Quarterly Call | Where Does Multifamily Go From Here With Walker & Dunlop Chairman&CEO Willy Walker

Garrett, it's a joy to be here.

So first of all, I appreciated your comments on the intro of built Walker Dunlop in sort of short order. Being that I've been here for 23 years, I'm actually feeling a little long in the tooth these days. But it has been a wonderful, you know, it's been a wonderful almost quarter century of building this company into what it is today. And I'm very thankful for our partnership with you and your team. It's too early to really assess what this rate movement is going to do.

As you know, Garrett, typically when you get this type of a rate move, it takes 60 to 90 days for cap rates to adjust and for transaction volumes to kind of pick back up. And as a result of it, typically only two weeks after all this has happened, it's too quick to make any conclusions, if you will.

There are some things that I think are pretty obvious are going to happen, though. One is that with cap rates moving to the degree that they have or will, and with financing costs moving the way that it did as far as investment sales activity, that is going to either have a lot of repricing or slow down in the short term. I had a lunch with a client yesterday who was bidding on an asset in Richmond, Virginia, had offered $70 million for the asset, repriced their bid at 58 million on Monday, and was sort of waiting to see whether the seller would take the $12 million discounted price on the $70 million asset all of two weeks ago. So you're going to get that type of price.

What is more dramatic is that for the last three to four years since the great tightening began, there has been an attitude in the marketplace of hope that rates would come back down. Most people in the commercial real estate industry have been used to since 2009 into 2010 a relatively low interest rate environment to transact business in. And starting in 2022 in December with the first rate hike, those rates have gone up precipitously. And as a result of it, there was sort of a hope trade in place of I hope that President Trump and his administration will push inflation out of the system further, that he will put in a new Fed chairman who will cut rather than raise, and we will be in a lower rate environment. And that was the hope trade. And oh, by the way, that hope trade was working for the first 14 months of the Trump administration.

Trump too, it was working. Inflation was going down, rates were going down, and we were getting back to a more normalized market. And then the president decided to invade Iran. And as everyone on this call knows, the world turned sort of upside down, particularly as it relates to where oil prices have gone, where inflation has gone, and where rates have gone. So what I think is fundamentally different right now, Garrett, is that that hope trade has turned to a fear trade. That hope that rates are going to come down has turned into a fear that rates are going to go up. And that, I think, is going to drive a tremendous amount of activity. It's going to drive deals that were teetering on the cusp of going under.

They're going to go under. Deals that need to be recapitalized are going to call for more capital immediately to get recapitalized to deal with this higher rate environment. And refinancings that might be out there that was, oh, I'll just wait until rates come down six months from now or two years from now, are saying I got to go, I have to manage my downside more than I have to manage my potential upside on the hope trade. And so I think that fundamentally the psyche of the market has changed significantly in the last two weeks. And I would think that that drives a ton more transaction volume, particularly on the debt side going forward, of people really working to try and lock in rates where they are today. The final thing I'll say on that is it's also challenging because as rates have gone up, values have come down. So a deal that we financed in pick your year 2021 that is up for refinancing, you generally speaking have had value degradation of between 20 and 30%.

And at the same time, you've also had the cost of capital go up 20 or 30%. So you've had this huge shift. So when we go back to refinance a deal, there was a 60% LTV loan back in 2021. Today, it's hard to get to sizing to take out that 60% LTV loan now that values are down by 20% and the cost of financing is up by 20 or 30%. So that's the challenge to the market today. That's driving a lot of borrowers to go short when many of them want to go long. But fortunately, we have seen a flattening of the yield curve so that the longer dated maturities are actually cheaper than they have been all year long. So people actually can borrow 10 years fixed rate today more cheaply than they can five-year fixed rate from the agencies, for example.

So, first on the rate side of things, Garrett, maybe I'm talking my own book, but I think something's going to break on a macro level, not micro as it relates to commercial real estate. I think something breaks on the macro level. Okay? And again, I want to be very clear. I'm not just kind of like crossing my fingers and hoping. I woke up this past Saturday reading the Wall Street Journal, I had three of them piled up and I was diving into them, and I felt like we were in July of 2008.

