Overview of Real Estate & Economic Updates feat. John Chang | Aspen Funds
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Overview of Real Estate & Economic Updates feat. John Chang

In this episode, our guest, John Chang, National Director of Research & Advisory Services at Marcus & Millichap, shares key insights into the current economy, trends, forecasts, and areas of opportunity for 2024. We discuss the impacts of inflation, the Federal Reserve’s interest rate movements and the evolution of real estate over the past 18 months.

Connect with John Chang on LinkedIn https://www.linkedin.com/in/johnchang/
Connect with Bob Fraser on LinkedIn https://www.linkedin.com/in/bob-fraser-22469312/
Connect with Ben Fraser on LinkedIn https://www.linkedin.com/in/benwfraser/

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Introduction and Guest Introduction

Ben Fraser: Hello, future billionaires. Welcome back to another episode of the Invest Like a Billionaire podcast. We have got a humdinger of an episode today. This was amazing. We got John Chang, who’s a returning guest. He’s the Senior Research at Marcus and Milichap and he just dropped a ton of bombs and we asked him.

All of our questions and just brain dump. And he just had some amazing responses about what are some things he shared and why should someone listen to this episode? 

Bob Fraser: Okay. This guy I’m telling you is my favorite subject for interview. This guy is a wealth of knowledge, my favorite guy.

So find out what’s really going on and what’s really happening at commercial real estate, interest rates, inflation. And stay tuned to the very end. So he calls me out where, where I was wrong and an economic forecast and he was right. And so listen to the end, you’ll get that piece.

Ben Fraser: This is the Invest Like a Billionaire Podcast, where we uncover the alternative investments and strategies that billionaires use to grow wealth. The tools and tactics you’ll learn from this podcast will make you a better investor and help you build legacy wealth. Join us as we dive into the world of alternative investments, uncover strategies of the ultra wealthy, and discuss economics. And interview successful investors.

Free Economic Report

Ben Fraser: Looking for passive investments done for you. With Aspen Funds, we help accredited investors that are looking for higher yields and diversification from the stock market. As a passive investor, we do all the work for you, making sure your money is working hard for you and alternative investments. In fact, our team invests alongside you in every deal, so our interests are aligned. We focus on macro driven, alternative investments, so your portfolio is best positioned for this economic environment. Get started and download your free economic report today. 

Guest Interview Begins: John Chang

Ben Fraser: Welcome back to another episode of the Invest Like a Billionaire podcast. I am your co host, Ben Fraser, joined by fellow co host, Bob Fraser.

And we’ve got a very special and returning guest to the podcast. I’ve been looking forward to this conversation for a long time. We have one of my favorites. Yeah. Yes. John Chang who is the national director of research and advisory services at Marcus and Milichap. We’ve known John for several years.

He’s on the conference circuit speaking on all these big picture things we want to get into on what’s going on in the economy. How is commercial real estate being impacted? Obviously, the last time we talked, if you were looking back, was May 2022. And fast forward to now, about a year and a half, there’s a lot that has changed since then.

And so we have a lot to catch up on. John, thanks for coming on the show. 

John Chang: Hey, it’s a pleasure to be here. I’m glad to have an opportunity to chat with you guys. 

Ben Fraser: Yes, it’s always fun. 

Discussion on Changes in Commercial Real Estate

Ben Fraser: So let’s dive right in. Help set the stage for us. Maybe, give us the over the past 18 months. What are some just things that have changed from then to now?

And we’d love to start there. 

John Chang: What hasn’t changed, right? And so the entire industry has been shaken to its foundation, right? We’ve seen the inflation spike. We’ve seen what the feds have done to us with their interest rate movements. And I actually watched our video from 18 months ago, and I think I undershot the Fed movements a little bit.

I was not planning on it. A lot of people did. I didn’t see 475 base point movements coming in a row. I really didn’t in May of last year, but that’s really impacted everything that it sends shockwaves through the banking sector. We’ve seen movements in commercial real estate. We’ve seen cap rates move.

We’ve seen markets slow down. So there’s really just been a real change throughout the economy, but we have not had a recession. And if you go back 18 months ago, if you go back a year ago basically every economist out there was saying we would be in a recession today. Yeah. And that has not materialized.

Now basically everybody’s talking about a South landing, which means there’s probably going to be a recession, right? So economists are just always wrong, but no it’s really been a dynamic market if you want to call it that, but it’s really seen a slowdown in commercial real estate activity.

Investors have moved to the sidelines in many cases. They’re looking at each other, trying to figure out what’s going on. There’s uncertainty and there’s a bid ask spread that’s opened up buyers and sellers are not on the same page. And we’ve seen a real transition from some of the best years in commercial real estate.

Some of the time, the tide was up and everybody was doing great and everybody felt good. To a more normal cycle, actually we’re in what would be considered a more normal market now. But, when you’re coming off of the big highs, it seems like a massive slowdown.

