Hello, and welcome to our Inside Real Estate outlook for the rest of 2025 and beyond. My name is John Berg, and I'm the Global Head of Private Real Estate at Principal Asset management and today's host. I'm pleased to introduce my colleague, Rich Hill, Global Head of Real Estate Research and Strategy.

Before I pass over to Rich to provide a macroeconomic and real estate overview, I'd like to share a very quick introduction to Principal Real Estate, our dedicated real estate investment team at Principal Asset Management. We've been investing in real estate for over 65 years, and as a top 10 global player with over 102 billion in assets under management, we are one of a handful of real estate managers with long standing experience, a robust platform, and investment solutions across all four quadrants of real estate, private equity, private debt, public equity, and public debt. Our team leverages our extensive experience in real estate investment, research, deep market knowledge, and asset management to help investors pursue their investment objectives through both real estate equity and debt strategies.

Now, before we begin, I'd like to invite you to submit questions at any time during the discussion using the Q&A box on your screens, and we will be glad to address those after Rich's prepared comments. And with that, let's get started. I'll turn it over to you, Rich.

Thanks, John. Thanks for everyone that's joining us this morning or this afternoon, depending upon where you are. I want to, first of all, start with a discussion of the macro outlook. Obviously, the macro is at the forefront of everyone's minds, and it seems to be changing daily, if not minutely. So let's just jump right in.

To be clear, we do think tariffs have created a global economic shock. To put that in perspective, consensus U.S. GDP estimates have fallen to around 1.5 from the low 2% range at the beginning of the year. That is up a little bit from where it was a couple of months ago, when it was around 1.4. And the other areas of the country have not been immune as well.

That said, the full impacts of tariffs have not been felt. We estimate that the full impacts of tariffs will be around a 1.7% hit to GDP. So if you assume GDP going into the year was 2.2, 2.3 range, that would put U.S. GDP below 1%, which would start to suggest that the U.S. might be moving into a recession. That's clearly not happening so far, which begs the question, why is the U.S. not in a recession?

Well, I think there's a couple of different reasons for that. First of all, the full impacts of the tariffs are not felt day one. They take time to play out. Number two, I still think that there is some uncertainty if foreign companies will absorb those tariffs, if U.S. companies will absorb those tariffs, or if the U.S. consumer will absorb those tariffs. But nonetheless, we do think that the economy in the United States is likely to slow to some degree, which likely puts the Fed between a rock and a hard place.

Earlier this year, a couple of months ago, we were calling for only one interest rate cut in 2025 at the end of this year. We're now expecting closer to two interest rate cuts this year, with a more likely case that the Fed will cut at the beginning in September next month.

But maybe more importantly, we do think that shifting trade stands have redrawn the global macro picture. What do I mean by that? Well, for the first time in certainly my career, or at least I can remember, the Eurozone and the U.S. look like they're on similar economic footing. As I mentioned to you, we expect the U.S. economy to continue to slow, but the Eurozone GDP growth is likely to accelerate in 2026 and 2027, driven by stimulus.

2026, we expect it to be call it in the high 1% range. In 2027, it'll probably be a little bit higher than that, with Germany leading the way. So for the first time in a while, the U.S. and the Eurozone are on similar economic footing. We do think that that has implications for U.S. commercial real estate, which I'll discuss in a little bit.

So let's set the stage. Where are we on U.S. commercial real estate? And for that matter, global real estate. We have seen a significant drawdown in capital returns over the past 2 and 1/2 years. U.S. commercial real estate returns, to put it in perspective, on a capital return basis are down more than 20%. That is what we would consider to be a generational decline in property prices.

The only time that we've seen similar to greater capital return declines than today are in the early 1990s, post the savings and loan crisis, and post the great financial crisis in the 2008, 2009 time period. So this is a very significant repricing that we've seen. And it's not just unique to the United States. We've also seen European valuations decline as well.

However, there are signs that the worst is behind us. In the United States, we are expecting around 5% total returns in 2025. But let me unpack what that actually means, because I think that maybe reads a little bit more bullish than what people might actually think once we explain it a little bit more. First, we have seen four consecutive quarters of positive total returns in the United States. It's actually five consecutive quarters in Europe.

