Commercial Real Estate Outlook with Kennedy Wilson's CEO Bill McMorrow

Man, okay. Bill, good morning, how's it going?

You find me at our HQ here in Beverly Hills. We built two buildings here in Beverly Hills about 10 years ago, and we're in one of those.

No, I think we really did it the right way. I'd really like to think that they did something that was built to last. We've got everybody back in the office. Wasn't the easiest thing I've ever done, but they're all here.

I would say anecdotally, it was probably the hardest period of leadership for many people and many companies. You go through this period where we're shutting down in 2020 or 2021, and nobody had ever done that before. I got everybody in the company together and said, 'Look, there's going to be unintended consequences for these actions because we've never done it before.' There were so many unintended consequences of this, but the biggest one was that all of us learned to love being remote. We could be anywhere and we were still doing well in our business. But I don't think anybody that's a leader of anything doesn't think that you have to have people together to generate ideas, to create your culture. I'm just a huge teamwork person, and I believe that some of the best ideas come from walking down the hallway and having a simple conversation with somebody. Once you've gone remote for what turned out to be a couple years, and everybody kind of adjusts their lifestyles around that, then now you're bringing everybody back. I didn't want to be the dictator of writing a memo that everybody has to come back to the office because I really felt that was stupid, to be honest with you. We started three days a week, we graduated to four days, and that's what we're doing now. At the beginning, we were providing lunches, dinners, time for beer in the afternoon, whatever it was that we thought would make people want to be at the office. But I think now that everybody's back, they're in the mode where they want to be here. The big $64 question is whether you go to five days next year. So we'll see on that one.

Well, you are making an interesting point about that because we spent a lot of time planning this building that really revolved around a couple things: making it a great place to want to come to work, but also setting it up in a way where hopefully it encourages communication with everybody. We went through many, many different iterations of this before we finally settled on what we did. It was some of the simplest things. We created a stairwell system here that I saw in one of the Apple stores, and it forces everybody to walk up and down this three-story building and talk to each other. Just simple things like that.

Well, how I got into the business was really pretty circuitous. I had the very good fortune of growing up in a great family, one of nine, had to learn to be independent in that kind of environment, and got taught the virtue really young in my life of how to work hard. When I got out of school at USC, I thought the world was mine. I went to undergraduate and graduate school there, but then I learned quickly after 50 job interviews, I got one job offer. People will say, 'What did you do?' I said, 'You're kidding me, I took it.' But it set me on a career path that I never dreamed of. I didn't want to go to work at a bank, and I had to move out of Southern California to Northern California at that time, which was like a big deal. I was working in a bank, and I got thrown into some early projects that really were in a certain way life-changing for me. In my 17 years in the banking industry, I had three people, maybe four, that were either bosses or mentors.

