Early 2023 Economic Trends with Dr. Peter Linneman

Dr. Peter Linneman, real estate economist and principal of Linneman Associates, joins Terry for another dynamic discussion on the current state of the economy. Listen for Peter’s projections on how the coming year may unfold in the U.S. and major Texas markets.

Plus, he examines the potential impacts of interest rate hikes and the battle of the economy vs. The Fed. The conversation then moves to capital markets and the future of multifamily and retail, as well as demographic and technology trends to watch for in real estate.

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Linneman Associates, LLC

Peter on LinkedIn


Terry Montesi: Peter, we are in the second month of the new year, early February. What are your thoughts on the current economic cycle that we’re in here in early ʼ23, and your outlook for the US and then for the major Texas markets?

Peter Linneman: Well Terry, if I’m a little less optimistic than normal today it’s because it’s the Monday after Philadelphia lost the Super Bowl. I encourage people to bear that in mind in terms of interpreting my state of mind. Is that fair disclosure?

Terry Montesi: Yes. There is some gloom.

Peter Linneman: There’s some gloom. On the other hand, tomorrow’s Valentine’s Day, right? So how do I look at the economy? As we’ve had these conversations, I’m one of the only people you’ve spoken to who steadfastly has said, we’re not near a recession.

And for really over a year now, there’s a big camp of people who keep saying, oh, we’re on the brink. It’s going to happen next month. It’s going to happen. And I keep saying, no, I just don’t see it. And I still don’t see it, though I do see a war going on between the economy let’s just call it the private sector, whatever you want to call it, which is still trying to catch up from the covid effects of shutdown and so forth.

Real GDP is still about 3% below pre-pandemic trend. Employment is still a million and half to 2 million below pre-pandemic trend. Yes, we’ve added a lot of jobs. Yes, GDP has grown, but we’re still behind, and so the private economy, if you will, is trying to make that up or the economy in general.

Now remember, we’re a million to 2 million workers short of pre-pandemic trend, and the Fed is trying its best to get a million and a half to 2 million people fewer than are currently working, employed. And you go, well that’s got to be the wrong prescription.

If you’ve got an economy with not enough workers, the last thing you need to do is get rid of workers. And yet that’s what the Fed and their policies keep saying. We’re in a situation where pent-up demand for trips and for cars and for still a lot of things are battling against the Fed doing its very best to increase unemployment, as crazy as that sounds.

Terry Montesi: Well, and the kind of demand and some of that triggered by the covid infusion into the economy through all the different areas of assistance to businesses and individuals.

Peter Linneman: Yes. And in fact, I’ve now adopted a new phrase since the last time we spoke, and it’s economic long covid. Economic long covid is we still have the symptoms of covid or we still have after effects in terms of we aren’t back to full GDP we aren’t back to full employment.

We’ve got inflation. You can go, we overspent, fiscally, et cetera. The claim people will make is that we, it’s only because of all this stimulus that GDP is so high. Well, GDP isn’t so high. GDP is below pre pandemic trend. That’s not high. And so yes, we did have some stimulus. The way I think of the best of the stimulus is we borrowed from our future to tide us over in bad times.

And you and I and our grandchildren and our great-grandchildren and so forth will pay for it by having slightly lower standards of living than they otherwise would’ve. But that was the cost of Covid in the same way that our parents and grandparents and us and our children paid for World War II.

Right. All that borrowing in World War II, and yes, we got a little less than we otherwise would’ve, but we got a lot and we had a free society. Right? And that was the price. There is this sense of it’s not overstimulated, it is still below normal. That’s the most fundamental point to understand. The inflation we got, I always maintained was simply that early covid supply and demand shut down. Then demand came back faster than supply.

And when demand grows faster than supply, you get prices up. And that’s what happened. And yes, the Fed put a lot of money in the system. But most of the money the Fed put in the system, sat in banking accounts. It didn’t get circulated. It didn’t go out and buy stuff. It sat in the form of cash and therefore, net, it didn’t really push price as much. I’m not saying none didn’t push price as much. I’ve been saying constantly that as supply catches up to demand, you’ll see inflation disappear.

Terry Montesi: Peter, isn’t that happening as the supply chain has calmed down?

