Tariffs, Taxes, Trepidation: Real Estate Capital Markets

- Good afternoon, everybody. I'm Richard Green, I'm director of the USC Lusk Center for Real Estate, and it's my pleasure to welcome you to episode 65 of Lusk Perspectives. And we are thrilled to have with us today the chairman of the advisory board of the Lusk Center for Real Estate, Kev Zoryan, a longtime friend of mine and a new founder of a new company called Arselle Investments. And I was gonna tell you all about that, except I'm gonna have Kev do that instead. So let's start, again, I didn't introduce you very much 'cause I want you to introduce yourself. Tell us about your professional journey to starting your own company within the last year or so.

- Well, great to be here together with you, Richard, in the podcast series. It's very exciting to spend some time together talking about real estate, and US Lusk Center altogether. I originally actually went to the USC because of the entrepreneur program, and it was one of those programs that kind of caught my attention when I was in high school, mainly around the notion of, you know, being part of something that was experiential, hands-on, et cetera, and was very excited about that. Came to USC with that intention. And then, you know, very soon thereafter, that was the early '90s, I realized that there was a very significant a gap, if you will, and sort of interest in real estate. And then of course, sort of having been a student dug in a little bit and realized that, you know, USC, you know, had the early days of a great real estate program and some folks who had, you know, really, you know, been leading real estate in Southern California. More interestingly than that, of course, at the time was that I found that the '90s was, you know, going through a pretty difficult recessionary period for real estate in particular in Southern California. And a lot of sort of changes in job patterns, and of course, the savings loan crisis, the resolution Trust Corp days. And so I started to get very interested in real estate in addition to the entrepreneur program, and ended up doing a dual major, between the two, within the business school, which I think it was before it was called Marshall, but nevertheless ended up doing real estate finance and consulting work in the beginning. And then of course, you know, the opportunity set became very much related to distress of what was coming out of those RTC type portfolios and ended up working.

- And Kev, excuse me, but for our audience, could you just say a little bit about what the RTC was?

- Of course, so the Resolution Trust Corporation, which again, one of the founders and architects of the RTC was our very own Stan Ross. And something that obviously is very near and dear to an individual that, you know, was a big part of the arc of the Lusk Center and the real estate program at USC. The RTC was set up very simply to clear the loans that were created, you know, in the period prior to that, that were non-performing or had issues. And so the opportunity thereafter was to invest in that. That's kind of what got a lot of Wall Street and private equity type investors interested in real estate and real estate investing. And so the early days of my career were around NPL, non-performing loan workouts related to a lot of the loans that were as part of that portfolio or the assets that were coming out of that portfolio. Obviously, many of 'em were distressed, many of 'em had complex issues that had to be restructured, redone. Obviously, properties, you know, needed to be dealt with. And so the early days were really tied to that distress. Ultimately, the opportunity became much more of a traditional sort of private equity set. And of course, from there, you know, having, you know, the formation of the closed ended fund world ended up working on that side of the business and spent the next 25 years perhaps unexpectedly having sort of been, you know, originally, you know, interested in entrepreneurship as I had sort of noted, ended up in a career for 25 years on, you know, a Wall Street, you know, sort of type trajectory for many years the formation of our cell. And sort of hit on that a little bit and I'm sure a lot of this will be, you know, part of the conversation that we have today, to me was about a few things. One, as a result of the recession in the early '90s felt really strongly that the number of individuals who were actually leading organizations today, you know, were facing significant tailwind, I'm sorry, significant headwinds as it related to their succession issues. And I think a lot of that was rooted in the fact that, folks didn't go into the real estate business in the early '90s as a result of the SNL crisis in the RTC days. And so I think that opportunity sort of fast forward 30 years, you know, really created a gap where you have great organizations, great principles, and leaders of these organizations looking for an opportunity to really sort of preserve their legacy in their organizations. But because people weren't in the business for a very long period of time, you know, there are gaps that sort of, that demographic professional gap, if you will, fast forward to today is what's showing up in many of these organizations. So our idea really is to help, you know, sort of if you will, step into the role of that GP, help capitalize and recapitalize these organizations providing the runway for the existing leadership to ultimately do whatever they wanna do relative to their transition needs. And of course, sort of helping the next generation step up and become a leader of the organization. Of course that requires capital and requires strategy. And so our idea is to, you know, really find a spot in that general partner role in those types of organizations going forward. We are a real estate investor first and foremost, but of course our idea is that if we, you know, approach it from that perspective, you know, we have access to differentiated flow, differentiated opportunities to invest in real estate through great organizations that of course are, you know, going through, you know, their various changes of needs. So that was the genesis for our cell, and it's been a fun journey. We've been in business for about three months now.

- So let me just come back to a few of the things you said, if you could expand on what you mean when you talk about GPs because our audience, I'm hoping they're members of our audience who don't think about deal structure and real estate every day. So when you talk about taking on the GP role, tell our audience exactly what that means.

- Of course, so I would say that in the industry today, the predominance of operating companies are smaller investor developers that basically are the ones that find the deals, that acquire the deals and then asset manage and execute the deals. And that individual, that group of individuals serves the role of the GP of that deal. They serve the role of, you know, the team that executes the business plan. So in that way, ultimately, there are many different types of organizations in our industry. Of course, there are REITs that have their own capabilities, both capital and operating. But on the other side there are these many, many great organizations that are specialty, you know, sort of experts in different product types, different market types, et cetera, different types of investing in terms of risk. And we'll talk about that I'm sure in a little bit. But the general partner is the one that really takes the lead and executing those things. And the limited partner is the capital that comes in, which is the part of the business that I spent most of my career doing. So that's the sort of difference between the two at a very high level.

