The Fed Starts Playing “Mind Games” as Rates Rise, Home Prices Fall

Dave:
Hey everyone. Welcome to On the Market. I’m your host, Dave Meyer, joined by James Dainard. James, what’s going on, man?

James:
Oh, just enjoying my time out in Seattle, Washington, this trip.

Dave:
Good. Good. Henry, how are you?

Henry:
What’s up guys? What’s up? Life’s good, man. Glad to be here. Thank you.

Dave:
Good to see you. Kathy. What’s new with you?

Kathy:
Well, I’m just enjoying that you all got to see Rich’s 480 bench press video of the ’90s.

Dave:
If you guys don’t know Kathy’s husband, Rich, he’s the man. And if you want to get a sense of what he’s like, go Google, Rich Fettke 480 pound bench press on YouTube and enjoy yourself. It’s an incredible video.

Kathy:
Oh, he might hate me for this, but it’s worth it.

Dave:
It’s incredible and he should be very proud of it. Anyway, Jamil. What’s up man? How are you?

Jamil:
I’m fantastic. Honestly, after watching that, I wasn’t sure if that was a ’90s SNL sketch or if it was really Rich Fettke bench pressing 480 pounds, but phenomenal, incredible. I’ve always been a Rich Fettke fan, and today I know why.

Kathy:
New levels.

Jamil:
New levels.

Dave:
It’s very impressive. We should check how many YouTube views he has on that video right now. And then right after this episode airs, see how many YouTube views he’s got because hopefully several thousand people should be watching this immediately after hearing this.

Jamil:
It’s one of those things that I think will end up going viral because it’ll get picked up and found from all the increased views from this. And he’ll be a viral sensation.

Kathy:
And mullets will come back so strong.

Dave:
The hair is very good.

James:
Well, fanny packs are back, so why not mullets?

Dave:
Yeah, the ’90s, late ’80s, ’90s, it’s all coming back.
All right, well we have a lot to talk about today. We’re doing a correspondent show, and if you’re unfamiliar with this format of show, Henry, James, Kathy, and Jamil have all brought a story about the real estate market that they’re following and we’re going to talk about it, but I have a story I feel like we need to talk about first, and that is today, we are recording this on the, what is it, the 22nd of March. We just found out that the Federal Reserve raised interest rates once again. And I kind of felt like this one was the first tossup we’ve had in a while. I actually thought they were going to pause hikes due to the banking crisis and to try and reduce some stress on the banks, but Jerome Powell just doesn’t give a. He just went for it. So curious what you guys think about this.

Kathy:
I wasn’t surprised. He’s still battling inflation and he’s made it really clear, he’s going to do that no matter what breaks. But I also, on the other side of it, it’s like it’s the Fed. They could bail out banks, they’ve done it before. They’ll do it again. They’re going to keep doing it, and that could create more inflation if they’re printing more money to do that. So it’s a quandary. But for real estate, real estate performs generally well in inflation, and then it brought rates down, mortgage rates.

Dave:
Yeah. Somehow today after they announced a hike, bond yields went down, for some reason. So mortgage rates might go down as well. So it’s very interesting. I guess what I was reading is that the logic here is that obviously, inflation is still too high, so they want to keep raising rates, but I was thinking because a lot of the banking crisis, not direct result of Fed policy, but it indirectly is pretty tied to what’s going on with interest rates, that they were going to just take a pause to reduce stress on the banks. But apparently, the Fed was concerned that if they did a pause, they would make the banking crisis seem worse and signal that there is a lot of stress on the banks when they don’t want people to think that. So it’s just all these crazy mind games and I’m going to just give up on predicting what’s going to happen at this point.

Jamil:
I think it’s interesting though that they did signal that rate hikes would likely pause after this. And so I think that looking at it, we’re in this weird world where bad news is good news, good news is bad news. And so the economy, it has suffered. And that’s what the Fed was trying to accomplish, was to slow things down, and that it’s done.
But I understand the logic that if they had stopped or if they had paused the rate hike now, they would’ve signaled that there was a further crisis in the banking sector. And it was also interesting that they were very clear in calming any fears with respect to what’s going on it with US banks and made a point to comment on the stability of the US banking system in general. And so I think that it is a mind game, Dave. I think that the mind game is being played rather effectively and we can almost guarantee that the next meeting will result in a pausing in rate hikes because they couldn’t do it too quickly. They had to give us some runway. And so I think at least we see some reprieve around the corner.

