January 1, 2018

JF1217: 2018 Market Predictions From An Expert Economist

Peter is with us for the first episode of 2018, and that is not by coincidence. An economist by trade, we get a TON of great advice when it comes to how we look at the economy and markets. Some of his best advice is to take a step back and look at the bigger picture, don’t just focus on your business or you’ll never see the full picture. At the end of the interview Peter gives us a 2018 economy prediction. You don’t want to miss this one! If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!


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Peter Linneman Background:

Principal of Linneman Associates the CEO and founder of American Land Fund and of KL Realty

– Named one of the 100 Most Powerful People in New York real estate according to New York Observer

– Linneman Assoc. a premier consulting and research firm, specializing in commercial real estate investment strategy.

– For 35 years, has advised leading corporations, served on over 20 public and private boards, including serving as    

 Chairman of Rockefeller Center Properties

– Based in Philadelphia, Pennsylvania

– Say hi to him at: http://www.linnemanassociates.com/

– Best Ever Book: Capitalism and Freedom


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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any of that fluff. With us today, Peter Linneman. How are you doing, Peter?

Peter Linneman: I’m terrific. It’s lovely where I’m at today in Philadelphia.

Joe Fairless: Nice, I’m glad to hear that, and welcome to the show. A little bit about Peter – he is the principal of Linneman Associates and the CEO and founder of American Land Fund and KL Realty, named one of the 100 most powerful people in New York real estate according to The New York Observer. Based in Philadelphia, Pennsylvania, and for 35 years has advised corporations, he served on over 20 public and private boards, including serving as the chairman of Rockefeller Center Properties. With that being said, Peter, do you wanna give the Best Ever listeners a little bit more about your background and your current focus?

Peter Linneman: Sure. I am a PhD economist by training; I taught many years at the Wharton School of Business at the University of Pennsylvania, and also started Linneman Associates very early in my career, focusing on economics, finance and strategic advice. We branched out over the years into some boutique investing and investment management as well. The client base tends to be major families, major REITs, major private equity funds, and it’s been a lovely career for a long time.

Joe Fairless: How do you spend the majority of your time now, from a business standpoint?

Peter Linneman: Thinking. I’m trying to understand the environment that we’re in – the economic environment, the capital market environment, and the real estate supply/demand fundamentals. Because if you think about it, it’s really the interaction of those three things that are the turbo-charger behind all investments. Yes, you need a decent property and yes, there are real real estate fundamentals – can you fix the property up? Can you reposition the property? I’m not trying to minimize those; those are sort of the tools of the trade. But what I really spend my time on is that interface of where’s the macroeconomy going, where are capital markets going and where are real estate supply and demand fundamentals going?

Joe Fairless: Would you say when you’re hired by families, REITs, private equity firms, you’re addressing those areas with them in some capacity?

Peter Linneman: Yeah, primarily. It can be in a very specific way of “What do you think of this investment?” or “What do you think about this sale?”, but it also can be “Help us think through risk management, help us think through how we should grow,  think through how we should protect ourselves as we move forward”, and I certainly have no monopoly on insights. I like to think that if you think about professional… Almost anything – think of professional basketball; if you can make 45% of your shots, you’re gonna be around a long time, even though you miss more than you make, because it’s a very tough, competitive environment you play in in professional basketball. And I think that’s investing. It’s a very tough, competitive environment, with a lot of other smart professionals trying to figure things out. You’re not competing against five-year-olds, you’re competing against other real pros. And if you can help and be 1% or 2% better with a substantial asset base, that’s worth a lot. So my goal is not to try to be 100% right, because that’s a silly goal, but to help people think through, help myself think through risk and opportunities, maybe to be 1% or 2% better in understanding both the opportunity and the risk than the other really good professionals.

Joe Fairless: I imagine we can become 1%-2% better if we have a grasp on those three things you identified earlier – where is the macroeconomy going, the capital markets and supply and demand? Let’s dig into each of these three and just talk about it a little bit. What should we look for when we are attempting to identify where the macro-level economy is going?

Peter Linneman: Step back and move away from the painting. What do I mean by that? There’s a very famous painting, Sunday in the Park With George by Seurat. It’s a huge painting in the Chicago Art Museum; it takes the whole wall, and it’s just dots. If you get too close to the painting, all you see are dots, you don’t see a picture. If you stand back in the room, you get some picture. In fact, if you get far enough back, you can almost start understanding the story of what’s going on in the picture that was Seurat’s attempt. I think that’s the economy – a million dots.

