In this episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi go myth busting with Senior Commercial Real Estate Economist Xander Snyder, debunking three prevalent economic and real estate myths making headlines recently – stagflation risk, a pending housing market crash, and the commercial real estate doom loop.

Don’t miss a single REconomy episode, subscribe today.

Listen to the REconomy Podcast™ Episode 90:

“And that's not to say we won't see price declines. As I mentioned earlier, prices declined briefly on a year-over-year basis in 2023. There are also markets, such as Austin and San Francisco, that have experienced price declines from the peak. As higher rates undermine affordability, it's natural to expect some house prices to adjust downward. However, limited housing inventory will likely keep a floor on how low national house prices can go.” – Odeta Kushi, deputy chief economist at First American

Transcript:

Odeta Kushi - Hello and welcome to episode 90 of The REconomy Podcast, where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist, and Xander Snyder, senior commercial economist at First American. 

Mark Fleming - Hey Odeta. Hello Xander. And listeners, we have a very fun episode for everyone. Today, we're going to be discussing and busting -- for those who might have watched a little too much TV in the past -- three myths that have been circulating in the real estate headlines. 

Xander Snyder - That's right, just call us the 'Economic Mythbusters.' 

Mark Fleming - Yeah, not that the name hasn't been used before. 

Xander Snyder - Hey, Mark, hold on one second. I think I hear legal calling me.

Odeta Kushi - Exactly. Well, while we won't be disproving the five-second rule today, which was a classic but extremely disheartening Mythbusters episode, we will be covering three economic myths that have received some attention, but aren't quite what they're made out to be. We'll focus on one macro-economic myth, a residential real estate myth and a commercial real estate myth. Now, one concept that's been making headlines lately has been the idea that the U.S. is at risk of entering a period of stagflation. But, what is stagflation? And why is it something to worry about? 

Mark Fleming - And, of course, I'm always the one that has to explain the hard stuff. The word Stagflation describes a scenario where inflation is high and economic growth is weak, usually indicated by high unemployment. Stagflation is an unusual scenario, since typically when inflation is high, it's a consequence of either too much demand relative to an economy's productive capacity, driving prices up, or some sort of supply restricting shock that drives prices up. In either scenario, you would expect unemployment to be low. Conversely, as the macro-economic theory goes, in a weak economy with high unemployment, why would prices be going up at all in the first place, not enough demand relative to productive capacity? So the portmanteau of stagflation is an economic anomaly. Two big words on the Scrabble board to get us started.

Xander Snyder - Yes, stagflation, in other words, is when inflation is increasing, while the economy is stagnating. I also feel like stagflation would be a great name for a monster truck that like rolls over other cars. You know, like this weekend come down to the Forum to see Stagflation, the truck that eats other trucks, 

Odeta Kushi - You know, I might be convinced to buy tickets to that.

Mark Fleming - I'm having a hard time keeping a straight face. I imagine some listeners like me are actually remembering the great monster truck jams of the '80s right now. 

Xander Snyder - Yeah, and we managed an '80s reference early in this episode. 

Odeta Kushi - Way to go team. But, let's go back one more decade. A classic example of stagflation in the U.S. was actually the early 1970s, when both unemployment and inflation surged. While the cause of the rising inflation in the early '70s was multifaceted. Part of it was driven by the oil embargo that OPEC had imposed on the United States that made everything that needed to be transported more expensive, resulting in an economy-wide supply shock. When a recession struck in December of 1973, unemployment began to rise alongside inflation and, by 1974, inflation reached a then record high of 12%, while unemployment peaked shortly thereafter at 9%.

Mark Fleming - But today, inflation is still certainly a cause for concern, as anyone that follows the Fed's interest rate decisions will tell you. But high inflation? The Fed's preferred inflation metric is core personal consumption expenditures, or PCE, excluding food and energy, and has the benefit of being a more inclusive measure of economy-wide prices than the CPI. As of the last reading for March core PCE grew at 2.8% compared to a year ago. While not yet at the Feds 2% target, we at least have a two on the left hand side of the decimal point. 18 months ago, that was high inflation. Not coming down further or faster in recent months is not the same as high inflation today at 2.8%. 

Odeta Kushi - We'll take that progress. And the general trend for most inflation indices over the last two years has been a decline, though there was a real acceleration in headline CPI in the first several months of this year. And what about unemployment? 

Mark Fleming - Well, unemployment remains near all-time lows currently at 3.9%. So, even if you make the argument that inflation remains elevated, which is sort of barely true right now. The fact is that unemployment is so low, I thought not too long ago, all the pundits expected a recession because rates are being raised so quickly to tackle inflation. Isn't that what always happens when the Fed raises rates?

