Webcast Transcript:
Willy Walker: Good morning, everyone and welcome to the Walker Webcast. It's a true pleasure to have my friend and frequent guest Peter Lineman joining me today. We have over 6000 people registered to listen to this webcast live and with my last discussion with Ivy Zelman having been watched on YouTube over 100,000 times in the past two weeks, I’m sure today's discussion with Peter will be listened to far and wide.
The 10-year treasury is at 131 this morning. Back in January, my friend Mike Altman, Chief Investment Officer at Cortland Partners, said to me we’ll see a 1% 10 year again before we see a 3% 10 year and looks like Mike was right on the money. I’m looking forward to hearing Peters thoughts on why we are seeing this rally in rates and how long it will last. This is a fun time of year for cycling, tennis, and soccer fans who get to wake up in the morning and watch the Tour de France, Wimbledon, and the European Cup being played live. A Business School buddy of mine quipped this morning that it wasn't going to be that productive a day for him with so much on television and it made me think about how less productive homework is today versus a year ago since we all have other things to do with our time. Watch live television versus a Netflix rerun, go to lunch with a friend, take a yoga class, go to the mall, what have you.
David Faber who was on the Walker Webcast three weeks ago, said on CNBC yesterday that we will never get back to a normal work week since employees have spoken and they want flexible work schedules. I completely disagree, we all know that collaboration and teamwork make companies more competitive, and if you can make your company five or 10% more competitive by simply getting back into the office and working together, everyone will do it. I liken the thought that employees have spoken, and they want flexible work schedules, to the 18-month accelerated MBA program that Harvard launched back in the early 2000s. They heard from students that two years was too long and that being able to accelerate the MBA program and get a degree in 18 months versus 24 months would be terrific. The 18-month MBA met the needs of the students and failed miserably for two major reasons; the accelerated groups didn't form the social relationships and friendships that the longer format MBA students did. And also, they didn't get a summer internship to try a new industry. As Peter will discuss in a moment, the U.S. economy is a service economy. And service businesses from the way products are developed, sold, and used are based on social interaction. We will get back to the office this fall once kids are back in school and commute patterns are reestablished.
So Peter, this is the sixth time we've gotten together, and you've been amazingly insightful throughout. You underscored the trade-offs between shutting down the economy to save a relatively few number of lives. And while we'll never know what would have happened had the government not shut down the economy, your numbers on total infections and deaths so far, we're amazingly prescient. You warned about social unrest, which we got. You outlined a butterfly recovery which since last summer has essentially been just that. Then you instructed us to watch the attendance numbers at sports stadiums as an indicator of when we’d get back to normal and sure enough even at Wimbledon this week the stands are packed with no masks. But we've gone from the flight of the butterfly to comparing every data point in the recent Linneman Letter to pre-Covid at best. So how do we go from watching the flight of a butterfly kind of moving up and moving back to all of a sudden, going back to comparing the numbers right now to the very best numbers, we saw before the pandemic recession/depression.
Peter Linneman: Great great. Well it's great pleasure to be here and always have fun with you and the only thing I’d add before I answer, that is, those of us at Wharton knew the Harvard experiment was doomed. You know it's pretty obvious.
There still is a wild card, they're actually two wild cards and then we'll go to the more substantive, which is one wild card is variance. And where every new variant, the question is how effective is Pfizer, Moderna, J&J and so forth. So far, the answer has been not bad, and in general the answer has been quite good. But that's going to continue because the other big wild card is it's going to take a long time for the “rest of the world” to get to a place where a lot of people are vaccinated and the odds of variants developing go down, don't go away, but go down. And I say to people that's why with polio, for example, and smallpox we went to the most remote villages of Pakistan. Because you wanted, not only from a humanitarian point of view, but from a get rid of the variant possibility that could override the vaccines. So, with those wild cards in mind stadiums are back. And at least in our country, and they're coming back in Europe and other places. I think we now stumble around the next two months, largely because of shortages in labor in some key areas that have been brought about in the U.S. by the top up of the federal unemployment insurance. We can come back to that. But that's going to keep the labor market choppy until September 6th when that burns off. Since the labor market will be choppy it means I can't fully get my restaurant back even though I want to, even though I’ve got the demand. And so, I flew the other day to Europe, I was telling you, they have no staff and they just have no staff. You go to a restaurant; they have no staff. So right now, that policy, which was well intended, is holding back probably a three to four million job growth spurt. And when we get on the other side of September 6th that's going to come.
So, we butterfly around with a little better speed in July and August and then I look for tremendous speed September, October, November. And I pick up what your opening comments were Willy, people are going to go back to the office because it's more productive and it's even more productive now that there are more distractions. And I love these surveys that say, do you want to work from home or work from the office? And, most people are going to answer, whatever is easiest for me, right. By the way, why don't we also asked would you like to be paid three times as much? Why don't we all ask a question, would you like to be paid and do nothing? I mean if you ask stupid questions, you're going to get stupid answers. All the analysis that I’ve seen, including I’m asked, I’m on audit committees, and I ask people, we’re getting the work done, how much more time is it taking. The answer is 20 25% more. I’m sure if you ask your people and your auditors that's the answer. They're getting the work done 20-25% more time is required. Well in the short term, you could absorb that you can’t absorb that forever.
