Real Estate Rebound Post-COVID (#40)

Almost 50% of the total carbon emissions of a building happened during the time of construction. And so the opportunity for us is definitely in creating better buildings, mostly from the existing buildings we have and then growing the lettable area.

Full transcript:

Ben: [00:01:47] Zsolt. Thank you very much for joining the Structural Shifts podcast. This is quite a wide-ranging topic.  What I wanted to do is jump in initially by talking about urbanization.  I read that according to the UN world population report, 70% of the world’s population will live in cities by 2050. Is urbanization the mega trend that is underpinning the real estate sector?

Zsolt: [00:02:15] Thank you very much, first of all, for having me, Ben.  I would say that urbanization is a positive trend that helps because when people move, they have new needs for location in terms of residential, but also in terms of meeting spaces that today are certainly offices. We’ll talk about that later and how that may change.

I think it helps, but I wouldn’t say it is the theme for real estate because for real estate, the real thing that you need to take care of is what changes. We as human beings change and once we change, we have different needs and that means we need different type of buildings.

We have to refocus real estate, not just to growth. We have to refocus ourselves to actually refurbishing what we already have. 

Ben: [00:02:58] You said the urbanization was one of the mega trends as it pertains to what changes and what changes is really what matters. How much has the urbanization trend been paralyzed or maybe even put into reverse because of COVID? Because, anecdotally you hear lots of talk of people moving to the countryside or at least moving to the suburbs. How much of that is really playing out in reality?

Zsolt: [00:03:21] I think one of the easy truisms of the pandemic has been that the pandemic has accelerated existing underlying trends.  It’s not that these trends didn’t exist, it’s just that we’ve seen in five, six months, what may have occurred over five to even 10 years.

 One of those trends has been the move by a certain age group to the suburbs.  In my previous life, when I was a partner at a global fund, we invested a lot into this trend already over the last decade in the US: people who have children and can no longer afford to live downtown because they simply can’t get the square meters, the square foot they require.

They’ve been moving to the suburbs for a while. That has accelerated now, but it’s not a new trend. It’s something that we have seen and there’s a certain acceleration, but I certainly don’t believe that that in turn spells the death of major cities, either. 

“Affordability is a very big factor. You can get a certain quality of life that you can obtain in a second-tier city versus a first-tier city just by the sheer affordability ratios, which normally is expressed in how many years of wages do you need in order to buy a home. That tends to be over double in the first-tier cities than the second-tier cities.”

Ben: [00:04:18] One of the trends that we’ve seen over recent years is because of the strong spiller affects you get within cities. Is it that the larger cities have been growing or doing better than all other cities?

 I feel like we’ve seen this trend towards mega cities. Do you think that stays the same or do you think one of the effects of COVID might be that people disperse a bit more? I now second that third tier cities might actually benefit. 

Zsolt: [00:04:41] I think that that trend certainly has been the case for a long time. That is correct. I also think that there has been a trend for what we’re calling second tier cities.  It’s always important to say what we believe by that. To me, second, tier cities would be Manchester in the UK or [00:05:00] Gothenburg, for example, in Sweden or Lille in France, or think about Atlanta or Denver in the US.

These cities have been growing for the last decade. They’ve really started to accelerate and mega cities are very attractive. They give amazing opportunity to the people who move to them, but we do have an increasing affordability problem. Affordability problem then gets into the problem of actually people getting access to the cities, how far they are from the downtown center and there is a pinpoint where it is no longer worth it. So second tier cities, I believe, have a real potential. Again, it’s a trend that has accelerated because of the…

“the one other thing that has been accelerated by the pandemic is that we’re thinking about healthcare metrics, which were not front and middle center of mine before. Nobody ever used to look at what is the air quality I breathe on a daily basis.  In the future, when people buy a home, that will start to become a natural metric that people will look at.”

Ben: [00:05:42] pandemic. So the trade-off is really between having enough square meters, potentially having a garden, and quality of life, versus not having a commute. Therefore, is that what’s driving people in smaller cities because there isn’t such a big trade off in that respect?

Zsolt: [00:05:59] I think it’s one of the trade-offs. I really liked the idea that you look at the cost of accessing the downtown areas or wherever you may work or go for fun, and that cost is expressed both in terms of physical costs, how many dollars, pounds it may cost, but also in time terms. There comes a time when that pain barrier becomes quite big, but that’s not the only factor.

Affordability is a very big factor. You can get a certain quality of life that you can obtain in a second-tier city versus a first-tier city just by the sheer affordability ratios, which normally is expressed in how many years of wages do you need in order to buy a home. That tends to be over double in the first-tier cities than the second-tier cities.

Then, the one other thing that has been accelerated by the pandemic is that we’re thinking about healthcare metrics, which were not front and middle center of mine before. Nobody ever used to look at what is the air quality I breathe on a daily basis.  In the future, when people buy a home, that will start to become a natural metric that people will look at.

Ben: [00:07:09] What does it say to you? We’re not actually in the same room, unfortunately, because of the pandemic, but we are both in the same city. Where does a city like Geneva rank? Because, on one level, it’s always top of the Mercer quality of life index, but on another level, it’s not a big city. And in some ways, it’s not that economically dynamic., So is Geneva a tier three, tier four city?

