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Spencer Levy
It's that time of year again when we take a deep breath, look at the economy and recalibrate our perspective. On this episode, our annual MidYear Outlook featuring two thought leaders with unique approaches to their analysis of commercial real estate and the economy.
Glenn Mueller
To me, real estate is really a delayed mirror of the economy.
Spencer Levy
That's Glenn Mueller, PhD., a professor at the University of Denver. In his 48 year career in real estate, he's held jobs at just about every level of the industry, from loan analyst to homebuilder, developer, investor and more. But he's best known as a pioneer who brought in the notion of real estate cycles through his widely read Cycle Monitor reports, which offer insights based on his analysis of five major property types in the 54 largest markets in the country.
Richard Barkham
The question is, are we at the end of the cycle or are we mid-cycle?
Spencer Levy
And that's Richard Barkham, CBRE’s Global Chief Economist, to help us answer some of those questions. Richard is a leader of CBRE worldwide research team. He's a PhD himself, also serves as a visiting professor at the University of North Carolina and is a senior fellow at Harvard. Coming up, examining current economic events and an outlook with insights for the road ahead. I'm Spencer Levy, and that's right now on The Weekly Take.
Spencer Levy
Welcome to The Weekly Take. And we couldn't have two better folks who joined us today, starting with Glenn Mueller. Glenn, thanks for coming out.
Glenn Mueller
Thank you for having me.
Spencer Levy
Great to have you. And then Richard Barkham, who may be our most regular guest on this show. Richard, thanks for coming back.
Richard Barkham
Thank you for having me.
Spencer Levy
Thanks for coming out. So let's begin. Very big picture. What's going on in the economy and what does it mean for real estate?
Richard Barkham
Yeah, I mean, the economy is slowing a little bit, Spence. But the question is, are we at the end of the cycle or are we mid-cycle? And there are a couple of very distinct end of cycle indicators out there. We still got an inverted yield curve. We've got some tight credit spreads. But there are other factors in the economy that suggest that we're actually achieving something that’s a soft mid-cycle landing. The health of the consumer is still strong. Consumer finances are not that stretched. And the corporate sector is still quite profitable. So we've got mixed signals on the economy from a cyclical perspective. And I think the emerging consensus is that we're achieving something like the mid-1990s soft landing that Alan Greenspan pulled off, which means that interest rates aren't going back down to zero, but we can think about some years of economic growth to come. This is the first time, in my view, in the last 30 or 40 years that you've actually seen three or four end-of-cycle events in the real estate market when you don't have an end-of-the-cycle macro situation. So you’re actually seeing a proper real estate cycle playing out.
Glenn Mueller
For me, what drives real estate in the macro economy is really employment growth. And employment growth has been – and I'm going to use the word good. It's not huge. And part of the reason is we don't have enough people actually out there. The unemployment rate is low. We keep getting positive employment numbers every single month. They may be growing a little faster or a little slower than what economists are predicting, but to me, that's where demand from real estate comes from. And I don't see – at least everything I read and I’m really a real estate researcher, not an economist. From that standpoint, it appears that we should be able to continue on without having negative employment growth, which means to me, it's not a recessionary thing that drives it down, but I'm going to then flip around and agree with Richard that we've got a unique situation on the real estate side in the cycles and it really is different for each property type. We obviously are crashing in office, but we're booming in retail. There was on the opposite ends of the cycle spectrum at this point. Since 1990 when I started this, I've never seen that before.
Spencer Levy
So let's go back to the comment you made a moment ago, Richard, about the mid 1990s being maybe the best analogy. And so I would take your analogy one step further that – in addition to the similarities to the mid 90s, I see similar opportunities to the mid-nineties, certainly in the office segment. Glenn, maybe you can comment on that. Now, office may be crashing macro, but micro, there may be opportunities there.
