B (4:28)

All right, so on the plus side.

A (4:30)

For multifamily apartments as well as think BTR as far just the general living or rental housing space, whatever you want to call it, it's still the king of the hill in commercial real estate. Here's a great chart from Newmark. They always have some good charts. By the way, this one shows multi multi family comprise about one third of all CRE sales nationally over the past 12 months. That's still well above the long term average which is just under 28% even if down a few ticks compared to the peaks a few years ago.

B (5:00)

So you know, we've talked about this.

A (5:01)

A lot every survey surveys from groups like a fire, John Burn, Siri Daly, et cetera, they all show investors still love multifamily. And btr, we see we, you know, the long term Story very much intact. Everyone knows that story at this point. Short term a lot of investors still looking for better pricing and or rebound in rents or drop in interest rates to get more deal flow going again. But certainly you have groups that still love the sector. But as I mentioned before, cap rates just haven't risen nearly as much as interest rates. Here's a chart that shows you apartment cap rates versus Treasuries and the federal fund rates and federal fund effective rate. And what shows you is the cap rates are still holding in the mid-fives on average. That's only of course we see some deals trading in the fours, particularly for well located class A. And those cap rates, they're up only about 100bps from the market peak or rather I should say the bottom of cap rates back in 2022. Now by comparison the 10 year treasury yields are up about 300bps from their low point. The federal funds effective rate is up more than 400bps from its low point. So just 100 basis points expansion in apartment cap rates is obviously much less than that. And it's a good reminder that the great Peter Lemon was right when he wrote years ago that the correlation between interest rates and cap rates is weak. Just it does not move like some of us want to think it should or think it does historically, not just in this recent cycle, but going back a longer period of time. Peter's study, it just shows that it's not as related as we think. But it's not to say it doesn't matter. Peter did point out that interest rates do impact deal flows a lot more. Tighter spreads and price your capital just means fewer deals are able to transact. It's a market that favors groups with, you know, lots of capital ready to get put to work, less leverage. And also the reality as we talked about before is that most would be sellers. You know, they're still bullish on multifamily as are would be buyers. It's not like in office or others. We have other sectors. You have maybe groups that are just.

B (7:06)

Wanting to get out of the space.

A (7:07)

You have some patient capital. So there aren't a lot of owners looking to exit at deeply discounted prices unless they have to, even if there are a lot of buyers looking for those deep discounts. So still some mismatching expectations there and that's going to prevent a big jump in cap rates regardless of what we see in interest rates. So anyway, that's a hot topic of course and I'm going to ask Jim's take on this later on as well and and see what he thinks about Peter's research on that topic. Speaking of values, let's talk about pricing indices. MSCI shows apart in values actually improved about 40bps year over year according to their property price index. That follows declines in 2023 and 2024. So it appears we are now trending in the right direction. Has the market bottomed or at least is it starting to turn the corner? It certainly does if you base it based on the pricing indices from MSCI and others. So certainly some ways to go to get back to the values we had prior to the run up in interest rates. But maybe we're now trending in the right direction. One reason for stabilizing values is again, there's a lot of capital that wants to be in multifamily. More liquidity equals more stability. And part of that story is debt coming back into the market. Here's a good slide from Newmark again showing debt originations by year, year over year. Multifamily debt originations were up 43% through the first half of 2025. And the first half totals, well, of course, again far below the peaks of 21 and 22. Of course now those first half totals in 2025, they're back to where we were in 2019 pre Covid and it's actually more than what we had in 2017, 2018. So that's a good sign. And we've talked about this before in the on the podcast here. We'll talk about it with Jim Layer today as well. With so many groups shifting into debt or expanding their debt funds, you know, we're seeing that impact the market, provide some stability in the market. You know, there is debt available. It's maybe more expensive than you want, but that debt is available. And it's not just debt funds, by the way, we saw acceleration in originations among banks, insurance companies and the agencies, the GSEs. So again, we'll get to Jim's thoughts on this later. And particularly the question of, hey, you know, when is equity going to follow all the debt back into the market?

B (9:28)

Now that takes us to distress.

A (9:30)

You know, everyone of course thought that by now we're going to see more distress, more distress transactions given that ominous wall of maturities. Peak maturities are here in 2025 when you look at these maturity wall charts. But that really hasn't played out. We've talked about this previously. Why is it? Well, first and foremost we had the great James Ray of CRE analyst and MetLife when he was on the podcast here, the Rent Roll, and he made the point very eloquently, and I won't say it as well as he did, that those wall of maturity charts are often misleading because they only show the first maturity, you know, and lenders are going to operate in their own best interest, of course, and if they believe the sector is going to bounce back, they're incentivized to work with borrowers. And hang on, except in cases where it's just too, you know, there's just too little light at the end of the tunnel. And there's certainly some of that, but generally speaking, there's still, you know, I get asked this a lot. How long will lenders stay patient? And, and the honest answer is really a boring one. It just, it depends. And that may seem like a cop out, but it's true. But, you know, certainly lenders are aware of the same factors that investors are, you know, the equity side investors are aware of. And in many cases it just makes sense to be a little patient and, and do extend. And I don't even think it's a pretend, it's just an extent. Now, in other cases, there's a chunk of true distress that's going to be painful to work through, but as we've said before, it's smaller than you probably think. Newmark estimated potentially distressed maturities this year totaling $81 billion. Now that's obviously a lot of money, right? You know, $81 billion. I've seen other groups estimate a similar number, but, but, but, but there's, remember, there's more than $2 trillion in active multifamily debt here in the U.S. so again, $81 billion is a lot, but it amounts to just 4 billion, 4% of the total multifamily debt in the U.S. so, and then we have Newmark's estimate, 62 billion in potentially distressed maturities in 2026. That's only about 3% of the market. So again, more distress is likely coming. I think we're going to get, you know, more noise, more mess, more challenge, more, more stories and headlines of challenge deals. Don't get me wrong on that. But again, probably not at the volumes you might think, think. And for a lot of investors, it's probably also not something. We've talked about this a lot. For a lot of investors, the distress that's coming probably is not going to be the product types, the vintages and the locations that you want either. There's a mismatch in the buy box between, you know, the stress that's going to be available or is available versus what opportunistic buyers really want to be looking at. Much of that true distress is more likely to be older product busted value adds poorly located bought at the peak with high leverage. You know the math just isn't great on some of those deals even with you know, some, some rate cuts and even with a little more rent growth like it's those, some of those deals are just you know going to be in a tough spot and there just aren't a lot of buyers lining up for those types of assets either. That's the traditional buyer for those is often the profile is still sidelined. May have their own challenges to work through right now.

