2023 Global Real Estate Outlook

Greg Campion: 2022 has been a difficult year for investors across virtually every asset class, and commercial real estate markets in the US and Europe have been no exception. Heading into 2023, the outlook remains unclear.

Joe Gorin: We're reconsidering everything right now. We're slowing down. We're pausing. I'd say anything that people have been buying over the past couple of years at razor thin cap rate spreads, which goes across industrial multifamily in some of these markets where you've had explosive rent growth over the past two or three years, there's some real exposure in some of those really tight areas that might sound contrarian. They were the safest. But when you move cap rates from a 2. 5, 3 by 50 to a 100 basis points, that is a massive impact on value.

Greg Campion: That was Joe Gorin, head of US Real Estate Equity Acquisitions and Portfolio Management at Barings. And this is Streaming Income, a podcast from Barings. I'm your host, Greg Campion. Coming up on today's show, my colleague Greg Eudicone moderates Barings' 2023 global real estate outlook, garnering the latest views from the firm's experts across equity and debt markets in the US and Europe.

Greg Eudicone: Hello, my name is Greg Eudicone. Thank you for joining the Barings 2023 Real Estate Outlook. I am managing director and head of client portfolio management for the US real estate. What a year 2022 has been, macro issues and real estate issues. From a macro perspective, one filled with distinct challenges, fed rate movements, inflation, lingering effects of the pandemic, Russia, Ukraine. In specific real estate issues, structural changes to the use of office space, emerging asset classes, data centers, life science, and more recently a lack of price discovery, frozen capital markets and the dreaded denominator impact affecting many institutional investors. But as we know, real estate is not a local business. It's a hyper- local business. And in our experience, sophisticated investors are not only looking at markets from the top down, but also from the bottom up. So today, our panel, with that in mind, is intended to give you a different and unique perspective than you might be hearing in other similar forums. We want to understand and provide guidance on what is really happening in local markets that can help inform you as you move into 2023. Today I'm very grateful to be joined by four members of my Barings real estate team, and I'll allow everyone to introduce themselves. Valeria, do you want to kick off?

Valeria Falcone: Thank you, Greg. Yes, I'm Valeria Falcone, and I'm managing director and portfolio manager and head of value add investing Europe.

Séverine Maumy-Laffineur: Séverine Maumy-Laffineur. I'm a managing director and I'm a portfolio manager working for core strategy in Europe.

Joe Gorin: Hi folks. Joe Gorin, I am a managing director and I head up US equity real estate acquisitions and portfolio management.

Nasir Alamgir: Hi, I'm Nasir Alamgir. I head up our real estate debt portfolio management team here in the Americas.

Greg Eudicone: Our goal today is to give you a unique perspective of what is going on in the market, dictated by our on the ground experts in their respective market. So we're trying to give unique perspectives on what is really, really happening. And so with that in mind, let's get going. Obviously 2022 has been incredibly difficult. What unique aspects of this market and how many of these aspects in this market are keeping us up at night and why? Séverine, maybe I'll have you kick off.

Séverine Maumy-Laffineur: Well, it's true that what we are facing, for almost the last three years, is pretty unpredictable. And in any case, if you had told me three years ago what we are going to live for the next three years, I would probably have not believed it at all. What is very complicated here is that we are not facing a real estate crisis, we are facing an inflationary crisis due to external shock we had over the last two years. And that has an impact on our industry. The first shock we had is a shock on demand due to the pandemic, and especially the lockdown we had following the pandemic that has completely disrupted the whole economy. We have 20% more demand in projects and goods, and 25% less demand on services. That's the first shock, I would say. The second shock is really the energy crisis. And that's very more European, I would say, specific. But that's two shocks that we have, facing a very strong inflation in the US and in Europe. And that cocktail means that we are in this kind of situation today. And I've been quite shocked by the fact that the government have clearly denied that situation at the beginning, and the reaction coming from the central bank have been pretty late, I will say March, for the US, and more July for the European Central Bank. But what is clearly complicated for us is all the uncertainty around the macro because clearly this is not a real estate crisis. Everything around real estate is pretty positive in terms of demand and everything. So for me, what keeps me awake at night is all this uncertainty and that volatility that are going to last for sure within for me the next 24 months.

Greg Eudicone: Thanks Séverine. Nasir, Some perspective from you from the real estate debt side.

Nasir Alamgir: I think I'm going to grab onto a little bit of what Séverine was saying with respect to inflation, but I'm going to look at it through the lens of consumer spending. So we're entering into the holiday season. Here in the US, nearly 20% of all retail sales take place in the months of November and December. So this is going to be a very telling sort of statistic as we go through the next several weeks and, again, the next two months. On average, we've seen retail sales grow 4% to 5% over the last decade. But once we got to the pandemic, those sales skyrocketed. So in 2020, retail sales grew by over 9%, and then 2021, over 13%. If you look at inflation alone, you'd expect 2022 sales to be up six to 8%. And that's pretty much in line with forecasts from the National Retail Federation. But that means US consumers are going to spend nearly a trillion dollars this season. Now, like a lot of data today, that's both good and bad. It's good because consumer spending drives economic growth. But at the same time, it's bad because it's going to lead to persistent inflation, and that's going to require tighter monetary policy, and the Fed is going to choke the economy into recession. So those are the things that, again, maybe it's not necessarily keeping me up at night, but it is something that I'm spending a lot of time focusing on over the next several weeks or the last two months of the year.

Greg Eudicone: Joe.

