Real Estate's Reset: Where Almanac Sees Stress and Opportunity

Anu Rajakumar:Real estate has had a tough few years. Higher interest rates, lower valuations, and slower deal activity have all taken a toll. For certain types of investors, that kind of backdrop can also create real opportunity. At the same time, big themes like AI, the growth of data centers, and housing shortages are changing the way people think about the asset class, and more traditional areas like office are still under real pressure.

This year, Neuberger's Almanac Realty Investors is marking 30 years of company-level real estate investing. Over that time, the team has seen multiple cycles, good and bad. What have they learned? How can providing capital at the platform level help real estate businesses navigate a tougher fundraising and exit environment? My name is Anu Rajakumar, and today, I'm joined by David Haltiner, Managing Director, Almanac. We'll talk about how Almanac's approach works, how the opportunity set is shifting across different parts of the market, and some of the areas investors might be overlooking right now. David, welcome to the show.

David Haltiner: Thanks for having me.

Anu Rajakumar:David, the last few years have delivered lower distributions, longer holds, and a tougher fundraising environment in some private markets. How is that shaping the opportunity set for you in real estate specifically?

David Haltiner: I think there have been a lot of similarities in real estate and some other alt sectors, as you describe lower distributions, fundraising, challenges, and the like. I think what's maybe unique in real estate is that we've seen a very meaningful drawdown in values. We've seen values decline 10%, 15%, 20%, sometimes 25%. I think that's a much bigger drawdown than you might see in some other sectors. Now, out of that creates opportunity, and we'll talk about some of that. It's a challenging environment that you're starting with.

What happens when values fall that far is you see elongated hold periods. Folks who don't have to sell are doing their best not to sell. At some point, they will, but they're holding on for hopefully a better day. That slows the system down because the system relies on asset sales, returning capital to investors, new capital being committed to fund managers, and then so forth, you buy more assets. You certainly see a clogging of the system because of this. Because of that, you have other opportunities. You have opportunities like what we provide. We think that's a really interesting prospect for us today.

Anu Rajakumar:Terrific. When we think about where we are in the cycle, how would you describe the current situation?

David Haltiner: It's hard to pick the bottom of the cycle, so I'll stop short of that. What I will say is that we've seen indicators of recovery in the real estate cycle. You can see them at a lot of places. Volumes have certainly started to pick back up. 25 volumes are higher than 24 volumes. We talk with brokers and bankers on a regular basis.

I was talking to one recently. In their book, their Ford book is something like 20% to 30% higher than what it was same time last year. You're starting to see some nice leading indicators. That most likely leads to a recovery of the sector. It's going to take some time to get there, but we think that the real estate has really got some prospect going forward now.

Anu Rajakumar:Absolutely. Almanac is marking 30 years of company-level investing, so, first of all, congratulations on that milestone. For listeners who are less familiar with your team's approach, what does platform-level or company-level investing actually mean, and how would you say that differs from traditional deal-by-deal real estate strategies?

David Haltiner: It's a great question. There's certainly some confusion in the marketplace as to what platform-level investing really means. We've done it for decades, frankly, at this point. We started investing in platforms about 30 years ago, raised the first fund at that point in time, and really have focused in that arena ever since. In a very simple form, platform-level investing is investing in both the real estate assets and the operating company of those businesses. You're gaining exposures to the real estate side, but also to the service business side. We do it for a variety of reasons.

Alignment of interest is something you'll hear a lot from us. It's probably one of the most fundamental reasons we like to invest into both the assets and the operating company. There's other reasons to do so as well, some of which could be economics. Investing in the operating company can provide additional economics, GP economics, and the like. There's a variety of ways of making these types of investments, but if you distill it down to real estate investing and operating company exposures, that's platform-level investing in real estate's mind.

Anu Rajakumar:Now, why would you say that platform-level capital feels especially relevant now and today?

David Haltiner: It goes back a little bit to the volumes that we've talked about. What's the backdrop of real estate today? Volumes are slower, sales are slower to occur, fundraising is challenging. You've got a lot of these real estate companies that are out there. They need to raise capital. Real estate is a capital-intensive business.

They need to raise capital for a variety of reasons. They need to raise capital, one, to provide liquidity to existing investors. That's something that's becoming more and more important. Number two, many of them need to right-size their debt stacks. A lot of them are over-leveraged given the drawdown of value. Number three, a lot of them want to grow. Raising that capital is something that's very hard to do.

