Hello, and welcome to another episode of the Old Lots podcast. I'm Tracy Alloway and I'm Joe. Wi isn't all Joe? People have been asking for this episode for a long time. Yeah, there's a lot going on right now, definitely a lot of a lot of balls in the air. But there is a one topic that one particular topic that's been brewing for a while as a source of concern is what's going to happen with commercial real estate, particularly office buildings. That's right, So we recently had the collapse of Silicon Valley Bank and that set off, you know, a little bit of a banking crisis. But a lot of people are talking about the next shoe to drop really being on the property or the real estate side. And obviously there's been a lot of concern about what exactly is going on with office buildings. But you know, just interest rates going up in general tends to be bad for real estate as a broader category. So I think this is something that we really need to dig into. Yeah, I mean right, So obviously real estate, my understanding is that it's a highly leveraged industry in almost any factor, whether it's malls or office buildings, or apartments or single family homes. There's a lot of borrowing. Ergo, I think rates matter, and like every other industry, it's dealing with this reversal of a long downtrend. And then with office reads in particular, we all know that working from home is still a thing. Not everyone goes to the office every day like they were, and so companies are reducing footprints. And so if you are the owner of commercial property, you may be looking at a double whammy in which a your loan is set to reset or your commercial mortgage that you plan to roll over is set to reset, and at the same time, because of vacancies, your business is not as good as maybe it was in twenty nineteen. So potentially a major stress point emerging for a lot of players. And the other thing I would say is even without the pandemic, and even without the work from home trend, there was concern about excess in commercial real estate or CRI, you know, even prior to twenty twenty. I remember when I was at the Financial Times, I was writing a lot about the bond market and credit markets, and I used to write a lot of stories about you know, subpar underwriting in commercial mortgage backed securities and investors really reaching for yield in that sector. And there was one person I spoke to quite a lot when I was doing those stories, and so I am very pleased to say that we do have the perfect guest for this episode. We are going to be speaking to Rich Hill. I knew him when he was an analyst at Morgan Stanley, but he is now over at Cohen and Steers as head of real estate strategy and Research. So Rich, thank you so much for coming on. All thoughts. Yeah, thanks so much for having me. So maybe just to begin with you know, Joe kind of alluded to this in the intro, but commercial real estate it's not a monolith. There are a lot of different subsectors within that broad category, and there are a lot of different actors, so lenders, investors, things like that. Can you talk to us a little bit about the ecosystem What is the ecosystem of CRI actually look like? Yeah, it's it's a great question. And look, I actually don't disagree with anything you said and your remarks to start this, but maybe we start off by talking about the size of the commercial real estate market. We estimated it's around a twenty trillion dollar market. That's a pretty big market. And if you think about commercial real estate, everyone thinks about it a singular asset class, but it's really fifteen different property types under one umbrella. And in many cases those fifteen different property types are sometimes like my kidnergartner, they moved to one side of the room and then the other side of the room. The fundamentals don't necessarily all act the same. So you have office for the fun of it, or is there a reason why the fundamentals don't move in the same direction, why people move around so much? Yeah, well, you know what I would Just the point I'm trying to make here is that you know, you have office, you have retail, you have multifamily. What drives multifamily fundamentals might be much different than what drives retail fundamentals. And we haven't even really started talking about some of the subsectors like healthcare, for instance, or data centers or cell towers. There's a whole host of different property types that are out there that you know, Yes, commercial real estate is a singular asset class, but in many respects you as a as a strategist and a researcher, I'm covering fifteen different parts of the economy that all have a singular commercial real estate umbrella, but they have different fundamental drivers. Right, So this is really important. Some sort of midtown office space here in New York that maybe in twenty nineteen was leasing out to being leased out to like tech startups or something is going to be very different from a building that's sort of specialized in doctor clinics in which probably there is not much like work from home activity happening and there, and so they're just too Yes, they're both commercial real estate, but they might be very different fundamental for sure. And frankly, I'll take that one step further. You know that the office property in Tampa, Florida might be very different than the office property in New York City. Are they going to the office in Tampa, Florida, believe it or not, they are going to be dead? What are the numbers like? How like you know, I know there's like trackers of like different cities, and there's a lot of coverage