From Where I Sit: Episode 8 with Spencer Levy Transcript

Tom McGee:

Welcome to From Where I Sit, I’m your host, Tom McGee, President and CEO of ICSC, the preeminent membership organization serving the commercial real estate and retail industries. Each episode, I’ll be joined by top experts to explore the trends impacting communities and commerce and the spaces where people shop, dine, work, play and gather.

I’m pleased to introduce Spencer Levy, Global Client Strategist and Senior Economic Advisor at CBRE, to the latest episode of From Where I Sit.

Spencer has nearly 30 years of experience in commercial real estate, with his last 15 years at CBRE. Over his career, he has served as a lawyer, investment banker, capital markets expert, and research leader. Today, he leverages his diverse background to share expert advice and insights on the present and future of the commercial real estate industry.

Spencer, welcome to the show.

Spencer Levy:

Tom, great to see you. Thanks for having me.

Tom:

Yeah, Spencer and I have known each other for years, so I look forward to a great conversation. And Spencer, you have such a broad role at CBRE. I know you just came back from an international trip and had a chance to interact with hundreds of clients. And you do that also here in the States. Maybe just level set. We'll talk a little bit about the state of commercial real estate, the state of the economy, but first level set for the listeners, just your role at CBRE, the scale of it, your scope of responsibilities, etc.

Spencer:

Sure. Well, I have a really broad and I think a pretty cool job and it's pretty cool because in addition to meeting with investor clients, I also meet with our largest occupier clients across all asset types and all over the world. As you just mentioned, I just got back from Europe, the Middle East. I was in Mexico City last week meeting with hundreds of clients, not just giving them my point of view, but to learn theirs and then to bring that advice to clients here domestically in the United States to help them make better decisions.

And so my job, titled Global Client Strategist, Senior Economic Advisor, really means I'm on the road every day meeting with the largest investor and occupier clients, trying to give them the best advice I can on how to, on the investor side, make the best returns and on the occupier sides, to make the best portfolio or individual asset decisions.

And I also, as you know, Tom, since you were one of our earlier guests, Tom was a guest on The Weekly Take podcast, which we've been fortunate to now be broadcasting for over five years. And it has been a terrific platform, not just to share ideas, but really to get to know some of the senior-most leaders of our industry, not just to hear what they have to say, but to get what they have to say and use it as advice for our other clients.

It's been a wild ride, certainly since COVID, it's probably been a wild ride longer than that. But certainly the last five years have been quite a busy time and only getting busier.

Tom:

Yes, commercial real estate is not for the faint of heart, for sure. You just mentioned you came back from an international trip to Europe, the Middle East, Mexico. Actually, and you said part of the reason you went there was not only to share your point of view, but to hear their perspectives about commercial real estate, their state of the industry, so to speak. Any tidbits for the audience just in regards to what you learned on that trip? We'll get into your views, but maybe just, it'd be interesting to hear what you heard from some of those geographies.

Spencer:

I'll give you the academic answer and then I'll give you the specific answer. The academic answer is this, Tom, is that I've been tracking international capital as long as I've been in the business, 30 plus years. And typically international capital represents about 15—one five—percent of our business. Last year was less than four. And you ask yourself, well, why? And the reason mathematically is because the US dollar is so strong relative to the Euro that it's cheaper to buy over there than to buy over here.

But there are other reasons and the other reasons are where I try to go into these places and try to demystify a few things. And so I'm not going to talk politics on this show, but I am going to say that there is some concerns expressed overseas over what the future state of tariffs are, what the future state of trade, immigration, all these big issues. And my basic point of view is the future always looks a lot more like the past than we think in the moment.

And in fact, when I take a look at some of my ideas I tied to express to our clients is border industrial is a place I like a lot because I think that, you know, some people may overreact on one side of the border or the other. I like things dealing with international trade. I'm, I'm very bullish on those areas, coastally that are focused on trade, notwithstanding some of the concerns expressed by some of our international clients. In fact, I tell them this represents an opportunity because the long-term prospects of global trade, long-term prospects of the US are terrific. In the moment, don't make that your long-term decision point. Make your long-term decision point essentially the math of the long-term, which is very bright.

Tom:

Yeah, there's certainly a great deal of uncertainty out there, both it sounds like internationally as well as here in the US and that has had some impact upon investment activity. I do want to delve down on one thing. I had not heard that perspective before around border industrial as a potential opportunity. Just delve a little deeper into that, explain what that is and then why you think that's a good opportunity.

