JF 4201: The Five-Year CRE Outlook, AI Disruption and Market Risks with John Chang

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All right, welcome back best ever listeners to the Horizon podcast.

Now, I'm going to do something today that I haven't done since I started the podcast.

I think about 70 episodes ago, and I'm going to focus the entire podcast on the horizon.

The next five years for commercial real estate investing.

And the reason is that I think it's time for me to sunset this podcast, the horizon.

I will be back in the future as a guest on other best ever podcasts, like Matt Faircloths

the podcast. And honestly, it's just time because I have so many other time commitments

stretching me in so many different directions. There's times when I'm having to shoot this in

hotel rooms at 11 at night or at airports or what have you. So I just have too many other things

stretching me. I'm speaking at a lot of events and participating in a lot of other things. So

I just feel that it's really time for me to step back from the actual commitment to all of you

to providing you some great content every week. Of course, you can still follow me on LinkedIn.

And I have weekly videos there that are much shorter, about five minutes that you can watch.

I'm also speaking at a lot of conferences on LinkedIn. I will highlight those as well as research

and other unique and interesting things shaping the commercial real estate market.

But this format, the podcast where you're hearing me or seeing me on YouTube or what have you,

I'm probably I'm going to discontinue this at least for now. I may be back in the future

once my work life settles down a little bit. But I will be out there generating content and sharing

what insights I can through various medium other than this. So let's dig in. And for those of you

who don't know me by now, I think most of the audience, based on the data I've seen,

most of the audience is a regular recurring audience. But I'm John Chang. I've been active in

real estate investing for most of my life. And since 2007, I've led the research and advisory

services team at Marcus and Milachap, which is the leading commercial real estate brokerage company,

recently recognized as the dominant brokerage firm for apartments and retail and

hotels and self storage. And our research covers all of those different property types, all of the

time. So, but anyway, I've been working with Marcus Milachap for many, many years, learned a lot

in that time. And I am still happy to share all of my insights with all of you. You can reach out

to me on LinkedIn, to contact me. And I'll be happy to get back to you. So as I do every week,

I do have to mention this podcast is independent of Marcus Milachap. And what I say on this show

does not reflect the opinions or positions of Marcus Milachap.

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Okay, so since this is my last episode, I'm going to let it all hang out here and really give you

my personal perspective on the horizon on the five year outlook give or take.

I'm going to start with AI just because actually it's a little simpler than the other part I have to,

you know, the other two things that I think are going to shape the real estate investment

climate. And when you say AI is easier, that means they're all hard, right? Of course,

AI is going to have a massive economic and employment market disruption.

It's doing a lot of jobs to put displacement already. We're seeing that in the numbers.

And that will only increase over time. Do I think robots are going to replace everybody? No.

But I think that AI is a powerful tool that is going to help people increase

productivity. Now, at some firms, like Mark Smith Milachap Research Services,

we look at that opportunity created by AI to increase our productivity, to bolster our production,

to be able to take on a lot of those tasks that are repetitive and somewhat generic and focus

all of our analysts time on deeper, drilling more insightful information. So for a company

and a team like I have, I do not anticipate AI reducing that labor force. If anything,

it could actually help us grow our labor force. But there are other businesses and other industries

where they look at this and they say, you know what, we can shave off five people here,

ten people there, whatever it is. And downsize our workforce and still be able to accomplish

the things we're trying to accomplish. Now, that's true in technology where you see a lot of the

programming shift over to AI. This includes data crunching. I think a lot of the financial

institutions will take advantage of this over time. And I think this is going to reshape the

professional business services sector, the white collar worker, a great deal. And that's going

to have some effects on commercial real estate directly and indirectly. But I think AI is also

going to spur some real challenges. It's drawing a lot of energy, the US energy infrastructure

and systems just probably aren't set up to handle this. So they're going to have to invest a lot

into energy production. And hopefully in cleaning up the energy grid for the country so that we

have the capacity to meet the needs of this AI industry. AI will also be a powerful economic

driver. And it's going to create a lot of wealth. It's going to create a lot of productivity

that what maybe wasn't there before. It's going to be a journey and it's going to take many,

many years. So if you reflect back on the impact of the internet, it really took about 10 years

to fully integrate into the business as we know it. And I think AI will be faster. But we're still

talking five, seven years for a solid integration of this technology. I heard that from a leading

economist that I spoke to who was better in tune with this than I am. But it's really, you know,

we're just still in the infancy. We're still learning to, you know, crawl with this technology.

