2022 Real Estate Economics with CBRE’s Spencer Levy

CBRE’s Senior Economic Advisor & Global Chief Client Officer, Spencer Levy joins Terry Montesi and Chad Colley of Trademark to discuss macro-economic trends in the global real estate market, with a specific focus on mixed-use and multifamily assets. Spencer shares his thoughts on CBRE’s research and 2022 predictions, as well as his research-based investment insight, including the recently published report Live Work Play: Millennials Myths and Realities.

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 Terry, Chad and Spencer’s discussion.



Terry Montesi: Hey, Spencer, thanks for being with us today. As a Harvard grad with almost 30 years of experience in commercial real estate and another podcast host, I might add, and one of the most insightful commercial real estate thought leaders, tell us a little about your career and how you got into real estate research.

Spencer Levy: Sure. I started off as a lawyer, Harvard Law School, and I was a real estate lawyer. And why did I pick real estate? I picked it because my dad was a real estate lawyer. And I think that’s the way a lot of people get into the business. And the truth be told, I actually preferred bankruptcy law to real estate law, but I had to choose, I chose real estate, and it’s been pretty cool. And what really helped me long-term is that when I was a young lawyer, I must’ve written millions of square feet of leases. And so, I understood the clauses cold. And then I became a banker, and I did the financing on them. And then I became a capital markets leader at CBRE. And then they realized I had a knack for not just analysis but communication. Everybody needs a big break every once in a while, and so I did this speech in front of 3,500 people in Denver in front of my boss, the Board of Directors. And he came up to me afterwards and goes, “Spence, this is what you’re going to do for a living.” And I’ve been doing it ever since in various capacities as the Head of Research, and now I’m the Global Head of Client Care and Senior Economic Advisor for the company and onstage, on TV all the time, having lots of fun.

Montesi: So, when was that speech?

Levy: That speech was in 2015 in Denver. And it was really cool because I’ll tell you what I did. As you guys know who’ve seen me speak before, I can be a little theatrical at times, and there I had a costume change. I walked onto stage wearing a cab driver’s coat, hat, a cup of coffee, the whole deal. And then I got a video up there, took it off, and then I put it back on at the end. And my closing line was, “The smartest guy in my family was my grandfather who was a cab driver. And you should never judge a book by its cover.” And it brought the house down, standing ovation, and here we are today.

Montesi: That’s interesting. I’m reading the Malcolm Gladwell book Talking to Strangers, the new one, and that’s the big idea in it, so you should read that.

Levy: I will. I will.

Chad Colley: Spencer, outside of your acting career, what are the notable trends you’re watching in real estate in 2022 in the US, commercial? What about specific to multifamily?

Levy: Sure. So, the big picture is money and a lot of it. And for the most part, the money is a good thing. And it’s a good thing because it’s coming from two basic sources. One source is government, the federal government or state governments. And the other is just the real estate industry. The way I put it is that the money has caused both positive and negative distortions in the market. The positive distortions in the market is that it’s supported values of hard assets, of stocks, kept jobs together, and kept companies together. So, the big picture is very, very good. And the good news for our industry is for people that own existing multifamily, industrial, and certain forms of operational real estate, including data centers, life sciences, things like that, let me put this in a very technical way, it is the land of milk and honey. I don’t know how else to put it more simply than that because that’s how much money is going into those spaces and bringing down yields or cap rates to record low levels. And that’s number one. And number two, it’s supported by the fundamentals because we’ve seen rent growth in multifamily, in some places over 20% in the last year. The highest we’ve ever had. By the way, we’ve seen it in industrial too. So even though we are seeing this record low cap rates, it’s fundamentally supported in the near term. Now we do think it’s going to get lower next year and will revert to its normal growth rate a couple of years out, but the multifamily market is doing unbelievably well. And there is a sister asset class called single family rental of build to suit, doing incredibly well as well, by the way, with very similar cap rates, and why? There’s a housing shortage out there. And that housing shortage isn’t going anywhere anytime soon. You can’t build it fast. So, the future of multifamily, single-family rental, and other forms of housing are incredibly strong because of fundamentals and because of capital flows that are supporting. Now, the risk factor, because money ain’t free, is inflation. Are we going to run into a wall of inflation because of the money supply? Are we going to run into it because of supply chain things? Because most of the people I speak to in the multifamily space and elsewhere are telling me that their labor costs are up, their cost of materials are up. So that’s good news and bad news. The bad news is if you are building, it’s bad news. The good news is it may actually limit supply in the near term, which will make existing product more valuable.

