New Home Insights Podcast Episode 56 Transcript | John Burns Real Estate Consulting

Episode 56: Jeff Adler on the Resilience of Real Estate

 

Transcript

Dean Wehrli:

Hey, welcome to the New Home Insights Podcast by John Burns Real Estate Consulting. I’m Dean Wehrli, your host. Each episode, we’re going to bring you some of the best minds in the housing business talking about some fascinating topics, or trend, or innovation, or issue, just like the one you’re about to listen to. Enjoy.

Dean Wehrli:

Hey, everyone. This is Dean Wehrli from the New Home Insights Podcast. Today, we’re going to have Jeff Adler from Yardi Matrix on with us. Jeff, say hi real quick before I introduce the topic.

Jeff Adler:

Hi, everybody. I’m the Vice President of Yardi Matrix. Yardi Systems is a property management and technology firm for commercial real estate, we run about half the multifamily properties in the United States that are professionally managed, cover all different types of asset types. I run the data vertical of Yardi Systems called Yardi Matrix. And we cover a whole wide range of asset types. Multifamily, single family, built to rent, student housing, self storage, office, industrial. But my heritage is in multifamily, and that’s kind of my first love.

Dean Wehrli:

Awesome. Before we get started, we’re going to talk about a wide range of issues, including a lot some stuff about the commercial sector that we don’t usually cover here on the show. But I wanted to make an announcement for the show real quick. Jeff, please bear with us. New Home Insights is the winner of 12 Gold awards. Now if that sounds made up is because it is. I was just at the IMN Conference in Las Vegas. Jeff, did you go to the IMN this year?

Jeff Adler:

I didn’t make to that one, no. Sorry.

Dean Wehrli:

Anyways, driving to the venue and I saw a billboard from a law firm and it said, blah, blah, blah law firm, “Winner of 11 Gold Awards!” I’m thinking, that sounds kind of like a fake thing. So why can’t New Home Insights be the winner of 12 Gold awards? We did one better. So we’re the winner of 12 gold. Richard, Richard Mones, he does this with me, we are the winner of 12 Gold awards. Please tell everybody that.

Dean Wehrli:

So sorry about that. Let’s get started here. I would be willing to bet that most folks have heard of Yardi and Yardi Matrix. If you haven’t, you should have, because you’re one of the best and biggest, and kind of the key source of intelligence and data on a wide range. It’s not just apartments, it’s build-for-rent, it’s the commercial sectors like office and industrial and Self Storage, and student housing as well too, which I didn’t know about that you guys covered that.

Dean Wehrli:

So we’re going to start with apartments, we’ll talk a little about commercial stuff. We’ll talk a little more about build-for-rent as such a huge sector, it’s dear to my heart. And then we’ll end up talking maybe some kind of big picture stuff with Jeff. So let’s get started with apartments and kind of broad outlines. How would you characterize the apartment market nationally, right now? Rental rates, its hotness?

Jeff Adler:

Yeah, well, I’d say it’s pretty hot. And what really happened, there was a bifurcation, if you go back to sort of the immediate COVID period, right? March, April 2020. There was a real immediate bifurcation with the movement of people out of the top big cities into the sort of sunbelt and Western. But in terms of overall rental rates, there was a deep declines in the major cities and modest increases in the Sunbelt cities. Well, February or March, it was kind of like a switch, because the supply that kind of needed to be absorbed in a lot of these sunbelt markets suddenly did get absorbed, and rental rates just took off like a rocket.

Jeff Adler:

So for March through August, rents have been just crushing in terms of growth rates. And it is most prevalent in I’ll call it the Sunbelt cities where average rent levels from COVID are up 20 to 30% higher than they were kind of March in 2020. And even in the major kind of international gateway cities, those rents have kind of recovered, except for the only two spots in the whole country, downtown DC and downtown San Francisco. Everywhere else, rents are either where they were or slightly above, or just way above. And again, the way above is really a function of the movement of populations associated with COVID and now kind of a lower cost of living.

Dean Wehrli:

Let’s hold off on that stuff. We’ll talk about that at the end here. I knew you’re going to say downtown San Francisco, that the kind of core Bay Area really took a huge, huge hit. Do you know, have they recovered? You’re saying they’re still net down from the beginning of COVID-

Jeff Adler:

Yes.

Dean Wehrli:

Okay.

Jeff Adler:

So, for example, San Francisco downtown, I look at, say downtown San Francisco, all right? At one time was down 15 points in occupancy and 25 points in rent. Through August, occupancy has recovered to where it was pre COVID. But rents are still down about 12% on a new lease, executed basis, new leases. There are still a lot of leases that have to burn off. But again, that and DC are kind of the exceptions, downtown DC, are kind of the exceptions to everything else is going on.

Jeff Adler:

So just last month, we put out a report that said, new lease growth around the whole country was up on an average of 10%. But we’ve gotten to some markets like Phoenix, it was over 20. Tampa was 20. Vegas, it was like 18, 19. I have never seen that kind of number, period.

Dean Wehrli:

Those or the hot markets.

Jeff Adler:

Those are the hottest markets.

Dean Wehrli:

Temperature and market.

Jeff Adler:

Hot yeah, and business wise. But even New York and San Francisco and Minneapolis have at least now forward movement where they weren’t there before.

Dean Wehrli:

Have we seen any sign of any kind of a normalization? In the for-sale sector, we’re definitely seeing that. Maybe depending on what market we’re seeing it for last month, month and a half, two months. We’re seeing clear signs, some anecdotal but it’s more than seasonality and the market’s calming down. Are we seeing that at all, in the apartment sector?

Jeff Adler:

I think it’s more a return to a certain level of seasonality. And I don’t expect necessarily this level of growth to accelerate. Usually July and August are kind of the seasonal peak. And we do expect to see increases, but not at the same rate that we’ve seen. But still, this is pretty darn healthy. And what I also look at is the month to month acceleration. And it’s been pretty stout. I do think we’ll see some kind of return to a somewhat normal seasonal pattern, where usually September through February are kind of the weaker part of the leasing year, and then it accelerates March through August.

