#323 - Nancy Lashine - Founder @ Park Madison Partners - Cycles, Crises, and Capital: Navigating The New Normal in Real Estate

Nancy Lashine: When you raise a fund, somebody gives you power of attorney on their capital until it's fully invested. When you go out to find money for a deal, an investor decides based on the price and the value you've structured, and they're negotiating a little bit. So when someone gives you discretion, you have to earn their trust. And therein lies the difference.

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Right now in America, the real estate capital markets are not what they have been for, let's call it, the last 15 years, and that would be an excellent place to start. You are at the intersection of what's going on in the capital markets. And so I'll ask it broadly, but where do you see things right now? What's going on from your perspective? We can talk about debt, equity, and asset classes. We can take this wherever you'd like.

Nancy Lashine: Sure. Well, it's been a tough year for real estate. I mean, you could say we're in a real estate depression. I was amused when I was reading my newsfeed this morning. One of the macro pundits said real estate is the next bubble to burst. And I was like, is that a newsflash? He's talking about commercial real estate; I've done this for over 30 years.

So, this is my fourth cycle. It is as deep and destructive as any cycle I've lived through differently. We can talk about how it's not just macroeconomic like the SNL crisis was like the, you know, the tech bubble was even like the GFC, but there are some secular changes in how we use real estate.

What's happened with the office is changing it. But the most significant thing about real estate from our perspective, which is the perspective of an investor, a long-term investor in the asset class, is that. So much of it, you know, depends upon where valuations are, and appraisals are an essential part of that as well because there's an embedded, enormous portfolio and institutions who broadly started investing in real estate as an asset class in the 1980s.

Some 40 years later, you know, have huge portfolios, which are getting written down very slowly. So, it's an ice cube that melts much more slowly than any other capital market. If you look, for example, at the publicly traded REITs, they're down today, selling it and implying a cap rate. It is a broad stroke of about 6%. They are down, you know, probably twice the level that real estate is down at, you know, in terms of its appraised values, but yeah, so they're down maybe 36%, depending upon what date you want to use, we're down 17, 18 percent in appraised values, depending upon which metric you're using, but we know that that's probably, you know.

Six percent is too low an average cap rate because it's still negative leverage. And so we know we are less than halfway there. So, revaluing the asset class is a prolonged, torturous process. And given how quickly interest rates are, it's all interest rate-driven. Obviously, because of, you know, the feds.

The response to trying to control inflation has been to raise interest rates faster than we've seen in two decades. As a result, values decline because roughly half of real estate and commercial real estate are generally bought with debt. So the cost of debt's gone up dramatically. The cost of equity has to be readjusted.

And if Nobody has a confidence level yet. In the last week or two, people have started to feel the interest rates have leveled out, and the feds will no longer rise. And that's a little bit of a cause for optimism, but it depends on whether we have a soft landing, which, you know, the Wall Street Journal declared last week, but I don't think anybody's entirely betting on that yet except for the equity markets.

So when you have an illiquid asset class that you'll have to hold for a very long time, it just takes a long time to revalue. And that's going on for at least another year. And everybody got so used to these rapid cycles par, particularly with COVID, where people thought, Oh my gosh, it's terrible.

And we're going to have a big adjustment. And, you know, two months later, we were flooded with capital, and we did not have that big adjustment. So there's an expectation on the part of many folks in the industry who have not been around for that long that this would be a short cycle, which will be much longer than people think.

That's our view, and the uncertainty is just causing people to do nothing when in doubt. And that is a mantra, frankly, of the institutional business. So transactions aren't, things aren't trading. Transaction volume is down 80%. And Nobody has a real sense of confidence about where they should change.

So that's why, you see, everybody's latest darling is something like Preferred Equity, where you can fudge it. You know, you're higher in the capital stack. If the values decrease, you get some current yield and are still okay. And so everybody wants Preferred equity today, but that's just a hedge.

Chris Powers: Oh, man, you said so much there.

Nancy Lashine: I know. Sorry, I just went on and on.

Chris Powers: No, I love it. I'm going to pick this apart. So, when you say long cycle versus short cycle, is your definition of long cycle the time it takes to hit bottom and return up? What do you mean by long cycle?

Nancy Lashine: Yes, it's the amount of time; if you're at a value, let's say you buy something for a hundred and then values decline, it's how long it takes for you to recoup your hundred to get back to your cost basis if you will. One of the things about real estate is it was initially part of institutional portfolios viewed for three reasons. It was the classic asset allocation theory, income diversification, and less volatility than equities and other asset classes. So you always want to maintain principle with real estate.

And that's the first tenet of any institutional investor: don't lose principle.

Chris Powers: You said we're less than halfway there. Are we less than halfway to the bottom, or what are we less than halfway to?

