Magic 8 Ball for the Markets - Dr. Peter Linneman

GDP growth, unemployment rates, interest rates... on the most recent Walker Webcast, Willy Walker and his guest Dr. Peter Linneman covered all the hot-button topics in their discussion about the state of the U.S. economy.

They dove into:

  • When the economy may be back to "normal"
  • Government spending and the potential for another stimulus package
  • Why Dr. Linneman is still bull-ish on Multifamily
  • ...and more!

A bit about each speaker:

Willy Walker
Willy Walker

Willy Walker is chairman and chief executive officer of Walker & Dunlop. Under Mr. Walker’s leadership, Walker & Dunlop has grown from a small, family-owned business to become one of the largest commercial real estate finance companies in the United States. Walker & Dunlop is listed on the New York Stock Exchange and in its first seven years as a public company has seen its shares appreciate 547%.

Dr. Peter Linneman
Dr. Peter Linneman

Peter Linneman is the founding principal of Linneman Associates, a leading real estate advisory firm. For 35 years, he was a leading member of Wharton's faculty, serving as the Albert Sussman Professor of Real Estate, Finance and Public Policy. For over 40 years, Dr. Peter Linneman's unique blend of scholarly rigor and practical business insight has won him accolades from around the world, including PREA's prestigious Graaskamp Award for Real Estate Research, Wharton's Zell-Lurie Real Estate Center's Lifetime Achievement Award, Realty Stock Magazine's Special Achievement Award, being named "One of the 25 Most Influential People in Real Estate" by Realtor Magazine and inclusion in The New York Observer's "100 Most Powerful People in New York Real Estate."

If you have any comments or questions about the evolving economic landscape and how it is impacting the CRE space, our experts are available and fully operational to help. Additionally, if you have topics you would like covered during one of our future webcasts, we would be happy to take your suggestions.

Webcast Transcript

WW: Thank you Susan and good afternoon everyone. Welcome, and Peter thank you for joining me once again on the Walker Webcast. We had a terrific discussion at the beginning of the pandemic where you laid out a number of thoughts that were both controversial and in hindsight very accurate. First, you projected the economic impact of the virus in terms of unemployment, hit the GDP and overall cost of the U.S. economy very accurately. Second, you compared COVID to past pandemics such as the 1918 Spanish flu and suggested that while deadly we couldn't let a disease that was predominantly impacting the elderly shut down our economy and our lives. And finally, and very unfortunately, you predicted the social unrest that erupted in the United States after the death of George Floyd. So first of all, well done on predicting extremely accurately what has happened over the last seven months and second…

PL: I’m great at predicting bad news.

WW: Yeah exactly, and second Peter if you look back over that period of time what's the biggest thing you missed?

PL: Oh, it's so obvious. You may remember I said something like without jobs, without confidence and without a down payment the single-family housing market is going to collapse because if you don't have money for a down payment, you can't get a loan without a job and I thought single-family housing would just utterly collapse, and it dropped, there was a notable drop in April-May but as you know single-family has been one of the brighter spots, not the brightest but one of the brighter spots, especially suburban, and I missed that. And if you say why did you miss it? It's very simple. What I missed was that involuntary savings occurred. What was involuntary savings? You had your vacation plan to go to Disney, it was cancelled, suddenly you had that money and you had, all kinds of involuntary savings occur, you didn't make that trip, you didn't have to pay for parking at work, etcetera, etcetera, refunds on your concert tickets whatever it was. And when you go through the math in six months of savings, largely involuntary savings, people had a down payment that would have otherwise taken them two or three or four more years to get. And I think people looked around and said, oh, I've got a down payment available now, I'm going to buy a home now rather than two years from now or three years from now, interest rates are low. But I missed that totally, it was just, who knew that this involuntary savings would be such a dramatic effect.

WW: So for the rest of our conversation I'm going to dive into data that's in The Linneman Letter and to those of you who are watching today who do not either get The Linneman Letter, or read The Linneman Letter, I would strongly encourage you to do so. It is jam packed with incredible data that if you take the six or eight hours that I took over the weekend to dive into it you can, two things, one fall asleep really quickly and second of all learn a heck of a lot about the economy we're in and what's going on in the world. So, let me start Peter with the economic damage done. I don't want to look too much backwards but I think it's important for you to bring us and kind of set the table again on what's happened in the pandemic and then where we're going to go from here. So as far as damage done and where we are today, you estimate that 55 million people lost their jobs during the shutdown and that while the official unemployment numbers from the Bureau of Labor Statistics currently sits below eight percent, that isn't the true unemployment number. What is the true unemployment number today and why do you say in The Linneman Letter that the economy feels much weaker today than it did in 2009 with 10.3 percent unemployment?

PL: Sure, so the unemployment, by the way nobody is intentionally lying to us, it’s not like the government is, there's not some conspiracy, it's that the data collection was never designed for what we just went through, and for a whole lot of technical reasons. So, when you get the official unemployment rate you get like it's not that bad. Well go to Vegas and it's bad, and go to Orlando and it's bad, I mean really bad, and go to New York, and the restaurants are really bad, and so far, worse than anything you saw. and so, it is worse, it is worse. The unemployment rate today as best I can estimate it, and I do it two or three different ways. If you use the size of the labor force at the end of February, and by the way remember that labor force would have grown over the next eight months just from population and so forth. If you use that we're probably at about a 14 percent unemployment rate and the reason the official is lower is people dropped out of the labor force because they can't find jobs, what's the point. You graduated from high school in June, what's the point of even looking, right? So, the labor force dropping, those people would be working if the economy was good. And the second part is a whole bunch of people who have been furloughed basically answered that they're employed even though they're not, and it's not like there's anybody trying, the BLS is aware of this, it's not like they're dumb, but in apples to apples if the unemployment rate was 3.5 percent at the end of February, which it was, in a comparable labor market sense it's around 13 to 14 percent today, today literally as we sit here.

