We Built This City: The Construction Outlook Amid COVID

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Spencer Levy
I'm Spencer Levy and this is The Weekly Take. On this episode, I'm joined by a crew of CBRE experts to drill down on the very foundation of the real estate business. We're talking development and construction.

Ann Sperling
It's bricks and mortar, which by nature are inflexible, but tenant demands and needs are all about flexibility. So it really requires you to try and have vision about what's going to be important.

Spencer Levy
That's Ann Sperling, a senior director at Trammell Crow Company based in Denver. Trammell Crow is an independently operated subsidiary of CBRE and the largest commercial real estate developer in the United States.

Jim Dobleske
We're seeing a lot of pent up demand for project work, either projects that were put on hold or projects that they were planning, and we're seeing some different solutions or outcomes based on what COVID is bringing.

Spencer Levy
And that's Jim Dobleske in Charlotte, North Carolina. As the global president of CBRE’s Project Management Group, Jim oversees a team of more than eight thousand two hundred professionals serving clients around the world. And to help us put it all together, James Millon joins us from New York, a vice chairman in debt and structured finance at CBRE. James has originated more than thirty six billion dollars in commercial real estate loans across property types throughout the United States.

James Million
I think we're still in the first few innings. Right. Which means we're still searching for the availability of capital. And the second derivative of that is what is the cost of that capital?

Spencer Levy
We'll look at the landscape of the sector as it's evolved and adapted throughout the pandemic. We'll explore the availability of capital as well as the state and future of project development around the world. We'll discuss productivity in the workplace, infrastructure operations and ESG and the climate for risk taking across commercial real estate. It's a ground up look at the nuts and bolts of development and construction. That's right now on The Weekly Take.

Welcome to The Weekly Take. Well, folks, we're here to talk about development and construction in connection with a terrific report that CBRE is publishing this week on development and construction and opportunities across the country. So let me start with you, Ann. Where are we today with construction? Are we full steam ahead at the moment? Are we still seeing slowdowns and other challenges due to the pandemic? 

Ann Sperling
Well, you know, Spencer, it's sort of interesting because it really varied market by market and almost city by city in some parts of the country like Seattle and Portland was really shut down, which had a huge impact on loans, performers, tenant deliveries, et cetera. But actually in places like Colorado where I live, it was an essential service and continued on. What actually has happened is that the supply chain was disrupted. We saw materials delayed or unavailable. We saw labor who weren't available because of either being sick or being exposed or taking care of people. And so we saw time delays, but we also saw things like protocols and cost increases and reporting requirements that were instituted. I think that most of that has become stabilized and sort of incorporated into the construction process. And so I think we're now back to a new normal where people know how to function in this environment. 

Spencer Levy
Well, Jim, do you agree with Ann's answer that we're largely back to normal?

Jim Dobleske
Yeah. So, Spencer, project management is big business here at CBRE. And I tend to agree with Ann in the sense that everyone's still trying to figure out what that new normal really is. We've seen projects that were paused early on, placed on hold, and a number of them have come back online. We're starting to see firms really start new projects, projects that are fitting out full floors now. So some of the bigger projects, but they're in full alignment with the overall strategy of that firm, regardless of the COVID impact. I think the big difference that we're seeing right now is the volume of projects depending upon the industry sector, as Ann alluded to. So, for example, we've seen delay in most of the office projects yet some of the industrial work has actually grown based on the impact of COVID and the bigger impact that has had on the retail distribution network. 

Spencer Levy
Well, let's dig in a little bit deeper to that, because I think that's the number one question we're all asking today, which is the state of the office market. When does it come back? How does it come back? Are you still building out office space? For some of our clients?

Jim Dobleske
A lot of it has stalled. I'll be honest with you, the volumes that we've seen in past years just aren't quite there. However, they are starting to come back again where clients know that those fit outs fit in with their overall business strategy. We've been able to continue that work where the impact COVID has had on their overall strategy of the business. Those are the projects that have been delayed. And we've been working very closely with our clients on their capital planning capabilities and prioritization of those projects. And it's going to be very important for the occupiers to make sure that they have a very clean and clear capital plan in place so that when money does start coming back and the floodgates open a little bit, the project management team is there with a clean capital plan fully aligned with the strategy of that firm so that we can be first in line, make sure that we can secure that money and therefore start to bring projects back online. I think, Spencer, what we're going to see is we're going to have some projects that are going to need to take place one way or the other, depending on the impact COVID had on that firm and their overall strategy, meaning it may be as simple as some HVAC retrofits, where we're pulling in more outside air to full floor renovations, where we're adjusting how that space is currently utilized to fit more of the new normal based on post COVID.