The interest rate was down a quarter of a percent today, exchange rates are up – just go through a million points. You decided to sell something, I decided to buy something. A million dots. The problem for most people is they get too close to the dots; they see the dot, but they don’t see the picture and they certainly don’t see what’s the story of the picture.

I attempt to look at a lot of dots and not be overwhelmed by any of them. So GDP information comes out – I look at it, I absorb it, but I take it with just one more dot. Employment – one more dot; interest rates – one more dot; stock market up or down – one more dot. And I try to see a broader picture. I think it’s one of the reasons I love impressionists so much, it’s because you really get the point that you have to step back and observe the broader strokes, the broader picture.

So I think most investors, even good ones, are too close to see the economy. It’s the logical thing, you focus on your company. How many times have you heard somebody say, “No, the economy can’t be doing well because my business is not.” Yeah, but there are a lot of others that might be doing well, or vice-versa. So I think that’s the number one message I’d give – either step back, or if you don’t have that ability to step back, outsource it. Subscribe to somebody like me, or hire somebody like me occasionally to help you… While you work on the dots, at least occasionally step back and take a look at the broader picture.

It’s not that people like me are, again, always right. We’re looking for a 1% or 2% improvement in our edge, and if we can see that bigger picture at least to some clarity, I think you can help both in the opportunity sense and in the risk sense.

Joe Fairless: At the beginning sometimes it’s knowing just what are those dots that we should be looking at. You’ve mentioned some specific things – employment, interest rates, GDP, stock market… How many dots do you look at? There has to be a certain amount, versus an…

Peter Linneman: Five hundred, if I were to say. And would I weight them all equally? Probably not.  12 of them have to do with employment, and again, there are shades of red in a painting, right? So 500… In fact, when I meet business people, one of the first things I’ve done my entire life is to say, “So how’s business?” I think people think I’m just being courteous – I’m not. That’s one more dot. I actually want to hear you say, “Well, things are a little slow” or “We’re selling the high-end stuff.” I actually listen to what people say to that. It’s another dot. It’s an attempt to confirm or challenge some other issues.

So I’m pulling 500 out of the air, but it’s a lot. I try to read everything – I don’t succeed – I try to listen to a lot, I try to look at a lot of charts and graphs and don’t just take them at face value. I’m trying to put together that painting, and it’s not so easy. By the way, for every painting that you put together that really has a clarity and a story to it, there’s paintings you put together that aren’t that clear, aren’t that moving and don’t have that much story.

Joe Fairless: When you look at — let’s just assume there’s 500 different inputs… If you look at all of those, do you have a dashboard that you use to input that info, or is it just less mechanical than that?

Peter Linneman: Well, I think both. We keep a library, if you will, of charts and graphs that I go through regularly – I see them, update them as the new data comes out; some more important than others. But a lot of it is — little bits of it are statistical, but I don’t believe in these big macro models; I think they’re kind of a waste of effort, and a fool’s errand in many cases. I have the most expensive computer I can own on top of my shoulders, and it is a very holistic and non-linear kind of computer, namely our brains, right? And if you train it and you use it and you try to twist it, that’s the game. And I’m not saying I’m the best at it, but that’s what I try to do.

Joe Fairless: Let’s talk about the capital markets. First, for any Best Ever listeners who might not be familiar with what that means, can you first define it and then can you talk to us about what you look for?

Peter Linneman: Sure. Capital markets are where money is flowing from, where it’s flowing to, what are the reasons that it’s flowing one direction or another — literally, where is the money coming from? Is it coming from German institutions, is it coming from mom-and-pop Main Street investors etc.? And who wants that money, and what are they willing to pay and what conditions are they willing to live with? And again, that’s an evolving story, it changes; there are a lot of players in it. No one will ever fully understand it, including me… But that’s what I mean about the capital markets, it’s the ebb and flow of where money is coming and going and why. Yesterday everybody wanted that, and today everybody wants out of that, and the balance of fear and greed. These days there’s a heavy international dimension to it.

Again, trying to read what are people trying to do with their money, why are they trying to do it, why are they changing what they’re trying to do?

Joe Fairless: And what specific reports or databases do you reference when looking at it?

Peter Linneman: A lot of Fed funds information, Federal Reserve data on flow of funds, a lot of information about commercial banks… Commercial banks are the dominant source of capital in the world, because once the federal governments of the world give them deposit insurance, people are willing to give them a lot of money, because they know they’ll get it back because of the government’s deposit insurance… So understanding what they wanna do.

