The 2024 State of the Real Estate Economy with Dr. Peter Linneman

In this episode of Leaning In, we welcome back Dr. Peter Linneman, authority on real estate economics and principal at Linneman Associates, for an update on the current economic landscape. Peter shares his predictions for 2024, discussing pent-up demand, inflation, and the Federal Reserve’s role. He also sheds light on how housing data affects inflation measures and the impact of lower interest rates on capital markets. Plus, broader trends like shifts in healthcare costs and demographics.

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Terry Montesi: Today, it’s our pleasure to welcome back to the podcast, my friend, Dr. Peter Lineman. Peter is a frequent contributor to our show, and we’re excited to have him with us today to talk about the economy and its likely impact on commercial real estate in 2024.

For the last 40 plus years, Peter’s unique blend of professorial wisdom and practical business insight has won him accolades from around the world. His esteemed business career is highlighted by his roles as founding principal of Lineman Associates, LLC, a leading real estate advisory firm. For the last 40 years, he’s also advised leading corporations and served on over 20 public and private boards.

On today’s show, we’ll look back at some of his predictions from a year ago and explore how economic conditions have unfolded over the past year. In addition, we’ll dive into the current state of the economy, a 2024 forecast, and the ramifications for the capital markets and the health of real estate. All of that, plus much, much more. Thanks for listening. Now let’s lean in.

Terry Montesi: Well, Peter, I’m sorry about your Eagles, as you probably are about my Cowboys. The NFC East didn’t make us proud this year.

Peter Linneman: We were the one of the greatest collapses in sports history. And then we did it over seven games. You just did it over one game.

Terry Montesi: Yeah, I don’t know which is worse. Anyway, sorry about that. So, we’ll move on. So, there’s a little gloom we’re both talking about regarding our football teams. But last year when we visited in February, you were fairly gloomy about the prospects for the U.S. economy. And obviously, aside from football, are you feeling a little less gloomy a year later?

Peter Linneman: Well, I actually was one of the few people who said we weren’t going to have a recession in 2023. I said the economy would slow down, but it would slow down because we had this enormous growth rate as we came out of the COVID shutdown. It was an artificial number. It was a real number, but it’s like a child can’t grow that rate forever. So, I thought we would have no recession, I thought we would have growth and was right on.

I also thought we would get greatly diminished inflation, which we have, and I don’t think people even understand how diminished. So, if you say how I feel now, looking forward for 2024, I don’t see a recession. We’ve got a lot of pent-up demand still in the economy, autos pent up, travel and tourism pent-up, medical, healthcare, very pent-up demand, people that forestalled getting treatments during the worst of it are now getting things done. So, I think that the economy looks good. The Fed is doing its best to ruin it, but it can’t because it only affects about 20% of the economy. Now, it can have a notable effect on that 20% of the economy. But I think the pent-up demand, we’re still- to put it different, in the last four years, we’ve grown three years and two months of normal growth.

So, if you look forward to 2024, we would have a normal year of growth possible, plus 10 months that didn’t occur over the last four years. And the pockets of where it didn’t occur are pretty obvious, auto and so forth. So, I feel pretty good about this year’s economy as well, in spite of the Fed being, how shall I say, misguided. And I feel very good about inflation. In fact, I believe for truth, we have deflation right now. Truly have deflation going on, minor, very modest.

And my view was always that we were getting the inflation coming from, not from the monetary issues that normally did, because most of the money that the Fed pumped into the system, and Lord knows they pumped a lot of money, went into bank accounts. If you put it in bank accounts and don’t use it, it doesn’t bid up prices. Yes, people saw the Fed put a lot of money in the system, but what they didn’t appreciate is most of it just sat in a banking account. Cash balances went up almost to the extent that the Fed put money in the system.

Terry Montesi: Peter, how big do you say? I’ve heard some people say four or five trillion and I’ve heard some people say six or seven trillion.

Peter Linneman: No, they net, I’m doing it off the top of my head, my memory is they put in about six trillion and about four and a half trillion of that is still sitting, quote, buried in our backyards.

Terry Montesi: You’re kidding. That much?

Peter Linneman: And by the way, if we would have spent the whole six in a year or two, that would have created enormous inflation, but we didn’t. And we still have it. We still sit with enormous cash balances. And that’s what’s done.

So, you say, well, where did the inflation come from? So, I’m an old Milton Friedman student. Most people don’t remember him, but he gets cited for saying, and correctly so at the time, that inflation is always and everywhere a monetary phenomena. That is, the Fed prints too much money or the central bank prints too much money. And that was true when he said it. But I sat in classes with him and talked with him, and he would go on and say, because, and nobody would tell us-

Terry Montesi: Peter, you’re old enough to have hung out with Milton Friedman, huh?

Peter Linneman: Fifty years ago, I was taking classes with him. It’s amazing. Over 50 years ago, I was taking classes with him. And his because was he would say, I can imagine the market for bubblegum being excess demand, and I can imagine the market for automobiles being excess demand. I can’t imagine the market for everything in a relatively free economy being excess demand. It just doesn’t make sense. Some would be excess supply, some excess demand, some in pretty good balance. That was the rationale, and he had research to back it.

