Navigating Real Estate Market Cycles

Dr. Glenn Mueller
University of Denver
Professor & Thought Leader

Glenn R. Mueller, Ph.D. is a professor at the University of Denver, Burns School of Real Estate & Construction Management. Glenn has 48 years of real estate industry experience, including 41 years of research and internationally known for his Market Cycle research on income producing real estate, his real estate securities (REIT) research and his public and private market investment strategies and capital markets expertise.

Dr. Mueller has held top research positions at Black Creek Group, Legg Mason Inc., Price WaterhouseCoopers, ABKB/ Jones Lange LaSalle Real Estate Investors, and Prudential Real Estate Investors. He is the secretary of the American Real Estate Society Foundation, has been a visiting professor at Harvard for the past 23 years, is a board member of the Arden Real Estate Group, and former chairman of the board of European Investors REIT securities group. Published 100+ research articles & won many awards. He authored 130+ quarterly issues of his Real Estate Market Cycle Reports.

Kirby Rosplock

Welcome to the Tamarind Learning Podcast. I'm your host, Dr. Kirby Rosplock, and today we're talking about Real estate. I'm thrilled to have a wonderful professor of real estate from the University of Denver, Glenn Miller with us today. And he's going to share more about his real estate market model that he uses to evaluate and monitor all the changes and shifts that are happening within the real estate markets. I'm so appreciative of your time today and can't wait to learn more about your model. Glen, let's just start a bit about your background, because it's impressive, and share how you got to develop this model.

Glenn Mueller

Sure.  Let me go ahead and I'm going to bring up my screen now and share that. So, I've actually been in the real estate field for 47 years and it’s easy to remember because that's also how long I've been married to my wife.  As Kirby said, I'm a professor at the University of Denver. We have the second oldest real estate program in the country (just behind University, Wisconsin. We started in 1938. I'm also a visiting professor at Harvard. I'll actually be there next week in their executive program. I’ve guest lectured now, at 43 different universities around the world on my market cycle research that I'm so well-known for. 

At the same time I'm a type A personality. I've got an undergrad degree, a MBA and a PhD, actually in real estate. I've also worked in the field. I started my career as a loan analyst at a bank and realized that builders made a lot of money. So, I was a home builder for a number of years . I worked at Prudential real estate Investors in 1990. They were the largest investor in real estate in the country at that time and also advised all the major pension funds and institutions. As you probably all know, CalPERS or California Public Employees Retirement System is the largest pension plan in the US, and of their $450 billion, I think, they're at about 400 plus billion dollars in real estate investments as well.  And then a number of other places but basically two jobs for the past 30 plus years, or so.

And the main research that I do is in real estate market cycles.  I believe that market cycles basically follow the economy, that real estate market cycles follow the economy. And there's three demand drivers. First of all, the demand population. The United States keeps growing. We're right at a rate of about three million people a year. And to put that into perspective, for real estate, that means we need to build a city the size of Denver, Colorado, to give people a place to eat, eat, sleep, shop, work, play, play, store stuff, et cetera.

The economy grows. We always look at GDP. And here, I just went back to give you a perspective on where we are, back in the 90’s. The economy is growing at an average rate of 3.2% GDP. Then, we had the Great recession. After that, between the great recession and the COVID recession, we're growing at 3.2 % . Then going forward, you know, the forecast is for only about 1.9% growth, or just a slower growing economy going forward. The number one thing that drives demand for real estate really is employment growth. Here, you can see that it was 1.3% pre the Great Recession, 1.4% between the Great Recession. Then, you know, we're now looking at less than half of that at 0.6% going forward. 

And that's really a case of just simple math. We're going to have more baby boomers, like me, retiring than millennials coming into the workforce. And so the growth rate is just slowing down, but it's still positive. And every time we have someone get a job, they need a place to work, to eat, to play, to shop, to live, et cetera. And that's what drives demand for real estate. 

