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Dan Loney: Well, how is it that
the real estate market is doing
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right now, as we finish out 2024
and head into 2025 there are a
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variety of questions that need
to be answered on both the
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commercial but also the
residential side. And a pleasure
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to be joined here in studio by
Wharton Real Estate Professor
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Susan Wachter, who is also Co-
Director of the Penn Institute
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for Urban Research. Great to see
you again. How are you?
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Good to be here. Good
to see you, Dan.
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I remember when we talked a year
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ago, your phrase about what we
were going to see coming up was,
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"Survive until 2025."
Have we survived?
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Just. We've just survived. Yes,
and muddy waters ahead. But
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it's— the big surprise of 2024 is
this incredible GNP growth on
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all cylinders. Atlanta GNP Now
is saying 3.3% right now, which
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is almost twice as high as
anticipated. And that, of
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course, is affecting across the
board demand, but it's also
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affecting inflation expectations
going forward, and the likely
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expectations about rate
decreases.
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As I said, there's a lot of
questions to be asked and still
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lots of things to be answered.
So when you look at the two
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segments, commercial versus
residential, where's probably
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more of the questions that have to be
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addressed, do you think,
moving forward?
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Well, I think we know more about
residential. And we know more
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the long run outcomes of
residential. The demographics is
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a big driver. The supply— supply
conditions are what they are,
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and they're not going to change
rapidly,
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except for the locked in effect.
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So there is that
really narrow point which we can
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talk about. On the commercial
side, so much is short term, and
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things can change very quickly.
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All right. So let's start with
residential and the lock in,
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which obviously you saw so many
people going to refinance their
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mortgages when the rates were
down three, three and a
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quarter, three and a half
percent. You still have a lot of
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those people in there, and I
think the expectation is they're
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going to stay in there. How do
you kind of make the residential
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market more palatable, so that
people can feel like, you know,
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they're getting the best type of
deal moving forward? Well,
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Well, right now, the supply side is
locked up because of the lock in
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effect. So homeowners, with their
three, four, even 5% mortgages
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are staying put. They're not
going to move when the mortgage
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market is 6.8% today. So we've
got to unlock that tight embrace,
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in a sense, of, your home is where
you're going to stay, and then
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supply could increase by about a
third. That all depends on the
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future of the 10-year treasury
and mortgage rates. And that has—
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hasn't come down as much as one
would have hoped. They were
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coming down. Totally depends on
inflation expectations, which
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were coming down, but then we
had this big surprise in terms
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of— economy going on all
cylinders, and inflation has
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come back. Inflation, latest
number just this morning, is
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not so bad on the PCE. The core
is 2%, so that's really a good
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number. But the non-core is 4%,
reflecting demand for food
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items, which always heats up
when the economy heats up. And
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there we are, and that is going
to affect, of course, 10-year
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treasury, and it affects the
mortgage rate even more, which
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means that that 3% mortgage,
which majority of people have
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less than 4%, looks better and
better all the time.
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How— and I guess you also have to
throw in the factor that I think
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there's still some hesitancy out
there amongst the home builder
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segment. You know, those
companies that are putting,
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putting those properties into
the mix, about A, finding the
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property, but B, what they're
building?
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Well, I wouldn't say it that way,
hesitancy. They're all in.
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- Right. - The home builders are all
in, producing more than they
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ever have. The percentage of
supply that's coming from new
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construction is at a height, and
the housing prices, which
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normally new construction is
considerably higher than
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existing, are now converging,
which reflects the fact that
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home builders are building to
demand. They're building to— they
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know that they're facing
resistance because prices are
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just simply too damn high, rent
and price too damn high, and
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they're facing resistance. So,
in fact, margins are down, and
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the large builders are feeling
all that. But they're trying to
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get affordable product out, and
they're doing pretty good job of
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it. However, all that said, their
cost structure— the cost
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structure, just as you're
saying, in terms of lot
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availability, in terms of labor
supply, in terms of raw
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materials, whether that's— that's
a bit down. But labor
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supply is more than
compensating, and availability
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of lots. So they're having a
hard time getting affordable
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product. In fact, affordability
is at all time, 40-year lows for
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new construction. But what are
new construction—what are
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construction firms doing?
