The text below is a transcript of audio from Episode 32 of Onward, "Buying the Bottom."
Disclaimer: This transcript has been automatically generated and may not be 100% accurate. While we have worked to ensure the accuracy of the transcript, it is possible that errors or omissions may occur. This transcript is provided for informational purposes only and should not be relied upon as a substitute for the original audio content. Any discrepancies or errors in the transcript should be brought to our attention so that we can make corrections as necessary.
---
Cardiff Garcia:
Hello, and welcome to Onward the Fundrise podcast where you'll hear in-depth conversations about the big trends affecting the US and global economies. We are recording this on Wednesday, December 20th, 2023. And before we start today's show, we'd like to ask that you please keep rating and reviewing the show in those podcast apps. We really love hearing from all our listeners. We've heard from many listeners throughout the year, and we want to keep that going through the end of the year and into the new year. Also, evergreen reminder that this podcast is not investment advice. It is intended for informational and entertainment purposes only. And with that, let's get on with the final episode of the year. This is the happy holidays. Whether it's time to buy or time to sell, surely we can agree it's time to celebrate. I'm Cardiff Garcia, Bazaar Audio, and I'm joined, as always, by co-host Ben Miller, CEO of Fundrise. Ben, seasons greetings. How are you, man?
Ben Miller:
Great. You're looking good. Cardiff.
Cardiff Garcia:
For our podcast listeners who can't see us, I'm wearing my festive year end holiday glasses. And I'm going to take them off in a second, but I thought we'd kick things off and fun and celebratory mood. Ben, is that how you're feeling? When you look at the markets and you look at the economy, you look at the fact that at least till this point, we've avoided a recession, and on top of that, asset markets have rallied, how are you feeling, man? How are your animal spirits this December?
Ben Miller:
Tides have turned, Cardiff. Pretty exciting.
Cardiff Garcia:
In a positive direction.
Ben Miller:
Well, we hit bottom in real estate, in my opinion, and it's up from here.
Cardiff Garcia:
Hit bottom. That is, by the way, a huge call, and that is in fact the topic of this episode, one of the topics of this episode. So maybe that's a great place to start, Ben. What is it that gives you conviction that at least when it comes to real estate, it's time to buy?
Ben Miller:
The last six weeks have been such a reversal. Since November 2nd, wow, have we seen everything change? Fever's broken. The inflation, I think, is clearly on the way down. I don't think that's up for debate. And the big change, which you know better than anybody, is that the Fed also admits it.
Cardiff Garcia:
One of the big changes certainly has been that we're no longer talking about whether or not the Fed might have one more rate hike in them. Now, the conversation has definitively shifted to, well, when is the Fed eventually going to start cutting rates, because it seems like soon, they might have the space for it. And when I say soon, I don't mean at the next fed meeting or anything like that. I mean that it might be some time within the course of the next year. But that very shift in the conversation seems like a big deal. And certainly in the last couple of months, we've seen equities rally. We've seen a huge rally in 10 year treasuries. Yields have really sharply collapsed there, and it's been fascinating to watch. I'm wondering what it is about the stuff that's been happening in markets that has convinced you that in real estate in particular, now is a good idea to explore some buying opportunities and put to work some of that cash that you've been holding for precisely the moment when you would make this call.
Ben Miller:
We're waiting for this day, Cardiff.
Cardiff Garcia:
It's long wait too.
Ben Miller:
Yeah, it was a tough slog. The simplest way to think about it is that interest rates are the biggest driver of real estate, and basically they move inversely. So as rates go up, real estate prices go down. And now that rates have topped out and the fed's saying that they're not going to keep raising rates, which would've kept punishing real estate, they not only have said that they are not going to raise rates anymore, more or less, but also forecasting cuts. So the wind is now at our backs, and the question everybody's now debating is not whether or not we're going to have more punishment, but the size of the cuts, how fast, how big. And that's just how big a Christmas present. Is it what you wanted or is it just socks?
Cardiff Garcia:
Or is it a big flat screen television?
Ben Miller:
That's true. But the point is it's all to the good. That's why I basically think real estate is bottomed, and it's basically we can shift from defense to offense.
Cardiff Garcia:
And which parts of real estate do you think in particular represent good buying opportunities now? Are we talking residential? Are we talking commercial? Are we talking, I don't know, industrial? What is it that you think is appealing? Or is all of it appealing?
Ben Miller:
In a way, what happened is that everything in real estate was punished because interest rates are the background radiation field of all of finance. So some things were punished worse than others, but everything essentially has been marked down or discounted by high rates. So that's a question about where you think long-term growth is going to come back, and then where you think the pain is most acute. So I'm a bear on office. I think the pain is most acute on office, but the upside is not going to be there. So I'm basically not thinking office. But yes, almost everything else. We're focused usually on a few sectors, but I think to some extent, it's an everything rally.
