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January 27, 2021

Fireside Chat with Lusk Chair & Vice Chair


William A. Witte
William A. Witte | Chief Executive Officer, Related California
Nadine Watt
Nadine Watt | Chief Executive Officer, Watt Companies, Inc.

William A. Witte and Nadine Watt join Richard Green, to discuss their perspective on the broad trends and challenges facing real estate and urban economics in 2021. The leadership offers viewpoints on California outmigration, how rents are changing in unexpected ways as consumers respond to COVID, and the potential growth (and pitfalls) that remain for Southern California infrastructure. The Lusk Chair and Vice Chair insist that capital availability continues, meanwhile the industry as a whole continues to maintain a “wait and see” strategy to accurately assess how COVID and consumer trends have impacted product types and financial feasibility in the long term.

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- Welcome, everybody, to the first Lusk Perspectives of 2021. Great seeing you all, my name's Richard Green, I'm Director of the USC Lusk Center for Real Estate and it pleases me that our first event will be a conversation with our new leadership, but before I introduce our new leadership, let me again acknowledge Emile Haddad for the great work he did his three years as chair of the Lusk Center, we are now on a three-year term for chairs and vice chairs of the Lusk Center advisory board and I can't help, but think about the fact that Emile in our last live session together opened the session by saying, "I think this looks really bad." And this is before we all knew that it was going to be really bad and so our new leadership has a high bar to clear in terms of their ability to prognosticate and let's hope that the first words out of their mouths are not going to be, this is going to be really bad. This is a spontaneous conversation or as if you remember from the days when Meet the Press was hosted by Lawrence Spivak, which was when I was a kid which will tell you one, how old I am and two, what kind of weird kid I was, this is an unrehearsed conversation, so Bill and Nadine and I are just going to talk but we are also gonna elevate everybody in the room to panel status, so if you wanna just barge in with a thought feel free to do so, otherwise you can use the chat function or the Q & A function I will make sure to pass your thoughts on along to our panelist. So the new leadership of the Lust Center, are people everybody in this room knows well, Bill Witte the Chairman, CEO and founder of Related California that has done all sorts of stuff, particularly well-known for mixed use development and affordable housing development along with not so affordable housing development here throughout California and Nadine watt, who is now the Chief Executive Officer of the Watt Companies and I think that's the first time I've been able to introduce you with that particular well-deserved title, Nadine has been part of us since long before I became Director of the Lusk Center which was nearly 13 years ago, her family of course, has been very important to the USC community for some time and she has various leadership roles at the University, so Bill and Nadine great seeing you both and thanks for spending time with us today. So I'm gonna start with the chair Bill and then move on to the vice chair Nadine, and I just wanna start with a fairly simple question, as I said, Emile said to us nearly a year ago, things look pretty bad, how do you think things are looking at the moment? And you may answer that question any way you see fit, so Bill, let me start with you.

- Well, first of all, as I think others have commented I think the challenges we have today are very very different from the previous recession, it's not a supply and demand question, it's COVID induced, there are business challenges in the state and in local government but the metrics in terms of markets are far better than they were in the previous recession, so I'm going to resist the urge to attempt to prognosticate specifically because I view that as kind of a fool's errand, you can only look bad, I will say this, we are fairly bullish on the future of commercial real estate including apartments and in a modified way office but it's not gonna happen in a year, I mean, if rents have dropped 25 to 30% even when the market improves, as we think it will you're not gonna increase them back by 25 or 30% in one go, the second thing that we believe is that as in any slowdown with supply decreasing, there is going to be less competition for those who can weather the storm and move forward and then the last comment I would make is that some of this isn't just about markets, but it's about the response from government, now, we're seeing a very ambitious response from the Biden administration at the federal level exactly what gets approved and what comes down the pike, including an infrastructure which hasn't come out yet, will have some bearing on how things recover and where they recover. But in California, the positions or actions of state and local government which have gotten a lot of attention recently will be very significant, for example, in one of our core markets in San Francisco and perhaps one could argue in Downtown LA how the cities deal with social issues including homeless will have some bearing on how the market can move forward more so than in other sub-markets, what if anything the state does at the moment perhaps doing nothing would be preferable to taking some of the actions that are being proposed, so, that's sort of a long-winded way of how we look at things, the last comment I would make is for all the talk about people leaving the high end for sale markets at least outside the urban cores are booming and rates we've almost haven't seen before, so there's still a lot of money in California.

