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Foreign.
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Hi, I'm Mark Savatelli, and welcome to Inside CRE conversations with the people developing the future of commercial real estate. On this podcast, we talk with developers, investors, owners, and industry leaders about the ideas, strategies, and trends shaping the built environment. The Commercial Real Estate Development association provides education, advocacy, and connections to help commercial real estate professionals succeed. Inside CRE is proudly sponsored by Majestic Realty.
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Today's guest is Rebecca Rocky, head of Quantitative insights and principal economist at Cushman Wakefield. Rebecca recently delivered a keynote presentation to a packed audience at NAOP's Icon east conference in Jersey City, where she explored how AI, demographic change and global economic fragmentation are reshaping the economy and commercial real estate landscape. Rebecca's probably a familiar voice to most of you here on Inside cre. This is her third appearance on the podcast, and we are so excited to have her back to discuss the shift from efficiency to resilience, the future of labor and automation, evolving supply chains, opposite industrial trends, and what investors and developers should be watching over the next decade. Believe it or not, Rebecca, we're going to cram all that in in about 30 or 40 minutes, so. Hope you had your coffee.
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Had my coffee. Let's strap in.
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All right, well, let's. Let's jump in. So when you spoke at ICON east, you know, the crowd was so deeply engaged with your message. Why do you think there's such a strong interest right now in the intersection of macroeconomics and commercial real estate?
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Well, I think we're entering into, or we've entered into a fundamentally different period of time, and that really began in 2020, but it has evolved in meaningful ways since then. And this is a new and challenging environment. And it feels like the focus has become much more data driven. Understanding different dynamics, trying to quantify them and put them into strategy, has become something we've seen more of, not less of. And, you know, I know we're going to dig into different parts of that, but it fundamentally, we're in a new paradigm. And, you know, when you have 40 years of falling interest rates and suddenly that that shifts, that's really important for our industry. And that's just one example of one of the dynamics we're facing. And so understanding that is just super critical. And the interest level is very high.
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You actually used an analogy going back to kick off your presentation, going back to ancient Greece, if I remember correctly.
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I did. I don't think anybody expected to hear about Athens and Sparta, but we certainly did begin the presentation there. And the whole point of that opening was to highlight the role of economic choke points as one way that geoeconomics can manifest. And it's been something we've been seeing more and more of in recent history, but it goes as far back as ancient Greece. In that example that I gave you
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mentioned a minute ago, you talked a little bit about kind of regime shift in the global economy. What makes this shift perhaps different from the cycles we've experienced over the past few decades?
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I'm sort of being facetious, but not at the same time. Everything is different. I think the one thing that really stands out is that we have entered into an era that is very defined by repeat supply side shocks. Over especially the last 20 years, we've had a lot of demand shocks to the economy and a huge one in the GFC followed by deleveraging. And you, you had worries of the great stagnation. You had, you know, worries that we would never get back to 2% inflation, if you can believe it or not. And from the, the pandemic itself to the invasion of Ukraine in the war, to very different approaches to foreign policy, to trade policy that have resulted in just different economics around those decisions, let alone the national security element of some of those changes as well. We've had intense, SO storms and whether it's hurricanes or wildfires, some of these things are great, happen outside of the United States and impact food supply globally. We have the conflict in Iran more recently. So there's just so many things that affect the economy's ability globally and in the US to produce things that even with steady demand, create inflationary impulses. The Fed is not as equipped to deal with these. So it complicates understanding markets and understanding where rates may be going. And we're a leveraged sector, so that really does matter for us. I think supply side shocks is definitely a defining feature of the regime we're in. And I would also say that there are other structural things like, I mean, the continued aging of the population. But just take the US for example. We're operating at deficit levels that we do typically don't see outside of recessions, and we're definitely not in a recession. So there are these other aspects of what's going on right now that are uncharted territory in some ways for the US Economy.
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I noticed, and perhaps it was because it was a laundry list of things that potentially are sparking this regime change. But one thing that didn't come up was AI so let me ask you a little bit about that because you also talked about some demographic shifts here, particularly the aging of the population. Can you give a little bit of insight about how the convergence of AI, those demographic shifts, how these forces are connected to one another, and why they're so important for commercial real estate leaders to understand?
