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What the World’s Most Successful Real Estate Investor Is Buying

Jon Gray provides his views on a range of topics including the booming property market on “Bloomberg Wealth with David Rubenstein.”

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Blackstone Group Inc. President Jon Gray has some advice for investors looking to make sense of the wild real estate market in the U.S: Don’t fear a bust anytime soon.

Home prices have surged the most since 2005, cheap mortgages are encouraging buyers toward new homes, and building costs are spiking because of rising prices for raw materials. At the same time, a worker shortage means new construction is failing to keep up with soaring demand. And in commercial real estate, the wider acceptance of remote work during the Covid-19 pandemic is threatening to decimate office properties.

In spite of all that, now’s a pretty good time for the market, according to Gray, who has been at the center of the biggest booms and busts in the industry over the past three decades.

The market isn’t showing the typical warning signs — too much leverage, too much capital, too much building, Gray said in the inaugural episode of “Bloomberg Wealth with David Rubenstein.” There will be a “rediscovery” of cities such as New York and San Francisco, fueled by immigrants, creativity, entrepreneurship and technology, he said.

The billionaire also spoke about where he’d put $100,000 today, what to avoid pouring money into, the best way to invest in real estate and how President Joe Biden’s tax policies could affect property owners.

Gray’s journey at the New York-based firm began in 1992, working on M&A pitch books and ordering dinner for associates at the fledgling private equity shop. About a year later, the real estate market collapsed. Sensing an opportunity, Blackstone founders Steve Schwarzman and Pete Petersen formed a real estate business and tapped Gray, a recent University of Pennsylvania graduate who had once considered a career in journalism, to help get it off the ground.

By 2005, Gray was running the unit and spent the next 13 years building it into a behemoth with about $115 billion of assets. In 2007, he took the Hilton hotel group private, and then had to restructure the deal during the financial crisis, ultimately more than tripling the investment when Blackstone exited 11 years later.

“Be a high-conviction investor,” Gray, 51, told Rubenstein, the co-founder of Carlyle Group.

The interview has been edited and condensed.

The economy has been pretty good, but it probably will head down at some point, so if I want to invest in real estate, is now a good time?

It’s still a pretty good time for real estate for a couple of reasons. The warning signs are twofold — too much leverage, too much capital — and we don’t really have that in the real estate system today. The other is too many cranes and too much building, and we’re actually below historic levels in terms of new supply.

The other thing I’d point out is that the S&P 500 delivered something like four-times the return of public REITs since the beginning of 2020, before Covid. So real estate is lagging coming out of the recovery because obviously people have been concerned about the physical world. As the economy reopens, people go back into spaces, real estate is gonna see a little bit of a bounce. I think the risk is if interest rates move a lot.

One positive thing about real estate also is inflation drives up the replacement cost of buildings. And that gives you a little bit of a cushion on existing real estate.

Is residential less risky or more risky than commercial real estate?

If you talk about for-sale, single-family housing, there’s probably more risk, in the sense that you’re building something and you’re selling it, and it’s a function of the market. If you’re talking about rental housing — an apartment complex — that tends to be less risky because it’s less cyclical. People don’t give up their apartments. There’s some volatility but nothing like, say, office buildings or hotels.

Quote from Jon Gray, president and chief operating officer of Blackstone Group LP:

“Buildings are back to full capacity, and in Europe people don’t have as much space in their home lives. So not all geographies are the same.”

And then commercial real estate involves office buildings; warehouses, which has been the biggest theme for us over the last 10 years; hotels; shopping centers; senior living facilities. And all of them have different risk-returns, depending on geography.

New York City has seen a lot of people leave during Covid. Do you expect that people will come back, work five days a week, and use all the office space in New York or similar cities that they did before?

There is sort of a recency bias — that because we’ve been home, we assume that’s the way it’ll be. When we think about our company, we know we’re better together. We’re better at being creative, we’re better solving problems, we’re better training our young people. It’s really an apprenticeship business, learning how to invest. We have a lot of smart, talented people who are connected by culture. Being together matters.

