On-Demand Webcast: Changing Valuation & Investment Dynamics
March 16, 2021
Our panelists discussed the way real estate markets will be impacted by economic, employment and interest rates trends in 2021 and beyond.
Lisa Knee:We are happy to welcome you to our special and timely series, Real Estate in a Pandemic, focusing on how the real estate market will be impacted by economic, employment, and interest rate trends. We at EisnerAmper are focused on helping clients respond to the pandemic and it's impact on the real estate market through a wide array of advisory and accounting services, including property level accounting, and construction financial oversight. We have published a compendium of articles which is available on today's screen.
Today, we welcome you to the third in a series of webcasts to keep clients and advisors up to date on what's happening in the markets and what they should be thinking about as they refine and redefine their business strategies. Our expert panelists will discuss transaction volumes, or lack thereof, across property sectors, and how investors are pricing and evaluating deals. The panelists will address jobs, migration, the overall economy, and inflation, as well as impact on pricing and market conditions.
Joseph Rubin, a senior advisor here in real estate group at EisnerAmper will lead today's discussion. Joe has over 35 years of experience in the industry, I hope I get all this in, advising family owned and operated, REITs, private equity funds, just to name a few, to help develop and enhance strategy, governance, managing risk, due diligence support, financing and restructuring. Let me welcome and thank all of our speakers for taking their time today to share their expertise with us. With that, Joe I will turn the program over to you. Thank you all again for being here.
Joseph Rubin:Thinks so much Lisa, and thanks everyone for joining today. We're really thrilled to have you all, and I'm especially thrilled to have my wonderful panel, really extraordinary panel today, to talk about some of the big trends that are going on in the economy, and in transactions, that will impact real estate investing the rest of this year. So I'd like each of our panelists to introduce themselves, we're going to start with Cate Agnew who's the chief appraiser at Natixis, we'll go on to Jim Costello of Real Capital Analytics, and then Mike Fratantoni from Mortgage Bankers Association. So Cate, if you would like to just introduce yourself, that'd be great.
Cate Agnew:Thank you Joe. Good afternoon everyone. So glad you could join us here. I'm Cate Agnew, I'm head of valuation for Natixis, which is a French investment bank based in Paris. We're part of the second largest bank in France. As I like to say, we financed Napoleon and it went really well for a long time. I head up the valuation part for all of our deals, whether they're going to CNDS on distribution, or retained on our balance sheet. I've been in the industry for about 25 years and hold the designations both US and International. Glad to talk to anyone offline if you need to. Thanks, Joe.
Jim Costello:Hi I'm Jim, I'm with Real Capital Analytics. We are an information firm that tracks commercial real estate, financing sales, anything capital markets related worldwide. I've been in the industry since the early '90s, so I've lived through a few of these recessions, and every one of them is different, it's always an interesting story to tell about them.
Joseph Rubin:Thanks. Mike?
Michael Fratantoni:Good afternoon everybody, my name is Michael Fratantoni, I'm the chief economist at the Mortgage Bankers Association. As many of you probably know, MBA is the industry's trade associations, we have about 2000 companies as members on both the residential and commercial and multifamily sides of the industry. I head up our research and industry technology group, so spend my time providing forecasts about where the macro economy is headed, and then also likely path for both the residential and commercial multifamily markets, so really appreciate the opportunity to be here with you today.
Joseph Rubin:Thanks to all of you again for joining, and as Lexi said, we do encourage questions as we go through. We're going to have each of our panelists do a presentation to give their thoughts on what's happening in the markets and real estate, and then we'll have a general panel discussion.
Michael Fratantoni: Perfect. Thanks, Joe. So that forecast from the group actually does line up pretty well with the way I'm thinking about the world. So our forecast would have the 10 year end 2021 at about 1.9%, so closest to 2.0. So let me tell you a bit more about how we get there. So Joe asked me to give sort of our thoughts on the broader, macro situation, and I think one of the most important drivers, as I'm sure you've been watching on the news the past couple weeks, is the fact that the government, both in the form of several stimulus bills, with the most recent being this American Rescue Plan, another 1.9 trillion, but also the December stimulus, and also the CARES Act, has just pumped a tremendous amount of cash into the economy, and you can see that in the personal saving rate, which for most of the past decade has been sort of 5, 6, 7%, we're at 20.5% right now.
So households have a tremendous amount of pent up demand, they've not been able to spend on any in person activities for more than a year now, and as soon as they are unleashed we think that consumer spending is going to jump and there's just going to be a burst of activity as we enter later this year, and that I think is really going to be reflective of what has been a very, very unusual downturn. When you think about the job market, this is one of the measures that I think is most revealing. It's looking at the number of unemployed individuals for every job opening in the economy. So actually taking data from two separate surveys that the Bureau of Labor Statistics runs, one is on the employment situation, one on job openings.