But I'm focusing and emphasizing total returns for a very specific reason. And that reason is that the vast majority of the total returns are driven by income returns. So when I talk about 5% total returns in 2025 for the United States, what I'm really saying is the vast majority is going to be driven by income returns with capital returns remaining relatively muted.

So I like to tell investors, when you think about the outlook for not just 2025 but beyond that, I think it's important to understand what are we talking about? Are we talking about unlevered returns versus levered returns? Are we talking about total returns versus capital returns? Are we talking about fund returns versus asset level returns? When I talk about 5% total returns in the year ahead, I'm talking about unlevered asset level total returns. Again, that's driven by primarily income returns with capital returns remaining relatively muted.

I do want to make a comment about how we expect those returns to play out over time. Over the next call it five years or so, we would expect annualized total returns to rise to around 7% or so. And over the next 10 years, we would expect them to be in the 8% to 9% range.

Just for a minute, let me contrast what we're expecting in Europe in 2025. We are expecting Europe to generate slightly better unlevered total returns in the 6% to 7% range. Why is that the case? Well, first of all, we think fundamentals are on equal to maybe slightly better footing. Number two, cap rates are wider. And number three, levered returns are actually really attractive in Europe, because risk free rates, sovereign debt yields, are quite low in Europe relative to the United States.

What does that mean for Europe? Well, historically we've thought about Europe as a deep value asset class, but it actually might be emerging as a growth asset class as well. I'm going to front run myself for a moment. But what we think this means is that we think property portfolios are going to become more geographically diversified. Yes, there will maybe be a little bit more interest in Europe for all the reasons I just mentioned, but we don't think the U.S. is going to be ignored.

And this comes back to the theme of our outlook, back to basics. If you think about what drove total returns over the past decade, decade plus, it was really driven in many respects by financial engineering against a backdrop of historically low interest rates. We think we're moving to a back to basics environment. What does that mean to us? Well, it means that selecting the right property types in the right markets, regardless of if it's industrial, multifamily, or retail, just to use a few examples, is what's going to drive total returns. In other words, net operating income growth is going to be a big driver of returns going forward.

So what do we think about long term returns in the United States? As I mentioned to you, we think they can be in the 8% to 9% range. That's in line with historical long term averages. How do I know that? Well, if you're looking at average rolling annual 10 year returns, that's a mouthful, but on a quarterly basis, we're basically looking at what the forward 10 year annualized return was going to be.

Whether you started in the 1970s, the 1990s, the 2000s, or the 2010s, can see that annualized returns have averaged 8% to 9%. That's not to suggest that they're always 8% to 9%. As illustrated on the right hand side, we're showing the range of 10 year annualized returns by decade. So in the 1990s, there were a minimum of around 4% to a maximum of around 11.5, with an average of around 6.2. Fast forward to the 2010s, the average was around 8.2, ranging from 5.3 to around 10.6.

The point I like to emphasize to investors is the last 10 years when we've generated 5.3% annualized returns, we're actually not such a great environment to be owning commercial real estate. Why is that the case? Well, first of all, you're dealing with a low point right now. As I mentioned previously, valuations drew down more than 20% over the past 2 and 1/2 years. So that is impacting returns.

Secondly, I strongly believe that a low interest rate and falling inflation regime is actually not good for commercial real estate on a relative basis. Why is that the case? Well, it incentivizes investors to take riskier decisions. It incentivizes investors to go up the credit curve. It incentivizes investors to go buy TMT stocks, for instance. We actually think a slightly higher interest rate environment and a slightly higher inflation environment is good for commercial real estate.

I'll put a bow on this comment, but I'm often asked, what do you think about this new normal environment of higher interest rates and higher inflation? I reject the premise of the question. I don't think this is a new normal environment. I think we're returning to an old normal environment. And guess what? Commercial real estate has produced strong returns for decades and decades and decades prior to 2010. We just think it's going to require more back to basics fundamental analysis, which is going to be the primary driver of returns.

Manager selection will become increasingly important against this backdrop. A rising tide is not going to lift all boats to the same degree like it did from 2010 until call it the end of 2021. And you can see there is a wide range of returns, whether we're looking at core funds, whether we're looking at opportunistic funds, or we're looking at value add funds. We think the top quartile of funds will continue to do really well.

I do get one question a lot, which is, all right, Rich, if you're expecting core returns to be in the 8% to 9% range, is that generating an attractive enough return for me? I think it depends upon what type of investor you are, and we like core assets.

