In this episode we take a deep dive into the world of REITs. Nareit’s John Worth and CBRE’s Richard Barkham join host Spencer Levy to offer insights on the global economy and trends in commercial real estate investment.
A Matter of Trust(s): Real Estate Investment Trusts and the Global Economy
October 25, 2021 38 Minute Listen
A Matter of Trust(s): Real Estate Investment Trusts and the Global Economy
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Spencer Levy
I'm Spencer Levy, and this is The Weekly Take. We talk about many ways of being in the business of real estate on our show. Residential ownership, operating a warehouse, developing an office building. I'm breaking no news to you in our audience. But we're here to talk about a different kind of real estate entity altogether and the intersection between commercial real estate and the global capital markets. On this episode, we'll consider the business of REITs -- real estate investment trusts -- and the role of these publicly traded products in the economy at large.
John Worth
One of the great things about REITs, even if you're not an active investor, it's a great way to see through to what's going on in the commercial real estate market in sort of a real time manner.
Spencer Levy
That's John Worth, executive vice president of research and investor outreach for NAREIT, the leading trade association for REITs in the U.S. Based in Washington, DC, John will help us better understand the sector, along with the challenges and opportunities it presents for investors.
Richard Barkham
The recovery from COVID is a bit volatile, but it's pretty much happening now and will play out over the next six to 12 months. But underneath that, we've just had an ordinary recession.
Spencer Levy
And that's our old friend of the show, Richard Barkham, CBRE global chief economist and head of Americas Research, joining us from Massachusetts. Richard's here to offer broader economic context to our discussion, perhaps some fodder for debate. Our conversation will span the globe to cover issues that are making business headlines. We'll look at the state and future of the recession and the recovery -- and consider whether it may be something of a two stage recovery at that. And we'll get down to the nitty gritty of REITs what they are, how they are traded, why they offer a hedge and an indicator of future values, and more. Coming up the economy and everything you wanted to know about REITs but were afraid to ask. That's right now on The Weekly Take.
Spencer Levy
Welcome to The Weekly Take. And this week, we're going to talk about REITs and the economy and megatrends that will affect it all. We can tape the whole show on the economy. But this is a REIT show, so the economy will just be a piece of the action. But what I've been seeing is that notwithstanding the delta variant, we're still chugging along. Interest rates haven't spiked. Stock market’s still good. What's your point of view, Richard?
Richard Barkham
Well, I think it's exactly that, Spencer. The US economy is still moving along at a fair old clip, probably around four to five percent GDP growth in the third quarter, with the forces acting on the economy, obviously the reopening. And sectors might have taken a little bit of a hit during the delta surge, but not as much as everybody thought. We've got very supportive government policy. We've got low interest rates. We got fiscal expansion. We've got the reopening of the global economy. So I think everything is moving along quite quickly. That said, it's quite clear that we're running into some issues in the global economy -- not so much the American economy -- that will throw up some volatility. The supply side, the supply chain shortages, the difficulty in getting goods to market. The difficulty of getting people into jobs. It’s proving much bigger than we first thought. And slightly more worryingly, big picture, in the background I see a slowdown in China taking place. And I will just say as a final comment, Spence, it looks like real estate is in full recovery with the only thing remaining is just some question marks about the office sector
Spencer Levy
On the full recovery thing. Richard, you and I have debated a lot of things over the years, but one of the things that you have been very firm on is that the cycle is the most important thing. And I think it's fair to say that since real estate is in full recovery after the apocalypse that was 2020, the cycle may not have reset. What do you think?
Richard Barkham
There are two things going on, and we got to be very clear that you distinguish them. One is the recovery from COVID, which is a shock. So the recovery from COVID is a bit volatile, but it's pretty much happening now and will play out over the next six to 12 months. But underneath that we just had an ordinary recession and it's been a relatively mild recession. And you can see that in the number of workers that are not temporarily laid off statistics. So I think we did have a recession and we are at the start of a new cycle over the next seven or eight years. And that, I think, will be dominated by some new trends emerging. One of which is decarbonization. One of which is just productivity growth in the United States. And I think also we've got the shift of millennials out of cities into suburban areas, which is going to kick off a housing market, a single family home market revival, which we didn't see in the last cycle. It was completely absent in the last cycle. So I do believe that we had a mild recession and that we’re kicking off a new eight year cycle.
Spencer Levy
Well, Richard, let me just say that I hope you're right. But since you and I are both on our global economics calls every month, I do know that our forecast for three years out is for the economy to revert back to its slow growth rate, pre-COVID, around 1.8 percent. How do you reconcile those two comments that the cycle is going to go another seven, eight years, but we're going to have a big slowdown in three years?
Richard Barkham
Well, I think one of the things that people are not keeping an eye on is just over the next five years, the labor force in the United States is actually going to shrink. So that's going to constrain growth. And to unleash the power of the cycle in the United States. We need to think about how we increase the labor supply. But that is for them, not for now. I think the low growth rates that we see in three years are perfectly consistent with a new cycle. But there a new cycle constrained by labor supply.
Spencer Levy
OK, well, let's come back to the inflation question for a moment. I want to bring in our good friend John Worth. I promised him a reader episode and doggone it, we're going to have one. So, John, since you live and breathe REITs just very basically for the average listener, just as fine. What is a REIT?
John Worth
Happy to. So REITs or real estate investment trusts are operating companies that very simply put. Own and operate commercial real estate. They can also own and manage commercial real estate based assets. There's really three types of REITs you might be familiar with. Listed equity REITs. These make up the vast majority of the market capitalization. They own and operate commercial real estate structures, office buildings, apartments, data centers and so on. Mortgage REITs own and manage commercial real estate and residential real estate based assets, mostly mortgage backed securities typically backed by Fannie and Freddie. And then what we call public non-listed REITs, which are REITs that are public. They are filed with the SEC. They filed 10Ks and 10Qs, but they're not listed on a stock exchange, so they're a somewhat unique creature.
Spencer Levy
Last year, at the depths of the cycle, it was a pretty dark day in the REIT world, but it's staged quite a recovery. Tell us how things have changed in the last year.
John Worth
Yeah, I think that this is where we can have a good discussion about commercial real estate generally, because I do think one of the great things about REITs, even if you're not an active investor, it's a great way to see through to what's going on in the commercial real estate market in sort of a real time manner. And so, of course, what we saw was a real plummet in REIT share prices back in March and April of last year. And then really a two-stage recovery since then with really from April through November being a kind of a digital led recovery where we saw logistics, infrastructure, data centers, cell towers leading the share price recovery. And then starting in November of 2020. Really, almost November 8th to the day when we had some great vaccine news. We've seen this reopening play, which has played out where we've seen retail come back tremendously, hotels come back. And then on a separate track, we've seen the tremendous results in multifamily tracking sort of the growth, everything that's going on in housing markets generally. So over that time we've seen a good REIT recovery. Over the entire course of COVID, which is the way I like to look at it rather than year to date 2021, you lose a lot of the color of what happened in 2020. Over the whole course, you know, we've seen equity reads up about 12 percent over that entire period, despite being up 27 percent this year.