Ben Fraser: So where have you seen, from your perspective, the most stress, right? You’re saying things have fundamentally changed. Where has the stress been most acute? 

Impact of Pandemic on Office Sector

John Chang: Obviously the office sector, right? The office sector has just been hit hardest. And that’s a byproduct of the pandemic and changing behavior, people working from home.

When they could work from home they moved out of the city. They moved to the suburbs. They moved to a completely different city. They moved to a completely different country and worked from there. We’ve seen a real change in the office market. Some cities have been hit harder than others.

Definitely major urban hubs have been impacted the most. But, absolutely the office sector faces the most stress. It faces the most change. The vacancy rate was, like 12% before the pandemic. And now it’s up at 17. And when you cut inside of the office sector, actually there’s a lot of nuances there.

It’s not all bad, but it’s definitely the property type that’s seen the most stress. 

Challenges in the Multifamily Sector

John Chang: We’ve seen apartments change. We have a lot of development coming online, 420, 000 units in, in 23, 480, 000 units expected in 24. So we have the shock wave of development coming through the system, and that’s creating some challenges in some markets because it is a little bit more concentrated.

I think it’s about a dozen markets that have about half of the construction. We’re still facing that. That’s impacting fundamentals. And when we. We’re talking, a year ago when we were talking about recession risk, we were talking about hyperinflation. Everybody started to get scared and consumer sentiment dropped to a record low and consumer sentiment relates closely with household formation.

So when everybody was scared, nobody wanted to go out and rent an apartment and we saw negative absorption at the same time we had a huge wave of development coming online. It’s going to take some time to make that back up. So those are two property types where we’ve seen a lot of action.

Bob Fraser: Let me jump in there on, on that. So it sounds like you’re saying we’re not yet seeing the bottom of the, let’s call it the multi family meltdown. Multifamily has been such a gold standard for many years. It’s considered, everybody needs a place to live.

So it’s considered very safe as commands kind of premium cap rates. And I guess my view is that it’s, we’re not seeing, we’re not seeing the bottom yet. And with all the, as you, we point out the massive amount of deliveries coming in as well as the troubled units that I don’t think we’ve seen the bottom of.

Where do you think we’re at with regard to the multifamily? 

John Chang: Sure. Firstly, I want to start by saying this. If you look longer term, if you’re looking five years out, we still have a housing shortage, right? Even with all these new units coming online.

We still have a housing shortage. I don’t think this is a long term structural problem, but what we do have is a we had an absorption drop and it was negative in 2022. We were losing tenants on the net as an industry and we were building quickly and we still have more units coming. Absorption has gone positive.

It’s back into positive territory in 2023 every quarter and it’s rising. It’s getting better each quarter. So we have that going for us now in terms of, are we at the bottom yet, probably not, we still have 480, 000 units. It’s a lot of units that’s a lot of construction and to come on top of the 420 this year and whatever it was in 22 just light of 400, 000.

That this is a lot of development that’s been happening. And I think we’re, we still have a ways to go. The good news is that we have seen stars drop significantly. And as we go into 25, 26 we expect the wave of development to abate and things will ease up a little bit. In terms of operations, yeah, absolutely.

Some of these investors got out, a little bit over their skis. And they really are facing some challenging times. I think there will be some distress that emerges from that. But so far it’s been pretty limited. And yeah, I just don’t think that it’s going to be this huge wave. We’re not going to see the blood in the streets.

But we are going to see Some investors who are trying just to get out of their skin. 

Bob Fraser: Yeah. And so there’s going to be some distressed sales and just, a lot of rescue needed that will rescue capital data and probably prices falling, for the next year or so, that’s my view is it, would you agree with that?

John Chang: Yeah. We’ve seen, we’ve seen upward pressure on cap rates, right? Anywhere, compared to the peak of the market, where anywhere, depending on the market, the property, everything else, anywhere from 75 to 200 basis points of lift on cap rates from the top of the market.

And we expect to see continued upward pressure, and, a lot depends on where you see the Fed going, and that’s going to be a big part of this and what happens with the interest rates. The 10 year treasury touched 5% just a couple of weeks ago, and then it came back down a little bit.

It’s at four, four four, four right now. But we could see in this new interest rate climate and what the buyers are trying to do and what they’re willing to pay. We’re still seeing some gaps there. That said, there is a tremendous volume of capital on the sidelines. There are a lot of investors, a lot of institutions that are sitting on the sidelines and waiting for the right pieces to come into play where they come back into the market aggressively.

And so it’s a, it may be a bit of a famine feast situation where there’s a, it’s hard to raise capital right now. It’s hard to get out and get deals done right now. But when the market turns, we could have this wave, the shock wave of capital coming into the market that makes it really hard to get a deal done because there’s too much competition.

Bob Fraser: So the capital on the sidelines is looking for deals, right? Looking to buy stuff that’s distressed and distrust kind of pricing based on, Hey, yeah, we five years from now, there’s a housing shortage, et cetera. It’s a good market. So this is called a buying opportunity, right?

