Market Update with Walker & Dunlop experts Ivy Zelman, Kris Mikkelsen, and Aaron Appel
Willy Walker : Thank you. Good afternoon, everyone, and welcome to another Walker Webcast. It is a real joy for me to be joined by Ivy Zelman, Kris Mikkelsen, and Aaron Appel when and if they can figure out how to connect to a Zoom call to join me today to talk about the markets and what's going on. As everyone who listens to Walker Webcasts knows, we typically bring in outside resources to talk to people and get a sense of what's going on in the world, both in the commercial real estate industry as well as more broadly across the industry and outside. But today's a special one because I've got three great experts with me to talk about what's going on in the markets, what they're seeing, and what we should be thinking about in the upcoming months and quarters. So let me start here, Kris and Ivy. A disappointing CPI print yesterday. Had the equity market sell-off. Had the ten-year jump precipitously. How much of your view of 2024 changed over the last 24 hours as it relates to everything from transaction volumes to stress in the market? Did we have a sea change yesterday with that CPI print, or is the thesis for 2024 still intact? Ivy, let me start with you.
Ivy Zelman : I'd say the thesis is still intact. I think that the CPI print and the reaction is overdone. Frankly, our real-time surveys support decelerating rent growth. And we've seen, across the multifamily space, a new move-in has gone negative for the fourth quarter. The public rates on average were down 3.4%. And we're seeing deceleration. New move-in rent growth for the single-family rental is now gone. Slightly negative on the margins flat to down. This is not reflected in CPI. So I think eventually it shows up. And I think that the Fed is not looking at real-time data, unfortunately. So I don't think it changes our thesis at all.
Willy Walker : But let's double-click on that a little bit Ivy before I turn to Kris. We've talked a bunch and Peter Linneman on our quarterly call has talked for quite some time about the fact that the Fed isn't looking at the right data and that the CPI component for rent is a misread. And at some point, that catches up, unfortunately for the January read, it reads “hot.” And here we are dealing with a materially different market today than we were yesterday as it relates to the cost of capital, should investors, in commercial real estate take confidence that that lagging indicator does catch up and that whether it's in May or June or August, that because it's a look back that all the deflationary pressures that we've seen in rent catch up and that it's kind of baked into the numbers going forward.
Ivy Zelman : I think so. We’re talking to operators, owners, and operators every month that are pretty significant in terms of sample sizes, and they're real boots on the ground. And that's, in our mind a better indication of what rents are doing relative to what the Fed's you know, and using to calculate OER and applying, you know, what rents are for single-family renters. And then applying that across the stock is a very backward-looking, modeling exercise that frankly, they're not talking to owners and operators like we are. So it's a very different methodology. So yeah, I feel confident that the inflation will catch up. Historically, there's always been a lag. We have a recession analysis that shows you know, correlations are there. And we just have to be patient. And the challenge will be patience and recognizing that shelter is such a significant portion of CPI, 40% roughly is, you know, cause great concern for those who are not as like we are in touch with it every day.
Willy Walker : Kris, do you want to dive in on that for a second?
Kris Mikkelsen : Only to say it feels like we're a, you know, 1 or 2 third-party data providers away from having the Fed have a little bit of a better indicator about where rents are going versus the lagging look that Ivy mentioned earlier. I don't think the last 2 or 3 days have really changed our outlook for the year at all. I think if anything, our message declines at the beginning of the year has been pretty consistent, and that's that. If there is something that you need to do in terms of a capital transaction and over the next 18 months, then we feel like sooner is kind of better than later. There's a real scarcity in the market right now. We'll talk a little bit more about that going forward. But the consensus was so one-sided as we got a fed pivot in November and we got rate relief in December. I think everybody forgot that the pathway to normalcy could be potentially paved with a few speed bumps. And I think what we got yesterday was a speed bump. But I think long-term directionally we're kind of right where Ivy is. And I don't think there's been any sentiment change, broad sentiment change from our client base, in the last 48 hours based on kind of one hot print.
Willy Walker : So talk for a moment, Kris, as it relates to the bid-ask spread on multifamily, properties and buyers and sellers. Do you think that these higher rates flush some of that out if you will and that people were sitting there saying, I'm waiting for rates to fall and therefore my ask has gone up the bids have stayed static, and therefore you've got a pretty consistent bid-ask spread that isn't being able to get closed. Therefore transaction volumes have been slow and this actually might spur some activity.
Kris Mikkelsen : I'll put some numbers to it for the folks listening, to just illustrate the size of the bid-ask. So in 2023, we took the same amount of product to the market as we did in ‘21 and ‘22. So extraordinarily active years took a pretty similar amount of product to market in ‘23, only about 45% of the product that we took to market got to the point where he was even awarded to a buyer. Of the 45% that we awarded to buyers, about 85% of that plus or minus either closed or is still under agreement. So that kind of illustrates the size of the bid-ask that persisted throughout 2023. And in some ways, the rate relief that we got, starting really in the first week of November, did kind of re-adjust seller expectations after we were all firmly in this higher for longer camp from really the summer through the end of October. So the bid-ask spread for certain assets has certainly widened out since we got a little bit of rate relief. I think there are a lot of sellers that like to think that we're returning back and reverting to the mean as quickly as possible. I think the reality is, is equity that is being deployed today still recognizes that there is some scarcity in the market, but they want to get a kind of a premium risk paid for, transacting in an environment that has really several question marks around it. So, I think the bid-ask is narrowing in certain corners of the de-risk market, but I think it is still very real in some of the more stressed parts of the market. And we'll talk a little bit about the stress later. And that's really where that gap is stubborn and staying wide.
Willy Walker : Let me talk about stress. Let me pull up a slide. Would you put up the slide that shows the impending wave of debt maturities? And, Aaron, I want to come to you for some commentary on this.