Spencer Levy
Let me pause there. I wanted to clarify what that twelve and twenty seven is. That's 12 percent above where they were pre-COVID?
John Worth
Twelve percent above where they were at the pre-COVID peak. Yeah, actually, I'm actually looking at that as of like February 21, 2020, which was that pre-COVID peak. They've seen a full recovery, plus 12 percent, and we're going to get into sectors -- because I think right now you really can't talk about commercial real estate as a whole, you have to go down into the sectors -- because each sector is telling us a different story and are experiencing very different trends. On Richard's point about or this debate about, are we in a new cycle or is this a continuation of a cycle after a shock? The economy was not overheating by any stretch of the imagination coming into COVID. And in most sectors, we weren't seeing commercial real estate supply at particularly high levels. I view what we've gone through as much more of a shock than necessarily a resetting. But we were going through a period where we were seeing very modest increases in supply and I think very restrained supply, and I don't really see anything changing that going forward. I think we're going to continue to see, in some ways, sort of a new paradigm around supply, of more controlled supply coming into the market.
Richard Barkham
Yeah, if I may, if I may just jump in Spencer. And one of the reasons I was reasonably optimistic that once policy kicked in and once we got on top of the virus, which I thought we would, we'd come out of this COVID shock with a bang was that level of corporate balance sheet strength was true across the whole of American industry, corporates in general. We were very well prepared with ample liquidity as we went into the COVID crisis. With one exception, of course, which was the retail sector where you had relatively high levels of leverage. And we saw quite a lot of retail restructuring over the course of the crisis.
Spencer Levy
So John, let's turn back to REITs. Let me ask you two basic questions. First of all, so notwithstanding the fact that the industry has blossomed over the last 25 years, 25 years are still pretty small number two. What do you say to people who aren't dedicated? REIT investors. Why should they buy REITs?
John Worth
To answer the question, I'm going to go backwards. So the why REITs, I think it’s quite simple, because it's the same answer as why have real estate in a portfolio. Real estate is a tremendous, diversifier in a portfolio. It provides generally pretty stable, stable income returns, opportunities for capital appreciation. Very inexpensive inflation protection -- that is, get inflation protection typically, but you also do well in non-inflationary periods. So the why REITs is the same as the why real estate generally. And, yeah, the size of the market, you know, REITs own today somewhere between 10 and 20 percent of commercial real estate in the United States, depending on how you measure it. And that really goes back to the structure of real estate. Real estate has historically had a lot of private ownership. It does make real estate very unique among stock market sectors in the sense that REITs would make up about three percent of the S&P 500. There are 11 GICS sectors. Real estate is the 11th, recently added. When you look across the other 10 sectors, you really don't see this situation where the vast bulk of the economic activity in that sector is taking place outside of the listed stock exchange traded space. I actually view that as a huge opportunity for investors, right? Because we've seen in property sector after property sector where REITs are able to go to the private market, bring properties in and in some cases professionalize their operations and thinking. In particular, self-storage has been a great example of a place where a mom and pop business has been institutionalized over time, in large part by rights, and their investors have enjoyed the benefits of that. It's a unique space because we have so much private ownership and that in some ways depresses the stock market share of it. And that's why when we talk to individual investors, target date funds, DC plans, one of the things that's very important is that for you to get a meaningful exposure to commercial real estate that matches with its share of the investable universe generally, you have to own REITs above their market cap share.
Spencer Levy
John, I think, opened the door to the issue I skipped earlier, which is inflation, about real estate being a good inflationary hedge, which is its historic reputation. Which brings up where is inflation going, Richard? And you know, there's two schools of thought of this. There is our school, which is not going too bad. It's just a short term thing. And then there's a school that we're about to be in for a period of three to five years of, well, inflation. Well, Richard, where are you?
Richard Barkham
Well, I'll probably be somewhere in the middle. Definitely see high levels of inflation, largely related, I have to say, to reopening the economy and labor shortages and goods shortages. They're all disruption related issues. And there is a little bit of a concern now that the price rises are sort of broadening that they're not just focused in transport or in a few kind of sectors that they were in the early phase of the reopening. Transitory is a marvelously ill-defined word. It could be six months or it could be two years. I definitely think that we're in for more inflation than we expected over the next 12 months or so. But I don't see it turning into a three to five year inflation cycle. And there are many reasons for that. One is that the impact of people staying at home and not coming back into the labor force. That will ease. That will go away. The Asian economies will open up more. Chips will arrive. It'll all take place next year. So a lot of those disruptions that we saw over this year, they will ease. But the thing that worries me about the global economy is just the slowdown in China. The Chinese have put the brakes on their economy, and I think that's going to take some of the wind out of the sails of the global economy in 2022, which will help for controlling inflation. And of course, China is one of the big consumers of raw materials and commodities. So most of the time you worry about a China slowdown and the impact on the world economy. I'm thinking that it might actually be helpful in the current situation to take some of the inflation out of the system. Not that I thought that it was going to turn into a wage-price spiral. You know, we just don't have the same conditions with union power and lack of globalization that we had in the 1970s. But I think the slowdown in China will be one of the reasons why inflation won't be as high as people expect next year.
Spencer Levy
I was reading in a paper today, the stagflation risk of the 70s unlikely and also can just put a few numbers on where you think the 10-year Treasury is going to be at the end of this year and the end of next.
Richard Barkham
I think the 10-year Treasury likely to be around where it is now at the end of this year -- 1.7, 1.8. As underlying growth picks up, the level of unemployment in the US economy continues to fall. So I've talked about volatility in the global economy. I've talked about hitches and bumps along the way. But we're basically optimistic on economic growth in 2022. As a level of real unemployment comes down, then I think that's going to push the 10 year Treasury up, maybe to 2.4 or 2.5 percent at the back end of next year. And I do think that -- and it's a fine judgment -- that the Fed is going to probably move on short-term interest rates more quickly than people expect. But that's a sign of success and recovery in the US economy.
Spencer Levy
John, let's turn to the global thing that Richard brought up about how the impact of China, what that's having on our economy. But there also will REITs all over the world or reach in Mexico. There's REITs in Canada, there's REITs in lots of other countries. If I'm an American investor and I want to buy some of that, what do you say to them?
John Worth
There's a REIT regime in about 40 countries around the world. From the humble beginnings of the system in 1960, it's grown obviously not just in the U.S., but lots of other countries have adopted the approach. And there's also even countries that don't have a REIT regime. We have, you know, listed real estate companies around the world, and I do think the U.S. has really been the place to be a REIT investor over the last several years. Just in part because the U.S. has been faster in terms of embracing some of the newer property sectors. But I think the global investment horizon, when you look out over a meaningful time period, we're going to see obviously more growth in Asia and faster growth in Asia. That is something that a lot of investors are interested in. And there's ample exposure through REITs and the red regimes around the world. They vary, I would say, mostly in the details. What they have in common is typically you're getting one level of taxation at the shareholder level. So it sort of mirrors private ownership of real estate in those countries. So the global outlook, I think, is reasonably strong, particularly in Asia. Europe has been a slower growing area in terms of both the growth of listed real estate generally as well as the REIT performance. But as I said, we see a lot of investors very interested in using REITs to fill out the global portion of their real estate exposure. If perhaps they have U.S. strategy that they do through direct real estate, they used REITs to be that completion portfolio globally. Now we're seeing investors really doing the same strategy, but by sector as well, using REITs to complement where their private exposure isn't getting the access that they need.