WW: So your numbers right now are a net loss of 8 million jobs in 2020 followed by gains of about three million next year and the year after and then down to 2.5 million for the subsequent two years and with manufacturing jobs today only representing about nine percent of U.S. jobs and all the real gains coming back in the service sector, what are your projections as it relates to, you know you've got three million jobs coming next year, is there anywhere that you're looking and saying this service sector is going to start to recover in this area. Is there any guide-post to where you're projecting these jobs to come back?

PL: Well I think in our second talk Willy I said the sector that would come back the strongest was going to be medical health care and that was certainly true. Medical healthcare has come roaring back after a big drop and that has been a big driver, and that's service obviously and that will continue. The sectors that needs a lot of help are travel, leisure, entertainment and they need us to feel confident, they need improvements in treatment if you get the disease and they need probably some help vaccine wise or otherwise. And those are big sectors, travel, leisure, and entertainment. I mean Vegas and Orlando exist for travel, leisure, entertainment. New York, Times Square exists for travel, leisure, entertainment and we can go on and on. And international travel is zero. Well that's not good for New York, that's not good for D.C. So, until those things come back those sectors can't come back, they can't come back without that. And all you have to do is look at the NFL stadiums, right, you get a real good sense of how far back that sector is. Half the stadiums have 4,000 or 5,000 people in them, right, that gives you a barometer, watch that, when that's back to 70,000, we're back in that sector.

Unlike China services is a big part of our society and so it's much easier, I’m not saying easy, much easier for China to come back then if all you are is a service sector and we're not just a service sector. The other service sector, it's not categorized as service, but education. And yes everybody, not everybody, lots are doing virtual, what about the janitor, what about the supply keepers and all that, so education being where it's at which is largely virtual, that's holding back that whole sector from recovering jobs. So those are things to watch. If I had to give you one thing to watch that's fun, watch NFL attendance. And I don’t mean just this year, I mean even if you're not a fan of the NFL, turn it on and see how many people are in the stadium this year and next year and when they're back we are back. We're really back is the way to view it.

WW: So your projection is that we’ll lose $2 trillion of GDP this year and that that won't be back in the economy for another two and a half years and what you just said as it relates to the service sector and travel and leisure coming back and NFL stadiums getting filled back up. But is there any chance Peter that you're looking at if you will traditional economic activity and as we have adapted to this new online activity that, I mean you look at the stock prices of some of these companies that are “benefiting” from the pandemic. Is there a chance that, I don't know, Netflix and Amazon and Facebook all drive so much additional economic activity that they offset the fact that Delta Airlines is flying at 50 percent?

PL: I don't think so. They are offsetting some of it there's no doubt, but not that much. We're a social being, we're going to travel, we do want to go to ball games, etcetera, but we want to do it safely and that's going to take a while and even after it is safe it's going to take a while for us to realize it safe. You don't go out the second the blizzard ends, you wait an hour or two to make sure the blizzard’s really over because I don't need it that badly. So yeah, I include that, I think it's unlikely by the end of next year we're back. I think it's into 2022 and largely because of this education, travel, leisure, entertainment is a big part of our society. We got the huge advantage of medical coming back, medical healthcare coming back. And it's not 100 percent back but it's come back pretty close to a 100 percent.

WW: So, as we talk about the loss in GDP and the amount of debt that was added to the federal government's balance sheet which at, you're writing is about $8 trillion of additional debt…

PL: It would be about $8 trillion. It's only about $2 trillion at the moment but they’ve got a bill of about $2 trillion they're going to pass, that'll make it $4 trillion; and they're going to do $2 trillion more in the next couple of years is my gut and we end up at $8 trillion all told.

WW: Okay, so in your letter you write this statistic that I’ve just got to state, and I’ve got to state it slowly, so everyone grasps this. But you state that in July of 2020 total real monthly federal government net interest payments stood at $26.3 billion, only $1.2 billion above federal interest payments in August of 2008. So even though we’ve added $15 trillion of federal debt between 2008 and 2020 we have only added $15 billion of annual interest payments, with those kinds of numbers shouldn't, I mean shouldn't we have passed the next stimulus bill back in July?

