David Lehman - Managing Director at HPS Investment Partners

Colbert Cannon: Welcome to season 10 of the HPScast. I’m your host, Colbert Cannon. If you’re new to the pod, HPS is a global investment firm. We manage over $100 billion in assets for a broad range of institutional and individual investors. That capital is invested across private credit and public credit strategies. Each week, I sit down with key relationships to, partners of, and friends of the firm to learn from their experience, ask how that experience shapes their current roles, and give insights into HPS and how we operate. So, with that, let’s bring in our guest.

Our guest this week is a leader of HPS’s real estate finance practice. This gentleman graduated from Washington and Lee in the late 1990s and started his career in finance trading structured products at Morgan Stanley and later Deutsche Bank. In 2004, he moved over to Goldman Sachs where he would spend the bulk of his career, first in structured products and mortgage trading and eventually becoming the Global Head of Real Estate Finance. Like many prominent Goldman alums, when he stepped down in 2019, he moved into the public service sector, becoming Connecticut Governor Ned Lamont’s Senior Economic Adviser and Commissioner. He served the Constitution State for four years in that role before we successfully convinced him to join HPS about a year ago.

This gent is a great investor and a great business builder, but he’s also a great person who I’m honored to call a partner. So, without any further ado, I’m thrilled to welcome in this week’s HPScast guest, David Lehman, of HPS’s real estate business. David, welcome to the pod.

David Lehman: Thanks, Colbert. It’s great to be here and an honor. That was quite a bio. I’m flattered.

Colbert Cannon: It’s a “this is your life” moment.

David. Let’s go all the way back. Where’d you grow up? Where are you from originally?

David Lehman: I grew up in Central New Jersey, a small town called Montgomery just north of Princeton. My mom was a teacher, and my father was a professor at Rutgers University.

Colbert Cannon: Well-educated folks. So, you end up going to undergraduate at W and L. Why was that the right choice for you, David?

David Lehman: I wanted to play tennis in college, and I was able to play at Washington and Lee. It was a Division 3 tennis program, and I really fell in love with the campus, fell in love with the people there.

I went there in the mid-nineties and never looked back, and it still holds a very special place in my heart.

Colbert Cannon: David, what did you study undergrad?

David Lehman: Business Administration. Initially, I thought I would do chemistry and perhaps medicine or science but ultimately shifted to business, and here I am.

Colbert Cannon: So, you end up going down the finance path. Tell me about that first job out of college. You started on Morgan Stanley’s structured products trading desk. Tell us about that first opportunity. What were you doing?

David Lehman: Yeah. So, one of the neat things about Washington and Lee is it’s a very small school but a very engaged alumni network. So, I kind of lucked into that job in in in many ways. I was able to intern at the New York Stock Exchange in the late nineties, and this was during a bull market in stocks before the tech bubble but the run-up to the tech bubble. And I met a lot of people when I worked at the Stock Exchange, including a number of folks from Morgan Stanley. And they asked me to apply for their program as an Analyst. And, of course, I wanted to do equities given that was all the rage in the late nineties, but they said, “No, no. We may have a spot in fixed income for you. Why don’t you consider that?”

So I did, and I met a bunch of people. The mortgage department had openings. The structured products group had openings, and that was, kind of, a natural place for me.

I liked math. I ultimately really enjoyed fixed income and and getting to understand the bond market and how it worked. And basically, I was the analyst supporting many parts of the structured products trading desk. So, that was everything from spreadsheets to getting a lot of Starbucks back then.

Colbert Cannon: Let’s define some basics for those less familiar. What is a structured product, David?

David Lehman: So, a structured product was pools of assets, whether it’s mortgages, credit card receivables, could be residential, commercial, other types of loans that were pooled into, what were then, securitizations and still are securitizations. So, tranches of those asset pools were then sold to investors with different risk profiles and different credit ratings.

From a structure perspective, they could also take different time to repayment. There is variability around repayment, in particular, for residential mortgages when you could be paid back very quickly or in a very long time, depending on the rate environment.

Colbert Cannon: So simply, you know, if there’s an individual mortgage, you could buy or sell it, or you could take, hundreds or thousands of mortgages, pool them together in one big pool, and then tranche it up and sell off and trade various pieces of it, yes?

David Lehman: That’s right. It was a way to access a market as opposed to just be reliant on an individual investor. If you wanted to take out a loan, you could access big pools of investors that have different risk tolerance.

Colbert Cannon: Alright. So, you’re getting coffee. You’re running spreadsheets. I always think first jobs are, on some level, formative. Tell me about the lessons that you learned in those early days working at Morgan Stanley.

