On-Demand: Real Estate Principals Series | Economic Update and Commercial Real Estate

We'll start with Jeff's economic snapshot, and then Jim will follow-up with some market statistics and then a Q&A. Jeff?

Jeff Bellisario: All right. Thanks so much, Bruce, and happy to be here. I'm going to flip the slides forward here. Bruce, I think this is part of your commercial, though, so maybe I'll pause for two seconds. So again, my name is Jeff Bellisario, I'm with the Bay Area Council Economic Institute. We're think tank based in San Francisco. I think either myself or one of my colleagues has given a similar presentation, and maybe some of you on the line have seen us talk in the past on the Bay Area's economic outlook. We do this every year. Generally, we have a funny title. I think 2018 was “Best Year Ever?” 2019 was, “Will the party ever stop?” 2020 though, gets no jokes, because we are in a dire economic situation, particularly here in California. I'll give you a bit of my outlook for where things are headed going forward.

So, I'm going to show you a bunch of charts and graphs, but, I, today want to focus a little bit just on some of the key indicators rather than my opinions going forward. There are a lot of opinions out there, but we can definitely get into opinions during the Q&A. As a first slide here to kick things off, we've mentioned this in every presentation that we do, these are new unemployment claims for the state of California. The yellow bars here are the pandemic unemployment assistance, which is for contractors, green is your traditional unemployment plans. In the state, while we've had a little bit of economic recovery here, and in the US, here in California, we actually are seeing unemployment claims going up. We think a part of this is due to, just, the system's, these are people that are working through the Employment Development Department systems, and their claims are finally getting filed here in early September.

But, we also know just last week, 28% of the weekly claims in the US came from the state of California. We only have 12% of the labor force living here so a big focus on California in terms of the unemployment. Just in terms of this scale here, when we look back at the last recession in California, we topped out about 100,000 new unemployment claims each week. Here, we're talking about traditional employment claims two or three times higher than that, still, six months into this pandemic. So, just the setup here, in terms of where we are in the economy, unemployment wise.

I'll go forward and compare California to other states. We're at 13.3% unemployment in California as of July, so the data lags a little bit here. It's down from 16.4% at its peak, but we're sixth highest in the nation. If you looked at California, pre-recession, we were on the left-hand of this list. Our unemployment was extraordinarily low, particularly here in the Bay Area. But, if you look at the grouping here at the top, you talk about California, New Jersey, New York, Massachusetts, all places that have had pretty bad experiences with the virus, have been locked down, again, this is from July, or Nevada, a place very reliant on tourism. In California, we've got both, entertainment and tourism, big parts of our economy, but, also, the virus and the lockdowns we've had here have been longer, more stringent than other places.

So, this is just a key indicator we're watching, everybody cares about unemployment. 13.3%, even higher than where we were at back in the last recession. We were at 12% for about a year. So, the depths of this recession have been greater, but we do think we're going to move out of it more quickly. So, we looked at the Bay Area and just looking at the number of jobs we've lost here, in the bottom right-hand corner, we are down still 400,000 jobs from peak. In fact, our recovery is moving a little bit slower. We added 100,000 jobs in June. But, growth actually slowed to 60,000 jobs in July. Again, we think a direct product of some of the virus resurgence and the lockdown. But, we'll be watching these stats going forward to see how quickly the Bay Area economy recovers. So, here we're at 10% unemployment in the region lower than the state. We didn't have quite the downturn in terms of jobs here in the Bay Area, but we have had a much slower recovery than the rest of this data has.

So, we looked at what sectors have been impacted most, and I think most people are viewing this as a small business recession, as a leisure and hospitality recession, but we have lost jobs across basically all categories. Again, of the 400,000 jobs lost, 130,000 have been in leisure and hospitality. So, these are restaurants; Anything that requires face-to-face contact or travel within this category. That's 30% of that category, the jobs have been lost between January and July. But, there have been rebounds on that right-hand side, the black numbers show where jobs have rebounded, but, in fact, we're still losing jobs in government. We're still losing jobs in information. Tech companies are pulling back now. We're losing jobs in trade. So, not every sector is rebounding. They're not all rebounding at the same rate. In fact, some are still losing jobs.

Then, I alluded to this earlier, just in terms of our recovery, so while in the Bay Area, we haven't lost as many jobs overall or unemployment is not as low, we aren't building back up at the pace that California or even the US has, so we've only brought back a quarter of the jobs that we've lost in the Bay Area, while for the state, it's more like a third in the percent. So, as we think about recovery, in the past, the bay area has generally recovered more quickly. We lean on tech, we lean on these high wage, high growth jobs, but in this recovery, we don't seem to be moving as quickly to bring back some of our small businesses, particularly retail, restaurants and hotels.

So, let me shift gears just a little bit. I think the big pieces we think about economic recovery, we think about spending, right? I think I'll tie this back into real estate in a bit here. But, as we think about consumer spending in California, it's down about 12%. So, these are credit card transactions. We're down about 12%. We've flat lined a little bit in the state. In the US, we're down 7%. So, California performing worse from a consumer standpoint. I want to pick on San Francisco here. I think this is where I'm going to tie it back into the real estate aspects. In San Francisco, it's actually the worst MSA for consumer spending, as of the end of August in terms of the downturn, from January, more than 20% downturn in consumer spending. Then, in Oakland a little bit better, San Jose a little bit better. But, then you look at a place like Sacramento, even better than the US average.

