Inflation, Cap Rates, The Fed... Are We Headed For Recession? Interview With John Chang

This is the Invest Like a Billionaire podcast, where we uncover the alternative investments and strategies that billionaires use to grow wealth. The tools and tactics you'll learn from this podcast will make you a better investor and help you build legacy wealth. Join us as we dive into the world of alternative investments, uncover strategies of the ultra-wealthy, discuss economics, and interview successful investors. Welcome back, Invest Like a Billionaire podcast listeners. We've got a very special episode for you today. This was an interview with John Chang, who's the senior vice president and the national director of research at Marcus Millichap. And wow, he dropped some major bombs.

This was so good. There is so much information this guy is giving. As I've said, You know, the way to make money in the investment world is you got to know what the tides are doing. When the tides are going in, all boats float. Tides are going out, all boats sink. You know, so you got to know what the tides are doing. Well, this, this John Chang and Marcus Millichap, they're, they're really the heavyweights in the industry. And he is the head of research and just unloaded major data on are we going to have recession? What's the future of inflation? What's the— what's likely with Fed rates and how does it affect real estate. So, so guys, this is a must, must listen to.

So, and probably multiple times. I'm already thinking I gotta go back and listen to this.

Get ready for this.

All right, enjoy. Welcome back to the Invest Like a Billionaire podcast. I am your co-host Ben Fraser, joined by fellow co-host Bob Fraser. And today we have a very special guest, John Chang, who is the senior vice president at Marcus Millichap. And if you are not familiar with Marcus Millichap, they are a heavyweight in the real estate space doing a lot of economic and real estate analysis, as well as I believe brokerage. But John, give us a little bit of context for your background and Marcus Millichap. And again, thanks for coming on the show.

Sure, thank you. I'm happy to be here. Marcus Millichap is one of the leading commercial real estate brokerage firms. We have over 2,000 agents across the country. Uh, we're in U.S. and Canada, uh, we're in every major city, and, and our core job is to help investors buy and sell commercial real estate, and we also help with financing. My job is to run our research services team. Uh, our focus is on gathering and synthesizing all the different types of data that's out there and smashing it together and trying to translate it into something useful to help investors make decisions.

Yeah, it's so great that you guys are doing this. You know, there's a lot of brokerages out there, but you guys very, very, very much are data-driven and research-driven, which, which I love. And, and as investors, we're going to be— we're going to do a lot better when we know the currents and the tides that are in place. I, I love the— I love the, the emphasis there. Yeah.

One of the reasons why I get you on the show is just at your level where you're seeing so much data and you're aggregating this all. And you're seeing it really, the big shifts that are happening. So we're super excited to dive into it.

And a lot to talk about, right? A lot to talk about.

Now. Now.

So, yeah. So we actually were on a panel together debating economics at the Best Ever conference recently. So that was a lot of fun. A lot of fun. That was a lot of fun. Unfortunately, you won. Oh, I don't know if you're going to admit it or not, but yeah, yeah.

But it was— But it was— it was— it was well fought. It was. It was a lot of fun.

But so tell, talk about the big picture, what's happening right now. Just give us, give us the, the broadest strokes. You know, what are the things that are going on right now that are of the most importance?

Sure, sure. So, I mean, the top thing in the news right now, of course, is inflation. Uh, we see that going up and, and we just got, you know, some new numbers recently. Headline inflation is up, uh, 8.5% and There's a lot of factors that, that fed into that, uh, and the real impact of it— of course, the cost of everything's rising quickly— but the real impact is what the Fed's going to do about it and what they've already started to do about it. And that's going to have a direct impact on commercial real estate and commercial real estate investing as the Fed puts upward pressure on interest rates. But we see a lot of conversation about these headwinds, about inflation, about rising interest rates. And there's a lot of talk lately about recession. But I have to remind people, you know, look, we've added 1.7 million jobs in the first quarter this year. That's, that's the second strongest quarter on record. If you look at retail sales, retail sales are up 10% on a year-over-year basis, inflation adjusted, right? And, and you look back, it's 15% above where we were before the pandemic, before all of this, this, you know, slowdown of the economy happened. So we kind of have to keep things in mind. We have to gather all the facts, right? We have inflation. We have rising interest rates. It is going to weigh on the economic growth. But we still have a lot of forces that are driving the economy forward. And so it's not all bad, even when the news starts to really get negative.

