As I depart this week in the City of Angels, I leave just about as confused as I arrived.  Strange times indeed.  Interest rates would prove to be THE topic of most conversations and presentations.  In addition, it seems as if the following list summarizes the rest:

• Inflation
• Climate
• Homelessness/Public safety
• Housing affordability
• Debt refinancing challenges
• Office challenges

So where was the good news?  I didn’t hear much.  So that IS ACTUALLY THE GOOD NEWS….for a contrarian that is.  As you can imagine, the herd mentality is pretty negative particularly as it relates to new development in the short term.  All capital, equity and debt now have the opportunity to find higher yields in pure debt instruments outside real estate.  In particular, government bonds and high-quality corporate debt.  Therefore, it will be much more challenging in the near term to find capital for development risk.  While predicting interest rates is generally a fool’s errand, I would say there is much consensus that we are seeing normalized rates today that could last for many years.  While there is some reason to believe they could drop a bit, I would say plan for current levels with the 10-year Treasury bouncing around 4.5-5.5% for the foreseeable future.

The second area that will soak up capital is acquisitions/recapitalizations.  As many loans come due over the next year, many borrowers will find themselves unable to refinance their current debt.  Those deals will hit the market and in some rare cases will trade at attractive prices.

In the meantime, there was consensus that for any development deal that gets funded, the owners will be well rewarded for their efforts.  Clearly, sponsors with a good pro-forma, a proven track record and a good relationship with a local or regional bank will be able to proceed.

I actually believe that office investing may actually be a place to consider.  It is soooo out of favor now it reminds me of the RTC era.  Nobody was buying office in the early 90’s with the exception of speculators who believed in the product and had the fortitude to get in early.  I heard more than one person talk about the next generation of young folks coming into the workforce and lacking the proper experience and guidance offered by more seasoned co-workers in an office environment.  Interestingly, the US is furthest behind the return to office as compared to all of the other industrialized nations.  The new order of the day will require both employers and office building owners to create a compelling experience for employees to make it worth the commute.  Examples include food & beverage, events, fitness/wellness opportunities and whatever additional creative ideas to make the experience of coming into an office worthwhile.  I also personally believe that people will simply find it annoying to work in the space where you live and the attitude towards office by the employees will begin to shift as well.  At least for me personally I need the separation of work and living space.  The big question is how long and how much.  Time is uncertain, but I think every year will continue to improve.  I also believe that much of our office building stock is obsolete.  The obsolescence comes both from the building itself as well as the location.  In particular, walkable amenities such as an office near the Pearl or a regional town center will outperform a basic suburban office building surrounded by a parking lot.  I thought it was interesting that one company has a Director of Workplace Experience.  She said the office needs to be a destination as opposed to an obligation.   Additional examples to enhance experience include walking trails, bike facilities, wellness amenities, food and transportation, all of which can be a solution to employee friction. It was also pointed out that a #1 amenity is safety for both employees and customers.

Regarding public safety and homelessness, it was highly recommended to read San Fransicko in order to gain an understanding of how we have gotten to such difficult and sad conditions of people living on the streets.

San Fransicko: Why Progressives Ruin Cities

Michael Shellenberger

National bestselling author of APOCALYPSE NEVER skewers progressives for the mishandling of America’s faltering cities. 

Progressives claimed they knew how to solve homelessness, inequality, and crime. But in cities they control, progressives made those problems worse.

Michael Shellenberger has lived in the San Francisco Bay Area for thirty years. During that time, he advocated for the decriminalization of drugs, affordable housing, and alternatives to jail and prison. But as homeless encampments spread, and overdose deaths skyrocketed, Shellenberger decided to take a closer look at the problem.

What he discovered shocked him. The problems had grown worse not despite but because of progressive policies. San Francisco and other West Coast cities — Los Angeles, Seattle, Portland — had gone beyond merely tolerating homelessness, drug dealing, and crime to actively enabling them.

San Fransicko reveals that the underlying problem isn’t a lack of housing or money for social programs. The real problem is an ideology that designates some people, by identity or experience, as victims entitled to destructive behaviors. The result is an undermining of the values that make cities, and civilization itself, possible.

Switching gears, I heard an interesting anecdote regarding apartment leasing.  On a majority of leasing tours or first interactions, prospects want to know about retail amenities in the neighborhood before they ask about the specifics of the apartment unit itself.  Therefore, it is clear to me that mixed use developments and great neighborhoods will continue to outperform.

Not much was said about construction costs.  I suppose, much like trying to predict interest rates nobody wants to touch the possibility of declining costs.  That said, I heard one that actually didn’t surprise me.  A brand new 500,000 sf, class A warehouse in Northern Virginia shell cost declined from $65 per sf to $42 in recent days.  Another person highlighted a reduction of 9% on a warehouse in the DFW market.  That should be a real sign of cost reduction that I believe is forthcoming.

Quick hits:

-self storage, student housing, industrial outdoor storage (IOS) and other alternatives to the major product types are popular

-start loan modification requests with a $1M check

-insurance quadrupled and killed an affordable housing deal

-cap rates vs BBB bond rates are highly correlated

-Architects:  people are stopping cd production.  Only 6 of 10 moving forward.

-Civil engineers:  busier than ever and yet more no and slow pay than ever

I will finish with this.  Real Estate is and always has been a long-term investment.  Short term thinking will not be good for the next couple years.  Stick to your strategy:  build quality and operate with excellence and you will be fine.  That is why the line “Marry the asset, date the debt” is so perfect for right now.