Is real estate the next shoe to drop in
the aftermath, what we saw with the banks, the challenges and real estate
are gonna be tied to the economy. So it all depends on do we have a
recession? How deep will the recession be?
How long will interest rates be high? And the answer to that question will
determine the challenges that the real estate industry will face in the
quarters ahead. We had a Bloomberg report saying that
vacancy rates for office properties in Manhattan were at a record high right
now. I think something like 50 percent,
something like that. You know how much of that is because the
economic downturn and how much it's because people just aren't coming back
to the office. They're working from home.
Yes. I think that's a big misperception in
the market today. The office business faces two
significant headwinds. One is a slowdown in economic
conditions. And the other is work from home.
When you have a slowdown in the economy, businesses are more challenged in terms
of their personnel and they do things to cut costs.
And you see layoffs going on almost every day right now.
And as you have layoffs, companies take less space where they put sublease space
back on the market. And by the way, this is no different
than any other downturn that we've ever experienced.
Office and many forms of real estate are economically sensitive.
So I think in the premium end of the market, what's impacting our leasing
activity today is much more the economic conditions and work from home.
And the evidence of that that I would give you is in 2022 last year, our
company leased nearly 6 million square feet of space, which is basically 95
percent of our long term averages. And if you think about it, last year,
you know, interest rates started to go up and the economy was much more solid
and there were a lot fewer people in the office.
Now you've moved to twenty three. Office leasing is slowing down.
The economy's worse, and there are actually more people working in the
office. So what is your spring to BHP,
particularly in the tech area? Because we've heard about a lot of
layoffs in tech, downsizing in tech. Are you seeing that in your office
situation? Yes.
Well, that has an impact. The technology firms, particularly the
larger ones, were important net absorbers of office space since the
global financial crisis. And as you know, over the last six
months, many of those companies, their growth has slowed and they're focused
very much on their profitability. And they many of them have done layoffs
and many of them have put sublease based on the market.
And by the way, they've all announced some form of return to the office as a
result of this as well. How does this affect valuations?
Because we have, I guess, net profits gold, which gives this appraisal the
valuations. I don't and saying we've got a Bloomberg
buried index of Reach Office Property Index, which is not that which is down a
lot more than appraisals. So how can you get your arms around
exactly what's happening with valuations in real estate?
Yeah. So let's divided between the private
market and the public market. On the private market.
It's hard to determine value because there are very few transactions going on
right now. Interest rates have come up off, bids
are lower and sellers are so far unprepared to accept those bids.
So where is real estate trading? It's trading in the public market.
The rates, as you mentioned. And if you compare these two areas, you
know, office rates today are off, you know, 50 plus or minus percent from
peaks in March of last year. But the NIKKEI Creek intra index, which
is appraisal based, that dictates where private market values are, it's only
down about 5 to 6 percent from peak. Higher interest rates obviously affect
the economy. Slow the economy down, may affect
vacancy levels. It also affects financing for these
properties. How is that playing out right now?
For example, if you're putting up a new building, I understand you have
construction financing. That's short term.
You're going to turn it into longer term in some time.
Are you in the process right now of refinancing and how does that work?
Yes. Well, financing is harder to get today
because of concerns about real estate. And also buildings have to have strong
cash flows to support the higher interest rates that are associated with
financing. From our company's standpoint, most of
the financing we do is in the bond market.
So we're an investment grade issuer of unsecured bonds and that
market is open to us, albeit at higher spreads.
We do have some mortgage financing and I do think mortgages are available to
office real estate, but that building has to be well leased.
It's got to be of high quality and it has to be owned by a strong sponsor.
What about the high quality you just mentioned?
Because I've heard conflicting things that there's a huge difference between a
building's in B's and C's or some people say basically if it applies across the
board. Yes.
No. This is a very important issue when you
think about office real estate. Last year I mentioned all the leasing
success that we had. Yet we saw all these reports showing
many of our cities being 15, 20, 25 percent vacant.
And then an important measure in office, real estate is.
Absorption. This is how much the occupied space goes
up and down in those segments. And if you look at the premiere
workplaces for the last two years ended the year in 2022.
The premiere workplaces had a positive 7 million square feet of net absorption
where everything else was down. Twenty five million square feet.
So there is a very in all the years that I've been doing this.
This is one of the strongest moves towards quality office and real estate
that I've seen. What about prime cities?
If I can put it that way. What's the geographic dispersion?
We hear reports of, for example, San Francisco really struggling.
New York maybe not doing so well. There there's a big move into Austin and
Miami, places like that. Yeah, well, there is some migration out
of the coastal cities into lower tax states and cities like in Florida and in
Texas. But there is also in migration from
employees in New York and San Francisco as well.
So I do think and believe in the long term vibrancy of cities like New York
and Boston and San Francisco. What about that ecosystem more broadly?
At this point, are places like BSP and others pulling back on future
development properties, which can affect things like construction, construction,
workers, employment? Yeah, well, with the slowdown in demand,
clearly there's gonna be a slowdown in development.
And that's one thing that will help owners like ourselves because they're
going to be less supply in the future because construction is being pulled
back. We do have sites and we would consider
future development, but it has to be deep risked and for us that means pre
leased. What's the biggest opportunity for XP
right now? And is it in fact part because of the
valuation question and maybe some bargains out there at the moment?
No, I think that will come. I mean, a couple of things that had
mentioned. We have also been in addition to our
premier workplace business. We've also been developing life science
assets. We're building a large lab building for
AstraZeneca and Cambridge. We're converting a large building in
Cambridge for the broad institute. So that's an area of growth for us.
Another area of growth for us is simply leasing our portfolio, increasing the
occupancy, because we're at about 88 or 89 percent occupied today.
And that will grow our income stream. And then I agree with you.
I think as this downturn unfolds, I think additional investment
opportunities will present themselves to strong players like ourselves.
