5 min read
In a recent edition of the Walker Webcast, one of our fan-favorite guests, Dr. Peter Linneman, came back for his quarterly economic update. An internationally acclaimed economist and expert on the real estate space, Peter is also the principal of Linneman Associates, his consulting and research firm. There, he publishes his quarterly Linneman Letter, covering the happenings of the economy and the real estate sector. He is also the CEO and founder of the American Land Fund and KL Realty.
When Peter was on the Walker Webcast last July, he made some bold predictions, most of which came true. For instance, when stocks were falling last year amid rising interest rates, Peter proclaimed that you shouldn’t bet against the US economy for the long term, and he was right.
Peter also said that the reopening of China would be crucial to the reduction of inflation, which was correct. He made the prediction that oil prices would not remain at the near all-time high they achieved, and they have since fallen roughly 35 percent.
The ever-growing job market has been a focus of many economists and the Fed. Many believe that growth in the job market is inherently bad for inflation. However, Peter made an excellent point against this. Government entities at the local, state, and federal level make up around 35 percent of the US economy, and the healthcare/medical sector makes up another 18 percent.
These two sectors alone make up slightly more than half of the economy. Peter made the case that no one is going to delay a surgery they need because of interest rates. Additionally, there have been countless headlines about layoffs, but not one of them has been focused on government entities. In fact, many government and medical facilities are chronically understaffed. Given the fact that these two behemoth industries don’t seem to be slowing down anytime soon, job growth likely won’t either. This means that roughly half of the US economy is almost completely interest-rate insensitive.
Despite the interest rate headwinds that the real estate market is experiencing at the moment, Peter pointed out that there is still a fair bit of speculative development happening. Much of the development is, surprisingly, within the high-end office market. This is shocking, given the severe slowdown we’ve seen within the market.
However, office is not the only space seeing speculative development. We’re also seeing a good bit of multifamily being built, which is inherently speculative, as well as some industrial development. We are undersupplied from a multifamily standpoint, and industrial projects are relatively easy to build, so starting/stopping is relatively frictionless.
Given the state of rates currently, you might expect consumers to be facing financially tough times. The opposite is true. The average consumer is fairly well-capitalized, and there are plenty of job opportunities for them to change jobs if they desire to do so.
Overall, consumer wealth is higher than it was three to four years ago, and many people have more than enough cash to pay off their outstanding debts. Most people have incomes that have outpaced inflation, and around 42 percent of people with mortgages were able to lock in incredibly low rates on 30-year loans.
This isn’t to say that no one is having financial difficulties though. There will always be people who are down on their luck, and can’t find a job, or are facing debts that they simply can’t pay back. However, Peter asserted that the average consumer is in a great spot.
Peter shared a very simple principle that he relies on in times like these: if you have capital and courage when others don’t, there’s a good chance you’ll do very well for yourself. At this point in time in the real estate market, many simply don’t have either of these things. Peter shared his opinion that there are some great deals that exist if you can secure funding and take some very calculated risks. Unfortunately, though, most people don’t like to be contrarian. Instead, they like to move with the flow and buy when others are buying or sell when others are selling.
Peter has a large, varied commercial real estate investment portfolio, so I always like to hear what he’ll be doing with it in the coming months. When I posed this question to Peter, he said he would be looking to buy and hold apartments through REITs. Assuming capital is available, he would also be looking to do some development in the apartment and industrial spaces, simply because by the time he starts drawing down on a construction loan, interest rates will likely be much lower. This, of course, would result in the project turning out much better than what was projected in the initial numbers. Peter also mentioned that he would stay away from the office space completely and he would not make any moves in hospitality and retail.
I regularly have the pleasure of interviewing guests like Dr. Peter Linneman on the Walker Webcast. While our main focus in this episode was on economics, our guest list is widely varied, and we cover almost every topic from activism to sports and more. To hear the full interview with Dr. Peter Linneman and see our list of upcoming guests, be sure to check out the Walker Webcast!
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 Walker Webcast, we would be happy to take your suggestions.
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Willy Walker: Good morning, everyone. I have to say, Peter and I have done this many, many times. And there are some of these conversations that I have read, The Linneman report, and it's got so much data and I'm trying to kind of find my theme. Today is one of those days that I have an abundance of questions for Peter. So many of the things that Peter has said are coming true, happening, what have you, and we'll run through all that. He, like anyone, is going to get some things not exactly right, but it's just fun to see it all happen.
We'll talk about this morning's CPI, print and some other things. I want to do a little housekeeping before we dive into the discussion, though. First thing, Peter, in my last discussion in Philadelphia, which we did live, and to anyone in New York, Peter and I are going to do our next quarterly update in New York live in I guess it's October. So be on the lookout for an invitation to come. Listen to this discussion live in New York in October. But our last one has been viewed by 267,000 people on YouTube. It's a pretty incredible number. It's a record for Peter and me. And I would just say to everyone who tunes into this, if you enjoy this, Peter and I don't get anything from this, we do it because he's got such great research and I in my company are so involved in these markets that it's just a great way for us to share knowledge with people throughout the industry. But if you enjoy this, forward the invitation to someone that you know who might enjoy it, if you watch it on YouTube, on replay for the YouTube replay. And the final point I would make is that while I try and do my best to summarize The Linneman Letter and pick out the most important pieces to it, I obviously only scratched the surface and I would just make a plug that if you are in the real estate markets and you really want great research, that gets down to the very, very micro level, subscribing to The Linneman Letter is a great, great thing to do.