Joe Gorin: Well, I'm going to grab on to what Nasir said if it's what keeps me up at night. And I think they're doing what they have to do, but the Fed keeps me up at night because we just don't know how far they're going to go with these Fed funds rate increases, and that just creates uncertainty in terms of pricing equity. You've got a lot of maturities coming up in 2023. The average rate of a CMBS loan, you have to assume, is maturing at about 4. 5%, And the new debt, if you can find the new debt for it, it's easily 200 to 300 basis points over that. So that's really impacting our ability to price anything. It's impacting our ability to price stocks, it's impacting our ability to price real estate, it's hitting every asset class. And we're very rate sensitive in the real estate sector. Also, you have to look at it, when you're buying, we're not buying a lot. So that keeps me up at night. We have some dry powder. It might be a great time to have dry powder, but not right now. If you're an owner of real estate, how you value your real estate is confusing. And what does keep me up at night is some of the private managers may not be marking their assets down fast enough. Some are, some aren't. So I think there's more equity devaluation to occur in the private sector, we've seen it in the public rates. And then the sellers need to realize that the bid inaudible spread needs to narrow if there's going to be transactions. So there's a lot today to keep you up at night. It doesn't necessarily keep me up at night. It keeps us very focused on how we're going to navigate this challenging environment.

Greg Eudicone: Valeria, some thoughts from you?

Valeria Falcone: Well, I mean I'll recap what you said. If you look back in the last 24 months, I think that everything that could possibly happen has occurred as a reality, pandemic, a war, unprecedented energy crisis, which has led to inflation. And I would add another point which is, at least for Europe, the inability of the traditional instrument of central banks to function. Because despite the sharp increase, and you might argue that maybe the increase is not sharp enough, the sharp increase in interest rate, inflation is far from being under control at all in Europe. And therefore, there's some question rising linked to this, which is, when are we really going to see the peak of the consequences of everything that has happened out there? And is, really, the recession the only medium term consequence we're going to face or are we going to see more political consequences too on the back of what's happening today? And then finally, I think also that we should pose ourselves the question of, are we sure that the target of 2% of inflation is going to be met anytime soon, or maybe we'll have to think about higher inflationary environment for some years ahead? And so the answers to all these questions have a big impact on all our investment decisions. So what keeps me awake at night is that I'm trying to understand how we best position our portfolio to resist through the storm. But most importantly, I'm trying to understand how do we take advantage for future investments?

Greg Eudicone: Valeria, picking up on what you just said, you're all portfolio manager looking to position the portfolio going forward. In 2021 and 2022, there's just been these emergence of either hot asset types like life science or data centers, or hot markets in the US, there's smile states and migration from the gateways downwards. From your perspective, are there any sort of hot markets or property types that are giving you pause that you're looking to just sort back off of?

Valeria Falcone: Well, given the strength of that asset class, I think that logistic problems being one of the biggest surprise in a way, not so much for the extent of the decompression of cap rate happening there. But because the prolongation of this situation is and will slow down, in the short term at least, some of the fundamentals of the logistic market, which is losing some momentum, in a way, with declining purchasing power affecting sales. We mentioned that, including online sales and distribution, we might see some weakening of the fundamentals of the logistics. However, it is very possible that this will be counterbalanced in Europe by an increase in demand from manufacturing companies as a result of increasing near shoring business strategies. So all in, taking in consideration, research indicates that the hit to cap rate for logistics will be in the region of 70 BPS at the year end, taking average cap rate in Europe at 4.1%. But we had a peak in UK, more than 200 BPS jumps in six months, or a decrease of 60% in land value for example. Now all this is something that is there, we have to deal with it, but we also have to see that the online sales expansion is a no return path. And so a new modern logistics space will be developed and will be needed to fulfill the demand. And also, the wide variation of the internet penetration rates between European countries means that there is a considerable expansion potential in the logistics in the medium to long term. In this respect also, we also have to consider that the supply has been short. So in a way, we see a weak short term situation in logistics, which, again, was the big difference compared to few months ago. But we still see very strong medium to long term fundamentals, and we believe that those will persist in this asset class.

Greg Eudicone: Thanks Valeria. Joe, any hot markets or sectors that you're starting to reconsider?

Joe Gorin: Well, I would say that we're reconsidering everything right now. We're slowing down, we're pausing. In terms of hot, I'd say anything that people have been buying over the past couple of years at razor thin cap rate spreads, which goes across industrial, multifamily and some of these markets where you've had explosive rent growth over the past two or three years, we're really focused on that potential economic slowdown and where rent growth is in the future, and the moderation and the cap rate widening. So there's some real exposure in some of those really tight areas that might sound contrarian. They were the safest. But when you move cap rates from a 2. 5, 3 by 50 to a 100 basis points, that is a massive impact on value. It's a lot more challenging than just moving it 50 basis points on a cap rate of 5%. There is an area, aside from those razor thin cap rate product types that have traded. Life science has been trading at some higher cap rates, but it's also been trading at price per pounds on a fundamental investment basis at over a thousand dollars a foot, $1, 500 a foot, even eclipsing$ 2, 000 a foot in markets like Boston and San Francisco. You've had massive rent growth, massive demand. That white hot demand is slowing down. Venture capital is slowing down in life science. And arguably, people might have been investing at premiums to replacement cost, which is a fundamental no- no. And so I think there's going to be a right sizing of some of those deals. We still believe in life science long term, and we're excited about the price disruption that may prevail here. But I think that a lot of those deals that some of the life science capital and maybe some folks who weren't as expert in the field invested in are going to be very challenged going forward, especially some of the conversions of physical real estate that really probably shouldn't have been underwritten that way. So I think there's some exposure in life science because it was just so white hot.

