#129 - Cathy Marcus: Real Estate Reset

Speaker A: Welcome to the Insightful Investor Podcast, a, ah, weekly series that seeks to share industry, investment and market insights. Learn more about our show@insightfulinvestor.org today my guest is Kathy Marcus, co head and global COO of real estate at PJIM. PJIM manages more than $1.4 trillion in assets and its real estate platform oversees $217 billion, making it one of the largest real estate managers in the world. In today's conversation, we're going to talk about opportunities in real estate following a, uh, major repricing how different property sectors are evolving, what higher rates mean for the asset class, and what decades of investing through major downturns have taught Kathy about risk leadership and decision making. We're so pleased to have you join us, Kathy. Thank you.

Speaker B: Thank you.

Speaker A: I know you've known since a very young age that you wanted to work in real estate. What was it about real estate that pulled you in so early?

Speaker B: I think it's the tangibility of it. Uh, you're sitting in real estate, I'm sitting in real estate. We live in real estate, we shop in real estate, we go out to eat in real estate. It's everywhere. And I've always had much more of an affinity for things that are tangible and physical versus, you know, the more esoteric areas of finance. And I always knew that I wanted to be, um, in fine finance somehow and in the business world. And real estate just felt like actually the most fun way to approach that.

Speaker A: Interesting. So when you were young and you were in a mall or in some property, were you asking, I wonder who owns this and how is it finance or those thoughts going through your head or at an, at a young age?

Speaker B: Yeah, probably not as a child, but definitely as my curiosity grew. And um, I find myself now as an adult, especially after being in the business for a long time that I like, whenever I'm in a new place, I'm just like looking out the window constantly. Either looking out the window from an Uber or from a building or from my hotel room. Just, um, looking at sort of land use. I find that fascinating. I feel like if I wasn't in real estate, I might have done something around like urban planning. I find place making and kind of, you know, different ways of using land. Land and being able to learn about a city through its land use and its neighborhoods.

Speaker A: It's really interesting. So looking back at the early years of your career, are there aspects of real estate investing that you feel turned out to matter far more than you expected and what mattered much Less many

Speaker B: people who have started out in any kind of an investing business. As a junior person, you spend a lot of time running numbers and running models and having corrections made to your models by, uh, the senior people in the firm. And there were definitely times when I was young when I would say, like, really, is it that important to change that, you know, such a small amount, especially back in my day when that meant manually making a lot of changes, you know, changing three numbers probably had you staying up all night. And I would, you know, always think, really, is that. Is that m making such a big difference? And then as you become a decision maker, you start to realize it does make a difference. Especially when you're acquiring an asset. The one thing that you can never redo is you can never redo the price at which you buy something. Um, and that's the kind of the starting gun, if you will, for how you do with the investment. So that was the type of thing that, when you're really junior, it's very hard to understand by small tweaks can make such a big difference. And really, I think that at the end of the day, that lesson in really understanding the different components of value and how, you know, a tweak here and a tweak there, how that kind of runs through a model and how that can change things, I find that to be the most beneficial thing. Um, the reality is right now, the technology has changed enough, and I've been away from it long enough that I would probably ruin any model put in front of me if I were to try to make some changes to it. Um, but I can still tell if something's wrong because I know how things are supposed to flow and I know where the mistakes are often made. And that really is all, um, from those years of making all those changes late at night.

Speaker A: And on the other end of the spectrum, were there things that you thought originally were very important that over time you realize are not as important?

Speaker B: Yeah, I think especially when you are first getting to understand the industry. There are flashier aspects of real estate, particularly around, you know, flashy development. But fortunes have made with things that are, you know, really not that sexy at all. In industrial assets, affordable housing, um, you know, today, things like, you know, industrial outdoor storage. We used to say, um, you know, this asset's never going to be on the COVID of the annual report. And I would love to see a correlation between the assets that are, you know, kind of pretty enough and interesting enough to be on the annual. Of the COVID The COVID of the annual report. And what the performance of that is, you know, versus, um, I remember years ago buying some really unattractive self storage assets and joking, well, these will never be on the COVID of the annual report. We'll probably never bring our investors to any of these. And it was a home run. So, you know, that correlation is especially for someone who is attracted to the space in many ways, um, because I love architecture and I liked the physicality of the asset. You know, the reality is that, you know, some of the most basic assets, I mean, real estate, making money in real estate is really about income producing income and durable cash flow. And at the end of the day, durable cash flow, you know, can come from the most understated places and often does.

