WEBVTT - Good Real Estate Assets With Bad Capital Structures

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<v Speaker 1>You're listening to Bloomberg Business Week with Carol Messer and

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<v Speaker 1>Tim Stenebek on Bloomberg Radio.

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<v Speaker 2>We wanted to get some thoughts on the world of

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<v Speaker 2>private market opportunities and with us as Margaret McKnight, partner

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<v Speaker 2>and head of real Estate Portfolio Solutions over at Stepstone Group,

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<v Speaker 2>they focus on the private market, and she joins us

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<v Speaker 2>on zoom in San Francisco. Margaret Height, nice to have

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<v Speaker 2>you here.

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<v Speaker 1>How are you.

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<v Speaker 3>Fabulous? Pleasure to be here.

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<v Speaker 2>Thank you, Well, it's good, good to have you here.

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<v Speaker 2>I feel like it's really timely. Give us a little

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<v Speaker 2>bit more insight on your firman, who you guys are

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<v Speaker 2>typically investing for and or working with.

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<v Speaker 3>Yeah, so we are leading capital allocator to the private market,

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<v Speaker 3>and we work across real estate, which is my specialty,

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<v Speaker 3>private equity, private debt, and infrastructure on behalf of large

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<v Speaker 3>institutional clients and also private wealth clients.

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<v Speaker 2>So what's the demand that you're seeing right now for

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<v Speaker 2>these type of investments? Has it kind of tapered off

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<v Speaker 2>a little bit, especially within a higher rate of environment.

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<v Speaker 2>I'm just curious about the impact.

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<v Speaker 3>I would say that new commitments have tapered off, and

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<v Speaker 3>interest has not because a lot of the conditions are

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<v Speaker 3>riped for these to be some very good years to

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<v Speaker 3>deploy new capital. For our institutional investors. First of all,

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<v Speaker 3>the appraisals are very slow to catch up with the

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<v Speaker 3>price changes, so they're still carrying a lot of their

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<v Speaker 3>real estate at relatively high values. And also they make

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<v Speaker 3>commitments to funds that then call the capital to make investments,

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<v Speaker 3>and that whole process is very much slowed down. So

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<v Speaker 3>for example, over the last year, capital calls are down

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<v Speaker 3>sixty or down twenty five percent, and the return of

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<v Speaker 3>capital is down sixty eight percent, So don't have money

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<v Speaker 3>to redeploy and they're kind of full up, but not

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<v Speaker 3>for lack of interest.

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<v Speaker 1>So is that a cause of concern or something, especially

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<v Speaker 1>if you're looking, for instance, in the private credit space,

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<v Speaker 1>it's around one and a half trillion dollars in that corner.

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<v Speaker 1>But when you're looking at other areas like private equity,

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<v Speaker 1>private debt, real estate, does it make sense that you'd

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<v Speaker 1>see this happen at this point or is it a

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<v Speaker 1>cost for concern?

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<v Speaker 3>It is a natural part of the real estate cycle

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<v Speaker 3>which is kind of slow to adjust, and it creates

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<v Speaker 3>a lot of dislocation and a little bit of a

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<v Speaker 3>shortage of capital on both the debt and the equity

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<v Speaker 3>side at the same time as people are motivated to

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<v Speaker 3>sell and raise capital so it can create That is

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<v Speaker 3>the opportunity emitted the turmoil right now.

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<v Speaker 2>So I'm curious, like for our audience who are listening,

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<v Speaker 2>because I think real estate we're trying, we're a little

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<v Speaker 2>bit on trying to see if it's another shoe to

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<v Speaker 2>drop right as you would imagine, we certainly talk about

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<v Speaker 2>office real estate a lot. Let's go there in terms

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<v Speaker 2>of that segment of the market. We talked about law

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<v Speaker 2>firms earlier that they are kind of helping out fill

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<v Speaker 2>up some of the office space here in New York

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<v Speaker 2>City because of their return to office mandates. But for

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<v Speaker 2>commercial office real estate, what's the outlook there, what's the demand,

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<v Speaker 2>what's the interest, what's the concerns?

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<v Speaker 3>So first, it's really important to understand that what's happening

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<v Speaker 3>to office is part of a bigger trend of changing space.

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<v Speaker 3>He was partly driven by technology, and office is a

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<v Speaker 3>loser in this game. But it's really important to note

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<v Speaker 3>that there are winners and we can come back to

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<v Speaker 3>those later. Those make interesting places to invest. Office is

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<v Speaker 3>getting hurt by both the cyclic weakening, particularly the tech

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<v Speaker 3>tenants pulling back, and it's also had really a big

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<v Speaker 3>step down in demand because of work from home, which

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<v Speaker 3>is here to stay. Employees and employers are in a

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<v Speaker 3>giant experiment to figure out what hybrid work looks like

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<v Speaker 3>and also what it means for office leases. The capital

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<v Speaker 3>markets saw this and they basically shut down on office,

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<v Speaker 3>and they are the grease that keeps the engine moving.

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<v Speaker 3>So on the office side, it's pretty seized up. That

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<v Speaker 3>is not true of the rest of real estate, which

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<v Speaker 3>is just going through an adjustment to higher interest rates

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<v Speaker 3>amid mixed signals with the downdraft from the economy and

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<v Speaker 3>then real secular support, and then you have to get

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<v Speaker 3>down into the details to figure out what is more

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<v Speaker 3>and less interesting.

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<v Speaker 1>Who do you think are the winners.

