September 19, 2025 • 35 mins
The starting gun has gone off: The Federal Reserve lowered interest rates 25 basis points. Now CRE can be off to the races.
At least that’s the narrative.
In practice, CRE cares more about long-term debt, and the 10-year Treasury ran counter to expectations and actually rose 10 bps, Jim Costello, MSCI’s director of real estate economics, said on this week’s show. Besides, the industry’s problems go far beyond interest rates, and 25 bps isn’t large enough to make much difference.
“If you want to be successful in CRE, it’s not about that home run of capital market forces lifting the value tremendously,” Costello said. “It’s going to be a lot of singles and doubles.”
That means a focus on proper leasing, getting the right broker, careful analysis of tenants and focusing on operating expenses.
How about all that money waiting on the sidelines — will that finally loosen up with the drop in rates?
“Here’s the thing about dry powder: When you get a little wind, it can blow it away,” Costello said.
“If you don’t have a situation where managers can place money effectively and hit their IRRs, that dry powder will dissipate.”
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Mark Bonner (00:09):
Okay. Welcome to First Draft Live. It's Friday,
September 19. I'm Mark Bonner,business owner and chief coming
to you live from New York. Thankyou to so many of you for tuning
in from across the country andoverseas.
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(01:17):
So go on. Head tobiznow.com/firstdraft. That's
biznow.com/firstdraft. Okay. Nowlet's get to today's story.
The Fed finally pulled thetrigger. A quarter point cut,
the first since 2024. It wasenough to spark the headlines,
but I don't think it's enough toshift the math. Yes, volumes are
(01:39):
stirring nearly $110,000,000,000in trades last quarter, but
vacancies are climbing acrossthe board. Industrial is at an
eleven year high.
Retail is inching higher.Multifamily rent growth is
fading. And office, still thegravitational drag.
$70,000,000,000 in debt isalready wobbling. Prices are
(02:01):
down more than 50% from peak.
Cap rates are drifting higherwith only the faintest signs of
leveling off. Even the sectoronce thought to be untouchable.
Data centers is beginning toshow cracks. New AI campuses are
attracting billions, but legacystock is bleeding CapEx and
slipping in value. Here's thereal tell.
(02:24):
The Fed changes the conversationthis week, not the fundamentals.
It gives CEOs a story for theirboards, GPs for their LPs,
lenders for their committees.Momentum is back. At least
that's some of what's in myinbox this week from PR shops
trying to take back control ofthe prevailing narrative. But as
(02:46):
we've been reminded this week,the Fed doesn't control the long
end of the curve.
A tweak in rates may buy time,but workouts, write downs, and
income growth will decide whosurvives. That's where we are.
Relief without rescue, at leastfor now, or so I think. And
that's why we've got JimCostello here today, executive
(03:08):
director of MSCI Research, tocut through the noise and show
us what this moment reallyrepresents. Send your questions
in the chat.
We'll get to as many as we can.Jim, welcome to First Draft
Live.
Jim Costello (03:21):
Thanks for thanks for having me here.
Mark Bonner (03:24):
Jim, make sense of it all. What is your big
takeaway here for what happenedand perhaps what has not
happened based on JeromePowell's decision this week to
drop basis points by 25?
Jim Costello (03:36):
Yeah, it's there was a lot of optimism in the
industry around the potentialsfor a cut in the fund spread
rate. The hope being that youcut this and it's a signal to
the market and it helps reducethe borrowing cost for other
items. It helps reduce the costof capital, reducing the tenure
(03:57):
treasury, eventually reducingmortgage rates. But that's not
what happened. The Fed, again,it only controls the short end
of the yield curve.
The long end is the market andthe market saw a 25 basis point
cut and just didn't react howpeople were hoping instead of a
decrease in rates. The ten yearTreasury went up about 10 basis
(04:20):
points and that there's a weeklysurvey of residential mortgage
rates I look at, but a dailyone, showed about a nine basis
point increase. Now that'sresidential, it's not
commercial, but they're kind oflinked. They rhyme over time.
And with that kind of momentumthere, if it's sustained, it's
(04:42):
saying that all the hopes thatpeople were pinning on Fed rate
cuts, just aren't beingrealized.
Mark Bonner (04:51):
I mean, that sounds like a little bit like a bummer,
Jim. Mean, hearing in my inboxthis week, I'm seeing CRE
celebrating a lifeline. Right,and look anytime you get a cut
like this, especially in amarket over the last eighteen to
twenty four months wherecommercial real estate has been
asking and begging for interestrate reductions. Why are they
(05:13):
celebrating? I mean, theyfooling themselves while
fundamentals deteriorate in youropinion?
Jim Costello (05:19):
It's not fooling themselves with deteriorating
fundamentals. In fact, there'ssectors I think that
fundamentals are not that bad,but it's more that there was a
lot of optimism. There's a lotof hope that it would both be a
bigger cut and it would havemore of an impact. And in both
(05:41):
cases turned out differently.You know the impact, the markets
in terms of what investors arewilling to do on that credit
side.
They're just not following thatsignal that they that the hope
was folks would follow. So youhave that one issue, but then on
the fundamental side, yeah,there's some strains showing in
(06:04):
the market, but some of them arelagged strains. It's not as much
because of the currentconditions. The industrial
sector, for instance, we had twoyears of record high industrial
construction. So sure,availability rates are at levels
not seen for a decade.
(06:24):
It's not necessarily a sign ofjust weakness in the economy.
There, I think it's really asupply driven issue. Maybe some
apartment markets are driven bythe same issue. Some of the
markets in the South, folks werereally tied up in this whole
boosterism of people are goingto leave New York and move to
Atlanta. And sure, there weresome moves in COVID, but it
(06:45):
didn't continue forever.
That's one aspect of commercialreal estate that I think people
are often really bad about. Theysee a trend and they just
extrapolate it in a linear senseinto the future. You don't have
once once the low costadvantages in housing for places
like Florida started to go away,it changed the narrative on
(07:09):
migration where it's kind ofback to pre pandemic trends and
growth. Still good growth, stillgood reasons to be in some of
these markets in the South. Butthe momentum that had been there
is slowing, which is notnecessarily because of anything
current in the economy and anycurrent challenges.
It's a little bit of laggingimpact. Any current challenges
from the discussion about a weaklabor market, think are yet to
(07:33):
be realized.
Mark Bonner (07:34):
So what's next, Jim? I mean, beyond your
sharpest insight of what thisactually means from earlier this
week, what's next? What is thenext hurdle that you think real
estate needs to clear on thisfront in order for it to get on
a path where it can truly beginto recover from five or six
(07:54):
years from the pandemic, youknow, altering society at large
and also capital markets, butalso the current policy that
we're in in America inparticular.
Jim Costello (08:06):
Yeah, what's next? We're taking a look at the loan
maturities that are upcoming.We're trying to produce a report
next week looking at just thatand how many of the loans are
going to be above water and howmany are below water. And the
challenge on that is thatthere's a lot of loans out there
where, you know, they'll needcapital. They'll need to
(08:28):
refinance at some point.
