An investment opportunity in offices? February 2, 2024

34:08If it does, it means the economy's in some trouble, right? You kind of go, well, hang on, that's not great. So yeah, we want rates to come down a little bit. That'd be lovely for everybody with a mortgage. If you've got savings in the bank, you probably don't want to come down at all. But in between there, somewhere is, as you say, that that soft landing that the RBA and other central banks are trying to desperately engineer, which is slow inflation without breaking the economy. I will say, I think that the soft landing path is wider, perhaps now that it has been for a little while, but not exclusively because with the good news of inflation comes the bad news of retail sales.

34:43I mean, we saw retail sales early in the week were down 2.7 % from memory. Yeah, it wasn't pretty, was it? For the month of December, right? Now, they're up 1.6 % in November. The bases are different, so you can't just compare them directly and you can't do the math and subtract one from the other. But broadly speaking, I really honestly, I think you've got to ignore December other than including it with November's numbers, look at year on year. And I did that numbers and it's up about half a percent, which is bugger all. When you think inflation is probably 5 % during that period and population growth, I estimate about 2.2, 2.3%.

35:17So you go, hang on, well, actually, we're buying, in terms of number of units per person, somewhere close to 7 % fewer things. Yes. Just doing that very basic math. And that's absolutely real. So that's all happening at the same time. So yes, the economy is stuttering. It's what the RBA wanted to do to get inflation down. They realized that was the issue. We have said a million times that given the choice between recession and inflation, they'd take recession. Not they want it, but if it came to it, they'll earn it. Oh, no, no, no, they'd take inflation, right? No, they'll take a recession. You think they'd take it?

35:49No, I disagree. I think recessions, I don't, well, I don't think any, except people above 60, really have an idea of what a recession is. We haven't had one. I mean, it rolls off the tongue. You know, two quarters of negative growth. It's like, what it means is that, you know, mom and dad don't have a job anymore. That's right. And there's a lot of financial, it's like a lot of financial stress. It is real world implications. And if you have, I'm not talking a depression, but even a nasty recession like we had in the early 90s, that was anyone who lived through that recognized how bad that was.

36:28And that is not good for politicians. Now, inflation is not good for politicians. Oh, by the way, I'm talking about central banks, not politicians, by the way. So I make that distinction. I think as politicians, you're right. They'll do anything to avoid a recession, including pumping 600 ,000 people into the country to make sure of it. Right. He says in quotes, I think the central banks, with a slightly less populous need to satisfy their own employment, would do different things. Oh, okay. Yeah. So, Polly, yeah. Sorry. Polly just give you 10 % inflation if it meant they could keep the economy in a plus 0.1 % growth mode.

37:05I absolutely, I think that's absolutely true. But I think central banks would – no, once they prefer it, I think if it came to it, they would lean more heavily on contracting money, supply, or increasing the cost of money, whichever way you want to kind of phrase it, to slow things down. And if that tipped into – if they had to choose between a setting that was slightly likely to cause a recession or more slightly likely to drive inflation higher, they'd absolutely push on the first button every day of the week. yeah i mean i i guess we we differ a little bit in i think that there's more political influence with central banks than they let on i mean phil lowe lost his job right he didn't lose his job because everyone loved what he was doing yeah that's right he said i've got to put rates up and you know i've got to do it very aggressively one of the fastest tightening cycles ever and he lost his job michelle bullock is there going lesson learned lesson learned that was the thing No, I'd give Michelle Bullock five stars.

38:01Yeah. She came out the first week or two and said, we're probably going to put rates up. Things are pretty tough. Can I say, I agree with you. Flo lost your job absolutely for political reasons. That is unavoidably true. And Bullock could have absolutely, as you say, gone, okay. In the US, they choose their Fed chairs, normally not from the bureaucracy, normally from outside, sometimes universities or business. That's absolutely political appointments, right? But I will give... So Chalmers, in my opinion, did absolutely the wrong thing by dismissing Lowe. I think he actually took a reasonably courageous decision to say, I'm going to get the same bureaucrat out of central casting who looks like Phil Lowe, but not Phil Lowe, Michelle Bullock instead.

38:41But I'll give Bullock even more credit, mate. She absolutely came out, literally week one or week two, and just said, I'm going to keep doing what he did. And I reckon that's pretty gutsy, right? Because she knows exactly what happened. And she may not do it, but the words were very clear. We need to see actions. I agree. I agree. But I just, I feel as though even if the right, quote unquote, right decisions are made, whatever you think that might be, it is hard to, I imagine that those people cannot divorce the reality of their situation. It'd be a factor, even if it is a subconscious one. Yeah, maybe.