Spencer:

Sure, so when you take a look at macro and political issues, tariffs, trade, immigration, there are inflection points. There are points where you're going to see the greatest amount of stress. And the points where you're to see the greatest amount of stress are in these border areas. So when I was in Mexico, we had some clients who were thinking about bringing some of their manufacturing to El Paso, as an example, I spoke to my clients in El Paso. This is actually happening on both the investor side and the occupier side. But when I speak to my Mexican clients, I'm like, well, this represents an opportunity on your side of the border. Because I think that if you look at the long term, this is likely an overreaction to some of the things that are being said today because the long-term trade relationship of Canada, Mexico, US while it's certainly, there's a lot of talk about it today. I think the long term is still very bright.

So what I'm really saying is this, Tom, when I advise my investor and occupier clients, I look for those points of uncertainty and I try to go against the grain. The grain is, oh, let's just reshore everything or let's not buy office. Let's—remember, Tom, you're in the retail business. This is kind of like, “Let’s not buy retail anymore.” That was 10 years ago. And I remember distinctly, and I think I had this conversation with you, Tom. And I've said this a hundred times. I said, start saying in five, six years ago, I said the single most undervalued opportunity in real estate is open-air retail. And I got thrown out of a lot of offices for saying that.

But a lot of people capitalized on that because they saw that you can't build these things because you're buying them well below replacement costs. Tenant demand didn't fall off with COVID. And the significant shift, which has now happened recently, is that a lot of the money that has left office needs a new home and needs retail as one of those large chunky homes where they can put a lot of capital out.

And so back to the original point is when you see these areas of short term stress, and I see that now in border industrial. I see that in office. I see great opportunity.

Tom:

Well, it's a little bit of Warren Buffett's old saying: When everybody's scared, that's when you should buy. If everybody's euphoric, you should probably keep your powder dry to some extent.

Spencer:

It’s true. Look, I can give you positive and negative examples of that, Tom. I mean, you take a look at data centers today. The hottest sector in real estate, a lot of money chasing it. Now there's good demand drivers there and from AI to crypto to the big tech firms all getting into the space. There's also a scarcity of it because of scarcity of electricity and water. And so there's a lot of great demand drivers, but there's also a tremendous amount of capital chasing it. Is it going to end like it ended for life sciences three years ago?

I don't think so because I think the fundamentals in life sciences are much, much smaller. First of all, the entire life sciences industry is about 180 million square feet, which is half the size of Manhattan. So it's very small. But nevertheless, you had a tremendous amount of capital chasing a very small space. And then when that capital dried up and some of the tenants started getting weaker because venture capital dried up, you had a really bad outcome. I don't think you're going to see that outcome in data centers because I think, as I mentioned, the demand drivers are much better. But nevertheless, when you see a lot of money chasing a specific space, what you're going to get is real estate priced at fair value. You're not going to get it at a discount.

And that's why, when I talk about retail, while everybody's favorite retail segment is grocery-anchored retail—I like grocery anchored retail—but you're not going to get it at a discount. You're going to get it at fair value because of all the capital chasing it.

Tom:

And there's been limited to no development in the last number of years for the reasons that you are articulated. It's actually interesting. I want to talk about the state of commercial real estate now, but the last point on border industrial and to your point, kind of about macro trends and so forth. And if you exclude the current conversation around tariffs and the impact it may or may not have, one of the lessons of the pandemic, there was a move towards nearshoring or onshoring more goods because there was a scarcity of goods and just the challenges associated with the pandemic.

And border industrial, I would think would fit into that macro trend of nearshoring and/or almost onshoring goods.

Spencer:

There's two elements there, Tom. One of them is manufacturing. The other is inventory. And I think you have seen because of tariffs and increase in inventories, not dissimilar to some of the lessons we learned from COVID. The question is, will you see the reshoring of more manufacturing? And I think you will see higher value add manufacturing. You're going to see chip manufacturing like we've already seen because of the CHIPS Act. But I think that lower value add manufacturing and some lower value add goods—and this is not to diminish the goods, it's just certain goods take more energy. They take more technology to make. But if you go lower down that chain, it's still materially cheaper to make those goods in China and Mexico and in other places, even if you have significant rises in tariffs.

Tom:

You probably will see almost certainly an increase in US manufacturing. It just may be manufacturing different than what we saw 30 years ago, a lot more robotics, a lot more technology supporting it.

