Walker Webcast: Live and Unplugged: The Most Insightful Hour in CRE with Dr. Peter Linneman


I recently had the privilege of chatting with Dr. Peter Linneman, a long-time friend and regular guest on the Walker Webcast. For those unfamiliar with Peter and his work, he is the CEO and founder of the American Land Fund and the principal of Linneman Associates, one of the most prominent consulting firms in the real estate industry. Each quarter, Linneman Associates publishes the quarterly Linneman Letter, the latest of which we discussed at length.

Are We Facing a Recession?

For quite a few months now, everyone has been asking if the U.S. is in a recession. It’s tough to tell whether we are truly in a recession or about to enter one, as some sectors in the economy are doing quite well, whereas others, like commercial office real estate, are not. When you look at commercial real estate at a very granular level, the performance of a given asset is likely highly correlated with the type of debt used to acquire it. Those with fixed-rate or long-term debt are much more comfortable than those with floating-rate or short-term debt.

Commercial real estate is not faring very well amidst rapidly rising interest rates, but Peter does not believe that the country as a whole is headed toward a recession. Most other industries have not been as negatively affected as real estate. Nearly three-quarters of all industries in the U.S. are adding jobs, which bodes quite well for the economy.

Is Inflation Gone for Good?

Inflation has been on the decline for quite a few months,but it’s still quite high. We just saw a slight tick-up in month-over-month inflation, leading some to believe we’re not entirely out of the woods yet. Dr. Linneman does not share this opinion.

He compares our current inflationary environment to entering a highway in your car. When entering a highway, you’re moving relatively slowly and need to get up to highway speed rather quickly. Once you’re on the highway, traveling at highway speed, there is very little variance in your speed.

Inflation has been behaving similarly. The economic impacts of the pandemic ramped up inflation very quickly. Now that things have stabilized, we’re seeing very little variation in inflation from month to month. This means that year-over-year inflation metrics will continue to decline until we reach the one-year anniversary of when inflation began to taper off month-over-month.

Is Now the Time to Buy?

Peter has long been a proponent of buying assets using fixed-rate debt and not opening yourself up to the risks associated with floating-rate debt. He observed that you can tell who made purchases with fixed-rate debt over the past few years because they’re the ones who are “still smiling.” Although floating-rate debt may seem more appealing at times, interest rates can become very volatile over time. Far too many have learned this lesson the hard way over the past year or so.

Even though we are amidst the highest interest rates we’ve seen in years, Peter still believes now is the time to buy, as long as you’re using fixed-rate debt. He believes that the Fed will start cutting rates soon. Those who can take on some debt now while real estate prices are a bit deflated should be able to refinance at a lower rate in the next year or so. Even if, for some unforeseen reason, interest rates don’t go down, the numbers should still work out, as long as you have fixed-rate debt.

How to Thrive in Real Estate

Peter believes you need two things to thrive in real estate - capital and courage. Those who are well-capitalized and have the courage to buy and hold real estate when others don’t will achieve significant returns on investment. One of the best ways to maximize the appreciation of an asset is to buy when assets are discounted. It takes courage to buy at a time like that, because assets do not get discounted when the economic landscape looks healthy.

If you’re lacking in courage, however, that doesn’t mean you can’t be successful in real estate. Although the courageous ones will often achieve the best returns, you can still make good returns investing in real estate without buying when things look bleak.

Consumers and Mortgage Rates

Recently, there has been a strange phenomenon in the single-family housing market. Roughly 42 percent of Americans have a home mortgage. A majority of those people refinanced their mortgage when rates were at historic lows just a year or so ago. Those who refinance are saving thousands of dollars per year in mortgage interest compared to what they were paying before the pandemic. These consumers now have much more disposable income.

The dark side of all of this is that many Americans have the lowest interest rate they will see on their mortgage throughout their lives. Given how low their mortgage rate is, they’re not very willing to sell their home. If they do decide to sell their home, they will be giving up all of the money they were previously able to save, which is not an attractive proposition for most consumers.

While this certainly doesn’t mean that people will never sell their homes, it does mean that we’re very likely to see much less liquidity in the single-family space compared to pre-pandemic levels.

Want to Hear More?

Each week I have the chance to interview some of the most prominent leaders in their respective industries, like Dr. Peter Linneman. If you want to see our other interviews or view the full live, in-person interview with Dr. Linneman, be sure to check out the Walker Webcast.

Webcast Transcript

Willy Walker: First of all, to all of you here LIVE thank you for joining us today. It's a real pleasure. Given that Peter and I have done fifteen or sixteen of these, I thought it was a good idea for us to actually get together and not be on the Zoom screen. When I last checked, there were 6,000 people registered, and all of our listeners across the country going by this point. Welcome. Nice to have all of you here at the Constitution Center in Philadelphia, Pennsylvania, and the Zoom screen.

Let's focus for two seconds about where we're having this conversation. So, before we dive into recession, interest rates, the Fed, commercial real estate, Peter, why don't you just for two seconds, give people a sense of the historic importance of this?

Dr. Peter Linneman: This is amazing. I mean, if we think we're living in tough times, just not so long ago in 1776, they declared two blocks from here that we aren't part of England anymore. A seven-year war began. You think those were tough times? And there's a park across the street from us, Washington Square, that has 3,000 unknown dead, buried under it from that era. So, it's always a tough time. But two blocks from here, for those of you who don't know, is Independence Hall in all its glory. We're in the Constitution Center. Independence Hall was the host of both the Declaration of Independence and then subsequently the Constitution. And for six of Washington's eight years, he was president about two blocks from here in Robert Morris’ house, who was the financier of the Independence War. Congress was also here for six years.

I encourage you to come and see Congress Hall for two reasons. One, you go, oh, my God, we used to fit the whole government in that building. That would be a nice step forward if we did that today. And the other is it's where the Upper House comes from, because when you go there physically, you see that the House of Representatives was on the lower floor and the Senate was on the upper floor, and you get a great sense of how they viewed themselves differentially. So, welcome to Philadelphia!

