Building Durable Real Estate Portfolios at Morgan Stanley – Lauren Hochfelder (EP.514)

Lauren Hochfelder is Head of Global Real Assets at Morgan Stanley, where she oversees a team of 300 investment professionals across 13 countries, managing $80 billion across real estate, infrastructure, equity and credit. Lauren joined Morgan Stanley as an investment banking analyst directly out of Yale 26 years ago and has spent her entire career at the firm, helping build one of the industry's leading platforms. Our conversation traces Lauren's journey from analyst to Global Head and the evolution of Morgan Stanley's real estate business before, during, and after the Global Financial Crisis. We cover the firm's thematic approach to investing behind structural demand tailwinds, combination of global perspectives and on-the-ground teams, operational improvements to assets, portfolio construction, and themes across industrial real estate and infrastructure, senior housing, and net lease properties. We also touch on riskier areas of real estate and Lauren's new role adding infrastructure to her real estate oversight. Learn More Follow Ted on Twitter at @tseides https://twitter.com/tseides?lang=en or LinkedIn https://www.linkedin.com/in/tedseides/ Subscribe to the mailing list https://capitalallocators.com/ Access Transcript with Premium Membership https://capitalallocators.com/signup Editing and post-production work for this episode was provided by The Podcast Consultant (⁠ https://thepodcastconsultant.com/https://thepodcastconsultant.com https://thepodcastconsultant.com/⁠ https://thepodcastconsultant.com/)

• 0:00Speaker 00

  We focus heavily on sizing our funds to the opportunity set. What you've seen over the last 10, 20 years is the rise of the mega cap fund. Scale is no doubt a superpower. It's hard to even express how valuable that is. However, when you've seen the rise of these individual closed-end funds that are $20-plus billion to be deployed over a four-year period, you can be the world's most extraordinary investor. But if you have that much scale, you are going to be forced to deploy. We position ourselves on both the real estate and infrastructure side for closed-end

• 0:45Speaker 00

  funds as squarely mid-market. It gives us competitive advantages in a few ways. We are able to be super selective. We have these broad themes. We size our funds that we can cherry pick and only make those investments that are particularly well-priced and the right asset within that. There's by nature less competition. So much of the growth in real estate and infrastructure over the last 20 years has been in these mega cap funds. That means it's pretty crowded. We're making individual investments that is too small for the mega caps and too big for the locals. We get better pricing.

• 1:30Speaker 01

  I'm Ted Seides and this is Capital Allocators. My guest on today's show is Lauren Hochfelder, Head of Global Real Assets at Morgan Stanley, where she oversees a team of 300 investment professionals across 13 countries, managing $80 billion across real estate, infrastructure, equity, and credit. Lauren joined Morgan Stanley as an investment banking analyst directly out of Yale 26 years ago and has spent her entire career at the firm, helping build one of the industry's leading platforms. Our conversation traces Lauren's journey from analyst to global head and the evolution of Morgan Stanley's real estate business before, during, and after the global financial crisis.

• 2:15Speaker 01

  We cover the firm's thematic approach to investing behind structural demand tailwinds, combination of global perspectives and on-the-ground teams, operational improvements to assets, portfolio construction, and themes across industrial, real estate, and infrastructure, senior housing, and net lease properties. We also touch on riskier assets of real estate and Lauren's new role, adding infrastructure to her real estate oversight. Before we get going, we're hiring at Capital Allocators. Two roles that will shape our next chapter. They're two of the best jobs in the business, at least in my opinion, that'll help us bring together our community of allocators and managers to compound knowledge and relationships.

• 3:00Speaker 01

  And best of all, we get to serve this community without really selling them anything. Full descriptions of the role are available at capitalallocators.com. And thanks for spreading the word about our two new roles at Capital Allocators. Please enjoy my conversation with Lauren Hochfelder. Lauren, thanks so much for joining me.

• 3:23Speaker 00

  Thank you. It's so great to be together.

• 3:25Speaker 01

  I'd love you to take me back to your path to this building.

• 3:31Speaker 00

  It was a short path because I joined right out of college. I joined as an analyst, straight out of Yale, no finance experience at all. I'd been an investment banking summer analyst at Bear Stearns, but with that small exception, I joined straight out of college and have been here since.

