Forecasts from Economists Panel | Top of Mind Series

Hello, future billionaires. Welcome back to another episode of the Invest Like a Billionaire podcast coming at you with another top of mind episode. If you're just new to the podcast, these are shorter episodes where we kind of talk about things we're reading, either conferences we've just spoken at, things that are interesting that we're already having conversations offline. So just recently, as a week or two ago, Bob Fraser was speaking on a virtual panel with the Best Ever Conference. And they do a great job, by the way, if you haven't been to their conference. And there were some, some big heavy hitters on there that are kind of bigger names in the real estate space. And the big question was, what do we do right now? What, where is the real estate market going? Is real estate headed for a complete, you know, demise? Is, you know, multifamily over? Is office over? You know, are we all just done? Right. And so really trying to understand with these interest rates where they're at right now, what does that impact have on the industry and where do we go from here? So, Bob, you had some, some great things that you came to bring to the table. Maybe share a couple of those, but then also, you know, what were some of the takeaways you took from that? Right? Because there's some really high-level people on this panel that we respect a lot.

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It was, it was great. I mean, a bunch of heavy hitters and of course no one ever sees 100% eye to eye. But a lot of consensus as well. So a couple of the, a couple of the main topics we talked about first was interest rates. Of course, everybody's favorite topic. Are interest rates going up or down? You know, are they going to keep going up? Are they going to— when are they going to come down? When are they going to come down? Everybody's waiting for kind of interest rate relief. Well, the consensus of the panel was higher for longer. And this is— this was my, my view. And my view is based on because It is 100% driven by inflation numbers. And Powell has said, you know, we're going to— we're going to get 2% core PCE inflation. That's their measure is PCE and core PCE. And well, right now core PCE is 4.25%. So it's a long ways to go. And my— in my view, that's going to be very, very difficult to get to 2% PCE because of two main drivers. One is wages. Continue to be, to be, to be strong. So wages continue to grow. And, and they're still— so right now we still have twice as many job openings as unemployed. Right. You know, in spite of, you know, people coming back to the workforce and we just did episode on this a week or two ago.

So you check that out. The top of mind is the job boom over because some people are saying it is, but we don't think it is.

It's not yet. And, and then the other is energy. And because we have a, a, um, a systemic issue with energy, and both these are not cyclical, you know, the, the, the, the job shortage and the, the energy, energy crisis, they are not cyclical. They are, they are, they are systemic, right, uh, issues, and they're not easily solved by simply supply and demand issues. You know, and so I— so basically my contention is that inflation is going to be higher and therefore, therefore, you know, interest rates are going to be higher. So, so that would— that was— that was interesting. And, and everyone pretty much agreed with that. Now, and now not everyone agreed with me on inflation. So Neil Bawa basically said because of AI, we're going to see massive disinflation across the entire globe. It's going to completely gut the economy, you know, which I think is, you know, kind of extreme. And he said, he said I was wrong and I said you're wrong. And so we'll see. We'll see who's right.

But, you know, you know, I mean, to that point, then we've talked a little bit about if you forecast out long term, we actually have a pretty big deflationary challenge ahead of us because of productivity and technology. But In the short term, it seems hard to believe that that would all of a sudden take hold of, of jobs and disrupt. Right.

And I actually don't disagree with him that it does discern any, any, but I'm like, okay, when is AI going to mow your lawn? When is it going to fix your plumbing? When is it going to build a house for you? Right. Um, it's just, it's not gonna do those things. It's going to take some jobs, you know, I think, okay, marketing copywriters maybe, right? And, and other, other things. Even he was pointing out analysis and other things. But if you look at— I mean, the internet really hit in the '90s, right? Really took off. And everybody was saying the same thing. It's going to destroy the entire job market. Well, it certainly changed. We think about the way you purchase stuff. How many people do you call and place an order on the phone now? Well, now it's all internet. And what about customer service? A lot of it's self-service and it's internet. So It has replaced a lot of customer service jobs, and it has definitely disintermediated. Internet has. But it's also taken— we're at now, you know, 35 years in from the internet, and it's still disintermediating. And it took, it took decades to do. It isn't instantaneous. And same with AI. AI is, is, is going to take a long time to do, to, to, to do mass at that level of disruption.

And we've talked about before in other presentations where, sure, it's going to create, you know, loss of jobs and turnover and disintermediation in certain parts of the market. But it's really skilled versus unskilled labor, right? The, the unskilled labor are probably the most at risk of losing jobs to technology. You know, one example I think of is, you know, there's a McDonald's, you know, which is a guilty pleasure of mine. You know, um, that you drive through and now the attendant that takes your order is a robot. It's AI, and it's actually pretty dang good, right? But, you know, they still need programmers to create AI. And to your point, with the internet, it created a whole new set of jobs, right, that didn't even exist before that has now become a huge part of the growth of our economy being service-based and technology-based. And it's will probably do the same thing. It creates, you know, uh, you know, negative, uh, you know, job rates in certain areas but actually positive growth in others, right?

And, and a lot of these low-income jobs are protected. I mean, is AI gonna pick lettuce, you know, or pick apples? I mean, is it, is it going to, you know, plant a crop? Is it going to, to plumb a house? Is it gonna—

yeah, especially—

and I'm a licensed electrician. I mean, you know, or framer, it's never going to do these things, right?