When you see cap rates rising, so yeah, a lot of capital in the market, but so talk about price discovery there really, we’re still super thin on price discovery. And, but I think that’s going to happen more as you go look at, as these, you maturities happening, people are going to be forced to either find new equity, do capital calls or, rescue capital or something, or they’re going to have to sell and you’re going to see forced price discovery coming and then becoming, and 2024 really.

John Chang: I think there will be some. Now we have to remember FDIC came out with guidance in June that basically said leaving it up to the banks, but the banks will have the opportunity to be creative in extending loans, right? So the same playbook we saw in the financial crisis, same one we saw. In the pandemic, there’s, blend and extend or extended rebuy, all of these things kick the can down the road.

It’s worked the last two times, right? So they like that playbook. And I think that we’ll see some of that, especially with the clients that the banks have a relationship with. The banks are not excited about writing new debt right now. So even though they’re open for business, technically.

The terms that they’re offering are not great and they’re really focused on increasing and strengthening their balance sheet. So they may say, yeah, we’ll loan you the money for this deal, but we want you to deposit 2 million in our bank so that we can boost up our balance sheet a little bit.

We’re seeing some very unique situations. CMBS, by the way, CMBS is the one proper lender that has no mercy, right? There’s no person there that you’re having a conversation with. So CMBS debt that gets distressed, that will pop out almost assuredly. But the stuff held by the banks probably will get blended in or extended and refinanced or something like that.

Bob Fraser: I agree. 

Predictions on Federal Reserve Actions and Interest Rates

Bob Fraser: What about the bridge, the bridge lenders, a lot of the thought of the bridge, they, went very high into high, higher LTVs and more aggressive lending and pretty much out of capital now. So they’re, they’re going to be, they’re going to be forced to deal with this. How do you think that’s playing out? 

John Chang: I think the bridge lenders that I know a lot of are very hands-on real estate investors. So they said it’s hard to buy a deal right now. We’ll go out and we’ll offer some bridge lending. And a lot of it’s private capital and they have no fear of taking over a property.

So the bridge lenders are going to be in a position. If somebody goes into default to come in and take over the asset and take ownership and possession of any kind of property. Those are professionals. Those are not banks. That’s not a financial institution. Usually they’re going to be in a good position to come in and manage those assets if they take them over, they go in, they clean it up and they resell it.

So there will be some stuff coming out through there. 

Bob Fraser: So what’s your opinion on what the Fed is doing? We saw the markets are definitely believing that rates are going to come down next year. Markets started, did a crash here recently and rates dropped.

I’m of two minds. I still see inflation being high and the Fed’s not changing their playbook. They’re saying we want 2% and we’re not close to 2% and yet the markets believe, Oh they’re making that up. And, it’s what it feels like to me.

And so I’ve always believed that I just think it’s going to be higher for longer. I’ve been saying this for a year and a half now. And what’s your view? Do you think the markets are right and they’re smarter than all of us and we are going to see the Fed, dropping rates or how do you see it playing out?

John Chang: So I track FedWatch, right? Right now they’re saying they keep rates flat in December. If you go out on May 24, you start to see a divergence of about half of the 50% likelihood of flat. And about 50% saying they’re going to go down 25 or 50 basis points by May. Now, when you look at where we are with inflation and in the Fed’s eye, they’re really looking at core PCE, right?

That is the actual measurement they want to get to 2%, not CPI, not some of these other ones, but it’s a core PCE. And that’s at 3. 7% right now. It was at 5. 1% 18 months ago, so it’s down pretty considerably, but it’s only halfway there. And when you listen to Chairman Powell, he explicitly says hire for longer and he says that with conviction.

Now he also says they may raise rates and I don’t believe him, right? So I don’t think there’s any more rate increases coming. I think that the. The rates are sufficiently restrictive to put downward pressure on inflation. Incidentally, we had a webcast with Mark Zady a year ago, and he was saying that we should look for the tenure treasury to come in somewhere in the, four point a quarter to four point a half percent range would be quite unquote normal in this climate.

Really when we look at what the Fed’s going to do. I don’t think they’re, I don’t think they’re going to race it. I think they’re done racing. I think that the likelihood of a substantive decrease any time in the next year is low. I think you may see a 25 basis point drop somewhere along the line, maybe in the third or fourth quarter next year.

But I just don’t see them. reducing the overnight rate substantively until inflation not only gets to 2. 0%, not until PC core PC is at 2%, but I will, I think they’re going to want to keep it at 2% for a few months before they start really moving rates. Yeah. You have to consider that a lot of people think that rates are going to go down because this is abnormal.

This is this, it’s a generation gap for millennials, right? Who has grown up in our business community, right? Millennials in their thirties, early forties, they’ve grown up in real estate over the last 10 years. And the average cap for the average 10 year treasury over that time is about two and a half percent.