• 3:49Speaker 01

  Take me through what that path is to be working at the same firm for a couple of decades.

• 3:55Speaker 00

  It's certainly one of the great surprises of my life that I am here still 26 years later. It's been extraordinary. When I joined as an investment banking analyst, two-year gig, at that point, I'm not sure I knew if I was going to go back to business school or back for a PhD in Ancient Greek philosophy. It was pretty broad. What's been extraordinary is that I get to come here every day and still learn. I don't need to change firms to have multiple careers. I feel like I've been surrounded by incredible colleagues, partners, and consistently been given opportunities to do more and more and more, sometimes even before I realized I

• 4:40Speaker 00

  was ready. That keeps it exciting.

• 4:42Speaker 01

  Walk me through the path of those major milestones over those 26 years.

• 4:47Speaker 00

  I joined as an investment banking analyst. At that time, our real estate investing business was housed with an investment banking. I had this fantastic opportunity to work on all things investment banking, M&A, equity raises, strategic transactions, also investing in real estate on behalf of our funds. I was quickly drawn to that. As an associate, I became dedicated to the investing side of our business. I've, with one small exception, spent my whole career in a linear fashion. I was the associate underwriting and executing the deals. And then, over time, I came to be promoted to Head of Acquisitions, Deputy CIO, then

• 5:30Speaker 00

  ultimately, Global Co-Head of the Real Estate Business. Six months ago, I took on broader responsibilities to oversee broader real assets. So that includes real estate, infrastructure, equity, and credit. It's been extraordinary.

• 5:44Speaker 01

  What was it about investing that drew you in early on?

• 5:47Speaker 00

  What I loved about investing from the beginning was that interdisciplinary approach, understanding how the world works, understanding the drivers of growth or where the risks lie, ultimately having the accountability for outcomes. The intellectual curiosity with the rigor. You're forced to make decisions amidst uncertainty. I spent my Yale years at coffee shops at 4:00 in the morning debating things endlessly in investing. You need to make a call, then you're held accountable. I also loved that it's not just the upfront decision. Should I do this? How will this play out? Then you have an ability to effectuate change once you own it.

• 6:30Speaker 00

  For the assets we own, it's not just buy and hold, it's buy and change. You can transform these assets. That's one of the things that's less understood about both real estate and infrastructure is how active those assets are. It's not just that durable cash flow, but it's about affecting change, renovating, or leasing, or shifting, or repositioning assets. Having that active edge was also part of the appeal.

• 6:56Speaker 01

  Real estate is this interesting blend of numbers and then real-world assets and development. How did you find your place in that different blend of activities?

• 7:10Speaker 00

  One of the things I love so much about it is it straddles the two. You have the analytical, high-finance element to it. It's also tangible. It can be kind of gritty, on-the-ground. That combination makes it endlessly exciting and gives opportunity to arbitrage a bit. Part of the initial appeal was how tangible it is, how you want to avoid being too self-referential in any type of investing. You can understand, real estate is just a function of how people use space, where they want to live, how they want to work, how they want to consume goods, whether it's

• 7:53Speaker 00

  in-store or online, how they want a vacation. That constantly brings you back to basic judgments about how we live today and the early signs of how we might be changing that behavior.

• 8:07Speaker 01

  What did you find as you moved up from associate to principal to Head of Acquisitions to running a group of the different skillsets that you needed along the way?

• 8:18Speaker 00

  They definitely change over time. Some of the basics, the rigor, the approach to working with people, some of that stays constant. If there's one overall image, it's that zooming out. Early on, it was all about the underwriting and the analysis. Over time, you realize how the judgment comes into it so much more, and it's not just the math. The biggest change, if I think about my job today, to simplify, it's deals, money, people. The investing of the capital, the raising of the capital, and the managing of the teams, structuring our teams in a way to optimize outcomes. When I started, all I wanted to do was invest.

• 9:03Speaker 00

  If you had said to me, do you want to think about managing a business, thinking about new products, new ways to grow or shift? That was less exciting to me. I've realized over time that the most important investments my senior partners and I make every year is thinking about who on the team to be investing in, compensation decisions or team structuring decisions, thinking about how to build a business with consistent, durable processes, team setup, alignment structures, optimize those outcomes.

• 9:36Speaker 01

  What are some of the things you've learned about hiring, retaining, optimizing the people on your team?

