Why This Investing Pro Is Looking to Europe

Hello, everyone, and welcome to AdBarrons. I'm Andy Serwer, and welcome to our guest, Henry Cabot Lodge, the third founding partner of Lodge Quay. Cabot, great to see you. Thank you so much for joining us.

Thank you, Andy. It's a pleasure to be here. So tell us about your investment firm, Lodge Quay. What is exactly what they do?

Well, it's a business in an industry that I've been involved with for, gee, 45 years, I think. I've switched between running the credit tenant lease business for New York Stock Exchange companies and then going into starting my own business. The first foray was with William E. Simon, former Secretary of the Treasury, where we formed a fund that we merged into the largest publicly traded real estate company in New York Stock Exchange.

I left there to start another fund with a guy named Ray Wurta who had just formed CBRE. He was CEO and chairman. And I then went back to Europe with Bill Carey at a company called WP Kerry and was president there for four years. And I found that Europe was very interesting for this asset class because, well, for a number of reasons, which we can get into later.

But there was a point in European history, I'm sure you'll remember the era of the pigs, where it was uncertain whether US investors wanted to invest dollars in Europe. And so I left to say this is the exact time where we ought to be investing. The PIGS is an acronym for? Portugal, Ireland, Greece, and Spain.

I think Spain was the other one. Now, of course, Greece and Ireland are thriving economies. So Dan Quay and I, we met on a deal, a big German company that had never sold a piece of real estate called Metro. We gave them 300 million euros and bought their Italian footprint.

Metro sold to the hospitality industry everything you'd need in the fourth largest tourism market in the world. And their bonds were trading at about 2% to 3%. We did an unlevered deal at 8% with moderate leverage could return 12%. So the decision for those investors looking to invest in Metro's credit, would you rather buy the stock, would you rather buy the bonds, or would you rather buy a, have a real estate position where you could get double digit returns?

Even though it was in Italy, we took a parent guarantee because Italian legal real estate law has certain quirks, which is common in Europe. And so that was a transaction where Dan and I spent a year together. Now Metro doesn't own one piece of real estate. And I think it's indicative, somewhat of a bellwether for what companies in Europe are looking at for this form of financing.

Yeah. I mean, so maybe taking a step back, Cabot, what are net leases? Just give us sort of the basic 101. How does that work?

Well, we provide the intermediation between companies seeking to pull the capital out of their fixed assets and redeploy it in either paying down debt, doing an M&A deal. We don't like them to use the proceeds to pay dividends. It has to go back into the business. And the other side of that trade are investors looking for long-term safe income that is asset-backed.

Unlike fixed income or debt, we actually own the real property. And we own it under what's called a triple net lease, meaning that the tenant pays all the expenses that a landlord typically would suffer, insurance, taxes, maintenance. So it's somewhat of a passive landlord role, and it's very much of a hybrid between credit and real estate. And why, you explained this a little bit, but maybe you can expand, why is Europe so much more appealing to you than the United States?

Well, for a number of reasons. First of all, there's a bigger market. There's about $8 trillion of corporate-owned real estate in Europe versus $4 trillion in the U.S.

There's about over 4% of the market in REITs in the U.S. It's less than 1% in Europe. When we compete for a deal, we're competing against maybe 5 to 10 other bidders, whereas in the U.

S. it's 30 to 50 bidders. So there's a bigger market, less competition. The 10-year bond is trading today at 3%.

The 10-year treasury is 4.5%. So with financing rates in the 5% to 6% range, we can realize significant positive leverage on our which is tough to get in Europe. Cap rates are about the same in Europe and the U.

S., depending on credit quality of the counterparty. I think also you have sort of a moat to entry, if you will, in Europe. It obviously multilinguistic It different legal systems a different currency and so it hard for a U platform to sort of pick up and say they going to go to Europe You really need a team there that has those skills and can recognize this idiosyncrasies, if you want to call it that, in the market.

Europe also has, it's a lot tougher to blow up a company there. Chapter 7 really doesn't exist. With the insolvency regimes, they want to retain jobs. So if you have a company that gets into trouble, they work with you to maintain a going concern value, if you will.

And for that reason, what we do is focus on the most strategic or mission-critical asset of the counterparty. We like to buy the manufacturing asset, not the office building. Office is ubiquitous. You can always get cheaper office space.

But to buy a plant where the tenant improvements generally are four, five, six times what you're actually buying the real estate for is a very sticky asset. So we like large industrial plants, single tenant properties that are not immune to administration, but certainly have an appeal to us because they're very hard to discard, if you will. And what is the manufacturing environment like in Europe right now? Do you have an AI play, data centers?

