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- Someone once said, "You never hear of anyone retiring and moving to the north."

(Chris chuckling) While that is a pithy comment, there's also a great amount of truth in it.

Welcome again to the most widely watched and the longest running source of Carolina business, policy, and public affairs.

Seen for more than three decades across the Carolinas, one of the biggest pieces of evidence of in-migration and growth in the Carolinas over the last few decades has been the development and growth of cities and communities.

No doubt, hands down, but much of that is literally built on the backbone of commercial real estate.

CRE, as it's called, has most likely never seen the kind of growth it's experienced over the last generation.

But now what?

We'll unpack it with a panel of experts that knows something about commercial real estate.

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And Martin Marietta, a leading provider of natural resource-based building materials, providing the foundation on which our communities improve and grow.

(upbeat music) On this edition of Carolina Business Review, David C. Lockwood of Colliers, Chuck McShane from the Costar Group, Andy Andrews of Dominion Realty Partners, and Quentin Fogan from Bank of America.

(upbeat music) - Hello, welcome into our program.

David, we're starting with you 'cause you're closest, quite frankly, so why not?

David, how would you say the state of commercial real estate is right now, just broadly?

- Well, broadly, you start with North and South Carolina.

And thank goodness, we are in the Carolinas because it's not the same everywhere, but thank goodness we're in the Carolinas.

You opened up with inward migration.

We'll talk about that.

We see that impacting the commercial real estate markets in a very positive way, but all of the property sectors, they're evolving at a different pace right now.

They're all at a different stage.

And who would've thought this soon after the pandemic that retail would be on fire and as hot as it is?

Who would've thought we would've seen the mass growth of industrial markets in the Carolinas over the last 24, 36 months?

That's a little slower now today, but it's evolving.

And then you've got the office market that just constantly, constantly is evolving as companies decide what they want their footprint to look like and what they want their interiors to look like.

So all of the markets just tend to evolve over this period of time at a different pace.

And we don't know where it's going, but it's still good, because we're in the Carolinas.

- Chuck, you're a scientist.

What's the data say about commercial real estate right now?

- Well, as David mentioned, it's really sector-dependent.

So property-type dependent.

I think we're in a little bit of a holding pattern currently in terms of where we're going next in terms of commercial real estate.

The office sector in particular is taking a while to unfold.

Lease terms tend to be longer in that sector, but I do think you'll see in 2024, more decisions get made.

The industrial sector, I think got a little out over its SKUs in terms of total building.

So that's gonna take a while to get backfilled.

But overall, the continued growth of the Carolinas, the continued population growth, continued demand and wage growth is going to keep demand for commercial real estate more broadly strong.

- And keep the best for last, Andy.

I'm getting to you, don't worry about this on you.

Quentin.

Quentin, the media seems to have, and we do hear as well, 'cause I'm gonna ask you about it.

But the media seems to have this fascination with commercial real estate loans for good reason.

So how would you say the current state of the market is when you look at it through the loan portfolios?

- You know, from a lender's point of view, you can't really understate the impact that the increase in interest rates had over the last 18 months.

So when you look at all of the underlying property fundamentals that we just discussed, the impact to growth, the impact to borrower's ability to service their existing loans, the impact to refinance and acquisition, when we talk about property sales as well, all of that has been dampered to a degree by the increase in rates.

Broadly, I would say that lenders right now are in a position of trying to really understand what that implies to their portfolio.

When we talk about this taking time to work its way through the system, you look at financial performance of properties at each individual property type, some of those properties have outperformed, right?

As we've seen coming out of COVID, and some of them have suffered, right?

So all of those, on the whole, I think in the backdrop as well of Fed policy, when we think about inflation, when we think about the regulatory environment that we're looking at, and when we look at the consumer, you take all that as a whole, and from a lender's perspective, there's some volatility there, right?

So that dynamic piece of the market makes lending something that I think everybody's taking a little bit more focus and a little bit more pause on in terms of how specific we look at properties, and each property is different.

- Yeah, Andy, how do you characterize the industry right now?

- Well, to me, we sort of tried to recover from a shock factor, what happened during COVID and what happened during the riots.