You go back to 2009, great financial crisis, there were six people unemployed, actively looking for work in every job opening in the economy, and it took the better part of seven or eight years for that to come back down to normal, but you think back to the great financial crisis, this was a credit shock. It hit every sector of the economy with a really substantial blow, and companies were very hesitant to hire or post new job openings coming out of that. Look to the right side of the page, this experience has been very, very different. Last April the unemployment rate jumped to almost 15% as the initial pandemic lock downs were put in place, but beginning last spring, as soon as things opened, it got better, it got better quickly for a good part of the economy. So this measure peaked at four and a half unemployed individuals for every job opening last April, has since come down to about one and a half, and we think it's going to keep getting better.
So the headline unemployment rate which was at 6.2% in February, we said we see getting down to about 4.8% by the end of 2021. So a very, very rapid improvement as this pent up demand hits the economy. Now before Joe asks the question, I'm going to jump in and say absolutely, the unemployment rate does not fully capture what's going on in this job market beyond people who are counted as unemployed, those who are without a job and actively looking, there are a lot of people who have just stopped looking. Some because they don't think there are good opportunities for them, particularly if they might work in leisure, hospitality, or travel sectors, but a lot because this pandemic has been extraordinarily disruptive.
I think this picture really captures it. Look at what's happened to labor force participation for women during this past year, and particularly for women in the 25 to 34, 35 to 44, who unbeknownst to them have signed up to also be teachers during this time period as schools have shut down for the most part. Now this suggests there are going to be two, again, fairly rapid turnarounds in this job market. One is that there are a million individuals who typically would be employed in education, elementary school, middle school, high school education. As soon as schools reopen, they're back to work. So that's a million gain in employment almost instantaneously. But then beyond that, look at this, this is three, maybe between two and three percentage points of participation from women in the beginning of their careers who have it looks like paused so they could be home with their kids at this time. So pretty dramatic turn around here if schools reopen and that certainly seems to be the plan going forward.
So an improving job market, definitely one factor that we think is going to be putting some upper pressure on rates, and we've seen that so far this year. Initially you had the Georgia runoff elections in January which lead to democratic control of the senate, couple that with the Biden administration and democratic control of the house, markets bet correctly on additional stimulus being passed quickly, and it's not just the 1.9 trillion American Rescue Plan, the talk now is towards a two to three trillion dollar infrastructure plan, partially paid for with some higher taxes, but partially debt financed.
If you look at this picture on the left, the congressional budget office just puts out some beautiful charts. Look at what's happened with outlays with respect to receipts. We are, again, unprecedented is one of the words nobody wants to hear anymore after 2020, but we're in a very, very unusual situation with respect to the federal budget deficit. The debt to GDP ratio is around 100%, as high as it's been since World War II, and again, you look at this difference between outlays and receipts and the desire to spend more on this infrastructure package, deficit is going to be north of three trillion dollars in 2021 as well as they were in 2020, and not much lower than that in 2022. And what I like to highlight, if you look on the right side of the page, courtesy of the international monetary fund, it's not just the US trying to support their economies, their households, their businesses, with large outlays, it's the rest of the world as well. So just about every country, and that includes China, which is a different feature from what we had in 2008 and 2009, but certainly most of Europe, running very large deficits.
So the US Treasury auctioning more than three trillion dollars in debt last year, and then this year again, they've got a lot of competition out there when they're trying to sell 10 year or five year or seven year or 20 year securities as was the case today. And that's another factor with that's going to be putting some upper pressure on interest rates.
Another, which has gotten a lot of debate in the press recently is to what extent are we going to see an increase in inflation? So our forecast here is a pretty benign picture. It's suggesting that we're going to see a tick up in inflation in 2021 and then we'll fall back close to the fed's target of about 2% inflation, at least on a headline basis and certainly on a core basis. Now what's driving that? If you look at the right side of the page, you could look at almost any commodity, almost any indication in any sector of the economy right now, there are supply chain difficulties. This is looking at the cost of freight, but whether you look at the cost of raw materials, look at the cost of lumber which has tripled, particularly relevant to the housing industry, we are just trying to ramp up too quickly from a deep recession to what is likely to be close to full employment in just a few months. Some of that is going to be sort of bled off as higher prices and will show up as at least a temporary increase in inflation.
The worry is does that temporary increase lead to some medium term increase above and beyond what the fed would like at that 2% level. I don't think that's the most likely outcome, but it certainly is a risk. Again, another factor we think putting an upper pressure on rates.