39:15But yeah, either way, it's bad and it's a question of degrees. Well, what do you mean recession or inflation? Well, a very modest recession is one thing. A bad one is another. Just as above target inflation is one thing and 12 % inflation sustained for many years is a disaster. So you've got to tread carefully there. And that's the other thing I was just going to say too in terms of inflation being under control now. What we don't know yet is that everyone's getting more after-tax money after the changes that were made recently as well. So that's - Literally every taxpayer, I think, every taxpayer, why G taxpayers have more money on July 1 than they have on June 30, yeah.

40:00Yeah. Even the very highest taxpayers will be seeing, I think, three grand extra roughly in their annual tax. They were expecting six and now it's three, but everyone is getting more money. And in fact, the more money you give to those that the lower parts of the scale are actually far more likely to spend it as well. So that's another - Anyway, something else to watch. I'm not trying to be negative, but this is a moving feast. You can go from, hey, this is looking pretty good, to disaster very quickly and back again. And that's why at the moment there's a range of forecasts for rate cuts. I think I'm right in saying, I think one commentator is saying rate cuts as early as March, literally next month.

40:40Others are saying September, November. There's still a couple of lone voices saying rates aren't high enough. I think they can pretty much, even if they're right, they can put those out of pasture when it comes to what the RBA will do. There's simply no grounds. I don't think any reasonable economic orthodoxy. And again, not that orthodoxy is always right, but the reality is these are orthodox economists. They are, given the circumstance, inflation, retail sales, unemployment's ticking up. I think, you know, again, who knows what they will do? I'm not going to make a prediction, but you could knock me over the feather if we haven't seen the peak of rates for this cycle.

41:11I don't know when they'll start to come down. If I was a betting man, I'd probably frame a market that favoritism is probably September quarter. July, August, September is probably when I'd bet on it. By the way, stage three tax cuts, now they put money in more people's pockets, but also are inflationary by definition. So there's that reality we've got to deal with as well. And the other thing that'll screw with your brain is the dynamic nature of markets in the sense that I think it's very natural to think, particularly those who are out there looking for a home to buy, right? You'll go, oh, thank goodness, interest rates are coming down.

41:45That's going to make things more affordable for me. and I was like well yeah that's that's a very understandable thought except everyone has that thought everyone's capacity to borrow more has just increased and so you have that sort of feedback in where it sort of will normalize to some extent um so you know just just as a first homeowner's grant is really not going to help you because every first homeowner gets it it kind of sort of just lifts the bar for everyone. So it would be, it would be for those that are trying to fix that problem and let's not get into it because we've talked about it to death.

42:22But I think that's going to make it an added challenge. If we see any reasonable degree of interest rate cuts, it's going to make the housing situation worse, not better counterintuitively. Yeah, I think that's a good point. Mate, speaking of all that, let's go to negative gearing because while we're generally an investing podcast, generally a finance podcast, we generally talk about shares. You have been known to rant about property from time to time. But despite that, or maybe because of it, I'm not sure, there's been reports in the papers that the government might, on the back of the stage three changes, maybe they've been emboldened, maybe they've just always wanted to do something or maybe, I don't know, maybe Treasury Charm has been let off the leash.

42:59It's hard to know what's going on. These could be completely unfounded rumors. They very, very rarely are, let's be honest. The policy of this is called trial balloons. You kind of leak to a journal that you're thinking about something, they report it, and you look at the response, and you go, oh, they don't mind that. Let's push ahead. Or, oh, no, no, I would never have done that. I don't know where that leak came from. That's terrible, scurrilous news. But my cynicism aside, apparently, there are at least considerations of changing negative gearing. I have my views. And let's keep it about the policy, about the population, rather than the investors themselves.

43:33We'll talk about the impact on those, of course. But negative gearing, mate, is it doing a job? Is it necessary? Is it a principle that should be applied evenly? Should it come off residential property? Should it come off all property? If you were treasurer for a day, what would you do with negative gearing? Oh, gosh, that's so hard to answer quickly. I mean, one, I don't think it'll ever happen. I know it's being talked about, but look what happened when they tried to get rid of franking or change franking. It is political poison. So it's an interesting topic, but my cynicism prevents me from thinking it will ever happen.

