Navigating Interest Rates, Politics, and Economic Resilience

Could the tides be shifting beneath the foundations of commercial real estate? This episode sails into the heart of how interest rates, intertwined with the tentacles of election year politics and burgeoning national debt, are reshaping the commercial property seascape. We navigate through the Federal Reserve's monetary policy whirlpools, dissecting their strategies and unintended consequences, such as inflation's sneaky currents which may force the hand of higher rates. With a lens on the Fed's recent maneuvers, including the pause on rate hikes, we chart the potential courses this might set for various real estate classes, with particular attention to the resilience and vulnerability of multifamily spaces in these choppy economic waters.

Amidst a landscape where residential real estate prices stubbornly cling to stability and the scarcity of housing persists, we anchor down to examine this paradox. The episode probes beneath the surface of low unemployment and interest rates, unveiling why homeowners are anchoring down their properties, turning mortgages into treasure chests in an undersupplied market. We then steer toward the sturdy vessel of healthcare real estate, exploring why it remains buoyant even when economic storms rage. I share my compass on investment strategies, navigating through election cycle winds and speculating on the course back to the low-interest rate harbors of yesteryears. Hoist your sails and join us for this insightful voyage into real estate's shifting tides.

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Transcript

Speaker 1: 0:01

Today, I want to talk about interest rates and how those are predicted to move, how we think they're going to move, and also how that's going to affect commercial real estate. And so, to start off, you've got two opposing forces working against each other. Right now you have a election year, which means that things are going to get political, as they always do, and so that is one to encourage the Fed to lower interest rates to make the economy look good for the incumbent right. It happens almost every election. They want to want to interest rates to go down. People feel like things are more affordable, they can buy houses, everybody's happy Increases their chances of winning.

Speaker 1: 0:44

However, we've also gotten a lot of debt and a deficit on top of that. Debt being we owe money, a deficit being we're going to continue to owe more money as time goes on. We're expanding the debt that we owe. That's the deficit. The goal of this show is to help health care organizations scale by leveraging real estate strategies and interviewing high-level health care executives who are actively in the trenches in order to pull out lessons learned along the way. If you'd like a free site selection analysis from our team or you'd like to learn more about how we're acquiring real estate through our fund on the blockchain. Visit us at wwwreuniversityorg and drop us a line. That's RE, as in real estate universityorg. We've got, I think, $34 trillion in debt, which is absolutely mind-blowing and that's a whole topic for another day. But what that means when we have debt to that extent is it's impossible to tax away out of that. The US government cannot raise taxes enough to cover that debt or to cover that deficit.

Speaker 1: 1:43

And the Fed? They make money different than you and me. Like they make money, they actually manufacture it. Like we try and make money, they're making money. So the laws don't really the rules don't really apply to them. It's not like you're running a business, you're running a country and so when you're short on cash, you can make some cash to bridge the gap. But what does that do? It means we're going to have more quantitative easing, which is just another fancy term for money printing.

Speaker 1: 2:06

And what happens when you print money? You obviously debase the currency and that causes inflation. The print-to-go money itself does not necessarily cause inflation, but it does when it debases the currency. They are very closely linked. So when you debase the currency, that means that you're going to have inflation assets or going to see inflation. We saw that back in 2020 and 2021 during COVID. Assets rose very quickly, and so you've got the market. Participants are going to be making a decision.

Speaker 1: 2:39

Okay, by one extent, we can invest in equities, like stock markets, or we can invest loan out debt. So if you loan money, if you're a lender, you're getting a fixed rate of return. It's a lot safer, but smaller than investing in the equity. So when you're investing in a real estate asset or a stock of a company, and so when you're doing that equation, it's okay, we're printing a lot of money. We're in a period of qualitative easing or quantitative easing. I know these assets are going to rise a lot. That's going to create inflation, and so people who have debt are looking am I going to get as good of a return on the debt? Probably not, and so you have to raise the interest rate in order to keep people lending, but also to cycle the economy and bring down inflationary pressures. So it's very difficult to have low interest rates in an economy where there's high inflation, and we are going to have more inflation as we try to surface this debt and get out of this debt. So really, those are the two forces that are pushing and getting each other right now, and the question is what is going to happen and what does that mean for commercial real estate? I don't like to think in terms of yes or no, but rather in terms of probabilities. So what's the probability that interest rates go up versus interest rates go down? And then you can make decisions based on the outcome that you think has the highest probability, and that's what we're reflecting right now. That's what we're trying to come up with right now.

