The transcript from this week’s, MiB: Kathleen McCarthy, Global co-head of Blackstone Real Estate, is below.
You can stream and download our full conversation, including the podcast extras on iTunes, Spotify, Stitcher, Google, YouTube, Bloomberg. All of our earlier podcasts on your favorite pod hosts can be found here.
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ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: Strap yourself in for this one, it’s absolutely fascinating. Kathleen McCarthy is the global co-head of real estate for private equity giant Blackstone. She and her team manages over $565 billion in real estate assets. And if you are at all interested in commercial real estate, residential real estate, logistics, warehouse, laboratory and medical facilities, multifamily and apartments, offices, on and on in the U.S., in Western Europe, in Asia, India, Japan, this is just a tour de force education on how to invest in global real estate.
Blackstone has been in this space for over 30 years, according to their 10-K filings, their opportunistic fund is up 16 percent a year over those 30-year periods. That’s really an astonishing return. Kathleen has been with Blackstone since 2010. And I just can’t say enough as to how absolutely fascinating and knowledgeable and intriguing this conversation is, that you won’t hear the gaps between her answers and my questions because we edit that out. But she answers a question, I’m just sitting there dumbfounded by how she’s just like, oh my God, that’s just an absolutely comprehensive explanation about something I had no idea about, and now I feel like I really know. I don’t even know where to begin other than saying strap yourself in, this is monster podcast. My conversation with Kathleen McCarthy, global head of Real Estate for Blackstone.
Kathleen McCarthy, welcome to Bloomberg.
KATHLEEN MCCARTHY, GLOBAL CO-HEAD, BLACKSTONE REAL ESTATE: I am so excited to be here, Barry.
RITHOLTZ: So I’m excited to have you here because, wow, what perfect timing to talk about real estate, just towards the end of the year, rates are going higher, real estate prices are getting a little wobbly, and I have a million questions about all of that. But before we get to that, let’s talk a little bit about you and your background. You started your career doing M&A at Goldman Sachs. Tell us a little bit about that experience. What was that like?
MCCARTHY: I’d back up actually a little bit further in thinking about how did I get there, because I don’t think it was very obvious actually that I would come out of Yale with an ethics, politics and economics degree —
RITHOLTZ: Perfect really, right?
MCCARTHY: — and end up in M&A on Wall Street. But so much, of course, for all of us probably comes back to those formative years with our families. And in my house, I was the eldest of three girls. My mom was a high school science teacher in our public high school, and my dad worked for a cosmetics company, Avon Products, you know, like the Avon ladies.
RITHOLTZ: Sure.
MCCARTHY: And so for most of my life — I mean, really, for all my life that I remember, his company — and if I would go to visit, they’d have things on the wall that says the company for women. He routinely had women who were his managers, his bosses, and there was a female CEO for a really long period of time. And so as people were thinking about, okay, what do you do after college? I was thinking any number of things and mostly that I didn’t really know what I wanted to be when I grew up, but I was not kind of at all informed by, you know, gender norms that people asked me a lot about now, in particular how do you know a woman, how did you think about ending up in this thing?
RITHOLTZ: So how did that color, what you focused on at college, and how you molded your career?
MCCARTHY: Well, I thought about — when I thought about college and what I did there, and why I selected going to Yale, it was largely, I think, the start of me recognizing that I’m a person who loves to learn, and loves to just keep expanding skills. And so I, in college, did a lot of reading and writing and thinking. It’s what you do, I guess, with a liberal arts degree.
RITHOLTZ: Sure.
MCCARTHY: And then when I was going to Goldman, there were a couple of objectives, I guess. One was you wanting to be able to pay for my life in New York and pay off —
RITHOLTZ: And pay for your tuition.
MCCARTHY: Pay off student loans. Exactly. And then also build a set of skills that could be used anywhere. And I wasn’t, at that point, sure if I would end up in a corporate role, or I would end up, you know, in the Peace Corps or something like that. And so, what investment banking I thought offered and I’d say, ultimately, really delivered was an experience where you could learn a ton of different analytical skills, writing skills for business context, persuasion skills, you know, the opportunity to be in a boardroom watching senior professionals, whether it was the chairman of the board, or the CEO of the company, or the investment banker leading your deal, getting to ideas and outcomes that were influenced based on information. And so I felt that my experience doing M&A at Goldman gave me this whole stable of skills that set me up for really just about anything.
RITHOLTZ: And how did you shift into real estate principal investment at Goldman Sachs? That seems like a big leap from traditional M&A?
MCCARTHY: Well, I would say that probably the vast majority of folks who are in my analyst class at Goldman, particularly in the merger group, when they were looking for their next thing to do, we’re looking more towards private equity, more traditional private equity, kind of like what my colleagues in our BCP team do, which is investing in companies. Some people maybe were going to hedge funds as well. But I’d say, overall, folks are more kind of corporate-oriented, you know, investing in companies.
And for me, that was interesting. I definitely wanted to gain investing skills. I found one of the things that was a little unsatisfying as a merger banker is you’d work on a transaction, you’d help a company buy something or sell something, or merged with another business. But then you really never knew whether your model was at all close to accurate. How did it work out ultimately? All of the things you thought were going to happen, did it ultimately happen? And so I wanted to be part of that kind of follow-through, and that’s why moving to the investment side was interesting to me.
But I would say when it came to kind of what part of investing, I think being a merger banker did inform what I wanted to do next. Because when you’re doing that, every day, you’re interacting with different clients in different industries and having to learn a whole new set of vocabulary, whole new business. And I thought, you know, if I want to start to be a great investor, and in particular, I didn’t know this term at that time, but you know, Steve Schwarzman refers to it as pattern recognition. Great investors are really great at pattern recognition. I want to start building that — building expertise.
I felt I wanted to move into something that was still large and wasn’t going to pigeonhole me or pigeonhole me at a very young age in my career, but where I could be working in and out of a common vocabulary that could apply across all kinds of geographies and asset classes. And real estate offered that.
I’d also say, you know, interestingly, when I was going to interviews at different private equity firms or different real estate firms, it was noticeable that in the real estate brochures of those companies, there was a huge amount of diversity in the kinds of people that worked at these firms. And it was all sorts of dimensions of diversity, including kind of the nature of people’s degrees. You had people who never had a college degree, folks who were architects, folks who were lawyers, folks who had a more traditional MBA. And what I found was these were all people who were really interested in participating in a people business ultimately, which is where do people live and work and shop, and you had great cities come together and things like that. And I really wanted to be attached to those kinds of those people, and they’re passionate about what they were doing.
RITHOLTZ: So let me engage in a little bit of pattern recognition. M&A, the success of a deal depends on that structure, the price paid, how it is structured in terms of upfront costs, ongoing costs, what you’re getting. And real estate, in many ways, especially commercial real estate, kind of parallels that thing. What are you paying? What’s the structure the deal? How is it financed? Am I oversimplifying, or is that a fair comparison?
MCCARTHY: No. I mean, again, there are so many things that carry over from one thing to another. And interestingly, I’m happy to come back to these things I learned in helping companies through mergers, particularly around things like communications and shareholder relations, and employee engagement that have now served me really well, couple decades later in my career.
But I’d say those are all similar things, whether you’re talking about, you know, companies that make something, or companies that own real estate or real estate assets. And I’d say when I think about Blackstone and how we work on our transactions and what has served us so well over time, it certainly has to do with buying great quality real estate and the price we pay for it. Big part of it also, though, is the capital structure you set up.
RITHOLTZ: Right.
MCCARTHY: And is it able to withstand anything that can come your way, including tough environments that you might not control?
RITHOLTZ: So I’m glad you mentioned that because before we get to 2010 when you moved to Blackstone, let’s talk about a tough environment. You’re at Goldman Sachs, in the real estate division, in the middle of 2008, 2009, right through the worst of the financial crisis. So I have to ask, what the hell was that like?
MCCARTHY: Well, it was definitely a difficult time. I’m not laughing out of joy, but out of, you know, kind of —
RITHOLTZ: Listen, it’s a —
MCCARTHY: — it’s always at least stunner when I think about it.
RITHOLTZ: Can I tell you all of us who were in markets and real estate and derivatives and trading, and anything who survived that baptism of fire, people have told me stories that they came through that and that affects you the rest of your career, that colors — it leaves a mark and colors you forever.
MCCARTHY: Yeah. Well, I would say I feel like in the first decade of my career, I actually had two somewhat similar experiences in that way. Because, remember, I came out of college three months after dot-com bubble burst. So I was sitting at graduation, and classmates were getting emails saying their offers were rescinded because their company was going out of business. And I went from, again, this merger group at Goldman which was focused only on the biggest possible deals to working on what were relatively small transactions, but for important clients.
RITHOLTZ: Right.
MCCARTHY: And by the way, you know, for me, again, with the learning agenda, there’s learning in all of that. But environments change quickly, and whether it’s the investment you make, or you personally, it’s your ability to kind of keep putting one foot in front of the other and move through that. 2008 through 2010 was a particularly tough and very formative experience. And I would say there are so many important lessons learned for me.
