Investing Billions - E381: A16Z Partner: The Tax Strategy Hidden Inside Real Estate

Episode Date: June 2, 2026

What if the biggest inefficiency in investing today isn’t asset selection—but the fact that most investors still optimize for pre-tax returns instead of after-tax outcomes? In this episode, I sit down with Jeff Bramel, Partner at a16z Perennial, to discuss why real assets remain one of the most misunderstood areas of institutional investing. Jeff explains how structural diversification works beyond traditional portfolio theory, why private real estate behaves differently from public markets, and how tax efficiency can dramatically reshape long-term returns for taxable investors. We also explore opportunistic investing, portfolio construction, risk management, and why real estate may offer one of the largest remaining pockets of structural alpha.

So, Jeff, your partner at A16Z Perennial, Andrews-Nhorwood's Family Office Group, and you run real assets. Family office is heavily investing in real estate. Why? As people's wealth grows and people's balance sheets grow, diversification to a lot of asset classes that they may not already have exposure to

becomes a really important way that will build meaningful portfolios. And have you run that math, the public markets, let's say the S&P 500, What's the correlation between that and real estate? That's a good question. And I'm going to take the fifth on that a little bit.

And I think the main reason is real estate and real assets, at least the way we do it and the way a lot of large institutions do it is a private asset class. It's not marked to market very frequently. If you look at REITs and listed securities, you probably would find a higher correlation because those things are being buffeted and driven by, public market phenomena. But for the private markets, I think you have to take a step back and think

structurally about whether they're correlated or not. And I would argue that in many cases, they're quite structurally uncorrelated. So in preparation for this interview, I did the research. Private real estate is roughly correlated 0.2 to 0.5 depending on the type of real estate versus the public markets. Why is real estate such a great diversify? Maybe you could unpack that intuition. It's a great diversifier, David, because you have consistent contracted long-term cash flows. That means in sort of a financial theory sense, you have a much lower financial duration than an asset like something in the stock market, which even if it's got a little dividend stream, typically doesn't distribute much in the way of cash flows, not relative to what private real estate

often does. And that shortening of the financial duration gives you a lot of insulation from the ups and downs in the market. The other thing, David, is real estate is, covers a lot of things, and many of the things that people pay you for real estate for have nothing to do with the economy at large. So people living in apartment buildings, they need a place to live. They need a place to keep the rain off their head. And whether the financial markets are up or down, they're still going to be paying their rent. And even if you get into, let's say, a severe financial downturn, like a strong market correction, maybe at the margin, a few people, move out or can't pay their rents or need lower rents. But your rent on an apartment building

might fall by three or four percent. It's not going to fall 20 or 30 percent the way that stock market might. The other thing is you can own a huge number of assets that have nothing at all to do with the mainstream sectors of the economy. And I always give silly examples like if you own an ostrich farm in Timbuktu, that has very little to do with what's going on in the tech economy in the United States. And we don't literally own an ostrich farm in Timbuk, too, but one of the things I think that any real assets investor is trying very hard to do is build in what I call structural uncorelation, own things that are just not correlated by construction with what's going on in the stock market. And we certainly try to do that. I would go a step further

and say, when you look at equities, so many of the equities are correlated with each other in real estate, it's just such a diverse asset class. You mentioned the ostrich farms, but I grew up on Section 8 housing, which is literally being paid by the government. It's the most secure. It's almost like a treasury to a certain extent. You have that. And then you have very correlated to the stock market, things like trophy assets. My wife sells luxury real estate in Manhattan, extremely correlated to equities and these kind of instruments. So real estate by itself, it almost shouldn't even be called one asset class because it's so different in the sub-ascent class. I'd use the analogy that, you know, talking about real estate and real assets as one monolithic thing is a little bit like saying all members of the animal kingdom are the same, right?

I mean, the reality is you've got, you know, you've got zebras and you have jellyfish. And they're not the same at all, right? They're completely different. And I think with real estate, it's the same. As you said, you know, there's Section 8 housing. There's ostrich farms. There's, you know, you've got apartment buildings and hotels, retail complexes. Some of that, for sure, is more economically linked.

than others. But if your goal is to build a really diversified basket of exposures, you can absolutely do that in real estate and real assets by being deliberate about what you pay. And perhaps a dumb question, but so many of the taxable investors I talk about, they invest in real estate for these tax advantages. Maybe it's explained to high school or the tax advantages to investing in real estate. Why is it so tax advantageous? For sure. And I would say that's not a dumb question at all. That is really an important thing to grasp, and I think a lot of people maybe don't grasp it. For real estate and real assets, there are two or three really key things to understand. The headline thing that people always talk about with real estate is depreciation.