As you can see on this slide, we've got a significant amount, $930 billion, that matures in 2024. I thought interestingly on this, you can see how much is with banks. Almost half $1 trillion is with the banks. Life insurance interestingly, on this slide, has a pretty consistent share, which shouldn't surprise people who know how much the life insurance companies have played in the commercial space. But then also noticeably at the very top of it that the GSEs only have $28 billion maturing in 2024. So most of this is non-agency debt. And if you think about multifamily being half of the commercial real estate debt outstanding and the agency being half of that, it's very, I think, instructive to see how little agency debt is up for refinancing in 2024. Aaron, my question to you is, is there enough capital out there from banks and CMBS and debt bonds and life insurance companies to be able to deal with this wave of refinancings in 2024?
Aaron Appel : No there isn't. There's a lot of capital in the marketplace. The problem is that capital all wants certain types of assets and transactions, and loans to value covenants and debt service coverage ratios and debt yields. And then those covenants really don't work for the majority of credit. That's outstanding on assets. So there's capital out there. And you can source that capital and you can transact it at levels, where there's liquidity. The problem is that those transactions typically require larger cash infusions, that many sponsors don't have either the capabilities to contribute or the desire to. And when you take a look and step back and look at the office sector, which is a huge component of the wave of maturities coming. There's just no liquidity available for the most part. There are certain groups are dabbling in the sector and willing to issue some levels of credit. But the larger scale checks that need to get written into that space and that's been predominantly done through, the securitized mortgage markets or on occasion an insurance company or foreign based bank that capital is not available, for the most part. If it is it’s available on a smaller scale basis. But if you have a $4, or $5, $600 million office maturity on the horizon, you're going to extend with your servicer. There is no avenue or outlet currently at this time still to be able to transact. And it's putting a lot of pressure on the system and it's devaluing assets even further in that sector and then really need to be.
Willy Walker : So I guess the question then would be what happens? One of the interesting things is that the number that we just saw, the 930 was 660 and about $300 billion of paper rolled from ‘23 into ‘24, which is the reason that there's almost $1 trillion of maturities in ‘24. There wasn't that number in ‘23, ‘24 had $660 billion, and it's now up over $900. So there's been a lot of pushing forward. Do you see banks continuing and the major lenders continuing to work with clients to extend and pretend? Or do you think that we get to a point where there's some forced resolution, where people are forced to either pay off the loan or default, and we start to get some real breakage in the system?
Aaron Appel : So we had a bank in our office last week. They're a top five by AUM in the country. And they told us in 2022 they put out $35 billion of credit, real estate-oriented credit. And they lent out of their New York Metro region for $3.5 billion. And they told us in 2023, they lent $5.5 billion of credit. And the New York metro market. They did about $500 million. And we said, so effectively, you were in business last year, and they said yes. And they said, to make matters worse of the $5.5 billion that we lent into the market, 4.5 billion more in subscription lines to drawdowns for equity funds, and credit funds. So they did about $1 billion of asset based lending. They said the goal for ‘24 was to maybe go from $5 billion to $8 or $9 billion, and maybe they got up to $800 million in the New York metro market. And that is a top-five bank in the country with a huge balance sheet. And they said the modus operandi for them was in the event, a deal went sideways, or a sponsor couldn't pay us back at maturity, we're not looking to extend loans. We told them, they should go sell the asset and, and we'll sit with our asset management team and make sure the asset gets sold. We're not looking to take assets back. We're not looking to split notes into A/B structures. We're not looking to reposition assets. We just want to sell, and we will sell every asset that comes back to us. If the sponsor can't refinance, we will force the sale to happen. And if there's equity left over for them to get great. And if there isn't, we'll worry about a market seller. And I think we're going to see more of that coming. I was not surprised to hear that. I was a little surprised to see that it took that long to get there, but I think they're feeling it. We need to clear the decks.
Willy Walker : So, Ivy, when you hear Aaron talking about that, I mean, the kind of the extended pretend. Are the banks under any pressure right now to start to resolve all of this, or do they have enough liquidity to the point where while all of this isn't great for them from an earnings standpoint as it relates to liquidity and another banking crisis, and we saw New York Community Bank increase their reserve significantly, cut their dividend, just two weeks ago when they did their earnings? Do we have another replay, if you will, of SVB and others coming to a theater near you? Or is the banking system, from your view right now, strong enough to be able to withstand some of the chinks in the armor, if you will, that Aaron was just outlining?
Ivy Zelman : Well, unfortunately, I'm not a bank analyst, so I can't say any.
Willy Walker : Nor do I know a ton about it. So I ask you.
Ivy Zelman : I just think that what we have right now is a slow bleed with banks facing reality, predominantly the regional banks, small banks. When you look at the percent of CRE, it's the large banks. I think it's 11% versus the regionals, at 38% I think is the breakdown. So you're going to see some bleeding for these small banks, which will likely result in a credit crunch. It will affect the consumer at some point. So people ask me what's your outlook for ‘24. Are you worried about a recession? I think we're just kind of like today dealing with torture. It’s going to be slow and it's going to be regional and it's going to be specific markets that are hurting and the banks are going to be forced to tighten credit in other areas where they lend in order to deal with the problems, they have in CRE. That's how I think about it. I mean, appraisals, as we know, are going to be a lot lower than what they were when they were originated. So that's going to be pretty painful in any of the CRE categories, including multifamily.
Willy Walker : And you said, a weakening consumer does that. How does that play into your outlook as it relates to either multi or single-family and sort of the competitive forces there in the market as it relates to people buying or continuing to rent?