One, as an investor, the importance of buying super high-quality assets, putting resilient capital structures in place, having access to reserves, so that in a moment where you need to invest more capital in your transaction or where you need to, we have an opportunity, I should say, to buyback debt at a discount. And being able to capitalize on those kinds of opportunities is so important. And frankly, we didn’t have all those opportunities, and we hadn’t set ourselves up as well at —
RITHOLTZ: Really? I’m surprised to hear that.
MCCARTHY: — at Goldman. Blackstone, meanwhile, we’ll get to that, had, and that’s a big part of how Blackstone has been set up for so much success in the decades that followed. But I would say —
RITHOLTZ: Let me interrupt you one sec.
MCCARTHY: Yeah.
RITHOLTZ: So everything you described are the sorts of things that you would imagine, everybody should be prepared for does. And I’m kind of surprised to hear that one of the largest and savviest shops on the street kind of wasn’t prepared for it. Is that the sort of thing that the lesson we learned from it? Is that the takeaway? Obviously, Goldman has so many different moving parts, and the derivatives group on that side might be working across purposes with long-term real estate investment on this side. So hold that aside.
But is the takeaway from the financial crisis that you have to be resilient, you have to have reserves, you have to purchase assets that are robust enough that they can withstand a beating, and you have to have enough dry powder that when these opportunities come along to buy high quality assets at distressed prices, you have to be ready to jump?
MCCARTHY: I think you pretty much have it, Barry. I mean, I think about, for example, Blackstone’s track record. We’ve been investing in real estate for over 30 years. And then our opportunistic funds, so these are the funds where we’re trying to generate higher returns for customers in a relatively short hold period for the assets we buy for them. We’ve had 16 percent net returns on all of the capital we’ve invested over 30 years.
RITHOLTZ: 16 percent annually, net of fee?
MCCARTHY: Net IR — net of fees.
RITHOLTZ: Are we going to get a red flag from a compliance, or is that an official statement we could use?
MCCARTHY: It’s in our public statements.
RITHOLTZ: Oh, that’s — so —
MCCARTHY: It’s our opportunistic real estate strategy.
RITHOLTZ: 16 percent per annum net of fees 30 years.
MCCARTHY: Net of fees over 30 years.
RITHOLTZ: That’s an amazing return.
MCCARTHY: It’s an amazing return. And when you look across that and what I always think about is there were a lot of different kinds of environments we were investing in, things that felt great, things that felt really terrible, things that felt good when we bought real estate and didn’t feel so good a couple years later perhaps. But what you just touched on is what I think is most important, you can’t control the environment you’re in, but you can control the decisions you make leading up to that and through it.
RITHOLTZ: That’s good.
MCCARTHY: And the things that I think really distinguished what we were able to do at Blackstone and what got us to the other side of the financial crisis in a way most real estate investors did not were these things; good assets, resilient capital structures, access to reserves, access to new capital to go on the offensive, and take advantage of moments where there’s distressed pricing for our customers.
RITHOLTZ: So you’re at Goldman and you’re looking around at the end of the financial crisis, and you’re aware of, hey, we missed opportunities here. This could have been a little tighter. This could have been a — and you run into Blackstone, and it’s like, wow, these guys — I wish we had that where we were, how do I get involved with that?
MCCARTHY: It’s interesting. It was a little — it came out I think a little differently than that. I would say is I had an amazing experience at Goldman, including, I’d say, the learnings that I had an opportunity to access through the financial crisis. And particularly getting those learnings at a relatively early part of my career I think is so important. What really got me thinking about doing something different was just, you know, was continuing to learn? Was there a will to keep investing in real estate, having had some of those traumatic experiences as a firm?
And I felt like I wanted to make sure I was in a place where I personally was not treading water, and I had an opportunity to keep learning. And I knew that I wanted to continue to be in real estate, I was not sure exactly in what aspect. And I was actually quite surprised when Blackstone reached out to me about a role to work with institutional clients and do capital raising and investor engagement. And I was surprised, mostly, because I had no experience with that at all. I had come at Goldman, almost all of our capital had come from high net worth clients. Also, I had done acquisitions. I didn’t have investor experience, really.
And what Blackstone was just kind of, I think, looking at it a little differently and saying, if there’s a person who understands real estate and can understand markets, but also can you help our clients understand better, what are we doing with their capital, or if they’re not yet a client, why —
RITHOLTZ: Should they be?
MCCARTHY: — is what we are offering compelling? There could be an interesting match there. And I think just generally feeling like we — and probably our performance was strong for the financial crisis. We were able to open doors and keep open doors with clients. But it was all about stewarding those relationships, and how do we do that better.
And so what got me ultimately really excited about the Blackstone opportunity was not so much that I had any confidence that I want to do investor relations, or you know, that was going to be my long term career destiny. It was that I wanted to work with these people who were really focused on doing a great job not only through the investments they made, but through the interactions they created with their clients. And I felt like that move would allow me to continue to learn and grow, and frankly, diversify my skill set so I’d be better set up to be a leader in a bunch of different capacities in the future.
RITHOLTZ: So let me ask you a very obvious question. You shift from high net worth individuals. And no matter how high net worth they are, they’re individuals. They react to markets. They can be emotional. I remember, I have a vivid recollection in the midst of the financial crisis, the news flow was just really — and we were on the right side of it, but it was so relentlessly negative. Even people making money in the downturn were unhappy of it.
And then you shift to institutions that have a much longer time horizon and a very different headspace, even though there are individuals at those various endowments, institutions, what have you. How does the energy and the vibe and the conversations change? Is it still people are people and they’re freaking out? Or, hey, we have a perpetual lifespan, and so we don’t care about next quarter, we care about next century? Am I exaggerating or —
MCCARTHY: Well, I would say I think for all investors of any type, whether it’s size, or whether you’re an individual investor, or institutional investor, really what matters most is performance. In the end, and especially we as a manager, if we can show up and say we continue to generate great performance on your investments, it could be any kind of client on the other side of the table. That is what’s most important.
RITHOLTZ: That itself is a lot of pain. Yeah, I can imagine.
MCCARTHY: That is what’s most important. I think, from my perspective, the biggest difference, and this may evolve over time, but the biggest difference between an institutional client so that state pension plan or charitable foundation or university endowment versus an individual investor, I think, for the most part, institutional investors have decided that they want and need real estate to be a core position in their portfolio in and out of cycles.
RITHOLTZ: Right.
MCCARTHY: And that’s because real estate in strong economies can generate a basically very strong alpha in weaker times or in an inflationary environment we’re in right now. For example, as a real asset, a hard asset, it preserves value as cost to replace those assets go up. It’s a cash flowing asset where you can remark your rents to market in a rising cost environment. And so I think those institutional investors are really committed to real estate.
Individual investors, for the most part, have not yet determined that real estate is something they want to need to leave as core to their portfolio in and out of cycles. I think that is changing. And I think in particular, when you look back to environments similar to what we’re in now, where you see rising interest rates, persistent inflation, you think about how well real estate has performed in those moments. I think individual investors are starting to appreciate, you know, how attractive this is as a part of their portfolio. But that is a different kind of approach to portfolio construction.
RITHOLTZ: And for individual investors, I always run into the — when we discuss real estate, I find I have to say stop focusing on individual homes. That’s just one tiny aspect of real estate. You have to think in broader longer terms and commercial sides, not your neighbor’s house sold for $30,000 less than expected. Let’s talk about warehouses. Let’s talk about farmland. Let’s talk about things that it doesn’t matter necessarily what the economy is doing. People got to eat. Goods are still being moved around the country.
MCCARTHY: A 100 percent. I mean, I think separating the for sale residential market from for rent commercial real estate, including rental apartments is so important. These are different things. And I think you can’t just mark what’s going on in the single family for sale housing environment with what might be happening in warehouses, or rental apartment complexes, or office buildings, et cetera.
RITHOLTZ: Quite fascinating.
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RITHOLTZ: So let’s talk a little bit about your team that you run, how large is the real estate team at Blackstone?
MCCARTHY: The real estate team at Blackstone is about 900 people globally.
RITHOLTZ: Wow. That’s a big chunk of the firm.
MCCARTHY: It’s a big chunk of the firm. And I think what actually that understates is the impact we have through all of the portfolio companies we own in our funds. So we own 55 portfolio companies, and that really forms a huge extension of what we’re able to do, and then also see in terms of people on the ground across the world operating in specific real estate sectors, and then sending back the information they’re working with every day.
RITHOLTZ: So when you say portfolio companies —
MCCARTHY: Yup.
RITHOLTZ: — I immediately think of like Vornado, or are you talking about specific privately held companies who themselves own lots of various commercial real estates?
MCCARTHY: So these are specific privately held companies by our funds, and these are companies that for the most part, we own and control 100 percent of the company.
RITHOLTZ: Oh, really?
MCCARTHY: And sometimes we buy companies and then continue to help grow them by new asset acquisitions, or just growth in their cash flows. In other circumstances, we will build up companies through a series of smaller acquisitions. So an example would be in the U.S., we’re one of the largest owners of warehouse properties. We have a company called Link Logistics and owns about 400 million square feet of warehouses.