B (12:32)

Anyway, that's, that's our, that's, that's your.

A (12:35)

Quick overview rounding up the current state of US Capital markets for multif family. Much more to come later in the program when we welcome in Jim Costello from MSCI and we'll get his take on where the market goes from here. All right, next up, the rental housing trivia.

B (12:56)

All right.

A (12:57)

On the topic of multifamily capital markets, that's, that's going to be the part of our rental housing tribute. Question of the week, which is which MSA recorded by far the largest increase in trailing twelve month apartment sales according to MSCI Real Capital Analytics. So which one had the largest? This Is among major MSAs had the largest increase in apartment sales over the last 12 months. I'm gonna give you five choices to make it a little more manageable here. Is it A, Columbus B, Las Vegas, C, New York, D, Riverside or E San Jose. So you know, in this market, just give you a little bit of a hint, sales have really did plunge and previously but it's, it's, it's, it's a boomerang back up over these last 12 months. It's up more than 4x in July 2025 on a trailing 12 month basis compared to July 2024. No other MSA was up even 2x. So this one really stood out. What market is it? All right. We'll get to that answer in a little bit. But first let's talk about some headlines with in the news. All right. We got a handful of headlines this week. You know, some weeks we get a lot of news on rental housing. Other weeks you don't get much at all. So this week I had to pare it down a little bit. There's quite a, quite a number of relevant stories. This first one I posted on LinkedIn. I'll talk about it briefly here. It's from the New York Times. It says, why are more millennials Millennials. Sorry, why are more millionaires renting? The number of millionaire renters in the United States more than tripled between 2019 in 2023. And by the way, that, that's. That period 2019 and 2023 tells us this isn't about just high mortgage rates. This is something bigger than that.

B (14:50)

All right, so let me just say.

A (14:53)

The way, it's not a huge denominator in terms of number of millionaire renters in the United States, but it is a notable upward Trend to be up 3x. And this is a really good quote from a broker in Florida. He was quoting the New York Times article. He said they're choosing flexibility and liquidity over ownership. They don't want to be bothered with the inconvenience of homeownership, which includes paying real estate taxes and insurance, especially in markets like Florida and California where we're seeing a lot of natural catastrophes. I would say especially probably on the coast, specifically not the interior markets. That's my own editorializing there. Now, I think you know, whether millionaires or not, and this is defined as you who actually have incomes of $1 million or more for those with means, you know, renting can free up cash to. Read the article. Renting can free up cash to invest elsewhere, like in the stock market, where those investments can be sold quickly. Quickly. All right. So first and foremost, again, I don't want to overstate this. We're talking about a relatively small number of people. Most people making a million plus in income are still home buyers and by a large margin. But I think it is again, more reflective, this broader trend of wealthier people, even if not all millennial millennials. There we go again. Millionaires. Millionaires to choosing to rent longer. And this is a trend that again, predates the run up in mortgage rates for a lot of younger adults today. They just value flexibility, the flexibility that comes with renting over the benefits of homeownership. And homeownership is great, but it's a commitment, a longer term commitment. Not everyone wants a longer term commitment. Plus, over the last 15 years, again, this is a factor I haven't talked about before. I don't think it's talked about enough. We've built a lot of very nice, well located, condo quality rental apartments. So that makes the apartment experience stickier too, in the lines of people waiting longer to get married, have kids, et cetera, all the traditional drivers buying a house. All right, next Headline, this one comes from Axios Boston. And I mentioned this, I teased this up briefly earlier. I mean if you're investing in the Northeast, here's one to pay attention to. It says Massachusetts rent control ballot proposal clears first hurdle. All right, so the nuke the NIMBY nuclear option is on the table for voters in Massachusetts Rent control. Capping rents at inflation or 5%, whichever is less lower developers. You know, developers tend to like Boston, especially institutional developers. But in the Boston msa, the suburbs as well. But they're obviously have a lot of trouble making deals work and raising capital for deals. If this passes, it undoubtedly would reduce construction even with a, a 10 year exemption for new supplies if investors can't look at a calendar. Anyway, before we get into the details.

B (17:37)

Here, this is what it means.

A (17:38)

