"The markets still haven’t reached their peak,” says Blackstone president

“People think of inflation today similar to how Americans once thought of real estate prices - that they can only head in one direction,” said Jonathan (“Jon”) Gray. “Between 1945-2007, real estate prices in the U.S. only climbed, and people said: ‘those prices can’t go down,’ but then the financial recession of 2008 hit and we saw what happened. The inflation today reminds us of that time, since prices have been going down for four decades. It makes it difficult for people to remember and believe that the direction can change, but when it does change it can cause a dramatic fluctuation in the markets. Nevertheless, the markets still haven’t reached their peak.”

When he says “we,” he’s referring to Blackstone, the largest alternative investment group in the world, which deals with assets like real estate and infrastructure and not stocks or bonds. Gray is the president of the group and its COO, number two to CEO and Chairman Stephen Schwarzman, and the person considered most likely to succeed him at the helm. Schwarzman (78), a former Lehman Brothers employee, founded Blackstone in 1985 (with former US Secretary of Commerce and former Lehman employee Peter G. Peterson). Since then, the firm has grown relentlessly. Today, it manages $731 billion, nearly twentyfold from a decade ago. Over the past year alone, it invested more than $100 billion, and it has over $100 billion available for additional investments. Over the years, Blackstone has become a symbol of American capitalism; an example of an aggressive investment firm, one that is a fan of leveraged acquisitions and extensive intervention in companies’ operational aspects, and is inspired by Schwarzman’s motto of “always think of what will eliminate your competition.”

Gray joined the firm in 1992, and became one of the top earners on Wall Street, and a real symbol to investors and critics alike. In 2020, he earned $216 million - through his annual salary of $123.2 million with another $92.8 million in dividends. That money raised his personal capital to $4.5 billion, and landed him on Forbes’ List of the 400 richest Americans. Gray has accumulated impressive compensation as well as extensive experience in markets, investments, and real estate, which has given him a unique perspective on financial matters in both the U.S. and Israel which he discussed during an exclusive interview with Calcalist from his New York offices.

During a recent interview with Bloomberg in October, you said that it’s time people realize their assets. Doesn't that contradict your previous statement that markets haven’t yet reached their peak?

“In that interview I was asked whether it’s a good time to sell, and I said: yes, for mature assets the markets are strong and there’s liquidity so if you have a business or an asset that achieved its goal then it’s ready to sell, but I also said that we’re still investing a lot of capital in the market. In the third quarter, we set a record for selling assets and also deploying capital. I think that’s reflective of our worldview that there are still investment opportunities out there. We recognize that in some areas it makes sense to sell those assets.”

So you don’t share Warren Buffett’s difficulties, who claimed last month that everything is so expensive that there’s nothing left to invest in?

“We recognize that prices are full-blown in some places, and in certain speculative places prices are at very high levels. But the globe is a big place, and we operate everywhere and in every sector, with different types of capital such as credit, private equity investments, secondary financing, real estate and infrastructure, and are focused on those sectors that we believe in. It works for us, so my short answer is yes.”

Are there still sectors or geographical locations where prices are undervalued?

“In Europe, asset prices are probably a little less expensive, particularly in the U.K., especially since coming out of Brexit and Covid. I think that interest rates will move more slowly upward, but the growth rates, particularly in continental Europe, are slower. In Asia, I’d say that things are a little bit slower because coming out of Covid most of those countries haven’t yet reopened, so it makes it tougher for an economy to function. In China, there are also some head winds around their housing market and with their capital markets. I think that in the long term China will grow at a faster rate than more developed economies around the world. What we’re seeing around the world is once countries have reopened after Covid, people still have a lot of money in the banks. Their governments have created a very accommodating environment, and we all have cabin fever - we want to go out, travel, and spend. I think the economies will be pretty good in the foreseeable future, so I’m not concerned about a dramatic slowdown. I belong to the camp that is warning against the overheating of the economy.

“We’ve invested a lot in storage this year. We have warehouses valued at $140 billion, and there is still a long way to go considering the growth of e-commerce. (Blackstone holds the most storage facility properties in the world, some 80 million.) In light of that growth, the payments sector still has far to go. Fundamental changes taking place are a result of digital transformation, and will happen even if the economy slows down and interest rates rise.”

What do you think could be the black swan that would shake investors?

“I think the big risk is the one people are really starting to talk about: inflation. What we’re seeing now is broad-based inflation globally, particularly here in the U.S., and it’s a function of the money supply growing by more than a third in two years because of the Covid crisis, and then shortages in energy, housing, and labor. That combination of lots of capital in the system and these structural shortages is driving the price spikes, and it doesn’t feel like it’s going away anytime soon. I think the shock, if it happened, would occur at some point where people would realize that it’s not transitory.”