Look at what we had happen. It was not something Milton had ever seen. What happened? We shut 40% of the world’s economy down, and we did it for months and in some cases years on end. When demand came back, it wasn’t hard to see that almost everywhere, we had excess demand. Even though demand was not back to its previous levels, we had excess demand because supply got shut down, companies went out of business, they shut down lines of production, and so forth. So, we had it economy-wide.

So it’s interesting, the Fed, New York Fed has an index of supply shortfalls and sometimes economy-wide, and sometimes it shows a little excess supply economy-wide, sometimes it shows a little excess demand, most of the time, not much of anything. That went to 4.25 standard deviations of excess demand. When? Right when inflation was spiking. That’s not a random occurrence; that’s not coincidence. It’s because everywhere in the economy, you didn’t have enough tankers, you didn’t have enough waitresses, you didn’t have enough restaurants because demand came back faster than supply.

It wasn’t that demand was so high. By the way, I just told you GDP is still not back to the trend that it should have been at. But because supply was so lagged. And by the way, anybody who’s listening who doesn’t know what 4.25 standard deviations means, it means we’ve never seen anything like it before. That’s literally what it means. You just never see 4.25 standard deviations. When you saw 4.25 standard deviations of excess supply, you saw inflation like we never saw before occur. Those high prices were good. Why were they good? They’re painful for some; they were productive for others. They were good because they sent up signals saying, bring on more supply. It is highly profitable.

So, let’s take one in real estate, apartments. Apartment supply collapsed because they weren’t allowed to build them during much of 2020. You had to stop construction in many places. Late 2020, early ’21, lumber goes up by like fourfold in price. Why? People are trying to build, but they can’t get product because the supply chain’s not rebuilt. So you have a big shortfall in supply. What happened to rents? Demand came back, people moved out of their parents’ home, and rent skyrocketed. What happened next? What happened next is it sent a signal, build more apartments.

Guess what’s going on now? What’s going on now is a slight excess supply of apartments in most markets and rents are going minus 2% to plus 2%, call it zero, flat. And you go that happened in almost every- that same scenario played out in almost every product in the economy, not every real estate product, bubblegum, shoes, computer chips, automobiles, that same scenario played out. Rents shot up, prices shot up, then they stopped shooting up because supply came about. Why has the US inflation subsided faster than elsewhere? Pretty simple. We respond to profits more than any other economy in the world.

Terry Montesi: We’re a more nimble economy.

Peter Linneman: So, when our prices went up, then we responded. Did we respond overnight? No, it took like 18 months. I thought it would take six to ten months. I was wrong. It took like 18 to 24 months. Inflation is gone. So, we’re now in a situation, and by the way, I’ll give you how inflation has gone. Personal consumption expenditure price index, which the Fed definitely monitors, put out by the US government, came out and over the last three months, over the fourth quarter, it was exactly the same. There was no change in the last three months of 2023. So, if you annualize zero, it’s still zero. I went to Catholic grade school in the old days. I know how to annualize zero and still get zero.

Terry Montesi: There you go. So did I, by the way.

Peter Linneman: No inflation. No inflation in the fourth quarter based on that index. Now, why do I say we we have some minor deflation? If you look at it, they go out and collect for like, I think it’s 18,000 products, they go out and collect prices in December, in November, bubblegum, shoes, etc., etc. But for housing, they put in eight months earlier. Bubblegum they do November to December, but for housing they do eight months earlier change.

Now you know what happened, we just described what happened in the market for housing. Rents were still high and still rising, but falling, the rate of growth was falling fast. So, by the fourth quarter, rents were flat. All you had to do was talk to Greystar, Cortland, do the REITs, etc. And yes, some were getting plus 2%, some were getting minus 2%, basically flat. You know what they had in the government data? They had 5.5%, an annual increase of 5.5% for the fourth quarter.

Now you know that wasn’t what was actually happening in the fourth quarter. If I told you that was happening eight months earlier, you’d go, yeah, maybe. Maybe. But not in the fourth quarter. Now, why is that important? 20%, I’m rounding, 20% of the PCE index of inflation is housing. They had it at 5.5% and when it was really zero. That is about one percentage point of inflation. So, if you put in zero for housing, let everything else be the same, if you put in zero, you come up with an annualized rate of about minus 1% during the fourth quarter.

You get the same result if you do the CPI. If you do the CPI, you get the same basic result. However, the initial inflation number is higher. Why? The initial inflation number is higher because in the CPI, housing is about 40%. Ah. They also have housing rising by about 5.5%, but that’s 40% of the index. Well, that’s two and a quarter percentage points of inflation. Guess what? When you then compare that to what inflation was, you’re slightly negative.

Terry Montesi: So, play that forward. What does that mean you’re going to see 60, 90, 120, 180 days from now?