- And since we're here in Los Angeles, I always think of the parallel between a GP and a real estate deal and a producer on a movie. It's basically the person who takes the idea and then tries to get it executed. So in the end, if you're a general partner, you wind up with a property that's finished. If you are a producer, you wind up with a movie that's finished.

- Yep.

- And I think-

- I also think of it as the conductor of an orchestra, 'cause ultimately in order for, you know, the music to be created, it requires, you know, all the different instruments to play together in different ways. And every instrument is a different expertise.

- That's true. Although I think the general partner has a harder job because generally once you've assembled the orchestra, they're all there at the same time and you can get them to do what they do. And what the general partner has to do is choreograph a whole bunch of people to do different things at different times to get the sequencing right. And it's a skill that I don't know that many people understand or appreciate from the standpoint of getting a building up out of the ground and completed.

- Yep, look, it's a very, very important point and a very important question of course, having, you know, been on the capital side of our business, you know, having the right team in place is incredibly important. And the right team also, you know, in addition to the general partner, you know, requires all the different, you know, parts of the real estate ecosystem to be a part of this team. Everything from the entitlement and permitting piece of it to the design and the structural, all the different components of what goes into, you know, putting together a project then executing at the construction team. And then of course, once the building is built, there is leasing, and then eventually there is, you know, the sale and the monetization, and of course, how you capitalize the deal along the way. I think, you know, the ecosystem of real estate is very rich in terms of the, you know, the various different ways that someone can participate with all the different types of disciplines, backgrounds, expertise, of course, working together, you know, under, and together alongside, you know, that general partner.

- So I'm going to step away for a little bit now from what you're up to with your business. We're gonna return to it toward the end of the conversation, but I just wanna now start talking more broadly about what's happening in real estate capital markets. And again, given that I'm hoping we have a more general audience here, could you just tell us a little bit when you hear the phrase real estate capital markets, what do you think that means?

- I think that real estate capital markets is ultimately the process of identifying and pricing the risk of a particular deal and then finding the appropriate capital and funding to attach to it, right? At the end of the day, there is all kinds of different types of liquidity and illiquidity, of course, in real estate. And that capital is looking for different types of attachment points into real estate, and real estate sort of being part of the broader investment ecosystem. Of course, there's equities and you can get to real estate through different types of real estate equities, REITs, et cetera. And then there's debt of course, in the world of sort of bonds, et cetera. But in the world of real estate alternatives, the act of identifying a willing investor that has capital and a willing project that needs capital, to me is the capital markets. And then the more complicated answer is that, each of those different types of sources of capital will attach at different parts of the capital stack. It'll attach at different points of risk within a deal. Even the deal itself, you know, has to be assessed. So I think our role as capital markets individuals in real estate is really the price risk. And then to find the liquidity that's available that is interested in attaching to that risk. There are of course many, many different roles within that. There are intermediaries, there are lenders, there are equity providers, and consumers of all that capital. Of course, in what that is in that sort of total ecosystem of individuals to me is the sort of real estate capital markets. Again, very many different ways to slice it, but in particular as it relates to how, you know, we think about a real estate deal on the balance sheet, you know, there is many, many different types of risks that are taken on any given deal, you know, based on how the capital comes in, how it's structured, how long it stays in there, et cetera. So that to me is the function of the capital markets for real estate.

- So this is gonna prompt a question that I did not send to you in advance, but I'm thinking about, you can think about categories of providers of capital, right? You have insurance companies, you have pension funds, you have sovereign wealth funds, you have private equity, and there are others. But let's just talk about those four briefly. How do their motivations differ in terms of how they're thinking about placing capital? Or do they not? Or is it more that within each class you have different players with different motivations, but the classes themselves, if you look at them as a whole, are quite similar to one another.

- They are very similar at a very big picture, but they're also very, very different, right? At the end of the day, each one, you have to understand the motivation of what they're trying to accomplish. You have to understand their own underlying investor motivation. You have to understand what those investors are seeking in terms of long-term returns. And then, you know, of course, you know, as you get the larger and larger in these organizations, you know, there is a whole portfolio theory piece that goes into it. So if you sort of take equities, big picture, you take, you know, fixed income instruments, big picture, then you have the alts. And inside the alts you have this world called real assets and inside real assets is real estate. And so each of those different providers of capital are, you know, have their own various strategies around how they want to put capital under real estate alternatives. And real estate alternatives could be everything from going into, you know, fixed income type instruments and debt instruments. Or it could go into open-ended funds with evergreen capital, the ability to continue to sort of redeploy capital for a very simple description of what that is. Or close-ended capital where, you know, the capital would go in with a specific intention, purpose, and timeline. It goes in and it comes out. And so I think as it relates to each of those different types of investors, the ultimate intentions and goals are tied to what they're trying to accomplish. If they, you know, if their basket of, you know, investments in the portfolio, you know, require more risk, less risk, whatever it may be, you'll see different, you know, different types of investors come to different deals. Some wanna be in funds, some wanna be in direct deals 'cause they have, you know, some ability to sort of select product types. Some wanna be in particular markets, some wanna be in global funds, you know, in global investment situations where they're, you know, investing across, you know, a whole spectrum of different types of deals on a commingled basis. But ultimately, you know, each one has their own strategies. I would say the thing that's probably most interesting is to really think about the investment duration of the source of funds of each, right? And so ultimately, life insurance companies are obviously, you know, their predominant sort of focus and goal was to have an basket of investments that are there for their life insurance customers. Sovereign wealth funds obviously are, you know, tied to whatever goals they have for their long-term investment needs. Private equity funds, you know, to the extent that obviously, you know, private equity funds are likely getting their capital from a life insurance company or a pension fund or a sovereign wealth fund, you know, their intentions are really tied to the particular strategies that they're advocating, the particular strategies that they're sponsoring. And so from that perspective, you know, they all may look very similar at a very big picture, but each one attaches a little bit differently based on the risk, the duration of their capital and you know, the strategies they have within their broader portfolio.

