Deputy Chief Economist at Cushman Wakefield, Rebecca Rockey, joins the Inside Economics crew to talk about the outlook for commercial real estate and the economy in general. After unpacking the week’s economic events and a quick primer on outrigger canoe paddling, Rebecca walks the IE team through the different segments of CRE and how they’re faring. Mark goes through a “what’s bugging me about CRE” list but Marisa can only see the bright side. Finally, Rebecca and Cris discuss their views on the possibility of a CRE doom loop.
Deputy Chief Economist at Cushman Wakefield, Rebecca Rockey, joins the Inside Economics crew to talk about the outlook for commercial real estate and the economy in general. After unpacking the week’s economic events and a quick primer on outrigger canoe paddling, Rebecca walks the IE team through the different segments of CRE and how they’re faring. Mark goes through a “what’s bugging me about CRE” list but Marisa can only see the bright side. Finally, Rebecca and Cris discuss their views on the possibility of a CRE doom loop.
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Follow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight.
Mark Zandi: Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and I'm joined by my two co-hosts, Cris deRitis and Marisa DiNatale. Hi, guys.
Cris deRitis: Hey, Mark.
Marisa DiNatale: Hi, Mark, Cris.
Mark Zandi: We had a busy week.
Marisa DiNatale: Yeah. We saw each other in person for the first time in a very long time.
Mark Zandi: That was kind of cool.
Marisa DiNatale: Yeah.
Cris deRitis: It's very cool.
Mark Zandi: Yeah. It was all-hands day or we had actually two days where everyone came together in Westchester, Pennsylvania, our kind of previous HQ. There's no HQ now, right? We're remote, but it was good to have everyone in person. Did you see anybody that you go, "Oh, you're taller than I expected," or, "You're shorter-…"
Cris deRitis: Absolutely.
Marisa DiNatale: Yeah, that happened a lot.
Mark Zandi: That happened to me a lot.
Marisa DiNatale: Yeah.
Mark Zandi: Yeah. All right. Do you want to name names? No, you don't want to go there. No, that's all right. Right. Yeah, but it was a good two days. I think remote is... This is Mark Zandi's view. I think remote's working well, but you got to have these events where you get together and see each other. It just doesn't work otherwise. You guys agree with that?
Marisa DiNatale: Yeah.
Mark Zandi: Absolutely. Yeah. Yeah, very much so.
Cris deRitis: Probably more than once a year too.
Mark Zandi: That would be nice. That would be nice. In a nice spot, it doesn't have to be in Westchester, Pennsylvania, does it?
Cris deRitis: No, it does not. We could go visit Marisa next time.
Mark Zandi: Yeah, I'd be all for that.
Marisa DiNatale: Yeah. I don't know if we have the budget for that, but yeah. That would be nice.
Mark Zandi: She's in this hoity-toity... Where are you, Laguna Beach or something? I don't know. With the movie stars?
Marisa DiNatale: Yeah, I'm in Dana Point.
Mark Zandi: Oh, Dana Point. Oh, yeah. See, Laguna Beach isn't hoity-toity enough for her. She has to say Dana Point.
Marisa DiNatale: I think Laguna Beach is a little more hoity-toity.
Mark Zandi: Are you a surfer? I mean, I think anyone who lives on Dana Point has to be a surfer. Isn't there like a Ritz-Carlton on Dana Point or something?
Marisa DiNatale: Mm-hmm. There is.
Mark Zandi: Yeah, and you look down into the ocean and there's surfers all the time in there, aren't there?
Marisa DiNatale: Yeah, that's big surf beach right below it.
Mark Zandi: Right, and you see the seals and the sharks and all that kind of stuff? No?
Marisa DiNatale: I don't know about that, Mark. You see the surfers.
Mark Zandi: I thought there were sharks. Anyway.
Marisa DiNatale: There are.
Cris deRitis: Marisa's a paddler.
Marisa DiNatale: Yeah, I'm a paddler.
Mark Zandi: Oh, is that right? Interesting.
Marisa DiNatale: Outrigger canoe paddler.
Mark Zandi: What does that mean exactly, outrigger canoe? It's a canoe?
Marisa DiNatale: It is. It's a Hawaiian sport and I'm on the Dana Point team. It's a team. So it's a racing team. So six months out of the year, I do this three days a week, three to four days a week, and we race other teams up and down the Southern California coast. Some people go to Hawaii to do races. Yeah, it's a big part of my life, Mark, outside of worrying about economics.
Mark Zandi: That is cool. Is it an Olympic sport?
Marisa DiNatale: No, it's not an Olympic sport yet, but my coaches certainly treat it as if it's an Olympic sport.
Mark Zandi: Oh, you have coaches too?
Marisa DiNatale: Oh, yeah. It's a big-
Mark Zandi: Oh, it's serious.
Cris deRitis: It's a real thing. It's a real thing.
Mark Zandi: It's a real thing.
Marisa DiNatale: It's a big deal here, yeah.
Mark Zandi: Oh, wow.
Marisa DiNatale: Yeah. This is the largest and oldest outrigger... The Dana outrigger team is the largest and oldest outrigger team in the United States, and the women's team in particular is the best in the world, I would say. Maybe Tahiti's better, but our top crews are... Yeah.
Mark Zandi: I know crew, where you race in a straight line. Is that kind of sort what you do here, you race in a-
Marisa DiNatale: No, no. So these are longer races, so our first couple months are 10 to 12 mile races, then the last part of the season are these Nine-man races where there are 30-mile races and you switch paddlers out in the water. People jump in the water, the canoe comes, the people in the canoe jump out one side and the people getting in the canoe get in the other side. It's like a relay,
Mark Zandi: That is so cool.
Marisa DiNatale: And you have one paddle, right? Cruise oars, you're rowing. This isn't rowing, you're paddling. You do several strokes on one side and then everybody switches over to the other side. So every other person is paddling on a different side of the canoe. Six people in a canoe.
Mark Zandi: My whole worldview of you just changed completely. I thought you were this Maven statistics game player, but you're a Maven statistics game player and an, what did you call it, outrigger canoer?
Marisa DiNatale: Yeah.
Mark Zandi: Cool. Very, very interesting. Cris is much more boring than you.
Cris deRitis: Oh, yeah.
Marisa DiNatale: No, Cris is pretty interesting.
Mark Zandi: We're going to have to dive into that. I know he likes bocce ball, I know that. He's big in the crypto markets, I know that.
Cris deRitis: You got me pegged, Mark.
Mark Zandi: I got you pegged. Man, I got you pegged. And I know you like going to Italy in the summertime for three, four, it feels like six, eight weeks he's sitting in some wine cellar somewhere, sipping something while he's chatting with us.
Cris deRitis: We can dream, right? We can dream.
Mark Zandi: I called you out, man. Yeah. Anyway. Well, we have a guest, Rebecca. Rebecca Rockey, good to see you.
Rebecca Rockey: Yes, thank you for having me, Mark.
Mark Zandi: Did you know that about Marisa, Rebecca? Did you have any idea?
Rebecca Rockey: I did not, and my worldview just changed us as well actually. So we're in the same boat. No pun intended.
Mark Zandi: Yeah, right. And Rebecca, you're the... What's your official title? I know... Deputy chief economist at Cushman & Wakefield? You are? Yeah.
Rebecca Rockey: That's correct.
Mark Zandi: Yeah, and maybe you can tell us a little bit about you, how you landed at Cushman & Wakefield and became deputy chief economist, and maybe a little bit about Cushman as well, because we're going to talk about commercial real estate and obviously Cushman's a force in CRE, and maybe can tell us a little bit about that as well.
Rebecca Rockey: Sure. So I ended up in CRE kind of by accident, but from what I hear that is sort of normal for the industry-
Mark Zandi: And Rebecca, can I ask... Can I ask, while you're telling us the bio, can you fill in, are you like an outrigging canoe kind of person or something similar? Do you have any of those things going on? I'd be very curious just so I get the right worldview of you.
