Ben Miller is the co-founder and CEO of Fundrise, a real estate investment platform. On this podcast, Motley Fool host Deidre Woollard caught up with Miller to discuss:
- How slow reaction times from the Fed impact the economy.
- The home equity buffer.
- Opportunities in innovative investing.
- The AI boom in private markets and start-ups.
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This video was recorded on Oct. 15, 2023
Ben Miller: The result of that, essentially, is that it's super lagging. Today, the Fed would say that, I don't remember, but I think that rents are currently 5% and they're slowly getting down to where they should be, which is 3%. On the ground, they're -2.5%.
Mary Long: I'm Mary Long and that's Ben Miller, co-founder and CEO of Fundrise, a real estate investment platform. He's also a returning guest to Motley Fool Money. Deidre Woollard checked in with Miller for a chat about what real estate data says about inflation, the boom in artificial intelligence investing, and the great lag between the Fed and the economy.
Deidre Woollard: We've last chatted tail end of last year, and you were putting out some gloomy podcasts and forecasts about future real estate credit and this phenomenon that you called the great deleveraging. Tell us what is the great deleveraging and what are you seeing right now.
Ben Miller: Wow, yeah. That thesis was that zero interest rate policy for 15 years and quantitative easing led to an excess amount of debt build up. As that debt build up comes due in a new higher interest rate environment, people have to pay down the amount of debt they have. Because you used to have a 3% mortgage, instead you have a 7% mortgage, which means that if you're a company or you're a commercial borrower, and some individuals just can't support that, then they're going to have to pay down or sell. That's a deleverage, reduce the amount of leverage in the system. You're talking about trillions and trillions of dollars of that. It's a great deleveraging as a result of higher interest rates hitting the economy.
Deidre Woollard: One of the things I remember you saying was turtles all the way down. This idea that the debt would keep going and going and going, and borrower after borrower, and lender after lender.
Ben Miller: People don't realize this, but the biggest borrower in the market is the lender. Maybe they do now because you started seeing Silicon Valley Bank and other banks blow up, but there's actually very few people or companies that don't leverage their credit. They make a loan, a bank makes a loan, and then they borrow against it. There's a lot more debt in the system than might be apparent. Typically, that debt or debt, in general, makes you fragile. That fragility is the risk. So far we've seen some breakage, but we've not seen any collapse. Even a month ago, people I think would have said that like, "No, it's going to be soft landing. This great deleveraging thing was way off base," but I think we're starting to see a turn, even just recently, and that maybe all of this leverage combined with high interest rates are actually going to hit the economy harder than what was consensus in the summer.
Deidre Woollard: It's interesting because of what happened with the banks. You were talking about great deleveraging before that, then we had Silicon Valley and some others. I know Signature Bank, there's the need to sell off those loans. What are you looking at in terms of the commercial real estate loans that are coming due and being sold off by banks?
Ben Miller: I mean, it is a great time to be a lender because the banks have stopped lending. There's a supply demand mismatch. You make great investments when there's a mismatch between the markets. Either you can sell when there's a lot of demand, there's not enough supply or you can buy when there's a lot of supply, not enough demand. Right now, it's incredible time to be a lender because everybody's being forced to borrow more because of the great deleveraging, and the normal lenders are out of the market. Banks virtually out of the market. So we're making loans of 12-15% interest rates, where would have been half that one year ago. That's definitely something we're focused. I mean, it's a problem for some parts of the market, and a problem is an opportunity.
Deidre Woollard: Those are some spicy rates there. You're absolutely right. You would not have gotten those before. I know you now have a closed end fund for opportunistic credit investing. Obviously, I understand why now to do this. Are you amassing money to then invest in different things?
Ben Miller: I think the part where there's still disconnect is there's been a big lag and somebody started saying, "You should call it the great lag instead of great deleveraging. But the lag between when monetary policy gets tight or when interest rates go up, and when actually the impact seen in the economy is much longer than people intuitively expect, it's funny. I was just reading, not to get too nerdy here, but I was just reading a paper in 1961 by Milton Friedman where he wrote the famous line. He said, "Empirically, monetary policy has long and variable lags." Long and variable lags is this famous quote among economists. That's 1961. He says typically two years from when they raise rates to when you see the impact in the economy, so they started raising rates summer of last year. Started in April, really got going by summer of last year. We're still nine months away from really seeing the impact on the economy, and already you could argue that inflation has come down a ton. This happens a lot in rivers where there will be a flood up river. It takes a long time for it to come down river and finally wash out the town. But that's, in my view, definitely going to happen. I guess it's not definite. There's the possibility that Fed reverses itself, but I think it's highly unlikely. That preparation for the flood, whether it's a defensive or offensive opportunity, is I think the big thing happening in real estate markets.
Deidre Woollard: What you're saying is you don't feel like the soft landing is happening. You feel like the Fed's impact has not been felt yet. Do you think that there's a possibility that the Fed actually has to backtrack or do you think that they are going to stick there? Because I don't think there's any way that we might really get to that 2% inflation rate anytime soon. I don't know what you think about that.
