The Real Estate Wealth Podcast with Edward Aloe

Is the Economy Headed for a Crash?

August 01, 2023 Ed Aloe Season 2 Episode 5
The Real Estate Wealth Podcast with Edward Aloe
Is the Economy Headed for a Crash?
Show Notes Transcript

Ed Aloe sits down with Lu Chen, Associate Director and Senior Economist at Moody’s Analytics. We will explore how the affordability crisis is affecting renters and impacting real estate investors. Join in on this relevant conversation.

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Ed Aloe (00:03):

Welcome to The Real Estate Wealth Podcast, the show about how you can build wealth by investing in real estate. I'm your host, Ed Aloe, founder and CEO of CALCAP Advisors. I'll dive deep into multifamily investing in today's current market. I'll also help you acquire the knowledge and tools necessary to generate passive income for life through discussions with friends and experts in the industry.


I would like to welcome Lu Chen to the podcast this morning. Lu is an associate director and senior economist at Moody's Analytics. She specializes in commercial real estate economics with a focus on multifamily and affordability. She has a special interest in urban economics and urban migration. Lu has been with Moody's for over 10 years, and I think she actually started out as an intern, which I love because we hire interns here. And actually, one of our interns we just hired on permanently too, which I think is fantastic. So Lu, welcome to The Real Estate Wealth Podcast today.

Lu Chen (01:03):

Thank you, Ed. And hello, everybody.

Ed Aloe (01:06):

So Lu, based on starting at Moody's as an intern, it sounds like you've spent your entire career, if not the greater part of your career there. Would you mind kind of giving our listeners a little background about yourself and how you ended up in the industry and at Moody's specifically?

Lu Chen (01:23):

So I started off with my education back in China and that's when everybody was seeking the opportunity in the commercial real estate world. And I went to the US to study a little more on the capital markets. So that's how I landed the internship in Moody's Analytics. So that allows me to communicate with my clients, utilizing some of the credit risk modeling, analyzing commercial mortgages and the risk associated with it.


And I spent a good 10 years immersing myself into the credit risk world. And a few years back, I joined the Commercial Real Estate Thought Leadership team because I want to spend more time and shift my focus on the space market a little bit.


And urban economics allows me to study more on the supply and demand, the market fundamentals, understanding the shifts of people's preference, the migration pattern. And I was able to combine the capital markets and space market into the commercial real estate world. So single-family housing, rental market, single-family rental altogether is a full ecosystem. And extensive data from Moody's Analytics allows me to dive into the underlying, the fundamentals and being able to provide insights to my clients, to all of you guys.

Ed Aloe (02:43):

Okay, great. We'll get into affordability and how the markets are changing, but let's kind of start out with talking about the pandemic now three years ago that hit. We saw major, and I remember when the pandemic first hit, kind of looking at everything shutting down going, "Oh shoot, as a multifamily owner, no one's going to pay us rent. What's going to happen?" I thought there would be another kind of 2008 scenario with values just plummeting. And I think I mentioned to you before the call, I started this company during the great financial crisis in 2008. So I thought, "Wow, there might be another opportunity. This time we own a lot of assets, so hopefully we can get through it."


But actually the opposite sort of happened. At the same time, rents were also increasing at a pace of double digits during the COVID years. And the phenomena of people kind of working from home and with that flexibility started moving out of urban areas. I think for many reasons. Some people early on were afraid of living in a high-rise with the virus and taking elevators and public transportation and whatnot. But we saw the flight to some of these more suburban, lower-dense areas and it really caused a boom in the real estate market, which was unexpected.


And so here we are now three years after that event. I'm just curious, with those patterns, do you see things returning back to normal? And I know you're in San Francisco, so you really felt what I'm talking about firsthand I believe. So kind of give me your overall thoughts of what you saw during the pandemic and are we kind returning back to more normal times now?

Lu Chen (04:31):

Three years, wow. It feels like we have gone through a lot. I was just thinking about how significant March means in the past few years. And it just happened that if you look back a couple of Marches ago, March 2020 is when the nationwide lockdown happens. So all of a sudden, everybody was forced to leave the offices, go back to their home, and set up their remote working equipment. And it seems like completely 100% fully remote all of a sudden become a trend.


One year later, in March 2021, that's when the vaccine rollout started to be more widespread. We started off with the older population and eventually roll into the younger, into the kids, and the economy seems to be ready to reopen. And later in that year, a lot of the people in their working age started to get ready for return to work on the hybrid mode.


