On Friday, October 21, the Norris Group proudly presents its 9th annual award-winning black tie event I Survived Real Estate. An incredible lineup of industry experts will join Bruce Norris to discuss perplexing industry trends, head-scratching legislation and opportunities emerging for real estate professionals. Proceeds for the event benefit Make a Wish and St. Jude Children’s Research Hospital. This event is not possible without the generous help of the following platinum partners: HousingWire, PropertyRadar, the Apartment Owners Association, the San Diego Creative Real Estate Investors Association, InvestClub for Women, MVT Productions, the San Jose Real Estate Investors Association, Inland Empire Real Estate Investment Club, Think Realty, and White House Catering. Visit www.isurvivedrealestate.com for event information and tickets.
Bruce Norris is joined this week by Peter Muoio. Peter is the Chief Economist of Ten-X, formerly Auction.com. He is a renowned real estate economist and trusted industry analyst and forecaster. Muoio leads Auction.com research and is the founder of New York based Maximus Advisors, a widely respected CRE consulting firm that became part of Auction.com in 2012. Previously the head of Deutsche Bank real estate research, Muoio and his trusted research team provided a trusted economic barometer that helps guide Ten-X’s business decisions.
Episode Highlights
- How has the internet made a difference for property auctions?
- What are the different types of auctions?
- Has commercial property sales outpaced residential?
- What has changed with demand, and is it still strong?
- Where could interest rates potentially be five years from now?
- Is there a threat of inflation, and what would the Fed’s do about it?
Episode Notes
Ten-X is the parent company, and Auction.com is underneath this. Ten-X has the Ten-X homes and commercial properties, and Auction.com includes the bulk sales of residential homes. What is interesting about the company is that it has been a revolutionary concept. When Bruce first met the owner of the company holding his first auction, he was auctioning off a group of homes that did not sell. There was a lot of competition that had existed way before he started the auction business. Now Ten-X and Auction.com are the leader, and this is a very interesting transition. What they did was revolutionary and took advantage of the changing of how people would buy at auctions.
In the 90s they would attend live auctions in ball rooms. Suddenly this started to transition, and now the transition is close to being complete. They can still do the ballroom auctioneer voice, but all these years later they are reaching globally on an online platform, both for residential and commercial real estate. They have worked with distressed real estate as well as everyday real estate that is owned by investors who are selling to other investors. These include those of all different sizes and categories, from institutional to mom and pop buyers and sellers. It has been quite the revolutionary story.
Bruce bought a track of lots in California to use for rentals, and he wondered if they had any commercial properties in Leasburg. Sure enough, there was a storage place that was up for auction. He would not have known about that auction any other way if it was not online. The reach of that auction would be so different than it is today. At Ten-X they work with a lot of brokers, and the feedback they are receiving from them is it expands the potential audience of buyers for the property they are helping the seller sell. If you were looking at someplace outside of California, you can look for similar markets to the one you are selling in and give them the same advice. You can get that kind of exposure both regionally and internationally, working with it from any country at any time of the day. It is mind-boggling.
If you saw a residential auction for a builder back in the 90s and it did not sell, then you had some form of motivation on the other side. This was a given. You see an auction, you see the deal and the motivated seller who is under the gun. Bruce asked if this opinion has changed. The reality may have changed and the seller is a very different person, but Bruce wondered if the buyer is still of that mentality and that there must be an issue with them choosing auction. Peter said it is changing, although not completely yet.
One of the things that is interesting that came along coincident with the re-branding of Ten-X is the options for buying and selling on the platform are no longer just auction. You have two different types of auctions you can choose from if you are the seller. They also have a program called Offer Select, which looks and feels like the traditional way of selling non-distressed real estate. You have the seller with the information, and you have potential bidders showing interest and communications back and forth between seller and buyer. The timing of it is all determined by the seller and how long he wants to have it out there. Another factor is how many buyers he limits it to based on initial indications of interest. He then gives them information in terms of what they are trying to find.