Spencer Levy
Two more technical questions, and then we'll get into the sectors. The technical question number one is: why don't you tell our listeners a little bit about the dividend policy -- or the dividend law, better stated -- of how much dividends REITs are required to pay? And then the second question, I think is really interesting, which is what qualifies as a REIT. I remember -- I don't want to date myself -- but I was around when we were forming the first cell tower REITs. And is that really real estate and somebody said, Yeah, well, I guess it is really real estate. So number one, the dividend policy number two, what qualifies as a REIT or what can qualify as a REIT?
John Worth
Right. So, yeah, the dividend policy, which really does go sort of to the core of what it means to be a REIT is that in the U.S. and other countries, countries are very similar. REITs are required to pay out at least 90 percent of their taxable income. Most REITs pay out 100 percent of their taxable income and often more because there's obviously a spread between their gap income and their taxable income because they have different different rules of depreciation and what counts for each definition of income. But that provides, as you know, what most people know about reads is that they pay strong dividends. So over the last couple of years, REITs have paid a dividend that's more than twice the average of, say, the S&P 500. And today the yields are around 2.85 percent. So they've been known as income producers because of this dividend policy. What that dividend policy really provides from a public policy perspective, that really allows the taxation of a dollar of income that flows through a REIT and a dollar of income that flows through a partnership -- so really the two dominant ways of owning real estate -- to be aligned. And that was the original purpose of REITs, was to create a structure where a broad base of households could gain exposure to commercial real estate in a way that they probably couldn't through being a limited partner in a partnership owned piece of real estate or directly owning the real estate themselves. And so that dividend policy allows for that alignment of tax treatment. In terms of what qualifies as a REIT, really it comes down to: Is the income derived from a real estate activity. So you use the example of cell phone towers. You know, I think it's a great example because some people look at a cell phone tower and they go, how could that be real estate? But if you really break it down, it's a structure on land and the income is derived from rent. It's actually quite straightforward. You look at data centers, it’s a structure on land and that you're renting out space in it. In this case, you're not renting out an apartment or an office space. You're renting space for a server. But it is nevertheless very clearly real estate. And so we've seen over time. I wouldn't say that the definition of real estate has expanded. I think what has happened is that people have been using all sorts of structures on land for centuries and centuries. But what we've seen is that more and more of those different types of structures have become institutionalized as property sectors and really in a way, professionalized. And REITs, I think to their benefit, have really been on the forefront of that.
Spencer Levy
Well, let's now turn to sectors. Richard, let's go to what John just said about the institutionalization of some of these Op-Re -- or operational real estate -- asset classes: datacenters, life sciences. They may be the hottest sectors in real estate today. Why, Richard?
Richard Barkham
The amount of capital that wants to deploy in real estate is huge and growing. All of the other sectors are priced to perfection. So I think capital is always looking for new opportunities within real estate. And of course, the digital economy is expanding and it's creating changes in usage patterns. And real estate investors are really trying to leverage that by looking into these new avenues. Now that they’re still relatively small. Let's remember that it's still a relatively small part of the real estate investment landscape. But I have to say we're slightly running to keep up with all of the new sectors that are opening up in real estate. We need to research them. We need to find details and data on them. And this is the way the new cycle is going to go, with more new sectors created by the growth of the digital economy.
Spencer Levy
I agree with you, Richard. The two scarcest things in the world, I often say, are large pockets of talent and large pockets of high-0yielding investments. And REITs and real estate really do provide opportunities for both because they both go hand in hand. John, let's turn back to you now because there's a terrific paper that came out recently, published in the Journal of Portfolio Management. And if you guys could see my screen, I have a copy of it sitting right next to me here. But what the paper really tried to show was the difference in the return profile of REITs versus other ownership structures, whether it be private equity or otherwise. Tell us a little bit about the paper and what it concluded regarding the REIT structure versus others.
John Worth
Yeah, the paper was authored by three great academics, one of whom happens to have had a long career as a practitioner, Tom Arnold, who until about a year ago was the global head of real estate for Adia. So one of the one of the world's largest real estate investors, along with David Ling and Andy Naranjo, who are well-known, well-respected real estate academics and have done a lot of research in REITs and other areas of commercial real estate. And what they really set out to do in this paper was to do head-to-head examinations, what they call horse races between closed-end private equity real estate funds and REITs. So really asking the question: On the day you agreed to invest in a private equity real estate fund or really when the capital call occurred, what if instead you had invested in a diversified portfolio of REITs? How would your performance have matched up? And they're able to do this with the data set from Cambridge Associates and look at over three hundred seventy five U.S. funds over a 14 year period, basically. And what they find is with no adjustments, you would have won using REITs in 53 percent of the trials and. Overall, you would have outperformed by about 165 basis points per year by going with the REIT strategy. They then make actually some adjustments for the cost of waiting for your capital, to be called, illiquidity and leverage differences. And after they make those adjustments and the paper is very transparent about what they are, and readers can kind of choose their own adventure in terms of how much they want to make an adjustment for those. They find that REITs actually win 68 percent of the trials and outperform by almost six percentage points per year. It's really pretty dramatic outperformance. We think it's an important piece of research, especially for institutional investors to understand that there have historically been returned differences and that they need to take those into account as they build their portfolio. Just to be totally clear, NAREIT’s not saying that REITs are the only way to hold commercial real estate. Really, what we view is that public and private real estate can be complementary in a portfolio, and they both need to be in a portfolio for different uses.
Spencer Levy
I'm going to ask a broader question if I can. You hear some of the criticisms of the structure and the criticisms of the structure include things like number one, very hard to develop new product under a REIT umbrella. That's a criticism. No one criticism. Number two you hear is that because these REITs are fully integrated, meaning they do everything from ownership to leasing to management to property management. Is that really the most efficient use of their time and money to do all of these functions rather than outsourcing? So how do you respond to critics and say, you know what, it's great to have publicly traded real estate, but maybe REITs aren't the optimal publicly traded structure. Response?