Glenn Mueller
Oh, absolutely. Absolutely. And I'm sure as you guys are seeing too, there is some new demand for office, but it's all in the – I'm going to call it premier Class A space these days. Everybody wants new, great, fantastic. And there's actually some people that I know that are talking about building new buildings, like in New York City. And the flip side is San Francisco is like the worst market in the country, right. Part of it is, you know, I always look at demand and supply. The amount of office use and employment, which is – think of all the different things that are but mainly tech and things like that was starting to slow down. And then along comes artificial intelligence. And AI is the new boom that's demanding office space, right? But it's got to be high quality space. At the same time, a lot of these people that are doing the AI stuff can be doing it from home, too. So if we are getting to the new normal of being in the office three days a week instead of five. Every firm needs X amount of less space. So the demand while it's growing, its growth rate has slowed down substantially. And figuring out usage is the other part of that, right? I mean, I've got people that really only want to be in their office Tuesday, Wednesday, Thursday. They want to basically work from home four days a week, which means they really want a four day weekend. Let's be honest, right. We're trying to figure that out. That hasn't happened in some of the other countries. Right. And Europe, pretty much everybody's back in is kind of back to normal. But, in the United States that's not the case. We also are this year, flipping over to the supply side. We're seeing the finishing of a number of new Class A properties in a lot of major markets around the country that were started pre-COVID. Right. Because let's face it, in any major downtown, it could take five to eight years, from okay, let's build. We just bought this vacant parking lot. Let's go, let's go build a new office building. That's a Five to eight year process. And a number of those are coming online in different cities. So they are, if you will, over supplying.
Spencer Levy
Let's go a little bit deeper into the cycle monitor for a minute, Glen, a little bit into the real weeds, the nuts and bolts of quarterly. When you do it, what goes into it? What are the key inputs? What is objective? And tell us if there's an element of subjectivity to it as well.
Glenn Mueller
It's pretty darn simple. It is the occupancy cycle. I need to have a minimum of one, hopefully two. And after doing this for since the 1990s, I've got three or four cycles in there, right? I literally take and take the historic occupancy level up and it goes and it cycles up and down, right. And then I take – for each city and each property type, and I do and I take and say, okay, what's that long term average. It allows you to look at markets and compare them as opposed to just pages and pages of data. It's a visual representation of where things are moving in the cycle and just easy to understand. A lot of people like to use it. I've got a lot of banks, a lot of investment companies, etc. that say, hey, this gives us a quick idea of this. So it's just a very macro overview of what's going on, doesn't look at some property types, doesn't look at submarkets, but just kind of gives people a very quick, easy to understand, way of looking at things.
Spencer Levy
Let's run with that for a moment. How do you invent it? How do you use it?
Glenn Mueller
Back in 1990, I got pulled out of academics and went to work at Prudential Real Estate Investors and beautiful downtown Newark, New Jersey. And, as you may recall, that was a down cycle, if you will. We had a little bit of a recession. We obviously had the crash of the office markets that happened due to all the overbuilding of the 80s. And they said, can you figure out what happened, why it happened, can we monitor it, model it, forecast it to make better investment decision. Our biggest client was CalPERS, California Public Employees Retirement System and we had to put money to work in real estate markets. And where do, where do the acquisition people go? And what I found was there, there's really two parts to the cycle. There is the physical cycle, which is demand and supply for space, which is very local. And in each city that I look at, we look at the economic base industry or driver of growth. In other words, an economic base and street produces a good a service. It exports outside of the local market, which brings money in and makes it grow. So in Detroit it's always been, automobile. In New York, it's finance. In Chicago it's trade and transportation as well as finance. And every city is trying to diversify their economic bases as we go. And of course, now tech is the big one. So it was literally looking at the demand, employment growth in each market and supply coming on, which is different in each, in each property sector obviously. And then putting those together to get to the occupancy rate, which is just the inverse of vacancy. And the reason I use occupancy is it's easier to say things are good and occupancies are up, then things are good and vacancies