Name: Future of Finance 2024: What’s Next for Real Estate in the Era of High Interest Rates
Uploaded: 2024-05-16
Duration: 17 min 46 s
Description: 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

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

Future of Finance 2024: What’s Next for Real Estate in the Era of High Interest Rates

Conferences

Sean Dobson, Chairman, CEO, and Chief Investment Officer, Amherst, Julie Ingersoll, Chief Investment Officer, Americas Direct Real Estate Strategies, CBRE Investment Management, Shawn Tully, Fortune

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