Dr. Peter Linneman, Principal of Linneman Associates, joins Trademark CEO, Terry Montesi to discuss the state of the commercial real estate industry midway through 2021. Peter shares his views on consumerism, retail real estate, and how the economic cycle will change as we move closer to the end of the pandemic. Additionally, the two discuss pandemic-induced changes including what trends will cease to exist and what trends will remain after the pandemic ends.
Dr. Linneman is a distinguished real estate economist, and serves as the Founder and Principal of Linneman Associates. For more than 35 years, he has advised leading corporations and served on over 20 public and private boards. He is a former Wharton School professor, and was the Founding Chairman of the real estate department and Director of the Zell-Lurie Real Estate Center at the University of Pennsylvania.
Leaning In is published every second and fourth Wednesday of the month. Be sure to follow the show on your preferred podcast app to hear Part 2 of Peter and Terry’s discussion.
Montesi: Today, I’m joined once again by Dr. Peter Linneman, Principal of Linneman Associates, and a wonderful, insightful real estate economist. We explore Peter’s views on consumer and retail real estate and how the economic cycle will change as we move closer to the end of the pandemic. We also discuss the multifamily sector, the office sector, retail, malls, the consumer, how things have changed since the pandemic and what will remain after the pandemic and what will go away.
You can also find my 2020 discussion with Peter on our website, trademark property.com, or wherever you listen to podcasts,
Peter, now that we’re obviously close to the end of the pandemic, how do you personally view the overall economy? How do you see this unfolding? And then how do you see it impacting commercial real estate?
Linneman: So, I think there’s one thing that all of us have to bear in mind, which is, I think we’re nearing the end of the pandemic in the U.S. but there still is a long distance to go internationally.
And the reason obviously that’s important is it leaves the opportunity for variants to arise. And it also means full, free international flows, Like we knew in 2019 are still going to be a bit restricted moving forward, economically. Now having said that, you may remember Terry, one of the comments I made was: watch the stadiums, watch the concert arenas, watch the ballparks.
Well, if you watch them, unfortunately, I watched the Sixers lose last night, but if you watch them, essentially, the stadiums are full. I’m told ticket prices aren’t where they were in 2019, but they’re full. People are back and that’s a great barometer of where the economy is at.
Is it back a hundred percent? No, because using that barometer, it would be back if ticket prices were up, what, 5% from 2019. And they were still sold out for the playoffs. So, they’re not fully back, but they’re back. Same in baseball, obviously. And I think that’s a great indicator.
Now, as you know, in retail, there were these people who made what I thought were ludicrous statements, and I’m on record saying I thought they were ludicrous; that brick retail was dead, that online had replaced it so forth. And I kept saying, all you had to do was look at how much brick retail occurred, even during the shutdown, and how little of retail transitioned online.
Now people say: “Oh yeah, but a lot went online!” And I don’t know if I’ve ever said this to you Terry, but I played basketball, reasonably competitive in city leagues and such until I was 53. And, I had a downward trend over my life. And you can imagine online sales has an upward trend as a share of retail. So, my trend of my team’s scoring was downward over my life.
And online retail was trending upward, as you know, as a share of overall retail sales. Here’s the reality though, and this is what people don’t get: The trend was rising, and I’m just going to round, at about 1% of the share of retail per year. So, from 2019 to today, you would have expected the share to be up one and a half percent.
So, it would have gone from like 15 and a quarter percent to 16.75%. At its peak, it got to about 18 to 18 and a half percent. Apples to apples measurement. That is to say it was up 20 to 25%, but most sales were still not occurring online. Like, only one out of every $6 was occurring out of that. Now, why do I mention basketball?
If I told you I went from scoring eight points per game, to 10 points per game when my opponents had their hands tied behind their back. One: I don’t think you’d have been that impressed with my skills. And two: Well, what do you think happens when I untie their hands? You would say, you’re going to go right back to eight points with a downward trend and you’d have been right.
What do you think happened to online sales? They rose by about the same percentage of my scoring, going from eight points per game to 10 points per game, with brick having its hands tied behind it’s back. Think about the big malls. Many of them were literally closed. A lot of the stores were closed in strips and big box, or very restricted.
And yet they could only increase by 20 to 25%. And by the way, what do you think as soon as the hands got untied was going to happen? They’re going to go right back to trend. And in fact, what you’ve seen happen is they’re heading right back. There are absolute sales that are increasing, but their percent of sales has been going down for two quarters.
