Episode 27: 5 Ways The Outpost Economy is Changing America
What might have been temporary work-from-home is now permanent for large swaths of employees, particularly those at tech companies. Both employees and employers have shifted to current and budding secondary markets where better quality of life waits. In this episode, we dive into the 5 main effects we're seeing.
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Ryan Swehla:
You've got a situation where the employee and the employer relationship has shifted. Wages are going up. More people than ever have left jobs. And when people leave jobs, it's because they believe that they have better opportunities to find another job. So, you've got an environment that also allows the employee not to state terms but at least to say, "Hey, employer, these kind of things are important to me.”
Speaker 2:
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Joe Muratore:
All right. So, today we're talking about five ways the outpost economy is changing America right now. Interesting title. Let's start by framing this by talking about what might be called the great renegotiation. So, COVID happens and essentially, the pent up demand and the... if there's a fault line, if it had shifted it, it changed. Everything changed. It went up into the air and the great renegotiation said, everything can be renegotiated right now; global status, local status, employer, employee, whatever, it's on the table. And I'd start by saying that in many ways, this is a healthy thing. There was pent up demand or whatever in different spots, and when this happened, there was an opportunity to create a new equilibrium, a new way for things to play out. And in many ways, that supports secondary markets. And when we talk about the outpost economy, in many ways we're speaking to secondary markets; things that are not the primary markets but things that are other than.
Ryan Swehla:
Yeah. And I think of this COVID environment is an, kind of an existential crisis, essentially. And we all agree with that in the sense that, "Oh, there's this disease and what does it mean for me? And am I going to die?" Certainly. But there was also a deeper thing that happened, or at least as deep, which was, "What am I doing? Is this the life that I wanted to lead? Now that things all got shook up, is this where I want to be going with my life? Is this where I want to be going with my career? Is this the family balance that I want to have? Am I building the stability that I want in my life?" All these big, important questions came to the surface in a way that we never would've fathomed. And that had a huge impact on where things have gone since then.
Joe Muratore:
I like to think of it, maybe biologically, in two categories; family formation and wealth creation. So, if you're a millennial and you're in San Francisco and you're turning 30 or 35, you're wondering two things. Number one, "Do I want a family? And what does that look like? Do I have children? Where are they? How are they walking to school? How do I feel?" I mean, at the end of the day, most of what we are is our feelings. And people are asking, "How do I want to feel?" And if I feel like I have not built the family I want to build, it gets really urgent really fast. Secondarily, if they haven't purchased a home or they haven't done things that are going to lead towards quality of life later in life and in retirement, there's an urgent sense that I need to be building some sort of wealth, some sort of store of something right now. And the secondary markets provide those, in a way, I mean, that the primary markets often don't; affordability, the opportunity for family formation, and the opportunity to purchase a home are much stronger in secondary markets.
Ryan Swehla:
Yeah. And back to this idea of the great negotiation. For context, we are now in one of the tightest job markets that we've been in, in recent memory. So, you've got this... And then on top of that, actually I should add, we have tremendous demand for goods and services. People have been saving up money, they've been staying home, whatever the case may be. And now they want that new car, they want to go places, they want to do things-
Joe Muratore:
The stock market topped 36,000 today.
Ryan Swehla:
Yeah.
Joe Muratore:
Another record. I mean, wealth is there.
Ryan Swehla:
Yeah. And so, you've got a situation where the employee and the employer relationship has shifted. Wages are going up. More people than ever have left jobs. And when people leave jobs, it's because they believe that they have better opportunities to find another job. So, you've got an environment that also allows the employee not to state terms but at least to say, "Hey, employer, these kind of things are important to me. And being in an affordable, high quality of life place to live is important to me, and I'm willing to trade the job opportunity that you have for my ability to be in those places."
Joe Muratore:
Yeah. But it requires leverage. It requires a knowledge base, something you possess, because if you don't have any control over your job or over your knowledge set, you can move to Albuquerque and leave your job, but if you don't have something of desirability, then you just move to Albuquerque. So, I think this speaks to a group that has developed a set of skills, that is in the position where they can go to a quality of life somewhere else and use those skills. I would add on the employer side, I think there's great attractiveness to this. Our company is in the secondary markets and it's a challenge to find the talent pool we need. We have an exceptional team of 40 people, but increasingly we have people that work in other states and that I talk to on the phone regularly, and so do you.