And so, the final thing on housekeeping is that we receive hundreds of questions from people prior to the webcast, and Peter and I review those. I rarely take specific questions and put them into my questions, but they are very helpful for me to understand what's on people's minds. And so, I would just say a) thank you for those questions, b) keep them coming and c) thank you for not making snarky comments about my hair, my shirt, or the lack of insight in my questions to Peter.
Next week, we are live from Sun Valley, Idaho, with my guest, Kiril Sokolov, who is the founder and CEO of 13D Research. If you think that Peter and I are going to review the real estate markets in-depth today, tune in next week for that discussion. Kiril and his team and his fund invest across the market and have had spectacular returns on everything from oil to alternatives to uranium to Greece, to India, and a bunch of other themes that they follow and invest in very, very effectively.
And after that, I've actually got Condi Rice that I'm interviewing next week at the Walker & Dunlop summer conference. We are not going to publish my interview with Condi Rice live next week. Unfortunately, the former secretary of state is very particular about the publication of interviews that she does, but I'm very much looking forward to talking to former Secretary Rice about everything from 9/11 to China to Ukraine to being the first female member of Augusta National.
The final thing that I will point out is that when we go to Peter on the screen, you will see that he is wearing a hat that says “Sam” on it. Peter and I met thanks to Sam Zell. And our friendship emanates from a conference that Sam has put on every year during his life until he died recently. And Peter and I were just together with a bunch of our friends at that conference back at the beginning of June. And as was said at that conference, Sam Zell's impact on the commercial real estate industry is probably the most significant of anyone in the history of commercial real estate, certainly in the United States. And whether it be from having one of the very first REITs to his opinions on the market that many of you would watch and listen to on CNBC on a very consistent basis. Sam's insight in the market, his investments in the market, and quite honestly, his training and upbringing of this generation of commercial real estate executives is just profound. And so, both Peter and I are both saddened by the loss of our friend Sam, and this industry hopefully will continue to move forward in a great way – but it will clearly do so without the leadership of the great Sam Zell.
A couple of headlines as we dive in. I was looking back at last year at this time and some of the things that Peter said, and I want to run through a couple of the headlines and then Peter and I'll dive into them deeper.
So here we go. Last July, Peter said, “Don't bet against the United States economy.” And he was right. You said in your current letter, “We hope that by the end of the summer, the Fed realizes that they have misdiagnosed the station in the strength of the economy and finally cut rates.” I will say ahead of time, keep on dreaming, Peter. You said, “The reopening of China was crucial to the reduction of inflation.” And you were right. You had 2023 GDP growth at 3.5% last July. You've now revised that to 2023 at 2.2%. You said the price of oil would come down last July and it has fallen from $104 per barrel in July of last year to $75 as of today, down 35%. You said the consumer was still in good shape and it remains so today. You said, “Office occupancy would pick up.” You were wrong. You stated in January of this year that “40% to 50% of U.S. homeowners refinance their 30-year fixed rate mortgage by around 3% over the past several years, and that this would benefit the consumer and also restrict the supply of existing single-family homes in the for-sale market.” This narrative that you identified in January of this year has been used extensively in May, June, and July to underscore what's going on in the Single-Family housing market. You've highlighted student debt and the August 29th, 2023, date when the payment holiday ends. You state this quarter the down payment squeeze that existed after the GFC has returned. You also state “Just because a computer says something doesn't mean that it is true.” The final headline from this week, from this quarter's letter that I will state is you use a stat that Savills estimates that there is $811 billion of global real estate, private equity, dry powder sitting on the sidelines. And I sent that stat to Chris Nicholson, who runs investment sales at Walker & Dunlop. And Chris's response to me, Peter, was the following: The dry powder number is like my son's fish story. It keeps getting bigger and bigger, but harder and harder to find. So, I want to dive in on this. You got your CPI print this morning, Peter. Ten year has rallied 15 to 20 basis points and I guess at the end of the day, you were right. You've been sitting there, you said to me this morning that the headlines are economists over predicted where inflation would be and were basically right in line with what you said it would be.
Dr. Peter Linneman: Yeah, I mean, the inflation it's a little like the oil story when we talked back then. I didn't know where oil is doing exactly going back then. They had to go down because of extraction costs versus look, all you have to do. We've been through this. Look through the data. Just look at the data. And you saw producer prices weren't rising. In fact, in some cases they were falling. You saw the supply chain issues were largely evaporating. There's still places where there are some issues. You saw that the main driver of the inflation numbers were two things. One, they were doing it year over year and the year ago was very bizarre during the first half of this year. And so, when you were doing that mathematics, it was very bizarre math, and the second issue was that they were borrowing what was happening now to housing.
And housing is, as we've talked about, a big component of those indexes. It is completely mischaracterized in terms of what's going on. So, I'm going to do just real quick off the last six months now, if you took the month-over-month CPI increase and annualized, and for those who are not real good at math, just multiply by 12, right? So, as you annualize. So, the last six months have been 1.3%, 4.8%, 1.3%, 4.6%, 1.3%, and now 2.5%. What's the picture there over the last six months? And I don't want to get too precise, but what would you say, three? Two and a half? Some numbers like that over the last six months. When you strip out the insanity of how they measure housing, it gets even lower. And we don't have time to go into it. And if you want to, we can. But just note, all of you who own homes, you had no inflation on your home price. They pretend you did.
Willy Walker: Peter, let me jump in there for a second, because last July you stated, “A year from now you will see normalized consumer price inflation with increased asset price inflation.”
Dr. Peter Linneman: Yup.
Willy Walker: That hasn't happened.
Dr. Peter Linneman: Well, home prices are moving back up again in the last few months. Stock market has moved up again in the last few months. The bond yield came down. Now it's flipped back up. I don't know what it's done today with the CPI numbers.
