Alan Forman – Yale Endowment Real Estate (EP.340)

27:04And in hindsight, Harry then did the deal with him at the GM building five, six, seven years later. It was a good ending for everyone. What was the decision process to sell all of the direct real estate and moved into this private equity model? David Swenson was a first principles investor, And he looked at the real estate business in the 80s and said, this doesn't make any sense. And he thought that the fee -based nature of the business, there was no alignment of interest. There was lots of separate accounts. It just wasn't the right model for how he was looking at it with a blank sheet of paper.

27:40He looked over at the private equity venture capital business and said, that's a business that is structured in the right way. And we should model our real estate business off of that. And that's what we did. So essentially, right when I joined Yale, Ellen and Donna, and to some extent myself, wrote a strategy paper on how we would transform the portfolio from a directly held to more of a partnership model. And it's funny because we went to all these very impressive Yale professors and asked them, how do we create a portfolio? How do we find the efficient frontier? All these economists like Ibbotson and Stephen Ross and people like that.

28:21and they just said, find good people. It was the opposite of the ivory tower mindset. Just go find good people doing really interesting things and set up the right structure and it'll take care of itself. That's what we did. We obviously were learning as we were going. And one of the exciting things was David was learning as he was going. So he was shoulder to shoulder to us and we could watch him in action in his early prime. You've got an idea for structure and how to change how real estate asset was delivered to investors. How did that all take hold? You're using your relationships. You're kissing a lot of frogs, trying to see who's out there.

29:01And you have to realize at the time, money was really scarce. This is the early 90s. So when you are approaching people with a newfangled idea to do a new model, it wasn't like they had a lot of other options. We were going to write a decent size check at the time. That was very appealing to them. They wanted the alignment of interest and the long -term partnership offering that we were providing them. We're going to take a quick break in the action to tell you about SRS Aquium. Want to make sure your M &A processes aren't stuck in the past? Partner with a company that's been defining the future of dealmaking for nearly two decades instead.

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30:36Well, we're very focused on alignment of interests. So whether it's having a meaningful co -invest, whether it's fees that cover overhead and hopefully aren't a huge profit center, there's one pool of assets. So we're all in it together for better or for worse. Some of these things have been tweaked over time, but the original thesis was a very pure structure. We're getting married. We're in this for the long haul together. we'll eat our own cooking and hopefully it will work. And it was a true sense of partnership. So real estate, you hear about location, location, location. You think about different property types and how that might drive returns.

31:16There's just like locality to it. How did you think about what assets you were buying alongside of finding the people that you wanted to be partners with? It was very bottom up. It started out with just people. If we didn't get the people right, we didn't worry about what their strategy was. we really focused on people, alignment of interest, and then understanding their strategy too. And we didn't worry about sectors back in the day that we weren't involved with. First of all, there weren't that many sectors back then. I mean, it was literally office, apartments, retail and industrial and lodging.

31:49So there weren't as many options to invest. So we thought if we found people in each sector, over time, we would create a diversified portfolio that worked for Yale. How long did it take before you had this fully built out real estate portfolio? It took a while because the endowment was growing like a weed. So essentially, even though the portfolio was growing and the manager roster, we couldn't keep up with the growth of the overall endowment. So it probably would have been fully built out sooner had the endowment not grown as much, but it was growing so fast that we were always trying to project where we needed to be and we would never get there.

32:32And that was true in all private asset classes. So it was a nice place to be in that there was a lot of capital to play, but there was pressure to grow the portfolio. In situations where there's an opportunity set you'd like to pursue, you're trying to find the right partner. How do you decide if you're not finding the partner, whether you just get exposure to it, think of it as like a beta to that space while you're waiting compared to just saying, no, unless you line the opportunity with the people, you're just not going to deploy the capital at all. Historically, we took a pass on the sector.

