Michael Simanovsky - A Platform Approach to Real Estate - [Invest Like the Best, EP.344]

My guest today is Michael Simanovsky. Mike is the Managing Partner of Conversant Capital, a real estate investment firm he founded in early 2020. Conversant aims to be the most flexible capital provider in real estate, investing across public and private markets as well as equities and credit. The firm will also incubate platforms where they see an opportunity to take advantage of a compelling theme that lacks existing business models for investment. We cover the most undersupplied part of the market, why he’s building Conversant to be so flexible, and the surprising appeal of billboards. Please enjoy my conversation with Mike Simanovsky. Listen to Founders Podcast Join Colossus live in NYC with Patrick O’Shaughnessy and David Senra on Oct. 19. For the full show notes, transcript, and links to mentioned content, check out the episode page here. ----- This episode is brought to you by Tegus. Tegus is the modern research platform for leading investors, and provider of Canalyst. Tired of calculating fully-diluted shares outstanding? Access every publicly-reported datapoint and industry-specific KPI through their database of over 4,000 drivable global models hand-built by a team of sector-focused analysts, 35+ industry comp sheets, and Excel add-ins that let you use their industry-leading data in your own spreadsheets. Tegus’ models automatically update each quarter, including hard to calculate KPIs like stock-based compensation and organic growth rates, empowering investors to bypass the friction of sourcing, building and updating models. Make efficiency your competitive advantage and take back your time today. As a listener, you can trial Canalyst by Tegus for free by visiting tegus.co/patrick. ----- Invest Like the Best is a property of Colossus, LLC. For more episodes of Invest Like the Best, visit joincolossus.com/episodes. Past guests include Tobi Lutke, Kevin Systrom, Mike Krieger, John Collison, Kat Cole, Marc Andreessen, Matthew Ball, Bill Gurley, Anu Hariharan, Ben Thompson, and many more. Stay up to date on all our podcasts by signing up to Colossus Weekly, our quick dive every Sunday highlighting the top business and investing concepts from our podcasts and the best of what we read that week. Sign up here. Follow us on Twitter: @patrick_oshag | @JoinColossus Show Notes (00:03:32) (First question) - Real estate investing through the lens of the capital cycle (00:06:50) - The capital cycle in practice (00:12:07) - Using evaluation of supply to determine where you are in a capital cycle (00:13:16) - Why real estate drew Mike in (00:15:35) - The quality of investors in real estate (00:16:41) - What the US market needs most (00:20:26) - The range of returns in real estate (00:23:01) - Insights that stand out (00:26:45) - Starting a new company vs. building a portfolio of assets (00:28:46) - Key trade-offs and choices when building a firm (00:31:10) - Where things go wrong (00:33:59) - Best investment decision he ever made (00:38:06) - Philosophy on CapEx (00:39:52) - Misconceptions about real estate investing (00:41:31) - Cold storage real estate (00:43:13) - The most interesting corners of the real estate market (00:46:13) - AI and its impact on the future (00:48:30) - Common investor missteps (00:50:51) - Three guests Mike would invite to a dinner party (00:52:34) - The most impactful questions to ask a real estate investor (00:53:17) - A defining moment of his career (00:53:17) - The premise of the platform approach (00:56:20) - Possible opportunities and an understanding of the current landscape (01:03:38) - Lessons Mike learned from basketball coach John Wooden’s philosophies (01:04:30) - The kindest thing anyone has ever done for him

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Patrick O'Shaughnessy?

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• 0:35Patrick O'Shaughnessy?

  Hello and welcome, everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts and you can access all our podcasts, including edited transcripts, show notes and other resources to keep learning at joincolossus.com.

• 1:00Speaker 01

  Patrick O'Shaughnessy is the CEO and founding partner of Positive Sum and the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Sum or O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Positive Sum or O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast.

• 1:32Patrick O'Shaughnessy?

  My guest today is Mike Simanovsky. Mike is the managing partner of Conversant Capital, a real estate investment firm he founded in early 2020. Conversant is unique in that it aims to be the most flexible capital provider in real estate, investing across public and private markets, as well as through equity and credit. The firm will also incubate platforms where they see an opportunity to take advantage of a compelling theme and there are no existing business models to invest in. We cover the most undersupplied part of the market, why he's building Conversant to be so flexible, and the surprising appeal of billboards. Please enjoy my conversation with Mike Simanovsky.

• 2:09Patrick O'Shaughnessy?

  Mike, maybe an interesting way to frame our entire discussion of real estate is through the lens of the capital cycle. You just told me on a long enough time horizon, everything is sort of cyclical. What is the capital cycle and why is it an interesting lens through which to view real estate investing?

• 2:24Speaker 02

  Yeah, sure. So I think at the highest level, early in my career, I learned about the capital cycle through this book, Capital Returns by Edward Chancellor, which I happen to be holding in my hand and I keep in my office.

• 2:33Patrick O'Shaughnessy?

  I just started his other book, The Price of Time, which is excellent as well.

• 2:37Speaker 02

  I actually haven't read that one, so it's next on the list. But it's a book I keep in my office and it really influenced me. And I think the basic premise of it is that high valuation of businesses or assets encourage a supply-side response as new entrants to the space become excited about the prospect of high returns. Ultimately, what I find so interesting is that rising competition for some period of time won't really deter returns, but eventually rising competition causes returns to fall well below their cost of capital or through the cycle cost of capital. And then investment declines as people are like, wait, I thought I was getting a really high return, but now I'm getting a lower return. Then a lot of consolidation will exist and that consolidation could be bankruptcy, it could be selling a company, it could just be capital fleeing a space. And ultimately,

• 3:21Speaker 02

  that to me is the best time to think about entering a space, which is an improving supply-side picture causes returns to return to a point in excess of the required cost of capital. I think what's so interesting to me is at the peak of the capital cycle, investors tend to be the most optimistic and they extend their duration. So they look really far out to get the required return. There's a lot of imagination required in that. And I'd say as fundamentals are deteriorating, naturally you're seeing asset values change, you're seeing multiples or cap rates in the case of real estate change, and you're seeing meaningful asset value or share price underperformance. And then ultimately get to the bottom of the capital cycle where investors are max pessimistic with the shortest possible duration

• 4:02Speaker 02

  possible. And to us, that's a really, really interesting lens to think about real estate. There are assets in real estate and there are several subsectors of real estate to which the capital cycle probably doesn't imply they're irreplaceable or they're super regulatorily supply constrained. But overall, on Average, I think, real estate is a commodity style sector and it benefits greatly to look at it through the capital cycle lens. And if you actually think about some high level principles, very generally about real estate, I'd say number one, it is a highly cyclical asset class, but often with very long supply cycles and very long demand cycles. Depending on the asset, it could take a year or three or four years to build an asset before you actually see that deterioration of fundamentals.

• 4:43Speaker 02

  On the demand side, you could be looking at millennials aging into housing and you have a 10 or 15 year cohort to think about it. I think a lot of people up until maybe last year, forgot about real estate cyclicality. On top of its cyclicality, it is highly capital intensive. The land is an asset that in theory appreciates in value, but the building on top of the land constantly needs capital to stay refreshed. And it's often financed through debt capital to facilitate those capital needs to make sure you can meet your equity return objectives. And because of that reliance on debt, it's naturally more sensitive to the prevailing cost of capital. And then on top of it, just sort of to the side and related, there's a ton of operating leverage if you own a fixed cost asset.