Insurance company information, stock market information, bond market returns… And then obviously, in our case, real estate – what are the REITs doing, what are private equity funds doing, what are major institutional and family investors doing? And again, some of it you can get pretty clearly, some of it is more holistic. And again, it goes back to when I meet somebody and ask them, “So what do you think of a fund or a REIT? What are you doing today?”, I actually wanna know, and I’m not looking for non-public information, I don’t mean it in that sense. I wanna have a sense of their texture and what’s going on and what are the flows that they’re into.

Joe Fairless: For the first two out of three, there’s clearly perhaps up to 500 dots on the first, with the macro-level economy and then capital markets, you’ve got different sources… There’s a lot of stuff. Logistically, within your company, how do you organize it so that it shows up in a way that makes sense and isn’t overwhelming?

Peter Linneman: Well, we have this publication, the Linneman Letter, and it’s a quarterly publication, and it’s interesting that we’ve been doing it now for like 15 years or some number like that, 17 years… One of the beautiful things about it is that we regularly have to assemble it with all the information we wanna put out and highlight and emphasize, so we have this data bank that we do and we update, and that forces me not only to look at it casually as the information comes out, but it forces me on a quarterly basis. But on a quarterly basis it means each week as I’m working through drafting stuff and redrafting stuff, I have to be reacting in real time.

The other thing is I give probably (I don’t know) 20 presentations, 30 presentations a year to boards, to large corporate audiences, to industry association audiences, and in so doing, pull together the usual slides and charts and graphs, and I have to think through the story I want to elaborate, and that means going through — you can’t do a million charts… What are the 20 charts? What do I really wanna point out about them? And if somebody saw me yesterday, what would I say differently and why?

Yesterday, for example, I gave one of those presentations, and that keeps me focused. The interesting thing is in speaking and in teaching and in answering questions in front of an audience and in writing, I often find that I get an insight on how to express something, how to think about something, how to look at something. Questions make us think and challenge what we know, and so I really enjoy having the opportunity to do the quarterly publication, to do these speeches, to have people question me, to ask questions that I may not have thought about, or if I have, I haven’t fully figured out “the answer”, or at least my answer as I believe it now. Those tend to keep pushing me.

Joe Fairless: And then the last part that you mentioned – supply and demand. What resources do you look for and what do you look at?

Peter Linneman: We have about 50 metropolitan areas that we follow in the major food groups of real estate on metropolitan levels… Not so much in very micro, sub-market levels, because the data is not very good. And on those we’ve tried to track occupancy and rents, and we adjust rents to put them in real terms, that is adjusted for inflation… Because a lot of times people say, “Oh, we’re at all-time highs” – you’re not. You’ve had ten years of inflation, and when you consider there was 2% inflation a year, and that’s 24% compounded, and rents are only 10% above where they were, they’re 14% below their previous high. And we kind of do that type of stuff.

We try to keep track of the supply pipelines that various brokerage firms and others put out of the major food groups, we try to keep track of the stock of existing property, plus the new pipeline versus our own forecasts of what demand growth will be, which mostly trigger off of our forecasts of employment. We have some local-level employment forecasts models we’ve developed that are reasonably helpful.

We’ve got analyses of how local metropolitan areas react in the presence of an economic recovery by the US or an economic downturn by the U.S. That is to say to what extent do all ships rise or fall on the tide? They don’t rise or fall on the tide the same, and we spend a lot of time analyzing how they’re different, by various in some cases simple, in some cases sophisticated statistical models.

Joe Fairless: On that part, is there a certain region that acts one way versus a different region?

Peter Linneman: Oh, sure. I’ll give you a very simple one that we have found. I’m sure out of the 50 states you can find an exception to what I’m about to say – state capitals have more muted growth as the U.S. employment grows, and they have more muted downturns when U.S. employment turns downward. And if you think about it, it’s because governments don’t react as fast as private employers, either on the up or the down. They’re kind of a ballast. So you think of that… So state capitals have a more muted performance relative to the U.S. economy. On the other hand, places like Vegas and Orlando are super performers – that is when the U.S. economy is hot, there’s a lot of discretionary money, and you can very clearly identify kind of a turbo-charge pattern to their employment growth and their absorption.

The flipside to that is they’re very sensitive on the downside, because one of the first things you can easily forestall is going to Disney this year, or doing to Vegas this year. “I’ll get there two years from now when I got my job back.” So they’re hyper-reactors.

Other places, and I give New York City as an example, basically are a reflection of the U.S. economy. And it’s not surprising in an odd way that New York is a reflection, because it’s such a corporate headquarter kind of place, so it’s not surprising that they’re a pretty good reflection of the U.S. economy. So those give you a flavor of some of the differences.

