A publication of Winter issue 2015 sponsored by CRE Finance World Winter 2015 19 Stephen Renna: Well, speaking of returns, what is your view of real estate debt investment in a relative value sense? Howard Marks: Well, again, it depends on how you define real estate. We are optimistic regarding real estate assets. But we aren’t active in so-called core real estate: class “A” buildings in prime cities. But in the things that we are active in, we are optimistic. We think that prices are not bubblish in our assets. In the non-A buildings and the non-prime cities, we think prices are not unreasonable, and so we have been active. That includes real estate lending. And I think real estate lending is a reasonable thing to do now. Among other things, number one, real estate is not homogenous. Retail money doesn’t flow there as readily; there aren’t as many readily accessed vehicles for the kind of thing we do and so their prices don’t get forced up by the flow of retail money to the same extent. And then much of the lending we do is private. And private debt, I think, today, is cheaper than public debt, in part for the same reason, and in part because people have developed something of an aversion to private assets because holders of private assets suffered greatly in the crisis. And so it is not attractive just because it’s real estate debt, but it’s against assets that haven’t risen in price so much and it is private lending as opposed to public. Stephen Renna: I’ve had the privilege of reading some of your client memos. In them you talk about the concept of risk and how investors should think about risk. Please comment on that. Also, what do you see as the top risks in your business and in investing today? Howard Marks: I define risk as the probability of permanent loss — that is to say, not fluctuation or volatility. And I think risk comes primarily from two things. Number one, the level of prices, and so you should look at valuation metrics relative to history, relative to alternatives and so forth. And second, risk comes from investor behavior. So when buyers are enthusiastic and optimistic and riskoblivious, that is a dangerous time. That’s really how I think about risk. You have to look at valuation metrics, which is quantitative, and you have to do what I call taking the temperature of the market, which is qualitative. I think that in many asset classes, risk is elevated today. It is not maximally elevated, but it is elevated because of the behavior I described before, which is the result of the need to invest in prorisk asset classes to make money. Stephen Renna: Also in your memos, you commented that in order to perform better than the pack, you have to “be comfortable with being uncomfortable with your investment portfolio”. Can you just comment on your thinking with respect to that? Howard Marks: The things that people are comfortable with and feel good about, they will buy into. And the things that everybody has bought into are unlikely to be bargains. Things are likely to be bargains only if there is some aversion on the investor’s part to buying them. That is to say, bargains are usually found among the things that people are not comfortable with. The word “uncomfortable” actually came from a quote from Dave Swensen’s book, “Pioneering Portfolio Management,” in which he describes the need to have portfolios that are “uncomfortably idiosyncratic”. I think that is a great phrase. And, I don’t think I put it in the memo that you are referring to, but there is that Yogi Berra quote, “nobody goes to that restaurant, it is too crowded.” It is kind of equally oxymoronic to say there’s an investment that everyone knows about, understands, likes and feels good about, and agrees that it’s a bargain. If everybody knows about it and likes it and feels it is a bargain, won’t they have bought it up to the point where it is not a bargain? Stephen Renna: Absolutely, right. Sure. Howard Marks: I think I said in one of my memos, all great investments begin in discomfort. Stephen Renna: Yes. Excellent. Can we shift gears to talk a little bit about Washington, since I’m sitting here in DC, the epicenter of law and regulation? Howard Marks: If you must. Stephen Renna: Well, I don’t think we could escape our conversation without raising the concept of regulation. As you know, the Dodd-Frank legislation spurred a wave of regulation on the financial services industry. Most recently and most notably are the risk-retention regulations. What is your view with respect to the impact of these regulations on the financial sector and investment? Howard Marks: I wrote a memo three or four years ago, in which I said regulation is a pendulum which swings from too little to too much. And you know, when we have a crisis or a crash, everybody concludes that the financial industry was at fault and that we need more regulation. And so we get more regulation and then, maybe because things are better for a while or maybe because the industry behaves better for a while, everything goes smoothly and everybody says, “well, I guess we don’t need regulation.” So then we deregulate, and the pendulum swings toward deregulation. Then, eventually, it reaches an extreme of deregulation, and things stop going as well, and eventually we get another crisis. And then it swings back toward regulation. It’s hard to say what the right level of regulation is. I’m not a libertarian who says the best regulation is no regulation, because I think that people need laws to live by. And so it is just a pendulum, and it is hard to say where the proper point is. If you think about the pendulum, it never stops at the happy medium. It is usually swinging from one extreme to the other and back toward the other. Now, for example, take a look at the risk-retention rule. That is certainly an example of something that shouldn’t be necessary. But on the other hand, in the last go around, it probably would have been a good thing, because you had people making loans who did not have a stake in the long-term success of those loans. CREFC Exclusive Interview with Howard Marks
CREFW-Winter Edition
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