in the media provis reasons because many of us are here in New York City. But how does New York City like, why don't you talk a little bit about what the numbers look like, yeah, if you're talking about New York City return to our office, we're still well below you know, call it fifty percent, you know utility rates, if you will people actually using office, call it in the thirty to fifty percent range. But if you go to the Sun Belt and there's a lot of reasons why this is the case, if you go to Sun Belt States, return to office and use of office space is a lot higher than that. It's not surprising to see at sixty seventy, maybe even a little bit higher than that. So there is a big difference between how people in maybe let's say New England States are using office versus let's just say Tampa, Florida, Austin, what have you. So, one of the things I wanted to ask you is, in addition to there being a lot of subsectors within the umbrella of commercial real estate, there are a lot of different ways that people actually measure what's going on in that market. So, you know, one CRI specific term that you hear a lot is cap rates. You obviously have property prices, and then you have valuations, and you also have what's going on with the mortgage reets. So publicly listed real estate investors, and you know, depending on which one of those you look at at the moment, you kind of get a really mixed picture of what's actually going on with crin. Can you explain that, like, why are these different things painting a different view of the market. Yeah, it's a it's a really great, great question, and I think it's something that's maybe sometimes misunderstood. If you were to go back to three Q twenty two, so not that long ago, Yeah, the riat market was down more than thirty percent year to date, but believe it or not, private valuations or still up more than ten percent on a year to date basis huge divide forty percent divide between what the list of market was telling you, what the private market was telling you. What happens is the list of market. So that's publicly. Trade at rates are always a leading indicator for the private market. They go down before the private market and they go up before the private market. Why is that the case, Well, list it rates, you get a mark on them every single day people buy and sell stocks. On the other hand, valuing a property can be pretty hard. You have to go get an appraisal for that, and so there is an inherent lag on when private markets actually correct to list it markets do they allow hand in hand? Not always. If you go back to the late nineteen nineties, post the Russian debt crisis and everything that was going on with tech, roots were under pressure and the private market kept chugging along. I don't think that's going to happen this time around. Case in point in four Q twenty two, the nucrief Odyssey Index that's a widely followed index of open ended mutual funds. This index was down almost five percent in the quarter. That is the greatest decline since OZ nine, and it's the second greatest decline since nineteen seventy eight. So we're talking about almost a twenty percent decline on an annualized basis, not that much different than what roats were pricing in. Rots were up five percent during that quarter as well, So there is a little bit of a lead lag relationship that's going on here. We'll see what the year holds for us. For listed roots, they're about flat on the year after a really good start to the year. But I think I think private's going to be down, and I wouldn't be surprised to see it down ten to twenty. So as you point out, like even if my conception of what commercial real estate is as New York office buildings, we can't just like form a view of all real estate or commercial real estate based on that. That being said, like, how much of that do you say? Twenty trillion rough VideA is how much of that is sort of distressed right now or in some sort of trouble and how much is sort of chugging along? Like we're of that twenty trillion, how much should we be concerned about? Yeah, so it's the right question to be asking. And there's a lot of different ways you can think about distress. The first way we think about distress is distress sales as a percent of overall transaction volumes. Before I go there, let me also just be clear. Transaction volumes are down pretty significantly on a year of year basis, almost seventy percent down. I can talk about why that's happening. But distress is sort of like someone having to sell a property when they don't want to. It's a foreclosure. For instance, Distress sales are very very low right now. I don't think they're going to stay low. I think they're going to increase. But the reason distress sales are really low right now is banks haven't started foreclosing on their loans and the bid ask spread between buyers and sellers is pretty wide. So distress sales are low. We can talk about delink, CMBs, delinquencies, bank delinquencies, whatever you want to, but the stress sales, which is the first thing I look at, is low. It's showing signs of ticking up. I think it's going to rise. So just going back to the private valuations for a second. You know, this is something I've been thinking about and writing about and a lot of other people have as well. But how long can private valuations kind of resist the gravity of lower prices and maybe deteriorating fundamentals, like what is the catalyst or what is the process for someone to actually take a hit on that property, Because clearly, you know, if you're a big investor, you are going to want to