Overview of Real Estate & Economic Updates feat. John Chang

Hello, future billionaires. Welcome back to another episode of the Invest Like a Billionaire podcast. We have got a humdinger of an episode today. This was amazing. We got John Chang, who's a returning guest. He's, you know, the senior research at Marcus Millichap, and he just dropped a ton of bombs. And we asked him all of our questions and just brain dumped, and he just had some amazing responses. So Bob, what are some of the things he shared and why should someone listen to this episode?

Okay, this guy, I'm telling you, is my favorite subject for interview. This guy, is a wealth of knowledge, my favorite guy. So find out what's really going on and what's really happening in commercial real estate, interest rates, inflation, and stay tuned to the very end. So he calls me out where, where I, I, I, I was wrong in an economic forecast and he was, he was right. And so listen to the end, you'll get that piece.

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Yeah.

Yes. John Chang, who is the national director of research and advisory services at Marcus Millichap. We've known John for several years. He's on the conference circuit speaking on all these big picture things we want to get into on what's going on in the economy. You know, how is commercial real estate being impacted? Obviously a lot. Last time we talked, you're looking back, was May 2022. And fast forward to now, about a year and a half. There's a lot that has changed since then. And so we have a lot to catch up on. John, thanks for coming on the show.

Hey, it's a pleasure to be here. I'm glad to have an opportunity to chat with you guys.

Yes, it's always fun. So let's, let's dive right in. Help set the stage for us. Maybe, you know, give us the— over the past 18 months, what are some just things that have changed from, from then to now? And, and we'd love to start there.

Well, what hasn't changed, right? And so the entire industry has been shaken to its foundation, right? We've seen the inflation spike. We've seen what the Fed's done to us with their interest rate movements. And I actually watched our video from, from 18 months ago, and I think I undershot the Fed movements a little bit. I was not planning— a lot of people did. I didn't see 4 75 basis point movements coming in a row. I really didn't in May of last year. But that's really impacted everything that, you know, it sent shockwaves through the banking sector. We've seen movements in commercial real estate. We've seen cap rates move. We've seen markets slow down. So there's really just been a real change throughout the economy. But we have not had a recession. And if you go back 18 months ago, if you go back a year ago, basically every economist out there was saying we would be in a recession today.

Yeah.

And that has not materialized. Now, basically everybody's talking about a soft landing, which means there's probably going to be a recession. Right. So economists are always wrong. But no, it's really been a dynamic market, if you want to call it that. But it's really seen a slowdown in commercial real estate activity. Investors have moved to the sidelines. In many cases, they're looking at each other trying to figure out what's going on. There's uncertainty. And, and there's a bid-ask spread that's opened up. Buyers and sellers are not on the same page. And we've seen a real transition from some of the best years in commercial real estate, some of the, you know, the time when, when, you know, the tide was up and everybody was doing great and everybody felt good to a more normal cycle. Actually, we're in what's what would be considered a more normal market now. But, you know, when you're coming off of the big highs, it's— it seems like a massive slowdown.

So where have you seen from your perspective the most stress?

Right.

You're saying things have fundamentally changed. Where is the stress kind of been most acute?

Well, obviously the office sector, right? Office sector has just been hit hardest. And that's a byproduct of the pandemic and changing behavior, people working from home. People when, when they could work from home, they, they moved out of the city, they moved to the suburbs, they moved to a completely different city, they moved to a completely different country and worked from there. So we've seen a real change in the office market. Some cities have been hit harder than others. Definitely major urban hubs have been impacted the most, but They have, you know, absolutely the office sector faces the most stress. It faces the most change. The vacancy rate was, you know, like 12% before the pandemic and now it's up at 17%. And when you cut inside of the office sector, you actually— there's a lot of nuances there. It's not all bad, but it's definitely the property type that's seen the most stress. We've seen apartments change. We have a lot of development coming online, you know, 420,000 units in, in '23, 480,000 units expected in '24. So we have this shockwave of development coming through the system and that's creating some challenges in some markets because it is a little bit more concentrated. I think there's about a dozen markets that have about half of the construction. So We're still facing that. That's impacting fundamentals. And when we were talking, you know, a year ago when we were talking about recession risk, we were talking about hyperinflation, everybody started to get scared and consumer sentiment dropped to a record low. And consumer sentiment relates closely with household formation. So when everybody was scared, nobody wanted to go out and rent an apartment and we saw negative absorption. At the same time, we had a huge wave of development coming online. So it's going to take some time to make that back up. So those are, those are two property types where we've seen a lot of action.