So, we think there's some people movement. There's something happening where San Francisco is losing more than other places around the region. Then, just to dive a little bit deeper, these are San Francisco here. So, key industries are looking at spending, down 50%, restaurants and hotels 25%, just on general merchandise and retail, 70% in entertainment, recreation. So, part of that is due to lockdown, part of that's a product of fewer people. That fewer people is both during the day, but we think overall as well. So, remote work has had big impacts, but we also are anecdotally seeing people moving out of the city and we're seeing a redistribution of population within the Bay Area itself.

So, remote work. This is the million-dollar question here. I'll run through these pretty quickly. We've seen announcements from Facebook, and Pinterest, all rethinking their workforce in terms of remote work. When we look at remote work in the region, we're trying to define occupations that are eligible. So, in San Francisco, more than half of the workforce is eligible for remote work. In the Bay Area, that's 45%. Much higher percentages than other counties in California and even across the US. If you look at remote work today, just 28% of people are saying that they're working remotely across the US. 52% of the professional services sector is working remotely, 60% of legal occupations remotely, and 68% of tech occupations remotely. So, while this doesn't necessarily paint the picture of what happens a year or two down the road, it does show that there is this risk, particularly in the Bay Area of folks actually not needing to come into work and potentially not needing to live and work in this geography.

I also wanted to Look at new job postings here. Again, at the bottom of this list. San Francisco used to be at the top of every list. From January to September though, we've had the biggest decrease in new job postings in the San Francisco MSA. I showed Denver and Austin here as well. Other places are also down. But, San Francisco does have by far the largest decrease in total new job postings. So, remote work is a factor. We're not necessarily adding jobs into the city in a big way. Then, when you think about just population, where are people moving? Because, I will say, as we think about the future of commercial space, companies are going to move where people move. In the Bay Area, even before this pandemic, we were losing people on a net basis in 2019 for the first time.

So, green here is international migration, yellow is net domestic migration. We've been losing people on a state to state basis but have balanced that out with people coming in from international locations. We think, as we look at 2020, that gold bar is going to become much, much larger on the Bay Area change, as housing costs, and the availability of remote work, push people to think about, whether it's Denver, or Austin or Idaho and Montana, even those more low cost locations. I think people will be thinking about moving to those locations going forward if remote work sticks around for a long time.

This is the most up to date data we do have on where people are moving, or at least thinking of moving. This comes from Redfin, you see San Francisco, and our MSA here in the Bay Area, has the second largest percentage of net outflows of Redfin searches. I think the one key thing to note here, is that Sacramento could be the biggest beneficiary of all of this. We talk a lot about the mega region, but Sacramento does offer that connectivity to the Bay Area if you need it, for one or two days per week, but a much lower cost market both for housing and for doing business.

Then, I also just wanted to show in terms of where we are today, our transit ridership and our activity. So, we know transit usage in the region is down about 85%. But, we know that total travel in the region is down just about 15%. So, there's much more reliance on cars recently. As you look at San Francisco versus other geographies here, we're quite low in terms of where we are in terms of transit ridership today. So, I think something to watch here as well as we rebuild the economy. Hopefully, it's not an economy that's based totally on cars and that transit is still important for people getting to and from work. It's important when you think about real estate decisions as well. But right now, no one's on transit, and I think the big questions about how we build transit up, particularly, with some of the fiscal issues that transit agencies are seeing.

So, let me end on a positive note here. So, I've given you the remote work, the population shifts. These are the things that we're quite worried about in the region, because it's all about people, particularly as we think about commercial real estate and where businesses choose to locate and where they put their people. If the people and the talent aren't here, then those companies will not be growing here. But, we do have 50%, basically, of the new venture capital investment in the US. So, even in the second quarter of 2020, 45% of US venture capital investment went to a Bay Area company. I think, while only 20% of the Bay Area job's base is in tech and in startups, these do drive employment in legal and HR and marketing and all the things that happen in a dense urban environment. So, these are fast growing high wage jobs. These people also go to restaurants and retail, and all the things that are driving real estate transactions. But, if these people don't work here, again, could be big concerns for the region.

 So, VC is one. That's led me to this. So, this is the last chart I made before the pandemic, this was the last time I was truly happy. I put a bunch of unicorns on a slide. In the Bay Area, we've got 113 of these billion-dollar companies. No one else comes close. So, while you may talk about movement to Denver, and Austin and Seattle, those places don't have the startup environment that we have. While this isn't the entire economy, this is really what's driven the last 10 years, pre-pandemic. As long as these companies are still here and growing here, I think we're going to be okay. But, the key question is, do these companies grow up here? Do they move from 5 employees to 50 employees to 500 in the Bay Area? Or, is it 5 to 50 in this region, and 450 somewhere else?

So, let me just close then. This will be my transition slide with a little bit of history, particularly, for San Francisco, office vacancies peaked at 18% during the Great Recession, we moved all the way down to 5%, pre-COVID. So, I don't want to portray this as the sky is falling for commercial real estate. We survived the last recession, came all the way back extraordinarily quickly. But, I did just want to look at some of the drivers of how we might recover going forward. So, I've refrained from giving any actual opinions, but we'll get to that in the Q&A. I think next, I want to move over to Jim, and he'll give us a deeper rundown on some of the commercial real estate aspects. Go ahead, Jim.