David Lehman: There are always two main lessons, I think, that come to my mind sitting here, approximately 25 years later.

One is, a very, very strong analyst – and what I found that was being most helpful or useful, whether it’s the clients or people that I was working for – is the ability to anticipate. What is the next question? What is the next issue? What’s the problem that’s coming up, and how can I be one or two steps ahead in terms of starting to solve that problem and be useful?

So, I learned very, very quickly that those who could anticipate and were proactive in that regard – they were the ones that were being very successful. And just making making sure that you’re useful, you’re accessible and available, but always thinking forward is really, really important.

And the second thing I learned really quickly on a trading desk is situational awareness. You know, the ability to understand very quickly what’s happening, the emotions on the floor, in-person, on the phone, and how important empathy is in terms of the business and the leaders of the business, and how they manage the team. You really learn very, very quickly in in that trading floor environment, and I love it, to this day. I miss it from time-to-time still as the as the world has moved on.

Colbert Cannon: It’s funny, David. I always say that people, sort of, forget the human aspect of our job. On one level, trading is numbers and analytics. On another level, emotional intelligence matters greatly, and being able to read the room, I always think that matters more than people give credit for.

Okay. So, you’re trading. You spend some time at Morgan Stanley. You spent a year in a similar role at Deutsche Bank before you eventually joined Goldman as their Head of CMBS Trading. Why make the move over to Goldman then? What was the appeal of that transition?

David Lehman: For me, and really both the moves from Morgan Stanley to Deutsche Bank and then from Deutsche to Goldman, it was about that more responsibility and growth opportunities, like how many people make moves or decide to make moves. And Goldman was unique at the time in structured products. They didn’t actually have the presence that Morgan Stanley had or that Deutsche Bank had. They had an incredible investment banking franchise. They were aspirational in many parts of the mortgage and structured products business, but I viewed it as a real growth opportunity to take on more responsibility as it relates to the commercial mortgage training business and to potentially expand beyond that, to learn new products, to work in different areas, not just the U.S. for example. I spent some time in Europe as well. So, that was really important to me at that point in my career when I thought about growth and where the next 5-10 years were.

Colbert Cannon: Okay. So, January 2008, you become the Co-Head of Mortgage Trading at Goldman Sachs, which is really incredible timing. I mean, you take that job staring right down the barrel of the global financial crisis. You had a front row seat to history.

Start with the big picture. How did you manage your business through the most volatile markets in the history of CMBS and really global finance, broadly?

David Lehman: Yeah. It was truly a unique time, and it was a business that I’d been involved in – the mortgage business broadly – 9 or 10 years at this point in time. I continued to learn more about the business, clients, the products, and really managing the risk of that business, both on the commercial real estate side of things and then beyond to more broadly structured products.

You know, when I think about those times today, they were incredibly long, stressful hours, whether it was at Goldman, really all around trading desks and our clients. And you saw just precipitous declines in in asset prices and bond prices, which further exacerbated that stress. And one of my big takeaways from the financial crisis, in particular, is when you have that magnitude of losses at levered institutions, you know, the cascading effect or the cycle that leads is quite violent in terms of the magnitude of those losses, and losses beget more losses. And it was really a rough 12 or 18 month period there, but ultimately, we managed through it.

One of the other really important things from my vantage point was making sure that the team was motivated, because you’re working 7 days a week, long hours each day, So, making sure that the team understood where true north was and how we were trying to navigate through it and work with our clients to navigate through it.

Colbert Cannon: You raise an interesting point there. Well, first on your lessons learned, I always think you learn more when things go wrong than when things go right. And the lessons learned of the secondary and tertiary impacts of a market disruption, I think any of us who live through the global financial crisis carry with us. But in a career path like yours, you did make a transition over time from directly testing and analyzing to managing businesses and people, and you touched on that. How do you manage people differently in a moment of stress like that? Like, it’s one thing to be aware of it. Of course, that matters. What actually do you do when things are like that and help make sure, as you say, that you keep people focused on true north?

David Lehman: Yeah. For me, it was listening more and talking less, which isn’t always easy.           But I I think going back to my point when I was an analyst one or two years out of college, the situational awareness, understanding what’s happening in the market, what’s happening with the team, what’s happening with our clients. Really, in times of stress, you need to do an even better job of that and make sure that you’re spending time, whether it’s walking the trading floor, on the phone with clients, understanding the issues that are out there with all of the stakeholders. It’s  really important. And then when communicating to the team, in particular in times of stress, doing it as concisely as possible but with as much empathy because everyone is under considerable stress. You certainly don’t want to be adding to it. So, being long-winded, that is less effective in most times, and it’s very ineffective in times of market stress.