So, I mean, I completely concur. And, you know, the data I've seen shows, you know, 20% increase in household net worth since the beginning of 2020, 15% increase in household net income since the beginning of 2020. And, you know, so consumer demand is obviously very, very strong.

As—

and the job market is, of course, on fire. We've seen wage growth very strong. It's hard for me to imagine a recession happening now in GDP, you know, even though I know, you know, one of the— one of the— the yield curve's inverted, you know. But so, so I'm kind of with you. It's like, you know, you see there's— you see the headwinds, but you see the tailwinds, too. And You know, so, so what's going to win? And here you see inflation, which is kind of magic for, for commercial real estate. You know, it's, it's a massive tailwind, but then you see Fed rates, you know, so how do you think it plays out? Give us, give us, you know, your kind of the bottom line of which wins. Does inflation win and prices go up? Does, does the Fed win and prices go down? You know?

Sure, sure. Well, and I don't know necessarily that the, that either of those are real winners, right? Nobody wants to see these numbers where they are and where they're going. But, you know, inflation has such a negative impact on the psyche of people. You go out to a restaurant, you go to the grocery store, you go out and buy something, and it's more expensive today than it was a year ago. But the thing is, is that we have to remember, from a commercial real estate perspective, from an investment real estate perspective, inflation is not the enemy, right? It is helping to push up, uh, the, the rents, and it helps to drive income growth. So real estate is actually one of the best places to be invested during an inflation cycle because it is able to keep up with that inflation, at least to a degree, right? And, and, you know, certain property types are better at this than others. You look at, say, apartments, self-storage, hotels, they all adjust their rents, you know, whether it's daily, monthly, or annually. And so they're able to capture that inflationary pressure as opposed to many other types of businesses and investments. But even like, uh, some of the long-term lease product types like, like a single tenant or retail centers or office buildings, they still have some inflation resistance One of the key things driving up inflation is construction costs, right? So, we have, you know, 8.5% inflation right now, but construction costs are climbing at 17.5%, right? So, that means that the underlying value of the building is rising faster because you can't replace it as easily. And so, you're gonna get a lift across all the different types of commercial real estate. And in fact, that high construction cost is going to reduce the amount of construction that we see out there today. It's already being curtailed. And that reduces your supply risk, which in turn helps support your occupancy levels. So inflation overall, you know, if you look at it as an economist or as an average citizen, you know, it's not good. But as a real estate investor, I don't wanna necessarily say necessarily say it's a good thing, but it's not a bad thing. Yeah.

What is your perspective on, you know, inflation and where does it go from here? Right. Does it keep going up? Does it go down? You know, we've, we were looking at the latest CPI numbers and, you know, from, from our kind of analysis, you know, the, the two biggest changes, um, were, uh, fuel and were, uh, automobiles. Yeah.

Which those were the By far supply chain issue and then temporary, you know, political, geopolitical issues. So not necessarily sustainable, but, but, you know, clearly worrisome. So what's, what's your take on inflation next 12, 24, 36 months?

As we came into the inflation cycle, uh, you know, the, the Fed kept saying, this is temporary. It's going to go down. It's supply chain related. Uh, and then they, they shifted their stance and said, well, it's a little worse than we thought. It's going to be around a little longer than we thought. And they're still saying, hey, by the second half of 2022, you know, we should have this back under control. I think that might be a little optimistic. If you look at the underlying drivers, you know, you have wage growth at about 5.5%. You have energy's up 32% on a year-over-year basis. Home prices up 15.5% in the last year. And construction, as I said, 17.5%. Producer Price Index just came out today. Up 11.2% on a year-over-year basis. That's a big number, right? And Producer Price Index is the cost of everything that's going into the manufacturing as inputs. So that means that the PPI is leading that inflationary trend and it's still on the rise and it's saying, hey, the products that are being sold, you know, 3 months from now, 6 months from now when they get done being manufactured and out to market are going to be higher in their cost. So Inflation, I don't think we wrap that up this year. I think we still see a lot of pressure there. It carries into '23. I think that we're going to start to see things flatten out later in the year. But, but it's going to be a while to get, get this thing back down. The Fed is being very aggressive there. The Fed notes just came out the other day and they were talking seriously about a 50 basis point increase in March. They backed off of that because of what's happening in Ukraine. But we can expect that there will be a couple of 50, 50 basis point bumps this year in the federal funds rate. By the end of the year, we can expect the Fed funds rate to be up, you know, 1.5 to 2, to even 2.5% higher than it is today. And that's going to put upward pressure on short-term rates. So the Fed has a tough job. But again, you kind of have to put this in perspective. 40 years ago, when inflation was super high, Paul Volcker came in. He pushed the Fed funds rate up by 10% in 6 months. Right. So this is small change. That's why I want to laugh, John, when you say he's being super aggressive.