• 9:43Speaker 00

  Culture matters. One of our key competitive advantages is that part of building such a strong culture is the accumulated trust over time. My partners and I, many of us grew up in the foxhole together. Through those experiences, you develop a sense of trust and understanding of people's risk appetite. There's a greater efficiency of communication. That trust and respect we have for each other allows us to challenge each other. One of the issues you see when culture breaks down is consensus building or group think.

• 10:25Speaker 00

  Because we've lived through cycles together, we're very comfortable challenging each other. That helps drive optimal outcomes. Culture is a big part of it. We raise people to be great investors, or we endeavor to.

• 10:41Speaker 01

  How would you describe some of the defining aspects of the culture on your team?

• 10:46Speaker 00

  Our CEO, Ted Pick, when he talks about culture, talks about three things: rigor, humility, and partnership.

• 10:55Speaker 00

  Ted says it so well, that captures the essence of the culture across Morgan Stanley and the culture within our business. That rigor underlies everything we do. You have a warm, kind culture, but also a lot of rigor in everything we do. That is paramount. That humility, it's particularly important with investing. Understanding, acknowledging mistakes early, having the humility to say, I got this wrong. Let me understand why. Going through cycles that way. Then that partnership. The best single performers in the world in any category haven't done it alone. We have a way to work together to maximize outcomes.

• 11:41Speaker 01

  You mentioned that when you first started investing, there was already a platform here, Morgan Stanley, let's say 26 years ago. How has that real estate part of what you've been involved with for so long evolved over the years?

• 11:55Speaker 00

  When I started, Morgan Stanley was one of the first amongst the largest real estate private equity businesses. We've seen the space institutionalized pretty dramatically. If I think back to 2000, the real estate private equity business was largely opportunistic closed-end funds and US pension fund capital. We've seen over time a diversification of the types of investing, more core, open-ended or different strategies. We've seen a diversification of the investor base. It's super global today. Our business was a leader in a few regards there.

• 12:36Speaker 00

  We were one of the first to say, we want to serve our investors more holistically. We were one of the first entrants from the opportunistic space into the core space. Fundamentally, we're in the client service business. We first and foremost focus on what role should real estate play in investors' portfolios? What is most important to them? Ultimately, having strategies that serve their purposes. Having core and opportunistic, having a few core plus strategies, being global in what we do, has given us much better perspective. It's enabled us to have better judgment across the strategies and attract extraordinary talent as well.

• 13:18Speaker 01

  Has it changed the most in the last 10, 15, 20 years?

• 13:22Speaker 00

  A defining moment for us in terms of change would be pre and post GFC. I had been in real estate virtually my whole career. I spent one 18-month window as an associate in firm management. One of the great things Morgan Stanley does is it plucks top performing associates and puts them in different areas of the firm to cross-pollinate and educate. I was privileged, I got to do that. That happened to have been '05, '06. I had been a few years in real estate investing. I vividly remember coming back in '06. It was like we are not in Kansas anymore. Our business, but the industry writ large. Cap rates had compressed massively. The velocity, the leverage, more, more, more, more, more.

• 14:07Speaker 00

  It all came crashing down. Shortly thereafter, virtually everyone senior to me was gone. There were a handful of us left in the foxhole together. We stayed, we worked through the portfolio, a lot of complexities. We learned a lot as a team. Coming out of that, we made some meaningful shifts to our business. It changed our approach to investing, but it also changed how we organized ourselves. We streamlined the business. We had been in a lot of different strategies and we simplified and said, we are going to do fewer things, but we are going to be category killers, top performers in each of those things. We restructured alignment. Turns out alignment matters.

• 14:50Speaker 00

  The incentive structures within our funds became pooled incentive structures. Instead of having individual deal level or regional level incentives, we have pooled incentives. That shifts behavior and forces people to work and think holistically. We centralized decision-making. We're managing a global business, people can fall victim to regional bias. When you have, for example, an Asia investment committee and a Europe investment committee, you're not getting the full benefit of that perspective that matters. It wasn't just our approach to investing or financial risk or duration risk.

• 15:30Speaker 00

  It was building a business with the right structures in place and the right processes in place to induce repeatable strong outcomes.

• 15:41Speaker 01

  When you had the whole breadth of strategies going into the financial crisis and you wanted to focus, how did you decide what areas to focus in?