- So that's gonna prompt another question about duration. So real estate by its very nature as an asset, has long duration, right? So you wanna match it against long liabilities. So for a life insurance company, you have very long liabilities, right? Although I suppose as we as a society are getting older, those duration of those liabilities are getting shorter. Pension funds, similar sort of thing. Whereas private equity, if you have a close ended fund, you may be five, six, seven years from the end of the fund. Does that... It's sort of like, you know, banks shouldn't be taking on long-term assets because they have short-term liabilities. And one of the things that got Silicon Valley Bank in trouble, and First Republic Bank in trouble was that mismatch. Do you see mismatch problems with close end private equity funds and real estate? And I'm not just talking about today under current circumstances, but just as a class, does that create a complication for closed-end funds that you don't have for these other vehicles?

- Yeah, I would say that a couple things. One, you have the bigger picture, the availability capital, each of those different sources of capital have their own, you know, forecast of what is going out and of course what's coming back. And so to the extent that, you know, you sign up for some type of a closed ended structure that requires capital to be called over a period of time, you're obviously planning for that. And, you know, in a situation where to your point, you have an illiquid asset like real estate, the duration needs, that could change based on different, you know, things that happen in the capital markets, illiquidity at a moment in time, availability of financing, et cetera. The other piece of course, and I'm sure we'll talk about it in a little bit is, you know, the need for financing and refinancing, right? Ultimately, those could be things that could have an impact on the big picture outcome. But I will say, I think the more important thing as it relates to these types of capital, these buckets of capital is, you know, they're investing based on, you know, certain repatriation periods of their own timeframes, et cetera. And the ability to continue to invest in real estate or other alternatives is obviously tied to the liquidity that's available for that strategy. And of course, as we're seeing now, you know, for, you know, organizations like some endowments where there's questions around, you know, how taxes may work, et cetera, you know, that need for liquidity and illiquid assets is created, you know, a whole different market now, in fact, a whole different market that I don't have a lot of experience in, but around secondaries. And so ultimately, the ability and need to, you know, the right matching of capital to strategy is obviously very important. It's a lesson we all learned in the great financial crisis. You know, you match your, you know, assets and liabilities in terms of duration, and you leave enough flexibility, and therefore some things to change, 'cause invariably they will.

- So let's now just go back to sort of a broad sweeping statements about the history of capital markets. What are the innovations that you've seen and, you know, innovation could be a good word and not so good a word. So like subprime mortgages were an innovation, I think it did not end very happily, but there are other innovations that, I'll give an example. Treasury inflation, treasury inflation protected security-

- Scripts.

- Right? Great, great innovation and financial market that allows people to hedge their inflation risk. Sort of within the world of real estate, what innovations have you seen since the early 1990s when you started working on this stuff and which have worked and which haven't?

- You know, it's interesting, you outlined the different types of investors that, you know, have gone into this business over the years. I would say that historically real estate, real estate, private equity investors, if you go back far enough, were very long-term holders, right? They were very long-term holders. They owned land over a long period of time, generally self-finance or financed through some kind of, you know, other sort of cash flows, et cetera. And for lack of a better way to describe it, those investors were highly multiple focused, right? They were focused on the multiple of returns of their investments, or in some cases, if you're a long-term holder of real estate or long-term holder of land, you were obviously very much focused on the return of new capital being deployed into real estate. I think today, obviously, the industry's gone, you know, to a very different place, right? There is a complete stratification of that risk, right? You can be a lender, you can be an equity owner, you can be an open-ended equity owner, you can be a closed-ended equity owner, you can be an owner of a development deal, you can be a cashflow. So I think at the end of the day, you know, what I think is probably the biggest innovation is the notion that obviously, we've sliced up and stratified the risk in very, very significant ways over the year. And I think ultimately, you know, that is, you know, the innovation there is the sort of advancement of pricing risk. And then of course, sort of taking the risk that you price and matching it with the liquidity in investors. And at the end of the day, what you're trying to do is get more bespoke products for the risk someone is willing to take, right? And so that probably is the greatest innovation. I will say that as it relates to closed ended capital going into real estate, I think it's a very, very important part of our real estate capital ecosystem. And it will continue to be the... I think the key considerations around is making sure that when you bring closing into capital, you have adequate amount of reserves, and capacity flexibility to be able to flex up and down as it relates to the investments you hold, or the timing 'cause ultimately, you know, some of these investments will take longer to, you know, go through a life cycle. It'll take longer to get through entitlements. Entitlements today are very complicated and many municipalities. And, you know, on the front end.

- Just real quick, is that a uniquely California phenomenon or is that pretty much everywhere?

