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Dan Loney: Well, the real estate
market has had an up and down
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time this year. The high
interest rates look to take its
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toll, lack of inventory has also
done that. And all the while,
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home prices staying fairly
elevated. And then there are the
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concerns about the future of the
commercial real estate market as
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well. To discuss that and much
more, pleasure to be joined here
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in studio by Susan Wachter,
Professor of Real Estate here at
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the Wharton School. Great to see
you again, Susan. Thanks for
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your time today.
- My pleasure.
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How do you kind of
put a framework on
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what we've seen in 2023?
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2023 has been a very difficult year, and
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the housing market came to a
screeching halt starting in late
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2022, because of Fed action.
There's no way that a 7%
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interest rate won't cause the
market to freeze. Which it
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did. But it wasn't simply on the
interest rate side, as you
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reflected. It is also the
inventory. So the two do enough
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to kill the market. So this is a
market where we haven't seen the
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lows in activity for decades.
And at the same time, housing
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prices are so elevated, and the
cost to become a homeowner makes
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it, for most households, simply
impossible, at a time when
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the Millennials are looking to
become homeowners. So a painful—
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a painful housing market, a
housing market in recession. Not
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much good to say about 2023.
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So let me start with the
inventory side of things.
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How do you try and get that
turned around? Because obviously
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there are the factors of
interest rates, there's the
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factors of cost of materials,
there's the labor side. I mean,
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there are a lot of components in
here that seem to me would have an
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impact. And realistically, this
is a story we've been talking
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about for many years. This isn't
just because of what we've been
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dealing with, with the— with the
impact from interest rate.
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Well, there are two sides to the
inventory issue and the supply
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issues is what you're going to. And
one is the existing inventory,
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which is totally governed by the
Lockean problem. So this is a
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problem that will solve itself.
That's the good news going
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forward. The supply side in
terms of new building— yes, of
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course, we're going to continue
to see high costs there. We're
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going to continue to see— labor
costs are a challenge and
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availability is a challenge. But,
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you know, construction
is happening. In
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fact, we've seen more
construction as a percentage of
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housing sales than we've seen in
decades. So the construction
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industry is actually being part
of the solution. The essence of
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the problem is the Lockean
effect, the low amount of
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inventory, which is due to
people simply saying "We're not
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gonna give up a 3% rate to get
to a 7% rate. Am I crazy? I'm
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not going to do that." And that
is only going to be solved by
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one thing, which is interest
rates declining.
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How, then, do you solve the—
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because even if you
see interest rates come from
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7 to 5%, somebody that's got a
three, three and a quarter
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percent interest rate, it's
still not as enticing for them.
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I mean, maybe they feel like,
"I can put up with"—
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- It will make a difference.
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- that extra point and a half, point and
three quarters, to be able to go
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get that that next house? - It
will make a difference. Because
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we do have people who are there
at 4%, and four and a half
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percent. So if we hit 5%, that
will be a remarkable turnaround.
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And what's interesting is you
see that two things go together.
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Not only does the interest
mortgage rate go down— and that,
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of course, has caused the cost of
mortgage to go up by a third—
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and— but also, the price of
housing will go down. So the two
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points of pain will transfer—
translate to points of gain. So
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I see— while 2023 has been
extremely painful and 2024 will
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be a continuation, by the end of
2024, I see considerable relief
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ahead, mostly because inflation
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is considerably under control.
This is a story that hasn't been
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well covered. But actually, over
the last six months, we've
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solved inflation. Inflation's gone— is—
for annually, if you look
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at it, it's 4%. But over the last
six months, annualized, it's
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2.5%. And that's before we have
this current slowdown, eventual
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we see slow, no-recession
landing. Whatever it is, it's
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coming down. So we have solved
the inflation problem. It's— yet
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we have three to four months,
whatever, to see it, and six months
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for to hit the mortgage market.
But once it does affect long-
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term interest rates, it will
also affect this huge gap
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between mortgage rates and 10-
years, which is very unusual.