- So Bill, you said you don't wanna prognosticate, but there's a way in which you must, which is presumably your company does proformas to think about things going forward, which is a type of forecast, so without giving away the company secrets can you say how you've changed your modeling going forward as you think about the development that you're doing?

- Well, I'd say a couple of things, whether it's a short term or slightly longer term response to the situation, higher end or well located suburban markets, which we've typically stayed out of are generating a little more interest for us not in lieu of the cities, but in addition to and that's a function of two things, one, we've seen even with one lower scale project we're doing in San Francisco that has a lot more open space, a greater interest in the market on a little more room, a little more space, things of that nature, that's not a complete change from before but it's something that we've observed, second thing is demographics, which always drive demand at some level and while through, as I understand in 2024 there's still a significant millennial population which helped drive the rental pop, the rental demand in the last decade as the millennial population ages with or without COVID, there's always been and always will be some move to home ownership, some move to the suburbs for social and other conditions and I think that's affecting what we see demand in these locations as well. And finally, whether it be Silicon Valley or West LA we'll be watching to see what the major employers do, there still seems to be growth among the big tech companies and certainly the biotech world, regardless of the negative press about California, how deep does that go? How extensive is that? I see Michael Barker on the call, who's experienced office guy, be interesting to see how that progresses, so that's beginning to frame how we're looking at things, perhaps we're looking at things perhaps a little differently.

- Nadine, give us your peek around the corner?

- We are fortunate to be in a lot of different asset types right between home building and commercial, industrial, apartment, office so we're seeing a lot of different things, seven sales a week in the home building division, right? That's big numbers that we hadn't seen previously, our industrial a 100% occupied, a 100% paying rent, or apartments class A, 95% are paying rent and--

- And excuse me Nadine, 95% is just normal, right? It's that what you would get even without COVID right?

- Correct, but class B you're getting lower at 89% and class C, you're closer to 82, 81%, so it varies by your asset your ABC level of apartment, office, very, very challenging, especially our high rise office but so our low rise as well, definitely seeing challenges, occupancy dropping, rates dropping and closer to 80% of people paying rent and only 20% are even coming into the office, so, definitely it depends on where you're investing, what you're seeing happening and what you'll see going forward. I think the vaccine is gonna have a huge impact obviously with that rollout, I think by summer a lot more people will be going back to high rise office and I think that you'll see a big change there, but up till now, it's dramatic. how difficult it's been.

- So I wanna pick up on your comment about selling seven houses a week and how strong that is, it is so many people have talked about is the land pipeline being an issue and that's going to sort of put the kibosh on the ability of housing to grow even more rapidly, is that something you're seeing that you're dealing with? What's your view about available land for sale?

- Yeah, that's a good question. Definitely narrow or pipeline, we have a couple of projects in Northern California Sacramento area that we have about two years worth of build-out ahead of us, so, those projects will continue to sell well, I think but we don't have a lot of other things in the pipeline to talk about or you know, so, there will be an issue of lack land and to keep that velocity up of seven homes a week is gonna be impossible.

- So--

- They also have an apartment project in Las Vegas that we're doing 30 leases a month, so that's one a day in a project we're in lease up there, I mean and that velocity is tremendous, that doesn't happen.

- So, Bill, you look like you wanted to weigh in on this.

- Well, two different comments, one to Nadine's point about the Las Vegas project while rents in coastal California in class A property, have predictably dropped although I think with the vaccine and other things will improve rents in class A property in Sacramento have actually increased, literally increased, I don't mean stable, they've actually gone up, we hear a lot about the Inland Empire to a different market but Sacramento is kind of a core market in a second here, so that's just one observation about what's going on.