resist crystallizing those losses for as long as possible, it would seem. Yeah, to answer your question upfront, it can take. It can historically take twelve to twenty four months for property for private property valuations to correct to what the list of markets pricing in. Why is that the case? Well, let's talk through how private valuations actually correct. The first thing that happens is transaction volumes bottom out. You have to see transaction volumes decline precipitously before property valuations begin declining. Why is that the case. Well, at the early start of a correction, sellers don't want to sell at the level buyers want to buy. There's just a huge bid ask spread between the two. It's sort of like the grieving process. I'm not trying to be too flippant about it, but there is a grieving process. It's denial. There's anger than its acceptance. So we think we're actually starting to get to this place with transaction volumes down seventy percent year of ear. That starts to feel okay to me. But I think this time is going to be different. I think the correction and private valuations is going to be much much quicker than seen previously for maybe one of the reasons that you talked about at the very beginning, which is the rise in financing costs. So I'm gonna get not try to not get too wonky here. No, please get get wonky as you like. Actually are as wonky as you. I'll stop you if you if we need something clarified, but always yes, all right. So here's a great stat for you. Since nineteen eighty prior to twenty twenty two. That is, there has been less than five years five months since nineteen eighty. That's a lot of months where the treasure ten year treasury was not lower a decade forward. Something Unpack that and explain to you what that means. That means in January nineteen ninety the ten year treasury rate was lower than where it was in January nineteen eighty, and January two thousand it was lower than where it was in January nineteen ninety. There has been a secular decline in ten year treasure rates. Why does that matter? Well, it matters because, as you correctly said, commercial real estates inherently elaborate asset class. There's very few owners of commercial real estate that buy a property without some amount of debt on it. So, as you've been in a secular decline in ten treasury rates, and typically commercial real estates finance with tin year debt, you have always been able to refinance into lower and lower financing costs over time. So this is the idea that usually cap rates decline into a rising interest rate environment. I sort of say, that's not the right thing to be thinking about cap rates decline into a rising instrate environment, because historically that rising interest rate environment is symptomatic of an improving economy, right at a time that your financing costs are actually rolling down, So of course your level re turns expand, which allows cap rates to contract. This time is much different because financing costs are significantly higher, not just because of the risk free rate and widening credit spreads, but also because guess what, growth is slowing. We were in a stag stag stagflationary environment in twenty twenty two that doesn't really exist since like nineteen seventy. It's a much different ball game than what we played before. So just to do a little Devil's advocate question here, but what does the maturity wall actually look like? And even though you know, I take the point that financing costs are going up, but as long as the market remains open, you can still roll over your loan, presumably to infinity. And I can't remember the exact saying, but you know, there's that old joke about a rolling loan gathers no distress or whatever it is. Can people just keep rolling these over in theory? Sure, but so let me maybe answer your question first. So there's about four and a half trillion dollars of mortgage debt outstanding. That tells you, on average, the LTV is around twenty five percent for commercial real estate. That might sound lower than what people think, but reat LTVs or less than thirty percent. Then a crief Odyse index which I mentioned previously, which is high quality core and core plus properties, that's around twenty two percent. So yes, smaller borrowers that don't have enough, don't have a lot of capital, will push the LTVs up to fifty to sixty percent, which you typically see in a CMBs transaction. But debt's around call it twenty five percent of that twenty threeion dollars market. What is actually maturing well on average, it's about you know, call it five hundred billion dollars over the next five years. Each year, so you're talking about call it fifteen to twenty percent of maturing debt coming due each year over the next five years. You're what you should hold up five hundred billion per year, five hundred billion per year and over the next five years, over the next five years, so two and a half threeion dollars over five that makes sense. Yeah, cool. So you're talking about, you know, call it fifteen twenty percent of debt coming due on a pran on basis over the next five years or so. And most of the debt that's coming due in two thousand and twenty three were either loans that were originated in two thousan thirteen or in two thousand eighteen. Now, one of the interesting things about this maturity wall that I don't think a lot of people are really considering is how much property prices generically have risen since two thousand and thirteen. Property prices are up a lot. That doesn't mean they're up for office, that doesn't mean they're up for