Spencer Levy
Well, James, let me ask you a question. The cost and availability of capital. Things got pretty squirrely back in March when there was no cost or availability of capital. Can you just give us a quick snapshot of what the cost of capital looks like today versus pre COVID?

James Million
Sure. And Spencer, I think we're still in the first few innings. Right. Which means we're still searching for the availability of capital. And the second derivative of that is what is the cost of that capital? So today there's been many lenders that have frankly stepped away from construction projects and that's created a supply demand imbalance and liquidity deficiency. And so we have to search far and wide to find capital that's financing these types of projects. And because of that, it's more expensive capital. We're having to dip into buckets of lenders and capital that we haven't had in the past. And so the long and the short of it is we're still in the first few innings in terms of availability of capital. Yes, it's available. It's getting better by the day, literally, but it's still very expensive, far more expensive than it was pre COVID. And to put numbers around it, you're probably looking at cost of financing. That's roughly double what it was.

Spencer Levy
Jim, when we come back to you for a minute, going back to the COVID question about changes, have you seen any mid construction changes that our occupier clients are doing to adapt to the COVID or the post COVID world?

Jim Dobleske
Yeah, Spencer, as a part of that, the work that we've been doing and supporting in capital planning, we're seeing a lot of pent up demand for project work, either projects that were put on hold or projects that they were planning. And we're seeing some different solutions or outcomes based on what COVID is bringing. And some of that is just the de-densification of space overall. And so our project work has shifted from trying to pack as many people into a certain floor as possible to now spreading them out a little bit more. We're creating more conferencing areas than we had in the past, that our larger conference rooms, not just small, four person rooms so that we can meet the COVID requirements. Firms believe that those requirements are going to stay beyond the vaccines coming out. And so they're building out space a little bit differently. They're retrofitting that space differently than they have in the past. Those are some of the bigger changes that we've seen. And we think those changes are probably here to stick around even beyond the post COVID era.

Spencer Levy
How do you approach that question, Ann?

Ann Sperling
You know, it's really difficult because when you think about development, it's bricks and mortar, which by nature are inflexible, but tenant demands and needs are all about flexibility. So it really requires you to try and have vision about what's going to be important. Well, not having clairvoyance, really, of what's going to be important when you deliver three years later. The kinds of things that are important today actually started being important four or five years ago is just that COVID has accelerated them, in my opinion. So things like health and safety and wellness, those are not new ideas. Indoor air quality has always been important. It's just now more important. Things like safety in terms of touchless entry, that's really accelerated. It was something that was not a high priority. It's now a high priority. And I think that Jim's comment about densification is really interesting because in commercial real estate, there's a pendulum. And, you know, if you think about 20 years ago, private offices and separation were really important for productivity, then densification was really important for efficiency. Now, we're seeing the pendulum swinging back where space and time to health and wellness is tied to both efficiency and productivity. Really, for developers like us, it's trying to prognosticate what is it going to look like in three to five years when we deliver projects that we're thinking about today and building in enough flexibility into the physical plant of bricks and mortar to be able to respond to and anticipate what tenants need and respect their need for flexibility. That's the challenge. That's the magic actually in development. It's trying to read the future.

Spencer Levy
First of all, you know that productivity is my favorite word and I use it in all these podcasts. I think it's the single most underrated and the single most important word in commercial real estate. A lot of people focus on efficiency more than productivity. But nevertheless, I want to read to you now, James, because when I think of productivity, I think of Manhattan, I think of San Francisco. I think of Los Angeles. How are the big lenders looking at the major markets today, James?