John Worth
Well, REITs actually have limits on their ability to be developers. It's very difficult for them to develop to sell. But we do see a meaningful amount of development for their own portfolio and REITs are really a material purchaser of newly developed properties. So they're not the optimal vehicle to be a developer. In fact, that's sort of by design. In terms of REITs’ internal versus external management. This is a debate that sort of comes and goes over time, and the US is fairly unique, you know, the U.S. and Europe. In the US today, about 97 percent of the market cap of equity REITs is internally managed. But if you go to Asia, virtually all the REITs are externally managed. That top level decision of whether you're going to have any internal or external management, to me, that is something that is really driven by investor preferences. And in the U.S., there's a very strong investor preference for that internal management. But, of course, as you make the point, that doesn't mean that the REIT has to internalize every function. Ultimately, what you need to see is what is the individual REIT’s operational performance? Where can they have world class operations? Where can where can they outsource to get world class operations? And for the investor, it's ultimately what is my long term return net of the G and A, and then the fees I need to hold the real estate in this particular form. That's ultimately the determination of what the best model is, as far as I'm concerned. But yeah, but I do take your point. Not everybody has to do everything.
Richard Barkham
And Spence, if I could weigh in on this. And John would probably agree. I started watching REITs as an adjunct to those kind of fundamental real estate research that I would do back in the 1980s. And back in the 1980s REITs, they were pretty freebooting. They were merchant developers. They would buy anything. They were these kind of very eclectic mixture of assets. But really coming out of the 1990s recession and over the last 20 or 30 years, you've seen a degree of specialization in REITs and professionalization of management coming out of that specialization. So I think many of the innovations that we've seen in real estate -- particularly in the shopping center industry, but not limited to that -- have actually come out of the specialization and professionalization that's taken place in the REIT sector. So I think some of those criticisms of the sector are kind of misplaced.
John Worth
Yeah, Richard, I think that's exactly right. You know, when you look at this role of specialization, it's really quite incredible. Today, only three percent of the REIT market cap is in diversified REITs. The rest of it are in pure play of one variety or another REITs. And that's really been driven by investor demand. The REIT specialist investors who serve a lot of institutional investors have basically said, we want you to be pure play, so you become best in class and we understand exactly what it is you're investing in and doing. That's helped, I think, grow efficiencies. And then I think particularly in the the digital real estate sectors -- in that I'm including logistics data centers, cell towers -- that operating platform, that idea of having a permanent operating platform, I think becomes very, very important because there you really scale really starts to matter as well as having some network effects come into play.
Richard Barkham
One of the downsides of REITs, I think, is just how much they depend on the corporate bond market, the fixed interest market, bond rates. So they're very, very sensitive to interest rates, not just the Treasury market, but also in the corporate bond market. So if you see corporate bond yields going up on fears of inflation, some of that noise can spill over into the REIT market. It's short term, but it's sometimes amplified that REITs are a little bit subject to bond market events, which are unrelated to real estate. That's just something you've got to watch out for if you're a REIT investor.
John Worth
I think that's right, and this is something we look at a lot. And what we've actually seen is that short term correlation with, say, the 10-year Treasury. It actually flips back and forth from being positive to negative, and it appears as though it really depends on what kind of monetary policy environment we're in. And this goes back to something you said earlier, Richard. When you look out over a year, a rising 10-year Treasury is highly correlated with both positive REIT returns and REITs beat the S&P five hundred about 50 percent of the time. It's about a coin flip with the broader stock market over a year when you have rising treasuries. Because over that period when Treasuries rising is telling you is that we've got a strengthening economy. And that's just good for fundamentals.
Spencer Levy
I'm now going to ask a wrap up question to each of you. And John, let's start with you. So REITs just went through this tremendous shock, but a tremendous comeback five years from now, looking back, what are the big changes positive or negative in the industry?
John Worth
Well, I think they're going to mirror the changes in the broader commercial real estate space. I think the two big dynamics that are just impossible to overlook are one just the increased digitization of the economy. Our economy is getting increasingly virtual, increasingly digitized and real estate is built to house that economy in one form or another. And we have to assume that real estate is going to continue to evolve to meet the needs of this more digital, in the U.S., I think more increasingly intellectual work, creative work-driven economy. The other point and is the need to come to terms with the impact of all human behavior, but in our space, this is structures on climate and the role of climate, both in driving risks in the near-term, in the long term and the role of changing policy and how owners of real estate structures are going to have to react to the change policy. And I think it's just something that has become more important over the last five years and moving from a nice-to-have to a need-to-have it over the next five years is going to move from need-to-have absolutely critical-to-have a handle around how the climate impacts your properties and how your properties impact our carbon footprint.
Spencer Levy
Well, I agree with you on that one, 120 percent, because every dinner I have with large investors -- and I have a lot of those dinners -- they say they want to tackle the environmental issue. So, Richard, same question to you. Five years from now, looking back, what do we see big picture from an economic perspective -- not just for the economy, but how it impacts real estate?
Richard Barkham
Five years ahead, I think first thing we'll notice in that first period of the five years is just probably continued recovery in the office sector in a way that people are still not quite comfortable with or anticipating now. I think we might also see some outperformance of physical retail. One of the things I think the COVID crisis has done is just prompted, as I said earlier, the kind of millennial cohort to start to move to the suburbs and own property there. And I think all of those retail assets that exist in the suburbs are going to benefit from that. I see that happening. I see, as John pointed out, further digitization of the economy feeding through into demand for data centers, into demand for industrial and logistics and who knows other nonstandard real estate. And I believe in the decarbonization story. I think that is going to play out over ten years. I think we'll get some missteps along the way. I mean, people don't quite know how to deal with this. Even governments don't know quite how to deal with it. So I think the risks of capital misallocation here are quite high. But this is the early stages. We need to decarbonize the economy, so I think we'll probably see some mistakes in policy around decarbonization emerging. There's no getting around it. We've got to experiment in order to move forward in this area. So people are just beginning to figure out in five years time what actually is going to work long term. So that's what I say, I think over five years. But in the framework of reasonably good growth in the US economy and globally.
Spencer Levy
Well, on behalf of The Weekly Take, I want to thank John Worth, the Executive Vice President, Research and Investor Outreach at NAREIT. John, thank you for joining us.
John Worth
Thank you for having me. It was a great conversation.
Spencer Levy
And Richard Barkham, the global chief economist, head of Americas research and a good friend of mine. Richard, thank you.
Richard Barkham
Pleasure.
Spencer Levy
For more detail on REITs and more economic insights, check out our Weekly Take home page at CBRE.com/TheWeeklyTake. We'll be back next week -- after Halloween, that is -- with a packed schedule of informative treats that we've got in the works, including a look ahead to other holidays with an episode on retail, an enlightening episode on healthy buildings, and more. If you enjoyed this program, of course, please share a link to the show. And don't forget to subscribe rate and review us on the platform of your choice. For now, I'm Spencer Levy. Be smart. Be safe. Be well.
Spencer Levy
I'm Spencer Levy, and this is The Weekly Take. We talk about many ways of being in the business of real estate on our show. Residential ownership, operating a warehouse, developing an office building. I'm breaking no news to you in our audience. But we're here to talk about a different kind of real estate entity altogether and the intersection between commercial real estate and the global capital markets. On this episode, we'll consider the business of REITs -- real estate investment trusts -- and the role of these publicly traded products in the economy at large.
