Walker & Dunlop, Inc. (WD) Earnings Call Transcript & Summary

My professor, Dr. Peter Linneman joined me again, [indiscernible] in Fort Worth, Texas at the Dominion Annual LP Meeting, and it is a real joy to be here with our partners at Dominion and seeing all of their investors in many of the projects that Walker & Dunlop and Dominion have worked on together.

So Peter, a lot has happened. The last 3 weeks have been incredibly tumultuous in the real estate capital markets. I -- my phone has been inundated with Walker & Dunlop customers calling me and saying, can we get you on a call with our team to figure out where our rate is going? Where is the market going? And should I be running to refinance a property today? Should I have been selling a property? Should I be concerned about being able to get out of this property a year or 2 from now. And my feeling fear has been that for the last 3 years, we did it what I call the hope trade, the waiting and hoping that inflation would come out of the system, that the President would replace the Fed share with a potentially new Fed share who would start to cut rates in line with what the President has been calling for, for quite some time. And that we would be sitting in a sort of a 4% 10-year, maybe even [indiscernible] which is 3 points out of 5% 10 year, and you were very straightforward in saying at the beginning of 2026, the inflation print is looking good. If you strip out a lot of various things such as housing from the CPI and other inflation rents that we should start to see cuts and you predicted that we would see 2 rate cuts by the Federal Reserve in 2026. And you made that prediction, not knowing we would invade Iran. You made that prediction thinking that oil would be somewhere between $60 and $70 a barrel rather than $90 and $110 a barrel. Other than the Iran war what did you get wrong?

Well, that was the main one. Really, that was absolutely the main one. When did the 10-year start [indiscernible] and was as the Iran conflict began and It's picked up speed. I would -- anybody who's not told you, Willy, I think just called me, and ask the same questions. And they probably called me because your phone was busy and so I was the second choice to ask those questions. I can tell you the spirit of what I'm answering people. we are the highest 10-year and now 25 years. That's an abnorable situation. A lot of the people who are saying it's going to stay high forever, with the same people -- not you -- with the same people that were in 2018 and '19, same yes, negative interest rates make sense, and they don't. Maybe the interest rates makes totally sense, this doesn't make sense. I think a lot of people in live view real estate as a 8- to 12-year investment horizon, that's why the research I've done tends to focus on this performance over a longer period, you got to be around and allow adjustments. And people have [indiscernible] after sort of 2 to 4 years. That's like judging who won the [ NAA ] championships this past year based on the halftime score. And it wasn't the New York mix, that 1 based on half time scores. By the way, take another example, the Philadelphia Eagles we're winning with 4.5 minutes to go. Unfortunately, they played 4.5 more minutes. That's why they play the full game and they know us. And what you've got to do with real estate, I think, is play the whole game. Don't judge it at half time, do judge at it middle of the second [indiscernible].

Peter, let me jump in there for a second. First of all, so everyone knows my password to access the online copy, the PDF of this quarters Linneman Letter is [ Go Birds 2 ], which kills me as a Washington Commander [indiscernible] and not a [indiscernible]. So I appreciate the fact that you push those birds all the time. But the issue here is this many people's game on a specific asset ends in 2026 or ends in 2027, they have a refinancing coming up. They have an investor who wants to recite capital, so while I get your analogy of, hey, this is an 8 to 10-year game, unfortunately, for many people, they do have another 4.5 minutes to play as it relates to what to do with a specific asset, whether to sell right now? Whether to refi right now? Because the clock is running out on it. And so to them, what do you counsel them to do now that their gain is coming to an end on that specific asset.

Gold [indiscernible] you don't have to an advantaged market. Therefore, talk to you and see about arranging a 2-year or some such product, a 3-year. By the way, and as you know, I'm generally a person that says 7- to 12-year financing on the cents. But I play the slope a little bit here right now. And are you supposed as a result of that? Yes, but you're dead the other way. and better to be dead 2 years from now to be dead today. I'd rather have the alive today and the [indiscernible] value of it improves. That's what my advice is.

So you would go on shorter-term floating rate financing to refi your crop of you today that go and [indiscernible] at either pref equity or new equity if you can find it and put longer-term financing on, even though that would obviously cost you some of your ownership of that asset?

Yes. That's -- and by the way, that's very contrary to my normal view.

And you say that because you think rates are coming down?