They're making deals. They're
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doing buy downs. If interest
rates fall a bit more, and they
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have fallen since last— since
their height, about almost a
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full 10 years, a full percent,
and mortgage rates are down from
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their height for about 100 basis
points. So all that's good, but
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if they fall a bit more, they'll
be able to make more deals.
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We'll be able to get more homes
out there. But right now,
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construction is really what
we've got. Existing sales are
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down and out.
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And they've relied on the multi-
family market. - Correct.
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- Significantly.
- Correct,
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because when home ownerships are
not affordable, what happens? You
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go to the rental market.
And in the rental market
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supply's up so much that we are
seeing relief. So we're not
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seeing price relief, but we are
seeing rent relief. Many markets
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rent, on average, if you look at
new— newly built, rents are flat.
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So markets rents are down. The
Southeast. Austin, where we
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actually have oversupply. So we
are seeing relief, the new rental
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supply, and that is feeding in
to the CPI actually. For— for
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the first time in a few years, we've
actually seen the shelter
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component of CPI rents fall. Now,
it's less than the inflation,
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right? Which is a good news
because that was what was
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driving inflation. So that's a
good news factor going forward.
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And as you say, rental supply is
helping the overall supply
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considerably at this point.
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Is there a way, then, to kind of
loosen up the existing home market?
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That's going to happen when we
have the big picture issues
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dealt with, which is interest
rates, mortgage rates and
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inflation expectations come
under control.
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But when you hear from some of the
analysts out there, it doesn't
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feel like that that's, you
know, something that— we're
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pushing more towards 2026, almost,
to get to that point. - I agree.
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What about the commercial side
and the concerns of the volume
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of commercial property that you
have out there right now?
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Well, the good news on the
commercial is that the bad news
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may be bottoming. And we're
seeing capital markets open a
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bit. The deal flow, which has
been zero, is coming back. So
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REITs have done quite well this
year, actually, because off of a
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really bad bottom. Real estate
is still in a recession,
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commercial real estate, but it's
coming back. We can see the
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growth of the overall economy,
and the overall economy is
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growing strong. And what
we were really worried about
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last year, what I was worried
about, was a potential systemic
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crisis, because the banks,
holding so much real estate—
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especially the regional real
estate holders, the real estate—
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the regional banks, which are
considerably in real estate—
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were in a difficult spot. But at
this point, the banks are
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actually quite solid. And that
combination of short term rates
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down, long term rates up, is very
bullish for banks. So that's
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good for real estate, because
that means that debt market is
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open again. So we can see deals
being made. We can see some come
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back and— well, you know, office
market conversions, very small
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to housing, but you know, that's
beginning to happen. So we're
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seeing the fear of a systemic
crisis— unless, and of course,
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this is always possible— we have
an interest rate surge again
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because of some geopolitical
problem, geopolitical stress
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problem. We— I see that curing
over this year and getting
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better. Not— not that we're going
to— we still have vacancies are
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far, far greater than normal,
20% in some markets. And— but, you
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know, there are markets which
are actually beginning to lease
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up again. New York City. And the
overall economy is just doing so
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well that the demand for office
space, it's not— we're not— remote
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work is not over. We're not
going to fill those old
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buildings. But the class A
buildings are happening and are
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being leased.
- Right.
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And that's kind of the
interesting thing, is— because I
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had wondered whether or not we
were going to start to say, and
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obviously you said, remote work
is going to stay as a component.
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To what level—
- Right. - We're trying to figure out.
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We're all figuring it out.
Still figuring it out.
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But companies are calling their
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employees back in. Whether—
whether they were, maybe they
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were remote a day a week, or two
days a week. They want them back
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in the office now, three or four
days a week, and that changes
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the dynamic of how these
companies are thinking about
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that— that footage, that square
footage footprint that they have.