James Million
Productivity is a word that I think everybody focuses on. Balance is another word that I think I've heard, probably more so than I have in a very long time, because I think we all, or at least many people in my space came from a school of thought that there was not balance, right. In fact, imbalance was balance for many of us. And what you did was you got up early, you went to the office, you worked late, you worked weekends. And that's just kind of what you did. So from a lender perspective, how are they thinking about. I think there's again, there's real concern over just long term viability of CBD office and are people going to need the same amount of space that they once did, or are they going to be setting up regional offices and decreasing their footprint in some of these major cities and working from home maybe a couple of days a week? And I think it's going to be very interesting, you know, over the next year or so when we actually have the ability to go back and measure, you know, what productivity truly meant over the course of COVID, because I think that's the bottom line for a lot of a lot of companies. It's really productivity.

Spencer Levy
Not to be boastful because I think this is actually a negative comment. I just did my Year-End memo and I counted up the number of speeches I gave last year. In 2019, I gave one 165. In 2020, I gave 291. And while I did more, I don't know that I did them better. In fact, since March, I've had a grand total of two business lunches. And last time I checked, you can't fax a pastrami sandwich and it makes for a better meeting as far as I'm concerned. But it's that type of human interaction that's been lost. Even if we have produced more, we're being more efficient, not necessarily more productive. So, Jim, let me turn to you. Has there been a shift of the money that our occupier, our clients are putting out from the big market to some smaller, less well-known markets? 

Jim Dobleske
We really haven't seen that shift yet. Spencer, you have to remember, a lot of these big occupiers have major campuses that they've already invested in. And so they haven't made the call as to whether or not to go out and spend that money in other locations right now to create more of that flexibility that Ann was talking about. I do think people are waiting. I think right now the bigger occupiers are looking to say, how do we continue to utilize our space in the most efficient and effective manner, the space that we have today and then in areas where we can make it more efficient what are those games that we can make and how do we make those investments? There's still a little bit of wait and see, and we just haven't seen the big occupier's pull the trigger that fast on the really building up those remote and regional offices.

Spencer Levy
Well Ann, let's talk about those smaller markets like Denver, like Salt Lake City. Let's talk about because you've built all over the country. But why do you find those types of markets attractive today and for the future?

Ann Sperling
Well, I'm not a believer that the big cities are dead or that office is dead. But, you know, we've seen a trend that didn't just start during COVID of people migrating to cities like Denver, Austin, Charlotte, Nashville, Phoenix, and why: it's a combination of the cost of doing business, the quality of doing business lifestyle and what happened with COVID is that because there was more flexibility, I think people are looking forward and thinking what their future life is going to be, is going to allow them to work from the office part of the time, work from home part of the time, and work from somewhere else part of the time. And why not live where you want to live? And what's happening is many of those employers, those corporate users that Jim works with, are making decisions about where they want to locate their regional headquarters or their main headquarters based on where their employees want to live, because as we've talked about many times, it's all about employee attraction and retention. So used to be that people migrated to where the jobs were. Now that the companies are migrating to where the people are and these smaller cities have attracted a lot of people because of quality of life.

Jim Dobleske
Interesting point here. In the last three months, I've had two people come to our house, knock on our door here in Charlotte and offer to buy our home one from Chicago and one from New Jersey, because they're just looking for a better quality of life and they feel that Charlotte's the right area. So they're going around neighborhoods, knocking on doors to find those locations so that they can work remotely because whatever companies they worked for is now giving them that option and that flexibility that they just never had before.
 
Ann Sperling
And ditto, you know, we've had three people from San Francisco overpay for houses on my street and lots of people who are millennials who moved to San Francisco, New York, Chicago, are now moving to smaller cities where they can work, live, play, because they can and doesn't mean that those cities are dead because I think they're not they have too much going for them. But it's just diversity of options.

Spencer Levy
Well, times have changed. But nevertheless, I'm still extremely bullish on the big cities because of the quality of the employees they attract the productivity. So they're certainly not dead. But at the same time, we have a short term problem with the big cities, which I believe will pass. But nevertheless, we also have a short term problem with certain asset types, which is why the lending community is now looking at certain things like life sciences, like data centers, like other forms of what I would call operational real estate. That's actually a lot harder to run and own and manage. Tell us about the shift in lender preferences towards some of these smaller asset classes. James, what are your thoughts on that?