I don't see them going up. They're at 25-year high inflation where I say that. Inflation for the 30 years average inflation private [indiscernible], which totally reshipped the debt, right? That's why I taking project [indiscernible], it's 2.2% for the things people actually purchase. For the 2 years prior to the Iranian situation beginning, by situation, I mean, bombings, etc, right March okay? For the 2 years prior that was 2.3% for those same items. Okay? We had kind of stabilized. We then add the oil situation. The oil situation has increased inflation, you go from 60 to 100 a barrel. That's less than [indiscernible] a barrel. It's to the mathmatics, and you get a higher inflation rate. but it doesn't stay inflated. Why? Less suppose oil stays at $100, right? Let's just suppose for the next 2 years, inflation assuming oil stays at $100. What's the inflationary impact of oil over the next 2 years, if it stays at $100, 0. What will that do the measured inflation, pull it down well, right? Yes. If you do a [indiscernible].

Except for the fact, as you and I have discussed, of the 41,000 goods that are on the CPI print, 70% of them are impacted by the price of oil. So what you're seeing is shown there. those 70% move up and then once they move up, you're flat. Then you're flat.

That's all I'm saying. I'm just reminding people of manics. So even if oil stays up, it will become noninflationary, okay? And much less is some reasonable solution occurs and evolves. Now why is that relevant? What do I think happens when it stops being inflationary. The Fed will it something lower the rate. And when they lower the short rate, we saw what it looked like in large issue in February. If you started out in your [indiscernible]..In February, people thought, yes is the 4% sure rate stays the same or falls and that loan rate was at 4%. What happens if there's no inflation that the Fed says they have to tan. And as you go back down, much less of oil price fall because that will really pull down inflation. The Fed will declare success even though they had nothing to do with success because they don't control the Strait of Hormuz moves, at least last time I checked, I -- by the way, did anyone notice -- you got a big audience -- did anyone on the audience notice that immediately after the Fed increased rate by 25 bps, the Iranians immediately said, we were reputing any attempt to go nuclear. We're destroying all our weapons the Republican Guard is being disbanded. We're opening the straight of Strait of Hormuz, and we're sending lollipops and marshmallows to all Americans children on their birthdays. Of course, now they have no effect on those sakes, and yet they pretended as they did. And that has rolled the market. There's no doubt that it's confused me, it's confused to everybody. So it is not [indiscernible] legal. There is an important thing to make here. You and I talk about the federal deficit for years outstanding debt. There is this selling narrative that for the last 40, 50, 60 years the investor has been a sleep to the fact that the deficit occurs and that the debt outstanding rose and suddenly like [indiscernible] week, they awakened, and solve the deficit and scrambled and said, oh, we've got to increase the rate we demand. That's soon. If that -- it's just intellectually silly, if it were true, why is it that every country has about the same increase in the long way rather than being very nuanced depending on their own fiscal situation. So that's why I want to go short. I don't want to go short. Let me clarify that. I don't -- you know what it's like, I don't want to give rent concessions. I really don't. But the reason I give rent concession is to give you from here to there. So let me -- at the same thing on the people have to finance.

If I had listened to the Walker webcast in June, when you said they're going to do 2 rate cuts in the subsequent to meetings. You actually said that they weren't going to cut in July, they were going to come back and cut the September. So if I listen to you then, I said, great, I'm going to float because Peter says that rates are going down, short end of the curve to go down, I can play a SOFR plus 200, well, and then I'm going to do well. Well, if I follow you to then, it's cost me 100 basis points between that point and today to have floated rather than a fixed in a long-term option at that point. So my question to you is what confidence should we had? And obviously, I'm asking you to try to predict rates and nobody can predict rates. But why is it do you think that we are at the all-time high? And if I listened to you 4 months ago, that probably would have made the long move.

Well, SP1 Because of how dramatically has moved since then, right? I mean, I don't know how to say it more obvious I hear you. I don't think there's anybody I don't know of anybody. I'm sure there's some hedge funds somewhere. I don't think anybody when we talked in June would have ever predicted. I don't know where we're at today, [indiscernible] for a 10-year Yes. I don't think anybody would have picked it, right? You might have had a few people saying, oh, upper 4s and 5. And so the fact is it's run -- it's just run to a point that's not justified by the economics. That's the simplest way to say it. And I think even the Fed, and I stress even and figure that out.

So as you look forward, you just talked about sort of, if you will, a normalized, we get out of Iran oil comes down, rates come down, the Fed doesn't see inflation pushing rates and therefore, they can cut. Do you think that there's a scenario where something breaks? And if you think that something breaks to get them to cut, what do you think breaks?

