Webcast transcript:
Willy Walker: Thank you, Susan, and good afternoon, everyone. It is a real joy to have Ed and Billy joining me today. Let me do some brief introductions of the two of them, and then we will dive into our conversation on issues that are so pertinent to the commercial real estate industry today.
Ed Walter is the global chief executive officer of the Urban Land Institute, a global real estate organization with more than 40,000 members, dedicated to responsible land use and creating thriving communities. Prior to ULI, Ed was chief executive officer of Host Hotels and Resorts. And prior to that, he was Host CFO. Ed served at Host, overlapped with four-year, tenure at Georgetown University as a professor where he created and taught the real estate public equity course. As industry volunteer leadership experience is equally expansive, including roles at the Real Estate Roundtable, the National Association of Real Estate Investment Trust and The American Hotel and Lodging Association. He is an active member and current chairman of the Federal City Council and is also on the boards of Avalon Bay Communities and Ameriprise Financial.
Billy Grayson is an expert in sustainability program development for companies and organizations and is the executive director of the ULI center for Sustainability and Economic Performance, which is dedicated to creating healthy, resilient, and high-performance communities around the world with a special emphasis on value proposition of sustainable design and development.
This includes the work of four programs within the center. The ULI Green Print Center for Building Performance, the Tenant Energy Optimization program, the Urban Resilience program, and the Building Healthy Places initiative.
Prior to ULI, Billy founded Bent Branch Strategies. And prior to founding Bent Branch, Billy was director of corporate sustainability at Liberty Property Trust, where he oversaw Liberty's sustainability strategy for more than 700 buildings in 14 markets, including standards for sustainability and development and property management.
So first of all, thank you both for joining me today. It's fantastic to see you both. Let's start with this Ed. I was at the JP Morgan bank CEO conference last week. There were a lot of smiles around the room. It's been a great time for the banking sector. And I've been to that conference at this time of year, many, many times where right after the great financial crisis, there were a lot of gloomy looking faces and as Dodd-Frank and other things were rolled out also a lot of consternation. This year, it seemed to be all smiles. As you look and talk to members of the commercial real estate industry, what's your take of the state of the of the industry in December of 2021?
Ed Walter: Willy, first of all, thank you for having both Billy and I here today we welcome the opportunity to engage with you on what we know is very well-regarded series of conversations that you guys have been putting on. It's fascinating to talk about sort of the current situation compared to the other one you reference, right for the great financial recession. Because to think that we would be looking at property prices where they are today in most sectors. Eighteen-twenty months after the beginning of a once-in-a-century pandemic, I'm not sure any of us could necessarily have predicted that when we entered into this back in March.
If you look across the sectors, the reality is that industrial, multifamily, single-family housing are attracting record amounts of capital, are looking at incredibly low cap rates across the board. And are seeing very strong demand. A lot of that driven by some of the trends that had started pre pandemic that the pandemic accelerated. And I'm sure we'll get into some of that a little bit later. Think the sectors that continue to struggle and were probably facing a little bit of a struggle before the pandemic, but the pandemic again, accelerated trends that were causing some of those problems are office and retail.
And ultimately, it's very much a lack of clarity around what the future of those sectors are going to face. That's creating some of the challenges there. But even in those sectors, I think, they're in a better position today, and have a brighter outlook than they did certainly this time last year. And my still favorite sector lodgings, the one that probably generates some of the most conversation. I mean, it's going to get better, right? Now, it's going to get better because I don't know that it could have gotten any worse. Having lived through 911, having lived through the financial recession in my two senior roles at Host, I thought I had seen the worst, but I was wrong because obviously what happened with the pandemic was even worse for lodging than either of those two things.
The numbers are getting better. We're actually seeing some weeks in the lodging business where RevPAR revenue per available room is actually better than 2019. And so that's unusual. Those tend to be weeks, at least what I've noticed, are weeks that are driven primarily by leisure business, because leisure, especially domestically, has recovered. Business travel, not so. I tell you the convention business as that's a big part of what we do is coming back. But it's probably not at the levels that it was before, but to sort of sum it all up. It is a bright picture for real estate right now. The outlook for the next couple of years is for continued strong demand growth. Rates are still low. You can question how long they stay that low. But we've all been asking that question for a while. As a result, cap rates are really low, so value is still pretty strong.
Willy Walker: So we're going to dive deep on a lot of those issues that you just brought up Ed, but Billy, thinking about the pandemic and its impact on commercial real estate and to the point that Ed just made as it relates to specifically in sectors such as hospitality, where we thought the GFC was about as bad as it gets, and it got a lot of worse. As we come out of the pandemic, have the issues that you focused on as it relates to sustainability, design, functionality, kind of gone to the back burner as people are trying to just figure out how to make buildings and industries work?
Billy Grayson: Yeah, going into 2020, things were looking amazing for the world of sustainability and ESG. People were finally starting to acknowledge climate risks and start to work them into their development and investment strategy. We're making great progress on the increasing the number of green buildings worldwide. And we were starting to understand what healthy buildings look like and integrate health into our development strategy. And I, honestly for one was nervous that this might fall off a cliff in 2020 as people focused on core bottom line issues. But all of the metrics that we're looking at suggest that's not the case. So, since 2020, we've seen a doubling in green bond issuance with more than $100 billion being invested in real estate projects through those green bond issuances. We've actually seen a premium for those green bonds. They're actually trading at a better rate than conventional corporate bonds. We've seen a number of owners of leading real estate companies make bold commitments to get on a path to net zero carbon with some of them achieving it in 2020, twenty to thirty years earlier than target, through a combination of deep energy efficiency that they could take advantage of while their buildings were mostly investing in on- and off-site renewable energy. And the prices come down dramatically for both on and off-site renewable energy in the last two years.
