This week we interview Boris Dorfman about real estate debt problems and opportunities. We also discuss, the next recession or crash, what is going on in California, skyrocketing vacancies, the office market looming doom, inflation and when rates will start to drop. Join us for this great interview.

Real Estate Outlook: Bright Spots Amidst Uncertainty

In the ever-changing landscape of real estate, perceptions, and market reactions play a crucial role. Our instinctual lizard brain tends to be cautious, making us overly concerned about a potential crash or recession. However, history has shown that things often turn out better than anticipated. Nevertheless, the advent of COVID-19 has altered the mindset of many, with some becoming less cautious and more adventurous. Additionally, the stimulus packages introduced during the pandemic have given a false sense of security to some individuals, leading them to believe that the government will always be there to provide assistance.

The Influence of Media

Undoubtedly, media plays a significant role in shaping public perception. With fear-mongering becoming increasingly prevalent, media outlets have become more politically driven rather than focusing on objective reporting. Instead of informing the public, they seem preoccupied with the trivialities of celebrity life.

Strong and Weak Real Estate Asset Classes

In the California market, location remains a critical factor. While office spaces evoke fear due to past experiences, such as the dot-com bubble, it is worth noting that this period also witnessed the emergence of the residential market in downtown Los Angeles. Developers seized the opportunity by converting vacant office spaces into lofts, apartments, and condos, thus breathing new life into the area.

Currently, single-family and multi-family markets, along with hotels, demonstrate remarkable strength. Industrial space is also thriving, with vacancy rates in the Greater Los Angeles area nearing zero. However, the performance of each asset class depends on the specific geography and local dynamics within a city.

On the other hand, vacation markets are expected to experience a decline. Investors who overbought properties in popular vacation areas like Big Bear and Palm Springs in California, particularly for short-term rental platforms like Airbnb, may face challenges.

Real Estate Price Forecast in California

Over the next 2-3 years, it is unlikely that we will witness a decline in residential prices, be it single-family or multi-family properties. However, commercial properties, especially those with adjustable-rate mortgages (ARM loans), may face some challenges as these loans reset. The office sector is likely to experience a decline, but the overall resilience of the market will reveal the full extent of the impact in due course.

Federal Reserve and Interest Rates

While some members of the Federal Reserve express the desire for 1-2 more rate hikes in the coming months, a general expectation of lower interest rates looms. A reduction in mortgage interest rates is anticipated between Q1 and Q2 of 2024. Nevertheless, the Fed's actions appear increasingly political, which raises concerns as the 2024 election approaches.

Inflation Trends and CPI Calculation

Headline inflation has started to decline significantly, although it may not be receding at the desired pace. The infusion of approximately $11 trillion into the economy demands an eventual exit strategy, but the future of inflation remains uncertain. The Federal Reserve targets a 2% core inflation rate, yet the political influence on their decision-making processes cannot be ignored.

The Consumer Price Index (CPI) encompasses a basket of consumer goods, reflecting the expenditures of an average family. This basket includes expenses related to shelter, groceries, cars, fuel, vacations, and more, comprising over 200 items. Notably, shelter costs make up a significant portion of the CPI, amounting to approximately 40% of a family's income.

The Outlook and Banking Sector

Despite the prevailing uncertainty, the future holds great promise. Contrary to negative media narratives, the outlook is optimistic. As a nation, we are resilient and live in one of the greatest countries in the world. Therefore, things will likely fare much better than anticipated.

However, we are not entirely out of troubled waters yet. The possibility of more bank failures remains, as numerous factors contribute to their instability. Negative media coverage can trigger panic among depositors, leading to a sudden withdrawal of funds and potentially forcing a solvent bank to close its doors. Other factors, such as reserve requirements and the valuation of investment portfolios, also influence the stability of banks. Moreover, some institutions have taken undue risks by lending to cryptocurrency companies, which may jeopardize their own viability.

Conclusion

In conclusion, real estate markets exhibit both strengths and weaknesses, with location continuing to be a paramount consideration. Despite media-induced paranoia and the uncertain economic landscape, there are reasons for optimism. While certain asset classes face challenges, others, like single-family and multi-family properties, hotels, and industrial spaces, demonstrate resilience. Real estate prices in California are not expected to decline in the near future, but commercial properties may experience some turbulence. The Federal Reserve's decisions, inflation trends, and potential interest rate adjustments all add to the complexities of the market. However, as a nation, we have weathered storms before and emerged stronger. The future holds promise, and the inherent strength of our economy will likely prevail in the long run.

Boris Dorfman,

The LBC Capital Fund Manager & Founder