PL: Well that's politics that's not economics, right, and interestingly the first Recovery Act was the least political government spending I ever saw. And by that, I mean not only was it not terribly Democrat-Republican it wasn't your district is a hot district, but you’re also chairman of the Appropriations Committee, etcetera, right. It had none of that, it was just we're going to go out. This bill that their talking about a little less so more political. The one after that will be even more political, the one after that will be even more political. Look people ask this rather, they ask it well but it's a stupid question, can we afford any debt associated with this and I say wait a minute of course we can. That's why I use the $8 trillion Willy is that would be four times where we're currently at so we do the one we're talking about and more, $8 trillion would be the top. GDP is $21 trillion. If we put that debt in total debt would be about $25 trillion and GDP would be $21 trillion. Can real estate guys pay off all their debt with a year of income? Not likely. The country can basically be what I'm saying, right. Second, your point, when you calculate the interest costs of that additional debt it's like $100 billion and that's if it's $8 trillion, it's $100 billion a year. 2019 government budget was $4.3 trillion, it’s rounding here. Another way to view it is net household wealth is $115 trillion and we owe foreigners about $15 trillion of federal debt. That means we take our $115 trillion, we pay the foreigners the $15 trillion we owe them, and we still have $100 trillion. We can do that. And the fourth way is, do the present value of the U.S. economy, present value of U.S. GDP. So that's around $800 trillion. $800 trillion is around the present value of U.S. GDP. That's equivalent to the value of availability, the present value of future income streams is $800 trillion”ish”. $8 trillion is 1 percent. Of course, we can afford one percent shifted from the future to today to help out pain and suffering. That's not the question. The real question is not can we afford it but who's going to pay, right, And I want you to pay Willy. And Willy wants the guy in Seattle to pay, and the guy in Seattle wants tall people to pay and the tall people want short people to pay. It is not an issue of can we pay it's I want everybody else to pay. Everybody sitting in the room pointing you pay and that's why we have politicians unfortunately is to decide who pays and that is a hard issue of who pays but not if we can afford it.

WW: So, as you look at that amount of federal debt outstanding obviously rates come into play and where are rates going to go. You state in the most recent Linneman Letter “rates will remain low for years to come as global monetary authorities will repress rates to keep government debt affordable.” And you even note a very, you know you have to be sort of a Fed watcher like you are to be able to pick this up, but in their last notes where they moved off of a set target of two percent inflation to an average inflation rate of two percent. Can you talk about that shift and then also give us a sense of where, if you say for years to come we’re going to stay low, give us a projection of rates for the next two or three years in a range, just kind of are we talking about that the 10 year could go to 150 or do you cap it at 2?

PL: I can't see it, let me do the backwards way. I can't see it going above, the 10-year going above two for five years or so. Now you get beyond that, you have a whole change in officials and so forth and so on, I just can't see it and the reason being, it's actually twofold. One is a belief, right or wrong, I tend to disagree with them but that's beside the point. The belief of the people in charge is low interest rates stimulate the economy and as you know as a past reader, I think in some ways they hurt the economy. They help borrowers but they hurt savers and I don't know why borrowers are more noble than savers. So, I don't see how hurting one person by $1 but helping another person by $1 stimulates and there's a long discussion but that is the prevailing view and that's going to be there for four or five more years. And the second is, that whether they explicitly say it or not they're going to help the government cover their deficit in the way we were just talking about by keeping interest rates low. And this is very similar to what happened after World War II and what happened in many countries where you can repress rates and it will hurt the economy in the long term because look, let's face it, it makes government debt cheap, that's good, but that means that encourages the government to be the spender rather than you.

And at the end of the day, in normal times I'd rather have you deciding what to spend on than a politician because you're doing it on an economic basis and they're doing it on I'm the chairman of the Appropriations Committee and therefore they're trying to buy votes, you're trying to buy goods and services. And so, in the longer term it will hurt the economy. In the short term it doesn't matter much because, and I don't mean this in an arcane sense, but in the short term nothing has a big impact if it's only done for a short time. But they're going to do this for a long time, let's say five years and I think it has a hard time getting above 1.5 percent on the 10 year over that period.

WW: What's the outlier Peter. In other words as you probe at that what if inflation starts to run and a lot of people sit there and say okay but there's excess capacity in the labor markets, there’s excess capacity in the manufacturing markets so you sort of say well that's not going to tip it because we're not going to get inflation. The dollar is still the reserve currency of the world, there's really not a competitor to the dollar so you're not going to see people investing in Euros all of a sudden as the reserve currency. Is there something out there that's a curveball to these rates are around us for three to five years?

PL: There are two. One is if a set of Fed appointments occurred like a Paul Volcker, that was a sea change in the view of the world at that time, so that they would say I don't think keeping rates low is stimulating the economy, it's hurting savers, and that would be a sea change, right. I don't see that in the near term but that would be a sea change if you had that. The other is, no, I don't think you get big consumer inflation. People make a mistake. They say we've had no inflation for the past decade and you're dead on about currently there's a lot of excess capacity and so forth. But let's take 2009 to 2019 and people say we had no inflation, and that's wrong. We had very little consumer price inflation. But what happened to the price of gold, what happened to the price of stocks, what happened to the price of homes, what happened to the price of apartment buildings, what happened to the price of warehouses, we had enormous asset price inflation. Why, because we put a lot of money into the system during the financial crisis, it didn't come out immediately, it came out slowly over the subsequent seven years, eight years and it didn't go to goods and services it went to asset crisis, and what I think will more or less happen is the same thing. We put a tremendous amount of money in the system with QE infinity, which is really what it is, is the Fed has said we're going to put in whatever amount of money we need, forget four or five or six, infinity. And it won't come out immediately, but it will come out somewhere, I just don't think it's going to come out much in consumer prices. It's going to come out in asset prices. And I think in a way a decade from now we're looking at the same kind of run on asset prices that we witnessed and we’ll say there was no inflation and you go wait a minute there was tremendous inflation but it was of assets not goods.

