In this episode, JLL’s CEO of Capital Markets Americas, Mark Gibson, joins Terry Montesi and Tommy Miller to discuss a wide range of topics from inflation to supply chain issues, and the overall impact on global capital markets. Mark comments about the recent JLL and HFF merger, and the net positive for both companies that is exceeding expectations. The three discuss real estate investors’ motivations, and Mark names the two property sectors he expects to boom. Stick around to hear Mark take charge and ask Terry and Tommy about the creative things Trademark is across their portfolio.
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Terry Montesi: On today’s episode, I’m joined by Tommy Miller, Managing Director and Chief Investment Officer at Trademark. We talk with Mark Gibson, CEO of Capital Markets at JLL. Mark shares his experience with HFF’s merger with JLL, one of the top global commercial real estate service companies in the US. We also discuss JLL’s and Mark’s personal stance on retail, office multifamily, and mixed-use real estate investing and what Mark thinks of COVID’s impact on the industry and what he predicts for the future of real estate investing.
Hey, Mark, thanks for joining us today. Why don’t you start by telling our listeners how the merger between JLL and HFF has gone and what’s different for you and your team now? Why don’t you fill our listeners in? I know they’re interested.
Mark Gibson: Well, thanks Terry, and Tommy, good to see you as well. I know we’re not going to do an infomercial, so let me just be very, very quick with this. One is it has turned out better than our expectations, and it’s primarily because JLL needed something and HFF needed something. Let me just speak to the HFF part of it. We were a small cap company, traded on the floor, doing very well and growing market share and performance was great. But when we looked out five years, we had some holes that we needed to fill. First of all, was overseas. It took us almost ten years to open a London office, to find the right people and the right culture. The JLL merger immediately gave us the number one market share in both EMEA and APAC, and that’s really important for our US clients because of the amount of overseas capital coming into the US. And if we’re taking care of them in their home countries as well, it just really solidifies us as that intermediary for them. Second of all is just the information exchange. In the leasing business and the corporate services business, we just didn’t have that information as a standalone capital markets business, and now we’re so much better informed in terms of real trends in demand from tenants in every product sector, and the corporate outsourcing is really just understanding what the largest corporations in the world are doing vis-a-vis their space planning because we’re managing it for them and managing their facilities. So that information has been fantastic. And then the last two points are we gained a Fannie Mae DUS license, which is really important to us. And the technology spend that we were able to do as a small tech company versus the broader JLL reach was something that we knew was important because technology is changing, it already changed our business in quite some way. So at least from the HFF perspective, phenomenal because we have all these new weapons, so to speak. And for JLL, I just think they wanted to bolster their domestic capital markets business substantially in the US. And hopefully we filled that for them as well. But now, we are one JLL and it’s all, again, it’s exceeding expectations. It’s been great.
Tommy Miller: Yeah, Mark, give us your macro update on the capital markets today, real estate capital markets. Stay high level, maybe focused on the asset classes, retail, multifamily, and office that Trademark’s focused on today.
Gibson: Well, first of all, I can include all of that in the overall view of the market, Tommy, because it applies to every product sector. The liquidity is the best it’s ever been in the history of the real estate business. And the reason for that is really twofold. One is real estate has performed and it’s performed well relative to other asset classes. And so, the allocations have been increasing over the last ten years, doubling as a matter of fact, as a result of performance, but we’re also at this unique period where you have very low yields across the board, and therefore this phenomenon known as fixed income rotation is very real. So, if you are a sovereign wealth fund or a state pension plan, and you have promised your constituents a certain package of benefits, there’s a rate called the actuarial rate that you have to hit, which is a rate of return on your portfolio to pay those constituencies what you promised. Those rates are 7 to 7.5%. With fixed income yielding less than 2, you’re not going to get there. So real estate has become the best surrogate, if you will, for fixed income. So, you see a lot of money that here before may have comprised 25 to 30% of a large sovereign wealth fund’s portfolio moving to maybe 5 or 10% and the remainder going somewhere else, and real estate is the largest recipient. So, we’re benefiting from that phenomenon as well. And it helps some of the sector preferences, because if you think about the fixed income rotation, what is the best match up or surrogate is really low capex asset. So, you think about industrial or multi-housing, etc., which is why they’ve been in vogue over the last, we’ll call it, couple of years in addition to the ones, which are significant in terms of demand in both those segmentations. Having said that, it’s gotten so competitive, given the amount of liquidity in the marketplace, which is at an all-time high, essentially going into two sectors, even if you meet market, which is priced very, very well, you can’t deploy in any large scale for a number of reasons. So now you have rotation of capital out of – not completely out of – but into, we’ll say, retail, office, and hospitality, to get to your last point of the question, Tommy. So, we’re seeing ample liquidity really across all sectors, and the only delta or difference between them is the risk premium that someone perceives in office or retail over a multi, industrial, life science, and some of the other alternatives. So that’s really where we see it. I’ve never quite seen it the way it is currently in terms of availability of capital.