Cardiff Garcia:
Do you want to discuss what some of the key dynamics are to watch when it comes to real estate prices and where, again, specifically inside of real estate, you might be looking for great deals for Fundrise to start deploying its money into.
Ben Miller:
Let me just stay at the high level for one minute, which is that it's a strange dynamic for me because I'm a fundamental investor. So real estate is now pricing at 20 to 50% discounts to where it was, and stocks are at an all time high. Stocks are close to the peak they hit in 2021. There's two possible explanations on that one we can come back to, one, that basically real estate will catch up to it, or two, the stocks basically are priced too high.
Cardiff Garcia:
Or some combination of the two.
Ben Miller:
But it makes it all the more attractive to me to be able to buy the discounts that exist in the private markets, where private markets are now deeply discounted, and public markets have essentially taken the fed's rally, pulled it forward rapidly.
Cardiff Garcia:
And in practical terms, what does that mean for you now? Now that you've made this call, does that mean that you're looking to build more communities of build for rent homes? Does it mean you're looking to invest in industrial fabs and things like that? What's lingering in the back of your head about how you actually put this into practice?
Ben Miller:
When I think about the opportunity, or I think about almost everything, I always think about it two ways. I think about it bottom up or top down, or inductive reasoning versus deductive reasoning. So we can talk about this either way. Let's do bottom up first, and then I come back to top down. I did top down a little bit talking about supply and demand. So on the bottom up example would be looking at a deal with details of a deal. So I have deals that we're buying under contract. I have deals that we're seeing in market, and I have deals we own. And I can tell you the story that more or less repeats for all of them. But basically what's happening is there's this dislocation, there's not enough money, because mostly demand in investments is dollars and assets. So you can either have price wrong because there's too much dollars or too little dollars, or not enough assets.
What's happening in real estate is that there's actually not enough dollars and there's too many assets. Because so many assets went under construction in 2021 and 2022, that multifamily in particular, there was just this massive spike in starts. So you have this double disequilibrium. You typically don't see supply and demand B in disequilibrium or fall far out of equilibrium for long. It happens during shocks, like the pandemic or interest rates. But it moves back equilibrium, and that's why it's time to buy. Because when it's out of equilibrium, you want to buy. And today, it is. And that's the top down answer. That's basically what you're seeing everywhere. Because when somebody is going to build an apartment building an industrial building, really anything, or they do something called value add, which basically is minor construction, replacing kitchens and cabinets, like a flip, but on a larger scale of a whole apartment building, is that you basically have to buy it by the land, by the building to then renovate it or ground up development.
And in order to do that, you need a loan that is designed for that activity. And that's a bridge loan or a construction loan. And it's a short-term loan, and that short-term loan typically has floating rate debt because of course you can't fix it because you don't have any fixed revenues. You're under this business plan to drive additional value. Basically, there was this massive bulge in supply of assets started in '21 that's basically starting to come to market today. And the scale of it's in the probably across everything in real estate, hundreds of billions. It's large. Multifamily alone is probably 200 billion approximately, if you take value add and construction. So it's a significant amount. And they're coming to market, there's too much supply, so they're competing with renters. And their loans that they got back when the times were hot basically need to be paid back, refinanced, and basically they can't because essentially the amount of lending and money available has diminished so much.
The essence of the theme of what's happening is there's this bridge to nowhere. They bridged from 2021 and the other side of the bridge. The bridge is not long enough or they're coming into a market that's really problematic, so there's just stress. And they're just stuck with a choice which is basically take money that's expensive, borrow money that's expensive or recap equity or sell. And both choices are very unattractive, but they can only delay so long. So 2023, they've been delaying. Everybody wants to kick the can, but it's inevitable they're going to have to take this pain and just question the size of the pain. And that basically is the opportunity.
Cardiff Garcia:
And what you just described there is the recent decline in longer term interest rates. Of course that will help a little bit, but it's not like interest rates have fallen down to where they were when the money was initially borrowed. And now that all these loans are coming due soon, what you're saying here is that there's going to be some reckoning in the market. And when that happens, there could be considerable pain in terms of the asset prices that you're talking about here. The real estate prices of all these multifamily properties that you're discussing, their prices are going to come down and there's going to be buying opportunities for somebody that does have the capital ready to go and doesn't need to refinance at these much higher rates, or rates that were much higher than when the money was initially borrowed.