• 5:27Speaker 02

  And so you have this dynamic where you can have cyclicality overlapping with operating leverage, overlapping with financial leverage. And that is an amazing lens, in my opinion, to use the capital cycle.

• 5:37Patrick O'Shaughnessy?

  Is there a favorite example, whether you want to zoom in on housing or office, or I don't really care the category, that you could tell us like a historical, you know, end to end version of this cycle, just to nail home this point of how it actually works in practice in the real world?

• 5:51Speaker 02

  I think the example I would use would be senior living. So I'll give you 20, 25 years of history at a very, very high level. And senior living is a more operationally intensive business than most other real estate asset classes. So I guess with that caveat, there was a big supply surge in the late 1990s. And ultimately, at the turn of the century, the capital cycle caught up to the senior living, such that a number of distressed funds came into the space and took over the existing asset basis. So kind of that bottom of the capital cycle dynamic. A lot of distressed funds naturally aren't thinking quite a bit about development. They're thinking. Let's rationalize what we have. Let's consolidate the industry. Let's create

• 6:32Speaker 02

  large platforms. While there was some development, there was modest development between 2001 and 2008, like the GFC, relative to what happened in the late 1990s. As a result of that, the senior living space went through the GFC and unlike multifamily or office or industrial, it actually didn't have a drawdown in its operating performance and it skated through unscathed. So naturally, thinking about the capital cycle framework, what happened? Capital saw that it performed better than multifamily, et cetera, and capital came back to the space very significantly. Coming out of 2011, there was a very large supply cycle that started in 2013. On average, let's say it takes about 24 to 30 months to deliver a property. You started

• 7:14Speaker 02

  to see the impact of that supply in 2015, which was probably the peak of the prior cycle, and it extended all the way until Q4 of 2019. If you actually look at nationwide data absorption, which would be demand minus supply, turned positive for the first quarter in about four and a half or five years in Q4 of 2019. Take it a step further. Unfortunately, COVID happened and senior living was at the epicenter of that. The way to think about growth in the senior living space is you try to acquire a customer, you get a lead, that lead becomes a tour, that tour becomes a move-in, and then net of your move-outs, you try to grow occupancy over time. And so what we saw was no tours allowed during the COVID period, and you saw industry occupancy

• 7:58Speaker 02

  fall 1,000 basis points. So you went from roughly 88% in the month before COVID to about 78% of its trough. And then to make matters worse, in 2022 in particular, because labor is the largest component of the cost structure of senior living, remember earlier I mentioned it's an operating business. In addition to a real estate business, it had pretty significant sort of negative operational performance for a period of time. What we see today is an opportunity where occupancy has started to mean revert to its prior COVID highs. However, supply is down 80% from its highs earlier in the 2010s. Yet you have an environment where if you think about it through three lenses, one is, what's the capital cycle? We think we're at a troughing supply. I would argue that

• 8:40Speaker 02

  the bottom decile of assets are going to be converted into some other asset, drug and alcohol recovery, whatever it may be. You may, not necessarily, but you may have a situation where supply growth actually goes negative or flatlines for a period of time. It's a pretty good setup when you think about the capital cycle. Then the next thing we ask is, okay, capital cycles, then cohorts, what's the demographic picture? If you have an asset base that's roughly half independent living and half assisted living, the average age of entry today is about 83 years old. All of that supply that was built on the back of the outperformance in the post-GFC period, I think presumed a 75-plus age cohort. What I think the reality is, is you got to evaluate the 80 and 85-plus cohorts. I always make two jokes when I talk about demographics. One is, I follow my sister-in-law around.

• 9:24Speaker 02

  She was born in 1990. That is the peak millennial. Whatever she's up to, I want to do. And the second thing is, I always follow my parents around. They were born in 1947. That's peak boomer. There's a large trend behind them. They will turn 83 in 2031. On our math, the growth rates accelerate from earlier this year through 2031 as that 80-plus cohort gets bigger and bigger and bigger. And so what we see is a dynamic where it feels like bottom of the capital cycle. There are banks that are getting tired and selling non-performing loans. There are fatigued sellers. There's a long runway of growth. One of my mentors, my old boss, Doug Silverman, taught me, don't do distress for the sake of it. Do it because

• 10:07Speaker 02

  you're excited about the opportunity to own the asset for a long period of time. And I think that applies in this case. And then lastly, we ask ourselves, where can we plan the capital structure? And right now, we're seeing a lot of defaulted loans on developments that were started in 2017 that just haven't gotten the occupancy that the bank and the operator thought they would. We're seeing a lot of private equity firms that are just fatigued. They got in in 2016 and it hasn't gone the way they wanted and they're just ready to move on because everything else has gone really well. So that's probably the end-to-end two-cycle example I'd give you.

• 10:40Patrick O'Shaughnessy?

  When you're thinking about capital cycles and using that as a great lens to evaluate the broader opportunity sets, say senior living writ large, before you decide here's exactly surgically at the asset or even the cap structure level where we want to play, you're just making a bigger evaluation. Do you find that evaluation of supply or demand is easier to help you suss out where you might be in a capital cycle? Or is it just both?

• 11:08Speaker 02

  I think the easier thing to get your head around and get excited about is supply. We feel comfortable that supply is coming down. It will take this amount of time to rationalize. You tend to see people exiting the space at times like this. And we recapped the senior living portfolio 18 months ago. We've been working to grow it. It feels a little lonely out there buying assets and hopefully that turns out to be okay. But I think to get really, really excited about the opportunity, you have to believe that you've been making attractive enough return in a benign demand environment, but you can make a terrifically exciting return in a growing demand environment. So that's the lens. I think with supply is step one, demand is step two. What's the best way to participate in the capital structure? That's step three. That's our lens.

• 11:52Patrick O'Shaughnessy?

  Having talked to you several times about real estate, it's pretty clear like you're a fairly surgical investor. Like you're really interested in all the variables that go into a good investment. With that in mind, why real estate? Like what is it about real estate that drew your career rather than equities or anything else that you could have done with the same skillset or the same interest and curiosity? What is it about this asset class that made you pick it?

• 12:17Speaker 02

  Yeah. So I think from an asset class perspective, I grew up, I was on the sell side for a couple of years before the financial crisis. I had the opportunity to go to a firm that had a major distressed bias in 2008. I joined the month before Lehman failed. It was an unbelievable apprenticeship on understanding how to think through the downside of things. But it was also an unbelievable opportunity to see how big the real estate market is and how scalable it is. And you have the opportunity to evaluate bonds of a distressed small company or buy residential mortgage backed securities. You just have a great opportunity to understand. That there's literally always something to do in real estate. And so that's the motto around which Conversant was built. It was built around, there's always something to do. And the next step on that is that we're the most flexible possible capital provider.

• 13:01Speaker 02

  So we don't think about equities or credit or public or private. We do all of them, but it's a hyper cyclical sector. It's one that has really long reinvestment runways. It's highly scalable. The example I always think about is Prologis is the largest REIT around. It has about a hundred and fifteen billion dollar market cap. It is an owner of warehouse and distribution facilities in the U.S. And they only control five-ish percent of the stock of the U.S. And they've been building that company for thirty plus years. And so when you think about it through that lens, it's in a tremendously scalable sector. I think if you take it even farther, Prologis and all the other industrial REITs combined on less than ten percent of the industrial stock in the U.S.

• 13:44Speaker 02

  And so when you think about fragmentation, it's just an opportunity to really build businesses, which is one of the reasons we take a platform approach to real estate when we do it. It allows us to seamlessly navigate across public and private markets.