Ben Miller: There's a few different factors in there. There's pure economic questions, and then there's institutional psychological questions. What will the Fed do? Let's just give an example. In 2021, inflation appeared roaring, and it was May 2021, Fundrise has something like 20,000 apartments, and we saw a switch went off in May 2021. Our rents increased over that period 20-30%. That never happened before. Normally, rents increased 3%. May it hit. It was obvious that inflation has just gone rampant. The Fed did not raise rates until March 2022, a year later, and then they really didn't get going until May. It took them one year from when you could see it. It wasn't like inflation is coming. Inflation was already here. It was very high. They didn't raise rates for a year until after that happened. I expect, and this is not a mathematical projection, like the way monetary policy lags, that the Fed will be slow because of institutional bias. There's a great quote, I don't know if you know this quote, it's "the Fed talks like a trader, but acts like an accountant." They're forward-looking in what they say, but they're backward-looking at what they do. Another thing I see is that multifamily construction. Today, if you're going to borrow multifamily construction debt, you go to a bank, you're going to pay eight-and-a-half, probably 9% if you go borrow, 55% leverage, 9% interest rate. Eighteen months ago, that was 70% leverage at 3% interest rate. You pretty much can't get bank lending. It's really difficult like a normal bank lending. You're talking about that's a quadrupling of multifamily construction interest rate costs. That had happened and that was obvious to me and the team here, anybody in the business, almost a year ago. Almost a year ago, you could be on the ground and see the multifamily construction was basically going and grind to a halt. We started doing lending, mezz lending, and bridge lending, and gap lending, emergency rescue funding lending into that space starting about a year ago. I think we closed the first one in October. I think it was October. It only showed up in the data like the FRED, which is the Federal Reserve St. Louis has a great source of data. It only really showed up in their data this summer. It fell off a cliff in the data really in August, September. You're like there's just this massive lag just in the data and then there's a lag in the reaction to the data. There's just a lot in the system that basically likely we're going to stay too high for too long, just like we stayed too low for too long. The consequences of that are likely to be painful.
Deidre Woollard: In terms of rent, you mentioned that what we saw in 2021 with multifamily rents going higher, they've been getting lower and lower. With multifamily, with these developers taking on more cost, do they then have the ability to raise rents enough? Are they kind of stuck?
Ben Miller: No. Rents nationally have gone negative. This is another example. Rents today, this is how the Fed does housing inflation. I don't know if how much you know about this. It's like an obscure piece of knowledge. But basically, they used to have housing inflation based on housing price and that went crazy in the '70s. Under Reagan, they changed how they calculated inflation and they call it owner occupied equivalency. It's this strange formula. Basically, it doesn't look at asset prices. The result of that essentially is that it's super lagging. Today, the Fed would say that the number, but I think that rents are currently 5% and they're slowly getting down to where they should be, which is 3%. On the ground, they're -2.5%. I think they go more negative. As they go more negative, that's going to hurt the overlevered borrower. But also, I think housing is 30% of inflation and you have literally at -2.5% today on a year-over-year basis and over a week-over-week basis down 0.1. It's equivalent to -5% on an annualized basis. The economy is like a giant 350 million person freight train. Once it gets going one way or the other, it's hard to turn it. It was going like a freight train up and now it's going like a freight train down. 2021 was so crazy, the pricing got so crazy in stock market, meme stocks, SPACs, and NFTs. So those high highs can also happen on the low lows. I think people are not prepared for that type of problem that I think is basically a natural consequence of the high highs. It's like winter follows summer in a very natural way.
Deidre Woollard: Well, it's interesting, though, because you've got the situation with jobs staying relatively steady. That's keeping things up and consumers are still spending. We're starting to see a little bit of weakness in terms of credit card delinquencies and things like that. But so far the consumer sentiment is that we're still OK and I think that contributes as well, and maybe people aren't seeing it.
Ben Miller: Well, if you look at the history, which is that the jobs is a lagging indicator. People say, "Look at jobs." Well, jobs lag. What are leading indicators? Typically, and I go back to 2007 or 1999, I went back and pulled quotes from like before every recession and right before every recession, jobs, unemployment was super low. Unemployment in 2007 was historic lows. In 1999, it was historic lows and everybody would say, "Look, job grew so strong," and then it falls off a cliff. It typically moves, on average, across every recession in the US history, has moved 3.3% in 18 months. That would put five million people out of work in 18 months. It would basically start hitting most acutely in the late spring of 2024. That's what the historic average is because there's a lag. Because companies on the ground, and I see it right, they're not going to build apartments, manufacturing and industrial is slowed down because they're worried about the cost of borrowing to actually build anything. I've been consistent on this and people call me bear. I'm a bull on AI. I'm going to talk about AI. I think everything will turn back up again like as a cycling. It goes up and then it goes back down, and then it goes back up again. I think it will go up again. 2025, we'll get back on track, but this is how it works.
Deidre Woollard: But one of the things that is different this time though is, at least for homeowners, they have so much more equity in their homes. Nobody's moving right now, the whole market is at a standstill. But people do have equity. There is something hopefully to be able to tap into.