On the cost side, there are two things to worry about; inflation. Inflation was 2.6% back pre, the Great Recession. It dropped to an amazingly low 1.8 average, between the Great Recession and the COVID Recession . Going forward, according to the Congressional Budget Office numbers, they're looking at averaging 2.5 %. Of course, the Fed says they want to have inflation be down at 2%. Talking with Mark Zandi, Moody’s top economists, who's been a longtime friend, says maybe it's time that we consider resetting that number. Maybe inflation will be running at like three. In which case, the Federal Reserve would probably stop raising interest rates.

And then of course, the second big one: interest rates. Real estate is such a large asset that is typically financed. We use a 10 year treasury, which is the risk- free rate here in the United States, where you're pretty well guaranteed you're never going to lose your money. And back, pre, the great recession, it was 5% average, and then between the great recession and the COVID recession, it was 2.4 %. And going forward, the Congressional Budget Office average is looking like it is going to be in the 3.8% range. So somewhat different. 

I think the good news is that if we go back in history, here's both GCP and employment growth. You can see that expansionary periods are typically fairly long, 5 to 10 years on average. And recessions are typically very short, less than one year to maybe a year and a half. And, of course, the Covid recession being the worst one that we see. The forecast, again, is for things to move forward at a more moderate rate than they have been past.

So, the three main investment categories out there really are stocks, bonds, and real estate. And when I talk about real estate, I'm talking about income producing real estate. I didn't use the word commercial because I had apartments there, as opposed to residential, home ownership, real estate, and, of course, everybody's got a house. That's a “use” asset just like your car, and if it goes up in value, good for you, but if you sell it and buy a house, you're going to spend the same money. So, it's really not something that you live on, you live in your house or houses.

From a standpoint of the bond market, most people think that bonds are the safe bet. Good place to be. The problem is, that what we've had is, over the past 30 years, we've had bond rates going from the 10 year Treasury at 15%  in 81, down to an all-time low, 0.6% during COVID. And now, going forward, looking at it, that 3.8% rate. And while the average yield, as you see there, is the middle line, at 5.8% for four bonds over the last 70 years, it looks good.

We aren't even there yet, but the average total return is 8.6%, because as interest rates go down bond values go up. However, look at the start of this graph and from 1953, forward, the average yield was 5.8%, the average return on bonds between 53 and 73 was 1.9% and in 53 and 81 when it peaked at 3.9%.

Because as interest rates go up, bond values fall.  I personally have gone to a zero allocation of bonds just because of this and replaced it with real estate because of the income producing characteristics. And if we look at the size of these asset classes, you've got stocks, bonds, real estate. Commercial real estate makes up about 20% of that investable universe. And if we look at institutional investors, they typically have a range of 5% to 20% invested in commercial income producing real estate in their portfolios. CAlPERS that I just talked about. They're currently at 14%, California State Teachers Association, the second largest, just to increase their allocation last year from 14% to 16%. 

So, again, my research has been in market cycles for a long time. Two parts to the cycle. A physical cycle, which is demand and supply for real estate. That drives occupancy. And if occupancy is going up, rents are going to go up and I can see an increase plus rent increase gives me the income side of real estate. 

And the second part of this talk about the prices of real estate and where they're going. So, the research study that I did is about how real estate goes through a cycle just like the economy. You got a recovery, an expansion, a hyper supply, and a recession phase.And my research between 1968  and 1997, showed that, when you're in recovery, you start with negative growth.  Because when you have too much of any product,  what do you do? Drop the price.  Then picked up and got positive at the long term average in the middle there, the dotted line at 0.6% .You can see a 4% increase in real estate. That was actually the average rate of inflation during that time.

Then, you see, in the green square there.  The growth phase of rent growth got really strong and hit a peak of 12.5% near the peak and then it starts to slow down or decelerate. It's still positive and pretty good in the hyper supply phase, where we're building slightly more than we need. Then goes low and negative again in the recession.