It's like we might hit 2.5%.

I mean, come on.

I know. I mean, when inflation is this much, are you kidding me? It's like, I'm going to throw some drops of water on this fire. You know, it's like, it's a joke. I mean, honestly, it, yeah, it is going to have an impact, but it's still not that material in my, in my estimation. I mean, correct me if I'm wrong.

Real rates will still be massively negative.

Yeah.

Yeah. Well, the other thing the Fed's going to do is they, they stacked up their balance sheet, right? During the pandemic, they increased their balance sheet from $4.4 trillion. They went up to $8.8 trillion. Uh, and, and in the Fed meeting notes, they did say that they were going to start using quantitative tightening and start selling off stuff on their balance sheet. That's going to push that long-term rate.

That will— that, yeah, that could be dramatic, you know. And what's the construction of that balance sheet? Is it primarily mortgages, or is it Treasuries, or is it a mix?

It's a mix. It's, uh, uh, it's long-term Treasuries, short-term— some short-term Treasuries actually, and a lot of mortgage-backed securities. So they were, they were using quantitative easing to hold the rates down. Now they're going to flip that. They're going to start to accelerate rates.

Yeah.

Push up the interest rates.

Exactly.

You've already seen pretty big adjustments in the mortgage, mortgage rates right now. I mean, I'm looking right now, shopping around, and rates are up already 2% over last year.

I mean, yeah, 90 days it's gone up, you know, I mean, you know, what, 70% increase in rates.

Yeah.

Wow.

You know, that's definitely going to, going to put a chill on things.

Yeah. They're going to keep going. They have to raise up those rates in order to slow down the inflationary pressure. They have to take out the, the, you know, the liquidity in the marketplace. You know, looking back, if you go back last year, right, and just the flood of capital coming into commercial real estate last year was a record-breaking transactional year in commercial real estate space because there's so much money looking for yield and, and that pushed those cap rates down. There was so much money out there. It's still there. It's still really aggressively competing for deals today, uh, and we've seen that through the first quarter. It's still carrying into the second quarter. We're starting to see a little bit more pushback in the marketplace from the buyers because their cost of capital is going up and it's causing a little bit of, um, Expectation gap between buyers and sellers, but it's not problematic yet.

Yeah.

Okay.

So let's say the Fed raises rates to 2.5% by the end of the year and, and that, you know, mortgage rates and lending rates are, you know, you know, 4 or 5 or a percent, maybe, maybe 6. But inflation is still 8.5%, right? And as you point out, probably going to be probably in the year. You know, that kind of a range or close. It's still negative rates. It's still negative real interest rates. Right. It's— it makes a lot of sense to borrow that money and invest it in, for example, you know, multifamily because, you know, assuming that, that, that, that your NOI grows with inflation, well, so will the property price grow. And so it's still even— the Fed is a little late here. And yeah, they seem to be getting aggressive, although as you point out, they're not Volcker yet. And, you know, it still is going to be a very positive environment in my book for real estate. And yeah, no one likes inflation, but I will say as a real estate investor, I'm okay with it.

Yeah.

Well, you know, I saw an article. All I do is read about this stuff all day, every day. And right. So I saw an article produced by a major brokerage firm saying, hey, for your retirement funds, what you should be doing is investing, you're buying more bonds. And I'm sitting there thinking, I'm like, okay, you can go buy a 10-year Treasury at 2.7%, but inflation's going at 8%.

That's nuts.

How does that work?

That's a guaranteed money loser. Light a match.

Real estate, you know, you may get in at a 4 cap or whatever it is, 5 cap, But it's going to continue to rise and it's going to move with the market. It's going to keep up with that inflationary pressure. And so you're not losing ground like you do with something like a Treasury or something like that. Yeah.