Speaker 1: 4:03

You saw that in December I believe it was December 18th of 23, the Fed announced a pause and markets shot up. Stock markets went crazy and interest rates actually dropped. So there was no rate drop from the Fed funds rate, fed friends. Rates remained the same. They just announced no more hiking, rate hiking. They were only going to pause. Of course, it signifies a turning point, right, because in the future we're going to have rates start to drop. You got to pause before you can drop, and so we actually saw.

Speaker 1: 4:30

So we're getting loans quoted and typically commercial banks will be about 300 basis points above the 10 year treasury. So at one point the 10 year treasury got all the way up to five and a quarter or so, five and a half interest rate, and so we're getting quoted at 8% interest rates and just with the announcement of the pause, the treasury dropped to 4% and our quotes that we were getting were now closer to 7%, and so that means that we see we've already started to see kind of interest rates go down. Now, interestingly enough, since then the Fed has said that they're not going to be cutting rates as soon as they anticipated. Now we're looking at the end of 24. And that's again that's. It's an election year, right, so I don't necessarily believe them, because they've been wrong multiple times in the past several years. They've said one thing and done another. It's, I think, what's going to happen.

Speaker 1: 5:29

I think the reason that we haven't seen prices fall that much is just a simple supply and demand issue, and what we've seen in real estate has been like, drastically different among real estate asset classes. For instance, the multifamily space has not been a good place to be in. It might be a good place to get into now, but it's seen a lot of distress. People were underwriting these deals with developers and acquirers and purchasers thinking that the rate of increase of rental, like the rental increases, were going to increase, like at that rate, indefinitely. So they were buying them at 2% cap rates, thinking you're going to have 10% rate increases or rental increases, which is just not. It's not sustainable. So now you overpaid and your rent is underperforming in an environment where interest rates are going to be higher. So a lot of these guys are going to be left to have forced to refinance, because in commercial real estate you have to refinance every five years. You're going to be forced to refinance with the deal that's under water, and so they're going to be losing all their equity or losing the building, which in that case they lose their equity too. So it's a situation where you're going to have to put cash in and it's going to be worth less than your initial investment. So you're like, for those guys in office, space is dealing a lot of the same things too. Now it's different than residential and healthcare, the two areas that I deal in a lot.

Speaker 1: 6:40

In residential I thought for sure, as soon as the rates started hiking, then prices were going to come down, because people can only banks only approve a 40% debt to income ratio. So the cost that monthly rate is going way, way up. Surely prices will come down to adjust for that, to keep those monthly rates the same for people to qualify for the loans? No, that didn't happen. The reason that I think it didn't happen is because just a lack of supply there's. You also have to combine that with a lack of distress, and when I say lack of distress specifically, what I mean is unemployment is low and interest rates are low.

Speaker 1: 7:14

So when the Fed knocked out interest rates to historic lows and people refinanced it sub 3%, that became an asset. That asset, your mortgage, became an asset and a very valuable asset. Anybody who has low interest rate is going to be very reluctant to sell, especially if you have to sell a 3% interest rate and your next purchase is going to be at 8%. That doesn't feel good. You're essentially paying the same amount for a house. That is A the house probably is more expensive now than the one that they bought when they refinance and B the interest rate is higher and so, like the cost Delta from selling and buying is massive and that's going to discourage a lot of people from selling, which is going to keep inventory very low in a environment where we already have low inventory because we stopped building to the rate that we needed to build back in 2008 with a very financial crisis.

Speaker 1: 8:00

So that's residential, residential is very separate from commercial. There's some overlapping, but it's very separate in general. And so with the residential real estate, what you have is just a situation where we're going to be under supply for a long time and so even when rents rates went up drastically threefold, prices did not drop anywhere near to that same extent. Prices might have dropped 5% to 10% maybe, and again, it is regional, it's real estate, but for the most part we did not see very many price drops like very steady, which is just was mind blowing to me at the time. Now, upon reflection, it's making a lot of sense.