33:08If we couldn't find the right group, we just did not pursue the sector. And industrial was a good example where even once the sector became much more interesting and institutional, it took us a while to find the right person. And we missed some opportunity there. I think one thing that's really interesting that's changed in the real estate business that you were getting the beta regardless of the property type. So focusing on alpha was all that mattered. Unfortunately, post -GFC, that's completely flipped on its head. So now you have office is in the tank today, and industrial has been super hot for the last 10 years.

33:49So all of a sudden, you've had sectors just go completely in opposite directions. And getting the beta would have been really good for those property types, even if you didn't get a lot of alpha. Coming from where we came from, that wasn't the mindset that we had coming out of the GFC, that that was necessarily the way we should play it, because that's not what had happened over the past 30 years. And that was a change that was harder to see prospectively. After you built out these relationships, you're adding a manager into your portfolio. How do you think about the construction of that portfolio within real estate?

34:26It's a level of conviction with the manager that you're thinking about. How much conviction do we have about the manager and what's their opportunity set? And you're trying to balance those two things. And you're also trying to maintain your seat at the table. So you try to think about being tactical, but also being long -term in terms of the relationship and making sure that you have a seat at the table that you want through thick and thin, even if at some times you'd rather have a bigger or smaller seat. How do you balance that in what's thought of, at least over time, as a cyclical sector? It's challenging.

35:04You're relying a lot on the manager to make the investment decision of how much they want to buy and how much they want to sell. We relied on that heavily with our alignment of interest. Could we have been a little bit more tactical at times? Maybe. It's hard to judge. But the model was to trust the managers and be informed about what they're doing and make judgments about what they were doing. But if they had demonstrated ability to navigate cycles, that gave us a lot of confidence. That wasn't always easy because as the cycle became longer, different managers behaved differently. Some took a lot of chips off the table and sat on their hands.

35:44Others went longer the market. We tried to rely on our managers and also our own judgment to calibrate risk in what they're doing. And really, the more expensive things got, the more we would try to understand what they were doing and how much risk they were taking. And that's when it became challenging. Some things were foreseeable and other things were coming out of left field. Once you built a mature portfolio and you have certain organizations that you've been with for a while, and then you're looking at newer ones. What was your experience in the relative risk return profile of the investments that they're making?

36:25Well, there's always the excitement of the younger, newer Affirm, where they're just starting out. The energy level is as high as it can be. They're really excited. And you have to temper that with they're unproven, on the other hand, and you're trying to balance those two things. And then you have on the other side, the groups that you're more comfortable with, that you've known a long period of time, you know what they're all about and what they do, but maybe that spark is just not as bright as it once was, but they're also better at what they do because they've done it for a long period of time.

37:00And how do you sort of balance those things? We tried to create a mix of both. And And I think you wanted to have a portfolio of up and coming potential superstars. And you also wanted to have a bunch of existing guys that were really good at what they did. How do you think about generalists versus specialists? We tended to focus a lot on specialists. I'd say the portfolio was probably 80 to 90 percent specialists. And we just thought being really good at one thing was the way to go. And a lot of the companies were vertically integrated and they had an ability to add value and do it all themselves.

37:38The generalists tended to be a little further away from the assets, but also the flip side is they looked a little bit more at relative value. There was sort of a balance there versus the specialists that knew the asset probably better and the sector better and the market better, but also doesn't have the benefit of seeing the bigger picture in the same way that the generalists do. We tried to learn from the generalists. If somebody has a choice and they're doing one thing, that's a signal that maybe we should think about. Some of those choices you'd see at times in organizations that came at it differently.

38:15So you could think about a distressed credit shop that adds real estate or adds mortgages. You think about hedge funds at time that have private allocations that move into real estate. What was your experience when they participated opportunistically in real estate? We didn't invest with a lot of groups that had these really broad platforms. There were some hedge funds that did stuff. There were definitely some real estate firms that tried to do multiple strategies. We tended to move away from them over time as they tried to do different things. Essentially, the groups where we did see some sort of sideline business or adjacent business, There wasn't a lot of that in our portfolio.