- Excuse me, what's the typology of that stuff in Sacramento? Was it high rise, the garden what--

- No it's the urban stuff in Sacramento in West Sacramento is four, five, six story product, obviously rents are below coastal California rents, but they've been increasing and Sacramento like other markets has benefited by people for high cost or remote work reasons moving in that direction for sale markets really strong there, Nadine can comment on that, but in the other directions something to think about in our affordable business, we're busier than we've ever been that's a function, not only of the demand but available resources at the state level, having said that while we talk about for sale home prices rising and all of that, at least to me, we're in this business, it means that if you're a first time home buyer, good luck and at our affordable properties it's not unusual to see waiting lists of two, three, four, 5,000 people and so my concern is that while we're talking about all these commercial real estate metrics, that for lack of a better word, the inequality dynamic is gonna continue to grow and apart from just a societal comment, I'm concerned we're already seeing this in progressive political places like San Francisco and Santa Monica is that it's gonna impact public policies and not necessarily in a good way, not that there shouldn't be more focus on affordable housing, we think there should, the second thing I would say is to Nadine's comment about land availability, there's been a spate of attempts at the state level to force cities through RHNA numbers and Housing Element analysis to provide more land for housing including but not limited to affordable and on the good side and I give the governor's office some credit for that, you see cities that I'm aware of, at least like Newport beach and Laguna beach never thought about this, they're actually taking it seriously to a point, on the other hand, we see a lot of cities like Santa Monica and others fighting back, just don't tell me what to do, leave me alone and they're playing to sort of typical NIMBY type sentiment, so I am concerned that there are still despite all the talk and all the agreement about we need more housing, we need more supply, we need more affordable housing, I don't necessarily see that happening at the local level, so, I am concerned about public policy, lastly, all the state legislation, as we've discussed, putting aside whether one thinks this is good or bad nothing comes out of the state that doesn't have a labor requirement on it and in a lot of parts of the state there simply isn't the contractor subcontractor workforce to deliver on that, so I just wonder about how meaningful a lot of these statewide efforts will really be.

- So I can't help, but know, I have lots of data points I like to share with people is if you go back to 1960, Los Angeles County had about five and a half billion people and it now has about 10 million people, so, not quite doubled, Santa Monica had 80,000 people in 1960, now it has 90,000 people, so it has not kept up with... And it's an enclave, right? It's not in the middle of Los Angeles, but it's in the middle of economic activity in Los Angeles and yet, so it should if it were keeping up with the county have roughly 200,000 people now, I don't see it getting there anytime soon.

- Well, they're not allowing density, right? I mean, they're not doing or market isn't density because they're not doing high rise dense projects that would allow for growth in Santa Monica.

- Right, exactly.

- Well, the other thing is, if you look at the local elections, Santa Monica being a prime example, the local elections not the state or federal elections in November, that in a lot of cities they've become significantly more progressive, however, one defines that than they were before and as Nadine suggests in Santa Monica progressive is not always a meaningful term because you can pretend to be progressive but you're really just anti-growth, so I don't know if that's progressive.

- So I wonder, this is a question for both of you, how much more housing do you think we could build in California before we got ahead of our skis? How far away are I you mean double triple and I don't mean the stock, I mean, per year? How much room do you think if zoning allowed it, there would be for more housing in California, just because of demand.

