Reflecting on the 2020 economy and insights for 2021 with Dr. Peter Linneman

Walker & Dunlop's CEO, Willy Walker, spoke once again with top economist Dr. Peter Linneman to reflect on how the commercial real estate space and overall economy performed in 2020, and dive into the data that Dr. Linneman is using to inform his 2021 predictions. 

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 ten years as a public company has seen its shares appreciate over 800%. 

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

Willy Walker: Thank you, Susan, and good afternoon and welcome to the first Walker Webcast of 2021. I'm thrilled to begin the New Year with my friend Peter Linneman, one of the most insightful and analytical minds you can find on the markets and commercial real estate. Our discussion today will be grounded in the data Peter published this week in his quarterly Linneman Letter. And to any of you who don't subscribe to the Linneman Letter, as you will hear over the next hour, it's packed with data and valuable insights on the markets that I would highly recommend. 

Before I dive into my discussion with Peter, a couple of quick comments about 2020 and what we have in store for 2021 with regard to the Walker Webcast. First, we did 38 Walker Webcasts in 2020 and I'm deeply thankful to the wonderful guests and the team at Walker & Dunlop that helped produce those webcasts, and to you, our listeners, for making the Walker Webcast such a hit. We had over 230,000 unique views of the webcast both live and on replay last year, and well over half a million views of some portion of the webcast. Second, we plan to continue holding the webcast in 2021, and given the guests we've already lined up, the webcast should only grow with its insight and its popularity. In the coming weeks we will have the group President of Marriott join us to talk about the hospitality industry; the President of Walmart to discuss the future of retail; and the author of the best-selling book, 2030: How Today's Biggest Trends Will Collide and Reshape the Future of Everything. And as I think Peter knows, that's another Wharton professor who wrote that book. 

Because of the quality of our guests, I've moved away from giving my Walker & Dunlop market update at the beginning of the calls. To start off 2021, I'll just for two seconds give a quick W&D-related comment before diving in with Peter: WD stock ended 2020 up 46 percent, which is without a doubt, the best performing stock in the commercial real estate ecosystem of lenders, REITS, and service providers. The only two companies with similar returns on the year were CoStar and REIS. And for Walker & Dunlop’s performance to be nicely tucked in between two technology behemoths like CoStar and REIS is simply a fantastic performance. The reason for our performance is due to the people, the brand, and the technology we have developed at W&D. Our focus on multifamily financing also helped. And we continue to see multifamily outperform other commercial real estate asset classes at this time in the pandemic and economic cycle. We have seen treasury yields spike this morning, but we are still deploying huge amounts of capital at extremely low interest rates. The Multifamily Investment Sales market was very active in Q4, and we will dive deeper into the volume of properties we sold, and in what markets on our Q4 earnings call at the beginning of February. 

Finally, I need to thank all of our customers, partners, and W&D employees who are listening to this webcast, for all we did together last year. 2020 was a year we will never forget, and for it to have been such a successful year for Walker & Dunlop is extremely special, so thank you. 

Okay, Peter, let's start with your analogy that the exit from the pandemic is going to be “like a butterfly's flight path.” Explain that analogy and tell us when you think it's going to morph from a butterfly’s flight path into a migratory bird heading north for the summer. 

Dr. Peter Linneman: Happy New Year, Willy, and it's a pleasure to be back. The first part of the bounce back from the shutdown back in early part of the year was easy. And I had said that was going to be elective medical, all that kind of stuff came back and that would be quick. And then after that I said it would be like a butterfly. And if you think about a butterfly’s flight, not terribly fast, quite erratic, yes, moving forward, but up-down-sideways-stop-backwards. And I started saying that I think it was around September that this is going to be that kind of recovery for two reasons. One - and it's played out - governments around the world continue to say you can't do this. I'm not saying right or wrong, I'm just saying that was inevitable. And so, not just in the United States but state, local, and federal governments around the world saying you can't do this. Oops, then you can! You can't go to the gyms last week, but you can this week. But who knows in three weeks from now, you can still go to the gym? And then on top of that, is even if I'm allowed to do it, do I want to do with it? 

So, Willy, you and I… big travelers, historically. I haven't been on a plane since the 4th of July weekend. I can, I just choose not to. And partly because of my age, and so forth. So, when you combine, “You can't do it” and “I don't want to do it,” it's going to be a butterfly… until enough people get vaccinated. And then when enough people get vaccinated, both are going to start receding. They're going to stop saying, “You can't go to the ball games.” That's jobs for popcorn salesmen and parking lot attendants. And we're going to start saying, “I feel safe going to the ball game because 50/60/70 percent of us are vaccinated.” That's when it becomes a migratory bird. When does it become migratory? Probably doesn't start until June or July, and that's where, as you and I were talking the other day, if I got my jab right now, my first jab right now - for me, the Moderna or Pfizer - it's basically two months until I'm fully immunized, right? Because you need a second shot, and the time it takes. So, I think we're going to have a lot of shots by the end of May, but it's going to take months though for that to be fully effective. So, expect the butterfly transitioning into a migratory bird as we start getting to June/July/August. So, head home for the good times, right?