Ivy Zelman : Well, I think that our world is focused on the mortgage market, and mortgage credit is, you know, right now pretty average in terms of availability. But if there will be if there is more pressure again, outside of the agencies and banks are in trouble, we're going to see the loans at banks hold on the balance sheet will be tighter and in credit offerings. So that means some consumers won't be able to buy. I think that it goes back to our developers who are dependent on bank financing. You know, public homebuilders, for example, today account for 50% of the new home market. Private builders are going to be challenged to borrow from banks to fund their operations. And we'll see more consolidation. So from a consumer perspective, I think you'll see a tightening. But it's going to be again, more likely in my opinion, slower than just sort of a quick cut the cord, kind of like we saw with the great financial crisis. I think this is going to be playing out over time as the banks are finally capitulating on the unfortunate situation, they find themselves in, in those CRE loans that they have that are probably underwater.
Aaron Appel : But this wasn't supposed to happen like that. Play out the way it is. The regulation that got brought into the marketplace, post-GFC was supposed to protect the banks, and transactions were supposed to be over equitizes. When I got into the business, a traditional bank loan was at 80% loan to value and that LTV was taken down to 60%, 65%. A lot of these deals are over equitized. There's a lot more equity in these deals. Mezzanine financing pre-GFC used to go up to 95-100% of the cost. in today's environment or as of a couple of years ago mezzanine financing went up to 75%, 80% of the cost, maybe the low 80s. So there was a lot more equity in these deals, which I think is part of the reason why you're seeing this slow, this slow-moving cruise ship. But what wasn't planned was that was that the abrupt shift in the use of offices in the asset class and then coming out of post-Covid and Kris and I were talking about this the other day. The crime issues in urban infill environments around the country and primarily in the coastal cities. And that is where the bulk of the investment capital investment is both on the equity as well as credit side. And that is putting even more stress on the system right now.
Willy Walker : Bea, will you pull up the slide, the NCREIF appraisal cap rates versus transaction cap rates for a second? Kris, I want to go to you on this one because Ivy just talked about appraisal values and where appraisers are coming in. And I thought this slide from our investment sales group was a very interesting one. You want to dive in on this as if you will, the gap between a rate appraised value and transaction value for ‘23.
Kris Mikkelsen : Yeah. So we get the question a lot about when we think open-ended fund capital will be back in the market, when redemption will be either satisfied or rescinded and we can see that capital moving again. I remember being on this call in December of ‘22, and I made a comment on how long it had been since we had closed an asset to an open-ended core fund, I think, since the beginning of the hiking cycle. We're still at one multifamily transaction to an open-ended core vehicle. since early second quarter of 2022. So this data is from NCREIF. And for those of you who are watching that or aren't as familiar with this, you've got a collection of open-ended funds that comprise the Odyssey Index. NCREIF tracks those funds. There are about 2,500 multifamily assets that sit inside the funds that comprise the index. All 2,500 of those assets are appraised quarterly. So when we hear conversations about where various funds are carrying their assets, what marks they're taking, really what we're referring to is that light blue line on the bottom of this graph, which is the average of the appraised cap rates on a quarterly basis. That appraised cap rate has been significantly lower than where the private market is transacting since the beginning of the hiking cycle. In the fourth quarter, we were encouraged that the majority of the funds that comprise the index took further write downs on their multi to try and bring it more in line with where the market is transacting, their ability to onboard new capital becomes much easier when you're buying into a basket of assets that are valued much closer to the market. So they took a 5% plus or minus write-down in the fourth quarter, but that took the average appraised cap rate from 4.03% to 4.29%. So the average appraised cap rate in these Odyssey index core funds are still dramatically below where we're seeing trades occur. The head-scratching thing about this math and these numbers is the dark blue line on top. So when one of the assets that are in the funds that comprise the index trades, they go and track down the transaction data from that trade and report on the transaction cap rate. We had a pretty robust fourth quarter. I think we will announce earnings tomorrow. So I can't talk too much about our activity and numbers. But if you look at the balance of trades that we cleared in the fourth quarter, we saw cap rates somewhere comfortably in that 5 to 5.25 kind of best-case range. So we were left scratching our heads when the transaction cap rate data came out for the fourth quarter and reported a compression in cap rates by about 30 basis points down to 4.59. According to NCREIF data, it’s an average cap rate of 40 transactions. I think the folks who are listening to this call who are active market participants find it hard to look at 40 transactions that closed in the fourth quarter, keeping in mind that a closed transaction in the fourth quarter was likely awarded as we were approaching peak rates, with the ten years cresting above 5% in late October and early November. But this spread, this stubborn spread that we have between the light blue line of appraisal cap rates and where the private market is trading, is what's keeping those redemption queues filled and that open-ended capital really on the sidelines. We believe that it's likely to take the balance of ‘24 and maybe even end to ‘25, before these carry values get right sized, before capital starts moving again in that institutional space, their LPs are getting capital return to them, and they're willing to come back into the funds at revised valuations. But to have a fully functioning market with liquidity coming from all four corners of the market, we need to have this capital back transacting again. But this is the spread, the kind that goes behind the issue as to why a lot of them continue to be on the sidelines.
Willy Walker : I think one of the interesting lines here is demand has been strong but supply has been stronger. Talk about supply and demand particularly in the Sunbelt as it relates to multi.
