Even giving my two cents worth each month is shrinking! Mike Tyson is famous for once saying, “Everyone has a plan until they get punched in the face.” I wonder what his seatmate’s plan was when he repeatedly insulted the former world boxing champion on a recent flight? My parents taught me that “sticks and stones may break my bones, but words can never hurt me.” In today’s rude and “cancel culture” it might be time to rethink that colloquialism!
Speaking of a punch in the face, we seem to be climbing a wall of worry. The S&P 500 is down more than 10% from its peak in January. Inflation is at a 40+ year high and ongoing supply chain issues are being extenuated by China’s COVID lockdown and the Russia/Ukraine war. Add rising interest rates and the U.S. political mess and you have to wonder how big a wall we can climb?
In general, inflation is kind to real estate. It can boost cash flow (raise rents) which leads to higher valuations. But that’s with 2% to 3% inflation. With 5% to 10% inflation, it starts eating into consumer spending forcing the Fed to pump the brakes. Consumers are already tapping the brakes themselves. Gas prices were up more than 18% in March, yet sales at gas stations grew by only 9%– telling me people are just not driving as much. In a recent survey, 53% of those surveyed said they had cut back on driving in the last six months. When tenants can’t pay higher rents and cap rates rise because of higher borrowing costs, it can be unkind to commercial real estate or an “RYFO” moment – (Rip Your Face Off)!
I was recently asked if a recession is a certainty, will it affect the booming housing market? My answer, “Yes, it is the only way people will know we are having a recession.”
The second question I am regularly asked is, “What about all of the office vacancy?” My answer remains the same, “It will fill back up.” Sam Zell recently said, “There is no substitute for motivation.” He also said, “I don’t know how you motivate by modem.” I can’t agree more, business leaders I speak with are concerned their culture is deteriorating. People need to be there to hear what they are saying about you. They need to be there to get the plum assignments.
Despite the rise of the metaverse and online working platforms, the vital role of the physical office as a place for collaboration and collective creativity will continue. But what will offices of the future look like? Many experts believe they will become social hubs, suggesting we could see the integration of bars, wellness spaces, expansive communal tables and residential-style lounges. Spaces will be adapted to enhance creativity, relationship building and face-to-face communication between professionals, while the hybrid working model will allow workers to use these new facilities in ways that best fit their own lifestyles and working needs. Cubicle farms are out. In 2022 and beyond, workspace providers will be delivering seamless video-conferencing suites to convivial social spaces, recording studios, hot desks that can be booked by app and al fresco forums for team gatherings.
For many companies, cutting-edge design will be used to boost motivation, creativity and a sense of ‘culture’. Even fun will have an important part to play – just think of tech giants such as Google, which, even pre-pandemic, had Lego zones, slides and bowling alleys built in. Access to green space will also become a major boon, suggesting that major companies could invest in surrounding parks and gardens for employees. Within the building, touchless technology powered by facial recognition, for example, could ease virus concerns. Workplace experience is clearly connected to other areas of focus, such as mental health and well-being, as well as employee retention and productivity. Companies such as Netflix and Jaguar Land Rover are powering the shift, leading the way by employing workplace experience managers to make their offices places where staff are happy to spend their days, and build a positive culture that manifests brand values. Although hybrid workers will only be going into an office or coworking space part-time, when they do, they will have a highly motivating experience. Workplace experience managers can also assist with events and extracurricular activities for teambuilding, which is essential to ensuring a sense of togetherness and inclusion.
Speaking of togetherness and inclusion, as we return to the office and work in these edgy belligerent times, how do we get along, so we don’t get punched in the nose? After all, we are supposed to be working together, not against each other. As we like to say here at CDC Commercial, “We’re here to do deals!”
We live in a world right now of noise and pressure and people feeling polarization everywhere they go. It would be nice for the world to stand still so everyone can catch their breath, but that’s not realistic. So instead, we need tools to work with one another harmoniously. Here are some that we use every day while “doing deals”.
- Start with empathy – find something to talk about that’s not the subject of your difficulty.
- Let them empty their cup first – when there is conflict, let the other person speak first. Find out why they believe so strongly in the other direction.
- Be curious – lead with a question (my favorites always start with “why”. Remember everyone is comfortable in their own realty.
- You may be closer than you think – find points of agreement.
- Choose acceptance – acceptance is understanding the situation for what it is, even if you don’t agree.
- Show respect – agree to disagree.
As much as I love our new digital world of Venmo, DocuSign and wiring funds, fraud is on a huge increase. Please be careful with your wire transactions:
- Call, don’t email (get numbers from original documents or business cards)
- Be suspicious – there shouldn’t be changes
- Confirm all #’s
- Verify when sent and/or received
Last year, Prop 19 went into effect. The impact of Prop 19 is just starting to be felt – another RYFO moment for many families. As most of you know, Prop 13 caps property taxes at 1% of the assessed value. So, property taxes typically didn’t increase much until a sale of the property. Prior to Prop 19, parents could transfer/bequeath property to their children, and the transferred property would retain its property tax basis despite the change of ownership. Now, either your heirs (under a gross lease) or tenants (under triple net leases) could see a big property tax increase. Time will tell, but the impact could make it difficult for heirs to retain property (there are some exclusions, but it affects residential property as well). For generations now, many homes were passed from homeowners to their children, providing them with homes in areas that would otherwise be impossible for them to move into, such as San Francisco or the beach communities of Southern California. You should definitely speak to your tax advisors, but there may be some workarounds available. A long-time friend, partner and attorney, Larry Murnane, provides this one as an example.
To illustrate Don’s point about inflation and the accompanying loss of confidence by consumers and small business owners, I have enclosed a couple of very illustrative charts. If you would like an evaluation of your property value, let me know.
Please give me a call or email me if you would like an analysis of your properties’ value or discuss what you should be doing with regards to interest rates or inflation and their impacts on your business, tenants, or property (Nick Zech, 858-232-2100, email@example.com).