Peter Linneman: You’re going to see for another month or two, the official inflation is still going to be positive. Why? Because if you go back to what was happening to rents, eight months ago, they were rising at, let’s say, five and a half. Let’s assume the data was right. They’re rising at 5.5%. Six months ago, they were rising at 3.5% annualized. Four months ago, they were rising at 1% annualized. And as you know, in the fourth quarter, they were doing nothing.

So, with the lag they have in housing, it’s going to make inflation, measured inflation, be positive. It’s already locked in. It’s basically locked in because the housing numbers are already done. It’s like you already know the housing numbers. And they’re locked in and they’re 20 to 40% of the whole thing. Economy-wide, you’re back to a world of pretty balanced supply-demand. Some markets a little shortage, some markets not so short, but you’re back to kind of balanced. That means the rest of the economy will go back to some number like 1, 1.5% inflation. They’re going to overly put in housing for the next several months, and it will make it higher than it really is.

But if you do the adjustment I just said, you’re going to come out slightly negative. And more to the point, you’re then going to hit a period where housing is going to be- When do you think rental markets will be adjusted supply demand? What, probably a year from now, roughly by the time the pipeline comes out and so forth and so on, and you’ll be back to getting 1 or 2% increases a year from now. Well, this lag issue is crazy, what it does to the data. So, you have to kind of adjust for that. So, we have no inflation. We have mild deflation.

The Fed has the interest rate at 5.5%, with no real inflation. That makes no sense. They didn’t create the inflation, and they didn’t eliminate the inflation. What created it was supply shortages. What’s eliminating it is supply coming online. What have they done? By the way, people don’t understand, most of the economy is absolutely insensitive to interest rates. Take somebody who never borrows. You never borrow. That’s a lot of households. You are insensitive to the interest rate. Take businesses that never borrow.

Terry Montesi: Or you’re only borrowing is a long-term loan on your house.

Peter Linneman: Or you’re a household and you have a mortgage that you locked in two and a half years ago at a low rate. So, I don’t care what the short rate does if I’m that person. People say, oh, what about credit card debt? Credit card debt. I see all this credit card debt. Most of what measures, you can’t know the exact number. My best estimate is probably around half and rising. Most of what measures as credit card debt isn’t really debt.

You say, what the hell do you mean? I charged lunch today. We had lunch. I used a credit card and charged it. Do I view that as debt? No. Why? I’m going to pay it in the 21-day grace period. I’m never going to pay interest on it. The interest costs never entered into my calculus in any way. When you charged your dinner two nights ago, you didn’t say, oh, and the interest cost on this is going to be- because you’re going to pay it off in the grace period. And the main reason credit card debt rises faster than the economy grows is we use credit cards more for convenience than we used to. You are old enough to remember writing checks for three dollars at the supermarket, right? You don’t do that now. You use a credit card, but it’s not real debt.

Let me tell you about interest rate non-sensitivity. Two sectors, I’ll get you in a heartbeat. Federal, state, local government. They don’t care what the short-term interest rate is. They hired like mad. They expanded like mad. They’re going to pay social security no matter what. They’re going to pay policemen no matter what. I’m not saying they shouldn’t. I’m just saying if the Fed changed the interest rate, it had no impact on those state, local, and federal government activities. That’s 35% of the economy right there, just interest rate insensitive.

The other sector is healthcare. Medical is 18% of the economy. I sit across the street from major medical offices. Nobody who went in for hip surgery across the street said, oh, I think I better forestall the hip surgery because I’m going to wait until Powell lowers the interest rate. Well, that’s absurd. There’s no woman being wheeled in to deliver a baby today who says, no, no, no, I’m going to hold it in until Powell lowers the interest rate. If God forbid, either of us had a heart attack right now, you’re not going say, no, no, don’t call emergency until Powell lowers the interest rate. Just those two sectors are 53% of the economy combined. Those two sectors, no interest rate.

Then you add all the things we were talking about and toilet tissue and groceries and so forth. So, you have about 20% of the economy is interest rate sensitive. What are they? Two-thirds of all people that buy automobiles buy it with a loan. They have some sensitivity to short-term interest rates. Businesses, particularly manufacturers and retailers with lines of credit secured by inventory and receivable, they’re sensitive to the short-term interest rates.

Banks, banks are sensitive to the short term interest rates because the way banks make money is they live off the slope of the yield curve plus a credit spread. When the yield curve goes flat, they lose the spread they were getting from the slope of the yield curve, and they have to widen the credit spread to get the same return. And when the yield curve went negative, they had to widen the credit spread they got even more to make up for the fact they’re getting nothing from the yield curve, and in fact, they’re giving something back.

That meant they came to you and said, I want a 450 basis point credit spread. And you said, you’ve got to be crazy. I’m a 150 basis point credit spread. That’s what I am. I’m a 150 basis point risk. They said, well, no, I have to charge you 450 or I can’t make the loan work because of the yield curve. And you said, no, thank you. So you say there’s no money available. That’s how you describe it as a borrower. The way the Fed describes it is there’s nobody willing to borrow. And they’re both true but they’re not true.