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Sure. So I think, I think of AI as definitely having supply side shock elements to it, but positive supply side shocks in the sense that if it goes as expected, and we know there's a lot of uncertainty around what that even means, that the US workforce will become more productive and higher productivity growth should result in higher economic growth. As an example, when you think about the timing of this, in a period when we know the population is aging not just here, but around the world, and the US is actually relatively attractive compared to other nations that are aging faster or to greater degrees than we are, it's a really convenient time to have something that could enhance worker productivity. Unfortunately for the industrial sectors, at which I highlighted, the aging of the population is coming to them first, so to speak. And what I meant by that is the average age and the share of the workforce. For example, in the industrial sector, the wholesale or manufacturing, the share of workers that are 55 and older is much higher than in the rest of the economy. The one sliver of the industrial sector that is actually younger than the nation is in warehousing, but that's a minority of employment within the sector. And so this challenge is going to come front and center to the occupiers of the industrial sector and to the supply chains that support them first and foremost. And you know, it's interesting because in a macro sense, aging is often thought of as slightly deflationary, but it can also have these hyper localized inflationary impacts when you have things like labor markets that tighten significantly. And we're seeing a little bit of a double whammy there with the transportation sector already, I think how all of these things come together is obviously complicated and multifaceted. And AI and demographics can be paired like I just did, in a complimentary way, where aging and a more productive workforce might offset each other. In fact, the consensus is that AI actually provides more uplift than aging, detracts from growth, and that we ultimately have, you know, the consensus is around 50 basis points or so more GDP growth than in the past. I think the geoeconomic angle that I took is less so driven by demographics, but it, it is embodied in the notion of the AI race, but it's embodied in so many other things, which is this is an imperative for the US economy. There is this winner take all race like element, specifically with respect to how China is advancing with AI. And so that national security lens, the resilience lens that comes into the way that we think about not just AI, but full supply chains, our ability to manufacture things independent of other nations becomes just more and more critical. And that's a regime change that's been happening since, frankly, before the pandemic, but certainly accelerated since President Trump's first term.
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We'll take a different look at AI here for a minute because you also termed when you spoke, what you call the three A's driving economic growth, asset values, affluence, and of course, AI. Can you unpack a little bit that framework for our listeners?
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Sure. This is an adage that I think some of the economics community has certainly coalesced around, which is the growth in the US Economy is fairly uneven. Under the hood, you see a bifurcation by industry, by market, by income segment. And so the three A's really describe what this bifurcation or several ways that this bifurcation is happening. So the first one with asset values, thinking about what has gone on with the stock market and elevated levels of valuations that we see there. Well, there's a few things. One, we've added tons and tons of stock market wealth since ChatGPT was launched. I, I mentioned that it's over $30 trillion and just gave a frame of reference that, you know, our national Debt is around 39 trillion or so, depending on maybe it, maybe it reached 40 by today, I don't know, which is just incredible. And high asset values support the wealth effect, which in turn generates additional consumption. And you also have this aging demographic that as they age into retirement and start to really lean on that as a source of spending, that wealth effect becomes quite important. And it, it actually has driven anywhere from 35 to 40 basis points, points of additional GDP growth in any given year since the pandemic. So we can't underappreciate the role that's had in channeling additional consumption into the economy. Affluence is tied to asset values. We certainly know that the share of households that have the highest incomes also hold a disproportionate amount of wealth, whether that's in the form of housing or stock market wealth. But we also know that the higher income brackets, the top 10%, the top 20%, even the top 30 to 40%, are accounting for historically high shares of consumer spending. And I think that gets into a bit of the hangover in the aftermath of higher rates and inflation, which have really challenged budgets of the lower 10, 20, 30 40% of households by income. And so this affluence really matters. And that makes sensitivity to asset values even greater, I think in this, in this particular period. And of course AI itself, the build out that is going into data centers and power infrastructure to support those cannot be understated. Just AI itself, if you were to look at that, we think has added around 30 to 40 basis points of growth in any given quarter to GDP. And that is likely to go up as we know what the investment and capex intentions are over the near term. So this is all a great source of growth. But then you also have to think about what are the sensitivities, what are the risks. And it really reflects an economy that's not as growing in as broad based of a manner. Although I will say there may be some early signs that that could be shifting, but it's very early to make that call.
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Shifting in what way perhaps?