• 13:55Patrick O'Shaughnessy?

  It seems like a disproportionate percent of the billionaires whose name you've never heard are real estate owners and investors. Do you think that on average, the quality of investor in real estate is any different from in equities or anywhere else? Your competition, let's say, or just in general, professional institutionalized real estate investors? Are they of a similar caliber as you'd find in the best equity shops or the best credit shops or what have you?

• 14:26Speaker 02

  Like you think about individuals and the billionaire comment you made. In my view, there is, there's a ton of tax efficiency in owning real estate and owning it for long, long periods of time. I think as a result of that, there's a lot of people that bought assets in the nineties, two thousands, twenty teens, whatever it may be. And the benefit of having the ability to withstand the volatility and duration has actually been a massive competitive advantage. So that's on the billionaire point. On the private equity point, I think the space is institutionalized so much over the last fifteen or twenty years. I think some of the smartest investors I've ever met focus on real estate. Some think about it the way we do, some think about it at a single asset level. I think there's a great opportunity to find great investors. And the biggest private equity firms in the world, the biggest asset managers, real estate generally is a huge component of what they're doing.

• 15:11Patrick O'Shaughnessy?

  If you think about the needs of the country, let's say, so. If you thought about a version of the US which was thriving in as many ways as possible, where some of that thriving would be enabled by its physical infrastructure, its various different kinds of real estate assets, what is most missing from that picture? Like, if you could inject X, Y, and Z, or whatever, into the stock of real estate in the US, what do you think it most needs? I'm curious, the other side, too, like, what it has too much of, if anything?

• 15:42Speaker 02

  I think the American that earns, on average, between $60,000 and $100,000 a year has a dearth of affordable and available housing. I'm sure you've seen the charts that are floating around, but there's lots of charts showing housing stock over $400,000 at prevailing rates, the most unaffordable it's ever been. I think for a person making some $100,000, given the availability of credit today, I think it's very challenging to be in reach of that housing. And then circling back to the capital cycle comment, I think, given what happened in the GFC, no two crises in a row are ever the same. And I think what happened is you had a significant pullback in capital availability of housing, which is, I think, in some ways, created the home price appreciation that we see.

• 16:24Speaker 02

  And so, to me, if there was some way to provide the sort of median consumer in the US with an affordable housing objective, and you could inject it into the veins of the United States and do it everywhere, I think it would be a tremendous positive.

• 16:38Patrick O'Shaughnessy?

  What about the other side? Anything that we have just way too much of?

• 16:41Speaker 02

  There's this narrative around office that it's about work from home. And we think work from home simply expedited the fundamentals that were already prevailing. In some ways, it's funny, because I laugh when I hear people say, well, COVID moved people into the suburbs. If you actually track the data, it started in 2017, which is when you would have expected it to start, given the aging of the millennial cohort. The same dynamic, in our opinion, is occurring in office, but to the other way. We just have had too much supply, and we've had too much supply in the CBDs, in central business districts of major cities. We've had too much suburban office supply, which doesn't get used the same way it used to. And our general view is that I think this work-from-home phenomenon has highlighted

• 17:24Speaker 02

  A couple of things is highlighted this narrative around office. You can look in New York City, which is near and dear to your heart and my heart being probably exactly in between us and we delivered one Vanderbilt, Hudson Yards, Manhattan West, all around the same time, class A plus office. And what's interesting to me is if you actually look at demand data for office and you look at a city like New York City, over 100% of the incremental absorption from the GFC through the COVID time period was related to tech or tech related users. That includes WeWork, we went from nonexistent to several million square feet of space. And so our view is office, it just needs to go through its supply, demand dynamic.

• 18:06Speaker 02

  I think it needs to go through the somewhat same scenario that malls went through. The death of retail conversation started in 2015. I think malls have probably gotten to a point where they rationalize themselves as we sit here today in 2023. And I think what we've observed is that the class A mall is probably more valuable than it ever has been because class B and C malls have gotten a lot less interesting and worthless. I think as you've seen other asset classes appreciate in value and be able to drive higher rent, you've been able to see the ability to switch from a class C mall to something else. I think that is a good playbook to think through the office sector. And our view is that's going to take a few years to sort of materialize.

• 18:49Patrick O'Shaughnessy?

  As you think about returns for investors in real estate, especially with your lens of public, private, credit, equity, you can do anything you want. Are you just targeting the highest possible return? Are you targeting the best risk adjusted return? How do you think about the range of available returns to a real estate investor with an open mandate like you have versus equities where it seems like there's sort of an accepted wisdom? You earn about 10% a year in equities, public equities over time, over the very long term before inflation. And there's sort of just like a gravity to it. That's kind of what equity returns are. Is there something similar in real estate or do you think about it differently?

• 19:28Speaker 02

  Yeah. So I think when people think about real estate, they generally quantify them in core returns, core plus returns, value add returns and opportunistic returns. And I think depending on the prevailing cost of capital, those numbers move around a little bit. But that core capital is sort of mid-single digits return on equity. That core plus is high single digits, that value add is low teens and opportunistic is equity-like returns. Our view, given that we can constantly, and to use the word you used earlier, be surgical about where we spend our time, we're happy to look in through the cyclicality. We're constantly seeking opportunistic returns. That's something that we're looking for across private markets and public markets. And the way we think about private markets is twofold. We're always investing in platforms where we can either incubate them ourselves.

• 20:12Speaker 02

  If it's the best way to take advantage of a particular opportunity, or we can buy into a platform if there's a capital need for whatever reason. So on the incubation side, we're building a platform, we're identifying a theme, we're finding a management team. And ultimately, that management team is exclusively working for us and we're building a vertically integrated platform. But we're doing that when we otherwise can't get access to a business model. One of our largest investments is a company called Quinn Residences. It's a private platform. We started it right before COVID. It owns entire communities of single-family rentals all over the Southeast. I've been studying the single-family rental space for the better part of the 2010s. Super, super excited about the space. In 2019, started learning more about this dedicated rental community approach, what

• 20:56Speaker 02

  people call build to rent. And the thought was you can bring a brand-new product, highly amenitized, with an operational focus that looks and feels like multifamily, which is very different than scattered site single-family rental. But when we looked at the available options to invest in the public side, there are three great public companies. There's American Homes for Rent, there's Invitation Homes, and there's Tricon. None of them were pure play on what we were really, really excited about, which was the build to rent concept. And so we were able to partner with a great management team, a few other founders, and incubate this business that we think is now one of the larger dedicated build to rent platforms in the country. And then conversely, we're happy to buy into a platform where there's dislocation or distress, like how we entered our senior living business almost 18 months ago.

• 21:40Patrick O'Shaughnessy?

  Can you talk me through what it was like to study a market like single family for a decade before making a decision like this? So like, what were, if you think back on that period of learning, what were the biggest insights that stand out from all that study that coalesced into the idea behind this platform? Like, what are the ingredients that became the platform?