And that's why folks are sooptimistic about rate cuts,
thinking that if it translatesthrough to lower commercial
mortgage rates, then maybe thehigh LTV loan I did at 2022 in
January at a record low coupon,maybe I'll be able to survive
that. But if rates don't drop,if they stay high or even follow
(08:53):
the residential and maybe go upa little bit, some of that stuff
is gonna have a more difficulttime refinancing. And so what
would happen next is, is, youknow, some folks taking a bit of
a loss as lenders end up takingproperties. Now, not everything.
It's not gonna be a totalcollapse.
In fact, like distressed assetsales really haven't spiked much
(09:15):
in this cycle. Three years afterthe start of the financial
crisis, distressed asset salesand commercial real estate hit
20% of all transaction activity.We're now just about three years
on from the increase in interestrates that really kind of is
driving the change in mentalityin the market. And now we're up
(09:36):
to 3% of the market asdistressed asset sales. So the
total impact, even though it hadsome big price declines, the
total impact is not as intenseyet.
Some of it is due to differenttypes of lenders, the financial
crisis, so many loans that wentbad were CMBS version one point
zero and you didn't have muchwiggle room with the special
servicers then. Now you haddifferent types of lenders,
(10:00):
particularly private creditworld. That's been a big source
of growth. For like the firstmortgage position, a report next
week is going show like about15% of the markets this year has
been the private credit space. Ithink part of it is, and I'm
still trying to make a case forthat and build a data center,
(10:20):
but I think some of it is thatthe distressed opportunity that
happened last cycle, privatecredit has stepped in in a way
that nobody else could followingthe financial crisis.
And there, you know, a lot ofmezz stuff. And so maybe then
properties trade hands and endup in the hands of some of these
mezz funds.
Mark Bonner (10:39):
But just one more note on the on the decision on
Wednesday. I mean, it was 25basis points. A lot of people
were screaming that it shouldhave been 50 certainly from the
White House. You know, I mean, II think the president would have
liked to have seen it be a 100cut. That's neither here nor
there.
What is here is that JeromePowell, sort of insinuated in a
lot of economists backing upthat we're gonna probably see 70
(11:00):
basis point reduction betweennow and the end of the year,
possibly further cuts going intotwenty twenty six. Let's assume
for a second that that comes topass, Jim. Like, what will that
mean? Will that be moremeaningful once we get into
January and February 2026? Doesthat change the math for you as
you look at the landscape?
Jim Costello (11:20):
The the thing that I'm concerned about is the
underlying trend in inflation.If if you're making cuts and
we're in a low inflationenvironment and you don't have
any momentum kind of going theother direction. I wouldn't be
concerned, think it would havethe impact that folks want of
(11:41):
the market looking at that as asignal, but you know we do have
the situation of a weak labormarket combined with. Inflation,
it's not at a high level, butthe momentum is now moving in
the other direction. And if I'mlooking at that, I'm going to be
a little bit concerned aboutgetting into instruments that
(12:04):
are just giving me a fixedpayment that doesn't take into
account anything with theinflation.
So buying bonds might beproblematic. Now, can't do it in
an easily leveraged basis with alot of real estate given the
cost of capital in thatenvironment if the rates are
going up. But in real estate, ifyou're worried about a little
(12:29):
bit of unexpected inflation,that could be a benefit for the
sector as people try and lock inCPI adjusted income streams. So,
you know, there's a lot ofnuance on this. There's some
things that are bad, but thenother impacts that can be
beneficial.
But it's certainly easier foreverybody when you have high
(12:53):
growth and a low cost ofcapital. But right now we're
facing a challenge of, you know,still challenges on growth and
the cost of capital is, youknow, and you know, it's kind of
funny. There's folks looking atthe cost of capital today and
looking at where rates are andthinking, oh, it's still
expensive because theirmentality has been shaped by
(13:15):
everything we've gone throughsince, I mean, really over the
last fifteen years, we've beenin a weird environment of
excessively low cost of capitalbecause of all the QE and all
the response from the globalfinancial crisis and the long
scope of things right now, tenyear treasury this morning when
we looked at us at 4.1, youknow, in the long scope of
(13:37):
things for commercial realestate, that's a low interest
rate environment.
Mark Bonner (13:41):
It's just All right. And I'm glad you brought
this up Jim, because you need,you got an entire in, you got an
entire generation of commercialreal estate players that have
known that period of time thatyou referenced, which was by the
way the longest expansion of TheUS economy in history near zero
rates for a very, very longtime. Double, maybe even triple
the length of the typical cyclefor something like that.
(14:01):
Pandemic happens, we're herewhere we are today. I mean, that
a large group of people thathave a lot of power in this
industry that were doingbusiness one way and now see
this and you're right to bringup the macro, the history of
this.
Like, how would how does thatresolve itself, Jim? Because I I
(14:22):
still have people in my inboxand on my other than my phone
where I'm talking to peoplesaying, this is ridiculous. This
is way too high. And I'm withyou. I'm looking at the longer
twenty or thirty year historyhere and I'm thinking, I don't
know what, how do you squarethat Jim?
Jim Costello (14:38):
Well, we need a generational change is happening
for commercial real estate inline with some of these secular
shifts in the market. If you goback to the mid 1980s, you and
were investing in real estatefrom then to around 2019, you
(15:01):
always had capital market forcesat your back when you're making
an investment. You had, the tenyear treasury on a general
downward trend over the wholeperiod. And so generally
mortgage rates and cap rates, Imean, they're not gonna move one
to one, but they'll rhyme. Butthe issue is that if I, average
commercial property investmentsare held for about seven years
(15:22):
in The United States.
So anytime from the mid 1980s to2019, when you're buying
something, were buying it fromsomeone who seven years
previously likely went in at ahigher mortgage rate and a
higher cap rate. And so youcould mismanage an asset. You
have the wrong leasing team inplace, spend too much on CapEx
and still eke out a positivereturn just from the capital
(15:46):
market shift. That game, let'ssay magically the ten year
treasury stays at this 4.1%level here for the next ten
years, never moves. That's avery unlikely scenario.
I'll say that, but let's saythat happens. If that does
happen, it's still not going to,capital market forces are not
(16:08):
going to be a tailwind anymore.There'll be a headwind because
everything that was bought andsold from that period when the
ten year treasury was unusuallylow relative to history with all
the QE that was happening, allthose deals are gonna face
challenges when it's time fordisposition and a fund, time for
(16:31):
the new loan to come due andrefinance. Capital market forces
are going to be a headwind. Sowhat this means is if you want
to be successful in commercialreal estate, it's not about that
home run of capital marketforces, just lifting the value
tremendously.