Quite frankly, all the urban centers really got impacted by both those events.

The office market, the employees aren't back yet.

We know from a fact that in all the office markets that we are in, which is in Virginia and North Carolina and South Carolina, we see right now about a 50% occupancy for employees being back in the space.

The buildings might be full, but the employees are not yet back.

We got down to 18% at one point during COVID.

Now it's growing up.

It's over 50%, but it's not much over 50%.

So that number's got to grow by another 30%.

Employers have got to make the decision to force their employees back to the office.

The reason that that's impacting local restaurants, it's impacting people, stylists that are cutting hairs, impacting gas stations.

If you just look at how far reaching that is, it has a tremendous impact.

Now, from the growth perspective, like you talked about, the apartments are doing pretty well because we still have somewhere in the neighborhood of a hundred and some thousand people graduating each year from these universities.

And they're not moving to New York anymore, they're not moving to D.C., and they're not moving to Atlanta.

They're staying where they went to college.

So that in itself, is helping the apartment business continue to see some growth.

Interest rates, though, and cost of construction did more damage than anything is out there, because we are passing that along to the user.

And nobody wants to see that happen, but it's costing more people to rent apartments than it used to.

- That's right.

- They can't afford a house and they don't wanna make a commitment, so they're deciding to go into an apartment.

So now those people are having to move out on the periphery instead of in the urban core because they just graduated, got a job, maybe they're making $50,000 a year, they gotta go a little further out of town.

So to David's point, the retail is killing it.

They really are, 'cause people are eating out a lot.

What I would tell you is, from the apartment's perspective, we are still bullish on the locations.

- Because of the pricing in residential real estate?

Is that the biggest thing for you?

- Sunbelt.

- Sunbelt.

- Sunbelt.

If we went to city of Iowa, we would not be building those.

We have currently a billion dollars coming outta the ground right now, and the ones we're delivering, we're still leasing right now at about an average of six a week, which is a pretty steady number.

These aren't just relocations, these are new people moving in from different town.

- Okay, so it's come up a couple of times in this idea of work from home.

I mean, it's not the elephant in the room, but it's a pretty big dynamic on how you might look around a corner.

Chuck, is there, again, is there good data that shows that, as Andy talked about this 50%, they're back in the office in general, is that continuing to grow and expand?

Could you interpolate out when that becomes a tipping point finally and et cetera, et cetera?

- We've seen a little bit of plateau in that.

When you look at the data of badge swipes, people coming into the office, it's important to look at the distribution of that over the week.

So that 50% to 60%, that could be a 100% of your people coming in three days a week.

And I think that's more likely what it's going to be than 60% of your people coming in five days a week.

And that does have some impact on those office-centric urban cores, those central business districts and the retail that supports the office space there.

- Are we closer to a permanent understanding of what that long-term number's gonna be?

- I think we're a lot closer to it.

I think that the facts will bear themselves, but I think working remotely is here for the long term.

Is the frequency of an employee coming into the office, how often do they need to be there?

Do they need to be there for an entire workday or are they coming in half days?

What does that look like?

But that's shaping the entire office market.

And I use the term "an evolution of the office market."

We're clearly seeing the office market evolve and it's going to take a while for it to shake out.

But employers, I believe are making a decision.

For us to be able to hire and to retain good employees and get our employees into the office, we have to have some really nice office space with a lot of amenities.

And so you've seen a flight to quality, you've seen a flight to quality in suburban markets in larger cities, but in the smaller markets in the Carolinas, the Charleston's, the Greenville's, Columbia's, the Asheville's, the urban area, they call it urban of a small town, they're doing quite well with their office occupancy because there's not a lot of distance from the suburbs.

So I think remote working is here, now it's up to the employers to decide what they want that office environment to look like so that they can get those employees there even more frequently than they are today.

- Go ahead.

- Can I say, yeah, to his point, to add to what David said, and another really important aspect is a lot of the employers, especially publicly traded companies, are moving to green certified healthy buildings.

So they're moving out of the old buildings.

- Correct.

- 40 years old with bad air conditioning, bad lighting, and probably bad water too.