Jim Costello:Great, thank you. A lot of the focus I'm going to have is on the commercial real estate investment market, how are assets being priced, what are the bigger picture concerns that investors have, and where does San Francisco, stand in the middle of all these issues globally? In terms of price trends, nothing's happened yet. Frankly, nothing's happened yet, and it's also, despite some negativity, things could be much worse. I'm looking here at commercial property prices around the world for the 18 largest global markets. I only highlighted a couple, you can see some light gray lines highlighting some of the other markets. There were a few I wanted to call out, just as a point of comparison. How bad could things be? Things could be as bad as Hong Kong, where it's not just an economic challenge you're facing, but political turmoil calling into question the future of that city. The extreme gains of prices at the market as seen in 2019, from a lot of flow of capital from Mainland China to Hong Kong, that's just savaging expectations on prices there.

By contrast, the Golden State Warrior gold, the San Francisco price trend, it's been pretty flat over the last couple years. Now, it wasn't like there's a small group of cities just above that, Seoul, Toronto, Sydney, cities that have ties to the global economy, but have also dealt with COVID stuff a little bit better than anybody in the United States. Have not seen the flattening that we had in San Francisco and parts the United States so far and this year. But again, things could be worse. I see there's a behavioral reaction in every downturn. When I go and visit cities in the middle of a downturn, people talk about their city as, "Oh, things are horrible here, it's never going to be good again." That's true, whether you're in San Francisco, or Tulsa, or Detroit, there's a sort of a behavioral reaction. You get into an upswing in the economy, and, then, for a while, everybody's, "Hey, things are great here compared to everyplace else." You get to about the peak, and then people start talking about, "Well, maybe I should look elsewhere. The grass might be greener for opportunities in another". Every cycle, that kind of behavior happens.

So, I bring this up to point out Chicago at the bottom, because I'm a Chicago native originally. So, sometimes I'm too negative about Chicago, but it falls in that psychological response. But, look at Chicago, that's a city that, it has not even gotten back to the price level seen in 2007. That's a city where the economic structure moved away from the manufacturing industrial base the city had, and it just hasn't fully recovered, even over a 30-year period. So San Francisco, it's still on the cutting-edge of things that are growing and new. That might change a bit. It might disperse a bit. But, look at New York. New York, we have growth that's up at the top. The financial markets, it used to be that 70% of all financial sector jobs in the United States in the 1970s, were headquartered in New York. That we had vast new technologies that allowed some dispersal. Things like fax machines, long distance telephone calls becoming inexpensive, and suddenly, you could move some of your people over to a lower cost location like New Jersey, or suddenly a satellite location in Charlotte or Omaha.

That happens over time. But, the city still a hub, because the movers and shakers and players want to be around the others. Game recognizes game, and the top of the totem pole will want to be around the others of their like. I think San Francisco, from that perspective too, this notion that I'm going to be a hotshot programmer living off in Banff, in the middle of nowhere connected remotely, good luck when the internet goes down. Jeff showed a chart on contractors and contractors getting benefits, that's an important part to the tech sector. The tech sector is not sort of 1950s IBM with a bunch of guys and white shirts and black ties trying to work their way up the corporate ladder. It's a lot of quick interactions with people on projects for a few months and jump into another company for projects. It's harder to do that remotely.

It's something where finding the next person is having your network there in the city and someone can ride their bike over and talk quickly about a project they're going to help on. That clustering effect, it's a temporary change. But, I think that there's still going to be a desire of people to access that stuff. In any case, COVID and the current recession is having an impact on deal activity. I'm showing here what's happening across United States overall. The different blues, its monthly deal data, and the different blues are different types of deals. The dark blue is when you have investors buying one property at a time, the lighter blues are when someone's buying a portfolio and the very light blue at the top, people buying whole companies at a time.

The thing to take away from this is that, you see where we are in 2020, we're above $10 billion a month. We're not back to the levels of the global financial crisis when we're at five or six billion-dollars per month. So nationally, it's not as if we're at the worst parts that we've ever been. It's happening faster. The shutdown is faster than before. But, part of that is just because of the physical constraints. Nobody can get on a plane, until recently, to go look at a property in Boise or Tulsa, or San Antonio, to kick the tires and talk to the appraisers and just make sense of what's happening there. So, some parts of the market were just frozen. So, you have to disaggregate the fact that there's less activity from how much is just investor skittishness versus the market being frozen. That's impacting prices as well. You see the orange line there, that's our measure of commercial property prices where we look at it in the same store basis. It's starting to come off the peak a little bit. But, even on a year-over-year basis, it hasn't fallen yet. It's as if the market is still wait and see and let's see what happens mode.

Yeah, that notion of San Francisco versus other parts of the United States. There's really no part of the United States except Raleigh Durham, because of a few odd deals that really escaped the decline in deal volume for the first half of the year. I'm just going to highlight here, just so you can see them, in particular, San Francisco, San Jose, the East Bay, huge double-digit declines in sale activity. But, they're middle the pack. San Francisco, they were ranked number 10, nationally in 2019 for sales activity. First half of the year, even though it's down 45%, it's still number 10. So, as bad as you might feel at times in the Bay Area, you're just as bad as everybody else. So, you've got that going for you. It's not the end of the world in that sense. Now, some of it is just this current situation of illiquidity and being unable to do things. That should start to change. When that starts to change, then issues around buyer and seller expectations and changes there and expectations for future growth, that'll start to come into play. But, we're not quite there yet.

Working with some folks up at MIT, we put together some figures on this issue nationally, on the gap between buyer and seller expectations. Prices haven't really moved yet, then when you look at the asset level, they have when you look at REITS. People look at that and say, "Oh, well, maybe people aren't really there yet." But, part of the issue is that, the property level is different than what happens when you trade in a REIT where you're trading in the value of a company. At the property level, people don't necessarily need to sell. The debt markets are still quite liquid. If I have an asset and the loan is coming due, I could still get a loan from banks. Banks are still very liquid and accommodating. Part of the plan for recovery with Cares Act is to make sure that there's credit available. That was a big killer in the financial crisis, the lack of credit availability.