When does that go away? That goes away when the Fed lowers the interest rate to something realistic. What’s realistic? If inflation is 1.5 to 2%, we know the interest rate should be something like the short-term rate should be no higher than 3%. No higher than 3%. You could even argue lower. So they’ve got to lower the rate 250 basis points, maybe even 300 basis points.

They’re going to be late. They’re going to be- It’s interesting, we were talking about Milton Friedman. One of the first lectures I heard from him in 1973 was the Fed is always late, they’re always arrogant, they always believe they control much more than they do, they always overreact. Does that sound like the DNA of the institution you’ve just witnessed? So, they’re late. They overreact. They were too late raising the rate. They overreacted and raised it more than they needed. They believe they control 100% of the economy when they only had some influence on 20% of the economy. And they’re way late. They misdiagnosed. So, they’re going to lower the rate when?

You saw yesterday, they’re still muttering around about inflation and so forth and so on. I don’t know what they’re looking at, but it can’t be the same data I’m looking at which is their data. And nothing I said was rocket science. That is, look at what rents did last month, not what they did eight months ago, and you’ll get a very different answer. And that is the main driver of, quote, measured inflation right now. But by the way, if you’re a tenant, you’re not paying higher rents today than you were three months ago.

Terry Montesi: Well, that’s a lot, but it answers a lot of my questions. I’m probably going to have to reload some of them, but thanks for that. And that is a lot of very positive news. But when we go to, I have a question, when will rates come down is one of the questions.

Peter Linneman: Whenever the Fed gets over their arrogance and lateness.

Terry Montesi: But doesn’t it seem like that you need this, you said there was like a four to six month lag or whatever, so when inflation is sort of really obviously one to two, even though it is two the last couple of months, so that’s probably more like mid-year since they just advertised-

Peter Linneman: Yeah, I think they’ll do it sooner. I think they’ll do sooner. I think it’ll probably be April. It should have been a year ago they should have started. They shouldn’t have raised a year ago.

Terry Montesi: So you’re thinking, he says it probably won’t be March, which is a way of telegraphing April or May probably, right?

Peter Linneman: That’s what I’m seeing. That’s what I see. They’re terrible predictors of themselves. They predict their behavior about as well as a 15-year-old boy does.

Terry Montesi: And last year you did say that you thought we’d end ’23 at around 4%. And so, they’re late, as you say. Do you have an idea if they start in April or May how much they lower rates this year, if you were guessing?

Peter Linneman: I would hope at least 150 basis points, and it should be more, but because they’re late and arrogant and they don’t want to admit a mistake, I don’t like to admit mistakes, but since they’re late, my guess is they’ll lower 150 basis points, which would get it down to the 375 to 4, which would still be too high on the short end. As they do that, I think the long end is going to settle out at around 3.5.

Terry Montesi: You think Treasuries 10-year would go, if they go to 375 on the short rate, you think Treasuries settle close to 3.5.

Peter Linneman: And as there’s more evidence about inflation, the way we talked about, it will settle out. By the way, just one, not to go into all the technicalities, the reason they lag with housing but they don’t lag with bubblegum, I’m just taking bubblegum as a- is they say you signed a lease for 12 to 18 months. So, what we’re going to do is take kind of the middle of it.

Terry Montesi: Ah, they go six months forward.

Peter Linneman: Now, having said that, did you chew all the bubblegum you bought in the month you bought it? Did you use the car that you bought just in that month?

Terry Montesi: Or the shampoo.

Peter Linneman: Or the shampoo, or the coat, or the… And so, they don’t do it for any other product. They do it for this one. It doesn’t matter if it’s in line with everything else. If it’s in line with everything else, it doesn’t matter. If six months ago was the same as this month, it doesn’t matter. But we’re in this huge transition. If they had done shampoo and shoes and coats and all those things with an eight-month lag, inflation would be a lot higher just because of the dynamic that’s been going on. The only one they do it with is housing. It’s kind of stupid.

I mean, I get why they do it, but if you’re trying to measure what’s happening now, just- And by the way, one of the things I’ve said to people is, if you’ve got one component that’s essentially driving all of inflation, and it’s housing, don’t you think you’d pick up the phone and call Bob Faith at Greystar and say, Bob, you’ve got whatever they’ve got, 700,000 apartments you touch. Is that consistent with what you’re seeing? Or call C. DeFrancis at Cortland and say you have a hundred whatever thousand and call Equity Residential. Wouldn’t you think if it was that big, but they don’t.

Terry Montesi: We touched on this, the COVID relief funds still in the system, you said maybe four to four and a half out of six trillion still on the sidelines.

Peter Linneman: Yeah, it’s in your bank account. I don’t know your bank account. I’m willing to bet, if I went to your bank account, your balance sheet, your personal balance sheet, and I went to those of the listeners, you would have massively more cash than you did literally four years ago. Because it was almost four years ago.

Terry Montesi: PPP loans, ERC.