Willy Walker: The ten-year has rallied by about 15-20 basis points.
Dr. Peter Linneman: Yeah. So that's a notable improvement on six months ago or a year ago where we were at. So, it's not an asset price explosion, but it's a leveling off. On real estate it's hard to say because you've got people looking to make the bargain of a century and owners of like multifamily who put a loan on seven three years ago, cash flowing like mad as long as it was fixed. Cash flowing right now they're not going and sell into that. I mean, and so you have an oddity going on. And in fact, among the questions people ask, as you know, is what's cap rates and so forth. One other thing about inflation, though, is that, take the numbers, I just said. Those are not my numbers. Those are the numbers. And if you do it over the last six months, you come out to around 2.7% annualized inflation. The Fed keeps saying 2%, 2%, 2% like it was handed down from Mt. Sinai. It's a made-up number. I don't know how else to say it. It's not derived from a study of what's optimal. It's a made-up number! There's no difference between 2.5 and 1.5. There's no difference between 2 and 3. There's a difference between 3 and 13. Right?
Willy Walker: So, the odds are I think the number that Steve Liesman gave on CNBC yesterday was right now 92% of the people they polled say that the Fed's going to raise again. We've had robust job growth, which seems to be the issue that continues to propel us forward. You know, 850,000 jobs in March, April, and May. And you projected the U.S. is going to add 2.7 million new jobs in 2023, 3 million in 2024 and 2.5 million in 2025. But the Fed is sitting there saying you need to get unemployment up to 5%. So, they want to get inflation down, what gives?
Dr. Peter Linneman: Too many levels of stupid give! Let's start with one thing about interest rates and jobs. Okay. I’m going to do real fast math. State, local, and federal governments are roughly 35% of the U.S. economy. Just roughly. And by the way, health care is roughly 18% of the economy. Those two sectors alone are 53% of the U.S. economy. Is anybody not going to get a hip replaced because of interest rates? Is anybody not going to get their glaucoma taken care of because of interest rates? Is anybody at the government not going to get hired because of interest rates? I haven't seen the Fed letting go of a lot of people.
I mean, so well, there are other sectors, as you know, without even trying, you get 53% of the economy. Is interest rate insensitive? This is very different from when I was a little boy in the 1950s where manufacturing was the main thing, etc., etc., and there was some degree of interest rate sensitivity. It's not the case today. Big government, big, big medical say over half of the economy is essentially interest rate sensitive. If you had a heart attack right now, are you going to go “I’m not going to go. They raised the interest rates 25 bps.” Not going to happen.
Willy Walker: I hear you on that. I hear you loud and clear on that. And you've said that, and you've talked about, you know, you do not hold back on your wording in The Linneman Letter as it relates to the stupidity that you believe is inside the four walls of the Fed Board meeting.
So, here's the issue, though. I mean, you write in the letter that you think that they will understand their stupidity by the end of the summer and start cutting rates. The forward curve, which, as you and I both know, had projected six weeks ago a 4.13% Fed funds rate by the end of the year has now reverted completely back after reading the minutes of the last Fed meeting and is now looking at a 5.25% to 5.50% dead bonds rate by the end of the year. What leads you to believe and write that you think that they're all of a sudden going to figure out the wrongs of their policy and turn around and start cutting in a month or two? You're saying they don't get it, and at the same time you're saying they're going to do it. What's the message they get that all of a sudden says, oh, we're heading in the wrong direction?
Dr. Peter Linneman: Sooner or later, it is just so obvious. That's the real point. I mean, look, think of it this way Willy, we just talked about what inflation is, forget year over year, what it is happening in real time the last six months, way down, way down. Let's say 3%. Let's just take 3% as the rate it is right now. Why do you need a five and a quarter percent overnight rate on a safe thing? I mean, that's crazy, right? It should be 25 to 50 bps higher than inflation. And so, when you've got it at five and now you're saying take it from five, five and a quarter to five and quarter to five and a half. You understand how distortionary, and you know, it is interesting. I said it doesn't affect health care and it doesn't affect the government. You know what it does affect? Anybody reliant on short term money. You think banks might fall into that category? So, what's going to happen if they raise rates is they're going to just create more balance sheet issues at banks. So, banks are going to let people go. Banks may go out of business. So, we're going to adjust the entire economy by putting banks out of business? The Fed's not going to do that. It's a bizarre, bizarre approach to the world. And when I say I don't get it, people think I'm kidding. I don't get it.
So, I said this in The Linneman Letter. Humor me, I'll say it again. I'm not saying they're evil people. I'm not even saying they're stupid people, although they try. But, you know, I take the example of the Super Bowl ads and smart people work all year long to create these dynamite Super Bowl ads. At least half of them are such complete bombs that they never are replayed in any form after running in the Super Bowl, right? You know how that happened. And the answer is groupthink. They fell into groupthink. Somebody thought it was cute. Somebody thought it was funny. Somebody thought it was impactful. They talked to other people who told them it was. And you come up with these disasters and you know, and I use the other examples there a lot. But I don't think anybody who was planning how to execute the extrication from Afghanistan was ill-intended. I don't think anybody was trying to do harm. I don't think they sat around the meeting saying, you think we can get to where we leave, and people are hanging on to the undercarriage of planes. But they fell into groupthink. And smart people working hard delivered dumb results. It is the danger of groups and it's the danger of insularity. My profession is subject to it.