Xander Snyder - Well, so what about the aspect of slower economic output? Or GDP? What does the current pace of growth in GDP, say about whether or not we're facing the risk of stagflation? 

Mark Fleming - Well, the classic economist answer here, it depends. In this case, it depends on whether or not you're willing to read the footnotes of the actual GDP data release. 

Odeta Kushi - Well, I'm assuming that means that you are willing to read the footnotes.

Mark Fleming - Assume correctly and, sadly, yes, I read footnotes of GDP releases. The latest GDP estimate from the first quarter of 2024 showed that the GDP grew at just 1.6%. That's pretty low by our standards. That could be a point in favor of the risk of stagflation, unless you get into the details, which show that the slowdown in GDP in the first quarter was due entirely to a decline in business inventories and the trade balance. Consumer spending, which makes up roughly 70% of GDP, grew at an annualized rate of 4%. In the first quarter, hardly a sign of a slowing economy and, actually, maybe a little too hot for the Fed's comfort. 

Odeta Kushi - Yes, consumer is king in the U.S. So, it seems like people are still spending money just more on services and less on goods, hence the decline in inventory. 

Mark Fleming - Right, and if you exclude inventory and trade from the first quarter GDP read, it would have come in closer to 3%, hardly an indication of stagnating economic output. 

Xander Snyder - So, what's causing this uptick in stagflation concerns? Google searches for the term stagflation have been increasing since the beginning of the year, and nearly tripled in the latter half of April compared to the first half. 

Mark Fleming - Well, it's probably primarily due to only considering the headline GDP numbers. And the spikes in stagflation searches seem to occur around periods of economic uncertainty or recession. So, while we're not in a recession right now, there is still fear that one could occur, given the rapid rise in interest rates over the last two years. So stagflation fears appear with recession risk, not necessarily inflation risk. 

Odeta Kushi - Yes, indeed. In fact, the last time searches for stagflation surged was in early to mid-2022, when interest rate hikes began. All right, well, Mark, I think you're off the hook with explaining the macro-economic stagflation concept, because we're on to our residential myth. And there were so many possibilities to choose from, but I think we should talk about house prices and the potential for a housing market crash. First, I should mention that house prices, they don't always go up. While over the long run, house prices tend to increase, we've certainly experienced periods of house price declines. 

Mark Fleming - Odeta, say it ain't so. They don't always go up? Yes, the Global Financial Crisis does come to mind. 

Xander Snyder - Yeah, many still bear scars from the GFC. It wasn't that long ago. 

Odeta Kushi - That's right. And, while that was probably the most severe and sustained period of house price declines, there have been others. On a year-over-year basis, house prices declined in the early '80s, '90s, and very briefly in 2023, depending on the price index you're looking at. 

Mark Fleming - House price declines can happen over time and in certain geographies, but we should separate periods, such as the early 1990s and even 2023, from the Global Financial Crisis. The GFC was a housing bubble resulting in a bust. 

Xander Snyder - So how then would you define a housing bubble? 

Odeta Kushi - Good question. A housing bubble can generally be defined as an unsustainable period of house price growth generated by artificial demand, such as loose underwriting or speculative buying. Importantly, a housing bubble implies an eventual pop. 

Mark Fleming - Ah, so I know one way to define it, we can all see it, after it pops. I can see why many believe that we are due for a housing bust today. Annual house price growth peaked at over 20% in 2022. And, from February of 2020, otherwise known as the pre-pandemic era -- seems so long ago -- to current, house prices have increased over 50%, according to our First American Data and Analytics House Price Index. 

Xander Snyder - So, our myth bust here is that not every housing boom turns into a housing bust. Is that right? 

Odeta Kushi - Exactly right. And we're specifically referencing today's housing market, right. The pandemic housing market, unlike the housing market of the mid-2000s, was not driven by loose lending standards in subprime mortgages, nor did it feature large numbers of homeowners who are highly leveraged. The house price appreciation during the pandemic was characterized by a shortage of supply relative to demand. Millennials were aging into their prime home-buying years during a period of historically low mortgage rates, which fueled demand during a time of historically low supply.

Mark Fleming - I feel like I have to say, well, but this time, it's different. And it was during a time when our home was more important than ever, our office, our home, a gym, a restaurant, everything. 

Xander Snyder - Yes, irrational exuberance was not the driver of this house price boom. 

Odeta Kushi - That's right. And that's not to say we won't see price declines. As I mentioned earlier, prices declined briefly on a year-over-year basis in 2023. There are also markets, such as Austin and San Francisco, that have experienced price declines from the peak. As higher rates undermine affordability, it's natural to expect some house prices to adjust downward. However, limited housing inventory will likely keep a floor on how low national house prices can go.

