🎙️ Apartment Trouble

Virtually everyone feels the effects of rising prices, even as inflation cools off. But how do prices today compare to those of another era, before the pandemic?

💭 The difference is clear-cut: Statisticians at the Bureau of Labor Statistics found you need about 17% more cash today to do everything you did in January 2020.

Side hustle ideas, anyone? 😅

— Matthew & Shawn

Here’s the rundown:

Today, we'll discuss the three biggest stories in markets:

• Why apartments are in trouble

• The big business of American self-storage

• Artificial intelligence fatigue picks up

All this, and more, in just 5 minutes to read.

CHART OF THE DAY

IN THE NEWS

🌇 Add Apartments to List of Real Estate Worries (WSJ)

Apartment complexes are in trouble. Not because of a lack of demand, though. Rather, higher interest rates have made debt costs unmanageable, threatening to “wipe out many multifamily owners across the country,” writes the Wall Street Journal.

It’s a tough time for multifamily real estate investors: Apartment-building values have fallen 14% over the past year while borrowing costs have doubled, building expenses have risen, and rent growth is slowing.

• One real estate veteran called it a “hydrogen-bomb scenario” for apartment landlords.
  

• He added, “Everyone is focused on office,” but apartment defaults are “a really big issue that isn’t getting the attention it deserves.”

Apartment buildings have previously been known as a safe haven in real estate investing, given their typically low vacancy rates, since people always need a place to live. But stop us if you’ve heard this before: The pandemic flipped things upside down.

What happened: Investors dove into the market while interest rates were low, betting they could raise rents enough to push the property values up and then refinance or sell the buildings at a much higher valuation.

• Many opted for short-term floating-rate loans (meaning their interest costs rise when market rates rise) instead of locking in the low rates with long-term, fixed-rate mortgages.
  

• Of course, few anticipated interest rates to rise again so dramatically.

And after regional banks faced bank runs earlier this year following Silicon Valley Bank’s demise, many are lending less, drying up a critical source for refinancings.

Why it matters:

Big banks like Goldman Sachs and JPMorgan have been trying to dump their loans for properties backed by offices, hotels, and apartments, opting to sell at a discount now than deal with foreclosures down the road.

• Why hold low-yielding “dead money” loans made during the pandemic when new loans can be made at much higher, more profitable interest rates?

Not all doom and gloom: For apartment owners, property values rose 25% over 18 months spanning 2021 & 2022 before falling this past year.

• How bad things are for these investors depends largely on whether they paid peak valuations for their buildings and locked in their interest rates (fixed rate) or relied on floating-rate mortgages.

Still, most analysts expect housing shortages, and high rents, to persist.

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📦 No Limits to America’s Storage Addiction (WSJ)

What hasn’t changed over the decades? Americans’ fascination with and desire to accumulate more stuff.

Storage is the rare business that does well in good times and recessions. Profits exploded during the pandemic, and shares of public storage companies have crushed the S&P 500 since the late 1990s, despite a shaky 2023.

• While occupancy rates have fallen from records during the pandemic, about one in 10 Americans lease storage space, paying about $165.55 monthly.
  

• Driving demand: Death, divorce, natural disaster, marriage, babies, and new jobs.

Last month, Extra Space bought rival Life Storage for $11.6 billion, creating the country’s largest storage operator, with about 270 million square feet at more than 3,500 locations.

• Many storage renters know that even amid rising storage rents, it’s still better than leasing an apartment with an extra bedroom or moving to a bigger house with a high-interest rate.

The economics: Storage is profitable because of month-to-month leases, in which rents can be raised on short notice, and human nature. Most people have a lot of stuff, need a place for it, and then keep paying for years.

• “Once a customer stays with us for a year, they end up staying for five years,” Public Storage’s CEO said.

Flashback: In the 1960s, small businesses invested in the storage business as American consumerism shifted into a whole other gear. They took warehouses and added garage doors for individual access.

• The storage business has taken off over the past 20-30 years in all market cycles. It even held steady in the 2008 foreclosure crisis because people still needed a place to store everything.

Why it matters:

There are roughly 60,000 storage facilities in the U.S. Many companies provide units month-to-month, with prices ranging from $77 to $561 in New York or $50 to $233 across the U.S. Size of unit and location matter most.

• In 2020, “there were questions as to what the future of storage would look like,” noted Blackstone’s real estate acquisitions head.
  

• “I think the market has been caught off guard and surprised at how strong the fundamentals are.”

Behind the fundamentals: A strong residential customer base and commercial clients that lease storage space rather than expand office space. Many customers tend to be “sticky” – long-term users are reluctant to switch units even when rents increase.

• In this way, many storage units are price-inelastic businesses, meaning price changes don’t drive notable changes in supply or demand.
  

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📱 Apple’s iPhone 15 reportedly set for mid-September launch

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🤔 Every Start-Up is an AI Company (WaPo)

Who else has artificial intelligence fatigue?

All year, chatbots have dominated the news cycle. But consumer interest is dissipating, and some onlookers caution that the AI-related hype cycle might run out of steam.

• UBS, an investment bank, published a report earlier this year, saying OpenAI’s ChatGPT would hit 100 million users just three months after launch. That pace would beat TikTok (nine months) and Instagram (2.5 years).
  

• “In 20 years following the internet space, we cannot recall a faster ramp in a consumer internet app,” UBS analysts said. (OpenAI doesn’t disclose its user numbers.)

Meanwhile, venture capitalists have invested billions in AI start-ups; tech CEOs now say “AI” more than they say “good culture” and “strong balance sheet.”

But it’s unclear when AI technology will become profitable as some reports indicate declining ChatGPT usage and the high costs associated with running “generative AI,” from chips to data server computing power to expensive engineering talent.

All the noise: “Everyone and their mom” is adding AI technology to their startup to attract attention, noted one executive. “I’m just worried that so much noise gets to the point where it pops this bubble, and suddenly no one cares anymore.”

• It’s worth noting that the social media wave and rapid growth of the e-commerce space benefited from inexpensive online advertising and cloud storage. But AI is much more costly, which could hamper related business models (at least for now).
  

• Noted another exec: “At the end of the day, AI is just software, it’s expensive software. It’s low-margin software unless it does something that’s 10 times better.”

Why it matters:

For those looking to profit off AI with stocks, Morgan Stanley strategists warn caution. If Nvidia is a proxy for AI enthusiasm, then the rally is seemingly nearing a peak, with the stock up over 200% year-to-date. But even a broader index, like the MSCI Robotics & AI index, is up nearly 50%.

• AI could stick around as “The Next Big Thing” for years, or decades. But sometimes, tempering expectations around hyped developments is warranted, even necessary.

Early innings: In recent earnings calls, Big Tech CEOs praised AI as a key element in their plans for the next decade.

• Here’s Amazon CEO Andy Jassy: “We’re a few steps into a marathon in my opinion. I think it’s going to be transformative…But I think it’s really early. I think most companies are still figuring out how they want to approach it.”
  

• Apple CEO Tim Cook echoed Jassy, saying this year that “there are a number of issues that need to be sorted” regarding AI. But last week, Cook celebrated AI, saying the company had been working on it “for years” and that AI was “integral to virtually every product that we build.”
  

See you next time!

That's it for today on We Study Markets!

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