• 15:49Speaker 00

  If I look back to the period coming out of the GFC, a lot of money was made on interest rates coming vertically down. You saw cap rate compression, cheap, heavy borrowing. We benefited from some of those tailwinds in our investing. We took the approach that we want to be invested in those sectors and markets that have more durable drivers of demand, more structural tailwinds, because there are two theories of investing. The things you know are going to happen and the things you think are going to happen. The truths and the, I think so.

• 16:26Speaker 00

  We focus on investing in those spaces where you have structural drivers of demand, regardless of market cycle. Today, we know we're living in a multipolar world where there's a U-turn on globalization. We know we have aging demographics in most global markets, increased power needs. We position our portfolios and our investment strategies to capitalize on those structural durable drivers. If you think about post-GFC, multiple expansion or cheap borrowing drove a lot of return. Today, we live in an environment with rates more elevated, relatively range-bound.

• 17:08Speaker 00

  That means you need to be invested in those spaces where you can see outsized income growth. That orientation in terms of investment philosophy has served us well through this period.

• 17:21Speaker 01

  I'd love to start walking through how you implement that. You come up with a theme. How do you then take that and look for actionable ideas?

• 17:31Speaker 00

  Across real assets, we manage about $80 billion of investable capital. We have over 300 people, 20 offices, 13 countries. We're thematic and top-down, constantly assessing this. Part of the magic of our business is those local teams who are super embedded in those local markets. It's not just that global perspective that I have the privilege of looking across the world with my senior partners, assessing where the best risk-adjusted opportunities are. Those local teams are so embedded in their markets that they are able to better source and better execute those opportunities. We cherry pick.

• 18:15Speaker 00

  You can be in a hot sector and still get burned if you pick the wrong asset. We are fixated on only investing where we feel like we're making money on the buy or it's sufficiently well-priced. We never set ourselves in a place where we're forced to invest. It's also cherry picking within the strategies. That's particularly important today because you're seeing such divergence. Industrial is a high conviction strategy for us. You need to be selective within industrial. It's not just the markets, but the sub-markets, the size, the specs. By way of example, I take the state of California.

• 18:54Speaker 00

  We've been investing in industrial assets in and around Silicon Valley that are benefiting from the physical AI trends, among other things. Rents are up 40% over the last several years. If you drive 400 miles due south to the Inland Empire in Southern California, which was always the hottest industrial market on the planet, rents over the same period of time are down roughly 40%. That selectivity is a key part of it. You can only do that with that on-the-ground edge. We're so privileged to have these incredible local teams.

• 19:29Speaker 01

  I'm curious how you balance the people on the ground looking at the assets with you're trying to get the trends right because that Inland Empire at some point in time went from hot to cold.

• 19:41Speaker 00

  It's an important part of our process. It's iterative. We were early believers in global supply chain realignment, long before tariffs. We were totally focused on, we are at the early innings of a global supply chain realignment that is going to create winners and losers. Probably it's going to create more demand for industrial as companies diversify where they manufacture their goods and how they get those goods to the end consumer. We thought long and hard about what are the knock-on effects of that. We looked in particular at the Inland Empire, which is a market where all the goods came in from China to the US consumer, always one of the strongest markets. We always had a huge presence there.

• 20:26Speaker 00

  And we said, uh-oh, this market is going to get hurt. Spent a lot of time studying and focusing on it. With everything we do top-down, we're constantly testing it within our underlying asset base. We're so fortunate that we have this huge asset base that gives us real-time data long before it's known by the market. We get to make decisions based on that inside information in our assets. That's a huge advantage. In this instance, what was so interesting is even as we're sitting here saying, gosh, IE is going to get hurt, rents kept going up and up and up. Our team on the ground is saying, I'm still signing rents 20% above where they were, 30% above where they were.

• 21:11Speaker 00

  Because we were so attuned to it, we saw the early indicia of change. Our team out West said, look, I know you've been watching for this. I want to tell you, you're not going to see it in the data. You're not even going to see it in the data in our portfolio because I'm still signing rents higher than I did yesterday. What I can tell you is, whereas 90 days ago, I had 20 guys fighting for like any vacancy I had, today it's like two. I'm trying to keep competitive tension. They used to just sign my LOIs and I was done. The depth of market is fading. That constant iterativeness is valuable. That enabled us to reposition quickly.

