Motley Fool Money - The Great Lag

Episode Date: October 15, 2023

The Federal Reserve may act on a forward looking basis, but the bank isn’t always quick in action. Ben Miller is the co-founder and CEO of Fundrise, a real estate investment platform. Deidre Woollard caught up with Miller to discuss: - How slow reaction times from the Fed impact the economy. - The home equity buffer. - Opportunities in innovative investing. - The AI boom in private markets and start-ups. Company discussed: NVDA Host: Deidre Woollard Guest: Ben Miller Producer: Ricky Mulvey Engineer: Rick Engdahl  Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi everyone, I'm Charlie Cox. Join us on Disney Plus as we talk with the cast and crew of Marvel Television's Daredevil Born Again. What haven't you gotten to do as Daredevil? Being the Avengers. Charlie and Vincent came to play. I get emotional when I think about it. One of the great finalies of any episode we've ever done. We are going to play Truth or Daredevil.

What? Oh, boy. Fantastic. You guys go hard. Daredevil Born Again, official podcast Tuesdays, and stream Season 2 of Marvel Television's Daredevil Born Again on Disney Plus. And so the result of that essentially is that it's super lagging. Like today the Fed would say that like I think, I don't remember,

but I think that, you know, rents are currently 5% and they're slowly getting down to where they should be, which is 3%. On the ground, they're negative 2.5%. I'm Mary Long and that's Ben Miller, co-founder and CEO of Fundrise, a real estate investment platform. He's also a returning guest to Motley Fool Money. Dieter Willard checked in with Miller for a chat about what real estate data says about inflation,

the boom in artificial intelligence investing, and the great lag between the Fed and the economy. We last chatted a tail end of last year, and you were putting out some gloomy podcasts and forecasts about future real estate credit and this phenomenon that you called the Great Deleveraging. So tell us, what is the Great Deleveraging and what do you see right now? Wow. Yeah, so that thesis was that zero interest rate policy for 15 years and quantitative easing led to an excess amount of debt build up. And as that debt buildup came, comes due in a new higher interest rate environment, people have to pay down the amount of debt they have, right? Because you used to have a 3% mortgage instead you have a 7% mortgage. percent mortgage, which means that if you're a company or you're a commercial borrower and some individuals just can't support that, and they're going to have to pay down or sell. And that's a de-leverage, reduce the amount of leverage in the system.

And that is talking about trillions and trillions of dollars of that. And so it's a great de-leveraging as a result of higher interest rates hitting the economy. Yeah, one of the things I remember you saying was turtles all the way down. So this idea that the debt would keep, we keep going and going and going and, you know, borrower after borrower and lender after lender. Yeah, people don't realize this, but the biggest borrower in the market is the lender. The banks, maybe they do now because you started seeing Silicon Valley Bank and other banks blow up. but there's actually like very few people who or companies that don't leverage their credit. They make a loan, a bank makes a loan, and then they borrow against it.

And so there's a lot more debt in the system than might be apparent. And typically that debt or debt in general makes you fragile. And so that fragility is the risk. And so far we've seen some breakage, but we've not seen a collapse. And even a month ago, people would have, I think, would have said that, like, no, this is going to be soft landing. It's a great deal leveraging thing. It was way off base. But I think we're starting to see a turn, even like just recently.

And that maybe all of this leverage combined with high interest rates are actually going to hit the economy harder than what was consensus in the summer. So, yeah, it's interesting because of what. happened with with the banks so you know you you were talking about great deal leveraging before that then we had silicon valley and some others i know signature bank is uh there's the need to sell off those loans what are you looking at in terms of the commercial real estate loans that are that are coming due and and being sold off by by banks yeah i mean there's a great time to be a lender because the banks have stopped lending so there's a supply demand mismatch and where you you make great investments when there's a mismatch between the market, the markets, either you, you can

sell when there's a lot of demand, there's not enough supply, or you can buy when there's a lot of supply, not enough demand. And so right now, it's an incredible time to be a lender, because everybody's being forced to borrow more, or because of the great de leveraging, and there's, and the normal lender's out of the market. I mean, banks virtually out of the market and say there's, you're stuck, I mean, we're making loans of, you know, 12, 15 percent interest rates where would have been half that, you know, one year ago. So it's, that's definitely something we're focused. I mean, it's a problem for some parts of the market and a problem is an opportunity.