Nancy Lashine: When I said that, I was using as a proxy the number, the decline in appraised values for, say, the Odyssey, which is the open-end fund index, and relative to, say, NARIC, which is the public markets.

So, the public markets are down twice as much as the private markets in terms of valuation, and they still need to be down more. So, every time I say all these things, this is all true. If you're investing in indexes, but most of us don't invest in indexes.

We buy properties, we buy property types, and we purchase specific situations. The beauty about real estate is its unique sets and people, so we should talk about later where this is true and where it's not true, but generally speaking, if we've been in this decline for about a year, year and a quarter, it's at least another year before we've hit bottom.

And then how quickly do we come back? So much of it's a function of what happens to interest rates and what happens to the economy.

Chris Powers: Again, we are still determining what will happen an hour from now, but let's say things are stabilizing, and interest rates aren't increasing much further.

Is this kind of? Let's sit and wait and keep working its way through the system for another year before you start seeing a pickup in transactions.

Nancy Lashine: So you have to say what will cause things to change and what will cause things to move is debt coming due and significant transaction volume.

So in past cycles, when we've seen significant bank loan sales, that's been, you know, new market makers, and people use those as metrics. Signature Banks, a big loan sale will come up shortly here. And that will be an interesting metric for people. And you've seen a lot of data about the flood of loans coming due.

So what's happening today is that groups who took out floating rate loans are coming due this year; next year is a peak year. They're going to need what's called gap equity. Because they bought and borrowed here, values have come down, the loan to value won't change, and the interest cost will go up, so the coverage will go up.

So they'll need an equity slug, and either they'll be able to get that through pressed equity or mezzanine debt, or the bank will have to take back the assets. The bank doesn't want to take back assets. They've learned that lesson. But those will be the catalysts for things repricing in the market.

Chris Powers: You answered the second question then, which is, you know, banks taking back. Is this a cycle where only a little will transact? The transaction will happen within the capital stack rather than ownership changes.

Nancy Lashine: Good question. I don't know the answer to it. There are office owners today who would be very happy to give back the assets because one of the rules I learned, I remember this, early on in my career, was the 80-20 rule.

When you have an institutional investor, and you have a problem, you know, what happens is at the board meetings, 80 percent of this time is spent dealing with 20 percent of the assets. And so there will be, and you've seen major important institutional investors hand back the keys on office buildings in particular, where they feel that the value is below the debt today.

And they don't want to spend the time figuring it out because they need to see the upside. So it depends on what it is and where it is, but there's going to be a flood of, you know, in multifamily and an industrial, you'll see a lot of preferred equity. Interestingly, we have a transaction that we're about to come to market with, and the number of people who say they're interested because it's preferred equity is staggering. We'll see how it prices, but it is perfect with these prices in the mid-teens today, and that's a pretty attractive return to people.

Chris Powers: That's the flavor of the day on industrial. Do you see it being like a new development? Is that coming to market, or where do you see preferred equity fitting into the industrial side? I'm an industrial guy. I have to hear your ideas.

Nancy Lashine: It's not on your properties, Chris, but new property rents have been increasing in industrial, obviously in-class industrial. And even, you know, better than I in class B industrial. So we're still seeing strong ability, solid rental growth, and the ability to rent these assets.

And so you don't need the preferred equity, a new one development. You'll only see as much of this, generally speaking, in industrial if you have somebody who overleveraged a property; you'll see it more. You'll see it in multifamily because multifamily when it was trading at three and a half caps and multifamily debt was plentiful at meager rates.

And relative to other property types, it's still plentiful because of agency debt. It's twice as expensive. Also, it's a significant asset class, and many non-institutional multifamily owners exist. You'll see a lot more opportunities in the multifamily space.

Chris Powers: You get to sit at the forefront of people who have ideas to raise funds or JVs, or they have some idea. And I want to go back to the office. Have you seen anybody trying to raise distressed office funds or have some angle on office or even those folks saying, we don't want any part of this mess at any price?

Nancy Lashine: Yeah, one handful of folks want to do something in the office space, and most want to do office-to-residential conversions.

So, they're very hard to do in the central business districts. They're expensive. It's good if you have experience. We have seen, you know, a couple of successful JV raises or club vehicle raises there. And we've seen, you know, interesting one-off transactions. We have talked to out of the 2,000 investors we cover.

I know two say they want to do office as a distress play. I'm sure there will be more, but it's just like, that's a Monday morning conversation. Everybody's going, what? Really? That's so interesting. We are seeing, for example, we have a manager whom we work with who's buying office parks in suburban areas.

They have great locations and move the tenants from one building to the next as they could sell off the rest of the parcels for single-family rental development because it's zoned for Residence. So, he finds a multiple-use, and he calls it taking the melting ice cube.