RITHOLTZ: Wow.
MCCARTHY: That is a company that we have built through a series of acquisitions. We identified a world-class management team, and we said we want to build a great company. But we’re not doing it through just kind of one acquisition of one company, we’re going to build it up through a series of transactions.
RITHOLTZ: And the idea is as things grow, there’s massive economies of scale and expertise. And what might have been a reasonable investment at 1x, when it becomes 100x, it becomes a very, very different experience.
MCCARTHY: I would say yes. And I think one of the things that’s so important about the scale of these businesses and the scale of our business together across all of these companies and our funds is that we have a huge information advantage. We get data real time proprietary to us constantly, coming off these businesses, and it really helps us make better decisions that you otherwise would be able to do if you didn’t have access to this.
And so rather than wait for a research report to tell us what’s really happening in apartment rent growth or in new leases for warehouses in Northern Europe, we’re getting those data points real time. And that can help us inform on whether we’re going to buy more of something, want to sell something, pivot how we’re managing assets. And those are all just important decision-making tools for us. You know, so much of what our work is, is not just mine real estate, but it’s all about what is the value we can create? How can we grow cash flows?
Most of the time how you make money in real estate is growing the cash flow. And those data points coming from all across the world in what’s really happening in these assets, how are our tenants making decisions, help inform those strategies as well.
RITHOLTZ: I have heard from a variety of different companies that their internal data creation and analytics is just a huge thing. It used to take like a year or two, you get reports out back from the field, what’s selling, what’s not selling, what’s rising? Now, it’s almost real time. It’s almost instant.
MCCARTHY: Yeah. We definitely benefit from that. And I think we have the good fortune that there’s been a heritage kind of from day one of using insights that we uniquely have access to. And the technology, infrastructure around that has definitely improved. It’s needed to improve at our scale for us to really be able to use all that information.
But I think, you know, even just 12 or so years ago, when I joined the firm, you’d have senior professionals with legal pads, taking notes and meeting, saying, what did we just learn from that sale? Or how many people were in our process? What do they want to pay? And using those notes to kind of inform the thinking around next investment choices —
RITHOLTZ: Not exactly cutting edge?
MCCARTHY: Not exactly cutting edge. But I think this is one of the things that is so special about not just a real estate business so far, so but really about our whole firm, is the way we not only use data provided to us through tools, but also we’re in constant conversation. I mean, we are a meeting heavy culture. We are a conversation heavy culture. And so much of that is about harnessing information and insights people have that can help make those decisions.
And it’s how we built our investment committee process, one global investment committee, where you’re drawing insights and expertise from around the world. It’s just trying to say, okay, we have access to advantages through information that others may not, and let’s use that rather than kind of risk that that just stays on the sideline.
RITHOLTZ: That’s really interesting. So let’s talk about market timing. You’re a fantastic market timer. And what I mean by that is you joined Blackstone right at the tail end of the financial crisis, when real estate was the worst it’s been in decades. And from there, you’ve had the wind at your back for a dozen years. So I have to ask a silly question, how much of what’s happened the past 12 years has just been spectacular timing? And how much of it is just recognizing, hey, things are very cheap, financing is inexpensive, now is the time to get aggressive?
MCCARTHY: Well, I would say timing can matter. And we’re definitely in a moment where we think dislocation in the market is going to create interesting buying opportunities and values that are going to feel like very attractive bases. But I would say —
RITHOLTZ: In the future, or are we there yet? We’re not there yet?
MCCARTHY: We’re getting there, but not quite there yet, I’d say.
RITHOLTZ: Okay. 7th inning, 6th inning?
MCCARTHY: I don’t know. I’m really bad with the —
RITHOLTZ: How can you — I want you to tell me Tuesday at 11:43, back up the truck.
MCCARTHY: If I knew that, I would share that with you, Barry. But you know, I would say the general idea of like market timing, it can be helpful, of course, to pick your really interesting moment to enter a market by company buying asset. I would say, though, if you look at the history of Blackstone real estate, some of our best investments were made at the worst possible times.
RITHOLTZ: Of course.
MCCARTHY: I mean, Hilton Hotel is always the example we give. You could argue buying that in 2007 was the worst possible time. But going back to what we were talking about earlier, we bought a great company. There was —
RITHOLTZ: But they were fairly distressed in ’07, weren’t they?
MCCARTHY: No. No. When we took the company private, it was definitely not a distressed company.
RITHOLTZ: Okay. I’m assuming that.
MCCARTHY: But what we were excited about was the ability to grow the company and really capitalize on its ability to grow in a capital light way. And by bringing in an incredible management team led by Chris Nassetta, we were able to help propel the growth. And we were excited about that from day one.
RITHOLTZ: Despite the timing?
MCCARTHY: Well, we then hit the financial crisis, and there were a lot of really dark days. And I think if we did probably an article search right now, you’d have found a lot of prognosticators in 2008, ‘09 and ‘10 saying, you know, this was going to be a terrible black spot for us. And it ended up being —
RITHOLTZ: But all this goes back to exactly what you said.
MCCARTHY: Right.
RITHOLTZ: Buy robust properties in a good structure, that can tolerate —
MCCARTHY: A 100 percent.
RITHOLTZ: And if it survived that hurricane —
MCCARTHY: Right. And it became the most profitable private equity investment ever made and — it is true.
RITHOLTZ: Is that true? That’s amazing.
MCCARTHY: It’s amazing.
RITHOLTZ: I may not know that.
MCCARTHY: So that’s why, again, buying in more distressed environments, definitely helpful. But it’s not really the only way to find success —
RITHOLTZ: Sure.
MCCARTHY: — I think in anything. And to your question about when I joined Blackstone and what’s been happening, the way I think about the last 12 years for me and for our business, it’s really that story of what happened coming out of the financial crisis, and the fact that during that period of time, most real estate companies struggled to return capital to their investors, let alone generated profit.
And Blackstone’s funds through that period, generated substantial profits because we had made those good choices, not just about the investments —
RITHOLTZ: Right.
MCCARTHY: — but the capital structures, about the reserves, about having dry powder. And when we got to the other side of the financial crisis, our clients really trusted us to start doing more for them than just those opportunistic funds I was talking about.
RITHOLTZ: Right.
MCCARTHY: And that has given us an opportunity to serve more clients, and with more products that access more parts of the real estate market than just those opportunistic strategies I talked about before.
RITHOLTZ: I have used the phrase financial crisis, PTSD, and in no way being disrespectful to people who actually suffered PTSD in combat, or whatever. But everybody who came through that felt the — use the phrase trauma. But you’re now saying something even more interesting, which is, when you come through that intact, and demonstrating an ability to navigate that environment for your clients. At that point, hey, we want to go pedal to the metal, they open up the floodgates and say if you survive that craziness in a normal economy, whatever you say, go with it. How does the trust that’s built up over that time get put to use following a crisis like the GFC?
MCCARTHY: Well, I’d say really in two ways. One is that our clients have given us more capital. And I think many clients came through the GFC deciding rather than sprinkle their investments around with a lot of managers —
RITHOLTZ: Right.
MCCARTHY: — they would want to do more with their more successful managers. And we’ve definitely been a beneficiary of that. I think that trust has also allowed us, like I said, to expand into different types of real estate. So really, so much of our focus today is on growing and expanding our core-plus business. This is real estate that has a very stable cash flow profile, where we’re able to generate compounding returns over time by adding value in assets that we want to own for long periods of time and structures that allow us to do that. And we’ve done that more and more for institutional clients. We’ve expanded to doing that also for individual clients. And it’s really that trust from the good performance in tougher environments, and really any environment that allow us to do that.
RITHOLTZ: So I want to put a little context around the $565 billion in commercial real estate assets that you guys own, globally. What is the real estate market, something like $100 trillion?
MCCARTHY: I think it’s like three times that. It’s like —
RITHOLTZ: Oh, really? So —
MCCARTHY: Yeah. And — but — and that’s why —
RITHOLTZ: Because where I was leading to is, hey, at what point does this get too big? At what point are you picking B deals, or C deals? $300 trillion versus half a trillion, I’m assuming that means you have a ton of headroom to just keep growing this.
MCCARTHY: That’s how we feel about it. I mean, the real estate market is so widely held. It’s in so many places. There are so many different opportunities. And interestingly, we should come back to this, but the opportunity has changed, right —
RITHOLTZ: Sure,
MCCARTHY: — and based on kind of how people are using assets. And so we feel like there are plenty of opportunities that we can create. And I’d say, again, our capital also is structured in a way that we’re never under pressure to deploy capital. And this —
RITHOLTZ: You can sit in cash and nobody complains?
MCCARTHY: And this is part of the trust, right? It’s the structure the investors give you in terms of the flexibility of when you draw their capital to deploy into opportunities and what those look like. We have a lot of flexibility in our capital to move across sectors, to move across geographies, to wait to deploy the capital that they have committed until we find great opportunities. That’s all our relationship built on trust. But it also means that we can be patient.