Yes, some companies will conclude they don’t need quite as much space, so that’ll create some additional vacancy. People will be concerned about owning office buildings, and that may create an opportunity. There will be some headwinds for a number of years and then, over time, things will recover.

I would point out, though, outside the U.S. — for instance, in China — buildings are back to full capacity, and in Europe people don’t have as much space in their home lives. So not all geographies are the same. And even here, I think there’ll be a bias toward going back to the office, even though it won’t be like it was before, in full.

A lot of people have moved to Florida and Texas, maybe for warm weather, maybe because those states don’t have income taxes. Do you think that trend will continue? And is that a good place to invest in real estate now?

It’s a bit of both. The weather, the lower cost of living, lower taxes, concerns about quality of life. Texas is one of the fastest-growing states in the country, even though it’s enormous. I think that will continue, and it was accelerated a bit by the pandemic. On the other hand, New York City, San Francisco, these are amazing places. And when you think about technology and innovation, entrepreneurship, immigrants — there will be a rediscovery of these cities. But, yes, Texas and Florida are well-positioned.

You’ve been buying a lot of rental housing. Is that because you think young adults aren’t as interested in buying their own homes?

Home ownership rates have gone down a bit, but if you look in the last 12 months, during Covid, there’s been a surge in people wanting to own homes. Our investment in rental housing is based on the fact that we just haven’t built a lot of housing since 2008-09. So that has created support for single-family values, but also rental values. And now, as the economy reopens, the shortage in housing will become more acute, so we continue to like it as a sector to invest in.

One of the most favorable parts of the tax code for real estate is the 1031 like-kind exchange. President Biden has proposed changing that. Will that affect real estate very much?

It’ll affect individual investors who’ve owned assets for a long time, will harvest gains and then buy a new piece of real estate. For institutional investors, it’s less of an impact because we’re selling, we’re paying taxes. The way it may impact us is if there’s less selling as a result. The same thing could happen if capital-gains taxes go up. You could see some individual owners of real estate be more reluctant, but I don’t think as much of an impact on the institutional market.

If I have $100,000, where should I put it today?

In real estate. We love what we’re doing in the private REIT space. You can invest in a good basket of public REITs as well. More generally, I think the S&P 500. You’ll do fine over a long period of time. There’s a lot of exposure to fast-growing tech companies in there.

Where should I not invest my money?

You should stay away from buggy-whip businesses. You should stay away from land-line phone companies, and some of the legacy retailers, some legacy media businesses. You want to focus on the future. On real estate, in particular, if I had one piece of advice — go where the creative and technology types are, because those are the markets where there will be the most economic activity. So the West Coast; Austin, Texas; Cambridge, Massachusetts; Shenzhen; London; Amsterdam; Tel Aviv; Bangalore. Tech is driving so much of the growth in this global economy.

Do people come up to you at cocktail parties and ask you for investment advice?

They often ask me residential home prices, which is not my area of expertise. What I tend to tell people is to focus on the longer term. What you want to say is, “Is this fundamentally a good business? Is it in a good sector? Is this a good piece of real estate, where supply is limited, demand is favorable?” And if you own something good, hold it for a long period of time. Find those right neighborhoods to invest in, deploy your capital and then be patient.

What did you do in the beginning at Blackstone?

The first deal I worked on was a shopping center in Chesapeake, Virginia. It was a $6 million transaction. We borrowed $4 million, so it was a $2 million equity check. And you would have thought I was buying the island of Manhattan. I was down there for three weeks. I met every tenant, I was counting the car traffic, I was learning the business. And it was an amazing experience. We were this tiny, little business and I was learning it firsthand.

What was your thinking about buying Hilton? Was it a real estate play, or a corporate play?

