The Federal Reserve cut interest rates for the first time in over four years. So, what does that mean for inflation, future rate cuts, and real estate?
In this episode, Trademark CEO Terry Montesi speaks with esteemed economist Dr. Peter Linneman about the impacts of rate cuts and why he says the Fed’s recent actions are “a year late and 150 to 200 basis points not enough.”
Plus, Dr. Linneman, known for his sharp analysis, weighs in on the factors he believes truly drive inflation and economic growth.
From inflation trends to interest rate trajectories in the current cycle, this episode explores the dynamics between policy and the retail, multifamily, and mixed-use real estate markets.
To stay up-to-date with real estate developments and insights from industry leaders —subscribe to Leaning In.
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Transcript
Terry Montesi: Welcome to another episode of Leaning In, brought to you by Trademark Property Company, where we explore the forces shaping the future of retail, multifamily, and mixed-use real estate. I’m your host, Terry Montesi, Trademark’s founder and CEO. And today we have a great guest with us, my friend, the legendary economist and professor, Dr. Peter Linneman. With decades of experience and deep insights into the intersection of real estate, finance, and economics, Peter has been a trusted voice in the industry for many years. We’re excited to have him back on the show at this pivotal time in our country, in the economy, and in commercial real estate. Now, let’s lean in.
Well, hey, Peter. Good to see you. As we record this, we’re just days past the widely anticipated first rate cuts from the Fed. So, the obvious first question is, what is your planning forecast when you think about rate cuts, both the Fed, so short rates, and the 10-year?
Peter Linneman: So, I think it’s important to understand what inflation is to understand where interest rates are likely to go. Inflation, CPI, came in at 2.6% a couple of weeks ago, year over year, but if you look at the last four months, it is unchanged, zero, zero. Prices have not risen over the last four months based on the consumer price index. Personal consumption expenditure index was just released today, and it came in year over year at 2.2%, but also basically for the last four months, no change. So, we’re at an environment where we’re very close to 2%, but more dramatically, we’re in a period now of four months where we’ve had no systemic price increases.
It’s more dramatic than that, however, Terry, because there are roughly 78,000 items in these indexes. If you take one item out that no one has ever bought, nor will ever buy, and you only leave in the 78,000 that somebody actually buys, you get a different picture. And the one item is something they call owner equivalent rent. It is the rent that they say a homeowner is paying to themselves.
Now as a homeowner, I have no idea what that means. They say it’s risen by 6% over the past year, but since I don’t know what it means in the first place, I have no idea if it did or didn’t go up 6%. It is 24% of the consumer price index gets that 6% attributed to it, and 12% of the personal consumption expenditure index gets that attributed to it. So, if you take out owner equivalent rent, which by the way Europe does, Europe does not include owner equivalent rent as a concept, they only focus on things people actually purchase. So, if we only focus on the 78,000 items that people actually purchase, over the last year, inflation is 1.1%. And over the last four months, it’s actually negative.
Now, what does that mean? I think last time we talked, I told you inflation is over. Supply chains have adjusted. It’s back to a different world. And therefore, inflation, it’s going to be similar for the next couple of months. What does that mean? If inflation, for the things that people actually buy, has been 1.1%, why would you have a short-term rate on safe liquid at 5.5%? That makes no sense. That’s getting money for nothing.
So, when they cut 50 basis points, it was a nothing burger in the sense that we still have miles to go. It’s important. You’ve got to start somewhere. But it’s like the first shovel full of dirt when you’re excavating a site. You’ve got to start there, but you’ve got a long way to go.
How far do you have to go? I think the inflation rate stabilizes at around 1.5%. That’s what it was all prior to the pandemic for 30 years. If inflation stabilizes out at 1.5 or so percent, that says the short rate should be 2.25% to 2.5%. They’ve got it at 4.75 to 5. You have enormous still to cut, over 200 basis points still to cut on the short end. And they’ll cut again, and they’ll cut again, because they’ve seen zero for the last four months, and it’s a bit shocking. I don’t think they fully appreciate the owner equivalent point, but it’s a shocking phenomenon. And there’s more cuts to come, a lot more to come.
The long rate, I think inflation stabilizes around a percent and a half, as it was prior to, and the long rate should be 150, maybe 200 basis points over inflation. That says the 10-year should be 3 to 3.5%. It’s a little higher than that. It’s like 3.8%. Why is it not all the way down? Because people are being paid to stay in short-term money. They’re being paid.
So, think about it. I don’t have to invest in property, I don’t have to invest in stocks, I don’t have to invest in long bonds. I could sit in short term money and still get 4.5, excuse me, 4.75 to 5%. Inflation currently is 1%. The train hasn’t left yet. The train is getting ready to leave, but it hasn’t left. And so people are sitting on that cash, rather than going into 10-year treasuries. They’ll go into 10-year treasuries, and that will bring down the bid spread. You’ll get more action.