That is normal in the mind of somebody who has only been in the business 10, 15 years. Those who’ve been in here since the nineties, the nineties all the way up to oh seven, the average 10 year treasury was about five and a half percent. And for the quote unquote old timers who’ve been out here for the, for doing this for 20, 30 years.

We look at it and go, eh, it’s not so bad. We can make this work. We know how to do these deals. And so it’s a matter of perspective. A lot of people say, Hey, it has to go down because this is abnormally high. And then there’s another group saying, actually, it’s not abnormally high. This is actually pretty normal.

Bob Fraser: Yeah. A hundred percent. So why haven’t cap rates moved as much, as much, I would have predicted with the dramatic move in, in in, rates, why haven’t cap rates moved more? What is, what’s the sauce behind all that? What’s going on? 

John Chang: Let me ask you this: what would it take for you to sell a property right now?

Bob Fraser: Gotta find something better, right? 

John Chang: You gotta find something better, but essentially you have no motivation, right? There’s no reason to sell. You look at it and go, eh, I, we’re doing good. We’re making money. The property is doing well. We’re running it effectively. I don’t have any motivation.

Now, if somebody came in with a truck full of cash and said, we’re going to dump this on your house and you can have all this money, far more than you think that property’s worth, you’ll take it. And that’s where we were in 2021 and part of 22, right? The prices were so high that people were motivated to sell because they couldn’t believe what somebody was offering them.

They were basically being offered so much money that they couldn’t say no. And we’re not in that climate. We’re back actually into a normal transactional climate where motivation is driven by investor needs, right? Whether that is for private investors, say, traditional death, divorce, breakup of partnerships, maturity of a fund.

Those types of things are going to be the drivers, but for a while we were being motivated because there was just so much money on the table and you can redeploy it and play the whole game again and again, people were, instead of holding for five years, they were holding for two or three years because the values went up so fast.

And so we had a lot more velocity. And right now there’s, you’re not going to make, extra money. It’s not that big a giant number. So your motivation is limited to traditional motivating factors and there’s just not a lot of motivation being created unless you have some sort of life change or a fund that needs to be turned over.

Bob Fraser: Yeah. Perfect. 

Transaction Volumes and Market Predictions

Ben Fraser: You said, transaction volumes are more normal, but year over year we’re down probably what, 75%. Is that a kind of a normal transaction, or just normal to the reasons for it? Do you expect that to take up over the next 12 months? 

John Chang: Yeah, the reasoning behind it is moving back to normal, but we’re still going through a little bit of aftermath, right?

So you look at transaction activity, they’re down about Give or take 50% compared to 50. Okay. A year ago. It depends on how you measure dollar volume or transactions. There, there’s a lot of different ways to look at it. What’s your minimum threshold? But basically transactions are down about 50%.

But compared to say 2014 to 2019, we, a more normal cycle. We’re down more than 20%. So we have to, we’re gonna come up a little bit. I expect that in 2024. We may still be a bit slow through the first half, but I think it’ll pick up momentum as the year progresses. I think, again, if the Fed just holds rates flat, then I think it gives investors the opportunity to calibrate to the market and we’ll start to see transaction activity improve.

Now, compared to, when we were in that cycle in 2022, when the Fed was moving rates, 75 basis points every month. And over the span of four or five months, they moved that overnight rate up by 300 basis points. It’s very difficult to underwrite a deal in that climate.

So just having a period of stability will allow investors to recalibrate, move to the market. We’ll see the pricing come out and we’ll have a discovery process and that expectation gap between buyers and sellers should narrow as we go through the year. 

Potential Risks in the Banking System

Bob Fraser: Now, I’ve been seeing some scary articles about regional banks and the commercial real estate crisis.

And my research and banks just, everybody looks pretty healthy. I just don’t, there may be a few little failures, but I’m just not seeing it. I don’t know. Are you seeing a, you seeing, are you seeing bank stress and what are you predicting? 

John Chang: So if you look back at what happened Over, over the cycle and Bob, you and I were both at the best ever conference when we, when Silicon Valley was going under and people were, I was literally at the conference.

Somebody goes, Hey, what do you think of the Silicon Valley bank thing? And I don’t know what’s going on. I was busy and he said, yeah, my friend is trying to pull 200 million out of there right now. They can’t get their money. And I was like, 200 million, who puts 200 million in one bank? But so anyway, they were.

They were clearing it out and we don’t need to go through all the details there, but basically Silicon Valley bank couldn’t cover the bets. So then money started coming out, they got shut down. Then the whole conversation centered on real estate. And everybody’s wow, yeah, real estate, small banks hold 80% of the debt, which is wrong.

We came out there early and squelched that as a matter of fact, right after we came out, Moody’s came out with a report in our real capital analytics and came out with a report of all backing up our position. And actually a lot of those articles saying the small banks held 80% of the debt got pulled off the internet, which was pretty good to see.