Let me jump in there on that. So, so it sounds like you're, you're saying we're not yet seeing the bottom, you know, of the, let's call it the multifamily meltdown. I mean, you know, multifamily has been a, you know, such a gold standard for many, many years. It's considered, you know, everybody needs a place to live. So it's considered very safe, has commands kind of premium cap rates. And, you know, I guess my view is that it's— we're not, we're not seeing, we're not seeing the bottom yet. And with all the— as you point out, the massive amount of deliveries come in as well as the troubled, the troubled units that I don't think we've seen the bottom. And, you know, where do you think we're at with, with regard to the multifamily?

You know, sure.

It's, you know, firstly, I want to start by saying this. If you look longer term, if you're looking 5 years out, we still have a housing shortage, right? Even with all these new units coming online, we still have a housing shortage. I don't think this is a long-term structural problem.

Right.

But what we do have is a— we had absorption drop and it was negative in 2022. It was— we were losing tenants in net. As an industry and we were building quickly and we still have more units coming. Absorption has gone positive. It's back into positive territory in 2023 every quarter and it's rising. It's getting better each quarter. So we have that going for us. Now, in terms of are we at the, at the bottom yet? Probably not. You know, we still have 480,000 units. It's a lot of units that, that's a lot of construction. And to come on top of the 420 this year and whatever it was in 2022, just light of 400,000, that this is a lot of development that's been happening. And so I think we still have a ways to go. The good news is that we have seen starts drop significantly. And as we go into '25, '26, we expect the wave of development to abate and things will, will ease up a little bit. So in terms of operations side, yeah, absolutely. Some of these investors got out, you know, a little bit over their skis and they really are facing challenging times. I think there will be some distress that emerges from that, but so far it's been pretty limited. And yeah, I just don't think that it's going to be this huge wave. You know, we're not going to see the blood in the streets, but we are going to see some investors who are trying just to get out with their skin. Yeah.

And so there's going to be some distressed sales and just, you know, a lot of rescue needed, rescue capital needed, and probably prices falling. Right. For the, for the next year or so. That's my view.

Is it—

would you, would you agree with that?

Yeah, we've seen, we've seen upward pressure on cap rates. Right. So anywhere, you know, compared to the peak of the market, we're anywhere depending on the market, the property, everything else. Right. Anywhere from 75 to 200 basis points of lift on cap rates from the, from the top of the market. And we expect to see continued upward pressure. Right. You know, a lot depends on where you see the Fed going, and that's going to be a big part of this and what happens with the interest rates. I mean, the 10-year Treasury touched 5% just a couple of weeks ago and then it came back down a little bit. Is that 4 or 4, 4, 4 right now? So but we could see in this new interest rate climate and what the buyers are trying to do and what they're willing to pay We're still seeing some, some gap there. That said, there is a tremendous volume of capital on the sidelines. There are a lot of investors, a lot of institutions that are kind of sitting on the sidelines and waiting for the right pieces to come into play where they come back into the market aggressively. And so it's kind of— it may be a bit of a famine feast situation where there's a— it's hard to raise capital right now. It's hard to get out and get deals done right now. But when the market turns, we could have this wave of the shockwave of capital coming into the market that makes it really hard to get a deal done because there's too much competition.

Right. So the capital on the sidelines is looking for deals, right? Looking, looking to buy stuff that's distressed and distressed kind of pricing based on, hey, yeah, we 5 years from now there's a housing shortage, etc., you know, it's a good market. So this is called a buying opportunity, right? When you see cap rates rising, you know, so yeah, a lot of, a lot of capital in the market. But so talk about price discovery. They're really— we're still super thin on price discovery. Right. And but, but I think that's going to happen more as you look at, you know, as these— you see a lot of maturities happening. People are going to be forced to either find new equity, do capital calls, or, you know, you know, rescue capital or something, or they're going to have to sell. And you're going to see forced price discovery coming and then coming in, you know, 2024, really.

I think there will be some. Now, we have to remember, FDIC came out with guidance in June that basically said leaving it up to the banks, but the banks will have the opportunity to be creative in extending loans. Right. So same playbook we saw in the financial crisis, same one we saw in the pandemic. There's, you know, blended extend or extended refi, all of these things kick the can down the road. It's worked the last 2 times.

Yeah.

Right. So they like that playbook. And I think that we'll see some of that, especially with the, the clients that the banks have a relationship with. The banks are not excited about writing new debt right now. So, so even though they're open for business, technically the terms that they're offering are not great and they're really focused on increasing and strengthening their balance sheet. So they may say, yeah, we'll loan you the money for this deal, but we want you to deposit $2 million in our bank and so that we can boost up our balance sheet a little bit. So we're seeing some very unique situations. CMBS, by the way, CMBS is the one lender that has no mercy, right? There's, there's no person there that you're having a conversation with. So CMBS debt that, that gets distressed, that will pop out almost assuredly. But the stuff held by the banks probably will get blended in or extended and refinanced or something like that.