Colley: What about, Spencer, specifically to Texas? So nationwide, you’re seeing that, but specifically to Texas, what are you seeing?

Levy: Again, good news, bad news as well. I always have two sides of the coin. And the good news is that what we’ve been following demographically is the flow of people here and the flow of people and the flow of jobs. There have been certain high profile moves here to Austin, Texas – Tesla, as an example. But Dallas-

Colley: Oracle.

Levy: The Dallas Fort Worth area is one of the fastest growing areas in America. In fact, Dallas is now I think the sixth- the Dallas Fort Worth area is now the sixth largest MSA in America, which is enormous, diversified. But you could speak about that for the broader state of Texas as well, obviously led by Austin. But even Houston, which is obviously an energy hub, is getting more diversified, coming back faster than you think, certainly in the multifamily space, though office has been a laggard to be fair. It’s been a little bit of a laggard here in Dallas Fort Worth as well, but all of the positive economic factors, the climate factors, ease of doing business factors, those are all good. The one thing to take into consideration in Texas, and this has always been its reputation, and again, I’m not knocking it, I’m just giving it to you straight, is that because it’s such a laissez-faire place to do business, easy to do business, you do sometimes run into, A, supply risk, and B, you have a lot of competition in multifamily from very cheap single-family homes. So multifamily here is a great market for all the reasons we just talked about, but you do have some supply risk questions from single-family and some new building.

Colley: I heard a stat the other day that said a U-Haul going from California to Texas is $1,500. A U-Haul going from Texas to California is like a hundred dollars. They’ll pay you to take it back basically to California. So that’s interesting to hear.

Montesi: Hey, Spencer, what are the questions your clients are asking y’all to be looking into right now from a research perspective?

Levy: Sure. So, I would say I would put that into the macro and micro perspective. So, from the macro perspective, inflation’s coming up every day, construction costs are coming up every day, and we’re going to be putting out a piece on that. Energy, ESG, I would say is the other one that we’re doing a tremendous amount on. We just did several papers from both the investor perspective, the occupier perspective. In fact, I just helped write a small piece on the data center space and how they are trying to tackle that issue because data centers use a lot of power, and Dallas, by the way, is one of the data center hubs. Crypto mining takes a lot of power. So, a lot of people looking at unusual things like, believe it or not, nuclear power is back on the table in some circles as well. So that’s really the macro questions. Inflation and ESG, I would say, are the one and two in how they relate to interest rates. But from a micro perspective, the question I get every day is what is the best place to put your money and why? And there are two answers to that question. And I always answer that question by saying what is the cost and time horizon of your capital? And then I’ll answer your question. Because a lot of people come to me and say, oh yeah, multifamily three caps, industrial three caps. Can I buy more of it? My answer is yes, you can for two reasons – because you’re going to have great rent growth in the next couple of years, and believe it or not, cap rates can get lower. And the reason why I believe cap rates can get lower, even though they are incredibly low today, is you take a look at Europe, and European cap rates are typically 50 to 100 basis points lower than today. If our inflation, after this period of time, gets lower, you could see that. But there’s another end to that spectrum as well. I also like open air non-grocery anchored retail. And the reason I like that space is because the delta between the cap rates there and the most popular asset classes is so wide, it could be four or five hundred basis points, and the fundamentals are so good from retail sales, and on many of these sites, you have out pads to build multifamily, office or other uses. I think the market is inefficient there right now, and there may be opportunity.

Montesi: Interesting.

Colley: As you learned, Trademark is shifting its focus more to multifamily development than it has in the past. Based on your expertise, what is your advice for us and others following suit? What secrets is the data revealing that we should know about?  