Willy Walker: Exactly. So, let's discuss politics for a second before going back to the economy. Your take on the Biden economic team is summarized in the Linneman Letter in the following manner: “If you like the economic policies of the Obama administration, you will be happy with Biden's team. While it is diverse, there is no policy diversity. As it is loaded with Keynesians who drove Obama's economic and business policies. While there is no evidence that these policies have ever worked anywhere, they will hold sway for the next four years.” So, my question to you is, is that fair? And the one data point that I would raise in asking whether that's fair, is a data point that you gave in your Q2 letter, which is that corporate profits, both in aggregate, as well as a percentage of GDP, were at all-time highs in 2012 and 2014 respectively, even with the dramatically higher tax rates and the enormous added regulatory burdens that existed during the Obama administration. So, can you comment on that?

Dr. Peter Linneman: Sure, so first of all, it is accurate, that it is largely the same people and trained by the same people, as was the Obama [administration]. They are unashamedly, I'm not saying good, and they believe in Keynesian and interventionist activities, and therefore, if you did like the Obama policies, you'll be very happy. If you didn't like those economic policies, you're not going to be as happy. Now that the question is, is there empirical evidence? It's very little empirical evidence out there that Keynesian phenomena really exist, other than in classrooms. And you mentioned the corporate profits. 

Don't confuse corporate profits with how well the economy's doing. Corporate profits have an interesting history, in that when labor markets are really terrible, when they're terrible, that's when corporate profits tend to be high. Why? I use the phrase, “The beatings will continue until morale improves.” Which is another way of saying all of the gains to productivity during weak labor markets go to the ownership of the companies. And then as the labor markets rebound, as the economy grows and we get to a market more like we were at in 2016/2017/2018/2019, the rewards of productivity growth generally go to the workers. And that's well-known and goes back and forth. And so corporate profits were very high in the early years of the recovery, because the labor market was so weak, that's why. And so, what's an employee to do if you say, I'm not going to give you your share of the productivity? There's no place to go. So, I think the real point is to focus on GDP growth, employment growth, etc. And it lags. Now I think on that….

Willy Walker: On that Peter, just one quick question on that. Then shouldn’t we be more focused as it relates to the stock market and corporate profits and stock prices, on the cost of labor versus tax rates, because if you just use what you just said, and you go back to 2012 and 2014 with tax rates that were well over 10 percent higher than where they are today. Yet you still had as a percentage of GDP and aggregate corporate profits at peak levels. Does that mean that we are chasing taxes, and that is not what we ought to be focused on, but actually on the cost of labor? 

Dr. Peter Linneman: Well, over the long history employee ease capture about two thirds of productivity gain over the long period and employers gain about one third, and in some periods employers gain it all and some periods employees gain it all. I think what happens is people get too fixated on almost a Marxian struggle story between employers and employees. The truth is employers and employees are in this together, and by and large employees do well when there are lots of jobs, and lots of opportunities, and that tends to be one and companies do well as well. It's not a struggle so much as they're in it together. 

Willy Walker: Okay, so let's, let's focus for a second on the employment numbers and unemployment, because right now the Bureau of Labor Statistics says that the unemployment rate is 6.7 percent at the end of November, and you look at that number and say that's an under classification of unemployment and predominantly by looking at the 4 million furloughed workers in the United States, and adding those to the unemployment ranks your actual unemployment number at the end of November was 8.9 percent. But as you remarked in your Q2 letter when Barack Obama was reelected in 2012, we had 7.9 percent unemployment. And so, while the shift from 3.5 percent which is where we were at the beginning of the year, to either the BLS number of 6.7 or your number of 8.9 percent is a dramatic shift. It's not like we're in uncharted territories. So, I guess the question to you is, is all this stimulus that we're talking about really needed? Given that, even your number, adding to what the BLS number is doesn't put us in some range that we haven't seen before as far as unemployment.

Dr. Peter Linneman: Well, we were in truly uncharted territory when we go back to our let say six months ago, or eight months ago. We've massively improved. It could be as high as 12 or 14 percent. The Linneman letter lays out why and how. No one is lying, by the way, it is simply data issues. Um, how much help do we need? I don’t view the government spending that is being talked about, certainly not Cares I and mostly not Cares II and there will be a Cares III. I don’t view it as about stimulus Willy, I view it about society was faced with a very unique disease situation and decided to shut down certain parts of the economy. Okay. And again, whether it was shut down by the government, or by you deciding not to do it, does not matter. Society decided to shut down a big chunk of our economy. In so doing, we made innocent victims out of hotel workers, airline workers, restaurant workers, you know, we can go through the laundry list. They became innocent victims of society's decision, and mind you, society should more or less try to compensate them for that. Now, those people can't go borrow for themselves. I mean, who is going to, are you going to lend to somebody who does not have a job? It doesn't look like their industries coming back for the next six months, you're not going to lend to them. The U.S. government can go out and borrow very cheaply on their behalf and give them the money through unemployment or PPP or all the mechanisms. That's what's going on. That’s what is really going on, and it is so doing keeping those people alive, which I think is a good thing. And that is why this has been productive spending. 