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<v Speaker 3>So when we look at the big trends, e commerce

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<v Speaker 3>kind of hurt me tell and that actually went through

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<v Speaker 3>a correction much the same as office, by the way,

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<v Speaker 3>and it took about ten to fifteen years to weed

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<v Speaker 3>out the successful tenants and formats and now it's back

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<v Speaker 3>in favor, and I think office will take a while

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<v Speaker 3>more like ten to fifteen years than two to three

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<v Speaker 3>years to get fixed. But the winner there was industrial.

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<v Speaker 3>E commerce hugely benefited industrial, and industrial is also benefiting

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<v Speaker 3>from deglobalization. Residential is benefiting from a general housing shortage

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<v Speaker 3>of affordable homes. And again details matter because in the

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<v Speaker 3>high growth Southeast markets we have had a lot of

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<v Speaker 3>new deliveries that need to get absorbed. But it's actually

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<v Speaker 3>benefiting this cycle because high interest rates make it hard

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<v Speaker 3>to buy homes and so there are more people you know,

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<v Speaker 3>staying in the renter pool unfortunately unless they want to

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<v Speaker 3>be there right. And then also technology is helping to

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<v Speaker 3>bring a lot more formats into the institutional arena, like

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<v Speaker 3>single family homes for rent, where you need technology to

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<v Speaker 3>effectively manage a large portfolios, and that's property type. I

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<v Speaker 3>think even the bigger winner this cycle is kind of

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<v Speaker 3>the pricing opportunity. We think that we have some of

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<v Speaker 3>the best conditions set for potentially the best buying years

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<v Speaker 3>of the cycle.

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<v Speaker 2>You're talking about for an investor in particular, because okay,

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<v Speaker 2>because of some distressed opportunities and I know you guys

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<v Speaker 2>play into certainly in a big time in recapitalization. So

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<v Speaker 2>I am curious how much of that you're already seeing

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<v Speaker 2>where they need to kind of rethink a certain asset.

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<v Speaker 3>We are at the leading edge of kind of a

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<v Speaker 3>two to three year workout of existing commercial real estate debt,

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<v Speaker 3>and we're focused on the interesting property types of course,

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<v Speaker 3>but the higher rates mean that outstanding loans are bigger

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<v Speaker 3>than the new loan that you're going to get because

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<v Speaker 3>the properties can't support as much debt when it's more expensive.

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<v Speaker 3>So if you're an owner with a promising property and

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<v Speaker 3>you want to keep your property, you have to fill

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<v Speaker 3>that gap. Not everybody has that money, and so they

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<v Speaker 3>are raising it and doing Our sort of favorite way

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<v Speaker 3>to do this is what's called GP led secondaries, where

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<v Speaker 3>you work with the GP to provide the gap equity,

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<v Speaker 3>and then you also take out any LPs that want

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<v Speaker 3>to move along. So it really solves two problems, and

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<v Speaker 3>we are starting to have flow that's at the similar

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<v Speaker 3>pricing to what we saw in the post GFC period,

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<v Speaker 3>which then led to really and trusting returns.

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<v Speaker 2>Margarete, let me help help me in because I know

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<v Speaker 2>you guys play in the private equity the private debt.

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<v Speaker 2>You know part of the thing, are you are you

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<v Speaker 2>creating new funds specifically from investors real estate funds to

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<v Speaker 2>put that money to work, or you're not doing it

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<v Speaker 2>in that way.

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<v Speaker 3>We do it in a variety of ways depending on

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<v Speaker 3>the needs of our clients.

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<v Speaker 2>Yes, but I'm just curious, is there demand for new

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<v Speaker 2>funds and for investor money to come into it. I'm

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<v Speaker 2>just curious if you're investor saying we've got money, we

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<v Speaker 2>want to put it into a real estate fund.

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<v Speaker 3>Investors do understand that this is a very interesting thing

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<v Speaker 3>to do, and not everybody is tapped out, and you know,

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<v Speaker 3>we have a global business and investors around the globe

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<v Speaker 3>are affected in different ways, so that so there is

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<v Speaker 3>capital available and it is a great time to be

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<v Speaker 3>playing it in this manner in our opinion. And also,

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<v Speaker 3>you know, institutional investors do keep to a generally consistent

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<v Speaker 3>base over time, So doing this and then also just

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<v Speaker 3>doing value added and opportunistic funds, they are going to

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<v Speaker 3>buy the things that can't be saved. You are very interesting.

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<v Speaker 1>Today, if you're looking at a particular portfolio strategy, how

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<v Speaker 1>should investors allocate that particular segment to the construction of

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<v Speaker 1>their portfolio?

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<v Speaker 3>Really lean into where they see potential buying opportunities, good

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<v Speaker 3>pricing combined with a relatively resilient outlook for fundamentals. We

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<v Speaker 3>published twice a year our house used that summarizes our

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<v Speaker 3>opinions on where this will be in some amount of detail.

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<v Speaker 3>So that's a resource that's available. And obviously we are

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<v Speaker 3>pretty excited about the RECAP and gp LED secondary opportunity.

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<v Speaker 2>All right, you're certainly in it, and it's interesting to

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<v Speaker 2>kind of get your perspective on a topic that comes

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<v Speaker 2>up so often, especially in this higher rate environment. Margaret McKnight,

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<v Speaker 2>thank you so much. She is partner and head of

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<v Speaker 2>real Estate Portfolio sous over at Stepstone Group, joining us

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<v Speaker 2>on Zoom from San Francisco, and interesting to get our

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<v Speaker 2>thoughts just in terms of weighing in, especially when it

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<v Speaker 2>comes to the office side of things as we try

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<v Speaker 2>to figure out our way forward.

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<v Speaker 1>And we've been talking about the office space it seems

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<v Speaker 1>like all afternoon as well as in the last couple

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<v Speaker 1>of years. In addition to that, but obviously how things

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<v Speaker 1>have changed so much because of COVID