Greg Eudicone: Séverine, from your perspective, anything that you're sort of cautious on right now?

Séverine Maumy-Laffineur: Yeah, for the core strategy we have for Europe, we entered the residential market, the alternative market a few years ago, in advance of the COVID crisis, as a diversification of our portfolio because we saw that we had no hierarchy anymore in yields between different assets. And it's true that residential has always offered very good, stable cash flow. You could also spread out your CapEx over time, which sometimes you cannot do for offices. So in terms of risk adjustment, it was very good. But the more we're entering in that market, and we were also predicting some very strong CPI increase and rental growth. But the limit of the exercise when we are talking about resi is that, at the end of the day, the people paying is people like you and I. At some time, you are facing some potentially insolvency of the people that occupy this kind of housing. So we see a lot of people coming back to that market. And to make things happen in terms of return, they had to focus very, very aggressive CPI increase on rental growth, which is not sustainable anymore in that market. So clearly, yes, I do think that we are on pause on the resi side. Even if I do think that on the long term basis, inaudible you have a very long term view on this kind of asset, you are always going to win because the component on the capital value over the time is very strong on this kind of asset. On the other side, what I like on the resi side is all what we call operational assets, like PBSA or senior housing, everything which is around the house, which is extremely interesting. Here again, as soon as you get the right pricing around this asset. The right managers or the right, I would say, covenant entity, you are facing some very good and stable cash flows for core strategy, I would say, which is absolutely the best. But again, resi alternative, yes, but right pricing with the long term view. And for the moment, in any case, we have not seen the strong decrease or enough decrease in pricing to get this asset sustainable over the time at the moment.

Greg Eudicone: And Nasir, from the debt perspective, areas that you're focused on are backing away from?

Nasir Alamgir: I'll probably echo what Séverine was saying with respect to residential multi- family properties being a hot asset class where we're probably scrutinizing a little bit more. Like the asset classes we've all talked about, there are pros and cons to them. And I think what's really interesting about this time in the market is that there are still really good fundamentals for all of those asset classes. But in the multifamily space, we've seen an incredible amount of new supply coming online. There are over 900, 000 units under construction right now. That's obviously an all time high. There's obviously an all time high in terms of demand too, which is offsetting that. But still, there's this incredible pressure on rent. And rents were up nationwide across all sub sectors of multifamily 17% in 2021, and it's close to 6% so far this year. That's just not a sustainable growth pattern because effectively, right now, nearly one in every two households is paying over 30% of their household income to rent, and nearly one in four is paying over 50% of their household income to rent. That's just, again, not a sustainable level. I don't think that means that people are going to move back home and sleep on mom and dad's couch, but it is going to present a problem. Offsetting that, obviously mortgage rates have nearly doubled, if not more. In some markets, almost tripled. So even if you have single family homes selling at 15% to 20% off of where they were last year, it still makes the cost of renting more affordable than the cost of buying. Maybe the risk really in the multi-family space here in the US might be legislative risk. So if we think about this pressure on the average individual. At some point, you may see government regulation in terms of implementation or expansion of rent regulation, which could be a real threat to the multifamily sector. So those are things to keep an eye on. Obviously, not all markets are created equal here in the US, so we're looking at that hyper local focus of location even within sub markets where those properties are attracting tenants and what's driving that demand.

Greg Eudicone: Thanks Nasir. So we spent the first 15 minutes of this panel talking about the risks in the market. So this popular sentiment remains that this is sort of a risk off period where you want core dollars or core euros to deploy. Is that the prevailing sentiment, Valeria? Do you agree with that?

Valeria Falcone: Well, considering that today it's very difficult to price assets, actually in the scenario in which we are where uncertainty is ruling, as we've been hearing from my colleagues, probably the best risk adjusted returns stays in value add today. And there's a number of reasons for this. I will say that, first of all, the price readjustment for value add deals in the months ahead should be quicker and wider, which means buying cheaper, which is always a good start in our job. And then also uncertainty normally brings less competition, we saw that during the pandemic. More off market deals have happened historically in such periods. So this could also translate into more purchasing power and also allowing some time to optimize capital structure. For example, we've been seeing vendor loans or loan passporting getting around the higher cost of new financing, for example. And then at the same time the overall lack of financing itself will shrink future supply and will delay projects, which eventually will result into an even tighter supply in all asset classes. And we have been saying just a few minutes ago that on the other hand, the fundamental, medium to long term fundamental of logistics, of residential, they're still there. And therefore, in a way, you will see that the crisis will just probably exacerbate one aspect, which is that, in general, demand is looking for higher quality asset, higher quality product. And this is for sure a big positive for value add strategies. But I think that in Europe we also have another element, which is playing a big role in value add, and this is that there is a clear request from people to politics to seriously tackle the climate change. And this has resulted into stringent energy consumption regulations which are already in place and that will be in place soon around Europe. So in real estate, this will imply that a big portion of the stock will either be non leaseable or in need of consistent CapEx in order to be repositioned. This is a devastating element in accelerating asset obsolescence, I think. So all this creates incredible opportunities for European manager focus on value creation and ensures that you could, in a way, potentially buy cheaper and then expand, and produce assets with very strong ESG credentials that will respond to the new awareness of the demand in structurally under- supplied markets, which makes a very strong point for value add in future months.

