CRE Analyst

Here are the trends and events that we think will define commercial real estate in 2024.

How to make a fortune: storytelling If you can combine observations in a way that resonates with human nature, excites, alarms, inspires laughter, wows, or motivates your followers, you'll make a fortune. And if you can spin a narrative that taps into the most fundamental aspect of human nature (fear) you can be rich, powerful AND famous. There are a few problems with narratives, though. Whatever you read/watch/listen to has a pulse on your sensibilities. Your outlets feed you what you love and what you love to hate. And since most of us depend on only a few outlets, they collectively keep pockets of us together like schools of fish, united around topical (but temporary) currents. Eventually, narratives shift and our schools scatter or get distracted. We regroup and move on to another narrative. But we rarely backtest old narratives. Consider these recent headlines: -- Return to office is 'dead,' Stanford economist says (CNBC) -- Real-Estate Doom Loop Threatens America's Banks (WSJ) -- The Real Estate Nightmare Unfolding in Downtown St. Louis (WSJ) -- The 'office apocalypse' is upon us (Business Insider) Now flip through this short 'quiz' on the state of the office market. Do these stats fit with the headlines above? Do they fit with your narrative? Do they make you want to attack the stats or attack the narrative? A bit of good news... The growing gap between narrative and reality creates economic opportunities. What are they? ------------- Thanks for sharing insights from CBRE's recent occupier survey Jessica M., Charlie Donley, Julie Whelan, and Richard Barkham. And thanks to Green Street for consistently publishing insightful real-time reads on property values (CPPI).

Why is U.S. housing so expensive? Politicians seem to have the answers... -- Greedy corporate landlords -- Not enough sites -- Not enough affordable homes -- Too many Illegal immigrants -- Restrictive zoning -- High downpayments -- Restrictive financing Mark Zandi, similarly recently provided the following summary: "The cause of the rising cost of housing is not a mystery: We simply don’t have enough affordable homes for rent or for sale. We have enough homes at the top of the market — homes that wealthy families can afford. But we don’t have enough homes for sale that aspiring homeowners can afford, or enough to rent that working families can afford. We estimate that, all told, the nation is short approximately 3 million homes, almost entirely in the bottom half of the market." From "Harris plan could solve the longtime affordable housing crisis," Washington Post editorial (8/21/24) ------------------- Here's what they're missing... 1. Plenty of available apartments: There are 1.6 million vacant multifamily units in the U.S., an increase of about 10% over the last 12 months. 2. Plenty of available single-family homes: The inventory of unsold new homes has grown meaningfully over the last year and sits more than 2x higher vs. post-Covid's tight market. 3. Zoning doesn't move the needle: One of the largest multifamily owners (EQR) owns more than 20,000 units in southern California, where ADUs are more viable. EDR estimates that it might be able to add 350 units via redevelopment. 4. Are housing costs a top concern? [We were surprised by this one...] Gallop polls Americans every year on what they're worried about economically. Housing concerns are relatively elevated, but not at an all-time high and most survey respondents aren't at risk of not being able to cover their housing costs. 5. Only 1% of U.S. homes are owned by illegal immigrants: Illegal immigrants don't move the national housing needle. 6. Rent caps don't work: Most researchers have concluded that, at best, rent caps don't make housing more affordable and, at worst, exacerbate affordability challenges. 7. Homes are expensive to build: This is the most important point. The cheapest apartment in a large market likely costs $250K+ to build. The cheapest single-family home is similar in cost in a far-out suburb. Add another $100-150K to that cost if you want to deliver a home in an infill-ish suburb. Bottom line: Housing is a complicated problem. Don't buy the simple solutions.