What could you do if you're a real estate platform? You could go out and sell your assets. That's an option for them, liquidate assets, in a pretty tough sales environment to do so. Those type of sales have implications on their service business and their growth prospects going forward.

What's a better alternative for them? Well, if you do a platform-level recapitalization, you're able to raise capital at an upper-tier level. You're able to hold onto the assets, still own them, still manage the assets, and that has service company implications, and participate in the upside of the company going forward while raising growth capital to go buy new assets in the marketplace.

You're bringing something to the market that's really needed today. We're providing a capital solution to these companies that's a bit unique. It's a bit tailored based upon their needs. You say, "What do you have? What are your objectives, Mr. and Ms. Operator?" and you try to solve this. Liquidity, growth, recapitalization, all of those things, we try to provide those type of solutions.

Anu Rajakumar:Sure. Makes a lot of sense. Now, David, your focus is primarily private, but you also use public markets selectively. How do you think about the roles of public and private real estate in the strategies that you manage, and when do public opportunities become interesting enough for your team to act?

David Haltiner: It's a great question. We spend a lot of time looking in the public markets. If you go back to the origins of Almanac in the mid-'90s, I mentioned fund 1, there was a healthy amount of public company investing at that point in time. We were doing pipes, convertible preferred pipes into the REIT market. The REIT market back then was a nascent market, a much less efficient market, and we were able to invest $25, $50, $75 million into those companies and really move the needle for them.

If you fast forward what happened over the last 25 years, the public REIT market clearly has grown significantly and has become, I would say, much more efficient by and large. If you look at public companies today, they tend to be large entities. They tend to have a fairly similar profile, meaning pretty high-quality real estate, pretty low leverage, pretty stabilized assets. People love the underwritability, the stability of those dividends and the like. That's interesting, opportunity set, but for us, we're more value-add-oriented investors. We're looking for opportunities, missed priced assets and the like.

We have focused much more in the private markets because of that. The private markets is significantly larger, as you guys know. The private markets' numbers will be stale at over $20 trillion in the private markets, and probably 10% of that value is in the public market. A much bigger addressable market in many ways. That being said, there can episodically be opportunities in the public markets. Given our history and understanding of the REITs, we're there to take advantage of that. It's not the majority of our activity, but episodically, for sure.

The ways in which we are equipped within our mandate to take advantage of it is you can either do a pipe with a public company today. We have the ability to do a take private. In all honesty, it's something we've done less of. We find other opportunities elsewhere. Then the third leg to really look at is buying public shares. We only do that when we see very significant sell downs in values.

We have a very good read of what the value of real estate is. We can look at the public wrappers and we can see are they trading at very big discounts. If you find that, it could be a great opportunity to buy shares. It happened right after Liberation Day. You saw the REITs sell off significantly, particularly the industrial REITs given the impact to industrial. We could go into that market and buy shares at 20% discount to GAV, 30% to 40% discount to NAV. At those type of screaming buys, we can go in and buy them. When those shares recover, we sell out of those.

It's an opportunistic place where we don't spend most of our time. Given our dexterity in public and private, given the corporate wrapper and the way in which we invest, we should apply that skill set in the public markets when it exists. That's by and large on the investment side. We do have the ability, as we invest into private companies, to take them public. That's more of an exit strategy. We will periodically do that. I would say that it's more the exception than the rule. The instances that we would consider that would be if that sector and that company would trade at a premium to NAV.

Today, not a lot are trading at premiums. Maybe, say, for a sector or two out there. If you are seeing a sector trading at a significant premium, that's a capital markets opportunity. We've got a ready-built company that could go public, we'll take that company public if that's the case, but it has to be in a very specific instance that we're going to invest into or exit out of the public markets.

Anu Rajakumar:That's a great explanation. Just that flexibility that you have to be opportunistic and to be the capital provider as the groups that you're speaking to need is really terrific. Now, shifting gears a bit, there's a lot of excitement around AI and data centers alongside some concerns about housing shortages. I'd love to know how you're approaching these themes. Where is your team leaning in? Where are you cautious? How do macro factors like demographics shape your view on these sectors?

David Haltiner: Data and AI is the biggest topic out there today, so clearly, we spend time thinking about it, talking about it. It affects two parts of your business, either how you might invest into it and then how you might use the applications to operate your business. I know everyone out there is thinking about that. We've certainly been keen to invest into the sector, and we've actually been able to do so.