- Well, I would say it's not a uniquely California phenomenon, but I would say that most of the, you know, most of the coastal markets where a lot of the institutional capital over the years has gravitated to, it has become much more complicated to get entitlements. It has become much more complicated to put projects, you know, into production, into motion, that's not to say that it's easy other places, but there are some places where it's easier. And of course at the, you know, the other part of way to sort of thinking about this is if you have a forecast, a pro forma for a deal that assumes the basic sort of certain timeline, anything that takes longer, especially where you have, you know, in today, again, we talked about pricing risk and matching that return, the biggest difference today is that stratification of risk has led us to being focused on returns in terms of internal rates of return and those types of metrics for return as opposed to multiple. And, of course, you know, in a scenario where you have, you know, duration, extension, et cetera, obviously, there is a big impact to those returns over time. So if you don't get the timeline, that you thought you were gonna get, of course, you know, that has a big impact on how the outcomes of your deals are. And that is of course sort of the, you know, the way that the industry works today. And then of course, you know, now we also have larger, you know, commingled structures, and of course, you know, put those risks together, you know, tries to blend out if you will, smooth out those risks and ups and downs to, you know, ultimately end up with a basket or a portfolio of real estate assets that, you know, combine into a blended return.

- Let me ask about, I'm gonna ask another question that I didn't send you, but we're talking about return measures. I think it's worthwhile to spend a few minutes talking about IRR. Now as I'm sure you know, finance professors hate IRR as a metric. And I think the principle reason is because it's so easy to manipulate, it is just depending on your timing of when you lay cash out versus, you can make IRR look better than it actually turns out to be. So that's the first thing. The second thing though is I think about something that I heard Rick Caruso say once, and for those of the audience who don't know who Rick Caruso is, he is a well known developer here in southern California. He's the developer of the Grove of the Americana to very well known shopping centers as well as others. And I remember him once saying, he doesn't use IRR because to do IRR, you need to know what your exit is. And he never really knows what his exit is. And he's absolutely right. It's very sensitive to when you sell and what you sell for. So what is, you know, not the market's view, but what's Kev Zoryan's view about the right way to think about return metrics when you are doing real estate investment?

- It's a very good question. And of course, just like anything else in real estate or any type of investing, you know, you're expected, your willingness to put your liquidity into something is based on an expectation of what the returns are gonna be. And you know, certainly there is a way to do it based on multiples and those types of, you know, or it could be based on a yield, based on cash flow, right? The sort of net cash flow of a deal or the NOI of a deal over what your basis is. But at the end of the day, I think ultimately because our industry is, you know, and all of portfolio investing ultimately ties to what are the annualized returns of an investment irrespective. And of course when we talk about that stratification or risk, right, you're talking about the different buckets of things that you can invest in. Ultimately, you need something to create that consistency in the normalcy across how you would calculate those returns. So in as much as IRSs at the end of the day can be, you know, the forecast can be anything for a deal, of course, you have to find, you know, the right metrics of what something would lease for or sell for, what you think the ultimate exit would be in terms of yields. All those things are very, very important assumptions that go into it. At the end of the day, the IRR at the end of the deal, and that which compares it to every other alternative you have is the, you know, the way to measure the outcome of those deals. That's number one. Number two, it's how the entire ecosystem is set up in terms of how profits get split up between the various different investors and operators and so on and so forth. So ultimately, that is the more traditional sort of method of calculating returns and how it ultimately sort of ends up getting divvied up at the end when you know the transaction is, you know, held to success. Of course, again, there are other ways to do it, but that is the case. Of course, if you are a long-term holder and you're buying and building and holding great real estate, what matters is the return, the cashflow capabilities of that asset, the ability to lease that asset over the course of a long period of time. In the case of assets that require a lot of capital, of course, you know, tenant improvements, et cetera. You have to put that in your calculation as well, 'cause your basis continues to change. And then ultimately, you know, the goal is for, you know, the value appreciation to carry, and that is important as well. But again, most of you know, the liquidity that ends up in real estate alternatives ends up in alternatives for a finite period of time for a finite particular purpose, and then is repatriated and redeployed.

- So you're discussing splits makes me think about how GPS are compensated and I think it would be great to have you talk a little bit about the evolution of that over time. Because again, for those of the audience, GPs are generally compensated two ways. One is they receive fees for putting the development deal together and the fees are some percentage of the amount of money outstanding to do that deal. And then they get a split on top of a preferred return to the limited partner. So you will set up a deal that says limited partner until you get all your money back plus say 10%, the GP gets nothing. But once you achieve that goal, the GP gets some split 20/80, 30/70 above that 10% return to the limited partner. Have these compensation arrangements been changing over time over the years that you have been doing this business?