So let's talk about commercial real estate. We brought up the pandemic. We're five years from the pandemic, believe it or not, or from the beginning of the pandemic, and commercial real estate was very much at the epicenter of it. And the implications of the pandemic have had different implications depending upon the sector. Office, the whole return to work issue. Retail, people rediscovered the joy of shopping in the post pandemic environment. And retailers are using their stores as little mini fulfillment centers, the growth in industrial, the growth in data centers, as you mentioned. So let's start at a macro level first, and then we'll talk about each sector. The state of commercial real estate in your mind right now.

Spencer:

I think you got to look at from both perspectives of the investor and of the occupier. I think from the investor's perspective, it's getting better, but it's been tough sledding. And when I say tough sledding, because the interest rate inflationary environment of the last three years has been very difficult and it's getting better, but it's not going to get a lot better. Our house forecasts for interest rates, terminal value—if we had this conversation 18 months ago, Tom, I would have told you that the 10 year treasury is going to terminate 3% and at the short end of the curve might terminate under two. We're a hundred plus basis points above that on both sides of that right now, where we think that the long end would terminate around four and we think the short end terminates around three and a half. That's a big difference. And because of that, people that bought at the peak of the market, which is 2019 to 2022, they're going to have assets that have been devalued from a capital markets perspective.

But I think the shift from a investor standpoint is—this is the macro shift I think you're going to see in the next 10 years—shifting where you're going to get the majority of your return from cap rate compression to getting the majority of your return from being a better operator. And you know what they call that, Tom? That's called old school real estate. That's what real estate was when I got into this business when the 10-year treasury averaged 6, 7%, right? That was called normal, but I'm not saying the 10 year is to go to 6, 7%, but it is going to be higher for longer and the good operators are going to do better. In fact, we just had change in leadership at my firm. We have a new CEO, a division of our company called BOE, Building Operations and Excellence, Jamie Hodari. And he says all real estate now is operational. And I agree with that, including retail, including, and dare I say it, and I say this because I'm speaking at the Net Lease Conference tomorrow, including net lease retail.

I use this crazy example, but I love this example. It's actually a global example. So what was I wearing when I was over in the Middle East and in Mexico? I was wearing a hat from Buc-ees, the gas station convenience store. And I use that example because I don't know, Tom, what you would define as the oldest of old school industries. How about gas stations and convenience stores? Been there, done that. Well, guess what? If you can reinvent that mousetrap of an old school industry by operating better, you can make anything better.

And I think that it's a very optimistic point of view. It's challenging for old school real estate that's operating in an old school way. But I think it's very optimistic for the future, if you see this industry that's being not completely disrupted, but partially disrupted by a new group, that's just operating better.

So flipping perspectives to the occupier. Interestingly, my answer for the occupier isn't that different than my answer for the investor. And this is where we're seeing a little bit of convergence where, let's face it, Tom, and I say this with no disrespect to retail, there's really only two types of real estate—commercial real estate—you need. You need multifamily, a place to live. You need industrial, a place to store your stuff. Everything else is a want, including retail. You got to want to go there. You got to want to go to the office. You got to want to go to most forms of real estate. And because of that, if you're an operator, you need to operate more aggressively. You need to think more about opex and CapEx, about what's going to take to get people there, people to go to your shopping center, to go to your office, need to want to be there, not need to be there. And that's where operations become much more important on that side.

In terms of the location of where these things are, I say often that I would rather have the worst property in the best location than the best property in the worst location. And I mean that in terms of live or play and other drivers of that location infrastructure and otherwise. So I think that from an occupier perspective, location selection has never been more important than it is today.

Tom:

Well, you talked about in some respects, we're going back to the way things used to be in the focus upon operating and becoming a good operator. And that last comment you made, the number one rule of real estate is always and always shall be location, location, location, right? No matter what the sector is, including residential.

So let's talk about office because you've talked about it a few times. And whenever I am having a conversation with anybody and I say, I'm in commercial real estate and etc., they always jump to all the office, that office market. That's really struggling. That's tough, right? So give me your perspective around where we're at in this journey of this new normal. Because I don't think everybody would agree. We're not going back to pre-pandemic levels in regards to people coming in the office five days a week and the same way that they used to. We're in a new normal. I don't know where that pendulum will land but that has implications for office. And so talk to me about where you see the office market today and where you might think it'll be five years from now.

