Conflicting Signals: What do Layoffs Mean for the Labor Shortage?

In recent news from the Washington post, tech giant Meta is cutting around 11 000 jobs, representing 13% of the company’s workforce. Twitter is also continuing with layoffs, after already slashing jobs drastically earlier in November.

Meanwhile Forbes reports large-scale layoffs at Amazon, adding that multiple other major companies – from Disney to Barclays, Salesforce, and Lyft have all already cut jobs or have announced cutbacks and hiring freezes.

With all of these changes incoming, the question that’s top of mind is: How will this affect the labor shortage we’ve seen since 2021?

In larger context

The names above are some of the biggest players (and employers) in the market, so it’s natural to assume that these cuts mean the labor shortage is inevitably reversing. Before making that deliberation, however, it’s worth taking a look at some of the figures from the U.S. Chamber of Commerce (USCC) to get a sense of the bigger picture.

In October, Stephanie Ferguson, the USCC Director of Global Employment Policy & Special Initiatives outlined the magnitude of the shortage, stating: “We have a lot of jobs, but not enough workers to fill them. If every unemployed person in the country found a job, we would still have 4 million open jobs.”

State and sector

The shortage stems, Ferguson says, from the unprecedented number of jobs added in 2021 – approximately 3.8 million. At the same time, the labor force has shrunk, with many workers retiring early, and workers quitting their jobs in unprecedented numbers as part of the Great Resignation.

USCC data shows that these shortfalls are  largest in Northern and Eastern States, and that certain industries, like hospitality and healthcare, have disproportionately high levels of job openings.

All of which is to say, that while the big moves happening in the tech sector right now are certainly concerning, they still form part of a much larger, and more nuanced, picture.

CRE concerns?

For the commercial real estate (CRE) industry, the effects are likely to be similarly varied, depending on where and what type of business we look at. We have already seen some sharp downturns for specific Proptech companies. Redfin, for example, has cut a further 13% of its staff, following on from an earlier round of layoffs in June.

Other Proptech outfits are facing similar difficulties, as 2022 shapes up to be a tough year for CRE startups.

Labor market outlook

What these cuts ultimately mean for the labor market, and CRE operations in the Bay Area where many tech companies are concentrated, is still unclear.

For now, it seems that worker availability, even in tech, is still falling short of demand from employers. Amid the current economic uncertainty, however, that situation might well change as we head into 2023. As always, we’ll be keeping a sharp on the trends, and potential impacts in CRE markets.

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Risky Business: Why Cybersecurity Should be Top of Mind for CRE Professionals

Over the past year, it’s sometimes felt like the number of factors that we, as commercial real estate (CRE) professionals, need to keep track of have grown exponentially. Especially in the face of challenging market conditions

At the same time, there’s an ever-increasing need to be conversant with new technology and tech tools that help boost productivity and add value for clients. The tools available  span the spectrum from social media to drone technology, climate-savvy building tech, and even augmented or virtual reality software.

For brokers, building managers, and developers incorporating these game-changing technologies, the possibilities are nearly endless.

There is, however, a flip side to this coin. And, like many things tech-related, it’s an area where CRE professionals have often been slow on the uptake: Implementing the right cybersecurity protocols.

A growing threat

Part of the problem is the idea that cybersecurity is something that’s handled exclusively by a dedicated team, or automatically built into the software being used. While that’s true to some extent, the fact remains that the tactics cyber criminals use, and the number of incidents each year, are continually growing.

Sophisticated “phishing” attacks, which aim to get staff to unwittingly compromise system security, and ransomware are the order of the day, and, as a recent incident in Australia shows, the real estate sector is far from exempt from these threats.

Given the amounts of sensitive data passing through or stored by the CRE industry, the question we need to ask is: Are we truly prepared in the event of a breach?

New risk vectors

The first thing all CRE businesses should consider is whether all possible systems, and avenues of access to those systems, have been identified and are properly protected. 

In an excellent recent interview on cyber threats in CRE, security consultant Coleman Wolf points out that many possible avenues of attack go unnoticed. These may be linked to building control systems (think temperature or lighting management) and other smart tech, or even to the specialized Internet-of-Things (IoT) systems being used in industrial operations.

