KKR, TPG Eye Real Estate Funds In Diversification Move

While real estate hardly offers certainty some five years after collapsing property values triggered the demise of Lehman Brothers, some of the clouds around housing and property values have started to clear at a time when buyout firms face competition for fresh dollars from limited partners.

“The market is looking for some combination of decent valuations on real estate and yield,” said Ken Lehman, managing director, Kendall Investments, an independent private-equity investment specialist. “It seems to be a good time to try to accomplish both of those and that’s why you’re seeing some new funds.”

Nan Leake, a partner at Partners Group and a specialist in private real estate, said limited partners are under pressure to find yield in a low-growth environment. “In the large space, there’s a dearth of players” after the financial crisis, she said. “Through their success in the private equity platform, they can cross-sell with their existing client base.” But she warned that real estate demands a “different skill set” that may not guarantee huge success by a private-equity player. Risks include “fully priced” valuations on many real estate properties and challenges posed by a possible rise in interest rates.

Irwin Loud , chief investment officer of private equity fund-of-funds specialist Muller & Monroe and the former head of private equity at the Florida Pension Fund, said it’s not surprising to see big funds wading into real estate.

“This follows a trend in the industry of trying to capture market opportunities where there’s an arbitrage opportunity,” he said. “In real estate, there’s a pocket of inefficiency due to the overhang of distressed properties.”

In a favorable sign for the future of these new funds, 41 percent of the 500 institutional investors that took part in the 2013 Commonfund Investor Outlook Survey plan to increase their allocation into the real estate sector over the next 12 to 18 months.

KKR & Co. plans to launch its first fund focused primarily on real estate investments with a $500 million commitment, according to a Bloomberg report citing two people familiar with the matter. KKR spokeswoman Kristi Huller declined to comment.

Scott Nuttall, head of KKR’s global capital and asset management group, highlighted the firm’s diversification moves into real estate and other areas in a presentation to Wall Street earlier this month. KKR’s newer business lines such as energy, credit, direct lending and real estate investing offer “a lot of running room” for growth, he said at the time.

Nuttall told analysts last summer that KKR had committed $300 million to real estate “ahead of having a fund basically to build a portfolio and start to build a track record in that space, and then we’ll go out at some point [to] talk to to third-party capital in joining us in that endeavor.”

KKR named Ralph Rosenberg, a former partner at Goldman Sachs Group, as head of its real estate group back in 2011. The firm, founded by Henry Kravis and George Roberts, has moved to buy the Legends Outlets in Kansas City for $132 million, paid $196 million for the Yorktown Center shopping mall near Chicago, and teamed up to invest in a residential home project in North Dakota to serve the booming population of oil workers in the region.

Also jumping into the property pool, TPG Capital is readying the launch of its first real estate fund with a goal of more than $1 billion, according to a report by The Wall Street Journal. TPG spokesman Owen Blicksilver declined to comment. The fund would follow more than $2 billion in equity channeled into real estate by the firm since 2009, including a $200 million PIPE investment in Parkway Properties.

Meantime, Lone Star Funds, the specialist in distressed real estate founded by John Grayken, is raising a new property fund, Fund VIII, with a $5 billion target, according to reports.

Still, these funds would be dwarfed by The Blackstone Group, which announced the closing of its Blackstone Real Estate Partners VII with $13.3 billion from 250 investors late last year. “The current environment provides a highly attractive opportunity to generate favorable returns,” said Blackstone Group, whose real estate unit managed more than $50 billion in equity. Blackstone Group has been investing in foreclosed single family homes, for example.

The latest move by Blackstone Group comes after the vintage 2007 Blackstone Real Estate VI rang up an investment multiple of 1.21 as of April 30, 2012, as one of the top performing real estate funds tracked by Buyouts—see accompanying chart.

But such gains have been rare among real estate funds after running into a real estate price buzz saw in the wake of the 2008 financial crisis. Among the 33 real estate funds from private equity firms tracked by Buyouts, the average investment multiple stood at 0.81 as of April 30, 2012. Much of the performance data comes from the New Jersey state pension, which appears to have invested money at the height of the real estate market, just ahead of big drops in property values..

Only eight carried an investment multiple more than 1.0. Among those, the top performer is the vintage 2001 Carlyle Realty Qualified Partners II LP, which turned in an investment multiple of 2.1 and an internal rate of return of 28.1 percent. That fund earned a No. 1 ranking among the funds in the California Public Employees Retirement System’s Vista portfolio. (See Jan. 2 issue of Buyouts).