Real Estate Rebound Brings Deals, Fresh Capital

  • Dozens of 2013 deals tied to construction, real estate
  • Buyout firms exiting older deals
  • Blackstone leads fundraising parade

Acquisitions continue at a steady pace, not only for actual real estate assets, but also for targets in construction, materials and services tied to real estate. Among the signature deals this year, London-based Woolgate Exchange was purchased by TPG Capital and Ivanhoe Cambridge for $420 million, while Berkshire Partners LLC invested in SRS Distribution Inc, the fourth-largest residential roofing distributor in the United States, for an undisclosed sum.

Exits also remain on tap, as sponsors cash in on investments made during the depths of the financial crisis to sell to strategic buyers and other private equity firms that see opportunities for more growth ahead. The window for initial public offerings remains open as well. Sponsors able to take advantage of the strong exit markets for real-estate-related deals include The Blackstone Group, Sun Capital, The Carlyle Group, Bain Capital and Clayton, Dubilier & Rice.

Focusing on one indicator of activity — buyouts of construction material firms — the year has seen seven deals by U.S. sponsors thus far. If the pace continues in the second half, 2013 will mark the second-busiest year for the deal category since 2007 after 15 deals in 2012. During the depths of the financial crisis in 2009, only nine construction materials deals closed, down from 13 in 2007 and 11 in 2008 —see accompanying table.

And fundraising appears to be healthy, with sponsors launching real estate vehicles and big pension funds such as the California Public Employees Retirement System stoking limited partner interest with reports of double-digit returns in their property portfolios in the past fiscal year.

On a macro-level, sponsors and their clients have benefitted from rising residential and commercial real estate values, which hit an all-time high in December, 2007, dropped to a trough in January, 2010 and started to recover after that. Values have risen about 35 percent since the depths of the financial crisis, according to the Moody’s/RCA Commercial Property Price Indices.

To be sure, some investors remain skeptical that real estate is the road to quick riches. Brian Gallagher, co-founder of TwinBridge Capital Partners, a Chicago advisory shop, cautioned that the economic recovery remains sluggish. “The climb back for housing and construction has been very slow and is still well below the industry’s expectations,” Gallagher said in an email to Buyouts. “This has caused hold periods on these investments to be very elongated and returns lackluster.”  

Adam Blumenthal, managing principal of Blue Wolf Capital Partners, nailed down two building supply-related purchases from his new $300 million fund, Blue Wolf Capital Fund III, but he’s not sure if he’ll find any more low-hanging fruit. “We do see pricing in that area increasing quickly so I’m not sure how many (more) we’ll be able to do,” he told Buyouts.

But others feel like now is the time to pounce. “When something drops so far and it starts to come back up, you’re going to make a lot of money-—that’s what’s happening now,” said Jerry Gates, managing director at Hamilton Lane, a private equity adviser to the Los Angeles City Employees Retirement System, Wyoming Loan and Investment Board, Louisiana Teachers’ Retirement System and other big institutional investors.

While interest rates aren’t expected to go any lower than they did in the first half, a recent spike tied to jitters over the U.S. Federal Reserve’s plan to taper its Quantitative Easing program has eased back. Moving to diffuse concerns by Wall Street, The Blackstone Group President and Chief Operating Officer Tony James said July 18 that economic expansion will help property values increase, even if interest rates rise.

“It’s really driven by the fact that there’s just very, very limited supply and it doesn’t take much economic growth to start to drive this,” James said. “And we’ve got enough economic growth.”

Momentum Building

While the overall M&A market remains subdued, buyout firms have delved into a variety of deals aimed at tapping into the lack of supply and expected uptick in the housing market.

An informal survey of the estimated 579 leveraged acquisitions in the first half of the year by Buyouts turned up 55 deals either tied to real estate, construction materials or services in the first six months of the year—see accompanying table.

Blackstone Group ranked among the more active deal makers with three acquisitions, including a warehouse in Orlando, assets from GE Capital real estate retail fund in Poland and $242 million for First Potomac Realty Investment LP, an industrial properties portfolio based in Virginia. The largest disclosed price on the Buyouts list came from the $420 million acquisition of U.K.-based Woolgate Exchange, an operator of office buildings, by an investor group comprised of Ivanhoe Cambridge Inc and TPG Capital LP.