44:11Would you do it though? Let's say you're treasurer for a day. You're a fixed-term treasurer. You're going to be sacked tomorrow morning anyway. And today you've got to do things that are good for the long-term health of the Australian economy. Do you keep it, modify it, get rid of it? Yeah, I grandfather it because I wouldn't want to, as much as it may not have been appropriate in the past, at least to the degree that it's been applied. I mean, people made decisions based on the expectation that that was the landscape. So I think you could sort of grandfather it going forward. I think – I don't actually mind – I don't mind being able to claim a loss against your investment.

44:51Claiming it against other sources of income, I think that's where it gets a little bit – and that's the definition of it, I suppose, negative gearing. but I also and you know my views on property I don't think it's the magic bullet everyone thinks it is is it a factor? 100 % it's a factor will it help improve things? Yeah definitely but I don't anyone thinking that you know wow price to income ratios at 13 in some of our capital cities are going to go back to where they were I don't think that's going to happen I saw your tweet I'll give you some rope here to expand on it but yeah but it's i mean you make the right point which is which is what a year nine um economic student will understand which is supply and demand and it's just until that supply or demand angle changes it it's it is uh uh look i would do it i would do it right for what it's worth you'd grandfather it okay i think it would have a bit of an impact yep but i don't think i don't think it solves the housing crisis yeah um i hadn't mentioned i hadn't meant to go to my my down my entire tweet path um but but i will very quickly given you mentioned it i i and you've you've sold my thunder beautifully because i would do exactly what you just said mate i think there is there is no the objections sorry let me start again why is negative gearing a thing it's a thing because there's a principle in tax that says you should be able to deduct reasonable expenses incurred generating an income.

46:23That's how that works. So I run a business from home, right? I'm allowed to claim various things. Correct. Because it's not just the revenue, right? There are costs. Right. And you pay tax on what's left. Yep. And if you make a loss in a year, you upgrade the, you know. The throne. Yeah, the throne. Exactly. I was going to go with other things. Let's go with the throne. And you spend that much money on it that it overwhelms your income in a given, your revenue in a given year. you make a loss and you can carry forward that tax loss and offset it against future income. Now, in this case, as you've rightly pointed out, offsetting rental or investment losses against personal income is an interesting thing to do.

47:02So that's where the company analogy breaks down a little bit. But you could have two separate business lines. It could be strawman property and strawman.com and strawman property makes a loss and gets to offset that against strawman.com as a business, the billions of dollars you're raking in on that, on your private online investment club um so you know that's that's not unreasonable the thing the problem is that you say why should it be done for residential property and the only answer i can get from people is twofold one is well it's the principle that applies to everything else that should apply to property to which uh i say well there only needs to be a principle that's universal if you choose to make it universal there's lots of things we do in certain circumstances like for example we exempt our homes from capital gains tax if it's a principle then you should be arguing to pay capital gains section in your home are you doing that oh no no i'm not doing that okay so then what we're saying is principles apply right that's and that's okay like it's fine but people should be at least honest with themselves about what they're saying which is really i like it i'd like to keep it please the other one is that incentivizes supply i think that's partly true um but it's like saying well hang on i need to give it tax breaks so people buy woolly shares so why would you do that well we have to now there are tax breaks for startups for businesses and often in the case, grants and stuff.

48:14So there is some reality there. I would say right now, mate, the incentive for supply is a 0.8 % vacancy rate. There are so many people desperate to get into housing in some way, shape or form. I'm not sure you need a tax break for that. Now, might you need it at some point in a different economic circumstance? Maybe, maybe, maybe, maybe. I just think we take a lot of things for granted. You know, there's kind of the accepted wisdoms. Well, of course we need negative gear because it incentivizes the supply. So, okay, well, if you paid me double to go to work, you'd incentivize me to work too. But the need to put food on the table kind of already gives me a reasonable incentive.

48:49You know, I'm kind of okay with that. So yeah, to your point, mate, I completely agree. I would stop negative gearing tomorrow. I'd grandfather the existing stuff because I don't think we want to throw people on the scrap heap. Do they deserve protection? Some do, some don't. We've had this conversation before. I tend to think that most property investors are misled by their accountants and by the general public and you know do they deserve to be protected deserves a funny word uh can we afford to protect them and not make their lives terrible yeah i think we probably can so why don't we kind of is my view and at some point negative gear becomes positively geared as rents rise on a fixed level of debt anyway so existing purchases grow out of that either way with your grandfather we say it's a five-year or a 10-year thing it kind of ends up being roughly the same that said as you've said and this is my tweet thing very quickly i don't think it has a meaningful impact on prices it might bring them down by a couple of percent or stopping going out by a couple of percent um because it might make a few properties a little bit less valuable or and therefore people pay a little bit less for them only for those that are negatively geared which excludes owner owner occupiers those who've already got positively geared properties so it takes a tiny portion of the heat out of the market that's not a bad thing by the way i'd be okay with that personally property prices fell five percent overnight i think we can probably be okay with that it doesn't make it meaningfully more affordable there's other issues and we've banged on this.