But we want to be very clear that opportunistic and value add strategies are quite compelling. And if you look at the top quartile, the upper quartile of those vehicles, regardless of the vintage, they do produce very attractive returns that are, frankly, competitive with private credit or private equity, which we think is taking a lot of the attention away right now.

So how do we think about building better portfolios? We think core matters. We think the market has missed and not fully appreciated that income returns are very compelling for core funds. Plus you get some appreciation returns over the long term. So we think investors should have core portfolios, but you should have satellite positions and opportunistic and value add funds.

Don't take my word for it. I've been painting a fairly bearish or bullish perspective right now that maybe the worst is behind us, but we're really big believers that listed REITs, the public markets are leading indicators in both downturns and recoveries.

So let's go back to 2022. Listed REITs were down 25%. I think that we were getting a lot of questions if listed REITs were acting irrationally at that period of time. Lo and behold, they weren't. They were a leading indicator that weakness was likely to come in the private real estate market.

But if you believe that there are leading indicators in downturns, what do I mean by that? Well, if you look at where we are for 2019, the European market is still lagging the U.S. market. So you're starting to see a catch up, and we think that's one of the bigger themes that's going to emerge.

We do see very strong capital markets conditions in the United States in the first half of 2025. There's two things that I'm looking at in particular. There's two things that I'm looking at in particular to suggest capital market conditions are on strong footing. First of all is transaction volumes. Transaction volumes, believe it or not, were up in the first half of the year by around 13% or so. A really strong performance, given all the concerns that maybe the market was focused on post liberation day in early April.

Do we think the full impacts of tariffs have been felt? Likely not. They're probably still coming, and we would expect maybe some slowdown in transaction volumes. But there's a mitigant to this. The tax bill that was passed is an undeniable positive for commercial real estate, because it preserves, if not enhances, many of the tax benefits of owning commercial real estate.

The second point is lending standards. Lending standards are actually holding in pretty well. We like to tell people that the lending markets are open and liquid. There's a lot of other lenders beyond just banks. And even if we focus on banks, big banks are actually loosening lending standards and seeing greater loan demand right now. Small banks are still tightening standards and seeing declining loan demand, but big banks are back. Insurance companies, like Principal Financial Group, are active lenders right now, and debt funds have really increased their market share.

So it's not to suggest that lending standards are remarkably loose by any means, but we think the debt markets are actually much more viable and open than a lot of people are talking about right now. That's important, because commercial real estate is inherently a levered asset class. And so the viability of the debt markets matters and matters a lot.

So as I mentioned to you previously, transaction volumes are holding up better than anticipated. But what's maybe even more interesting is that foreign acquisitions into the United States were actually still positive in the second quarter of the year. I think that surprised a lot of people. It certainly surprised myself. It comes back to the point that I made previously that I think the U.S. markets are actually too big to ignore. I think investors are going to become a lot more selective about what property types and what markets they invest in into the United States. But we do think that foreign investors will continue to find value in the U.S. commercial real estate market.

So what's one of the major reasons that valuations are holding up better than anticipated and we see a recovery coming? You've heard me emphasize this multiple times, net operating income growth. Net operating income growth is on really solid footing compared to historical averages. There's a couple of different reasons for this.

First and maybe foremost, the commercial real estate market has become much more diversified over the past 10 years or so. Call it 10 to 20 years. 20 years ago, it's what I would refer to as my grandparents' commercial real estate market, dominated by the core four, things like multifamily, office, and retail.

But what's happened over the past 10 to 15 years is that commercial real estate has become a much more vibrant asset class and has actually become a new economy asset class. That's important, because many of these sectors that didn't exist 20 years ago, or at least in scale, are now leading growth. Things like senior housing, data centers, industrial, manufactured housing, single family rental. These are some of the fastest growing asset classes, and they're a really important part of the commercial real estate ecosystem. Maybe to put this in perspective, around 70% of listed REIT market cap is now in this what we refer to as next generation asset types.

Now, the private commercial real estate market isn't that high, but still, around 40% of the $25 trillion U.S. commercial real estate market is probably in these alternative sectors. So we think the market has to be aware and cognizant that the commercial real estate market has evolved and your portfolio positioning should reflect that.