- Is that a competitive advantage then?

- It is a competitive advantage, barring one thing that the banker would not like to hear, and that is they're not gonna pay anymore.

All right, they're gonna pay you the same rate.

They're just gonna move there because they do feel like it's like an amenity.

They do feel like they're getting something for the employees.

And so what Dave was talking about about amenitizing the building, having outdoor space, having just conveniences, fitness rooms, common area, conference rooms, but the building's gotta be healthy.

So that has become more of a, you know, if you have top five things you're looking at at an office park, that's in the top five now.

And it used to not even be much.

- One more thing, Chris.

Consumers are hungry for change.

Consumers want to see change, change, change.

And the consumer who is leasing an apartment project, they wanna see the newest, the best apartments out there.

They wanna see the newest, best office space to work in, and they certainly wanna see the newest best in retail, which is why they're flocking to the different styles of different restaurants and shopping areas.

They want to see that change occurring.

And they're driving the market.

- Yeah.

- That's an interesting point.

So I think what we're circling on are two things.

One is place, the creation of a place as it relates to the attractiveness to its employees and to the tenants in that building.

And the other is utilization, right?

Occupancy and utilization are two different things.

And I think when we look at the market, certainly from a lender's perspective, understanding the difference there and the nuance there is very important.

You know, you can't blanket office, as we all know, in one broad stroke.

- Right.

- The delineations between the sub-sectors within office, whether it's class A office, whether it's medical office, whether it's life science, all of those are different nuances and they require different amounts and aspects of utilization.

So I think when you talked about the headline risk, it doesn't appreciate the nuance and the degrees to which all of these property types are being experienced.

- Quentin, this is a little wonky, but I wanna ask it is a banker.

(chuckling) - Sure.

- How much of the credit decision to make the loan on a new or existing property, how much of that is based on whatever that arcane work from home model mix is now?

So when you're making the decision to thumbs up or thumbs down on a loan, how much of that is built into it?

- Yeah, it's a great question.

When we look at underwriting, in this example, an office building, we're looking at all the tenants in that building.

We're looking at their lease terms, we're understanding the financial strength of those tenants as well.

But one of the things that we're trying to model and understand going into the future is, how much space will those tenants need?

How many people are expected to occupy and utilize that space?

The trend that we've seen over the last couple years is that the amount of square footage that office tenants are taking upon renewal is diminished.

And the number of people occupying that space has increased.

Meaning, right, to our point, that hybrid model, some people call it hoteling of an office space has increased.

Now the amenity packages there are also increased as well.

So I think every transaction has to be underwritten to that nuance to try to understand what are the drivers behind the tenancy?

Is that sustainable?

And if it is sustainable, then there's a lending decision that you can put upon it, where it's cloudy and you don't have clarity into a tenant's probability of renewal or their utilization of the space.

It makes the lending decision harder, and I think that's why we've seen pause amongst some lenders, broadly speaking, particularly around office over the last year.

- Do you see anything like that, Chuck?

- Yes, I agree a hundred percent.

In terms of the size of office leases, we've seen those declined by about a quarter.

So pre-pandemic, we were looking at about 5,000 square foot average office lease.

It's down to about 3,300 square feet in 2023.

And I think that gets back to those occupancy planners at those corporations looking very closely at how they're using their space and how much of that space they actually need.

A lot of companies have moved into new office buildings, new spaces, they're continuing to expand their hiring, but they're not expanding their square footage, they're just looking at it.

They're refining how they use their square footage.

- Coming up...

Thank you, I didn't mean to interrupt you, Chuck.

Coming up in a couple weeks is Harry Lightsey, he's the Secretary of Commerce for the State of South Carolina of a quieter Secretary of Commerce than many we've had on this program.

But no doubt that still waters run deep.

He returns to this program with no doubt, an interesting dialogue.

Andy, I wanna come back to the, you know, the specter of the empty but once very vibrant mall, hundreds of 'em.

In Carolinas, there are three in Charlotte that are in some type of bankruptcy protection and they're big malls.

Does that specter hang over the heads of the public when they hear about some large commercial real estate projects or developments in urban cores or suburban cores?