What do you think the chances— I mean, you don't have a crystal ball and nobody does. And I think everyone's trying to figure out, you know, the, the current Fed is, has, you know, shown to be pretty dovish up to this point. And now they're trying to, you know, channel their inner Volcker. But it just seems like it's more posturing than, you know, actual, you know, teeth. Do you think they're going to, you know, pull a 180 and just, you know, really try to put a hard stop on this inflation? Or do you think it's going to be more kind of incremental? I mean, do you have a sense of what you're reading out there?

They've kind of revealed their playbook with the notes, as you're pointing out, you know, of half a point, you know, each meeting kind of thing. Don't you agree?

Yeah, they're trying. And the thing is, you kind of— what I try to do is put myself in Jay Powell's shoes, right? So now think about this for a second. If you want to be, you know, Paul Volcker— Paul Volcker was not a, you know, a well-liked guy. Oh, yeah. And so you put yourself in his shoes and say, you know, am I ready to pull the trigger on really aggressive rate increases and have everybody hate me, first of all. Now, if it works, you come out—

And have the politicians get thrown out of office. I mean, that's the— all the politicians have been pretty silent right now, which is interesting to me, talking about, right, interest rates. And so I'm just so curious, what are the behind-the-scenes conversations going on? You know, I'm not privy to any of that, but it's, it's so hard.

If you push rates like that and you fail, you go down in history as that guy. And so, I kind of have a little sympathy for Jay Powell here because there's what he thinks he should be doing and what he thinks he can execute on. And how do you kind of walk that balance? So, what we end up with is what may ultimately be a half-hearted attempt and kind of crossing the fingers and saying, gosh, I hope this works. But it's challenging. This is not an easy job. I certainly don't want it.

So exactly.

So let's say the Fed raises rates, rates, real rates are still negative. And one of the things that we've looked a lot at in the past is even nominal rates. And in the terms of the global money world, right, in Europe, you're seeing negative nominal interest rates, meaning You put your money in a bank, you're writing a check to the bank every, every, every month. You know, who's going to do that? And at that point, you're, you're, you're, you're driving cash into to the to be active out of, out of, you know, and it drives so much demand for investment demand. So and we live in a global world and America is a fantastic destination. It really is the world's number one investment destination still. If you look at real estate and and equities, you know, corporate equities and other things. So, so negative rates are real at both nominal and, and real interest rates. Yet we've seen cap rates over the last year compressed down to unheard of lows, right, in real estate. Give us, give us, you know, what is the bottom line with, you know, are cap rates correlated to nominal rates? Are they correlated to real interest rates? And where do you see with this battle of inflation driving up real estate and demand for real estate, right? Because it is inflation. It's the ultimate inflation investment. And the same time, interest rates, you know, creating a headwind. How do you, how do you see cap rates playing out?

Sure. This is, this is an open debate, right, within the industry. And I talked to so many investors who say, Well, when interest rates go up, cap rates will go up, as if there is some sort of—

they're linked, right?

It's going to be held no matter what. And, and, but when I meet with the research analysts and the people who are digging into the numbers, and you look at historical trends, and you look at the movement of the 10-year Treasury relative to cap rates, you see there's very little correlation actually, right? Over the long term, they've both been going down, kind of go back here over 20, 30 years. They've both been going down in general, but when interest rates go up for short periods, and by short I mean a year or two, you still see the cap rates still going down, right? And so, that correlation, and the exception that it would be the global financial crisis in '08-'09, that's the exception. Then cap rates did go up, but there was very little liquidity in the marketplace.

Right.

But the thing is, there is not— it's not like you can just, you know, map this out with a ruler. And we say, okay, interest rates are going to go up, cap rates are going to go up because of what you were talking about. There is so much capital pursuing commercial real estate right now, and all of that capital is competing with each other to place that into property. Now, you mentioned also foreign rates are negative, nominally are negative. I was on the phone the other day with some very, very large investment groups with capital coming in from Europe. They said it is coming in more aggressively than they've seen in years because U.S. real estate— to America, yeah, to America— U.S. real estate is considered to be kind of a gold standard for an inflation cycle. It is stable, it's performing very well, and it's generating a positive yield. And, and to somebody in Europe If they're looking at a 10-year bond that's negative in Germany or Switzerland, that's pretty good. And when they compete with the US investor, the US investors say, man, I need to hit, you know, a 5% return or whatever going in. That money out of Europe saying, look, we don't care, 4% is a hell of a lot better than what we're going to get over here. And we're just happy to put it somewhere safe that can ride out a recession. If it comes, that can ride out the inflation and continue to grow. And we're going to be in a better place. So the, the US investor who's saying, well, gee, you know, interest rates are going up, I'm going to wait for the cap rates to rise. You might be waiting a long time. Right.