And as the tenants leave, you move them to one corner of the parcel. That's an exciting play, and you can do that on Leverett and make a 2X. There are specific strategies, but I'm standing in my office watching the most spectacular construction of the J.P Morgan building, which is north of, I'm on 41, it's 70-something stories. And it's when I first saw a hole in the ground a few years ago. I started. I watched the whole thing go up, and it's a beautiful building. Will they fill it up, and will it be a spectacular fulcrum for the organization?

So, you know, I think if you're in New York City and you want to be between 42nd Street and 61st Street, you know, within a couple of blocks of Park Avenue, you're paying up for rent right now because this is the hundred percent location that it still exists. But there are a lot of mid-block B buildings that they're going to go, you know, they need to be able to command more rent.

Chris Powers: Are those going to go to rest, or is it just going to trade at land value? We'll see much stuff coming down in New York as it relates to New York specifically.

Nancy Lashine: Well, it's location-specific. As you saw in the last cycle, many of Wall Street's older office buildings were converted to Resi.

So, many people now live in the financial district in these converted buildings, and they love it. And some of them are crazy expensive. It's not my cup of tea, but it can be successful if you're in the correct location. New York has some cavernous buildings on Sixth Avenue, which would take much work to convert.

You have some smaller buildings on Third Avenue and could convert some of them, but there's look, it's the, you know, the doom cycle that everybody talks about. So you have, you know, people stopping coming to the office, and then you have people moving out of the city, and you have lower tax revenues.

And so then you have homeless issues, and then the government comes in and raises taxes to try to increase the services, and more people move out. So it's this kind of doom loop that we've seen in many of the cities, not Dallas and, you know, not in the South as much, but we have got to figure out how to fight that I'm a born and bred New Yorker, so I will never, ever bet against the city.

It'll be fine, we'll be back. But, you know, I grew up on Avenue C and 21st Street. It's a little bit of a wasteland today, but for sure, where Chelsea pierces was much more of a wasteland, and, you know, that's where you went to do things you weren't supposed to do.

And if you look at the West side today, I'll get to mind-blowing how beautiful it is. So things, you know, things will cycle.

Chris Powers: You said that capital's sitting on the sideline right now is the institutional capital. There are family offices, and there is sovereign wealth. Are any of those buckets moving more than others, or is everybody silent right now?

Nancy Lashine: Well, one of the many things I love about our role in the real estate business is there's always something to do. And so we've been busy working in niche sectors, some of which are, you know, offshoots of the industrial space, and we've been quite successful in them, even raising capital for them this year.

So we've raised capital from every category of investor. So, It's not that people are doing nothing. They're institutional investors. If, on average, the big public pension plans, let's say, invested, on a scale of a hundred last year to this year, they're at 35%.

So they just scaled back their allocation because they were over-allocated. As a result of the Portfolio, the equity markets came down. Obviously, the fixed income portfolio value had come way down, and their real estate portfolio had yet to be revalued as quickly with the equity markets coming back; there's hope that the portfolio allocations will increase next year.

And they will, to some extent. So we won't be at 35%, but we'll be at something high. We won't be at 100, but we're somewhere in between. So, public pension funds are still investing, but at this lower rate, endowments and foundations are still investing. Some of the sovereigns are very active, and some are very quiet.

Interesting, there's a little bit of a dichotomy there. We've seen more capital or interest from the Middle East this year than in many years. Oil prices are returning, and diversification and what's happened in Saudi Arabia are contributing factors. And we continue to see money coming here from Asia slowly, but less so from Europe or Latin America.

Chris Powers: What do institutional investors care about as it relates to in contrast to private investors, like family offices? They care more about allocation and portfolio construction. Are there fundamental differences in how institutional investors look at the world as opposed to an ultra-high net worth, a family office, or a sovereign that aren't necessarily deal-related but more like allocation? Do they want exposure to things?

Nancy Lashine: And again, you know, in the category of all generalizations are false. Generally speaking, you're managing a target return if you're a CIO or of a large public pension plan. That could be 7%. And so you're looking at the diversification within your Portfolio to work that over a more extended period.

And you have a consultant giving you an allocation mix, and you manage your real estate to hit that target. And that's important. It's interesting because if you look at many of the studies that have been done about return, most of the differential in return is not by manager but by property type or region.

So, if you get that broadly right, you will outperform indexes. For example, if you look at where the Odyssey one-year index traded right now, it traded down around numbers 10%, but Industrial is only down 7%, and the office is down about 20%. So if you had just been an office, you'd be down 20.

If you were just an industrial or down seven, that's a nice, yeah, that's a big difference. So you want to get the property types. And when you look at differentials of managers, the ones that have earned that right tend to be able to raise more capital over time. And they're not necessarily institutional investors like large ones; they don't get paid not to make big mistakes. They don't get paid to outperform. That is distinctly different from someone managing a foundation or driving a family office, where foundations typically have a much higher hurdle rate for real estate. So they're looking at it often to compete with private equity, which means a 20 percent return and a two X, which is super hard to do, as you know, in real estate and family offices may have a lot of real estate that's not even in their investment portfolio. So, if they're looking for it, they're looking for outperformance typically because it feels like they have the diversification of homes, even though you can argue that it will perform differently.