The second point is that supply of new properties, so this is construction of new properties, is plummeting. Plummeting is a word I'm using for emphasis. It's going down substantially, and that's leading to better supply versus demand technicals, which will likely lead to stronger net operating income growth.

The final point I would make is that we're coming from a position of strength. Occupancies across most property types, with the exception of office, is quite at high levels. And so we do expect an economic downturn and why growth will slow, but it's likely not to slow anywhere close to what we saw in prior downturns.

Now, before I go on and talk about what we like in this next cycle, I do want to be very clear that we think distress and delinquency rates are likely to continue to rise from here. A big catalyst for that is maturing loans, which I'm sure you've heard about the wall of maturities. It's about $2 trillion over the next several years. That is going to lead to more distress in the commercial real estate market.

But there's a very important point here, and that point is that distress is a lagging indicator. If you go back and you look what happened in the TFC, CMBS delinquency rates peaked two years after private valuations troughed. And if you think I'm just picking on the CMBS market, bank delinquency rates and insurance company delinquency rates peaked a year after CRE valuations troughed. Why is that the case?

Well, typically lenders don't like to sell distressed properties into distressed markets. They like to sell distressed properties into stabilized markets. So we do anticipate that the headlines are probably going to get worse before they get better. That's a contrarian indicator that gives us actual confidence that you should be investing in commercial real estate.

Said another way, and I like to pick on myself when I say this, commercial real estate investors do a pretty bad job of buying low and selling high. They like to buy everything when it feels really good, sell everything when it feels really bad. It actually behooves you to do the opposite of that, because commercial real estate is a cyclical asset class. So you want to invest counter-cyclically.

So as we transition to the last section of this deck before I open it up for questions, at Principal, we take a four quadrant approach to investing in commercial real estate. That's public versus private, equity versus debt.

In the current market, we favor private real estate debt. There's a number of different reasons why we favor private real estate debt right now. A lot of it has to do with higher risk free rates and wider spreads, but we think two other things are really misunderstood about the attractiveness of private real estate debt.

First, risk adjusted returns are quite attractive. You're lending at conservative lending metrics and at valuations that have already reset. So what do I mean by that? Well, if you're lending at, let's just use a round number, 50% LTV, that means valuations have to fall another 50%, 5-0 percent before your loan takes a loss. That's a very significant decline. And even in our bear case where we expect valuations to fall maybe another 10% to 15% similar to what we saw during the GFC, you're still not touching debt levels.

The second point, which I think is really misunderstood, is private debt. Open ended debt funds have very stable total returns. There's actually not been a single period of time since call it 2014, 2015 where you've seen negative total returns. So the stability of returns, we think, complements portfolios quite attractively. We're waiting for our entry points when private equity and listed REITs become a little bit more attractive.

But to be clear, I'm often asked, do you like private debt versus, let's just say, private equity? We think it's not an either/or proposition. We think all of them work in our portfolio. They help to balance a portfolio. They help to optimize the portfolio. You're supposed to be overweight one versus another at certain points in time, depending on where you are in the cycle and where there's valuations. We happen to like private debt now, but it's private equity, both listed and private, starts to become more attractive, we'll probably change those allocations over time.

And as I said before, having a four quadrant approach does produce alpha over time. As you can see, what works best on a given year really depends upon where valuations are and what's driving the cycle. So when you take a four quadrant approach to investing, it actually smooths out returns over time and delivers alpha. What that really means is that you're having better Sharpe ratios.

I said this at the very beginning, but as we start to think about how we're building portfolios, we strongly believe that commercial real estate portfolios are going to become more geographically diversified. And there is a huge opportunity set across all of the globe. Yes, commercial real estate in the United States is the biggest asset class. But Europe is also very large. Asia is very large.

We think investors need to start thinking about their portfolios globally and start to think about, all right, what is the best net operating income that I can achieve, regardless of the property type, regardless of the market? And most of our discussions that we're having, I'm traveling a lot right now, it does seem to suggest that investors are recognizing that.

So where are those opportunities? In the United States, we like data centers, residential, and health care. I want to make a couple different points about this. Data centers, yes, everyone understands AI. We think this makes a lot of sense. When we talk about residential, we think about the entire ecosystem of residential. That means apartments. That means single family rental. That means manufactured housing. That means seniors housing. That means student housing.