Peter Linneman: Huge, and in fact, if you go back and you say, gee, Peter, you told me the supply was going to catch up with demand a year and a half ago, in the next six months, I was late. I was wrong. It took more like 18 months. I was used to saying six to 12 months, and it didn’t take six to 12 months. It took six to twenty-four months. But as you just said, there are no ships out in the harbor anymore. There are no trucks, there are no piles of stuff waiting to be delivered.

There’s no shortage of computer chips at this point. In fact, if you go to the holiday season, when we talked in the summer, it was like, well, the big problem for the holiday season was going to be a shortage of things to sell. By the time the holiday season came, there was a surplus of things to sell.

The same with building supplies. If you go back to March, you go back a year ago let’s just say. The problem was not only were materials expensive, they weren’t available. I couldn’t get a sink, and if I got one, it was expensive. Refrigerators, you can get them now. You can get a car. It’s still a little expensive.

I’ll tell you the most amazing non-understood data point. People keep talking about inflation. I think the numbers come out either today or tomorrow, and you’re going to get a headline, I’m guessing, that says inflation is down to some number, like 5%. Well, that’s not true. Inflation as it is occurring now is zero to negative. And the reason that 5% number is a year over year comparison, year over year. Well, I don’t care about a year ago, I care about now.

Since October, this is data not just gut. If you look at the data since October, the rate of inflation in the economy is zero. It’s actually slightly negative. As you sit here, since October, we’re doing this, as I just said, on February 13th, there is no inflation. Why? Because all those supply chains, or whatever you want to call it, supply lag, supply chains, whatever, that were the effect of long economic covid, economic long covid are gone.

Now that you could still find bits, right? There’s always bits. But it’s pretty much gone and gee, inflation disappeared as that happen. Now the Fed has this odd situation where they continue to raise the rate and they continue to say they want to raise the rate even though there’s no inflation. There’s no inflation.

Well, why are you raising the rate if there’s no inflation? Why are you having a 5% interest rate if there’s no inflation? Do you really deserve 5% to lend your money short term to the US government in a world of zero inflation? I don’t think so. That will massively distort the economy and be unproductive. So why did the Fed raise rates a week ago? The answer is, I went to Catholic schools in the day when kids got paddled regularly.

Terry Montesi: Me too.

Peter Linneman: Okay, so you’ll identify with this?

Terry Montesi: Yes.

Peter Linneman: Why did they give the kid 11 paddles? It was like 10 and one for good measure, right? As if 10 wasn’t enough. If you ever got the paddle, trust me, it was plenty. One was enough.

Terry Montesi: Yeah, it was plenty.

Peter Linneman: Two was too many. Three was way too many. I didn’t need one more for good measure. That’s the Fed. They’re in the good measure. It’s not productive, it’s hurtful, it’s harmful. I don’t think they’re going to admit they’re wrong for at least another four months or so.

I remember 50 years ago, five zero years ago, I’m a graduate student at University of Chicago and I meet Milton Freeman. I hear Milton Freeman. He’s ranting on very sweetly ranting. He wasn’t a nasty ranter about the Fed is always too late and overreacts. And by the way, 50 years later, if you had to characterize the Fed’s DNA over those 50 years, they tend to be too late and overreact.

They were too late raising rates. They probably should have started raising rates I think I started saying in December 2020. They could have done them 25 basis points and not shock the system. But instead, they said no. And then they suddenly got to basically August 2022 and said, oops. Yeah, 75, 75, 75, 75.

They’re overreacting, they’re too late, they’re going to be too late in reducing. That’s why I say there’s this battle, right? The battle is the economy versus the Fed trying to kill the economy. I’ll give you one number, Terry. This is back with the envelope. I’ve done it more than back of the envelope.

42 percent of all American households, there’s about hundred 31 million households in the United States, have a mortgage on their home. The others either have no mortgage or they’re renters. 42% have a mortgage on their home and the average mortgage is $200,000 almost to the penny. If you just take total outstanding residential mortgage divided by the number of people with mortgages.

One thing you know is that essentially everybody who has a mortgage today locked it in at 2% or less in 2020, ʼ21, and early ʼ22. Would you agree? I mean essentially all of them. There’s probably like six households who didn’t, right? But essentially everybody locked it in at 2% or less. If you say that normally the mortgage interest rate would be four and half percent in our last 15, 20 years.