So, the orange line here are commercial property prices, and we see nothing really falling yet. But, the orange line measures the gap between the buyer expectations and the seller expectations on pricing. There's just a big gap today. That's why deal volume is down, because if the potential buyers think something's worth $80 million, and the potential sellers think it's worth $150 million, guess what? Deals won't close and activity is going to be frozen for a while. Now, that said, we think that is going to start to open up and part of it is going to start opening up because of changes in distress. We're starting to see a big spike in distressed loan situations. I'm showing here, the blue bar tracks. Going back to the financial crisis to today, the newly troubled loans, loans during special servicing, most of this actually is going to be CMBS, given, both, last cycle that's where most of the problems were. This cycle, so far, the information that's coming out is mostly from CMBS, because it's securitized, it's more transparent.

The gray is stuff that's been worked out. We've seen the net change, there's been just an increase in distressed debt situations. But, nothing's been resolved yet. If we look at distress sales as a percentage of total, that's the important thing to has to start happening before we see price discovery. There's all this uncertainty about, are people going to work at home, are people going to move to other cities, none of that is resolved yet. Nobody quite knows the answer. Buyers and sellers are far apart on that. But, something that would start to send signals, is when some of that distressed debt finally translates into people being forced to sell assets that are distressed. That just hasn't happened yet. The percent of total sales are still in the low single-digits for distressed sales.

Now, it's different in the hotel market. The hotel market, we're up to around 8%, nationally, of all sales in the hotel market, that being distressed activity. Granted, it's on small base, it wasn't very much in the second quarter that was sold in the hotel market. But that said, once we get people, just, giving the keys to the lenders and selling it at any price that the market will bear, those distressed situations are where we start to get that price discovery. So, the prices, we've got a bit yet before we see that. Honestly, that's a pattern we've seen across previous recessions. To get at long term price growth, and I cobbled together the RCA CPPI with some earlier survey based data, some stuff from the Fed going back to the 50s. The orange lines are recessions and blue's commercial property prices. Every recession we see a decline. But, it's always a bit of a lag. The other thing I want to point out here, as I'm doing presentations, in the last few years, I started to notice that the audiences were getting younger and younger. Many more people who had never worked in a recession before or, if they did, it was only in the global financial crisis.

So, their expectation what should happen in this recession versus their previous ones, it's just set on the global financial crisis. They're not all the same, prices don't always move down 20% in the middle of a downturn. The recessions in the 70s, in some respects, are more like the recession we're having today where it's a demand shock. People want to spend but they can't. That's what the problem was in the 70s, you look back at pictures of people with giant hair and bell bottom jeans, standing in line with their cars waiting to get gasoline. That's the same kind of thing we've got today. Now, instead, it's hipsters wearing masks, waiting in line trying to get a latte, or off in another city. But, there's unmet demand that they would be spending if things were different.

I'm not convinced that the debt-driven recession where everything was a vicious downward spiral, like we saw in the financial crisis, is what we should expect today. So, as bad as things may feel at times, take heart that for you folks there in the Bay Area, it's bad elsewhere, too. This recession, I don't think that the forces since it's a shock to the real economy, and not so far, knock on wood, a shock to the financial economy, that the downward spiral in prices we saw last time will necessarily be about the same. So with that, I'll turn it over to questions or anything you got there, Bruce?

Bruce Carlson:Can you guys hear me? We've got one from Daniel Gold. "Have any of those calculations measured the fact that the taxes are likely to go up in California? I'm suggesting this because there is a big hole in budgets at the state and municipal levels." I don't know which one of you guys wants to grab that.

Jim Costello:Go ahead, Jeff.

Jeff Bellisario:Well, I think, one of the things as we think about San Francisco, in particular, lots on the ballot coming in November, particularly. That might impact the tech economy. I think we've tracked these things in the past. While taxes are a piece of where companies are deciding to locate and put their employees, they're not all of it. We actually think that talent is the bigger driver. So, as California increased taxes back in 2012, 2013, San Francisco has done various tax increases. We know that there's potentially more coming, right? We do need to fill these budget holes somehow either with cuts in government jobs or with new revenues. But, I'm not sure that the taxes aren't necessarily going to be the drivers that are going to be pushing companies out. They are something that's layered on top of many challenges, whether it's the cost of doing business in California, your labor costs. It's difficult to build new space in San Francisco, in many parts around the Bay Area.

So, I do think there's a concern there, but as far as our projections go, we're not necessarily at that point on the Laffer curve, where the taxes are so high that everyone's going to be moving away. Though, that is something we're worried about, it's something that we're not necessarily going to know until we get there. So, the Bay Area Council on the policy side, we are very active in making sure that taxes on businesses and taxes on the wealthy aren't necessarily driving away employment, and the people that are driving employment.

Jim Costello:What I'd add to that is, again, you're not alone. Nationally, there's moved to try and plug holes in local government spending by soaking commercial property owners. So again, misery loves company. Chicago, that's an issue in the state of Illinois. That's an issue in other parts of the country. Another trade organization I do some stuff with the Counselors or Real Estate, we have a little committee looking at these issues nationally, because they're also playing games with the appraisal standards at the local level, that might generate a little bit more tax revenue. There are budget shortfalls, and that's the issue.

