The Good News From Meta Platforms

In this podcast, Motley Fool senior analyst Asit Sharma and host Deidre Woollard discuss:

• Meta's soaring ad impressions amid a tough advertising market.
• If Mark Zuckerberg will need to choose between AI and the metaverse.
• How Chipotle is using robots to boost efficiency.

Motley Fool contributor Matt Frankel interviews Walker & Dunlop CEO Willy Walker on commercial real estate debt and the challenges facing multifamily housing development.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on July 27, 2023.

Deidre Woollard: Over three billion people a day use a Meta product. But will they follow Zuckerberg into the Metaverse? Motley Fool money starts now. Welcome to Motley Fool Money. I'm Deidre Woollard here with Motley Fool analyst, Asit Sharma. Asit how are you today?

Asit Sharma: I'm great Deidre, good to be with you.

Deidre Woollard: Hi, I'm excited to talk to you about Meta because the market's excited. Meta had their first double-digit year-over-year revenue increase since 2021. But I think the thing that blew me away, was that this company now has over three billion daily active people on its family of apps. Wow, so could it attract more users and do you think it's making the best use of all of that attention so far?

Asit Sharma: I think it is Deidre. Just the fact that Meta can continue to grow that user base. The monthly active users by 3% is a good use. Because at this point what you're trying to do is to drive further engagement, drive further monetization. You've got three billion out of what some eight billion people on the planet. We know that Meta isn't going to be able to grow users at some amazing clip anymore. But just think about the magnitude of a few percentage points increases, every so often on a number like three billion. That's very substantial when you think about how absolute profits are generated and this quarter, Meta drove $7.8 billion to its bottom-line. It doesn't need to grow at 15% clip. When you think about its user base, just to keep that growing one to two to three percentage points each year and concentrate on further engagement for the monetization.

Deidre Woollard: That's a very good point. One thing that stuck out to me in the report was at the ad impressions are up 34% but the ad prices were down 16% so I'm looking at that. That seems like a mixed bag, not necessarily a sustainable one. We know the ad market is tough right now, do we just have to wait that out?

Asit Sharma: Partly we do if we're Meta's management. But partly we're going to make that as a choice. We're going to be a little proactive about going for that lower price impression. Why is that? It's because the growth for Meta's advertising isn't going to come necessarily from North America and Europe anymore, it's going to come from Asia, it's going to come from Latin America, Africa. In those regions the pricing power isn't quite what it is in more developed geographies. Meta and Facebook in particular are going to where they can get more ad impressions and they're going to sacrifice some profitability, some pricing power now to secure that base for advertising in the future. But you're right. Deidre a lot this does have to do with that poor macro-environment. If things were running full steam, I think we would have seen better metrics on the pricing than we did this quarter.

Deidre Woollard: We looked at Alphabet. They had earnings earlier this week. YouTube shorts also growing, is short video content going to be where the growth is coming from?

Asit Sharma: It certainly seems like it, more and more. I think the major social media platforms have driven down our attention spans to where we just have an appetite for short form video content. We're more than happy to let minutes go by, half an hour ago by, an hour go by [laughs] even though you're right. It's taking more time to generate that ad impression on YouTube's behalf, on Meta's behalf. But the fact that we seem to stay glued longer to short form content points to a future in which this becomes a more lucrative type of advertising as it scales.

Deidre Woollard: Well, I thought the conversation around Threads during the earnings call was interesting. Because this an interesting thing for Meta. They've got this side of desk project, Zuckerberg was very clear, there are just a few people working on it's not a big deal. But then it launched at this time, which Twitter now acts. Now whatever it is, is melting down. What's next? Do you think they're going to put more energy, more bodies behind the project? You know they're trying to figure out how to monetize this and and get people to stick around.