WW: And we'll talk about single-family housing and supply and the affordability index in a moment but obviously that plays into that picture dramatically as well. But before we get to that while we're on interest rates, federal debt, one of the other things that many people are focused on is the corporate tax rate and there are a lot of people, a lot of market commentators talking about what rising tax rates will mean for the economy if Biden is elected president and you provide a data point in the most recent letter that I still have gone back and reread about five times and still need you to explain it to me because it's an incredible statistic. So, you say that in Q2 of 2020 corporate profits in the United States stood at $1.6 trillion or 18.7 percent below their peak in nominal terms in 2014. So in nominal terms U.S. corporations brought almost 20 percent less to their bottom line when the corporate tax rate was at 35 percent versus 21 percent today and you go on to give another statistic that says that as a percentage of GDP corporate profits were at a peak in 2012. So again in 2012 and 2014 you have a 35 percent corporate tax rate, in 2020 we have a 21 percent corporate tax rate, yet you're basically saying that corporations were making about 20 percent more back then and bring it to the bottom line, how can that be?

PL: So, think about when the peak in corporate profits as a percent of the economy were, 2012. I'm doing it off top my head. I think you're right, that's because we were still having technological progress, we saw that productivity increased but labor was plentiful. And as I say the prevailing view was productivity occurred, who gets it, the capital or the labor? Well if labor’s plentiful, it goes to capital, the beatings will continue until morale improves, what are you going to do, and then things start changing and labor markets start improving and what history shows is as labor markets improve productivity gains go to workers and you saw that in 2016, 2017, 2018 dramatically that the gains went to workers. And I'm sure you had to do it, right, I mean you had improvements but if you didn't give people more money they could actually leave. We're now in a period where profits will rise because the beatings will continue until morale improves but, by the way, once things tighten up those gains will go back.

Does the tax rate matter? Sure, there's a lot of research and it does, if I were to summarize all the research by everybody serious on corporate tax rates and economic growth the answer is yeah lower taxes lead to more growth. And the way I view it Willy is, let's say you lower taxes and 90 percent of the companies do nothing different, you do nothing different, I do nothing different but 10 percent of the companies do 20 percent more, right, that's the nature of how it's coming. It's not liked every company is doing more because of lower taxes. It's that a company comes into existence, a company expands discreetly. So, the research shows clearly that lower taxes do encourage economic growth. Same on the individuals. We do know probably 90 percent of the people will work the same amount of hours as long as the tax rates are in a certain band on individuals; if they push beyond that band 95 percent tax rates you’ll get a change, but 10 or 20 percent will work more at lower taxes. So, when people say what will happen if we raise taxes, we will get lower growth but it's not night and day. And by the way, you know it's not night and day. I'm 69 years old and I've seen taxes high and I've seen taxes low and I've seen taxes in between and we grow. You've seen those GDP charts in The Linneman Letter, right. You go back and tell me when a Republican was in, you to back, based on that chart alone of GDP, you tell me when taxes were high or taxes were low or Republican Congress, can't do it right, it just grows. The growth differential is small. Now think about it, 20 basis points for a year is nothing. 20 basis points for 30 years would be a lot. And what has happened in the U.S. system is so I get 20 basis points lower growth for a couple of years based on tax policy and then the pendulum swings and we get 20 basis points more of growth and we make up a bit and that's probably what will happen as we move forward in life. I hope I'm still around when I'm 109 and I get to see 40 more years of that.

WW: So you mentioned Paul Volcker just a moment ago and I actually, when I read that stat I went back to see what the corporate tax rate was during the Reagan years because many of us believe that the Reagan years was a big financial success. And for the first six years of the Reagan administration the corporate tax rate was 47 percent and it was dropped down to 42 percent in 1987 and then it went to 39 in 1988. And so it was just interesting to see that we've come from there down to now 21 but to your point it's really very difficult to look at those charts and figure out what tax rates you actually have in place based off of GDP growth.

You also mentioned Peter the growth in average household income. And just to give numbers to people who are watching because you know these but in 2012 average median income in the United States was $56,300 and in 2020 that number is $64,600 so up almost 15 percent so just underscoring your point about what has happened to average household wealth and income over that period of time as corporate profits have come down those if you will riches have gone to the American consumer, to the American worker.

PL: Yeah, and in fact as you know in ‘17, ‘18 and ‘19 the largest income gross as a percentage were going to the lower tiers and that's because jobs are plentiful, economic activity was plentiful so that happens. By the way one of the other things and I won't go into it, but people need to understand about all this inequality kind of stuff. Inequality has to rise over time in our society for statistical reasons. And, you know, what's that about? Well when I was 16 and I got my first job I knew nothing, and they paid me as if I knew nothing. By the way a 16 year old who gets a job today also knows nothing and gets paid like they know nothing. But the 40 year old of today gets paid like somebody who has all that productivity growth that occurred over those years. Whereas the 40 year old when I was a kid got paid for the productivity that existed then. So, you can imagine the bottom and just think of a 16 year old kid when you think of the bottom, they're all the same, they know nothing. Over time they do but at that moment, and everybody else moves up, so just imagine a society where you constantly have new idiots getting zero for a short period while everybody else moves up, of course inequality would go up for that. And the other thing, I have a book that will come out next year, National Geographic is publishing with the head of wellness at Cleveland Clinic Mike Roizen and Al Ratner, and us living longer, we know life expectancy has gone way up, just think of the power of compounding what it does to inequity, namely if you live an extra 10 years your wealth’s got to have 10 more years of compounding then when we used to die young. So, there are other issues, but those mechanics and people don't even think about those.

