Inflation and Real Estate With Dr. Nick Axford

Foreign this is Real Estate Investing Live from New York with James Nelson, the principal and head of Avis and Young's Tri State Investment Sales Group. In this program you'll learn about the world of commercial real estate and find out why it's one of the largest investment opportunities in New York and around the world. Now here is your host, James Nelson. Welcome to episode number 113 of Real Estate Investing Live from New York. This is your host, James Nelson. I am principal and head of Tri State Investment Sales for Avis and Young. And I have some incredibly exciting news for you all, which is we are going to be changing the name of this show, which will be the name of my upcoming book. Drum roll. The Insider's Edge to Real Estate Investing. And again, I wrote this. I am writing this book with the help of my writing partner, Rachel Hartman. For you. This is going to tell you how to go about and find opportunities, improve opportunities and capitalize on them. And so super, super excited to be doing this the next 10 part series actually with an introduction, we'll make it 11 is is going to be covering each of these steps and I'm gonna have an in depth conversation with Rachel on these topics to make you the best investor possible. Again, this is an insider's game and I'm here to give you that advantage. So stay tuned for that. But when you're looking for the show in weeks to come, don't be confused. If you're looking at real estate Investing live from New York, we are not stopping. We have been growing now for two years strong every week. It's a lot of work, but it's also a lot of fun and I know you all getting a lot of benefit for it. So again, all the links should transfer. But still in the future, if you're looking for the show or spreading the word, please let everyone know that it will now be the insider's edge to real estate investing. So for our last show ever as Real Estate Investing Live from New York, really, really thrilled to have back with us Nick Axford, Avison Young's own Nick Axford, who is our global head of Insight. Nick is brilliant. He understands all the macro trends of what makes our market go. And it's so important to understand the fundamentals, but also what are the driving forces in the market. And today we're going to be talking about a topic at the top of everybody's mind, which is inflation. And the old saying has always been that real estate being a hard asset is a great inflation hedge. So we're going to be talking about that today along with a bunch of other super important topics to make you as educated as possible moving forward. So we're going to have a quick break from our sponsor and then we're going to get right into that interview with Nick. But before I go, please if you have not already subscribe to the show. I so appreciate your comments and your ratings. It helps others find the show and and also make sure and connect with me Jon James Nelson NYC if you have not already. That is my handle for Instagram and LinkedIn where I'm incredibly active and you can also find great content on jamesnelson.com where you can find these shows as well as a lot of other helpful information. So we're gonna have a brief word from that sponsor and we'll get right into that interview with Nick Axford. A different approach to putting our clients first Avis and Young's Tri State Investment Sales Group sells multi family office retail development and specialty sales throughout the New York metro area. As experienced thought leaders in their industry, our 35 member group is available to help you make informed investment decisions by advising you on your current holdings or identifying new opportunities in the marketplace. Our one unified team is built on an industry unique platform which promotes unparalleled collaboration and and teamwork. We share core values of hard work, integrity and expertise. We put our clients first providing tailor made strategies to achieve superior results. Please Visit us at aytristateinvestmentsales.com and follow us on Twitter LinkedIn and Instagram amesnelsonnyc to learn more. So it's my pleasure to welcome back to the show today Davis and Young's own Nick Axford who is our principal and global Director of Insight, coming to us live from London. So Nick, thank you as always for joining us. We've had such incredible conversations in the past and we need your insight now more than ever.

Pleasure. Delighted to be back with you James. Always great fun. So looking forward to the conversation.

Wonderful. So we're going to be talking a lot. In fact it is the topic of the show, inflation and real estate and your group did an incredible report here and I just, I want to read the introduction. I rarely do this but it just, it really sets the stage for what's taking place today. So really want our our listeners to get the background here but I really hope that they do go and find this report. And Nick, please remind our audience the best way to find your insight and resources. Where can they find this report that we're going to be referring to the.

Best way is if you go to our global website, www.avisonyoung.com. it'll either be on the slider on the front. The report's called Inflation Real Estate, or if you go to the thought leadership and the sight lines section, then you can find not only that report, but a whole load of other interesting things about the world of real estate that I'm sure your listeners will enjoy digging into.