malls, and we can talk through that, but generically they're up a fair amount. So if you happen to have originated a loan in twenty twenty two when you bought a property, your effective LTV is actually a lot lower than fifty to sixty percent right now given that property and price appreciation, and even if valuations fall ten twenty thirty percent next year, there's a good chance these loans are not in the water yet again or not underwater. Should I say this is not the case for office. I don't want to give you that impression that you know, you're talking about effective LTVs that are you know, probably going to be a little bit higher than that, And it's certainly not the case from malls. Malls effective LTVs we think are you know, around ninety ninety five percent right now, that's probably a pretty good case study, we think for where the office market's going. But office, and since this was a focus of this office, is only about twenty five percent of that fifteen to twenty percent that's coming due? Okay? And who's holding that? And like yeah, so who's who's expose to that? So it's like, okay, Office, maybe if there's maybe one hundred and twenty five one hundred billion coming due over the next each year for the next five years, that sound right? Yeah, yeah, yeah, that sounds about right. So who is who who holds that? Is that it banks? Is it a private funds? Like what's the distribution? Yeah? So Tracy mentioned that we we talked a lot when we were at when she was at the Financial Times, and everyone likes to talk about the commercial mortgage backed security market because it's easy to look at you get spreads. You know, you understand linquencies. You have a lot of really good reporting. The CMBs market is at best twenty percent of the lending market. It's actually not that big a part of the lending market. Not to bury the lead and get where you're going. The majority of the debt coming due is held on bank balance sheets. Okay, we think you know, call it fifty percent. More than fifty percent of the debt coming due in two thousand and twenty three is held to bank balance sheets. Okay, And that does make some logical sense because twenty thirteen, these are ten year loans. In the most part, there wasn't a lot of capital markets activity in twenty just out of the Great Financial Crisis, So if a bank originated a CMBs loan, there's a good chance it's still under books. There's a very good chance it's still on the books. So most of this is held on bank ballot sheets. What sort of comes back to your question at the very beginning, like, how are we thinking about this risk that has been out there but has come a little bit more to the forefront over the past couple of days, given some of the news with bank collapses can you maybe talk a little bit more about underwriting standards throughout the years, because this is something that was a big talking point pre pandemic. You know, CRI slash CMBs. It was a really hot market. You saw a lot of people pouring money into it, and so as sometimes happens, you saw some of the underwriting standards start to slip. Can you maybe like tell us what you saw and give us some examples of the kind of deals that you saw coming through that could in theory be problematic. Now, there's two ways people think about underwriting standards. The first one is sort of headline underwriting metrics, things like loan to value, and the second thing is all the other things that lenders might require or not require to provide a loan to a borrower. So let's talk about LTV first and Foremost LTVs are actually fairly conservative right now, and certainly we're conservative. Heading into the pandemic, they were approaching call it fifty percent LTVs, and that's sort of where they stand right now. I think that might surprise a lot of people that lending standards were actually tightening from a headline perspective. But let me explain to you why that's the case in two thousand. You know, if you would ask me where the upper center of froth was real technical term for lending standards post GFC, I would have told you it was around twenty fourteen. Two fifteen, things were feeling really good. The banks were giving out a lot of money, so much so that the regulators and a joint statement came out and told lenders, hey, guys, you basically have to slow this down, and if you don't slow it down, we might have some regulations. And here's that slapping of the rist, if you will. Actually sort of worked and banks did start to bring in lending standards. It also occurred at the same time that risk retention under Dodd Frank was mandated. So what's risk retention underd Frank? That basically said CMBs issuers had to have skin in the game and they or a third party had to retain five percent of the entire deal for at least five years. And so when you actually have to eat your own cooking, that changes things a little bit. So headline LTVs went down, headlined dscrs went up. These are all good things, but maybe where the devil devils in the details, and you were starting to see a lot more io loans, So interest only loans. These are loans that don't you know, pay down over term and have a blue maturity payment. There was you know, certainly reserves for any number of different things. This is cash that's put on the sidelines, so that those a lot more prevalent pre financial crisis interest only loans, Like I feel like you heard about commercial mortgages that idea, Yeah, I'm gonna be a little bit flipping here, but but anything sort of went prior prior to the GFC. But look, ile loans are are pretty prevalent over the