Marcus: Commercial Real Estate Doom and Gloom is Overblown

Summary

The speaker discusses the current state of the real estate market, noting that repricing is about 20% on average across sectors, with variations such as manufactured housing seeing almost no decline and office space experiencing up to 35%. They express optimism, suggesting that the market's downturn has been overblown. Advising investors that June 30th could be an attractive entry point, they highlight a broad consensus on capital readiness to enter once values have bottomed. Addressing concerns about a 'wall of maturities,' the speaker shares insights from 35 years of experience, emphasizing that borrowers typically manage maturities proactively. The conversation also touches on the diversification within the office space, the importance of green certifications, and the strategy of investing in existing office buildings for ESG compliance. The multifamily dwelling sector is seen as promising due to suppressed homebuilding and sales, leading to longer rental periods. Lastly, the data center market is deemed not close to saturation, with strong demand and a landlord's market driving double-digit rental increases.

Takeaways

• 📉 The repricing in the real estate market is about 20% on average across sectors, with variations from almost zero in manufactured housing to around 35% in office spaces.
• 📈 PGIM Real Estate forecasts an average peak-to-trough repricing of about 22%, suggesting that the market is nearing a potential bottom.
• 🚀 The speaker feels that the negative sentiment around the sector might be overblown, indicating a more optimistic outlook.
• ⏰ Advising investors that June 30th could be an attractive entry point, with the possibility of being a quarter early rather than late to capture opportunities.
• 💰 There is a broad consensus that a significant amount of capital is waiting on the sidelines to enter the market once values are perceived to have bottomed.
• 🧱 Despite concerns of a 'wall of maturities' with $2.2 trillion coming due between 2004 and 2007, historical patterns show that such predictions often do not materialize as borrowers refinance or restructure loans.
• 🏢 The office sector is currently the least homogenous it has ever been, with significant divergence in how different office spaces are performing.
• 🌿 'Winners' in the office space tend to be buildings with green certifications and good access to transit, which are faring better than others.
• 💹 Investing in upgrading existing office buildings to meet ESG standards is a strong strategy, especially in Europe, where there is high demand for such certifications.
• 🏠 There is a trend towards longer renting periods for single-family dwellings due to higher interest rates and a lack of attainable ownership options, leading to increased rental demand.
• 📈 The cost differential between renting and owning a single-family home has widened significantly, from a historical 30-35% to nearly 70%, which is expected to normalize slowly over years.
• 💿 The data center market is not close to saturation, with continued strong demand driven by cloud computing and AI adoption, and a landlord's market with double-digit rental increases expected to continue.

Q & A

What is the current status of the repricing cycle in the real estate sector?

The repricing is about 20% on average across the sectors, with variations from almost zero declines in manufactured housing to a 35% decline in office spaces.

How does PGIM Real Estate predict the peak to trough repricing to be?

PGIM Real Estate projects that the peak to trough repricing will probably average around 22%.

What is the speaker's perspective on the doom and gloom about the real estate sector?

The speaker believes that the negative outlook has been somewhat overblown and that they are feeling a lot better about the sector.

When does the speaker suggest could be an attractive entry point for investors?

The speaker advises that June 30th could likely be a very attractive entry point for investors.

What does the speaker say about the 'wall of maturities' and its potential impact?

The speaker acknowledges the existence of a wall of maturities but notes that in the past, similar predictions of a crisis did not materialize. Borrowers tend to get ahead of their maturities, and loans are extended, restructured, or repaid.

How does the speaker describe the current state of the office space market?

The office space market is highly divergent, with the public markets treating it as homogenous, which it is not. There are clear winners and losers, with winners typically having green certifications and being close to transit.

What is the speaker's view on investing in existing office buildings to upscale them?

The speaker considers it a strong strategy, especially in Europe, to invest in existing office stock to achieve ESG certifications that are desirable to tenants and investors.

What trend is observed in the multifamily dwellings sector?