What is depreciation? Think of it as like an allowance for the wear and tear on a building. But the U.S. tax code and many other tax codes of many other countries allow you to gradually take sort of incremental write-offs on the, the value of your real estate asset over time, your building. And what is interesting about that is the tax code allows you to offset the operating income you get from rents and other things against this sort of non-cash depreciation allowance. So you make, you know, you make $100,000 on your office building. You might get to write down $100,000 in value. The result of that

is that your taxable income for the year might be zero, even though you've received $100,000 cash flow out of your asset. That's the basic concept of depreciation. And there's no free lunch. On the back end, if you eventually sell the asset, you do have to pay that. But you're getting to defer that taxable income until some date far in the future. And then secondarily, it's converted from ordinary income into capital gains tax. And that's a little bit of a, I won't get into the details on that. But that's the characteristic of depreciation. So you defer and you may reduce the income tax rate applicable to all the income that you're getting out of a property. That's far in a way the biggest thing.

Like when people talk about real estate being tax efficient, 99% of the time they're talking about depreciation. The second thing that I would say is just, and this one applies to any asset, don't sell very often. You probably know capital gains taxes. You only pay them when you realize the gain, which means when you sell. And so if you hold assets longer, again, you can defer the date at which you're becoming obligated to pay that taxable capital gain. And with real estate, there's an interesting little

thing that happens, which is their cash flowing assets a lot of the time. Lenders love to lend against cash flows. So you can typically take your appreciated asset, go to your bank and say, hey, I've got this really appreciated asset. I'd like to do a cash out refinancing of that asset. And a lot of times the lender will say, yes, we'd be happy to lend you an extra $1 million or an extra $2 million because clearly the value is gone up. That cash out refinancing, event is a non-taxable event. And so you can take sort of all that liquidity that you might have gotten from selling the asset and extracted in a non-taxable way. And then you still own the asset. So that's another biggie that I think is lost on a lot of people. And then past that we get

into this long tale of kind of special things like 1031 exchanges and other stuff. But those are maybe the biggies. Let's talk about 1031. There's these research that shows that there's high friction that people end up picking worse assets when they do the 1031 exchange, basically these hidden costs to this quote unquote tax benefit. What's your stance on that? Yeah, I think that's absolutely a real phenomenon. And look, I think markets are mostly efficient. Anytime that you've got something where there's an advantage and the market's aware of it,

the market's going to compensate for that and sort of jacking at the prices. So like, if you show up ready to buy something and the seller knows that you're in a 1031 exchange situation and you've got a finite amount of time where you must find something, of course, they're going to, if they're smart, they're probably going to try to jack the price up on you a little bit. Does that mean that it's a bad idea to do a 1031 exchange? No, not necessarily. It just means buyer beware and be cautious about the situation. But I think if you're Joe average or Jane average off the street and you own a small apartment building and you're thinking about doing a 1031 exchange, try to be thoughtful about the fact that if people know you're in a 1031

exchange situation, they may try to take advantage of you. So I'd say, yes, it's a real risk. the reason we're talking about the tax consequences of this type of investing, the best way to display that is to actually talk about the opposite, private credit. Yesterday, I was at one of my favorite Indian places here in Tribeca, Tamarind, and we had this dinner with a bunch of people in different funds, and I was talking to a private credit manager, very successful private credit manager, and I was trying to figure out, is there an effective way that taxable investors access private credit?

Now, obviously, he was talking about principal life insurance and all these different edge cases. But the brass tax is if you are getting, let's just pick a number, 16% on your private credit and you are a New York City resident or California resident or even in Florida where there's no income tax, you are getting a much worse net in net result because you're paying income tax. And the break even for something that's depreciated, at least on the front end, the order of magnitude difference there,

the way the entire ecosystem is set up from wealth managers, to CPAs, to invest. The whole system offuscates for taxable investors exactly what return they're getting on that basis. And that is the most important question taxable investors should be asking himself. That's a really insightful point, David. And it's one that maybe a lot of people don't quite grasp.

And if you'll indulge me, I think it's really helpful to walk through like a hypothetical example. So let's compare a private credit, like a credit opportunity fund, which has been, I mean, has been some credit turmoil lately, but in general, like credit office already funds in the last three, four years, private credit.

Super hot, you know, tens, hundreds of billions of dollars flowing into this stuff. Let's compare one of those to like just a generic plain vanilla real estate investment and kind of look at the before and after tax. And so starting with private credit, let's assume you're in a private, some kind of opportunistic credit opportunities fund that's got a, you know, a pre-fee and carry, pre-promote, pre-tax headline return of 15%. And that's a good solid return from credit. I mean, you know, 15.

It sounds exciting. senior in the cap structure, not a lot of risk. Okay, what's the catch? So if you decompose all the things that kind of eat away at what you as the taxable investor get to keep, it's pretty shocking. So start with that 15. So the first thing that you have to subtract from that, if you're in some kind of credit opportunities fund, is there's going to be a carried interest that the manager gets to keep. Let's call that 20%, which, you know, typically, maybe some or less, but 20s maybe typical. Okay, so that takes your 15 down to a 12. Now, if you live in New York, like I think you do, Or if you're in California, a lot of wealthy people live in New York and California, all the income you're getting from credit instruments is ordinary income.