38:59How about international markets? We did do some international. One of the smartest things we didn't do is we didn't do any emerging market real estate. And we actually didn't spend any time even looking at it. We just didn't think it was an interesting place to be. We tended to be a value investor. It was all new builds in India and China and Brazil. So we literally didn't do anything. Most importantly, we didn't waste any time spending a lot of resources traveling around the globe. We did do a modest amount of investing in Europe, and I'd say the outcome was mixed. I think our network and all the stuff that we brought to the table in the US was just a little less good in that part of the world.

39:43And that probably showed up a little bit in the results. We definitely backed some good people. Timing also matters. And we started that later. So when things did go bad in the GFC, there was less history there of good deals before the lesser deals showed up. But there were still some good outcomes in Europe. How do you think about where to participate in the capital stack of a deal? So essentially, Yale has always just been an equity investor. Unless it's an opportunistic thing within an equity structure, we tended to only invest in the equity. and we only wanted the inflation protection. We wanted the upside and we thought our managers could add a lot of value and that would inured to the benefit of the equity holders.

40:30As you were in your last couple of years looking at opportunities, how did you decide where to spend your time on different opportunity sets? When we decided where we wanted to play, I think it was a combination of looking at our portfolio, seeing where maybe there were some holes in it, what we're seeing out in the market where maybe there's some interesting stuff going on, usually because it was some distress where we thought maybe we should be taking a harder look at this and finding, A, we'd have a bigger seat at the table during a distress period, and B, hopefully with all these new managers, it's great to get in when things are cheap and have them get their firm off to a good first start.

41:09It was still a people -based focus, but we definitely looked at different sectors and tried to figure out where we could find the next interesting opportunity. And I'd say we were a little slow on some of these nichier sectors where these non -traditional real estate sectors like student housing and self -storage. part of that was the people in the business by definition almost didn't have a lot of experience and there wasn't a lot of institutional players and we were trying to find people that were just as good as the other people in the rest of the portfolio which made it challenging early on to find the best and the brightest when they're early and that's where i think having these relative multi -strategy shops is very helpful because they actually help educate us to understand, oh, there's these other sectors over here.

42:04They think it's relatively attractive. Maybe we can do that in a bigger way somewhere else with someone else once we understand the opportunity a little bit better. As you invested alongside of organizations that you may have first put early capital and then they expanded and grew over time. What are some of those aspects of building the business the right way that you saw that you found yourself giving certain kind of advice repeatedly to some of the managers? I say this to a lot of our managers, you're managing three or four different things at once. You're managing a portfolio of assets, you're managing a fund, you're managing an investment management business, and you're managing a team.

42:48And you have to manage all of these things in a way that works for all the different constituents. And it's really hard. And it's really complicated. The guy who got to the top of a lot of these real estate firms is a deal guy. And he's not a organizational guy. And he's not an investment management guy in the same way that maybe in other asset classes. So helping them think through these types of issues that they should be thinking about or even just raising them so they start thinking about creating an organization that can handle all these different constituencies that need to be addressed.

43:25Did you find over time that a person or small group of people that start the organization that are focused on deals can evolve to being able to build all those roles? It's all over the map. And I think that's the interesting part about the real estate business. Each one is different. Each one has their strengths and their weaknesses and their blind spots. And they're all trying to figure this out in some different parts of the cycle of where they need to be. And to me, that's what's really interesting about the business. There were some that the managers were more on autopilot because they were at a phase of their company's evolution where they didn't need a lot of oversight and others where they were early stage or maybe they were reinventing themselves where they needed more advice.

44:10And that was a nice thing to work on it where you had a range of groups. The goal was always to get them closer to autopilot. And you start out with a young 32 -year -old that's creating a firm. And over time, they hopefully get to a place where they need less oversight. Maybe one of the mistakes I made early in my career is just because less oversight is needed, they still need oversight. Yale still needs to be on top of things. When a manager is shooting the lights out, you still need to make sure that they stay on the straight and narrow. If you looked at your more recent decades at Yale, what are the aspects of what did change in the way you went about investing?