So, you’re just seeing the beginning of the thing we’ve talked about in the past, which is as they cut rates, they’re going to cut the incentive to do nothing. And doing nothing is not productive. And as they lower the rates further, which they will, people are going to say, oops, I better get on the train before it leaves. And it’s the train of buying long-term assets, whether it’s 10-year treasury or real estate or stocks, all of those are going to see favorable movements, not day to day or week to week, but over the coming period as the rates get cut.
Terry Montesi: Well, so in your mind, the direction has definitely been set.
Peter Linneman: It definitely has been set. Even the Fed has figured it out.
Terry Montesi: It was interesting you said that you’re not sure they understand the homeowner equivalent. And it boggles my mind, though, that… You say they, you mean the Fed governors?
Peter Linneman: Okay, I’ll give you a little secret, Terry, and I’ve told this to a couple of audiences, and we put it in the Linneman Letter recently. People in PhD programs in economics and professors study the topic of the day. I mean, that’s how you make your bones. You don’t make your bones teaching and studying ancient history.
So, I happened to go to graduate school in the 1970s, and inflation was the topic of the day because around the globe, inflation was running 10 to 100% a year, depending on what country. So, you can imagine everybody, young PhD students, old PhD students, luminaries, new faculty, everybody was studying inflation in one way or another and what it meant. You couldn’t walk… And by the way, every course was filled with all these articles. So, you were steeped in it as a study.
Now, by 1984, inflation had been tamed by and large in the developed world. What do you think happened to the study of inflation? It kind of disappeared because now there’s a new topic of the day and a new topic of the day and a new topic. And you don’t put on your reading list articles that are 40 and 50 years old. You just don’t. So now think about, by the way, inflation pretty much ends as an issue by 1984, that means the bright-eyed, new 28-year-old PhD who had just gotten steeped in it is a cataract-ridden 68-year-old who’s past their sell date. I’m 73. I’m way past my sell date. Larry Summers, past his sell date. He’s like 71. Alan Blinder is like 74. It’s not perchance that the only people who had been onto this, and we all disagree a little bit, Joe Stiglitz, it’s not that we’re brilliant, it’s that we were steeped in it, and we were trained in it.
Now imagine somebody – by the way, the Fed has like 200 staff economists, typical age is probably about 32 years old. That means they got their PhD four years ago. What do you think their syllabus and their thesis were about? I saw the topics. It was about serving minority communities and this and that, whatever the topics of the day were. They were things we didn’t study. I’m not saying they’re not topics to study. I can’t tell you as much about them, those topics, as they can. They had nothing on inflation. It would have been as if smallpox suddenly came back. And there are no doctors or nurses who know how to treat smallpox.
Terry Montesi: So, inflation just hasn’t been an issue during their life.
Peter Linneman: Hadn’t been an issue. So you have doctors and nurses that are talented, it’s not like they aren’t talented, they have no idea of what to do with it, even though, 50 years ago, there were plenty of doctors and nurses who knew how to deal with smallpox. So it’s a little like that. So when I say I don’t think they’re really tuned into it, that’s why. And when people ask me, well, how could they miss it that badly? Because they’re young. And it’s not because they’re stupid and young, it’s that they weren’t trained in it.
Terry Montesi: Yeah, it’s not so much that Jay Powell doesn’t understand it.
Peter Linneman: But he’s not an economist. He’s not steeped in that. He’s a banker type. It’s a different skill. He’s an administrative type. He’s relying on staff, and most of them are relying on staff.
Terry Montesi: Got it. So, he’s reading the data he’s given. Got it. That’s interesting. Well, that’s a big one. And we’ve talked about it before. I understand it better now. And at this moment, it’s even more important, certainly. So, in your mind, the Fed has gotten inflation down to 2%?
Peter Linneman: I don’t give them credit. I’ll tell you what I think got inflation down. We talked about this, Terry, about two years ago, I think. What made inflation go up? Because during the pandemic, supply shut down and then demand came back. So, the example I use…
Terry Montesi: They increased capacity and that’s what…
Peter Linneman: And until capacity caught up, prices shot up. And once capacity caught up, supply and demand were imbalanced. So prices moderated in terms of their increase. By the way, they would only drop if supply got way larger than demand. If supply and demand are imbalanced, they just stop rising.
And you can think about, I was thinking about this the other day, I was going to an NFL game. And four years ago, you couldn’t go to an NFL game. All those employees had been let go, all the parking lot people and all of this and all of that, capacity had been eliminated.