"Even Oprah has bad hair days, she just has a better stylist." There's no shortage of real estate players who have had a tough couple of years. Apartment syndicators, banks, and office investors get most of the headline attention, but everyone has their baggage. ---- Example: BX ---- Blackstone is the 800 lb gorilla in investment management and commercial real estate. The firm just completed what was arguably the best 10-year run in the history of real estate investing. Since 2013, BX's real estate AUM has grown by 18% per year and associated revenues have grown by 4% per year. But since the Fed's interest rate hikes, revenues have declined by about 5% per year and AUM has grown by less than 2%. ---- Takeaway ---- Had a tough few years? You are not alone. Even Blackstone is, relatively speaking, trudging through the mud. Ps - What's next for BX? Where do you look for future revenue and AUM growth if you're Blackstone Real Estate? Historical growth has been organic, but BREIT (a big historical driver) is now a headwind. Best guesses: huge data center bets, debt, and another monster BREP fund in a year or so. Then what? External growth/acquisitions?

Will it take 25 years to get back to 2022's peak capital markets activity? ---- Perfect storm ---- To call the post-pandemic property trading frenzy 'anomalous' feels like an understatement. Everything came together to promote transaction activity: -- Near 0% default rates -- Once-in-a-lifetime 0% interest rates -- Once-in-a-lifetime rent growth trends -- Relatively constrained supply (at the time) -- All-time-high dry powder -- Extremely active debt markets --- Big commissions ---- Which led to extreme brokerage earnings... More investment sales brokers than ever pulled in seven figures a year in 2022 and 2023. ---- 25 years?! ---- How long will it take to get back to those levels? At 3% annual growth, it would take nearly 25 years to hit CBRE's post-Covid peak. At 7% annual growth (CBRE's pre-pandemic investment sales growth), it would take more than 10 years. ---- Good news, bad news ---- Good news: transaction activity seems to have bottomed. Bad news: there's not enough to go around. Lots of people entered brokerage since 2020. It looked like relatively easy money. But it wasn't. Brokerage is hard. ...especially in investment sales, where advisors have to understand the intricacies of fundamentals, debt, equity, valuation, and partnerships. Will we see a widespread exodus out of investment sales? Probably not. But will many people find other career paths? Certainly. Those who stay and invest in themselves will be rewarded, but the light at the end of the tunnel is faint. ---- Office leasing? ---- Is office leasing the most underrated position in real estate right now? Leasing brokerage revenue is off the recent bottom and only down 9% from the peak. CBRE's leasing brokerage revenues cover multiple asset classes (mostly office, retail, and industrial), but office is a big driver. If you're a leasing broker, keep plugging. We see you climbing out of the abyss and with virtually no new supply and most tenants needing to reconfigure their space, you don't have to get too creative to pencil some productive years ahead. Source: CBRE quarterly filings. We use CBRE as an industry proxy since it is the largest brokerage and provides detailed revenue figures going back many years.

The fastest way to catch up on this week's happenings...

Clear as mud... The BLS made a big downward adjustment to benchmark employment earlier this week. The revisions disproportionately affect job types that often drive real estate activity, but the biggest impact likely relates to the Fed's dependence on unclear data in deciding when and how much to cut rates. From Oxford Economics: "Job growth was not as strong as previously thought between April 2023 and March 2024..." "The level of nonfarm employment for March is set to be revised lower by 818,000, or 0.5% (Chart 1). This is a noticeably larger than a normal revision." "The Fed is attempting to calibrate monetary policy in a data fog..." "The preliminary downward revision implies a reduction in monthly job growth of 68,000. Average monthly job growth between April 2023 and March 2024 appears to now average 170,000, compared with the 242,000 prior to the preliminary benchmark revision." "The pattern of revisions is interesting and implies that job growth during the benchmark period was even more dependent on government and education/healthcare than thought."

Rhyming (but different) real estate cycles... A real estate slowdown: 1. Lending slows 2. Spreads gap out 3. Equity requires higher returns 4. Equity fundraising slows 5. Dry powder dwindles A real estate depression: 1. Lending declines 2. Spreads gap out 3. Defaults mount 4. Losses mount 5. Banks/lenders fail 6. Equity requires higher returns 7. Equity fundraising stops 8. Dry powder dwindles What do these patterns have in common? They both start with debt. What do they NOT have in common (so far)? Debt contraction. A few days ago, we said that debt is the sun of the real estate solar system. This is what we meant. When mortgage lending slows, real estate investors experience pain. Not fun. But when mortgage lending contracts, i.e., lending institutions effectively pull debt out of the system, everyone suffers and the downturn feeds on itself. ...often needing governmental assistance to get out of the spiral. This downcycle increasingly feels like a painful reset. It will spark meaningful losses for some. e.g., office investors, apartment syndicators, etc. But, unless we see a sudden contraction of debt, income growth seems positioned to pull us out of this downturn.