Since I got into the business, I have heard about 18-hour and 24-hour cities (think London, NYC, and San Francisco). Envious cities have tried to grow to this status. Frankly, it’s never been that attractive to me. However, my head was recently turned by an idea pioneered by French academic Carlos Moreno. It’s called the 15-minute city. The idea is for your work, live and play to all be within a 15-minute walk or easy bike ride. This could be one of the most dramatic and long-lasting legacies of the pandemic. I hope you enjoyed my two cents worth this month and the story…
Pennies from Heaven by Julie Bain
My dad loved pennies, especially those with the elegant stalk of wheat curving around each side of the ONE CENT on the back. Those were the pennies he grew up with in Iowa during the Depression, and Lord knows he didn’t have many.
When I was a kid, Dad and I would go for long walks together. He was an athletic six-foot-four, and I had to trot to keep up with him. Sometimes we’d spy coins along the way – a penny here, a dime there. Whenever I picked up a penny, he’d ask, “Is it a wheat?” It always thrilled him when we found one of those special coins produced between 1909 and 1958, the year of my birth. On one of these walks, he told me he often dreamed of finding coins. I was amazed. “I always have that dream, too!” I told him. It was our secret connection.
Dad died in 2002. By then, I was living in New York City which can be exciting, or cold and heartless. One gray winter day, not long after his death, I was walking down Fifth Avenue, feeling bereft, and I glanced up and found myself in front of the First Presbyterian Church, one of the oldest churches in Manhattan. When I was a child, Dad had been a Presbyterian deacon, but I hadn’t attended in a long time. I decided to go.
Sunday morning, I was greeted warmly and ushered to a seat in the soaring old sanctuary. I opened the program and saw that the first hymn was “A Mighty Fortress Is Our God,” Dad’s favorite, one we’d sung at his funeral. When the organ and choir began, I burst into tears.
After the service, I walked out the front doors, shook the pastor’s hand, stepped onto the sidewalk—and there was a penny. I stopped to pick it up, turned it over, and sure enough, it was a wheat 1944, a year my father was serving on a ship in the South Pacific.
That started it. Suddenly wheat pennies began turning up on the sidewalks of New York everywhere. I got most of the important years: his birth year, my mom’s birth year, the year his mother died, the year he graduated from college, the war years, the year he met my mom, the year they got married, the year my sister was born. But alas, no 1958 wheat penny—my year, the last year they were made.
Meanwhile I attended church pretty regularly, and along toward Christmas a year later, I decided I ought to join. The next Sunday, after the service. I was walking up Fifth Avenue and spotted a penny in the middle of an intersection. Oh, no way. I thought. It was a busy street; cabs were speeding by–should I risk it? I just had to get it.
A wheat! But the penny was worn, and I couldn’t read the date. When I got home, I took out my magnifying glass and tilted the copper surface to the light. There was my birth year.
As a journalist, I’m in a profession where skepticism is a necessary and honest virtue. But I found 21 wheat pennies on the streets of Manhattan in the year after my father died, and I don’t think that’s a coincidence.
“The point to remember is that what the government gives, it must first take away.”
~ John S. Coleman
Although the quote above is both funny and true, it is not entirely accurate. If taxing was the only way our government paid for things, our taxes would be much higher. Instead, our government prints more money by borrowing it with no intent to pay it back. This simply devalues our currency, effectively taxing you out of your money. In a simple example, that $3 gas or $3 hamburger you used to enjoy is now $6 – you just experienced a 100% tax!
The two-edged sword is that the Federal Reserve is tasked with fighting inflation. They started doing so at their March meeting by raising interest rates a quarter percent. Unfortunately, this increases borrowing costs which leads to greater costs of goods and services until…it puts a damper on economic activity.
Shorter term rates (overnight lending all the way to two-year Treasuries) are affected by the Federal Reserve rate increases. Long-term rates 10–30-year Treasuries (and yes, home and commercial loans) are determined by market supply and demand. However, there is a warp in the universe when those short-term rates are higher than the long-term rates. This makes no sense. Why get a better return on a short-term loan than a long-term one where there is far more risk? Going back to the 1950s, every time the two-year treasury yield has exceeded the yield on the 10-year Treasury, a recession wasn’t far behind. The last time such an inversion occurred, briefly, was in August 2019, and we all know what happened the following year. Although there is no way the pandemic could have been predicted, an economic pullback was highly probable. This phenomenon is called the yield curve inversion.
This month Bank of America sounded the alarm, telling clients it expects an inversion to occur sometime this year as the Fed is forced to raise rates to slow inflation and slow the U.S. economy. With inflation running at a scorching 7.5% over last year, the Fed may be compelled to hike rates more aggressively than initially planned, which could shock economic growth.
BREAKING NEWS: Yesterday March 31st the 10/2 Yield Curve became inverted – Beware!
As of the first of the year, California is 1.2 million jobs above last year, but we are still 690,000 below the pre-recession December 2019 peak. The 2020 recession was officially the shortest on record, but the hangover continues today. Government stimulus (see printing money above) is catching up with us in the form of inflation (“pay me now or pay me later”).
While lost income from high unemployment normally results in reduced sales volume and prices in real estate, the opposite occurred in 2020-2021. Recessionary conditions never took hold in the housing market due to the combination of historically low inventory for sale, unparalleled loan rate reductions, massive cash disbursements to consumers and foreclosure and eviction moratoriums. As these events reverse course in 2022 hang on to your hat and look for opportunity.
If you are like most of us, looking for your next mini-series to watch, you might check out “WeCrashed.” It is the story of WeWork, the co-working office space company, and it is on Apple+ (you can subscribe free for a week). Being in real estate makes it fun to watch how landlords, tenants and brokers are portrayed. It’s the repeating real estate story we see daily as leasing brokers. The guy with a dream–faking it until you are making it. In Adam Neumann’s case, a zero to $47 billion valuation. If you want to see the antithesis of how “fake it until you make it” doesn’t work out, you may want to watch “Inventing Anna” on Netflix.
As March madness comes to an end, I reflected on how people pick their brackets. Some people pick their favorite team to win and then work backwards. They fill in their pool based on a fixed notion for which team is best. They disregard the path no matter how hard it might be for their team to become champion. This reminds me of how some people buy real estate. “It doesn’t matter what the price or value is, I want it.” Others pick their bracket based on potential match up, analyze records, schedule strength, skills, weaknesses and even how the team travels. This also reminds me how people should buy real estate. They pick based upon a path to becoming a champion.