And then in the lead up to COP26, global governments and major US cities made big pledges, to cut carbon emissions. But these pledges were dwarfed by global capital who came in with a commitment to spend tens of trillions of dollars over the next thirty years to decarbonize every sector of our economy. And with real estate being responsible for 40% of those carbon emissions a big chunk of that investment is going to come to the real estate industry.
One other just quick anecdote that I would say, our green print members report to us on an annual basis on their energy and environmental performance. We were worried that 2020 might be a rough year for energy projects. They usually report all the energy, water, and waste efficiency projects that they're doing over the course of the years. Usually about 400 projects across 50 companies. This year was 1,447 projects. I think that speaks to the commitment that they have to driving decarbonization and also the value that they're getting out of it. While they could, they made these investments in decarbonizing their buildings, generating over $100 million a year in operational cost savings. You put a cap rate on that, they created a lot of real estate value during this downturn economically for many real estate sectors. So that was really heartening for us to see in our annual report this year The State of Green.
Willy Walker: Ed, I hear Billy dive into all of those statistics which quite honestly are quite surprising given I thought his response was going to be, “yeah, pretty much kind of survive for tomorrow has been the theme of the day and not sort of invest for the future.” And in the past, ULI has focused a lot on sustainability. The issue of the environment and the built world has been on creating a sustainable future. It now seems to be that it's changed to a survivable future. Talk for a moment about Net Zero or trying to become carbon neutral. And how big a challenge that is for the built environment, given that we contribute 40% of CO2 emissions to the globe every year.
Ed Walter: Yeah, it's a huge challenge. Right? I mean first of all, it's huge... but at the same time that it's a huge challenge, it's a huge responsibility and a huge opportunity. The stats we use regularly, the one you just quoted... so we're 40% of the use of energy. We have, if we're going to, as long as you believe the science, certainly at ULI we do. It's clear that we're going to have to reduce greenhouse gas emissions and we're going to have to work our way towards a Net Zero future, because Billy was describing GreenPrint is probably our leading way of trying to accomplish that and they are well on a path to a 50% reduction by 2030.
I think the strategy for us is both to find the ways to help the industry, find the ways to get there, what are the steps that you can take and at the same time to work with our communities and with local governments and organizations like that to make certain that the path that is charted for the industry is one that is sensible and makes sense. So, we did, I think, some great work with Washington, DC a couple of years ago, because Washington is one of the cities that has been most forward thinking of trying to establish targets and guidelines for the real estate industry in terms of energy consumption., I think that we were able to do some good work to help the city understand what the real estate industry could do and should be sensitive to as opposed to just issuing an edit that were supposed to be meet, without necessarily understanding the rationale or the repercussions of doing that. Billy, you might want to layer in on top of that, to be honest.
Billy Grayson: Yeah, I think one of the great things about how DC developed its climate action plan is they had a multi stakeholder, deliberative process, of setting their climate targets and the pathways to achieve them. So, for example, with existing buildings, we now have an opportunity for buildings that are in the bottom half of energy performance to hit a 20% reduction over the next five years through low cost, no cost strategies. They can follow a prescriptive pathway and work with a provider, the DC Hub to help train them up on how to achieve that 20% reduction through a specific set of things that they can do with the building. They have a green bank that they can tap into for below market financing, if they needed to hit their goals. Or they can pay a fine and just start to work on their performance improvement. And having that level of flexibility, I think was important to help all real estate owners be able to achieve these climate goals over time.
Ed Walter: Willy, I throw one other thing into this too, because it sort of relates to the question you asked Billy about what you thought might happen over these last two years. The sea changes happened in our industry, at least at the higher levels to me over the last twenty-four months is remarkable. I don't know whether the pandemic gave us more time to focus on it, or it simply is what happened. But the reality is, if you look across whether it's at the capital provision level, at the developer level, owner level, at the tenant level, it feels like we've gotten to a critical juncture where more and more people are no longer thinking about this just as a nice thing to do. It's coming something that we have to do. And I think that's... I can definitely feel that I've been here for 3.5 years. and I would say that number of conversations that I have around this topic, the member interest in this topic has transformed remarkably over that time period. And so, you could have seen the pandemic slow it down, but I think the reality is, if anything, it's just accelerated since then.
Willy Walker: So I want to shift gears a little bit here and focus on the trends report for a moment. And then I want to loop back to environment sustainability and many of the other things that we've just been touching on. Billy mentioned Ed, older buildings in DC being able to tap into this fund to do retrofitting of HVAC and other energy systems to try and bring down their footprint. One of the stats in the trends report that shocked me. I mean really shocked me. As we think about office, and office and retail being under significant pressure right now, is that there really isn't a market for B and C office right now. There's a very healthy market for A office, but B and C office is under a lot of pressure right now.
And one of the stats of the trends report put out was that in the United States right now, there is 4 billion square feet four B with B, 4 billion square feet, or close to 25% of the office stock that is B and C class that is in buildings that are over sixty years old. Just a shocking statistic to me because as I look at what's happening in the urban core in our country today, people aren't spending or going to spend the money to retrofit for office that B and C asset.
