Hello, everybody. It's Sam from the Financial Samurai podcast. And in this episode, I have a special guest with me, Ben Miller, founder and CEO of Fundrise. Welcome to the podcast again, Ben. Hey, Sam. How's it going? I'm really looking forward to talking to you because you have made a pretty big turnaround in terms of your outlook for 2024 real estate.

Last time we spoke was at the end of August 2023, and you seemed much more cautious back then. But I listened to a latest episode on Onward, the Fundrise podcast, and it was entitled Buying the Bottom. So to me, I was like, wow, buying the bottom. Is this it?

Are the good times back? So I'd love to hear from you what your new thesis is for this year. Yeah. I mean, it's exciting. I'm very bullish on real estate. We went through 18 months of declines in real estate as a result of interest rate hikes. So real estate is inversely correlated with interest rates.

Another way to think about interest rates is just like your P/E multiple. So same thing happened in tech. Same thing happened in the stock market. You know, multiples fell. And basically in real estate, they essentially fell 50%. So a property that was pricing at a four-cap rate is now pricing at a six-cap rate or something like that, for example.

And so a cap rate is the same as a multiple. It's just inverse of multiple. So, you know, like a five-cap rate is a 20 multiple. So interest rates drove multiples way down, and that drove prices and valuation way down. And now interest rates have, in my view, they've peaked, and we're going to see interest rates start to fall this year.

And as they do, it's going to start driving real estate prices and multiples back up. Sure. So in some ways, it's really simple. I mean, I honestly believe most investing actually is about trying to keep it simple. Right. And so back in August 2023, I was a little bit more bullish, partly because I was in the hunt to buy another property.

But it seemed to me that inflation did peak already, right? 9.1% in, I think, June 2022. It's been rolling over ever since. So back then, wouldn't it have been clear that eventually, sooner or later, the Fed would cut rates? Therefore, nobody should be selling in 2023, and people should be buying?

Or is that just easy to talk about in hindsight now that Jerome Powell has specifically said, well, three rate cuts potentially in 2024? Yeah, I think technically the bottom was October. And so in October, just to try to put us into the mindset we had then, there was a lot of talk about interest rates going essentially to 10%.

The Treasuries, they'd gone from 3.5% to 5% in about 90 to 100 days from August when we were talking to October, they went up, was equivalent to like 35%. And in that moment, people were arguing that there were so much supply of Treasuries coming to market, there was going to be a lot of borrowing by the federal government, there's going to be huge deficits, and all of that would basically lead to higher interest rates because the market couldn't absorb that much new borrowing by the government.

And so there was an expectation by part of the market that the long-term interest rate would go to six or seven, or even 10. And there were people out there talking about that. So it wasn't clear until November that that basically wasn't likely. I didn't think that was likely either, but essentially, I can tell you why.

As a result of that sort of uncertainty about the long-term rate, you had basically reluctant buyers because you didn't want to buy a falling knife, and reluctant sellers because basically, they didn't want to sell into a market that they think would improve later. So there was a frozen market, essentially zero transactions of consequence happened last year.

It wasn't a good time to sell for sure. I don't think it was obvious in August that inflation and rates would basically be tamed by the end of 2023. Well, in terms of buying the bottom, so that implies that sellers probably should not be selling at this time. What do you say to that?

And why would someone want to be selling at this time if we're really just off the bottom right now? Yeah. There is no willing seller. There's only forced sellers in the bottom. And so, what's happened in the real estate market is that basically, a lot of borrowers borrowed too much money when rates were zero.

And they basically have to either pay down their debt or sell. And that's inevitable. Those rates aren't going back to zero. True. And so, the question is basically, how long can they hold on? And what's happening is like a herd that slowly loses the weakest members of the pack and you sort of hunt it.

The borrowers can only hold on so long. And the two things that are happening is that there are borrowers who are capitulating and also buyers like us who look at the long-term rate and price and say, "Okay, the gap is basically not so large as it would have been in October." And so, sellers and buyers have to meet somewhere in the middle.

And that means if you're a buyer, you have to get a little bit aggressive. Everybody wants to buy at a price that makes them feel comfortable. Normally, when you're buying something in a downturn, like I remember I bought something in 2010 and I was freaked out. I just thought, "Oh my God, I can't believe I'm buying this thing right now.