Terry Montesi: Did you go to an Eagles game?
Peter Linneman: Yeah. And then they say, now you can go, now you can go suddenly when they opened up, but they didn’t have workers. And so, what happened to the price of beer and what happened to the price of parking and what happened to the wages they had to pay? That had nothing to do with the Fed. That nothing to do with the Fed.
They eventually got the workers back, they eventually got the Dixie Cups back, they eventually got all that, and as they did, prices stopped rising. But remember, they would only fall if supply got a lot bigger than demand. It’s not if supply and demand are imbalanced. So did the Fed have a little to do with it? Yeah, but not much. I’m happy to give them credit if they do smart things though.
Terry Montesi: So, have they done anything smart?
Peter Linneman: Rarely, but cutting the rate is smart, but it’s a year late and 150 to 200 basis points not enough. And you can see the kind of distortions it does. It encourages people to invest short term instead of long term. It encourages people to hold more cash than is reasonable. It’s the distortions.
I’ll give you another one. We have a shortage of automobiles that have been consumed in the last four years. We’ve probably under-consumed automobiles to the tune of about 8 million over the last four years, maybe more. Why? Because during the pandemic, you couldn’t buy them. Then, just as you could buy them, they didn’t have the parts to make them. Then as they got the parts to make them, you started going out and the prices were outrageous because of the shortage, but then the supply’s coming back. And just as the supply’s really back, what happens? They raise the interest rate, so anybody who borrows to buy can’t afford it. So we have a huge shortage of autos. So what the high interest rates have done is discourage people from buying autos that they need. Those are the real harms.
Terry Montesi: And houses, right?
Peter Linneman: And housing is the same story. Housing is exactly the same. Housing is even a bigger story in the same way. And in fact, it’s interesting, Terry, if you say there is a reason why the economy responds to short term interest rates, it goes as follows. If the economy is really overheated, way above sustainable norm, if it’s overheated, it’s almost always because housing, auto, and manufacturing are way above normal. So we’re not buying the normal number of autos, we’re buying 1.25 the normal number of autos. We’re not buying normal housing, we’re buying 1.25 the number of housing. And that creates the bubble.
And you say, okay, those do respond to interest rates. Why? Because auto, if they raise the interest rate, not only does the manufacturer have a higher cost, but the borrower has a higher cost on an auto. So they do less, and it cools it. And for homes, it’s actually not so much on the buyer’s side, on the short-term rate. It’s the producer because they use floating rate money to produce, interest rates go up, it cools it. Manufacturing gets cooled because they use lines of credit secured by inventory and receivables that float.
We had underheated housing, underheated auto, and underheated manufacturing when they started raising interest rates. What did it do? It cooled all three needlessly. It slowed the economy needlessly. We’re still 2% below pre-pandemic trend. We’re above where we were in 2019, but below trend. They’ve cooled an economy that doesn’t need cooling; it still needs heating. Why is it still below trend? It’s all auto, it’s all housing, it’s also still healthcare a bit.
Most of the economy, I think we talked about this once, Terry, most of the economy, people don’t realize, has no responsiveness to interest, short-term interest rates, none. And I’ll give you my favorite example. I had a heart procedure a week ago. I just was out of a general anesthesia a week ago, two and a half hour procedure. And the reason I had the procedure was I got a call from my cardiologist who said, gee, you need this procedure because if we don’t do it, you’re at risk of a stroke. I did not say, well, let’s see if Powell cuts the interest rate a bit more.
Terry Montesi: Yeah, the prices might come down a percent.
Peter Linneman: I said, can you get me in on Friday? Or somebody delivering a baby, they’re not saying, well, wait, I’m going to see what interest… healthcare, anybody taking a prescription, they’re not asking what the interest rate is. That’s silly. That’s 18.5% of the economy.
Terry Montesi: Not much price elasticity for heart procedures.
Peter Linneman: Yeah, I mean, there’s not much. And so, there’s no sensitivity in healthcare. If we need new police hired, if we need new teachers hired, there’s no response to short-term interest rates. State, local, and federal government, 35% of the economy, not interest rate sensitive. I don’t know if you sent your kid off to college, did you ask what’s the interest rate before you sent them? Or if you’re sending your kid to a private school, you didn’t ask what the interest rate is. So, there’s huge swaths of the economy that aren’t interest rate sensitive.
Terry Montesi: Well, along those lines, Peter, how interest rate sensitive do you think multifamily, office, and retail real estate are to the first cut, but then let’s say the somewhat sustained cuts over the next 12 to 18 months?
