James Cameron
The Opportunity Zone Expo Podcast
Real Capital Analytics Provides Real Time Pricing Answers
Transcription
Jack: Welcome back everybody to the OZExpo Podcast. I am your host, Jack Heald. Joining me today is Jim Costello with Real Capital Analytics. Jim, welcome to the show.
Jim: Thanks for having me.
Jack: It's good to have you. So, we always start this way. I want to find out who it is I'm talking to. So, tell us about yourself. Who is Jim Costello? Where'd you come from? How'd you get here and why should we listen to you?
Jim: Sure. That's a pretty open ended. I'm an economist and you know, my company has a whole bunch of data on commercial real estate performance in terms of the sale prices and loan information. So for me right now I'm like a kid in the candy store as an economist, I love data, I love playing with data, finding unique trends and I'm sitting on top of one of the biggest databases of commercial property information in the world. So, for me, this is just a fun place to be.
And I kind of came to this world, I had been working at CBRE kind of in the corporate world for a number of years. So the current company I'm at is privately owned. But CBRE I was working with the research people, a professor Wheaton at MIT, Professor Turow who's at Harvard and they had a research group Wheaton research. And I've worked with them. And before that I grew up in Chicago. So in some ways I've always lived in these cold northern cities. Kind of need to move someplace south at some point to someplace warm.
Jack: You should come to Phoenix. We're going to hit a hundred today.
Jim: Well, certainly in winter. In winter I go down a lot. My parents live in Tucson. There's snowbirds and I love it in winter. Summers I don't think I could deal with.
Jack: Yeah, it is absolute paradise from about November through April. It really is. So you went to the University of Illinois at Chicago. That's not the Champagne Campus.
Jim: No, although I spent some time on the Champagne Campus, but you know, to any University of Illinois facility you could use, and I would go back and forth for a couple of reasons. One. There were a few things in the economics world that could get at Champagne. This is in the days before Internet was a research tool. So those of you had to spend a little bit more time in the library. The other thing is that I had to do…
Jack: What is this? What is this library thing you're talking about?
Jim: Yeah. How about it? How about it? Although, there's still a lot of good information that hasn't been digitized yet. In fact, at MIT, I was running into some stacks just a couple of years ago and found a report from an economist written in the 1920s looking at the office market.
Jack: Wow.
Jim: And just talking about, you know, the pace of construction, how the economy that had been going and it was, you know, the approaches were things that someone might be doing in a brokerage market report today. So what's old is new again, but University of Illinois, Chicago, the one thing that is really good about the programs there, they have a very good urban planning school.
Jack: Oh.
Jim: So, the economic stuff that I was studying was related to urban planning. I had originally thought I was going to go in urban planning. I had been working for an urban plan or urban development agency in the suburbs in Du Page County in Illinois after college. And I thought that I might want to become an urban planner, but I migrated more toward the economic stuff simply because I really realized that I had more of an affinity for data and playing with data than for the design elements. And so, it was more of a natural fit.
And at the time, there weren't programs, like if I was starting today to do the stuff that I was interested in then I would probably migrate more towards data sciences. You know, that there's more programs like that as a field of study. It just wasn't around as much. But did you know the other thing with the University of Illinois, I was an undergrad at the University of Chicago and I had a few friends from college who went down to University of Illinois at Chapin in Champagne, Urbana. And so that was also sort of the other thing was drawing me down there. It's just seeing old friends…
Jack: So, urban planning would actually dovetail pretty nicely into what's going on these days with the Opportunity Zone. I don't know how much you've got your fingers in urban planning end of it with the data that you work with now. But I was just pondering the opportunities for urban planning with Opportunity Zone program just last night as I was thinking about our conversation this morning.
Jim: Yeah, it's funny as things kind of come around, I am more interested now in urban planning than I had been when I was working at an urban planning outfit, I think part of it was just the geography of where I was working at the time. I love the people I work with. Du Page County outside of Chicago. There's a lot of good stuff to say for it, but it didn't hold my interest at the time, partly because it was greenfield development, putting highways in a building, big suburban office campuses, residential subdivisions. It's not the kind of stuff that seemed exciting to a young man in his twenties. You know, there's a reason you want to go into the cities when you're 20. And, so it didn't hold my interest there. The stuff I see in New York, I've met a number of folks in urban planning.
I'm working more in urban areas since then. Folks from the Harvard Graduate School of Design. I know if you folks from there and working there right now who have introduced me to other folks in the urban planning of world, people I've met working as urban planners. And it's much more than just, you know, thinking about how the new subdivision fits. It could about the value of place and how different locations could be integrated better into a city.
So, the stuff that I see happening with Opportunity Zones, the data that my company collects, and you know, think about how it all relates to how cities get designed to built into the future. I think it's all interrelated. And, and for me too, the other thing, this Internet thing is opposed to libraries. I've, I've gained a lot of knowledge from just being on Twitter of, of all things, right.
Jack: Oh, good Lord.
Jim: It is not just a place for shouting matches.
Jack: No, I don't believe you. I truly don't believe you
Jim: I have met some people there. Yeah. It's not just a place for shouting matches.
Jack: I will trust you on that, but my experience would tell me otherwise.
Jim: I met this one guy, and he's very public. Isi Roman. I met him online when he was a grad student at Berkeley in economics and he was doing a degree in some urban issues and I just, I felt the fit, an affinity for, the kind of arguments he was making. So reach out to him and met him for coffee. Since I've introduced him to folks within the real estate research and investment world, and now he's chief economist at Trulia.
Jack: Oh really?
Jim: But that kind of interaction I've found useful because, you know, if you cut through the noise, you can still find some interesting stuff and you know, really lives up to the promise of that. I remember I was in grad school in you know, the mid-nineties. I remember walking to campus one day listening on my radio, my little Walkman radio to live reports from the Middle East as you know, the Gulf War was going on the first one. And so it's a different world today. But the promise back then was the Internet would be this giant democratizing force that we have all sorts of information flowing freely and a great exchange of ideas and it hasn't happened quite like that. But if you work at it and you use that tool, you can find your community and find those people that are insightful.
Jack: Some of my very best friends in the world are people I met online a long time ago, which is, that's it. We'll go down that path and maybe when we're not recording. Hey, I want to know because I am a recovering economist. I want to know at University of Chicago, that's a Friedman school, isn't it?
Jim: Yeah. What's funny is that I was an undergrad at University of Chicago, but I wanted to be a lawyer. And so it was a political science student and Jerry Rosenberg, he was the professor that just made me open my eyes to what I wanted to do in life. He was my constitutional law professor and he was a left wing professor he was famous for driving an old Saab around campus, like one of these 1960s kind of cars that he kind of kept cobbled together, covered in leftist bumper stickers.
Jack: I know the car. Yes.
Jim: He also taught some at the law school at the University of Chicago and one of his good friends was Justice Scalia, because he was a professor at the University of Chicago law school first. And so you say to yourself, wow, those are polar opposites. They could be friends. And part of it was, you know, they also were intellectual friends in terms of the understanding of the role of the courts in our system.
The courts were not to, you know, lead society, they were two, there were social issues where they'd be decided outside of the court system first and then the courts can enforce things. Then they both kind of felt that and then they want a different social goals but they both sort of felt that should be led from the legislative and executive side first. So they had, they had an affinity on that, but he had Justice Scalia in on one of our classes once and he had a very small class session they set up so that 10 of us could engage in a discussion with Justice Scalia.
And I got into an argument with him.
Jack: Oh boy.
Jim: And with Justice Scalia. Yeah. And I had my ears pin back of course, and afterward, the professor, talked to me. It's like “I'm so proud of you. That was great. You were destined to lose, you know, you think about it, you're arguing with, with a Justice of the Supreme Court.” But it was fun, but the whole class made me realize that sort of the gray issues in the world that we really see, I think in probabilistic outcomes.
Jack: Uh huh.