Joe Gorin: Valeria, I'm sure you're having a challenge with this too. In the US, with value add, the challenge is to get to the higher double digit returns, you really need it on a levered basis. And the debt is really challenging. How are you dealing with that?

Valeria Falcone: Well, as I say, we are seeing a repricing. And the truth is that it was quite difficult for us to buy stuff in the months before the summer because pricing was just not in the position we wanted the price to be. So in this respect, we believe that in the next month we will see more room. And actually, it happened the same during the pandemic. Before the pandemic, it was difficult for us to buy. And then as soon the pandemic hit, we had some rebalancing of the market and we could take advantage of it. So we believe this will last longer because there are stronger factors around it. But at the same time, the repricing is definitely something we need. In terms of financing, as I say, we're trying to be more creative in a way. So in times like this, we can try to put to different type of credit structure. But bottom line what we're really, really doing here, we are looking at unlevered deal because we see that the finance in this moment is not a creative for our business plans. So we're concentrating on creating value, looking at unlevered return. And then if we believe that those unlevered returns are in the position of satisfying the interests of our investors, then we go ahead with the transaction. Otherwise, we simply have to drop it. And once again, this lack of financing to me will just have to hit the acquisition price in a way. So again, more to come there. We are not there yet, to be honest with you. But we believe that in the next month, we'll see more and more repricing, which will allow us to transact.

Greg Eudicone: Séverine, are you completely risk off right now?

Séverine Maumy-Laffineur: We are, actually. Well, the difficulty of the core strategy is that whole market is dead at the moment. Clearly, it's dead in Europe. You have no core deals coming through, you have no core investors working. They are all on pause. And when you look back at what happened on the whole market, on the micro market over the last, I would say 10 months or 12 months, all these core investors have seen their portfolios decreasing very significantly with what happened in the fixed income. So the allocation in real estate, as a consequence, has increased very, very, very largely. Currently, which is difficult for us, is that what is the good moment, what is the best moment for us to come back on that core market? We are talking about repricing or yield shifting by, let's say, 50 BPS, 75 BPS in prime yields, whatever in office or logistics. Honestly speaking, we don't know because there is no market. So everything is based on negative sentiment at the moment. And when you have deals coming through the market, and vendors and buyers talking together, the expectation of the vendors are not those of the buyers. So they are not selling, if you are not forced to sell, you don't sell. So we have that difficulty today where potentially we'd like to come back because we have money to invest and we want to invest in properties where we see the good fundamentals. But what is the right pricing at which I'm happy to invest? And the shift in yields I can really see today, is that enough with what I consider will be a good deal on the long term side on the core strategy? So it's very complicated for us. We are mostly buying with equity so we are less careful about the debt even if we do put debt in our portfolios but much lower, of course, leveraged than Valeria. And we are looking exactly at the same way Valeria is looking at ideals. I mean, we are looking at the right fundamentals, we are looking at the unlevered return and all that. But in any case, with the long term view, which is probably better than the value add side, we have a long term view. But still, we are very much focused on what is the best price today to come back on the investment side. And currently, today I must say I don't have the answer because we have too much uncertainty in that market.

Greg Eudicone: Is an opportunistic strategy sort of just a bridge too far right now or is there deep value there for sort of an equity construction project? That could be interesting. Joe.

Joe Gorin: Right at this very moment I think it's a bridge too far. The debt just isn't there. And if we're talking about a really dynamic deal that isn't$ 30 million to$ 50 million. If you're developing, usually you're putting some more equity in. We're an institutional investor so we like to invest in deals that are 75 million and above, and we finance it and we can put$20 million to $ 70 million of equity to work. And those larger deals are just hard to pencil on an unlevered basis. We've bought some smaller deals. So I agree Valeria, on the value add side, you can find some smaller boutique deals and price them to unlevered for value add and opportunistic returns. I do think, and for those who are investors out there watching, it's not going to be regular way, but it could be very interesting over the next two years. And I don't know when that's going to start, but banks are starting to take assets back, especially on the office side. So if you want to find a dynamic value add opportunistic return, don't talk to your commercial broker. Go talk to your bank. Find those discounted purchase options. You might get a financing from seller financing. It's going to have to be a very structured transaction, you're not going to compete for it the way we did even the past 7 to 10 years. We're going back into a distressed investing environment for value add and opportunistic, and I think it could get really interesting, but you're probably going to be dealing more with banks than equity counterparties at this point.

Séverine Maumy-Laffineur: Well, I agree with you, Joe. The thing is that when you have a distressed landlord or lender, and with banks willing to take the asset back, it would probably not be the asset you want to buy.

Joe Gorin: Well, not necessarily. I mean, the equity may not have an ability to invest in it and the lender says, " I'll take the keys back," and is willing to negotiate a structure. I actually like those deals from a fundamental perspective. But to your point, they have to match the location, the ability to create something special. But there's a lot of equity guys out there, if it's a closed end fund that has no more equity to invest, and they can't deal with their bank, and they can't pay down the loan, a lot of those banks aren't in the business that we're in where we have the expertise to actually finish what the previous owner intended to do. They just overpaid for it or they got caught in a timing cycle.

Greg Eudicone: Nasir, can you be risk on from a debt perspective or is there no need to be right now? Just curious your thoughts on risk on, and just relative value throughout the capital stack from a debt perspective. Because it seems consensus is it's a great time to be a lender.

