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The Millionacres Hour: Interview with Richard Kalvoda of Altus Research

In this video, Millionacres Editor, Deidre Woollard, interviews Richard Kalvoda, Senior EVP at Altus Group US Inc. . Their conversation covers topics from projections about the international real estate market to perspectives on the future of the construction industry. Rick Kalvoda is a Senior Executive Vice President at Altus Group and serves as the Head of Global Advisory, which provides valuation consulting services for over 190 real estate funds comprising more than 750 billion USD in GAV. Rick has over 30 years of experience in commercial real estate consulting and has presented at various real estate conferences, including AICPA, Appraisal Institute, NCREIF, PREA, Argus Connect, Pepperdine University, and IMN. He was also a contributing researcher and presenter for Emerging Trends in Real Estate, an annual survey publication of PricewaterhouseCoopers and Urban Land Institute. Prior to Altus Group, Rick was a Principal with PricewaterhouseCoopers’ Real Estate Advisory Practice. He received a Master’s Degree in Real Estate from the University of Wisconsin – Madison and holds the MAI, CRE, and FRICS designations.

This conversation took place on October 19, 2020, on The Motley Fool Live.


Deidre Woollard: Hey, Fools. I'm Deidre Woollard. I'm an editor at Millionacres, which I hope all of you know is The Motley Fool's real estate investing arm. In the next half hour, we're going to talk commercial real estate. I'm here with Rick Kalvoda, who is the Senior Executive Vice President of Advisory at Altus Group. Altus Group is a leading provider of software, data solutions, and it's a platform for commercial real estate assets. The reason I wanted to have Rick on today is because they recently put out this global property development's trend report and it goes into all of the things that are happening in commercial real estate. They published one in January and then this is an update and obviously, the picture has changed a lot. Rick, thank you for joining me.

Rick Kalvoda: Thank you. Well, I'm glad to be here.

Deidre Woollard: Awesome. Let's get into it. The picture has changed dramatically. One of the things I wanted to ask you, because I think it's interesting in this report, is the picture for commercial real estate here in the U. S. is different than it is elsewhere around the world, right?

Rick Kalvoda: Correct, yep. Sorry, go ahead.

Deidre Woollard: No. Please tell us what you're seeing.

Rick Kalvoda: It's actually very similar trends that we're seeing. We are global. We are across the different markets or different regions; APAC, EMEA as well as in the U.S. Some of the trends are relatively similar. It's just the degree that we're seeing in terms of changes in valuations, changes in underlying values. We have insight in about a trillion dollars worth of real estate. That is commercial real estate that's valued every quarter. The trends, whether how it's impacting warehouse and logistics versus retail, that's similar, but just how much it's being impacted is really relative to how much coronavirus has impacted the different regions. So even though APAC was impacted first, the degree it impacted the economy has been less and therefore, the impact of the underlying real estate is less as well. But one thing that is very similar is just the uncertainty that where we are going to be six months from now, a year from now because things can change very quickly when it comes to COVID-19.

Deidre Woollard: Absolutely. In terms of commercial real estate transactions, I've noticed that commercial real estate transactions here in the U.S. have gone down a lot. It seems to be a little bit different in Europe and in the Asia-Pacific regions. Is that what you're seeing as well?

Rick Kalvoda: Yeah. They haven't been as impacted much, if you think about it. Especially the first wave, the U.S. has been impacted more and so there's more uncertainty. There's more immediate impact on the underlying fundamentals and also, just doing the transaction itself, the social distancing, the lack of travel, you can't go out and do your due diligence on that but transactions also. When you look by the property sector, we've seen more transactions on logistics, on warehouse, and even multi-family where there's a little less uncertainty there. There's also some positive trends that have occurred from COVID, so if you think of e-commerce, online shopping, and warehouses. Then on the flip side, much more need for price discovery because there's less transactions with retail of properties as well as with office. That's the whole thing. "What happens with work-from-home going forward?" is the big question right now.

Deidre Woollard: Yeah. We're seeing that a lot in real estate and Real Estate Investment Trust. We're seeing industrial REITs do really well. Datacenter REITs obviously do really well. Then we're seeing things being weaker is retail and also hospitality. One of the reports I read recently said that as many as 25 percent of hotels in the US could be facing foreclosure, something like that. I think there's a lot of activity going on in terms of people thinking about where there might be opportunities and is that something you're seeing as well, is that some companies are massing capital and looking to take advantage of the weaker market?