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Well, we're starting to see, at least in labor market data, that there is a broadening of strength that is happening. And of course labor is for most firms over 50% of opex. So if you start to see more sectors in an enduring way having positive employment trends, that's definitely a sign that they're feeling better about their sales, they're feeling about their prospects and all of those kinds of things. It's pretty early. We only have a few months of data signaling that. But if that were to continue through the rest of this year, I would expect to see broader growth throughout the economy. On the real side, as we head
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into next year, I think if you
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want it, Rebecca, there's an opportunity for you to do some commencement speeches next year because so many of them got booed for talking about AI. And that message here seems to be a little bit different. We are seeing perhaps a bit of a stronger labor market. To that end, one more question. On the demographic side, we do have a workforce that's definitely aging and a lot that are approaching retirement. And yet this perception that AI is going to take jobs, is there a little bit of a balance there? Because we're losing so many workers compared to how many folks are coming in to potentially replace them. Particularly when you look at Gen Xers like you and I, where it's we're the small demographic, there's not a lot of us.
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Yeah. The forgotten one.
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Yes.
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Yeah, you know, I think so. The notion of like what does AI do to jobs? Does it just automate away all of these different jobs? I think what one, it's too soon to exactly know but our view is that yes, there's some displacement. Certain occupations especially that are rote and highly sort of mechanized or repeatable are certainly at greater risk. You often hear about these exposure scores that are out there and they get a lot of media attention, but they really don't tell you a lot. They tell you what's the percent of individual tasks maybe within this particular occupation that can be done by AI at commensurate quality? Maybe? Well, it doesn't really tell us a lot about, you know, to what degree are all of these tasks integrated with each other? What is the, you know, functionality of this role or the team that that role is on? How much do they have to collaborate across silos within an organ? What kind of judgments come in to some of these tasks? All of those things matter and I think they can really overstate the case. And one great example that's been front and center is software developers. This is an area where, you know, we've, there's just a lot of attention. Obviously this is very tech centric. And what's interesting is if you look at job postings nationally in the last six months, software developer job postings have risen and it's month by month, sequential, every single month getting higher and higher. And the share of job postings that are seeking AI skills is also rising rapidly. And so we're moving into a paradigm where we're going to start to see the real time shifts. There might be job destruction in certain occupations, like I said, but there's also a need for new roles. AI managers, AI, you know, just the datafication of everything. So AI can even be implemented. There will be so many things that go on. We think while that might kind of cancel out a little bit in the near term over time that this will be accretive much like all prior technologies have been.
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So I want to follow on a couple of things that you said. We talked a little bit about automation, we talked a little bit about AI and you also mentioned power. It's a big, big issue right now. What do you foresee about energy access becoming one of the defining competitive advantages in commercial real estate moving forward?
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Well, I mean, it's absolutely critical. It's often associated clearly with data centers at this time. But the reality is, and I talked a bit about this, automation ready warehouses require much more power, different design. Right. The floor floors need to be able to handle much more weight and the capex that goes into these facilities is very significant. So even things like the lease structures start to change for those, for that future of Warehouse, you need to have access to a greater amount of power. So this is becoming a sort of gating constraint, whether it's automation or electrification or the digitization that all raise the baseline energy needs for industrial users. I think that this is going to result in a little bit of maybe widening geographic dispersion where, you know, secondary markets that may have more available power or faster permitting may become on the margin slightly more competitive. And I think, you know what's going to be interesting to watch is there's a lot of competition for this power with data centers and that can cut either way. You might be competing for power with data centers or you know what, new additions to power will be coming. You might be competing in a line, in a queue. But at the same time, those markets where we're seeing the greatest amount of development are markets where there's either already ample power or a significant pipeline of power and transmission. And so you, you might actually find it beneficial to be co locating because those are markets where the investment on the power side are happening. So I think it's, it's absolutely a necessity. I, I gave a very interesting statistic which frankly also sort of surprised me when I was preparing and it was, you know, since the pandemic, the industrial market has grown by about 20% in size. The stock of space square footage in automation ready warehousing, the stock has grown by two hundred and seventy five percent. Wow. This discrepancy and. Right. The capital flows into that segment of the market. I mean this is because it is absolutely becoming a necessity to have these kinds of facilities as we think about all the other stuff we've already discussed around demographics and so on. So you know, power is going to be that sort of gating constraint I think on decision making over the next five to ten years.
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Yeah, who knew to get our projects approved we'd be queuing up like we would at Disney World, trying to get on Space Mountain when it comes to electricity here. That's not something I think I would have guessed about five, 10 years ago. You highlighted a couple regions that appear particularly well positioned. You know, we were talking about at least in terms of power a moment ago, but you did highlight a few that are well positioned for long term growth. And you specifically identified Texas, the Southeast, the Intermountain west and parts of the Midwest. What are some characteristics of those markets that separate them from the others?