So, why do many investors use a less rigorous process in investing than they do in filling out their NCAA tournament brackets? Over the long run, those who follow a well-thought-out, time-tested, process-oriented approach will raise the odds of success in compounding wealth by limiting damaging losses during significant market setbacks and being afforded generational opportunities when others are fearfully selling.
Real estate investing deserves considerably more thoughtfulness than filling out a bracket.
Here is a chart that illustrates Don’s point about the yield curve and recessions.
Please give me a call or email me if you would like an analysis of your properties’ value or to discuss what you should be doing with regards to the Coronavirus pandemic and its impacts on your business, tenants, or property (Nick Zech, 858-232-2100, firstname.lastname@example.org).
Like most of you, I have been shocked and appalled by Russia’s invasion of Ukraine. Corporate America has responded by pulling brands out of Russia, but in a weird turn of events, closed McDonald’s locations have been taken over, renamed Uncle Vanya and had the famous “golden arches” turned on their side while maintaining the same color scheme (I wonder if Uncle Vanya is dressed as a red headed clown?).
As you prepare to give the government a share of last year’s income, I hope you enjoy this month’s story…
The IRS decides to audit Grandpa and summons him to the IRS office. The auditor was not surprised when Grandpa showed up with his attorney.
The auditor said, “Well, sir, you have an extravagant lifestyle and no full-time employment, which you explain by saying that you win money gambling. I’m not sure the IRS finds that believable.”
“I’m a great gambler, and I can prove it,” says Grandpa. “How about a demonstration?”
The auditor thinks for a moment and says, “Okay. Go ahead.”
Grandpa says, “I’ll bet you a thousand dollars that I can bite my own eye.”
The auditor thinks a moment and says, “It’s a bet.”
Grandpa removes his glass eye and bites it. The auditor’s jaw drops.
Grandpa says, “Now, I’ll bet you two thousand dollars that I can bite my other eye.”
Now the auditor can tell Grandpa isn’t blind, so he takes the bet. Grandpa removes his dentures and bites his good eye.
The stunned auditor now realizes he has wagered and lost three grand, with Grandpa’s attorney as a witness. He starts to get nervous.
“Want to go double or nothing?” Grandpa asks. “I’ll bet you six thousand dollars that I can stand on one side of your desk, and pee into that wastebasket on the other side, and never get a drop anywhere in between.”
The auditor, twice burned, is cautious now, but he looks carefully and decides there’s no way this old guy could possibly manage that stunt, so he agrees again.
Grandpa stands beside the desk and unzips his pants, but although he strains mightily, he can’t make the stream reach the wastebasket on the other side, so he ends up urinating all over the auditor’s desk.
The auditor leaps with joy, realizing that he has just turned a major loss into a huge win. But Grandpa’s attorney moans and puts his head in his hands.
“Are you okay?” the auditor asks.
“Not really,” says the attorney. “This morning, when Grandpa told me he’d been summoned for an audit, he bet me twenty-five thousand dollars that he could come in here and pee all over your desk and that you’d be happy about it.”
02 Mar / 2022
In June of 1812, Napoleon with all of his generals plotting to invade Russia was strategy. Getting half a million soldiers to march into Russia was culture!
In a recent interview, a glass half full of water was placed in front of me. I was asked if I was a pessimist or an optimist. I proceeded to knock back the glass of water and responded, “I’m a problem solver.” These days it is easy to get bogged down in fear. However, it is important to notice something needs to be done and get it done. So many today might entertain a thought and consider it worthy of action but leave it for later (or never). It is easy to get bogged down in fear. At CDC Commercial we are working daily to cut through the “stuff” and get the job done!
We experienced Another Upbeat Year according to local economist Alan Nevin. His great report is linked below. Note, however, he does start out with the 12 plagues that we have experienced.
COVID-19’s second anniversary is upon us, now what? We have lost over 900,000 Americans and over 4,800 San Diegans who have died with COVID. We are experiencing challenges with child development as kids lag from two years of modified school and the lack of social contact. Behavioral health issues have increased dramatically while drug overdoses have spiked. The precautions we exercised due to COVID separated us. Social media exacerbated everything. If you spend five minutes on social media, you’ll see a chasm of divisiveness. Debates spin out of control creating another kind of separation. We live in a society of people who want the front of the bus, the back of the church and the center of attention.
On a regular basis, I am asked, “What’s going to happen when the Fed raises rates?” What I know is when the Fed starts to slow or drain its monetary liquidity, the clock starts ticking to the next corrective cycle.
History shows us what will happen. Once the Fed begins to hike interest rates, corrections in markets occur quickly– generally within 2-4 quarters. However, recessions and bear markets generally take a while longer and have sometimes been extended due to ongoing interventions. The current median time frame between the first-rate hike and the onset of a recession is 11 quarters.
Note: there are ZERO times in history where the Fed hikes rates that did not end negatively.
In the meantime, in the field or battlefield as it often seems, we are seeing lots of different activity. Commercial space is starting to get upcycled. We are seeing office space be converted to residential, shopping centers and office buildings being converted to biotech and lab space. All kinds of property being torn down for multifamily construction. In retail, we are seeing a resurgence of store inside of a store. Toys ‘R’ Us is back but within Macy’s. Sephora is expanding within Kohl’s and Bed Bath & Beyond is opening within Krogers.
Meantime, millennials are finally heading to the suburbs. Whether it is COVID that has flushed them out of urban markets or their biological clocks going off, millennials are going to urbanize suburbia! Look for more Amazon delivery and Uber Eats in the neighborhood and small pop-up shops in old downtowns and shopping centers. Look for more multigenerational housing (millennials using parents’ money to buy in return for living in the ADU (additional dwelling unit) or “Granny Flat.” Time for the gray wave to start moving into the millennial’s basement! (Payback is a bitch!).
Biotech is booming which is what is forcing the upcycling of properties to create more space.
I threw in an extra chart illustrating Don’s point about rate hikes and recessions.
Please give me a call or email me if you would like an analysis of your properties’ value or to discuss what you should be doing with regards to the Coronavirus pandemic and its impacts on your business, tenants, or property (Nick Zech, 858-232-2100, email@example.com).