The state attorney general certified a ballot initiative to bring back rent control in Massachusetts. Ballot supporters now have to get enough signatures to actually get it on the November 2026 ballot. So this will be November of next year and there's a number of steps that to happen. So it's not a sure thing. But it's now been, you know, green lighted to essentially start the signature process. All right, so let me read a little bit from this. It says the proposal will limit annual rent increases by 5% or by the CPI's annual inflation increase, whichever is lower. All right, so think about this. I would imagine that that number is pretty much a deal killer even in otherwise attractive investment developed market like Boston and its suburbs. The lower of CPI or 5%. So if CPI is 2%, your rent cap is 2% even if CPI is on a proxy for your operating costs. And if CPI is 10%, you're max at 5% rent cap, no carve outs for renovation or repairs. Again it does exempt new construction, but only for 10 years. And so that's not, that's not nearly enough to make the construction market liquid because again a lot of construction is from merchant builders who build the cell and who's going to buy something that has a, that's, that's attached to, to, to a 10 year, a 10 year clock. Make sure two more wild details about this ballot measure as it's currently written. Number one, rent caps we based on rents as of 1-31-2026. So that creates an interesting administrative burden. If this ballot measure passes more than nine months later, you're now potentially reverting back to rents from earlier in the year. So if you renewed a renter at say 5% in March 2026, it basically means at Least as I would read it, that you have to go back to, you may have to cut the rents once it passes. If CPI was less than 5%, because again, you're capped based on the rents as of January 31st. So it's a weird retroactive component to this. So that'll create. If it passes. That's going to create some real challenges. Second, crazy detail, take a guess at who's exempted from rent control under the explicit terms of the ballot measure, public housing and nonprofits. So let's cap rents for wealthy renters in class A plus towers in downtown Boston in the Seaport district. But let's for, for low income renters and public housing, they don't need the rent caps and non profits doing affordable housing. We don't need to apply rent caps. So conditions like that just make clear this is much more about going after landlords and about helping renters in need. Last thing I'll say here, ironically, Massachusetts voters actually voted in the 1990s to ban rent control statewide. That was in reaction to cities like Cambridge, you know, outside of Boston, having rent control. And they saw firsthand the problems it created. There's a really great episode of the Freakonomics podcast on this from a few years ago. Harvard professor Ed Glazer and Stanford professor Rebecca diamond talk about Massachusetts on the podcast on this episode. And, and it's a. They use it as a case study for why rent control has proven not to work and what ultimately backfires in the very heels intended to protect. So they noted in this podcast that after rent control was removed in Cambridge, when the state ballot measure overrode it, building maintenance improved, property values went up and street crime went down. And professor diamond said this, she said rent control had negative externalities on the neighborhood. So, you know, we never see that talked about in these news articles. So that's what these rent control advocates want to unwrap. Wind. So crazy.

B (21:26)

All right, so let's go a little.

A (21:28)

Bit west of Massachusetts to the Midwest, to Minnesota. And here's a headline from the Minnesota Star Tribune. Should public housing renters have the same protections as other tenants? Lawsuit moves ahead. A discrimination lawsuit says the city allows people on public assistance to live in homes unfit for habitation. All right, so here's another head scratcher in the Twin Cities. You know, how crazy is it that this is even a question? Basically, it's saying the public housing is exempt from city inspections because they do their own inspections instead. But tenants are arguing that the building conditions are substandard. So, you know, the Government kind of has a double standard here in Minnesota. The private sector must maintain housing in better condition than the public sector. At least that's what this lawsuit is alleging. So again, more crazy stuff. All right, let's move on. Next one comes from the Wall Street Journal. New York's Airbnb crackdown, in force for two years, hasn't improved housing supply. Apartment buildings have fewer rowdy tourists now, but rents keep rising. All right, so rarely do we see, you know, we're actually back up a little bit. Oftentimes we'll see a lot of fanfare around initial idea like, oh, let's rally to ban short term rentals. That's going to fix everything. But rarely do we see a major media outlet following up on, you know, one, one of these crazy ideas and saying, hey, look, let's, let's see if it actually worked. So kudos to the Wall Street Journal for doing that. You know, I give them a hard time for some of the stuff, but you know, this was, they did a good job holding elected leaders accountable to what they had promised. All right, so I'll read a little bit from this. It says two years after New York City crackdown on Airbnb and other short term rentals, it's harder than ever to find an apartment to rent in the city. Lawmakers had pledged that curtailing Airbnb and other short term rental companies operations would protect the city's tight housing supply. And yet apart in rents are at all time highs while the vacancy rate is next to nothing. The new legislation removed tens of thousands of short term rentals from New York City's apartment buildings. But it is unclear how many of those units are now occupied by year round tenants.

B (23:35)

Okay, so real quickly here, I had.

A (23:37)

Airbnb's head of real estate, Jesse Stein, on the podcast a while back and he made a point that I always make. That's all about supply and demand. We just need more housing of all types. Banning short term rentals is a good example of an emotionally satisfying vote that gives policymakers talking point, hey, we did something and too often, you know, they aren't being held accountable for these promises that aren't playing out and it ends up being a false promise. I think it's probably, you know, well intended. I just don't think a lot of them do their homework. And so it ends up being a false promise. And if you really genuinely care about rental affordability, you got to focus on what's proven to work. Stop just passing whatever harebrained ideas get proposed. You know, focus on the science, the data, the focus on getting more housing supply built. When you focus instead on disproven or, you know, kind of silly ideas, you're wasting time and energy. And we're not being serious about solving the issue that we claim to care about. So let's focus on what works. All right? Speaking of bad ideas, here's a real gem from Denver. And I know we've got a lot of policy stuff this time, but this is, you know, again, you can't make this stuff up. CBS News in Denver reports that affordable housing advocates float idea of new ghost tax on Denver landlords. Okay, so the idea feeds off a popular conspiracy theory fueled by so called vacancy truthers on social media. Okay, so if you don't know vacancy truthers, they contend that landlords are just sitting on thousands of vacant rentals with no intent to lease them out. And if they were forced to rent them or they want to see rents so much higher, don't worry the rents. In other words, they're just going to sit on a vacant. And so if we can force them to lease them out, that would magically solve homelessness. And so their solution is to tax landlords for long term vacancies, generally anything vacant more than six months. So let me read from this article. It quotes an advocate for this idea saying that there are, quote, an estimated 27,000 empty rental units in the Denver metro area and she believes corporate landlords are refusing to reduce their rents to appropriate levels of affordability. So I love the mention of corporate landlords here. That always gets people fired up. And I'm sure this person sincerely wants to solve homelessness. I get it. I don't want to doubt someone's intentions, but come on, please do your homework. You are spreading misinformation to people who just don't know better. And for anybody who does know better, you don't.

B (25:52)

You don't look very smart.

