Building Durable Real Estate Portfolios at Morgan Stanley – Lauren Hochfelder (EP.514)

0:00Lauren Hochfelder:We focus heavily on sizing our funds to the opportunity set. What you've seen over the last 10, 20 years is the rise of the mega cap fund. Scale is no doubt a superpower. It's hard to even express how valuable that is. However, when you've seen the rise of these individual closed-end funds that are 20-plus billion dollars to be deployed over a four-year period, you can be the world's most extraordinary investor. But if you have that much scale, you are going to be forced to deploy. We position ourselves on both the real estate and infrastructure side for closed-end funds as squarely mid-market.

0:48Lauren Hochfelder:It gives us competitive advantages in a few ways. We are able to be super selective. We have these broad themes. We size our funds that we can cherry pick and only make those investments that are particularly well-priced and the right asset within that. There's by nature less competition. So much of the growth in real estate and infrastructure over the last 20 years has been in these mega cap funds. That means it's pretty crowded. We're making individual investments that is too small for the mega caps and too big for the locals. We get better pricing.

1:30I'm Ted Seides, and this is Capital Allocators. My guest on today's show is Lauren Hochfelder, head of Global Real Assets at Morgan Stanley, where she oversees a team of 300 investment professionals across 13 countries, managing$80 billion across real estate, infrastructure, equity, and credit. Lauren joined Morgan Stanley as an investment banking analyst directly out of Yale 26 years ago and has spent her entire career at the firm, helping build one of the industry's leading platforms. Our conversation traces Lauren's journey from analyst to global head and the evolution of Morgan Stanley's real estate business before, during, and after the global financial crisis.

2:15We cover the firm's thematic approach to investing behind structural demand tailwinds, combination of global perspectives and on-the-ground teams, operational improvements to assets, portfolio construction, and themes across industrial real estate and infrastructure, senior housing, and net lease properties. We also touch on riskier assets of real estate and Lauren's new role adding infrastructure to her real estate oversight. Before we get going, we're hiring at Capital Allocators, two roles that will shape our next chapter. They're two of the best jobs in the business, at least in my opinion, that'll help us bring together our community of allocators and managers to compound knowledge and relationships.

3:00And best of all, we get to serve this community without really selling them anything. Full descriptions of the role are available at CapitalAllocators.com. And thanks for spreading the word about our two new roles at Capital Allocators. Please enjoy a conversation with Lauren Hochfelder. Lauren, thanks so much for joining me.

3:24Lauren Hochfelder:Thank you. It's so great to be together. I'd love you to take me back to your path to this building. It was a short path because I joined right out of college. I joined as an analyst straight out of Yale, no finance experience at all. I had been an investment banking summer analyst at Bear Stearns, but with that small exception, I joined straight out of college and have been here since. Take me through what that path is to be working at the same firm for a couple of decades. It's certainly one of the great surprises of my life that I am here still 26 years later. It's been extraordinary. When I joined as an investment banking analyst, two-year gig, At that point, I'm not sure I knew if I was going to go back to business school or back for a PhD in ancient Greek philosophy.

4:14Lauren Hochfelder:It was pretty broad. What's been extraordinary is that I get to come here every day and still learn. I don't need to change firms to have multiple careers. I feel like I've been surrounded by incredible colleagues, partners, and consistently been given opportunities to do more and more and more. sometimes even before I realized I was ready. That keeps it exciting. Walk me through the path of those major milestones over those 26 years. I joined as an investment banking analyst. At that time, our real estate investing business was housed within investment banking. I had this fantastic opportunity to work on all things investment banking, M &A, equity raises, strategic transactions, also investing in real estate on behalf of our funds.

5:05Lauren Hochfelder:I was quickly drawn to that. As an associate, I became dedicated to the investing side of our business. I've, with one small exception, spent my whole career in a linear fashion. I was the associate underwriting and executing the deals. And then over time, I came to be promoted to head of acquisitions, deputy CIO, then ultimately global co-head of the real estate business. Six months ago, I took on broader responsibilities to oversee broader real assets. So that includes real estate, infrastructure, equity, and credit. It's been extraordinary. What was it about investing that drew you in early on?

5:47Lauren Hochfelder:What I loved about investing from the beginning was that interdisciplinary approach, understanding how the world works, understanding the drivers of growth or where the risks lie, ultimately having the accountability for outcomes. The intellectual curiosity with the rigor, you're forced to make decisions amidst uncertainty. I spent my Yale years at coffee shops at four in the morning debating things endlessly. In investing, you need to make a call. Then you're held accountable. I also loved that it's not just the upfront decision. Should I do this? How will this play out? Then you have an ability to effectuate change once you own it.