If these systems are connected to the internet, but not adequately protected, they may act as a springboard for access to other systems or data. Hackers may then be able to tap into sensitive information, including financial and personal data stored elsewhere. Alternately, simply taking control of building systems can be used as a tactic in ransomware attacks.

As the CRE industry begins to adopt new smart building technologies, and we increasingly repurpose buildings for niche markets, like the booming medical office sector, the potential for sensitive information to form part of breaches also grows exponentially.

Other trends, like the Bring-Your-Own-Device (BYOD) movement where employees use personal devices in the office, create additional avenues of attack if those devices aren’t properly secured.

Best principles

While all the above may make it sound like it’s impossible to keep track of potential threats to a building or CRE enterprise, the good news is that there are certain essential principles that can be followed to mitigate the risk.

In a recent article on cybersecurity best practices in CRE, J.P. Morgan advises that:

  • CRE companies should ensure all employees, beyond just the IT team, are aware of potential risks from phishing or ransomware and have been trained in how to minimize those risks.
  • Companies ensure there’s appropriate access control. For example, implementing multifactor authorization (MFA) and other safeguards.
  • Employees are aware of the risks of oversharing on social media (e.g., detailed information on job responsibilities and the type of data they have access to, which could make them phishing targets).

Of course, these recommendations are only starting points, and the exact requirements and level of detail needed will vary based on each firm’s unique context. There’s certainly no “one-size-fits-all” solution for CRE cybersecurity.

That said, an excellent resource to familiarize yourself with upcoming benchmarks and strategies for cyber-security can be found in PwC’s “C-suite united on cyber-ready futures” guide (you can register for free to download the report).

Securing the future

As we head into 2023 and beyond, some of the most exciting aspects of the CRE industry come in the form of new technology. There’s an ever-expanding array of Proptech tools on hand to help us close deals. Smarter building technologies ensure we meet environmental and climate imperatives while also offering something new and different for tenants and investors alike.

As CRE professionals, we’re right to be excited by the possibilities on offer. But we also need to make sure we keep security top of mind as we begin to integrate these tools.

As PwC summarizes: “Digitization makes security everyone’s business. The future promises more connected systems and exponentially more data — and more organized adversaries. With ever expanding cyber risks, business leaders have much more work to do.”

The Winner’s Circle

Alec J. Pacella, CCIM

Last month, we continued our “back to school” theme and started a discussion regarding capital accumulation. And equally important, we took a walk down memory lane, discussing slot car racing sets that were a part of my childhood in the 1960s and ’70s.

If you read last month’s column, you may recall that although Internal Rate of Return (IRR) is a well-established measure of an investment, it has some deficiencies. This is particularly true related to what I called the investor’s total pile of cash. IRR only cares about money in the deal and gives no consideration to money that comes out of the deal – even though an investor can reinvest these cash flows. Interwoven in that discussion was the story of AFX, a leader in the slot car racing scene of the ‘60s and ‘70s, and upstart Tyco, which proved to be a worthy alternative. This month, we are going to continue this discussion as AFX vs. Tyco isn’t the only battleline being drawn. This is the last period before our lunch break so let’s go! Modified Internal Rate of Return (MIRR) was initially developed in the 1960s and primarily used by businesses to make a more accurate comparison between investment alternatives. It addressed one of IRR’s main limitations of ignoring cash flows produced from a primary investment by introducing a couple concepts. If you recall, last month I used the analogy of putting money produced by an investment in a mason jar and burying it in the back yard. This would equate to a reinvest- ment rate of zero, as the money in that jar would be earning nothing. But we can do something more productive with those cash flows – like redeploy them at a realistic reinvestment rate, usually a rate comparable to the firm’s cost of capital. Also, any additional outlays that would be needed to cover anticipated shortfalls (i.e., negative cash flows) over the holding period are assumed to be funded upfront at the firm’s cost of debt. Figure 1 illustrates the MIRR process, using an 8% cost of capital and 4% financing cost. As you can see, the $10,000 negative cash flow anticipated to occur in year three is acknowledged at the beginning of the investment by dis- counting the shortfall back to time period 0 at 4% and adding this to the initial investment. Meanwhile, all of the positive cash flows are reinvested at 8% to end of the fifth year. As a result, the $108,890 initially invested is anticipated to produce $201,501, which equates to a MIRR of 13.10%.