And there was no specific reason why I felt like July of 2008. And to those of us on this call who can remember back to July 2008, that was sort of the relative calm before the storm. At the beginning of the GFC, we'd seen Bear Stearns go under, the market was kind of teetering, and then all of a sudden, boom, October of 2008 was when everything imploded. I look at the amount of debt outstanding to data centers. I look at the revenue streams to the hyperscalers that is evolving and changing every single day. And I sit there and say the equity markets have had this amazing run. And by the way, my friends who are really savvy equity investors all think the equity markets are poised to continue to crank forward. They're trading at a 17 times trailing PE, except there's like five of them that are causing the entire market to grow. But with that said, I just feel like something's going to break here. And if something breaks, that's going to be net beneficial to hard assets and to where rates go. So I am sitting there. It may happen, it may not happen. Who the heck knows? But I think that we might be looking at some recessionary pressures that come in that would be favorable to hard assets and to where rates go that could get us out of this predicament of what we're seeing right now of just higher for longer. That's point one.

Point two is it relates to your question about rents. Right now it's really concessions, as you know, market dependent. But how many months of concessions are in the market that when those concessions start to burn, you're not having to raise rents by 3%, 8%, 10%. You're picking up 10%, 20% of your effective income by going from three months concessions to two months concessions to one month's concessions to none. And it's really there because in many markets what we are seeing now is we've gotten occupancy levels up to where concessions should be burning off and they haven't. And so once we get to a tipping point where new supply has been curtailed to the point where occupancy levels stay at 95, 96%, and here in the Denver market for instance this is a three-month concession market right now. Three months and all of the new A product pulled people from B's into the A's and from C's into the B's because they could go and live in a much nicer property for three months free rent. So what we need to do is see that phenomena start to change and go from three to two to one more than I'm raising my rents by 5% or 6%. And once we get that effective income at the existing stock, we'll move up commensurately and all of a sudden now we are in much better shape than we are today with three months free concessions. The Boulder market for instance right now doesn't have concessions. It's a supply constrained market and people who own in Boulder aren't having to give away concessions. If you're in downtown Denver, you are solidly in a three-month concession market even with brand new supply. So that's I think what has to happen in these markets. We're clearly getting at occupancy levels that would indicate that we can take off concessions and we're clearly at a downward draft on new supply that would say that should be able to hold. The question is how quickly can we start to peel concessions?

I think point one on that, Garrett, is that the fact that we have $40 trillion of government debt outstanding and growing at a pretty significant clip, that's not new.

You got it. And so, you know, we've got some big printing presses in Washington that can, you know, that can inflate our way to a much, much bigger debt load and we can, quote unquote, afford it. One of the things that my friend Peter Linneman loves to say is that if we are adding five to ten trillion dollars a year of net wealth to America, which is about the clip that we're at at current GDP growth, you can easily afford to run a $2 trillion deficit on an annual basis. No doubt. Like we've got the growth machine here to be able to do it and afford it. The question is, is it the smart thing for us to be doing? And why aren't we demanding of our government officials that they get some fiscal discipline? And you know, the sad part to me is that neither party is offering that today. Neither.

We used to have a Republican party that stood up and said, we are the ones for fiscal discipline. We are the ones who don't like spending. We are the ones who want to have a balanced budget. They are the ones, that's the party of Newt Gingrich and let's sit there as the Tea Party and push Bill Clinton to have a balanced budget, which was the last time we had a balanced federal budget. That's gone. We now have a Republican party that is spending more than Democrats. So you think about these elections and you just say what's the alternative? That, you know, Democrats want higher taxes and higher spending and Republicans want lower taxes and higher spending. You tell me which is worse. So I feel like to some degree we've lost the thread as it relates to any kind of fiscal discipline, but that's going to be there and we can afford it. So I don't think that while I think that everyone sits there and says 40 trillion, that's a lot and it's more than annual GDP, which I think that number caught people. I do think it's not a news flash that we got 40 trillion of debt outstanding being greater than the 38 trillion of annual GDP is eye-popping, right? So that one I think caught people of sort of like, can we actually afford this now that we've got more debt than we have annual GDP? But that's just a, you know, most people don't understand the numbers behind that or what it costs us to service that, etc., etc.