- I think the biggest change I think that happens in waterfall structures and carried infrastructures, promote structures, really they're all kind of interchangeably used in terms of how they're defined, ultimately is the setting of the hurdles, right? Is sort of what do you, where do you set the first hurdle? What is the right preferred return relative to the risk you're taking? And some of that is a spread to what is less risky, right? What is the sort of, you know, the range of different types of risks that you could take. And then of course from there, you know, the ultimate splits, you know, would get, you know, likely based on the outcome of a transaction and how you sort of move from this step to this step to this step. You know, you participate in better upside. And of course, the intention of this is to create an incentive alignment so that you know, a deal will, you know, be a great performer, and that, you know, as the deal is a great performer, you know, the folks that are executing it have the ability to participate in. It's a structure that obviously is deployed in many types of, other types of private equity structures, et cetera. The only other thing that has come into play over the years and then mainly is because you know, we are now obviously in an environment where there is much more near term volatility in investment hold periods. Lots of things happen in a shorter period of time versus sort of longer drawn out cycles. Now you have interest rates will move fast or there is something like COVID, which obviously none of us would've ever predicted. Ultimately, those kinds of I impacts. And of course, you know, the movement of, you know, interest rates and cap rates, you know, will potentially, you know, motivate you to sell something or to, you know, make a change in your business plan based on whatever you're seeing in the environment. And in those instances you might have situations where you have high IRRs, you know, high IRRs ultimately, you know, move through the waterfall. And so, of course, you know, you have situations such as minimum multiples and things like that that now, you know, are every now and then introduced in some of these waterfalls. It's not very common, but certainly something that we see. And then, of course, the other piece, and I think this is the nuance to every single deal, is depending on the risk that is embedded in a deal and depending on the alignment, the actual skin in the game that, you know, the operator or the sponsor, you know, will put in the deal. Of course, there is subordination of certain types of economics of course as well, you know, whether that's fees or the things that, you know, you'll see in different types of structures. Not always the case, and obviously they become very complicated in terms of how they're structured. But those are the nuances and things that I think have changed over the years. Of course, the biggest change in the industry, and a lot of this came after the great financial crisis was that the large funds, of course, ended up in for the most part in situations where their returns were crossed against the entire outcome of the fund. So in as much as the operating partners were in, you know, deal by deal or smaller buckets of deals mode, the bigger funds obviously, you know, in that, for those that have that, you know, ended up, which is again a more of an industry standard today are, you know, have those returns crossed against, you know, all the outcomes within a portfolio of deals and a vintage.

- Yeah, the other thing, and I don't wanna get too much into the weeds on this, but I also understand catch up rules have changed and limited partners are not interested in allowing for catch up, which was a method that general partners could use to recover some of their money more quickly. Is is that true?

- It depends. I mean, everything, everyone's a little bit different. I think catch up, you know, still does exist, but you know, there's definitely nuances to how that would work ultimately. And when, you know, when you get, you know, again, if you're crossing the old portfolio to get to a catch up, you know, you already have returned all capital, you've already returned to pref, so now you're participating in some type of an acceleration of economics after a lot of things have happened in those instances. There are a lot of different toggles.

- Well, so let's now talk about, you know, more generally, how do you see the capital market environment right now?

- I think that there definitely is a pretty significant trade off.

- Excuse me, now is June 19th, 2025, if somebody is watching this in 30 years. So Kev, go ahead.

- I think there is a pretty significant trade off in sort of the marginal availability of capital and risk. And what I mean by that is you hear a lot of, why would I take that risk if I can get a credit, product that gives me X returns, right? If I can do a preferred return, if I can do some type of a bridge financing or whatever it may be and get a higher, you know, private credit type return. And so I think what's really, really important is, you know, those types of situations where, you know, you have quote unquote lower risk to get more relative returns that are attractive could be interesting. However, I think it's really, really important to make sure you actually underwrite in those instances the incremental risk that you're taking as it relates to that type of private credit construct. So, you know, are you getting a, you know, an X% return and for 2 or 300 more basis points, I'm getting this, I think there's a lot of trade offs. I think that's sort of the trade off in understanding the marginal return and marginal risk of equity or debt. But debt could also be, you know, kind of equity like if you will in some of these constructs. You need to really be careful and understand sort of how those incremental risks and those returns relate to each other. I do think that there is a fair amount of capital. We hear about, you know, the formation of a lot of private credit funds of different types. There's obviously the availability of pretty significant opportunistic and value add type capital that has been uncalled. There's probably less availability of capital and some of the more sort of lower risk open-ended structures because in those instances, obviously, you know, there, we know there are redemption issues that, you know, many are working through that. I would say that I think a lot of those redemption issues are, you know, starting to find their way. I think the thing that's probably the most.

- So again, Kev, tell the audience. When you talk about redemption issues, tell the audience a little bit about what exactly you mean by that.

- Sure. So in a closed-ended fund, you put the capital in, it's called over a certain period of time, that money goes in as it's called into specific situations up until the, you know, the cap amount, et cetera, of the fund. And then it's repatriated back to the investors and then the investor decides how they want to redeploy the funds back into whatever strategy, real estate, et cetera. In the construct of open-ended vehicles, you put the money in, it goes in some, you know, some period of time, quarterly, over some period of time, number of quarters, et cetera. And then if you want your capital back in those instances, you have to go into what's a queue and then the queue over time releases the capital to you as funds become available in, you know, in those different various buckets. And there's obviously different examples of that type of thing that's happening today. When the redemption queues are increasing, in other words sort of the inability of the underlying fund to, you know, pay out someone immediately based on their demands that, you know, obviously stacks up and it takes time to get out. And so in those instances, again, real estate isn't a liquid asset class and those structures, you know, that's the, you know, it's more liquid than a closed-ended structure where you're in and out over the period of time you're in. It's obviously less liquid then just buying, you know, a public security where you can get in and out on a moment. So it's sort of the in between, if you will. And you know, in those situations where there are, you know, open-ended structures, you know, the happening of redemption queues obviously will limit those buyers' ability to make acquisitions because the liquidity they have is being utilized towards ultimately reducing those queues. And so those buyers end up on the sidelines, they're not as active unless they have, you know, particular other abilities to spend money or obviously, you know, their investors are generally patient. And I think in most instances, you know, investors generally are patient and they're trying to sort of understand in those constructs that, you know, they're gonna, it's an orderly, you know, way in, it's an orderly way out. And so they're, you know, waiting for, you know, their turn, and some of it also has to do nothing with real estate. It could ultimately be just purely, you know, rebalancing their own portfolio because stocks went up and they need less of this or more of that or whatever it may be. I think that ultimately, you know, has an impact as well. So as we get into these bigger structures, of course, the outcome of how capital flows is very much tied to, you know, other things that are going on in these portfolios.