Wonderful. And I know this is definitely front and center and it is on as we speak to our clients, investors from around the world. It certainly one of the hot topics right now. So just to give the background, you began the report by saying at the tail end of 2019, as the first signs of disease were emerging in parts of China, most developed economies were focused on driving growth and tackling the threat of deflation. Interest rates remained at historic lows, in some cases in negative territory. If anything, higher inflation was seen as a target rather than a threat. Fast forward two years and the situation is very different. Supply chain disruptions, labor shortages and energy price hikes have all contributed to a sharp increase in inflation. Debate rages about the extent to which this increase is a temporary hangover from the pandemic. But in recent months, central banks on both sides of the Atlantic have become significantly more hawkish. Monetary stimulus has been reduced and interest rates are either already moving up or are already expected to start doing so. So, Nick, I mean, so succinctly put and wow. I mean, if anything, I would say that when you said that two years later, the situation is very different. I mean, this really seems in many ways that the world has been turned upside down here. But I think for us to understand where we got here, what's interesting to me, and I've only been in the business for 25 years and I have never seen, I mean, I think there's few of us who've seen this phenomenon, but this stagflation, I mean, this goes back to the 1970s. Right. Where we've been in this last cycle. So maybe you could explain why things have been so slow and steady for decades. And what was the impetus? I assume it was more than just Covid that has created the situation in this environment that we're in today.

Yeah, sure. And great intro, by the way. It sounded much better when you read it than it did when I wrote it. I'm going to get you to do the audiobook version of all my reports in future. That's fantastic. Yeah. I mean, if you think back, it seems impossible now to even sort of really Remember it for most of us, but back in the 1970s, we had a point when inflation in the US had reached 15%. In the UK it would hit nearly 20% in the 70s and early 80s. So that's far, far higher than anything we're seeing at the moment, up around 8%. But at the same time, the levels that we're seeing now are kind of unprecedented in terms of our recent memory. And if you, if you think back to the 1970s, what was happening with changes in policy, exchange rates starting to float freely, which was having a big impact on international trade, it was having a big impact on the levels of imported inflation. And crucially, we then had the oil shocks of the 1970s. And what happened was that we got into an environment with what was called a wage price spiral, where the supply shock that came in, that pushed up prices, that fed through into squeezing margins for companies who then put their prices up, that led workers to say, right, well, we need higher levels of wages, so that pushes business prices up and business costs up again, so that pushes wages up again. So we ended up in this very unproductive environment where the economy wasn't growing, but costs and prices were going up very, very rapidly. So that needed to be tackled. And so we saw interest rates then being pushed up in the UK, they hit 17%. The Fed's reserve policy rate hit 19% in 1980. So really, really dramatic action needed in order to contain inflation. But since then we've had a period that basically from the early 1980s became known as the Great Moderation. And a combination of banks really setting out to target in central banks setting out to target inflation, but particularly a whole load of changes going on in the world. We saw very, very rapid globalization through the 1970s into the 1980s onwards. So we saw the creation of a lot of trade blocks. We saw real integration of countries into the global economy, lots of exporting of manufacturing to lower cost countries, which was helping to bring prices down. We'd also got a lot of practical things around global trade. So growth in technology enabling sort of better communications to make it much easier to construct these sort of global production lines. We've seen sort of the rapid growth of containerization, just making it much, much cheaper to move goods around. So all of that started to bring down the cost of production. We've also generally seen a big change in the way labor markets work. Always less regulated in the US than they were in many other parts of the world. But generally we've seen a real deregulation of restrictive practices. We've seen fewer, far lower levels of unionization. Employment law has been deregulated. Labor has been able to move around a lot more. So all of these things tending to come together. And then lastly, of course, we've had the real impact of technology through the gig economy through people with mobile phones and laptops making cost comparison much, much easier. So all of those things have come together to firstly, make it far harder for anybody to raise prices in the first and secondly, make it far harder for labor, for workers to press the claims for higher levels of wages. So as a result, we ended up with this persistent low level of inflation that's now existed really since, for about 40 years, since the early 1980s.