It's that global money flows are a very big deal. Money is, money is very global. And so we'll, we'll see how that plays out. I'm super curious if you have long data, you know, I mean, back in the, in the '70s and '80s, the high, high inflation eras, you know, what were cap rates back then? And, and I haven't been able to find any data on, on, on historical cap rates.

And it doesn't go that far. We have good data back to 2000. That's kind of when, when CoStar, or back then it was Comps, was founded, when Real Capital Analytics was getting started and they started really getting good quantified data. We have weaker data going back to 1990 that we have leveraged and modeled in. But going back prior to that, it's really hard to get any real numbers. And so we haven't been able to track anything down.

So there is stock market data, right? And then the stock market, you have the, you know, the Tale of Two Cities here. You have companies that have pricing power with their products. They, in other words, Apple, can they raise the rate of the price of their cell phone?

Yep.

And so they have pricing power, right? Probably Amazon, same thing. Well, those companies tend to do well in inflation because they're inflation protected, right? They, they will tend to track inflation. Then companies that do not have pricing power and those guys tend to not do well. And so my estimate is that real estate, because it's really, it's a superior inflation protection investment. Right? And so that it's going to be priced more like a growth stock than it, than it is a non-growth stock. And so there will be a premium, a growth premium added to, to the price people are willing to pay. If I know, yeah, it's a bad deal today, but I know they have pricing power in 5 years, I'm getting all my money back. Well, then you can afford to pay a higher price today. So any thoughts on that?

Yeah, and even within real estate, right? There are some property types that are going to be more inflation resistant than others, right? So, if you have a property, let's go to extremes, a hotel, you reset your rates every day, right? You have almost complete inflation resistance with the hotel. Now, it's a different thing to run it and it takes a lot of skills and knowledge of that business, but that's one type of real estate. At the other end, you have, you know, like some high-credit single-tenant net lease investments which are on 15-year leases that have renewals at the discretion of the renter and maybe no price bumps even built into that. So, you're looking at flat revenue over a long period of time. That has less inflation resistance except for a couple things. One, it may be— it depends on the underlying dirt, right? The underlying real estate, that will keep value, and also the structure itself and the replacement cost, that will keep value. But it's not getting that cash flow change the way, say, a hotel or apartment building is. So they tend to be a little bit less inflation-resistant.

Makes sense.

So, but for some investors, I want to point out one thing. For some investors, though, a single-tenant deal makes a lot of sense because it has safety. It has almost no recession risk, right, depending on the tenant who's in there. So it's very low risk with a fixed return. It has less inflation resistance, but it could make sense.

Good investment. Yeah. So will there be an inflation growth premium for some real estate assets because of its inflation characteristics?

Yeah, in a way. It's not truly a premium, but you see the capital moving there, right? Yeah. So, we're seeing, you know, we've seen multifamily getting a lot of attention. Same with self-storage. If you look at those, the cap rate compression in both of those property types is pretty significant, you know, over the last year, you know, 100 basis points compression for both of those. Hotels, 100 basis point compression in the last year for hotels. Those have really started moving, especially limited service. Um, now on the other end of the spectrum, uh, some of the longer-term, uh, uh, real estate investments, uh, haven't seen as much. And then there's the performance of the individual asset. There's a lot of question about what's going to happen with office. You haven't seen nearly as much interest in that property type, but industrial is behaving just like apartments. You're seeing huge compression there and a lot of capital going after industrial. So, you know, those are kind of the hottest products. And, you know, so there's the real estate side of it, right? So industrial is going to do great. It doesn't matter. You're seeing 9% rent growth. If that beats inflation, you're good, right? Yeah. But other property types a little softer.

So one of the surprising things, or maybe not, was I at your— at the BC conference, you made a presentation and you talked about retail and you were, you were very bullish on retail, which I love. I love the contrarian, contrarian plays, right? There's, you know, when, when everyone hates someone or something, right? It's probably a good time to be taking a look at it, you know? And, and we're seeing really, I mean, nutty cap rates, you know, in, in retail. Is retail dead? Is there— is it, is it time for a contrarian play in retail? You know, what's your view?