Nasir Alamgir: Yeah, what I would say is, I think debt in general is a risk off strategy, with the exception of distressed debt. So yes, there are different risk styles across real estate debt, from core to opportunistic. A lot of times opportunistic is defined as construction lending or construction mez lending. And there's value across that entire spectrum. If I were to just look at it insularly from a debt perspective, I think there's probably less relative value in core versus those other asset classes. And a lot of that has to do with when you look at where the illiquidity premium is for core lending versus the historical illiquidity premium, it's either at or below that historical norm. Where in the core plus or value add or opportunistic lending spaces, you're looking at levels that are above historical illiquidity premiums. But net net, the coupons are significantly wider than they have been for quite some time. I think what's really unique about the market for us in real estate debt right now is you're seeing a significant increase, not only in base rates, but you're also seeing it in spreads. And that really hasn't happened for three or four decades. So a coupon that might have looked like 2. 75% just nine months ago, is now 6.5% to 7%, and that's across core, core plus. When you're looking at value add and opportunistic, you are looking at unlevered deals. So if you're looking at just a straight balance sheet lending versus a levered lending platform like a debt fund, you're looking at high single digit coupons in either of those spaces. Coupled with that, we're also actually seeing lower leverage, lower loan to values, lower loan to cost loans taking place today because there's that pressure on valuations. We haven't seen enough activity in the acquisition markets, so people don't really know where values are resetting. There has to be some pressure on cap rates because that cost of capital is coming up. And if we think about the impact of a potential recession, whether locally here in the US or globally, that's going to have a toll on valuation. So you're building in that question into your LTVs today, you're seeing a little bit more structure and loans, particularly in floating rate loans around interest rate caps, making sure those are in place because the cost of those caps have significantly risen over the last nine months or so. But at net net, whether it's core or opportunistic, real estate lending is incredibly attractive. My two favorite spaces within that risk spectrum are probably the core plus and opportunistic or construction lending. And that's simply because in the core plus space, you don't have to take a lot of risk. It's usually lease up. You can do it in the safest asset classes like multi- family and industrial, and you're getting paid really attractive coupons. On the opportunistic side, instead of having to do construction mez to generate double digit returns for some of these really large construction loans where there isn't as much liquidity in the market, you can achieve almost that same type of return on an unlevered basis. What's going to be challenging is probably deal flow. So if you think about it historically, acquisition financing is made up anywhere from 40% to 60% of a lender's pipeline. That's nearly gone. And I think that, as Séverine pointed out in Europe, if you're looking at core transactions, non- existent. Here in the US, it's pretty much the same thing. So without that, with the absence of acquisition financing, you're looking at our pipeline being down probably 30% to 35% in 2022. And that's clearly going to be the case for most of 2023. And depending on how hard this lending is, it could trickle into 2024. So that is a little bit of an offset. But I'd also think that there's pressure on lenders across the board. We've seen banks pull back, whether regional, super regional or international. We've seen life insurance companies who are very aggressive in the first half of this year, certainly quiet down in the second half of this year. And we've seen the capital markets almost evaporate. So if you look at CMBS issuance, it's almost negligible. If you look at CRE CLO, it's faced a lot of pressure and it was on the sidelines for many, many months. So again, if you have dry powder, it's a great time to be a lender, but it's probably not a good time to be trying to fill up all of your coffers. You want to pace yourself into this market because there's still a lot of uncertainty there.

Greg Eudicone: Nasir, you mentioned construction lending, which is interesting. How do you feel about inflationary pressure, supply chain issues? To me, I would think that would be a risk there that would be troublesome. Thoughts there?

Nasir Alamgir: Yeah, well we're actually seeing some easing in the supply chain and some flattening of construction costs. So they had been going up fairly significantly. I think the one thing that's really interesting about going into construction lending into a recession is it is a little bit of a contrarian trade. But historically, those assets have performed the best in terms of coming out of a recession. If you think about it, the average duration of a recession is less than two years. The last time it was longer than two years, you have to go back to the depression, here in the United States. So from that vantage point, if most of these construction projects are taking 18 to 24 months to deliver, maybe industrial and multifamily take a little bit less than that. But again, if you look at the supply demand fundamentals, they're generally very attractive. The other thing that you're doing in construction lending is building those projects of the future. I think that's particularly true in office when you look at the world of the haves and have nots in terms of office rents and occupancy rates. The best in class properties that are prepared for a new, whether it's an ESG world or clean technology or efficiency, those are the assets that are going to succeed going forward and those are the assets that you're financing, generally speaking, in the construction lending market. So it's actually a really interesting time, even with inflationary pressure, we're seeing some balance with costs sort of flattening out.

Joe Gorin: I'll just add, Nasir and I work a lot together. We cross pollinate and we share pricing, which really helps both of us. And the development deals that Nasir looks at, I look at and say I'd like to be in his position for the equity inaudible returns. You're getting double digit returns and you're at 65% of the stack. And so I'm not sure I want be the equity. Or the equity may save itself, but it may not get that high teens returns they think they're going to get. But Nasir's position, I'd love to be doing the deals in my equity book that he's doing in his debt book.

Greg Eudicone: That leads me to another question then, Joe. From your purchase, head of portfolio management for the equity side of the house, you can't just sit on your hands. And so we talked about we like value add dollars more than core. Let's put it into practice. What is one of the last deals you've done or liked or actually really underwrote in diligence, sort of get it over the finish line? In this market, where are you allocating, if at all?