So why are people going to come back the office? It's real simple they want that 20 to 25% compensation. And if productivity falls their compensation is going to fall 20 to 25% that sends us back 30 years in terms of living standards. There goes the vacation. There goes that's third car. So, people are working, they're going to back the office, because they want those things. In spite of the hassles, and so I think you ask dumb question, not you, but when you ask someone a dumb question, you're going to get an even dumber answer.
Willy Walker: Let me take us from that then to the employment numbers. You and I before this got a lot of questions from people of sort of saying sort through fact in fiction as it relates to the Bureau of Labor statistics numbers on employment and then inflation and I really want to dive into these two because your insight into both of these is fantastic. Not only from the perspective you provide but also because of the data you have.
So, let's go to employment for a second. Your numbers have us that there are 7 million people in the United States who were employed a year ago who are not employed today. And then you add to that another 2 million people who should have come into the labor force over the last 14 to 15 months so you've got 9 million is basically your delta of employment, where it should be, and where it is today. And that then rolls into where the Bureau of Labor of Statistics number right now is it a 5.8% unemployment rate. And you think they're low by about 370 basis points or the actual number being up closer to 10%. Talk through those numbers for a minute Peter.
Peter Linneman: Okay, and by the way the only correction Willy, is versus February 2020 not a year ago right because it just as everybody's got it in mind verses 2020. Look, we had 5 million and change unemployed in February 2020, collecting unemployment insurance and being unemployed. We've got 16 million people collecting unemployment insurance, that is to say they're saying they're unemployed. If you take 16 million, and you divide it by roughly 160 million labor force, I mean that's not hard math, that's 10% unemployment, right. And that doesn't count around the edges. So that's one way. The other way is to do what you were just doing, which is we have 7 million fewer working on 160 million labor force that's three or four percentage points that gets you from 5.8 up to nine something, and there are several other ways. I do think the BLS did the right thing, which is they're not unaware of these issues, the media is. But they're not unaware, and they decided their job was to be consistent, and I think they were right, because as a as a record keeper they were right to keep it in a consistent way and footnote the flaws. It's like when Barry Bonds, hit whatever it was 73 homers, it was still a home run. But you might put an asterisk that he was juiced, right. And that's what they've done and I don't know what else they would have done and, by the way, Willy imagine if the BLS during the political, a highly political 2020, has said no, no we're going to do everything very different nobody would’ve believed anything. And so, but we're easily up around a 10, 9.5, 10% unemployment rate versus the three and a half percent apples to apples in February 2020. I view that as good news because I think three or 4 million of that Willy disappears as soon as the $300 a week goes away.
Willy Walker: So, on that so you're going to me right now is without that $300 top up we'd have three million more Americans employed today than are employed. September 6th is the magic day when that comes off. Talk for a moment, then, about are we right now there's not a person trying to hire someone right now that isn't frustrated about you put a help wanted sign out there and people don't even show up for the interviews, right. I’ve talked about the cafe in our basement of our building here and Heidi can't get laborers, they don't even show up for the interviews. Is this what Jerome Powell talks about this transient effect of inflation in the sense that once you get to September six all those benefits go away, huge numbers of people come looking for jobs, and wages come down or are we stuck that if someone is out there, offering 15 bucks an hour to make a sandwich downstairs in this building, you're not backing up to $13 an hour you're sticking it 15?
Peter Linneman: Right. So, let's take it in two parts Willy. Roughly it depends what state you live in and assuming you're unemployed. But remember something like 75 million people have lost their jobs since the pandemic began out of roughly 154 million that had jobs when it started. So roughly half the people have lost jobs at one time or another that's why that 300 is important. Having said that, look if I told everybody in America, you could make 130% of what you make working by not working, including you, if I told you Willy if you'd stop showing up for work, I’ll pay you 130% of what you're making, right down to your lowest paid, how many you're going to keep working? I mean incentives work, I learned that in economics. It may not be perfect. When that's gone people, who are unemployed are going to go back to picking up like 50%. And that's a huge difference 130% versus 50%. They're going to come back to work and, as you say, there are jobs. So that's one and you're right, you're going to see some of these wage pressures normalize etc., until then it's choppy. But Powell picked on, I had said it a couple of months before Powell, not that others hadn’t also said it, which was come on April last year, the price of oil was negative.
Willy Walker: Zero.
Peter Linneman: It was not zero, it was negative, right. That's how screwed up, it was in April, May, June, July, August last year. So, if you take a year where oil is negative, a month or two months or three months, where oil was negative and a whole bunch of other things think hotel rates, etc. Year over year, what do you think inflation is going to look like, if you get anything like normal? And we're back to GDP in real terms being around 2019. So, we're back to kind of normal and all those measurements are transitory, they're going to go away when you stop comparing it to April, May, June, July, August last year. And the other thing is, you say the transitory in the way. There's a third transitory which is capacity got greatly reduced in lots of sectors anywhere from 3% to 30- 40% in March last year April, May. We're back to the same GDP. So, demand is crudely the same and supply is three to 30% less. Again, economics isn't perfect, but what do you think happens to prices they skyrocket. How long? Until people realize they're making a fortune and they can make even more if they expand capacity and nobody else does. So lumber, remember last time we talked, lumber was I think what 38% or 40% above where it's at today now; it's still high, why? Capacity, not demand going down, its capacity and that's going to happen across the economy over the next three to 24 months, depending on the sector. That's transit that's not a monetary phenomenon.