Rebecca Rockey: Yeah, so on the side for 15 years I did teach fitness classes, and I spent a great deal of time doing indoor cycling. I taught for Flywheel before the pandemic. For five of the final years I did that. Had a small business that ran boot camps and taught kickboxing and all kinds of random stuff.
Mark Zandi: Oh, so you're in great shape. You and Marisa can hang out.
Rebecca Rockey: I was. Yeah. Well, probably not ready to compete with Tahiti's outrigger canoe team. But yeah, definitely enjoy being active. I have a 20-month-old, so things have changed a lot, but that's really fun as well. Yeah, so I had that sort of-
Cris deRitis: Sorry, I didn't mean to interject. Yeah.
Rebecca Rockey: No, to let you know, that was my... I would moonlight at night as a fitness instructor at 6:00 AM. But yeah, I ended up in CRE sort of by accident. I moved to D.C. originally and was thinking I was going to go into international development. I was really fascinated by microfinance and I just thought this is where I'm going to go, and turns out some of the more quantitative work in that field, it was a bit nascent at the time, and that was something that intrigued me, was doing more quantitative work, and I actually don't remember applying to the Congressional Budget Office, but evidently I did, and I was hired in the financial analysis division and did a lot of work. And actually my first manager was Deborah Lucas, who's now at MIT. I was there under Doug Elmendorf and Damien Moore was my manager when she left.
Mark Zandi: I didn't know that. That is so interesting.
Marisa DiNatale: Damien told me that when I saw him the other day. Yeah.
Mark Zandi: For folks out there, Damien is with us at Moody's and manages our financial economics unit, so that's really cool. I didn't know that. That's really interesting.
Rebecca Rockey: Yeah, I was there in that research assistant role that's very typical of CBO and the Fed, worked on a lot of federal credit, sort of FICRA-related work. The group I was in did a lot on the GSCs, but I was sort of working on the first fair value, comprehensive fair value estimate of the federal credit programs, which at the time was about, I think, 3 trillion in outstanding exposure. And so definitely did not arrive with that expertise. So it was a great experience. I have very fond memories of CBO, and of course, keep in touch with many people, including Damien, from those days. I left there, I briefly went into consulting. Fannie Mae was my primary account that I was working on, doing modeling of loss reserves and things like that. It was not quite the best fit and it wasn't that it was being at Fannie, it was just something was not quite a fit, and one of-
Mark Zandi: Were you at Fannie? Did you go to Fannie, or you-
Rebecca Rockey: Well, I was consulting for them, so I was basically there.
Mark Zandi: Cris is a Fannie alum, yeah.
Rebecca Rockey: Yeah, yeah. And I got a call randomly from a guy I was friends with at CBO and he said, "My wife is a land broker at Cassidy Turley. They're looking for an economist who's going to sort of be the right hand for the chief economist. I think you'd be a good fit. Do you want to kind of explore this?" And I thought, "I really don't even know what Cassidy Turley is, or commercial real estate," but I thought, "Why not? I'm not loving what I'm doing," and so I went and I explored this option. I got an offer and decided to go into commercial real estate. I just had my 10-year anniversary in January, but the firm has gone through a lot of evolution. So I joined in January 2014. Cassidy Turley was a sort of large player in the U.S. market, but it was not a global firm. We merged with DTZ pretty much within that first year. I think it was January of 2015 or so, and we became global in that merger.
Then nine months later we merged with Cushman, and we were already global at that point, but we became now the third-largest commercial real estate firm in the world, and since then it's been a journey. The company's evolved a lot, we went public, we went through a pandemic, and the market has changed tremendously over that 10-year period. So I think what I love about CRE is it touches everything from policy to demographics to technology to the economy. Every property type interacts with the world we live in different ways. So it's just really interesting and that's what I fell in love with. Our firm is, as I mentioned, the third-largest in the world. Last year, revenues of about nine and a half billion. We have about 50,000 employees around the world, around 400 offices or so. So we're pretty large.
We're full service, so what that means is we don't just do brokerage, although we do obviously have a tremendous brokerage business, and for those of your listeners that aren't familiar with CRE or full service brokerage firm, brokerage is really just for representing buyers and sellers in the capital markets, and we're representing landlords and tenants in the leasing markets. But we also offer things like valuation and advisory. We have property management, asset management. We have a global occupier services business to really bring together all of our functions to serve the largest occupiers of real estate in the world, and in many cases, they own and rent assets across different kinds of property types for their business, and we offer a slew of other services, but that gives you a flavor for the kinds of things that we do and really having more tentacles out there than just transactions.
Mark Zandi: And you're around the world at this point, so you're global?
Rebecca Rockey: Yeah.
Mark Zandi: Yeah. That's such a cool history. I didn't know that. Can I ask who's one and two? When you say Cushman's number three, who's one and two?
Rebecca Rockey: CBRE and JLL.
Mark Zandi: JLL. Okay. Okay. Interesting. Very interesting. Well, we're going to have to have you back to talk about fair value. I know that's a Debbie Lucas thing, but I've got my own pet theory about... We probably shouldn't go down that rabbit hole, but no.
Rebecca Rockey: About the discount rate?
Mark Zandi: Yeah. Yeah, exactly.
Rebecca Rockey: Yeah.
Mark Zandi: But anyway.
Rebecca Rockey: It was a contentious thing. OMB was very stick with FICRA. CBO is just saying we should have this second estimate that's more fair value, more representative of the credit risk embedded in that discount rate.
Mark Zandi: Yeah, it is a whole thing. Probably shouldn't go there because you got to explain FICRA. Yeah, but it's a very important, because a big part of what the federal government does is provide a backstop to all parts of the financial system, and provides credit, backstops the availability of everything from small business lending to mortgage lending and everything in between, and the question is how do you assess the impact of all that on the government's budget? And that's a complicated issue and actually has enormous implications. How you do the accounting has enormous implications for what you can do here or not do. But anyway, but we're not going to do... We'll have you back if you're willing to go into that can of worms.
Rebecca Rockey: I'd love to get Damien for that one.
Mark Zandi: Oh, yeah. Yeah. Actually, I haven't talked to him... I guess I've talked to him. You know Damien, he's one of these guys, you talk to him and you're not sure where he stands after you talk to him. If you talk to me, I'll tell you exactly what I think. Damien, I guess a little bit more academic, right? I mean, he thinks about it from all sides and second order, third order conditions, that kind of thing. Before we dive into the commercial real estate market, let's talk a little bit about the economy because that's obviously key to what's going on in CRE, and maybe the way we can do this, and I'll turn it back to Cris at this point just to talk about, got a plethora of... How about that for a big word, plethora? Is that a big word? Yeah, I think it is. It's a good word.
Marisa DiNatale: Medium word.
Rebecca Rockey: It's a good word.
Mark Zandi: Medium word. A medium word. ... A plethora of data this week. And maybe the question is to Cris, after seeing all this data this week, how are you thinking about the economy? What do you think, stronger, weaker, better, worse?
Cris deRitis: Yeah, I'd say the word comes to mind is resilient. Incredibly resilient, right? It seems like months or weeks ago, but past weekend we had the Iranian attack on Israel. So Monday morning the mood was things are going to fall apart here in terms of oil prices spiking, but despite that, we've seen things kind of hold together, and then we had a slew of reports this week on the U.S. economy that indicate that consumers remain relatively strong. I look at the retail sales report, shows consumers are still spending, still willing to spend. So I think there's a lot of strength here. There are certainly some... As usual, we can always point to some causes for concern, but overall, it still seems like a very robust, resilient, strong economy.
Mark Zandi: Yeah. I mean, the events in the Middle East played out at least... Well, it's still a script being written. It's going to be written for a long time to come, but at least the script that's written over the last few days probably couldn't have been any better given what happened last weekend when Iran attacked Israel. I mean, it feels like... Of course, the Iranians didn't, it feels like they didn't really want to do a lot of damage, they just wanted to send a message, and the Israeli response... Whereas this Friday the 19th, the Israelis responded by doing an attack in Esfahan in Iran, but they didn't want to do much damage either. They just wanted to send a signal that, "Hey, we can bomb in Iran as well." So it feels like couldn't ask for a better outcome given where we were a week ago. Agreed?