James Million
Yeah, so there's certainly a favorite asset class as we've hit on industrially from multifamily and I would say selectively office products. We have long duration credit tenancy in major markets. Right. Those are still assets that are very easily financeable. The other what we used to call off the run asset classes are now somewhat in favor as well. And I think life science is clearly one of them. We worked on a very large assignment in New York City at 345 Park Avenue South. That was a life science conversion of a traditional midtown south office building. The challenge there was people didn't understand, the lending community in particular did not understand life science did not understand how to underwrite life science and understand, you know, the infrastructure required to attract the lab tenants. And they didn't understand how, you know, a life science project could exist outside of Cambridge or maybe the seaport district in Boston. But we're seeing life science projects pop up in very you know what I would have considered, you know, nontraditional markets. Right. We've seen life science projects in Chicago, in Atlanta, in Dallas, working on something in Philly. The key is having access to talent. You have to have access to the scientists to the researchers, you have to be close in proximity to hospitals, oftentimes because of the need for testing. Now, it's really interesting because everybody who has got a project of some sort, whether it's, you know, an existing office building that has the, you know, the proper infrastructure to house life science or somebody who's, you know, acquired a piece of real estate but happens to be zoned, you know, something that could ultimately be life science is contemplating life sciences, the highest and best use, which is something that, you know, we had never seen before.

Spencer Levy
Interestingly, I've gotten a lot of phone calls from my clients that old movie theaters or gyms that have high ceilings who say, hey, could we get life sciences? But, Jim, let me talk to you about that adaptive reuse question, because when we do project management, we're not just building ground up. We're actually adapting these existing buildings. So tell us how big of part of the project management practice is adapting another use for our clients, whether it be retail to industrial, scraping the retail, putting up industrial or otherwise? Jim.

Jim Dobleske
Yeah, it's becoming a bigger and bigger part of our business for sure. We have seen that grow through the COVID impact. And a lot of clients are coming to us not only looking for us to do that work, but looking for us to help them think of different uses for those sites so that workplace consulting and how we occupy the space is a big part of what we're doing in project management today, going in and then actually designing that space for them. And we're seeing a lot of repurposing of space, whether that's retail, restaurant sites trying to be repurposed right now and a number of different areas. We have a mall actually about 10 miles from the house here that is being repurposed right now for more distribution space. So we're starting to see it more and more. CBRE Project Management is getting more and more involved in those types of opportunities, not all coming from the occupier side, but we're seeing it on the investor side as well.

Spencer Levy
Well, Ann let me let me talk about Trammell Crow, because I know that most of what you do is ground up. But what's your point of view on adaptive reuse? And let's go to the office sector. What if we need less multitenant office? You see that as an opportunity for conversion to multifamily or otherwise?

Ann Sperling
You know, it really is difficult. Adaptive reuse for office to multi-family or senior housing or hotel. It happens. I mean, I've seen successful adaption to boutique hotels, but truly, what you don't want is to have a building that is sort of the worst of both worlds rather than the best of both worlds. And so it's harder than people think. I mean, the HVAC systems, the parking accessibility, brand and identity, location, it isn't completely transferable. So it's much harder to do adaptive reuse for certain uses than you might think. In the other categories like retail, I think that there's more opportunity. We've looked at malls, for example, looking at densification, adding multifamily to the periphery of malls where there's excess land or excess parking capacity, where you can add senior housing or multifamily, where you end up with a mixed use project when it really just started out as a single use product. So, I mean, that's one example. The industrial or distribution conversions make sense if the locations serve sort of final mile type of needs and if the rights within the ownership group allow them to do it, which is not always the case, whether it's zoning or tenant rights, et cetera. There's quite a bit of complexity in adaptive reuse that goes beyond just the footprint of the building.

Spencer Levy
Let me go to some of the disfavored asset classes at the moment, senior housing, some degree student housing. Even though we had on this podcast leaders of senior and student housing thought they were great places to be. And let me ask you a question, James. What do you do for a client that comes to you with a senior housing deal today that needs financing?