Peter Linneman: On the demand side, for rent and occupancy side, not a lot. Because that’s being determined by real things. Okay, yeah, warehouse, if autos pick up, then there’ll be more auto parts and so forth, but at a first approximation, not much on the demand side. On the supply side, because as you know, new supply is funded by floating rate money almost always, that will pick up. It won’t pick up immediately, but that will pick up.
The other thing that will pick up is capital flows, though. And capital flows will pick up because all that money that’s sitting there saying why invest in anything long-term is already starting to say, maybe the train’s leaving. By the way, you cut rates another 25 basis points next month and 25 base points the month after that, they’re going to start saying, I’m going to get on the bus. And as you know, there’s money on the sidelines. In all forms, there’s money on the sidelines. That will raise the flow of money.
So even if NOIs don’t change, the valuation of NOIs will go up because there’ll be more money chasing NOIs. So it’ll be good for stocks, it’ll be good for real estate, it’ll be good for long-term bonds. All of those things will benefit as money flows. Real estate will particularly benefit because it’s so capital intensive. And we’ve talked about cap rates before. Cap rates are not determined by interest rates in and of themselves, they’re determined by the flow of money. And right now, short-term interest rates are deterring the flow of money.
So, I expect to see, let me just take apartments because mark to market rents make it easier to talk about. I expect an apartment complex that you might be looking at at a five cap today, you’ll be struggling to get for a four and a quarter cap in a year. And not because NOI changed or the market changed, but because capital flows changed. There’ll be more money chasing about the same amount of product. And by the way, you’ll be back to kind of where you were 2019. That says get on the train now. I want to be a buyer when transaction volume is below normal. If I ever sell, I want to be a seller when transaction volumes are above norm. And as you know, transaction volumes of everything are well below norm.
Terry Montesi: Time to be a buyer. Well, I’m very much in sync with you on that, and that’s that’s very helpful. So, as you think about inflation, you see that it’s under control right now. As you look forward and you think about what happens to the economy, interest rates come down, more in balance historically like you discussed, where do you see, is there anything on the horizon that you see that would cause upward pressure of significance to inflation the next few years?
Peter Linneman: Not notably in a long-term sense, but let me give you why I mean in a long-term sense. It is not inconceivable that what’s going on in the Middle East further escalates. There’s a short term – short term could be a few months – embargo that some of the Middle East producers create that would shorten the supply of oil. Yes, fracking would offset it, but it takes a little time. Yes, Guyana would offset it, but it takes a little time. So you could get spurts, but not sustained. And you even saw with the Ukraine situation, there was a spurt, and then you figure out how to do workarounds.
Terry Montesi: So, ex event risk or energy-related inflation from event risk, you don’t really see anything in our economy or the global economy that would cause a big inflation risk?
Peter Linneman: No. And people say, well, Congress is spending too much. Congress always spends too much. The bad politicians, we’ve always had bad politicians. Bad economic policy, I always tell people, can you show me the time we had great economic policies? Because I must have been sleeping then. So I don’t mean this in a demeaning sense. I just mean it in an observational sense.
I’ve said this before, which is I’m 73, and every year of my life, you can make a list of reasons why the US economy is in trouble. They’re real reasons. The education system doesn’t work, bad politicians, deficits, whatever, whatever, whatever you can make. And yet we grow. We may have a short period where we don’t grow, but we grow. And in fact, we are still, remember, we’re 2% below trend, so we have a lot of growth built into us, a lot of pent-up demand. Just think of the auto example. A lot of pent-up demand to drive the economy as we go forward on top of normal growth. Plus, the Ukrainian war is adding about 30 to 40 basis points of growth to us because we’re a major oil producer, we’re a major weapons producer, we’re a major agricultural producer. So those will continue.
And then you don’t get recessions typically until six to eight years of recovery. We’re only in the third year of a recovery. We’ve got a long way to go. When you’re really worried about recessions, they rarely occur. When you’re really worried about being hit by a car is not when you generally get hit by a car. It’s when you’re not looking that you get hit by a car. And so I think we’re in a very good period. Are there enormous problems in the economy? Yes. There always have been. There always will be. It’s not nirvana. It’s just progress.
Terry Montesi: Do you see any risks or unintended consequences of the rate cuts for real estate investors?
Peter Linneman: Well, I think almost all the consequences are good if you’re a short-term borrower.
Terry Montesi: Unintended negative consequences.
Peter Linneman: I don’t see any negative. You always hate to say none because the fact that they’re unexpected means I should have thought about it, right? But I think this one is pretty straightforward for most real estate people. It’ll be neutral to better as it happens.
