The tremors of recent bank collapses have sent shockwaves through the foundations of real estate financing, bringing to light the sector's hidden frailties. With Dr. Chandan's insights, we navigate these choppy waters, discussing the shifts in risk perception and the heightened scrutiny on commercial real estate within bank portfolios. The emergence of private debt firms and the allure of more liquid assets in this volatile climate prompt us to question the resilience of real estate investment strategies. Our exchange also contemplates whether we've reached a turning point in property value adjustments or if the market is bracing for further revaluations.
Finally, we broaden our lens to the diverse tapestry of the single-family rental market, the generational wealth transfer, and the technological disruption poised to transform the sector. Dr. Chandan ponders the maze first-time homebuyers must navigate, the implications of built-to-rent communities, and how AI could revolutionize business practices in ways as significant as the iPhone's impact on global society. Engage with us on this journey as we uncover the nuanced intersections of economy, technology, and real estate, where certainty and surprise coexist in the ever-evolving landscape of our world.
Want more discussions like this? You can connect with KP Reddy at https://kpreddy.co/ and follow him on LinkedIn https://www.linkedin.com/in/kpreddy/!
The tremors of recent bank collapses have sent shockwaves through the foundations of real estate financing, bringing to light the sector's hidden frailties. With Dr. Chandan's insights, we navigate these choppy waters, discussing the shifts in risk perception and the heightened scrutiny on commercial real estate within bank portfolios. The emergence of private debt firms and the allure of more liquid assets in this volatile climate prompt us to question the resilience of real estate investment strategies. Our exchange also contemplates whether we've reached a turning point in property value adjustments or if the market is bracing for further revaluations.
Finally, we broaden our lens to the diverse tapestry of the single-family rental market, the generational wealth transfer, and the technological disruption poised to transform the sector. Dr. Chandan ponders the maze first-time homebuyers must navigate, the implications of built-to-rent communities, and how AI could revolutionize business practices in ways as significant as the iPhone's impact on global society. Engage with us on this journey as we uncover the nuanced intersections of economy, technology, and real estate, where certainty and surprise coexist in the ever-evolving landscape of our world.
Want more discussions like this? You can connect with KP Reddy at https://kpreddy.co/ and follow him on LinkedIn https://www.linkedin.com/in/kpreddy/!
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Speaker 2:Welcome everyone to industry insights with KP Ready, featuring one-on-one conversations with impact leaders in the world of business, technology and innovation. Today we're very excited to welcome back to the Shadow Network Dr Sam Chandan, who is the founding director and professor at the Chen Institute for Global Real Estate Finance at the New York University Stern School of Business. Sam is one of the most sought after global economists and we're very fortunate to have him today as a friend and colleague in the industry. Today, kp and Sam are going to discuss some of the macroeconomic trends that are affecting the built environment. So strap in and really lean into this great, exciting conversation. Welcome, sam. Thanks again for joining us today and KP, go ahead and take it away.
Speaker 3:All right, thanks, ian. Hey, sam, good to see you, great to see you too. How have you been? I've been good, you know. It's always fun to see you and you come to our summits and it's always everybody. Always you're always the highly rated speaker. I ended up coming in number two, but always good to catch up. So in the, in the world of what's what you know, obviously Big macro stuff happening with interest rates. It looks like we're just seeing kind of early fall out on the commercial side. But I'm not going to lead the witness. What are you seeing? What are you talking most about? Like what's, what are you seeing out there?
Speaker 4:Yeah, the biggest thing, as you point out, is that the Fed has reached what is likely to be sort of a peak in the monetary policy cycle. By that I mean that their baseline outlook at this point does not anticipate any further rate increases. You know inflation is moving down not as quickly as anyone would like and it's stalled out. You know the inflation has stalled out a little bit in the last couple of months, but overall, directionally, things are going where they should, and that's allowing the Fed to now in the FOMC in particular, you know to adopt a more accommodative monetary policy. What that means for us is that, you know, over the course of 2024, we might get a couple of rate cuts. You know further rate cuts in 2025, assuming that everything remains on track. You know again, sort of with inflation not suddenly rebounding because of some exogenous or unexpected shock to the economy, but if it does keep on trending lower, you know, anticipate a couple of rate cuts this year and a couple next year. What I'd say on this, though, is that the market is consistently run ahead of the Fed's own language, so the Fed is signaling pretty clearly, you know, what it intends to do, based on the data that it has available Every week we're looking at options trading data that you know reflects and helps us to understand what the market is expecting in terms of the timing and extent of rate cuts. And you know the market is pretty consistently, you know, over the course of the last year, year and a half, run ahead of the Fed and it's thinking about how quickly rates will come down. The you know that gap is narrowed a little bit in the last couple of months, or it's in the last couple of weeks, and so you know the market is getting a little bit closer to. You know what the Fed has signaled, which is really sort of, you know, not a rate cut in March and maybe one before mid-year and one or two in the second half of 2024.
