Episode 153 - Marks on the Markets: Real Estate: Hope or Apocalypse? with Tom Hahn and Ben Erskine
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How would you finish this sentence?
“Today’s real estate market is…”
On today’s Marks on the Markets episode, words like “hopeful” get thrown in as well as “apocalyptic.”
There are a lot of moving parts and here to help us make sense of how we think through them with a Kingdom lens is Ben Erskine and Tom Hahn.
Each of them have been longtime leaders in the redemptive real estate space. They join us to talk about what they’re seeing right now in the market and what they expect it to look like in the future.
They also discuss ways we can redeem this industry, which our team explores in a new video series “Redemptive Real Estate.” Find it here: https://www.faithdriveninvestor.org/video-library#real-estate
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All opinions expressed on this podcast, including the team and guests, are solely their opinions. Host and guests may maintain positions in the companies and securities discussed. This podcast is for informational purposes only and should not be relied upon as specific investment advice for any individual or organization.
Episode Transcript
Transcription is done by an AI software. While technology is an incredible tool to automate this process, there will be misspellings and typos that might accompany it. Please keep that in mind as you work through it.
John Coleman: Welcome back to the Faith Driven Investor podcast. This is our monthly Mark's on the Market podcast. I'm John Coleman, one of the managing partners at Sovereigns Capital and a host of the Faith Driven Investor podcast. And today we have a very interesting marks on the market focus on real estate, which has become a boogeyman in the markets right now, whether that be soaring mortgage rates, falling home sales, vacancies in office. There are so many things to talk about right now and also a lot of innovations happening in the way that faith driven investing happens in real estate. Led by two of the gentlemen we have on the podcast today. Our first guest everyone is familiar with, Ben Erskine was the founder of Callus Capital. After a lengthy career in real estate. He launched a fund one a few years ago and is now leading the real estate function with sovereign's capital. And then alongside Ben, we have Tom Hahn. Tom Hahn founded a real estate firm called Prudent Growth in 2015. He's now the president of that organization, which invests across the real estate markets, but with some interest, particularly in places like retail. And these two gentlemen have deep expertise in the real estate market. So we're very happy to welcome you on. Tom and Ben, thanks so much for coming.
Ben Erskine: Glad to be here.
Tom Hahn: Thank you for having us
John Coleman: So I want to start at a very high level. You know, marks on the market is about just taking the temperature of an asset class or of markets. Right now. We're filming this right at the beginning of July. This will air on July 10th. What in your mind is top of mind in real estate markets right now? Obviously, there are a lot of dynamics, but what are the headlines that you're paying attention to right now? And Tom, we may just start with you, if you don't mind.
Tom Hahn: Sure. Absolutely. So thanks for having me. You know, and we've primarily focus on neighborhood retail and smaller bay Industrial Flex and multifamily in the Southeast and the southern Midwest. So in our area, what we're primarily talking about and what we're seeing in the markets are obviously higher borrowing costs, which are having some, you know, pretty significant impact on the ability of buyers to get into a deal at the same kind of valuations they were achieving, say, 12 months ago. I think that we're certainly seeing a lot of talk in the retail and industrial space around more of a bullish side around just very low vacancy rates. We've had very strong leasing activity and new construction certainly in retail, new construction is at like two decade lows. So you sort of have low vacancy, very little new construction. I think you're going to have even less new construction with these higher borrowing costs, which are really hampering the ability of developers to get projects started. So we're sort of cautiously optimistic. I think it's a good time to buy. We like to say that if we can make a deal work at today's borrowing costs, you know, we're like six, six and a quarter percent on a lot of our debt. We're really going to like the deal in two or three years when rates are moderating again. You know, we look at the yield curve every day. We look at the interest rates every day. And you can certainly see the pricing of the two years and the one year notes versus the five years. You know, you're going to probably have a 200 basis point cut in rates in the next 24 months or so. You know, certainly that's what's priced into the market. So we think it's a great time to buy and kind of get out in front of that and, you know, take advantage of some slightly higher cap rates.
John Coleman: Super interesting, Tom. And I know we're going to circle back and focus on retail in a moment, because I do think the dynamics are fascinating there, especially given I remember four or five years ago retail was actually the big question mark in real estate from my experience. But before we dive in, Ben, what's top of mind for you? What are you focused on at the moment?
Ben Erskine: Yeah, I mean, I'd echo a lot of what Tom said. Certainly the interest rate environment has done a lot to slow down transaction volume. We see volumes down, you know, 40, 50, 60% depending on the asset class, depending on the part of the country. So higher borrowing costs and just a little bit of dislocation or a bid ask spread is slowing down volumes and it is very much a kind of sector by sector analysis. You know, the kind of big, ugly gorilla in the room is office. That's where fundamentally there's been such a loss or uncertainty around where is demand really going in that asset class, what is the need? But in other areas, there's plenty of brightness and hope around demand. I mean, we still think that fundamentally there's a lot of support for the housing sector. You've got to be really thoughtful about how you buy. But we think that the housing sector still has fundamental support. And, you know, I think Tom will talk more about retail in particular. So, you know, it's a tale of several cities now.