So, what do you think happens? Because by definition if the building sixty years old, it sits at main and main, if you will. The city built up around that infrastructure. And so, it's really well located. It's now to a great degree obsolete and with the patterns that are happening in office usage, hard pressed to think that many people go and invest new dollars in it. What's your thought is what happens to that stock?
Ed Walter: I agree with you. That stat was fascinating. I immediately underlined that when I was reading the report. And the other one that kind of goes with it is that the median age of the office in the US is for forty years.
And I never would have thought that either. Both of them suggest that the product that we have here is quite old. When I have talked with a number of the office developers and re-developers, I get a very mixed story about those older buildings and the ability to actually renovate them even still for office. Because they do say that some of the oldest buildings actually have the higher floor heights, depends on the building obviously, but sometimes have more space built into them that makes them easier to adapt either to continuing office space, taking advantage of that main and main location that you're describing, but certainly helps if you want to go towards housing. And my sense is that if that we do find that over the next few years, that we don't see the return-to-work levels, that we don't go back to normal. That was certainly the conclusion of our report is what we all saw prior to March of 2020 is not what we're going back to. Then I think for all of our cities, creating a way to encourage those older buildings or any building to be converted to residential, to bring people back downtown is going to be a critical step. Because we've got to make certain that there's still that activity level in the downtown core. We want those businesses that service those residents, which used to be office tenants, it now needs to be residents. We're going to need those people to come back to the city. And I think that's something that we will see. I don't know that it would happen at a main and main location but the other thing that I could envision is recognizing that the industrial sector is getting pushed further and further out in terms of new development. I think that ability to have facilities in the city for that last mile part of the distribution chain becomes another alternative for some of those buildings. But probably not the ones that are truly at main and main because the highest and best use will be something other than warehouse.
Willy Walker: Billy, are you seeing anything a from a retrofit standpoint? There's a big article today in the Wall Street Journal about malls and the pressure that many malls are under, and that it's tough to retrofit a mall even though some developers are buying them and using the land for more residential development and other uses. But as we think about the urban core and if that office space does become obsolete for office use, what are the dynamics that developers and investors need to think about as it relates to the cost and regulatory hurdles to retrofit?
Billy Grayson: That's a good and very complex question. We're seeing a lot of innovations in re-adapting spaces across the board. Very creative things. And some of them Ed mentioned. The biggest opportunity is creating more affordable housing and last mile logistics. But we've seen people look at urban agriculture and vertical farms as a solution for some of these.
Willy Walker: We just financed our first vertical greenhouse.
Billy Grayson: Yeah, which is fantastic. People are thinking about whether there's a way to build a new generation of retail that's multi-story and immersive through office buildings. People are thinking about ways to more effectively connect these buildings to the grid. And maybe it's the load shedding and load shifting and the power of that building that is going to help make the economics of the building more effective going forward. All of this re-imagining and re-purposing of buildings is great economically. But it's also a great sustainability story, because the most sustainable building is the one that's already been built. We're just starting in this country to get our head around the idea of embodied carbon and the life cycle of building materials. or every building about half of the carbon that it will create, it creates during the generation of the materials and the construction of the building. So, figuring out ways to re-purpose and re-imagine these buildings is not just good for the economy. It's also good for the environment.
Willy Walker: Billy just spoke about affordable housing, whether you could potentially re-purpose some of these buildings into affordable housing. In ULI's trends research report, which you do in partnership with PWC, you've done for forty+ years, and you interview, I think it's 900 people individually, and then have a survey out to another 1,200 people. So, it's a broad swath of owner/operator, participants in the commercial real estate industry. In that report for the last three years, the number one issue as it relates to housing, whether it's single-family or multifamily is affordability. It has been an issue that's been out there. It's not new to the table, but it seemed to be getting exacerbated today. As we see, single-family home prices escalate dramatically to price out a whole cohort of people who would be hoping to move from rental into home ownership. And as there is limited supply of new multifamily. And as a result of that, rents are rising precipitously. In your report, three of your four solutions to the affordable housing crisis rely on federal and local government. And when I read that, I sort of paused for a moment and say, where we going to find real solutions here. How optimistic or pessimistic are you, given ULI's influence on city planning and on regulation, and on the way that government officials view this issue, that we can come up with some real solutions to start to put a dent into this crisis of affordable housing in America?
Ed Walter: Willy, that is a great question. If you look at the track record that we've seen over the last fifteen or twenty years. Outside of the low-income tax credit program, it's hard to be particularly optimistic about our communities coming together to find solutions for this. I would say that there are some communities that seem to be taking this a bit more seriously. And governments actually making the changes that could be designed to drive more housing. Let's face it. This problem, it's an affordable housing problem, but it starts with the fact that we're not producing enough housing in the first place. So, we have so many policies across the country and so many roadblocks that are created that drive either larger lots, don't encourage density in the places where it should be encouraged, or just make it more difficult for a developer that might have a plan to do something that could be viewed as affordable to actually allow that to get off the ground.
Now you have seen, you know number one, there is, I think, part of the federal discussion right now, is increasing the dollars associated to be targeted to the tax credit program. That's a good thing. That's proven to be a generator of affordable housing. We should do more of it, and it's allowing the private sector to work its magic, as opposed to just relying totally on a government handout for that type of activity. I think the second thing is, and this is something we're trying to help communities understand better with the work we do in our attainable housing study. Is start to make it more clear to communities that because of the policies they've implemented, they're actually pricing the people that sustain that community, whether it's the teachers or the police, out of the... eliminating their ability to live in that community.
