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Welcome to Altus Insights Podcast Series. This podcast brings together some of our leading brainiacs at Altus Group to discuss, debate, and on occasion complain about the evolving state of Canada's residential and commercial real estate. Join Ray Wong, Marlon Bray, and Avi Zelver for monthly podcasts covering the latest market and construction cost trends across major markets in Canada.
Welcome to Altus insights podcast series with Ray and Marlon hosted by me Avi. This podcast will cover monthly market updates and construction cost impacts across major markets in Canada. Welcome back to the Altus podcast series with Marlon, Ray and Avi. Today we continue with part two of our US Canadian discussion. Omar Eltorai, the director of research at Altus group, joins us again with more than a decade of experience in the industry, in the investment management and finance roles. Omar's focus at Altus is on macro capital market trends affecting the US already market. In the first part of the discussion, we went with an overview of the capital markets trends, the overall flow of investment activity in 2022, and what we expect that in 2023, North and South of the border. And we're going to continue on with our discussion of the part two covering the industrial and office market. So, Omar, welcome back again. I'm glad you actually came back for the second round. Happy to be here. Thank you. And Canada has been red hot for a last number of years with their record low availability rates across Canada, with 20% to 30% increase in land and rental rates. So, Omar, what do you see in the US market? Yeah, so industrial remains to be one of the, I would say, hotter segments of the CRE property types in the us, whether that's based on pricing. But just overall demand is still there not only for transactions but also for the space itself. You still see rather low single digit vacancy across many of the major markets. And the absorption is still very, very strong, even though the even though the property type has seen some, I would say skepticism enter the market, especially when compared to the 2021. It's the fundamental that there is a case across most of the major markets that the fundamentals are still intact. I and then also I would say from a pricing standpoint, it is one of the areas that is still desirable and it is not it hasn't necessarily fallen off and there is still transaction activity taking place. I'm sorry. Go ahead. So this is where I go on to the negative thing. Where does this eventually end? Because the gold rush to the klondike, it started. Fantastic It looked great until it wasn't. And the way I usually look at this stuff is a lot of it's driven by online shopping. And my buddy Brian, as much as he likes to buy every tech humanly possible from Amazon, at some point there's nothing else for us to buy. So when does it slow down or is this like forever now? Yeah so this is where I would take it. Even though real estate is know, it is local, it's understanding assets, it's understanding the market that those assets are in. I actually think that to answer your question. I would look at the macro level because I do think that that's where there are some bigger signals coming through there that are a little bit more concerning. So on the highest level, I would say looking at health and now I'm speaking just about us, right? So looking at households financial position going into or sorry, coming out of the pandemic, it's really the strongest financial position that households have had ever. Right so they had large cash savings. They had low levels of debt obligations. So essentially, whether it's credit card, mortgage, auto loans, they were able to service that they had robust investments. Right so looking across their stock portfolio, their bond portfolio, they just market marketable securities and that put them in a very high. The high is kind of like net worth that the American household has been in before. But a lot of that has started to change. We're not at the red flag level. But as the Fed started raising rates in earlier in 2022, that hit a lot of the rate sensitive assets, largely home prices, which were starting. Those move a little bit slower, but we're starting to see some softening there as well as marketable securities. So as the markets became more volatile markets and 2022. Year for stocks really was a sell off year and during a similarly to how markets will react during times of stress. Or distressed red, you see growth asset correlations heightened. So even though the stock market was falling, diversification wasn't really possible or you didn't get the benefit there. And so a lot of the overall both fixed income and equity markets happened to lose. That hurt the household position. You're starting to see, even though the American consumer has not slowed down their spending, they've been fine because they were eating through a lot of the savings that they had accumulated during the pandemic. However, we're starting to see that more borrowing is needed to fuel their consumption. And on top of that, which makes this extra painful, is that credit card or installment loans, which are which is how you would effectively fund this if you have no cash savings and those rates are at all time highs. Right and so the money that they are borrowing now to buy the thing that they wanted yesterday, today now just cost them about five times. Is it as much as it would if they had bought it last year? So that's a really long winded way of saying. And if it were the trend, if the American consumer continues to purchase at the same rate that they have been, the way that they will be able to do that is by buying it with a much more expensive money. And that will. So either something like something's got to give here. OK so Omar pulling back to real estate there that you just said with respect to, you know, the problems