There is a trend of more people renting for longer periods due to factors like higher interest rates, a lack of new homes, and affordability issues, leading to increased demand for rental properties.

How does the speaker assess the current pricing difference between renting and owning a single-family home?

Historically, the cost difference was around 30-35%, but due to interest rates and the cost of for-sale housing, it has increased to nearly 70%.

What is the speaker's outlook on the data center market?

The speaker does not believe the data center market is close to saturation. There is still significant demand, and the lead time to bring a data center online is long, indicating continued growth potential.

What factors contribute to the current strength of the landlord's market in data centers?

Factors include the ubiquity of cloud computing, the continued adoption of AI, and the time it takes to get the necessary power for a data center, leading to double-digit rental increases.

How does the speaker suggest investors should approach the timing of their investments in the current market?

The speaker suggests that it's better to be a quarter early than a quarter late, implying that investors should act with a slight lead to avoid missing opportunities when values potentially bottom out.

Outlines

00:00

📉 Real Estate Repricing Progress

The speaker discusses the current state of real estate repricing, which is about 20% on average across sectors, with variations from nearly no decline in manufactured housing to a 35% drop in office space. PGIM Real Estate forecasts an average peak-to-trough repricing of 22%. Despite some doom and gloom, the speaker believes the sector is closer to recovery, and advises investors that June 30th could be an attractive entry point. There is a consensus that capital is waiting to enter the market once values have bottomed. The speaker also addresses concerns about a 'wall of maturities', explaining that despite past predictions, borrowers typically manage to refinance or restructure their loans ahead of time, even in a capital-constrained environment.

05:03

🏢 Office Space and Green Certifications

The conversation highlights the diversity within the office space sector, noting that the public markets tend to view it as homogenous, which is not the case. The speaker identifies 'winners' in the office space as those with green certifications, which are closer to transit and have lower availability rates. Investing in upgrading existing office buildings to achieve ESG certifications is seen as a strong strategy, especially in Europe. The discussion also touches on the multifamily dwelling sector, where there's a growing trend of people renting for longer periods due to higher interest rates and a lack of attainable single-family homes. The pricing gap between renting and owning a single-family home has widened significantly, leading to a greater number of people opting to rent.

💾 Data Center Market and Demand

The speaker assesses the data center market, arguing that it is not close to saturation despite the high demand. The process of bringing a data center online is lengthy, often taking years due to the need for sufficient power supply. The speaker cites the prevalence of cloud computing and the ongoing adoption of AI as factors that will sustain long-term demand for data centers. Currently, it's a landlord's market with rental increases in the double digits, which are expected to continue.

Keywords

💡Repricing

Repricing refers to the process of adjusting the value or price of assets in response to market conditions. In the context of the video, it relates to the re-evaluation of real estate assets, with an average repricing of about 20% across sectors. This is significant as it indicates a shift in the market and is a key theme in the discussion about real estate investment opportunities.

💡Manufactured Housing

Manufactured housing is a type of residential housing that is constructed off-site in factories and then transported to the location where it will be occupied. The script mentions that this sector has seen almost zero declines in repricing, highlighting its resilience compared to other real estate sectors.

💡Office Space

Office space refers to commercial real estate that is used for business purposes. The video discusses the repricing of office space, with a decline closer to 35%, indicating a significant adjustment in its market value. The discussion also touches on the divergence within the office space sector, suggesting that not all office spaces are equally affected by market changes.

💡Green Certification

Green certification is a designation given to buildings that meet certain environmental standards and practices. In the video, it is mentioned as a factor that can influence the performance of office buildings, with those having some level of green certification faring better. This ties into the broader theme of sustainability and its impact on real estate investment.

💡Maturities

Maturities in the context of the video refer to the expiration dates of financial instruments or loans. There is a discussion about a 'wall of maturities' between 2004 and 2007, which implies a large volume of loans coming due within a short period. This could potentially lead to refinancing challenges, but the speaker suggests that such concerns are often overblown.