It's going be a lot of singlesand doubles now. So just
(16:55):
bringing it back to Sportsview,helping you with your Mets. But
the singles and doubles, thoseare gonna be proper leasing,
getting the right broker inplace that gets tenants into
your property, doing a properrisk analysis of the tenant
who's coming in to make surethat they're actually gonna pay,
(17:15):
making sure that your CapExspend is in line with market
averages and that your OpEx isalso in line with market
averages. You're not too far outof line from what your
competitors are doing. That'sgoing to be the recipe for
success.
And it's not going to have thesame oomph as what you had when
(17:36):
tenure, when the tenure treasurywent from a 20% rate to a single
digits.
Mark Bonner (17:43):
You mentioned my Mets, they're going need a lot
more than singles and doubles,Jim. If you're just joining us,
this is First Draft Live. We'reunpacking the post cut reality
with Jim Costello, executivedirector at MSCI Research. Send
your questions, and we'll get asmany as we can. Jim, let's talk
about price discovery.
Office distresses balloon past70,000,000,000. Cheap debt may
(18:05):
unlock deals, but at what cost?Fire sales risk rewriting the
comps across entire markets. Inyour opinion, are we witnessing
genuine price discovery rightnow? Or do you think this is
capitulation in disguise?
Jim Costello (18:20):
Well, no, capitulation is price discovery.
The issue was that currentowners of buildings, nobody
wants to take a loss, right? Andjust people are risk averse for
everything and nobody ever wantsto lose something. And you had
many investors who held theseassets. You had a big shift in
the way people react to and useoffice space And nobody wanted
(18:44):
to realize that loss untilthey're forced to.
And so you had current ownersdelaying delaying delaying and
just not realizing a loss untilthere was some outside event
that made them. And one year in,two years in, you're not going
to do anything. And so dealvolume was low. So you had
buyers and sellers really firepart. But over time as some
(19:08):
loans came due, some assets weretransferred to somebody else,
whether through a manageddefaults or just some outright
foreclosure activity, it sentsignals to the market.
And we're five years in from thepandemic. The waltz that was in
place pre pandemic is slowlyburning off. So the message is
(19:32):
getting out to current officeowners and as a result, prices
for like CBD offices are likedown 52% from the peak and you
get a 52% decline for some ofthese buildings that are still
kind of stable and income.There's still people in the
office. I'm in the office today,but I'm a real estate person.
(19:52):
So I eat my own cooking. Right.But, but even beyond our sector,
there are still some other folksin the office because there's
still some benefits of beingaround other people. There's a
happenstance of, just pointinginto other people you work with
in the company and the cross,ideas that come with it. But
there's some value there, it'sjust not the value that was in
place.
(20:13):
And so the current owners arefinally starting to come to
grips with that as they seecompeting assets go through
distress. It impacts theirunderstanding of the value that
they have in place. So yeah,there is capitulation. They're
finally meeting the market andthat's where we're starting to
see deal volume climb again forIt's not like Manhattan, we're
up like 5% year over year lastquarter. It's not, and some of
(20:37):
it was distressed, but even ifyou strip out the distress,
they're genuine assets thatpeople are, are selling in a, in
a, arm's length transaction atthis point where they're
reflecting on the fact that thedistress shows that what was the
value before has changed.
Mark Bonner (20:53):
Look, in a situation like this, there's
always starving dogs and fatcats, right? And moving on to
data centers, right? This hasbeen a fat cat for commercial
real estate for quite a while,but that fat cat is starting to
not look so pretty anymore. Datacenters are supposed to be
bulletproof, right? But salesare down 50% year over year,
(21:16):
even as AI ready ground upsexplode.
The bifurcation is widening,balance sheets are already
starting to show some bruises.Is CRE's crown jewel at risk of
becoming its next bubble?
Jim Costello (21:29):
I never would have categorized data centers as a
crown jewel, But I think one ofthe issues
Mark Bonner (21:36):
I mean, it's got a lot of momentum, Jim. I mean,
it's something that the industryhas been really proud of and
they've ridden the trajectory ofit for quite a while. So, I
mean, you know, semantics, but,you know
Jim Costello (21:45):
It has momentum, but it's I think the issue there
is that is how institutionalinvestors create portfolios.
Like every meeting I've had withasset owners and asset managers
over the last year has beenthere's the focus of discussion
is what big major sector betsshould we make. Any investor who
(22:08):
over allocated to industrialfrom around 2015 on, they beat
everybody else in our ACOEindex. That's the all core open
end index we create from all theappraisals of the institutional
managers when they give them tous. So they know that the folks
who won, they won by making abig sector bet on industrial.
(22:30):
There's still some good thingsabout industrial, but some of
that game has played out. So nowpeople are thinking what's the
next big sector bet I can makethat will help me to outperform.
And with some transformationgoing on with data centers and
the digital economy and the AIstuff, people looking at it and
thinking, maybe this is a bigsector bet I can make that will
(22:53):
help me boost my performance.But there's some problems with
that. I mean, I still thinkthere's great reasons to be in
data centers and there's somegreat properties out there, but,
not every, but not everyproperty is the same.
You know, in line with thatcomment earlier about it's
(23:14):
singles and doubles are going tomake you win. Think about that
from the property perspective aswell. There are data centers
that are older, don't have theright power supply, don't have
as good of access to water forcooling needs, don't have the
right capacity for more modernapplications. So if I'm so
(23:37):
hungry to get into the sectorthat I'm looking at anything,
you know, why is that currentowner selling it in this
environment? So I think there's,you gotta be careful that you're
not buying into the expansion bybuying the obsolete assets.
So there's a challenge in that.The other issue I'd focus on
(23:57):
there, if, I've been looking atthe life sciences sector as a
proxy for what we might see withdata centers. A couple of years
back, that same optimism was inplace for life sciences. And to
me, was clear at the time thatsomething was going to change
because I took a look at MSCI,the public markets, there's a
(24:20):
ton of data and information onthat side. We have an ETF tied
to that we create the numbersfor, tied to the life sciences
companies.
And if you look at the ETF forthe life sciences index and the
performance there versus theACWI, the ACWI is our, on the
public equity side, the, thejust it's, it's the everything
(24:41):
index. It's like, it's like theS and P 500 or but if you look
at the life sciences indexversus the ACWI, life sciences
was tremendously outperformingACWI for a bit. And what does
that mean? That means these lifesciences firms, the market was
saying these life sciencescompanies are more valuable. So
they invested in their owncompanies.
And when you invest in your owncompany, that means more plant
(25:01):
and equipment means more realestate demand. And then that
performance slipped below Acreeand about nine months later,
nobody wanted to be in lifesciences anymore because it So
takes a bit for that spendingcycle to I'd be careful looking
at data centers to make sure I'min the right physical kind of
locations. I think that part ina world where the singles and
(25:24):
doubles are just getting thefundamentals of property
management right are going bethe driver of success. That's
what I want to be in to makesure that my data center
strategy is focused right. Butthen I also look at that macro
concern of just how do thevarious tech firm indexes that
we produce compared to the ACWI.
And if they startunderperforming, then suddenly
(25:46):
these firms aren't going to haveas much to spend on occupying
data centers. So when thathappens, they'll still spend,
but they'll only be in the rightproperties. And so that will
create winners and losers inthat data center world.