John Coleman: Well, I want to start where you ended then, because real estate is such a fascinating segment of the market and that it's one of the few that touches everyone very personally. And I know neither of you is a residential housing investor necessarily. You're not rolling up residential, single family homes, etc.. But I do think it's relevant to the audience now to start there because it's such a big segment of the economy. I read an article just this morning that referred to the real estate market for single family homes in the US as stagflation. Right now, you know, mortgage rates have risen. Folks are not selling their homes. There's really a dearth of availability of existing homes in the market. We've seen new housing starts tick up. I think it was like 12% in the last month, just as developers are starting to build new housing. But we haven't seen pricing coming down and we're not seeing a lot of sales because mortgages are so high. Can you give us some insight into what you're seeing in the residential housing market and what you think the next 12 or 24 months might look like? And then maybe since you brought it up, we'll just start with you.
Ben Erskine: Yeah, I mean, gosh, single family home ownership affordability is so dramatically different today than it was, you know, a year ago when mortgage rates go from 3% to six and a half percent. That just changes things dramatically in home price appreciation. As you alluded to, home prices haven't really adjusted and it's largely driven by a lack of inventory. So it's this funny thing going on in the market right now. You know, construction costs are still pretty high. Certainly financing costs are high, yet a lot of developers are pretty active because there's such a shortfall of supply of inventory to buy that there's room for new construction. It's a funny dynamic, but all of that to say, you know, we're more active in the multifamily space. We typically think that demand rises and falls for housing, driven by things like household formation, whether rental or ownership. But those two things really move in concert for the most part. But right now, you know, given just how difficult it is for new home ownership, we actually think it's a support for rental housing, at least in the near term. So it's a part of our thesis around multifamily housing investing right now.
John Coleman: Tom, are you seeing anything different there?
Tom Hahn: No, I would chime in and say 100% agree with Ben on that. I mean, a lot still depends on where you are in the country. But if you're in, you know, the southeast, maybe the southern Midwest, some of the states that, you know, are business friendly, there's strong household formation and strong migration patterns into those states or still a shortage of housing. And I think one of the challenges for the Fed is, you know, the occupancy costs, rent or mortgage are about 40% of the CPI. So it's like every time they raise interest rates, they actually are then, you know, making it more expensive for people to buy homes, which means people tend to stay in rentals longer, which means there's even fewer available rental apartments or homes to look at. And then that drives occupancy costs even higher. So it's a bit of a vicious cycle that they're in, and I think it takes a lot of time for that to work through the system. But we're certainly seeing the same thing. I mean, we do have 11 or 1200 units of multifamily. We've been in and out of thousands in the past. But, you know, we're certainly seeing rental increases that we can pass along that are, you know, quite a bit higher than where they used to be, especially when you're in the Class B and C space where all of the new availability, all the new construction is obviously Class A, And so when you're in small town America and you've got a suburban garden style apartment, there's just a severe lack of that product, period, and nobody's really making that anymore. So it's an issue. It's a tough one for people that have to live in more like workforce housing, kind of, you know, that lower income bracket. And they're unfortunately really getting hit hard right now with rising rates and prices.
Ben Erskine: Just an interesting statistic, too, John. I think that I read it yesterday that more than two thirds of current homeowners have mortgage rates of less than 4%. Right. So you think about how far they have to come in before it makes sense to sell and relocate. That's what's tying up the inventory right now.
John Coleman: Well, what's scary about that is it's so far below the structural average. Over time, you know, 4% would be well below the average for mortgage rates if you look over a 40 or 50 year period. And so the question is really, do we actually get back to that level or does this just have to shake out where people normalize and a new set of rates?
Tom Hahn: And I'll say to a lot of parts of the country, particularly in the southeast, in towns like Nashville or Raleigh or and Austin or Atlanta, you know, ten years ago you had a lot of just natural movement around jobs and like, hey, I need to spend more time now in Texas or California. I'm going to move, relocate. And with the hybrid work environment, the ability for people to work from home more easily, I think you're definitely seeing I haven't seen a lot of statistics on this, but just anecdotally, you don't really have to move as frequently now, even if your job or maybe your manager you're reporting to is bouncing around the different cities in the country. So I think it's just a really interesting dynamic. And I mean, I don't see any short term change to that.