- So just by the way briefly for the audience is there's this phrase for large portfolios called the denominator effect. So you'll have a target allocation to different kinds of assets, stocks, bonds, real estate, et cetera. If the value of one of those assets goes up a lot, like if the stock market goes up, that means automatically you have too much money given your allocation targets in the stock market. And so what you're gonna wanna do is sell that money in the stock market, put it somewhere else to return to your previous allocation targets and that is something that moves money around and many of these funds.

- Yeah, and what's interesting actually-

- Yeah.

- To that point is as the stock markets have appreciated the last several years, the notion of sort of what that has done to the denominator, you know, obviously real estate in particular, if you haven't added to your real estate portfolio, again, everybody has their own strategies. Real estate would become a smaller piece of the total puzzle. And in instances where you see people are increasing their allocation to real estate. One is, you know, is it catching up to that denominator. Two, you know, are they over allocating relative to the past for various different reasons? Of course, you know, in the last several years, inflation has been a real factor and real estate, you know, clearly has benefits as it relates to inflation to some degree in, you know, the total portfolio. So ultimately, there are lots of different reasons why the denominator will have, you know, an impact. And it's important 'cause ultimately that, you know, should for the most part, you know, be a good, you know, sort of guiding light to how, you know, capital will ultimately find its way into alternatives and real assets, et cetera.

- So there's still are not a lot of transactions going on in the commercial real estate market. And so the classic problem of a bid ask spread is we don't have price discovery yet. Let me put you on the spot and ask you, when do you think price discovery is coming? And it's gonna come in the next six months, it's gonna be a year, it's gonna be five years. How long are we gonna be in this sort of limbo, which we seem to be right now in the real estate market?

- I would say in general markets have been relatively optimistic. Of course, it is really tied to the haves and the have nots around product types or balance sheets or whatever it is. So there's a pretty significant bifurcation. I think the bigger more important thing, which doesn't have an answer of course, is uncertainty and stability. The perceptions of what that means and ultimately, you know, it's the three Ts, it's tariffs, it's taxes, it's trepidation. And ultimately, you know, someone's willingness to take a step in something is tied to their willingness to feel confident that they're making the right decision for the environment. And so new capital, you know, if you're worried about sentiment and you're worried about the complexity of what's going on, you're gonna be less likely to be willing to part with, you know, your liquidity in dry powder. And so I think that's certainly a factor. The other part of it is you need to have willing buyers and sellers, and I think in a lot of instances you have scenarios whereby, you know, the capital availability in situations, you know, has met the needs of the, you know, the need for the exit on the other side. And they're, you know, you end up with a willing buyer and seller, but they're fewer and further between, 'cause ultimately someone doesn't have the pressure to sell the need to sell. This, of course, this expectation that interest rates are gonna go down has been something that has, you know, been been driving a lot of that confidence in, you know, sort of not moving. Of course, you know, what ultimately happens with lenders and this notion of sort of, you know, the extending, the pending maturity. I'm sure we'll spend more time talking about that, but those are all things that have to happen. So I do think that, you know, overall the most important thing that can happen is, you know, more certainty, you know, those types of things, obviously, will continue to always be the case, but you know, they're all, they all go on that calculation, and we do why we price risk, right?

- So did you just coin the three T's? Is that yours or did somebody else come up with that?

- No, I just wrote it down earlier. I'm like-

- It's really good. Tax and tariff and trepidation. I like that. I'm gonna .

- I came up with it, but you know, if someone else has done it before, then I give them.

- No, no, I haven't heard it. So Kev, you need to copyright it right away so that nobody else can take it from you. So I mean, tariffs are gonna be the next thing I talk about because you know, one of the things that is the mirror image of goods markets of trade or capital markets. So the way the last, I don't know, several decades have worked at the United States is because we don't save a lot of money and because we run federal government budget deficits. We've needed foreign capital to finance our investments and both in terms of our government investments and in terms of private investment. And the way it works is you could say they give us goods in exchange for us giving them assets or we give them assets at exchange for thus giving them, I don't know which drives which is actually kind of an interesting question, but with the current administration seeming determination to basically kill trade. If you kill it on the... And maybe I'm wrong about that, I mean, of course, tariff policy changes by the hour, but if that were to happen, it would surely have an influence on the capital flow side of the market as well as the good flow side of the market. Do you see foreign investors talking about this? Do you see foreign investors looking anywhere else? Or is the United States still because it's so large and its demographics are not great, but not as awful as a lot of other people in the world still the place that people are gonna wanna look at when they're investing.

- It's a very hard question, and I'm absolutely not qualified to answer all the next order effects. I will say that ultimately if the intention is to, you know, bring some of that balance back here, that means you have to actually do different things here, right? Different things with your capacity, your production, your whatever. And so there's obviously impacts to that, and of course, there are returns on that ultimately as well. And perhaps I think the sort of, you know, the trepidation point, if you will, is that sort of interim step of how we sort of get from here to there. We can't, you know, I don't think we can grow bananas in the United States, right? So how do you sort of.

- No, that's not happening. Well, maybe in

- Yeah.

- Yeah.