Wonderful. That's incredibly helpful background and I think, just to clarify for our audience, maybe it'll be helpful because, I mean, it would seem based on what you said, this is a global phenomenon. And yet, yes, in your report you're talking about what's going on in the uk, the us, Canada, so our countries moving lockstep barrel. Has it been pretty uniform around the world?

Yeah, I mean, we still see sort of, you know, isolated, have seen isolated periods where inflation's tended to go up. But yeah, absolutely. Generally this and a variety of other factors have combined to mean that generally inflation's been pretty low, interest rates have been very low right the way around the world for certainly in all of the developed economies for most of that period. And so the exception, you know, the shock has come through in, in recent years as we came out of COVID where obviously we had a very, very sharp downturn. We had lots of people either being permanently laid off or choosing to leave the workforce or in many countries we saw them being sort of furloughed so put onto sort of government schemes to sort of put their jobs into suspension. But the key is that, you know, that for 12, 18 months we had the economy not quite grinding to a halt, but as close as it's ever got to doing so. And that did take a lot of productive capacity out of the system. Some of those companies kind of collapsed and have never been able to come back. And in many cases those companies are sort of cogs in the machine of other companies. You know, when, when suddenly you come back because your customers have come back, but you find two or three of your key suppliers have, have gone bust. It takes time to rebuild that capacity. There's also, you know, just sort of, you know, basic stuff like if all the ships in the world and all of the containers in the world stop moving around on the timetable and the plan that they've been on and they will sit in port for six, nine months when things start moving again. Everything's in the wrong place. And people who are producing, who couldn't get goods moved out were storing them in containers stacked up in their car parks and those containers can't then go out and be used to move goods around. So there's lots of real hard nosed practical stuff around getting the global economy moving again. That started to happen. But clearly with the sort of the on off nature of COVID around the world and the sort of the gaps that there are in labor markets, that's really what started driving inflation up and causing costs to start rising.

So it's a great segue to talk about where we are now and the outlook. And so you've already begun to talk about why the rise. I mean, I would characterize this as a spike. I mean, I've got to imagine this is pretty unprecedented. So I think you've already alluded to some of the reasons. But I think a lot of our listeners are curious, is it going to continue at this level? Is it going to settle? If so, when is it going to settle?

Yeah, that's right. I mean generally and certainly if you were listening to central bankers and economists late last year, the word was transitory. We knew that inflation had gone up, but the view was that as soon as all the containers and the ships get unloaded and stuff starts moving again and people get back to work, then it's all going to subside. And that has proved to not be the case for various reasons. Firstly, it's just taken longer for us to get back to normal for those sort of supply chain blockages to unblock. Secondly, Covid keeps popping its head above the parapet. We're coming to terms with it in the west, but in China and other Asian countries that are key parts of that global production and supply chains, you know, they haven't got such high levels of vaccinations. They're still pursuing a zero Covid type policy which means that they keep shutting down parts of the country or parts of the economy. So that's causing problems. And then of course, you know, more latterly we've had the up spike in energy costs for various reasons. And that's been hugely exacerbated of course by the tragic events in Ukraine, which, you know, generally are not likely to be very significant. For most Western economies they're impacting Germany, but for most Western economies they're not making as big an impact. But they are definitely contributing to inflation because Ukraine and particularly Russia, obviously massive exporters of energy, particularly in terms of oil and gas. Ukraine is a major, major exporter of grain and a number of important sort of precious metals and other commodities. And so those are all being disrupted now. That's going to have some positive effects. If you look north of the border from where you are, James, up at Canada, the terms of trade for a lot of Canadian industries are actually improving very rapidly. That's going to give big stimulus to the Canadian economy. But generally, you know, we've seen very, very sharply elevated energy prices, big increases coming down the line in grain and various foodstuffs. And that is going to feed through into what was already an elevated inflationary environment. And the concern is firstly that that is going to start raising prices everywhere. Because if energy costs go up, every business that uses energy sees its costs go up and eventually that just feeds through into rising prices everywhere. The big concern and the thing that we're watching very carefully is what happens to wages and labor costs, because that's where the nasty element of are we back in the 1970s again? That's where people are being worried. Because if this starts feeding through into more significantly elevated wage settlements, then you could start seeing that sort of kickstart of the inflationary spiral. And Ben Bernanke said that over the long term, the one key thing behind the subdued level of inflation and thus interest rates over the last 40 years has been the low level of interest rates, the so called anchoring of expectations. Because we believe that Ben Benche and his successors, we're always going to jump in and stamp on inflation because we believe that inflation is always going to be targeted and moderated. We don't suddenly expect to see a huge pay rise just because inflation goes up a bit, because we know inflation is going to come down again. But that's a sort of fragile relationship. So the key thing is to make sure that we don't let inflation take hold because that would then destabilize everybody's sentiment and would lead us back to a period of higher inflation. But that's not our expectation. Most of those things that I talked about as keeping inflation in check are still there. Some of them are changing, some of them are weakening a bit, but they're still there. And therefore we do expect during the remainder of this year that we'll see a peak to the level of inflation. And sometime around the middle of the year, maybe late summer, we hope it'll start tailing down. It'll definitely be heading south by the Time we get to the end of the year and we expect inflation then to continue to moderate as we come through 2023.