Speaker A: Right. And if something is really beautiful, the price may also reflect that as well.

Speaker B: Exactly.

Speaker A: Uh, so you alluded to this earlier. You spent many years running PGMs Real estate investment Strategies before moving into senior leadership where you sit today. What surprised you most about the transition from investing to running the business?

Speaker B: Yes, well, my first transition was from being a portfolio manager for our flagship fund that I worked on for many years to being our global coo. And that was an absolutely huge transition that I completely underestimated. I really, I was approached about taking a COO job, um, by our CEO at the time. And he said, you will learn how to run a business by doing this job. And I said, well, I already know how to run a business. I'm running the largest fund that you have and there's lots of people working on it. And I know how to, I know all of this. And it ends up I knew nothing, I really didn't know, um, you know, the ins and outs of the business. I had always been, you know, kind of, ah, an investment professional in my entire career. I would say one of the most humbling things that I learned early on in my transition to operations was I did not have a high enough appreciation for what the, quote, back office did, uh, to support my investment activities and the fund that I managed. I learned that very quickly that the, uh, people like in fund operations, your fund accountants, people in compliance, people who are supporting the efforts when things are going well, nobody even notices that they're around, frankly. And then, you know, when one mistake is made, which might be, you know, 0.025% of the time. And I was as guilty of this as anyone where you just blow up like, how can you do this? How could you have made this mistake? And I really became actually quite sort of, um, embarrassed by my behavior in the past. I was a bit of the stereotypical primadonna portfolio manager. And I really did not have enough appreciation for, you know, this notion of it taking a village. The reality is that of that village that it takes to produce strong investment returns, there's only a very small portion that is, you know, kind of visible to the market and visible to the clients and, you know, the people who get invited to the dinners and get the awards, et cetera, that's a very, very small percentage of the effort. It just happens to be the most kind of outwardly facing one. And so that was really, uh, just a huge eye opener for me, learning how important it is to appreciate all of the efforts that go into running the business and producing excellent outcomes for our investors. And it's not just that small handful of people. And that was a very, very valuable lesson for me to learn. And I'm 100% sure that I would not be in the seat that I'm in now if I hadn't learned that lesson and I hadn't come to appreciate the business and the effort in its entirety.

Speaker A: It's sort of like a movie where you go watch the movie and you see the actors on the screen, but you don't realize how much goes beyond behind the scenes.

Speaker B: Exactly.

Speaker A: And all of the components that actually put in front of you to build it.

Speaker B: Yeah. And in contrast, if you think about a movie at the end, you know, for those who have the patience to sit through it, there's credits. Right. In investing, uh, there's no similar concept unless you. Unless you make it. Unless you actually go out of your way to call out those people when you have a successful deal and to celebrate their contributions, because they're many, they're just not often celebrated.

Speaker A: So when you transition from investor to coo, that becomes. That's all of a sudden in front of you and you're managing that process. That's a steep learning curve.

Speaker B: It is. It's a steep learning curve. And, you know, for me, they were now my people. And to also, you know, kind of sit and watch how others maybe don't have a high enough regard for your people, knowing that you did the same thing. That, that's a tough thing. And, um, and that really changed me very significantly.

Speaker A: Over your career, real estate has become far more data driven. What has that evolution clearly improved and what may have been lost along the way?

Speaker B: I don't think the story is entirely told at this point, so I'm not sure we know exactly what's been lost along the way. But my experience in this business, which I've been in since 1987, is that every time we introduce a greater level of transparency into this business, the business grows and it becomes, you know, that much more institutional. There are more and more participants. And I think about the fact that, you know, when I first started, I'm going to say the average pension plan's allocation to real estate or real assets probably was somewhere between 2 and 5%. And now, you know, it's somewhere between, call it 12 and 15% depending upon, you know, which type of investor. And I do think there's a direct correlation there between the increased transparency in the market, much of which actually was driven by the REIT market becoming um, that much more institutionalized. Also the CMBS market, where suddenly there was a much greater level of information that was available to a broad group of people, the same information. And it was almost um, veering toward kind of a public markets level of transparency. We're obviously still a private illiquid market and a somewhat inefficient market. But the level of transparency now is so much greater and I think it's just so much better for the business. When I first started out and you needed to get a comparable sale for a, ah, business plan for an asset or for uh, an investment committee submission for an acquisition or disposition, you would sort of set aside a day for making phone calls to appraisers and brokers and you would just call all day to try to get that information. And some people didn't want to share it with you. You never knew if they were giving you the actual right numbers or whether they were, you know, spinning it in some way. And now somebody logs onto, you know, some data sharing platform and, or market information platform and there's every comp you'd ever want to see. So that just, I think again, it just makes people feel more comfortable despite the fact that this is a private illiquid asset class for the most part.