Right now, if you look across the country, in 60% of the top 100 markets in the US, a teacher earning the median income can't afford to buy a home. If you look at some of the major, in the major markets across the country, so are those big gateway cities where everybody has been doing well in the real estate sector, less than 15% of the homes in those markets are actually affordable to a family earning 80% of the median income, which is going to pick up a lot of those people that I just was describing. That are the people that make that city work.
So, it starts with the community recognizing that they have a problem. I think in a lot of cases, certainly around here, when I've talked to people in government here, they recognize that they have an issue. They're challenge is really getting our citizens to get in line with some of the solutions. But concepts like accessory dwelling units, concepts like in Minneapolis, where they, I think they've essentially prohibited single-family zoning within the city limits. Those sorts of steps do create an opportunity for more housing to be developed, and it doesn't necessarily have to be in big developments. It can happen in smaller, maybe in a more natural way. And that's a good way for cities to move forward to begin to address this problem, but we cannot underestimate the hole that we have created. I think I heard on the way in this morning that maybe this was quoting the journal article, we're short over 3 million housing units right now, and that's with the high level of activity that we have had on a new construction side this year. We just, we've got to make it easier for housing to be constructed in this country, or we're not going to solve the issue.
Willy Walker: So on that, let me jump on that as far as 3 million missing units, if you will, because the trends report puts another stat in it, which is very clear, which is July to July, ‘19 to ‘20, the US population only grew by 35 basis points, 0.35%, which is the lowest growth we've had in the history of the United States. As I think, both of you know, Zelman came out with a report called Cradle to Grave, where Ivy Zelman and Dennis McGill took a reasonably contrarian view to the lack of supply of housing in both single and multi and basically said that if the demographic patterns in the United States continue at this rate, with really no population growth and significant limitations on immigration, that we aren't going to have household formation in the United States like we've seen over the last several decades. And as a result, we actually aren't undersupplied in housing. Given the stat that was in the trends report, but then also Ed, given the stat that you just said that most people believe that were under supplied by three million, which is it? Focus on the demographic trends that say that unless we change immigration policy, we're going to run into a big wall here, and we're actually not going to be under supplied. Or is it that we're going to figure out a way to get household formation going? And that, if you will, long tail that Ivy and Dennis have focused on is going to be a long-time materializing?
Ed Walter: There's a lot in all of that. Let me see if I can unpack some of this. And then I'll let Billy correct me after I've said a few things. So, first of all, I don't view 35 basis point growth in population is necessarily the best course of action for the US. I think that certainly from a standpoint of strength of the country, strength and certainly strength of our industry, we should be targeting to see growth that's above that level, because I just think in general, for the health of a country or the health of a city, growth outweighs no growth.
The interesting thing in that stat, by the way, on the 35 basis points, is half the cities in this country, the major cities lost population last year. So, if you're in our business, you do not want to see that trend continue. Now tying that to the housing stat, I think that there's... certainly if we see population growth slow for a prolonged period of time as opposed to one year. And if we stop immigration, which again, I think would be a mistake because there's no reason why we shouldn't be trying to bring the best and the brightest from the rest of the world here. We will... the need for housing but will decline. But remember there's other things that are happening within our society too, with a standpoint of ...I don't have the stat readily at my fingertips. But reality is the size of the average housing unit has shrunk. So, we need more housing units in some ways for the same population because the nature of what constitutes a family has evolved too.
Willy Walker: And they're also working from home now. So, they need that home office that they never needed.
Ed Walter: That's exactly right. So, I think we still… we've got a shortfall, and we need to work through that shortfall as we look to the end of this decade, does it mean that whatever the number is of housing units we've been creating, if the average I'm making a number up here a little bit. But if the average has been over a long period time, a million and a half, that may come down, but that doesn't eliminate the problem we have right now, which is that we don't have enough housing units. And the other piece of this, too, of course is pricing. We probably don't lack units at the high end of the price range. But, where we've got a problem is at the lower end of the price range. And you drive in this morning, and I go to Union Station, and I don't think that 20 tents in the plaza in front of union station is the solution to affordable housing.
Willy Walker: Hence why Walker & Dunlop just made our largest acquisition ever in the affordable housing space. Billy, you want to add to what I just said as it relates to supply and demand on the housing front?
Billy Grayson: Yeah, I would just say that it's going to take a lot of years of negative growth in population until we actually feel a stress on our housing supply with 6 to 10 million people currently unhoused or under-housed, and probably another 10 million feeling housing stress because they're paying more than 30% of their income every month on housing. We are still deeply in a crisis. And I don't think population demographics are going to get us out of there for the next ten or twenty years.
Willy Walker: One stat I saw this morning on CNBC was that there are 11 million unfilled jobs in America right now. 11 million. So, as you talk about 6 to 10 million people looking at housing, there are 11 million jobs out there that are not filled. It's unbelievable.
Billy Grayson: I promise I won't tie everything to sustainability butt one other tie in between housing, affordability, and sustainability. We need to think about being modular, and adaptable. You know, we need to design structures that can be adapted for the use of the changing population, changing future of work, changing dynamics of families, changing immigration policies. If we adaptively re-using our buildings, creatively for what the needs are of the moment, and we're making them flexible and modular so we can take them apart or move them or reconfigure them in ways that will serve a future population, I think we're doing ourselves a service to be more adaptable for how these demographics are going to shift in the future.
