Real Estate

Finance & Economy

Most insightful hour in CRE: Live from the New York Stock Exchange

October 11, 2023

Most insightful hour in CRE: Live from the New York Stock Exchange

Dr. Peter Linneman

Founding Principal of Linneman Associates

Check out the latest installment of The Most Insightful Hour in CRE as Peter Linneman discusses key takeaways from the latest Linneman Letter.

The New York Stock Exchange was the setting for my recent chat with one of our fan-favorite guests, Dr. Peter Linneman. Most of our readers are familiar with Peter and his work, but for those who aren’t, Peter is a world-renowned economist with a keen eye for the real estate market. He is the founder of the American Land Fund, KL Realty, and Linneman Associates, where he publishes his famed Linneman Letter quarterly. During our conversation, we discussed the state of commercial real estate and the key takeaways from his latest Linneman Letter.

Before we began our conversation in earnest, I felt it was important to recognize that this is an exceedingly scary time for Israel and the Middle East. Thinking about the people impacted, both directly and indirectly, Peter and I agree that it’s important to show all the support we possibly can during this trying time.

Why the economy is still going strong despite interest rate hikes

While the Fed has been drastically increasing interest rates over the course of the past year and a half, some are still scratching their heads, puzzled by how the economy keeps growing and job numbers are staying strong.

However, Peter believes the answer is quite obvious. In reality, most of the economy is not interest rate-sensitive. 35 percent of GDP is derived from state, local, and federal governments, and another 18 percent of the GDP is made up of healthcare. Using this quick math, over half of the US economy isn’t sensitive to interest rates. At the end of the day, governments need to continue functioning and expanding the breadth of services they offer, and as for healthcare — well, people can’t exactly delay treatment for a heart attack no matter what’s happening with interest rates, can they?

You can then add in the more difficult-to-quantify things like consumer staples, home and car repairs, and cars and houses purchased in cash. All of these things are also interest rate-agnostic. When you add together all of the pieces of the economy that aren’t interest rate-sensitive, you find that these sectors make up roughly 80 percent of the economy. So, there’s no wonder that the steady increase in interest rates is doing little to slow economic growth in the US.

The cyclical nature of economic problems

In Peter’s 72 years of life, he’s seen countless country-specific and worldwide problems come and go. We live in an imperfect world, so there will always be civil unrest, wars, pandemics, and the like.

However, Peter believes it’s important to remember that despite the problems the world faces, great investments have always appreciated in value. There may be hiccups and downturns in markets for short periods of time, but great investments tend to trend upward over time. This is true with every type of investment, whether it be the stock market, real estate, or some form of alternative asset.

The causes and implications of rising credit card debt

Although there is a trillion dollars in outstanding consumer credit card debt, Peter remains relatively unconcerned with the state of the consumer. Although many believe that the average consumer’s balance sheet is a ticking time bomb waiting to burst, Peter believes quite the opposite. While there is a lot of outstanding credit card debt out there, Peter believes that this debt is being paid off during the grace period, and consumers aren’t paying interest on the money they borrow. This means that they are not using their credit cards as a source of long-term financing.

After all, consumer spending is still rather strong, credit defaults are still relatively low, the job market is still very strong, and companies are still hiring. When you couple this with the fact that most consumers have a very low-interest rate, 30-year fixed rate mortgage on their home, consumers are actually in an incredibly powerful economic position.

The pros and cons of office-to-multifamily conversions

Given the precarious state of the office market, many are looking to convert existing office buildings into multifamily housing. However, it’s a rather risky process that requires extensive experience in real estate, as well as the proper financing, because these conversions aren’t cheap. Walker & Dunlop has helped finance a few of these deals, and Peter is actually working on a conversion himself.

Believe it or not, the most difficult part is not actually the conversion. Although adding all the utilities necessary to facilitate a proper conversion is difficult, finding a building with the right occupancy is even more difficult. That’s because most office buildings are not 100 percent vacant. Oftentimes, they are at 25, 35 and sometimes even 50 percent occupancy. Many of the tenants have long-term leases locked in, which makes them incredibly expensive to buy out. It is simply not economically feasible to convert most buildings with mid-level occupancy rates and long-term tenants.

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