- Well, the last person who used the number like that was Governor Newsom and he's now getting ridiculed for saying, we're gonna build 3 million housing units a year, so at the risk of avoiding ridicule I'm not gonna propose a number, I would just say that I'm not a advocate of statewide housing policy, it's politically difficult, this is a very complicated diverse state, so, I tend to look at it regionally which is how markets and sub-markets occur and there's just realities, you're not gonna build more high-rise along the coast, you're just not politically, so the question is where do you focus your efforts to get to that? And I think the answer is twofold, one, the cities, the Newport Beaches of the world can do more, they're not gonna move the needle but they certainly can do more and they're at least outwardly trying to take it seriously like a Newport built near the airport, no, you're not gonna build on the coast but there is some room, to me the real fights are gonna be in the suburban areas, I don't know how to answer the question without looking at the political realities, city of San Mateo a pretty big city in the peninsula in the Bay Area had two dueling ballot measures and that would have allowed for more height and the no growth has one, so we said, we think we're in this pro housing climate but at least outside some of the urban areas I'm not seeing it, Downtown LA, you can build until the cows come home, but that's not where the market is going to justify a lot more development, so, Richard I don't know how to answer your question without ducking it.

- Nadine you want to try to avoid ducking it?

- Again, it is a political regulatory question, I just I don't see all activists allowing for the number of houses that we need or that we could sustain, I think there are corridors where we could do more dense projects, but politically they won't get past we're building on Transit, we're building on Exposition in Crenshaw 500 units but there are corridors that could sustain it, it's just very, very difficult to get them built.

- I will say that if Richard, one of the things that is going on and we'll see how successful it is, is the lowest hanging fruit is publicly owned land, there are in the affordable world, the Governor has instituted a policy of any surplus state owned land should go for affordable housing, we recently won an RFP and of all places, South Lake Tahoe to build 250 units in three projects, that's not nothing, especially in a sub market like on a surplus state site, competing on a few others and then--

- Now California side or Nevada?

- California side, but the market better than I do probably, but also there are two very large sites in Pomona or the Pomona area, one owned by the LA County fairgrounds where we're involved the other by Cal Poly Pomona, so Cal Poly is not a public institution but very large sites that are at least close enough into it's LA County, not out in the woods somewhere where a lot could be accomplished and there seems to be some political will to do it, so I think the first place to start is institutional or government controlled sites where there may be political will and control of a lot of underutilized land.

- So I wanna come back to the point that he made about our Crenshaw project, which involves infrastructure and I think one of the problems facing California is we've way out grown our infrastructure, if you go back 30, 40 years ago, California had I think most people would agree world-class infrastructure, it had the highway capacity, it had the airport capacity, it had the rail shipping capacity, it had the port capacity and so on, thinking forward, and so I'm just going to ask you to use your imagination a little bit here, if you were to think about how California should expand and change its infrastructure and try not to worry about political constraints, I'm asking you to have a bit of a vision exercise here, what would new infrastructure in California look like? And I was particularly interested in Bill's comment about where development might happen? And it seems to me that has some implications for future infrastructure. And I'll start with Nadine on that one.

- You know I feel like we need a better Metro system, right? Or we need a better way to move people around and we can't even get high-speed rail going in our state, let alone have a better Metro system, but if we did have good mass transit and we were building dense on those corridors we could see some success here.

- Bill.

- We give it an example of it doesn't necessarily have to be public funding, but we have a very large with our New York partners site that's fully entitled that we hope to start construction on sometime this year in Santa Clara, 240 acre public golf course, but it's on landfill, so, we have to build a platform over the landfill in phases to accommodate that and the city has been good about working with us, so that's effectively our land cost, but in addition to Nadine's comment about transit and improvements to transit, I think I would add to publicly owned sites or underutilized sites for I don't know if that's an environmental reason, but that's where you kill two birds with one stone, they haven't been available for development for I'll call it site constraint reasons, but are particularly well situated for development, there is already transit there as such as we have proximity to jobs is unbelievable, in some respects that's how Playa Vista happened, right? Nadine I mean, it took a while and that's another whole discussion. So--

- Environmental wetland.

- Right. I think some creativity and public private partnerships can accomplish a lot in those kind of spaces and you're cleaning up, you're improving sites that are otherwise challenging even as you're accommodating new develop without just going into someone single family neighborhood.

- Well, let me ask a sort of a big question which is since the day you raised high speed rail.