Former Federal Reserve Chief Ben Bernanke used to say the Federal Reserve was a hall of mirrors. He said this because the Fed listens to the market and the market listens to the Fed. It would seem we need some leadership…or maybe some culture instead of strategy. In the meantime, last month I questioned where all of the workers were. I am glad to report our research has found the answer to that AND why you and I are sooo tired. I hope you enjoy the story…
Are you tired?
I have run across some irrefutable statistics that show exactly why you are tired. And it’s no wonder. There aren’t as many people actually working as you may have thought, at least according to recent surveys.
The population of this Country is about 300 million. 85 million are over 60 years of age, which leaves 215 million to do the work. People under 20 years of age also total about 85 million which leaves 130 million to do the work.
There are about 30 million employed by the government, which leaves 100 million to do the work. There are about 5 million in the Armed Forces and about 23 million unemployed (as of April 2020) which leaves 72 million to do the work. 55 million have mental health issues and 15 million work in city and state offices leaving us with 2 million to get the work done.
Now it may interest you to know that there are 1,999,998 people in jail, so that just leaves two people to carry the load. That’s you and me and I don’t know about you, but I am sure getting tired!
03 Feb / 2022
He was a lowly intern in Philadelphia picking up dry cleaning or fast food for coaches… He was promoted to a coach’s assistant for a few years and then a scout for a few more. A decade later in Kansas City, he was mesmerized by a player on video no one else saw. “What’re you watching? Kansas City Chiefs Coach Andy Reid asked Brett Veach. “The next quarterback of the chiefs,” replied Veach. He wasn’t just enamored by Mahomes, he was borderline obsessed. He contacted Mahomes’ agent for 94 straight days heading into the draft. Yet no one saw it. When Mahomes was drafted he was graded as a C+ pick at best. Yet with that one value-based decision, one man is the face of the NFL (maybe not as much after Sunday’s loss to the Bengals!), and one lowly intern is the general manager of the Kansas City Chiefs!
I keep reading the economists prognosticating that 2022 will be a strong growth year, and no stop to rising markets (real estate, stocks, etc.). However, I am reminded of the quote, “Economists know the price of everything but the value of nothing.” Just remember that market conditions can and do change. Football analysts, economists, and investors like to believe things will continue to be the same in the future as they are now. This is called, “normalcy bias.” We’re still in that fear of missing out (FOMO) stage. Rates are rising and buyers of property (residential and commercial) are trying to jump in before they go up further. Eventually, the pendulum swings to FOBO – fear of better opportunities. This phenomenon occurs when buyers hold back because they are afraid prices will go down further. It is also referred to as, “Don’t try to catch a falling knife.”
To be clear, I am not saying we are in a bust, but trees don’t grow into the clouds. At the same time, commercial property investors have been getting it wrong for two years waiting for distressed sales which haven’t materialized. The apartment industry thought it would face an eviction crisis, instead, rent grew 11% and owners hung on and many sold for record prices. The pandemic killed almost all retail but in 2021 there were more store openings than closings. Unemployment levels skyrocketed during the pandemic, yet unemployment rates are now near pre-pandemic levels. Another one we got wrong is inflation. Fed Chair Jerome Powel said inflation is “transitory” but it doesn’t appear to be coming down anytime soon.
President Calvin Coolidge once said that inflation is repudiation. Webster defines repudiation as, “an act or declaration before performance is due under a contract that indicates that the party will not perform his or her obligations.” Thought-provoking!
During recessions, central banks typically respond by cutting interest rates, which stimulates the economy by encouraging more borrowing and reducing the relative debt cost. This process of debt accumulation and lowering interest rates repeats itself for decades. When interest rates hit the floor at 0% it marks the beginning of the end of the long-term debt cycle and the start of a deleveraging period where central bankers begin to devalue their currencies. Interest rates can no longer be lowered because they are at zero. Therefore, policymakers only have two remaining options: quantitative easing (i.e., printing money and buying financial assets) or printing money and putting it directly into the hands of people in the form of stimulus payments. In the words of Ray Dalio: “When the risk-free interest rate that they control hits 0% in a big debt crisis, central banks lowering interest rates doesn’t work. That drives them to print money and buy financial assets. That happened in 1929-33 and 2008-09. We call the power of central banks to stimulate money and credit growth in these ways “the amount of fuel in the tank.” Right now, the world’s major central banks have the least fuel in their tanks since the late 1930s so are now in the later stages of the long-term debt cycle.”
The late economist and stock picker Richard Russell used to say, “inflate or die.” He meant that the Fed was committed to fighting deflation and when faced with debt, they would crank up the printing presses.
What stops inflation? People’s belief and acceptance that it is contained. How does that happen? Interest rates go up and everything else goes down (yes, that includes real estate). Then the Fed steps in – see paragraph above. Goldman Sachs recently predicted that the Federal Reserve will be raising rates four times in 2022 (up from earlier predictions of three times).
Goldman Sachs also reports that 98% of small business owners in CA report that labor shortage is affecting their bottom line. Eighty-one percent report inflation, 77% site supply chain, and 70% say COVID-19 is dragging on their bottom line. The mystery to me, however, is the disappearing workforce. Although the San Diego unemployment rate has dropped to 4.2% in December (5% for CA and 3.7% for the U.S.), we still have almost a million fewer workers employed in California than in January 2020 before the pandemic.
One thing you can expect to go up is property insurance. The supply chain and inflation are making repairs to commercial properties more expensive with higher costs for labor, lumber, and steel.
Please give me a call or email me if you would like an analysis of your properties’ value or to discuss what you should be doing with regards to the Coronavirus pandemic and its impacts on your business, tenants, or property (Nick Zech, 858-232-2100, firstname.lastname@example.org).
Another thing that boomed in the pandemic despite predictions was the industrial market! Biotech accounted for 15% of the new office and industrial leasing in San Diego in 2021. Amazon signed 4 leases in the County for almost 2 million square feet accounting for 13% of completed leases in 2021.
A little early but Happy Valentines Day to you. Did you know that chocolate manufacturers currently use 70% of the world’s almonds and 20% of the world’s peanuts? And now for the interactive part of this letter. Email me and let me know if 2021 were a candy, what would it be? And if 2022 were a candy, what would it be?
This month’s story is a video production that I thought you would like. It is a bachelor-like episode poking fun at what it is like as a tenant being courted by a property owner (get it – won’t you be my Valentine humor!). Hope you enjoy it…
06 Jan / 2022
Before you criticize someone, you should walk a mile in their shoes. That way, when you criticize them, you’re a mile away and you have their shoes.