Rick Kalvoda: Yeah, absolutely. We saw that back with the GFC as well in 2008- 2009. There was a lot of capital sitting by the sidelines waiting to take advantage if there was disruption in the market, if prices go down to a level where there was an opportunity with distressed assets. We're not seeing that yet. If you think about it, part of the stability in the markets overall with the government stimulus with the Fed, the low interest rates and the amount of money that's been put into system. There's a lot of capital out there looking for an investment even with some of the disruption to the bottom line, the NOI, the returning of underlying income return of commercial real estate. It's still a relatively attractive investment relative to bonds and even stocks in some cases because of that income component, even if there's near-term volatility with the income.

Deidre Woollard: That makes sense. In your report, one of the things I noticed is that tenant/occupier expectations are changing a lot and that is changing how different commercial real estate, developers, and landlords think about leasing. I know one thing that I've seen is that leases themselves are changing. Can you explain a little bit about how tenant expectations are changing?

Rick Kalvoda: Yeah, what's definitely ultimate when it comes to the development is what's the demand for that real estate which comes from the tenants and the occupiers. Again, if you look at different asset classes, the demand for that in retail, very questionable going forward. There will always be some physical retail component, but it will likely be less than what it is right now. We've said for about 10 years with retail, it wasn't so much in oversupply scenario; it was under demolished situation. There was just too much retail out there, and that's a trend that's been happening and will likely continue but won't go all the way. It's really ultimately who are the tenants and how much demand is there. You think about offices and that's a big trend going forward as well. Post-COVID, how much will work-from-home impact the demand for physical office? It's not only how much and then also where is that demand? You hear a lot about the migration from the urban centers out to the suburbs and how much is impacted there by tenants. What are they going to be looking for? That I think will take a little bit to play out post-COVID, post-COVID vaccine, but retail definitely, you'll see that trend and then logistics on the opposite side. There is still strong development demand there just because there's strong demand. Your other question just with leases is how leases are structured. With retail, the big question is if the building is closed and the retailer can't open their business, do they need to pay rent? You'll see leases being restructured from that perspective as well.

Deidre Woollard: You mentioned an interesting fact about offices. A lot of our investors are invested in office REITs and obviously, work-from-home has changed in the short-term. Do you see that as a long-term thing or something that is going to shift back a little more towards normal in the next couple of years?

Rick Kalvoda: Yeah. I think one, I would say that's probably the biggest question we have out there across the different sectors. That's the one that internally, even a lot of people are trying to figure out what the extent of work-from-home will be. Back to an earlier comment, I think definitely there will be a shift back more to normal, but not back all the way to normal. That leaves a broad area that you can drive a truck through, but I think there will be changes going forward. So instead of just a small percentage of your workforce working from home, you will have an increase in the number working full-time from home. The rest, you'll probably see instead of not working from home at all, you will probably see one, two maybe up to three days a week that they work from home because I think what's happening right now is being forced. You'd need that culture. You'd need that connectivity and the collaboration that comes about being in the same physical space so you definitely will see a return back. I don't think it will be full normal but it'd be close to normal than what it was before.

Deidre Woollard: I hope so. I wanted to ask a little bit about trade regulations because your report obviously looks at global trends. Trade issues were bubbling up before COVID and backed off a little bit but could come up again. I know the price of lumber is rising. There's concerns about the price of steel. How is all of that impacting, whether or not people are going to build right now?

Rick Kalvoda: It definitely goes into the underlying feasibility of a development project, construction costs. Not only the materials but the labor, as well, is a huge component of what determines what the viability of a development project is. The more changes or increases you have in those costs, that impacts the viability of a project and so you may see some projects never moving forward. Potentially, even some projects are being paused partially because of the cost but then also because of the demand side as well, but then labor as well. You talked about tariffs and materials and availability of materials, but then also labor is a significant component, whether it's the physical distancing on site, on the development, especially when you enclose the building, that has a big impact on it. But then just also the availability of labor to the extent that immigration or anything else that impacts the number of labors and the skillsets of those, that's going to have an impact on the cost, viability of the project as well.

Deidre Woollard: I know before COVID, a lot of people were talking about skilled labor, skilled construction, the average age of the construction worker keeps rising. I know that different companies have put out initiatives to try to get younger people and attract younger people into the trades. Do you feel like that's something that still is going to be a concern? Obviously, the unemployment market has shifted a little bit. Has that made things easier for people to find more workers?