Willy Walker: And Billy, I hear you put sustainability up there, and obviously, first of all, you're incredibly insightful on it and it's an issue we all need to focus on. But I want to ask the two of you, as you talk to developers, as you talk to owners about where they're going to go buy product. And whichever product, office, retail, hospitality, residential. And if you will, the intersection between public policy and development or ownership. And as I think about sustainability and read so much of what ULI's putting out, I can clearly sense that you all say this is a really big issue and it's coming to a theater near you. But it seems like very few are making their investment decisions based off of climate change or sustainability.
I wanted to ask the two of you, as you talk to developers and owners, if you had to rank order, what they look at as it relates to some policy issues that are driving their investments today. Is it climate change, tax policy, social issues on racial justice and defunding police forces, or rent control? Because those are four issues that are in the headlines every single day. What I'd love to get from the two of you is, how are people looking at those four very significant sorts of government social policy issues and the way that local jurisdictions are putting in laws to either control rents, defund the police, change tax policy, or focus on climate. Ed, can I come to you first to try and kind of sort through that list? And then I'll jump to Billy.
Ed Walter: No. I think that's fine. And I think that it's a very interesting question. At some of this, I think a lot of this can depend on, unfortunately, who you're talking to. My sense on this is that the major institutional level at the larger company level, when you look at those four issues, it's probably climates, number one. But I've seen a huge move on this over the last two or three years. So, we did some work with Heitman. We're on our third study with Heitman to try to understand how the investing world looks at climate. The first version of this basically came back when we surveyed folks. The answer we got was, we worry about it, but we basically handle it through insurance. And maybe we adjust our portfolio. And literally, I heard the head of one of the major opportunity funds essentially say I've got a short-term view. I just figure I can always address this with insurance.
A year later, same group, literally a year later, from the same group of people, he admitted that they were now doing a climate review, essentially, or resilience review of every asset they were buying. Starts in Europe, but it's come over here. We just actually had a board meeting for Billy’s center this morning, with some major institutional investors as part of that. They are all really focused on the climate issue. They're worried about it both from a standpoint of what it does for returns and then at an extended view, so they're sort of the risk of what the climate could do to you. But then there's also the issue of buildings becoming obsolete because they're not designed to perform well under sustainability standard. So, I think if you drop down to multifamily or single-family, I don't think that those issues matter quite as much. Some of the other points that you raised, which probably are more neighborhood focused issues when you think about policing, social, and racial justice, I think that probably matters more at that segment of the buyer population of investing population. But that's because they are driven by some different factors. Tax policy, it's hard... having come from the real estate industry, it's a tax product, right? Taxes always have mattered to our industry. It's been, fortunately, it seems like we're not going to get whip sawed the same way we have in the past by the legislation. So maybe that probably is what makes that less of an issue at the moment. But we both know that if something major is proposed, that will become all important for most of our investors.
Willy Walker: Two things quickly before I turn over to Billy and get his thoughts on that. The first one that is, I was in New York last week met with lots of big institutional investors. And interestingly, there was some talk about sustainability, but there was a lot of talk about rent control, and most of them are multifamily, they were focused on multifamily. And so, to your point, it depends on who it is and what product they're going into. But one of the comments that came out in one of the meetings was, Minneapolis is off our list of potential targets to buy in because they've just passed rent control measures. So, I do think that those issues of rent control as well as defunding the police are playing heavily in the minds, particularly on the multifamily side of a lot of big institutions.
The other thing is I mentioned at the top that I was at the JP Morgan bank CEO conference last week. I listened to ten presentations, including Jamie Diamond talking about the global economy, including Michael Cembalest, their chief economist talking about the core economy, and Karl Rove and Paul McGalla talking about politics. So pretty wide and broad. Not a person in ten presentations mentioned tax policy. And you think about it, that taxes have been an all-consuming issue, particularly in the real estate world. But broadly in the country, since the election, through the election and then with a new administration that was putting out there that they wanted to raise taxes dramatically. The concept that there would be ten presentations and not a word, not literally a word on tax policy is unbelievable to see where we've come from. And to your point, really nice to see that we're not going to be, at least for now whipsawed from where we were to where we thought we were going.
Ed Walter: I suspect that if that conference had happened in the beginning of September, when all those different provisions are being talked about that you would have probably heard a little bit different discussion.
Let me get back to your rent control point though, because I think it's an important one. I think that... I honestly can't figure out how governments think that rent control is the solution to the affordability problem. Because every study that I've seen would indicate that as soon as you put in an aggressive rent control ordinance, the only thing that happens is you choke the flow of new supply. I mean as you mentioned before, I'm on the board of Avalon Bay, and while I'm not speaking for them, I can tell you as a board member, that as we evaluate markets where we should build, and we are one of the most prolific builders in the country. It's a concern if there if a particular jurisdiction is talking about rent control, because it creates, even if it’s out of the box, it's not necessarily restricting what you can charge. The reality is it's going to undermine returns. And so, I wouldn't want to underestimate the negative effect that has, but it is limited generally to one segment of the real estate industry.
Willy Walker: Just to play on that for a second, I think it was four or five years ago. Fannie Mae held their annual DUS conference in Portland, Oregon. Clyde Holland, without a doubt, the largest developer of multifamily in the state of Oregon and Pacific northwest, said flat out, we are not developing anything in our home city because of the rent control measures. Here's the person who wants to see more than anybody the supply of new apartment homes, and yet at the same time is saying, given what's going on in my backyard, we're not putting dollars here. And so, they went and look for opportunities in Washington. They look for opportunities in Arizona. They look for opportunities in Colorado.
