Real Estate Ponders Industry’s Future Trajectory At ULI Conference

Peter Rummell (Chairman, ULI): Permit me to share a phrase I love, “Some decades are longer than others.” Well, we are finishing up a very long decade.

Our ULI report is divided into six sections: work, live, connect, renew, move, and invest. ‘Work’ looks at employment drivers and talks about the impact of generation-Y on employment. ‘Live’ looks at the changes in housing demand and size over time. It notes that we’re going to end up with a lot of houses that are probably in the wrong places for the future. ‘Connect’ looks at opportunity in two different ways. There is an enormous focus on high density, mixed use, and transit-oriented development, which is something that is very popular at the moment as we all know. At the same time, however, technology drives us towards jobs that can be performed anywhere. Those two are opposing forces impacting us today. ‘Renew’ examines new sources of energy and the impact they will have on investment and development. ‘Move’ takes into account transportation and infrastructure investments. ‘Invest’ looks at the changes in the financial industry. 

The one thing I’m sure about is that the next decade, however long it is, will not be like the last decade. We are in a very different place in the world, and there are an enormous number of things coming together now. How that plays out is going to be critical to ULI, its mission, and its members. 

Patrick Phillips (CEO, ULI): Panelists, what about the report causes you the greatest amount of concern based on your present activities in the industry? And what gives you cause for optimism? 

Joseph Azrack (Managing Partner, Apollo Global Real Estate): I’ll start with the cause for optimism. I do think that some of the technological innovation happening in the U.S. and around the world is creating a different and better world. It gives people more choices, provided that there is an educational system in place. I think that growth that we’re seeing, particularly in the developing world, is encouraging. The impact of technology on political systems is also cause for hope. 

On the concern side is the impact of government regulation in different areas. In the U.S. and Europe we have to reinvent our institutions that intermediate capital flows into real estate, into infrastructure, and to some degree into all of the markets. We don’t know the impact of Dodd-Frank, the Volcker Rule, Basel-III, and new deliberations taking place in Europe. So in terms of the financial markets there are a lot of volatility and a lot of uncertainty. 

But on the other hand there are reasons to believe there will be increased productivity. Hopefully the U.S., in particular, will be able to continue its tradition of innovation and competitiveness so that we will maintain and maybe even enhance our position over the next decade.

Victor MacFarlane (CEO, MacFarlane Partners): I think there is cause for optimism regarding how the U.S. competes globally. We have a lot of ingrained head starts in terms of transparency, in terms of our capital markets, and in terms of education and workforce. The things I’m worried about are the fact that democracies respond a bit slower than countries without enlightened democracy. In China it doesn’t take a lot of time to make decisions, and when they decided that Pudong would be where our office went, that’s where our office went. We need leadership to understand what we need over the next 20 years in terms of infrastructure, clean technology, and government’s effect on consumer confidence. As businesses we need a lot more certainty. 

Peter Rummell: Patrick and I just came from a meeting of the Asian delegation, and they politely but firmly made the point that the mess we’ve had over the last 18 months would not have happened in China. They were very clear on that. 

Tom Toomey (president and CEO, UDR, Inc.): The positives in the United States relate to a third of our economy being connected to the real estate market. It’s a mature market, and it’s a transparent market. So we’re well ahead of a lot of other global economies in terms of how best to manage our real estate and make it efficient, make it transparent, and make it user friendly. 

On the challenges, I believe now we’re going through a period where real estate is a partnership between the user, capital formation, and civic responsibility. With all three of those in states of flux it’s a question of when they will return to the same page. Who is going to lead that? 

Patrick Phillips: One of ULI’s priorities is the understanding of market forces and sources of demand. This report speaks to the very interesting characteristics of generation-Y. It is a bit bigger than the baby-boom generation, so they will obviously have a significant impact on real estate over the next 20 years. If we start with housing, we see the aging baby boomers and we have the emergence of gen-Y. Tom, your company is in the business of apartments, which are suited for both of those populations. How are you thinking about the impacts of those two generations on product characteristics?

Thomas Toomey: We have record enrollment in colleges and universities, and these folks are now arriving at the doorstep of work. When they arrive, what’s interesting is their working style. We’re seeing that they want their own space, they want it smaller, but they want more of a community, which ends up being a handheld device. 

So what are the implications on housing, and what are we doing as an industry? Elements of self-service, internet speed, and ease of interacting socially all become now part of the planning process of your communities. That’s going to be the de facto standard needed in order to be competitive. Interestingly enough, if you go to the other extreme and look at the retirement group, the baby boomers, it’s about the same type of principles. That’s what translates to flexible housing, and I think that represents both a challenge but also an opportunity. 

Patrick Phillips: Victor, you also have some experience with this kind of product path. How are you thinking about these two generations?

Victor MacFarlane: One of my daughter’s friends lives in a studio in Downtown New York City and says she would relocate to Brooklyn before she would to Midtown. These folks are making decisions based on social connections, creativity, and where they live, work, and play. They want to be where the cool people are shopping and where the cool bars are. For example, in Williamsburg, Brooklyn they have these outdoor concerts that people can go to. But this girl chose to live in a studio rather than move someplace else where she could get more space, and now she can just walk places to meet with her friends and socialize. 

When we made the investment in the Time Warner Center, the decision to put Whole Foods in the basement as well as to subsidize signature restaurants on the third floor proved to be a key element of that project. I think that this is indicative of what everyone is expecting on both sides. 

