Finance & Economy

Real Estate

Live and unplugged: The most insightful hour in CRE with Dr. Peter Linneman

April 12, 2023

Live and unplugged: The most insightful hour in CRE with Dr. Peter Linneman

Dr. Peter Linneman

Leading Economist, Professor Emeritus, The Wharton School of Business

I recently had the chance to chat with Dr. Peter Linneman, author of the Linneman Letter, and incredibly insightful predictor of market movements.

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

Are we facing a recession?

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

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

Is inflation gone for good?

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

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

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

Is now the time to buy?

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

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

How to thrive in real estate

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

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

Consumers and mortgage rates

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

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

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

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