And where’s it going to go down to? It’s going to go right back down kind of trend, and then it’ll start back up again. So, I think we’re in a good place. Retail, it’s an experiential thing. And so, I think retail looks good. It’s not that I think online retail doesn’t look good. My point is not that it doesn’t look good, but it can look good, and brick can look good.
And just take one more comment: If you owned bad retail In 2019, it is still bad retail in 2021, even though the economy is improved. If you owned good retail in 2019, you still own good retail. It’s got a lot more stress and headaches because a couple of good restaurants went out of business.
On the other hand, a bad retailer went out of business and you’re going to replace them in the next year with a better retailer that’ll make your center stronger. So, I think the economy is poised in a good place, being dragged down for the next couple of months by these federal unemployment insurance top-ups and that’s because people have finally figured out what normal people figured out.
It’s funny, normal people figured out that, “Oh, If I’m making less than about $25 an hour, I’m better off not-working than working.” Well, if you figure that out, a lot of you aren’t going to work until that situation changes and it doesn’t change until early September. Now, some states are adjusting in the meantime.
Montesi: Aren’t we up to about half the states?
Linneman: Yeah, roughly. It’s not half the population, but it’s roughly half the states. By the way, the reason those states are doing it is it’s draining their unemployment benefits too. It’s not just the federal money. So those people, instead of working and paying into taxes and the unemployment insurance program and so forth, they’re draining it.
So those states want to get people back to work. But until the beginning of September, it’s still going to be a bit of a struggle, getting a lot of workers back to work. Because if I said to you: “You can make as much or more by not working, as you are working for another couple of months.” How driven are you to get back to work?
And that’s just reality. So, nobody intended it badly, it was a good intended, but it has had a kind of adverse consequence as the economy has come back. And the employers have the oddity of, imagine that somebody who was making $13 an hour, but I have to give them at least $25, I can’t raise you to $35 an hour.
My economics won’t support it. My little restaurant doesn’t support $35 an hour. Remember, if I pay you $35 an hour and 25 is the breakeven: I’m only giving you 10 bucks an hour more, right? It’s not like I’m giving you a whole lot more. So, the whole thing is going to be very complicated for another couple of months.
And then the economy’s really going to take off. We’re about 8 million jobs short of February 2020. GDP is about where it was at the end of 2019 In real terms and employment is down about 8 million jobs. That tells you about the skew, right? It tells you that we’re producing roughly the same amount, but with 8 million fewer workers, and that means it’s skewing to lower wage workers are the ones not working.
And another way, then I’ll stuff up. I know this is kind of run-on, I’ll stop. But if you think about GDP is about the same as where it was at the end of 2019, absent COVID, it’d be three and a half percent higher right now. So, on the GDP side, we’ve got runway, pretty easily, of three and a half percent to make up for what we didn’t do.
And on the employment side, we’re 8 million jobs short. And by the way, over that time period, the last 18 months or 17 months, we would have added two and a half million jobs. So, we’ve got runway of about three and a half percent of GDP, and about 10 to 11 million jobs. That’s really going to drive us over the next year with it really taking off after September when the unemployment burns off.
Montesi: As you answered the question about the economy, you gave us an idea of your views on the consumer and retail. What about the office business? I’ve read your reports, you’ve made a lot of commentary about the office business and what remote work is going to do with changing corporate cinema, et cetera. How do you see the office business coming back and unfolding and post-Covid?
Linneman: So, I’ve gotten my stadium equivalent. I try to constantly come up with something that captures the imagination. And I tried to explain my view on office and that people are going to come back. Here’s my most recent way to do it: A lot of your listeners are going to have children or grandchildren who stumbled and stammered and struggled and were distracted with homeschooling virtually, right?
And by the way, all of the research that exists suggests that virtual schooling may have been better than nothing, although that’s not totally clear, but the general evidence is that it was a disaster everywhere, not just the U.S.
Montesi: Well, it was suboptimal at minimum.
Linneman: Yeah. Suboptimal at minimum.
And my new comment to parents and grandparents when asked a question about office: Why do you think it was so much more efficient? What makes you think it was so much more efficient with work? And all the same limitations exist. Yes, you probably have a little better attention span, but come on.
