AIPIS 163 - What to Expect with REI and Interest Rates Under Donald Trump with Newmark Grubb Knight Frank's James Kuhn

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It's my pleasure to welcome James D. Kuhn to the show and he is president of Newmark Grub Knight Frank and he has some interesting perspectives on the real estate market and the new Trump administration coming in and what that means to us as investors. Jimmy, welcome. How are you?

I'm great. How are you?

Good, it's good, it's good to have you on. And where are you located?

We're in New York City on 42nd and Park.

Yeah, I'm a native New Yorker. I grew up in Stuyvesant town, went to public school here, went out to college, came back and the only place I've ever lived.

Fantastic. Well, you have some views on the new administration, what it's going to mean, maybe what it means for interest rates? There is all sorts of speculation and I think the Trump administration represents a bit of a wild card where people don't really know what to expect. But I mean, the tenor seems to be pretty bullish. I would kind of agree with that. What are your thoughts?

Well, look, I think that when you have somebody who comes into power as the president without a political track record, it is hard to predict outcomes. I think the fact that he has the wind at his back in terms of having a Republican Congress will help him depending on where he puts his efforts. Day one From a purely business standpoint, I think that you have two interesting dichotomies here. One is that I think it's no secret that President Elect Trump ran on the platform of job growth, of tax reform.

And so I think if he goes ahead and lowers corporate income taxes, lowest capital gain rates, allows corporations to bring back inversion capital that's been sitting offshore, billions and billions of it, with some kind of one time amnesty tax, I think it can help to certainly in the short term.

Spur.

Economy, especially real estate. I think that if corporate taxes are really cut dramatically, companies will have more cash to invest and hopefully will create more jobs. If the capital gains tax is lowered considerably, it certainly hopefully encourages investors to invest. And in our particular field, I think We've always benefited from low capital gains rates. There's tremendous risks in developing real estate. And so I think that having a lower capital gains tax as a, quote, reward for building, buying and holding and then eventually selling is a good thing for real estate. The converse to that is that when you have these kind of programs, you potentially have inflation, you potentially have higher interest rates. I think that we were going to have higher interest rates regardless of who won the presidency. I think that the Fed has.

Kept interest rates low. I think trying to weigh the economy over the last five years, I think has been difficult. Depending on the metrics you want to use, I think it's healthy. It may not be growing as fast as China.

But you know, I think corporate America took advantage of the last recession to develop productivity, to cut workforce. And I think corporate America is basically healthy, leaving aside the oil companies and leaving aside what happens in the Middle east with the potentially controlling oil rates, oil prices.

So that is quite an opposite. I mean, this is like 180 degree about face from the Obama's administration, the Obama administration's sort of attack on oil, on wealth. And you know, the talk about removing a lot of these tax benefits and why should there be a lower rate for capital gains? You know, shouldn't there be a wealth tax? I remember candidate Obama talking about that a long time ago. Just a tax on wealth, even if you don't do anything with it just because you have it. So this is a very, very different environment. Additionally, you know, one thing I didn't hear you mention mention is trade. And you know, I agree with you that Trump is possibly inflationary, which is fantastic for real estate investors, but also his trade policies being inflationary, you know, if it's more protectionistic, you know, we'll just have to pay more for everything. I mean, does that start the cycle of inflation?

Well, look, I think there's going to be winners and losers, right?

Those who depend on product that they buy from offshore companies versus those who are exporting. And so there'll be winners and losers regardless of the trade policy direction.

I will tell you as a lifelong Democrat, you know, we all struggle with.

Job growth, good economy and.

How much of that beneficial production of goods and potentially.

Great economic gain for corporate America and for wealthy investors, how much comes back into the system so that programs that are important for the middle class and the lower class are not dramatic, dramatically cut to shreds and it's a balance. And I will tell you, notwithstanding being a Democrat, I don't think either party has gotten this. Right. In a long time. I think it's very difficult to.

Have everything to grow the military, to reduce taxes, to build infrastructure.

I think that, that both the Republican Democrats have good issues. And, you know, we've had this sort of paralysis in Washington for a long time. And I'm not, you know, it'll take the president who can bring both parties together to sort of walk this fine line between a healthy economy and every American in this country being able to afford health benefits and everybody in this country gets the proper education and, and it doesn't go one way or the other.

Right, right. Do you, do you believe that, you know, these things that you mentioned at the beginning of the show when we started talking, Jimmy, that they don't, you know, say, say lower capital gains rate, bringing, you know, maybe a amnesty on, on bringing, repatriating all of this money that's offshore or, or, or maybe not an amnesty, but some kind of a reduction in penalty or punitive taxes and so forth. You know, doesn't that trickle down, if you will, I almost hate to use that phrase, but doesn't it trickle down to everybody? Or does it just concentrate in the, the very wealthy classes? Or does that money reach the middle class and the poor?

Look, I think that's the $64,000 question. I think that if these policies are done correctly and enforced correctly and the money that comes back into the country has some kind of mandate to actually create the jobs. I think you look back to the Reagan administration when they lowered taxes. I think by any standard, we had growth in the economy.