past couple of years. You know, all those all the additional money on the sidelines reserves, if you will, those were sort of you know, not to say they were waived, but but there was less requirements. So while while I think the hard LTVs and dscrs were pretty good, maybe the soft underwriting requirements were or softer than they had been in the past. So a little bit of give and take care, I would say, you know, if anything, it's really a question about where do you think the debt service coverage ratios are going. So coming out of the GFC, there was this concept of debt yield that came about. That's how banks underwrite loans. Debt yield is effectively inoy divided by your loan balance. Prior to the GFC, and certainly the early two thousands loans were underwritten on debt service cover ratio. But after the GFC, no one was concerned about falling interest rates. They were only concerned about falling NI. So you underwrote to debt yield. There's a really good scenario that some loans with really strong debt yields, because NI is pretty good right now, might have pretty poor dscrs in the future, given how much interest rates have risen. So I think, maybe Tracy, to answer your question about like, what's the what's the biggest risk here, I think it's a debt service coverag ray shows NI debt yields could still be above ten percent twelve percent because NI is pretty strong right now. Fundamentals feel pretty good. But if you have a big shock to financing costs, your debt service coveragray show could be a lot lower than two and a half times, which is going to require recapitalization. Let's set aside office for a second. Let's set aside some of the troubled cities. Are there any old pockets that are weak because again, we hear about certain categories of weakness that are obvious that we've talked about them office building in New York. How are some of these other categories I think you said they are like fifteen in total or something like that. Are most of the other ones still looking pretty good or are their weaknesses elsewhere? I mean, you're talking about a reap market that was down twenty five percent in two thousand and twenty two, and if you believe our views that this leading indicator, you know, all the proper types experienced, you know, some level of of of weakness to various different degrees. But a lot of that presumably was like multiply multiples. Right, but but but yes, but multiple is just a fancy way of saying valuation terms. You take one, you know, if you take the inverse of the multiple, that's capriate. But right, So, what I'm saying, are there any other that are sort of like clearly seeing poor revenues or poor rental in the way an office landlord? Yeah, An, the answer is not not really okay, because if you think about NY growth overall in twenty twenty two, you at one point where plus ten percent plus eleven percent in a Y growth on a year of year basis, that's close to a historical high. We are obviously seeing deceleration right now. We're probably around seven percent right now, and we're underwriting even slower in a Y growth in twenty twenty three, given recessionary headwinds that we think are real. But a lot of what's happening here is actually the refinancing risk, and it's because valuations are lower because financing costs are higher. I don't want to make two light of this, but Office in many many respects is the exception to the fundamental story. YEA, many of the other asset classes are having quite fine in a Y growth. But I don't want to be two probably dogs and rainbows over about this because I truly believe that idiosyncratic risks are real. You're going to have some multi family properties that were purchased that really tight cap rates in advance of improving and are accelerating revenue growth, and that business plan is not going to come to fruition. So there is there is some real risks here beyond just financing that that is going to pressure valuations lower across property types. It's going to lead to higher distress, lead to higher delinquencies. Office is the poster child for this. But I don't want to give you the idea that commercial real estate fundamentals are uniquely as bad as office because they're not. We sort of think office is the exception, not the norm. So you mentioned refinancing risk there, and that's exactly what I wanted to talk to you about next. And I'm trying to avoid um sounding like a Judy Bloom novel here or something. But where does refinancing come from? And like, is the assumption that I mean, I assume a lot of it is from banks. Is the assumption that banks are just going to pull back on it in the current environment. Yeah, So where does refinancing come from? First of all, it's banks, it's insurance companies, it's the CMBs market, it's debt funds and mortgage rate it's the GSS in the case of multi family and student housing and seniors housing. So there is a wide variety of financing sources out there. Banks are a big portion of that. Insurance companies are are a big portion of that. CMBs is a smaller portion of that. But but there's a roide variety of of of financing sources. So in terms of refinancing, look, I think a lot of people are focusing on the cost of financing side because that's real. You can see it every day by looking at just where the risk free rate has gone. You know it's at call three and a half three point six percent today. You know it was two hundred basis points lower a year ago. That's a big deal. And when you think about where credit spreads are going, those are wider as well. Tracy, just maybe just give you some live