Of mine that gave me a lucky break to do something I wasn't ready for. In my case, when I went to work for Crocker Bank, which is now part of Wells Fargo, they asked me to write a report on the airline industry. What did I know as a 23-year-old about the airline industry? But the bank had a big exposure to it, and so one of the older guys said, 'Would you like to go visit the manufacturing plants of the people that are building these aircraft?' I said sure. It was such an eye-opener to me to be involved in financing these manufacturing facilities. It really launched me, as I got off this training program, into the corporate lending world where we were lending money to big companies here in California and midsize companies. In those days, there wasn't a business development part of it; it just didn't exist. But I started calling on big companies here in Los Angeles, and my simple pitch was, 'I have money to lend. Would you like me to come and see you to see if you want to borrow it?' So early on in my career, I was able to start developing business. When I was 25, I got hired by what was the ninth largest bank in the country to run their corporate lending group. I was 25 years old. I moved to Philadelphia, got to see what was going on in New York, got to travel all over the United States to every inch of this country to visit clients' manufacturing facilities. We were a big lender to the public utility industry. Most of the people working with me at that time were sometimes twice my age, so that's where the hard work part came in. I'm giving you the long-winded answer. Then when I was 30, I got hired by a bank here in Los Angeles to essentially run a bank that had lots of issues related to the real estate industry because in 1980 the interest rates were 21%. You could have been the smartest person in the world, but you were not going to make money in the real estate business; in fact, you were going to lose your real estate. We started taking back real estate into ownership. We decided to bring in 35 people that were not bankers and take over the real estate that wasn't bad real estate but was a victim of these high interest rates. That was where I really learned the real estate business. I was fortunate to be working for one of the great entrepreneurs here in Southern California who was the primary owner of the bank. He was in his 60s, I was 30, and he became kind of my father figure in my career. As we got the bank cleaned up and it became very successful, the bank was sold to Cerica Bank. I wanted to do something on my own; I didn't want to work for a bank in a big organization any longer. I came across this company Kennedy Wilson, which had already been started and was in different businesses, and I was able to purchase that company in 1988. The business we were in was a real estate auction business, primarily auctioning real estate for financial institutions. That was an interesting time to do that too. That's where the luck part came in because what happened from 1990, the S&L crisis came, and the regulators, particularly the FDIC, started taking over all these S&Ls. They needed a way to liquidate real estate, so the auction business, which was this tiny business at Kennedy Wilson, actually turned into a really great business. Off of that, we became principals buying real estate. The whole idea was to have a fee-generating business alongside an acquisition equity business. Because of my banking background, a lot of what we were doing on the acquisition side focused on buying things at bargain prices from the banking industry, in some cases the same banks that we were doing auctions for. That principle that we started with in 1988 has never changed. If you think about Kennedy Wilson, we started a business from scratch in Japan in 1994 that revolved around their banking and economic downturn. We went to Europe in 2010, to the United Kingdom and Ireland, where nobody wanted to go, but everything we were doing there related to us being a counterparty with the banking system. Because there was nobody in the United Kingdom or Ireland with capital, we were able to become the largest real estate owner in the country during that period of time, and probably still are in the top three. It was all of these circumstances that allowed us to do the things and create these great careers.

A lot of it was foundational that I learned in the banking industry and from people in the banking industry. I've always had this concept or idea that you have to say yes at the beginning of any idea because if you say no, you foreclose every opportunity. In 1994, I had to make a trip to Japan because we had to get approval from one of the Japanese banks to do an auction for their client here in Southern California. I had never been to Tokyo in my life. When I got over there, I said, 'I've traveled 6,500 miles, why don't I talk to a bunch of banks?' So I went around and made appointments on my own to see people in the various real estate departments in these Japanese banks. I came to the conclusion that the type of lending they were doing to their clients, which was primarily focused on coming to the United States and buying real estate, was not a very sound practice. The first week I was there, we opened an office in Japan. Of course, everybody thought I was out of my mind, but it actually turned into an unbelievable career moment for Kennedy Wilson. We hired this extraordinary person to start our business. In 2002, we grew to a point where we took our company public in Japan. We were the first US real estate company to ever go public in Japan on the Tokyo Stock Exchange. That little idea of just going to Japan led to that. Then in the Great Recession, we viewed that as a period of time where there was going to be extraordinary opportunities, but there was no ability to raise capital anywhere. I had a thousand meetings in 2009 and 2010 trying to raise capital. I was at a Berkshire Hathaway annual meeting and met the CEO of Fairfax Financial, one of the largest property and casualty insurance companies in the world. I met the CEO for a half-hour meeting. He said, 'I really like your idea, and if you're ever on the East Coast, can you come and see me?' I dipped a little bit and said, 'I'm planning on being there next week. Would you be available?' He said, 'Come and see me Thursday.' So I go and see Prem Watsa, who is just one of the most extraordinary business leaders I've ever been around. I go to see him, there are like 10 people in the room. We're making this presentation. He says, 'Can we go in the other room?' I go in the other room with him, and he said, 'I really like your ideas here. How do we make this happen?' I said, 'I'd like you to have an ownership interest in KW, and then I'd like you to give us capital alongside that to invest.' He said, 'Sounds like a great idea. How much?' I told him, and he said, 'That seems like a lot.' But we closed that in three weeks. Now, 14 years later, Kennedy Wilson has done 15 billion dollars of joint ventures together. That first 350 million turned into 15 billion. That was a defining moment for us. Going to Europe was a big defining moment for us, and we created a public company on the London Stock Exchange in 2014. Those two things I had learned from my time in the banking business: every once in a while, if you can roll these companies out from underneath your own umbrella, it didn't make sense to do that. The last piece of this was in 2023 when we had the meltdown in the banking system here in the United States. Another opportunity raised its hand. That was to buy a 5.7 billion construction loan portfolio from a regional bank, but it had to be done in 30 days. That was a big challenge. We got that done, and fast forward, that is our incredible credit business that we have today. All of these things were very transformational for the company, but it took a lot of great teammates who were willing to see through it. I should also say the other thing I'm leaving out: we bought a real estate asset management business in Ireland in 2011. We only had 14 people, but I learned from Japan that if you can have your own team on the ground, you can really do amazing things.