💡Multifamily Dwellings

Multifamily dwellings are residential buildings that contain more than one living unit, typically apartments or townhouses. The video highlights a trend towards renting for longer periods, especially within the single-family segment, due to various market trends including interest rates and supply constraints. This trend is expected to drive growth in the multifamily sector.

💡Data Centers

Data centers are facilities used to house, power, and maintain large numbers of servers, networking equipment, and other components for storing and managing data. The script discusses the ongoing demand for data centers, despite the lengthy lead times required to bring new facilities online. The demand is driven by the ubiquity of cloud computing and the continued adoption of AI, indicating a strong fundamental market for data centers.

💡ESG Certifications

ESG stands for Environmental, Social, and Governance, which are a set of standards used to measure a company's commitment to sustainable and ethical practices. The video mentions investing in existing office stock to achieve ESG certifications, which are increasingly sought after by tenants and investors. This reflects a growing emphasis on responsible investment in real estate.

💡Interest Rates

Interest rates are the percentage rates that represent the cost of borrowing money. The video discusses how higher interest rates are affecting the housing market, making it more difficult for people to afford to buy homes, which in turn is driving more people towards renting. This ties into the broader economic context and its impact on real estate trends.

💡Supply and Demand

Supply and demand are fundamental economic concepts that describe the relationship between the availability of a product (supply) and the desire for it among consumers (demand). The script refers to a suppression in the supply of new homes and the impact of demand on rental rates, particularly in the context of data centers, where demand is high and supply is constrained by long lead times.

💡Entry Point

An entry point in investment terms refers to a specific time or price at which an investor decides to enter a market or invest in a particular asset. The video advises that June 30th could be an attractive entry point for investors to get back into the real estate market, suggesting a strategic timing based on the current cycle's repricing.

Highlights

The repricing in the real estate sector is about 20% on average across different sectors.

Manufactured housing has seen almost zero declines, while office sector has declined by closer to 35%.

PGIM Real Estate forecasts an average decline of 22% from peak to trough in the real estate market.

The current market sentiment is that the doom and gloom about the sector has been overblown.

Advising investors that June 30th could be an attractive entry point into the market.

There is a broad consensus that a significant amount of capital is waiting to enter the market once values have bottomed.

Despite predictions, a 'wall of maturities' has historically not led to a market crash.

Borrowers typically refinance or restructure loans ahead of their maturities, even in capital-constrained environments.

Office space is not a homogenous sector, with significant divergence in how different offices are faring.

Offices with green certification and proximity to transit have better availability rates.

Investing in upgrading existing office buildings to achieve ESG certifications is a strong strategy, especially in Europe.

There is a growing trend of people renting for longer periods, influenced by interest rates and housing supply.

The cost difference between renting and owning a single-family home has widened due to interest rates and housing costs.

Data center demand remains strong, with a long lead time for new data center construction.

The ubiquity of cloud computing and continued adoption of AI are driving long-term demand for data centers.

The data center market is currently a landlord's market with double-digit rental increases expected to continue.

Transcripts

Okay, so tell us where we are in the cycle.

Last time you were with us, you said it's coming.

The basically the repricing is not quite done yet.

Where are we on the repricing in terms of the repricing?

It's about 20% on average across the sectors.

And that can range from something like manufactured housing that has had really

almost zero declines to office. That's closer to 35%.

So at PGIM real estate, we've projected that by the end of the day,

the sort of peak to trough, it'll be probably on average 22%.

So for a 20 were very close. And so we're feeling a lot better.

And, you know, from my perspective, a lot of the doom and gloom about the

sector has been somewhat overblown. So I'm sure you're not a market timer.

At the same time, you have to have some sense of that cycle because if you wait

too long, the present can come back up and you lose some opportunities.

Do you have any sense of where it really makes sense?