Willy Walker: So, do you see anything Peter that is going to change the dynamics of labor on two fronts. One would be companies have learned how to make do with less. I used an example, a couple weeks ago on the webcast of a McDonald’s across from Anschutz Medical Center here in Denver. The actual restaurant still closed, but the drive thru window is open and I don't know what they're aggregates sales are at the McDonalds, but they got three people in there, they don't have to clean tables, they have don’t have to clean toilets, their cost of labor is significantly reduced, and if they've got anything close to what their normal output is as far as selling Big Macs my assumption would be they just keep with that new business model. So, have you seen anything that says that we're going to come back where that incremental unit of labor isn't needed? And then the second part to it after you've gone to that is just as the numbers reflate and as people are going back to work, are you seeing anything from an employment standpoint that says that those people who moved from New York to Columbus can now stay in Columbus versus going back to New York?
Peter Linneman: We can take it in two parts. So, a changed business model, short term, yes, particularly because of this labor shortage created by the $300 phenomena. Which is if I got to pay $25 an hour just keep the three employees in a drive-in window. If I can go back to 10 bucks an hour and get employees, I’ll open up because there's incremental profit and there's a fixed cost nut that I go to cover. So, will there be a few business models, yeah people learn. Every downturn, I’m 70 now, and every downturn people say this time labor will never recover and then you've seen the employment chart historically. What does it do, it just picks right back up and goes? This will be the same. Because incrementally its profitable and not everything. So, people will ramp back into it and they're going to do that. I’m 70 so I forgot the second part.
Willy Walker: The second part is those people who moved from New York to Columbus as you're looking at the reflation and the employment numbers do you think that person is going to be able to stay in Columbus and keep doing what they're doing, or are they going to have to go back to New York?
Peter Linneman: They're going to go back to New York, and I thought Gorman at Morgan Stanley was incredibly eloquent on this, which was I’m not trying to quote him but I’m not going to pay your New York salaries to live in Boise. Or you know, I want you here, you're more productive here, and the other part, that I thought he said I wish I’d have thought of it, because it was if you feel safe in restaurants, and you feel safe at the ballgame, and you feel safe you know meeting with all these people and having a party. Come to work we're safer, we got better filters, we've got better spacing and so forth, and I think he called him out. When I say them, he called us out and once… you and I talked about this, I think, six months ago, when everybody is remote there's no competitive disadvantage to being remote. But as some people come back and others stay remote there's a huge competitive disadvantage and people say what do you mean by that and I give the example imagine I’m going to do a big merger and I call Fried Frank, I’m just picking a firm, I call Fried Frank and they say, yep we're happy to set up a zoom and we do it all virtual. And I call I don't know Skadden Arps and they say come on over or we'll come over with the whole team and we're going to roll up our sleeves, which am I going to hire. They're both very talented and I know one's going to be 20% more productive than the other and they're billable hours, so I don't want 20% more billable hours because of the unproductiveness. Once people start coming back that will pick up steam of the competitiveness of it.
Willy Walker: So, I want to go to some of the macro numbers that you have inside of the Linneman report, which are so fantastic and I’m going to share my screen here so that our watchers can see some of this as you talk through it. But you basically say this quarter Peter, you know you can't really look at numbers on a year-on-year basis because we're looking at such a distorted Q2 2020 versus a Q2 2021. But if you would talk through a couple of the numbers here as it relates to what in these numbers say to you, we’re still digging out versus you’re well above projection.
Peter Linneman: Well, in general, this is a summary page that we do, we've done it, we really started it during the great financial and as it just a kind of what summary sheet, a scorecard of where we're at. By and large, everything on this page is below trend and is below pre-COVID or if it's back to pre-COVID you have still below trend. So, to your point, yes, GDP is back to about where it was in 2019 but, by the way, it should be about 4% higher, right, and so that type of phenomena going on. And, in general, this chart is a good scorecard to have, it says make big progress, but still have a good distance to go to get back to fully, fully healthy.
Willy Walker: And one of the things that you point out Peter is on the GDP number you talk about single family housing and autos being well below demand and well below historic deliveries. And you put a number out there saying that if you could just get the two of them backup, single family housing and autos, you'd add something like 60% of the delta in GDP. That surprises me that in those two industries alone, you could close that GDP gap with just getting back to, if you will, the normal run rate.
Peter Linneman: So I am you know, Ken Rosen has had this comment, I had this comment, I know Ivy Zelman has had this comment that if you look at anything in the last 20 years in housing, and to a lesser degree in auto, it's really 12 years in auto and 20 years in single family, we just way under produce versus any benchmark. And you could argue about which benchmark, but no matter which benchmark we've under produced. Why have single family home prices skyrocketed over the last decade? It's not low interest rates it's, by the way we have low interest rates in 2009 they didn't skyrocket, we under produced. And if you under produce you're going to get skyrocketing and we've systemically under produced, and I would guess if you went to, at least the people I think well love, we all agree it's somewhere between 3 and 4 million single family homes; that's like 3% of the stock. If you have capacity reduced by 3% and people can afford stuff, you're going to get home prices going up.