James:
I’m just going to say a quarter point, not half or three quarters because those three-quarter hikes were brutal. And so I don’t think this is going to do much to what’s going on in the current market conditions. And I could see that he continues to raise a little bit though because this labor market still isn’t breaking. I mean, I’ve had an accounting job up for a month and man, I can’t get anybody in the door. It’s just like, it’s tough to hire right now. And that’s half the reason, it’s not just the rates. They’re also trying to beat back that labor market and slow the economy down. And it has not slowed down in certain sectors. I mean people still can get paid and things are still moving pretty fluidly.

Jamil:
It could also be that there’s very few people that want to be James Dainard’s accountant, but-

Dave:
The numbers are too high.

Speaker X:
It sounds like a nightmare.

Jamil:
The numbers are too… Yeah.

Dave:
It’s much easier to be someone else’s accountant where the figures are a lot smaller.
I think it is worth noting though that I read something that the recent bank issues, some economists have equated to something like a 25 or 50 basis point hike, just by the tightening of credit will have a similar effect as another 25 basis point hike or so they estimate. And so that could give the Fed reason to pause, as Jamil said.
And there is something that released that’s called the Dot Plot, which is basically a forecast of where the Federal funds rate is going to go. And right now, the median is 5.1 and so that is similar to where expectations have been. So it’s not like people are thinking it’s going to go that much higher. So if that happens, there’s not too much different that’s going to happen in the mortgage market or anything like that. So hopefully, that’s where it is and I would like at least to just see it pause for a while and just see what’s going on. It’s not like they can’t raise again in the future if they need to. It just seems like the take your foot off the gas for a little while to see what’s happening.

James:
But is that a red flag? Is that a red flag though? If they do cool down, does that mean they’re just totally lying to us about the banking market and the small banking because they’re like, “Oh, we’re going to break this in half”? That’s actually what my concern is, if they really, really slow it down because they’ve been so aggressive the last 10 to year. Are they backing off?
Even though they’re saying it’s healthy over here, is it really just not that healthy and we could see something else? I don’t know. I think I’ve lost all trust in anything the Fed has told us because it’s changed so many times in the last 12 months that I’m like, if they tell me one thing, I’m like, “Oh, it’s other.”

Kathy:
It’s a different scenario though. It’s very different than 2008 when just bad loans were given and they never should have been. In this case, the banks actually do have assets. And it seems like this was more of banks buying other banks and big banks getting bigger. The big banks seem to be in good shape, for the most part.
It’s just kind of buying a distressed asset that has assets. They’re just not good right now, but if you wait it out, they’re going to be, they just have to mature, the bonds that the bank bought. So to me it’s not as big a crisis. This may not age well, guys, but in my opinion it’s not as big a crisis as people are saying. It’s that they made some bad decisions, they bought bonds that weren’t mature yet. If they sold them now, it would be bad. So if someone else has got the cash, is buying these banks, and they get to hold onto those assets till they mature. So it just means, but there will be effect, that there will be an effect on real estate. Anyway, that’s just my humble opinion.

Dave:
Well, if you want to hear more about it with last week, I had a conversation, if you haven’t listened to it yet with Mark Zandi from Moody’s Analytics. It was really interesting. He shared similar sentiment, Kathy, that the banks are… their balance sheets are actually in really strong position. The concern is people panicking. It’s not really even necessarily the banks, it’s psychology.

Kathy:
I mean if you really were worried about your money, you wouldn’t put it in a bank because it’s being lent out. If everybody tried to take their money out of a bank at the same time, it wouldn’t be there. That’s just a known thing. So do you know what-

Dave:
Yeah, you would bury it in your backyard like the rest of us.

Kathy:
Buy some real estate. Don’t stick it in a bank.

Dave:
At least buy a bond. Yeah.

Kathy:
Yeah.

Dave:
All right. Well, that was my story. I just wanted to vent about the Federal Reserve, as usual. So we’re going to take a quick break and then we’re going to come back with our correspondent show.
All right. Henry, you’ve got some updates for us about the housing market. What have you been following recently?