Rick Kalvoda: Because the trend over the years has been for more skills needed for construction, you can't just immediately shift someone into the labor force. It will take years and I think that's been happening and that will continue to happen. I think also that was part of the report as well, just the technology side of it; so more robotics, more modular development where you build parts of it in a facility, in the warehouse, and then bring it to the site to make it more efficient, less labor-intensive. I think you're going to see more trends with that as well. But also just the availability of labor, it's something that really impacts. It's really a demographic way, where as the baby boomers are retiring, almost any industry you pick, especially on the skilled side, there is a concern about the age of the average skilled worker in that industry. But then you have the millennials coming behind it and you'll see a lot of that fill in the demand for that as well, maybe a little less so on the construction side but as that becomes more skilled, then the younger generation will fill that gap in more as well.

Deidre Woollard: I feel like modular plays a role there too, because I think for the younger generation, it's easier to imagine themselves working in factories, assembling things using technology versus being on a construction site with a hammer. I think one of the things that is really changing is that construction, in my opinion and I don't know if you agree, has been really slow to be disrupted. We've seen disruption across all other fields. We haven't seen it so much in construction. Do you think that what's happening now is going to maybe help speed some of that up? You talked about technology earlier, is that helping?

Rick Kalvoda: Yeah, absolutely. I would even broaden it to where real estate, as a whole, has been much slower to adopt technology and automation. Internally, we're more of a PopTech company. PopTech has been very big over the last several years. But if you go back, real estate overall is probably still 15-20 years behind the other asset classes, if you look at stocks and bonds and some of the other components. Real estate as an investment, but then also the physical aspects of real estate definitely has been slow. I think, as robotics, as technology, algorithms, machine learning, AI, as that becomes more and more, better and improved, you're going to see that take hold of sectors like real estate where it's been slower to adopt and then even to the point where it deals with robotics specifically on the development side as well. You can even go back. At some point, we will see inflation. Real estate is a good inflation hedge because costs go up and therefore, the values of the underlying real estate goes up. You will see those, as cost goes up, it becomes more important to be more efficient on development. So if you can keep cost down, that's where you see more and more of the technology come in just for the developers to have a differentiator, have an hedge on the development process.

Deidre Woollard: I'm really fascinated by what robotics can do. I've seen some of the robots that can lay bricks and there's obviously 3D printing. There's different groups that are making those 3D-printed houses that use concrete and even construction, almost androids that can hammer nails and do things like that. Do you feel like the construction site of the future is a hybrid of traditional construction and then more integration of robotics and technology?

Rick Kalvoda: Yeah, absolutely. You can liken it to, think of a warehouse 30 years ago, the number of people in that warehouse, manufacturing and building things. To the manufacturing plant of today, it's much more robotics and a lot of times, it's just a few individuals overseeing and monitoring those robotics. It will take a while before that comes and how quickly, and it will always happen -- you don't expect it, it's taken a while and all of a sudden, boom, it's there. It's definitely going to take quite a few more years but it'll be here, I think sooner than most people think just because of the advances that have been made over the past five years.

Deidre Woollard: I liken it a little bit to self-driving cars, is that part of the issue of adoption of self-driving cars, is that you also have regular cars and regular people on the same roads, and I think with construction, there's also that, too. You have to build for the middle ground before you can get to maybe the end result where it's more technology than people.

Rick Kalvoda: Yeah, absolutely. That's a great analogy with your autonomous cars. I think that definitely will be here sooner than most people think. If you think about it, the construction sites are much more controlled environment than out on the road with bikes and pedestrians and everything else and all the other drivers. Whereas in a construction site, you can definitely control that more just like in a manufacturing plant. So that'll be an hedge to help the adoption of that as well.

Deidre Woollard: Absolutely. One of the things that I'm looking at right now in the US is the potential for a second stimulus. Obviously, everyone is waiting on that and also on government legislation in general. When all just look at the worldview, are you looking at other things like that happening around the world to maybe boost real estate development in the coming years?