For 48 years. But I think the point you're making is a good point. And I don't know that, you know, within my pay scale to be able to sort of predict.

How that money is trickling down to the entire economy. I think that President Elect Trump wants it to. It will. I think that when you create new tax policy, it's based on the fact that people will actually transact and pay the taxes. So if you lower capital gains rates, and let's assume, and I've never heard it said openly, but if you index it so that the longer you hold onto a property, the lower your capital gains tax, you hope that it incentivizes.

Venture capitalists and private equity to create new opportunities, new growth.

And that it's new growth with jobs, not just technology and productivity don't necessarily create jobs.

Yeah, interesting. Technology is also a huge wild card. I mean, I personally am pretty concerned about the prospect of much higher unemployment rates with automation, robotics, self driving Cars, trucks, Ubers, Lyft cars, taxis. Wow. It seems like we really are at an inflection point now. In the past, technology has ultimately only benefited the world in so many ways in raising our standard of living, increasing prosperity. I just can't help but wonder, Jimmy, if this time it's different because.

Certainly all of the zillions of people around the world in the transportation business of one kind or another, they won't become robotics engineers.

Maybe this is a different time. What are your thoughts?

Well, look, I think that the key to the successful linkage of job growth and lower and middle class being able to benefit from that.

I think it's important that the taxation policy not be totally one sided. But I think the real key is education. Because today anybody with a computer.

And an iPhone can start a business. And I think this is a global phenomena that enables anybody to create something.

Through technology that they can turn into a business. And I think it's really important that we don't lose sight of the importance of educating the entire population.

So that every American who's living here has an opportunity to use their education to rise up through the system. And I think if we lose our sights.

And only the top, you know, 20% of the country benefits, it's not going to be a good thing for the country. I think that.

We have unrest in the country.

From the middle class, from the lower class. I think people are scared of what's going to happen.

I think that you can't just look at job growth in the economy and say that that's enough. I think that you have to be able to blend job growth and a healthy economy.

With a civilization in the country that looks after everybody. And that's a very difficult bouncing act. And the question will be.

Can this administration do that? Do they want to do it?

Well, it's incredibly difficult. I mean, nobody's ever gotten it right.

I'm certain that nobody would ever agree that anybody's ever gotten it right. So you're definitely right about that. So the question is, should that education be provided by the public sector, teachers unions, the nea? With technology nowadays, I don't know why anybody has to pay for college. Not because the government should subsidize it, but because literally one professor can teach the entire planet on the Internet. You know, it's 100% scalable. And it just blows my mind that these universities can get away with charging what they're charging.

Look, I think the university system, the university system needs to be fixed. But what I can tell you is that online college education is growing like wildflower. And I know that we started an online program at Syracuse University, and it's just been, the demand has been phenomenal. And so I don't agree with you that college is not important, but I think that.

Oh, I didn't say that. Don't worry. Go ahead.

In any case, I do think that making online education, college education available to everybody, I think will take some of the sting out of about the university costs. And the universities are finding it harder and harder with healthcare costs and professors rising salaries to be able to keep tuition down. And I think especially since with the emphasis on diversity in a lot of schools, you know, somewhere between 30 and 50% of the students are on scholarships. So you have to make it work.

Yeah, yeah. It just, the online thing is popular, but it's not cheaper or not much cheaper. It should be, it should be almost free. That's, that's the thing I'm saying, hey, we're not education experts, neither of us. At least I'll speak for myself. But back to, you know, real estate. So, you know, since the election, what has been the tone, if you will, of, of the different parties that you deal with and maybe just explain for our listeners a little bit about what you do. I mean, your company is involved in very large deals. You know, I assume you're, you're dealing with a lot of insurance companies that are investing in large office properties and multifamily and so forth. But, you know, just go ahead and explain that a little bit and tell us about the vibe, the tone, the tenor, if you will, of what people are saying.

So I think people like predictability and certainty. And right now there's uncertainty.

And I think it's a combination of change in administration and the question on where interest rates are going. And so, you know, if, and we don't just represent large, huge owners. We sell $14 billion of apartment houses, and those are all over the country. And some of those are in places from Kansas City to San Antonio to Houston. So, you know, it's not necessarily the largest projects only, but I think right now you're seeing a couple of things. We had a very big run up in pricing. I think that before the election, I think that investors were pulling back a little bit from class A trophy properties because they couldn't predict the growth in rents at this point in time. They didn't know that was sustainable, the rent growth that has been prevalent in the last four years. And so even before the election, there were a number of investors who felt that the market looked pricey and it was hard to find value. There are number of investors, we call them core and core plus investors that are not looking for very high rates. They're just looking if they're pension plans, if they're insurance companies, that, you know, a reasonable return to reinvest the proceeds.

But I think that now if you're going to go into the ground to build a building and you don't know where interest rates are going and you think they're going up, you have to think about when it's time to finance the property, when I finish building it with a permanent loan, you know, how much higher that cost is going to be. And so I do think that, I think that people are cautiously optimistic about job growth and about lower capital gains react, lower corporate taxes. But there is an inflection point between when those benefits are offset by higher interest rates at some point. And so, you know, you have to sort of guess at, you know, where interest rates will be and where could they be that it would make any of the positive job growth become moot.

