JPMorgan Chase & Co. (JPM) Earnings Call Transcript & Summary

Hi, and welcome to REITworld and spotlight session on the outlook for REITs and the economy. I'm Lindsay Dutch, a REIT equity analyst with Bloomberg Intelligence, and I'm excited to moderate this panel. With me today, I have Laurel Durkay, SVP Portfolio Manager with Cohen and Steers; Mark Streeter, Managing Director at JPMorgan; and Calvin Schnure, NAREIT's Senior Economist.

Calvin, let's start with you. Maybe you can discuss the macroeconomic backdrop for us and provide some perspective on what happened in the third quarter and what you're expecting for economic growth as we head into 2021 and how the timing of the vaccine may impact that outlook.

Sure. Thanks, Lindsay. You look at what happened over the past 6 months and how we got where we are, it actually gives us quite a few clues about what might happen over the next 12 to 18 months. I'm going to stress 3 things in particular. One is the question, well, is this a V-shape recovery or what's keeping us from a V-shaped recovery? We had a long debate about the letters of the alphabet earlier this year. Second thing I want to talk about is the nature of this economic being a 2-track economy, a 2-track recovery in the year with COVID. And then third, I can point out that there are some aspects of the economy right now that are going to be really important for the growth once we move beyond COVID. So in terms of the letter, is this a V, W, K, whatever you want to call it? In the second quarter, the economy saw a 31% annual rate. Then we saw the third quarter, it came back at 33% annualized. So does that look like a V? Well, no for a bunch of reasons. One, just the math, if you fall 31% from a large number and then rising 33%, you don't get back up to it in percentage terms. Economic activity in the third quarter is still about 3% below a year ago. Now that's equivalent to the depth of a moderate to bad recession. So we got back to the point where we're only in the middle of a recession, not a financial crisis, not a major crisis. When you look at the job market, we're still down maybe 10 million jobs, 9 million to 10 million jobs. We have a long way to go. Second thing is the 2-track nature of the recovery of the economy. The COVID pandemic did not hit all parts of the economy equally. And those with a high risk of infection: the travel, the hotel, the lodgings, the restaurants, the entertainment, those areas had a very big impact and they're still quite a bit depressed. We are not going to have a full-fledged recovery until the pandemic is brought under control, a full-fledged recovery of the health situation and the economy. And that's kind of a parallel in the real estate sectors. If you look at which sectors of commercial real estate are doing well, doing moderately and which ones are struggling, you see the same 2-track pattern. You can just map into the hotel lodging and sorts, the retail sectors. But finally, looking at this overall economy and how we got into this recession and are coming out, it's really important that this was an external shock rather than internal weaknesses. Most other economy -- economic recessions happen when there are internal weaknesses in the consumer sector and the banking sector are overheating that cause the Fed to raise rates to the economy. Those really were not present. If you look across the economy, you see consumer household balance sheets are much stronger. Many people are struggling, those who've lost their jobs. But in the aggregate, the household net worth, it is still quite a bit stronger than it was, say, during the Great Financial Crisis. We don't have the banking system on the ropes the way it was in 2008, 2009. A lot of corporations have stronger balance sheets than they did then. What that means is if you remove the cause of this, that people still can't congregate freely in other places, whether you're traveling, eating in a restaurant, going to a movie or entertainment. Once you remove that, there are a lot of other parts of the economy that should be able to come back. So what do I expect for the economy? Obviously, we're in a real surge again of the pandemic. So we're still going to be touch-and-go with good news and bad news based on the pandemic over the next 3 to 6 months. But beyond that, we do have some chance that many of these parts of the economy will come back quicker. There will be some financial damage from bankruptcies and losses to clean up. Those are going to be important. But the rest of the economy still does have a lot more strength than it would have in some other downturn, economic recession in this magnitude. So it's cautiously optimistic for next year.

Great. Thanks. Laurel, Calvin mentioned jobs; you manage a global portfolio of REITs. Maybe you can dive right into the office market and discuss the differences you're seeing around the globe when it comes through a near-term office demand, but also the possibility for a longer-term shift with working-from-home trends?

