Webcast transcript
Willy Walker: Good afternoon, everybody. Welcome, Peter. Great to see you again. I am in New York today for a number of different things, but I did CNBC this morning and I was sitting on the set of Squawk Alley and David Faber said, “Willy has got this amazing webcast he does every week.” And Carl Quintanilla turns to me and he's like, “Really?” And we start talking about it. And I said, ``Yeah, we've got 7,000 people registered to listen to Dr. Peter Linneman today.” And Carl's like, “Really?” And he said, “Where do you do that? Like, you got a studio setup?” I’m like, “No, I'm just doing it here in my office.” It was great to be sitting on the on the set of CNBC on the New York Stock Exchange with all the lights and the cameras and everything else, and be like, well, in a couple of hours, I'm just going to go hang out with Peter and have a have a Zoom call, which thousands of people will tune into.
It's very evident, Peter, that people want to hear where your mind is on the markets, given the number of people who have already dialed in today. I want to back up for a moment as a lead in, because I went back to my notes on this call a year ago and I looked through what you and I were talking about a year ago. I will say it is unbelievable what has happened. And I think it's very human, if you will, to forget how far we have come in only a year. And then I want to dive into where we're going from here. So, first of all, from this you still like office, which I can't believe, and we're going to talk about that in a bit. You basically like everything other than seniors housing, which we'll talk about that as well. Interestingly, you don't talk about politics at all in this issue. And although you do talk about consumer confidence coming down, which I would put forth going to really hurt the Democrats come November, no tax policy. I think it's super important for all of us to remember that a year ago there was lots of talk about a big tax bill coming through and taxes going up. Lots of people did transactions in ‘21 that now end up looking like great timing from a market standpoint, but we're totally tax driven. And so, you know, better to be lucky than smart, but at the same time, unbelievable that we've come from there. No price control efforts so far on a national basis and very unlikely that we see anything between here in the election. And then if you have one of the two chambers go, it is probably unlikely that we see any real national price control.
Let me run through a couple of things that you said last year, and then I'm going to lead in with my question. A year ago, the federal government had only just stopped paying supplemental unemployment benefits. And I asked you in our call, you know, you think people are going to come back to work and your comment was they're going to come back to work the moment those things burn off. And sure enough, we've added close to 5 million jobs over the last year. A year ago, Salt Lake City was the only MSA that you tracked that surpassed its pre-COVID employment number. Today, 25 of 49 covered MSAs by you are above where they were pre-COVID. You did say a year ago QE infinity will keep banks awash with liquidity that will ultimately come out chasing assets. This will cause stock multiples to expand and cap rates and bond yields to fall over the next 3 to 7 years. So, I'm going to give you a hall pass that you couch it at 3 to 7 years. But a year later, we're clearly not seeing that. And I actually on Squawk Alley this morning bemoaned the fact that all the banks have pulled back more than they should have. I want to talk to you about that in a moment.
And then finally, a point from a year ago. I mentioned your former colleague, Dr. Siegel, from the Wharton School, who at that time was saying inflationary pressures are real, Fed is going to have to raise rates and the stock market is going to fall off. You were much more in inflation. Pressures are transitory and rates stay low. A year later, having walked around the floor of the New York Stock Exchange this morning, I would only say that Dr. Siegel's looking a little prescient on that one from a year ago, when many people thought that all the inflationary pressures were going to be transitory. So, here's the whopper of a quote from this quarterly letter, Peter, and it's on the back of Jamie Diamond's bearish comments on CNBC the day before yesterday. And you say, “The increases in interest rates to date will enhance economic growth, not cause a recession.”
Dr. Peter Linneman: Of course. Of course. Better pricing of things that are valuable. Step back, Willy, and just ask yourself a general economic question: should things that are valuable have a zero price, if what you're trying to do is maximize resource efficiency? And the answer is, of course not. Something that's valuable should not have a zero price. If what you're trying to achieve is economic efficiency. By the way, it's great if you're the beneficiary of the zero price, but somebody else is the loser from the zero price. Well, what's a zero-interest rate except a zero price of something that's valuable, and it gets overused. When you price something valuable as if it's free when it's not, it gets overused, and that draws resources from other things. Therefore, interest rates going up, at least to a certain point, gives a better signal of where money should best be flowing, and that will enhance economic output. And in fact, it's not so much where interest rates are at that has the market frightened. It's the journey. Interest rates, as you know, are basically where they were at in 2019. The economy is more or less around where it was at in 2019. By the way, it should be three years bigger than 2019. So actually, we haven't grown anywhere near what we should have.
Willy Walker: Except that cap rates are significantly below where they were in 2019. So, from a real estate perspective, a lot of people are sitting there saying, I'm upside down, rates have moved. And so, I mean, yes, it's I guess it's easy to say rates are back to where they were in 2019, but you didn't have that, if you will, inversion as it relates to value versus rates and the cost of case.
Dr. Peter Linneman: So, let me tell you the parable of Uncle Ralph. People say, where's the economy going? And I said, well, it's like Thanksgiving. You're going to grandmas. And when you get to Grandma's, it's not perfect. There's tension, but it's generally pleasant. That was the economy in 2019.
Willy Walker: You used to drive with Aunt Millie, and it was slow, and you'd get there, and it was all predictable. And now Uncle Ralph picks you up, having had a couple of cocktails and you barely get there. It's a rough ride, but you still get the Thanksgiving dinner, right?