Henry:
Yes, sir. So I brought an article from CNN Business Release just yesterday saying that home prices have just broken a decade-long streak and that streak is that the median existing home price fell a whopping, drum roll, 0.2% from a year ago.
But why that’s significant is because it’s been a decade since it’s actually dropped. And obviously, this is a national number. When you look regionally, there are some markets down where the median home price was down 5.6. It says some down four and a half. And so as you look across the country as a whole, this is just saying the average.
But the sentiment in the article is that there is an expectation that home prices will drop some more, even though this percentage is a very small percentage. Now, does that mean it’s going to be a 5% drop or is it going to be closer to a 2% drop? We don’t know. Obviously, real estate is regional, which is why it’s important to make sure you understand the metrics in your individual market and the economy that’s driving your market. But yeah, what do you guys think about the first decline in average home price in a decade?

Jamil:
Not shocked.

Kathy:
not shocked.

Jamil:
We’ve been seeing it. Look, I’m in Phoenix, Arizona and I feel that we’ve taken the brunt of that decline. If you’re looking at statistics, we’re the one statistic that’s pulling. We’re probably the reason why we pulled it into a decline in all honesty, because of just how much we’ve dropped.
But looking at that, I am not shocked at it. I do however feel that it’s misleading because a 0.2% drop nationally spread off over all of those markets, it’s not really painting the picture of what’s going on. And if you look at the major metros, there’s more pain than 0.2% of a price decline in some pretty concentrated and important areas in the country. And so an interesting stat, but I’m not super buying it, just because it’s got so much data involved in it. This average doesn’t paint the right picture, in my opinion.

James:
And I think a lot of what we’ve seen too is the 0.02 decline seems a little low to me, but that’s also because I think a lot of us are feeling, or investors are feeling the pain because we bought… It wasn’t off the median home price. We were buying off peak price for a lot of times.
And what we saw in that first quarter of 2022, I know in the Seattle market, which is similar to where Jamil is, right, we had hyper acceleration in certain markets. They’re off median home price. These homes were jumping 10 to 20% in the first quarter, so they were up 20% over that median home price the first quarter and then it snapped back down. The stat is actually a good thing if we’ve increased money by 40% and it’s only brought us down 0.2%, that’s a good thing actually.
That shows that the market’s a lot healthier than even I would expect. But I think what that does indicate though is there could be a little bit more of a slide because that’s not the impact it should be. And so you just got to be cautious. And the other thing is it depends on what market you’re in because like Scottsdale, expensive. Bellevue, Washington, expensive. We are well outside the median home price. I know in Bellevue our median home price dropped 22% year over year. So really, it depends on where you are and then dig into those specific sections because 22% is a big hit. 0.2 is not. So just dig into the markets that you’re looking at.

Dave:
If you are listening to this and are confused by this statistic and saying prices have been falling. I just want to clarify what this stat is, because prices in a non-seasonally adjusted way, not year over year have been falling on a national basis since June. But what Henry’s talking about is year over year data, which is basically comparing February of 2023 to February of 2022. And that is generally considered the best way to look at real estate prices because real estate data is seasonal. And so by looking at the same months over several different years, you get to take out that seasonality and you can understand the real trends. And so this is the first time that in a year over year basis, on a national basis, prices have declined. But if you have seen prices decline from June in your market to now, that is also true. So both can be true. There’s just different ways of measuring the same thing.

Kathy:
If you look at it that way and go “Year over year?” I mean last year was just the beginning of the rate hikes and mortgage rates were pretty low. So the fact that it’s dropped so little given the backdrop, given that mortgage rates have doubled and payments have doubled, that’s phenomenal. And also when you look at the averages, that means that some areas were higher. That means some areas actually still grew during all of this craziness, payments doubling. And obviously those markets had to have something going on where people were coming from areas that could afford that higher payment or maybe lenders are sellers are paying points to buy the rate down so that people can still afford. It’s just phenomenal that a year ago when people were really certain that 2022 was going to be the year of the housing crash, to just a year later be down so slightly, it shows the strength of the housing market.

Henry:
Yeah, I agree. And to echo all your sentiment as well as Jamil is this doesn’t really paint the full picture. It does. The article goes on to talk about how it’s not reflective of the home sales that have happened over the past month. So we got the home sales data for February that’s come out and it’s showing a percentage increase, which I know James is going to talk about. So yes, we have had a decline, but at the same time, I think in lots of market, we’re starting to see pending sales go up, more offers coming in on properties, more buyers entering the market. And so I think it’s a great point to dig into that February data.

Dave:
Well, thank you for doing my job for me, Henry. I appreciate that.

Henry:
You’re very welcome.

Dave:
James. Take it away. That was a buttery transition.