Spencer:

So let me rewind this tape to where I started my career 30 years ago. was working for a developer in New York City and we bought half of Wall Street. We bought The Woolworth building, bought The Daily News building. We bought 20 Exchange Place, 156 William, 33 Maiden Lane. I can go right down the list. Why do I mention all these old buildings—with the exception of The Daily News, which is in Midtown—the downtown buildings were all converted. They were all converted into either multis or to condos. And I remember buying these buildings for around a hundred bucks a foot. And we were hoping, hoping that we'd get 300 bucks a foot on the sale. And now some of these condos are selling for like $4,000 a foot. So that gives me hope about the worst segment of the market, the market that will no longer be economically viable as office. The problem is that took years, decades in some cases, to get them converted and turned into another building. And obviously the cost of conversion today is probably approaching $1,000 a foot in Manhattan, wherein back then it was probably a couple hundred dollars a foot.  So a very, very different math of how it works, which is why, speaking about the worst end of the market, before I speak about the best end of the market, I don't think the solution this time is conversion. I think the solution this time is demolition.

So I'll give you a case study, Tom. I just had on The Weekly Take the other day, the US president of a company that owns the Mandarin Oriental down in Miami. And what are they doing? Swire Properties. What are they doing? They're demolishing it. Even though it's 25 years old, it's a beautiful hotel. It's right on Brickell, right on the water because they realized that the economic case can be made for not only a newer, better hotel, but also for 200 residential units starting at 5 million bucks each. And so you take a new building and if you can make the case for demolishing a new building, what's the case for the older building?

So I think at the challenged end of the market, we're going to see more demolition. On the good end of the market, which is the high end market in the best submarkets. I'm not going to go so far as say that the world has never been better, but the world has never been better for some of these assets. So you take a look at One Vanderbilt in New York, not far from where you're sitting right now, Tom. Take a look at Hudson Yards and I can point to buildings like that in Century City in Los Angeles, in North Dallas, in Nashville. And I just go right down the list where, not only are they new, but there's new construction going on. I was in Mexico city on Wednesday at the St. Regis Hotel—which by the way, last year Madonna was there and I was disappointed she wasn't there this year—but nevertheless, right next to it, they're building a new office building.

So even in markets like Mexico City that has a glut of office space, if you have the best building and the best submarket, you can still make the case to build because you're getting rents that are off the chart records in most of these submarkets in New York. One Vanderbilt I've heard rents over $300 a foot, Hudson Yards over $200 a foot. And these aren't outliers because you're seeing record rents in Century City, North Dallas as well. So the tale of two worlds, best stuff, best submarkets, great place to be. The toughest stuff. I don't see a lot of conversions. I see some, but I see much more demolition. But I think the future of office is bright. And I think that 20 years from now, Tom, when you and I are sipping brandy in Nantucket.

Tom:

Is that what you do in Nantucket? You sip brandy.

Spencer:

After you're done with clam chowder, you got to sip something, right? But in any event, you and I are going to sit down and say, you know what? The office space in 2025 looks just like the retail space in 2015, and I wish I got in sooner.

Tom:

Yeah, there's certainly some parallels between office and retail. And in some respects, it's an omnichannel kind of moment too. And the work environment has to be flexible. You have to be able to offer your employees the opportunity to work at home, but you have to have a compelling reason for them to go to the office as well.

I want to delve down a little bit. You actually said something that spurred a thought in my mind. I had spoken recently to Kathryn Wylde, who is the CEO of the Partnership for New York. And we were talking about office here in New York. She leads a large business group here. And she had made the point around, at least as it relates to conversion. This is something that's happened in New York in its past. You mentioned the Financial District. In both pre-9/11 and then 9/11, there was a—post-9/11—a whole lot of conversion happened down there. So she felt confident that you would see that in other parts of the city, because the city would have some muscle memory around that.

But you brought up demolition. I just want to delve a little bit deeper because I am sitting in Midtown Manhattan and that is the epicenter of the office market in the United States because of the scale of New York City. Do you see that happening in Midtown, that you could see some of these buildings demolished and rebuilt into new residential buildings or new, more amenity-filled office buildings? The economics would support that?

Spencer:

So the example everybody gives, and it's a wonderful example is JP Morgan's new headquarters on Park Avenue. They demolished a 60-story office building to build a new one. Now they are an occupier, not an investor at least on that side of the house. So they may have been doing it for not the same type of math that a investor might've done, but nevertheless they did it. And so it comes back to this stubborn math thing where it's easy for you and I to put together an Excel spreadsheet to build from the ground up. It is next to impossible to do that from a building that is currently existing without a tremendous amount of additional due diligence.