Dr. Peter Linneman: You get there and you're probably going to get there without a wreck. You're probably going to get there without a rack, right? Because the roads aren't that full. And he's speeding and he's weaving and he's a little... But it's not the journey. It's the way the journey is being done. Going to grandma's is not terribly difficult. Going to 2019 kind of an interest rate environment, more or less in and of itself is nothing special, right? Nothing special. Not perfect, right, but nothing special. It's the way they went there. It's the way they went there. Where I got concerned and I think Jeremy got exasperated is when the statement was made that we're going to keep raising interest rates until employment goes down. Now you have to think about that as a bizarre statement. The beatings will continue until morale improves. I mean, first of all, there's no evidence of a tradeoff between inflation and employment. None. None. You can go through the empirical literature. This was well-established in empirical literature in the 1970s and 1980s. And yet you hear that verbiage. Well, when you go to a doctor and a doctor says, I'm going to use some medical practice that was done in 1970 and was proven not to work. And you go to that doctor and that doctor says, yep, I'm going to do that treatment of 1975, even though it's been proven repeatedly to have no ability to work, you are really concerned about that, doctor, because they don't know what they're doing. That's the situation we're in. And that's the frightening thing. That's truly frightening. That should turn greed into fear. And when greed turns to fear, money sits on the sideline. The difference, Willy. And then I'll let you follow up the difference. You were talking about the banks sitting on their hands. They're sitting on their hands, but their hands are full of cash. Full of cash.
Willy Walker: And Jamie Dimon and Charlie Sharp and others are going to have to start generating them. I mean, the thing is, they're not I mean, I literally said it on CNBC this morning. I said the bank, as you write in the Letter, Peter, on Q2, bank defaults on commercial real estate loans one basis point, one basis point. Delinquencies in their commercial real estate portfolios at 72 basis points versus 8.9% during the GFC. So, there's clearly no credit issue today and yet they're sitting on their hands.
Dr. Peter Linneman: So, there's a big difference. And you're a young guy. You kind of remember your dad telling you about, you know, the early 1990s, right? But then they had no money. They literally had no money, and they didn't have much money in 2001 and they didn't have any money in 2008. They have their hands full of money and they want to make their bonuses. Right. They're human. They want to make their bonuses. If they have no money, I can't tell you that they'll start lending. But when I know they have money, all you have to do is look at the reserve positions and the Federal Reserve reports. They have stunning reserves and capital adequacy. Forget Credit Suisse. And you know by the way, the Swiss government will bail out Credit Suisse. So that's not even that relevant. They've got money.
Willy Walker: Let me go to let me go to something you say in this, which is great. You say, “since real GDP fell in the first two quarters of 2022, are we in a recession?” And your response to that is “The answer is that if this is a recession, I want it to last forever.” Now, Amazon stock price. They've lost $1,000,000,000,000 in market cap, the arguably the best company on the face of the planet. Somebody else might come in and say Apple. But whatever the case is, they've lost $1,000,000,000,000 of market cap. So, if this is such a great time. Why are the markets so pessimistic?
Dr. Peter Linneman: Okay, uncertainty markets hate. You would agree. I mean, markets hate uncertainty. There's a lot of uncertainty out there and markets hate it. Secondly, I was reading this morning that an estimate of about $22 trillion of wealth has been wiped out in the stock market, in the bond market and so forth. That's one way to look at. Another way to look at it is that our real wealth is unchanged. What do I mean by that? We have the same stock of human capital. We have the same stock of physical capital. We have the same stock of people who are creative. That didn't change. That's the real wealth of the country. And I'm not being cute. You say, well, I like it when that gets marked higher. Okay, great. You like it when that gets marked higher. But that is the real wealth. The cash flows are the real, real flows. So, yeah, when fear sets in a market, you and I have seen it, values go down, big shock. And when greed returns, what happens to values, Willy?
Willy Walker: I mean, look, SL Green. I'm in one of their buildings right here. Their market cap is, I think, $2.3 billion. I think this building alone, Peter, is worth $2.3 billion.
Dr. Peter Linneman: Yeah, right.
Willy Walker: But SL Green stock price, if you bought it on February 1, 2009. And you held it from February 1, 2009, to February 1, 2015. It was a ten bagger. 10X. So obviously, you're not going to time it perfectly to buy it on February 1st when it hits low and you're not going to sell it perfectly in 2015 when it hits its high. But the point is that to exactly what you're talking about, it certainly feels a lot like February 1, 2009, right now.
Dr. Peter Linneman: It does.
Willy Walker: But it defies the numbers. And that's what gets me, is that you go $3.3 trillion of excess deposits from banks. I remember distinctly on February 1, 2009, when we couldn't get a warehouse line at Walker & Dunlop, you couldn't get it. We've got $5 billion off warehouse lines today. What I guess I'm trying to figure out here, though, Peter, is this, you know, back in the spring, you said 3.5% GDP growth in 2022, 3.5% GDP growth in 2023 and then 2.5% GDP growth in 2024. And now, six months later, you revised 2022, down 150 basis points. That's no minor adjustment.