Does that have anything to do with it?

- I think the media sometimes blows it up bigger than it is to just what you were mentioning.

You can't paint a picture with a broad brush when you're talking about real estate.

It's more location-driven.

For an example, we took a defunct movie theater that happened to be in a nice location in Raleigh and tore it down and made it to apartments.

A lot of people are taking some of those old mall, regional malls, and bifurcating 'em out and making a mixed use project.

So they're very vibrant.

It just takes a lot of time though.

You have to go through a rezoning process.

You gotta go get entitlements, you gotta do site plan approvals, and then you've gotta go find the debt and the equity, which we all know, in this little hiccup we're in.

We're not in a crash, this is nothing like, "Oh, people aren't jumping off of buildings."

This is just one of those typical hiccups, which it will also work its way out.

I don't have a crystal ball, but it's certainly better today than it was eight, nine months ago.

We've got hopes and prayers for lower interest rates, please, and we've got, we know for a fact that construction rate, construction costs have already come down anywhere from five to 10% lower than they were in.

- Does that offset the cost of lending?

- It offsets the cost of the total project, which all sets the cost to the renter.

- Really.

- So it also engages with the equity to say, "Hey, this is now..." Everybody's looking for a basis on how much you're going to build your project for.

And everybody wants to keep that basis down, Chris, so that when they do exit, there's actually a good exit point, because if the basis gets too high, then the exit gets so high that they don't feel like they could ever get out.

- That's right.

- And so all this is intertwined in the sense of, we just, in 2012, we could deliver an apartment complex at 300 units for a $118,000 a door.

Today, we're delivering that same exact apartment complex if we break it down at $280,000 a door.

And that's only a, call it 11, 12-year span, that's how much it's increased and that cost is being then passed along to the consumer.

We wanna drive that down.

It's just a greed grab by a lot of subs and by the general contractors to charge you as much as they possibly be.

- So is that artificial, that cost artificial?

- We know it has been.

Now it's correct in itself because their book of business in '24 and '25 is not what it once was.

The only reason they're pretty busy right now is because they're finishing projects that were started in '21 and '22, and now they've gotta have a new book of business, which is non-existent in '24, '25.

We're not building office buildings, so let's go on record.

- Okay.

- Well, no one is building office buildings right now.

- Were you gonna say something, Quentin, on that?

- Well, you know, it's interesting you talk about all those things being connected.

I think that's exactly right, and I think that when you look at it from a variable input standpoint, you talked about the cost of expenses and construction costs.

One of the biggest things that I think was hampering the market in 2023 was the variable around rates and that rates increasing to the level that they did in the window of time that they did really made it hard for people to pencil projects on the whole.

Right?

- And no one would buy, because they couldn't get a loan 'cause they didn't know what rates were gonna do.

So it's all intertwined.

- That's exactly right.

- But most of the things that we talk about are really almost short-term in nature.

Real estate, commercial real estate is long-term.

We've gone through so much in the last three years with the pandemic, with rising construction costs, now with rising interest rates.

And we have these discussions which are almost very short-term in nature, but there are decisions that are being made for the long-term about commercial real estate.

And when you go back, to your opening, inward migration, such a pro-business environment in the Carolinas, there's so much good happening right now in the Carolinas that from a commercial real estate standpoint, I don't need concern about these small short-term hurdles that we have to overcome.

- Exactly.

He's hit the nail right on the head.

We broke ground last year in 2023, which was for commercial real estate, a fairly poor year, okay, from the bank shutting down and equity, putting their pencils down.

You know, that was $200 million worth of apartment complex that we broke ground on and people believed in.

Why, that's 'cause of the Sunbelt.

- Because just plain location.

- They wouldn't even talk to us.

- Obviously.

- Sioux City, Iowa not happening.

- Yeah, okay.

- Raleigh, Charlotte, you name it, Columbia, Greenville, those areas are still driving investors and still driving lenders to make good decisions because of the locations.

- Okay, let's take this and turn this a little bit, and, Chuck, I wanna bring you in on this one.