It's so dangerous." And I looked back and I was like, "Oh my God, I stole it." Yeah. So, during a downturn, emotionally, you feel fearful. And during an upswing, emotionally, you feel confident. And it's really ultimately the opposite of what's happening in reality. Yeah, right. So, Ben, you just gave me an idea regarding using the cash in various funds to take advantage of opportunities.

So, for example, let's say you buy a distressed property deal, which you think is good from the flagship fund. Could you then support that deal with the cash from the income fund to try to make a better return for the income fund and support the deal for the flagship fund to make it a success later on?

Or is this wonky thinking on my part? From a regulatory point of view, you have to be really careful crossing funds and/or co-investing. So, you can't have a perception or reality, but either can be problematic, of one fund bailing out the other. Even if you do it with good intentions, nobody presumes good intentions of anybody in the financial industry, which is largely right.

So, you can have funds investing shoulder to shoulder, side by side, same price, same terms. But even that requires independent review, which you have to have independence to basically make sure that the transaction is kosher. So, it's challenging. You want to be careful and generally want to avoid excess complexity.

Yeah. No, that makes sense. Thanks for clarifying that. So, Ben, what are your thoughts about office, big city office properties? Because you see the big coastal cities like New York, San Francisco, office properties are getting sold for 50%, 60%, 70% down. To me, I'm thinking to myself, if there is a fund out there that is specifically looking at buying office property down 60%, 70%, whatever, 80%, I want to allocate some of that capital right now because I think in 10 years, 20 years, it could be worth much more.

What are your thoughts on investing in that space and potentially starting a fund to invest in that space? Yeah. I've been waiting for the office market to really reprice and it actually hasn't repriced very much. I saw a transaction happen outside DC in Bethesda, which is the wealthiest part of the suburbs of Washington.

And somebody had bought this 40-year-old building, but it had been fully renovated. It was purchased in 2019, fully renovated, went into foreclosure and got purchased. And the difference was in 2019, the price was $390 a square foot, plus they invested in renovating the building and bringing it up to kind of a modern standard.

So they probably were into it for 450, I bet, maybe 500 a square foot. And the new buyer bought it for $89 a square foot. I mean, it's unbelievable. I mean, just that fact makes me salivate and want to buy. Yeah. But is there potentially no upside to that?

That one I think is interesting. I'm just trying to give a specific example of what makes it interesting and then what the risk might be. So it's near the metro, it's in Bethesda. And so if I think about it from a macro point of view, you sort of say, okay, well, you probably at this point, you want to be investing in sort of less urban neighborhoods actually, where you still have public transportation, but you're not going to worry in that instance about crime and the suburbs have seen a lot of growth as a result of work from home.

So that deal actually was one of the first deals I saw where I thought like, that's probably a really good deal. Mostly I haven't seen transactions that deep a discount in that good a location. And so you really have to be pretty deeply discounted, I think, before it becomes attractive, because the problem you have with office is that it's a vicious cycle.

This is the danger of investing in distress, is that distress can get more distressed. It's like when Sam Zell bought the Tribune because he thought it was a distressed newspaper and then it just went bankrupt. How much risk are you actually taking I think can be tricky because over the next probably decade, you're going to see deterioration in office space.

And so you'd have to be getting a really good discount. You have to be getting the right property in the right location. And I think it's still early, super early. I mean, I think we have half a decade, sort of like the mall industry. I mean, it's still dying and it hasn't died yet.

You're just such a long downturn. I mean, malls have been dying since the introduction of e-commerce 20 years ago. And I think of e-commerce in 1997 versus now, think about work from home now versus what it's going to be like in 10, 20 years. We're going to see a lot more change, virtual reality, 3D, AI, and it's just going to continue to eat away at office.

It is getting interesting, but it's not clear. I don't think it's at the bottom with some exceptions. Yeah. No, that makes sense. I mean, if I put on my economist hat, could I say that the destruction in office property wealth can simply be shifted towards the value creation of residential property wealth because more people are permanently going to be working from home longer?

Could that be a simple thesis? And if so, does that mean residential will permanently see an uptick in value for, I don't know, as long as we shall live? Well, I mean, I'm hesitant to say permanently, but I think that the parallel between e-commerce and work from home is there.

And so just to put a finer point on it, right? So retail and malls were just devastated by e-commerce and industrial was the beneficiary because industrial was not an institutional asset class back before e-commerce. And what happened was every three square feet of retail you lost, you picked up one square foot of industrial.