50:08I've certainly have banged about this before, but I think immigration is the big issue right now because of that vacancy rate I talked about. I think you can do anything else you want, but if you've got less than 1 % vacancy rates, people are going to stretch as far as they can and they need to get to where they need to get to. Supply and demand sets prices. And if you have demand outstripping supply, we've just talked about inflation for 15 minutes. It's kind of where we end up. You end up in the same sort of situation, right? So I don't know. It's not the solution, but it's part of the solution and it makes things better.

50:37And I think you don't have to have a silver bullet every time, right? A few things that make things a bit better, they're worth doing because they're worth doing. It's a net positive for the economy, for the society. It's worth doing. It doesn't have to be the only answer or the whole answer or even the biggest answer. It's just part of an answer that actually has a positive outcome, in which case, why would you not do it? Anyway, it's not going to happen. I don't know. I really, really didn't think the government would change stage three, I've got to say. So I am, I'll say hopeful. I don't mean hopeful in a political sense.

51:09It's not Labor versus liberal or current government versus last governor, that sort of stuff. Maybe I'm, a bit of faith has been restored, but I'm less cynical. I honestly, you could have knocked me over with a feather when they announced I'm going to make the changes. They talked about it, then walked away, talked about it, walked away, walked away, walked away, promised and promised and promised. And they changed. I'm like, okay, that speak of things that wouldn't happen. I would have put a small amount of money. I would have put, if you're offering me a$100 bet that they wouldn't change stage three.

51:35I would have taken the bet. I would have lost my hundred bucks. Put it that way. Yeah. Yeah. Yeah. Yeah. I wouldn't bet a huge amount of money on it, but I, there is, there is a situation with this where, so we've said before, two thirds of households either own their house outright or in the process of paying it off. So you've got two thirds of the population that they're against, that are going to be against it. And there's a third who would think, oh, that's great. So the people who most jump, we're all self-interested. I know I am. Everyone is. right? So sort of like the people most loudly calling for it are those that think it will help.

52:09And then not unfairly, right? And it's not everyone. There are some that are very comfortable, but we'll sort of see it as a more fair society kind of thing. So that's all good. The difference of the tax, flipping on the tax cuts was that everyone benefited. You annoyed, I think it was like less than 3 % of the population or whatever the number was, a very small percent who still get a benefit, just half of one. And then everyone else who's better off so i was like that's an easy political calculus to kind of make um or easier i should say um so anyway we'll find out we'll find out i mean i hope so but i'm just not going to hold my breath yeah exactly i might bet a hundred bucks with you as a friendly bet i'm not i'm not gonna bet 10 grand on it you know i'm not so i should say i'm not even sure it will happen i'm not pretty to bet a hundred bucks it will happen i just would have said about stage three i would have bet against it happening oh i would have too yeah well yeah well sorry yeah it it turned out that it was well this is the lesson right you know the unexpected happens all the time correct correct speaking of unexpected mate maybe this is not unexpected this is totally expected we've talked about this before a number in the in the paper in the australian excuse me on thursday that the vacancy rates vacancy rates for offices so you know literal commercial office premises are now at 1990s level speaking of 1990s recession that you mentioned before 14.8 % apparently is the vacancy rate among offices.

53:34Now, think about 14.8%, and as always, that's an average number. In other words, someone's below and someone's above. Now, I'm going to assume - Some will be full occupancy and some will be empty altogether. Right. Right. And they're the extremes, but they'll be the really good properties in the Sydney CBD, the Melbourne CBD, Brisbane, Perth, Adelaide. Don't add me about your preferred capital city. They're probably at 2 % or 3 % occupancy. And also vacancy, sorry. And so others are going to be at 20 % vacancy. You know, those are the realities of these sort of numbers. And I don't know, it's worth noting for a couple of reasons.