The next piece to it is try and run out what actually will bring oil prices down. The US has become the world's largest producer of oil. We have right now at the current price of oil, oil exploration and development going at an unseen pace. So you're getting a lot of exploration right now which will add more capacity on and many people have said once you get on the other side of the Iran conflict, oil should come down fast and hard. But they always say once we get on the other side of the Iran conflict. So, I was with a Walker and Dunlop client a couple weeks ago in New York who happens to be of Iranian descent and happens to be Jewish. And I sat there and he said, rates are going down. And I said, really? Explain to me. You come from Iran, you're Jewish, so you know a lot about Iran and about Israel. And the first thing he said to me, Garrett, was, oh, well, this conflict's going to take a very long period of time because Iranians have been negotiating for 3,500 years and the United States of America has only been negotiating for 250. And I looked right back at him and I said, and therein, why do you think that this conflict gets resolved anytime soon? Like the first thing out of your mouth was, this is going to take a long time. And so I think again that was before the rate run-up and I'm assuming that that client right now has changed his thinking of the hope for lower rates to the fear that they go even higher from here. So I don't see anything on the landscape post, I mean the president has said numerous times after the elections we'll solve the Iranian conflict.

Nobody seems to have a path forward that is an easy exit ramp or the president would have already taken it, right? Without a doubt, he would have taken it to try and get the cost of oil. I mean, there's not an Instagram feed that does not have on it $7 a gallon diesel prices in the United States and how that is affecting everything in the supply chain. So, he would have done it if it was there to be done. So, I sit there and say if it wasn't done, the election isn't going to do anything there. So I think that we're in a higher for longer rate environment right now and other than some type of macro slowdown, a recession, a debt crisis where the Fed is forced to cut and people flee to safety. Barring that, if you continue to get the play on the only other piece to it, Garrett, which you know is a lot of people have been sitting there saying that AI is going to come in and create massive efficiency. It's going to be deflationary and therefore it's going to run inflation down.

Oil is in 70% of the products in the CPI. So you look at that CPI list of I think it's 42,000 goods that are in the CPI list. Of 42,000, 70% of them have some component of oil in their price. So, as long as oil is where it is, good luck getting AI to come in and be deflationary and all that great stuff. Oh, by the way, we have not seen big layoffs due to AI. So, it's not going to, right now it's not creating excess supply of labor and therefore pushing down the cost of labor in the market. And so, all it's done is push up the cost of labor. All it's done is expand the economy and GDP. So nothing that would lead you to believe that it's going to be deflationary so far has kicked in.

There's been a, I mean, the consistent theme across both single family and multifamily has been that there is a housing shortage in America. And that has been talked about extensively. And clearly if you are on the supply and demand side of just any type of market, you would sit there and say housing is so expensive because there is a lack of supply. At the same time, her report basically says that we're not really in a housing supply. We're in a housing affordability crisis that the product that is needed to meet the demands of the market is not priced properly for where the demand is. So, I thought that her comments on that and kind of pushing back a little bit on the narrative of where housing, you know, we're supply constrained was a very important one. I think the other one is just her demographics as it relates to going from being a country that was creating new households to a country that is going to very soon be in a deficit position as it relates to new household formation due to the demographic trends of the country due to the number of 20 to 39 year olds who are living at home which has gone from 15% to 22% of 20 to 39 year olds in America today are living at home.