Speaker A: And it is an area that is naturally more difficult to get aggregated data within. So uh, it seems like there's a lot of room for increasing the transparency and the availability of data over time.

Speaker B: And it's interesting because for someone like me it seems like we're, we have so much data, but that's just because we're starting from almost nothing clearly, you know, as compared to the public markets. It's, it's still, you know, very, very different situation. But you know, you can just see this continuing to evolve as it becomes easier to collect the data, as it becomes easier to you know, share the data, to cleanse the data, to really harmonize the data. You can just imagine, you know, how much better it can be and actually how much more global the information can be.

Speaker A: I'd like to ask you a few questions about just your general outlook on the market at a high level. How do you frame the current real estate environment in terms of tailwinds versus headwinds? And where do you think we are in the broader cycle today?

Speaker B: So I think that there are both tailwinds and headwinds. And the tailwinds in real estate are very, real estate fundamentals, um, specific. So things like the fact that we have had very little construction in most sectors over the past couple of years, you know, so therefore supply has definitely been kept in check. Therefore occupancies are generally pretty high. And therefore in many sectors, landlords have pricing power. So that is all good. And when you look back on other, you know, real estate crises over time, I'm thinking about the SNL crisis in particular. It was all about supply. It was what we used to call see through buildings, you know, back in the day where there were all of these buildings that, you know, had never been occupied at all by anybody. We didn't do that to ourselves this time. Now there are definitely a couple of, you know, multifamily markets in the Southeast that are definitely overbuilt and there are some pockets of distress, you know, in, um, industrial. But that is all working itself out. And it's going to, to work itself out. So those are what I would say. The tailwinds are very specific to real estate fundamentals, to supply and demand. On the other hand, you know, the headwinds are the headwinds that everyone is facing. It's a crazy world out there, as we know. You know, the interest rate, volatility and uncertainty is not good for real estate. We don't have to have zero interest rates to make things work. But people are reticent to transact when they are not sure which way rates are going. And any level of uncertainty, it just kind of mutes the activity in the market. And that's really the situation we've been living under in some way since mid 22. We've had periods where it seemed more stable, periods where rates definitely went down, periods where there was more activity. But it has felt like, you know, in the fourth quarter for the past two or three years, everyone in the business has looked forward to the next year and has said next year is going to be a normal year. We're going to have normal activity. It's going to be great. We're very excited. And then something tends to happen, you know, somewhere around March or April of every year where you know, you're disabused of that notion of, you know, of a normal year. And you know, it could be war, it could be tariffs, you know, all of the rate instability. It just feels like there's kind of always something that's like a, I'm not going to say an exogenous factor because it's not exogenous. But you know, it's not a self, self inflicted wound of the real estate business. It's something that is going on that we have zero control over, you know, in the broader economy or in the broader world.

Speaker A: So Covid and the 2022 rate shock were a double hit for many sectors. Do you see those event as a temporary disruption or a true inflection point similar to what happened post gfc?