Dr. Peter Linneman: And so okay, so here's the challenge. There is this factual myth. I don't even know what that is. Factual myth that real GDP fell the first two quarters of the year. Real GDP fell the first two quarters of the year. Can't be true. I'm not saying the numbers have been fudged. How do I know it can't be true? In those two quarters we added about 2.7 million jobs. And as you know, the only reason we didn't add more than 2.7 million jobs is that people couldn't find people to fill the jobs. Okay. Now you have to think about this for a minute, Willy. If we added 2.7 million jobs and GDP fell, that is the pie got smaller. It means that those 2.7 million people who were hired not only didn't produce anything, they destroyed and yet employers kept hiring. Now, think about that. Employers on the ground kept hiring people who came in and destroyed value. And yet we said, bring it on. I need to hire more. Can't be. Can't be. There's just no way. And by the way, you look at industrial output, you look at retail sales, you look at profits, it can't be. Interestingly, you look at gross national income, which almost always is the same as gross domestic product. Gross national income is up several percent in the first half of the year and gross domestic product is down, and they should move the same. And which do you believe? Do you believe in gross national income when you've added 2.7 million jobs in six months? Remember the whole population this year, the entire year. It's only going to grow like 1.5 million -1.6 million people, we added 2.7 million jobs in six months. Of course, the pie grew. Of course. Okay. If the data says it didn't. It doesn't mean it didn’t.
Willy Walker: Okay, but you're good at keeping us all balanced as it relates to what the macro numbers are saying. And at the same time, you do your canaries in the coal mine analysis on a quarterly basis. A year ago right now, that report was a clean sheet other than three canaries about a COVID resurgence. That was the only thing that you thought were kind of red herrings out there at the time. But this quarter we've got a bunch of canaries showing up. And so, I want you to comment on the one that's most concerning to you. So, as I said a year ago, you had three canaries on the COVID. Now you're down to one canary on the COVID. And at the same time, you've added two the speculative real estate development boom and you got in one too narrow spreads and rising LTVs and record buyout deals. And then the final one is an empty space being worth more than full space. Okay, so if I want to go to your narrow spreads and rising LTVs, because spreads from a lender standpoint are obviously tight relatively speaking. And I know that the last time you went out and got a loan, but we don't have a single borrower at Walker & Dunlop, who feels like they're getting a solid LTV, they're all debt service constrained. And so, our LTVs are in the low fifties right now because of where cap rates are and where proceeds are going to. So why are you concerned about LTV?
Dr. Peter Linneman: I'm concerned because I think the original one, if you go back four months ago, something like that, it was starting to show that, and I think people overreacted. I just think they overreacted. So, they saw the signs that I saw. And said, I'm not going to get caught out again. I'm just not going to get caught out again. And in the short term, they've staunched it in the way you're describing. And in fact, they've overstaunched it. They've way overstraunched it, given the amount of money that's there. So, that isn't true literally as we speak, because fear has what? Fear has papered over almost everything. Right? Just fear is the only thing. Now could fear itself trigger a recession. I guess. It's not the typical way a recession gets triggered. Right. But it could. Maybe I should add a new Uncle Ralph Canary. Right?
Willy Walker: Uncle Ralph actually put the car into the ditch. Peter, though, what are the other ones in there is speculative real estate development. And so, you track multifamily starts very closely and there's a great analysis of it in this quarterly letter. And so, I give everyone some sense of where we've come from and where we are right now on a trailing 12 basis. Multifamily starts in 2019 – 389,000. In 2020 – 380,000. In 2021– 459,000. If you take the trailing three months over this summer and annualize it, it's closer to 600,000. It's from 571,000 in June to 621,000 in August. Does the number of multifamily starts a) concern you and b) change your outlook for multifamily?
Dr. Peter Linneman: Well, the first question is that and industrial, you could pretty much do a similar discussion of industrial as you did for multifamily. Right. In terms of it's what I was reacting to when I was saying speculative. It's not hotels and it's not office buildings. Right. It was warehouse, industrial and apartments. Does it change my outlook? It softens my outlook. Right. We still have people. We still have activity. We have all this. We still have a national shortfall, even at the numbers you're talking about. But my numbers show 500,000 units nationally, 600,000 units nationally, a one and a half percent kind of shortfall, less in Texas, where NIMBYism isn't as much. So, yeah, when you start running that pace, you could make up a couple of hundred thousand units pretty quickly, particularly on a submarket basis. So that's largely what I was reacting to there. Does it make me think it's in the tank? No, I don't think it's in the tank. You have good demographics, as you know. You have people view it as a good asset class from a capital market point of view. Supply shortfall is weakening, but the single-family shortfall is still there. So that alternative is still going to see its price outstrip inflation over a longer term, which means people have to save longer to get a down payment. Right. And so, I still like it.
The other thing really, I kept trying to figure out where that huge surge in demand? Not just growth in demand, but that surge from about, what, November, December of 2020 through all of 2021? Where did that big surge really come from? And doing some back of the envelope, putting together bits and pieces of data. Here's what I think the surge came from. You had two roommates. You were in a 600 square foot apartment. All three of you worked and all three of you partied all night. So, you didn't mind having two roommates in 600 square feet. And then COVID said, you're home all day, and you're home all night, and I can't take it. And so, the desire to shorten up my roommates created a lot of demand, and the ultimate roommate that got shortened up were parents. Because it was fine to live with mom in the basement as long as I worked all day, which a lot of them did and partied all night, which a lot of them did, and mom never came to the basement. Well, suddenly, what did COVID do? Mom had to Zoom from the basement. She's home all day. I'm home all day. I'm home all night. Jesus, get me an apartment. And that's where the surge came from. And it was about a million, as best I can guesstimate/estimate –about a million in about a 14-month period, which is a two and a half percent increase in the demand for something that supply didn't beyond normal growth. Of course, there was a surge.
Willy Walker: Do you think rent growth can stay up?