Asit Sharma: Yeah, I think they will, Deidre. This is really interesting because Meta has a talent for copying other social platforms. We saw this with Instagram, we've seen this with Real, so they're good at this. It's natural for them to have these side of desk projects where they just pause it, look, let's build a Twitter replica just in case there's an opportune time for us to take advantage. We have Twitter users who are in a love hate relationship with the platform. Many things that platform has been degraded, it's lost its branding, it's lost what was special about it. Many Twitter users complain that Elon Musk has really grew in that platform since he took it over yet it's hard to get away from it. After this huge spike in users going over to Threads and checking it out, Threads engagement has plummeted by 70%. Why is this? I have my own Thread theory. I think neither Elon Musk nor Mark Zuckerberg, really understands what made Twitter so special. People just want content engagement. They want an easy way to send direct messages, they want to be able to control what they follow in that content stream. You see Twitter moving away from that into an algorithmic feed and Threads itself is so algorithmic because that's what Facebook is really good at. That's their ethos. I think so many users went over and maybe out of this revenge idea. If I could just get to something a little bit better than mastodons or these other platforms. Maybe this is the answer. They're going back to Twitter even though they don't like the experience as much anymore. But to answer your question, yeah, I think Meta is studying this. They're going to spend a lot more time and allocate some more serious capital to pulling users away on a more permanent basis.

Deidre Woollard: Yeah, I think so. I'm certainly on my own journey with that because I've loved Twitter. I've been on Twitter like 15 years, but I'm looking for the alternative. Threads doesn't feel like it yet but if they start changing it to make it a little bit more like Twitter, maybe people will stick around.

Asit Sharma: Totally. This is such a you lost that love and feeling [laughs] happy environment for users of Twitter.

Deidre Woollard: Yeah, absolutely. Well, this was supposed to be Mark Zuckerberg's year of efficiency. He talked about that on the earnings call. He said he's still wants to run the company lean, he's trying to determine what the appropriate CapEx is for AI. This was reminiscent of things I've heard from other companies, from Microsoft and Alphabet, that we need to spend money right now. There's seem to be like telling investors, we need to spend money right now, but maybe don't expect results anytime soon. It seems like but with reality lab, they're like they talked about the long time horizon for expecting results. Are they just trying to make us feel better about how much money is flying out the door?

Asit Sharma: Well, I think whenever Meta management talks about AI, investors warm to the idea that they are investing so much and allocating so much toward CapEx because that's something we can understand a little bit more easily. You need high tech talent to develop things like LaMDA too, which is an open source competitor to OpenAI and ChatGPT. You need lots of server space to be able to deliver those instances of interaction with large language models. All this makes sense to wall street analysts, to retail investors. Where we all start to get a little worried is this huge investment into the Metaverse, into the things that don't have this tangible investment return. Now, along the way, we do see Meta starting to develop technologies that could circle back to its advertising business. Developing headsets with eye tracking movements could be something that yields a lot more precise advertising in the future and more pricing power for Meta, more advertising has. There are some indications that maybe all of this investment will have a purpose but as long as Zuckerberg keeps talking about the Metaverse, investors don't want to hear it, talk AI and CapEx, the billions are OK.

Deidre Woollard: That's what I noticed is that there is that the company made sure they were talking about AI and Metaverse almost at the same time. But I feel like if Zuckerberg had to only choose one, I used to think it was going to be the Metaverse, now I don't know. What do you think if he had to choose one or the other, which way is he going? Is he going away his heart ones are going the way the people who are invested in the company want to go.

Asit Sharma: Well, I think that Zuckerberg is still going to follow his heart. He still wants to create a world despite what Meta says that we don't need to be the ultimate destination in the Metaverse. I think they still want to do that. I think the idea of controlling the way you reached the world, which is the headsets and the world itself, is a way to monetize users for their lifetime, to keep them as lifetime customers and that vision is still one that really intrigues Mark Zuckerberg. Along the way though, the investment in AI, which they haven't dented on, Meta invests quite a bit in artificial intelligence, it invests quite a bit in Gen AI, I think he can rationalize that to himself that those two worlds converge because to deliver the best possible Metaverse experienced unique generative AI, you need generative AI across multiple modalities. Text to creating a world, speech to creating a world maybe I'm trying to meet you in the Metaverse, Deidre, and I'm like, I'm tired of this hangout. Let's meet on the party of this great cafe in Europe because you like outdoor cafes in Europe and so do I, so, boom, there we are in that environment. This is some of the type of future you can envision where the two worlds collide and I think it makes it easier for Zuckerberg to say, I'm going to keep on this pet project because everything I invest in AI has an outcome in my Metaverse world and I'm not sure that's the best outcome necessarily for Meta shareholders. I still remain a little bit skeptical of where this business is going in the long term. But for now, the credits that it develops in AI, whether they're for the Metaverse or simply to further their ultimate value driver, which is advertising revenue, that's going to be something they'll continue for a while.