RITHOLTZ: So do you do, hey, someone says I’m going to give you a billion dollars, here’s $100 million, and you do a capital quorum on balance as deals come up? Or do they shovel all the money to you and you have to find a home for it until the correct opportunity comes along?
MCCARTHY: I would say the vast majority of our capital, it’s the former, where you —
RITHOLTZ: There’s a capital call as needed?
MCCARTHY: There’s a capital call as needed. Exactly.
RITHOLTZ: And that’s got to help ROI. It’s going to make numbers look really good because you’re not forced to make a decision, because you don’t want to sit there earning half a percent.
MCCARTHY: Yeah, absolutely. And more than anything, you don’t want to be ever in a situation where you’re either a forced buyer or forced seller.
RITHOLTZ: Right.
MCCARTHY: And we set up all of our structures to make sure that we’re able to generate continued great performance by deploying capital to great opportunities when we find them. And then also selling when we think the opportunity is right now because we’re forced to do so.
RITHOLTZ: What’s the great Warren Buffett quote? The difference between baseball and investing is there are no called strikes. You could just sit there with a bat on your shoulder and wait for the pitch you like, and there’s no — they’re calling strikes on you. You can really be patient, and it has to make a huge difference.
MCCARTHY: Patience matters a lot.
RITHOLTZ: To say the least.
I’m Barry Ritholtz. You’re listening to Masters in Business on Bloomberg Radio. My extra special guest today is Kathleen McCarthy. She is the global co-head of real estate at Blackstone. They manage over $565 billion in real estate investments around the world.
So let’s talk a little bit of what’s going on today. There’s a quote of yours that I found really fascinating, “We are entering this tougher economic moment with capital and with cranes, more in check than they have been in prior cycles, and I think that positions our real estate assets to do quite well.” So I love the idea of capital and cranes and check. That’s a great phrase. You’re referring to people waiting to invest, and people waiting to build.
MCCARTHY: Well, I think where that quote came from, it’s just the concept that most real estate down cycle, so periods of time where real estate is under more pressure from a performance perspective, come about because there’s been a lot of new capital often lent to people who then go build speculative real estate, and speculative, meaning that —
RITHOLTZ: Right.
MCCARTHY: — they’re building an office building without a tenant in mind. And oftentimes, what you’ve seen in prior cycles is that the market gets really nice and healthy. People are really happy with performance. Lenders get more comfortable, they lend. Folks provide equity to new projects. You end up with a lot of construction. And something happens, either there’s been too much construction, or the economy softens. And then real estate is under —
RITHOLTZ: The rates go high.
MCCARTHY: And when real estate is under pressure because there’s been too much capital and too many cranes.
RITHOLTZ: Right.
MCCARTHY: And I think what feels very different about this moment is that we really never got back to those more heady levels of lending and more significant amounts of new construction prior to, for example, the Fed responding to inflation and interest rates. And so we’re heading into whatever we’re heading into, with record low levels of vacancy. Relatively, I’d say disciplined capital structures. That’s not to say people won’t be under pressure from either debt service coverage challenges or loan-to-value challenges.
But I think the combination of as you talked about some of the learnings from the global financial crisis, some of the restrictions on banks, I think also we can’t underestimate how COVID did create an interruption to, you know, what was a very healthy market —
RITHOLTZ: To say the least. Sure.
MCCARTHY: — and probably changed things in terms of not every project that was ready to go was put into production in the summer of 2020, for example. And so what we’re seeing on the ground now is that fundamentals, particularly in our preferred sectors, which our biggest sectors are warehouses. That’s 40 percent of our portfolio globally —
RITHOLTZ: Really? Wow.
MCCARTHY: — and rental housing. Some very strong —
RITHOLTZ: Rental, I like to see. I had no idea logistics and warehouse were like giants.
MCCARTHY: Yeah. We are high conviction investors, and we pick themes that we think are really benefiting from the way people are living and working and shopping, and just mega trends. And so starting actually in 2010, we started buying warehouses, not I think, at first, even recognizing what was happening with e-commerce. But like I mentioned, we pay really careful attention to what’s happening in our portfolio, and we started to realize what e-commerce was doing to drive demand for warehouse space. There was a fundamental shift that started happening historically. Warehouse performance just track GDP performance. It was basically a 1 to 1 correlation. And what —
RITHOLTZ: Warehouse performance track GDP 1 to 1.
MCCARTHY: Yeah.
RITHOLTZ: Okay.
MCCARTHY: And then what you saw is, with e-commerce demand and the shift, you know, moving goods online —
RITHOLTZ: Right.
MCCARTHY: — it just changed. It just totally changed.
RITHOLTZ: What is it now? Is it 2 to 1? 3 to 1?
MCCARTHY: You know, I don’t know how —
RITHOLTZ: But it’s more than 1 to 1?
MCCARTHY: But it’s definitely more than 1 to 1. And I would say again like — but going back to the point of cranes, there has been new supply, but it really has not kept up with the explosive growth in demand for warehouse space, particularly in urban areas, so what we call some of last mile logistics. So where are the warehouses closest to the densest population centers, those assets are in demand because of e-commerce, retailers wanting to get things to people in the same day or within a few hours even. We’re also seeing really the impact of reshoring and realignment of supply chains. A lot of the demand —
RITHOLTZ: And that’s ongoing, right?
MCCARTHY: And that is ongoing. And that is — both of these phenomena are global. One of the most interesting things is these are often global stories, these themes. The mega trends are rarely isolated to just one economy. And so when you think about the performance of our warehouse portfolio in this year, it’s been some of the strongest fundamentals that we’ve seen. And you know, things are softening in certain pockets, but it’s still really benefiting from that lower new supply environment.
RITHOLTZ: You mentioned the pandemic. First, Blackstone, are you guys hybrid? Are you in the office? What is your —
MCCARTHY: We’re fully in.
RITHOLTZ: Really?
MCCARTHY: We’re in in five days.
RITHOLTZ: So that’s really interesting because I wanted to ask the question, Bloomberg, this is a big building. It’s hybrid, but they’re encouraging people to be in more often. My own office, we’ve kind of always been virtual. And we tell people, we do a Monday morning meeting, which you can call in on. But we ask people to come in the office one or two days a week. I’m hearing more and more offices are moving to a hybrid, with an anchor day. So all of this back and forth is really what will cities look like post pandemic. Is there going to be a huge piece of the commercial office space that’s going to suffer from some form of a hybrid workforce?
Because it doesn’t feel like we’re ever going back to every office in every city five days a week. You guys are an exception. Most companies are not full five, it’s three and two, or four and one, or two and three. Like, five days a week is kind of a rarity. I know Jamie Dimon wants everybody back in Chase five days a week, but it ain’t happening.
MCCARTHY: We come at it, I think, as part of a mission orientation, which is we have this incredible responsibility from our investors to do the absolute best job we possibly can with their capital. I need to —
RITHOLTZ: That’s such a smart thing to say, can I tell you? Because as much as the younger generation loves the hybrid workforce, hey, we’re stewards of capital and our clients expect us to be here every day.
MCCARTHY: Yes. I mean, and so many of our customers as well, I would say, are our frontline workers and emergency workers, and teachers and firefighters.
RITHOLTZ: Right.
MCCARTHY: And so I feel like —
RITHOLTZ: They have no choice.
MCCARTHY: — how can we say, okay, you all need to be at work every day. You’re protecting us, teaching our children, but we’re going to be hybrid and not necessarily deliver the best we possibly can.
RITHOLTZ: Nobody wants their money manager in their pajamas in their fuzzy slippers —
MCCARTHY: Correct.
RITHOLTZ: — when they’re responsible for billions of dollars.
MCCARTHY: It’s a huge responsibility. And I would say I also personally think we have a huge responsibility to our own team, to training and learning. I mean, I’m learning and training all the time. And I think about it a lot like all the research on children in school, right, the learning loss from children not being in school.
RITHOLTZ: It was devastating.
MCCARTHY: It’s the same thing in a workplace, where all they’re learning and then doing better. And so I think being together is so important. Now, I would love to convince everyone in the world that being back in five days is really, you know, the right thing to do for the whole ecosystem, the economy around where you work, and your own professional development and your customers experience. I firmly believe it.
But I would say as we think about what is happening in the broader world and how that’s impacting office demand, I think we’re in an era of experimentation. We believe that the office in some format and for some periods of time in a week, will continue to be a really critically important part of culture for organizations and corporations. And what we’re seeing happening is really, actually, I’d say, an acceleration of a trend that was started pre pandemic. I mean, it’s so interesting. COVID really did accelerate so many trends in so many
ways.
RITHOLTZ: Right. Technology, remote work, cloud —
MCCARTHY: Totally.
RITHOLTZ: — and all that just — it’s funny because when we launched our firm, we had a national footprint, but we were New York based. So all the things that we’ve been doing during COVID, we started in 2013.
MCCARTHY: Right.
RITHOLTZ: And I was shocked in, like, 2020, people discovered Facetime. And it’s like, you know, that this technology came out in 2008. This is not a — but it was a massive — it feels like the pandemic brought 2030 forward a decade.