44:53I just think we tried to be a little bit more involved in the real estate and trying to be a sounding board for the investment decisions. We never had discretion. We never had legal authority, But we really wanted to understand what they were doing and how they were doing it and why they were doing things that they were doing. And also, I'd say our role changed as I got older in terms of being more involved in helping the manager manage their business and helping them think through things that will affect their business long term. That's a part of the business that I really enjoyed. I found as I got older, I was more of a peer with these general partners.

45:37So I was viewed as more of an equal and had seen a lot. I really enjoyed being more involved strategically, helping them think about the business as opposed to just the specific deals. What was one of those partnerships that worked really well for you? Well, one of the early ones was a group called Douglas Emmett. And they're a public company now, very successful. This was back in the early to mid -90s, and they were pursuing massive distress in Los Angeles. One example that always resonates with me, when we were underwriting some of their early deals and trying to understand how they look for opportunity, things were so bad in California back then that we underwrote no residual to the assets in at least one deal.

46:24It was not even a land residual. We assume that these assets just went away at the end of the lease term because things were so bad. It's almost impossible to get your head around it today. But back then, that was not a completely far -fetched outcome that was going to happen. And we would underwrite deals. Is this a reasonable risk -adjusted return, assuming the world comes to an end? And then if it doesn't, we'll do great. I think they had nine funds. They all did very well. And then they went public. And they did a great job for themselves and for Yale. In a situation like that, the exit of going public, how did that play out for you as an investor?

47:04I'm coming from the lens of knowing that David wasn't particularly fond of any outside ownership. Once one of our partners goes public, it's the beginning of the exit of the relationship. It may not happen overnight. We're usually a very large shareholder of the entity. Sometimes we're on the board. So exiting is slow, but there's no more opportunity to invest on a private basis. It's just you own your shares. In most cases, the going public route is the end of the investment relationship over time. And that's fine. It was a great run with Douglas Emmett. We all made a lot of money. If they ever decide to go private, we'll think about maybe there's something to do again.

47:48And that's the way we operate. Some worked overtime for decades and some worked overtime for shorter windows. And then they went elsewhere. Douglas Hammett was a good example that was a shorter relationship that didn't go on forever. And there are others like the Shorenstein Company was one of Yale's early relationships where it was a great partnership for 30 years. And we've navigated markets with them and helped them and worked with them. And it's just a very rewarding relationship in all senses of the world. When you have a relationship in the one hand that lasts for 30 years and in others don't last for as long, what happens that tends to lose your attention and interest?

48:32It could be a lot of different things. It could be the manager decides to do something different. Like in the example of Kempton, they sold their management company and they were no longer an operating company. And that changed how they did things. Hard to say. At the time, they thought this was a good thing. It didn't fit exactly what Yale's model was. others decided to do other things. They wanted to broaden their product offering and things like that. Obviously, track record is a huge piece of this. And the better they did, that's a big wind at their back. And the worse they did, more questions were asked.

49:07One thing that David was really good about, and this taught me a lot, was looking around corners and looking at the people and everyone's going to have a slump or an issue. And how do they respond? What's the opportunity going forward as a result of the mistake? Was it a mistake by the firm? Was it the market? So we dug in a lot on underperformers to understand whether we want to buy more when it's cheap, like a value investor, or do you want to exit because it wasn't a great place to be. There was one manager that got off to a really rough start in the Bay Area, and their investment period was up and they were only about half invested.

49:50And Dave stepped up to the plate and said, let's extend this investment period. And they've just hit the ball out of the park. That's hard to do. It's really hard to do. In that example, what were some of the factors that led you to step up as opposed to walk away, which is probably the more consensus -driven approach at the time? I think it was the people. It was the investment opportunity. trying to understand, was that an unforced error or was that a market thing that is understandable and they still have what it takes to turn the ship around? So after a long time in the investment office, you recently have retired, stepped away.

