Willy Walker:
Good afternoon and welcome to another Walker Webcast. This is a good one. I know we have a lot of people interested in this conversation because I've been traveling extensively for the past couple of weeks and going on Zoom call after Zoom call with Walker & Dunlop clients across the country. And the questions that they pose to me are, quite honestly, better presented to my three colleagues and incredibly insightful professionals in Ivy Zelman, Aaron Appel and Kris Mikkelsen. Ivy runs Zelman, a Walker & Dunlop company that does amazing research on everything in the housing industry. Aaron runs Walker & Dunlop's Institutional Capital Markets Group, and Kris runs all of Capital Markets at Walker & Dunlop.
I got a lot of data for us to dive into and lots of specific questions to the three of you, but this is about as close to the All-In Podcast on commercial real estate as we'll get. I want to have a little bit of the just kind of back-and-forth banter between the four of us about what we're seeing in the markets and kind of what the general outlook has been. Kris, you asked me yesterday, as we were doing our pre-call, what are the top three things that clients are asking me when they call and I get on calls with them?
And my very quick response to you was, the first question is, what do I do? Do I sell, do I refi, do I hold? And given where interest rates have gone, given where cap rates are today, what's your advice to clients right now who are trying to navigate what feels like an extremely tumultuous market given what's happened with interest rates and the overall outlook for both housing and commercial real estate?
Kris Mikkelsen:
Look, I think a lot of it depends on the nature of the capital that you're geared with. I think what the market is saying right now, if you just look at transaction activity, is anyone that has the ability to hold is trying to hold. I don't think there are a lot of rash decisions. I think we get a lot of calls about when all the distress is coming. And when you look at the composition of our pipeline, it's very, very little distress-oriented selling. We took a look at our entire pipeline for the year about 45 days ago, and the number one motivation for sellers was people had just completed their business plans, and it was time to recycle capital. And that remains the primary motivation for the majority of the pipeline that we're selling.
I might answer your question a little bit differently, Willy. I think anyone that has sold in the last 12 months is probably happy that they sold. I think the people that have missed out on acquiring assets over the course of the last six to eight months are probably relieved that they missed some of those opportunities. And I think everybody's sort of sitting around saying, what does this mean for transaction activity in 2027? And I think about the world in able-to and have-to sellers. And I think what's happened over the course of the last 30 to 45 days has sent a number of the able-to sellers to the sidelines. And so I think that part of the market will be quiet for some time. But I do think some of the pressure that is building with rates and re-margin requirements and all the things that we're talking about with our clients every day are going to be a forcing mechanism for some transactions that, frankly, probably needed to have occurred over the course of the last couple of years. But because the credit markets are as liquid as Aaron will talk about, candidly, this is a little bit of a direct comment, but there's been a lot of impaired equity that's been able to hide because of a hyper-liquid credit environment. And I think what's been going on over the course of the past month, if this sort of interest rate regime persists, it's going to shine a light on some of that.
Willy Walker:
Aaron, your team is wildly prolific in putting debt capital and equity capital on assets across real estate asset classes and also across all sources of capital. What's going on in the last three weeks as it relates to both spreads, deals getting closed, or deals falling out?
Last time we had this discussion, one of your big points, as Kris just said, was debt capital is just wildly abundant. Has anything shifted in the last three weeks since rates jumped up as it relates to the ability to get debt capital for deals?
Aaron Appel:
It's a good question. I think it's a multi-answer question. One, just addressing spreads.
Spreads really haven't moved much. You've seen a little bit of widening, maybe 10, 15 basis points here or there on some securitized product, and depending on the lender, there could be some banks that are widening a touch, but no sort of severe or massive credit spread widening. Spreads have maintained; they've been relatively stagnant. I think the bigger issue that we've seen is we've seen a big shift in how people are valuing real estate. I think this last real thrust up above a 5% Treasury and certainly trying to test maybe 540, which has been backed down into the low 5s, but certainly staying and hovering above a 5% Treasury, I think has affected valuation that lenders are looking at and also buyers. And we've seen, I would say, debt yields or lender cap rate margins widen by 25 to 50 basis points, depending on the location of the asset for multifamily.
We've seen a similar widening in industrial for assumptions. We have not seen that widening necessarily in office or hospitality, but those cap rates that lenders were lending into on those asset classes are certainly wider. We haven't seen much of a move in data, although that has its own set of capital markets-related issues right now.
But we still see a tremendous amount of credit available across the board. The other issue I would say that we've seen is, and we have somewhat 50-ish transactions in the pipeline to close by year-end, is we've seen 7 or 8 deals in the last week that were slated to close where we're not closing right away. And there are minute issues that normally would have been, I don't want to say, swept under the rug, but there would have been some sort of agreement around them. And we're seeing lenders really behaving in a fickle manner around issues on deals.
Willy Walker:
Aaron, those are all on the financing side, not on the sales side?
Aaron Appel:
Those are on the financing side. On the sales side, I think you're seeing that also. I think the sales side is more just a pure play monetary issue where people are coming back for repricing, or equity is not willing to transact at levels that they were.
On the finance side, we're seeing a lot of issues amongst lenders where they're really taking more heavy-handed positions and non-monetary issues around transactions in order to maybe try to get to a better spot or maybe not transact. We're not sure.
Kris Mikkelsen:
I can throw some red meat out there for the industry participants that are listening to this call on the transaction side, Willy. In our sales business, which is predominantly a multifamily sales business, we've awarded 120 transactions since the month of May. 65% of that, two-thirds of the deals that we've awarded since May, have either closed or are getting done with no price adjustment.