Cris deRitis: Well, you can always ask for more, right? It's still a very tense situation, to your point.
Mark Zandi: But oil prices are down, they're not up.
Cris deRitis: Correct. Right. But I think you need to emphasize your point about this script is still being written. This is just the first round in some way. We want to get fearful that we've kind of opened the Pandora's box here now. It's no longer off limits for these countries to attack each other directly. So still need to be cautious here, but at least for now, this seems like it was a more measured response.
Mark Zandi: Hey, Rebecca, do you watch the economic data just as closely as obviously we do? I think you do, don't you? You're all over the data.
Rebecca Rockey: I do. I pick and choose the ones I pay more attention to than less, but I absolutely watch the data and the markets every single morning.
Mark Zandi: Mm-hmm. And what's your sense of things at this point in the economy?
Rebecca Rockey: I would echo what Cris said. Well, one is resilience. Two, I've been sort of surprised to the upside about how oil markets have responded to what's going on. I would've guessed if you had asked me last week if this happened, probably oil would be closer to 90 than to 80, but that's obviously not the case, and generally, I think we can agree that's good for U.S. consumers in the U.S. economy that oil prices didn't spike in any way. But looking at some of the data that came out this week that are relevant for CRE, we saw retail sales. Again, Cris mentioned that. Pretty robust report on the back of some weaker reports, but we generally tend to see weaker reports at the beginning of the year. So that was moving in the right direction.
I also look manufacturing, we got some early indications last month from the ISM. Things could be stabilizing there. We saw some more diffuse activity in the manufacturing output, capacity utilization still low, but kind of at least moving up a little bit. So those were the two that I looked at a little bit more closely. I don't want to talk about the other one because I might use it for the statistics.
Mark Zandi: I'm glad you're going to play. I have a feeling you're going to be really good at it. So the retail sales, obviously for the retail part of CRE, and we'll definitely come back to that in a minute or two, and then industrial manufacturing activity. You mentioned the ISM, the Institute for Supply Management. I think that's what it's called, right? The purchasing managers, which gives you a read on manufacturing activity, and that feels like it's starting to perk up here a little bit, and that's a good thing for the industrial market.
Rebecca Rockey: Yeah, and for freight markets, which a lot of the freight activity is generated from the U.S. manufacturing sectors, and that has been really experiencing some tough conditions. I wouldn't expect those to turn quite one-on-one with manufacturing parking up, but if it's sustained, that's a really good indicator for where the freight markets could head.
Mark Zandi: Mm-hmm. Hey, Marisa, anything on your radar screen?
Marisa DiNatale: Yeah, I was just... After yesterday's events with Israel attacking Iran, I was scared to look at the oil market, but I was surprised that prices were actually down. Jobless claims still not going anywhere. We got median weekly earnings too. They're falling on a year ago basis. They're three and a half percent year-over-year. That's BLS data. So that's good from an inflation standpoint, which is good to get some positive inflation data. I guess home sales were not good, right? Home sales fell quite a bit, but as Becky said, the manufacturing data was good. We got industrial production data, that was positive as well. So yeah, it's remarkably resilient so far.
Mark Zandi: Yeah, I was looking at those unemployment insurance claims, because those are the window into layoffs, and it's like someone is drawing a line.
Marisa DiNatale: Yeah, it went from like 211 to 212. I mean, they've been in this 210 range forever, it seems. They're not going anywhere.
Mark Zandi: And the moving average, I think, I'm making this up, but it's like 215 or it's 210, and it's been that way for a long time. I've never seen anything like it actually. It's pretty bizarre. And 210 is low. That's a low level of claims. So Rebecca, obviously for CRE, interest rates matter a lot for lots of different reasons. Given the resilience of the data, and of course last week we were talking about inflation, we got all that inflation data, which was on the hot side. CPI came in hot and interest rates have pushed up here a little bit, and expectations for the first Fed rate cut had been pushed out. What's your view on interest rates both of the Fed, in terms of long-term rates?
Rebecca Rockey: I think... Well, I'll start with the Fed. We had been in the June camp for the first-rate cut up until the CPI report, and I think coming into that report, I knew as well as our team knew, we need to see some really almost perfect reports for the next few, given how many jobs the economy is creating and so on, and for CPI specifically, you can go back to last summer and see on the three-month annualized rate basis, it started to pick up, and this was just a continuation of that. And so we knew we needed to see that pattern start to reverse and when didn't, when it came in hot yet again, and the Fed's been very clear, "You've got to have multiple reports that tell us this is moving in the right direction." Although, it's not their preferred measure, they look at everything and it really was the nail in the coffin, we think, of the June cut. Markets obviously generally agree.
We did push our first cut out to September as well, and we had a September into December cut, so we were thinking three 25 bips each. Now we pushed it out to September. Really, my view on that is for September to happen, we do need to start to see those improvements and consistently, and we're really hanging our hat on housing inflation starting to unstick a bit. So if you look at housing inflation, PC or CPI, it's been kind of leveling off on a six-month annualized rate basis. So that should come down with a lag. That lag is just taking longer than we thought, and I think really than anyone thought, but assuming that that historical relationship reasserts itself, given the importance of housing in either index, even though it's lower than in PC than CPI, we would think that the Fed would also want to get ahead of any further slowing in the economy given how monetary policy does operate with long and variable lags.
So we're still holding onto the September call. We acknowledge the risks of fewer rate cuts has gone up than even, that more no landing scenario. I think Apollo's chief economist has said no rate cuts this year, and he's been there for some time. I think the likelihood of that has gone up. That's not our base case, put it that way. On the long end, there's no doubt about it seeing a four, five-
Mark Zandi: By the way, maybe on the Fed, just very quickly, because our forecast is the same. We had a June with a cut in a quarter point, then one in September, one in December, and with the CPI report, that dashed the prospect for June cut. So we now have a September cut and a December cut and then a quarter point each quarter after that in '25 or into '26, but I'm beginning to wonder if I were sitting at the Fed, and we're talking now September, right before the election, and clearly this election is going to be very contentious. It's going to be close and very contentious, and very easy to see the Fed getting politicized. In whatever decision they make, they could get politicized, if they don't cut rates, if they cut rates, but it feels like they have a much greater chance of getting politicized if they cut rates in September because that's right in the teeth of the back and forth politically.
I'm beginning to think if I were sitting there, if I'm going to wait till September, I might as well wait till November. November would be just right after the election to cut interest rates. What do you think of that kind of thought process?
Rebecca Rockey: It makes sense. I mean, I don't disagree. The whole political cycle is just starting to ratchet up, and it's going to be intense this year. My hope, and I think what they iterate is data dependence being independent and having that as part of their reputation and credibility I think is still a way that we think about the Fed, but I don't disagree it's a possibility that they just want to abstain from having any kind of influence on outcomes and weight. It is a possibility. I think on the margin two months till you cut 25 bips. I mean, I don't think it makes or breaks the economy in that way, but I do think we haven't moved our base case to that because of the election or something like that.
Mark Zandi: Yeah, I think Cris wants to move it to November, don't you, Cris? The first-rate cut.
Cris deRitis: Yeah, I'm leaning that direction. I think the threshold for September for our first cut is really high. You really need that perfect set of reports that Rebecca mentioned. I'm just not clear we'll get it.
Mark Zandi: And by the way, this is all about-
Marisa DiNatale: If you don't get it, then why not wait, right?
Cris deRitis: Yeah.
Mark Zandi: This is all about what are they going to do, not what they should do. They should be cutting interest rates in my view, but anyway, it's a whole different kind of discussion. So Rebecca, long-term interest rates. So the 10-year treasury yield didn't look today, but we've been hovering now at four and a half percent kind of on the high side of the range it's been in over the past year. We've been kind of close to four, up to four and a half. Actually, we've got a little as high as five for a brief period of time, but back in, so where do you think the 10-year yield is going to be over the course of the next year or two?