And then you have the ultimate X factor and the ultimate X factor is the permitting time that it's going to take you. Like, let's assume the math is perfect. How long is it to take me until I can get my people to swing a hammer in there? So I had on my show about a year ago, Scott Rechler, Scott Rechler, who is the chairman of RXR Realty.

And we had this debate on air. I said, what do we need to convert more of these buildings? And he said more tax incentives. I'm like, listen, I'm down with more tax incentives, but I got a better idea. Scott said, you don't need more tax incentives, you need more money. You need more of your own time. If your time was certain, meaning that you know with certainty when you could swing that hammer to actually start constructing in that old building to convert it, that's worth more to you than the incremental dollar that you're going to get from the city. Now you need both, of course, but I think that permitting is the key. And so this is going to take us—here’s a little non sequitur.

So the terrible tragedy of the fires that went down in Los Angeles, terrible tragedy. And it was particularly tragic for our own company because CBRE used to be based in LA. So we had about 20 colleagues who lost their homes. It was just terrible. In any event, if there's a silver lining to the apocalypse, the silver lining there is that you took a look at what the governor did. He reduced the permitting times to rebuild these buildings. And I use that example every which way I can now with saying permitting is the challenge. The reason why we have an affordable housing crisis. Permitting. Yhe reason why we have the challenges of conversion. Permitting. If you had a as-of-right process that was streamlined, that was clean, that was no gray, you would see far more conversions than what I'm suggesting, which is demolition, because the math right now really points in that direction if you don't have the certainty of time.

Tom:

Well, it's interesting you brought—I'm a native Los Angelino, so I share with you a lot of heartfelt sympathies for the folks there and a lot of friends and acquaintances that were impacted by the fires. Your point around when government wants to move fast, it can move fast. And another example from the Los Angeles area was back in the Northridge quake in the mid-90s, the 10 Freeway, which was the most populated highway in the United States, cracked in half in that earthquake.

And the governor at the time incentivized the contractor to speed up the repair of that. And what they estimated was going to be a multi-year kind of thing ended up getting—they fixed it and the freeway was open again, I think it's within six months. So things can happen when government wants to move. And maybe to your point, if they speed up the permitting and zoning and eliminate some of the zoning restrictions that those would help.

Spencer:

There's an expression, Tom, and think a lot of people have used it. Rahm Emanuel, the guy I know used it. He said that a tragedy is a terrible thing to waste because it causes you to do things. And you wish that you didn't need that because what's going to happen in many of these cities is, I don't want to be melodramatic about this, but it is a slow motion train wreck to the tax base and that slow motion train wreck to the tax base is eventually going to hit home where people are—They have these huge deficits and firemen and teachers are to get laid off. That's what's going to happen unless we can revitalize these cities. The tax base, you know, putting it in just very raw economic terms—before you talk about the degeneration of downtown areas with what I might call a zombie building, a building that is not operating is a blight and it needs to be remedied either through demolition or somehow renovation. Otherwise it not only diminishes the tax base. It diminishes everything around it.

Tom:

You're right. mean, the challenge for the central business districts and the impact that'll have upon the economies in those local communities and cities is concerning.

Let's talk about retail. I love retail and live in the retail industry. And to your point, retail has really had a resurgence in the post-pandemic environment. And I never, as you know, and we had conversations around this, I never bought into the retail armageddon or apocalypse concept. And there's been such limited development, really since the great financial crisis, in retail, particularly in suburban open-air retail, which is kind of on fire right now.

One of the trends is densification around mixed use and this convergence of residential and office and hospitality and retail all in one space. That is an opportunity, I think, that densification kind of bringing a city living type of experience to the suburbs to some extent, but it's not an easy thing to do either. Not every project can do it. So talk a little bit about mixed use, your outlook around that, because that is a phrase that comes up in most conversations around retail. “Oh, the opportunities in mixed use are significant,.” But it's not easy either, is it?

Spencer:

Well particularly in suburban environments. So every one of my open-air owner clients, REITs, private, otherwise, have been doing analyses over the last 10 years of what kind of pad sites do they have on these areas that they can put multifamily. And it makes a lot of sense for every reason you just suggested, because I think the virtual live, work, play environment, virtual or the actual live, work, play environment by putting multifamily there, sometimes putting office there is the solution to many of these suburban centers. And I think the bottom line is that it's a great outcome if you can do it.