If you look at the third that is getting repriced, it's really 50-50 as to whether or not the deal reprice and gets done or just completely falls out. And I would say the thing that I think is different about multi is it's more than just a, hey, here's the impact to my cost of financing. I was underwriting a four-and-three-quarter to 5% exit cap. I can no longer have an exit cap that's inside the 10-year Treasury, so I'm gapping out my exit cap.
A 50 basis point move in the cost of your financing, if you're a total return IRR-oriented buyer, is a 2% to 3% correction to purchase price. That residual cap rate, once it expands out, particularly if you're expanding it out 50 basis points, is going to be a lot more impactful to value. But what's happening right now, that 50-50 is you've got some people that are keeping the conversation constructive and say, here's the impact to my model. But then you've got overly opportunistic actors in the market that feel like this is a moment of dislocation; this is a moment in time where they can actually rein back in growth assumptions and really sort of pull every lever to the conservative side. And so when those asks come in, and they're beyond my cost of debt with some exit cap expansion, and now all of a sudden I'm bringing in my rent growth CAGR by 150 to 200 basis points over the term, those are the deals that just, frankly, we're not even really engaging with those groups. Those are the asks that are coming back in the 8%, 10%, 12%. And very few, if any, of those deals are getting done. Most of that is just going by the wayside.
Willy Walker:
Before I come to you, Ivy, I had a meeting yesterday, Kris, with one of our big clients, and they are going after two assets right now, one in Phoenix and one in the DC area. And they'd looked for a 3% price adjustment. And I asked them, my question was going to be, did you have a big ask at first, and then when rates rallied a little bit and came back in from that 535 down to 510, were you asked to give up on some of your ask? And they said, no, we only asked for 3%, so we didn't have to go and reprice our reprice.
And I said, that was probably a constructive and smart thing for you to do. And they were like, we're still at the table trying to get those deals done. I hear you loud and clear on what you said right there.
Kris Mikkelsen:
I've yet to ever have a buyer raise his price during diligence because rates went down, so…
Willy Walker:
Got it. Ivy, the backdrop from both Kris and Aaron is a little challenging for commercial and multi, but in comparison to the single-family world, things are actually looking pretty good on the multi side. Give us your perspective as it relates to just housing generally, and then more specifically on what you and your team are seeing in the multifamily space.
Ivy Zelman:
So broadly, over the course of the last six weeks, we've seen a definite step down, which was already at pretty depressed levels of activity. I think we've been bumping along a level of pricing that's kind of hovering in the existing home market, call it up 1% and maybe 2%. And I think we're going to see prices fall further.
Inventories are rising. Builders that had been very prudent about buy-downs, which negatively impact their margins pretty substantially, now can't buy them down to the 499, which allows people to qualify. It's just too expensive.
Maybe some are still doing it, but I think generally we're seeing a pullback to a buy-down in the mid-fives. The move-up market had been not strong, but the luxury move-up, luxury second-time, and third-time move-up had been healthy. That, because of the geopolitical backdrop and the weakness in consumer confidence, we've seen a lot of those consumers step to the sidelines. There's really nothing positive, Willy, unfortunately.
I was in a meeting last week in New York and doing a Zoom while having clients present. And a question I kept seeing, I need green shoots. I'm like, well, look at the rental market. The rental market is definitely on a relative basis, definitely, green shoots are present there. And what we're seeing with the multifamily market is why, while we still have too much supply and markets that have been very depressed, we're seeing the rate of change is less negative. And those are positive green shoots in our opinion. We also, overall, think we're hovering around the level of rents. We did have our multifamily operator survey published today. And while renewal rates kind of held in, the overall new move-in went back to being negative at 0.4%. And really that was likely due to the operators pushing occupancy going into the seasonally slow period over price and willing to offer better pricing. And at the same time, kind of playing with concessions.
It feels like we're bumping along the bottom there. And I feel pretty confident, given the strength that we see demographically for rental households growing, that we're going to absorb that supply and we're going to continue to see low turnover, low move-out to buys. Lease-up competition is still very elevated, but multi, in our opinion, relative to for sale, it's no question, it's going to be a better-performing sector holding all metrics constant today, i.e., the long end of the curve.
Willy Walker:
Let me pull up a quick slide here, Kris, and have you talk about this. Ivy was just talking about her most recent survey data. This shows on this slide, and to those who are just listening today and not looking on the webcast, this slide shows where rent growth has gone for the last three years in ’23, ’24, and ’25, where rent growth was doing pretty well for the first six to seven months of the year and then tailed off to be flat to negative over the last three years.
Year to date in ’26, we're holding in there on this one at 2.83%, which is a number that is higher than what Ivy just said on their most recent survey data. But Kris, how promising does that look to you right now that this graph is showing 2.83% through September, and that with the real opportunity that we might actually have a green number for 2026 rather than a red number, as we've seen for the past couple of years?
Kris Mikkelsen:
I look forward to celebrating absolute growth versus rate of change. That'll be, I think, a welcome transition point for a lot of operators. You can't broad brush the rent growth story.
Obviously, in these areas that have been heavily regulated and repelled capital for a long period of time and saw no development and now all of a sudden have significant amounts of economic growth, you see exponential rent growth in the Bay Area. You see super resilient, strong rent growth coming out of New York. You see slow and steady in the Midwest. And in the overbuilt Sunbelt markets, you still see real pressure on rents. The rate of change has improved. But interestingly enough, some of the deepest bid sheets that we have are in those overbuilt Sunbelt markets where the basis has just gotten so low relative to replacement costs that it's attracting a lot of capital and a lot of contrarian capital.