Levy: Again, macro and micro – I hate to give the same answer to every question, but it is always macro and micro. But actually, some of my most sophisticated investors are actually some of my simplest thinkers in that they say macro is everything and the micro will follow. And the macro that we’re talking about here is what we started today’s conversation with – follow the demographic positive trends, and then, build multifamily there. And so, the demographic positive trends isn’t just the aggregate number of people. You also have to break it down further by talent levels and education levels. And those places that have the greatest flow of people with the highest education are places where you’re going to have the best opportunities, and many of the places we’ve already talked about it, including cities like Austin and Dallas as an example. But what you’re seeing now, which is very interesting, is a shift from some of our clients who would typically want to build right downtown, right where the office towers are, they’re now building a little bit outside of that. In fact, one of my clients is a big REIT in the Southeast called Highwoods Properties, and they suggested that they’re now buying in what they call better business districts, BBDs, not necessarily CBDs, because that’s where you’re seeing – now I’m going to give a really fancy economics term here – the agglomeration effect, the confluence of talent, capital, infrastructure, and live, work, play in this space. And some of these are basically, to use a very basic term, off the beaten path of where you used to want to build. That’s where you’re seeing some of the greatest opportunity because that’s where the talent wants to live, work, and play. Follow the demographics, that’s where you should build or renovate.

Colley: Do you believe job growth is a big pillar behind that? We follow a job growth, and kind of a statistic I’ve always used is for every hundred jobs, thirty of those people need an apartment unit.

Levy: Well, it’s funny, we can stop the interview right now, because I was going to give you the same stat. Because office using job growth is the most important statistic in real estate. So, I’ll give you a few more multiplier effects to your thing. So, I’d always used for every office using job, for every five or six office using jobs, demand for one more multifamily unit. For every office using job, demand for eight more hotel mights in that market. For everybody making over a hundred thousand dollars, demand for two more retail jobs in that market. And it all comes back to that office using job thing, but you then have to go one more layer, and that layer is the quality of those jobs. Are they durable? And what will be the additional multiplier effect? So even though we’re sitting here today all in violent agreement, Texas is doing incredibly well and will continue to do well, it doesn’t necessarily mean the death of New York or San Francisco or LA because even though they have a net demographic outflow of people in the aggregate, they’re still going to have an inflow of some of the most highly educated, highly talented people which will drive real estate demand as well. So, it’s a long, fancy way of saying this: I agree 100%, office using job growth is the most important statistic, but you should dig a little bit deeper as it relates to talent levels among other things.

Montesi: Well, you may have hit this a little earlier, but I’ll ask it a little differently. So, with your money, where would you be putting your money the next few years?

Levy: Well, I gave my answer about non-grocery anchored retail, but now to veer the conversation back to multifamily, and I’m not just saying this because I’m talking to you guys, the reason why I like those places is because they have the ability to become mixed-use developments. And that’s where they have the out pads to put multifamily. They have the out pads to put office and other uses. And I’ll go one step further than that. The reason why I’m saying not grocery anchored is not because I don’t like grocery stores. Of course, I like grocery stores. I’m looking at it from a capital markets perspective, but if you have these big box, as one of my clients calls four-wallers, you have the ability to have retail in the front and then industrial type of use in the back, distribution out of the back. So, you have the best of all worlds. You have retail, you have industrial, you have multifamily all in one place. So, I think mixed-use is probably my answer, which is sort of an amalgamation of all of them, other than putting your multifamily development in the best demographic areas.

Montesi: Yeah, well, we like that answer because we are in the mixed-use business. So, what about malls?

Levy: I think that for A malls with A retailers, you’re going to see them not only survive but thrive. I think the open-air version of them is going to do better than the close, but nevertheless, A malls will continue to thrive. But the B malls, they’re going to have to have a change of use. And that actually represents great opportunity. The opportunity, I think the first thing that people think about is industrial, but I think about it differently. I think about mixed-use and the mixed-use could be something along the lines of either multifamily or single-family rental, and single-family rental has to be taken into consideration when you’re dealing with a suburban environment. Because as you know, it’s very difficult to go vertical in a suburban environment because of exclusionary zoning. So, if you have a mixed-use development that has single family, some multifamily, retail, I think you’ll have a better shot of getting that done then if you go pure multifamily in a suburban environment, but that’s what you’re going to do with some of these old malls. I hate to say scrape it, but you’re going to have to scrape a lot of them and have an alternative use, and these are some of them.

