Blackstone Inc. (NYSE:BX) Goldman Sachs 2022 US Financial Services Conference Call December 7, 2022 12:20 PM ET
Company Participants
Steve Schwarzman – Chairman and Chief Executive Officer
Conference Call Participants
Alex Blostein – Goldman Sachs
Alex Blostein
Alright. Well, thanks, everybody. We are going to get started with our next session. It is my pleasure to welcome Steve Schwarzman, Chairman and CEO of Blackstone. With $950 billion in assets under management, Blackstone remains the largest and one of the best in the world. While macro environment has clearly become more challenging, Blackstone continues to deliver very strong results in 2022 including $180 billion of capital raised so far this year and over 30% growth in distributable earnings per share for the first 9 months of the year. With lots of macro uncertainty, we obviously look forward to getting Steve’s perspective and his insights into private markets and the economy broadly. So, it’s always great to see you. Thank you for doing the conference. Thanks for being here.
Steve Schwarzman
My pleasure.
Question-and-Answer Session
Q – Alex Blostein
So I want to kick it off with a bit of a minor question. Blackstone clearly has a very deep breadth across investment capabilities around the world. Why don’t we start with the macro question on the outlook for the economy for 2023?
Steve Schwarzman
Sure. Well, we have a pretty wide footprint. We have 250 companies in private equity, 600,000 employees, and that’s global, the largest real estate business in the world. And so we get to see a lot of things in a lot of countries. And one of the things of course that characterizes the world now is high levels of inflation in the developed world and central banks all raising their interest rates to slow their economies. And U.S. has been quite aggressive, as you know, from living here and that’s starting to impact the economy. I think the way business people think about it is if they are serious about 2%, that’s a tough place to get and that needs a lot of aggressive interest rate increases. If you are prepared to go to something like 3% to 4%, that’s different than 2% and that’s a lot easier and you can have a more moderate slowdown. So, most people are prepared for something lower. We are seeing consumers who have huge amounts of money after the pandemic mostly from staying home and they didn’t have a [Technical Difficulty] they didn’t have to buy clothes, they didn’t go out to meals, go to movies drive any place. So they have a lot of income.
We felt that Jamie Dimon said they have an extra $3.5 trillion and they are spending that money. It’s starting to get spent down, but it still exists. So that will give you, in the United States, at least sort of more growth than you might think for a while until those consumers start really feeling the pinch and that will put more pressure on the Fed. It just makes companies themselves more conservative. You are starting to see inflation moderate, certainly in the construction areas, commodities, that’s all starting to happen. Housing starts are down 19%. Just to give you a sense, in the normal recession, housing construction has gone down on average 35%. So that can tell you almost where you are in this situation.
Alex Blostein
Great. Let’s take this conversation to a little closer to home and talk about private markets. Obviously, it’s been one of the fastest growth areas within financial services for many years. There are many structural reasons for that as we all know. But record low rates over the last decade have definitely amplified a lot of these tailwinds. So one of the questions that we are grappling with is how this higher rate environment structural changed or evolved any allocation toward private markets, not because of the capital deployment ability, but really because now there is an alternative in liquid fixed income and does that pressure how institutions think about their allocations to private markets?
Steve Schwarzman
I think the answer is not much. It will lead to some shifts with more allocation within private markets to credit. Right now, for example, we can create in our BCRED product a 10% yield on that product. If you were to leverage that, not recommending that, I am saying if you did, you can get it to 13% to 15%, which is on senior debt that’s like a real equity return. Interestingly, credit is getting more flows, but other asset classes are also getting flows. The United States is the only difficult allocator right now, because the pension fund system did so well with private equity and other alternatives that they accidentally became over-allocated. So it’s harder for them to put money out. But outside the United States, where we are very active on whether it’s the Middle East or Asia, there are very large amounts of money that are looking for private equity. We raised just as for example, $183 billion, excuse me, in 9 months. For me, that is an out-of-body experience. I remember when we started the firm, somebody gave us $5 million or $10 million, I thought that was one of the most successful days of my whole life, raising $183 billion in 9 months tells you that the private markets and the people allocating to it around the world are alive and well.