Miller: And what do you think about the current fear of inflation, stagflation, whatever you want to call it, supply chain issues, and all the liquidity that the federal government is putting in the system and how that might impact capital markets over the next one to two years and your comments on you hear people talking again that real estate is such an effective hedge in a period of inflation? And what’s your view on that today? Does that theory still hold up?
Gibson: So, let me put your audience at ease and both of you. So, I won’t give you my opinion because it would be dead wrong, I’m sure. So let me tell you the consensus in the opinions of people that run the largest amount of capital in the world, and I’ll tell you what they think, and then you can decide if that makes sense. The question is inflation real or is it transitory is the first element of the question, Tommy, that you posed. And their view of it is it’s probably 60 to 70% real, and they cite a few things. One is labor costs they do not see declining in the near term. The second is energy prices. And given the push toward ESG and Green and the lack of investment in carbon-based energy and we’re a good way off from making a full transition, they see energy prices not abating but rather escalating. So, when you just look at labor and energy for the time being, those are two very, very large components that have sustained inflationary influencers. You mentioned logistics, logistics are going to be transitory. So that would fall into the 35% or 30%, however we want to define it, of not real in terms of inflation. So, it is heightened by the inability to efficiently transport goods and services in the ports to the remainder of the US, and that’s primarily due to labor shortages and issues. And then finally on the stimulus, they do believe that that is contributing to labor shortages as well as to the permanency side of the inflation. And that’ll be for the next three to five years. And how does real estate play out in that regard? If history holds, which we don’t know, at some point in time, the fed will be needing to think about raising once its employment rates are hit and it becomes very concerned about inflation being real, and that would, generally speaking, have a negative impact on real estate aside from the fact, to your point, that it has historically acted as a hedge against inflation, and that really is a result of just being a growth minded asset class. So, in the event the economy is generating results such that they are inflationary, that’s generally very good for real estate. So, the growth outpaces any increase in cost of capital. And that’s generally the view of large owner-operators of capital not only in the US but overseas as well, investing in the US.
Montesi: All right, thanks, Mark. Early in ’21, Trademark entered the multifamily development business. Give me your view on multifamily development and investing and whether you’re neutral, positive, or negative on the multifamily asset class the next three, five, seven years.
Gibson: We’re very bullish on the multi-housing asset classes or even industrial because the tailwinds are palpable and measurable. So, I think about trade out, not that we’re seeing across the border, it really doesn’t matter where you are or what region, there are higher trade-out numbers in your high growth markets where you have employers and people relocating to, and Texas happens to be one of them where you are primarily based and focused, but it’s really across the US. When you are getting 15% trade out numbers on average, it’s showing demand there and ability to pay for that. We’re bullish on the development side of it because if you’re developing unique product and it changes in highly amenitized locations, you’re going to outperform. So, we like both of those aspects. And there is a difference in your urban gateways versus some other markets, and there is a difference between your urban high-rise communities and your suburban communities. But those are on the margin, generally speaking, they are all seeing a rising tide, which is really healthy.
Montesi: And next for retail, how do you see retail real estate performing the next three, five, seven years?