Terry Montesi: Sure. Okay.

Peter Linneman: Let’s say four and a half percent. That means those households, 42% of the American households have locked in two and half percent savings annually on $200,000. Well, that’s $5,000. Their disposable income on a household level is about $55,000. Those households have basically got 10% more disposable income available to them than almost any time in our history.

Right. You follow? And that’s why the consumer is trying like mad to readjust, to get back. That’s a powerful driver of the economy. And by the way, it’s not just this year, that $5,000 I just described, it’s going to be there next year. It’s going to be there the year after next. It’s going to be there year after next.

And yes, some of those people are going to sell their home and lose it, but you get the image. That’s huge. That’s huge afterburner on the economy. That’s not even really kicked in yet. I feel good about the economy when I realize these households have low debt, they have low interest on their debt. And more importantly, that low debt interest on their mortgages for 42% of the people is $5,000 a year of available money beyond normal.

Now you say, well, what about the other 60? Or what is it? 58%? Yeah. Well, the other 58% are no worse than normal, right? It’s just normal for them. I don’t have a mortgage, so I get no benefit or disbenefit from the mortgage rate.

58% of us have no advantage or disadvantage from that, but 42% do. When you blend that, that’s like 2,000 average per household. That’s a big cushion, that’s a big driver. I feel good, but you’ve got to have the Fed stop trying to kill the economy. 

Terry Montesi: Got it. Thank you for that. Let’s stay on that as you see what they’ve been doing and why. And recently they’ve only raised the Fed funds rate by 25 bps. What do you think happens in the balance of ʼ23 to the Fed funds rate, to their behavior and as they measure inflation what will read about inflation, et cetera? What, how do you think things unfold in the balance of this year and early in the next year?

Peter Linneman: Just to make clear the listeners I’m looking at the same data they are. The only difference is I’m not looking at it year over year. I’m looking at it month over month or two months over, or three months over since October. Okay. I think they probably will raise another 25 basis points if you ask me why I have no idea.

I then think that they finally have it set in that supply chains have adjusted. There is no longer inflation. We’ve probably put the rate way too high, but we can’t lower it in a hurry. In about four months they’ll be declaring victory and start having a bias to reducing it like 25 basis points every meeting or two. Such that, by the end of the year that would get us back down to maybe 4% on the Fed funds. Another 25 up and then 75 or maybe a hundred down over the last few meetings of the year. Still too high but at least no longer declaring overt war on the economy.

Terry Montesi: Got it. Thank you. Let’s see where we want to go next.

Peter Linneman: By the way, one thing on that, Terry, it would say that those of you with floating debt stay alive. And the other, for example, those of you with construction budgets that you’re trying to figure out what your floating rates going to be as you go through construction. I think by the end of the year you’re going to see rates come down. Not as much as they should but they’re going to come down a bit.

Terry Montesi: Which is encouraging. Next, I think we’ll head to capital markets. While we’re talking macro impacts on the economy and the real estate business. Let’s talk about the capital markets. One thing, Peter, a lot of people said in the fourth quarter was the calendar would turn and institutions would have more liquidity and they would feel differently about investing.

Are you seeing or hearing any of that from your institutional contacts? How do you see the capital markets? And what was in the, certainly the fourth quarter capital markets freeze and distress, how do you see that unfolding the balance of this year? The real estate capital markets.

Peter Linneman: The most important source of debt are always banks and you say, well, what about non-bank banks? Well, non-bank banks get a lot of their money from lines of credits from banks, right? Yes, Fred and Fanny and others matter, but banks are the dominant. What happened to banks? Well, banks make loans. And then package them or syndicate them and roll them out.

At any moment, they have a lot of loans in inventory. The Fed wrong footed the banks. The Fed said we were going to basically do like we did in the early 2010’s and keep rates really low, and the banks believed them. Right? When the Fed raised its rates quickly by the last four months of 2022, some of those loans were underwater just on interest rate math. Just straight, simple interest rate math, and they weren’t fully hedged, and nobody can perfectly hedge, et cetera.

In my view they could have sold those loans at a loss. They would not have gone out of business because they had enough reserves and regulatory capital. But had they sold those loans in late 2022 and recycled the money, make new loans with those proceeds, what would’ve happened is they’d have wiped out their bonuses.