Figure 1

Capital accumulation is newer, developed in the 1980s. While the basic premise is the same as MIRR, the concept is more specific to a real estate investor and introduces a few twists. A primary difference is the treatment of negative cash flows. MIRR eliminates future anticipated deficits by setting aside the additional capital necessary upfront, at time period 0. Capital accumulation discounts negative cash flows back one year at a time, offsetting it against any positive cash flows produced in the preceding year(s) until the deficit is eliminated. This is done at a “safe rate,” which represents the rate of a secondary investment that can confidently be achieved. After eliminating any negative cash flows, the remaining positive cash flows produced by the primary investment are assumed to be reinvested at rate representative of an investment alter- native readily available to the investor. But rather than compounding the positive cash flows produced each year to a corresponding future value at the end of the time horizon, capital accumulation only compounds each annual cash flow forward to the following year. This is added to any cash flow expected to be released in that following year and then the entire sum is again compounded forward one year. A second, related nuance is that capital accumulation can have multiple, or tiered, reinvestment rates. A higher reinvestment rate may be available as specific dollar thresholds are met. This acknowledges a premium in return as a result of the aggregate amount being reinvested. This kicker is a concept similar to “jumbo CDs” of years past. By compounding cash flows one year at a time, the opportunity to exceed any established thresholds can be realized. This acknowledges a premium in return as a result of the aggregate amount being reinvested. This kicker is a concept similar to “jumbo CDs” of years past. By compounding cash flows one year at a time, the opportunity to exceed any established thresholds can be realized.

Figure 2 illustrates an investment with the same series of cash flows but utilizing the capital accumulation approach, with a tiered reinvestment assumption of 8% for positive cash flows up to $50,000 and 9% thereafter as well as 4% safe rate for negative cash flows. Note the differences in handling of both positive and negative cash flows as compared to Figure 1. Capital accumulation uses periodic positive cash flow in year two to offset the discounted shortfall from year three. It then compounds the remaining positive cash flows one year at a time, which allows it to take advantage of the higher 9% return as a result of exceeding the $50,000 threshold in year four.

These subtle nuances have a significant cumulative impact on the results; the $100,000 initially invested is anticipated to produce $190,077 by the end of year five, resulting in a capital growth rate (CGR) of 13.71%.

AFX slot car racing has several similarities to MIRR. Both are more established and set a standard in their respective worlds. Both have a wide following. And both take a more conservative approach. Tyco and capital accumulation also have several similarities. Both are upstarts and offer some twists to their more established counterparts. Both have a niche following. And both take a more unconventional approach. By understanding these nuances and choosing the path that best fits your needs, you will be in a better position to end up in the winner’s circle.

What I C @ PVC                

STILL HOT Investment sales, particularly industrial warehouse product, continues to achieve record pricing. Last month, a 125,000-square- foot facility in Middleburg Heights sold for $13.7 million or $109 per square foot. This is the 12th industrial investment sale to break the $100 per square foot mark this year. –AP

From December 2022, Properties Magazine

DEAD IN THE WATER

Joseph Hauman

Do you know where the saying dead in the water comes from? It was originally used to refer to a boat that was stuck out at sea with no wind. No wind means no movement and as you could imagine, no movement is not good for a boat in a large body of water. Over the last 2 years, people have been telling me that the office market in Cleveland is “dead in the water” as everyone from your nephew’s Lemonade stand to Google decide if they need more space or if they even want any space. To be honest with you I believed it for a little bit too. I thought there is no wind in the sails of the office market in Cleveland, but then I allowed myself to take a real look at the industry.

Sailboats are great but they need something to push them. A tide, current, or wind is needed to make a boat with no motor move. I believe that office rents in the Cleveland Market have stayed stagnant because they have been the tide, current, or wind in the sails of our largely vacant office market.  What do I mean by that? Owners in Cleveland often think that they are in competition with each other. They attract tenants to their buildings by offering a low price, free rent, and higher tenant improvement allowances than what they view are their competitor’s. That, in turn, makes other owners lower their prices and it becomes a price war at its most basic level. For years, that has been the reason why the office market continued to truck along with very few new buildings and stagnated rent growth. Lower prices and increasing free rent packages were the slow wind that was pushing the sails of a fundamentally broken office market.