How much do we need? Fast math of where we are sitting, Um, 15 percent of the economy. We could argue about that, but I am just taking 15 percent of the economy really struggling. Hotel workers, etc., right. Ticket salesman at the ball games, etc. Let's say 15 percent of the economy. It's going to take another six months, on average, some longer than six months. Some shorter than six months. So, we need a half a year for 15 percent of the economy right. That is seven and a half percent of GDP. This is all back of the envelope, right, just to give a sense. Um, 10 percent of GDP is $2 trillion, and so, we need a trillion and a half. Cares II is about a trillion, not quite, but let’s call it a trillion, but it is all not going to help them some is going to other things. Let's say $700 billion is going to them, we need another $700 billion over this calendar year to be authorized to help those people and then we're back to something like the Migratory Bird takes care of it. 

Willy Walker: So, let’s go from the macro numbers and those big back of the envelope numbers down to some stats that you put into the letter that talk about the consumer. So, um, you point out that the individual at service ratio was below 9 percent in Q2 of 20. Down from 9.6 percent in Q1 and dramatically below its peak in 2007 of 13.2. You also point out that credit card delinquencies were down to 1.2 percent in Q3 of 2020 from 1.6 percent in Q4 of 2019. I want to repeat that one so, everyone picks that up, so credit card delinquencies were 40 basis points below Q4 2019, when the economy was absolutely humming, and finally you note that the savings rate rose from 8.3 percent in February pre pandemic, to 33.7 percent in April, but subsequently came down to 13.6 percent in October, as people were returned to more typical spending habits, which increased consumer spending to real monthly retail sales in October at 5.5 percent above their pre-COVID peak in January. So, if you look across the board the consumer debt service ratio is excellent. Credit card defaults are at historic lows and better than pre-pandemic numbers and consumers are back spending at pre-pandemic levels. So, I reiterate my question. Is all this stimulus needed?

Dr. Peter Linneman: And the answer is if it is focused on that 15 percent, yes. To the extent it is not focused on that 15 percent, no. And so, you point out the retail number that we hit this real high. You are right, but remember, part of that is catching up for what we didn’t buy in March, April, May, June, July, etc. So, one of the reasons it came up was it had been so low, kind of a catch up. 

So, this is the problem with the government spending and moving forward is if it is focused on what I'm calling the 15 Percent and that 15 Percent will become 14 and 13 and 12 as the butterfly goes. If it's focused on that, it's going to do great good. It's going to keep them from defaulting on their rent. It's going to keep them from defaulting on their mortgage. It’s going to keep them to keep falling on their credit cards. It's going to allow them to keep their kids in college, all that's wonderful because they're innocent victims of this social decision of shutting down for the disease. If it is spent on quote other stuff, it is misdirected, and it is not going to be productive. It's not going to be productive. It is about, and you just said it well, which is for 85 percent of us do not need stimulus. 
Willy, what is the old phrase that you can have a lot of people drown in water that is on average six inches deep. Right. So right now, what you are accurately saying is for the economy as a whole, the water is not that deep, right. The water is not that deep. But if you're in that 15 percent and I'm not trying to be precise with the 15 percent, but if you're in that 15 percent you're like up here (hands at chin level) you're right there, and giving you a little boy to bring it to where it's there is life and death. That's the critical targeting dimension. It's not about spending. It's about targeting the people who are the victims.

Willy Walker: It's a great analogy and I wish people on Capitol Hill would realize that they need to lower the level of the water in the tub from six inches to three inches to make sure those people who are susceptible right now don't drown. Let’s go to jobs for a second Peter. I looked back and couldn't find it, but right now you project that we lost 8.6 million net jobs in 2020, and your projection is that we gain 8 million of those 8.6 million in 2021. Was that revision up, I believe, as far as the snapback due to the vaccine development?

Dr. Peter Linneman: Hundred percent hundred percent. I mean I had it coming back Willy, but not to that extent. It went from a possibility to a reality of several high efficacy, no obvious major side effects vaccines, and in light of that it's going to stumble around, and as you know, not only stumble around be very bad right now. But on the other hand, if you look at the year, every jab we get one close one step closer to normal. And what is normal? I think we said at the last gathering Willy watch the sports stadiums, watch the concert arenas. We get one step back to normal every time somebody gets two jobs and it waits, or if J&J comes, one jab, and wait a few days. Um, that's why it's revised up and to that extent, there's a good chance I miss, but it's a timing miss. You know it's like did you close all the loans you thought you were going to close in December. There is two ways you missed one is no and we will never get them and no we will pick them up in January. So, to the extent I miss. I think it is only because it takes longer to jab people and it spills some of those over into next year.

Willy Walker: So, if we talk about a recovering economy. The re-employment of those 8 million people that you're now projecting that will happen in the year. The M1 money supply increased by a stunning 52 percent between December of 2019 and October of 2020 -- 52 percent. Doesn't economic theory tell you that that will undoubtedly lead to inflation?