Alex Blostein
Let’s dig into this a little bit more. You mentioned the challenges in the U.S. market with respect to private equity, again, that’s the theme that we have been kind of hearing about over the course of the year. The denominator effect that exists in the U.S. really doesn’t seem to impact other regions so far. Is that sustainable or do you think it is a matter of time where the denominator expectations will sort of catch up to other asset classes as well?
Steve Schwarzman
No, no. I think what happened historically in the U.S., we are the first people doing alternative investing in all these other geographic areas were much later. And so the U.S. has higher allocations and they have selected good managers and the returns over the last year or two have been so strong that they just find themselves mechanically, if you will, out of outlook [ph]. And so that’s made it harder for managers to be – for private equity, in particular, though for a firm like ours, that’s truly international. The foreign groups in the Middle East and Asia have plenty of [indiscernible]. And they are also very anxious to do co-investments to put even more money out beyond what they give you. So they have become very significant investors. And so it’s a regional problem rather than a global problem.
Alex Blostein
Got it. Why don’t we pivot a little bit? Let’s spend some time on the private wealth business. Clearly, it’s been a big focus over the last couple of weeks, last couple of months. It’s been a huge success for Blackstone over the years. You have over [indiscernible] billion of private wealth asset under management, recently flows in the area have become more challenging with the acceleration of redemptions out of BREIT in October, November? So, couple of questions around that. I guess, one, I was hoping you could share the feedback you are getting from your distribution partners as far as why are we seeing accelerating redemptions, the outlook for private wealth into 2023, so a bit of a near-term backdrop. But also when you take a bigger step back, to what extent do you think this could be a setback for the ambitions you have in private wealth and the kind of the vision of that part of the business for Blackstone longer term?
Steve Schwarzman
Well, thanks for the question. Alex, just to talk about private wealth, we started in this area 12 years ago, somebody from the firm came to me and said we want to start a sales service business. So as we sell products to the private wealth channel, we will be able to be as professional as possible. It was the first time I ever made a decision to voluntarily lose $10 million a year, because this was like a new concept. I didn’t see what the revenue would be, but providing first class service, I thought, was a good idea. But we now have over 300 people doing that. It’s become a big part and a good part of our business. And the reason is that the private wealth market has $80 trillion of money and very little of it is allocated to alternative assets.
When I started raising money for institutional capital, institutions probably had something like maybe 3% in alternative assets that was in the mid-80s. And they now have an average of 25%. It’s 8x growth something like that. Some of them get up to 50%. And the ones, the most allocations we tend to have the best performance. So we looked at private wealth area and said $80 trillion is basically almost nothing that they are doing. Why did they deserve inferior returns to what the institutions are getting? So we decided to make a major push in that area and deliver institutional type product to the private wealth channels. And that’s been enormously successful, whether it’s $230 million that we have so far. But what we have been trying to do in 2016 is do a special product in our real estate area, where we have enormous success and adapt that for private wealth. So what we did is we did a non-trade degree and we constructed it so that it would prosper in a variety of different environments. And we put special types of assets in it.
