Serial Office 2016 Plus 64 Bits
Gaspard Xenos
Jim Farley: We are designing our second cycle product in the EV space that will be coming out in the next couple years. I think it'll be fully competitive with Tesla on a cost basis, but they're really good. They're really good competitor. We're number two in the US and we want to continue to grow from, say 20,000 a month now production to 50,000 by the end of this year.
Jack Hough: Hello and welcome to the Barron's Streetwise Podcasts. I'm Jack Hough. The voice you just heard is Jim Farley. He's the CEO of Ford, which will soon host a day of presentations for investors. I spoke with Jim a week or so ago, and in a moment, we'll hear his thoughts on autonomous driving, where we are in the auto demand cycle and how to compete with Tesla. We'll also talk a bit about workers slow footing it back to the office and what that means for real estate investment trusts.Listening in is our audio producer Mette. Hi, Mette.
Davey Friedman: Hey, Jack, this is Davey Friedman from Seattle and hi Meta, big fan of the show. Okay, here's my question. It seems like a very painful, very volatile time in the office market right now, and I'd love your opinion on how this could impact commercial real estate investors. Who do you think will be the winners and losers from all the change that's happening in the office market and is there an opportunity for smaller everyday investors? Thanks.
Jack Hough: Thank you, Davey, for your excellent and timely question. This has been on people's minds since the beginning of the pandemic really, and I think we've reached a point where we've seen enough and gathered enough data to come to some near term conclusions about how people might behave and what it might mean for commercial real estate. There's a study just out from a research group called Placer.ai, and it talks about the new hybrid normal. Let me read a few lines from it. It says, return to office mandates seem to be everywhere for the pandemic squarely in the rear-view mirror. A growing number of companies are cracking down on fully remote work, but hype notwithstanding, few workplaces are demanding that people show up in person five days a week. Our friends at the Wall Street Journal wrote about that this past week, citing that study and other sources.The story was titled The Return to the Office Has Stalled. It says that office usage had reached more than 50% back in January, but it hasn't pushed much higher since. One source in that story said that the company's requiring employees to be back in the office full-time. That percentage has actually declined to 42% from 49% three months ago. Among workers at companies with hybrid work strategies, the average number of days they go into the office is two and a half, and it has a chart of the days that workers like to go into the office, and it appears like the new Monday through Friday, is a Tuesday through Thursday.This is a sensitive subject. People have passionate views on both sides of the merits of workers going back to the office full-time most of the time, what have you. We're going to put those views aside and focus on the investment implications. And if you're an ordinary investor, that probably doesn't mean buying an office building at a beaten down price, but it might mean buying a REIT. REIT stands for Real Estate Investment Trust, and Davey, I think this is what you were talking about when you mentioned everyday investors. Real estate investment trusts buy property and collect rents and pass that along to shareholders as dividends and some of them specialize in office buildings and you won't be surprised to learn that shares of REITs like that have been hit pretty hard lately. Boston Properties, that's ticker BXP, that's down 60% so far this year. The dividend yield, of course, gets higher as the share price falls, so it's now 8.3%. Here's another even more extreme example, it's called SL Green Realty, ticker as SLG. That one's down 71% so far this year, and the dividend yield is over 15%.
Jack Hough: Yeah, it's humongous. When you see one that high, it makes you think, is there something wrong here? Is this a dividend payment that's about to be cut and therefore I shouldn't rely on our percentages high? And in the case of SL Green, it already did recently cut its dividend. It's just that the share price is down so much that the new yield is that high. Even on the reduced dividend, we'll see what happens to that dividend. So as you can imagine, one type of investor might be saying, "Office REITs, this is a terrible time for that. Why on earth would I buy something like that?" And another investor might say, "You know what? I think the worst is priced in here. The outlook is so gloomy, and these shares look so cheap, and the dividend yields look so high that even considering the risk that landlords in the future can't collect all the rent they had hoped for, and the dividends have to be cut, I still think long-term make out okay."So the question is, are there opportunities in office REITs? And for a fresh take on that question, I reached out to Jon Petersen, he's the head of the US REIT team at Jefferies.We had a question from someone who just basically wants to know what's the situation with going back to the office. It seems like there's a lot of strain on these landlords, and we could see how that would be harmful for some of these office REITs, but might it be the case that it's so bad, it's good. Are there opportunities out there? Are there any shares that you see in that space that are so beaten down that they're attractive or is it best to just stay away?