You need to get back in. We're advising our investors that June

30th could likely be a very attractive entry point, and at that point it's

possible that maybe or a quarter early, maybe there's one more quarter of some

value declines. But in this case, we really believe that

it's better to be a quarter early than a quarter late.

There's broad consensus that there's a lot of capital on the sidelines that is

going to come in as soon as they feel like the values have bottomed.

We've heard some talk about a wall of maturities.

Is there a wall of maturities coming where people are going all have to

refinance at the same time and have problems?

There is a wall of maturities. There's lots of different numbers out

there. One of the more popular numbers is $2.2

trillion of maturities that are coming somewhere between 2004 and 2007.

I've been at this for a little over 35 years.

In that time, there have been at least three other times where a wall of

maturities was about to crush us any minute and it never came to fruition.

And what happens in real life is very different than what a chart on a piece

of paper is going to tell you. The fact is that borrowers get ahead of

their maturities. Loans are extended, loans are

restructured and loans to repay. And even in a very capital constrained

environment like we're in right now, loans are being repaid every day.

We tend in the media, we tend to talk about real estate or commercial real

estate. But how specific is it?

Even within the office space, some offices presumably are created more

equal than others. There's a lot of divergence in the

office space, and it's a really good point because in reality, especially if

you look at the public markets, the public markets are pricing office the

sector broadly as if it's a very homogenous sector and it's not a

homogenous sector. It's never been a homogeneous sector,

but right now it's the least homogenous that it's ever been.

And there are, you know, as many people have talked about, winners and losers in

the office sector. And what do the winners look like?

The winners generally have some level of green certification.

We've seen recently that there's about a 50% difference in the availability rate

in office buildings that have some level of green certification are close to

transit. There's a huge difference in how those

assets are faring. At what point does it make sense to

invest in an existing office building to bring it up upscale when it comes to

things like green in office air quality? That's actually a very strong strategy

right now, and in particular in Europe, in Europe.

You know, one of the investment theses that we believe very strongly in is in

taking existing office stock in some place like Paris and investing to make

it, you know, enable it to have the ESG certifications that both tenants and

then ultimately investors are looking for.

So we've been talking about offices. What about multifamily dwellings?

I mean, where does that stand? Because we've seen some sort of a

suppression in the building of new homes?

Yes, for sure. We are seeing a suppression in supply of

new homes, but also in sales of existing homes, which is really being driven by

interest rates. So we're very we have a lot of

conviction around the living sectors broadly and in particular in this idea

of people renting for longer, more people renting for longer.

So there's a lot of growth in the population cohort that tends to rent

single family dwellings and single family dwellings from an ownership

perspective are less and less attainable by people because of a lot of trends

that we've talked about, this longer, higher for longer interest rate

environment. The fact that there's not a lot of

supply of new homes. All of that leads to, you know, less and

less people being able to afford to actually buy a single family home and

therefore they're going to rent one. So historically, the the pricing

difference, the cost between renting a single family home and owning a single

family home has been somewhere in the 30 to 35% range.

Now, because of interest rates and the cost of for sale housing, it's closer to

70%. So it's.

Really like an historic delta. And it's going to take a while.

It will come down, but we think it's actually going to be years before it

even gets close to 40%. One of the topics we touched on this

last time as well, and that's data centers.

We hear about data centers an awful lot. Where is that market right now?

Is it close to saturation? I wouldn't say it's close to saturation.

From a demand perspective, there's still a tremendous amount of demand.

There's a very long lead time in terms of, you know, bringing a data center

online along, if you will. It can be years because first you have

to get the power and then you start building.

So it really can be and there are certain markets in the U.S.

where it's years to get the power that you need.

And if you think about, you know, the investment thesis and the demand side,

you think about the ubiquity of cloud computing and you think about the

continued adoption of A.I.. You know, we see a long term demand

fundamental here. And, you know, you also it's very much

of a landlord's market right now. And the rental increases have been

double digit and are expected to continue.