James Million
So I think you need to assess if we're talking about short or long term risk, if we're talking about short term risk and something that we're all navigating through COVID. But people believe and investors believe and lenders believe in the long term viability of that particular asset class in that location. Then there's plenty of financing solutions. I think it's a far more difficult conversation with a client when there's an asset class that structurally something has changed out there, buyer behavior, infrastructure, government regulations, something has changed the viability of that asset in the long term. That's a much harder conversation. We've had a couple of situations recently with some senior housing. And again, it's in our mind, it's very temporary, but unfortunately when you think about what has happened with COVID and where COVID has been the deadliest, it's been in many of these, you know, senior housing facilities or acute care facilities, and it becomes somewhat reputational risk to lenders. And it's frankly just better to wait things out, let the storm blow over and start financing these asset classes again. Now, it's not the perfect answer for many people who are in the middle of a situation where they absolutely need financing. And for those, again, there's available capital. But to the point that I think we made earlier, it's certainly more expensive because alternative lenders, many of which who have equity mindsets in equity sides of the house that take equity risk more than happy to step in and provide bridge financing on a temporary basis because, again, they believe in the long term viability of a certain asset class.

Spencer Levy
Ann let me go back to something you mentioned before about wellness in construction and light and air and certainly indoor air quality. Has the case been made economically to make these wellness changes to buildings today?

Ann Sperling
Yes and no. I would say that there's two types of economic investments. One is capital and one is operating costs. Right. And so the capital costs what you're just talking about in terms of HVAC systems or structural changes to design, I think are a work in process. I think that that the case has not yet been fully made, but that architectural and engineering firms and thought leaders are working on those underwriting cases as we speak. Sadly, I would say that our industry sort of lags in terms of being sort of forward thinking in some of these sort of back into these kinds of decisions based on demand from tenants. And so the operating cost issue, I think, has already been made that of tenants are demanding safety. They are demanding a different level of cleanliness and prevention. They are demanding certain behavioral changes in terms of how buildings are operated. And so that has I think the case has been made and incorporated into the operating costs stack of buildings. But I think the capital is lagging. And part of that is that, you know, developers are aligned with their joint venture partners and they're looking at returns over a long period of time. And there hasn't been evidence that the income side the tenants will pay to generate similar returns to the returns that are needed to get these buildings built. So it's a little bit of a chicken and egg kind of situation, in my opinion. 

Spencer Levy
Let me introduce a new fact, if I can. The rise of so-called ESG capital, environmental, social governance capital.

Ann Sperling
There are capital sources that are exclusively focused on environmentally sensitive investments they define in different ways. So it's not just all one kind of criteria, but we have definitely seen sophisticated institutional capital who wants to invest, let's say, in green buildings, which is a form of, you know, the E of ESG. And I think that there will be an increased focus on that. I think the S and G will follow. And I think that that will come out of the boardrooms in the United States and globally and it'll be forced down into the market rather than bubble up from the market.

Spencer Levy
So, James and Jim, let me ask you the same question. How much are you seeing this ESG either capital or policy among your lenders or investors? So, James, are you seeing this bubbling up?

James Million
I think just coming back to the office conversation, I think, and hit the nail on the head, it's pretty simple, right? This is about tenant demand. And if tenants are going to require this. In the next two years, where you're going to have a huge imbalance of who has leverage between landlords and tenants, and it's the haves and the have nots between buildings that have these requirements and ones that don't on the environmental side, then it's necessary. That's the bottom line, right? Maybe the ROIC doesn't look great on a project by project basis, but when you're competing for tenants and it's binary and they put out RFPs and you either have it as part of your building or you don't, that's really the only thing that's going to matter. I think as it relates to, you know, in our world kind of drilling down into the micro of it. I look at a perfect example, which is, you know, a basically a government subsidized program, which is, you know, Fannie Mae and Freddie Mac and what's happening there. When you have a multifamily building that is qualified and eligible for green, well, your cost of financing is significantly cheaper than one that isn't. So there's a real economic benefit there as it relates to finance ability. And that's not even getting into various tax credit programs that are available out there and the like. So it's is incredibly important in the in the financing spectrum.