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That's right, they are. And they're
optimizing, and that's a good
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sign for the overall economy.
They're optimizing at who needs
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to be there? And where can
they actually get an advantage
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of getting workers that are
remote, that may be a little bit
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less expensive, that don't need
to be there. So we're working
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that out. But the the remote
work drain is, if anything,
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turning in the other direction.
Not much, but somewhat. So
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that's helping out too on the
commercial side. The demand side.
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And the— on the supply side,
then, you know, the multi-family,
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when you have 0% rent growth,
the new supply is down and out,
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and that is going to help with
filling up an absorption. It's
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happening right now in the multi-
family space. That does mean
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that we're not likely to see
this rent relief that feeds into
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the CPI forever. But I'll
take it over the next two years.
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I think then, if you look longer
term, isn't it going to be more
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interesting to watch that
dynamic of multi-family versus
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single family homes, and how we
see the progression between the
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two moving forward? Because if
we do see that— that push back
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towards more single family, then
obviously you're going to have
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potentially more issues with
with the multi-family
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properties, which obviously have
have grown and surged in the
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last decade as well.
- That's
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going to continue. I don't see
owner-occupied— even if, and I
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hope they do, and I believe they
will— rates will come down.
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- Right. - It's not going to be
enough to make them affordable.
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So the rental market is still
where the demand will be. The
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supply is more than sufficient
right now, but the demand is so
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high that that supply is going
to be absorbed in another year,
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year and a half, two years, and
we'll start seeing rents go up
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again.
- Right.
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Can you start to theorize, then,
with some of the dynamics we
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have in play— and obviously the
other component of this is the
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new administration that's going
to go in, and how that's going
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to impact a lot of different
elements of the economy. But a
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lot of people said there's no
way we're going to go back to
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seeing mortgage rates at 3% ever
again. Is there, like, a territory
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that you believe we will go to
and we will feel comfortable in
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as we move forward? Is it five,
five and a half, six, in that
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range, that maybe we will see
come up in the next couple of years?
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If all goes well,
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we could be at high fives
at the end of 2025. That's a
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hope. That's not a prediction,
but it's possible.
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That's— that— so how do you get to
that point?
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Well,
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10 years have to— last few days
have headed up. They've got to
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head down. So inflation, we've
got to see some more good
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numbers, like we saw on the PCE,
which— the non-cores too. We
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have to see that. You know,
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we're at a very
tentative moment here. It's
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amazing how we have such
extraordinary growth, and we
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haven't really seen a resurgence
of severe inflation. So in fact,
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even with this growth, there is
signs of easing in the economy,
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allowing for a slow— this is
going to be not every month we
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can see it happen, but a slow
decline in inflation. And
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inflation expectations are
probably a bit on the high side
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anyway, so that those can come
down. It's a combination of,
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there is some slack. You can see
that in the unemployment rates
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slightly gone up. There's a
little bit of slack. And, you
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know, the fact that wage growth
is not what it was, and buying
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power is actually pulling back.
You see that even the resistance
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of housing prices. So all of
this at the same time that we've
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had this surge in growth, is a very
interesting combination. The
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bottom line is, we could
continue. This is the good— the
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good picture that I'm drawing
now, is that we could continue to
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see 3%-plus growth and inflation
heading from the 3% high point,
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which I think is where it is, to
a closer to two and a half
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percent. And when that happens,
when we get under two and a half,
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between two and two and a half,
we can see mortgage rates coming
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to that five and a half or five
and a half towards the six. And
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that could happen. That's the
best case scenario. But it's—
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hey. It's the holiday season. So.
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So if we're not surviving till
'25— till 2025— is this just
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kind of a year to see how things
play out?
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This year forward, I've never felt
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more in the sense of,
there are so many
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known unknowns.
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Susan, great to see you again.
Thanks very much. - Thank you.
00:14:26
Susan Wachter, Real Estate
Professor here at the Wharton School.