Rebecca Rockey: As we look at a year or two, we think it will settle down into that 4% range. Obviously there's a lot of movement in any given period, and I have to say, I mean, obviously this resilient data has been feeding into a shift in expectations for Fed funds policy. Fortunately, we've continued to see, as you guys probably know, throughout the pandemic, expectations have remained very anchored, but the growth outlook is continuing to be revised up across consensus forecasts, including our own, and so I think that may create some of that upward pressure in the near-term, but ultimately, we think kind of what happened last year when we had that rally to five, it ultimately came back down into the 4% range.
I mean, the Fed will ultimately, with through forward guidance, whether it's later this year or some other time, start to give guidance on the pivot, and we would expect as they start to normalize monetary policy, we should see the tenure come down, and roughly... If you believe two and a half percent are star, which I know that's a moving target, that's unknown, we would expect something like 4% over the medium term. That's where our forecast is at, kind of range bound 3.8 to 4.2 over time.
Mark Zandi: Yeah, we're kind of in the same place, same ballpark for similar reasons. I think the stake in the ground for us is nominal potential GDP growth, which is about four to four and a half. That's 2%. Actually, real growth feels a little stronger right now for labor force growth, productivity growth, so maybe we're two and a quarter, something like that, and then you throw in 2% inflation, that's four and a quarter. In the long run, abstracting from the vagaries of the business cycle, those two things should be roughly equal to each other, and they are, if you look historically. So it feels like we should be somewhere in the low fours, something like that at this point in time, but that makes... Of course, we're all going to be wrong about this for sure.
Rebecca Rockey: Yeah. One thing I would say is what we saw in CRE at least, with coming off of the 5% and then being stable at four, we were seeing the market respond well to that. CRE can operate in 4% treasury, 4.2% tenure treasury. It's that volatility that really creates issues in the market. So I'm sure we'll dig more into that, but that's been a little bit of, I think, cold water and sentiment that had been persisting in the first three months of the year where we were really seeing some unlocking in the markets, and we'll just have to watch how temporary this rally to 4.6, 4.7 is.
Mark Zandi: Well, maybe it's a good point to go right into commercial estate. So I know you're play-by-play in the CRE market, but most of us aren't quite as play-by-play. So what were saying is if you go back, if you rewind to end of last year, six months ago, the sentiment was pretty dark. Rates had gotten up 5%, CRE prices were starting to come in. There was a lot of discussion of the so-called commercial real estate CRE doom loop, and we can talk a little bit about that, but you're saying at the beginning of this year when rates came back in, when we got back down to a 4% 10-year treasury yield, and it felt like the economy was going to avoid a recession, and now we're talking about how resilient it is, lots of jobs and retailing and so forth and so on, the sentiment has improved. But then now you're saying with the backup in yields, things feel a little less-
Rebecca Rockey: Yes, sort of just skittish like, "What's going on?" I think it just tends to create a momentary pause, because if you really think, "Oh. Well, we'll get it down to four really soon," then that can have a real impact. 50 basis points can have a real impact, and that quick and swift movement, the volatility is we call it kind of the enemy of transactions, and we'll just have to see how long that lasts. I think another part of the sentiment coming into this year was not only getting away from the 5% range, which probably scared us all to a certain degree for different reasons, but the shift in forward guidance from the Fed, right? Seeing that the terminal rate is likely the one that we're at. Now, we could debate that, some people are, but we tend to think it is, and they've sort of reiterated that in their recent communications.
And that forward guidance really, I think, sparked belief and conviction in the notion that CRE is nearing bottom, especially on the capital market side. The pricing is in private markets, likely bottoming the first half of this year. That was sort of what we were calling for, and so with that combined with Fed saying, "Hey, we think we'll probably be cutting rates next year and the 10-year's coming down," all of those things I think created some sentiment and tailwinds for CRE capital markets. I still think they're there. This one week of data I'm not going to extrapolate for even the whole month or quarter, but the kind of thing we saw this week is really just introducing that uncertainty, the uncertainty of interest rates that really creates more hesitance in transactions, and once we see stability, that's when we start to see people move forward with decisions.
Mark Zandi: So your thought or thinking is that commercial real estate prices broadly are near a bottom? Is that what you're thinking?
Rebecca Rockey: Broadly, yes.
Mark Zandi: Really? Okay.
Rebecca Rockey: It depends on the asset class, of course, as I'm sure we'll talk a bit about, but we do think in private markets, middle of this year will be the trough and the second half of the year we're not going to see crazy double-digit price growth or anything like that, but we'll see probably some stabilization at that trough and then we think we'll start to see some value growth next year.
Mark Zandi: And when you say prices, what do you use? Do you use our price... You should be using our price index from, Rebecca, I'm just saying.
Rebecca Rockey: Well, we certainly do have that in our toolbox. We look at it.
Mark Zandi: What do you use when you say prices are going to bottom? What is it that you're measuring?
Rebecca Rockey: Well, we look at a lot of different measures. So there are different price indices and some are repeat transaction-based, like yours, and we look at those. Some are appraisal-based, and we look at those. Those tend to lag a little bit if they are truly based on appraisals. Green Street has a more novel method with real-time appraisals in not necessarily using appraisal methodology that appraisers use to determine what they think is happening to values, and they tend to lead private markets, so they do give us a good indication with a bit of a lead to other indices, but of course, we also think about things like cap rates. We construct our own price index using some NACREIF and RCA data, and we look at all of them, and try to think about broadly what's happening. And then of course, we also have intelligence on the ground, what we're seeing in spot cap rates and bids that we're fielding on behalf of buyers and sellers.
So all of that points for most property types, absent the tenure really remaining anchored where it is, but if it were to hang out where all of us think it's going to go, that we're likely near that trough. And we're seeing that with institutional investors starting to make actions based on that. You've seen some major transactions happening with debt funds, equity funds the first part of this year under the premise of we want to get in before that value growth starts, we want to get it in the window at trough pricing.
Mark Zandi: Yeah, it's interesting... For folks that don't follow the CRE market... And I follow it and then I don't follow it because I'm following something else and I come back, whenever there's a problem in CRE, I'm following it, and of course after 35 years of being an economist, I followed it a fair number of times. I'm always amazed at all the acronyms and different ways of measuring things, and you can get some very different perspectives, particularly in terms of price. You say, "How hard can it be to measure a price?" Well, it's really hard. It's really hard.
Rebecca Rockey: It's very hard.
Mark Zandi: Yeah, really hard to do. So Cris, let me ask you, and everything you just said is in your baseline worldview, meaning no recession, resilient economy, interest rates kind of hanging around the low fours, that kind of thing. You're saying prices are, broadly speaking... Yes, it varies across property type and regions, so forth and so on, but broadly speaking, we're near a bottom. Cris, is that... Because Cris spends a lot of time on CRE too and he manages the construction of our repeat sales indices. What we do is we get all the transactions that occur and know what the price is, and then we look at prices for properties the last time they transacted, and based on that, we can construct an index, and in theory, it controls for mix issues and that kind of thing. Cris, we're not saying there's a bottom, are we? We've got more to go here, don't we, in our forecast?
Cris deRitis: Our view based on our index, certainly yes, that there is more to go, particularly, and maybe this can start to pivot into some of the property types, it's office. For us, office is just still at the beginning of its real correction.
Rebecca Rockey: Yeah, that's the one exception to the rule of what I just said.
Cris deRitis: Yeah, one exception. Yeah, but you're right. If you look at multifamily, it's already come down a lot. We don't expect there to be much more of a correction here. It just may take some time for it to grow at a very robust rate. Just plateau here for a while as things adjust, but then other property types, industrial certainly looks great. It's actually continuing to grow. Retail, it's pretty solid. Hotel even looks pretty good. So I don't know that we're too far apart, right? Maybe a bottom is a little further out for us because of maybe the wait on office, but yeah, I think the story kind of holds here.