Mark Bonner (26:01):
You know, I'm a student of boomerang economics
and you and I spoke earlier thisweek for the first draft
newsletter that I was talkingabout top of the show. Cuts are
meant to heal, but they are alsoa signal of weakness. Jim, if
inflation reignites, the Fedmight be forced into a whiplash
tightening cycle just asoperators re leverage. Do you
think Powell is bailing out CREor perhaps setting it up for an
(26:24):
even harder crash down the line?
Jim Costello (26:27):
Well, I don't think they're trying to bail out
CRE. So as much as everybodywho's listening might hope that
honestly, the central bankstypically, they have long
memories to a lot of thesecentral bankers. Real estate is
still stuck in the 1980s. Oh,they caused all these recessions
for us. And there is also arecognition, well, real estate
(26:50):
made a lot of money in, the lastcouple of decades.
So we don't have to reward thosepeople now. So I don't think
that they're trying to act toprotect us. They're trying to
act
Mark Bonner (26:59):
Well, I mean, in defense of commercial real
estate, you know this betterthan I do. This is a massive
part of the American economy,trillions and trillions of
dollars. For anyone in thegeneral public can understand
the power of this industry. Theydefinitely understood it in the
middle of the pandemic when theycouldn't go to the office or go
to a ball game or go to thestore, right? And we saw the
economic impact of that trenddownward just broadly, right?
(27:22):
But I mean, you know, forgivethe phrase but I mean, this
question still remains, Are wesetting ourselves up for a
harder crash down the road givengiven everything else that you
already talked about, in termsof other economic indicators?
Jim Costello (27:37):
I am worried about the chance for stagflation where
we have weak labor markets,potentially slowing growth and
higher inflation. If we do hitthat kind of situation, that's a
difficult environment for anycentral banker to be operating
in. And that's, that's a fear.If you go back to the last
(28:00):
period of time when we had thatkind of activity in The United
States, The real problem is justnot a lot of good data on
performance of real estate backthen. The notion of real estate
was different then than today.
Today it's an investment and yougauge the performance relative
to other investments in yourportfolio and other asset
(28:22):
classes. Back then, there washardly any good information out
there. And so it's just hard tosee how it performed. So if, if
you can catch them, what youwanna do is just sit down with
coffee with, you know, some ofthe senior execs from your firm
who were around back then whoare retired now and just, visit
(28:44):
with them and catch up and askthem for stories about when they
were junior analysts in theseventies when we dealt with,
stagflation because that's, thatinstitutional memory is really
all we can go about because wedon't have data.
Mark Bonner (28:57):
I'm going to get to one question from the audience.
Jim, can you talk more to theweakness you were seeing in
retail?
Jim Costello (29:05):
Well, it's funny retail. I'm actually kind of
optimistic about retail, retail.I mean vacancy, looking at some
data from CBRE, their quarterlyretail trends on availability.
It's been kind of flat recentlyfor the performing assets.
There's been a growth in kind ofolder obsolete assets that are
(29:29):
contributing to vacancy, but thesurvivors are, you know, kind of
flat on vacancy.
It's not so bad. The issue withretail, we got into this period
of just, you know, uncertaintyin 2020 and, you know, folks
(29:49):
weren't sure what would happennext to consumer spending and
everything, but the market hasslowly been removing older
obsolete properties. And so thathas helped the existing
properties, to improve thebottom line, NOI per square
foot, all the institutionalstuff that goes into our ACOE
(30:11):
index, NOI per square foot isnow above where they were,
before the pandemic. And largepart because of, you know, the
removals, but you know, andalso, you know, this notion that
people had that, oh,everything's moved online.
There's no more need for retail.
(30:32):
That just doesn't fit yet. Themore spending still happens in
store than online and onlinespending, it's still growing,
but it's growing at a slowerpace than the past. And it's
slowly starting to converge within store sales because at some
point there's only so much moreyou can sell online.
Mark Bonner (30:52):
Sure. Let's go over one more question from the
audience. Since real estate is aphysical asset, when will
climate change risk finallyswing a bigger bet? Isn't that
big OpEx exposure?
Jim Costello (31:06):
Yeah, it's, the climate risk is, well, that's a
good way to put it. That's CapExexposure though for folks that
they have to spend more on riskmitigation in different areas.
And it's a tricky one becausethere's a lot of views on, in
(31:27):
politics that kind of cloud theinvestment decision. The way I
just frame it for folks is justthink about the physical risk
aspects of it. If I'm, if I'mmaking a loan on a warehouse
property that's in a low waterzone, rather, it's close to sea
level in Florida, you know, Igotta be careful about the fact
(31:50):
that there might be a, an eventas opposed to, something that's
more inland and up, up from, upfrom the waterfront.
That's a, that's a safer bet,for myself personally. I bought
a house in Florida. I still livein New York, but you know, it's
the winter kind of place. And Iactually looked at our climate
(32:13):
risk tools first for my owndecision about the location so
that I made sure I was on thehigh ground because that storm
surge is the biggest risk forvalue. That's where the most
damage comes from.
And so it just how you pricethat risk of those locations and
(32:34):
what kind of mitigation stuffyou put in there, that's, that's
an important thing.
Mark Bonner (32:39):
Jim, I know we're running a little long on time,
I'm going to end on this lastquestion. Everyone talks about
dry powder. Liquidity, there's alittle bit of optimism in the
market right now, but no onewants to talk about structural
cracks, stalled absorption,zombie offices, capital stacked
on shaky marks. What's the realsystemic risk that no one wants
(33:03):
to admit on stage right now?
Jim Costello (33:06):
Systemic risk. Yeah, there's dry capital out
there, rather dry powder outthere. But think about dry
powder. You get a little stormand the wind can blow it away. I
mean, if you've, if you've evershot with, with the old muzzle
loaders, with the flintlockstuff, you know, that's why they
(33:29):
went to caps as opposed to justpouring the powder in because
the caps it's in place, but youknow, wind pulls up and it sends
everything out of your pan.
But in the same kind of context,in the middle of the financial
crisis when it was starting,there were people optimistic, oh
no, no, no. We have plenty ofdry powder out there. The
market's not going to collapse.But then when investors saw
(33:50):
that, listen, you told me thatyou'd hit a 9% unlevered and
there's no way you can do thatin this market. Then they were
able to, withdraw their capitalfrom those funds.
So you saw people, you saw thedry powder drying up. And so
that's the, that's the worryI've got about the dry powder.
If you don't have a situationwhere managers can place the
(34:14):
money effectively and hit thetarget IRR, so promising that
dry powder will dissipatequickly.
Mark Bonner (34:22):
Okay. That's the, that's our show for today. Jim,
thanks for being here.
Jim Costello (34:26):
Hey, thanks for having me. It's a, this went too
quick. I, there's tons more wecould have talked about.
Mark Bonner (34:31):
Get you on for a part two, man.