Dean Wehrli:

Actually it’s funny, that’s my next question was your crystal ball says that we are going to kind of calm down a little bit in the apartment market?

Jeff Adler:

A little bit, but it’s still pretty high. But yes, I do expect it to calm down some.

Dean Wehrli:

Do you do like national level prognostications? Actually, projections of year over year rents in say, for 22 or 23? Can you share that with us?

Jeff Adler:

Well, I mean, we do forecasts both at a national in a market and even a submarket level. And so we do expect this year to be kind of just… I’m rummaging around for my sort of a crystal ball here. Nationally, we do expect rents to be rather high, like an 8-10% kind of range. We do expect that to come down over the next few years and hit a more normal level, as the supply response catches up to this shift in the demand curve.

Dean Wehrli:

That’s another great segue, Jeff. A fantastic segue. So it’s supply?

Jeff Adler:

Yeah, we definitely do have… What’s kind of happened, and so you see this burst, right?

Dean Wehrli:

Yeah.

Jeff Adler:

And the reason that the burst happened was initially in the first wave of COVID, there was a fair amount of supply in the Sunbelt markets and you can use Austin as an example, where there’s a lot of supply in Austin in multifamily. And Austin didn’t show any rent growth for multifamily, and again, all the businesses were moving there, up until this spring, because it was a lot of supply to get absorbed. But the demand kept coming. And all of a sudden, Austin went from no rent growth to like, bang! And you’re in the high digits. And it now like last month, it was at 15% year over year.

Dean Wehrli:

Wow.

Jeff Adler:

And in Austin before that, had just… So what’s really happened is there was supply that in excess of demand in a number of these sunbelt tech hub cities. The shift in the demand curve soaked it all up. And as the demand kept coming, prices have escalated. And then new supply is being added, but it will not deliver in time for the next 12 to 18 to 24 months. It will come because these markets are generally supply friendly. But there is a period of time now where demand is outstripping supply.

Dean Wehrli:

That’s interesting because, again, to make a sort of comparison to the for-sale sector, we think there’s been a lot of activity here this year from the biggest builders in the country. So we see supply increasing next year in calendar 2022. You’re saying that, of course, there’s a longer build time for apartments, that sort of next wave of supply is more like 2023 ish.

Jeff Adler:

It was pretty much because of the timeframe it takes to get permitted and get going, and get through the planning process. And it does vary by city. And we take that into account in our delivery forecast. But we see 21 and 22 delivering about 355,000 or so units. We do expect the supply to ramp up 2023, 2024, 2025. But it’s not as easy as it seems, just because there is a process one has to go through with the exception of Houston when there’s no zoning. There is a public policy process that has to be kind of worked through.

Dean Wehrli:

Yeah, no, high rise next to a church, go for it, says Houston.

Jeff Adler:

Right. But they’re the exception, as opposed to the rule around the country.

Dean Wehrli:

How about, let’s end the apartment part of our discussion with values. Where do you see, first of all, have property values for multifamily residential, just have they skyrocketed roughly in time with rents?

Jeff Adler:

So what happened with values, and this is something we began talking about right after COVID. Because there was a significant reduction in debt costs. And as a result of that, what we saw almost right out of the gate, we could tell is that values in the core cities would be level. We didn’t see a lot of impending distress, and we didn’t see it. We saw a few properties in trouble, but not a lot. And then we saw rather significant, we expected 15 to 20% increases in valuations in all the Sunbelt cities. We’ve kind of seen that and more.

Jeff Adler:

So values are up a lot, what we call cap rates, which is just a kind of a price earnings ratio, is now, because again, because the drop in both interest rates and the expectation of revenue increases, it is pretty much everywhere sub four. And you can even get in the mid threes, and it isn’t that hard to do in some of the hot growth markets. And it’s because debt costs are so low, that’s still a positive spread, and that’s still an IRR, people are stretching, people a little complaining about how competitive it is to get to assets. So obviously, that’s making development interesting, right? Because that creates an opportunity to develop, but it does take some time.

Dean Wehrli:

Now low cap rates typically are associated with the idea that the investor sees less risk. Is it being driven by that now, are these caps rate also been driven by the competition to raise those dollars?

Jeff Adler:

So one, it’s driven by debt costs. It’s driven by large, by capital flows, because that really is the sort of the competition of assets. What we’re seeing here is, I’ll call it asset inflation, right? So if you have a lot of money sloshing around, and there is a lot of money, and cost of debt being very low, and the prospect for rent increases, revenue increases being stout, not 15%. But even a reasonable four or 5%, one or 2% over inflation, historically rents have gone up 1% over inflation.

Jeff Adler:

So what’s your inflation number, tag one, then add on a couple extra, right. You can get to that number without being too crazy. And there is a lot of capital that’s coming out of the office sector, is coming out of the retail sector that looks at multifamily and industrial is kind of the darlings of commercial real estate, and they want to get into the party. And so there’s a fierce competition to put that money to work.

Dean Wehrli:

That is another great… You’re helping so much with segues, by the way, Jeff.

Jeff Adler:

That’s because it’s my job, right?

Dean Wehrli:

Let’s turn to the commercial market. And before that, before we actually turn to one of my favorite topics, which is build-for-rent, we’ll talk a little bit about commercial market. So let’s start with Office. Is that bouncing back at all from the COVID shutdowns?

Jeff Adler:

It is stabilizing. The big issue, and it’s not surprising, the big issue with office is, what is the future of work? What is the nature of the way work is going… in particularly office using employment, right? What is the nature of how that work’s going to be performed in the future? And that is going through a sort of radical evolution, potentially revolution, between how often do you need to be in an office? What’s the value of teamwork? How does one build relationships that work? And so there’s very much this push pull, right? I mean, people have been working from home, most of the employment had been working from home for 18 months now. They have a new routine.