Real estate, as people talk about it, different people have vision to what real estate means. Some people think it means your house, some people think it means a shopping center, some people think it mean it’s an office building. And when they talk about it, it’s just real estate. Actually, that is not how it works at all. These are almost discrete performance outcomes in these different sub-asset classes. So for example, if you were buying office buildings, your experience over the last 5 to 10 years would have been most probably quite an unhappy outcome. People staying at home, office building is empty, bad place to be in general, new office buildings not so much, but older office buildings definitely. Regional malls, as the pandemic hit them, that was a real problem. And also just home shopping was going to take away from those malls. And so what we did is we sold all of our malls, and we started buying warehouses because that’s what you needed for online shopping to position your goods to show them. That turned out to be a fantastic strategy with enormous growth, and we’re now the largest private owner of warehouses, you call it industrial, that’s the name of the asset class in the world. It was very rapid increases in growth that we’re in. Apartment buildings are another multi – that’s called multifamily. That’s been a really good place to be. In large part because at the global financial crisis, we only spent half the money to build housing stock in the United States and so really shortened housing. So the beneficiary of that are apartments because you got some place in housing now is being adversely impacted by the very high interest rates.
So what you’re seeing is all kinds of different kind of outcomes with real estate. And one of the ways we got to be the biggest in the world wasn’t by buying somebody and merging different money managers together. It’s all just sort of like organic growth. So what we did with BREIT is we concentrated it in warehouses and apartments and we avoided almost all the other asset classes. We have 80% of the fund in those terrific performing asset classes. And we also located them in real estate. Another thing that’s important is where is this real estate? Those 70% in BREIT is in the Sunbelt.
Just to give you an idea how profound the decision that is, the growth, the population growth in the Sunbelt have been a bit of the West, it’s 5x the population growth in the rest of the country. So that’s where we put all these properties, 70% of them. So we’ve got perfect locations with terrific assets. We also did something else for BREIT. We believe that interest rate is really going to go up. And so we bought a big hedge so that as interest rates go up, our investors at retail make more money. And that’s been generated $5 billion of profits. So it wasn’t just real estate we were looking to protect against higher interest rates, which, of course, happened. Now those rates are going down a little bit in the tenure. So we may have some little bit of reversal of that. But what’s important is that if interest rates go down, the value of all the real estate will be worth much more. So we’re actually rooting for that, and that’s what’s happened. When we constructed this vehicle, we realized this was not meant to be a mutual fund with daily liquidity. These are pieces of real estate.
And so we set it up originally 6 years ago so that we would not permit redemptions beyond 5% a quarter. So we could always make sure we have liquidity to make that 5%. And what happened is we went over that 5% last month. We had been selling the last 2 years as much $3 billion of this BREIT a month. So what happened? We started asking ourselves, what’s going on? And we found how to fasten anything that these redemptions were preponderantly coming from Asia. Same product is in the United States. It’s U.S. real estate. What was going on in Asia? And it didn’t take long to figure out that the Hang Seng Index went down 40% and the Asians tend to use more leverage, more margin debt.
So if you are an investor who has got margin debt and your market goes down 40%, you can imagine what it was like to be one of those into the pools. You’re under excruciating financial pressure, and so they were just looking for liquidity. So BREIT, because it was so successful, its returns have averaged 13% a year for the last 6 years. That’s 3x the return of the REIT index. So the performance has been 3x, has invested better than investing in REITs. It’s got like a 4.4% dividend, but it also has a tax shield from depreciation, which adds like another 3%. So you don’t sell it again. So if you’re a long-term holder, you’re getting more of the equivalent around 7% current. And this year, the fund was earning 9%. So if you’re earning 9% in an environment, where the S&P was touching down 25%, this should be a very happy group of investors. And in fact, they are very happy, and why wouldn’t they be? If you had all your money in BREIT instead of wherever you put it, if you put it in an index fund or almost any place, this has been one of the worst years in history for economic returns. And meanwhile, the people in the BREIT products are doing very well.
So the idea of that jump, there is something going wrong with this product because some people are redeeming, is conflating completely incorrect assumptions, completely incorrect assumptions. One of the interesting things on what we own is that the real estate is 20%, at least 20% below market prices. So the market for warehouses and multifamily is still going up Green Street, which is a big adviser, an analyst said that they think those two asset classes will be up somewhere in the 8% to 9% zone this year. And we have this large portfolio that rolls off its leases. Leases terminate pretty quickly in this area in the 3 to 4-year zone. And if you just mark that up to current market without the appreciation, you can see this will be a very positive experience for investors. So we have a lot of happy people. And we have some people who are under financial distress some people want to do something for tax selling, which is totally sensible. And so what we found is for most investors at retail, BREIT is about the best thing they have. And so we’re very pleased to be involved with it, and it performs particularly well against publicly traded REITs.