Rick Kalvoda: Yeah, absolutely. Because that is how quickly things turned earlier this year, just a month or two after the U.S. lockdown, can largely be attributed to the three trillion-plus dollars that was put into the economy and the resulting low interest rates. Looking specifically at multi-family, even though the NOI has declined not as much as everyone expected, again, partially because of stimulus but it declined the amount of capital available. Whether it's lending or investors looking to get in because of the inflow of capital after them, it definitely impacted the values of multi-family departments. As you go around the world, all governments around the world have done some sort of stimulus, some sort of infusion of capital or lowering of interest rates, and that has a big impact on value. So we are following that very closely around the world. I would say that's more near-term. We're also following "nothing comes for free." What's the impact of that a year down the road, five years down the road? Just the amount of debt and at the same time before this, we not only had a lot of debt, but a lot of the unfunded liabilities out there as well. Areas like Chicago, which from a government perspective is probably more impacted by unfunded government debt, unfunded liabilities of the government, we're seeing that relative to the other parts of the country impacting real estate, especially now with COVID and the amount of money that has been spent and the of lack of revenue coming in from governments. It's an acceleration of how soon they're going to have to deal with that issue as well. That's something we're focused on as well. Again, more medium to long-term. Short-term is how much more stimulus and it definitely will come, is just how much and when, it's the question there.

Deidre Woollard: Obviously, we have to put funding towards this, but another thing, especially in the U.S., that we really need to start funding is infrastructure. I'm wondering if the changes in infrastructure are also going to have an impact on this. One of the things I want to ask you about is transit-oriented communities. Before COVID, a lot of money, a lot of interest going towards public transportation hubs, building around those areas. Is that going to change with work-from-home?

Rick Kalvoda: There'd still be demand for that development around the TODs, the transit-oriented development. There'd still be demand for that, but I think it will be impacted and it goes back to the urban centers. This isn't a new trend as millennials have aged and they drove the demand more to the urban centers and that lifestyle as they're aging now and looking to buy a home, raise a family, get married. You're seeing some of that trend go back to the suburbs and so I think there will be slightly less demand for TODs, for development around those hubs just because urban on the margin will be less than what it was before. Again, the trend was already there. It just was a very small trend. COVID will accelerate that slightly. Ultimately, the New York's, the San Francisco's, the LA's, even the Chicago's, there will be a long-term demand for that. While that backs off and there may be a lesser demand, I think ultimately it'll return more medium-term because it is something that the urban centers will be there. If you look over the millennium, there's been more and more of that. Humans are social beings and they want to be in areas and what the urban area bring. To answer your question is, yes, the demand will come back slightly, but I think it'll return eventually.

Deidre Woollard: I think even before COVID, one of the things that we were watching was the rise of secondary and tertiary cities here in the U.S., and this whole urban exodus thing is definitely having an impact on San Francisco rents and New York rents. Is that something you see, too? Do you see the rise of these smaller cities as an ongoing trend?

Rick Kalvoda: Yeah, absolutely. You're right. It's been for a while, the Austin's, the Nashville's, the Raleigh's, and especially as the students come out of colleges, and a lot of these areas have good colleges in that area, that's where the ultimate staff, the people that they hire at a school want to be located. That's where they're going to move. It's a better quality of life. I think as the urban, you could say it was almost over done as the demand for real estate in housing in the New York's and the San Francisco's reached a level where the trade-off of being in an urban center like that, the lifestyle, the restaurants, the nightlife, all of that, now you can only afford a very tiny apartment or you shared it with several people. The trade-off of that is now shifted more to those other tertiary markets. Again, COVID accelerated some of that. I think that will continue as well.

Deidre Woollard: Anyone who had multiple roommates during the pandemic is now rethinking that. So I think there's definitely a need for space, too. The other thing that has really been in the spotlight this year has also been the environmental impact. We've seen fires in California. It's been a big, active hurricane season. When you look at it long-term, what are you seeing developers thinking about? What is Altus thinking about in terms of giving people information about potential for climate disruption in certain areas?

Rick Kalvoda: Yeah. That's definitely something that over the last few years has become more and more important. There's been something out for a while, TCFD, its financial disclosures on the impact of your company and even down to the real estate. We're working more closely with owners of real estate as the tenants, and really even the owners of real estate are looking for more information about where they're building is, whether they are in a hurricane area, a flood zone or an area that could be impacted by wildfires. Collecting more and more information around that and not only just where you're located, but what the potential impact could be. Investors are more and more looking at stress testing their portfolios. What if this happens? Well, it might be higher insurance costs related to owning something in an area that's prone to flooding. Really, it's not only just the costs and insurance; it's the insurability and you're seeing that in Florida where some of the insurance companies are actually leaving the state and I've experienced this personally. They're not reinsuring properties there if their roofs are more than 15 years old, if they were built before because they're not up to the current standards. As you see, more and more liabilities for the insurance company as more and more of these events happen, it's impacting that. What we're trying to do, back to the PropCheck, is the data, the transparency, and the analytics around that data, helping clients understand what their potential risks are related to the environment.