So going back to something that seems unrelated to what we're talking about, but now comes right back home. If you think it's tough to get permits to build multifamily in a city, good luck trying to do it in a suburban environment. Once again, it's the same issue, different location of getting the permitting, the zoning, all these things together to be able to build what is the highest and best use in that location is the limiting factor. It's not the idea. The idea is a great one and it's been proven to work everywhere. It's the execution that prevents people from doing it.

Tom:

We obviously have a housing shortage crisis in this country. And many retail properties do represent a great opportunity with large parking lots, don't need the changes in kind of parking requirements, etc., create capacity to build multifamily. But the town I live in, I know there's an ongoing battle around that very issue in building a new multifamily, which they need, but the politics around it can be quite challenging.

Spencer:

That's a polite way to put it, I would say this, is that affordable housing is the most human made problem imaginable. Therefore, it is the most human solvable problem imaginable, if we have the will to do it. Because money doesn't win. It is people having the will to do it, which is much more than that. It's much more of a community thing of we want to have a lot more housing for people in this community that work here. And that's a challenge.

Now, some places have tried to fix it in a lot of different ways. You saw what happened in Florida where they came up with the what's known as the Live Local Act that you take some of these old office buildings, if you want to convert them and have a portion that's affordable, you get almost as-a-right conversion that they basically said in exchange for this, you get permitting faster. That's the kind of thing you need, but even that has been tied up in all kinds of litigation, as you can imagine.

Tom:

Well, let's move to just a couple other sectors real quick. And then I want to talk about the economy broadly. Industrial, data centers, you touched on them, just your perspective, a lot of money's gone into both of those over the course of the last few years. Do you feel like that's still a place that more capital is going to go? Or do you feel like we're at a little bit of a tipping point and maybe there's going to be a calming off period in regards to investment in both industrial and data centers?

Spencer:

I think in the near term, and I would define near term next five to 10 years, data center demand from an investor standpoint is hockey sticking. It's still going up. Every investor I meet with wants to get into the sector, including what I would consider to be more conservative core, core plus type of investors want to get into that sector. Because you could write big checks. You often get great credit when you have one of these big tech firms that takes the entirety of the building.

So I'm very bullish on the future of investor demand for data centers. I’m also bullish because there's a supply constraint, very difficult to build them, very expensive. Water and electricity are the limiting factors. As far as tenant demand goes, as long as AI and crypto and data analysis continues hockey sticking as well, you're to see great demand there. So I'm very bullish on data centers, but the cautionary word is exactly what we described earlier, Tom. There's a lot of money chasing a relatively small sector. And that is never a recipe for good things historically.

Maybe this time will be a little bit different because of all the demand drivers there. The industrial side is soft right now. When I say soft, I want to be clear about this. You got to break down industrial from the big box warehouse distribution down to the smaller distribution down to the last mile down to self-storage—rather flex and self-storage. Okay? So you can go all the way down the list. As you get further down the list, the market gets better and better and better at the moment because there was an oversupply of some of the big box warehouse distribution centers, which has caused more softness there than you have seen below it. That's the bad news. Here's the good news. Industrial is easy to build. It's easy to stop building. And so what we've seen is a huge fall off in new supply of industrial. And because we are bullish on the long-term trends for distribution, we're actually bullish on long-term trends for trade.

Notwithstanding some of the things you're hearing in the press today, we think that the future of industrial is bright, but it has to get through this short term period, meaning the next year, 18 months of relative softness before we get back to a landlord friendly market.

The other thing that needs to happen is I think that you have seen some softness in tenant demand because of some of the trade issues of people hitting the pause button at the moment. Once you get more certainty, you're going to see industrial do just fine.

Tom:

Well, that's a great transition in to talk about the economy and you use the word—the need for more certainty or to get more certainty. And we are operating, at least a few months, in some level of uncertainty as new policies get rolled out, tariffs, there's conversations around tax reform. So there's the need to either extend or change a lot of tax policy that was passed in 2017. That's created some level of uncertainty in the economy and in the investment community. At the same hand, the consumer has continue to be quite resilient throughout all of this, even in the face of inflation, although you're starting to see cracks in the consumer. Consumer debt delinquencies have gone up, consumer confidence has taken a hit. Where do you think we are from an economic perspective? I mean, your kind of 10,000 foot level in the economy in general. Are we okay? Are we headed into possible recession territory? Tough question, I know, and answer it any way you feel comfortable.