So exactly to your point, Ed, there's clearly a narrative that Elizabeth Warren is promoting, that rent control is needed and that she needs to be the savior for the consumer. But her economics are completely upside down if you talk to anybody who understands these issues as it relates to supply and demand.
Billy, let me come to you on this issue because I think it's a really important one. I know you have something to share.
Billy Grayson: Yeah, before I heard you guys talking, I would have said taxes broadly defined whereby far the number one driver, corporate income, and property taxes. Otherwise, we wouldn't see this tremendous boom in the sun belt and Florida, for example, if we were just thinking about climate change, social impact and rent. I do think it's worth noting, Ed mentioned this as well. There's a bifurcation in terms of the focus on climate change. The largest private equity, largest sovereign wealth, and institutional investors and the biggest global real estate investors have already assessed, priced, and started to mitigate climate risk in their portfolios. You may not see it with all the other noise that's happening in the market. But it is happening in real time. They are assessing those portfolios and re-weighting them to be de-risked when it comes to the long-term effects of climate change. At the same time, I don't think that's broadly happening in the market. Otherwise, it would be affecting the transaction price of a lot more assets at a lot of different levels.
On the rent question, I agree with everything has been discussed about rent control. We have a report coming out on this, I think tomorrow. So, it'll be an interesting report to read. But the report will also touch on the effect of eviction moratoriums than rent relief, which I think is another important part of this rent discussion. Because of the uncertainty of these programs, how long they'll last, how much money will be available, how well rentals will be able to access that money. It's causing a liquidity challenge for people who want to do transactions, because it's hard to... it's hard to project rent rates and vacancy rates in properties based on when these moratoriums will lift. And how long that relief will last. So, it's really hard to price an asset. I don't know that it's going to be a long-term problem for these assets, but in the short term, it definitely is complicating transactions, because it's hard to project NPV on a property that you don't know whether you're going to be able to get market rents, collect rents from the people who are there, or what your vacancy rate will look like when these programs ultimately run out.
Willy Walker: I'll be interested to see that report Billy, because I would just tell you from the volume of investment sales in the multifamily space that we are seeing and our competitive firms are doing, the market is wildly liquid right now, and there are transactions. The volumes are unprecedented as it relates the amount of transaction volume that's happening. And so, I very much look forward to seeing that to seeing kind of where those pockets are, that people are having a difficult time.
There was an article this morning in the Journal about Cipriani in New York. The fact that their rent forbearance is about to run out on them and that they own their landlord some massive amount on their defaulted debt of $54-55 million. We had a team dinner at Cipriani last week and I joked with my team that I thought they spent so much that they could have actually brought that debt current.
But the point being is just that to... exactly your point on that one. If you own that retail, if you own that office building that has the retail of Cipriani on the first floor, and those forbearance agreements are coming to their end, that's obviously exceedingly difficult to underwrite. Particularly if Cipriani goes bankrupt and isn't a great anchor to the retail in that space.
Let me, if I can, as we talk about markets, the trends report segments the country in a very interesting way. And I'd love to get your thoughts as it relates to the way what's happening today. I mean Billy you mentioned it relates to tax policy and the migration to Florida and to Texas. So, your report kind of segments the country into four distinct kinds of markets. So, you’ve got the magnets which are the cities that are attracting people and companies due to tax policy and other things. You’ve got the establishment, which is the gateway cities of New York and San Francisco, which one of the interesting points that your report brings up Ed, is that the population base in your magnets and your establishment is essentially the same. And yet at the same time, the productivity in the establishment is 44% higher than in the magnets. It's amazing that these, you know, the tech center, if you will, of San Francisco produces so much more output than some of these magnet cities that obviously have robust economies, but they're not kind of at the same level. Then you have the niche cities, like Baltimore that have medical and education due to something like Johns Hopkins sign of, not that I want to call Baltimore one trick pony, but what I'm... you know your report really focuses on something like Baltimore that people move there to really be around Johns Hopkins University and the research and the medical services that they provide. And then finally, the backbone, the cities that are cheaper to operate in, they're still vibrant, but they're not growing anything close to the magnets in the establishment. Talk through Ed, first of all, I thought the way that the report segments, basically what's happening in the country into those four buckets was fantastic. But talk about why it's different today than it was before.
Ed Walter: I think the trend that we've seen over the course of the last decade as we've done this report, is that we tended to identify what you described as the gateway cities or in our current vernacular, the establishment, routinely showed up as the top places that investors wanted to invest. And I think that was one of the things I noticed at Host is that all the capital seemed to flow to New York, San Francisco, LA, DC, Boston, those five markets seem to attract almost everything. And I think that's also, a safety element to that. But it was also that I think the recognition, as you described about the greater economic output that was happening there.
But for the last, I'd say, really the last four or five years. We've seen a shift, and I think a lot of it was driven by cost factors in those cities that they just got so much more expensive. That for a whole variety of reasons, whether it was home affordability, whether it was the commute, whether it was the overall lifestyle, you see and as Billy mentioned before, to some degree, tax policy, right? Because most of those places I just announced have pretty significant state income taxes. We’ve begun to see people move more aggressively into the sun belt. So, we kind of look at that magnet group when we talk about super sun belt cities, right? So that's Atlanta, Phoenix, and Tampa. We talk about eighteen-hour cities. So, they're not, obviously from the description. They're not open twenty-four hours a day, but it's more than just 9:00 to 5:00. There's a morning and evening component to it. Then the ones that just are the supernovas are Austin, the Nashville, the Raleigh/Durham, which are cities that are just growing aggressively and it's happening because the lifestyle is attractive, there's a lot of jobs there. Those last three that I mentioned are picking up on the tech. Really, the whole tech trend that drove San Francisco and Boston, but now is migrating to other locations, because it's an easier place to live and a more affordable place to live.