Multifamily, to a lesser degree, probably 700,000; that's why rents are holding up. Auto to the same phenomena, but not as extreme. So during the financial, remember after the financial crisis Willy, where people were saying nobody's ever going to buy a car again everybody's going to, you know, cars and everyone is going to ride buses well that was bullshit and now nobody will ride a bus. And now they'll say people will never ride a bus again, and when we meet again 10 years from now, they're going to be on buses or something equivalent. People use the word never too much right or always. So, these sectors for each for their own unique reasons have been shorted and single family had two really brilliant periods, brilliant in the sense of booming on the production side. One was during the housing bubble when down payments went from 10 to 20% down to 1 to 3% and the other was in the past year, when people suddenly had money for down payment. And where did they get money for down payment there was nothing to buy their vacations were canceled their concerts were canceled. They weren't buying clothes, etc., and they looked around and they suddenly said oh my God, I have enough for a down payment. And they bought a home and the down payment is a key and the other one on the down payment. Do you ever think Willy, I did back of the envelope, about 300,000 Americans over the age of, assuming about 300,000 Americans inherit $50,000 or more, 3 to 10 years sooner than they otherwise would have because of grandparents or parents dying of COVID. And you think of 300,000 Americans that got checks of $50,000 or more, much earlier than they ever anticipated, there's their down payment. Well, that's going to go away now that everybody's not dying, those unexpected inheritances are going to go away. So, it's about down payment for the homes, it's really about down payments. So, I see single family normalizing but that's why they've been under produced in a funny way Willy it's been under producing single family historically because we'd rather go on a vacation to Europe then save for a down payment in this generation. In my generation, we would rather have bought a home than go on a vacation to Europe. When we were 27 to 35. I’m not saying one is right or wrong, but that's a big, big inhibition.
Willy Walker: So, as we look at that sort of scorecard that you had where the majority of the categories are outperforming, some are still lagging. You also have in the Linneman report this wonderful canaries check and I’m going to, I’m going to put it up on the screen here for a second to show people what this is. But it, basically looks across the economy and tries to identify areas where there is a canary in the coal mine that might die on us. And you monitor this and what's interesting about this slide Peter is a year ago, this had a lot of dead canaries on it. And there are a lot of concerns in the Linneman report, a year ago versus where it is today, and the only one out there, of all these are all five birds are living and living, I think, from your picture pretty healthily. Other than the chance that to your top point at the at the top of the webcast, which was if this delta variant moves out, we might have another risk. And so, you've got one dead canary on this chart. But I look at that and I say wow it is unbelievable that your analysis from a risk standpoint right now is that there really is nothing on the landscape, other than mutations of the virus, that could slow this train down.
Peter Linneman: Yeah, other than something that could wipe out the entire human species, but don't get worried about that Willy that's…
Willy Walker: Because you only got it is one canary, I’m not the one who did this slide. You’re the one who put one canary.
Peter Linneman: Although it's funny, somebody asked me aren't you worried, in terms of your investments that you're investing and then we all die, and I say no, I don't worry about it at all if we all die, what I worry about is like half of them die because that will really undercut my investment. No, what I think that canary picks up is, if you go back to fourth quarter ‘19 early ’20, before the pandemic, there were excesses they weren't crazy excesses, but they were excesses, right and you could identify them. You could identify little excesses this year bigger excesses there. What COVID, the pandemic, the shutdown did was essentially eliminate most all excesses and we hit a reset button. Now in the economy, we hit a reset button and that's why we have this kind of clear runway because where we had questionable runway as we ended ‘19 everything's been reset. You don't have to worry about these excesses catching us, and when you look at fundamentals you end up more with pen up than you do excesses and that's why that chart is what it is. The canaries are basically like, can you find an excess? Of course, you can always find an excess, but not just everywhere.
Willy Walker: So, you have a chart that surprised me, which is, it's on satisfaction with America, and it basically is showing that from having plummeted down to almost where we were right in the depths of the great financial crisis, back in 2008 and 2009, we got down to similar levels in 2020 as it relates to satisfaction with America. And now all of a sudden that number has come back up to basically at baseline or a little bit above of where we've been over the last decade. And so, we've had a quick turnaround even though to the numbers you just use previously, we still have 13 or 16 million Americans who are unemployed, how can that be?
Peter Linneman: So, first of all it's not my, just for clarity for the listeners it's not mine…
Willy Walker: It's Gallops, it's Gallops’ numbers, I got it you're reporting the Gallops numbers.
Peter Linneman: That's just so people know. Look, my guess is some combination of political dissatisfaction, some combination of fears that were high among all of us, a year ago and frustrations that were high among us all economically and otherwise a year or so ago, have receded. My gut, and it's only a gut, is we're going to hit a peak probably October, November and then we're going to go back to what are you done for me lately, you know, we're going to look more at what we don't have than what we do have. And I think part of the satisfaction is yes, somebody's grandmother died, but mine didn't right, and I thank God my grandmother is still alive, that sort of feeling, emotional, if you will. But as people go back to stadiums, as they go back to shopping as they go back to, so I think that's what it's really picking up. And once we're back to normal we'll go back to saying well, they still don't have my size, when I go to the store. My team still loses when I go to the stadium half the time, and my boss and my coworkers aren't nearly as perfect as me and you'll see that dissatisfaction kind of go back, maybe not as low as it was right, but kind of drift back a little bit.
