What is the current state of the real estate market and is there a recession coming up? What are some investment strategies for healthy investments? Jeremy Roll, president of Roll Investment Group, shares his knowledge.
Tell us a little bit about yourself.
I've been a full-time passive cash flow investor since 2007, about 17 years. But I started in 2002 while I was still in the corporate world, that was about 22 years ago. I invest predominantly in stabilized cash flow, mostly real estate, but also businesses, that's my primary focus. I'm highly diversified across many different asset types. I've been through the last cycle, and am in the middle of going through this cycle, and I'm very cashflow-focused.
What do you think is the state of the market now? What's in your mind in terms of the economy and your investments?
On the economic side, one of two dominoes has fallen that is going to impact investors in general: 1) interest rates spiked up which caused a lot of other domino effects and a huge adjustment in prices. But there has been a 20 or 30% price adjustment in the stock market, and everybody calling it a crash. I've not heard anybody call it a crash but that's factually what's happened here on the real estate prices. Some assets have gone down more, and some have gone down a little less, but on average is like 15 to 30 say. And I think that's domino number one. 2) This domino that I am still waiting for is a recession that I think is a very high probability based on other data, macro data. And then when you get that, you would typically have a stock market crash. And unfortunately, this time around, there's a direct correlation between the length and an inversion of the yield curve, how long that goes for, which is at a record right now. And the amount that the stock market goes down during a recession. If you were to chart it out, which I've seen and I've done, it implies like a 45 to 50% stock market crash, which honestly, even when I say that I can't picture it, but that's what theoretically should doing, taking history and applying it to today in terms of the length of inversion. The real simple reason for that is that the longer the yield curve is inverted, theoretically, the higher the stock market has gone before because it's just a longer route. It makes sense.
I'm bracing for a very major second domino to fall and not a lot of people I think are talking about. And a lot of people are talking about interest rate cuts, I'm expecting that at least one and possibly two before the end of the year. But I think what a lot of people tend to forget is that the reason why they cut rates is because there is a recession or about to be a recession and the economy is doing bad. It's not just randomly happening.
We had some interesting data today. They released the CPI data, it was -0.1 month over month and it was at 3.0% for a year over a year, that's the regular CPI. The core CPI was at about 0.1%, I think 3.4 but it's trending down. There's a very high probability that it's going to continue to trend down because 43% of the CPI is comprised of what they call the owners’ equivalent rent, which is a highly likely 18-to-24-month lag indicator of rents. The CPI number has been overinflated for a long time, by measuring rents in a different way than the actual real-time data we have. And now, it's catching up to the rents that have been declining, or at least the pace that's been coming down in a lot of markets for the past 12 to 18 months. Because of that, we have a lot of months left, where it's going to impact the CPI data negatively, meaning it's going to continue to go down. Because of that, the Fed is almost certainly going to end up reducing rates towards the end of the year. But while that sounds great, again, that's usually in response to bad economic situation. I'm still waiting and bracing for a very bad economy 8 to 18 months ahead, possibly after the elections, we'll have to see. And then, I think, we'll have probably the best time to buy since 2009.
You think we're heading to a major recession because of multiple macro variables, and besides the yield curve, what else?
I'm not sure if we're going to have a major recession necessarily, I think we're going to have a significant stock market correction because that's been running for so long because of the length of the inverted yield curve. The actual severity of the recession is much more complicated to kind of determine I don't have one opinion or another about that. It's funny because everyone looks at the unemployment rate currently 4.1% and it is historically low, but the trough of that was 3.4 at the bottom. Typically, once you have over 50 basis point increase in the unemployment rate as an example, you're due for a recession very shortly thereafter. We've already hit the four and a 4.1 months ago, I also want to warn everybody that if everyone thinks, "Oh, the stock market's doing great, nothing's ever going to happen" the funny thing is that the stock market usually starts to go down, one to three months after the first rate cut. Some people think, "Oh, there should have been a crash." If the economy is not doing well, that's not the way that it works. There's like a whole process to it. And if you're not familiar with it, I recommend you research it because the more you know, the better informed you are and the more you can be prepared to go in at what you think might be the right timing.