Our NOI went up this year at 13%. The average REIT went up 8%. So we’re out-earning that by like 65%. And so we’ve been at this real estate business for 30 years. And in a way, BREIT is some of our best work. The idea I watch on television sometime and people are concerned about it, I find it a bit baffling. But part of the fund of coming down to Goldman every year because you never know what’s going on in the world and what people will be interested in and what you’re going to talk about. So this is like a happy coincidence, and Alex is nice enough to invite us down.
And you ask the question embedded there is what happens to retail if the flows go down. Well, one thing I would say, and I’ve only been doing finance for over 50 years, is finance is cyclical. And we’re in a cycle now where retail investors are less apt to be investing in things, and you can see it just simply with the IPOs, and there almost are no IPOs, that’s because it’s a risk off time. Investors are being cautious. And that happens every cycle. And so I always expected flows to be down for BREIT and any other sort of new issue of product, because as the world is busy shrinking, people get scared. That is completely normal. It’s not a concern. What happens with IPOs, you will find they come back again, right. The world is not over. Maybe over for this week or over the next few months, but then IPOs will come back again because they always do because people need the money. And this asset class needs to invest at high returns with safety. And so I look at this and say this is just a pause, expected pause of people putting money out in a product like this. And then when there is more confidence, whether it’s when the Fed stops raising interest rates and much or some other triggering event, people have more confidence, then they will put money in these type of products if they perform. And we believe that all of the base on this product is that they will, I just shared a bunch of reasons why I thought. One other reason just to give you an idea of the power of what we have is when our warehouses are rolling off of leases, typically 3-year to 4-year leases that are now being priced up approximately 40%. This doesn’t sound like a problem to me with this kind of real estate. So, I give you that to absorb, and I am always anxious to take questions. But this is a really interesting product. And when we do things like this in retail, this product has about $70 billion that we have raised so far just for this one fund, and the investors have had a great experience. And we think the future will be supported by the assumptions from Green Street and others and our own experience. We have also been selling some assets. But just to give you an idea, we just sold two casinos out in Las Vegas, real estate, not the operating business. We bought this stuff in 2020. We have owned it for a little less than 3 years. It’s more of a fixed income type of lease. And we just sold it for 2x profit when these things were shut for six months, and it doesn’t have a lot of upside. And something like that, selling that above our marks, and we have sold $5 billion of real estate this year. All of our marks makes us pretty comfortable that there is a good market for what we own and what goes on. So, we are pretty positive about this.
Alex Blostein
Great. Thanks for that. Let’s pivot a little bit. I want to spend a couple of minutes on capital deployment sort of the other side of the business, the other side of the coin. Blackstone is currently sitting on $180 billion of dry powder, even after deploying almost $170 billion over the trailing 12 months. So, as you take your macro framework into count and seeing what’s going on in the ground, what are your expectations for 2023 deployment in the areas that see more compelling and the areas that you are trying to avoid?