Colbert Cannon: Yeah. It makes total sense. Alright. So, the crisis has weathered the world and Goldman recover. You eventually move over to run real estate finance on the banking side. Tell me about how that move came about.

David Lehman: Yeah. It’s a great question. The thought was, at the time, Goldman had become a bank during the financial crisis. So, there were opportunities to grow the bank’s balance sheet in various businesses, and mortgages and real estate lending was certainly one of those businesses.

Secondly, the primary market business originating loans from Goldman clients to either pull together or single loans or single loan portfolios to securitize both in the US and in Europe, we thought that was a really interesting time to do that business, to lean into that business and to try to grow market share.

Colbert Cannon: Tell me about that transition. You spoke wistfully about the hectic days on a trading desk. It is different on the banking side. How was that transition for you?

David Lehman: Yeah. Well, I think it wasn’t too different in that I was on the fifth floor, I think, of Goldman’s headquarters at the time. And I moved up to the seventh floor. And, actually, the financing group at Goldman was still in a trading floor layout. So, it was a little bit different in terms of the pace, ant the hours were a little different.

Colbert Cannon: Maybe marginally less yelling.

David Lehman: There was less cursing for sure in the more stable world of investment banking. So, I needed to I needed to adapt myself, I think, in many ways to that. But one of the great things about Goldman was you had a very consistent culture and really strong communication. So, I’m sure there were some bumps in the road, but it was fairly seamless.

Colbert Cannon: Well, it’s interesting, David. I think firm culture is a hard thing to put your finger on. I joined Goldman to start my career in 1997, and I remember they really drilled into us early that ethic of over-communication. And when you think about what I think of Goldman in the old private days, one of the things that made it really unique, culturally, was that team-driven environment. And you can’t do that if you’re not aggressive about making sure that everybody’s looped in, that there’s great communication, and all of that. And it’s one of their real calling cards that I think they’ve continued. If I can compliment us for a second. I do think that one of the things that HPS culturally has gotten right is that old school Goldman ethic of communication that fosters that team-driven environment.

So, you have a great run over your career at Goldman. In February of 2019, you stepped down. Why was it the right time then to leave the mothership?

David Lehman: I wasn’t sure it was the right time, I guess. And maybe the best way to describe it is it was the end of 2018, and the political division where everyone was either on the left or the right and there wasn’t a pragmatism in government – at least this was my perception in corporate at the time – bothered me. We live in Connecticut. My wife’s from Connecticut. We’ve lived up there since 2009. We had a new governor, Ned Lamont, elected. I didn’t know him at all, but he struck me as a pragmatic technocrat as a former businessman, not a lifelong politician, and he had a very matter of fact, genuine style and middle of the road centrist mindset from what I could tell.

So, I cold-called him, effectively, and said, “If I can be useful to you, here’s my resume. I’ve been at Goldman for 15 years, and this is my skill set.”  And sure enough, after 2 or 3 meetings, a couple of weeks later, we jointly established this role where I served as economic adviser on things related to policy for the governor in his first term. And then I ran economic development in Connecticut, which is roughly 110 people, focused on everything from marketing and culture, museums, business retention, recruitment, and other parts of the portfolio. So, we were really the eyes and the ears of the administration to the business community and vice versa.

Colbert Cannon: I’m always interested in how people manage transitions like this. Like, you’re going from for profit to the government sector. It’s a very different environment. How did you learn what you didn’t know? You’re an incredibly bright guy, but I’m sure there’s a million things that you’re asked to do that were outside of your core skill set. How did you successfully make that all work?

David Lehman: In a similar way to when I was leaving college in the late 1990s and starting at Morgan Stanley, you spend a lot of time with the stakeholders, the decision makers. So, in government, when I moved there, it was understanding the the senators, the representatives, the governor’s core team, the various different state agencies, my peers in Department of Transportation, Environmental Protection, and getting to know them and establishing that rapport and understanding where there’s an overlap in the Venn diagram in terms of what needs to be done and what can be done in the administration.

Colbert Cannon: So, you did a lot during those four years. And as a Connecticut resident, what are you proudest of accomplishing for your home state?