Yeah, very good point. So your thought about higher interest rates that you did mention toward the beginning of the show, are you thinking that that would be a response to inflation or an end or a response to an economy that's overheating, or at least the Fed sees it as overheating? I don't think it's just been, is it just been delayed so long that, you know, you can't have the zero interest rate environment forever?

Well, I think the Fed is looking at 2006, 7 and 8, and they're trying to figure out at what point the economy is ready to have inflation and to head inflation off by starting to raise interest rates and sending a signal to the marketplace that they don't want massive inflation. If you wait until you have inflation to start to raise interest rates, that's a disaster. So I think that we walked this line for so many years now where the economy has been good enough but not great. And therefore the Fed did not want to create another recession by raising rates too early. Because if you think about, if you're a real estate owner or a corporation with floating red debt as interest rates go up and your profits don't, you're, you're infringing on your profits. And so once again, that fine line I keep talking about, I think the Fed is trying to prevent inflation and will, you know, I think everybody has built a quarter of a point into their models already. I think when the Fed raises rates in December and it's a quarter of a point, it'll be a hiccup.

And by the way, you said that as a foregone conclusion.

That's right. It depends on what the, it depends on what the message is from the Fed when they raise rates. Depending on how they phrase it, it could scare investors, depending if they think that rates are going up 200 basis points or not.

Very interesting. What else do you want people to know? Maybe just anything. I didn't ask you or just any general comments. Anything you want to share?

No, I think, look, I think real estate is one of the last great entrepreneurial businesses. And obviously when we think about our business, we think about large office buildings, apartment houses, hotels. But there are so many opportunities for small investors who know their markets in their backyards and they're going to know before anybody where that market is going. And so if you think about.

New York City and the, I mean, if I had asked my son when he was 16 or 18, where should I invest in Brooklyn, I would have made a lot more money than waiting around until it happened. And I think that if you are a small investor and you saved a few dollars and you live in Kansas City or you live in Austin or you live in Seattle, you may not be able to buy in the prime urban downtowns, but as you watch your market expand, you can see trends before the big institutional players and buy smaller properties. I know a number of people who buy single family homes, rent them out, try to find neighborhoods that are on the rise.

It's a great strategy that just works every time, you know.

Yeah, if you followed the young people to Williamsburg and then you follow them to Bushwick and then you follow them to downtown Brooklyn and to Astoria and Queens.

And the thing is, Jimmy, though, you don't have to be that good at it. It's great if you are and you can really predict the trends where those, those hip areas go. But usually, you know, the prices are, are so high that the rent to value ratios don't work that well in those areas. But you know, that's great if you can predict that. But you don't even have to be that good. You just buy some decent quality properties and hang on to them.

But here's the question, and this is the downfall of every investor over leverage is what kills investors. Because markets go up and down. And if you buy a piece of property with low leverage with not too much debt, you will be able to ride out the ups and downs. And the history.

Of real estate has always been it's worth more in the future than it is today. The people have lost money in real estate, have overleveraged their property and they can't sustain a bad environment.

Let me ask you to, let's just drill down on that for a second before you go. Is it a problem of over leverage or is it a problem of buying properties that don't make sense the day you buy them in the first place? And what I mean by that is if you buy properties that rent for 1% of the value per month or somewhere in that neighborhood, the good old 1% rule, in other words, you buy $120,000 single family home that rents for 1,200amonth. I mean, I don't care how much leverage you use, it's pretty hard to get hurt on that deal, you know, I mean, when you're talking about buying $500,000 houses that rent for 2,500amonth. Yeah. Then you really better be careful of leverage. I would certainly agree with you there.

Look, here's what I always say to people. In a market that's in a good environment, good economic times like we're in now, it's easy to think you can buy those kind of deals. But I will tell you that I don't think this is about what your return is day one when you buy it. It's really what you're paying related to replacement costs.

So I would agree that's a good metric. Yeah, absolutely.

You may be able to buy something with it's empty but it's below replacement code. And when you're done fixing it up and renting it, you'll have a good return. So it's really more about having a little bit of vision and a little bit of guts and saying I know this property is worth more when I'm done with it. I know the market's going to get better because it's undiscovered. I've seen the artists have gone there, the musicians have gone there because they can't afford the last neighborhood. And I think that's when you jump.

In and you're talking about neighborhoods like Brooklyn, like South beach and Miami. That's years ago. But you know, that's. Yeah, that's what happened. Those hip, hip, swanky areas that become really popular and trendy. Yeah, very good points. Give out your website and tell people where they can find out more about you.

Well, we, we are at NGKF www.NGKF is our company, Newmark, Grub, Knight Frank. And you can find out all about the company and myself and you can find me certainly on Google.

Fantastic. Well Jimmy, thank you so much for joining us and I want to wish you very happy investing in the coming year. We appreciate your insights. Thank you.

It's my pleasure. Take care now.

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