50:30Love to hear your thinking of why that time had come. It was funny because I said to David at my 30th review, I've done this for 30 years. I'm not sure I want to wake up in 10 more years and say I've done this for 40 years. It's been a great run. I want to see what else is out there. I don't know if I want to do something else. And he was very nice about it. He said, why don't you explore for a little while and see what you want to do? And I came back to him and I said, I think doing this for 10 more years is probably not exactly what I want. So I decided to leave soon thereafter. He asked me to stick around for a little while longer.

51:09Unfortunately, during that window, he passed away. So I ended up sticking around for another year to help out the transition. I used to go to these annual meetings, and I was the youngest kid in the room. And now I go to the annual meetings, and I was the oldest guy in the room. That didn't feel great. I felt a lot of my peers were aging out of the business or becoming CIOs. I found myself gravitating toward the GPs anyway, because they were more of my peer group. So I spent the next year really thinking about what I want to do with this 30 years of experience. And where has that brought you? What I really like doing is working with the general partners.

51:46And so I'm working with a bunch of general partners, hoping to work with some younger up and coming groups and help them become the next great new firm. really enjoying that piece of the business and being a strategic advisor and helping them navigate all the stuff that I've seen over the last 30 years in a way that hopefully will enable them to get where they want to go a little faster, a little safer, and fewer bumps in the road. What are some of the things that come up in those conversations? What I try to do is try to ask them, where do you want to go? Where do you want this firm to go? what are your goals and objectives?

52:24My goal is to help you achieve your goals. It's not about me. I want to be in the background. I want to help you achieve whatever you want to achieve and getting people to really think about what they want and how they want to get there. And that can be a lot of different things. It could be lifestyle -wise. It could be wealth -wise. And also acknowledging where they have shortcomings. If they do well, I'll do well. And it's the same thing with when we found partners at Yale. If the partner did well, we structured up a deal that Yale did well. And that's the win -win that we're always trying to create in a world that's not always about win -wins.

52:58Well, Alan, I want to ask you a couple of closing questions before I let you go. What is your favorite hobby or activity outside of work and family? I would say golf and skiing. What's your biggest pet peeve? My biggest pet peeve on the investment side is lack of disclosure, just being open and honest about what the issues are and as opposed to having to dig in and trying to find them. What investment mistake have you made that you'd never make again? I think the biggest mistake I made at Yale over the years was managers that had some strategy drift in their portfolio. And because they had done very well in a different strategy, we gave them a little bit of too much of the benefit of the doubt.

53:42And I wish we had just dug in a little bit more. Not all strategy drift is bad, but I'd say the bigger mistakes were people took their eye off the ball. Which two people had the biggest impact on your professional life? I would have to say David and Ellen Schumann. Ellen was my boss for my first eight, 10 years in the office. And she was the one that I worked very closely with day to day. Obviously, David was on top of that. Ellen is still a mentor to me today. I'm on a board with her. I have lunch with her all the time. And it's been 33 years since she hired me. Hitching my wagon to Ellen and David was a good thing and it pays dividends today still.

54:22What teaching from your parents has most stayed with you? I would say just perseverance and hard work, working hard, doing the business, and just being present and diligent is a huge portion of this business. And I think finding something that you're passionate about makes it all that much easier. All right, Alan, last one. What life lesson have you learned that you wish you knew a lot earlier in life? Work with people that you really like. And that's one of my cardinal rules of my new business is I'm only going to work with people I like and enjoy. And that's what I did most of the time at Yale.

54:57And it served me really well. Alan, thanks so much for sharing your long experience in the business and exciting new venture. Thanks, Ted. Thanks for listening to the show. To learn more, hop on our website at capitalallocators .com, where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more. Have a good one, and see you next time.