Last summer, for the first time in this country's history, and I think it was lost on a lot of people, Bloomberg reported that six southern states, North Carolina, South Carolina, Tennessee, Florida, Florida, Texas, Georgia, combined gross state product for the first time in the nation's history, eclipse that of all the Northeastern states.

So we can say that the center of gravity for wealth has now shifted to the southeast.

We knew it was happening, we knew it was unfolding, but we have evidence of it now.

Chuck, number one, would you agree with that, Chuck?

And number two, how do we make sure that now we're kind of the dog that caught the proverbial car, now what do we do to make sure we don't have the same issues that drove people out of the northeast and the West coast?

- I think it comes down to housing, and making sure that we have enough housing.

I think that we...

There's a little bit of a discussion now in the apartment side that how we overbuilt.

I think that's another, as David was mentioning, that short-term thinking, that's another idea of short-term thinking.

In the longer term, we're going to need to have enough housing and we're gonna need to keep this a welcoming place, the right types of infrastructure throughout both our urban areas and our suburban areas.

I was driving from Fayetteville to Greensboro over the holidays, and 421 corridor, you can't imagine what's gonna change there when Toyota comes.

But we're gonna have to have housing there to keep, and we're gonna have to have enough to keep that housing affordable.

So I think that's a focus on housing and strong business-friendly and building-friendly laws and policies is gonna be crucial.

- How do, as a banker, Quentin, and you represent banks, big banks, the top-tier banks, how do you make sure that you make all that, that capital available for housing long-term and not just the short-term decisions about credit worthiness?

- It's a great question.

I think when you look at it in the longer window, the undercurrents that we've all, I think adequately described here, make that lending decision a little easier, right?

When you look at the macro trends that the Sunbelt experiences and appreciates right now, I agree with your comment that infrastructure, affordability of housing and access to housing are important to it.

From a lender's perspective, when we look at multifamily, we've talked about industrial growth here.

I think that the business community's interest in the business-friendly environment that the Sunbelt and the Carolinas specifically that it provides, I think that when you see that corporate interest, it helps propel lenders and banks by and large to have conviction behind those corporations coming in.

I think those existing partnerships really grow when you see that formula come together, right?

Strong lending community, strong business community, and the infrastructure to support that growth.

That in the long-term, I think, you know, gets through these cycles.

- Okay, less than a minute and a half left.

I wanna ask you both, is the red licked off the candy for apartment homes?

Apparently, I know you don't think so, but I'm gonna give you a chance on that one.

- No.

No, there's enough need for housing.

There's a lot more apartments that need to be built and I'm not just speaking for myself, even though that's all self-serving.

I'm speaking as a whole.

If you look at the three states that we're in, especially in the Carolinas, we've really gotta focus on, especially with these new corporate relocations that we need.

We don't have enough single family homes for sale to even attract a large user.

We truly don't.

And if you look at the data, as you well know they're not many single family homes out there for sale right now, because a lot of that development is stopped.

And the only way these people have to reside is an apartment.

And without, you know, the equity believes in this territory.

The equity does, and when I speak about equity- - The equity behind the deals is- - The equity behind us, the 800,000-pound gorillas of the world.

The institutional equity, they believe in the Sunbelt.

They do not think we're even close to being over 50.

- And there's a lot of that capital there.

- It's pin up though, it's just sitting on the sidelines.

- 15 seconds, do you agree with that?

- Single family for rent, multifamily will continue to be strong.

What's interesting is, multifamily still developing in the urban core area when we see some office users vacating, whole another conversation there.

- Oh, well, you can't leave us hanging there, David.

(David chuckling) But you're gonna have to.

Thank you very much.

Good to see you both.

Good to see all of y'all.

- Thank you.

- Please come back.

Hope we didn't scare you off.

I know you haven't been on before, and, Chuck, you've been here.

- Wonderful.

- But... - This is great.

- Yeah, okay, come back.

Gentlemen, thank you.

- Thank you very much.

- Thank you for watching our program.

Have any questions or comments, CarolinaBusinessReview.org.

Until next week, I'm Chris William.

We hope your weekend is good.

Goodnight.

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