#315 - Dean Adler - Co-Founder @ Lubert-Adler Partners - Current Market Conditions, Private Credit, Pref Equity for the Win, Office, and Their Best Deal of All Time

Chris Powers: Dean, welcome to the show today. Thank you for joining me. 

Dean Adler: Thank you, Chris. 

Chris Powers: I will come out hot with 10-year treasuries ripping up.

I've listened to you speak three or four times, and I will throw a broad question out there: what are you thinking right now? 

Dean Adler: We have a capital market environment that doesn't turn well, and in the real estate space, even though fundamentals are relatively pretty good, except for office where there's been some natural structural obsolescence, we are, the industry is in disarray because for 20 years, we lived in an environment where interest rates were low and whenever you would either buy or develop, Your yield exceeded interest rates and cap rates and today you're in the negative arbitrage situation.

The interest and cap rates are more significant than what you would buy or develop real estate. So things have turned upside down, and the second transformational component assumes that many groups or owners are out of 3 or 4%, 4 or 5 years ago. Now their loans come up, and because of the increase of the rate from 0 to 5 and a half, the short-term SOFR rate, they now have to refinance at 8 or 9%, Assuming they don't want to lock in long when their current loan was 4%, and so you can't borrow enough money based on the higher debt service to pay off your old loan.

Then, the final factor is the usual source of lenders; the banks, CMBS, and even the Wall Street debt funds are pretty much all side-lined right now because of this capital market upheaval, so even if you could borrow other than Fannie and Freddie, the sources of liquidity have been significantly diminished.

Chris Powers: You've been through multiple cycles. Is there one that you could compare this one to? If we went back to 08 an l, many folks might say, well, the banks take better advantage. They're less levered. It's different this time. Are there similarities, or is this very different? 

Dean Adler: The similarity is that in 2008, the capital market meltdown, no one had money to lend.

And even if your banks are more vital today, they're not lending because of the anticipation of taking, you know, revaluation of their assets and higher regulations on banks today. So, very similar to that, you don't have the liquidity from the capital markets. The difference and why this period may be one of the most significant periods of new investing is in 2008 and 09; it shattered the whole system.

There was no investment rate, and many assets decreased in value because people lost jobs. There was no demand; rents went down. Here is a different period, in 2023, put aside office. Fundamentals are okay. They're not roaring, you know, on the multifamily front. You know, rents are not going up 5 10%.

They're flat, they're going down. And there's new supply coming in, but it'll get absorbed. There's nothing new that will get built. Industrial still is okay. Grocery stores are excellent, with open-air centers, not necessarily malls. The hotel industry peaked a little last year post-pandemic, but it's relatively stable.

So it's interesting here because you have a period of capital market illiquidity, but yet fundamentals are okay. 

Chris Powers: And if we go to all the loans coming due, I mean, the obvious is your loans come and due, you either need to refinance it or pay it off. Assuming that this kind of tidal wave is coming over the next few years if you had to have some insight into how that might play out, is this going to be many people dropping deals?

Is this going to be banks extending and pretending? How do you think banks will think about this, as these are coming up for renewal? 

Dean Adler: Yeah. So, first of all, the goal of any borrower is to extend, extend, and extend till 2025. Okay? 

Chris Powers: Stay alive till 25. 

Dean Adler: Stay alive to 25, where you are hoping 24 months from now.

The short-term rates go down to 2.5, not 5.5. You typically borrow 200, 250 over. We're never going to; I don't believe we will ever see the period of the zero interest rates that we lived, that we had for about seven years; that's artificial. But could we return to an environment where the average borrowing rate is four and a half to five, the rate I've lived most of my career?

Yes, you can make things work there. But you're not; you may not see that for 18 to 24 months. So the 1st goal is how do I push out a few years? So when your loan comes up, the 1st thing you have to say is that the best lender you have is your existing one, so if you don't have to find new capital, pay the money.

Pay them off. If you can get a new lender to extend, that's goal number one: get two more years, whatever it costs. But even to grow, you may have to buy a new SOFR cap. It'll be at double the rate. The lender may want to pay down for you to extend. You'll need gap financing, but one idea is to go along with the rates.

Six and a quarter, not 9, but often, people want to avoid falling alone and lock up their assets for ten more years. So they have to go short. The short-term rates are high, so you're going to have a lot of situations where I'll call the gap refinancing opportunity, which is, let's say, the 40 million loan before, now it's 30 million, what you could get, but we have to pay it out, so you need 10 million.

You could go to your investors to get it, but they're typically not handing it out. So you've got to go to the world of borrowing money from Preferred Equity or Mezzanine. It may cost you 15%, but that 15 percent may only be for 2.5 years, and you may bite the bullet. To get you to 2025 because you can't sell the property today, remember, if you go to sell your property, the new buyer will try to buy your asset with a 9% debt rate at 55%.

The new buyers need help to make their numbers work. For the sellers to get their price, save a total standstill on the sale market. You have a complete halt on new development. Tell me why people are building apartments at five and a half before, going out three years to five and a half, yielding six percent.

Why would you build new to five and a half and six if my floating rate debt is eight or nine? It would help if you found out where your cap rate is. You're in a negative arbitrage position, meaning activity will shut off until you move into the capital markets. 

Chris Powers: I want to describe the situation and hear your thoughts.

So many folks think I have locked in low fixed-rate debt in the high threes and low fours. If a bank has that on their balance sheet, that's probably not good for them. It's suitable for the borrower but could be better for the bank. Covenants overlooked for the last 20 years will start making their way. If a bank can foreclose on somebody that busts a covenant or at least create a way for a pay down, many of these low fixed rate loans become actual issues for the borrowers.

What they thought was their best asset might become a thorn in their side. What do you think about that? 

Dean Adler: The banks have so many fundamental issues they have to play around in the 3 to 4 percent loan. It's different from where their workforce should be. So, yes, could they play with you on that? Yes, the truth is, there are more significant issues than having loans coming due.

They can't get refinanced. And what do you do about that? Because that's a real issue. So, will the 3 or 4 percent gain people will banks be renegotiating? Will you break a covenant? It may be, but that's not a big business for the banks, and I don't think they're; this is a way for them to make money.