Ben Miller:
Yes. Let me just get a little deeper into that. Part of the delay was the buyer and the seller weren't sure where interest rates would top out. So the buyer didn't want to buy if interest rates were to keep going up, and the seller didn't want to sell until they felt they had to, basically. So the real estate market bottoming or interest rates now flattening going down is a signal to all the participants of a yellow light. It's not a full green light, but it's definitely okay, proceed here, where before it was just a red light shut down. What you said is really right. Interest rates were at zero, they went up, the feds brought them to five and some change, but they're not going to go back to zero. Exactly where they go back to, we can debate, but it's probably two to three percent, two to three and a half percent. So it's still way higher.
And the essence of what happened if you think about valuing real estate or pricing real estate is that when interest rates doubled, instead of borrowing at 3%, you're borrowing at 6% approximately. When interest rates doubled, the real estate value, a market price fell in half. So it was that simple. Interest rates are so heavily correlated to price. When interest rates doubled, the real estate value fell in half. But the reason why public shares our real estate prices haven't fallen in half is that there was a lot of inflation or a lot of rent growth over that same period we saw, and everybody saw probably 20 to 30% rent growth, off the charts amount of inflation, and increase in net income. So what you're seeing is the net difference, which is across the real estate market between 20 and 30% down because the interest rates brought everything down in half, but NOIs went up upwards of inflation by 20, 30%.
So you're seeing this net difference and that's where prices are today, but nobody believes interest rates. They're going to stay where they are. Everybody believes they're going to go down, so this is when you want to be buying. And nobody wants to sell this moment. And if you can get ahold of assets, it's actually hard to get somebody willing to sell at the bottom typically. That's basically the essence of what's happening with real estate prices.
Cardiff Garcia:
It's fascinating too that point about how prices kept going up throughout that period because there was such high rent growth, but that period of super high rent growth is totally over. And at the same time, you have these loans coming due at higher rates than when the money was initially borrowed. So it is, in that sense, a double whammy for asset prices from this point forward.
Ben Miller:
Why is it a good buy though, is that if you think that the equilibrium will come back into its natural or previous normal, then you want to buy the disequilibrium. You want to buy the wacky supply demand mismatch. And today, you have basically not enough money and oversupply of certain assets. You have to talk about both. You talk about, do you think that interest rates and money supply will normalize? And then you have to look at supply of assets because you think that basically demand for housing or industrial will normalize as well. And we should talk about both, I think both will normalize. So you can buy an asset at a 2x disequilibrium at the moment, which doesn't come around very often. I haven't seen this since 2008,
Cardiff Garcia:
Especially if you've also been holding on to a lot of cash, so you have readily available capital to put into play, and presumably then you'll get these assets at a discounted price, and you can also put into place the patience to wait for things to normalize and for asset growth in this market to return to what you would normally expect based on, I don't know, a longer term trend or your understanding of the fundamental economic environment.
Ben Miller:
If you are a relatively long-term investor, you're not talking about that long, probably three to five years, maybe sooner before things normalize. I can imagine that we'll be there by the end of '25, but certainly it feels reasonable to believe by end of 26. So it's not that long of a hold. The problem is a lot of people, a lot of borrowers, real estate borrowers, they definitely can't hold until 2026. So just to parse that for a second, we keep talking about supply of money and supply of real estate, or one person's supplies, another person's demand, whichever you want. This is where your expertise is better than mine. But the fed's saying they're going to cut interest rates three times next year, and the market's saying the fed's going to cut interest rates five times next year, and then three more times in 2025. So you're talking about eight cuts, which is about 30%, 35% cuts in interest rates.
To me, it's almost that debate between the two, to some extent, it misses the point because directionally, it's basically positive for real estate, and it's a question of how long it takes to get there an extra year or so. If you're a real estate investor or long-term investor, an extra year or so, it shouldn't matter. I'm interested in your view. I'm taking a fairly strong call here that I think interest rates have peaked, and that basically we see mostly progress from here. Where are you on that?
Cardiff Garcia:
That is my suspicion, and it's for the following reason. I think there will be more progress on bringing down inflation. I don't think that's over yet. And if you look at it now, inflation, depending on which measure you use, is still running at about three to 4%, which is above the fed's target. But quite a few things have happened recently. We have goods now in active deflation. In services, you still have somewhat above average or above target inflation. That's still there, but goods are actively in deflation. A bunch of other things have also happened. There's been disinflation all throughout the world, which does tend to feed into the US a little bit as well. The US growth story is very powerful right now, and that means that the dollar is likely to remain pretty strong. That also further dampens inflation.
And to me, one of the big underappreciated stories of the year is that it seems OPEC has lost control of oil prices, that the combination of incredibly impressive US production of oil, and the fact that OPEC just can't quite enforce its own quotas, its own restrictions on output means that oil prices are going to stay low after their recent decline, or at the very least, at any future growth, will be somewhat restrained, and for all I know, might even fall further. So if you look at commodities prices falling, goods prices falling, progress throughout the rest of the world, the dollar likely to be strong, and the fact that, let's be honest, the fed is still keeping a close eye on inflation, everybody knows that they don't want to call mission accomplished too soon, and even that message I think contributes to further progress on inflation.