Well, obviously, something dramatic and Iran. And it's interesting you're seeing the same if I did. In the first few months, every little announcement, every head fake on -- looks like we made progress, oil would drop like $7 to $8. And then it would go back up and the rate was kind of bouncing with it. And there's almost people have gotten desensitized to that inflation, and it's kind of staying at $100 and -- or a little above $100 a barrel. And the rates saying, "I don't want to screw around and figure this out. I'm ensuring myself against the Fed being stupid.

I think it's actually come down to the low $90s in the last couple of days because of the release of the G7 oil reserves, which I would underscore the fact that China has released so much of their reserves and lowered their oil consumption since the beginning of the Iranian conflict. And now the release of the reserves on the G7 is a big reason why we actually have $90 a barrel oil and not $120 a barrel on oil and not something that is sustainable at least on the G7 side of releasing reserves. The Chinese very clearly seem to have built up enough reserves and lowered their demand for oil to be able to stay in their current demand situation quite some time. And it's kind of ironic that we can look to thank the Chinese for what they've done to keeping oil prices. Last I filled up on Sunday, and I was $4.10 a gallon. I'm not at $4.10 a gallon in Denver, Colorado, if the Chinese haven't pulled back their oil consumption on a global basis. as significantly as they have. But Peter, let's switch for a moment to unemployment because I think that a lot of what you're focused on is GDP growth and the overall acceleration of the economy. GDP growth, you're actually looking at '26 GDP growth higher than what you'd predicted it would be in '25. But on the unemployment side, your unemployment calculation is about almost 2x what the official unemployment numbers are. Talk about that latency or that underemployment in the economy and whether that is people who have permanently retired. So they've -- they're a 55-year-old person who's just removed himself or herself from the labor force, and therefore, generally speaking, is just going to be a drag on the economy going forward. No criticism to someone who's of my age, who's decided to step out of the labor force. But or is someone who is 22 years old living with mom and dad and sitting there not employed, but has the ability to come off the sidelines and enter the labor force that actually could give us a lift from a GDP standpoint?

The reason my number, so to speak, is higher, is all it is the same, look, there's a -- just to remind people, the unemployment rate comes from a survey that says, are you employed? And if you answer yes, yes, fine. And if you answer no, they ask you the next question. Are you actively looking for work. And the numerator is those who say they're not employed but actively looking for work. The denominator is the sum of employed and those who say they're actively lucky. It's that simple. What it misses are I'm not looking -- I'm not employed and I'm not actively looking. And that is still fairly high. And it's a bit abnormally high. And there's a whole field discussing why that is the case, ranging from rank entitlement to parents that spoil their kids to there are no opportunities to -- there's a lot of labor out there. And it's not not working. It's not unemployed, it's not because of wages not occurring. There's a lot of wage activity that's occurred. I don't think anyone, including me fully understands why it's as high as it is, but it is. And it's a drag on the economy. It is a drag on the economy.

So it's a drag not a potential catalyzer of significant economic growth?

It could be, but you have to wonder why are they not there after such a prolonged period because as you know, it's been up there for some time. It's -- the recovery has occurred. We went through a very hot period. Wages have been up in real terms, et cetera. it probably is much more a drag. Now it's interesting on employment. On employment, the numbers are really strong. If you look at people gettting fired because nobody is getting fired. They get unemployment insurance claims, new unemployment insurance claims. Nobody is getting fired. That's great, right? That's a strong labor market. If you look at new jobs created, it appears fairly mediocre kind of a run rate of about $900,000 this year, which is not terrific.

It's actually super slow -- in comparison to the last, I mean, since ChatGPT was launched in November of 2022. We've added 4.6 million jobs, I believe, and that goes to like 2.1 1.8 in '23 and '24. And then '25 is somewhere around 700,000 or 800,000. And if you add up all job in Trump too, it's a 700,000 jobs.

That's why -- let's assume it's going to end this year around 800,000, not a great number, not a great cover number. We're down probably to to 2.5 million legal and illegal immigrants that came in, in a particular year. If you say half of those would have gotten a job, which is not wildly off, that would have been another 1 million workers. If you add the 1 million workers to the 800,000, you say 1.8 million, not spectacular, not bad, right? But absent the immigration, there's a whole bunch of people not looking for work, just not looking for work. And you say, "Well, why doesn't that. Remember, immigrants get jobs, and they take jobs, but that also increases the demand for jobs. Why? They buy sweaters, shoes, they buy Brooks, 9.5 shoes for exam. The people said, "Oh, immigrants come in, and it's an additional supply of labor that destroys and take away the opportunity. What they forget and what the research shows is, they also get jobs, and they do what everybody else does when they give job. They add to the U.S. economy's productivity. They buy sweaters, shoes...