The reason we say that is, yes, the U.S. is undersupplied of housing in aggregate, but it's actually a housing mismatch. Some markets have not enough supply, and other markets might have too much supply. We think thinking about housing holistically allows you to take advantage of that. Senior housing is one of our top opportunities. There's an aging Baby Boomer demographic in the United States, but it's a very affluent demographic that's able to pay for the senior housing and facilities under private pay.

Why is retail and industrial marked yellow? It's because we think the asset class is a little bit more nuanced. In retail, we like open air shopping centers. In industrial, we're really focused on those property types and those markets that can deliver outsized NOI growth relative to the market as a whole.

In Europe, we like data centers, residential, and logistics, for many of the same reasons that we like them in the United States. I do want to focus on logistics for just a quick second. We think there is a huge opportunity to develop modern logistics facilities in the United States or in Europe, what we call future proof assets. A lot of the stock in Europe is older logistics facilities. We think developing modern logistics facilities, given everything that's happening with trade wars globally, will prove to be a very interesting strategy. Similar to the United States, we have hotels and retail as yellow. We think there are opportunities, but you have to be a little bit more select.

So with that, in summary, opportunities are emerging, but a measured pace in 2025. Investors should focus on emerging and structural trends, but there is uncertainty, and we're at the beginning of a new cycle. In that new cycle, it's a back to basics investment thesis where you should focus on what property types and what markets drive net operating income growth, because that will be the primary driver of returns.

So with that, I'm sure you're tired of hearing me talk. I'm going to turn it back over to John to help moderate Q&A.

All right. Thanks, Rich. Great comments. Much appreciated. Just a reminder to our audience, please feel free to submit your questions using the Q&A box on your screen. And we already have several questions. So I'm only going to give you about a 15, 20 second break there, Rich, and we're going to fire some questions at you.

So first question. You mentioned a bear case for real estate valuations in which values may fall a bit further. What's your bull case and what are the catalysts and the resulting value, presumably value increase forecast?

Yeah, John, as you know this, I have a background in debt, so I like to focus on the downside and probably don't do a good enough job focusing on the upside. I come back to the slide that I mentioned which talked about the range of returns. And if you think about what the bull bear case can be, I have a hard time believing that the next 10 years are going to be nearly as challenging as the last 10 years.

On the other hand, I think there's a really good chance that we surprise to the upside. Why is that the case? Well, some of it has to do with sentiment. Commercial real estate has been out of favored asset class at least over the past couple of years. I think as the market begins to recognize that property valuations are rising, income returns are important, appreciation returns are compelling, the market's going to begin recognizing that commercial real estate has an important home in portfolios.

Specifically, it does something different than what you see in your fixed income portfolio or your equity portfolios. That has a chance as capital flows move back to commercial real estate, net operating income growth remains strong, fundamentals remain intact, that we actually could see commercial real estate returns maybe in the 10% range or maybe even a little bit higher than that.

Because usually in the aftermath of drawdowns like this, you see very strong early cycle returns. We're not baking that in right now, but I think there is a scenario that we're being too cautious in how we're viewing things, especially if income returns hold up very well and appreciation rebounds sooner than we're anticipating.

OK, another question here, and you addressed this in part, at least in your comments. Are loan defaults playing out similar in the cycle to previous cycles? You mentioned the S&L crisis. You mentioned the global financial crisis. It sounds like they're playing out fairly similar, but are there any differences or magnitude issues to note?

Yeah, every cycle is very different. And so while, as a research analyst, I like to compare today to history to level set expectations, I do think it's important to think about where delinquency rates, at least for CMBS, were during the GFC. Delinquency rates during the GFC actually were well above 10%.

That's actually where office delinquencies are right now. So when people say office delinquencies are at 10%, oh my gosh, the sky is falling. Not to be flippant, but I sort of chuckle. Office delinquencies are going even higher from here. 10% is really nothing.

If you look at where multifamily delinquency rates were for CMBS during the GFC, they were actually around 16% or so, certainly north of 15%. So there's precedence for office delinquencies to continue to rise. There's precedence for delinquencies across the board to continue to rise. We're sort of still in the relatively early innings, to use a sports analogy, of where distress and the debt markets are playing out.