Wonderful. Well, I know you've definitely made some predictions there in the report, and if I'm not mistaken, I think not only did you say it was going to settle hopefully by the end of this year, but your inflation targets were a little bit higher than maybe elsewhere reported. So maybe talk about kind of the methodology and how you came to your numbers. I think it was a high 2%, and right now we're seeing more in the 6, 7% range. Is that.

Yeah, I mean, we've got inflation very high at the moment, but bear in mind that there's, I mean, there's a big denominator effect in this, which is that inflation is all about where our price is now relative to where they were at the same point last year. So at the moment you're comparing prices in this April with prices in April last year. Well, at that stage, not only we've not had Ukraine, energy prices were lower, Inflation hadn't really started to kick off to anything like the same extent. The economy wasn't really picking up. So you're comparing a high level now post this sort of uptick with a low level once you get through to, say, September, a load of those price increases have happened by then, so they're baked in. So you're comparing high prices now with high prices then. But the rate of inflation is naturally going to subside, coupled with the fact that as prices go up, you know, those of us who are maybe not seeing our wages going up as much, there's a bit of a squeeze on income. So we expect the economy to slow a little bit as well. But generally our expectation is that the rate of inflation is going to start moderating and should be back down towards heading towards the government's targets of around 2%, sort of, as we come into sort of the middle part of next year, it'd be on a downward trajectory to that point. So hopefully that's going to mean that interest rates, they'll have to go up and we're expecting several rate rises during the remainder of this year, but hopefully they'll be kept in check and we won't have to see the very high levels of interest rates that we've seen at some points in the past and certainly nowhere near what we've seen back in the distant past.

So I would love if you could talk a little bit about the correlation between inflation and interest rates and how that works.