Look, I think the fundamental story, if I were to just try and broad brush it, I think everyone is frustrated and fatigued that the recovery in operating fundamentals hasn't come more quickly than we all would have hoped. Certainly, when you looked at the underwriting of the most aggressive bidders when we were transacting in ’24 and early ’25, they were underwriting a much, much steeper recovery curve than has actually played out in real time. But it's undeniable at this point to look across the market, look at the absolute absorption figures that we've been able to produce over the course of the last 18, 24, 36 months, that we are working our way through the excess supply that we delivered into the industry.
And the one thing that I would say is, with all due respect to my great friends in the development community, this has put the headwinds in their space on steroids. And so, Ivy and I have gone back and forth on our view of what start numbers actually are over the course of the last couple of years. But I think we can both agree that the pressure that's on the market right now will hugely suppress start figures going forward and give NOIs room to breathe and time to grow. And that's ultimately really what we need in the multifamily space.
Willy Walker:
Aaron, Kris talked about certain markets that have seen low supply and high growth. New York, where you and your team do a tremendous amount of deal volume, is one of them. How are investors dealing with the sort of completely contrarian data inputs of what the Mamdani administration is doing from a housing and regulatory standpoint and the underlying fundamentals of the New York market as it relates to saying I'm risk on or I'm risk off in this market? Because the fundamentals tell you one thing and the political backdrop tells you something else.
Aaron Appel:
I think there's a specific set of institutional investors that are comfortable investing in New York and continue to invest capital here. There are private families that have operated here for multiple generations, some dating back 120-plus years, and they continue to invest capital and operate here. And there's a large subset of investors that will not invest capital in multifamily housing in New York right now outside of pure, plain market rate housing because of the political climate.
Willy Walker:
What about as it relates outside of multi into the office? You and I went to visit with a client of ours about a month ago who's looking to build an office tower in Manhattan, and the conversation went to a recently signed lease in the mid-$300s a foot. And the prognostication by this developer was that a $400-a-foot lease would be signed before long in Manhattan.
Talk for a moment about the office market in Manhattan, what you're seeing.
Aaron Appel:
It is the healthiest and strongest leasing market in the history of New York. That has been what has been told to me from my friends at JLL, CB, Newmark, and other leasing brokers that are close friends, and the market's on fire. Space is tight. A lot of stock has been taken offline. A lot of corridors that people thought were going to be full-blown residential corridors, like 3rd Avenue from 42nd Street North in Manhattan, where you have some residential conversions taking place. Other buildings that were slated for conversion are staying offices. We're seeing vacancy absorbed, and rents are being pushed. And in true Class A space, rents are close to double, if not more than what they were, call it, in 2019 before COVID took place.
There's a massive supply-demand imbalance. And at the end of the day, real estate, when you come down to it, we can talk about rates; we can talk about a variety of different factors. But at the end of the day, it's a supply-demand business, and we have a massive supply shortage in markets where people want to work around the country, not just in New York. And the capital markets have been behind that. They're starting to catch up a bit. There is equity capital looking in the space to invest in offices, albeit for the most part at capitalization rates that are not existing right now.
Ivy Zelman:
Hey Aaron, where are cap rates right now in office?
Aaron Appel:
I mean, that's a great question. One could argue that a trophy tower could trade, a true trophy, like One Vanderbilt will reset, could trade at negative leverage today and could trade somewhere in the low-five range, but it's just not available in the market. Real quality Class A that's not necessarily new-built could be something in the high 6s to 7 today. That used to be in the 5s. There's certainly a widening, but I would tell you return expectations are somewhere in the, if you're taking on lease-up risk or development risk, and it's a real value-add transaction, I think those deals need to have an eight handle on a return on cost or cap rate to the equity. And we do know of a couple of large speculative new office developments that are under construction, one of which is being developed on a leasehold in the Plaza District of Manhattan, and that's getting built to about an eight, but it's on a ground lease, and one's being fee-developed. And we're told that's getting developed to a sub-seven return on cost somewhere in the high sixes. And both those projects are just finishing their foundations and starting to go vertical.
That's a tight margin on each of those deals, but it just goes to show the equity that's going into those deals is playing the scarcity trade. They can't buy that quality of asset. It just, if it comes up for sale, it comes up once every 20, 30 years. It's a different type of deal.
Kris Mikkelsen:
And when you look at where costs have gone, I mean, sitting here in the Sunbelt, to justify new office construction, you're going to need plus or minus $90 a foot rents. The highest rent per square foot lease in Atlanta just got signed. It just cracked over the $70-a-foot barrier.
You've got rents that are 20 to 25% below replacement cost rents. It's very hard to see a world where there's another new office building delivered in Atlanta before 2030. Listen to Colin at Cousins talk about sort of their view on growth in the near term.
To Aaron's point, there is no inventory. You look at the amount of capital that's going to retail today because there is a tangible near-term growth story. They rhyme. When you turn off the supply spigot, and you give demand time to catch up and absorb, the growth returns. And so, to go back to housing, I think one of the challenges that we've had is the start numbers that we've been delivering have been stubbornly high. I do not think that that continues into perpetuity. I think there's an extreme amount of pressure on development starts today that has ratcheted up significantly over the course of the last 45 to 60 days. Ultimately, I think for the health of the market, that's a good thing. That'll allow some of the growth that we need to return.
Aaron Appel:
The multifamily housing sector has had more capital in it, in subordinate positions willing to go up to 85%, 90%, even the low 90% of cost range, which is really, in our opinion, sort of delayed or extended the supply sphere, which probably should have slowed substantially 36 months ago. And it extended that window probably two years. And really what happened is all the equity capital that was invested in new development or looking for new development for returns, said, you know what, we're going to slide down somewhere between 7 and 15 or 20% lower in the capital stack, charge a low- to mid-teens or even upper-teens return in certain cases, and see if we can get money out the door. And there ultimately were a lot of takers around the country for that capital. And those deals maybe were built for fees, but for the most part, none of those transactions, we think, will work out in a positive light for who is building them. And that's really now helped to slow the supply spigot.