Is there any of that going on or is it just good old-fashioned stuff? It is not as much as in the U.S. you know we bought the largest copper plant in europe for instance our themes are critical materials non-discretionary retail consumer verticals things that are generally immune to ai influence although if we look at a data not a data center but a call center or some other type of real estate that has a significant number of employees that might be susceptible to AI.

It's not necessarily the human capital that we're concerned with. It's what goes on. I remember I did a deal for the General Motors electromotive division where all the replacement parts for all the diesel engines that GM produced was in this million square foot facility. And it doesn't matter whether a robot's picking those materials or a human being is picking those materials.

What was important to them is they needed that plant. So energy is another thing that I think with the energy shocks, we're looking at underwriting companies who can pass that cost onto their customers and not be subject to, you know, margin dilution. So, yeah, I think some of the things that we're confronting now from a geopolitical perspective do influence how we acquire and underwrite assets. And who are your customers and how much capital, what is your AUM or capital that you're deploying?

So right now we're about $600 million in AUM. We have institutional investors, sovereign wealth funds, family offices, pension funds, charities. It's really an array of investor types. I think the common factor is they're all looking for safety, income, highly visible income, and something that is somewhat unique in terms of deciding which part of the capital stack you want to invest in.

The one thing that we don't offer is immediate liquidity. And that's why there's a premium that we get in the case of the Metro deal, 400 or 500 basis points premium over where their bonds were trading, because a piece of real estate isn't as liquid as a bond. You can't trade it in a minute. It takes 45, 60 days to trade.

So you have an illiquidity premium. And some investors are concerned with liquidity and others don't want their money back. They just want to keep getting the income. And the other is residual uncertainty.

You know, at the end of the day, you're probably, if you make a good credit choice, going to get par at maturity. In our case, you might get more, you might get less for the building at the end of the term. And are these investors primarily in Europe or are they global in the U.S.?

both? Both. I think most of the capital in Europe though is US-based coming to this market. You know what we have found Middle East and Asia as well.

I think the the European institutional capital by and large will do a joint venture with you. They don't want to invest so much as in a fund but they'd like to be your partner and have discretion over what they deploy their capital in. So we're raising a fund right now, which has discretion, because we believe that a diversified pool of corporate assets with staggered maturities is the way to invest in this business. Others want discretion over, I like that property I going to buy it I know what I doing rather than invest in a blind pool I think US investors are more willing to invest in a blind pool When the world keeps shifting we there to help you act with confidence At HSBC, we bring together the people, ideas, and capital that drive growth, backing your ambitions at every stage.

So when you're preparing for the next generation, strengthening your portfolio, or you're entering new markets, we're there, bringing 160 years of experience to help you move forward. HSBC, opening up a world of opportunity. You mentioned interest rates are a bit higher. How is higher longer impacting your investment thesis or your business model?

Well, real estate cap rates and interest rates do move hand in hand. It used to be a longer lag than it is today. I think that the higher rate environment is creating some concern with those corporations because they're looking at maturities that they need to refinance. And if they've never considered a sale leaseback before, this is a source of capital for them where they still get a positive arbitrage.

We do a lot of business with private equity funds and family offices. And the multiple they pay for the business is seven, eight times. And they sell us a piece of real estate at 10 to 12 times. So they're still getting accretive capital compared to what their multiple is that they pay for the business.

I think the longer that high rates exist, you're going to see more credit funds in the market because they like that income. I think there are two things that will challenge that. One is a reduction in rates. It won't discard all of the credit funds from the market, but it'll bring back the traditional commercial banks into lending, notwithstanding Basel III and IV, which has created capital requirements that they apply a cost to that private equity funds don't.

And the second are these looming maturities. I think, you know, once those are met and digested, I think it would possibly pressure the credit funds to find investments elsewhere because it'll bring the, you know, the commercial lenders back. And speaking of those commercial lenders, Cabot, do you guys consider LodgeQuay to be part of this wave of disintermediation, I should say, of the traditional commercial lenders? Are you basically taking market share away from them with your work?

No, because we utilize them as part of our acquisition structure. We're generally 50% levered. And so because this is an asset type that really lends itself to leverage, it's highly visible, highly transparent. They can underwrite it easily.

They don't have to look at what market rates are for replacement costs and this type of thing. So, you know, I wouldn't call us disintermediators. I think we've been around long enough, certainly in the States and now more in Europe, to be an accepted form of financing. but because of the I guess complexity of dealing in Europe with different legal systems currency everything else that's why these premiums exist and that's why I like Europe over the US in a sense we bring US technology if you will to Europe in how we structure these with specific covenants in the loan agreement or the leases that restrict a change of control or use of proceeds are things that aren't typically provided for in a European lease.

