Nick Halaris: Commercial Real Estate Hanging In There Despite "Crushing" Interest Rate Shock

Episode Summary

Executive Summary: Nick Hilaris argues multifamily remains fundamentally healthy despite severe price declines and negative leverage, but transaction volume is frozen by high rates. He sees office as deeply distressed yet potentially a long-term value opportunity, while immigration, supply shortages, and falling new construction could reignite housing inflation. Banks are cautious but flexible, and public REIT pricing may signal a better entry point than private-market valuations.

Main Topics: Multifamily remains resilient but repriced (Priority: 5/5): Apartment fundamentals have held up better than expected: rents are being paid, leasing remains solid, and distress is mostly driven by financing rather than operating weakness. However, values are down sharply from 2022 peaks due to higher borrowing costs. Interest rates and negative leverage crush deal economics (Priority: 5/5): Higher short-term and fixed borrowing costs have pushed many new deals into negative leverage, freezing transaction volume and reducing development feasibility. Hilaris explains why current cap rates often fail to exceed debt costs. Supply constraints, immigration, and future housing inflation (Priority: 5/5): The combination of reduced development pipelines, high construction costs, and large inflows of people into the U.S. could tighten housing supply further and reignite multifamily inflation in 2025-2026. Office market capitulation and long-term contrarian opportunity (Priority: 4/5): Office values have been wiped out in many markets, with some assets trading below early-2000s prices. Hilaris sees this as a bottoming process and potential long-horizon opportunity, especially for buyers with patient capital. Bank behavior: flexible on workouts, tight on new lending (Priority: 4/5): Banks are extending and modifying existing loans rather than foreclosing aggressively, but new lending is difficult and heavily constrained by leverage, rates, and risk appetite. Rent control, policy distortions, and the housing shortage (Priority: 4/5): Hilaris criticizes rent control as ineffective and distortionary, arguing it discourages maintenance and fails to solve affordability. He favors more supply and targeted subsidies over price controls. Public REITs vs private-market pricing (Priority: 3/5): He notes a disconnect between public multifamily REIT valuations and private-market transaction pricing, suggesting public REITs may offer an attractive but volatile entry point.

Key Arguments: Multifamily fundamentals are still strong because labor markets have not cracked; widespread job losses would be needed to trigger serious deterioration. Apartment values are roughly 20% below 2022 peaks on average, but declines are more severe in lower-quality or weaker markets and milder in luxury coastal assets. Current borrowing costs often exceed property yields, creating negative leverage and making new acquisitions or refinancings unattractive. The new development pipeline is shrinking because high rates, elevated construction costs, and uncertainty make projects impossible to pencil. Large-scale immigration is adding marginal demand to housing and hospitality, potentially offsetting some apartment oversupply and supporting rents. Office assets are extremely distressed, but replacement-cost economics and zoning barriers could make select office properties attractive long-term buys. Banks learned from the GFC and are more willing to work with borrowers on existing loans rather than force immediate foreclosures. Rent control can protect some incumbent tenants but generally worsens supply, maintenance, and affordability over time. CPI shelter data may understate actual rent weakness because landlords are offering concessions instead of cutting face rents. Publicly traded multifamily REITs appear to be pricing in more distress than private-market transactions currently show.

Data Points: Apartment value decline from 2022 peak: ~20% down on average - Hilaris says the multifamily market is roughly 20% below peak, though variation by asset class and geography is wide. Value decline in Class C suburban apartments: ~40% down - He gives a rough example for weaker assets in places like suburban Atlanta. Luxury Los Angeles apartments decline: ~10% down - He suggests super-luxury Los Angeles buildings have held up better than the average. U.S. migrant inflow: 3-4 million in the last 12 months - He argues this adds pressure to housing, hotels, and urban rental markets. Multifamily deliveries in 2024: ~500,000 units - He notes 2024 was expected to be a record year for deliveries. Potential comparison of migrant inflow to deliveries: 5-8x deliveries - He argues migration flows greatly exceed annual multifamily supply additions. Construction loan rate: Under 10% is considered a victory - He says construction financing is expensive and often eats most of the return. Bridge debt pricing: SOFR + 300 to 350 bps, or about 8%-9% - He cites current bank pricing for multifamily bridge loans. Private lender pricing: ~10.25% - He says his current private financing rate is similar to prior-cycle levels. Public volume decline in 2023: ~75% below 2022 - He attributes the drop in transaction volume to bad economics and negative leverage. Office pricing in Los Angeles: $130-$200 per sq. ft. - He says some office trades are far below replacement cost. Office replacement cost: $500-$1,000 per sq. ft. - He uses this to highlight the magnitude of office markdowns. Very distressed tertiary office sales: ~$20 per sq. ft. - He describes some trades as effectively land value only. New York rent burden: ~70% of households severely rent burdened - He cites LA as an example to show how stretched tenants already are; the transcript later mentions similar affordability pressure in major cities. Households spending almost all income on rent in LA: 600,000 households - He says these households spend about 90% of income on rent. New York median rent: $4,000 - Used to argue rent control has not lowered rents in the city over decades. Housing shortage in the U.S.: ~6 million units short - He says the U.S. faces a large cumulative housing undersupply. Annual U.S. housing production: ~1 million per year - He contrasts current production with the estimated shortage. Shelter CPI peak rent inflation: ~8% - He references official lagging inflation data. Concessions in new LA construction: 2 months free rent - He says concessions can equal roughly one-sixth of a year, implying meaningful hidden deflation. Case-Shiller-type housing declines in some markets: Double-digit to 20%+ in select places - He cites Palm Springs and parts of Idaho as weaker housing markets. Average new home size in America: ~2,200 sq. ft. - He contrasts modern homes with smaller, potentially more affordable builds. Tiny homes example in San Antonio: ~500 sq. ft. - He uses this as an example of shrinkflation in housing.

Pivotal Quotes: "the market clearing price of a multifamily deal is at a humongous discount to the 2022 peak" — Nick Hilaris: Explaining why multifamily owners are underwater even though operating fundamentals remain relatively healthy. "literally every deal on planet Earth has negative leverage" — Nick Hilaris: Describing how current debt costs exceed property yields, making new acquisitions unattractive. "I think the pressures come out of that and shelter CPI is such a huge component" — Nick Hilaris: Arguing that housing shortages and falling construction pipelines could eventually push inflation higher.

Implications: Real estate remains bifurcated: multifamily is stable but financially strained, office is distressed but may offer deep value, and policy-driven housing shortages could reaccelerate rents. Investors should watch rates, job growth, and REIT/private pricing gaps closely.