This week’s discussion opens with Blue Owl as a proxy for the private credit boom—and what happens when “semi-retail” capital discovers it wants liquidity all at once. Peter argues the worry is “all of the above”: higher-risk lending should mean higher defaults (if properly priced), but the real reflexive risk is a liquidity mismatch and the perception that sellers liquidate their best paper first, leaving weaker assets behind.

The conversation then broadens to how investors perceive volatility: private funds can look stable due to appraisal lag and smoothing, while REITs can look volatile due to shifting demand for liquidity—even when underlying real estate fundamentals change more slowly. Peter frames the post-2008 shift as a preference by large LPs to pay for less mark-to-market pain, even if it’s not purely financially optimal, and notes that this same risk psychology creates arbitrage: multifamily in recently “burned” markets like Austin, Denver, Phoenix (and Nashville) can be attractive precisely because capital is temporarily avoiding them, despite the demand story remaining intact.

Daniel

Peter, good to see you, welcome.

Peter

Nice to see you.

Daniel

So let's start today with Blue Owl. Blue Owl, as most of our readers know, is the poster child for private credit. It's gotten famous for lending to higher risk borrowers and owning, call them semi-liquid debt obligations, all in this private credit space. It's been very active lending there.

In the last week or two, it's gotten negative press for selling assets primarily to pay for increased redemptions. Notably the stock over the last year has been trending down from $21 to today around $11. Ares, KKR, Apollo, and even Blackstone have fallen on similar private credit concerns, although those firms all do lots of things besides private credit.

One question that I had that I didn't see well covered: Is the worry that these companies will see big defaults on their existing assets? Or is the worry more about something that’s fundamental to stock market investing overall, the present value of future earnings, and market investors say the salad days for these firms are over and their future prospects are worse because rates are coming down and credit overall is warming?

Peter

All of the above. Obviously there is some concern on credit per se though remember if you're lending to higher risk borrowers, you're supposed to have more defaults and lower collections and that's what you're being compensated for.

People sometimes forget that. I remember when I was in college, Peter Lewis had just started Progressive Insurance, insuring people who had high risks. All the car insurers back then avoided them. And his point was, I don't need to avoid them, I just need to price them.

And he turned out to be completely right. And Michael Milken did the same thing subsequently on junk bonds, right? Of course they're going to have higher defaults, although not every day. The question is, did you price it? And you're going to go through these episodes on credit where everything's fine, everything's fine, everything's fine, oops, and then you hit a bump in the road and then you get defaults. But then you have to look at it as an overall history, from a collection point of view.

But I do think people are worried and wonder have they taken on too much risk? You add to that what you were saying, I think it was semi-liquid investments, and it's the classic problem: If you try to raise money from semi-retail pockets, they don't want liquidity right until they want liquidity and then they want it right away. This is a problem open-end funds have always had, for example, in real estate.

The flip problem is if you don't give them that illusion of liquidity, they don't want to get in at all because they don't want to be locked in. So everybody tries to say, well, I'll give you liquidity, but the minute you need liquidity, you don't have liquidity.

Now the concern among some investors is they sold their best stuff and what they've got is lesser stuff. I’m not saying I know that’s true, but that’s a concern, and as an investor, if I don't get out I may not be able to later.

That's always the concern in these situations, which is when you need liquidity, you sell your best stuff, your most liquid stuff, and then you leave the other stuff behind. And as an investor I don't want to be the last one holding the bag.

And finally, a lot of money was raised for private credit, probably too much, right? And it's hard to place that at the premiums they thought they were going to get. Is there a market for private credit? Sure. Is it as deep as the money raised? Probably not.

Daniel

So let's hold on that last point. If you ran a private credit fund, let's say you started one today and were out raising money for it, and you wanted to set investor expectations appropriately, what would you be saying to them and what would you be investing in?

Peter

I think what I'd be saying is the fact that some people are getting out, maybe forced to get out, that's why I want in.

A number of these funds over history have always said this. “We just got clobbered in hotels and so now is the time to get in to hotels.” Maybe that’s why now is the right time to get an office because we just got clobbered in office. So there's nothing new to that story.

I’d say there's still credit opportunities out there and I’ll get a better selection of them than when everybody was active.

Daniel

So now let's pivot to the perspective of a borrower, because Blue Owl is real estate lender, among other things. If you were a borrower running a financing process now for an asset, and I don't want to pick on Blue Owl, let's just say private credit lenders showed up on the bid sheet that your broker brought you, how would you think about them? What questions would you ask?

Would you start to think that there might be counter-party risk there in a way that you don't see with other more traditional lenders?

Peter

I think if I had a bid from a life insurance company, for example, or a major bank, that basically has pretty close to the same proceeds, pretty close to the same spread, I'll go with the life insurance company or the bank. Now that was probably already true.