They're not necessarily looking for real estate to generate a specific return type. So when we talk to foundations, and now it's family offices, we're typically offering them much higher return opportunities. And some of those groups are much more focused on multiple because they don't want to have to keep; you can't eat IRR, right?

So they're looking for a two or two and a half X, and they also want the tax, there's, an apparent big difference is whether you're taxable or tax exempt. So, if you're a taxable investor, you pay your tax and reinvest every time you sell an asset. You're worse off than if you had just held it for an extended period.

And the power of compounding allowed you to grow your equity multiple even higher. Taxable investors tend to like a more extended hold period when something is more tax-efficient.

Chris Powers: Okay. So if a deal was producing, let's call it a 20 over five, or we believed it might, that just naturally.

I'm not saying it wouldn't be a fit for institutional, but since they're probably looking to take less risk and lower return. Based on the risk profile, you would need to show that deal to an institution or that it immediately goes to family offices and endowments.

Nancy Lashine: Oh, we would show it for sure; I mean, look, it depends on what it is. If it's a development deal of an environmentally tainted site and you're buying the land, you're going for a cleanup. We know an institutional investor is not going to do that, but if it's just, you know, a distressed debt play, sure.

Chris Powers: The development cycle will be much longer than the normal cycle, meaning the first money will probably be acquiring existing assets at discounts as it takes longer for ground-up deals to pencil. Is that what you're thinking?

Nancy Lashine: Are you talking, sorry, are you talking about in this cycle or just generally speaking?

Chris Powers: It just seems like, like, the development valuations are getting everything to work with construction cost up, interest rates, price of land is so upside down right now that money into new development might take a little bit longer than maybe money into the first assets that start trading. Does that make sense?

Nancy Lashine: Well, it does conceptually. Still, I'm thinking about two development projects or strategies we're working on that make more sense today than they did a year ago. They make more sense today because land values are down, and you can buy the land for 20 or 25 cents on the dollar of what you could have purchased at, you know, a year or two ago. So even if the land is only 15 percent of your cost, that's material, and then inflation's mitigated. So we're hearing from folks who are, you know, in the construction business. Materials prices are certainly going up differently than they were.

And even if they've stayed slightly higher because there's no development, labor costs are way down, so contractors want to keep their teams employed. You can find that you can get a guaranteed max price contract with labor at a cheaper rate because there's not a lot of work around supply demand.

So we're seeing some enjoyable, particularly in sectors that need development. So built to rent is an exciting sector in which we see a lot of activity. Fourteen thousand built-to-rent homes were delivered last year compared to a million single-family dwellings.

There are few scaled purpose-built, built-to-rent, and people want it. So will it be able to continue? There was an article in the paper today about how rental prices have stayed high on homes. Will you still be able to rent those that yield on costs that make new development make sense?

I think so. So again, it depends on what you're doing unless you're JP Morgan and you've planned this for a very long time. Is anyone building a new office building today? Probably not.

Chris Powers: Are any unique structures showing themselves as people are raising right now, like raising in ways you haven't seen before?

Is it all still down the middle of the fairway typical raises?

Nancy Lashine: That's a great question. The concepts du jour are disintermediating the GP. So many, many investors now want to own a piece of the general partner so that they share in the fees and the promotion, and they're willing to take more risk in funding some operating expenses or going in and buying out an older partner and buying into an operating company.

So we're seeing more of that activity and interest. And then the other, you know, big. We've talked about preferred equity, but the other thing that you'll see a lot of is secondary trading. We have yet to see many secondary trades happen again because of valuation, but we're starting to; we're working on a couple, and once values are more known. We'll see more secondary trades and GP-led recaps becoming more accepted. So we've done a few of them. You'll see a lot more. And what that is, when you have an operator or general partner or an investment manager who controls a fund and some of those assets and the fund is coming to the End of its useful life, or it's running out of capital.

There's a need to bring in new investors and more capital. As part of that, you can do a tender and offer to buy out existing investors. More often than not, you'll take the pool of assets and put them in a new structure and recapitalize that structure with a longer tail life so that whatever the value add proposition was, there'll be time to do it and capital to do it, and we've done we're very focused on that business.

That's a big part of what we're seeing right now, and that will be more and more interesting to investors as well.

Chris Powers: Okay, I'm just going to ask a dumb question. Why is that called a GP-led recap meaning? A bunch of assets. GP doesn't necessarily want to sell them. He wants to keep working on them or holding them.