• 22:02Speaker 02

  So I think that every incremental real estate asset class that institutionalizes comes out of some dislocation. So think about towers. They became an institutional asset class as the cable companies and fiber providers had to work through their debt issues in 2001, 2002. That's when the towers became a real asset class. You think about multifamily became an asset class. If you think about 92, 93, that was out of that crisis. That's when REITs really became what they are today, or the early start of what they are today. And I think that 2010, 11 time period birthed, single family rental as an institutional asset class. It was a natural time to do it. There was a lot of distress. There was a lot of dislocation. I think having made investments in the space early in the 2010s and 11s and getting really close to investing

• 22:47Speaker 02

  in a platform in my prior firm, what we observed was, could you price the asset at such a discount to replacement costs? Could you make a view, again, on the capital cycle, there was going to be limited new lot development for some period of time, such that knowing the demographic trends that you get really excited about rental growth. So would you be really excited about buying an asset at such a discount that you'd be just fine with it, quote unquote, being a trade? And I think the big question mark for a long period of time was, is there a good operator or set of operators around the asset? I think in around 2015, 16, 17, 18, you saw a lot of consolidation. American Homes for Rent acquired some other companies. Invitation Homes acquired some other companies. And the best operators took

• 23:33Speaker 02

  The largest swaths of assets. But you still had this dynamic where these homes were scattered all over the place. And imagine a city like Atlanta. You had a cohort of homes up north of town. You had a cohort of homes west of town, et cetera. And a lot of these homes were bought at the courthouse steps in 2012 and 13, or they were bought through other portfolios. And so there was a massive disparate quality feature of the homes. And so we said to ourselves, this is a super interesting sector. There's not a lot of supply, at least in 2019. There's a great demand setup, which I can walk you through. The average age of a renter in the U.S. is about 39 years old. You think about the single family cohort being 35 to 49 years old.

• 24:16Speaker 02

  That cohort is going to grow from here through the end of the 2030s at about 2X the population growth. So not quite as fast as senior living we talked about earlier, but faster than the population cohort. It's going to grow much faster than what we describe as the multifamily cohort, which would be 20 to 34 year old. And so we saw an opportunity. If you actually think about the complexion of that cohort aging out of multifamily, aging into single family. What did they have in multifamily? And what could they achieve in single family? So a lot of folks had reasonably new apartments. They had unamenditized experience. They had a doorman or something like that. And so that didn't exist in single family rental. On top of it, according to data that we tracked from John Burns,

• 25:01Speaker 02

  which is a great consultant around the space, 88% of all multifamily is studios, ones or two bedrooms. So as you age into family formation, there wasn't a renter option that gave you that new, large enough amenitized experience. And we started to hear about built rent in 2018 and 2019 and just met every operator we could and turned over every rock. And ultimately, that landed on meeting the team behind Quinn and putting in place, in our opinion, a best in class management team to grow it. And so now we have a portfolio with 39 communities and over 5,000 homes all over the Southeast.

• 25:35Patrick O'Shaughnessy?

  Do you think about that, like you just starting a new company versus building a portfolio of assets? Everything you just described is like product thinking, not so much asset evaluation or something like that?

• 25:46Speaker 02

  I'd say at the highest level, we have to start with a sort of thematic thinking if we're going to try to take advantage of a sector. And then the question is, what are the asset level returns? How do we think about the short, medium and long duration opportunity set? So the holy grail for us is to build a platform or buy into a platform that has what we call resilience, that has scalability and it has optionality. And what I mean by resilience is a high quality, reasonably predictable rental growth stream and sort of earnings stream. The perfect ones are defensive or countercyclical, like single family rental, but senior living has proven to be a little bit more cyclical. And there's a favorable long-term supply-demand dynamic, especially when we start to get involved. So that's how we think about the resilience of the asset. And then we say, to my example

• 26:31Speaker 02

  earlier about the industrial market, how large is the market? What's the length of the reinvestment runway? Are we able to acquire assets at an attractive return in what is likely a growing addressable market? And then the question is optionality. Can we use our platform to keep growing over time to get better return on invested capital? And then ultimately, can the space institutionalize in a way where valuation parameters look and feel very different than when we started? Maybe there's a bunch of mom and pops at the beginning, and there's a bunch of institutions at the end. And the optionality is maybe we'll get a platform premium. But at the end of the day, we're still doing the asset level work that every single asset owner is going to do. But that's how we think about

• 27:14Speaker 02

  building these businesses. They're real estate businesses with a platform approach.

• 27:18Patrick O'Shaughnessy?

  Maybe even one step back from the platform approach, which we can dive into more in a minute. I'd be curious to hear your philosophy on building an asset manager in the first place. You're catching me at a time when I've been spending some time, as I'm building one, studying lots of different models. There's so many interesting historical examples of different kinds of asset manager. How have you thought about the trade-offs and the choices that are key as you build your firm? Because that'll let us, I think, understand your platform approach even better.

• 27:47Speaker 02

  So I've mentioned a couple of times, and I'm probably mentioned it a couple of times more, but the thing that I'll say every day in our office is there's always something to do. So we need to figure out what it is, and then we need to go attack it. We need to study it, and we need to find a way to take advantage of it or deploy capital into it. And in order to do that, we have to be a totally flexible capital provider. We need to have the ability to invest passively in public equities. We need to have the ability to take a control minded approach in the private real estate markets. Again, with a platform approach. And then we need to do the things in the middle and the things in the middle tend to be credit oriented, which would be providing capital up in the capital structure. Pretty relevant today, given what's going on in the market or the distressed opportunity set when it presents itself.

• 28:32Speaker 02

  So every decision that we've made surrounds that. I think another thing that we say around here is we're not for everyone and that's absolutely okay. So we're very hard to put into a box. Every decision that we've made at this firm is simply about being flexible and making sure that we can maximize the return opportunity, not necessarily maximize the size of the firm. That's why we have a hybrid fund. That's why we offer a lot of co-investments to our investors. That's why, as we think about the natural progression of our business, we think about giving us more private capacity because the private markets are much, much bigger in real estate than the public markets are. We usually think nine times the size. And so every decision that we've made here is about ensuring that. So then you go down one layer further.

• 29:16Speaker 02

  Well, a lot of great real estate managers only do privates or a lot of great real estate managers only do publics. And I think our view is we had a blank sheet of paper at the beginning to educate folks on the way that we invest and to build a team around that with a flexible skill set and ensure an incentive structure in place to where everyone is indifferent to investing in the public markets or the private markets. We're simply seeking the best return opportunity that we can. And so I think that was the key decision-making framework for me at the beginning.

• 29:47Patrick O'Shaughnessy?

  Where do things most commonly go wrong for you, do you think? Like this seems like such a considered. Approach with a really long-term, you said resiliency, like really long-term trends, thoughtful about the capital cycle with a good sense of what's going to drive the outcomes. It's not like you're taking big product risk or something. So where do things go really wrong if they do?

• 30:12Speaker 02

  We get the capital cycle wrong. We get the supply dynamic generally correct, but the demand, we're just wrong. There's obsolescence in the asset class, for example. So to the extent we're wrong in senior living and to be around that independent living is going to emerge with a new form of asset, which is age restricted apartment housing. And that IL stock's not actually going to be needed in the same way it was in the past. It could be that that 83-year-old average age of entry moves to 86 or 87 down the road and we're a handful of years early. It could be that nursing staff continues to be harder and harder to make sure that the residents have a great experience. It could be that we buy into the sector and we hold too long and the capital cycle does its thing again. And in 2026, there's a lot more supply coming back online than we think.

• 30:55Speaker 02

  I think those are the ways that we generally would get it wrong. There's obviously a cost of capital dynamic occurring today that's been occurring for the better part of 18 months. And I think we're very fortunate to only have a handful of platforms that we got involved in in 2020. And so we're looking to play offense into this environment.

• 31:14Patrick O'Shaughnessy?

  Can you tell the story of the worst investment mistake you've ever made?

