Original Interview from
https://www.youtube.com/watch?v=UKkykksZHOU
Transcript
“When I met my wife in
English class I showed up wearing a suit and tie. Everyone else was in
Birkenstocks. It was clear I'd made a decision which path I was on.”
“I think it's still
pretty good time for real estate. Texas and Florida are well-positioned. You
should stay away from buggy whip businesses.”
"Go where the creative
and technology types are because those are the markets where they'll be the
most economic activity."
"I say to my kids all the time luck is a core competency but it wasn't all luck."
- Jon Gray
Jon Gray went from aspiring journalist to become
one of the top real estate investors in the world.
Jon joined Blackstone in 1992 and was the second
employee in its real estate division.
I've had the opportunity to do work with Jon
since his second day of Blackstone when he had just gotten out of Penn. Well I
think to a degree luck is you know involved in anybody's success. I think with
John it's a gross overstatement. I think it is. It is just simply raw talent.
By 2005 Jon was running Blackstone's real estate
unit and spent the next 13 years building it into a behemoth with about one
hundred and nineteen billion dollars of assets.
I think he has a very unique ability to combine
tremendous amount of vision and understanding trends generally ahead of a lot
of other people and conviction. And he
turns that conviction unlike few people I have seen into very bold big moves
that have generally paid off.
What put Jon on the map was Blackstone's 26
billion dollar deal to buy Hilton on the eve of the financial crisis.
There were a lot of things going really, really
wrong. I'd say Jon's leadership throughout was what I would describe as sort of
a steady hand on the wheel.
The Hilton deal ultimately became one of the
most successful private equity investments of all time reaping more than 14 billion
dollars in profits and catapulting Jon to the number two job at Blackstone.
He’s a natural. He's just got it all.
Seems like journalism's loss has become private
equity’s gain.
David R:
When you're growing up in the Chicago area. Did
you say one day I want to be the greatest real estate investor in the world?
Jon G:
No, I got here as an accident. I had grown up in
suburban Chicago. I've never really been to the East Coast prior to going to college.
And when I got to college I decided that I really wanted to be an English
major. I wanted to be a journalist. I
wrote for the Daily Pennsylvanian and about a year into school I realized a
bunch of my friends and fraternity brothers liked business. They were in Wharton and I owned a few stocks.
I liked numbers.
So I decided to get a dual degree. And that was really
important for me because my senior year in college I met a young woman who was
an English major. A few weeks later I got a job working for a small investment
advisory firm— that was about 30 years ago. And that was Blackstone and that
was my wife Mindy. So that really set me off.
And so I went from Philadelphia. I came to New
York and I started at Blackstone in the private equity area and in the MBA
area. And I was mostly running numbers doing pitch books for clients and
ordering dinner. I had to make sure the associates got their food by seven
o'clock for about a year.
And two things—
1.
The real estate market
had collapsed.
2.
The visionary founders
of Blackstone Steve Schwartzman and Pete Peterson said look real estate is a
place we should go.
They found a guy in Chicago, John Schreiber – a
terrifically talented investor and they formed a real estate business and they
had no people. I had been helping them
draft their private placement memorandum for the first real estate fund. They
said you seem like a reasonable person. Do you want to move over and join this
group? And I talked to Mindy and to my parents and I came back and said yes—
and that's how I ended up in the real estate business.
David R:
Ok, so what did you all do in the beginning that
you have money to invest because you didn't have a fund I presume in real
estate? So what did you do to raise money?
Jon:
We had very little deals to begin. So the first
deal I worked on was a shopping center in Chesapeake Virginia. The Great Bridge
shopping center. It was a $6 million transaction. We borrowed $4 million,
so it was a $2 million equity check. And you would have thought I was buying
the island of Manhattan. I was down there for three weeks.
I mean I was down there for three weeks. I met
every tenant. I was counting the car traffic. I was learning the business. And
it was an amazing experience because I was the chief bottle washer. I was the
waiter. I was the maître d – we were this tiny little business and I was
learning it firsthand.
David:
Let's talk about two deals that you did
eventually that became two of the best known deals in the history of U.S. real
estate I would say. The first is EOP built by Sam Zell. Can you explain what
that deal was? Why was it such a risky deal and why it turned out to be for you,
a very good deal? (Blackstone sold 2/3s
of the EOP portfolio, 27 billion worth of Assets, within 3 months of closing)
Jon G:
I stumbled on the public real estate markets
when there were companies that owned real estate that were trading well below
where these buildings traded out individually.
During that time, there's this new commercial
mortgage backed securities debt stack which is much lower cost than leveraged
loans, and high yield that you typically use in a buyout. And we convinced the
banks to let us use that to go buy real estate companies.
And beginning in late 03 through 07, I think we
did 12 of these deals— where we started buying these big public real estate
companies.