You know, Garrett, when you and I were that age, we were out building families and wanting to live alone. And if you said to me, you know, go back and live with Mallory and Diana, whom I love dearly and stay with every time I go to Washington rather than staying in a hotel, I'd say, you know, come on. I'm trying to create a family and grow and be on my own. Today, 22% of Americans between 20 and 39 live at home. That's a massive shift. Now, she also puts in that, Garrett, that if you get 22 going to 21 or 21 going to 20, I think that's something like 500,000 people who go back into I'm a home buyer, I'm an apartment seeker. So, the numbers are huge. If you get any turnaround to that, but you know, first-time home buying has moved out from early 20s to late 30s. Now, no coincidence that people living at home in that demographic have gone from 15% to 22% over the same period of time that people buying a home has gone from the late 20s to the late 30s. So, and our birth rate has gone down dramatically and our immigration policy has made it so that there has been a hard stop at the southern border on illegal and there has been no commensurate increase on legal immigration. That to me from a policy standpoint is the most important issue right now. If the Trump administration would focus on it and say we have done an expert job of shutting down illegal immigration, give us a star. Give them the star for doing that. But then turn to we're right now allowing 600,000 people a year to come into the country legally. We are going to increase that to a million. If they did that and added another 400,000 immigrants, legal immigrants, taxpaying immigrants, talented immigrants who want to come join our job force and create homes and families in America. Big difference. But what they've done is they've shut it off and they haven't increased legal at all. And that is a real problem.

Well, I don't think the data would tell you that. I mean, you look at wage growth in America, Garrett, and it's not as if we have negative, we have inflation in wages in America and we also are at full employment. So if we were in a higher unemployment market or we were seeing deflation in wages, I totally concur. People can't afford to go out. Multifamily is as affordable as it has ever been in my 23 years in this seat. I have, if you look at the numbers of housing affordability and multifamily affordability of rent to take-home pay, it's never been this cheap in 23 years. It's never been this cheap. So, it's not that people can't afford to do it. I think one of the reasons may be remote work. When the pandemic hit, people moved back in with their folks and if their employer hasn't required them to come back in person, they just say, why don't I keep on working here? Two, there has to be some wealth effect in place. When you and I were that age, my parents had a very nice house that I would have liked to live in. But, you know, the bottom line is we have big homes that people can now stay in with their parents because there's been so much wealth accumulated in the baby boomer generation that people have the spare bedroom, they have the ADU in the backyard that the child can live easily and differently.

If you climb back 50 years, not so much. There wasn't that space to do it. So, I think that has something to do with it. But I don't think it's that housing is just unaffordable. I think it's that it is affordable. They are making the discrete decision to double up and unless they have a driving need to go out and get coupled, have kids, start a family, if they want to stay single and live with mom and dad, it's a pretty good solution.

Forgive me because I'm going to sound a little bit too political in the response to that question, but I think it's unavoidable.

My concern is that there has been this xenophobia that has been promulgated by

this administration. And again, that's as political a comment as I will ever make, but that is going to be hard to unwind in the sense of we need to open the doors to more legal immigration. Paul Begala, who many people listening to this may recall, Paul Begala was in the Clinton administration and the Obama administration, and he and Tucker Carlson used to do this kind of Republican-Democrat hour-long kind of tit-for-tat in front of audiences that many people on here have gone and listened to. I used to see them at the JP Morgan Bank CEO conference every year and they were really funny. They would throw darts at one another about how messed up the policies on the left and how messed up the policy is on the right and it was fun and it was constructive and you could point out all the disconnects between the two sides. Paul Begala said in a recent interview that he thinks that Tucker will run, which by the way Tucker has not in any way indicated that he wants to run, but he said if Tucker runs, he will run roughshod over all the other Republicans because he will pick up on the xenophobia that Trump has started and drive it straight to the ceiling. And he will pick up on the populist Democrats of a Bernie Sanders movement and combine those two together that will make him a candidate that no one can get in the way of. And I sat there shocked first of all thinking about that reality. But he was picking up on two big themes right now. One is the social democratic movement which is driving to this giveaway economy and the other is this fear of foreigners, this fear that foreigners are going to come here and do all sorts of bad things to us. So to your point about legal immigration, I think the sound and smart thing to do is for us to raise the amount of legal immigration to make it so that this economy has real growth to it. And at the same time, I am fearful, and again, I'd go back and apologize for my very clearly political comment, that the xenophobia that has been promulgated by this administration is going to make it so that that's an impossibility. And so that's my fear on that issue. I certainly hope that some adults show up and say, 'What? This is the way we can solve this.' But so far, I haven't seen anything to lead to that.