Willy Walker: Nice to be here. So, you start this quarterly Linneman Letter, Peter, with the question of: “Will we have a recession?” And I read that, and I said to myself, well, I don't know what world, Peter or other people in the commercial real estate industry are living in, but it really feels like we've been in a recession, if not a depression, as it relates to commercial real estate for the last two or three quarters since the Fed started raising rates. And I was asked by Barron's last week in an interview I did, they said, are we headed into a recession? I said, quite honestly, we've already been in the midst of this storm for quite some time in commercial real estate. So really a recession or no recession doesn't have that much impact. With that said, what's your take on, are we headed to a recession?

Dr. Peter Linneman: We talk about it as the economy, look, going back during World War II, we were at war, but not everybody was in war. Not even everybody in the military was always in war, in combat, if you will. And there's certainly sectors that are in combat. Right. And parts of commercial. The office sector has been in combat, real combat for three years now. And it's maybe not getting worse, but it's also not getting a lot better in office.

And then anybody who borrowed floating or borrowed short term, they're in a very difficult situation. And that's because the Fed has declared war on the economy. It's kind of crazy what they've done, but they've done it. And will the economy in a broad though, be in recession? I don't think so. We still have 68% of all the industries in the United States adding jobs. And it may not be our business that's adding jobs, but 68% of all the industries are adding jobs. And it's not like a funny number. It's a real kind of indicative number. We're adding lots of jobs still. We added over 200,000 jobs last month.

I said that we live in a bizarre world. You want a sense of how bizarre the world we live in is? If the job numbers last week had come out minus 500,000 jobs, that we lost 500,000 jobs last month, everybody in America would be really unhappy, upset except nine people. The Fed would be thrilled. And if we came out last month and we said 500,000 jobs were added, everybody in America would be really happy except nine people. That shows you how screwed up the economics are. Really does. It's a very simple, oversimplified situation.

Willy Walker: So, you say in The Letter that inflation is dead. Today, we got a minor uptick month on month of ten basis points of inflation. Year on year, we're still up about 5%. Talk for a moment, Peter, about looking at it on a year-on-year basis versus on a month-to-month basis and why going back in the rearview mirror is an incorrect calculus.

Dr. Peter Linneman: All of you accelerated your car from 0 to 50 miles an hour. So, if I look back and I look at the change in your speed, it's quite dramatic. But now you're going like 50, 51, 53. That's what's going on. That's simple. So, a year ago, the world was still incredibly screwed up from COVID. And it's what I've called an “Economic Long-Covid”. We know about the physical long COVID. We have an economic long COVID. The things that we did to our economies, not just the US, but throughout the US, around the world. They don't go away like that, right. You don't shut down businesses and not have some long-lasting effects. You don't have people not allowed to travel or get elective surgery for months on end without some long-lasting effects.

We're living through those long-lasting effects, whether it's inflation, whether it's the lag in jobs. All of those are happening. They're working their way through. So, what happened was, if you compare us to a year ago, yes, prices are up, but if you compare us to the six months ago, over the last six months, we're running about two, two and a quarter percent inflation on an annualized basis. That's the car is accelerated already and now it's kind of bouncing between 50, 51, 52, 53, back down.

That's where we're at. So, today's numbers, everybody can do this math. Follow me. Last month, inflation prices on average were 1/10 of 1% higher than the previous month. So, if I said: “Annualize that.” Well, you have to exponentiate. Well, that's too complicated. I don't know how to do that. Multiply by 12. Just multiply by 12. That's a 1.2% annualized inflation rate. 1.2%! That's what they're worried about? And by the way, wage data came out and the wage inflation always should be higher than the price inflation because of productivity growth. If we had no price inflation, I'd still expect wages to go up about a percent and a half a year because of productivity growth. Well, when you net productivity growth out of the month over month numbers for the last several months, you're coming in at one and a half to 2% inflation. I have no idea what they're worried about at the Fed. None.

Willy Walker: So, do they raise in May?

Dr. Peter Linneman: Well, the impossibility is to predict people that you don't understand what they're doing. And I'm not trying to be evasive. I would like to…

Willy Walker: You used the example of when you got spanked that you'd get one or two for good measure.

Dr. Peter Linneman: And I think they're in the good measure business. And I didn't get spanked. My brother got spanked, I was well behaved. So, no, but you know what I mean. And that to grow on that kind of crazy stuff that people used to do, they're in the dishing out punishment to show they can dish out punishment to show that they're righteous.

Willy Walker: And you think they have to cut in August?

Dr. Peter Linneman: They should have cut in December.

Willy Walker: Regardless of how irrational they are, your prediction is that they cut in August?

Dr. Peter Linneman: Yeah, something like that. They can't fly in the face of reality. I think about a month ago or little, they raised the rate at the same moment they're saying all deposits are insured. So, they're so worried about the effects of the rate increases on the banking system that they're saying all the bank deposits are insured. And by the way, we're raising the rates 25 basis points to make sure anybody who's got assets held in portfolio, they're worth less. And by the way, since they're worth less, we're going to lend to you if they're of a certain quality at full face. That's crazy. I mean, sometimes you have to call things as you see them. And I try to be nice. I try to understand them. But you know, I'll anticipate a question that a friend asked me the other day who says: “Well I read your stuff, I hear you and I get you, and I understand you know how to read data. Like, I know how to take 1/10 of a percent and multiply it by 12. That's what a Ph.D. got me, by the way, is I can take 1/10 of a percent and multiply it by 12. But I don't understand how the Fed can be so wrong?”

And I very seriously, this is not meant to be political. So, I'll take two examples. Some of you may be old enough to remember Watergate. The Republicans were in there. They had all these bright guys and all these people and so forth and so on. And they tried to cover up stuff in an election that was going to be a landslide anyway in their favor. How is that possible with smart people yet it happened. And I'll come to the current administration just so you can say I did a Democrat and Republican, which is I'm sure there are a lot of smart people who analyze the Afghanistan situation and think a lot about how to get out. And you saw how it turned out when we left. I'm not saying I know how to do it better, that's not the point. But it was a complete disaster. It wasn't because they aren't intelligent. It's not because they didn't go to good universities, it's because they got it really wrong. And it happens. And it happens very often. You think the Nixon administration on Watergate, and the Afghan situation with Biden are the only times it happens. That happens all the time.