John Coleman: Well, and I think we could see regional differences shake out. The other stat I saw yesterday that I thought was absolutely fascinating was for the first time in history, the. GDP of the Southeast. So kind of Texas over to North Carolina, down to Florida outpaced the GDP of the Acela corridor. So kind of D.C. up to New York, Boston, you know, forever. That's been kind of the leading GDP area of the country. And now the southeast is actually greater in terms of GDP. There was $100 billion switch during COVID with people migrating. And so, especially in the Southeast, it's just been this boom. And so I could definitely see a situation in which the segments of the U.S. just diverge in terms of the dynamics that we've been talking about. One thing I'll touch on briefly, just because I know, again, it might be relevant to some of the folks listening, even though it's not quite a focus for you all. I find it fascinating. You know, during COVID and shortly thereafter, there was a boom in the sale of second homes. People who lived in New York or who lived in Atlanta went and bought homes in rural areas or in New Hampshire. You know, all these places. And there was a boom in Airbnb, right? Because over the last five or six years, VRBO, Airbnb became so easy that there was this huge cottage industry in that. And Ben, you and I both saw yesterday Airbnb released results for I think their revenue is down 50% or something of that nature. You know, as we think about housing supply and what might happening with dynamics, obviously with those collapsing, you could potentially see a scenario where these Airbnb VRBO owners begin to sell or try and get out of properties because they can't make the mortgage payments anymore or people just abandon the second home idea. You know, they thought, I'm going to go live in Vermont instead of staying in New York or staying in D.C.. And maybe that reality is not quite what they thought it was. And so I didn't know if you guys had any perspective on whether you think that might be taking place. And if so, does that have a meaningful impact on the market or do you think that's pretty marginal?
Ben Erskine: Yeah, I'm happy to jump in for a second, Tom. I know that's not where either of us spend most of our time, but I did read a lot about that same stuff and have been over the past month or two. I think the article yesterday suggested that some of the worst hit markets have seen 50% declines in revenue. Not necessarily sweeping. Yeah, but still significant. Yeah, and plenty of markets that were, you know, 25, 30, 40% down. And I think that it could be interesting. I think it'd be easy to conclude that, hey, there's going to be this glut of inventory that comes back on the market because the model doesn't work anymore to hold it as a rental. The last number I saw was that I think there's about a million and a half units of those kinds of rentals around the country. So even if ten, 20, 30% of those come back online, I don't think it's a major flood of inventory in the market, but it will be interesting to see. And then, you know, the reading that we've done and the research that we've done into the short term rental space, fundamentally in the right markets, it is a really attractive option in particular for families or groups that are traveling economically. They can usually just a short term rental or an Airbnb or their competitors can offer a home or three rooms or five rooms for a much lesser cost than you could get in a traditional hotel. And so I do think that there is a segment of that demand that's not going anywhere. But it was certainly on fire through COVID for obvious reasons. And maybe the second and third home rentals will temper.
Tom Hahn: Yeah, I was just there real quick. I'd jump in and agree with that. I do think to me, that's the canary in the coal mine that I kind of like to watch is at what point do people start to say, I'm so financially stressed that I love having the beach house and mountain house, but let's just see if we can dump it. And we do talk to we have a decent network of some of these brokers. And, you know, I look at people that list houses up in coastal Maine and down in Florida and in the coastal areas of Carolina. And it is still interesting and the demand is still really good. I mean, houses are hitting the market and they're getting viewings and they're selling. But yeah, you do wonder how long will that persist if rates stay this high? It is a very expensive luxury. Good, you know, for sure.
John Coleman: Yeah. I will say just this for you then. This is not a promotion of any stock or anything, but I've got a family of. I've got four kids, basically. So we're a traveling army whenever we go anywhere, and they're often in-laws staying with us. And I don't think we've stayed as a family in a hotel in probably five or six years for exactly what you said, because we don't want the kids down the hall. They're young, you know, we want them kind of in a contained space. So that innovation in the market has been really positive for us. But I can also see how it's kind of probably gone a bit overboard over the course of the last couple of years. I want us to now dig into a couple of topics that I think are much more central to the models of prudent growth and of your strategy. Then want to start with multifamily housing. You guys have both touched on this right now. I know it's something you both pay close attention to. You know, there are competing dynamics here with rising rates, with rising rents, but also with this structural housing shortage. What do you think is the. Near-term outlook for multifamily housing and what are the risks and opportunities that you're paying attention to right now?