A (25:53)

Okay, nearly every vacancy is a short term vacancy. Normal churn. Someone moves out, someone else moves in, there's downtime to clean the unit, make repairs, market at someone else to lease, then lease it out. Sometimes you're leasing to someone for a date in the near future. So there's downtime between leases and that downtime is typically around 30 days. In only the most rare of circumstances would a unit sit vacant somehow for six plus months. So this is just silly. I mean, at best it'll raise dozens of dollars or maybe nothing at all. Berkeley, California of all places, has the long has a vacancy tax in place on long term vacancy. And there was just also this week an article talking about the impact of this. I think it was 2022. So it's been a few years that this has been a place. And guess how much tax revenue it's raised from modern professionally managed departments.

B (26:47)

Take a guess.

A (26:48)

Okay, you got your guest locked in. If you picked any number north of $0, you overshot it. Zero. Nada. So come on, let's just again, stop wasting people's time with bad ideas. Let's do the homework, focus on what works. These are real challenges, but we gotta, but every time we're spending time on, on disproven ideas, we're taking time, energy away from better ideas. All right, so that's a wrap on in the news. Let's get back to this week's rental housing trivia question. The question this week was which MSA recorded by far the largest increase in trailing twelve month apartment sales? According to, according to our friends at MSCI Real Capital analytics, was it Columbus, Las Vegas, New York, Riverside or San Jose? Well, the answer was B. Las Vegas. It's up more than 4x with a trailing till month total topping 2 billion in the year ending July. So it got real slow there for a while, but it has come back strong. Nowhere else had anywhere near that level of a comeback among major markets. Now that said, we did see meaningful upticks in sales activity in other places including Riverside, Milwaukee, Memphis, Portland and Virginia beach. But none were even 2x. So Vegas really stood out.

B (28:04)

Now, of course, you know, sales volumes.

A (28:06)

These data sets are a bit noisy by msa. You know, the MSA data can move a lot based on a single portfolio sale. So I don't look too hard at year over year change by msa. But even still, I do think that jump in Vegas is notable. Next up, it's time for today's interview which is sponsored by funnel, the AI and CRM software trusted by four of the six major REITs and many more leading operators like BH and Cortland. To learn how Funnel can help your property, centralize operations, automate everyday tasks, visit funnelle leasing.com all right, so today's interview is with Jim Costello. Jim is the chief Economist at MSCI Real Capital analytics, or MSCI Real Assets as it's known. Jim is an absolute legend in the commercial real estate capital market space. He's been a friend of mine for a long time and he was just named a finalist for the Pension Real Estate Association's James A. Grass Camp Research Award which recognizes outstanding contributions to advancing research on Real estate. Big honor and well deserved to Jim as well as the other finalists for that award. So here's my conversation. We Jim Costello.

B (29:33)

All right, now we enter the interview portion of today's podcast. And I am honored to welcome in my longtime friend Jim Costello, the chief economist at MSCI Real Assets. So, Jim, first and foremost, thanks for being here.

C (29:44)

Always great to talk with you.

B (29:46)

Yeah, I always enjoy our conversation. So I'm thrilled, even if no one else are listening to this, I get to pick your brain. So I'm excited about that. But thankfully we'll get people who do. So, Jim, I want to take us back a little bit and if I told you, unfortunately I wasn't smart enough to figure to know this, but if I were, and I told you a few years ago that the 10 year treasury yield is going to jump 400bps, fed funds rate, it's going to be up 450 and apartment cap rates would increase by 100bps. Would you have believed me?

C (30:15)

So basically, like I'm waking up from a coma and first thing I see as I come out in the hospital, you come in and I ask you, Jay, what's happened in the last 10 years with CAP rates? That's the scenario you're talking about?

B (30:29)

Absolutely. Yeah.

C (30:31)

Well, I believe it because it was coming from you. But then the next time, oh, thank you. The next thing I'd be asking is how did we get here? The fact that interest rates have moved does have an influence on cap rates, but it's not the only thing that matters. There are other forces at play that drive that. I worked on a paper in 2009 with Bill Wheaton up at MIT and our colleague Sergey at the time. We found that there were other influences at play driving relative pricing of assets. It's not just interest rates, but interest rates have an influence. You have market liquidity. That's an important part. All other things equal. If there is more investor interest in a sector for whatever reason, there's going to be more competition to bid for assets and drive down cap rates. Income growth is, is important as well. If income growth is stronger, all the things equal, investors are going to get excited about the asset class and bid down the cap rates. Interest rates going up, sure, if nothing else changes, then that's going to lead to some upward influence on cap rates. But the other things have changed. And let's think about the apartment sector and what's changed there from a liquidity perspective over the last 10 years or so used to be that the, the apartment sector was the biggest sector for investment in the United States. But you'd have the office sector sometimes surpassing it in some quarters simply because of the intense institutional investor interest in this sector. But that's really scalp back and that money has to go someplace. And there's been a bit of rotation out of offices and retail and into the industrial sector and especially into the apartment sector. So that change in liquidity is clearly having an impact.

B (32:45)

Oh, absolutely. So on a related note, when digging this a little more, our mutual friend Peter Linneman wrote in his Linnemann letter five plus years ago, so for all this cycle began obviously the craziness of the post Covid era. He wrote a little an article in his newsletter that said the correlation between cap rates is quote, the same level of correlation that exists between Pool Drownings.

A (33:10)

And Nicholas Cage films.

B (33:12)

So his view is basically that, hey, interest rates are going to impact sales volumes, but not the actual cap rate. And so do you agree with that or disagree with it?

C (33:25)

Well, number one, if somebody said something in 2020 and then trying to figure out, you know, today I'm not holding, I'm not trying to badmouth Peter Linman. There's a lot of things that have changed along the way. I bet even if you asked him, he'd probably have some different views than today. But I don't know how many Nicholas Cage movies have evolved like people are drowned in Nicholas Cage movie. Is that the analogy? I don't quite understand it. But you know, the, the, the, the simple fact is they do kind of rhyme. But it, it doesn't always move one to one. It's, you know, again, other things matter on that. Income growth, liquidity, you know, and really what, what I think the issue is, real estate people sometimes think about it in too much of an isolation, especially in the appraisal process. The appraisal process. People tend to treat these things as objects. How does this apartment building compare to another apartment building, a physical asset? What they really need to be thinking about these things as is investments, investments across the range of all investments. I'm investing in an apartment building in Atlanta. I'm investing in X amount of bonds. I've got an ETF that I'm invested in. And how, how do they all compare? That's how they should be thinking about it because that influences the ability of capital to move in and out of a sector. And you know, if you're just thinking about the values of, of a real estate asset based on how real estate is performing versus, you know, the changes in capital availability and cash flows in the rest of the investment universe, you're only getting part of the picture.