Speaker 4:On the short end of the yield curve, that does not imply much for us in terms of, you know, the kind of rate relief we would need to ease some of the pressures in commercial real estate markets. But again, think about from a macro perspective. They're looking at the labor market, they're looking at the broader economy, and so surely there are some segments of the economy and labor market that could always be performing better, but overall the job market is exceptionally resilient Not for everyone, but overall, you know, it's remarkably resilient given the rate hikes that we've seen over the last two years. And so, with the labor market holding on, the economy generally performing well, they're not in any rush to start lowering rates. You know they've, they feel like they've got a lot of discretion here.
Speaker 4:The other thing that you know I think that they have, you know, got in mind is that while historically a lot of attention focuses on, sort of you know, what Volcker did with the Fed in raising rates, the more pertinent and relevant sort of you know, historical time period for the Fed today is the Fed immediately before Volcker joined, and what we see at that point in time was that sort of, you know, benefit hindsight. You know, sort of being able to play Monday morning quarterback. You know, 20, 30 years later, the sort of, you know, looking at, you know, the Fed probably, sort of you know, started to cut rates too early, you know, before they, sort of you know, won the inflation fight and that, in part, you know, created the conditions that allowed for inflation to come roaring back, and so the Fed had to reverse course on its previous rate cuts, the on its previous rate cuts and start raising rates again. That's a really problematic scenario. So I think you know it's something that a lot of folks in policy are looking to as a benchmark for us in thinking about.
Speaker 4:You know the dangers of cutting rates too early and I think this is sort of you know this does reflect sort of a split between real estate and folks pretty much everywhere else, folks pretty much everywhere else. Things are chugging along, you know and we're seeing that. You know rate, the rate increases are not pulled to rug out from under the broader economy. In real estate it doesn't feel that way at all. You know and this isn't to say that we're not starting to see cracks elsewhere you know we've got sort of you know some stresses showing up in credit card loans and in auto. You know sort of you know in auto loans that's a leading indicator for us. You know reasonably sort of useful leading indicator for us on what might happen with, you know, consumer spending and consumer activity.
Speaker 4:But overall, you know, on the interest rate outlook, you know maybe two or, based on the data we have now in the language room, the Fed, maybe two or three rate cuts in 2024. If you're in real estate, if you're levered. If you're thinking about refinancing, you know that that's going to mature in the next year. You know that that doesn't imply a significant change in your financing costs. You know, as compared to a couple of months ago, it just it's not going to get much easier. You know for, for you know for real estate financing this year we may see more debt, we may see a larger number of originations, but the overall stresses on on the refinancing market, you know not not seeing that changes in Fed policy are not going to be sort of you know are not really going to help the industry very much this year.
Speaker 3:But you know, we, we tend to, and I think we clearly have a bias lens because our investors, our markets, exposure to commercial real estate, et cetera, we have a bias towards how interest rates are affecting that world. Probably less. We're probably thinking less about credit card debt and all those things on any given day, right. But beyond rates, what about just credit availability? Right, I mean it's. It's like great, the rates come down. If nobody's lending, it doesn't really help a whole lot.
Speaker 4:Yeah, no, 100%, and sort of. You're raising sort of this really important feature of the market, which is that you know, on one hand, we can look at the cost you know the absolute cost of the financing, with those interest rate differentials look like between you know what's what's the interest rate on your maturing loan versus what's it likely to be, or so what are the market numbers tell us. You know those numbers are for for new debt and those differentials are pretty big. But there's that that's only one part of the story. You know the other pieces. You know what are. You know what kind of leverage can you get, what are the debt service coverage ratios? What are the debt yields, completely independent of the higher cost of the financing? So the you know I think what we see is that credit availability or finance availability for commercial real estate was, again, you know, held up very well in response to, you know, rising interest rates.
Speaker 4:The you know the the the turning point for us was really sort of, you know, march ish of 2023 with Silicon Valley bank, and then, you know, a small number of other bank failures, small in terms of, you know just the count, but seismic in terms of you know the impact on, you know financing terms for commercial real estate and sort of. You know banks posture. You know one of the attitudinal surveys that we can look at. You know captures sort of. You know it comes from the Fed. And then we have a lot of pressure, sort of perceived risks to financial stability in the United States and even in you know, but before SBB even an environment where rates were, you know, markedly higher and where you know we had sort of real issues around. You know the fundamentals outlook for real estate, office buildings. You know most obviously, you know we've got a lot of pressures on real estate and what we see in that financial stability report is, you know folks not really seeing, you know commercial real estate and you know the deterioration of commercial real estate loan performance as being significant threats to the economy. Right, what they were citing was sort of the response to monetary policy tightening China, potential trade disruptions.
Speaker 4:And when we look at that you know the same, you know that same attitudinal survey after you know SBB what we see is a real shift where, all of a sudden, commercial real estate is, you know, the most significant of the threats to financial stability and that stands to. You know it's understandable. You know why. You know folks in the policy arena would sort of view that to be the case. What it reflects is that half you know roughly half of the bank balance sheet in the United States is commercial real estate and construction lending, and so you know if those loans come under strain, that the banking system you know. By extension, you know it comes under strain as well.
Speaker 4:And what's perhaps more remarkable is that you know, given the challenges that we faced in commercial real estate since the pandemic and again that's I don't want to pay too broad a brushstroke there are some sectors that continue to thrive and that have benefited from some of these shifts and there are other very obvious ones that have struggled but given sort of those disruptions to how we're using space, you know how it's impacted, you know a large part of our collective real estate portfolio and rising interest rates and an understanding of how debt dependent we are as an industry.