Willy Walker: I want to throw this slide up for a second, because I think one of the interesting things here, I was looking at this slide Peter and, as you can see. The satisfaction with America has you know, is really high at the beginning of the 2000s and then came down and since 2010 it's been in this kind of zone, and you can see a dip down and come back up as we just talked about. But I was wondering about charting against that, U.S. cable television viewership and whether there's a there's a direct line from the bottom half to the upper right as it relates to people watching the extremes, from a political standpoint, bringing down general satisfaction in America.
Peter Linneman: You're showing your age Willy and social media right, and social media. Jonathan Haidt at NYU has written a fair amount about mental health issues and so forth, as it relates to the rise of social media, I think you're probably right though. My comment to a lot of good friends when they whine and complain and they say they aren't happy today is, and I seriously say this to friends, is stop watching what they call news because it's not news, it's entertainment for people who are masochistic, stop doing social media, it's not making you a better person is making you a worse person, and live and interact and work and be productive and I’ve had several who have stopped. I stopped about six years ago on, on the cables and such because I realized they're just manipulating me, and I was getting unhappy and I’m not an unhappy guy and I don't watch it. And people say, do you miss it and I go no, I have other forms to deal with my masochism.
Willy Walker: So, you touch in the Linneman report a lot on the health of the U.S. household and the health of the U.S. banking system, and I want to dive in on those two things. The first piece to it, though, is the health of the household is unbelievable. We've got more money in the bank than we've ever had historically. You've got, per year numbers, something around $6.2 trillion of excess deposits sitting in banks, and that's both people taking their savings and putting it in there, and then also the banks just overflowing with liquidity, but you go through this Peter and you say that we're setting ourselves up for a redo of the roaring ‘20s. I hear that and I get a little nervous immediately thinking about what happened on the other side of it, but I think everyone's sitting there right now saying, “Okay well if it's coming, how do I take advantage of it?”
Peter Linneman: So, let's take it in two parts. One, if I told you you're going to be dead in two years, you'd say bring it on, right? Bring it on and I’ll leave a ton to my heirs on those two years. No, I think we are set up for roaring 20s. We have huge amounts of cash. We have debt service for businesses and for households, very low by any kind of historic standard. We have most accesses have been eliminated. We're going to have quite high employment within a year as we've talked about when those people come back to work. We're going to have a desire to release this pent-up, and a lot of good things are going to happen. There's been tremendous amounts of money put in the system that have not come out, and when it comes out, it's going to chase assets, and is going to bid up the value of our assets, if you own assets. And so, I just think there's a tremendous amount there.
Now you raise the negative of it, which is, can it be overdone? And the answer is, of course, and that's why it will end. When excesses create their own death, right? They create their own death, but until that excess comes, it will be a really good time. How do you take advantage of it? Don't fight the Fed. If the Fed is giving the world staggering amounts of money, think about what that means for asset values. They're going to go up. Not every day, but they're going to go up because you got a lot of money chasing a lot of assets and understand that owning assets will become even more valuable. There'll be periods where greed turns to fear temporarily, but then it'll come back in greed. So, take advantage of it that way. How else? Expand capacity. Expand capacity because you're going to want it. Yes, in the short term, you can make more with low capacity charging exorbitant prices, but if you don't expand your capacity, your competitors will. They're going to steal your customers, and it’s going to be very difficult to get them back. Expand capacity. Borrow and understand that the Fed is going to keep rates low. I think the person who commented that they were more likely to be 1% on the long is right. Why? Because the Fed is going to do everything they can to help the federal government afford its debt, and you can say that's not part of their mission, and they can say that's not what they're doing, but come on, they’re human, right? They're human, and they're going to do everything they can. Does it go to one? I don't know, but it stays low, and the short rate stays low a long time, because they believe, (they being the Fed), they believe that low-interest rates, stimulate the economy. I don't believe that interestingly, and I don't think there's any evidence of it, but that's not what's important. They believe it. And therefore, they're going to keep it there. By the way for those that don't know, and you haven't read Linneman Letter for the last 10 years, the reason low rates don't stimulate the economy, and there's no empirical evidence that they do, is yes, it helps borrowers, but it hurts lenders. And, to the extent, it is just a transfer right from lenders to borrowers. Doesn't net stimulate anything, and in fact, it gives a lot of money free to the biggest borrower in the world, which is the U.S. Government and other federal governments, and they're not terribly productive borrowers, you know? So, it's a net negative arbitrage. But yes, I think, rates stay down and you're in for a roaring asset market that will have periods of little up and down, but you're in for a roaring asset market trend, for a roaring employment market, you're in for a roaring travel market, I mean, just name it. There will be bumps though.
Willy Walker: I want to put up a slide from the Linneman Letter that I think just puts it so clearly, what you're talking about, about asset prices rising, and rates staying low, and this spread between the 10-year Treasury and the transaction CAP rates on the REIT index. As you can see here, since 2000 and the great financial crisis, all we've seen is rates stay low, and asset values continue to go up and that spread, particularly in the real estate world of asset values appreciating and debt cost staying down, is the opportunity for everyone listening.
