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Where One Asset Manager Sees Opportunities in the Current Real Estate Investment Landscape

Brookfield Managing Partner Zachary Vaughan spoke with WMRE about the firm’s debt investments and how its partnership with Oaktree has expanded capabilities.

Brookfield Asset Management raised $93 billion in capital in 2022 and despite some of the uncertainty swirling around commercial real estate, the firm is bullish on a number of strategies.

The firm predominantly focused on equity in the past, but has increasingly moved into the debt strategies where it sees potential for attractive returns given the current state of capital markets.

Brookfield is also four years into its partnership with Oaktree Capital Group, in which it acquired a 62 percent stake in 2019. The combined firm’s offerings include private funds, a non-traded REIT, mutual funds, an interval fund and a strategic credit fund.

Last year, Brookfield Oaktree Wealth Solutions, doubled its team dedicated to bringing its alts products to the registered investment advisor channel with plans to continue to grow that team.

Zachary Vaughan is managing partner in Brookfield’s real estate group, global head of Brookfield’s core plus and perpetual real estate funds and CEO of Brookfield REIT and spoke with WMRE about the firm's investment outlook.

This interview has been edited for style, length and clarity.

WMRE: Let’s start with something that caught my attention in the 2023 Brookfield Real Estate Outlook video. You mentioned that it’s an attractive time to be a real estate debt investor. Can you expand on that?

Zachary-Vaughan.jpgZachary Vaughan: I think it’s a very good time to be a debt investor. Sometimes it is good to be a borrower. Sometimes it’s great to be a lender. Right now it’s a great time to be a lender. There’s a widening of spreads and a premium to the risk-free rate. We’ve been very focused on working with Oaktree. It’s a real differentiator. They are able to source and identify debt investments and we can work on the operating side to help understand the underlying assets. And just as important as the asset is the sponsorship. … I think a combination of pure economics and the ability to move very quickly between equity and debt is an advantage. Currently, we believe debt is attractive. We are getting returns that are in some cases equity-like returns for debt-like risk.

WMRE: What part of the capital stack are you looking at? Is it mezzanine, preferred equity, senior debt or all of the above?

Zachary Vaughan: Where we have been most active is in acquiring pieces of mortgages—in bond form and in CMBS form. These are single asset single borrower bonds. We understand the asset, the sponsor, what the prospects are, and what the long-term plans are. Generally, where we sit is at 50% or sub 50% of value. So, we’re very much in senior debt. That’s been the opportunity we’ve been most aggressive with recently. We will start to look at more structured transactions, whether it’s mezzanine or preferred equity as well. To us the obvious opportunity is in the senior portion of the debt structure. Cap rates would have to go into double digits before you felt an impairment in capital. So really, it’s where we’ve been the most active lately, but we do look throughout the capital structure.

WMRE: Do you find it’s a challenge to educate investors about commercial real estate and dispel any notions they might have?

Zachary Vaughan: We do think it’s something people generally understand. It’s tangible and in a lot of cases, it’s very personal. Over the past 30 years, large-scale sophisticated institutions started with real estate when they got out of the traditional stock/bond mixes in their portfolios. Individual investors are now on a similar path. There’s appetite for a private format—something outside the public equity markets that’s invested in high-quality assets, but they don’t have to run themselves. They get to invest in portfolio of good assets, but don’t have to take phone calls about the heat not working, for example. The formats and vehicles today for individual investors are structured in a way that is virtually identical to what our institutional investors participate in, but they do have a few other features. This combination of investors wanting alternatives and the market having products with managers, governance, and proper fee structures. That makes it an interesting time.

WMRE: Just from my seat it seems like the variety of options to invest in real estate in the private markets has proliferated. There are a lot of different formats and products that have emerged. Is that accurate?

Zachary Vaughan: I think the options today are much better. The quality, alignment, and transparency are materially better than they have ever been. Investors can now have access to institutional-caliber products.

WMRE: How does the tie-up with Oaktree factor into what you’ve been doing?

Zachary Vaughan: In 2019, Brookfield acquired a 62% interest in Oaktree. The balance is owned by their partners and we are a partner in their business. We work together on product distribution in the wealth channel under Brookfield Oaktree Wealth Solutions. We have created products that utilize both of our strengths and provide or offer them to financial advisors, private banks, and intermediaries.