March 2022, Federal Reserve started to rise interest rate aggressively to curb the run on inflation. And this year, just last month, we have encountered the banking events. There has been a lot of uncertainties and there has been discussion on the aftermath. And here we are looking at the multifamily market. We have gone through a significant rent decline. So at the peak, we are seeing in major metro, taking New York and San Francisco as an example, we are seeing double-digit rent decline.


And then there has been a strong rebound triggered and supported by the stronger than average household formation and migration pattern. And standing today, looking at the still volatile macroeconomic environment, a lot of uncertainties, ups and downs in the consumer sentiment, the still high but somehow decelerated inflation growth, multifamily market seems to be okay. We have steady demand. The supply, there has been some down year and up years. This year, we'll be having a record inventory growth for 2023. But overall, the market seems to be striking a balance.


So majority of the metro, if you look at the nation as a whole, has been recovering and they have gone above and beyond as compared to their pre-pandemic rent level. Vacancy was at 3%, 4%, below 5%, very healthy in many different places. The only metro unfortunately which hasn't caught up to their pre-pandemic rent level is the San Francisco city, is close to where I live. Of course, there are other economic and social component which is driving that gap. But if you look at the nation by and large, we have fully recovered and looking even into by the end of 2023 onto 2024, we are positive that the market will be holding up and being able to absorb a lot of the potential shocks coming from the macro-economy.

Ed Aloe (07:52):

And that's good to hear as a multifamily owner. I always talk about kind of long-term when you look at just pure housing supply-demand, it's a very undersupplied situation as you know. I think Freddie Mac estimated the country's under supplied some four to five million units. And so I am very bullish on housing and multifamily housing in particular over the next 10, 20 years because I think the pure supply demand fundamentals play out. But let's kind of talk about short term because now we're seeing tremendous record new construction. I think I read the other day that there are more units coming out of the ground right now, the highest level since 1973.

Lu Chen (08:41):


Ed Aloe (08:42):

So almost a million units I think are coming out of the ground right now.

Lu Chen (08:46):


Ed Aloe (08:49):

Okay, very good, Lu. Thank you for correcting me. 958,000. And with the household formation is causing a softening of the market. And now, like you said, we're starting to see kind of rents either not growing as fast in some markets, which we all knew. I mean, you can't have 15% rental growth every year, which clearly outpaces wage growth. So then you come into the affordability problem. But now we're at that inflection point I think where there's record number of units coming out of the ground, demand is softening, things are normalizing in the post-COVID world, and we're starting to see rents decline. Right?

Lu Chen (09:29):

Yeah. So I'm only 50% agree with you, Ed. I hope you don't mind.

Ed Aloe (09:35):

I don't mind at all.

Lu Chen (09:37):

I don't think we're at an inflection point just yet. So we might see some near-term softening. I know a lot of the listeners and Ed probably you have come across a lot of news from different resources talking about the rent decline. So we are seeing that. But how long that'll be lasting is a question.


So let's just look at the supply and demand. I know you have packed a lot into where we are in 2023, early 2024. I want to just talk about the supply a little bit. So if we look at the multifamily units. So multifamily building was more than two units in there. There are 958,000 which are under construction. Absolutely the highest level since November 1973. So we are in this high-inflation environment. We are seeing a potential softening in the household formation. But why we are seeing a record level of inventory growth?


So multifamily, there has been a lot of construction delays. I think a lot of investors who's listening to the podcast will agree with Ed and I. And a lot of the multifamily starts happened in later half of 2021, early half of 2022 when we are seeing relatively low construction loan interest rate. And at that time, thinking of when we started seeing the soaring of the rent growths, so that really started in the summer of 2021, onto the early part of 2022. And that's where we see a lot of double-digit growth. Even at the national level, we are seeing over 11% of market rent growth on a year-over-year basis. And of course, that is also what has been driving the CPI high. And that high return really encourage a lot of multifamily investment and construction.


And what this number means. So if you look at the total delivery in 2022, which is the year before, that was particularly low. And there has been a lot of factors which has been driving that low deliveries and a lot of the factors are related to the labor shortage, the soaring price in the raw material, and even some of the delay in approving the permits. So considering now the multifamily construction takes about anywhere between one year to two years and in certain cases even longer and 2022 was extremely slow and a record year in 2023, if you combine 2022 and 2023 together, that record high in 2023 going to even out and smooths out some of the trough in 2022.