Dr. Peter Linneman: So, I am an old Milton Friedman student that is literally true. I am now an old Milton Friedman student and Milton had the comment that Inflation is always in everywhere monetary phenomena, and if you push enough money into the system, prices will rise. What people forget and they get tricked by the experience around the world, particularly in the 70s and 80s, is they think that the consumer prices are the only prices in the society, and they are not. There are all kinds of prices in the society that are not consumer prices like stock prices, gold prices, silver prices, home prices, office prices, etc. We pumped a lot of money into the system in 2008, 9, 10 and 11 it came out of the system, starting in 11 through 18. We had no consumer price inflation to speak up, but we had huge asset price inflation. If you don't believe it. Go look what happened to the stock prices, bond prices, gold prices, home prices, etc. Okay, so we had inflation. My guess is that we pumped a lot of money into the system. Once again, it has not come out yet. It's in there keeping people solvent and as it comes out over the next five to seven years, you're going to see a replay it is not going to be chasing bread and cigarettes and chewing gum. It's going to chase assets. Why? 

Because in the 70s, banks, which are the ones getting the money, banks were set up to give money to mom and pop America. So not surprisingly went up in prices were things mom and pop America consumed. Today, you are not giving that money to a bunch of little local banks, you are giving it to JP Morgan, Goldman Sachs, Morgan Stanley, etc. They are not set up to give it to mom and pop America, they are set up to give it $100 million here, $200 million, $80 billion here a billion there. Those are the prices that go up. Asset prices are going to go up. So, I think you're going to get kind of a replay of not a lot of consumer inflation, but a lot of asset price inflation. And that has, just like consumer price inflation has winners and losers, asset price inflation have winners and losers. Just to put the final point on it. I mean, I think the previous Linneman letter was a piece of research with Matt Larriva of FCP, and we examine what causes, what determines cap rates. And the answer is, it's not interests rates, and it's not GDP, its flow of funds. And the simplest is Willy, if I told you there's 50 percent increase in the money supply and it all chased apartment buildings over the next two years. What will happen to apartment prices? Now, I am not saying it will just chase apartments, but if it all chased apartments. What would happen to apartment prices? In two years will have what 3 percent more apartments, and we have 50 percent more money chasing. The prices will go up. That is the asset price dimension I see coming, and I think it is going to be a decade of asset price inflation, again, which for us is lower cap rates.

Willy Walker: So Peter as it relates to inflation and acid inflation versus consumer inflation, if you will. Do Jerome Powell and the other fed governors disregard asset inflation as they think about setting interest rates and therefore, as long as consumer inflation stays low interest rates, stay low?

Dr. Peter Linneman: You know, they are aware of. And in fact, Alan Greenspan was very articulate on exactly this point during his term. Which is, remember the housing bubble phenomenon and Trudy cricket [sic] and I don't know that I want to second guess asset prices, but they definitely are inflating in ways that would appear purely inflationary and so forth. So, intellectually, they are aware of it. Historically, they have been hesitant to direct monetary policy around asset price inflation. There are some pros and cons to that, but they have historically been hesitant to do so. But let's face it asset price inflation gains is a big gain for those that own the assets and a big drag for those who don't. It's, I mean if I own a home, I like asset price inflation. If I plan on buying a home for the first time in the next five years, I don't like home price inflation. It's no different than if I own the apple. I like apples that you eat but I own an apple, I like to see apple prices inflate. If I am the person about to go to the store and buy it, I do not want to see inflation. So, it’s no different price is a price.

Willy Walker: So, let's go from inflation and asset inflation versus consumer inflation to the yield starved world that we live in. So, you point out that in October 2020 real personal annual interest income was $111 billion or 6.5 percent less than it was in 2007. Okay, and people listening stick with me on this one. So personal interest income was 6.5 percent lower in Q3 of 2020 than it was in Q3 of 2007 even though the United States government and private issuers of debt have issued $15.3 trillion of additional debt since 2007. So just to get a sense of, there is $15.3 trillion of additional debt outstanding and yet the personal income off of that debt is 6.5 percent lower in Q3 of 2020 than it was in Q3 of 2007. If you add on top of that real annual dividend income was down 4.8 percent year over year through October, due to companies pulling back on dividend payments. So, we are not getting interest income, we're not getting dividend payments, where are people going to get yield and is that not an incredible reason why commercial real estate will continue to be a great asset class to invest in?

Dr. Peter Linneman: So, if you think about it, all that incremental debt was issued at what amounts to a negative interest rate. Right. Namely, I have lower interest payments, even though I got a lot more depth. So, the incremental debt, was effectively negative. It literally wasn't but you go wow what a world. People are starved for yield and what is happened is assets that were never intended to be kind of zero coupons have sort of become zero coupons. Why, because if asset prices get pushed up enough by a lot of money chasing it, it's all on the back end. So, all on the back end, right? Now not literally all. So, what's happened is, by the way, you mentioned how stock yields are down. The stock yields are down, so I don't get my money by “dividends”. I get my money by have to sell shares every once in a while, to eat. But since the share prices are up, I win, right? As long as, I own shares to start with. 