Yeah, those are some spicy rates there, and you're absolutely right. You would not have gotten those before. I know you now have a closed end fund for opportunities. student-to-state credit investing. So obviously, I understand why now to do this. So are you amassing money to then invest in different things? Yeah. I mean, there's, I think the part that where there's still disconnect is there's been a big lag. And somebody started saying, you should call it the great lag. Because you have a pretty leverageing. But the lag between when monetary policy gets

tight or when interest rates go up and when they're actually the impact seen in the economy is much longer than people intuitively expect. And it's funny, I was just reading, not to get too nerdy here, but I was just reading a paper in 1961 by Milton Friedman where he wrote the famous line. He said empirically monetary policy has long and variable lags. So long and variable lags is sort of this famous quote among economists. And that's 1961. And so he says typically two years from when they raise rates to when you see the impact

in the economy. So they started raising rates summer of last year, started in April, really got going by summer of last year. And so we have, you know, we're still nine months away from really seeing the impact on the economy. And already, you know, you could argue that inflation has come down a ton. And so we're sort of, it's like there's a, this happens a lot in like rivers, where there'll be a flood upriver. It takes a long time for it to come down river and finally wash out the town.

And but that's like definitely, in my view, definitely going to happen. I mean, I guess I'm not definitely, the possibility that Fred reverses itself, but I think it's highly unlikely. So that preparation for the flood, whether it's a defense, or offensive opportunity is, I think, the big thing happening in real estate markets. So what you're saying is you don't feel like the soft landing is happening. You feel like the Fed's impact has not been felt yet. And so does that, do you think that there's a possibility that the Fed actually has to backtrack? Or do you think that they are going to sort of stick there? Because I don't think there's any way that we might really get to that 2% inflation

rate anytime soon. I don't know what you think about that. I mean, there's like, there's a few different factors in there. There's sort of pure economic questions. And then there's like institutional psychological questions. You know, what will the Fed do? So let's just give an example. In 2021, inflation appeared roaring. And it was May 2021.

We, you know, we own, Fundrise has something like 20,000 apartments. And we saw, you know, like a switch went off in May 2021. And our rents increased over that period, 20, 30%. You know, and that never happened before. Normally, rents increase 3%. So May it hit, okay? It was obvious that inflation has just gone rampant. The Fed did not raise rates until March 2020, a year later,

and then they really didn't get going until May. So it took them one year from when they, you know, you could see it. I mean, it wasn't like inflation is coming. Inflation was like already here. was very high and they didn't raise rates for a year until after that it happens. So I expect, and this is more of a, this is not a mathematical projection like the way monetary policy lags, that the Fed will be slow because of sort of institutional bias. And there's a great quote, I don't know if you know this quote, it's the Fed talks like a traitor, but acts like an accountant.

So they're forward looking in what they say, but they're backwards looking at what they do. Right. And so, like, and I know another thing I see is that like, so multifamily construction, today if you're going to borrow multifamily construction debt and go to a bank, you're going to pay eight and a half, probably nine percent, nine percent if you go borrow. And you have 50 percent leverage, 55 percent leverage, nine percent interest rate. and 18 months ago, that was 70% leverage at 3% interest rate. And you pretty much can't get bank lending.

It's really difficult, like a normal bank lending. So you're talking about that's a quadrupling of multifamily construction interest rate costs. And that had happened, and that was obvious to me, you know, and the team here and anybody in the business, almost a year ago, almost a year ago, you could be on the ground and see the multifamily was construction with basically going and grind to a halt. And we started doing lending, mezz lending and bridge lending and gap lending, emergency, rescue funding lending into that space starting about a year ago. I think, I think we closed the first one in October.

I think it was October. So, and it only showed up in the data, like the Fed data for, the Fed, which is the Federal Reserve, St. Louis, has a great source of data. And it only really showed up in their data this summer. Right. So it fell off a cliff in the data really in August, September. And so you're like, there's just this massive lag just in the data. And then there's a lag in the reaction to the data.

