My unsolicited advice to all CRE monkeys is to listen to your elders. If you are lucky enough to work with a 50+ year old who is cycle tested, study under them.
It’s been a great ride, the music is finally stopping. 2023 is going to be the start of a shitshow. This is CRE’s Brave New World.
Professionals under 35 have pretty much only seen the market go up.
Professionals 35-45 think exclusively in terms of 2007-2010 when it comes to recession.
Every recession is different and the only thing I can guarantee is this one will be different than 2008.
Office is going to get absolutely crushed. I heard someone estimate that upwards of 80% of downtown buildings in a major market I cover are currently underwater. A few trophy assets will do fine as there are always law firms willing to pay too dollar, but any dated B product is already near worthless.
Multifamily might do okay as single family homes become increasingly unaffordable at such high rates and prop up rental demand, but once people start losing their jobs, bad debt will become a bigger problem.
I hear the bullish arguments that there is a ton of capital that needs to be deployed and prices can only go so low before buyers buy up from the bottom, but I’ve also heard that those who try to pick bottoms get stinky fingers…
I'm just a dirty little tenant rep guy but on the leasing side you have some insulation to whatever you want to call this current cycle due to our business being LED driven. Leases roll when they roll and a decision has to be made, so there are deals to be made.
Our capital markets team is definitely in the thick of it since the debt markets are a disaster and owners think their building will return to its value from two years ago. It’s definitely pencils down for a while. This is all office I'm talking about. Industrial rents have not softened in our market.
Are you seeing tenants downsize or increasingly seek subleases?
Yes, they need space, but if hybrid environments stick around, space is an easy cost cutter.
Bay Area is obviously an outlier in terms of hybrid work but we're seeing a lot of tenants downside by 50% - 75%, if they are retaining space at all.
I’ll weigh in as someone leading multifamily ground up developments executing Class A garden style, institutional size projects in tertiary markets - although we know many companies currently in a holding pattern, we are optimistic for our niche.
Higher interest rates, construction costs and disconnect on land values between sellers and buyers are our biggest issues right now but all can be mitigated. Supply can be a drag on rental rates in select markets but that is localized and can be accounted for in new deals. Interest rates are a double edged sword as they hurt exits but they help add demand for product for those who can’t or didn’t buy a home. The land values are lagging today’s conditions but that is always the case so hopefully by the time that adjusts we will start to see some cost relief.
There are still some big potential existential risks out there such as the compounding effects of mass layoffs (if they start), particularly in areas with significant new supply and given that rents have started to level off in certain regions but overall residential rent is inflation resistant given it is a need versus a discretionary want.
As long as your firm is flexible/liquid without too many forward commitments then you should be in good shape. Speaking to other large MF developers, some feel that the deals getting tied up today might be the best of the cycle given everyone else’s big pause but that’s a hot take up for debate.
Disagree & generally don't see the train of thought
What will precipitate a recession and/or massive increase in unemployment?
Supply chain struggles and COVID shock to the economy is dissipating. Logistics are moving more smoothly, ports are less congested, the hamster wheel is starting to spin normally again. We are forecasting labour and materials to peak sometime in 2023 and likely experience some slight compression within 2023 as well (consensus seems to be that everyone is padding budgets out of fear of future, this should reduce in the coming quarters).
Barring black swan event (idk--FTX?), things will stabilize and get better. World has recently gone through a global event (COVID) and it'll take longer than a second for things to right-size. Groups that were aggressive at the top of the market will get hit hard, but if you believe in a free market, then they absolutely should.
re: office - define underwater. Cashflow negative? Below replacement value?
re: undeployed capital - some people still don't understand the magnitude. If my personal stocks went up 30%, maybe my portfolio goes from $100k to $130k. Yay, $30,000 happy days. What happens when a pension fund, sovereign wealth fund, or multi-billion dollar asset manager has to rebalance their portfolio with an extra $10B to $100B? Do you realize how much land and buildings you can buy with a warchest that size? These groups have time horizons over 30+ years. The stinky bottoms/don't catch a falling knife is a 1980s stockbroker mentality. Doesn't apply here
You aren’t very smart
Re: pension funds, sovereign wealth funds, and asset managers...that effect works both ways. S&P is down 16% over the last year. Bonds are also down over the last year. So all of these large managers of capital will have to rebalance their portfolios, which means less $$ available to real estate. It's already happening. Want to hear a horror story? Talk to a REPE fund that is out in the market trying to raise capital right now. Unless you count yourself among the Blackstones of the world, it's a bloodbath out there.
Banks are going to have to start raising rates to bring in more deposits. I had dinner with a large regional bank last week and they, along with their competitors, are all seeing deposits drop.
People are generally terrible at predicting when a recession will occur and how severe they will be. Is there going to be a recession next year? I don't know. Maybe. Maybe not. Any time I think that I have a read on where the economy is heading, I re-read a Howard Marks memo.