Deidre Woollard: What you talked about reminded me of the video that Zuckerberg did where he was surfing and all of that stuff and trying to sell the Metaverse. I'm not sure people bought that but one of the things that he's talked about so much is the lower cost point of the Quest 3, which is going to come out this fall, it's around $500. He positioned it a little bit versus a higher priced device, which I'm assuming is the Apple VisionPro. I was wondering if people are so excited about Apple, but they don't want to pay what I think it's going to be what, 3,500 or we don't really know yet, but a lot. Does that create an opportunity for people to maybe choose the cheaper device just to get a taste of what the future might be?

Asit Sharma: Now, I think an astute observation on your part, Deidre, I think that will happen. It's not going to move the needle for Meta earnings, but it will help further the idea that it's OK to wear a headset, and as they become more refined, I actually think we will see a weird progression where businesses will have more of an uptake of these headset devices and that adoption will at some point in the, let's not call it near future, but at some point in the future will drive more consumer adoption. There is a great business case for collaboration using augmented reality. Already, Meta and Microsoft have been collaborating to make that more and more normalized in the coming years. As for the consumer, both on the business side and the consumer side, sure, it creates some economic principle where I want to try the technology out buying a pen, 3,500 bucks. Let me try 500, I could spend that.

Deidre Woollard: I don't think businesses want to pay that either. Let's switch over and talk a little Chipotle, the earnings came out pretty decent. The market didn't love this, but comparable restaurant sales up 7.4%. The thing I'm fascinated by is how they're streamlining their back end because they added 47 restaurants this quarter, 40 of them had the Chipotlane, that's their cute name for basically a drive through. But they're adding it they're really thinking about how to streamline. They're adding IN more robotic assistance. They already had the chipmaker now. They've got a machine that's prepping avocados for guacamole. Really thinking about how Chipotle and other companies like Starbucks deal with these digital orders, is the fast food of the future just going to be even faster?

Asit Sharma: Yes, sure it'll be faster. Everything that goes around comes around though, Deidre. Teens '70s all over again. In the '50s, we had this new experiential way to eat out. That was the McDonalds chain. By the 1970s, people didn't want to go inside McDonald's, but they really liked the drive through and then we had years later fast casual come around, which you and I are students of this business, the fast casual business. It was all about the experience of Chipotle's early iterations. Even though they learned how to make burritos using McDonald's ideas of throughput, it was on the experience, it was on the sustainable ingredients. The same you have with Starbucks. Starbucks really went high in high-end into the roastery concepts, trying to make sure that they can convert customers. Now everyone's going back to where we were in the previous time, which was all about convenience. I think they got a big lift from the pandemic where we all just wanted to quickly get our food and bring it back home. But throughput is more and more going to be a keyword that we hear just as we have. It's cyclical, like every few years we have this swayed between people wanting to go and enjoy things in a new way and then wanting that same thing, but in a more convenient fashion. This is playing into the trends in robotics, especially cobots, so robots which are merely an arm that smart, and can help you pack or develop something and some techniques that have been more breakthrough techniques with grills in the commercial space. All this comes together, I think for another wave of building out a lot of high capacity for something that's essentially just getting a product a little bit faster to consumers. I'm waiting. I don't know, and I don't see it yet. I'm waiting for that next wave that wants to bring us back into a totally new fast dining experience.

Deidre Woollard: It's interesting. I think what you meant, like with the avocados, like it'll cut the avocados, but you still have the person who has to match up and make the guacamole. There is this interesting thing of how do you make sure that the person still feels like they're having a connection with another person watching someone assemble a burrito, while a lot of the other stuff happens behind this, yes.