They have to deal with what they own in their books. Legacy assets, and they have to spend their time cleaning up legacy assets right now. And so, there are other sources. The banks are not that Machiavellian, maybe wrong. I don't think. And I will focus on those things they should focus on.

So, there isn't a significant risk. 

Chris Powers: What needs to happen to start seeing a normalized market? Is it just pricing coming into check and deals penciling, or are there other factors that need to occur for a call to normalize and come out of turmoil and chaos? 

Dean Adler: The Fed has to be convinced. They've tamed inflation and reached a point that will not happen this year.

I'll gently lower the rates because you have two situations now: the rates went up, and the spreads ballooned. Looking back at spaces in 2008, it's much narrower for another period. You had a double whammy here. You had the short-term rates going from zero to five and a half.

And yet the spread's ballooning. And I mean, it's unbelievable. You'll get to five and a half, and then you want to borrow for a standard loan. It could be 400 over. But five and a half or 400 over, that's nine and a half. By paying your cap rates, you're ten and a half. And you're only borrowing 55%.

So the other 45, if you couldn't find that equity, will be much more expensive because of lower debt and lower returns. Yeah, that's why out there, the most preferred asset class for investment is in preferred equity, private credit, and the whole private credit area is just amazing right now.

Look, in any investment business, we talk about risk-return, and if in real estate, you say, okay, the lowest risk is senior loans, then maybe preferred, then core assets, then core plus, then value add, then opportunistic, then development. You go up a curve, a risk-return, and that's a standard setting.

You're, you know if you go through development deals, the only reason you do them is you think that the returns are highest. But you also take the highest risk. The dream of any investor, I don't care if it's real estate equities, is to seek symmetrical returns. And what do I mean by a balanced return?

Is there a place on that graph where I'll call the upper left-hand corner where you can get equity-like returns? With the lower risk, that is the dream investment. Can I find a vehicle? I could get equity-like returns in the upper left-hand corner of the graph with the lowest risk, and I've been investing for 40 years.

And I've rarely seen that scenario very well; guess what? Today, you see that. So, let's go back to the original model. We said someone had a 40M dollar loan; probably, the asset was worth 60 M. They can only borrow 30M today. It would help if you had a 10 million dollar slug. So that 10M dollar slug is between 60 and 75 percent of today's value, not 22's, during a period where you could come in at today's value, which is lower, and go between 60 and 75%.

What's different today is what you can charge for that piece. So people are doing senior loans at 10, you can set 13, 14, or 15 percent for that piece. So one could earn 15% between 60 and 75%. So your risk is lower; I'd rather be at 60 to 75 than 75 to 100. See risk lower from getting equity returns.

Okay? That is the ideal scenario. Okay? Now, you may say, but Dean, you know what, you know, if you get it for two years, that's fine. You got a little better return for two years. But as things cycle through, reinvestment risk in 2 years. So it's an excellent little ditch, but it's very short-term.

The key to the strategy is what I just said: the short term. How do you create an investment instrument between 60 and 75 that has a duration for that? We will carve 5-year and 10-year papers if you could write them. Okay, that piece of paper you're creating as a 13 and a half percent of 14 base rent.

Base return and the duration give it a lot of value because if someone wants to pay you off in 3 years because of the time, you have a lot of upside in the duration. So we're focused on, in the multifamily space, taking that preferred linking it to 10-year Fannie or Freddie paper. 

We could get 13.5 percent for the next three years. If rates ultimately come down, I have six years of yield maintenance to sell. You could prop that to an 18, 19 percent rate return by entering today's preferred equity position. So the key is not just to play private credit preferred equity. It's what asset you play in, and number two, how do you create more of a longer-term duration to just not a stock gap?

And that is the goal for what I think, you know, the people who do well today have to have that mindset, not just to trade in and out because the trade in and out sounds reasonable for 18 months, but if they pay off and that's all it's for. 

Chris Powers: And I realize it's all just a negotiation, but is there a reason you all might be able to get 5 or 10, and there will be other groups signing for 18 months or two years?

Are you just asking for 10, or is there something else?

Dean Adler: No, that may be borrowers who are saying if I float the rates eight and a half, okay, or nine, the ten years with the 10-year treasury paper, maybe six and a quarter. Okay. So, even though it's not great, I want to lock up my real estate on one on return.

Other people may just be mad. I want to extend and get me to 2025, which is excellent when the rates drop, and I could sell my position then so that you know if there is an ability to pre-pay you. You have to put in bells and whistles in a shorter period. How do you structure it to get paid for the short duration of where you're putting your money, and that's where the artist is?

So you get more duration or get paid for making someone pay you off early. 

Chris Powers: Are you seeing, like, at LooperDaddler? Are you all raising a fund dedicated to that? Are you seeing folks who had raised equity funds, rewriting their docs, and now allowing them to enter the private credit space?

How is this going to form up?

Dean Adler: If I think you had equity funds and could get a 15 percent rate return at a lower risk, it qualifies for the equity funds. You know, the equity funds, whether you're preferred equity or common equity, you're still equity. And what's wrong with trying to get a 15 percent rate return with lower risk in your equity funds?

Number 2, we are creating our private credit pool, but the key for equity groups like myself is. We may underwrite equity sufficiently, but every equity player thinks they can be a preferred equity or lender by switching a switch, and you can't. So, we brought in some of the best capital market people.

We brought it into our firm to combine the capital market expertise of people doing it daily with a common equity approach that we've had or a preferred equity approach, which has been our business for five years. And it's the combination of the two that makes for what I'll call a strong pool of capital, and number 2, you've got to do it.

So you're creating a business longer term to create private credit for two years is not a business. You want to be into it. So you've got to be able to take advantage of the situation, but then, as the industry evolves, continue the business. Because anytime you invest in business, you're looking to build a business, not just a trade.

Chris Powers: Okay, let's role-play a little bit. I come to you, I say, Dean, I've got a multifamily deal I bought in 21. I'm getting squeezed. And we'll go back to that situation you just described. And I'm going to need some private credit. What are you asking me? How are you vetting who you'll give money to and what situations you want to put money into?

