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What to Buy During the Newest Real Estate Crash



Commercial real estate has been teetering on the edge of crash territory for months now. With banks tightening their funding, forcing investors to refinance at higher rates and occupancy down across multiple sectors, commercial could be crashing very soon. But we aren’t here to prompt fear for real estate investing; instead, we’re presenting some opportunities to build wealth, even when most investors think the sky is falling.

To help give us a read on the whole commercial real estate situation is Willy Walker, CEO of Walker & Dunlop, one of the largest commercial real estate finance companies in the nation. Willy knows precisely what’s happening in the industry because he is the industry. As the third largest apartment lender in the US, valued at over $2 billion, Willy’s ability to forecast the commercial real estate market has helped Walker & Dunlop grow to new heights. And he has some news to share.

Willy touches on the “pain to come” for commercial real estate, why residential has stayed safe, big investors’ refinancing dilemma, and why banks are pulling out of lending for large assets. With commercial investors needing cash to fund their deals but failing to find it, everyday investors (just like you) could help fill the void and walk away with a sizable profit. If you want to fuel your wealth, not your fear, stick around!

David:
This is the BiggerPockets podcast show bonus episode. Today, Dave and I interview Willy Walker, the CEO of Walker & Dunlop, a financial services provider that did over 63 billion in commercial loans in 2022 alone. Willy is a very smart guy who understands things at a high level, and we are here today to talk about the economy, a little bit about the debt ceiling, about what to expect in the commercial markets as well as how the economy is likely to adjust to some of the big changes that we’re seeing. As you guys know, real estate investing, the economy overall is changing in a faster rate than I’ve ever seen in my lifetime, so it is more important than ever to stay abreast of what’s going on. Dave, what were some of your favorite parts of today’s show?

Dave:
Well, I just love that we’re doing this show because honestly, every day, I saw one in the Wall Street Journal this morning, there is an article about how commercial real estate is crashing and there’s a lending crisis going on in the commercial space. It’s hard to make sense of what’s going on. Since Willy is deep into this industry, he runs one of the largest commercial lenders, it really shed light on what is actually going on in this industry. I think some of the stuff that you see in these articles are true, but there’s a lot of nuance to it that you really need to understand if you’re going to position yourself properly over the next couple of years during this correction that we’re going through.

David:
Yeah, that’s right. We also talked about ways to make money in real estate that might involve getting involved on the debt side as opposed to equity or ownership. So if you’re interested in new ways to make money in real estate, you should listen all the way to the end because we have a fascinating discussion then. Before we bring in Willy, a very brief quick tip. Go check out On The Market’s YouTube channel where you can see the YouTube version of this show as well as more economics and news content. If you’re listening to this on the BiggerPockets main channel, I want you to let me know in the comments if you think Willy could play Guile in a real life updated version of Street Fighter II.

Dave:
Are we dating ourselves that we know Street Fighter the movie? I feel like no one knows who it is. I’ve seen it many times, but I am curious if our audience knows this.

David:
I may be dating myself, but Dave, I got to tell you, if I didn’t date myself, nobody would date me.

Dave:
I think they’re making a new street fighter, aren’t they?

David:
That’s what we want to know. Could he play Guile in the new Street Fighter? I haven’t heard that, but if you guys have any information on if a new Street Fighter movie is coming out, I definitely want to know that in the comments as well. All right, let’s bring in Willy with a sonic boom. Willy, welcome to the show. So glad to have you. I am really excited to talk. I’ve been wanting to get someone on the show that we could talk about the increase in the cost of capital and the ripple effect that that’s going to have in the real estate market, specifically the commercial market, which I think is going to be a little bit more exposed as well as what’s going to happen with lending.
Are we going to see traditional lenders come in and bail us out or do you think we might have some new lending sources that step in? Then just overall, what’s going on in the commercial market and the economic state of the country in general? I can’t think of a better person to interview. Thank you for being with us today. Let’s get into this thing.

Willy:
Nice to be here, David. Thanks for having me.

