Sean Dobson, Chairman, CEO, and Chief Investment Officer, Amherst Julie Ingersoll, Chief Investment Officer, Americas Direct Real Estate Strategies, CBRE Investment Management Moderator: Shawn Tully, Fortune
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00:00 So I've posed this question to Sean Dobson so many times,
00:05 and Sean has always said that what really makes people decide
00:11 to buy a house or not buy a house, a huge factor
00:13 is their monthly payment, Sean.
00:15 And now we're in a situation where
00:17 we've seen this unusual phenomenon of interest rates
00:20 going way up, mortgage rates going way up,
00:23 and prices going way up too in many, many markets,
00:26 although not all.
00:27 So what's going on, and what could justify this and prevent
00:31 what we've usually seen under these circumstances?
00:34 Well, thanks for having me.
00:36 And I'm not sure I'm the best source,
00:37 because I lost a lot of money on this in the last couple
00:40 of years with interest rates spiking so much
00:42 and home prices going up.
00:43 But I think most of you probably already
00:45 know the fundamentals of the story
00:47 is that what caught a lot of us off guard, maybe just me,
00:50 was that so much of the housing market
00:52 is now locked up with these super low interest rate
00:55 mortgages.
00:56 So the float of homes fell about 35% or 40%.
00:59 And in some markets, a little bit more, a little bit less.
01:02 So you had this--
01:03 You're talking about the inventory of--
01:04 Yes, we think about the--
01:05 I mean, I'm a math nerd at the end of the day.
01:07 But we think about housing.
01:08 There's the stock of housing, all the homes that exist.
01:10 And it's upwardly floating a little bit,
01:12 but not fast enough.
01:13 And then there's the float of housing, which is that stuff
01:16 that's for sale.
01:17 And that float, or the homes listed available for sale,
01:19 is down about a third, as you all know.
01:21 And that's really a difficult thing
01:23 to thaw because of something that's truly only American,
01:28 the 30-year fixed rate, freely prepayable,
01:31 and it turns out non-recourse mortgage.
01:35 So these homeowners are enjoying really low interest rates
01:38 for a really long time.
01:40 Right.
01:40 And Julie, what do you see in the markets you're covering,
01:44 in terms of maybe some offsetting factors,
01:46 low unemployment, rising incomes?
01:49 Are they counterbalancing some of the pressures
01:52 from higher rates and higher prices?
01:54 You know, we really thought that the multifamily rental market
01:58 would be buoyed by this lockup effect.
02:02 But we have seen some of these inflationary pressures
02:07 impact our tenants.
02:08 And so we have seen a little more doubling up
02:11 than we'd expected.
02:12 We also, frankly, delivered a lot
02:15 of new supply on the multifamily side to many of our markets.
02:18 So we thought the multifamily renter and the renter
02:22 would be relatively strong, and rents
02:27 would be relatively robust during this period of time,
02:29 because there wasn't enough stock to buy.
02:32 And we thought that this new paradigm of the American dream,
02:36 which is to try different cities,
02:39 to move around to see where you fit best,
02:41 versus buy a home and live there for 30 years and never leave.
02:45 You know, we thought this mobility option
02:48 would drive a lot of the multifamily rental market.
02:50 And it's not as dire, maybe, as the office market.
02:55 But the multifamily rents have been a little softer
02:58 than we expected this year.
03:00 Right.
03:00 And now we're seeing, on the long end of the curve,
03:03 rates go down in the last few days,
03:05 some positive information regarding inflation.
03:10 But we have really high real interest rates.
03:13 And I know Sean has focused on this a lot.
03:15 You look at the TIPS rate, it's well over 2%.
03:18 Exactly.
03:19 And the equity risk premium is practically zero,
03:21 and you know the whole story.
03:24 And I'm wondering-- and I think Sean's position has always
03:27 been it's just too high.
03:28 Exactly.
03:29 Yeah.
03:30 And so if it adjusts and goes back to a 1% growth economy,
03:34 you're not going to have a 2.2% real rate, right?
03:36 So that would help housing, wouldn't it, guys?
03:39 Yeah, I think so.
03:40 I mean, I'll dive on that one.
03:41 I think that real rates are about 100 basis points too
03:45 high, in our opinion, which basically makes mortgage rates
03:47 about 100 basis points too high.
03:48 There's another problem that creates an opportunity for us
03:51 on one hand and a problem on the other.
03:53 Mortgages themselves, the security of mortgages,
03:58 the bond itself has become really under-sponsored.
04:02 This doesn't get much coverage because it's kind of geeky,
04:06 fixed income nerd stuff.
04:07 But basically, pre-financial crisis,
04:10 you had large, large inventories of mortgages
04:13 held by the street and very large inventories held
04:16 by Freddie Mac and Fannie Mae.