Willy Walker: No, I realize that. And you make the good joke that you became a Ph.D. economist rather than becoming a tarot card reader was more challenging. Let's go to this: everyone always asks me when I read The Linneman Letter, Where is he on canaries? So, on canaries, you've got 50 potential canaries in the entire analysis this quarter. In the 45 just are going to take out one on stupid Fed policy because you're at four out of five dead canaries on stupid Fed policy.
Dr. Peter Linneman: Only because I'm nice. I give them a four out of five.
Willy Walker: Exactly. You give them one still alive. But only five dead out of 45 across everything else that you tracked, which is great. But you've got two of five on “speculative real estate development boom.”
Dr. Peter Linneman: There are three little pockets. One is, as you know, there are a lot of office still being developed, and it's very high-quality office. They're making, what would I call it? They're making a fair bet that even if the demand for office goes down, that the demand for high-quality office will go up. So, I'm not saying they're dumb in that. I'm just saying that's happening. Right. And you see it in the data. The second place you see it, and I think you and I both were amazed is in multifamily, which is by definition speculative, right? You don't have pre-leased. And much to my confusion and amazement, multifamily starts instead of dropping further over, they rose, and I don't get it. I don't know if it's a data quirk. I don't know how it's possible. You talk to even more people in the industry than I do. I expected to fall another, you know, another month, and another month as the high interest rates weed out development. I can't imagine how that spurred it up, but you still have a little bit too much multi. And the third is industrial. There's a fair amount of industrial spec, there's very strong demand, and it doesn't take long to build. So, if you overbuild, you shut the pipeline down. But those are the three little pockets of speculative. That's why I got a couple of debts. You don't have widespread.
Willy Walker: On your comment on development of office assets and kind of scratching your head on it. One of the data points I'd give you on that one, Peter, is that trophy assets right now receive an average rent of $79.14 a foot with class-A only receiving average rents of $40.65 in the United States. So, there's almost a $40 discrepancy on a per square foot basis between trophy office and class-A office. And then don't even take a look at B’s and C's. So, to your point, there is a bet and you said it's a calculated bet that's going on right now. People saying people want to be in new brass in glass and that they will pay to be there. When you and I were last in Chicago, you and I were doing this for a private group. And I went to a meeting with a Walker & Dunlop client. And we were talking about office. And one of the executives spun around in his chair, and we're looking out at the river in Chicago. And he goes, “Look, you go five blocks that way, and there's about 5 million square feet of office that should be condemned and turned into something else.” He goes, “You go five blocks that way, and we're getting the highest triple net rents we've ever gotten in the history of Chicago.” What's different about it? It's location, location, location. Now, there's a bigger play going on here.
And one of the things I wanted to raise with you, Peter, is this. Their headlines every single day that commercial real estate is under siege. And I wrote an author on one of the articles the other day where they say commercial real estate values are down 30 to 40%. And then you read the article and they don't talk about anything other than office. I wrote the author and I said, “Either talk about all commercial real estate and all the asset classes or just focus on office. But commercial into just office is a misnomer.” And so, this is my concern. There's $4.4 trillion of commercial real estate debt outstanding. Half of it is multifamily. But in the office space, about 19% of commercial debt outstanding is to offices. Okay. So, it's like $750 billion. And from a conversation I had this morning with Jamie Woodwell, at the Mortgage Bankers Association, something around 140 billion of that number is coming due in 2023. And so, I sit there, and I look at what Walker & Dunlop did in office financing in 2022, where we did $2.2 billion of office financing last year. We've done a whopping $140 million of office financing this year. So, if you've got 140 billion of office loans that need to be somehow worked out, that are maturing in 2023 and someone like Walker & Dunlop is down that much, my question would be where's the time bomb and when does it get worked out?
Dr. Peter Linneman: Yeah, I mean, look, I've been thinking about office a lot. What happened is the historic relationship between job growth and absorption has been broken over the last four years. We have more jobs than four years ago, and we have less office leased and certainly much less office occupied at the moment. That broke. Now that didn't break in multi. That didn't break in industrial, that didn't break in hotel. I mean, they had a dip in hotel but when you look 19 to today all those relationships still hold.
If you're a lender, it's frightening because how do you underwrite when the historic relationship doesn't hold? Now, you may say, okay, I think it returns. You know, I think it returns, but that's neither here nor there. I can't back that up with data other than pre the last four years that makes underwriting really hard. And remember, all lenders do at best is get their money back at an interest rate. Right?
So, I can imagine entrepreneurs willing to take that bet that the historic relationship returns, unfortunately, they want some debt. The debt providers are going, “We can't underwrite. We don't know the relationship.” Therefore, we don't know how big our problems are going to be. Back to that book you're just talking about, and some of that will probably 20% of that book will very easily roll. Right? I mean, they're well leased, they're great sponsors and they're low loans compared to even whatever you might say value is today.
And then you get to the rest where you just don't know. So, I used this analogy, I think, with you before. It reminds me of the scene in Blazing Saddles where the sheriff comes into town. They're all ready to kill him because they don't want a black sheriff. And the Black sheriff pulls out a gun and holds it to himself. And suddenly all the townspeople freeze and panic. The bankers are ready, the lenders are ready to kill the borrower, right until the borrower takes out the piece of paper and says, “It's yours.” And there'll be a lot of work out. There will just be a lot of extend and hope and hope certificates. That's all I can see for the next year. And what really you need is transparency on what that relationship is between jobs and absorption.