David:
Yes. Now I have been waiting, what’s the word, not waiting on pins and needles. Hey, waiting with bated breath, that might be a better way to put it, to talk to somebody about macroeconomics because my personal opinion is that they affect real estate investing much more than the average investor probably realizes. Rents rise, values rise when we have inflation. Would you mind just giving us a brief summary of who you are, why you’re here and what you do for work?

Willy:
Sure. Why I’m here is because you all asked me to come on.

David:
Yes, that’s very true.

Willy:
What I do, I’m chairman and CEO of Walker & Dunlop. Walker & Dunlop is the sixth-largest provider of capital to the commercial real estate industry in the United States. On those league tables, we sit between Citigroup and Goldman Sachs as far as the amount of capital we put out to commercial real estate on an annual basis. That’s in 2022. We’re very big in the apartment space. We were the largest lender on apartment buildings in the United States in 2020. We were number three last year behind JPMorgan Chase and Wells Fargo. So we know the apartment business and industry exceedingly well, but we lend on all commercial real estate asset classes and we also sell properties. We have quite a large brokerage operation that sells just apartment buildings, but we did $20 billion of apartment building sales in 2022, so we do a lot in that space as well.
Walker & Dunlop is a publicly traded company. It was started by my grandfather in 1937. I joined the firm in 2003.` My dad and I estimated the firm was worth about $25 million when I joined it in 2003. Our market cap got to $5 billion last year before the current Fed tightening cycle hit in. I think our market cap now is about two and a half billion dollars.

Dave:
Wow. Congratulations, Willy. It’s a remarkable success story there. You are in a perfect position to answer some of the questions we have about the commercial real estate market. It seems that every day now, a major publication media outlet is talking about this pending commercial real estate collapse. What are you seeing in the commercial credit space right now?

Willy:
I think, Dave, the thing that people have to keep in mind is that there’s clearly pain to come. It’s going to be a slow burn. I think unlike the great financial crisis where we clearly had a crisis that appeared almost overnight and it was a lending-generated crisis and it was a credit crisis which made it so that there was significant pain in the banking system, and when the banking system seized up, the entire financial system seized up and therefore you had no liquidity whatsoever in the markets. That’s not the case today. There’s plenty of liquidity in the markets today. The issue is that as the Fed has raised interest rates by 500 basis points or 5% over the last year, the cost of funds has gone up dramatically for borrowers. While a borrower may not like the rate at which he or she is borrowing, there is capital to borrow and that is dramatically different from the great financial crisis.
The reason I say it’s going to be a slow burn is that with this higher cost of capital, there are without a doubt going to be borrowers and owners of commercial real estate properties who need to go and refinance a property, need to go take out a construction loan with new permanent financing that’s going to cost them a lot more than they thought it was going to cost them. They may not quite honestly be able to afford that cost and someone else may have to come in and buy the asset from them. But the bottom line is it’s going to take time. We also have the opportunity to see where interest rates go between now and a year from now, two years from now to know exactly how prolonged that burn is, if you will. But I think there’s been a lot of talk recently about some big cliff that we’re going to fall off of because of where interest rates are and quite honestly, you’re just not seeing that in the markets today.

Dave:
Willy, I’m hoping that for our audience who primarily, I’m just estimating here, but is familiar with residential lending, can you just tell us a little bit about how commercial lending differs from residential lending and why it is that commercial seems to be having these questions around the fundamentals of the industry more than the residential lending industry?