Almanac, our history is one that's very much built into some levels of conservatism, some level of what can go right, but really what can go wrong. I think that's an incredibly important attribute when we're thinking about investing for as long as we've invested. You've got to apply that to data centers too. As we looked at that space, we wanted to think of ways in which we could participate that was meaningful, but with the Almanac mentality of downside protection. It was very important to us.

We looked at it and we said, "We know what can go right." [chuckles] The base case is evident. You're seeing insatiable demand. You're seeing the hyperscalers take down tremendous amount of space. What could go wrong as we looked at it? A variety of things. One, these are very big check sizes. Because of that, you've got a lot of capital at risk. That's concentration risk. That's something that we're very mindful in any investment that we make. Don't let any single investment have a major implication to a fund and so forth. How do we invest in a smaller scope?

Number two, the demand quotient right now is massive, but there's nothing to say that won't slow down or change. Technology changes very quickly. Power changes very quickly. These hyperscalers are taking down space hand over fist. There's a race right now between all of them, and that won't last forever. At some point, you have a risk of that demand dropping pretty significantly. There will be some folks that might have some trouble at that point in time. We had those thoughts in the back of our mind.

For us, the best way to invest into it would be smaller check sizes, which is more in the power procurement phase or the GP position of the vertical construction of those. That most makes the sizing of the investment appropriate and the timeframe in which we invest appropriate. Shorter timeframe achieve that liquidity quicker in those investments. It's very important without a doubt in our mind and many others. It's a secular change. It's one that we should be investing into.

Anu Rajakumar:Absolutely. Just following up on housing and residential. Thoughts there?

David Haltiner: Yes. Housing, for a very long time on the investment side, has been one of the favorite asset classes, and it continues to be so. On the single family home side, which is part of the question that you've asked, you certainly see affordability issues that have become more than evident they've been obvious in so many ways. There's a variety of reasons for that. Some of it has to do with the limited amount of housing that was built.

Home builders didn't come out of the GFC building a lot. Zoning is challenging. You're complicating it and amplifying it further by the fact that the lock-in effect of the mortgages folks have, they're reluctant to sell homes. By the fact interest rates today are so much higher, by the fact that insurance and taxes are so much higher, the carry cost of these homes are really not affordable.

Now, we don't invest as often or regularly in the single family space. That's more of a for-sale model. We like the rental model a little bit better. You can translate that dynamic into what happens in rental. A lot of thesis you'll see out there, a lot of research and investment books you'll read will talk about the demand for rental is so much larger because the unaffordability of homes, of course, which I think is true. I think it is a positive long-term indicator in the rental space and it's one of the reasons to invest into rental properties.

You could argue that housing has less technological disruptors out there, so you probably will need someone who needs a home in the future. Of course, all of those we think are nice backdrops to invest into apartments, but I don't know that that theme is enough by itself just to make investments in the space.

Frankly, if you're more specifically looking at apartment investments across the country, you'll find a range of fundamental backdrops and some real softness today. Some of that softness is based in sunbelt markets where you've seen supply issues. Notwithstanding a very good demand backdrop, when you add too much supply to a market, you're going to see rental pressure. You're seeing that in some markets and you're seeing accelerate in some markets.

I think you've got to be a little bit picky about the way in which you invest. We certainly think these growth markets will have great long-term fundamentals. They're having in migration. The supply will burn off over time, but it's probably going to take longer than you think. We've focused a little bit more on some other markets.

We've been looking to the Midwest a lot more, the Mid-Atlantic, even some of the coastal markets, and there's some political reasons to think about investing in those, but we've seen very little supply in those markets. I think you just can't brush it with one broad brush. I think you got to look at it and say, "We've got great secular tailwinds in housing and in rental property, but there's going to be a bit of a bumpy ride for the near term that you've got to be prepared for.

Anu Rajakumar:Now, speaking of bumpy rides, I can't let you go without talking about office a little bit. I know it's been subject to a lot of conversations over the last few years, I think. How you think about office today versus other areas like senior housing, student housing, self-storage, and even the core food groups, industrial, retail, etc, where are you seeing the opportunity and where are you more cautious?

David Haltiner: Office is a favorite topic for so many folks because it's been in the headlines and it is a very big asset class historically, particularly. We've been fairly cautious on office for a very long time. The reason we have been is, when you look at how office historically priced, it was a fairly tight cap rate. In a lot of ways, it didn't take into consideration the amount of below-the-line CAPEX, TI's leasing commission. The free cash flow of the office sector isn't that attractive as a standalone basis. We've long had a little bit of caution in that sector.