Terry Montesi: That makes sense. But the unintended was important. Well, you alluded to it a second ago. I have to get to it. Because you are one of the few voices in the country, economists, business leaders, et cetera, politicians, that don’t seem very worried about the increasing federal deficit. And there are plenty of examples, I think, of deficits causing devaluations of currencies and crippling economies around the world. I’m not smart enough to know a number of examples where countries accumulated big amounts of debt and things went fine long term.
So, help explain why you’re less worried than most. And are you starting to get worried? Does it get to a level where you start to get worried?
Peter Linneman: No. If I told you Bill Gates has a lot of debt compared to you, is that a problem? And you go, well, no, he has so much wealth compared to me. Well, maybe that’s not true for you. I should say for me. And if, however, you’re not Bill Gates, think of Botswana. You’re poor. You have very low prospects. You have a very weak economy. You have very little strong economic future. These deficits can kill. They can truly kill.
Terry Montesi: A few years ago, right? Greece.
Peter Linneman: Yeah, absolutely. You’re spending what you don’t have, you’re spending in ways you shouldn’t have, you’re borrowing from a future you don’t have.
Now let’s compare that to the United States. We have net of the government owing debt to itself, the federal government. So, when you hear the headline debt, a lot of that is money owed by the federal government to the federal government. Well, that’s a bookkeeping exercise. That doesn’t count. Because if we paid it, we’d still have it. So, when you net that out, we have about $23 trillion of debt, federal debt. And by the way, a lot of that is because of really dumb spending, not all of it, but a lot of it was just dumb spending. The dumb spending is the problem whether we have a surplus or a deficit. Dumb is dumb. Wasteful is wasteful, whether we have a surplus or deficit.
Now, 23 trillion, and we have a GDP of about 28 trillion. So, think of it this way, your property has 28 million in income, and the total debt on the property, total debt, is 23 million. Is that a highly leveraged piece of property? You can pay the entire debt off with 9 months of NOI. No way. You would say that’s a really, really low leverage. Why? Because the income capacity is huge, not Botswana. By the way, if you had no income and you had that debt, that’s huge. But if you’ve got that kind of income, it’s not huge.
And let me take one other variant. We have about $163 trillion of household wealth, and we have $23 trillion we owe to the federal government. We’re responsible. When I say we, the citizenry, all the households, we’re responsible for that. Let’s say we paid off the $23 trillion. You’d say, well, that would reduce our wealth from 163 down to 140, paid off the 23. But it wouldn’t. It would only reduce our debt, I mean, our wealth from 163 to 156. Why? Because we’d be paying ourselves. You own some of that federal debt. So, when it was paid off, you’d be getting income from it being paid off. It would only fall by about seven trillion because that’s the money we owe foreigners.
We would never, we should never, ever, ever, given our income capacity, pay off those foreigners. Why? Because we have the option to stiff them. And you never want to give up the option to stiff them if times are really bad. Now, it would come with consequences if you did it, but you’d want that option. But we don’t have much debt compared to our income. We don’t have that much debt compared to our wealth. How many of your buildings are worth $163 million and only have $23 million of debt on them? Not many. How many of your buildings have 28 million of income but only have 23 million of debt? Not many.
Terry Montesi: What is everybody else getting wrong, so wrong? Because the politicians, economists, so many smart businesspeople, seemingly smart, are saying there’s a fire brewing. What are they getting wrong?
Peter Linneman: They’re confusing a political problem with an economic problem. Think about it. By the way, I should have you convinced we have the resources. We’re not Botswana. It’s not a building with zero income and debt. That would be a problem. That’s an economic problem.
What is the problem? The problem is we have 335 million people in the United States. And we owe $23 trillion. And every one of the 335 million people has a reason why they shouldn’t bear the burden of the debt. They have resources. There are resources there. Every one of them has a reason. I’m old. I worked hard all my life. I shouldn’t have to take any of it. You are investing in high tech, and high tech is essential to our future. You shouldn’t have to bear any of it. Somebody else is a student. They shouldn’t bear any of it because they’re a student. And on and on and on.
Terry Montesi: That’s the political problem.
Peter Linneman: It’s a big political problem. It’s not a big economic problem. And that’s why people… and people conflate the two. So I can’t tell you how to solve the political problem. But I can tell you, it’s not an economic problem. It may get you voted out of office, but it won’t be a problem that the economy can’t handle.
Terry Montesi: It’s not going to bankrupt our country. But it’s interesting, even the ratings agencies in the last few years from time to time have thought we had too much debt. So, it’s very interesting.
Do you think the results of the election, and there’s three parts of it, House, Senate, and Executive branch, do you think the results of the election matter much? Is there a scenario that it does matter, but several that doesn’t matter much to our retail, multifamily, and mixed-use real estate business over the next few years?