I agree. What about the, what about the bridge, you know, the bridge lenders, a lot of the, a lot of the bridge, they, you know, went very high into high, higher LTVs and, you know, more aggressive lending and pretty much out of capital now. So they're, you know, they're going to be, they're going to be forced to, you know, deal with this. How do you think that's playing out?

Well, I think, you know, the bridge lenders that I know, a lot of them are very hands-on real estate investors. So they said, well, it's hard to buy a deal right now. Well, we'll go out and we'll offer some bridge lending. A lot of it's private, private capital. And, and they have no fear of taking over a property. Right. So the bridge lenders are going to be in a position if somebody goes into default to come in and take over the asset and, and, you know, take ownership and possession of any kind of property. Those, those, those are professionals. Those are not banks. That's not a financial institution. Usually they're going to be in a well-positioned to come in and manage those assets. If they, if they take them over, they go in, they clean it up and they resell it. So there will be some stuff coming out through there.

Well, so what's your opinion on the, on what the Fed is doing? But we saw the markets are definitely believing that rates are going to come down next year. Markets started, you know, kind of did a crash here. Recently and, you know, rates dropping. So, you know, I, you know, I'm, I'm of two minds. I still see inflation being high and the Fed's not changing their, their, you know, their playbook. They're saying we want 2% and we're not close to 2%. And yet the markets believe, oh, they're, they're making that up. I mean, and, you know, it's kind of what it feels like to me. And so I've always believed that. I just think it's going to be higher for longer is really— I've been saying this for, you know, a year and a half now. And so, but what's your view? Do you think the markets are right and they're smarter than all of us and we are going to see the Fed, you know, dropping rates or how do you see it playing out?

So I track FedWatch, right? So right now they're saying they keep rates flat in December. If you go out to May of '24, you start to see a divergence. About half of the, you know, 50% likelihood of flat. And about 50% saying they're going to go down 25 or 50 basis points by May. Now, when you look at where we are with inflation and in the, in the Fed's eye, they're really looking at core PCE, right? That is the actual measurement they want to get to 2%, not CPI, not some of these other ones, but it's core PCE. And that's at 3.7% right now. It was at 5.1%, you know, 18 months ago. So it's down pretty considerably. But it's only halfway there. And when you listen to Chairman Powell, he, you know, he explicitly says higher for longer. And he says that with conviction. Now, he also says they may raise rates, and I don't believe him. Right. So I don't think there's any more rate increases coming. I think that the, the rates are sufficiently restrictive to put downward pressure on inflation. Incidentally, we had a webcast with Mark Zandi a year ago and he was saying that we should look for the 10-year Treasury to come in somewhere in the, you know, 4.25 to 4.5% range would be, quote unquote, normal in this climate. So really, when we look at what the Fed's going to do, I don't think they're— I don't think they're going to raise it. I think they're done raising. I think that the likelihood of a substantive decrease any time in the next year is low. I think you may see a 25 basis point drop somewhere along the line, maybe third or fourth quarter next year. But I just don't see them reducing the overnight rate substantively until inflation not only gets to 2.0%, not until, you know, PCE, core PCE is at 2%. But I think they're going to want to keep it at 2% for a few months before they start really moving rates. Yeah, you have to consider a lot of people think that rates are going to go down because this is abnormal, right? This is, this is the, you know, it's a generation gap. Or millennials, right, who have grown up in our business community, right? Millennials in their 30s, early 40s, they've grown up in real estate over the last 10 years. And the average cap rate, the average 10-year Treasury over that time is about 2.5%. That is normal in the mind of somebody who has only been in the business 10, 15 years. And those who've been in here since the '90s, you know, the '90s all the way up through '07, the average 10-year Treasury was about 5.5%. And for the, for the quote unquote old timers, right, who've been out here for doing this for 20, 30 years, we look at it and go, it's not so bad. We can make this work. We know how to do these deals. And so it's a matter of perspective. So a lot of people say, hey, it has to go down because this is abnormally high. And then there's another group saying, actually, it's not abnormally high. This is, this is actually pretty normal.

Yeah, 100%.

Right.

So why haven't cap rates moved as much as much I would have predicted with the dramatic move in, in, you know, in, in rates? Why haven't cap rates moved more?

What, what is—

what's the sauce behind all that? What's going on?

Well, let me ask you this. What would it take for you to sell a property right now?

You got to find something better, right?