Ryan Swehla:
Yeah. Yeah.
Joe Muratore:
And so, solving this productivity and culture thing in other states, in other places, is a great opportunity too for employers.
Ryan Swehla:
Yeah. So, let's move into what we think some of these big changes are going to be as a result of the outpost economy.
Joe Muratore:
Sure. So first one, let's talk about deglobalization. So for the last 30, 40, 50 years, we've been hearing about globalization and just-in-time delivery, but now we've got... I order a refrigerator a month ago, it's not going to be here for three or four more months. I mean, we have both ordered new laptop computers. They're-
Ryan Swehla:
Who knows when?
Joe Muratore:
Good luck. They might come when they come. But what we're seeing, and it's now starting to be more widely reported, is that control is more important than cost. And the pendulum has swung back to having products where you can control them rather than having other companies in other countries be part of your supply chain.
Ryan Swehla:
Yeah. And in a sense, I would say that that's also from centralization to decentralization. What we've been operating on a paradigm has been around major economies. It's been major economies providing for the world. It's been around major metro markets providing the economic engine for the country. And what we've seen is that spread out a little bit. It's not to say that it's going away by any means, but what it has been, the analogy I like to use is, take the Bay Area, for instance. You have a fire of economic and innovative activity happening, and a breeze came along and spread those embers across the rest of the country. So, it's not to say that that fire is somehow going out or anything like that, but rather we've now got flames in other parts of the country.
Joe Muratore:
Yeah. And there's a disruption and a new equilibrium that needs to be created. That talent exists out there and now it can be purchased at different price points than before, it can be worked with in different ways. People are doing part-time, flex time. They're starting their own small consulting firms, there's gig economy. It reinforces the secondary markets in that talent exists there, but also real estate costs are lower. So, warehousing costs are lower, you're more likely to have supply chain items there in major markets.
Ryan Swehla:
And when you look at, I think that The Wall Street Journal reported recently on the top five markets that they expect to see the highest rent... or I'm sorry, home price appreciation. And there were all these cities I hadn't even heard of.
Joe Muratore:
Yeah.
Ryan Swehla:
So what's happened, back to the kind of the deglobalization or the decentralization, is as people have the ability to work a little bit more remotely, all of a sudden you can look on a map, and I think a lot of people did this last year. They looked on a map of the United States or even of the globe and said, "Where do I want to go?" And on the one hand it spreads things out, but it also makes things a little bit more interconnected. Macon, Georgia, has more connections to San Francisco today probably than it did two years ago.
Joe Muratore:
Well, and there are probably people in Macon, Georgia, that could benefit our company, and to have the ability to work with someone in Macon, Georgia, is incredibly powerful. So, it's almost like there's this new supply of talent because not only did people leave the Bay Area and move to Macon, Georgia, or Chattanooga, Tennessee, or wherever. But there were talented people that never left, that maybe went to Georgia State or something, or Georgia Tech, and lived in Macon, Georgia, and could have added value to companies in the Silicon Valley but they didn't want to move. They had family reasons or whatever. And this opens up a whole new piece of capacity for the country that I think private equity and companies will just be like, "Great. How do we unlock this talent?" It's a powerful force.
Ryan Swehla:
Yeah. And that speaks to our second point, which is an amplification of the gig economy. I think one of the statistics that sticks in my mind most recently is the number of new business applications, and that's measured by new applications for tax ID numbers. So, they've been recording new applications for tax ID numbers since 2004, and if you look at that chart, the historical average up until 2020 was a certain number, and I don't remember what that number is. Right now, it is almost double that average. So just since COVID hit, we have seen a doubling in the number of people applying for new business applications. And what's even more interesting is, I saw a chart that looked at what they call high propensity jobs or businesses. These are businesses that are likely to add additional employees. That number hasn't changed a lot. The number that has changed a lot is businesses that are not high propensity.