But what does that mean? It means that there's more scope for interest rates to keep falling. So to get back to your original question, yes, I think there will be further progress. I hesitate to predict exactly how fast that'll happen, but I don't think we're in a world where a year from now, we'll see inflation actually being higher than it is now. And if you look at your own call, Ben, on what might happen in the economy next year, where there might be a significant slowdown in growth, or even a mild recession for all we know, that also tends to bring down inflation and further contributes to the likelihood that interest rates are going to fall.
So the fact that inflation is going to come down seems to me most consistent with various different outcomes in the world. So that's probably my strongest conviction call for the next year or two, is that we'll see further progress on inflation. And therefore, yeah, I think there's a lot of scope for interest rates to keep coming down and whatever's happening in the rest of the economy. You yourself have said, lower interest rates tends to be pretty good for asset prices, and in particular, for real estate. So that's my macro forecast and always be careful with forecast. I'm very, very alert to being wrong, and I will change my mind in a heartbeat. If new evidence comes out, new information comes to light, economic indicators contradict me, I'm happy to change my mind. But as of right this second, December 20th, 2023, yeah, I think interest rates are going to keep falling.
Ben Miller:
I obviously agree with you, and I think the risk is that they fall faster than people think, which is what the market also seems to think. Because even though the Fed is not going to raise rates anymore, it's still fairly tight monetary policy. The interest rates are still a lot higher than they were, and quantitative tightening. They're still printing a trillion dollars a year. So all of that's likely to keep driving down inflation. It's a bottom in that sense. And then directionally, we're going up. And then it's just a question of the path actually rather than the direction. And one of my big learnings from 2008, I learned this the hard way, is that the macro is so much more important than the micro. I'll back that up in a second. So there's two macros here. There's a super macro, which about interest rates and money, which we're saying is directionally positive, at least from this perspective. And then the more regional, [inaudible 00:20:25] sector micro is that there's a oversupply of multifamily and maybe industrial.
But if you look out past that, so the supply hits now through 2025, but what has also happened is that starts of new construction has plummeted, and there's basically no construction lending happening for multifamily or industrial or anything that I see. Banks are really conservative in their lending, pulled back. Cost of construction lending's very high, so you're seeing basically the supply of multifamily and assets get choked off. So by 2026 or 2027, or maybe even late 2025, you're going to see I think a flip in supplies again where you're going to see not enough housing or not enough industrial in the growth markets. Because essentially people stop building all of '23 and most of '24, probably most of '25. The supply and demand, I think, is going to flip for the asset side and flip for the money side. I think both are basically directionally headed in a positive way with a period, a window of disruption and during window of disruption you want to run into it. That's the opportunity.
Cardiff Garcia:
It's fascinating because it was just a few months ago that you and I were doing an episode where we looked at that Wall Street Journal article that essentially concluded there is no money in commercial real estate. There's no money left for any of this stuff. Maybe that stuff will loosen up eventually, but the fact that it has been choked off for a significant period of time means that some of these fundamentals will shift on these long cycles. And we're seeing that now, and we're likely to continue seeing that into the future. And then on the demand side, I think it's important to remember that in the last few years we've seen this really massive cohort of people in their prime home buying and household formation ages. That late 20s through early forties ages, those age cohorts have been absolutely massive.
They've been hitting the market, and that also contributes to what might eventually emerge as a massive supply demand imbalance, and one that already is contributing to something like that imbalance. Except that to this point, as you noted, there have been a lot of completions, but now there aren't that many starts. So eventually, that will feed back into the market. And I think that's just fascinating, how these cycles operate on a lag
Ben Miller:
In some ways, the big story is there was a pandemic in 2020 and we dropped a meteorite into the ocean, and then everything we're talking about are the ripple effects from it. Because there was this huge effect in 2020. And this oversupply in 2021, it was a consequence of 2020. And now we're finally working our way through the shock waves or the disequilibria of all of the downstream consequences of the pandemic and the response to the pandemic and the response to the response to the pandemic. And each time basically, you wish you'd bought at the bottom of 2020. You wish you'd sold at the top of 2021. I believe you want to buy the bottom again, and you go back and forth. High positive economic dynamics in this country for the boom that comes after this. Because of AI, there's something like $16 trillion of wealth locked up in housing at the moment that I think would get unlocked if interest rates came down.
There's just so many positive dynamics in the country that we're going to see come roaring back, in my opinion. I think back after 2025, Goldman Sachs thinks 2024. So yeah, that's why I keep arguing that I think it's time to buy. You got to buy before you can't buy when it's obvious.