• 31:17Speaker 02

  The worst investment mistake I've ever made on the public side was actually in 2015 at my prior firm. It was an investment into Macy's on a real estate thesis in the public markets. And the reality was there was a lot of real estate value there. But unless you had a way to assert control over that, the direction of fundamentals is far more important than the quote unquote special situation, which would be extracting value. And so that's led me to largely avoid situations like that going forward.

• 31:54Patrick O'Shaughnessy?

  Say a bit more about like how the mistake became clear to you. So you make the investment on a thesis. That's a powerful lesson. I just want to pick it apart a little bit more. Like what came out? Was it just price action against fundamentals?

• 32:08Speaker 02

  So the company, there was a cohort of investors who had the same thesis. There was an activist who became involved in the company. Nonetheless, the activist wasn't able to get the management team or the board to get excited about separating the real estate. This activist had had quite a bit of success in a similar company in the restaurant space. And so they weren't able to get the board to sort of focus on the real estate effort. And over the course of two or three quarters, we saw numbers deteriorate and deteriorate. When I say numbers, I don't mean price action. I mean, actually, direction of revenue, direction of earnings was deteriorating to the point where it didn't matter if they owned all the real estate, they weren't going to do anything with it.

• 32:51Speaker 02

  And so, again, to simplify the lesson, it's the direction of numbers is far more important than the special situation.

• 32:56Patrick O'Shaughnessy?

  What about what you view as the opposite? The best investment decision you ever made?

• 33:01Speaker 02

  I'm a big believer that in the public markets, the direction of return on invested capital is far more important than the static level of ROIC. Said another way, I would be really excited about finding something that has a 0% or 2% ROIC that could become a 6% or 8% rather than buying a 14% that just stays a 14%. Because the 14% that stays a 14%, everybody knows it, and in theory, it's priced into the multiple. And so, one of the key attributes of the way that I think about public market investing is not just a capital cycle framework, but it's also where is a company-specific transformation occurring? And that company-specific transformation could be the result of jettisoning a bad

• 33:40Speaker 02

  business, it could be a new management team, it could be acquiring an asset that's misunderstood or whatever reason, there's probably some special situation component to it. And so, one of the best investments, I think you and I have talked about in the past, was an investment we made in July of 2020, was to acquire a large stake of a company then called Colony Capital, now called Digital Bridge. And it actually had three transformations going on at one time. It had many businesses. One was a healthcare real estate business, two was a hospitality business, three was a mortgery, and four was they just acquired a company called Digital Bridge, which I knew pretty well. Those businesses, except Digital Bridge, were all particularly impacted by COVID.

• 34:24Speaker 02

  As part of the acquisition of Digital Bridge, they named Mark Gansey the new CEO. So he had a management team transition, he had a business model pivot. His plan was to exit healthcare, hospitality, and the mortgage business and all the private equity assets. And you had an interesting balance sheet pivot. Every single one of those verticals had its own nonrecourse balance sheet. Meaning if you actually studied the balance sheet, you could have bankrupted the hotel business and it wouldn't have impacted the balance sheet of Digital Bridge. And so, over the course of 2020, after dealing with their one loan corporate maturity in Mark Janzi, Jackie Wu, the whole team over there, they pivoted that business aggressively. And today, they're largely a digital infrastructure asset manager. They have a few assets they own on their balance sheet, but they're continuing to pivot away into a completely asset-light balance sheet

• 35:09Speaker 02

  with a fairly low leverage profile. And it's something that we've been involved in since 2020 and continue to own to this day.

• 35:14Patrick O'Shaughnessy?

  What about that whole story stands out to you as most exceptional? That's a big switch. So, any pivot of that size with that amount of dollars at stake, I'm sure is just hard from a complexity standpoint. But is there anything about that whole change that feels the most exceptional to you, looking back on it?

• 35:35Speaker 02

  Yeah, and I think this is probably the same for all business model transformations. It's you get paid when complexity becomes simplicity, when it's very easy to see through the numbers of something that's really complex or hairy with a big balance sheet, overlevered, really bad ROICs because of where they found themselves in the capital cycle or investment cycle. And when you spent time with the management team, if you understood the balance sheet, you could really clearly hear them say, this business is going to look totally different and it's actually going to be very, very simple. They did the heavy lifting in 2020 and 21, and they're doing the last of the cleanup now. And we think when we look into 2024, it'll be a pure-play asset-light asset manager with an incredibly high ROIC

• 36:18Speaker 02

  that's growing with tailwinds from digital infrastructure with a particular focus on data centers, cell towers, fiber billboards, et cetera. So, I think it's that complexity to simplicity, which is the key thing. Because otherwise, if it's complex and stays complex, I think you'll never get the multiple that you think it should deserve in the public markets.

• 36:35Patrick O'Shaughnessy?

  Do you have, you're coming on data centers, maybe think or wonder whether or not you have a philosophy on CapEx? And I remember Will Thorndike telling me one time, you could compare like a data center, real estate business to like a record storage business. And he loves the record storage because there's like, you don't ever have to do anything. It's some walls and some shelves. You put papers on them and they just sit there. Whereas a data center, like you gotta buy new servers all the time. There's a lot more maintenance CapEx that is required. Give me your reaction, just like maintenance CapEx as a concept and how it relates to the attractiveness of different investments in real estate.

• 37:07Speaker 02

  Data centers, to me, they're huge assets. They're highly capital intensive. They actually have more obsolescence risk than probably any other real estate asset class, at least on a shorter time horizon. But they benefit from the digitization of the world, right? We started the iPhone in 07 and now every day you can't look at Twitter or pick up a newspaper without hearing about AI or Nvidia or whatever it may be. And so our view is they, from a analog perspective, look and feel the most like office and malls, meaning they're big chunky assets. There's a period of time where they had an amazing tailwind. Think about malls from the 1980s to the early 2010s. I mean, they just grew all the time. Yes, they have a lot of

• 37:51Speaker 02

  capital, but because of the institutionalized nature of the asset class, they're constantly receiving that capital. Offices are a similar dynamic. A lot of attention from sovereign wealth funds and large institutional investors because you could write a 200, 300, $400 million check per office, deploy a lot of capital very quickly. But I've always had a hard time with the office building because through the cycle, I don't think it actually earns its cost of capital when you actually consider true CapEx. So our view on data centers is that finds itself in a really good moment right now. The data centers that are adaptable for artificial intelligence, I think it creating a very, very tight market. I think there is a high degree of obsolescence risk in really, really old assets. And I would worry about the capital needs in those assets. I'd be really concerned about that.

• 38:32Patrick O'Shaughnessy?

  So maintenance CapEx is just a case by case thing. There's not a sweeping statement to make about it.

• 38:37Speaker 02

  I don't think so, because you look at maintenance CapEx for industrial or self-storage is very, very low. So the way we think about it is let's just look at true free cash flow recycling.

• 38:46Patrick O'Shaughnessy?

  What is something about real estate investing that people think is true from the outside but isn't?

• 38:53Speaker 02

  People on the outside think real estate is one big thing, but it's actually not. It's quite the opposite. In fact, if you have a curious mind and you have the ability to have a flexible mandate, it's probably the most unbelievably curious endeavor you can have because we've had a conversation today about senior living, just talked about data centers. We've talked about malls and offices. We could talk about cold storage and ground leases and we could talk about so many different things. We could talk about marinas. And so from my perspective is the basic premise that there's something called real estate isn't actually the case. There's so many different sub ecosystems that are proliferating at the same time that

• 39:36Speaker 02

  you have to dig in and find where the great opportunities are. Where is that really good business that owns a lot of hard assets that has the ability to reinvest over a long period of time? And so we're constantly thinking about, so what does AI mean for data center? Who wins? Who loses? What are the biggest population cohorts? And how do we think about investing in that asset class? What are the trends in e-commerce? What does that mean for retail? What's been going on in retail over the last 10 years? And so to me, outside looking in, the nomenclature of real estate just means something that's a hard asset to me, but there's so much subtext and context below it.