The marginal tax rate on ordinary income could be close to 50%. It's a combination of federal and state, city, county tax, all this. So you take your 12 and you cut it in half. Now you're at a six, but we're not done. You've got management fees. And management fees for funds under the current tax code are not tax deductible. So that's why you've got to subtract your taxes first, then subtract the management fee. If you got a point and a half of management fee, you take your six and you're down to a four and a half.

So we started with a 15% sort of raw gross asset level return. And the net amount after tax that you get to keep might be four and a half percent. That's sort of the sad, dark reality with private credit for most taxable investors. So if you compare and contrast that now with like, let's say a real estate investment off the shelf. And I'm going to play a little bit fast and loose with numbers. And of course, much depends on the numbers. But you own an apartment building that you financed with, let's say it's a $3 million apartment building.

You used $1 million of equity, $2 million of debt. And you bought it at, let's say, a 7% cap rate. And you're financing it with 5.5% debt. And these are slightly aspirational numbers. I mean, that's maybe not exactly where the market is today. But I want to use those just for illustrative purposes. So let's kind of add up the pieces. and see what we own, right? So we own, if we're levered two to one, we're getting three bites at the

seven percent income apple. So that's a 21 percent gross. But then we have two turns of interest that we got to pay. So we have to subtract five and then another five and a half and then another five and a half. That's 11. So it takes us down to sort of a 10 percent net income that we're getting on this asset. But we're not done because typically over the long run, if you believe that the economy inflates or grows or whatever, and you have, let's say, 3% annual inflation, you're getting 3% but you're levered 2 to 1, so you get 3 bytes at that growth from inflation, Apple. So that's another 9%. So you're making before fees, before taxes, maybe like a 19%.

And again, I'm not saying every asset will get there, but if you can find a sort of a seven-cap asset that's financable with 5.5% debt, you know, the math would tell you sort of in that zone. You've got to subtract management fees and carry and all this. But before we do that, let's just talk at a high level about what your tax hit on that asset looks like. You have 10% from income. The other 9% is from compounded growth that's deferred to the back end. But against that 10% income, if it's an apartment building, you're able to depreciate a little over 3% per year on the value of the asset, which is $3 million. So 3% on $3 million, that's about $90,000.

$90,000 a year, let's say. that you get to depreciate. Well, now, David, we already calculated you're making 10% on your $1 million. So you're making $100,000 a year in sort of gross income. But you've got a $90,000 a year offset against that. So your taxable income is only $10,000 a year.

And let's assume that you're in the same 50% tax bracket on that $10,000 a year. You're paying $5,000 in taxes, right? On your $100,000 of income. So your tax bracket is way lower than it would be on an opportunistic credit investment. You know, so you're getting, I mean, we said 19%, you know, that's on a $1 million equity check, that's $190,000 per annum in growth.

You're paying $5,000 in taxes. Let's say that you're paying, I'm just going to make up a really big number here. Let's say you're paying 2% in management fees and costs on your equity. That's another $20,000. So you're paying $25,000. So you've got your $190,000 growth, $25,000. in fees and taxes, that's down to 165,000, if I've done my math, right? Let's take it down to 150,000.

Let's just put other expenses and stuff in there, right? You're still making 15% after tax per annum on this hypothetical real estate asset versus four and a half percent that we talked about for the fixed income asset. Now, I fully really, I'm playing fast and loose with numbers and it may not be that good, but conceptually, it can be a much more efficient asset class. for taxable investors. Expert calls have always been one of the most powerful ways to build conviction, but today investors are asked to cover more companies,

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Let's call it 3% per year. Just super rough numbers. And I will add, of course, on the back end, it's not like you'd never pay the taxes. You're deferring them into the future. But as time value of money would tell you, you know, from Finance 101, the net present value of a liability that's kicked out way into the future is a lot lower than a net present value of a liability that you've got to pay today. And as a bonus, your effective tax rate may be lower because you're converting it to a cap game.

Super helpful hypothetical. So let's say you're a little bit more ambitious and you want more than a seven cap rate. You might want to be an opportunistic investor, meaning you're trying to make the best relative investment within real estate. And last time we chatted, you called yourself an opportunistic investor. How does that work in practice? How do you execute an opportunistic strategy in real estate? Yeah, it's another great question, David. Thanks for that.

And I want to start by saying in the real estate world, people throw around the phrase opportunistic in a very narrow sense. Often the real estate world gets chopped up into four levels of risk tier. Core, core plus value add and opportunistic as like the risk riskiest. I'm not talking about being opportunistic in that narrow real estate sense. I'm talking about being opportunistic in the broader way that you and I as general purpose investors would think about it. being reactive to the best opportunities that we see in the market.