WW: So I want to talk for a moment about the banking system and the consumer right as we went into the pandemic and the downturn because the data that you provide is exceedingly compelling to say that we were extremely well positioned, better positioned than ever before heading into the pandemic from a banking system standpoint and from an individual sort of debt to equity ratio if you will.

On the banking system first you mention that up until 2008 the banks had zero reserves at the Fed because they were constantly taking that money and putting it out into the market and because of Dodd-Frank and a lot of other regulatory measures banks are now required to hold reserves at the Fed, and going into February of 2020 there was $1.5 trillion of excess bank reserves at the Federal Reserve and that by May, with QE infinity, that number had gotten up to $3.2 trillion of excess bank reserves at the Fed. I read that data point Peter, you make a very well-articulated long sort of proposition that because the banking system is so well capitalized we are not going to see the foreclosures that we saw in the Great Financial Crisis. That most loans will go into forbearance and be worked out because of the huge amounts of capital and therefore there aren't going to be that many distressed opportunities for people to pick up. Can you talk about, I mean do you worry about bank losses and bank failures this time around or do we just have so much capital there that that should be completely in the rearview mirror and it's more of are there going to be opportunities?

PL: We changed our banking system and while Dodd-Frank wasn't perfect it did do this well. It meant that if loans can't be serviced you don't have a systemic collapse because there's so much reserves that you don't have to call the loan, you don't have to put it on the market as distressed to meet your regulatory standards, and by the way they've eliminated reserve requirements even on top of that. So, I got this one right. Starting about three years ago I was writing that when the downturn comes this will be very different because of all these excess reserves and as you say they pumped more in with QE infinity. So, here's the scenario. Interest rates are essentially zero, I'll charge you 150 over, I'll do a two-year loan over 150 basis points on the two year and you can service that, and if you can't service that you probably have negative operating income, I'll come back to that. So, I won't even push the can down the road, I'll actually make a new loan that you can service at 150 over the two year, right, because the two year’s so low. So, the bank can make money. You don't have to face foreclosure, I can roll it over, I can do that, you can cover, all those things. And at the end of the day what the bank really cares about is covering, right, they just want to have their money. So you won't get big foreclosures and you add to that the Fed is saying don't foreclose idiots we gave you all these reserves for a reason, don't foreclose and don't worry about your tier one capital just don't do dividends or buybacks. So, banks, not just with real estate, banks are forbearing. And in fact, the only financial bankruptcies you're seeing, and I'm not talking about the restaurant that just discontinued operations, they’re with bonds, right. If you look at the companies who have gone into bankruptcy, it's because of bonds. The bank part, the line of credit, they’re forbearing, it's the bonds and you’ve got to renegotiate. So, what does that mean? That means in real estate you'll see I think opportunities in two areas. CMBS, that's our bond and they're not set up to forbear easily so you have to renegotiate and do something, and foreclosing is part of that. And the other is negative operating income. Because it's one thing to say I'll forbear and I'll charge you 150 over on a zero interest rate essentially, right. It's one thing to say that and you can cover it and I'll do it for two years and then by the way at the end of that I'll do it for another two years and so forth. It's another thing to say I'll fund your operating losses, but I'll let you keep your equity. And I don't think the banks are going to do that. I don't think they're going to fund big op; they might fund temporary operating losses like TI’s or something. And what that means is opportunities for re-capitalization, rescue money, foreclosures are going to center around negative operating income. Negative operating income is going to be high end hotel, I mean you can tell me better or I can tell you, high end hotels, weak retail, not so much strong retail, they can cover right, but weak retail and office buildings that had the misfortune of losing a big number of their tenants so that they couldn't cover anymore. And it could actually be a good office building, but they just had the misfortune that they lost enough tenants that they can't cover in that window of time. It also could be a bad office building. You tell me, those are the main places you'll get negative operating income. That's where you're going to get opportunities because the banks aren't going to fund those negatives, you're going to need rescue capital or you're going to get foreclosed on and then the buyer or the rescue capital has to say how many years of negative operating income do I have to budget for, what can I pay for the residual. That's how I see it playing out at least.

WW: So off of that you do mention that the large excess reserves at the money center banks, the massive QE activity and the $147 billion in real estate private equity, dry powder targeting North American commercial real estate, that you expect cap rates to revert once the market freeze recedes and investors gravitate towards core and core plus strategies. So, I guess the question there is what causes the market to thaw. In the sense of we’ve got an election coming up, we're waiting to see if there's a vaccine, we’ve got another stimulus bill, I can keep going down the uncertainties out in the market today, but as I look at your projections pretty much across all commercial asset classes Peter, you are modeling out sort of peak vacancies in sort of Q4 2020, Q1 2021 and then you start to see absorption rates and occupancy levels go up and absorption rates continue to go. What's it going to take?