updates on on where these things are. The triple A CMBs market is pricing about one hundred and thirty basis points over the ten year treasury, and the triple B minus market is north of nine hundred at this point. So these are these are those are much wider spreads. The good news is, you know, the CMBs market, the debt markets are actually pricing in all these things that we've been talking about. Yeah, it's not like the CMBs market is you know, naive about this nine hundred over the ten year treasury when the ten ye treasures at three fifty you're talking about it almost a twelve and a half thirteen percent yield. That's a that's a pretty attractive yield given you know the risk of loss. So I do think there is is a lot in the price of where the spreads are right now. But look, availability of debt capital it's probably not going to be, you know, as as robust as it was last year or even twenty nineteen. So when you think about who's gonna be able to get debt capital, I think a well qualified a well qualified sponsor that's well capitalized with a good business plan, they can probably get debt right now, even on an office property, believe it or not. The problem with thought with office just to use maybe an example, is this binary you can get debt at attractive levels or you can't. It's it's it's not like an office. A lender is going to come back and say, hey, guess what, I don't feel really comfortable with you as a sponsor your business plan. I'll give that to you at a thirty or forty percent LTV instead of a fifty percent LTV. That's not the way it works. It's almost like bit out interesting, Wait, why is that is that just like a sort of like norms and cultural thing, or is it does not make business sense to try to deal with someone in those marginals. See all of the above. Okay, yeah, it's if you're going to if you're a lender and you have to go to your investment committee and you're saying, hey, look, I'm going to lend on this office property, you gotta pretty much make sure your eyes are dotted and your teas are crossed. Now. Now, the other reality is lenders are really focused on one thing and one thing only getting their money back, right. And you know, if you don't get your money back, you take a loss. It doesn't matter what that spread was, you're not gonna get paid enough. So just on office I know, we're sort of saying, there's a lot of other categories besides the one. The stairs us in the face every day of New York real estate. But New York office space, the publicly traded instruments that seem to track your office space. I mean they look like really dismal. I don't know, I'm not asking for your like views unnamed, but like, I know, you know, it's like sl Green is a company that you see, you owned a lot of buildings in New York and they're publicly traded, and that was an eighty dollars stock in March of twenty twenty two, and today it's a twenty eight dollars stock. Prior to COVID it was over one hundred dollar stock. Like, what is the market saying, look about this type of property that's getting so hard and for not them specifically, but for someone who owned property like them, what kind of situation are they facing next time they have to refinance a building or you know, remortgage your building or whatever. Yeah, well let me first you know, yeah, yeah, let first be clear that we're pretty cautious on office in our list of portfolio. Look, we have very little office exposure. Why is that the case? Well, maybe to answer your first question, the public markets are telling you that office valuations are going to be down substantially. Why is that the case, Well, it's the it's for three three reasons. First of all, you don't know where the NY growth is going. Okay, it's uncertain. Yeah, I just wanted to make sure. Sorry, sorry about that, which is basically revenue minus expenses for those playing at home. You don't know where your NEBT operating income is growing going. You don't know how much capex you have to spend to generate that NI, and you don't know what amount of debt you can get on it. So if you put NY and capex and financing into it, that's how you get your leveed IRR and cap rates just a product of that. The market is telling you that, the list at market is telling you that cap rates have to go substantially higher. I mean, maybe just to come back and and and and talk about this a little bit more. The listed market, on average across property types is trading at a high five percent implied cap rate right now. The private market, as measured by the Newcrief Odyssey Index is still at three nine. That's a crazy difference between public and private values. Yeah, the listed market is at a high five percent caprate. Okay, so last week it was like at five to seven. It's gonna be wider than that now. And it cap rates is like a inverse P, so that means that's that's in stocks, you would call it twenty P. You call it a five percent capri. So multiples right now for multiples after taking ato account, cap x in the reat space around eighteen and a half times, so you're pretty close. My only point to you is that there's a two hundred bases point difference between where reats are pricing cap rates and where the private markets pricing cap rates. We think, you know, before before we went on, you're asking me, hey, aren't you a little bit more constructive? And I was like, well, look, I am constructive on reets because I think the entry points are pretty attractive here. But the private market, you know, we still think valuations are going down. So if you're a legacy holder of private valuations, you're