Ryan Swehla:
So what that means is, most of these applications are for business types that are going to be freelancers or independent contractors. We've taken what we knew as the gig economy and we have just amplified that, because as people move across the country, or like you said, in Macon, Georgia, they already live there but now they realize that they can do business in other parts of the country, it's just, it's amplified that. More people feel freedom to pursue entrepreneurship, self-employment, than ever before. I think that's powerful.
Joe Muratore:
So, how do you think that plays out over the next five years? When, if we're talking five years from now, what's different?
Ryan Swehla:
I think what's different is the gig economy was this idea that more people are using independent contractors as a means, as a proxy for employees. And I think that that's probably a permanent shift, especially when you have people that are in other parts of the country. You have, like someone we're working with right now. They are an independent contractor and they have the ability to work remotely from where they work, but the quality of work that they do made it worthwhile for us to say, "Yeah, I'll accept that relationship." And so, I think going forward we will see kind of a permanent new shift into more of that gig economy.
Joe Muratore:
I think that that promotion of entrepreneurship will have a major effect on the country and a multi-generational effect, because when someone starts that, I mean, that first kernel of entrepreneurship is, "Hey, I was doing a job there. Can I do it as a consultant?" That's the most immediate kernel. But with every business, there are pivots and changes and new opportunities to add on services and learn new lessons. And certainly, some of those will just stay as consultants but some of those will say, "I really need an employee, or two or five. And hey, I need to hire people in different spots because it's more convenient."
Ryan Swehla:
"And I need an office space."
Joe Muratore:
Yeah.
Ryan Swehla:
"Instead of working out of my home." There are a lot of kind of far reaching implications when people can be employed in an independent contractor relationship anywhere in the country.
Joe Muratore:
Yeah. So, let's talk about the next idea, the idea that we're going to see more single family home rentals. I'll start by saying I was at a conference last week where the group was talking about this. It was an investment manager's conference. And number one, this has been a major trend over the last 10 years. The idea of single family home rentals is about a 10-year-old trend. Not... let me say, single family home rentals at scale; companies buying hundreds and thousands of these units. But the comment coming back at this conference was this industry, this piece of investment, investing is still a bit in its infancy. These next 10 years are going to be a much bigger deal.
Ryan Swehla:
Why?
Joe Muratore:
Well, part of it is that they're unlocking an investment opportunity. This has been predominantly a mom-and-pop industry; a rental home here, a rental home there. But everything can be done better at scale. And so, many of these groups are no longer doing what's called scatter site single family home rentals, which is that you own a bunch of little ones all over the place, but rather developing single family homes for rental from the start, which means that those, the product can be tailored to the customer, to the demographic. It means all the water, hot water heaters, are in the same spot with the same meter, with the same whatever. And you can service them, they can be tech driven, they can have solar. When that hot water heater goes out, it can alert an app or a headquarters so that things are fixed more quickly. And interestingly, people who rent single family homes tend to live there three or four years versus in an apartment where they tend to live about one year. So this serves a, rather than a more single or a couple demographics, serves more of a family.
Ryan Swehla:
Well, in a sense you're saying it's not necessarily creating a new product type as it is institutionalizing.
Joe Muratore:
Yeah.
Ryan Swehla:
Because we all know people who, "Hey, I got an inheritance and I want to figure out what to do with that money. I'm going to go buy a rental house and rent it." I mean, most of the single family homes rented in the United States are probably private individuals. If you can then bring scale and institutionalization to that, what ends up happening is the market develops better. And the people who you're meeting their needs, their needs are better met because now they have a product that is more reliable, that is exactly what they expected, versus, "Okay. I rent a house and Bob is my landlord. And Bob only owns one house and maybe doesn't really know how to rent houses very well, and maybe doesn't know how to upkeep them very well."
Joe Muratore:
Well, for companies, this is a multidisciplinary approach. On the one hand, you've got development groups who know how to develop houses, which is a very complex process. You have to go through municipal entitlements, which are different in every city, and then that, there's a state layer on top of that. There's the capital raising for the developments, and then there's the market cycle overlay of making sure you develop them at the right time and sell them at a price point that makes sense, which means you have to develop them with your land cost... you have to balance that gap between land cost and sale price to get right into the right part of the market. It's a challenging piece of investment in development. But these companies are not property management companies. These companies are not familiar or super comfortable with managing multifamily apartments at scale. There's other companies that are outstanding at that. And then you've got capital on top of that. So, what hasn't happened well yet is the joining of those things, and it's starting to happen.