Peter Linneman: And yeah, we spent some of it. I’m not saying we didn’t spend any of it, but most of what went in, we kept. And it became a balance sheet item rather than an income item. And by the way, it’s also consistent, not to make this an homage to Milton Friedman, Milton Friedman had this permanent income hypothesis, and he always had this view that if you dropped wealth, you won the lottery, you wouldn’t spend all the lottery. You’d spend part of it, but a lot of it you’d just put into your wealth for the rest of your life. The guy who won the billion dollar lottery isn’t going to spend a billion this year in all likelihood. And that’s all Friedman said. They’re going to spend something like the return on it more than.

Well, we dropped on America, think about what we did. We borrowed. Who did we borrow from? Effectively, we borrowed from our future. And we borrowed from ourselves. And we said in the future, we- and we’re borrowing from our future to tide over our present. Now, suppose you went, I don’t know, your son comes to you and says, Dad, I may need some money. Can I borrow from you? I’m not sure if I’m going to need it. I may because it looks like it could be bad, but I don’t know if I’m going to need it. If your son was wise, he would have borrowed it, he would have saved it, he would have used it only to the extent he needed it. Otherwise, he’s still got it. So, if I looked at it as a family wealth, it’s still there. And all we did was borrow money from our future to tide us over through this horrible moment.

Now, we continue to borrow; that’s a separate matter. But we had that horrible moment. We didn’t know what would happen. Of course, it made sense to borrow. By the way, could you borrow personally after you lost your job? No. Could you borrow as your business was about to go out of business? No. So what did we do? We had the US government borrow for us and then give it to us. Because I just lost my job.

Remember, 23% of the labor force was collecting unemployment insurance and there are not a lot of lenders looking to give to them. But what we did do was borrow enough to have 23% of the labor force be on unemployment. I’m just using that as an example. And we just borrowed from our future. So, we shifted some of the spending, some of the money, but we didn’t spend most of it. We spent some of it. Most of it we kept. It’s still in our wealth, still in our wealth.

Terry Montesi: Yeah, what’s so crazy, the idea, and I know you have a real propensity to let the economy do its thing, but the idea of helping some folks out for something that happens once every hundred years, that makes some sense to me. But the fact that you would indiscriminately offer big chunks of money to every business, even those that didn’t have any distress at all. And then three years later, there’s still ads for people that want to help me with the employee retention credit. Until recently, I was getting a call every two or three days, we want to help you with your employee retention credit, and it’s seven figures for a firm of our size. Three years later, they’re going to reward us for keeping employees. And they already gave us two PPP loans for keeping our employees.

And they never even asked, how hard would it have been just to ask to have sort of the honor system? Did COVID negatively impact your business and your cashflow? Does your business have some distress due to the pandemic? So people would have at least had to lie. Like if they were a law firm, their business didn’t go down, they were businesses whose business didn’t go down, they would have had to lie at least. But we made it so easy. It just blows my mind.

Peter Linneman: I take it, by the way, as you know, I’m historically not a big fan of the way government spends.

Terry Montesi: Yeah, or of stimulus.

Peter Linneman: Or of stimulus. However, I can get, I think, where you’re at, I can get to where we say we’re about to do something or we are doing something the world has never seen before. We’re shutting down 40% of the economy. None of us have any idea of what that really means. Now, you can argue, should we have done that, that’s separate.

But once we cross that line of we, and I mean we the world, not just we the US. Once you cross that line, I can imagine people saying, well, let’s just make sure we borrow plenty from our future so we’ve got it when the moment comes. In other words, like don’t try to draw your line of credit when they’re trying to pull your line of credit. Draw it before. That’s essential. So, I get shoveling out money, and you say, well, did all those businesses need it in March and April and May of 2020? You didn’t know. I mean, your business, you didn’t know. I didn’t know. And you say, okay, with hindsight, but you didn’t know.

I totally get where you’re at on this stuff today. That’s just scandalous. But I do get we don’t have time to do a careful cost-benefit study to figure out. And by the way, if we did a cost-benefit study, we’re doing a cost-benefit study of a situation that’s never existed in history. So how good’s the study going to be when you’re really done? So, let’s just shovel out, draw the line of credit, make sure we’ve got it, and then we’ll deal with it from there. So I give them some credit. Was there waste, fraud, and abuse? Of course. And was there- And I view the original stuff, that was the cost of… That was just part of the cost of the pandemic.

Terry Montesi: I get that. It’s just that PPP2, did we really need the second one? Did we need to give it to every business that kept their people? And then this long-lasting employee- Anyway, that kind of goaded all over me.

Peter Linneman: I’ll take it a different direction, Terry. I’ve never been bothered by the deficit. And I’m not even bothered by, quote, government spending. What I’m bothered by is a fundamental question that you have every day in your business – am I getting my money’s worth? If I order a bunch of pencils, am I getting my money’s worth? If I invest in a property, am I getting my money’s worth?

That’s what consumes you if you think about it. If I hire another employee, am I getting my money’s worth? That’s what consumes you. What should consume people? And by the way, if they’re productive, you’re going to order pens. And if it’s net productive, you’re going to hire an employee. And if you think it’s net productive, you’re going to invest. You’re not always right, but you’re going to do those things.