I was looking the other day, I think the projected GDP from GDP now for Q2 was 1.5%, we'll have to see what it comes out at. It's a very well-known fact that unfortunately, the jobs numbers, I think 70% of that number is estimated, fabricated. And if you take a look at what's happening, unfortunately, last two one to two years, it's all been revised significantly lower to the point where some people think that a recession started about October of last year because of that. And so, we'll know that in hindsight, there's a lot of very specific because I just read so much stuff and they're all lining up. It all makes sense. And watch for the yield curve to start to flatten and then steep and again, back to normal. That happens typically before everything just hits the fan, then you watch the rate cut, and then I would expect to see the stock market go down within a few months after that.
Are you selling your stocks? What are you doing right now?
I own no stocks; I have not known any real stocks since 2007. I'm all in on the alternative investing for cash flow. What I'm doing with that space is I am very much on the sidelines, with very few exceptions. The best way I can describe my thought processes, is if somebody says to me today July of 2024, "What should I invest in? What are you doing?" My answer is, "Well, if you asked me that question in July of 2008, what would be a good answer?" I'm not saying it's going to be the same type of person; I feel like the timing is very similar and that's really where my mentality is in terms of waiting. Keep in mind as well that real estate tends to move very slowly. Personally, it's very different, it's the opposite of the stock market, which moves very quickly.
With real estate, you're better off being a little late than a little early because if you're a little late, you have plenty of time because it's not going to just shoot back up in a year, it doesn't work like that, typically. And it's all going to be very interesting to see the banks. The banks have very few failures so far, with the degree of interest rate increases, we've had. There have been some very high-profile, very smart billionaires, all saying that they're expecting hundreds of banks to eventually fail. And I agree because historically, that's what would happen in this type of environment.
How many deals do you have right now under your belt? And how are they doing?
I'm highly diversified because I have been doing it full-time for so many years. I'm currently in over 60 active LLCs, and I've been in over 150 to 200+ over the past 22 years. They're all different because some of them are from the 2000 era and some of them are from last year, or even this year. One thing that I think was very important is I didn't invest in any floating rate bridge loan deals, which was very difficult to not do because in 2020 to 2023, let's say, literally 90%+ of anything I got was that. If you wanted to invest in anything, it almost always had to be that, but it didn't match with my bucket, which I typically look for a 10-year fixed rate loan long term because I'm looking for predictable cash flow. I sidestep that so I'm not dealing with any of that, thankfully, although a lot of people are and I feel horrible about what's going on right now.
On the real estate side, I'm in one deal that is kind of borderline -ish, as I call it, which is a retail strip center that I invested in back in 2014, with a 10-year loan. The only issue with it is that, we had a buyer because the loan was coming due this summer, and as they were under contract to buy it, with I think two or three months left, one of the major anchor tenants, 99 cent stores announced that they were closing all the locations in California. While it was under contract to sell right in the 11 and a half hours, the sponsor is trying to find a tenant to replace that anchor and he's been continuing the loan payments even though the loan is due, and talking to the lender to sort out what to do about it. That's the one piece of real estate distress.
Anything with insurance problems like double, triple, or quadruple?
A lot of things have been hit, especially multifamily by insurance increases that have reduced cash flow and some of the things probably hit it by a couple of points per year. I'm in with one sponsor who has multiple billions of dollars in multifamily and I spoke to them this week and they told me that they went overseas to negotiate with an insurance company in the UK. And somehow, because they said the insurance companies are cheaper over there, they're going to reduce the bill for insurance across their properties by 30 to 40%, which is ludicrous. When you think about what's going on in the US right now, I don't know how they're pulling it off. It might be their scale. There are some solutions but I know a lot of people have been struggling with that. When you get insurance, it reduces cash flow. I'm all like 85 to 100%, occupied stabilized, you're not going to go negative, you're not going to have a problem covering debt, none of that, you're just dealing with less cash flow, essentially.