Jeff pointed out that I think the real issue is talent. Most corporate costs are not real estate, most corporate costs are personnel. You want to go where the best workers are at and get that best talent. It's a push me, pull me kind of, thing. You're located in San Francisco, because there's great firms there, as a worker. But, as a firm, you're going there because there's great talent there. It's that whole agglomeration and network effect. COVID is temporarily disrupting it. If we get the magic vaccine, then maybe that will go away and all that can come back. But, the thought that you're going to drive companies that never worried about profits, that never worried about costs, because they were focused on getting scale and achieving dominance in their field, that you'll drive them away, just because you're trying to save a nickel on rent is, it just doesn't fit in my mind.

Bruce Carlson:Great. We got another question from Matt Regan. "How much churn will we see in our built environment? Will we see massive conversion of commercial to residential?"

Jim Costello:I used to be part of CBRE and there was the Trammell Crow company that CBRE bought or was bought by. One of the fellas I was talking with used to work with Mr. Trammell, who founded that firm, and he told me, Mr Trammel had a real simple, back of the envelope approach to figuring out the renovation costs for converting a building from one use to another. It was a really simple thing, just talk to one contractor, get some estimates and costs, but you got to keep that person honest. So, put on a clipboard, let the other person know you've been talking to somebody and you get estimates from a second person. Then, the same thing, get three opinions, so there's some dynamic there. Then, take all three of those numbers, add them up, and there's your renovation costs.

When you change use from one type to another, there's so much that's unknown. So, the value of some assets has to drop so much before it's worthwhile to scrap it and turn it into something else that you need severe decline. So, it's usually end of life type buildings. An old office building that made no sense anymore in a city. Maybe, somebody can convert it to a residential use if they can buy it at an extreme discount in an area where there's severe housing shortages, like San Francisco. Assuming, of course, that you have regulatory authority to do that. I think that's the bigger issue. A lot of these malls, they have an appointed with a bulldozer, assuming that local officials will allow people to do that. There's still local officials that are focused on the fact that the retails where they got their tax revenue and they're holding out for the thought that, oh, well, there will be some retailer that will come here.

So, the standard way of the market, designating the highest and best use, which is in some of those mall cases, an appointment with a bulldozer. I think there are select cases and locations where, through wise city leadership, that's going to happen. But, in many cases, it's going to be, unless you get something at a huge discount, it's going to be difficult to make that conversion work.

Bruce Carlson:Yeah, I think it's a real likely opportunity in malls for residential. This is from Jim Ferris. "If you look at the net outflows in California, you see they start around the same time that the state taxes were increased in 2013 and '14, are we overlooking the potential negative effect that additional tax on businesses will do for both California and San Francisco?"

Jeff Bellisario:Yeah, I think hat's the key question that a lot of people are thinking about, as we grapple with these new tax proposals coming out of Sacramento or out of City Hall in San Francisco. I think when you dig into the research, it's less about people moving away, particularly, at the high income levels, as opposed to people shifting their assets, or deferring income or thinking about ways of getting around certain tax liabilities. So, the research shows that it's not necessarily the highest income folks that are moving out, and those are the ones most impacted by the last tax increase in the state. In fact, the people that are moving out are the people at the lowest end of the income spectrum, because those are the people that are being priced out, either through increasing rents, or an inability to purchase. The biggest outflows are actually going into San Joaquin County and Sacramento County.

So, at the Bay Area Council, we talk a lot about the mega region and the key goal on the mega region is not just to connect all those people back into San Francisco, or San Jose or Oakland where all the jobs are, and using transit, the key goal is thinking about how we can do economic development differently in Sacramento, or even in a place like Stockton, so that two thirds of the mega regions jobs aren't all concentrated in just two or three large urban areas, that you don't need to make that commute from Sacramento all the way back to San Francisco.

So, I've deviated away from the question a little bit, but I do think that the taxes, particularly as we think about raising taxes in a recession, and in a time when companies are potentially rethinking their office footprint and how they think about work going for, I think, there is a huge risk there. But, it's mostly about the talent, and if the people are not moving away. Jim mentioned, if game knows game, I'm going to steal that. The agglomeration economy in San Francisco and Silicon Valley. These companies want to be around each other, this is where the talent is, it's where all the essential services are around tech. So, unless we really see a big shift of people, I don't see all of the jobs going away as well.

Jim Costello:I like your comment on thinking about it in the broader region. It's not just everything right on the water, but bringing in San Joaquin Valley, looking at Sacramento. You go to other global cities, you go to Hong Kong, even with the political difficulties that Hong Kong has with Mainland China right now, it's totally connected to everything else in on the Pearl River Delta. You go from there to Guangzhou quickly on a high-speed train. Very modern and clean. You have people zipping back and forth, living in one area, working on another, and it becomes a way of leveling the prices so it can be more affordable for people to live in a balanced setting in an urban environment. So, you get some of those issues resolved with transit linking these areas better and maybe less onerous development restrictions, and the area could really shine.

Bruce Carlson:I've got another. What are your guys’ view on the shape of the recovery?

Jim Costello:Shape like ladders.

Bruce Carlson:Right.