Speaker 4:I think the thing that's most remarkable is that there wasn't much attention to potential problems in commercial real estate much earlier in the monetary policy cycle and we started raising those rates. And you know, quite honestly, commercial real estate is a potential you know as being sort of one of the sectors that would be most significantly impacted by those rate increases and understanding how that would then impact you know, bank performance, you know, and bank help overall. These should have been again. Yeah, through benefit of hindsight for a lot of folks, but these should have been on the radar of a lot of people much earlier than they were.
Speaker 3:Yeah, no, it's also interesting too, you know, with with the. If you look at the risk-free rate right now, right, you put money in a money market, you have 5%, so that's like the risk-free hurdle, so to speak. It seems like capital allocators were pretty comfortable, like I'm just gonna keep my money liquid, I'm getting a return, and then, you know, in the side of their eye, they start seeing the SMP moving, you know. And then all of a sudden, you know, there's the capital starts flowing back into the public markets. And if we look at lack of debt availability and if you start looking at private debt or even Pushing more equity into these commercial projects, it just seems like the ability to attract those capital flows is going to be a challenge, right, for people that do have risk capital. I have a lot of friends that are building private debt firms right now because it's they know, with the rates and the unavailability, there's going to be a market for private debt, but it doesn't seem like they're. You know, are they going to chase real estate though?
Speaker 4:Yeah, no, it's. I think you're right. I mean, what part of what we're counting on when we talk about sort of, you know, a surfeit of capital or dry powder on the sidelines, that some of that is, you know. You know allocated to real estate. And so you know, I think, we're at a point in the market where there's, you know, debate around whether or not the bid-ask spread has started to narrow. But to your point, you know, given the returns that we can get in other parts of the world, if you can get 5% in a money market, then the yields on real estate, you know, need to adjust and you just start looking a lot more attractive. And so you know, I do expect that. You know, as more of the debt in the market matures, that over the course of 24 and 25, certainly in 24, you know the difficulties that we'll face in refinancing some of that debt. The need for rescue capital or gap capital, you know, will drive more seller capitulation and again. So this is, you know, admittedly a difference of opinion. You know that I have some of my colleagues in the market.
Speaker 4:There are folks who will argue that you know we are at the, you know that we've hit the bottom of the of sort of. You know the repricing cycle and that your real estate is really sort of captured. You know and internalize the downside on asset values. I don't think we're there yet and so, but it does come back to your point. You know, if you know if I had the foresight to move my entire portfolio into Nvidia stock, then why? Why do you real estate? But if I get the other extreme, you don't need to do in video stock.
Speaker 4:You know if you've got, if you can get, 5% on your money market and you know 5% on an thank you, 5% on a, you know an absolute basis, you know feels much better. I mean it's a much higher number than anything we've seen for a long time. But you know, in real terms it's not that great but it's. But what it does reflect for us is that we you know it's. You know it's tough to price these things in and under. You know and understand through the. You know the competitive positioning of real estate assets if we're also aiming for or fixated on. You know 5% to 6% cap rate. Yeah, that they're going to have to be some adjustments unless there's, you know if that's a, that's a going in cap rate based on current income, there's got to be a lot of upside you know on on your revenue over the next couple of years for that property and I think the market is fairly reserved and it's thinking about what the net operating income upside is going to look like for a lot of assets.
Speaker 3:Yeah, you know what's what also find interesting this is just kind of talking to people, right, the cost of capital is going up. The demand doesn't seem to be there specifically for office. Yeah, so in order to make it work, you actually have to raise rents in a market. Yeah, you know, it's just so contrary that there's no market. I've looked at some spaces here and there. Every once in a while I get a wild hair. I'm going to rent office and not work from home and I've been shocked at how high they are. I just assumed, if you read the news, I can go get office space for right now they're going to give me a year free and you know, like throw rose petals in front of me when I walk in, Like I just it's not the case, though there's the people that they're still holding their the rents high.
Speaker 4:They are. It's a really tough environment given what's happening on the expense side of the pro forma to concede on rents. I think what we'll see in the market, you know, and a lot of this data is fairly opaque, you know, in terms of data availability, we answer to dig in on these questions much better place today than where we were 10 years ago, certainly, but these markets are still fairly opaque. I think what we'll see is that if you're potentially a large tenant that will sign a long term lease, then you know there are. You know there are substantial concessions available. If you're a relatively small tenant, then you know those are. You're far less likely to be able to capture a substantial concession off of asking rents. So the bottom line if you're bringing 10, 15, 20, 30 people in, you may not be able to get the kinds of concessions that you know intuitively, we think must sort of, you know, characterize the market today.
Speaker 4:There are a small subset of properties as well where you know if the you know next life of the asset is a something other than office, you know they don't want to impair, you know, that option by signing leases today. You know there there are certainly, you know, parts of midtown Manhattan, particularly, you know, midtown east, where there are assets where you know key to being able to reposition the asset or undertake any kind of, you know, repositioning of the asset, whether it be as a multifamily or anything else, it depends on being able to clear the building out. So you know that that is, I think, part of what you see reflected as well.