David Lehman: I think it’s a couple of things. I would say fiscal responsibility was something the governor was really, really strong and vocal on. So, there were, I think, close to $9 billion of surplus over a five or six year period now. Two-thirds of that, roughly, went to pay down pension debt, and that was a problem created in Connecticut over 70 or 75 years. Governor Lamont really wanted to address that. And the state has a best-in-class rainy day fund. So, the fiscal guardrails and fiscal conservatism that was really underscored by the governor are there.

Lastly, I’ll say I got to do things from an economic development perspective, with a number of companies coming into the state, and lots of jobs created in the state, certainly post the COVID area. But the other thing that we did is when the state allowed sports betting back in 2021 and online Casino gaming, I was part of the team that worked with Native American tribes in Connecticut on how will that work, how will that get operationalized. So, lots of stuff like that I would not have been able to do at Goldman Sachs. For anyone that has the bug to do public service, I highly recommend it. It’s the most fulfilling job I’ve ever had, and one of the hardest jobs I’ve ever had.

Colbert Cannon: I imagine you must have learned so much, too. I mean, you were just asked to do so many different things across so many different disciplines, and as you say, with multiple different stakeholders. There’s just a lot of learnings, I’m sure. Super interesting.

Okay. David, you did that for four years, and then I want to talk about the decision to come here. So, when our CEO, Scott Kapnick makes the call, what were those first discussions like? Tell me what was the fireside pitch?

David Lehman: I knew I wanted do something back in the private sector, and I thought it was a great time to re-enter real estate on the credit side, given where we are in the market, the movement in interest rates, and some of the disruption in the market with existing lenders, banks in particular. I think I think there’s a lot of opportunity. So, I spent time with Scott, and that led to a number of conversations. The way that I think about it is, HPS has developed a track record and reputation in private credit and direct lending. You have done that well for over 15 years now. When I think about adjacent legs of the stool as HPS continues to expand its business, real estate is absolutely one where I think we can and should build a much bigger business here. So, that was a lot of the conversation, and I’m really glad to be here.

Colbert Cannon: You mentioned this in terms of the timing and the rates move. You know, real estate is a cyclical business, which people forget because we spent the better part of two decades with the most accommodative central bank policies in history. When you look at that landscape now, what gets you most excited about real estate finance?

David Lehman: The 15 years of the zero interest rate environment that you referenced before caused a lot of investing, a lot of growth in portfolios. For example, banks doubled their portfolios in real estate lending from 2012 to last year, and you just saw decision-making, as a result of that environment, that I think is being unwound right now. And I think that is the opportunity. When you had real interest rates go from close to -100 basis points at the end of 2021 to close to 200 basis points now, that type of move coupled with the growth in portfolios and where assets have been aggregated, I think you’re going to see new lending and new owners of those assets for the next cycle, whether that be 15 or 20 years.

Colbert Cannon: Yeah. So on that, David, you we’ve seen several banks fail. You’ve seen pressures in commercial and regional banks given their portfolios. Let me put your macro prognosticator hat on. Complexity creates opportunities, but how does this all play out? With that unwind you were hinting at, give me some perspectives as to where you see opportunities in real estate and where that complexity is going to really arise.

David Lehman: So, maybe just to put some numbers on it first. So, you have pricing in commercial real estate broadly across the market down roughly 20% in terms of asset prices since the beginning of 2022. Public markets imply, roughly, an incremental 10% decline. So, if you’re 30% peak to trough, that’s a pretty big move. You’re not at financial crisis levels, and you’re not at the S and L crisis of the early 1990s levels, but given some of the risk around office and some of the obsolescence risk on some of the real estate that’s out there, you’re going to see, in my opinion, real estate change hands, whether that’s through foreclosures, just sales from existing owners to new owners, or other means of assets getting recapitalized. You have this reckoning in the market given the price decline, and unlike right after the financial crisis where you had very low interest rates, and arguably, that minimized the pain for many, you don’t have that right now. In my opinion, it’s not clear that’s coming. So, as a result of that, you’re going to have a longer period and more protracted period, where you’re going to see this decline and these changes of assets that’s going to create new financing opportunities and new asset acquisition opportunities across asset classes.

And then last thing is I’ve been in the real estate market now for 25 years. There were times when hotels were out of favor, when retail and malls were out of favor. Office was long viewed as, kind of, a core, rock solid asset class, and you’re seeing the disruption there with work from home and the power that tenants have relative to the power that landlords have in the current market. And that obsolescence risk coupled with the change in discount rates and borrowing rates in real estate is really causing this opportunity. And, again, I think it’s going to be a longer time period than what you had coming out of the financial crisis given where the interest rate market is.