Willy Walker: On jobs, you have an extensive analysis in this letter about unemployment pre-COVID and unemployment today. And you focus in on a number of markets where we've seen a positive variance, if you will, or unemployment going down. And you highlight Phoenix, Cincinnati and Detroit, Miami, Kansas City and Columbus as being markets that the unemployment level is lower in April of 2023 than it was in February of 2020. And in markets like New York, where it's up 160 basis points, Vegas up 140 basis points, they have higher unemployment rates today than they did pre-COVID. And I'm reading your data, Peter and I go to myself, but hang on a second. San Antonio, Dallas and Austin and Houston all also have higher unemployment today than they did pre-COVID. And I said something doesn't give. So, I went further into your data, and I looked at where payrolls have grown. This data point I thought was unbelievable because Austin's payroll employment is up 15% since February 2020. Dallas is up 9.8. San Antonio is 6.5. Tampa 8.7. Orlando 6.9. Interestingly, Miami is the laggard of employment growth. It's only up 4.6%.
Dr. Peter Linneman: Correct.
Willy Walker: As I think the narrative which everyone knows, L.A. flat. New York City negative. D.C. negative. Portland - negative. Pittsburgh - negative. Minneapolis - negative. And even Detroit, this was the one that you point out has a lower unemployment level today. But even there, their payrolls have gone down by 1.2%.
And so, I guess my question to you is this: Is all the growth still happening in the Sun Belt? And as a real estate investor, do you chase that employment growth, or do you look more at unemployment numbers because that is a better indicator of the local economic health?
Dr. Peter Linneman: So, the answer is, there's like 100 indicators of the local economy's health. That's why I report the unemployment rate and the employment growth and so forth. Because, we talked about years ago what I view looking at the economy, the economy that you might be investing in. It's like a surreal painting, right? It's a whole bunch of dots that are left to themselves, don't tell you much of anything. So, the unemployment rate doesn't tell you a lot on its own, but you combine it with other stuff, it starts mattering. And the trick of the unemployment rate is if I have 15% employment growth and 18% migration of people looking for work, the unemployment rate goes up even though it's a pretty good labor market rate. That's kind of what you have to sort out through all this. So, they're all interesting metrics.
Where's it going to grow? Look, the best predictor statistically in the last 30 years, and I've studied this four different times, the best predictor of growth. Yes, weather. Yes, politics, Yes, taxes. The single best predictor of growth is growth. And you say, well, that's kind of a cop-out, but it's statistically true. And you can't ignore that.
So, will the South continue to grow? Yeah. Can they hit turning points? Yeah. Take San Francisco. You know, San Francisco historically and Philadelphia have grown. I'm talking about metropolitan areas. They have about the same growth patterns historically. I'm not talking about the last whatever. They both are very slow growth markets. Somehow San Francisco gets characterized as a fast growth market and Philadelphia gets characterized as a solid growth market. They're both slow growth markets. They both have always been in the last 30 years of slow growth. Do you want a fast-growing market? Go, Houston. Go Dallas, go Atlanta, go Orlando, go to Vegas. And they will continue to be.
The Miami one is headline mania, right? Like three guys who moved from the Upper East Side…
Willy Walker: One is a very good friend to the two of us.
Dr. Peter Linneman: Yeah, and three guys moved from the Upper East Side and from Chicago to Miami and it's suddenly headline worthy.
And did they move? Yep. Did it hurt where they left? Yep. But they weren't everybody. They weren't everybody. There's always been people making that move. They're going to continue. And I'll take just for example, you know, Zell did not move out of Chicago. That didn't make a headline. Ken Griffin did move out of Chicago. That made a headline. And they're both part of the reality.
Willy Walker: So, let's talk about the consumer for a second, because I think it's important in the context of job growth and GDP growth. You talk about the consumer still being in good shape, credit card debt, auto loans and mortgages, total household debt as a percentage of GDP is now at 71% in Q1 of 2023, which is slightly above the long-term average of 69%. And as a comparison point, well below the 99% in 2009 as we were in the midst of the GFC. You talk about the fact that there's a huge amount of cash that's still sitting in the economy, that this massive, inflated injection of M1 into the system has $2.1 trillion of additional cash sitting out there, which as you explain in The Linneman Letter, Peter, right now household debt is only moderately at $18.3 trillion above household cash at $17.3 trillion.
Is that the story of this economy that there's so many cash circulating around that that's what continues to drive consumer spending?
Dr. Peter Linneman: Yeah. And but think of it this way. Suppose you didn't know anything, and we just started a conversation and I said, you know, the consumers have basically enough cash they could retire all their debt tomorrow as a group. They have tons of jobs available to them. They're all working if they want to work. Their wealth is higher than three years ago, four years ago, by about 3%, 4% per annum above inflation. Their incomes are tracking above inflation over the four years, and they were able to lock in 42% of them were able to lock in super, super, super low interest rates for the next 30 years. Does it surprise you that consumers are strong?
I'm not saying they're out of sight, but it doesn't surprise you. Are there cracks? There's always a crack. There's always people who can't pay their debt. There's always people who are going to lose their job and they have a hard time finding a job even in a booming labor market. There's always somebody who's going to be sick and struggling. That's not new. It's just that there are fewer of them. And it's not about Biden and it wasn't about Trump. It's about the dynamic nature of the US economy.
And you've heard me say the US economy is so good, even our politicians can't screw it up. And that's true. You know, I'm 72 and I've seen a lot of politicians come and go. I've seen a lot of Congresses; I've seen a lot of presidents. Even our politicians can't screw up our economy. They can put a little dent in it. But the consumer's in good shape. The consumer's in good shape.
Willy Walker: You predicted accurately that the Supreme Court would rule that the Biden administration student loan forgiveness plan was going to be not unconstitutional. It was just the HEROES Act that didn't work for them to be able to change the obligations, and they voted six three on that. So, we've now got to 1.7 trillion of student loan debt that is coming back online. As I said at the top, August 29th is the day that the holiday is over. And you've said previously, good luck collecting it. And I'd imagine that the government does a pretty good job of getting into the rating agencies and the consumer credit agencies and making it so that people have to start paying back their debt.