PL: That’s because pipelines shut down, the economy grows, and the pipeline and the construction shuts down. Look, I think there's a very, one of the most important pieces of research I've done in my career is with Matt Larriva of FCP and it's in the current issue about cap rates and what drives cap rates and it picks up on some stuff I had started talking about five years ago. It's not about interest rates. It’s about flow of funds. It's about how much money is out there, and the mental experiment is simply imagining there's twice as much money chasing real estate a year from now as today. What will happen to prices irrespective of interest rates? And you say they're going to go up, cap rates would come down. And that's what that research that we summarize and is more sophisticated than what I had originally done, Matt brought a lot to the table that way, shows. Now you're back to where we were. There's a lot of money in the system and I don't know if it comes out next year. I don't think it comes out this year. But I think by late next year it really starts coming out, it's going to chase. At the same time incomes going to be improving because the pipeline empties of construction, growth occurs. It'll be slowest in hotels, it'll be slowest in anything travel and entertainment focused like tourist hotels in New York, but the income will rebound and you're going to see notable price increases and cap rates will come down. Right now, we're in an odd period with office buildings and retail and a little bit senior which is we lack imagination, we as a species lack imagination. We think we do but we lack imagination. And by the way if we had great imagination, we wouldn't be surprised by what magicians do, we’d say of course, we lack imagination. We kind of say how’d they do that and as you know if you ever knew how a magician does it, of course that's how they did it. And the lack of imagination right now is no one's ever going to work from an office again, no one's ever going to work from an office and that's nonsense, that's just nonsense. We couldn't have been that wrong, we're social beings and you're going to hit a tipping point and the tipping point you're going to hit on office is, I don't know if it's 60 percent, 65 percent, when most of the people are going to my office, I’ve got to be there too unless I'm vulnerable health wise. Why? I'm afraid they're talking about me. I'm afraid I'm going to miss the opportunity. And I want the social. Right now, nobody's at the office so what the hell is the point of going in, there's no social. So, there's a tipping point and I think that tipping point is some combination of psychological and medical and as you noted going around your office it's very different, the psychological in different places. But what will solve it for offices when they don't have to use their imagination, imagining people to come back to work. What will solve it for hotels is when they don't have to have imagination that people will travel again, and that international travel happens again and that's why it's out there farther. What solves it for retail is when people feel very comfortable to go back and shop, and they're allowed to go back and shop, and the restaurants are operating full capacity. And you don't have to have imagination that they'll go back to full capacity. And I think it's several years still but it's a lack of imagination. By the way on the lack of imagination Willy it’s one of the reasons why protectionism exists. I can see the jobs we’re losing but I can't imagine the jobs that are being created in its wake. You know when farming was the dominant way of employment, we had machinery come along, all we saw was a machine and we got rid of the young men working on the farm and the young women. We couldn't imagine that they'd be doing what you and I are doing. And that's what's going on now is a lack of imagination.

WW: So, I want to ask one other point. When you mentioned the construction pipeline falling apart and get your quick comments on something you said in the Letter. And then I want to loop in to ask some specific stuff. But as it relates, you warn investors Peter to not purchase assets well below replacement cost due to the fact that construction costs are going to fall between 10 and 25 percent over the next 24 months and as development pipelines go through the floor. You want to expand on that a little bit?

PL: Yeah, I mean obviously you want to purchase the low replacement costs. What the real thing is just because you think you're purchasing below replacement costs today and, by the way, I started saying this two years ago when construction costs were at record highs, because construction costs fall during every downturn. The construction pipeline shuts down, the construction loan activity even in multifamily, construction loans are way down in multi. The only area where they probably are anywhere near norm is industrial and even there they're down. But office, way off and so forth. So as the pipeline empties the trades have no work and they cut their rates. And the building supply vendors have no pipeline and they cut their rates. And so, if you look at the history of construction costs during good times it runs faster than inflation and in bad times it goes down. Historically it averages over the long term about one percent rise in real terms, one percent faster inflation over the long term. And we're in one of those cycles where it's going to go down. So just suppose you think it's going to go down 10 percent and you buy a building today and you say I'm 10 percent below replacement costs. My answer is no, no, no, you're at replacement costs, you just don't know it.

WW: Okay, so then as you look at REIT’s your capital asset pricing model indicated that REIT’s were undervalued by a stunning 63 percent in March of 2020 and it moderated to “only” being undervalued by 24 percent in September. So, what do you like?

PL: Almost everything and in fact the irony is the one you like least. By the way this is not for a three-month hold, this is for like a five-year hold, you know this is a fundamental if you will. The one you like least is industrial because it's fairly fully priced. When you do the same analysis on it it’s fairly fully priced, it's a little underpriced. Unless you think retail disappears, unless you think offices disappear and that goes back to the imagination issue. And I just can't believe we were that wrong in February. I just can't believe that we suddenly in March came to the realization we don't need half of the office space in America. We just couldn't have been 50 percent inefficient, that's just defies credibility. Five percent maybe. And the same on retail. And in fact, the good retail will ultimately end up being helped by this. Why? Because all the crap retail gets closed and you get consolidation in the better. And by the way the REIT’s don't own the crap retail, somebody does. The nail salon in the crap retail went out of business. There's nothing left in the crap center anymore, it’s gone. People still need to get their nails done, they're going to go to the good center to get their nails done, right. And I’m just kind of pointing out the obvious that getting your nails done doesn't disappear, it may temporarily but not permanently. Getting Chinese food, the Chinese restaurant went out of business in the crap center, people are still going to eat Chinese food somewhere in a year or two and it's going to be in the good center that it will be. And the crap center will end up empty and that's the nature of things. So, what people forget is yes retail is challenged at the moment, but the nature of competition means that will ultimately make the surviving retail stronger. The surviving retail properties stronger. Same for hotels, same for everything.

