Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / Why Stagflation Is Reshaping the Commercial Real Estate Market
Transcript
- Lucas: So Luna, we talk a lot about how stagflation squeezes consumers — groceries, gas, rents. But there's one corner of the economy that's been quietly rewriting its entire business model, and it's not something most people think about over breakfast: commercial real estate. Luna: You mean like office buildings and shopping malls? Because I feel like we've been hearing about the death of the office for years now. Lucas: Exactly, but it's more than just empty cubicles. We're seeing a perfect storm of high interest rates, sticky inflation, and a structural shift in how companies use space. And the numbers we got this week paint a pretty stark picture. Luna: What numbers? Give me something concrete. Lucas: Well, first off, real GDP growth came in at just 1.5 percent annualized for Q2. That's down from 2.1 percent in Q1. And at the same time, core inflation is running at 3.3 percent. That's the stagflation cocktail — slow growth, high prices. And commercial real estate is particularly sensitive to both. Luna: So you're saying the economy is barely growing, but costs are still rising. That's got to squeeze property owners who have floating-rate debt. Lucas: Right. And that's exactly what we're seeing. Take office vacancy rates in major cities — they're hovering around 20 percent, which is near record highs. In San Francisco, it's even higher, something like 25 percent. That's not just a cyclical dip; that's a structural change in demand. Luna: But people have been saying 'the office is dead' since 2020. Why is it different now? Lucas: Because now we've got the added weight of financing costs. A lot of these buildings were financed at low rates, and when those loans come due — and they're coming due in the next couple of years — refinancing at today's rates is brutal. You're looking at a 6 or 7 percent mortgage on a building that's only half leased. The math just doesn't work. Luna: So what happens to those properties? Just abandoned? Lucas: Not abandoned, but repurposed. That's the fascinating part. We're seeing a wave of adaptive reuse — converting old office towers into residential apartments or lab space. In some cities, there are tax incentives for exactly that. But it's not cheap, and not every building works. Luna: And that's where the industrial side comes in? Because I've heard warehouses and data centers are booming. Lucas: Exactly. Industrial and logistics properties are the bright spot. E-commerce still needs warehouses, and data centers are exploding because of AI. That demand is real and growing. So it's not all doom and gloom — it's a rotation. Investors who can pivot to those sectors are doing well. Luna: But what about the little guy? I mean, the pension funds and the REITs that hold all this commercial debt — they're the ones who get hurt, right? Lucas: Yes, and that's the systemic risk. Lenders are getting nervous about commercial mortgage-backed securities, or CMBS. We saw some stress in that market back in 2023, and it's still fragile. If you're a regional bank with a lot of commercial real estate exposure, rising defaults could be a real problem. Luna: So is this a 2008-style crisis in the making? Lucas: Probably not, because the leverage isn't as extreme and there's more equity in the deals now. But it's a slow bleed. We're seeing more distressed sales, more foreclosures in the office sector. It's not a cliff, it's a grind — which fits the stagflation theme perfectly. Luna: And the Fed — they're stuck. They can't cut rates aggressively because inflation is still above target. Lucas: Right. The fed funds rate is still elevated, and with core PCE at 3.3 percent, they don't have a lot of room. That keeps borrowing costs high for commercial real estate. It's a tight spot. Luna: But what about the jobs data? We saw initial jobless claims tick up to 197,000 last week. Does that change anything? Lucas: It's a small uptick, but it points to a softening labor market. And if companies start cutting back on office space because they're worried about growth, that's another headwind. But so far, the labor market is still fairly resilient — unemployment is at 4.2 percent, which is low historically. Luna: So what's the play for an investor who wants to navigate this? Is it just avoid office buildings at all costs? Lucas: Not necessarily. There are opportunities in distressed assets if you have the capital and the patience. But for the average person, it's probably better to look at REITs that focus on industrial or data centers. And be cautious with anything that's heavily office-heavy. Luna: Interesting. I also read that some cities are rethinking zoning to make conversions easier. Is that happening at scale? Lucas: It's happening, but it's slow. For example, New York has a task force on office to residential conversions, and they've relaxed some rules. But the construction costs are high, especially with inflation in materials and labor. It's not a silver bullet. Luna: And what about the financing side? Are there any new instruments or government programs to help? Lucas: There are some pilot programs, like the Federal Housing Finance Agency looking into backing loans for conversions. But it's early days. The private market is still figuring out how to price risk in a world where a building's income stream is uncertain. Luna: So it sounds like we're in for a prolonged adjustment period — maybe years. Lucas: Exactly. And that's the thing about stagflation — it's not a sharp recession, it's a long, slow correction. Commercial real estate is going to be a key part of that for the next few years. It's not going to be pretty, but it will be interesting to watch. Luna: Before we wrap up, I want to say — if you're finding these conversations useful, the way we keep the show ad-free is through listener support. If you've gotten something out of today, you can buy us a coffee at buy me a coffee dot com slash fexingo. It really helps. Lucas: Yeah, it does. And it's totally optional, but we appreciate it. Now, back to the grind — one thing I didn't mention is the impact on property taxes. As valuations drop, cities that rely on property tax revenue are going to feel the squeeze, which could lead to budget cuts or higher taxes elsewhere. That's another little ripple of this whole transformation. Luna: Oh, that's a good point. So it's not just the building owners who are affected; it's the whole local economy. Lucas: Exactly. And that's why this isn't just a finance story — it's a broader economic story. So as we look ahead, the question is: can we repurpose all this space fast enough to avoid a prolonged drag on growth? Luna: Well, I'll be watching those vacancy numbers. Thanks, Lucas. Lucas: Thanks, Luna. And to our listeners — keep your eyes on the buildings. There's a lot going on behind those facades.