I guess my question would be this, Peter, had that amount of debt been wiped out, it probably would have had a pretty big impact on the rental housing market because all of that money would have been found money. And as you said during the pandemic, people who got it in early now had down payment money and could go do something if all that debt had been wiped out. A lot of people who are renters today might actually have the opportunity to jump into single family ownership. With the reinstatement of that, is that a tailwind for multi? Just specifically as it relates to the balance sheet of individuals. How does that play, or does it end up tipping over some people if this relatively positive consumer outlook actually turns to the negative because of this burden?
Dr. Peter Linneman: So first, I don't think most people are going to pay for it. They haven't paid their loans for about three and a half years now. And I think this is very behavioral psychology, which is not my field. I just kind of think it's very difficult to go to people who for three and a half years have not paid their loan and say, oh, yeah, come Tuesday, start paying again.
Willy Walker: Don't they just go to the consumer rating agencies and say if they don't pay it, it's coming back here, and your FICO score goes down?
Dr. Peter Linneman: The government has to do it. And the government, by the way, how efficient or how efficient is the government in your dealings? I don't know about yours, but in mine, the government has always been a horrible debt collector. Horrible. They were horrible on agricultural loans. They were horrible on student loans. There was a pitcher, I think his name was David Cone. This goes back in time. He pitched for the Mets, and he owed debt, this is like 20 years ago. And there was a congressional hearing about, you know, students not paying their loans and they said they couldn't find these people. And he was one of the people they couldn't find. And then the congressman in a hearing plays the tape of him pitching at Shea Stadium that afternoon or something. You're a congressman. I don't care if you're a Democrat or Republican, you're up for election. The cycle is about to begin. Are you really going to turn a deaf ear to people who haven't paid in three and a half years when they say we aren't going to pay when they're young voters and there's a lot of them? Was it 24 million voters? I just think it's going to be a bit of a game of chicken. Now, there are going to be some they're going to pay. When you think about it, over half of the student loan is less than $20,000. So, if we took $20,000 as the number and you say 3% interest rate, you're talking about 600 bucks of an interest plus amortization. And, you know, you put on it's a number it's not a staggering number. It's a number that says, okay, I cut back on my drug and alcohol consumption for a while. But, you know… Was that too much?
Willy Walker: That was a much! But let's go to a number that is a real number. Total Fed debt. You and I have talked over the years extensively about the fact that we've added trillions and trillions and trillions of dollars of debt since the Obama administration, and yet the federal debt service payment went down and down and down because we were in a lower and lower interest rate environment. Now, obviously, we're back up into a much higher interest rate environment. I think we paid 60.3 billion in interest payments in April. And I was actually with a former Treasury secretary earlier this week and asked how the Treasury thinks about sequencing the issuance of Treasuries and whether you go with two years or five years or ten years? And this former Treasury secretary looked at me and said, we just kind of issue what we think the market needs and wants. We don't really think about what the portfolio ought to look like. Obviously, if rates are lower, we go longer. But there's not a whole lot of, you know, science that goes into that, which I have to say, I was a little amazed with that response. But anyway, it's 3.5 trillion of total Fed debt outstanding. You point out that 6.6 trillion is intergovernmental. So that's a net debt of 24 trillion. And then you point out that the Fed has another 5.9 trillion. So net debt is $18.6 trillion.
Dr. Peter Linneman: That's a less worrying number, we have to admit.
Willy Walker: It is a much lesser number than 30.5 trillion.
Dr. Peter Linneman: Just so listeners understand, Willy, take that roughly 12 trillion that intergovernmental, including the Fed. Roughly 12 trillion. So fine. The federal government pays it to the federal government. So, the money comes right back into the federal government. So, you're left with the 18 trillion owed, 17 and a half, whatever the number is owed, not by the government to the government. It's a big number.
But remember, most of the increase in debt during the pandemic was bought by the Fed that was intra government debt. And yes, the Fed technically is an independent agency, blah, blah, blah. But all their net revenue and all their net liabilities and so forth go to the government. So, am I worried about 18 trillion? Well, 18 trillion is 60%-64% of GDP. We could pay it off within eight months of our work. It is another way of saying we took everything we earned in the next eight months; we can pay off real debt. Can we afford it? Of course, we can afford it. I've always said the issue is not can we afford it, it is are we getting our money's worth. That's the real issue. The real issue is are we getting our money's worth?
But think about it. GDP is like 24 trillion. Okay, round number. You do the present value of that GDP into perpetuity, not just next year, but the kids who are unborn yet and all the ideas yet to come up. You know, you're $800 trillion. What's an extra trillion here or there if it's really well spent? If it's really well spent, it's nothing. If it's badly spent, it's staggering! And I just always have thought people focus on the wrong thing. They focus on the number rather than did we get the money's worth for that number?
Willy Walker: So talking about money and having a lot of money, you in The Linneman Letter point out the data from Q1 per PREQIN as it relates to the number of funds out raising money for commercial real estate. And I put out the stat earlier of the, the survival stat of $811 billion of global private equity capital waiting to be invested in commercial real estate. And Kris Mikkelsen's comment which I thought was great, but in Q1 2035, real estate funds were in the market seeking half a trillion dollars of capital. I thought it was interesting that the breakdown value added 31% of the fund raising that's out in the market right now, opportunistic 26%, core 15% and debt funds 15%. And if anyone goes and does that math on it - there is a gap there. The other is other strategies.
