On Wednesday, May 5th, we tuned in to listen to famed real estate investor Sam Zell weigh in on the current status of the real estate market in an interview with Bloomberg. Generally regarded as one of, if not the, most prolific multifamily investors in U.S. history, his interview with Bloomberg offered insightful detail into his predictions for various areas of the real estate market.

General Outlook

Zell is not looking to make any major investments at the current point in the market because he believes pricing has not yet adapted to the new reality. At this juncture, buyers and sellers are finding themselves at deal stalemate with sellers holding out for pre-Covid prices and buyers, who believe the world has changed drastically, are expecting price discounts. Zell’s general outlook is that the coronavirus pandemic will leave the same kind of impact on the economy and society as the Great Depression 80 years ago, with long-lasting changes in human behavior that affect many business models. That being said, Zell typically takes the long-view approach on any of his deals and disagrees with the common idea that large cities like New York and San Francisco are doomed.

The Bad News

In his interview, Zell focused his criticism on three asset classes that he believes will struggle the most: Retail, Hospitality and Industrial.

The good News

Despite his negative views on Retail, Hospitality and Industrial, Zell continues to have faith in the long term for other classes, primarily multifamily and office.

our conclusions

Zell’s outlook on the multifamily class were very reassuring. This has done nothing but support our confidence in our product and confirm what we have been experiencing with our own portfolio. It has always been our doctrine to focus on the multifamily asset class for long-term value creation.

Although Zell may be right that now is not the time for buy-and-hold acquisition of the type he engages in, we actually believe that we have reached the ideal moment to acquire properties that involve significant value creation. Because we are focused on ground-up development, we believe that now is an opportune time to acquire new sites. The bulk of our costs (~80%) are in construction, which means that it is imperative for us to time our construction period to the trough of the construction cost curve. Looking back, in 2008 most developers in the Bay Area saw a ~13% drop in construction costs, which is about 20% in real terms. A 20% drop in construction costs and a 10% reduction in land cost would translate to an 18% drop in total stabilized cost of our buildings.

Our faith in the future of America’s cities remains strong. As Zell noted, the last 300 years of human civilization have been primarily focused on the City as the center for human activity. CNN anchor Fareed Zakaria echoes Zell’s confidence in the future of cities. He recognizes that a large majority of people are saying that for many reasons, this pandemic will be the death of American cities. People are quick to assume that a city’s density makes them a hot spot for disease and with modern teleconferencing technologies, people will no longer sacrifice their living space for a better commute to the office. He noted that, maybe they’re right, but historically they are not.

Calling on a large span of human history, Fareed references Florence, Italy at the peak of the Bubonic Plague, which was effective in killing more than 50% of the Florence population. Giovanni Bocaccio, a prolific Renaissance author and a critic at the time, pleaded with his fellow Florentines to flee the city and isolate with a small group of friends – advice that sounds eerily familiar today. All of that considered, after one of the worst plagues in human history, it was in those the same European cities, Florence in particular, that the renaissance started.

Similarly, in 1793, America’s leading metropolis and capital city, Philadelphia, witnessed 10% of its population die from yellow fever. The nation’s own Secretary of State Thomas Jefferson was quoted saying “This disease, like most evils are the means of producing some good. The yellow fever will discourage the growth of great cities in our nation.” As we know, he was also incorrect.

In Harvard Economist Edward Glaeser’s book “Triumph of the City”, he references 1970’s America when globalization and automation wiped out many major urban industries including textile manufacturing and shipping. The car had proven to be an important technological development, slightly more so than Zoom, for allowing people to live outside of the City. Additionally, phone service was cheap and easy, and a series of race riots and crime were destroying city life. Those same American cities that were on the verge of collapse reinvented themselves in the service sector, flourishing in the finance, consulting and healthcare industries. These cities drew upon one theme that transcends modern human history: human beings like to mingle. Glaeser notes that in industries like finance and technology, people gain huge advantages by being close to the action, meeting new people, learning day-to-day from mentors and comparing notes, much of which happens accidentally.

Against the common assumption that city density is a major contributor to the spread of disease, statistically that has proven to be false. Manhattan, New York’s densest borough has the lowest rate of infection of any New York borough. Furthermore, across the US, per capita rates of infection are highest in some of the least densely populated regions. This theme is common internationally as well, with Singapore reporting fewer than 30 deaths, and fewer than 10 deaths in either Hong Kong or all of Taiwan.

Drawing on the precedent of history over centuries, as well as in the 2008 crisis, and then combining today’s interest rate environment with Sam Zell’s conclusions, we see reason for cautious optimism in the development of workforce housing.

We can’t know how the current economy will play out. Cities may look different in the near future, and may include fewer children. But chances are low that young people will abandon cities for the suburbs. Cities are the most efficient way to organize people, providing services like housing and utilities, or opportunity for success. Cities like Oakland that are warmer, spread out, and make it easier to bike instead of relying on public transportation or rideshare services like Uber, will continue to be seen as superior options.

We see the enduring power of cities in our own experience – even in the middle of a pandemic, we’ve leased a 90-unit building to 67% full in just 60 days. With all that is going on, housing strategies that make cities more affordable will continue to be critical to making these livable places for the essential workforce.