Jim: And the law everything was black and white. And so that's where, you know, working in the world of economics and thinking about what's the probability of an outcome, how likely is something to happen, is a more natural environment for me versus the law, which, you know, as it was being presented, everything was black and white. When it just doesn't feel to me that the real world's like that. That plus, you know, I still had that computer bug in in my brain, it's time to like to fiddle with things. In fact, like when I was in grad school, I helped this one student, but we had an exchange student, not an exchange student but it was one of the first students coming over from the former Soviet Union and he had a Soviet clone of a 386 computer. Yeah.
Jack: Oh my. I remember, I have a diverse background too. I remember hearing about the Soviet 386 clones.
Jim: And it had a bad, you know, they didn't copy the Intel chips that properly. Um, so I remember dumpster diving with them once, looking for replacement pieces. So that was more my speed and that was, you know, sort of the, that got me going that way and to economics. So I had a bit of a change between the Undergrad and Grad school.
Jack: Oh, yeah. Well that's, that's a great story for getting from law too, to research to economics. You know, now that you tell it, it makes sense. But telling me that it “started with the law got me into economics,” I knew that was going to be interesting. So, let's talk about RCA, about Real Capital Analytics. Specifically how the work that you guys do can be leveraged, can be used for the Opportunity Zone program. All of the stakeholders involved in Opportunity Zone, building an investment.
Jim: Sure. It's an interesting company it got founded in 2000. Bob White who started it, he had been working as a broker at Eastdil and he was really frustrated because there just wasn't the type of information for our sector, just real estate that there was for other asset classes. He was here in New York, he had friends working down on Wall Street, they go to a Bloomberg terminal, they can pull up the value of any security, see how much it was being traded, what kind of prices were being achieved. And there was nothing like that for real estate.
Everything was a phone call, you know, a few promises to help someone with something later and then you'd get information on transactions. And so he figured that our industry would be better if it was more transparent, if there was more information about the asset class and with, you know, a few friends who were in the sector who promised to share some data with him of deals that they were involved in.
Uh, he started the company in 2000, just that, you know, a real changing time in the economy. It wasn't exactly the best time to be starting something, but he was able to survive and make a go of it. And so what, what he created is a platform where, for the worldwide. You can look up any building and see who bought it last who, sold it. What kind of terms in terms of pricing?
And then, in every part of the world, we have some information, we go deeper in the United States, really get into the financing of the assets and the financing and the terms, what kind of capital's funding construction in areas and who's financing that in what are terms for the financing. So the platform in the United States, it really helps the Opportunity Zone folks in terms of just providing an information base to understand what types of projects are there, what your competitive set is, and then really finding the opportunities within Opportunity Zones.
Jack: I'm a little bit stunned when I think about what must be involved in gathering that data. You know, I'm thinking of title data that sitting in many places sitting in a file drawer in and some county clerk's office. Maybe I'm way behind the times, but geez, that kind of blows my mind.
Jim: Yeah and pulling that together takes a lot of resources and in some cities, there is great public information available digitally. New York is probably the best city in the world for information flow and just from government sources and but when you get outside of New York and if you're going to West Virginia, great place, beautiful towns, but you know, things are much more just on paper copies at the local government level.
Jack: Yeah.
Jim: And so, it takes a different skill set to dig into what's happening.
Jack: I guess.
Jim: In some of those other areas, it takes a while for, for that information to flow. And so we set up a system where we can work across every county recorder and deal with a variety of data sets for every area and make a go of it that way.
Jack: Well, just knowing that this exists, I instantly see the value of it just be, well, yeah, it's blatantly obvious. I've got a buddy who buys tax liens and I'm in Phoenix, I'm in Maricopa County, we're the fifth largest metropolitan area in the country and the amount of manual labor he's got to do to track this stuff down just kind of blows my mind.
Jim: Yeah.
Jack: And I think we're pretty good by comparison. Okay. So, well let's talk about Opportunity Zone activity in particular from where you sit. Just kind of give us your bird’s eye view of the Opportunity Zone program. Here we are, what, a year-and-a-half into the program. What do you see? What are the trends? What are the opportunities, what are some of the surprises?
Jim: I think the Opportunity Zone program is already having an impact on capital flows into these designated areas, how it's flowing and the types of transactions that it's flowing into are a little surprising to some. The biggest change so far is with the self-development side. There are people going in and buying raw land or buying older buildings that really the only value left is for the land underneath them. That's growing nationally.
That kind of activity, you know, people buying development sites. And the timing of when the signal came to the market that hey, you should do this. It came at the same time as a change in the regulations for bank lending around construction. So it was a national upswing in the cell development sites, but it came in much more strong for the Opportunity Zones. And in a pattern where once you got over the initial hump of the change in regulations that led to a bank, regulations will lead to a little bit of an increase in sales. That started to taper off nationally. But it kept growing for the Opportunity Zones.
Jack: What was the change?
Jim: Sure. In 2015, there was something called the high volatility commercial real estate regulations. That's HVCRE. Has an acronym where banks were mandated that they hold more capital in reserve for construction loans. The so-called high volatility commercial real estate.
Jack: Right.
Jim: And in addition to holding more capital, there were some qualitative assessments of the projects at the banks had to undertake in terms of underwriting projects to the as-built value. To think about the value of what they had to hold in reserve. But that qualitative rule around what as-built meant was not really specified in the regulations.
There were a lot of things in initial regulations where the language was loose and banks pull back on their lending because with the loose language on the regulations, nobody wanted to be that lender. That got made an example of by them interpreting the regulations one way and the regulators interpreted in another way.
Right. The early 2018 all those regulate regulations got straightened up and, just at the same time that the development side sales picked up. It's related because banks traditionally have been the biggest lenders for construction projects. This, nationally, there are a number of different capital sources for existing commercial real estate projects and whether it's life insurance companies, the CMBS market debt funds. But banks have traditionally been the biggest source for construction lending. It fits a risk profile if it's their local mandate to help their local communities.
So, they've dominated that space. So when capital's pulled back from that. It, you know, if you can't get a loan, you're not going to buy the dirt. And so that, there was an initial downturn into 2016, 2017 in the aftermath of those regulation changes. But once those got cleared up, development site sale activity picked up, but much more so within the Opportunity Zones.
And even when I look at the other aspects of the Opportunity Zones is that we're talking about the ones where the census tracks that met the criteria of the program in terms of the economic characteristics and then they were selected. But there were some other census tracks that fit the same economic characteristics that just happened to not be picked.
Activity increased in those areas as well after the roll off of the regulations. But that too is starting to fall off. As it continues to grow for the Opportunity Zones. And I find that particularly significant because you know, there is an argument out there that the Opportunity Zone program is just providing something where, you know, money that was already flowing to gentrifying areas of the country are going to get a tax break but it didn't need it cause it was already going to flow there anyway. And there are some areas that were economically qualified to join the program that weren't selected. Those areas, like I said, activities starting to fall off there for the cell development sites. It just falls that national trend of, you know, an initial recovery and then a pullback, but the selected, the qualified Opportunity Zones, the pace of investment sales for development sites is growing at a level that suggests that there is more capital selecting these areas now.
Jack: So, who's the prime target for your data? I'm sitting here thinking, if I was this kind of person, would I be going for, what data would I be looking at? Who's the primary users of RCA's tools?
Jim: Yeah. The biggest users of our tools are the institutional investors, the folks investing money on behalf of third parties. But even beyond that, we do have clients in the private capital realm. People active in one particular market or maybe just a handful of markets and investing in their own family and money. They've got a small business. We have some of them as well, but largely it's the investors, the answer to the institutional world where they are putting money to work on behalf of someone else that, that they use our information base to make sense of underwriting their deals.
Jack: What's some of the more interesting data points you've come across here in the last 18 months that's either direct or indirectly related to the Opportunity Zone program?