It'll move to a walk and then it'll move to a run. So the pace of change and the integration of

this will accelerate over time. And it's going to change business as we know it. It will

impact all types of commercial real estate directly or indirectly. So that's pretty much

what I have to say about AI. I don't have any real in-depth thoughts on how this is going to shape

the demand for, you know, office-based industrial space, apartments, retail centers, you know,

seniors, I was seeing any of that. It's one of those things. It's just going to be a force that

they gradually increases its impact over time. And it's going to force adoption and adaptability.

People who are able to shift to the needs of the new economic climate. I don't think it completely

disrupts the employment market to the point where we have massive job losses. But I think it is

going to have a significant impact. All right. So that's what I got on AI. I know it's not,

you know, the answer to anything. It just, it just merits continued watching and adapting

and flexibility. Now, the next thing I want to tackle is the geopolitical climate. I think

this is probably the single biggest force, even greater than AI, that will affect commercial

real estate over the next several years. And the road ahead is bumpy, uncertain, and challenging.

And hopefully it will become less bumpy as we go forward, but no promises there. I mean, any given

week, you never know what's coming. You really just don't know what to expect anymore.

The changes have been dramatic. The policy shifts have been done without notification.

You know, we've we've done things in this current political administration that we've never

seen before. And some of these things could be unconstitutional, which is part of why they've never

been done before. But that policy-driven uncertainty is going to continue to be significant.

And I'm, you know, when you think about it, you have so many forces in play. We are

attacking for countries. Okay. Right, wrong or indifferent. I'm not saying this is a good policy,

a bad policy, legal, not legal. I'm not saying any of that. What I'm saying is that

it creates uncertainty when the president of the United States unilaterally launches

a significant military attack on a foreign country. And it has ripple effects on the ability

to make decisions. It influences how business leaders drive their businesses forward.

It influences how commercial real estate responds. And so on. So you have that.

You have global trade and political relations that is going to have a profound effect on the

US economy over the coming years. You have tariffs. Okay. That restricts trades. It's a hidden

tax. The Supreme Court ruled that the way they were done was illegal. They're putting in new ones.

You know, the Trump administration is not backing off at this point. So these tariffs

are going to continue to shape trade policy. And they're going to continue to shape the economy.

Okay. Tariffs are inflationary. Full stop. This is, this is commonly accepted by pretty much

every major economist out there. Tariffs will create inflation. The question is how much

and when. And so far, we really haven't seen it. But remember, different measurements of

inflation. You have CPI, a PCE core inflation, core PCE, and a variety of other ways of assessing

inflation. But in general, tariffs will be inflationary. We will see it at some level at some point.

Less so in CPI, more so in PCE. We're already starting to see that a little bit. And that is going

to influence the Fed policy. Now, we have a new Fed chairman coming in. We don't know how he's

going to manage it. But remember, there are 12 voting members of the Federal Reserve Board.

And not all of them are in agreement that we need to reduce rates. In fact, many of them are

pushing back on this idea that we should reduce rates. So we will have to see how that plays out

ultimately. But the geopolitical climate is forcing the hand of an independent organization

charged with balancing job creation and inflation. This is going to create challenges as we go

forward. And again, it raises uncertainty. When you look at the immigration policy, at the end of

the day, the US has fueled economic growth by importing labor. This is a long standing thing. We've

been doing this since the very beginning of this country. And so we have very inefficient

immigration rules. And they've become so convoluted and complex that it's a real

maze to navigate for people who want to move here legally. And we've had a huge challenge

with illegal immigration as well. Everybody agrees on that. But what has not happened is nobody has

sat down and tried to fix the problem. Okay. Nobody has tried to sit down and fix the systems

to manage immigration. And so what we have is a knee jerk reaction. We started kicking people out.

We've made it a hostile process to become a US citizen or to move here from a foreign country.