Sure. Thanks, Lindsay. I think offices really have been a really interesting sector to look at and to understand the sort of reaction that offices have experienced within different cities across the globe. And I think it's important to note that it's definitely not a one-size-fits-all reaction. And the different cities are reacting differently. And therefore, different property portfolios are reacting differently to what we've seen unfold throughout COVID. Certainly, across the world, work from home absorption rates are at record high levels. And so the efficiency and productivity that corporates and enterprises have been able to realize, has really exceeded expectation. But that being said, it does not mean that you're going to have permanent work from home everywhere, 100% of the time. And instead, you really need to take a step back and understand some of the idiosyncrasies of the global cities that we invest in. So when you think about the main factors, how I would frame what you should focus on, it really is about the industry mix of the city that you're looking at. To the extent you have a city that has a disproportionately high number of office jobs concentrated in healthcare or education, we think their propensity to work from home longer-term is going to be lower than that of other industry types. The other thing to look at is really going to be the average residential size in a particular city. So you look at Tokyo, average residential size for a family of 4 is about 700 square feet; you foil that against an average residential site in Washington, D.C. for a family of 4 is probably double, triple, quadruple that. The propensity for that individual to want to work from home and be able to productively work from home is going to be very, very different. The other thing to look at is just what's the big space users in the individual market? So a market like New York has over 40% of their users take a significant amount of square footage, 50,000 to 100,000 square feet. Whereas there are other cities where the average tenant size is under 5,000 square feet. So the ability for a large-footprint tenant to rationalize space in reaction to work from home absorption trends is significantly greater than that of these much smaller footprint tenants. And then there's also cultural considerations. There are simply some cities in which face time and in-person work is valued more dearly than in other cities. And then finally, and this is more of an emerging market versus developed market concept, you need to understand the digital infrastructure in place within different cities to help facilitate that work from home versus in-office work. I mean we've looked at all of this across the board, and we really do believe that ultimately, demand will be impaired somewhere between on the very low end, around 2% to 3%, to the high end, 15% to 20% over the next several years. So of course, that's just one element of the equation. Work from home will likely have a negative impact. But you then have to look at, well, what's job growth going to be in individual cities? Are there actually de-densification trends that are going to unfold? Certainly, there is an increased focus on health and safety. And health and safety in the office means maintaining appropriate social distances from our colleagues. And so the densification trends that had been playing out, really over the past decade or so, will likely reverse, and you're going to see some de-densification that will be a benefit to office in almost every city that we look at. And then, of course, you also need to look at where supply is because there's already supply on the ground across the board in different cities. And so that is always something that you need to consider when looking at what is that net demand going to be. At the end of the day, I think that to the extent you have a property portfolio that is much newer, and you have a portfolio less prone to some of this new supply that is coming online, and you're in a city that is anticipated to experience pretty robust job growth, that is a good place to be and a good portfolio to have.

Great. Thanks. And back to you, Calvin, just quickly, Laurel mentioned the job growth, but is there any other macroeconomic data points that we can be looking at to sort of give an indication of what's to come in office and maybe which of the regions may be better that are suited for those -- the landlords there?

Sure. As I was listening to Laurel, I was going through it and ticking off, everything she was just saying was on my list as well. Obviously, looking at job -- overall job growth, the reversal of the densification spend, the new supply, and actually on new supply what you didn't really point out is that there's been a moderate level of construction but it was much lower than we had at the peak of previous cycles. 2% or less of the market in most places as opposed to 4%, sometimes even higher amounts. What that means is we're not going to be receiving a lot newer deliveries, right, in the trough of this crisis, that's an overall positive feature. I actually did a research study about 2 years ago with a colleague, Lexi Thompson. We looked at regional patterns -- the regional migration and how that affected the fundamentals for the apartment market and for the office market across gateway cities and secondary cities in the U.S. And the main difference in population growth and job growth in the different metro areas is just because of migration. And so -- so you have a lot of the larger, established cities that have had very little job growth on variable population growth. But then you have something like Seattle, that's been growing 2%; Austin, Texas, with even much greater; in Nashville, Denver and those cities. And what's interesting is we were talking about jobs from a professional composition of the jobs in that city is a pretty strong indicator of the migration patterns. So particularly if you have finance management and to a bit lesser extent, tech jobs, information technology jobs, those are the cities with higher in-migration that's going to support the office market for several years in the future. And what's really important for this is, those migration patterns are fairly persistent. These are not things that reverse over 18 months or something like that. The cities that were growing pretty rapidly, the 3 to 5 years prior to this crisis, are probably going to the one -- be the ones generating more jobs, drawing people from across the country as we come out of this crisis. So those are the areas where the office market is probably going to recover more quickly. Now fortunately for our industry, for REITs, that's where the majority of the REIT properties are located. So to the extent that there's a lot of geographic dispersion of different types of buildings, the REITs in many cases are in the right markets for how we come out of this pandemic.