Opportunistic in that sense, which is what I try to practice in my daily job, I mean, staying flexible and buying right. I think of the Benjamin Graham quote about Mr. Market. You know, Mr. Market is a slightly schizophrenic person who sometimes shows up with a really low price, sometimes shows up with a really attractive price, and you have to use your wits to think about

whether the price you're being shown on a given day is a good price to buy something or not that. But to me, a lot of what I mean by saying opportunistic comes down to recognizing a great opportunity when you see it and responding to it. That's really what it means. If you want to dive even more deeply into this, I'll contrast it a little bit with some of the rigid asset allocation frameworks that we all know that some of the big institutional investors use, you know, where they say, I'm going to be invested in, you know, 17 to 18% in office and 22 to 23% residential and so on and so forth. And it sounds great to have a framework. It sounds like they've been very deliberate and thoughtful about their risk diversification.

But what gets left on the cutting room floor when you do that is the opportunity to go put your capital to work in really interesting situations. And this is allegorical, but literally happened to me. I was sitting on the investment committee of a large institution that had a very, very rigid asset allocation firm. And I will remember this for the rest of my life because I think it's so aptly sums up some of the challenges with an overly specific, overly prescriptive asset allocation. I was sitting in this investment committee meeting. And one of the investment committee members was advocating for this acquisition of a building. And they literally said, I know this acquisition is only a 3% cap rate, but we're seven points under our target for this sector. And this is

the best thing we can find. So we need to do it. And then, I don't know, like that sums up everything I think you can say about overly prescriptive. Goodhart's law, which is the metrics drive the decision making instead of decision making trying to be from first principles. Exactly right. And it can advocate responsibility for figuring out if the investment's actually any good or not. And at the end of the day, we're all doing this because we want to make good investments. And we sort of have that duty. And if you're too prescriptive in your framework, you can get too fixated on risk diversification and risk management and forget to, you know, forget about the business of making a good investment. Well, even taking a step back, obviously people use real estate for different reasons. I had my therapy session with your CIO, Michelle, talking about my portfolio.

It's like 90% venture illiquid. And I was talking about how to balance, how to balance that with different assets. The way that I think about it is like, what are you trying to do with the real estate? So there's many reasons to buy real estate. Some people literally want to live in the real estate or like the city or want to execute some kind of geographical view on the market. But let's take that aside. at its very basis, real estate is essentially a semi-liquid way to get a tax-advantaged income. And if you think about it from that perspective, then whether you're buying a data warehouse in Ohio

or Section 8 housing or these different types of real estate platforms, from a first-man-level basis, you should be thinking about what is the best relative investment and how do I achieve my stated goal of income in a tax-efficient way? I think that's right. And I would maybe slightly refine that. I think it's not necessarily that you're looking to get the biggest tax advantage that you possibly can. I mean, we're not like, I don't think when you go and invest in real estate, you should be engineering for the absolute biggest tax advantage. But the slightly different way I'd phrase that is you want to engineer for the biggest return after tax. Like whatever the taxes are, the reality is if you're a taxable investor, you want to be thinking about the investment. landscape and thinking about your returns through an after-tax lens. And so one or two things ought to be true, right? Either the return is, I don't know, moderate or medium, but it's really tax-efficient, and so the after-tax number is good. Or like if the tax treatment is poor, but the return is just so darn gigantic that after-tax, it's still really good. Like, that's okay,

too. But you mentioned having a portfolio that's like 95% venture type of risk. And I think a lot of the people that we know in our community at A16Z step into the world of thinking about their balance sheets from a similar perspective. They load it up on, of course, lots of kinds of venture risk. And so what's the attraction of real estate and real assets to someone who's in that situation? If you own a lot of venture or maybe you've had some exits and so you've got some of the Mag 7, you know, tech stocks and you got all this tech, tech beta, your daily net worth is heavily, heavily correlated with what's going on in the tech sector and what's going on with AI and what's going on with, you know, crypto, what's going on with sort of all these technology things. And, you know,

maybe that's great, but it's also very concentrated. It's also very, very volatile. And most of these tech things don't produce a lot of dividend. They don't produce a lot of cash flow. Real assets and real estate can be a complement to that, where again, as we talked about earlier, you're not so highly correlated with what's going on in the tech economy every day. You know, the ostrich farm in Timbuktu and the apartment, the Section 8 housing apartment building, they kind of do what they do. They produce the income that they're going to produce day in and day out, regardless of what just happened with Open AI or what just happened with Anthropic or what just happened with, you know, Amazon. So you get this diversification and things like that. And then there's also a big chunk of the

total return that comes from cash flow. And of course, if you're invested in these things and you're sort of owning that cash flow stream, whether or not you actually collect it and distribute it, the fact that so much of it is coming from cash flow, just like when you own a bond that produces a big fat cash coupon, the volatility is lower because your financial duration is lower. And so those are things I think that investors can think about when they sort of think about the theory of what can real estate and real assets do for that. Said another way, it goes back to first principles thinking if you're in a bunch of tech startups, you probably don't want to buy real estate in San Francisco as part of your real

