The typical Phoenix homeowner is sitting on an additional $100,000 in home equity since the pandemic began, according to real estate data firm Black Knight Inc.

Something telling about the efforts to crunch data to flip houses is that a) the short side isn’t really available — how do you “short” a physical product by sourcing a borrow? and b) accounting for regime change is even more important than when assessing stocks. Furthermore, the informational asymmetry is not as tough of a game for the individual investor in real estate as it is in the stock market, where banks and fundamental funds have armies of analysts crunching financials and doing due diligence — remember that old adage, “statistics do not apply to individuals in a population”? While an overall neighborhood may be sinking, an individual house might be doing well, as exemplified by one retail flipper in this passage:

In a sweater decorated with leopards, Wilder sits on the kitchen countertop, her cowboy boots tapping against the dishwasher. She offers Yousif some advice: Make a lowball offer for the house he sold to Opendoor in April for $265,000, now listed for $218,000. Yousif knows it well. He was the one to update the house with a new bathtub. He fixed two broken stairs and put in 2,000 screws to stop the floor upstairs from creaking.

Wilder suggests Yousif make a $180,000 offer, 17% below the asking price. She tells him to buy it with a different LLC to disguise his identity. Nobody wants to sell a house to a buyer who sold it to them for tens of thousands of dollars more just months before.

A few days later, Opendoor comes back with a counter: $208,000. Yousif decides to wait. He figures the price has only one way to go—down.

While from an investment point of view, where one should be treating housing as a physical rates product, selling a house does require taking into account the fact that someone wants to live there and settle down. This is why housing is “illiquid”, even when the market is hot and homes are getting sold in a week — it’s simply not as reliable as, say, trading a rates product directly itself. The beauty of this article is that it highlights that information asymmetry and position sizing and a lack of a need to allocate capital can be realizable edges, whether in a housing market or in equities, even though you might be up against a much larger, more powerful player. It’s nice to see someone get one up on Wall Street every so often.