Ryan Swehla:
It's starting to happen, yeah.
Joe Muratore:
There are a few companies that done it well, but...
Ryan Swehla:
Well, in tying that back to our outpost economy, one of those existential things was, have my own space. Have space to raise my family. Be able to live in a environment where not all of my money is going to rent. And so, even though we normally associate that with going out and buying a home, there's also a certain segment of the population where that means moving to a location where my overall cost of living is lower. And I still want to have a home, I still want to have a family, but I don't, for whatever reason, want to purchase, or purchasing is within reach.
Joe Muratore:
I recently read that housing prices are a product of a cap rate applied to a market rental rate on a house. And I imagine that cap's a high three or a low four cap. But the point being that, when in an outpost economy setting, when new talent is moving into markets or talent is being unlocked from people already existing in markets, essentially more money is coming inbound, the ability to pay more rent increases and probably the markets become less risky, which would mean cap rates go down a little bit. And that is the equation that drives home prices going up, which also drives a need for rental housing, especially for groups that either think the market's topped out or feel like they might be there a few years but not forever, sort of thing. So, it's an interesting equation.
Ryan Swehla:
Absolutely. Well, let's talk about our fourth idea that's how the outpost economy is changing America. And that is this, I would think, permanent shift in how we do work. So during COVID, obviously just a huge disruption to how we do work. Kind of a violent disruption where we all had to figure out what this thing called Zoom was and how we use it on a daily basis, and how we maintain our productivity in this isolated, work from home environment. We all know that that's not going to be the new norm going forward. But the question is, what will be the new norm? And if you've got a dispersion of people, say, whatever the number is; 10% of people move out of primary markets into secondary markets looking for that quality of life. Those are very sticky moves. Those people aren't moving. So, what does that mean to, for how we do work? And we've talked a little bit about the gig economy, but what does a day in the office, quote, unquote, "day in the office" look like going forward?
Joe Muratore:
Yeah. Well, it seems like companies are starting to adopt a three-two methodology; three days in the office and two days out. We are still generally five days, although we're not, that's not like an enforced sort of thing. We have people that work three days or two days in the office and three days remotely because they live two or three hours away.
Ryan Swehla:
Yeah. I think what this has done is it has given employers, whether they wanted to or not, the opportunity to explore more flexible environments, but with a focus on productivity, because at the end of the day, the reason businesses exist... business is a competitive, in some ways, a violent environment where the ones that rise up are the ones that are most effective and the ones that are least effective decline. And so, effectiveness has to be the number one driver, but we now have seen that adding a little bit of flexibility into the work environment hasn't meaningfully decreased productivity. And in many cases, has actually increased productivity.
Joe Muratore:
Absolutely.
Ryan Swehla:
I think Google is probably a good example of maybe where things are going. I heard the CEO say recently that they're moving to that three-two environment; three days required in the office, two days flex. So, people could still be in the office if they want to, but they're not required to. And he said that, "We're recognizing that many of our employees do have a challenging commute situation. And if we can mitigate that without losing the effectiveness and the comradery, the innovation, the collaboration, the mentorship that occurs in the office environment, we'll do that." But he also said, "We anticipate that 20% of our workforce will be permanently remote working," and I think that's probably, from a real estate standpoint, that's probably the part to be thinking about the most, because the three-two work environment won't meaningfully affect the amount of square footage that employers occupy.
Ryan Swehla:
What will happen is there's certain job duties, certain fringe that doesn't need to be in the office. An example, I was talking to a friend of mine recently and he's in a very large organization. And he says there are expense statement analysts. These are people who, all day long they analyze expense statements. That's probably a function that could happen anywhere in the country and anywhere or in the world, arguably. And I think those job duties, it has brought into question, which of these job duties do we really need to be in the office, and which ones do we not?