estate portfolio. You have to be thinking about how to avoid that correlation. It's a funny question that we think about a lot, of course. And I would say by extension, like maybe if you're heavily loaded on tech already, investing in data center real estate may not be the best diversification play for you, right? Like, yeah, I think you're absolutely right, though. Not all real estate is automatically going to be a great diversifier for you if you're loaded up on tech exposure. So I'm going to put you to a number. So you mentioned you're an opportunistic investor going between different real estate classes. What kind of alpha are you trying to generate by picking specific sub asset classes or picking

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slash go slash how I invest. That's SQUA-R-E dot com slash go slash how I invest. With Square, you get all the tools to run your business with none of the contracts or complexity. Run your business smarter to Square. Get started today. That's a great question. The answer is all, all the alpha. Of course, I mean, I like to find good investments. I think any investor does, right? So it's a little bit of a tricky question to answer, but I'll rephrase it maybe a slightly different way if you'll indulge me. And I think what you mean by that is if you're prepared to be opportunist, if you're prepared to be responsive and not adhere too strongly to a rigid framework, how much extra value is available by being responsive and being reactive? And my gut tells me

that at least several hundred basis points per annum of kind of incremental pickup is available. So like if you take investor A, who's rigidly wedded to a framework that gives them no flexibility, and they must go in and buy a certain type of real estate asset every single day, because that's what their prescriptive framework says they've got to do, versus investor B, who's got the ability to not participate in the market sometimes, or wait around for a really good opportunity to come, or be a little bit more creative or flexible, I think just the application of that creativity and that flexibility and the ability to kind of wait for the best investments may, add, yeah, I don't know, 300, 400 bits per annum.

That's, of course, super fast and loose, but I do think there's a real penalty for being too wedded to an overly prescriptive framework. And the other thing I'd add, you know, it's not just about the return. If you're able to find things that can outperform by that kind of margin, it ends up being lower risk too. Because very quickly, if you own an asset that is appreciating at a greater rate, let's say, than some other asset,

within a couple of years, provided your time horizon as long, you've accumulated a pretty large margin of safety versus what you would have achieved on that other asset. And so even if ostensibly it's higher risk, once you've sort of got that accumulated surplus, you can weather the storms more. And it matters less and less if what you bought is a bit more volatile. So I just perspective to think about.

That's the other side of alpha. People always think about how do I make higher returns, but it's also how do I make the same returns or even in theory a little bit lower returns with much less risk. It's about return per unit of risk. That is what alpha is. And there's two sides to it. Return per unit of risk and the extension that I'd make.

And this goes into pretty nerdy, you know, sort of quant finance theory. But the amount of risk grows as the square root of time. All else equal, right? I mean, if you just look at like, you know, sort of volatility of markets and volatility of assets, The total risk grows as the square root of time. But your total return grows exponentially over time. And if you layer together the exponential from good returns over this sort of square root of time propagation of risk, you will find that inevitably the exponential totally dwarfs the square root.

And so a good returning asset, if your time horizon is sufficiently long, theory will tell you is always a better choice. Maybe explain that as you would to a high schooler. So when we think about risk and volatility in a financial theory sense, we're talking about the standard deviation of returns. That's kind of the standard theoretical model for this. And if you own an asset for some people are familiar with a notion of volatility, if you own a stock and the volatility is I'm just making up a number, 20%. What does that mean? It means that over one year, on average, the price may be higher or lower by 20%.

But over two years, one standard deviation is 20%. Correct. Does it mean that over two years, the expected standard deviation is 40%. No, that's where it's not actually double. You multiply it by the square root of two, which is about 1.4. So it's actually only about 28%. Expected total deviation over two years. Over four years, the square root of four is two.

So over four years, your expected standard deviation would be 20 times two is 40%. And so on and so forth. That's what I mean that the total amount of risk that you absorb only scales up with the square root of time. It's not linear with time. Meanwhile, your expected return, your average return, goes up exponentially with time. So if you're expected annual return is, you know, 8%, well, let's pick 10. 10 is going to be an easier number. After one year, you expect to be up 10%. After two years, do you expect to be up 20%? No, you expect to be up a little bit more than 20,

because that 10% compounds. You expect to be up 10% on your original capital plus 10% on the 10% that you made the first year. So you expect to be up 21%. And by the third year, you're up something like 33%. It accelerates. That's the magic of exponential compounding. And so if you own an asset and you're patient and you sit around and wait enough time, that exponential growth from the expected return, according to theory, should always eventually outpace the square root of time growth of your risk. And this is difficult to sort of break down to a high schooler, but you can you can find plots online and see evidence of this. And so this is what I mean by like, if you're patient, it's often good to go for that higher returning asset,