The real question with government spending and the deficit is not the deficit or the spending. It’s a real simple question. Are you getting your money’s worth? That is not- And by the way, I’m sure on some things like, I don’t know, Operation Warp Speed off the top of one’s head, probably. Am I probably getting my money’s worth for that? Probably. I’m not sure I got my money off of the second round of PPP or, or, or, or any of these things. And so, some government programs, you do probably get your money’s worth, some you don’t. I’ll give you my favorite. You want to know my favorite you got your money’s worth example of government spending? All time favorite.

Terry Montesi: Negative or positive?

Peter Linneman: Positive. You’ve gotten your money’s worth. You’re old enough to appreciate this. Some of your viewers won’t. It is estimated that about $280 million, I think that’s about right, were spent trying to impeach President Clinton back in the 90s, including defending him. Investigating, defending, attacking, defending, attacking, and at the end, he was still president. Now most people look at that and say, we spent 280 million dollars and we had nothing come out of it.

Terry Montesi: It sounds like it would be a big waste.

Peter Linneman: My view is there were about 280 million people in the United States at that point. It was a dollar a person. Have you ever gotten more entertainment for a dollar in your life?

Terry Montesi: I got it. Or you could argue a little less sarcastic sort of premise.

Peter Linneman: You think that’s sarcastic?

Terry Montesi: A little, yeah. It would be that, hey, we paid to have the system work.

Peter Linneman: That’s also, that’s the relevant way to view it.

Terry Montesi: The system is set up that way, we paid to have it work, it worked, we moved on, and it was only a dollar a person. That’s an interesting perspective.

Peter Linneman: But just, we paid a dollar a person to have the system work and an endless number of good jokes.

Terry Montesi: Yeah, exactly. I’ve got a few more questions. Let’s try to get these a little quicker, get through these a little quicker. So, I’m going to go to real estate now. Let’s go to real estate capital markets.

And just generally, fairly quickly, Peter, what do you think is going to happen with the real estate capital markets if the interest rate reductions and inflation softening happens as you predict? How will the capital markets respond? How will they thaw? When and how does that happen? The pension funds are on the sidelines for the most part with everything other than industrial. Give us your view for ’24 in the capital markets.

Peter Linneman: So, two parts of that answer. One, the real rate, if inflation is zero right now, and the short term rate is 5.5, the real return for taking no risk is 5.5%. Why am I going to screw around with much of anything until that goes away? Because if I can get money for nothing, literally, I won’t do it forever, but I’ll do it while I can. So that’s the first part of the answer. So, as the Fed lowers that, and inflation ultimately normalizes up a little bit to 1 to 2%, some of that will disappear and that money will start doing something.

Terry Montesi: So, I want to clarify. So, you say as the short rate goes down over, say, April into next year, as the short rate goes down, the capital markets will gradually thaw, is that-?

Peter Linneman: Yeah, and I’ll do the second part of that. Remember we were talking about normally to get my return, I got the slope of the yield curve plus a credit spread. I made up a number, I was getting a 150 basis point credit spread from you. And then I suddenly said given the nature of the yield curve, I need 450 from you. What happens is the Fed lowers the rate, and now the bank says, well, I don’t need a 450 basis point credit spread from you. I can go back to a 200 basis point credit spread.

Terry Montesi: So really that’s generally good news for the real estate capital markets if in fact the Fed starts lowering in April and gradually lowers through next year.

Peter Linneman: And by the way, that means the main determinant of cap rates in my empirical studies is the flow of money into real estate.

Terry Montesi: So cap rates can come down as well.

Peter Linneman: Come down as well. By the way, transactions are 20% of normal last year, and that means there was no money flowing. You would agree? And when no money flows, what happens to cap rates? They go up. If we get back to normal, it’ll be because of what we’re saying. You’re going to see a lot more money flowing. Cap rates will come down a good bit. And I think they’ll end up back at around where they were in 2019 by the end of ’25.

Terry Montesi: Wow. Perfect.

Peter Linneman: And by the way, you were pretty happy with where cap rates were as an owner in 2019. It could be better, but you were pretty happy.

Terry Montesi: Yeah. I’m going to stay on real estate. I’m going to now go a little more specific. So just as you look forward to ’24, ’25, ’26 in the multifamily sector, give us your overview.

Peter Linneman: Soft rents much of this year, particularly in Sunbelt markets, particularly in urban core. Why? There was more supply that came on there than elsewhere. Good demand, by the way, it’s just a bit overreaction like it did in most of the economy.

The market rate construction starts have fallen by about 40%. And that means by, what, late 2025, we’re going to have a shortage of units coming online. We’ll still have growth. The fact that we have a shortage of single-family housing that’s profound means people are going to have to continue to rent longer. And so soft this year, getting more solid as we move into next year, and then you’re actually going to get some spikes in late ’25, ’26.