Jim: The one that I found particularly interesting, I was mentioning that I guess you'd call them bridesmaids’ zones. The areas that were qualified but weren't selected, you know, the way that the activity is pulled back there and decide to sell development sites.
Other stuff that I've been looking at that I've found interesting, there is a bit of a price disconnect between the Opportunity Zones and the rest of the market that the rent cap rates are higher for an Opportunity Zone. You know, there's just nationally that's the case. You look inside an individual markets. That's the case. Some of that disconnect on cap rates is a function of location, like here in the New York area and most of the Opportunity Zones are in the outer boroughs in the metro area, very little in Manhattan was selected and Opportunity Zone Manhattan has lowest cap rates.
And as you go out to the boroughs, cap rates get higher. Some of the, some of the cap rate differences about location, the further out you go know land gets less and less expensive. But when I had an analyst run some numbers to kind of calculate, well what's the value of the location versus the value of the property.
And when we separated that out, it was clear that within the Opportunity Zones, they're the ones that were selected. It is clear that these are areas that there's a bit of a price discount still. And that's where I think that the real opportunity is, even we're at the high point in the cycle, commercial real estate prices have never been this high. And there's people talking about, no worries have, you know, maybe we get to the current instability of interest rates, but eventually it'll go back up again.
Cap rates will go up, prices will come down a little bit. That's the consensus in the investment world. And so, you take this Opportunity Zone program and know coming in at a time with a record, high prices and some people have raised the question. Well, gee, if I'm going to be compensated on capital gains in an environment where prices might be declining a bit, uh, you know, is it really going to deliver value?
Jack: MmmHmm.
Jim: But I think it can deliver value. Uh, just in that locational benefit. I mean, when you strip out the, the fact that the cap rates are higher in the areas because they're just geographically more dispersed. And when you strip that out, it's still is the case. The cap rates are higher in those areas because they are, you know, as the program identified them, they're more economically depressed. Bringing them into those areas of properties, locations into the modern economy. It's going to lower the cap rates for those assets. And for the areas around that and you know, there will be, there will be gains there even as the broader markets might face some headwinds.
Jack: What are some of the tools available to your users, to your subscribers, what kinds of things are folks looking at?
Jim: The main tool, the folks look at our transaction query tools. If an investor is trying to understand what development sites have been sold within Opportunity Zones in the last six months in their systems where they can drill down and it can pull up information about a list of development site sales who bought it, who sold it, at what terms and that it's not just within an Opportunity Zones it's outside.
Jack: Right.
Jim: Various segmentations of that data to give you a list of the top brokers are who the top buyers, sellers, who the top lenders within those areas are and that that kind of transaction, tool information that delivers both a business intelligence purpose of seeing who your competition, who are your potential partners might be. But then also it just gives you a sense of, you know, the types of deals that have been common and what terms and so it can help you think about, you know, when you approach investments that can help you with your underwriting decisions. In addition to that transaction information and then the business intelligence information, we then generate a lot of trend analysis.
Jack: Yeah that's where I was going.
Jim: That's mostly what I do. Taking the broad data and writing stories about it, looking at what's influencing the market, helping people understand what's driving the market today. You know, what characteristics of capital are of interest of late and helping to make sense of current activity. In addition to that, it's, you know, on the trend stuff a lot of charts that people will take and put in to say their pitch book for their fundraiser and their capital raise information and the datasets and the aggregates really helped with telling those stories.
Jack: I can imagine. There's probably some sort of boundary between where you've got objective data and subjective interpretation. When you're looking at trends, how do you manage that transition from the objective? These are the facts and the subjective of these are, these are our explanations, these are our stories for the facts.
Jim: Yeah. Well, statistics always helps. For instance, if you look at prices and an average price per square foot, say for like an office building, that can move around an awful lot just based on the quality and what sells in any one time. So, you know, the statistics help us check that out. We've worked with a couple of academics up at MIT to build the RCA CPPI. It's a Commercial Property Price Index for that.
Jack: Oh, I saw that acronym and I couldn't figure out what it was. Now I know.
Jim: Yeah. But it's an, it's an approach for the commercial sell prices that we innovated where it is looking at prices on a repeat basis. You know, looking a building and the price at which it transacts and then wait 10 years and see what it sells for next time. And you know, you do that with another building and maybe in between it's two years and you see what kind of price change do you have for that building and if you look at the price trends on a same store basis and you stack up thousands and thousands of transactions across the country, we can build an index of looking at what is happening with real prices, controlling for the quality differences between buildings. So you look at the real trend in prices and not just sort of the noise, what happens with, you know, the averages as they should come to market.
So statistics helps to some degree with getting away from a subjective interpretation, by giving you sort of an objective benchmark that you can look at that says, yes, this is the true movement and what's happening in the market. Now on the subjective side though, in terms of thinking about what is motivating capital, what's motivating prices to change?
You know, that gets a little trickier because the challenge I see that the people have as analysts in the industry is, there's always stories floating around. There's always somebody trying to sell something and they've got a story that goes with it and sometimes that story just doesn't hold air. For me, you know what I've done, I've got in my own mind a structural interpretation of how the market works and then someone throws a story at me and I dissect it against the razor of the structural interpretation of how the market works.
And, you know, if it doesn't fit, then there's two ways to interpret it. Either there's something wrong with the data or there's something wrong with the assumptions of the story.
Jack: MmmHmm
Jim: And this case, I know I'm confident in our data. It's, when things don't fit that structure, it's usually because it's not a true story. It's something that someone's really just pitching to try and sell something that, that's a technique I really learned from Bill Wheaton, when I worked for him at this research group.
Jack: Hmmm.
Jim: Professor Wheaton at an MIT, you know, setting up a structural model of how the markets operate and interpreting stories in that context. And I think that's important because it acts as a filter.
Let's go back to the late nineties again. It was hard to get information. I remember reading this one economist that, I still read your stuff, Diane Swonk. It was hard to get the kind of business-focused writing she did at the time. It was hard to get to research reports if you weren't, you know, wired in and working in the business world.
Jack: MmmHmm.
Jim: And at the grad school I was able to get some of her stuff. Now we're just flooded with information. There's just so much. And so it takes some work and some discernment to figure out what's a good story in the financial markets and what's just flop where someone is trying to sell you something. And by thinking about things in that kind of structural way and kind of thinking about how the markets should interact, that helps filter out some of the noise.
Jack:Well that, that prompts me to ask a question about hurdles, challenges. And I suspect I don't want to be leading the witness here. So, I'm going to ask the question. What is the single biggest obstacle or hurdle that you are seeing right now in decision making? In terms of investment and I would prefer to focus on Opportunity Zone work, but I'll leave the question open ended enough. What's the single biggest hurdle that you're seeing out there right now that you think still needs to be solved?
Jim: They're both the same thing. It's not just Opportunity Zone stuff, the other hurdles related to it. It's uncertainty. Uncertainty is the biggest issue right now. There's a lot happening that's generating uncertainty in the financial markets. You saw the 10-year Treasury whipsaw from a spiking growth in the fourth quarter to a sharp decline in the first quarter.
There was a lot of uncertainty around economic growth, about what was happening with government shutdowns. Uncertainty around trade. And so there's just policy uncertainty right now that's causing confusion in the market broadly within Opportunity Zones. It's the same thing because deploying capital in the face of policy uncertainty becomes a challenge with respect to the Opportunity Zones. It's even more problematic though, because you're deploying capital based on a set of very complicated rules that haven't fully been finalized yet.
The government shutdown at the, at the end of 2018, you know, has impacted that level of certainty because you don't have everything wired in place yet and that they have people deploying capital and assuming that, hey, we're probably close to what the final regulations going to look like and I can work with my tax accountants to, you know, figure out how can I adapt whatever I'm doing now. But it's, this is too great of an opportunity to pass up and I want to put this to work now. But you know, if the rules were finalized capital like certainty and you know, if you don't have everything spelled out ahead of time, you're going to get some hesitation.