Gibson: Well, I’ve been very bullish on retail primarily because we think that it’s been painted with one brush primarily due to malls and/or outdated formats by retailers that should have changed their business model 20 years ago and didn’t do it. But when you look at the growth in retail sales, particularly of late, it’s caught people by surprise, but really it hasn’t caught you or Tommy by surprise or me by surprise because those retailers that have made the omnichannel, the true omnichannel conversions have figured it out. And they’ve seen where consumer demand is and they’re maximizing their business models, and their earnings are representative of it. So, you have a true have, have-not in the retail world and the have retailers want to be in the best locations. So as usual, the best locations are going to outperform and are going to do extraordinarily well. And those locations, which we are over retailed in inventory, as most people know, that don’t really have a reason to exist, they won’t. So, it’s truly a have or have-not environment, probably more so than any other asset class that I know of. But I’m very bullish on it because for the most part, you can tactically make the right choices and we believe outperform when you look back on the market, given the risk premium that you can garner in retail versus let’s say logistics or life science or multi-housing.
Montesi: Yeah, how about the same for office – neutral, positive, negative the next three, five, seven years, and what research to your personal view is on the long-term impact of the spread of work from home policies throughout our economy?
Gibson: Well, it could take a long time to answer that question. I will be very concise to the extent I can. So, we’re bullish on office primarily because you can’t run a growing company and a dynamic company in a work from home environment. You need culture, you need mentoring, you need training, you need what comes with people to people contact in terms of creativity and new product generation, etc. That’s been proven through so many case studies over the years that it’s just surprising we’re having this discussion. Having said that, we think the work from home is an extraordinary development that we think will keep more people in the labor force long-term, so we’re very positive on that because it gives more flexibility to the office environment to allow some flex times for people that need it; particularly in high commuter areas, it’s even more important. So, we’re actually positive on that relative to office. And that’s been a good thing that we’ve discovered because it forced all of us to get good at how do you do work in a remote location – we think that’s a good thing. We think the net demand from de-densification, which is spreading people out further, both for health concerns, future health concerns, but also productivity concerns versus work from home and what does that do to the overall office format or demand? And we’re predicting an 8 to 10% decrease in demand in general for office as a result. Having said that, that is a very general comment and does not apply to fast-growth markets nor does it apply to new buildings in the best submarkets in high growth markets because that just doesn’t play out. JLL’s own leasing space planning data tells us that we’re not seeing yet this 8 to 10% we’re forecasting because the space planning, in deals that are currently underway and they are very substantial from a tenant rep standpoint and not changed pre-pandemic. So, we haven’t seen it manifest itself yet despite what you might see in the media or hear in the media. And relative to the media, I would ask your audience to look at what is actually happening versus what people are talking about. If you look at the demand and absorption of office space and who is absorbing it, it’s generally the tech firms are at or close to 50% of the absorption in 2021 of the space, yet you wouldn’t necessarily believe that if you are listening to media. So, we’re not seeing any net production real time in space planning. Our tour activity, pretty much across the board in every metropolitan area of any size is at or beginning to exceed 2019. And we believe that more and more CEOs are coming out, defining that they’re a work from work culture with flexibility, and we think that’s a good mix between those two concepts. By the way, everything I just described was existing pre-pandemic, so the trends just accelerated a little bit.
Miller: Mark, is there a trend away from Midtown Manhattan hundred story office buildings versus more mid-rise buildings that are a little easier to get in and out of and you can spread out a little more?
Gibson: I think it’s too early, Tommy, to make that call. I will tell you what we can say is newer buildings in growth markets that are in highly amenitized sub-markets are preferred pretty much across the board. From an investor standpoint and a tenant standpoint, we can make that statement because we have the facts, and we see what’s happening. In the investor world, new buildings are trading at pre-pandemic levels, and there’s substantial amounts of capital coming into the office space. So, in terms of investment performance, we see that there is cap rate compression. relative to the high rises, I think it would be market specific and sub-market specific, and I think it’s too early really to make the call.
Montesi: That’s interesting. I heard someone the other day say something I thought was really interesting, I’m thinking about applying in our own business, about a new perk they gave their people. They have their people working from the office four days and one at home, and they think they might go back to five, but they’re giving everyone at their company two weeks – or no, his was four weeks, I’m almost sure, where they can work remotely for like for a chunk. Actually, it was Whole Foods. Paul Hilliard was telling me that they’re going to let their people, hey, you’re working, but we’re going to let you work remote a four-week chunk in a row. So, if you want to go get an Airbnb for a month during June or whatever, you can do that, you’re working, but they then are going to want them to come back to work. I thought that was an interesting idea for the sort of flex work from work as you call it.
