Editor’s Note: Today, we have another interview with Editor Brad Thomas where we’ll discuss the year that was and make predictions for the year ahead. Today, Brad will share his view of the bumpy road for real estate and reveal why real estate developers are some of the unsung heroes of the American economy.
Van Bryan (VB): Brad, I think it’s fair to say you’re an expert on real estate and real estate investment trusts (“REITs”). You wrote two books on real estate investing and were a commercial developer for years. I’d like to ask you about real estate in general.
Brad Thomas (BT): That’s kind of you to say. But, yes, I’ve devoted much of my life to the real estate markets. And yes, I’ve written several books on the topic. So, fire away.
VB: Real estate as an asset class has been on a bumpy road in recent years. Do you think that’s fair to say? And what do you think is the reason?
BT: Well, let’s back up a minute. When we talk about “real estate,” we have to be specific. The mistake a lot of people make is thinking of this asset class as one big monolith. But that’s just not the case.
Are we talking about multi-family housing or apartment buildings? Because those are doing quite well. Or what about office buildings? Certain segments of that market are certainly struggling, but there’s some bright spots as well. Or maybe we’re talking about data centers. Because those have been going absolutely gangbusters.
Perhaps later we can talk in a little more detail about the different parts of this market.
But I understand what you mean. Just looking at the S&P 500 Real Estate Index, it was down 26% in 2022, which really hurt. It was up about 12% last year. And it looks like the index will return somewhere between 8% and 9% this year. That’s okay, but it’s still behind the overall index return.
The elephant in the room is interest rates. It’s not a coincidence that 2022 was a bruising year for the real estate index. That’s when the Fed began hiking interest rates rapidly to catch up to inflation. Even the broader index was down about 18%.
Generally speaking, this asset class is very rate sensitive. All else equal, rising rates makes it more expensive to finance purchasing or building new structures. And so, firms just do less of it.
For real estate as a whole, the question will be: Where do interest rates go from here?
VB: And what do you think the answer is?
BT: A lot of people think the Fed dictates all interest rates across the economy, which just isn’t true. But the Fed can be a big influence by raising or lowering its key rate, so let’s look there.
Psychoanalyzing the Fed Chair is always a tricky proposition. I remember when Jerome Powell gave his Jackson Hole address back in August, and he seemed pretty definitive. He said the “time has come” for a change in policy. If memory serves, the S&P Real Estate Index was up close to 6% 30 days later.
But ever since, Powell’s been talking out of both sides of his mouth. “Not in a hurry” seems to be the phrase that keeps getting thrown around now.
Nobody really knows for certain what the Fed will do next. But, barring something totally unforeseen, the safe bet seems to be that rates will be lower over time. When that will happen and how much is another question. But the prospect of lower interest rates is bullish for real estate in general.
VB: What about the incoming Trump administration? Does that factor into your opinion of the real estate market?
BT: Well, Trump is a builder. I think he knows the positive impact new construction and development can have on growth and job creation. And I’m not just talking about construction jobs.
When I was a developer, I definitely wanted to see a return on investment. I couldn’t justify a project without it. But what made me really happy was going to those ribbon cutting ceremonies. Maybe it would be a shopping center, and there would be 50 people standing there who all had new jobs because of this one project.
There’d be managers, associates, bag boys. By the way, bag boys prefer to be called “courtesy clerks.” I should know, I used to be one.
But you had dozens of people who were now employed thanks to this one building that I had built. That was a really good feeling. And it wouldn’t just be the people who worked at the store.
Think about new shipping and trucking jobs that are created. Think about the attorneys and the appraisers who work on these deals. Or maybe the bankers who finance everything. That building will need repairs over time, so now you’re creating jobs for plumbers, electricians, and contractors. It goes on and on like that.
I don’t think people really appreciate all the positive economic impacts that are created up and down the line from new building.
VB: Do you think the new administration’s emphasis on government efficiency could help?
BT: You know, in movies you’ll occasionally see a real estate developer cast as the bad guy. It’s always some cartoonish villain who wants to knock down a tree or something to build a shopping mall. And of course, this is treated like some great evil.
But take it from somebody who has actually done this work. Real estate developers are unsung heroes of the economy. There’s a byzantine system of federal, state, and local regulations you have to deal with. Something always goes wrong. There’s always a delay.
I’ll give you just one example…
I remember one time I was building a shopping center up in Boone, North Carolina. It took me two years to build that shopping center. I went through all the traditional permitting, acquiring the land, getting tenants; all of that. Every day, money is just going out the door.
At one point, the project was slowed down because the people in the country’s zoning department were taking absolutely forever to get through the proposal. And come to find out that it’s all being caused by “concerned environmentalist” saying I wasn’t adhering to this regulation or that regulation. And it just went on forever.
Look, I think there are some very common-sense regulations that everybody can agree on. But it’s not like I was building an industrial plant or an oil refinery. It was just one shopping center. And trust me, I’d done everything by the book. But it was just roadblock after roadblock.
And of course, the whole ordeal went on for so long that I missed the window to pave the road. Because in that part of the country, there’s only a few months out of the year the weather is good enough for paving.
And so, it was another 10 months or so before I could actually pave. And the entire time, I’m paying interest on the loan. And the tenants refuse to pay their rent. And the whole time, the building is just sitting there.
I’m not complaining. And I’m not saying anybody should feel bad for me. I’m just making the point that, with all that headache, it’s a miracle anybody builds anything at all!
And yet, they keep doing it. And it produces all the economic benefit we just talked about. And that was just on a micro-scale. Multiply that experience exponentially and you get an idea of what developers, and businesses in general, are dealing with.
So, that’s a very long way to say that any improvement in the regulatory regime would be very welcome. Even just a step in the right direction would be great to see.
VB: Thanks for your time, Brad.
BT: Of course.
Editor’s Note: Wide Moat Daily will be off tomorrow, Christmas Day. On behalf of Brad and the entire team, we wish all readers a Merry Christmas and Happy Holidays.
But be sure to check back on December 26 where we’ll share part two of this conversation. We’ll ask Brad his favorite investment ideas in the real estate space, including the REITs he says are “criminally undervalued.”
MAILBAG
Do you agree with Brad that real estate developers are sometimes the “unsung heroes”? Write us at feedback@widemoatresearch.com.