Photography by Keith Barraclough
It is an unusual, perhaps unprecedented, time for the global commercial real estate market. As it navigates through the end of a once-in-a-lifetime crisis, the covid-19 pandemic, the industry is now bracing for what could be a period of generational volatility stemming from steep inflation, quickly rising interest rates, and the impact of the war in Ukraine.
For Jonathan Pollack, senior managing director and head of the Structured Finance Group at New York-based mega-manager Blackstone, there is a rational way to adapt to the current situation. In an interview with affiliate title Real Estate Capital USA in early June, Pollack laid out a strategy fueled by data-driven pragmatism, conservative leverage, and an understanding that the commercial real estate market of tomorrow will be substantially different than what it is today.
On June 11, the US government reported an 8.6 percent year-on-year increase in consumer prices in May – a 40-year high. And on June 15, the Federal Open Markets Committee raised interest rates by 75 basis points – the largest increase to the Federal Funds Rate since 1994 – and raised the prospect of a similar increase at its next meeting. But there are more factors to consider than just looking at the numbers, Pollack says.
“In normal times, 8 percent inflation would be the dominant headline for an entire year. But at this moment, there’s much more than that going on in the world, including the war in Ukraine, which is not only a humanitarian crisis, but also has broader impacts around the world,” Pollack says. “Now, you also have the fight against inflation, the pullback of excess liquidity following the pandemic, and central banks from around the world – including the Federal Reserve – are raising rates and shrinking their balance sheets. All of these have real-world impacts on individuals and businesses, and contribute to a great deal of volatility and uncertainty in the marketplace.”
Blackstone’s investment strategy, particularly in its real estate debt business, is informed by a few key principles, a broadly conservative approach and analysis of data from its $550 billion real estate equity portfolio. As an institutional manager, Blackstone’s primary focus is on the preservation of capital, Pollack says.
“That is job number one, and in order for us to achieve that, we have to believe that the value of the real estate will grow, and this has to do with the modernization of purpose,” Pollack says. “Being a transitional lender was very valuable coming out of the financial crisis, but it was also where our capital sources wanted us to be focused – that is still a very important part of our DNA.”
The firm’s lending process is driven in part by data and analysis gleaned from its $550 billion equity portfolio.
“We can talk about real estate fundamentals because we have the benefit of being a part of the largest owner of commercial real estate in the world,” Pollack says. “We have access to tremendous data, and incredible asset management and portfolio management teams that provide data to our investment team in real time so that we can make decisions about new investments, as well as [for] our existing portfolio. We are driven by where we see growth, where we see supply challenges, and we build our portfolio with those factors in mind.”
Having that kind of information to hand gives Blackstone an edge, particularly given the firm’s approach of taking very conservative views of the attachment point of loans, argues Pollack.
“That helps us run that conservative attachment point playbook in lending or in securities, where we have a very big presence in commercial, as well as residential, mortgage-backed securities,” Pollack says. “We’re consistently looking at the instrument and underlying real estate and asking, ‘Are we at a comfortable attachment point?’”
Historically, in both Blackstone Mortgage Trust (BXMT), the firm’s senior loan-focused mortgage real estate investment trust, and the real estate debt platform, average loan-to-value ratios have been in the mid-60 percent range.
“There’s a lot of equity cushion,” Pollack says. “I’d say that this is also a product of the world since the financial crisis, because, at the time, one of the biggest challenges our sector faced was excess leverage. Since then, both lenders and the equity investors have done a better job staying away from that.”
The firm is a floating-rate investor in almost all the investments it makes across its strategies. “We do not have exposure to the interest-rate volatility that the market has experienced in recent months. Looking ahead, we feel we are positioned to benefit on the return side as central banks have raised base rates, trying to slow growth and inflation,” he says.
As an investment company, Blackstone has been focused on what it believes are fundamental drivers of growth, and the firm’s real estate equity and debt businesses are no exception.