What were some other things that you think you did right so that you only have one property that is a little bit hurting right now?
Who can predict that chain is going to close while we're under contract to sell it an hour before the loan is due that month? That's actually what I call a 1% risk. It's really important to understand, to learn from that because you have 20 different 1% risks all the time in any deal that seems perfect and that's why it's important to be diversified. Back in 2005 to 2008, at that point, I was on hold because of real estate valuations and I was only in 1 foreclosure that was a similar situation to this in 2012 or 13, unrelated to the downturn, it was one of those 1% situations. That's the only foreclosure I have ever been and I think now that may or may not have this one foreclosure, we'll see but besides that, I think that I'm in relatively good shape because when I was looking at these bridge loan deals, I wasn't saying to myself, "I shouldn't do those. Interest rates are going to skyrocket. I didn't know what was going to have with interest rates." What I was saying to myself was, "It doesn't fit my box, and I'm not going to conform to a different box, just deploy cash." This is very difficult to do, you have to be very disciplined but more importantly, because I follow the macro data, in 2020 and 21, we are at a record-long economic cycle. When someone is presenting a deal to me that let's say is a three or bridge loan, which I don't do anyway but let's say I was considering doing, I would have to take a hard look at that and say to myself, "We're at a record long economic cycle, we will eventually have a recession, is this the right time to do a short-term loan type of structure?" It's a higher risk at the end of a cycle and a lower risk at the beginning of a cycle. I'll entertain a shorter term when I say short term, five-to-seven-year deal, shorter term for me at the beginning of the cycle, but not at the end of the cycle. That was one of the key things that I did as well. They said this is the wrong time to entertain anything that has medium or high risk because we're at the end of a cycle. I don't know when it's going to end but we're at close to or at the end of the cycle.
When did you start thinking that?
At the beginning of 2017, we were heading towards a recession, and we would have had a recession in the spring of 2020 had there not been a pandemic, there was an inverted yield curve for a long time already. I wasn't pushing sponsors to sell stuff from 2017 to 2020, I was in over 30 exits. And that to me, it was really when I was like there's I'm doing nothing except for it's unique. Those three years and it was exactly the right timing, had there not been a pandemic that then caused money printing, and money printing just extended the cycle.
It was back then. If you think about it, I've been sitting around for seven years, trying to be disciplined, that's why I'm in this position right now. And by the way, I've given up a lot of returns a lot. Some people have done much better than me during that time to be fair, who have taken more risk but now I'm in a good position, maybe I had a lower return, lower risk at this point. I didn't do any of the shorter-term deals but I'm also not in a lot of distress at the same time because that also doesn't match my personality. I still think we need to wait and it's very difficult. But I think until you see the full adjustment and carnage, which I don't think we've seen yet, that's when you're going to have the proper opportunities. You got to look for positive leverage in real estate and we're almost not seeing it yet.
When you see the carnage, would you buy an office in San Francisco?
That is not my personality, because I look for stabilized properties but my answer is yes. If you have the personality for that, that is the time to do it. When you see an 80% reduction in pricing, which we've seen, you can argue that it is time to do it. It doesn't make sense for people to have done that already. What I'm looking for is positive leverage by 150+ basis points, because honestly, historically, that's what we would get as a risk premium. It went completely away, was all negative leverage and we're barely there even on C class right now. And on being a class for both a filming, for example, we're still not there. And in some cases, we're still at negative leverage, which is crazy to me and that tells me that we haven't had the full reset.
Is there anything else that you think is important for our audience to know that we haven't covered yet?
Just be very careful right now. I feel like I'm sitting on a beach, I see the storm coming and I'm just waiting for the calm before the storm but once the storm passes, times will be better. And that's exactly where I think we are right now.
Jeremy Roll
Jroll@rollinvestments.com