Retail's been getting beat up for years. It was a retail apocalypse, right? You know, Amazon's gonna stomp it into the dirt, retail's going away forever. Then you have a pandemic, and, and what happens is, is the entire sector gets lumped together and thrown in the garbage bin, and, and people think that the whole sector is dying. But the thing is, if you look at, uh, like a grocery-anchored retail center in a growth part of the country, Atlanta, Florida, Texas, Arizona. If you look at grocery-anchored retail, it's done very well. In fact, cap rates are down compared to pre-pandemic. The cap rates are up— actually, no, they're down about 30 basis points, right? They're down a little bit. So, that type of retail has a lot of staying power, especially with the migration and demographics and household formation Suburban retail, grocery-anchored suburban retail in the southern half of the United States is doing great. Now, if you look at, you know, I read an article the other day, Kmart's down to, I think, 2 stores, 3 stores, right? So, if you got a, if you have one of those, if you have that Kmart, that retail, right? And Sears was doing that to shopping malls. They were killing the shopping malls. They wouldn't go away, wouldn't die. Actually, the pandemic helped clean out a lot of that stuff. It really kind of shoved a lot of those businesses that have been dying for 20 years. Push them off the cliff. Yeah. So, that actually helped clean up the balance sheets on a lot of those properties and turn them into something viable and something usable. I really do believe that retail is positioned to do well. In general. And the thing is, is you have to look at the local demographics, you look at the foot traffic, and you look at what's— what retailers are going in there and who the customer is. And there are a lot of retail properties that can do very well that were— that are being overlooked. You don't have the bidding wars that you have in apartments and industrial properties. Retail's a little bit overlooked there, so there's some opportunity for investors to place capital into those properties.

Right. There's always something dead. I remember being offered data centers at, at the end of 2001. Right. And the market had been totally overbuilt. And literally you could buy these data centers, I think, for 50% of cost, 50% of cost. You could buy a data center. And of course, now you'd, you'd be brilliant, right? Had you done that right at the time, it was like no one, no one had any faith that the internet would ever be important again or ever that would ever use capacity, you know, to that degree again. And of course, course, here we are, you know, and yeah, and had I done that, you know, I'd be genius, right? Having done that, right. You know, I, I, I do think there, this, this retail apocalypse is gonna make genius out of some investors, right? But as you point out, it's not all the same, right? Let's, let's be super careful about where we stick the fork in.

But so, so what, what is your prediction on cap rates? I mean, in general, I know it's, it's different for every asset class, but you know, you've mentioned earlier there's a little bit of a disconnect in the market right now between buyers and sellers and, You know, we're feeling that a little bit on some of the assets that we're looking at and having to underwrite a little bit differently with the higher cost of capital. But do you think it slows down, you know, the transaction volume? Does it— do cap rates revert a little bit or do investors just accept lower returns? I mean, where, where do you kind of see this playing out? I mean, we're kind of right in the middle of it, so it's hard to know exactly, but—

Yeah, we're in a transitionary period. It's, but it's, it's not uniform, right?

Yeah.

So one of the things I do, I travel around the country. I go and I speak at a lot of conferences and events. And so I travel to different cities all over the country, and I'll walk into, you know, even 2 months ago, I'd walk into a conference room, and if I was in one state, nobody's wearing a mask. And, and if I walk into a conference in another state, everybody's wearing a mask and they're all sitting 6 feet away from each other, right? So It's completely different realities depending on which city you're standing in at any given time. And that's true with cap rates, right? If you're looking at Florida and Texas, Arizona, and Las Vegas has entered the fray now, you're seeing, you know, bidding on those assets and it's very aggressive. And it's really just kind of a knife fight when you walk in on those deals. There's a lot of bidding activity. If you walk into a deal in San Francisco, New York, Seattle, Portland, some of the markets that were more aggressive in their efforts to fight the pandemic, it's not as strong. There's not as much bidding activity there. Those markets are actually still coming, the cap rates are still actually coming down. You're seeing more bidding activity than you were a few months ago, whereas in, say, Phoenix, you've seen the bidding activity start to level off and pull back a little bit as interest rates have risen. Those cap rates already compressed in those hot markets, but you still see a little bit of softness in some of those late recovery metros. So it's not uniform by product type or by, by metro. It's really, really different. So it's hard to speak of an overall trend because some markets are still, uh, strengthening and some are starting to soften up a little bit.