“We own a lot of industrial, multifamily, life sciences, office and hospitality [properties]. That is because fundamentals in those areas are strong and you can experience growth that is supportive of the long-term value of the asset, notwithstanding the inflationary environment. Being in markets where people are moving, populations are expanding, businesses are hiring – that all drives fundamental strength underlying those types of real estate assets,” Pollack says.
“The transition and the improvement of real estate is one of the most fun parts of what we do. Being a part of that process in different markets and seeing the creativity that goes into it is exciting. There is always some reason for real estate to be in transformation mode – today it feels specifically substantial.”
Building a career
Pollack credits three key points as vital to his experience that are key to how he runs Blackstone’s structured finance business: taking a role on Deutsche Bank’s CMBS trading desk in 1999, helping the bank launch and build its European business a few years later, and the international experience gained by working in London.
“About two years after I started my career, I got the opportunity to move to the CMBS trading desk [at Deutsche Bank] where we were trading bonds, pricing loans for securitization and doing syndications,” Pollack says. “I worked with sales teams and our trading counterparties, and I traded bonds on my own. Being thrown into that at such a young age – with especially good guidance and mentorship – really forces you to think independently and commercially.”
“We’re consistently looking at the instrument and underlying real estate and asking, ‘Are we at a comfortable attachment point?’”
The context of Pollack’s earlier experiences gave rise in part to how the team at Blackstone is bringing along the rising generation of lenders. “Hopefully, the experience of working at Blackstone includes that type of education, because for me, that experience throughout the earlier part of my career was foundational. It can be easy in a big organization to let the organization make decisions and just go along for the ride – and my experience was not that. We strive to not let that happen here at Blackstone, either,” Pollack adds.
Pollack got the opportunity to further hone his ability to think independently 18 months after he joined Deutsche Bank, when he moved to London to help the bank launch and grow its CMBS lending business. Pollack was the associate-level person in New York dedicated to that effort, moving abroad to work with new senior leadership that had been tapped to build the business.
“We went from two or three people on day one to about a hundred people by year five. I was able to see that growth unfold from the front lines and help build that business and manage others,” Pollack says. “Getting that chance at a relatively young age, seeing it happen from the beginning, was an incredible opportunity to learn. It opened my eyes to how you go about building a business and how to think about all the various factors that come into play during that type of growth, from risk management, personnel, and infrastructure of the team – all things that need to be done well to build a lasting business.”
The experience of working in London was invaluable to Pollack, who is now based in New York. “There is no substitute for putting your feet on the ground somewhere else for an extended period of time and learning how to adapt to different cultures, learning how to transact in a new market. It broadens your thinking and gives you the tools needed to operate in all different environments,” Pollack says. “London is connected to so many different places and it was a wonderful place to be. While living and working there, I developed great relationships that I still rely on today and it also gave me valuable perspective as we have built out our European team.”
Pollack brought out this toolkit when he joined Blackstone in 2015 as its global head of real estate debt and used it to expand the firm’s business in Europe. “It was important for us to bring those things to bear every single day, thinking commercially and with an international perspective. Fortunately, we built a very big business in Europe,” Pollack says.
Pollack cites Michael Nash, the co-founder and chairman of Blackstone Real Estate Debt Strategies, and Jon Gray, president and chief operating officer of Blackstone, as key mentors when he joined the business. The senior management team now includes Tim Johnson, who stepped into Pollack’s shoes as the global head of real estate debt (when Pollack became global head of the Structured Finance Group); Katie Keenan, the chief executive of Blackstone Mortgage Trust; Mike Wiebolt, who manages the real estate group’s liquid securities activities; and Steve Plavin, a senior managing director who heads the firm’s European real estate debt business. This team, Pollack says, has been key to the ability to grow assets significantly over the past eight years.