Where the private credit had their advantages, they were willing to give higher proceeds, maybe an extra 3% loan to value, or an extra 4%. So instead of doing a life company 62 % loan, they were willing to do 65% or 66%.

If you did a project and you started it in 2022, it’s tight right now and you’re coming up for refinancing as you stabilize your leasing. You don't want to have a capital call if you can avoid it. And the private credit generally will go higher in proceeds, which means I can avoid on a capital call. Okay, I'll stretch a little farther. I'd still look that way.

Your real risk is 30 days from now, they don't close or 60 days from now, they don't close. Once they fund it, I don't have a big counter-party risk. It's just the risk I took on between when I told everybody else go away and closing.

Daniel

The high redemption request situation that Blue Owl finds itself in will echo for a lot of people with what happened to open-ended real estate funds, notably B-REIT. And I think of them a little differently. One really owns hard assets. One owns loans. People will merge those in their minds. How do you think of these different types of investment platforms that are seeing redemption requests? How would you separate them in your mind?

Peter

Paper is probably easier and faster to sell than bricks and mortar. So whereas it might take me six months to get execution on real estate with all the diligence and the environment, with paper, you know, you have some equity in front of you, etc. Generally credit sells easier, sells faster to meet liquidity. So I think Blue Owl has a little easier situation than the real estate owners.

On the other hand, real estate, you might have a better chance of levering a bit. Depends how levered the portfolio was to start with. But if you had a relatively low levered real estate portfolio, you could lever a bit to make the redemptions rather than selling stuff.

But I think in every case, the concern is, okay, even if they make the redemption by selling, they're selling their best, most liquid stuff. And what they're leaving behind is the chaff. And that's not always true, but let's face it, if you had to sell, you'd take your most liquid, highest quality, because you could execute and because it would send a signal that you got par, or above par in the case of real estate, right?

Daniel

Right. Okay, left field question. We at the Haystack have been reading research that talks about the volatility of public REITs vs. the non-volatility of private funds that own real estate. So we’re talking about the same assets owned, different ownership structure. And returns for privately owned real estate are known to be smoothed as they’re valued quarterly and in wonky ways, so investors in private real estate funds actually have a lot more volatility than they know, but there's just not a great way to know how much because the assets aren't marketed and the securities are not publicly traded.

There's another school of thought that REITs and private funds own assets that are actually not very volatile, but because REIT stocks are public and the investors in REITs have other investments and are whipsawed by other factors, REIT volatility happens unrelated to the underlying assets, and thus REITs don't accurately reflect how much volatility there is NOT in the assets.

What do you think of that?

Peter

So I think there's a bit of both. I mean, there's obviously on the private side appraisal smoothing. You get an appraisal once every year for your asset. The appraisal looks backwards 18 to 24 months to transactions that occurred. So I'm lagged and smooth. Gee, what a shock that the appraisal doesn't move so much, right? Just by definition.

Having said that, 20 years ago, I don't think I fully appreciated that what you're seeing in the volatility of REITs is the changing demand for liquidity. Some days people really want in, some days people really want out. I'm not sure why they want in or out, but if they want in or out on whatever, on Iran or whatever, there’s more volatility. That means there’s volatility around true value, if you will.

Remember, most people don't sell their REITs most days. So for most owners, that volatility doesn't really mean much. But it does if you want to get in and it does if you want to get out. So there's no doubt volatility gets induced by ever changing whims of desire or lack of desire for liquidity triggered by all kinds of psychological and personal factors and all kinds of news flashes.

The last thing I'd say is I had several clients I've run portfolios for in REITs, but I told them, “I'm going to run it like it's private equity.” Namely, we're not going to have liquidity volatility. And they say, how do you achieve that? And I say, we're just not going to look at the stock price. Don't look at the stock price, come back five years from now, and we'll look at the value. But don't look every half hour, or every day, or every week. Funny how the volatility disappears when you do that!

Daniel

There is a derivative of one of these schools of thought, which was that private investors, pension funds, consciously or otherwise, want to eschew volatility and thus invest in private funds as a preference over REITs. These private funds’ returns are smoothed, which is upside, but the illiquidity is part of the price you pay. They pay an illiquidity premium, which is the first time I had ever heard that term, to be in privately owned real estate, which does not typically perform as well as REITs have historically.

They pay it because they're doing a version of what you just said. But instead of buying REITs and not looking at the stock prices, they buy private.

Peter

I think that's pretty accurate. I think the two definitive events in this whole evolution start if you go back to 1990, I know you guys were in diapers then, but go back to 1990, there were all these institutional investors that mostly through direct accounts owned real estate. And they kept getting reports saying how good it was going. And then suddenly in the early 90s, it all fell apart and they didn't trust the direct accounts anymore.