Yeah, I've Been getting lots of questions about this because obviously we think we know what's going to happen to inflation, but we might be wrong. And so a lot of people are saying, well, this has got to be good for real estate, hasn't it? Because real estate is a good inflation hedge, isn't it? So in the report we spend a lot of time looking at what the relationship looks like and important to say when we use the term hedge to say sort of something to protect against inflation. Technically a hedge is something that moves at the same time and in the same proportion. So it completely protects you from the impacts of whatever it is you're hedging against. So in this case, a true hedge would mean that property values would move up and down sort of directly in line with inflation. But I think in practice what people mean is does real estate do relatively well? Does real estate help to protect us from inflation? Now in theory you would expect that real estate, particularly real estate income, should provide you with a pretty good protection against inflation. Because you know, real estate is just one business cost. In an environment where costs are rising, whether that's labor, goods, raw materials, whatever, all other things being equal, you'd expect the price of property to be going up as well. And of course the price of property is the rent, typically. So, you know, that would suggest that generally you'd expect there to be some protection. I mean, clearly it does depend on the lease terms. So what does the lease say about how often the rent gets marked to market? I mean, obviously if you've got indexation or some sort of fixed uplifts, then you've got some protection in there against potential inflation. But it does also depend on supply and demand in the market. Because no matter what inflation's doing, then if you've got an oversupplied market with plenty of space around, then the rent ain't going up. That's Economics 101. So I think it's overly simplistic to say that real estate is good in times of inflation generally. It's also important to think about what's the type of inflation that we're talking about. If it's so called demand pull inflation, where you've got really strong economy, the demand is running ahead of supply, whether that's for labor or goods or, or property or anything else. That sort of strong economy, you would expect strong demand for real estate and then you'd expect real estate to perform pretty well where you've got cost push inflation. So sort of costs are just going up and pushing up the rate of Inflation, and that's really what we're seeing now, that's a slightly different thing because that doesn't give anybody any particular benefit. And therefore in those situations, arguably you could see weaker levels of demand. And so real estate might perform sort of pretty poorly.

What I love about your report is that you're not tainting the entire real estate market with one brush, because a huge consideration here is obviously what type of asset you're buying, where you're buying it, and then what's your business plan? Are you a short term holder, are you a long term holder? So maybe we could kind of talk about each of the major asset classes and would love to get your observations on inflation's impact on that sector. So let's start with multifamily.

Yeah, I mean, sort of. So sort of residential, typically. I mean, that's an environment where you really would expect, you know, typically you've got relatively short leases, you've got an ability to mark to market, you know, as and when you get turnover of people coming through the units and so residential. Given that again, historically wages and inflation rates tend to be fairly closely tied and wages are pretty key to the ability to pay residential rents there, you would expect there to be a pretty good relationship. Retail is another area where obviously inflation tends to reflect the rising price of goods. And so you would expect retail turnover and retail revenue, not necessarily profits, but revenue, to be going up so that retail will also sort of. Retail rents would also, under normal circumstances keep pace when inflation, office and industrial, depends very much more what type of inflation we get. But those are probably two good examples. I mean, retail in particular a good example. It very much depends on what the dynamics of the market are. There's not many places where we're seeing retail rents going up at the moment, no matter what inflation's doing. And from the analysis we've done, actually incomes, the income side of real estate, does correlate reasonably well with inflation, particularly when inflation is stronger. Rents generally do tend to perform reasonably well, but of course, from an investment point of view, it's not just about what your rent's doing, it's about the total return. And when we look at total returns, that's where we really see the difference, depending on what different types of inflation we've got. So the correlations between real estate performance in total return terms, if you look at the uk, it's negative. If you look at the us it's virtually zero. Almost no correlation. In Canada there is, but really the relationship is pretty weak. And if you then Turn and say, okay, so what is driving that relationship? Actually the correlation between real estate returns in those markets and GDP growth are much, much stronger. And that's the key. It's back to my point about cost push versus demand pull inflation. If you've got a strong economy with strong demand growth, then real estate does well. And if you've got a weak economy and weak growth, real estate doesn't do as well. And that's really the key. And what inflation doing is doing has some impact, but not really at the total return level.

Perfect. And how about the holding periods? So how does timeframe impact your opinion? So office and you alluded to it, leases are longer term, obviously multifamily turning over yearly. But how do you think about real estate as an inflation hedge relative to the holding period?