Jim Costello (34:33):
All right.
Mark Bonner (34:33):
But thank you very much. If you missed any part of
this episode or want to catchearlier shows, every
conversation is on your favoritepodcast app. Just search First
Live. We'll be back next Fridaywith another deep dive into
where markets, policy, andcommercial real estate collide.
I'm Mark Bonner.
This is First Draft Live. Have agreat weekend, y'all.
Okay. Welcome to First Draft Live. It's Friday,
September 19. I'm Mark Bonner,business owner and chief coming
to you live from New York. Thankyou to so many of you for tuning
in from across the country andoverseas.
You know, every week, thousandsof you drop in here and on this
podcast to watch us wrestle withthe chaos that is commercial
real estate. But here's the partyou might not know. First Draft
(00:33):
Live is actually the spin off.The main show? That's our daily
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If you're not reading it yet,you're catching the trailer
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(01:17):
So go on. Head tobiznow.com/firstdraft. That's
biznow.com/firstdraft. Okay. Nowlet's get to today's story.
The Fed finally pulled thetrigger. A quarter point cut,
the first since 2024. It wasenough to spark the headlines,
but I don't think it's enough toshift the math. Yes, volumes are
(01:39):
stirring nearly $110,000,000,000in trades last quarter, but
vacancies are climbing acrossthe board. Industrial is at an
eleven year high.
Retail is inching higher.Multifamily rent growth is
fading. And office, still thegravitational drag.
$70,000,000,000 in debt isalready wobbling. Prices are
(02:01):
down more than 50% from peak.
Cap rates are drifting higherwith only the faintest signs of
leveling off. Even the sectoronce thought to be untouchable.
Data centers is beginning toshow cracks. New AI campuses are
attracting billions, but legacystock is bleeding CapEx and
slipping in value. Here's thereal tell.
(02:24):
The Fed changes the conversationthis week, not the fundamentals.
It gives CEOs a story for theirboards, GPs for their LPs,
lenders for their committees.Momentum is back. At least
that's some of what's in myinbox this week from PR shops
trying to take back control ofthe prevailing narrative. But as
(02:46):
we've been reminded this week,the Fed doesn't control the long
end of the curve.
A tweak in rates may buy time,but workouts, write downs, and
income growth will decide whosurvives. That's where we are.
Relief without rescue, at leastfor now, or so I think. And
that's why we've got JimCostello here today, executive
(03:08):
director of MSCI Research, tocut through the noise and show
us what this moment reallyrepresents. Send your questions
in the chat.
We'll get to as many as we can.Jim, welcome to First Draft
Live.
Jim Costello (03:21):
Thanks for thanks for having me here.
Mark Bonner (03:24):
Jim, make sense of it all. What is your big
takeaway here for what happenedand perhaps what has not
happened based on JeromePowell's decision this week to
drop basis points by 25?
Jim Costello (03:36):
Yeah, it's there was a lot of optimism in the
industry around the potentialsfor a cut in the fund spread
rate. The hope being that youcut this and it's a signal to
the market and it helps reducethe borrowing cost for other
items. It helps reduce the costof capital, reducing the tenure
(03:57):
treasury, eventually reducingmortgage rates. But that's not
what happened. The Fed, again,it only controls the short end
of the yield curve.
The long end is the market andthe market saw a 25 basis point
cut and just didn't react howpeople were hoping instead of a
decrease in rates. The ten yearTreasury went up about 10 basis
(04:20):
points and that there's a weeklysurvey of residential mortgage
rates I look at, but a dailyone, showed about a nine basis
point increase. Now that'sresidential, it's not
commercial, but they're kind oflinked. They rhyme over time.
And with that kind of momentumthere, if it's sustained, it's
(04:42):
saying that all the hopes thatpeople were pinning on Fed rate
cuts, just aren't beingrealized.
Mark Bonner (04:51):
I mean, that sounds like a little bit like a bummer,
Jim. Mean, hearing in my inboxthis week, I'm seeing CRE
celebrating a lifeline. Right,and look anytime you get a cut
like this, especially in amarket over the last eighteen to
twenty four months wherecommercial real estate has been
asking and begging for interestrate reductions. Why are they
(05:13):
celebrating? I mean, theyfooling themselves while
fundamentals deteriorate in youropinion?
Jim Costello (05:19):
It's not fooling themselves with deteriorating
fundamentals. In fact, there'ssectors I think that
fundamentals are not that bad,but it's more that there was a
lot of optimism. There's a lotof hope that it would both be a
bigger cut and it would havemore of an impact. And in both
(05:41):
cases turned out differently.You know the impact, the markets
in terms of what investors arewilling to do on that credit
side.
They're just not following thatsignal that they that the hope
was folks would follow. So youhave that one issue, but then on
the fundamental side, yeah,there's some strains showing in
(06:04):
the market, but some of them arelagged strains. It's not as much
because of the currentconditions. The industrial
sector, for instance, we had twoyears of record high industrial
construction. So sure,availability rates are at levels
not seen for a decade.
(06:24):
It's not necessarily a sign ofjust weakness in the economy.
There, I think it's really asupply driven issue. Maybe some
apartment markets are driven bythe same issue. Some of the
markets in the South, folks werereally tied up in this whole
boosterism of people are goingto leave New York and move to
Atlanta. And sure, there weresome moves in COVID, but it
(06:45):
didn't continue forever.
That's one aspect of commercialreal estate that I think people
are often really bad about. Theysee a trend and they just
extrapolate it in a linear senseinto the future. You don't have
once once the low costadvantages in housing for places
like Florida started to go away,it changed the narrative on
(07:09):
migration where it's kind ofback to pre pandemic trends and
growth. Still good growth, stillgood reasons to be in some of
these markets in the South. Butthe momentum that had been there
is slowing, which is notnecessarily because of anything
current in the economy and anycurrent challenges.
It's a little bit of laggingimpact. Any current challenges
from the discussion about a weaklabor market, think are yet to
(07:33):
be realized.
Mark Bonner (07:34):
So what's next, Jim? I mean, beyond your
sharpest insight of what thisactually means from earlier this
week, what's next? What is thenext hurdle that you think real
estate needs to clear on thisfront in order for it to get on
a path where it can truly beginto recover from five or six
(07:54):
years from the pandemic, youknow, altering society at large
and also capital markets, butalso the current policy that
we're in in America inparticular.
Jim Costello (08:06):
Yeah, what's next? We're taking a look at the loan
maturities that are upcoming.We're trying to produce a report
next week looking at just thatand how many of the loans are
going to be above water and howmany are below water. And the
challenge on that is thatthere's a lot of loans out there
where, you know, they'll needcapital. They'll need to
(08:28):
refinance at some point.
And that's why folks are sooptimistic about rate cuts,
thinking that if it translatesthrough to lower commercial
mortgage rates, then maybe thehigh LTV loan I did at 2022 in
January at a record low coupon,maybe I'll be able to survive
that. But if rates don't drop,if they stay high or even follow
(08:53):
the residential and maybe go upa little bit, some of that stuff
is gonna have a more difficulttime refinancing. And so what
would happen next is, is, youknow, some folks taking a bit of
a loss as lenders end up takingproperties. Now, not everything.
