Despite the fact that real estate assets are oftentimes substantial money makers for private equity firms more readily known for their buyout activities, they hardly ever get mentioned. However, in the past few months, with deal volume down and fund raising a pain, real estate has been getting more attention from limited partners and general partners alike. This isn’t to say that fantastic real estate deals abound or that every firm should have a real estate fund, but activity in the sector is worth taking a look at, especially since the process in which real estate funds are raised and the deals are carried out is practically indecipherable from the way buyout funds and deals are managed.
A few firms with buyout vehicles as well as real estate vehicles include The Blackstone Group, Apollo Advisors, the Carlyle Group, Goldman Sachs & Co., Landmark Partners and Credit Suisse First Boston. It’s no secret the strategies behind these two vehicles are only differentiated by a thin gray line – the money is raised in the exact same way, from the exact same people and institutions, invested at about the same pace and expected to yield comparable returns.
“The buyout business and the real estate business are both valued on the same metric – cash flow,” says Tom Saylak, co-head of Blackstone Real Estate Advisors. “If you look at an office building or a company that makes specialty chemicals, they’ll both get valued on multiples of Ebitda, not by some quirky venture capital-oriented valuation metric where you have to value the business at 200 times the year 2050’s revenue.”
Finding the Roots
There’s actually a good reason for why firms like Blackstone, Apollo and Goldman, which started out as something other than real estate investors, took on a real estate initiative. It stems from the real estate collapse of the late 1980s. With the collapse, the conventional buyers and sellers of real estate assets were virtually wiped out, leaving financial engineer type firms with a way to get their foot in the door.
These financial firms, sporting pristine records in terms of real estate, were the only ones left that were capable of taking advantage of the assets being sold by quasi-government agencies and the like. Noticing the opportunity to strike, one thing stood in their way – their lack of experience in the sector. But creativity was key in allowing them to pick up the pieces of the broken real estate market. Blackstone, Apollo, Hicks, Muse, and George Soros . . . they all did the same thing. They reached out to the relatively young people that weren’t completely shell-shocked by the devastating turn in the real estate cycle, and brought them on board. This worked out well at the start – the firms gave their new hires a base of capital that allowed them to act in an opportunistic-, or vulture-, type way, collecting distressed assets at a cheap price.
But like many buyout firms that start out buying companies on a deal-by-deal basis, the financial firms realized they couldn’t get involved in real estate on any significant kind of scale without a team and a vehicle. While the stories of the separate firms take a few different turns from this point on, at least in the case of Blackstone, a team of partners was hand-picked, partner by partner, says Saylak, and a new product was developed. The firm realized that getting involved in real estate on a permanent basis would “expand its assets under management and increase its profits as a partnership.”
Sources of Money
As real estate funds have evolved and interest in the sector has become consistent, the amount of capital made available to those looking to raise it, has also increased.
Just last year and continuing this year, pension fund after pension fund has upped its allocation to real estate, just in time for several significant real estate fund-raising efforts.
“Fund raising is picking up some momentum and real estate is back on everybody’s radar screen,” says Tony Roscigno, a partner at Landmark Partners, which is currently raising Landmark Real Estate Fund IV, its third real estate secondary fund. “People are finding it to be very attractive again, both on the secondaries side and the direct side. There are a lot of interest and new commitments being made.”
To be sure, New York Sate Teachers’ Retirement System revised its asset allocation this year and increased its real estate target to 6% from 5%. Also, the $12.2 billion Illinois Universities Retirement System of Champaign, Ill. increased its real estate allocation by 1% in February and two pension plans in Indiana, the Indiana Public Employees’ Retirement Fund and the Indiana State Teachers’ Retirement Fund made significant increases to their real estate percentage.
Sources say, however, that it is important to note that while real estate allocations are increasing, so are allocations to alternatives. One might think, being so closely related, that the two would have adverse effects on each other, but that is not the case. Instead, the two are rising together.
In fact, LP sources say they feel comforted by the fact that they can invest in real estate and buyout funds with the same firms in many cases.
One LP, who declined to speak on the record, said he expected his real estate investments to perform better this year than many of his other investments, for the primary reason that real estate funds are being proactive in investing in Europe.
And this LP is not alone in his thinking. Barton Biggs, chief global strategist and chairman at Morgan Stanley Investment Management, says he thinks pension funds and major institutional investors should allocate 15% of their funds to global real estate. It will be the only major asset class that could deliver double-digit returns over the next five years, he says.
“Even low double-digit returns are going to be hard to come by in stocks, venture capital and private equity,” he says. “In the long run, say 20 to 30 years, we all recognize that equities are the place to be, global real estate could return 10% to 14% per annum over the next five years and its probably the most effective inflation hedge.”
In case you’re wondering, the worldwide real estate market is $4.2 trillion, according to Morgan Stanley reports. That’s almost 60% bigger than the global equity market of $2.7 trillion, of which publicly traded real estate securities are less than 2%.
No Coverage Here
No matter how much attention investors or private equity firms give to real estate now or in the future, Buyouts will continue its policy of only including real estate stories and statistics when they are likely to affect the buyout market and its players.