The losses on those loans being sold would have wiped out the profits they received for loans origination in the first eight months. So faced with that proposition, the bank sat on their hands. And they didn’t sell loans and so they couldn’t recycle that money in new loans. It was a lender strike.

It wasn’t that they didn’t have money. They had money. Yes, they would have to take a haircut on some of it. They didn’t want to recycle the money, so they went on strike. When the lenders went on strike, as you know, most equity providers went on strike because most, not all, equity providers count on loans.

Well, if they’re not going to lend to me, I may as well go practice my golf game until they start lending again, because I know they never go on strike permanently. When did I see this breaking and how do I see it breaking? I’ve sat on a lot of corporate boards and around this time of year, which actually we’re a little past late December, January, very early February is when budgets are set for the year.

The budgets for 2023 for these banks were being set, let’s say last month, etched in stone. And those budgets are including selling loans at losses. Now why? Because they want to recycle that money and generate fees, right? And profits on the trade. And if they don’t sell the loans, they don’t generate that set of fees.

Their budgets, then allow them now to sell their loans at losses and still get bonuses. Why? Because the bonus targets for 2023 are set around selling loans at losses which was not the case in 2022. Those budgets did not have selling loans at losses. You’re starting to see some movement, but you can imagine that movement doesn’t really start until all those budget targets are locked into compensation programs, and that’s kind of happening in real time as we speak.

And late this quarter, you’ll start seeing more loans being sold. As you see loans being sold, you’ll see loans being made. That will pick up speed in the second quarter and third quarter. As the lender strike ends, what you’ll see is spreads narrow, LTBs go back up, underwriting, normalizes, and equity that generally relies on debt as its partner, so to speak, as its compliment will start coming off the sidelines. And there’s a lot of equity out there, right? And they’re just kind of waiting. I see the capital markets for real estate picking up pretty effectively as you move certainly into the second half of this year, even late in the first half.

Terry Montesi: Great, that’s very helpful. On capital markets, the last discussion we had, Peter, you mentioned to me that virtually every time you’ve seen an investor make an investment in a property in which the only distress in that situation was capital markets distress, they’ve almost always been successful. I’d like everyone else to hear your perspective on that.

Peter Linneman: If there are deals, let’s just think of normal times, there are deals where the real estate is not good enough or the fundamentals are not good enough, that even in normal capital markets or even in giddy capital markets, you can’t kind of make it work, right?

I’m not talking about that. I’m talking about a piece of real estate that would work as long as capital markets were normal. What do I mean by normal? I mean more or less normal LTVs, more or less normal loan covenants, more or less normal loan spreads, right? Interest rates could be a little higher or a little lower. Although as you know, the long rate is not so high right now.

The long rate is three six, and that’s where it was in 2019 and 2019 was a fine year. It was the spreads blowing out. What I’ve seen is when deals don’t make sense because people aren’t going to lend to me like normal and I can’t get my return targets. That’s probably when you should be doing it. Why? Because most people aren’t, you want to zig when others zag, right?

Terry Montesi: Sure, contrary mentality.

Peter Linneman: You don’t want to be a complete contrarian. I’m not saying underwrite like capital markets get crazy. All I’m saying is underwrite like capital markets are normal.

Don’t underwrite like they’re going to do 90% LTBs at 12 basis point spreads. Underwrite like they’re going to do 65 or 70% LTBs on a quality piece of real estate at a 150 basis points spread. Underwrite to that. To do that and to make the transaction happen when they’re only doing 40% debt means you got to come up with a lot more equity.

And a lot of people can’t come up with that equity or won’t come up with that equity, and that’s why it’s an advantageous time. Just think of the developers, right? I mean if you’re a, a heavily leveraged, dependent developer, you can’t do it. You can even agree with what I’m saying, but you can’t come up with the equity. You just can’t. So, what do you do? You first stall. 

Terry Montesi: Yeah. There’s a lot of that happening.

Peter Linneman: I want to be there when others are for stalling if I can make it happen. You say, well, yeah, I’ve got to come up with more equity in the math. I understand the math. History shows that extra equity and the extra debt cost will only be there for a year or two, and then you’re going to rejigger your balance sheets, you’re going to rejigger those things moving forward. And the deal becomes, and look, we’re in a business where it’s hard to find an edge, right?