6:30Lauren Hochfelder:For the assets we own, it's not just buy and hold, it's buy and change. You can transform these assets. That's one of the things that's less understood about both real estate and infrastructure is how active those assets are. It's not just that durable cash flow, but it's about affecting change, renovating or leasing or shifting or repositioning assets. Having that active edge was also part of the appeal. Real estate is this interesting blend of numbers and then real world assets and development. How did you find your place in that different blend of activities? One of the things I love so much about it is it straddles the two.

7:14Lauren Hochfelder:You have the analytical high finance element to it. It's also tangible. It can be kind of gritty on the ground. That combination makes it endlessly exciting and gives opportunity to arbitrage a bit. Part of the initial appeal was how tangible it is, how you want to avoid being too self-referential in any type of investing. You can understand real estate is just a function of how people use space, where they want to live, how they want to work, how they want to consume goods, whether it's in store or online, how they want a vacation. that constantly brings you back to basic judgments about how we live today and the early signs of how we might be changing that behavior.

8:07What did you find as you moved up from associate to principal to head of acquisitions to running a group of the different skill sets that you needed along the way?

8:18Lauren Hochfelder:They definitely changed over time. Some of the basics, the rigor, the approach to working with people, some of that stays constant. If there's one overall image, it's that zooming out. Early on, it was all about the underwriting and the analysis. Over time, you realize how the judgment comes into it so much more, and it's not just the math. The biggest change, if I think about my job today, to simplify, it's deals, money, people. The investing of the capital, the raising of the capital and the managing of the teams, structuring our teams in a way to optimize outcomes. When I started, all I wanted to do was invest.

9:03Lauren Hochfelder:If you had said to me, do you want to think about managing a business, thinking about new products, new ways to grow or shift? That was less exciting to me. I've realized over time that the most important investments my senior partners and I make every year is thinking about who on the team to be investing in. compensation decisions or team structuring decisions, thinking about how to build a business with consistent, durable processes, team setup, alignment structures, optimize those outcomes. What are some of the things you've learned about hiring, retaining, optimizing the people on your team?

9:43Lauren Hochfelder:Culture matters. One of our key competitive advantages is that part of building such a strong culture is the accumulated trust over time. My partners and I, many of us grew up in the foxhole together. Through those experiences, you develop a sense of trust and understanding of people's risk appetite. There's a greater efficiency of communication. That trust and respect we have for each other allows us to challenge each other. One of the issues you see when culture breaks down is consensus building or group think. Because we've lived through cycles together, we're very comfortable challenging each other.

10:30Lauren Hochfelder:That helps drive optimal outcomes. Culture is a big part of it. We raise people to be great investors or we endeavor to. How would you describe some of the defining aspects of the culture on your team? Our CEO, Ted Pick, when he talks about culture, talks about three things. Rigor, humility, and partnership. Ted says it so well. That captures the essence of the culture across Morgan Stanley and the culture within our business. That rigor underlies everything we do. You have a warm, kind culture, but also a lot of rigor in everything we do. That is paramount. That humility, it's particularly important with investing.

11:19Lauren Hochfelder:Understanding, acknowledging mistakes early, having the humility to say, I got this wrong. Let me understand why. Going through cycles that way. Then that partnership. The best single performers in the world in any category haven't done it alone. We have a way to work together to maximize outcomes. You mentioned that when you first started investing, there was already a platform here, Morgan Stanley Real Estate, 26 years ago. How is that real estate part of what you've been involved with for so long evolved over the years? When I started, Morgan Stanley was one of the first amongst the largest real estate private equity businesses.

12:03Lauren Hochfelder:We've seen the space institutionalized pretty dramatically. If I think back to 2000, the real estate private equity business was largely opportunistic closed-down funds and U.S. pension fund capital. We've seen over time a diversification of the types of investing, more core, open-ended, or different strategies. We've seen a diversification of the investor base. It's super global today. Our business was a leader in a few regards there. We were one of the first to say, we want to serve our investors more holistically. We were one of the first entrants from the opportunistic space into the core space.

12:46Lauren Hochfelder:Fundamentally, we're in the client service business. We first and foremost focus on what role should real estate play in investors' portfolios? What is most important to them? Ultimately, having strategies that serve their purposes, having core and opportunistic, having a few core plus strategies, being global in what we do has given us much better perspective. It's enabled us to have better judgment across the strategies and attract extraordinary talent as well. Has it changed the most in the last 10, 15, 20 years? A defining moment for us in terms of change would be pre and post GFC. I had been in real estate virtually my whole career.

13:31Lauren Hochfelder:I spent one 18-month window as an associate in firm management. One of the great things Morgan Stanley does is it plucks top performing associates and puts them in different areas of the firm to cross pollinate and educate. I was privileged I got to do that. That happened to have been 05, 06. It had been a few years in real estate investing. I vividly remember coming back in 06. It was like we are not in Kansas anymore. Our business, but the industry writ large. Cap rates had compressed massively. The velocity, the leverage, more, more, more, more, more. It all came crashing down. Shortly thereafter, virtually everyone senior to me was gone.