So Ed, as you mentioned, we're still having this housing shortage overall because when we look at the multifamily and the entry-level starter houses, we're still at a deficit. So if we are looking at 2022, 2023, if the total delivery is still on par with the average, then we should embrace the opportunity that 2023 play a catch-up for 2022, and then look at the how that is going to drive the rent growth. Sure. We are seeing at the metro level, many of the Sunbelt metros have started seeing the new leases has been offering a concession, a small discount to attract tenants. In that sense, so we are seeing the rent decline.

Ed Aloe (13:13):

So just so our listeners know, I mean there's kind of two different components. There's year-over-year comparison of new asking rents, and then there is renewal rents. And so if someone has lived in a community for a while and rents have been increasing dramatically, the odds are when they go to renew, they're going to be far below market. And so you might see a larger bump for those people in an increasing market versus year-over-year growth on a new unit, for example. But now we're kind of seeing in some markets, like New York and San Francisco you're saying, we're seeing in the opposite trend happening where rents have declined that much since the pandemic.

Lu Chen (13:57):

Right. So San Francisco was still lagging. So while it's playing that catch-up game, it's actually showing the trend line is still upward ticking, right? But in other Sunbelt places, as you mentioned at the year-over-year growth, I was quickly sorting my data and I see on the year-over-year basis we have three metros which is showing decline and the majority of other metros are still in that positive territory. So Sunbelt is where we see the fastest growth in the rent. During the pandemic is the places we are likely to see levels of correction. So if you put that into the dollar amount, it's probably less than a hundred in many cases. But if you put that into a percentage sign, it's showing 1%, 2% decline on a year-over-year basis.


And overall the labor market is still very tight. So that is where we see people are very sticky. So the demand is very sticky and people needs to find a place to live and especially when the single-family housing market has been cooling. And we started seeing the single-family housing cooling down in the summer of 2022 because the single-family housing is very sensitive to the market rate.


And what that means to multifamily. So those potential first-time buyers has to stay in the multifamily market for longer because they started to be waiting on the sideline until the next opportunity comes to buy. And when they stay in multifamily is secure the demand. That's number one. And number two, millennials. So millennials right now is taking a bulk of the total population. So people in their twenties and thirties. So they could be potentially be the single-family housing buyer, but they decided to live in a multifamily market is securing that steady demand.


We might be seeing some adjustment from the affordability front. We might be seeing some concerns on the single family. But overall, as long as the labor market is still steady, I wouldn't bet on the condition to be this tight in the next few months up to quarters. But overall the labor market seems to be healthy. So multifamily demand should hold up a little bit in the souring economic condition at least until unemployment rate deteriorate to some degree and for some longer time.

Ed Aloe (16:39):

Okay. So you're still relatively bullish, at least in the short term from a demand standpoint?

Lu Chen (16:46):

I am. Absolutely.

Ed Aloe (16:46):

And you don't think the excess supply coming in will affect that as long as employment stays strong, is that what you're saying?

Lu Chen (16:52):


Ed Aloe (16:53):

So do you want to talk a little bit about the disconnect between rent growth and wage growth from an economic perspective and then how that leads into our discussion on affordability because the bigger that gap grows and that causes more affordability issues?

Lu Chen (17:10):

That's such a good segue. So from my standpoint, because my research area is in multifamily, so I focus on the rental-income ratio, which is a measure of the rental unit affordability. And as you said, during the COVID, when we see the big shift, the significant ups and downs in the rent growth, it created or exacerbated the rent burden in many places. And I have to say many of the places are indeed in the Sunbelt. And why is that so? It's tied down to people's migration pattern.


So when COVID hit, a lot of the residents in the Northeast region, in the West have enjoyed extended flexibility of working remotely, and they like to live in the places which they are not confined to a tight space. They want more spacious unit and they want to be close to their family and friends and they want to also enjoy some cheaper rents because they don't have to be living so close to where their offices are. So that created a lot of positive migration flow to the Sunbelt cities.

Ed Aloe (18:25):

Right. If I'm working for a tech company in the city renting a tiny one-bedroom for 4,000 a month and the pandemic hits and now my boss doesn't expect me to be in the office every day, I'm like, "Shoot, for 4,000 a month I can rent a spacious home in Arizona or Texas with land for my dog and, et cetera."

Lu Chen (18:45):

That's exactly what we saw. Even before the pandemic hits, we are seeing the smaller counties, so counties with smaller population and to be more precise with fewer than 30,000 people have been losing population. But during the pandemic, between 2020 and 2021, that has flipped. So these least-populous counties has gained people through domestic migration. But in 2022 when that rush has been over and when people has been rushing back to the major city, the most popular places, the most expensive cities in many cases, getting ready to the hybrid remote-working mode, all these smaller towns which has enjoyed the population influx has reverted back to normal. So they experienced smaller population bumps from domestic migration. And they [inaudible 00:19:49]...