They come to you as the GP, and they lead an opportunity to recap. And I'm assuming they've already told their LPs before engaging with you or some firm that we will digest this. And LPs have given the thumbs up, assuming that the valuation is intact or everybody can agree.

Nancy Lashine: There are a lot of steps to making this happen, and there are fairness opinions, and there's a lot of things that you need to do to make sure that as a fiduciary, if you're the GP, you've done the right thing by your existing investors. So that's a whole other conversation, but as a GP-led recap, as opposed to an LP-led outline, because the GP decides that the investors want to recapitalize that Portfolio or those and those assets.

Whereas if an investor says. I had this conversation the other day, you know, we just took over this Portfolio. There's a bunch of assets and fund investments in here. We want to do something else. They'll just put those on the market as a secondary. So, in that case, somebody comes into the LP position, no incremental controls, nothing to do with, you know, which assets get to stay in or stay out.

You're replacing one LP, a limited partner, with the same subscription documents, partnership agreements, and structure. And it's just a question of trading it: net asset value or its discount or premium to that net asset value.

Chris Powers: Why is that in vogue now more than in other times?

Why is that the flavor of the day right now?

Nancy Lashine: The GP-led recaps are because many investment portfolios have been financed with floating rate debt. And so when the debt comes up, they will need more capital, and they didn't plan appropriately for it, but there needs to be transaction volume for the assets.

If you want to sell an asset today, you will likely have to take a haircut to the value you feel because people are nervous to buy anything. So it's the wrong time to sell. You may be better off getting recapitalizing it and with preferred equity. Or with mezzanine or new investors, and the existing investors may feel like I don't want to sell at that price.

I'm happy to stay in and let this manager continue to do what I hired them to do in the first place. It's a function of debt and a lack of transaction volume.

Chris Powers: Going back quickly on LPs, wanting a piece of the GP. How should GPS be thinking about this? And let's say they're going out to raise money through that process.

And we're going to talk about first-time funds in a bit. It would not be suitable for me to have this conversation with you publicly, knowing that I'm probably in one of those camps, but before we go there. If I asked what work they do or what they should know about if they meet an LP and the LP says, great, I love your deal.

I want to own a piece of you, too. What matters to one is how that LP or investor will value the GP and what the GP has done or pre-work that they should have thought about before they get asked that question.

Nancy Lashine: Well, the number one issue is what controls are you willing to give up?

So, are you looking for capital and want to keep everything as it is? If you sell a 10 percent interest, can you do that? But if you're looking to buy out a partner or need a lot of capital, it's what level of control this investor would have in your business.

And then, Who is the investor? How do they operate? Are the people sitting across the table likely to be there in two years because you know you will be there in two years? What's their board process? Do they have allergies? You asked the question a while ago about the difference between institutional investors and high net worth and headline risk.

Some institutional investors have a real headline risk issue, while others don't. So, are you compatible in all those different ways? And it takes a lot of work to have a checklist. I've been doing this for a long time. Like you sit down, and you know, you'll know, or you hopefully will know.

You won't always know; look, it's like life. You learn by making mistakes, and the things you, you know, that you thought were going to happen didn't happen the next time you'll make different mistakes. So it is, it is a tricky thing though, because if you're selling an asset or you're selling a portfolio, you know, so it's an asset, it's a portfolio, it's very reproducible, selling a piece of your business is super hard and it's not just the valuation, it's about.

That's your livelihood and culture; all those things are so challenging. Most people will ultimately make this trade because that investor will bring limited partner capital to them, or LP capital. So, there are lots and lots of folks who could come in and buy X percentage of your operating company, but how many of them can give you half a billion dollars to invest as well?

And that's when we see investors and operators willing to make that trade. Because they grow your business at a level that you wouldn't be able to grow it, or it would take you so much longer to grow it on your own.

Chris Powers: And when they make those investments, are they usually, let's say, you know, first engagement, they're buying a piece of the operating company.

It is just a generalized question, and the answer is it's deal by deal, but are they usually looking to take a smaller piece of the GP with some contract to continue to buy more and grow? Or a small amount with a way to get out of it over time. Like, how are those usually structured?

Is it? It's not just this good faith. Like we're here forever. There's usually some mechanism one way or the other.

Nancy Lashine: It depends on when and why you did the deal. If you do the value initially it starts. So let's say you sell a 20 percent interest in the business, and they will give you 100 million to seed each of your following three funds so that you know that once this business is up and running, you don't want.

Now you'll have assets. You'll want the ability to buy that investor back, and they may be willing to do that. You may have a buy-sell mechanism based on your AUM, time, the number of funds you've raised, or something like that.

Suppose you're doing it to buy out a partner. It needs to be clarified. You don't have a timeline; you may be willing to do it. You'll always have some buy-sell mechanism, but it may not be as time-constricted. There are probably five or six large firms that do this all day long.