So those, when you look at the markets that were identified by the almost 1,000 people that participate in the survey, first one is, Nashville second is, Raleigh/Durham, third is Phoenix, fourth is Austin, fifth is Tampa, sixth is Charlotte. So, you kind of look across that mix and it's all sound. It's all... Phoenix is probably the largest one of those cities. It's all smaller cities, but they're all dynamic, and they're all growing incredibly quickly right now.
Willy Walker: Billy, do you want to add anything to that? Because I got a question specifically on sustainability in that, but anything from a more general approach as you look at the segmentation of the different cities and where people are moving?
Billy Grayson: No, I love the sustainability question. Growth is hard, and shrinkage is hard for sustainability.
Willy Walker: Here's my question. You hear the cities that Ed just talked about. And you hear Phoenix at the top of the list. I was in Phoenix in August, and it hit like the 62nd consecutive day or triple digit heat. And first of all, I looked at my colleagues and said, how do you all live here? They're like we go outside at like 5:30 in the morning and I was thinking I like to go outside 2 o'clock in the afternoon personally, but anyway, what's the ideal place for us to be built? If you could wave a wand Billy, and say every commercial real estate development should happen at this spot from a sustainability and from an energy usage standpoint. So really, is it better to be building in Phoenix today? Because you get three to four months a year where the HVAC turns off, but then it's running really hot for eight months of the year. Or is it better to build in Minneapolis where you're going between heating in the winter and cooling in the summer? And you've got two months in the shoulder season where the HVAC system might actually not be running at full capacity?
Billy Grayson: It's a very complicated calculation, and actually, at the extremes ends up closer to a wash, and it really depends on how many months you're running the heating or cooling. From a greenhouse gas perspective, Phoenix is probably better because you're only really cooling in a deep way for several months out of the year. But Phoenix presents its own challenges, right? You have to size your air conditioning to deal with the hottest day, the hottest fifteen minutes of the day, the hottest part of the year. And your entire utility infrastructure for the entire city has to be built around that fifteen minutes, because you need the power to be available on August 22nd, when it hits 115° and everybody's air conditioner sit at 68°. So, when you think brought about the building, Phoenix is going to be easier to handle from a greenhouse gas standpoint than Minneapolis.
But when you think about the entire infrastructure necessary for that hottest day, anything at the extremes is really terrible from an environmental standpoint. The best is areas that are temperate. You want to have a place that has a pretty good temperature year-round where you can keep those windows open and be able to take advantage of natural cooling and heating for your buildings. And you also want to be near a large body of fresh water that is not that likely to flood very often. So, a lake is better than a river, for example. You don’t want to be too close to the coast, both for sea level rise and extreme weather events.
Willy Walker: So on that point, Billy, you did this great segmentation in the report, which is the magnet, the establishment, the niche, and the backbone. Then you went into, and you segmented the country from an environmental standpoint on fires in the west, floods in the central zone and storms in the east. So exactly sort of a similar type question. What's the better... what's the easier natural disaster to deal with? I mean Ed I'm coming to you in a second on what we're paying for. But before I get to that, as you sit there again, back to the magic wand of energy usage, talk to me about, are you better to be in the west, in the center of the country, or on the east as it relates to this increased volatility in climate patterns?
Billy Grayson: So first I would say no place is safe if we don't figure out a way to stay below 1.5℃ of warming. So, if we don't hit our net zero by 2050 goals all bets are off in terms of the livability and the variability of certain climates. That being said, the safest place to be long-term is going to be north central, United States. Again, temperate more and more temperate climates every year access to fresh water, less exposure to extreme weather events and the long-term impacts of climate change.
I think that over the next fifty years, you'll start to see these stressors of extreme heat, polar vortex related cold, and drought become more and more of an issue to be coupled with storm and inland flooding events, hurricanes, and wildfires, which are also going to increase in frequency and intensity.
I hate to be a doomsday purveyor, but there really isn't a safe place. It's all about whether your city has the adaptive capacity to deal with those physical risks and make the investments necessary to make the city more resilient to that changing climate.
Willy Walker: It's interesting you say that only because when I was in one of my meetings last week with the institutional investor, said, we're no longer looking at Minneapolis from a rent control standpoint. I should have countered saying there's a lot of water and the climates getting more tempered by the day.
Billy Grayson: We've heard the same thing with Chicago and pension liability as the main reason that they're worried about, you know the long-term economic prospects. But place like Chicago is also in a pretty good position when it comes to being able to have the adaptive capacity to be resilient, but also being somewhat sheltered from some of the climate risk that we're starting to see.