Mark Zandi: Hey, so I'm looking at the clock here. I think we've been at this for 45 minutes already. I don't know where the time went, but this is what I want to do. I want to talk a little bit about the individual property types and for each one of them that I want to focus on, I've got something that's bugging me. So I'm going to ask you to help un-bug me with regard to... Then we're going to play the game, The Stats Game, and I got a great statistic that no one's ever going to get, but it's a great statistic, but I'm just saying, and then we'll come back and then we'll end on the reassessing this idea that there's this commercial real estate doom loop very quickly. We won't dwell on that, but just a little bit on that. Does that sound like a good game plan? Everyone okay with that? Okay.
So on what's bugging me, obviously the office market is kind of front and center for concerns because remote work, vacancy rates have risen quite considerably, rents have actually held up pretty well, I guess, so far at least, because leasing takes a while to really filter through. But when I look at office, I have a hard time constructing a scenario where that ever comes back. Remote work is here to stay. You can see it in the swipes data. There's swipe cards where you can see it in the number of people going into the office and they're not coming back, and these kind of leveled off in most markets across the country well below pre-pandemic.
And then we've got this demographic thing going on where the number... We've gotten a little bit of a bailout here because of all the immigration, but once we get past that, everyone's retiring and leaving, and the number of people in the labor force isn't going to grow nearly as quickly, therefore you're going to have fewer jobs, so less demand for space, and it is hard to convert a lot of these office properties, I think. So isn't office going to be a problem for ever, Rebecca, or am I overstating the case?
Rebecca Rockey: If it is a problem for forever, I think fortunately in the long run we're all dead, but I think it has the transformation to go through. There's no doubt about it, and it's just a matter of which office we really dig into. So it's absolutely true that vacancy rates have been rising in most markets around the country. In some, not as much, but there are, I think, important underlying themes there. So one would be the smaller the market, the greater the return to office has been, the less significant the supply wave, and actually the increase in vacancy has been very marginal, maybe 250, 300 basis points.
Mark Zandi: What would be a good example of that? When you say smaller market, what would that be?
Rebecca Rockey: You could put like a Boise, a Palm Beach, a Fredericksburg, Virginia, Omaha, Nebraska, anything that's... We consider them sort of tertiary markets would be how we describe them, and I point that out because that's where a lot of smaller banks or lending. So when you worry about office exposure, the smaller the bank, the more likely their exposure is to these more resilient markets on the fundamental side. As you move into secondary markets, we've seen a more significant increase in vacancy. You've seen more influence from the supply side, which will thin out and it's thinning out very, very rapidly. So examples of that would be Charlotte, Nashville, Salt Lake City, Raleigh, Durham. They've had a huge supply wave that has contributed to a large degree to that increase in vacancy.
So on net, for example, Nashville has had positive occupancy gains. In terms of the level of occupied stock has gone up. There has not been what we call negative demand or negative absorption. Their vacancy has gone up because they're building a lot, and they're experiencing tremendous office job growth as migration patterns benefit some of these lower costs on belt markets. Of course, we do have an issue in some of the more larger cities, including our gateway cities. In those markets, vacancy has gone up about 12 percentage points, and there's no doubt that there is obsolete office product out there, that the impacts of remote work will be lasting, and that they will structurally impact demand.
The way that we think about that is one is we have a transition to get through, and then on the other side, for every new office job that you get, you get marginally less demand. So you want to think about that from a longer term basis, but you also have to account for the adjustment of all the existing office leases that house the 33, 34 million office workers that we had before the pandemic, and figure out how they're going to adjust. Now, our weighted average lease term across the 5.4 billion square feet that we track is eight and a half years. In larger cities, it's about 10, but in the aggregate it's about eight and a half. If companies that had space before the pandemic were just downsizing by 20% because of hybrid work, our vacancy rate would be roughly 40%, but it's not.
It's 20%, because not all companies are downsizing, not all companies, if they are, are downsizing by 20%, some companies are expanding, and we have this offset that we account for in how we model that, a disproportionate share of new jobs, even as demographics drive job growth lower over time are created in knowledge sectors that use office space and all of those things point to after this adjustment and transition period, which we're still in, that we will on the margin start to see incrementally positive absorption in, we think it'll probably be late next year, more likely 2026, onward, and that we'll start to see these gains re-accrue, but you're going to have this overhang of vacant space.
And so right now we've just hit, for the first time ever in our data, 20%. 20.2% vacancy is the first time we went over that threshold. We've estimated that roughly 30% of that is just obsolete. It needs to go. And so I think of the transformation is we're going to be removing stock over time, and it's the weakest stock. I didn't think this was a fair stat for The Stats Game because it's obviously a Cushman stat. You wouldn't know it, but-
Mark Zandi: All's fair in that game.
Rebecca Rockey: So class A is in fact about half of the office market, and people say, "Oh, B and C are really where it's hurting the most," and that is true, but there's a lot of class A that is struggling as well, more commodity, older class A, especially suburban office parks and so on. So when we look at the overall class A vacancy rate right now, it is 22.8%, and just remember all new construction hits class A, so there is a supply impact in that vacancy rate as well. About 12% of office buildings in the country, they're not disproportionately large, they're about 12% of inventory. So 12% have a 50% or higher vacancy rate, and if you took those buildings out, you said, "Well, I'm just going to get rid of that 10%, 12%," instead of the vacancy rate being near 23%, it's actually 15 and a half. So you'll hear about flight to quality and you hear about obsolescence, but I think quantifying just the true concentration of weakness is really eye-opening.
There really is a bottom 10, 15% in most markets that are weighing on these headline market stats, and most other product even is performing okay or even pretty well. In class A, about 35% of buildings are fully leased, and another 12% have a 10% or lower vacancy rate, and that's four years into the pandemic as companies have been adjusting and recording this record-setting negative demand in the sector. So I think there are a lot of signs that companies really need this space, that it's not just this outright downsizing, or the counterfactual would be 40% vacancy, and that's just not what we've seen, but there is this, I would call it even more than a trifurcation, but I don't know what the actual word is to what's beyond trifurcation, where it's-
Mark Zandi: I like that word.
Rebecca Rockey: Yeah, top tier is doing great. We know that the bottom, the obsolete stuff is really, really bad. Huge impact on vacancy. 730 basis point delta in the rates I just gave you. And then there's this middle which is just going to reinvent itself, and that's going to take time, and it doesn't mean that that's easy or fun, especially for the owners of that, but we do believe that that space will ultimately serve a function in the office sector moving forward.
Mark Zandi: That's a really cool frame. I hadn't thought of it in that term, so that's very interesting. Well, just really quick, because I want to move on to a couple of What Bugs Me, AI, artificial intelligence, any concerns about that? Because it feels like that would be focused on kind of office using occupations and employment. Any concern there or is that still not on the radar screen?
Rebecca Rockey: I think, well, one, it's too soon to tell. We know there's obviously going to be displacement of some jobs. Any technology does that. We know there are going to be many jobs that are augmented, that's in fact in real-time in the CRE industry where we see deployment of AI is to help workers do their job, or to help an asset manager, or facilities manager manage that asset more efficiently, not replace the job of that facilities manager, to get smarter and more efficient with how we use buildings. So I think in that way, the jury's still out. Over the longer run, when you look back at literature and technology disruptions...
I followed some of the work of Daron Acemoglu, and he's looked at when in the '90s and the early 2000s, you have these technologies coming in and over roughly half of all the new jobs that were created in that time period were jobs that never existed before, and I tend to have a glass half full view of creative destruction and the ingenuity of the American economy and the American spirit in that way, and frankly, to your point earlier about demographics, there couldn't really be a better time to get a technology to supplement labor and make us more effective when we have, despite recent immigration, this longer term demographic deceleration on the horizon, to be able to augment the skills of labor, to continue to produce two, two and a half percent GDP moving forward seems like great timing, but I think we'll just have to watch and see how it plays out. That's just my tilt is glass half full on we'll find a way to create new jobs.