Zsolt: [00:07:32] I have to make a small precision there, Ben. Geneva does not make it to the top of the Mercer list. Actually, in the recent list, it’s not even in the top three for Switzerland. You normally tend to get Bern, Basel. So you’re getting more third tier cities at the top in terms of quality-of-life index, which is interesting in itself, I guess.

Back to your question, Geneva has very unique drivers. Having been in real estate 26 years and then moving to Geneva, what I realized is how peculiar the city is because the drivers here are unique and are somewhat related to the pandemic. I think there’s a real inflow at the moment in terms of new population. That’s because people tend to look for security in uncertain times and the pandemic has created uncertainty.  That has meant that globally, but in particular French and Brits are looking to Geneva as a potential solution there to that uncertainty. That has created an influence, which will push home prices more than you would have seen without them coming to Geneva.

The other factor though, is that Geneva is a very high-cost location to live. That is now truly affecting the livelihood of the middle class and so I think that Geneva will face that problem, that it will start to become less attractive for the middle class if these trends continue despite the high wages – but the high wages almost don’t compensate for the very high-cost base.

Geneva has not been a net growth city recently. I think it will grow on the margins, on the high-net-worth side, but I’m not sure that it will grow as a healthy city in the mid-market. If there’s not some kind of a rebalancing in relation to the cost base that that you need to support with the wages here.

Ben: [00:09:20] London is still a good investment from a real estate point of view, because I read that something like 700,000 people left London in 2020 because of Brexit, because of the pandemic and so on. Where does London stand on that?

Zsolt: [00:09:33] I think that global cities, London and New York, will go through a bit of a dip right now. And again, it goes back to the point I mentioned earlier. I think that the per kilometer costs both in terms of time and money to reach downtown is very high in these cities. So when people have the opportunity to feel that they can work remotely, that they can secure themselves a better quality living, then London and New York have a slightly tougher go.

As a very quick side remark, New York, has another headwind, which is tax. If you moved down to Florida and you earn above a certain minimum threshold, you will keep almost 25% more of your wages than if you stay in New York. That’s a pretty hard equation to fight against at the moment at a certain income threshold.

Back to London, I think that Brexit and the pandemic have less people looking at working from second home, sometimes even in France and beyond. I think that over time London will regain its glory. This may well take three, four or five years, but London has a unique set of features. The infrastructure, both physical, but even more the mental infrastructure, in terms of some of the smartest people from the roles being together in one city, is not something that is repeatable elsewhere in Europe. And London still has the benefit of having English as its mother tongue as well. So I think London will come back, but I expect that’s a take a little bit of a while, and that means some interesting opportunities to buy if one has a mid to long-term horizon.

Ben: [00:11:14] Where in Europe is benefiting because of Brexit? Which cities are benefiting most, because I guess a few cities are reaping of Brexit dividend?

Zsolt: [00:11:23] Ever since the Brexit debate has started, I’ve seen and followed numerous studies and had numerous, very interesting conversations. Even with former chancellors of the exchequers of the UK about this theme, about what will happen with Brexit and who will benefit.

What I am seeing so far is that the actual move has been more muted than people would have thought. It has accelerated somewhat in the last three, four, five, six months. I would say that it is interesting to observe that with all this preparation time up to Brexit, most people have decided not to make a big move. In a big way, I do see an acceleration trend.

The main benefactors are Amsterdam, definitely, because English is a very strong second language, where virtually anybody in the street will speak it, because the infrastructure is very, very good. Schiphol has many more runways than Heathrow can ever dream of attaining and the infrastructure simply works, and you have a very educated population that is very welcoming and again, speaks English. So overall, Amsterdam is one of the main beneficiaries.

Dublin is often cited. I always just feel that Dublin is not very big and it is the wrong way. Hence, the travel times, if you ever want to travel anywhere within Europe is not great. Dublin has been a benefactor in particular on the tech side, but I just don’t see many companies saying “Hey, I want to move my headquarters from London to Dublin”.

Frankfurt -often cited. The problem with Frankfurt is that very few of the people who are the actual decision makers want to live in factories.  I think it’s an image problem for Frankfurt, because I think the city has become better, more cosmopolitan. There was more leisure available around the river, but it still has a problem of how it is perceived.

 The last, and somewhat very surprising contender is Madrid. Nobody would have said three, four, five, six, seven years ago that Madrid would really be a contender. The metaphor is almost like New York to Miami. They have brought in very interesting tax for people who are willing to relocate to Madrid, so I think tax is certainly a factor. Good weather, just as in Miami, is a factor. Also, it is a city that is very easily communicable. You can get to anywhere in the city, given the very wide avenues within 14, 15, 16 minutes.