Deidre Woollard: Well, you brought up an interesting point which is the insurance factor. One of the things I've seen in California, in certain rural areas, certain insurers won't insure people and so then people have to rely on the state plans. I feel like that we're going to see that when fires hit a place over and over again as potentially something to be concerned about.

Rick Kalvoda: Yeah. Absolutely. If it's one or two major events a year, the insurance company overall can handle that when you have multiple insurance and tens of billions of dollars, in some cases, hundreds of billions of dollars of impact is there's only so much they can raise all insurance the costs for that so they will have to start focusing on where is the greatest liability, where is the greatest risk and adjust premiums, or whether or not they even provide an insurance there. Absolutely, California is one of them. As California has grown, it's gone more into the mountainous and the wooded areas in the forested areas, that's where there's more of that risk, and probably hasn't fully been reflected in the insurance premiums so you'll see more of that especially after this year. You'll see more of that coming through and will impact where future development will be and also where it would be and also what type of development to help protect against it. If there is an event, how did they protect against it or limit the damage associated with it?

Deidre Woollard: Well, that's a really good point, too. Like in Miami, for example, I've seen the buildings, commercial developments that maybe have a lobby that essentially is prepared if it floods or something like that. Is that something that you're seeing as well but there's changes in the developments themselves?

Rick Kalvoda: Yeah. Absolutely. This even goes back to where hotels in Hawaii have for a while; they're prone to tsunamis or typhoons or rising waters. Is the lobby same thing? The water can come splashing through. They squeegee it out and put the furniture back, and they're right back to normal. I think you'll see more in that, similar with the hurricane areas of Texas and Louisiana where they put individual houses up on steels and development for hurricanes with the roof and the walls and how they're connected out here with earthquakes. I'm actually in California where we've been impacted by earthquakes. All it takes is one of those before it gets people thinking about that again. But over the years from 20 years ago, big changes in how the development is done here in California as well.

Deidre Woollard: Of course, and that then changes zoning codes and things like that. Obviously in Florida, we saw that too with different changes to the building codes to protect against things like that. As we wrap up here, we've got a couple of minutes left. I want to talk to you about 2021. We're in the fourth-quarter. What is your company thinking about? What are you feeling about next year, and what can we look forward to or be warned against?

Rick Kalvoda: That is the big question right now. Again, I think it goes back to how we ride out the short-term will be the level of stimulus when we get it and how much. Again, I'm pretty confident there will be something. It is needed. I'm actually more concerned about 2022, 2023, and beyond because you can cover up the short-term concerns. It's what happens after that in terms of how do we pay for all of this, and how does that impact the state governments, the local governments, the cities. For 30 years, we've been looking at the impact of social security and at what point will no longer be sustainable. You have that on top of the government debt, on top of the amount of baby boomers that are retiring, a lot of that just caused a lot of concern in terms of how is that handled going forward, and then how does that impact investments and specifically real estate investment is a big question. Near-term, I think is great. I think the one thing one sector of commercial real estate that focus on or look at is office. Again, post-COVID, what happens there? That's the biggest question. Then e-commerce is just a wave that's going to continue, a trend that's going to continue.

Deidre Woollard: You mentioned technology, what one technology piece for real estate are you most excited about?

Rick Kalvoda: I'd say, and maybe this is a little bit specific to myself or to Altus, is the data. The amount of data that's now being collected on, whether it's the development, whether it's the operation of building, whether it's the financials of a building, is just phenomenal. Data scientists is a big term now that's in the real estate industry. It's been for a little bit, but given how big the commercial real estate market is and getting bigger, there's more and more dollars getting into it. I'll just mention quickly, the single-family homes, single-family rentals, just such a huge wave that we're seeing right now, the amount of capital going into that data and the analytics on that data is going to be a huge component. That's, I would say, the exciting thing I'm seeing specifically in investment commercial real estate now.

Deidre Woollard: Awesome. Thank you. That was great. People can go to to get the reports; is that correct?