- And I will tell you, this is something where I was for it and then I was against it because I think it's been so poorly done from everything I could tell, but one of my PhD students is writing a paper on the impact of high speed rail in South Korea and the impact there has been enormous and it allows people to work at Seoul and not pay the exorbitant cost of living in Seoul, now, South Korean Samsung actually knows how to build the stuff, it takes them less than 10 years to build a substantial line a 200 kilometer line which we can't even and they, by the way up mountains and other stuff that makes it hard to deal with it's not like it's a unchallenging place to do it. Could you wanna envision a world where say Bakersfield becomes a bedroom community for all the jobs that are in the Southern California Basin, or is this just hopeless to think about things this way?

- Well, again, it's a political football because of the mismanagement of the project and the exorbitant costs, but it seems to me that's the only way we could make sort of those bedroom communities is to have a fast rapid way of moving people, traffic has been heavenly this last year, right? I mean, there's no traffic anywhere, but going forward once the vaccine hits and everybody goes back to school and work traffic is gonna be at a standstill again, so I have sort of been a proponent of high speed rail and being able to get to San Francisco, in two hours or an hour, whatever it is that we would normally be sitting in our car for that time, you can get a lot done on the train or what about these new Hyperloop ideas, the test loop or whatever, I mean, I think those could be a reality at some point as well.

- So Richard, let me ask this question and maybe somebody has an answer for this, I voted Rick for the original high-speed rail proposal, like Nadine I agree that it would be nice, but quite apart from quote unquote mismanagement, if any community through which this goes can challenge the proposal on EIR and environmental grounds, how are you ever going to get something approved? It's impossible and people seem to not wanna confront that, you look at countries or they do this, the rules change, they have changed, the state has changed the rules or accommodated, some sports arenas and other things under sequel as long as they pay prevailing wages or something, I'd be all for that, if they would say, I'm sorry, but as long as they pay say prevailing wages or something, we're gonna do this, if you don't have that, we're struggling to get it from the Fresno area will you get to the house? Will, you get to post? How is this ever going to get approved? I'm just asking that question not when--

- You will have to be able to wave a magic wand, somebody just has to say this is happening.

- That's right. And so we can talk about high speed rail to blow in the face, until someone addresses that it ain't happening.

- Yeah, I mean it comes down to one of the things cities do get to a point where they just become too big and they're expensive simply because the value of being in the middle of the city is so great relative to being on the periphery that it's very difficult to solve the expensive big city problem, London is very expensive, Tokyo is very expensive Seoul, et cetera and so it occurs to making it easy to get access to the city and not requiring people to live there, is a way to solve this problem but without that, it's hard to see, I mean yes, LA can be denser than it is, but LA is like every other city of its size of the world it's expensive and it's just hard for me to solve this problem without figuring out how to transport people better and faster. I'd like it, so first of all, why don't we invite the crowd to weigh in or ask questions or give opinions as they would like and then, but before I do that, let me just turn to one more topic myself, which is the state of finance at the moment real estate, has COVID changed it? Do you think it's a temporary change? What are you seeing in terms of underwriting? What about sources of capital, like our debt funds becoming increasingly important relative to banks, et cetera, so just your views on real estate finance going forward as a result of the last year.

- I think there's a lot of capital out there, they're all looking for a good deal, they're looking to get yield and they're waiting for some distress that hasn't exactly come yet because of the eviction moratoriums and you can't evict anybody, you can't charge a late fee, you can't charge interest, you can't do anything to get them out, you're sort of in limbo and so people aren't seeing distress yet, but I think there will be some as soon as these moratoriums are lifted and I think there's gonna be a lot of capital out there looking forward.