“Together, we were able to expand this business from $9 billion in AUM to north of $50 billion today,” Pollack says. “We ask the questions, ‘What are the organizational structures? What will the future look like, and how do we get there responsibly? How do we expand at scale?’”
Pollack and the rest of the senior managers at Blackstone are now working to mentor the next generation.
“The young people who join our organization learn how to be investors, learn how to think for themselves so that when they come to the conference table to present a deal, they’re not just reporting on it and looking to the senior people around the table to make a decision about it. They’re making the case, and that is very valuable.”
One of the benefits of having a real estate equity portfolio of Blackstone’s scale is the ability to dig into data on a real-time basis. For commercial real estate, historically a backward-looking industry in terms of data and analysis, being able to do this is a game-changer, argues Pollack.
“There is rarely a property we look at financing where we don’t have a view on that property from the equity side, whether it’s because we own something else in the market nearby, where we have real-time leasing data, or we maybe have even owned those assets in the past. I think that is a scale that is not rivaled and is a big benefit to us. If you’re trying to be a lender and keep yourself out of trouble, there is nothing better than that,” Pollack says. “We haven’t had a realized loss in our lending portfolio.”
Part of the reason why the firm has been able to build such a large business is there is a bigger ecosystem of work in which the firm has multiple touch points with clients on the debt and equity side.
“We’ve created an ecosystem for the counterparties in the marketplace and the people we lend money to,” Pollack says. “They’re buying real estate from us, we’re selling real estate to them. There is a broader ecosystem that evolves where those relationships really matter on a lot of different fronts. And with our scale, we are able to find different ways we can be supportive to those borrowers, including, for example, at the basic level of procurement. We have been able to build a strong business because we are a performing loan provider and we’re not in the business of trying to foreclose on a borrower.”
As a floating-rate lender, Blackstone is able to participate on the upside as rates rise.
“Normally when rates are rising, fixed-income investors don’t get to experience wider spreads as well. That is because when base rates are higher, total returns are therefore higher. Spreads tend to tighten and offset that impact and right now because of the volatility from all of those forces in the world, spreads are wider,” Pollack says. “Especially in our securities business, we have been able to buy safe bonds, and we’ve migrated up the capital structure to be focused closer to the investment-grade part of it, where we are picking up not only the base rate increases, but the wider spreads.”
Across the return spectrum, the firm is lending at a time when real estate debt has really become an institutional investment class. In the higher-yielding end of things, there was a breaking-in period for institutional investors to identify how real estate debt’s return and risk profiles made the strategy a place they wanted to allocate their portfolio.
“We have experienced the flywheel effect from that. We have our high-yield platform that we have managed from day one, but it’s not the only thing we do anymore. Managing BXMT, a publicly traded REIT that invests in senior mortgage loans that are almost exclusively floating-rate, opens us up to a different part of the lending market, with different spreads and different types of borrowers,” Pollack adds.
And over the years, the firm has also become a large-scale manager of insurance company capital, another more historically classic investor in real estate debt. “The impact on our business has been positive from having the toolkit to address the market for each of these things – making 10-year, fixed-rate loans on stabilized properties, buying 10-year fixed-rate CMBS at the single-A level,” Pollack says.
The insurance business gives the firm another way to engage with its borrower base. “We have more than 500 borrowers that we’ve done business with, and we are able to address their construction loan, transitional financing, bridge loan and stabilized needs. Each of those gives us another touchpoint with the market and also helps us see more opportunities, which gives us more flexibility. Conversely, it also gives us more of a scope into what’s working in the market and what’s not – and that allows us to steer away from certain things,” he says.
Navigating a post-covid world
The firm was one of the early re-entrants in the market, working to get its teams back to the office in September 2020 after the initial easing of covid restrictions.
“A lot of the normal baseline activities around investing, including traveling to see properties, are so important to our business,” Pollack says. “I think one of the things we found culturally was that it was great for our team to get back to a rhythm instead of just being stuck at home.”