- So there's how you're replacing those things, obvious are important. The thing I think is interesting, and we have had a number of different discussions with international investors in the last few weeks, and just our relationships over the years, and I think a lot of folks have sort of come to the, we can underwrite tariffs, we can understand for the impacts of that there's, you know, there's dollars and there's friction costs and how that gets shared, could be something that, you know, you can sort of get analyzed. I think the thing that I hear more from folks out, you know, outside the US is I need to understand the tax policy and is how is that gonna change? I need to understand, you know, the sort of interrelationships between sort of various governments and treaties and things of that nature, whatever it may be. It's again, it's a lot of that uncertainty. And so I think the feedback that I seem to be hearing is we don't like, you know, sort of some of the noise, right? And so as a result, we're just gonna wait till we see where the dust settles. And I think to some degree that really is the more complicated side of the equation 'cause it's kind of hard to make those assessments. The other part of it, of course, is also, you know, most of the decision makers in many of these organizations around the world, you know, have very personal relationships with the United States, whether that's the educational system, obviously, I don't know, very significant 25% of the USA students or international students and so on. And I think ultimately those kinds of, and maybe my math is wrong on that, but it's a significant number and ultimately.

- That's about right. Yeah.

- Ultimately, you know, those interpersonal personal relationships also have a factor. So ultimately, their decision point's gonna be, well, we're gonna wait, until we find out what's gonna happen. And so I think that waiting in, you know, combined with the lack of transaction activity, the very selectiveness of capital probably actually creates more distress in balance sheets in the system than helps. And I think from that perspective, you know, the other side of the coin is as capital pulls back, that probably creates, you know, more uncertainty and more economic uncertainty and ultimately, you know, more situations where, you know, things, you know, may unlock, but they're gonna unlock because that sort of marginal availability of capital that will take, you know, that incremental risk, or just even liquidity in the system, you know, will not be the same. And so ultimately pulls back and creates, you know, more stress on balance sheets overall. So I think that's a factor. I'll talk about it a little differently too, just in southern California obviously, very significant trade port and warehouse distribution market and I think that's really, really important because, you know, we have, you know, the base of, you know, the billion plus of, you know, of industrial real estate here. Obviously, is heavily impacted when you see, you know, port activity fall as much as you have, you know, even in sort of short spurts or whatever it may be. Ultimately, you know, that, you know, that over the course of time is important for that. But the other side of it of course is, you know, this notion that advanced manufacturing and access to skilled labor and all those kinds of things, you know, probably are more important today, right? And so there is a trade off between, you know, the more sort of traditional warehouse distribution and you know, what may be, you know, infill well located industrial. And so, you know, it's hard to sort of paint paintbrushes that are very broad because I think the impacts even within the real estate ecosystem and within product types are gonna have different impacts and different outcomes.

- So I wanna ask one more question sort of about capital flows, and it involves the banking side as well as the broader capital markets. And then I just wanna... We will finish by talking about some of the other projects that you're involved with, but there's this constant worry about maturity cliffs. So again, for the folks at home who haven't done a commercial loan, the way commercial lending works is different from home lending and when you borrow to buy a house, you get a 30 year loan, it self amortizes, you pay it until it's zero when you're done. In commercial lending, you amortize over a long period of time, but you usually have to repay the loan in fall in somewhere between 5 and 10 years. And that's what's being referred to as the maturity cliff. And people often got loans, think about if they got a loan five years ago, it had an interest rate of 2 1/2% and now they need to refinance that loan at 6, 7, 8%. So even if their building is fine, the ability to service that loan is much more challenging than the old loan. So Kev, how much of this is a problem and are we going to start seeing waves of default because of the inability of people to refinance their commercial loans?

- I think it's a very important question and let's step back 'cause you hit on a couple of really important points around the backdrop. One in the great financial crisis, through that we changed, you know, lending policies generally, big picture and we didn't, coming into this cycle, we didn't necessarily have higher leverage, highly leveraged balance sheets like we had in 2007, eight. So that's sort of backdrop number one. So in that construct we didn't over lever like we had in a previous cycle, which I think is important from a fact. Backdrop, number one. Two, if you bought an asset with the intention of, you know, taking, you know, your cap rate up 200 basis points through rent depreciation or you know, CapEx you're spending, a few things happened. One, the cost of that CapEx went up because, you know, inflationary pressures on the underlying business plans probably had an impact, number one. Number two, your expenses probably went up faster than your forecast. And three, your revenues probably went up but didn't go up as much as you probably expected. On a net basis, your margin actually shrunk. And so overall, you're talking about a business plan that you thought you were gonna get a 200 basis point increase with your strategy, maybe you got 100 basis point increase, so whatever it may be. You borrowed floating rate at SOFR 300, you know, SOFR was zero for a long time and that cost financing, you had an interest rate cap in place that allowed you to basically preserve that, that low interest rate for some period of time, unlikely that it was for the entire period of the hold. And so ultimately the cap, you know, rolled off, you didn't achieve exactly how much you did in terms of the appreciation of your business plan and your cost of financing went up by three, four, 500 basis points as your caps burned off. And so on the margin you have, you're borrowing now negative leverage. And again, I think the math on a lot of that, you know, just sort of taking big broad brush numbers is somewhere between 10 and 15% of your loan balance. And so if you levered it say 65%, and you've lost 10 to 50, and you've lost 10 to 20% of the value of the real estate, and let's just put aside, you know, the binary situations of office or other things, aside for a second, the math that you need to sort of cash in is 10 to 15, 10 to 25% of your loan balance. So you're basically calling, you know, effectively 50% or more of the equity you called in the beginning to actually remargin and refinance that loan. And I think that's the decision a lot of people are facing. So you have equity to protect, it's not necessarily-

- That makes this very different from 2009.