Great. Mark, I really want to get you in this conversation. I think that one thing that has separated some REITs during the pandemic is their balance sheet. And that's been really important and the ability to access the capital markets. So could you talk about debt issuance with the pandemic? And how this time around is a lot different than the Financial Crisis? And how does the investor appetite vary by property type?

There's a couple of things going on. First off, relative to the Financial Crisis, leverage parameters, in general, are just much, much lower, right? Going in the old rule of thumb, again, going back 10, 15 years ago was 50% leverage, thereabouts, right? And when you have something that's a shock to the system like the Financial Crisis, where people are extrapolating 30%, 40% declines in property values and so forth, all of a sudden, that 50% leverage looks like 80% or 90% leverage and you result in some of the dilutive rescue capital that came in and so forth and all the self-help measures that the REITs had to pursue back then, which of course was very dilutive to shareholders. And created certainly a lot of angst in the credit markets. Now what we've seen this time around going into this shock to the system, this pandemic, was that leverage had come way down relative to where it was previously, sort of more into the sort of the 25%, 30%, 35% range. And there's a lot of thought out there, a lot of academic studies about what is optimal leverage and so forth. Green Street likes to push that REITs should have no leverage. And we're not -- maybe I'm talking about book a little bit as a credit analyst, but I don't like to see REITs with 0 leverage, right? I don't think that's efficient for all stakeholders, right? I think the -- certainly sitting at a 30% leverage level, even if you have that 20%, 30% correction property values, you still end up in a situation where leverage isn't really more than sort of 50%, 60% tops at the bottom of a cycle. I think you have enough cushion. And what we've seen, of course, is that REITs own institutional quality assets for the most part, right? So if commercial real estate is falling and values are falling by whatever that extreme measure is, REITs are going to fare better than the overall market, just simply because of the positive selection that the public markets have on -- with most of the REITs. So going into this pandemic, leverage was a lot lower. Now last year, we had had, in 2019, we had had record issuance of refis. And so this year, and there was a lot of pull forward, and REITs have done a good job, given still record low all-in yields and cost of funding last year, a lot of REITs had really already did -- addressed their 2020 and their 2021 maturities back in 2019. So we were actually expecting REIT issuance to be down very significantly this year from around $40 billion last year, the way we track it, which excludes American Tower and some of the nontraditional property sites; we're just talking about the major property types. Last year, we saw about $40 billion in issuance. We thought this year, we might start the year -- or our expectation to start the year was maybe around $30 billion, so down about 25% or so. We're probably going to end up pretty close to last year's level right now on an apples-to-apples basis. We're about 35%, 36% -- we're in the low 30s right now, but it's growing every week. We've got some more companies doing calls today. So we probably will get to around $36 billion, $37 billion by year-end. So year-over-year, it's not going to change all that much. And that is, of course, because when the pandemic first hit, we had an awful lot of REITs that just had to do that emergency liquidity to, whether they had CP programs outstanding or just wanted to bolster the balance sheet, fortify the balance sheet, to show the liquidity -- really to put to bed any sort of solvency concerns, while collection risk was going to be an unknown. And of course, we all saw what happened to collections back in March, April, May, and how they've continued to improve and progress, perhaps stalling out a little bit; we'll see what happens now over the winter. But at least we've improved to the point where, certainly, there's very few REITs that we're really worried about. Obviously, the weak hands have sort of fallen. We've seen the CBL bankruptcy. WPG, for example, is in a -- close to a restructuring type situation. We saw Penn REIT filed. And so -- so the malls, the struggling levered malls, ended up succumbing to the pandemic, so to speak. But really our sort of fallen angel list, which is what we talk about, which are the names that were investment-grade rated that could fall to high yield, at the beginning the malls were already -- the B malls, if you will, the CBL's, Penn REITs, WPGs, they were already rated high yield. But going into the pandemic, we had just a few names around that cuspy list. Names like service, Service, SVC, names like EPR with movie theater exposure. And those have all now fallen in transition from investment-grade to high yield, but that was pretty much expected, right? Hotel REITs, movie theater-exposed REITs -- [ et cetera in Sabra ], but they've been able to maintain their low investment-grade ratings. And right now, I would say the base case is, they'll be able to make it through. But clearly, the impact of the pandemic, first and foremost is that we have seen more issuance than we would have thought. And what was really interesting, too, just in terms of sector performance real quick, was that going into the pandemic, REITs did incredibly well. They were outperforming because of that positive technical where there wasn't going to be a lot of supply. So in the first quarter of the year, REITs were a top-performing sector. And when the pandemic hit, REITs actually reacted very late. It really took until sort of the middle of March. The rest of the corporate market blew out the end of February, beginning of March, REITs had a lag. But when REITs finally blew out in terms of credit spreads, and they blew out hard and they were late to recover. And that's where we are right now. We're still in recovery mode. The rest of the corporate bond market has come all the way back inside of where we were pre-pandemic. REITs are still outside of where we were pre-pandemic. So it's one reason why our sort of house view, and my view, is still bullish on REIT credit because I think we can continue to rally in versus the rest of the market.