Because we can assume there'll be a lot, and you'll only do a few of them.

Dean Adler: You got it. So, number one, the real estate, the real estate business, it all starts with the people. Okay, borrowers who are high-quality organizations and people who've respected their partners over the years, who are in it for the long term and not syndication, who have their own money behind it, and who are not looking to cash out.

I would never do a preferred and let someone cash it out. Yeah, that's a no for me. So, it all starts with the quality of the borrower. And here's the beauty for us. In the C M B S world or the Wall Street world, they make it in a mezzanine with the U C C or C M B S type product. And as soon as they make that investment, they can syndicate; they take it off their books.

And so, therefore, the borrower is going to deal with some service or some 26-year-old kid, uh, some service, or they don't even know. And if they ever have an issue 3 or 4 years, they're dealing with; there's no relationship point to where the relationship business and so we're going to keep these positions.

In our shop on the book, old-fashioned real estate money so that the borrower or the common equity will understand that the people on the phone are seeing them today. The people that I see in 3 years. And for me, that's been critical. I've had a big problem with the banks and not CMBS because if I work with Wells Fargo and they make me the loan, they will hold it.

And if there's ever bumps in the road. We could sit down and work things through if it was C, M, B, S, and the circuses there; they have no relationship. You have a goal to make your life miserable for 18 months to the fee business and then move it along. They're not in the industry, and real estate is a long-term game.

So that's step 1. Step 2 is the form of what I'll call the recap capital mezzanine, which most Wall Street people like to use. It's three years, 15%, get a UCC. And if your business plan doesn't work. And 90 days, they could own it. Well, if I'm a borrower, it's a little scary. Don't love them, and number 2, if you don't have cash flow for two years, you suddenly owe this mezzanine 1.3, 1.4, 5 times. So, the common equity becomes a zero coupon bond. So those positions are out there. Well, we take a different approach. We treat our money as follows. I call it common equity with a liquidation preference. And what do I mean? Let's assume the loan is 40 million, the preferred is 10, and the common equity is 10.

So, hey, we have 10 million up. We're going to go 50 50 on all cash flow. I'm going to allow leakage to the borrower as a preferred participant. So, that induces the borrower to keep infusing capital below me. They can only attract capital if they have a chance to get cash flow and there is zero coupon bond.

They'll be subordinate to mine. So we go 50-50 cash flow, let's some leakage go through, and ultimately, when there's a refinance or a sale, we say hey, as long as the deal did better than 12 and f IRR, You keep your 50-50. However, in the event of Celeste, we will have a liquidation preference Of our capital plus 12 and a half, then Chris, you would say to me, Dean, the common equity, they give you this preference.

What did they get in return? And I give them a more extensive promotion on my money. So, I said, instead, we found 50-50. If I have a liquidation preference of my money in 12 and a half, I'll take a 20 percent kicker above that on the profits. I'll give up more upside in exchange for downside protection.

But it's preferred equity, so if they don't hit their targets in 3 years, I can't just UCC them. And here's the second big point. If I have quality borrows and believe in the asset, I want to work with that borrower because we could bring value creation skill set to make it better for all of us.

If I'm a mezzanine player, you cannot deal with the borrower's lender liability. Stay away, and I'm a lender. I want to prefer widespread equity with the liberation preference so I can help build value with the borrower, and here's the exciting statement: years ago, they told me to invest in a distressed debt fund to do mezzanine pieces in Europe.

Okay, and the group did do it, but the group I liked a lot, and they had a team in Europe. So, I invested. So they go ahead, and they buy into the debt. They're buying it 60, 70 percent of value, and they believe a few billion dollars of this. They buy their position, and then a year later, they sell all the loans and earn a 20 percent IRR.

So the head of that company called me and said, Hey, Dean, are you available for round two? You know, we gave you a 20 percent IRR in round one. And I said, no, you did a terrible job because I got a 1.2 multiple. I'm paying ordinary income tax. I got a 20 IRR but a 1.2 multiple. You should have been accessing this real estate at a great access point, 75% of the value. 

It would help if you worked overtime to take your advantageous position, work with the borrowers, and then, upon the recovery, add value creation skills and improve the assets to get the best of the world. You get in at a lower cost basis. And you ride the upside through value creation skills; I would much rather earn a 17 IRR and a 2.2 multiple over five years than a 20 IRR with a 1.2 equity multiple.

So one of the reasons we do the preferred with our borrowers is that we want the advantageous cost advantage of between 60 and 75%. But I want to work with the borrowers that pound things of recovery. I want to work with them and share part of that upside. So that goes back to my same piece of asymmetrical risk.

If I could be on a lower cost basis today to protect my downside, and I could help ride the recovery up on the upside, can I get equity-like returns in the 60 to 75%, and you can do it most advantageously through a preferred equity concept, which has been our business. Then, the strict mezzanine, and here's the last piece.

Everyone loves secondary's out there. Secondary, secondary, secondary. So, you know, the institutions invest in the funds. If they don't like it for five, they could go and have a secondary. And people, brothers, sisters, and cousins, are all raising secondary funds, so when most people do their preferred equity pieces.

They put their investments in, then they go on to the next deal, and then they go on to the next sale, which I'll call the family and friends. The individual marketplace has no secondary out there. Like the Berry's for Blackstone, there's no secondary's for those people. Okay, they're stuck.

Good, bad, or indifferent, they're stuck. When we do a preferred equity into a deal, remember my example: 40th, senior, 10 of our preferred, 10 of theirs. Once you're in and you understand the asset better, you have an opportunity to approach the limited partners from the old, you know, from the former deal and say, by the way, we're thrilled to have the end, and we're going to work this over the next 3 to 5 years.

And I hope we all win but in the unlikely event. You want some liquidity today, you know, there's 35, 40 cents on the dollar. So the beauty of these preferred, let's say, you're initially marketing at a 15-way return. You have a secondary opportunity over time. If you can value the asset, you can't buy it.