Ivy Zelman : Well, as we've talked about, the backlog of multifamily is at the highest levels, nearly a million units, and the highest since the 70s. We're seeing completions increasing at a pretty robust pace. And then, the significant backlog or the Sunbelt is where we see a significant portion of that getting delivered. The reality is, as it's getting delivered, though, they are actually leasing up those properties. And while rents, they're choosing occupancy over lease rate. The demand has been fairly robust enabling them to deliver and provide decent NOI growth. And let's say it's not what it was, but, you know, they're running at 95-96% occupancy levels. And I think that as long as the job market continues to be more resilient, I think that our outlook is that while rent growth will slow and be down in the 1 to 2% range in ‘24 and ‘25, I think we could still see occupancy holding up. So it's going to be a tough ‘24 to ‘25 compared to previous years. But I think that it's very contingent on the job market, and overall consumer strength remaining resilient. And as we look at the transaction market, a lot of what Kris mentioned, I would just say that what we're hearing about in the channel is that there's more buyers sitting on the sidelines, that they believe that valuations have to come down further. And that has a lot to do with that wall of capital and the refinancings that need to come to fruition. But there are a lot there's a significant amount of interest. Say the vulture funds are actively aggregating enough capital to get involved. But today they're just patiently waiting.
Willy Walker : So talking about vulture funds. Aaron, I will come to you in a moment on the wall of multifamily maturities. So, Kris, talk for a moment, Ivy was just talking about vulture funds this, showing the dry powder being allocated towards value add and opportunistic strategies. Why don't you talk about this for a second?
Kris Mikkelsen : You and Peter (Linneman) talk a lot about just the amount of dry powder that's been raised. I think the important thing to point out, when you look at $250 billion capital that's on the sidelines waiting to get into the market. It's important to note that 90% of that capital is geared to generate value add and opportunistic returns. In an environment where transitional financing is, it remains as expensive as it is. You know, when you're pricing over SOFR in the low fives, the ability for that equity to price an opportunity to a value add or opportunistic return profile, the ability to get to a price that any seller is a taker of is extremely challenging. And if I had to point to one thing that has changed in the market in the last 60 days, more than anything else, I would point to that blue line. That's $80 billion of dry powder in the value add space largely, really probably all in closed end fund vehicles. There are a number of sponsors that are in that cohort that have been very discerning with their capital over the course of the last 12 to 18 months. Many of them have businesses that are built on moving that capital. They cannot sit on the sidelines into perpetuity. And the shift that we've seen in the last 60 days. Now, this is not on every asset, but we have certainly seen it in corners of the market are the groups that have that $80 billion worth of dry powder have said, look, the Fed has pivoted. I'm confident that the development pipeline has now turned off. We will get on the other side of the supply wave. I need to start moving my capital again. I'm going to do that in assets that I know, I've got a strong level of conviction and I want to own it long-term. So that same $80 billion of capital that if we had approached them six months ago and asked them to commit to a transaction, the response would have been for me to commit my value add capital, I need opportunistic returns to commit amongst all this uncertainty. Today they're coming to us and saying, hey, we're going to be eager pursuers of assets, that we have a high level of conviction around. And we've seen pricing improve in that space because a lot of that capital ultimately wants to pursue the same type of assets. So those trades have gotten more crowded. And that corner of the market has gotten more expensive over the last 60 days. Because I go back to Peter and I love that term, the weight of capital. We were talking about it in the context of the non-traded REITs that were raising all that capital from the retail market a few years ago. I think some of these sponsors that have the dry powder that we've been talking about for the last few years are starting to feel the weight of that capital again, and they're willing to move it only for assets that they've got a high level of conviction around. And in a market where there's not a lot of inventory, you know, out in the market, that's really kind of moving the needle on pricing for us. Again, this is an observation just over the last 60 days.
Willy Walker : Aaron, you all do a bunch of construction financing in your group. I'm just curious. Kris was just talking about… Well, Ivy was talking first of all, about supply and supply outstripping demand right now. Kris is talking about where some of this opportunistic capital is going. Is there a sense now that if someone puts a shovel in the ground and they're constructing for the next year or two, they're supplying into an undersupplied market and that it's time to start building, or is that conviction not gotten into the market yet?
Aaron Appel : I would say that conviction exists in the multifamily space in New York, just because historically has been relatively supply-constrained. And now you don't have tax abatement programs in place to subsidize property taxes, which makes developing multifamily housing pretty much impossible. So I think there's conviction around there. But in most markets and certainly, the markets where everybody has wanted to invest their capital in the multifamily space, which has been the Sunbelt growth markets, there's certainly ample supply that is being delivered this year, next year, and probably in the beginning of ‘26. And the development deals that we're doing in those markets are deals where the equity has been committed to the transaction. There's maturing credit on development sites. There are motivations other than just the standard IRR and equity multiple that people look to when they go to develop those assets. And we are doing construction loans in those markets for those assets. There is liquidity. It is not nearly as attractive as it was. But that is primarily where we're doing development in the multi-space right now. And I think the same goes for the industrial market. The big box, speculative industrial development, that we used to see a tremendous amount of liquidity for has thinned out. Most developers do not want to develop that product right now. There's a supply glut in the market. Large corporations have cut back on signing leases. And those that are going vertical on projects have an ulterior motive or requirement other than generating a certain type of opportunistic return. That being said, there is certainly no question that there is a strong belief in the multi-space and even more conviction, in my opinion, in the industrial space, that there will be a recovery of, or development will again make a lot of economic sense sometime between ‘25 and ‘26 to go vertical.
Kris Mikkelsen : I was gonna say even with that conviction Aaron, we had this conversation yesterday morning. Even with the conviction of delivering into late ‘25, ‘26, the belief that the outside of these edge cases that Aaron's talking about, the belief that the starts picket has been turned off. The reality is that development economics are as broken today as they've been in a long time. And I would say that they're broken to the tune of just probably at a minimum 100 basis points worth of development return that you need to generate above what a market deal looks like today before you get that capital. So I think a middle-of-the-fairway type development opportunity today when you take an honest set of underwriting to it is probably somewhere in the mid-fives. This is a multifamily centric conversation and capital need to see something closer to the mid-sixes to get on board. So what is it going to take to get from a mid-five to a mid-six? You need 20% cost relief or you need 17 or 18% NOI improvement. And with the rent outlook that Ivy outlined. And as we work our way through this delivery wave, it's hard to look at top-line growth with the expense pressure that we have right now, particularly around taxes and insurance. It's really hard to see the NOI improvement closing that gap. And on the construction cost side, so much of this cost is built-in labor. And the fact that our economy has been as resilient as it's been and, employment is as full as it is, it's hard to look at, broad brush pullbacks and costs, certainly on the margins here and there. But you know, we need a at a minimum, probably a 20% pullback in an overall cost. That's hard and soft. To really kind of justify development yields again. So it’s a real challenge.