Jeff Adler:

It’s most of employee again, there’s lots of tons of employee surveys. Most folks, let’s say, if the people who worked full time from home were like 5%, that’s going to probably, could go to 20 to 25%. So people who work full time from home hardly ever come into an office. Then there’s another big bunch, a kind of thinking hybrid. “Yeah, I’ll come in two days a week, maybe two and a half,” whatever. And then there’s still about a third, I think of workers, will truly come back to work full time. And it’s really industry-based. If you’re in the financial industry, or certain deal teams, they need to be face to face and they are right now face to face.

Jeff Adler:

So it really breaks upon, if you’re looking at a city, what is the composition of industries in that city? That’s why you see different New York versus San Francisco is a bit of a dichotomy financial versus heavily tech, though, New York has a lot of tech in it. So this is where this is all playing out. And there’s really, everyone’s feeling their way. And so for office, you see that new lease rates are effectively down 30%. A lot of companies are sort of rethinking their footprints, nothing radical, nothing crazy. But trimming, like scaling things back. Sculpting, reorienting what their space could look like. And they have to be flexible, because no one really knows, you’ve just seen Apple or Microsoft push back their return to Office dates into January, and so that’ll be almost two years.

Jeff Adler:

And so there’s a lot that’s still in flux, though, from an occupancy standpoint, things look like they’ve stabilized. From a subleasing standpoint, things look like they’ve stabilized. But there is a lot of space, the new supply pipeline there is declining quite a bit. But it’s a sector where it’s still in flux.

Dean Wehrli:

Stabilizing, but stabilizing at a historically pretty low rate, am I right?

Jeff Adler:

And just, again, everything, the assumptions of the last 100 years have been significantly challenged. Now, in five years, we’ll be reformulated back to the way things were. Maybe, right? But usually, when you go through these kinds of just revolutions, you don’t come out the same way you came in, right? And so this sector, if you look at this so much more in flux, the reason that multifamily in the Sunbelt are so strong, is because of this exact issue on the office side. So they’re basically the other side of the coin.

Dean Wehrli:

How about industrial research and R&D stuff, warehousing? That’s kind of been the opposite, right?

Jeff Adler:

I would say in office, I was talking about general office, right? If I talked about lab space or medical office, different story, different dynamics. Those little slices of the office world are doing great. Now, if you go to industrial, industrial is being driven by eCommerce. So there is a incredible, like rents are escalating at enormous level. New supply and demand are roughly balanced. So there’s a robust new supply pipeline, but it’s getting absorbed. I mean, Amazon just saying they’re going to take down an extra 100 locations. And, I don’t know, 125,000 people just says that… And Amazon has been like 35% or 40% of all the new absorption of industrial space in the US. So they have a huge role.

Jeff Adler:

Industrial, again, is another one of the kinds of investor darlings. It’s got a lot of tailwind. And if there’s any sort of re shoring of some manufacturing, that’ll be an additional tailwind. So industrial is kind of on fire.

Dean Wehrli:

I mean, how long can that… It can play out forever. Is that how they-

Jeff Adler:

Well, forever is a long time, but if you look at the penetration of eCommerce into retail sales, it was growing at a certain pace before all this. It had like a one time jolt. And it’ll come down a little bit, but it’s still you’re now at maybe 15% of total retail sales, being in eCommerce. It could go to 30. I mean, so it could maybe take five, six, seven years to get there. So that’s a doubling. It’s got a fair amount of runway to it. And also throw in Self Storage is on fire. Again, Self Storage is a little niche sector, like it doesn’t sit anybody’s heart on fire, but it benefited from the movement of people.

Jeff Adler:

So Self Storage did great in the course, in the international gateway cities when multifamily got crushed, because people were leaving. It did great in the Sunbelt cities because people were coming. It got better. And it was in such a dire issue with new supply. Street rents were declining for like two years, all of a sudden, boom! They’re up 15%. So they’ve had a demand shift as well. So if I look at any asset type that is related to the housing of people or the movement of people, it’s on fire.

Dean Wehrli:

Or selling people things, right?

Jeff Adler:

Right. So all of these COVID issues, or were trends that were there that have been accelerated, right? It’s where things have kind of been going. And retail is struggling, it was struggling before, it’s struggling still, it’s finding a footing. Before the savior of retail was experiences, in person experiences, were going to save retail. COVID blew that out of the water. So it’ll find a footing and there is sort of like the marquee, best malls and the best strip centers, those are okay. But it’s going through a transformation itself, where both retail and office are becoming more about the experience as opposed to the function. Again, so high variance of outcomes in those two asset types.

Dean Wehrli:

That’s exactly the point. If retail is not experiential, it’s not for selling things. Everybody’s getting there, they’re buying things online. So a retail center really has to be about enjoying yourself while you’re there, because otherwise you wouldn’t be there.

Jeff Adler:

Right. Or even grocery anchored retail, which was like the best thing since sliced bread. Well, more of your food is being delivered, right? The bottom line is we’re talking about housing, and the housing of people. This is the place to be, like where people live is where there’s been enormous success. And also, you got a lot of tailwinds ahead of you. So it’s a great bunch of sectors to be in.

Dean Wehrli:

How about student housing, though. That’s a little bit different in terms of where people live, because people aren’t physically on campus like they were. Has that sector been a little bit more like office?

Jeff Adler:

Student housing did go through a shock, because it’s about the gathering of people, right? The gathering of the kids and being in person. And the 2020 school year was like a cluster. And the fact of the matter is, going into the fall of ’20 into the end of 2021, the sector didn’t do so bad. It was three, four points off the leasing. Rents didn’t go up much, but it didn’t fall apart in any way. Except, except, so the sector did fine, except if you were a school in a big city where the state had kind of shut stuff down. New York, California, those schools didn’t do well. Or you were a third tier school.