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Well, there are a few things and I certainly want to be clear that in all markets I think there are going to be very exciting opportunities, you know, for Some of the markets you didn't just list, for example, if we kind of head to our coastal gateway markets, they're higher cost, you know, they maybe aren't as business friendly, but they have the two mega cities, the only two mega cities in the United States. They have a lot of other competitive advantages with skilled labor. It becomes very asset specific anywhere that we go. In any market. In an era where we don't have cap rate compression, or at least not, you know, falling treasury rates, that can lead to easy cap rate compression. The markets that I highlighted as relative winners might be classified into those buckets that you mentioned. Texas Southeast, what I call the sort of intermountain inland Southwest. And that's that corridor between the west coast and the Rocky Mountains. So that's your Phoenix and Reno and Vegas, Salt Lake City, et cetera. And they all have slightly different dynamics. So in one case, that corridor between the west coast and the Rockies, this is a natural area where you're going to traverse as you bring things from ports on the west coast inland, particularly in Texas, with the population centers there. But they're also much more cost effective from a warehousing standpoint. So there was a lot of cost arbitrage that was happening as we saw rents, particularly in the supply constrained coastal markets, go up by 2 or 300% during the pandemic. So there are these natural release valves. And if we're in a period, which we think we are, where there are some structural upward pressure on inflation, we want to be mindful of the markets that could benefit from that dynamic. There are also general measures of business friendliness. And that can be a lot of different things from, from tax rates to regulation to right to work state laws or the presence of unions. Sorry. And all of those things go into different decision making, whether it's by manufacturers and their suppliers. And so we've seen a lot of benefit, for example, to the Southeast as a result of that. The Midwest continues to dominate in certain kinds of manufacturing. Relatively low cost, relatively. Actually the least volatile area of the country in terms of returns and rent growth. It's sort of steady as she goes, kind of all the time. It's a little bit more predictable. The one group or specific area, which you can't really call a specific area that very clearly has been a winner and I believe will be a winner over the next five to 10 years are border markets. Because although we are going to go through whatever the experience of renegotiating, slash renewing USMCA looks like, I think that there is strong Commitment for continuing that policy into the future and the regionalization and the co location upstream of suppliers into that I think are going to continue to benefit these border markets in very meaningful way. And I, I had a stat or a sort of map I pulled up that, you know, in the last five years when you look at demand relative to the size of markets in the top 15 were pretty much all border markets. And you know, that has been on the back of NAFTA turning into USMCA and this very clear commitment to regionalizing supply chains.
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Liberi biss. You know, while we have you here not to talk about office a little bit, you know, it kind of has taken an awful lot of arrows over the past few years and even since you had an opportunity to speak to our group at IconWest, NAOP just released its latest office demand forecast which showed for the first time in four years, three consecutive quarters of positive net absorption. Now this was not record breaking absorption by any stretch, but it was absorption. What trends are you looking at right now? The closest when it comes to the office sector at the moment.
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So I, I don't know if people know this about me. I love the office sector because it's so complicated. I sort of joke it's like you know, a soap opera where you have to watch every day to understand each character. And by the way, I say this as somebody who has never watched a soap opera for real, but I just, that's sort of what I think of. So I think a few things should be watched. One is we've clearly seen a collapse in the pipeline. We're, we're looking at just about 30 million square feet under construction. This is going to result in historically low levels, persistent low levels of new supply coming to the market. And so that's one dynamic that will feed into the next one, which is the top echelon of the market. We've talked about top tier a lot in the office market and everybody knows that that's performing, that's there's been a flight to quality. Even if you maybe have right size since the pandemic, your, your floor plate you might have upgraded and in some cases even incurred more cost as a result. The reality is that market is tightening and it's tightening fast. So take a Manhattan for example. Top tier vacancy is below 2019 levels.
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Yeah.
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And so the market is tightening rapidly. And so the question then becomes where does it go next? And you can see a trickle down, right? Because there still is this demand for quality in a work from home hybrid world. Why you Want to come to the office and using your space to create the right experience for workers is more important than ever. So there is that kind of trickle down into quality. And I would expect to see the next few echelons and we kind of create those in certain ways with our data start to tighten incrementally. And we also see very strategic movements by owners to either full scale renovate, which will not be necessarily as intensive as a ground up construction, or to do significant renovations on the interior. So one involves almost, you know, full removal of all tenants, the other one does not. But when we see those investments happening, we are seeing significant leasing velocity shifts post renovation. We're seeing significant rent premiums and that those assets can compete and sort of move up the quality spectrum. I expect to see that continue while the broader new construction market remains isolated. But to be honest, given the flight to quality and the lack of options, I think we're going to start to see in our more mature gateway markets perhaps the first signs of the new spec cycle in construction. And that's definitely something I am looking to see here in the next 12 to 24 months.