So, you're right, we're in a world where for the financial crisis pump tremendous amount of money in the system. It went into the asset prices that lead to lower yields, they kept interest rates down so we could service the debt. And you go, but asset prices go up. If you have assets, you are better off. But if you didn't have assets, you're worse off, because how do you get assets now. And I take the home as the best example. If you say is it good for multifamily and commercial real estate. If you can generate a cash stream in a world hungry for cash streams and a world awash with money, you're going to do okay, you're going to do okay.

Willy Walker: So, Peter in the letter you outline a hypothetical multifamily investment and with rents going down by 10 percent in 2021 and 2022. Can you run us through that because I think this low yield environment is very indicative to why you still believe that if you're going to even have a reduction of rents or your NOI by 10 percent in 2021 and 2022, it still makes sense to invest.

Dr. Peter Linneman: So, I kept getting asked, Willy, the questions, go back six months ago, or eight months ago. I kept getting asked, well, what would you invest in today if you could? Right, and I really started thinking about it. So, I started going I am not going to invest in zero yield, zero yield, zero yield, right. And I looked at multifamily and multifamily you could buy at a four and a half cap. I know some markets are less and some, but it's not a crazy number to say four and a half cap. Right, I mean it's not a nutso number. You can borrow, you could go get me 10 years, 30 years am at two eight?

Willy Walker: Two and a half, two eight. I think your model is two eight, which is great.

Dr. Peter Linneman: Two eight and then I started doing the math and going, gee, if income rises, NOI rises by 2 percent a year for 10 years I can't lose. And I looked at the cash on cash and coverage and so forth. Then I started to say, well, that's all great, but what if it falls? What about NOI falls 10 percent, and then another 8 percent over the next couple of years. And as I show, you still do great, you still do. I know it's all just math, but it's straightforward math you would agree. Even if you buy and the day after you buy NOI goes down 10 percent, goes down another 8 percent the next year. Then it takes four years to get back to where it was. So that's not a crazy recovery and then it goes two and a half percent a year after that for another four years. You do, what is it a nine, nine and a half IRR. In what world can I always have interest coverage, always have debt coverage, get a nine to nine and a half percent IRR when incomes fallen 18 percent. And by the way, 10 years later income is only up by 10 percent total at the end of 10 years and I get a nine and a half. Sign me up. Sign me up.

Willy Walker: I think one of the other interesting things about the model that you do in the letter is that you don't have imputed in there, some massive cap rate reduction on exit and from it. And so, you are, it is all on cash flows. It is not on some great valuation jump 10 years from now.

Dr. Peter Linneman: It's the spread. That is why I say it's only 10 percent increase in NOI over 10 years not 10 percent annual, 10 percent total over 10 years, and a stable cap rate. Now go back to what we were just saying, I think if anything you're going to get some more cap rate compression, right. because there's so much money out there. And then by the way in the paper I model. Well, what if cap rates get worse? And even if they get noticeably worse, you're still doing a 5 percent and you have coverage.

Willy Walker: So why doesn't this work for office and industrial?

Dr. Peter Linneman: Okay, so it doesn't work for, let's take the industrial first. It doesn't “work” as well for industrial because industrial is lumpy. Right. It's lumpy, namely income may fall by 18 percent over two years, but my property has the tenant that went out of business. And so theoretically, I have coverage, but my particular property doesn't. So, by the way, somebody else is doing really well. So, the lumpiness of tendency makes industrial not work quite as well. It works a bit though because you can borrow in the industrial market right now. 

Now let's go to office, doesn't work at all for office. Why because, one, I can't borrow, right. If I said I want to buy you know a $100 million office building how much Is somebody going to lead me through that these days, Willy, not much. So, I've got to go in it essentially all equity. Maybe I get 20 percent debt, 30 percent debt, 40 percent debt. But go back to the multi what's driving it is, that big spread, Freddie and Fannie are there lending, and others are lending. So, I can really borrow, and I can really get the spread. I can't really borrow so I can't really get the spread on office. And then on office, you have to add the lumpiness factor and again. Unless I've got a great long-term lease. So, the lack of debt is gone, that is a big part of what makes this a “golden age” right now for multifamily. I think you're going to look back and it's not such a golden age in the sense of supply and demand of, you know, the demographics versus how much we build, it's okay over the next few years. But what I think is the golden ages, what do we say four and a half cap, and a two and a half or 2.8, that just doesn't exist in history. It just doesn't exist. And by the way, ultimately, that's why you'll get yield compression if there's a lot of money out there, you'll get cap rate compression.

Willy Walker: And on that, you do note as it relates to cap rates, that because of this massive QE activity and I think your estimate is $147 billion of real estate private equity dry powder focused on North America, you expect cap rates to revert to pre-crisis levels during 2021 and then potentially compress from there?