You're not going to make it obligatory. People have the right to stay in, but if they don't, you could create a secondary business on these preferred. And they have what I call a second part of the app. And so to me. It's not anything treacherous or anything. They can stay in, but you find it for many reasons.

People say I don't know how I got that deal in the 1st place. I don't even know what the property is, but someone got me in, and yes, my life changed. I want some liquidity, and even the, you know, there are better markets than this. We'll take the offer and move on. So you always have to be thinking in this business of the assets that, you know, best are the ones you need to try to capitalize on. And when you're inside support where I already have an investment. Versus being on the outside, that's good, and that offers more opportunity. So, you have to keep thinking through the different components. And how do you get out? My job is to get outsized returns while always mitigating the risk.

That is our total risk. 

Chris Powers: If I come to you and you say, okay, I'm in your deal. Should I have already gone to the common equity that I started with in my lender and said, I'm trying to do this deal and get their permission, or do I get your permission first that you're in, and then I get consent from the parties that are already in?

Dean Adler: Well, make this easy. First of all, the lender wants to pay them. So they'll, they love this. Okay. Especially if it's preferred and not matched. There needs to be an interpreter agreement. And we structured ours as common equity with a liquidation preference. We're the dream of the lender. How do we deal with the limits?

So the limits can say, oh, my God, a 15 percent piece of paper is paying down the debt. I'm behind 15 percent. I wouldn't like it. And by the way, do you know how to deal with that? You give everyone the right to co-invest on the same terms. So, to the limits, you want half the action?

Feel free to write your check; I get the same terms. So, as long as you provide the existing limited partner base with the same right to invest, that's fair. And we are happy as long as we control these half the piece. We're delighted for the business to invest in these come along, and to me, that takes away the conflict as long as people know they have the right to do what we're doing.

They're on board, and if you don't give them the right, they can object, and then it gets ugly forever, not for us. We're already out of there. The right to bring people along is the best way to deal with that upfront because everyone has the same opportunity to participate.

Chris Powers: Okay, I want to move to a little more discussion on asset classes, and I'll start with the big one in the room.

Now I come to you, and I say, I got a busted office deal, which we can put in its category. Now, with multi, at least, you're probably thinking. Yes, some people are always going to live here. It is a market office that is different. Let's start with How are you thinking about the office?

And I know there are different types of offices and classes, but when I say office, what do you say? 

Dean Adler: Today, it's a challenging asset class to evaluate. There needs to be more transparency and certainty. And I'll go through that in a minute. And because of those factors, it's a difficult place for us to play in.

So, for example, a building may be 90 percent leased today, 95, but when you walk the building floors, you see only half the space occupied. So, even though you may have an eight-year wall, where that's the average term of the rest of the building, you're sitting there and saying, what's the likelihood of these tenants renewing?

And if they're only utilizing half their space, how do you underwrite that? Okay, so number one, until we have greater transparency, how many days a week people come back to work? If people only return to work three days a week, you need half your space. Why are you going to build out all these fancy offices?

They sit empty half the time, so we need more transparency to make that call. You could argue that Europe is substantially back in occupying its office space. So it's time for the US to fall that way, but I don't know. So, it is tough to underwrite with conviction, and many other places exist to make money today. Do I need to take that risk? Number 2. You're very unfriendly capital markets. You're going to need more than buy and get financing. Now, what you could do is, if it goes back to the lender like I said, your best lender is your existing lender.

So you cut a deal with that lender and take back the paper for five years. Number three, and we'll say this. The office is not going away. The number of offices may be going away, but the office itself will still have people working and going to the office. So, you're going to tend to the better buildings, to survive the buildings, you know, get crushed.

There's probably no room for that, but there will be office space and office tenants. It's just not at the level we've had in all these years. So, you know, with someone or some groups make money in office. Yeah, okay, you know that they'll follow through the next five years and come out the other end, but there's another Chris fundamental mispricing of office, and I've been talking about this for 40 years.

No one seems to listen to me. I will articulate it again in multifamily and industrial and retail and hotel. You take a multiple of the net operating income. So if you have a 10 million net operating income, and it's a 15 times multiple, 12 times multiple, the property is worth 120 million, and the net active income is after reserve.

So if I have 10 million of NOI, I get 10 million to pay my bills. Okay, so the cap rate is really off of net cash flow in the asset classes. I articulate the office is entirely different. So, if you have 10M of NOI, but you have tenants rolling every two years, the level of 10 allowance and leasing commissions.

Soak up your cash flow. So, even though your NOI was 10 million, your average net cash flow is 7 million. Okay. Tell me why The business for the last 30 or 40 years was not doing that 12 months month 7 million was to be 84 million versus 120 million. There has been a massive disconnect between net cash flow and NOI, and now the argument must be, well, the ten allowance you put in, you'll get higher and higher rents.

So, you get higher rents as you do the annual tenant allowance and the leasing commission. So you were creating value on the top line by putting in that 3 million a year below. I'll make an argument today that whoever's putting that money in today, you probably, unless you're in an extraordinary market, you know, you're Miami or, you know, just, or you're the best of the best that the bottom line 3 million is almost an annual expense.

To stay even, and if it's an annual expense, you have to start capitalizing net cash flow and not NOI, which is a differential of 400 to 500 base points of the cap rate. Once the industry sees it like I do, I can only pay bills of NOI in the office. Because my below-the-line is so high, you must capitalize cash net cash, not NOI, to pay your bills.

So you have that, and it will be challenging. You have to burn that point because I don't think the 10 miles of leasing commission. In a market of access, supply everywhere will mean higher rents. It's going to be flat rents. So, if you're going to have flat rents, you must treat it like annual expenditures.

And that's why even if you go to the public markets and look at companies and people, you do a multiple EBITDA. There's a big difference between various EBITDAs where the capital expenditures below the line represent 10 percent of EBITDA. But there are plenty of companies. That below-the-line could be 40 percent of EBITDA.

So, you know, why aren't I doing it? Not at EBITDA, but again, a net cash flow to multiple. So, the office building market has its structural impediments. How many days could people come to work, and what is the impact on supply? There are some rental adjustments. The whole nature of buying office buildings has to shift from a multiple of NOI to a multiple of net cash flow, which will be significant.