John Worth
One of the great things about REITs, even if you're not an active investor, it's a great way to see through to what's going on in the commercial real estate market in sort of a real time manner.
Spencer Levy
That's John Worth, executive vice president of research and investor outreach for NAREIT, the leading trade association for REITs in the U.S. Based in Washington, DC, John will help us better understand the sector, along with the challenges and opportunities it presents for investors.
Richard Barkham
The recovery from COVID is a bit volatile, but it's pretty much happening now and will play out over the next six to 12 months. But underneath that, we've just had an ordinary recession.
Spencer Levy
And that's our old friend of the show, Richard Barkham, CBRE global chief economist and head of Americas Research, joining us from Massachusetts. Richard's here to offer broader economic context to our discussion, perhaps some fodder for debate. Our conversation will span the globe to cover issues that are making business headlines. We'll look at the state and future of the recession and the recovery -- and consider whether it may be something of a two stage recovery at that. And we'll get down to the nitty gritty of REITs what they are, how they are traded, why they offer a hedge and an indicator of future values, and more. Coming up the economy and everything you wanted to know about REITs but were afraid to ask. That's right now on The Weekly Take.
Spencer Levy
Welcome to The Weekly Take. And this week, we're going to talk about REITs and the economy and megatrends that will affect it all. We can tape the whole show on the economy. But this is a REIT show, so the economy will just be a piece of the action. But what I've been seeing is that notwithstanding the delta variant, we're still chugging along. Interest rates haven't spiked. Stock market’s still good. What's your point of view, Richard?
Richard Barkham
Well, I think it's exactly that, Spencer. The US economy is still moving along at a fair old clip, probably around four to five percent GDP growth in the third quarter, with the forces acting on the economy, obviously the reopening. And sectors might have taken a little bit of a hit during the delta surge, but not as much as everybody thought. We've got very supportive government policy. We've got low interest rates. We got fiscal expansion. We've got the reopening of the global economy. So I think everything is moving along quite quickly. That said, it's quite clear that we're running into some issues in the global economy -- not so much the American economy -- that will throw up some volatility. The supply side, the supply chain shortages, the difficulty in getting goods to market. The difficulty of getting people into jobs. It’s proving much bigger than we first thought. And slightly more worryingly, big picture, in the background I see a slowdown in China taking place. And I will just say as a final comment, Spence, it looks like real estate is in full recovery with the only thing remaining is just some question marks about the office sector
Spencer Levy
On the full recovery thing. Richard, you and I have debated a lot of things over the years, but one of the things that you have been very firm on is that the cycle is the most important thing. And I think it's fair to say that since real estate is in full recovery after the apocalypse that was 2020, the cycle may not have reset. What do you think?
Richard Barkham
There are two things going on, and we got to be very clear that you distinguish them. One is the recovery from COVID, which is a shock. So the recovery from COVID is a bit volatile, but it's pretty much happening now and will play out over the next six to 12 months. But underneath that we just had an ordinary recession and it's been a relatively mild recession. And you can see that in the number of workers that are not temporarily laid off statistics. So I think we did have a recession and we are at the start of a new cycle over the next seven or eight years. And that, I think, will be dominated by some new trends emerging. One of which is decarbonization. One of which is just productivity growth in the United States. And I think also we've got the shift of millennials out of cities into suburban areas, which is going to kick off a housing market, a single family home market revival, which we didn't see in the last cycle. It was completely absent in the last cycle. So I do believe that we had a mild recession and that we’re kicking off a new eight year cycle.
Spencer Levy
Well, Richard, let me just say that I hope you're right. But since you and I are both on our global economics calls every month, I do know that our forecast for three years out is for the economy to revert back to its slow growth rate, pre-COVID, around 1.8 percent. How do you reconcile those two comments that the cycle is going to go another seven, eight years, but we're going to have a big slowdown in three years?
Richard Barkham
Well, I think one of the things that people are not keeping an eye on is just over the next five years, the labor force in the United States is actually going to shrink. So that's going to constrain growth. And to unleash the power of the cycle in the United States. We need to think about how we increase the labor supply. But that is for them, not for now. I think the low growth rates that we see in three years are perfectly consistent with a new cycle. But there a new cycle constrained by labor supply.
Spencer Levy
OK, well, let's come back to the inflation question for a moment. I want to bring in our good friend John Worth. I promised him a reader episode and doggone it, we're going to have one. So, John, since you live and breathe REITs just very basically for the average listener, just as fine. What is a REIT?
John Worth
Happy to. So REITs or real estate investment trusts are operating companies that very simply put. Own and operate commercial real estate. They can also own and manage commercial real estate based assets. There's really three types of REITs you might be familiar with. Listed equity REITs. These make up the vast majority of the market capitalization. They own and operate commercial real estate structures, office buildings, apartments, data centers and so on. Mortgage REITs own and manage commercial real estate and residential real estate based assets, mostly mortgage backed securities typically backed by Fannie and Freddie. And then what we call public non-listed REITs, which are REITs that are public. They are filed with the SEC. They filed 10Ks and 10Qs, but they're not listed on a stock exchange, so they're a somewhat unique creature.
Spencer Levy
Last year, at the depths of the cycle, it was a pretty dark day in the REIT world, but it's staged quite a recovery. Tell us how things have changed in the last year.
John Worth
Yeah, I think that this is where we can have a good discussion about commercial real estate generally, because I do think one of the great things about REITs, even if you're not an active investor, it's a great way to see through to what's going on in the commercial real estate market in sort of a real time manner. And so, of course, what we saw was a real plummet in REIT share prices back in March and April of last year. And then really a two-stage recovery since then with really from April through November being a kind of a digital led recovery where we saw logistics, infrastructure, data centers, cell towers leading the share price recovery. And then starting in November of 2020. Really, almost November 8th to the day when we had some great vaccine news. We've seen this reopening play, which has played out where we've seen retail come back tremendously, hotels come back. And then on a separate track, we've seen the tremendous results in multifamily tracking sort of the growth, everything that's going on in housing markets generally. So over that time we've seen a good REIT recovery. Over the entire course of COVID, which is the way I like to look at it rather than year to date 2021, you lose a lot of the color of what happened in 2020. Over the whole course, you know, we've seen equity reads up about 12 percent over that entire period, despite being up 27 percent this year.
Spencer Levy
Let me pause there. I wanted to clarify what that twelve and twenty seven is. That's 12 percent above where they were pre-COVID?
John Worth
Twelve percent above where they were at the pre-COVID peak. Yeah, actually, I'm actually looking at that as of like February 21, 2020, which was that pre-COVID peak. They've seen a full recovery, plus 12 percent, and we're going to get into sectors -- because I think right now you really can't talk about commercial real estate as a whole, you have to go down into the sectors -- because each sector is telling us a different story and are experiencing very different trends. On Richard's point about or this debate about, are we in a new cycle or is this a continuation of a cycle after a shock? The economy was not overheating by any stretch of the imagination coming into COVID. And in most sectors, we weren't seeing commercial real estate supply at particularly high levels. I view what we've gone through as much more of a shock than necessarily a resetting. But we were going through a period where we were seeing very modest increases in supply and I think very restrained supply, and I don't really see anything changing that going forward. I think we're going to continue to see, in some ways, sort of a new paradigm around supply, of more controlled supply coming into the market.