Speaker B: Let's talk about the different sectors. If you start with Office, which you know, was a headline grabber, you know, during um, especially when many people were working from home all the time, I mean, you know, Covid was definitely a game changer in the office sector. However, it is not accurate to say that Office was just doing fabulously. And then Covid hit, you know, if you look from um, you know, call it 10 years prior to 20, 20, 15 or 20 years also will bear out similar results. Office really kind of underperformed generally and it's because of all of the capital that has to be invested in office and that just continues to get higher and higher and higher. And as I mentioned earlier, real estate is about cash flow and the durability of cash flows. And when you are executing a large office lease, especially in you know, a major cbd, New York, San Francisco, you may not get paid any actual rent for three years from the time that you sign that lease between sort of the build out period, which is about a year in most markets, and then there's probably a year of free rent. There could be more than that. There could be a phasing in of the rent. So office can be very challenging from that perspective. So I always try to make sure people understand that it wasn't like Office was the highest performing asset class for 30 years and then Covid hit. That's definitely not the case. Uh, the level of volatility in total returns for Office in the NCREIFF property index was huge leading up to Covid and that was why frankly many people, including us were, you know, had been Underweighting office pre Covid, it wasn't that we, you know, had some, you know, great vision of what was going to happen with work from home. It was just that, you know, it was hard to outperform when you had one asset class that was sucking up a lot of cash and then ultimately not producing great total returns. I also am not of the school. That office is dead. I'm in, you know, my office in Manhattan. If we wanted to expand in this building, we could not. So, you know, very high end class A newer office space is doing extremely well pretty much around the world. You know, it's kind of the middle of the pack. Not fit for purpose office assets that are really struggling. Although leasing is picking up in the office, um, in many markets and then you know, at the very like kind of definitely not fit for purpose end of the spectrum for office. That is where you're seeing, you know, some of the conversions to residential and you know, some of those buildings are a bit older, they might have smaller floor plates that makes them, it's more conducive to, you know, residential redevelopment. So I feel like office is finding its footing. And what I think has really, really changed since COVID and I find it hard to imagine going back to the way it was is that, you know, companies would go out to lease space, office space so that their employees had ah, someplace to come to work. And for some companies they'd have some portion of the space built out in a very nice way for clients. This is where the clients would come for meetings. This is where the bankers would come for a meeting. But that was it, it was shelter, right Office. Now companies view it as uh, it's, it's part of the total rewards package that you're offering to your employees. And we see very often that HR is front and center in, in making decisions on office space these days. It used to be, you know, as a, an owner of assets, you know, you'd kind of fear uh, the cfo, right, the person on the other of the tenant who was going to really look at the numbers and maybe, you know, kill the deal. Now you, you fear the HR person like is, is the HR person going to come on the tour and say, yeah, this is, this is a place where I can attract and retain the best talent. I don't see that changing.

Speaker A: So after decades of low rates, how do you think about a world that may be higher for longer and how does a higher cost of capital change what makes a good real estate investment in such a leveraged asset class?

Speaker B: We like leverage, you know, in this business, we even like putting leverage on leverage. So, so, um, you know, leverage is a very helpful, uh, financial tool in real estate. And when rates go up, you know, in many ways, certain types of real estate, industrial in particular, can often be valued similarly to a bond because it's a long term cash flow that just gets kind of revalued, uh, as interest rates go up. So rising interest rates, high interest rates, not great for real estate. That being said, we went through a period of time of zero almost interest rates, and that, uh, obviously made every deal look great. It's really hard, you have to try really hard to make a big mistake when, um, your cost of debt is zero. Um, and so, yes, it provided all kinds of buffers for maybe deals that shouldn't have been done, maybe deals that were underwritten too aggressively, maybe developments that didn't really have the demand or the rental power that people thought, you know, low interest rates, which in real estate that translates into low cap rates, you know, that is, that cures all evils. Right? You can, you can fix a lot of mistakes with that. So we don't have that anymore. We're now back to really the old fashioned way of, um, successfully investing in real estate. And that is with very careful underwriting. Right now there's very little margin for error. And you are really counting on asset appreciation that is coming from income and cash flows that are growing, not because interest rates are going down. And that's the traditional way to. That's how I learned to invest in real estate. I mean everyone before the gfc, you know, that that's how it was done. And uh, and people did very well. So it's just kind of a back to basics type thing. Um, but as I mentioned earlier, knowing that rates were going to be higher for longer in our business is actually better than not knowing. Right. And the uncertainty, uh, is just really not a good thing for the industry in general and probably for the broader economy.

Speaker A: And it's, I think, easy to understand why. Because you talked earlier about you're modeling these and you're underwriting them. You need to put in some assumptions. And if there's a wide range of potential assumptions, that makes underwriting much more difficult.