Jack: And that would be where RCA comes in. That makes a lot of sense. I'm going to ask you to speculate. I know this is sheer speculation, but you're a trained economist. How has this weird fed interest rate thing that we've been dealing with literally for I guess, what, 10 years now? The Fed is just inching their way out of this zero-interest rate program, quarter point by quarter point. How has it changed, not just investing but the certainty equation. We used to use the Fed funds rate as kind of an indicator of what we could expect going forward, at least maybe near term. And there just seems to be such a disconnect between the Fed funds rate and everything that we used to know. How's that? How's that affecting us across the whole range of investing?
Jim: Yeah. Here's the thing. You know, that's one thing they controlled the Fed controls the Fed funds rate. And they don't control much else. The demand for capital on the parts of companies I might invest for new business equipment, new business lines, and really that's what you'd be driving the long end of the yield curve. That in the end is what should impact property investing. We've been in an environment of kind of a little more anemic growth. We don't have the pace of investment that we had in the past.
Frankly, I don't feel that some of it is really a function of fed policy. I think some of the slow pace of investment is just the nature of housing markets. You look at the pace of investment in the United States and what we've been investing in, and this cycle since the financial downturn is different in that housing just hasn't been pulling its weight. We're building far fewer units then we need; we built nearly as many housing units in the last year as Japan did, a country with half our population. So it has two impacts. One, you have, less investment coming around that way. It means fewer jobs created. And so that component to growth is lower too, it means the rent is too damn high.
Jack: There you go.
Jim: We have Google engineers sleeping in their cars because they can't afford to live in Silicon Valley. Yeah. So, but that's not something the Fed can really control.
Jack: That's true.
Jim: The market would build that. It's an issue at every local level. And this isn't a political issue. Both the Obama administration and the Trump administration with some studies Herman Cain has put out, highlighted that yeah, we have a housing market problem and it's over regulatory. Constraints within the dynamic areas, U.S. economy that are growing, that are limiting housing choice. Then if you want to gin up, you know, higher investment, forget about the Fed permit, just strip away some of the anti-competitive housing issues in Silicon Valley, in California in general. And you'd see a lot of construction activity and which would lead to great investment and more moderate housing prices in the region.
A challenge preventing that though it is actually a labor market issue we just don't have, after that last downturn, construction didn't seem like a good job opportunity for a lot of folks. And so I think construction workers now is a big problem for a lot of folks. And then, you know, the dirty secret is a construction world had a lot of folks from outside the United States.
We're working for subcontractors, migrants working for cash. I used to live in Boston and everybody knew that if you wanted some people that work on a project, you went to the field and it's an Irish bar in Cambridge and there all these Irish construction workers there. You could talk to one of the guys and he'd know who, who to talk to.
Jack: Yeah.
Jim: You go there now, and all those guys are gone.
Jack: Right.
Jim: I mean, there's benefits for the construction workers who have remained, it's been higher wages and that's a better, and that's a good thing. But just given the nature of the labor force at the moment and the, the small end gap falling pace of growth and population, there just isn't enough growth there where people have felt that they can move into that sector. And I think it's the other issue is that there's a stigma attached to some of these good solid jobs. Folks want to be Instagram influencers.
Jack:Instead of a welder, right.
Jim: Yeah. Even though, you know a welder, car mechanic, is worth their weight in gold, I feel that what we kind of need to do is just change the, yeah. We need to give other types of jobs, you know, afford them the dignity that they respect. Maybe it changes things around. Maybe you get an associate's degree in the manufacturing arts, as sort of further training, which is helpful for the high-end manufacturing jobs that this world needs now. And it's not the low-skilled labor manufacturing jobs to high-end working on CNC machines working for folks handling a lot of computers, but do it not in the context of just a training program, do it in the context of using the community college program. So we have and a call it an associates degree there and you know, that help might help reduce the stigma.
Jack: I like you're doing some policy stuff here. This is good. I like it.
Jim: These are just my ideas.
Jack: This kind of conversation, particularly with something that's based in data abroad dataset really turns me on. I really liked these conversations. We've been going a long time. So I don't want to drag this beyond my listeners’ ability to survive. So, I'm going to ask you, I want to know a little bit more about Jim Costello real quick. So, when you're not wonking out on data on the weekend, what kind of stuff do you love?
Jim: Biking. On Sunday here in New York, if the weather's good enough, I'm going to try and take my bike down to Coney Island for the first time this year. In New York, some of the streets get a little bit dicey at times. They got a lot of policy implemented by the mayor now kind of favoring cars over bicycles. But there's some areas if you know where to ride, it could be a little bit safe. And so, I'm going to try and get out to Coney Island and see the sights of the year. It's a good to exercise as well.
Jack: Hmm. Not whiskey or cigars or high fat food?
Jim: Definitely not cigars, but I've been known to partake in a wee dram time-to-time.
Jack: A wee dram. Okay. So, here's my favorite question. Everybody loves this question and I always get good answers. I know you're a data guy. I'm going to ask you to move into the realm of imagination for a moment. This'll feel good. I promise you; you get to be king of the world for one day, one day only, and you get to solve with your sovereign powers. One problem, one problem only. How you going to use that power? What problem are you going to solve?
Jim: Only one day.
Jack: You only got one day.
Jim: Yeah. You know, Rome wasn't built in a day. I don't know what I can change in a single day that that would have any kind of staying power.
Jack: Oh, you're the king. You get to do whatever you want. You got a day; you can solve something.
Jim: Yeah, I'd have to think about that because something where, you know, there's a lot of structural issues that you can't address in a single day. That takes generations to change because ultimately some of the problems get down to…
Jack: You're dodging the question. You've got a day; you can use your power for great good. I had a guy say he wanted to ban Robo calls. Okay, that will make the world a little better.
Jim: The next day, they start up again.
Jack: So, you really need some help with this imagination thing, don't you?
Jim: I think what I do with, if I'm king for a day, I changed the rules. So then king for life.
Jack: Okay, well there you go. I don't know how that solves anybody's problem but your own, but still…
Jim: Yeah.
Jack: I understand where you're going. You are taking a serious approach to it and recognizing that the significant problems in our world are, are structural and systemic and they, there, there are no magic wands. There are no ways to fix it overnight. I appreciate that.
Jim: There's an old movie. Eric, The Viking was one of them. I think Eric Palin from Monty Python put it together. It's a funny movie. Uh, but this Viking era, he wants to stop war and it's a great movie, but he meets some of the gods and they're like, “Eric, what do you think? And you're gonna make people stop fighting. You know, even us Gods can't do that.” There's human nature and you know, there's things we can do to channel human nature to make ourselves better people, to work better in our communities. But that takes generations of getting everybody kind of focused on a certain lifestyle and it's just getting everybody to be productive. You can't just mandate it overnight. It takes societal pressure to get there so he can't do it in the day. But you know, that kind of changing things, it's hard work.
Jack: Spoken like a true scientist. Well, Jim, I have really enjoyed this conversation. Before we sign off, any last words for our listeners?
Jim: You know, I'm looking forward to meeting you next week in Las Vegas at this Opportunity Zone Expo. I think it's rather Opportunity Zone program. I think it's going to be interesting to see how this plays out and see how this impacts some of these areas. I think it's going to have some positive impacts on some markets, other parts of the country. Maybe it doesn't come together as much, but I think it's going to have an impact on some communities to the positive.
Jack: Well if folks want to get ahold of you or Real Capital Analytics, what's the best way for them to do that?
Jim: Well Real Capital Analytics our website is just rcanalytics.com and for me, I'm on Twitter a lot. Easy to find there. Jim Costello, CRE.
Jack: Very good. And for our listeners, this information is going to be available on the podcast website, so you don't have to wreck the car trying to write it down. Well, on behalf of, on behalf of Jim Costello, Real Capital Analytics, I'm Jack Heald for the OZExpo Podcasts. Thanks for listening. Please be sure to subscribe and we will talk to you next time.