A (35:22)

Sure.

B (35:22)

No, you're, that's, that's totally fair point. So. And I guess and, and also too obviously, you know, some buyers will argue.

A (35:29)

There'S metrics more important than the cap rate as well.

B (35:31)

But I want to dig into some of your data on from MSCI Real Capital Analytics. Obviously there's limited transaction volumes right now, but your data shows cap rates have actually inched down a hair from the recent peak. Your commercial property price index for multifamily shows values ticking back up about 40 bips year over year. Now that doesn't offset much of the decline that we've seen of about 20%.

A (35:56)

But at least it's trending in the right direction.

B (35:58)

So. So Jim, is it safe to say, assuming, you know, no major economic slowdown or black swan event, that we've bottomed out and maybe the worst is behind us? Can we say that yet?

C (36:10)

I could make the case for that if we had an unsustainable surge in apartment prices. From 2020 to 2022, there was a great deal of excess optimism for the sector. With 10 year treasury hit 60 basis points. A ton of fast money moved into the sector and it impacted some markets more than others because you had the intersection of the temporary capital move plus some temporary moves of workers out of some expensive states with more Covid restrictions into areas in the south and Southeast that had fewer restrictions. And there were investors that were looking at this temporary zig as a permanent feature of the market and that they were baking in prices as if it continued forever. But it was. There's the market zigging and zagging and if you're paying top dollar for class C apartment complex in Mobile, Alabama, you know, it's, you know, because you raised a bunch of money as a syndicator and you bought it in 2022, in January. You're probably having a hard day right now. But the price level that we're at, it's still higher than like 2017, 2018, 2019. You know, we, we had a, a boost up and it's come down to a more normal level. But like if you just kind of draw a straight line from where we were in the years from like 2012 to 2019 and then to today, it's, it's at a decent level compared to the past. And some of those folks who made investments well before then, well before the COVID boost, are going to be sitting pretty some sizable capital appreciation along the way. So it's not, you know, the vintage of when you got into the market matters tremendously there.

B (38:24)

Yeah, no, that's an excellent point. So just looking at the overall average as mean, you know, we're about 5 and a half percent cap rate according to MSCI data. We're seeing obviously some trades back in the fours. And of course, I mean, as we talk here today, you know, interest rates haven't really come down much, if at all. We've not seen the rate cuts, at least the volume rate cuts we maybe expected to see or the Fed DOT.

A (38:53)

Plot survey told us we would get this point.

B (38:55)

In the apartment sector. We're still seeing pretty soft rent growth in some cases rent cuts. So what's driving this modest improvement we're.

A (39:03)

Seeing in the overall cap rates right now?

C (39:07)

I think there's a couple things that are driving it. Let's talk about rents first, just for fun. Yeah, we saw a hefty pace of construction for a bit and there's some questions about recent publications on construction data. But we're not going to be building as quickly as we did in the recent past. And managers looking to buy assets understand that. And they understand that the supply peaked and it's probably going to be coming down simply because construction costs have gone up. Material costs are a challenge, labor is a challenge. All those things are combining to make it a little more difficult now to develop assets. Even if we had a couple years of relatively high supply, there's an understanding that it's going to be harder in the future to keep that going. So if that happens, they still have some demographic growth, still some apartment demand that's going to drop to the bottom line on rents eventually. So there's going to be some element of not just, well, current rents are this, but there's some element of investors stretching a bit to get into apartments because the expectation, the future of some healthier rent growth, they're looking at it also because they're, they're also in this issue of where else are we going to put our money. The, the, the market has changed quite a lot over the last seven years or so and even started before COVID The, the. There was an understanding from around 2017 to 2019 that as the Fed ended the whole QE process that the cost of capital was going to go up because they were kind of helping to artificially push the 10 year treasury down and the cost of capital was kind of artificially lowered. So at that point when that was going away slowly, slowly, slowly people realized that, you know, funding all the CapEx requirements that go into an office building or a regional mall or a high end hotel, that's going to become more expensive and more difficult. I mean even, even before COVID that's going to become more expensive, more difficult in this new environment of no QE out there. So, you know, Covid happens, everything gets thrown up in the air. Now we're coming out of that and we're coming back to something more normal in terms of, you know, less government interference in that QE kind of sense. So there's some stabilization there, but it makes it more expensive still to own an office building, finance all those CAPEX requirements and finance the capex requirements for hotel or you know, anything that's just so operationally intensive. So investors have still shifted over to industrial and apartment because there's just a, it's just easier on that sense in a time when there's less of a CAPEX requirement to finance. So there's a little bit more liquidity now. I know that, yeah, volumes down, but there's more investor interest still in some of those. There's still many more dollars flowing into the sector. So that's helping support it. Those features are there helping to counteract what's happening with interest rates on cap rates. But here's the other thing. With the interest rate environment you are pricing in with interest rates, sometimes not relative to cap rates, not just here's where the current level is, but it's a momentum issue. If I'm trying to close a deal and rates are going up very quickly and I'm on the phone every day with my mortgage broker trying to figure out when do I lock in. If rates are going up quickly, it's going to be more expensive to lock that in. It's going to be more of a challenge to figure out the financing and that in and of itself the uncertainty on how fast it's going to continue to go up and where does it peak that in and of itself that uncertainty is going to reduce deal volume to some degree. Because just the hurdles you have to go through of working everything out with your mortgage brokers and arrange your financing, get the right pricing in place, the stabilization, I mean, let's say, let's say we don't see any change in the 10 year treasury in the future, just drawn out some crazy scenario where it stays current level flat for the next 10 years. In that stability there would be generated more investor interest because you could then remove some uncertainty around. Well, what's, what's the volatility of the pricing going to be what's the, my cost of debt going to be now? You know, because you know, for whatever reason some, someone waves a magic wand at the Fed, they, they invent some, some magic and they get that and you know, all inflation is fixed at one rate forever and are fixed at one rate and you never have to worry in that kind of environment. Even though it's higher than you know, where we were in like 2022 when you had the 60 basis points for a 10 year Treasury. The stability in and of itself would reduce some of the uncertainty and drive a little bit more deal volume around that. It's not saying you get the same deal volume as the past, but there's a certain amount of deal volume that doesn't happen when there's more uncertainty in the market.