Dr. Peter Linneman: I think rent growth can't stay up in real terms. You know, in the high single digit in real terms. It can't stay up in the high single digit, low double. But I think it can outstrip inflation. I think it can outstrip inflation. By the way, the outstrip inflation the Fed has fallen prey to defining inflation by consumer price inflation. And we talked about this some time ago. The 2010s we had not much consumer price inflation and lots of asset price inflation. Yeah. And when you balance them, we have inflation. Now what's happened in the last five months, six months, eight months, however you want to take it. We've had consumer price inflation.
Willy Walker: Yeah.
Dr. Peter Linneman: Why did we get consumer-price inflation? We got consumer-price inflation because of supply shortfalls. Demand recovered faster than supply and we got asset-price deflation. Why did we get asset-price deflation? People sat on money. Now, go back to the research I've done on what determines cap rates. It's the flow of funds. Not just that I have it in a stack somewhere. It's the flow. And what you have is big stacks not flowing. And then, we come back around. I do think it still flows. That's why I gave myself that longer period, because I don't know when it will flow, but it will flow. It will flow. And this actually, you know, this current episode where cap rates are soft is a good way of saying it, not much transactions, etc..
Willy Walker: Soft? How about undefinable? I sat in a meeting last week in Atlanta with my team. And Kris Mickelson, who runs our investment sales group, was asked point blank by a client, so where are multifamily cap rates? And he went into a six-minute soliloquy before he actually answered the question. It was sort of like, I'll tell you whatever you want to know what I'm going to give you an actual answer. He actually ended up giving him an answer. But anyway, yes, it's hard to define.
Dr. Peter Linneman: Think about it Willy, you go back to my research, my view on what determines cap rates, it's flow of funds.
Willy Walker: But hang on a sec. Go straight to that data point because it's in the peak. So, LREI peaked at 170 in 2009. Okay. And it bottomed at 133 in 2014. So, everyone's tracking these numbers who haven't sat around and kind of what I just said just sounds like a number. So here you are, 2009. The Linneman real estate index.
Dr. Peter Linneman: It's just the money relative to the economy.
Willy Walker: Absolutely there's no capital out in the marketplace at that point. And that's why it's at 170. Then it crashes down to 2014 where there's tons of capital, but no one's deploying it. That's at 133 and we're at 157 right now in Q2 of 2022. And so, if you think about where cap rates moved from 2009 to 2014, are we correct on cap rates right now being at about 475 on multifamily?
Dr. Peter Linneman: Probably in that range because people are sitting on the money. But remember, unlike 20-30 years ago, they're sitting on money. In the past, they had no money to sit on. Big difference, right? Big. You know, I take another data point, Willy, I was thinking about the other day. You may recall I was chairman of Rockefeller Center and reorganization in 1994 and 1995. Do you realize that I went to everybody who either had money or pretended to have money. And the big opportunity, Blackstone had about a $300 million fund and Goldman had about a $500 million fund. Apollo had about a $500 million fund. Zell had about $1,000,000,000. And that was it. That was it. Now compare that to today. Lots of money. Lots of dry powder. And. It's sitting on the sidelines, but it can't sit on the sidelines. I don't believe it can sit on the sidelines forever. You know, I did this Haagen-Dazs.
Willy Walker: It’s sitting in the freezer. And you actually ate some this week.
Dr. Peter Linneman: Not this week but right before I left. I'm in Europe right now. But right before I left, I had. So, it was four quarts and now it's three. Somebody who has four quarts of Haagen-Dazs in the freezer is going to use it. I don't know when, I don't know if they're going to use all of it. Somebody with three and a half trillion dollars of available reserves is going to use it. That's what they do. Not all of it necessarily, right? Some of it. Same for dry powder for private equity, sovereigns, etc..
Willy Walker: Let me put some numbers behind what you just said. And then I want to move to another question. So Preqin reports that there's $1.2 trillion in AUM in real estate private equity funds today and that has grown over the last 21 years at a compound annual growth rate of 15.3%. So, your point in the Linneman Letter is if you want to get in the way of that train, good luck. But there's a massive amount that has gone into commercial real estate, private equity firms and that there's $325 billion in global dry powder today focused on commercial real estate. So back to exactly what you said. I mean, this is sort of like the people who are anti-ESG and the state of I think it was South Carolina that pulled $800 million out of BlackRock. And everyone sat there and said, yawn. It's like it doesn't make a difference. I mean, you're making a political statement, but you're not going to make a dent in what BlackRock does. Similarly, here, there is so much capital there that at some point it's got to come off the sidelines and invest it.
Dr. Peter Linneman: And again, I don't know exactly when and I don't know exactly which assets it’s gonna chase. I just don't think. And by the way, households have like $4 trillion beyond normal. I don't say they bring it all out tomorrow, but do you really think people sit on $4 trillion forever? They're going to use some of it to buy a car because they're behind the pace for cars. They're going to use some of it to go to Europe or someplace. But the bulk of it, they're going to rotate out of cash into more active assets, particularly as inflation or some matrix of inflation are up because I got to get my money to work or just watch it erode.
Willy Walker: So, one of the data points you put in the Letter, Peter, is that the real average multifamily sale price in July, this is per Costar was $254,000 per unit. That's an all-time high and it's 50% above the historic mean of $166,000 per unit. So, if you own that multifamily property today and it's cash flowing nicely and you've got the prospect of real rent growth in north of 5%, why would you ever sell?