Ben Miller: I totally agree. Before 2008, there was a saying it was safe as houses. Because before 2008, across wherever 100 years, houses have never gone down. People are looking in 2008 and say, housing is going to be fine. Housing is almost always fine. 2008 was an exception, so I think housing and households actually will be OK. I don't think it's actually a source of the risk. Most people have locked in long-term interest rates and they have home equity, and they aren't on ARMs and things like that. I think this more in the corporate sector. The problems are, I think, going to come from housing. I think housing should be fine. Maybe it goes down a little bit, but I don't think it's a source of risk. All of the companies that have private equity and some real estate, there's lots of business borrowers out there who have debt that will come due and they won't be able to service it. Or any business, I mean, the ability for businesses to expand in this environment is really difficult, except for AI, which I still want to talk about.
Deidre Woollard: Yeah, we will.
Ben Miller: That's an opportunity. I'm not saying it's a problem. I think it's an opportunity for people who are prepared. A problem is always an opportunity, you have to reframe it, but denying that there'll be a problem is usually a bad approach.
Deidre Woollard: Well, let's talk a little bit about some of the other things you're investing in because you've got the innovation fund. One of the things we talk about all the time is like the IPO market is slow. Companies are looking for funding anywhere they can get it. You've been investing in a variety of different companies. I noticed that you invested in Canva, which is the content creation platform. Everybody seems to love Canva. How are you thinking about the opportunities right now? Are you seeing a lot of companies looking for money? Are they feeling that pressure?
Ben Miller: Well, AI is a big deal and I think it's even unclear what AI even means. But it's this, there's like wheels within wheels here. Generally, venture capital is I think the best performing asset class in the US history, they venture private tech companies, and historically individuals have no access to it. It's not an area you can invest in, both regulatorily and also structural to the market. Our mission has always been to democratize good investments. We've been chasing that for a while. Then we were lucky because right when we launched the fund, there was a generational breakthrough. AI is a generational breakthrough. Is it bigger than the Internet? I think probably ends up being bigger than the Internet, definitely bigger than a personal computer. It's so fundamental that it's hard to actually get your mind around, but there's patterns to it and essentially it's really exciting. There's going to be a lot of money, and growth, and excitement. Most people won't be able to participate because it's happening in the private markets. There's 10 companies in the public markets that are leveraging AI, and NVIDIA is like one of them. You can buy NVIDIA at 1,000 times revenue or whatever it is. But most of the stuff is happening with start-ups. Individuals couldn't invest in that until we created a new way. That's what's so exciting that we've basically broke the oligarchy hammer lock on or something.
Deidre Woollard: But it's a little bit different than investing in real estate because your end is different. You're looking either for the company to be acquired or to have an IPO, so the exit is a little bit less clear. How are you thinking about that and how do you prepare investors to understand the ways that this is different?
Ben Miller: Well, it's different because it's fundamental. That's one thing. Because what's happening with the AI or in technology is fundamental, it's generational. It doesn't have anything to do with interest rates or inflation or anything like that. Fundamental things, they don't care what you want, when you want to exit, how exactly it works. People mostly want to orient investments to what they want to have happen. But if you're inventing the future, what's happening with OpenAI, you need to give them what they need. That's how you get great value. But in some ways, it's similar to real estate, The companies we've invested in so far or vast majority of the dollars have been later stage companies that are still private like Databricks. We invested in Databricks. We invested in Canva. Both those companies I think have plus two decades of growth ahead of them. Databricks is I think like the next generation thing. It'll be well known as the guts of AI. But nobody knows about it now who's not like deep in tech, but it's the inner workings of the data and technology revolution happening with AI. It has such a long horizon on it that is a little bit like real estate and that even if it goes public doesn't mean you're a seller. Like selling Google after they went public would have been insane.
Deidre Woollard: With Databricks, they just had a Series I at 500 million, that gives them this massive 42 billion valuation. They've been talking about IPOing for a while. Your plan there is to hold on after the IPO and is that something that you're seeing for a lot of companies? Is that part of the innovation fund, is that you'll hold for longer?
Ben Miller: Yeah. The fund is mostly private, but we do hold and expect to hold some publics. The essence is you should be agnostic about public or private. The problem is that you were blocked from investing for most people because it's a regulatory barrier. The interesting thing about being a private investor is you get a lot more information. Like it's funny, people talk about public companies and transparency, but the K's and Q's of public companies don't actually tell you that much about the business. You get a lot more information from a private company when you're investing in them. A lot more information. You actually have a lot better understanding of their business. We would be a holder. It's irrelevant to today. We're just buying privates, but when they go public, which I think Databricks will, that doesn't change our strategy. What you want to own is the best companies so you can look back and say it was so obvious that NVIDIA was a great company. But I think you really have to have known a lot about the tech to really have known that earlier, and I think that's true with Databricks. We invested in a company called DBT Labs. DBT is like the fastest-growing data and AI software I think in the world. Most people never heard of it and we invested in it. That's incredible, it was amazing. Just let the compounding power of their technology just drive growth.
Mary Long: As always, people in the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Mary Long, thanks for listening. We'll see you tomorrow.
