So today we're going to talk about which real estate domino will fall first.
As you can see from the slides here, I broke real estate into three categories.
And a lot of times when you're watching the news
or you're talking to people, they love real estate into one big category.
But you and I both know that real estate can be broke in multiple categories.
We're going to start with land, commercial and single family.
So the majority of the news is centered around single family.
And of course, we hear about the interest rates and the prices.
Prices dropping, prices rising, all of those kinds of things.
What's important to know here that all three of these are very connected
in many, many ways, primarily through debt and equity.
As many people invest in all three categories.
And each category has an independent behavior on its own.
When you're watching something on the news or reading something,
it's typically primarily around single family real estate.
And I just want you to understand that that's a very, very small percentage
when you look at real estate as a whole.
So as you can see, as you're looking at land, commercial and single family,
you need to consider the markets that they're in, the type of real estate,
the demand, the supply of each individual market,
interest rates, migration patterns, which we're going to talk a lot about,
work from home, government policy, the cost of living, weather and crime.
Now, of course there are more, but these are very big ones.
That can be the difference on whether somebody moves somewhere
or moves away from something.
These items right here can be the difference on whether somebody
buys land, moves into a commercial building or out of one
or even buys a single family home in a particular area.
And as all of these items are tracking very differently,
each one of these categories also react very differently.
So for today's video, we're going to focus on commercial,
because I believe that this is the first domino that's going to fall.
Specifically commercial office. Stick around.
We're going to get into more detail about that soon.
As you can see, as you dig a little deeper on the commercial side,
there's office, industrial, retail, medical, multifamily, self-storage, mall.
And there's even more than that.
Actually, what's important to understand under the commercial umbrella
is that all of these types of assets react differently based on
every single one of these categories all the way to the right of the slide.
So now that we've got that out of the way, I want to talk about heard mentality.
So a lot of you know that I went through the 2006 seven
and eight debacle, which was one of the largest
real estate crashes in the history of the United States.
There are a lot of lessons that you can learn when things are crashing
and you don't learn a lot of lessons when things are rising.
So the definition of the herd mentality is one you're influenced by the majority
when you conform with others in a group as opposed to thinking individually.
So as we go into these very uncertain times with high inflation
and high interest rates and all kinds of other things
that are very big red flags, I want you to consider what you're doing
and how you're investing and be an individual
as opposed to be conforming with a group or a herd mentality.
So on this first slide
of a herd mentality, you can see the different guys are cycles in red.
Now, those are traditional bell curves.
We've all seen those, as you probably should know, is that real
estate does have highs and does have lows, just like pretty much everything.
The green words represents people's emotions
of how they're feeling at different points in the real estate cycle.
As you guys know, I did a video on Procession
of exactly how I thought things were going to roll out at that point.
At this point in March of 2020 was when they officially declared the pandemic,
they officially declared a recession
and inflation was sitting at 1.23%.
The federal funds rate was zero and the price
of a single family home $374,000.
That meant in March of 2020, you could buy a $374,000 home
with a very low interest rate and move into it very affordably, though
less forward one year to March of 2021, where now
the average inflation for that year is 7%.
As a result of all the stimulus money that was given to the people
and of course to the PPE loans for the businesses themselves,
It's important to note here is that the federal funds rate was still zero
and the single family homes had gone up from 370 for the 14 on the average.
Now, let's go one more year to March of 2022.
Just one year later, all that stimulus money has now made it into the economy.
People savings rates were high and they were consuming and spending
lots of money which continue to drive inflation up.
At one point in 2022, we peaked with inflation at 9.1.
As you can see from the average, it's settled out around 6.5%.
So as you can see, in just a period of two years, homes
went up about $150,000 on the average.
And the federal funds now started to go to work by raising the federal funds rate.
So now let's look at March of 2023.
As you can see, this is our third year and the Fed is now started
to really react.
They increased the federal funds rate another eight times from 2.5 up to over
5%. Which creates all kinds of chaos in the real estate industry.
So when interest rates go up, the entire commercial market changes as well.
The difference is most of the commercial buildings are being acquired
by professional money.
So for today, I'm
going to focus on what I consider to be the first dollar or a fall.
If you take a look
what has happened to the office market, specifically from the work from home.
And you understand also that most of these leases
are three, five, seven or even ten year leases.
As those leases start to renew
their downsizing or just eliminating their offices altogether.
So office buildings will be the first domino to fall
because many of those people do not want to come back to work.
The vacancies in those buildings are much, much higher
and the landlords are barely able to service both the expenses and the debt.
So as we always talk about on the Ken macro right channel,
you got income expense, debt and cash flow.
When income is down, it barely covers the expenses and barely covers
the cash flow, if at all.
And therefore, these office buildings are going to have severe cash flow needs.
The second thing are the interest rates, which we've been talking a lot about.
So imagine if you bought this office building three years ago or four years ago
and it was full a tenant.
And today a lot of those same tenants, employees now
want to work from home and your loan is coming due.
And this is the biggest issue because three years ago
you probably have a loan of somewhere around, let's say, 3%.
But today that same loan on that same building
with those same tenants are closer to 6%.
The office buildings, occupancy and income continuing to decline.
Also, their expenses are rising as well.
Property taxes are up. Insurance is up.
Utilities are up.
All those kinds of things are up.
So that's a recipe for a lower net operating income
or lower and a why, as we talk a lot about in our videos.
So now these office buildings are facing a double whammy.
One, they have a lower net operating income from lower income and higher
expenses.
And two, they have higher interest rates on the existing loans
or if they're trying to refinance something, let's say their loans do,
they're not going to be able to refinance it because the actual
property that they bought is actually worth less than the loan.
So in a lot of office building areas, we're going to have what's called
a debt crisis, just like the United States is in a debt crisis.
And just like the normal America in many cases is also in a debt crisis.
So here's a couple of things to consider.
The vacancy rates in a lot of these office buildings, specifically in Manhattan,
Silicon Valley and Atlanta are hovering around 20%.
I've heard in San Francisco, it's even higher.
What's important to understand is that this is a record high.
Never have we seen these kind of vacancy rates before in commercial office.
The next piece should be alarming to you.
Developers might default on a big chunk of the $3.1
trillion in commercial real estate loans that Goldman Sachs says are outstanding.
Almost a quarter of that number needs to refinance in 2023.
So as you can see, the commercial real estate faces a brutal combo
of higher rates, tighter lending and looming debt.
And the fallout could be disastrous.
And what's important to understand here is somebody holds this paper.
There's debt and there's equity on buildings
like this throughout every city in the United States.
There's both debt and there's equity.
So how does this affect you?
Because a lot of this paper
and a lot of this debt is held in a lot of these regional banks,
this commercial debt and this commercial equity is a big deal,
but only because they have to actually
refinance in 2023 or 2024.
Otherwise it's just a normal property
with the equity going up and down based on the interest rates at the time.
The reason I'm doing this video, because these banks are actually
pulling back on their underwriting.
They're pulling back on the loans that they're going to do
because they already know this stuff.
So this is going to be the first domino to fall.
And what's going to happen
is this commercial paper is going to hit your local, regional and big banks
and they're going to pull back on their underwriting
and their loans that they're going to be giving you for more consumption
and whatever it is that you're going to do
further slowing the economy even more than it already is
and potentially tipping us all into
now what could be finally called a recession.