Montesi: Have y’all studied how many malls you think will survive? As large retail concentrations, you hear people talk about 300, 250, 400. I heard some folks at our ICSE trustee meeting were staying as low as 150. Do you have a perspective? Have y’all studied that?

Levy: Well, what we did study is alternative uses for all forms of real estate, not just malls. So, I did an event yesterday in the Washington DC area and we had a list a mile long of all the office buildings there that are being converted into multifamily. So, malls is one of those things. But to be very candid, as you know, there’s going to be a disruption in the office space, particularly for commodity office that it’s too expensive to convert it into modern office. So yes, you’re going to see a lot less malls, which is the bad news for retail for at least those malls. The good news is there’s great alternative uses. And I think there is a silver lining here just because it’s so difficult to build housing in suburban environments, and that’s where most of these malls are located.

Montesi: Can you help us understand the technology that y’all are using nowadays to collect data for your primary research and how that’s changed and then what you see for the future?

Levy: Sure. So, I just did a presentation on data, and in my presentation, I say, look, you’ve got the usual suspects of data, rents, occupancy, vacancy. I was like that’s great. That’s table stakes. You need to start looking at the stuff that is off the beaten path and say why is this relevant to me? So, I’ll give you something traditional, and I’ll give you something nontraditional. So, I was talking about why I thought multifamily was going to come back in major metro areas even though you saw in the short-term people move out to the suburbs. Where did I find that? I didn’t find that in the multifamily space. I didn’t find that in the office space. I found it in self-storage because when you took a look at the self-storage statistics last year, you saw this enormous spike in demand in the CBDs. And what did that mean? It means that you were going to have a boomerang effect that people were going to come back. So, if somebody says, oh, multifamily all day long, well, you should be looking at the other asset classes too and glean what you can from it. So, point A is look at the other asset classes because there’s lessons to be learned for your own. The other is the nontraditional forms of data that you can get out there. And I think some of them are well-known at this point, having to do with credit card receipts, having to do with walkability scores. But the truth is I have a funny story about retail. We were valuing a shopping center in Northern New Jersey. And if you’ve seen any type of retail development, you’ll see it’s like, oh, we put a ring of one mile, three miles, five miles of who is going to show up. Well, they wanted to make sure they picked up Manhattan in it, so they made it like a five-mile ring. And then we actually studied the market of who actually was going there based upon cell phone pings. And do you know how many people bought stuff in that mall or that shopping center in New Jersey from Manhattan? Zero. But here’s the real punchline – because of the demographics in those circles, the average demographics of their traditional way of valuing it had the median income at around $55,000. When you actually saw the shoppers, excluding Manhattan, it went to $75,000. So, they were actually selling themselves short by not using modern data to be able to see what the true trade area was.

Montesi: You alluded to this a little bit earlier, Spencer, post COVID, there was this actual and talked about flight to the suburbs. And you just mentioned the boomerang effect that’s likely to come because of self-storage. So, do you see that actually happening now? Are you forecasting that happening? If so, when? And what other COVID related trends are you tracking and which of those do you think will stick?

Levy: Sure. So, I think the most overused phrase in the crisis was called acceleration of trend. But some of that was true and some of that benefits Texas as it relates to the aggregate and movement of people. Now, some people said that with respect to the movement from the cities to the suburbs. I’m not one of them. I believe you did see an acceleration of use of suburban housing, but that’s going to end. Because what happened was CBRE did a study about four years ago, it was called Millennial Myths, Live, Work, Play, and what it showed was it wasn’t age that mattered, it was life stage. And if you’re married and you have kids, you’re going to move to the suburbs like everybody else does for schools in particular. So, a lot of people did that, and there was a spike in value, but I think that is going to plateau because all of the moves that were likely to have occurred in the next two to three to four years happened in one year. And that’s why you’ve seen some very big buyers of single family like Zillow stop buying because they say we can’t value this stuff anymore, maybe we have peaked. Now, are we going to see more people living out in the suburbs? We will, but these people are still going to work in the CBDs. Will you see more flex space in the suburbs? You will, but the main offices are still disproportionately going to be in the CBDs. And why? Because that’s where the “talent” wants to be. They want to live there. There was a case study I can give you about what happened in the late 1990s. Two large banks moved out of Manhattan to Connecticut. And they said, oh, we picked the perfect formula here. The younger folks can reverse commute from Manhattan, and the senior executives can drive to the office. Well, to quote Keith Moon, that drummer from the Who, “That went over like a Led Zeppelin,” did not fly, and it did not fly because they could not attract talent. So, to your question about the suburbs, I am bullish on the suburbs for multifamily and single-family rental in the suburbs, and I think that use is going to grow. But as far as the sale of single-family homes, that may have peaked in the short term, and most people are still going to work in the office albeit less than they did before.