Mark Fleming - And additionally, homeowner mortgage payments as a percentage of their income, what we call their mortgage burden, remains historically low. And homeowners have high levels of home equity today, which helps to protect against foreclosure and the contagion of price declines that we saw in the Global Financial Crisis. 

Odeta Kushi - So no housing bust in sight. All right, two myths down and one to go. Xander take it away. 

Xander Snyder - Great. So our third myth of the day, is that all commercial real estate is in a doom loop or the death spiral, or some other.

Mark Fleming - That sounds like a good name for one of those monster trucks. 

Odeta Kushi - Yeah, exactly.

Xander Snyder - Yeah, the Stagflation death spiral. There is this idea that all commercial real estate is in this catastrophic-sounding, inescapable cycle, right. And, while it's certainly true that some commercial real estate is going through an incredibly challenging period, with distress concentrated in the office sector, but there's also some in the multifamily sector to a lesser degree. Not all commercial property types are struggling, certainly not like office, and in fact, some are actually doing relatively well. 

Odeta Kushi - Right. And Xander, I know, we've talked about the industrial asset class on prior podcasts that, while a lot of supply is coming to market, the long-term demand drivers for warehouse and logistics space remain relatively robust. Is that the example we're using to bust the myth of the death spiral today? 

Xander Snyder - That's certainly one example worth mentioning, yes. And, for listeners curious to learn more about the resilience of industrial property specifically, check out Episode 85 of The REconomy Podcast, where we talk about that in a lot more detail. And we'll have a link to that in the show notes. Just as a very quick recap on the industrial sector, a lot of supply is coming to market, but there's also a lot of demand to lease up that new space. But, another story that's being lost in the doom loop noise is that of the resurgence of retail properties. In the first quarter of this year, transaction volume for most asset classes fell to the lowest levels seen since the early pandemic days, it was really hard to do anything except for retail properties. In fact, compared to the second quarter of 2020, the quantity of office, industrial and multifamily space transacted only grew slightly, or was pretty much stagnant. But retail transaction volume in the first quarter of this year was nearly three times what it was early in the pandemic. 

Mark Fleming - But, I thought retail has been in a death spiral ever since the dawn of online shopping? What happened to the death of mall culture? Hanging out at the Mall, the Orange Julius store in my day, with your friends, seeing a movie and grabbing lunch in the classic food court gone by the digital wayside? 

Xander Snyder - Well, it's true that there are still pockets of challenges in the retail sector such as class B, or C shopping malls that might require a bit of a drive to get to. And online shopping only accounts for about 15% of total retail spending. Thing is retail properties have come out of the pandemic as one of the best positioned asset classes. And this is because the strong demand to own retail space is being driven by a strong demand to lease retail space. And there's a limited supply of new retail space. In addition to that, there's been demolition or conversion of some existing retail space. So people are still spending money at retail locations, especially service-based retail locations, and there's not a whole lot of new supply coming to market. 

Odeta Kushi - Right, and going one step further, the demand to lease retail space has been driven by continued strong consumer spending, even though that excess stock of pandemic-era savings is now estimated to be fully depleted. Real wage growth is still positive, despite our latest bout with inflation.  Well, it seems like I shouldn't have bought the story of eCommerce being the death knell of retail real estate then. 

Xander Snyder - Not for goods-based retail at least. Experiential retail, so locations where you actually need to visit a store to receive the good or service being purchased is far more difficult to supplant with eCommerce. So, while you do see some retail companies struggling right now, they tend to be those that are struggling tend to be selling products that can be purchased online. But if you run a gym, or daycare center or restaurant or bar, you need to actually go to these places to buy their product. And consumer demand for these services has remained strong, so demand by companies to lease the space has also remained strong.

Odeta Kushi - So the takeaway on myth three then is that, despite doom loop headlines, both industrial and certain types of retail properties are doing fairly well, due in part to ongoing demand to lease that space. CRE is not a monolith. I'd call that myth busted. So those are our three – stagflation, housing market crash and doom loop. Thank you, Mark and Xander. We left no real estate legend untested, and I think I'm off to go to the mall. Thank you so much for joining us on this episode of The REconomy Podcast. If you have an economics-related question you'd like us to feature in the future, you can email us at economics@firstam.com. And, as always, if you can't wait for the next episode, you can follow us on X. It's @OdetaKushi for me and @MFlemingEcon for Mark and @XanderSnyderX for Xander. Until next time.

Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2024 by First American Financial Corporation. All rights reserved.

This transcript has been edited for clarity.