Asit Sharma: I think that's very important actually, Deidre. For me, as a consumer, I don't speak for everyone, of course, I like to see the human element. I don't like to order something and go pick it up off the shelf, which is always an option if you're doing something fast casual or going to something like Starbucks chain, to go in and chat with people a bit. But finding that balance is a challenge for the management of these companies.

Deidre Woollard: Absolutely. Well, I was chatting earlier this week with Jason Moser when Domino's earnings came out and we talked a little bit about how they were retooling their loyalty program. Chipotle's loyalty program is huge, 35 billion in the program. They scale that back a little bit last year then they added new things earlier this year now they're venting with some personalization, some fun incentives. How do you think about loyalty programs when looking at retail or restaurant businesses as an investor like is that is that a number you look at?

Asit Sharma: Totally, and I think they are very important. The reason is we don't have an equivalent in the restaurant world, the retail restaurant world with what we have in the software world, like a recurring subscription-based business. I think Taco Bell tried a subscription a couple of years ago, it didn't work out that well. But what we do have our these loyalty programs and those enable companies that manage them well to play with their throughput. If you see that you're not making your numbers in a given month, you've covered your fixed cost base. Now the rest is incremental profit. This is how the month falls out in the restaurant industry. Those last few days are where all that incremental profit comes in. You can incentivize people to go into the store on the fly, management can sit behind a dashboard and throw out an offer and with generative AI, you can make it very personalized. To me, the companies that have this, they have an extra bit of value driver, an extra way to make sales and they can really manage how and when customers come into their restaurants. Those that are building loyalty programs, I always assign a little bit higher value if I'm looking at the value thesis or trying to dream out the cash flows over a five or 10-year period. It's important to me. What about, you know, you study this industry so much, do you think? I know there's a big counter-argument that they can be more intensive than it's worth to run them. What are your thoughts?

Deidre Woollard: I think they can be more intensive, but I think they're also extremely powerful. What you just said about people to push the consumer where you want to go. I think that's important. I think about companies like Ulta Beauty, which is another favorite of mine and they're able to push sales where they want them to go and that is really, really important. I think we're going to see, especially right now, as we're looking to maybe a consumer that feels a little bit less spending than they have in the past six months. Loyalty programs and price incentives become even more important, especially with Chipotle where they raised prices recently. I got to know, are you a burrito guy or bowl guy?

Asit Sharma: It might not surprise you to know that any given morning. I can be a bowl guy or a burrito guy. Part of this is middle age, Deidre. You're thinking I've had too many burritos as of late, i got to switch to a bowl. But sometimes you just want to be healthy and the way it's presented in a bowl is very enticing. Yourself.

Deidre Woollard: Burrito all the way. Thanks for your time today Asit.

Asit Sharma: Same great to be with you Deidre.

Deidre Woollard: High prices and low availability of single-family homes have set the table for multifamily demand. Matt Frankel interviews Willy Walker, CEO of Walker and Dunlop, one biggest multi-family property financing companies on the current state of commercial real estate.

Matt Frankel: Let's get right to it. I'll start with this one. We've all seen plenty of headlines about a real estate crisis that's about to happen, especially in commercial real estate. Is this kind of a broad thing that you're worried about or do you think this is more just focused on offices and the property types that are really suffering right now?

Willy Walker: I think it's important Matt, to keep in mind that if you will, clarifying comment you just made, which is that people say commercial. But inside of commercial real estate, they're really five different asset classes and each one has strengths and weaknesses right now. Inside of commercial real estate, if you think about the amount of debt that's outstanding in the commercial real estate industry, the number is about $4.4 trillion of debt that's outstanding and most people are concerned about the debt side of things, not the equity side of things because most commercial real estate equity owners are either private equity funds or high net worth individuals. The public markets really don't have big equity positions other than possibly owning a REIT and we can talk about that in a moment if you'd like to.