So every cycle is different, but I think this cycle is playing out in a somewhat similar fashion where you should expect distress to continue to rise, maybe at a decelerating rate, delinquencies to continue to rise. And don't be too concerned about the headlines, because there's going to be a lot of headlines about the death of commercial real estate.

I always remember a headline by a major media newspaper in 2013 talking about how commercial real estate was about to double dip. And that was just the beginning of a relatively good period of time to be investing in commercial real estate.

So that's a long way of saying, John, every cycle is different, but I think you can look at the past to suggest distress is still rising, delinquencies are still rising. That's a lagging indicator. It actually gives us comfort, in a contrarian sort of way, that this is an interesting time to be investing in commercial real estate.

Yeah, fair enough. Rich, you touched on some of your comments there about the office market. What are your views on the sector today? It seems like the headlines, maybe some green shoots in some of the headlines, full story isn't written yet. But what are your current views on the sector?

Yeah, look, valuations are down tremendously. And on average across markets, they're down 45% to 50% on capital return basis. Some markets are down substantially more than that. If you're just looking at NCREIF data or CoStar data, there's some markets that are down 75%. So it's been a really big hit. Any time that you see an asset class underperform that much the last cycle, it's hard to bet against it the next cycle.

So my view is on the office sector are multi-part. I think it's hard to be investing in office today only because CapEx is unknown, and you have to spend a lot of money to generate net operating income growth. But if I was a longer term investor, certainly taking a 10 year view or even longer than that, I think it's actually becoming really compelling.

And you're starting to see some capital that has long term investment objectives, 100 year plus money, I not all of us have 100 year money, beginning to step in and say, do I want to bet against New York City? Do I want to bet against San Francisco? I think that's really interesting.

The next point I would make to you is, I do think a big portion of this is when the market starts to paint office with not too broad of a brush. JLL has a great statistic that says 90% of office vacancy is concentrated in around 35% of buildings, and around 30% of buildings have no vacancy whatsoever. New clean and green office is doing quite well.

So I mentioned previously, I'm still a little bit cautious investing on the equity side, but I'm really bullish about lending on it. It's still a red line asset class to lend to. You can lend at a conservative basis. You can get paid for that. I think that's a really interesting way to begin playing the office thesis.

And if you're looking at the public REITs, they've been volatile recently, but they've staged a really remarkable recovery over the past 12 to 18 months, which if you think is a leading indicator, maybe you should be looking at that signal. And certainly, there's positive headlines seemingly coming out of the New York City office market almost every day, with deep institutional money starting to step in and buy office properties.

Yeah, I agree. It seems if you can make a conservative loan on a high quality property on a value that's 40% or 50% down from peak, that could be very good relative value for the sector. Where do you see the best relative value across the four quadrants of real estate?

Yeah, I touched upon this a little bit in my prepared remarks, but we think private CRE debt is the best opportunity right now. You can generate annualized total returns, net of fees, and call it the 7% to 8% range. That is very attractive to us on a current basis relative to the other three quadrants that we look at.

I want to be clear, John, that when I bring this up with CIOs or people that are asset allocators, their immediate response is, well, that sounds OK relative to the other three quadrants of commercial real estate. But what about private credit or private equity where I can generate much higher returns? And I think that's a fair thought, but two comments.

First of all, when we think about private credit and private equity, if I'm putting on my asset hat for a second, I think you have to be really cognizant of what loss adjusted returns look like, particularly in the private credit space, where we're seemingly still in the early innings of a default cycle.

Number two, we actually think private credit complements private-- private CRE credit complements private credit and private equity by having more stable returns over time. So don't dismiss the volatility of adjuster returns. We don't think investors are spending enough time on that.

We like CMBS, but that's a little bit more of a nichey asset class. And the way I would describe it is if you want it liquid private CRE credit, the SASB market is really interesting. In the debt markets, or excuse me, in the listed REIT market. we're looking for a better entry point to invest.

We think given that the public markets can act irrationally from time to time relative to long term fundamentals, we think that property type-- we think that opportunity will come. And it's not that we don't like private equity, private CRE equity by any means. But as I told you, 5% annualized total returns, there's probably some opportunities for us to generate higher returns over the near term.