Peter Linneman: Huge! Huge! And you know Willy, everybody who does business with you, including me, has a model that says CAP rates are going to be 50 basis points on exit then when I buy it. I’m talking about a stabilized or semi-stabilized, right? And for the last 10 years, we've all been wrong. And we were wrong because so much money went in the system with QE1, QE2, QE3, it was a complete reset. And by the way, QE Infinity has even put more money in the system, and when it comes out it's going to be even a further reset, and my anticipation is CAP rates are going to be 10 to 15% lower seven years from now than they are today. So, when people say the asset is priced to perfection? No! Not priced to perfection. You've missed analyzed it in a way versus reality because there'll be so much money chasing assets that CAP rates will come down not go up. So, I just think it's, you know, I wrote and we talked about, I think, was it two times ago, Willy, that the golden age for multifamily and it's that chart, right? It's the spread. And the thing that makes multifamily different than say office or retail is I can really borrow and take advantage of that spread, right? Whereas I can come to you and you'll arrange a terrific loan for me for multifamily. If I came to somebody and said arrange the similar loan for office, it’s not there right, so you can't take advantage of that spread nearly as much. And that spread is still pretty handsome. Is that spread as good as it was in January? No. It's probably 70 basis points thinner between the borrowing rate and the CAP rate than it was in January?
Willy Walker: Until this week. Until we got to 131.
Peter Linneman: No, you're right. You're right. Now it's like yeah, 40. It's still like any historic standard a huge, huge spread. So, I just liked that as a situation. Now if I’m a flipper, it's always difficult, that's a whole different thing, right?
Willy Walker: Yeah, yeah. You mentioned money supply, I want to throw up a graph here because I want you to just, the money supply and what's happened to M1 is well, not only is it historically, you know, we'd never seen something like this before. So, I think people see charts like this... I understand what that chart is telling me, but then in your comments, Peter, you said there's so much money in the system, but what happens when it goes away? What happens when they pull the punchbowl away from the party? What happens when the Fed starts to tighten with this much excess liquidity in the markets?
Peter Linneman: They won’t. They won’t, right? They may slow the rate of increase but they're not going to decrease the amount of money. It's, you know, they can go from expanding it, I’m just making up a number of 10% a year, to only expanding it by 2% a year. That is not shrinking the money supply though, right? So, I tell this little anecdote in the current Linneman Letter about my grandmother Linneman who was an immigrant and so forth, and I was a highfalutin University of Chicago Milton Friedman student, you know, in the ‘70s and the price of bread is going up, and my wonderful grandmother said, “Well surely bread prices are going to go back down,” and I would explain, “No, no. There’s so much money chasing bread,” and she says, “But surely they'll go back down!” Well, bread prices just never came back down. They stopped going up as fast, right? They stopped going up 12% a year, but they still went up 1-2% a year. They didn't drop by 10%, 20%, and reset, and that's because there was permanently more money in the system, and I think the same thing is true now except it's more asset focused than goods and service focus, and that's because of the nature of the banking system in the last 10 years which was highly concentrated versus 40 years ago. What was it, 50 years ago, 52 years ago, I go to college and the State of Ohio only allowed banks to have one location and one branch. Ok? Gives you an idea of how fragmented the banking system had to be. Today, I mean baking is online, it's everywhere, it's everywhere. Very concentrated system and they give money to asset buyers and therefore, people say we got no inflation in the 2010s. We didn't get much goods and services in place, but we had enormous asset price inflation. That's inflation, too, and it just isn't included in CPI. So, I just think it's a great period ahead, but could the market correct as greed turns the fear? Of course! But what have we seen, Willy, in your lifetime and certainly mine? Every time greed is turned to fear come back a year later and greed has returned.
Willy Walker: Yeah and have some cash ready during that period of time.
Peter Linneman: And have some cash ready, absolutely.
Willy Walker: On that, you said they won't do it as it relates to tightening. But you talk extensively about the Fed buying treasuries, and the Feds holding of treasury notes has gone from about a trillion in 2010 to over $5 trillion today, and U.S. bank holdings of treasuries has gone from $250 billion to $1.5 trillion. What happens when that buying dries up?
Peter Linneman: You will, and that is why I think they're going to keep buying, they being the Fed, and that's why they're going to keep leaning on the banks to shore up their balance sheet by owning treasuries because they want to keep the price of federal debt cheap. This happened after World War II when we had the high debt, it will happen again here. You can again, it's not part of their official mandate, but come on. They're going to work hard to avoid what you're implying, or what you’re inferring could happen. By the way, we saw it. We saw it, Willy, after the financial crisis, right? You get to 2016, the economy is going quite well, and the short-term rate is still zero, and they haven't narrowed their balance sheet. They had stopped buying and expanding their balance sheet, but they hadn't really sold much, net net. So, I think you're going to get a replay of that.
Willy Walker: So, the Euro at one point was viewed as a potential competitor to the U.S. dollar, and we all know where that has gone. And the U.S. dollar is still the global currency, but we've got crypto, we've got an emerging China. Any chance that the U.S. dollar stops being the Fiat currency?