Speaker B: Yes, it makes it much more difficult. And you know, there are different reasons why interest rates might be going up. One of them could be that the economy is doing super well and therefore rents are going to grow, you know, a lot. And so that's one bucket. But then you have the bucket that we have been fearing for the past couple of years, which is the stagflationary uh, scenario, which is obviously horrible for real estate. You're in a situation where your interest rates are not really supportive of what you're doing and you know, there's less demand, your rents are not growing. Um, and if it's, you know, an inflationary environment as well, then your expenses at the property level are also going up.

Speaker A: So if you're, if you're an investment manager, you're trying to generate outperformance. And we talked earlier about data becoming more readily available and in an increasingly competitive market, what do you think the best investors actually add value relative to their peers?

Speaker B: If you look at a lot of outperformance that occurred in the last cycle, it was very, uh, much attributed to um, being correct about certain sectors. A good example is industrial and logistics, that if you had a fund that was overallocated to industrial logistics, you automatically were outperforming. And while I don't see the next cycle being like that, I don't think it's just going to be, you know, sort of calling it with a sector. But um, data can really help you with that. As an example, um, you know, many alternative real estate sectors are now becoming much more institutional, much more popular, much more accepted by investors. A really great example right, uh, now is seniors housing. We've been investing in seniors housing for about 28 years, but there are a lot of newcomers to that space. That's a space where data, um, is obviously super supportive. The data is available. A lot of it's just demographic data that you can get from the government. That's a perfect example of where should you build a new and very modern seniors housing facility. Um, how many people in that market area are going to be turning, you know, call it 78 to 83 in the next five years. You know, all of that data is, is super valuable and super important. Other, you know, other things that real estate companies follow that are less specifically real estate oriented. Moving vans. Right. Uh, where, where are moving vans being hired and where are they going to, you know, people having a new uh, wi fi subscription. Something about where people are uh, having to register that they've moved. Like coders. You can track where coders are coding that can tell you where young people are moving. There's all kinds of extremely interesting non real estate data. It used to be that we tracked um, square footage, we tracked new construction, we might even have tracked, you know, job growth in the city. But that was it. It was very kind of Basic nuts and bolts of real estate type data. And now there's so much data out there. And I think, you know, to your question of how does someone outperform, in a way you're, you're outperforming by thinking of what is the data that's going to tell me that this area that is, you know, not booming is going to be booming. And you know, we always use internally the example of, you know, what could we have known 25 years ago that would have told us that Nashville would be what it is today versus what it was 25 years ago? And if we had known what those things were to look for, um, we would have bought every acre of land in and around Nashville. Right. So it's that in a way you kind of do have to. We've done several, um, exercises like this use cases using uh, data and AI of back testing. Like what were the signals that this was happening? And that's really, I think going to become in the future much more of a kind of routine way of assessing a market and putting together a strategy.

Speaker A: Uh, so when you break the market down by sector today, residential, industrial, retail, and you talked about office already, but where do you see the biggest gaps between perception and reality?

Speaker B: Retail is probably where there's still a big perception gap. And not of those in the know, but, um, but more broadly in, in the market. And if you think about it, retail was office before office was office. Right. Um, you know, retail was the death of the mall is constantly being talked about. You know, the uh, rise of E commerce. No one was ever going to go into a store again. None of that came to fruition. E commerce continues to grow, People continue to go into stores, people order things online, they return them to the store and they generally end up leaving, having spent somewhere between 1.2, 1.3 times the cost of the item that they went to return. That, that's just human nature. And um, so retail is actually doing a lot better than anyone would have thought. You know, call it at the very worst in, you know, early 2020. But even before that, people are using retail differently. You see less, you know, like new department stores, but you see a lot more experiential type retail. Lots of different restaurant formats. You know, people are wanting kind of a, uh, one stop shop entertainment. I'm going to grab something to eat, I need to return something, I need to run to whole foods, like that type of a, you know, the outing of the day. Right. And retailers are, you know, there was a lot of consolidation in retail. A Lot of stores were closed, a lot of retailers didn't survive. But those that did are really, um, you know, quite strong. And we're starting to see some development finally in that space. It had been many, many years with little to no development in the space and in particular in the grocery anch space. And I think the other thing that was a misconception was that, you know, grocery anchor retail is one of those, again, um, unsexy kind of investments, that it's just great cash flow. And people have made fortunes with, you know, grocery anchored retail for, for many, many years. When it started to become popular to have your groceries delivered and to do, you know, sort of online shopping, which, you know, many people do, there was this thought that, oh no, all the grocers are going to close. What are we going to do with all these giant stores? Well, the reality is that, you know, most of the time if you do an online grocery, uh, order, that order is fulfilled in the actual physical store. It's very rarely fulfilled in some random warehouse 30 miles away. So, um, again, it's. People are using the space differently, they're doing different things. But, you know, retail definitely is much more vibrant than I think the average person thinks. And if you think about it, you know, in 2020, that would have seemed pretty improbable.