still gonna have some headwinds and feel some pain in twenty twenty three. But if you have new capital to invest in private, that's probably pretty good. I want to buy low, sell high. I think that's going to happen in twenty three, and I think the reat markets pricing in a more pain than private markets are pricing in right now. Yeah, it does feel like I mean, in addition to interest rates, it feels like the wild card here is basically the availability of capital. Sure, I mean, I'm not pushing back on that at all. I mean, commercial real estate, Tracy, I think you probably heard me say this before, it's inherently a level asset class. So it's financing cost in the availability of capital. I think you're going to quickly figure out who can swim really strong against As the tide's going out, why can't it keep getting worse? And But the reason I ask that is, you know you're like, oh, I want to buy low and still high whicheveryone does. And maybe this is a moment to buy low because there is clearly a lot of distress out there. But you know, again, it was the rates move. You know, we had a forty year down, we had a forty year decline in rates. We're like one and a half years into the increase in rates. Why couldn't, Like, do you worry about higher and higher for longer? Do you worry that that for offices, that there's not a trend that's going to bounce back soon? This is like in these distress cities, distress can build upon distress. The few people not coming into an office can erode an area's tax base and make people wanted to stay home too, Like do you worry about acceleration of headlands? Are you asking me what keeps me out at night? But beyond my forecast, I guess I think the single if I was on here a month ago, Yeah, I would have been telling you the single biggest risk was a stronger economy that begets higher inflation and the Fed has to do more and more to temper that. And so look, I'll be very clear if you know the terminal rate, so that's basically where the Fed Fed funds target rates going. If that's closer to six than six and a half, tenor treasure rates probably before all of this was happening, probably aren't supposed to be at three and a half. They're probably supposed to be a lot higher than that. And so you know, again I'm gonna get wonky here a little bit, but we think real rates are really what drive commercial real estate valuations. Real rates is the different between nominal rates and inflation expectations. I think if real rates go to around one, that's probably pretty good for real estate, but if they're going to be closer to two, that's actually probably not so good for real estate. So yeah, that's absolutely keeping me up at night. Our views heading into this year was that we were transitioning from a stagflationary to a stagnationary market. What does stagnation mean? Well, let me let me first of all say what is the stagflationary environment. Stagflation is where interest rates are rising and growth are slowing. The FED was in a really awkward position in two twenty two for reasons that happened in two thousand and twenty one. They didn't raise rates fast enough, so inflation was at record high levels. They had to raise interest rates at a record pace to slow growth in the economy and the hopes of taming inflation. That's stagflation. We thought, we think, we still think that we're moving into a stagnationary environment. That's where interest rates come down and growth slows. That's actually really good for listed markets. Not so great for private markets because sort of start catching up, but it's pretty good for listed markets. You know. Best case scenario is that all the Fed's medicine starts to work, inflation slows, and they don't have to they stop raising rates, but they also don't have to cut interest rates. The other thing that's keeping me up at night, to be very clear, is that the market's pricing in six interest rate cuts over the next eighteen months. I don't want to see interest rate cuts. I think about when the Fed cuts interest rates, it's because something bad is actually happening. That's not a good thing for the market. So you know, we actually thought we were, you know, sort of in this not too hot, not too cold environment. You know, maybe the unintended consequence of these bank failures is this. It actually a showing that the FEDS interest rate hikes are finally working and it's starting to break some things. And that makes me feel, maybe counterintuitively, a little bit better about where we're going. I hope it doesn't push us into a really deep recession. I think recession is our base case, but but you know, it's the two extremes that me up at night. A much hotter and stronger economy where interest rates have to go higher than where they are right now, and a pretty hard recession, which you know, I would argue that a recession is the base case. It's just a matter of degree. Yeah, So there was one thing I wanted to ask you, and I think Joe and I are gonna try to do an episode that focuses on, I guess the physical challenges of converting offices to residential at some point, but maybe from a financing market perspective, you know, could you have a situation where a lot of these offices do get converted to resie and what would that mean first, CRI investors and lenders in general. Do you know, do CRI people who have a big portfolio of office properties do they suddenly become residential lenders? Or I mean, I guess they would all be classified as multi family. But how would that work exactly? Yeah, it's sort of a good tie into some of the other podcasts that you've