So all into the polling question, if you look at the green line here, that's the 10 year treasury, we were 10 basis points or so at the worst of the pandemic. As Joe said we're about 160 today. We think we'll probably top out this year at about 2% and then head up to what sort of a more natural equilibrium for that 10 year, somewhere between 2.5 and 3 by the time we get to the end of '23.
Now everything I've talked about, stronger job market, large deficits, rising inflation, putting some upward pressure on rates, obviously the fed is pushing back against this. If you look at their short term rate target, the blue line here, we think they're going to keep that target at 0 all the way through 2022, we're projecting two rate hikes in 2023. Beyond that, they're adding to their balance sheet, buying an additional 80 billion in treasuries, and 40 billion in MBS per month, and they're going to do that until they get substantial further progress, in quotes, toward their employment and inflation goals.
If my economic forecast is right and we get to 4.8 by the end of the year in terms of unemployment rate and inflation is above 2.5%, that counts as substantial further progress. So I'm not going to be surprised if they begin tapering those asset purchases by the end of this year, that means they announce the intention to taper later this summer, or perhaps early in the fall. Now risk free rates going up, the economy recovering, not surprising to see credit spreads on almost any asset class come in. I'm sure Jim and Cate might talk more along this angle. But we're seeing this in many different asset classes across the financial sector, that as treasury rates go up, we are seeing spreads to those treasury rates come in in many cases.
In terms of performance and then here in terms of the multifamily sector, Joe you had a great newsletter on this that I had a chance to look at, totally agree with what you're saying. This sector has performed well, and whether you look at the difference between the peak of the unemployment rate versus the performance of renters and making their payments, or rental payments not made and yet multifamily borrowers continue to pay on those mortgages, just shows that there's a lot of buffer in this sector, and the sector as a whole, performing quite well.
Last couple of slides before I turn over the clicker here, we've put together just a couple of neat charts, and this is just worth taking some time looking at. Thinking about, again, how different this crisis has been from the last two recessions, the global financial crisis of 2008 and the dot community and 9-11 recession of 2001. This chart and the next, looking at how some economic variables traced out compared to in one, the path of NOI for different property types, and then the other, cap rate spreads relative to treasuries. So this is sort of your homework to look at when these charts go out but happy to take some questions as we get into the Q&A time. Joe, I'm going to turn it back to you.
Joseph Rubin:Thanks so much, Mike. We're going to move to Jim to give his remarks. Jim, I will ask you to pick it up from here.
Jim Costello:Okay. I'm going to talk about the commercial real estate investment markets. We had a terrible year and what comes next. Here's the thing though, everybody's saying 2022 until we get back to normal, we were at an elevated level of activity from that period, from 2015 to 2020 as prices continued to increase, investors are still looking for yield opportunities and commercial real estate just bit the bill, so deal activity was growing.
Funny thing is that in December of 2020, even though we had the pandemic last year, December of 2020 was actually the most heavily traded market for us ever in any month. There's two reasons for that, first there was a lot of catch up from deal activity that was delayed earlier in the year, people just kind of rushing things through that had been in place, and then I think the second thing that happened there, there was a lot of 1031 activity where Mike's talking about all those deficits, you've got to get the money from some place, and for a while now, and we see there's been talk of maybe soaking it to the commercial real estate investors and getting rid of 1031 exchanges, I've heard some buzz that maybe this year that's not the year that it'll happen, maybe next year. Nonetheless, when people saw the change, there was a lot of activity that went through that way to try to bring that down.
The very last little bar here on the deal volume, that's January figures, and we saw a retreat down in January in terms of total deal activity, and it's not nice to see that after the December activity being at a record level, but that always happens every January. Every January you see a retreat, but it's kind of getting it back to that Q3 level that was around before that January spike. It was delayed there jumping forward. Here's the thing, you're not going to be able to read through all these on the deal one and by sector, this is the, like Mike said, this is the homework portion. Here's the breakdown by deal volume. I think the key thing to take away from this is that it's been hitting every sector. It's not like one sector does great and everything goes south. It's also not like one regional geography is doing well and others are doing poorly, the big cities are down at double digit rates, the six major metros. Any secondary, tertiary areas that have made some better cost advantages, activity has been down in those locations as well.
There are marginal differences, a little bit better industrial performance, development site sales is one thing that did do well in terms of growth. But there's not a whole lot of stories here, it's really just a story of some sectors did just marginally better last year.
One thing that didn't fall as a share that was a little bit surprising to folks, but also reflects just a change in the nature of the market, is that cross border money didn't plummet last year. Cross border investors when they come in, typically they're coming in with deep pockets and a hunger for yield with cost to capital that's lower than some domestic competitors, and so the fear was with restrictions on travel, nobody would be doing deals in the United States, but you can see in this chart, the orange are different scales of deal volume, dark orange is global, meaning outside of North America, the light orange is continental which is mostly Canada, there's a little bit of private money from Mexico and the Bahamas that comes in, but by and large that's Canada.