Peter Linneman: You got to have an alternative. The U.S. economy, hence, the U.S. dollar has a lot going against it. The problem is every place else has got even more going against it. And in an odd way the dollar is, what you going to take on the Saudi currency, you're going to take on the Polish loti, you're going to take on the pound, it's not a big enough economy. You're going to take on the yen where they still quote it by the penny, if you think about it. You're going to take on the peso. How about Argentina? And then you say the euro, and then the problem in the euro is when push comes to shove exactly who backs the euro? Who backs the euro? And you say well the Central Bank of Europe. And if you follow it on any given day Germany wants out and if it got really out of control, that is a real raid, I don't know if they would stay in or stay out. And they say well they've got a treaty. I don't know if anybody's noticed, but the history of wars is a lot of broken treaties, right. It's not like the world has not seen broken treaties. So, you're going to get broken treaties if it ever gets down to that.
So, Willy here's what the U.S. dollar its attractiveness reminds me of. I am a shadow of myself physically versus when I was 20. But, compared to other 70-year old’s, I’m looking better than I did when I was 20 comparatively. And it's all about the relative; it's all about the relative notion. Some of those guys who were great professional athletes when I was 20, you know, Charles Barkley, give me a break right, he's not 70 but you get the point. That's the U.S., that's the U.S. situation. And until you can answer who, crypto, you're going to hold something that in what a month and a half fell by 50% in value and another month and a half went up by 50% of value. As the storer of value, right. That's what a reserve currency does as a storer of value. I mean, if I’m a drug lord and I just view that as part of the cost of laundering, yeah maybe, or if I’m a ransomware kind of guy, it was stolen money, who cares, right. But not as a storer of real value.
Willy Walker: So, in the Linneman Letter you dive in by asset classes and we've only got 10 minutes left and I got to dive in here because I think everyone wants to hear where you're placing your bets right now. Back in January when we when we spoke, you said it's a golden age for multifamily, you continue to like multifamily even though deliveries are actually still pretty significant in multi versus all other commercial asset classes. You seem to… retail sales, you're very big on pointing out that as much as everyone thinks that Amazon and UPS are dominating the world, and that's the only way we buy goods and services, actually online sales dropped down below 16%, below 16% of total retail sales in Q2, you point out. So, as a result of that online is growing much faster than bricks and mortar but you still like bricks and mortar, you still like industrial because of all the flow of goods and services. You seem to be sideways on office, is that a fair take still? Do we get back to the Office, do we need more space deliveries coming back in? And then the final one that I’d love you to run through is hospitality, your numbers on hospitality and on per square foot basis Peter, surprised the heck out of me. That on a year on year basis, on a per square foot basis, hotels are way up even though CAP rates are also up, and so that data point confused me a little bit.
Peter Linneman: So, let's work backwards, RCA data (Real Capital X data) and I think that is largely reflective of the only hotels that are selling are skewed. It'd be like if the only thing that sold was Warren Buffett and Bill Gates homes, right and you'd see home prices go up, even though they might have quote “really gone down.” So, I think the hotel, it's a real number but it's not an apples to apples number, in any meaningful way. And I now face the same issue, I mentioned about the BLS which is consistency. So, I’m doing it consistent, but be mindful of. So, I think the hotel is not a real phenomenon, okay fair enough. But I’m bullish on the hotel because of the pent up, roaring 20s phenomena. If you then say retail, I always want to own great retail and I never, have ever, wanted own bad retail. And I still remember Al Taubman, rest his soul, who was one of my great teachers of real estate, saying, you can't buy retail cheap enough by the pound, because you can't lower rents enough to change the price of a box of cheerios and if you don't change the price of a box of cheerios, you don't change shopping patterns. Whereas I can buy an apartment cheaply enough that I can lower the rent enough to attract somebody, so bad retail never makes sense. But good retail will do great, you're going to have to work, constantly figure out how to take advantage and maximize and so forth, so I like that, and especially with a roaring 20s come back. I like industrial for a different reason which you've alluded to, but it's the three X factor and without going into it, if you buy something online it takes about three times the amount of square footage of warehouse space as if you bought it in a store and there was a shadow warehouse for it okay. 3-to-1 factor is something we don't run into a lot; we normally think a one to one or close to one to one and what's been happening is online sales unrelated to COVID were trending up. And as they trend up 3-to-1, 3-to-1, 3-to-1 so we would produce 2% of the stock and the 3-to-1 factor said demand grew by 4%. Big excess demand, rents go up, demand. So, then we did two and a half percent new stock but because of the 3-to-1 factor, 4% increase in demand. Then we did 2.75 and four point. So, on its fundamentals, industrials got a good runway because most people haven't figured out the 3-to-1 phenomena. So, it's got good runway there, fundamentals. Apartments I like because we already talked about, the capital markets allow you to take advantage of that spread. And you have good growth fundamentals, they’re not spectacular growth fundamentals, but they're good over the next decade so you'll do okay and we've under produced.
The problem in office is, I believe people come back to the office and you clearly do as well, Gorman thinks they will, but we could be wrong. My wife occasionally, my wife of 48 years, some of you know, occasionally reminds me that I’m wrong a lot. And so, yes, I believe, people are going to come back, but what if I’m wrong Willy, what if you're wrong? And I don't think it's a terrific bet right now, because why don't I wait another three months, six months, eight months, I don't need that kind of risk. So yes, I believe it comes back, but there is a chance I’m wrong, there's a bigger chance I’m wrong there, I think then in the other categories. And I don't want to look like an idiot any more than I normally do, right. So, that's why the office is come back in six months and you'll have a much better answer on that, and I don't need to invest in six months that badly.