You got to find something better. But essentially, you have no— you have no motivation, right? There's no reason to sell. You look at it, you go, you know, we're doing good, we're making money, the property is doing well, we're running it effectively. I don't have a motivation. Now, if somebody came in with a, you know, with a— with a truck full of cash and said, We're going to dump this on your house and you can have all this money, you know, you know, far more than you think that property's worth. You'll take it. And that's where we were in 2021 and part of '22, right? The prices were so high that people were motivated to sell because they couldn't believe what somebody was offering them. They were basically being offered so much money they couldn't say no. And we're not in that climate. We're back actually into a normal transactional climate where motivation is driven by, you know, investor needs, right? Whether that is, you know, for private investors, you know, say, you know, traditional death, divorce, breakup of partnerships, you know, maturity of a fund, those types of things are going to be the drivers. But for a while, we were being motivated because there was just so much money on the table and you could redeploy it and, and play the whole game again and again. People were instead of holding for 5 years, they were holding for 2 or 3 years because the values went up so fast. And so we had a lot more velocity. Right now, there's— you're not going to make, you know, extra money. It's not, it's not that big giant number. So your motivation is limited to traditional motivating factors. And, and there's just not a lot of motivation being created unless you have some sort of life change or a fund that needs to be turned over.

Yeah, perfect. Now, you said, you know, transaction volumes are more normal, but year over year we're down probably, what, 75%? So is that kind of a normal trend? Normal to all you see or just normal to the reasons for it? And you expect that to kind of tick up over the next 12 months?

Yeah. The reasoning behind it is moving back to normal, but we're still going through a little bit of aftermath. Right. So you look at transaction activity, they're down about give or take, 50% compared to 50.

Okay.

A year ago. It depends on how you measure it, right? Dollar volume or transactions or— there's a lot of different ways to look at what's your minimum threshold. But basically transactions are down about 50%. But compared to, say, 2014 to 2019, you know, kind of a more normal cycle, we're down more like 20%. Right. So we have to— we're going to come up a little bit. I expect that in 2024 We may still be a bit slow through the first half, but I think it'll pick up momentum as the year progresses. I think, again, if the Fed just holds rates flat, then I think it gives investors the opportunity to calibrate to the market and, and we'll start to see transaction activity improve. Now, compared to, you know, when we were in that cycle in 2022 when the Fed was moving rates, you know, 75 basis points every month, and over the span of 4 or 5 months, they moved that overnight rate up by 300 basis points. It's very difficult to underwrite a deal in that climate. So just having a period of stability will allow investors to recalibrate, move to the market. We'll see the pricing come out and we'll have a discovery process. And that expectation gap between buyers and sellers should narrow as we go through the year.

Now, I've been seeing some scare articles about regional banks and having commercial real estate crisis, and my research on banks, just everybody looks pretty healthy. I just don't— I mean, there may be a few little failures, but I'm just not seeing it.

I don't know.

Are you seeing, are you seeing bank stress? And what are you predicting?

So if you look back at what happened over, over the, over this cycle. And Bob, you and I were both at the Best Ever conference when we— when Silicon Valley was going under and, and people were— I was literally at the conference. Somebody goes, hey, what do you think of this Silicon Valley Bank thing? And I don't know what's going on. I was busy. And he says, yeah, my friends are trying to pull $200 million out of there right now. They can't get their money. And I was like, $200 million. Who puts $200 million in one bank? But so anyway, they were, they were clearing it out and we don't need to go through all the details there. But basically Silicon Valley Bank couldn't cover the bets, right? So then, so then money started coming out. They got shut down. Then the whole conversation centered on real estate and everybody's like, wow, yeah, real estate. Small banks hold 80% of the debt. Which is wrong. We came out there early and squelched that. As a matter of fact, right after we came out, Moody's came out with a report and Real Capital Analytics came out with a report all backing up our position. And actually a lot of those articles saying the small banks held 80% of the debt got pulled off the internet, which was, was pretty good to see. But in reality, the sector with the greatest risk right now is office. Right?

Right.