James:
I know. That was smooth, man. Yeah, so I have an article. It’s from the NAR realtors and what it talks about is we have broken a 12-month slide on existing home sales for the last 12 months. It’s been sliding for the amount of sales that are going on. And in February, they jumped 14.5%, which is a huge jump, but that is still down 22% year over year.
Why I think this is a great stat and a great article is that the market’s becoming alive again because everyone got so shocked and they were waiting for this crash. And we were just talking about how the median home prices down .2. And I think to a lot of people’s expectations, the market didn’t do what they thought was going to happen. We thought they were going to go into a free for all and so everyone kind of stood off side the sidelines. And now as the seasonal turnaround has came back and the market, we’re going in that spring market where it gets hotter and hotter, we’re seeing a lot more bodies come through houses.
For us, we have a lot of listings. We’ve over 60 listings. The amount of people we’re getting two to three showings a week, now we’re averaging seven to eight showings a week. And so there’s way more bodies in the market. And I think what is happening is people were waiting for the crash. It didn’t quite happen. It has gone down and it’s made it a little bit more affordable with the pricing. We’re seeing some compression, but now they’re seeing homes sell and they’re getting FOMO. And they’re going, “Okay, I’m never going to get a house.” And so they’re back in the market.
And I think one thing that people should remember, and I had to remember too, is quarter four, since I’ve been doing this for 18 years, it’s always a dead quarter. I would never ever list one of my projects in December. But during the pandemic, the rates were so low, we would list in that time because it would still get absorbed up fairly quickly. And so that seasonal slowdown did happen. We had the fear of the market crashing, plus we had our seasonal slowdowns. I think those are back. Like quarter four will be slow, just like it should be. And now we’re seeing this kind of spring back and things are transacting, which is a great sign. I don’t know if this means the market’s going to go up in value, but it shows that we’re getting back to stability, and stability is key for all of us as investors.

Dave:
That’s an interesting take. And I’m curious what the rest of you think. Have you seen pretty consistent upticks in activity in the housing market since the beginning of the year? Because part of me was wondering when I saw this data, and it is pretty amazing that it jumped so much, is was it a result of January having relatively low mortgage rates? They dropped down to about 6%. They’ve come back up in February and March. So I was kind of wondering if this momentum that we saw in February is going to be continued. And since as James said, there’s sort of these lead indicators that we can look at, which is traffic at showings and seller behavior, open houses. Are the rest of you seeing that as well now into February and March as well?

Jamil:
From the wholesale side, I can tell you that our inventory is flying faster than it has in months. We can’t keep our wholesale properties on our website for longer than a day.
And so that shows me that investor sentiment is strong or returning. We had a lot of investor… We still had investor activity when things were looking a little grim, but they were taking advantage of pricing. At that time, investors were coming in and they were banking, they were expecting deeper, deeper discounts and they were getting them, but those discounts have seemed to bottom. And pricing has seemed to bottom.
So I think what’s happened is that, A, the investors realize that prices are going to start to… If they haven’t leveled off, they’re going to start to kind of uptick a little bit now, slightly. It’s just slightly because I feel like we’ve seen the worst of it.
So with that said, in the wholesale side, there’s a lot of activity. The investors are gobbling up everything that they can possibly get their hands on, expecting that there’s going to be fewer resale properties hitting the market because home buyer or home sellers, would be home sellers are locked into their houses and they’re becoming landlords instead of sellers. So that inventory crunch is creating demand and that demand is being absorbed rather quickly. So from my perspective and from the investment point of view, in the single family asset class, it’s bananas right now.

Kathy:
Yeah. Same for us. We are seeing, our webinars are full, our property tours are full, and this is from an investor perspective, we help investors buy investment property. It’s again, flying off the shelf, to use the words you used. Do one webinar and it’s all sold. So I do think that initial fear that the headlines that have been literally claiming a housing crash for 10 years, for a decade. In 2014, I was on so many TV shows with the background saying “Housing crash,” like no, no, no, no, you got to look at the demographics. And we, again, know that there’s such little inventory, less than a million again on the market and a growing population of people at household formation age. So it’s just simply the matter of not enough inventory and a slight shift in interest rates. Just a slight shift down brings in a few more a hundred thousand people. A half a percent down brings in millions more people who can qualify. And that’s what we’re seeing.