Joe Fairless: Well, you spend your time now thinking and understanding the environment we are in, so the question is in 2018 what environment should we expect to see?

Peter Linneman: I’ll go through the three… The first on the macro-economy, the Seurat painting to me is pretty clear, which is I don’t see any end of growth for the U.S. economy in 2018, and probably on into ’19. There are just no notable excesses or notable policy errors that could occur that would derail the ongoing growth. Now, it eventually will derail, but I don’t see it happening in ’18 or ’19. So that’s the first thing.

In terms of capital flows in the capital markets, there still is a lot of money out there. The Fed and the other central banks of the world pumped unprecedented amounts of money into the system over the last decade. That money is still awash, and in fact, it’s still sitting in hoards of cash… So it’s hard to see that money going even massively more so into cash, because it is so far beyond norm cash holdings that I have the belief that that money will come out more in 2018, rather than staying in. So I feel good about the capital flows in ’18, I feel good about the economy in ’18. When you then get to the local supply/demand of real estate, that does vary by product type and geography. In general, supply and demand is in pretty good balance; yes, we are producing more than 2-3 years ago, but in general it’s reasonably muted, and demand is still growing quite strong, so in most places I expect NOIs to outstrip general economy inflation by a percent or so. There are pockets though where that’s not true – New York hotels, there’s a lot of supply coming online, and a few multifamily markets, offices in Houston, a few places you can find… But generally, the supply and demand in real estate is pretty good.

If you then go back to looking at value, it doesn’t look like a spectacular time to make spectacular amounts of money, but it does look like a decent time to keep making money… Namely, growth will occur, supply/demand of real estate is in pretty good check, and capital is not gonna disappear. A decent environment to continue making money.

Joe Fairless: What would you need to see in order to have an opposite opinion?

Peter Linneman: I gotta see real weakness in the economy – I think that’s the first one. And it will come, but there just are not notable signs of it today. A 19 trillion dollar economy doesn’t fall apart overnight. In fact, even if you go back to the financial crisis, there was a lot to be seen a year and a half and two years earlier, and a lot of those dots. Not everybody saw them, not everybody wanted to see them… Interestingly, I actually got that one right, in that as much as two years ahead of time I called the recession when it occurred. I certainly didn’t call it that it would be as big as it was, but I actually got it in that there were enough signs. So that would be one.

The second is you just start seeing supply outrunning demand. You see fundamentally demand is growing at 2%, 3%, and you see supply running at 3% and 4%. That will make a weak investment market pretty rapidly. Right now we don’t have a lot of that. We have little pockets of it, so I watch that very carefully.

And the last is that we go from a market where greed is conquering fear in the capital markets to the flip of that. That can move very rapidly. That’s kind of the hardest to see. I’ll give you an analogy – how many times have you been in a place you were unfamiliar with and in the daytime you felt real good, and suddenly it got dark and you got spooked?

Joe Fairless: Sure.

Peter Linneman: It can happen in a matter of a half an hour. That one, because it’s purely psychological, can happen and it can happen quickly, and capital markets can react very quickly. So I think the hardest by far is to get when greed turns to fear or fear turns to greed. In general, greed is gonna win about 80% of the time, but when it flips from greed to fear, it can move very rapidly, and make something that wasn’t frightening in the daylight quite frightening in the dark, even though objectively it is exactly the same. That one is the hardest one to predict, and all I can do is try to keep out feelers to get a sense of how spooked people are.

Joe Fairless: Based on your experience, what is your best advice ever for real estate investors?

Peter Linneman: That’s easy – invest, if you can, for the long-term. Don’t try to time markets. Real estate is a long-term asset. Most people who invest should think about “Do I wanna own this ten years, not two years?” If you own stuff ten years and you own it with low enough leverage that you’ll never have trouble servicing your debt, you’ll do just fine. Almost invariably, investors who have held real estate for 10, 15, 20 years never having to face a squeeze because they over-leverage do just fine.

Where people get in trouble is over-leveraging so that they can’t cover their debt during the down cycles, and they can’t roll over their debt, or having a flip mentality because this fear/greed phenomena can change values very quickly. And if you’re rolling your debt in a fear mode rather than a greed mode, you’re gonna have a difficult time rolling your debt, you’re gonna have a difficult time refinancing, you’re gonna have a difficult time selling.