Well, yeah, even in— I mean, anything trade related is— you can't replace that with AI. And then I was thinking too about, you know, oil and gas, like boots on the ground jobs in the field of the oil industry. They can't find people to go work for them and they're paying crazy salaries right out of school. And it's just, you know, they're not going to be able to replace that with—

I mean, maybe it'll replace us, right? Maybe podcasters will, you know, become the AI, AI bait. But somebody is going to have to doesn't it just devolve to nonsense at some point if you don't— there's not anybody pulling the strings behind there, you know? Even if you got some AI puppets. And what about doing deal analysis? Really, AI? I mean, can it assist? Yeah, it's hard to imagine, you know, possibly. What about— I mean, all the functions of accounting and all the functions of back office and asset management? And, you know, you pick 100 jobs, it's like 3 of them are going to be affected by AI, you know. So, yeah, I don't know. I think it's all overdone. Now, they did mention, okay, we had the— we had a great guest on, Jay Parson with RealPage. Right. And, and he was actually predicting that we're going to see inflation drop. And, and, you know, and it was because rents are dropping and rents are a very big part of, of the CPI. Well, interesting. Rents are roughly you know, 30% of the CPI, the Consumer Price Index, but only, only 15% of the PCE, which is what the Fed uses. So it's going to, going to have less impact, but it is going to have an impact.

So, yeah, so there's a lot of questions about between when the rents are reported versus, um, you know, when they're actually being realized in the market. So, so what was— give us one other takeaway because we're talking about is, is the you know, the world over for real estate, what were some of the other—

so I'll hit a couple other points. So one was cap rates and what's happening to cap rates. Well, officially, according to, I think it was— which was the— I think it was Newmark that said we're seeing cap rates drop about 90 basis points. So, so which is roughly 15%, say, you know, but, but, you know, I made the point that a lot of our deals, we've not seen cap rates decline in storage or in, in industrial, we're not seeing any changes. And Ryan Smith said the same thing. He said in, he said in well-located pro, pro, you know, projects that are, that are Class A, they're not seeing, they haven't seen, they haven't seen cap rates move. Now in multifamily, cap rates have moved. And, and Neil Bawa said is actually more than 90 basis points they're seeing generally. So you see this general cap rate idea. The idea is that, well, for storage and industrial, they haven't moved, but for multifamily, they've moved more than the average. And for office, they've, they've doubled. I mean, you're seeing, you know, which means values have doubled. So, so for those that aren't 100% sure on what a cap rate is, it's your cash on cash return, which really goes to the pricing. You know, what are these things priced at? And so You know, a 5 cap means, you know, you're getting, you're getting basically, you know, 5 times the— sorry, a 5% return on cash. Yeah.

On cash return. And you think— I mean, I think about it too. Obviously, office is kind of the outlier because that's got massive systemic issues that, you know, no other real estate class is facing with hybrid work and return. To home, all these kind of things going on. But I also think multifamily, it's traded at some of the lowest cap rates of any asset class historically, years. And so it's the most susceptible to any reversion, especially with the higher interest rates. It's the most, you know, negative leverage asset class of all of them. And it's, you know, inherently has to move the most because of these interest rates and the more movement there is with the lower cap rate you go, the more movement, you know, basis point standpoint has a higher impact on values, the lower those are. And so it's actually, I think, partly driven by how low the cap rates were trading out before.

I think everyone was surprised at why, you know, kind of expressed surprise at why cap rates haven't moved more because as you pointed out, it's negative leverage. So if your cap rate is below your interest rate, right, um, or sorry, above your, above your interest, your interest rates higher than your cap rate, well then leverage doesn't help you. And you know, it's actually negative. It actually reduces your returns. In the, where in the past leverage is supposed to enhance your returns. So, and we're, we're seeing negative leverage in multifamily and in most asset classes. And you know, everybody was expressing surprise, but So why is that? Well, because, you know, you know, my view was that, you know, real estate is the perfect asset class. It's the high-growth asset class in an inflationary scenario. Right. It's one place you want to be. It's, it's the, you know, whatever the, the rocket ship stock investment you could make, you know, Tesla or Amazon in the '90s. This is the real estate. Is that an inflationary scenario? So I think that was interesting. You know, two more points. One was construction costs. So now we in industrial have not seen a lot of change in construction costs. And, and but, but a lot of folks expressed pretty much pretty massive changes in construction costs across the industry. So I think in storage and in multifamily and I'm thinking about it, you know, there's a lot more trades there, right? So the electricians, plumbers, a lot more finishing work, framers and all that. I think about industrial. I mean, this is, you know, our industrial builds are mostly air, right? It's, you know, pour some concrete, you know, lay some rebar and put up a little structure and pour concrete and tab up the walls and you're done. So it's a much simpler build. And so we've not seen construction costs, but a lot, a lot of deals are being nixed right now. Because of construction costs.

Yeah.

So just in the final, final point was, you know, BTR, and they were making a point that several of the, several of the investors and several of the economists were making a point that build-to-rent, which we haven't done a lot of and we haven't talked about a lot of, actually pencil better. They're, they're cheaper on a, you know, on a square foot basis or you know, resulting basis to construct and they have, they have, they actually pencil better. So very interesting for the build-to-rent, a lot of, a lot of options there. So again, you know, area we want to dive into a little more on the podcast.

Awesome. Well, thanks for sharing the takeaways. And it's always interesting to kind of see where, you know, some of these people, you know, diverge but also have some similarities of, of, you know, thought of where we go from here. So If you enjoyed the podcast, I always appreciate you listening and sharing your thoughts with us. Please subscribe if you're not already and share it with someone who may get some value out of it. And until next time, hope you do well and tune in on our next episode of the Invest Like a Billionaire podcast.