MCCARTHY: I think in many ways. And in different — if different sectors for real estate, it feels like whether it’s like three years of acceleration or 10, it’s definitely that pull forward. And what I’d say for office buildings, if we had met in 2016, let’s say, one of the things I would have probably called to your attention is the fact that so many office buildings, particularly whether you think that the lobbies or the amenity floors for tenants, it started to feel more like a hotel. I mean, look at this beautiful Bloomberg building with the food.
RITHOLTZ: It’s crazy, right? It really is.
MCCARTHY: I mean, first of all, it’s a beautiful building. And then you have your food and amenities, and I don’t know if you have a fitness center, but so many buildings now do. All of these —
RITHOLTZ: The pool off on the roof, it’s unbelievable.
MCCARTHY: All these things to really attract people into the office and to create a sense of community while they’re here.
RITHOLTZ: Culture, community —
MCCARTHY: Culture.
RITHOLTZ: — and collaboration, that’s really — the fascinating thing about this building is kind of designed the way the original Pixar building was designed, and ultimately the Apple spaceship, which is everybody comes in the elevators through the sixth floor no matter where you work, because it just creates these random interactions.
MCCARTHY: Right.
RITHOLTZ: And you’d be amazed how often things spiral from that, that collaborative — forced collaboration. It’s really a very impressive thing as it works.
MCCARTHY: It’s super important. And again, that goes — that feeds our theory that the office is definitely going to continue to be a part of culture, and building culture, and creating more from the team you have.
RITHOLTZ: So wait, let me interrupt you again. So the consensus seems to be, hey, I want to invest in real estate, but not offices. Their distressed offices are going away. Put me into hospitality or farmland, but no office space. You guys aren’t buying into that?
MCCARTHY: Well, I would say for office specifically, or what is known as traditional office, we’re seeing a real bifurcation in demand between — with really the greatest man going to the highest quality, newest, best amenitized, most sustainable office buildings. And New York is, you know, a perfect example, I think, of what is happening. The office stock in New York is very old compared to another city.
RITHOLTZ: There was a giant — I don’t remember if it was New York Times or Wall Street Journal article, I think it was the Times, about all of this real estate along Park Avenue that were built in the 50s, ‘60s, ‘70s and have none of the amenities that modern clients want today.
MCCARTHY: And I think it goes beyond amenities. It’s also the ability to create flexible space, and create open spaces that you can move and change as your company’s needs change —
RITHOLTZ: Right.
MCCARTHY: — gathering places. And so I think that is a real challenge for older office buildings. In New York, the average age of an office building is 67, average.
RITHOLTZ: Really?
MCCARTHY: So — and only about 7 percent of the office stock in New York is less than 10 years old.
RITHOLTZ: Wow.
MCCARTHY: And listen, you don’t have to be less than 10 years old to get the demand. But I would say we’re seeing those assets attract much more demand at higher prices. And so we think those are going to come out as more winners in this kind of this trend change.
RITHOLTZ: Meaning newer flexible space.
MCCARTHY: Newer —
RITHOLTZ: So you want little to do with the older spaces. At what point you take a 60 or 70-year-old building and say knock it down, put up a new one.
MCCARTHY: Well, I would say these traditional office assets have been a relatively small part of our portfolio for a while. Because going back to our thematic investing, our portfolio is 80 percent concentrated in warehouses, rental housing, lab office space and hospitality asset.
RITHOLTZ: Lab — so we’ll get to hospitality.
MCCARTHY: Where biomedical research is happening.
RITHOLTZ: Is that substantial enough that it’s an asset class and you’re — because I would imagine there’s a lab here, there’s a lab there. You’re seeing this is much more substantial?
MCCARTHY: Much more substantial. And actually, what I think is super interesting is that there are a few critical nodes in the world, there’s — they say our whole portfolio is concentrated really in five —
RITHOLTZ: Massachusetts.
MCCARTHY: — Cambridge U.S., Cambridge U.K., South San Francisco, Seattle, San Diego, and actually now Boulder, Colorado is emerging. But these are — like, we sometimes described them as kind of the pulsing heart of research. And there is not enough space, actually, for all of the demand —
RITHOLTZ: Wow.
MCCARTHY: — from biomedical tenants in these places. And like, how did we even come upon this theory and why this versus traditional office? I mentioned 2016, ‘15, going back to that period of time, when we started recognizing, wow, your tastes and trends are changing a lot for more traditional office assets. And we were quite concerned actually, to your question about if you have an older office building, it could be quite expensive to try to repurpose it —
RITHOLTZ: Right.
MCCARTHY: — reconfigure it to really attract tenants that are great, you know, the best tenants in the world. And so we started thinking, okay, if office is going to be under pressure, are there segments or sub segments of the office market that we think will do better? And what we started to realize is that there was all of this capital and really a changing tide in terms of the research demand and dollars being funded into it. Everything from immunotherapies, which of course now we all know a lot about things, the pandemic genomics, Big Data intersecting with personalized medicine, and a change also in how and where this research was being done.
Like, if you think about — when I was growing up, all of the big pharmaceutical companies had these corporate campuses that were highly securitized, deep in suburbs. And what started happening is all of those researchers said we want to be in cities, adjacent to some of the best research institutions in the world. And companies needed to be where their talent wanted to be.
And so we, in 2016, took private, a nearly $9 billion company called BioMed —
RITHOLTZ: Oh, sure.
MCCARTHY: — and really concentrated the business in those best markets, and then helped to grow. One of the great things about having the capital we have access to is that we were able to help continue to grow their footprint in those different cities, and then therefore serve the tenants that we think are the most attractive in that space. And so that is an example of why you can’t just paint the whole office market with a broad brush.
RITHOLTZ: Right.
MCCARTHY: Lab office was never a darling of real estate investors until the world changed, and the nature of the research happening, the volume of it and where it was getting done changed. And we — I think we’re at the forefront of really participating in that for our investors because we were looking for, okay, what is the mega trend and what’s changing in the world?
RITHOLTZ: That’s totally fascinating. The lab stuff is really — I had no idea it was that huge. You can see, obviously, labs are large and important. I just didn’t know it was large enough to be a substantial asset class. The other area you have been very enthusiastic about is hospitality sector. You guys are super bullish on that.
MCCARTHY: We have been long believers in hospitality. And part of this is just a very long term growing demand trend for hospitality, for experiences, for travel and tourism. If you look at just about any graph of demand for air travel, demand for hotel room nights, whether it’d be leisure or business, you’ve seen a long term trend up into the right and pretty much only interrupted in a meaningful way by COVID. And the great news, I think, if you’re a hospitality owner is that you’ve seen a very strong bounce back. In fact, I think demand for our hospitality assets, it’s well exceeding what we saw in 2019. So we remain very enthusiastic about it.
Now, hospitality assets are a more operational asset class. When you think about it, if you have a warehouse or rental apartment, you have very limited exposure to labor costs, very limited exposure to capital costs. And so in inflationary environment, your cash flow growth can be more robust in those asset classes because you can really see top line rent growth pushing through to the bottom line cash flow.
In a hospitality asset, it can be more challenged. But I think the good news is that is something that we have a lot of experience with. And we have the opportunity as a private investor to work into our underwriting as we’re thinking about buying assets, recognizing the environment you’re in, recognizing higher costs. And so we remain really attracted to attaching ourselves to the growth in demand for that asset class.
RITHOLTZ: So let’s talk a little bit about the structure for hospitality because I suspect a lot of people may not understand when they look at a hotel, any of the big brands were Hilton, whatever. Very often individual hotels are owned by separate people, but the management company comes in and it’s of the same management company. But every hotel might be distinctly owned by a separate investment group, individual owner, family owner. How does that challenge your investment process?
MCCARTHY: We’re, first of all, very accustomed to operating in a world where we may own like we did with Hilton, both the real estate and the brand on it. We’ve actually seen a lot of opportunities in something like that to basically grow the brand and those franchises, even on to real estate that the company may not own. And then there’s other circumstances where we just own the asset, and we work in partnership with a brand to help us operate and brand it. And I would say there’s great power in great brands, in real estate, you know, just like any other segment of the economy.
One of our hotel companies that we own today is something called Great Wolf Lodges. Many of your listeners may have been there. It’s waterparks with hotels, and these assets are located within a couple hours driving distance of something like 90 percent of the U.S. population. And it’s a very affordable, attractive drive to destination vacation for families. And so that’s an example where we’ve reinvested in a company that has a brand, and we’re really trying to propel both the real estate strategy and the brand strategy to help it be a growing and faster growing company.
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RITHOLTZ: As we’re speaking, I’m looking up the name of the hotel in the Grand Cayman that I remember collapsing early in the financial crisis because — it was the Ritz-Carlton.
MCCARTHY: The Ritz-Carlton, Grand Cayman.
RITHOLTZ: Because the underlying owner just kept leveraging and leveraging and leveraging, and somebody very smart in private equity, went out and bought up 51 percent of the debt for pennies on the dollar. And the next time they went to refinance, they said, nope, pay. Oh, you can pay? Thanks. We’ll take that billion-dollar hotel. That story is just fascinating. How often do you see sort of unusual crazy investment themes blowing up like that?