The local municipality is as business friendly as they come. They simply make things happen. Interestingly, during the pandemic, they’ve been almost fully open for the last six months, whilst everywhere else, including in Spain, people are closed. Madrid has just kept open, prioritizing business. We can debate the ethics of this, but I think that overall Madrid has shown a lot of interests. Recently, of the data point that I saw which I thought was fascinating, was that credit Suisse, a completely non-Spanish bank, has moved its European investment banking headquarters to Madrid. That is a first. We’ve seen Santander make such pronouncements moving their investment banking back from London to Madrid, but there you understand why, as it is a Spanish bank. But a Swiss bank putting its European investment banking HQ in Madrid is a first. I believe not a lie.

Ben: [00:14:36] Somewhat conspicuous by its absence in that list you just gave is Berlin, because Berlin has always been tipped as a city that was about to boom, right? It had supposedly all the right conditions. You had very young, well educated workforce, relatively cheap housing costs. Why hasn’t Berlin done better today?

Zsolt: [00:14:54] I think Berlin has done well. It’s almost a victim of its own success because the legendary price advantage that it has been chipped away at very substantially over the last few years, given its popularity. Berlin used to be famous and realistic for what we called pancake reps, because rents never grew there for well over a decade. But since 2015, we’ve seen a skyrocketing of brands in Berlin, which has actually taken away one of the key advantages that you’ve just mentioned. Now it goes back to quality of life and Berlin has the opposite of Madrid. It has a very reformist municipality that is very slow, that doesn’t necessarily create the right environments in many ways, including, for example, now rent controls, which means that many people are no longer improving the flats as they know they can no longer get higher rents. That hasn’t helped Berlin, but overall Berlin has done very well.

When we talk about benefactors, it’s always for different reasons. If there’s a tech company looking to relocate from London, that would likely look at Berlin as one of its absolute top picks because Berlin has been good on the tech side, but the tech companies are less in a need to move than, for example, financial services firms as a result of Brexit.

“Harvard Business School did a really good study on the fact that innovation that normally happens in the 10% of interactions that are spontaneous at work, where two people meet at, for example, the coffee area and they discuss something that they were not timing -that’s when innovation happens.”

Ben: [00:16:12] People are working more and more from home and they’re much more comfortable mixing going to work with working from home. I guess that opens up a much bigger remote workforce, which I think we’ve talked about in the context of cities, but what does it mean for city center office space? Does the demand go down or is it just a different type of office space that we’ll seek?

Zsolt: [00:16:33] That is the $40 trillion question. Offices have been the largest asset class for real estate investors today. I was recently on a panel for the major publication in private equity real estate and we were six different peers who run different firms and there was no agreement on the point. I’ll give you my thoughts, but I think it’s very interesting to point out that I think that there’s no full agreement. In my personal view is as follows.

I think that peak fear about people returning to offices was last June. Last June, everybody enjoyed their first three months. It was great weather throughout. Everybody said wow, I can work from home, I’m sipping my macchiato on the terrace, I’m getting a sun tan. This is great. Following that, people started to realize certain things. Harvard Business School did a really good study on the fact that innovation that normally happens in the 10% of interactions that are spontaneous at work, where two people meet at, for example, the coffee area and they discuss something that they were not timing -that’s when innovation happens. Now, innovation through Zoom or Microsoft Teams is very difficult because you don’t have by chance encounters or by chance points. That’s one. Two is collaboration just amongst the team and team spirit. On three, which is the one I never heard anybody else talking about, but I believe in very strongly, is socialization being a requirement, not only at home, but work socialization being a requirement. For our mental balance, if we’re only in a private socialization environment and we don’t get the work socialization, I think we’ll lose our balance. We’re slightly different people in these two social environments and I think we require both to be balanced. Lastly, you can’t educate young people. The young workforce that you’re trying to bring up is virtually impossible to bring forward to an online medium.

So, for these reasons, I believe we’re going back to the office. I think we’ll never go back in exactly the same way as we were pre pandemic. You will very likely see an increase on the working from home trend one of the agents just put an exact number to. They thought that on average people work from home 1.2 days a week, and they thought it would increase to 2.3 days a week. I am not sure we can say this specifically, but people will have days when they will work from home and I think you’ll, you’ll likely have Tuesday to Thursday, Tuesday to Friday or Monday to Thursday, when everybody agrees that we will be in the office because people need to meet up.

One other trend that people may not appreciate is that the average square meter per employee in 1989 in the US was 26 square meters. By 2018, that same metric was nine square meters. We’ve gone from 26 to nine. One of the things you will see as a result of the pandemic and increased focus on health is that we’re going to increase the individual space we give people almost as a benefit. The benefit is, you’re coming back to the office, I’m giving you increased space.

All of these things, what they will likely lead to is pretty strong office demand in locations of desire where somebody, a tech company like Google or Microsoft wants their people to come back with happy and energetic faces so that they can innovate. I think those places will work fine. That is the downtown center that you asked. Where I worry more is a B location where there’s a call center, because there is no real hands-on deck. It’s much harder to explain why a B location really needs to be an office today.

Ben: [00:20:17] So potentially B locations suffer and the offices within A locations, they’d probably need to be redesigned, right? To allow people to have more space. Where do you stand on the coworking trend? What do you think happens to the co-working post pandemic?