I updated the study recently for the last 20 years, and you can see almost identical results. Again, the highest rate of rent growth happened at the peak of the site. So if you know where a city is in its cycle, that is really helpful. And what I do is look at demand, which comes from, again, employment growth and people leasing space to use and supply. Here shows the average percent growth and why over the last number of decades. And you can see it moving up and down with the economic cycles. And more recently, basically since the end of the code recession, you see that the two running higher than the 2% line are apartments and industrial space.

And we'll again now talk about the individual property types separately. So, right now, the office ,as everybody probably knows, is the biggest jump ball in real estate.  How much office do we need? We definitely need some office. The question is exactly how much do we need? Do we have too much? And, I think it’s going to take us a decade to really sort through all of that.

Here the occupancy cycle is blue and then the rent growth cycle is in red.  And the two correlate. So if occupancy isn't growing, rents are growing, and there is a good correlation there. I'll save any kind of questions for that.

So what I do is I look out. This is the first quarter of 2020 forecast. You can see that the markets are all over the board. And the main reason for that is that we actually had a nice, strong growing economy. We were at the point of needing to build some new office space. Most of it is downtown. In the downtown's, it takes a long time. We're talking about a piece of land that I want to build on.  Getting it planned, permitted, approved and built  can take 7 to 8 years.

So we have a bunch of new space coming on in many markets across the country, and that creates some over supply. The good news is for these builders. The new space is what's in demand. Really nice, high quality space that attracts employees to want to come back to the office. The lower class B and C space is what is really vacant at this point and having problems.

When we look at industrial space, you'll see that we're at the highest rate of occupancy that we've ever seen. The Amazon effect is still going, and while you may have heard some headline news, that Amazon was letting go of some of the leases that they had put together. That was because, if we looked at internet sales, pre COVID it went from 8% to 9%, 10% to 11% and to 12% of sales over that five year period. And then it jumped to 18% during COVID. That's a 50% increase.

When we look at industrial space, you'll see that we're at the highest rate of occupancy that we've ever seen. The Amazon effect is still going, and while you may have heard some headline news, that Amazon was letting go of some of the leases that they had put together. That was because, if we looked at internet sales, pre COVID, it went from 8% to 9%,  10% to 11% and  to 12% of sales over that five year period. And then it jumped to 18% during COVID. That's a 50% increase. 

So Amazon went, wow, we need to get going here and really expand. But post COVID dropped back to 12.5% and went back on its normal trajectory. So I think the good news is that a lot of retailers who also want to be competitive have to have that warehouse space. We're able to finally get a hold of it.

And now the construction costs are a lot higher. The amount of new industrial space has been cut down. So industrials have been the top performing property type over the past five years and should be number 1 or 2 here over the next five years.

So if we look at industrial, you see better than half the markets at their peak occupancy level, which means they can continue to raise rents and the ones that are in hyper supply are there only because a lot of  space that is comig online  hasn't been released yet. If we look at apartments, you see that the apartment occupancy has, again, followed the cycles.  And post COVID bounds to its highest occupancy level that we've seen, but also the highest rank growth. See tons of new apartments being built across the United States. 

Especially in downtown, because that's where millennials want to live and work. And when we got this big spike post COVID in rents. The average US was up 11.5%, whereas the most popular and highest grossing ones, like Austin, Texas in Denver, Colorado, they're growing at 25%. Here is a quick example of one of the people I worked with at Black Creek Group. She had been living downtown in a very nice, little 500 square foot efficiency apartment in the newest building in town with every amenity under the sun and it was a three block walk to work.  COVID hit. All those amenities are shut down. She's working from her bed. So she and three friends went to rent a house in the suburbs.  Then, she comes back downtown, goes back to the same place and asks can I have my apartment back? Yep. And now the red, $2,500 bucks, a 25% increase. That's a little hard to swallow. She doubles up with a friend and now they've got a two bedroom for three grand a month, but that took two households and combined them together. So we're seeing what they call a decline in household formation because of that. I believe that goes away over the next couple of years.