Speaker 3:Do you think? I spoke to this conference this week in Vermont and the topic I spoke on was basically the formation of new asset classes. Yeah, you know, for institutional, for large institutional capital allocators. If you look 1520 years ago, you couldn't get a mixed use development funded Because it was like nope, we either do office or we do retail or we do apartments, we don't do them all together, right? And then eventually over time, it's like no, multi, multi uses, it's an asset class, right. So then allocators say, oh, we need to allocate x dollars towards mixed use developments. And you've seen in self storage, right, it's become institutionalized. And it seems to be, you know this idea that like, well, we keep forming these new asset classes, the, which large pools of capital then chase because it's become professionalized. How do you see that like this, the rise of large capital pools and just the, the influence you know, we see, we've seen it now with the single family rentals.
Speaker 4:Yeah so.
Speaker 4:SFR is a really interesting one. Yeah, I spent a lot of time, you know, focused on the SFR space because there's a significant policy angle, there's an affordability angle, there's Sort of you know, a housing, an important housing choice angle to it. Right there there are a lot of folks who, at prevailing mortgage rates and given our expectations of where they might go, and we think about sort of what's the neutral interest rate of the country going forward? You know what does that imply for mortgage rates. There are a lot of people who two years ago, you know, were on the may have been on the cusp of becoming homeowners. You know the challenge. They could get the financing and it was, you know, available cheaply enough that you know that's a move that they could end up with, that's a move that they they were at the right place in their households lifecycle. You know that they can make the move to home ownership.
Speaker 4:The challenge was supply and availability, for particular for first time home buyers. The you know, given that prices have only come down a little bit, you know, for single family homes and again, variation across market, the but mortgage rates gone up considerably. They may be off of their peaks, but not by that much the you know, home ownership is at best aspirational for millions of American families that might otherwise have hoped to be in an owned home. Today. There are a lot of folks who you want the benefits that accrue to being in a home in a relatively more suburban sort of your setting, you know, principally access to good quality public schools. You know, in a lot of our cities, you know, but you're for whom ownership is just not viable today or doesn't make sense. Right, it could be they could be wanting to rent a single family home, you know, because of an income constraint, because of a wealth constraint or or maybe, maybe by choice. Either way, there's, you know, when we think about providing a diverse set of housing opportunities, you know.
Speaker 4:You know my view on SFR is that this enhances the range of options available to two American families and that's a net benefit. It's obviously become very, very political because of the perception that you have large institutions in the United States that are buying SF, that are buying single family homes on a scattered site model, just pick up homes where, wherever they become available, and and then reposition them for the rental market, and that that somehow is the thing that is constraining the single family home supply curve, driving up prices for people who want to buy those homes. There are going to be some sub markets of the country where you know that might be a reasonable characterization. Nationally it is not a reasonable characterization, the. So I think you know, given the political dynamic.
Speaker 4:I think you know SFR, really I think the opportunity over the next, you know, over the next cycle, is going to be more on the. You know certainly SFR as well. But we're also seeing a larger number of those firms that otherwise might have acquired assets, acquired homes on a scattered site basis and we're seeing, you know more of them develop a complimentary. You know built to rent platform that it has benefits, right, being able to acquire a large plot of land and then build single family homes for rent that are net additions to the inventory. So you're not sort of you're taking out of the inventory, you're adding to it, but that all are also physically co located. Just the economics make a lot more sense. So I think that becomes part of what we see here, the.
Speaker 4:But overall, I think what you're pointing to is that there's, with the adjustment in the office sector, there are gonna be some folks who raise those debt funds or those opportunistic funds, and are gonna wanna work really, really hard to identify office assets whose values are impaired because of the negative sentiment but that are fundamentally good office assets that will improve on the other side of things in their value and their occupancy and their revenue, versus those office buildings whose values are impaired on a permanent basis because they're just not viable as office buildings anymore. When we look overall at what it means, when we try to bifurcate those two, is that there's a lot of money that may have been within a pension funds interview, a real estate allocation or a sovereign's wealth allocation or a large institutional allocation may have been through your office, where folks are saying, listen, it's not. I'm gonna take advantage of good deals in the office sector where it makes sense because there are some good buys out there, but at the same time I'm gonna overall have less capital allocated to office or less allocated to urban retail and I'm a little bit more reserved on the near term multifamily outlook than I was a year or two ago. I know it will improve, but right now I wanna be cautious, folks. We're talking about the core property types and so folks are invariably having to look for alternatives. Where am I gonna deploy my real estate capital if it's not an office Not everyone gets to.
Speaker 4:There's clearly demand in major urban areas for extraordinary new office buildings that are responsive to how we think about the office experience, that are co-located with transportation hubs, that are replacing functionally and competitively obsolete inventory. But there's only so many of those buildings that we can absorb in any market. So folks are having to look to alternatives because they've gotta put that real estate allocation to work. So that's gonna be sort of, I think, a feature of the market. We know that those alternatives only come into the mainstream if we've got liquidity and that liquidity also depends on the availability of good data and analytics and transparency in the market. So a lot of things have to come together. But I think you're gonna see a lot more interest in alternatives over the next couple of years because we've got the capital that needs a home.