• 21:56Speaker 01

  If you look at today, some of the hottest areas in all of the AI infrastructure of real estate, what are the things that you're looking at within your portfolio to see if those trends continue or you have to be careful because maybe there's a change in the capex cycle?

• 22:16Speaker 00

  There's the demand side of it that you're referencing, the supply side, and then questions around what residual looks like. When AI comes up with anyone in real estate or infrastructure, it's immediately just data centers. There's no question that that is probably the single biggest beneficiary of the AI trend. There are also a lot of other ways to play AI in real estate and infrastructure that get less attention and that therefore have better risk-adjusted return because you have a better basis on entry. Industrial real estate is a huge beneficiary. It's simple things like AI is an accelerant to e-commerce growth. It's advanced manufacturing.

• 22:57Speaker 00

  How AI is accelerating that, particularly here in this country, as a driver of demand. There are types of real estate. On the infra side, we've been doing a lot with power and fiber, the things that are ultimately powering these AI-focused data centers. In terms of how we're testing it, having a large asset base enables you to feel demand in real time. We're constantly assessing that. We're looking at for these underlying companies, the tenants, whether it's the hyperscalers or others, what decisions they're making, where they're owning the assets themselves versus where they're leasing it perhaps to have a little more optionality,

• 23:41Speaker 00

  double clicking under some of those decisions.

• 23:43Speaker 01

  When you're underwriting a deal, how do you balance the desire for the thematic trend with what you think you can do to improve the asset when you own it?

• 23:55Speaker 00

  For virtually any investment we make, we want to feel like we can make money in a few ways. Being in the right theme is important. You want to be where that structural demand is there, where you're owning the physical infrastructure that underlies human lives. Needs to be structural demand. We also want to believe that we can affect change in the asset. We can have the right theme, we can buy it right, then we have another bite at the apple because we can improve it. It's different by region in terms of how that value add comes into play. Given the nature of the sellers, we're always looking for ways to improve these assets. If you take infrastructure, for example,

• 24:37Speaker 00

  we've obviously seen a massive institutionalization and growth of that space over the last 20 years. Because of that, you're not going to make a 15% return on a toll road anymore. You want to stick with the stability that's paramount and so fundamental to infrastructure investing. But to generate returns, you need to be in assets where you have that value add.

• 25:00Speaker 01

  What are some of the examples of things you've done to significantly improve an asset under your ownership?

• 25:06Speaker 00

  It ranges pretty dramatically. Sometimes it's a super light value add, sometimes it's heavier. One of the pitfalls of real estate investing in particular is people can become very seduced by business plans with a heavy reposition. As much as we are obsessed with creating value in the underlying assets, we are also extraordinarily disciplined about investing. Every dollar we invest gets the same level of scrutiny. A lot of times you see investors super focused on the buy, but then can pour capital in with a little bit more ease. Like in physics, what comes up must come down. In real estate, not every dollar that goes in comes out.

• 25:50Speaker 00

  We are rigorous in terms of that, which means that some of our value-add business plans can be lighter. There are times we are doing a light renovation or figuring out how to slightly reposition an entrance. Small things can have high ROI. We also have the history of doing more substantial value adds. I happened to be in Boston last week. The Boston Seaport was an investment I led as an associate back in '06. We bought 23 acres of surface-level parking. We had this incredible vision that if you understood Boston and all the dynamics, that this could be the hottest spot, which by the way, it is today.

• 26:34Speaker 00

  Over time, we really engaged in a master planning of that whole area, which was one of the most vibrant mixed-use urban submarkets arguably in the world. We went through a financial crisis, debt restructurings, we went through it all. But taking surface parking, we didn't develop it all. We master planned it and ultimately sold parcels. That was transformative and exciting.

• 27:01Speaker 01

  With the thematic backdrop, how do you think about constructing a portfolio of assets?