MCCARTHY: Well, I would —
RITHOLTZ: Or is that just leverage and don’t —
MCCARTHY: Yeah. I would say —
RITHOLTZ: — do too much.
MCCARTHY: — that’s a — I think, you know, it sounds — I’m a little bit familiar with that story. I’m definitely familiar with that hotel. I think it’s just an example of a capital structure that didn’t work and wasn’t prepared to withstand —
RITHOLTZ: Dead capital structure, overleveraged, too much.
MCCARTHY: Yeah, it was — and that’s something — in the hospitality space, certainly you can have cash flows that dip in a tougher environment, or if you’re not managing it well, and you need a capital structure really built to withstand it.
RITHOLTZ: You mentioned that earlier. But every time I think about a hotel that changes hands sort of in a very rapid period of time, it always feels like somebody took on too much debt, bad capital structure, not building enough resiliency to withstand any sort of change in conditions.
MCCARTHY: Yeah, definitely. I mean, in a positive way, in an inflationary environment, hotel has the ultimate short duration lease. So we talked a lot about —
RITHOLTZ: Ultimate. Right. It could be overnight, right?
MCCARTHY: Yeah. Average lease duration, one night in the hospitality world. And you know, if you’re managing it well, if you want a great asset, if you have a great capital structure, that can be a really good thing when rates are rising. But certainly, if you’re not operating it well, or if those rates come under pressure, it can be really tough if you haven’t capitalized it.
MCCARTHY: So let’s talk about related hospitality issue, casinos, the Supreme Court decision said, sorry, Nevada, you don’t get to be the only state that has gambling. How has this changed landscape for investing? Is this a growth area, or are we pretty well casinoed up in the United States or around the world?
MCCARTHY: Well, our focus in hotels that have casinos, as part of their offering, is really trying to find world-class destination resorts that have demand drivers beyond just what’s going on in that casino. And actually, our most profitable single asset investment ever was the Cosmopolitan Hotel in Las Vegas, which was an investment that we purchased from a bank that had had to foreclose and complete construction on the project. And we saw it not just as an opportunity to kind of reset and reset operations versus how a bank was handling it. But we tried — we thought really creatively about how could we turn this whole opportunity on its head, make it the coolest place as a destination in Las Vegas.
And we renovated every inch of the property, $500 million of capital invested to not only offer better guest rooms, but also, you know, an amazing set of food choices, and shows and entertainment. And when we sold it also, we had a very creative exit that found the right capital for the property itself and the right capital for the operations. And what I think is — that’s just emblematic of buying an asset that is — you know, somebody might have just said, oh, that’s a casino or casino hotel. We saw this as an entertainment destination and a strategy that we can then apply in other places as well.
We recently took private a company in Australia called Crown Resorts. And it’s really taking that same playbook of how do we transform these assets operations, in that case as well, you know, really help support a very carefully constructed compliance and legal structure around it as well. But I think it’s, for us, beyond just a casino. It’s about that whole entertainment and tourism experience we can deliver.
RITHOLTZ: So let’s talk a little bit about multifamily and apartments. It feels like since the financial crisis, we have wildly built single family homes, multifamily homes, large apartment buildings. It seems like the demand for rentals is a key driver of inflation because there just ain’t enough apartments. What does that space look like?
MCCARTHY: Yeah. I think you nailed it. As a country, we have not built enough housing of all forms since the financial crisis. Depending on how you’re calculating it, it’s something like we’re short 4 to 6 million units in housing.
RITHOLTZ: That’s unbelievable.
MCCARTHY: It’s unbelievable. And it’s a really hard —
RITHOLTZ: It sounds like a growth opportunity.
MCCARTHY: Really tough to dig out. And I would say the environment we’re in is actually making that affordability question more challenging because you’ve seen homebuilders pull back from new construction.
RITHOLTZ: Right.
MCCARTHY: It’s harder for people to afford to buy a home. Today, the monthly cost of owning a home is I think something like nationwide one and a half times the monthly cost to rent a home. And so that is driving demand for rental housing. And so that is a big part of why we’ve continued to see rental housing be so resilient. And it’s already — I would say, if you look back to prior tough periods, 2008 to 2010 is not an exception either.
I’d say rental housing tends to perform quite well in tougher economic environments. It does really well in inflationary environments as well. I mentioned the shorter duration lease, or the average lease of a rental housing or rental apartment is about a year. And so these are assets that are in great demand today, and I think you’re poised to perform well in the environment ahead as well.
RITHOLTZ: Unless anybody accuse me of suffering from home country bias, which it certainly sounds like I have been, let’s talk about around the world, where else does Blackstone see real estate opportunities outside of the United States?
MCCARTHY: So in our business, we invest not only U.S., Canada, but also Western Europe, and then across both developed and developing markets in Asia. I’d say —
RITHOLTZ: Developed meaning Japan, Korea?
MCCARTHY: Japan, Korea, Australia, and then more developing would be India is one of our biggest markets globally —
RITHOLTZ: Really?
MCCARTHY: — and then particular in Asia as well. And so — and in terms of what we like outside of the U.S., there’s a lot of consistency in the themes, I would say, in terms of logistics, rental housing, hospitality assets, lab office.
RITHOLTZ: These are all global. It’s not U.S.
MCCARTHY: These are all really global.
RITHOLTZ: Everybody is experiencing the same trends.
MCCARTHY: I would say, yeah, there’s of course nuances in different markets.
RITHOLTZ: Sure.
MCCARTHY: And in particular, rental housing is not something that exists in the same way in a lot of markets around the world. So for example, Australia has hardly any official rental housing market, the way we would have it here. It’s just beginning. There’s lots of people that own a condo and rent it out. There’s not a lot of owners who own a couple of 100 units and professionally manage it and rent it out. And so — but that’s just beginning. But that’s — you know, that’s an example of where things are a little different in different parts of the world.
But I do think, for us, one of the advantages we have of being so connected globally is this — as we talked about kind of the pattern recognition of saying, okay —
RITHOLTZ: Right.
MCCARTHY: — we had a theme in warehouses that was working really well in the U.S. Where else in the world do we see that and maybe other people don’t? And for us, that was the U.K. and Western Europe, Canada, Australia.
RITHOLTZ: Post Brexit in the U.K., because the U.K. is having a real hard time.
MCCARTHY: Yeah. The U.K. is having a hard time. But I would say we — the U.K., though, for the assets where we focus on, which our main focuses in the U.K. have been warehouses, also really affordable housing, providing affordable housing capital. Those have been the biggest parts of our investment activity, and the performance has continued to be very strong there.
RITHOLTZ: Let me ask you a challenging question.
MCCARTHY: Okay.
RITHOLTZ: So you talked about Steve Schwarzman says pattern recognition. One of the things we preach to investors all the time is don’t fool yourself with pattern recognition, meaning, don’t think that every setup is the same. And oh, this is a great opportunity, where really only looks a little bit like a previous great opportunity. How do you protect yourself against being fooled by what looks like, oh, I see this pattern when it’s not really what we all think it is?
MCCARTHY: I do think one of the like, really — I mean, I guess you could say challenging, but really fun things about investing is that the environment does change constantly. So something that worked yesterday or transaction you were able to create yesterday, you can’t create again today, or you shouldn’t maybe. And I would say one of the ways we protect ourselves goes back to this process where it is highly collaborative process and we’re bringing together insights from all around our business.
And I would say we force a lot of connectivity and collaboration between our investment team and our asset management team who is with our portfolio companies every day creating value. And so what that allows us to do is, I think, spot as early as you probably possibly can, where things might be changing, where those conditions are changing. And it’s not always that something has turned negative, it just may be less positive.
So an example of this would be, you know, just to keep going back to the warehouse example, the e-commerce revolution, and reshoring, and supply chain realignment has really propelled demand for all types of warehouse space. But where it has driven the most rent and cash flow growth is in these more urban areas that are more supply constrained almost by nature, less land available —
RITHOLTZ: Right, right.
MCCARTHY: — and more demand because tenants really need to be there, both to access their customers and to reduce the cost of transportation and labor to move goods around. And so we pivoted our portfolio to focus on those markets and assets in those markets, away from other elements of the markets that are again doing well, doing fine, but just not growing as quickly. Our job, we feel, is to end up in the assets with the best possible performance. And I think that leads to shifts that might feel, you know, a little nuanced or a little minor at that time, but ultimately lead to much better outcomes.
RITHOLTZ: I feel like I’m getting real estate education like no other. If we’re talking about real estate of all sorts, and capital structure, we obviously have to talk about the cost of capital and interest rates. Where you guys sit, the Federal Reserve is obviously really important. Jerome Powell is in the midst of an unprecedented rate hiking regime. How do you look at what’s going on with the Fed?
MCCARTHY: Well, I would say this is an environment that we feel like we’ve been preparing for, for a long time.
RITHOLTZ: For 40 years, we haven’t seen anything like this since ’82, ‘81.
MCCARTHY: Yeah. And I would say going back seven or eight years, maybe a little more, we were spending a lot of time thinking about, okay, how do we get ourselves invested in assets that are going to perform well? Should we be in a higher inflation, higher interest rate environment?