Willy:
Cool. We’ll go in a bunch of different directions on that one, Dave. Let me start with the following. The US consumer is very strong right now. Average household wealth in America is at almost historic highs. You have a debt to income ratio for the average American consumer that is historically low right now. That all has to do with the pandemic, the massive infusion of capital into the system that the federal government did and the fact that we’re at 3.6% unemployment today. People have jobs. People are making money and household finances are going well. On the residential or single-family side of the world, the system, the housing market, most people who own a home, two-thirds of the people who own a home have a mortgage on those homes and most of those people went out and refinanced their home mortgage in the last two to three years since interest rates went basically to zero.
The estimation is 40% to 50% of homeowners in America have a 30-year fixed rate mortgage that is somewhere between 2% and 3%. What you end up having there is that people who own a home went out. They put long-term fixed rate financing on their home and they’re doing fine because their interest payment is on a two and a half percent interest payment or a 3% interest payment. What that’s done as well is freed up a huge amount of capital, of income for people who typically in the past would be paying 4% to 5% on that home loan and they’re now paying 2% to 3%. So they’ve got $5,000 to $7,000 on the average home of disposable income that’s allowing them to go to Disney World with the family, go buy the home improvement at Home Depot that they hadn’t thought they’d be able to buy.
So that side of the world, unlike during the great financial crisis, is sitting very good right now. The commercial side of the world is a little bit different and the reason for it is the following. On the commercial side, the term of loans are typically shorter than on the single-family side. So most people on the single-family side go out and get a 30-year mortgage and to refinance that mortgage, which many, many people did during the past couple of years, there’s no prepayment penalty to do so. You just go. The rates are low. You pay some closing costs and you redo your loan. In the commercial side, it’s shorter term paper, typically 7 and 10 year loan terms and those loans are prepayment protected, which means that a lot of the borrowers who had commercial properties in 2022 who would’ve loved to refinance their loan, they couldn’t because to refinance the loan would’ve cost them a huge amount of money. So they had to hold onto those loans coming out of the pandemic when rates were so low.
Now all of a sudden, they’re faced with refinancing those loans at much, much higher interest rates. The first thing is that as those loans term, a loan that was done, let’s just say in 2017 is now coming up for refinancing, if it was a seven-year loan in 2024, and if it was done in 2017, the interest rate on it might have been four and a half percent and right now they’re looking at redoing that loan at a seven, seven and a half percent interest rate if it’s office retail, hospitality or industrial. So the cost of debt financing has gone up dramatically. Then the other piece to it is office and office is really driving the debate right now because things have changed dramatically. I’m looking at you and David and it looks like both of you are in home studios.
People aren’t going into the office at the rate that they used to and as a result of that, occupancy levels are down on offices and CEOs of companies like myself are making decisions about how much office space we need and whether we want to redo leases across the country. That’s put significant downward pressure on occupancy levels in office and therefore made office as an individual asset class extremely difficult to refinance.

David:
Now, the refinance part I think is a critical component, if I’m hearing you right, with potential complications in the economy. For residential investors that don’t understand when they got their 30-year fixed rate loan, rates going up affect a residential investor like, well, that’s a bummer. It’s harder to buy more real estate. My mortgage is higher. A commercial investor, or really, when I say commercial, I just mean a commercial loan, it could be used on multifamily properties, five units or above, or actual commercial properties like you mentioned, office, strip malls, stuff like that, they have structured lending architecture where there’s going to be a balloon payment due usually anywhere between three, five, maybe up to 10 years, but most of them in the past, I think, were structured with shorter periods of time because lenders knew these rates are stupid low. I don’t want to be locked into this for a really long period of time. We are now coming to a point where many of them are going to start resetting if it hasn’t already happened. If I’m hearing you correctly, that’s what you’re describing as what could be problematic. Is that correct?

