by David Gilbert, Franklin Templeton Investments
Here are some highlights from their conversation:
- “The apartment sector property type has been the most resilient. Although there’s been quite a bit of job loss of late tragically with COVID…the apartment sector has still continued to perform well. In many states, there is still a housing shortage, in California in particular. People need a place to live and they continue to pay their rent. But long term, it’s job growth, job creation and wage increases that will help dictate rent growth.”- David Gilbert
- It’s really been a 10- or 15-year phenomenon of the increased penetration rate of e-commerce sales and the adoption has been accelerated dramatically by COVID for all the logical reasons. There’s nothing better than the ability to stay home and have something safely delivered to your doorstep if you’re trying to socially distance, but that just accelerated this trend that’s been going on for quite some time… The mall area is where the greatest pain is. The future of malls is very uncertain.” – David Gilbert
- “Office is a big question. I do think there’ll be less demand by virtue of the need for flexibility and the ability for people to work from home. It’s still early, but we’re developing greater conviction what it really means…You don’t abandon the office. It’s just a less of a need to be there every single day. There’s still a very unique need for office—the collaboration, the culture-building, the training and the onboarding are extremely difficult to do remotely.” – David Gilbert
- “We’re very excited about [life sciences]. It is unique because it is a fabulous growth area and the real estate to support life science, R&D [research and development] is quite unique. All sorts of things make that environment quite specific, and it’s quite expensive. And… the scientists actually want to be in a cluster. They like to be in and around each other. There’s collaboration.” – David Gilbert
Stephen Dover: David, welcome.
David Gilbert: Thank you, Stephen.
Stephen Dover: David, let’s just talk broadly about the real estate market first, and the impact of the election on the market.
David Gilbert: Well, it begins with the macro view, the US economy. The market, I think, has initially reacted well. The market hates uncertainty; real estate investors equally hate uncertainty. And I think having the election results hopefully behind us is a very good thing. The policy prescriptions were quite different between the Trump and the Biden administrations. It’ll take time to see what Biden can actually get done. And a few of those are decidedly friendlier towards real estate investors, but it’s modest. The real key is that we’re poised for the US economy to begin to grow again.
Stephen Dover: The news this week on a vaccine, how do you feel that might impact the real estate market?
David Gilbert: Well, I think that interestingly, the greatest contribution in our view is that it will restore confidence, and confidence is so key to the fundamental driver in the US economy, which is consumer confidence. And while it actually doesn’t change markedly our own forecast, where the vaccine gets implemented and deployed in a way that brings people back to work with that level of protection. So, we were thinking about late spring, early summer, it does validate that. But importantly, I think it provides the consumer with a great deal of competence knowing the solution is in hand.
Stephen Dover: Yes, I think the way I looked at it is we know that there’s going to be a solution. We just don’t know the timing, but in the meantime, there’s a huge shock, particularly to the cities and states, estimate of US$550 billion fiscal shortfall for cities and states. Of course, that dramatically affects the real estate market. We’ve seen some migration out of the cities. How does that affect the real estate market?
David Gilbert: Yes, it is a concern. It’s been a concern pre-COVID, some of the challenging fiscal positions that many states and cities, some of those have been deteriorating over time. Many of them are in the Northeast—New York City, New York state, the tri-state area more broadly is a good example. We have seen an out-migration over the past 20 years to the coast and to the South, right? The Sunbelt has benefited. Texas, and most notably, we’re seeing Florida also. One of the reasons—and it’s extremely difficult to do perfect attribution on this—but naturally, low-tax states are an advantage immediately. Housing costs, costs of living, are lower and the job market in many of these places, locales, particularly Texas, has been really robust. So, that was going to happen in any event, and time will tell to see if the federal government provides much of any support or what kind of support, but it’s exacerbated the fiscal challenge for cities and states who don’t have the option to issue debt like the federal government, and that inevitably will lead to higher taxes and/or a deterioration potentially in services. Both are concerns to accelerate out-migration.
Stephen Dover: So, let’s talk a bit about the apartment sector and how that sector has benefitted or hurt over these last few months with the pandemic, and how you see the apartment sector going forward.