Ed Aloe (19:48):

That's interesting. So people who thought they wanted small town living, or at least maybe they knew it was temporary during COVID...

Lu Chen (19:56):

I like that...

Ed Aloe (19:56):

... are kind of going back to more urban.

Lu Chen (19:58):

Absolutely. I like that word temporary because last year we published a paper which really described the phenomena. And because Census data was a delay, we were able to utilize some demand measurement in the commercial real estate world. And in particular, we use, I have to throw out a jargon, but I will explain what that means. So we use the net absorption, which is really a measure of people who move into the unit minus people who move out of unit. So it's the net movings.


So we use that measure to see if that can sense any early indication of people moving from one place to the other. And that is showing people are very sticky and very loyal to the urban lifestyle. So when museum opens, when the park has been accessible to the public, when the gyms are open, restaurants are welcoming people to either dining inside or outside on the street front, and people are really, really enjoying that lifestyle.


So when they come back, and our net absorption data, the net moving data is showing a strong rebound. And that is very evident in the biggest metros and in their central business district. So where we see clusters of office and retails. So whether they decided to work full-time five days a week in those offices is still up in the air, but people are getting back and getting ready to adjust to the lifestyle changes.

Ed Aloe (21:39):

Yeah, that is interesting because I remember when people were fleeing, you were hearing everyone saying, "Oh, places like New York, it's dead. It'll never be the same again." And lo and behold, it always comes back and it seems like it's coming back once again.

Lu Chen (21:56):

Without a doubt. So I'm personally enjoying working from home every single day during my work week, but on the other hand, I hope the city could do something to draw the workers back. So I get the opportunity of traveling to New York and also observing the street front in San Francisco. And those are drastically different.

Ed Aloe (22:20):

So it seems like there's a few factors. I'm glad to hear you saying that traffic and things are coming back, especially in a city like San Francisco, which is such a great city in my opinion. Because you do hear the other side of it where workers are afraid and all of a sudden this company shuts down in the city and they're moving out to a different state or the suburbs, et cetera. So do you see that as a factor or you think overall the overarching positive factors will bring people back?

Lu Chen (22:45):

I really think it requires a collaboration between the public sector and private sector to draw people back. So that actually gets on to the other side of the coin. The commercial real estate world is a whole ecosystem. So when the office is not performing, when we are not having a solid physical occupancy or utilization rate for the office, it affects the retail, it affects the residential. So in San Francisco's example, when people, the worker are not coming back to the city to work and they have less incentive of leaving the city and paying high-rise rent.


And on the other hand, when we see the healthy recovery of the multifamily market in New York is because the city is coming back to their usual life. They have the day life, that nightlife. And although it's not 24-hour city, but we are almost there. So that city vibe is essential, it's critical for the multifamily market.


And San Francisco's example is a little bit more sad, but that's why we would like to see the incentive of employer drawing the employee back and recreate that ecosystem for the city.

Ed Aloe (24:02):

You hear all the time, "These people from California are coming in and they're ruining our city because driving up the price of real estate and the locals can't afford to buy or rent in this case." Yes. And we've seen that phenomena of certainly across the Southwest.

Lu Chen (24:19):

Right. So we used a common measure which is called the rent-to-income, just to see how bifurcated the rent has been growing as compared to their median income households income has been growing. And there has been a growing gap over the past few years, especially between the time of 2021 and the last year. By the end of 2022, the US officially has become rent-burdened nationwide for the first time in nearly 25 years of our tracking history.


And just to give the listener a perspective. In 1999, that's when we first started having the data representing the US national average. So at that time, the US rent-to-income ratio was only 22.5%. What that means? That means for a median income household to pay the average rent of the United States, they are only paying 22.5% of their monthly income on the multifamily rent. But now, by the end of 2022, they're paying 30%. And 30% is a rule, a rule of thumb that a household should spend no more than 30% of their income on housing costs. And that has been accepted and heavily used in academic research and often included in a lot of blog pieces and website uses on family budgeting. So reaching that 30% is introducing how rent-burdened the medium income household are burying into this rental market.

Ed Aloe (26:11):

So in your mind, if someone is paying 30% of what they earn towards their rental housing cost, that's sort of the point where you would say it becomes a burden. Anything more than 30% becomes a burden in terms of the affordability of the cost to live in that house or that apartment building.