You would see all that show up --

And that creates jobs.

But yes, I get that, but that would show up then in inflationary pressure on wages.

No, no. Because roughly there's a positive net effect, but it's not huge. And the reason is they supply creates its own demand. Just think of immigrants as a new country of 2.5 million people. okay? New country comes in, the 2.5 million people go to work, the 2.5 million people get hired because they make stuff that they want. There's a circularity to it. and we're not getting them. So we drop them out, right? And you're right, we lose the labor side, but we also lose the labor demand side because they're not buying as many shoes and they're not buying as many -- just go through the list. So the demand is also down. That's why you don't see the spikes. And you made this great point very articulately, I think at your MIT presentation. I'm doing this from memory that you get asked everywhere. Are there labor shortages and basically the answer -- and it's the same answer to the hotel people give, not terribly, a little here, a little there, not terribly. And that's because, yes, the supply got reduced, but the demand got reduced, because those immigrants were getting jobs and working and buying stuff. And that courses through the economy. So we've dropped the demand and we dropped the supply.

Let's switch then to a sector that is using a lot of labor right now, which is data centers. If we back up to the January of 2025, you and I were together at the Constitution Center in Philadelphia, and I said to you, what is the best sector for you to invest in? And you said, well, if I want to stay rich, I'd invest in multifamily. I then said to you, what's the get rich asset class and you said, office. And then I said, well, what's the getpoor asset class and you said data centers. So in this quarterly Letter for the first time ever, Peter has these canaries in a coal mine to anyone in the room who doesn't read the Linneman Letter on a quarterly basis. And he goes through and typically has 55 different opportunities for canary to be dead as sort of a leading indicator of trouble. I think the lowest it's ever been since I've been reading the Letter, Peter, is like 2 or 3 canaries. I don't think you've ever had 0 canaries.

No, I never had 0.

But over the last 3 years, it's gone from 12 to 16 to 18 in the most current Linneman Letter, 18 out of 55 potential dead canaries. But this is the first time you've had data centers as a dead canary. And on each 1 of these sectors, if you will, there can be a potential of 5 canaries. So Peter is just starting to feel the -- if you will, the vapor is coming out of the coal mine on the canary. It's not -- it hasn't shown that we've got a real issue down in the coal mine yet, but it's coming along. Peter, the growth in data centers, we've gone from -- in the last 5 months, we've gone from 570 data centers in the United States to something like 1300. We've got 2,000 data centers planned to be built. So with that amount of capital and the hyperscalers are putting $800 billion into data centers in 2026. So with that amount of capital going to it, a, do you think something breaks as it relates to just there's default, there's not demand. If something happens in the data center AI construct that breaks. And then the follow-up to that is if all that capital continues to flow there, and you don't have anything break there. What is suffering from the amount of capital that's going to data centers that would, in a traditional way, be flowing to other asset classes?

Remember how good apartment demand was rent, occupancy wise, and what 2021, first half '22 something like that.

Boy, do I remember it finally.

No supply, no supply because COVID has shut it off and demand, pretty robust demand from credit tenants, namely residents, pretty credit, right? They pay the rent mostly, how did that end? That ended by a huge supply spur for a lot of reasons, you still have demand and the supply spurred overwhelmed. What's my concern on data centers. You see anything that gives that good yield sooner or later, it's going to get overbuilt. I don't know when. And how do I know something -- if you look at what's happening in data centers, this is overly broad. Everybody says these hyperscalers are credit. Credit tenants, credit. And by the way, you're old enough to remember just barely when people were building shopping centers saying, Sears and Kmart or credit tenants. And by the time they opened or a year or 2 after they opened their ones dead and the others almost dead, right? Credit rose for a lot of reasons, competitive and otherwise. And I just -- so here, if 1 of the hyperscalers, came to to 1 of our developer friends and said, build me an office building or build me a warehouse or kind of yield on cost, were they negotiated down to on a 15-year lease 6% or 7%. Let's just say 6% to 7% yield on cost because they are who they are, right? -- they're going to negotiate it down, maybe even a little lower, okay? On the data center, what are they doing it for? 10 And maybe 9.

10, 12.

