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Stewart: Welcome to another edition of the InsuranceAUM.com Podcast. My name's Stewart Foley, I'll be your host. Welcome back. Thanks for joining us. I really want to say a heartfelt thank you to all the people. We just celebrated our 250th podcast and there's been a lot of people who've helped us and supported us along the way. And I just want to take a moment and say thank you very much. It is sincere and heartfelt. We're approaching a hundred thousand downloads of the podcast. Hopefully, we're helpful in teaching folks a little bit about insurance asset management and various asset classes and hearing from industry leaders and so forth. And so, I just wanted to take a minute and say thank you.
We've got a great podcast for you today and the topic is Real Estate Debt and we're joined today by Doug Bouquard, partner of TPG, head of Real Estate Credit. Doug, how are you? Nice to see you. We've done a little bit of prep work so we know each other a little bit, but it's great to have you on and thanks for taking some time with us.
Doug: Absolutely great to be here.
Stewart: All right, so here we go. Where'd you grow up and what was your first job? Not the fancy one. How does one become a partner and head of Real Estate Credit at TPG.
Doug: First of all, I grew up outside of Philadelphia, really have spent effectively half of my life in Philadelphia, call it the first half. The second half has been in New York City. My first job I would say, I had a handful of first jobs I felt like during my high school years, but I spent some time spooling battery cable and that was in between school breaks, which was basically working in a warehouse. A forklift would bring over a large spool of battery cable and then we would basically cut custom orders into a smaller spool of battery cable. That was one of the more memorable jobs that I had in between school breaks. I did that and then also I did a lot of different sports growing up, so I did a fair amount of teaching younger kids as well. So it was probably those two stand out, very different experiences, but that was a little bit of what I was doing when I was growing up outside of Philadelphia.
Stewart: I got to tell you man, turning long cables into shorter cables of certain lengths is exactly the level of technical expertise that I had in some of my experiences growing up as well. Talk to me about what did you know about the industry you're in today in college or in high school? Did you know that this industry existed and how did you get into your seat today?
Doug: Yeah, no, I didn't really grow up, I would say in a world where my parents or other adults around me were kind of heavily involved in finance or real estate frankly. And ultimately, really probably sometime during college I started to have a sense of having more of an interest in terms of potentially working in finance, potentially working in real estate. And when I think about my path over about the last 20 years, what is probably unique about it is that I was a history and economics major. So went to a liberal arts college in upstate New York called Colgate University, and I was fortunate that they had a really great program to basically connect students into certain investment banks. I basically applied to, I probably applied to about nine different investment banks and I got think about seven rejections, and one of the two investment banks that provided me an offer to join right out of undergrad was Goldman Sachs.
So I got really lucky with both my time at college and some of the methods through which recruiting happens. Ended up starting at Goldman and I really joined Goldman at a really fascinating time for the mortgage business without really to be clear, having any idea of what I was stepping into. And if you look at the arc of the mortgage business, and I would say generally real estate credit in the broadest sense, 2004 through 2007 or 2008 really were these boom years in terms of innovation. And so I sat at a really young age learning during that innovative period of time, and then ultimately, that role continued from an investing perspective through the financial crisis where I also learned firsthand where mistakes were made, particularly when loans go into default, how to work a loan out, when there are distressed securities, distressed loans.
So I would describe it as the shortest answer to why I'm doing what I'm doing today is I was definitely very lucky with my timing. I was able to see, again, innovation into deep distress within the first five to eight years of my career, and that was pretty lucky timing wise.
Stewart: There was a lot to learn there. So when you think about real estate debt, it seems to me that it can fit into a number of different allocation buckets. Can you talk a little bit about that?