Mark Zandi: Yeah, it makes sense. Hey, okay, so let's... Offices seems to be the problem child. The one property type that kind of a surprise to the upside, and you definitely correct me if I'm wrong, but this is just me from my perch, and really confusing to me is retail. It's like retail is this darling property type, and that's despite continued increase in the share retailing that's going to online. I mean, if you believe the data. And that was supposed to be the stake in the heart of retail forever, but maybe this is an important thing to think about when you think about office in the current context. But what about retail? What the heck? What's going on there?
Rebecca Rockey: Well, we weren't surprised by this shift. In fact, we put out a series last year on the resilience of retail, and you can kind of think of it as like a one-two-three punch. You go through the GFC, e-commerce really started to accelerate in the property market impacts in the 2010s. So yes, it was happening before that, but it really wasn't until 2012, '13, '14, we started to see big players, one, juice the industrial market, going in and getting warehouses and selling online these 1 million square foot facilities and bigger. And so you had that penetration happening. You also then had the pandemic, which that's kind of the final stake in the heart of any retailer that didn't-
Mark Zandi: You see how she's using my terminology? I'm influencing the way she speaks. Did you see it? I'm sure she never said stake in the heart until she heard me say it.
Rebecca Rockey: It was not part of my regular vocabulary, it's true. But if you survived all of that, you were generally in a pretty good position, and then you have an economy that's performing pretty well. Obviously there's disparity among different kinds of income groups, and that translates into the kinds of retail categories that are in more aggressive expansion mode versus those that are in consolidation mode, but on net, the last few years we've been recording positive absorption. We have a 40-year low in the vacancy rate, and it was, I think, some of the fears that you articulated in how people thought about retail that led to an underdevelopment cycle. So we were overbuilt on retail now. Right now we have something like 12 million square feet under construction. Just to put that in perspective, that's across 83 cities and 4.3 billion square feet of shopping that are stock.
So you literally only have 12 million square feet that's underway, and that... We have a 5.3, 5.4% vacancy rate. If you're a retailer, you have very few options, and when store closures happen, in many cases there's a line of tenants waiting for that space provided it's well located and meets their actual requirement needs. But we've really been excited about it. I would also say just in the context of the interest rate movements, it was the least overpriced. I mean, it went through a pricing correction for a period of time, and so it had a lot of spread over the 10 year that as that went up, we really didn't have to see cap rate expansion nearly to the degree that we have in other sectors.
So that's something I can tell you is an investment theme heading forward as consumers rotate back to services, as we see certain kinds of shopping centers really perform well. I always say 1% of retail stock are buildings. The number of buildings or malls is 8% of the stock, 1% of the buildings, and so most retail are not malls, and even many malls are performing quite well because they're not all class B, C, struggling in areas that have deindustrialized over the last few decades. So it's an exciting time. I think for those in the sector who watch it, we weren't surprised, but I think because the media says retail apocalypse and those kinds of things, it can be surprising.
Mark Zandi: Yeah. I've got one more What Bugs Me, but maybe, Marisa, do you have a What Bugs Me in the CRE market that you want to ask? Because I've been monopolizing the conversation. If not, no worry, or Cris, if... It's got to be a good What Bugs Me.
Marisa DiNatale: I don't have a What Bugs Me. Actually, I have the opposite.
Mark Zandi: Oh, what's the opposite of What Bugs Me?
Marisa DiNatale: Well, I'm curious about the warehousing and the data centers and that segment of commercial real estate, which is, as far as I understand, doing very well for obvious reasons, and I was just curious to hear Becky's take on that.
Rebecca Rockey: It's a really great point because CRE is so diverse and industrial is truly a darling, and I say that very genuinely. So we came off of a period where things were building out from an e-commerce penetration perspective before the pandemic, and so we knew what healthy runway rates were for demand given the e-commerce taking up more and more share of core retail sales. Then the pandemic hits. I say this all the time: It was bananas. I mean, the levels of demand were wild. We estimate that half of the excess demand beyond normal was e-commerce providers essentially pulling forward future demand because they had to meet the needs during COVID.
So there was this pull-forward influence that occurred during COVID and really juice demand, and supply was trying to respond, but vacancies got below 3%, and just for context, in our data nationally, the best of the best during the housing boom, during the '90s expansion, we would maybe get to six and a half, 7% vacancy at the low point, and we got to under 3%. And so that just threw rents through the roof. They grew 22% year-on-year in '21, or sorry, 2022, that was the fastest growth year. We saw supply start to respond.
What's happening now is a bit of a normalization in the market. So people will see vacancies are going up. We're now kind of in the mid-five range from 2.8, but again, that's historically better than anything we've ever seen before and demand is slowing, and we actually made an unpopular forecast that not only last year would demand slow, but this year because of that pull-forward effect, and that sort of right-sizing with respect to the e-commerce trajectory, which we think will work its way through by the middle of next year, and then we'll start to see an acceleration in what we call net absorption again.
So this re-calibration in industrial from the fundamental side is really, okay, well, we're going to get probably a peak vacancy rate middle of next year around 6.8, maybe 7%. That's on par with the lowest we had ever seen before in prior cycles. And so this window of opportunity that tenants have to actually get some space and have some pressure off the rent growth is finite. And that's been really probably the biggest challenge is companies that occupy this space absorbing the cost increases, and they've been most acute in places you'd expect. Southern California, New Jersey, where markets are very, very tight. But from an investor perspective, remember that the weighted average lease term is still about 6.7, 6.8 years.
So even as rent growth slows down, we see some upward movement in vacancy, although it's still very low. We still have many leases that with their escalations are under-priced to market, and so when an investor has that in their portfolio and that lease rolls, they're able to market to market and that income growth is going to fuel NOI returns, which in this environment with interest rates is a very important dynamic and that is why it remains so favored. You still see pricing going up. You don't see cap rate expansion because you know that if you come in and buy a building, you're still going to be able to push the NOI and your effective cap rate would even be different in one year from now. So that asset class just remains absolutely favored. There's structural demand for it. It's going through normalization right now, which we think is healthy and good for the market.
Data centers we track separately, and this is again an area where it's structural demand. We're tracking right now the pipeline of future data centers and the amount of... We track them not by square footage, but by energy, and so the amount that's underway will increase what we have by two and a half times what we currently have at the moment. So it's a 250% growth rate over the next few years. The number one constraint that really dictates how that can come online is power availability, and that's really where the rubber hits the road in terms of, okay, how do we get this? The number of requests coming into utilities is insane and they haven't had to expand their bandwidth for two decades, so this is very new to them. They're not used to building 250% ability to generate power in just five years, so that's going to be probably the constraint, it's making that market.
Where there is a rental market for that space, vacancies are at 1%, 0%. Rents are going up 10, 20% depending on the market. We're seeing some shifts into secondary markets. It depends on... Every mega player has their own strategy in this way. We're seeing huge swaths of land being taken down for the purpose of building huge data centers and/or also co-locating next to micro-grids so they don't need to rely on utilities building out power. So we're literally seeing anywhere from 200 to 500 acres, a thousand acres being purchased. We've had some that are much more significant than that.
I would say where we're watching power come online, the greatest is happening in the Southwest and then up into the Pacific Northwest. Texas has a tremendous amount, particularly in that Dallas-Houston corridor, right around Long Island in the Northeast you see wind energy, significant amount of wind underway, and that's important just because a lot of companies that are building data centers or providing data center services to other tech companies or other companies, there are sustainability goals that need to be met. So we're very focused on what is the kind of power also that's fueling the ability of these data centers to come online, but absolutely a growth area and you see capital following it on an institutional basis.
Mark Zandi: Well, I like rubber hits the road, bananas, those are things I wouldn't say, but so those are Rebecca Rockey aphorisms, but those are good ones. Let's play the game real quick. The Stats Game, we each pick a statistic, the rest of the group tries to figure it out with the cues, deductive reasoning and clues, and the best stat is one that's not so easy that we get it immediately, one that's not so hard we never get it, and if it's apropos to the topic at hand, all the better and we always begin with Marisa. Marisa, you're up.
Marisa DiNatale: Okay. First, let me say this is not a... I'm not going to say anything. Never mind. Sorry. 27.4.