You don’t think the expectations for inflation are already being priced in by the market?

“If we look at the consumer price index, it’s rising even faster than we previously saw, with a leap of 6.2% in October and November in the U.S. I think it will take some time before we see the reality on the ground reflected in the actual numbers, mainly in real estate, but I think the market shock will come from there. I think it’s possible to see inflationary numbers coming in consistently higher and the Fed being forced to move faster and more aggressively than market consensus and then you could see a sell-off. In that type of environment most assets are at risk. But I think we’d see greater risk around long-duration fixed-income. The real risk is in the long-term bonds.”

And the stock market won’t be similarly affected?

“Obviously, the stock market has gone up a fair amount - multiples are higher. If you have movement in rates, it could have a negative impact. If that happened, you would see some decline in the stock market, but this doesn’t feel like the year 2000. It doesn’t feel so bad, particularly when earnings are continuing to grow. We could find ourselves in a new reality in which we concurrently see higher growth and higher inflation. And that’s not necessarily bad for all companies.”

Should we be worried about banks? Central banks have become the central source for credit, so where does that leave regular commercial banks?

“I wouldn’t identify any weakness there. I think that banks are in pretty good shape, and have less leverage than in 2007. Credit-quality across banks is very strong, and their capital ratios are strong. The capital markets have been healthy as well. I don’t see any weakness in the banking system, and remember: banks can earn more as interest rates start to move up.”

The question of rising Israeli real estate prices

Like Schwarzman, Gray grew up in a middle-class Jewish-American family and has visited Israel several times. He lives in Manhattan with his wife and four daughters. After his sister-in-law died from breast cancer, he and his wife donated $100 million to fund research into the BRCA gene.

At age 22, after he completed his studies at the University of Pennsylvania, he started off at Blackstone’s real estate division that was founded a year prior. Later, as the head of the real estate division, he signed off on one of the firm’s biggest successes: its acquisition and sale of Hilton Hotels Corp. Gray led the $26 billion acquisition of the hotel chain right before the 2008 crisis. It was a bold move, which originally was regarded as a flop, but Gray’s nerves of steel helped him withstand criticism for a decade, until Blackstone sold its holdings and registered a profit margin of $14 billion. Following the sale, he continued to receive promotions at Blackstone, and in 2011 led the real estate division’s global operations. In 2018, he was promoted to president, where he continues to closely follow real estate investments. This year Blackstone completed an additional realization of real estate assets which is considered the most profitable lone asset in its history. It sold The Cosmopolitan, a luxury hotel in Las Vegas for $5.65 billion, seven years after it acquired it for $1.6 billion, and after investing another half a billion dollars in renovations. The firm is particularly fond of Vegas: it occupies the largest share of its real estate portfolio, and comprises 17% of its overall investments.

In Israel too there is the notion that real estate prices can only climb, and the government is trying to cool the market. What do you think of governmental attempts to intervene in this sector?

“A government can take steps regarding mortgages and real estate investors, and try to slow the market down a bit. But in Israel I’d say the underlying problem is that you have good population growth. I would say the combination of the shortage of housing and very low interest rates are to blame. Once the cost of borrowing goes up, it will slow down the housing market. Home prices can’t keep running at levels that are much faster than income. What a government should do when it has a housing shortage is try to stimulate housing construction. In the U.S, we have very difficult zoning laws that make it hard to build, so I think that governments should try to make it easier to build, particularly in dense places. Governments can help people with low-income to buy houses or rent housing.”

What about the social responsibility of companies and investors? During the subprime mortgage crisis, Congresswoman Elizabeth Warren (D-MA) criticized you for “making a shameless profit” from the housing market. Has anything changed at Blackstone since then?

“After the crisis, there were homes that were foreclosed on, but banks sold them. We bought homes, and started a company to rent them out, called Invitation Homes.” According to reports, the company, which was founded in 2013, invested $10 billion over the course of four years in purchasing homes that were being foreclosed. “We built a really great business, we provided good service, better than private renters, and people who rented those homes had less income than people who would’ve otherwise bought those homes. There was a lot of anger surrounding the financial crisis, and people wrote reports saying that Wall Street destroyed the housing market, and ‘now they’re back at it again.’ The reality is we helped stabilize the real estate market.”

“People have become less trusting of financial institutions, and as a company we recognize that we need to exercise a social conscience in every aspect of what we do. Every Monday we hold giant Zoom meetings with employees around the globe, called “Blackstone TV,” and talk about how we can be a force for good. We essentially do that through deploying capital from pension funds, and help people retire in a better way. We also invest in companies and help them grow as well as communities. And there are other areas where we’ve become real agents of change, such as in the carbon emissions context: every time we buy a piece of real estate company or infrastructure we control, we commit to reducing hydrocarbon emissions by 15%. The more we’ve grown, we’ve come to realize how great our impact is. Also in terms of employee diversity - half of the new analysts that we recruited this year are women, and 20% are from underrepresented groups.”