Part of the rebranding was to abet this process. Just because it is part of an auction does not mean it is a distressed property. They still do a lot of work with the big special servicers and the properties with which they are disposing. The percentages of other types of assets is growing consistently over time, and as that is happening the perception is continuing to diminish.
There are two different types of auctions. One is called live bid and the other manage bid. The manage bid is more controlled in terms of who the bidder pool is. There are variations on what type of auction the seller can choose. Bruce asked if they are all reserve auctions, which Peter said they are. Bruce asked what percentage of commercial properties choose the auction route. Peter said he is not sure of the actual percentages, but of those auctioned versus being sold off they are dominated by the auction process. Peter gets emails as each property goes up on the system. What he sees is more of them are choosing select versus auction. It seems the offer select process has been really picking up significantly five months since it started.
Bruce asked if commercial property has outpaced residential since the downturn and done better. Peter said yes, and the story he likes to tell is in regards to there not being just one cycle. If you look at each of the property segments, they each progress at a different pace. The apartment and hotel cycle has outpaced the single-family residential cycle. However, the office and retail segments have been slower than single-family residential. Industrial is also on the same kind of timing somewhere.
Bruce wondered why this was the case, whether it was people losing their homes in foreclosure or they became incapable of being able to be a buyer. If they became renters, it seems this would lead to an increased demand for a certain period of time. Peter said this is correct. What he has seen is a sharp drop in the homeownership rate from almost 70% to below 64% to levels not seen in 4-5 decades. Every 1 percentage point drop in homeownership rates is 1.2 million households shifting from owning a home to renting a home. This is why the apartment segment could have such a fast and furious recovery compared to other property segments like commercial and single-family homes. Even though the early part of this economic expansion was notable weak and saw-toothed, the shift of people into rental properties was so massive it generated a sharp increase in demand. Coming out of the recession and financial crisis, there was not a lot of development taking place. Therefore, the juxtaposition of strong demand and very limited new supply brought vacancy rates down very quickly from near 9% to near 4% over the course of a few years.
One of the early talks Bruce did this year was with the Apartment Owners Association. He had 650 people, and he told them he guessed they were either really excited or really afraid. Somebody asked if he thought that segment of the industry was over-priced and if we had a bubble. Bruce then asked them if they would buy their apartment building at its current valuation. The whole place laughed, and Bruce said this was the sign of a bubble. Bruce then asked Peter if he thought in that segment we had a pricing issue that could be a problem going forward. Peter said the apartment segment is in the late cycle. What they have been testing for some time that is transpiring is the increases in vacancy rates and slowdown in rents that is resulting in potentially some weakness in valuations.
Peter said he is seeing the reverse of strong demand. We still have strong demand and it has remained healthy for the apartment segment. However, what has changed is we have had significant increases in development activity. Some markets particularly stand out in that kind of way, and what that is doing now is it is a digestion issue. Even with healthy demand, supply is too great to meet all that supply. Vacancies are moving up and rents are weakening, so it is a late inning story for the apartment segment. If you look at it from a market NLI perspective, it is really being driven by rent increases. As occupancies have started to decline and vacancies rise on the national level, valuations have held up by cap rates being assisted by the decline in treasuries. This has surprised many market participants.
Going forward 5 years from now, Bruce asked Peter if he thinks interest rates will be higher and lower than where they are. Peter believes they will be higher, which would put pressure on the cap rate and lower the valuation. One of the things they look at across the property segments is cap rate spreads to treasuries. Not surprisingly given the different pace of fundamentals change and the degree to which investors have piled into greater or lesser degrees to different property segments, the cap rate spread for apartment properties is narrower. How Peter likes to look at this is that gives you less comfort or wiggle room when interest rates start to rise and the cap rate spread declines to mask the impact of rising interest rates. It makes the apartment segment more vulnerable to that than office, retail, or industrial.