Announcer: This podcast is for informational purposes only and does not constitute legal tax or investment advice. For specific recommendations, please consult with your financial, legal, or tax professional.
Jim: Thanks for having me.
Jack: It's good to have you. So, we always start this way. I want to find out who it is I'm talking to. So, tell us about yourself. Who is Jim Costello? Where'd you come from? How'd you get here and why should we listen to you?
Jim: Sure. That's a pretty open ended. I'm an economist and you know, my company has a whole bunch of data on commercial real estate performance in terms of the sale prices and loan information. So for me right now I'm like a kid in the candy store as an economist, I love data, I love playing with data, finding unique trends and I'm sitting on top of one of the biggest databases of commercial property information in the world. So, for me, this is just a fun place to be.
And I kind of came to this world, I had been working at CBRE kind of in the corporate world for a number of years. So the current company I'm at is privately owned. But CBRE I was working with the research people, a professor Wheaton at MIT, Professor Turow who's at Harvard and they had a research group Wheaton research. And I've worked with them. And before that I grew up in Chicago. So in some ways I've always lived in these cold northern cities. Kind of need to move someplace south at some point to someplace warm.
Jack: You should come to Phoenix. We're going to hit a hundred today.
Jim: Well, certainly in winter. In winter I go down a lot. My parents live in Tucson. There's snowbirds and I love it in winter. Summers I don't think I could deal with.
Jack: Yeah, it is absolute paradise from about November through April. It really is. So you went to the University of Illinois at Chicago. That's not the Champagne Campus.
Jim: No, although I spent some time on the Champagne Campus, but you know, to any University of Illinois facility you could use, and I would go back and forth for a couple of reasons. One. There were a few things in the economics world that could get at Champagne. This is in the days before Internet was a research tool. So those of you had to spend a little bit more time in the library. The other thing is that I had to do…
Jack: What is this? What is this library thing you're talking about?
Jim: Yeah. How about it? How about it? Although, there's still a lot of good information that hasn't been digitized yet. In fact, at MIT, I was running into some stacks just a couple of years ago and found a report from an economist written in the 1920s looking at the office market.
Jack: Wow.
Jim: And just talking about, you know, the pace of construction, how the economy that had been going and it was, you know, the approaches were things that someone might be doing in a brokerage market report today. So what's old is new again, but University of Illinois, Chicago, the one thing that is really good about the programs there, they have a very good urban planning school.
Jack: Oh.
Jim: So, the economic stuff that I was studying was related to urban planning. I had originally thought I was going to go in urban planning. I had been working for an urban plan or urban development agency in the suburbs in Du Page County in Illinois after college. And I thought that I might want to become an urban planner, but I migrated more toward the economic stuff simply because I really realized that I had more of an affinity for data and playing with data than for the design elements. And so, it was more of a natural fit.
And at the time, there weren't programs, like if I was starting today to do the stuff that I was interested in then I would probably migrate more towards data sciences. You know, that there's more programs like that as a field of study. It just wasn't around as much. But did you know the other thing with the University of Illinois, I was an undergrad at the University of Chicago and I had a few friends from college who went down to University of Illinois at Chapin in Champagne, Urbana. And so that was also sort of the other thing was drawing me down there. It's just seeing old friends…
Jack: So, urban planning would actually dovetail pretty nicely into what's going on these days with the Opportunity Zone. I don't know how much you've got your fingers in urban planning end of it with the data that you work with now. But I was just pondering the opportunities for urban planning with Opportunity Zone program just last night as I was thinking about our conversation this morning.
Jim: Yeah, it's funny as things kind of come around, I am more interested now in urban planning than I had been when I was working at an urban planning outfit, I think part of it was just the geography of where I was working at the time. I love the people I work with. Du Page County outside of Chicago. There's a lot of good stuff to say for it, but it didn't hold my interest at the time, partly because it was greenfield development, putting highways in a building, big suburban office campuses, residential subdivisions. It's not the kind of stuff that seemed exciting to a young man in his twenties. You know, there's a reason you want to go into the cities when you're 20. And, so it didn't hold my interest there. The stuff I see in New York, I've met a number of folks in urban planning.
I'm working more in urban areas since then. Folks from the Harvard Graduate School of Design. I know if you folks from there and working there right now who have introduced me to other folks in the urban planning of world, people I've met working as urban planners. And it's much more than just, you know, thinking about how the new subdivision fits. It could about the value of place and how different locations could be integrated better into a city.
So, the stuff that I see happening with Opportunity Zones, the data that my company collects, and you know, think about how it all relates to how cities get designed to built into the future. I think it's all interrelated. And, and for me too, the other thing, this Internet thing is opposed to libraries. I've, I've gained a lot of knowledge from just being on Twitter of, of all things, right.
Jack: Oh, good Lord.
Jim: It is not just a place for shouting matches.
Jack: No, I don't believe you. I truly don't believe you
Jim: I have met some people there. Yeah. It's not just a place for shouting matches.
Jack: I will trust you on that, but my experience would tell me otherwise.
Jim: I met this one guy, and he's very public. Isi Roman. I met him online when he was a grad student at Berkeley in economics and he was doing a degree in some urban issues and I just, I felt the fit, an affinity for, the kind of arguments he was making. So reach out to him and met him for coffee. Since I've introduced him to folks within the real estate research and investment world, and now he's chief economist at Trulia.
Jack: Oh really?
Jim: But that kind of interaction I've found useful because, you know, if you cut through the noise, you can still find some interesting stuff and you know, really lives up to the promise of that. I remember I was in grad school in you know, the mid-nineties. I remember walking to campus one day listening on my radio, my little Walkman radio to live reports from the Middle East as you know, the Gulf War was going on the first one. And so it's a different world today. But the promise back then was the Internet would be this giant democratizing force that we have all sorts of information flowing freely and a great exchange of ideas and it hasn't happened quite like that. But if you work at it and you use that tool, you can find your community and find those people that are insightful.
Jack: Some of my very best friends in the world are people I met online a long time ago, which is, that's it. We'll go down that path and maybe when we're not recording. Hey, I want to know because I am a recovering economist. I want to know at University of Chicago, that's a Friedman school, isn't it?
Jim: Yeah. What's funny is that I was an undergrad at University of Chicago, but I wanted to be a lawyer. And so it was a political science student and Jerry Rosenberg, he was the professor that just made me open my eyes to what I wanted to do in life. He was my constitutional law professor and he was a left wing professor he was famous for driving an old Saab around campus, like one of these 1960s kind of cars that he kind of kept cobbled together, covered in leftist bumper stickers.
Jack: I know the car. Yes.
Jim: He also taught some at the law school at the University of Chicago and one of his good friends was Justice Scalia, because he was a professor at the University of Chicago law school first. And so you say to yourself, wow, those are polar opposites. They could be friends. And part of it was, you know, they also were intellectual friends in terms of the understanding of the role of the courts in our system.
The courts were not to, you know, lead society, they were two, there were social issues where they'd be decided outside of the court system first and then the courts can enforce things. Then they both kind of felt that and then they want a different social goals but they both sort of felt that should be led from the legislative and executive side first. So they had, they had an affinity on that, but he had Justice Scalia in on one of our classes once and he had a very small class session they set up so that 10 of us could engage in a discussion with Justice Scalia.
And I got into an argument with him.
Jack: Oh boy.
Jim: And with Justice Scalia. Yeah. And I had my ears pin back of course, and afterward, the professor, talked to me. It's like “I'm so proud of you. That was great. You were destined to lose, you know, you think about it, you're arguing with, with a Justice of the Supreme Court.” But it was fun, but the whole class made me realize that sort of the gray issues in the world that we really see, I think in probabilistic outcomes.
Jack: Uh huh.