Zsolt: [00:20:32] How we work will need to have more flexibility, as we said earlier, and that will lead to various innovative ways to how we think about space. One of my favorite examples now is that Accor hotel in France is in big trouble because there’s no tourist into Melbourne, but they have repurposed many of their hotel lobbies to act as working space. There’s coffee available, there’s space available, so when people don’t want to commute into a big town, there may be a hotel lobby nearby where they can work from.

 Increasingly, we will see companies thinking on a slightly more latching way about what it really means to work from a space. Coworking has a role to play in that, obviously, because if you’re a coworking operator and you have multiple locations and you can provide that flexibility, that will have a benefit.  I foresee that there may well be companies above the co-working companies that provide that facility to various coworking operators. I think flexible space is here to stay. There were some really good thoughts around the co-working with some pretty crazy valuations at the time, but flexibility in office space is only going to grow and the need is only going to grow.

 Real estate investors that were used to buying an office building with a 10-year lease and not thinking about the office for 10 years will no longer have that luxury. One of my key themes is that real estate is growing towards the hospitality sector.

It used to be only in the hospitality that you were measured every day. In most real estate products, you have a nice, comfortable life once you’ve secured that lease for a term. I think that is changing. Our role is speeding up on us, which again is another accelerating trend and this has accelerated further. For offices, the same will hold. Hence, coworking operators have a role, but I think that the valuations that were discussed and then that they will change the role is maybe slightly overstated.

Ben: [00:22:35] Yeah. Not wanting to be too specific, but somebody like WeWork, you would say has a fundamentally sound business model, but just the valuation was elevated.

Zsolt: [00:22:44] I think WeWork is maybe the best example of a non-sound business model. Initially it started as a very sound business model and they were truly innovative in what they were trying to achieve. Unfortunately, somewhere in between, also due to the push by SoftBank, they received so much money that the business model became unsound.

WeWork was well known overpay by over 20% for every lease versus anybody else. So if you could get a rework lease at one of your buildings, you were very happy, but now they have these 10-year commitments that are 20% above the pre pandemic market levels at which they need to try to make money. WeWork in particular does not have an easy setup. They will have to renegotiate with landlords a fair few lease and really try to rebalance into something a bit more sustainable. But again, coworking as a model is not unsustainable, perhaps not on the metrics that we were trying too though.

Ben: [00:23:43] Just to go back. You get the excellent example of how the square meterage per employee has gone down and you think that it will need to go back up, people will need more space. How do you square that with the co-working model? Doesn’t the economics stack up? Because you’re doing exactly the opposite, which is you’re taking a long lease and you’re carving it up into fitting many more sub tenants into that same space.

Zsolt: [00:24:04] Not quite. The real nuance in the co-working model is the assumption that most people are not experts in real estate. I could put it as simple as that.  If a company has, for example, one person who’s responsible for the real estate lease, then that person may not do the best planning for the company. So the real benefit for a company is -I will pay more per person and per square meter for four space in a coworking space than I pay in a normal office building, but when I need that flexibility that I need to grow further, I need to reduce, I am not stuck. When I need the flexibility of more meeting rooms, less meeting rooms, I’m not stuck. That’s the real offer. So the per square meter doesn’t translate into pushing people more closely or not more closely in the coworking space. That’s not the real game. The real game is having real estate experts provide you with the flexibility that you may not be able to achieve yourself.

The last mile logistics space really competes with light industrial space, but those activities have not disappeared. The supply of this space keeps diminishing because, as we build new residential towers, there’s less and less of this space and there’s more and more needs.

Ben: [00:25:05] So it’s like a premium for optionality. Got it.  I want to ask you about the retail market, because this is a trend that’s been accelerated because of the pandemic. E-commerce has just taken off. We’ve moved in months what people projected we would move in in years. What does that mean for retail spaces? What does it mean for distribution centers? How does that mix change within cities?

Zsolt: [00:25:27] That will be probably the most noticeable change for all the listeners as they walk on their own high street and shopping centers. This trend has been here for the last three, four years unabated, but we have done, as you said, in five, six months, what would have happened in seven, eight years.  What we’re seeing is a twofold on the traditional retail space.

There will need to be a re-purposing. Now that re-purposing in my mind is actually very interesting. I think what will happen is, in particular on hunch streets, what we’ll see is a repurposing towards everything health-related. The pandemic has made us more conscious about our own health. You’re gonna see more clinics of all sorts, but you will also see more soul cycle or boxing or you name it.  You will see people taking care of their health in a much more active way being the growth sector and you will see retail gradually disappearing. It’s incredibly acute and apparent in the UK. 20% of all the stores on Oxford Street are not supposed to open up after the pandemic. We’ve never had a statistic like that. Oxford Street is the premier street in the UK. That really shows the level of the problem.

The real issue that we have for physical retail is that we have too much space. This space will need to be changed. The issue is the capital value used to be much higher because the retailers used to pay much higher rent than the next user will pay. This will unfortunately remain a falling knife or a point that needs to bottom out where the capital value works for the next use. We will be inventive.