04:18 And then large inventories held by the banks.
04:20 Those three constituents are gone.
04:22 And the mortgage market is lacking a sponsor.
04:25 So mortgage interest rates holding everything else
04:27 the same could be potentially almost 1% too high because
04:32 of a lack of investor base.
04:33 Right.
04:34 Julie, your view on what lower rates may--
04:37 will they happen and what will they cause?
04:39 Well, I think the real story for residential and multifamily
04:42 and single family for rent is that this new supply
04:47 wave will ebb.
04:48 And so we'll have a lot more opportunity to grow rents.
04:51 But I do think that lower interest rates will unlock
04:55 a little bit of mobility, maybe bring a little more housing
04:59 stock back in the market, which would benefit some other asset
05:02 classes like self-storage and retail.
05:05 Right.
05:06 And we just suffer from such a dearth
05:09 of new construction in America.
05:10 We see some of it in the Sunbelt. You
05:13 don't see any of it in places like New Jersey.
05:15 The supply has been frozen forever.
05:19 What needs to be done?
05:21 For example, if you look at markets like Jacksonville,
05:25 if there's new houses being built and coming on the market,
05:28 it tends to have a very moderating effect
05:30 on price increases.
05:32 You have a fixed supply.
05:33 Any jump in demand causes these huge spikes, as you guys know.
05:37 What do you think could be done to improve this situation?
05:41 That's all you.
05:42 Yeah, well, we just saw a big law get passed here
05:46 in New York, didn't we, which is trying
05:47 to address that very thing.
05:49 So how do you add more to the housing stock?
05:51 But the reality is it's municipality by municipality
05:54 tax incentives.
05:57 And whether it's conversion of office to multifamily,
06:01 or it's the ability to remove some of the obstacles
06:04 like in California to providing new construction,
06:08 whether it be for multifamily, for single family,
06:11 it is fortunately and unfortunately
06:13 a municipality by municipality story.
06:15 And that's where NIMBYism, unfortunately,
06:18 has really prevented us as an industry and as a nation
06:21 from providing enough housing stock,
06:23 and certainly from providing enough affordable housing
06:26 stock.
06:26 Yeah, and I think, Sean, you had a project involving
06:29 the construction of very affordable homes,
06:32 a manufacturing process.
06:33 Can you talk about that?
06:34 Yes, we're developing it.
06:37 We're not sort of new in that.
06:39 This isn't a new business.
06:40 But we think that the key to unlocking supply
06:43 in the urban core--
06:44 and that may involve taking down some of the old toxic housing
06:47 that's been around too long--
06:48 is building the home either in pieces,
06:51 or the majority of the home in a factory,
06:53 and bringing it in and placing it.
06:55 So these are the same construction techniques
06:57 you would use on sites, which is off-site construction.
06:59 So we've built a factory.
07:01 We've completed about 250 projects.
07:04 So we're just learning how it works.
07:06 But I think that one thing to remember about the US housing,
07:08 single-family housing stock, is that the development mechanisms
07:12 in the US are designed to build neighborhoods.
07:15 And every trade is set up to go and build 10 foundations,
07:20 or 10 frames, or 10 roofs, kind of in a row.
07:23 When the homes are ready to come down,
07:25 the nation doesn't have a development infrastructure
07:27 to go replace that one home.
07:28 That one home, yeah.
07:29 So that's what we're trying to build.
07:31 Right.
07:31 And I know in California, there's
07:32 been a proposal to allow landowners with one home
07:36 on their-- obviously, on their property-- to subdivide
07:38 to two lots.
07:39 Is there any potential there?
07:41 Yeah, so our headquarters is in Austin, Texas.
07:43 Austin was very aggressive with its zoning.
07:46 Basically made single-family lots illegal.
07:49 And that allowed people to put up to three homes on a lot.
07:51 It's just now coming into play.
07:54 And as Julie said, the city can pass the law,
07:58 but that doesn't stop there.
07:59 There's still neighborhood associations.
08:01 There's other barriers.
08:02 And they're not really sort of desirous of having
08:04 their neighborhoods densify.
08:05 Right.
08:06 It's this tension between the cities trying
08:08 to create more housing and the landowners trying
08:11 to preserve what their view is of housing
08:14 is really the source of the friction.
08:16 Julie, who's going to win?
08:19 Well, I think when the tax revenues start running out,
08:25 that's when real estate investors will win.
08:27 Because I think when tax revenues start drying up
08:31 because you've had degradation in office,
08:35 you've had degradation in retail,
08:37 and people don't have an affordable place to live
08:40 and they vote with their feet, that's
08:42 when the pressure will come to these communities, which
08:44 is, what are we going to do with these obsolete, vacant office
08:49 buildings?