It's not gonna be a totalcollapse.
In fact, like distressed assetsales really haven't spiked much
(09:15):
in this cycle. Three years afterthe start of the financial
crisis, distressed asset salesand commercial real estate hit
20% of all transaction activity.We're now just about three years
on from the increase in interestrates that really kind of is
driving the change in mentalityin the market. And now we're up
(09:36):
to 3% of the market asdistressed asset sales. So the
total impact, even though it hadsome big price declines, the
total impact is not as intenseyet.
Some of it is due to differenttypes of lenders, the financial
crisis, so many loans that wentbad were CMBS version one point
zero and you didn't have muchwiggle room with the special
servicers then. Now you haddifferent types of lenders,
(10:00):
particularly private creditworld. That's been a big source
of growth. For like the firstmortgage position, a report next
week is going show like about15% of the markets this year has
been the private credit space. Ithink part of it is, and I'm
still trying to make a case forthat and build a data center,
(10:20):
but I think some of it is thatthe distressed opportunity that
happened last cycle, privatecredit has stepped in in a way
that nobody else could followingthe financial crisis.
And there, you know, a lot ofmezz stuff. And so maybe then
properties trade hands and endup in the hands of some of these
mezz funds.
Mark Bonner (10:39):
But just one more note on the on the decision on
Wednesday. I mean, it was 25basis points. A lot of people
were screaming that it shouldhave been 50 certainly from the
White House. You know, I mean, II think the president would have
liked to have seen it be a 100cut. That's neither here nor
there.
What is here is that JeromePowell, sort of insinuated in a
lot of economists backing upthat we're gonna probably see 70
(11:00):
basis point reduction betweennow and the end of the year,
possibly further cuts going intotwenty twenty six. Let's assume
for a second that that comes topass, Jim. Like, what will that
mean? Will that be moremeaningful once we get into
January and February 2026? Doesthat change the math for you as
you look at the landscape?
Jim Costello (11:20):
The the thing that I'm concerned about is the
underlying trend in inflation.If if you're making cuts and
we're in a low inflationenvironment and you don't have
any momentum kind of going theother direction. I wouldn't be
concerned, think it would havethe impact that folks want of
(11:41):
the market looking at that as asignal, but you know we do have
the situation of a weak labormarket combined with. Inflation,
it's not at a high level, butthe momentum is now moving in
the other direction. And if I'mlooking at that, I'm going to be
a little bit concerned aboutgetting into instruments that
(12:04):
are just giving me a fixedpayment that doesn't take into
account anything with theinflation.
So buying bonds might beproblematic. Now, can't do it in
an easily leveraged basis with alot of real estate given the
cost of capital in thatenvironment if the rates are
going up. But in real estate, ifyou're worried about a little
(12:29):
bit of unexpected inflation,that could be a benefit for the
sector as people try and lock inCPI adjusted income streams. So,
you know, there's a lot ofnuance on this. There's some
things that are bad, but thenother impacts that can be
beneficial.
But it's certainly easier foreverybody when you have high
(12:53):
growth and a low cost ofcapital. But right now we're
facing a challenge of, you know,still challenges on growth and
the cost of capital is, youknow, and you know, it's kind of
funny. There's folks looking atthe cost of capital today and
looking at where rates are andthinking, oh, it's still
expensive because theirmentality has been shaped by
(13:15):
everything we've gone throughsince, I mean, really over the
last fifteen years, we've beenin a weird environment of
excessively low cost of capitalbecause of all the QE and all
the response from the globalfinancial crisis and the long
scope of things right now, tenyear treasury this morning when
we looked at us at 4.1, youknow, in the long scope of
(13:37):
things for commercial realestate, that's a low interest
rate environment.
Mark Bonner (13:41):
It's just All right. And I'm glad you brought
this up Jim, because you need,you got an entire in, you got an
entire generation of commercialreal estate players that have
known that period of time thatyou referenced, which was by the
way the longest expansion of TheUS economy in history near zero
rates for a very, very longtime. Double, maybe even triple
the length of the typical cyclefor something like that.
(14:01):
Pandemic happens, we're herewhere we are today. I mean, that
a large group of people thathave a lot of power in this
industry that were doingbusiness one way and now see
this and you're right to bringup the macro, the history of
this.
Like, how would how does thatresolve itself, Jim? Because I I
(14:22):
still have people in my inboxand on my other than my phone
where I'm talking to peoplesaying, this is ridiculous. This
is way too high. And I'm withyou. I'm looking at the longer
twenty or thirty year historyhere and I'm thinking, I don't
know what, how do you squarethat Jim?
Jim Costello (14:38):
Well, we need a generational change is happening
for commercial real estate inline with some of these secular
shifts in the market. If you goback to the mid 1980s, you and
were investing in real estatefrom then to around 2019, you
(15:01):
always had capital market forcesat your back when you're making
an investment. You had, the tenyear treasury on a general
downward trend over the wholeperiod. And so generally
mortgage rates and cap rates, Imean, they're not gonna move one
to one, but they'll rhyme. Butthe issue is that if I, average
commercial property investmentsare held for about seven years
(15:22):
in The United States.
So anytime from the mid 1980s to2019, when you're buying
something, were buying it fromsomeone who seven years
previously likely went in at ahigher mortgage rate and a
higher cap rate. And so youcould mismanage an asset. You
have the wrong leasing team inplace, spend too much on CapEx
and still eke out a positivereturn just from the capital
(15:46):
market shift. That game, let'ssay magically the ten year
treasury stays at this 4.1%level here for the next ten
years, never moves. That's avery unlikely scenario.
I'll say that, but let's saythat happens. If that does
happen, it's still not going to,capital market forces are not
(16:08):
going to be a tailwind anymore.There'll be a headwind because
everything that was bought andsold from that period when the
ten year treasury was unusuallylow relative to history with all
the QE that was happening, allthose deals are gonna face
challenges when it's time fordisposition and a fund, time for
(16:31):
the new loan to come due andrefinance. Capital market forces
are going to be a headwind. Sowhat this means is if you want
to be successful in commercialreal estate, it's not about that
home run of capital marketforces, just lifting the value
tremendously.
It's going be a lot of singlesand doubles now. So just
(16:55):
bringing it back to Sportsview,helping you with your Mets. But
the singles and doubles, thoseare gonna be proper leasing,
getting the right broker inplace that gets tenants into
your property, doing a properrisk analysis of the tenant
who's coming in to make surethat they're actually gonna pay,
(17:15):
making sure that your CapExspend is in line with market
averages and that your OpEx isalso in line with market
averages. You're not too far outof line from what your
competitors are doing. That'sgoing to be the recipe for
success.
And it's not going to have thesame oomph as what you had when
(17:36):
tenure, when the tenure treasurywent from a 20% rate to a single
digits.