I mean, it’s just hard to find an edge. What I’m saying is it’s an edge when you have equity when people don’t. You have the ability to execute when others don’t because of a capital market kind of abnormality. That’s an edge.

Terry Montesi: Follow up on that. We are in the multi-family business now. We have a lot of friends in the industrial business and multi-family business. And there is, you can say that there is negative leverage when you are building to a six or six and a half and you are borrowing at an eight. Follow up on what you just said because that’s interest rate distress in the capital market.

How do you behave? What do you advise during a period of static negative leverage for your long-term project you’re building, your short rate is higher than you’re building for. Address your view on that.

Peter Linneman: The way to think about it is it’s a long-term asset. Don’t get fixated on just the short term. So yes, you might have negative leverage for a year or two years, but not for the lifetime of the property in all likelihood. You just have to understand that markets tend to normalize, markets tend to adjust, and they’ll tend to come back to normal and it will not be that leverage situation forever.

You go in with more equity, and yes, your cost of capital is higher, but it’s only higher, not for the lifetime of the project, right? But for maybe two years of the lifetime of the project. And when you view it in that regard, you say, well, gee, if I knew it was only going to be more expensive for two years, that’s a very different model, right?

That’s a very different way of thinking about it than when you’re underwriting it like it’s forever going to be like that. And I just don’t think it will be forever like that.

Terry Montesi: Yeah, that’s how we’ve been thinking about it. And of course it’s a little scary, which scares a lot of people away, which creates that healthy contrarian opportunity.

Peter Linneman: Yeah, I mean I go back, Terry. This is a competitive business. Any edge you can get, and I mean that in a legitimate sense, I don’t mean in an illegitimate, any edge you can get. And one of the edges you can get is have equity. Another is I’m willing to understand that what exists today does not exist forever and is part of a long-term assets life.

Terry Montesi: Yeah, this is a short-term phenomenon.

Peter Linneman: I’ll take it this way. I said this to a very high wealth family that doesn’t trade much. I mean, they almost never sell. Think of the New York families, for example. This wasn’t one of the New York families, but if your you do something today, let’s say it’s development, but it could be a purchase.

You do it today and your next generation comes back 25 years from now and does a full backwards looking performance analysis of that property, right? They go, how’s that property performed over the last 25 years? What’s been our return? The impact of what’s happening right now is pretty minuscule into the five-year performance of that property, right?

I mean, just mathematically, just intuitively, it’s going to be driven by things you haven’t even dreamed of yet, right? Good and bad. When you view it that way, you say, don’t get so fixated on the current as if it never changes.

Terry Montesi: Peter, what are your current thoughts on some various real estate sectors, particularly multi-family and retail? What do you see for multi-family and retail in the balance of ʼ23?

Peter Linneman: I think, let me take retail first. I think retail is a tale of two types of properties. I think we talked about this before. If the retail is where consumers want to shop, it’s a great time, best time it’s been and probably. Seven years, eight years, 10 years. If it’s a location where retail, where customers really want to shop, you have a good consumer base, you have a good position in the market, you aren’t cut off, et cetera.

Terry Montesi: Well, Peter may be the best time since ʼ08, ʼ09.

Peter Linneman: Well, oh yeah. And the reason I put the timeline I did, Terry is starting about what, eight, 10 years ago, the question was, well, how much is online going to take away from me? What’s online going to take away from that?

Terry Montesi: The retail apocalypse coming.

Peter Linneman: And nobody quite knew the answer. I mean, I had guesses. You had guesses. But in truth we didn’t know the answer. And then Covid happened and we got about five to six years of experience on what happens with online in about 18 months. Right. And we saw very vividly what online cannot sell profitably and what they can sell profitably, and we didn’t know that prior to Covid.

I mean, we had ideas. We know massively better. All you have to do is look at Wayfair. All you have to do is look at Walmart’s number. All you have to do is look at Amazon’s number. These are not subtle. You found out groceries can’t be sold online, so you better get a lot of value from advertising and brand because you aren’t going to make any money on your groceries being sold online.