Jeff Bellisario:Well, I can tackle that one first. I think from the beginning of this, I've been talking about some type of check mark or square root sign. I'm not usually right on these things, but I do think that's playing out a little bit where we did see many jobs come back. Also, within months, we've effectively leveled off a little bit, whether it's the United States or in California. You talk about consumer spending, and consumer confidence, is still somewhere between 10 and 20% down from where it was. As much as remote work works and this recession hasn't necessarily impacted people in office jobs or at the top of the economy, there's a big chunk at the bottom of the economy that does drive a lot of that spending, that benefited from the extra 600 bucks and unemployment. But, without some type of intervention going forward, I don't see a quick recovery, all dependent, again, on the vaccine.

I'm not an epidemiologist, but even if we are to get a vaccine at some point next year, which I think most people would say is likely, at what point do you get full uptake? How does the distribution work? When do we get back to a situation where you say this is quote, unquote, normal? Then, I think the recovery can move relatively quickly, but there are just so many people on the sidelines today and so many small businesses in particular that have shut down in the retail, restaurant, leisure and hospitality space, arts and recreation. If those businesses don't come back, who employs that very large chunk of people? Particularly, if there's no social safety nets for them, where does that spending get replaced?

So, for me, that's a big piece in thinking about how we retrain coming out of this. But, for me, I'm not a U or a V guy, I'm just medium slow. This is not a tenure recession by any means. I'm one of the young people that Jim mentioned, that benchmarks everything off of the last massive recession, but we're nowhere near that. I would point to maybe a couple years until we get to a more normal feeling in the economy.

Jim Costello:Well, since you're one of the young people, one of the ways that I've been describing to older audiences, the shape of the recovery, here's something that you won't understand. It's a cursive V. So, the old flowing scripts that the nuns taught me in grade school, a capital V has a big sharp decline, a big sharp increase, but the tail end is lower than where you started. It's kind of, like a check mark. But, the thing I've been increasingly focused on is the discussion around the so-called K-shape recovery.

Now, for this downturn, it hasn't impacted me all that much. Yeah, it sucks to stay at home and you can't go out. But, there's other people at the lower end of the income spectrum, who can't work from home, they've got much more challenged economic situations and it's very much a game of haves and have nots. I'm living here in downtown Brooklyn in New York and it's one of these areas gentrifying clash of cultures as people move in. You can very much get a sense that there's people struggling. At the same time, there's people almost living life the same. So, that K-shaped issue, I think there's so much tension, I think, at the moment, also in the political realm, because there are a lot of people very much hurting. I think that this is an issue that is going to be lagging for some time.

Bruce Carlson:Great. What about the future of cities? Future urban environments? What do you guys see?

Jim Costello:Yeah, I'll put some historical perspective on this from reading some stuff. People have been decrying the depth of cities. You go all the way back to the Black Plaque, people said, "Oh, no one's ever going to live in cities, again, they'll be more dispersing and living out in states." This has happened before. People have always said no, no, no. But, there's benefits of people being in one place. Especially, there's a demographic issue. People will have been highlighting. I don't know if this talk has been going on so much in the Bay Area. I haven't seen this talk from my sources, where I follow the Bay Area. But New York, there's been a big discussion, a big comparison, of what's happening today to what happened in the 1970s with that famous Ford to City: Drop Dead timeline. The thought that we're going to go back to Fort Apache, the Bronx type situations here in New York, and the city will become lawless and wild again and empty.

Part of the issue that happened then, that is not happening today, was a demographic change. You had in cities across the United States, people left the cities as we started to introduce new technology of highway systems, and suddenly have these wide open areas and suburbs opening up all this new housing. There was a natural progression then of people leaving cities. There wasn't enough population to backfill, so you had some depressed urban areas because of that. Then, you had a demographic wave that supported that, people started moving in close areas. It was only later into the 80s, 90s, that young folks started moving back into cities, because lower cost and a demographic wave that supported it, and then really into the millennial generation when they came in.

But, there's differences today, you don't see the same type of outright subsidies of people moving further and further out. In some respects, I wish that would happen. The sense of tighter integration of satellite cities into every urban core. In the northeast, let's knit Hartford and Harrisburg and Philadelphia more closely into New York with, let's just get trains from China and put them here in the United States. Actually, they're doing that in Texas. There's a group that is going to build the Shinkansen railway system from Houston to Dallas. It's private enterprise. I think they're going to get it done, and it's a real estate play as well. As a train fan, I'm hopeful that one moves forward.

But, I digress. The big issue is that the demographics today, you don't have the same collapse after the baby boom to the Gen X that led cities to be empty for a while. Millennials are starting to leave cities just because they're aging out. They're getting to be an age where they're having kids, they're pairing off, and they need a house. They need a yard because dad does want to deal with the kids when he's in a Zoom call. So, you need to be in the suburbs and have a yard they can run around with, play with the dog. So, there's that natural progression demographically, but the group that comes after them is very large as well. So, you don't have that hollowing out afterwards that happened with Gen X. So, I think cities in that near-term demographic wave will be okay as well.

Bruce Carlson:Great. Jeff, you have anything?

Jeff Bellisario:This is a somewhat crass coming from a different economist, but the young folks or the Millennials or the next wave, they go where they can get a date, right? You can meet people more easily within a city, there are more places to go on that date within a city. I do think we're going to see some shifts in terms of the population, urban to suburban around many metro areas around the country, I think those are shifts that would have occurred within the next two or three or five years anyways, and people are making those moves today. So, I don't think the city is dead by any means.

The one thing I would add, though, is that I do think that there are certain suburbs that could win coming out of this, particularly the ones that can recreate a bit of an urban atmosphere within their suburban landscape, whether that's through something like office parks, or more walkable downtown areas. Again, oftentimes, not feasible politically, but I do think the suburban areas that look like that today, or could transform into that within the next few years. If there is a big shift to remote work, which, maybe, that can be your next question. But, if remote work is here to stay in a bigger way that many people think, those suburbs that look like cities, I think, are the places that win coming out of this.