even if it comes with the higher risk penalty. So the way that I would explain that intuition is if you have, the SMP 500 has a, let's say, 10%, just to make it round numbers, 10% expected return per year. And let's just say again, 10% standard deviation. These are not the real numbers. What that means is that 67% of the years,

it's going to be between 0 and 20%. I believe that's exactly what that means. Yeah, I don't know if it's literally 67 or not, but approximately yes. What that means is that every thing, third year, you're going to have an unlucky year. It's going to be below zero, although it's not going to be unbounded below zero. It's going to be probably between zero and 10 percent loss. It's a dice with three numbers on it. One is bad and two is good. If you keep on rolling it over and

over, what are the odds that you keep on rolling the bad number? The more rolls you have, the more I'll come to this expected return. I think that's right. And this is maybe a concept that your viewers will have heard of is the law of large numbers, right? Over time, you tend to get this sort of average performance. And really, okay, maybe the simplest way to say this is that as your time horizon gets longer and longer and longer, the volatility starts to matter less and less and less because the law of large numbers says that the return ought to go toward that central tendency. Maybe that's the simplest way.

But, you know, this is a whole other topic. I mean, the rabbit hole on risk goes miles and miles deep. You could have a whole week of podcasts on risk management. And it might be too nerdy and esoteric, but like it's fascinating and it's subtle. And it's really, really, if you really want to wait into the weeds, it's a super interesting topic. And I'll just leave, I mean, one thought for your viewers. If they don't know what the Kelly criterion is, that's a super interesting topic to research. I would encourage everybody who's listening to this.

If you've got any interest in like quant or risk management, go look up the Kelly criterion. You can find it in Wikipedia or whatever. It talks about how risk and return interplay to tell you what the optimal amount of risk to take is. Super fascinating topic. One of the ways that me and my business partner defined the audience is people that find structural alpha as sexy. So I think you have the right audience here. We did actually have an entire episode

with a former professional Jackback, former professional blackjack player on the Kelly Criterion. Oh, fantastic. Good, good. Well, then you can refer back to that. Risk of ruin. Take a step back. One of the confusing things,

whether taxable or not taxable investors, is that there's so many asset classes, so many portfolio constructions, how should an ultra-high net worth investor think about real estate in their overall portfolio? What are some principles? Again, it goes back to diversification is the one free lunch that everybody gets. It's always, I think, at the margin good to diversify. And, you know, the philosophy I have is that real assets is just very structurally different than a lot of the other things.

It's structurally very different than, equity markets, it's structurally very different than venture capital. It's structurally very different than private equity. And it's structurally, it's got important differences from credit too. And you can achieve a huge amount of diversification just by owning a chunk of real estate and real assets because of the fact that they're so different from anything else on your balance sheet. At least in theory, it's possible to do that. And then within the world of real estate and real assets, it's such a big, vast world that you've got quite a lot of ability. to achieve diversification just within that one asset class.

And we talked about this a little bit before. You know, you own the ostrich farm in Timbuktu, you own the Section 8 housing, you own the, you know, the solar farm, you own the cell tower portfolio, all these different things that where one of them has a bad day, hopefully it's not too correlated with all the others. And hopefully it's not correlated with anything else in your portfolio. And I think that's really the key. And then maybe if there's a secondary thing, it's you don't have to sacrifice. So if you want to, you know, people think of treasuries as a way to diversify, right? And I'm not knocking treasuries. Treasuries have their role.

But the return on treasuries is not super interesting. And so I think with real assets, you have this opportunity to add diversification without necessarily retreating to a totally anemic return. You mentioned the one free lunch in finance is diversification. I agree with that. But I disagree with the industry's fetish towards. towards diversification and hundreds of asset classes. And now I'm going to get some more exposure to this one asset class.

Is there a good golden ratio? And how do you think about the right amount of diversification that a taxable investor should have? Wow. What an interesting question. And I could nerd out on that one for a long time. So I'll try not to be, it's hard for me, but I'll try not to be too nerdy. There's a lot of ways to come at that. And I maybe through just a personal anecdote.

So I grew up as a quaint. And I started my finance and investment career believing sort of this naive orthodoxy that we want to have, you know, 500 different positions of 20 basis points each and like have all this diversification. Market neutral, beta neutral, factor neutral, and just like extract the alpha and and build this portfolio that just goes up all the time because of all this magical diversification removing all volatility from the world. I think what you learn and start to absorb in some sort of. of heuristic way over the course of your career, it turns out that alpha's really hard. Great investment opportunities are a rare bird. They don't come along very often. And when you find one, you're supposed to back up the truck and really commit a lot of

capital to it, even though like from this naive super diversification risk management perspective, you'd have the quant market neutral fund managers screaming and hollering, don't do that, don't do that, don't do that. But it goes back to this idea that when you find the rare opportunity to invest in something, that you believe really will outperform. If you know what you're provided, you know what you're doing and provided that conviction is real, you're probably supposed to go for it in a much bigger, more concentrated way. And so that's something that I think a lot of investors maybe that start as quants come around to as they experience the way markets actually behave. So that's one perspective.