Joe Gorin: I tell people, a lot of groups, they say pencils up or pencils down. I would say our pencils are halfway up. So we have to be in the market, we have to be understanding where pricing is. Because there's so much confusion, we've got to have a huge cushion on the enumerator, which are the basic rent assumptions and where you're going to stabilize your income and the denominator, what is it going to cost you at the end of the day, and where are you going to stabilize that? We need a cushion everywhere. So a deal that we actually did recently, we're looking a lot at, and we're a little contrarian, we're investing in tech office and life science, just as Nasir said, buildings of the future, the haves, and we're looking in the best locations. So we recently closed on a life science transaction that has two buildings, and we ended up pricing it in a process at a number close to$ 70 million. And it was a public REIT as a seller. They said our number was about$ 10 million to$ 15 million too light. We dropped the deal, we called them a few weeks later because we knew that they were trying to release some news at their September 30th earnings report. So we sensed there might be some price disruption. So we called the seller back, said, " If we sprint to the finish line and we get this deal done by the end of the quarter, will you sell it to us?" And they said, " Well okay, did you move your number up?" And we said, " No, we actually moved it down another 15 million from where we were." So now we're about$ 30 million lower than their ask price. And they said, " Okay, we'll sell it to you." And it was a great life science conversion play in the heart of Cambridge. And so we had a huge cushion on the numerator, huge cushion on the denominator and we took advantage of this price disruption, the devaluation of the public REIT markets, and the news that they need to raise currency in their markets. So nothing we do is going to be regular way now. It's going to be from, I wouldn't call this company a distressed REIT, but their currency doesn't work for this asset right now, and ours does. So that was a recent deal that we did.

Greg Eudicone: Valeria, what about from your perspective, a recent deal?

Valeria Falcone: Well, the last deal we closed or my strategies, basically, I had to look back at the beginning of 2022. And those deals were agreed probably let's say a few months earlier, so in 2021. We were seeing the market moving and therefore was very difficult for us to accept the asking prices. So once again, I am more positive going forward. We have recently looked at deals from UK pension funds for example. UK have also faced a lot of turbulence in the last month, and therefore trying to approach this pension fund that we are in the position to sell assets. The truth is that we have not reached the value that we want to reach, but nevertheless, we always discuss with the team internally. We have a long pipeline still live there, and we're not killing it because we see that sellers are becoming more and more reasonable, so to say. So we think that there could be two directions in which we are going to move. One direction actually has got a lot to deal with the fact that in Europe alternative lenders are less, let's say, present compared to, for example, US or UK. And therefore, the play that Nasir was mentioning before sometimes is made by value add players, and therefore we think that there are going to be opportunities to partner with developers. Up until a few months ago they didn't need us because they could go with banks. They don't go with alternative lenders or there's not enough alternative lenders out there to take them down the line, therefore we enter into the game, still manage to do some preferred equities or sort of deal. We believe that that's going to be one of the areas in which we will succeed. And then the other area is basically what also Joe has mentioned. So buying from people that are in need to sell for whatever reason. But also, most importantly, taking advantage of what I said before. And so thinking that, for example, if you buy an under- rented asset that you can hold for a couple of years, then you can actually start improving the credentials of this building, repositioning this building in some months ahead, and also taking advantage of the inflation in a way of the existing leasing. So therefore, I think these will be the two areas in which we will move. But the truth is that we don't see a complete repricing yet. Not to the point that we like, but we believe that it will happen.

Greg Eudicone: Thanks Valeria. Séverine.

Séverine Maumy-Laffineur: Well, for the core strategy in Europe, the last deal we closed is a portfolio of four, inaudible markets in France. One south of Paris, one close to Swiss border and two on the east of the country. This is a seller lease back, 12 year lease with a local, not local brand, but family group, quite sustainable, very good covenant. So this is offering very stable and long cash flow for the next 12 years. What we like in the deal that's probably pretty core for the very beginning of the lease, but we expect to have asset management opportunities at middle term because, as you know, the model of a hyper market is moving a bit since the last years. But this is what we like because we have the opportunity, potentially, in case they downsize to completely review the format of the hyper market and to potentially add more value on the other part of the hyper market that might be vacated because we are buying at 25% below the ERV for hyper market. Potentially much higher in case we can install some other kind of retail. But what we like in that deal also is that we were buying at a very low capital value, which is almost at replacement cost, if not below replacement cost. So very, I would say, very securing over the time. What we like also is that we have this kind of asset management opportunities over the time. But also, overall, we are buying inland. And during the discussion we had with the vendor, we secured the deal at the beginning of the year, and we had the opportunity to reprice the deal during summer, but we tried to do quite a clever renegotiation in not only downsizing, repricing the existing portfolio but also adding some land on what we initially bought so that in case tomorrow we want to do something else on that land, we are completely free to do it without potentially renegotiating again with the guys. We wanted to keep a little bit off land around that. So this is the last deal we closed. But months before, we also closed quite a big logistic deal in Sweden, north of Stockholm, which is a former printing asset, which has become, over time, not only a printing asset but also last mile logistic and also a data center. What we like in that asset is the diversification around this asset, different typology of use, but also the fact that we have the possibility over time to expand some of these tenants not only on the logistics side but also on the data center side. So negotiating with existing tenants to increase and extend their lease on additional areas, but also part of the land on which we can build some other potentially new logistics, standalone logistics or data center. This area is one of the favorite areas of the municipality of Stockholm to increase the power of energy, so this is why the data center is there. And this is what we can potentially increase the footprint of the data center. And on top of that, for the logistics side, this is also a crucial area because we are going to increase all the road transport around that area by creating a bypass between city of Stockholm and that area. So what we like in our strategy is not by pure core asset, we need to have an end goal of what we buy in terms of asset management to potentially increase the value of this asset over the time. And this is why we always have an angle, but also long term view on our asset.