Dave:
Yeah. Just yesterday I did what I do, which is nerdy things, and I overlaid these two graphs, which was mortgage demand and sorry… It was purchase applications and bond yields. And basically, you can see that the second that mortgage rates are going up, the number of mortgage rates are just start to spike.
So people are clearly waiting on the sidelines for any fluctuations in mortgage rates and are jumping in. And that’s only as to Kathy’s point, been pretty slight fluctuations in mortgage rates. It’s gone down from, it was like 7.1 or something, down to mid to high sixes. So if we talked about the fed’s projections, they’re projecting to get the Fed fund’s rate down to 4.1 next year in 2024. If all this happens, that’s millions of people who will probably jump back into the housing market.

James:
And one stat that doesn’t ever get reported because you really can’t do it, is like what we’re doing with all of our listings is with these showings increasing in our pricing, we’re going, “How many showings are we getting in this?” And then we go half mile out for looking for same price product in the same. And right now in the last month, we’re having a four to one. We have four to five buyers for every house that’s for sale. And so regardless if it’s not transacting, there will be a buyer in that mix. And so that’s a healthy sign, is like because for a minute, it kind of got out of whack, but the inventory’s still not there and there’s way more buyers. And so if you have a property on market, it’s a good stat to track, how many showings you get in there, how many competitive properties are in there, go half to a mile out and really see. If you have way more buyers in the market, I would stick with your list price at that point. Even if you’re not getting the offers, there’s people looking and you can transact.

Dave:
All right. Well, another great story and really interesting. I think, we’ll have to update you all, but I think it’ll be really interesting to see if this momentum in sales volume continues because that is a relatively good sign for the real estate industry and it’s not just investors and stuff. Obviously, real estate agents, mortgage brokers, these type of people depend on real estate transactions. And so seeing more of those is obviously helpful to the entire industry. With that, I think we’re going to move on to the commercial side of things. Jamil, what do you got for us?

Jamil:
Well, I don’t tend to speak on a lot of activity in the commercial real estate market, because you guys know that I tend to trade in a single family asset class, but I am a wholesaler and I love finding opportunity. And I can tell you that right now, there is going to be an opportunity in commercial real estate. And typically, what I like to do is zig when everybody’s zagging, right?
And what I have brought to the table today is an article by globus.com where they are reporting seeing discounts that they haven’t seen in the commercial real estate sector. So this is, we’re talking small office and they have not seen these discounts in 14 years. So price declines and pricing that reaching levels not observed since 2009. So if you’re looking for an opportunity, this is one of those asset classes that I would say you would have to play the long game on.
I don’t think you’re going to come in and snag up some opportunities and find an immediate spike in values in a return, but it’s a kind of perfect storm that we’re seeing, especially in the office space sector. We have many companies that have implemented very flexible working arrangements so that people can work remotely. I know for instance, especially in New York, they’ve got so much of their workforce that has remained remote. Even here in Phoenix, Arizona for my company, many of our staff members are still working remotely and taking advantage of some of the pandemic type working arrangements that became very popular during the lockdowns.
So that’s one of the factors that have people have lower vacancies, or sorry, greater vacancies in the office space sector. The second thing is, of course, rate hikes have put a lot of downward pressure on pricing because people just can’t get loans, they can’t tee up funding for their projects or to refinance whatever project that they might be in right now.
And so this is putting a lot of downward pressure on pricing in the commercial sector as well. So I think that there’s going to be a tremendous opportunity for people that are holding powder. And what I mean by that is actually having ready and available cash. I don’t think that lending is going to be very robust for getting your hands on these types of product, on these types of projects, but if you can come in and have cash available to take advantage of some of the pain that’s being experienced right now in the commercial sector, you can get your hands on some pretty incredible deals. And so for me right now, I’m going to be looking at opportunities to pick up some holds in the commercial, especially in the office, small office space sector.