Jim: And the law everything was black and white. And so that's where, you know, working in the world of economics and thinking about what's the probability of an outcome, how likely is something to happen, is a more natural environment for me versus the law, which, you know, as it was being presented, everything was black and white. When it just doesn't feel to me that the real world's like that. That plus, you know, I still had that computer bug in in my brain, it's time to like to fiddle with things. In fact, like when I was in grad school, I helped this one student, but we had an exchange student, not an exchange student but it was one of the first students coming over from the former Soviet Union and he had a Soviet clone of a 386 computer. Yeah.
Jack: Oh my. I remember, I have a diverse background too. I remember hearing about the Soviet 386 clones.
Jim: And it had a bad, you know, they didn't copy the Intel chips that properly. Um, so I remember dumpster diving with them once, looking for replacement pieces. So that was more my speed and that was, you know, sort of the, that got me going that way and to economics. So I had a bit of a change between the Undergrad and Grad school.
Jack: Oh, yeah. Well that's, that's a great story for getting from law too, to research to economics. You know, now that you tell it, it makes sense. But telling me that it “started with the law got me into economics,” I knew that was going to be interesting. So, let's talk about RCA, about Real Capital Analytics. Specifically how the work that you guys do can be leveraged, can be used for the Opportunity Zone program. All of the stakeholders involved in Opportunity Zone, building an investment.
Jim: Sure. It's an interesting company it got founded in 2000. Bob White who started it, he had been working as a broker at Eastdil and he was really frustrated because there just wasn't the type of information for our sector, just real estate that there was for other asset classes. He was here in New York, he had friends working down on Wall Street, they go to a Bloomberg terminal, they can pull up the value of any security, see how much it was being traded, what kind of prices were being achieved. And there was nothing like that for real estate.
Everything was a phone call, you know, a few promises to help someone with something later and then you'd get information on transactions. And so he figured that our industry would be better if it was more transparent, if there was more information about the asset class and with, you know, a few friends who were in the sector who promised to share some data with him of deals that they were involved in.
Uh, he started the company in 2000, just that, you know, a real changing time in the economy. It wasn't exactly the best time to be starting something, but he was able to survive and make a go of it. And so what, what he created is a platform where, for the worldwide. You can look up any building and see who bought it last who, sold it. What kind of terms in terms of pricing?
And then, in every part of the world, we have some information, we go deeper in the United States, really get into the financing of the assets and the financing and the terms, what kind of capital's funding construction in areas and who's financing that in what are terms for the financing. So the platform in the United States, it really helps the Opportunity Zone folks in terms of just providing an information base to understand what types of projects are there, what your competitive set is, and then really finding the opportunities within Opportunity Zones.
Jack: I'm a little bit stunned when I think about what must be involved in gathering that data. You know, I'm thinking of title data that sitting in many places sitting in a file drawer in and some county clerk's office. Maybe I'm way behind the times, but geez, that kind of blows my mind.
Jim: Yeah and pulling that together takes a lot of resources and in some cities, there is great public information available digitally. New York is probably the best city in the world for information flow and just from government sources and but when you get outside of New York and if you're going to West Virginia, great place, beautiful towns, but you know, things are much more just on paper copies at the local government level.
Jack: Yeah.
Jim: And so, it takes a different skill set to dig into what's happening.
Jack: I guess.
Jim: In some of those other areas, it takes a while for, for that information to flow. And so we set up a system where we can work across every county recorder and deal with a variety of data sets for every area and make a go of it that way.
Jack: Well, just knowing that this exists, I instantly see the value of it just be, well, yeah, it's blatantly obvious. I've got a buddy who buys tax liens and I'm in Phoenix, I'm in Maricopa County, we're the fifth largest metropolitan area in the country and the amount of manual labor he's got to do to track this stuff down just kind of blows my mind.
Jim: Yeah.
Jack: And I think we're pretty good by comparison. Okay. So, well let's talk about Opportunity Zone activity in particular from where you sit. Just kind of give us your bird’s eye view of the Opportunity Zone program. Here we are, what, a year-and-a-half into the program. What do you see? What are the trends? What are the opportunities, what are some of the surprises?
Jim: I think the Opportunity Zone program is already having an impact on capital flows into these designated areas, how it's flowing and the types of transactions that it's flowing into are a little surprising to some. The biggest change so far is with the self-development side. There are people going in and buying raw land or buying older buildings that really the only value left is for the land underneath them. That's growing nationally.
That kind of activity, you know, people buying development sites. And the timing of when the signal came to the market that hey, you should do this. It came at the same time as a change in the regulations for bank lending around construction. So it was a national upswing in the cell development sites, but it came in much more strong for the Opportunity Zones. And in a pattern where once you got over the initial hump of the change in regulations that led to a bank, regulations will lead to a little bit of an increase in sales. That started to taper off nationally. But it kept growing for the Opportunity Zones.
Jack: What was the change?
Jim: Sure. In 2015, there was something called the high volatility commercial real estate regulations. That's HVCRE. Has an acronym where banks were mandated that they hold more capital in reserve for construction loans. The so-called high volatility commercial real estate.
Jack: Right.
Jim: And in addition to holding more capital, there were some qualitative assessments of the projects at the banks had to undertake in terms of underwriting projects to the as-built value. To think about the value of what they had to hold in reserve. But that qualitative rule around what as-built meant was not really specified in the regulations.
There were a lot of things in initial regulations where the language was loose and banks pull back on their lending because with the loose language on the regulations, nobody wanted to be that lender. That got made an example of by them interpreting the regulations one way and the regulators interpreted in another way.
Right. The early 2018 all those regulate regulations got straightened up and, just at the same time that the development side sales picked up. It's related because banks traditionally have been the biggest lenders for construction projects. This, nationally, there are a number of different capital sources for existing commercial real estate projects and whether it's life insurance companies, the CMBS market debt funds. But banks have traditionally been the biggest source for construction lending. It fits a risk profile if it's their local mandate to help their local communities.
So, they've dominated that space. So when capital's pulled back from that. It, you know, if you can't get a loan, you're not going to buy the dirt. And so that, there was an initial downturn into 2016, 2017 in the aftermath of those regulation changes. But once those got cleared up, development site sale activity picked up, but much more so within the Opportunity Zones.
And even when I look at the other aspects of the Opportunity Zones is that we're talking about the ones where the census tracks that met the criteria of the program in terms of the economic characteristics and then they were selected. But there were some other census tracks that fit the same economic characteristics that just happened to not be picked.
Activity increased in those areas as well after the roll off of the regulations. But that too is starting to fall off. As it continues to grow for the Opportunity Zones. And I find that particularly significant because you know, there is an argument out there that the Opportunity Zone program is just providing something where, you know, money that was already flowing to gentrifying areas of the country are going to get a tax break but it didn't need it cause it was already going to flow there anyway. And there are some areas that were economically qualified to join the program that weren't selected. Those areas, like I said, activities starting to fall off there for the cell development sites. It just falls that national trend of, you know, an initial recovery and then a pullback, but the selected, the qualified Opportunity Zones, the pace of investment sales for development sites is growing at a level that suggests that there is more capital selecting these areas now.
Jack: So, who's the prime target for your data? I'm sitting here thinking, if I was this kind of person, would I be going for, what data would I be looking at? Who's the primary users of RCA's tools?
Jim: Yeah. The biggest users of our tools are the institutional investors, the folks investing money on behalf of third parties. But even beyond that, we do have clients in the private capital realm. People active in one particular market or maybe just a handful of markets and investing in their own family and money. They've got a small business. We have some of them as well, but largely it's the investors, the answer to the institutional world where they are putting money to work on behalf of someone else that, that they use our information base to make sense of underwriting their deals.
Jack: What's some of the more interesting data points you've come across here in the last 18 months that's either direct or indirectly related to the Opportunity Zone program?
Jim: The one that I found particularly interesting, I was mentioning that I guess you'd call them bridesmaids’ zones. The areas that were qualified but weren't selected, you know, the way that the activity is pulled back there and decide to sell development sites.