that they had to start to go out with consumers. And we may see a slowing because the interest rates. And for industrial the rate of again kind of increase 20% or 30% Right you must be seeing the same thing in the US with pressure points. So there's only so many increases that companies can kind of push on to consumers and businesses. Do you see a bit of a risk there regards to the last, last increases in rental rates and as well as the costs of some of these, especially these newer buildings with the Super flat floors and the high automation with rocking that cost these buildings. Right do you see those as a bit of an issue going forward, especially for owners and investors? Yeah and I would say one of the big areas that is also a bit concerning. So at the high level. Right, is knowing that there is demand and the market is tight. I think that is there that is quite supportive. But really the way that I see industrial is that it is this is going to become very market focused and I know I know that I'm sure, you know, listeners may be rolling their eyes because I was always I was always told that real estate is, you know, especially commercial real estate. It's idiosyncratic. Right but you need to understand the individual. No, no. Two assets are the same. And I get that right. So but I acknowledge that now. But we can move on. I think that the story for industrial, when we're talking at the sector level is very much going to be market in there. You're going to see some pretty drastic differences in performance based on the market. Omar which markets? And I would say one of the tightest is like inland empire, whereas, you know, and I think that there is know, there's a real those fundamentals I think can support and not only within that market, but in the role that the Inland Empire serves for the overall kind of like supply distribution across the US. OK so what else what other markets do you think? That is basically a safe bet on industrial that we should have a challenge with higher rental rates? OK new Jersey, because we've heard stories within Jersey with respect to some of the vacant land, has actually been a little bit more on demand whereby they're keeping the goods in trailers and they're actually renting the land out to store goods. So that's actually a that I love that you brought this up. And is it going to be, you know, maybe not going off script here. But I think that they have recently learned a little bit more about. It's called industrial out worst storage. So I was which I actually think is a pretty cool way of or it's an interesting it's an interesting evolution or innervation of a business plan of monetizing a, you know, monetizing a real asset in a way that I honestly I had not thought of or really before. But it's and it's ultimately falls under that industrial use case. But I think that it's pretty that I happen to like that because one of the things that I'm looking at, especially across sectors now, is if we do have sticky inflation plus high cost of financing and/or volatile markets, that means that really understanding the stability of cash flows is huge. And if you're top line growth rate and we touched on the prior call is that if your top line growth is maybe variable, but that expense management component is in my view, like really critical because you can't have this volatile top line but have only steadily climbing expenses because that will ultimately erode kind of your overall profitability. And something like industrial, I think has had the kind of attractiveness because it's been relatively lower kind of expenses here in the last two years. And whilst I made that share from just in time to just in case there's a further increase in that demand, we're I think we're going to put industrial into a little bit more detail with the future. But guys, well, before we jump over to the office side, where do you see cap moving specifically for office industrial? You know, go into the office. I would refer everybody to the last episode when I went on a long tangent there. But I think the hands are up. We do and that's as a that to be fair on this. Yeah so we'll leave it at that. All right. Go on out now. So let's move over to the office sector. So there's this whole thing of going back to the office has been a big discussion for the last 2 and 1/2 years. First it was temporary. Now it looks was longer term. Now there's a lot of discussion with the evolution of office on how we actually utilize the space. So the space itself, how we utilize it, and how the space adapts to the needs of the workers and companies. What are you seeing in the US with respect to the office market and this battle with trying to bring employees back into the office? Yeah so I think and I'll answer the second one first is that, that, that bringing employees back to the office, I think is going to remain a real challenge. You have a number of firms that are taking strong stances and saying, you know, we're expecting you back in three, three days, but you get to remote. Some come in saying that you effectively, you know, they want their employees back the entire time. But so long as we have kind of stubbornly low participation in the labor market plus, you know, even though you've heard about layoffs, the labor market is still in the US is still super tight and employee cost. So the cost of labor is still climbing higher and is just expensive. The remote option for a lot of employers is will remain a benefit of sorts. It's a non-monetary benefit. So that they can put out there to attract employees. So I do think that it's going to be tricky to force everybody back to the office. And then on that, with that like for office, if looking at the most recent capital data that if really occupancy is right around kind of sorry I'm sorry the castle data is a security pass. Cards are. What is that. Yeah, exactly. Yes Yes. Sorry Thanks for pointing that out. Yeah, it's