Peter Linneman On How To Make Sense Of Today’s Economy

How can two people look at the same economy but interpret it so differently?

To Peter Linneman, economist and former professor at the Wharton School of the University of Pennsylvania, the phenomenon is like two people standing before the same painting, except one of them is viewing the complete canvas from a distance while the other is up close and squinting to make sense of minute details.

“My view of the economy is to go to an art museum and see a [Georges] Seurat painting,” Linneman told Walker & Dunlop CEO Willy Walker and his audience on the Walker Webcast, broadcast live this week from the New York Stock Exchange. “Seurat was a pointillist, and as you get close, you see nothing except little dots. My point is that if I get too close, I don't understand anything.”

Linneman said a similar dynamic is responsible for many people’s negative view of the economy. However, by not getting hung up on “little dots,” he has been able to predict over the past year or more that the U.S. economy isn't in imminent danger of falling into a recession — something he said the Federal Reserve’s interest rate hikes deserve very little credit for.

Linneman said only about 20% of the U.S. economy is actually impacted by the Fed's rate hikes. Significant portions of the economy, such as spending and job creation in the healthcare or government sectors, aren't sensitive to short-term rates, he said.

Those sectors account for more than half of the economy and have continued to grow in recent years. But the Fed persists in either raising or maintaining interest rates at historically high levels.

“The Keynesian models never worked, and yet they’re constantly surprised it doesn’t work,” Linneman said.

Getting hung up on dots can also distract a person from appreciating significant drivers of the economy, such as pent-up consumer demand for cars, housing, medical care and other necessities, he said. Travel and tourism are also major drivers, including business travel to convention cities such as Las Vegas because people seek in-person interactions. 

However, that same desire for human connection hasn't come to the rescue of the office sector. Even as local economies such as Dallas have added hundreds of thousands of jobs since the start of the pandemic, office vacancy rates have remained elevated due to hybrid work schedules that have businesses rethinking their office space needs.

“There was always a strong positive correlation between net job growth and net space absorption,” Linneman said. “And what we've had for the last three and a half years is a modest negative correlation.”

This recent trend makes lenders wary about working with an office sector whose performance can’t be easily quantified using traditional metrics. As a result, Linneman predicted that the allocation of capital will shift to multifamily and industrial properties and away from office. 

Noting that rents and occupancy levels in the multifamily sector are doing well, particularly in comparison to office, Linneman and Walker talked about the rising use of multifamily conversions to address office vacancies. Walker cited a recent office-to-multifamily transaction that was a “home run of a deal” for Walker & Dunlop. 

Both men said that such successes are relatively unique. The office properties that stand the best chance of a successful conversion to residential tend to be ones that are completely empty of office tenants. 

“What's the biggest enemy of office conversion to residential? It is [office] occupancy between 20% and 80%,” Linneman said, adding that a property that retains a significant office rent roll can be uneconomical for a would-be buyer. “As I listen to people talking about how easy it is to convert office to residential, it reminds me of my friends who have no children talking about how perfect their children would be if only they raised them, right? [Both are] hard. Really hard.”

Looking at the bigger picture, Linneman said it is easy to get a negative perspective on the economy and state of the world from reading headlines. However, what we are experiencing today, while painful, amounts to a “small doldrum” in the greater arc of history — which is why it helps to step back from the canvas to really make sense of what you are seeing, he said.

“We've had good presidents, bad presidents, good Congresses, bad Congresses, high taxes, low taxes, and Republicans and Democrats over my lifetime, and the one [constant] thing is that the U.S. economy grows,” he said. “We don't grow every minute, but we grow, and real estate's a long-term asset, and I'm going to bet on that growth.”

This article was produced in collaboration between Walker & Dunlop and Studio B. Bisnow news staff was not involved in the production of this content.

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