By Sartaj Dhillon '14
On December 10, 2014, Christopher Mayer, Co-Director of the Richard Paul Richman Center of Business, Law, and Public Policy & Paul Milstein Professor of Real Estate, Columbia Business School moderated a panel titled "The Implication of Secular Change" at the Barclays Select Series 2014 – Real Estate: The Year Ahead. The illustrious panel of industry veterans included Mr. George Marcus, Chairman, Essex Property Trust | Marcus and Millichap Company, Mr. Sandeep Mathrani, CEO, General Growth Properties (GGP), Mr. Hamid R. Moghadam, Chairman & CEO, Prologis, Inc., Mr. David R. Neithercut '82, President & CEO, Equity Residential, and Mr. William Strange, SmartCentres Professor of Real Estate, Rotman School of Management, University of Toronto. A special thanks to Columbia Business School alumnus, Mr. Ross Smotrich '83, Managing Director and Senior Research Analyst, Equity Research, Americas, Barclays, for organizing the panel. The following is a brief review of some of the themes that were discussed by Professor Mayer and the panel:
The Continued Growth of "Superstar Cities":
William Strange commented that "superstar cities" (those that have high price growth but low growth in the number of available units) have shown persistently superior performance over a 50 year period. For example, the San Francisco metro area has enjoyed annual appreciation of 3.5% compared to Buffalo’s rate of 0.5%. Strange also noted that superstar cities like San Francisco and New York both have high restrictions on land supply when compared to other cities like Houston, which have minimal land use regulation. George Marcus chimed in on the discussion by talking about the demand side ingredients that make a city successful and a destination where the intellectually capable (both millennials and boomers alike) want to be.
Opportunities in Gateway Cities and Beyond:
David Neithercut commented on re-urbanization and accumulating assets based on forecasted economic activity in large gateway cities on the coast (noting that these cities are vibrant, energetic and that this would continue for the longer term). Echoing the sentiment of George Marcus, Neithercut has focused on both millennials and baby boomers who are interested in proximity to transportation, nightlife, educational facilities and good quality healthcare. He also noted that 50% of American adults are single and that 43% of units are occupied by a single individual. Because of the flexibility of rental housing, the multi-family sector will see continued success with the ability to underwrite reasonable rent growth into the future.
Projected Growth Trends for Gateway Markets:
Growth in supply constrained markets will continue, but likely at a slower pace. The trend will be more global – so the rate of growth will be high, but not has high as some other places in the world. Negative demand and supply should also be considered, particularly in places like Detroit. Notwithstanding future economic decline, when looking at investing capital over an extended period of time and providing optimal risk-adjusted returns to shareholders, the panelist still believe it makes good business sense to invest in high quality cities that attract highly educated people, noting also that such cities typically recover quickly after busts. There panelists also discussed prospects outside of superstar cities. Equity Residential sold $10 billion of multi-family assets in secondary markets over the past few years, and their investors were pleased because the spread between financing rates and cap rates at those times was the largest it had ever been. Developers and asset managers will need to regularly forecast changes in the economy and take a closer look at macroeconomic factors such as supply and demand and try to understand the broader implications of employment.
Affordability and Consumption:
Affordability and consumption will continue to be hot button issues, particularly with respect to the differences between consumers in lower and middle America. Professor Mayer observed that people shopping at malls seem to be doing well, but on the other hand, the data suggests some bifurcation. Sandeep Mathrani stated quite plainly that affordability is a major driving factor for GGP. Catering to the educated American in the super regional mall business, GGP is noticing that traffic is up and disposable income is higher versus the strip shopping business or lower quality retailers, for whom low prices are crucial for their lower cost consumers. Mathrani mentioned that GGP’s business is less impacted by bi-furcation and emphasized the importance of "barriers to entry" being key to GGP’s business.
Economic Competitiveness:
Hamid Moghadam noted that a lot of jobs that typically pay well (particularly manufacturing jobs) are now outsourced. He underscored the importance of global competitiveness and education as a means to improve the country’s employment situation. Sandeep Mathrani shared GGP’s difficulties in attracting employees with the right experience and proposed that it would be better to educate and train people that have lost their jobs. With respect to manufacturing, the United States will remain competitive with the rest of the world in an era where energy prices and wages are lower with predictability. Mathrani noted that people who have left the US are slowly starting to come back and that although the creative side is moving from St. Louis to New York, the reverse is also true, in that a lot of back office moving from India to Iowa.
The panel underscored the difficulty of creating competitive superstar cities and emphasized the tremendous impact that high standard education can have on the economic viability and growth of communities. William Strange highlighted the importance of the mobility factor stating that both "skilled" and "highly skilled people" tend to be very mobile and that the problem is people in the middle. He discussed barriers to entry at the city level and why it is difficult to create new competitive and high quality communities. He cited the example of Frederick Terman, who was brought in to do in New Jersey what he did for the growth of Silicon Valley vis-à-vis Stanford University. However, Terman was unable to engineer the process, presumably because Princeton is not as applied in its orientation as Stanford, and as a result, New Jersey today remains very different from Silicon Valley.
Implications of Secular Change:
Professor Mayer discussed post-recession trends including the lack of household formation, the tendency of people to move away from single family housing and marry much later and asked if the panelists saw any reversion in these trends. George Marcus noted people are thinking hard about home ownership after the devastating changes in home prices after the recession. Ownership has dropped from 66% to 61% and is far from the 67% or 68% levels. Home builders have been struggling and there is some evidence of secular changes that will last for a long time but the panelists did not say what that time frame might look like. Neithercut commented that the trend of people marrying and having kids later is not in response to the recession but a long term secular change that we will see for some time to come. Married people will likely continue to prefer the suburbs and bachelors will continue to live in rental apartments/condos in major cities with entertainment hubs. This will continue to drive demand for the apartment class (owned and rental) - and whereas acquirers were previously able to buy apartments anywhere in the country at 7 or 8 caps, are now doing so at 4 caps.
What will be Most Relevant Going Forward:
The panelists were collectively of the view that developers and real estate investors will have to take a closer look at (a) consumption and lifestyle patterns, (b) finding places where people of the current and next generation will truly want to live and (c) factor in lifestyle changes when designing and building communities to attract new residents.
The Impact of Technology on Real Estate:
When asked about technology and disintermediation, Marcus commented that his brokerage business would have been wiped out if not for a partnership with Loopnet (later acquired by CoStar). Apartment buildings now have Facebook models where tenants communicate with other tenants in their buildings. Surprisingly, 95% of all purchases now take place at the physical retail outlet itself compared to 90% five years ago – and Sandeep Mathrani noted the importance of technology on GGP’s business through "showrooming" and the fact that consumers are doing more research online before making an online or offline purchase. David Neithercut pointed out that technology has changed the way their residents communicate with each other and where they live. People seem to have no desire to own and maintain automobiles today and are opting to shop online, which has created a huge problem in managing packages at apartment sites. Moghadam also commented on the reluctance of the younger generation to obtain their driving licenses, which has further enhanced demand for locations with great amenities and easy access to transit.
Real Estate: The Year Ahead Conference – Key Takeaways