Willy:
Well, David, balloon payments, and to anyone who’s listening, a balloon payment is essentially, it’s like popping a balloon. The reason they call it a balloon payment is you owe the entire thing at the end of the loan. An amortizing loan, you’re paying down the principal balance of the loan over the life of the loan. A balloon payment, during the course of the loan, you’re only paying interest on the loan and at the end of it, you own a balloon payment. Unfortunately, if you don’t have the capital to repay the balloon payment or you can’t get a new loan to repay the balloon payment, the balloon bursts and you’re left with a bunch of shards of the balloon on the floor and your property goes away. There’s plenty of balloon payment, IO structures in the single-family world as there are in the commercial world.
The real issue here is that the debt outstanding on a lot of these properties needs to be rolled over. You need to go get a loan to step in to refinance it. Let’s just use an example for two seconds on a loan that you took out let’s just say in 2017, going back to the same example I had previously. I’m going to make the math really easy, so we’ll go with a big asset. The property was worth $100 million and you took out a 70% loan. Over the life of the seven years, all you were paying was interest on that loan. So at the end of that seven-year period, you still have a $70 million balance on that loan because you’ve been paying just interest over the seven years. And now all of a sudden, we go to refinance it and the value of that property has fallen from $100 million down to let’s just say, $85 million.
The value of it has dropped by 15%. It’s $85 million is the value on the property. We’re going to underwrite a new loan at 70% of $85 million. If my back-of-the-envelope math gets me, that’s 25.5 million off of $85 million. So we’re looking at doing a $60 million loan rather than the original $70 million that you have to pay off. When your loan at 70 million is being paid off, we can only give you $60 million of proceeds, which means you’re upside down by $10 million. So if you want to keep owning that property to pay off the $70 million that you borrowed back in 2017, you got to go into your pocket and give another $10 million of equity to hold onto the property. So if you’re in that type of a situation, and by the way, that’s only a 15% price reduction I just put into that $100 million asset. In many instances, the value has fallen by 20% or 30%.
So that’s the problem we’re facing right now is that someone will write that new loan at maybe not 70% as well. The other thing about it is given some liquidity requirements in the market, we’re actually writing 65%, 60% loan. So just think about that. 15% down on the value and rather than writing a 70% loan, we’re writing a 60% loan. We’re now looking for you to reach into your pocket and find somewhere between $10 million, $15 million to pay off the old loan to be able to continue to go forward with the property. So that’s what’s happening in the market almost on a daily basis given where the cost of capital has gone to and given where values have gone.

David:
And it’s compounded by the uphill struggle that now that rates are higher, that money that you’re trying to borrow is going to cost you more than it did before. Are you already working that into why the value of the property has gone down?

Willy:
No, no, no, no, no, you’re exactly right. On that, you’re holding onto the property. Let’s just say that net operating income, I’ll just swag this, but net operating income on the property was a million dollars. On that million dollars of net operating income, your interest expense was 25% to 30% of that net operating income. Now all of a sudden, interest rates have gone up 2X to 3X, and instead of paying 25% to 30% of that net operating income on interest expense, you’re now spending 50% to 60% of your net operating income on interest expense. So the cost of capital has now gone up if you can figure out how to re-equify the deal to hold onto the asset.
Those are the types of things that our borrowers are running into today, mostly on office, a little bit on hospitality, CBD, central business district hospitality, a little bit on retail, big-box retail, not a lot on strip retail, and very little as it relates to multifamily because the fundamentals of multifamily have held up very much and Fannie Mae and Freddie Mac play a huge role in the multifamily industry to provide liquidity to that market.