Yeah, that's a really good point, James. I mean, because actually most real estate investors aren't necessarily looking for a true hedge. They don't need it to move up and down year on year exactly in line with inflation. What we mean is, does real estate provide some protection against inflation? Particularly people generally mean capital value protection and particularly over the longer term. And there the news is actually pretty positive. Look at the UK market where we've got some nice long run time series data and the correlation gets up to about 0.75. One is a perfect positive correlation. So the two are sort of absolutely in lockstep. Zero is there is no relationship at all. Over a 10 year period, on average, the correlation between real estate and inflation is 0.75. Over a 17 year period it's above 0.9, which is extraordinarily close. So the message there is that over the longer term, if you're prepared to hold, real estate does deliver very good levels of capital value capital preservation. Now compared to something like equities, the equivalent correlation over 10 years, real estate's 0.75. Equity markets 0.36. So much, much lower equity returns are typically higher because you're taking on more risk, you get more volatility, you haven't got the certainty. And that reinforces the point that the part that real estate tends to play in most investor portfolios, it's a good diversifier, it gives you good reliable level returns and it gives you good long term capital value preservation. And it doesn't perform quite as strongly as equities over many periods. But if you look at all the various hold periods across different markets, typically if you hold real estate for five years, then in the vast majority, certainly 75% of all five year periods at least. And in many sectors it's higher, you get a positive real return so your assets will outperform inflation if you hold for eight years, then in all bar a couple of sectors you get a positive real return after allowing for inflation pretty much over any eight year period that we look back at. So real estate does very well in giving some protection against inflation, although it doesn't necessarily massively outperform.

So we had a really interesting conversation yesterday with our debt equity team and our investment sales group and talking about the impact of inflation, rising rates and what that's doing. Specifically we were talking about multifamily and cap rates. Right. So here if you look at where you could borrow five, seven year money 30, 60 days ago to today, in many cases there's been 50 to 75 bips of movement and buyers, and yes, they'll be the first ones to point this out and they'll say as a result I need a greater yield. And so the question is, is this going to put upwards pressure on cap rates but just to simplify valuation to the two basic levers, yes, you've got a cap rate and that rate of return that investors are going to require, but you also have, you have to look at rental growth and at least here in New York and I'm sure you've seen the same thing in London, I mean there has been exceptional growth in rents and again I'm talking about residential now, in some cases here our rents are higher than pre pandemic levels. So you know, the case I tried to make is yes, interest rates are going up. Yes, that, that might certainly impact the valuation on a longer term core type asset. Right. With long term fixed leases. But in a, for an investment where you have really exceptional rent growth that the hope is that will certainly offset or maybe more than offset these recent interest rate hikes. So I would love to hear your thoughts on.

Yeah, yeah, I mean, I think various points, various good points in there. Firstly, I think the thing to bear in mind is that the current spread between real estate cap rates and government ten year Treasuries, the sort of the benchmark with bonds that we tend to assess against those spreads are at relatively comfortable levels, they're relatively wide and therefore essentially investors have a choice before they start saying that they need to push up the yields they're going to buy at, they can actually accept a lower spread. Something that's a bit more typical of what we've seen in the past. That will very much depend generally on what they think about the prospects for rental growth. And that still tends to vary quite a lot, sector by sector and market by market. But we certainly think a proportion of that uplift in yields in cap rates is going to be absorbed in the spread. Partly, I think that it's the weight of money and it's a question of what other assets are there out there that investors can look at and how attractive are they going to look and how do they look in a, in a higher interest rate environment as well. So I think that there is going to be an element of pressure of money. I think that the, this is certainly going to limit the scope for further downward movement in yields in cap rates in most cases. But, and it's possible that, you know, at the margins, deals that organizations, you know, investors were thinking were maybe a bit marginal before, they may now look a bit more difficult. And frankly, investors, it's difficult finding the right kind of stock out there at the moment. If you've got a good asset, you might be willing to part with it if someone's going to pay you the right price. But if not, you're probably going to sit and hold, particularly through a period of uncertainty. So I think it's possible that we'll see a period of some sort of slightly lower level of transaction activity. And bear in mind that's off the back of around the world, a record level and in the US a record level of transactions last year. So the market slowing down slightly is not surprising. Anyway. My suspicion is that what we'll see is that some deals may not happen and we might see a slightly lower level of transaction activity rather than any material impact on pricing, because I don't see sellers in a position where they're feeling they've got to sell.