14:12Lauren Hochfelder:There were a handful of us left in the foxhole together. We stayed. We worked through the portfolio. A lot of complexities. We learned a lot as a team. Coming out of that, we made some meaningful shifts to our business. It changed our approach to investing, but it also changed how we organized ourselves. We streamlined the business. We had been in a lot of different strategies and we simplified and said, we are going to do fewer things, but we are going to be category killers, top performers in each of those things. We restructured alignment. Turns out alignment matters. The incentive structures within our funds became pooled incentive structures.

14:55Lauren Hochfelder:Instead of having individual deal level or regional level incentives, we have pooled incentives. That shifts behavior and forces people to work and think holistically. We centralized decision making. We're managing a global business. People can fall victim to regional bias. When you have, for example, an Asia Investment Committee and a Europe Investment Committee, you're not getting the full benefit of that perspective that matters. It wasn't just our approach to investing or financial risk or duration risk. It was building a business with the right structures in place and the right processes in place to induce repeatable, strong outcomes.

15:40When you had the whole breadth of strategies going into the financial crisis and you wanted to focus, how did you decide what areas to focus in? If I look back to the period coming out of the GFC, a lot of money was made on interest

15:56Lauren Hochfelder:rates coming vertically down. You saw cap rate compression, cheap, heavy borrowing. We benefited from some of those tailwinds in our investing. We took the approach that we want to be invested in those sectors and markets that have more durable drivers of demand, more structural tailwinds, because there are two theories of investing. The things you know are going to happen and the things you think are going to happen. The truths and the, I think so. We focus on investing in those spaces where you have structural drivers of demand, regardless of market cycle. Today, we know we're living in a multipolar world where there's a U-turn on globalization.

16:41Lauren Hochfelder:We know we have aging demographics in most global markets, increased power needs. We position our portfolios and our investment strategies to capitalize on those structural durable drivers. If you think about post-GFC, multiple expansion or cheap borrowing drove a lot of return. Today, we live in an environment with rates more elevated, relatively range-bound. That means you need to be invested in those spaces where you can see outsized income growth. that orientation in terms of investment philosophy has served us well through this period. I'd love to start walking through how you implement that.

17:24You come up with a theme. How do you then take that and look for actionable ideas?

17:30Lauren Hochfelder:Across Real Assets, we manage about$80 billion of investable capital. We have over 300 people, 20 offices, 13 countries. We're thematic and top-down, constantly assessing this, part of the magic of our business is those local teams who are super embedded in those local markets. It's not just that global perspective that I have the privilege of looking across the world with my senior partners, assessing where the best risk-adjusted opportunities are. Those local teams are so embedded in their markets that they are able to better source and better execute those opportunities. We cherry pick. You can be in a hot sector and still get burned if you pick the wrong asset.

18:20Lauren Hochfelder:We are fixated on only investing where we feel like we're making money on the buy or it's sufficiently well-priced. We never set ourselves in a place where we're forced to invest. It's also cherry picking within the strategies. That's particularly important today because you're seeing such divergence. Industrial is a high conviction strategy for us. You need to be selective within industrial. It's not just the markets, but the sub markets, the size, the specs. By way of example, I take the state of California. We've been investing in industrial assets in and around Silicon Valley that are benefiting from the physical AI trends, among other things.

19:04Lauren Hochfelder:rents are up 40 % over the last several years. If you drive 400 miles due south to the Inland Empire in Southern California, which was always the hottest industrial market on the planet, rents over the same period of time are down roughly 40%. That selectivity is a key part of it. You can only do that with that on the ground edge. We're so privileged to have these incredible local teams. I'm curious how you balance the people on the ground looking at the assets with you're trying to get the trends right because that Inland Empire at some point in time went from hot to cold. It's an important part of our process.

19:43Lauren Hochfelder:It's iterative. We were early believers in global supply chain realignment. Long before tariffs, we were totally focused on we are at the early innings of a global supply chain realignment that is going to create winners and losers. Probably it's going to create more demand for industrial as companies diversify where they manufacture their goods and how they get those goods to the end consumer. We thought long and hard about what are the knock-on effects of that. We looked in particular at the Inland Empire, which is a market where all the goods came in from China to the U.S. consumer. Always one of the strongest markets.

20:24Lauren Hochfelder:We always had a huge presence there. And we said, uh-oh, this market is going to get hurt. We spent a lot of time studying and focusing on it. With everything we do top-down, we're constantly testing it within our underlying asset base. We're so fortunate that we have this huge asset base that gives us real-time data long before it's known by the market. We get to make decisions based on that inside information in our assets. That's a huge advantage. In this instance, what was so interesting is even as we're sitting here saying, gosh, IE is going to get hurt, rents kept going up and up and up.