Cardiff Garcia:
Well, at that point, everybody's buying. And if everybody's buying, it's too late. You've already got the price appreciation, and you're just following the herd at that point. Like you said, it's helpful to buy before everybody starts jumping in and making that call early. One of the things that I know you like to do, Ben, is to go out into the market and get your own intel. Sometimes you're able to share some examples of the things that people are telling you. And I don't know how much you can reveal about your recent conversations, but I know I'm curious, and I'm sure our listeners are curious to know what you've been hearing directly from a lot of these market participants.
Ben Miller:
Actually, I love that. I love getting to the bleeding edge of transparency. So I want to walk through some examples of deals we're buying, deals in market, and deals we own. We have a couple deals, I think, are just illustrative of the opportunity. We have an industrial deal under contract in Charleston, South Carolina. Charleston's a great market, growth market. We're buying it at around a six cap, which to put that in a comparison, ProLogis, which is the best and biggest industrial company in the world, they're trading at about a 3.6 cap. So to put that in simpler terms, on a levered basis, we're buying that asset at 100% higher return. That's a huge difference in pricing between the public markets and private markets. Private markets are now pricing a massive discount in public markets.
Cardiff Garcia:
Let me see if I can even clarify that further. For listeners who don't know a lot about cap rates and the real estate markets specifically. This is if you have two different bonds that are roughly backed by the same thing, by the same institution or company or whatever, but one is yielding 3%, the one you just bought is yielding 6%. And that's just way better. It's way higher. It's twice as high. That's excellent. So that's essentially the argument you're making right now.
Ben Miller:
That's the deal we have under contract. So that's the opportunity in market because it was new construction. So basically it's coming to market, so it has to sell. Same thing. We have built for rent communities. We build... Or there's a whole industry of people build housing and communities that they rent, and this is an example of one we have under control at $230,000 a house, and Zestimate literally for those exact same houses say they're worth 300,000. So that's a 30% pricing difference. And then deals in market, the same thing over and over again. We track a lot of the deals. There's a build rent community in Arizona that we actually offered on in December, 2021 and they ended up selling someone else. I can give you numbers. We offered two $50 million. They sold to someone else for $300 million. It's now on the market for 187 million.
Same thing with apartments. Apartments in North Carolina, 250 units, pricing guidance was 63 in 2021. Somebody bought it for 66. They're having "loan issues," according to their brokers, and it probably sells for 50, 55 million. So there's just discounts, the same pattern of repeating over and over. And then actually, I'm going to do something that hopefully compliance team lets me put on the air. I'm going to talk about some assets in the portfolio, our portfolio that we own because I think it's, again, the bleeding edge of transparency here. So two assets, very similar story, but it's just helpful to see it twice I think. One is an apartment building we bought in Jacksonville, Florida. It's three one units basically. I don't know. Who knows? Jacksonville with new constructions, it was built in 2020, and we tied it up at the end of 2020 and winter 2020. It basically sits between Jacksonville and the Ponte Vedra Beach, if you know the beach, my favorite part of Jacksonville.
So it sits right halfway in between three miles from the beach on Beach Boulevard, and we tied that deal up. Winter 2020 was not a good time to be a seller. So we tied that deal up, I think, at the bottom, and we did the exact same thing with another project in Orlando. Poor Orlando, 300 units, new construction tied it up fall, winter 2020. So these basically bought at the bottom. Both of those things saw massive rent growth, massive inflation. The deal in Jacksonville, rents went up 18, 20% market rents, and the one in Orlando went up 28%. So rents going up 20 to 30%, occupancies, 90s. The net income on these properties were up 160, 190% because we bought them basically vacant. We bought them in lease up because people in the middle of the pandemic of 2020. It was hard to get people to move in, and sellers were really worried that they couldn't get these things leased up because the pandemic made it hard for people to move.
So there's a lot of distress when we're buying these assets, and there's a lot of growth since then. Okay? So let me just give you the pricing of the valuations and appraisals of these assets. So the one in Jacksonville we bought at 66 million, it was appraised at peak at 85 million, and now it's back down to 65 million. So it's at our valuation inside our funds. It's actually lower than it was in the bottom of the pandemic. At the same time, rents are up 20%.
Cardiff Garcia:
So in other words, you've got this asset now being valued at actually slightly down from where you bought it a few years ago, even though the fundamentals for that very same asset look way better than they did when you got it, and they look better going forward than they even have in the last few years is what you're saying.