Right now we have about a 1.5-1.6% tenure. We have unemployment around 4.8%, which is almost considered full employment. We also have 1% GDP growth as well. Bruce said he is looking at the sovereign debt of the world being at 30% of negative territory, so it looks like we are fighting deflation instead of worrying about inflation. Bruce wondered what will occur in the next five years that says they have to raise interest rates. Peter said it was interesting because he had just discussed this with members of his team. In December they put out their predictions for the next six months, and one of the things they said for December was the Fed was not going to be as fast at tightening as everyone thinks they are.
The debate is that there is not any threat of inflation at the moment. To his way of thinking, the Fed tightening will be more as a way to a means to rearm their toolbox or rebuild it. This would give them more wiggle room in the event of more negative events in the future with which then to ease. If something were to happen now, they would not have a lot of firepower. There is talk that people like Janet Yellen will take inflation and ask for it to be made less of a target for what the Fed should be doing. He thinks right now they are itching to put themselves in a position where if they need to they have an arsenal to fight a negative event.
This is why Bruce used the timeframe of five years and now 12 months. He thinks whatever they do is immaterial in 12 months since they would need to take it back if we have a recession. What is interesting about having a recession is you may have a ten-year T-Bill that says 1. If that occurred, your valuations could actually go up. Peter said from his research he would say when you look at cap rate movements historically, about 50% is driven by interest rates and the other 50% is driven by real estate specific events. Real estate would involve both the capital and fundamental flows, which can be capital flows into real estate versus other assets. If you have a downturn or recession and have no pressure on interest rates going south again, that is certainly the potential to bring down cap rates.
The flip side of this is that there will be decreased capital flows into real estate, so therefore the other 50% of the movement in cap rates could be moving in the other direction. This leaves you in no man’s land of where to move, but you would not see anything dramatic one way or another.
Auction.com was really part of revolutionizing something. Bruce said if he were in the hotel business, he would not like that Airbnb showed up. Looking out in the future with robotics and 3D printing, Bruce asked Peter if he sees changes that could affect the real estate world. Peter said yes, two which were already mentioned. The third is decreased office space for a thousand reasons having to do with various elements of technology stemming from having laptops we can stick on any desk and hotel people within the office. The fact that we are all in the cloud and can work from anywhere would lead to decreased office space.
The flip side of this is the one property segment benefitting from technological changes is the industrial warehouse sector as a result of the need for distribution and fulfillment space, both for retailers and better competitive response from brick and mortar retailers. This has been one of the reasons the industrial segment demand has held up as well as it has, even amidst low oil and its impact on that part of the mining sector. Occurring along with this was the weakness in many of the countries abroad and the slowdown in trade that occurred along with that. They think these secular headwinds for real estate are not going away and will be continued factors for commercial property.
Bruce sees the same thing coming to college campuses. You could have the greatest history teacher in the world teaching 1 million students at time, doing away with college debt. This would change the game for a lot of people. It is like the end of social interaction in that we don’t need be in an office, shop in a store, go to a hotel, or be on a college campus to do all the various things that used to get done in those places.
Thank you for joining us this week for the real estate radio show with Peter Muoio. The Norris Group would like to thanks its gold sponsors for supporting I Survived Real Estate: Auction.com, Coachella Valley Real Estate Investors Association, Coldwell Banker Town and Country, Elite Auctions, In a Day Development, Inland Valley Association of Realtors, Jennifer Buys Houses, Keller Williams Corona, Keystone CPA, Las Brisas Escrow, L.A. Green Designs, LA South REIA, New Western, North San Diego Real Estate Investors, Northern California Real Estate Investors Association, Orange County Investment Club, Orange County Building Industry Association, Pacific Premiere Bank, Pasadena FIBI, Pilot Limousine, Real Wealth Network, Realty411 Magazine, Realty Executives Inland Empire, Rick and Leanne Rossiter, Sonoca Corporation, South Orange County Real Estate Club, Spinnaker Loans, uDirect IRA Services, Westin South Coast Plaza, Wholesale Capital Corporation, and Wilson Investment Properties Inc. See www.isurvivedrealestate.com for sponsor links and event information.