And you can see here that pretty much every market I expect goes through a hyper supply phase, just because of that doubling up of household formation. But the good news for apartments, and again, to me, it's one of the top two property types to own is that the National Association of Realtors just updated their study. We are 6.5 million housing units short in the United States. And that's both ownership and rental because we cut down production of single family homes after the Great Recession, to almost half of the previous production level of two million a year.  

And so there is a pent up demand for housing, both rental and  homeownership in  the U.S. today. And so that will bring everything, I think pretty much every market back into the growth phase sometime within the next two years.  Retail is probably going to be the biggest surprise to everybody. Retail is at the absolute highest level, since we've been collecting data. And it goes, yeah, but retail is being killed by Amazon and yes, in some cases. But that also meant that we weren't building a lot of new retail. And every time you build 3000 new rooftops, that's either an apartment or a house, you need a new grocery store. And so as things expanded, we needed more space. And all the retailers that were considered essential, like home goods and building materials, their sales went through the roof. So they started building more stuff. All the older, crappy retail, if your state has legalized marijuana, gets used for marijuana.  And we also converted, over the last decade, a lot of retail into office space, apartments, and now they're converting into warehouses. A student In my development class took a downtown Denver office building and converted it into self storage.

So, low supply with moderate growth. The market is actually in  good balance. Malls are recreating themselves, if you will, so interesting. So, again, most of the markets, at their peak occupancy level, point at 11% on the cycle with a handful of them over the top, just because new space is coming online in those markets. 

So, let's now turn to the other side of the return. Any return you ever get comes from both income and appreciation. And prices are driven by capital flows, as I'm sure you all know. When the economy looks good, and people think that risk is going to be low, everybody piles into the stock market and prices go up. When the economy's bad, they pull out of the stock market  and bond prices go up. Bond yields go down, unless the Federal Reserve is artificially pushing them up to slow us down. 

So, same thing for real estate. When people come into real estate, they invest into it and start to drive prices up. If we looked at income producing real estate, you will see that 22% of the investable universe is real estate versus bonds and equities. And if we look at capital flowing to real estate, you'll see that it has gone from about $20 billion back in ‘01 and to $160 billion in’07, down to $15 billion a quarter ‘09 during the Great Recession, and then bouncing back up over that 160 mark, a number of times here over the last decade. And then the red line is the property price index, which peaked in ‘07 just after the Great Recession. And then peaked at the end of 2002.

I'm actually going to show you that the most recent one shows that we've had a 15% decline in real estate prices, since the Federal Reserve started raising rates and really only since the start of this year, which means a potential buying opportunity. We can break that down by property type. And you see that the highest property price increases in manufactured housing or mobile homes, followed by industrial, and then self storage, and then apartments. And everything else was somewhat modest as far as their prices since 2016.

We typically look at and express real estate prices based on cap rates, or the cash on cash return bond yield.  You can see it back and ‘01 cap rates were around 9%. In ‘07 they came down to about 6.5%. During the Great Recession, they bounced back up too and then they slowly worked their way down to 2001. 2002 down into the five to 6.5% range. And only since the beginning of this year, they started to move back up. In other words, property prices are dropping, meaning the yields you're going to get is going up a little bit.

But what you have to realize is that we're in a lower interest rate environment, and so when you say I want to invest in real estate, the question is, how much more income am I going to get over the risk free rate of a 10 year treasury? So the spread over treasuries. This graph shows you that we went from kind of a 4% average rate, with  different property types, dropped to about 2%, in ‘07, bounced back up and is still running in the 4 to 5% range above 10 year Treasury.

So on a relative basis, in today's lower interest rate environment (funny for me to say that)  we are at a point with, still real estate being an attractive investment. And finally, in my now 40 plus years in real estate, when I started, real estate was a local buyer, local seller, local bank doing the financing. In the 1980’s  the institutions got into real estate. All of a sudden we had national buyers, national sellers, and national financing. In the 1990’s, real estate got its first access to the public capital market, the stock market through rates, and the bond market through CMBS. But since the year 2000, real estate has gone global. What you see here are transaction volumes from different countries. What you see first is like, the United States in 2002, invested 11.3 million dollars into Germany. A 27% increase over the previous year. Number four Germany came in the U S with 5.6 billion dollars, a small 1% decline from the previous year. Part of that could have been because of currency exchange rates.And I'd say that when people look to go into different countries, local knowledge is super important.