Willy Walker: But so, on that if we're going to bank on stupidity and you say that the Fed starts cutting in August, one of the things you have long been a proponent of, for as long as I've known you and well before you and I became friends is buy an asset, put a fixed rate debt on it, and if the fixed rate debt works at the time of acquisition, that's going to work for you over the long term. So, anyone who followed that advice during this entire past cycle is doing really well right now and an asset that's probably producing a lot of cash flow and has fixed rate debt and is doing really well because they've got cheap fixed rate debt.

Dr. Peter Linneman: And you can tell who they are because they're the ones still smiling.

Willy Walker: Correct. But right now, you are saying that if you go out and buy an asset, put a floater on it. Bake into your model 100 basis points of additional interest expense because of whatever you're calling but then you're going to have the opportunity to refinance it with a fixed rate loan within two years at 100, 250 basis points below where we are today.

Dr. Peter Linneman: Correct.

Willy Walker: You believe the forward curve, in other words?

Dr. Peter Linneman: Well, yeah, I believe the curve. I believe rationality. I don't believe that I'll be precisely right. I believe I'll certainly be directionally right. I remember in a directional sense, remember a year and a half ago you asked me about oil. And I said, it's going to be below 80. And it's not like I had some sophisticated algorithm and so forth. This is the got this right. And I don't know if it's going to be 72 or 81, but, you know.

Willy Walker: Below a hundred by a bunch.

Dr. Peter Linneman: I probably said below a hundred by a bunch. Yeah. This is that same sort of directionality. Why? Because you're seeing these really low inflation rates. You're seeing these really low wages. By the way, why is wage growth slowing? It's really slowing because we're adding a lot of jobs. And as we've gotten people back, job openings start falling back towards normal. They're still above normal and gee, supply, and demand. So, demand is what supply is and of course, so I believe it. And your point is, I believe it so much that it's contrary to all my instincts, all my instincts.

Willy Walker: You also do a really interesting analysis as it relates to “Is now a good time to buy?” So, you went back and looked at past crises of ‘82, ‘91, ‘02, ‘08 and so you put in the NEREIT and the NCREIF returns, which you've done for quite some time on three years, seven years, and ten years. And what's really interesting about that is that you do it on a running average, which really shows you hold for the long term. You get to ten years. Not only are you in very positive returns at any hold period and never have a negative quarter.

Dr. Peter Linneman: Correct.

Willy Walker: Whereas if you hold for a shorter period of time on a three year, not only are the returns lower, but you also have plenty of down quarters where if you happened to have sold during that quarter, you had a loss.

Dr. Peter Linneman: And that was the deal, right? The deal is you get some bigger ups, but some unpleasant downs. And so, the hold period, not the real estate, is sort of the messy traded stuff. The point is you're pretty much good enough on the real estate side, but you may not be really good enough on the hold side and more time you give yourself, your real estate ability dominates the hold problem, if you will.

Willy Walker: In that analysis, not looking at those low points, generally speaking, asset by asset, office, retail, industrial, multi, multi is the best. I think over a ten-year hold on average over that period of time, it was like a 9.8% return. And on the low end is office. It is like seven or seven two, not a huge disparity of returns but look, no 200 basis points. But on the stressed one, the market returns go through the roof. So, talk about that for a second.

Dr. Peter Linneman: It's pretty simple. Just so you know, the only reason I use NCREIF and NEREIT is because it's there. It's not data I created. I don't think it's perfectly correct, but it's kind of correct and it's consistent. And what it shows, basically is if you have capital and courage, when people don't have either and you can hold, you're going to do well. It is that simple. If you're in real estate and you have capital and courage when others don't, you're going to do well. You may not do well the next day, may not do well the next even three years but you’re going to do well. Now, in particular, you did well in the three years in these. Right. But not three days. If you have capital and courage while others don't. It's not a surprise that you do particularly well in those periods. And it's a little like, if Joel Embiid had to go out of the game because he twisted his ankle in there inspecting it - make hay while the sun shines right, that's when you really have to try to run up some points if you're the opposition and so forth.

Well, it's kind of the same in real estate and investing in general. It's a hard business. It's a hard business. And if you have courage and capital when others don't, it's a real asset is what the studies show. And we just went back and took the I think everybody would agree the times we took were the stress periods. We didn't think it was funny that way. It really says something interesting, which is that the average return you said was kind of a little disproportionately driven by those he had to have capital and courage moments. Some people have capital, but not courage. Some have courage, but not capital. You need both. And if you miss out on the periods…

Willy Walker: You can still have fine returns.

Dr. Peter Linneman: You can still do fine.

Willy Walker: That is what your analysis shows. You don’t have to tell people.

Dr. Peter Linneman: And by the way, I played football very badly in college. And the coaches used to tell me, you know, there would be a 270-pound guy coming with a running start to hit me and I would be a little smaller than this size. I was a little quicker than I am now. But they said, all you have to do is get down low. Well, that's great in theory, but when the 270 pounds hits, that's really hard. So, all I'm telling you is you have to have capital, courage and patience, and we'll all be fine.

Willy Walker: Let's focus for a moment on the banking crisis and the SVB, Sovereign bank failures. One of the data points that's been running around for the last week, it was announced last Friday by the Fed was that over the previous two weeks, bank lending in the United States had gone down by $110 billion. And the previous week, banks have borrowed $160 billion from the window. And so, there's this big drive towards liquidity. There is no new liquidity going out into the market. a) Does that impact the Fed's actions in May? And then b) let's dive into for a moment what the impact on the commercial real estate industry is going to be.

Dr. Peter Linneman: There are a couple of interesting things about what happened there. One is we had unwound $600 billion roughly of the Fed's balance sheet. And in a matter of like eight days, we rewound half of that. So, we got a quick burst of QE, really quick, intense. That's one.

Second is lots of money has gone out of banks into money market funds with presumably the notion that they mostly hold treasuries and blah blah, blah on short term. And I'm not so exposed and I don't have to worry about limits. And presumably, if there ever was a run on a money market somehow, if it was big enough, the Fed would be there to back it, even though they have no legal requirement. That's been a big change.