The one last thing that will happen in the UK is that you will see the non-central part of high streets being converted into residential because we continue to have a residential shortage in the UK. Ground floor, lower ground floor, all of these work. So most smarter councils will designate a key area that they want to keep as a high street, which should be a very short area, and then let the rest become residential.  Conversely, for every billion dollars of retail that goes online, you need about 1.25 million square feet of fulfillment space. Last mile logistics, basically. This is something that we’re in our own fund. We’re investing heavily into last mile across London. It’s a strategy that I’ve liked for many years, but has accelerated now because somehow those packages that miraculously arrive on everybody’s doorstep several times a day, they need to be fulfilled from somewhere.

The last mile logistics space really competes with light industrial space, but those activities have not disappeared. The supply of this space keeps diminishing because, as we build new residential towers, there’s less and less of this space and there’s more and more needs. We have these two very different effects where last mile is becoming very valuable. These are sheds that are not very beautiful. Sometimes, near the M25, for example, in London, whilst these are becoming ever more valuable beautiful shops, sometimes in very beautiful locations are losing value. Unfortunately, it’s the reality of how we’re living now and what are the underlying needs.

Whenever we’ve had the climate debate, it’s always been about aviation cars and so on. Real estate got away almost scot-free, which is very interesting to me because people have come to the conclusion earlier that we need to live and work somewhere.

Ben: [00:28:43], I think you alluded to this at the start, when you said the real opportunity in real estate is capitalizing on what’s changing. It sounds like area to play here is in changing the purpose of buildings, right? Hotels to affordable housing, offices to warehouses retails space to housing and so on. Would you say that’s fair?

Zsolt: [00:29:01] The first point I would make is that where I definitely believe that there’s a very large opportunity is re-purposing, refurbishing buildings. 76% of all European buildings are over 20 years old. The statistic would be very different in a Southeast Asian developing country.

 Essentially, we have the buildings we need. The environmental footprint difference of demolishing that building and building something new up that is beautiful and has all the relevant energy certificates that make it sound like it’s very energy efficient, the cost of doing that is very big. Almost 50%, 40 odd percent of the total carbon emissions of a building happen during the time of construction. So the opportunity for us is definitely in creating better buildings, mostly from the existing buildings we have and then increasing the lettable area.

The opportunities that you mentioned are great, but they’re slightly harder because change of use always encouraged an even higher capex capital expenditure. There are times when it works and it’s very exciting when it does. I love doing those types of transactions when it’s possible, but one must understand that when you change from a hotel to an affordable housing or you name it, then you’ve got to knock two rooms together. That has a real cost. The repurchasing cost, whilst very exciting, is often quite expensive. So either you need low capital values or sometimes what you do is you take an old office building and you create something new, a new office building that is a building of desire because the floor layouts are different, the air quality is different than so-and-so, but it may still have the same use.

Ben: [00:30:46] You just mentioned the carbon footprint that comes from real estate. I think I’ve read something like 40% of all carbon emissions come from real estate. So, reducing the footprint of real estate will be critical to reducing emissions overall. Where is the pressure coming from to do so? Is it top down because UN’s decided that the sustainable cities need to be one of our development goals or is it bottom up from consumers? Where’s the pressure coming from to make housing more sustainable or real estate more sustainable?

Zsolt: [00:31:16] I’ll answer your question with just one remark, which is that I have always admired that now you know the statistic and it’s starting to come out that real estate is 40% of all carbon emissions over half of all cement, over half of all basic materials we use, but nobody’s mentioned real estate. Whenever we’ve had the climate debate, it’s always been about aviation cars and so on. Real estate got away almost scot-free, which is very interesting to me because people have come to the conclusion earlier that we need to live and work somewhere. So it is what it is. 

The big change now is that the urgency of improving the carbon footprint of real estate is probably the only positive outcome I see from this pandemic, more or less in real estate, because it’s suddenly been massively accelerated. Our views on how important the environment is to us and therefore the role that real estate plays in that is being accelerated by the pandemic. It’s probably the only real big, positive I can draw from this otherwise pretty dreadful time.

You asked where the pressure comes from. I think it comes from two places. If you look at commercial buildings, most firms are looking into how can I look better from an environmental standpoint to my clients and to my investors, for my shareholders. One of the easiest ways to achieve that is let me change the environmental footprint of my headquarters, of my production facility unit.  That’s a very big driver in the residential sector, people taking a harder look at the quality of the beer they’re breeding, do they have a terrace or not -much more important in today’s post COVID time.

The other side is that institutions, real estate investors tend to do value add transactions where we create then an asset that will be sold to a pension plan or insurance company that will likely hold it forever. These end investors who are holding the assets plan told us 30, 40, 50 years, they want to be able to say on their annual report how they’re contributing to the improvement of the environment. They want the ESG to be less right- middle in the transactions they knew now.

I’ve been saying for the last three, four years, there is going to be a premium for environmentally friendly buildings and I think it’s now evident that that is the case, but that hasn’t been the case up until a few months ago. That’s the pressure.