David Gilbert: Well, going back 45 years, the data that we have in the private markets, we’ve got really good, transparent data now, particularly including great public companies. The apartment sector property type has been the single most resilient, and on a risk-adjusted basis, probably the single best property type to invest in over that entire time period. Interestingly, there used to be two: apartments and retail, but retail has gone through tremendous disruption. And, in a way, leaving apartments as that unique winner over a full 45-year time period. Although there’s been quite a bit of job loss of late tragically with COVID, we are still collecting rents at a very high percentage. People need a place to live, and there has been some support in a variety of locales to prevent eviction, etc., but the apartment sector has still continued to perform well. In many states, there is still a housing shortage, in California in particular, I would note. People need a place to live and they continue to pay their rent. So, it continues to perform well, but long term, it’s job growth, job creation and wage increases that will help dictate rent growth.
Stephen Dover: Some pretty dramatic changes with COVID, just a leap in online sales over the last six months or so. Maybe talk a little bit about the retail sector in real estate.
David Gilbert: Yes. Well, it’s really been a 10- or 15-year phenomenon of the increased penetration rate of e-commerce sales, and the adoption has been accelerated dramatically by COVID for all the logical reasons. There’s nothing better than the ability to stay home and have something safely delivered to your doorstep if you’re trying to socially distance, etc., but that just accelerated this trend that’s been going on for quite some time. There’s a generational shift. The younger people, they adopted these technologies more quickly, but what is interesting now is, is it as broadly adopted across an even much wider age group. Amazon in particular has helped lead this trend in its ability to provide very responsive delivery, and their goal is to get same-day, but they can serve something like 80% of the US population in a day now. And the way they’ve been able to do it is by building a new type of distribution, a new type of warehouse.
Stephen Dover: And when we look at the malls, what do you see as the future of malls and retail? Kind of the traditional way that people shop going forward.
David Gilbert: The mall area is where the greatest pain is; there are two areas of pain. One is mall, and the other is high-street retail, think of very high-rent, very expensive boutiques in that place like Madison Avenue, New York, every city has a high-street retail. Historically that’s been a pretty good investment. Of late it’s come under a great deal of pressure, not just because of COVID. The mall itself has evolved. Two major phenomena here. The deterioration in sales at what were the traditional department stores. There are very few left. They were the anchors to these malls. They were the draw, and the mall owners made their money on the in-lines. The anchors typically owned their own space. The Sears and the JC Penney’s, etc., would bring the traffic to the mall and mall and would make their money on rents from all the other smaller tenants. So, the deterioration of the department stores has been a long, evolving trend. And it then meant it was very difficult to sustain the economics of a mall, and the ability to click and have something delivered in a day or two has proven to be quite challenging, even in the area of apparel, which many thought would be very difficult to find high degree of online adoption. The future of malls is very uncertain. Most forecasts are somewhat alarming that they might call for a closure of roughly a third of all malls in existence. The top-quality malls certainly have a future. They are extremely well-located in dense populations of high-income earners. And there’s an appeal to going to the mall. Part of the change in malls will be entertainment, more restaurants, more other types of entertainment, not just shopping.
Stephen Dover: So, working from home, how do you see that impacting how we work, off the office market going forward?
David Gilbert: That is the single biggest question on our mind and on our investors’ minds. And frankly, on the mind of every CEO running a business where an office environment was critical. The good news is that we’ve been able to manage through something, the trauma of a COVID by virtue of this incredible backbone of technology that was not available not that long ago. Without that, I can only imagine how challenging this would have been. So, the technology is a great solution, and it provides flexibility. And we’ve proven to our own surprise that these organisations seem to run seamlessly from home and with people distributed across a whole variety of locales. So, our view is that there’s a place for that, and there’ll be an increased adoption of greater workforce flexibility. It’s good for the worker, and if it doesn’t disturb productivity, then I think it’s great for companies. The productivity question is in some minds; are people really working as hard at home as they might. Otherwise, there is an argument that you work harder because you get up first thing in the morning and you have no commute. So, it’s immediately to work. But, still too early to see what magnitude of impact will prevail in the long term.
Stephen Dover: Unlike prior recessions and other situations, this whole recession has really increased in inequality, and I’m wondering maybe you could make some general comment on that, but how does that affect the real estate market?