Third, banks just froze. Just froze. Now, the regionals were not where the big reserves were. I always talked about the big reserves. The big reserves were always at the money center banks, because that's when the Fed exercised QE. They were buying Ginnie’s, Fannie’s, Freddie’s, and some other high-quality paper at different times. They weren't buying what regional banks had, like a line of credit on a hot dog stand. They weren't buying that stuff when they were doing QE. So, and that's what the regionals disproportionately held, right, or commercial real estate. They weren't so much buying them. So, the big reserves were and are still held at the big banks, big money center banks. The regionals are thinner. What is its implication on real estate? Well, one of the implications clearly is I have no idea what the bank regulators are doing. None. right?

Willy Walker: I can tell you one thing. They're going to regulate more.

Dr. Peter Linneman: And that's what I was leading up to. If you look at SVB, the typical bank regulator problem has been banks have loans to a real estate development that's halfway done. They have a loan to a hot dog stand. They have a loan to somebody who's got a fitness salon, etc., etc.. Well, how the hell do you expect bank regulators to value those? And so, when things go bad, they don't know how to value them and it's hard to value. SVB had 3-to-5-year treasuries, 3-to-5-year treasuries! And by the way, they're valued every minute. And here's a bank regulation network that's sitting in their offices and presumably took bond financing. You know, like one of the first things you learned in your economics course was interest rates up, fixed income down. They didn't act. Give me a break. And so you go, oh, my God. So, what will happen is overreaction. That's going to be largely taken out of the skin of not 3-to-5-year treasuries. It's going to be taken out of the line of credit for a hot dog stand. It's going to be taken out of a construction loan, etc., because they're going to strike out at everything. And so, it will get tougher for the hot dog stand owner and for commercial real estate and development.

Now, what that will mean for commercial real estate is it's going to be a tough next year or so for developers independent of everything else because of that environment. It'll be a better period than expected if you own real estate, especially if you already have fixed rate debt on it, because that supply pipeline is going to get a little thinner than you thought it might be a year and two years from now. Yeah, it has that implication. They're going to take it out on the wrong people, though. I mean, that's nature, right? The nature is you used to get punished as a class because one kid did something. But I don't want to crucify that kid. So, I have to punish everybody to show that's what's going to happen.

Willy Walker: So, a couple of things on that. And then I want to go to office and liquidity for office. So, there's $4.4 trillion of commercial real estate loans outstanding across all lending sources, CMBS, life insurance companies, banks. About half of that is non multi. So, office retail. So, you've got about $2.1-2.2 trillion of commercial, the rest is multi to get to your $4.4. Banks hold about 40% of total outstanding’s on commercial. And so, one of the things that we've been looking at Walker & Dunlop is the following: If you've got a $4.4 trillion total outstanding’s and banks hold 40% of it, to Peter's point, if banks pull back, let's just say for kick sake, 5 to 10%, which I think is way too conservative, given what you just said as it relates to regulation. Okay, but if banks pull back from holding 40% and they go back to 35 or 30% of it, you're talking about $200 or $400 billion of lending that has to come from other capital sources. And so, whether that's private capital, whether the CMBS markets come back, what have you, this is a serious shift in the marketplace.

Dr. Peter Linneman: Yeah, and it could be one of those moments you look back on a lease for several years that changed the template of lending. And remember, one of the things I've said, and my research shows is that real estate values are about capital flows.

And by the way, this episode in the last six, eight months has proven that if you reduce the capital flows as much as the capital flows have been reduced and we've seen it in other times, we saw it in other times without interest rates going up. By the way, we saw it in other times when the interest rates went down, the same reduction of capital flows. And we saw in real estate pricing. We're seeing it again that when capital doesn't flow, real estate pricing suffers, and it'll probably suffer a little more because I just think you're going to get this banking. I don't think they'll go as far as Elizabeth Warren would want, but it's just a human reaction they're going to have to. And so, you're going to have less capital flowing.

Willy Walker: Your point about cap rates actually going down, because you think in the back half of this year, bank capital starts to flow back to commercial real estate. And from what we're seeing right now, that isn’t going to happen.

Dr. Peter Linneman: Yeah, that's a close call. Prior to SVB, I thought it was a pretty easy call.

Willy Walker: 100%.

Dr. Peter Linneman: When I say the end of the year. I was saying the late, third and fourth quarter, I thought that was a reasonably easy call. With SVB and the reactions associated with it regulatory wise, whether there are good or bad reactions. I think that's a close call whether we see a reversal by the end of the year, we still have a lot of money out there, but the money will be a little more careful, a little more expensive, and the ones are going to get hit are less so who JP lends to, which are big companies, big projects, big this, big that, certainly less so those have been Fannie and Freddie lend to and the ones that the big insurance companies lend to. It's going to be more America and not just America - real estate America, the hot dog person with a line of credit. You know, I include in that. That's who's going to feel the pain, even though they weren't the ones that created the problem.

Willy Walker: Yeah, I think this capital flow issue is a huge one. And where that capital comes from and who raises the private capital to meet the need. The one other data point, $4.4 trillion of commercial real estate outstanding, 40% of that sitting on bank balance sheets. There's another half a trillion that's in land loans and development loans on top of that. So that one is one where if you're sitting there and you go to try and get a new loan to go build something and there's a banker sitting there saying, I need liquidity because the regulators breathing down my throat and down my neck and wants me to have liquidity on my balance sheet, am I going to extend a three-year construction loan. Right now, I think the answer to that is no.

Dr. Peter Linneman: By the way, you could add office to that, which is I've got an office building that is 60% occupied and my loan comes due. And I'm not going to put money into it. It's one thing if I'm 95% occupied and I have a 30% loan. But if I thought I was 75% and my loan is due, I'm not going to put the good news money in. And so, I look at the bank and say, it's yours. And they're going to look back at me and say, I don't think so.

Willy Walker: That's the other thing. So here in Philadelphia, 1500 Market Street went into special servicing a year ago in August. And everyone saw that happened. You sold that years ago?

Dr. Peter Linneman: No, that was Equity Commonwealth. They sold that. And people thought Sam Zell was a little nut getting rid of all these great assets.

Willy Walker: Well, it went to special in August, and then the next one was the Wells Fargo Center in Denver, which went to special. And then there was the Brookfield Defaults on two office towers in L.A. And now all of a sudden, the Wall Street Journal seems to be covering every single office building, default front page news that the end is coming for office. You put some really interesting data in the Letter as it relates to castle systems on back to office.