In reality, the sector with the greatest Risk right now is the office, right? And when you look at the total debt held by banks in general only 25% of the debt they hold is in commercial real estate. The rest of it’s in residential or consumer loans or business loans, only 25% of the debt they hold is real estate.

And of that only 15% is in office. So their real risk factor. oNly about three and a half percent of the debt held by banks is in office. And of that only, whatever, 10, a quarter of it is truly at risk. When you look at what’s the actual risk of real estate to the banking system, it’s not what is in the headlines, but there is a perception issue, right?

So when you look at say. First Republic Bank, they had a lot of real estate and structurally they were operating. They were fine. They weren’t really in a bad situation, but they kept getting beat up in the headlines. And I almost felt Chase Bank was chumming the waters when they said we’ll loan them 30 billion.

And so that they make sure that they’re stable. And then everyone goes, Oh my God, Chase Bank’s loan him 30 billion. They must be in real trouble. Everybody starts pulling their money out. They go, they’re at risk. Now everybody’s pulling their money out and they have a run on the bank. And then guess what?

Chase Bank comes in. So I guess we’ll buy him. So they bought it out, Jamie, that was a smart guy who knows. But my point here is the true risk is not what but there is a perceptual risk. If somebody says this bank is in trouble and they have too much real estate and they’re going to default on all this debt and they’re in trouble, everybody should pull their money out by pulling the money out.

You’re yanking the rug out from under their feet and then you have a bank at risk. 

Strategies to Reduce Financial Risk

John Chang: And so FDIC, And the federal reserve came up with a lot of strategies to try to reduce that risk. They backstopped a lot of the holdings, right? The treasuries. Yeah. Yeah. Yeah. Basically now instead of having to sell off their bonds before maturity, they can borrow against them at base value and try to secure their finances.

Impact of Real Estate on Banking System

John Chang: Net there’s, I don’t think there’s a real risk to the banking system from real estate. Bye. That doesn’t mean that real estate can’t be part of why a bank gets put under. And if a bank goes under in the next 12 months or something like that, because of these things it will send a shockwave through and lending will get worse.

Locked up again, right? We’re already in a, we’re already pretty close. 

Ben Fraser: Yeah. 

Credit Tightening and Its Effects

Ben Fraser: What’s interesting is that the credit already feels like it’s tightened a lot, right? A lot of, like we looked at some refinances for some of our assets and deals just aren’t sizing up at the leverages that really make sense at the higher rates.

And then I’ve talked with, this is more anecdotal, but a lot of the banks that we’ve worked with and that we have relationships with are saying. We’re just, because we’re having to extend and pretend or, continue to push maturities or work out deals, they’re not clearing their ballot sheets to have new capital to lend.

And so that’s further creating less available capital for new deals. 

Banks’ Approach to Lending and Its Future Impact

Ben Fraser: Do you see that having a lingering effect going into 2024 as the banks are just not willing to lend at the leverage that. Makes, the capital want to purchase at those prices or does that kind of get leveled out here, the next couple of quarters?

John Chang: If you look at the last lender survey, the banks are still tightening their underwriting. And if you go down and you dig underneath the surface and you go look at the actual survey information, basically one of the top answers was we’re trying to build up our balance sheets. We want more cash in the bank.

We don’t want to lend out right now. Now, I have an existing client. They have a loan with us. We’re going to work with them. We’re going to try to take care of that deal. But we’re not going to put more money out unless it’s a real sweetheart deal and they give us deposits. That’s really the criteria right now.

Multifamily is a little bit better position. You have Fannie and Freddie, the GSEs out there. So there is some available debt through there, but in general, the banks really are being cautious because they don’t want to be the next one that shows up in the wall street journal as having extra risk and, think about it.

If you’re a bank executive. The last thing you want is for your bank to have a run on it and you get put out of a job and you can’t get a job after that because everybody says you’re the guy who was running that bank and you got killed. So anyway it’s really a cautious play from the banking sector right now.

Now, this smooths out over 2024, I believe, and the reason is because the Fed stops raising rates. The financial pressures on these banks are going down the economy levels off. The one risk factor in a way is a recession but by the same token, a recession, if we had a recession. That may be the one thing that causes the Federal Reserve to reduce rates, right?

If they see a significant recession, they’re not going to do this for just a very small, mild recession, but if there’s a severe recession that comes through they could reduce rates, and that could take some of the pressure off too, but you have to see what happens with job formation and all the other economic drivers.

Bob Fraser: Hey, random question. 

Potential Impact of China’s Property Bubble

Bob Fraser: So I’m tracking what’s happening in China, and you’re seeing a pretty bad property bubble popping in China. My guess is they’ll use the same playbook the Fed has used, to keep the banks, prop up the banks. So I don’t know how much you’re tracking that and do you think any bubble popping in China hits the shores of the United States or the globe in any significant way?

John Chang: It’s, I don’t track it very closely but one thing about China is, first of all, their economy can be controlled more closely. So the government has a lot more latitude in how they run things. They can head off issues more easily should they choose to do that. aNd they can manage their fiscal policy from the top down.