Jeff Adler:

The schools that did well, and we can see a continued consolidation here, is major state universities where the population is growing and the business climate is pretty good. And so we’re seeing this continued consolidation, where weaker universities are losing out, and the stronger, larger universities are winning. We do see a trend toward hybridization of schoolwork and education. But at the end of the day, this sector, finishing up this academic year, has done great. Overall rent growth, it was 2%, which is good for students. Occupancies were sort of very close back to 2019. So as you go on from the ’21 to ’22 school year, the bottom line is just like a K through 12, people are going to go to school. There may be disruptions, but they’re out of the house, and they’re in the school.

Jeff Adler:

So student housing survived. And it actually proved its resilience. It didn’t do quite as well as some of the other sectors, but it also proved its defensive nature.

Dean Wehrli:

That’s interesting, because it might be a little bit like retail in the sense that college life to actually want to go there has to be again kind of experiential, and student housing coming back kind of indicates that things are going a little bit back to normal.

Jeff Adler:

Right. And they had a bit of a tailwind because the dorm capacity just didn’t quite work. The dorms weren’t set up for social distancing, and they had to basically take out dorm capacity for COVID isolation wards and stuff like that. So it actually, student housing did okay, and it set up now for continued… It’s got demographic issues which is driving into consolidation, but the sector is in solid shape.

Dean Wehrli:

Okay, let’s switch to one of my favorite topics, which is build-for-rent. First of all, build-for-rent versus build-to-rent, BFR versus BTR. It’s a battle going on, who wins?

Jeff Adler:

So the sector that we cover is communities over 50 units that are purpose built to be rented.

Dean Wehrli:

Yeah, I mean, just the term–

Jeff Adler:

Build-for-rent, build-to-rent. My little sort of thing is SFR BTR. Single Family Rental Build to Rent. There’s a bit of a nomenclature war over exactly how you’re going to call it. I’ll put in my two cents, we’ll see what happens, all right?

Dean Wehrli:

We use BFR, by the way, not BTR.

Jeff Adler:

All right, BFR, BTR.

Dean Wehrli:

Either way, it’s booming. And I know you tried that space.

Jeff Adler:

We do.

Dean Wehrli:

Single family rent, SFR data was used as a proxy for a long time and they’re really going for build-for-rent. And I know, single family rental a year on an annual basis, I suddenly like 30 years has never had a negative year in terms of price change.

Jeff Adler:

Which is amazing.

Dean Wehrli:

That’s incredible. What’s happening right now with respect to like you said, purpose built, BFR, BTR, purpose built communities of rental houses. What’s going on in terms of depreciation right now there-

Jeff Adler:

I mean, so just to describe to you what we do, we have identified about 875 properties that comprise about 120,000 units of this sort of asset type. So remember, we have 19 million multifamily units. So it’s small relative to multifamily, obviously, it’s also small relative to the single family inventory. But within that 120,000, 35,000 are in some form of new supply. So it was a super small segment, and it’s growing rapidly. And the amount, there’s like $11 billion that are committed to it, and there’s more coming. And if you think about this sector, and I was involved in the single family rental business, scattered site business back in 2010 with one of the earlier companies. So the whole sector began to professionalize coming out of the GFC. And it sucked up excess supply. And the big issue was to develop the technology to manage scattered sites, and they have done that enormously well.

Jeff Adler:

And then you got to a point, and this started pre COVID, where certain developers both traditional single family developers, as well as traditional multifamily developers said, “Hey, we’ve run out of the cheap stuff that we can gather scattered site. It’s tougher, and we’re going to go start building these communities purpose built.” And there’s been a couple generations. NexMetro started out in Phoenix, which is the hotbed of it, where it was started out really for people who wanted pets. Not three to four bedroom house, but one and two bedroom with a yard for a pet. And they’ve had success, and then Lennar has built some properties that look like real traditional, single family, three, four bedroom homes in a community that’s centrally managed. And this sector, like with COVID, it was already kind of happening. But it’s really quite small. There’s a lot of runway here.

Jeff Adler:

If you think about the fact that single family homes are expensive, and you still need a big down pay. And the demographics are that more people are aging into the prime home buying years, and if they can’t buy the home because of cost, but they still need the space, single family rentals that are purpose built are a great option. And again, if you look at this, if you go back 25 years, 30 years, single family is following the same trajectory as multifamily did coming out of the S and L crisis. Same trajectory, same level of technology development, same level of developing new communities builds for rent.

Jeff Adler:

So this is a natural progression. The sector is burgeoning. There’s a lot of supply coming. There’s a tremendous amount of demand, we’ve done a lot of work on just looking at price points. The prices themselves are growing at twice, up until last month. So if multifamily was at, I think July, multifamily was eight and single family rental build-to-rent was like 14. Then this month with August, so multifamily was 10 and single family rental 14. I mean, that’s a big number. And again, like rents growing at that level probably are not sustainable forever. But the product type, it makes a ton of sense. There’s a need. Most people are paying not far off of what multifamily rents are, they’re going further out for more space. And the economics are totally there.

Jeff Adler:

It tends not yet to be sort of families with kids. Families with kids, if they’re renting a house want it in an established School District. And that’s really scattered site. What you’re getting is people who are couples with preschool aged kids, or people with pets who need more space, and are willing to go a little further out to get that space, pay about the same as what they were paying before a little closer in. And because there’s more flexibility about working in your work environment, that’s not that big a deal. So the economics are there, the sort of space trade off is there. I feel what I think this asset subtype is going to do extremely well in the future, there’s significant demand for it.