Speaker A: Uh, the other theme that is commonly talked about is the housing shortage. How do you think about long term supply and demand in residential real estate, especially given affordability constraints?

Speaker B: It's definitely an issue. Um, I do have some hope now that there is at least more of a public conversation around the fact that it's a supply issue. You know, the affordability, uh, issue cannot be solved without more supply. It's just not possible. And you know, there's so much discussion around, you know, rent regulation in different parts of the country. And if you look around the world, when you see, you know, rent regulation, you see shortages of housing. It's, that's just kind of how it works. And so I do feel like there's more conversation about that and I do hope that there's a solution there. It really has to be a combination of the private sector and the government in order to make it easier for people to build. And, um, you know, there are many municipalities that have just completely banned new multifamily development and some of it is coming from a really good place. And it makes sense that the schools are overcrowded and so they don't want to overcrowd the schools more. But that's not a solution. Everyone needs Someplace to live. And so we need to focus more on, okay, well, maybe we need to do something with the schools. So people are trying to solve for problems with a bit of a zero sum approach. And you know, it just doesn't work. And you know, the, the affordability issue is really acute in some areas where um, you know, the general rule of thumb is you don't want to spend more than 30% of your income on housing. And even that's a stretch for many people because everything else has gotten so much more expensive. But there are cities where people are routinely spending 40, 45%, you know, of their, of their, um, income on housing. And that's just basic housing that doesn't include, you know, your electric bill and all of that. It is, uh, a problem. It's a problem really almost everywhere in the world that, where there's just not enough housing. And you know, similarly I mentioned seniors housing. There's not enough seniors housing for the aging baby boomers in this country. And you know, people are able to stay at home longer. People are healthier. You know, even as recently as maybe 10 years ago, the average age entering, um, a seniors project in our portfolio, or really the industry would be somewhere around 78 years old. And now it's, you know, 82, 83 something in that neighborhood. So people are staying home longer. But at some point, you know, most people need some level of, you know, even minor care, maybe just a reminder to take their medication or they need a little help in the shower. You know, they can still live, you know, pretty active lives, but maybe not at home in a two story house. It's just not, it's not safe. And it is a safety issue. And it's a basic, it's a need. And when a family is faced with having to really think constantly about the safety of a family member because they're older, frail and living alone, that's super stressful on everyone and on the whole system. And it's not like you can say, okay, well sorry, there are no vacancies, um, you have to stay in your two story house. It's kind of like, yeah, but grandma can't walk up and down the steps anymore. What are we going to do? So it has to be solved for. And you know, seniors housing is, it's changing in terms of, you know, what types of projects people are looking for, the types of amenities. People are living longer and therefore have more memory issues. So we need more memory care units in this country. You know, I would say the housing. My point is the housing Affordability and supply issues are not just related to kind of, you know, typical housing for, uh, a family. It really spans the generation.

Speaker A: And a lot of it comes down to basic economics. Not enough supply for the demand. And that creates pricing issues.

Speaker B: And especially if you think about seniors, you know, in this country in particular, where you had this huge population surgeon, you know, with the baby boomers, and the baby boomers are starting to turn 80. And so this is something that literally for 80 years we have known that this was going to happen and have insult for it. And of course, when the baby boomers were born, I don't know exactly what life expectancy was then, but it was probably at least 10 years less than it is now.

Speaker A: The other, uh, area that's getting a lot of attention are data centers. What are the biggest risks in that space that investors may be underestimating?