Tom Hahn: Well, I'll jump in first, and I know Ben's going to have some additional perspective on this. I mean, big picture, kind of the two city kind of theme or the best of times. Worst of times. There's a huge difference in my mind between urban and rural, no matter what the product type is. We're talking about kind of urban. Suburban, I guess, is a better way to say. I think that there's a big difference in apartments between class-A new construction, which tends to be the highest price point. Right. And more existing Class B B minor stuff. And what we talked about like a Class B picture, like the suburban apartment building that was probably built in the nineties, maybe the early 2000 is the way, say, apartments used to look before now. And everybody can picture this, you know, their four stories, flat roof kind of modern looking that might have retail on the ground floor and apartments up top and and a parking garage you know kind of built into the structure. So you're seeing these pop up all over the southeast, whether it's Austin, Atlanta, Raleigh, Charlotte. You know, I think the risk is a lot of these developers and a lot of these guys that were buying maybe early 2000 vintage deals and pumping tons of money into them to improve them, or in the case of developer to complete the construction, they utilize bridge financing. Right. So you would typically get a three year loan with a couple of one year extensions and bridge was ridiculously inexpensive. The 12 to 18 months ago, you know, you could borrow at three and a half or 4%, maybe a couple hundred points over LIBOR and lock that in for three years by an interest rate cap. And you know, on a $30 million project, your cap would be a few hundred thousand dollars. And as that debt is now starting to come due, if you have not executed very quickly on, let's say it's a value add deal, if you haven't gotten in there and really significantly invested in the asset boosted rents turned over units, your interest rate costs are skyrocketing. Those same caps that you could buy for two or $300,000 are now, you know, 2 to $3 million. And your monthly debt service is really going to be strong. So, you know, I don't think we've seen the full impact of that yet. But I do think you're going to start to see guys having to get out. There was the big story in Texas, right, The 3200 units that kind of got given back. I think that operator had some significant issues beyond just, you know, the interest rate environment. But, you know, he bought a ton of property for absurdly low rates and did not do any real value add. And as the rates were getting ready to reset, I mean, you know, it just didn't work. So you're going to see good operators separated from bad operators, guys that were able to get in there and improve and drive rents higher and OI higher. You know, I think they're going to be okay. But yeah, I don't think we've seen the full impact yet of these higher rates. But I mean, I think that what's happening now is the cap rates on the new stuff, particularly in some of the cities where there's a little bit of oversupply, they're starting to widen out. Right. So, guys, if you got to get out of a property, you're going to sell to a five or five and a half cap. The stuff that was trading at a 4% cap rate, which for your listeners is simply the net operating income divided by the purchase price. And now that's going to ripple into the suburban market. So you're going to say, well, if I can buy downtown Charlotte at a five cap, do I want to buy a suburb of Charlotte like, you know, 30 minutes outside of town at a five cap? I think I want to get a six cap for that or a six and a half cap for that. You know, so we've certainly started to see pricing improve. But an old friend of mine told me one time, if you're going to catch a falling knife, you really need to grab it by the handle. And I don't know if we're quite there yet on a lot of the suburban stuff, so we're sort of taking more of a wait and see approach. On acquiring more multifamily. I think next year is going to be a really good year to be a buyer.
Ben Erskine: Yeah, I mean, I won't add a whole lot to that. I think that Tom speaks to it well. We've been really, really patient, really slow to deploy over the past, you know, really 15, 18 months now, you know, kind of reading the writing on the wall early last year and then certainly have felt like there would be an opportunity on the back end of everything that's happening. And it's maybe been a little slower than we thought it would be to kind of be realized. I do think that there's patience. There has been some patience on the part of lenders, Right. A lot of lenders have said, hey, fundamentally, we do see the support here. We do see the [....] growth. We understand that debt service is going to eat into a lot of that. But if we can kind of get through the woods, we'd rather not take possession of the asset. Right. There's been some patience. How long that will last, I don't know. But I think, you know, putting it simply, there will be a separation of good operators from some operators that have just hopped into a market that was benefiting from constantly compressing cap rates for a decade where, you know, you could kind of limp through a business plan and make it work. That's not really the case anymore. So we do think that there will be really good opportunity probably in 24 a lot of it in 24 maybe. And in the 25 as well.
John Coleman: Hey, Ben, before we leave that topic, I know that this is the faith driven investor podcast. And I know that one of the things you've been so great about doing and perhaps you as well, Tom, is pioneering this spiritual integration within multifamily area. Could you talk to us, apart from the financial dynamics of multifamily right now, what are some of the opportunities for faith driven investors for spiritual integration in multifamily that you're seeing emerge?
Ben Erskine: Yeah, I mean, there are groups that have been doing great work for a long time. I think we've discussed groups like Apartment Life in the past, which is a not for profit that partners with the owners of apartment buildings and is really tasked with developing community right point into the fabric of community, ultimately using that to develop relationships and just have an onsite presence that's pretty distinct relative to a lot of property owners. And ultimately that accrues to the business plan because you know better community translates to better retention, often better attraction of tenants. They've got some incredible statistics. You know, a tenant with deep relationships in their apartment building is between 30 and 60% more likely to renew their lease. And reducing turnover is such a driver of margins in apartment investing. So that kind of stuff has been happening. I mean, things that get us really excited are starting to see creative applications in other corners of the housing market. You know, senior living is an example. How is that market of tenants and community members different and what would loving on those folks look like? How could you be kind of curate a plan around an assisted living in a memory care community that looks different than an apartment community? And on the other end of the spectrum, what about student housing? Right. There are some really cool opportunities in student housing. On campus, Off campus. Pouring into the lives of those students with the same heart right. And it can all accrue to the benefit of a really excellent business plan. Those two things can can work together.