Why are low prices so bad in an office market? The answer is they aren’t when they can be controlled and used to attract quality businesses that will help the area grow. That, however, is not the situation that the Cleveland office market is in. We are in a vicious cycle of rent reduction to attract businesses that don’t choose Cleveland because of the lack of amenities, in both buildings and the city, and because they don’t choose Cleveland both the owner and city miss out on valuable tax and rental income that could be used to pay for new amenities to attract new businesses. This is the reason why the Cleveland office market is “Dead in the water”.

Nobody cared about this issue until the past two years when work from home skyrocketed and tenants didn’t care how much you reduced their rent; they just wanted out. It was no longer a price war because price mattered very little anymore. It became an agent’s job to keep tenants from bull rushing out of a building. Any wind that was ever present, was lost. No hope, right? Wrong.    

Going back to what I had said earlier when technology advanced we learned that we could put an engine on a boat and we had no more need for the wind to propel us. The wind and the sail didn’t matter anymore because the fundamental idea of a boat changed. It was no longer difficult to maneuver, slow, or relied on something totally out of one’s control. Instead, a boat became fun, attractive, and a sign of success for most. Office buildings need a motor. The entire idea of an office building needs to be changed. Low rent and new paint aren’t enough anymore. You need a space that makes people want to come to work. If your building doesn’t do that, then you need to take a hard look at the future success and viability of that building. If you are a landlord you must know your effective vacancy on any building you own. I don’t mean how many people you are getting checks from every month or the number of available square feet you tell your broker to put on the flyer. I mean how many people are coming in and using your space on a DAILY basis? If you have amazing tenants that don’t want that stuff then, congratulations, you have won the jackpot. If you have large amounts of vacant space and are wondering how to change it, then hold on because I’m going to tell you.

ASK AND YOU SHALL RECEIVE

I know most office buildings or parks are purchased as a semi-passive investment which is great and I fully support it, but if you have a high vacancy you need to get a broker, or property manager or go yourself to each tenant and ask what they are looking for. Ask what your building lacks and where it could be improved. If you have current amenities in the building ask if they use them and how often. If you have someone that works in an amenity like a dry cleaner, food service, or gym, ask them how often people come through and what sort of mood they are in when they come in. If you have services in the building you need to find out if people are using them because the service is good or if it’s convenient. If tenants are using it out of convenience then that’s great, but it’s not enough to keep them there at your building. The true testament to the amenities that you provide should be if a tenant leaves and still comes back to your building to use your amenities. Obviously, not all amenities are offered to people that are not tenants, but ones that are, such as an open cafeteria or dry-cleaning service should be good tests. If you ask tenants for their opinion make sure they are valued and listened to. Asking them questions only to do nothing in hopes that they will stay is going to do you no good. If you want to have a low vacancy you need to get things in the building that people want. Let the ideas flow. Everything from a VR gaming setup, driving simulator, or golf simulator might be options that are relatively inexpensive in comparison to renovating a cafeteria or building out a new gym. Take the answers to the questions that you get from your tenants and mix them with your ideas and see if it’s possible. Maybe call me and let me come take a look and allow me to give you my opinion.

If your building represents a sailboat that is quickly or slowly losing wind then pull it out of the water and put an engine on that sucker because if you don’t make a change soon your boat will be dead in the office market water. 

Have something to say? Great, I would love to hear it. Shoot me an email at Joe.Hauman@NAIPVC.com or give me a call 440-591-3723.

Second Period

Alec J. Pacella

Last month, we went back to school and discussed some useful financial calculations incorporated within Microsoft Excel formulas. This month, we are going to continue the school day and, along the way, weave in the theme of renovation being covered throughout this issue of Properties. Both fit perfectly for me; I teach a course at the University of Denver and just finished writing a question for the midterm exam, as follows:

An investor is contemplating installing an automated ticketing system in their parking garage. If continued to be operated with a manned attendant, the garage is expected to produce $100,000 next year and anticipated to grow $2,500 annually in subsequent years as a result of planned increases in the parking rate. The reversion value at the end of five years is expected to be $1,200,000.