So what does that tell you? It tells you they're desperate for that product, and they're doing something they normally would not do. no credit tenant would normally do it. Why? They view they're in a race that challenges their existence, which means they're afraid they go out of business if they don't win, okay? That's why they're doing it. They want to get it, and we know they're paying a [indiscernible]. Now by the way, let's go to the other capital parts. Let's go to the capital parts. Lenders, lenders are lending 90%. And 85%, 90% first mortgages, okay? Why? Because of their credit tenant, even though the tenants are worried about their existence, that's why they're willing to pay that rent, and you go that's interesting. So the lenders are viewing it as no risk. How has that generally turned out in history that when lenders view something is having no risk, it turns out well when they provide 90% debt or 85% debt. Why are they doing it? They have no exposure to it currently in their portfolio. They got a lot of apartment exposure. They got a lot of warehouse exposure. They have a lot of office exposure, a lot of them. So they all say, okay, we're going to go get it. and we're going to get it while they're getting to it. So they're flooding into it. And they're doing something we don't. So we see tenants doing something we don't normally see. We're seeing lenders do it. And then we see equity providers saying, I got crushed in real estate in the last 3.5 years on everything else. Let me try it there, especially with 90% leverage. And by the way, the developer makes the development fee, they have to work hard for it. I'm not taking I mean away from it, but the developer's development fee with 90% leverage, they can't lose as the developer. So I think it gets overdeveloped in a strange way. Remember, the office market in the 1980s, you had very good demand growth and yet somehow vacancy got to 18% in spite of great demand growth. That's because unbelievable lending, right? That's why I have concerns. If the tenants are worried about -- just think of this for a second. The tenants are worried about their existence, okay? Why aren't the rest of the capital stack worried about their existence?

Well, they also though -- I mean they have multitrillion-dollar market caps. I mean, I hear you about the "worried about their existence". And by the way, I mean, I would -- your concerns as it relates to the hyperscalers, if you listen to the all-in podcast, which I listen to on a weekly basis. So I'm just stealing from the guys from All In. This is not my own research, but I listened very intently last week. And in their discussion last week, they talked about a couple of things that concern me on exactly this topic, Peter. The first 1 was they looked at frontier models versus open models. And 90 days ago, Frontier models were 80% of AI usage in the United States and open models were 20% of AI usage in the United States, 90 days ago. Today, it's the inverse. It's 20% frontier models and 80% open models. So at [indiscernible].

Really do you think that has anything to do with why they're now saying, oh, let us get together with the government and regulate and set up barriers on who I think they're going to set up barriers to?

1,000%. It's called regulatory capture. It's let's put up barriers so that we can create whatever monopoly, duopoly, triopoly you want to put together but let me keep going on this for 2 seconds because at Walker & Dunlop, we use ChatGPT. We have a closed environment of that GPT that makes it so that we can keep all of our data, run all of our analysis inside of our own environment. It's protected, and I love it. except for the fact that we spend a tremendous amount of money on tokens with ChatGPT, and my CTO is going to come to me sometime in the next 6 to 12 months and say, if we moved from ChatGPT to an open model. We pulled a server and put all of this on our own servers, we would drop our token usage from X to wide and we would save Walker Nello x millions of dollars a year. And by the way, we don't need to be using frontier models at Walker & Dunlop. I'm trying to process mortgages for everyone in this room. If I were trying to solve cancer, I got to stay on ChatGPT or Anthropic and keep on that frontier model. But for W&D, my big issue right now is not necessarily the capabilities of the technology it's the implementation challenges I have of taking the technology and putting it into our work streams to make it so I can process loans for all of you quicker, more efficiently and more cheaply. And so as I think about that shift in just the last 90 days of the Frontier models, you listen to the all-in host, talk about it. And they sit there and they talk about if these frontier models don't stay 6 months in front of the rest their value goes to 0. That's their words, not mine. That's their words.

That's the existence concerns.

That's the existence concern. That's exactly what you're talking about. So I don't know. I don't like personally. If you said to me, Walker & Dunlop's future is based on, and I know Pete is here from Wells Fargo. So let me just use him as an example. Walker & Dunlop's existence is based off of staying 6 months in front of Wells Fargo, everything that you do as it relates to loan origination and loan processing, I might be running for the exits pretty quick. And so I just think about that change in the amount of capital that's gone to these data centers, but the 1 conflicting point, Peter, in your quarterly Letter that I want to have you discuss is this. After all of that doubt you have about data centers, you state that demand will exceed supply in data centers between now and 2030. So if you think we have another 3.5, 4 years of demand exceeding supply, why are you concerned about a crisis?