We used the public CMBS stack and then in many cases
we would sell off pieces.
Think about it as a fruit basket. You'd sell the
grapes to the people who wanted that and the bananas over here.
And that's what Equity Office was all about. We
bought the biggest collection of office buildings in the United States. And so
it's like running a store, where in the front end you're taking in the
merchandise and in the back and you're selling it.
And so within 60 days we ultimately won the
auction. We sold almost two thirds of the real estate. We paid down our debt,
and we ended up owning really great real estate.
One thing people don't focus on is we kept the
assets in California, New York, and Boston.
Had we kept suburban assets like Chicago and
Stamford, Connecticut, our results would not have been so good.
So at the end of the day— it was a wholesale to
retail arbitrage.
But the key was what we kept and held, which
ultimately tripled investor capital.
David: In
the end it turned out to be a great deal for you.
Jon: Yeah,
right.
David:
That people you sold the real estate to. It
wasn't so good for them because the real estate market collapsed— more or less when
you completed the deal.
So ultimately, did you ever buy some of that
stuff back from the people you sold it to before?
Jon: We
ended up buying some of it back. And a lot of those people are my friends. No
one knew at the time the music was going to stop.
David:
Let's talk about another deal you did that. This
also turned out to be probably the most profitable buyout of all time. It is
real estate related— right before the market crashed in 2007-08, you bought the
entire Hilton Hotel Company. What was your thinking about buying Hilton Hotel?
Was it a real estate play or a corporate play?
Jon:
It was a bit of both. We did the transaction
with our real estate private equity funds, and our corporate private equity
fund, because Hilton owned great real estate, like the Waldorf Astoria, the
Hilton Hawaiian Village. But it also had this amazing management franchise
business.
And when we bought the company it was similar to
the Equity Office transaction in that we thought we were able to buy something
because of the scale and because it was in the public markets more
inexpensively than we could buying these assets individually.
And we also believed that the multiple was
reasonable. We were paying 13 or 14 times cash-flow for what we thought was a
great business. Our mistake, of course, was that our timing was terrible. We
closed on the transaction at the end of 2007.
In less than a year, of course, Lehman would
collapse, the global economy would be melting down, and global travel would
decline dramatically.
This company's revenues would go down 20
percent. Cash flow would go down 40 percent. And we marked our largest
investment ever as a firm down by 71 percent. That was not a good feeling. But
what I would tell you is we believe the decline was cyclical in nature.
We still saw tremendous opportunity to grow the
company around the world, and so we invested $800 million more at the bottom,
we stuck with the company, it started growing. There was a cyclical recovery.
We ultimately took it public, we broke it into
three different companies: a management franchise, time share, and real estate
business, and we made $14 billion for our investors. So it ended well.
David:
So, when it wasn't looking so good that you go
home to your wife and say you knew told me to go into real estate and maybe it
wasn't a good thing? You didn't say that?
Jon:
You know it's funny in all seriousness. My wife
and my children. And that that was really important.
As you know in a period of time when things are stressed—
having people you can rely on and talk to and who still believe in you is
really important. And it was hard because you felt terrible. You felt badly
with your colleagues with your investors.
But we never lost faith in and really, for me,
that experience— that searing experience at Hilton was probably the most
important thing for me as an investor— because
what I learned was we bought it the worst time possible and we ended up having
the most successful deal of all time.
And what that said is— we had bought a really
great business in what we call a great neighborhood— it had terrific tailwinds
people global travel to growth industry. These brands were super valuable. And
so what it's led me to think is, too often when we invest capital we focus on.
I'll call it the individual house— not am I in the right sector? Do I have
those tailwinds?
And in this case, this was a fundamentally great
business— and we could afford to have paid too much and do it at the wrong
time. But ultimately with the right management team, the right financial
support— we made a bunch of money and that has really impacted everything I've
done since then.
I think this shortage in housing will become
more acute. And so we continue to like it as a sector to invest in.
David Rubenstein
Call it the incredible shrinking office
building— As more Americans work from home, demand for office space is
plunging. The result— big investors are putting their money into warehouses
that have centers and studios and other production spaces used for streaming.
In January Blackstone took a majority stake in dozens of warehouses— most of
them in California and Seattle. The rise of online shopping has made warehouses
and other logistics properties more valuable.
Last month Blackstone bought data center
operator UTSA Realty Trust for roughly 10 billion dollars. The numbers tell the
story. Office space in the U.S. made up 90 percent of Blackstone's portfolio in
2015. Now it's 4 percent. Hotels where twenty three percent of the firm's portfolio
in 2015 now 6 percent. But logistics properties have surged from 9 percent in
2017 to 38 percent now.
David R:
Let's talk about different two different types
of real estate is residential and there's commercial. So is residential less
risky or more risky than commercial?