There is a ton of dry powder in real estate right now. That doesn't mean that all of it will be deployed. If real estate is not attractive on a relative basis to other asset classes, that dry powder is going to find another home. LP's are going to put a ton of pressure on their fund managers to give back capital if they can't find attractive investment opportunities. You are seeing this dynamic playing out with a lot of VC funds right now. You don't have to give back thie money of course, but good luck raising a subsequent fund if you don't. Leverage levels have also dropped, which means more and more equity has to go into each deal. That will offset some of the dry powder as well.
As with everything, markets are complex and have a lot of conflicting dynamics. I can write a bullish thesis and a bear thesis by highlighting some dynamics and ignoring others. My general take on the real estate market is this - current property values do not adequately generate enough returns to compensate investors for the risks inherent in investing in real estate, relative to other asset classes at the moment. I'm still hoping to find select opportunities that are attractive, but I am not in favor of making a beta bet on the market right now. But I could be wrong!
re: raising capital -- I agree and am seeing the same thing. No one wants to buy today because they think better opportunities (ie. worse economics) are coming soon. Things will remain slow / challenging in the short-term, but recover quickly thereafter. That also means that folks sitting on floating debt will have to either sell projects or try to ride it out. This should present some opportunities. OP's post came across as we are at the cusp of a new recession or prolonged down market, to that I disagree.
re: deposits -- good? Savings rates have been piss poor for years now. There has to be an incentive for people to save when inflation is crushing their monthly bills.
I like Howard's memos too, rare to find someone write so simply and candidly on complex topics
re: dry powder -- agree with all
In general, I think things will get slightly worse in the short term, then better thereafter. As someone who works in real estate, I see this as a good thing because it represents buying opportunities. I don't think there are enough cautionary flags up to be concerned about a recession, in fact, I think we are leaving the cautionary times
I would love for you to be right but you’re not. Major retailers cancelled hundreds of millions in orders from overseas as inventories grew last year and demand shrunk. Also labor troubles at ports in Long Beach caused many shippers to reroute their supply chains to the east coast instead. Thus, the illusion that logistics are improving. Consumer consumption drives the US economy and demand is shrinking. Consumers are tapped out, savings built up during Covid has been spent, credit card balances are skyrocketing and we’re about to see record auto loan defaults and repossessions. Amazon and other large users backing away from space commitments. Multifamily collections problems are growing as well, probably a matter of months before we see home mortgage defaults start. Unemployment is a lagging indicator but it’s coming. However, it may not be in the blue collar space this time but in middle management and white collar jobs instead. Elon just showed the world that he could fire 75% of his (well-paid) workforce with few, if any, business disruptions. Don’t you think every other CEO is now looking at how to do the same? I’m old and have been through several cycles and this one feels like it could get ugly. But I’ve been wrong before and hope I am now.
You know, I was reading this and nodding my head and thinking "this makes sense" until I got to this part, and then I realized "this jackass has no fucking clue what he's talking about." And it only got worse from there
The great thing about a concept like household savings is that... we have data! And the data says you made all this up. I know that spending 5 seconds to validate a couple of your assertions is hard and really bites into your day, but just a little research will help you avoid this exact situation; namely, being called out for not having your shit together. As that link clearly shows, household savings in the US are still well above where they were pre-pandemic. Or I assume they are, since this data is from October, though I think it's a safe enough assumption that households haven't burned through an extra trillion dollars of savings in the last 8 weeks.
He did this a matter of weeks ago, and it's a massive exaggeration to say he had "no business disruptions". In fact, it's once again just flat out wrong. We know for a fact that a ton of advertisers have left Twitter since Mr Musk took over, and the reason is tied to the layoffs you mention. Mr Musk wants to turn Twitter into a cesspool of hate speech and bigotry, or rather he wants to dismantle the safeguards that keep that from happening, the moderation staff (except of course when it comes to moderating opinions and accounts that are critical of him). Advertisers don't want to be associated with a company that is implicitly supporting things like overthrowing the American government, so you can't disassociate Mr Musk's layoff decisions and the fact that Twitter's user base and ad revenue will suffer a decline from those choices.
And for all your talk about unemployment being a lagging indicator, we can only use the data we have, and that says that the employment market is about as strong as it's ever been. Every doom and gloom pronouncement you just made was based on the back of not only no evidence, but evidence that is the opposite of what you stated. Given that, why should anyone believe you?
re: shipping -- fair enough, I was speaking from a construction background, basically what I am seeing at work with projects under construction or projects out for tender.
re: economy -- I think that predicting consumer behaviour en masse is a waste of time. Meanwhile, a lot of the "contraction" that companies are undergoing (eg. Amazon commitments, hiring freeze, layoffs, etc.) are simply rightsizing after being super aggressive while rates were at historic lows. It makes sense that when money was cheap, firms were aggressive in expansion and growth initiatives. Now that money is not as cheap, those expansion and growth initiatives are being reduced and/or cancelled outright. But isn't that exactly what we want in a healthy economy? The ability to re-balance and rightsize.