That's why they raise capital to do this. And when they raise money, they typically raise it in a private equity format. So if you're investing in a fund that goes and buys GP stakes, that's like a seven-year fund. So whoever that group is doing a deal with knows that in seven years, they're going to be sold again.

And you see a lot. Now, we've lived through two or three cycles of that. And, if you're in that position, come talk to us because it's interesting to see what people learn over time. It's hugely important if we, if Park Madison partners as a placement firm, are approached by a group that has just sold an interest in their business or a majority interest in their business. It's tough for us to raise LP capital around that. Because investors are like, I want to see how this settles. I want to see who stays and goes. I want to see what happens to compensation. I want to see who's making the decision.

One of the things about our business that I love but is hard, and it's taken years to learn, is our job is not just to find the best product and managers but to figure out how the decisions are made in the firm. And that's like seeing through the spaces, right? And you know, it's Warren Buffett, you never, when the tide goes out, you learn, he's not wearing a bathing suit. So he said it differently.

Chris Powers: You see it coming naked.

Nancy Lashine: Yeah, that's true, but the point is that you have to see in the spaces of how decisions are made. And it's tough to figure out when you're just sitting on the other side of the table as an investor. And when there's a change of control or even a new investor, that's somewhat disruptive to that process.

And investors want to watch it settle. Before they commit, once you're invested in these funds, you know, you're locked up for five or ten years, and all you have is one of our investors said is whining power. You can't vote with your feet, unlike the public markets.

Chris Powers: The reason you would do it is A, you want, you need more capital to grow your business, and B, maybe they're bringing something to the table, whether it's connections or insights or something that is a value add to the company. Are there any other reasons that aren't coming to mind why selling a piece of the GP matters?

Or is it usually to open up capital opportunities and add a different strategy, insights, or network that didn't exist before?

Nancy Lashine: Yeah, that's generally it. Again, you might need capital to buy out a partner, but those are the reasons.

Chris Powers: And in a way, it's valued. Do they love any of the existing promotions in the current Portfolio, or how do they come to the valuation on this?

Is it a multiple of EBITDA at the operating company plus promotes, or what's generally the formula?

Nancy Lashine: Yeah, you know, it's so interesting, and obviously, this is cyclical, but you know, at the top of the last cycle when valuations were quite lofty and, you know, Chris, you'll live to see this again. It's a multiple of EBITDA.

So it's your fee income. Typically, new buyers have allowed the partners to keep the promotions from the existing funds in full. So they're essentially buying the future. And that's if it's attractive, mainly if you've succeeded.

Chris Powers: I hope to live, to see another market top. That was fun.

Nancy Lashine: I have no doubt you will, Chris; you'll be here before you know it.

Chris Powers: All right. So there's a lot of folks, and I'll put myself in this category, but I know many people right now; we've syndicated for 18 years. And there's a lot of people going into this next cycle that are thinking, having pre-committed capital, raising our first fund doesn't matter the structure, but going into this thinking, we're going to change our business model.

You guys have done over 14 first-time funds. And so I wanted to spend some time, maybe some wisdom you would share if this is a route you want to take. Here are some things to consider when doing this: many people get value from this.

Nancy Lashine: I feel incredibly humble whenever anybody asks me for wisdom.

Look, the cross is a significant consideration when you think about raising funds versus going deal by deal or Portfolio by Portfolio, that is, crossing all your deals and promotions, which changes the timing arc of how you get paid. If you are raising a fund, it might take a year to raise it.

It might take you to have a two to three-year investment period, and you'll probably have a five to eight-year holding period. So, you only earn a promotion after you've returned all the capital plus a PREF. So realistically, even in a super hot market, you're five years in, and you could be longer than that, and by crossing your promotes, you know, it was, I had the absolute privilege last year of going to the Berkshire Hathaway annual meeting.

And I mean, I just sat there and tried to soak up some of the unbelievable wisdom and, you know, scribbling different notes and things. And Warren Buffett made the comment, which I didn't appreciate. However, my son, who came with me, said, you know, Mom, you said that before. But yeah, what do I know?

He said he's the beneficiary of making one excellent decision every five years. You can think about Apple stock. It's been like a great performer for them. And I thought to myself, if I did that, I would have been out of business so long ago because, as a placement firm and an investment management firm in the real estate business, you have to be in the business of hitting singles and doubles.

And every so often, you'll hit a triple or a homer, and that's great. That'll be your outperformer, but you can't afford donuts or fry balls, and it's just if you were thinking about having a fund and having your promotes all be crossed, and you lose the capital on one deal. You know, you've just worked for three years for no promotion. So that's the bargain, if you will, of having discretionary capital. But it's essential as a firm to have a process where you feel comfortable that your process will allow the entire team to be in consensus on making these investment decisions.