WW: And so on that you may have seen that Starbucks is out buying up or taking additional space next to their existing stores so that they can transform their retail strategy and all they're going to do is cement their position as the only brand in coffee in that sort of space going forward as these weaker retailers fall out and they gobble up their space. But on this Peter there was a there's a data point that I've repeated in the last three days to all of my colleagues at Walker & Dunlop and nobody is compelled to believe it and it's out of your letter, And you point out that in Q2 of 2020 retail sales in the United States were $1.3 trillion of which e-commerce accounted for $211 billion or an all-time high of 16.1 percent. Now before I got to the 16.1 percent I sat there and said, e-commerce, I mean the only person I saw during Q2 was my family and my UPS delivery man and my FedEx delivery man. And here it is that you're saying an all-time high in Q2 when the world was locked down and we all thought we were only getting everything from Amazon and from and it peaked at 16.1 percent and I think that stat says a lot about the strength of bricks and mortar and the fact that they're not going to evaporate.

PL: I come away from the shutdown, the extreme shutdown, right, that kind of four-month shutdown, not disappointed in brick retail but amazed by brick retail and what e-commerce could not do. Not what it could do but what it could not do. It could not sell groceries profitably. It can sell them, but not profitably. And you go, huh, I always thought that was the case, we had a perfect storm to test it, they failed the experiment miserably. I always thought that they a were tremendous amount of goods that it's going to be years and years and years before online can compete with brick and you know what we found out that's true. There are some things that can be disintermediated but most not, so what does that say? What that says is the retail that survives is going to be around that part that is very difficult to disintermediate. And in a funny way all you did was time shift. Some of that growth that you mentioned in e-commerce that was going to occur anyway over the next four years. It all occurred overnight. But it's not going to occur overnight again and then another occur overnight again on top of that. They kind of grabbed it, they kind of grabbed it and having grabbed it they can't grab it twice, right, they’ve already got it. And what we did was find out what brick does really well that e-commerce at least can't come close to doing. That's going to make surviving brick much stronger in retail.

WW: So, on the multi sector Peter in your letter you state you’re quite bullish on the outlook for multi. As you know I had Mark Zandi and Ivy Zelman on over the past six weeks on the Walker Webcast and both are very bullish on single-family. You mentioned at the beginning of the webcast that the strength in single-family was one of those things that you hadn't predicted to have happen. But you know rent rolls have held up extremely well in multi. I've given stats throughout the pandemic as it relates to Walker & Dunlop’s loan servicing portfolio and it is unbelievable. We have the largest Fannie Mae multifamily loan servicing portfolio in the United States of America at Walker & Dunlop, and we have one loan in forbearance today, one, okay. And one of the things that you point out is that going into the pandemic the American consumer as a debt to income ratio was actually very healthy and the stat you point out there is that debt to income ratio peaked at 13.2 percent back in 2007, probably not a big surprise to everybody, and it had come down to 9.7 percent in Q1 of 2020. So people's personal debt was down at a very, very, if you will from a historical standpoint, manageable level going into the pandemic but even so we haven't gotten a stimulus bill or additional stimulus since August, we've gone through August, September and now halfway through October. Rent collections have been extremely strong and there are a lot of people sitting there going how long can this hold up. Yet you're quite bullish on multi. Why are you so bullish on multi?

PL: Well I’m bullish on multi, if you go back to what I got wrong on single-family was big involuntary savings. Well slowly those involuntary savings are going to disappear. Why? Because some people did take a vacation at the shore, they did go to the mountains. Well that meant that involuntary savings, remember people could have decided to save more but they said I'd rather have the vacation, I'd rather have a new car, whatever it was. As their lifestyles go back closer to what they used to have from a spending point the savings go down and they need those savings for a down payment.

Down payments… Susan Watkin and I did I think in 1990 what was considered a pathbreaking research that says income is not the problem, income determines how much home you buy, it’s a down payment, if I don't have a down payment even if I have the income I can't buy. So, the surge in buying single-family home is being driven by the involuntary savings. As the involuntary savings disappears you go back more to the world, we knew which is I can't save enough, it takes me forever to save because I try to live a high lifestyle. Now there will still be some involuntary savings going on because the NFL only has 6,000 people instead of 17,000 people so there's some involuntary savings going on. And the other thing is you still have a lot of young people. If you look at the demographic coming in, yes, there are a lot of 34-year old’s moving out but there's almost an equal number moving in to take their place. So, you still have a lot of young people. It'll skew a little suburban for the next couple of years. It'll send a false signal that everybody's leaving the city, they're not. What you're going to have happen is everybody who was going to leave the city this year or next year and the year after are going to leave this year. And again, it's like the e-commerce, you can't do it twice. If they've already left, they can't leave again. So, you're going to have everybody who was going to leave in the next two or three years “leaving this year”. But that means next year nobody's leaving and anybody coming is a gain. So, you're going to get some skewed data out of how much strength in the suburbs. I've always been pro-suburbs for the multifamily because they've always had more growth of young people in the city. But I mean the fundamentals are young people don't have enough savings to buy a home, that's the fundamental.