Dean Wehrli:

So speaking of that, I know in the SFR long term data norm, it was kind of a slow and go price change. It didn’t go negative, but it was slow and go. But 14% in the BFR world-

Jeff Adler:

Unbelievable.

Dean Wehrli:

Okay. So, do you see BFR having more fluctuation more like apartments, than SFR? Does that make sense?

Jeff Adler:

Yes. It will probably be more volatile than scattered site, just because of the nature of the renter and the decision making. And quite frankly, new supply will continue to be added. And so there will be more fluctuation in the rents, but the people who are in the business of managing them are in a better position to absorb that volatility and to manage that volatility, because it’s professionally managed. They have revenue management systems, they have better marketing systems. so I think this sub sector has a very bright future for us.

Dean Wehrli:

It’s funny, you say that, because we do a lot of market feasibility studies in the BFR world and site specific potential developments. And we’ve noticed that, often, if we’re in a market that doesn’t have existing BFR, which is a lot of market still shockingly. You often will look at apartments as a proxy, and then also the mom and pops, the single family, the scattered site, things. We’ve noticed that the mom and pops in this fast moving market, they just simply aren’t attuned to how rapid rents have gone up. And they’ll lag significantly time one – time two the apartment sector. So the professionally managed BFRs can capture that, can’t they?

Jeff Adler:

Yeah, and look, if you’re a mom and pop and you have a small portfolio, you care much more about the… I just did the same thing in the apartments, right? You care much more about the volatility of your cash flows, because you have to make your mortgage payments. And so you will not try to optimize rents, you’ll try to optimize occupancy and accept sub optimal outcomes for rental achievement. If you’re professionally managed, you’re better capitalized. And you’re going to go for the sort of optimization and you’re willing to accept some volatility and occupancy in order to achieve higher rent growth and therefore also higher valuations upon exit. So they have different objectives as investors, and that sector is big enough for both.

Dean Wehrli:

Yeah. And of course, as we know, the vast majority of rented homes are from mom and pops.

Jeff Adler:

Right. And it’s a very kind of favorite asset class for the small investor because the entry the entry cost is lower. And there will be continued consolidation. I can go talk about how multifamily took many, many years for it to be become more professional kind of institutionally owned. Self Storage is still largely Mom and Pop owned, but there is an institutional sector manufactured housing, similar destinations. So single family rental is going through that evolution, but it’s just a huge asset class, that it will take an extended period of time for this to happen. And there are public policy questions that are sort of beginning to bump up against, is that a good thing? Or is it a bad thing? What’s good about it? What’s bad about it?

Jeff Adler:

If you look at the, what’s the individual kind of property owner has been the person who’s borne the brunt of the eviction moratorium. And they’ve been the ones that have been most affected because they were the ones who tended to rent to, let’s say, they didn’t have a super professionalized screening. They didn’t do a lot of rent income analysis. And so they’ve gotten hurt. And they’re the ones who also have not really gotten any relief from the rental funds that are supposed to be there to cover those obligations, and there’s $46 billion, which is supposed to go largely to them.

Dean Wehrli:

Okay. Let’s talk about supply a little bit. I know Phoenix is by far the king of the BFR world in terms of just volume units.

Jeff Adler:

And new supply, the new supplies coming there. Sure.

Dean Wehrli:

I just at the IMN Conference I mentioned a little while ago, I can’t remember who it was, but a panelist there mentioned that in a couple of the key sub markets in Greater Phoenix, like the Northwest valleys, something like half the pipeline was for BFR units. Half the residential pipeline.

Jeff Adler:

Yeah, which surprised me. Look, if you’ve got apartment rents going 20% a year, like the economics of a single family home in a build-for-rent community is going to look pretty darn good. So again, this doesn’t surprise me at all. There’s a significant shortage of housing in the metro Phoenix area, largely driven by migration of people out of California. And that’s affected Las Vegas and it’s affected Reno, and it’s affected Boise, and it’s affected to a lesser extent, Portland, Seattle, and Denver because they were a little more expensive in the first place. But it’s also affected Albuquerque.

Dean Wehrli:

Is there a next Phoenix specific to BFR? Maybe not at that volume, but a next where you see BFR, a market where you see it just starting to build.

Jeff Adler:

Well, the Carolinas are busting out. So Raleigh, Charlotte, anywhere in South Carolina. Florida, Orlando, Tampa. These are markets where there’s pretty decent access to land and growing populations and rising values and rising rents. So a lot of these markets are going crazy. Obviously, the Dallas Metroplex, Austin. So you pick any rapidly growing metropolitan area, and you will see meaningful supply, both in multifamily for garden apartments in the suburbs, as well as single family build-for-rent, build-to -rent.

Dean Wehrli:

One thing we’ve not yet started doing these BFR studies, as we do. I’m based in Northern California, I kind of cover Northern, Central and Nevada. I’ve done studies all over the country, but you don’t have to get in a plane anymore except to Vegas, occasionally. But I’ve noticed that the studies have gone from places like Merced or Modesto or Carson City, smaller, outlying cheaper markets. And now we’re in, hopefully  you know the Sacramento area, places like Roseville, Elk Grove, more core suburban, more expensive markets. We’re starting to get some play in the core Bay Area, and some folks looking at those kind of areas. Do you see that nationally? Do you see, because BFR was on a national basis, is in the cheaper, the relatively less expensive land markets. Do you see that starting to migrate into more expensive markets yet?

Jeff Adler:

On the fringes of those markets, yes. I mean, look, in order to make the numbers work, land still has to be relatively inexpensive, because you’re talking about, you can’t go up in terms of the space. And part of it is in fact, the fact that there is no one over your head, and there is a little bit of space and a bit of a yard. And so, it is on the fringes, you have to look at the land use in the highest and best value of that land. And it is on the fringes, the suburbs, the outer suburbs of those major metropolitan areas. But those areas are growing rapidly. So it doesn’t take a lot of thought to think, well, within five or 10 years, that section which is on the fringe will not really be on the fringe, right? Because it will grow into, the area, it’ll grow into it.