And you have said once we get to 60% office occupancy, we're going to get to a tipping point. If you're not in the office, you're going to miss that promotion. You miss that job, the data that you put forth. And I think the interesting clarifier this quarter that I read and it kind of took my breath away, was that you're very clear this quarter and saying pre-COVID this number was 100%. In other words, either your key fob swipes at 100%. That dropped to 14% in April of 2020 and we're now back at 49%. So, I think the clarification I want to say here is in the past, when I read that 49 or 45 number, I was thinking, oh, well, only 60% of the people were actually in the office pre-pandemic.

Dr. Peter Linneman: No, no, no its fobs.

Willy Walker: And so, we're still begrudgingly at 49, you've got some Texas, Florida have 60, 70% occupancy. San Jose, California is the worst MSA covered by the castle at 40%. Do you still have conviction that people come back?

Dr. Peter Linneman: Put aside the sociological and psychological. I was just down to Cayman last week. People are coming in five days a week. Five days a week! 98%. Now, how is Cayman different than us? I mean, by the way, I was talking to somebody over in Tokyo. They're basically at 97%. I don't think that they’re different than us. People say, Oh, it's because the commute must be easier in Cayman. And only somebody who hadn't done the commute knows would say that the commute is easier in Cayman than it is in Philadelphia.

Willy Walker: Is adoption of Zoom and Microsoft Teams greater in the United States than it is in other developed nations?

Dr. Peter Linneman: Not notably in this regard. No, no. And you go by the way, anybody who believes it's about the commute, then Tokyo should never come back, right? If you've ever been part of a Tokyo commute, they would never come back. By the way, France is running up in the 80%, Paris when I say France. London is running up in the 80 to 85%.

Willy Walker: What’s the catalyst, is it that just CEOs like Jamie Dimon say, you know what, I'm going to require people back in, but then because they now have the leverage to say it?

Dr. Peter Linneman: It's just that simple. I made a comment, I didn't mean this in a nasty way, by the way, anything I ever write, I never mean nasty. I mean that seriously.

Willy Walker: I think Jerome Powell would take issue with you saying that. On his canaries this quarter, there are 50 different canaries in the coal mine if you read the report, and he puts out: there are five canaries, and one of them is dead, you got a little bit of a problem. Two is dead -more, you can get the picture here. If you've got five canaries out there, you've got a real problem.

This quarter of the 45, which there's overbuilding in commercial real estate, PE, stupid deals, etc., etc., things that Peter's tracked as far as precursors to trouble. He's got five dead canaries across 45. So really no big insights as far as problems coming on the horizon on real economic indicators. But as he has done in the past, he adds one at the very bottom, which is and he doesn't say this in the report, I'm going to use my own words on this. Fed fu@ks it up. He's got four dead canaries and one alive. I think Jerome Powell would be disappointed.

Dr. Peter Linneman: I wrote a couple of issues ago that CEOs earn your pay. There's a reason you're getting paid the big money. Right, earn your pay. And by the way, the real estate industry has actually been quite good about this. Most of the real estate companies had their people back quite early. People weren't dying.

Willy Walker: They have a vested interest in it.

Dr. Peter Linneman: They do. But people came, they lost some people. And guess what? They pretty much replaced them. They found by and large the people they lost tended to be relatively weak performers. They were the people who were probably going to leave them for other reasons, most likely. And I say, Look, you're being paid $20 million. You tell me privately that you believe the company is much more productive and much more profitable when people are there. You tell me that privately. And then in spite of your $20 million, you wimp around and don't bring them back for your shareholders.

Willy Walker: So, talking about somebody who you point this out in the Letter that Ken Griffin and his returns at Citadel have been off the charts. And one of the things that Ken Griffin has said by his returns being off the charts is that he got his team back early in that for ‘21 and ‘22 returns, they beat everyone because their team was together.

I would put one little note on that. Many of you may have seen it. Ken Griffin made a $300 million donation to Harvard University yesterday and they just renamed the College of Arts and Sciences, the Ken Griffin College of Arts and Sciences at Harvard. So, I guess he's not only putting his actions behind his words, but he's also made enough money to be able to write a gift.

Dr. Peter Linneman: I think he's probably accurate. I'm not saying he would have had a bad year and I don't think he was intimating he would have had a bad year, but he wouldn't have had that year was what he was saying. And I really mean it when I say earn your pay, you expect the people who are delivering packages for you to earn their pay. Well, then CEO earn your pay and get people back. And the only way you shouldn't say come back is if you really believe it's less productive and less profitable. And that is not what I've heard from most executives I've spoken to in private. In private.

You can come up with a couple of exceptions. I'm not saying all. So, I think people have to do that. Office got in this country the problem that people are slow to come back. I think our executives are less imperial than a Japanese executive or something in that regard. So, they're less, they want to be touchy feely and I want to be nice and so forth. I don't think Japanese or Mexican executives spend a lot of time worrying about that.

I'm not saying they're callous, but we're much more enlightened. If there was an accentuation in that, it was intended. But the problem office has, if you think about it, is the economy is adding jobs net versus pre-COVID. In that period when the economy is net added jobs, office is falling apart. It's not that the office had trouble when we were in early COVID, and nobody was there. That's what you expect, right? The disturbing part is even as we net added jobs, it's still weak. I just don't think we're that different than most people.

Willy Walker: That's really a good segway to the section, because I think 36 of the 49 markets that you cover have replaced all the jobs they lost in COVID. Yeah, the strongest are Austin, Dallas, and Salt Lake City. And yet, Austin and Dallas are two of the weakest office markets in the country and a lot of it is because tech companies went and took lots of space and then have backed out of those office leases.

Dr. Peter Linneman: And that's to the point, the concerning thing is, in spite of job growth, and these strong markets especially, it's disturbing to see a lot of job growth and not a lot of office demand growth. That's disturbing because then you say, well, what happens when the decline comes? You suspect it'll still occur. Office has got a challenge on the capital side. There's not a lot of courage that I've seen.

Willy Walker: And there's $80 billion of office debt that needs to be refinanced in 2023.

Dr. Peter Linneman: So, you haven't got a lot of conviction or courage. The people who believe in office like Owen Thomas. I think Owen really believes so.