David:
If I understand you correctly, and for people that are unfamiliar with the commercial financing terms, residential real estate is valued by comparable sales approach. What did the neighbors pay for their house? And that’s what your house is worth, which is always, as a side note, struck me as a very silly way to value real estate. It seems like it was absolutely created for people that are not business minded. When the Joneses want to buy their house, they ask, “Well, what did the Smiths pay?” They don’t want to pay more than that, so that’s where the appraisal number gets set. But commercial lending is based on evaluating properties that were intended to be a business. They were intended to cashflow. So there’s basically two main levers that determine that. One is, as you mentioned, net operating income. That’s NOI. That’s basically is taking your income and subtracting your operating expenses. It doesn’t include the mortgage, which residential investors are used to always including in the ROI calculations.
Then the other is cap rate, which is a somewhat complicated concept to explain, but I tend to look at it like it is a number that represents the demand for an income stream in that area. The lower the cap rate, the lower your theoretical return would be if you paid cash for the property, which means more people are willing to buy it. The higher the cap rate, the higher the return, which means less people are willing to buy it. When cap rates compress or go down, the value of the asset goes up very quickly, which was happening when we had interest rates that kept going lower and lower, tax incentives like cost segregation studies allowing for accelerated depreciation, and stimulus. There’s all this money and it needed to find a home. And now that rates, like you said, the cost of capital have gone up, cap rates have expanded also, meaning that the value of the properties have gone down at the same time that the mortgage payment on that thing has gone significantly higher, making it less profitable.
You have all the stuff that was just shoving commercial loans forward at breakneck rates, in my short life, the fastest I’ve ever seen, has now abruptly halted, which has created this confusion which is why we’re talking about that today, is we’re all trying to figure out, does this mean foreclosures are coming? What about all these people that are in syndications that pooled their money, are they going to be able to buy? If you just think about, like you said, a big problem is you’re underwater. You owe more money than that asset is worth. So now that owners are underwater in many cases, meaning that their asset is worth less than what their loan balance is, they’re going to have to refinance. They may have to bring extra capital in to do that.
The cost of that capital is also higher, so their cash flows are disappearing. The profitability of these investments, if they borrowed money at 3%, three and a quarter, now maybe they got to refinance at 7%, 8%. You’re talking about mortgages significantly increasing. A lot of things are working against those asset classes. Will, what’s your thoughts on, is there going to be blood in the water? Should investors be saving their money and jump in, they’re going to get the deal of the century or do you see institutional capital coming in and buying some of these assets before they ever make their way to mom and pop investors?

Willy:
On the commercial side, the question here is the following. What commercial assets are purchased by, owned by smaller investors? Because the example that I used of a $100 million commercial property, there are a couple of high net worth individuals who can own that, but mostly, that’s going to be owned by institutional capital. If the question is a small four-unit multifamily property, multifamily is held up very well. So in that situation, cap rates, back to what you were talking about, haven’t moved that much and there’s a lot of capital for that industry for that asset class because of the role that Fannie Mae and Freddie Mac and HUD all play in the multifamily financing space. If it’s not a small multifamily property, then maybe say retail, maybe it’s a strip retail center. Strip retail, infill retail has done quite well and continues to do quite well.
Should we hit a recession, there may be opportunities there for people to pick up distressed properties, but right now, the retail numbers and well located retail is doing very well. Hotels, they’re clearly boutique hotels. They’re smaller hotels, but the hottest hotel space right now is in resort communities. Most of those hotels are very, very expensive and very, very big, and so there’s not a lot of smaller investors in those. But there’s clearly a bet to be made on suburban hotels that might access an office park or something like that. I think that the issue here is it really does matter the asset class and then “blood in the water,” I think it’s back to it. Are there going to be problems? Yeah, there’ll be problems, but right now, what we’re seeing is the default rates across all of the big providers of capital and commercial real estate, banks, commercial mortgage-backed securities, life insurance companies, and the agencies, Fannie and Freddie, their default rates are still at not historic lows, but very, very low.
They’re nowhere close to what they’ve gotten to during the past two crises, during the pandemic and during the great financial crisis. And so the bottom line on that is just that so far, you’re not seeing the blood in the water, but a lot of people, given all the things that you just outlined say at some point, there is some capitulation here, properties are in distressed sales, and those people with capital are going to be able to step in and buy assets at good prices.

Dave:
Willy, that’s a great segue to what I wanted to ask you, which is how would you assess where we are in this cycle? Are we still at the beginning and we’re going to see how things play out or can you see a line of sight on the end of this situation we’re in?