54:05One is I think the flexible work thing continues to roll on. And for all the headlines about going back to work and some employers talk about this a lot. Well, I think it is, mate. I think it is. And I think the numbers tell us. It was always going to happen. Right. COVID just accelerated. That's the thing that people think that, oh, COVID caused this. It was in train and it was always going to happen. and it just that that just yeah put rocket fuel under it sorry go on it did it's you know what's really really so this is a this is a tangent what's really really funny is people assume businesses are rational you know and so a lot of the responses i get are um well if it could have happened it would happen anyway or would have been happening already or we couldn't possibly do that because of this and what it really reflects is manager's own preferences and i'm not even going to say they're necessarily good or bad i have my views but if you put that aside we couldn't possibly have our staff work from home because it wouldn't work and then we did it for two years and we went oh actually it works and we have to go back to the office because it's not working so well it's kind of working you know it's just it's those things that we assume and managers are human right and they're in good and bad ways um and when we kind of say well businesses will be doing this if they did that it assumes managers are these automatons who always make perfectly rational decisions um there are good managers and bad managers there are some fearful managers and some some you know some uh supportive managers at the monthly fool i've worked from home the entire time i've been at the fool why because employee number one was on the gold coast i joined the company's employee number two in sydney so i was going to move to the gold coast and didn't need to and turns out it works and that's kind of the thing right now it doesn't work for every company there's people listening saying well hang on i've got to go to the supermarket till or i've got to go to the work site you know i go to the bank branch i get a lot so again i'm not saying it's right for everybody but to to imagine that it would snap back for its own sake well we've just kind of shown the benefits of it for everybody was interesting so anyway that's the work from home thing but the office vacancy thing mate i think is real we've i've talked about this a lot um i think you've done the same i've said to people if i had to invest in reits right now bulky goods wholesale and retail think about uh the warehouses that amazon of which I'm a shareholder, you know, pull stock from or any of the online retailers or multi-channel retailers that have an online business, that's a booming part of the business.

56:24If I had to be in retail, I'd be in Westfield or Centigroup. That's the really, really top-end retail. I don't want to be in a B or C-grade retail mall because when people stop shopping in physical retail and go online, it's those little ones are going to suffer most. And we've seen some of that. We saw Godfrey's collapse this week, closing down after 1931 the business started. but the fashion from the retail. I chuckle because I wrote an article in 2015 suggesting it was good value. Probably was then. I'm sure you would have sold it at higher prices after that, mate. No, it wasn't. Look, you've got to own your mistakes.

56:59I read it because I heard it on the news and thought, oh, I'm pretty sure I thought that. Is it on the interwebs somewhere? Yeah, it is. It is, and unfortunately, it's under a Motley Fool banner. Oh, no. Because I was with you guys at the time. We officially just own you from here on. Yeah, like, so I'll own that one. But it is a good reminder. This is another topic, but it's a good reminder of the so-called value trap, which we should talk a little bit later on. It looks great. It looks like, yeah, and I do this a lot. It's like, yeah, it's got problems, but look how cheap it is. You know, it's like the person who's buying the house.

57:33It's like, oh, it's only, you know, remember a couple of years ago they were selling a power station for a dollar? That's right. You were like, oh, I'll buy it. It was like, well, there's a lot of pension liability. It's a mediation work. You're buying a liability. You might, you know, that mansion on the hill might only be 10 grand, but it's going to come with a huge amount of like work that needs to be done. Correct. Yeah, so anyway, that's, yeah. Shouldn't have mentioned Godfrey's, but go on. That's fair, fair. And just running that out, office, I don't want to be in at all. I guess if you could find a high occupancy office at a reasonable price, you might be interested if that's for some reason has particular, and this is always the case, right?

58:11We talk about categories or sectors. There will be great office buildings and terrible office buildings. If you're in the middle of the CBD, your rents are reasonable, you're close to amenities, transport, food, maybe those things stay full and people move to there away from those other places. So as always, I'm a massive, massive fan of investing in quality, demonstrated quality. In this case, I don't think you'd make me touch offices, certainly not an office REIT. We love diversification generally, but a bit like we found during the subprime crisis, bundling up a whole lot of rubbish mortgages and saying therefore they're diversified is still a terrible investment um if you have an office reit gee i'd want to know that the vast bulk of the value was in this really really really really really high end i don't mean high in terms of price just the really desirable uh high occupancy investments because i don't know i don't know what will happen mate i don't i'm not going to predict anything um i don't know at what point well at At what point, you know, 14.8 % average vacancy starts to weigh too heavily on the cost base?