Tom Hahn: Yeah, and I'll chime in and 100% agree. I think what we've tried to do is so we recently expanded our staff and brought on several people that are really tasked with community engagement events across all of our holdings. And you know, on the multifamily, we tend to own more of these kind of B, B minus properties. So we call that like workforce housing. It's not really affordable like, you know, voucher or section eight, the older models like that. But you know, you have a lot of families, have a lot of people that tend to stay in place for a while. It's difficult to attract like an apartment life model works a little bit better in newer products. That tends to be where their teams would prefer to live, you know, But we'll go down and do food trucks, we'll do backpack. We partnered with the local school district down in Tupelo, Mississippi, on a project we have there and gave out a lot of backpacks. And it was really cool, you know, And this little girl comes up to Jason Autrey, who runs like an engagement and said, why is this backpack so heavy? And said, oh, you need to open it up and look inside and there's notebooks and stuff. And she was just blown away. And, you know, we've had residents come up and pray with us and just talk about how the other owners have never done this before. A lot of it is just how you do your business, you know, just taking care of things the right way. It's very easy to slap a band aid on a problem or take a shortcut. And a lot of these operators just want to get in, improve and get out, and then they leave behind a lot of, you know, half fixed things. And residents that have just been residents have come to expect that their stuff's not going to get fixed. And when we can come in and do it the right way the first time, which I think is our call to do as part of loving the poor and working for justice, you know, it leaves a big impact. We've had residents reach out to us even while we're raising rents and say, I'm proud to live here now, and they don't want to move because they're worried they're going to go down the street and, you know, try to save 30 bucks a month on their rent. But going to be back in a situation where stuff's not fixed. So, you know, it's a real holistic approach.
John Coleman: That's awesome. And producer Joey has reminded me that we should engage in some shameless self-promotion here and that the faith driven investor website has a redemptive real estate series live on video in the library right now with the stories of places like Launch Capital, Walden Fields in the Marsh Collective. And so if you're interested in this topic, apart from the expertise of these two fine gentlemen here, there is an entire video series where you can delve into this more deeply, Ben, I think you want to do jump in with the closing work.
Ben Erskine: Yeah, you know, I was just going to chime in and brag on Tom and PDP Prudent growth for a second because he won't, you know, the work that they have done. He and he mentioned Jason Autry is really innovative and exciting in terms of how they're viewing retail real estate in a way that has really been pioneered already in multifamily. Right. So what does community investment look like in a retail center? It looks different than it does in an apartment building, But when you've got, you know, the nail salon and the coffee shop and. A local restaurant and the Taekwondo studio, and you've got people coming in. Can you hold an event there? Can you invite residents and community members in? Can you love on them in a distinctly Christian way? It's really exciting to just think about the way that they are pouring into the lives of these people, investing socially and spiritually in retail, real estate. They're leaders in the space.
John Coleman: Let's stay on this topic for a minute on retail, because I remember pre-COVID in my old firm when we were talking about real estate. The most frightening area of real estate was retail, right? The big trend or one of the big trends everyone was talking about was the collapse of retail. People don't go to malls anymore. They don't go, you know, they don't go shopping in physical stores. There was the rise of Amazon, etc., and all the skepticism about retail. Let's stay on that topic, because, Tom, I know you're deeply now, what does that look like now? Is that still the case or have those dynamics shifted? And then I would love to hear more of your insights on what Ben just mentioned, how retail can actually serve a redemptive purpose in development.