Dr. Peter Linneman: Well, some people have to sell because the partnership dies literally, right. The partner dies or something. Well, there is that. Some of it has to sell by end of funds situations. And, yes, I may not get as good a price today as I could have gotten, as you said, in the fourth quarter last year. And but, by the way, if I bought seven years ago, even if I sold into a kind of a softish market today, however you want to define it, I'd make money on my apartment on the seven-year-old. Would you agree? And I'm in my promote pretty handsomely on that. And I will probably refi this I went pretty handsomely. So that's why I would sell to realize my promote and give my money back to investors and hope that they give me right back. Right. So, I'm going to give them 100 and they're going to give me 100 right back.
Willy Walker: So, on that, then, if we're sitting here today and you say, okay, if you hold or if you're not a forced seller, why sell? But there are people who are selling. So, what's to give someone conviction to go buy today? So do you listen to Jamie Dimon saying we're going into recession in 2023 or do you listen to Bill Ackman saying, you know what, Jerome Powell is not going to come out and say ali income free, go invest. You've got to have some conviction in where the economy's going and that today given price movement that we've seen clearly from cap rate adjustments and prices and where BOV's and actual sale prices are coming in. Is today the time to start to deploy some of that capital?
Dr. Peter Linneman: Feels like. I mean I bought an apartment complex down in Baltimore in early January 2009 or February. People thought I was crazy, and I figured, I'll hold it for eight years. It'll do fine. I don't know exactly what it will do. Don't lose perspective with all the shiny objects. That's my new phrase right now, which is that it's really easy to get caught up in shiny object. Right? Let's talk about the elections. Let's talk about the environment.
Willy Walker: Or Ukraine. It isn't really a shiny object, right? That's the real deal.
Dr. Peter Linneman: I think we have at least as many shiny objects as we've had in my career. I'm not saying more, but at least as many, and it's very easy to get distracted by shiny objects. If you're a trader - Mike Milken had this great phrase that if you're a trader, you have to know what comes across the wire in five minutes. But if you're an investor, you just have to know what the newspaper is going to say five to seven years from now. I feel pretty good about what the newspaper says five to seven years from now. I have no idea what it's going to say in Mike's five minutes, and he didn't literally mean five minutes. But if I'm a real estate investor - focus on the asset and focus on the fundamentals. Your performance has never been right. Never, no matter how good you've been. You know, I had a conversation where we just refinanced out of a really nice opportunity zone project on an industrial project after like 20 months. And we're all patting ourselves on the back. We missed our pro forma. Enormously. It turned out twice as good. So here we spent all this time and were congratulating ourselves, and I said to the team, let's have a little humility, because if we can miss it that direction in a 20-month period, we can miss it the other direction and 20-month periods. But I don't think we're going to miss it that big over a seven- or ten- or 12-year period. Don't get distracted by shiny objects. Focus on the fundamentals. And I think if you do, this is not such a bad time.
I'll give you another example that I've been thinking about. Okay. So fine, I come to you, and you say, boy, I can't get you that 85, 80% loan. Great. I'll take a 50% loan with Willy. And you say, well, that doesn't give me a lot of leverage. Yes, it does, because you're going to structure in a way that in three years or two years, when the money comes back, I can top up money and take money out. And when you model it that way, rather than I with a 50% LTV that goes down as value increases, if you view it the way reality would work, right, the way reality would work is you go in with too much equity and then two years or six months or 20 months, you're going to refinance more money into it and therefore get some of your money out of it, which changes the return profile dramatically. In the meantime, the risk is quite low, right? At 50% leverage. The risk is very low.
Willy Walker: That's one of the things that when we you and I were talking about, the Linneman Real Estate Index, one of the things you point out as you go back to why the numbers in the Linneman Real Estate Index stayed relatively low as far as liquidity in 2018 and 2019 when they should have shot up is because of lender discipline at a time when lenders really should have been showing discipline. And I think when I read that and it was such an insightful point, Peter, it is really interesting that right now as we're sitting there looking at bank charge offs of one basis point in Q2 on commercial real estate, and the delinquency rate of 70 basis points, it's important to keep in mind that in the great financial crisis as well as in the pandemic, the first thought I had as a lender was: How is my credit? Like, who's going to default? How many loans are coming back to me? And to be perfectly honest with you today, that's kind of the last thing we're focused on. Credit has been exceptionally good and from an underwriting standpoint, very, very disciplined for the past several years, which says that you're not looking at defaults, if you will, on a 2018 or 2019 loan that was originated. I do want to go to some asset classes beyond multi and we only take risk on our multi portfolio, but it does speak very well. I think the only other thing that I would put out there that we've been talking to a bunch of people about is there going to be an opportunity for deals that were originated in 2021 or to early 2022 that were done with CLO debt at extremely low coupon rates, floating rate for a bridge loan of 2 to 3 years. The property doesn't stabilize and meet pro forma, and there's a refinancing obligation that hits the wall, if you will. And is that an opportunity for people with dry powder to step into the market? Not in the Q1 2023, but more like Q1 2024 and 2025.
Dr. Peter Linneman: I think you're right on and there will be opportunities, but they're not going to be steals. And the reason they're not going to be steals is there's too much money, right? There's just too much money to steal the opportunity. There will be opportunities, but not opportunities to steal the asset, if you will.
Willy Walker: So, on construction spending, I was amazed at the numbers that you put in there because you show the year-on-year swings as it relates to investments into all the major asset classes. But what got me was just, if you will, the percentage that's going to various asset classes. So, of the 390, I think it's $393 billion of construction spend that's going on right now among the major asset classes.
Dr. Peter Linneman: That's about right.