Interesting. Another kind of thing I'd love to get your perspective on are just development trends, right? You know, we see, you know, just at a macro level and several asset classes, um, a really big supply and demand imbalance, right? And, uh, especially residential housing, uh, multifamily, you know, storage, industrial. Um, and so, you know, as investors, we're, we're seeing opportunity on the development side. And what are the bigger trends you're seeing? Is that— is development, you know, are the trends really, really positive right there? You see construction costs might create a little bit of a headwind and slowing down some of that, but I'd love to dive into the development side.

Yeah, the margins we're seeing are still good. I mean, even, even with higher construction costs, the difference between your, your cost to build and your— and the price that it's valued at is significant. All right. You know, there's, there's margin.

So, so in terms of the outlook, both apartments and industrial, we expect record levels of construction completions in 2022. You know, they're both still on the upswing and they're still falling short of demand. Right. They're not building fast enough.

Even post-completion, still falling short.

Still falling short. You know, you look at housing, the housing has a huge shortage. This is going to drag on for years. I keep reading articles about a housing bubble and how housing is going to, is going to fall off a cliff. I just don't see how that's going to happen when the entire millennial generation is out there trying to find a home. They're, they're, they postponed weddings and marriages and now they're starting to get married and moving out, creating new households. They need a place to live. There is a housing shortage in the country. Even though we're going to put out 400,000 apartment units, give or take, this year, that's still not going to keep up with demand. So, our forecast for vacancy rate this year for multifamily is basically flat, down a little bit, but it's hard to do. Vacancy rates are already low. Yeah, 2.8%, actually 2.4% vacancy rate for apartments, which is unheard of. And we're still forecasting they go down a little bit more despite record completions. The same is true with industrial— record completions can't keep up with demand. But that construction cost, anything that's marginal, right, that construction cost is a barrier. And even within, say, multifamily, there are other problems like getting an appliance to put into the unit. I talked to builders who literally go into the Home Depot and buy all the appliances in order to get certificates of occupancy to get those units out on the market because their suppliers have run out. So, you get, you get that shortage. Self-storage, another one that I track a lot, is running into challenges. There's a lot of interest in developing new units, but they can't get self-storage doors. The self-storage doors are made out steel and the self-storage door manufacturers, and there's really just one major one, they can't get steel to make the doors because it got bought by the appliance company who's next in line behind the auto companies. So nobody can get the steel down to that level at the, at the self-storage door manufacturer, which is shortening up the new supply construction in self-storage. So you kind of have to look beyond the surface. There's a lot of nuances inside that really impact whether or not a building actually is constructed and whether or not we have something there to meet demand, which is at a record high.

And that, that kind of goes back to kind of the economic, you know, drivers of all these things going on. But do you see, you know, some of these supply chain challenges being solved anytime this year? Or is this something that, you know, continues on because it's, it's been so dislodged?

You know, The supply chain problems are not going away very fast. This has been a problem all, all this year and into last year. We keep thinking we're going to solve this, but the city of Shanghai is in a lockdown. I mean, that's one of the highest population cities in the world is locked down because of a zero COVID tolerance policy in China. That can shut down an entire port overnight. That can shut down manufacturing facilities overnight. So your supply chains that reach into China have a real challenge because you don't know, the whole thing could just be flipped like a switch. Meanwhile, you know, again, down in Texas, you have the issues with the new laws that were put in place there requiring trucks to be inspected as they come in from Mexico. And of course, the truckers don't like that. And so they're basically blockading the port of entry I was reading an article about how that's going to disrupt the supply chain for basic necessities. Food in Texas is going to run into shortages over the course of weeks because of this policy decision. So there's a lot of decisions being made, and somebody says, hey, this is a good idea, let's do this. And then they go, oh shoot, you know what, we ran out of food. Now we got another problem. Let's fix— we'll have to go back and fix that. So Whether it's ports, whether it's shipping containers or it's trucking or whatever it is, there's something happening. The price of oil is up over $100 a barrel. That drives up the price of fuel. And guess what? Everything moving around our country is on a truck and those trucks need fuel and that's driving up shipping costs. So there's a lot of challenges that are still there. It's getting better. The backlog of ships at the Port of L.A. is down from whatever, 120 down to 40 or 50. But But there's still a backlog of 40 or 50 that we're trying to sort through. That will take time. Hopefully by the end of this year, we kind of get to a resolution. We can get through that supply chain problem. But, you know, we got to, you know, stop shooting ourselves in the foot.