Debt is the sun of the real estate solar system, and every few decades we live in darkness for a few years. Is this one of those times? There have been 10 (ish) real estate recessions over the last 70+ years. Every one of these recessions felt like a crisis at the time. Too much supply, falling incomes, high interest rates, higher default rates, more losses, etc. Serious stuff, no doubt. But two of these downturns were much more punitive than the others: the early 1990s and the GFC. In both instances, values fell by 40%+. Lenders experienced 30%+ default rates. Widespread bank failures. What differentiated these really bad downturns? Deleveraging. i.e., the amount of debt in the real estate system contracted. Lenders slowed their new loan production in every cycle, but they didn't actually pull debt out of the system (on a net basis) outside of those two really bad downturns. Both of those big contractions lasted about three years. ---- 1920s: the original real estate crisis ---- We don't have great data on outstanding mortgage debt before 1950, but we know there was a third deleveraging in the 1920s. Anecdotal evidence suggests it was at least as painful as the early 1990s and GFC experiences. So let's assume there have been three really bad real estate downturns over the last 100 years. ---- YoY Debt Growth ---- Jul 2022 9.0% Oct 2022 8.0% Jan 2023 7.4% Apr 2023 5.8% Jul 2023 4.7% Oct 2023 3.9% Jan 2024 3.3% 3.3% YoY growth in real estate debt is the lowest on record, outside of the 'really bad' real estate contractions mentioned above. Will we flip into a deleveraging cycle, or will this be a historically insignificant downturn? Your thesis on this should probably inform your real estate risk appetite. If you think we're in for a deleveraging, you should run and hide. If not, you should probably be 'risk on.' [This isn't investing advice.]

FastTrack: A unique (and proven) learning model for real estate professionals After five years and 15 cohorts of FastTrack, we recently analyzed the outcomes of our 1,000 alumni. Pre-course assessments: -- Overall (average): 55% -- Only 4% scored over 90% overall -- 82% scored below 70% overall -- Worst module: 95% scored below 70% on joint ventures -- Best module: 57% scored below 70% on acquisitions/diligence Post-course assessments: -- Overall (average): 85% -- Largest gains: JVs (+108%), debt (+91%), capital mkts (+72%) -- 44% scored above 90% overall -- Only 11% scored below 70% overall "What is the value of FastTrack?" -- Average answer: $25,218 -- Average from first five cohorts: $22,525 -- Average from most recent five cohorts: $29,164 -- Average cost of program: approx $5,000 ---- Our model ---- 1. Aligned participants: FastTrack isn't for everyone. It's hard. It's also not a career discovery course. It is built for dedicated professionals who need high-impact skills training. No dabbling. Every student and member of the teaching team signs a pledge before each course promising to engage fully in the content. 2. No grades, no certifications: We deliberately avoid certifications. Everyone involved believes that commercial real estate skills and fundamentals are valuable in and of themselves. 3. More than lectures: Traditional courses revolve around lecturers who share knowledge with students, who then affirm information on quizzes and exams. 4. Curration > teaching: Skills are learned, not taught. Our program is about getting the right people in the room, arming them with key industry frameworks, then putting them into real-world situations to solve on-the-job problems. 5. Large teaching team: We have a 25+ person teaching team of active real estate professionals. 6. Taught by practitioners: Every member of our teaching team uses the FastTrack frameworks and fundamentals in their day jobs. 7. Professional development: Our teaching team is overseen by two practitioners with decades of deal experience, a Real Estate Finance PhD with 20+ years of academic experience, and a Harvard-educated instructional coach. 8. Miminal marketing costs: To keep tuition as low as possible and fully invested in student outcomes, we don't pay for marketing. 100% of our alumni found us through former students, their employers, and/or LinkedIn. Ps - If this all sounds interesting to you or if you know someone who might be a good fit for FastTrack, our next cohort kicks off next week.