But you add that new risk of the monetary exchange rate, currency exchange rate, into the formula as you're doing that. So, a fun example in 2019. The top billing or the United States highest price, was a Class A office in New York City. It went for a 4% cap rate. In London, Class A’s were selling for a 2% cap rate and in Tokyo and Hong Kong, they're going for a 1% cap rate. So to a European investor, the U.S. looks like a 50% off deal.  An Asian investor we looked like a 75% off deal.

So I believe that we'll continue to see strong capital flow from international buyers.They mainly go to the big, major gateway cities and that will help support prices there.Then, the institutional investors that were the main investors in those gateway cities, move into the second tier markets, like Denver and Austin, helping support those prices. Then other investors, family offices, et cetera, where they're not seen as great a yield move potentially down into the third tier markets to make those deals work. 

My conclusion is economic cycles can be long and short. Is it really a recession if GDP goes negative but employment stays positive? Which is most likely, with 11 million jobs, need to be filled out there. I'm guessing we're going to get negative GDP growth, maybe in the third quarter. But again, positive employment growth.

Real estate is demand and supply driven  (very local in nature). So you've got to know your city and what's going on. What industries are driving that growth? Supply is going to be slow.  Materials and costs have gone up.  Labor costs are up substantially.
Labor is still hard to find in the construction business. And so while we were in a growth phase in 2022, I think we're bouncing back and forth between that and the hyper supply phase here in 2023 and into 2024. 

On the financial side, capital flows drive prices. You got a volatile stock market, and rising interest rates. COVID was that black swan. Now, bank failures. Who knows what's next?
That creates, again, a difficult situation, but, you know, real estate is a long lived asset that you're going to hold for many, many years. And, you know, we learn how to work it through the cycles.

Plus the world is just awash and a lot of cash. The US savings rate used to be 1 trillion a year and during COVID 4 trillion. That gave people a lot of extra savings to be able to buy houses. Houses are still selling which is amazing and makes investments. So that's coming.  Debt financing is getting harder and more conservative, but that actually helps keep people going especially when you put a 40% equity instead of a 20% equity into a deal. And again, differentiate between home ownership and income producing real estate, as you're thinking about real estate. They're really two totally separate markets. So with that, I will open it up and Kirby, you probably have some questions.

Kirby Rosplock

Well Glenn, thank you for going broad and pretty deep actually to give us a lot of good synopsis of the whole space. Tell us a little bit more about your real estate Market Cycle Monitor. I think it's important people know that you're ongoing and continue to do the research and evaluate the opportunities out there and provide a lot of good data.  You're still ongoing evaluating, trying to figure out where we are in the cycle. 

Glenn Mueller

Right? Yeah, so. I actually posted my Market Cycle Monitor report online, here's how you can get it And then my forecast report is on a subscription basis. Kirby has that and, you know, you're welcome to share that with your clients. It is a donation to our research fund of $1,000 a year, if you'd like to get it directly. And again, I come up with that every quarter, because real estate data comes out every quarter. You can also find it at the Family Office, Real Estate Institute. It's in their quarterly magazine.

Kirby Rosplock

Well, real estate is the core asset and almost, I don't think I've ever met a family office that doesn't have real estate somewhere within their portfolio. Certainly I would say it's probably central casting to most investment focused family offices where it has a larger role to play.  So I am so appreciative of your wisdom, Glenn, and then just the time to spend with you today just learning more about your research, your contributions to the field, and also the complexity. And we've got a lot of interesting nuances in our current markets.   I wish I could have a crystal ball to sort of see what's going to happen with some of these global economic situations and geopolitical situations.  I'm so grateful for your time today. This was an excellent podcast for our Tamarind Learning series.  

Glenn Mueller

Great. Thank you very much, Kirby, I appreciate it. 


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