they do the security passes on a lot of buildings and they put out these weekly reports and they break it out because apparently lawyers are very different. They but lawyers. Lawyers are always in the office. Apparently so. But I guess so. The occupancy right now, if you squint your eyes over these reports, right. It's roughly in that 40, 50% range across the big cities which pre-pandemic you had, you know, really in that 70% to 80% And so that's a big drop right there. Before the pandemic, remote work existed, but it just wasn't adopted. Pandemic happens fast forwards, behavioral changes that on their own before would have taken years and years to kind of play out. But the adoption was very fast. That has shifted where the office market now looks over dramatically oversupplied. Now, now we know that the return back to office is relatively low, right? Yeah what do you think going forward with demand for space, do we still need office? And I get this question. Timbaland's comments that were in poor performance standpoint are a wise standpoint. Do these reasons sort of make sense down the road with respect to supply and demand? Yeah so I do think we still need offices. I but I also think that we're dramatically oversupplied now. How that I guess how the office. What do we do with the oversupply? You know what I think is also based on a region. I think a place like Nashville has a little bit more. You have a younger population and same thing with our accounting office. But people are now talking about the Calgary market, which has started about 30% office vacancy rate, but it's improving. But then I'm always a reminder, so 30% office vacancy rate, but there's a lot of young people there. It's becoming dynamic. So same thing with Nashville. I think there's a demand for office there just because of the lifestyle, the number of young people. Demographic shifts. But I think something like the larger markets will use Chicago's and new York, which not just have problems bringing people back into the office, but they also have a two hour commuting problem that Rolland I have in Toronto. See, that's the problem. Really bad transit systems that don't function. Yeah so when you look at that from that perspective, Amara, where do you it's a difficult question to ask and we're not asking for what the total answer is as are thinking of possible direction on some of the positives and negatives on the office front. And that would be a corporate question. Yeah, no, absolutely. I do think that there are some positives, especially before. So in the last couple of years. Right, you have seen big migration. There have been a number of places that have seen huge influxes and others of outflows of of, you know, residents. Right and so a lot of those markets I'm thinking of, like the students are thinking of Miami's that have seen huge growth. Those, I think, are certainly under threat, whether it's undersupplied or they've been able they will be able to, you know, essentially have enough demand for office space. Yeah you know, I am a very proud New Yorker. Right? and. And I do. But I do. I do think that there is know, it's going to be tough to justify, you know, whether it's prices, values or just cash flows remain in the same, you know, remaining the same when half the use or half the demand has been really wiped out. So but I know that that's also especially like in New York. Right? that's on our mayor's radar in I think it was January he announced plan to support conversions of empty office to other uses including like residential. But Marlin I mean you can probably chime in on of the practicality of those conversions. No, it's very low. But I mean, the other way to look it, though, doesn't this move into a state that's natural anyway, in that the older buildings that don't fit for use anymore, the culling from actually makes natural sense. So in essence, we get rid of the garbage and the trees to have the highest standards. Well, in the States that haven't banned the word CSG yet, but places where you just recognize those tier buildings, the veil and maintain the value, because we get rid of the stuff below them. So that oversupply vanishes and it may be conversion, it might be replaced. Now, I think part of the challenge for going to see them replaced, I was looking through BSG, the carbon. OK, if I demolish a building I've done a lot waste. Well, that's good. But if the buildings are useless, the building's useless. There's no way of solving that problem. And the office conversion like one in ten, maybe if you look, you've got any suitability. It even then is difficult and huge risk. But to me I think it's a natural sense. So we just got to make sure one of the pros having Toronto is if you tear down an office building, you have to replace that work, use some of the same. Sorry even if the site is the most ridiculously useful site in the history of mankind, they still force you to do it. So they can pick a box. I think if we had plenty to change from policy that promoted this natural evolution of office, the office will just evolve. The buildings will be in demand to still have those higher rents. We can claim it's just the garbage vanishes from the bottom of the food chain on the asset type. Summer cooperates direction. I'm going to predict this one. He's going to say, oh, wait, see, I knew that was coming. OK I think we're going to explore a little bit more with some of the similarities and differences with the US and Canadian markets going forward. So I think we're going to have our back for at least a few more sessions to expand on this discussion. But Thank you very much again for round two, Omar, and Thank you for actually coming back. Not very many people do. So I thought that was a really good and interesting episode on office and industrial trends. So again, Thank you very much for everyone attending and listening to this podcast, so we'll see you for the next one.