Willy Walker: There's a stat that you put in the Linneman Letter that talks about the vibrancy of the commercial real estate markets, which I thought was noteworthy to point out, which was that in 2019 were about 10,000 commercial real estate transactions globally for $444 billion dollars of actual value across all asset classes, and that number basically dropped in half in 2020. So, we went to about 6,000 transactions and $222 billion dollars of transaction volume. For all of the service providers, you know Walker & Dunlop’s direct competitors and lots of others. From a transaction volume standpoint, giving your backdrop of a really strong macro backdrop, with rates low and with transaction volumes coming back, your view of that sector is got to be positive?
Peter Linneman: Very positive but remember transaction velocity is largely about bid ask spread. I mean you know that better than anybody. If I got people like you and Roy March and so forth in the room, you'd say bid ask spreads are the enemy, right that's the enemy. You can deal with low values, you can deal with medium values, you can deal with high. But if there's a big disagreement. And so, what we had was if I believe, think office pick up where we were, if I believe it comes back why would I sell on today's value on office building? And you say, well, the market is, no I don't have to sell in any market, I become the buyer right. In the old, you buy every day what you don't sell. And so, bid ask spreads in office are out of sight. Multifamily and industrial have smaller bid ask spreads and they've come back. Because in multi-family there's ongoing cash flow that's easier to underwrite, not easy, but easier and Freddie and Fannie sit there and so you have a deeper capital. And industrial because rents are a bit easier to underwrite, they’re shorter leases and the demand is so strong right now and we'll stay so for a while. So, the bid ask spreads are narrow. But you get to retail. I’m just going to take a Center, I’m not using this specific, look at Short Hills Mall and somebody comes to me and says I’m going to buy it as if it's a distressed situation, I’d say, I’m not going to sell it at that price. And so, as things come back, I think bid ask spreads normalize and they're going to particularly normalize in office. By the way, even if I’m wrong, if you and I are wrong about the office and office doesn't come back, transaction volume will pick up. Because there'll be less disagreement right, and so same on retail. I could be wrong, maybe people don't go back and shop, we've already proven they do. But that would normalize values, so the gap between bid and ask would become more normal and velocity would pick up. So, when I look at velocity, I always think bid ask, what's driving bid ask? And I think your right, transaction volumes pick up enormously over the next three years.
Willy Walker: So final question to you. You've been so good throughout the pandemic, where there were so many moving parts that it was very difficult for anyone to sort of think three weeks ahead, much less three months ahead. Things seem to have normalized a lot, the data in the Linneman Letter sets a really positive backdrop for continued growth. The opportunity for asset appreciation low borrowing costs, it's a great setup. What's the one thing beyond the virus, which is you've said, look nobody knows that but you know we can all die any day and there are other threats that might come around to impact us from a health standpoint. But other than that, what's the one thing in the back of your mind Peter, that you sit there and if you had to add a new line of canaries what's the one that's right in back of your mind saying let's watch that?
Peter Linneman: Okay so, this is not a democrat, republican kind of comment. It’s that if tax policy went crazy, went crazy, that doesn't mean changes, went crazy. It would hurt the economy a lot and I’ll give you, I’ll take capital gains, there’s been a lot of research by a lot of economists of all colors and shapes and sizes and political beliefs on what's the capital gains tax that raises the most revenue for the government. And the answer, these are not my studies, are somewhere between 22 and 28. That's not to say the tax should be 22 to 28% but it says, if you want to maximize revenue for the government. And you then get the supply side people, like me saying, therefore, make it a bit lower and don't give the government maximum revenue and get a little more economy. But as you go beyond 28 you're collecting less revenue and you're hurting the economy, at least as you go from 18 to 19 to 20 to 22 to 26 you're maybe hurting the economy, a little bit, but you are raising more revenue and that has some benefits. What would be crazy, setting capital gains tax at 40% because the economy loses and we don't collect more revenue, we collect less. That's what I mean by crazy and if we just burn resources, you know we decided we were going to spend $6 trillion dollars building a bridge from New York to London, that would just burn money, that wouldn't help the economy. But I focus on the tax stuff and the spending stuff, they're never going to spend perfectly they're never going to tax perfectly and people have a disagreement about what perfectly is. But crazy is, you're achieving nothing to help the economy and you're achieving nothing in terms of a governmental societal goal. I don't think that will happen Willy, but if that did that's a real wild card.
Willy Walker: It's a great note to end on and let's hope that things continue down the path that they appear to be going down where that crazy tax policy hasn't shown its ugly head. But I think that's a very eloquent way of summarizing what could be a risk out there based off of what we've seen the Biden Administration put out there as proposals. Fortunately, the reality of the situation is, other than reconciliation which it appears they've sort of done what they can do in reconciliation. They may have one more bite at the apple, but right now, if there is this bipartisan view that President Biden is putting forth, we could end up with something that isn't crazy and that would be very positive.
Peter, thank you. As always, great to see you and I greatly appreciate you joining me from across the pond, enjoy your vacation.
To everyone who took the time to listen in today, I hope you enjoyed it as much as I did. We will be back next week with another Walker Webcast and I hope everyone has a great Wednesday, take care.
Peter Linneman: Thanks, Willy. Take care, bye.