Steve Schwarzman
What happens in our industry, we are in the business of buying assets, fixing them up, improving them, investing in them and then ultimately selling them, that when markets really the flat roll out of markets and they drop, the people who are the sellers remember their old price. The people who are the buyers forget the old price, they only remember the new reality. And so when you go to the person who remembers the old price and say, well, here is the new reality, sell me your asset. You find you don’t get a lot of traction. It takes about a year to 1.5 years for the owners of these assets to forget what something used to be worth, and then they are willing to transact. In the meanwhile, assuming the Fed raises rates and you have economic weakness, you will have some companies that get in trouble or you will have debt decreases in value that is basically pretty temporary. So, that when the economy recovers, debt goes up, we can buy debt, we can do recapitalizations. But there isn’t as much money invested until buyers and sellers get those things on. What we do find, however, is when that happens, we have with $180 billion, about as much money as I think almost anyone in the world to buy assets. And when that moment comes, it is a truly wonderful thing. And we end up buying huge amounts of assets near bottoms, and then the economy goes the other way, as the Fed raises interest rates, and then we do that on leverage, and that’s how we end up in our industry generally. And Blackstone, in particular, 500 basis points to 1,000 basis points over liquids over the cycle. It’s a wonderful economic model. Why, we have gone from no assets to almost $1 trillion. And the industry has done really well and different asset classes within it are doing really well. When we start the real infrastructure business, it’s now got $34 billion. We started it with no assets. We have done this with a lot of different areas. We are constantly starting new businesses. And it’s fun to do this stuff. I must tell you, it’s exciting to come up with new concepts, the ways of doing things. It satisfies our investors and works very well for the firm and the people who work there.
Alex Blostein
Great. Let’s spend a couple of minutes on fund raising. Aside from the wealth products, you guys are in the market with a number of big flagship funds. You are targeting $150 billion fund raise. We talked about some of the challenges in the market earlier. It doesn’t seem like that’s been weighing on fund raising too much. But as you think about the remaining slug of that $150 billion fund raise, how do you expect that to unfold?
Steve Schwarzman
I expect that to unfold pretty well. We are finished real estate, which was targeted at $30 billion, which is 60% bigger than it was before. That’s all been allocated out. We are waiting for people to go through committees. We are up with the $1 billion or $2 billion on our secondaries fund. And then we think we will also hit its cap of private equity just because it started raising later it’s a $15 billion in its last close with its target in the 25-plus region, and they are marching through doing that. We have a host of other funds. They are all doing quite well surprisingly on their way to hitting their targets. So, we are pretty confident that we will be in that $150 billion target area that we have set up for this generation of funds. It’s a bit of this super cycle for us, for some of these flagship funds. So, that’s going really well. Had we not had this footprint all over the world, this would have been perhaps a different story.
Alex Blostein
Right.
Steve Schwarzman
But that’s not the case.
Alex Blostein
Another really important area of growth for Blackstone has been your suite of core products. When I think about core real estate, obviously, core private equity, core infrastructure, and that’s been an important theme, I think for you guys for quite some time as well as you kind of think about the real estate [ph] flagships, wealth management and this core. In a world of higher interest rates, is that product base as relevant as it was before, because it’s lower return, not quite opportunistic. Is that product still resonate?
Steve Schwarzman
Yes, that product, it still resonates. And it’s interesting, we made a discovery years ago, we tried to invest to get the highest returns possible. That was for our opportunity funds. And somebody asked us to help them buy some real estate instead of making 20% return of pre-fee, which we have been doing forever. We have got 16% after-fee return in real estate. They asked us to buy something that was at a 12% return. We couldn’t figure out why, we helped them. It was a good piece of real estate is actually in San Francisco, right, on the water. And then they want to buy another one. The two points sort of make a straight line in what were they thinking. They like less leverage and a property that didn’t need as much restructuring. So, we found out that, in fact, there are many people who don’t want the highest returns. You can’t share that with your finance professor, because that’s not what they talk, to me at least. People wanted to maximize. And what we found is this whole return swath in the middle, sort of 10% to 12%, maybe 13% was perhaps over time even bigger, which is why we started BREIT, which actually had a lower target than that. Because we thought that people would want that level of return, often with current income, less appreciation. And so that’s become a huge business for us, and the main cell as long as you are targeting those types of returns.
Alex Blostein
Great. Well, Steve, I think we are out of time. So, thank you so much for being here. Really appreciate it and hope to see you again next year.
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