• 27:07Speaker 00

  One of the things that we try to do very well is focus on portfolio construction as opposed to some investors out there, it's almost a compilation of deals. We're focused on geographic diversification, sector diversification, but also diversification of the underlying types of risks we're taking. Because you can have risks that are more correlated than meets the eye, even though your pie chart says, well, I'm X percent here and Y percent there. So we're focused on thinking about that underlying correlation or driver. Then setting our portfolios up to really have duration. When people in real estate or infrastructure think about duration,

• 27:51Speaker 00

  a lot of times they go to financing. Having financing can give you a lot of runway. The other thing that can give you a lot of runway is having durable cash flow. Cycles are inevitable and you want to be able to weather them.

• 28:05Speaker 01

  In the competitive landscape, how does the size of the pool and the differentiation that you bring play out in the process of deal making?

• 28:16Speaker 00

  We focus heavily on sizing our funds to the opportunity set. What you've seen over the last 10, 20 years is the rise of the mega cap fund. Scale is no doubt a superpower. It's hard to even express how valuable that is. However, when you've seen the rise of these individual closed-end funds that are $20-plus billion to be deployed over a four-year period, you can be the world's most extraordinary investor. But if you have that much scale, you are going to be forced to deploy. We position ourselves on both the real estate and infrastructure side

• 29:00Speaker 00

  for closed-end funds as squarely mid-market. It gives us competitive advantages in a few ways. We are able to be super selective. We have these broad themes. We size our funds that we can cherry pick and only make those investments that are particularly well-priced and the right asset within that. There's by nature less competition. So much of the growth in real estate and infrastructure over the last 20 years has been in these mega cap funds. That means it's pretty crowded. We're making individual investments that is too small for the mega caps and too big for the locals. We get better pricing. This is maybe a little counterintuitive.

• 29:42Speaker 00

  One of the reasons we've been able to do that is being a part of Morgan Stanley. You've seen more and more mega cap managers that are publicly traded alt asset managers. Their share price is ultimately going to be a function of their AUM growth. People follow incentives. They are doing the right thing by their shareholders to grow. We have a substantial business, but we are ultimately a small part of Morgan Stanley overall. We are able to not be slaves to AUM. We are able to continue to grow and grow smartly. We are able to maintain these mid-market funds on the closed-end side.

• 30:23Speaker 01

  What are some of the strengths and drawbacks that you see of being part of a global bank?

• 30:30Speaker 00

  This point on fund sizing is an important one because it enables us to incentivize our team entirely based on performance as opposed to, gosh, I have to grow AUM. The bigger thing is we have both breadth and depth at the same time. Our team, real assets and the multiple businesses that comprise it, have incredible scale. We also have the benefit of sitting within Morgan Stanley that has that depth of expertise within individual sectors that we can go leverage tremendously. Then we have the breadth across. Being able to be both deep and broad at the same time is an enormous advantage.

• 31:11Speaker 01

  As you're talking to your clients, we're in this world where there's been a lot of liquidity bottleneck in private markets broadly. How are people thinking about real estate and infrastructure as part of their portfolios in a constrained liquidity world?

• 31:28Speaker 00

  On the real estate side, we are four-plus years into a real estate correction. Trailing performance doesn't look particularly good. Beyond the liquidity constraints, you have recency bias. What we're seeing for the smart investors is two things. One, a recognition that should be a time to go in, not out. Real estate values are still down 20-plus percent, while the broader investable universe is at all-time highs. Real estate well-priced relative to other asset classes. Also a recognition that because we're coming out of this, new supply is way down. One of the major determinants of how this cycle will play out is the supply side. That new construction falling way off,

• 32:12Speaker 00

  on top of it, construction costs still being so elevated, means we think this cycle, there'll be more room for rents to run and values to grow before that inevitable supply-side response kicks in. From a cyclical perspective, you're seeing investors saying, this seems interesting. Beyond the cyclical, there's been renewed focus on what role does real estate play in our portfolios? What are we trying to get out of this? Fundamentally,

• 32:40Speaker 00

  The role real estate plays, and it's largely true for infrastructure as well, it's that durable cash flow inflation hedging. Real estate is one of the most effective inflation hedges across the broader investable universe. While we believe investors should have multi-dimensional inflation hedging, it's an inflation hedge that has a good basis entry point today versus some others. Cash flow inflation hedging renewed focus on the physical essentialness of it. It enables you to play these structural drivers. There's a lot of focus today on defense. You see defense stocks up 40%. Real estate also gives you a way to play defense.