Bruce Carlson: Yeah, I'd agree with that. I've got another question from Roger Snell. "Can you explain the disconnect between the pricing of the stock market and what is happening at the personnel and company level? Main Street, Wall Street?"

Jim Costello:Well, looking at real estate companies, and real estate assets the stock market REIT shares fell, initially, on all the fears around what's happening on COVID, but property prices have still been fairly flat, just a little bit of a decline. Part of it is just the differences in how you finance a company versus a property acquisition. An investor, individual investor or investment company, a fund managed company, buying a property, they've got a certain amount of equity, and then that's fixed in place. Then, the debt, you get a loan from a bank and you're there. If you're still cash flowing enough to pay off that debt, you don't have to sell the loss. You don't have to realize the loss until later if you want to. So, prices aren't the mechanism of change, the mechanism of change is the decline in deal volume as buyers and sellers move apart. This market for assets acts differently than the stock market, that equity position keeps changing as people trade in and out quickly. That's going to be more susceptible to the whims of people's fears in the stock market. So, don't take repricing of REITs as an immediate sign of what's going to happen with property pricing.

Jeff Bellisario:I would only add that there's an exceptional amount of money out there right now and that's part of the reason why many people think that recovery will be quick. If you look at FDIC insured deposits, they're at $16 trillion, as of just a couple weeks ago, up from 13 trillion in January. So, that's basically a 20% increase that we haven't seen in the past. Part of that has to do with how much of the economy is still working. People are able to work remotely. Even if you were unemployed, there's a lot of data out there that shows that total incomes in terms of wages plus government benefits actually went up over the last few months. So, there's a lot of money on the sidelines, that could be invested and is being invested.

I would also point, as we look at the stock market, and we look at it as just another indicator for the overall economy, but, generally, people are looking long-term at the stock market, you're buying future earnings. I think that's a sign that most people think that this recession does not last extraordinarily long, and that long-term, there's still positive outlooks in many sectors. The only one that had a long-term outlook in terms of revenue as flat or negative, is various types of brick and mortar retail. Again, I think going back to that previous conversation, how does the retail conversion or transformation solve some of our other issues, whether it's on office or residential, or just thinking about those open spaces? So, I'll just add those two things in looking at the long-term, but also just the amount of money that's currently on the sidelines today.

Bruce Carlson:Yeah. Jim, could you drill down a little bit more on relative the asset value? The real property asset value to the REIT property asset valued? I'd assume it's similarly impacted. It would move with the stock market. Do you have any-

Jim Costello:No, again, I made that point that we've seen some tremendous declines in the REIT shares that have not translated through to property pricing yet. I just would not assume that the price moves you see in REITS are necessarily what you'll see in moves in actual asset pricing. The asset pricing for REITS, that's market fears at the time and some of it got unwound. Actually seeing the questions, Roger may have a broader issue on that, not just companies themselves. I think Jeff brought it up, this notion of, how do you value future income streams? That's why the S&P's up so much, I think, because the big components, they're all the tech firms and stuff that's concentrated in the Bay Area.

It's almost an infinite duration play for some of these folks thinking that the tech sector will be around forever. Until somebody could figure out a way to email me a pizza and just have it magically materialize next to me, there's all kinds of crazy stuff to come up with and build and do. That center of innovation in the tech world is something that makes sense for the future. The brick and mortar old line stuff, somebody owns a small privately-held company that, say, makes ceramic tile, great, interesting stuff, during an upswing, great construction materials, there's a lot of demand for it. But, it's not high tech, it's not permanent. It's not going to get a great valuation today. So, that disconnect between market pricing and what we see with the broad stock market indices. Think, it's also just a function of how much of it is tech-focused, and people viewing these handful of tech stocks as an infinite duration play as a way of just protecting some of that capital that's sitting on the sidelines.

Bruce Carlson:Thank you. What about, as we get a vaccine? There's another question relative to public transit and our repopulating the urban environments, whether it's office or residential, urban living. Jeff, any thoughts on that?

Jeff Bellisario:Yeah, I'll be quick, I think that is the one area where without some type of state or federal support, there will be changed within the transit system, either reduction of routes or fewer trains, or in a perfect world, a consolidation of many of the Bay Area's transit operators, as they look to lower their overhead. I had a 50% remote work number up there. It's not going to be anywhere close to that long-term, but I do think there will be more people particularly back-office type jobs that work remotely more days per week. So, I do think ridership will be down and many agencies are projecting down ridership even beyond a vaccine. So, I don't know what the restructuring looks like, but think that's something to look for within many transit agencies around the country, because they're really struggling right now.

Bruce Carlson:So, I'm looking for a few more questions. Let's see. "Isn't it still too early to know the ultimate change in value of properties, given the lack of price discovery, the difficulty of predicting rents, and the accommodative stance of regulators that has allowed banks to kick the can down the road?"

Jim Costello:Yeah, all those issues make it hard to determine the value of a property today. So, if you don't have to sell a property today to an environment where a buyer - if they're going to come in, they're going to want to get a tremendous discount, in most cases, why bother? Why do it? Wait till later and see where it goes. There have been a handful of sales where it's clear. Some great apartment properties have transacted that have stable occupancies, good income in place. They're still been getting healthy prices. Industrial properties, it's clear from the downturn, just a shift to more online sales, that there's demand for industrial for the logistics space. That stuff, again, property prices are starting to increase a little bit.