Willy Walker: Well, he not only believes, but he's also got A class buildings where people actually want to be.

Dr. Peter Linneman: Put aside selling this book, I think Owen really believes. I think he has good reason to believe.

Willy Walker: The people at SL Green & Vornado, they've got a little bit trickier situation because they got B’s and C’s and not A's.

Dr. Peter Linneman: But the problem is they've already got a lot of exposure to office, so they're unlikely to double down. They got a lot of exposure. And the people who don't have exposure to office are all right now going, thank God, thank God. And so, it's not like you've got this obvious source of money looking to come in and capitalize. Now it'll come eventually it'll come. The question is, at what price? But so far, I mean, it's a little like, what, ‘90, ‘91, You know, there were papers being written, we'd need no new office buildings for 20 years. That turned out to be wrong. But nonetheless, it's a difficult place in this country. But I got to tell you, I was knocked out down in Cayman. Now, granted, it's a small little market, but you go their absorption unchanged. Unchanged. People are showing up. No effect at all.

Willy Walker: So, let's go to the U.S. consumer for a moment and then go to housing after that, because I think that that leads nicely into it. So, we've got, you know what, 36 or 49 MSAs back with all the jobs that they lost during the pandemic. And then you've also got household net worth where it is down year on year by about 9.2%, and yet it's up 9.2% from pre-COVID.

Dr. Peter Linneman: That's real. So, you know, it's 3% a year. Not stunning, but not so bad to have it 3% real a year.

Willy Walker: And the thing that I look at every quarter is your household debt service ratio. So, talk for a moment about that, because I think right now with rising interest rates, everyone's sitting there going, is the consumer going to tip as it relates to mortgage costs, credit card debt, etc.?

Dr. Peter Linneman: What people and I think the Fed hasn't figured out is the consumer. I will give you real simple math, you can do this more complicated. Two thirds of Americans own their home. Everybody got that. That's basically right. And of those, about two thirds have a mortgage and the others have no mortgage. I'm just making this very simple. That means that around 42% of all Americans have a mortgage. And they had a mortgage, by the way, by the middle of 2002. Fair enough? Okay. So, like 42% of the American population had a mortgage by the middle of 2002. Everybody in America refinanced when rates were low. That means 42% of American households have mortgages that are locked in for 30 years at around 2%, and it could be a little higher than two. It depends when they actually struck their mortgage versus a norm that you would have expected of about four and a half percent.

That means 42% of Americans have $4,000 to $5,000 more spending power than is their historical norm. And to put that in context, that's on a $200,000 mortgage. That's the average literally, that's the average mortgage in the country. Obviously, it's higher for some people, lower for others. $4,000 to $5,000 for 42% of American households and median income for households is like $68,000. That's real money.

So, I looked up a two-week vacation for a family of four. That's it. And I just only look that up as an indication of purchasing power. That's all I did it. Not only can they do that for one year. They can do that for 30 years. They're going to give you an extra two-week vacation for 30 years. That's in the economy. That's long COVID. That's an after effect, right. And by the way, it has another side to it, which Willy has pointed out, which is that's the good news coming through the economy. That's a huge, good news coming through the economy. The flip is, I'm not selling you my home. I'm not going to sell you my home, because if I sell you my home, I give up $4,000 to $5,000 a year that I locked in. Now, will I ever sell it? Of course. I'm not going to sit. You know, I have one child now and I'm going to get two promotions and two more kids. Okay, I'm going to get a bigger home, but I'm going to get it a year or two later. So, the housing market is going to be tight on the resale side. And you can do a present value calculation, right, of $4,000 to $5,000 a year. Expected value, $40,000. Some number like that, $30,000.

Willy Walker: On a $350,000 home. That's huge.

Dr. Peter Linneman: It's huge on somebody with a $68,000-$70,000 income, huge. So, what you're going to see in the single family you're already seeing somewhat is, I'm not selling. Unless you really hit a high price. I'm perfectly happy to sit here.

Willy Walker: So, I want to segway that into housing and undersupply on single family. Before we do that, I want to finish up on the consumer. So, the consumer income to debt burden has dropped to almost a 40 year low right now. So that's your major point.

You take a good focus on student debt. And one thing you point out is that the student debt forgiveness that came in place during the pandemic expires on June 30, 2023. So just as a point, all the people who had student debt that the federal government said, you've got to vacation, you don't have to pay it and you're not in default and you're not going to have accrued interest on it, just take some time off during the pandemic and then we'll start back up. It starts June 30th. That could have a big impact, as Peter points out in the Letter on that younger demographic going back and getting a new job, that some of those people might be on the sidelines, might get back into the game now that that is back as a burden for them. But there's one other point I wanted to make on this, which you point out, which is that since 1999, when the federal government really stepped into the student loan program, the federal government has lost $170 billion on student loans.

Dr. Peter Linneman: And by the way, we know it's higher than that because that was like six months ago.

Willy Walker: In context, I looked at this last night and I had to do this. The federal government spent $191 billion bailing out Fannie and Freddie. Subsequently have gone back all $191 billion and have made another $100 billion. So, Fannie and Freddie have returned $100 billion of excess capital to the federal government since getting bailed out for $191 billion. The new student loan forgiveness plan proposed by the Biden administration, which you point out is being challenged in the courts right now, could cost us another half a trillion dollars. So, there's this federal debt on it. But then there's also the fact that the moratorium of having to pay your student loans expires at the end of June. Do you think that has a big impact?

Dr. Peter Linneman: I don’t think it will be big, but it will have an impact. The irony is that when the new student loan program was introduced, the Congressional Budget Office did a study, and it was going to be a great cash flow to the U.S. government every year. Not so much. So much for studies. I mean, I'm wrong sometimes, too. I hate to say that while my wife is here, but, you know, I think she sometimes thinks that. I try to convince her otherwise. But, you know, you talk about a miss, right? A big miss. It will have an impact. The reason I don't think it will have a staggering impact is in the big scheme of things, it's small money.