Ben: [00:33:38] You think these things are now a constant? We’ve got a combination of we’re going through a pandemic, people have become very sensitive to environmental factors, health factors at the same time as interest rates are very low. Do you think, if the circumstances changed, interest rates go up, the economy changes, there’ll still be this drive to improving buildings? Because if yields go down, more people’s still be prepared to set aside the money it takes to make buildings more environmentally friendly.

Zsolt: [00:34:03] The short answer is yes; I believe this is a long-term trend and I think it will become a bit like hygiene. It will start to become a basic must and it will turn around.  Essentially you will be shamed if you have a non-environmentally friendly building to the point where you lack liquidity and people will want to avoid that and that’s why they’ll do. Just as much as we always get more regulation or more taxes, this will become another important thing to do for business. At the moment, it’s been mainly investors who are passionate about this who’ve done it. I think it will just become a necessity.

Ben: [00:34:41] Do you think that we can reduce net emissions from big cities?  Because you’re saying that in well established, Western cities, we’re just refurbishing buildings. So we’re not adding that many new buildings. But what about cities that are growing very fast, but there’s a large influx of new people, presumably in those cities we’re having to erect in new buildings. How do you do that and still lower carbon emissions?

Zsolt: [00:35:06] One small precision is that we refurbished buildings up until their useful life. We do have to build new buildings. There’s no escaping that fact, but we shouldn’t demolish buildings that still have a strong, useful life.

Ben: [00:35:19] What’s the useful economic life of a building?

Zsolt: [00:35:23] I would say it can vary anywhere from 30 to 200 years. The opportunity on the environmental side for real estate is tremendous. The reason it’s tremendous is because we’ve never really paid sufficient attention to it. The UK is a great example. What I love is the windows that are single windows. We don’t have in the UK the double windows, which means that the amount of insulation, the amount of heat that escapes in a residential home is incredible.

If you even take old buildings and you just do a few things, if you install environmentally friendly, HVAC heating and ventilation system that can very often lead to in excess of 20% savings…

What do you mean by ventilation system?

Heating and ventilation systems up to moment… many buildings are still heated with gas boilers, gas engines. On the minute you change that to electric heating sources, this also implies that we get more energy sources that are renewable of that, you make a significant contribution to lowering the CO2 emissions. The HVAC systems, as we call them, are heating and cooling systems at the same time.

I think that is a massive contribution opportunity. If you insulate buildings better and you create double or triple glazed windows, those savings are also in the low double-digit percentages in terms of what you can spare.

Lastly, one thing that we’ve hardly done -Australia does a lot of this, because they just brought in certain tax incentives to do so and now almost half of all Australian households have solar panels and generate almost half of their electricity within their homes. Obviously, the sun shines a bit more in Australia than elsewhere, but there is a tremendous opportunity in onsite electricity generation which we haven’t done. If we do a combination of all of these, we can significantly reduce the carbon footprint that we have today. And so, the tradeoff does not have to be, as often cited, on less square foot in order to save the planet. The trade-off is whenever we have a decision on how we renew a building, how we renew an HVAC system, how we create a new wall, if we take the right decision, we put in the right insulation, we put in the right type of HVAC systems, we will achieve the goal of very significantly taking down carbon emissions without decreasing the floor plates.

Ben: [00:37:55] I wanted to come back to something that you mentioned earlier on which is around the demographic composition of cities, because I think you talked about this when we were talking about Geneva, which is a successful city. If not well managed, becomes quite bifurcated because prices go up. Middle-class people start to move to the suburbs or to other cities. The government normally always looks after a certain proportion of housing to be affordable housing. As you said, there’s a middling out of cities. How do you stop that from happening? How do you make cities desirable to live in and affordable to live in at the same time?

Zsolt: [00:38:30] That may come to that may be one of the first questions that come to my limitations because I’m not an urban planner, I am merely a real estate investor, but I think it’s a tough call. The attempts that real estate investors have done have been various trials at innovative micro living, multiple use of spaces. A space becomes an office during the day, a sleeping studio at night and so on in order to allow young people on lower salaries to still stay in very central locations. Those are the kinds of things that as real estate investors we’ve done.

Sometimes my feeling is that urban planners don’t have an easy job in achieving that lofty goal of creating that balance and I think that sometimes the harsh market economics makes it happen.  New York right now is an interesting example because the affordability has gone to relative extremes. Right now, New York house prices are down very significantly. You can pick up an apartment at 20, 30% less than you could about 18 months ago. That harsh reality may then help some of the rebalancing that you referred to, so it may happen over time, naturally.

Ben: [00:39:40] The other trend is to turn more city centers into green spaces, but that’s a difficult thing to marry with increasing density, making centers affordable to live in and so-and-so. Is there a driver to that? Is it a sustainable or a long-term driver do you think?

Zsolt: [00:39:56] If you’re trying to create a location where you want people to desire to live and work, then some green areas are very helpful. Certainly what I felt is we have 20 different things we look at for at any building that we’re looking to buy and one of them is biodiversity. So we do try to think about how can we create some kind of a livable environment, but not just for us, but something a bit more than us throughout a building. Of course, loose tops are one idea which is being more and more exploited. I see vertical gardens now, which I think are very interesting, amazingly more efficient and greater for the environment. People can walk by and buy produce that’s made there and not having to do all the shipment that happens to supermarkets.  I really liked the idea of vertical gardens.