Today, is there an opportunity? If there's an opportunity ever, it's most likely today in that sector. You're seeing more people return to the office. That's definitely helpful. Definitely more opportunity in the A space than the BC space where there's some question of obsolescence. If you can invest into office assets today at significant discounts to replacement cost and peak valuations, depends on your markets. It's about $300, $400, $500 a foot. You're going to put another in $200, $300 a foot, so don't forget to count that, but you can make a profit doing so. I do think office is investable.

I think it's a little bit more of a trade today versus buying assets to compound over a long period of time, which is a lot of the way which real estate should be owned. I don't know that we would look to hold office for a long period of time. There's an adage in office that if you own it for 10 years, you'll have bought it twice. I think it's true. It's amazing how much you have to spend to maintain the occupancy of those buildings.

Anu Rajakumar:It's probably more opportunistic as you see them, right?

David Haltiner: Absolutely. You ask about the alt sectors. We're big advocates of the alt sectors. We're not alone in that. We've long invested into that space. If you go back Almanac in 20 years ago, we were investing in storage platform. We invested into an MHRV platform about the same time we--

Anu Rajakumar:What is the acronym? Sorry, I should explain.

David Haltiner: Sorry. I should explain.

Anu Rajakumar:Sorry. [laughs]

David Haltiner: Manufactured Housing Recreational Vehicle space. It has become one of the most popular segments of the space. We've long been investors in that. We got into the senior housing space in 2007, a long time ago. Those are all very strong performing investments, and we did well. We've liked the sectors a long time.

If you look at what they look like today, I think you'll hear a lot of people tell you senior housing is an attractive opportunity. We tend to agree with that. Senior housing, aside from office, has probably been the worst performing sector over the last five years. The fundamentals have just been very challenging, and it was a result of COVID. The outcome of that pandemic to the sector was pretty severe.

You have a very long time to restabilize those properties, but you can invest into them today at a very good basis with a very good future prospect of both demand as well as limited supply. A lot of folks are focused on that today. We, of course, are as well. I don't think it's as easy as just buy something at the market. That's an operating intensive business, and the operator will make all of the difference. Same building, same location, different operator, different outcome. It does take a certain skillset to invest into that sector.

Storage, we've been investors in for quite some time. Today, our storage portfolio is more in the New York City as well as Chicago MSAs. If you look at storage nationally, it's been relatively soft. We talked about housing velocity a little while ago. The housing velocity is one of the demand drivers in storage, and that's been relatively muted. That will come back, and that will only push storage rates higher at that point in time. It's also on the other end of the spectrum from, let's say, an office asset where the free cashflow profile is very good. Very little dollars are spent below the line in that case. We like that sector.

The New York market and the Chicago market have really performed well. They've been outliers. A little bit different demand drivers there. We would look to invest nationally in that asset class. We think there's going to be great opportunity, what's defined today as alts. We'll most likely, as we think about investing in the fund, we'll have a cohort, a section of our fund capital invest into those sectors.

Anu Rajakumar:Makes sense. Maybe I'll just turn quickly to talk about the investor base. Historically, Almanac and private real estate in general has been mostly for institutional investors. How do you see the wealth and defined contribution channels, potentially the 401(k) plans, how could that change the investor base for private real estate?

David Haltiner: It's a great question. Almanac has very much been institutional client-based. We've got great partners. We've had them for decades. We expect that will continue to be a foundation of our business. It's important that we maintain those partnerships. That being said, there's certainly an increasingly growing segment of the capital market in wealth. Within wealth, it can be high net worth all the way to the 401(k), as you describe. It is an opportunity set that is significant.

Real estate as an asset class most certainly fits within those portfolios. We do expect, over time, to build those relationships to increase our investor base through those channels. You ask about 401(k), and if you think about 401(k), it's designed to be a very long-term holding account. What's a great asset for a 401(k) long-term holding account? A real estate asset. Real estate asset compounds, it cash flows, it's an inflation hedge. I think it fits very nicely.

I do think you're going to have to work the specificity as to when you're investing within those 401(k)s because the liquidity profile in all of these alts, be it real estate or anything else, is different than public companies. If you're 35 years old investing, and you're going to have a portion of your portfolio allocated within your 401(k) to these alts, real estate included, great.

If you're 65 and you're thinking about tapping into some of that liquidity, just need to be advised well. Be mindful of what that liquidity is because I think that's what you have to protect. I think we can. I think you can do this the right way, but it has to be thought through. Real estate certainly should be within that. It's a paradigm shift in the manager space to open up that channel of capital. There's tremendous amounts. It fits very well with the end client. It fits well with the manager. It's just going to take time to architect that out.

