Peter Linneman On The Office Market And Why The Fed Is ‘A Terrible Predictor Of Themselves’

Even as the commercial real estate industry grapples with high interest rates, a highly anticipated presidential election and uncertain capital markets, Peter Linneman has some advice for the sector: Don’t bet against the U.S. economy, as it’s much more resilient than we think. 

On the Walker Webcast on Wednesday, Walker & Dunlop CEO Willy Walker sat down in Chicago with the economist and former professor at the Wharton School of the University of Pennsylvania to discuss today’s most pressing topics, from the nuanced dynamics of the office market to inflation’s sustained impact on the CRE industry and GDP growth — and interest rates, of course.

Linneman is still predicting the Federal Reserve will cut interest rates three times this year, even as the Federal Open Market Committee’s four meetings thus far have resulted in no such cuts. Walker pushed back, saying that right now Linneman “is not even as good as a broken clock” when it comes to making these predictions so far, because “at least a broken clock is right twice a day.” 

“I believe fundamentally in rationality, and [the Fed] just hasn't been data-driven and rational, even though they think they are both,” Linneman said.

Linneman said the Fed has been a “terrible predictor of themselves,” but people often forget that. 

“When people say, ‘But they’re telling you they're not going to cut this year,’ go back to what it was two months before the fastest increase,” he said. “They said, ‘Don't worry, we're not in any hurry.’” 

Linneman added that there is an abundance of capital sitting on the sidelines that the industry is still trying to figure out what to do with. He said that while some of this money is being held as reserves, that is largely because no one in the major finance system, such as private equity firms and lenders, is incentivized to be a first actor.

“They're paid to do things when others are doing them,” he said. “They're not generally paid to take the risk of doing things when others aren't.”

Walker pivoted the conversation to the office market, asking Linneman what he calls the “unsolvable question”: Have office/work patterns changed in the U.S.? 

Linneman said that Kastle Systems, a popular security platform that tracks who is swiping in and out of office buildings, shows that workers are back in the office about 55% to 60% of the time, with some areas as low as 50%. But if you talk to office owners, you get a different picture depending on the day of the week.

“[Building owners] show basically back to normal levels of occupancy on Tuesday, Wednesday, Thursday, with some number like 50% to 75% on Monday and, as Barry Sternlicht once said, Friday is a national holiday,” he said. 

When asked about office-to-residential conversions, Linneman said that while these types of conversions can be successful, you need to meet a certain set of criteria to make them happen.

“When I listen to people not in the business, like politicians, talking about converting all these empty office buildings into apartments, I say it reminds me of people who don't have children talking about how perfect their children would be,” he said. “The point is, it's hard.”

Making deals work in this economy is no easy feat, since this year “money has kind of been available, [but] not as much as you want and not at the price you want,” Linneman said. There is a sense of entitlement to 65% debt at 4% interest, but in current economic conditions, this may be unfeasible, he said.

“Real estate people, if the price of debt goes up, they still want 65% debt,” he said. “If the interest rate is up and your NOI is whatever it is and you want comfortable coverage, you have to deleverage a bit. That's just logical.”

The conversation turned to inflation and GDP, as well as how geopolitical tensions are playing into economic growth for the U.S. 

Linneman said that during normal economic growth periods, the population rate grows at about 1% and productivity grows at about 1.5%, accounting for a real GDP growth of about 2.3% or 2.4%. Any growth beyond this is considered to be a lot, he said. 

The Russia-Ukraine War has caused a 40-basis-point increase in GDP because of the war’s trickling effects for more food, arms, and oil and gas products produced by the U.S., he said — putting any recessionary fears to rest.

“The Ukraine war is a horrible thing,” he said. “However, the U.S. is really good at making defense systems. The world's demand for defense systems went way up, and that net benefits the U.S.”

Walker and Linneman then dove into the topic of single-family housing. Linneman said the country needs 1 million to 1.1 million homes built to keep up with current demand. However, as demand is expected to grow, this number should reach 1.4 million to 1.5 million, a number that he thinks the regulatory process won't allow. 

He said local politics and NIMBYism may be partially to blame, but given that many U.S. homeowners have mortgage rates at 4% or less, no one is in a rush to sell their home.

“I don't know how we make it up easy, I just don't,” Linneman said. “In the near term, it's not only the shortage, it's the people who are locked in. So in addition to this macro of ‘we don't have enough homes,’ we don't have enough used homes either.”

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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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