Peter Linneman: So, this is similar to what we were just talking about, Terry, which is there’s a difference between the economics and the political of it. And I’m only going to talk about economics. I’m not going to talk about… I’m not a specialist in abortion and immigration and all those kind of things, although immigration obviously helps labor force-wise.
If you look at the history of the growth of the economy in my 73 years, you could not figure out when a Democrat was in charge, a Republican was in charge, the Senate was controlled by the Democrats, Senate was controlled by the Republicans. It was mixed; you can’t tell. And I don’t mean as a memory test. You would just see that the economy grows, except every once in a while it doesn’t, and then it grows again, no matter what. And that’s because we’re better than our politicians. Botswana is not better than its politicians. That’s why they struggle. We are better than our politicians. It doesn’t mean they can’t have an impact on us.
Most of what government activity is about is redistributing resources, not growing the size of the pie, because they get elected by redistributing resources much more easily than growing the size of the pie. It’s much easier to say, I took 3% from somebody else and gave it to you, than it is to say, I increased the economy by 6%, took half of it, and you got it. You and I would do the same thing.
So, here’s my example of how to think about the impact of the election on the economy. It’s a little simple, but I think it captures it. If you’re a fossil fuel producer, you want the Republicans to sweep everything big, because they’ll be more favorable regulatory, they’ll be more favorable to tax policy, to fossil fuel than current. If you’re in renewable, you want the Democrats to sweep everything big, because they’ll be much more favorable to renewable. It has huge impacts on individuals, on players.
Either way, we’re going to go home at night and turn on our lights. Either way, we’re going to turn on the heat when it’s cold. Either way, you’re going to fly a plane. Either way. Might it be a little more expensive or a little less convenient one way or the other? Yeah, but compared to the money being changed hands, that’s second order. The economy will go forward. Might it be a little better, might it be a little worse? You’re going to have to have a pretty good pencil to figure that out. You don’t need a very sharp pencil to figure out who won and who lost. So the economy will not be massively affected. There’ll be a lot of action.
And as you look at the economic policies for every one that they mumble out that might make sense, they mumble out six that make no sense. And that’s true of all of them. And you don’t even know if they’re going to do any of the things they mumble out. So I don’t worry a lot about it. Will it have a big effect on? Yeah, I mean, if they decide to change the tax laws in certain ways that reduce depreciation and so forth and so on. Yeah. First approximation, tax laws are hard to change. That’s why they change very rarely. We worry about them changing. How many years, the 1031? 1031 has existed for like 103 years.
Terry Montesi: And they’ve been talking about going after…
Peter Linneman: And they talk about it every time, and it survives for a reason. It doesn’t mean it will always survive. There’s an element of that in all of it.
Terry Montesi: Do you agree, does that, even under the scenario where one party gets control of all three, that doesn’t worry you too much?
Peter Linneman: I generally prefer mixed governments because, look, our system does have checks and balances naturally in it. And we saw when Trump had a unified Congress and White House, and we saw when Obama had it, and we saw with Biden, even when they had it, it’s hard to get stuff through. You can kind of pick one, like Obama. It was a very popular election, et cetera, struggled like hell and only got healthcare, which was his number one thing through with not gimmicks, but it wasn’t through the front door. And it shows.
And therefore, if you have a divided government, it puts even more checks and balances on. Having those extra checks and balances does mean sometimes things that should happen don’t happen. I understand that. But it also means sometimes things that shouldn’t happen don’t happen. And I’ll take the latter in exchange over the former.
Terry Montesi: Yeah, I often hear people that are so worried about the election and what it’s going to do to the economy, et cetera, et cetera. And I remind them that if you look back and what I’ve heard from economists and friends like you is that really who’s in charge has not really had that big of an impact on our lives. It has an impact maybe on our psyche because we watch TV and we get worried about things, but in reality, it really doesn’t have that much of an impact on the actual economy.
Peter Linneman: I’ll tell you my analogy. I grew up in Northern Ohio and for God knows how long, since Jimmy Brown retired, every top draft choice of the Cleveland Browns is going to completely change the destiny of the Browns. And they will have a completely new direction. And they have all the stories saying why this one will. And you can go through the litany. And more or less, the Browns struggle, more or less. Now, they’ve got a… But it’s the disconnect between the narrative and the reality.
By the way, the Detroit Lions, while the Ford family owned it, even more so that way. There was always a new draft choice, a new coach, a great story, this one’s different, and the same thing happened. Now they’ve got a new ownership that did change things and so on. So I’m not saying nothing changes, but it always reminds me a little of that. The hyperbole is so much greater than reality.
Terry Montesi: Peter, what’s your view on the consumer and its impact on the economy and then on the retail real estate business and other things to be cognizant of on the retail real estate business like supply and demand, etc.?