RITHOLTZ: The last interest rate spike we saw was mid-2000s, leading up to the financial crisis. But that was nothing like ‘21 and ‘22.
MCCARTHY: No. And again, it wasn’t that we called this environment. It was more just a recognition that we had been in a very persistently very low interest rate, very low inflation environment. And we started talking with our investors and amongst ourselves about, okay, you know, what happens in a world with higher rates, higher inflation, maybe sustained geopolitical uncertainty, it feels like?
RITHOLTZ: So you’re just war-gaming different scenarios?
MCCARTHY: Just different scenarios.
RITHOLTZ: Yeah.
MCCARTHY: And when you think about —
RITHOLTZ: Smart.
MCCARTHY: — at the most simplistic level, the way you value real estate, the way you make money in real estate, is it’s a combination of your cash flow and the multiple you can put on that cash flow. In real estate parlance, it’s the inverse of a multiple cap rate yield, people think about in yields. By the way, when I’ve switched from M&A to real estate, I spent basically 18 months, in my mind, just converting yields into multiples because I learned — relearning the lingo of valuation.
RITHOLTZ: It’s the same thing, you’re just looking at it from different perspective.
MCCARTHY: Different perspective, just flip it around. And so what we think about is that if you have an environment like the one we’re in, where there’s upward pressure on interest rates, therefore upward pressure on cap rates, or said like another way, downward pressure on multiples. The way to mitigate that is through cash flow growth because you want to be in assets where you can grow cash flows, both because as a matter of what’s happening in the economy, the wind might be at your back, and also because of what we can do with our interventions for value creation.
And that is a big part of how we ended up with this very concentrated portfolio in warehouses and rental housing, and lab office and hotels, where you have short duration leases. So as rents are going up, you can capture that higher rent growth.
RITHOLTZ: Right. Like shorter duration bonds?
MCCARTHY: Like shorter duration bonds. Exactly. Also, the vast majority of those assets, as I mentioned, have relatively low input costs. So you’re not as exposed to higher input cost pressure in an inflationary environment. And again, you may have headwinds in terms of what’s happening with rates or what’s been happening with cap rates, but you can still perform well because of the cash flow growth you’re able to generate.
And there’s — you know, we’re not just I’d say making this up, there’s precedent for it. If you look at — if you look back to, I think, it’s 1978 to ‘82, the last time we were on, you know, a significant rate hiking cycle, you saw that rental growth in apartments kept up with inflation, even though actually interestingly, supply was 2x what it is right now. This is part of why we have confidence.
RITHOLTZ: Really?
MCCARTHY: Yes. You can also look in U.K. because I think it was between 1970 and 1980, real estate return is something like 16 percent in an environment with very, very substantial inflation. And so we — you know, again, we wanted to position our portfolios for this environment. And so what we see happening now is the Fed is hard at work, trying to cool the economy in a way that you, ideally, doesn’t have a tough landing.
RITHOLTZ: Right.
MCCARTHY: But that certainly you’re seeing some of that comes through to our market in the form of more uncertainties, transaction activity slows down because people are unsure of what — how should I value it? Where can I borrow? Borrowing costs have gone up. And that seems like kind of a natural outcome of what’s happening in this environment.
RITHOLTZ: So let me ask you the opposite question of investing during a rising rate environment. How would you respond to the criticism that some people have floated, well, of course Blackstone real estate has done great over the past 30 years? Rates have done nothing but go lower. Their cap structure has been super friendly. I’m assuming your pushback is we’re doing well in a rising rate environment also, it’s not just the cost of capital.
MCCARTHY: Yeah. I would say there’s always something —
RITHOLTZ: Right.
MCCARTHY: — that people want — you know, seem to want to say is, like, you know, why it’s now not going to work anymore for us? And there’s — I’ve heard a lot of different versions of things. And I would say we have done this for 30 years in a lot of different parts of the world. We’re not in every —
RITHOLTZ: Right.
MCCARTHY: — circumstance, have we had ultra-low interest rates. And I would say we’ve continued to generate great performance in all of those different types of environments, in all of those different places. And I think it is by sticking to this thematic approach, a really disciplined approach in terms of what we buy, and then how do we capitalize it? And then importantly, how do we create value as we own it?
I mean, interestingly, there’s — one of my favorite examples is Japan. So Japan should have all the hallmarks of a tough place to make money in real estate. You have a shrinking population. You have very low cap rates persistently, very low borrowing costs —
RITHOLTZ: Yeah.
RITHOLTZ: — and very low growth. And yet, it’s been one of our most successful markets ever. And that’s partly because of the nature of the transactions we buy. We can buy more — do more complicated investments that others maybe can’t tackle, larger situations where we buy portfolios of real estate, not single assets. And then we manage the heck out of it. We do every last thing we can do to create value, enhance those cash flows. And that’s how we do well. And so, again, all different kinds of environments can come our way, but I think the process is built to perform in any one of them.
RITHOLTZ: Quite fascinating.
(COMMERCIAL BREAK)
RITHOLTZ: I know I only have you for a limited amount of time. Before I get to my favorite questions, I have to ask you about a curveball question. Coachella?
MCCARTHY: Yes.
RITHOLTZ: You’re like a regular at Coachella? Like, you don’t like — by the way, when I think of Coachella, I think of burning man and mud pits. Coachella is not quite that crazy. But how often you go to this and what t does that experience like?
MCCARTHY: Well, I’ve been 14 times.
RITHOLTZ: Get out.
MCCARTHY: I mean, the pandemic —
RITHOLTZ: Come on. First of all, you’re not old enough, you’ve gone 14 times. So you started going when you were 12?
MCCARTHY: You’re very kind to say that. No. I started going because my then boyfriend, now husband was at business school at UCLA. He’s super into music.
RITHOLTZ: Right.
MCCARTHY: And he drove down there in 2006 or 2005 — yeah, 2005 or ‘06, and he —
RITHOLTZ: And you went with him?
MCCARTHY: I was not with him at that time, at that festival. And it was so different then, you could buy single day tickets.
RITHOLTZ: Right.
MCCARTHY: It wasn’t this whole thing it is now. And I remember him calling me and saying you have to come out next year for this.
RITHOLTZ: Really?
MCCARTHY: It’s so amazing. And even at that first Coachella, there were so many bands you got exposed to, that have become some of our favorites, and really just opened us up to listening to a lot of different kinds of music. You know, the proverbial undercard, if you go all day, you hear a lot of new and interesting music.
RITHOLTZ: So Coachella music is a lot of all tour.
MCCARTHY: Yeah. I’d say it grew up, I think, as a more alternative rock festival and it has really branched now. There’s a lot of rap, and dance, and EDM. We’re still there mostly for the rock music —
RITHOLTZ: Right.
MCCARTHY: — which is a diminishing part of the schedule. I’d say I’m probably — you sort of identified it, the dorkiest and maybe now getting to the oldest person with the most sunblock on at the whole festival.
RITHOLTZ: My wife and I, every time we go into a show, we have a fun little thing we do, which is what’s the demographic of the crowd and are we at the bottom or the top of that age bracket? And every now and then, like, we’ll walk — so we sort of show the other day. There’s a great band called The Fab Four that do Beatles covers.
MCCARTHY: So fun.
RITHOLTZ: It’s all — it’s Letterman, Jimmy Fallon, their band does this. And we were amazed that they were like teenagers and 20-something, singing along, knowing every word.
MCCARTHY: Yeah.
RITHOLTZ: It’s like, oh, some of the stuff is generational. But we’re not talking Boomer rock or classic rock. You’re talking something much more — give us a few bands that you’ve seen that have stayed with you. What sort of alt music do you like at Coachella?
MCCARTHY: Well, probably one of the favorite Coachella experience ever would be actually Roger Waters, who played Dark Side of the Moon in its entirety. And I was not a Roger Waters or Pink Floyd fan before seeing this. And I — the show and including the pig flying and dropping the leaflets was so amazing. It was just — it was so memorable, in part, and this is not the only example of this. But it was a band or a performer, where I was kind of like, eh, do I really want to stay up late? My body is jetlag. I’ve been tired. Matt makes me go at noon and see all the early bands.
RITHOLTZ: Right.
MCCARTHY: Like, do I really want to do this? And it was so interesting and amazing. There was a similar experience, also seeing The Cure for the first time. I’ve always loved The Cure, but I’ve never gone to their show.
RITHOLTZ: Kiss Me, Kiss Me, Kiss Me, I love that album.
MCCARTHY: Oh my gosh, they played so long that they were — they basically pulled the plug on them and they kept playing off their amps. But, you know, of course, the city of Coachella will fine them for this. And they just kept going. They finally had to, like, you know, move Robert Smith off the stage.
RITHOLTZ: Get out the hook. I’m —
MCCARTHY: But it was so amazing. And I’ve now seen The Cure many times, but part of it —
RITHOLTZ: No kidding, I’ve never seen The Cure and I was a fan.
MCCARTHY: I highly recommend.