So, I think that the risk of that splashing into the U. S. directly is pretty slim. I don’t think that there’s a financial market shakeup or anything like that as a result. There’s talk about how China has been reducing their purchases of 10 year treasuries and reducing their U S treasury holdings.

And that’s true. That has been happening, but it is also just a drop in the bucket compared to the federal reserve. They’re like 10% of the total holdings. Of what the federal reserve holds. It’s really a small amount of the total treasury. I think it’s 3% of the total treasury. 

Bob Fraser: That’s more of a function of the balance of trade anyhow they, when they receive dollars from American purchasers, they got to buy, they got to see if they’re spending it or buying treasuries.

I’m not concerned about that. Okay. Last question. I’m going to throw it back to Ben. We’ve talked about all the bad stuff that’s going on in the market and how ugly it all is and all, but let’s talk about the good stuff. Where are the outsized opportunities? 

Opportunities in Industrial and Retail Real Estate

Bob Fraser: Some of the things that we love right now that we’re just very bullish on is industrial big box industrial.

That’s warehousing, transportation, logistics and manufacturing. We’re really seeing, we haven’t seen cap rates hardly budge and. Still a lot of demand slowed from the recession slightly, but still hugely bullish on that. And the other area that we just absolutely love, we can’t get enough of, is the small neighborhood retail, the little neighborhood retail centers.

And these things, we’re buying these at an eight and nine cap rate. With just, they’re beautiful, they’re great locations and I don’t know how you lose money on this. And we’re buying them at 50% of replacement costs. So nothing’s been built in that space for the last 15 years. Comment on those couple areas and anything else that’s your happy place.

What do you, where do you say investors, you got to back up the truck right now and stick, put your money to work because this is where it’s going to be amazing. 

John Chang: Bob, 18 months ago in our video, I said, Hey, retail is looking good. And you guys are like I’ll give you credit for that one, buddy.

You called it. So yeah, retail is still fantastic, especially neighborhood community centers. There’s no construction to speak of. They’re outperforming. The vacancy rate is at 4. 6% for retail overall. And I think in those centers, it’s even below that you look at especially secondary, tertiary markets, suburban areas, right?

We had that migration pattern out of the major urban hubs into these outlying areas. Those are all doing great. That is probably the best performing asset out there and vacancy rates at a record low. And the performance is rock solid, especially if you got a good anchor or a shadow anchor center. And the yield on them is some of the highest you can get.

And they’re performing well. So retail is doing good. Also, if you look at retail sales. Retail sales have outperformed everybody’s expectations. Now, they are softening, they’ve flattened out over the last 18 months, but they’re still at a record high on an inflation adjusted basis, right? When you see the retail numbers, they don’t normally inflation adjust them, we’ve been doing that.

Retail sales on an inflation adjusted basis, I think you’re up about 0. 2% on a year over year basis, but that’s perfect, right? That’s soft landing, right? That’s right where you want it to be. So you have gains. Retail’s looking great. Industrial, you still have a wave of development that’s in process.

400 million square feet coming online this year. I expect that next year it may come down a little bit. And then in 25, we see the pace of construction really drop off. But right now there are some markets that have a lot of development. I think about half of the total square footage being added is in eight metros.

That’s Chicago, Dallas, Houston, Atlanta, Phoenix, Inland Empire. I think Philly is up there and there’s one other one, but so there are areas where you could get overdeveloped. infill industrial. It looks great. Can’t beat it. That’s doing really well. 

Potential in Medical Office Space

John Chang: aNother one another property type that I like right now and I’ve really been tracking is medical office.

You gotta remember 10, 000 people turn 65 every day. And as people turn 65, their use of medical services goes up. They average seven visits to the doctor per year, which is double the average overall. As the baby boomers age into their 60s and 70s, use of medicine is going to continue to grow.

And the construction of medical office space has been very limited. So that’s another property type that’s been doing well. 

Bob Fraser: But what about the stress since COVID on the medical space? We’re seeing huge job shortages and service delivery problems, so you, you think this is, it’s gonna, doesn’t matter because the demand is just going to be there and we’ll, they’re going to need real estate either way.

John Chang: Yes. Yeah. Yes. To all of those. I, the demand’s going to be there. So we got to fulfill it somehow. We can’t not provide medical services. I think what, this is one of those areas where and we’ve seen some of this showing up in, in, in Congress, the H1B visas. There is an opportunity to pull medical personnel from other countries and allow more immigration.

Our immigration policies, if we can loosen those up, we can solve a lot of our labor shortage issues. Amen. Especially in the skilled services like medical services I think there’s a huge opportunity there. At some point I think that we may need to do that. Actually, I think we already need to do that, but at some point, maybe Congress will be able to focus on issues that need to be solved.

Bob Fraser: That would be amazing. Any other happy sectors in real estate before we 

John Chang: I think there’s a bounce back in Sears housing that’s out there on the horizon. I think. Hotels are doing very well, actually some of the best numbers on record in terms of the revenue per unit basis I think really the office sector is getting punished.