Peter Linneman: So, the consumer is in quite good shape. They have the highest wealth they’ve ever had in history, including lower income people have higher wealth than they’ve ever had. It doesn’t mean they have high wealth, don’t misunderstand. They have higher wealth. They have higher real wages than they’ve ever had. Their wages have outstripped inflation, not as much as they would have liked them to, but they’ve outstripped inflation. The retired consumer has been protected from inflation to a large extent by two things. One is Social Security being indexed to be inflation plus, and the second is their retirement accounts have done quite well over the last couple of years.
So, they have jobs. The economy is still early in a recovery. Their debt is up, but it’s up from extraordinarily low levels. Their defaults are up, but they’re up from extraordinarily low levels to closer to normal levels. So I’m not saying there aren’t some consumers in trouble. I’m just saying the overarching. And as a result, the consumer is in pretty good shape, not perfect shape. They’re never in perfect shape. So I think the consumer will do quite well over the next few years. I think the economy does okay. I think the consumer will drive that. That will be good for retail real estate.
The retail bricks have shown that they can hold their own with online at least in lots of things. For example, as you know, groceries. If we talked five years ago, you weren’t sure if your grocers could succeed versus online. Today, you’re very comfortable that they can succeed versus online. By the way, that’s true of anything that has real low margins and has high returns. And so, brick retail will do quite well with the consumer.
There will be things that continue to get disintermediated. The online sales will take a way disproportionate chunk of the growth in retail sales over the coming years, but that doesn’t mean brick retail sales go down. It just means they don’t go up as dramatically as online. Six out of every, or five out of every six dollars that are sold, not counting auto, are sold through bricks. And let’s say that 10 years from now, instead of five out of every six, it’s 4.3 out of every six dollars are sold through brick, but there’s 10 years growth of more retail to offset that.
Terry Montesi: That’s what’s been happening in the last 10 years.
Peter Linneman: And there’s not a lot of development. The development, as you know, is laser focused. There’s net destruction of retail. That doesn’t mean that… I said to the audience, I learned real estate from Al Taubman. We couldn’t have a much better… I learned economics from Milton Friedman and real estate from Al Taubman. You’ve got to admit, I have good taste.
Terry Montesi: I know Billy and Bobby, and I had lunch with Al and Billy and Bobby one time, and what a character.
Peter Linneman: He was amazing. And one of the things that I remember Al telling me like, I don’t know, in the late 80s was that retail is a hard business because you’re using long-term leases to satisfy ever-changing consumer tastes. And consumer preferences constantly change, and therefore they want this retailer instead of that retailer, but you just signed three years ago the hot retailer to a 10-year lease, and three years ago they were red hot, but now they’re not.
And what makes retail interesting is it’s natural barrier to entry. And my view is you have to be willing and able to deal with ever-changing consumer preferences. And the typical institutional investor has a hard time doing that. It’s too much work. It’s hard work. It’s harder work than I want to do. I want to outsource it to guys like you. Because that’s hard work. And think about how quickly consumer preferences change in retail versus for apartments or for warehouses. Do they evolve for apartments and warehouses? Yeah, but not nearly so fast, not nearly so fast.
Terry Montesi: So, regarding multifamily, we’ve seen rents flatten as supply growth was a little overheated and then to see the capital markets slow, which also slowed the supply. What’s your view on the multifamily business, the multifamily real estate business, particularly in the Sunbelt over the next three to five years?
Peter Linneman: So, two things. One, the best thing unambiguously that multifamily has going for it is we have about a 3.5% shortage of single family in the country, more in some markets than others. And that’s fundamental. And that means home prices are going to go up, continue to go up faster than inflation. And that means people are going to have to rent longer to come up with the down payment, which is good for apartments. That’s a fundamental good. And that shortage is not going to disappear anytime soon. That’s going to be a long time. That’s number one.
The second thing is you come to the shorter term. We went from, just like everything else in the economy, demand came back faster than supply, and the rents went way up, income went way up, we produced a lot of supply, just like I was saying happened all across the economy. What happened? What happened was that supply came online. In the case of apartments, it took a little longer than for most products. What happened to rents? They stopped rising. And in some cases, they even fell because of the excess, downtown Nashville or some places.
But what happened to supply? Supply responds. So, what’s going to happen to new supply coming online in late ’25 and into ’26 and early ’27? It’s going to be a shortage. The economy is still going to be good, the demographics are good, people are still going to have to save longer to buy homes, and you’re going to see the rents go up notably faster than inflation.