Kris Mikkelsen:
And we're going to find out how many of those accruals are actually going to be recognized.
Willy Walker:
You guys jumped through a whole bunch of different stuff.
Kris Mikkelsen:
You said to keep it free-flowing, man.
Willy Walker:
I love it. Let me jump real quick to a slide that just—on that, this slide is the refi wave, if you will, that's coming up in multi. And as those watching the webcast can see, we're going from 2026 of about $300 billion. And then over the next four years, we've got about a trillion dollars of multifamily debt maturing in ’27 through ’30. That's a significant amount of paper that needs to be rolled. And Aaron, to your specific comment, as it relates to where investors have gone in the cap stack, how challenging from your standpoint is it going to be to get that trillion dollars of debt on multi refied out?
Aaron Appel:
It's like one quarter of the amount of money we need for data centers. It shouldn't be very difficult at all.
Willy Walker:
Alright, I don't want to jump to data centers right now, but so you don't view that to be a challenge. But I mean, one of the things that we continue to see is people who, I don't know, bought an asset, the value was 100 million bucks when they bought it back in 2020, 2021. They're coming up for a refi, the asset's now worth 80. They had a $60 million loan on it. We're sizing a new loan to 50 million bucks, and they got to do a cash-in refi of 10 million bucks, and they don't exactly have 10 million bucks just sitting on the sidelines. How's that going to get filled? How's it going to work out?
Aaron Appel:
They'll recap it with somebody, subordinate their interests. They'll sell it if they can. There's no buyer. A lot of times, the difference in this market, and I think when we started the discussion, Kris mentioned, when the distress comes, is the stakeholders in these transactions and the capital providers are all too comfortable to hold real estate. It's a different ball game than what we've seen historically. And we're looking at refinancing an asset for an investment manager, and they sent us their schedule of real estate owned, and roughly a quarter of their credit fund was REO.
And they have capital that can sit there for a generation to own the real estate and operate it. That's why you're not seeing the distress. I think it's just people in capital stacks that are comfortable sitting there. If it's not there, if the exit liquidity is not there, the refinance is not there, there's just patient capital that will sit and wait. And I'm not sure when that breaks. If you had asked me, I would have thought it would have broken 25 times over, but it just hasn't. And it doesn't seem like it's on the horizon.
Kris Mikkelsen:
The one exception that I would see is that, it's been shocking to me over the course of the last 24 months how many cash-neutral refis we've been able to facilitate within the multifamily space. I pulled this stat a couple of weeks ago. In the last 18 months, we had done $20 billion worth of bridge debt, and we had sourced that bridge debt across over 125 capital sources. It was 350-plus executions.
It's one thing to be able to facilitate a cash-neutral refinance, but as Aaron referenced, we are executing these not with debt service coverage-focused lenders. We're executing these with debt yield-focused lenders. That's the only way that we're getting to the proceeds that we need to get to. What's on the other side of your refinance with your bridge debt is basically very, very low single-digit return on equity at best. And at this point, we're through the sort of first wave of maturities, and we're starting to look at sort of bridge-to-bridge executions.
And so my question is, at some point, equity will become exhausted of 1% to 3% current returns in a world that has much more attractive alternatives. I think that becomes a little bit of the forcing mechanism is that exhaustion point. In addition to just the obvious, which is my proceeds were at 100 30 days ago, and now they're at 90, and I'm going to have to come up with a 10.
I actually take a little bit of the other side of the trade from Aaron. There is a lack of willingness to recapitalize an asset and subordinate your existing equity to new capital. I think there's a lot of capital that feels like, on paper, there should be a tremendous number of recapitalization opportunities. We just haven't seen as many get realized. Part of it is the pricing disconnect, but also just the—there is no yield to the existing investor once you introduce the new third-party capital into the cap stack and a recap. I think the more likely scenario for those assets, if they cannot call the capital themselves and fund the re-margin, is those deals just go to the trading window.
Willy Walker:
There are two things on that, Kris, that I would just throw in there. One is you mentioned, as it relates to, if you will, bridge-to-bridge and debt funds being the supplier of that capital and the debt funds investing on a debt yield basis and not on a loan coverage basis. I was in a meeting this morning here with a large client, and one of our bankers said that on one of his go-to debt funds, they've changed their debt yield parameters from six and a half to eight over the last three weeks.
That debt fund right there on repricing from a six-and-a-half debt yield to an eight debt yield; just what does that capital look like, and what are the underlying fundamentals of it? The other thing that I would go to is something that Aaron said a moment ago as it relates to the office market in Manhattan. I mean, stop for a second and think about what Aaron was talking about in the New York office market in January of 2025.
Nineteen months ago, the office market in Manhattan was flat on its ass. There was not a bid to finance an office property in New York, and bang, 19 months later, he's talking about the hottest leasing market you can find. While I clearly see this rate movement and changes on debt yields and all that slowing things down right now, I do think that some of the stuff that Ivy's talking about, about some of the green shoots from a fundamental standpoint, are going to help this market tremendously in ’27 and ’28 that could get some of these fundamentals turning in a way that makes it a more attractive investment than sort of, if you will, Kris, the very realistic yet dour outlook you have as it relates to operating fundamentals and return on equity.