Doug: Absolutely. I think real estate credit is unique in a variety of ways. I think at the top of the list is really the fact that real estate lending historically has really always been primarily driven by banks. And you see it today in the data where close to about 40% to 50% of all bank lending still sits on bank balance sheets. What is evolving, I would say in the market currently is a lot of what happened within the corporate credit market over the last few decades, which is that banks have basically largely pulled out of a lot of the principal investing and holding of corporate debt. And there's been new products, namely what I'll call the private credit business, that has evolved and provided a new source of liquidity for corporate borrowers. Within real estate credit, simply put, we're just somewhat delayed in that evolution and we're really at the very beginning I think of an exciting period of time where banks will be not necessarily pulling out of the real estate lending business, but they'll be changing the way that they lend.
And also, I think that the private debt businesses will be the beneficiary of banks pulling back. So I think those are some of the really key important themes that we're seeing across real estate debt.
Stewart: Yeah, I mean one of the things, you mentioned it in your earlier remarks, but the capital markets evolve and this seems like an incredibly exciting time in the capital markets for innovation. You're seeing it all over the place. And when you think about real estate credit, what are the various flavors and how do you think about investing in one over the other?
Doug: I think that's one of the greatest features of real estate debt is that it is very much, I would say, a customizable bespoke product where an investor can find various risk, return, duration, certain property types, certain markets. It really does allow you to kind of build and invest a very diverse portfolio.
Stewart: And so, when you look around the market, who are the largest providers of real estate debt capital and where do insurers fall into that mix?
Doug: We're at a pretty exciting evolution point there. I mean, again, historically the banks, and you can pretty much list a lot of the largest US banks, take a Wells Fargo, for example. They historically have tended to be some of the largest providers of capital. When you look at some of the other parts of the non-bank universe that really have the ability to potentially grow, it really kind of falls into what I'll describe as four other areas of what I call non-bank lending. And the first of which I would say is insurance. Insurance has definitely been evolving and a very active lender within real estate debt for years. There's a lot of data around performance and volumes and commercial real estate as a percentage of insurance companies balance sheets. So I would say that insurance is both an active provider currently, but could be one of the pockets of capital that fills in as banks pull back.
Now the other three pockets that also could kind of play here could be CNBS as well, which in a way, that also can flow into an insurance company's balance sheet because insurance companies can buy CNBS products as well. So again, that could be another kind of boom for the insurance area. And then really, the other two primary larger buckets of capital for real estate debt are going to be the agencies Fannie and Freddie, who drive frankly a lot of the multifamily lending in the US. And then lastly, it's really debt funds and that's really where TPG sits.
Stewart: So, when we look out today, what are the current market trends supporting the opportunity set in real estate credit as you see it? And then, a knock on question is what are the longer term opportunities for real estate credit? As you know, the insurance industry is, insurance has been around for a long time and it's going to be around for a long time and some of these folks have very long-dated liabilities that they're trying to fund. And so, I always think it's important to point out the opportunity set both today and going forward for the insurance investment community.
Doug : Absolutely. Well, there's probably a lot going on within real estate debt, so I'll cover all of that. I'd say first just the very kind of basic purpose for real estate and specifically real estate credit is really, it's meant to be a downside protected cashflow. As a real estate lender, you are lending on assets, so this is asset-based lending. And then one of the benefits of the assets that you're generally lending on is real estate tends to, particularly relative to corporates, real estate tends to have a more stable net operating income profile. And generally speaking, real estate is characterized by long-term leases, and that again is why it historically has been a great match for insurance. I'll call that kind of like a sort of foundational statement around just where real estate credit sits. I think secondly, when I think about opportunity set, I'll speak first maybe in just absolute value terms and then for a moment I'll talk about relative value.
But just on an absolute value perspective, there's been a lot of dislocation within real estate. It's no secret all the dislocation that's happened within the office market for example. And when you go back even about a decade, we went through a pretty similar repricing and revaluation within retail as well. So when you think about really all the property types within real estate, despite it being a theoretically lowerball underlying cashflow, there have been some pretty powerful trends that have really happened across multifamily, industrial, office, retail, and many other property types. So on an absolute value perspective today, we're seeing great opportunities, frankly, within multifamily and industrial particularly. And really a lot of that relates more so to, there's a preponderance of high quality assets that have, we think, very stable long-term NOI profiles, but they have broken capital structures, which really means there was a lot of peak market activity in 2020 and '21 that was financed at perhaps high proceeds.