Tom Hahn: Yeah, no, thank you. You know, retail has been I've invested in retail for 20 plus years, both personally and with prudent growth since 15. And you always feel like you're the underdog trying to convince people that, hey, we can actually do this and do this profitably. So, you know, you don't get the respect right that the multifamily and the industrial guys get. But it's been very interesting. I mean, I think that going back over 20 years leading up to the great financial crisis of 08 to 10, we were building in this country a little over 200 million square feet of retail every single year. I mean, it was I think we had a huge amount of oversupply. Everybody was building strip shopping centers, grocery anchored centers, and in 08 that really fell off the cliff. Right. And I think we dropped like 40 million square feet and 50 million square feet a year. We kind of recovered, got close to a hundred, but we're back down now. Last year, according to Costar, we delivered the least amount of new constructed retail space in over 20 years. And I think what's happened is household formation. You know, people continue to move to the suburbs and we're that supply demand imbalance has really started to correct. So we now have the lowest vacancy rate that we've had in 20 years. COVID, we like to think about the fact that we're buying a shopping center in small town America in a secondary tertiary market. You're really buying the community where people go. So if there's a Walmart and you're buying the Wallmart [.......] center, which is, you know, typically in the parking lot of a Walmart, there's a shopping center, right, with like a great club and a pizza place and so on and so forth. You think about small town America, particularly in the Southeast. I mean, that's where you go to get your kid's first haircut. That's where you're going to grab and get lunch. You're going to stop by the bank. You're going to you know, you see your neighbors. You know, it's a that is an activity that people will continue to do with or without Amazon. And during COVID, obviously, COVID was scary at first with this is it, you know, it's over. And I'll say real quick, the crazy thing about COVID was leading up to COVID. We all wanted to buy stuff that was Amazon proof, right? There was Internet resistance. So that meant what? Gyms, restaurants, service based stuff as opposed to people selling things like a clothing store and then boom, all that stuff got shot down during COVID. There was a little tough sledding there for, you know, 4 to 6 months. But coming out of that, what all of a sudden happened was everybody stayed home. So suddenly, suburban retail has real and there's lots of articles on this. The Wall Street Journal had some great reporting on just the return of the open air shopping center, the neighborhood strip centers. So lots of different names for them in the suburbs. Right. And there's a real disconnect now between urban core downtown where, you know, you still have 25, 30% vacancy and the offices. And it's a big difference. You don't want to own a sandwich shop in the lobby of a 40 storey building in San Francisco. But you're quite happy to own a sandwich shop in a suburb of Charlotte, let's say. So we've seen really strong foot traffic. I'd say our leasing activity has never been stronger. We have about 45 retail shopping centers in ten or 11 states right now. When you say 600 or so tenants and our vacancy rate is less than 5% and some of it's planned vacancy because maybe you had to carve out a space to put a tenant in and you have this straggling 500 square feet that's never really worth finishing out. So our true vacancy is very, very low. So we like the dynamic. And getting back to the spiritual integration model, like Ben said, we love knowing that if we're going to own a shopping center in a community, we want to try to bless that community right on back to like Jeremiah, working for the good of the city. It's like, Hey, I own this thing. How do you do that? And we found it's a combination of reaching out to tenants. A lot of our centers, we might have a church, we might have a, I don't know, a consignment shop that's linked with a Christian ministry or just a general secular ministry. You know, if there's an entry point like that, we'll try to springboard off of that. Say, Hey, do you guys want to help, too? We want to help to underwrite and host a community day. Bring people out or a sidewalk sale or We have like a youth theater. It's run by a Christian family moving into a center that we own outside of Hilton Head. And we're going to be grand opening down there for them. Like roll out the red carpet, welcome them. The other tenants are excited about it, you know, so they'll participate. And there's lots of interesting conversations that come up when you start to do that. So the tenants love it, the community loves it. We make great relationships with important people in the community, right? Whether it's a planning board or we've even had lenders come to us. This was kind of blew me away when you thought about this. But we do borrow from banks and some of the local banks. They like that publicity, right? So they've come and offered to underwrite the cost of the event. We got financing on a property outside of Virginia Beach terms that were probably 50 basis points lower than market because it was a credit union and they saw what we were doing to some of the brothers centers and they said, We want to lend to you guys. So anyway, it's a virtuous cycle, which is what you would expect if you're doing the right thing. You know, it kind of comes back around. So, yeah, that's our feeling.
John Coleman: That's an awesome overview, Tom, and a very rosy picture in the spirit of going now apocalyptic. Let's bring up the elephant in the room, guys, which I think everybody's concerned about, which is office. You know, gosh, between the interest rate environment and the fundamental dynamics of rising remote work, hybrid work, you know, people borrowing at very low rates, which are now resetting even as vacancies rise. I have seen some absolutely terrifying predictions about the office market. Then maybe to start with you, what is your outlook for office? And are things quite as bad as people are characterizing them or is there some hope on the horizon?
Ben Erskine: Well, first, I just want to say thank you for letting Tom talk about wonderful things in retail and spiritual integration. And I get to talk about the apocalypse in office. This is fun. Yeah. You know, we're not active office investors at this point anyway. I've spent a lot of time in the office sector in my previous career, and I think it is it's going to get a lot worse before it gets better. I think Tom mentioned on the front end that, you know, vacancy rates right now across the country are north of 20%. And that's what I've been reading as well. The way that most office leases work, at least the big chunky ones for corporates, is there long dated write these are five, ten, sometimes 15 or longer year leases. And so, you know, when a big corporate user has a lease expiration in 2027 and realizes that they only need about half their space, they might just punt that problem to the lease expiration. And so there are big chunks of underutilized office space that will hit the market in the coming years based on those long dated leases. There's a lot of pain yet to be felt. Fundamentally, I don't know how this corrects. It's very difficult to redevelop most office space to other uses. You know, a lot of people think, well, just convert it to housing, right. And kind of hand it from the left hand of the right hand. But the reality of those floor plates, the reality of that construction and the support systems for the building, it's just very, very difficult in nine out of ten instances to convert. So I don't know exactly where that is going. There are bright spots, right? Not totally dissimilar from what Tom talked about in retail. You know, you get into some secondary markets and smaller office buildings and there's tightness, right? Small users that are now obviously in close to home. There are some bright spots. But by and large, you know, I think that the 20% number across the country is going to continue to go up for a little while. I think that urban cores like, you know, downtown San Francisco, downtown Chicago are going to be in a tough spot for a while. I mean, it's hard to understand exactly how that corrects. Valuations are down dramatically.