And obviously Amazon got a lot of the economics too. So it wasn't one for one. So maybe a third of the value that was destroyed was picked up by industrial. So I think that some ratio like that exists for residential too. And as office loses a trillion dollars in value or maybe more, residential picks up something pretty significant.

And so it's my experience buying in real estate and also in tech is that it's much easier making money when the tailwind, when the macro's behind you, pushing you, helping you. And it's really challenging to make money when it's against you, when the wind's at your face. There's things that are really hurting.

I was in the retail business. I actually have a decent experience in it. And so you just have to work a lot harder. And I'm not sure the return, let's say if you can get teens or even greater return in residential, how much more are you getting for buying office?

You're not going to get that much more. And you're just taking... Because the problem is the other side of that is where's your liquidity? Who's the buyer? I have a friend who went to work for TV news. He was a TV news professional in 1999 and his career just never...

20 years later, he got out of TV news because the ratings only went down his whole career. My experience with macro is all things being equal, you definitely want it at your back, not at your face. Right. No, that makes sense. That totally makes sense. In terms of price forecasting, what I found interesting is in 2023, if you look at the St.

Louis Fed data, it shows the median home price is down 8% as of third quarter 2023. And maybe it'll only be down 5% once the fourth quarter data comes out. But then you look at the Freddie Mac index and the Case-Shiller index, and it says the median home price is up 2% to 3.5%.

So I guess two questions for you. One, which index do you believe and where do you think or how much did home prices increase or decrease in 2023? Single family homes is like a non-institutional business. It's home buyers want to live there. So it's a consumer product actually. And I don't really think either is probably correct.

It's probably some mix of the two. I think generally what people saw was that prices didn't fall very much and sometimes they went up a little. And so 8% down seems high to me from the Fed data. But at the end of the day, I think that my takeaway is that home prices didn't fall, which I basically was pretty sure I was saying at the time.

I didn't think they were going to fall. They didn't fall because the way homes are priced is based on supply and demand. And when rates went up, there was no supply of existing homes to market because no one wanted to sell a home with a 3% locked in mortgage.

And so there was undersupply of housing available for sale and that kept prices up. So I think that the risky look at pricing is the primary stat when you're thinking about value. 2021 should have proven that out for anybody who is an investor. Right. And so in 2024, do you think there will be an increase in demand more than the increase in supply?

Therefore, prices will go up. And if you believe that, how much do you think prices can go up in 2024? We're talking about for housing and for institutional real estate because I'm much more in the weeds of institutional real estate than single family consumer housing. Right. Let's talk about institutional real estate where investors can benefit from what Fundrise invests in.

I don't think of it in terms of like a 12-month cycle. I think of it in terms of like you're buying a price and usually you look at price based on a price per square foot or price per pound. Like the office building, $89 a square foot. Well, that seems like a good price, right?

You don't even know what the yield is on that office building. It might be terrible. It might be attractive. Buying yield in 2021 was a mistake, right? Because interest rates were so low. Yields were pushing prices up. Today is the opposite. Interest rates are a lot higher and that's pushing the price down.

So I look at the price per square foot and say, "Okay. Well, I'd much rather buy a depressed price per square foot even if it looks like the yield is not as good as it was in 2021." So anyways, just to get at your question, real estate multiples or real estate cap rates, they fell 50% in the last 18 months because interest rates went from zero to five and a quarter or five, you know, or so.

Or if you think about it like all in, you could borrow at 3% or less during 2020, 2021 and then now you have to borrow at six or 7%. So interest rates basically doubled. That's why cap rates fell 50%. I don't think interest rates are going back to zero.

They probably end up halfway in between where they were and where they are. I almost call it 2.5%. That'd be 2.65% or something halfway in between. So that would basically mean that you have multiples could increase by 25%. They still fell 50% and you get back half of it just on normalizing interest rates.

You should have 25% potential gains in movement in rates. And that doesn't include natural growth from rents or from buying something really cheap or renovations or things like that or income. You buy a property that has a 5% income, you get that too. So if I think about returns, I stack them in three ways.

You look at your income and that might be typically 5% to 8% on a stabilized property. You look at your rent growth or inflation and let's say that's historically been 3%. So you end up with like a 8% to 12% return there, something like that. And then if cap rates can move 25%, you know, over say two years, that gets you to a pretty good total return.