are down. And when I graph that with rent growth, the two you see the visual correlation there is just – it’s huge. It's basically it's about 80% as occupancies move so goes rent growth. And if you take occupancy change plus rent growth that gives you the income side of real estate. And any total return comes from income plus price change. So my second report is on the physical side, the income side of real estate. And pretty much every market in the country today is at peak. In cycle. In, in retail, everything is full. But, the last couple of years it's been 80% of new retail being built was pre-leased. And a lot of it is just standalone retail, triple net leased, typically. Apartments have been doing very well, except we started to overbuild. What's everybody building? Brand new Class A downtown and what do we need? We need Class B, Class C workforce and affordable housing. We are 6.5 million housing units short in this country, according to the National Association of Realtors and pick other sources. And I've seen five to as high as 7 million short. And I used to be a home builder and we had a saying back in the 70s and 80s when I was building home – carry kills. If I build a new home and it doesn't sell in nine months, my profit has just been eaten up by my construction loan. So every major homebuilder, after the Great Recession of 2008 and ‘09 stopped building a lot of specs and said, when I sell one, I'll start the next. And our home production went from 2 million a year to 1 million a year. That's why we are short and putting people into an apartment, and they're staying in longer now because homes are too expensive, is part of that. So while we've oversupplied the Class A in the apartment, I believe that long-term apartments gonna just do fantastically well as well as single family homes, if we can get them built at all. And so retail, apartment – fantastic. And industrial, again, same thing. The demand is not going away. We buy more stuff. We need more space to store it in. It's got to come faster, that type of thing. And of course, hotel, our most volatile of property types, bounces up and down. And right now it's booming. Although, finally, the lower budget hotel stuff the occupants reserve started to fall off because with these higher prices, a lot of the middle and lower class are traveling as much. Premier. Again, just like, just like Premier A, Premier hotels, their occupancies are really high and doing really well. They're pushing their rates up. As you know, when we go to visit New York, the price for a hotel room is just through the roof for us.
Richard Barkham
Here's the thing, Glen. As I'm sure you're aware, I think approximately 45,000,000ft² coming online this year, 15,000,000ft² next year. So the supply of that Grade A space is drying up. Granted, everything you say, and I agree with it that people want less time in the office. But, office-using job growth has been very strong. Even as the occupied space or the amount of office space occupied has gone down. Office-using employment has continued to grow, so.
Glenn Mueller
Oh, no, it has, but it went from what was in the numbers I look at from a 2% growth rate to kind of a 1% growth rate.
Richard Barkham
Sure. But there's still a lot of great potential out there for you.
Glenn Mueller
No question. No. Office is not going to go away completely. No question about that. Right. But, I think we got a number of years of the settling out. You're right. The major growth, the major supply kind of drops off this year and is much more moderate in 2025. And then pretty much goes to – let's let's face it, just about 0 in 2026.
Richard Barkham
But if we make the argument that the rental growth is going to – rents have held up in the prime space of offices, and if we say that that's a sector that's going to get the rental growth, that's like every other office cycle I've ever seen, it kicks off in the Grade A space. And then when that gets tight, it moves to B, B plus. And there may be a weaker cycle, but I just see the start of a new office cycle.
Glenn Mueller
I'm agreeing with you on all of that. The question is does the B and C come back? There are a number of markets where it's the suburban office space is doing better than the downtown too. So the market is – I’m gonna call it, it's a jump ball. You literally have to dive deep into every single market to figure it out. We can't make a generalization across the country anymore. It's so unique. And, I heard an interesting group, the – I think it's called Gensler, one of the big national architectural firms. Like every week they were getting questions, can we convert this building, this office building into apartments? And so they finally sat down and built a model where they can plug in the location, the footprint, which is hugely important, where the elevator core is and stuff like that, and go, that'll take us a week to figure that out. So now they plug it in their model and in three hours they go, this building can be that building. And they said they've done a couple of markets and said it's about, depending upon the market, 20% to 35% of buildings are economically feasible to turn into apartment buildings.