And so there's just a lot in the system that basically likely we're going to, stay too high for too long, just like we stayed too low for too long. Right. And the consequences of that are likely to be painful. So in terms of rent, you mentioned that the, you know, what we saw in 2021 with multifamily rents going higher, they've been getting lower and lower with multifamily with these, you know, developers taking on more cost. Do they then have the ability to raise rents enough? Are they kind of stuck? No, no. Rents nationally. are have gone negative. So this is another example. So rents today, this is how the Fed does housing inflation. It's a, I don't know how much you know about this is sort of like an

obscure piece of knowledge, but basically they used to have housing inflation based on housing price. And and that went crazy in the 70s. And so Reagan, under Reagan, they changed how they calculated in inflation, they called it owner-occupied equivalency. So it's this strange formula that basically doesn't look at asset prices. And so the result of that essentially is that it's super lagging. Like today the Fed would say that like I think, I have a number, but I think that, you know, rents are currently 5%, and they're slowly getting down to where they should be, which is 3%, on the ground they're negative two and a half percent and i think they go more negative and and as they go

more negative like that's going to hurt the over levered borrower but also like you know i think housing is 30 percent of of inflation and you have literally at negative 2.5 percent today right on a on a year over year basis and over a week over week basis down point one so as equivalent to negative 5% on an annualized basis. So it's, it's, it's, it's about like, it's a, the economy is like a freight train, like a giant 350 million person freight train. So once it gets going one way or the other, it's hard to turn it. And so it was going like a freight train up and now it's going like a freight train down. And as in 2021 was so crazy, right, the pricing got so crazy in stock market, meme stocks, specs and NFTs. And so that, those high, high, high,

can also happen on the low lows. And I think people are not prepared for that type of problem that I think is basically a natural consequence of the high highs. It's like winter follows summer in a very natural way. Well, it's interesting though because you've got the situation with jobs staying relatively steady. And so that's keeping things up. And, you know, so consumers are still spending. We're starting to see a little bit of weakness in terms of like credit card delinquencies and things like that.

But so far, the sort of the consumer sentiment is that we're still okay. And I think that that contributes as well. And maybe people aren't seeing it. Well, so like if you look at the history, which is that the jobs is a lagging indicator. Right. So people say, look at jobs. Well, jobs lag. So what are leading indicators?

And so typically, and I go back to 2007 or 1999 or before, I went back and pulled quotes from like before every recession and like right before every recession, jobs, unemployment was super low. Unemployment in 2007 was historic lows in 1999. There was historic lows. And everybody was saying, oh, job growth so strong. And then it falls off a cliff. and it typically moves on average across every recession in the U.S. history has moved 3.3% in 18 months. So that would take us, that would put 5 million people out of work in 18 months. And it would happen, it would basically start hitting most acutely in the spring of 2024,

or late spring of 2024. That's what the historic average is because there's a lag. Because companies on the ground, and I see it right, they're not going to build parts. You're not going to, you know, manufacturing and industrial is like slowed down because they're worried about, you know, they get the cost of borrowing to actually build anything. So I, I've been consistent on this and people call me bear. I'm a bull on AI. And I'm talking about AI. And I think there's, and I'm not, I think everything will turn, will turn back up again.

Like, it's a cycling. and he goes up and then he goes back down and then he goes up back up again. And so I'm not, I think it will go up again. 2025 is going to be a, you know, we'll get back on track. But like this is how it works. But this stuff, one of the things that is different this time, though, is at least for homeowners, they have so much more equity in their homes. I mean, nobody's moving right now.

The whole market's at a standstill. But people do have equity. There is something, hopefully, to, to be able to tap into? Yeah. I totally agree. And before 2008, there was a saying it was safe as houses. Because before 2008, across whoever 100 years, houses has never gone down.

So people are looking in 2008 and say, oh, housing, but like housing is going to be, looks like housing's going to be fine. Yeah, housing is almost always fine. 2008 was an exception. So I think housing and households actually will be okay. Like, you know, I don't think it's actually a source of the risk. Most people have locked in long-term interest rates and, and they have home equity and they aren't on arms and things like that. So I think this more in the corporate sector, it's the problems aren't, I think, going to come from housing. I think housing should be fine.

Like, it's not, you know, maybe it goes down a little bit, but it's not a source. I don't think it's a source of risk. I think it's really all the, all of the, all of the, um, I mean, I just, the companies that have, like, private equity and some real estate, I mean, there's lots of business borrowers out there who have debt that will come due and they won't be able to service it. And or any business, I mean, the business, the ability for businesses to expand in this environment is really difficult, except for AI, which I still want to talk about. Yeah, we will. And so that's an opportunity. I'm not saying it's a problem, I think it's an opportunity for people who are prepared.

And that's like that's a problem is always an opportunity. It's just you have to reframe it. But denying that there'll be a problem is usually a bad approach. Yeah. Well, let's talk a little bit about some of the other things you're investing in because you've got the innovation fund. You know, one of the things we talk about all the time is like the IPO market is slow. companies are looking for funding anywhere they can get it. You've been investing in a variety of different companies.