done over the past a couple of weeks. Look, let me say in an outset, we do not have enough housing in the United States. I think you've covered that in prior podcasts. We can debate why that's the case. I think you've already covered it, But we don't have enough housing in the United States. So the highest and best use for a lot of these office properties is not office. And you could make a case in New York City that we are have a significant shortage of affordable housing in New York City. So it does make sense if I could make way my magic Verry Wand and say convert from office to multifamily. You're probably supposed to do that for a variety of reasons. It's actually it's actually much easier said than done. For a whole host for different reasons, including zoning. It's not like all of these properties are zoned from multifamily, and so again you could come back to how do you think about commercial real estate. It's a single asset class with a lot of different property types. All these different municipalities have different zoning laws, and so you have to go through a rezoning. It's sort of like the same reason why prior to COVID we were talking. There was talk about, well, let's just make all of these malls industrial facilities. It's just not so easy. There is one off examples where you can get it done, and it makes a lot of sense, but again it's it's not a cure for everything yet. All right, Rich, we're going to leave it there. That was such a good overview of the space, and you know clearly there's a lot going on, but you were very good at walking us through the nuance of the different subsectors and the different way of looking at prices and valuation at the moment. So thank you so much. Sure, thanks for having me again. Thanks Rich, that was great. So Joe, I thought that was a really good walk through through all of these different parts and for me, I guess the most salient thing is what rich was talking about, the discrepancy between the public and private valuations at the moment, because you have seen a lot of the mortgage rates just collapse in recent months, you haven't seen the same pressures on the private side. Although you know, I guess the clues in the name those particular valuations aren't quite as transparent right now. I mean, if you look at like some of them, I mean, you know, listeners like pull up a chart of like Vornado or sell Green, like some of these names, I mean they're real dismal, like below the COVID lows when people were talking about oh, no one would ever go into an office ever. Again, so like between the interest rate increases, between concerns about just like the actual net income and so forth, the public market is given clearly a very grim assessment. Yeah. And then also the definition of CRIS sort of a leveraged bet on interest rates and availability of capital. I think that's going to be a really good way to frame it going forward, because even before recent events and the collapse of Silicon Valley Bank and worries over the wider banking system, there was obviously concerned about what was going on in CRE And it's going to be really interesting to see how this financial crisis shakes out, because if it leads to the FED cutting interest rates, well maybe that would be better from a purer financing cost perspective, but to Rich's point, it would mean something bad is going on in the economy, and it would probably mean that there was less brisk appetite in general out there. Yeah. Right. You know, it's the same intuition with stocks, which is that if the FED is cutting rates, it's probably at a time when revenues are coming down, when net incomes are coming down, Like it's often the case that it goes hand in hand. So ostensibly it seems bullish, you know. I guess to my mind, the question is like, yes, there's going to be some cyclical shift at some point, but you know, this is an area if it's so rate sensitive, well we're coming off like you know, the forty year rate bull market, and it could be that these sort of elevated rates not just stay elevated for years. Maybe they're going to keep getting elevated. I don't think we really have like any I don't think anyone like knows for sure. I mean you could see why it's a stressed area. I did appreciate though, and I do think it is easy for us in New York to think that all commercial real estate is like a handful of half empty buildings and they're like clinics and data center totally. Although Jim Chano's you know, he's he's short the data centers, or he at least was, so he has negative aspects of those. But there's data centers that's its own distinct area. You know, There's there's a you know, assisted living spaces that in commercial real estate, so all kinds of categories. It is crazy to think that with you know, the pace of interest rate hikes last year, you still saw commercial property prices go up as a total, and that, you know, that is because it is not a monolithic sector and it is not just massive office buildings in Manhattan. So I'm sure we're gonna end up talking more about this topic, but for now, shall we leave it there? Let's leave it there. Hey, this has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway, and I'm Joe wisn't Thal. You can follow me on Twitter at the Stalwart. Follow our producers Carmen Rodriguez at Carmen Arman and Dash Bennett at Dashbot. Check out all of our podcasts on Twitter under the handle at podcasts, and for more Odd Lots content, go to Bloomberg dot com slash odd Lots, where we post transcripts. We have a blog and a weekly newsletter comes out every Friday. Thanks for listening. Two