David Gilbert: Yeah, so this is quite unique. The data shows that if you looked over the last three or four recessions, including the global financial crisis, the pain threshold was felt relatively pro-rata. The rich and the poor and the higher and the low earner all were affected in what was the tragic and deep and broad global recession. This one is quite different and it actually dovetails because of the commentary we just had on work from home, the office worker, the white-collar worker, and many of those are in growth industries, take the areas of technology have been able to continue to get to work, be productive, get paid and seamlessly continue, while the lower-paid hourly workers, other than those that are exempt and considered essential. Many of those, think restaurant workers, have been furloughed or laid off—and hopefully temporarily—because of the requirements, the social distancing. So, the pain has been felt much more disproportionate for the first time in any of these recessions, by those least able to sustain that economic shock. They had lower degrees of savings, etc. Now the government did recognise this, and then the stimulus was largely focused in toward those populations, but the stimulus is waning now. And the question does still remain: what kind of stimulus? Can the administration work with Congress to get another stimulus? Virtually every economist I’ve spoken with would argue that it’s needed and necessary notwithstanding, we still need to borrow, whether we do another trillion [dollars] or so but it has been tragic. That’s the downside, if there’s a silver lining at all in this very tragic story, is that a lot of those hourly jobs, we can rehire and fill those very quickly as opposed to a lot of the destruction in corporate employment that we saw that was more lasting in the global financial crisis. Think the banking sector—many of those losses of jobs never came back.
Stephen Dover: Let’s talk about the industrial property sector and maybe a question on that is that with the tariffs with China, there’s some argument that instead of outsourcing to China, we’ll have more building in the United States. What’s your view on that? And, and just sort of in general, in the industrial sector?
David Gilbert: You know, there are two inputs that are really critical here. One is labour, and we have higher unemployment now. We think in a recovery that gets back to a reasonable level, I don’t think we’ll have an excess amount of labor for too long. But the other critical component is energy, and the US now has reduced its energy costs dramatically with fracking and the cost of that critical input, depending on the type of manufacturing for instance, is really important. So, the US, while it doesn’t have a labour cost advantage, it has an enormous energy advantage and speed to market and time, etc. So, we’re optimistic there’ll be more onshoring.
Stephen Dover: Another area that’s interesting that that perhaps is overlooked is the life sciences, and that has been a bit impacted by the election here in California. There was a ballot measure that increased funding for the life sciences. And I know that area highly concentrated in California, and also, I understand in Cambridge, Massachusetts. How do you see that sector?
David Gilbert: Yes, we’re very excited about it. It is a fabulous growth area and the real estate to support life science, R&D [research and development] is quite unique. You might drive by an office building, it would be otherwise indistinguishable, but they have very costly specifications, air handling, for instance, in the amount of power and the ceiling heights. And there are all sorts of things that make that environment quite specific, and it’s quite expensive. And the other thing that has prompted the clustering effect is that the scientists actually want to be in a cluster. They like to be in and around each other. There’s collaboration between companies, there’s collaboration, importantly, with universities, and this is a place where MIT [Massachusetts Institute of Technology] and Harvard, etc., have helped propel Cambridge to probably the life-science hub of innovation in the US and I think still leads the world. California is very important as well. San Diego, South San Francisco.
There have been remarkably exciting innovations and discoveries in the life sciences area that will continue in the future.
Stephen Dover: So, David, we’ve talked about a lot of different factors. Can you just kind of summarise what sectors you’ve seen in your opportunity then and what sectors you’re sort of cautious in within the real estate marketplace?
David Gilbert: Well, the perennial favourite for the last six or seven years has been industrial; we’ve been really bullish on industrial. It won’t last forever, but the demand is driving a need for new space again, I mentioned that perennial long-term favourite people need a place to live. Interest rates are very low and the cost to buy a home is much lower as a result, but you still need an equity down payment, which is challenging for many. There are still 20 million kids living at home with their parents; many parents would like to see them out on their own and renting. We believe there’s a lot of pent-up demand. Retail is challenging, but if you put the mall and some of the power center, some of the high-street retail that I mentioned aside, there’s a huge swath of really solid, good performing retail. Think your neighbourhood, community, grocery-anchored food and drug center that all of us need and are going to continue to visit notwithstanding e-commerce, there’s a segment of retail that we still like. Office is a big question. I do think there’ll be less demand by virtue of the need for flexibility and the ability for people to work from home. It’s still early, but we’re developing greater conviction that what it really means is four days in the office or three days in the office. And then two days working somewhere else, remotely, you don’t abandon the office. It’s just a less of a need to be there every single day. And so, it may reduce the footprint of office a bit, but there’s still a very unique need for office, the collaboration, the culture-building, the training and the onboarding extremely difficult to do remotely. And those are, I think, sort of the tops of the waves across the four big property types.
Stephen: Thanks David, the CEO and chief investment officer of Clarion Partners.
Host: And thank you for listening to this episode of Talking Markets with Franklin Templeton. We hope you’ll join us tomorrow, as our special series related to the US elections continues. And, if you’d like to hear more, visit our archive of previous episodes and subscribe on iTunes, Google Play, Spotify, or just about any other major podcast provider.
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