Terry Montesi: So I’ll just give you a little feedback on what we’re doing. We just started construction yesterday. Oh no, I guess it was Monday. We started construction Monday this week on our first ground up multifamily deal here in Fort Worth. So, it’ll open, I mean, we start delivering units in second quarter, mid-ish ’25, and we’ll deliver most of the units from mid-’25, to early ’26. So, you like our timing?

Peter Linneman: Your timing will be maybe a month or two early, but you’ll like your timing.

Terry Montesi: Well, I’ll take being a month or two off, pal. And then, we hope to start our next one maybe third quarter of this year. So, you like that timing a little better.

Peter Linneman: That’s even better timing.

Terry Montesi: Okay. I’m trying to nail it for you, bud, but anyway, I’m a little off. Okay, so next, retail. We’ve had this enormous shortage or under supply since really 2009 in the retail development business. And so now you’ve got very tight vacancies, etc. What do you see for the retail real estate market the next two, three years?

Peter Linneman: I like it if it’s good retail. I never liked bad retail.

Terry Montesi: Nor do I.

Peter Linneman: Good retail. By the way, good retail, you have to work day and night constantly to get new tenants and to change the profile and this and that because you’re trying to satisfy consumer preferences which constantly change. And today’s strong retailer will almost certainly be tomorrow’s weak retailer, just by the nature of the beast. It always has been that way. But I like it. Good retail will do well, but it’s always hand-to-hand combat because you’re trying to work yourself with long leases through rapidly changing consumer preferences.

And you’ve been in the business long enough to know when you sign the lease today, you’re real thrilled you have the hot retailer, and six years from now, you’re going, oh my God, I got them for another three years. And that’s the nature of the business, but nothing’s being built to speak of. And by the way, the other good news about retail, the pandemic proved what cannot be sold effectively online. And we didn’t know that. I had opinions, but we didn’t know that in 2016, ’17, ’18, ’19. We know groceries can’t be sold efficiently and scaled profitably online. We know that low margin, what do they call it, instant fashion can’t be sold.

Terry Montesi: Fast fashion.

Peter Linneman: Fast fashion can’t be sold profitably online. There are some items that can. And therefore, we just know the enemy much better.

Terry Montesi: Yeah, well, that’s a great point. I just wrote down, as you said it, you didn’t say the exact words, but you inspired them, that the pandemic really proved to be a tremendous learning and innovation opportunity for the industry.

Peter Linneman: Absolutely. By the way, you’re talking about the innovation. What was one of the most popular things in March, April, May, June 2020? Selling groceries online in stock variation. You know what all the grocers found? They lost a fortune.

Terry Montesi: Yeah, they can’t really do it well.

Peter Linneman: They can’t do it. It just can’t be done. You can do it. You just can’t do it effectively and profitably in mass.

Terry Montesi: I’ve got two or three more. I’ll try to keep them reasonably short. One is to me, maybe my favorite question, megatrends. Here it is. It’s ’24. So let’s say the rest of this decade, the next seven years, what are some of the megatrends, and obviously cheat towards the next three or four, megatrends you’re paying attention to that you think are going to impact business, the real estate business, the capital markets, the economy, etc.?

Peter Linneman: So, we’ve already talked about the Fed and that as a mega whatever. I think more fundamentally, everybody talks about AI, and I don’t claim to be an expert. I’ve tried to get smart. I think these drugs like Ozempic and others are just staggering what they’re going to do, and it may take them more than two or three years. For example, the company that makes Ozempic I think had their sales rise something like 36% last year. It just came out with their earnings.

And it works. And the side effects are relatively muted. And it’s important because we spend something like 14% of GDP on problems associated with overweight/obesity. And by the way, you can say, well, people, it’s funny that people say once you go on these drugs, you have to stay on them. Well, you stay in shape. Once you start exercising and eating well, you have to do that the rest of your life. If you stop it, you’re going to put on weight. So, it’s no different.

So, I think the potential for that set of drugs and knock-ons to generate enormous purchasing power for the economy and to generate enormous savings for the federal government is just, think of the Medicare, Medicaid, and insurance premiums if you could just cut, it’s 14% of GDP. If you could cut that to a half of it, just think of all the things you’ve got, you can do with money. So I think that’s a mega trend.

Second mega trend, and I think particularly for retail, though I don’t know how it plays out, is me. Literally me. It’s the oldest, healthiest, wealthiest, highest income generation in history, the boom. And we’re not going to die in the near term. And we have more wealth than ever. And we have more time now that some of us are starting to retire, not all of us, some of us are retiring and so forth. And I think the big question is, what are they going to do with their money?

My favorite little example, Terry, is the retail industry. The retail industry largely screams, we don’t want that customer. How do they scream it? Go to the parking field and what does everybody do with their parking lot? They stripe it so that the parking space is narrower. Now I don’t know about you, but how many 70 year olds are as good at getting in the parking space as they used to be?

Terry Montesi: Or 80. Theres a lot of 80 year olds and there’s going to be a lot of 90 year olds.