Jon G:
If you talk about for-sale, single-family
housing, there’s probably more risk, in the sense that you’re building
something and you’re selling it, and it’s a function of the market. If you’re
talking about rental housing – think about an apartment complex – that tends to
be less risky because it’s less cyclical. People don’t give up their apartments
when there’s some volatility but nothing like, say, office buildings or hotels.
So I would say, residential rental rates in real
estate is safer and less volatile. And then commercial real estate involves
office buildings; warehouses— which has been the biggest theme for us over the
last 10 years. Hotels, shopping centers, senior living facilities; all of them
have different risk returns depending on geography.
David:
Another way of looking at real estate are things
that are already existing and things to be built. So is it riskier and higher
reward to build something, or are you more in the category of trying to buy
things that already exist?
John:
We generally are in the business of trying to
buy existing real estate at a discount. So we bought that cosmopolitan hotel
and casino in Las Vegas and we bought it for less than half of what it built
for because it was built during the financial crisis.
So that to me is ideal.
Occasionally we'll build things. But in general
we like to try to get into real estate at a lower basis when it's already
producing income.
The problem with development is it's a bit like
saying I'm an IPO three years from now. When you show up to lease up your
building, you could be in a different economic environment and therefore, you
may not have tenants, you may not have revenue. So we've generally bias towards
existing real estate.
David R:
Now
as a general rule of thumb over the last hundred, two hundred thousand years,
real estate prices generally go up— values increase generally. But why is it that sometimes real estate
developers— you read about them going bankrupt— is it because of leverage or
because the values actually went down?
Jon G:
I'd say that the classic sin in real estate is
you have long duration assets and people finance them short term. And so, for
developers who often rely on a lot of leverage— that can get them into trouble.
The other thing that could impact real estate—
particularly today, are changes in technology the ways we live and work.
So if you think about enclosed shopping malls.
They were from really the postwar period until a decade ago— the best assets. A
large shopping mall anchored by department stores lots of retailer’s food
court. They grew value 5 percent a year on leverage 40-50 years because they
were very hard. They were really fortresses.
And what's happened of course is the Internet showed
up. E-commerce showed up. And that's really impacted those businesses. And
we've seen sharp declines. But that happened over a long period of time. So it
can be secular changes in the way we live in work. But the bigger thing generally
to your point has been leverage.
David:
Some people say that real estate is favorably
taxed by the US government. I assume that's because of depreciation and other
kinds of things. One of the most favorable parts of the US tax code for real
estate is the “like-kind” 1031 exchange. President Biden has proposed changing
that. Will this affect real estate?
Jon G:
It will affect individual investors who've owned
assets for long time, who will harvest gains and then buy a new piece of real
estate. For the institutional investors, it's less of an impact because we're
selling, and we're paying taxes. The way may impact us is if there's less selling
as a result.
The same thing could happen if capital gains go
up. You could see some individual owners of real estate be more reluctant. But
I don't think as much of an impact on the institutional market.
David:
New York City has seen a lot of people leave
during Covid. Do you expect that people will come back, work five days a week,
and use all the office space in New York or similar cities that they did
before?
John:
There is sort of a recent bias -- that because
we’ve been home, we assume that’s the way it’ll be. When we think about our
company, we know we’re better together. We don’t have the formula for Coca
Cola, but we have a lot of smart talented people who are connected by culture. Being
together matters. It’s really an apprenticeship business, learning how to
invest.
I would point out, though, outside the U.S. --
for instance, in China -- buildings are back to full capacity, and in Europe
people don’t have as much space in their home lives. So not all geographies are
the same. And even here, I think there’ll be a bias toward going back to the
office, even though it won’t be like it was before, in full.
Yes, some companies will conclude they don’t
need quite as much space, so that’ll create some additional vacancy. People
will be concerned about owning office buildings, and that may create an
opportunity. There will be some headwinds for a number of years and then, over
time, things will recover.
David R:
A lot of people have moved to Florida and Texas,
maybe for warm weather, maybe because those states don’t have income taxes. Do
you think that trend will continue? And is that a good place to invest in real
estate now?
Jon G:
It’s a bit of both. The weather, the lower cost
of living, lower taxes, concerns about quality of life, crime rates— Texas is
one of the fastest-growing states in the country, even though it’s enormous.
I think that will continue, and it was
accelerated a bit by the pandemic. On the other hand, New York City, San
Francisco— these are amazing places. And when you think about technology and
innovation, entrepreneurship, immigrants – there will be a rediscovery of these
cities.
My daughter is graduating from college; she
wants to live there. But I think longer term the policymakers in these cities
can have a big impact.
We saw it, obviously, in the 60’s, 70’s, and
80’s when these cities suffered. I don't believe that's what's going to happen.
I think with the right policy I think these
cities can really thrive.
But, yes, Texas and Florida are well-positioned.