We've put all sorts of barriers to entry. It's very isolationist. And historically speaking,

those policies tend to weigh on economic growth. In other words, we're not going to have the people

that we need to fuel growth in the US economy. Now, maybe some of these people who are displaced by AI

end up being repositioned into other roles. But there are a lot of studies about the economic

impact of immigration to the United States. How many of them start businesses and so on. And ultimately,

we could have a declining population within just a couple of years if these policies remain in place.

So that is something that's going to force adaptation. Right now, the way we're looking at it,

the total number of jobs to maintain an equilibrium on the unemployment rate has been reduced to.

And there's a lot of estimates out there, but somewhere between 30, 40,000 jobs per month give or

take. But even that may not be achievable in 2026. And again, there's a lot of questions about how

this is going to evolve over the next few years. But this combination of policies, geopolitical,

trade, tariffs, immigration, these things ultimately lead to a slowing pace of economic growth,

slowing job creation, slowing demand for all types of commercial real estate space and housing.

And the thing is though, when you look forward, these policies could change radically and very quickly,

depending on the results of the midterm elections and the presidential election in whatever,

2028. So this could be a massive pendulum shift over time. We just don't know. And so when times are

uncertain, businesses become cautious, investors become cautious, and that in turn also slows economic

growth. So when it comes to commercial real estate, the economy does have a significant effect on

all types of commercial estate. And if we are going into a slow growth cycle, then that means the

demand for commercial real estate goes into a slow growth cycle. And so that has some inherent

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Max, $100 cashback per month. So the third force and economic driver that I think investors need

to really focus on is the stock market. Now, a lot of people have identified that the stock market

is richly valued. That's the term I keep seeing. They don't want to say it's overvalued, but it is

when you look at a lot of the key metrics, it's high. It's really high for what's out there,

and it's really being driven by seven stocks, Alphabet, Amazon, Apple, Meta, Microsoft,

Nvidia, and Tesla. Quite frankly, for those of us who live through it, this is highly reminiscent

of the .com era. You have a force that is reshaping the technology. In that time, there is a lot

of speculation about the future of that technology. There's a lot of capital that flows into the stock

market to favor those things. And then at some point, they recalibrate often with a stock market

correction. So as an investor, I think that this is a time right now, literally right now,

when you look at a five year horizon, where you could strongly benefit from diversification.

And I mean real diversification. Away from the stock market and the forces that are driving that,

that includes REITs. Even though REITs invested in commercial real estate, I think that

they are still so closely tied to the stock market that their value is going to be driven by stock

market, you know, broader stock market movement. So in this case, I think you need to get away from

the stock market altogether with a portion of your portfolio.

I'm not saying get out completely, not jump out of it altogether. What I am saying is that

diversification into other types of assets will be beneficial. Because if the stock market is

richly valued, then it could face a correction, which, you know, it takes the, you know, elevator

down and the stairways out, right? So this could have a significant impact. And even drive

a recession because a lot of the spending today is being done by the upper echelons of the

income spectrum, which tend to be more heavily laden and heavily invested into the stock market.

So a stock market correction could impact consumption. And as a result, we could go into a recession.

So that is a risk we have to consider. Diversification will be the key to

managing for that. Gold has traditionally been an option right now. It's so richly valued.

And I've talked to some investors and it may be richly valued for, you know, for what it is.

I think it's, you know, whatever. It's north to 5,000 announced now. And so gold silver,

those precious metals. Again, I'm not a fan. Oil, maybe, right? With the, you know, with the

attack on Iran, the value, you know, the cost of oil has gotten up pretty significantly in the

last week. And ultimately, it could be a good play, especially given the policies that are in

place today, which do not favor alternative energy sources. There could be a run, you know, where,

where oil outperforms. But just purely speculating if this thing with Iran drags out for a while,

I think the price of oil keeps going up over the short term. And then once we get to a resolution,

it drops back down. The US produces a ton of oil. And I think once we get over the scare and the

disruption and the straighter hormones, I think this, this restabilizes. And, and you know,

it's back to business as usual. Crypto, I can't speak to that as a diversification strategy. I just

never viewed crypto as an investment. I see it more like a more like gold. It's more like a commodity

in many ways in my mind. So I can't, I just honestly, I can't speak to them. But commercial

real estate does truly diversify you from your risks on the stock market. And whether you go out and

buy a piece of real estate or you invest indirectly as an LP, there are ways to invest in commercial

real estate that I think can generate healthy returns and not run as much risk given the uncertainty

and the headwinds that we could face over the next year, two, three, four years. So with that said,

let me jump into kind of my real estate outlook. First of all, let me start with apartments.

