The Monthly Multiple — February

We talked last time about how the “vibecession” may be receding. This momentum continues, with the coiner of the term now declaring a “vibespansion.” People are feeling better about things (and we hope you are feeling good too). What do the vibes mean for your portfolio?

We’ve spoken in several recent Multiples about what history portends in this moment: the stock market may not end up being as vibey as we might hope through all of 2024.

Looking at historical data around other burgeoning “vibespansions,” the stock market could be in store for a rather bland period. Per MarketWatch, “The median S&P 500 SPX change when consumer sentiment picks up to this degree is a rise of 3.4% over 6 months and a gain of 7.6% over 12 — so below the average S&P annual gain of 9.9%. Put a different way, by the time Main Street has noticed the economy has improved, Wall Street has already made its money.”

How has the stock market fared in past decades when consumer sentiment turns positive? Bit of a mixed bag.

There’s another way that not-so-distant economic history may prove instructive: productivity. In most academically accepted models of GDP growth, productivity is one of the key, if not most important, variables. As Nobel Laureate Paul Krugman has said, “Productivity isn’t everything, but in the long run it is almost everything.” And how do we drive productivity growth? Technological innovation. However, the last 20 years have been rife with innovation (think smartphones, internet of things, robotics, and now AI) yet labor productivity growth has yet to materialize in any major way.

Let’s go back to the early 90’s. Economists coined the term “productivity paradox” to describe their consternation: computers had been around for decades but hadn’t created a productivity boom… yet. As Robert Solow, godfather of macroeconomic growth models, said in 1987, “You can see the computer age everywhere but in the productivity statistics.” We all know what happened next: the internet happened, Microsoft Office products became omnipresent, and an era of robust economic growth followed. The S&P 500 returned an average annual rate of 26.3% over the back half of the ‘90s.

Are we in a similar place now? This kind of optimism goes beyond the “soft landing.” A productivity boom would mean that the economy, already nearing full employment, would be able to crank on without inflation concerns. In other words, it’d blow the top off the Phillips Curve (the theoretical relationship between unemployment and price levels) that hems in classical Fed strategy.

Here are a couple of major reasons to be optimistic about a coming “productivity boom,” and what it could mean for real estate investors:

Artificial Intelligence… It’s a Thing

The naysayers — those who insist we’re in a new ‘productivity paradox’ — note that it took decades for past major innovations, like computers, electricity, and the combustion engine, to drive meaningful economic growth. Others note that the benefits of AI (unlike computers generally) are likely to confer benefits mostly on the tech sector. Don’t be so sure. AI has something that no major prior innovation has: the potential to improve itself. Hence, productivity growth from AI may look more like an upward parabola than a straight line or stepwise function. By that same token: yes, it will benefit the tech sector first… but beyond that, who knows.

Hybrid Work

There is no consensus on how “hybrid work” impacts productivity. That’s partly because the data is weird, and partly because employers and employees are doing it a billion different ways and no one has truly figured it out yet. There does appear to be consensus, though, that hybrid work is here to stay and that neither full-time remote or full-time in office is optimal for anyone in the long run. Therefore, you just need one thing in order to believe that hybrid work will yield massive productivity benefits: a little faith. We’re so early in the process that best practices have not emerged. As we all settle in, it’s quite possible that employers and employees will find an equilibrium where hybrid work generates cost savings, more focused collaboration, and more sustained headspace for transformative productivity. While we can debate the statistics, maybe the more important consideration is simple, albeit squishier: hybrid work makes employees happier. Even the most mirthless economist can get on board: studies show that even when carrying out mundane tasks, happy workers are more productive.

How Does This Impact Real Estate Investors?

Productivity growth is good for the economy, and generally what’s good for the economy is also good for real estate markets. That said, there’s one general reason tech-driven productivity growth could benefit real estate investors: it could mean growth that’s rate-hike free. In theory, paychecks and profits could grow sustainably without inflation becoming a fixture. Broad-based growth without rate hikes is the holy grail for real estate.

That aside, AI and hybrid work are, to use the most tired terminology, “paradigm shifts.” Hybrid work could bring the types of real estate investment opportunities we talked about throughout the pandemic, except hybrid workers and workplaces would no longer be a temporary bandaid. AI could revolutionize any number of sectors. True, the most immediate advances may be in software and clerical work, but in short order AI may spur changes in the built environment that could both optimize real estate investing and call for new real estate investment, e.g. autonomous vehicle infrastructure or adaptive, high-efficiency HVAC systems.

Some other CRE sectors, or new strategies, that may be ushered in my AI and hybrid work:

• Amentized multifamily and build-to-rent (BTR)
• Conversion of obsolete warehouses and retail to data centers
• Office conversions to support density housing shortfalls

In the near term, don’t sleep on the student housing and data center asset classes. We’re gonna need more servers and more nerds!

Checking in on Cross-Asset Correlations

We’ve explored at length the relationship between asset classes, the imperative to “de-correlate,” and the potential power of private-market real estate to help decorrelate from a traditional 60/40 portfolio. Where do we stand now?

Looking at the last couple decades of data, including the pandemic and the beginnings of the current higher-rate, higher-inflation environment, private real estate stands out.

• Private real estate equity bears a significant negative correlation with large and small cap stocks in positive market environments.
• Private real estate debt bears almost no correlation with stocks in any environment
• In any environment, private real estate equity bears significantly less correlation with stocks than do REITs.

So, if you’re a believer in the “vibespansion,” private real estate equity may be an extra strong potential diversifier. Whether we go north or south, and to what extent rates stay “higher for longer,” a blend of private real estate equity and debt may serve investors well. This isn’t a matter of adding one or two assets. This should be a long-term strategy of creating a diversified private real estate portfolio across property types, expected maturities, positions in the capital stack, and strategies. (A strategy EquityMultiple facilitates via low minimums and diverse offerings.) As discussed above, we don’t know exactly how the future demands on the built environment will take shape, and where those opportunities will be most concentrated. But we do know that the winds of change are blowing.

What will the rest of 2024 hold for markets? Even AI doesn’t know. No matter how transformative AI will be, and regardless of how the next phase of the cycle plays out, it’s probably a good idea to grab onto something tangible.

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