Spencer:

Well let's look back and then we'll look forward. Looking back, the economy materially outperformed our outlook. We had predicted a recession a couple of years ago and we had predicted it because we had seen cracks in the banking system and we saw a few those cracks show up, Silicon Valley Bank, Signature Bank. But what happened was the government said, we're not going to let that happen. We're going to create mergers of these banks so that we don't have a banking crisis. And in fact, one of my many hats that I wear, I'm proud to be the chairman of The Real Estate Roundtable’s Research Committee. And so I meet with these government officials regularly and they will say that community banks are the backbone of American finance and commerce, and we're not going to let them go down. Okay. Fine. They're going to cause mergers and other things, but that prevented a recession, which is a good thing, right? For everything except one.

We're in the real estate business here, Tom. And because we didn't have a recession, it's a—probably the most significant factor of interest rates not coming down. Yes, we had too much money in the money supply. Okay, I'm not going to deny that. What I am saying is if we had a real recession, you would have seen interest rates significantly lower today than we are currently seeing them.

Okay, so now let's look forward. We had an outperforming economy in part because of government intervention on the banking side over the last couple of years. Looking forward, we still have a very positive outlook, though we did recently downgrade our economic forecast for 2025. In part because of the, there's that word again, uncertainty around tariffs in particular. Do we still think the outlook is very good in the next couple of years? We absolutely do. And we haven't really downgraded our out-year forecast growing around two and a half percent in the out-year. So growth will be good. Interest rates will be lower, but they're not going to be a lot lower and growth is not going to be a lot faster. And we still have this big X uncertainty factor combined with the cracking of the consumer, which has increased the risk of recession.

So that's the big picture outlook, but let's bring it back to real estate now. Okay. So the good news in real estate is we're not building a whole lot of it. None of it in retail or very little. We're not building any of it in industrial or very little multifamily, the area, which is a tragic and maybe tragic is too strong a word, but it's close to that. The place where we have the greatest shortage is the place where we're not building a lot more anymore. And we did have a record year last year, but permitting is way down.

And that's because of the cost of construction. So where does that leave real estate? It means that from a supply demand standpoint, it's good to have existing assets today in retail, in multifamily and industrial because they're not building anymore, even though there's a little softness there.

I do want to bring up a tangential issue here for just a moment, since you brought up taxation. The taxation issue is a complicated one because it impacts you both individually and then at the corporate level. So there are a few things you got to watch out for the corporate level of potential tax changes that are afoot because of some of the promises that the new administration has made. Some of them are positive in terms of extension of the 2017 tax act, but some of them may have negative implications. So one of the things that's been discussed is raising the ceiling on the SALT tax, which means that state and local taxes, if you live in a high tax state, your taxes actually went up under Trump in the first administration. They're talking about raising that. Well, they got to pay for that somehow. And how do you pay for that?

A couple of things that could impact our business. First, they're talking about extending the carried interest tax change. Right now it takes three years to get capital gains treatment. They may extend that to five years. All right, that's one thing that could impact our business. The other one that people are talking about now, now I don't think this is going to happen, but this should ring in the ears of everybody who's listening. The 1031 exchange is on the table again, the 1031 exchange is on the table all the time, every time they have a tax law change. While I don't think it's going to happen, it is something that you should take into consideration. It could happen because it would have material impact on not only the number of trades, but when you trade. So again, don't think it's going to happen, but you should know that there's some talk of that being on the table.

Tom:

You are singing to the choir here, so to speak. We just spent a week in Washington, D.C. recently in our Federal Fly-In and brought a hundred ICSC members to talk about tax policy and other issues. I'll add to your list. One of the items that's quite concerning and actually from a impact on real estate would be so much more significant than even the important items that you raised, Spencer, which is you had raised the individual SALT, on the cap on the individual salt. And there is some momentum around raising that cap. You do need to find a pay-for for it for that.

One of the items that they're talking about is corporate SALT or B-SALT, including property taxes and excluding the deduction of property taxes, which would obviously be catastrophic for the commercial real estate industry. And quite frankly, for any asset-heavy industry period, whether it's commercial real estate or oil and gas or manufacturing, etc. We're hopeful that won't happen, but it is being talked about as a menu of new things that they're looking for. I would just encourage our listeners to get engaged, whether it's through ICSC or through The Roundtable or other organizations to really make your voice heard around these important tax issues that are being discussed. I will tell you that ICSC is heavily engaged right now in Washington, D.C. around all those issues and is quite concerned around even having a conversation around excluding property tax deductibility at the federal level, which just seems contrary to kind of investing in real assets. That's certainly disincentivizing.