Jeff Adler:

And that’s really where the biggest growth. That’s where my head’s at, is I just love it. It’s doing fantastic. And I think it’s great to see innovation in meeting consumer needs. And so this is an innovation in the meeting of consumer needs that people want extra space, they don’t want to or don’t have the capital to put into a home, but they want the use of the space. And I see, it’s great that our industry is able to respond to meet that consumer need. It’s a very positive development.

Dean Wehrli:

Let’s wrap up with a few big picture kind of questions. Let’s start with investors and finance. Where do you see or are seeing most of your investor attention going right now? And say the sectors you cover?

Jeff Adler:

Well, so if you think about this, it’s really a question of which investor with what return threshold? And that’s really the issue at hand. And usually, it starts at the top tier of the investment world with the lowest sort of acquired returns, and then things cascade down, honestly. So what has been happening in the sectors that are covered is office investment was the purview of organizations that had needed to write a very big check that we’re looking for sort of bond like returns, and loved office, because of the both large amount, the marquee locations, the creation of wealth in these international gateway cities. And that capital, which was a significant amount of capital, it’s not necessarily going back into office, is looking for a home elsewhere.

Jeff Adler:

And that capital had tended to be concentrated into the large international gateway cities. So as that capital has moved out of those cities into what we would call the next tier of the top 30 or 40 metropolitan areas in the US, we call them tech hub ish, right? They have entered those markets with lower return expectations than the investors currently in them. And prices have gone up, values have gone up. And that means other than those investors have said, “All right, well, I’m either going to have to go further out in that metropolitan area, find a more deeply distressed property if I can, or I’m also going to search for new markets that were smaller than the top 30 or 40 markets I was playing in.

Jeff Adler:

So there’s a cascading movement of investors basically deploying their capital to try to hit their returns. And so it flows from the international gateway cities to the tech hubs, the tech hubs, the tertiaries, the tertiaries to the fourth level Metropolitan area. Every time you say that, I can’t come up with the term. Or, we have other folks who are just sort of saying, “You know what, I know these cities, I’m going to basically go into development.” But I saw a lot of developers that were only doing core high rise international gateway cities say, “Nope, I’m going to next 30, 40 cities. I’m buying every damn piece of land I can get my hands on in the suburbs, and we are building.” And they are.

Dean Wehrli:

But they’re not omnivorous in the sense. I mean, are they thinking BFR? Are they thinking apartments? Are they-

Jeff Adler:

No, they’re thinking apartments. What I meant was, you also have a group of developers, right? They were funded by big institutions, big life insurance companies, international investors, who were building either office or they were building multifamily international gateway cities. And they just said, I’m just going to pick up my chips, and I’m going to go to an Austin, a Dallas, an Atlanta, a Tampa, an Orlando, a Nashville, a Raleigh. We look at the demographics, they look at the land, they say, “Okay, where can I buy land that’s in the suburbs? Boom! I’m going.”

Jeff Adler:

So, that is kind of playing itself out. Yes, cost of construction have gone up, material costs have gone up. But rents have gone up a lot too. So it hasn’t stopped development. There’s been pauses where people need to say, “Okay, I need to redo my numbers. See if they still pencil.” So, yes, but things are moving pretty nicely. So, the investment community is very active. There’s a lot of capital that wants to find a home. There’s no crazy underwriting, like it’s not nuts. There is a reasonable amount of discipline. There’s also reasonable amount of transparencies in these industries. So it’s not opaque, people know how much supply there is. They know where the next deal is because services like mine expose that information. So there’s a fair amount of transparency in these previously opaque asset types which have tended to reduce the fluctuation in supply overhang.

Jeff Adler:

If you go back historically, the amount of supply overhang has progressively gotten squeezed out over the last 20, 30 years.

Dean Wehrli:

Yeah. How about in terms of the motivations? We talked a little bit ago about this great migration.

Jeff Adler:

Yes.

Dean Wehrli:

I mean, on a national level, these folks have followed the activity into these new and upcoming emerging growth markets.

Jeff Adler:

That’s right. Look, the reality is, it is driven by the fundamentals of population movement, and the earnings power and wealth of those populations. So, what we are seeing is, again, if you remember the renovation of the urban core was a 1990 to 2020 experience. 30 years, where the urban cores that have been hollowed out in the 68, 69 period, and the 70s came back and those cities became revitalized. Now, it also was coincident with the sort of millennial generation entering the workforce. So there was there was a movement from the suburbs into urban areas, because the demographics favored it.

Jeff Adler:

We always knew that as the millennial generation age, which is very large, I think, 80 million or so, that as they age, they would be a gradual movement to the suburbs. We also knew that there would be a gradual movement to lower cost cities, because not everybody would become a gazillionaire. And they would acquire obligations. And they at some point, they couldn’t afford a home in San Francisco, and they’d have to move. And these things were already happening. They were happening a little bit on a slow roll. COVID just turbocharged everything. We had about five or six years worth of migration happen in about six to seven months. And then you’ve got this overlay, so the movement of people isn’t done yet. Because people are still sorting out like, where do I want to live? Where do I want to work? Where do I need to work? That’s all still happening. And I think there’s another two years at least of the population is sorting itself out. And investor activity is just going to follow the people flat out.

Dean Wehrli:

On a market basis, then that’s been this kind of flight from urban to suburban or exurban spaces-

Jeff Adler:

You’ve got to understand, so there is a recovery, though. I don’t want to be Cassandra like. There is a recovery, which has occurred in the international gateway urban cores. There are younger people who do want to live there. If they don’t have to work there, they want to live there for the lifestyle, for the urban, for the number of other people that they’ll meet. So it’s not as if those urban cores, international gateway cities are dead. Far from it. Okay, far from it. They do face some headwinds, they still have some new supply coming on.