Aaron Appel:
I mean, we're in just two live examples. We're in the market with a $1.1 billion office transaction that'll likely be a SASB. We're expecting to have eight or nine bids. And we think that there's a bank syndicate to do that deal also, given who the sponsorship is, that syndicate was non-existent. The public markets a year and a half ago were functioning, and they were constructive in office, but go back six months before that, and they were not.
On the other end of the spectrum, we have a mid-block building in the Plaza District that the entire rent roll rolls. It's about 300,000 feet. It's an older Class A space, but that deal wouldn't have any liquidity. There would be no bid for it on a credit fund or on a bank 18 months ago. And we think we'll have 10 to 12 offers today. The capital markets have certainly caught up in many ways, but there are still a lot of participants that won't participate in office just because of losses that they've taken. The other thing I would say is the office market; it seems like office, industrial to a lesser extent, hotel, people are willing to take their lumps in those spaces, and more keys have been turned over. We've seen more credit available and move around versus housing and the multi space. It's the last space to crack. It's the one where we've seen capital most comfortable to take assets back, sit on them, and wait.
Willy Walker:
Aaron, on that, just real quick, you talked about the bank syndicate that you might be able to put together on this large office financing. Is that due to just the underlying fundamentals of the office as an asset class, or is that due to some type of pullback on their allocation of capital to data centers?
Aaron Appel:
No, I think it has to do with it, it's a great asset. It's a great sponsorship. It's extremely well leased. The coverage is there from a debt yield or coverage ratio standpoint. And the asset was also substantially leased up in a softer leasing environment a couple of years ago. There's embedded upside in the rent roll relative to where the rents are today. It checks all the boxes for what you would want to put on your balance sheet as a credit provider.
Willy Walker:
Ivy, I'm going to transition for a second to another slide here, if I can. Let me see if I can find the slide I'm looking for. It has to do with the consumer. I'm going to find it; pardon me, everyone.
This slide here, again, I'll just describe it quickly for those that are just listening and not watching the webcast online. But this shows consumer sentiment in the dark blue line, which, since they started doing the consumer sentiment survey at the University of Michigan, is as low as it's ever been since they started in 1952.
And the blue line is consumer spending. And typically when consumer sentiment falls off, consumer spending falls off, as you can see on the left-hand side of this slide. But for the last year, we have seen consumer spending continue to chug along, getting up to somewhere between about $745 billion a month as of September, at a time when consumer sentiment is in the tank, if you will.
Ivy, how do you kind of make sense of this slide as it relates to the disparity between consumer sentiment and consumer spending? And then what does this tell you about overall housing and people spending money at Home Depot to fix up their house versus spending money on either buying or renting a new place?
Ivy Zelman:
The way I would look at this is, say, for the most part, it's indicative of our K-shaped economy with consumers: the haves are spending, and the have-nots aren't, and that's being masked by the haves. And I think that today, consumer spending is at risk of definitely being impacted by a very significant deterioration in the housing market. And I don't think you're going to see positive results out of Home Depot or other companies in our ecosystem because all of them are highly correlated to not only housing turnover, but the rate of change of home prices.
And if we're looking directionally, we just saw this week that the pending home sales actually hit like an all-time low or a low in 25 years. I think that consumer sentiment will follow. Historically, consumer spending has been about 70% correlated to housing starts. And while we haven't seen it, even with the flat five years we've had in housing, I think as we see home prices deteriorate further and turnover remains sluggish, I think it's going to take some confidence out of the overall spending of the market.
Now, I saw a recent chart: instead of looking at the haves and the have-nots in our K-shaped example, it's AI and everyone else. How much will AI mask what's happening with housing, typically being a leading economic indicator for our economy or leading us in or leading us out?
I'm not sure, but I can tell you right now, there isn't any part of our ecosystem, with maybe the exception of multi and SFR, that is feeling like maybe ’27 can be an up year with respect to fundamentals. It feels kind of squishy at this troughing where we are, but I'd say the consumer is going to likely pull back if I just use my old playbook.
Willy Walker:
And is there anything that you see, I mean, you very famously called the housing bust before many saw it coming in 2007. Is there anything in the housing construct, mortgage companies, home builders, owner-operators, SFR, BFR, what have you, that right now you look at and sort of look at with some concern that something might break there? Or do you think it's pretty well managed as it relates to the risk?
I think one of the things you said to me yesterday was that there's sort of this slow trend down. It's not like a big break. Is that your feeling as you look across the housing landscape?
Ivy Zelman:
Yes, I think the housing market, while definitely depressed and likely to see further downside, I don't expect the housing market to take down the broader economy like it did during the GFC. I'd be much more worried about the AI bubble that's forming and everything that goes behind that. Housing might become a very, very challenged market and we could see a recession, but I don't see it breaking everything else in the economy by itself.
Willy Walker:
Aaron, I sent you a graph yesterday as it relates to where credit default swaps have gone on a lot of the AI infrastructure companies. Everybody who's listening today probably knows very well about what happened to the credit default swaps on CoreWeave last week. You and your team are deep in the data center financing space. What's your take on the activity that's going on inside of that market as it relates to credit spreads? And do you see that having a contagion effect on commercial real estate? Or is that completely separate from what we've been talking about in this conversation as it relates to commercial real estate?
Aaron Appel:
I think it's pretty isolated from the rest of the commercial real estate sector. Hyperscale credit, such as Google or AWS, spreads are pretty stagnant. Leverage is pretty stagnant also. That credit's still really able to get underwritten. I think it's when you go a level below, you go to some of the neoclouds or non-rated credit that's out there that's taking space and taking energy. That's where you're seeing a substantial widening in credit spreads to the tune of multiple hundred basis points. You're seeing a decrease in leverage. Those are the assets that are having a harder time at the current moment getting financed.