So the best advice by far – and I think it applies to most people – is… Jeremy Siegel, my colleague at Wharton has this series of books called Stocks For The Long Run, and it basically shows that even if you would have invested in stocks at the very peak, right on the day before each crash, and you held for 15 or 20 years, you did just fine. The reason is because the economy grows, and then when the economy crashes, supply gets limited and cashflows rebound and valuations rebound, as greed once again replaces fear.

I think the same thing is true of real estate, which is even if you invested at the absolute peak in 2007 and 2008, you’ve done okay in the subsequent decade, as long as you didn’t get squeezed out of the property… Because supply shut down, demand rebounded, greed returned, and you did okay. Being able to hold the asset for the long run means you’ll do okay, and if you’re good at real estate and you can add value on top of that, that’s the real deal.

Joe Fairless: What is the book that you referenced that has that study, where if you buy the day before the crash…?

Peter Linneman: Jeremy Siegel has done it; he’s at Wharton. He’s done several of these updates, and I don’t know what edition he’s on, but it’s called Stocks For The Long Run. When you hear it, it’s kind of a shocking result, and then when you think about it, we just lived this in real estate in the last decade, almost literally a decade ago – nine years ago you could give real estate away because when greed turned to fear, the economy dipped. If you had to refinance your debt you were dead, and if you had to sell you were dead.

You come back nine years later after one of the most horrific downturns in U.S. history, and real estate values are kind of doing fine, and cashflows are kind of at all-time highs, even adjusting for inflation, and it’s because when the things got really bad, supply ceased. And therefore, as the economy rebalanced, you start filling that space back up. The world didn’t come to an end, and as the economy grows, you fill the space back up and eventually, after a couple years, fear flips back to greed, and the valuations return. So that’s the spirit of what’s going on.

Joe Fairless: We’re gonna do a lightning round… Are you ready for the Best Ever Lightning Round?

Peter Linneman: Sure.

Joe Fairless: Alright. First, a quick word from our Best Ever partners.

Break: [00:31:02].17] to [00:32:00].16]

Joe Fairless: What’s the best ever book you’ve read?

Peter Linneman: Capitalism And Freedom by Milton Friedman, many years ago.

Joe Fairless: Why is that the best ever?

Peter Linneman: Milton had a unique understanding of the power of capitalism, which is I think important to understand the economy AND how while it fails in many cases, governments also fail in their attempts to tame markets, and the choice is not between an omnipotent government and a failed or imperfect sense of capitalism, but rather imperfect capitalism and imperfect government.

Joe Fairless: Best ever project that you worked on that delivered results that could be measured?

Peter Linneman: Probably when I was on the board and chairman of Rockefeller Center Properties in the early to mid ’90s and it was a very difficult real estate market, and I led a team that worked through and ultimately generated good value for our shareholders.

Joe Fairless: How were you measured?

Peter Linneman: In that context?

Joe Fairless: Yeah, in that context.

Peter Linneman: By stock returns, from when I took over to when we did the ultimate transaction.

Joe Fairless: What’s the best ever way you like to give back?

Peter Linneman: I have a very large effort in education for destitute children, orphans, a few in the United States, but mostly in Kenya. I have a charity called “Save a Mind, Give a Choice” in Kenya that we now support 140 children of abject poverty in rural Kenya. Most of them are orphans or near orphans. We put them through school, we provide all the clothing and school materials and living expenses; we put them in not [unintelligible [00:33:57].02] but good schools that can house them in a way that’s safe. We’ve been fortunate enough to have about 50 of our children graduate, and it’s been a remarkable experience for me and it’s helped a few children.

Joe Fairless: How can the Best Ever listeners learn more about your company? Where should they go?

Peter Linneman: I would go to www.linnemanassociates.com. Or if you google, you can find me pretty easily.

Joe Fairless: Well, Peter, thank you for being on the show. Thanks for giving us a preview of what’s ahead in 2018, and talking about where we’re at from a market standpoint and what to look for from a macro level, and then your thought process and how you approach coming up with that analysis or that assessment. One, looking at the macro level. Two, looking at the capital markets, and three, looking at the supply and demand.

One very tactical thing that I really perked up and I bolded when you said it – and again, this is a tactical thing; there’s macro level stuff that you said more important than this, but when you said, “When we read headlines that say the rents are at an all-time high”, I bet 90% of the time those reporters are not adjusting for inflation, and that’s something that I will now start looking for and I will also be aware of that whenever I’m speaking about our projects, too.

Thanks for being on the show. I hope you have a best ever day.

Peter Linneman: My pleasure, thank you for having me. Great day to everybody.

Joe Fairless: Talk to you soon!

Peter Linneman: Thank you.

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