Jim Dobleske
I think we're seeing a lot more of it on the investor side. Our team has is really focused on that. We're seeing quite a bit of it on the occupier side as well. And it's been a little bit more led top down there on the occupier side, I would say, with firms making big statements as to goals and objectives that they're trying to achieve and hit from a sustainability and a wellness standpoint and then driving that through their portfolio, I think the returns have yet to be seen. Part of the challenge is that some of the occupiers believe in it, want to do it, and they're waiting for others to take a bit more of the lead and they'll follow on some of these areas. But it is a big topic. It's a topic that everyone is talking about right now.

Spencer Levy
How much will regulations drive this versus, say, tenant demand?

Jim Dobleske
Quite a bit. I think that's a simple, simple response. And we're seeing it already in Europe. Our biggest ESG team is led out of the U.K. They're really driving a lot of the best practices that we're seeing that are being adopted on a global basis. So a lot of that is going to come from more stringent regulations, depending on where you're at.

Spencer Levy
Well, now time for final thoughts. And James, I don't want to lead you with a leading question, but I'm going to leave you with a leading question. I am a big borrower that is looking to refinance my building or to build a new construction project. Do I go to you today for the money or should I wait until the pandemic is over?

James Million
It all depends on what you're building and where you're building it. I'd say that if it's an industrial complex state of the art bulk distribution and this is as strong a financing market as we've ever seen, and it doesn't matter if it's leased or it's vacant, if we're talking about, you know, a developer who's owned a piece of land in New York City or San Francisco or Boston and it's zoned for office, I frankly think that we need to let COVID work its way through the system. We need people back in the office. We need, more importantly, lenders back in the office. We're going to be financing these projects and not, you know, processing things from their basement. And I think once that happens and, you know, those deals will be back out in the market.

Spencer Levy
OK, so same question to you, Jim. What are you advising your clients? Go now or wait.

Jim Dobleske
Similar to James. The answer is: it depends. Right. Does it fall in line with the overall strategy, with the goals and objectives of that firm? And I go back to the capital planning process and making sure that we revisit and we prioritize the capital plan and the projects that are building up that capital plan to ensure that they are fully aligned. If it's in alignment, I would say let's get started. The costs have not gone up much. We don't see them changing drastically over time over the next several months. There's available talent out there from a construction standpoint that we can leverage. And I would say, you know, if it fits with the overall strategy, then we should move forward. If you're unsure of the strategy and what the future of office looks like and what the future of your portfolio is going to look like, I would recommend holding off.

Spencer Levy
Ann let me ask you the final question. There are a lot of cool jobs in our business, but some jobs are cooler than others. And I think building big, complicated projects is as cool as it gets. So there are a lot of younger listeners on this call. I speak to college students all the time. What would you advise them if they want to get into the development business?

Ann Sperling
I would say, first of all, you got to be sure that you really love it and that you're willing to have a career that has a lot of ups and downs, because by nature, real estate development is cyclical. It has long time horizons. So if you have a short attention span, it's probably not going to work for you. Ultimately, I think the people who will enjoy development the most and be successful are people who are generalists rather than specialists, people who are equally good at visioning and marketing and selling as they are at digging into details of finance and operations and execution. So really, people who are willing to roll up their sleeves and get their hands dirty and dig in, it's a long time horizon business. From the time you think of something good to the time you actually cut the ribbon, can be five years so short attention spans. It's not going to work for you.

Spencer Levy
So on behalf of The Weekly Take, I want to thank three of the really great leaders, not only of CBRE, but of the whole industry in their various areas of expertise. James Millon, vice chairman, debt and structured finance based in New York. Thank you for joining us.

James Million
Thank you, Spencer. It's great to be here.

Spencer Levy
Jim Dobleske, our global president of Project Management based in Charlotte. Jim, thank you for joining us.

Jim Dobleske
Thanks for having me, Spencer. Appreciate it.

Spencer Levy
And last but not least, Ann Sperling, a senior director of the Trammell Crow Company based in Denver. Ann, thank you so much.

Ann Sperling
It's a pleasure.

Spencer Levy
For more information on our show and to find CBRE’s new report on the construction sector, U.S. Development Opportunities Uncovering Market Strength, check out CBRE.com/TheWeeklyTake. We'd also love your feedback. So if you found us on Apple podcast, Spotify or another platform, please subscribe, rate and review us wherever you listen. Thanks for joining us. Until next time, I'm Spencer Levy. Be smart. Be safe. Be well.