So good. Okay. Last, last question I have for you. So I'm going to make you— I'm going to make you make a call on recession. Is it yes, yes or no? So we've got the Fed raising rates, trying to channel Volcker. You've got, you know, all these these, these tailwinds, as you point out, you know, the yield curve has inverted.

Woe is us.

Recession. Yes. Recession next 24 months. Yes or no? Recession.

Recession. Now, I want to point out real quick, the yield curve, the 2-year versus the 10-year inverted.

Right.

But the 3-month versus the 10-year did not invert.

Which is more predictive, right?

Yes, it's more predictive. So do I believe that there will be a recession within the next 2 years?

Yes.

You know, I've been debating that with everybody in my department for the last few days.

And what does John say?

I think there's a real risk. It will depend on the Fed, how aggressive they become. And actually, the one other thing, small business sentiment is falling. And that's a big problem. Okay. That is that if that falls low enough, that creates a recession. Consumer confidence is starting to fall. If that falls enough, that, that pulls back on consumption, right? 70% of our economy is driven by consumption. If the consumer loses confidence, that means consumption starts to pull back. That can drive a recession. So the key thing is what's going on between people's ears. And right now, the flood of negative news whether it's, whether it's founded, whether it's real or not, but the negative news can actually create, right, self-fulfilling prophecy, right? Yeah, self-fulfilling prophecy. So I say the risk of a recession within the next 24 months is, is, is high. It's elevated. Okay, I, I'm not going to say definitely yes, but I'm going to say I'd prepare for it. Be ready.

Very good.

Last question for me, but you know, from an investor standpoint you know, where are you seeing the most opportunities? You mentioned retail has potential being overlooked. You know, you hit some other asset classes, but where, where as investors should we be looking?

So here's, here's the thing. Here's the property types that people aren't looking at that are actually have good potential. You know, retail, especially suburban retail across the southern, southern half of the country, suburban office. In the southern half of the US. If you look at markets like West Palm Beach suburban office, it's crushing it. There are some markets that are looking really, really good. People don't want to buy off— they hear office and go, no way, I'm not touching it. There's opportunities there. When you look at housing, I think housing still has a great runway. I think that there's good 5 years of runway to for housing demand that is going to outstrip supply and keep performance metrics good.

Multifamily and single-family, or, or one or the other?

Yes, yes, both, both. Uh, industrial, you know, we can't get enough of it. There's a reshoring that's happening because of those supply chains we were talking about. Uh, I was talking to the head of, of, uh, research for one of the major retailers in the U.S. They said, look, I have a ton of this product and I have zero of that product. And in order to iron out our supply chains, we're having to store more inventory here in the U.S. We need more industrial space. So industrial is looking good. Let me think. Hotels, for those who know how to operate them, are great. Self-storage still has runway. And let me think, what's, what, what's higher risk? I'm going to kind of I keep listing off all these properties. They're good, right? What, what has caution flags, right? So, uh, urban office, urban office still has, you know, yellow flags around it, maybe red flags. Uh, uh, urban hotels, especially the ones that cater to conferences, are still yellow, red flags. But that could change soon if we get a full return to the office and companies start doing more business travel, those, those types of hotels start to pick up. Urban retail still has challenges. I'd say northern U.S. cities like New York, Chicago, Detroit, Seattle, Portland, those types of markets tend not to have as much strength right now as the ones in the south. And I think they're probably the toughest deal right now is an apartment building in St. Paul, Minnesota, where they put in very, very stringent rent control. Oh, I think there's that. There's that.

John, this was so insightful. Thank you so much for taking the time to share with us. What's the best way for our listeners to— I'm sure you guys have free reports you guys put out in different asset classes to, you know, get access to some of Marcus and Millichap's research. This is really, really insightful information.

Yeah, absolutely. Just visit our website, MarcusMillijap.com. Our research is all posted there. I record weekly videos that are posted up there. And people just have to register, enter their email address, and they log in. They can access all of our research. Also, those who follow me on LinkedIn, I post most of our research up there as well. So So there's a lot of ways to access all of that information. And, you know, we're here to help.

Awesome. Thanks so much for coming on, John.

So good. Thank you for being here.