Speaking of Europe and the United States and maybe the entire globe, what do you make of the geopolitical situation, maybe in particular the European-United States relationship? Well, I travel a lot in Europe. They like Americans. I think America has become not, you know, the partner that it's traditionally been.

But I haven't found really any friction in, you know, doing business there with, look, I'm an American. My partner's Australian and Italian. The head of our acquisitions is German. He's supported by a South African.

our head of underwriting is French. We're really a team that presents ourselves as a multicultural outfit. And so I think the friction that exists between, if there is one between America and Europe, doesn't really affect our business. Have you ever given any thought to how you got yourself into what is, I won't call it esoteric, but a niche perhaps era facet of finance I like the obscure I like creating new businesses.

I like describing, you know, when you go to investors who think they, you know, know all the asset classes and you describe this type of, you know, financing, they say, this is great. I've, you know, I've never heard of this. So less so now, but years ago, it was quite new in terms of those looking for long-term income, mostly insurance companies, pension funds like that. Maybe I guess what I'm asking, though, also is how did you get into it as opposed to, say, running long-only equities or something?

Well, this gets into a personal story, Andy. Good. Because there's a guy named Parker Llewellyn who used to run the offices of career services at Harvard Business School. And Parker and I would play golf every Saturday morning.

And Parker said, Cabot, what do you want to do? I said, well, I think I want to get back into consulting. And the next week, he said, what do you want to do? I think I want to go to investment banking.

Next week, I think real estate is for me. So he knew I didn't know what I wanted to do. So the next week, he shows up. He says, Cabot, I got two leads for you.

One is a guy who runs a real estate investment bank in New York, which is banking real estate. and he's looking for someone to come in and take hold as a second position. And the other guy just sold his tech business on 128, which is a sort of Silicon Valley of Boston. And he made a lot of money, and he's going to start a new tech business, but he needs a business guy.

So two days later, the phone rings, and the guy says, Hi, it's Bill Carey. And I said, Oh, yeah, you just sold your tech business on 128. I had a 50-50 chance, and I blew it, because this guy ran the Industrial Bank in New York. He came to Cambridge.

I liked him a lot. And I said, I never thought I'd move from Boston and live in New York, but I'm going to take this job. And I was there for 15 years. Speaking of where you were brought up, you come from one of America's most prominent families in terms of public service, certainly.

And I'm wondering what it was like sitting around the dinner table with your father, George, maybe your grandfather, Henry Cabot Lodge Jr., talking about issues of the day. Did you do that? What was it like?

Yeah, I did that. Actually, one of my first memories is meeting Khrushchev when he came over to visit the U.S. And Mrs.

Khrushchev gave us these, you know, the Russian dolls that fit all. I don't think the State Department allows presents being given, or at least you have to pay taxes now. But then it was a different story. And Grandpa had a lot of time for us.

He was ambassador to, you know, Saigon and Germany and the Vatican and Paris peace talks and would take us around to those locations that gave me a sort of understanding that maybe the U.S. isn't the center of the universe and that there are other countries, other constituents that have their own issues, own problems, own, you know, economies that I appreciate. At the same time, I think we do it better.

And so what encourages me now is, as I said before, Andy, you know, how could we bring what we learned in the U.S. to make it better in Europe, at least for this type of financing? Did you ever consider or have you considered going to public service yourself?

The last person who died in my family or who had any money in my family died about 200 years ago. So I went to education on that and paid for me and I had to get back to work. So I didn't. My father did once run for the Senate against Teddy Kennedy when his brother went to be president and then decided he wanted to teach.

So no, I never really considered politics as a career for me. And final question, where do you see Lodge Quay going, say, over the next five to 10 years? What's the future of the business? Well, even though, as I told you before, you know, I've created my private equity funds and then merged them or sold them to large New stock exchange companies.

I'm 71, so this is my last gig. And so I see my role as passing this on to my employees with the knowledge and asset base that will create a thriving business. I work for them, really, at this point. Cabot Lodge, founding partner of Lodge Quay, thank you so much for joining us.

Thank you, Andy. Appreciate it. This is At Barron's. I'm Andy Serwer.

We'll catch you next time. The production team for At Barron's is Ellie Esmailadou, Joe Lusby, Kinga Rojjak, Rebecca Bisdale. The executive producer is Melissa Haggerty. We'll be back with a new episode next week.