Dr. Peter Linneman: Yeah, I mean, what we have right now as you know is in multifamily there’s not as many transactions. In industrial there's not as many transactions, but as best you can tell those two sector’s cap rates are not much different than a year ago. You know, it's hard to tell because there's not as many transactions. In the other sectors, there's not much price discovery, right, there's just not much. And so you have the public market, which has reacted, but the private market hasn't. But I just think that people haven't fully figured out, there's a lot of money out there. Interestingly, the public stock market in general has figured out, there's a lot of money out there and it's going to drive values into the future, which is why values are where they're at.

Willy Walker: So, let's focus on those other asset classes for a second and let's go to retail. So, as I mentioned previously retail sales in Q3, and as you said bounce back, but that was a lot of the pent-up demand from Q2 being, if you will, expressed in Q3. But I want to talk about online versus bricks and mortar because real quarterly retail sales stood at over $1.4 trillion in Q3. Of which e-commerce accounted for $206 billion or 14.3 percent of total. And I think that this data point is an unbelievable one that people have to keep in mind as it relates to the brick and mortar retail world versus e-commerce. 

Many of us, all of us who could buy things on Amazon in Q2 and have the UPS delivery truck show up at your house, thought that the entire world was being supplied by Amazon and walmart.com and UPS and FedEx. But to your data, we reached a peak of online sales in Q2 during the shutdown of 16 percent of total retail sales and that retreated, as I just said to 14.3 percent in Q3. So, 85 percent of retail sales are still going through bricks and mortar. What's your outlook as it relates to e-commerce versus bricks and mortar over the coming years and did the pandemic basically pull forward e-commerce growth?

Dr. Peter Linneman: It pulled it forward, but people misunderstand that Willy. To the extent they got sectors and sales that they weren't going to get until 21 or 22. But they got them in 2020, they can't get them again right they already got them. If you picked up all the gold that's there last year, including gold that you didn't think you were going to pick up until this year, you can’t pick it all up last year and find it again. You've already picked some of it up. So, and I think people just missed that phenomena. Second, don't forget that as the migratory bird part of this recovery happens that 85 percent, you're talking about becomes a more competitive, beast. It's been a handicapped beast, and it will be a better competitor as the migratory bird part of the recovery happens then it’s been during the drop or the butterfly part. 

So, do I believe online sales will continue to grow? Yeah, but people forget where it started from. It started small and yes; it's growing I’m not taking anything away. I did a quick calculation, and by the way, I also net out the fact that online just basically wiped out catalog and people forget that a big chunk of online sales were all the catalog sales that did occur or would occur going forward. So, not all the online sales came out of brick. A lot of them came out of catalog. Okay. If you look back net net at brick sales as best, I can estimate, basically over the last decade brick sales in real terms are flat. They're up like 3 percent. That's not great for a decade but remember, it's real. Adjusted for inflation. So, okay, they're putting through 3 percent more. But remember, the real estate they're putting it through is probably less than a decade ago because net over the last decade, we've had retail footage net shrink. What that means Willy is that essentially 100 percent of the growth in real retail sales over the last decade occurred “online”. But it didn't mean brick disappeared. It meant they still had huge amount of sales 85 percent as you point out. That's kind of how I see the next decade, playing out. Which is the growth way disproportionately going to online but brick being an important part of delivering effectively. Huge amounts.

Willy Walker: So my next comment I was going to ask you to comment on: I'm going to make the statement and then I'm going to jump from there to office. In your letter, you also point out a stat that amazed me, which is that of total consumer spending, American consumers spend 4 percent of consumer spending on restaurants and only 3 percent on groceries. So, we spend more money going out to restaurants and buying fast food than we do buying groceries for our own home. And I think that's a very interesting one as to how important restaurants are to retail and then second, as we go from stocking up the refrigerator to going back to eating out how much that will change the dynamic of retail.

Dr. Peter Linneman: Huge. Huge. People don't understand it. Hans Rosling, brilliant man, wrote this book Factfulness a few years ago. If you've not read it, it's a great read. One of the things he points out is, we fix in our head the world that we grew up in 30, 40, 20, 50 years ago. I grew up in a world where you ate out, rich people ate out once every two or three weeks. And I kind of assume that's what people do even though I know that's not. Then you see the data and you go “Oh my god” And you go “It’s not just rich people, it's everybody.” And it's not just once every three weeks, it's like three times a week. And yes, some of those are McDonald's, but those are real sales. Right, so yeah, it's huge. It's huge. And it goes to, by the way, take that restaurant number another way, back to the 15 percent that are suffering. Those people are suffering. Right, those owners and workers together are suffering, and you start saying, “Well, where'd you get the 15 percent suffering?” Four percent of what we do is restaurants and probably three quarters of that is really suffering. It is remarkable as a number, though, it's a staggering number.