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That is going to— that gap is
also going to deflate. So we'll
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have a very good potential
decline in mortgage rates for
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the sake of the housing market,
which will go a long way to
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solving the problem. Because at
the same time that the cost of a
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mortgage goes down, housing
prices are likely to ease,
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simply because we will have more
housing on the market. We will
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have people who have, today, five
and a half percent, 5% mortgages,
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four and a half percent
mortgages— as mortgages start
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going down to the 5%, then, you
know, buying down, which is
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happening right now— buying down
from 5% to four and a half
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percent is a lot easier than
buying down from 7% to 5%, which
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is what we're seeing. And that,
of course, is rare and difficult
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to achieve. Not so difficult to
get to a four and a half percent
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rate when the markets are saying
5%. And I see that. That's the
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good news for 2024. - So it's
interesting, then, with that buy-
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down, I guess you're seeing it a
little bit now. - Yes. - As we're,
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you know, in the month of
December, as we're taping this
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from, you know, seven to 5%.
- Yes. Yes. - By a lot of
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builders. - Yes. - Because they have
some of these properties out there.
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- Yes. - And they want
to move them.
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- Yes, yes. So buy-downs are
happening because they have
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to happen. But it's only a
limited capacity to get that
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done. But of course, if the market's
on your side, if the interest
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rate, ten-year interest rate
starts moving— it has. It's moved
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already. But this is— we're going
to see, I think a dramatic
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decline in ten-year rates over the
next 12 months. - Do builders need
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to look at the types of
properties that they're putting
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out in the market? And I ask
that because a lot of the new
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properties out there seemingly
are very much— you— there's a lot
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of IOT that's involved in the
property. Big houses, couple car
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garages. - Sure. Sure, you're right.
- And look at that middle market or
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- Yes. - lower market, individual,
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single-family home,
to build those
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properties out as well. - And they
are. There's a shrinkage in house
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size, there is smaller lots. This
is happening. Builders are
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responding to the increased need
for that starter home. - We're
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joined here by Susan Wachter,
Professor of Real Estate here at
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the Wharton School. So you're
optimistic, then, as we look at
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next year, in terms of what we
may be able to see, with maybe
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the caveat of interest rates
coming down. - Yeah, well, that's
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a caveat. And I'm— I keep on
saying 2024. But that's really the
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sad part. But it's really, stay
alive to '25. It's the end of '24
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relief we're gonna see at the
end. It will take time for these
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issues to resolve and for
inflation to be obviously
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solved. It's— I see that. But for—
actually to be in the market,
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and the Fed isn't going to
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announce that it's over until
it's over. - What do you think
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this all means, then, for the
amazing run up we've seen the
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last few years in multifamily
properties? Which, I mean, it
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seemed like there for a while
every new property that was
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going up— - It's amazing.
-— was a big apartment building.
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It's amazing. It actually is.
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And it's a— it's a great cure
for the potential oversupply of
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multifamily, which we're seeing
in the market right now. We're
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seeing price points come down,
we're seeing rents come down.
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That's actually another good
thing for inflation, because a
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very large 40% of the CPI is
rent equivalent. So this is
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another optimistic— again, rents
are not likely to fall a lot in
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2024. But as as 2024
continues, this oversupply
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problem is going to put downward
pressure on rents, as well as
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housing prices. So it's quite
unlikely that we're going to see
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housing prices continue on this
unbelievable, unaffordable
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upward trend. They're likely to
be down. Very— not much, again,
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because of supply restriction. But
once we've got relief on supply,
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we can see— we'll see more
activity. At that point, again,
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because interest rates are down,
I don't see— you're not— you
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haven't asked me outright about
prices. But I don't see
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tremendous relief on prices. But
it will be a relief simply when
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interest rates go down if prices
don't rise significantly. - So let
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me ask you about that. Because
obviously, when the pandemic
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hit, and we saw the rates come
down so much, and there was just
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this rush for people buying
homes— I mean, you were
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literally seeing homes not even
have the sign out in the front
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yard. - Yes. - And you had 15—
15 offers on them. - Right.
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And prices went through the roof.