Speaker B: Well, one very large risk is that there's a growing amount of NIMBYism in data, uh, center construction. And what we have seen is that it used to be the number one kind of obstacle to getting a new data center built was procuring the power. And power is still definitely an issue. But now the number one obstacle in the US is NIMBYism. And so in a way, um, maybe there's some positive here that some of the nibbyism that was so focused on housing, in particular multifamily housing, has now shifted over to data centers. I don't know, maybe that frees up some capacity on the housing front. But I do think that that is definitely an issue in that there's a bit of a disconnect where, you know, I know people who don't want data centers built in their neighborhoods. It's, it's. I, I get it. But there are also people who are constantly clutching their phone and, you know, who have, you know, devices all over their house and who are asking chatgpt all kinds of questions all day. So there's, there's a disconnect between how people really want to live, what is practical. Now we have this amazing technology with AI that it's not just about being able to satisfy your curiosity 24 7, but it really could make a huge difference in curing certain diseases. And there's so many really positive, especially in the sciences, things that could happen with AI and it would really be a shame if that was somewhat thwarted because, you know, of the NIMBYism. Um, you know, I think there's also, uh, we're all learning about data centers at the same time. If you think about it. And there are, you know, real estate investors who are investing in data centers, a lot of infrastructure investors who are investing in data centers. The hyperscaler tech companies, they're investing tremendously in the sector. Um, so, you know, there's certainly an argument to be made that there's a concentration of, you know, capital being invested in one sector. Um, but I don't think we've ever, I know in my lifetime I haven't lived through anything this transformational. So I think it, it is something that, you know, you kind of have to see how, how it plays out, you know, in terms of risks around the technology and things changing. You know, you just don't really see those risks being as huge. There's, you know, kind of an evolution of how these things go. There was a time we started investing in data centers in, uh, 2013. And I remember then people would say the servers are going to get so small, they're going to be the size, you know, of an iPhone. So in those days, the idea behind really data centers was largely from, uh, everyday person perspective. It was about streaming movies and TV shows and then it became about working from home and then it became about AI. So it's one of these things where, yes, the technology is changing, but it's evolving because the uses are evolving and becoming more sophisticated.

Speaker A: Uh, with such strong demand for data centers, how do you think about the risk of overbuilding versus the risk that land and construction costs capture most of the upside?

Speaker B: Yeah, I mean, I don't see a huge risk in overbuilding, mostly because it is so difficult to build. You have to have many, many stars align around the right site, the right connectivity, the right power, the right energy cost, you know, water availability, NIMBYism. I, um, mean there's just so many stars that have to align that um, it's actually a very good governor on having excess supply. I think the other thing that some people are bumping up against is that you need a lot of financing to build these, you need financing to own these long term. And there's such a concentration in the hyperscalers that are most active that you start to get concentration of credit. And that's definitely something that will also be a governor on development.

Speaker A: How do you factor in scenarios like sticky inflation, slower growth, or even mild stagflation that you alluded to earlier when underwriting long duration real estate investments?

Speaker B: Inflation actually is not always a bad thing for real estate. Right? Your rents, your rents go up, the cost to develop goes up, making, you know, much higher barriers to Entry for more supply. So as a landlord, inflation is not necessarily a bad thing. If you have an environment, uh, potentially facing a stagflationary environment, that undermines the confidence in the, uh, entire system. And that's not good for anyone. It's not good for real estate. I mean, all you can do is to try to, you know, underwrite all kinds of different scenarios. And we're actually doing that now with all of our new acquisitions around the world. We're underwriting scenarios that kind of have the war in Iran going on a bit longer, oil prices causing inflationary shocks, and you have your downside scenario, and you look at your downside scenario and say, okay, well, this isn't the outcome I'm hoping for, but this is an okay outcome if this all happens. So I think you just have to be eyes wide open, you know, in terms of, you know, you mentioned that the past couple years, you know, chaos has become much more of the norm. And, you know, maybe there's some argument to be made that maybe that's going to be what the next 10 years look like. Maybe just the geopolitical situation, everything is moving faster. Maybe, maybe that's just kind of how we always have to underwrite going forward that, you know, there could be some exogenous event. And that's why, again, back to, you know, when I was junior and not understanding why, you know, tweaking a rental growth rate by 50 basis points, you know, was so important. It's, it's back to, you know, kind of, um, really stressing a model and your assumptions and then at the end saying, okay, it's not a home run, but, you know, it's fine not losing money, you know, that. That's why you have to really be super thoughtful.

Speaker A: I think personal experience is also very valuable. So you've lived through the SNL crisis, the GFC and today's adjustment. What do you learn about risk by living through crises that you simply can't learn from textbooks?