So, there's a few areas where there's signs of future growth that are translating to higher property prices. The areas where there's a lot of uncertainty and challenges, the hotel market is probably the worst. We're already down about 4% on prices from a year ago. That's even really before we start factoring in impacts from COVID. The hotel market was already facing trouble from just oversupply and emergent competition from the likes of Airbnb. So, how much more is it going to go down, it's hard to say. If you don't have to sell, you won't. But, that's an area in the hotel market where I think that rising distress is going to accelerate, and you're going to be forced to sell, and you're going to see much more of a fire sale type of price.

From my perspective, too, I've been advising my clients that are trying to think about what to do next for investments, to be looking at the hotel market because I think there's going to be distressed opportunities that people will be able to jump onto and pick it up at a song and then ride a wave of recovery once we get a vaccine.

Bruce Carlson:Great.

Jim Costello: I know I plan to go some place after all this isolation and travel stuff has stopped. The last place I was, right before we got locked down here in Brooklyn, was San Francisco and I'd love to come back.

Bruce Carlson:Awesome. Got a couple more questions. You're going to have more insight on this, Jimmy, you've touched on it. What's happening with the lenders and banks? They're clearly enabling us to kick the can down the road, but we've got a lot of penalties that the landlords are incurring relative to the legislation. Any thoughts on that?

Jim Costello:Yeah, the bank lenders, let's start with that. The bank lenders always have more leeway to work with a borrower, when they run into trouble to help them restructure alone, help them think about other ways to stay current. As opposed to CMBS, where you can't hit all the requirements and it ends up in special servicing. In this cycle, since 2010, most of the lending in the commercial real estate world has been bank lending. Just over 50%. Then, the GSC's were the biggest component for the apartment sector. So, it's not as rigid of a lending market as it was in the financial crisis, where more than 70%, for a while, of all lending, was CMBS lending. Once you have trouble on the CMBS loan, you're dead. You're gone to special servicing, that's it. There's no way to restructure things.

So, that issue is something that creates a little bit more flexibility on the part of the lenders and they are kicking the can down the road to some extent. However, they are also supported in that from the regulators, because the regulators could step in and say, "Guys, realize a loss here. You're way out of whack of reality in terms of what you're lending against." But, they're being accommodative today. That's from the top on down and the notion is, let's not add fuel to the fire. We know this is a temporary situation, we'll get through it and then we can start to realize what's happening. The benefits from that, also, coming from the Cares Act, do not expire until the end of this year. So, maybe, early 2021, we'll start seeing the banks under some pressure to start realizing some losses that have probably happened, and they've just been papering over and kicking the can down.

But, certainly, not for the rest of this year, I don't think we'll see any movement from the banks. They don't have an incentive to now, they're not being pressured to do it, so I don't think they will.

Bruce Carlson:Here's another question from Roger. "Jim, when it safe to come back?" Oh, sorry.

Jim Costello:When will it be safe to come back, and what will it look like. I'd love to come back and do something like this over cocktails, kind of thing. That'd be fun, too.

Bruce Carlson:It would be. Thanks, Roger. That's funny. Unless anyone else wants to throw a question in quick, that's about all I've got. Do you guys have any other closing remarks, or are we out?

Jeff Bellisario:Hey, Bruce, can I jump in and actually ask a question to Jim? Matt Regan asked the question in the chat here. In California, we're talking about reassessing property values, basically, looking at the split roll, I guess, for you and the numbers that Matt throws out here at $12 billion in additional revenue on property value reassessments for commercial spaces. Are there examples of other cities or states that have large commercial property tax increases, and what has been the impact on the commercial real estate market given a large tax change in a jurisdiction?

Jim Costello:Globally, if you look at relative levels of taxation, cities that tend to have lower tax rates on sale have more transaction volume. So, you go to London, there's a huge transfer tax. So, the relative liquidity of London versus New York is lower, because anytime you sell a building, you have a huge transaction cost that goes with it with higher taxes. Perversely, I think the split roll might increase transaction activity in California, in the sense of, if I've held a property for a long time now and then I sell it, then the next buyer is going to get a big increase in property taxes. It gets reassessed then. So, if you reflect the markets down every year on ongoing reassessments, honestly, it's probably a fair way to do it. It's going to hurt for current owners to see reassessments, changing the income structure of what they thought they owned.

Chicago went through that recently. Chicago had a big change. It's tricky because some of it was just, once a decade review, that the tax assessor does for Cook County, on the structure of how different areas of the county get assessed, and it made big changes in terms of the taxes law commercial property owners paid. But honestly, you talk to people and some people thought, oh, it was just them trying to grab money. Maybe, at the margins it was, but the reality of the situation was that there was a big shift that had happened that hadn't been realized, because they had been waiting a full decade for that. So, one of the things that the assessor of Cook County talked about doing was, maybe, we don't do this in a decade long basis in the future, maybe we can get this process changed to be more frequent, to help the market adjust to things better and operate more smoothly.

 So, I think that, maybe, in that sense, that could be the silver lining of a split roll, in the sense that you won't pay for things over and tell people that your tax is lower, that you get reassessed on a more frequent basis. So, at least you know where you're at, and once that stabilizes, then maybe we can see some more transaction activity relative to previous times in San Francisco, because you won't have that huge extra barrier that people have to get over to get to a new sale.

Bruce Carlson:I agree with that. Thank you. Hey, thank you, guys, both, you were brilliant.

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