• 33:23Speaker 00

  We own R and D facilities, among other things. It gives you that combination of a center of a Venn diagram where you have durable cash flow, but also really long-term growth potential that make it pretty unique.

• 33:37Speaker 01

  In addition to some of the things we talked about, industrial assets, a little bit of infrastructure, defense, what are some of your favorite themes in the portfolio today?

• 33:46Speaker 00

  Another sector we love is senior housing. We've been very active in that. It goes all back to structural drivers. We know the 80-plus age cohort's growing at nearly 5% a year, while the overall population is dead flat. It's not only where all the growth is, it's where all the wealth is, too. There are a lot of them with a lot of money. That translates to a lot of demand and need for senior housing. That's a space we've been focused on because of the demand side, coupled with a dramatic drop off in supply. Another one is net lease. Net lease is a lease structure in which the tenant pays the rent and all the expenses. It's the type of real estate where you, as the asset owner, have the most predictability

• 34:29Speaker 00

  of cash flow, the most downside protection between long-term contractual cash flow tied to credit tenants, tantamount to a credit investment, but you also have the hard asset ownership, the benefits of that real estate ownership that give you the inflation hedging, the appreciation potential, the ability to play these long-term mega trends. For individual investors, tax efficiency, that's been a very big focus for us as well.

• 34:59Speaker 01

  What are some of the areas you're decidedly avoiding?

• 35:02Speaker 00

  We try to avoid bubbly behavior. Having lived through the GFC or other periods makes you better at identifying irrational exuberance. You start to spot tulips and beanie babies. One thing that we had been investing in but pulled back pretty dramatically on was life sciences. What we found is when people started to say, oh, supply doesn't matter. If you build it, they will come. Notwithstanding, we had a strong foothold, we pulled back dramatically. These lessons learned are seared into your brain. Another space that we avoided and pulled back on pretty meaningfully was US office pre-COVID, not because we were so brilliant to think Americans wanted to work in their

• 35:46Speaker 00

  pajamas, because having that global perspective enabled us to understand the capex intensivity of US office. We would look at cap rates in Tokyo, cap rates in the US, and if you looked at them relative to rates, the US looked okay. Then, when you looked below the line, that capex adjusted yields, you're constantly pouring more and more capital into these assets just to keep someone in place. We said these net effective yields don't make any sense. We pulled back from that space. Historically, we've been able to get ahead of some of these market pullbacks sector-wise.

• 36:26Speaker 00

  Today, if I look at what we're avoiding, it has much more to do with picking the right assets within the sectors we like. There's just much more divergence within categories than meets the eye.

• 36:40Speaker 01

  In the US office market, even talk about New York as we're sitting here, how has that settled out post-COVID?

• 36:49Speaker 00

  Fortunately, we're done debating whether people are going to go back to the office. We know they are. Now, the question is what type of office they're going back to. It's not just this question of the best and the rest. What we're seeing is the best of the best assets are almost becoming an oasis in the office desert. We look across our office assets, and we are seeing all-time high rents. That demand for the best of the best office has never been stronger in many markets. In contrast, I think the weaker assets may continue to depreciate. That relates to demand pullback. It also relates to the capex intensivity of those assets. You still have to pour a lot of capital in, and if you're never going to get the top-line

• 37:32Speaker 00

  rents, the ROI on those dollars are pretty challenged.

• 37:36Speaker 01

  How do you think about repositioning of assets? Say, as an example, a Class B or C New York office building that may not have the demand but could be very cheap?

• 37:48Speaker 00

  We've historically converted office buildings here in New York to high-end residential condos. 10 Madison Square West was a condo investment we made with a great developer partner. What the market misunderstands a little bit when they get excited about repositioning is there's no question that the highest and best use of some of these bones is not to be Class B office, it's to be residential or something else. Not all bones work. Understanding the physical plant, what is going to convert well based on floor plate size and column spacing and window lines and just the physical construct, understanding that is paramount.

• 38:31Speaker 00

  In a world where construction costs continue to rise, given inflationary pressures, given immigration curves and supply chain breakdowns, understanding the cost to reposition. Every dollar you put in is going to be a hundred cent dollar. Understanding your finished basis is critical. In some instances, understanding how the public incentives play out over time will be an important part of this.

• 38:55Speaker 01

  As you recently took over non-real estate, real assets, real assets, infrastructure, how's that changed your perspective on these different opportunity sets?