Willy Walker: About 20% is going to Office, $72 billion, 40% is going to Industrial, which is $150 billion. 9% is going to retail, which is $33 billion, only 4% or $16 billion going to lodging and almost $100 billion or 26.5% going to multi. So, my question to you is that Peter, who's building an office building right now? Why would you build an office building?
Dr. Peter Linneman: So that's a great question. Largely, remember, those are construction outlays, right? So, I didn't start a new office building. You know what I did? I'm doing the fit out on that building that SL Green started in 2019 or 2020. There's a lot of work, that's a three-year project on a high rise. So, there's still a lot of spending that's going on in those buildings. It's pretty much the same with hotels, that it's the larger the spending the big spending in hotels heretofore has largely been finishing out the big hotels, not starting new big hotels – finishing out. That I have my construction loan Willy, I'm going to finish it. That's the only chance I got to finish it. So, most of that office number, most, not all is finishing projects that started two or three or four years ago. And now you're in to the fit out, into the TIs. You're into the last parts of the building, not the core and frame. Right. But the rest of the building. That’s where most of the office numbers are, that’s where most of the hotel numbers are.
Willy Walker: So, you nailed it a year ago as it relates to people coming back to work once the federal unemployment subsidies wore off. And you've got a great quote in there that just basically says, you don't think people will sit on the couch while they're getting paid to sit on the couch? You also get them working when they're not getting that subsidy. It's a great quote. But you also in our last call, Peter talked about once we get back to 60% in the office occupancy, we're going to hit kind of a tipping point. And everyone's going to want to come in because if Susan is in the office and seeing her boss and getting the promotion, someone else can come in. You know, back to the office, forward to work however you want to talk about it. It's a slow grind. Is your outlook as it relates to office changed at all since the last time we talked?
Dr. Peter Linneman: No, it's slower. And I think I said this last time, it's been slower than I would have thought. I still think there's a tipping point. There's some evidence of this of around 60 to 70%. And I jokingly say that if six out of ten people are in the office, I got to be there to make sure they're not talking about me. Right. I got to get there to protect my flank, not to be productive, just to protect my flank. The reason I feel good is, as you know, the percent there is coming up at about 2% a week. Right. Some numbers like that. It's not moving fast fast, but it's moving. However, I'm over in Germany, they're basically back four days a week. I was talking to people, some people up in Toronto and a couple of the major banks there came back for three days, then they came for four days. And I think they were saying to me three weeks ago, they said five days, you know, and by the way, people still have flexibility for stuff. In Israel, in Tokyo, as I talk to people they’re basically back.
Willy Walker: But you talk about Tokyo, and you make a very good point that they live in smaller spaces that, you know, back to your point about what happened to make the surge in the apartment sector and all these new renters. It was everyone saying, I don't like crawling all over each other. And that's clearly the case in somewhere like Tokyo, where people literally do live on top of each other. And going to the office is a nice break from it. But structurally, the United States doesn't have that. And so, by looking outside of the United States, I got to kind of push back a little bit and sort of say, I mean, is that a fair model to say we're going to follow the rest of the world rather than the United States being somewhat unique?
Dr. Peter Linneman: It's not perfect, but Toronto is not so different from Chicago, right? Tel Aviv is not so different than some of our places. Nothing is perfect. Obviously, Tokyo is a very special place. London has come back much better than we have. I just think the reality of productivity wins out. It's that simple and it's funny. Yesterday, Willy, I’m at a daughter-in-law and her husband had to do a zoom and I had to do a zoom. And the kids, it was bedtime, and it was chaotic in a 1,500 square foot apartment with three kids. How does real work get done day after day? Once in a while, yeah. But every day? Most people don't have that kind of environment and discipline. And by the way, what does the person that has an 800 square foot apartment do? Now, granted, they only have two screaming kids, but they also have the game Celebrity Feud on or something to distract them. So, getting back to the shiny objects. Employees and even executives are very easily distracted by shiny objects, their Family Feud, their children.
Willy Walker: An interesting point on shining objects. And then I want to go to this next point on technology. I was listening to a Peter Attia podcast this past week where he had on somebody who'd written a book all about pushing your physical limits and then also being bored. And then they went into this long conversation about hunting and how hunting is actually one of the few times if you're going elk hunting, that you actually sit out in the middle of nowhere with no cell coverage, with no books, and you actually are bored. And one of the comments that Attia said was that 2007 was the end of human boredom. And I was like sitting there going, I'm going to say, why does he go to 2007? That was the advent of the iPhone, the moment that the iPhone put everything at your fingertips. We all are constantly being inundated with information to the point where the human brain is never bored. It might be on something that makes no sense to be focused on, but it is always getting input and its never being able to stop and just sort of think a bunch.
But with that on technology, Peter, you spend a bunch of time in this Linneman Letter talking about technology and you cite a very, very impactful Accenture study that talks about technology laggards and technology leaders and that they've gone and looked at companies. The leaders outstripped the laggards that leaders of the top 10% on technological adaptation and implementation, the laggards of the bottom 25%, and they've grown revenues at a 5x rate over the laggards, and that's up from 2X only in 2019. So, the rate of acceleration or of revenue growth is much, much higher.
But so, I read that, and I said, okay, let's take a look at some of the CRE technology companies and let's see how they're doing right now. So, I pulled up Compass because you mentioned Compass in your write up. Compass went public with a market cap of $7 billion. It's now down below $1,000,000,000. And their stock chart literally looks like the 90-meter ski jump that made Eddie the Eagle famous. And I can go from one to the next. And, oh, by the way, I'm throwing darts here. Don't look at the Walker & Dunlop stock chart. We've gotten hammered over the past year as well. So, I'm happy to take shots in the back as well. But my question to you is this, is now the time for companies to be focused on technology or is it all about earnings?