James:
Yeah, I think there’s a ton of opportunity in the commercial space coming our way. The debt’s getting harder to get, for sure. And as debt gets harder, it’s harder to buy. I know we’ve been looking for a building for ourselves to move into for the last six years and we couldn’t get it. And now we think this is the time. I think if you’re an owner operator, investor, it’s a really good opportunity coming your way. The only thing I would say on the commercial space, as I remember in 2008, I bought this building for 30 cents on the dollar from an appraisal. We paid a million bucks for it, and it was like this mortgage company that went out of business. Because every mortgage company went out of business.
We bought this building, we paid 90 bucks a foot for this build… It was just ridiculously cheap. And we’re like, “We are doing this.” And I would say, I think there are opportunities there, but you still got to find the tenants to make sure it’s leasing. Because we bought this building, we had it up for rent for two years and couldn’t get it filled, and we ended up having to move our whole office down there and it was like the first WE Space. We were making these little offices and renting them out.
And I think the key to this is there’s a huge opportunity and if you have a tenant attached, the financing will be there. And if not, you’re going to have to pay cash. And so it’s going to be like a double search. As you’re looking for buildings, you’re going to be looking for tenants too, and almost buying based on who the tenants that you are locked in because then it’s going to be easy to get the financing. But from everyone I know in the commercial space, they said the inventory is massively stacking up for him. Like our commercial broker locally that we work with, he’s like, “I got all sorts of stuff for you guys to look at in the next couple months.” And he’s had zero for the last five years. And so I think Jamil is right, there’s a huge opportunity, and it’s going to be a matter of whether you can execute on it or not.

Henry:
I wholeheartedly agree with you. There’s absolutely opportunity in this space. What we’re having trouble finding is banks willing to lend, because the cash flow’s just not there for them because the interest rates are so high.
And so all I think that that means is that we’re not there yet. I think the prices will continue to come down. And as the prices come down, then you are going to be able to make an eight and a quarter percent cash flow. And I mean, that’s the ideal investment spot, because if you’re cash flowing at eight and a quarter, if things start to cool down with rate hikes and we level out and start coming down at some point, then wow, the opportunity is massive. The wealth you’ll be able to build. If you can get in the game, I think what it’s just going to take is it’s going to take some extreme diligence in your search and extreme diligence in your underwriting.
And James made a great point about finding the opportunities that have tenants in place because what you’re doing is you’re making a bank’s job easier, right? They’re saying they want to invest in something that is lower risk, right? And so if you can bring an opportunity that you’re getting at a discount with a good tenant in place, you’re setting yourself up to build massive wealth in the future.

Jamil:
Henry, to speak, just to add to that, if you are… For instance, my company, KeyGlee, we are just in this funny spot where purchasing a commercial building could be on the horizon for us because our lease is coming up and we could be looking at making a move.
So with that in mind, I see this as an opportunity for us to go out there and have our… Because my company’s got over a hundred people, that we need 20,000 square feet in order to house our staff. So we would be an ideal tenant. And if I can find a building that is, I can buy cheap enough and put myself in as a tenant and pay market rent for that, I’ve now created value. I’ve now created wealth with myself as a tenant, and I can generate cash from something that I would just need to do as a business anyways. So I think that there’s a tremendous opportunity, to add on to what James and Henry said, especially if you are a business owner and you can provide your own tenancy as part of the package, you can hit a grand slam.

Henry:
And Layer on cost segregation on top of that.

Jamil:
Boom.

Kathy:
It’s like a house hack, but it’s an office hack.

Dave:
Yeah.

Jamil:
Yep.

Dave:
That’s interesting, Jamil, because otherwise I want nothing to do with office space, to be honest. I just feel like it is, especially in big commercial in large areas like New York, San Francisco, the vacancy rates are really going up and I would be pretty concerned about it, but if you have to spend the money and like you’re essentially house hacking, like Kathy said, I think that’s an interesting approach. But let me know how it goes.

Speaker X:
Yes. Thank you.

Dave:
[inaudible 00:33:41] into office investing.

Jamil:
So again, paying attention to the fact that right now, there’s just not a lot of lenders out there that are willing to loan on these types of assets, look for those opportunities, look for that, because that’s where the pain is going to be. And I think that there’s just, especially for some of those buildings that are going to need to refinance in the next 12 months to two years, tremendous, tremendous opportunities.

Dave:
All right. Well, Kathy, it sounds like you brought a story that’s sort of related to that, right? You’ve something with commercial lending as well?