Minimizing risks in tech investments

Israel interests Gray not only from afar, but also from an investment standpoint. Since he took the helm at Blackstone as president, the firm is expanding its operations into new areas, for example launching a special $14 billion fund for investing in infrastructure and expanding to new geographical locations as well with a third fund of $9 billion being set up for investing in real estate in Asia. In other words, Blackstone has crossed the boundaries of its traditional operations as a private investment firm, one which makes high-leverage deals to buy dysfunctional companies, slashes their costs, and resells them. For Gray, the focus is on thematic investments, and he is aiming for the firm to distance itself from its reputation as “the wolves of Wall Street” after it was led in its early years by people who were the inspiration for the character portrayed by Michael Douglas in the film “Wall Street,” with his message that “greed is good.”

Blackstone’s connection to Israel is meant to come through its investment in growth companies, i.e. the high tech industry. Two years ago the firm recruited investor Jon Korngold from General Atlantic and raised $4.5 billion for him in the Blackstone Growth (BXG) fund. According to reports from the U.S. media, it is raising $10 billion for its second growth fund. And those who are looking to invest in high tech, set their sights on Israel. Six months ago Blackstone announced that it would be opening an office in Israel, which will be led by former LeumiTech CEO Yifat Oron, one of the most connected people in Israel’s high tech ecosystem. The firm has already purchased $120 million worth of shares from Wiz (with other additional investors).

“We haven’t been involved in Israel until today, but we work with institutional investors in Israel,” Gray said. “Over the years, we’ve examined several opportunities but haven’t made any deals or really deployed capital. The moment we decided that we’d enter the growth investments sector, it was clear that we must be in Israel too. I’ve seen statistics that showed that Israel has more unicorns than all of Europe. To me, that is just another example of the old saying: ‘fish where the fish are.’”

The interest in tech firms is clear, but as you are already opening an office here will you also be looking into more traditional sectors like real estate?

“Our aspiration in most places is to bring the best of Blackstone everywhere, to the extent we can. If you look at other markets, we start typically with one product, it could be like in Australia where we started with real estate and then private equity, and now offer broad credit. In an ideal world, you would start with more tech growth investing, and then over time if there was opportunity you'd look to things like real estate and private equity and the need to buy companies. What tends to happen is you’re in a market, you build relationships, good things start to happen and you tend to do more. The tip of the spear here is technology and growth, and our goal over time would be to do more. All in due time.”

In his autobiography, “What it Takes,” Schwarzman repeats that the main rule in investing is not to lose money. How does that match up with investing in tech companies, who lose a lot of money and are sometimes even proud of it?

“The bulk of our technology investing has been in growth investing with companies that are more mature. So if you think of traditional venture capital investing, then you’re starting with a company that is very early in its life cycle, it may not even have revenue, so the risk of loss is fairly high. If you look at larger growth companies like Bumble (a dating app where women send messages to potential partners, and Blackstone invested $2 billion at a $3 billion valuation, and within less than a year and a half the company went public at a $14 billion valuation), or Spanx (a shapewear business which Blackstone became the controlling shareholder in October at a $1.2 billion valuation) which we just bought - these are more mature businesses. Companies that have a large range of customers and are generating revenue, and in many cases are profitable. I think it really depends on where you are in the life cycle of technology in terms of risk of loss, we tend to come into the picture a little later. Over time, I think we’d love to be involved in some of that and it may involve some losses, but for now our focus is on those growth areas where companies are more mature and you don’t have as binary an outcome. You’re unlikely to lose all your money in such a company.”

And there’s also the political aspect. According to U.S. media, after being elected as President in 2020, Donald Trump offered Gray the position of U.S. Treasury Secretary. Gray, a well-known Democrat who has donated to former presidential candidate Hillary Clinton’s campaign, declined.

Many have spoken of Blackstone’s ties to U.S. authorities, about that being the secret sauce in your investments, whether that’s Schwarzman’s ties to Trump or yours to the Democratic Party.

“You meet people through politics and business. Politically I’ve been a Democrat my whole life, so I know many Democratic politicians. My focus is on my day-job here, which is helping to run this credible firm and I feel so lucky to have an opportunity to do this. Our mission here is to generate returns for customers. And customers stick with us because for more than 35 years we’ve managed to generate good returns. In the end, that’s the main mission. It’s a bit like a restaurant that serves good dishes - customers will come back and are willing to try new things on the menu. The image of firms like ours being ‘vultures’ on Wall Street is very different from reality. We are good people who care a lot and work incredibly hard.”

And if U.S. President Joe Biden gives you a call and offers you a position?

“I’ll tell him that I already have the best job in the world.”