Lu Chen (26:35):


Ed Aloe (26:36):

Lu, let's shift gears here in the last few minutes and talk a little bit about where we are today in terms of recession possibilities. I mean, I think now we pretty much hear it from everyone, "Yes, we're definitely going to go into one." The Fed I think is in a very tough place right now. Will they be able to avoid a hard landing?

Lu Chen (26:57):

So March, as we mentioned at the beginning of the podcast, we talk about the March in 2020, '21, '22, and '23 was a very unique situation when we are seeing some regional banks are showing their vulnerability and weakness. And as you said earlier, the risk is largely contained, but it does open up the discussion of the probability of a recession.


So we elevated the probability of recession a little bit. So we have been always somewhere between 55 to 65% of entering a recession later 2023, 2024. Now we're still roughly there, but that probability has been raised up a little bit. So instead of calling, we are going to have a hard landing, we are going to enter a recession, recession, Zandi's team has created a very unique term called slowsession. So the economic growth... They even register, that URL, just to say, "Hey, this is something we thought is going to happen."


And there is explanation for listener who's interested in exploring a little more. But essentially, the economic activity and growth will be muted a little bit, but we probably wouldn't run into a situation we are seeing significant decline of the GDP. I think last time we checked, the GDP is still going to grow by the end of 2023, but only by a marginal 1.2 percentage point. The labor market will soften, but it's not going to collapse.


I know we are better off than other places in the universe, but we are still at a elevated, uncomfortably high five percentage point. And going back to what goes into that 5% is that shelter inflation. So at over 40% of weight, this is the largest weight in history that we are seeing the shelter has been contributing to the CPI growth. So with moderation of the shelter inflation, we'll see the CPI is going to further decelerate somewhere around mid-2023, and that certainly helps with the policymaking.


With that, with all of that being said, we have been living in a weird world where good news is bad news. Why? Because when we are seeing the GDP has been switching the sign from two quarters of negative growth into the positive territory in summer of 2022, and everybody was nervous because that means the Federal Reserve is going to continue raising interest rate and raising aggressively. And a lot of the positive news from the macro-economy will translate into a longer interest rate hiking period. And that is bad news.


But we might be soon enter into the era where bad news is bad news because if we see further softening on the labor market, if we see the layoff continued on, if we see more higher unemployment rate, and if we see that being dragged for longer, that may mean really bad news because that might be an indication of a recessionary period. So the moment of truth is almost there.


But on the other hand, that softening of labor market could also work its way into dragging down the service inflation because if you look at the goods inflation versus the service, the goods inflation, which comes from the energy price, from food, are coming down month-over-month. But the service inflation, which is the sticky component of the CPI, has been still at the elevated position and has been still climbing up. And the reason was from that sticky wage growth. So if the wage has been increasing, and it's very difficult to get that wage downwards unless we really hit into a recessionary period.


So the shelter inflation does account for both single-family housing and rental units. The multifamily market is serving as a substitute. So when the potential first-time buyer is waiting on the sideline and sustaining the multifamily demand, it's creating that steady demand. But when we look at the latest projection on the 2023 rent growth, it's certainly back to the ordinary range.


So we're forecasting somewhere around two to three percentage and leaning towards 2%, and that is a healthy rent growth. Traditionally, if we are seeing three, four percentage growth, that's normal. But now we are slightly below, but it's still positive.

Ed Aloe (31:58):

Well, thanks Lu for joining me today. I think we had a very fascinating discussion. There's a lot going on in the economy today, so I really appreciate you walking through with our listeners today and explaining a lot of what's happening and some of the good things as well as the challenges and how it affects affordability as an apartment owner and investor. And I think for all of our listeners that are investors in the marketplace, it's always important to kind take a step back and look at the macro picture of what's really going on in the economy and how it affects your personal investments as well. So thanks Lu for joining me today.

Lu Chen (32:34):

Thank you for having me, Ed.

Ed Aloe (32:44):

I hope today's show inspired you just a little bit and would like to thank my guests again. I'm excited to bring you more episodes with interesting and informative experts to help you navigate your way to wealth in real estate investing.

Credits (33:04):

Thanks for listening to The Real Estate Wealth Podcast. The Real Estate Wealth Podcast is produced by Gusto, a Matter company. Our producer and audio engineer is Jeanette Harris-Courts, with support from Gabe Gerzon and Susan Rangel. Maia Laperle is our writer. For show notes and more information about this podcast, visit And for more information about CALCAP Advisors, visit us at or follow us on Twitter @CALCAPAdvisors.

Ed Aloe (33:41):

I'm your host, Ed Aloe, and thank you for listening.