Great. And going back to those mall bankruptcies just for a second, so what should we be thinking about in terms of those -- as those REITs look to restructure? And how might changes in mall asset values really impact the process or the end results?

Yes, it's interesting, right? Because if you look at CBL, CBL really is the first equity REIT in 27 years, which happens to be my career in REITs and really the modern REIT market started in the early '90s -- it's really the first modern REIT bond that had all the standard equity REIT covenants, right, in the bonds: an unencumbered asset test, a total leverage test, a secured debt test and interest coverage test. If you remember, those of you that follow General Growth and Rouse and so forth, those Rouse bonds that defaulted didn't have an unencumbered asset test. But CBL does. So this was really a watershed moment with CBL filing because one of the things that we've constantly had a very interesting debate with the rating agencies, for example, is why are REITs rated BBB if they never default? I mean BBB implies that over a 10-year period, you might default 5% to 7% in any given cohort, yet we just went basically almost 3 decades with no defaults. Well, we finally have one, and we'll see what happens here with CBL and with Penn REIT and so forth, but CBL being very interesting just because of the unsecured bonds there, and there's lots of headlines just today about the banks and the bondholders fighting. But clearly, the value diminution there had been ongoing well before the pandemic, right? And all the secular changes because of e-commerce and so forth. And I think what would have been really interesting to see how long someone like CBL or Penn REIT could have muddled along here, dealing with, obviously, all their anchor bankruptcies and so forth. Clearly, the pandemic was the catalyst for the filing here, but there was a path for them to at least try to get through the next year or 2 and see what happens. But clearly, JCPenney, Sears, everything, Bon-Ton, et cetera, on top of the pandemic, that really exacerbated the situation. And you tell me where the values are for a mall right now, for a B mall. If it doesn't have an alternative use, and we're just looking at the existing tenant roll, sort of rolling down over time and so forth, is the value down 35%, 50%, 75%? I mean those are the types of debates we're having with investors. I mean the only saving grace -- and it doesn't really impact malls, it's really for other sectors -- is that we are still in a very low interest rate, low yield environment right, which is keeping a lot of that sort of downward pressure on cap rates. But that doesn't apply for malls where you have no idea what that cash flow is going to look like over the next 12 to 24 months. So how are you going to apply a cap rate to what you don't know? And that level of uncertainty has again resulted in what we're dealing with right now.

Perfect. Thank you. Laurel, maybe you can give sort of an equity perspective on retail, sort of the longer-term view there. What is the future of retail real estate? And if you have any thoughts on asset values.