Kathy:
Yeah, it’s a MarketWatch story called Bank Jitters, puts spotlight on commercial real estate, three charts to pinpoint the potential trouble. And then the quote says, “I don’t think it’s going to be a repeat of the ’90s, but it is going to be harder to get a loan.”
So it’s basically what I also learned at the best ever conference when I talked to a lot of lenders there. And basically what we’ve been talking about for a year in liquidity, my whole keynote speech at the Best Ever was focused on liquidity and what that means. And it’s basically available cash, whether it’s cash you have, whether it’s cash you can get from a bank, the cost of that cash. Can you get it from investors? Liquidity is needed generally when buying real estate. Most people don’t buy properties with all cash. If it’s cheap enough, maybe.
But when you get into the commercial real estate range of prices, it’s usually needing liquidity of some kind, whether you’re raising it from investors or again, getting it from a bank. And when that liquidity dries up and you can’t get it, well, obviously that’s going to have a huge impact on the number of sales and the pricing of those if you just can’t get your hands on the money.
And I went through that totally in 2008 when there were great projects, but banks had no money to lend. And that’s when I started syndicating. That’s when syndicators came out of the woodwork because you didn’t need a syndicator before 2008. You could just go to a bank and get the money. That’s where you got the liquidity.
So today, we know that the Fed is trying to pull money back out of the system. That’s why they are raising rates. They’re trying to remove some of the liquidity. There was so much of it that people were trading deals all day long, because if you can go to a bank and get the money and go buy the deal and it makes sense, you’re going to do that. When you can’t get the money, what are you going to do?
So the situation right now of course is we’re seeing banks being cautious, obviously because of these bank failures. And there’s a lot of talk about, “Ooh, is the whole financial system going to crash?” And you already heard me say, I’m not worried about that. I think it’s more of a consolidation of big banks buying small banks that just didn’t have enough liquidity. They didn’t think that went through, they didn’t think there’d be bank runs and so forth. They thought they were investing in something safe, treasuries, right?
So right now, kind of where we’re at with banks and us as investors trying to get that money from the banks, there always seems to be enough money for single family, because the Federal government backs that through Fanny and Freddie. They want people to be able to get home loans. So again, I’m not too worried about the one to four unit conventional loan sector. It’s the commercial loans and what’s happening there.
And in this article, I thought it was really interesting. They talked about the number of small banks that have been involved in doing transactions this past year versus big banks. And with the small banks, it’s 68% of all commercial real estate is with small banks. And the big banks, much, much less, like 20%. And this past year, the big banks only increased their exposure by 5%, where the small banks kind of went all in. That’s where commercial investors were getting their money this past year.
The reason why I’m not worried about the big banks is because they sell those off to commercial mortgage backed security, CMBS. It’s the bond holders who hold those, and it’s not the banks at risk, it’s the bond holders who bought the commercial real estate backed securities. It’s the small banks who don’t do that, and they’re holding onto what could be some trouble.
And so that’s another thing to pay attention to. How are the smaller banks going to handle some of the issues that come up when these loans come due and the borrowers are not going to be able to refinance into the higher rate and these smaller banks are going to have to take back these distressed situations?
So that’s really, to me, what this article is about is liquidity, who’s got it, who’s got the money, and who’s going to be lending it? It’s going to be tighter, stricter. There’s concern now with these bank failures that there’ll be more regulation, which may be a good thing. The Dodd Frank laws prevented banks that had over $50 billion… Well, I should say banks that had more than $50 billion had stricter regulations, and that changed in 2018 where it was if you had to have 250 billion.
So a lot of the small banks got to do more without the regulation that big banks have over the last, I don’t know, four or five years. So more regulation, less money circulating. It’s just going to be harder to get a loan, and that is going to affect commercial real estate. Even if you’ve got a great project and you just can’t get it financed or you’re trying to refinance. It’s a great project, but you just can’t get it refinanced. These are the things we’ll be paying attention to at Best Ever.
Again, I talked to some high level people, Marcus & Millichap, John Chang, he’s like, “It’s going to be a problem for some syndicators who aren’t going to be able to refinance,” but the bank’s okay, because there’s equity there. It’s really more the equity that gets lost and another. There’s plenty of money on the sidelines ready to scoop up the deal just for the amount that the bank has lent on it.
So I don’t really see it, commercial real estate crashing so much as some syndication projects crashing and the equity crashing, people not getting their money back on those deals, but I think banks are going to be fine and there’s plenty of money to swoop in and pick up the pieces.

Dave:
Well, that’s what I was going to ask you, Kathy, is do you think people like hedge funds or private equity or some non-bank lenders are going to get more into this space? Similar to what happened in post financial crisis in the single family space. A lot of these institutional investors got in there and they’re pretty active in commercial real estate now, but I’m curious if you think they’ll start stepping in an increased way.