Jeff Adler:

The demand will be among younger folks. Remember, you also had like two years of migration that would have gone into the urban centers, didn’t happen. And so that will kind of come back, and so you’ll see a bit of a pop. I don’t think you’ll see the rapid kind of rent growth in the urban cores that we used to see. I think it’d be more muted because you don’t have the demographic tailwind in those places that you had six, seven years ago.

Dean Wehrli:

Yeah, I agree. We see some signs that urban is coming back and being a little more… just from the waning of COVID. But the siren song of twice the house for a third the price is pretty powerful. I mean, do you see… Labor, it seems really does want to work from home for that reason. Do you see there being a battle here?

Jeff Adler:

You have to slice this by demographic and also psychographic components, right? So because the population is aging, and it is aging, right? And the center of gravity is shifting a bit middle aged ish. So yes, you have a fair number of people in this demographic bulge who are like, “I didn’t become a gazillionaire. I’ve got a family.” And so there’s a big pull to those secondary cities and the suburbs of those. But there’s also a continued revitalization of the secondary cities’ urban core. Those are vibrant neighborhoods, and those are vibrant areas.

Jeff Adler:

So I guess what I’m kind of saying is that there is a lot that’s in flux, a lot of people are in flux. There’s a declining birth rate there and the population growth is the lowest it’s been in a very long time. So you have, sort of working conditions have changed but you have a backdrop to that of demographic, and all this is sort of playing out. And so there’s still a lot in play. There’s also been, if you look at through the recovery there, there’s all these supply disruptions. Supply disruptions, inflation. And what frankly, the question about how durable inflation is, the Fed thinks it’s transitory. I’m thinking it’s a little more permanent, because as the transitory components fade, the cost of housing is not transitory, it is more permanent. And it’s really a function of people going from high cost areas to lower cost areas.

Jeff Adler:

So while it looks like that rents are up a gazillion, and they are, but if you think about the people who are paying it, it’s not a burden to them, because they’re paying higher prices. And really, we’ve pre COVID, we had this big problem thinking about, economic growth is concentrated, you can’t get new supply in these global gateway cities, prices are rising. And we’ve got this sort of existential affordability crisis. Well, to a certain extent, the affordability crisis is being to a certain extent solved by the movement of people from high cost cities to low cost cities. So it’s a great free market experiment in that the regulatory structure couldn’t solve this problem. And so the movement of people is on its way to doing that.

Dean Wehrli:

I just think that in a lot of these metro areas where you do… I agree, it’s not like urban is dead. But when Tim Cook said, “We want to go back to three days a week for everybody,” in my understanding, I heard anecdotally that there was a tremendous amount of pushback from Apple’s workforce. Tech companies need talent. And if the talent says, “Sorry, I want to work from home,” I think they’re going to win, at least for now.

Jeff Adler:

And so this is where this is all playing out, right? Because even if a company wants it for cultural reasons, they want people back together, because they think it’ll help for their culture. Well, the labor market for office workers is tight. So it is at the point of like, “Well, but if I want to work from home and you don’t want me to, guess what, see you later. I got options. I don’t need to be dictated to.”

Dean Wehrli:

Yeah, for now. For now they win. We’ll see what happens in-

Jeff Adler:

For now. But if you think about, if I look at the economy, I don’t see a recession, OK. I see potential inflation, but I don’t see a recession until the Fed actually does something to stop it. And that’s not going to happen for several years out. So we’re going to have a pretty tight labor market for the next several years. So now you’ve got not just two years of changed habits, you maybe up to four years have changed habits. And so the longer something new re solidifies, the harder it is to go back to exactly the way it was. And quite frankly, our companies is going to say, “We’re a tech company, we’re a more mature tech company. But our people like working from home, our offices are open, but no one is showing up.”

Jeff Adler:

I manage three offices for our company, and we’re open. Anyone can, if they’re vaccinated and they want to come back to the office, they’re welcome to come back. I can count on less than one hand, the number of people per day that are in any one of these offices.

Dean Wehrli:

Wow, that’s true. I hear the culture thing. And that is not untrue-

Jeff Adler:

There is truth to that.

Dean Wehrli:

There is truth to that, but I also hear some of that, I think it was Tim Cook again. Not to pick on Tim Cook, he can handle it. But it was like, “Oh, so many great ideas happen at the water cooler.” I’m thinking, really, Tim? Or is that just because you bought a ton and built an immense amount of office space, and you need to use it?

Jeff Adler:

I do think there’s something to it. Here’s what I would say, that it’s very hard to bring in new people, and to establish tight bonds, and to form a connection with a team. Now, we’ve been living quite frankly, I think as a workforce, we’ve been living off of the relationships that were previously built. And it’s pretty good, but I do think that the pace of change and innovation has taken a little bit of a hit. I think that’s true. However, if you’re talking about stable processes, and this is where, again, companies that have stable processes. Well, people are far happier executing those stable processes, not in an office.

Jeff Adler:

So it’s only where you’ve got like unstable processes, where new things really have to change. That’s why the deal teams, right? Or maybe the product development teams. They’re innovating the ideas of what to do. Not know how to do it, but what to do in the first place. They kind of need this together. But if you think about that as the percentage of the entire workforce of a company, it’s not that big.

Dean Wehrli:

That’s true. Yeah, exactly.

Jeff Adler:

It’s not that big. And so that’s what I’m saying is like, a third of the workforce probably is going to go back to work full time, five days a week, because that function needs it. But it’s much more at a function by function, team by team decision as to where the value of work is relative to also the efficiency and retention of talent.

Dean Wehrli:

Yeah. I think, at least, for the next several, until the economy slows down markedly and unemployment rises, I see labor winning and work from home being a revolution, not an evolution and being just a huge part of the workforce.

