So we hear a lot of commercial real
estate right now and not all of it good. A lot of focus on office buildings.
But we've learned that commercial real estate is more than just office
buildings. It's part of it.
But not all of it. Give us a sense overall how commercial
real estate is doing. Well, of course, office buildings are
the most difficult part of the commercial real estate story today.
When you look at other asset classes. So, for instance, industrial buildings,
which is a big asset class, medical office buildings,
hotels, life sciences buildings, multifamily institutional quality,
apartment buildings, basically very strong fundamentals.
And when I say fundamentals, I mean the following.
Well, east, in fact, some of them historically well leased, strong rental
rates and upward pressure on rental rates in a lot of cases, not a lot of
new supply coming on. That's what we mean by fundamentals.
And when you get beyond office buildings, the fundamentals in the
commercial real estate group of asset classes are generally very strong.
And even within office buildings, there's a slice of office buildings, I'm
going to say, for 30 to 40 percent of them, these newer, better configured,
better infrastructure office buildings where companies are trying to create a
really high quality experience for their employees to get them back in the
office. Those assets are doing quite well.
So the storm, the headlines, the headline grabbing stories of an 80
percent vacant office building. That's an anecdote.
That's not a proxy for what's going on in commercial real estate.
So we still have the newer buildings. We're learning to call them A's or a
plus, as has the BS and CS. Yes.
But if you take a look at commercial real estate, the office portion of it
right now. How much of it's a how it is being,
which would see, would you say, in general?
Well, I think if you look at true A or a plus, it's maybe a quarter of the a
quarter of the space out there. But you could go down a little further
and have some very nice buildings that, if upgraded appropriately, would be true
ways. And then you probably have the bottom
core quarter or so that are real problematic buildings that are either
going to have to be mega redeveloped or probably scraped and turned into land
sites. And then in between, you have a variety
of different kinds of buildings, some of which can be repurposed maybe into
multifamily or. That's very difficult to do.
Some of them will be upgraded to class A buildings and someone will go the way of
land also. So if different parts to commercial real
estate and then within the office part of commercial real estate, you've got
different classes to look at. What about geography?
Because another thing that we have heard is that it depends on what metropolitan
area you're talking about. San Francisco, maybe troubled.
New York, maybe that's a great Chicago. But then there are others, whether it is
Miami, for example, some parts of Texas are doing pretty well.
Well, you mentioned San Francisco first. So that's that's probably the toughest
story out there in office buildings. And it's for more reasons than just the
tough to get people back in the office. First of all, everybody knows that's
where so much concentration of tech occupancy is.
Those companies have laid off a lot of people.
But David, think about this. We all know that the technology
companies that are going backwards with head count now are going to go the other
direction for sure in the long run. We know that's going to happen in that
part of what's going on is going to come back.
And then, of course, you do have the cyclical thing with the with the economy
being down a little bit and you have the secular thing with people not being back
in the office as much. And technology companies kind of led
that charge. But by the way, if you see what's going
on now, the technology companies are talking about getting their people back
into the office, talking about it, but they're getting that done.
I mean, we just this week passed the milestone in New York of 50 percent
occupancy, and that is by use of the sort of security cards they know they're
actually in the office. Is it ever going to come back to where
it was before? Well, New York is a good example of
quite a bit of the spectrum of what's going on.
So in in class, say, top quality buildings here in New York, you go over
the Hudson yards or you go to one Vanderbilt midtown across from Grand
Central Station. These buildings are doing well and
they're going to continue to do well and they're doing well because they create a
great, great story for the client or for the
tenants and their people, a great experience for their people.
Other buildings are suffering more because they don't create that
experience, but they're all slowly filling up.
We did see a flat spot for quite awhile. I'm going to say from earlier this year
till about now. But we're starting to see it rise a
little bit again now. And you really are seeing a push from
companies to get people back in. I do not think it's going to go back to
where it was. And in fact, the work we've done would
suggest that in the long run, companies are going to take maybe 80 percent of
the space. Maybe as little as 75 percent of the
space they previously had. As you mentioned, there's the financing
aspect as well. We read a lot right now about maybe some
arrears building up, maybe some concern about a New Year refinance this year.
What is the situation in financing of office buildings right now?
What are the risks out there? Well, we've looked at that everywhere.
You can imagine. I would start with banks.
So you've heard a lot. We've all heard a lot because of some of
the bank challenges we had a couple of months ago, that commercial real estate
was going to put a lot of pressure on banks and office buildings in
particular. We're going to put a lot of pressure on
banks. The facts are about about one and a
half, one and a half percent of bank assets or an office building loans one
and a half percent. And that's all office building loans,
all office buildings, loans. Now, we think that there is going to be
some jeopardy among that portfolio loans.
But we think it's going to be like 20, 25 percent of those loans.
So take 25 percent of one and a half percent.
And you can see that the banks aren't going to have a really big problem
coming from commercial real estate. They will have some problems.
They will have some loans that need to be restructured.
They'll have some foreclosures. We know that some of that's going on
already. But again, this headline, this anecdotal
driven, sensationalized headline about all the crashing down that's going to
take place, it's really overstated, putting aside crashing down.
There are some adjustments going on. How far along that adjustment period,
particularly aspect of valuations. Obviously, valuations come down both
because interest rates are going up. So it's more expensive to finance
things, but there's somewhat less demand for at least some office buildings.
Where are we on that adjustment evaluations?
Well, I mentioned all those asset classes earlier in our discussion.
Values have come down for all those asset classes.
And the reason that one of the real drivers of that is the cost of debt goes
up when the cost of debt goes up. It's more expensive deleverage or
buildings devalue, the equity goes down. Office buildings have gone down the
most. The other asset classes may have gone
down 10, 15 percent, office buildings, maybe as much as 30 percent.
We do think that the decline in values has kind of run its course and will
stabilize now and we'll start to come back later this year.
The fact matter is, interest rates have stabilized.
We think they're going to start to come down.
Inflation appears to have peaked. It's coming down.
And so we think the decline in values has kind of played out.
So I do want to put words in your mouth, but I think what I'm hearing you say is,
by and large, looking at as far as you can, you think maybe the market has
largely discounted what it needs to discount at this point?
I think that's probably the case now. We all we all need to figure out what's
going to go on with the economy right now.
The economy has performed better than we thought.
It was going to perform quite a bit better around the world.
And in fact, there's now an expectation that we won't even have a recession in
Europe if we ended up with a worse recession
than we think we're gonna get. Values would come down further because
people would stop spending money of all types, including try to spend less on
rents. But we think values have kind of hit the
bottom, are going to start recovering. And we think we believe that we're going
to have a mild recession. That's going to take place later this
year. Be relatively short and you'll start to
see things come back. By the way, there is a massive amount of
capital on the sidelines that wants to invest in commercial real estate.
And there is a massive amount of real estate that wants to be refinanced or
sold. And everybody's uncertain about what's
going on with values. And as soon as we have some certainty,
as soon as we think interest rates have peaked and are coming down, you'll start
to see those assets trade and get refinanced.
As in so many places, you need the buyer and the seller to agree on that price.
And they need him to be confident that it's kind of gotten where it's going to
get to.