Gibson: Yeah, there’s going to be a lot of creativity there. The net result is human beings need to collaborate. And if you just boil this down for the audience, competition is going to drive that collaboration. So, what I mean by that is if Jamie Dimon comes up and says everybody’s back in the office, then B of A and Wells and everyone else is going to follow, or vice versa. It could be Wells Fargo who says it and Jamie Dimon follows. But then they start out performing because they will. And how do I know that? Because we have hundreds of case studies where companies have opted for work from home in some form or fashion, and they got lapped both in professional performance and in employee retention and new product development. The other side of competition is internal. And that means if you’re work from home and particularly a young person, and you see your peer in the office on a Zoom call and he’s near the decision maker or she’s near the decision maker, who do you think is going to get the next raise and get paid a little more? And so, when you look at both those competitive elements, both internal and external, and you really think about networking, particularly for the young people in the United States, they generally don’t have enough space wherever they’re living to effectively manage the same productive output as they would in a work environment because they have distractions. And what we’ve seen is different than maybe some. Young folks are the ones desperate to get back to the office and folks that have already established a network and maybe in their fifties or whatever it may be find that they can work from a lot of different places. So, it’s actually a reverse of what people would’ve thought, but both are going to be required to really have best-in-class dynamic business to where you’re winning in the competitive set in whatever industry you play in. And that is becoming a realization really across corporate America as we’re speaking.
Montesi: You mentioned a couple of different times, one when talking about multifamily and one just then talking about, you mentioned the words amenitized and highly amenitized, and we’ve been focused on mixed-use development for the last 19 years. And I know that HFF before the merger and JLL have both done some research on product sector performance in mixed-use projects. So, I’m wondering what research you’ve seen and what your cut is on that. And have institutional investors finally started to get the mixed-use thing and even want to own all the parts of mixed-use projects?
Gibson: So, Terry, it is a good question. The short answer is all the research data will say pre-pandemic demonstrably showed higher performance in every sector in terms of rents, cap rates, etc., in a mixed-use environment versus non-mixed-use environment. So, you’re better together, so to speak. But the very definition of mixed-use means you have mixed-use. So, you have office, you have multi-housing, you have retail, you have hospitality, or some mixture of those, and not all of those behave the same in code. So, there was a pause in terms of what are we doing and how’s it going to work and where are we going to be as an investor? Because they had very different risk premiums for each one of those asset classes. So, it diverged a little bit during COVID. Where we stand now is that luster is now coming back. People are getting very comfortable with hospitality. You see some of the hospitality trades now happening, and office we’ve already discussed, and we’ve talked about retail, all of which are necessary for a vibrant living experience. From where we sit, the investor demand is now back because really the tenant demand is picking back up where it left off pre-pandemic. So, we think the mixed-use model is very valid. As you know, not all mixed-use is created equal. So, I think it’s more important than ever to think about the percentages of what makes up mixed-use going forward and what elements of mixed-use are you including and what do those space planning development components look like. So that is going to change. And I think that you’re on the forefront of that. You and Tommy are both on the forefront of it, and you’re thinking about that in a smart way. I think what we call mixed-use and maybe even best-in-class mixed-use pre-pandemic, I think that definition is going to change post-pandemic. The mixed-use nomenclature is still going to be very valid in the business model, it’s just what does it look like.
Montesi: Yeah, we’re planning, whereas some of the projects that you guys have worked on with us and are aware of, we may have had 70, 80% of the income from retail and the balance 20, 30% office and multi or office and hospitality. We think, going forward, that we’ll still be developing mixed-use, but it might be 20% retail and 80% the other uses, but the retail as amenity will be no less important. There won’t be the same demand for as much square footage. And so that’s the sort of obvious, easy answer as I see it today.
Gibson: Yeah. I think tenant selection on retail in terms of the consumer, when I say experience, I’m not talking about parks and beauty, I’m talking about the actual tenant experience. So where are the unique tenants? What are the unique tenants? And if you can get the unique tenants within a mixed-use construct, it drives a lot. So, to your point, it’s no less important than it was when it was 70.
Miller: Maybe more important.
Gibson: It could be more important, Tommy. So, you’re exactly right.
Miller: Less, but more, but better, I guess. So, Mark, you talked a little bit about you see the tailwinds and multifamily and industrial and they seem enduring. I’ve heard some other people talk about this as well. And these are really macro, secular trends that are still very powerful. Are there any other macro trends out there other than the usual life science, industrial, multifamily that you’re seeing emerge as maybe the next powerful macro trend?