Willy Walker: So, you have a headline that says, “Don't write off the cities”, and you and I are firmly in agreement on this one. Talk for a moment, Peter, about your numbers as it relates to office usage and square footage. You spend a lot of time talking about how, for a decade, we've seen square footage per employee shrink, shrink, shrink, shrink, shrink, and law firms were going and trying to make people work in 30 square feet. They are just down and down and down and now all of a sudden, because of the pandemic, your assumption is when we get back to offices, we're going to need more square footage.

Dr. Peter Linneman: Oh, yeah. We over downsized. We overdid it. The pendulum swung too far. And when you add the pandemic and the concerns of the pandemic, a lot of people who built their offices out, and I don't just mean WeWork’s, I mean you, me, everybody who's got their space built out over the last 10, 15 years, you went too far. We went too far. We put workers too close, we sacrificed productivity. I wrote about that over the last few years. And we've sacrificed sanitation and so forth. So, we're going to find as people come back, we need more footage. We don't need more footage now because if only 5 percent of us are going into the office today, we got plenty of space. That's not our problem. But when everybody comes back, and they will, we need more space. So, somebody said to me, “Why do you think people come back?” You want to know the real honest answer is because they have spouses. They have spouses and their spouses are all saying, I don't care if it's a male spouse or a female spouse, they're all saying, “leave.” And by the way, they don't want to be home either. 

I said jokingly, but only half-jokingly, that how many people go to the office on Saturday or Sunday or stay late on nights, because they don't want to go home and have to deal with the kids. And it may not be a nice truth, but you know all of us, if you listen, there's some truth to that. There's a sociological dimension of protecting my interest by being in the office. There's a social dimension of people having friendships and such. Do they like to commute? Not generally, not generally, but you put up with all kinds of stuff. Would you rather commute or have to share a 1000-foot space with your children and your spouse? That's not close. That's not close. And people will, you know, they're going to come back. 

By the way, just to jump on Willy, how do I know hotels will come back. And conventions. And the reason is because spouses are saying, “Get the hell out of here. I was much happier when you weren’t here.” And we all know that's true, right, “except for us” right? And so, people are going to go back to the office.

Willy Walker: Let's go to hospitality for a second. So, the occupancy rate in 2020 was 47 percent. Your projection is that through the first half of 2021, we hold flat at about 47-50 percent occupancy on hospitality and then as the jobs get in and as people get back to traveling that it rebounds quite nicely. And you think that occupancy will get back to 2019 levels, which was 66.3 percent by year-end 2023. And I guess my question to you is, can owners hang on that long?

Dr. Peter Linneman: Not if they are a CMBS borrower. If they're a bank borrower, yes, because I think the Fed is going to continue to tell banks “work with them.” And the ones that have the biggest problem in that regard are negative operating income because it's one thing to work with you and it's another thing to fund operating costs. So, the full-service, full operation high end, they're working at negative operating income, which is why you're seeing some of them just close. I'm not even going to try to make money because if I do, I'll lose money, which I think is not such a dumb strategy right now on those things that just limit the negative operating income loss. But they'll come back and they're going to come back because people like to travel people. I mean, you know, I was watching Schindler's List the other day. People rebound from catastrophes. People rebound. The world came to an end, effectively, and it rebounded, you know, after World War II. You know, people talk “Will people come back to the city?” And you go, Willy, what was the year 1997 or such when the earthquake hit San Francisco during the World Series, something around there, right? They rebuilt San Francisco. Why not? They could have just said, “Never again. Leave the highway laying on top of one another, and let's pick up and move to Boise.” They could have. 

Dr. Peter Linneman: They rebuilt. They rebuilt all the cities after World War II, right, all the cities. They rebuilt New York City after 9/11. That's because cities are vibrant economic engines and vibrant social engines. They have not been very vibrant over the last 10 months, but we all know the reasons. It's not because they can't be. It's because temporarily they aren't. I lived in the center of Philadelphia for the last 40 years. If you take away its vibrancy, all I'm left with is bad government, high taxes, and dirty streets.

Willy Walker: Some pretty good universities and hospitals as well. I would say.

Dr. Peter Linneman: That is true. That is true.

Willy Walker: So, I want to make one more comment on hospitality and then I want to move over to multi versus single. In reading your letter and then reading a lot, everyone says that travel is going to rebound on the vacation side of things and personal travel, but that corporate travel is going to be very slow coming back. And I would say that, as much as I would love to think that if I'm recruiting somebody who lives in Los Angeles or in Miami, that I can go and just do a zoom call with him or her, and that's going to have the same impact as having a dinner with them. But I think what everyone has forgotten, is that the competitive landscape is going to make it so that some competitor of Walker & Dunlop is going to hop on an airplane, travel to LA or Miami, have dinner with him or her, and have a much bigger impact on them than my zoom call. And I'm going to quickly figure out that I'm being uncompetitive, and I'm therefore going to get back on that airplane, I'm going to go stay at a hotel in LA or in Miami, and I'm going to do exactly what the competitive landscape is driving me to do. And I just think that being in this dispersed model, the competitive landscape is what you and I are doing right now. But if nobody would watch this because you and I are remote, and I could actually get in a studio with you, and you and I could see each other face to face because that was what the competitive landscape was requiring me to do, I would have flown to Philadelphia today to meet with you, face to face, and do the face to face interview. And so, I just think there's this sense that, like, what we're doing today lasts forever without a thought about what the competitive landscape looks like.