And when you look at the total debt held by banks in general, only 25% of the debt they hold is in commercial real estate. The rest of it's in residential or consumer loans or in, you know, business loans. Only 25% of the debt they hold is real estate. And of that, only 15% is in office. So their real risk factor, only about 3.5% of the debt held by banks is in office. And of that, only, you know, whatever, 10%, a quarter of it is truly at risk. So when you look at what's the actual risk of real estate to the banking system, it's not what you see in the headlines, but there is a perception issue, right? So when you look at say, First Republic Bank, they had a lot of real estate and structurally they were operating, they were fine. They weren't really in a bad situation, but they kept getting beat up in the headlines. And I almost felt like Chase Bank was chumming the waters when they said, well, we'll loan them $30 billion and so that to make sure that they're stable. And then everyone goes, oh my God, Chase Bank's loaning them $30 billion. They must be in real trouble. Everybody starts pulling their money out. They go, they're at risk now. Everybody's pulling their money out and they have a run on the bank. And then guess what? Chase Bank comes in. So, well, I guess we'll buy them, you know, so they bought out. So, you know, Jamie Dimon, smart guy, who knows? But my point here is the true risk is not what you see, but there is a perceptual risk if somebody says this bank is in trouble and they have too much real estate and they're going to default on all this debt and they're in trouble. Everybody should pull their money out. By pulling the money out, you're yanking the rug out from under their feet and then you have a bank at risk. And so FDIC and the Federal Reserve came up with a lot of strategies to try to reduce that risk. They backstopped a lot of the, of the, of the holdings. Right.

The Treasuries. Yeah.

Yeah.

Well, yeah, basically now instead of having to sell off their bonds before maturity, they can borrow against them at face value and try to secure their, their, their finances. So net-net, there's— I don't think there's a real risk to the banking system from real estate, but that doesn't mean that real estate can't be part of why a bank gets put under. And if a bank goes under, in the next 12 months or something like that because of these things, it will send a shockwave through and lending will get locked up again. Right. We're already in it. I mean, yeah, we're already pretty close.

Yeah. I mean, what's interesting is that the credit already feels like it's tightened a lot, right? I mean, yeah, a lot of like we looked at some refinances for some of our assets and deals just aren't sizing up at the leverages that, you know, really make sense at the higher rates. And then I've talked with— it's more anecdotal, but a lot of the banks that we've worked with and that we have relationships with are saying, you know, we're just— because we're having to extend and pretend or, you know, continue to push maturities or work out deals, they're not clearing their balance sheets to have new capital to lend. And so that's further creating, you know, less available capital for new deals. I mean, do you see that having a lingering effect going into 2024 as the banks are just still not willing to lend at the leverage that makes, you know, the capital want to purchase at those prices? Or does that kind of get leveled out here, you know, the next couple of quarters?

Well, if you look at the last lender survey, they— the banks are still tightening their underwriting. And if you go down and you dig underneath the surface and you go look at the actual survey information, basically one of the top answers was we're trying to build up our balance sheets. We want more cash in the bank. We don't want to lend out right now. Now, I have an existing client. They have a loan with us. We're going to work with them. We're going to try to take care of that, that deal. But we're not going to put more money out unless it's a real sweetheart deal and they give us deposits. That's really the criteria right now. So, you know, multifamily is a little bit better position. You have, you know, Fannie and Freddie, the GSEs out there. So there are some— there is available debt through there. But But in general, the banks really are being cautious because they don't want to be the next one that shows up in The Wall Street Journal as having, you know, extra risk. And, you know, think about it. If you're a bank executive, the last thing you want is for your bank to have a run on it and you get put out of a job and you can't get a job after that because everybody says, well, you're the guy who was running that bank and, you know, you got killed. So anyway, it's really a cautious play from the banking sector right now. Now, this smooths out over 2024, I believe. And the reason is because the Fed stops raising rates. The financial pressures on these banks are— go down, the economy levels off. The one risk factor in a way is a recession. But by the same token, a recession— if we had a recession, that may be the one thing that causes the Federal Reserve to reduce rates, right? If they see a significant recession, they're not going to do this for just a very small, mild recession. But if, but if there is a severe recession that comes through, they could reduce rates and that could take some of the pressure off too. But you have to see what happens with job formation and all the other economic drivers.

Random question. So I'm tracking kind of what's happening in China and you're seeing a pretty bad property bubble popping in China. You know, my guess is they'll use the same playbook the Fed has used, you know, to keep the banks, prop up the banks. So I don't know how much you're tracking that. And do you think any bubble popping in China hits the shores of the United States or the globe in any significant way?

Is— I don't track it very closely, but one thing about China is, first of all, they have— their economy can be controlled more closely, right? So the government has a lot more latitude in how they run things. They can head off issues more easily should they choose to do that, and they can manage their fiscal policy you know, from the top down. So the— I think that the risk of that splashing into the US directly is pretty slim. I don't think that there's a financial market shakeup or anything like that as a result. You know, there's talk about how China has been reducing their purchases of 10-year Treasuries and reducing their US Treasury holdings. And that's true, that has been happening. But it is also just a drop in the bucket compared to the Federal Reserve. They're like 10% of the total holdings of what the Federal Reserve holds. It's really a small amount of the total Treasury. I think it's 3% of the total Treasury. So that's more of a function of the balance of trade anyhow.