It was a bit of both. We did the transaction with our real estate private equity funds, and our corporate private equity fund, because Hilton owned great real estate, like the Waldorf Astoria, the Hilton Hawaiian Village. But it also had this amazing management franchise business.

And we also believed that the multiple was reasonable. We were paying 13 or 14 times cashflow for what we thought was a great business. Our mistake, of course, was that our timing was terrible. We closed on the transaction at the end of 2007. In less than a year, of course, Lehman would collapse, the global economy would be melting down, global travel would decline dramatically.

We still saw tremendous opportunity to grow the company around the world, and so we invested $800 million more at the bottom, we stuck with the company, it started growing. There was a cyclical recovery. We ultimately took it public, we broke it into three different companies: a management franchise, time share, and real estate business, and we made $14 billion for our investors. So it ended well.

So when you were doing these big deals, did your friends from college call you up and say, “I thought you were gonna be a journalist, now you’re a capitalist?”

When I met my wife in romantic poetry class, I showed up wearing a suit and tie. Everyone else was in birkenstocks. So it was clear I’d made a decision which path I was on.

What’s the best investment advice you ever received?

To be a high-conviction investor — that when you dabble, and just put a bunch of money here on things you don’t know or understand, it tends to work out badly. But when you see something, single-family housing, global logistics, the movement of everything online, and you lean into that, that’s when you have the best outcomes.

Finance

Tech Stocks Power Market to Record on All-Clear From Treasuries

For months, the threat of inflation grounded the tech stocks that drove the post-pandemic rebound. And yet, when data this week showed the threat is real, the Faangs took off.

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For months, the threat of inflation grounded the tech stocks that drove the post-pandemic rebound. And yet, when data this week showed the threat is real, the Faangs took off.

Investors in the tech megacaps can thank the bond market, where an epic change in sentiment sent 10-year yields tumbling the most in a year even after data showed inflation accelerated at the fastest rate since 2008 — normally a recipe for a spike in rates and trouble for stocks with high valuations. Instead, the Nasdaq 100 jumped 1.7% over the five days for a fourth straight weekly gain. The yield drop took the shine off value stocks, with banks slumping 2.4% in the week.

The signal from the bond market — that inflation isn’t a threat because the Federal Reserve is hellbent on keeping rates near zero — sets up a “great recipe for risk assets,” according to BNY Mellon Investment Management’s chief strategist Alicia Levine.

“The Fed has convinced everybody that they’re going to roll with it,” Levine told Bloomberg TV and Radio on Friday. “A mild inflationary environment is actually great for equities, it’s great for businesses, it’s great for wages and you don’t have a Fed that’s going to come and kill it all. So you’ve got cyclicals going and you’ll have tech going here.”

The Nasdaq 100 had languished as rising inflation was perceived as making tech shares’ already-stretched valuations impossible to justify. While investors rotated into value stocks for a while, the market’s loss of its heavyweight leader kept indexes in a rut since March.

The dam broke Thursday after the consumer-price reading came and went without market histrionics. The S&P 500 rallied to its first all-time high since early May and the Faang block climbed 0.6% in the week. The Russell 1000 Growth Index outperformed its value counterpart by 2.4 percentage points.

“The continuation of quantitative easing, the continuation of low rates is providing support to market multiples and perhaps to earnings”

Amazon.com Inc. jumped more than 4%, Twitter Inc. rallied 2.5% and Alphabet climbed 1.5% in the week. Meme stocks that captured much of the period’s headlines faltered along with Bitcoin.

Investors took solace from the nature of the rise in inflation even though it exceeded estimates, a third of the surge came from a jump in used vehicle prices, with airfare and hotels also rising — categories in stark demand as the economy reopens. Those price pressures are the type the Fed has been warning won’t be permanent.

And the central bank’s calculus is unlikely to change at next week’s meeting, meaning risk assets may continue their rebound. Policy makers are widely expected to stick to their ultra-easy monetary and downplay any risks from inflation. The bond market reflects as much, with traders closing out bearish positions en masse while trimming bets on Fed hikes.