I've had the advantage of going through seven or eight cycles. I told everybody when the Great Recession started that this was going to be the greatest opportunity we ever had if we could raise capital, and it turned out to be that way. Everybody thought, 'Here he goes again.' But I think the issues... look, the unintended consequences of COVID were the printing of money everywhere in the world by every government, which led to inflation. I knew from my time in 1980, when inflation was 14% in the United States, that the only way you could slow it down was to raise interest rates. We got the triple whammy: everything went remote, everybody printed money, we got the highest inflation rate in 40 years, and we got the highest interest rates in 22 years. That was the deck that everybody in the real estate industry got delivered. Fortunately, office is not a big part of our core business. But then nobody wants to go back to the office, so obviously if you've got floating rate debt and it's the highest it's been in 22 years, and nobody wants to go to the office as companies' leases mature, they're not going to renew. This was self-inflicted by the various governments around the world in my opinion, and you had to deal with it. When I think about five and a half or six percent interest rates compared to 21%, you figure out a way. It's not that far from the long-term average. If you look at the last 20 years, you might be conditioned to thinking they should be closer to 1% or zero, but that's not normal; it's absurd. The hundred-year US bond rate touched over a hundred years around 6%. We were doing a financing in 2007, and I had to make a decision whether to let it float or fix it. The prime rate in 2007 was 8%. I made the dumb choice of fixing it, and we ultimately ended up paying it off because the interest rate was 9%. But I thought, 'Wow, if I could get 100 basis points above a short-term rate, that's amazing.' But we got spoiled by the 10-year going down to 1.40%, thinking that was going to last forever. We were fortunate because our credit business has been such a dominant part of our capital deployment the last 15 months. Including what we have in closing, we've done a billion dollars of new construction loans, all to multifamily or student housing. We're probably the largest student housing lender now in the United States. The average loans are about 100 million and generally 55 to 60% loan to cost. The number of banks doing it shrunk to nothing, and the number of borrowers with that kind of capital shrunk to a small room. That means if you are the lender that had the capital, you got the best borrowers and the best projects. That's been a good space for everyone who got into the credit side. The equity investing we've done over the last year and a half has been modest compared to our credit business, but I think it's going to get better next year. People are finally having to be realistic about what values are, which is more than anything what drives equity investing. I do believe that particularly in the United States, because I travel all over the world, the appetite for capital to come here is huge. Everybody wants to invest in the United States. I'm optimistic. I think it will be another challenging year in the real estate business, but once you get past 2025, you're going to see tremendous opportunities. You've got to recognize that and get in front of it. You've got to be willing to take chances. We just formed a venture with CPPIB, the big Canadian pension plan, and we're buying single-family homes to rent in the United Kingdom. We have almost $400 million of homes that we purchased from the big builders in the UK, all generally in the same community. That's what I'm saying: you still have to move forward and try these things.