Speaker 3:Shifting gears a little bit and I might be quoting the stats incorrectly, but I mean they're saying from the boomer generation there's gonna be a $70 trillion transfer of wealth to the millennials and the Gen Zs and that the boomers were great savers, they were pragmatic, they did everything right and made big sacrifices right. There's this massive transfer of wealth coming. I like talking about the near term stuff because I think people are trying to make decisions near term, but there's also a patience aspect. So when you think about this transfer, it feels like the millennials and Gen Zs maybe know they're getting some money coming their way.
Speaker 4:Yeah.
Speaker 3:And they're just kind of playing the waiting game a little bit right. They're not worried about oh, did I max out my 401K? Do I need to worry about investing other than maybe crypto to generalize everything, millennials and Gen Z? But their long view is like I'm gonna inherit more money than I need.
Speaker 4:Yeah, so I'd say that I mean there are a couple of things there. It's always difficult to disentangle and attribute sort of motivation to the behaviors that we observe in the market. I think you know, if you're starting point with this was the potential for a significant transfer of wealth. I think you've got a lot of members of the boomer generation who will be like hold on and not, it's not coming yet. It's like I'm still here for a little while. So you know, don't get ahead of yourself. So I think that wealth transfer will occur, as it does with any generation. I think that when we look at the savings of retirees in the United States, what we see is that meaningful wealth and the kind that sort of will, meaningful wealth accumulations, meaningful wealth transfers we're still talking about a subset of the population. We're also in a world where I think a lot of retirees are having to think about the balance of what they expend now versus what they leave to their kids or grandkids and that balance might be shifting a little bit because everything's getting more expensive. Certainly, I think there's folks in your and my generation who are gonna be potentially based with much, much tougher choices because of changes to the way that we fund and support Medicaid, medicare, social Security. Now, these are not issues that, in the political environment, are very palatable. The idea of raising retirement ages, cutting retirement benefits, phasing them out for folks above certain income thresholds these are political non-starters right now. But when we look at the budget of the United States, when we look at how much more indebted we are today than we were even just prior to the pandemic, when we look at sort of the share of the budget that is allocated to debt service at the federal level as compared to where we were just a few years ago, and what that number where that tracks over the next several years that we are in a much more difficult position than we have been historically. And so, while you may have sort of a generation that it was perceived as having been focused on savings, you're also gonna have more. You're also likely to have more significant financial demands on that generation and there may just, at the end of the day, be less left over at the end for them to transfer. Part of what that also reflects is that, apart from all these other things going on in the fiscal environment, people are gonna live longer. Yeah, we'll argue about sort of some of the public health challenges that we have in the United States and why it is that we've kind of stalled out on life expectancy. But as compared to 30 years ago, we're gonna live longer and so those retirement savings do have to go much further than they have in the past. I don't know that.
Speaker 4:It's the case that a lot of younger people are saying, oh, I don't need to be engaged in the labor force or be thinking about sort of my long-term plan because there's a payday coming. As much as it is sort of a lack of long-term thinking. Generally, there's a lot of short-termism and not a lot of long-range planning around sort of why it's important to say. I should be careful of characterizing that way. As a closing point, though, I think a lot of younger people will say I realize it's important to say I realize it's important to engage in long-term planning. Right now I'm trying to figure out how I'm gonna pay my rent. And so to your point about short-term. A lot of young families, a lot of young individuals. You find that, particularly after a couple of years of high inflation and given what's happened with housing affordability and major markets around the country, that they would love to be planning for the long-term. But the very immediate issue for a lot of people is I've gotta pay for groceries, I've gotta pay for rent.
Speaker 3:Yeah, and I think we just saw the earnings from all the builders just crushed it. The builders all seem to be doing well. There seems to be, interest rates are moved up, but there also is a ton of inventory.
Speaker 4:On the single family side. That will likely remain. That's how I think we'll continue to characterize the market for a while that we're supply constrained. House prices remain high, and so you'll do well in this space if you have the capacity, resources, materials to actually bring new inventory online and, importantly, if you are in a privileged position in your cost containment strategy. There are, and that, I think, will favor the large builders.
Speaker 4:If you're a smaller single family home builder, having to manage a round volatility and software lumber prices, securing a pipeline of skilled construction labor, these are not easy things to do. It's part of why we are supply constrained because, amongst other things, it's just been difficult. Given the labor market constraints, given the material constraints, given constraints on the availability of financing to the developer, it's a tough environment to bring new inventory online. Also, don't want to understate that while we've not had a lot of entry level homes built, I wouldn't put the fault for that entirely at the feet of builders. A lot of that and a lot of markets has to do with local zoning and artificial constraints on our ability to bring starter ownership opportunities into the marketplace.
Speaker 3:Yeah, and so the other. We have relationships with a lot of the engineering firms. They seem busier than ever, hiring as many if you could hire, if you're a civil engineer right now, which I might have to go back into it, name my price a little bit. And it's interesting because it feels like just now some of the inflation reduction act money, a lot of that money that was earmarked and approved a few years ago it's just now kind of flowing. And when I talked to the contractors they're like we're tapped out, we literally are turning down work and it just doesn't seem like there's an answer out there for this. So you talked about the flow of money, the indebtedness, but we don't have the capacity to spend it.