But you can see that blue line, that's the share of total activity, and it was kind of flat. Part of the issue is that these cross border investors actually it's becoming a bit of a misnomer. I may be a fund operating out of the Middle East, but I have staff in New York. I may be an investment management company based in Hong Kong, but I have a team in Orange County. So that is starting to change that, but it is interesting this capital that is hungry for yield and has a low cost for their money, they're still interested in the United States, they're still about the same share of the deal market. That's going to have an interesting impact I think when distress finally come through.
We've seen a spike in distressed loans, but it hasn't translated through yet to distressed asset sales. So on the right, there's a table and homework by property sector, the outstanding distressed debt by property type, and then what we're calling potential distress, it's largely stuff that's entering into forbearance. You see for instance, the apartment market, there's a lot of potential distress, a lot of forbearance, but nothing actually has been getting to a delinquency kind of situation yet. But on the left, that's a chart showing distressed asset sales, and what's happening with properties sold out of those kind of distressed debt situations, goes all the way back to December 2007 when the global financial crisis started and you can see that after about a year and a half it really started to ramp up as a share of total investment activity.
Two things to take away from here, one, if you're banking on trying to buy distressed assets, you've got to be patient. Last time, all the stress came through largely from the CMBS market, and there was pressure to move that stuff quickly, as opposed to today, there's a lot of bank lending. Banks have more of an ability to provide forbearance, the waits, the so called extended pretend, or at least just honestly wait and see what happens next with respect to property income from what's been happening in the pandemic. So it may not come through as quickly. And to the extent it does come through, it may not just be a simple situation of a property that is otherwise capital impaired but is cash flowing, what might come through with distress will be true distress.
A mall in Toledo, Ohio, sorry for anybody in Toledo, I'm not picking on you, but built in the 1970s, aimed at manufacturing workers buying goods there. The fundamental economic rationale of an asset like that has changed, so that's where I think we'll start to see the distress. So it will be a different kind of distress from last time. There's been a buzz in the industry about K shaped recovery in terms of what happens with different jobs, different industries, it's showing up with different property types as well. I'm showing here a price trend from our commercial property price index, the repeat sample index looking at how a building sold between two different periods, and breaking it down by property sector, there are clear winners and losers. The apartment sector and the industrial sector continue to see price growth approaching double digits. There is tremendous investor demand for these, there's a flight to quality and safety underway, and those are showing that.
The sectors where there is trouble are the office, the retail, and the hotel sector. Those have been on a downward trend throughout, and so there's a division underway. That creates some problems because we've never seen such a great divergence in commercial property price growth by sector. In the past, everything kind of moved together because so much of the previous downturn, for instance, was financial driven. When you take away 60% of the capital stack it doesn't matter what your fundamentals are, you're going to have a bad time. This time through, it's not, like Mike said, it's not that credit crunch. So the fundamentals matter more and the industrial and apartment sectors are just seeing better price growth from it all.
So what happens next? I'm going to close on this thought. People are asking a question well when do cap rates go up? And should we expect that? So here's what I did. I took cap rates and I decompressed it to three things. Normally you'll see a chart where people will show maybe cap rates against a 10 year treasury, and that's in here, the top of all these three bars equals the commercial cap rate, and that's an amalgam of all the office, retail, and industrial. And then the 10 year treasury is down there at the bottom, and in between though I put something else in there. We generate a mortgage rate for sort of seven and 10 year fixed rate commercial properties, that's just a benchmark. I know there's a lot of other types of financing, but that's the one where it's the most consistent. And it matches the rationale of a lot of acquisitions people I talk to, they think about well what's the cap rate it can body at and what's the mortgage cost, because if I've got some spread between those two I've got some leverage to work with.
And what we see is that while the interest rate environment moved down, the lenders didn't chase that decline. When it went below 1% for the 10 year treasury, it's not like the commercial mortgages shrank dramatically. So as that interest rate environment comes back up, let's say we get up to a 2% range, pretty close to the forecast Mike was talking about, you add in 100 basis points in there, it's not as that the cap rates suddenly go up 100 basis points. You can see that spread there, there's plenty of room for that to narrow and plenty of room for that equity spread to narrow, and it should if the interest rates are going up because we have all that growth in the economy that Mike was talking about. Because at that point rents are going to start to be growing and people are going to be optimistic about the income situation of the properties moving forward.