Dr. Peter Linneman: You're 100 percent right. Let me extend it on the competitive landscape. You talk about the context of hiring, what about getting a client? What about getting a deal? Right now, if none of us are getting on a plane, I don't give anything up by not coming out and talking to you, trying to get the deal or to get the contract. Now, all it takes is one of my competitors to get on that plane, and I got to do it. Then, push the situation one step further. You send a lot of your people to conventions as a reward. Yes, they're doing business. But there's also a reward dimension. If no one is sending any of their employees to a convention, you have no punishment for not doing it. Now, imagine everybody else is sending their people to Disney or Vegas or wherever for the convention and you say, “nah, we're going to phone it in.” You're not going to attract the best talent over the long term. So, you're 100 percent right. People are thinking of this as a static, and it's quite the opposite, it's a dynamic. 

I would like to think Willy, seriously, I'm not joking on this, however good you are at this, however good I am at this, we're a lot better live. We've done it live together. I can see your whole body, I can see crinkles in your face, you can see how old I am. I mean, they can see how impressive physically we both are, right. However good it is like this; you would agree it's better live. For the audience, it’s better live.

Willy Walker: So we're tight on time as always, but I want to get to multi versus single because there's not a day that goes by that CNBC doesn't have, “single-family home prices are up by 8 percent, there's no inventory,” etc., and many people in the multifamily space are sitting there going, “whoa, is there a tectonic plate shift going on here between multi and single?” In your letter you talk extensively about pent up demand and the lack of supply, not only on single but also on multi. In the three minutes that we have left, give me a quick summary on multi versus single and where you see that playing out in 2021.

Dr. Peter Linneman: We've been pointing this out for more than a decade now. If multi and single had been in balance, roughly, when all this started and you saw the single-family happen as it did, it would have been terrible for multi right now. But the truth is, both started out in great shortage, particularly the single side, in a great shortage situation. So, at the margin, is there some single-family benefiting more than multi? Yes, but there's such a shortfall in the product that's been created over the last, basically, 18 years on both sides, that in spite of that, multi can state quite healthy. By the way, would it be even a healthier if…? Sure, but it can stay quite healthy, and the analogy, Willy, remember how Washington DC (central DC) and central New York City always had these, like, 2 percent vacancy rates. And then they’d go up by 50 percent to 3 percent. It wasn't a disaster because it was still a shortage market. That's a little bit what's happening. And the only exception tends to be, as you know, urban core apartments. And urban core apartments, if we had done this session a year ago, we both would have said urban core apartments are ahead of themselves, right? Not that they'll never get filled. They are ahead of themselves by 18 to 36 months in terms of supply. And so, what was 18 to 36 months with the demand phenomena of, “there’s nothing to do in the city,” that has increased the softness in the urban core. But once there's something to do in the urban core again, it'll catch up.

Willy Walker: So, final question: you've got a REIT that's generating $100 million a quarter for you to deploy. So, you have $100 million of equity capital that you must deploy in the commercial real estate space, whether it be in notes, whether it be in properties, whether it be in investing in REITs, what have you. Where are you going to put that $100 million?

Dr. Peter Linneman: I think if I’m a REIT and I have a long hold horizon, you know, I’m not a trader, if you will. If I have a long hold horizon, I have a multiple objective rather than an IRR objective, I just think you're in a golden age for multifamily in a kind of straightforward way. As long as the mathematics is even remotely close to what we talked about. Now if I went and bought at 2 cap, an apartment, that mathematics we were talking about disappears because I'm buying it at a 2 cap and borrowing at a 2.5 or 2.8. But as long as I'm playing that spread at abnormal rates, I just think you're in a kind of golden era. You're going to look back and see it as a golden era. And, you know, the golden era in multifamily in the early 90s was, nobody had money. So, if you did it, you won. It was in the early -- a decade ago in 2011, 12, 13, 14 it was supply shut down and there was a shortage, so that when demand came back, rent and occupancy did terrific, and you add asset price inflation. And I think this one is spread. The spread is so outlandishly attractive, and a lot of money's going to be flowing to the sector, that I just think it's going to look back and say this is the third golden era of longer term whole multifamily.

Willy Walker: Well, on that, Peter, as you can tell, I devoured the data inside of your letter. It’s as insightful and as informative as anything that I read. I greatly appreciate you taking an hour to run through and give us your input on all of the numbers that I put out there today, and I wish you well look forward to see in person. Maybe next time we do this, we both have had our poke and we can actually sit across the table from one another. It would be really great.

Dr. Peter Linneman: I'm older, so I hope to give mine before you.

Willy Walker: Well, great. Happy New Year. Thanks for taking the time, and everybody who joined us. We'll see you again next week with Stephanie Linnartz from Marriott to talk about the hospitality industry. Thanks everybody.

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