Richard Barkham
Yeah, if I may, if I may just jump in Spencer. And one of the reasons I was reasonably optimistic that once policy kicked in and once we got on top of the virus, which I thought we would, we'd come out of this COVID shock with a bang was that level of corporate balance sheet strength was true across the whole of American industry, corporates in general. We were very well prepared with ample liquidity as we went into the COVID crisis. With one exception, of course, which was the retail sector where you had relatively high levels of leverage. And we saw quite a lot of retail restructuring over the course of the crisis.
Spencer Levy
So John, let's turn back to REITs. Let me ask you two basic questions. First of all, so notwithstanding the fact that the industry has blossomed over the last 25 years, 25 years are still pretty small number two. What do you say to people who aren't dedicated? REIT investors. Why should they buy REITs?
John Worth
To answer the question, I'm going to go backwards. So the why REITs, I think it’s quite simple, because it's the same answer as why have real estate in a portfolio. Real estate is a tremendous, diversifier in a portfolio. It provides generally pretty stable, stable income returns, opportunities for capital appreciation. Very inexpensive inflation protection -- that is, get inflation protection typically, but you also do well in non-inflationary periods. So the why REITs is the same as the why real estate generally. And, yeah, the size of the market, you know, REITs own today somewhere between 10 and 20 percent of commercial real estate in the United States, depending on how you measure it. And that really goes back to the structure of real estate. Real estate has historically had a lot of private ownership. It does make real estate very unique among stock market sectors in the sense that REITs would make up about three percent of the S&P 500. There are 11 GICS sectors. Real estate is the 11th, recently added. When you look across the other 10 sectors, you really don't see this situation where the vast bulk of the economic activity in that sector is taking place outside of the listed stock exchange traded space. I actually view that as a huge opportunity for investors, right? Because we've seen in property sector after property sector where REITs are able to go to the private market, bring properties in and in some cases professionalize their operations and thinking. In particular, self-storage has been a great example of a place where a mom and pop business has been institutionalized over time, in large part by rights, and their investors have enjoyed the benefits of that. It's a unique space because we have so much private ownership and that in some ways depresses the stock market share of it. And that's why when we talk to individual investors, target date funds, DC plans, one of the things that's very important is that for you to get a meaningful exposure to commercial real estate that matches with its share of the investable universe generally, you have to own REITs above their market cap share.
Spencer Levy
John, I think, opened the door to the issue I skipped earlier, which is inflation, about real estate being a good inflationary hedge, which is its historic reputation. Which brings up where is inflation going, Richard? And you know, there's two schools of thought of this. There is our school, which is not going too bad. It's just a short term thing. And then there's a school that we're about to be in for a period of three to five years of, well, inflation. Well, Richard, where are you?
Richard Barkham
Well, I'll probably be somewhere in the middle. Definitely see high levels of inflation, largely related, I have to say, to reopening the economy and labor shortages and goods shortages. They're all disruption related issues. And there is a little bit of a concern now that the price rises are sort of broadening that they're not just focused in transport or in a few kind of sectors that they were in the early phase of the reopening. Transitory is a marvelously ill-defined word. It could be six months or it could be two years. I definitely think that we're in for more inflation than we expected over the next 12 months or so. But I don't see it turning into a three to five year inflation cycle. And there are many reasons for that. One is that the impact of people staying at home and not coming back into the labor force. That will ease. That will go away. The Asian economies will open up more. Chips will arrive. It'll all take place next year. So a lot of those disruptions that we saw over this year, they will ease. But the thing that worries me about the global economy is just the slowdown in China. The Chinese have put the brakes on their economy, and I think that's going to take some of the wind out of the sails of the global economy in 2022, which will help for controlling inflation. And of course, China is one of the big consumers of raw materials and commodities. So most of the time you worry about a China slowdown and the impact on the world economy. I'm thinking that it might actually be helpful in the current situation to take some of the inflation out of the system. Not that I thought that it was going to turn into a wage-price spiral. You know, we just don't have the same conditions with union power and lack of globalization that we had in the 1970s. But I think the slowdown in China will be one of the reasons why inflation won't be as high as people expect next year.
Spencer Levy
I was reading in a paper today, the stagflation risk of the 70s unlikely and also can just put a few numbers on where you think the 10-year Treasury is going to be at the end of this year and the end of next.
Richard Barkham
I think the 10-year Treasury likely to be around where it is now at the end of this year -- 1.7, 1.8. As underlying growth picks up, the level of unemployment in the US economy continues to fall. So I've talked about volatility in the global economy. I've talked about hitches and bumps along the way. But we're basically optimistic on economic growth in 2022. As a level of real unemployment comes down, then I think that's going to push the 10 year Treasury up, maybe to 2.4 or 2.5 percent at the back end of next year. And I do think that -- and it's a fine judgment -- that the Fed is going to probably move on short-term interest rates more quickly than people expect. But that's a sign of success and recovery in the US economy.
Spencer Levy
John, let's turn to the global thing that Richard brought up about how the impact of China, what that's having on our economy. But there also will REITs all over the world or reach in Mexico. There's REITs in Canada, there's REITs in lots of other countries. If I'm an American investor and I want to buy some of that, what do you say to them?
John Worth
There's a REIT regime in about 40 countries around the world. From the humble beginnings of the system in 1960, it's grown obviously not just in the U.S., but lots of other countries have adopted the approach. And there's also even countries that don't have a REIT regime. We have, you know, listed real estate companies around the world, and I do think the U.S. has really been the place to be a REIT investor over the last several years. Just in part because the U.S. has been faster in terms of embracing some of the newer property sectors. But I think the global investment horizon, when you look out over a meaningful time period, we're going to see obviously more growth in Asia and faster growth in Asia. That is something that a lot of investors are interested in. And there's ample exposure through REITs and the red regimes around the world. They vary, I would say, mostly in the details. What they have in common is typically you're getting one level of taxation at the shareholder level. So it sort of mirrors private ownership of real estate in those countries. So the global outlook, I think, is reasonably strong, particularly in Asia. Europe has been a slower growing area in terms of both the growth of listed real estate generally as well as the REIT performance. But as I said, we see a lot of investors very interested in using REITs to fill out the global portion of their real estate exposure. If perhaps they have U.S. strategy that they do through direct real estate, they used REITs to be that completion portfolio globally. Now we're seeing investors really doing the same strategy, but by sector as well, using REITs to complement where their private exposure isn't getting the access that they need.
Spencer Levy
Two more technical questions, and then we'll get into the sectors. The technical question number one is: why don't you tell our listeners a little bit about the dividend policy -- or the dividend law, better stated -- of how much dividends REITs are required to pay? And then the second question, I think is really interesting, which is what qualifies as a REIT. I remember -- I don't want to date myself -- but I was around when we were forming the first cell tower REITs. And is that really real estate and somebody said, Yeah, well, I guess it is really real estate. So number one, the dividend policy number two, what qualifies as a REIT or what can qualify as a REIT?