Dr. Peter Linneman: Well, I don't think it's all about earnings, but it's a lot about earnings. And I think I've always believed it's a lot about earnings. Technology can be a shiny object, right? I mean, you know, in some ways, one of the great frustrations of running a company, being on boards is you just every meeting, you're approving more money to update your technology and they tell you this is going to be the great solution. Two years later, they're telling you how terrible it is. And then you have another, you know, amount of money you pour in. I think the Accenture report is partly about technology, but I think probably their result is probably more about an openness to ideas. You know that companies that do a lot of technology are probably a bit more open to ideas and to ideas that challenge them. Not just technology, right? There's a kind of compounding effect. Technology for technology’s sake, is nothing special, right? Am I the only one listening to this who's so frustrated by the IOS updates that after every IOS update, there are things that don't work the same and you have to figure them out and they're no better. And what did they change it for? And it's like solving problems that don't need to be solved. And there's a lot of technology that solves problems that didn't need to be solved. However, having said that, being open to ideas, being open to trying to do it differently and better, probably is the source of that at least as much as the technology itself.
Willy Walker: So, another prognostication you make in the Linneman Letter is that oil prices are actually going to go down from here. You cite one data point, which I found to be fascinating, which was the number of rigs in the Permian Basin. So, you put out there that there were 408 rigs in the Permian Basin in February of 2020, just before the pandemic that shrunk. And I thought that the rate at which it shrunk was fascinating, Peter. It went from 108 to 117 over a four-month period. I mean, that's literally just ripping stuff out of the ground.
Dr. Peter Linneman: Turning off the taps.
Willy Walker: Just turning off. Okay. And so, we're now back up at 340. But your sense is that oil is going to settle in somewhere around 80 bucks a barrel. Given Ukraine and given the fact that the Biden administration is tapping the Strategic Petroleum Reserve to a level that we haven't seen in a long time and has got to start building that back up from a national security standpoint at some point. Post-election, clearly. I mean, aren't fuel prices going up next year?
Dr. Peter Linneman: Okay. My answer is pretty simple. I started studying fracking 12, 13 years ago, first on natural gas and then oil, which came a little later. And what I came to understand, I think I understand, is the extraction cost, breakeven cost, if you will, price, I should say, rather than the cost is probably in the $40 range, could be as low as $35 a barrel range. It depends on exactly the conditions. If something costs $35 to $40 and you can get $80 for it. I don't care how unpleasant the regulatory environment is. Somebody's going to figure out how to take advantage of $40. I mean, barrel oil is not that big. You and I can pick it up with a little help. You know, you're a fit guy. So, you know, we could pick up a barrel and, you know, $40 a barrel - I think that's too big of a spread not to be taken advantage of. Now, would it have been taken advantage of a lot faster if there was a much more favorable environment for oil in a regulatory context? Of course, of course. But there isn't. That's the fact. But that doesn't mean it's not going to be taken out. It's too profitable, it's just too profitable. If you told me we were at $40 a barrel and the regulatory environment is not friendly, eh, but that's not the case.
Willy Walker: So, I said at the top, you're pretty bullish on all commercial real estate asset classes other than seniors housing. Talk for a moment about seniors and why you don't like it.
Dr. Peter Linneman: Well, people can't do math. You know, I'm going to put aside….
Willy Walker: That's quite a statement, Peter. I think a lot of people on this webcast today can do plenty of math. So, tell us where we're wrong in our computation.
Dr. Peter Linneman: So, here's the thing. You go to the experts, and they say, yeah, people sort of move into senior housing in varying forms. I'm not talking about age restricted, let’s talk senior senior. Right. Even senior independent around 78. Okay. So, you go well, let's go back 78 years ago and see how many people were born, it’s the end of World War Two. It's like 1944, right? Well, 1944 is still raging. Well, there weren't a lot of births in ‘44. There were more in England, by the way, because the boys were over there, but they weren't at home. And so, it was a low birth cohort. So, you still got ‘44, ‘45, ‘46. The boys don't really get home in full mass until ‘46, and it takes them a year to get married, a year to have it after that to have a child. So, you really get the baby boom happening around ‘48. So, take 48 plus 78. That's when you're going to really see the surge. So, for 30 years, people are saying, yeah, I want to be in senior because the baby boom is aging. Well, the latter part is true of the baby boom basically ages a year each year. But it's not there yet right. And then you put on top of that a little of what Mike Roizen and I talked about, which is 78 could be 80 without a big stretch of the imagination. So now you have to say, well, you go back 80 years. Right. And you go back, and I go back 80 years. I mean, 42. I'm just starting to really hit the war years, which are low. And you can look at the births. Right. It's not a hard thing to look at the births. So that's why I'm not bullish in the near term. I'm very bullish. But I just think it's a little early to get in because there's too much disappointment yet.
Willy Walker: It's fascinating to go to the actual numbers and wind the clock back and use that. And also, to some degree, use that cohort in somewhat of a static view in the sense that at an average age of 78, we're going to stick on the 78 to exactly what you and Mike and I talked about a couple of weeks ago, which is just that longevity is very much here. People are living longer and they're also living more active lives. And so going to seniors used to be something that was really needed to be able to support the lifestyle you wanted to live. Now people are living and able to live lives with fake hips and fake knees in ways that they couldn't in the past.