Mark Zandi: What the heck was that? That's not fair.
Marisa DiNatale: I was going to help you out before I gave you this stat, but I'm not going to help you. 27.4%.
Cris deRitis: It's not CRE-related.
Marisa DiNatale: It is indirectly.
Mark Zandi: She always does this. You see how she does this? It is, but it isn't.
Marisa DiNatale: It's not a vacancy rate. That's what I mean, okay? It's not directly CRE-related, but it is very relevant to the conversation we just had about CRE.
Cris deRitis: Percent remote work.
Marisa DiNatale: Yes.
Rebecca Rockey: Is that the one from BLS?
Mark Zandi: After all that.
Marisa DiNatale: I guess you didn't need help. Yeah, that's from the latest Census Bureau's Pulse survey. The results of the March to April came out yesterday, and that is the number of people that are doing any remote work, whether it's one day a week or it's five days a week. So it's 27.4%. Guess what it was a year ago.
Mark Zandi: 30%.
Marisa DiNatale: 27%.
Mark Zandi: Oh. Oh, is that right?
Marisa DiNatale: Even. So to your point, we talked about this with the office, it kind of seems like it's at this level and it's not changing, right?
Mark Zandi: Because Pulse has only been around since... The survey has only been around since the pandemic-
Marisa DiNatale: And those are the only two data points for this. So they didn't ask specifically about remote work in this way prior to 2023.
Mark Zandi: Well, the broader statistics, that feels consistent with the broader... I think there's other similar-
Marisa DiNatale: Yeah, there are other measures and it's kind of in that-
Mark Zandi: I think it got up to like 35 or 40%, and it came back in and it's kind of stabilized around-
Marisa DiNatale: Yeah, you mentioned the badge swipe data, and it's somewhere. It's kind of in that ballpark, but the point is to the conversation that it seems to have settled into this sort of average, yeah.
Mark Zandi: Way to go, Cris. That was good.
Marisa DiNatale: I guess it wasn't hard.
Mark Zandi: Well, or Cris is... Oh. See, Cris, did you see that? That was a dig.
Marisa DiNatale: No, it wasn't meant to be a dig.
Cris deRitis: I'm used to it. I'm used to it.
Mark Zandi: Oh, yeah, yeah. Rebecca, would you like to go next?
Rebecca Rockey: Sure. I'm not sure how easy this will be for such experts as yourselves.
Mark Zandi: You mortals down there, non-CRE mortals. This is way above you guys. See, those are fighting words, man.
Rebecca Rockey: Oh, no, no. I think you might get it, that's what I mean. 44.3%.
Mark Zandi: 44.3%. CRE-related?
Rebecca Rockey: Yes.
Mark Zandi: She's just like Marisa, the way she does business. She's saying yes, but she's shaking her head no.
Marisa DiNatale: Is it office market-related?
Rebecca Rockey: It's not office market-related.
Marisa DiNatale: Okay.
Mark Zandi: So it's tangentially related to CRE?
Rebecca Rockey: Yes, and some would include it in their definition of CRE, others would say nonfarm and nonresidential.
Mark Zandi: That sounds like that's a big hint somehow. That sounds like a big hint.
Rebecca Rockey: Yeah.
Mark Zandi: Is it related to the multifamily market?
Rebecca Rockey: Yes.
Mark Zandi: Okay. I thought so. What's 44.3% in the multifamily market? Is that the share of multifamily debt that the banking system... The banking system has 44.3% of the multifamily mortgage debt outstanding?
Rebecca Rockey: That's not what it is. That seems high because of the agencies to me, but-
Mark Zandi: Oh, that's probably true.
Rebecca Rockey: I guess, yeah, but it's not debt-related.
Marisa DiNatale: It's not debt-related. It's not finance-related, credit?
Rebecca Rockey: It came out this week.
Mark Zandi: Oh, in the housing starts data, the multifamily housing starts? Well, what would be... Cris, you would know that data really well. What would be-
Cris deRitis: I can't think of a-
Mark Zandi: Is that right, Rebecca? It was in the housing starts data that came out? Yeah, okay. Because multifamily was low. It came in at like 300k or something like that. That was the total number of starts. Oh, and single family was about a million. It wasn't 44% of all starts were multifamily, or 44% of... No. Damn, what could it be?
Cris deRitis: We know it's a share. It's not a percent change.
Rebecca Rockey: No, it's a percent change. It's not-
Mark Zandi: Oh.
Cris deRitis: Oh, it is a percent change. Oh. It's permits of multifamily? That's high.
Mark Zandi: It didn't have a negative sign, it has a positive sign.
Rebecca Rockey: It is a decline of failure.
Mark Zandi: Oh, that's a decline in the number of starts. Percentage decline in number of starts.
Rebecca Rockey: That's the year-over-year change in the March multifamily starts, which the census data has been a little funky. We track the square footage and that goes into the pipeline and starts... It's off by 52, 53% on a quarterly basis. We don't track it monthly. Their data's bouncing all around, so it's finally lining up a bit more, but I chose it because we really see the construction pipelines thinning out, and it's true for all sectors, but for multifamily, obviously the supply wave has been the big phenomenon driving the market, and then there's this air pocket behind the supply wave, so the softness in that market will not persist indefinitely.
Marisa DiNatale: That's over what time period?
Rebecca Rockey: March last year to March this year.
Marisa DiNatale: A year ago? Okay.
Cris deRitis: Month was 20% down or something, right?
Mark Zandi: Yeah. Yeah, it was a big decline. Yeah. So Rebecca, so I just understand you're saying the census data on the number of multifamily units that have been started have been relatively elevated, but the data you track has been showing much weaker construction activity, is that what you're saying?
Rebecca Rockey: Yeah.
Mark Zandi: Yeah? Okay.
Rebecca Rockey: It's been consistently coming down and even at the end of last year, it was off by 50% year-on-year. So we were waiting. Sometimes when the census report comes out can be just a little volatile, so we sometimes get head scratching months, and this was one where things made a bit more sense to us.
Mark Zandi: So 300k, 300,000 units. It's annualized. It's more consistent with your data, not the four to 500,000 per month we've been getting previously. Okay, interesting. Which I guess it was just a matter of time given we have rising vacancy, we've got weakening rents, we've got lenders that are tightening down, underwriting, we've got price declines. Just feels like it was going to show up here at some point in terms of less construction and that's what we're saying.
Rebecca Rockey: Yeah.
Mark Zandi: Yeah. Okay. All right. Let's do one more, Cris, and then we'll move on. Cris, we want to do yours.
Cris deRitis: Okay. I'll give you the easy one because we're running out of time.
Mark Zandi: Oh, okay. Right.
Cris deRitis: 940,000.
Mark Zandi: That's not number of units under construction, is it?
Cris deRitis: Yes, it is.
Mark Zandi: Oh, jeez.
Cris deRitis: Told you it was easy.
Mark Zandi: He always goes to this. Every single time he goes to the same well.
Cris deRitis: Well-
Marisa DiNatale: He's not a housing guy.
Rebecca Rockey: You said you had a good stat, Mark. Maybe you can...
Cris deRitis: Yeah, give us yours.
Marisa DiNatale: Yeah, what's yours? Because you said we would never get it.
Mark Zandi: You'll never get it. You'll never get it.
Marisa DiNatale: Try us.
Mark Zandi: Actually, I got a lot of great stats. I'll give you the easier stat. 17%. I'll give you a hint. It's CRE-related. It's retail-related.
Rebecca Rockey: Is it from the release this week?
Mark Zandi: It is. Yes, it is. It's from a release this week from... Yes, it is. I won't say which release.
Rebecca Rockey: The percent change in e-commerce sales?
Mark Zandi: No, but you're in the ballpark. It's the share of total retail sales that are non-store, that are basically online. And that's up five percentage points from pre-pandemic. The peak was 19%. Guess which month we hit 19%.
Marisa DiNatale: April 2020.