And I will say that I do expect apartment performance to be choppy over the short term.

I think that investors who have a fair amount of 2021 vintage assets on their books face will

continue to face challenges. It's going to take years to resolve those positions. I think the older

vintage, you know, the pre-COVID vintage properties will be fine. I think anything purchased in the

last couple of years will be fine. I think that it's just that 21 22 vintage assets on a portfolio

will weigh on its performance. We'll continue to weigh on its performance for a while because

those values were so rich and the expectations of returns were not in alignment with what actually

happened. So there's still challenges there. But from the standpoint of going and buying a piece

of property today, going and buying an apartment today, I think that the outlook is healthy because

the market has repriced. It's already come to terms with the rent outlook, the vacancy outlook.

It's come to terms with the concessions. It's come to terms with the higher interest rates

that are out there today. And so I think the other thing that's favoring the sector is that the

lenders, at least until recently, have tightened their spreads on their lending rates, which has

allowed a lot of apartments to go into positive leverage. Now, slowing construction is another

thing that I think is going to be a positive. But I do believe that the slowing pace of job creation

will be a headwind for the sector. If you slow down job creation, you slow down household

formation. When you slow down household formation, you slow down demand for apartments. So in markets

where there is a supply overhang, zinc, sunbelt, zinc, Nashville, parts of Florida, major metros

in Texas, Phoenix, Denver, Nashville, Charlotte, Raleigh, you know, and so on, those markets that

had a lot of development, it's going to take a while to burn off that overhang. And so they do

face some operational challenges over the short to midterm kind of that as much as two years.

And there's always a question of whether construction bounces back. Every developer I talk to is

just frothing at the mouth, trying to get back out and develop again. Somebody has referenced them

as to them as sharks in that if they stop swimming, they die. So they are always looking to develop.

So I bear that in mind. Areas that are not supply constrained are going to have bear more risk

than areas that are supply constrained. Of course, the supply constrained markets probably face

more policy risk, rent control, things like that. I've seen it in New York. You're seeing it in

Massachusetts. You're seeing it in other markets across the country. So you have to balance what's

in between. What is my policy risk on one hand and what is my oversupply risk on the other?

I think that those two things are the two challenges on the ends of the spectrum.

But at the end of the day, I do believe the overhang will be absorbed. That construction will

continue to trend down. And ultimately, multifamily investments will outperform. I think that if you're

buying today, you can get in at a decent cap rate. You can get positive leverage on a lot of

these deals. And you can generate an outsized opportunity where the asset performs today

generates positive cash flow. But also has upside potential once the supply overhang burns off.

So I think that that's an opportunity. Also, if you're more cautious, you want to take a

a less risky quote unquote, risky approach going into a supply constrained market today.

There's a lot of opportunities I was talking to investors going hard into LA.

Historically, there's been an out migration of capital out of California into other places like

Phoenix and across the Sun Belt. And a lot of those investors have been telling me that they're

being closer to home right now because of the pricing recalibration and the opportunity of

presents. So a less investment strategy that involves less risk could involve going into supply

constrained markets. And again, if you look at LA, most of the rent controls already in place. So

at least you know what you're playing with. So there you go. I think that apartments are by.

I think that right now that they're a good opportunity. I think there will be some people

who want to sell right now. Basically, sell your dogs. Sell your assets that are not performing

to expectations, reposition, recalibrate your investments and your capital in order to maximize

returns. Going forward, don't tie yourself to a property that's going to underperform over

an extended period of time. You're losing out on the opportunities that are out there today

because you're strapped to something that you bought in 2021 or 2022.

Yes, they'll eventually out recover. But what are you you're recovering, you know,

to where you were over an extended period of time? It might not be the best investment.