It’s weird out there, folks!
Perhaps you have felt it yourself, your emotions at war with your better nature. A surge of anger when you enter a store and forget your mask, or your job or kids’ school is pushed remote. It is a strange, uncertain time. Things feel broken. Companies keep postponing back-to-the-office dates. The Centers for Disease Control (the “other” CDC) keeps changing its rules. Political discord has calcified into political hatred. And when people have to meet in transactional settings – stores, airplanes, customer service calls – they are in a word – devolving! It seems that instead of saying, “That really inconvenienced me,” people have a shorter fuse and now shout, “What the hell is wrong with you?”
This isn’t the way I want to live and it is not the way I want to feel. I don’t mind masking up and keeping a respectable distance to protect others, but I don’t like the empty zombie feeling I get in public. I crave human contact and refuse to be afraid of others. What I miss is connection. Connections make us feel human! What’s more, real estate is about connections. Office, retail, even industrial property foster connection. In the last two years, our real estate has taught us to not connect (glass shield, spacing stickers, disinfection stations). It is time to start looking at planning for how your real estate will foster connections once again.
2022 could become an interesting year. Will inflation and the Fed’s laggardly response be too little too late? Will we see a continuation of a totally bifurcated and expanding war of opposing philosophies in Washington and to a lesser extent throughout the whole country? Will the midterm elections prove to be a sea change or continue on the current path? Will the Omicron variant of COVID-19 become just another common cold or will it morph into another devastating illness that cripples our economy and kills thousands more?
As we enter 2022, I think we may be entering the “Jenga Economy.” It’s that place where everything is building back up, but we are all guessing which one block if removed, will cause everything to come tumbling down. It is a crazy time, stocks, bonds, real estate, car prices, oil/gas prices are all at or near all-time highs. Economists all seem to be reporting a strengthening economy will deliver strong fundamentals in all areas including commercial real estate. I read a recent survey that said more millionaire investors think the economy will be stronger in 2022 than those who believe it will be weaker (CNBC Millionaire Survey). However, most surveyed found little appetite for more risk. What I can’t figure out is how they think things will go up if they don’t want to buy more.
I also recently read an interesting theory that 2022 will see slower demand for physical goods as the service sector reopens and attracts more spending. (If true, will it be enough to give the economy a haircut? – Sorry I couldn’t pass it up!)
As we seem to be heading into an inflationary environment, rent increases – CPI or fixed– are worth rethinking. I saw my first fixed 4% (instead of fixed 3%) last month. When I first started in the business (yes, a long time ago!) we had a minimum of 4% max 8% as the standard and as inflation came down, we moved to min 3% max 7%.
“There are negative aspects when you encourage people to borrow, but later feel that you can’t raise rates because so many people borrowed. That’s something of a trap.” ~ Howard Marks, Oak Tree Capital
I know for years my dad produced “The Gold Report” with market data and statistics about the CRE market. If you still like to pour over this kind of information, here are some links to the best annual reports out there:
Well, whether we are entering a “Jenga Economy” or an “Everything Bubble” or a post-COVID boom, I wish you all a healthy and prosperous New Year. Just know that with every new change in life, you can either mourn for the past and waste time, or you can look for new opportunities and take advantage of them as they appear. Also, know that into every life a little bit of Murphy’s Law will rain. Hope you enjoy the story…
Who’s Murphy Anyway?
Murphy’s law is commonly referenced, but have you ever wondered who Murphy is? There are different opinions on who coined the idiom associated with Murphy’s law. One of the most popular is attributed to Capt. Edward A. Murphy Jr. in 1949. Murphy was working as an aerospace engineer testing the effects of rapid deceleration on pilots at California’s Edwards Air Force Base. He monitored the pilots’ stress levels while they were strapped to a rocket-propelled sled. During one of the tests, the strain gauges failed to record any measurements. Murphy discovered that the electrodes had been wired backward and blamed it on one of his assistants back at Ohio’s Wright-Patterson Air Force Base. He remarked, “If there are two or more ways to do something, and one of these ways can result in a catastrophe, someone will do it.” Weeks later during a press conference, Air Force Col. John Paul Stapp used Murphy’s phrase and nicknamed it “Murphy’s Law.” The adage is now used by everyday Americans but has been simplified too, “If anything can go wrong, it will.”
02 Dec / 2021
For me, the holidays are a time of reflection upon the year passed and intentions for the year to come, and especially thankfulness for the gifts in life for which I am most grateful.
Early in my career, I thought passion was everything. I used to grill clients and brokers and friends to find out if they had passion for their work. After all, if they didn’t wouldn’t they wake up someday with regrets? And that would be awful, wouldn’t it? I questioned why I thought you needed passion to be successful or happy. I have come to understand that it is how you act on your passions that really matter. Passion is quick to develop and quicker to fade. Mastery comes more slowly and commitment more slowly still. It is often said that you can find talent everywhere – that it’s commonplace. The same is true of passion. What’s not so common is the practice and discipline to achieve mastery. If there is any reason I continue to enjoy and pursue the work I do, it’s the layer upon layer of lessons and experiences I’ve had, which leads to greater confidence and mastery in my work.
When I got into the real estate business, I did it to become rich. Back then I was single and had no kids and I assumed that meant money in the bank and owning income-producing assets. I said my goal was to have enough money to be able to do what I wanted every morning without regard to money.
So, 37 years later, 36 years of marriage, four kids (all with the three “E’s” – Educated, Employed, and Elsewhere) all married, and three grandkids, I come into work today and realized I am rich!
Happy Holidays to all! Looking forward to a year filled with Happiness and Prosperity. Thought you would find this graphic on Happiness interesting!
Please give me a call or email me if you would like an analysis of your properties’ value or to discuss what you should be doing in the new year. Nick Zech, 858-232-2100, email@example.com.