You’re not going to make any money on H&M price point clothing online. We didn’t know that. I had surmised, and it turns out my surmise was by and large right. But we didn’t know it. Now we know it. If you’ve got a center where you know people want to shop, you know what you’re truly exposed on online and what you’re not. I would say you know in the same way people are much more relaxed about Covid today than two years ago. Good retail is much more relaxed about the threat from online than two years ago because it knows what isn’t and is vulnerable. Now if you have bad retail, that’s a problem. If people don’t want to shop there, that’s a fundamental problem. So we were, I got talking about Bed Bath the other day. If I have a shopping center that’s doing what, let’s take a number.

Let me take a crazy number, right? I have a shopping center that’s doing a thousand a foot. Okay? And Bed Bath is only selling 200 in that center. Are they helping me or hurting me? They certainly aren’t helping me. So when they go out, yes, I don’t get rent for 18 months. Yes, I have to do buildout of a year and a half of rent, something like that.

But you know what? I get a nine-year lease with somebody who can actually help my customer base, right? Attract customers. And net-net, if you did a present value, you win in a strong center. In a bad center, Bed Bath goes out, nobody wants to shop there.

Terry Montesi: Yeah, but we don’t want to own bad centers in any economic sector.

Peter Linneman: And that’s the point. So good centers are better positioned than any time. I think you’re probably right than about 2010 or ʼ11, because by 2015 you started worrying about online, big time. Then let’s go to multi, multi still has great demographics, right? That hasn’t changed. It is going to get supply, get rung out of it a little bit over the next year because of the interest rate phenomenon we were talking about for some developers.

So that’s going to help. You’ve got home prices up and yes, they’re down over the last three months, but home prices have risen mainly because we have a three and half percent shortfall in supply. We’re not going to get rid of a three and a half percent shortfall in supply of single family in a year or two, or three.

Terry Montesi: And the cost of ownership of single-family homes is up a lot. It’s up a lot more than home prices.

Peter Linneman: And people have got to live somewhere.

Terry Montesi: Yeah.

Peter Linneman: The fact that Nimbyism has so reduced in many locations, the attractiveness of, excuse me, the ability to own, is good news for renting.

I like it when my competitors are struggling, right? Multifamily is a bit underbuilt, kind of like 1% nationally, not three and a half, like single. And that’s not every market. You know that. You can go to some submarkets, we have too much, others you have too little, it’s going to get absorbed.

I like Multi, Freddy and Fanny will be there. Spreads are going to narrow, already have narrowed a bit, and you don’t get big volatility in your income stream. Yes, if we get a recession and we will get a recession at some point, I don’t think it’s this year, but these people who are predicting a recession, if they predict it long enough, they’re finally going to say, see, I told you so.

It’s like the people who have predicted that I’ll shut up. Eventually, they’re going to be right. Eventually. I just don’t think they’re going to be right in the next year.

Terry Montesi: That’s good. But we never know.

Peter Linneman: But you never know. You never know.

Terry Montesi: So, live like you’re dying as some people say.

Peter Linneman: That’s it.

Terry Montesi: And multi-family rents lately have been down, down a good bit versus last year. I saw that nationally they just ticked up versus the prior month, but that month was still down materially since last year. Do you have any insight on the rents and demand side?

Peter Linneman: Two kind of reactions. Big difference if you’re talking about a year ago versus a couple of months ago, right?

Back to this inflation phenomenon we were talking about. If you go back to May of 2022 year over year, rents were up big, right? But by the time you get to what, October of 2022 month over month is not doing much. You maybe have a property that’s up, you have a property that’s down and that’s continued.

That’s exactly the kind of phenomenon we were talking about. And so that source of inflation is kind of gone. On the rent side, I do think there was a, it was very real, namely you did charge your tenants that rent. But what happened was we had about a million households that when Covid hit, just froze.

Nobody knew what to do. Then they realized that if they had roommates, they can’t live like this. Because it was fine to have roommates if we worked all day and partied all night. But if we can’t work at the office all day and party all night, I don’t want a roommate.

And by the way, the most popular roommate was my parents. And once everybody was home all day and home all night, I needed an apartment. And we’ll figure out how to get the economics of that to work. And that created a spurt of about a million households above normal renting. That was that spurt from like December ʼ20 until about March ʼ22. That window where you saw all that, you kept going, why are rents going up like 12%? It was that spurt, and a million households is about two and half percent of all renters, just roughly. And so you go, oh yeah, if I suddenly had in an 18-month period, two and half percent more renters than normal, you’re going to see rent spurt. But that’s over. They’ve all moved. Anybody who going to move has already moved. They’ve already made that adjustment.