Kathy:
Well, again, that’s what John Chang said of Marcus & Millichap, and I’m happy to bring him on as a guest, if you guys want to interview him. He said that he was talking to major, major Wall Street funds who have to place money this year, and they’ve got a lot of it. They’ve got billions and they have to place it.
So they’re maybe not looking for the deals that you and I are looking for. Maybe they don’t need the kind of returns that we need. They need to just place the money. It can’t just sit there. And so he wasn’t worried.
The concern really is the syndicators who raised money, that equity gets paid last. So if you refinance and all of a sudden the payments are much, much higher and the cash flow is so much lower, either those investors aren’t going to get any distributions, or if it sells, it may sell at a price where they don’t get any money back. And that’s going to happen in quite a few deals. But I don’t think it’s the banks in trouble because like I said, someone will just take over that note because it’s cheaper now. If it’s a $50 million property and 10 million was raised in equity, but there’s a $40 million loan on it, let’s say, now that property, some other institutionals coming in to buy for 40 million instead of 50 million, but the equity got wiped out.

James:
I think the riskiest ones on those for the banks are those value add loans they were doing though, because some of them, they were taking 15% down on some of those deals, the small bank. I mean, I know Henry loves local banks like I do, and we all love them because they’re doing the percentage of loans that Kathy’s talking about. What, 65% of these deals were going with local banks. They were really easy to work with. They looked at you as a business.
Because the other day, I was trying to figure out, I was trying to research and I wonder if Dave knows how to find this, is there a way for us to figure out how much of those loans generated the 67% of them are actually on variable debt? Because the fixed debt will remain okay, but this variable debt was, a lot of that was going on, and when you have a variable debt loan set up with a two-step construction component with an operator that, like Kathy said, there’s been some new operators in the market that may have underquoted things and they’re going to get a little sideways, that’s the risk for the banks, is not taking it back when it’s stabilized but midstream.
And there’s a lot of stuff in midstream right now that are not hitting the rent perform… I mean, I was talking a few down actually in Phoenix of all places, and they’re like, “Yeah, our rents dropped so much. We didn’t want to put the money into the project,” and so they’re in this middle stabilization period. That’s where the loans can get risky, right? Because when you’re halfway through, the value of the building almost goes down, right? You’re vacated. Things are under construction, so that properties worth less than it was when you bought it just in where it is.
And that’s what I’m trying to research right now is how many properties are these midstream properties and how many are on variable debt? Because that’s the ones where they could walk away and then a bank has to remodel these things. That’s what bankers aren’t good at doing.

Jamil:
Which they won’t do, and they’ll just take the haircut.

James:
I think that’s where the opportunity is, is in… And I do think we’re not going to see this 2008 homeowner problems. It’s an investor greed problem. We’re seeing headphones getting their teeth kicked in right now. I know one that’s losing a ton of money in Seattle right now, and they’re all midstream projects and they’re bailing out.

Dave:
It’s the James Dainard special.

Speaker X:
It’s half-built.

Kathy:
Rates are down, what, 51% year over year, and that’s mostly office, and they are just absolutely getting hammered. I think what I read is 60 billion in fixed loans are requiring refinance and 140 billion in floating debt is maturing over the next two years and it’s going to need to refinance. So if rates stay high, there’s definitely going to be opportunity for people who know how to find it. Just my point was, I think there’s just enough people thinking this way that they’re getting ready. There’s money on the sidelines, and there’s institutional investors who have to spend it. They can’t just sit on it. We’ll see.

Dave:
Yeah, it’ll be very interesting.

James:
Well, if someone figures out how to create the commercial and the multi-family, somehow get the construction costs under control, then it will really rip. Then I think that stuff’s getting all bought and converted.

Dave:
Yeah, there’s going to be, I think there’s has to be some sort of public-private partnership, government incentive to do that in some locations. I didn’t know where those will be, but some municipality will get smart enough to help developers or investors convert office space as reasonable cost.

Jamil:
Well, we know the labor market’s broken as soon as James finds an accountant. So when we have that figured out, we’ll know that we may have some reprieve in construction costs, at least on the labor side.

Speaker X:
We have our market indicator.

Jamil:
That’s it.

Dave:
All right. Well, thank you all so much for bringing these stories. We really appreciate them. This was a very fun show. Thank you all for listening. If you like this show, we do always appreciate a positive review on Apple or Spotify. James, Henry, Jamil, Kathy, appreciate you being here. We’ll see you all next time for On the Market.
On The Market is created by me, Dave Meyer and Kailyn Bennett, produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, researched by Puja Gendal, and a big thanks to the entire BiggerPockets team. The content on the show On the Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.