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So if they go through the
roof, what's the expectation
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then for the current homeowner
as to the value of their home
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and where it might end up
here in the next couple of
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years? How much might it pull
back? Or what— are the increases
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that they saw a couple years
ago, are they fairly safe at
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this point? - They are. They're—
they're in. They're built in at this
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point, because there has been a
major transformation, a major
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shift in the role of housing for
families. And that is, people
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want more space. They want more
housing, they want owner
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occupancy— even though at this
price point, they're not able to
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get it. By 2025, more will be able
to get it, and we will see
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housing prices, I believe, once
again on the rise. - And so the
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DIY movement that we saw during
the pandemic, that really worked
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out to the benefit of all the
homeowners taking the time and
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in many cases doing— doing it
yourself. - Yes. It worked out
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economically as well as, more
space is a good thing when
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you're so many— so much at home.
- Absolutely. Let's touch on
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commercial for a second if we
can, because there's a lot of
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questions around where that is
headed. Companies are obviously
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reassessing their— their
footprint. Remote work has
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obviously played a role in that
as well. I think that's probably—
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is it safe to say a little bit
of a longer-term
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view that you have to have—
-Absolutely.
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- on where commercial real
estate is at? - Right. It's a great deal of
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uncertainty. And I do believe
the markets could stay frozen
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throughout this year. In fact,
we could have more distress in
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the commercial market as we have
this wall of debt that needs to
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be refinanced at still high
interest rates, far higher than
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the original rate. So banks are
pulling back and they're pulling
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back at a time when the
mortgages are coming— need to be
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refinanced. This— and we're talking
about commercial office space,
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obviously.
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Logistics, it's a different
story. Data centers, these are
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still— they're booming, actually.
And they will, as interest rates
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come down, continue to do
extremely well. But the office
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market resolving that problem is
way ahead of us. We don't see
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sales. We don't even know what
prices are, should be. Where is
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the price that's low enough to
see activity come back to that
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market? We don't see that yet.
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Did the banking crisis we had early
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in 2023 have an impact on that
to the downside, any?
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Absolutely, and it still is.
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Absolutely.
It's a pull, there's a pull
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back, especially on regional
banks, small banks in commercial
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real estate lending. And these
are the— 50% of the money for
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commercial lending is coming
from these banks. So it's a
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problem. - What do you think then
is kind of the takeaway for you,
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having followed this industry
so long, about this moment in
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time for real estate? And I'll kind
of throw that broadly, because
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obviously, this has been such a
unique period to see play out in
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how the pricing component has
played in. Obviously, the rates
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playing the role that they have.
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How do you view this last
three or four years?
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It's an extraordinary period,
it's extremely period in the
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divergence— the divergence
between owner-occupied and
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people who own their homes, how
actually well they've done.
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Those who are struggling to get
into the market, harder than ever
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for the Millennials and
Generation Z. And then looking
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at multifamily, production is
extraordinary. So okay, but
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rents are going up
significantly. Now they are
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easing. But then turn, in the
commercial, again, huge
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dichotomies within the sectors
of commercial. So there is no
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such thing as real estate. There
is owner-occupied, fantastic if
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you're an owner occupant. There
is— if you're renting, well,
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you're paying more. If you are a
multifamily provider, you're
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benefiting from that, even
though it's easing now. If you're
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in the office market, you're
hurting. If you are a commercial
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office REIT, you're hurting. Your
price of that REIT is in
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distressed territory. And that's
a potential pain point. And we
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don't know how that's going to
play out for the economy as a
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whole. And for banks as a whole.
I don't see a feedback loop to
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the extent we saw, for example,
in 2009, because I don't— we
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could, of course, if we had a
recession, like 2009. But the
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good news is, it looks like the
consumer is resilient. And that
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if we have a recession, it's
mild, and that interest rates
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will come down as a result. - So
I'll finish on this, because you
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mentioned about the component of
CPI that— that rental and
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shelter plays on a monthly
basis. How much, then, has the Fed
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really had to watch what has
played out in the real estate
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market over the last couple of
years when making this
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consideration about raising the
rates on the way up, but now
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also potentially lowering them
on the way down? - Yeah, I think
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the Fed has become real estate
economists. Our macro economists
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are real focused on real estate.
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Susan, great to have you with us.
Thanks very much. - Pleasure.
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All the best. Susan Wachter,
00:14:07
Professor of Real Estate
here at the Wharton School.