Generally speaking, although it's not as true today as it was a year ago, the highly regulated banking industry stepped back from the real estate industry unless you're already an existing customer of that bank that you had a relationship with, because they were under this whole specter of what's going to happen to our office portfolio. You've seen every private equity firm, the biggest growth parts of their business has been credit, but credit of all kinds. They're not just doing real estate lending; they're doing unsecured lending, they're buying bonds, and credit-rated companies. One of the big private equity firms just did a big financing for Intel in Ireland. That would normally be business that would be done in the banking industry. It's really gravitating away from the regulated banks to the private sector. How that's all going to turn out, because the speed at which it's all growing is almost unrecognizable. When lending tends to grow fast, that can sometimes have speed bumps. But the credit business for us has been in two narrow platforms: multifamily and student housing. Over time, we plan to add some other products to that, all related to the real estate industry. For us, we're in the information business. Real estate is our product, but information is really the key. We have a national business across the United States on the lending side. We have a view into every market. We had a really good year raising capital globally, in Canada and Asia particularly. I'm an optimist by nature, but I'm optimistic that once we get through the first half of next year, we're going to really see this turn. Clearly, we've got a more business-friendly environment here in the United States. I don't want to get into politics, but I don't think the business community was exactly the favorite of some of the politicians over the last four years.

You said it exactly correctly: there's a shortage of housing everywhere in the world. It's not just here in the United States; it's in Ireland, where we have a rental business, and in the United Kingdom. It's everywhere. It's not only housing, but affordable housing. We decided 20 years ago to lessen our reliance on California because it was clear that with the taxation structure, the costs, and the barriers to build here, it was pricing people out of the market. We started going to Seattle, which became a very big part of our apartment business, suburban Seattle, not downtown. In order for housing to really work for the equity, you have to have a great jobs market and a great education system that produces younger people that want to work at these companies. If you think about Seattle, Microsoft, Safeco, Nordstroms, I can go on and on. There aren't a lot of those companies here in Southern California anymore; they've left or been purchased. The cost of living is driving a lot of this migration to Boise, Idaho; Salt Lake City; Las Vegas; Albuquerque, New Mexico; and some of these other towns around the United States. I believe that housing is certainly the best risk-adjusted returns, the safest investment you could make in real estate because you're not looking for a single tenant in an office building. That's really our focus over the next three years: how do we grow from owning or financing 65,000 units to 100,000 units over the next three to four years? Alongside that, we want to grow our investment management business, which is a fee-driven business where we're managing capital alongside ours for big institutional clients. That's what we're really focused on.

We're financing some friends of ours that are building it, but we don't own any single-family homes for rent right now. We're financing people.

100%. Most people prefer to live in a house with a yard rather than a vertical building. That whole idea is here to stay. It's a question of whether you can find a big enough piece of land and get it through all the approval processes. It's a great business. We have one project like that in Albuquerque, New Mexico. We have 10 assets in Albuquerque now, and it's by far one of the best performing assets.

Our lending in that world is dictated by where the developers want to put it. We just did a very big loan at the University of Michigan. We've done several at Texas A&M. If you look at the enrollments of these bigger schools, like University of Southern California, Cal, the big name schools, their student populations are growing. They have not had any issues. The number of applicants is growing. There's going to be a consolidation in the higher education system, just like there was in the banking industry. When I started, there were 14,000 banks; now there are 4,000. My guess is 10 years from now, there will be 2,000. The same thing will happen, but it will all benefit these bigger universities in the end. Then you have the whole overlay of the international student population that really wants to come and get educated in the United States. The big ones, if you go back and track their 10 years of applicants and admissions, they're all growing.