Willy:
Well, Dave, if I could give you a really specific answer to that one, I would truly, I don’t know, I’d be placing some really big bets on that. By the way, I place bets on that every single day, to be honest, because of the size of the company that I run and because of what we do to try and provide capital in the commercial real estate industry. If you look at the forward curve, and to any listeners who don’t understand what I’m saying on looking at the forward curve, if you look out on where the capital markets are betting interest rates go between now and the end of the year, those people taking market positions, so this isn’t just prognosticating and sitting around in a bunch of economists saying, “Oh, we think it’s going to be this.” These are people who are actually making trades to buy securities in the future at a certain price. So this is what tells you where they think interest rates are going.
They think that the federal funds rate, which is the interest rate that Jerome Powell and the Federal Reserve control, is going to go from 5% today down to about 4.13% by the end of the year. They think the Fed is going to have to cut in 2023. Personally, I don’t think the Fed is going to cut in 2023, but guess what? Those people are betting their money. Mine is just my own sense that the reason I don’t think the Fed cuts in 2023 is because back up six weeks ago, Silicon Valley Bank fails, Signature Bank fails, and the next week when there was a very significant concern that we would have further bank failures in the system and that you could potentially have contagion, which means that the failure of those two banks would run throughout the banking system, they still went and raised by 25 basis points.
So in my thinking, here’s an organization that is so myopically focused on killing inflation, that even at that point where they could have seen the entire banking system meltdown, they still move forward with a 25 basis point increase. So I just ask myself, what would it take for the Federal Reserve to start to cut rate? It would have to be a really, really ugly financial situation, I mean a complete meltdown in our economy and I just don’t see the economy melting down to that degree in 2023. I think you should be planning for rates staying higher for longer and understanding what that means to your business, what that means to your property, what that means to your mortgage payments. I see a lot of people say to me, “The Fed is going to have to cut because we’ve got $31 trillion of treasury bills outstanding and we can’t afford to continue to pay debt service on $31 trillion and not have our entire fiscal situation as a country fall apart.”
I sit there and I go, “That’s great and good, but at the end of the day, if you still have inflation running rampant, the Fed isn’t going to just cut rates because they want to see the cost of capital go down.” So I think that from a macro standpoint, you’re asking the right question. A lot of people believe that in 2024, the commercial real estate market has healed and that there’s the opportunity for transaction volumes to come back in a very significant way, but right now, it’s a guessing game. It’s a guessing game to see what happens on a lot of different fronts. Most importantly, do we go into a recession or do we not go into a recession?

Dave:
For what it’s worth, Willy, I agree with you. I think the higher for longer thinking makes sense, especially given recent economic data. I appreciate you taking a stab at a difficult question there. How do you see some of this play out here, Willy? Do you think that you are going to start seeing a rise in non-bank lenders because I’ve been hearing a lot of talk about them coming into the market?

Willy:
Yes.

Dave:
All right. Let’s just end the show.

Willy:
Yeah, exactly. No, you’re going to have to, Dave. It’s funny because for the last month, I’ve been saying that and I’ve been questioned a lot of, what gives you such confidence that banks are going to pull back on commercial real estate lending? I have said at numerous public things that I’ve spoken at, “I’ll give you two acronyms, FDIC and OCC, that’s all you need to know.” Those are the two regulators over the banking system in the United States. And lo and behold, yesterday, the FDIC came out and put out a new rule that’s going to raise bank reserves by 20%. So banks are going to have to hold on to more capital, which means that they are not going to be able to go out and make that loan on a office building, make that loan on a construction project that they typically would like to do because they need more capital, they need a higher capital base.
So that pullback on lending by local, regional, and national banks is very real and is going to happen. As a result of that, we need other capital to come into the market. Life insurance companies will play that role. The securitized debt market will play that role when things stabilize a little bit when things settle down. It’s not doing that right now. Fannie and Freddie will continue to do that on apartment buildings, and then you’re going to have to have other capital come in. In 2021, 2022, a lot of debt funds were raised by private equity firms and they provided a lot of capital to the market. There’s no doubt that private capital will come into the market in a non-bank format to meet the borrowing needs of owners of commercial real estate.

Dave:
Do you think that’s a good play for real estate investors? Not all of us here can figure out ways to get into the credit markets, but if you are able to, do you think that will be a good profitable avenue for people to invest in the coming years?

Willy:
I do, but I would put a big caveat about that of it depends on who you’re investing with. It’s super easy to get lured into a varying degrees of promises on what types of either unlevered or levered returns a fund will return to you on commercial real estate lending. As we all know very, very well, it makes a difference, the access to deal flow, the types of loans they’re structuring, how they structure them. But yes, very much so, there’s the opportunity going forward to invest on the credit side of commercial real estate and make a lot of money.