So we view that as for us, a real sweet spot on just an absolute value perspective is again, high quality assets, but someone either pay too much or frankly over levered the asset. We can come in and provide debt capital solutions and we can generate some excess return for our investors as a function of being able to understand and value those assets. So that's, again, a foundational statement, and then a comment on just absolute value. Given that we at TPG sit in a pretty unique ecosystem, which is that we are a fully integrated debt and equity platform and that provides us a really sharp lens through which to look at relative value in terms of looking at an asset, looking at a building, and saying, would we rather invest in the equity or would we rather invest in the debt? And we acknowledge that to your point about opportunities both today and going forward, that's always moving back and forth, and there are times we're on the margin equity is more attractive, there's times we're on the margin credit's more attractive.
Our view right now is that across most property types, real estate credit offers a really attractive relative value proposition, driven primarily by the fact that rates are elevated, spreads are wider, and there is this dislocation in value. And that's what's been driving, I would say, that kind of relative value argument. Whereas on the equity side, I think that there is a little bit of a push and pull between where interest rates are today and where cap rates are. And I think our general view is that in certain property types, cap rates have not fully adjusted wider to acknowledge the interest rate market that we're currently in. So again, that's a high level there, but I did throw a lot at you there, but that's kind of how we're thinking about it just from a sort of absolute and then relative value perspective.
Stewart: That's super helpful. I'm wondering if you'll engage me in this conversation real quick. We have a lot of people come on and they talk about, I mean, the fact that banks are moving out of various markets, whether it's real estate or lending to businesses or whatever it is, and it's Basel III end game and people give a lot of reasons, but is there anybody that thinks that somehow, the other banks are not that's going to change direction? And the reason I bring it up is that it seems to me, and I don't have an ax, one way or the other, but it seems to me that it's like, thank goodness the insurance industry is here and thank goodness the fit... In banks, you've got your lending and I'm taking overnight deposit, lend them along, and I got the FDIC backing me up.
There's a lot of risk in that structure and we've seen that play itself out with SVB and other situations. But with the insurance industry, it's such a nice match because the insurer understands their liabilities, you can come up with deals that make sense for them on a duration and cash flow basis. And if the underwriting is done well, this looks like a natural transition that's going on in the capital markets that is in what seems to be relatively early innings. Is that a fair assessment or what have I got wrong there?
Doug: Look, I think that's a very fair assessment, generally. I think that when you unpack your first statement about banks, I think that when speaking about banks, you really need to break it into two buckets. One is going to be your large cap banks, mega cap banks. For the most part, when you go through the data about their balance sheets, they've actually, I would say, de-risked their balance sheets quicker in terms of commercial exposure. And they, I think have the ability to almost play offense a little bit more within commercial real estate. But unfortunately for banks, that's not where the bulk of the risk sits. The bulk of the risk, let's call it about 75%, sits within regional banks. And I think that's where you really haven't seen as much proactive risk management. It's been lighter in terms of loan sales and also those banks generally are really not lending or slowed their lending.
So, I think it's first breaking up large and small, but acknowledging that the real estate business really is centered on it and really hinges on regional bank activity. So when I think about insurance companies and frankly where they could deploy more capital is really filling in that void primarily moreso within that void that's going to be left by regional banks. And that's I'd say 0.1, 0.2 about banks, which is actually really interesting. What's happening right now is banks, particularly I'd say a lot of the larger ones, almost across the board have a pretty specific orientation towards how they're lending within real estate. What they're pulling back from is direct lending where they're lending to the owner of the building, let's say. What they're taking that capital and doing is they're pivoting and they're lending primarily to lenders like TPG. So that's a pretty big pivot for most banks that again, primarily were developing those client relationships, dealing with borrowers directly and providing them debt capital.
