A version of this article first appeared in the CNBC Property Play newsletter with Diana Olick. Property Play covers new and evolving opportunities for real estate investors, from individuals to venture capitalists, private equity funds, family offices, institutional investors and large public companies. Sign up to receive future issues straight to your inbox.
Fernando de Leon, founder of Leon Capital Group, started a small real estate development company with $100,000 in 2004 and turned it into a $10 billion company focused primarily on commercial real estate. He did this, he says, by predicting distress, observing sources of capital and relying on his Harvard degree in evolutionary biology.
While others lost their shirts in the great financial crisis, De Leon began to make his fortune. He left his job at Goldman Sachs to start his own company and made some deals in residential real estate development. A year later, he said, he saw some of the first signs of subprime mortgages and overbuilding that this would be “a difficult cycle change.”
“We basically said, look, we're seeing things here that are fundamentally wrong. We're going to take these real estate positions and sell them and then wait and see what happens,” De Leon told Property Play.
“We divested, we brought some liquidity back, and then we kind of waited it out, and then we became fixers from 2008 to 2012. We became people who were able to talk to banks, life insurance companies, companies that had credit exposures, and we were able to solve problems for them,” he said.
De Leon said he turned around projects that had stalled and become problematic for lenders. The experiences he now says influenced his thinking in the first years of the pandemic.
“In 2021, we sold a lot of multi-billion dollar properties because prices were high, and that was a result of low interest rates, euphoria and poor incentives in the market,” he said. “Part of it is understanding where the capital is coming from. You start to see market participants that shouldn't be there… and as they match up and that winds its way through the supply chain, you start to notice distortions and pricing.”
Now, De Leon said, he sees the same red flags waving over data centers.
The problem with data centers
While big players like Blackstone, KKR and Bain Capital are buying in, De Leon said he's sticking around.
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“What I can't quite understand is the role of the data center. I'm looking at a data center that's worth $10 billion, right? First of all, there haven't been any exits above $4 or $5 billion, you haven't seen any comparisons, so that worries me quite a bit,” he said.
“Then I see big tech companies, the biggest companies in the world, with a market cap of $4 trillion, saying, 'I don't want to own that asset. I don't want that on my balance sheet.' So I ask: Why? Why doesn’t the largest company in the world want to own its own assets?” DeLeon said. “The AI business is everything to them today, to the big hyperscalers, and so they say, 'No, you build it, you finance it.'”
De Leon suspects that what's in these data centers, the artificial intelligence technology, will quickly become obsolete. After all, AI is designed to make everything more efficient, including itself. And the value of the centers lies not in the four walls, but in what is inside.
He suspects that these 15- and 20-year leases that developers are relying on are “Swiss cheese” leases that are riddled with gaps in the agreement over time.
De Leon said his biggest concern is that large private equity investors are getting the money they manage from teacher, police and fire pension funds.
“If they say, 'I'm going to own this asset and lease it back to one of the hyperscalers,' they're putting other people's money at risk,” he said.
Evolutionary Biology in CRE
De Leon started in real estate as a teenager, working as a translator for a local developer in Texas. Instead of receiving a salary, he demanded participation in a project. And instead of getting a business degree, he chose evolutionary biology because understanding people was good business, he says.
“It was forward-thinking. I mean, it helped me make decisions about organizing businesses and running and building businesses,” De Leon said. “I think some of these things are about incentives, right? Basic commercial interaction between people is about incentives.”
He said this was particularly true in industries where there were established players.
“You always find a status quo group of incumbents that have certain advantages,” he said. “If we understand it from a sociological perspective, we can say, 'Okay, this company should compete on this basis. This is where we can win,' by looking outside the corner, so to speak.”
Big opportunity ahead of us
De Leon said he's excited about how much more capital is flowing into commercial real estate – from asset management firms, family offices, sovereign wealth funds and pension funds.
“If allocations to real estate increase from 3% to 6%, that number means about $4 trillion more capital is chasing a limited number of real estate assets,” he said. “When that happens, you get an oversupply of capital and a rise in prices for fundamentally sound real estate assets. And I think the story of the next decade is going to be that real estate capital markets are going to grow 10-fold.”