Once it starts adjusting that way, you may start looking at it, but until they modify it, you can only buy these things once they change it. And finally, 1 of the benefit of real estate, whether it be multifamily, you know, the industrial, is the ability to generate some current yield. So if you're targeting a 15 IRR, getting 6, 7, 8 in everyday work and 8 percent on the back end is a nice balance.

And when you go through downturns, those rental assets rebounded the best, which is always in theory. When you go through a downturn, how do you make out? Versus what I call a back-ended asset. A back-ended asset is like an office. If you keep spending money yearly, you have no cash flow, so you're waiting for years five and six to sell it.

All your return is back end waiting. I am not fond of the balance between cash flow and appreciation in the office. It's to enter the rental asset class, which it still needs to. It also gives me one more thing: I'll call rental assets versus discretionary assets. A rental investment, you need a place to live, multifamily.

It would help if you had a place to shop for groceries. It would help if you had some industrial to distribute goods. It would help if you had some hotels. Well, there you have rental assets. People need a place to live, work, and shop. And there's a mental state. And what I found in the last downturn, 2008 or 09, was that Rental assets got hurt, but they rebounded.

Okay, and I'll call them necessity assets or non-discretionary assets. Now, let's go to the discretionary assets. Second homes, condos, you know, residential resorts, land. Okay. When the downturn occurred, there was no floor. They're discretionary. Who needs a second home? Okay. Yeah, condos are scary.

It's all in the back end. There's no cash flow. So when you go to sell, you make money if you're in a reasonable period. So, people in Miami make some money. People in New York with the condos, when you hit a tough market, they sit there. Okay. So it's all backend-weighted. So the level in the downturns, there are no floors to these.

Discretionary non-necessity assets. So, if you are a big believer that you've got to create a portfolio of 90 percent winners and avoid losers at all costs because the losers destroy you, you can't have 50 percent winners and 50 percent losers. It would help to have 90 percent winners and 10 percent break even.

That's a portfolio you need. That's called portfolio composition. If you believe in that, selecting the type of asset, rental assets versus discretionary, is a critical component of your investment thinking. 

Chris Powers: So Charlie Munger calls EBITDA bullshit earnings, and you're calling NOI to office buildings bullshit earnings.

Dean Adler: Yeah. Why not? 

Chris Powers: All right, somebody told me the other day, and you can fact-check this or know this, that 30 percent of most institutional capital has flown to the office and coastal markets. So, if you look at the total allocation to real estate from institutions, most of it sits in these office buildings.

It could be 30, maybe it's less. How will that impact this next cycle when all this institutional capital is in a troubled asset where it's hard to define what to do? How does that affect the market, or does it? 

Dean Adler: Does it impact the market? It affects the market on the institutions, and if their goal was they had to earn 7.5 percent to meet the pension fund needs, I think you have to accurately mark the assets by just going from NOY to net cash flows, let alone the lack of equity 2 or 3 years. There are no buyers, whether it be the banks or the institutions. There were only two asset classes in the early part of my career.

Interesting, it wasn't multifamily industrial. The big institutions threw up on that stuff. They thought that was stuff for scrappy people like me; they needed to put significant dollars out and go to offices and malls. And that was, you know, growing up in this business.

Those were the big institute powerhouses. We couldn't play there because the institutions were so big. The malls went first, and you had 1,200 malls in America; if 200 were left there, there are real malls. And even if some class malls are operating, it's just a matter of time. The day a landlord says they won't invest in that mall to buy a tenant in, it's over.

And so say 200, but the excellent fortress malls. Yeah, those are terrific. A few players also own them. I mean, Simon. There's an outstanding portfolio of fortress malls, you know, Westfield, that he sold them. So those assets to me are, you know, the 200 gold. We talked about 1000 of them that are gone. And you will have some of the same issues with the office.

You have significant holdings in office, really the Class A, A plus buildings. Yeah, they're getting the better ones. You visit New York City, Vanderbilt, 425 Park, and Hudson Yards. The best of the best get tenants, but that's only 10 percent of the stock. What are you doing all the rest of the stuff where you have a hot market in Miami, an office, or Steve Ross, create a new Class A office in West Palm Beach, you know, you got demand.

But I want to focus on looking at assets; we're leasing space, period. I don't care what it's; what are your demand generators? There could be oversupplying markets, but eventually, people absorb the supply. The most important thing is, and John Grey says it, great, be in the right neighborhood, have the right assets, and have the demand.

As a tailwind, not a headwind, we firmly believe that whatever we invest in, I don't want to be just a low-cost provider and play the rearrange the chairs on the ship, the Titanic, buying people's tenants over. You have to be in a market where you can see future demand. So you have to start with what the man meets: population growth, the right demographics, et cetera. 

So, demand is everything. And if you're in a market with declining demand, you'll never get that phone call and say anything. You don't want to answer when the phone rings; there's bad news. Okay. So, you want to be in a market that you could look out for 5 to 10 years, and there's demand or an asset class.

That's an essential part of how I look.

Chris Powers: Do you think there's an asset class that exists today that nobody knows is dying? You could say malls did it; you could say big box retail. It's dying a little; we could throw the office there. Is there something else? It could be this Airbnb world.

Is there something in your mind where you're like, this thing's dying, and nobody knows it yet?

Dean Adler: So, this is an area I need to learn about. I'm just experiencing it here in Philadelphia, the life science space. So, on the one hand, life science, health care, and biotech are growing good businesses.

So people went on a rampage and built life science buildings with big cost spaces. Whether it be in Boston, in the MIT area, which is great, San Diego, Philadelphia, outside of Penn, and you had this mad surge in the life science, but then you have to say, who are the fundamental tenants of life science? So you got the big pharmacies and the potent pharmaceuticals.

The problem is they're so strong. They could build their buildings. So why go with the developer when you can make your building? So we see that in Philadelphia right outside my window. Sparks Therapeutics starts as a tenant; they need a million square feet, and they're building it themselves.