But as it relates to the exposure to the market, it's really on the debt side, 4.4 trillion of debt outstanding on commercial real estate broadly, half of that is on apartment buildings. So 2.2 trillion is on apartment buildings were one of the largest lenders on apartment buildings in the United States and the apartment sector has held up extremely strong. People are still living in apartment buildings across the country. People are still paying their rent we're at 3.5, 3.6% unemployment in the United States and so the apartment sector is doing very well and the fundamentals of apartment buildings are still very strong. Now in the other 2.2 trillion of debt outstanding, you have office buildings which are struggling to say the least. You have retail, you have hospitality and industrial. Now industrialist held up the strongest of almost all commercial real estate asset classes. That's the distribution facilities that Amazon and other e-commerce companies, as well as Target and others, use to distribute their goods. Industrial has done extremely well. Retail and hospitality have both rebounded very strongly since the pandemic and there obviously pockets of weakness but very strong. We're back on the hospitality side at revenue per available room RevPAR. That is not quite back to pre-pandemic levels, but occupancy levels are back to pre-pandemic levels and RevPAR is getting darn close to where it was pre-pandemic.

Then the laggard of all this is office and so the big concern is what happens with the future of office and are we going to have defaults on office loans that come back into the banking system, that then cause some banks to have very significant problems. As we've focused and looked at very significantly, commercial real estate exposure on bank balance sheets is an earnings issue. It's not a solvency issue. After the blow up of SVB and Signature Bank and First Republic, a lot of people have been concerned that commercial real estate loans would come back and cause another bank to go out of business. If you look at it in isolation, Matt so not clearly in the great financial crisis, it wasn't just problems with commercial real estate loans, it was problems with credit card debt, it was problems with CNI loans. It was across the entire loan book. But if you look at it just in a commercial real estate exposure standpoint, even the most heavily concentrated banks with a lot of commercial real estate exposure, like Wells Fargo, like Bank OZK, it's an earnings issue for them. It's not a solvency. They both have plenty of Tier 1 capital to survive whatever the real estate market will throw them as it relates to overall exposure to commercial real estate loans. That's a pretty long-winded way of saying, I think it's important for people to look at this on an asset class basis, not just say commercial real estate has problems and then as you dive in a little bit deeper, it's really an earnings issue with some of the banks. It's not really a solvency issue.

Matt Frankel: So far we've talked about what's coming down in the next few years. Let's talk about so far because the interest rates spike has already happened for the most part, hopefully we're done with the interest rate spike. How specifically have rising interest rates affected multi-family housing so far? Because people like me, we see how it's affecting residential real estate. It's a lot of would be home sellers are staying on the sidelines, for example. A lot of buyers are getting priced out of the market, things like that. What are we seeing in multifamily? Is it the same thing?

Willy Walker: A couple of things. First of all, I think it's really important as you point out, Matt to realize that whether the Fed does another interest rate hike or two more interest rate hikes, the worst is clearly behind us. We've already raised 500 basis points. If it ends up being 525 or 550 basis points, 90% of the raise is behind us. That's good in the sense that for commercial real estate in transaction volumes, you need rate stabilization to then allow cap rates to adjust to where rates are and then you get transaction volume happening again but when there's a disparity, if you will, between what the cost of capital is and where valuations are, that's when the market freezes for people to say, well I don't know what my financing cost is going to be and I don't really know what value is, so I can't transact.

One of the things that's important is to get to that rate stabilization, so cap rates can adjust and then you can start getting DealFlow again. As it relates to your comment on single-family versus multi-family, there are a couple of things to keep in mind. Somewhere 40-50% of homeowners in the United States of America locked in a very cheap 30-year fixed rate mortgage in 2021 and 2022. The numbers are 40-50% of single-family homeowners have a single-family mortgage of between 3% and 4% as far as the coupon rate that they've locked in for 30 years. They have absolutely no problem with that, there's no default risk with those loans, and those people are benefiting from an extra on a medium home price. They're benefiting from somewhere to between $5,000 and $7,000 a year that they typically would have had to pay for their mortgage so that they can put in their back pocket.