• 39:09Speaker 00

  There used to be a hard line between real estate and infrastructure. Today, it's more of a dotted line. In certain instances, no line at all. I've had so much to learn, and it's been incredible. Fortunately, we have a spectacular team. The investors within our infrastructure business are so good. It's been great to learn more about power assets and their data center platforms. I'd been on their investment committee for many years. It's quite different to be more directly involved. There are so many underlying similarities. These are both businesses where you are investing in the things that are essential to humans,

• 39:50Speaker 00

  those assets and services that human beings will need regardless of cycle, whether that is increasing power needs or a housing shortage. These are both asset classes that are focused on cash flow inflation hedging. These are asset classes where new supply is a fundamental question. These are assets that can be transformed on both sides within our infra teams and our real estate teams.

• 40:17Speaker 01

  How about some of the more cyclical real assets that are outside of infrastructure and real estate?

• 40:24Speaker 00

  Cyclical, we feel good about where we are on both. From a real estate perspective, one of our North Stars is replacement cost. This is the first time since the GFC where we're seeing real estate values trading consistently below replacement cost. The combination of that with a dramatic fall off in new supply is a very bullish indicator for where rents and values can go. Values are just a function of supply and demand. As we're seeing structural demand, we'll have time for those values and rents to grow before you see the supply-side adjustments to capture it.

• 41:05Speaker 01

  So you've just taken on this role. Where do the next 26 years of Morgan Stanley bring you?

• 41:11Speaker 00

  I'm not sure I'll be here for all 26 of them, that's for sure. We have quite a bit of talent at every level. I feel extraordinarily privileged every day to work at this firm. We are well-positioned to service clients, to help them raise, allocate, invest capital wisely. We will continue to focus on investment strategies where we are differentiated, where we can deliver to our clients not just great beta, but great alpha. I look across the broader Morgan Stanley, and we have such spectacular leadership and commitment to the collective outcomes that I just feel so optimistic about our future.

• 41:54Speaker 01

  All right, Lauren, I want to ask you a couple of closing questions. What was your first paid job and what'd you learn from it?

• 42:01Speaker 00

  It was for the New York City Ballet, performing in The Nutcracker here at Lincoln Center. I was 10 years old in professional ballet at that point. The level of rigor, particularly for that age, was amazing. The degree of precision and focus, but also working as a group. I wasn't the prima ballerina on stage alone. I was out there with other dancers, other professionals. Understanding the choreography and how we all work together was amazing.

• 42:33Speaker 01

  What's your favorite hobby or activity outside of work and family?

• 42:36Speaker 00

  Anything outside. Biking or jogging or hiking, any water sport, anything outside.

• 42:42Speaker 01

  What's your biggest investment pet peeve?

• 42:45Speaker 00

  Failure of pattern recognition. It's that old adage, this time is different. Yes, we know things don't repeat exactly as is. One of the privileges of doing this for a long time is you start to recognize the patterns, you start to recognize the bubbly behavior or the mispricing. Sometimes people can become so dialed into the latest thing that they lose sight of how it fits within a broader pattern.

• 43:12Speaker 01

  What's the best advice you ever received?

• 43:14Speaker 00

  To surround yourself with the smartest people possible. You never want to be the smartest person in any room. You always want to be surrounded by people that challenge you and push you. That is such a privilege, and I get to feel that way every day with my partners.

• 43:33Speaker 01

  All right, Lauren, last one. How's your life turned out differently from how you expected it to?

• 43:38Speaker 00

  I certainly did not expect to be sitting here in 1585 Broadway 26 years later. It's been an amazing privilege of my life to be at Morgan Stanley for this long and to continue to be challenged and grow and learn every day, even if I'm still here in the same building.

• 43:57Speaker 01

  Lauren, thanks so much for sharing this incredible journey.

• 44:00Speaker 00

  Thank you so much, Ted.

• 44:01Speaker 01

  Thanks for listening to the show. If you like what you heard, hop on our website at capitalallocators.com where you can access past shows, join our mailing list, and sign up for premium content. Have a good one and see you next time.

• 44:15Speaker 00

  All opinions expressed by Ted and podcast guests are solely their own opinions and do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Capital Allocators or podcast guests may maintain positions in securities discussed on this podcast.