Yes. No, absolutely. As Mark pointed out, I mean, what's happened this year has been a question on solvency for some of these retail landlords as well as the actual retailers. But what has come to a head and been accelerated by COVID-19 are actually trends that had been really unfolding for the past 5, 10 years at this point in time. Certainly, it was the growth in e-commerce and omnichannel distribution. It was the fact that you had increased spending on experiences and services and less so on apparel and more of these discretionary hard goods. But then you also have the department-store business model, which just wasn't really working as well as it had been historically in this new modern era of social media and influencers on the Internet. So it really has been accelerated, again, by what we have seen through COVID. Social distancing, quarantining, the closing down of economies here in the U.S. but also globally, really has accelerated store closures, has accelerated bankruptcies, that perhaps otherwise these issuers maybe would have been able to muddle through at markets today. And instead, they have had to just close down. That being said, when you look at the retail sector, I am a strong believer that you still need the physical storefront, and you still need that distribution point. Retail sales over the past 6 years haven't been falling off a cliff. Yes, they've been impacted this year but when you look longer term, it's not necessarily that retail sales have been significantly impacted. And instead it's just been this mix shift of where that consumer is looking to get their goods distributed. And so when I look at the impact to real estate, yes, there will be an impairment to values. The winners and losers really will begin to emerge; and the stronger platforms and more savvy management teams with a higher quality property portfolios are ultimately going to become even more dominant 5 to 10 years from now than they were historically. I don't think you're going to see the physical storefronts completely go away. But we will have a lot of these stores and a lot of these centers closed. But arguably, that was something that we needed regardless of what had happened with COVID.

Right. And do you [ see any different ] -- I know right now it's open-air is preferred because of the pandemic. Do you think that's a long term thing? Or is it really about quality, location, with a quality tenant mix and that's where people are going to go shopping, whether it's a mall, whether it's an outlet or whether it's a strip center?

I think it exactly is about quality, as you're saying. But I think the definition of quality is something that you need to delve a little bit deeper into. Because when I am looking at quality, I'm looking at the productivity of that center. And I am looking at area demographics and the density of population and the wealth of that population. Because ultimately, that is what is going to drive traffic into the center and that is what is going to drive the profitability of that center. And when I am looking to invest in a landlord, I want the landlords that have the ability to charge the highest amount of rent and be able to maintain the highest level of occupancies. And so I honestly, I'm indifferent: Is it open air? Is it a strip shopping? Is it power? Is it enclosed mall? What I'm caring about is the productivity of that center.

Perfect. [ I think ] about training, [ health care, especially ] for retail, there was basically a shutdown in the transaction market. It hasn't really picked up very much. So do you see that sort of picking up with a lowering of -- I'm sorry, or increase in cap rates? And do you see that sort of happening in 2021? Or what's your outlook there?

Yes. No, I think that's a difficult question to answer because, again, what you have seen are secular changes unfolding within the space, that is really impairing the value of this real estate. It is not a COVID-19 slowdown in the transaction market. And instead, it's much bigger than just what has unfolded this year. Ultimately, I do believe you're going to see capital come back into the retail market. It will likely be in smaller increments. So likely strip shopping centers as opposed to regional malls, and it will likely be in more of these quality, high productivity centers.

Got it. Right, let's switch gears a little bit and think about what are the sectors that saw an increase in demand: warehouse, data center, we talked about a little bit earlier, maybe some of the cell towers. Laurel, last one for you before I switch it off. But could you give some thoughts on those sectors and what you're sort of seeing, maybe going into 2021, but also longer term? And I think geography is also important here. I mean the big data center REITs, they have portfolios all over the world. They continue to expand. Obviously, that's a big, important piece of their growth.

Sure. I think this -- the new economy sectors are ones that have benefited from COVID-19. But again, take a step back, look at the bigger picture and understand the demand drivers that have been significant tailwinds to these new emerging asset classes, whether it be data centers or cellphone towers or the industrial space. And you have seen that those demand drivers have been very, very robust for quite some time. It's my belief that you're going to continue to see pretty significant demand and tailwinds within each of those individual sectors going forward. When you think about the new economy, it really is predicated upon the digital economy that we all live in today. And that is reliant on data exchange to help facilitate commerce and personal interactions and really our day-to-day life. When you think about what data centers, cell phone towers and industrial, in a different way, are doing is they, again, are helping us live our life. And it's not something, again, that has only been COVID-19 related, but instead, it has been this exponential growth in data exchange and how cell towers and data centers have facilitated that data exchange, that really is just awe-inspiring. And to your point, it's not something that is regionally focused. And instead, this is a trend that has been playing out across all regions of the globe. And when you look at the strength of the platforms, the extent you have a platform that does have a very global breadth, that is a data center platform or a cell tower platform that has been doing better. And I believe, will continue to be very dominant going forward. So it's an interesting dynamic when you see that the global trends really have been reflected in such strength. And you can see these pockets of opportunities within all 3 regions.

Perfect. Look, when I think about these new economy sectors, do they approach raising capital the same way as sort of the traditional property types? Obviously, their stock prices make equity issuance an option, but I was curious on how they have a different thought process?