They, they, when they receive dollars from American purchasers, they got to buy they got to either spend it or buy Treasuries. So, you know, I'm not concerned about that. Okay. Last question. I'm going to throw it back to Ben. So we've talked about all the bad stuff that's going on in the market and how ugly it all is and all. But let's talk about the good stuff. Where are the outsized opportunities? Some of the things that we love right now that we are just very, very bullish on is industrial, big box industrial. That's, you know, you know, warehousing, you know, transportation, you know, logistics and, and manufacturing. Huge demand. We're really seeing— we haven't seen cap rates hardly budge. And, you know, still a lot of demand kind of slowed from the recession slightly, but still hugely bullish on that. And the other area that we just absolutely love, we can't get enough, is the small neighborhood retail, the little neighborhood retail centers. And these things, we're buying these at an 8 and 9 cap rates.

With just—

they're beautiful, they're great locations. And I don't know how you lose money on this. And we're buying them at 50% of replacement cost. So nothing's been built in that space for the last 15 years. So, you know, comment on those couple areas and anything else that's your happy place.

What do you—

where do you say, investors, you got to back up the truck right now and stick— put your money to work because this is— this is where it's going to be amazing.

Well, Bob, you know, 18 months ago in our video, I said, hey, retail's looking good. You guys are like, I know it's true.

You—

I'll give you credit for that one, buddy. You called it. So, yeah, retail is still fantastic, especially neighborhood community centers. There's no construction to speak of. They're outperforming. The vacancy rate is at 4.6% for retail overall. And, and I think in those centers it's even below that. You look at especially secondary tertiary markets, suburban areas, right? We had that migration pattern out of the major urban hubs into these outlying areas. Those are all doing great. That is probably the best performing asset out there. And vacancy rates at a record low and the performance is rock solid, especially you got a good anchor or a shadow anchor center. And the yield on them is, is some of the highest you can get. And, and they're performing well. So retail's doing good. Also, if you look at retail sales, retail sales have outperformed everybody's expectations. Now they are softening. They've flattened out over the last 18 months, but they're still at a record high on an inflation-adjusted basis. Right. So when you see the retail numbers, they don't normally inflation-adjust them. We've been doing that. Retail sales on an inflation-adjusted basis, I think, are up about 0.2% on a year-over-year basis. But that's perfect, right? That soft landing, you're right, that, that's right where you want it to be. So you have gains. Retail's looking great. Industrial, you still have a wave of development that's in process, 400 million square feet coming online this year. I expect that next year it may come down a little bit. And then in '25, we see the pace of construction really drop off. But right now there are some markets that have a lot of development. I think about half of the total square footage being added it is in 8 metros. Wow. That's like Chicago, Dallas, Houston, Atlanta, Phoenix, Inland Empire. I think Philly is up there and there's one other one. But so, so there are areas where you could get overdeveloped infill industrial. It looks great. Can't beat it. That's doing really good. Another one, another property type that I, that I like right now and I've, and I've really been tracking is medical office. You got to remember, 10,000 people turn 65 every day. And as people turn 65, their use of medical services goes up. They average 7 visits to the doctor per year. which is double the average overall. As the baby boomers age into their 60s and 70s, use of medical is going to continue to grow. And the construction of medical office space has been very limited. So that's another property type that's been doing well.

But what about the stress since COVID on the medical space? I mean, we're seeing huge job shortages and, you know, service delivery problems, you know, so You think this is— it's going to— doesn't matter because of the demand. It's just going to be there and they're going to need real estate either way.

Yes. Yeah. Yes. To all of those, I expect the demand is going to be there. So we got to fulfill it somehow, right? We can't not provide medical services. So I think this is one of those areas where— and we've seen some of this showing up in Congress, the H-1B visas. There is an opportunity to pull medical personnel from other countries and allow more immigration. Our immigration policies, if we can loosen those up, we can solve a lot of our labor shortage issues.

Amen.

Especially in the skilled services like medical services. I think there's a huge opportunity there. So at some point, I think that we may need to do that. Actually, I think we already need to do that, but at some point, maybe Congress will, will be able to, to focus on issues that need to be solved.

Wow.