Aaron Appel : Yeah. Or growth. One or the other. So it goes hand in hand.
Willy Walker : But we just financed yesterday a $90-million construction loan on an active seniors’ development. And it had a 60 some odd million dollars first on it from a life insurance company.
Kris Mikkelsen : Don't say the spread. Don't say the spread.
Willy Walker : I think it's important data.
Kris Mikkelsen : Now, I'm saying it's painful for everyone. Once they hear it, it's expensive.
Willy Walker : It was an 8% first and a 14.5% mezz to get it up to 80% construction and an 80% construction loan. I asked the banker what's the projected yield on cost on this? And he said 6%. I don't know what kind of rent you have to charge in an active senior community to be able to get to a 6% yield when your cost of financing is north of 10%. And look, the developer clearly has conviction on this product, and it is at Main & Main in the market that it's in. But with that said, you hear about that cost of capital to get this thing built over the next 2 to 3 years. And you certainly hope that we get some real growth back into the market between now and when it delivers.
Kris Mikkelsen : But to Aaron's point on that particular project, with mid-50s loan to cost construction leverage at SOFR plus low five hundreds. The reason why they are moving forward with that project is they've been in that deal for over two years. They own the land and, you know, had a significant amount of pursuit outlay there. They had some leverage on the land to do some of the horizontal infrastructure development. So those are some of those edge cases, as Aaron talked about, where you've got a sponsor that's so deep into this project that they've got to really kind of build themselves out of that hole, irrespective of the cost of the capital, because the alternative is to essentially.
Ivy Zelman : Get nothing.
Kris Mikkelsen : Get nothing exactly. And so, but I think those are edge cases. And, logically, the longer we go through this, the fewer of those opportunities are going to exist because they will have been worked through. But look, even in 2009, starts didn't go to zero, right?
Willy Walker : So Ivy, I just talked about an active seniors development in the multi-space. Let's talk about a single family for a moment in some of the Zelman's outlook as it relates to single. Because right now you're focused on an aging and declining, well, lower population growth, an aging population. And one of the interesting things in your last research report that I read was also a far less mobile populace. Talk for a moment about that. Because of all the great stuff in your research, and I love it. But one of the things that jumped out at me was you sit there and think. Today, with job growth across the country, and a reasonably robust economy, you would have people traveling everywhere to find jobs. And your research says, no, that's not the case.
Ivy Zelman : Right. So we know that with today those homeowners that have a mortgage are disincentivized to move. So the low inventory levels that we see in single families are attributed to that. But really on top of that, more of a long-term secular headwind has been the aging population. So 20 to 24-year-olds, 50% in a given year, 50% of them move in a given year. They're moving. So the older you are, the less you move. So when you're my age and my cohort, less than 10% of people move. So as we have the Boomers and Xers aging and assuming they're not moving as much, that's hurting turnover and therefore mobility. And I think that's going to continue. And we're going to probably at some point deal with, unfortunately, vacancies that occur given a rise in death rates. And then we'll have inventory start coming back in to be accumulated in the market. But right now people are sitting and living longer. We don't anticipate that really to occur until after post-2030, but you're going to see from 2024 to the end of this decade, you're going to start to see incremental, call 50,000-100,000 unit-per-year incremental vacancies coming from those people that unfortunately pass.
Willy Walker : So there's also a slide in one of your most recent research reports that shows the total supply of single-family housing in both built for sale as well as built for rent. And one of the things that I thought was just amazing about those numbers is that the, that had peaked, in the 3 million plus number post-GFC and has steadily come down to the point where right now it's just at about 1.5 million. If you take SFR, BFR, as well as single-family into that number. A dramatically smaller new supply of single-family housing coming into the market today. Do you think that continues to come down, or do you think we stabilize at this sort of 1.5 level?
Ivy Zelman : I think that we're going to see modest growth. I think the biggest challenge is acquiring land. If you talk to builders today, not only is it harder to get land because of no growth moratoriums, and difficulty from the NIMBYs out there, but you also cannot pencil in the returns that justify buying the land because land has not taken a break. It continued to inflate throughout Covid. So I think that we have home builders today. They're reporting that community count growth for them is going to slow relative to historical levels to the low mid-single digits where historically they might have been growing community count 10 to 12, 15%. And that's part of the slowing and starts is really about the acquiring land and getting that sort of replenishment of what they've absorbed. They just can't do it fast enough.
Willy Walker : And your outlook on SFR/BFR, it's been a pretty hot product for quite some time, particularly as we saw rates rise and the cost of mortgages go up precipitously. Are we at an inflection point here where we're getting the mortgage rates kind of settling in? And the buy versus rent decision is sort of like there was a slide that you have in there that is kind of a toss-up between buying a home and renting a home and what your actual out-of-pocket expenses are, on a monthly basis. Are we at an inflection point here, or do you think BFR and SFR continue to get a lot of investment dollars and continue to be a hot asset class?