Spencer Levy
And I've heard that same stat from, from Gensler. And that must have gone up, because the first time I heard it, it was 10%. And I wonder what changed to get to that 20% to 35%.
Richard Barkham
Values fell a bit further. And if they, if they fall even further, in some cases may become negative, then that gives you more incentive. There may also be some government incentives come in to make that whole thing a bit more profitable.
Glenn Mueller
Right. I just saw that a New York office building just traded for 40 times less than it was purchased for 15 years ago. So that kind of thing is happening. The other thing is, you never know, real estate people are so creative. Article I just read yesterday – the new idea is taking schools. You know, a lot of our school infrastructure are really old buildings from back when we were kids – 40, 50 years ago. And they need to be redone and going to a vertical school, taking an office building to make it into a school. And they've done that with universities. DePaul University in Chicago is a good example. They're in a they're in an eight story office building. That schools may be another way to take up some of the off supply. This is not unlike what has happened in retail. If you look back a decade when the internet sales started to take off and the Amazon effect came along, and we have converted so many retail spaces out of retail into office or warehouse space or something else or apartments or whatever. Right. So I think we're maybe going through that kind of, secular shift of what were office buildings. I had a student in my development class who literally – and they ended up doing the deal. They took an office building in Denver right near downtown and converted into self-storage.
Spencer Levy
Well, look, I'm not a market person. I'm a very, very submarket person. And there are submarkets within all these places that are really tough. And they typically are the older financial districts with the towers. And these smaller areas, like the seaport in Boston, is doing great, but the financial district is not doing as well. So, Glen, when you do your cycle monitor, how do you go from market to submarket?
Glenn Mueller
Right. Well, obviously my cycle reports are just macro metro level areas. And you are absolutely correct about that. And as a matter of fact, in Denver itself, when you have Brookstone giving back two of the iconic towers in downtown Denver, Cherry Creek is like 99% occupied in office. Cherry Creek is number one market, number one office submarket, they say, in Denver in the entire country. And the Cherry Creek Mall is the highest grossing mall in the country outside of the forum shops in Las Vegas. And the number of people just waiting in line for – trying to find space there is incredible. So that's super high end submarket is just fantastic. So, Spencer, you are absolutely correct. It is a submarket. It's even more of a submarket play than it used to be.
Spencer Levy
I agree completely with what Glenn said. I always looked at the market level stuff too, but I've never believed more in submarkets than I do today. I think there's been a change in what neighborhoods constitute institutional grade, as there used to be the office district, the retail district, the multifamily district, and now many of them are converging. What's your point of view, Richard?
Richard Barkham
So CBRE has just released a Future of Cities project, where we look at the evolution of American cities. And I think because of all of the big macro factors going on, and the technology shifts, I think this focus on submarkets is really relevant. There are superstar submarkets out there that are focused on live-work-play dynamics. And I think the thesis that we have in the Future of Cities report is that cities in order to reinvent themselves, need to either engineer or have engineered more of these live-work-play superstar submarkets. But focusing in from a policy perspective on creating live-work-play submarkets as part of a brick-by-brick strategy to regenerate American cities, I think is what we're seeing – what we think will happen.
Spencer Levy
Let's now turn to the mid-year outlook and I'm gonna turn to you first, Richard. We are mid-cycle, may have a soft landing, but be a little bit more specific. Where are we going to be over the next 12 to 24 months – macro from the economy? And then what does it mean for real estate?