Willy Walker: Ed, you've talked from a sustainability standpoint, a bunch about the cost to protect the cities, particularly on the coasts from rising sea levels. And there have been some reports that I believe are calling for hundreds of billions of dollars of investment in sea walls to protect certain gateway cities from the impact of sea level rises and unlikely, even though the way the federal government spending money right now, you'd think that they'll come up with the money, but you would think that there is some... there's some winners and some losers as it relates to building sea walls to protect these urban environments. New York, clearly such a dense urban population probably gets the dollars. Maybe coastal Georgia or South Carolina doesn't. How do you see that and how are you talking to government officials as it relates to the need to...? And I guess the other question is, who gets it? Who's really taking proactive measures on it today?
Ed Walter: I'm not sure that we have a completely clear picture on this, but I think what it's going to ultimately driven by is the value of the real estate and the value of the businesses that are most likely to be affected. Right? To just the logic of what you're describing, you've got such a concentration of wealth in New York, in Manhattan, in particular, they are going to ultimately build some sort of a sea wall type construction to protect Manhattan against storm surge and probably also just in general rising seas.
I suspect there will be parts of Boston that will do the exact same thing again, because there's just so much, there's so much wealth and so much value that's concentrated in there. I'm not sure Staten Island is necessarily going to get treated the same way as Manhattan. I think, as you look at most of the coast along the country, that the cost of this is largely going to fall on the real estate community is my guess, because the most logical place to collect this is going to end up being real estate taxes. And, obviously, we can pass that over time. The cost of that can be passed on to all the essentially the consumers of that real estate. But I still suspect that it's going to end up falling to that.
So, where you have less density, you therefore have fewer properties to spread that burden over. And consequently, I think it's going to be a lot more difficult for that to happen. I think one of the things that Billy group has been working on is trying to at least get some sense of what might happen with what we call climate migration, which is really the movement of policies that communities might develop to not rebuild a second or third time after there's been a major event. There were stories after the flooding from Harvey that there were homes that were in particular areas of Houston, and this was the third time that they had been affected by a "two-hundred-years storm in a twenty-year time frame”. At some point, we got to get smart enough to say what take your insurance, and go build somewhere else, don't rebuild here, because it just doesn't make sense with where we are. We're going to have to do more of that going forward. It's not an easy conversation to have, but the reality is that I think the insurance industry is ultimately going to drive it, right? With the fires in California, you started to see that absent a government requirement that some of the insurers provide insurance, home insurance for those homes. They were going to walk away from that market. The risk was too great, and they could charge the prices that were required to be able to actually do on an actuarial table, support that providing insurance. That's going to happen more frequently going forward as models get adjusted and begin to reflect the reality of the world that we're living in.
We know every time there's a major hurricane you see some insurers go bust and go out of the market and pricing goes up that ultimately attracts new buyers. But I think you're still going to continue to see this go up. And I suspect in the world we're in, it goes up faster and the terms change more radically and that ultimately translate into... have an impact on our business.
Willy Walker: I'm running out of time, but I want to ask you one quick follow-up on that and then I'm going to come to Billy and then we got to close out. I think you said Ed, in an interview I watched that 2017 was the worst year as it relates to environmental damage to commercial real estate that there were $300 billion of losses and that only half of it was paid for by insurance. Am I correct on that stat?
Ed Walter: I think that's right. I think that came out of the report that that that we had done that year, so which kind of gets to the point, right? Think about the magnitude of that loss that was not recovered.
Willy Walker: Right? It's amazing.
And so, Billy, as you think about these issues, and as Ed talks about, maybe Manhattan gets the sea wall, but Staten Island doesn't. You're interfacing with governments all the time. Who gets it? Whose... what state or mayor is leaning in on these issues to be ahead of the curve? Is it a political issue? Or is it just that they really are thinking long ball and not short ball?
Billy Grayson: Yeah, that's a really good question. I think Ed is completely right. It's value at risk and cost to protect that is going to drive these long-term decisions. Broadly, we have this term adaptive capacity, and the big drivers are money and political will to make the investments necessary and mitigating climate risk as well as the speed of action. Different cities at different price points are going to handle this differently. Boston has done some really creative things with zoning to start thinking about long-term migration within Boston associated with climate risk. We've seen South Florida be really proactive in figuring out ways that they can start to encourage migration to higher ground as well as mitigation steps like flood barriers, but also living sea walls, coastal mangrove reforestation, and other green infrastructure that can help mitigate the impact of climate events.
We see in cities with policies like Coastal Jersey, with their flood BIO program, or Norfolk, Virginia with their long-term zoning plans where they identify areas where they want to defend at all costs. They identify the areas where they want to grow and densify the city. And then they identify the areas that they're going to leave. They're going to leave back to the ocean at some point and try and manage a strategic cost-effective managed retreat to help people move out of those areas and into other parts of the city, cost effectively.
And I think those types of programs are going to be more effective, long-term with driving smart migration out of harm’s way than say where current federal flood BIO program is structured, or maybe some of the programs that we currently have between the banking and the insurance industry that I think will need to evolve over time.
Willy Walker: I've thoroughly enjoyed this conversation. I had a script all laid out for how I wanted to talk to the two of you. And it went out the window in about thirty seconds once we started our conversation. I've loved bouncing all over the place and really diving into some of the really significant issues that commercial real estate owners and developers are facing today. Ed and Billy, thank you both so much for spending the hour with me. It's been a real pleasure.
To everyone, thank you for joining us today and we will be back next week with the head of commercial and single-family lending at Wells Fargo, two of the most influential women in commercial real estate finance that exists on the face of the planet. And so, I'm looking forward to my conversation with Kristi and with Kara next week.
Thanks, everyone and Ed and Billy, thanks again.
Ed Walter and Bill Grayson: Thank you.