That would be amazing. Any other happy sectors in real estate before we—

I think there's a bounce back in Sears housing that's out there on the horizon. I think hotels are doing very well. So actually some of the best numbers on record in terms of the revenue per unit basis. You know, I think really the office sector is getting punished. There may be some good opportunities there. Honestly, if you know office, right, and you know how to operate office, especially smaller suburban office buildings, I think there's an opportunity. Let me, let me— I have some notes here. But basically, if you break down office, right, it's the '80s— it's the '80s construction urban core office buildings that are over 250,000 square feet that are getting killed. Right. It's very specific. If you look at the vacancy rate of urban office buildings that were built in the '80s that are over 250,000 square feet, the vacancy rate is 25%. Now, if you go to the other extreme, you go to a suburban office under 250,000 square feet that was built in the last 13, 13 years since 2010. The vacancy rate is 11%. Hmm. So right now the whole sector is being kicked in the head. Everybody— nobody wants to buy office. Nobody wants to touch it. But there are segments that are performing very well. Las Vegas, Inland Empire, West Palm Beach, all markets that actually have office shortages right now and have some opportunity there. So that's kind of the hidden gem that's out there for those who have the skill and the guts to take it on.

Well, it's interesting.

That was probably right for those, you know, so.

Exactly. You know, you can get maybe, you know, maybe you're looking at a double-digit cap rate.

Wow. Yeah.

Property that's performing pretty well. I was talking to an institutional investor that I know and they have to clear their balance sheet up and they had a building in San Francisco that they had on the books for $120 million. They sold it for $45 million and they were happy to be done with it. And so they just said, we don't see any way for us to make money on that deal because our basis is too high. We're just going to clear it. We're going to recapitalize. You take that money back, we're going to go put it somewhere else and make money on that. We call that one a loss.

Ouch.

Yeah. John, I wanted to ask just one other kind of more nuanced question on, you know, class. And like you said, age of property and office really matters, but also other asset classes like multifamily where I'm kind of thinking, you know, A, B, and C, You mentioned there's a lot of demand on the sidelines, but what we've heard, right, and you probably have more aligned to this than we do, is that most of that demand is for newer vintages. Right. But what we've also seen is that a lot of the older vintage properties, you know, the '70s and '80s, more the Class C that was purchased predominantly over the past several years with bridge debt. Right. Because they could get really high leverage. You know, there's going to be less demand for them. So do you see One, do you agree with that? And two, do you see a kind of outperformance, you know, as we kind of come through the recovery here over the next couple of years between age of properties and class of properties? I'm thinking again, mostly multifamily.

So I think of multifamily class cuts as a cannibalization, cannibalization story, right? So your, your, your Class A property can take a tenant from a Class B property. All you have to do is offer some concessions, reduce your rates, and you can steal that tenant away. And the Class B property can steal the Class C tenant. So right now we're building out all this Class A and we see concessions rising because all of these new buildings have to fill up and get up to, up to the proper census so that they can then sell those properties off if they're a merchant builder or hold them. But basically they got to fill these things up. So they drop rents, they offer concessions, and they, and they suck the tenants out of the B buildings. And then the B buildings say, oh man, we just got it. We just got hit. We got to go fill those units. They, they do the same thing and they go pull somebody out of a Class C building. Class C building looks around and goes, well, there's nobody I can steal from. So they— so your vacancy rates on your Class Cs come up a little bit. As these other units fill up. But as we get kind of out of this wave of development, as we go into 2025, '26, '27, I think we see this come and normalize again. So I think we're really just dealing with this wave of development and the disruption it's causing in the marketplace. Ultimately, the, the demand for housing when you break it up, you know, different tiers of multifamily properties are going to cater to different audiences and different tenants. And the tenants always want to move up if they can and until they get priced out of that market. Right. So you give a 1-month free or 2-month free on a 12-month lease, that lease goes for 12 months. That person can't afford it anymore. They move back down into that, you know, from that A to the B or the B to the C and and so on. It resolves itself.

Yeah, that makes sense. Okay, last question. Biggest one for last. So, you know, we— last time we talked, recession fears. Now everyone's saying soft landing. We've avoided it. We still have a slightly inverted curve.

I said, by the way, 18 months ago. So I— so, you know, I'll give you that you woke me up on retail. But, but I've been saying, yeah, with this kind of consumer behavior, we're not going to see a recession. So Yeah. And yeah, what was the question?

Well, so we still have a slightly inverted yield curve, right? And that generally has been a strong indicator of a recession, you know, usually 18 to 24 months down the road. Do you think we've just delayed it because of, you know, the initial stimulus that's still, you know, in the consumer's pockets and, you know, it's going to hit at some point, or are we able to kind of manage through and muddle through the next, you know, 18 to 24 months and make it out without, recession, or at least a very, very severe one.