Cause you get one, you know, you get a pop out, and then you are in trouble for a long time. So what you'll see, and then sometimes the market just like this shift, is Nobody, very few people. So I'm sure some people will look back a few years from now and say, Oh, I predicted the rise in rates, and I was so bright, but people didn't predict this.

And at least not this fast. And so what you'll see as a result of this incredible transition and values is. They'll be as big a morphing of the investment management business. So many midsize firms will lose their talented bench because people will go out and start new businesses.

It's an excellent opportunity to start investing de novo and to be able to go out without a legacy portfolio. We discussed the 80-20 rule and how they lost their promotions. So, there's no reason to stick around. You're sticking around for salary and bonus, which is different from why many talented people in this industry want to be on the equity side of the balance sheet.

So you'll see many new firms start, whether they become large investment management firms or just operators doing exciting deals. And so we have, you know, all these other structures that aren't funds that we work with now, whether they're JVs or development platforms or co-investment vehicles. Still, if you're a manager or an operator, there are many other ways to raise capital that can be more programmatic than just a fund structure where you can have more flexibility on the crosses.

Chris Powers: One would be like a GP-style fund where you don't have to cross everything. Correct, I would like to know if you are out. That's a type of fund, but it's a different characteristic from the main one.

Nancy Lashine: Well, you would cross in the GP fund, but you wouldn't cross when, once you've taken down a deal with the GP fund, and then you go out to raise the equity that that investor can be bespoke because they've chosen that investment and they don't cross.

Chris Powers: You hit on a critical part: the lack of incentives to keep working on a fund or deals because the upside is not out there. Do you all work on anything where an existing fund manager might come to you and say, we must restructure these documents or this fund to motivate our staff to keep working on this?

Or does the fund usually play out when people leave, and you know, you hire more people to work another day?

Nancy Lashine: So groups come to us all the time and ask us that, and then our job is to say because our job as a placement firm is where the bridge we're representing the, the, the manager hires us, but we're representing the investors.

And we're successful at what we do because investors know and trust us. And that is the front center of every decision that we make. So we're looking at this fund and saying, okay, look, this happened. We were working on something like this not long ago. They are out of promotion but have done an excellent job.

COVID wasn't kind. As a result, we'd like to restructure the fund, allow investors who want to exit to exit at the current pricing, and then find new investors to come in at a value where there will be some new promotion to keep the team together. And that's the premise. So yes, that can work. It would help if you believed the manager was the right manager for that Portfolio.

You need to offer existing investors the choice to exit if they want to exit.

Chris Powers: Quick on finishing the fund discussion. If you've raised, if you're raising your 10th fund, you're probably being looked at differently than if you're raising your first, just in going through the last year, it's, it's like, okay, even though we've syndicated hundreds of millions of dollars, the narrative's always like.

But this is your first fund. Why is it that sometimes a track record of different ways of raising money only sometimes translates to you being ready for a fund? Like, why is that? Why does there seem to be this bridge to this gap that always has to be bridged?

Nancy Lashine: One word discretion. When you raise a fund, somebody gives you power of attorney on their capital until it's fully invested. When you go out to find capital for a deal, an investor decides based on the price and the deal you've structured, and they're negotiating a little bit. So when someone gives you discretion, you have to earn their trust. And therein lies the difference.

Chris Powers: I learned something new today and will remember that. That was drilled home. You talked about other structures.

Nancy Lashine: You make me sound like a schoolmarm. Oh my gosh.

Chris Powers: Look, maybe. I have heard it in meetings, and it didn't register.

But that, for some reason, registered. I will remember that. I'm a one-word guy; the fewer words, the simpler we say them, the easier it is for me to understand. You also talked about JVs, development platforms, and separate accounts. Again, I'll use myself as an example. If you've been doing things one way forever, and you've just been heads down, you're not necessarily privy to all the different platforms.

Is it through working with you all, or how should somebody think of this as how we should raise money? What puts you in specific buckets as opposed to raising a fund? Why would one bucket be more beneficial than the other?

Nancy Lashine: If you want to be in the fund management business, you have to decide that you also want to be in the client service business.

Fund management means you're a fiduciary to your clients, and you need to reorganize your staff to be responsive to those clients for reporting and answering their questions quickly; probably, as a senior person at the firm, you need to make yourself available to those clients. So you've changed; you've added a second group of people to report to, which is critical to the business in the same way that your tenants are critical to your business.

And so, if you think of yourself more as a real estate operator, you would want to find the cheapest source of capital at any given time, and capital is fungible. So, you have the flexibility to operate your business that way because your job is to maximize the operating return from your real estate.

That's a different business. Someone who's a good fund manager should have both characteristics. They have to be a great operator or allocator, depending upon their strategy, and they have to be a great fiduciary.

