Today, we're going to talk about three things that are going to affect
real estate.
And I'm going to make a prediction over the next 12 months.
So the three things are interest rates, the unemployment rate and inflation.
And to the right, you can see what I call the doom loop, which are the seven
waves of a financial crisis, which is really now a debt crisis.
So as you take a look at the doom loop, I want you to take a look
at where we are today.
More financial institutions look weak.
Economic asset price or growth slows.
People are running from weak institutions right
now, financial institutions unloading assets for sale.
This happening on office.
Asset prices continue to decline further As interest rates
go up, banks lend less and people spend less.
That's all happening right now, as you guys know.
And economic growth is slowing.
This one here, however, is actually growing by a little over 1%
as recorded by GDP.
So as we go through this presentation, I want you to focus on
each of these seven categories because each one is in a different anyway.
So first, let's start with interest rates.
And as you can see on the left side here, right now,
the federal funds rate is sitting at 5.08%.
We've had ten rate increases.
And then the last Federal Open Market Committee meeting,
they went neutral or they paused rates, but they're
now predicting to raise rates at least two more times.
As you can see on the right side, which is the Fed's new dot plot.
Each one of these yellow dots in this right graph here are one of the 18
participants in the Fed's Open Market Committee, and each one has predicted
where they think interest rates will be at the end of 2023, six months from now.
As you can see from the lower right hand part of the graph that at least half of
the Federal Open Market Committee believes that rates are going to be 5.6 to 5
at the end of this year or almost a half a point higher than they are now.
Two are at 5.8 and one as at 6.1.
So that means that the overwhelming majority of the Federal Open Market
Committee believes that rates
are going to be at least a half point or higher at the end of this year.
This and this alone is going to continue to make it harder to buy real estate
because the cost of data is higher, driving prices
further, further down over the course of this year.
The second thing I want you to look at on this chart is at the end of 2024
or almost 18 months from now, you can see from the Red Star that the majority
of the committee believes that rates will actually go down in 2024.
However, they're not going to go down any
more than they are currently at today.
And that is the point.
Maybe they go up through the end of the year
and maybe they go down through 2024.
But regardless,
the rates are not going to be any better than they are at this point right now.
So when people are talking about rate cuts, what they're really talking about
are rate cuts after they're increased over the next six months,
just bringing them back to where they currently are at the current moment.
Of course, this is all predictions, but the Fed themselves
have indicated that this is what they're going to do.
The second big topic is unemployment.
So most of us would obviously think
that a low unemployment rate would be good, but not the Fed.
The Fed actually has said publicly, as you can see in the lower right
hand corner here, that they're trying to grow the unemployment rate to 5%.
So let's just take a look at what that would actually do to real estate.
Currently, the unemployment rate is about 3.7%.
So let's take a look at the math.
Currently today there there's about 162 million people in the workforce.
If you take 1.3% of that,
that actually equals about 2 million people.
So we would have 6.1 million people, plus
2 million people or closer to 8 million people.
That would be unemployed in a year and a half.
That would be disastrous for a lot of reasons.
But yet that's exactly what the Fed is trying to do,
because counterintuitive to what you might believe,
low unemployment levels actually create higher wages.
And higher wages, of course, are inflationary,
which is exactly what the Fed is trying to solve.
This is one of the bigger issues that the Fed's going to be dealing with
in the next 18 months.
They're going to be growing the number of unemployed people in the United States,
which is going to create more social service issues,
going to create more renters and less buyers of real estate.
So if you're an employee,
this is obviously not good because they're now
going to be more people competing for jobs.
If you're an employer, the ties are changing to where you're now
going to be able
to compete with more and more workers because there's going to be more
on the market.
Now, let's take a look at the real big problem with unemployment.
What is labor force participation as too is the great resignation.
So as of April of 2023, there were 3.8
million people that decided to quit their jobs for good.
What this does is
it takes more people out of the workforce, which drives wages higher.
At the same token, there's almost 2 million less people in the labor
force participation, which means that more people are sitting at home.
There could be working, but they're actually not.
As of last month, we had job openings of over 10 million
with over 6 million people actually unemployed.
That, of course, could potentially go to eight,
which is exactly what we talked about in the prior slide.
This would be good for employers, bad for employees.
Now, let's take a look at inflation.
And this is exactly why I believe the Fed is going to continue to raise rates
through this year.