59:11And I'm talking about debt in particular of some of these businesses. They might get saved by rates dropping, frankly. But yeah, I would be very, very careful. Just know what you own, to use one of your phrases, mate. I don't think you could make me buy it. But if I did, I'd want to be really, really sure I knew they could get through and find a way to get to the right place in time. Yes. And the way that you would do that, or certainly the area you would immediately focus on would be the balance sheet. So let's think about, I mean, 100%, you own a 100-story office block in a city somewhere, and it's 85 % full.

59:51Now, that's not great. I mean, I could be making more money. There's all this empty stuff that's there. But it's not existential, right? And what a lot of these properties themselves will still be around. It's just a pile of bricks and steel. The building itself, exactly, yes. The building is not going anywhere. It might need some refurbishment. I suspect we'll see a lot being converted to different use cases. So in the city, there'll be more residential towers. Selling residential premises in Australia is good business, right? So I think that'll be fine. whenever you look at the REIT sector and the GFC was the classic example of this, it is the debt that kills you.

1:00:33Yes. And this is maybe a pointed, you know, remark to be said for other property investors in different sectors is that leverage is a wonderful thing, but we sometimes forget that it cuts both ways and what undoes these companies and why it is such a risky proposition is that you only have to go from 90 % to 85 % before all of a sudden you can't meet your interest payments. And then it's not like, oh, gosh, I guess we're earning less than we were hoping for. Or, you know, I'm getting a subpar return here. It's like, no, it's existential. I'm out of business. And I'm going to be a forced seller at fire sale prices.

1:01:11Yes. The asset structure is different from the asset itself. It is always. And it's kind of the way for various reasons because they're very capital-intensive assets. It's a lot of money to build one of these towers. and yeah they last a long time and yes you can depreciate and amortize costs over a long period of time but the cash the cash put up front is is is mammoth and and kind of needs to be done with with amounts of with a degree of debt and because it is seen rightly or wrongly as uber safe that the level of debt that and the cap the interest rates that are charged are usually pretty generous so uh financial engineers in this space will will push it to the edge they always do after a period of complacency and things going well it's just like it's a game theoretical kind of exercise where it's like well i'm only going to go up to 70 lvr i'll go to 75 because i can do this and you can make the numbers work and it just it just it just doesn't till it doesn't and you i'm i'm not going to look it up now but we've done it before in other pods where you look at some of the gpt some of the big uh property trusts i mean they they were they survived but they had to recapitalize which is a fancy way of saying they had to raise a ton of money and dilute the hell out of existing shareholders to stay afloat and they're still not back at those levels right it was just it was a it was a permanent loss of capital and a very brutal one on what at face level if you look at the revenue line in terms of the rent coming it wasn't it wasn't great but it wasn't oh really i'm wiped out under that scenario so yeah i i i feel as though that's what i would I echo your sentiments, but I would, the first thing I would do is look at the balance sheet.

1:02:54How highly leveraged are they? Go to the notes. What are the terms under which they have borrowed? You know, when are interest rates? How long are they locked in for? What are they reset to? You know, the building will be fine because someone will come in and buy it and turn it into units and they'll make a fortune off it. Like that's actually the time to get involved, right? When things are all washed out. But I'd be very careful. I'm pretty nervous. I think it's a fool's errand to think that the trend from working from home is going to reverse. By the way, Tangent, have you seen any of the images coming out for the new Apple headset?

1:03:32No, I have not. I have not. Oh, wow. Augmented, like virtual reality gets a lot of the VR, the AR, the augmented reality stuff. And I want to emphasize here that Apple's really pushing. It's not a gaming thing. It's a productivity thing. Yeah, right. And so all I'm saying and why I thought of it is that the kind of stuff that we could, for the longest time, work from home and pre-internet, I guess you could call up on the landline and have a chat. You could have those teleconferences, you know, the thing in the middle of the boardroom table. You know, that's just laughable, right? But people did it, you know.

1:04:07And then we got email. It's like, well, that makes it even better. And then we got Zoom and now it's fantastic. fantastic it's not hard to imagine a future especially when the tech's already beyond the demo phase here where it's just sort of like i just put on my helmet we're all in the same room we're all looking at the same thing when you know it's just that that is only accelerating that that trend and while there'll be some curmudgeons that are out there there'll be others that think actually this is a huge cost saving for our business we have happier employees because they're more flexible uh and we save a fortune on on rent now so yeah we're gonna do that and not all will but so yeah i i i'm with you i wouldn't i wouldn't be touching it with a with a 10-foot pole and i say that having had the godfrey's experience where the temptation will be is that is that you'll go like this is no secret what we're talking about like it is known right particularly amongst the experts in this like they everyone knows the risks that are out there And that's why prices are down.