Speaker 4:Yeah, we have to be careful with IRA. I'm going to be the first to say that, particularly living in New York City, there are no shortage of infrastructure projects that require attention and that need to be prioritized. At the same time, while there are clear opportunities to deploy capital and resources in improving our infrastructure, on the supply side of this we are really constrained. Do we have enough engineers? Do we have enough architects? Do we have a larger pool of skilled construction labor outside of residential but that could work on larger infrastructure products a different skill set? Do we have the materials that we need, because now we're not talking about softwood lumber, we might be talking about concrete or steel. Do we have the requisite zoning, approvals and clearances?
Speaker 4:When we look at the totality of this, the risk here is that we deploy, we make a lot of money available to improve infrastructure, but the resources, the supply, our ability to actually deliver it's constrained by all of the things that you're describing. We don't have enough engineers. That will tend to bid up the prices of all of the inputs to infrastructure investment and that will have a spillover effect into the cost of building in all other areas. Bottom line is, if we allocate a huge amount of money to infrastructure but are not investing and improving the supply of all of the things that we actually need to bring that new infrastructure online, then we are feeding inflation. This is the irony of IRA If we are not investing in making sure we have more engineers in this country, then while the name of the bill, the name of the law, implies that it's designed to tackle inflation over the medium term and could exacerbate inflation.
Speaker 3:What are your students saying? As your students are graduating and going into the workforce or coming and getting their graduate degree to have a shift. I've met with your students before. Some of them are coming back to grad school to shift their career move from maybe real estate into private equity or whatnot. What are they seeing? What's their appetite for, what they want to do? Because you know my kids, I hang out with these younger folks. It's like they all want to work at Bain or management, consulting or investment banking.
Speaker 3:They don't seem like they're that interested in being in. You know, even if they have an engineering degree, they just don't. They're not super excited about being engineers.
Speaker 4:Yeah, no, I've been. You know I've an engineering degree as well. I've never put it to work. It was. It was one of the toughest things. You know that I've done. You know, academically, the. You know it's hard work, the.
Speaker 4:I think that you know we do have students in the, in MBA programs all across the country that are pursuing careers today that are more diverse than would have been the case, sort of when you and I were in school, right. So, whereas you know, for us it really been would have been sort of a clear cut path. If you're in an MBA program, you're either going to banking or you're going to consulting. You know we see a larger number of students doing you know things. You know outside of those two areas, and I think in, you know, real estate over the last 20 years has become, you know, increasingly more formal. You know there are. You know there's a greater recognition on the part of MBA students everywhere, graduate students everywhere. I should say that you know there are. You know within real estate, you could be a developer, you could be. You know, in the proctech space you could be a disruptor, you could be on the finance side. Even just being up being on the finance side could mean a lot of different things. The so there's a greater appreciation for the range of opportunities that are available.
Speaker 4:The you know I'm, you know, heartened, a little bit surprised. You know, at this point in the cycle, you know how many folks you know are adamant on wanting to pursue opportunities in development, even when I also have a conversation with them about, well, you know, construction financing, you know is, you know, is tough right now. And so even where there are, you know, even where there are projects, I mean you have to be well positioned, right. You've got to be a big institutional player if you want to, if you want to sort of assemble the necessary financing for a very compelling large scale, your project, the mixed, you know, large, mixed-use project that you described at the beginning of our conversation, the, the, so you know all of that, the observio, all the, I think you know, is actually encouraging for me. I don't see any diminishment in interest in real estate and I see folks wanting to pursue a whole range of different paths within real estate, whether it be something more entrepreneurial or something development related, or on the finance side.
Speaker 3:So I assume you have to be being asked this because it's it's just, it's. It's what's happening, and I think I've texted with you my view of AI, which is, I would say, I think it's a super cycle, right, it's, it's that important. What are your like? What's the industry? And they have to be asking you, hey, what is AI saying? What does AI mean to real estate? What does AI mean to insert? You know, fill in the blank, yeah.
Speaker 3:I think there's a lot of any like data driven perspectives around like what AI could mean yeah.
Speaker 4:So I'd say you know a lot of a lot of our thinking is sort of more of a level of you know anecdotal evidence and you know strategy. Right, we want to be in a position to be able to say, okay, this is perspective for a lot of companies, the so can we anticipate what areas you know are going to be most most likely to be disruptive, or where the opportunities to disrupt? And that's definitely sort of you know the angle I'm taking with with my students. You take your real estate data science and AI and they think you know it. Folks find it to be a fascinating topic. But what I think we also find is that, while you know, an increasing minority of companies tell us today that they have at least some significant business process, you know where they're deploying machine learning, the most companies are still in the full mode stage of this, so they don't know how their business is going to be disrupted. But they are, you know, generally pretty nervous that their main competitor is going to figure it out, and so you know they're continuing to read the market. They are, you know, deploying. You know you know solutions in very specific. You know you know processes within, you know, within their business. Very few of those are proving to be revolutionary. You know thus far.