Okay, and then you get the look, the venture capital ones, you know, the young biotech, and yeah, they're around, but they need credit. They only take up a little space. The big business was that biotech company that went public at a two or 3-billion-dollar valuation. They had a lot of capital, so they went, you know, when the building, they take the space.

And they were very vibrant. Well, when the market started reducing the value of those companies, they lost 80 percent of their value, and they're no longer viable for tenancy. So the demand for space, even though I'd like the whole concept of health care and growth and, and, you know, innovation, you know, Penn just had 2 of their great scientists, you know, get significant awards for their work during the pandemic.

There have been few Lisa Stein in the last ten months in Philadelphia. Okay, in our life science here, you see the slowdown everywhere. Is it going to continue the slowdown? I don't know. I like the space, but people got very exuberant about it. And you know, looking on the next 24, 36 months, you don't see the activity yet on that; by the way, when people said retail's dead, retail's not dead, it's just reconfiguring.

The e-commerce business is 15%. It's leveling off. Brick and mortar still does 85% of your sales growth rate. We're very active there at Albertsons. It has been solid as a rock, outdoor lifestyle centers where people don't have to go to the mall but can get something to eat, and some of the big boxes you talked about are integrating themselves into more liveable lifestyle centers.

They're here to stay. They're strong. People are still there. So interesting when we said retail was dead, you know, five years ago, it's not over. So it was adjusting, and what was more interesting than what the pandemic did was it required those retailers who needed an excellent online presence. They created the one by force, or they were out, and like in the grocery business, we don't have a vibrant online business, but to retain our customers, we had to provide a service that period in the store or your home where you could order and pick it up outside.

We had to elevate our game in a year, 5 or 7 years. So, the integration of brick-and-mortar and e-commerce became the buzzword, and also, you can see e-commerce. Ten saying, hey, I need to get some brick and mortars to round out our offering and probably in the grocery space, you know, even though it's nice to say, hey, I can order online to be in the e-commerce grocery business.

Like, Amazon is complicated. Just think about when you package goods. If you put raw meat next to ice cream and hot chicken, it's not easy for a 40 order to deliver and package. It's much more different than if I'm doing e-commerce on TVs, electronics, or books, where you could send them out from a warehouse.

Chris Powers: You own real estate and just said the hot word; I've heard you say this before, Albertsons. How is a prominent real estate fund involved with Albertsons? Please describe how you got into it and a little more about how owning that asset or a piece of it informs how you look at the world.

Dean Adler: I did not wake up in 2005 and say, we're real estate people, but this is very interesting. So, we created a business with my partner where we wanted to buy real estate, where the seller or the real estate owner should have advertised their business. We wanted to go on roads that others didn't travel on.

So where could we go to buy adaptably reused valuable real estate out of the public eye? So, we started a business of tracking distressed retailers. Who may go into bankruptcy but own practical real estate owner at long-term leases that were cheap, and, you know, they were retail, but people should have focused on what they hold in their real estate.

So, our 1st way was heckling jurors. They're going to bankruptcy. We buy a few empty stores. And then, so well located, you can release them to better credit retail. Okay, number 2, Levitt's Furniture. And no one's walked around saying, let's buy real estate. Levitt's wasn't out there marking beds and couches, not real estate.

So we were attracting them when we, they went to bankruptcy. We said, oh my God, they own some fantastic real estate right on the 494 in San Francisco, right on the highway. And Paramus, it was terrific. And another bankruptcy court. I didn't see Blackstone or Starwood or, you know, amazing organizations playing the game.

A bunch of scrappy entrepreneurs are playing in this game. And so we'd go into bankruptcy. We'd buy all the leverages. Now we own these boxes at 20 bucks a foot. We go to the credit retailers at 8, 10 dollars a foot rent. Or we split the packages, or we level the boxes. It was a real estate business of buying vacant parcels in an area where the sellers were in bankruptcy court and not hiring east still to get the maximum price, and we would buy these and redevelop them.

Then we went to Mervin's 276 locations in California, unique real estate. Some are connected malls, some are outside, you know, Mervin's and Irvine, and a $2 rent. When it was a 20 market, it was interesting that we teamed up with service, and my son, Mervin's, was an operating business. So, we had to have a group operating the business while we looked to maximize the real estate.

So, you look for those situations where Mervin's was not performing well, but the real estate was incredible. And in finding problems to maximize the business and real estate, we did. We did some of this in the shop, which is crazy; I say this 170 million square feet of buying distressed real estate from retailers and banks, 170 million square feet is the size of the Simon.

Returns are extraordinary. So, in 2005, we looked at this company called Albertson's. At that time, 600 stores, Albertsons. There was another 700-store package of Albertsons that wasn't available. We looked at Albertson's as a real estate play, 600 locations, that over time, we would vacate those locations and release to other grocers or other users.

And over time, liquidate the 600 stores and release them to more vibrant retailers. In their case, Hersh and I, since it was a much bigger deal, teamed up with Kimco, a public brief, and Jay Shonstein, an excellent operator of these types of stores. And we said, okay, the 600 stores, let's take the 1st 300. We'll close them and release them.

So, we sold a bunch to save a lot in San Francisco. We closed the ones in Florida, which overall may have been a mistake, and those were good, but we released them to RossMarshall Bed Bath and Beyond at much higher rates. And so, since there are 600 stores, we found the former operator of Albertson said, do us a favor while we play real estate renovation; these 300 operate the other 300.

And then we'll call you in 2 years. Okay, so we buy these assets cheaply. We renovate them. After two years, we called Bob Miller, old-time, unique operations, about it's time for us to take the 300 stores. Thank you for operating them. You saved us a lot of money. And now the real estate guy has got to do what we got to do.

And he says, Dean, before you want to close and release them, I want to say, we're making a shitload of money. I said, what do you mean? We didn't give you any money to operate. You know, he goes. I use my old, you know, my skill set, and we're making money. So suddenly, we said to ourselves, Hey, maybe there's an opportunity to build this up.

So the 700 Albertsons that we didn't buy, and these were the excellent California stores, we ended up buying them. So we started with 600, went to 300, found out we could operate because we have this great team, and bought another 700. Suddenly, we're in the grocery business—a thousand stores and a Good operation team.