“The continuation of quantitative easing, the continuation of low rates is providing support to market multiples and perhaps to earnings,” said Rob Haworth, senior investment strategist at U.S. Bank Wealth Management. “That’s supportive for stocks.”

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Inflation scare? Look at this chart before freaking out

Breakdown of price rises not in line with enduring inflation surge, says UniCredit’s Vernazza

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Inflation is on the rise in America, but if price pressures were likely to persist, contrary to the Federal Reserve’s expectations, the data would be painting a different picture, one economist argued Friday.

In a note to clients, Daniel Vernazza, chief international economist at UniCredit Bank, highlighted the complicated but interesting facts below:

“Since higher inflation is largely explained by the reopening of the economy and supply shortages, it’s likely to prove temporary as the direct effects of the pandemic fade and supply adjusts to meet demand.”

The chart plots the change in prices (vertical axis) against the change in spending (horizontal axis) relative to pre-pandemic levels in February 2020, by industry. It uses the personal-consumption expenditures deflator instead of the consumer-price index because PCE is the Fed’s preferred measure of inflation and to make better comparisons with spending data.

It shows that most items have moved backward and forward along the horizontal axis, implying that prices have shown little sensitivity to changes in demand, Vernazza explained. And for service sectors hit particuarly hard by the pandemic, including airfares and accommodation, the reopening of the econony has led to only a partial recovery of prices, which are still not back to pre-pandemic levels.

It’s a somewhat different story for car rentals, where acute supply shortages have caused prices to surge, while spending in the sector remains well below pre-pandemic levels because of limited supply, he said. For used cars, the combination of a switch away from public transport by commuters and a global shortage of semiconductors for new cars has pushed up both demand and prices.

What’s important to note, Vernazza said, is that since higher inflation is largely explained by the reopening of the economy and supply shortages, it’s likely to prove temporary as the direct effects of the pandemic fade and supply adjusts to meet demand.

But what would a more enduring inflation threat look like?

In that case, most of the items would occupy the upper-right quadrant of the chart, reflecting what economists refer to as “demand-pull inflation,” Vernazza said. To date, “this is clearly not the case,” the economist wrote.

Higher inflation is typically seen as bad news for bonds, eroding the value of the interest payments delivered to holders. Stocks rallied Thursday, with the S&P 500 SPX, +0.19% edging to a record close on Thursday, while the Dow Jones Industrial Average DJIA, +0.04% remains not far off its all-time high and rallying tech shares, which are more sensitive to interest rates, pushed the Nasdaq Composite COMP, +0.35% higher.

The Federal Reserve holds a policy meeting next week. While Fed officials have largely stuck to their view that inflation pressures will prove “transitory,” several have also said it’s time to begin thinking about when it would be appropriate to discuss pulling back on asset purchases at the center of its extraordinary monetary policy efforts to support the economy and heal the labor market.

And some economists caution that signs of inflationary pressures in more cyclical segments of the economy are beginning to emerge.

“Both rent and owners’ equivalent rent have staged a clear turnaround over recent months, and food-away-from-home prices surged by 0.6%,” said Michael Pearce, senior U.S. economist at Capital Economics, in a note. “It is no coincidence that rents and restaurant prices are rising more rapidly when wage growth is also accelerating.”

Pearce said a continued surge in job openings shows that worker shortages “are real and intensifying.”

“The recent strength of inflation and signs of labor shortages could prompt a handful of hawkish regional Fed presidents to bring forward their projections for rate increases and strengthen calls for tapering asset purchases sooner rather than later at next week’s FOMC meeting,” he wrote. “But we suspect the majority on the committee will stick to the ‘largely transitory’ language and instead emphasize the yawning shortfall in employment from pre-pandemic levels.”