B (44:58)

Oh absolutely, yeah. Investors hate uncertainty. And I like your point earlier too is that sometimes people make the point. It's like well how could people be buying anything at today's cap rates? But to your point is there's not like they have a lot of options. I mean even outside of real estate yields have compressed and everything. You want to put your money to work somewhere and you know, you pick what you might think might be your best horse to ride.

C (45:20)

So and if you buy an apartment building, at least you know you've got a hard asset and you've got some scheduled income there.

B (45:28)

Yeah, I tell people all the time, you know, the great thing about an apartment building is even a poorly performing apartment building may be 90% occupied, which is bad for the apartment business. But in the grand scheme of things. Yeah. I mean could be a, could be a lot worse.

C (45:41)

Right.

B (45:41)

Especially if you have an office building where you know, one or two tenants move out. Yeah. So let's talk more about the composition of what's trading right now. Jim, much of what we're seeing in trade is, I would call, let me tell you if you disagree but seems to be higher quality, newer vintage deals, better locations. That's generally what fits the buy box.

A (45:59)

For Most these institutions. REITs, other large groups, private equity with.

B (46:03)

Has capital to deploy. And then you heard this earlier, the syndicators may bought at the peak in early 2022 in weaker markets. Some of these hairier deals, older assets busted value adds sub institutional seeing more limited activity. A lot of those buyers have been pushed out but they were a big piece of the pie at the peak. And so I guess first of all, am I characterizing that correctly? And second of all, if, and I want to follow up on this as well but if, if, if, if what is trading is indeed skewed upward at this point, how does that impact, you know, maybe the kind of average cap.

A (46:41)

Rates and numbers that we're seeing in the market right now?

C (46:43)

Okay, let me address that second part first and then get back to sort of the composition of the market. Yeah, it is the case that sometimes there is a skew in what happens to sell. And so if you look at just a simple average of prices, you get some wild movements on that. Where I sell a high quality building one month and the next month a bunch of low quality buildings sell, the average price per unit falls. And so it makes it look like the market's collapsing. But what we do on that, starting in 2003, we built this, the RCA CPPI. We were real capital analytics at the time, we still call it the RCA cppi. We worked with David Geltner up at MIT and put together an index where we look at every building when it sells and figure out when it sells next. And then we built a repeat sales index to control for the movements in the market on prices that were just about the market and not about asset quality by looking at the same building over time. And we control for was there any substantial improvement in the building along the way. But by doing that, we're able to control for some of the quality differences. We have another approach on that we call our hedonic indexes where we take the physical characteristics of each building, all the things equal. A larger building may get a lower cap rate because there's a little bit more investor interest in that from the institutional deep pocket investors. There's other things that impact pricing, such as an older building tends to get a higher cap rate, tends to have lower income as well, more physical requirements. So we control for all those physical issues and effectively make like a set of Bose noise canceling headsets for cap rates and show you not just the, the noise of what's going up and down, but show you the smooth trend of the signal in the market, not the noise. So you know the, the figures, you know, it is what it is on that, you know, we're, we're controlling for. It's not about the fact that only high quality buildings are selling because we're controlling for the fact that there are quality buildings. But the, the move of institutional investors, I think it really still gets back to this issue of relative liquidity. They have pulled back from certain sectors and they've exposed, they've increased their allocations to the apartment sector and that generates a little more deal Volume for them.

A (49:28)

Yeah.

B (49:30)

So let me go back to the hairier stuff that's more challenged, lower quality or older vintages, whatnot. That seems to be. You and I have had this conversation in the past. We see some groups out there pushing out this noise about all this distress in the market and that seems to be overstated. I think you and I generally agree on that. But there certainly is pockets of distress in these, in that type of category in particular.

A (49:51)

So I'm curious.

B (49:52)

Obviously there's a lot of question marks at this point, but how do you see that story playing out? Let's just take the example of you bought the peak, high leverage, tough market, older asset capex issues, softer rent. Roll those values. It's going to be tough to get back to the peak in the anytime.

A (50:11)

Soon for certain, certain deals.

B (50:13)

So how does that story play out, you think?

C (50:15)

You know, it's kind of interesting. In every, there's an article I've written about four times now about every downturn in the market cycle. I mean, so effectively my career, I've survived through four market downturns.

B (50:30)

It's heck of an accomplishment.