Another perspective, there's a quantitative risk analysis framework that gets it sort of analyzing how many unique risk factors you really have exposure to in your portfolio. And we call it principal components. You can do a lot of quantitative stuff to get at. How many principal components do I really have exposure to in my portfolio? And the reality is for most investors, most of the time, it's rare that they have meaningful exposure to more than two or maybe three different principal components.

What does that mean in layman's terms? It means that there's like two or three factors that are driving essentially all of the behavior of your portfolio, no matter how many different things you've think you may own. And I think there's an opportunity with highly diversified assets like real assets, especially if you're going inside the real estate in real assets universe and picking things that are structurally just really different from all the other stuff you own. There's an opportunity to boost that count of how many principal components and how many factors are working to help you diversify in your portfolio. So I don't know if that gets it sort of the answer you were

looking for, but that's some of the ways that I think about it. It's a great answer. And with AI, you just have access to so much more analysis. During this interview, I was asking AI about the correlation between private real estate and startup companies, which in the old days, pre-AI, aka three years ago, it would have taken probably five to 10,000 hours of research to do this kind of correlation analysis. But within a second, I saw that it was even less correlated than to the public markets as a punchline. The best way that I think about diversification, because people ask, are you diversified? There's two ways to look at it. There's a mathematical, which is how correlated is your portfolio. There's another way to look at it. I had a previous guest,

episode 257, Julia Toder, and she had a really interesting job at Goldman, which is essentially OCIO, and she would go and meet with the CIOs of every single family office. And she came up with this framework in terms of diverscation framed as a drawdown. In other words, what is your max drawdown that you're willing to take? Let's say it's 5% or 10%. And then she would frame it at 19 out of 20 years, you're going to be below this max drawdown. Because to your point, a lot of people over-obsessed about volatility, but just taken to the extreme, if you have an asset that has a 20% expected return

and a 20% expected volatility, that is better than an asset that has a 10% expected return and a 10% volatility. But the 20% will seem more volatile. Yeah, the 20% certainly will experience more ups and downs and may induce more heartburn in the early years of owning it. But the law of large numbers and sort of financial theory would tell you that eventually that 20% asset ought to dramatically outperform.

And by the way, you don't even need to call it a 20% returning asset with 20% volatility. You could have, I'm guessing in making this up a little bit, but like you could have a 14% returning asset with 20% volatility. And it probably still is going to do a lot better than a 10% returning asset with 10% volatility. Somebody check my math on that, but you know, generally speaking, over a long enough period of time, the higher return is your friend. And, you know, the other thing that I would say is you can do all kinds of math and all kinds of quantitative analysis on how diversified you are and how much, you know, how much you've built in by looking at historical returns and analyzing all that.

But at the end of the day, I like to sort of take a step back from that. And I'm a super quantum nerd for sure. Like, I get all that. I understand the math. But really, I like to think about structural diversification, which is, if I'm not allowed to do any math at all, how diversified am I confident that I really am? And this goes back to like, okay, I know I've got my stock portfolio. I know I've got my llama farm in Timbuktu. Like, I don't have to do any math to know that those things should be pretty uncorrelated with each other. And how many buckets in my own personal portfolio can I sort of look at and say, yep, that is not correlated with that. And those two are not correlated with this third one over here. And you know you've got a decent amount of diversification.

If you can sort of point to meaningful chunks on your balance sheet and say, I just know those are diversicated. I don't have to do any math to know that those are diversified from each other, just by construction, right? Like just because of how different they are. Frank question, you went to Caltech. You got your master's at Stanford. You are truly a quant nerd, which is the highest compliment I could give somebody. Are you not bored by real estate? Wow.

That's a super interesting question. Here's why I love real estate. Okay, I'll say it first. If you'd asked me at the beginning of my career, hey, what do you think about real estate? You want to go spend your career investing in real estate? I probably would have thought, ah, it sounds boring. I don't think I want to do that.

Here's what I've found sort of my truth about real estate is and why I like it. Number one, it's a massive, massive asset class. It is, I mean, most people would tell you it's by far the largest asset class in the world. Depending on exactly how you stack up the pieces, real assets, assets is larger than global public and private equity plus global public and private fixed income plus global currency markets all come by. It's something like $400 trillion of stuff. Every square foot of land on the planet is a real asset, right? So that's number one. Number two, it's a highly, highly inefficient asset class. Like price discovery is super opaque. It's complicated. No

two parcels of land are the same. You've got extremely tedious laws, brokerage fees, taxes, real estate operating costs, this is a very, very opaque, complicated, inefficient asset class. So just from the fact that it's so huge and so inefficient means there's a lot of there there. And if you like numbers, if you're nerdy and you want to dive in deep and figure something out, that's an incredible playground. The other thing is like, because I am nerdy, I like things where it's much more about the numbers than about trying to anticipate some future training. So like in the VC world, which I would never be a good VC,

because so much of being a great VC is to understand where the puck is headed and divine what's coming next in terms of what the next trend is. And I'll be candid. I'm not good at that, right? But I am good at looking at numbers. I am good at thinking about inefficiencies in markets. I started as an arb trader. I sort of am always drawn.