Just because you start to see stories about a little bit more inflation, and a little bit higher interest rate environment, don't assume that it all comes through to cap rates right away. So with that I'll just turn it back to you.
Joseph Rubin:I'm going to turn it over to Cate to give your opening remarks, thanks.
Cate Agnew:Thank you, Joe, and it's hard to follow folks like Michael and Jim, that's for sure. I'm Cate Agnew, and I'm with Natixis and I wanted to preface this by saying the opinions I express here are not necessarily those of Natixis, or major league baseball. Valuation is an interesting sub sector of the lending part of the equation. We generally get brought in towards the middle or last part of the transaction, where a lot of the transaction has already been baked into how we're doing our pricing and how we're going to be moving forward. As a result, it tends to be a little bit on the reactive side, and that's unfortunate, because what I'm noticing now in the deals that are coming across and we're beginning our pricing is that we're starting to see a significant gap between what the ask is on the lending side and what the reality of the appraisals are coming in at.
I think part of that is due to asset classes that are performing so well in this pandemic. Industrial is just on fire, although it's showing signs of stabilizing, and the multifamily market particularly in the suburban markets. I think the sentiment has been that the rising tide in those is raising all boats but it doesn't seem to be that factor. So there's maybe a little more exuberance than I would have expected at this point in the cycle for those two asset classes, and as a result we're beginning to not see the spikes that we anticipated, but also not the depths of the distressed transactions.
I agree with Jim that we are looking at distressed actions coming forward as someone working the banking environment I can also affirm what he was saying, that we're looking at moving forward with a bit of extend and pretend, but we are certainly in touch with our borrowers a lot more than we ever have been before. We want to work with them. We want to make sure that they know we're here to work with them, and that no banker ever wants to own real estate. It's a headache, and if we wanted to own real estate we would do something different for a living.
I think one of the things that we've all been discussing a lot from a valuation perspective and as we're looking at new deals coming across is what's going to happen with the office market. There's been a lot of speculation of what the office market will look like shortly, and everyday there's a new headline, Wells Fargo announced yesterday they're going to be rolling back their space in New York and in San Francisco. Now behind those headlines are the fact that it's not necessarily office that they're rolling back on. They're doing some branch closings, and that's accounting for quite a bit of that space loss. Part of that is again a result of the pandemic, people became very comfortable that were never comfortable before in doing their online banking. So the need for branches has gone down, but the marquee is they're reducing space in the immediately is that they're reducing office.
The fact is that there's not a lot of office rolling in the immediate term. We've got about 6% rolling in 2020, and the expirations, the average lease 10,000 square feet and over is about eight years long. So we're looking at the rollovers on that period of time, and it might not be as drastically hitting office as we think it's going to be. It takes until about the fourth quarter of 2024 before we get a 50% rollover in the office.
Having said all that, I was on the phone this morning with someone who's a special servicer, and they were indicating that if anyone that's invested in the office class thinks they're going to be getting off unscathed, it's going to be a very cold splash of water that comes to them. I think the story on offices going forward is going to be the story of the tenants themselves, and their appetites. It's going to be a story of the landlords sitting down with them and deciding what their footprints should be. It's also going to be whether the balance sheets and the financials of the tenants can bear to continue to pay for space that they may or may not be using. The negotiations between the landlords and the tenants are going to take forefront as well as measuring, which is difficult to do right now, what the appetite is to come back to the office.
You have some organizations that are saying work from everywhere forever, and other organizations that are taking a very hard line at the moment you can come back in, you're expected to come back in. I think one of the things that's keeping the distressed situation at bay isn't just the extend and pretend, is that we were so well disciplined in the lending that we've done in the recent past. The debt service coverage ratios have been very high compared to the prior years that we were concerned with, the economic crisis, DCSRs were really not helping themselves and when a property wobbled a little, the outflow situation became difficult.
Same thing with the loan to value ratios that are on this. In the past, from 2000 to 2019, the fund value ratios were fairly high and they began to decline, and really sort of level out. So there's a safety that's been built into the underwriting that I think has been extremely helpful for keeping us from having to push properties into a distress situation. There is stress in the market.
I think everyone has covered retail better than I ever could. Retail is such an interesting asset class and I mean that not in a way of may you live in interesting times, but the way even before the pandemic it was beginning to bifurcate into class A and class C, now we're looking at situations where it's class A, C, and D, and there's no way to determine which ones are going to ever end up in the B class again. I think the idea of repurposing retail is a bit more of a discussion point than actuality. At the beginning of the pandemic, people were speaking about perhaps doing fulfillment centers, the last mile, repurposing the retail in that way, repurposing the retail as service space, repurposing the retail as affordable housing, and I don't see that much of that has happened so far, but I know that many of the lenders are looking to that, particularly as affordable housing as part of the ESG initiatives at different organizations. ESG is going to definitely move to the forefront, affordable housing will remain an issue, even in cities where we're seeing drop offs in multifamily, and as a result, drop offs in the values of multifamily.