Ivy Zelman : On a relative basis? I still think it's a relatively hot asset class. I think with respect to BFR more so than SFR, I think what you're seeing today in BFR is capital is coming back. But keep in mind that part of the BFR story is that as you pointed out, there's not as many new starts coming to market. You know, our housing stock is approaching 50 years old across the nation when you look in the northeast and anything east of the Mississippi. But what people want are new homes. But it is actually more affordable to rent a single-family home than it is for owning a home by 9%, roughly on average. So given the increase in rates, because we don't like to look at Multi comparative rents versus ownership to single family, now we can look at SFR versus for-sale. So it's more affordable to rent than it is to own today because of the surge in rates. So I think that there's more interest in that space from institutions today, and real estate funds that are looking to allocate more capital to support new opportunities and new communities and build for rent. I hear a lot that if you know of any builders that need capital and they're looking for equity financing, let us know. We want to invest. So we don't hear about that in the new home market as much.
Willy Walker : Aaron, you just heard I will be talking about BFR/SFR as sort of a not a real tectonic shift, but it's a new product to the market over the last decade and has grown dramatically. You mentioned previously office and the real shift that's going on in some of our major urban centers, beyond office to multi-conversion, what are you seeing smart money do these days as it relates to investing in the urban core? You're in New York. You see all the smart money. What's the opportunity to play in somewhere like New York or Boston or San Francisco, for that matter, right now?
Aaron Appel : If I look back and a lot of these coastal markets, where the bulk of foreign and institutional capital wants to be. If you look back over the last decade and you take out certain isolated periods, a very limited period, if you were able to get out in the urban infill, vertical industrial boom or a select for-sale housing project, in a really strong residential location, the capital, the money has been made by groups providing mezzanine capital and preferred equity capital into existing assets and development deals of the returns have been made in those positions. The 15 to 20 IRRs, that money has been made in those positions. So we just see a plethora of money sitting there looking to inject capital into those positions. Equity groups looking to do the same thing is what the credit groups have been doing for years. Credit groups have continued to accumulate and amass more capital. We're not seeing, the equity do much. If I could say what I thought a smart equity bet would be, I would say you can buy newly built multi or relatively newly built industrial and you can pay 25-30% below replacement cost and you have staying power. And could sit there for 3 to 4 years and let the supply cycle through. On the upswing, you will do very, very, very well. Outside of that, it's very difficult to see where there's a trade right now. You know, some of this has certainly been in New York. Let's take New York and Los Angeles in the multifamily market, a lot of this has been hit, the problems that exist. And the reason why Signature Bank went under and New York Community banks on the ropes. And then it has to do with the political climate and the change in rent laws and in the prohibition to allow landlords to increase rent or return on capital invested. And it's devalued the assets and it's destroyed these banks' balance sheets. And it's made investing in these markets very, very challenging. And that has a reverberating effect, throughout the rest of the market. So it's been a tough climate.
Willy Walker : Kris, Aaron, a moment ago, just mentioned buying something below replacement cost. I was out at NMHC, meeting with a client, and I said, are you active and the client said to me, well, we're not active right now because we don't like negative leverage on our buys. And I kind of ran through a scenario saying, well, hang on a second. Let's just play around for two seconds and say that the fed starts to cut and cuts precipitously. And let's just say that the ten-year follows the cuts, okay? So the ten-year comes down another 25 basis points. And this was when the ten year was at four rather than at 425. but I said okay. And then you think cap rates are going to hold as rates start to come down. You're going to get cap rate compression and you're still going to be in that negative leverage situation. So like what's the scenario that all of a sudden gets you into a positive leverage scenario where you can go out and start to be aggressive? And this client looked at me and said, you know, that's probably a good point, that we ought to start looking at it as kind of like an IRR or a replacement cost analysis. Am I wrong in asking that question? Or does the paradigm need to shift from I don't like negative leverage to exactly what Aaron just talked about, about looking at as far as replacement cost and then holding it through the cycle?
Kris Mikkelsen : I think I don't want any negative leverage was a convenient way to just say that I'm out of the market and I'm watching things evolve, and that was kind of the response from a lot of that capital that remained on the sidelines throughout the year last year. I think there is absolutely a thesis, and some of the smartest capital in the market today is very keen on basis. And in particular, as Aaron was talking about those urban opportunities. We spent the last decade in an expansionary cycle defending premiums to replacement cost as we were selling assets. Everything that we have in the pipeline today is trading at a discount to replacement costs. It's just a conversation about the order of magnitude. We've look at these near urban and urban assets that oftentimes are trading 25/30, in some instances as much as 40% below replacement cost. And we look at that as really kind of justification for an even prolonged period of development being out of favor because as those trades rent, it makes it that much more difficult to capitalize the next new project. So we believe that the runway of no supply or no new supply that those assets will have to compete with is longer there. A massive discount or replacement cost. The challenge is like Aaron said a lot of these assets operationally have been under a lot of stress. So the going in yield are relatively unattractive. You know these are sub-five mid-four types going in yields. But if you can take a 7 to 10-year view and you look at what rents you know you can project on the recovery curve. When you get on the other side of the delivery wave, rents will not go back to growing at one and a half, 2 to 3%. The capital that has conviction in this thesis is assuming that rents rise mid to upper single digits in years three and four. And that's how they're generating those value-added returns that we talked about earlier in the call. And I think that that's a very sound thesis. And I think that the basic protection there really kind of underscores the rationale.
Willy Walker : So this slide, Kris, that I'm pulling up your team has a haves and a have-nots in today's market as it relates to multi. Just talk this through for a second about those that you're all seeing that are on the haves side and those that are on the have not.
