Is real estate the next shoe to drop in the aftermath, what we saw with the
banks, the challenges and real estate are gonna be tied to the economy.
So it all depends on do we have a recession?
How deep will the recession be? How long will interest rates be high?
And the answer to that question will determine the challenges that the real
estate industry will face in the quarters ahead.
We had a Bloomberg report saying that vacancy rates for office properties in
Manhattan were at a record high right now.
I think something like 50 percent, something like that.
You know how much of that is because the economic downturn and how much it's
because people just aren't coming back to the office.
They're working from home. Yes.
I think that's a big misperception in the market today.
The office business faces two significant headwinds.
One is a slowdown in economic conditions.
And the other is work from home. When you have a slowdown in the economy,
businesses are more challenged in terms of their personnel and they do things to
cut costs. And you see layoffs going on almost
every day right now. And as you have layoffs, companies take
less space where they put sublease space back on the market.
And by the way, this is no different than any other downturn that we've ever
experienced. Office and many forms of real estate are
economically sensitive. So I think in the premium end of the
market, what's impacting our leasing activity today is much more the economic
conditions and work from home. And the evidence of that that I would
give you is in 2022 last year, our company leased nearly 6 million square
feet of space, which is basically 95 percent of our long term averages.
And if you think about it, last year, you know, interest rates started to go
up and the economy was much more solid and there were a lot fewer people in the
office. Now you've moved to twenty three.
Office leasing is slowing down. The economy's worse, and there are
actually more people working in the office.
So what is your spring to BHP, particularly in the tech area?
Because we've heard about a lot of layoffs in tech, downsizing in tech.
Are you seeing that in your office situation?
Yes. Well, that has an impact.
The technology firms, particularly the larger ones, were important net
absorbers of office space since the global financial crisis.
And as you know, over the last six months, many of those companies, their
growth has slowed and they're focused very much on their profitability.
And they many of them have done layoffs and many of them have put sublease based
on the market. And by the way, they've all announced
some form of return to the office as a result of this as well.
How does this affect valuations? Because we have, I guess, net profits
gold, which gives this appraisal the valuations.
I don't and saying we've got a Bloomberg buried index of Reach Office Property
Index, which is not that which is down a lot more than appraisals.
So how can you get your arms around exactly what's happening with valuations
in real estate? Yeah.
So let's divided between the private market and the public market.
On the private market. It's hard to determine value because
there are very few transactions going on right now.
Interest rates have come up off, bids are lower and sellers are so far
unprepared to accept those bids. So where is real estate trading?
It's trading in the public market. The rates, as you mentioned.
And if you compare these two areas, you know, office rates today are off, you
know, 50 plus or minus percent from peaks in March of last year.
But the NIKKEI Creek intra index, which is appraisal based, that dictates where
private market values are, it's only down about 5 to 6 percent from peak.
Higher interest rates obviously affect the economy.
Slow the economy down, may affect vacancy levels.
It also affects financing for these properties.
How is that playing out right now? For example, if you're putting up a new
building, I understand you have construction financing.
That's short term. You're going to turn it into longer term
in some time. Are you in the process right now of
refinancing and how does that work? Yes.
Well, financing is harder to get today because of concerns about real estate.
And also buildings have to have strong cash flows to support the higher
interest rates that are associated with financing.
From our company's standpoint, most of the financing we do is in the bond
market. So we're an investment grade
issuer of unsecured bonds and that market is open to us, albeit at higher
spreads. We do have some mortgage financing and I
do think mortgages are available to office real estate, but that building
has to be well leased. It's got to be of high quality and it
has to be owned by a strong sponsor. What about the high quality you just
mentioned? Because I've heard conflicting things
that there's a huge difference between a building's in B's and C's or some people
say basically if it applies across the board.
Yes. No.
This is a very important issue when you think about office real estate.
Last year I mentioned all the leasing success that we had.
Yet we saw all these reports showing many of our cities being 15, 20, 25
percent vacant. And then an important measure in office,
real estate is. Absorption.
This is how much the occupied space goes up and down in those segments.
And if you look at the premiere workplaces for the last two years ended
the year in 2022. The premiere workplaces had a positive 7
million square feet of net absorption where everything else was down.
Twenty five million square feet. So there is a very in all the years that
I've been doing this. This is one of the strongest moves
towards quality office and real estate that I've seen.
What about prime cities? If I can put it that way.
What's the geographic dispersion? We hear reports of, for example, San
Francisco really struggling. New York maybe not doing so well.
There there's a big move into Austin and Miami, places like that.
Yeah, well, there is some migration out of the coastal cities into lower tax
states and cities like in Florida and in Texas.
But there is also in migration from employees in New York and San Francisco
as well. So I do think and believe in the long
term vibrancy of cities like New York and Boston and San Francisco.
What about that ecosystem more broadly? At this point, are places like BSP and
others pulling back on future development properties, which can affect
things like construction, construction, workers, employment?
Yeah, well, with the slowdown in demand, clearly there's gonna be a slowdown in
development. And that's one thing that will help
owners like ourselves because they're going to be less supply in the future
because construction is being pulled back.
We do have sites and we would consider future development, but it has to be
deep risked and for us that means pre leased.
What's the biggest opportunity for XP right now?
And is it in fact part because of the valuation question and maybe some
bargains out there at the moment? No, I think that will come.
I mean, a couple of things that had mentioned.
We have also been in addition to our premier workplace business.
We've also been developing life science assets.
We're building a large lab building for AstraZeneca and Cambridge.
We're converting a large building in Cambridge for the broad institute.
So that's an area of growth for us. Another area of growth for us is simply
leasing our portfolio, increasing the occupancy, because we're at about 88 or
89 percent occupied today. And that will grow our income stream.
And then I agree with you. I think as this downturn unfolds, I
think additional investment opportunities will present themselves to
strong players like ourselves.