Anyway, that's what I got to say about apartments. Office is going to be bumpy. I think it's

hit and miss. I think there are properties that are going to perform and there are properties

that are going to underperform. I think that the slowing employment market will favor the office

face demand. Ultimately, I think return to office is going to be a thing. But you need to know

what you're doing is going to be a hit and miss market. I think newer suburban walkable office

base is going to be in favor. I think that is going to be if you can find a suburban walkable

community with an office, those assets, I think I'll perform. I think if you look at

tertiary markets, they do better. But again, offices and investments, based on the people I talk to,

is something you really need to know what you're doing. Retail, I think as long as the development

of retail remains muted, we will continue to see positive performance. I still like grocery

anchored retail. I think necessity based retail outperforms. I think shadow anchored properties

can outperform. I think retail is undersupplied and underdeveloped. And as long as that holds true,

these properties will continue to do relatively well. I liked the retail in growth markets

in the Sunbelt because it was not overdeveloped, unlike the multifamily sector. And so I think that

there's still a lot of runway there and a lot of growth. I think we're still creating jobs in

most of those markets. We're still generating immigration, not to the levels we have in the past,

dramatically slower than what we've seen in the past. But I do believe it's positive.

And as a result, I think demand drivers for retail in those markets will do better than some of

the other markets. So that's I think I think there's still a lot of runway left for the retail

investment assets. Industrial, again, hit and miss. I think that there has been overdevelopment

of the big box industrial and that's going to continue to create challenges in development

markets like the Inland Empire, like Phoenix, like Dallas, Atlanta, Chicago, parts of New Jersey

and Pennsylvania. I think that that's going to be a little bit of a headwind. Also Atlanta,

I think that's going to create some challenges for the big box. But I think the smaller infill

logistics properties, the industrial properties and tertiary markets will continue to outperform.

There's been very little development of that. It's hard to develop. It's isolated. And I think the

needs of the consumers are going to continue to fuel those types of industrial assets. I think that

the pricing really calibration in many cases is positive. And I think the positive leverage

opportunity, especially in the smaller cities is good. The one thing, especially with the

one of the properties in the smaller cities, the one thing to bear in mind is that they're less liquid.

In other words, if you try to sell it at the wrong time, there might not be a good market and you

may sell it at a weaker valuation than if you sell it when there's a lot of demand in that market.

I've seen the ebbs and flows into some of these smaller cities. So that's a bienhold.

More often than not. And opportunistic selling, not something where you're tied to a time frame.

So, I'm going to move towards a wrap up here. As I look at the horizon, as I look forward,

a lot is going to depend on the politics. A lot will depend on what happens with the midterm

elections. A lot will be determined by the next presidential election. That makes it hard to

predict. But that's also why I like commercial real estate because it has a tendency to move

at a slower pace. It's not as volatile as a lot of the other investment classes. And it is very

durable. If you get a well-located property with a demand driver that you really understand,

the long-term valuation of that asset is positive. I think that that is an opportunity to get on

there. And when I run analysis of the performance of real estate versus the stock market, and it

entirely depends on where you start this calculation and where you end it. But generally speaking,

there are times when real estate outperforms in terms of its investment returns over the long-term,

especially on a levered basis. And there are times where it underperforms. I think we're in one of

those times where the long-term returns on commercial real estate on assets acquired today

are going to outperform what you're going to see with the stock market. So, if you bought something

today, if you bought S&P 500 index today, if you bought an apartment building or retail center today,

and you look forward five years, my personal bet, and take this for whatever you think is worth,

my personal bet is that the real estate is going to outperform over that five-year horizon.

And if you carry it out over 10, I think it outperforms over 10. And that's based on an acquisition

here some time in the first half of 2026. Before I stock market question, if the stock market

corrects tomorrow, then maybe the stock market outperforms. But I don't see that happening either. So,

anyway, the election is going to be key. Both of the upcoming elections and

as investors, we have to continue to monitor the policy. I think that a lot of the policies

that are in place today place a lot of under risk on the economy as a whole.

So, as I wrap this up everyone, I want to remind every investor to always think forward.

Look beyond the day-to-day. Look beyond the headlines that you're seeing in the paper today. Look

beyond the choppiness or the challenges that you're looking at over the next 12 to 18 months,

24 months, and think forward to your exit strategy on the back end of those assets.

Think forward five years and seven years. And really pause and consider what is going to shape

this investment over that time span. And as always, keep your eyes on the horizon.