John Coleman: When it does feel like they're going to be massive winners and losers. To your point, and I'll invite Tom into this. But, you know, you think about tech oriented cities like San Francisco that also have major city problems right now where people are moving out where there's crime. It's tough to understand who's going to occupy all that office space in downtown San Francisco right now. And even in Atlanta. My observation would be, you know, Atlanta is a pretty booming market. There actually is a little bit more return to work than in some major metropolitan areas because Atlanta was shut down for less time than a lot of major cities. And there weren't commute problems as there were in some of the big metro markets like New York. But there are winners and losers. When we were looking for office space, I go to some complexes that were 96% occupied and it was very vibrant and everybody wanted to get in. And then I'd go into some buildings where they would tell me their occupancy was 50%, you know, because that's what the leases covered. But there was no one in the building. It was a ghost town. I would have guessed maybe 5% of people were actually. In the building. It was almost haunting to walk through to see how empty they were.
Ben Erskine: And there was a pre-COVID trend right there, kind of the arms race, the amenities race. Hey, tenants want to be in the new class a building with the sweetheart amenities and the gym and the, you know, the conference center and kind of a concierge service. I mean, there was an arms race of the best amenities. And I think that continues post-COVID. If you look at where net absorption is, again, broad strokes around the country, there's actually been positive net absorption in class, A space like the tranche of buildings that were built after 2015 has had something like 100 million square feet of net absorption. But everything that's dated earlier than that has had hundreds of million square feet of negative net absorption. So it's there is kind of a traunching of quality and a flight to quality.
Tom Hahn: Yeah. And I'll chime in. It's a bit like once again, the suburban versus the urban, what we've found because we just got some new office space in Charlotte. We have seven people staffed out of there now. And you know, it sounds a little bit, John, like your experience. I mean, we were looking for space. When you look at a smaller space, you want to be walkable and kind of a nice part of town and you want to have inexpensive parking. Those spaces are still pretty much leased up. You know, there's not a lot of that type of product out there. When you think 20,000 square feet of space in a 40 storey building in downtown, there's going to be more of that. And I think workers want to live. They want to work near where they live. They want an easy commute, they want easy parking. Anyone can walk outside. So these cities, these downtown districts have the crime problems. They've started to lose some of their businesses. And then that's another headwind now that they're facing, like who wants to work downtown if like half the restaurants aren't really open and it's not like a cool, fine hip place, whereas like the south end of Charlotte, like booming, you know, Buckhead and areas like that in Atlanta are booming. So it'll be interesting to see how it works out. And I agree, Ben, you're right. I mean, the repositioning, you know, prewar buildings, I think one of the big things is do the windows open or not? You can't really make an apartment if you don't have it's code violations. So prewar stuff, Yeah, you might be able to renovate that into, like lifestyle housing or apartments or hotel use. But all the new stuff with the fixed glass sides, there's really not much else you can do with that. So it'll be interesting.
John Coleman: Well, I know we're coming up on the end of our time here, so we're going to do two more questions We always end with what are the two of you learning through scripture that you'd want to share with folks before we do that, maybe a concluding question. We haven't touched on industrial, we haven't touched on a couple of other areas. Anything else that you'd highlight right now is an interesting dynamic in real estate broadly or potentially an interesting opportunity for those listening. And Tom, maybe just start with you briefly.
Tom Hahn: Yeah, I'll say real quick, because I tend to be a glass half full kind of guy, but if I had to be, you know, just fair to the other side, I still think that we don't know if we've seen the end of the banking crisis and the impact on lending. We've been a little bit saved in our space by non-bank lenders like insurance companies. Life goes are very active lenders on the kind of thing that we're purchasing. But it would be I think your downside scenario would be there's continued stress in the non systemically important banking sector which could really ripple through a lot of small town America and secondary markets. And I think that if you see a continued I mean banks are starting to lend again, but their rates are not very attractive and they want to see you put substantial deposits into their bank in order to get a loan. So, you know, most people are bypassing that because there's still other avenues for borrowing. But, you know, that's a potential risk is something we think about. Industrial real quick. Just we love industrial. We do prefer smaller pay multitenant kind of stuff as opposed to like, you know, 120,000 square foot single tenant warehouse. But there's still pretty good demand. But even that is starting to soften just a little bit. It'll be interesting to see. A lot of people have been building that for a long time and we might need a year or two to absorb the stuff that's been built. But I still do believe that, particularly with the smaller base stuff, contractor stone and tile guys, carpet guys, they need the showroom or their offices in the front and the warehouse in the back, and we don't really see a significant letup in that type of product right now.