John Worth
Right. So, yeah, the dividend policy, which really does go sort of to the core of what it means to be a REIT is that in the U.S. and other countries, countries are very similar. REITs are required to pay out at least 90 percent of their taxable income. Most REITs pay out 100 percent of their taxable income and often more because there's obviously a spread between their gap income and their taxable income because they have different different rules of depreciation and what counts for each definition of income. But that provides, as you know, what most people know about reads is that they pay strong dividends. So over the last couple of years, REITs have paid a dividend that's more than twice the average of, say, the S&P 500. And today the yields are around 2.85 percent. So they've been known as income producers because of this dividend policy. What that dividend policy really provides from a public policy perspective, that really allows the taxation of a dollar of income that flows through a REIT and a dollar of income that flows through a partnership -- so really the two dominant ways of owning real estate -- to be aligned. And that was the original purpose of REITs, was to create a structure where a broad base of households could gain exposure to commercial real estate in a way that they probably couldn't through being a limited partner in a partnership owned piece of real estate or directly owning the real estate themselves. And so that dividend policy allows for that alignment of tax treatment. In terms of what qualifies as a REIT, really it comes down to: Is the income derived from a real estate activity. So you use the example of cell phone towers. You know, I think it's a great example because some people look at a cell phone tower and they go, how could that be real estate? But if you really break it down, it's a structure on land and the income is derived from rent. It's actually quite straightforward. You look at data centers, it’s a structure on land and that you're renting out space in it. In this case, you're not renting out an apartment or an office space. You're renting space for a server. But it is nevertheless very clearly real estate. And so we've seen over time. I wouldn't say that the definition of real estate has expanded. I think what has happened is that people have been using all sorts of structures on land for centuries and centuries. But what we've seen is that more and more of those different types of structures have become institutionalized as property sectors and really in a way, professionalized. And REITs, I think to their benefit, have really been on the forefront of that.
Spencer Levy
Well, let's now turn to sectors. Richard, let's go to what John just said about the institutionalization of some of these Op-Re -- or operational real estate -- asset classes: datacenters, life sciences. They may be the hottest sectors in real estate today. Why, Richard?
Richard Barkham
The amount of capital that wants to deploy in real estate is huge and growing. All of the other sectors are priced to perfection. So I think capital is always looking for new opportunities within real estate. And of course, the digital economy is expanding and it's creating changes in usage patterns. And real estate investors are really trying to leverage that by looking into these new avenues. Now that they’re still relatively small. Let's remember that it's still a relatively small part of the real estate investment landscape. But I have to say we're slightly running to keep up with all of the new sectors that are opening up in real estate. We need to research them. We need to find details and data on them. And this is the way the new cycle is going to go, with more new sectors created by the growth of the digital economy.
Spencer Levy
I agree with you, Richard. The two scarcest things in the world, I often say, are large pockets of talent and large pockets of high-0yielding investments. And REITs and real estate really do provide opportunities for both because they both go hand in hand. John, let's turn back to you now because there's a terrific paper that came out recently, published in the Journal of Portfolio Management. And if you guys could see my screen, I have a copy of it sitting right next to me here. But what the paper really tried to show was the difference in the return profile of REITs versus other ownership structures, whether it be private equity or otherwise. Tell us a little bit about the paper and what it concluded regarding the REIT structure versus others.
John Worth
Yeah, the paper was authored by three great academics, one of whom happens to have had a long career as a practitioner, Tom Arnold, who until about a year ago was the global head of real estate for Adia. So one of the one of the world's largest real estate investors, along with David Ling and Andy Naranjo, who are well-known, well-respected real estate academics and have done a lot of research in REITs and other areas of commercial real estate. And what they really set out to do in this paper was to do head-to-head examinations, what they call horse races between closed-end private equity real estate funds and REITs. So really asking the question: On the day you agreed to invest in a private equity real estate fund or really when the capital call occurred, what if instead you had invested in a diversified portfolio of REITs? How would your performance have matched up? And they're able to do this with the data set from Cambridge Associates and look at over three hundred seventy five U.S. funds over a 14 year period, basically. And what they find is with no adjustments, you would have won using REITs in 53 percent of the trials and. Overall, you would have outperformed by about 165 basis points per year by going with the REIT strategy. They then make actually some adjustments for the cost of waiting for your capital, to be called, illiquidity and leverage differences. And after they make those adjustments and the paper is very transparent about what they are, and readers can kind of choose their own adventure in terms of how much they want to make an adjustment for those. They find that REITs actually win 68 percent of the trials and outperform by almost six percentage points per year. It's really pretty dramatic outperformance. We think it's an important piece of research, especially for institutional investors to understand that there have historically been returned differences and that they need to take those into account as they build their portfolio. Just to be totally clear, NAREIT’s not saying that REITs are the only way to hold commercial real estate. Really, what we view is that public and private real estate can be complementary in a portfolio, and they both need to be in a portfolio for different uses.
Spencer Levy
I'm going to ask a broader question if I can. You hear some of the criticisms of the structure and the criticisms of the structure include things like number one, very hard to develop new product under a REIT umbrella. That's a criticism. No one criticism. Number two you hear is that because these REITs are fully integrated, meaning they do everything from ownership to leasing to management to property management. Is that really the most efficient use of their time and money to do all of these functions rather than outsourcing? So how do you respond to critics and say, you know what, it's great to have publicly traded real estate, but maybe REITs aren't the optimal publicly traded structure. Response?
John Worth
Well, REITs actually have limits on their ability to be developers. It's very difficult for them to develop to sell. But we do see a meaningful amount of development for their own portfolio and REITs are really a material purchaser of newly developed properties. So they're not the optimal vehicle to be a developer. In fact, that's sort of by design. In terms of REITs’ internal versus external management. This is a debate that sort of comes and goes over time, and the US is fairly unique, you know, the U.S. and Europe. In the US today, about 97 percent of the market cap of equity REITs is internally managed. But if you go to Asia, virtually all the REITs are externally managed. That top level decision of whether you're going to have any internal or external management, to me, that is something that is really driven by investor preferences. And in the U.S., there's a very strong investor preference for that internal management. But, of course, as you make the point, that doesn't mean that the REIT has to internalize every function. Ultimately, what you need to see is what is the individual REIT’s operational performance? Where can they have world class operations? Where can where can they outsource to get world class operations? And for the investor, it's ultimately what is my long term return net of the G and A, and then the fees I need to hold the real estate in this particular form. That's ultimately the determination of what the best model is, as far as I'm concerned. But yeah, but I do take your point. Not everybody has to do everything.