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Is this the Manchin rally? Bonds are rising and stocks at record high as spending expectations wane

World leaders from the Group of Seven are meeting in Cornwall, England, discussing plans for a global corporate minimum tax and to distribute COVID-19 vaccines, among other topics.

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You wouldn’t expect stocks and bonds to rise after a hotter-than-forecast inflation reading in a market that has been obsessed with the I-word, yet that’s what happened on Thursday.

With consumer prices excluding food and energy shooting up 3.8% year-over-year in May — the hottest reading since 1992 — the yield on the 10-year Treasury slipped 3 basis points, down to 1.46%. Yields move in the opposite direction to prices. The S&P 500 SPX, 0.12% finished at a record high, and the technology heavy Nasdaq Composite COMP, 0.15% has climbed four of the last five days.

Sure, there was some talk that what drove the consumer-price index higher were transitory items, like used-car prices, which should come back to reality once the semiconductor shortage is resolved, making new cars more easily obtainable. But a look at the Atlanta Federal Reserve’s breakdown doesn’t lend support to that interpretation. The sticky price CPI — that is, the cost of goods and services that are typically slow to change in price — shot up an annualized 4.5% in May, after jumping 5.5% in April. There haven’t been two back-to-back readings this strong in 30 years.

Kevin Muir, a former institutional equity derivatives trader turned blogger, called it the Manchin rally on his Macro Tourist blog. Sen. Joe Manchin’s unwillingness to go for a Democrats-only infrastructure package — on Tuesday, he said he wasn’t even thinking about using what’s called reconciliation, which would allow for passage without any Republicans voting — is tempering fiscal spending, as well as tax, expectations.

The West Virginia Democrat is part of a bipartisan group, which also includes another moderate Democrat, Sen. Kyrsten Sinema of Arizona, that is calling for $1.2 trillion in infrastructure spending over eight years, without tax increases apart from indexing federal gas taxes to inflation. That is well short of the $1.7 trillion President Joe Biden is seeking, who also calls for increased corporate taxes. Biden separately is calling for $1.8 trillion in investments in what he calls the American Families Plan, in areas like child care and healthcare, to be paid for by increased taxes on the wealthy.

“The firm rejection over the past several weeks of many of Biden’s tax increases,” added Joe Lieber, managing director at Eurasia Group, “is also likely to shrink a bill’s size to the bottom end of our base case $2-$3 trillion range, and increase reliance on deficit financing such a package.”

Reading the tea leaves in Washington is more art than science, but it is also notable this week that former Vice President Al Gore lobbied Biden to keep climate investments in the infrastructure package, a sign of the growing feeling that the president would accept a less sweeping deal.

“The 10-year yield continued to drop on Friday, sliding down to 1.434. U.S. stock futures ES00, 0.18% NQ00, 0.03% inched higher.”

World leaders from the Group of Seven are meeting in Cornwall, England, discussing plans for a global corporate minimum tax and to distribute COVID-19 vaccines, among other topics.

The University of Michigan’s consumer sentiment index for June highlights an otherwise quiet day on the economics front.

Tesla TSLA, -1.33% Chief Executive Elon Musk took a break on Thursday from his cryptocurrency tweeting to unveil the Model S Plaid, a high-performance version of the sedan.

Cinema chain operator AMC Entertainment AMC, 0.09% had its credit rating upgraded by S&P, due to the company raising cash by selling equity to meme-stock-obsessed investors. S&P nonetheless rates the chain as seven tiers below investment grade.

Chewy CHWY, -2.46%, the online pet-products retailer, beat expectations on earnings but also flagged the impact of labor shortages.

Vertex Pharmaceuticals VRTX, -8.74% fell 14% in premarket trade, as the biotech stopped development of a drug for a rare genetic disease, in what may be good news for Arrowhead Pharmaceuticals ARWR, 6.06%, which is working on a drug treating the same condition. Arrowhead shares rose 4%.

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