WMRE: What’s your take on the fundamentals in real estate right now? Overall, aside from well-documented exceptions, occupancies, rents, NOI, etc., all seem to be holding up.

Zachary Vaughan: I would start at a high level. I’ve been doing this my whole career for 25 years. What tends to kill real estate and real estate values is when you have a huge amount of speculative supply, and it collides with an economic slowdown. In this case, we haven’t seen that. There are pockets in the apartment world—Phoenix, Las Vegas, Austin—where a lot of apartments are under construction and rents will soften for a period of time. But, overall we are not facing overbuilding like we did in previous cycles. That feels good.

At the same time, the economy is undergoing some turbulence, although employment is strong, people are still spending money, and corporate profits are still healthy. What I would say is on the ground, fundamentals are as good as we’ve ever seen them going into a period like this. That feels like a pretty good place to be.

WMRE: What are some property sectors Brookfield is focused on?

Zachary Vaughan: Rental housing is a big area of focus, particularly for our income strategies. It has the potential for good stable cashflow and income, which we believe is downside protected if you own the right assets and avoid assets in markets with a lot of regulation. The tailwinds are there. The rent vs. own equation has never been more in favor of renting. Interest rates may stay higher for a period of time. That will favor the rental market. It’s an excellent place to be.

Commercially, things gets more varied. It depends on the sector, the market, the asset. … One area we spend a lot of time talking about is office. Brookfield is a large office owner around the world. Ultimately, it’s a difference between the “haves” and the “have nots.” When rents are going down everywhere, people will try and trade up and bargain hunt. We have not seen that. If you look at New York headline vacancy may be over  20%, but at the upper end of the market, the vacancy rate is sub 5%.… The leases Brookfield signed last year were above what we thought we could get at this point in time in 2019, so we are very fortunate to own the right type of properties.  

There are assets that are very tough in the current market and the demand for those assets may not be there at any price. But we believe properties that are well-connected, in good locations, with the right types of systems and amenities, meaning good vertical transportation, lots of light, and state of the art air handling airflow, will do well. In my view, they are actually doing better than I would have predicted at this period of time.

In terms of investment, there might be some greet opportunities to come, but we haven’t seen that yet. It’s something that we could see develop in the near term.

WMRE: What about the industrial/logistics space?

Zachary Vaughan: It continues to be strong. Vacancies across the market are very low. In some places, it’s almost 0%. There is huge demand for infill projects in dense environments. We believe over time as people look through their portfolios, properties that sit in areas with meaningful residual land value and can’t be easily reproduced  will be extraordinarily valuable. It’s a trend we’ve seen in the shopping center space.

Another positive for most types of commercial real estate is lack of significant new supply.  What really kills real estate performance and values is when a lot of new supply collides with economic contraction. Right now supply is generally in check and  any spec supply has probably stopped at this moment. So your risk that someone comes out of the ground with a lot of projects around you is quite low. This has the potential to bolster operating performance in the near to medium term.

Overall, it’s important that people understand that commercial real estate is not one broad brush stroke. All the sectors have different drivers and different things that will propel performance. Some will be challenged and that will grab headlines.

WMRE: Related to that, there has been a lot of focus of late on some non-traded REITs hitting their redemption caps. Is that something that’s caused concerns among your own investors? How do you go about communicating with them?

Zachary Vaughan: It’s hard to overcome a narrative that takes off in a news cycle. But what will prove itself is performance over time. The other positive of the story regarding these types of products is about how much liquidity has been created for people that have been asking for redemptions. People have been satisfied up the limits of what’s available. It appears that these products are functioning like they should. People are getting what they are asking for. That’s the positive story. That will be realized in the long-term.

WMRE: I also think there may be some hangover from the last generation of non-traded REITs not recognizing that the structures have changed and the sponsors today are different.

Zachary Vaughan: If you go back to non-traded REITs 1.0, there was no liquidity. There was no transparency. There was no third-party governance. Sponsorships weren’t great. And the assets weren’t great. In my view, now you have a fundamentally very different product that own higher-caliber assets with better managers that are better aligned with their investors. We believe stories about redemptions make for good headlines, but don’t tell the whole story.

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