Jon Petersen: For now, we're definitely in the camp of it's probably best to stay away, but that doesn't mean that the asset class is broken forever. I mean, basically what happened is if you think about the supply and a demand curve, the pandemic just shifted the demand curve down and the supply stayed the same.
Jack Hough: Jon says that small and mid-sized businesses, especially have gone in the direction of allowing for more remote work and even giving up their office space. And a lot of major markets in the US vacancies are 15% to 20%. The market has to adjust for that, and it won't be quick.
Jon Petersen: It's hard to invest in these stocks right now because it's going to take a lot of years to either grow in to all of this excess supply or take that excess supply off the market and turn it into something else. And in terms of the individual REITs, we don't have any buy ratings across any of the office REITs we cover right now. I think a lot of these companies have, some of them have balance sheet issues which they need to work through.
Jon Petersen: Yeah, for sure. I mean, I think that the face rents have stayed about the same. What you're seeing is a lot of additional incentives like offering more months of free rent in the beginning or a larger... what they call a tenant improvement allowance. Most office space you go in when a new tenant moves in, you kind of demolish the entire existing space and build it to the specifications of whoever is moving in there. So one thing that landlords can do is give them a larger allowance, kind of a piggy bank that they can use to make even nicer office space. And by the way, just as a bit of a tangent, I do think that's absolutely a trend that is encouraging that we've seen in the office space that companies that want their employees to come into the office are investing more in their office space.J.P. Morgan's building a nice large, tall tower here in Manhattan, in Hudson Yards, and just all across the country actually tends to get leased fairly well because companies that want their employees to come in can say like, "Hey, we've got this really nice shiny office space." It kind of gets into the other point that a lot of the risk is kind of the more class B type product that's 40, 50 years old that maybe 10, 15 years ago we would've called class A, but today just it feels like it's a level down from where it used to be.
Jon Petersen: It's doable, but it's expensive. Well, I'll give you a few examples. So after 9/11 in the financial district, there was a lot of larger bold office buildings that were converted into residential, successfully. One of the reasons that it worked down there is because if you've been in the financial district-
Jon Petersen: Exactly. It turned residential. But the reason that it works is because they're smaller streets and so the floor plates of each building are smaller, and so that's one of the issues with some of these large office buildings. In midtown Manhattan, you have these big expansive spaces and if you start cutting it up with apartments, you end up having a window problem. The plumbing is also very difficult.
Jack Hough: So, Jon says there might be an opportunity in office REITs down the road, but for now it's best to watch and see what happens. And he makes a comparison with mall REITs. Malls, of course, have been hit hard by store closures.
Jon Petersen: I would say the mall real estate is actually in a more healthy place today because of a lot of those old malls that were anchored by these department stores that went under were sold off, torn down, turned into something else reimagined, and so the supply side was fixed. It really took five to seven years I think, to get that done. And now we're in a place where I think if you go to most malls in the country, like the better malls, they're pretty well occupied. The rents are generally stable or growing. I think there's a lot of parallels to what's happening in office right now. It could be at this long painful transition, but there is a light at the end of the tunnel.
Jon Petersen: Almost entirely distribution warehouses. So this is a concrete floor, four walls and a roof, and you could do all sorts of stuff with it. One huge user of that space over the last five years or so has been Amazon, which doubled their square footage through the pandemic, drove market occupancy from the low '90s up to the mid to high '90s. There's been a lot of pricing power in that space, and so you've seen really strong rent growth, 30% to 50% in total over the last few years of rent growth, and you have about five year lease terms. So these companies are still rolling over leases today that were signed five to seven years ago in increasing those rents by 50%, 60%, 70% plus in a lot of cases. And so I think those kind of structural tailwinds of more people shopping online is going to continue to drive demand to that space.
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