Perfect. And we are certainly seeing a tremendous amount of momentum coming out of the fourth quarter of 2021. And we just wrapped up our first quarter numbers for New York City investment sales, and we've once again achieved a quarterly level beyond any quarter's results in 2019. So that was pretty interesting to see. And we've certainly had a lot of demand, so we'll certainly see if that activity continues. So, Nick, I would love to talk a little bit about development as well. I was with a developer client this morning and talking about, you know, how exceptional we're talking residential condos now that luxury pricing has been. And, you know, so in theory, you would think that land prices would be similar to where they were, you know, 2015, 2016, when you had that same level of pricing. And yet the construction Costs, the hard cost, labor costs, again, have been so elevated that to me that that has really been the one disconnect. So how are you viewing, especially with these supply chain issues for developers considering when to begin a project? Is this the kind of thing? Well, hey, if you can wait six months and material prices come down, would they be well suited or what would you say to the developers out there?

Yeah, I mean, I think that that's a tricky one. I mean, clearly, yes, a lot of the prices, the price increases that we're seeing through or seeing coming through our own construction materials, as, you know, as you say, construction costs have gone up significantly. You know, labor is an important component of that, but it's also the hard materials. And I'm not sure that we can guarantee in a matter of the next few months that all of those supply chains are going to be resolved, albeit that, you know, generally we are seeing over, you know, month over month, we are seeing a lot of those supply chains just starting to ease. So I do think that we would expect things to be, to be easier as we go through the summer and into the autumn. I think the, the key is how, as you say, how's that going to play out in terms of levels of construction, levels of construction, land values and rents? Because of course, you know, in an environment where demand is picking up, and of course it depends which sector and which submarine you're looking at, but, but in an environment where the economy is still performing pretty well, where demand's still pretty healthy, if construction margins aren't there and developers decide to just hold off, that starts to constrict supply, that starts to push rents up, and that's the transmission mechanism. There's no direct transmission mechanism between construction costs and rents, but it does come through that supply, demand, balance. If demand can't be met, if there's no new supply coming through, that'll push up rents, that then restores the margins that the developers are going to need. So if the demand's there one way or another, it tends to work through in the system. The difficulty is if you've got a slightly slower level of economy, slower level of growth, then it becomes much harder for developers to justify going ahead spec if they're doing so with squeezed margins.

That's incredibly helpful advice. So I hope our audience here is taking notes. There's a lot of to think about here and I think the takeaway here again is if I go back to what I said earlier, you certainly cannot paint this real estate market with one brush and so on. That Note. And with only a couple minutes left, I'd love to talk about safe havens. So if you're out there and you're listening and you're worried about the implications here, and you mentioned in your report, and we talked about some of the major food groups out there, but you also, you know, when we talk apartments, you also talk about student housing. You know, we haven't even talked about industrial maybe we talk a little bit about self storage, get into health care, you know, let's, let's, let's maybe expand a little bit on where some of the most interesting asset classes might be to play.

Yeah, so if you're looking for places to hide from potentially periods of higher inflation, you need to think about what is it that drives your return and how can you make that sort of immune from the higher costs. So firstly, short term leases, so they've got risk. Again, if it's an environment where you don't see much demand and there's a risk suddenly of getting vacancy, then that's a bad thing. But if we've got a reasonably healthy level of demand and rising prices, what you want are leases that allow you to mark the market frequently. So shorter term leases, that means you can relay at the new level of rent to capture that growth. Conversely, if you've got longer term leases, any assets that are longer term but with indexed rents, so they've got rents that are explicitly linked to some measure of cost or inflation. If you can get hold of that, then obviously that's wonderful. Particularly if you're concerned that growth might not be as quite as strong. Think about the market dynamics. Think about, you know, you mentioned the apartment market, James, but also student housing, very strong at the moment and you know, robust, reliable, high turnover demand that doesn't tend to be particularly sensitive to the economic cycle. Self storage again tends to be slightly countercyclical. If people are moving into sort of smaller rented accommodation or downsizing or whatever, they tend to make a lot of use of self storage. Healthcare, for obvious reasons is a big focus at the moment. And anything that's going through that sort of structural trend, structural change where you're not as dependent on the cycle, you know, so called beds and sheds, life sciences, a lot of those are well worth looking at at the moment. And also, you know, essential retail because you know, food stores and things like that, whatever else is going on, people tend to eat, need to eat. If the price of food goes up, they have to pay it. So therefore the rents and the, you know, the robust level of food Store, retail can be a good place to hide. So all of those can offer you relatively more protection, other assets.

