Forecasting the Fed and Falling CRE

Episode Summary

Executive Summary: The episode centers on Fed policy and the commercial real estate outlook. The hosts debate whether the Fed should hike once more in July and when cuts should begin in 2024, concluding the likely path differs from the ideal one. Guest Glenn Mueller argues CRE stress is concentrated in office and some hotels, while industrial, retail, and apartments remain comparatively healthy, limiting systemic risk despite significant refinancing needs.

Main Topics: Fed policy: one more hike, then cuts later (Priority: 5/5): The hosts debate whether the Fed should raise rates once more in July and when cuts should begin in 2024. They distinguish between what the Fed should do and what it likely will do, with the baseline shifting toward one more hike and a later start to easing. Labor market and inflation backdrop (Priority: 5/5): The discussion weighs still-strong payrolls against signs of easing in household employment, sticky core inflation, and upcoming student-loan repayment resumption that could slow consumption. Commercial real estate systemic risk (Priority: 5/5): Glenn Mueller argues that CRE is not a uniform crisis: office is the main weak spot, while industrial, multifamily, and much of retail remain resilient. The broader financial-system risk is limited unless losses trigger bank stress or deposit runs. Office market dislocation (Priority: 5/5): Remote work, reduced space-per-worker, high vacancy, and large upcoming refinancing needs are reshaping office demand. Older suburban and lower-tier office assets face the biggest pressure, while top prime A locations remain relatively healthy. Non-office CRE: hotels, retail, industrial, apartments (Priority: 4/5): Hotels are the most vulnerable after office due to expensive renovations and weaker business travel; retail is stabilized by limited supply and selective strength; industrial remains strong though supply has caught up in some areas; apartments remain best positioned long term due to housing shortages. Urban spillovers and city finances (Priority: 4/5): The hosts and Mueller discuss how office weakness can reduce downtown foot traffic, hurt retail, erode tax revenue, and worsen crime or public-service stress, especially in cities like San Francisco. Statistics game and demographic trends (Priority: 3/5): The episode’s statistics segment highlights work-from-home prevalence, aging population trends, and leading indicator weakness, reinforcing the themes of labor-market change and slow-moving structural shifts.

Key Arguments: The Fed is likely to hike once more in July, but the hosts increasingly think it should stop and wait for clearer evidence on inflation and growth. Monetary policy messaging may be strategic jawboning to keep inflation expectations anchored rather than a sign of aggressive future tightening. Student-loan repayment resumption could withdraw roughly $70-$75 billion annually from household consumption, adding a drag later in the year. Payroll data may be overstating job growth; household survey and QCEW benchmark data suggest future revisions could be meaningfully weaker. Commercial real estate risk is highly concentrated in office, where remote work, sublease space, and refinancing pressures are most severe. Office conversion to multifamily is usually not economically viable because of floor-plate constraints and high conversion costs, though niche conversions to storage or logistics can work. Big banks are generally resilient because stress tests already assume severe CRE declines; smaller banks are more exposed, but broader contagion would likely require deposit-run dynamics. Hotels face a second wave of pain because major-branded properties must fund periodic full remodels and business travel has not fully normalized. Industrial and retail are comparatively healthy due to e-commerce logistics demand, constrained retail supply, and continued leasing by necessity-driven retailers. Apartments are the best long-term CRE segment because the U.S. remains materially short of housing units, even though near-term rent growth may cool as supply completes.

Data Points: Fed funds rate: 5.25% - Baseline June forecast for the Fed to pause at the current target range through year-end Possible July Fed hike: 25 basis points - Hosts expect the Fed may still raise once in July Potential first Fed cut: March 2024 or later - Baseline timing discussed for easing, with some suggestion it could be pushed back to May/June Student-loan repayments resuming: $70-$75 billion annually - Estimated drag on consumption when the moratorium ends in September Work from home in 2022: 34% of employed people - BLS annual statistic on people doing some or all of their work from home Work from home in 2021: 38% - Work-from-home share was higher during the pandemic period Work from home in 2019: 23.7% - Pre-pandemic baseline for employed people doing some or all work from home Hours worked on an average day in office: 7.9 hours - BLS data cited for people usually working in an office Hours worked on an average day at home: 5.4 hours - BLS data cited for people usually working from home Hours worked from home in 2019: 3.3 hours - Pre-pandemic comparison for people doing any work from home Median age of U.S. population: 38.9 years - Census statistic for 2022 Median age of Maine: 44.8 years - Oldest state highlighted in the census data game Median age of Utah: 31.9 years - Youngest state highlighted in the census data game CRE debt needing refinancing by end-2025: $1.4 trillion - Total commercial real estate debt across lenders due to mature and be refinanced or rolled over Office mortgages on bank balance sheets maturing by end-2025: about $100 billion - Subset of office debt held by banks Conference Board LEI monthly change: -0.7% - Leading Economic Index decline cited during the statistics game Coincident index monthly change: +0.2% - Conference Board coincident indicator remained positive Lagging index monthly change: +0.1% - Conference Board lagging indicator also slightly positive Average monthly job growth, past decade: 170,000 - Historical average job creation over the last 10 years Office price decline expectation: 25% peak-to-trough - Chris’s CRE office price assumption, discussed with Glenn Great Recession CRE price decline: 40% - Historical comparison used by Glenn Bank loan-to-value post-Great Recession: ~60% - Used to explain how much price decline banks can absorb before losses become acute Marriott remodel reserve: $100,000 per key - Hotel owners’ required 10-year property renovation cost Historic hotel break-even occupancy: 62% - Glenn’s estimate for hotel profitability threshold Office space per worker historically: 200 sq. ft. per person - Pre-remote-work office planning norm Office space per worker in tighter layouts: 120 sq. ft. per person - Possible newer benchmark with more work-from-home flexibility U.S. housing shortage: 6.5 million units - NAR estimate cited to support apartment demand Mortgage affordability example: $1,000,000 vs. $500,000 mortgage - Illustration that at $100k income, 3% rates afford roughly double the mortgage of 6% rates Amazon share of U.S. industrial space leased in 2019: 20%-25% - Illustrates how concentrated industrial demand became before/around the pandemic Online retail sales share pre-COVID: ~11%-12% - Trajectory before the pandemic Online retail sales share at COVID peak: 18% - Temporary surge that drove warehouse demand National average warehouse rent: $11 per sq. ft. - Current approximate national average cited by Glenn Retail pre-leasing in 2022: 80% of new retail built - Shows retail supply discipline and demand strength

Pivotal Quotes: "The answer is kind of funny. I say, well, yes and no. Yes, you should be really worried if it's office. No, you should have no worry whatsoever if it's industrial and/or multifamily." — Glenn Mueller: Core thesis on CRE risk being concentrated in office rather than the entire property sector "What they should do and what they will do are one and the same. This recently, in the last few meetings... what they will do is now different from what they should do." — Mark Zandi: On the Fed likely hiking even if the hosts think it should stop "We've got the COVID have and the COVID have not properties." — Glenn Mueller: Describing the bifurcation within hotels and other CRE segments after the pandemic

Implications: Listeners should expect a near-term Fed hike, slower easing, and continued CRE stress concentrated in office and some hotels. Broader recession risk looks contained unless bank runs or sharp credit tightening spread the shock.