Willy Walker: In 18.7 of net net federal deficit. Yeah, federal debt. So, on that, let's just go to that for three seconds. One of the things you talked about their previously was the Fed and the fact that the Fed had shrunk their balance sheet by $600 billion and now all of a sudden turned around in over one weekend, took back $300 billion of that. But you also point out in the Letter that a lot of this is, if you will, intergovernmental payments. And so, while the federal debt is now at $40 trillion, you go through and talk about, if you will, intercompany loans where we're borrowing from one and paying the Fed back. So, it's just cycling, though. So, you get to an actual net debt number of, I think $18.7 trillion?

Dr. Peter Linneman: The federal government has one branch of the government: the treasury that owes money to other branches of the government. But if they sent payments on that debt from one branch to the other, it's still inside the federal government. That's pretty simple. No different than your inner company debt.

And so first you have to net that out, right? Because if they paid it off, they'd have to you know, it's a net wash. Then you say the Fed. Now, technically, the Fed is an independent branch of the federal government. However, all the money they make or lose flows to the U.S. government. So that's a branch of the U.S. government. It's a technicality that it's not. Okay, so you'd net that out, you then say, well then we have debt we owe to ourselves as U.S. citizens and debt we owe to foreigners. That's around the $16-$17 trillion debt that is owed by the U.S. government to U.S. citizens or foreign citizens. And of that, I think it's seven or $8 trillion. I can't remember which is owed to foreigners. Okay. And the rest we owe to ourselves. And one of the reasons Japan is coping so well with their debt situation is they all owe it to themselves. So, if I taxed everybody in Japan to pay off all the Japanese debt…

Willy Walker: They're paying themselves.

Dr. Peter Linneman: They're paying themselves now. Not necessarily the same individual. Right? But the money wouldn't be gone. It would just be a bit redistributed. Now if we pay off foreigners, that's gone, right? That's what I would call the unambiguous debt. The funny thing about the unambiguous debt that we owe the foreigners, it hasn't risen much during all this.

Willy Walker: And so, on that I know you're an economist and not a political scientist, but do you think we have an issue as far as the debt ceiling? Just real quick. Do you think we’d get through it?

Dr. Peter Linneman: Of course.

Willy Walker: Then as we have Bitcoin trading at $30,000 a coin, which defies all logic in my world, do you think that this move by Russia/China, what was the term that they used for them, the BRICS. Do you think them moving to China and trying to have their own currency is a real threat?

Dr. Peter Linneman: You have to have an alternative. I mean, how many were thrilled to hold the Russian ruble?

Willy Walker: No, but if they created a common currency?

Dr. Peter Linneman: Okay. But part of the common currency is going to be Russian rubles. How many of you are thrilled to hold that?

Willy Walker: That’s Peter’s point on that. Don’t worry, that’s not an issue.

On housing, we're under supplied by three million single family homes on the multi side, as far as the deliveries, we're actually getting quite close to being at mark, if you will. You spend a bunch of time talking about housing affordability and rents. And I think two of the data points that you put in there are both the HUD 40% number as well as the Wells Fargo Home Affordability Index. The thing that shocked me on the Home Affordability Index is that Wells Fargo's home affordability index, only 38% of median income people in the United States can afford a new or existing home.

Dr. Peter Linneman: Can afford the median newer existing home.

Willy Walker: That has averaged 61% and got to a high of 78% in 2012. To our point about people not wanting to give up on that single family mortgage, people are going to hold on to the stock. And unless there's a big supply of new stock, the cost of housing is just going to continue to go up and be less and less affordable for middle America.

Dr. Peter Linneman: We’ve underproduced. It's that simple. If you under produce something, it doesn't mean at every moment in time there's an upward pressure. I mean, on Christmas, people didn't go out and shop for six hours, right? There was no upward pressure on prices then. But when you under produce, there's an upward pressure over time. Housing has got that, and it's really got that in single family, which spills over and creates it in multi and especially when you put it, I'm not going to sell my home because I've got the $4,000 a year. So, you've got a lot of multifamily kind of good there. Doesn't overcome everything. But yeah, I think that looks pretty well.

Willy Walker: And you like multi, generally?

Dr. Peter Linneman: I like multi generally for a couple of reasons. One, the data kind of shows over a long, long term, it does a bit better. Okay, that's fine. And there must be something there. If it's over a long, long term.

Willy Walker: Fannie and Freddie?

Dr. Peter Linneman: And Fannie and Freddie are part of that, there's no doubt. And a capital-intensive industry having additional sources of capital is good. Trust me, there's no shopping center owner who wouldn't love it if Freddie and Fannie also lend to good shopping centers, offices, or whatever.

Second, I like it because no individual can swing me from positive cash flow to negative cash flow. No one. I can have an office building where one tenant swings me from positive to negative, even if the market's pretty good. Even in a warehouse, that can happen. Less so in good retail. But it can happen. So, I like the fragmentation of the demand. I like that.

And the third is, it's not so true of the high rise multi, but of the more garden suburban stuff, you can pause pretty easily, much more easily than you can a lot of other product types. So yes, I think it's one of the great things Industrial has going for it is you can kind of pause it more easily. And so, supply and demand don't get quite this out of balance. And then but, you know, having Freddie and Fannie there, you don't think the guys in office would love to have Freddie and Fannie there right now?

Willy Walker: So as far as markets you like in your research, because of occupancy rates, you think that vacancy rates in multi go down in Cincinnati, Cleveland, and Dallas (which Dallas makes sense, I didn't get Cincy and Cleveland) but we'll pause in that for a second. And you really don't like Jacksonville and Denver. You see significant supply in both.

Dr. Peter Linneman: You know my first time I went to ULI I didn't get it because I didn't grow up in real estate. I grew up in business, like water heaters, bags, and paper bags and such. And the focus was always on demand and supply. And then I went to ULI the first time in 1985, and everybody would talk as if it was unambiguous that if you had high demand growth, it would be good. Well, it's not good if I have high demand growth and faster supply growth. The challenge is which is which? So right now, you have several markets where, of course you like the demand, but the supply is faster.

Willy Walker: Yes.

Dr. Peter Linneman: And so, you look at a market like Cleveland. Am I excited about the demand side of Cleveland or Cincinnati? I mean, you can get excited about a micro market, right?

Willy Walker: If LeBron’s son goes to play at Ohio State, you might get excited about Columbus.