By the way, a Frankfurt jet real estate team. We do the same thing in the real estate. Yeah, we were like on Mervin's where we could upgrade the real estate assets from, we had a straw in Boston, right across from Fenway Park was a development site. We have several of those in DC, some of those in California, Santa Monica.

So we still worked the portfolio from real estate, but we were running the business too. And then in 2014, the David and Goliath, the David, our group. It goes after Safeway, and in a $14 billion deal, we added 1400 Safeway stores. Now we're at 2300 store chains, 275,000 employees, and $ 76 billion in revenues.

We're the second largest private company, and then we took the company public about three or four years ago at, you know, at a $16 shared value. Our deal was $3. Okay, and we took a 16, ultimately bringing in some additional management team. We've done a marvelous job, and last October, we agreed to sell the company to Kroger effectively at about 35 value.

Now, it's subject to FTC approval. And so this is just public confirmation. So, the FTC is reviewing whether they'll approve a sale to Kroger, and we'll see. So, you know, we'll see what happens. And, you know, we're all hopeful, but we'll see, but it's been a 14-year ride. We've had a great investor base stuck with us as we kept creating value.

But it goes to the point I said earlier: you want to be something other than a deal shop as you grow this business. How can you use the platform and infrastructure? It gives you the competitive edge in anything we do in this business. What's my bear century? What's my competitive advantage? And when I have a platform of 2300 markets, I can look at any grocery business nationwide.

I got superior knowledge. I got an operational team. So when we evaluate any retail center with gross rate, no one could compete with us because of our expertise in Albertsons. So you could use it as a strength. So when you could build a vibrant infrastructure in a platform to do additional transactions off of it, a platform that you have a competitive edge.

It is the way investment vehicles should go. If you're just at the one-off deal left and right doing that, it's a hard way to make a living. So this has been an evolution of the Luberto Agra funds to say, where's the fulcrum point? We have a good idea and a good concept. Where can we join it so we can replicate the investment success on a more and more extensive platform basis?

And, but when I was 25 years younger, yeah. You know, I had to look at everything. Okay? And that's the way you, you've made a living. But as you, you know, grow into this business over time, you learn that number one, you need a competitive edge. Number two, you need execution, local execution. Whenever I see a New Yorker doing a deal in Miami or LA, I say it doesn't make sense.

Local people execute better. I want to team up with the best of the best. Number 3, people matter, people count, who you do business with, creating relationships is how to build platforms together. And so you got to stick with the fundamentals. And once you have the fundamentals. The fundamentals give you that risk mitigation component to protect the downside, and then you try to create value through your value-creation skills.

Chris Powers: That is one of my favorite real estate stories I've ever heard. I've done 312 of these episodes. I have a question. Do things like that still exist? You said you did this in 2005. You proved there was a model to look at public companies for their real estate rather than their business. You've heard more of these stories over the last 18 years; as we sit here today, would you say an opportunity like Albertsons exists, or is that arbitrage gone?

Dean Adler: Well, when the retail space is challenging because you need new retailers to take the existing space. So, one of the beauties in 2005 up was the growth of the power retailers Marshalls, Roth, and Fed Bath, who unfortunately went into bankruptcy, okay? You had this significant growth of that 20,000 to 40,000 square foot user going along with you.

In today's world, you don't get paid for the growth of stores. You get paid for combining brick-and-mortar with e-commerce and owning your customers. So, the business plan for most retailers is that now, there are retailers like Family Dollar and Five Below, and they grow by stores. But the business plan for the big boxes is not necessarily to open 100 new stores.

It's you know what? We must integrate e-commerce with brick-and-mortar to do a better job for a customer. That's what's given credit only building more stores, not so even if you've bought a retailer, And they have only had a little cheap real estate. The ability to refill it today is much more complex. So I'll give you Some other examples to fill it today. You don't have ten retailers Lined up to gobble the space now; you can say, yeah, but Dean, well, you know, what about buying the real estate?

Why not buy Target for the real estate? Why not buy McDonald's for the real estate? Well, that doesn't make any sense. This target McDonald's is already maximizing the use of their real estate. So it's different than taking the target out and putting someone better in. They're already the best for that real estate.

We planned to take the retailers who need to utilize their space properly, not maximizing it, and go to someone. So, here's what happened. 2020 Toys R Us goes bust. And they have 400 stores. So we brought the teams together again, 400 stores, let's gobble them up. No one's better than us in this business.

So we, Tim Cohen, Shawn, Steven, and the same group, when we analyzed the 400 stores to the old days, had a temp for them here before we bid. We go out to the big tenants. And obviously, a lot of credibility with them. We've given them a lot of space over the years, and out of the 400 locations, we could only identify 30 tenants that would pre-commit to us. So, you know, Burlington and people like that. So those are we only bought 30. So the days of buying 400 that we did for 20 years were over because you needed to have the new people going down the last piece. So, I said, my God, there's a lot of Sears and pennies.

Who is the growth user for the space? And what was after 2020? It was Amazon for them. Amazon wanted to do 148,000 square feet, five regional warehouses—one giant warehouse. So we took the program and went to Amazon and said we could access 150,000 square foot buildings. In the suitable locations by keeping you up for distressed real estate.

Great kid for a year, great kid, and by the way, you buy these buildings cheap, and then they come up with Amazon credit. You're doing Amazon's at seven. Their bonds are at three, you know; I thought that was the business of the future until Amazon called us 1 December 2 years ago as a dean. Thank you for lining up 85 sites.

But we're shutting down. We need to add more. So that gig was an enjoyable gig for a while. Same concept: pandemic hits 2021, who's going bust the restaurants? Okay, so what did we do? We formed the group. There were a lot of restaurants going wrong, but then you had the nationals who wanted new pad sites because they needed double drive through the chick filets, the Starbucks, you know, all investment grade users.

So, we teamed up with the tenants. Forming a pool after the distressed restaurant is a great strategy. And we started looking at restaurants, closing 200 locations, and lining them up with chick filets, Starbucks, and Dunkin Donuts. So, we're buying distressed real estate but putting in investment-grade credit.