Ben Miller:
It's only because when you appraise something or you value something, you're valuing it based on interest rates. And interest rates have doubled, so it basically pushes down the value. Same thing with this other deal in Orlando. We bought it for 83 million. It appraised in June, 2022 for 115 million, is back down close to where we bought it. So in both instances, I did this math. Peak to trough, so from the peak evaluation to where it is today, they're down 41 to 49%. And from trough to trough from trough, basically bottom of the pandemic to now, they're both down 18 to 19%. So basically look at those things and be like, "Okay, I can buy a pandemic level asset pricing minus 20%." That's how we've had to value them inside our fund. If you buy our fund, that's actually the price you get for these assets, and that's where things appraised. So to me that's just disequilibria price. I don't think that's the long-term price. And I think it's super compelling to me. That's why I'm a buyer.
Cardiff Garcia:
Yeah, it's really interesting. And it sounds essentially what you're also saying to Fundrise investors is you're counseling for patients here. You're essentially saying, "Look, the value of the fund reflects what some of these assets have to be valued at, but we think actually that these assets are worth a lot more if you look at the fundamentals and the likelihood of what they're going to do in the future." Is that roughly accurate?
Ben Miller:
That's my opinion. It's interesting, each investor will end up with a different conclusion. Some investors actually will redeem, and it's okay. So you're a seller at that price, every investor doesn't redeem basically is buying them out. It's like the public markets where when people start seeing public markets go down, they sell, and then when public markets go up, they buy. Most people were really active trading on Robinhood in 2021 and they were buying NFTs. It's just-
Cardiff Garcia:
A lot of nonsense.
Ben Miller:
Well, the psychology of it.
Cardiff Garcia:
A lot of chaos and nonsense going on back then. I'll say you don't have to. It's fine. You don't want to get in trouble. I get it. I'll say it. There's a lot of stupid decisions back in 2021 when we saw a lot of very strange things happening in the markets. There still are some of those strange things happening, but things have, I think, normalized a little bit in the last couple of years.
Ben Miller:
Definitely. I think it's the opposite. I think that there's a lot more pessimism. There has been. I think a lot of people were on the sidelines this year and the stock market rallied like crazy. We can talk about what I think about the recession risks, but just one question I've gotten about basically the risks of a time to buy is, okay, if there's a recession, what happens? Because usually, recession is actually bad for prices. But the point that's counterintuitive is that if there's a recession, that's likely to mean interest rates actually come down more because the Fed basically is going to be worried about unemployment, and so they basically start lowering rates. And lowering rates actually drives up the price of real estate. And I have some data here. 2008 was a very bad financial crisis, way worse than I think we're going to see in 2024. Multifamily rents were down 4% in that downturn, and stocks were down 53%.
Cardiff Garcia:
The stock market absolutely collapsed. The S&P 500 was down in the 600s somewhere. For context, it's now at 4,700 or something like that. It was an absolutely miserable time in the public markets. And I agree with you. I don't know what's going to happen in 2024, but if there is a recession, I don't think it's going to resemble that. I don't think we see the risks that would lead to such an enormous collapse. But also, this is one of those clips that maybe will come back to bite me later on because we know that that sort of thing has happened, but I just don't see the same risks now that existed back then.
Ben Miller:
No, I'm optimistic about it. I think that if there's a recession, which I think there will be, it'll help turn the leaf over, and we can move to the next phase. Since I always come back to this recession, I was thinking about Cato the Elder. Every time he spoke on the floor of the Roman senate forum, he would always end his speech with, "Carthage must be destroyed." So I have to talk about the recession I think is likely to happen in 2024 because I have some juicy intel for you.
Cardiff Garcia:
Okay, please. Carthage [foreign language 00:34:03]
Ben Miller:
Oh yes.
Cardiff Garcia:
Four years of Latin in high school, man, that's what it gets you. That's what it leaves you with, is what that juicy intel.
Ben Miller:
When you're in market and you see certain things, you're like, wow, this is exactly why there's been no recession yet. There's all this delaying action happening on the ground that's invisible. So I'll give you a few examples that I have. They're confidential. Just kidding.
Cardiff Garcia:
Don't worry. Nobody listens to this podcast. This is just me and you having a nice chat.
Ben Miller:
I'll be circumspect about who the companies are. So there's a construction company that has a piece of land that you can build industrial on. The construction company is close to the top 10 largest in the country. So they have more than 1,500 employees, 5 billion in revenues. It's a big company. They're offering to contribute the land into a partnership to build on this land. They offer to contribute the land for free and build the building for no construction fees, as long as basically you hire them so they can keep their team employed.
Cardiff Garcia:
Are they making money on this?
Ben Miller:
No, they are just not having to lay off their team. So it's about staying alive, staying in motion, and they're basically willing to work for zero as long as basically they can get to the other side of this high interest rate environment that's killed construction. They don't have enough work. They want to be their whole and intact the other side of this. And the way to do that is keep everybody basically building something, so they're willing to basically build for nothing.