You know, I think once you're an arb trader, you're always an arb trader. I love this idea that I can go in and poke around in this big, vast, complicated, opaque market and find something that's inefficiently priced. So that's what I love about it as a quantum nerd. And then the second piece, we talked a lot on this show about taxes, right? The tax rabbit hole goes very deep and is surprisingly nuanced and complicated. And I think for a nerdy Kwan, there's probably more white space in the after tax return arena than there is in any other place in finance. And I would encourage anybody who wants like a virgin playground to go play in in the quant world to go look at, you know, tax and after tax returns in tax alpha.

So those are the reasons why I love it. It's such a good point. And listening to podcasts like these, you could say this is absurd. no way private credit is so inefficient, real estate is so efficient. How could this exist? And the answer to that is up until really probably two, three years ago, the taxable investor has not been a real player in these institutional markets. Nobody cared about the taxable investor. I had the CEO of I Capital, Lawrence Calcano, and he predicts 150 trillion with a T, roughly a third of the entire real estate market globally, is going from retail, which is really

taxable investors. into funds. Now finally institutions are waking up and saying, holy crap, this taxable investor is going to be our net new growth. We got to build all these products for the for them. Mark Rowan of Apollo has pledged a billion dollars, not in assets, but a billion dollars in spend for the retail investor. So why are these funds popping up? Why are these things being discussed for the first time ever? It's because for the first time ever, the retail investor, which has really qualified as somebody with over $5 million for all intensive purposes, is actually a force in the market,

which is why you have these crazy tax opportunities and crazy dynamics going on that for the first time are being talked about and paid attention to. I think tax alpha has been a bit overlooked. It's been a little bit like, you know, so many institutional investors and so many private fund managers,

you get trained to think about pre-tax returns. And it's a little bit like, oh, taxes, we'll leave that as an exercise for the reader. Or everybody's tax situation is different or it's too complicated or, you know, I'm legally not allowed to think about after tax returns. There's a whole laundry list of like excuses or reasons why nobody's focused on after tax return until now. And by the way, one of the reasons is you've got to have domain knowledge over more than one domain.

Like you've got to have all this knowledge about whatever the sphere of investing that you're good at is. You've got to be a good investor. And people spend an entire lifetime or an entire career focused on whatever they're good at is investing. But then wait a minute, you're saying, oh, I've got to be really good at taxes too. and most people out there are either good at investing or they're good at taxes. And so you've got to have cross-pollination and you've got to have dual domain knowledge to be an investor who's good at thinking proactively about how taxes fold into the investing that you do. And I think people are just starting to realize that because it's this huge, huge,

untapped opportunity. And you said investors have been trained on pre-tax returns. It's actually much worse. Investors have been incentivized on pre-tax returns. Investors have been incentivized on pre-tapped. tax returns. Every GP, we even talked about the taxable aspect of that, they are getting their carry and their management fees on gross, not on net. And it's actually even worse. Even if you did know the after tax returns, a cynic might say that that wouldn't even matter because that's not what you're being incentivized on. That's a really good point. It's a little more complicated than that because there are some very important legal and compliance reasons that crop in to how you incentivize or whether you can incentivize someone on after-tax returns. You know, you start getting into territory where then

the fund manager might be legally responsible for the taxes of the investors. That's a treacherous river to cross, I would say. But it's tricky in so many ways because the other challenge is the fiduciary challenge. If you're managing a commingled fund and you've got lots of non-taxable investors in there, you know, the traditional, the big fish, the pension, foundations, sovereign wealth funds, and to some extent the university endowments, those groups are largely non-taxable. There might be some little taxes around the edges, but as a first approximation, they're non-taxable investment. If you're managing money for them, then as a fiduciary, you actually can't manage money on an after-tax basis, because then you would not be necessarily optimizing

for what the non-taxable investors need. So the real answer is a product that's designed and optimized for taxable investors, in my view, really needs to be partition and not overlap with a non-taxable product. They're separate beasts. And you've got to approach it that way. Well, Jeff, this has been an absolute masterclass. Love what you guys are doing on real estate and at perennial in general. Looking forward to doing this again in person next time. David, this has been a lot of fun kind of trot out the nerdy side of what we're talking about here. And I really appreciate the chance to talk with you. And I'll look forward to talking again real soon. Thank you. you.