- Very different where it was just not worth the debt. Now you have equity to protect, but it's significantly less. And then you have the issue of maturity, which again, you know, we can talk about how banks ultimately I think we're seeing more and more banks that are, you know, starting to deal with those issues over time. But ultimately, you know, if you have equity investors or it's your own, you're gonna have to come up with, you know, some meaningful number relative to your original equity investment to protect that investment and to deliver the loan. And so that's the backdrop that's really, really important. And that's actually a lot of sort of the things that are going on within many organizations today is where do you sort of put that good dollar to protect an asset? So really, really important. I do think that we're hearing more and more that banks are seeing pay downs, there is availability of liquidity. Again, you know, there's different types of structured financing. And if you ultimately believe that interest rates are gonna go down, you would take on some more, you know, complexity or balance sheet with the hope that ultimately as rates go down, you have the ability to do something more, you know, as fundamentals recover, you have the ability to refine, et cetera.

- And Kev, is that more mezzanine lending or is it more raising more equity?

- I think it's both. I think, you know, to the extent that many people, you know, don't want to call equity, don't have the desire to sort of put in, you know, the significant amount of equity that is needed for these, you know, because again, it's just the math is, you know, pretty meaningful relative to your original capital call. Ultimately, you know, it is mezzanine or preferred. And then of course, the question becomes how do those get, you know, sort of resolved at the end? And so that's a big question. That's the moment we're in. I think that the opportunity, if you will, you know, sort of the word that I use is this funding gap, right? That sort of that 10 to 25% required to cash in refinance is a, you know, if it's a trillion plus of existing loans that need to be figured out, there's, you know, a couple hundred billion dollars of funding gap that needs to be figured out. And that's gonna be figured out through these credit structures, can be figured out through new equity or ultimately the repatriation of that asset. And so, you know, certainly we're hearing, you know, little by little, you know, news that, you know, there is more activity among lenders. You know, as they get more payoffs, they have the ability to absorb more, you know, more of the sort of impacts on the balance sheet so they can actually get product through and move so they can actually start redeploying capital, you know, into other things. And so I do think that's starting to happen, but a lot of it is still being held at bay because the expectation that interest rates, you know, would roll down. And obviously, that has not been the case, you know, throughout this year.

- So let's finish by talking a little bit about the other stuff you do besides your day job. And in particular, you've been very active with us at USC throughout the university and we're very grateful for that. But also, you were a chair of the Los Angeles District Council for the Urban Land Institute, and you were instrumental along with others on putting together report on how to recover from the fire, the fires that happened in Eaton Canyon and in the Palisades here in Los Angeles. And if you Google ULI USC Lusk, UCLA Ziman, I'm pretty sure that's the only response you'll get if you have all of those three things in quotes in a Google search, you will find a copy of this report that. We put together and that Kev contributed a lot to including leadership. What is it that motivates you to do these sorts of things and what would you recommend how other people pursue these sorts of things?

- Thank you for asking that question. And by the way, you were equally instrumental in that process for the Wildfire report, which obviously, you know, is an incredibly difficult and tragic situation, and many of our members and colleagues and friends were impacted. I think the number one thing for me is the, I feel very fortunate. I feel fortunate that I had the opportunity to go to USC. I feel very fortunate that I had the ability to learn from the folks that I did at USC in the early part of my career. And so for me, what's really important is, you know, that that give back and really important to, you know, find, you know, the types of things that, you know, I can give back to as a result of what, you know, was, you know, afforded to me, you know, many, many years ago. And I think that's part one. So I think education in particular is very, very important. And giving back to education, to me is very important. And I will say, and we can talk specifically about the wildfires, you know, that conversation is also very important as it relates to sort of the mission of USC, the mission of the Urban Land Institute, the mission of UCLA. At the end of the day, the conversation that you and I had, and the conversation that Claire and Lou and I had in those early days was we have a situation where the mission of our organization is to educate, is to teach, is to sort of expand people's horizons around information and what's available, et cetera. And ultimately, the only way we're going to solve that issue is by expanding capacity. We're gonna spend capacity in permitting and expanding capacity in the actual construction and the capacity of financing and so on and so forth. And so when you talk about organizations like the three, you know, the most important thing to me is, you know, you have organizations where, you know, the mission is education and helping others learn. And so ultimately that to me is what's really important that educational piece. Two, look, I think that, you know, we have, everybody has something that is a specialty, an area that, a focus, a thing. You know, being able to sort of share that, share the journey and help others is really important because I do think that, you know, our learning has become very soundbites, right? And I think ultimately the complexity of the things we're dealing with today are far deeper than soundbites. And so ultimately, you know, you can understand an issue at a soundbite, but then you have to actually, you know, have the mentorship and the training to really actually understand the problems. And then, of course, from that comes the solutions and things that will help us innovate in the future. You asked about financial innovation. I can't wait to see where this industry goes around. You know, how, you know, we innovate as an industry and I do think some of the things that are gonna get deployed, you know, specifically around the wildfire report will be innovations that ultimately help us with city planning and permitting and building in the days ahead. So, you know, those are all things that are in my mind intertwined together and very important.

- So Kev Zoryan, thank you very much for spending some of your time with us this afternoon. We really appreciate it. Very enlightening conversation, and we'll give our audience a lot to think about.

- Thank you, Richard. Great to be on.