Speaker 4:You know, I think, that you know folks sense that there is, you know, extraordinary potential here and that it will be. You know as significant. You know as trivia the internet, you know, was to. You know everything we do, you know comes from just sort of. You know the. You know how visually. You know you know attention grabbing.
Speaker 4:You know some of the developments that we've seen in generative AI have been, you know, the last week everyone's been focused on. You know the new. You know Sora, the. You know the, the video generation tool. When it, you know there's the sense that, my gosh, this is all evolving very, very quickly. Right, and I better, I better figure out what my company's strategy is. Yeah, the, the. But what we also see is that you know it's not, while well, to review, it does give the impression that it's all moving very quickly.
Speaker 4:The bottom line is that when we actually dig in on company processes, on things like you know how they're deploying smart building technology, how they're using AI to support, you know, sir. You know you know they're archery, sir. You know, sir, you're building design. You know the space optimization, whatever it is. It's not moving as quickly as the generative piece. Yeah, the so. Will it be disruptive? Yes, the. Have we seen parts? Yeah, we've seen to reveal whole parts of real estate that are being disrupted on a fundamental scale. You know sort of you know they're being fundamentally disrupted, not yet. I think there's more potential here in construction, development, architecture, design than there is in sort of the odd.
Speaker 3:We use chat, gpt to, you know, to create marketing material yeah, I think I think I shared with you in my new my, my new book, which hopefully will be out in the next month or so I kind of said, yeah, my position is that AI is not the new internet, it's the new electricity. And we're all staring at a light bulb called chat gpt talking about how many candles we can get rid of. Yeah, that's all we can really envision right now, where there's just so much more that, like the stuff we're not going to see coming right, that's, that's, that's my. My position has been there is so much going on, it's going to be the stuff that we don't see coming in the new business model, innovation versus just replacing candles with light bulbs absolutely and I think sort of yeah, we've got plenty of precedent for this right.
Speaker 4:So you know the. You know when they. You know my third you know touch point on this is the iPhone. You know, when we popularized the smartphone, did Steve Jobs or anyone else involved you know, have any understanding at that point of how would fundamentally change the way every person on this, you know virtually you know every person on this planet lives. Now I say you know not everyone, obviously you know I don't want to be naive to the fact that you know there are people all around the world, you know for whom. You know iPhone ownership. You know it is sort of. You know you know aspirational, or certainly not in the interview. In their hierarchy of needs, you know it isn't top of the list.
Speaker 4:But I'm also amazed when I go to India or other emerging economies, just how, how sort of your brah. You know the. You know the, the depth of penetration of. You know of smartphones. You know people won't have computers, they won't have tablets, but everyone's got a smartphone, the. So that's amazing, but it's reshaped the way we live and interact with one another on such a fundamental basis. The experience of being human today is different than what it was prior to. You know the introduction of smartphones, but I think you're right, the that this is. You know it has the potential to you know upend the, the way we live and interact with one another, but what the actual applications will be. I think we're really struggling to understand sort of you know the. You know sort of what the big picture is here. The big picture is not you know creating. You know having chat, gpt, right, my essay form.
Speaker 2:You know the big picture is much bigger than that all right, ian and Sam, how you know, when you were keynote again summit, shadow summit last fall, you presented a few idealistic fiscal policy reformations that could potentially shift. But you know, along these lines of AI and technology and social media and this uncertainty of, you know, government regulation versus not, you know, I'm curious you know if you there's been any update to your opinions from last fall today on that front?
Speaker 4:yes, I think. Thanks for this up. You know, I think what we had looked at together at summit was the, the Penn-Borton budget model that basically, you know, showed us three or four different policy policy paths that we could take to get, you know the, you know fiscal policy at the federal level. You have back on track and what I want to emphasize here, because I don't want folks to, you know, suddenly think I'm sort of this unusually hawkish person on on fiscal policy, and then, you know, you jumped any conclusions about my, my political affiliations. It doesn't matter whether your spending priority is defense or whether it is, you know, expanding prescription drug coverage or, you know, access to you know. You know, you know pre-k doesn't matter what your policy priority is, along the current fiscal path, there will be less money for everything, right. So, you know, I don't care whether it's defense or whether it's schools. Neither one of those you know policy priorities will be able to command as many dollars as it has in the past, because it's been crowded out by, you know, the, you know the rapidly rising cost of servicing our debt. I think what I see is that, from a fiscal policy perspective, nothing has changed. You know, we are still careening towards. You know fiscal instability. You know, in the same way that we were a year ago, there have been no meaningful developments in, you know the federal level and in the in the political environment, to move us towards fiscal stability. You know what's articulated in. You know, in that example used from the Penn Wharton budget model and this really sort of you know helps to drive home for folks is, you know how significant the changes would need to be to things like, you know, retirement ages. You know social security benefits to. You know. You know discretionary. You know categories of discretionary spending like what are the different? You know combinations of things that we could do to get us to fiscal stability. You know that, again, very little chain over the last year, but I think this is one of the most significant challenges that we face as a country.