Well, okay. So, so, yes, Bob Fraser's right. 18 months ago you were saying, nah, it's not going to happen. But and my statement was I would prepare for that just to be safe. Right. But the thing is, you know, I'm always nervous when it comes out into these things because all the economists are going one way. And like I said earlier, it could go the other direction. But But if you, if you look at the underlying drivers, GDP, the third quarter GDP of this year, just actually a revision came out today and it was revised up to 5.2% growth for the third quarter annualized basis, which is a huge number. It's just like off the charts. So, so the, you know, based on just simple math, 2023 has economic growth of like 2.4%, maybe, maybe 2.5%. That's a big number, actually. That's a— that's for a whole year to have 2.5% GDP growth is actually a really strong year. Forecasts for next year are coming in 1.2%, something like that, 1.4% maybe. And so when you look forward, yeah, everybody's pretty much saying soft landing now. That could get disrupted, right? Think about all the things that could go wrong. And you get— you have what's going on in Ukraine. You have conflict in the Middle East. You have— you have a dysfunctional Congress that doesn't have a budget. The budget, they kick the can down the road until January, February. We have a lot of things that could go wrong. But assuming that we don't have any of those things go haywire, You know, we go in and we, we manage a soft landing for the first time ever. Right. Nobody's ever had a soft landing from severe recession. This has never happened. But, you know, Bob's right. We got— we have good consumption. We have huge savings. Right. People talk about consumer credit being over $1 trillion. But when you look at that as a percentage of income, right, small, right. So, yes, it's the biggest ever, but income's at the biggest ever. And GDP is at the biggest ever. So debt as a percentage of GDP is down. Debt as a percentage of income is down. Households are actually have strong balance sheets. They're financially in a better position than they were in 2019 or '18 or '17. So right now, people are still looking pretty good. We're adding 200,000 jobs per month. The unemployment rate's 3.9%. Now, the yield curve has been inverted since July of '22. Now, the theory is, is that— and that's the 2-year versus the 10-year. If you look at the 3-month versus the 10-year, it's inverted since November last year. So about a year now. Now, the theory is you will— that is a signal of an impending recession from when it goes inverted. And within the next 18 months, you have a recession. We're almost out of time. Right. This thing's been inverted almost 18 months. The other measurement of a signal of a recession is a 50 basis point rise in the trailing 3-month average of unemployment, where— and so our average unemployment rate was about 3.5%. We're at 3.9%. We're close to that. But the thing is, is that the unemployment rate is rising because labor force participation is climbing. And that is not the normal way unemployment goes up. It's usually because of layoffs, people losing their jobs, but it's actually because more and more people keep coming to the workforce. Workforce. If you look at the 25 to 54 year olds, right, as we were coming out of the pandemic, it was like everyone's like, oh, these young people, they're not working. That's why this is all going wrong. But, but the labor force participation rate of 25 to 54 year olds is basically hovering at, at or near its highest point since 2008. Right. So labor force participation among young adults and middle-aged people is very, very high. It's actually the baby boomers who are working less, and that's because they don't need to. So in reality, that, that signal from the unemployment rate, because discretionary income is still holding up, That's not a signal yet. And it may not be unless we start to see some, some rise in the weekly unemployment filings. And those are still in the 200,000 range, which is actually low historically. So overall signs of a recession are very limited. Something could go wrong, right? Black swans happen. You know, nobody really saw a pandemic hitting the globe a few years ago, but something could always go wrong. But right now, assuming none of those major things go sideways on us, soft landing is really viable.

First time ever, potentially.

Yeah. John, it's like watching Airplane, right? The guy, the guy trying to land the airplane, the sweat's coming off. You know, he's like, I can do this. I can do this. So we'll see.

Yeah, John, this is so fun. It's such a pleasure and treat to have you on the show again and definitely love, love your perspective. So for anyone that is not currently subscribed to Marcus Millichap's research and just the things that you and your team are always putting out, best stuff, it's so good. You got to get on the list. Go sign up. It's just MarcusMillichap.com, right, John? And you can sign up for the research and they have different markets, they have national and all different asset classes. It's just really, really good stuff. What's another way that folks can kind of, you know, get into the world, what you guys are doing?

Sure. So if you go follow me on LinkedIn, I shoot a video every week with whatever's on top of mind for me. That's another way. John Chang on LinkedIn. I'm there. And I also want to mention on our research on our website, MarcusMillerChap.com, that in January we start releasing our investment forecast books for the coming year. Those cover, you know, 50 markets and rank them and say, here's the best ones, here's the weakest ones, provides national perspective and a write-up on every market. So those can be downloaded or we print hard copies. You can request a hard copy. We do it for apartment, retail, office, industrial, self-storage, hotels, and we also do a special one for Canada. So those will all be available starting in January.

Awesome. Okay, you heard it. Go to MarcusMillerChip.com and sign up for those. And if I could get all 50 sent to me hard copy, that'd be great. I appreciate that.

No problem.

Just— All right.

Thanks so much, John.

So good.

So good to have you, John. You're always a wealth of wisdom.

Love it.

Oh, good times, guys.