Mark Bonner (17:43):
You mentioned my Mets, they're going need a lot
more than singles and doubles,Jim. If you're just joining us,
this is First Draft Live. We'reunpacking the post cut reality
with Jim Costello, executivedirector at MSCI Research. Send
your questions, and we'll get asmany as we can. Jim, let's talk
about price discovery.
Office distresses balloon past70,000,000,000. Cheap debt may
(18:05):
unlock deals, but at what cost?Fire sales risk rewriting the
comps across entire markets. Inyour opinion, are we witnessing
genuine price discovery rightnow? Or do you think this is
capitulation in disguise?
Jim Costello (18:20):
Well, no, capitulation is price discovery.
The issue was that currentowners of buildings, nobody
wants to take a loss, right? Andjust people are risk averse for
everything and nobody ever wantsto lose something. And you had
many investors who held theseassets. You had a big shift in
the way people react to and useoffice space And nobody wanted
(18:44):
to realize that loss untilthey're forced to.
And so you had current ownersdelaying delaying delaying and
just not realizing a loss untilthere was some outside event
that made them. And one year in,two years in, you're not going
to do anything. And so dealvolume was low. So you had
buyers and sellers really firepart. But over time as some
(19:08):
loans came due, some assets weretransferred to somebody else,
whether through a manageddefaults or just some outright
foreclosure activity, it sentsignals to the market.
And we're five years in from thepandemic. The waltz that was in
place pre pandemic is slowlyburning off. So the message is
(19:32):
getting out to current officeowners and as a result, prices
for like CBD offices are likedown 52% from the peak and you
get a 52% decline for some ofthese buildings that are still
kind of stable and income.There's still people in the
office. I'm in the office today,but I'm a real estate person.
(19:52):
So I eat my own cooking. Right.But, but even beyond our sector,
there are still some other folksin the office because there's
still some benefits of beingaround other people. There's a
happenstance of, just pointinginto other people you work with
in the company and the cross,ideas that come with it. But
there's some value there, it'sjust not the value that was in
place.
(20:13):
And so the current owners arefinally starting to come to
grips with that as they seecompeting assets go through
distress. It impacts theirunderstanding of the value that
they have in place. So yeah,there is capitulation. They're
finally meeting the market andthat's where we're starting to
see deal volume climb again forIt's not like Manhattan, we're
up like 5% year over year lastquarter. It's not, and some of
(20:37):
it was distressed, but even ifyou strip out the distress,
they're genuine assets thatpeople are, are selling in a, in
a, arm's length transaction atthis point where they're
reflecting on the fact that thedistress shows that what was the
value before has changed.
Mark Bonner (20:53):
Look, in a situation like this, there's
always starving dogs and fatcats, right? And moving on to
data centers, right? This hasbeen a fat cat for commercial
real estate for quite a while,but that fat cat is starting to
not look so pretty anymore. Datacenters are supposed to be
bulletproof, right? But salesare down 50% year over year,
(21:16):
even as AI ready ground upsexplode.
The bifurcation is widening,balance sheets are already
starting to show some bruises.Is CRE's crown jewel at risk of
becoming its next bubble?
Jim Costello (21:29):
I never would have categorized data centers as a
crown jewel, But I think one ofthe issues
Mark Bonner (21:36):
I mean, it's got a lot of momentum, Jim. I mean,
it's something that the industryhas been really proud of and
they've ridden the trajectory ofit for quite a while. So, I
mean, you know, semantics, but,you know
Jim Costello (21:45):
It has momentum, but it's I think the issue there
is that is how institutionalinvestors create portfolios.
Like every meeting I've had withasset owners and asset managers
over the last year has beenthere's the focus of discussion
is what big major sector betsshould we make. Any investor who
(22:08):
over allocated to industrialfrom around 2015 on, they beat
everybody else in our ACOEindex. That's the all core open
end index we create from all theappraisals of the institutional
managers when they give them tous. So they know that the folks
who won, they won by making abig sector bet on industrial.
(22:30):
There's still some good thingsabout industrial, but some of
that game has played out. So nowpeople are thinking what's the
next big sector bet I can makethat will help me to outperform.
And with some transformationgoing on with data centers and
the digital economy and the AIstuff, people looking at it and
thinking, maybe this is a bigsector bet I can make that will
(22:53):
help me boost my performance.But there's some problems with
that. I mean, I still thinkthere's great reasons to be in
data centers and there's somegreat properties out there, but,
not every, but not everyproperty is the same.
You know, in line with thatcomment earlier about it's
(23:14):
singles and doubles are going tomake you win. Think about that
from the property perspective aswell. There are data centers
that are older, don't have theright power supply, don't have
as good of access to water forcooling needs, don't have the
right capacity for more modernapplications. So if I'm so
(23:37):
hungry to get into the sectorthat I'm looking at anything,
you know, why is that currentowner selling it in this
environment? So I think there's,you gotta be careful that you're
not buying into the expansion bybuying the obsolete assets.
So there's a challenge in that.The other issue I'd focus on
(23:57):
there, if, I've been looking atthe life sciences sector as a
proxy for what we might see withdata centers. A couple of years
back, that same optimism was inplace for life sciences. And to
me, was clear at the time thatsomething was going to change
because I took a look at MSCI,the public markets, there's a
(24:20):
ton of data and information onthat side. We have an ETF tied
to that we create the numbersfor, tied to the life sciences
companies.
And if you look at the ETF forthe life sciences index and the
performance there versus theACWI, the ACWI is our, on the
public equity side, the, thejust it's, it's the everything
(24:41):
index. It's like, it's like theS and P 500 or but if you look
at the life sciences indexversus the ACWI, life sciences
was tremendously outperformingACWI for a bit. And what does
that mean? That means these lifesciences firms, the market was
saying these life sciencescompanies are more valuable. So
they invested in their owncompanies.
And when you invest in your owncompany, that means more plant
(25:01):
and equipment means more realestate demand. And then that
performance slipped below Acreeand about nine months later,
nobody wanted to be in lifesciences anymore because it So
takes a bit for that spendingcycle to I'd be careful looking
at data centers to make sure I'min the right physical kind of
locations. I think that part ina world where the singles and
(25:24):
doubles are just getting thefundamentals of property
management right are going bethe driver of success. That's
what I want to be in to makesure that my data center
strategy is focused right. Butthen I also look at that macro
concern of just how do thevarious tech firm indexes that
we produce compared to the ACWI.
And if they startunderperforming, then suddenly
(25:46):
these firms aren't going to haveas much to spend on occupying
data centers. So when thathappens, they'll still spend,
but they'll only be in the rightproperties. And so that will
create winners and losers inthat data center world.
Mark Bonner (26:01):
You know, I'm a student of boomerang economics
and you and I spoke earlier thisweek for the first draft
newsletter that I was talkingabout top of the show. Cuts are
meant to heal, but they are alsoa signal of weakness. Jim, if
inflation reignites, the Fedmight be forced into a whiplash
tightening cycle just asoperators re leverage. Do you
think Powell is bailing out CREor perhaps setting it up for an
(26:24):
even harder crash down the line?