Kris Mikkelsen : We have these conversations and markets tend to get a broad brush and they're you want to have these kinds of one size fits all takeaways from the market. I think the best way to just quickly summarize where we are is we're continuing to reprice risk all across the spectrum. And on the left-hand side of this slide, you’ve got good locations, differentiated products, and favorable supply and demand metrics in the surroundings. You've got good clean operating fundamentals. You know what we're seeing in those trades are depths in the bid sheets, willingness to absorb 18 to 24 months' worth of negative leverage. We've got yields in the upper fours to the low 5% range. That's the crowded trade. As I've talked about earlier. The capital that's decided to move again is pursuing the assets that are on the left-hand side of this have to have-not continuum on the more commodity real estate. It doesn't have any kind of compelling near-term growth story, but it's still good real estate falls into the middle of this continuum. And that we feel like values for those assets will kind of move in lockstep with the all-in cost of financing because the reserve bid for those deals is the neutral leverage day one bid. So value there, 40 basis points ago, and the ten-year U.S. Treasury looked better than where it looks today, as the movement in rates has affected the all-in cost of financing. Now, on the right-hand side, we haven't talked a lot about distress in the multi-space. We didn't go down the route of talking about all the CLO products that are maturing in a $55 billion worth of maturities between now and mid-year next year, but you have some operationally broken assets that have been extraordinarily starved for capital. Some of those assets have been starved for capital over the last 24 months. Some of them have been starved for capital over the last decade. And there's real distress there. These are assets that the sponsors aren't funding any sort of CapEx. Really, a number of OpEx needs that aren't being addressed. You've seen occupancy deterioration. You've got ‘70s, ‘80s, vintage, tertiary market type stuff. That’s operationally broken, where we're having conversations about, you know when we value these assets, this after we put in all the capital and all the operational expertise to re-stabilize these assets, what's the appropriate stabilize yield. Is it six and a half? Is it seven? In some instances, it might be into the mid-sevens. So you know where values are and what kind of liquidity, you're going to have for your asset relies on the resiliency of the cash flows, the durability of the cash flows that your assets have been able to demonstrate that dictates where you fall on the spectrum. And really where you fall on the spectrum is ultimately going to dictate value.
Willy Walker : Ivy, Kris was just talking about yields. He also talked about rent growth for a number of years out here that would be projected at five, six, 7%.
Kris Mikkelsen : Come on Ivy.
Ivy Zelman : Well, I was going to say, what Kool-Aid are you drinking?
Kris Mikkelsen : To be clear, I said the investors that have conviction around that thesis, that's what they're assuming. So I'm not representing that as Ivy Zelman.
Ivy Zelman : Just look at historic rent rates. And as one operator I like to quote said to me once, you know, we used to do cartwheels if we could get 2 to 4% rent growth. And so historically, we've never seen mid to high single digits, with the exception of the Covid period where we hit double-digit rent growth. So I'm not sure what assumptions they're using. Now of course I'm talking nationally. So the markets they're looking in may assume they like going mid-single. I'm not saying that's out of the question, but not on a national rent on rent overall basis. But anyway, Willy continue your question?
Willy Walker : My question was going to be on just affordability because one of the big theses inside of your research these days is stretched affordability. As the consumer is finding it harder and harder. And there's a lack of supply. The cost of the inventory is going up. And we've got you know, Aaron talked a moment ago about rent control in a higher regulatory burden, particularly in some of these coastal states. Talk for a moment about affordability and the regulatory overlay, and, if you will, either the opportunity or the threat from a housing sort of standpoint writ large, single-family, BFR, multifamily as it relates to where there is the opportunity to get outsized returns in a market that seems to be quite regulated in a lot of different places.
Ivy Zelman : Yeah, I think we all saw the Dems just passed, put a bill out that is trying to get the hedge funds to no longer buy single-family rental community homes where they won't be able to. I don't think they'll get it. I thought it's dead on arrival, but they just issued that bill. But what affordability looks like for the existing market, it's 30% above the trend line. Stretched! 30% stretched. And interestingly, the transactions in 2023 for existing home sales were at 4 million on average. That was one of the lowest levels and pretty much recessionary levels. But we had 6% home price inflation; just doesn't go together. So it made it even less affordable. On the new home side, we had about 1% inflation, and part of that is net of incentives. Their builders can buy mortgage rates down and do a lot of things that offer consumers value. But we're 10 to 15% stretched above historic affordability levels. So you know what we've seen as a great American wealth transfer that's helping young adults, millennials, and generation Zers get money from their parents and their grandparents. And we've seen cash purchases at record levels. Going back historically, I think from any period that's helping to offset some of the affordability challenges. Will that continue? I think that we've seen the stock market at record levels. We've got, you know, a significant amount of wealth that was created for real estate, equity appreciation. So I think that today that affordability measure that we've used, Willy historically to say we're a little bit nervous right now, you know, we're going to see housing might pull back. We could even see home prices come under pressure. We're not expecting that right now because we're looking at that stretched affordability. Enough people are offsetting that, especially on the new home market where there are opportunities for builders to create value with incentives. So still looking for growth in home prices, but at a decelerated level, despite stretched affordability and the new home market and the same thing in resale, just not enough inventory, and not enough choices for the consumer.
Willy Walker : Aaron, we started with my first question to you at the top, is there enough capital out there to meet the wave of maturities coming up? And your response was, no. I think one of the capital sources that was somewhat of a surprise in ‘23 was CMBS. CMBS volumes went up by 16% to over $60 billion in 2023. And while it's 16% off of a very low base, it's $60 billion that quite honestly, a lot of people didn't think would be back on the market. Is CMBS not a savior of the market but will CMBS be active in 2024, given the secondary market and the ability to sell off the bonds? Or should we not expect a whole lot more out of CMBS in ‘24?
