ULI Fall Conference – Chicago 

October, 2021

“Back in Person!”

I was so glad to be attending in person after two years!  In fact, last spring I boycotted  the “virtual conference” format.  I understand our attendance was approximately 65% of the normal fall conference attendance.  I suspect it is due to a combination of things including Covid, the virtual option and sheer laziness to return to a traditional way of doing things.

One thing I was determined to spend time thinking about this week is “return to work” versus “hybrid”, permanent work for home (or “live at work” as one of my friends coined the phrase), etc…..  The analogy I have concluded that sort of applies is as follows:  If you surveyed 5th grade boys and simply ask them if they want 2 more hours of recess or 2 more hours of math and science, a high percentage will answer recess.  If you survey those same boys parents, I’m quite certain the answer would be 2 more hours of academics (with the exception of course of a few foolish parents).  So it is now clear to me that a majority of employees want more flexibility and the choice to work either at home or in the office and a majority of executives and CEO’s want most employees to return.  However, the two sides are not as far apart as I originally thought.  Pre-pandemic the average in office days was actually 4.2 days per week.  The average employee probably thinks they would like to work in the office 2 days a week and I suspect the average employer would like to see at least 3 days.  There are a lot of questions about how to actually make it happen logistically, and I suspect some companies will do that well and others will fail miserably.  However, when employees wake up to the reality that their income will begin to slip if they are at home, they will eventually realize that proximity to the compensation decision maker is really important.  Also, the employers will realize that the company culture will slip materially without the initial interactions of working together in a physical environment.  And then of course there will be plenty of Facebook postings from an area winery during normal business hours which will absolutely require a response from a manager…and I seriously doubt it will be a “Like” or 👍.  I am still solidly of the opinion that between 2-4 years, we will be mostly back to where we were pre-pandemic in terms of office square footage demand and occupancies, however the employees will have gained a little more remote work potential.  Which…by the way…is where our firm has always been.

With regard to overall sentiment, the bulls prevail!  Other than office, most product types have had exceptional performance following the initial lockdowns.  In fact, one developer I heard from sold approximately $300M in homes and lots during the time they would have had best hopes to sell $50M. Talk about profiting from a pandemic…if you are in the real estate business you likely exceeded your best hopes for income during this period….which is the strangest outcome from what we might have expected in April of 2020.  Industrial is on fire and the expectation is for continuing strong performance.  And all housing is as well.  The overall sentiment also calls for continued cap rate compression.  Of course, this is when the old dogs say….every time sentiment was like that in my career, it immediately preceded a massive shift to a down market.  That is actually my big fear..I guess I am an old dog now.  One thing that I rarely heard mentioned was economic happenings in China.  There may be a serious debt bubble there.  We probably need to spend more time trying to understand or prognosticate how their central government might react to an economic crisis.

One economist on the main stage from the University of Chicago was Austin Goolsbee.  He was formerly President Obama’s chief economist so he comes with a strong pedigree.  However, I would suggest he get off campus a little more often and visit with people on the actual streets.  However, he did make some really interesting points about this cycle.  For instance he pointed out that during normal recessions, people cut back on durable goods spending.  But this time, Americans went crazy buying TVs, appliances and everything else!  He and I do agree that there will be a return to trend line for most everything within 5 years.  And we both also agree that supply chains really won’t become more resilient like people are saying because just in time and cheap imports are the lowest cost.  And urbanization has been consistently happening since the days of Alexander Hamilton and will continue.  He also had an interesting take on toilet paper.  The issue was that 35% of toilet paper in the country goes to offices and 65% is fluffy Charmin for the house.  When the lockdown happened of course the supply chain for toilet paper broke because so much more was needed at home!  Now…can I go a little offline here and suggest that you really should do your major toilet paper using at home!!!  Now this brings me to my biggest complaint.  Goolsbee barely mentioned the giant money printing presses that our federal government has been running.  In fact, he only once mentioned quantitative easing.  And he said that inflation is transitory…and will diminish and return to normal.  He is waaaaaayyyyyy off here!  Imagine telling the good folks at USAA who received starting pay of $21.00 per hour that we are returning to$16.00.  I would not want that duty!  From $16.00 last week to $21.00 this week is an increase of 31.25% to be exact.  Energy prices are up, container ships cost an extra $15,000 per container to expedite service, wages are up all over the place, material prices are up, rents are going up…and on and on….

With regard to capital, the spigots are wide open.  The entire pension system is in search of yield.  And in part because office is a nasty four letter word at the moment, more money is pouring into other property types.  Industrial and multifamily in the sunbelt are clearly the darlings, but pretty much so is everything else with the exception of office and senior housing.  Contrarians wake up!!!  Maybe it’s time to start planning new office buildings!  Cap rates will continue to compress due to a variety of factors, most of which I mentioned already.  Trended rents for pro-formas will easily carry 3% annual growth rates.  Exit cap rates will only be 25 basis points above today’s cap rates versus more historically higher rates.

Suburban housing will continue to flourish.  Buyers and renters will continue the age old trend of chasing better schools.  And the master planned communities will continue to see demand for multi generational neighborhoods and product offerings.  Not to mention better flexibility for the work from home folks.

Job growth is expected to continue and be broad based.  Secondary and tertiary cities will receive much of that job growth.  Cities like San Antonio are primed to receive much of that growth so long as they continue to deliver real high quality improvements to infrastructure, great schools and better amenities.  All of which can be summed up as quality of life improvements.i

One little interesting data point I heard is there are 28M people living in households with combined income of more than $500,000 per year and 75% of those do not own any real estate beyond their primary home.  Prepare to see more and more of these folks investing in real estate.  They should be a prime target for raising capital by local developers and investment operators!

All that said, the big three questions remain out there:

1. Will people live at work or return to the office…and when?
2. Is the inflation we are experiencing permanent or transitory?
3. How will prop tech continue to disrupt real estate…if at all?

I hope to see you all soon…and in person!

DA

David M. Adelman
AREA Real Estate, LLC