That's sending them to Disney World, that's buying to go back to a movie that you and I probably remember trading places where they talk about buying the GI Joe with the Kung Fu Group. I'm probably dating myself a little bit on that from that, anyway, that extra cash flow makes it so that those people don't want to sell those homes. Because if they sell the home, they've got to go put a new mortgage on it at today's rates. That inventory of single-family homes isn't coming on the market, which means that really the only homes that an individual can go buy are new homes coming on being built by Lennar and the other big single-family homebuilders. In Lennar's last quarter, Matt, their average home price was $456,000. That is not affordable to most renters. What it means is that the cost of single-family housing is staying high, and people who typically would graduate, if you will, from being in a rental property to being in a single-family home, can't make the jump, which means that they are going to remain renters.

As a result of that, given the price dynamics right now, what it means is that typical churn that you would get from people who say, hey, I just got married, I've been living in an apartment, I want to move out to a detached single-family home and start a family, aren't able to make that jump right now given the price disparity between renting and buying. There are many people including us who think that higher cost of entry into single-family housing stays that way for quite some time, which means that multifamily stays well occupied, which means that today, we're seeing rents across the country are pretty much flat. There's some sub-markets where rents are still growing. Some that have negative rent growth on them, but basically across the country right now in Q3 of 2023, rents in multifamily are flat. A year ago were going up at exorbitant rates, right now they're flat. Many people are saying, we'll get rent growth back into the multifamily sector in 24 and 25, as you don't have people moving into single-family because of a lack of supply in the cost of entry and therefore, you've got more demand for the product than you actually have product, therefore, rents start to move again.

Matt Frankel: You touched on something there, the housing shortage is another big issue that is a problem right now, depending on what estimate you're looking at, we need another 4-7 million homes in the US, depending on your source. It's dramatically leaning toward the lower end of the income spectrum when it comes to the housing shortage. There's no easy solution, but I know affordable housing is near and dear to your heart at Walker and that was a big part of one of your recent acquisitions. What do you see as the solution both in the long-term and short-term sense?

Willy Walker: The numbers that I look at on the single-family side were about three million single-family home shy. On the multifamily side, we're somewhere between half a million and three-quarters of a million. You're somewhere between three-and-a-half and four million homes short of meeting the pent-up demand for housing. You're spot on in your numbers there, Matt, as it relates to what the need is. The fear is rent control, and the reason I say that is because rent control has not solved any housing problem in any city or state across the country since people came up with the idea of rent control, the only thing that has ever brought the cost of housing down has been new supply. It's a supply issue, not a control issue if you will. One of the interesting things is in many municipalities, for instance, in Boston Massachusetts, the mayor has done two things simultaneously, one that I view as being very positive, one that I view as being very negative.

On the negative side, the mayor has tried to push through rent control. It likely doesn't get through the legislature and will not get through but she is trying to push a rent control measure in Boston right now to try and freeze rent increases. I don't think that that's good public policy, they need more supply of rental housing. On the supply side, the mayor has proposed that there be a new tax policy put into place for people who want to convert office buildings into multifamily properties, so a residential. That's a very interesting proposal. It only came out yesterday, and the idea is to give a tax deferral for 30 years of 75% of the taxes that an owner would pay on a residential property if they convert an office building into a residential property. Now there's some other pieces to that, Matt, first of all, there's an environmental standard that they think is going to add about 2% to the overall conversion cost.

Then they also want 20% of the units in those buildings to be rent controlled and that's up from the mayor's original proposal at 13%. The question in all that is does the math work to convert those office buildings to residential given a 75% abatement on taxes for a 30-year period, and then also with the environmental standards as well as the Affordable Housing restrictions on 20% of the units? Time will tell, Gensler did a study and supposedly they're 90 office buildings in Boston that, if you will, qualify for this, that are right for conversion given floor plan, the ability to convert to residential, we'll see how many owners actually go down that path. But at the end of the day, what is really needed is supply of more affordable housing. That's the reason we bought Alliant, as you rightfully pointed out, a year and a half ago, we're one of the largest owners and developers of affordable housing in the United States. The final piece I'd say to it is Fannie Mae, Freddie Mac, and HUD, all parts of the US Federal Government are very focused on promoting and financing affordable housing. Although all three of them will do market-rate housing, the real focus that Fannie, Freddie, and HUD have, and their regulators have is to focus on putting their dollars into affordable housing properties.

Deidre Woollard: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Deidre Woollard. Thanks for listening. We'll see you tomorrow.