Now, those banks, again, they're still involved in the whole ecosystem, but they're more so providing capital to firms like TPG and then we're out there building and growing those client relationships and actually scaling our real estate credit platform. So that's a really big pivot, but that second point is a little bit of a window into what I see as again, the opportunity longer term is that trend continuing with a real amount of duration.
Stewart: Super interesting. So I've been around for a minute and the types of real estate, there's a whole lot of stuff that not that long ago, at least in my mind, didn't exist, right? So with the growth in AI, certainly the need for compute power in these very specialized data centers seems to be driving demand. You mentioned the weakness in office. When you look across, how do you analyze these different property types, these different geographies, and if you were to look out right now, what do you think's most appealing and what are you most cautious on? Assuming that's office, but just in case it's not.
Doug: Look, we think about what's a really big scalable opportunity set within credit, I'll speak broadly and just say it's really about housing and that could be multifamily, that could be single family rental, but in terms of what is a large liquid scalable ocean, if you're an insurance company particularly to make sure that you have a really strong view on, it's really housing. And that's where we've spent a substantial amount of our time lending has been within the housing market. Again, in some cases multifamily in some cases we even have done this year a few build to rent transactions across the US. So, housing, from a very big picture does provide as a lender some really important downside protections, so to speak. Solely as a lender, what I like about particularly any kind of income generating housing investment is you can really look at rental rates and the income generated off of the asset and be able to quantify with an increasing amount of certainty what a downside path could look like on that income.
I think that what's challenging about, for example, office is it can be very chunky and binary and you can see a big kind of quantum leap lower in rents. And so, that's a very simplistic difference, but it's really critical. Now it's much more complex to analyze those risks in many ways as an equity investor, but as a credit investor, I'm focused on timely payment of interest, return of principle, and that center is really around downside protection. So when I'm looking at an investment, I'm really saying what can go wrong? And when it comes to housing, I think that it is a little bit more transparent to be able to underwrite an asset and acknowledge these are the things that can go wrong and am I comfortable with basically making that credit investment. And then, when we look within housing, what we like about it is there are some really positive macro trends that can really power NOI growth over time.
A lot of that is the shortage within housing within the US. A lot of that is the fact that we do have certain demographic trends that we're following market by market. And you mentioned earlier, how do we pick assets and what's our selection process? But when you think about housing, it's following, where are people moving, where are the job's moving? So I think a lot of the big macro trends are very observable and there's data that we can use to substantiate our investment thesis. And again, that's why for us, housing is a big focus.
Stewart: Somebody threw out a shortage of 3 million homes. Do you have a number that... Does that sound right? You mentioned the housing shortage, which is what spurred this question.
Doug: Yeah, I mean when we think about, particularly as we have insights both in terms of single family residential, but then also multifamily, there is a little bit of a Venn diagram there where they do merge. And that is for many renters right now, given that mortgage rates are elevated or at least elevated relative to recent history, that's really slowed the ability for some of those first time home buyers to basically move out of that rental and into a new home. And as we think about housing, it does ultimately kind of boil down to jobs, demographic trends, and we invest nationally across the housing ecosystem.
And again, I think that following demographic trends is one of the most powerful things that we've been following. And in many ways I think COVID and a lot of what's happened with office has really accelerated some of these demographic trends in a way that anyone would acknowledge, many people are just much more mobile now. So some of these trends can really accelerate quickly. So really being on the tip of the spear as to where is there a need for housing, where are their jobs, where are people moving? Again, they're very glaring, bright lights, but this is what we're really focused when we think about investing.
Stewart: When you think about, you've mentioned build to rent, which is a... It seems, and maybe I'm wrong about this, but it seems like that's a relatively new asset class. Are you seeing good strength there generally?