Spencer:

The only thing I'd add to that, Tom, is, and I encourage all our listeners to get involved. I would say most issues though, that impact our business, we're talking federal now, actually happen at the local levels. And we talked about permitting, we talked about zoning, we talked about—good luck getting a curb cut on a new facility, right? I mean, a curb cut is a hugely controversial issue. Sounds like, oh, it's a big nothing. Trust me, it's a big deal. And so get involved. We've got some great people, ICSC, The Roundtable, National Multifamily Housing Council, we're all over the federal issues. We can really use your help with the local levels.

Tom:

Before we leave this topic of uncertainty in the economy, does that create some new opportunities for commercial real estate? The cost of uncertainty, is there areas that we should be looking at and saying, well, that's an opportunity in an uncertain environment. Kind of to that Warren Buffett, when others are fearful, that's when you lean in. And maybe that—you maybe raised that when you raised the border industrial as one opportunity.

Spencer:

One of the interesting things about what I do is I meet with everybody. I meet with the big institutions. I meet with high net worth individuals. I meet with occupiers. I've seen a noticeable split today between the behavior of institutions on the one hand and high net worth individuals on the other. And the behavior really boils down to more risk taking among the high net worth individuals than among the institutions because they have a longer time horizon. And so going in and buying the best office building in the best submarket at north of a 10 cap sounds like a great deal because, you know why? It is! And you can't tell me that the best office building in the best submarket in just about any city that's trading at north of a 10 cap won't be trading at an eight cap or seven cap five years from now. It is that type of risk taking that has disproportionately gone to the high net worth because you can't get through investment committee, anything with the dreaded “O word”, today, the “office” word going on today.

The other thing I've seen high net worth doing more than I've seen institutions is building. I'm encouraging people to build because the best time to build is always when nobody else is building. And the reason why people aren't building is because they can't get to their magic 6.5% yield on cost. Well, if you look at your assumptions differently and you look over the long term and you're going to be the only game in town three years from now, you're going to get rent well in excess of what the market rent is.

And that will get you a higher yield on cost, but the institutions can't do it today because they're looking at it really through a, I think too narrow of a prism. So the opportunities, and I say this matter of fact is to look at how longer term investors are acting today. Act more like that in building and in buying some of these disfavored asset classes.

And then when you build, I'll give you one other thing. This also, you know, tragically came out of the Los Angeles fires. We had an episode on The Weekly Take, which we taped the morning of January 7th when the fires really got out of hand, and it was on property and casualty insurance and resilience. Another thing you're seeing more of among the high net worth crowd than the institutional crowd is building more resilient properties, building that building three feet above the hundred-year flood plain rather than at level, building with better materials. And the reason why you don't see as many institutions doing that, and it seems obvious is because I can't look an institution or even that high net worth individual in the eye and say, you're going to get that money back on the backend because the market hasn't moved that way yet.

But I believe the market is in two ways. One, I think a more resilient building will trade for higher down the road. But here's the area where the real X factor comes in. Property and casualty insurance is no longer just a blanket. Not, you know, got to have it and you rest on your pillow at night. No, it is a piece of your puzzle that includes resilience—building a better asset you don't have the kind of claims—and then here's the other one, self-insurance. What you're seeing now more among our multifamily crowd but you're seeing it more and more because self-insurance, and lower deductibles, meeting with the reinsurers over in London or wherever they might be. These are becoming things that I think the high net worths are at the Vanguard institutions are a step behind

Tom:

Interesting. Well, Spencer, we're at the end of our time. Any final words for the listeners?

Spencer:

Well, first of all, Tom, thank you for being—having me on your show. Thank you for being on my show. And I know this is primarily a retail show so I’ll say it one more time. Five years ago, I got thrown out of every major institution pounding the table that open-air retail was the most undervalued asset class. And doggone it, I was right.

Tom:

That's a good way to end. You were right and we're glad that you were. Well, thank you, Spencer. Wonderful to spend time together. Look forward to seeing you in not too distant in the future in Las Vegas.

Spencer:

Absolutely. Or New York or both.

Tom:

Please follow and rate this podcast five stars on Apple and Spotify and share it with others that might find it interesting. Thanks for listening.