Mark Zandi: There you go, April 2020, yeah. Yeah. Actually, I've got another great statistic, but I'm going to wait for next week to give it to you because it's a really good one, on multifamily rent. It's a really good one, but we got to move on. We're getting long in the tooth. I want to come back. Rebecca, a lot of happy talk in this conversation, and actually Marisa led you down the Primrose Path here, "Tell me about data centers." Yeah, and you're going, "Oh, it's bananas. It's bananas. 1% vacancy. No problem. No problem." Okay, the whole-
Cris deRitis: That's a great impression.
Marisa DiNatale: Yeah, that sounded just like me.
Cris deRitis: It was perfect.
Mark Zandi: Right. I would've taken you down the dark path, the dark path, the multifamily path, but the darker path, because everyone was hair on fire six months ago. Doom loop. We're going to see rates are up, vacancy is up, prices are down. We're going to see more defaults on mortgages, CRE mortgages, that results in more property being thrown onto the market at distressed price, prices come in and you get into this kind of self-reinforcing cycle down, and adding to the concern is the banking system is exposed, the financial system broadly exposed because they make loans into the properties and we're going to see some bank failure and that's just going to add to the overall problems out there, and then on top of that, most, if not all, of the problems are in large downtown urban areas and those areas are going to be much diminished by what's going on here. San Francisco is the poster child for that.
But that feels like the hair on fire has been put out. People are much more relaxed about that, and should they be? And maybe I should ask it this way because I'm sure you're going to say, "Yeah, they should be more relaxed about it." What is the scenario where things don't play out well? What could cause that? I mean, I don't know if that's a fair question, but I'll just pose it just to see if you have a perspective on that.
Rebecca Rockey: Yeah, I think the unsexy part of the credit cycle going on in CRE is just that it takes time, and so we're in the early stages. We think we're in probably just 18 months into a seven-year cycle. So think about that, and it's just going to take time to materialize, and usually it's in years two, three, four, where you start to see the preponderance of distress start to pick up. And so it isn't to diminish and say everything is fine in the world. Absolutely these large urban centers, especially in gateway markets with elevated vacancy, they have distress coming. You're seeing that in sort of one-off headlines around the owners walking away, the kinds of price declines that are out there, and there is absolutely more to come, and you can see it in real-time delinquency rates on CMBS where you basically have sub 1% delinquency in most property types.,
Mark Zandi: Commercial mortgage-backed securities, CMBS. Securitized mortgage loans, yeah.
Rebecca Rockey: Right. Multifamily actually jumped up this month to about one and a half-ish percent from about a half a percent, and that was due to one property of student housing property in San Francisco. So that's not a nationwide issue, that's that one property. Office has gone up from around a low of one and a half during the aftermath of the pandemic and forbearance and all the things to seven and a half, and it's still climbing. So I think that's indicative of just how it stands alone in this particular cycle. From my point of view, it's manageable. So any given owner, whether it's a bank or otherwise, generally has limited exposure to office, and I think this particularly becomes of interest in the banking sector, because of course, banks have lots of tentacles into the economy when they're struggling with putting reserves aside and managing their portfolios and their tightening standards on lending, it just really sort of crimps activity and growth, and that's what we're seeing in the commercial real estate markets now more broadly.
But they're finding ways to work through. We've seen actually in this quarter with some of the bank earnings calls, some positive news actually with respect to how CRE is holding up. Some write-offs that maybe led to some charge-offs, but manageable in the context of their broader portfolio. Keep in mind, CBD office is something like 5% of the big bank's CRE portfolio. So yes, it's there, but it's part of this $2.9 trillion exposure that they have. That exposure is diverse across markets, property types, and CBD office really just one of those, let alone CBD office in the harder hit urban markets. You also have, of course, extensions going on, modifications. We're seeing actually cash-in refis, which is something that's unusual. We usually see cash-out refinances in commercial real estate. You're seeing banks get a little bit of an upper hand actually and require deposits, or some other form of recourse that they wouldn't typically be able to demand as they work with borrowers.
Of course with office, they have an incentive to do that in the sense they also don't want the property, but at the same time, you can't inevitably forestall what is going to happen, which is more defaults, more credit pressure on the office sector in particular, and that being more acute in these gateway and larger urban centers. So I think that's just going to play out. Cris and I have spoken a bit about the doom loop in the past, and does that move the macroeconomic needle? Does that cause some kind of recession? Probably not. It's just a slow burn, and that ultimately then starts to materialize in things like state and local governments and cities and their budgets, and so on, and that just also takes time.
And it's not inevitable, especially if you're able to do successfully what some cities have done in the past, which is reinvent that downtown area, which I think we're in the very early stages of. And in that way, I think about it as there are going to be losses, but there are going to be tremendous gains as you put that real estate to its highest and best use in this post-pandemic world, and so there is a sort of value gain. Perhaps even on net we can add value to the commercial real estate stock if we're removing low quality office and adding something higher value there. And how that plays out from a doom loop perspective, I think, is just... It's not inevitable and it's difficult to distinguish between a cycle in commercial real estate, whether that's in the fundamentals, or even the credit market versus actually a doom loop taping place.
I do think some cities face a real risk of that if they do not make a concerted effort to think about policy, public-private partnerships, getting the downtown to adapt from a place where maybe there was an over-dependence on office workers and office worker production, and to make themselves more of a consumption destination, and that's something that we're in the early stages of. I mean, there are signs all around the country that that's happening.
To your question about a darker scenario, I think anything that triggers bank stress beyond in an economy that's expanding, a 10-year that's at four-ish, and we just have this slow burn of a credit cycle for all lender types, including banks. I think something that really puts acute stress on the banks or a rapid run-up in interest rates that sustained beyond what markets are pricing in at this point, that I think could create outcomes that are much darker than the ones I just described. So I don't think anybody's base case, but there are black swan events all the time, and so we remain aware that that's always a possibility at the tail end. But that would be sort of how I frame that up.
Mark Zandi: Yeah. I mean, I joke. I agree with you. I think the most likely scenario is... You said slow burn. I think that's kind of a way to think about it, like a bit of a corrosive, but there's no cliff event here. At least it doesn't feel that way unless something... You're going to need something else to go off the rails that cause the economy to pull back and interest rates to spike, that kind of thing. Cris, Marisa, do you want to push back on what Rebecca said? Anything there that you would push back on?
Marisa DiNatale: No, but what is a cash-in refi?
Rebecca Rockey: So typically when companies or investors have refinanced in the past, it's been in this environment where interest rates were structurally declining so you can refinance and actually take cash out right of the property. Now, in order to meet the lending criteria of LTV debt coverage service ratio, and so on, we're seeing refinances where borrowers actually have to bring equity into the deal, but believe it or not, there are actually a lot of office refinancings going on and just at the right price with the right kind of loan condition.
Mark Zandi: They're putting equity in. They need more equity. The bank's saying, "Hey, you got to put more equity into the deal," which is a good sign that they're willing to put the equity in. They think the value's there. Okay. Cris, anything you want to push back on?
Cris deRitis: Not really push back, just I think emphasize maybe some of that extend and pretend that's going on there, that the banks are accommodating and extending loans, but we're also kind of gambling on better days, that things will improve in the future, interest rates will come down so that we can re-consolidate and go forward here. So I don't think that the macro doom loop is a real risk, but I do think that there is some risk there certainly. If that scenario doesn't play out, you combine this with some more negative outcome at the end of the term, then we certainly could see more stress.
Mark Zandi: Well, Rebecca, it was a great conversation. Sorry we kept you longer than I anticipated, but I appreciate you taking the time with us. But thank you. Thank you for doing that.
Rebecca Rockey: Oh, my pleasure. Thank you for having me.
Mark Zandi: Anytime. And we got to have you back on Fair Value, although only three people in the world are going to listen to that podcast if we do it, but yeah.
Rebecca Rockey: It's pretty out there, yeah.
Mark Zandi: Yeah, it's pretty out... But really important. Actually, shockingly important. But anyway. Well, with that dear listener, we, I think, are going to call... Yes, we are. We're going to call this a podcast. Take care, everyone.