Cardiff Garcia:
So that reflects underlying longer term optimism then.
Ben Miller:
But it also... People talk about unemployment, "Oh, it hasn't been that bad." And I'm like, well, there's a lot of things happening behind the scenes to prevent it from getting a lot worse. So that's an example. I have more, but that's examples that just start well, it must be bad if a big construction company is willing basically to contribute land and contribute the team for cost.
Cardiff Garcia:
That's a fascinating anecdote. I will say, just by way of issuing a few caveats here, this is something that I think economists sometimes refer to as labor hoarding, which is the idea that all these companies have just gone through this period where it's been really hard to retain their workers, it's been hard to hire new workers because the labor market's been so tight. So now, even when there's a downturn in activity, they're afraid of at some point in the future, facing that same scenario where it's hard to rehire people. So instead, what they're doing is they're not laying people off now. They're basically eating the costs of keeping their workforces high through a downturn. Because when the upturn inevitably results, they'll at least be at full force. There is quite a bit of controversy about just to what extent this is something that's happening. And I think there are some good reasons to be a little bit skeptical that it's big enough for it to really influence those unemployment numbers, but I could be wrong about that. And finally, I would just say that this is something...
In this anecdote, you're describing something that's happening in the construction sector specifically. It could be a sector specific story as well. So didn't want to move on until I threw all that out there. That being said, if this is something that's representative of either the whole construction industry or maybe something else happening in the economy, then that's significant. But either way, it's a fascinating story, and it's the kind that we should all be attuned to, I think.
Ben Miller:
Let me tell another one, mortgage originators. So if you run a company that originates mortgages, as you might imagine, there's a lot less mortgages originated. It's down 65% actually. So we went to start selling some of our homes, because told you we can sell homes to retail buyers at a premium to institutions, we should sell retail and buy institutional to make the arbitrage. So we went to a bunch of originators, said, "Okay, we want to sell a thousand homes." And they basically said, "We're so desperate for origination work, we will give every home buyer who buys your home 1.5% at closing. So they will bring money to the table if we hire them as the mortgage broker."
Cardiff Garcia:
Well, that's quite a story.
Ben Miller:
This is a big company, and I think we're going to do that. There's another one. This one you probably know something about, but I got under the hood because we're going to sell 1000 homes. And one of the things we were struck by is we see that a lot of the home builders have these headline, like you buy our home, you can get a 4.9% mortgage. And I was like, oh, interesting. How does that work? So if you buy a new construction home, instead of having to pay an 8% mortgage in October, you're paying 4.9% mortgage. And it's a 30 year mortgage, 30 year fixed.
Cardiff Garcia:
So what's going on there? What explains the difference between prevailing mortgage rates and the fact that you can get one of these for so much less?
Ben Miller:
So the home builders are a little bit like the construction companies. They really make their money by flow, by building many homes, and they're taking market shares. You probably know the number of new homes sold compared to existing homes doubled in the last 12 months. So normally, it's 12 13% of homes that are bought are new construction, and it went to 30%. So it doubled. Okay, so how are they doing this? I was really interested. How are they doing this? It's really interesting. This is a few things happening. So basically if you sell a home to normal home buyer, they use FHA, Federal Housing Authority loan, or they're Freddie or Fanny. And so those lending institutions cap the amount of concessions a seller can provide. So they say, "Oh, okay. If you're home builder, or even if you're just a normal seller," normally it's a home builder, would provide seller concessions.
So at closing, they may cover different points. You typically cap to 6% of the sale price of the home. So if the home price is a hundred thousand, the most that home builder or seller can provide a closing 6%. So that'd be 6,000. Typically, obviously a 300,000 home would be 6%, 300,000. So the way that the home builders are providing additional incentives of 4.9% mortgage that doesn't count towards 6% is that they go out and buy something called a forward commitment. So they say, "Okay, I'm going to go to this mortgage originator, and I'll buy $100 million of 30 year paper at 4.9%, 30 year mortgage paper," and you're basically buying down the rate. And in October, it costs 12%, 12 points basically, to buy the rate down from basically eight to five. And I'll come back to why it's 12%. It seems counterintuitive, but anyway, so they can then essentially take this bundle of a hundred million dollars of mortgages, and then you use their mortgage to buy the home.
So now basically, they're not providing seller concessions. Technically, you're just using their mortgage. But when you add it all up, that home that allegedly sold for $300,000 had six points, 6% seller concessions, 12% buy down through the four commitment of the mortgage, and then the mortgage originator provided 1.5% also. So the reality that is close to 20% less than the headline price. So one of the things you asked me is, how come home prices haven't fallen? Well, there's a hidden 20% subsidy in the market that is basically both keeping prices up and keeping the home builders very active so they can basically build through this downturn. So that's an example, again, of a delaying action, but is unnatural. It doesn't feel like that's basically sustainable.