There’s one other thing, Terry. I can’t prove what I’m about to say. It’s more kind of statistical intuition. A lot of us use the rent revenue management models, the rent maximization models, and like any model, it’s built on historic data. The historic data had never seen that type of surge before, right? The historic data for those rent models was built around what I would just call normal, more or less normal. I have an intuition based on how I know statistics work. In other words, I don’t know the guts of those models. I know the kind of model that it is. It over raised rates is my guess. It over raised them because the data pushed it beyond normal and so it over pushed rents.

It’s kind of like, what do you do as it goes from 93 to 94% occupancy? What do you do as it goes from 94 to 95, maybe 95 to 96? That’s kind of normal range, and now it’s 98 and a half. Well, we don’t have any data in that model about what you do at 98 and a half, and you can imagine, you just kind of say, well, the same thing we did as it went from 94 to 96, we do when it goes from 96 to 98, and the answer is, probably not.

You can get away with it in the short term, but not in the longer. I think that’s also a little of what’s going on. I can’t prove it, but knowing statistics as well or badly as I do, I just have that hunch.

Terry Montesi: So Peter, what do you see as the key trends coming our way in ʼ23 that we should be watching for?

Peter Linneman: Okay. The most important trend is that the Eagles will again prevail. Except they will win the Super Bowl in February ʼ24. I just want that on the record. Just so you got it. That’s most important.

Terry Montesi: The Cowboy fans down here might be a little irritated with that, but that’s okay.

Peter Linneman: Well, they have to live with reality.

Terry Montesi: Yeah. How about economic and real estate trends? I didn’t clarify, so I threw you a softball.

Peter Linneman: Look, I think you’re going to see capital markets get a little more normalized in the way we talked about as you go through the year.

By that I mean debt spreads get normal. Fed funds rate gets a little more normal by the end of the year. The inflation rate gets more normal by the end of the year. The availability of product gets pretty normal again. The effects of economic long covid dissipate a bit more.

They’re dissipating, they dissipate a bit more. That’s a major trend. Because of that money I talked about from the 42% of households as well as lagging GDP, I think the trend is continued growth. I think you’re going to continue to see the same people saying a recession, a recession, a recession. I think for the first half of the year you’re going to see the battle of the Fed versus the economy, if you will.

And I hope and I believe the economy will win, but I’m not certain. I think that the market will start getting nervous by late this year about the elections of 2024. We’re kind of in a Goldilocks year from an electoral point of view. In that, I don’t care who your favorite candidate is or isn’t. That’s beside the point. I don’t care who your dreaded candidate is. Right now, for a year, it’s just dinner conversation. But as we get late in the year and early into next year it starts becoming a reality.

Terry Montesi: Yeah. It gets a little scary.

Peter Linneman: People will get a little scared. That will raise uncertainty and probably dampen things a little bit.

Terry Montesi: Any megatrends on demos, geography, technology, any things that you’re paying attention to?

Peter Linneman: Well, not unique. It’s interesting. Most mega trends move like glaciers. This is not a hundred percent true, but in I’m 71, I’ll be 72 next month. Almost anything that is a big trend, it’s not a big trend. It’s a fad more than a trend, right?

Terry Montesi: Yeah. Something we talk about more than something that actually happens.

Peter Linneman: Well, take the one everybody’s been talking about forever, which is the aging of the baby boom.

You know how fast it occurs? About one year every year. That’s kind of how it happens, and so, there are mega trends. People are going to live longer and healthier. I wrote about that with Mike Anin. But that’s going to be slow until it maybe gets faster and the baby boom, aging, that’s an important trend, but it’s going to happen slowly.

The millennials buying homes, they started but it happens slowly. Technology, certainly for our business, has been a slow phenomena, and that on one hand you say, we don’t do anything different than we used to 10, 20, 30, 40 years ago, and yet it’s unrecognizable versus 10, 20, 30, 40 years ago.

Whether you’re talking about the CAD design or the equipment being used, or the monitoring systems or the accounting systems, whatever. So that will continue. I’ll make one prediction that I feel completely comfortable in making, which is we’ll all spend a lot more on technology that we’re told we absolutely need. And after we spent the money on it, we’re not sure we’re in better off.

