Following what he called “a science experiment of quantitative easing for a decade and now quantitative tightening,” Waterton CEO David Schwartz believes the Federal Reserve has overcorrected by raising rates on the order of 500 basis points in a year. Even though the Fed paused on a further rate increase this month, “We’re starting to see the impact of that in all sorts of ways,” he told the audience at Connect Midwest Multifamily + Adaptive Reuse Trends, held in Chicago earlier this week. 

One of the effects of 10 consecutive increases in the federal funds rate has been “drastic illiquidity in all real estate sectors,” said Schwartz, in a keynote presentation moderated by Magnolia Capital CEO Maxwell Peek. “There’s tremendous volatility,” he said. “It’s hard to make investment decisions in this type of environment.” He pointed out that multifamily—the sector in which Waterton specializes–has been more fortunate on the financing front because of the GSEs. 

Schwartz told the 300-plus attendees at the June 13 conference that he doesn’t see the Fed lowering rates anytime soon, “because the headline numbers are hot.” With apartment rents contributing roughly 30% to the Consumer Price Index, Schwartz said the Fed has been operating on outdated information in assessing their impact on inflation.

“None of us in multifamily are getting 9% rent growth anymore,” he said. “That train left the station a while ago.” 

The resolution of this overcorrection, and its negative impact not only on commercial real estate but also on the banking system, is likely to be “a slow unwind,” Schwartz said. “The Federal Reserve may have to lower rates just to resolve things, even if inflation isn’t under control. And that creates a really tricky situation.” 

Turning the conversation to adaptive reuse, Schwartz said he’d just returned from a conference at which major office landlords were also in attendance, and they expressed a pretty dim view of the investment sales outlook for Class B product.

“The conversion of B office to other things is also not considered a great opportunity,” he said. “The valuation just has to come down so low and a good percentage of those B office buildings are really not good candidates to convert physical infrastructure” due to their floorplates and other considerations. 

Chicago’s previous mayor, Lori Lightfoot, proposed redeveloping the city’s LaSalle Street Corridor office properties, many with high vacancies, into apartments. For such an initiative to truly succeed, “you also have to invest in things like parks and infrastructure and make them more live/work/play areas on top of the incentives and tax abatements,” said Schwartz. 

Aptly evoking a legendary local figure in urban planning, Schwartz said it would require “a Daniel Burnham moment” of government support and collaboration to reinvent urban corridors, whether in downtown Chicago or downtown Los Angeles. “Chicago’s the type of city that does big things, so we’ve done it before,” he said. “I’m really hoping we can figure it out.” 

Peek asked Schwartz what business advice he’d offer to attendees at the Connect event. “In this environment, I’d be patient,” he said. “I don’t think there’s any rush. We’re in a good old-fashioned cycle. In all the cycles before the Great Financial Crisis, we weren’t bailed out by rates going to zero. So we got used to that.” 

Look for additional coverage of Connect Midwest Multifamily + Adaptive Reuse Trends in the next few days.