Dean Wehrli:

Let’s talk about labor, though, in terms of supply. I mean, like you mentioned a minute ago, labor is in short supply, almost every sector. Do you see that as kind of a governor on residential and other supply? That just, it can’t be built fast enough?

Jeff Adler:

Well, I mean, there is something to be said about that. I mean, I would say the supply of construction labor. There’s been shortages and disruptions of construction labor supply pre COVID. And that was a pre existing problem, because wages were rising in major cities, and there had been a curtailment of new immigration, which had tended in large part to be construction workers. So there was already a problem, that problem has been amplified, even though construction itself was considered kind of mission critical and continued through the COVID period.

Jeff Adler:

It is a governor. Well, it is a regulator, put that way, of the ability to add new supply, also construction costs themselves and material costs themselves. So it’s not easy to be in the construction business now. You’ve got a whole bunch of other problems. And yes, there are supply disruptions, but it’s also affecting… So if you kind of peel this back a little bit, the labor force participation rate of people over 55 has declined three or four points. We were kind of banking as an economy, that that labor force participation rate would stay high, and perhaps even go higher, because people were living longer, they had the ability to work longer. And we had frankly, we needed them to work longer. So that’s a bit of a problem at the upper end of the economy.

Jeff Adler:

And then childcare issues, and schools have kept some working women out of the labor force for some period of time. And then, at the very, very bottom end of the economic scale, though there is some discussion or potential dispute about that, economic reasons would kind of lead you to believe and it’s hard not to, is that if you pay people more not to work than to work, they’re probably not going to work. And the unemployment insurance was very, very generous.

Dean Wehrli:

Yeah, that’s true.

Jeff Adler:

Now, that’s burned off. We hope to see a response to that, as more people sort of re enter the workforce, and there are jobs to be had. So we-

Dean Wehrli:

That’s true. I would push back on that a little bit. But my understanding is the studies that have been done to date have shown it’s not a big motivator of that.

Jeff Adler:

There’s a dispute about that, about well, how big an effect is it. And the problem is you have multiple things going on. You have childcare issues, you have certain folks who are health compromised. And so they couldn’t really kind of work and they were largely face to face. So it’s a mixture of issues as is most things in life.

Dean Wehrli:

Yeah. And at the job you’re offering is a really crappy job with low pay. Maybe you have yourself to blame for that. Speaking of cost, though, do you guys track cost in development sector?

Jeff Adler:

We don’t formally track construction costs or anything like that. I mean, we sort of keep track of it in a generalized sense, but that really isn’t in our wheelhouse. I mean, I know it because I know folks in the industry and a lot of my friends are in the development business. But material costs are up, labor costs are up. It is in very few places, it’s not any easier to get projects approved. And this was an emphasis for quite a while of trying to make it easier to get stuff approved, but it’s not been easier to get stuff approved.

Jeff Adler:

We hope that this might change. But localities have not been very accommodative to the addition of new supply in their community, except when there is a very large consensus of the need for new housing supply. There’s a natural inclination to restrict supply, because the homeowners want higher values.

Dean Wehrli:

Yeah, or just don’t want congestion, exactly.

Jeff Adler:

Again, you can wrap that into a lot of other issues, but there’s a natural inclination to restrict supply. And so there have to be other sort of part of a public consensus that you have to support growth by adding supply at a reasonable rate.

Dean Wehrli:

Let’s end with kind of a potential solution going back to labor and even just the speed of construction, the ability to build things. What do you think about automation, and even more efficient kind of modular or offsite construction. Do you sight kind of becoming… Is this the time for that to get big?

Jeff Adler:

There has been so many attempts, so many attempts to try to improve the construction process and bring down the costs, and either building in factories or build modules in factories. It’s a very difficult thing to get done, I’ll call it logistically. The modular work that has been successful was mostly limited service hotels, with very high cost of labor. There’s been some encouragement of some of these techniques. They’re very capital intensive. And there’s also been regulatory kind of obstacles thrown in its path, that make that more difficult in terms of getting COs and permits, and such.

Jeff Adler:

I hope so. It would be a great thing if we could deliver housing at lower costs. But remember, about a third of the cost of housing is in the regulatory process. So there’s a lot of cost that has got nothing to do with the hard cost of construction, in terms of the final delivered finance cost. A third of it is regulatory in nature. So there’s opportunities to yes, but it’s very capital intensive. Boy, I’ve seen a lot of people just… Katerra is the classic case of… It all looks so exciting, like it all seems so good. But it’s just, it’s very, very capital intensive, and it’s hard to scale.

Dean Wehrli:

It always seems like it’s the next big thing that’s going to happen. We did have one of the early podcast here on this issue like three years ago, and I really thought that this is ready, this is the catalyst, the shortage of labor that was going to kick this up into a new level, and it just hasn’t happened yet, it’s too bad.

Jeff Adler:

I’m a little bit of a historian. These things take time. Innovation and technological change takes sometimes 30, 40, 50 years for people to fail multiple times for just the right combination to come together and succeed. So I wouldn’t count this out. I think there’s a big need, and the dollars are huge. So I think people will continue to experiment and try. But it’s been littered with a lot, a lot of people have tried very hard and have really kind of hit the rocks. So I’m hopeful, but boy, I don’t think I personally would invest in one of those ventures.

Dean Wehrli:

Okay, all right. Well, Jeff, I appreciate you coming on. We learned a lot about a lot. You know, some of these people, you learn a little about a lot or a lot about a little, this one’s kind of a lot about a lot. I appreciate you coming on.

Jeff Adler:

I hope everybody got something out of it, and I would love to chat with anybody who wants some more detail behind all this.

Dean Wehrli:

Awesome.

Jeff Adler:

Thank you very much for having me on the show.

Dean Wehrli:

Hey, thanks for coming on. This has been New Home Insights. I’m Dean Wehrli. We’ll catch you next time.

 

 

 


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