So, this year, I thank you not just for being there or reading this letter. I thank you for making a difference. In a year when the problems seemed so insurmountable and untouchable, I have seen how much can be changed by the smallest of intentions coupled with a passion for mastery. I wish you the merriest of Christmases and Happiest of Holidays! I am honored to get to move forward into the challenges of 2022 working alongside you to help you find your riches and happiness. Hope you enjoy the story…
A professor gave a balloon to every student, who had to inflate it, write their name on it and throw it in the hallway. The professor then mixed all the balloons. The students were then given 5 minutes to find their own balloon. Despite a hectic search, no one found their balloon.
At that point, the professor told the students to take the first balloon that they found and hand it to the person whose name was written on it. Within 5 minutes, everyone had their own balloon.
The professor said to the students: “These balloons are like happiness. We will never find it if everyone is looking for their own. But if we care about other people’s happiness, we’ll find ours too.”
Merry Christmas and Happy Holidays to All!
Team CDC Commercial
Don, Nick, Matt, & Cheryl
The first meal eaten on the moon by Neil Armstrong and Buzz Aldrin was roast turkey in foil food packets. It wasn’t Thanksgiving Day but after their long path to the moon, they sure had a lot for which to be thankful. All too often we don’t look at the path of our life and stop long enough to be thankful for it. The picture above is from a hike we recently took in Acadia National Park in Maine. A little downtime to reset and commune with nature wads truly appreciated. I also had a chance to get caught up on a lot of reading and made a lot of observations, some of which I will share here with you.
- Domino’s Pizza posted its first sales drop in decades. Is this a sign of the end of the pandemic as we move on from our pandemic habits?
- Chick-fil-A’s CEO reported that a third of their customers drive away from the drive-thru because of long lines.
- Airlines are replacing first class with a new generation of super business mini suites. They are more spacious than regular business class and have a privacy door, but without the over-the-top luxury of first class (will trains and cars be far behind?).
- Closer to home, Costco Business Center announced it will be taking over the closed Fry’s Electronics store in San Marcos. This 144,000 sf deal goes down as the largest retail deal in San Diego this year and the second business center site in San Diego for Costco.
- ICSC (International Council of Shopping Centers) has changed its name but kept its acronym. It has rebranded itself as Innovating Commerce Serving Communities (ICSC). Interesting pivot by the leader of the shopping center industry.
- Amazon backed out of a deal to lease a distribution facility (142,000 sf) in El Cajon. The reason given was a county proposal known as “The Working Families Ordinance” which calls for prevailing union-level wages including 56 hours of paid sick leave on projects built on county-owned land. The ordinance won’t be approved until next year, but sadly it just cost over 400 jobs.
- Meantime, Amazon will be opening an Amazon Fresh store in a 45,000 sf former grocery store in Poway (Twin Peaks Plaza). There are currently 17 such stores across the nation. Expect to see all kinds of cool technology like “Amazon Cart” which keeps track of your shopping list, tallies the total in your cart and avoids the checker by just charging your credit card as you exit.
- Storage is hot. We are regularly getting calls and emails from developers looking to build more. A friend of mine told me that storage is really just an aboveground landfill! Seriously though, we are seeing many “gig workers” running small businesses from home (or Starbucks) and using storage for product, completely avoiding retail, office, and industrial traditional leased space.
- Speaking of calls we are getting – the County Board of Supervisors just voted to allow cannabis businesses to expand in the unincorporated portions of the county – up to 10,000 sf without special environmental approvals. A word of caution, most lender still won’t loan on cannabis stores and most loans have a default provision around it. Even if you own for cash, the marketability might be impinged because a buyer may not be able to get a loan. I do think it is high time we get this sorted out! (pardon the pun!)
- While headlines blare that office leasing is coming back and San Diego leasing activity is booming, I am afraid much of it is made up of mega deals with Apple, Amazon, Microsoft and the life sciences industry as a whole. The third quarter saw a 15-year record – 2.2 million square feet absorbed. While the County workforce declined by 10% in 2020, the life science field grew by 6%. Apple has been gobbling up office space in 70-100,000 sf bites at a time (or should that be bytes?).
- Sam Zell, the billionaire real estate magnate said he expects normal office usage to return within a couple of years. But his best quote was, “Need for in-person interaction will eventually win out: How do you motivate by modem?” The University of Michigan (Sam Zell’s Alma Mater) Consumer Sentiment Index has taken a steep drop. Ordinarily, this would indicate a recession, but employment and wage growth would indicate otherwise. In the meantime, keep your eyes on inflation, supply chain disruptions and what happens to Evergrande in China.
Here’s the University of Michigan chart that Don mentions above. The current administration is still considering the elimination of 1031 exchanges and raising capital gains rates. If you don’t see a property you own as being held for the long term, we should talk right away. If you don’t exchange, the tax treatment you’ll receive today is likely the best you’ll see for the foreseeable future.
We here at CDC Commercial Inc would like to extend to all of you a very Happy Thanksgiving. No matter where we all are on our paths, we hope you are happy. We know we are, and we are thankful to you for your business, our relationship, and the trust you put in us. We hope you enjoy the story…
Glass Of Milk
One day, a poor boy who was selling goods from door to door to pay his way through school, found he had only one thin dime left, and he was hungry.
He decided he would ask for a meal at the next house. However, he lost his nerve when a lovely young woman opened the door.
Instead of a meal, he asked for a drink of water! She thought he looked hungry so she brought him a large glass of milk. He drank it so slowly, and then asked, “How much do I owe you?”
“You don’t owe me anything,” she replied. “Mother has taught us never to accept pay for a kindness.”
He said … “Then I thank you from my heart.”
As Howard Kelly left that house, he not only felt stronger physically, but his faith in God and man was strong also. He had been ready to give up and quit.
Many years later that same young woman became critically ill. The local doctors were baffled. They finally sent her to the big city, where they called in specialists to study her rare disease.
Dr. Howard Kelly was called in for the consultation. When he heard the name of the town she came from, a strange light filled his eyes.
Immediately, he rose and went down the hall of the hospital to her room.
Dressed in his doctor’s gown he went in to see her. He recognized her at once.
He went back to the consultation room determined to do his best to save her life. From that day, he gave special attention to her case.
After a long struggle, the battle was won.
Dr. Kelly requested the business office to pass the final bill to him for approval. He looked at it, then wrote something on the edge, and the bill was sent to her room. She feared to open it, for she was sure it would take the rest of her life to pay for it all.