Speaker B: Everything. So I think there's no way that you can really learn that in a book. It's life experience for sure. It's also baggage. There's also a little bit of ptsd. I think I still carry a little bit of a bit of that around with me from the gfc. But what I really noticed in this most recent interest rate driven, um, repricing that began in mid-22, and I actually started to notice it a bit in very early Covid, right when we kind of put the brakes on everything, there was a little bit of an inertia in the system of like, well, you know, this deal is, uh, underway. You know, let's just, just, let's just keep going. Everything's going to be fine. And if m. You've been through one of those periods, and in particular if you were a decision maker during one of those periods, you have a muscle memory that interrupts that inertia and that, you know, tells you, okay, you know, all bets are off the table right now. Like, we are not. We are pencils down on everything. And it's interesting, especially, you know, early Covid. That was the approach that we took because we had no idea what was going to happen. And then ultimately, you know, we started buying because the markets were doing fine in, in real estate. We made some excellent investments when very few people had capital or were willing to spend their capital. So it doesn't mean that you automatically shift into a. I'm too afraid to do anything and I'm just gonna sit on the sidelines. But you do have to have that instinct to just stop and to just kind of. And I feel like that, you know, in, in the 22. In, uh, particular crisis, I felt like that was very much my job of like, okay, I've seen this movie before. And the thing that was really interesting in the lead up from. If you think back, you know, from 2008 to, uh, 2022, you had many, many people either coming into 2020 or 2022 who, their entire career, they could be pretty senior, they could be managing directors. At that point, their entire career, they had never seen one of those really serious events. They're, you know, little hiccups here and there. Fine. But, you know, given kind of the demographics in the industry, uh, uh, bull market, it was. There were very few people from a percentage perspective who had been decision makers during the gfc. And that, you know, being a decision maker, you know, that carries with it definitely a different set of learnings than, you know, executing on someone else's decisions. So I, I have to say, if I were to be talking with, you know, someone who was just entering the business, I would wish for them a crisis early in their career. Right. Get a job, you have less to lose. That's how I was in the SNL crisis. I was, you know, had three or four years of experience, maybe a tiny bit more. You know, I had nothing to lose. I could take risks. I did. I took a job doing workouts, um, which I learned more about basic real estate and structuring and lending, doing loan workouts and foreclosures than I learned doing anything else. But I was at a point in my career where it was all upside for me that, that crisis. And I also think that if you have a crisis early in your career, those skills that you learn, they stay with you your entire career. Um, and you know, on the one hand, people who had a 12 or 13 year run of just everything was great. And you know, you could understand how people thought they were like real estate geniuses. Right. Because every deal was going super well. And uh, that, you know, that's not always the best thing. It's certainly the most fun, but it's not going to give you all the skills that you need.

Speaker A: Yeah. Because we know there are cycles and some of them are, can be extended, but there are cycles. So if you just happen to start during a, uh, bull run and you gain confidence and potentially leverage over time because of that confidence, you could experience a really painful experience. And then after that you're a different investor. So you just hope, like you said, it happens early so you have less to lose, so you get the lesson with less cost. So from your vantage point today, what mistakes do you see newer investors repeating that feel very familiar to those who have lived through some of these cycles that we described?

Speaker B: Many institutional investors are still on the sidelines and um, some of it is that they don't have much capital, but some of it is the uncertainty. And you know, I say right now I've never seen less FOMO in the real estate institutional markets that, you know, large institutional investors, they just don't feel like they're missing out on anything by not, you know, being in the game, not investing into this cycle. And while, you know, returns have definitely been, you know, muted for the past couple of years, they're positive. There's positive total returns, there's positive appreciation even in office. And yet people I think are so worried about not investing at the exact right time that they're missing the bottom. Ish. Right. I mean the bottom is gone, right? The bottom. In my view, the bottom hit, you know, mid 24. And while it certainly hasn't been this huge, uh, like up into the right kind of recovery, it's been a recovery and a lot of people have missed out on that and missed out on being in the market and investing during a period of time where they're just, just isn't as much capital. It's just a little bit less competitive.

Speaker A: Oh, Kathy, this has been a really fun conversation. I appreciate you sharing all your experiences and insights, uh, with me and our audience thank you for joining us today.

Speaker B: Thank you.

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