1:05:07And that's why, this is another point to sort of maybe elaborate on. A lot of these things are trading below their net tangible asset value. Why? Because everyone's factored in. In other words, to finish that thought, you will be able to make a case of, yeah, I get Andrew and Scott that it's going to be tough, but look how cheap it is. Well, remember Godfrey's. is not that you know sometimes value traps aren't value traps they're great buying opportunities but that that is the risk um i lost my thought what was their point that came up just then um oh gosh it's escaped me how frustrating that's at value there thank you thank you oh gosh senality senality it's it's a gentle it's a gentle slide into into that so that i've i've heard investors discuss this before where it'll be the share if i was the company i could sell the properties pay off all the debt and on a per share basis it might be two dollars each after everything is said and done net and yet the shares are trading for a dollar seventy in other words i'm I'm getting to buy$2 for$1.70.

1:06:16It's a good bargain. Just be careful of those net asset plays because that is based on what those assets are carried at on the balance sheet. And that will be based on a valuer's estimate. The only real test is the market. It's worth exactly what the market will pay. Generally speaking, again, it's like with the auditors and asking the barber if you need a haircut. You will generally, I would say there's more of a bias to assume a loftier price than is reasonable. But even without sort of that, that was done a year ago or could have been up to a year ago. Could have been even longer. And it may not be real.

1:07:05And maybe even if in an isolated situation it is reasonable, Is that a reasonable scenario when a lot of other stock is coming on the market? There's a lot of other people are having issues. In other words, the carrying value of those properties might be extraordinarily different to what it would in reality be if you had to liquidate it tomorrow. So you're thinking, it's like, well, they're in all kinds of trouble, but I'm getting a dollar for less than a dollar. It's like, maybe not. So just be careful. Yeah. Or by the way, it actually might turn out completely fine. I think that's the challenge is what is it likely to be worth over time?

1:07:39Maybe the discount is already factored in because even though it's a big discount, the property prices will fall by that much. In which case, it's still fair value, which is not the worst thing in the world. Don't fill your boots with it. Be careful of the risks. But also, as you mentioned, the balance sheet. Mate, I'd only add to the balance sheet the income statement, but for the same reason, which is the cost of that debt as a proportion of the profit you're otherwise making is important. Because if the revenue line falls and the interest expense doesn't fall, that's where you go. The balance sheet will tell you the size of the exposure.

1:08:08The income statement will tell you the degree to which, how close you were sailing to the wind to make good on that exposure. And those two, it's why we have multiple statements, right? The combination of those two combined. Combination combined is the same thing. Those two statements combined is, it tells you the story. How much risk am I taking? How much leverage is there? And how likely am I to be able to meet those repayments as and when they fall due? Vacancy is a vacancy number. Realistically though, what vacancy really is simply telling you is how much rent am I foregoing because I can't put bums on seats in those offices?

1:08:38And the answer is my revenue will fall or maybe not because it might already be down. That's the other thing, by the way, we're looking backwards. So if these numbers just say, well, yeah, thanks, Sherlock. It's already in the revenue numbers and I'm still paying on that interest bill multiple times over, then we're sweet. Yeah. But if you see that vacancy rate grow, revenues fall, interest rates doesn't, interest cost doesn't change, then it doesn't take much imagination to work out what happens if your But if your sales fall, but your expenses stay the same, at some point those lines cross over and you've got a lot of debt and not enough cash to pay the bill.

1:09:09You beat me to it. So we've talked about leverage, but there's the operating leverage, which, again, it has the potential to catch you by surprise. Yes. Because, I mean, think about it in terms of like our own situations with borrowing money to buy a house. I buy a million-dollar house. I put a 10 % deposit down. So I put it on$100 ,000,$900 ,000. It only has to fall$100 ,000, that property, 10%. I'm wiped out in terms of my equity. And you will find the same thing because the fixed costs of that asset aren't going to change radically. So you can have scenarios where a 5 % dip, you wouldn't even call it a fall.

1:09:51You'd use the dip or pullback or whatever adjective you sort of want to use there. and all of a sudden I'm making a loss and unable to meet my interest repayments. So you don't think that you need to see these massive drops in rents before things get hairy, which is why, yeah, you're right. Look at the balance sheet. Look at the income statement. Model it out. Just get a basic spreadsheet. Here are the fixed costs. Here's the revenue line. How much do I have to lower it before we get to zero profit? Anyway. No, it gets - Be careful out there. Very quickly. Also, too, just really quickly on that one, if vacancy rates improve, in other words, they fall, you get higher occupancy, that's great.