Richard Barkham
Yeah. So soft landing, probably two, three, four quarters now of softer growth than we've seen. Consumer is generally in good shape. Not too much stress there. But there is some evidence that consumer spending is slowing down. Slower economy, but I think as interest rates come down as we get on top of inflation, I think most of us see inflation trending down to 2% by the end of 2025. That will allow some cuts in interest rates. Obviously, not going back to 1% interest rates, but enough to unlock some further economic activity and propel this cycle. So that means – I think for real estate – that we will see continued absorption in – I mean, we're just bouncing back into positive absorption in office. And we will begin to see vacancy coming down there, particularly as we get to middle of next year, where people realize there isn't any Grade A space anymore and they have to scramble if they want to get the best quality space, they have to really start to move. We've got another, I think 12 months, four quarters of elevated supply in multifamily and industrial. So that means kind of weak rents and moderate levels of absorption there, but basically good fundamentals. And then probably continued outstanding fundamentals in the retail sector, notwithstanding some slowdown in consumer spending. I do think we're at the start of the new capital markets cycle. It's a long, slow beginning. Then it's a jump of acceleration to peak, and then it's a big drop off. And I think that can last two or three years.
Spencer Levy
Glen, what's your outlook?
Glenn Mueller
To me, real estate is really a delayed mirror of the economy. When the economy improves, real estate typically picks up six months to a year afterwards. And when the economy slows down, real estate takes a little while longer before it slows. That's been kind of what's been happening. We've been in moderate demand growth for a long time except in office and that's good news. And assuming that the Fed does start to drop interest rates, the capital cycle will start to pick up again. And, obviously, once that happens, once prices start to move back up, that will cost justify building more buildings. Because right now we’re – we’ve slowed down every – all new supply and all the property types, which is good news. That helps keep the markets in better balance. So I agree with Richard, that I think we're in for a long, long, slow recovery. And at least two years out. And, of course, any economist doesn't want a forecast out too far. Right. But I think we're this is hands down we aren't going to see prices much lower than this, except maybe office. And, demand is there and that's going to drive everything. It drives occupancies up, it drives rents up and then that drives prices up. I think we're coming into the next up cycle for real estate in general.
Spencer Levy
We're coming into a presidential election. There's all kinds of geopolitical issues going on. They always have, but they seem to be at a very high level right now. How should people look at geopolitics as it impacts their economic and real estate outlook?
Glenn Mueller
Well, I'll throw in my real quick point here, which is if you don't know which party's going to be running the next time, you're going to pause and wait, because of the uncertainty, once you've got your business plan to work forward with, that kind of takes a lot. I work with and see a lot of smaller companies that are going, okay, we need to wait and see what happens here with what our tax is going to look like. What are all these things? What are the different government programs going to look like, etcetera. We, we can't do anything till we know who becomes president and who's running Congress and that kind of stuff.
Richard Barkham
We've gone over the evidence backwards, forwards and sideways. And can we see any impact of presidential elections on investment activity, or real estate activity more generally or economic activity for that much? There is very, very little statistical evidence of that. Intuitively, I agree with Glen, that we might see a pause, but, how can you disentangle that pause with the pause between where we are now with the fed funds rate and the first cut in rates – very difficult to identify, very specific presidential impacts. Although, as you imply with your question, some of the geopolitical, and political policies that are being touted could be quite material for the economic environment.
Spencer Levy
So on behalf of The Weekly Take, I want to thank two friends of mine, Glenn Mueller and Richard Barkham, for joining The Weekly Take on the MidYear Outlook. Glenn Mueller, Professor at University of Denver. Glen, thanks for joining the show.
Glenn Mueller
Thank you.
Spencer Levy
And Richard Barkham, my friend, Global Chief Economist, CBRE. Thank you for coming back to the show.
Richard Barkham
Thank you for having me, Spence.
Spencer Levy
For more economic insights and analysis, look for related content on our homepage, CBRE.com/The Weekly Take, and make sure to subscribe and follow the show wherever you get your podcasts – and leave a review or send us your feedback as well. And for an even deeper dive into our MidYear Outlook, visit CBRE.com/GlobalOutlook for what to expect in the second half of 2024. Also, if you're interested in Glenn Mueller's Cycle Monitor reports, look for them on the website of the University of Denver's Daniels College of Business. That's Daniels.DU.edu. We'll be back with more next week with new podcasts exploring markets, sectors, and asset types around the world. Thanks for joining us. I'm Spencer Levy. Be smart. Be safe. Be well.
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