Other stuff that I've been looking at that I've found interesting, there is a bit of a price disconnect between the Opportunity Zones and the rest of the market that the rent cap rates are higher for an Opportunity Zone. You know, there's just nationally that's the case. You look inside an individual markets. That's the case. Some of that disconnect on cap rates is a function of location, like here in the New York area and most of the Opportunity Zones are in the outer boroughs in the metro area, very little in Manhattan was selected and Opportunity Zone Manhattan has lowest cap rates.
And as you go out to the boroughs, cap rates get higher. Some of the, some of the cap rate differences about location, the further out you go know land gets less and less expensive. But when I had an analyst run some numbers to kind of calculate, well what's the value of the location versus the value of the property.
And when we separated that out, it was clear that within the Opportunity Zones, they're the ones that were selected. It is clear that these are areas that there's a bit of a price discount still. And that's where I think that the real opportunity is, even we're at the high point in the cycle, commercial real estate prices have never been this high. And there's people talking about, no worries have, you know, maybe we get to the current instability of interest rates, but eventually it'll go back up again.
Cap rates will go up, prices will come down a little bit. That's the consensus in the investment world. And so, you take this Opportunity Zone program and know coming in at a time with a record, high prices and some people have raised the question. Well, gee, if I'm going to be compensated on capital gains in an environment where prices might be declining a bit, uh, you know, is it really going to deliver value?
Jack: MmmHmm.
Jim: But I think it can deliver value. Uh, just in that locational benefit. I mean, when you strip out the, the fact that the cap rates are higher in the areas because they're just geographically more dispersed. And when you strip that out, it's still is the case. The cap rates are higher in those areas because they are, you know, as the program identified them, they're more economically depressed. Bringing them into those areas of properties, locations into the modern economy. It's going to lower the cap rates for those assets. And for the areas around that and you know, there will be, there will be gains there even as the broader markets might face some headwinds.
Jack: What are some of the tools available to your users, to your subscribers, what kinds of things are folks looking at?
Jim: The main tool, the folks look at our transaction query tools. If an investor is trying to understand what development sites have been sold within Opportunity Zones in the last six months in their systems where they can drill down and it can pull up information about a list of development site sales who bought it, who sold it, at what terms and that it's not just within an Opportunity Zones it's outside.
Jack: Right.
Jim: Various segmentations of that data to give you a list of the top brokers are who the top buyers, sellers, who the top lenders within those areas are and that that kind of transaction, tool information that delivers both a business intelligence purpose of seeing who your competition, who are your potential partners might be. But then also it just gives you a sense of, you know, the types of deals that have been common and what terms and so it can help you think about, you know, when you approach investments that can help you with your underwriting decisions. In addition to that transaction information and then the business intelligence information, we then generate a lot of trend analysis.
Jack: Yeah that's where I was going.
Jim: That's mostly what I do. Taking the broad data and writing stories about it, looking at what's influencing the market, helping people understand what's driving the market today. You know, what characteristics of capital are of interest of late and helping to make sense of current activity. In addition to that, it's, you know, on the trend stuff a lot of charts that people will take and put in to say their pitch book for their fundraiser and their capital raise information and the datasets and the aggregates really helped with telling those stories.
Jack: I can imagine. There's probably some sort of boundary between where you've got objective data and subjective interpretation. When you're looking at trends, how do you manage that transition from the objective? These are the facts and the subjective of these are, these are our explanations, these are our stories for the facts.
Jim: Yeah. Well, statistics always helps. For instance, if you look at prices and an average price per square foot, say for like an office building, that can move around an awful lot just based on the quality and what sells in any one time. So, you know, the statistics help us check that out. We've worked with a couple of academics up at MIT to build the RCA CPPI. It's a Commercial Property Price Index for that.
Jack: Oh, I saw that acronym and I couldn't figure out what it was. Now I know.
Jim: Yeah. But it's an, it's an approach for the commercial sell prices that we innovated where it is looking at prices on a repeat basis. You know, looking a building and the price at which it transacts and then wait 10 years and see what it sells for next time. And you know, you do that with another building and maybe in between it's two years and you see what kind of price change do you have for that building and if you look at the price trends on a same store basis and you stack up thousands and thousands of transactions across the country, we can build an index of looking at what is happening with real prices, controlling for the quality differences between buildings. So you look at the real trend in prices and not just sort of the noise, what happens with, you know, the averages as they should come to market.
So statistics helps to some degree with getting away from a subjective interpretation, by giving you sort of an objective benchmark that you can look at that says, yes, this is the true movement and what's happening in the market. Now on the subjective side though, in terms of thinking about what is motivating capital, what's motivating prices to change?
You know, that gets a little trickier because the challenge I see that the people have as analysts in the industry is, there's always stories floating around. There's always somebody trying to sell something and they've got a story that goes with it and sometimes that story just doesn't hold air. For me, you know what I've done, I've got in my own mind a structural interpretation of how the market works and then someone throws a story at me and I dissect it against the razor of the structural interpretation of how the market works.
And, you know, if it doesn't fit, then there's two ways to interpret it. Either there's something wrong with the data or there's something wrong with the assumptions of the story.
Jack: MmmHmm
Jim: And this case, I know I'm confident in our data. It's, when things don't fit that structure, it's usually because it's not a true story. It's something that someone's really just pitching to try and sell something that, that's a technique I really learned from Bill Wheaton, when I worked for him at this research group.
Jack: Hmmm.
Jim: Professor Wheaton at an MIT, you know, setting up a structural model of how the markets operate and interpreting stories in that context. And I think that's important because it acts as a filter.
Let's go back to the late nineties again. It was hard to get information. I remember reading this one economist that, I still read your stuff, Diane Swonk. It was hard to get the kind of business-focused writing she did at the time. It was hard to get to research reports if you weren't, you know, wired in and working in the business world.
Jack: MmmHmm.
Jim: And at the grad school I was able to get some of her stuff. Now we're just flooded with information. There's just so much. And so it takes some work and some discernment to figure out what's a good story in the financial markets and what's just flop where someone is trying to sell you something. And by thinking about things in that kind of structural way and kind of thinking about how the markets should interact, that helps filter out some of the noise.
Jack:Well that, that prompts me to ask a question about hurdles, challenges. And I suspect I don't want to be leading the witness here. So, I'm going to ask the question. What is the single biggest obstacle or hurdle that you are seeing right now in decision making? In terms of investment and I would prefer to focus on Opportunity Zone work, but I'll leave the question open ended enough. What's the single biggest hurdle that you're seeing out there right now that you think still needs to be solved?
Jim: They're both the same thing. It's not just Opportunity Zone stuff, the other hurdles related to it. It's uncertainty. Uncertainty is the biggest issue right now. There's a lot happening that's generating uncertainty in the financial markets. You saw the 10-year Treasury whipsaw from a spiking growth in the fourth quarter to a sharp decline in the first quarter.
There was a lot of uncertainty around economic growth, about what was happening with government shutdowns. Uncertainty around trade. And so there's just policy uncertainty right now that's causing confusion in the market broadly within Opportunity Zones. It's the same thing because deploying capital in the face of policy uncertainty becomes a challenge with respect to the Opportunity Zones. It's even more problematic though, because you're deploying capital based on a set of very complicated rules that haven't fully been finalized yet.
The government shutdown at the, at the end of 2018, you know, has impacted that level of certainty because you don't have everything wired in place yet and that they have people deploying capital and assuming that, hey, we're probably close to what the final regulations going to look like and I can work with my tax accountants to, you know, figure out how can I adapt whatever I'm doing now. But it's, this is too great of an opportunity to pass up and I want to put this to work now. But you know, if the rules were finalized capital like certainty and you know, if you don't have everything spelled out ahead of time, you're going to get some hesitation.