The economy has survived and thrived at "high" rates before, and will do so now as well. Will some suffer pain? Yes. But the carousel will continue to turn unless we all decide not to go to work.
this is the guy who has never experienced a down market talking out of his ass lmao
Apparently only people with decades of industry experience are allowed to have an opinion?
Heres my 10K foot view on this. CDs are currently yielding 4.8-5%. I think savings rates lag little bit more. But in 2023, you will see savings rates hit 4-5%. Some banks are pretty close to 4% I believe already. Once this happens, money will pull out of the market, both stock market and real estate market. At this point it will discourage capital to be thrown everywhere. This is when the bloodbath will start to occur. I read somewhere that 75% of all CRE transacted in the last 10 years. Many of those paid higher because debt was cheaper and liquidity was excessive. Many will walk away unscathed or take a lower IRR when exiting a deal. But everyone here knows, many have overpaid for assets too because there was nowhere else to place capital. Those people will get hurt badly.
Well, I can see this being a huge issue in the stock market, but I'm not sure it tracks onto real estate. Households may pull out of markets to put their money in safer money market accounts, but I'm not sure how much of commercial real estate (so, not single family homes) is reliant on those kinds of retail investors. It seems to me that most of the LP money coming into real estate is being channeled through large funds, be they foreign sovereign wealth money, public/private pension plans, or mutual funds which are already being marketed as safe investments for retail. I don't see a compelling reason why those players will dry up; real estate will still have attraction as a cash flowing, inflation hedged investment. I agree we will see some blood in the water as people who bought at the peak of the market see a significant chunk of value wiped out. That's probably healthy, given that so much of the real estate bubble was based on speculation on the back of dirt-cheap credit. Losing 10% of values from an all time high doesn't seem like the end of the world, but rather a much needed dose of reality. Sponsors who weren't crazy overleveraged are still going to be sitting on performing assets, and the people who aren't.... well, no one deserves to be bailed out of a bad investment decision, and buying on the assumption that rates would stay at zero forever feels like the kind of awful investment strategy that deserves to be punished. Personally, and tangentially, I strongly believe that bad investors are too often bailed out.
I agree. However, during this cycle (post 2008), both residential and CRE saw the largest adoption of new investors. Prior to 2008, RE was big but not everyone considered investing in it. This time around, you have all these "Youtubers" and "TikTokers" touting real estate. The JOBS Act, passed during this cycle, also opened up the ability to publicly syndicate which further allowed people like Grant Cardone and so many other syndicators to go after retail money. Yes, the institutional money and sovereign wealth should be okay, but this time around retail does account for a large number of transactions. We've put offers in on multiple deals and surprisingly lost out on most of them due to large syndicators of retail money, not HNW or sovereign wealth funds.
Hi! Thanks for the post.
If you don't mind sharing, what did you study in uni?
I'm just curious about what any person who is interested in real estate (RE) did when they were in uni.
it’s time to stop studying and start making money. I’m buying my first $10mm of deals in 2023
Classic doom and gloom post.
How bad were layoffs during the GFC?
Unemployment rate hovered between 9-10% for most of 2009-2011.
Thanks. Do you have any information more specific to RE? Not necessarily quantitative figures, but would like to know how many lenders got laid off.
Not sure there are any official data sources to track so I'll give you some anecdotal stuff. One, residential lenders got crushed, probably 60-70% of mortgage guys got laid off or quit. My recollection is that while downsizing did occur in CRE lending, the industry didn't experience huge layoffs. A lot of guys went from origination to working their own deals out until the lending market came back in 2013/14. A bunch of new lending, equity and ownership shops were started in 2011-2014 by guys who saw opportunities and were able to align themselves with capital. Took me awhile to appreciate this point but there is as much, maybe more, opportunity in the down markets. Hope this helps.
Pure speculation along with your standard doom and gloom. You can't predict the future better than anyone else can.
what goes up... must eventually come down.... cash on cash is right
how fucked is CRE sales? We seeing a down turn forever or will supply entice demand?
I'm sitting on the front lines of office leasing. Traditional tenants in my NY/SF market (legal, real estate, professional services, finance, architecture) are not downsizing much. Maybe 5-10% on average and renewal rates are very high. We are seeing very few relocations unless the tenant is clearly upgrading their space/building. Those that relocate seem to be agnostic to pricing in this instance because trophy buildings are at all time highs in terms of price per square foot.
Landlords of commodity buildings outside of the top 20-30 best buildings are getting very aggressive on pricing and concessions. Rents are down 30%-40% in these buildings and concessions up 75-100%.
There is significant contraction in the tech sector where we are also seeing 50-75% reductions in space at time of renewals. I don't have a firm metric, but its all over the map. A the start of the pandemic, companies were not renewing and going 100% remote. Many of those who took to this strategy have not returned to the office.
Leasing transaction volume was not bad Q1-Q3, but Q4 was anemic and don't think it could get worse.
Waiting to see what happens here in the first quarter.
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