Anu Rajakumar:Absolutely. There's a lot of tailwinds trying to push the alternative investments into 401(k)s, so lots of opportunity there and I think clearly more education needed in the space to make sure that folks know what they're getting into, as you said.

David Haltiner: Absolutely.

Anu Rajakumar:David, I'd love to just end this conversation by asking, what do you think investors are not talking about in real estate today? Whether that's areas with too much optimism or too much pessimism? If you're someone who's already invested in real estate or think about investing in real estate, what should our listeners be asking their managers as they think about their portfolios going forward?

David Haltiner: Sure. Look, I think a lot of the topics are fairly well known in real estate, sectors-wise, market-wise, and the like. If there's some themes that maybe I'm a little bit more cautious on, one is credit. We're advocates of credit investing. We like yield. If you look at the way in which we invest in these platforms, many a times it's a convertible security. It has downside protection. It has yields. It has upside participation.

I'm mindful of how much capital has come into credit. I think if I've got the number right, the amount of loan originations, according to one of the brokers we talked to last year, was up about 50% from the year before. There are not major barriers to entry to get into credit. When more folks get into that segment, and what I mean mostly in this credit is traditional mortgage lending, be it bridge or fixed-rate financings, you're seeing the banks come back in, the lifecoats come back in. You're seeing non-bank lenders. You're seeing securitized lenders come into space.

What we've seen over the last, I'd say, 12 to 24 months is leverage levels and proceed levels have come back into the market. That's great for equity. That's great for us buying assets and the like, but I'm mindful of the competition that creates in the credit side of this and what people will do to reach to get a deal. They'll move up on their leverage level. They'll move down on their spread.

Spreads are about as tight as we've seen in a very long time right now in the real estate space. It's a sector that we've invested into that we've done relatively well. It's been a very popular sector over the last two, three, four, five years, partly because base rates were so high, partly because the unleveraged return in that sector matched, a lot of times, the equity returns. I think that dynamic is changing. I know some folks are repositioning their portfolio, accordingly, but I think we'd be cautious to be too heavily in credit.

Anu Rajakumar:Absolutely. Thank you very much for those thoughts. I cannot let you leave today without a quick bonus question. I'd love to know, I know you've lived in the New York City area for a number of years, but before you were in New York, what's one place that you've lived in your life that you've really loved and tell me what made that place particularly special for you?

David Haltiner: That's a good question. I have very few to pick from. [laughs]

Anu Rajakumar:Makes it easier, hopefully.

Anu Rajakumar:[unintelligible 00:24:41] because I only have one to pick from. What I'd probably say is it maybe doesn't count because it was pre-professional life, but Athens, Georgia, has a special place in my heart. I went to University of Georgia, so maybe that's why it does. It's a classic city. It's called the classic city. It's got a good food scene. It's got a good music scene. It just has a warm place in my heart maybe because of the time I spent there. It's a great place.

I don't know that I'd necessarily live there today, just where I am in my life and my family, but it's a great place to visit and it's really good people there, so I would definitely advocate. Many folks probably have gone to see Athens, but go see it if you haven't. It's a great place to be.

Anu Rajakumar:Lovely. It turns out we have a Georgia Bulldog and a Florida Gator on this episode, which is an interesting combination. I'm probably not supposed to admit that we like Athens, but I think like Gainesville. It's a pretty great town and lots of very special memories there, I'm sure. Thank you very much for sharing that. Hopefully, you won't hold that against me that I'm from the University of Florida, but here we are.

David, we covered a lot of ground today. You spoke about how today's capital markets backdrop is creating opportunities for investors. We spoke about Almanac being a 30-year industry veterans and how your team are capital providers with flexibility to invest across the opportunity set.

We spoke about how your team is thinking about the key themes like AI, data centers, housing, and some of your sector positioning. We talked a little about the evolving investor base and 401(k) opportunity set. I appreciate you sharing some thoughts on how investors should be thinking about the space going forward. It's been great having you on the show and I thank you so much for joining me today.

David Haltiner: Thanks for having me. I very much enjoyed it.

Anu Rajakumar:To our listeners, if you've enjoyed what you've heard today on Disruptive Forces, you can subscribe to the show from wherever you listen to your podcasts, or you can visit our website at nb.com/disruptiveforces where you can find previous episodes as well as more information about our firm and offerings.

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