Opportunities in Office Real Estate

John Chang: There may be some good opportunities there. Honestly, if you know how to operate an office , especially smaller suburban office buildings, I think there’s an opportunity. They may. Them. Eat. I have some notes here but basically if you break down the office it’s the 80 it’s the 80s construction, urban core office buildings that are over 250, 000 square feet that are getting killed, right?

It’s very specific. If you look at the vacancy rate of urban office buildings they were built in the eighties that are over 250, 000 square feet. The vacancy rate is 25%. Now, if you go to the other extreme, you go to a suburban office under 250, 000 square feet that was built in the last 13 13 years, since 2010 the vacancy rate is 11%.

So right now the whole sector is being kicked in the head. Everybody, nobody wants to buy up. Nobody wants to touch it, but there are segments that are performing very well. Las Vegas, Inland Empire, West Palm Beach, all markets that actually have office shortages right now and have some opportunity there.

So that’s the hidden gem that’s out there for those who have the skill and the guts to take it on. It’s interesting. That was probably right for those, so exactly, you can get maybe, maybe you’re looking at a double digit cap rate. Why? Yeah. Property that’s performing pretty well.

Yeah. Yeah. I was talking to an institutional investor that I know and they have to clear their balance sheet up and they had a building in San Francisco that they had on the books for 120 million. They sold it for 45 million and they were happy to be done with it. And they just said, we don’t see any way for us to make money on that deal because our basis is too high.

We’re just going to clear it, we’re going to recapitalize, we take that money back, we’re going to go put it somewhere else and make money on that, we call that one a loss. 

Ben Fraser: Ouch. Yeah. 

Outlook for Multifamily Real Estate

Ben Fraser: John, I wanted to ask just one other kind of more nuanced question on, class and like you said, age of property and office really matters, but also other asset classes like multifamily is where I’m thinking, A, B, and C, you mentioned there’s a lot of demand on the sidelines, but what we’ve heard and you probably have more aligned to this than we do, Is that most of that demand is for newer vintages, right?

But what we’ve also seen is that a lot of the older vintage properties, the seventies and eighties and the class C that was purchased predominantly over the past several years with bridge debt, right? Because they could get really high leverage. Yeah, there’s going to be less demand for them.

So do you see, one, do you agree with that? And two, do you see a kind of outperformance, as we come through the recovery here over the next couple of years? Between the age of properties and the class of properties, I’m thinking again, mostly multifamily. 

John Chang: So I think of multifamily class cuts as a cannibalization story, right?

So your class A property can take a tenant from a class B property. All you have to do is offer some concessions, reduce your rates, and you can steal that tenant away. And the class B property can steal the class C tenant. So right now we’re building out all this class A and we see concessions rising because all of these new buildings have to fill up and get up to the proper census so that they can then sell those properties off if they’re a merchant builder or hold them.

But basically they got to fill these things up. So they drop rents, they offer concessions and they suck the tenants out of the B buildings and then the B buildings say, Oh man, we just got hit. We got to go fill those units. They do the same thing and they go pull somebody out of a class C building.

Class C building looks around and goes there’s nobody I can steal from. So they, so your vacancy rates on your class C’s come up a little bit as these other units fill up. As we get out of this wave of development, as we go into 2025, 26, 27, I think we see this come and normalize again.

So I think we’re really just dealing with this wave of development and the disruption it’s causing in the marketplace. Ultimately the demand for housing when you break it up, different tiers of multifamily properties are going to cater to different audiences and different tenants.

And the tenants always want to move up if they can, and until they get priced out of that market. So you give a one month free or two months free on a 12 month lease, that lease goes for 12 months. That person can’t afford it anymore. They move back down into that, from that A to the B or the B to the C and so on.

It resolves itself. 

Ben Fraser: Yeah, that makes sense. Okay. Last question. 

Predictions for Economic Growth and Recession

Ben Fraser: Biggest one for last. Last time we talked, recession fears, now everyone’s saying soft landing. We’ve avoided it. We still have a slight inversion. 

Bob Fraser: I said, by the way, 18 months ago, so I, so I’ll give you that. You will be up on retail, but I’ve been saying, yeah, with this kind of consumer behavior, we’re not going to see a recession. Yeah. And yeah, what was the question, man? 

Ben Fraser: So we still have a slightly inverted yield curve, right? And that generally has been a strong indicator of a recession, usually 18, 24 months down the road.

Do you think we’ve just delayed it because of the initial stimulus that’s still in the consumer’s pockets and it’s going to hit at some point? Or are we able to manage through and muddle through the next? 18, 24 months and make it out without a recession, at least a very severe one.