Buyout pros said they see enough gas left in the tank of the U.S. real estate rebound to pursue fresh deals. Conner Searcy, managing partner of Dallas-based Trive Capital said it remains a “ripe time” to invest in building products. Trive Capital just closed its first fund in five months with $300 million in commitments.

While home construction has risen to its highest levels in years, housing starts could rise another 60 percent to 70 percent from current levels and still remain at historic rates.

“There’s very few end-segments that large with that kind of growth potential,” said Searcy, who founded the firm after working as a partner at Insight Equity. “We really like lumber, doors, flooring, roofing—anything that represents the guts of a home.”

Outside of companies with businesses tied to real estate, private equity firms continue to sift for property investments.

Partners Group said competition remains high for trophy properties in prime central business districts, but it sees more opportunities in non-prime properties suffering from mismanagement or recent tenant losses, according to the firm’s private markets summary for the first half of 2013.

“We believe select investments in this market segment present compelling opportunities to acquire assets that possess significant upside potential to be created through asset management,” Partners Group said. “In the U.S., our investment focus will remain on areas that are poised for recovery and possess unique real estate fundamentals, including the Southeast, West and Midwest, while likely avoiding the Mid-Atlantic and areas of the Northeast that have already experience a pronounced recovery in property pricing.”

Early Winners

Sponsors savvy enough to wade into the real estate and construction sectors in recent years may have missed out on peak selling prices in late 2007 and 2008, but purchase price valuations in 2013 have set the stage for handsome returns.

Sun Capital’s pending $542 million sale to Japan’s LIXIL Corp. of ASD Americas Holding Corp., the parent of iconic bathroom fixture brand American Standard, will close later this year after being announced on June 28.

Purchased from Bain Capital in 2007, it ranks as one of Sun Capital’s largest exits and suggests more potential deals to come from buyout firms with businesses linked to the U.S. housing recovery. Sun Capital’s limited partners “are very pleased” at the deal price of 13 times EBITDA and a roughly 3x return on originally invested capital on the American Standard deal and 2x on the total invested capital, said Leder.

“Remodeling and housing starts are growing finally, after a trough a year and a half ago — that was one of the elements that drove the deal,” Marc Leder, co-CEO of Sun Capital, said in an interview.

The IPO market also beckons for exits related to the real state upturn.

HD Supply, the building and industrial products distributor, ranks as the fourth-largest U.S. IPO this year with proceeds of $957 million. The June 26 IPO priced at $18 a share and has risen to nearly $20 since then, delivering a healthy post-IPO return for sponsors including The Carlyle Group,Clayton, Dubilier & Rice and Bain Capital.

TPG Capital LP and Oaktree Capital Management saw portfolio company Taylor Morrison Home Corp, a leading home builder, raise $629 million in an April 10 IPO. The stock now trades at $25 a share after debuting at $22.

“The company expects to benefit from the steady and broad-based housing market recovery, which continues to boost both demand and prices despite recent concerns over rising interest rates,” analysts at Zacks said in an upgrade of the stock to strong buy.

Home furnishings retailer Restoration Hardware Holdings Inc marks another real-estate related boost, with the portfolio company from Catterton Partners and Tower Three Partners LLC now trading at around $70, well above its IPO price of $24 a share on Nov. 5, 2012.

And coming up in the IPO pipeline: Blackstone Group filed an IPO for Brixmore Property Group, the second-largest U.S. shopping center landlord in a deal expected to raise $700 million, according to research firm Renaissance Capital LLC.

Fundraising

As major institutional investors turn in solid gains on their real estate investments, limited partners appear to be receptive to a slew of fundraising efforts by private equity firms.

Boosted by rising property values around the U.S., CalPERS and the California State Teachers’ Retirement System reported gains of 11.2 percent and 14.1 percent respectively in their real estate portfolios in the fiscal year ended June 30. The Maryland State Retirement and Pension System said its real estate portfolio generated a one-year return of 12.6 percent.

All told, a total of $19 billion was raised by real estate funds globally in the second quarter of 2013, according to Preqin. Outside of a $27 billion surge of real estate fundraising in the fourth quarter of last year, the second quarter’s fundraising total marks the fattest three-month dollar figure since late 2008, according to Preqin. North America-focused funds comprised the bulk of the activity, with 27 funds raising $15.6 billion in commitments.