Doug: Yeah, we definitely are. I mean, to your point, it definitely has evolved I would say, into what is becoming an institutional asset class. I think in the prior world, there was multifamily, and then there was owning a single family home, and now there's something in the middle. I think that more and more people are really looking at, renting a home versus buying it, which is obviously a pretty substantial departure from historically how most Americans thought about housing. And we want to be a capital provider really across the ecosystem. And I would say secondly, it does kind of dovetail back to I think what can be lacking in terms of available supply within multifamily for those renters can be a home that frankly just has a yard, has three or maybe four bedrooms.
Most multifamily, I mean, it generally kind of anchors around studios, one bedrooms and two bedrooms. So if someone requires more space or would like a single family home-like experience, the rental home product is really a nice midpoint. But again, as a lender, what we're really focused on is, again, downside protection and frankly income stability. So I think that what's really evolved recently is it just becoming a more accepted part of every market and there's more and more observable data as to how that income performs and some of the demand vectors around what can make that, again, a really stable series of cash flows to be lending on.
Stewart: That's super helpful, thank you. So what return range can be found within the real estate credit market, and what are some of the KPIs, for the lack of a better term, risk metrics and analysis that you perform to evaluate these?
Doug: Well, again, what I mentioned earlier in the call was that the beauty of real estate credit is there's a wide variety of risk return available. So in many cases, if you're an insurance company and you're thinking about investing in the space, I would acknowledge that you can really customize what it is that you need to match your assets and liability as it comes to returns, as it comes to particularly duration, by the way, which is obviously very important for insurance companies, and also the risk that you're comfortable taking. So to put some numbers on it, I mean, within senior lending, returns right now can be anywhere from SOFR plus 200 to 400 basis points. So in many cases, you're kind of in the mid to high single digit unlevered returns for certain parts of the senior lending market. And then if you look in the subordinate debt is where you can get into the low to mid to even high double-digit returns if you're comfortable taking subordinate debt risk or mezzanine debt risk.
So that's a comment maybe on just returns within the capital structure. On the other side of the investment type spectrum, you can look at debt securities as well. There's a liquid market within the CNBS space where you can buy everything from AAA rated securities, some of which are longer duration, that might be at a hundred over the risk-free rate. And then in other cases you can buy deeper in the capital structure that might be 500, 600, 700 basis points over the risk-free rate. So why I sort of answered with a really broad menu is that for me is exactly the beauty of real estate debt is you can go into the market and be able to find assets that are going to fit well for your balance sheet. To answer your question too about what do we look at, look, every asset is different, so we come at it both from what I'll call a macro and micro perspective.
A lot of the macro are things that we discussed, just what are the big picture trends within that market, within that micro market as well, from a valuation perspective, how will inflation and interest rates affect the potential value of the asset, etc. And then on a micro basis is where we are looking really, I'd say three different metrics.
I would say one is going to be your borrower, who are you lending to? Are they experienced within that sector and that market? Are they well capitalized? And then also, is that a borrower that you've dealt with before? Maybe it's a repeat borrower and you have a relationship. So, we first look at borrower.
Secondly would be we look at the business plan. Do we think that the business plan is viable? Is it achievable within the confines of both our macro and then our micro analysis?
And then lastly, because we're lenders, we're really focused on our basis. What is our debt basis per square foot? What is our debt basis in the event of a downside outcome? And as I mentioned during the podcast about our focus around downside protection and what can go wrong, that's where basis is really important. I always say that the equity investor may have a really aggressive view on above-trend rental growth. Maybe they have a view on their sale cap rate is going to be very tight. We don't really need to concern ourselves with that as much. We're much more focused on how can it go wrong? How much lower can rents go? How much wider can cap rates go? And so, that's where again, when we get into the micro, it's really about the borrower, the business plan, and then our basis. And those are some of the key metrics that we look at when we're making credit investments.
Stewart: That's super helpful. So phenomenal education today on real estate credit. What are a couple of key takeaways before we get to the fun questions that I've got for you on the way out the door?
Doug: I think the first one really is combining both the customization available within real estate credit and that you can again, invest across the capital structure, short duration, long duration, higher risk return, lower risk return. But combining that with being able to really get your hands around the real estate and understand the income profile, to understand the valuation of that asset is what really makes real estate credit unique from an investing perspective. And I would say secondly, it really does center around this moment in time.