Greg Eudicone: Really interesting, Séverine. Thank you. And from the enviable position, Nasir, from the debt side, I was just curious, a recent deal you might have closed.

Nasir Alamgir: Yeah, I think what we've tried to do is we've certainly tried to take maybe a little bit of a contrarian view when putting money to work. And what I mean by that is, in May of last year, still somewhat in the throes of the pandemic, there was a lot of uncertainty around office, which still exists today. But we realized that not all markets, not all assets were created equal. And one of the best performing office sub markets in the country at the time was Burbank, California. Which again, maybe intuitively didn't make sense. I mean, Hollywood was shut down, the movie production sites were shut down, there wasn't a lot of activity, but it actually had lowering vacancy rates and increasing rents during the pandemic. It was one of the few markets in the entire country that was doing that. And that's mostly driven by the fact that when you looked at the expansion in that media space, so when you look at the expansion of Apple and Hulu and Netflix and Amazon Prime, all of these other content providers, they were going to this market because it had a niche, it had an expertise, it had the talent that was needed for all of these firms. And it's a fairly infill location. So you'd have some natural barriers to entry because there isn't that much you could build. You could redevelop the location, but you couldn't necessarily build a lot of space. We had the opportunity to finance an acquisition of a property. It was right across the street from where one of the major studios was building a new campus. The property had just lost a fairly sizable tenant, and there was some pressure on the rent roll in terms of the existing tenancy not coming in, potentially being impacted by the pandemic, potentially losing more tenants. So the building had been high 80% occupied. By the time we financed it, it was 77%, and it quickly actually went down to just under 50% occupancy. But within six months, they had leased it back up to 91%. And then there's an LOI to one of the aforementioned big names moving into the market that is potentially taking the balance of that space and bringing the property up to 100% occupancy, and that's all within 18 months. So again, when we can provide financing that's thematic and consistent with what we're seeing on boots on the ground, that hyper- local focus as to how some of these markets or some of these assets can outperform the broader market, it makes a lot of sense to us. Where others might see risk, we see great relative value. And that was a win for our fund.

Greg Eudicone: Throughout this chat today, everyone sort of picked up on sort of office. And it strikes me as possibly some opportunity there. Maybe Joe, it seems to be a winner takes all market. From your perspective, what are going to be the winners and losers of office, not just markets but physical attributes?

Joe Gorin: Everybody talks about the haves and have nots, and what are they, and how is office going to perform? And it's really important today to look at leading indicators to figure out where those haves and have nots may be. We look at two really important fundamentals. One is card swipes. So what's the physical occupancy, not just the leased occupancy of an asset? But also sub- leasing availabilities. What tenants are looking at downsizing within buildings who still have lease maturities? The challenge with the office sector right now is the pandemic happened a couple of years ago. Leases in office buildings go 3, 5, 7, 10, 15 years, and not all these tenants are failing. So it's going to take them time to work through their occupancy needs, which is the frustration that a lot of office landlords have right now. They want the answer. Where's the stabilized occupancy? It's pretty daunting right now. If you look at the US, the highest sublease availability rate we ever had over the period we've been collecting data was the second quarter of 2009, the previous highest point was the second quarter of 2009 when subleasing availabilities were 143 million square feet. Today office sublease availabilities are 220 million square feet. So that's a daunting number. It tells you that there's more pain ahead for the office sector. So we're very focused. And to Nasir's point, we used to talk about market level rates for rents. What's the office rent in Boston, New York? I've been doing this for 30 years. It was always a market level rent. Now people are starting to talk about asset level rents. If you have the right asset in a location, and not just the location, the location is important, but the physical elements. What are the physical elements, you asked, Greg? It's the soul and character of a building. It's a building that you walk into that you want to work in, you almost want to live in it, you want to play in it, you want to attract.

Greg Eudicone: You want to do science in it. You want to do science experiments.

Joe Gorin: Well, science is easy. The life science, you're not going to replicate life science at home. So that's why we like the life science area. But these tech buildings, the decisions to be in these buildings are made less by the CEO and more by the HR department, because you have to be able to attract an employee to come into the office, not just to come into the office, but to want to work at your company. The unemployment rate for the skilled office worker is under 2% right now. It's probably under 1%. And so you're really trying to steal talent in these buildings. And if the employer sees the value in that building that you've created the right way, you've either redeveloped it, you bought it the right way, it's in the right location, the rent for that building can be 100% to 200% higher than the building across the street that doesn't fit that requirement. We all know, we didn't do it, but SL Green built One Vanderbilt. They're signing leases at$ 300 a foot in One Vanderbilt. There are plenty of buildings in Manhattan nearby that are having trouble leasing at$ 40 to$50 per square foot gross. It's new, it's modern, it's attractive. Yes, it's higher quality than a lot of these other buildings. But even some of the high quality buildings that don't have the amenities, the higher floor to ceiling, the light exposure, the amenities, the rooftop decks, the conference centers within the buildings, not just a fitness center but a real gym, a gym that you want to go to, like a Lifetime Fitness or an Equinox. So these office buildings really have to be amenitized right, in the right physical product. But we believe this bifurcation between the have and have nots will continue to grow. And there's real value in the haves, and I think that value will continue to grow into the future.

Greg Eudicone: Thanks, Joe. Let's wrap up the 2023 outlook with maybe a little bit of a game. Let's pitch each other our best ideas for next year, one to two minutes, can't vote for yourself, I'm going to vote too, and see where we'd like to put capital next year. Valeria, do you want to kick us off?