David:
Interesting. We don’t typically think about it making money in real estate through investing in funds or issuing debt. We typically think about owning the real estate, and in my experience, owning real estate is much trickier than people tend to think. Being a good operator is a skill set in and of itself. You can understand the numbers and the fundamentals but not be good at executing them, so I think that there is some opportunity in the future for people who are not good operators but are good with money in general. They’re good at making it and saving it to be able to make money in real estate without having to be the “landlord.” The question I want to get into, Will, here, and please don’t feel pressured to make any projections or forecast that you don’t feel comfortable with, but what can you tell us that we can expect from the recent news of the government increasing the debt ceiling? What can people expect to see in the economy overall and maybe the real estate market in general based on this news?

Willy:
Debt ceiling debate was completely generated by the federal government. There’s no reason that we should have that debate, if you will. I think that to your point of, what does it mean that we’ve got $31 trillion of debt outstanding from the federal government, well, the bottom line is that 31 trillion, we can’t afford it, period, end of statement because we took interest rates down so much. When Barack Obama came into office in 2008, there was $8 trillion of debt that the federal government had outstanding, 8 trillion. Between the Obama administration and the Trump administration, that 8 trillion went from 8 trillion to 22 trillion. During that period of time, because interest rates went down so precipitously, it costs the federal government less money on an annual basis to pay interest on the $22 trillion than it did on the $8 trillion that it had when Obama was in office. It’s unbelievable to think about that.
The interest payments when Obama came in on $8 trillion of federal debt were more than $22 trillion in the Trump administration to service that given the cost of debt. Now all of a sudden, we’ve added another almost 10 trillion on top of the 22 trillion and the cost of issuing that debt has gone up precipitously. So there’s very clearly a budget issue as it relates to, can we afford this much debt? The bottom line is today we can given GDP, given tax rolls. But it’s very clear that a lot of that $31 trillion of debt that sits on the federal balance sheet is low interest rate debt. As all of that turns and has to be refinanced at a much, much higher coupon rate, it costs us as taxpayers much, much more money. So that’s the problem is that the majority of that 31 trillion, like they’re issuing this week alone after getting the debt ceiling done, $170 billion of treasury notes, 170 billion. And inside that 170 billion, they’re issuing short-term paper on one month at 5%.
They’re issuing two-year notes at 4.75. So all that used to cost the federal government basis points, literally 75 basis points. To go and do a one-month issuance for the federal government at a coupon rate of 5.20 when it used to be 75 basis points, it costs you and me as taxpayers a huge amount of money to service that debt. So as they go and have to redo all of those long-term bonds sitting on at the Treasury Department where they issued them in 2000 and pick your date, let’s just say that they were issuing a two-year security in 2022 and let’s just say that they went and issued $10 billion of two-year securities in 2022 when the two year was at 1.25%. Today, the two year’s at 4.75% and that $10 billion has to be redone at that higher interest rate. That costs us as taxpayers that much more money.
So the bottom line is for now we can afford it, but the future, if you keep interest rates this high, looks really, really challenging. The savior to all of it, David, is the fact that the US dollar, the greenback is still the fiat currency of the world. We are still the reserve currency of the world, which means that everything is still dollar denominated and the world runs on dollars. So as a result of it, everyone wants dollars and that means that the issuing of federal debt, we can still do it. If the euro had been more successful and the UK hadn’t jumped out of the eurozone and all the other things that have happened to the euro, the euro today, after having come into existence I believe back in the 1990s, 30 years later, could have been a real competitor to the dollar. It’s not.
Then there’s this talk about how China and Russia and Iran are going to go and create some new currency and try and compete with the dollar. Those currencies and the amount of float that they have in the international system is a rounding error related to what the dollar is. There’s no real threat to the dollar for today and so as long as everyone wants dollars, we sit in a pretty good position, but there’s no doubt that Washington needs to focus on this issue and start to balance the budget and start to be fiscally more responsible.