Gibson: Well data is clearly on the leading edge. And I would put really anything that has a living aspect to it. So SFR, single family for rent, any kind of affordable nomenclature along with living and maybe some things that would surprise folks. So, I think some of the thematics around buying extended stay hotel product is actually with an eye toward conversion in some form or fashion to some form of RESI in a new format. So, all of those you could put into that bucket. But I would tell you that anything, any product type that features low capex is going to be in favor because it goes back to the comment I made at the beginning with the fixed income rotation. And so the perfect surrogate, real estate is a great matchup for state plans and long dated owners of capital that have long dated liabilities to pay because real estate is a great store of value long-term and everyone’s come to that conclusion, but if you can operate a real estate asset, get the inflationary benefits and protection from it, but don’t have near the investment you have to make to maintain that current yield, that’s going to be more favorable than not. So, I would say two answers to that. One is what I mentioned on living and data and a few others. And the other is just anything in a low capex construct. So manufactured housing for instance would fall underneath that nomenclature. It’s both under living, affordable, but also low capex.
Miller: So we- and you’ve seen this I believe in your shop, but there seemed to have been a pretty big capital surge to the retail sector recently; prices are surprisingly high, granted there’s a quality aspect to that. But do you think the surge of capital in the retail sector is sustainable, or maybe it’s a little bit overstimulated today?
Gibson: So, I’m going to divide that question with two answers. One is there’s a very valid question that has been asked that Terry’s very familiar with, and you’re very familiar with, and it’s regarding the earnings potential of the retail tenants themselves. So, is this a transitory one-and-done type pent up demand, stimulus driven? And importantly, the retailers have been extraordinarily disciplined on any inventory investments that they’re making, so the markdowns have been at historical lows. So, is that transitory? So that’s a valid point and it’s a valid question of the retailers specifically, but it has an impact into your second part of the question, which is what about the investor appetite? Well, the investor appetite is going to be driven in large part by the retailer performance. So, they’re correlated to some extent, but having said that, it goes back to my liquidity comment, that liquidity exists for all product types in real estate. The question is we have a bit of an asset gap that exists in some of the out of favor asset classes, which are primarily high capex, and retail falls under that category. At this moment, I don’t see a pullback at all of capital wanting to invest in retail but only certain aspects of retail and that is back to the have and have-not comment that I made relative to what type of retail and specifically where is it located? So, a long-winded answer, but that’s what we’re seeing right now. So, at this moment, no lack of capital, and to Terry’s point, we’ll see if this is a sugar high in terms of earnings announcements in the retail.
Miller: And talk a little bit about the performance of gateway markets looking forward versus, say, high growth, secondary, or maybe even Sun Belt markets.
Gibson: Again, this is not anything new. Trends in terms of demographic shifts, large swaths of population, as well as employment trends, they’ve been shifting to these high growth markets outside of gateways way before the pandemic. So, all the pandemic did was accelerate that trend that was already occurring, but it did accelerate it fairly dramatically for all the reasons that existed pre-pandemic, which were regulatory issues, taxation issues, commute times, just various, cost of living. All of those aspects existed pre-pandemic. Nothing really changed. What did change was to your point, Tommy, and that is safety. And safety has become- during the pandemic, the way certain municipalities have opted to govern themselves has resulted in a big differentiator between cities. So that is the one change during the pandemic. Everything else existed pre-pandemic, but the safety concerns are very real. And that’s interesting because it goes back to our retailer commentary in terms of performance. Terry and I were both at a trustee meeting at ICSC, and one thing that the tenants all made us aware of was the extraordinary loss from theft by organized crime. And in many locations, these retailers are just shutting their doors and opting not to operate in cities that won’t prosecute. So, tying it back to the retail concept, when you start seeing losses that are three and four and five x in certain cities in terms of just pure theft and write-offs versus others, that is a factor that did not exist pre-pandemic.
Montesi: Yeah. Like Walgreens in San Francisco and CVS in San Francisco, that’s going to be interesting to see where that goes. So, Mark, we both watched as capital has just run for the hills from the regional mall sector in general, at least for the last couple of years, including a lot of pretty darn good properties. Where do you see investor appetite, and for regional malls, where do you see values of regional malls, and how does all this play out going forward in your mind?