Dr. Peter Linneman: Mixed strategies.
Willy Walker: Right, mixed strategies. But you point out that only 92 funds closed on 23 billion in capital in Q1 of 2023, the lowest since Q1 of 2013. Right. Isn't now exactly the time when capital ought to be investing in commercial real estate?
Dr. Peter Linneman: Well, based on my analysis of history, yes, I don't know that history repeats itself, I would guess it does. The reason I believe history repeats itself is its capital-intensive business. And if you've got capital and courage, when capital and courage are in short supply, markets normalize. Give it a few years, they normalize, and your capital and courage pays off. And that's what my research shows, not just my intuition.
But my research shows. What's the problem? The problem is most people don't want to be contrarian, right? Most people follow the flow. It's probably the nature of our species. I will go to Kenya next month and I'll mostly see the animals and they mostly are herd animals, right? They basically follow the herd and there is safety in the herd most of the time. Not all the time, but most of the time. And I think investors are kind of herd-like. Their incentives are a bit herd-like. You don't get rewarded tremendously as an institution for taking away from the herd risk. So yeah, it is the time, but it's when people are most hesitant. That's why it turns out to be the time if you have that capital and courage. Look again, I go, I'm 72. I've seen a lot of markets. You're a young kid, you've seen quite a few markets.
Willy Walker: Say that again. Call a 56-year-old as a young kid. I love hearing that.
Dr. Peter Linneman: Well, give it 20 years and your hair will look like mine. But no, when you think about it, in moments when there's lender strikes, for example, you think it'll never end. It'll never end. In early 2010, it felt like this would never end. In early 1990, 91, 92, it felt like it would never end and then come back three or four years later and you're awash with money and you've got to be able, if you can get in when there's not money and stick around until it's awash with money, you do well on a capital-intensive asset. But you have to be a little patient, it is not a flip. You got to focus on decent real estate because you got to get to the other side.
Willy Walker: I was really interested in one stat that you put in, which was that over the trailing 12 months through Q1 of 2023, domestic investors acquired $580 billion of U.S. commercial real estate, and non-U.S. investors only acquired $40 billion. I think there's a headline somewhere in commercial real estate right now that says there's all this foreign capital that's coming to the U.S. commercial real estate industry. But over a trailing 12 number of foreign buyers, only 7% went to foreign buyers.
Dr. Peter Linneman: It was up to one point something like 24%, some number like that at one point.
Willy Walker: And is that just due to the dollar foreign currency exchange rate? Is that due to value in other markets? Why is that?
Dr. Peter Linneman: I think part is that a lot of countries are still struggling. There's not much money coming out of China at this point, probably as much for political reasons as economic reasons, or more for political reasons than economic. There is no money coming legitimately out of Russia at this point. And it's like Russia was big. When you go to places like Germany, and so I just got back from, they're kind of focused on themselves and their own problems right now. And I still think the U.S. economy is the most attractive place to be for almost all investments. And finally, I said for years and years and years and years, I believe in being exposed to foreign markets, but I don't have to go to the Turkish stock exchange to be exposed to Turkey's economy. I can own shares of Microsoft on the New York Exchange. I can own shares of Apple. I can own shares of Disney. They have exposure to Turkey in their business so that we have these companies that have exposure to international. And I don't have to take the vagaries of investing in those exchanges. And The Wall Street Journal finally had an article that kind of tumbled to what's been obvious to me for a long time. So, look, if you had money, I don't know where else I put it. You want to go to Mexico? I don't think so. You want to go to Brazil? I don't think so. Do you want to go to Chile or Peru? I don't think so. Canada is struggling a bit more than us. Western Europe is killing themselves on the energy altar. Great Britain can't get out of its way. Africa is nontransparent, can't get into China very effectively. We're running out of places. Australia, small, New Zealand, smaller.
Willy Walker: You and I were on an email chain yesterday with our friend Marc C. Ganzi at DigitalBridge talking about India and about the fact that India is like Hotel California. Once you check in, you can never check back out.
Dr. Peter Linneman: You know, it's interesting. I did some work about 10-15 years ago for some Indian families in India. And I came to the conclusion, and this is overly glib, there's a staggering amount of money to be made in India in real estate. There's a staggering amount of money that's going to be made and has been made. I don't think a lot of it's going to be made by people outside of India. They'll use our capital if they can get it, but we're not going to make a lot of money. They're going to make a lot of money. They control the keys to the kingdom. And so, I think what people do with an economy like India is see the opportunity. How can you not identify the opportunity? That isn't the issue, how can somebody like us or the people watching this literally access it and execute it and exit in the ways that they're used to doing? And the answer is can't do.
Willy Walker: So, let's run through a bunch of the asset classes that you go over. I'm not going to dive too much into that. You've got that great chart, Peter, that shows the development pipeline by city, by asset class that allows people to get a sense of sort of where you might be having some oversupply issues. But on multifamily, I'll quote you, “Multifamily sector is fundamentally strong, but many markets have aggressive supply pipelines.” You think the weakest multifamily markets by the end of 2024 are going to be Jacksonville, Salt Lake City, Raleigh, Durham, San Antonio, and Nashville. While the strongest will be New York, San Diego, Boston, Orange County and Seattle. Any rhyme or reason to that?
Dr. Peter Linneman: It is real simple, you can’t just look at supply and you can't just look at demand. And of course, as you know, what a lot of people like to do is just look at demand growth. And if all you do is look at demand growth, you're going to be misled. You have to look at demand and supply growth. And so, what we're trying to do and the way we get to those is we're making an assessment of supply and we're making an assessment of demand. So, you can get some cities where there's not what metropolitans where there's not a lot of demand growth, but there's even less supply growth. And you can get cities where there's a lot of demand growth and stunning supply growth. And so, you're trying to balance that out. And all I would point out, you know this, but I think a lot of people want a demand only answer or a supply only answer, and it is demand and supply that matter. I didn't learn much as an economics student, but I did learn that.