Speaker 1: 8:38

And then in healthcare we saw like the same thing. In general, cap rates were trading at about six and a quarter for retail backs good operating healthcare companies on the lease. They bumped up to about seven I'm some change. I think seven on average, like seven flat. And it's a weird situation where people are buying these buildings with negative leverage, meaning their cap rate is seven and their interest rate is eight. So the cost of service, the debt, is higher than the return that you're getting. And why is that? It's because of a lack of distress. I think sellers in general have not been motivated to offload their buildings unless they can get the price that they want.

Speaker 1: 9:15

Because you've got a performing tenant, your asset is performing there. They weren't in a stress, we've seen. Healthcare is resistant, recession resistant, pandemic resistant, inflation resistant and, in our opinion, healthcare real estate is just the safest asset, or one of these safest assets in the entire world. You've got real estate, which is like a very safe asset. It's a physical building, right, it's there no matter what happens. And you've got healthcare, which is like a very safe tenant and that they're growing with the influx of boomers getting older and requiring more healthcare services. So the combination of being healthy and being real estate I'm very bullish on, and you've got your, as a result, a non-detressed asset that's remains very expensive.

Speaker 1: 9:56

If we do see rates start to drop, then I think we will see an increase in prices. To what extent does anybody's guess? Again, I'm just playing a game of probabilities here. I think that the probability that rates go down right before the election is very high, and I just don't know how much. If I were to, I would work underwriting speculating deals to maybe come down to about 6% and, however, there's a good argument to be made that, after the election cycle, the the whoever wins the election that rates are going to go back up because we have to stifle, we're going to have to combat the inflation that's going to be created from quantitative easing. So it's all very complicated. These are things that I'm thinking about a lot, I think, like in terms of actionable steps or what to do to prepare yourself.

Speaker 1: 10:46

I think making sure you're buying deals at a good cap rate, like not overpaying. I think that in 2021, it was okay to overpay because prices ended up going up 2020. It was okay to overpay because prices kept going up. You're making the compromise hey, I'm gonna overpay for the price of the building, but I'm getting a great interest rate and so, at the end of the day, my expenses are not gonna be that crazy. I we acquired a Airbnb and wedding venue at the end of January of 2022.

Speaker 1: 11:18

And I personally thought, once rates were gonna go up, house housing prices were gonna go down, but I knew that the interest rate was so great. I was willing to make that trade off because I was gonna hold it longterm and I felt like my monthly expenses would still be lower even if I had to overpay a little bit and that's it. I think that's what the equation a lot of people were doing during that time Because, if you remember, real estate was just skyrocketing. I'm not making that same calculation moving forward, I think that longterm, I don't think we're ever going to get back to the hyper low interest rate environment that we were in pre-23, 2020, 2022, 2020. That was a historical low and unless we can get debt under control again, it's a equation of probabilities.

Speaker 1: 12:02

What are the odds that the our country is gonna stop spending money at this rate and get its fiscal policy in order? It seems very low to me, so I'm not really underwriting on that. I think right now I'm underwriting deals on maybe coming from 7% to maybe down to 6% by the end of the year in terms of interest rates, and then probably back up to eight by next year. So it means like if you wanna have positive leverage, you wanna have positive cash flow, you're gonna have to be buying deals at nine cap or higher, even at 10 cap, and nobody wants to sell right now because the interest rates haven't been high enough long enough. They've been very high.

Speaker 1: 12:38

It's only been maybe a year and a half since you really started having these rate hikes and, like I said, sellers don't have to stress. If they don't wanna, they don't have any distress, they're not gonna offload it. It's just gonna take time, a long time longer than I would have expected for the market to reach equilibrium where sellers who wanna sell are finally having to bring their prices down to a point where people who are looking to do this as an investment and get a return can afford to buy them. And when I say afford, it's a combination of how much they're willing to put down and how much the bank is requiring as a down payment. So, yeah, I think that for us moving forward, we're bullish. In general, I think that real estate is gonna be a great asset. I don't see a collapse or a calamity coming. I do see interest rates are running high and therefore having to be strict about your policy about purchasing real estate, and that's what we're gonna be doing.

Speaker 1: 13:28

And yeah, I hope this is helpful, and if anybody is interested in learning more, partnering with us as we acquire more deals, just email me. Drop me a line and we'd be happy to connect.

Speaker 2: 13:41

If you need help finding the perfect location for your practice or you're ready to invest in commercial real estate, email us podcast at leadersreecom. That's podcast at leadersree, reasinrealestatecom. Or go to leadersreecom and fill out our form. See you next time.