C (50:34)

Fingers crossed that it keeps going. But the, but the, in every one I write an article that's basically, you know, this cycle is not like the last. There's, there's a behavioral element in our industry. Kind of a monkey see, monkey do attitude of oh, I see that that person made a ton of money in the last downturn using this strategy. So I'm going to use we're in a downturn, prices are falling. So I'm going to use that same strategy thinking that they can step up and provide a solution to the downturn just by copying the previous, the previous winners. And it never works because while the headline figures on prices may rhyme, there is always a different underlying force driving the market and the things that have driven price changes today and driving some collection of distressed assets today. It's fundamentally different for most property sectors than what we saw in the gfc. Now for the apartment sector, it's probably closer to the GFC situation than other than other sectors where you had some excess optimism on prices and you're buying three, you're buying class C buildings at a three cap rate, you're going to have a bad day. It just doesn't, it doesn't work out long term except in some very special cases where you're able to manage it very properly. So you know, if it was all dependent on financing changes, that ends in tears. And that's what we saw where you Know, we had people paying top dollar in part because there's a lot of debt availability at the time and with the low interest rates and they were able to make it happen. Now that debt has pulled back, but at the same time it hasn't. There's another type of debt that's out there, this downturn. And the distress is different because you don't see the same kind of work around. You don't have the same kind of issues with all these opportunistic funds able to line up and buy notes on buildings quite the same way as before and do the things that people made money with after the gfc. And I think part of the issue there is that the growth of private credit, we saw so many debt funds created, we actually had difficulty keeping track for all the loan information we track. We had difficulty keeping track of all the new entrants at first because there were so many new debt funds launched. And what they've done in many cases is someone has a loan that needs to be refinanced and given where they were, it's just not going to work. You know, they have to bring in some outside equity to get to a point where they need to finance it. So what they've done instead is get some high cost debt from or like pref equity from a debt fund, almost basically paying anything to roll the dice one more time just hoping that, you know, okay, this high cost debt, if prices, if rates go down, if prices go up substantially, then maybe I can make it out of it with some capital. Otherwise, you know, I, I still win where I keep the building and I keep at least the fee income even if the, the value at the exit is not as great and I've got something along the way and I don't end up in a default situation. So I think the, the growth of private credit in this cycle and all the plethora of MES and Pref equity groups that have popped up are really kind of preventing the rapid collapse that we saw for the GFC when lending pulled back across the board.

B (54:46)

Yeah, that's a really good point. I want to come back to private credit in a moment, but first let's talk about deal flows. Your latest data from MSCI shows apartment sales volumes up 5% year over year, I believe year to date compared to the same time last year. But that's not saying too much. Obviously we were at pretty low levels in terms of volumes last year, especially when you look at actual number of transactions. But so what do you think gets transaction volumes going again? Is it, is it rate cuts or is it rent and NOI growth? And you know, what's more important to the buyers you're talking to and how long before all this plays out?

C (55:25)

It's lagging returns. What kind of investment return is the asset class throwing off? Especially so in the institutional world, in the institutional world, a pension fund, they will sit down with their pension consultant. The pension consultant will say, listen, the acoe, the apartment component of the ACOE underperformed relative to retail last year. So don't look at apartments, look at retail. And that will drive their whole approach to how they're working with their managers and putting capital to work. So once investment returns start to pop up in a strong way, that will tend to drive the institutional investors back into the sector. So what drives returns? And it's all the things you mentioned. It's the cost of capital, it's rents, it's demographic growth driving tenant demand and driving more rents. So, you know, all of them, all those factors combined, but the returns, they're, they're not where they were. You know, it's not, they're not at the strong levels of the past. And so that's the issue that's still limiting some of the deal volume because the institutions, they see, I mean, it's funny, at the same time, it's still the biggest game in the US for the biggest market in the US for commercial real estate investment. And the institutions are certainly playing into that. It's just not going to grow as quickly because the return opportunity is not as great.

B (57:07)

That's a great point. And so just to connect the dots here, if the mainstream thesis plays out and the economy holds up, supply drops off, rent growth rebounds next year, the return being a lagging indicator, that doesn't pop up until 27. And so then you're looking at really 27 and 20. If construction funding gets going again, 27, you look at 29 deliveries. I mean, that really extends things out quite a bit.

C (57:32)

Yeah, that's something I think it's, I've been digging more into. We have some construction return data. Like how do construction projects, what kind of investment return do they have? We haven't really done much analytically with it, so I've been working with a couple folks trying to expand on that. My thesis is that, you know, what you just outlined is a typical approach. You get to 2029 and that's when supply starts coming in and too much comes in at once, it's probably too late. My thesis is that if you can figure out that flexion point, you're best off starting construction a couple years before that inflection point says that construction should start now. The, it's, it's a daunting thing to be the first construction project out of the ground in that, in that recovery phase. But if you time it just right, you're probably going to win better than others by being the, the shiniest asset when nothing else new is available.

B (58:32)

You're 100% right. I mean, that's what the REITs are doing. They say, hey, we have lower cost of capital.

A (58:35)

We have a long term story. We're going to start now.

B (58:38)

They were trying to help starts this year. We're seeing that with large developers, better access to capital. But your average. Here's a good stat for you, Jim. So 75% of apartment starts in the US tend to come from small local developers. They don't have the same access to capital.

A (58:54)

So you're going to have lower starts.

C (58:56)

Yeah, I mean that's, that fits. I mean the, the market is still very disaggregated. It's not some big monolithic market where only giant institutions can control it all. It's very much an everyman market.

B (59:14)

Absolutely.

A (59:15)

Yeah. Contrary to some of the headline myths we hear.

B (59:17)

So Jim, let's shift back to you mentioned earlier about availability of debt and made a passing reference to private credit. And so I want to take a hard shift back that direction. We've seen a lot of institutional groups shifting the last few years from doing LP equity to private credit strategies or.

A (59:34)

At least greatly expanding into private credit.

B (59:36)

And so a couple things happen as a consequence. I've talked about this, a couple other guests on the podcast in the past. There's more debt available and you mentioned this earlier, that's keeping the market a little bit more stable, creating somewhat of a bottom. Maybe some of those groups though aren't getting quite the terms or the volumes they expected when they shifted into debt strategies. And now of course, buyers have plenty.

A (59:58)

Of debt options, but now they're struggling to find equity.

B (60:00)

And so question for you, Jim, is, is first of all, do we overcorrect as an industry? And second thing, from your conversations with.

A (60:06)

Folks out there, particularly among institutions, is there an argument now for shifting back.

B (60:11)

Into LP equity and away from the private credit space?

C (60:15)

Shifting into private equity just given the way.

B (60:19)

I'm sorry, shifting from. I'm sorry, I misstayed that. From back into LP equity away from the private credit space that they've all.