Willy Walker: On retail, Peter, you like retail, you talk about consumer product confidence still being strong. It's at one or two with the long-term historic average at 95. And you point out, as you've said many, many times before, and we're repeating again, you know, you've got $1.7 trillion of retail sales in Q1. Of that, 1.5 is brick and mortar. And 265 billion is online. So online is right now at about 15%. And so, while everyone signs off and says, no, it's all going to Amazon, it's actually not the case. And one of the things that you point out in the letter is that all of your covered retail markets were in balance in Q1 2023 and expected to remain so through 2024. So, you're very bullish on retail.
Dr. Peter Linneman: It's as simple as this: no supply being added. And in fact, in some markets, net destruction. That center finally went out of business. There's no new supply being added to speak of. And there's demand growth because there's income growth. How can you not like it? Now, does that mean I like every retail center? Of course not. There are some really crappy ones I hate, but that just means I really like the good ones even more.
Willy Walker: So, your projections on hospitality have been right on the mark. Right on the mark. You said we'll be back close to the same occupancy level at this time as we were in February of 2020, and we're about 3% below on an occupancy level. Our Revenue per available room (RevPAR) is up to $93.60, is average RevPAR which has not quite caught up to where it was pre-pandemic, but it's on track to be there, as you had projected by the end of 2023, and it's up on a T12 basis 16%.
The one other point that you made a number of times is that the Chinese citizen has not gotten back to travel. And I keep sitting there going, someone's going to make a ton of money investing in hospitality in markets that the Chinese population has time to go hit. And I saw the thing about Disney and Disney numbers being down dramatically, but there's a lot to be made here on the hospitality front. People have the right markets and can identify that consumer base?
Dr. Peter Linneman: Two parts. Let's just say your number of 3% is right, 3% below four years ago. But it's more than that, Willy, because if we were to talk four years ago to people and we have followed the data, you just said, okay, and in four years it'll be 5% to 7% higher. So not only is it 3% below 2019, it's like 10% below where the economics and demographics would have it. Huge pent-up demand, huge pent-up demand domestically, huge pent-up demand. Europe, Then you go to China and China is back to traveling a decent amount within China, but not much outside of China.
They're going to come back, and I don't know if it's next summer or two summers, but when they do, look, you remember being in Times Square or being in D.C., even Philadelphia over at Independence Hall, we saw huge numbers in 2018-19. They're going to come back. And when they do, you're right, domestic demand is going to get back and foreign demand. There's just huge pent-up demand. And that's one of the reasons I'm so bullish on the economy. We have pent up demand for travel and tourism. We have pent up demand for automobiles. We have pent up demand for health care. By the way, you know that all you have to do is look at the health care data. And clearly a lot of people did not go get their health taken care of like they would have normally done during the pandemic. We got a lot of pent-up activity associated with that. So, I feel really good about the economy in that way. Even though the Fed is trying like mad to wage war on the non 53% of the economy that we were talking about. So, I feel good about hospitality and supply. There's not much being built. So, you got a sector with not much being built and pretty identifiable good demand.
Willy Walker: So, we're almost out of time. In closing, here's what I want to ask you. We've gotten the inflation print that you had projected that we were going to get. The ten year, as I checked before this, we started 385 when I last checked. Who knows whether it's gone up a little bit or down a little bit. Between now and our next call, you own a diversified portfolio of commercial real estate assets. What are you doing?
Dr. Peter Linneman: Basically, I'd hold, and I'd probably be buying apartments on Wall Street. You know, I'd be buying apartments through the REITS only because it's more actionable quickly. If I had capital available, I would be trying to do apartment development. I'd be trying to do industrial development. Why? Because I think by the time I really start drawing down my construction loan, interest rates are going to be a lot lower than I pro forma. And I think the project turns out a lot better than I think. And there's going to be up to the oddity of the data we were just talking about. There's going to be a little gap out there and in two years. I'd be sitting cautious on office. I'd stay where I'm at on hospitality and I'd stay where I'm at on retail.
Willy Walker: So, our next Walker Webcast with you is in New York. Maybe you and I go check out some of those Wall Street apartment buildings that you think that we ought to invest in together.
Dr. Peter Linneman: Oh, no, not Wall Street that way. I meant REITs. That's very actionable.
Willy Walker: I was sitting there trying to figure out which apartment building you wanted the two of us to go and invest in.
Dr. Peter Linneman: Yeah, well, good catch. Good clarification. I meant right now, I would probably just do the apartment REITs, but if I could find apartment complexes, I would do them. But it's less instantly actionable is all I meant.
Willy Walker: Got it. Got it. Well, I very much look forward to seeing you in October. Safe travels to Kenya. You do great, great work. And anybody who reads The Linneman Letter, Peter outlines all of the wonderful work his foundation does over in Africa to help the communities where he focuses. So, to any of you who want to be generous there, it's a wonderful cause.
Peter, as always, I have 15 other questions I could ask you. I got so many notes. I may have to call you after this and finish up on my own discussion. But anyway, thanks. It's great, as always, to everyone who joined us today, thanks. Have a great week. And we'll be back next week with Kiril Sokoloff in a conversation about the broader capital markets and not just commercial real estate. Thanks, Peter.
Dr. Peter Linneman: Thank you. Have a great day, everyone.