Lending snapshot: 799 Broadway
BXMT originated a roughly $270 million loan to refinance debt on 799 Broadway, a newly constructed trophy office building in New York, on behalf of Columbia Property Trust.
The LEED Gold-certified property fit the mortgage REIT’s lending profile given its high quality, abundant light and great air – all factors that are proving attractive to tenants in a post-covid world.
The building also has floor-to-ceiling glass windows and 15-foot ceiling heights, 17,000 square feet of outdoor space, including private terraces on almost every floor, and a courtyard garden off the main lobby, Pollack notes.
Trying to execute the firm’s business plan was challenging in a virtual environment. “Trying to extrapolate our understanding of a property through Google Maps and photos is very difficult. Walking a building is very helpful – you experience the quality, the age, you see the vision and understand the building in the context of the market. There is no replacement for that,” Pollack says.
While there will always be individuals who prefer the work from home environment, there are drawbacks. “People appreciate coming to the office with a positive culture and environment and the opportunity to learn in person,” Pollack argues. “That is difficult to replicate. For us, it’s looking over someone’s shoulder to see how they model something in excel or how they talk about an investment in a room together – there is just no substitute for that.”
In terms of bringing up talent, this interaction is critical. “We’re trying to teach our team members to think like an investor and be able to present a case for a deal, both in writing and in person. We want our people from a very young age to sit at a conference table with the most senior people and explain why they think something is a good idea, and be engaged in that debate and learn how to hold the table. It is a very important part of training, and you can’t do that as well when it is virtual,” Pollack says.
Zoom can be democratic in the sense that it levels the playing field for everyone on the screen, allows people to call in when they need to be out of the office, and although Pollack believes it provides value, it is not the same as in-person interaction.
“Video conferencing is very valuable to the business. But having a positive culture, where people feel like they can be their most positive, creative self, is critical. If you can’t feel like you’re having fun, or there isn’t a good interpersonal dynamic, then you’re not exercising your full brain or capacity. It’s not just a strategic thing – it has a positive impact on the way the team functions and, as we grow, maintaining a positive culture is super important,” Pollack says.
The next mountain
After interest rates, the next summit for the commercial real estate market, particularly in the US, will be implementing ESG principles in bricks and mortar portfolios. But the task seems less daunting than it might have been a few years ago.
“ESG has been an integral part of how we think about investing, and has been for a long time. The opportunity and some of the challenges associated with the environmental impact is that the tools for measuring impact are evolving and they’re only just getting better,” Pollack says. “We ask, ‘What are the standards to which to hold an office building or an apartment building? What sorts of improvements can be made? What are the costs?’ These things are becoming more transparent and integral to how people invest in real estate.”
For Pollack and Blackstone, it’s not just a question of doing the right thing because it is green. “It is fundamentally impacting the value of the real estate, the demand tenants have to be there, the demand lenders have to lend on it and investors have to capitalize on it. We’re trying to do things to further impact what we can as a lender – we don’t own the real estate, but it is an important part of how we underwrite how we do things,” Pollack says.
The firm works with its borrowers to communicate the message about what it is trying to do with the asset class. This includes a major focus on the use of renewable energy, Pollack adds.
Diversity of the team’s staff is also important. Firmwide, 49 percent of Blackstone’s 2021 US analyst class is racially diverse. Additionally, Katie Keenan, the CEO of BXMT, leads a diverse board for the company.
“We are also very much focused on diversity, within our firm as well as with our business partners. Blackstone’s targets on board diversity for our portfolio companies on the equity side, as well as our programs designed to create career opportunities with communities, are initiatives we share with our counterparties. We’ve made progress, but we know we have a lot of work still to do,” Pollack says.
Bigger picture, there is great awareness at the firm of both the here and now, as well as the future.
“As a lender we’re trying to introduce our borrowers to the different things we’re doing and help them think about those opportunities for the real estate they own,” Pollack says.