A (60:27)

Kind of migrated to.

C (60:28)

Sure, sure. So more equity will Start coming in once returns pop up. It's just like deal. By the the way the institutional investors work. If you're going to go visit one of the big state public pension funds and try and get money from them for your, for your and fund that you're launching first you're going through the pension consultant. And the pension consultant is going to be looking at the lagging returns for different property sectors and different markets and they are going to be providing some advice to that capital source based on how the historical returns have moved. If returns still aren't at great levels they're not going to be so inclined which is kind of a difficult thing. I had a situation once where I was advising this one investor who in 2005 their pension consultant told them oh, you should double up on your hotel investment because hotel in 2005 has beat everything else in the index. And so the problem with that backward looking approach and not really thinking about what is driving returns is that they, they were being advised to effectively.

A (61:52)

Make.

C (61:53)

The wrong bet at the wrong time. There's a reason hotel beat everything else in 2005 and it really goes on. Well it happened just next door here in 2001 right after the attack in 9 11. Nobody was traveling for a year. We had a tremendous reduction in demand for travel, tremendous reduction in revpar for the hotel sector and prices declined dramatically. And that 2005 outperformance was just a function of that rebound from 9 11. And to say in 2005 that you should double up on your investment because the lagging return was outperforming everything. It missed the fact that it was not going to continue to outperform. So you know that's, that's the way the, the, the institutional investors act with you know, some of the backward looking advice from the pension consultants. But you know, sometimes I think that they, they need a bit of a forward looking view really make decisions because that, that is what you know, if you're buying now that this vintage might outperform relative to something that once the opportunity set is presented by 2029 or something.

B (63:15)

So I'm getting the impression that you're not a big fan of the pension consultants right now.

C (63:22)

I work with some great folks in the pension consulting world. I back in the day, Neil Meyer at Townsend was instrumental for my growth as a professional. He gave me some real good advice on stuff but it's, I think the backward looking approach that a lot of folks have to use is, is at times making the institutional market a bit slower than it needs to be. And so that's where, you know, the smaller groups, you know, Talked about the 75% of the market on construction. That's local. Developer, owner, operators. Creates an opportunity for these folks.

B (64:01)

Yeah, absolutely.

A (64:02)

And of course, I was just teasing.

B (64:03)

So, gentlemen, I don't want to take too much of time, but I want to ask you one more question. In your latest report on capital market trends, you noted or your team noted.

A (64:12)

There'S more than $75 billion of dry powder earmarked for US real estate.

B (64:16)

And so if you just talk about, we hear this term, we hear all.

A (64:18)

About dry powder, how it's all on the sidelines. Everybody loves commercial real estate multifamily, but it's waiting.

B (64:24)

So talk to us a little about what this means. I guess more specifically, how much urgency is there among investment managers to deploy.

A (64:31)

These funds and is there any chance.

B (64:33)

That stuff just doesn't get put to work?

C (64:36)

Well, a couple things on this one, that $75 billion figure, it's going to be much higher than that. That was just the $75 billion in closed end funds. Okay.

B (64:48)

Oh, that's right, yeah, I misread that.

C (64:50)

Yes, the open end funds, we launched a product, RCA funds. We're trying to track the whole fund universe. Not just closed end, but also open end. And we bought this company, Burgess, that had a ton of closed end fund data. And so our big challenge right now is figuring out how the two product sets match each other. But we know we have a lot more often than fund data. What's nice about the charts that was in the report and that closed end fund data, at least it's a consistent universe and you can see that there's still a lot out there. But this point about will the dry powder stick around? The, the, we saw this after the financial crisis. There were people saying at the time, as we went into that crisis, oh, there's all this dry powder out there. Prices aren't going to decline because all this dry powder can get put to work. But if, if you've ever shot a muzzle loaded gun, you know that, that dry powder, if you've got a, you're trying to put that in the flintlock and if it, if you got too much wind, the powder blows away. And, and so you know, that's why everyone moved to caps and bullets. But you know, and in the, in the, all the dry powder, it's out there. But at some point, if there is not a good investment opportunity for that capital, it's not like they're just going to put it to work simply because I kind of got a little sidetracked and didn't get all the way into the move from equity to private credit. It was going into sort of the backward looking approach. But you got this backward looking approach. And if I see only healthy returns in the debt space and minimal returns in equity space, for now I'm going to advise my institutional investors as a pension consultant to go into the safety of debt. So that's why you see so much more there. But that issue has made folks kind of go that way. But I think that at some point some of these managers are going to have to start stretching out on that and getting into the other side. But also the debt, the private debt that's out there, it's different than getting a loan from a bank. If Barry Sternlich, for example, and I normally don't like to talk about books, but he made this point publicly, he's looking to give you a loan on a building for his debt fund. I mean, he said publicly at some events at NYU that some of his lending is loan to own. And I think in some cases, case of, you know, managers who are paying anything to roll the dice one more time and hope they get through it and if they don't, then it's, it's a cheap entry point for someone, some equity on an asset. And that's what I think is different in this cycle as opposed. And I think it's actually a little more orderly compared to the past where we had, you know, distress asset sells everything kind of chaotically organized. I'm going to help you out and give you a loan. It's high yield. If it doesn't work out, it's going to convert to equity at some point. And I think that is helping us through this price change with a little less chaos than we saw previous cycles.

A (68:18)

Yeah.

B (68:19)

Well, Jim, I appreciate your insights. It's been really fascinating to pick your brain and so thank you for sharing with us and thanks for joining the podcast.

C (68:27)

Always great to talk to you.

B (68:28)

All right, thanks, Jim.

C (68:29)

Take care.

A (68:50)

And that's a wrap on episode number 50 of, of the Rent Roll. A big thanks to our sponsors, to jpi, to Madera Residential and to Funnel for sponsoring today's episode. And thank you to Jim for being our guest and thank you to all of you for spending part of your week with us. We'll see you next.