If I put a 15-year chick filet at 7 percent when the bonds are at 3, that's a good piece of real estate. The problem is PPP came in after about four months and said, Dean, I said to the world, no more of this. We're going to assist all the restaurants. Therefore, excellent strategy, the right idea of competitive edge, the fulcrum point, everything we talked about.

Where's your edge? Have a business, do it in size, replicate it. It was all lined up except that TP came in and stopped it.

Chris Powers: I will leave you with one question, and we will bring it home. You've been in this business for 40 years and seen a lot. What do you wish you had focused more on, and what do you wish you had focused less on?

Dean Adler: Great question. The business I missed. And the last 6 and 7 years were industrial; I understood e-commerce and its growth. I never fell in love with industry because I've always believed that location matters. So I needed the shopping center on the right corner or that office building.

In the heart of the town, industrial was in the value execution of a property to value-add skills. Industrial always bothered me because you didn't have to be at the right corner. You could be an industrial park down the road in a forest somewhere. There was no real value, a lot of value-added because it's a bumper building that needed to be more accessible for people to build and easier for people to replicate.

So, it felt like a commodity, and over the last seven years, many people have made a lot of money in the industry elevated to actual logistics and found ways to add value. So it was an arena that we participated in; we have a 2 million square foot facility right at the Philadelphia airport, right on the rail, right next to FedEx, right next to the airplanes.

To me, that was strategic right on the highway. We're going to buy that. But what I'll call the commodity-like industrial was a place that we should have played, even though we knew the strength of e-commerce and that you need three times more warehouse space as e-commerce grows. So, if I look back at one regret of an asset class, that was it.

What could I have avoided? We created this business in 2003 of creating these master plan resort communities. We bought big bulks, around 2,000 acres. We sold lots and used that money to build these communities with second homes, condominiums, and three golf courses. I like the fact that we were a high barrier to entry assets.

I like the fact that we are significant markets. And what hit us in 2000 was that we were keeping low leverage. The thought was if we went into recession since we had no debt on our balance sheet, we'd be the owner, like in Florida. There was no floor to these assets in 2008 and the great financial crisis.

So, we pre-sold 600 of them for 650,000 when the GFC happened. They became worth 250,000, why? Because they're second homes. People were worried about their first homes. They could not absorb two body punches. The sickening part was I go to those communities today; 12 years later, they're on fire.

Reunion in Orlando on fire, dealing Naples, on fire, we were right. We needed the proper capital structure and were going after something I said earlier. Rental assets only, we could balance cash flow and backend. When you go into investments that are backend weighted, discretionary, non-necessity, okay, second home, condo, golf courses, stuff like that, they didn't have the downside protection.

In a breakdown, investing is to avoid losses at all costs, with no disasters. You need 90 percent A number one; you've got to protect the downside, which is you've got to seek asymmetrical returns, where risk is the protection of capital, and then they create the alpha through real estate execution skills.

So you've got to limit any losses. It would help if you had the bulk winners. That portfolio has 50 percent high-risk losers or 50 percent winners. That's a terrible portfolio. So if you stick to that thesis that I got to protect capital at all costs on the downside, and I could go for the alpha through value creation, that leads you to the case of you're not going to do the discretionary type residential resorts that we did in 2008.

I was so sick about the results that I couldn't even look. I've never invested in that, and maybe people make money. I can't even look at a golf course today. It sickens me after we went through it. It was a harsh lesson to learn, but it completely revitalized our company.

It is saying we know what we want to focus on, and if our, and well, we thought we were protecting the downside by no debt, having a high barrier asset, and pre-selling things in advance. We thought our strategy was totally downside protected, but when you have a great travesty, like the great financial crisis, the rental assets rebounded, those don't, and that says it all.

If that's the case, let other people do that and play with that. I could never live through that period. And I always say one more thing in that 2008 period. 2009 and 2010 were tough years. And we still had like a billion dollars of buying power. So I said, this was my day in the morning; I would wake up and all the asset management issues of these resorts.

I said, get it. Punch me, kick me, scream at me. I'm working my head off, but let me have it. At 1 o'clock, I'd have lunch, and a miserable one. I'd have lunch at 2 o'clock, return, and enter the acquisition. I have the capital; I can buy things at a bargain. So all afternoon, I'd be out buying stuff at a deal, which we rebounded amazingly with the new capital. 

So that night, when I went back to bed, I felt great. Okay, so it was a way to work through 2 years. And then here's the last thing—the way into this real estate for cyclical business. There's a distress period, a recovery bureaus period, and an asset bubble period. 2008 was distress. The recovery was from 2012 to 16.

Then we had asset bubbles 17 to 19, and then we had distress again pandemic 20. And distressed again in 23, and here is the conclusion to 40 years of investing: you make the most money with the least risk during periods of distress because you can access assets and debt at a lower cost basis.

Hold your position and ride to recovery. The most significant risk is when things are great, the asset bubble 17, where people pay 25 times cash flow because of low debt, and then you go into a distressed period and are crushed. So, what you learn, this is the hardest thing to do. Back up the truck in distress periods, not because it's contrarian.

No, quite the opposite. It's logical. If you believe real estate is a fundamentally sound business over time, you go through cycles, but it recovers. The only time to access assets at a lower cost basis, having a lower cost basis is a competition advantage. I'd rather own positions at 70 percent of value than 100%.

It would be a winning strategy if I could accumulate positions at 70 and ride up the recovery. So the conclusion for all real estate people every ten years, work the first three years. When you're distressed, take the next seven years off and return. So that's how we'll conclude it for today. 

Chris Powers: Alright, I will ask you one question then.

You can answer yes or no. Are you buying yet? 

Dean Adler: No, I'm doing preferred equity credit. You can't buy; there are no everyday equity deals. But doing preferred equity, I'm getting equity returns for lending for credit risk. So yes, and it concluded asymmetrical returns are the dream of any investor in any asset class, whether in public equities, energy, venture capital, private equity, or real estate. The opportunity exists today in real estate.

Chris Powers: Dean, this was awesome. Thank you so much for today.

Dean Adler: Thank you so much, Chris.