21:03Lauren Hochfelder:Our team on the ground is saying, I'm still signing rents 20 % above where they were, 30 % above where they were. Because we were so attuned to it, we saw the early indicia of change. Our team out West said, look, I know you've been watching for this. I want to tell you, you're not going to see it in the data. You're not even going to see it in the data in our portfolio because I'm still signing rents higher than I did yesterday. What I can tell you is, whereas 90 days ago, I had 20 guys fighting for like any vacancy I had, today it's like two. I'm trying to keep competitive tension. They used to just sign my LOIs and I was done.

21:46Lauren Hochfelder:The depth of market is fading. That constant iterativeness is valuable. that enabled us to reposition quickly. If you look at today, some of the hottest areas in all of the AI infrastructure real estate, what are the things that you're looking at within your portfolio to see if those trends continue or you have to be careful because maybe there's a change in the CapEx cycle? There's the demand side of it that you're referencing, the supply side and then questions around what residual looks like. When AI comes up with anyone in real estate or infrastructure, it's immediately just data centers. There's no question that that is probably the single biggest beneficiary of the AI trend.

22:34Lauren Hochfelder:There are also a lot of other ways to play AI in real estate and infrastructure that get less attention and that therefore have better risk-adjusted return because you have a better basis on entry. Industrial real estate is a huge beneficiary. It's simple things like AI as an accelerant to e-commerce growth. It's advanced manufacturing, how AI is accelerating that, particularly here in this country as a driver of demand. There are types of real estate. On the infra side, we've been doing a lot with power and fiber, the things that are ultimately powering these AI-focused data centers. In terms of how we're testing it, having a large asset base enables you to feel demand in real time.

23:23Lauren Hochfelder:We're constantly assessing that. We're looking at for these underlying companies, the tenants, whether it's the hyperscalers or others, what decisions they're making, where they're owning the assets themselves versus where they're leasing it perhaps to have a little more optionality, double clicking under some of those decisions. When you're underwriting a deal, how do you balance the desire for the thematic trend with what you think you can do to improve the asset when you own it? For virtually any investment we make, we want to feel like we can make money in a few ways. being in the right theme is important.

24:03Lauren Hochfelder:You want to be where that structural demand is there, where you're owning the physical infrastructure that underlies human lives. It needs to be structural demand. We also want to believe that we can affect change in the asset. We can have the right theme, we can buy it right, then we have another bite at the apple because we can improve it. It's different by region in terms of how that value add comes into play, given the nature of the sellers. We're always looking for ways to improve these assets. If you take infrastructure, for example, we've obviously seen a massive institutionalization and growth of that space over the last 20 years.

24:44Lauren Hochfelder:Because of that, you're not going to make a 15 % return on a toll road anymore. You want to stick with the stability that's paramount and so fundamental to infrastructure investing. But to generate returns, you need to be in assets where you have that value add. What are some of the examples of things you've done to significantly improve an asset under your ownership? It ranges pretty dramatically. Sometimes it's a super light value add. Sometimes it's heavier. One of the pitfalls of real estate investing in particular is people can become very seduced by business plans with a heavy reposition.

25:22Lauren Hochfelder:As much as we are obsessed with creating value in the underlying assets, we are also extraordinary disciplined about investing. Every dollar we invest gets the same level of scrutiny. A lot of times you see investors super focused on the buy, but then can pour capital in with a little bit more ease. Like in physics, what comes up must come down. In real estate, not every dollar that goes in comes out. We are rigorous in terms of that, which means that some of our value-add business plans can be lighter. There are times we are doing a light renovation or figuring out how to slightly reposition an entrance.

26:05Lauren Hochfelder:Small things can have high ROI. We also have the history of doing more substantial value-adds. I happened to be in Boston last week. The Boston Seaport was an investment I led as an associate back in 06. We bought 23 acres of surface level parking. We had this incredible vision that if you understood Boston and all the dynamics that this could be the hottest spot, which by the way, it is today. Over time, we really engaged in a master planning of that whole area, which was one of the most vibrant mixed-use urban submarkets, arguably, in the world. We went through a financial crisis, debt restructurings, we went through it all.

26:50Lauren Hochfelder:But taking surface parking, we didn't develop it all. We master planned it and ultimately sold parcels. That was transformative and exciting. With the thematic backdrop, how do you think about constructing a portfolio of assets? One of the things that we try to do very well is focus on portfolio construction, as opposed to some investors out there, it's almost a compilation of deals. We're focused on geographic diversification, sector diversification, but also diversification of the underlying types of risks we're taking. because you can have risks that are more correlated than meets the eye, even though your pie chart says, well, I'm X percent here and Y percent there.