08:49 What are we going to do with our affordability and our housing
08:52 crisis?
08:52 So let's move on to the commercial side.
08:54 Of course, the big news has all been about office.
08:56 You mentioned, perhaps, the ability
08:58 to turn office space into residential.
09:00 That tends to be very expensive with lots of retrofitting.
09:03 But you see great projects like the Hudson Yards.
09:06 It's totally new.
09:07 KKR, all the big Wall Street firms,
09:10 have moved in there, JP Morgan.
09:13 And that space seems to be highly desirable still.
09:15 What are the areas or the categories in office
09:18 that have been hit hardest, and geographically, the areas that
09:22 are hit hardest?
09:23 Sure.
09:23 Well, I'm here to tell you folks that the headlines are
09:26 real for office.
09:28 Now, office as a percentage, overall commercial real estate
09:32 represents a much smaller amount of the commercial real estate
09:35 float today than it ever did.
09:37 So think in the past, office used
09:39 to be 40% of the value of all US commercial real estate.
09:43 It's now down to 20%.
09:45 So it is meaningful.
09:46 It is material.
09:47 But we do have other asset classes,
09:49 like data centers, like single family for rent,
09:51 like student housing, that characterize the sector.
09:54 But what's going on in office is truly, I would say--
10:00 well, it's a century-long phenomenon,
10:03 meaning today we have 18% quickly going to 20% vacancy
10:08 in the office stock.
10:09 That has never happened before in the history.
10:11 Up from what, Julie?
10:13 Vacancy.
10:14 So the worst vacancy we ever had is in the high teens, right?
10:18 So 14%, 15%, going all the way back to the '60s.
10:22 So now we have 18% to 19% vacancy going to 20%.
10:27 And that doesn't even include sublease vacancy, which is
10:30 2x of its historical average.
10:33 And the winners, as you say, are the one Vanderbilts,
10:37 the Hudson Yards, the new shiny office building
10:40 that is the amenity that you use to attract your talent back
10:45 to the workforce.
10:46 You have your amenities in the bottom.
10:49 You have your breweries and your restaurants.
10:51 You have your pet spa and pet daycare in the middle.
10:55 And you have your rooftop deck lounge on top.
10:57 But those are expensive tenants you still have to buy.
11:01 So to answer your question, what happens
11:03 to the rest of the stock?
11:05 Well, we can look for malls.
11:07 The class B and C malls is an example.
11:10 I was driving up to Rhinebeck the other day.
11:13 And you see these malls still by the side of the road
11:16 that have weeds growing out of them, right?
11:18 Because they have not yet been knocked down and repurposed.
11:22 So a lot of these commodity office buildings
11:25 are only worth land value.
11:27 And they have to be knocked down and redeveloped.
11:29 Because as you said, this multifamily conversion
11:32 is not a salve for more than 2% to 3% of office stock
11:36 in the US.
11:38 That's kind of wild, right?
11:39 Right.
11:39 Wild.
11:40 Yeah, so where are we seeing pockets of good performance
11:44 on the commercial side?
11:46 Of course, Sean is an expert in single family rental.
11:49 And I know, Julie, you're also an investor
11:52 in single family rentals.
11:53 That market has been very good, hasn't it?
11:56 Yeah, it's been great.
11:58 Our demand side is the opposite of what
12:01 you're seeing in most commercial real estate classes.
12:04 And what I like to point out to people
12:05 is that occupancy itself in the US is up with population.
12:09 It's just shifting.
12:10 And all the things that we used to do someplace else
12:12 are happening at home now.
12:14 Everything from streaming and delivery and now working.
12:17 We were already shopping.
12:18 And so all of those things that we
12:20 used to do sort of out and about in town, so many of them
12:23 are just better experience at home.
12:24 And when you took work into that equation,
12:26 it really upset the apple cart.
12:28 And I think it upset it permanently.
12:30 Right.
12:31 So on the commercial side, we see strength
12:34 on the data center side.
12:35 We have two years of astronomical rent growth,
12:38 student housing, historically high rent
12:41 growth in that asset class, and then modern logistics.
12:43 So what most people don't realize
12:45 about warehouse space in the US is the average warehouse
12:48 is 40 years old.
12:50 And guess what?
12:51 The new robotics, the new stacking and racking systems
12:54 that Amazon uses to distribute solar panels on the roof,
12:59 battery storage to support EV trucking and EV fleets
13:03 cannot be supported by the legacy
13:06 stock of warehouses in the US.
13:07 So we see particular demand and resilience in that asset class.
13:12 So a lot of bright spots counteracting
13:14 some of the office storm clouds that
13:16 may be with us for a period of time here.
13:19 Want to hear an anecdote?
13:20 Yeah, please.
13:21 Sure.