Topping the list of top funds closed in the second quarter, Lone Star’s Lone Star Fund VIII raised $5 billion to invest in opportunistic distressed debt tied to residential, single-family homes in the U.S., Europe and Japan. In the No. 2 slot, Starwood Capital Group raised $4.2 billion for Starwood Distressed Opportunity Fund IX, a diversified opportunistic distressed debt fund aimed at the U.S., Brazil and India.

Competition remains steep, however, with 443 funds in the market and on the road with a combined fundraising target of $163 billion, according to Preqin. About 36 percent of those funds have been marketing for more than 18 months.

Among the funds in the works, Kohlberg Kravis Roberts & Co confirmed in April it’s setting the stage for its first real estate fund after reports surfaced it’s targeting $500 million to $1 billion for the fundraising effort. In an investor update in May, KKR said it’s focused on preferred equity and mezzanine investments in the U.S. and Western Europe. The firm also said it has committed $650 million of equity in 10 transactions.

Scott Nuttall, global head of capital and asset management at KKR, said the firm plans to “club together a group of investors, drop some of those investors into the fund and seed it with investments off our balance sheet.”

The fund would come after a variety of real estate investments by the firm, including a plan announced late last year to team up with Pfeffer Capital and CP Realty to develop housing on 164 acres in Williston, N.D., to meet residential demand fueled by oil and gas production in the Bakken region. Plans for The Ridge at Harvest Hills include up to 500 single family, townhome and duplex homes, along with up to 330 apartments.

Oaktree said recently that fundraising is “going well” for its Oaktree Real Estate Opportunities Fund VI LP, with $750 million taken in as of April. Oaktree expects to hit a $1.5 billion target before the end of the year. The fund group focuses on global investment opportunities, including direct property investments; corporate investments; commercial mortgage-backed securities; residential land, assets and loan pools; small balance commercial loan pools; and non-US investments.

Carlyle Group is reportedly planning to launch its seventh real estate fund with a target as high as $4 billion, according to reports. Carlyle Realty Partners VI, its predecessor, raised $2.3 billion for investments in the residential, hotel senior living, retail and office sectors in major U.S. markets.

Also in the mix: TPG Capital may seek $1 billion for its real estate fund, which will aim to acquire real estate firms and large groups of buildings instead of piecemeal properties, according to reports. Lone Star told Oregon pension fund officials in May that Lone Star Real Estate Fund III could raise as much as $6 billion for distressed debt and equity tied to commercial property.

Blackstone Group remains in a class by itself, with its $13.3 billion Blackstone Real Estate Partners VII, its latest core vehicle to invest in a wide variety of asset classes and geographies. That vehicle closed late last year.

Blackstone Real Estate Partners Asia marked its first closing on June 7 with $1.5 billion, but Blackstone expects to raise $4 billion in total for real estate investments in China, India, Australia and Japan, according to reports.

In one relatively new tack, Blackstone invested about $5 billion in 2012 to buy more than 30,000 single family homes in the U.S. available for rent under the brand name Invitation Homes.

But as private equity firms hotly pursue deals, some already expect a blow-up down the road. Al Rabil, CEO of Kayne Anderson Capital Advisors’ private equity real estate unit, has been following the property business since the 1980s. He focuses on less-cyclical parts of the industry such as student housing, senior living and medical space.  Easy credit is fueling pockets of strength in the real estate market, but it’s not necessarily a healthy trend, he said.

“With the Fed easing and (relatively) free money around the globe, we’re building toward another bubble,” he said. “How harsh it ultimately is depends on how long it goes on. It’s unavoidable. It’s just a question of when and how bad.”

Plenty of bullish sentiment remains. After closing the acquisitions of building supply firms Suwanee Lumber Co and Twin Rivers Paper Company Inc, Blue Wolf Capital’s Blumenthal sees more expansion in the U.S., particularly in hotter real estate markets such as Florida.

“We do see ongoing growth and a rebound,” he said, despite some reservations about dealÐ competition and pricing. “When you look at the underlying data on household formation and the housing stock you have to conclude that demand is going to continue to be very strong.”

Buyouts Editor-In-Chief David Toll contributed to this report.