The automated system is anticipated to cost $250,000 but income will increase to $125,000 in the first year, as a result of no longer needing an attendant and thus realizing lower expenses. Annual increases are projected to remain the same, $2,500 per year, and the reversion value at the end of five years is expected to be $1,500,000, based on the higher income level.

Using a discount rate of 10%, which alternative should the investor choose?

This is a classic renovation analysis – should the investor keep on keeping on, as-is, and not incur the upfront expense which will result in lower annual cash flows and lower reversion. Or should the renovation be completed, which will result in a significant upfront expense but higher annual cash flow and higher reversion. Who’s ready to go back to school?

We are going to use a three-step approach to solve this problem, dragging in our old friend the CCIM T-bar to help. The first step is to model the cash flows associated with doing nothing. The present value (PV) component would be zero, as no initial money is being spent. The payment (PMT) component would start at $100,000 in the first year and increase $2,500 each subsequent year of the holding period. And the future value (FV) would be $1,200,000. Figure 1 represents the T-bar for these cash flows. The second step is to model the cash flows associated with making the renovation. The PV component would be ($250,000), reflecting the cost of installing the automation system. The PMT component would start at $125,000 in the first year and increase $2,500 each subsequent year of the holding period.

And the FV would be $1,500,000, which is the anticipated value of the garage at the end of the holding period. Figure 2 represents the T-bar for these cash flows.

The third step is to calculate the net present value (NPV) of each T-bar, using the 10% target rate. You’ll need a financial calculator to perform this function (unless you were paying attention to last month’s column). Once completed, you will discover the “as-is” scenario has a NPV of $1,141,339 while the “renovate” scenario has a NPV of $1,172,385. At this point, the decision is simple; based on the assumptions provided, it is worth it to pursue the renovation.

We are not done yet – the university students also have a related bonus question, so why shouldn’t you? We can take this analysis one step further by using a concept known as “IRR of the differential.” Calculating it is straightforward and is the IRR of the difference between the renovated series of cash flows less the as-is series of cash flows. As you can see in Figure 3, the PV of ($250,000) is found by subtracting the PV of the renovated T-bar (Figure 2) minus the as-is T-bar (Figure 1). The PMT in year one in Figure 3 is found by subtracting the year one PMT of the renovated T-bar minus the as-is T-bar. Lather, rinse, repeat for the cash flows in years two through five and the reversions. Plug these into a financial calculator (unless, again, you were paying attention to last month’s column) and we come up with an IRR of the differential of 13.08%.

But the bonus question on this insidious mid-term exam doesn’t ask for the IRR of the differential. C’mon, these are graduate students! It asks what this concept means – because to me, this is the most important number on the board. And I’ll save you the grief. From a purely mathematical perspective, 13.08% is the exact rate at which the NPV of the as-is scenario and the NPV of the renovate $1,500,000, which is the anticipated value of the garage at the end of the holding period. Figure 2 represents the T-bar for these cash flows.

scenario are equal. You are welcome to try it but, trust me, you will come up with an NPV of $1,015,465-ish for either scenario if you use a discount rate of 13.08%. But mathematics doesn’t pay the bills, understanding the practical application is what’s important. The 13.08% discount rate is considered the point of indifference or cross-over point. At that exact rate, there is no difference between the as-is and the renovate scenario. They are equivalent decisions. But at any rate less than 13.08%, the decision swings to the renovate scenario and the lower the rate, the more pronounced the renovate decision becomes. Conversely, at any discount rate greater than 13.08%, the decision swings to the as-is scenario and the higher the rate, the more pronounced the as-is decision becomes.

Gang, our business is all about under- standing and quantifying risk, and the concept of IRR of the differential is a hallmark example. The break-even risk versus return for this proposed renovation is 13.08%. If you believe the risk associated with this proposed renovation demands a return greater than this point of indifference, you are better off to not spend the money and keep on keeping on. But if you perceive a low degree of risk associated with the renovation, and are good earning a return at some rate less than this break-even rate, you are better off to spend the money. And if you liked second period, just wait to see what we have in store for third period!

by Alec Pacella for Properties Magazine, November 2022