Valeria Falcone: Yeah, as I said before, I think that we're going to see a lot of discount pricing probably in land, and therefore partner with developers on buildable land in strategic locations in the major European cities where we can take advantage of entry at cost level, and having great opportunity to create demand driven products on the back of what Joe has just said is exactly what's happening in Europe. You just need to have the best product, you just need to have the right product and then you will attract tenants. And the big changes in the dynamics of the demand are actually telling us that this is the way to go forward.

Greg Eudicone: Séverine, how about you next?

Séverine Maumy-Laffineur: Yeah, I'm not sure I have the right answer in the current market. But I really still believe in the diversification in terms of jurisdiction, in terms of asset. And in any case, we have to play the cycle. So I'm not sure there is the right strategy in buying this kind of asset in these kind of countries. I think that, in my view, we need to be purely opportunistic. If we do see the right deals, the right asset at the right location, as Joe said, for example, on the office side. And we do think it's the right pricing, we need to go. And this is why it's crucial to have the team on the ground to make sure that we are monitoring very closely this market. And when we do think it's time, then it's time. We have to believe in our expertise, we have to believe in our experience. And above all, I think we'll have to be brave because we will have to be brave in 2023.

Greg Eudicone: Somebody who I know is brave, Nasir, how about you?

Nasir Alamgir: Well, I already sang the praises of construction lending, so I'm going to actually pick something else besides that, because I'm pretty sure that would win if I proposed construction lending. But outside of construction lending, I actually really like the hotel space, believe it or not. Typically, hotels can be very susceptible to recessions. And depending on your views on recessions, you could take a pause in terms of wanting to invest in hotel assets. But if you look at some of the statistics that are in the market today, you've seen ADR lead this recovery, right? And if you look at the past two or three major recessions, that's historically been the case. But what we've seen is ADR recovery at a much faster clip than either the GSC or the dotcom bust or further back you go. The other thing that's actually somewhat attractive, and again, it might be counterintuitive, is occupancy rates are probably going to take longer to recover. A lot of that has to do with some of the constraints around staffing for hotels. So it's really hard to fill back of the house, even front of the house jobs at hotels. The average number of open positions per hotel, it's 57% higher than what it was at pre pandemic levels. That just means you're going to have a natural constraint in terms of available rooms because you can't service those rooms, again, allowing you to push sort of ADR. The ability to reset rents at hotels, right? You can capture that inflation in the ability and pass that cost through. So if you look at the correlation between ADRs and CPI, it's almost 97%. So again, with this persistent inflation, if you believe it's going to be there, you're going to be able to continue to push ADRs. RevPAR penetration for resorts, we've all known sort of drive to leisure destinations have been outperforming for several years now. It's 127% above pre pandemic levels. But you're seeing it now in the luxury space and the upper upscale space, in the upscale space, so it's really across the board. And travel is back. TSA throughputs are in excess of 90% of pre pandemic levels. And across the globe, travel is back. People are getting back into that travel mode. So I think the hospitality sector, the hotel sector could be a really, really interesting space to deploy money. Again, the only place within hospitality I'd be cautious about is group. Large group settings and convention center hotels are still slow, but they are recovering. But again, I think there are plenty of spots to pick within hospitality with your capital, whether it's equity or debt.

Greg Eudicone: Joe, you buying hotels or you have a different idea?

Joe Gorin: I think this year just beat me again. I'm going to ask you, maybe we can split this between debt and equity and you can pick a winner on both just in case you don't pick me. So look, I like what Nasir said. I actually like, it's a bit contrarian, I like retail. I've talked about what we're looking at for our value add strategies. But retail's kind of interesting, experiential retail especially. People are still flocking back into retail. Retail sales have been improving. If we go into a recession, they may stabilize or come down. But you've also seen in a lot of these centers in the beginning of the pandemic, and even going back to the impact of e- commerce, there were a lot of leases signed at really low rates. And now you're starting to see people come back, and these really low rents are going to mark to market at an interesting level. So a lot of these opportunities you'll find, if you look at the rent rolls of the inline stores, especially around these grocery anchored tenants, or even the experiential centers, you've got some real interesting mark to market opportunities out in two or three years. And you can buy retail at a much higher cap rate than almost any other product type. So I think that the risk/ reward premium in retail is pretty attractive right now, and it might even get more attractive as we move forward.

Greg Eudicone: By the power of vested in me as a moderator of this panel, I think we're not going to vote because those are all unique ideas. I like them. So we're just going to leave our listeners with interesting ideas to take into 2023. So I think we'll leave it at that. Thank you all for joining us today. Grateful for your attendance. And thank you to my panelists. It was a pleasure. If you'd like to get in touch with anyone on this panel, please reach out to your Barings contact or us directly, we'd always be happy to have a conversation. And we want to thank you for your continued partnership. And have a very safe and happy holiday season. Thanks so much.

Greg Campion: Thanks for listening to episode number seven of season seven of Streaming Income. If you'd like to stay up to date on our latest thoughts on asset classes, ranging from high yield and private credit to real estate and emerging markets, make sure to follow us and leave a review on your favorite podcast platform. We're on Apple Podcasts, Spotify, Google Podcasts, YouTube, and more. We publish a new episode every other week. And if you have specific feedback, you can email us at podcast @ barings. com. That's podcast @ B- A- R- I- N- G- S. com. Thanks again for listening, and see you next time.