Joseph Azrack: I think there is a confluence from two areas of the demographic barbell: the boomers, which is a very large demographic, and then gen-Y, which is the largest demographic. They are both moving towards multi-faceted urban areas with services, cultural amenities, public transit, and some affordablility. These may be major urban areas like Los Angeles or New York, or they may be smaller urban areas like Columbus, Ohio, Hanover, New Hampshire or Raleigh-Durham, North Carolina, which are home to major universities and enjoy the economic benefits and the amenities that come from that. What’s driving this, I think, is partly economic necessity. It’s partly that people are going where they believe the strongest and most affordable economic base is. Part of it is the having the option for the social interactions we’ve discussed. 

One of the things we haven’t seen expressed much is the fact that most of the people I know are not retiring (I’m 64-years-old, so I’m at the front end of the boomer generation). They don’t want to retire. They may work part time; they may work full time; they may find a new industry. They want to be engaged, and that means being involved in an area where there are opportunities to be filled and where they can keep involved intellectually. 

Patrick Phillips: What about the suburbs? We’ve talked a lot about urbanization, mixed use, and higher density places. But a big part of American development today is suburban in nature. In light of demographic changes, employment structure, or transportation mobility challenges, what is the future of the typical American suburb?

Peter Rummell: The location of suburbs is changing. The greenfield 15 miles out is not going to dry up, but new opportunities that are not urban will either be rehabs, infill, or things that are in this middle ground between the downtown brownstone, the high-rise, and the two-acre mcmansion. There is a huge move to take advantage of that, and you’ve already seen it in close-in suburbs. There’s no such thing as hot real estate in today’s market, but that’s where it’s the least cold right now.

Joseph Azrack: The number one determinant of new suburban or exurban development is the housing market. Ownership is in the process of readjusting from about 68 or 69 percent down to somewhere in the low 60s, at the end of the day. In the process, which is occurring slowly in terms of reconciling the demand with the supply, there are literally millions of units that are currently over-financed. I think that one of the things that would impact viability in many communities outside of cities would be the ability to re-price that housing stock to an affordable level that fits the income and equity capacity of people who can occupy and maintain such homes. The sooner we get through that and find a way to put that inventory into productive use, the better off we will all be. 

Patrick Phillips: Let’s pick up on theme of real estate finance. Joe, when you look out a little bit beyond the current crisis, what do you see? What are the kinds of structural adjustments that might make sense for the industry five, ten, or fifteen years out?

Joseph Azrack: I will speak in the context of the U.S., but I think that Europe has a similar issue. If you look at the commercial real estate market it’s somewhere in the range of $3 trillion in mortgage debt. Most of this debt is owned by banks, and a significant portion is owned by the securitized market, insurance companies, and other investors. The equity number is probably around $1 trillion. 

We are now in a situation where the CMDS (commercial mortgage-backed securities) market needs to grow into CMDS 2.0. Concerning the bank market, I think the jury is still out pending the implementation of Dodd-Frank, the application of Basel-III, and to some degree the application of the Volcker rule. There will be new ways to provide finance debt to the commercial real estate market in the United States, but we are going to have to reinvent the rules with more transparency. There is probably going to be a higher ratio of equity, which is what you see in Europe, Asia, and other parts of the world. Ultimately we are going to have to figure out what kind of a banking system we are going to have because it’s under a great deal of stress and has not been lending over the last couple of years anywhere near the levels of the past. 

Victor MacFarlane: The key point is the institutionalization of real estate. I think we are definitely going to see more equity required. With more equity you’ll see more developers owned by institutions, as developers feel they need to have joint-venture partners. You’ll see an increasing number of REETs (real estate excise taxes). It’s harder for an individual to be a developer in today’s market because of the amount of capital required to get a project off the ground. 

Patrick Phillips: Tom, I heard somebody say yesterday that 80 percent of development activity is going to be done by publicly traded companies before long. Do you buy that?

Thomas Toomey: I’m not so certain about that statistic, but I do agree with Victor that you’re going to end up with well-capitalized partners. We now see it in our interaction with cities across the country placing ‘well-capitalized track records of execution’ at the top of their list when selecting people to execute development. Whether it is going to be public companies, I don’t believe that that is the case. There are a lot of private, entrepreneurial, skilled people in this business who have done it for many years and who prefer not to be public entities. 

Patrick Phillips: I want to spend a little bit of time on workplaces. Again, there is maybe a demographic dimension to this with gen-Y. Joe, what are you seeing in terms of the future of the workplace? 

Joseph Azrack: I think that the ‘What’s Next’ report conveys the picture accurately, where offices become more of a meeting space than a workspace. One of the most astonishing statistics I’ve heard in quite a while was that 40 percent less office space will be required over the next decade on a per capita basis. That creates a great impact on demand and the type of space. I think that we’re in the middle of a profound change in how and where we work. 

Peter Rummell: I live in Jacksonville, Florida, which is a million-person SMSA (standard metropolitan statistical area) and unfortunately not an education and medical hub. A friend of mine came to me with an idea to do what he calls a ‘co-work’ space downtown. I helped with a little bit of seed capital, really as a way to help downtown progress, not because I had any great expectations for it. He’s put it together, raised the rest of the money, and I’m going to make money on it! It is a terrific little space; it’s about 10,000 square feet. He’s going to have forty or fifty workstations in it, and there are people standing in line to get access to it. 

Thomas Toomey: What’s defining about this trend is what we all see at Starbucks. The guy in the corner working at eight in the morning is still there when you come back at lunch. That’s his mobile office. In truth, that’s what your friend tapped into.