That's how I would think about it. Okay. It's interesting how you think about it versus how maybe like just the average retail investor thinks about it. Because for us, we think, well, how much is my home going to go up in one year or how much is my asset, right?

Year over year growth. And from your perspective, there's multiple combination of factors and it's a longer term perspective. So I guess, you know, as an investor, let's say the property, there's no interest rate change, so no cap rate change. The only thing that changes is rent growth. So just trying to understand this.

So let's say rent growth is 5% for this one complex properties. How much does the NAV of that property change in the fund? Yeah. So if you had a property, like an apartment building, let's say had free cashflow or income of 5% and then you had rent growth of 5%, you would look at that and say, "Well, that's a total return of 10%." And then the NAV would pick up the 5% in appreciation and the dividends would pick up the 5% in income.

Okay. So it would be exactly how it is. Like if there's 5% rent growth, let's say there is no appreciation in terms of like no change in cap rate, it's 5%. Yeah. Because the income went up 5%. It's sort of like, if you think about a company, if their earnings grow 5%, right?

And their multiple doesn't change, then their stock price would go up sort of commensurately. Right. Got it. Okay. I think that's helpful for investors and listeners. So what I've gathered from this is, well, rates go down, cap rates go down. Over a two-year period, it sounds like we could see eight to mid-teens growth.

I mean, it's not going to happen linearly. Sure. Most change happens non-linearly. Sorry, not to get too philosophical, but we experience time in a linear way, but actually most change happens in these sort of catalytic ways where the market recognized in November that inflation was coming down and it just shifted by 20, 25% in 60 days.

So I believe that's going to happen in fits and starts and there'll be moments of fear along the way. But yeah, that's my view is that there's a lot of room for rates to come down, multiples to normalize and prices to follow. Right. Well, it's interesting in the last couple months of 2023, you saw bond prices increase, 10-year treasury bond yields go down to like 3.8%, stock market rally.

I feel like maybe we're getting a little bit ahead of ourselves. We've pulled in a lot of growth based on a huge rally in the end of 2023. And now you're seeing the 10-year bond yield go back up to back up to almost 4% again. What are your expectations for the number of Fed funds rate cuts this year?

And where do you see the 10-year bond yield finishing at the end of this year? It's currently at almost 4% again. I don't normally think that way. It's the whole Ray Dalio, I'd rather be approximately right than precisely wrong. Oh, okay. So whatever number I tell you is going to be precisely wrong on December 31st, 2024.

But I think approximately right is that rates are coming down. I don't think there's much debate about that. I think that the economy is still slowing, that high rates are slowing the economy and it's going to slow inflation and that may actually hurt the stock market because growth is going to slow for a lot of companies.

And it's like an interesting thing where the stock market's near the 2021 peak and real estate's pricing at 50% or huge discount, whatever you want to call it, 20 to 50% discount. So that seems to me like an opportunity in private markets where the public markets seem like they...

Yeah, they do seem like they got ahead of themselves, but it just depends on your horizon. I think two years from now, we're going to look back and say that's like too high a price, probably not. But six months from now, we get probably so. Yeah. No, I like that saying.

I haven't heard that saying. Yeah, at the end of the day, we're just making predictions, but we've got to operate our investments somewhat based on our predictions. Otherwise, we're being incongruent with thought and action. I'm pretty bullish on 2024, which makes me kind of hesitant. Every time I get bulled up, I'm thinking, "What am I missing?

What could go wrong?" I mean, it seems like maybe inflation could pick back up. I mean, I was at the gas station the other day and I was like, "What? Gas is back up to $5.40 a gallon. Natural gas prices for your home is probably back up." I'm thinking, "Oh, no.

Hopefully, inflation doesn't go back up like it did in the 1970s. Then it's going to be higher rates for longer." Do you have any of those type of fears that inflation could be kicking back up again in 2024? I mean, I've been fairly consistent about this and I've been wrong so far, but I basically believe that inevitably high rates and quantitative tightening will materially slow the economy.

I think it's happening as we speak. The Fed will be reluctant to drop rates soon enough. I think the biggest risk is on the downside where we end up with recession, not that we end up with inflation high forever or coming back. I think the Fed is, if you look at which error they're likely to make and they're likely to cut too much or cut too little, I think it's that they're likely to cut too little because of the whole institutional momentum behind their fear of repeating what happened in the 1970s.