You'll see the break down from the May 2023 chart.
And at the top, you can see some of the highest
inflationary items at the bottom, some of the lowest.
Right in the middle is red of the primary residence, which is sitting around 8.7%.
What this means is that rates are still growing year to year, month to month.
So when the Fed is taking a look at inflation and some of you might be saying
it's only 4%, they're looking here and saying, well,
housing or rest of the primary residence is almost 9%.
Housing is the biggest expense for the average consumer.
We all know this shelter costs were the largest contributor to core CPI in May.
So not only is it 8.7, it's also the largest component of most people.
In fact, they even say here, economists
expect housing prices to start falling in the second half of the year.
Time will tell.
But one thing is for sure, the Fed is going to continue to raise rates
to tamper down these higher housing costs that people are dealing with.
They don't care if we're real estate investors or not.
They're looking at the economy as a whole.
So as we take a look at the doom loop, we can see that
I start almost every single thing on there is happening right now.
Interest rates are up and will continue to go up.
Unemployment rate will continue to go up
because higher wages are inflationary, which is what the Fed is fighting.
And lastly, inflation is up, as you guys can see, and the biggest
piece of inflation is shelter, which is over 8%.
And the Fed is going to continue to combat that to help everyone.
So here are my predictions for the single family dropped equity
is going to stay put.
Refinances will continue to be down.
Sales for sure will be down because the higher rates, net migration
where people are going,
that will continue to drive pricing, but not interest rates.
Prices will continue to trend down.
The gap between the owned versus rent will continue to grow.
In other words, rental rates are going to continue to grow.
New construction will be down because of higher interest rates.
The cost to build will continue to go up because of inflation
and interest rates will continue to go up or stay the same.
As far as the banks are concerned, the debt service coverages are up.
Interest rates will continue to go up and their borrowing rate will go up.
Values will go down as interest rates go up.
So anything that they're holding right now could potentially be toxic.
The loan could actually be more than the value You should start to expect.
Loan defaults in every category led by office customers.
Savings rates will go higher.
As we all know, we're seeing four or 5% savings rates.
That's not good for the banks because they're actually lending at three
and paying and five.
We'll see tighter underwriting or in other words, loan values at 50%.
Refinance.
Refinance is down.
New construction is probably off the table.
And a lot of these customers
are going to move to bigger banks because of the potential exposure
on the commercial side,
which of course, is retail office malls, multifamily, industrial.
We're going to see higher interest rates,
cap rates are going to go up, which means values will go down.
And of course prices and sales will also down, Matzos will go up.
They already are.
And utilities, insurance and property taxes, etc..
The banks are worried and they're starting to tighten.
Their underwriting refinances are down.
The work from home is here
to stay shelling the office market and many of the retail categories
because buyers habits have definitely changed.
We're going to see very high office building vacancies, regional mall
vacancies and net migration
is going to continue to drive pricing in these areas as well.
Rental rates will continue to grow for multifamily as people
fall out of single family because interest rates are going to make
these mortgages even higher, pushing more people into rental
and of course new construction, which is exactly what we need.
We need more supply to offset all this crazy.
This is going to be way down because the cost to build
and the interest rates are so high that developers are not going to take that risk
or are the banks.
Here are some things that Ross and I are doing right now at MCI.
We're reviewing our asset exposure, just like the banks do.
We're selling off any marginal assets.
So anything that's negative or no cash flow gone,
even if you have to write a check to get rid of,
that's your debt that will head your up.
And then you can always refinance down if rate to go down, build
your cash reserves.
These are going to become
very important not only for buying but also for what the banks want.
If you're going to get new assets, expect more stimulus money and more money
to basement because unemployment is going to drive more social service needs.
And we're going to see some bank fallout which could potentially be
funded by using stimulus money in all kinds of ways.
The main message is use inflation as your strategy for 2023 and 2024
because it doesn't look like it's going to go down any time soon.
Expect more loan defaults due to the commercial real estate exposure,
and this is going to be mostly in the smaller regional banks.
And this bank instability and failure is going to be part of the process.
And that's actually where you need to go pick up your toxic assets.
So be patient, Just wait a couple of years and you'll be in great shape
when you're able to snap these up, just like Ross and I did in oh eight,
nine and ten, and you'll be buying at 40 $0.50 on the dollar.
Beautiful new assets in great location.