Colley: Spencer, multifamily, as you alluded to, is extremely hot right now. Based off of your latest research, what can we expect to see for multifamily in the coming years?

Levy: In the short term, you’re going to see accelerated rent growth. So, this year I could name some markets where we had an excess of 20% rent growth, I mean, stunning, stunning numbers, and next year is going to be stunning numbers again, but it’s not going to be 20%. It’s going to probably be cut in half in every market. And then in the out year, starting in, say, 2024, you’re going to revert to the mean growth rate of say 3%. So, fundamentals are going to be excellent for the next couple of years for multifamily, but then you’re going to have to be more selective about your markets, going into these markets that have good demographics. But we expect multifamily to continue its march with lower cap rates, even if the interest rates modestly begin to rise. Why? It’s because the wall of capital is going to increase for two reasons. One is demographics. With an aging population, and aging population needs yield, multifamily gives them a decent yield. The other thing is this: Multifamily is still a relatively new asset class in Europe. And what’s the relevance of that to here? More European investors are getting comfortable with the asset class and you’re going to have more of them buying multis in the US. So, all of the capital markets reasons are pointing toward exceptional returns or exceptional capital flowing to the space of multifamily. Fundamentally, it’s going to do well for many years to come because of supply shortages.

Colley: What factors can change that forecast? What should we be concerned about?

Levy: Well, inflation. It’s very simple. When I speak to most of my multifamily developers today, they’re saying the labor costs are skyrocketing, materials costs are skyrocketing, and what went wrong on inflation. And so, while our house forecast is that inflation is going to revert to its pre COVID levels, about 2% per annum, starting at the end of ’22, early ’23, there are some that disagree with us. So, a friend of mine is the Chief Economist for Moody’s, he is named Mark Zandi – he would be a good guest on this show, by the way, if you are looking for somebody else – he believes that inflation isn’t transitory, that you are going to see the ten year get well above 3% starting in ’23. That would be a material negative impact on the industry. I still don’t see material upward pressure on cap rates, so what you would likely see then is an inversion. There are many moments in history where there’s an inversion of cap rates and interest rates where they’re hire. I think you’d see that in the short-term period. So, inflation is number one, I would say number one risk factor for the space, pushing up interest rates. The other is a continued rise in the cost of labor and availability of labor to be able to build these jobs. Now, silver lining there, you’re an owner, less supply. So not everything is bad, even with inflation because historically – now, really going back – historically, real estate has always been a great hedge against inflation.

Montesi: Yes, so I want to follow up on that, Chad. So, inflation, labor costs hit operating costs, inflation for materials hits development costs. But what happens, what do you expect to happen to rents if we have 6-8% inflation in the next couple of years and today, 9, 8-9%? What does that do to rents in multifamily?

Levy: Inflation has a lot of benefits as it relates to if there’s a labor shortage, they’re going to get paid more. They have the pricing power to be able to raise rents. But at a certain point, if people’s buying capacity weakens, and by the way, there was a negative report this morning where retail sales did not go up quite as much as people had thought in the last month, in part because of inflationary pressures. And so then, what you deal with is the basket of goods that a consumer looks at, and the basket of goods are the things they need, the necessities, one of them being housing costs. And so, once housing costs get above 30% or so of somebody’s take home income, they become known as house poor or housing constrained I think is the term that people use. And so, a little bit of inflation is a good thing. Thomas Jefferson said, “A little bit of a revolution every now and then is a good thing.” It’s the same thing with inflation, but too much of it will begin to crowd out their ability to pay rent because of the price of other goods. So modest inflation very good, too much inflation would put negative pressure on rents.

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