So my analyses of rents in the Sunbelt basically says that they’re going to, if they haven’t already bottomed, will bottom in the next quarter and then start an upward movement. And you can imagine a market like Atlanta maybe still has to go down a little. You can imagine a Nashville has to go down a little. Austin has to go down a little. They’re all high demand growth markets though, and they’re going to eat up that excess and you’re going to see rents go back up.
So, I see rents going up basically over the next five years a percent or more, more than inflation on an annual basis, even though the next six to 12 months is going to be lower than that.
Terry Montesi: Great. Well, to follow up on that, we are under construction now for almost a year on our first multifamily project. So, it will be delivering mostly in mid’25 to early ’26. And then our second one will start later this year. So, it will deliver 15 to 18 months later to 30 months later. So based on what you just said, our timing is pretty good.
The other thing, Peter, I didn’t mention to you, we actually are in pre-leasing and deep into design development on our first three ground up retail projects in the last seven years. The first time we’ve had any ground up activity because the supply, there’s really nothing. The retailers are expanding and there’s nowhere to go and there’s now real opportunity to build in select areas to build some new supply.
Peter Linneman: Yeah, I think there’s opportunities there. Those are laser-like opportunities, though, I think you would agree.
Terry Montesi: Oh, absolutely. And my last question is macro – trends that you’re watching for, trends you would encourage me and our listeners to be paying attention to that are going to impact the commercial real estate business the next three to five years?
Peter Linneman: There are two. One I wrote a book with Mike Roizen and Albert Ratner a couple of years ago about, which is we’re going to live longer and healthier and the population is not going to fall nearly or stop rising nearly as much as they think, and people are going to be more productive and healthier. And the Baby Boom and older is the richest, most active society of that age in history, and they’re going to have a lot of impact with that and what do they do with their money. So, you want to watch what do they do with their money. That’s an important thing. If you can get in front of where this is the largest, richest cohort in history, if you can figure out what they’re going to do with their money and get ahead of it, you’re going to win.
The second one, I know everybody expects me to say AI, but I think far more important in the next five to eight years are the obesity-related drugs. The obesity-related drugs are incredibly game-changing. And the reason is we spend roughly 14% of GDP every year on maladies associated with people being overweight, not just obese, but being overweight. And people have a hard time managing their weight. And these drugs are making real inroads on people managing that, not solving it, but managing that.
And I always find it funny when people say, Terry, yes, but they have to stay on them or they’ll… you have to stay on healthy eating and exercise. That’s not so easy either, as you and I know. So anything you’re going to do is a life decision. For those that, for whatever reason, have a hard time doing the eating and exercise way, this is a real game changer.
Now think about the following. Let me just say that suppose that people now get healthier, they reduce their weight, they don’t become perfect, they reduce their weight, they get healthier, and instead of spending 14% of GDP on these maladies, we only spend 10% of GDP. Why? Because somebody doesn’t have diabetes as soon, they don’t have breathing issues and other kind of issues as much, and we save 4% of GDP a year.
That’s like a $1.1 trillion, $1.1 trillion a year, every year, that we now can do other things with, like go to your shopping centers and spend it, or get fancier apartments, or pay down that deficit if we want, or some of that money, think of it this way, a trillion dollars. Let’s do real fast math. If it’s a trillion dollars and we spend 90% of it, that’s $100 billion more to invest every year, $100 billion more than before. Let’s say real estate gets 10% of that. That’s a $100 billion out of nowhere to be invested in real estate in the coming decade. And that’s if it’s only a 4% phenomenon. This is potentially game changing in so many ways.
Terry Montesi: So, you think there’s really sort of a coming obesity drug dividend coming to our economy?
Peter Linneman: And I’m not saying it eliminates it, it’s a huge dividend. And I don’t think people have any understanding of how big that dividend is and how quickly it could be harvested. Because we’re still in the early phases of people moving into this drug or this drug class. And of course, you wonder about AI, but I’m willing to bet that the impact of the obesity-related drugs will be much larger in a five to 10-year window than will AI on the economy.
Terry Montesi: Well, once again, Peter, I thank you for your time. This was a lot of fun, and there’s a lot of good news for real estate, commercial real estate investors and developers and what you see in the economy. I’m very grateful for your time, again. And I’m glad that your procedure last week appears to have gone pretty well because you look great.
Peter Linneman: Well, and only because Powell cut the interest rate I decided to get it.
Terry Montesi: Perfect.
Thanks so much for tuning in today to the latest episode of Leaning In. We hope you enjoyed the conversation and gained some valuable insights. If you did, be sure to subscribe, rate, and review the podcast on your favorite platform. You can catch future episodes on Apple Podcasts, Spotify, or wherever you listen. Learn more at TrademarkProperty.com. Until next time, thanks for joining.