Speaker 4:On the AI side, one of the concerns that I've seen expressed is oh well, this is gonna make a lot of people who are currently engaged in the labor force irrelevant. Anytime we introduce a meaningful and relevant technology that has real application in the production function, some people are gonna be displaced. And it's not that those people are displaced, it's that the skillset that they bring to the labor market becomes less relevant or less marketable. What we also know, then, is that our ability to ensure high levels of employment and I mean sort of in the economic sense depend, then, on whether or not those folks that have been displaced because their specific skillset is less relevant do they have the opportunity to develop a new set of skillset, a new set of skills that will allow them to remain relevant. Are we investing in the educational infrastructure of this country in a way that allows people to reinvest in themselves and develop new skills that allow them to remain relevant? My biggest concern right now is we're not doing those things. We spend a lot of time talking about how AI could be incredibly disruptive, but in part because we don't know which sectors of the economy will be most significantly disruptive, which jobs will be most at risk. Neither are we, as individuals or at a policy level, thinking hard enough about how it is that we'll make sure that we're making it easy for folks to remain relevant in an AI enhanced labor force and labor market. Where this becomes problematic, then, is where we have a lot of folks that, just in terms of their skillset, aren't relevant and can't engage. So we have some real work to do, I think, in allowing the educational infrastructure of the country to adapt and evolve in ways that actually make it easier for folks to engage more directly.
Speaker 4:People are not gonna go back to college for another four year degree.
Speaker 4:They might focus on very quickly and rapidly developing a skillet, a new coding language or a new platform. Do we make it easy enough? I'd say no. A lot of the programs that people have access to because you could always point to oh well, this particular university offers this certificate online and that one allows you to take a short course that promises to make you better at X, y or Z the proliferation of those programs has not been met with a commensurate commitment to program quality and learning goals, and by that I mean a lot of these programs just aren't actually teaching you what they commit to, teaching you upfront, and are not necessarily succeeding in preparing you for whatever's next in the labor force. But we need to see an improvement in program quality and an interview, an investment in the transparency around which of these investments that folks might make, because none of them are cheap. But what kind of investment can you make in yourself and your skill set that will actually generate some kind of return on investment.
Speaker 2:Yeah, I wanna shift gears just slightly here for the last six or seven minutes or so. Anyone who's here live, we do offer for premium members of the Shadow Partners community ability to join these kind of conversations live and ask our guest Q and A. So we do have one question already from Nina Charsky and Charsky she's a director of the National Institute of Building Sciences and was asking about how much the cost of materials for development is impacting the cost of ownership.
Speaker 4:Yeah, I think that it's moving in two different directions. For commercial real estate, certainly we see that sort of a broader dynamic is exerting downward pressure on prices. But the overall cost of ownership apart from the value, the market value question the overall cost of ownership is rising Because we all know we're not only encouraging current costs to bring an asset online. There's an ongoing question around property maintenance, operations, capital expenditures and, as a country, as our relationship to the built environment continues evolving and changing today more rapidly than it has in the past, the relevant period over which your asset becomes functionally or competitively obsolete has gotten shorter. So you've got to be thinking about making those capital expenditures sooner than would have been the case in the past. So you know, to Nina's question, the cost of all the materials, not just the steel and the drywall but also the labor, the cost of all of these inputs rising, is driving up the cost of ownership. You know, one of the areas where we can see this is in, you know, sort of the multifamily market with rent stabilized multifamily. This is a segment of the market of multifamily that's come under some pressure and where we've seen some increases in the levels of stress. Part of what that captures is that while we have in some cases, some level of rent growth maybe two, three, four percent certainly in New York we've got a rent control board that sets rent increases and you know, on the other side of it, you know the expense part of the pro forma is rising more rapidly. So I think you know it's the combination of the. You know how material and labor costs are driving. You know day to day operation and maintenance costs, but also what that means for capital expenditures.
Speaker 4:You know one of the things that Ian and KP and I you know talk about is you know sort of. You know how all this relates to. You know our investments in. You know building decarbonization and sustainable real estate. You know a big question that I think a lot of us have to be, you know have to face up to, is that, while we want to make meaningful improvements in you know deep energy retrofits, you know for our assets to achieve, you know our climate goals that may be, you know, motivated by our investors, may be motivated by local laws the cost of actually making meaningful improvements and in you know decarbonizing, you know our assets or making other kind of energy efficiency improvements. You know it is getting more and more expensive to do those things. The biggest headwind, you know two biggest headwinds, I see you know two, you know greening our collective real estate portfolio. That are one of the high costs of the financing to make the improvements. But also that the actual capital expenditures required, you know, are, you know, rising, you know, with every passing quarter.
Speaker 2:Thanks, sam. We might have time for another question. Live if someone wants to raise their hand, but other than that, this has been fantastic.
Speaker 4:Thanks so much, sam, for joining you know thanks to both of you and to everyone who tuned in. Always a pleasure seeing both of you and a nice way to revisit some of our conversation from you know from our meeting in Atlanta. So hope to see everyone in person soon.
Speaker 3:All right, we'll see you Sam.
Speaker 2:All right, bye-bye. Thanks so much, take care.
Speaker 1:Thank you for tuning in to another episode on the Shadow Network here with KP Ready as always. Remember you can connect with KP and other innovators in the AEC and CRE industry in the Shadow Partners community. Go to bitly slash shadowpartnerscommunity to find out more today. Until next time.