I noticed that you invested in Canva, which is, you know, the content creation platform. Everybody seems to love Canva. How are you thinking about the opportunities right now? Are you seeing a lot of companies looking for money? Are they feeling that pressure? Well, so AI is a big deal. And I think it's even unclear to people what AI even means. but it's this

there's like there's like wheels within wheels here so generally venture capital is I think the best performing asset class in the US history right venture like private tech companies and historically individuals have no access to it it's not an area you can invest in both regulatory and also sort of structural to the market so our mission was always been a democratize

good investments. And so we've been chasing that for a while. And then we were lucky because right when we launched the fund, there was a generational breakthrough. And AI is a generational breakthrough. It's as, you know, it's bigger than, I mean, is it bigger than the internet?

I think probably ends up being bigger than the internet, definitely bigger than a personal computer. I mean, it's so fundamental that it's hard to actually, it's hard to actually get your mind around. And we can talk, but there's patterns to it. and essentially it's really exciting,

and there's going to be a lot of, like, money and growth and excitement, and most people won't be able to participate because it's happening in the private markets. There's, like, 10 companies in the public markets that are, you know, leveraging AI, and Navidia is, like, one of them. And you can buy Navidia at, like, 1,000 times revenue, whatever it is. But, like, most of the stuff's happening with startups, and you're just, you can't, individuals couldn't invest in that until we sort of created a new way. And that's like, that's what's so exciting.

I mean, that we've basically like kind of broke the oligarchy, like, you know, hammerlock on it or something. But it's a little bit different than investing in real estate because your end is different. You're looking, you're looking either for the company to be acquired or to have an IPO. So the exit is a little bit less clear. So how are you thinking about that and how you sort of prepare investors to understand the ways that this is different? Yeah, yeah. Well, so it's different because it's fundamental. That's one thing, right? Because what's happening with AI or in some this technology is fundamental. It's generational. It doesn't have any to do with interest rates or inflation or anything like that. And fundamental things move, like they don't,

They don't care what you want, right, when you want to exit and how exactly it works. Like, people mostly want to orient investments to what they want to have happen. But, like, you know, if you're inventing the future, like, what's happening with OpenAI, like, you need to give them what they need, right? And that's how you get great value. So, but in some ways it's similar to real estate. So the companies we've invested in so far, or the majority, vast majority of the dollars have have been later stage companies that are still private that I think

of is like you know like data bricks we invested in data bricks we invested in Canva both those companies I think have decade decade plus two decades of growth ahead of them there it's there I mean data bricks is like I think like the next generation Fang like it'll be well known as as like the guts of AI, but nobody knows about it now, who's not like deep in tech, but it's, it's like the inner workings of the data and technology revolution happening with AI. And so it has such a long horizon on it that is a little bit like real estate and that even who goes public doesn't mean you're a seller. Like selling Google after they went public would have been insane.

So with Databricks, they just had a series I at $500 million that gives them this massive $42 billion valuation. So they've been talking about IPOing for a while. So your plan there is to hold on after the IPO? And is that something that you're seeing for a lot of companies? Is that part of the innovation fund is that you'll hold for longer? Yeah, I think that the fund is mostly private, but we do hold and expect to hold. some publics and that you, I mean, the essence is you should be agnostic about public or private. The problem is that private you are blocked from investing for most people because it's a regulatory

barrier. And the interesting thing about being a private investor is you get a lot more information. Like it's funny. People talk about public companies and transparency, but you actually, like, the case and cues of public companies don't actually tell you that much about the business. and you get a lot more information from a private company when you're investing in them, a lot more information. So you actually have a lot better understanding of their business.

And so, yeah, we would be a holder. I mean, it's sort of irrelevant to today we're just buying privates. But when they go public, which I think Databricks will, that just, you know, that doesn't change our strategy. What you want to own is the best companies. and you know it's you can look back and say oh it's so obvious that in a video is a great company but i think you really have to have known a lot about the tech to really have known that earlier yeah and i think that's true with data bricks and and like dbt we invested in a company called dbt labs dbt is like the fastest growing data and i i think in the world

most people never heard of it and we invested in it and and that's incredible we're we're It was amazing. And, you know, you just let the compounding power of their technology just drive growth. As always, people on the program may have interest in the stocks they talk about. And the Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.