But listen, the five or six most successful people in the history of humanity, all are taking every dollar of cash flow they have in their companies. And then also borrowing on top of that to build out compute. And when I talk to people who have engineering backgrounds that are in their 20s that use AI every day and are developing different agents and using different tools, they don't think that there's any sort of bubble whatsoever. Can the public markets get a little bit irrational to the high side or to the downside? Sure, they can, but they don't see any sort of bubble whatsoever and have full faith and belief that the product is going to become more widespread than any of us can imagine. And a lot of the bubble talk comes from older generations that don't use AI day to day.
Ivy Zelman:
Aaron, as someone who's not an expert in AI or data centers, but just thinking about the magnitude of capital that needs to be deployed, but the power's not there. Oracle just did a force majeure, I believe in New Mexico. And what's to stop that from happening?
I myself am in a fund through Blue Owl and worried and thinking, and that's why you're seeing so many people exit these funds. There seems to be a mismatch with power and the actual completion of the data centers. And then there's a triple-net lease setup, and they don't want to pay the bills; who eats that?
Aaron Appel:
So, I mean, to me, that's a bigger issue than, like we have like a data center bubble. I think that's a supply constraint issue that we have.
Ivy Zelman:
That's what I'm thinking: that is the bubble, maybe not the compute side, but recognizing that we've got a real disconnect with expenses and negative cash flow that's been funding now, not contingent on cash flow, but leverage as well as companies like Oracle, which used to be a bellwether, it's now just above junk. And it feels really concerning.
Aaron Appel:
It is, I mean, look, that is the risk. The risk in the AI trade is getting the product online and getting it developed and getting the power access and dealing with the local politics and the different moratoriums when you go, basically red state versus blue state. That is the issue.
But there's a lot of, I mean, if you look at just last night, SpaceX, Musk was talking about the amount of compute that he's going to bring online in ’27. I forget if it's two and a half gigawatts or five gigawatts. I was breezing through the article, but look, there's a lot of this getting developed still. There are tons of new starts happening. There are some starts that'll struggle.
Ivy Zelman:
They just can't get transformers and other parts of the power.
Aaron Appel:
Stuff's on backorder until 2031. I mean, look, the market is so big, it's unclear. It all depends on who you talk to, what the math is behind the size and scope.
It's actually buildable versus not.
Willy Walker:
You sort of prompted this discussion by saying my question to you of, is there enough capital to, if you will, roll the $250 billion of multifamily debt that's up for refinancing in ’27 through ’30. And you said, look, in comparison to data center capital, it's a drop in the bucket. There should be plenty of capital for it.
I do think that, to Ivy's point, that if you go back to 1998, Long-Term Capital Management. That was a $3.8 billion crisis. $3.8 billion crisis in 1998 that caused a global meltdown in the capital markets. Now, fast forward to the Great Financial Crisis. The United States government stepped in with TARP. And the three of you will recall that TARP was funded with $800 billion by the federal government to essentially save the global banking system, $800 billion.
In its first two weeks of trading, SpaceX's market cap moved by $800 billion. One stock in 2026 moved $800 billion, which was the total capital the United States government put in to bail out the global financial system. I do think that one of the things to keep in mind here is the size and scale of these bets is so much larger than anything we've ever seen.
I mean, David Zussman from Related was out in Michigan speaking with me two weeks ago and talked about the data center down the street from Ann Arbor that Related is building. They're putting as much equity capital into that one data center as they put into the entire phase one development of Hudson Yards. We've never seen this kind of concentration of investments, which is the only, look, that may go brilliantly and might have the equity returns that everyone's penciling out on it. But I do think the size of these bets is something that many people haven't sort of considered as it relates to what the contagion effect might be should something go the wrong way.
Aaron Appel:
I mean, if it really went the wrong way, really, really went the wrong way, it would collapse the global economy. I mean, the economy at this point is funding this buildup, but at the same time, you have to understand every Western democracy has just printed insatiable amounts of money.
What was our debt balance in 2008? $6 trillion, something like that, 7? It's 42 trillion growing at they say 2.5 trillion. I think it's probably closer to 4 or 5 in any given year now and growing even further than that. And it's the same story throughout Europe. They just print the money. I mean, that's really what it comes down to. And that's why you see, like, the $800 billion number. I don't think anybody had ever even thought of $800 billion in the context of private capital or the banking system back in 2008. And now it feels, I don't want to say it's like Monopoly money, but to a certain extent, we've just printed so much money that that's why you see sentiment's down, but spending numbers are higher.
Yes, K-shaped economy, 100% agree with Ivy, but I think there's even more to it than that.
Kris Mikkelsen:
I just bring this conversation back to what we were talking about earlier, which is just demand. Anthropic's revenue has gone from an annualized basis of $9 billion a year at the beginning of the year to nine months later, it's at 67 to 70 billion.
Aaron Appel:
We've never seen companies like this, ever.
Kris Mikkelsen:
We've never seen this before.
Ivy Zelman:
What did their operating losses do?
Willy Walker:
They were $882 billion in the first half of the year.
Ivy Zelman:
Let's not forget that part of the equation.
Kris Mikkelsen:
There's never been a revenue ramp like this in the history of commerce.
Willy Walker:
But Kris, go down the path for two seconds about this; let's say there is some kind of break. Paul Tudor Jones, who is one of the great investors of our time, was on CNBC last week and said, it feels a lot like 1999. Okay, so if you sold the market in 1999, between 1999 and 2001, when we had the tech bust, you went up 40% over that subsequent 18 months. Congratulations if you were able to hold on for the next 18 months, get that 40%, and then get out. But many people, as we all know, got that 40% and got the 40 and plus on the downside of it. If it feels like 1999, so there's some time in the next two to three years, you get a reset.