Finally, she looked, and something caught her attention on the side of the bill. She read these words …
“Paid in full with one glass of milk”
(Signed) Dr. Howard Kelly.
“Confidence is that feeling you have before you understand the situation.”
I hope that people’s confidence continues to strengthen, and workers return to work. People returning to work is the key backbone to commercial real estate stabilizing and recovering. Hiring software, such as Indeed, LinkedIn, and ZipRecruiter, has made it super easy to list countless positions and send countless resumes. The problem is that AI technology makes it easy to never see the applicant. Job seekers aren’t getting rejected, they’re just not getting past the technology! My son who is a golf pro was looking for a shop assistant. He got 350 applications, not one had the word “golf” in the resume– leading the software to give him no qualified applicants. We live in an environment that the numbers are not adding up, though it feels like they should. The Bureau of Labor Statistics says there are 8.4 million potential unemployed workers, but it also says there are a record 10.9 million jobs open. The rate people are getting jobs is lower than it was pre-pandemic, and it is taking longer to hire people. Meantime, job seekers say employers are unresponsive. So much for technology making life easier!
This leads me to “fuzzy math” and commercial real estate.
“Fuzzy math” was first introduced to the public during the televised debates between George W. Bush and Al Gore in the 2000 U.S. presidential election. “This man has been disparaging my plan with all this Washington fuzzy math.” How many of you remember this humorous interface? Since then, these terms are frequently used by politicians and others to suggest that their opponent’s numbers are doubtful or are otherwise inaccurate.
How does “fuzzy math” relate to real estate ownership? Sometimes deceptive calculations can result in wide differences in financial outcomes, tax considerations, and the ultimate disposition of real estate.
Here are three definitions of rents:
Current Rent: What you’re collecting now.
Economic Rent: What the market says you’ll receive in rent.
Proforma Rent: What a seller will represent to a buyer that they should be able to get.
- Current Rents: The current rent, also referred to as contract rents, relates to the income generated by the existing owner. These current/contract rents may vary based upon the owner’s management skills or involvement, property condition, existing leases, and overall economic conditions.
- Economic Rents: Otherwise known as market rents is estimated based upon comparable properties in the unique marketplace. This involves compiling current information by property managers or appraisers, considering comparable rental units, and adjusting for quality, location, amenities, and condition of the overall property in a unique market. This is sometimes referred to as, “What will the market bear?”
- Proforma Rents: Sometimes called projected rents or potential gross income. A proforma rent calculation should be the same as “economic rent or projected rent.” Proforma rents are used interchangeably by owners, brokers, appraisers, and lenders. “Projected rents” is a term used to denote what a prospective new owner or new property manager may collect upon taking over ownership or management of the property. In some cases, these projected amounts are based on property upgrades, rehabilitation, and possibly more intensive management of the asset. There may be significant variations in the estimation of expected future possible rents.
The property owner’s goal is to maximize actual net operating income, which begins with maximizing rent collected. Gross scheduled income, less vacancy, fewer expenses equal net operating income.
When a property owner does his tax returns at the end of the year, they are interested in minimizing the income but maximizing the expenses to reduce the federal and state tax burden.
When a property owner loses interest in or mismanages the property, the rents will go down, primarily because of vacancy and diminished condition of the property.
When an owner approaches a lender for financing, the owner gets interested in maximizing the rents, so the property will appraise for more, hence a larger loan amount.
When the property owner passes away, their estate planners and attorneys work ferociously to attempt to lower estate taxes. This may involve showing lower rents and significantly poorer property conditions for tax purposes.
If the economy remains strong, the population grows, and there’s a solid demand for rentals, actual rents will eventually rise to the level of proforma rents.
If the economy doesn’t continue to boom, or worse, goes into the tank, unemployment rises, vacancies arise, and rental amounts collapse, then those proforma rents were simply someone’s optimistic illusion.
Understanding the differences in current rent, economic rent, and proforma rent makes us more confident to handle the situation.
More importantly, you are less likely to get your butt kicked if you can convert “fuzzy math” into “solid math” and know when and where to apply it.
I don’t know about “fuzzy math,” but these charts support what Don said about returning to work and the “great mismatch” that is happening in the job market.
This month, I would like to step past “Nick’s Numbers” and ask you some questions. Call or email me, I would love to discuss your answers and see how we can help.
- We’ve shared what we’re seeing in the market, what are you seeing or experiencing with your tenants/properties or the market?
- Where are you spending more time than you’d like right now?
- Which properties in your portfolio just haven’t turned out like you originally hoped they would?
- Which properties in your portfolio have done better than your expectations?
- Which states that you own property in give you the most concern about their political/economic direction?
- Which category of tenants in your portfolio seems to be having the most problems right now?
- I know you probably monitor collections strategically, which tenants seem to always be late or have trouble paying?
- Which markets that you own property in have seen the slowest rent growth?
- What areas that you currently own property in are you most likely to buy another property in?
- Which areas that you currently own property in are you less likely to buy again? Why?
- Do you have plans to upgrade your portfolio in any way? Which properties might need an upgrade?
- Do you have plans to change your portfolio’s product-type mix? What product type would you like to add to your portfolio?
As we enter the last quarter of the year, I am cautiously optimistic. There are still legs to this cycle and plenty of worthwhile opportunities. But the real estate market tends to overheat and then over-correct about every 10 years. That correction is still ahead of us, however, it doesn’t appear to be because of COVID-19 but something will eventually bite us in the rear…I hope you enjoy the story.
“Your mind is like a parachute. It only works when it is open.”
Why do some crises jolt us awake and we change and evolve? While other times we just roll over and go back to sleep. It seems like our collective alarm is busted. Faced with a crisis, we often fall apart, stop progressing and that becomes a window for antidemocratic forces to push society backwards, to become more unequal and unstable. This is backwards progress or “the shock doctrine.” In a crisis, we either grow up fast or become knocked back.
Understanding that change is occurring is what is essential. But, unfortunately, the reason investors ‘get trapped’ in down markets is that when they realize what is happening, it is far too late to do anything about it.
Bull markets lure investors into believing this time is different. When the topping process begins, that slow, arduous affair gets met with continued reasons why the bull market will continue. The problem comes when it eventually doesn’t. Bear markets are swift and brutal attacks on your capital.