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And it's an interesting take to hear that because we continue to hear, at least presently and have now for numerous quarters about this bifurcation across commercial real estate. I think office has been the headline of that bifurcation between where the best asset classes have outperformed while the weaker struggle. But it sounds like you think maybe perhaps we're hitting the end of that trend. Did I hear you correctly?
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I think in office there was this sort of continued growing bifurcation. I would even call it a trifurcation or something even more than that. And what we're starting to see is at least at the top end, there's starting to be some convergence. And that trickle down is in the early days of starting to happen because there's just not enough top tier and there's no new product. And so demand has to go somewhere. And it, it's really challenging, you know, tenants to think way ahead of time about what they need. I don't necessarily think the notion of bifurcation goes away for office or for any other segment of the real estate market. It feels like capital is concentrating on newer, well located amenitized assets, no matter what sector you're talking about. And I think multifamily is a great example of that. Right. So there's a lot of demand for multifamily investment, but the availability of product that that capital wants to go into is actually very limited because Many of these older, less well located, especially BC properties just really aren't what the target is for that money.
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Well, as we begin to wrap this up for the developers, the investors listening today, what are some of the biggest mistakes people could make if they continue to rely on some of those old assumptions that we spoke about? You know, whether it's with globalization, labor, economic growth, we're kind of in this new paradigm.
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Yeah, I think a big change has been this, this trade off and it's not a, I would say a perfect trade off because I think there's some synergy here, but that there is a lot more focus on resilience and there are supply side shock reasons for that and there are foreign policy reasons for that. And I think that that is only going to become more heightened, not less. And so we have to really factor that into how we think about the world. I would not underestimate labor constraints. We have aging, which we talked about, we didn't talk about immigration and how that is challenging labor supply growth. And possibly part of the story about why we're seeing some positive green shoots in the market. There's just not a lot of labor supply growth. And even with some of the improvements in the demand growth, it's clearly starting to signal that there's tightening in the slack in the labor market which is positive for the current market. I think I would also say we shouldn't rely on broad growth. There is this unevenness and this kind of movement in cross correlation between markets, between asset types that is becoming a bit unmoored from pre pandemic history. And so it becomes much more about nuance in the market, nuance in the submarket and at the asset level that that micro view is really going to be a defining feature of the next cycle.
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Interesting. Yeah, I mean we've all kind of have these perceptions of how we've developed decade over decade and it does seem like perhaps we are really at a point of transformative change in how we go about developing future projects. All right, one quick question for you here. Real small, real easy, you step back from all the noise, the day to day headlines. What do you think the commercial real estate industry is still underestimating about the next five to 10 years ahead?
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Maybe we're starting to underestimate this less now, but I think between everything around the electrification of the global economy to more recently data centers and AI, the the movement towards more capex heavy growth is very significant and it will fundamentally change opportunities within real estate which are becoming more broad based. If you think about everything as the built environment. It's not just the traditional office industrial retail anymore. There's a lot of opportunity to play in new spaces and infrastructure is just one example of that. And it ultimately will also reshape the fundamental lease structures because how you get the return on that capex back, it's going to take longer because we're, you know, it just takes a lot more money to build these things. And that's very different than the more services oriented growth that we've had over recent history. Not to say services go away, but the real economy, the infrastructure support supporting the built world that generates all of the GDP that is fundamentally changing. And I think it's exciting, but it feels like we're just starting to kind of have the aha moment where it's like wow, no, this is really fundamentally different. And at the same time start to prepare for the opportunities that will bring.
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Well, it's a great way almost to say, boy, we need to have you back for a fourth time with an answer like that to really get more elaboration on that. That's a great way to end it though. Rebecca, as always, another great conversation. Really appreciate you taking the time not only to join us in Jersey City, but to join us on this podcast as well for your third time and most importantly, sharing your insights with the entire commercial real estate community. Thanks again, Rebecca. Look forward to speaking with you again.
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Perfect. Sounds great. Thank you for having me.
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Thanks for listening to Inside CRE conversations with the people developing the future of commercial real estate, and thanks to our podcast sponsor, Majestic Realty for supporting the show. If you enjoyed today's conversation, please share it with a colleague and subscribe so you will never miss an episode. To learn more about NAOP and connect with more than 22,000 commercial real estate professionals, visit naiop.org.
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Sam.