What does that mean for hard assets? What does that mean for interest rates? And what does that mean for the majority of the thousands of people listening right now about what their investment is going to look like, not tomorrow, but a year from now, two years from now, three years from now?
I got all three on that. Let me go with Kris quickly, and then I'm going to go—I love it. I threw a good scenario out there. Go, Kris.
Kris Mikkelsen:
Where I would actually go with that, Willy, is people are thinking about sort of what it means. I think the question is, what does it mean for the people that own real estate that are listening to this call? I am firmly out of the business of forecasting the direction of interest rates because I just got so tired of people coming to us with convicted forecasts being dead wrong and having no accountability for it.
I'm not in the business of trying to forecast where the 10-year Treasury is going to be 18 to 24 months from now. I can see legitimacy in cases for either direction. What I would tell you is, look, I think a lot of this that we're going through in the real estate business right now, and really in multifamily in particular, is a return to the basics. Real estate was never meant to print venture capital-like returns. It became an attractive asset class because of three things. It had fixed income plus current returns. It had inflation protection vis-a-vis a real asset that reset its rates on some given schedule based on the product type. And you did it all in a tax-advantaged strategy vis-a-vis depreciation. But it was fixed income plus.
One of our biggest challenges right now is the success that we had over the course of 10 to 15 years of 0% interest rates that brought in a tremendous amount of equity capital that's trying to generate 15 to 20% returns. Historically, that's never been what real estate is. We can't attract capital that wants an 8 to 10% return on their equity because that capital can flow into credit funds right now. And the only risk that they're taking in the credit fund is they don't get paid back. Until that starts to change and we get some of that sort of core-plus priced equity, what I would call sort of levered 8 to 10% capital back into the space, we're going to continue to go through this repricing. But ultimately what we're doing, I think there's some pain in this, but a lot of this is a return to the fundamentals, cash flow, positive leverage.
I think if you own assets today and you've been responsible in terms of how you've capitalized that asset, responsible in a historical context, maybe not responsible over the course of the last three to four years, you hold. And you let market forces take effect. The market right now is forcing within multifamily a turning off of the supply spigot. And you give yourself time and duration to compound wealth.
Ivy Zelman:
I agree with Kris. I mean, look at San Francisco right now. Markets starved for new construction, seeing significant rent inflation. If we had, let's say a reset because the power couldn't match the demand or couldn't match the supply of data centers. And it actually rolls; we go—Fed, by the way, recently the head of the Cleveland Fed was speaking at the National Economic Council and said, I don't care why inflation is now rampant in our country again; we're going to do everything we have to do to stop it, with no concern of what they break in the process. And they're going to break the housing market. They'll probably break the lease, the transaction side, and values will be under pressure in commercial real estate if they continue and they push yields up even further.
But when the economy breaks, you're going to hope you held your assets that are cash-flowing that you assumingly are well capitalized. I completely agree with you. People talk about buying 20-year TIPS now, and we're going to protect them against inflation. How long before we see enough of a slowdown in the economy that rates actually rally is the unknown. We can all agree that inflation is not good for the long end of the curve. And that's what we're sitting upon right now is a Fed that's going to take every measure to stop inflation.
When we have diesel and everything else happening from the Middle East still rising, every developer that's out there, why they're stopping, in addition to what Kris mentioned earlier, is their hard costs are up substantially. You can't pencil it just because of the regulatory and hard costs. I don't know, I think owning real hard assets that cash flow, assuming you're well capitalized, is probably the best place to hide.
Willy Walker:
Aaron, I'm coming to you in two seconds. I just got to tell one quick anecdote that I saw last night. A broker from San Francisco selling an $8 million soft-price house in Pacific Heights gets an offer for $13.5 million with a demand for the existing owner to move out by Sunday. And in the offer, it says, we believe that this $5.5 million premium price is worth the seller moving out by Sunday. And then the punchline to his post on Instagram was, the buyer is 28 years old. I just sit there and think—
Kris Mikkelsen:
I hope every politician and every regulator listening to this webcast looks at San Francisco and sees what housing regulation and what an overly burdensome regulatory environment does to the cost of housing.
Willy Walker:
Hear, hear, Kris. Aaron, we were talking on that—
Kris Mikkelsen:
Get in a car and go to Houston, Texas.
Willy Walker:
Exactly. Or Austin for that matter, where single-family and multifamily are down significantly, even though the population of Pittsburgh has migrated to Austin, Texas, over the last six years. Aaron, we were in that scenario of sort of the break, and everyone jumped in. I want to go back to where you were on that. Was there anything in that that hasn't been covered by Kris or Ivy that you want to underscore?
Aaron Appel:
No, I agree with him. I mean, I think, look, the biggest issue is that we haven't had that break, and we should have had it a couple of times. And it's been pumped up by the government buying bonds and putting capital into the marketplace.
A break certainly would be helpful for CRE; it would help to constrain supply in oversupplied areas further. And a reset would bring back the return profile and threshold that people are looking forward to invest in commercial real estate.
Kris Mikkelsen:
I think, Aaron, one of the things that I would just add onto that, this, and I offered this—
Aaron Appel:
I don't think it's going to happen, but—
Kris Mikkelsen:
Well, I offered this up because I think this is a theme of a lot of our sort of smaller conversations. And I think it needs to be acknowledged in a broader format. We have a lot of excess capacity in the commercial real estate ecosystem. And I think part of that excess capacity has also contributed to the sort of lack of reset. And I think this will be a forcing mechanism for that to be addressed. If you look at our development pipeline across the Sunbelt and you add up the number of individual multifamily developers building apartments across the Sunbelt, like, the numbers would astound you. And it's not just the development side, it's the entire ecosystem. But at some point, look, that's going to need to get addressed. Go ahead, Ivy.