• 40:08Patrick O'Shaughnessy?

  Can you tell me about it? Marinas? I know nothing about marinas.

• 40:12Speaker 02

  We don't have a marina investment. There's one public company that has a component of its business that invests in marinas, but there are some asset classes that are regulatorily supply constrained. The example I would give you, actually stepping back, is if you go to Los Angeles, it's really hard to build a new house in Beverly Hills, but you can go into the valley where there's a lot of land and there's no supply constraints. And so the question is, where's the Beverly Hills of some real estate subsector? And there are pockets of marinas that fall into regulatorily supply constrained because folks don't want more marinas on handful of lakes or on ocean waters. And so there's this interesting dynamic. I think you can say parts of the economy around cold storage, billboards, probably

• 40:55Speaker 02

  most specifically cell towers, there's just lots of regulatory supply constraints that exist around that. When we think about marinas, we think about a business that has more supply constraints than the average real estate business, has had rising consumption. It got very exciting, I think, from a consumption perspective during COVID, but it's had rising consumption. And if you have a boat, you need to store it somewhere, you need to put it in the lake. And so it looks and feels like a storage business combined with a hospitality business.

• 41:23Patrick O'Shaughnessy?

  What about cold storage? That seems like an interesting subsector that I don't know much about how the businesses work or how the economics work relative to other types of real estate.

• 41:32Speaker 02

  Yeah, so cold storage is refrigerated warehousing. We have an investment in a private company here. In my prior firm, we actually had a large investment in a cold storage operator finds itself in the public markets. There's been a lot of consolidation in the space where the top two players in the US own, I forgot the exact number, but 50 or 60% of the market share. And then I think quite similarly to some of the other things that we have, there's lots of productivity enhancements in the new facilities with robotics, et cetera. But it's an industry that has pretty resilient demand dynamics. Cold storage doesn't care if you eat out or eat at home, they just care that you eat. And so if you look through the GFC, there was a very, very low drawdown in revenue through cold storage. And I think because of consolidation, there's been interesting changes into the contract

• 42:17Speaker 02

  structure, which has made the asset base more resilient. It is a far smaller business than ambient industrial, like we talked about with Pro Lodges earlier, but it's a business that we need. And there's different types of cold storage. There's cold storage that sits next to the farm. There's cold storage that houses your poultry, and then there's last mile delivery. So it's a business that we find really exciting and just due to its resiliency and the way that the two biggest players have been able to scale it.

• 42:42Patrick O'Shaughnessy?

  If I could somehow level set the potential returns that you would earn across all these different subsectors and credit and equity, and there was some like normalizing function. And I said, you just earn a return based on the amount of curious attention that you give something. So that's the only thing that matters. Which parts of real estate would you personally get the most drawn to then? Like if that equalizer was laid on top of you, I guess another way of asking this is which ones pique your curiosity the most or do you like learning about the most?

• 43:14Speaker 02

  It's the ones I spend a lot of time thinking about today, maybe obsessing over would be senior living. That's one that we've talked about here today. We think the billboard space is a super interesting space. Everyone thinks about it as a pole on the side of the highway, but a little bit less than a third of the space has been converted to digital. There's an opportunity to continue converting to digital. There's an opportunity to converge the way you track advertising consumption with geospatial technology and so forth. And that's a business that we find really, really exciting because the quality of the assets is really, really good. But then there's public market companies that have some unique issue that makes them potentially very attractive to invest in at the moment. From a curiosity

• 43:57Speaker 02

  perspective, we spend a lot of time thinking about data centers because it's something that everyone else is focused on and thinking about. And our view is we're very, very focused on how the expansion will occur, who's going to win, who's going to lose, because I don't think it's going to be as simple as everybody wins. And I said earlier in the conversation, but we would love to figure out a way, and we spend a lot of time thinking about it, to make investments in affordable housing ecosystem that also meet our return expectations because those tend to be lower returns than what we've seen. And we've spent some time with some really interesting folks that have some really interesting ideas, and we just haven't found a way to make it work just yet.

• 44:35Patrick O'Shaughnessy?

  Maybe just give us a behind the scenes look at what you're talking about as you consider sorting the winners from losers in data centers and also what will AI do to this world? You hear lots of stories now about it being a real supply problem, that the demand for GPU farms is going to be growing at a rate that we just literally cannot accommodate based on how long it takes to build these things, the CapEx, the literal locations where they go and how you cool them, things like this. So when you're with your team or whatever, talking about data centers, how do you think about the impact of AI and whether or not we can keep up with it and who might benefit and who might not?

• 45:14Speaker 02

  So I think from us, it's like, where's the content creation? And I think what we found, find super interesting is that chat GPT adoption was the fastest adoption on record of any consumer technology. So the questions that we're asking ourselves is, what are the commercial applications?

• 45:30Speaker 02

  What is the computing power required to assess those commercial applications? And our view is a lot of these compute-heavy workloads are housed in data centers. And so what we're trying to do is size the opportunity of what AI means for data centers. And I think to give you some context, the last big explosion of data center demand occurred around public cloud utilization, which itself drove 13 gigawatts globally of incremental demand for data centers, which was a real demand driver over the last several years. And so it's way too early to tell, but our view is we think the opportunity set could be at least as big as the public cloud opportunity, if not larger. Some of the large infrastructure funds that we talked to have quoted numbers as high

• 46:15Speaker 02

  as 38 gigawatts. And there's a lot of industry studies that show demand, data center needs will double between this year and 2030. And so it probably means we're in the massive innings of a growth cycle. But then the question becomes, in order to manifest that compute power, how are you going to service your energy needs? How much is that going to cost? What's the return on invested capital? And we think that ultimately, there's a handful of facilities, or there's more than a handful of facilities, that are just functionally obsolete, whether to do their size, whether to do with the amount of energy they can hold. And so that's something that we've been working on real time, trying to assess over the last little bit. I'd say unfortunately, all the big private asset managers have taken most of the public

• 47:00Speaker 02

  opportunities away. So Blackstone bought QTS, Digital Bridge bought Switch, GIP and KKR bought another one. There's not many public opportunities. And there's so much interest on the private side that it's hard to see how we can make it work with our cost of capital.

• 47:16Patrick O'Shaughnessy?

  If you think about the most common trip up or tripwires for real estate investors, what comes to mind? Like, what is the most common reason that an otherwise smart and capable investor trying to earn a good return fails to do so in this sector?

• 47:31Speaker 02

  I think, again, if we're talking about the sector writ large, I think you have to look at it through the lens of cyclicality, operating leverage and financial leverage. And so I think most real estate assets, just by nature of being hard asset and capital consumptive, have a lot of operating leverage. And we've talked earlier, but at different points in the cycle, credit availability is really robust. And today it's not as robust. But maybe you took capital and valuations are really high, put a lot of financial leverage on it to justify a return on equity or equity IRR that made sense for your cost of capital. And then unfortunately, maybe cyclicality ensued. And so I think the biggest mistakes occur when people forget about the cyclicality. It's sort of exacerbated rather by the financial leverage and operating leverage.