But how are we thinking about private equity? That's a generic comment. I get asked all the time, well, if I was taking a really bespoke approach to building a core portfolio, do you think I could do better than that in 2025? Could I be in the high single digits? Yeah, I think you could be. So we think it makes sense to have maybe a little bit more focused approach to core in the near term and then increase your allocations to core in a more broad sense as the recovery takes hold in the coming years.

OK, great. Here's a macro question. Do you think investor concern about the U.S. federal debt, $37 trillion, is putting a floor on how low long term Treasury yields can go?

Yeah, I spend an inordinate amount of time thinking about this, much to my family's chagrin. So here's our view. We don't think investors, and we're certainly not, but we don't think investors should be betting on 10 year Treasury rates going much below 4%. If you were to ask me what I think my long term capital market assumptions are, I'm going to tell you, look, I think 4% 10 year Treasury, 3% inflation, call it a 1% real rate environment, that seems reasonable to me. And by the way, a 1% real rate environment is really historically conducive for owning commercial real estate.

Why do I not think 10 year Treasury rates are going to go much below 4%? A lot of it has to do with the term premium. So that's what premium you should get for going out the term curve. That term premium, if you go back over the past 10 years or so, was actually negative, believe it or not.

And so the market has become accustomed to not much of a term premium for buying 10 year Treasury rates. That is a historical anomaly. Before we start thinking about the fiscal concerns in the U.S. we do think a higher term premium before you start thinking about the other dynamics that go into 10 year Treasury rates, will lead to a higher 10 year Treasury rate than previously.

So, John, this begs the question, well, what would drive 10 year Treasury rates meaningfully below 4%? We think the market might want to be careful about what they're wishing for. If you had the 10 year Treasury rate go to, let's just say 350, for instance, that's about 75 basis points using round numbers lower than where we are today.

But it could be for not so great reasons, meaning a recession. And if we're in a recession, we think credit spreads could maybe widen out even more than Treasury rates fall, which net net will lead to wider financing costs. So we're not rooting for a lower Treasury market. What we're rooting for is a stable Treasury market. If we can have 10 year Treasury rates stabilize somewhere in the 4% to 4 and 1/4, 4.35 range, we think that's a really healthy market, because it would allow investors to focus back on the fundamentals of commercial real estate.

What's my net operating income growth? How much leverage can I get on it? The market's become so focused on rates being the only driver of commercial real estate that we need stability. And that's really healthy, but we're not betting on a lower interest rate environment. Sorry for the rant there. I can get worked up about that question.

No, it's good. It's good. We'll give you another chance for an elongated answer here, because this is a good question, but I think nuanced and may require a separation of space markets and capital markets. But the question is, how will different interest rate environments, as well as geopolitical tensions and trade policies, impact regional real estate markets?

Yeah. So maybe to underscore this point, we think commercial real estate portfolios are going to become more geographically diversified, not less geographically diversified. Investors will probably have a little bit more European exposure over this next cycle than they did previously. But the U.S. commercial real estate market's not going to be ignored.

I'll give you an example about what I think European investors are acutely focused on when they're talking about investing in U.S. commercial real estate. Maybe for the first time in a while, what they're really saying is, I feel like I need to hedge the U.S. dollar back to euros. Previously, European investors didn't do that, because they were comfortable going naked to the U.S. dollar. So now they want to hedge it back. That doesn't come free. It's actually relatively expensive.

So we think the need to hedge U.S. dollars back to euros will make European investors just more selective on what they invest in. It'll come back to maybe some of these strong growing NOI growth asset classes, things like data centers and senior housing, and even industrial over the near term. That's really what's going to be the asset classes that deliver the returns necessary to put the U.S. on an equal footing relative to Europe.

But it's not like Europe has a plethora of just, like, let's buy everything. I tend to be a little bit skeptical that U.S. investors are going to invest in Europe in a huge way, only because I think U.S. investors want a premium to invest in Europe because it's not their home market. They're probably not going to get that premium. Maybe on a levered basis they will, but certainly not on an unlevered basis. So they're going to be selective as well.

And if you look at what's happening via INREV and they just reported some returns for second quarter, you're starting to see a big disparity. Apartments have done really, really well. Retail has done really, really well. Some segments of industrial haven't done so well. Other segments of industrial have done well. And office is a really interesting market in Europe. We happen to like Paris CBD office, for instance. We like West End London office. We think these are really attractive opportunities.