David:
When you were growing up, and certainly when I
was growing up; I'm older than you—
People really wanted to own their house. It was
part of the American dream— to own your own house. But you've been buying a lot
of rental housing.
Now is that because you think young adults are
not as interested in buying their own home and they want to rent now?
John:
No. Home ownership rates have gone down a bit,
but if you look in the last 12 months, during Covid, there’s been a surge in
people wanting to own homes.
Our investment in rental housing is based on the
fact that we just haven’t built a lot of housing since 2008-09.
So we've averaged less than a million homes
built in the United States during that period, versus probably a million five
to keep up with population and obsolescence. And so that's created support for
single family values but also rental values. And I think now as the economy
reopens here I think this shortage in housing will become more acute.
So we continue to like it as a sector to invest
in.
David:
So what's the pleasure of being a real estate
investor which you've been doing for almost 30 years as opposed to being a private
equity investor or being some other type investor? What is it that you liked
about real estate that kept you in it for 30 something years?
John:
I would say I love the people, I love learning
about all these different places. I mean, I got to see all of the United States,
and virtually all of the developed world.
You know, when you're investing in pharmaceutical
businesses or other companies, it's harder to say I have real expertise about
the efficacy of this drug versus that drug. But as an individual you can say—
“I've been in the neighborhood here. I'm in Oakland today. Gosh it feels a lot
like Brooklyn did. They are starting to gentrify the area. I'll connect the
dots and do that.”
So I think the tangible nature of it, the
experience, if you love to travel if you love to see places I think real
estate's hard to beat.
David:
So
let's suppose somebody is watching this, and I say OK this guy has done a great
job of building a great real estate business. I want to invest with him or I want
to invest in real estate as an individual investor. What is the best way to invest
in real estate?
John:
So for the individual investor I'd say there are
a couple of ways. One is there's a public reap market where you can invest in
some excellent companies here in the United States. There are REITS frankly
around the world. That's one way to do it. Another way to do it today is we
have things called private rates.
We have Blackstone have a vehicle called Beat
which today owns primarily logistics, and rental apartments, across the
southeast and southwest the United States. And that's another way to do it.
There are others who offer similar products.
For some who are more adventurous, they can
partner with local developers. The challenge I worry about is just misalignment
of interests and liquidity. How do you get out at some point? You’re investing
and you're generally not getting a lot of diversity with that approach.
David:
Are
you worried about the economy now? Its economy has been pretty good but it
probably will head down at some point. Economy's always correct. So if I say I won't
invest in real estate is now a good time or should I wait a while before the
economy to correct?
Jon G:
It’s still a pretty good time for real estate
for a couple of reasons. The warning signs are twofold -- too much leverage,
too much capital -- and we don’t really have that in the real estate system
today. The other is too many cranes, and too much building, and we’re actually
below historic levels in terms of new supply.
The other thing I’d point out is that— the
S&P 500 delivered something like four-times the return of public REITs
since the beginning of 2020, before Covid.
So real estate is lagging coming out of the
recovery, because obviously, people have been concerned about the physical
world.
As the economy reopens, people go back into
spaces, real estate is going to see a little bit of a bounce. I think the risk
is, if interest rates move a lot.
One positive thing about real estate also, is
inflation drives up the replacement cost of buildings. And that gives you a
little bit of a cushion on existing real estate.
David:
Where
should I not invest my money?
Jon G:
You should stay away from buggy-whip businesses.
You should stay away from landline phone companies, and some of the legacy retailers,
some legacy media businesses. You want to focus on the future.
On real estate in particular, if I had one piece
of advice— go where geographically the
creative and technology types are, because those are the markets where they'll
be the most economic activity.
So the West coast of the United States, Austin,
Texas; Cambridge; Shenzhen; London; Amsterdam; Tel-Aviv; Bangalore. Tech is
driving so much of the growth in this global economy. Those are the most interesting
places to invest.
David:
Do people come up to you at cocktail parties and
ask you for investment advice?
Jon:
You know, it's funny— they often ask me
residential home prices which is not my area of expertise.
I tend to tell people to focus on the longer
term. Focus on you know.
I think the danger in the world is that we live in
the sort of Snapchat, Tik Tok era which is dangerous.
To be a high-conviction investor — that when you
dabble, and just put a bunch of money here on things you don’t know or
understand, it tends to work out badly. But when you see something, single-family
housing, global logistics, the movement of everything online, and you lean into
that, that’s when you have the best outcomes.
What you want to say is, “Is this fundamentally
a good business? Is it in a good sector? Is this a good piece of real estate,
where supply is limited, demand is favorable?” And if you own something good,
hold it for a long period of time. Find those right neighborhoods to invest in,
deploy your capital and then be patient.
David:
John, thank you for a great overview of the real estate investment world and I
appreciate you're giving us this time.
John:
Thank
you David. It's been terrific.