Joe Muratore:
Yeah. I think that what's most important here, is how well the mission's being carried out and not where people are that do it. Our workforce and our office is getting maybe towards 20% that are on some sort of flex schedule. I think that's probably the right amount. I'm really enjoying getting opinions from other parts of the country and working daily with people that approach real estate in a somewhat different way than we have. Those opinions and ideas now cross-pollinate our geography and the work we're doing here and make us better. So, the questions I ask the managers are... gets it and wants it capacity. Do you feel that this person's engaged? Do you feel like they want their job? Are they moving the ball forward every day? And when the answer is, "Man, the email flow, the engagement, the desire is off the charts," which is frequently what I hear, it's like, I don't care that they're here or there. I care that the mission's being accomplished and that people are feeling engaged in their jobs. And that is happening, for a fact, remotely.
Ryan Swehla:
Well, and I think again it challenged us to say, which aspects of our business have to be here and which ones don't? And I think that's kind of what every business is asking themselves, is which ones work in a more remote fashion and which ones don't? And going back to some of our earlier points, when you have a spreading of talent across the country you almost have a necessity that you have to figure out how to make them work.
Joe Muratore:
Well, that's a discipline. I think companies have the incentive now to learn how to engage with people that they may see three times a year. It's in their company's best interest.
Ryan Swehla:
Absolutely. Well, that brings us to our last point, which is what does this mean for primary markets? As people have shifted out into secondary and tertiary markets, the question is how does this all shake out for primary markets? I think one of the key takeaways is the primary markets are getting a little bit younger. And that's not because young people... young people have always felt a draw to urban markets for job opportunity, for the excitement, for the friend group, the single lifestyle. There's just a lot of reasons why primary markets are very appealing to people graduating from college or frankly coming right out of high school. So, that flow probably hasn't changed but what has changed, and we know statistically has changed, is that millennials and older than that are the ones... that's the cohort that is most likely making that shift out to secondary markets. So, what ends up happening is you have a decrease in age in these primary markets, and part of that comes from the prices have reset and it makes those markets just a little bit more affordable than they were before.
Joe Muratore:
I'm seeing, and I was talking to another investment manager over the weekend who's more in primary markets, a shift towards Class A in the primary markets, especially on the core function. And the reason is, is that rents are down probably 10%, and Class A apartments have not been invested in recently. Class A offices, a big pullback, but there is an opportunity right now to outperform traditional core IRRs on Class A multifamily in primary markets. The market has shifted away. So like most pendulums, it's probably a three- to five-year swing. There's a reshuffling that shows an opportunity towards secondary markets and quality of life. But what do primary markets have? They have infrastructure. They have multiple freeways in multiple directions. They have airports that are large. They have universities, they have concentrations of talent, they have baseball stadiums. They've got bars and restaurants galore. They have a feeling, a feeling of a brand, of being a part of a city with a brand.
Joe Muratore:
And for all of us who wake up in the morning and try to do something with our lives, a brand is a piece of real estate in your brain that sort of creates a halo around your whole life and your whole day. And to be a part of a brand is powerful. So, the pendulum will swing back. I would say now is a great time to invest in Class A apartments in San Francisco. Probably a great idea. Maybe we should do it. But the pendulum will swing.
Ryan Swehla:
Absolutely. Yeah. And I think at the end of the day, our job as investment managers is to understand what all of this means to our investing strategy. And that's why we spend so much time thinking about stuff like this, because it doesn't matter what's happening right now. What matters is what's happening over the next 3 to 5 years or even the next 10 years, because that's what our investing horizon is.
Joe Muratore:
And this has been largely a macro conversation. But on the micro side, we work to invest in spots where there's some piece of arbitrage. There's an owner that hasn't managed their property well. So, if you can see these macro trends and then take a micro opportunity and add value to it, a couple of different margins of safety, you're in a really powerful [crosstalk 00:28:23].
Speaker 2:
Thank you for listening to Durable Value: An Investor's Podcast, where we demystify commercial real estate with safe, sound investment strategies to help you balance your portfolio. If you enjoyed this podcast, be sure to rate it on iTunes or wherever you get your podcasts. To learn more, visit graceadapartners.com where you'll find more information, investors' tools, case studies and more. This podcast is hosted by Joe Muratore and Ryan Swehla. It's produced, edited and mixed by Melodic, with intro music by Ian Post. Thanks again for listening, and we'll see you next time.