WW: And you underscore that by pointing out that the NAHB/Wells Fargo Housing Opportunity Index (HOI) has come down dramatically. So that index, which is basically at the average median income which is now $64,600 in Q1 of this year, that currently only 59.6 percent of all new and existing single-family homes are affordable to the median household income. That's down from almost 80 percent in 2012 and so if you, I mean one of the things I look at that number and say 80 percent of the single-family homes in America were affordable to the average wage earner back in 2012 and we went through an eight year period where multi completely outperformed single and now all of a sudden we have, we're in a recession/depression, people have clearly moved into single-family, but to your point what are the legs behind this particularly as asset values continue to rise and incomes either stay flat or go down?

PL: And if I'm right, if I'm right that the next decade is asset price inflation, kind of a repeat in the sense of asset price inflation, that's going to get worse, right, that affordability. Because my income is not going to go up so much, but the asset prices are and that includes single-family home and you're going to get the down payment I need being even bigger. That was one of the problems that happened in the past decade is the asset price inflation outstripped wage growth and therefore the down payment I needed was bigger and that's hard to put together. And I think you get a bit of a replay. I mean I think single-family does okay it's not like I think it's awful, but multi is well suited and the other side of multifamily has always been supply shuts down pretty quickly except for urban high rise, that's always been tricky. But if you leave urban high rise, which is not much of multifamily as you know, it's the photograph but it's not the mass of multifamily, the pipeline shuts down pretty quickly in multifamily. That's one of its saving graces, bad for developers but good for owners and lenders on multifamily.

WW: So my final question Peter, and this is, I loved to ask you all these questions about all the data because the data is so rich and great and you've helped, personally you've helped me understand a lot it and the context for it. But last time we spoke it was sort of economy and pandemic and you raised kind of what I would call at that moment sort of an outlier issue or a third rail which was social unrest. That if we don't get these rights it could produce significant social unrest and you were spot on in that. As you think about the outlook now as we head into 2021, is there an outlier issue beyond the pandemic, the election, and the economy, which are all three huge things, that we ought to keep in the back of our mind as sort of either an up or a down?

PL: Social unrest, and by the way I thought it was an obvious call. I made it originally in a web I did on March 24, I didn't know what would trigger it, as you know, I didn't say what, I just said if nobody's in school, nobody has jobs there's enough friction in life and society, you pen people up, you don't let them play basketball, you don't let them go swimming, you don't let them go to school, work, whatever, not good things happen. They don't have jobs, whatever, and then overreaction. If you said to me the outlier, the outlier is what happens post-election civil unrest and I have no idea. And I have no idea if it's from the right or the left or both or hopefully neither. That can do a tremendous amount of damage, that can set the economy back six months. It will not, well I hope it wouldn't end up in revolution, civil war, I don't think that, but the amount of damage, curfews, etcetera, etcetera. I encourage people to do the following experiment with your own little sample. I won't even tell you what my sample shows. Ask your acquaintances and friends what do you think, do you think they'll be notable violence of some type if Trump wins? And then ask, do you think there'll be notable violence of some type if Biden wins? And my guess is among your friends and circle you're going to get lots and lots of yeses, you'll get lots and lots of yeses. And the problem with violence is if it occurs it tends to create violence. It doesn't tend to eliminate it, right. So, if you look around the history of violence, if it goes on too long you even forget who started it. So, what I really do worry about, and the lag that may well occur between the election and the result could foment it, that is the big economic wild card.

WW: And so, on that just one final thing because we've run out of time which is just this. There are a lot of people who are trying to bet on a Biden economy versus a Trump economy and I watch Squawk Box every morning and everyone's like well these are bets that people are thinking if this happens and these are bets if this happens. How do you handicap your scenario of I just ought to take my money out of the market and put on the side until I’ve got a clearer picture?

PL: Well I think as long as you're a long term investor I wouldn't “take it out” because then you're going to face the question of when do you go back in and you're likely to screw that up. And I’d let the traders, the hedge fund guys make those gains and I'd say something slightly different which is be prepared for a bumpy November, December, January as the results get known. And you're going to have a lot of days where you're going to say I should have sold but if you're going to hold on to it, this is Jeremy Siegel’s stock result. If you're going to hold on to it 10 years who cares, right. And I know I would have picked the wrong day so get over it. But I do say prepare for a bumpy November, December in asset pricing and capital markets in general because there could be bad things happening, there could be quite bad things.

Willy the last thing I would say and I think I know your values, I’d think you’d share it, is I'd remind people that this thing is a long way over for a lot of human beings, many of them in our country and many of them abroad. You know I have my program in Philly I help educationally and my program in Kenya I help and I would just, and I'm sure you share this view, don't lose sight of the fact as we come up to the holiday season that the people on this call, on this web, are relatively blessed and try to reach out and help somebody during the next whatever because there are some people out there not just hurting in the general sense that there are always people hurting but like really hurting. And I see that very vividly in Kenya where they were always hurting but now, they're really hurting and, in the U.S., as well. So, I'm not trying to usurp your agenda, but I know your values and I think you would echo that.

WW: I echo it and it's a great note to end on. So, Peter thank you very much for not only all of your input today but also for ending our conversation on that note because I think it's the exact right note. So, to everybody on the call thank you very much. I've got a great webcast coming up next week with Admiral McRaven who many of you may have watched his commencement speech at the University of Texas where he said if you do one thing every day make your bed. I will have Admiral McRaven on next week to talk about leadership, to talk about foreign policy, and to talk about the education of our college students during the time of COVID given that Admiral McRaven ran the University of Texas system. So, Peter thank you again for joining me.

PL: Thank you Willy, always fun.

WW: Take care, bye-bye.

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