Most recently, one thing we did, which I learned a lot that we’re doing -putting beehives on top of buildings.  It turns out that bees that live in cities actually are much healthier than bees that live in the countryside. That’s very counter-intuitive at first, but the reason for it is because bees that live in the countryside tend to be exposed to a lot of the pesticides that is used in agriculture. Bees that actually live in the cities don’t have that particular issue, which normally makes them much healthier bees. You’ll be very surprised to hear this, but they actually take bees from cities to the countryside. It’s one of those reverse migrations that actually happens not just with people, but happens with bees as well. One of the things we were putting on one of our office rooftops – bee hives, because it’s something that we believe actually adds to the biodiversity of within a five-kilometer radius.

Ben: [00:41:43] It sounds like lots of the answers to squaring the circle here, doing all the things we want to do and, within all the constraints we face, meeting yesterday targets, moving more people to cities, reducing carbon emissions, all these things that I would say, historically -tradeoffs. The onset of doing them all at the same time without those trails is probably technology. So I wanted to start by asking you how you define a smart city, because that’s very much the buzzword, right?

Zsolt: [00:42:11] I wouldn’t even try to define it. I think Google tried to build a smart city in Canada and that hasn’t gone too well for them. They’ve had to abandoned midway. We have to be very careful with this point, especially post pandemic. I think there are genuine concerns around smart city, meaning that I am being observed and monitored at all times. The solution, what we would like to get to is a city where our lives are made easier, where energy consumption and our commute are made easier and more efficient to technology, but at the same time, we don’t feel monitored and that’s not an easy midway.

Ben: [00:42:54] Yeah, I agree. It’s a delicate balance. Just talk to us about some of the benefits of the Internet of Things. Where will we see those benefits?

Because one of the examples that people always use is that you wouldn’t have people driving around the city all day, because they’d know where the free parking spaces were, but they’re probably once that much more interesting and they have much more profound impact on urban lives.

Zsolt: [00:43:16] Sure.  On the transportation, I always think it’s interesting that many people don’t talk about the easiest one. I used to live in Singapore for a while. In Singapore, for over 20 years, they’ve had an intelligence system. You simply pay more for the usage of the highway when there’s more people using the highway. How simple is that? But it works wonders. You never get the traffic jams that you get everywhere else, because there will be some price conscious people who will simply say, I don’t want to spend that much money on it, I’ll go during the low tide. I always find it interesting that that example is not yet necessarily cited as often and that it hasn’t been copied more often.

In terms of buildings, a few thoughts. One of the things that we do really badly is that in all our buildings, the number of times that we use energy, heating or even water when nobody is near is crazy.  We’ve just bought an office building, to give you an example, it’s fascinating. We did a study on the energy usage. The building uses more energy at nighttime where there’s not a single person inside than it does during daytime. It’s crazy. It’s absolutely crazy. And I am sure it’s not the only building that does that throughout the world.

When we look at any building and we’re looking at acquiring it, we do a full study of what the consumption is over what hours, over what periods, how we see it because first you need to understand that. Once you understand that, then you can actually look at how that consumption compares to neighboring similar buildings and once you get to that phase, that’s when you can actually think about how you can improve.

Ben: [00:44:29] Why is that though, that it uses energy more energy at night? Did you come to the root cause?

Zsolt: [00:44:35] It’s a variety of reasons. I think that the night guard is churning up the heating just because he likes it hot. Of course, it’s a bit colder at nighttime, but if all the heating was turned off and we only needed the night guard’s particular area and returned on at 6:00 AM, you would have tremendous savings. The amount of times water taps are left on, not monitored, we’re not aware or there’s leaks in pipes and we’re not aware, the wastage in water, I believe the statistic was for London, the London water network loses close to 20% of all water before it ever gets to consumers.

If we had sensors monitoring where that water loss leakage is, if you think about water as not an abundant resource, it would be an incredible saving.  Having these sensors- and people also don’t feel necessarily monitored because they relate to the consumption of goods, as opposed to necessarily monitoring us- would be, would be a very strong and big advancement.

For example, if you have an air conditioning system that automatically adjusted if you open your windows, these kinds of things. Because, at the moment, nothing is connected. If we connect things, the amount of savings we can handle the will be tremendous. Certainly believe that these sensors will become ever more affordable, ever more ubiquitous and they will help us become smarter, but we’re one step away from this. This is the dreaming part.

What I find is that where we really are is that 95% of the people, maybe it’s even 99, need the first step which is actually to measure what they’re consuming. People simply don’t know yet. When we look at any building and we’re looking at acquiring it, we do a full study of what the consumption is over what hours, over what periods, how we see it because first you need to understand that. Once you understand that, then you can actually look at how that consumption compares to neighboring similar buildings and once you get to that phase, that’s when you can actually think about how you can improve.