Peter Linneman: And when you stripe it, I’m just taking a simple silly example, when you stripe it more narrowly, and by the way getting in and out of the car, just physically getting in and out of the car, you may as well just have a big sign saying we don’t want you if you’re over whatever.

So, there’s a whole lot of things particularly in retail that are going to change as there’s just too much money. It’s follow the money, and there’s too much money there. I think that’s a big mega trend. AI, although it’s not as transparent to me how AI plays out. I’m sure it’ll play out, it’s just not so transparent to me how.

Terry Montesi: I got it. Okay, let me keep- I’ve got two more I want to try to get in, Peter, before we’re out of time in six minutes. So, what’s the one prevailing thought that economists are saying or experts are saying about ’24, ’25 that you think is most wrong, that misses the mark the most?

Peter Linneman: They’re still saying we’ll get a recession this year. They’ve changed their tune from we’re going to get it in the next three months, which they’ve been saying, what now, for 20 months they had been saying we’re going to get a recession in the next- We’re not.

Terry Montesi: Well, it’s interesting that with all this positive news, as someone who studied economics in grad school, this thing seemed to be leveling out and going our direction. And Jamie Dimon just recently says he’s really scared about a recession. And he says, and I’m really scared about what the debt, our continued government debt could do to the economy.

Peter Linneman: And I’m not worried about that at all, except in the sense of not getting our money’s worth. I’m not worried about that because, think about it, we have household wealth of about 31 trillion. Excuse me, about 130 trillion. The total outstanding federal debt is 31 trillion. And by the way, remember, about 40% of that is the government owes it to themselves. So, we only have about $18 trillion household-wise. And by the way, half of it we owe to other U.S. citizens.

So, we have plenty of wealth for it. The problem is I want you to pay it. I want you to pay it. I want to receive it, and I want you to pay it. And whether it’s you in terms of rich versus poor, blue versus red, green, orange states, whether it’s I want it paid now or I want it paid by future generations, it’s a big political issue. It’s not a big economic issue. So, I don’t worry about the federal debt that way, though I do worry about it if we don’t get our money’s worth on the spend.

Terry Montesi: So my last one, I’m going to go to politics. We do have an election this year. So two things.

Peter Linneman: I didn’t know that.

Terry Montesi: Yeah, I know, I know you keep your head in the sand, so I thought I’d remind you. Now, so two questions. One is obviously is the economy materially different whether Trump or Biden wins, assuming they both make it to November? And do you believe this old, is it a wives’ tale or is it fact that it seems that interest rates always come down in an election year, so does the Fed-? What in the economy responds to the fact, if anything, that there is an election this year?

Peter Linneman: So I think, I don’t think it makes- it makes a huge difference who wins in terms of which people get redistributed to and redistributed from. And if you think about government, not just here, government is much more about you take money from these people and give to those, or you redirect money to those people. So just take energy. I’m not saying good or bad. It’s clear that Trump much more channeled money in one way or another to fossils, and the current administration much more to wind. I’m not sure they- to alternative. I’m not sure that the net net on the big economy was so much different, but it was a lot different if you were an oil producer or a wind farm or whatever. So, distributionally, it matters a lot.

It also matters if you’re an attorney or a compliance person because there’s no doubt that a Democratic, Obama was this way and Biden has been this way, much more pro-regulatory, much more interventionist, which means much more lobbying and much more compliance work. Again, they may be good regulations or bad regulations. We’d have to look at them one at a time, but there’ll be much more. But that benefits lawyers and compliance officers. It hurts the economy a little bit.

One of the things I’m struck by, and I’ve thought about this a lot over the years, if I just put up real GDP since World War II, and I said to you, Terry, you’re a smart guy, can you pick out when you think Democrats were in, when you think Republicans were in, when you think it was a united government, when it was a split government, when it was divisive, when the tax rate was high, when the tax rate was low, you wouldn’t be able to pick it up. You just wouldn’t. You just wouldn’t. And it is to say, does the government have some effect? Of course. But it’s more like, I don’t know, 20 basis points a year. Now 20 basis points a year on a $28 trillion economy is a lot of money.

Terry Montesi: I was talking to my wife the other night, the government really doesn’t have, and who’s in office, it really doesn’t have that big an impact on our lives. We let it get us worked up emotionally, but it really doesn’t have that big an impact on our lives.

Peter Linneman: And it does have impact on social things, and it does have impact on individual industries, and by the way your tax. So, I don’t think it has a big impact. By the way, if I told you that the growth rate was 2.4 rather than 2.2, you can’t identify that. You won’t notice it. Somebody notices it because it’s 56 billion dollars of economic activity, but most of us wouldn’t notice it.

Terry Montesi: That’s great. That’s a great way to end because I think that might calm some people that are all worked up about our politics. Well, Peter, thanks. Our time is up. And like I said earlier, I’m very grateful for your time and I’m grateful to have gotten to spend so much time together over the years. And thank you. I hope you have a great year and happy new year to you.

Peter Linneman: Same to you and my pleasure.

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