Richard Barkham
And Spence, if I could weigh in on this. And John would probably agree. I started watching REITs as an adjunct to those kind of fundamental real estate research that I would do back in the 1980s. And back in the 1980s REITs, they were pretty freebooting. They were merchant developers. They would buy anything. They were these kind of very eclectic mixture of assets. But really coming out of the 1990s recession and over the last 20 or 30 years, you've seen a degree of specialization in REITs and professionalization of management coming out of that specialization. So I think many of the innovations that we've seen in real estate -- particularly in the shopping center industry, but not limited to that -- have actually come out of the specialization and professionalization that's taken place in the REIT sector. So I think some of those criticisms of the sector are kind of misplaced.
John Worth
Yeah, Richard, I think that's exactly right. You know, when you look at this role of specialization, it's really quite incredible. Today, only three percent of the REIT market cap is in diversified REITs. The rest of it are in pure play of one variety or another REITs. And that's really been driven by investor demand. The REIT specialist investors who serve a lot of institutional investors have basically said, we want you to be pure play, so you become best in class and we understand exactly what it is you're investing in and doing. That's helped, I think, grow efficiencies. And then I think particularly in the the digital real estate sectors -- in that I'm including logistics data centers, cell towers -- that operating platform, that idea of having a permanent operating platform, I think becomes very, very important because there you really scale really starts to matter as well as having some network effects come into play.
Richard Barkham
One of the downsides of REITs, I think, is just how much they depend on the corporate bond market, the fixed interest market, bond rates. So they're very, very sensitive to interest rates, not just the Treasury market, but also in the corporate bond market. So if you see corporate bond yields going up on fears of inflation, some of that noise can spill over into the REIT market. It's short term, but it's sometimes amplified that REITs are a little bit subject to bond market events, which are unrelated to real estate. That's just something you've got to watch out for if you're a REIT investor.
John Worth
I think that's right, and this is something we look at a lot. And what we've actually seen is that short term correlation with, say, the 10-year Treasury. It actually flips back and forth from being positive to negative, and it appears as though it really depends on what kind of monetary policy environment we're in. And this goes back to something you said earlier, Richard. When you look out over a year, a rising 10-year Treasury is highly correlated with both positive REIT returns and REITs beat the S&P five hundred about 50 percent of the time. It's about a coin flip with the broader stock market over a year when you have rising treasuries. Because over that period when Treasuries rising is telling you is that we've got a strengthening economy. And that's just good for fundamentals.
Spencer Levy
I'm now going to ask a wrap up question to each of you. And John, let's start with you. So REITs just went through this tremendous shock, but a tremendous comeback five years from now, looking back, what are the big changes positive or negative in the industry?
John Worth
Well, I think they're going to mirror the changes in the broader commercial real estate space. I think the two big dynamics that are just impossible to overlook are one just the increased digitization of the economy. Our economy is getting increasingly virtual, increasingly digitized and real estate is built to house that economy in one form or another. And we have to assume that real estate is going to continue to evolve to meet the needs of this more digital, in the U.S., I think more increasingly intellectual work, creative work-driven economy. The other point and is the need to come to terms with the impact of all human behavior, but in our space, this is structures on climate and the role of climate, both in driving risks in the near-term, in the long term and the role of changing policy and how owners of real estate structures are going to have to react to the change policy. And I think it's just something that has become more important over the last five years and moving from a nice-to-have to a need-to-have it over the next five years is going to move from need-to-have absolutely critical-to-have a handle around how the climate impacts your properties and how your properties impact our carbon footprint.
Spencer Levy
Well, I agree with you on that one, 120 percent, because every dinner I have with large investors -- and I have a lot of those dinners -- they say they want to tackle the environmental issue. So, Richard, same question to you. Five years from now, looking back, what do we see big picture from an economic perspective -- not just for the economy, but how it impacts real estate?
Richard Barkham
Five years ahead, I think first thing we'll notice in that first period of the five years is just probably continued recovery in the office sector in a way that people are still not quite comfortable with or anticipating now. I think we might also see some outperformance of physical retail. One of the things I think the COVID crisis has done is just prompted, as I said earlier, the kind of millennial cohort to start to move to the suburbs and own property there. And I think all of those retail assets that exist in the suburbs are going to benefit from that. I see that happening. I see, as John pointed out, further digitization of the economy feeding through into demand for data centers, into demand for industrial and logistics and who knows other nonstandard real estate. And I believe in the decarbonization story. I think that is going to play out over ten years. I think we'll get some missteps along the way. I mean, people don't quite know how to deal with this. Even governments don't know quite how to deal with it. So I think the risks of capital misallocation here are quite high. But this is the early stages. We need to decarbonize the economy, so I think we'll probably see some mistakes in policy around decarbonization emerging. There's no getting around it. We've got to experiment in order to move forward in this area. So people are just beginning to figure out in five years time what actually is going to work long term. So that's what I say, I think over five years. But in the framework of reasonably good growth in the US economy and globally.
Spencer Levy
Well, on behalf of The Weekly Take, I want to thank John Worth, the Executive Vice President, Research and Investor Outreach at NAREIT. John, thank you for joining us.
John Worth
Thank you for having me. It was a great conversation.
Spencer Levy
And Richard Barkham, the global chief economist, head of Americas research and a good friend of mine. Richard, thank you.
Richard Barkham
Pleasure.
Spencer Levy
For more detail on REITs and more economic insights, check out our Weekly Take home page at CBRE.com/TheWeeklyTake. We'll be back next week -- after Halloween, that is -- with a packed schedule of informative treats that we've got in the works, including a look ahead to other holidays with an episode on retail, an enlightening episode on healthy buildings, and more. If you enjoyed this program, of course, please share a link to the show. And don't forget to subscribe rate and review us on the platform of your choice. For now, I'm Spencer Levy. Be smart. Be safe. Be well.
Guests
John D. Worth, Ph.D.
Executive Vice President, Research & Investor Outreach, Nareit
John D. Worth is the Executive Vice President for Research and Investor Outreach at Nareit, where he leads Nareit’s internal and external research efforts and directs Nareit’s investor outreach and education initiatives. Prior to joining Nareit, Worth founded the Office of the Chief Economist of the National Credit Union Administration (NCUA), spent nearly a decade at the U.S. Treasury where he served as the Director of the Office of Microeconomic Analysis and served as Acting Deputy Assistant Secretary for Microeconomics.
Richard Barkham, Ph.D.
Global Chief Economist, Head of Global Research & Head of Americas Research, CBRE
Richard Barkham leads a global team of nearly 600 research experts who help CBRE’s clients understand the forces shaping the commercial real estate industry. One of the world’s leading real estate economists, Richard combines the theoretical framework of an academic with hands-on experience in development to deliver actionable insights for real estate investors and occupiers.
Host
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Spencer Levy
Global Client Strategist & Senior Economic Advisor, CBRE
Spencer Levy is Global Client Strategist and Senior Economic Advisor for CBRE, the largest commercial real estate services firm in the world. In this role, he focuses on client engagement and public-facing activities, including thought leadership work performed in conjunction with CBRE Research. He also serves as Co-Chair of the Real Estate Roundtable’s Research Committee.