Dr. Peter Linneman: Columbus will do great. Am I excited about the demand side of Cincinnati or Cleveland, as I am about the demand side of Denver? Of course not. What am I liking? There's basically no supply. And so, if I get any demand growth, which those markets in the good submarkets will get, there's any demand growth and there's not much supply. I'll take that as opposed to lots of demand growth and maybe even lots plus supply growth in a short. It's that simple.

Willy Walker: And so, on retail, you put some stats out there that have retail sales super strong in Q4. Q1 retail sales holding up. To your point that you've consistently driven home, online sales got up to about 20% of total retail sales during the pandemic and are back down about 15% of total retail sales.

Dr. Peter Linneman: There's something there, right? They're going to go up. I like good retail. I've always liked good retail. I even more so like good retail since about the middle of ‘21. And the reason was if you'd asked me what do you think about retail in 2019. I'd say I don't think everything's going to go online, but I didn't know that. I say, I don't think they can do this online effectively. Well, by the middle of ’21, we saw what cannot be done profitably online. And so now you’ve got a battle tested retail. You know, they can’t do this. You know they can do that. You can then curate your shopping center, assuming it’s in a good location. And so, you can curate it to have what they can’t do rather than what they might do – they, being online.

Willy Walker: And you continue to promote industrial just because it takes for every dollar of regular retail it takes four feet of industrial to supply. Alright. Three-ish. You go back and look at rent par and occupancy and hotels and you basically paint a picture that the hospitality industry is back in 2013. So, was 2013 a good time to invest in hospitality?

Dr. Peter Linneman: It was a spectacular time to invest. I mean interestingly there wasn’t a lot of courage yet in hospitality in 2013, but it was a great time with perfect hindsight to have courage. But that’s about where hospitality is back. Let me give you a real simple picture of where hospitality is at.

When you leave, tourists are back. When we live a few blocks from here. When we came out in 2020, there was nobody like literally no one. 2021, like a handful. Certainly, no foreigners. 2022, some. We haven't seen the Chinese come back. Now, the Chinese pre-COVID were spending twice as much on international travel as Americans, twice as much in aggregate, not per person, but in aggregate - they're not back yet. So, what happens in I don't know, this year, next year, as the Chinese come back, and they'll come back.

Willy Walker: Could they save San Francisco?

Dr. Peter Linneman: Only San Francisco can save San Francisco.

Willy Walker: It needs to be saved.

Dr. Peter Linneman: Hopefully it will be. It has an amazing infrastructure. It's an amazing kind of place. It's a good example of how kind of communist systems can destroy things. I mean, think about this. You don't have to have a Ph.D. If I tell you, you can steal $900 and no one's going to do anything to you - what do you think's going to happen? This is not hard. And by the way, you can come back later this afternoon and steal $900 more. And you can either use it for yourself or go out and resell it. I mean, this is not hard. I think they did it for “good reasons”. I mean, noble reason, but stupid. But it can't be surprising to people. So, you have to change things like that. Interesting.

Most of you are Philadelphia people I think, and you saw the headline yesterday in the paper that Philadelphia crime is not up really that much, even though it was up a little. But you know why everybody who lives in the city knows why that is, which is you're not reporting lots of the crime. Anybody doubt that?

Now we could get into a long discussion about how much. But we live in a lovely neighborhood Willy, and I got punched one morning on the street. And fortunately, I'm like Spider-Man. It didn't affect me. Right. So, and it was very funny that when I talked to suburbanites, they all said, what did the police do when they got there? Didn't hurt me to be serious. Didn't hurt. And all suburbanites said, what did the police do when they got there? And what did anybody who live in the city said? I hope you didn't go after him. And of course, I didn't. And did I report it? Of course not. And I've lived for almost, what, 40 years and never got punched. Now, maybe it's because I'm gotten old. But there's that kind of problem. And these cities have to save themselves.

Willy Walker: And Chicago just made a move to not saving itself, and hopefully Denver… Whole Foods just closed another store in Chicago, the Democrats are going there for the convention etc. etc. so hopefully that helps and gives them a shot in the arm.

Final thing before we close, because we're right on time and then we're going to go to Q&A here in the room, when we close off of the webcast. But on a positive note, I think there's been a lot of talk about the BREIT and the fact that the BREIT had significant redemption requests in Q4 into Q1. One point, if the BREIT had been a bank, it wouldn't exist today.

Dr. Peter Linneman: Correct.

Willy Walker: Because it had the exact same redemptions that SVB did, that 40 plus billion dollars of redemptions. But because it has Gates, it still exists today. But then Blackstone turns around and it's the only thing Blackstone can do. And everyone in the room knows they just closed on a $30 billion global real estate fund. Your note is that there is $375 billion of dry powder in global private equity funds looking at commercial real estate. The data I saw this morning on that Blackstone $30 billion is Blackstone alone with that fund has raised $370 billion of commercial real estate private equity over its entire. This is Fund 10. This is the largest of all of them. But they've raised $370 billion, just Blackstone. Yeah, but the point is, there's a lot of dry powder out there, is there not?

Dr. Peter Linneman: Maybe we're all overly affected by our personal experience. Coincidentally, I was chairman of Rockefeller Center in like 1994-95, and I was trying to sell Rockefeller Center 6.2 million square feet. Radio City, the Christmas tree, the whole deal. GE was a third of the credit. You know, that's when GE was a great credit, and I couldn't find anybody who had money. I went around the world literally trying to find people who had money. And Blackstone had like a $300 million fund. Goldman had a $600 million fund; Apollo had a $500 million fund. Zell had $800 million. That's it. Yeah. And that was it.

Today, that's chump change. There were no sovereigns really doing anything back then. That was a form. There were rich guys. Today, if I told you somebody has a $300 million fund, you say they're doing okay, but you're not impressed. That was it, like five of them. And so, the notion I got to know a lot of friends simply because I had to knock on their doors to see if they might be interested in doing it. Not friends, but people. And there's a lot of money out there that's going to have to find a home. And it will ultimately attract debt to it. Ultimately.

Willy Walker: Let's hope. I'm going to close out the webcast on that and then open up for questions here at the Constitution Center. But Peter, thank you very much. It was a great discussion.

Dr. Peter Linneman: Always a pleasure to be with you.

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