Ivy Zelman:
I was just going to say, you and I are on the same page. I do think starts are going to slow, but then you get permits this week that were actually up 544.
Kris Mikkelsen:
My head exploded when you sent that to me last week.
Ivy Zelman:
I mean, I just didn't like, who's doing that? How are they penciling that? And maybe it's all equity capital, and there's no debt financing, but it seems like well above the trendline. Anyway, sorry, Will.
Willy Walker:
No, not at all. I mean, one of the things that we had a big debate, I had a dinner last night here in Denver with a bunch of our clients. And one of the big debates was the frequent number is that there's $340 billion of dry powder looking to be invested into commercial real estate right now. And I had three or four big owner-operators sit there and go, there's no way that number's right. There is no way there's $340 billion sitting on the sidelines waiting to be invested into CRE right now. And the conversation kind of went to how challenging it is to raise new capital right now, regardless of whether the 340 is out there; it's just that there isn't right now that desire to put additional equity capital.
But if that equity capital doesn't get activated, all the numbers as it relates to the refi and what's going to be needed to be able to not only refi out the multi, but all the other asset classes is going to be really challenged. ’Cause you're not going to go up to 80 or 85% LTV, LTC, whatever you want to call it, to get yourself out of this financing situation of all this paper that's rolling.
Kris Mikkelsen:
Look, I too am skeptical of the dry powder number. I mean, I quipped to you a couple of years ago, it was like the fish story for my 10-year-old. It's sort of just the fish kept getting bigger and bigger and bigger. And I'm sort of looking around, I'm like, where's the fish? As we're trying to sell these things. I don't think that there's as much capital in the system as we would all like to believe.
I think everyone who's out raising capital right now is in an absolute knife fight to raise your next fund. There is capital out there, that capital wants more discretion, and it wants to control its own destiny. But at the end of the day, the bigger problem is just price. And that's the cost of that capital. And it's the value of the assets. And that's what really we need to have reconciled with one another.
Willy Walker:
I want to end on this. We're rapidly approaching the beginning of 2027 or the closeout of 2026. As you look at the landscape for ’27 and where you see opportunity, and opportunity might be just hold. But that's sort of been a theme of part of this. But as you look out into ’27, as it relates to opportunity to deploy capital, to get return, what have you, Ivy, what's the idea in your mind as it relates to what would be the opportunity for ’27?
Ivy Zelman:
In my world, it's clear that the for-sale market is going to remain really challenged. If I'm looking at asset classes within our ecosystem, I'm going to look on the rental side for what may be attractive long-term returns. And whether that's multifamily or SFR, we didn't talk about it, but the United States is in a real pickle with demographics, Willy.
We know that by 2030, more people in the country will die than are born. And we're not going to need a lot of supply when we get into the 2030 decade. We'll need a lot less than we're currently running now, 1.2 million; the number was just annualized. I think where you can feel more confident about is renter households are growing. And so when I think about absorbing the supply, we will absorb the supply. If you're looking for opportunity because there's guys that can't refi, and you're a well-capitalized operator, then there could be an opportunity to add to your positions in ’27 to the portfolio. And I would be looking predominantly in that area.
Right now, I think the housing market, we need a reset, and that's going to come from more likely land prices coming down with Aaron's point about data centers. Virginia and Texas are crazy for builders to try to buy lots now, and they're competing against data centers. We don't anticipate a significant land reset. I'm hard-pressed to see opportunities in ’27. Maybe distress will come in for sale in ’28, but assuming rates remain elevated. Otherwise, we'll have a recession, and we'll have a lot of failures, and then there'll be opportunities in for sale.
Willy Walker:
Aaron?
Aaron Appel:
’27, I think rates are coming down, and cap rates are coming down. That's what I think.
Ivy Zelman:
Are we having a recession, Aaron? What do you think? Is it a recession?
Aaron Appel:
I think we'll see some deflation from AI. I don't know if we'll see a recession or not. I just think that we're very negative right now, and I think things are not as bad as people think they are. I typically will take the other end of the spear.
Willy Walker:
I was just going to say, that is as contrarian from my friend Aaron as you'll get of his own view on the world. Kris, let me finish with you.
Aaron Appel:
Can I show you a book? I've been reading this book.
Willy Walker:
There you go. That's great. To anyone who's listening to this, Aaron just held up a book from his desk called How Not to Be an Asshole. Kris, final word.
Kris Mikkelsen:
I think the biggest surprise of the year for me was over the first nine months, just the depth of the bid for these urban recovery plays that were just basis-oriented buys with no yield. I think the oxygen is out of the room for that trade today. I think yield is necessary again, and I think the reaction over the course of the last 30 days has been—there's been a reactionary sort of impulse that is fueling massive amounts of conservatism in underwriting.
And in my experience, whenever there have been windows in the market, and this is a multifamily-centric conversation because NOIs in multifamily are art, and in other asset classes, they are a science. But in multifamily, whenever there's been an environment where we are selling assets and the buying community is strictly focused on in-place and trailing operations and not making any assumptions around trend, historically, that has been a very good time to buy multifamily assets. And that's where we are in a lot of the market today.
Willy Walker:
Extremely well said. Thank you, three. It's always great to get together with you. We've had a fantastic live audience, and I'm sure this will be listened to on replay many, many times. Great to see the three of you. Thank you for your time. Thank you for your insights. And thank you, everyone, for listening today. And we'll be back next week with another Walker Webcast.
Thanks.
Kris Mikkelsen:
Thanks, everybody.