So I'm excited about the portfolios becoming more geographically diverse. I think what's happening with tariffs and geopolitics, it actually might end up making us all more disciplined fundamental investors.

All right. So there's a tariff related question. Are you seeing anything in port data that informs your view on industrial in the U.S. and Europe?

Yeah. So to be clear, it's still very early days. The clear takeaway is that West Coast ports are struggling a little bit more than East Coast ports. But we do have a working thesis that all ports are not going to be impacted the same, and there's probably going to be some winners that begin to emerge.

One of the themes that we're spending a lot more time on is the Port of Savannah. The Port of Savannah seems to be holding up quite well. And there's maybe some different reasons for that, taking some demand away from the Northeast ports, and there's not a lot of other major ports in the Southeast.

But we're really looking for where containers are coming in, if there's any source of strength. Right now, my major takeaway is that the Port of Savannah is maybe holding up a little bit better than I think some people would expect. And we think there's going to be winners and losers.

I will tell you, John, this is something that you and I have talked about in the past, I do believe that you might want to prefer trucks over boats. So meaning logistics is going to go North and South versus East and West. But it is a topic that I think is on a lot of people's minds. When we're having internal discussions about this, I feel a little bit more comfortable lending on industrial properties in port markets, because I think you have an attractive basis, and we're being really disciplined about what we do on the equity side of the business.

OK. How is the for sale residential market performing compared to commercial real estate?

Yeah, fascinating, fascinating question. Whoever asked that, kudos to you. Something really interesting happened over the past 2 and 1/2 years. For sale residential home prices skyrocketed while commercial real estate property prices declined. That's not a relationship that we historically see. In fact, usually the property prices across both housing and commercial real estate go up and down to the same degree.

Why did that happen? Well, the Fed hiking into a hot housing market created a weird dynamic where people are sort of kept prisoners in their own homes because they have really low mortgage rates, and it's really costly to move. And so that created a [INAUDIBLE].

But what's happening over the past call it couple quarters is that we're starting to see weakness in the housing market on a very regional basis. And that's leading to home prices at the national level depreciating o decelerating, should I say. Some markets like Austin, Texas are down significantly from their peaks. Other markets, like in the Northeast, are holding up quite well.

A lot of this has to do with for sale inventory. There are some markets in the United States that actually have more for sale inventory now than they had in 2019, where other markets have not. So we think it's becoming a very bifurcated market in the United States. And maybe for the first time in quite some time, we are expecting CRE price appreciation, CRE total returns, to be S than what we're seeing in the housing market. And that's going to play out as early as 2Q of 25.

All right. Another audience question. What kind of future conditions would need to exist for you to favor equity over debt?

Yeah. To me, it comes down to a number of things. First of all, stability in the 10 year Treasury market. Number two, the lending conditions, the lending markets starting to loosen. I think the lending-- and these are going hand in hand, because 10 year Treasury rates impact financing costs. And the lending markets not only have financing costs, but also the availability of debt capital.

But I want to focus on the lending markets for a, while for a moment, I think, getting back to your question, John, about what could be the bull case for commercial real estate, I think the markets are discounting the fact that lending conditions could start to loosen on commercial real estate. And so if you start to get more proceeds, prudent proceeds, mind you, and stable interest rates, that could be a really big tailwind to the U.S. commercial real estate market.

The other thing I'm looking for, and I don't how many people like to talk about this, but I'd love for puppy dogs and rainbows and the rest of the market to come back down to Earth. Sorry for using a flippant term like that. But what do I mean by that?

Well, think about what happened in the late 1990s. Commercial real estate was out of favor in the late 1990s because of a combination of rising interest rates, deregulation of telecom, which led a lot of money from real estate into telecom, and demand for dotcom stocks. Lo and behold, in the early 2000s, just as the economy was going into recession and risk assets were pulling back, commercial real estate had some of their best years. Some of that had to do with leverage coming back into the system.

I'm not arguing this is similar to the early 2000s, but I think there is a scenario where old school stable returns, stable appreciation could lead Private equity to be being a more favored asset class, which could accelerate to the upside. So really, what we're ultimately saying is once we get into 2026, 2027 and beyond and a property price appreciation starts kicking in, we think that's the time that you can start increasing your allocations relative to whatever your benchmark is for private equity.