Chris Powers: This isn't a loaded question. It is an honest question. Why would somebody want to be a fund manager?

Nancy Lashine: Discretionary capital.

Chris Powers: But you couldn't get discretionary if it were a JV or a separate account. Like, those come with little discretion. Those are always deal by deal.

Nancy Lashine: Sometimes you can have discretion in a box, but if you have discretion in a box, then you're effective; you are also a fiduciary. So, there are different structures.

You could have a programmatic JV, which is discretion in a box. If the asset fits these size-type parameters, you can do it. You have to inform your investor. You don't need their explicit permission, but you are acting in a fiduciary capacity to them. And you probably will be crossing promotes then.

Chris Powers: Is there a size or just something like a characteristic that may be early on in your career being more of an operator that's taking on JV capital or, you know, different structures make sense, but then maybe something's going on in your business where it's clear that you would make a move to more of a fund business or is that just total preference on the future of your company has nothing to do with size or scale?

Nancy Lashine: It's a great question, and for me, as I look at my career path, I just knew a lot more fund managers. I didn't know some of these large operators who found capital in different ways, but the truth is that businesses have grown in both ways. It's really about access to capital.

You can be a great operator, build your Portfolio in various ways, and then take it public. Now you're, you're managing a public company. You could do that, and if you look at the regional malls and many multifamily groups, they did that. And that's always an option, obviously with a different outcome.

It's really about having the desire to be a fiduciary to investors and having those long-term trusted relationships. And that's when we often will have groups come in. We looked at 148 funds this year and are seeking a placement agent. Some of them were first-time. Some of them were existing managers.

We did one. So, well, It's a host of reasons. It's a challenging year to raise capital. So today, to raise capital, you must have a unique fund strategy because there are enough existing managers who've had the wind at their back for the last 15 years to perform super well.

So, they will get re-ups from their existing clients, and finding new investors is hard. But if you have a unique strategy that investors don't have in their Portfolio, then they will find a new manager to do that. And they tend to be more niche strategies on the outskirts of office, retail, and multi.

So we've done those. Technology and data centers are an infrastructure coming into investor portfolios that has yet to be there before. Those are new managers. But if you're an operator looking to do a capital transaction, our ratio of operators who've come to us and transactions that we are actively pursuing or working on is probably 10%.

So, it's a much lower bar to do a capital transaction.

Chris Powers: And if you're raising a fund and those initial investors are coming into fund 1, I'm assuming their intent is if we're willing to go into fund 1, we're hoping to be investors in fund 2, fund 3 from 4. Do they even think that far out? Or is it? Let's get into Fund 1 and see how it does.

And then we'll talk again when Fund 2 comes around. Are they considering that allocation as something that could be made over multiple funds?

Nancy Lashine: Yeah, most investors need to be more staffed, and they want to make a decision that will last for, you know, 10 or 15 years. So they want to invest with the manager long-term.

It's, you know, awfully challenging to cover, you know, many, many managers in your Portfolio. Whereas when you have repeat funds with the same manager, it's just that you have one client conference to go to and one person to talk to. It's much more accessible. So that's always the goal. We have some investors who, when they commit to the first fund, tell us that they mentally allocate to the second fund because you probably will need more realizations or any realizations from fund one before you have to go to fund two.

So they think about it as a brilliant idea. I like that thinking. And we think about it as a two-fund commitment, by the way. When we work with a manager, we will only work with managers if we think it's, generally speaking, we will do something other than one-and-done. We did that in PPIP, Public-Private Investment Partnership, because it was a moment and a particular situation.

But of the 14 first-time funds we've done, we've almost always done the second and third funds.

Chris Powers: How many folks think they want to become maybe what we'll call a fund business where they're making, you know, a series of funds, and then do their first one, and they're like, this isn't for us or by the End of the fund, one of you kind of bit the cultures change the structure that what people are doing is change where it only makes sense to raise that next fund, assuming performance is there.

Do people often get through fund one and try to do something different, or does that usually set the course for the business going forward?

Nancy Lashine: Yeah, not voluntarily; if fund one is a success, almost always there's a fund two and on. If fund one is a disaster, that's not such a good thing, but you wouldn't. It's like having a child, right?

You know, it's, you have created something. Those long-term relationships and the fund will last for so long. Even if you decide, you have to decide about fund two when you've invested the capital and the infrastructure to manage fund one is now in place. You can only leverage that infrastructure if you have a fund two. It doesn't make any sense.

Chris Powers: All right, Nancy, that's a great place to bring it home. Thank you so much for today.

Nancy Lashine: Thank you.

Chris Powers: I hope you've enjoyed this episode of the Fort podcasts. Be sure to follow us on your favorite podcast platform or hop over to YouTube to watch full video episodes if that's what you prefer. For more information, you can check out the fort pod. com.