13:21 So we have a small business of lending to real estate
13:24 redevelopers, people that buy an old office building,
13:27 spruce it up, and then sell it at a discount,
13:30 or warehouse whatever.
13:31 So we financed an office building
13:33 that was the headquarters for the Phoenix Online
13:35 University in Arizona.
13:40 The borrower, very sophisticated borrower,
13:42 had a very sophisticated plan.
13:43 Went in, it was a single tenant building,
13:45 turned into a multi-tenant building,
13:46 pretty simple strategy.
13:48 Did all of their CapEx, got it going, advertised it,
13:51 COVID hit, nothing.
13:53 They gave us the keys back.
13:54 So we're a non-recourse lender, so they very politely said,
13:57 we surrender, we give up.
13:58 So they lost all their equity.
14:00 We own the building about 55% of their basis.
14:03 So we're like, ah, we'll just cut rents and lease it up.
14:07 Crickets.
14:07 Couldn't find a buyer.
14:09 This was a $50 million building in today's dollars.
14:13 The structure was less than 20 years old.
14:16 We're tearing it down, and we're putting back last mile
14:19 logistics in its place.
14:20 So we're taking down $40 million worth of improvements
14:23 and replacing them with another $40 million worth
14:26 of improvements.
14:27 And it's exactly, as Julie said, what goes back there
14:29 has to have the right ceiling heights, the right dock
14:32 heights, the right floor plan.
14:33 So even the economy is moving so quickly that even that stock
14:39 is a danger.
14:39 Yeah, but this is--
14:41 are you replacing it with a warehousing?
14:43 Yes.
14:44 We're taking a 300,000 square foot office to the ground
14:48 and rebuilding warehouses.
14:51 Yeah, and that's the solution for a lot of office.
14:53 Unfortunately, many of these municipalities
14:55 will not approve it.
14:56 They don't want the truck traffic.
14:58 They want their beautiful suburban office
15:00 or their old retail center.
15:02 And so you've just got this tension
15:04 between vacant buildings and municipalities
15:07 who want something in there.
15:08 They won't allow the developers to tear down the buildings?
15:13 They won't approve your entitlements?
15:14 They won't approve your permits?
15:15 I have another one in Phoenix that's
15:17 250,000 square feet, a beautiful 14-story tower.
15:21 And it's 50% occupied and the other 50%
15:23 has been on the market for three years.
15:26 We went to the city and said, you
15:27 know when these tenants go, so does the building.
15:32 And they said, no way.
15:32 They said, when this all turns around,
15:34 we need offices to run our city.
15:36 And we're not going to let you take that thing down.
15:38 So now we're like, OK, what do we do in the meantime?
15:40 Because we still have to pay property taxes.
15:43 And insurance and maintain the building.
15:46 Do you think what they're telling you is going to happen
15:48 will ever happen?
15:50 I don't know.
15:52 Will it come back?
15:53 I don't think so.
15:54 I don't think so.
15:54 I think that work from home works.
15:57 And I think that the two day or three day in the office work
16:00 week is with us for a long time.
16:02 In Austin, Texas, we have a traffic problem not too
16:04 dissimilar from New York's traffic problem,
16:06 where we had people that were not
16:09 in super critical creative jobs, but critical function.
16:12 The people that do payroll in our HR department.
16:16 Someone's got to cut paychecks every two weeks.
16:18 Those people were driving in an hour, sitting at a desk,
16:21 working either by themselves or a team of two
16:24 on something that wasn't super time sensitive,
16:26 and then driving home an hour.
16:28 Why make them do that?
16:29 Now, we know that a lot of this real estate debt
16:33 is parked with the regional banks.
16:36 And Julie, are we going to see a wave of distressed sales
16:41 from the regionals?
16:42 What's in store there?
16:45 So we've been waiting for this now for a little while.
16:47 And it's finally starting to accelerate.
16:51 Banks have realized they've got to cut some of their losses.
16:54 They've taken some assets back.
16:56 They've seen where the new values are.
16:58 And so they're willing to be more flexible and a little more
17:03 active on removing some of their exposure.
17:06 Remember, we have Basel end game coming,
17:09 which makes holding those distressed office loans,
17:12 especially, so much more expensive to banks for hold
17:15 and regulatory scrutiny.
17:17 So I don't think--
17:18 the Fed is saying, hey, friendly lender,
17:22 work with your borrower.
17:23 Help with the blend to pretend and extend.
17:25 Yet that regulatory pressure is doing the exact opposite.
17:29 So we're definitely going to see some friction there
17:31 as we move forward.
17:32 Well, thanks so much.
17:33 We're out of time, unfortunately.
17:35 We could go on much longer.
17:36 But it's such a pleasure to see Sean and to meet you.
17:39 Thank you so much.
17:39 Thank you, Julie.
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