Aaron Appel : CMBS, I think peaked somewhere around 60 or 70% of the volume. Roughly. I would expect to see in the coming years that CMBS exceeds volumes Pre-GFC. I think it's going to become a huge, huge factor in the market because I just don't see the commercial banking sector sort of coming back out of this. Anywhere as impactful, and important in the marketplace. People talk about how the market can't rally unless financials rally. And you look at banks and how poorly they've done. But the truth of the matter is the private equity firms, the new financials in the market, and the world has changed. And Apollo, Blackstone, and KKR. You look at their stock prices and you look what's happened to their stocks and, and how they've grown. They're the new financials. They're the ones providing substantial liquidity into the market. They all control billions of dollars of insurance company capital annually. That's being contributed. Outside of the traditional life insurance company, investors that have $10+ billion credit funds that are lending capital into the commercial real estate markets, they're hugely making their impact. And corporate lending, as well, now taking substantial market share, from banks. You're just not going to see banks in the same place in candidly with the distress in the regional banking sector, the only, the only exit strategy for small balance loans is going to be small balance CMBS so small retail strip centers, smaller office buildings, little industrial parks. The exit is going to be CMBS for those loans. So we expect the majority of those loans to wind up moving from bank balance sheets to the securitized markets. And then that'll open an avenue for private capital to continue to expand in the construction space. Smaller developments have been done by regional banks. Those days are over. The cost to build those projects will increase because it'll be privatized capital. But we're seeing it day in and day out, and we don't think those trends are going to change.
Willy Walker : So I was going to ask the three of you as a last question. Give me a plug on where the tenure will be at the end of the year. If you want to answer that one, go ahead. If you’ve got another prognostication that you've got more conviction in, like the Kansas City Chiefs repeating for a third year or something of that nature, feel free to throw that out there. But, Ivy, let me go to you. Do you want to project the end of the year that you're ready to stick by?
Ivy Zelman : Well, I thought you were gonna ask, where would we personally be investing right now? Because that was your question on our last several.
Willy Walker : Why don't you go with that? And then your projection. Where would you be investing right now?
Ivy Zelman : Well, I have the privilege of knowing a lot about how the public homebuilders think about owning land. And they don't want to own land on the balance sheet. And I think being land bankers today is a very attractive way to tie up capital and get a very strong double-digit return, because the builders want to juice up their returns, but not by not owning land. And I think that's an opportunity assuming we don't have any massive cyclical downturn. But as it relates to the ten years, I might be a little bit in a different camp than you guys because I am studying historical levels of yields. We have a long end that's sort of reflecting already what the short end should be doing. So if you think about, let's say the fed funds rate gets back to 2% and they bring us into a soft landing. Why would the ten-year go much lower? I mean that’s where I struggle. So when people are saying they're so excited the Fed's going to ease, it's going to make affordability better. I'm like, you know, the only thing that's gonna make it to be portability better for the at least for-sale market, are the wide spreads that need to compress that. The mortgage investors are still required to buy those securities. And if they compress, we’ll see mortgage rates come down. But I don’t think the ten-year is going to do much, frankly. And if it did, it would probably not be for good reasons. It wouldn’t be good for the economy.
Willy Walker : Kris, where are you? What’s your investment spotlight? And what’s your projection for the ten-year?
Kris Mikkelsen : I’m in Ivy’s camp on the long end of the curve. The point that I would make is we think about where rates are headed and where it will and will not provide relief. I mean, we could get 3 or 4 cuts from the fed and floating rate that is still in the upper 6s to 7%. But what we will see is we'll see some of this cash that’s in money markets move into treasuries on the shorter end of the curve. And you'll have that neutral leverage day one bidders that I referenced earlier in the middle of that have to have not continuum able to price five-year debt over a five-year Treasury that should be trading somewhere between 60 to 75 basis points inside the ten-year. The ability for that capital to get neutral leverage over three and a quarter, five year, with all in debt in the upper 4 to 5, enables that capital to pursue those assets in the low fives. We can transact pretty efficiently there. The difference between, transacting in the low fives up to six today is super impactful. So when I think about rate relief, I'm thinking about it on the shorter end of the curve because I tend to agree with Ivy, I think we kind of have the long end of the curve that we have. I'm going to take this call off from telling people where I would invest. And I'm going to take that time to remind Aaron that the first time we had this call, he said, Bitcoin and Bitcoin has been in the news a bunch recently. He looks prescient with his call right up until the point where you go back to the chart and you see that when he made that call on November 11th, Bitcoin was at $62,000. So Appel I love you. But I have to keep you honest. Over to you.
Aaron Appel : A moment in time, though.
Kris Mikkelsen : You got diamond hands, baby. You got diamond hands.
Aaron Appel : So I agree with everything Ivy said. I would also say, Willy you send a note around last night that said, Linneman thinks CPI was maybe 1.1% or 1.5% and not, you know, 3%. And I don't disagree with him. I think that the retail inflation has pretty much subsided, but we have severe monetary inflation. We're adding 10% to the domestic monetary supply every year. And that trend is not going to stop. So owning land, any sort of asset that you can own that is supply-constrained should technically inflate. Certain commodities haven't because the production is ramped up. So if you can find things that people need, that won't inflate or want, that have a scarcity of supply, then you should be able to protect your capital. And that's where I would invest money. And at some point, that will happen with commercial real estate again, less sensitive to where rates are. I think that's somewhat irrelevant. And I'm getting sick of the conversation. I think it's supply-demand-driven. You can get out of the rate issue if rents grow. We have too much supply in office. We have too much supply in multifamily. We have too much supply in the industrial. We have too much supply in life science. And that's creating problems in the marketplace right now, more so than interest rates, which were just a Band-Aid on something that became a bigger issue. So when you write size supply, the inflation protection will come back again. I think rates become somewhat immaterial at that time, but I expect treasuries to stay somewhere in the trading range they've been here for the last 12 months.
Willy Walker : Aaron, Ivy, Kris, thank you all for both joining me today and for all you do. And thanks everyone for joining us today. Great conversation. Have a great one. We'll see you next week.