David:
What about from a practical perspective going forward? Is this likely to lead to more inflation?

Willy:
Oh, that’s a tough one. I’m not trained as an economist and I read a lot of economists. The only thing I would say is that if you look at where we are from an inflation standpoint today, the Fed clearly missed it. They missed it on the way up. They’re going to probably overshoot on the way down because most of the inflationary pressures are out of the system other than in housing. The housing indicators that they use to figure out CPI are all lagging indicators. So all of the other inputs on consumer price index are down dramatically. What is lagging at a higher elevated level is housing and that lags by three to four months. So having a lagging housing indicator, what we’re seeing in rents and what you’re seeing in the value of homes is that that has come down, but it’s a trailing indicator and therefore they think that there’s still inflation in the system.
All this came out of the pandemic. It was something we’d never seen before. Supply chains got clogged and you’re now clearly seeing supply chains free up. I think they get inflation under control. As a result of that, if you could get inflation under control and get the 10 year to stay in this range of three to three and a half percent, you can get the economy back running pretty hard at that type of a backdrop. Clearly, something else is going to happen, hopefully something in the good side, but there’s something else that’s going to happen. Ukraine turns into a broader conflict or maybe it gets resolved. I have no idea which.

David:
And that’s one of the reasons I like investing in real estate because it’s one of the more solid, steady, and reliable asset classes in a world that has anything but that. Will, thanks very much, man. This has been enlightening listening to a form of a history lesson plus an economic lesson plus business lesson all in the same conversation. This is great. For people that want to find out more about you, I understand that you have a webcast that you’re very proud of. Can you share where they can find you there?

Willy:
Sure. It’s called the Walker Webcast. I had Alex Rodriguez, the baseball player and commercial real estate investor on today. Alex and I had a great conversation all about Monument, which is his fund and where they’ve invested and how they’ve invested. I have on week after next the CEO of Liberty Media who happens to own Formula 1. I’m really excited to talk to Greg Maffei all about Formula 1 and what they’ve done on having bought Formula 1 for about $3 billion and Formula 1 today is worth about $12 billion. Given all the talk about the PGA Tour and LIV Golf merging together and whether that ends up moving forward or not, I think Greg’s perspective on that will be super interesting. But anyway, it’s called the Walker Webcast. You can see replays on YouTube. Just put in Walker & Dunlop or Walker Webcast and it’ll come up, or you can go to the Walker & Dunlop website and there are links to the live webcast that we do on a weekly basis.

David:
That’s fantastic. Thank you very much.

Dave:
Willy, thank you so much for joining us. We appreciate your time.

Willy:
Dave and David, thank you both very much. It was a pleasure.

David:
All right. That was our interview with Willy Walker. Dave, what do you think about that?

Dave:
I thought it was super interesting. I think Willy has a really good take on the commercial industry. I think it’s interesting how he said it’s going to be a slow burn. I think we’re always waiting for the shoe to drop. One day, the market’s going to be fine, and then the next day, everything is chaos and that’s not really how things happen. I think in reality, given some of the stuff that we’re talking about, how slowly the private market works, it makes sense. This is going to play out over the next couple of months or even potentially years. Frankly, I find that a little bit frustrating. I don’t know about you, but sometimes I’m like, can we just get this over with? We’ve been talking about this recession for years. Let’s do it. We might be in a recession right now, I don’t know, but one way or the other, I just want to get it over with so we can move on. It just feels like these things drag out, but unfortunately, that’s just the way that they work.

David:
Yeah, and then you never know what it’s going to be like on the other end, so maybe we do go through a recession or we are going through a recession and then some new news hits and everything that you thought was what you understood immediately get shaken up and we’re right back to having new challenges. That is the unfortunate reality of living in a unpredictable world. It’s always going to be like this to some degree and that’s why having this information, being aware of what changes are happening and how those changes are likely to affect your financial opportunities is so important. We are excited to have you guys here today. Thank you for tuning in. I hope we see you on a future episode and let us know in the comments what you thought.

 

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