My view is basically, that's why I think the stock market is potentially a little bit ahead of its skis because if growth slows, then earnings growth, which are currently forecasted to be pretty decent, I think it'll be like 13.5%, if that slows, then basically that's going to be a problem for the market.

Conversely, a recession would be bullish for real estate because it brings interest rates down and interest rates pulled down are much more consequential than profit growth. Just to put some math on that. As you said, let's say that normal profit growth or rent growth is 3% to 5% in real estate.

I just said that multiples fell 50%. Take you a decade plus in profit growth at 3% to 5% a year to get back what you lost in multiples. If there's no change in rates. Yeah. Well, just to normalize, what's the bigger driver of returns, multiple compression or expansion or profit growth is clearly cap rate compression.

My point is that if there's a recession, profit growth for potentially everything slows down, but that won't matter as much to real estate as the decline in interest rates. Got it. No, that makes a lot of sense. In a way, real estate investors might be rooting for a recession because it would force the Fed's hand to cut rates faster, sooner, and more than expected.

Right now, the expectations are for three rate cuts, maybe 25 basis points each, bring down the Fed funds rate to 4.5, 4.75, which is still quite restrictive if inflation stays at 3%. That is restrictive. I'm of the belief that the Fed is going to cut more than three times and we can revisit this at the end of the year and that would bring more fuel or support the real estate market further.

Yeah. Hold on. I have two things I want to debate with you. First, just let me go to the point about bad news is good news. I mean, for the last year, slowing economy has been a point of rallying for the stock market. The bad news is good news cycle, I think, has driven down inflation and driven up the stock market.

But at some point, bad news becomes bad news. That's basically what I'm saying. A recession or a forecast around slowing growth is that actually bad news is not good news at some point. I think that when that shifts, the stock market could have a bit of a problem. Then your second point about rooting for the market to fall is definitely real estate industry and all these borrowers who have a problem extending their loans.

They're rooting for a return to the 2010s. 2010s in terms of rates or prices? Both. It's a great decade for real estate. Yeah. Well, the way I think about it, I think about myself as a capital allocator. I look at asset classes that performed over the trailing 12 months.

I look at asset classes that have underperformed over the past 12 months. I try to allocate more capital to the underperformers when there's a historical correlation with performance. We know real estate outperformed before 2023, but real estate underperformed in 2023 to the S&P 500 because S&P 500 was up 24%.

Real estate was pretty sluggish. Depending on which index you follow, down 5% to up 3.5%, 4%. That's big underperformance for that year. I'm expecting a normalization of performance. That spread can't be that wide for that long. There's so much liquidity on the sidelines looking performance. When I look at the S&P 500 at 47.50, I'm thinking, "Well, it's kind of fully valid in my opinion." I'd rather be plowing money into real estate at this point because I think there's better diversification and more upside potential.

Right. You're saying the same thing I'm trying to say. You're just saying it in a stock market or like a RIA language. Yes, that's exactly what I'm trying to say too. My view is totally aligned with what you just articulated. This is great. I think this is the first time in several years that we're totally aligned, which actually, again, makes me kind of worried.

I'm like a promo optimist. I'm a realist too, but man, we're totally aligned. Okay. Let me just say it because I've been a perma bear for the last couple of years and you were an optimist. Now, I'm an optimist and you're an optimist. I'm still an optimist. You're still an optimist.

All right. Well, I'll tell you what. Let's wrap up this episode here. It was great talking about real estate. In an upcoming episode, let's talk about the Fundrise Innovation Fund and Venture Capital. Thanks so much for coming on the show, Ben. Yeah, it was so fun, Sam. Thanks, everyone, for listening to the conversation I had with Ben about his outlook for real estate in 2024.

It's nice to hear he's optimistic as I am. I also found it interesting that he believes October 2023 was the bottom for this latest real estate cycle. If you would like to explore the various Fundrise funds, you can go to financialsamurai.com/fundrise, F-U-N-D-R-I-S-E. Lastly, if you enjoyed this episode, I'd appreciate a rate, review, and a share.

Every episode takes hours to record, edit, and produce, so I really appreciate your support. Fundrise has been a longtime sponsor of Financial Samurai and Financial Samurai is an investor in a Fundrise fund. Thanks so much.