Pay attention to these indicators. The Fed is discussing taper. The yield curve is flattening, and there is a risk the Fed will hike rates next year. These are all actions very reminiscent of previous market tops.
However, tops are hard to identify during the process as “change happens slowly.”
The entire financial ecosystem is now more heavily levered than ever, due to the Fed’s suppressing interest rates and flooding the system with excessive levels of liquidity. The ‘instability of stability’ is now the most significant risk. The “everything bubble” is here!
I had to chuckle when I read that the City of San Diego didn’t make their July rent payment in the disputed Civic Center Plaza Office building debacle. The Landlord immediately filed an unlawful detainer (eviction). The best part of the story though is that the city’s real estate department, treasurer, and city attorney all work in the building!
San Diego did score well in the 2020 census keeping its position as the 8th largest city in the country and the 5th largest county.
San Diego is also considering making outside dining (on the streets & sidewalks) permanent. I think this has been a great solution during the pandemic, but I think it is fraught with problems for the long term. Will the use run with the property (can you charge more rent because it comes with more outside dining?). What if the use changes? Do you lose the right to dine outside? Maintenance, liability, etc.…
Speaking of parking, I went to a shopping center the other day and looked for the first available spot, but as usual it was for handicap. Then I saw another, but it was for pick-up orders. At last, I was almost in the south forty and I saw a spot, but it was marked for mothers with infant children. Thoroughly defeated I returned home and ordered on Amazon.
Offices are starting to return to normal. Although the sentiment is still negative, it is less so and we are in hopes that we have bottomed and are readying for an upturn. We still hear, “I like working from home, I’m more productive.” However, it is not just an economic formula. The office provides a safe place where you can socialize with coworkers. Sure, you can socialize virtually but you can’t be vulnerable when you can’t meet people face to face. It is also next to impossible to onboard new employees, train people for new jobs or provide shadowing and mentoring. Worse yet working from home may be negatively impacting your relationship with your family or significant other.
The charts below show both the return of optimism and the extension of debt that Don spoke about creating “The Everything Bubble”.
Please give me a call or email me if you would like an analysis of your properties’ value or discuss what you should be doing with regards to the Coronavirus pandemic and its impacts on your business, tenants, or property (Nick Zech, 858-232-2100, firstname.lastname@example.org).
As you know from reading the news, we live in a “Cancel Culture.” At CDC Commercial, we prefer to approach it as a ‘Compromise Culture.’ In these crazy times, we all have to give and take a bit otherwise we break. I was once taught that the oak tree is the strongest, yet it can break under pressure, however, bamboo is soft, yet it flexes in the storm and doesn’t break.
Years ago, I asked my wife to marry me with a poem. I have given her a new one every five years since. We just celebrated our 35th wedding anniversary and I thought I would share this year’s poem. It’s a palindrome which means it can be read forward or backwards. I share it because it reflects our times where things aren’t always as they seem or what you first read. It’s call Aibohphobia (a palindrome in itself) which ironically means fear of palindromes. Hope you enjoy it… (be sure to read it a second time but from the bottom up!).
There are no happy endings in real life
I will never believe
There is true love on earth
Instead, I believe
That Cinderella loved the prince only for his money
It is just not true
That the World spins around Love not money
It is just a fact
But there is a way
That dreams can come true
I can never forget
I Love You
Who I Love
*fear of palindromes (and love and life are not always what you first read)
03 Aug / 2021
As I approach my 60th Birthday this month, I was encouraged by a recent study in Evolutionary Psychology Magazine that reports that bullshitting is actually a sign of intelligence. However, reading further I learned that people who were more willing to bullshit were more receptive to pseudo-profound bullshit. Which means I am probably more susceptible to fake news – who would have thought.
Epistemology is a branch of philosophy that tries to explain what it means to know things, and we know that we know what we know. I like to say everyone believes in their own reality. I also like to say that nobody uses their web browser to look things up to support them being wrong. Thus, we have an internet that supports everyone’s version of reality.
Today I am worried that people and markets are flush with cash but short on understanding value. It seems that people are willing to spend whatever it takes to have whatever they want – houses, cars, gas, toilet paper, eating out. When do people say, “enough, its not worth it?” We continue to see cap rates compress into the 4%’s and we are seeing asks in the 3%’s. The problem is that as inflation rises, so will cap rates and with rising cap rates values drop. A move from 4% to a 5% cap is a 20% drop in value! Another way that inflation erodes is through increased costs of materials. The recent rise in lumber adds about .10¢ – .15¢ psf in increased rent just to breakeven. The other sign is getting less for your dollar. Have you noticed how small an ice cream container is or how many less ounces of chips or cereal you are getting? I call this “shrinkflation!” With regards to leasing, it is probably time to go back to CPI increases instead of fixed 3% increases. Also, important to make sure future lease options are at market rate.
Another observation I have had is that it is not just work from home or work from office anymore. Lots of people are choosing alternative work environments. Starbucks and McDonald’s are stalwarts, but breweries, parks and hotel lobbies are growing in popularity. I recently saw a fancy dinner house open from 8am to 4pm with Wi-Fi and coffee for $25 a day. Also, big power cities are losing workers to new creative centers that are popping up all over the place. The suburbs are getting cool again.
With 1031 exchanges possibly being on the block with Congress, many people are looking to do exchanges while they still can. Many are moving from more management intensive properties to NNN Credit Tenant properties. If this is of interest to you let us know and we’d be happy to do an evaluation for you. Did you know that approximately 10-20% of CRE transactions use 1031 Exchanges to defer taxes on gains?
The chart below shows the rise in inflation (blue) but also the gigantic belief of over 70% of respondents that inflation is going higher not lower in the coming year.
Many of you know I like to golf, but work gets in the way to often. However, in August I am attending a fundraiser that saves me all the time spent on a round. You get 20 golf balls and shoot at 15” holes spread around the driving range for cash money prizes all the while partaking in food and drink. On top of that the cause is getting combat-injured vets out and golfing. If you are interested in going or donating, here is a link: Operation Game On.
While considering my birth year of 1961, I came across a dime from that year (which were still 90% silver). I checked and the dime is still worth a dime but the silver in it would be worth $1.50 today (15x). Another example of inflation. The story this month is a look back over 100 years to see how things have changed since 1915…hope you enjoy the story…