John Chang: Okay. Yes Bob’s right. 18 months ago, you were saying, nah, it’s not going to happen. But my statement was, I would prepare for that just to be safe. But the thing is. I’m always nervous when it comes out into these things, because all the economists are going one way and like I said earlier, it could go the other direction but if you look at the underlying drivers GDP, the third quarter GDP of this year just actually a revision came out today 2% growth for the third quarter annualized basis, which is a huge number.

It’s just like off the charts. Cool. The, based on just simple math 2023 has an economic growth of two point 4% maybe 2.5%. That’s a big number actually. That’s a, that’s for a whole year to have two points a half percent. GDP growth is actually a really strong year forecast for next year coming in at 1.2%, something like that.

1.4% maybe. And so when you look forward, yeah, everybody’s pretty much saying soft landing. Now, that could get disrupted, right? Think about all the things that could go wrong. And you have what’s going on in Ukraine, you have conflict in the Middle East, you have a dysfunctional Congress that doesn’t have a budget.

The budget kicked the can down the road until January, February. We have a lot of things that could go wrong. But assuming that we don’t have any of those things go haywire, we go in and we manage a soft landing for the first time ever. Nobody’s ever had a soft landing from a severe recession.

This has never happened, but Bob’s right. We have good consumption. We have huge savings, right? People talk about consumers’ credit being over a trillion dollars. But when you look at that as a percentage of income, right? So yes, it’s the biggest ever, but incomes are the biggest ever and GDP is at the biggest ever.

So debt as a %age of GDP is down. Debt as a percentage of income is down. Households actually have strong balance sheets. They’re financially in a better position than they were in 2019 or 18 or 17. So right now people are still looking pretty good. We’re adding 200, 000 jobs per month. The unemployment rate is 3.

9%. Now, the yield curve has been inverted since July of 22. Now, the theory is that and that’s the 2 year versus the 10 year. If you look at the 3 month versus the 10 year, it’s inverted since November last year. About a year now. Now the theory is, you will, that is a signal of an impending recession from when it goes inverted.

And within the next 18 months, you have a recession. We’re almost out of time, right? This thing’s been inverted for almost 18 months. The other measurement of a signal of a recession is a 50 basis point rise in the trailing three month average of unemployment. Where and so our average unemployment rate was about 3.

5%. We’re at 3. 9. We’re close to that. But the thing is that the unemployment rate is rising because labor force participation is climbing. And that is not the normal way unemployment goes up. It’s usually because of layoffs, people losing their jobs. But it’s actually because more and more people keep coming into the workforce.

If you look at the 25 to 54 year olds, right? As we were coming out of the pandemic, it was like, Oh, these young people, they’re not working. That’s why this is all going wrong. But the labor force participation rate of 25 to 54 year olds is basically hovering at or near its highest point.

Since 2008, right? So labor force participation among young adults and middle aged people is very high. It’s actually the baby boomers who are working less, and that’s because they don’t need to. So in reality, that signal from the unemployment rate because this directory income is still holding up that’s not a signal yet.

And it may not be unless we start to see some rise in the weekly unemployment filings, and those are still in the 200, 000 range which is actually low historically. So overall signs of a recession are very limited. Something could go wrong, right? Black swans happen. Nobody really saw a pandemic hitting the globe a few years ago, but something could always go wrong.

But right now, assuming none of those major things go sideways on us, soft landing is really viable. 

Ben Fraser: For first time ever, potentially. 

John Chang: Yeah. Watching the airplane, right? The guy trying to land the airplane, this one’s coming off and he’s I can do this. I can do this. We’ll see.

Ben Fraser: Yeah. 

Closing Remarks and Resources

Ben Fraser: John, this was so fun. It’s such a pleasure and treat to have you on the show again and definitely love, love your perspective. For anyone that is not currently subscribed to Marcus and Milla Chaps research and just the things that you and your team are always putting out, you need to, it’s so good.

You got to get on the list. Go sign up. It’s just marcusmillachap.com. John, and you can sign up for the research and they have different markets. They have national and all the fantastic classes. It’s just really good stuff. What’s the other way that folks can get into the swirl of what you guys are doing?

John Chang: Sure. If you go follow me on LinkedIn, I shoot a video every week with whatever is on top of mind for me. That’s another way John Chang on LinkedIn. I’m there. And I also want to mention our research, on our website, marcusmillichap.com, that in January, we start releasing our investment forecast books for the coming year.

Those cover 50 markets and rank them and say, here’s the best ones, here’s the weakest ones. It provides a national perspective and a write up on every market. Those can be downloaded or we print hard copies. You can request a hard copy. We do it for apartment, retail, office, industrial, self storage, hotels and we also do a special one for Canada.

Those will all be available starting in January. 

Ben Fraser: Awesome. Okay. You heard it. Go to marcusmillichap.com and sign up for those. And if I could get all 50 sent to me as a hard copy, that’d be great. I’d appreciate that. No problem. All right. Thanks so much, John. 

Bob Fraser: So good. So good to have you, John. You’re always a wealth of wisdom. Love it. 

John Chang: Oh, good times, guys.


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