Ben: [00:46:35] I was happy when we talked about smart cities or the Internet of Things. Do we not need to invest more power into certain central bodies? Because, as you said, everything, to achieve this efficiency that we’re talking about, everything needs to be connected. Then, we can’t as individuals have this devolved responsibility because then we won’t achieve the big goal. So do we need to invest more power in governments? who would be the right person to solve control internet platforms in real estate?

Zsolt: [00:47:04] I wish governments were up to the job. The problem is that governments are always playing catch up. One of my favorite recent examples is that, in London, every single planning application was put online in a PDF format, which means they’re on a search tool. So you’ve taken something digital after 30 odd years and you’ve made it manual online, which is completely useless. That’s a very good example of unfortunately how planners and regulators think. If you had forward-looking regulators, and there are some examples I -think Singapore is probably a very good example- then with absolute pleasure.

I think it’s a great idea but the problem is you need to be in the right city because you risk having nonsensical rules and regulations if your regulators are not for the job and that would be even worse. Normally, the way innovation works is, somebody has a great idea and they just go for it. If you stifle that innovation, then your city will become a laggard.  It’s a very delicate balance and I think it only works in cities where you have truly forward-looking planners and that’s pretty rare, unfortunately. I hope it changes. It’s pretty great.

We are living in this very interesting moment where people who don’t adopt to the new technologies and it will come in every way.

Ben: [00:48:16] What about the real estate operators themselves? Because I think I read this in something that you wrote that the real estate sector spends only one and a half percent of its revenues on it.

If we compare that to the sector in which you work predominantly, which is financial services, I think financial services spends 10% of its revenues on IT. So is a sector that spends just one and a half percent of its revenues on IT in a position where it can capitalize on smart cities, the Internet of Things, sensors and new tech?

Zsolt: [00:48:45] The point that you touched upon, and that’s exactly why I wrote an article by the way -I do spend most of my time in real estate luckily, it’s something I love and I’m passionate about- is that real estate is probably the most old school industry I know. Real estate is always very backward looking. Is felt by most people that, Hey, I bought a house, I can do real estate. It is also because it’s brick and mortar people feel that this will never change, this won’t get competed out as many other industries have. We are living in this very interesting moment where people who don’t adopt to the new technologies and it will come in every way. I think artificial intelligence will help smarter people make smarter acquisition decisions. It’s already in the works and we’re trying to look at it as well. It’s not quite there, but it’s very close and it’s going to happen.

The example would be the people who manage, for example, block of residential flats. If it’s managed by a local guy who goes there and tries to talk with the tenants versus a large company that will have an app on a phone where the minute your water pipe has a leak, you just push a button and that automatically goes to the local plumbing company that you have an agreement with and they’re out in 20 minutes. You’re not going to be able to compete. Technology will go through the whole value chain of real estate from acquisition to the ownership and asset management thereof. I think it’s finally happening. It’s amazing to me that it’s taken this long and I believe it’s going to change, but we’re just at the inflection point today.

[on tokenization of real estate] This is the Holy grail that, in an ideal world, I could buy a hundred dollars’ worth of an office building in New York.

Ben: [00:50:18] This is my last question. I can’t avoid asking this question just because I think it’s going to be of interest to lots of our listeners. Where do you stand on the whole tokenization of real estate? How far away is that as an opportunity and what will it do in terms of democratizing real estate as an asset class?

Zsolt: [00:50:32] We’ve reviewed a few opportunities. There’s definitely various efforts out there to achieve that goal. This is the Holy grail that, in an ideal world, I could buy a hundred dollars’ worth of an office building in New York. My key concern around it is around the agency problem. This last 26 years, what I’ve always seen is real estate suffers when you don’t have a true owner with capital aligned and working on it.

The minute you have this slightly misaligned and you have a management team that looks after the asset and you have a disparate group of owners that can trade their shares as they wish, then the management team is going to get comfortable. They’re not going to wake up every morning thinking how am I going to push this real estate and create the best value I can for myself and my fellow investors. They’re going to think I want my long holiday. I want to do the minimum I have to and I’m good because I’m getting my management sheet.  That agency problem and conundrum, nobody has really solved.

Until that is solved, I think that will hold back tokenization the way it is in the dream. The other big benefit of tokenization, which I think is probably closer, is the simple idea that today, in real estate, the frictional costs are very big.  Buying or selling a building in order to prove that the deeds of that building have gone from you to the other, normally you have to go through a notary and they charge literally a percentage of the whole transaction. Sometimes even 0.3- 0.5% of the transaction value and that makes no sense. That could easily be taken out by a sort of tokenization of the real estate that makes it clear through a dispersed ledger as a blockchain allows to prove the beneficial owner of any real estate buildings.

 It’s a bit more regulatory driven, so that involves the regulator being a bit more forward-looking because normally, to date, it’s been a city council that had the deeds of ownership.  So the city council would have to be forward-looking enough to allow that to happen in cyberspace, as opposed to at city hall.

The other tokenization of us owning a hundred dollars of a building in Australia and another one in Austin, Texas, I’m not sure that will happen really successfully in the short-term because of agency problem.

Ben: [00:52:54] Thank you so much for this highly interesting and entertaining conversation. Thanks for coming on the show.

Zsolt: [00:53:00] Thank you so much.