Jack: And that would be where RCA comes in. That makes a lot of sense. I'm going to ask you to speculate. I know this is sheer speculation, but you're a trained economist. How has this weird fed interest rate thing that we've been dealing with literally for I guess, what, 10 years now? The Fed is just inching their way out of this zero-interest rate program, quarter point by quarter point. How has it changed, not just investing but the certainty equation. We used to use the Fed funds rate as kind of an indicator of what we could expect going forward, at least maybe near term. And there just seems to be such a disconnect between the Fed funds rate and everything that we used to know. How's that? How's that affecting us across the whole range of investing?
Jim: Yeah. Here's the thing. You know, that's one thing they controlled the Fed controls the Fed funds rate. And they don't control much else. The demand for capital on the parts of companies I might invest for new business equipment, new business lines, and really that's what you'd be driving the long end of the yield curve. That in the end is what should impact property investing. We've been in an environment of kind of a little more anemic growth. We don't have the pace of investment that we had in the past.
Frankly, I don't feel that some of it is really a function of fed policy. I think some of the slow pace of investment is just the nature of housing markets. You look at the pace of investment in the United States and what we've been investing in, and this cycle since the financial downturn is different in that housing just hasn't been pulling its weight. We're building far fewer units then we need; we built nearly as many housing units in the last year as Japan did, a country with half our population. So it has two impacts. One, you have, less investment coming around that way. It means fewer jobs created. And so that component to growth is lower too, it means the rent is too damn high.
Jack: There you go.
Jim: We have Google engineers sleeping in their cars because they can't afford to live in Silicon Valley. Yeah. So, but that's not something the Fed can really control.
Jack: That's true.
Jim: The market would build that. It's an issue at every local level. And this isn't a political issue. Both the Obama administration and the Trump administration with some studies Herman Cain has put out, highlighted that yeah, we have a housing market problem and it's over regulatory. Constraints within the dynamic areas, U.S. economy that are growing, that are limiting housing choice. Then if you want to gin up, you know, higher investment, forget about the Fed permit, just strip away some of the anti-competitive housing issues in Silicon Valley, in California in general. And you'd see a lot of construction activity and which would lead to great investment and more moderate housing prices in the region.
A challenge preventing that though it is actually a labor market issue we just don't have, after that last downturn, construction didn't seem like a good job opportunity for a lot of folks. And so I think construction workers now is a big problem for a lot of folks. And then, you know, the dirty secret is a construction world had a lot of folks from outside the United States.
We're working for subcontractors, migrants working for cash. I used to live in Boston and everybody knew that if you wanted some people that work on a project, you went to the field and it's an Irish bar in Cambridge and there all these Irish construction workers there. You could talk to one of the guys and he'd know who, who to talk to.
Jack: Yeah.
Jim: You go there now, and all those guys are gone.
Jack: Right.
Jim: I mean, there's benefits for the construction workers who have remained, it's been higher wages and that's a better, and that's a good thing. But just given the nature of the labor force at the moment and the, the small end gap falling pace of growth and population, there just isn't enough growth there where people have felt that they can move into that sector. And I think it's the other issue is that there's a stigma attached to some of these good solid jobs. Folks want to be Instagram influencers.
Jack:Instead of a welder, right.
Jim: Yeah. Even though, you know a welder, car mechanic, is worth their weight in gold, I feel that what we kind of need to do is just change the, yeah. We need to give other types of jobs, you know, afford them the dignity that they respect. Maybe it changes things around. Maybe you get an associate's degree in the manufacturing arts, as sort of further training, which is helpful for the high-end manufacturing jobs that this world needs now. And it's not the low-skilled labor manufacturing jobs to high-end working on CNC machines working for folks handling a lot of computers, but do it not in the context of just a training program, do it in the context of using the community college program. So we have and a call it an associates degree there and you know, that help might help reduce the stigma.
Jack: I like you're doing some policy stuff here. This is good. I like it.
Jim: These are just my ideas.
Jack: This kind of conversation, particularly with something that's based in data abroad dataset really turns me on. I really liked these conversations. We've been going a long time. So I don't want to drag this beyond my listeners’ ability to survive. So, I'm going to ask you, I want to know a little bit more about Jim Costello real quick. So, when you're not wonking out on data on the weekend, what kind of stuff do you love?
Jim: Biking. On Sunday here in New York, if the weather's good enough, I'm going to try and take my bike down to Coney Island for the first time this year. In New York, some of the streets get a little bit dicey at times. They got a lot of policy implemented by the mayor now kind of favoring cars over bicycles. But there's some areas if you know where to ride, it could be a little bit safe. And so, I'm going to try and get out to Coney Island and see the sights of the year. It's a good to exercise as well.
Jack: Hmm. Not whiskey or cigars or high fat food?
Jim: Definitely not cigars, but I've been known to partake in a wee dram time-to-time.
Jack: A wee dram. Okay. So, here's my favorite question. Everybody loves this question and I always get good answers. I know you're a data guy. I'm going to ask you to move into the realm of imagination for a moment. This'll feel good. I promise you; you get to be king of the world for one day, one day only, and you get to solve with your sovereign powers. One problem, one problem only. How you going to use that power? What problem are you going to solve?
Jim: Only one day.
Jack: You only got one day.
Jim: Yeah. You know, Rome wasn't built in a day. I don't know what I can change in a single day that that would have any kind of staying power.
Jack: Oh, you're the king. You get to do whatever you want. You got a day; you can solve something.
Jim: Yeah, I'd have to think about that because something where, you know, there's a lot of structural issues that you can't address in a single day. That takes generations to change because ultimately some of the problems get down to…
Jack: You're dodging the question. You've got a day; you can use your power for great good. I had a guy say he wanted to ban Robo calls. Okay, that will make the world a little better.
Jim: The next day, they start up again.
Jack: So, you really need some help with this imagination thing, don't you?
Jim: I think what I do with, if I'm king for a day, I changed the rules. So then king for life.
Jack: Okay, well there you go. I don't know how that solves anybody's problem but your own, but still…
Jim: Yeah.
Jack: I understand where you're going. You are taking a serious approach to it and recognizing that the significant problems in our world are, are structural and systemic and they, there, there are no magic wands. There are no ways to fix it overnight. I appreciate that.
Jim: There's an old movie. Eric, The Viking was one of them. I think Eric Palin from Monty Python put it together. It's a funny movie. Uh, but this Viking era, he wants to stop war and it's a great movie, but he meets some of the gods and they're like, “Eric, what do you think? And you're gonna make people stop fighting. You know, even us Gods can't do that.” There's human nature and you know, there's things we can do to channel human nature to make ourselves better people, to work better in our communities. But that takes generations of getting everybody kind of focused on a certain lifestyle and it's just getting everybody to be productive. You can't just mandate it overnight. It takes societal pressure to get there so he can't do it in the day. But you know, that kind of changing things, it's hard work.
Jack: Spoken like a true scientist. Well, Jim, I have really enjoyed this conversation. Before we sign off, any last words for our listeners?
Jim: You know, I'm looking forward to meeting you next week in Las Vegas at this Opportunity Zone Expo. I think it's rather Opportunity Zone program. I think it's going to be interesting to see how this plays out and see how this impacts some of these areas. I think it's going to have some positive impacts on some markets, other parts of the country. Maybe it doesn't come together as much, but I think it's going to have an impact on some communities to the positive.
Jack: Well if folks want to get ahold of you or Real Capital Analytics, what's the best way for them to do that?
Jim: Well Real Capital Analytics our website is just rcanalytics.com and for me, I'm on Twitter a lot. Easy to find there. Jim Costello, CRE.
Jack: Very good. And for our listeners, this information is going to be available on the podcast website, so you don't have to wreck the car trying to write it down. Well, on behalf of, on behalf of Jim Costello, Real Capital Analytics, I'm Jack Heald for the OZExpo Podcasts. Thanks for listening. Please be sure to subscribe and we will talk to you next time.
Announcer: This podcast is for informational purposes only and does not constitute legal tax or investment advice. For specific recommendations, please consult with your financial, legal, or tax professional.
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