Gibson: Well, the investor appetite is not there. So today, what we can say definitively is there really isn’t investor appetite for large scale regional malls, generally speaking. And we’ll include the top 80 best-in-class malls in the United States. And the reason being is there’s just too much uncertainty regarding risk. Now, is there pricing? Sure, for the top 40 malls in the US, yeah, there would be pricing, but not any level that a seller would be thrilled with. Having said that, David Simon and others know the business very well and they are doubling down in the sector, and I really wouldn’t bet against them. So, when we look at the investments being made by the people that know the business, everyone should take note of that. And the investments being made are sizable. These are not small and they’re getting highly creative, and it’s really interesting to watch.
Montesi: It’s malls becoming mixed-use places for the most part is where the dollars are going.
Gibson: Just like any other business model, things are changing. But I would say that the investor market is lagging what I would perceive to be the reality in both the retail business in general and malls specifically because there’s a lot of upside there. And I don’t think the investor market is fully convinced of that.
Montesi: Well, Mark, is there anything else that you would suggest that we had asked you that we didn’t ask you?
Gibson: Well, I would turn it around on you guys and I would say what are you seeing? And where are you putting your time and capital to work? And I know we’ve mentioned mixed-use, and you’ve mentioned multi-housing, but tell me what you’re doing.
Montesi: Yeah, so I would say our real activity is in redevelopments of existing retail and mixed-use projects that big institutions own, and there’s no shortage of appetite for their needing help figuring out these retail projects. Oftentimes they need to be, you used the word de-densified, they need to go on a retail diet. And where we’re seeing new development opportunities, many of those have multifamily in them, but they are either a mixed-use project, like where my headquarter sits here in Fort Worth, or a mixed-use district. And it’s really exciting to be working on new development that has less perceived risk with mostly multifamily and a little retail as opposed to our business years ago when there was a lot of active development. So, that’s one thing we’re seeing. Tommy, what else would you add?
Miller: Well, not just multifamily, but working in all the uses into a mixed-use environment. Even though office may be somewhat out of favor, it might be very important to try to work the office component into a mixed-use environment. With living, starting to see, there are some terms for this, but the common areas sort of merging together. Office lobbies and residential lobbies were even thinking creatively about how best to manage a mixed-use asset. As opposed to having one property manager for every use, maybe they can be merged together. And then the delivery of amenities to the customer and adding- everybody talks about experience, but it’s sort of the nexus of experience and convenience which is kind of the holy grail. It’s public spaces, but it’s also walking your dog and delivering groceries, and all of that merging together. And you’re not seeing a lot of it coming, but I don’t know if you share this, Terry, but I think it’s coming, a new management operating model for the consumer, adding value to their day as they live and work in these environments.
Montesi: Yes, like we rolled out at Watters Creek where our guest services team services the office and the multi-family and the retail. One thing to give you a little information, our sales and our portfolio versus ’19 have just been super strong, up 15 to 20%. But even more noteworthy is our leasing activity. I took our leasing team to lunch last week, and they all said that leasing activity that they have right now is the best it’s ever been. And of course, there was a time where the retailers were frozen. So are we seeing two years of activity in one year, just like the pent-up demand from the consumer perspective. And I think we have to assume your 60/40 inflation transitory versus real argument, I’d say it’s kind of similar, I’m guessing it may be half real and then half pent-up demand, but it’s clearly all a lot better than when you and I talked when COVID had just started, what, 15 months ago, 18 months ago, what we were preparing ourselves for on the retail and mixed-use side was just way worse than the reality that happened. That’d be an observation I’d have, Mark.
Miller: And then the speed of the recovery, how quickly it changed when people were thinking we might be in this funk for multiple years. Well, here we are, two years early.
Montesi: And almost 90% of the deferral dollars, the rent dollars that we deferred, we’ve gotten those paid back at almost 90%. And certainly, that’s some good news. And it’s good to have a friend that’s very much a realist on the other side of the line, like we are, but where we can actually be realistic and have some good news to talk about. Hey, Mark, we really appreciate your time today. I know you’re busy and pulled a lot of different ways, but I appreciate you giving us your time today, and we’ll look forward to seeing you soon here over in Dallas.
Gibson: I enjoyed it, guys. Thanks very much.