• 48:15Speaker 02

  What I think is super interesting is if you take a typical levered private equity buyer, they'll buy an asset, they'll put 65, 70, 80% loan to cost on the asset. It becomes very much a cost of capital opportunity, or how can you drive rental growth or operating improvement? Well, what's interesting to me is the public REITs on average have spent the better part of the last 12 or 13 years delevering. So most REITs have sub 40% loan to value based on the implied valuation in the public market. And I think that's a lesson that they learned and REIT investors learned through the GFC, where you had these great assets and they had to be recapped at really distressed valuations,

• 48:59Speaker 02

  causing lots of dilution in 2009, 10, 11. And you have the, on average, there's obviously exceptions to this, but you have the opposite dynamic today, where the REITs are actually the best capitalized, have access to the bond market, aren't reliant solely on agency financing or bank or insurance companies. And they have this dynamic where we think, looking into 24 and 25, as fundamentals potentially start to turn back up. The best capital allocators and REITs are actually going to get premium valuations to let them go play offense and sort of allow a compounding effect of NAV growth on top of their normal course free cash flow per share growth over time.

• 49:38Patrick O'Shaughnessy?

  If you were hosting a dinner party just for real estate investors, can be someone at the peak of their powers, or a legend, or whatever, and you can invite three guests to it, who do you think would be the three?

• 49:53Speaker 02

  I think I would invite Sam Zell, unfortunately passed earlier this year. I had an opportunity to meet him last year. He was the original thinker around real estate platforms from my lens. And so he did it in a way where he, in essence, securitized real estate. So I want to spend a lot of time with him. I'd actually want to invite Charlie Munger because he has got a huge, huge multifamily portfolio. He's got this amazing lens of thinking about companies. I don't need to describe on this podcast, but he's got a huge multifamily portfolio and he's created a lot of incremental wealth for himself. I'd actually want to talk to him about comparing and contrasting what he sees in the equities market and what he sees in the real estate markets. And the third would probably be my friend Kevin

• 50:36Speaker 02

  Marquetti, who's the founder of Lineage Logistics, which is a cold storage company. I'd bring him because he actually founded and operated and ran from nothing to what's probably tens of billions of dollars of real estate value creation, just to have a conversation about what it's like day to day running those assets and building a business.

• 50:55Patrick O'Shaughnessy?

  You know, the origin of Munger's multifamily portfolio, was there some insight there that led to that buildup?

• 51:01Speaker 02

  I don't know the specifics. My understanding is there was a relentless person in his neighborhood in LA who kept knocking on his door and saying, hey, you got to look at this multifamily stuff. And this was 20, 30 years ago, and started acquiring assets together and they built up a very large portfolio.

• 51:14Patrick O'Shaughnessy?

  If you think about just like other real estate investors, and you had to put like a LP hat on rather than a GP hat on, what would be like one or two questions that you think would really get at the heart of whether or not that investor had something interesting going on? Like, what would be the most impactful questions that you could ask a real estate investor to suss out their skill?

• 51:35Speaker 02

  I think you would probably focus the questioning around what are you doing at various points in the cycle? Because I think a lot of people are really good at just investing in real estate equity or one type of asset. I would just ask them what they're doing at various points in the cycle. And I repeatedly ask the same question and see how the business evolves over time, how the investment style evolves over time.

• 51:57Patrick O'Shaughnessy?

  And so I understand what you're sussing out there is, is this just the person that knew how to do one thing that's valuable in a certain environment, but if conditions change, that skill may become way less valuable. So it's how adaptable is their skill set? If you think about your career so far, and I ask you to conjure up what you would think to be like the defining moment of your career, what would the moment be?

• 52:19Speaker 02

  In 2016, so seven or eight years ago, we were at a prior firm, invested in the various bonds of Caesars, the largest gaming company. And at some point that year, the company came out with its plan to reorg, which finalized the equity splits in the new restructured company to the various different creditor groups. The day that came out, a lot of folks were simply doing analysis around, okay, what's the bond trading at versus what the recovery is? I think the defining moment for me, and this was again, something my old boss and mentor, Doug, taught me is when you're looking at a distressed situation, you want to be excited about what can happen next. And I think what we saw was an opportunity for cyclical inflection in Las Vegas.

• 53:02Speaker 02

  The company had reinvested considerably through bankruptcy in its rooms, upgraded the quality of its asset. And the defining moment for me was going back and saying, look, all of these other distressed ones we know are selling, but these bonds can be worth two or three times what they're trading at if we actually look at it over three or four years. And it just got me really, really excited about the opportunity that investing companies going through transformations and that can happen through distress, it can happen through the public markets, it can happen through all kinds of different situations. But I think that moment was a defining moment in my career. We made it a very large position and went from there.

• 53:36Patrick O'Shaughnessy?

  If you had to teach a class on this platform approach to building an investing firm in real estate or otherwise, anything else that we haven't talked about around that approach that you think is really important to doing it well?

• 53:48Speaker 02

  The premise of the platform approach is that you're identifying a sector or asset type and you're going after it, you're leaning in. But the only way to do it is with a really quality management team. And so the thing we haven't talked about is you find that great management team, you put your capital, your time, your resources behind them, and you put them behind that one team. It's not like we're focused on building this industrial company over here and building another industrial company on the other side of the country or some competitive way. And so the question becomes, how do you assess the track record of a team or their ability to work for you? Because that team works for us, which allows us to create a vertically integrated platform. We want to let that management team go execute.

• 54:30Speaker 02

  We want them to replicate what our playbook is at the asset level. We complement those teams with significant strategic support, capital allocation, decision-making framework. Hey, guys, we should be leaning in. This is what we're seeing. We should be thinking about these different geographies. This is what we're seeing. And they're constantly giving us feedback. If done the right way, with a really good business, a really good management team, we don't become a financial buyer, become a real vertically integrated strategic player. And that means we'll get looks at single-family rental loan portfolios that commercial banks are selling off because they're overexposed, and we'll get them a conversant because we're the controlling shareholder of Quinn, which we probably wouldn't have gotten in the absence of that. What I would say in that class is I would focus

• 55:13Speaker 02

  in on how durable is the asset, what's the reinvestment runway, and what's the team and the characteristics of the team that you need to execute on your math?

• 55:22Patrick O'Shaughnessy?

  So we started the conversation with a discussion of the capital cycle. And then you just said when we're evaluating another investor, one great question to ask them would be how they act and what they look for at various points in the cycle, and maybe even where we are in the cycle. So maybe I'll just turn that question on you in closing to talk about the broad landscape, where you see opportunity, where you think we are in the cycle very specifically, and how you take that information and build a portfolio.

• 55:51Speaker 02

  Before we get into the specifics, our view of the current cycle is that we describe it as broadly the re-equitization. Of real estate. I'd frame the last couple of years with 2020 and 2021 as a period of low rates, a period of low risk premiums, probably a little bit of a FOMO, ease of raising capital, and all that led to elevated valuations, which I think people also got excited about the prospect of ever higher valuations, given what was going on in the environment. And so that landed us at the peak of the market in 2021. So said another way, and circling back to the premise of this conversation, good returns attracted a lot of capital, and it attracted a lot of capital in both debt and equity. On the other hand, if you think about

• 56:33Speaker 02

  today, as we sit here in the middle of 2023, capital is now flowing away from real estate. We'd characterize the current market for real estate by three pretty abrupt changes. One, an abrupt change in the availability of credit. Two, an abrupt increase in the cost of that debt capital. And then lastly, meaningfully reduced equity flows to the space. It probably does make sense to touch on those a little bit. So in terms of reduced availability of credit, I would say, if you read the paper, it's pretty well documented that banks have pulled back quite a bit from US real estate. But it's probably more important to zoom in on the regional banks. And the regional banks are the most important provider of development and regional capital for real estate. And what we're seeing from them is

• 57:18Speaker 02

  a pretty sharp pullback. So specifically, there's a data source called TRP that we use. And of the more than 4,700 banks, over 750 of them have CRE concentration issues well in excess of FDIC guidance. So when we think about that, that's 16% of all banks in the country in excess of the FDIC guidance. You have an issue that's really affecting the local and regional bank, the lifeblood of commercial real estate, and a lot less affecting the real large nationwide banks. So what you're seeing is a significant amount of pressure to pull back on CRE lending. And as a result, debt capital has pulled back. We think about the second point, which is the rapid increase in the cost of capital.