1:10:34Just be mindful of what they've had to do to get there. Oh, yes. Our vacancy rate's gone from 15 % to 10%. It's like, oh, that's great. We have to drop our rent by 25 % per square foot. It's like, okay, now we're talking a different thing again. So again, and the reverse is also true. I'm not trying to be too negative here. I just want to mention that plenty of companies are trying to push workers back to the office. So maybe this isn't an idea. Maybe the future is brighter. Maybe we've picked the bottom beautifully. Maybe we have the contrary indicator here. But the numbers in the Australian suggest that vacancies are growing, not shrinking on average.

1:11:03Just be careful of that because they say since the early 1990s, Centro Property Group is a business that you may have heard of, that investors were massively, massively wiped out, became federation centres, then vicinity centres, I think. Probably old enough now that you shouldn't draw too many parallels between the two. Management's probably changed half a dozen times. I think sometimes those sort of businesses' corporate histories are unfair or unkind because just because you happen to be the inheritor of that stuff doesn't mean it's run the same way. So I'm not saying anything about vicinity particularly, just using that as the example of the 1990s collapse that really did wreck a whole lot of people because the structure was inappropriately managed, not the assets themselves, which are completely fine and continue to this day.

1:11:44Yep. Yep. Yeah, so just be careful out there. It is, it is, it is, I do bristle a little bit when I hear people talk about different asset classes and the rest and they'll tend to say, oh, but this is lower risk. Because when all else being, I mean, it tends to be the kind of area where nothing happens for a long, long, long time. And then every, and all of a sudden something massive happens. And again, it's the maths that throws, that can really throw you out with, with all of this stuff. So, oh, the other thing I was going to mention too is, I mean, everyone's different. um so you have to look at on a case-by-case basis but we've and the entire media has been long discussing this mortgage cliff which we're only about halfway through by the way in australia but there is a similar phenomena potentially at play here that's a good point yep you know and i know in the u.s there is definitely some issues there as well where a lot of these developers and managers of these properties locked in uber low interest rates for a long time and in some cases like you know might be locked into 2028 but at some point that's going to reset to potentially higher rates and so there is that that's that's why i say when you look at the balance sheet absolutely but then look at the note associated with the borrowings line and just see what is the nature what is the caliber of that debt what does the structure look like when does it reset what interest rates are you paying now because everything else holds steady and all that happens is you go from while we were paying 3 % now we're paying 5 % and again so what does that seem like much well it could be it could be the difference between life and death so well you've got your work cut out for you think about debt right so if you go from 3 to 5 that's a 66 % increase in your interest payments because most companies aren't paying back the principal right so they're paying back just the interest so the cost to the company is a 66 % increase now if debt is and take and I don't I'm not I want to be careful I'm not linking the absolute numbers here with the example, right?

1:13:37So this is not about transurban at all. These are made up numbers. But let's say you're transurban or someone like that. Debt is your single largest cost. If your single largest cost was to increase by two thirds and you might get an inflation linked increase in revenue of 5%, I don't know. You did the numbers, as you say, Ram. 5 % increase in revenues, two thirds increase in interest cost. If it's your biggest cost, and again, I don't want to cast too many spurs on transurban, so let's not talk anymore about that. Sydney Airport is now no longer listed, so let's use that as an example. if sydney airport was listed with a massive amount of debt uh which it was for a while and that deck is more expensive uh you you put up price a little bit because you can but you can't put them up too much that p &l changes really really really really fast that's why you know leverage as they say as buffett said is the only way a smart guy can go broke it magnifies your gains in the good times magnifies your losses if it starts to go badly that that the slope on that curve gets really ugly really quickly.

1:14:33Yep. Yep. And again, regardless of commercial or industrial property, the same is true in another sector of the property market. I'll just leave it there. I'll just leave it there. I'll let it hang. Thank you, mate. It's nice to know you haven't changed, Ram. Will you, in that vein, join me on Sunday for a mailbag? I always look forward to the mailbag. Absolutely. Me too. Until then, as Ram says, let's be careful out there. And fully. Yeah, cheers. Trade carefully. The Motley Fool and people appearing in this program may have positions in the companies mentioned. General advice only. Please speak to your financial professional to understand how it may pertain to your situation.

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