So with that, I'd like to answer any questions anybody has later on, but I'm going to give it back to Joe.
Joseph Rubin:Okay. Thank you Cate. Now we're going to just have a bit of a panel discussion and we'll ask your questions, so please submit them. I want to start with Mike, and challenging a little bit on the employment situation because the employment rate now, what is it, about 6.3, it sounds like isn't really accurate because millions of people have sort of stepped away from the employment market and you showed part of that is due to a number of women who are no longer in the workplace, as your slide showed. I saw Janet Yellen the other day say that she thought the real unemployment rate was around 10%, so is the unemployment really as good as we think, and do you really believe we can get to full employment by the end of the year?
Michael Fratantoni:So there's two parts to that. One, does the unemployment rate reflect some of the distress that many households are feeling, and no I'm going to agree with Secretary Yellen and many others that it does not fully reflect what many households are going through because if they've dropped out of the workforce, not actually looking for a job, they're not pulling in an income, maybe they're making that trade off for family or other reasons, but they are definitely worse off than they were a year ago. But the other side of it is more macro economics, right? It's if the unemployment rate drops to 4.8 like we expect it will, to not quite full employment, but definitely substantial further progress, to use the feds terminology, if you're an employer, maybe in the travel sector, in hospitality, and your middle of the summer, this fall, posting jobs like crazy because your demand has returned because of that pent up demand that I just talked about, you are going to be boosting wages rapidly to try and get those positions filled. All those supply chain pictures that I showed, that's going to be the picture of the labor market, second half of this year, a lot of employers scrambling to try to fill positions and unable to because of what you're talking about.
And so that will fix itself over time, so there's going to be a period where the unemployment rate drops rapidly, we see some significant wage growth, and then it will cool off as some of those folks who have been on the sidelines come back in. So complicated answer to your question, but it's a complicated question.
Joseph Rubin:Yeah. There was a question from an old friend in the audience relating specifically to teachers, and if they're working remotely or they're not teaching because the school is closed, are they counted in those unemployment numbers?
Michael Fratantoni:Yeah, great question. So nationally, pre pandemic, there were a little more than eight million employees in the education sector employed by state and local governments, now we have a little over seven million. So I don't know the specifics, but my understanding is that the teachers have kept getting paid, but if you are a bus driver, or janitorial staff, or some of the support staff, they probably are not getting paid.
Joseph Rubin:Thanks. Jim, so you show that December was a great month, then as usual, things fell down again in January, what do you really think we're going to see this year? We know that there's just an extraordinary amount of capital out there. Some estimates are 300 billion waiting to be spent. Real estate is a relative value asset right now in terms of the spreads, and you show that cap rates were holding. Do you think we're going to start seeing a significant increase in demand and trades? Or is the bid spread ask between buying and selling still too wide right now?
Jim Costello:Yeah. At the very end of your question you got into the key problem, there is a huge bid ask spread. Rather than prices being the adjustment mechanism to this economic dislocation that we have, deal volume is the adjustment mechanism. Owners of assets, even assets that have some sort of income distress because of the pandemic, those owners are still basing their expectations on the pricing that they should get for the asset based on activity before the crisis, whereas buyers, given that they're facing some risk from taking on an investment today with the recovery pace still uncertain what things will look like in the future with job growth still looking uncertain, those buyers want a lower price if they're going to come in and take a risk. So those two groups are far apart.
On the apartment sector, in the secondary markets and garden apartment activity, there's probably a closer meeting of the minds on prices. Same thing with a lot of industrial properties, particularly large logistics space. There you've got a pretty good pace of activity and have prices still going, so there's more of a meeting of minds there. In the office sector, there's a big debate, do we go back? Do we not go back? There's some people really promoting the notion of going back, and others saying that everything is different. And then like Cate said, is there any B retail left? And in fact an answer to that polling question, yeah I would have said you needed another category, all of the above because there's not like one change for retail. It's not, every retail property is going to be different in terms of the performance moving forward.
Normally a rising tide lifts all boats, but there's so much divergence. When we look at the price changes, we're seeing a big divergence already in terms of the repeat sales in terms of prices. So it's hard to see some uniformity there. But will buyers and sellers come together? And yeah, the capital pressure, that's certainly helps the current owners trying to justify their pricing. The buyers will face that competition situation, but the buyers may become more comfortable as we start seeing more shots in arms, more of a decline in the daily cases for COVID, as all the job growth that Mike talks about starts coming into the second half of the year, I think we'll get people more comfortable with the current prices that the owners want, and if they're not forced to sell by all their bankers between now and then, maybe deal volume picks up without a big price change.