RITHOLTZ: So I’m going to out myself, here’s how old I am. Freshman year in college, me and my buddy, Joe, go to Nassau Coliseum, where we scalp a pair of tickets for $117 for the Pair —
MCCARTHY: For the Pair. Right.
RITHOLTZ: For one of the seven original Pink Floyd, The Wall tours.
MCCARTHY: Oh my gosh, that’s amazing.
RITHOLTZ: They did three or four shows in Nassau Coliseum, and three or four shows in the L.A. — I think it was the four in the Coliseum. And the only reason we paid that little for the tickets is the cops had come out on high stepping horses and were clearing everybody out. And I remember saying to the guy, you got about 30 seconds before you’re holding two worthless pieces of paper. And we had cash. He literally snatched the cash from our hands gave us the tickets. The cops come to us and we’re like, we got tickets. And we went running and this the first, I don’t know, three minutes of the show. Astounding.
MCCARTHY: Astounding. I would say —
RITHOLTZ: Right. That’s how old I am.
MCCARTHY: Well, I would say one of the — and you kind of mentioned it, it has been — you find it interesting to see live music not only comeback post pandemic, but I think people take real interest in this. And Matt, my husband, I talk about this all the time, he tells maybe a similar story where he — I forget what year it was. But he saw Radiohead at Radio City Music Hall and he was offended that he had — he scalped a ticket for like $35 or something like this.
RITHOLTZ: Right.
MCCARTHY: We don’t really understand how does like Pearl Jam concert at MSG work, where the whole thing sells out at a certain price. Why —
RITHOLTZ: Because it’s bots buying the tickets.
MCCARTHY: Why isn’t Pearl Jam just selling the tickets for a lot more? It’s sort of an interesting question. But you’re right.
RITHOLTZ: Because, A, there’s a monopoly. And B, all the secondary sellers have the firepower to — it’s like in the markets, hey, do you want to go up against Goldman Sachs trading desk as a day trader? If you’re stupid, you do. But ordinary people can’t compete, and ordinary people can’t buy tickets because all the bots are doing their thing. I could whine about this for hours.
MCCARTHY: It sounds like we need another podcast.
RITHOLTZ: Yeah. I won’t, instead I’m going to jump to our favorite questions. So normally, I would ask what are you streaming? But I think we’re past streaming. Let’s talk about what are you listening to today?
MCCARTHY: So I have Phoebe Bridgers on repeat, listening to her constantly.
RITHOLTZ: I will check that out. Tell us about some of your mentors who helped to shape your career.
MCCARTHY: I think mentorship is like a constellation of people that, in my case, so many different people at any different times.
RITHOLTZ: Give us two names.
MCCARTHY: Oh, two names. Sorry. You know, two of my incredible mentors, actually, themselves are friends. So I worked, when I was at Goldman, very closely with Brahm Cramer, who taught me a lot about, you know, just not only being a great investor, but I’d say also a great manager of people. And I think interestingly, maybe not surprisingly, it turns out he’s close friends with Jon Gray, who has been an incredible mentor and sponsor to me, and every single day challenges me to be better and work harder and think more carefully.
RITHOLTZ: Jon Gray at Blackstone?
MCCARTHY: At Blackstone.
RITHOLTZ: Let’s talk about books. What are some of your favorites and what are you reading right now?
MCCARTHY: I love to read. I would break what I’m reading into two categories; what I’m reading to my children and then what I’m reading myself. So what I’m reading to my children is we’ve been working our way to —
RITHOLTZ: A Random Walk Down Wall Street. Right?
MCCARTHY: Random Walk.
RITHOLTZ: Kids love that.
MCCARTHY: The kids love it. No. We’ve been reading the Roald Dahl books, which somehow even though I grew up in a family of reading, I never read those.
RITHOLTZ: There’s a bunch of those, right?
MCCARTHY: Yeah. Oh, yeah. And I somehow missed those as a child. So I really enjoyed reading Charlie and Chocolate Factory, and Matilda, and The Witches, and you know, all of those fun things. And then —
RITHOLTZ: How old are your kids?
MCCARTHY: I have a 7-year-old and a 10-year-old.
RITHOLTZ: So they’re right in the sweet spot, right?
MCCARTHY: They’re right in the sweet spot. We have a lot of Harry Potter happening in our house too. I’m actually —
RITHOLTZ: Movies or books?
MCCARTHY: Books. I read them all.
RITHOLTZ: My sister, when the kids were growing up, you can watch the movies, but only after you read the book. So all the kids had to read the book and then go watch it.
MCCARTHY: Totally. My 10-year-old I think has read all the Harry Potters like four times at this point. I’m listening to them on audiobook now.
RITHOLTZ: Are there like 50? How many?
MCCARTHY: Oh my God. There’s —
RITHOLTZ: Because they’re endless. It seems like there’s a different one every other year.
MCCARTHY: So they are so versed in all of it, that I was not able to keep up with dinner table conversation. So I’m now listening to them again because otherwise I’m not going to be able to keep up. And then for myself, I love reading novels. But I really enjoyed, in the past couple of years, reading Patrick Radden Keefe’s books. He wrote a book called Say Nothing, which was about the troubles in Northern Ireland.
RITHOLTZ: Oh, I’ve heard of that book.
MCCARTHY: And now I’m reading something called Empire of Pain, which is about, you know, basically the opioid crisis and how that came about. And it can be a little heavy, but it’s so interesting, but it’s written really well in such a compelling way that I enjoy it.
RITHOLTZ: Is that the one they ended up making the film about?
MCCARTHY: It’s possible. I am so behind on movies and TV shows.
RITHOLTZ: Something at HBO was on — right.
MCCARTHY: Well, my husband tells me that during the pandemic, when everyone else was making their way through the full Netflix catalogue, I didn’t watch a single show and I get — try to catch up.
RITHOLTZ: Oh, really? Come on, you didn’t watch The Crown?
MCCARTHY: I did. I had post — like post the pandemic. Now that I’ve gotten back to traveling, I binge watched The Crown. I binge watched Marvelous Mrs. Maisel. I love that too.
RITHOLTZ: I’m halfway — so good. So you caught the highlight.
MCCARTHY: Yeah.
RITHOLTZ: So I know somebody who is involved, and no spoilers. But one of the things — I’m like halfway through the most recent season, and I’m like, oh, so I guess she’s going to die soon. And he’s like, no, no, that’s next season. We have the last season. She’s still around.
MCCARTHY: There’s a lot of material.
RITHOLTZ: Oh, okay. Yeah, they have endless material. Although there’s some complaints, this season is inaccurate. I don’t care. It’s just the most gorgeous, beautifully told stories. And even if you’re not an Anglophile, it’s just fascinating. So digression side, let’s get to our last two questions. What sort of advice would you give to a recent college grad who was interested in a career in either real estate investing, or finance, or M&A, or any of the things that you have done so successfully?
MCCARTHY: I would say to have a long and great career focus on your writing skills. And that sometimes I think it’s a little counterintuitive for a job that’s more considered mathy and analytical. And of course, those are basic fundamental skills you absolutely need to have.
But I think when I think about my career, or what has created the best opportunities for me, it often comes about because it’s — we need to communicate something, either to our investment committee, or to our investors, or increasingly, to a much broader group of stakeholders that include elected officials, and tenants, and community members, and activists, all of whom are touching our business in some way. And I think that ability to take ideas that can be rather complicated, or sometimes seem a bit foreign to others, and really put them into terms that are clear, and compelling, and understandable is super important.
RITHOLTZ: That’s really interesting. Final question., what do you know about the world of investing today that you wish you knew 20-plus years or so ago when you were first getting started?
MCCARTHY: I think at that time, I wish I knew just how interesting this work would stay for so long, and how many amazing people I would get to work with, certainly at Blackstone, but when I think about the people who lead our companies, or you folks in the industry I now know, opportunities like this to talk to you. Like this — I think I spent a lot of the early days of my career worrying about how long will I do this, or should I be doing this a lot longer.
And if I had just kind of thrown myself into like, well, let’s just enjoy every moment with all of these people who are intellectually curious and smart and hardworking. And I’ve had the good fortune of always being with teams that were super collaborative and supportive. I wish I had known that because I think I would have been — had a lot more confidence of just every day enjoying the moment.
RITHOLTZ: That was really fascinating. Thank you, Kathleen, for being so generous with your time. We have been speaking with Kathleen McCarthy. She is the global co-head of real estate investing for Blackstone, running its nearly $600 billion in real estate investments.
If you enjoy this conversation, well, please check out any of the previous 450 interviews we’ve done over the past eight years. You can find those at iTunes, Spotify, YouTube, wherever you find your favorite podcasts. Follow me on Twitter @ritholtz. Check out all of the Bloomberg podcasts at podcast. You can sign up for my daily reading list at ritholtz.com. I would be remiss if I did not thank the crack team who helps put these conversations together each week. Justin Milner is my audio engineer. Atika Valbrun is our project manager. Sean Russo is my head of Research. Paris Wald is my producer.
I’m Barry Ritholtz. You have been listening to Masters in Business on Bloomberg Radio.
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