Ben Erskine: Yes, built on that. I'd just say two things. One, kind of thinking about industrial, I think there's six or 700 million square feet of industrial space under construction right now. So the supply keeps coming. To Tom's point, the bulk of that is big. BLOCK industrial, right? These are quarter million, half million square foot developments that were supporting some of the major logistical needs around the country. That's a very different part of the market than is small bay kind of flex industrial space, which as we have seen, continue to stay pretty strong even in the face of some softening kind of broad based industrial demand. And then the other thing I would highlight, I alluded to it earlier is just senior living. We think that when you look at the demographics go forward, you know, the population group over the age of 85 is going to double yet again. By 2040, it doubled from 2000 to 2020, it's going to double again. And so we think that senior living is going to be well positioned in the decades to come, in particular, assisted living and memory care. It got hit hard during COVID and is still digging out of that hole a little bit. But we think that there's some opportunity there.
John Coleman: Well, guys, this has been a fascinating discussion of real estate dynamics. I think real estate is one of the most interesting assets in the world right now because of all the dynamics we've talked about with interest rates, with the COVID fallout, with a number of other things, structural housing shortages in the U.S.. To conclude, The faith driven Investor podcast, maybe just a circle to spiritual matters, which we always like to do. We like to ask you just if there's anything you're learning from Scripture right now, even apart from real estate, that you'd want to share with our listeners. And Tom, maybe we'll start with you, but is there anything on your heart right now that you're learning you want to share?
Tom Hahn: I think I've been doing a deep dive over the last year or so into kind of anxiety and stress, and how do you manage that? Curtis Chang has a great new book. For those of you familiar with his work over at Good Faith podcast on Anxiety from a spiritual perspective. And you know, when you're an entrepreneur, when you run a real estate, there's always something to be anxious about, right? I mean, are the rents getting collected? Is this problem getting fixed? Like, what am I doing? What I like to do is read through the Psalms and really try to zero in. I recently read and really meditated on Psalm 91, for example. And when you see these great Psalms of David and references like Psalm 91, verse four, he will cover you with his feathers and under his wings you will find refuge. His faithfulness will be your shield and rampart. You know, one thing I'll try to do when I'm mentoring and talking to young entrepreneurs is say, like, you need to learn to personify those types of writings, right? And reflect on the market forces are the, you know, the things that are coming up against you and how are you going to respond to that? And just like in the Old Testament times returning to Jehovah, you know, the Lord, your God will be your refuge and your strength. And so I often think about that and pray about that when we're dealing with difficult issues and difficult stressors that come up. And I find that it really helps to alleviate some of the anxiety and the stress and kind of re ground you and remind you why you're doing what you're doing and that, you know, this too shall pass and we just try to do the right thing and push through.
Ben Erskine: Yeah. There's a book I read about a decade ago called Anxious for Nothing by Max Lucado. It's pretty good in that direction. And I've been reading through First Kings, and it's bigger than just real estate. But there's a passage where Solomon is just praying for wisdom and discernment, and that's a prayer that is not unfamiliar to me. But it hit home when I was reading that this week. If there's one thing that's helpful in real estate in life, it's wisdom. And so just pursuing kind of faithful, godly wisdom consistently is something I've been thinking about a lot now.
Tom Hahn: And John, I just want to give a shout out to Ben. He gave a nice shout out to me. But I will say that Ben, the work of the faith driven investor movement in particular and sovereigns capital, and there's a lot of overlap there to encourage us. You know, Henry and I have talked about this for years, about how do you think about a spiritual impact around a nonresidential investment. And, you know, when we brought on Jason and the work that we were doing, I mean, Ben's team was encouraging and really was a great resource for us to start to think about how do we do this, how do we do this well, how do you kind of measure things? So, yeah, we're very, very happy that you guys encouraged us to take some more significant steps in that direction. So thank you.
John Coleman: Ben Erskine's a pretty good guy. I would agree with you to say, well, listen, Tom Hahn Prudent Growth, Ben Erskine Sovereign capital. We are so grateful to you guys for coming on and sharing today and hopefully we'll get you back in a rosier time. On Mark's in the market in six months or so, we'll all be able to talk about how there are better times ahead. But thank you very much for coming on today and for speaking with our listeners.
Tom Hahn: Thank you.
Ben Erskine: Thank you so much.