We got very lucky in 2015 when we got introduced to a company by the name of Vintage Housing Partners, which is based here in Southern California. The company at the time was controlled and owned by a company in Boston, and they wanted to sell their ownership interest. We had just sold 50 apartment buildings that we owned in Tokyo, so we had some capital from that. Matt Wendish was the president of the company, and Kurt Zack and I went and visited with them and the principals of Vintage. We made a deal to buy half of that company in 2015. The two principals of that company, who were still running it, are just incredible people, partners, and talented at what they do. The idea was to take those 5,000 units we started with and see how we could grow it, primarily in the Western United States, mostly through new construction ground-up. In the last nine years, we've been able to build another 7,000 units, so we have now 12,000 units in the senior and affordable space. These properties generally lease up 100% in 90 days when you finish them. The reason is that we're building communities that look just like a market-rate property, but the rents are rent-restricted at a lower level. You're developing and providing a product that you can rent for less than a market-rate unit. We just finished a project in Camarillo, California, that was a big undertaking. We have about 700 market-rate units, and on the same property, we built 170 senior and affordable units. If you walked onto the property, you could not tell the difference; they all look alike. The myth is that you don't build high-quality communities. This is very much a centerpost of what we're trying to do in the multifamily business, and we're trying to expand that business away from entirely the Western United States. It'll be a big part of our business going forward.

You mean the risk or the long-term aspects? I assume you're continuously trying to grow the business. The hardest thing that takes the longest seed planting is capital raising. It's not the product you're investing in or financing, but the capital. Like I said earlier, I travel the world, and we're always in a capital raising mode. You don't just attract capital overnight; you have to plant the seed and nurture it over long periods of time. As long as you have the right teammates and the right culture, you're always able to originate opportunities. It's really about how you attract capital to that opportunity. Capital is attracted by your track record, but also by the people in your organization. Do they trust you? They have to trust you with their capital. We've been lucky; we have great people here at the company. A lot of the people at our company have been with me for 15, 20 years or more, but they started as interns. If you look at our senior management team, almost everybody started as an intern. That has always been our philosophy: bring younger people into the business, train them in the culture of our company, turn them loose, and then keep them. That's been the whole simple idea. The projects always seem to come if you've got the right team out there looking for it, but capital raising is the key to the whole thing.

We're competing against the technology world that seemingly is going up exponentially every day. Young people see that and think, 'I could go work for some AI company and two years from now when I'm 24, I'm going to be a billionaire.' That's one side of it. We started about eight or nine years ago with a summer intern program. At first, it wasn't really well received by senior management, but the wonderful person that runs that part of our business made it important to everybody. We bring 15 younger people into the business every summer, but now we're getting 600 to 700 applications every summer from every possible school in the country. It's not that we're not attracting people. You have to create an environment where they think they can have a meaningful career and be challenged. Every year, we're still continuing to add as we grow. The key is adding younger people to your team. We make a really conscious effort. I don't see any shortage of people interested in the business, but you have to go work at it to find them. You've got to make sure you've got the right person. You're going to have some failures, but frankly, our failures have generally been in the older crowd. The younger people we have a very high batting average with.

It's really simple, Vlad. You have to be willing to work hard. There is no substitute for success. If you're not willing to sacrifice your personal time and work hard, that doesn't mean I don't want everybody to play hard too, but you have to work hard. Then it really gets back to what I said earlier: you have to have a willingness to say yes. I could take you through a dozen friends of mine who are running companies today because they said yes to something. I have one friend who is big in the private equity world. When he was in his mid-20s, they said, 'We'd like somebody to go to South America to start our business there. Who wants to go?' There were like 10 people, and he raised his hand. He went. I went to Philadelphia, which I thought was like the other part of the world when I was 25. You've got to be willing to say yes no matter what it is. The young man that is 30 years old who runs our business in Japan could barely speak English when he came to the company. He was in the property management business, but then we had this idea to regrow our business in Japan. I said, 'Robert, I want you to go run that business for us.' He was like, 'What?' But he's doing an amazing job. It's really hard work, saying yes when there's an opportunity, and then being a really good teammate, being willing to do any job you're asked to do. Then you get recognized. That's the simple thing.

All right, Vlad. I'll see you later. Thank you for your time.