Dr. Peter Linneman: So, I don't have anything against senior housing at all. I kind of like it. You know, if you can get a good product, I like it as a product. I just think that people believe that they can do the math of you. Tell me what age you think they come subtract that off of today's day. Look at the number of people born. There weren't many. And when I get real aggressively interested is when we get a year or two before that. And that's still got like four years to go. Five years to go.
Willy Walker: So, you made the comment, Peter, about a property you bought during the GFC. I've often over the past couple of weeks gone back to think about every time I hear people saying I'm freaked out, I'm freaked out. I think about Warren Buffett making his investment in Goldman Sachs. Warren Buffett didn't try to time that investment. And actually, when he made the investment in Goldman Sachs, things were looking pretty shaky, kind of across the board. He had conviction that Goldman was an incredible firm, that it was going to find its way, and that if you put his capital in there with the ability to buy 5 million warrants or whatever the number was that he put on the table, that it was going to be a great investment. And he did it and it was handsome as can be. Could he have done it a month earlier and maybe gotten a little bit more credit than a month later and gotten a little bit less whatever the case might be? I'd been sitting there saying, where is my Goldman Sachs investment? What can I go and put money into today? That regardless of whether Uncle Ralph is driving to the Thanksgiving dinner or whether it's Aunt Millie, I'm going to get to the Thanksgiving dinner. And I wouldn't mind getting that ten bucks or on SL Green from February 1, 2009, to February 1, 2015. Where are you? Where is your Goldman Sachs Warren Buffett investment right now?
Dr. Peter Linneman: Not tech. I mean, if the cash flow, tech maybe. But not tech. But I think real companies with real cash flows, I would say apartments. I still like industrial, I like office. But it is risky because if I'm wrong when and they don't come back and I know that's hard for you to believe, but I could be wrong. And so that's a challenge. But basically, I'm not a trader. Most of the clients I have aren't traders. I think a lot of what I do for them is try to not look at the shiny objects. You know, it's kind of not. And you do some of that as well. Sometimes things come up.
So, as you know, my wife and I have this education charity in Kenya, and I have a WhatsApp group for the college students and alumni. And it was one of the kids' birthdays. And that, you know, we do happy birthdays to one another on our thing. And so, all these kids are chipping in, and the guy says, I'm 23 today, you know, and this is a tough time to be 23 years old and blah, blah, blah, Ukraine and this. I realized that I was 23 in 1974. There were two hour waits to get a tankful of gasoline. The price was sky high. The Arab Israeli war had ended. And who knew if the Middle East was going to be fine? Terrorism is really rampant, both domestically and internationally. Watergate, you had the president on the verge of resigning in disgrace. You already had the vice president resign in disgrace. The speaker of the House was about to become the president of the United States. I think that's a bit of a constitutional crisis. The Soviet Union was very aggressive, communism was clearly on the upswing at that moment globally, etc., etc.. And you get the point. Vietnam was just winding down and you're going, wow, we kind of and by the way, since then per capita real GDP is up about 130% in the U.S. Globally, about 5 billion people have left abject poverty. Many of them have left poverty. Probably 3 billion of them have left poverty. People are not free, but there's a much greater sense of freedom. You know, and you hit it with that horrible things are still happening, but we made it from ‘74 to today. Go look at ‘74 somebody, and you go, wow, I'm glad I'm alive now more than in ‘74, right?
Willy Walker: We're basically at time. But I would say to you, one of the things that I've always found, and I was down at the Florida State University last week speaking to both alumni as well as the student body. One of the things I said is these students were saying to me, you know, where do we go for a job today? And it's a really ugly job market. I said, you know, if you look at the commercial real estate industry, many of the luminaries today came out into a really, really bad commercial real estate market in the late 80s and early 90s. And I used Bob Faith and Barry Sternlicht as two perfect examples and Barry’s very happy to say that he got fired from his first commercial real estate job for working for a friend of yours and mine. That’s what put him and Bob together to create Starwood and then Bob went on to create Greystar. And so, you know, there is this sort of sense of, oh, if it's not a great job market, it's not a great time for me to be getting out of school. And to the contrary, this is when opportunity presents itself.
Dr. Peter Linneman: I think, you know, I advise, still to this day, a lot of students, and I certainly did over my career. And I always said: The worst is to get hired at the peak, with perfect hindsight, at the peak, because you're there, you think it's great, and then you're gone in a year and a half to two years. The best time with hindsight is at the bottom, because if you can get a position, you come in humble. Everybody's humble, and the people who got hired by figured out how to survive. You're learning from survivors instead of wild men. You have a better environment, though it's a more painful environment for a couple of years.
Willy Walker: Yeah. So, with that, I can't recommend this strongly enough to everybody. It's my quarterly bible and read the Linneman Letter. Get it. Peter, thank you as always.
I have a really fun webcast next week. I've got my mom, Diana Walker, former Time magazine, White House photographer, to come on and talk about her perspectives on watching history take place under President Reagan, under President Bush, under President Clinton, and all that my mother has seen. And then the week after that, I got James Stavridis, former four-star admiral, to talk about Ukraine, Taiwan, East-West relations, and many other things.
So, I hope all of you can join us next week and the week after. Peter, as always, thank you. I look forward to our next one. We're going to do a health one with you and Roizen again, talking about the implications of longevity on the real estate market in December. And then we'll be back in early 2023 to recap Q4 2022.
Thank you, Peter. Be well. Thank you, everyone for joining us today.
Dr. Peter Linneman: Terrific, Willy. Thank you all.
Willy Walker: See you.