And not to stop you, but I want to point out something very important you said in the middle of that, which I'm sure our listeners should be taking note of. I would be shocked if from now on in every single lease moving forward that there is a CPI index attached to it because anyone who kind of fixed in a rent with set increases might be having a little bit of a challenge. But conversely, I wonder if tenants now are going to say, you know what, I'm not going to take the risk of a CPI index, so it should be interesting to see how that plays out. But I'm sure that'll be a heavily negotiated lease provision moving forward.

Yeah, I mean, you know, bear in mind that there are equally times when, if you've got a CPI index lease at a time when you're in a market where market rental growth is really strong and you're sitting there just paying, you know, 1.2, 1.5% increases because you know, the Fed's doing it job inflation low, you've, you know, you came out on the winning end. And if you're, you know, people tend to want to try and match their liabilities, don't they? So if you, if you've got the kind of business that's reasonably well protected from an inflation point of view, if your income tends to go up at a time inflation goes up, then you can afford that trade off. So it'll depend.

So my clients only on the landlord side, certainly only like the three words the greater of. So that might be one way to manage that, get the most absolute best of both worlds. So, you know, the last thing I want to end on, Nick, is this flight to quality. And we've certainly seen it here in New York, you know, you know, we could do a whole nother show on the office market demand drivers there. But what, what is really performing is best in class. And you know, that's not only assets. And I'd love for you to maybe speak a little bit about ESG because it's such an important initiative that our firm is fully behind. But also maybe we could talk a little about geography as well. So is it the belief in times like these that best in class will be the best performer generally?

Yes, I think that is true that we're certainly core assets. The returns typically are driven more by income than by capital appreciation. And as we've seen, income tends to be better protected than the total return where you're starting to get involved in what's happening to cap rates over the shorter term so your income can be protected. The cap rate will look after itself over the longer term. ESG really important. We're certainly seeing from both an investor and an occupier point of view. And this is something that we've put out quite a lot of research on elsewhere. Both investors and occupiers now really focused on ESG compliant economic, social and environmental, social and governance issues. So from a real estate point of view that's particularly around energy efficient buildings, LEED and you know, and other types of buildings that are and Briam graded top graded buildings that are energy efficient, that obviously has both a direct financial advantage if you're energy efficient at the moment given the cost of energy, but also a big reputational advantage. And organizations increasingly measuring, monitoring and reporting on their carbon footprint. So that's becoming an increasingly important factor. So for both owners and occupiers, absolutely focus on that better environmentally friendly stock.

Wonderful. And Nick, I know we are going to do another series. We want to give ESG it's proper time. So as always we so much appreciate your insight, especially in times like these which are clearly unprecedented. So just want to thank you so much for your research and sharing your thoughts with our audience.

No problem at all. As ever, great speaking to you James. Great fun. Always, always happy to come back. Plenty of other topics that we can cover.

Wonderful. This is your host, James Nelson of Real Estate Investing Live from New York. I want to thank you as always for listening and sharing this show with our audience and friends. Please make sure to subscribe if you have not already and I really appreciate your comments. That's how we spread the word. And lastly, if you have not connected with me yet, please do so at James Nelson NYC. Connect with me on LinkedIn, Instagram, Twitter. These are the ways I love fielding your questions and helping give you the insider's edge to real estate investing. Until next week, thank you thank you for tuning in this week to Real Estate Investing Live from New York. Please join your host James Nelson for another program next Tuesday at 7pm in New York, 4pm Pacific Time on the Voice America Business Channel. All shows are rebroadcast on Wednesday mornings at 7am Eastern Eastern Time and 4am Pacific Time as well as always on Demand. We'll talk again next week.