Terry Montesi: Yeah. We didn’t figure out how to use it.

Peter Linneman: I was in a conference room at a company where I’m on the board of in New York, and we were laughing the other day saying, see that system sitting over in the corner?

We bought that right before Zoom. And we all had to buy that fancy system that never worked and then two months later, Zoom existed.

Terry Montesi: It’s obsolete. Now it’s obsolete.

Peter Linneman: And now it’s obsolete.

Terry Montesi: Video conferencing technology.

Peter Linneman: All that. Where you could have 88 million people zooming in. Anyway, I feel we’re going to keep doing that. If you said, is there a troubling phenomenon? Maybe I’m overly sensitized on this, but I think the private equity side, if you will, is under sensitized, and that is cybercrime is really real.

I sit on audit committees of public companies and I get these briefings and presentations and if you’re not frightened of cybercrime, you should be. And I’ll give you the simplest reason why. 10 years ago, most of the cybercrime was carried out by somebody in their mother’s basement, some 17-year-old geek in their mother’s basement.

Today, it’s all carried out by the major crime syndicates of the world including the Korean government and others. It’s one thing to be battling a 16-year-old geek in his mother’s basement. It’s another thing to be battling the major crime syndicates of the world. It’s real, that’s all.

If I said, is there one thing people in on listening this ought to make sure they’re up to speed on? It’s, when you look at cybercrime, remember it’s not about a geek, it’s about the major criminal organizations in the world.

Terry Montesi: Has anything changed relative to where you want to invest? The major Texas markets, et cetera? Do you see any big changes there?

Peter Linneman: Well, Texas is a great place for development. It just is because you grow. And if you’re a developer, you’re in the business of servicing growth. If I’m a clothes manufacturer, I want to be where there’s a lot of people. If I’m a developer, I want to be where there’s a lot of growth because growth requires more economic activity and growth will require more buildings to carry that out in. And Texas is fabulous that way, right? I was saying to somebody yesterday, a couple people my age I walk with on Sundays, we got talking about the difference between Texas and California.

So when I’m growing up, everybody wanted to be in California. It was where entrepreneurship was. It was where the cool people were. And so, if the Beach Boys or their equivalent were to write a song, it wouldn’t be California girls, it’d be Texas, right? Because it’s where the action is. It really is. And yes, you don’t have as nice a beach, but let’s face it, most of the people in California never went to the beach, right?

The Beach Boys didn’t even go to the beach. I think only one of them was a surfer, right? All the rest never did. In that sense Texas is great. The challenge of Texas for a real estate point of view is that because there’s so much growth, there’ll always be new product and you don’t build new product to old standards.

You’re always going to build the new product to new standards. In contrast, I own the only apartment project in New Philadelphia. I mean, in Ohio. The good news is, 10 years from now it’ll still be the only apartment project in New Philadelphia, Ohio. I don’t have to worry about anybody coming in with new and better products.

The bad news is there’s no growth to support anybody building a new project. The problem in a Texas context is you give me 10 years of 3% new product a year. I mean, my really cool building today is now kind of in the 30th percentile rather than the first percentile. Now yes, location and so forth.

So that’s the challenge in Texas. You have to know the obsolescence rate is higher than normal. I don’t necessarily mean physical obsolescence.

Terry Montesi: I understand.

Peter Linneman: I mean market competitive obsolescence.

Terry Montesi: There’s not as much supply constrained real estate in Texas. Zoning is easier.

Peter Linneman: The constraint in Houston is you used to have a library card but I don’t even think you need a library card anymore because nobody goes to a library. Actually, I’ll say slightly different though, Terry, and you would agree on this. Even Houston, even Dallas there’s certainly not California in their restrictiveness or New York in their restrictiveness, or Boston or Philadelphia or DC. But they’re more restrictive today than 10 years ago, massively more restrictive than 20 years ago.

Terry Montesi: As those markets have densified, just the supply of land that’s undeveloped has gone down dramatically. That’s happened organically over the last 20, 30 years. Well Peter, thank you again for your time. Good hanging out with you. Sorry about your Eagles last night. There’s always next year. And we’ll talk to you soon.

Peter Linneman: Thank you very much. Bye-bye.

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