- Richard I just listened to a presentation by one of your colleagues in the industry who made the point that I think is very true, which is, his talk initially about inflation and how he doesn't foresee inflation in the consumer price world, buying groceries or things like that for a variety of reasons, however, there's so much money available to chase real estate that he expects, which is at least in the short run, good for real estate that there will be significant inflation in real estate because there's so much more money than viable deals and we certainly see that too, then you get into the weeds about, okay how do you project underwriting and how do you trend rents in this kind of a climate? The office world is perhaps a little more vulnerable only in that there's more swing, it's more volatile, it'd be really high highs, but also low lows, if you lose a big tenant, what do you do? But there's a lot of money out there and then the second thing I would say is, we keep hearing well funds they're not gonna invest in California, their statewide rent control everything, we don't see that, I'm sure there are those who believe that or who are saying, well we should all go to Phoenix or Texas or something like that, but historically, when these issues have come up about California or rent stabilization or this or that we always heard the sky is falling and then it never did cap rates stayed low and I think they still will particularly with interest rates so low, so like Nadine said, I think there's plenty of money whether it comes from slightly different sources or not I don't know and I would add there's less arguably whether the Chinese capital has somewhat dried up but that's not in my opinion all bad because prices were surreal based on I think, artificial demand, so at least in terms of availability of financing, I think the scenario is pretty favorable.

- So you think things like underwriting ratios might loosen, LTVs will go up debt covers we'll go down, debt yields will go down or not so much?

- Yeah, so I mean, but what are you comparing it with? Today as you'd expect terribly conservative, I mean, a lot of us are holding off and starting construction on projects precisely for that reason because how do you convince lenders investors until the vaccine kicks in, for example, where rents are likely to return to or something like that, but if people have not soured on at least these core markets and as I indicated the strength in places like the Inland Empire and Sacramento probably there'll be more capital, it may be more mobile than it was before.

- Nadine any thoughts on that?

- I just was trying to think about our project in Las Vegas that we wanted to potentially bring to market early but the pricing isn't there because we're only 30% leased, so we're gonna wait until we're closer to 75 or 80% because people are still wondering where are we? What are your real rents gonna be? What is your lease-up velocity gonna be? Can you continue to have 30 leases a month for the next six months? So again, I think people are in a wait and see at this point and in six months, we'll know a lot more.

- So I'm curious, anyone else in the group wants to comment on sort of the state of underwriting and availability of capital going forward?

- Well, Richard let me just say one thing, let's not forget that pre COVID, we were pretty late in the cycle already.

- Yeah.

- It's not like we're about to boom and then all of a sudden COVID hit and whoo, oh boy what do we do now? We're already pretty... It's sort of a natural correction beginning to occur and COVID exactly exaggerated it and so we just to keep some perspective.

- So we have about three minutes left so I'd like to close by asking Nadine and Bill if they they'd like to share a few words of wisdom that I have not prompted them to share, so Nadine, let me start with you.

- Oh, I don't know, I think just hang on, I think I'm still bullish about Southern California about office, about commercial property, obviously home building I mean, I just think, hold on, how's that?

- So I have to say Nadine's comment on bullishness on office has a lot of credibility with me for the following reason, we were in a meeting together and I think it was Aspen 10 years ago and some guy was saying how great the office market was and this would have been in like 2010, right? And I remember Nadine, I think it's the first words I ever heard out of your mouth as a matter of fact in a meeting was, "are you kidding me? "Is we're getting slaughtered."

- So if Nadine is bullish on office, I actually believe that's a real important indicator, so Bill.

- So I mean I'll just say that everybody in this call is smart people on this call at that much we can add, I would only say despite all the political headaches if sites have been good in the past, locations have been good, they're still gonna be good, I know that's the hang on philosophy but it's certainly what we believe. The only other thing I would say which has nothing to do directly with real estate is, but we see this all over the state, the broader real estate or a business community either through alliances or organization has to do a much better job politically, We're getting out hustled and out organized at every turn and it won't affect the value of sites, but it will help address all of those questions you asked earlier about how many units can we build? And how much can we do? And how much you need this? Right now, nobody listens to us, we have to do a better job.

- And with that Bill Witte and Nadine Watt, thanks very much for sharing your thoughts with us for the last hour, thanks so much for joining us and have a great rest of your day.

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