Cardiff Garcia:
Yeah. And that is, I think, the theme that's consistent in all three of these anecdotes that you just told, which is that all these different institutions that participate in real estate are taking all of these actions to delay the moment at which they'll have to admit what the market is really like, what the economic environment for them is really like. And in some sense, it also has the effect of keeping other people from outside of real estate from realizing what's happening in real estate, because you can keep the nominal prices of those homes where they are instead of admitting that fundamentally, they're worth less than As in that last example, 300,000, that home is actually worth 20% less than that if you take into account all of these different delaying actions instead.
Ben Miller:
Let me just come back to the addendum, because it's counterintuitive that you can take up 30 year mortgage at 8% and only pay 12 points to get it down to five who you think it'd be three times 30. And that's because the mortgage securitization market presumes that anybody who has an 8% mortgage will refinance out of it when mortgage rates come down. So the duration is not actually 30 years on that mortgage in reality. In reality, if you're in a home that basically has an 8% mortgage and rates come down, you're going to say, "Oh, I better refinance." So one of the reasons why the mortgage market was so broken, and you probably saw this, but 8% mortgages were actually at a really high spread to treasuries, basically, it wasn't very attractive to invest in it. We looked at investing in it, 8% mortgage is pretty attractive. But then basically, the second rates come down, just gets paid back. And then you're like, "Well, that's not very attractive, to put my money into something that everything goes well, I just have to redeploy it into a bad interest rate environment."
Cardiff Garcia:
That's also just part of the fact that the 30 year fixed rate mortgage with the prepay option and all that stuff, it's just a very odd financial product. It is an artificial result of a lot of government policy and the strange vagaries of history. And we ended up with this really, really weird product that would not have existed were it not for all of these odd things that had to happen in very particular ways in the last 100 years or whatever.
Ben Miller:
Governor subsidies. So I have one last one. Try to do this one fast. But do you know what payment in kind is?
Cardiff Garcia:
Yes, but please explain it to our listeners who may not be familiar with it.
Ben Miller:
So a pick loan is, let's say you have a loan and you're paying 10%, for example, and you say, "Okay, I can't pay 10% a year, I can only pay 5% a year." They'll say, "Great, I'll take the other 5% as a PIK, as a payment-in-kind where basically it'll accrue, and you don't have to pay it to me until the loan comes due." So every year, the principal balance goes up by 5%. So they call that PIK, payment-in-kind. So what's happening is there's tons of lenders where the borrower, as we've talked about with interest rates went up a lot, can't actually pay the interest. So they're quietly changing the loan terms to payment-in-kind. Instead, you've seen this lot mortgage REITs where they, all these loans that really high leverage mortgage typically make higher leveraged loans. Even insurance companies will do this. It looks like a performing loan, but actually most of the interest is actually not being paid. It's being accrued. So there's probably billions of dollars of mortgages like that across the country. So the point is there's just this symphony of delay.
There's a lot of people on the grounds. And it makes sense if you're a home builder, if you're a mortgage originator, construction company, you're a lender, if rates do come down, and we're talking about rates being normal by 2025, then everything works out. And that's good, but it's masking the amount of weakness in the economy.
Cardiff Garcia:
So to the extent that payment-in-kind is being used more now, it's a sign of yet another delaying action in the markets.
Ben Miller:
So you roll that up to a conclusion, which is that even if there's not a recession, I believe that generally, inflation will keep coming down because all of these things drive down inflation. They slow the economy, which means interest rates will keep falling. And that's good for real estate prices, which is why I call the bottom.
Cardiff Garcia:
Excellent. Well, Ben, any concluding thoughts as we head into the final couple of weeks of the year and wrap things up essentially on the year that was, and maybe preview the year That will be, which will be the topic of our next episode in January?
Ben Miller:
Well, I want to thank investors. It was a hard year. I appreciate those who stuck with us. I think 2024 is looking up and it's pretty exciting, so onward.
Cardiff Garcia:
Onward indeed. And with that, I'm putting the glasses back on, and we are wrapping up this episode of Onward. Thanks to everybody for listening. You've been listening to Onward Fundrise podcast featuring Ben Miller, CEO of Fundrise. I'm Cardiff Garcia of Bazaar Audio. We invite you again to please send your comments and questions to onward at fundrise.com. And if you like what you heard, rate and review us on Apple Podcasts, and be sure to follow us wherever you listen to podcasts. Lastly, for more information on Fundrise sponsored investment products, including all relevant legal disclaimers, please check out our show notes. This podcast was produced by the podcast consultant. Thanks so much for listening, and we'll see you next episode. Happy holidays.