Joseph Rubin:So Cate, on that, let me come at that a different way. I'll ask it very simply, do you agree with Jim's assessment that cap rates aren't going to go up? What's your view on cap rates?
Cate Agnew:I think cap rates I agree with that assessment on the cap rates. I think if the cap rates were going to be increasing, they would have increased at this point in a distressed situation where someone had to get rid of the asset that they had on their books, I think where the price adjustment is going to be isn't going to be in the cap rates. It's going to be in the operating income in the properties and the increases in the cost to clean the building to make sure it's where it needs to be to meet hygiene needs, and then also in resets on rents on the top line. I think that's where the impact is going to take place on the valuations. I can't see cap rates increasing.
Joseph Rubin:Not even if people's view of risk in certain classes of assets goes up? The risk premium isn't there?
Cate Agnew:I think we're in a situation right now where the risk assets have been exposed and the cap rates have not risen as a result of that.
Joseph Rubin:Really interesting. Mike, I don't know if you gave us a prediction of GDP, and the overall economic picture, I was reading the feds, I think it was the February report, that was looking for around 4% this year and then it actually went down to maybe 2.5% by the next couple of years. Now that was before the rescue plan was passed and signed by the president last week. What's your view of the overall economic growth story and how do you think that correlates to the real estate values and real estate demand?
Michael Fratantoni:Yeah. Great question. So 2020 GDP fell by about 2.5%. We think it's going to grow in 2021 by almost 6%. Then 2022, mid threes, by the time you get to 2023, we're back to trend growth of about 1.8% per year. So we're going to be back to the level of economic activity that we had pre pandemic by the end of this year, and then we'll be back on that potential growth path by the end of 2022.
So in terms of impact on the real estate market, I'll leave it to my fellow panelists who are much better experts than me, but I think the point that they were both making of just the differentiation between multifamily which has fared reasonably well through here, retail which was on a downward slide before the crisis, industrial which was on an upward peak as eCommerce share kept growing before this, it's been in many cases it's an acceleration of trends we were already seeing, and then the big open question, if we gain, as I think we're going to, three to four million jobs through the remainder of 2021, that really is not going to translate into usage of office space as it has in prior recoveries, because I think there is this big open question about to what extent people are going to go back to the office even if they regain those jobs.
Joseph Rubin:Okay. I'm going to flip back to cap rates for a minute because we're getting a lot of questions about cap rates, and I'll open this up to whoever wants to answer, but if treasury is at the 10 year actually gets up to three, what would that do to cap rates? If it's around 2%, what do you think are the minimum spreads for debt and equity? Does anybody want to chime in on those?
Jim Costello:Actually I'll answer by kind of posing a question to Mike, it depends on why you think the 10 year treasury gets up to 3%. I mean if there's a stagflation type situation where you get a stagnating economy and inflation, that's not going to be helpful for real estate because if you have a growing economy where there's a lot of jobs created and that leads to a little bit of inflation, that means rents will be growing just naturally because there's more demand for space. But if you get stagflation situation where printing press goes burr and inflation picks up and there's no growth, that's what my goldbug friends are worried about right now, then that might not be a healthy thing for real estate. So Mike, stagflation versus interest rates going because of a growing environment, do you have a view on that?
Michael Fratantoni:Yeah, so the way I'm going to answer that is we think we'll get to a 3% 10 year by the end of 2023, but at that point we'll be at full employment, inflation at 2%, so pretty healthy environment. If we get to 3% 10 year by the end of 2021, that means that inflation has taken off in a very, very unsettling way. So totally agree with your point, Jim, it really depends on how we get there. If we get there fast due to a spike, due to fears about inflation, that's bad for the commercial real estate market. If we get there slowly and it represents underlying strength in the economy, that's probably going to be all right.
Joseph Rubin:Thanks so much. A lot of people are also asking about some of the property types, and we're quickly running out of time. So let's move to office and multifamily because I think those are the most equivocal property types right now. They're the least obvious. So on office, Cate, you already talked a little about office. I for one am a bit more concerned maybe than you are because I see the sublet market just explode, I heard one report was 150 million square feet on the sublet market nationally. I'm concerned that tenants, really not knowing what the behavior is going to be going forward on work from home and number of days a week that you're in or out, that they may want more flexible space, maybe shorter lease terms, and to me when the lease terms get shorter, that means when you run the Argus model the value goes down. So if anybody on the panel would like to talk a little bit about their prognostications on office values and what this all means to office, please chime in.