• 58:00Speaker 02

  Base rates were effectively nil five or six quarters ago, and today they're about 500 bips. And because of the availability of credit that I just described has pulled back, spreads have probably widened 100 basis points or so. Obviously, spreads will be fluid based on the availability of capital. But as of today, what used to be a 3% or 3.5% loan is an 8%, 8.5%, 9% loan. So there's been a real meaningful jump in the cost of capital. And then lastly, I'd say on the equity retrenching, you can look at the public REIT index, which is a good proxy for the direction of real estate values at times, and it's down 27% from its peak at the end of 2021. Obviously, there are some names in there that are more levered, that are down quite a bit more.

• 58:45Speaker 02

  That's proxy one. That's a good directional indicator for asset value. And then some of the core funds and other lower returning buyers are having some well documented redemption issues. And so you're seeing people pull back from the space. We also have general uncertainty in the economy. And then elevated supply in the sectors that people were most attracted to naturally, given the capital cycle dynamic. And so I'd say specifically multifamily, life sciences, self-storage, industrial have a probably have a period of digestion of that supply. Situation where transaction activity is down more than 50% year over year. Values are down quite a bit. Interest burden is up and loan to value thresholds are breached and debt service coverage ratio is quite real.

• 59:26Speaker 02

  And so to compare it to another bottom of the capital cycle, if the GFC were characterized by, let's say amend and extend. Our view is that this period will be characterized by pay down and extend. So banks need to recalibrate their credit risk to get capital ratios in line. And borrowers need to recalibrate capital structures to get debt service ratios in line. But given that there aren't a lot of lenders in the space, you may be paying down your existing loan with some capital to get your existing lender to play ball and extend with you. And so this probably means fresh equity or structured financing needs to come in at the asset or company level. It may mean forced or motivated selling of assets. It may mean pretty interesting and significant recapitalizations.

• 1:00:10Speaker 02

  That's why we call this period the re-equitization of real estate. It's going to be a period of meaningful asset and company specific deleveraging. Said another way, a lot of liquidity is leaving the system. I think you and I are both big fans of basketball and I'm a huge, huge fan of John Wooden, former head coach of UCLA men's basketball team, 10 national championships. And he has a line that I love, be quick, but don't hurry. And that line has always stuck with me about life. To me, it means it's important to be able to make quick and decisive decisions, but don't rush it. There's a time to be patient and time to be impatient. And as I apply that to where we are in the cycle, I think the last few years have been a time to be patient.

• 1:00:49Speaker 02

  And I'm hopeful that we're on the cusp of a time to be impatient, given the flight of liquidity and capital out of this space. And of course, I could be wrong about a lot of things. The economy could get worse or fundamentals could deteriorate. But us, a lack of liquidity today is driving a handful of opportunities. Number one will be rescue financing. So many companies or collections of assets won't be able to refinance their debt or will have issues with debt service coverage ratios like we talked about earlier. It will need capital on expedited basis. I think the second one will be structured corporate opportunities. So that'd be public or private companies that need liquidity. And I think what's interesting about that liquidity is it could be for defense or offense.

• 1:01:30Speaker 02

  Defense meaning to shore up their capital structure or offense meaning to go acquire something, but they don't want to just take very punitive pure equity cost of capital. They're willing to take something structured. I think third will be, and it's probably setting up to be an interesting time as we look out over the next year, not necessarily today, to look at discounted publicly traded companies, whether that's to own them passively or whether that's to evaluate them as take private candidates. And then lastly, given the uncertainty and challenges that I described earlier with the banks, there's going to be a lot of loan sales from banks and other lenders. And there's going to be some pressure to monetize those loans. And hopefully they might come at attractive valuations. And so I think a lot of these opportunities will present themselves in what were the favored sectors,

• 1:02:13Speaker 02

  the ones that have the short-term supply issues like multifamily life sciences, possibly even industrial where there's been a lot of supply added in a pretty short period of time. The positive here is that there's no new development capital available today. So when you look into 26 and 27 and 28, the supply picture could get a lot better.

• 1:02:32Patrick O'Shaughnessy?

  Can you imagine how good of a podcast guest John Wooden would have been?

• 1:02:36Speaker 02

  Oh, my God. It would have been amazing. What a great coach philosopher teacher.

• 1:02:40Patrick O'Shaughnessy?

  Is there anything else from him that sticks with you most? I remember reading all his books in my twenties and just thinking this guy, I would do anything to have played for this guy in some capacity.

• 1:02:50Speaker 02

  I think the best ones are you hear players talk about him and they're all excited to go play for John Wooden at UCLA, winning his coach, et cetera. And they get to practice the first day and he teaches them how to put their socks on, teaches them how to tie their shoes because if they can't get the fundamentals right, how can they get anything else right?

• 1:03:08Patrick O'Shaughnessy?

  Very cool. That's an interesting, wide-ranging conversation. Real estate, every time I talk about it, like you said, it is so fascinating because it's so multifaceted. We could probably do two hours on any one of the topics that you mentioned and get into all sorts of weird, nitty-gritty detail. Maybe we'll use business breakdowns, another show of ours to do that at some point on towers or cold storage or marinas or something like that. But I've really appreciated all the insight and all the time. My traditional closing question for everybody is to ask, what is the kindest thing that anyone's ever done for you?

• 1:03:38Speaker 02

  There's been so many kind acts that people have done for me, both personally and professionally. But the one that sticks out to me is when I was considering leaving my prior firm and stepping off the proverbial plank into this world of entrepreneurialism and building my own asset management firm and taking this approach to real estate. I was very fortunate that a mentor of mine, Sonny Calcy, who runs a large real estate firm called Bentall Green Oaks, sat down with me and what I thought was going to be a 30-minute conversation turned into a two or two-hour-plus conversation. And the worry for me when stepping off the proverbial plank was how much of what I had done in my career was because I had a very large balance sheet behind me?

• 1:04:20Speaker 02

  And how much of it was because of the hustle and forward-thinking or trying to find new ideas? And I went in to talk to Sonny and he said, come in and let's talk through everything you've worked on. And we spent two, two and a half hours together. And at the end of the two and a half hours, he said to me, something I'll never forget, he said, when you walked in here, I thought you were going to tell me 70/30 in favor of big balance sheet, great brand behind you. But I actually think it's the other way, 70/30 in favor of your hustle. He's like, you know what to do. And that was the kindest thing anyone's done for me professionally.

• 1:04:50Patrick O'Shaughnessy?

  Incredible. Such a cool story. Thanks so much for your time.

• 1:04:54Speaker 02

  Thanks, Ben.

• 1:04:56Patrick O'Shaughnessy?

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