They said, never again, we're not going to trust you. We want mark-to-market pricing. And there was a movement across all assets, not just real estate, toward mark-to-market pricing through the 1990s and into the 2000s. That's where you saw the money go.

And then I think it's very important that the financial crisis trough happened during the fourth quarter of 2008. And I stress the fourth quarter. If you had a mark-to-market portfolio of REITs or stocks in general you lost your job and you didn't get your bonus because the fourth quarter registered horrible performance and drove horrible performance for the year. It would have been interesting if the trough had occurred in the first quarter, you'd have had time for recovery.

If you had a private portfolio, you knew your values got hammered, but you basically had a year or two to sort it out. And I think that's where people on the LP side said, I'm willing to pay a premium NOT to mark to market, at least on some of my money. And that's when you start seeing huge flows into private equity real estate and private equity non-real estate.

Daniel

Is this desire for illiquidity economically inefficient for the beneficiaries that those LPs serve? We’re talking about pensioners primarily. Or are their best interests served by doing what you did, which is a perfect example, which is having their pension fund put more money in liquid assets and then just having a stronger stomach and a longer time horizon?

Peter

And by the way, just to the point you're saying about the longer time horizon, go look at S&P 500 over 20 years, 30 years, 40 years. The big drops, including the October 87 drop of 24%, when you look at it over 50 years or 40 years or there, it's a blip. But you had to have a strong stomach to ride it through.

Are they well served? Probably not purely financially. However, I'd make a counter, which is if you want fund manager employees who can sleep at night and make studied decisions, maybe so. You may have a harder time getting good talent to step into that breach.

We're painting this too black and white, obviously, it's a continuum. But we've seen huge discounts to NAV, and those are pretty reasonable NAVs for a lot of assets. Why is it out there? Because more money is willing to be private than public and not willing to arbitrage it. You do see arbitrages, right? You do see some, but not to the extent you'd expect.

And I just think, I think it's partly people, the big guys who have the money to arbitrage it, they don't want the volatility. They want as little volatility as they can get, unless the volatility comes from it's going up. Right? They like volatility going up.

Adam

You quoted Sam Zell in an earlier session: Everybody thinks they want to be contrarian right up until the point that they have to be contrarian.

Peter

Yeah, that's basically right.

Adam

In that spirit, if you could only pick one asset type to invest in right now and a few geographies or MSAs, I'd like to know what you'd do. And how big of a fund would you raise to do that? The second question being a thought exercise indicating how much would you be willing to try to put to work today.

Peter

Four years ago, I'm just picking four years ago, what were the darlings? The darlings were apartments in Austin, apartments in Nashville, apartments in Denver, apartments in Phoenix, a little bit Raleigh.

Everything you could say about demand four years ago about those markets you could say today, moving forward. Take Phoenix. It's going to grow. It's got wealthier. And you can say that about Denver, you can say that about Austin, etc. However, you had a lot of money who went into those markets with apartments four years ago, three years ago, and they got burned.

If they're lucky, they just didn't get a great return to date. And if they were unlucky, they did floating rate debt and got crushed. So at best, it's not been a great experience. And at worst, it's been a bad experience, right? So if you go to capital right now, there's no appetite for these investments.

I want to be there. Why? Because I don't think capital's going to avoid them for the rest of history. It might avoid them for two years or four years, but not forever.

Adam

You like multifamily the best?

Peter

Yeah, only because it's the least lumpy. You know, the problem with office is that you could be right on the macro bet but just wrong on my building. If I can’t lease the last 30% in my building, that bad.

Daniel

There was an article in the Wall Street Journal today, the headline of which is: “Once America's most affordable rental city, Austin is about to get more expensive.”

Adam

So in 2011, I was working for a hospitality firm. And hospitality investment at that time was still a four-letter word coming out of the GFC. And we had raised a GP fund and my job was to find debt and equity.

The two calls I had daily were equity guys saying, “we see the opportunity, we know hotels are coming back, we want to be in, pricing is great, the opportunity is great,” and then the second most common call was when I showed them a deal and the answer was no. They found ways to not like the deal.

So it was a really scrappy time to put deals together. And by 2014, we were the smartest guys in the room, not because we had done anything brilliant in 2012 except get deals done. And then when the market came back to normal.

Peter

And any deal you didn't get funded, had you gotten it funded, would have done terrific. Basically, right?

Adam

That's right.

Peter

I may be wrong on this, and it's taken me a long time to get here, but I used to think that investors and managers were paid to take risk. And I've come to say, no, mostly they're paid to take risk when others are taking a somewhat similar risk. And when others are not taking a somewhat similar risk, they're not paying you for it.

Daniel

That’s great and let's explore it in a future episode. This has been great. Peter, we'll leave it there.

Peter

My pleasure.

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