Colbert Cannon: Yeah. It’s such an interesting point, David, because it’s really the double impact. It’s not just the rates move. An 80% levered asset that has a 30% percent decline in value, suddenly your equity is underwater, but then what if the actual value, even beyond the rates move, is impacted, as you said, by obsolescence, work from home and all of these changes. Sorting through all of that is quite complicated.

The timing is also interesting to me. As long-time listeners will remember, I occasionally recommend books from previous economic crises, and I started reading books about the Savings and Loan Crisis because I was alive when that happened, but I wasn’t in an investing seat. And one of the things that I was really struck by was how long it took to play out, unlike 2008, 2009, which was a profoundly disruptive period. By 2010, from a capital markets and economic perspective, you were basically back to where you were pre-crisis.

Real estate takes a long time to play out, certainly from the Savings and Loan experience. Is that the same here? Is this a 1-2 year event, or is this a 5-10 year event in your mind?

David Lehman: I think it’s probably somewhere in between – 3-4 years is an educated guess but a guess nonetheless.

Colbert Cannon: We’ve got your we’ve got your crystal ball out, David.

David Lehman: That’s right. I think if you look empirically, you see activity trough roughly 3-4 years after crisis. Maybe it’s 2-3 years after crisis. And that’s typically right around when you see the maximum decline in terms of asset prices. And why I think you could see the investing opportunity be longer than that plus or minus three years is given where we are in terms of interest rates. And I just don’t think it’s going to be possible or probable that you’re going to see a zero interest rate environment coming back anytime soon, which I think is going to be be an added headwind to those asset prices. So, I think you could see asset prices bounce around for a little while longer than they typically do.

Colbert Cannon: I think that’s right, David. Super interesting. We’re incredibly excited what you’re up to. It’s always a pleasure to catch up. Thank you for all of those thoughtful insights.

With that, I want to move to the last segment of the pod, something we like to call “Best Ideas.” It’s where we offer up something that’s added value in our lives recently, and we call it “Best Ideas” because it’s our goal, as investors, to maximize exposure to those.

David, you’re our guest. I’m going to ask you to go first. What is your best idea this week?

David Lehman: You reference books. We talked a bunch about the financial crisis here, and one book, especially for those that weren’t in the business then, Andrew Ross Sorkin wrote a book called “Too Big to Fail.” So, that’s one for those that haven’t read it and just want to read one book, I would recommend you read that.

For my other best idea, let me take it away from work and the financial crisis. So, my wife and I have 2 teenagers at home right now, and trying to find an activity that keeps all of us engaged for a period of time is increasingly hard as our kids have gotten older. And two things I would just mention. One is a television show, “Modern Family,” which for those that don’t know it, we love it. There’s, I think, eight or nine seasons. There’s something for everyone in there, and the jokes are funny, regardless of age. So, I heartily recommend that.

Another thing along the same lines. We did a vacation last summer with a company called Backroads, an active vacation. It was a cycling, multi-sport type vacation in Europe, but they’re great for folks with kids that may want to do different things and keep the whole family engaged.

So, those are two things that I recommend, and you can bring Andrew Ross Sorkin’s book along with you.

Colbert Cannon: Those are great recommendations. If you’re too lazy to read the book, the movie “Too Big to Fail” is also quite good, though I think that anybody who’s really interested in what happened – the granularity and depth in the book is hard to beat. So, a great series of recommendations there.

So then for you, David, and for my “Best Idea,” as people know, I like to be inspired by the guest of the week. David, as we talked about, attended Washington and Lee. As you may know, the Washington in that name is, of course, the US founding father, George Washington, who in 1796, gave $20,000 as an endowment to save a then struggling Liberty Hall Academy, thus giving his name to what would become Washington and Lee.

I started thinking about Washington, and so, my “Best Idea” this week is, I think, the best telling of the story of George Washington: the incredible Ron Chernow biography, “Washington: A Life.” Today, I want to recommend Chernow’s 2010 masterpiece about the life of the first US president. Fair warning, it is a massive tome. It’s like 900 pages long, but like all of Chernow’s books, it’s incredibly researched and deeply educational. It also reads like a novel and will keep you engaged throughout.

So, in honor of a W and L grad, my “Best Idea” this week is Ron Chernow’s “Washington: A Life” – a truly stunning and important book.

Colbert Cannon: David, with that, it’s time to wrap up for the week. We sincerely appreciate you taking the time today and are excited for what is to come for HPS’s real estate business. Thank you so much for being here.

David Lehman: Colbert, thank you so much for having me.