Cate Agnew:I'll go ahead and take a little bit of that and then pass it off to someone else. Joe, I feel as though office is a story that will be told over time. I'm not in disagreement with you about the office rates and the sublease spaces on the market, or the future leases will be five years or less. I think those are all going to be rollover and future events. But the space that's going on some market right now to a large extent still has the underlying tenant paying the rent and keeping it going forward. So I believe that, as I said, the tale will be told over time, and the next 18 months will tell that tale. So with that I'll let another panelist chime in.
Jim Costello:But Cate, I have a question for you on that, if I'm asking you to reveal your secret sauce, you can say no, but do you underwrite that stuff saying that when the sublet burns off, it's going back to the landlord and not being leased up?
Cate Agnew:From a valuation perspective, not an underwriting perspective, so not giving away Natixis' secret sauce, but say going to this, we're looking at the rollover years and we're definitely putting those factors into there, shorter leases and so forth. When those leases expire, we're taking a look at that risk factor, and in fact, I recently did a project where I was bifurcating the cash flows between current and future and using different rates of return on them. So I think for right now in the immediate term, that we're not going to be changing much in the way of our MLAs, it's when we start getting the wobble, and we start seeing our leases rolling that we're going to be paying some attention to that. That's not to say we're not paying attention to it right now, at all, as I said, I was talking to a special servicer this morning, and they said it was going to be a splash of cold water.
Joseph Rubin:I'd just chime in that I'm a little nervous about refi risk and valuations of office in the next few years. Let's jump really quickly to multifamily. Mike, you had one chart on there that you went by very quickly that I think showed NOI and multifamily going way down during COVID. I don't know if you want to comment on that. While everybody's talking how great multifamily is and in most market it is, but in some markets it's taken on a new level of risk. So any thoughts you or anyone else has on that, and we'll have to do it quick because we're almost out of time.
Michael Fratantoni:Yeah, so this was what I was suggesting people look at for homework, the comparison of the last three recessions, and really the story there is that multifamily NOI tracks the unemployment rate very, very closely. The unemployment rate goes up, NOI goes down. To Cate's point about look at what happened at rent, that is the driver there, and it's very responsive to the turn in the cycle over these past three recessions that as the unemployment rate comes down, rental rates go up, occupancy goes up, and NOI increases. So it's the most responsive makes sense given the shorter lease terms.
Joseph Rubin:Thanks. And then with just a couple minutes left, something totally different we haven't talked about, migration. People are moving around the country or so we think, is it real? Is it not real? What does it mean for real estate trades? Who's getting their money in front of the herd and who's behind? Anyone have any thoughts on that? Jim you want to take a crack at it?
Jim Costello:Yeah. Here's the thing, there's a narrative out there that's oh everyone's leaving the cities, everyone's leaving New York and California and they're moving to Texas and Florida, and you've got to take a lot of the information that's floating around there that you need to take with a big grain of salt. If for instance you start doing some digging and you see that this opinion piece on an online journal is saying that people are going to leave New York and move to places like Atlanta, you may do some digging and find that the actual author was trying to raise a fund around Atlanta apartments. So there's a lot of self-dealing going on there in the information space.
Some people have been looking at these issues dispassionately however and have shown that this narrative is false. The Cleveland Fed did a great study looking at the location of where people are moving. It's not leaving cities and going to other states, though there is some of that. It's mostly people leaving the urban areas of places like San Francisco and New York, and moving to the suburbs. And I think there's two elements to that. One of it, it was already happening even before the pandemic. I have two friends in the millennial age group that have little kids and they moved to the suburbs of New York because that's what you do. You're in your 30s, you've got some kids, dad wants a little bit of space so he doesn't go crazy in the apartment, the kids can run around in the backyard, that's part of the natural lifecycle. That was already underway, this process just accelerated it.
The other thing that's happening is you have a certain class of people that have moved out, I think temporarily, but all my analysts have, except for one, have left the city and they've moved into their parents homes. After the pandemic I think they're all going to move back to the city and want to be in the office. Maybe not to be in the office, but they'll want to be in the city because you can't get a date living in your parents basement. So I think that that, again, the lifecycle issue is going to determine where people live. There are economic incentives young people have to be in cities just to be around other young folks. So you'll see that same kind of transition I think in the period ahead.
Joseph Rubin:So urbanization is not dead yet. All right. Well listen, we're out of time already, I have about 50 more questions I want to ask, I can't thank the panelists enough, Cate, Jim, Mike, thank you so, so much for joining us, and I want to especially thank all of you who've joined us today. The Real Estate in a Pandemic webcast series will continue, in April we'll be sending out invitations soon, and our topic will be the latest and greatest in the hospitality market. So thank you everyone for joining.