Jim Costello (26:27):
Well, I don't think they're trying to bail out
CRE. So as much as everybodywho's listening might hope that
honestly, the central bankstypically, they have long
memories to a lot of thesecentral bankers. Real estate is
still stuck in the 1980s. Oh,they caused all these recessions
for us. And there is also arecognition, well, real estate
(26:50):
made a lot of money in, the lastcouple of decades.
So we don't have to reward thosepeople now. So I don't think
that they're trying to act toprotect us. They're trying to
act
Mark Bonner (26:59):
Well, I mean, in defense of commercial real
estate, you know this betterthan I do. This is a massive
part of the American economy,trillions and trillions of
dollars. For anyone in thegeneral public can understand
the power of this industry. Theydefinitely understood it in the
middle of the pandemic when theycouldn't go to the office or go
to a ball game or go to thestore, right? And we saw the
economic impact of that trenddownward just broadly, right?
(27:22):
But I mean, you know, forgivethe phrase but I mean, this
question still remains, Are wesetting ourselves up for a
harder crash down the road givengiven everything else that you
already talked about, in termsof other economic indicators?
Jim Costello (27:37):
I am worried about the chance for stagflation where
we have weak labor markets,potentially slowing growth and
higher inflation. If we do hitthat kind of situation, that's a
difficult environment for anycentral banker to be operating
in. And that's, that's a fear.If you go back to the last
(28:00):
period of time when we had thatkind of activity in The United
States, The real problem is justnot a lot of good data on
performance of real estate backthen. The notion of real estate
was different then than today.
Today it's an investment and yougauge the performance relative
to other investments in yourportfolio and other asset
(28:22):
classes. Back then, there washardly any good information out
there. And so it's just hard tosee how it performed. So if, if
you can catch them, what youwanna do is just sit down with
coffee with, you know, some ofthe senior execs from your firm
who were around back then whoare retired now and just, visit
(28:44):
with them and catch up and askthem for stories about when they
were junior analysts in theseventies when we dealt with,
stagflation because that's, thatinstitutional memory is really
all we can go about because wedon't have data.
Mark Bonner (28:57):
I'm going to get to one question from the audience.
Jim, can you talk more to theweakness you were seeing in
retail?
Jim Costello (29:05):
Well, it's funny retail. I'm actually kind of
optimistic about retail, retail.I mean vacancy, looking at some
data from CBRE, their quarterlyretail trends on availability.
It's been kind of flat recentlyfor the performing assets.
There's been a growth in kind ofolder obsolete assets that are
(29:29):
contributing to vacancy, but thesurvivors are, you know, kind of
flat on vacancy.
It's not so bad. The issue withretail, we got into this period
of just, you know, uncertaintyin 2020 and, you know, folks
(29:49):
weren't sure what would happennext to consumer spending and
everything, but the market hasslowly been removing older
obsolete properties. And so thathas helped the existing
properties, to improve thebottom line, NOI per square
foot, all the institutionalstuff that goes into our ACOE
(30:11):
index, NOI per square foot isnow above where they were,
before the pandemic. And largepart because of, you know, the
removals, but you know, andalso, you know, this notion that
people had that, oh,everything's moved online.
There's no more need for retail.
(30:32):
That just doesn't fit yet. Themore spending still happens in
store than online and onlinespending, it's still growing,
but it's growing at a slowerpace than the past. And it's
slowly starting to converge within store sales because at some
point there's only so much moreyou can sell online.
Mark Bonner (30:52):
Sure. Let's go over one more question from the
audience. Since real estate is aphysical asset, when will
climate change risk finallyswing a bigger bet? Isn't that
big OpEx exposure?
Jim Costello (31:06):
Yeah, it's, the climate risk is, well, that's a
good way to put it. That's CapExexposure though for folks that
they have to spend more on riskmitigation in different areas.
And it's a tricky one becausethere's a lot of views on, in
(31:27):
politics that kind of cloud theinvestment decision. The way I
just frame it for folks is justthink about the physical risk
aspects of it. If I'm, if I'mmaking a loan on a warehouse
property that's in a low waterzone, rather, it's close to sea
level in Florida, you know, Igotta be careful about the fact
(31:50):
that there might be a, an eventas opposed to, something that's
more inland and up, up from, upfrom the waterfront.
That's a, that's a safer bet,for myself personally. I bought
a house in Florida. I still livein New York, but you know, it's
the winter kind of place. And Iactually looked at our climate
(32:13):
risk tools first for my owndecision about the location so
that I made sure I was on thehigh ground because that storm
surge is the biggest risk forvalue. That's where the most
damage comes from.
And so it just how you pricethat risk of those locations and
(32:34):
what kind of mitigation stuffyou put in there, that's, that's
an important thing.
Mark Bonner (32:39):
Jim, I know we're running a little long on time,
I'm going to end on this lastquestion. Everyone talks about
dry powder. Liquidity, there's alittle bit of optimism in the
market right now, but no onewants to talk about structural
cracks, stalled absorption,zombie offices, capital stacked
on shaky marks. What's the realsystemic risk that no one wants
(33:03):
to admit on stage right now?
Jim Costello (33:06):
Systemic risk. Yeah, there's dry capital out
there, rather dry powder outthere. But think about dry
powder. You get a little stormand the wind can blow it away. I
mean, if you've, if you've evershot with, with the old muzzle
loaders, with the flintlockstuff, you know, that's why they
(33:29):
went to caps as opposed to justpouring the powder in because
the caps it's in place, but youknow, wind pulls up and it sends
everything out of your pan.
But in the same kind of context,in the middle of the financial
crisis when it was starting,there were people optimistic, oh
no, no, no. We have plenty ofdry powder out there. The
market's not going to collapse.But then when investors saw
(33:50):
that, listen, you told me thatyou'd hit a 9% unlevered and
there's no way you can do thatin this market. Then they were
able to, withdraw their capitalfrom those funds.
So you saw people, you saw thedry powder drying up. And so
that's the, that's the worryI've got about the dry powder.
If you don't have a situationwhere managers can place the
(34:14):
money effectively and hit thetarget IRR, so promising that
dry powder will dissipatequickly.
Mark Bonner (34:22):
Okay. That's the, that's our show for today. Jim,
thanks for being here.
Jim Costello (34:26):
Hey, thanks for having me. It's a, this went too
quick. I, there's tons more wecould have talked about.
Mark Bonner (34:31):
Get you on for a part two, man.
Jim Costello (34:33):
All right.
Mark Bonner (34:33):
But thank you very much. If you missed any part of
this episode or want to catchearlier shows, every
conversation is on your favoritepodcast app. Just search First
Live. We'll be back next Fridaywith another deep dive into
where markets, policy, andcommercial real estate collide.
I'm Mark Bonner.
This is First Draft Live. Have agreat weekend, y'all.
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