What you've seen is elevated financing costs, you've seen a real big shift in terms of liquidity. And by that I mean we're actually watching in front of our eyes today, banks pulling back from lending and there are many capital sources of which insurance should absolutely be one of the drivers that'll be filling in from where banks are no longer lending. So when I think about the opportunity set, it's really both of those. Number one, again, the customization on an asset that is a downside protected, stable income stream. And then combining that with a remarkable moment in time where there's dislocation and where there's dislocation tends to be where you can find excess risk return.
Stewart: I love that. That's great. Thank you. So you mentioned you're a Colgate guy, and so I just spoke to a college class at LSU recently, and so I'm going to put you in the scenario that I was in and see what you think. So let's just say that you're addressing a class of, call it 50 Colgate seniors that are majoring in something similar to what you did because they may not have a finance degree, and a student raises their hand and says, "Mr. Bouquard, I'm interested in getting into real estate credit, that market. I'd like to follow your footsteps to TPG." What advice would you give someone in that situation?
Doug: I think first, at that point in one's development, I think it is most important for them really to follow what really inspires them. And I think being intellectually curious for me is one of the most important things at that age. And when I was at that point in my career, I didn't really know what I really wanted to do and I was able to get a job within mortgage credit right out of undergrad, but it wasn't until I really was in it for a few years where I realized I liked certain things about it, which was that real estate was a mix of both macro and micro, in the simplest sense speaking to a college student. So what I would first always highlight is don't be afraid to follow what makes you curious. My second bit of advice would be, I see this a lot. I'm very active in recruiting here at TPG and also was at Goldman, which is also don't be afraid to take a different path, particularly from what your other classmates are all trying to do.
I've watched how every year each class seems to center on a certain part of finance or part of real estate where they feel like that's where the opportunity is, but I would really recommend people at that age to look towards some of the uncrowded spaces. I think anyone like you has seen cycles. There's different products and markets and seats and roles that come in and out of fashion really quickly. So I think your ability to kind of push yourself into an area that's less crowded can actually end up in resulting in an outcome where you can actually have a much more accelerated career path because you really started in a relatively uncrowded part of the market.
And in reflecting on my background, I started in, I remember when I was really first applying, I didn't know I wanted to do real estate credit. That's frankly just where they assigned me. And at the time, there was probably a lot more interest around doing, for example, tech investment banking when I was graduating. And what I didn't realize is that I was arriving within mortgage credit in 2004, right at the beginning of arguably the most innovative period of the product and I really could learn a lot by effectively being in what was a less crowded part of finance. So I think, again, I think about those two things about following what really interests you, being intellectually curious, but just don't be afraid to go to an uncrowded job or an uncrowded part of any career because that's really where you can find a lot of career growth very quickly.
Stewart: As a dyed-in-the-wool bond guy, I love that contrarian approach. That sounds right. Sounds very, very sage advice from my perspective. My final fun one for you at the door is you can have a lunch with up to three guests. Who would you most like to have lunch with, alive or dead?
Doug: I mean, I think that would be, I'd probably ask for a fourth seat there, but I'd love to just have a great lunch with my grandparents. All different backgrounds, all different jobs, really fascinating lives, and I would love to have a meal with all four.
Stewart: Wow, that's cool. What a great answer. That's cool. That's great. Doug, thanks for taking the time and thanks for being on today. We really appreciate it.
Doug: Absolutely.
Stewart: We've been joined today by Doug Bouquard, partner of TPG and Head of Real Estate Credit, and CEO. Thanks for listening. If you have ideas for a podcast, please shoot me a note at Stewart@insuranceaum.com. Please rate us, like us, and review us at Apple Podcasts, Spotify, Google Play, or wherever you listen to your favorite shows. My name's Stewart Foley and we'll see you next time we on the Insuranceaum.com Podcast.
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