It is in the same way it was not optimal. It was practical, but it was not optimal. It’s still not optimal for businesses. And you’re seeing more and more employers saying, “come back” and they were going to wait until Labor Day. And now they’re saying, “come in July or August, we need to get you back.” For any big employer, culture is at real risk.
Hiring and integrating at real risk. Team and analysis at real risk. And my simplest view is people are going to come back to the office, and by the way, they’re going to do business travel. Because right now there’s no competitive disadvantage of working virtually.
But if your competitors are back working for real and I’m trying to work remote, there’s a big competitive disadvantage. My favorite little example is: “Gee, I’m thinking about, should I hire EY or KPMG as my auditor?” And I ring them up and say, “we’d like to have you interview. We’d like to come over to your place or you come at our place.”
And let’s just say, EY says: “Great! We will have the team over tomorrow at noon for a four-hour session.” And KPMG says: “We’ll do a zoom call.” Which one do you think is going to get the assignment? That’s just not hard to figure out. Right now, they’re both doing zoom calls, so neither one is at a disadvantage. So, the competitive advantage of face-to-face will take over.
I love it. They do these surveys of, “do you want to come back to work?” And of course, you get people saying “no, only under my terms.” That’s sort of what they say. By the way, why don’t we ask them if they want to be paid more, if they want to not work on any day they don’t want to work, I mean, it’s a fantasy question, right?
It’s not a reality question. The real question is: “If in order to support your kids and to support your family and to take vacations and to buy your home. You need to go back to the office to be maximum efficiency. Will you do it?” What do you think the answer to that question is on a survey? Very different.
And that’s the real question. It’s funny, the related one is people say, “well, tourism is going to pick up” and you know, tourism is picking up domestically. People will say, “but not business travel because there’s too many hassles associated with business travel.” And I say to people, the hassles of business travel are exactly those of tourism travel, right?
The TSA lines, the tickets to cramped planes, all that. They’re the same hassles either way. Which are you more likely to return to: the one that allows you to afford a vacation, or your vacation? If I don’t resume business travel, when it’s a competitive feature, I don’t have the money to take my tourist vacation.
And so of course business travel is going to return. Now, it’ll take a little time until it all kicks in. So, I think people will come back to the office.
Montesi: Peter, one thing on the business travel that I’ve heard that is worth considering is that maybe we do less business travel because we’ve gotten so good and so used to video calls. Instead of having in-person partner meetings four times a year, we might do one in-person and three virtually. Or instead of visiting a client four times a year, I’ll visit him once in-person and I’ll set up three Zoom calls. And that seems a reasonable premise. Not that we will not travel for business, but maybe because of technology, we all feel like we don’t have to travel as often.
Linneman: And I don’t know about you, but Alexander Graham bell invented this thing called a phone. And I was already doing what you said whenever possible with conference calls or personal calls, et cetera. And the fact that I can do it now with Zoom and Zoom only has two advantages over a conference call, you know, the traditional kind of conference call.
One, is I get to look at postage stamp sized pictures of people. Well, most of the people I see postage stamp pictures of, including me, are not enjoyable to look at. So maybe that’s not a big advantage. And then the other advantage is it’s encrypted. And I get that, as opposed to what we’re doing right now is not encrypted-protected.
However, how many of those calls that you made traditionally to your investors, your clients, your whatever. How many of them did you really need encryption? How many of them were really worried about it? Now, there are going to be some, and I can imagine some people, especially for a while will say, “well, I’ll keep doing Zoom or whatever.”
And slowly over time, it will go back to more normal for the competitive reasons, not overnight, but over time. At the margin, they’ll be a few fewer. And the fewer are going to be with guys like me. I’m 70 years old. Somebody invites me to give a talk. I was already cutting back on the number of appearances I was doing, just because of the wear and tear.
And you can imagine now, if I get asked, “will you do a guest lecture at my university?” I’m going to say I’ll happily Zoom in. But I’m not going to get on a plane to do a guest lecture, unless it’s a very special occasion. So, there’ll be a little of that, but that’s not what was filling the hotels and planes. So, there’ll be a little, but not notable when it’s all done after a couple of years.
Montesi: So, net-overall on office and retail, you think the long-term impacts will be marginal, not substantial. Is that safe to say?
Linneman: Yep. That’s a good way of saying it.