Talking Top Quartile with Kathleen McCarthy of Blackstone Group

The vintage 2007 Blackstone Real Estate Partners VI (BREP VI) drew in $10.9 bln when it wrapped up in early 2008. The fund turned in a net IRR of 14.2 pct, as of September 2014. A 2015 analysis of public pension fund data by Buyouts showed a top-quartile IRR threshold of about 9.2 percent and a median IRR of 2.9 percent, based on a survey of 33 real estate funds from the same vintage. More recently, the fund turned in a net IRR of 15 percent as of June 30, according to quarterly filings from Blackstone Group.
Kathleen McCarthy, senior managing director and chief operating officer at Blackstone Real Estate Group, spoke to Buyouts about the fund in an Aug. 18 phone call.
Blackstone Real Estate Partners VI LP ranked as the largest real estate opportunity fund ever raised. Why the strong interest?
Fundraising is never easy, but overall it was a pretty good environment. We started raising it in 2007 and had a final close in early 2008.
When we started the fundraising process, we had the fund’s first deal, Equity Office Properties, identified, as a $36 billion transaction.
Investors love having deals pre-identified when they’re committing capital to a fund, even in cases when it’s a smaller percentage of a fund than Equity Office Properties was. They like to go to their investment committees and tell them, ‘we understand what these people are trying to do and here’s a good example of that.’’’
Which BREP VI deals drove performance?
One of the most remarkable things about this fund was — and we’ve talked about this frequently — 40 percent of the capital was invested prior to the Lehman Brothers bankruptcy, concentrated in Equity Office Properties and the Hilton take-private.
We had the fund well-deployed prior to the Lehman bankruptcy. And these transactions ended up doing extraordinarily well. Hilton Hotels is the most successful private equity buyout ever with greater than a $10 billion gain. The same with Equity Office Properties. It’s very rare that transactions at that time and of that size would have done so well.
Hilton Hotel, Equity Office Properties, Brixmor Property Group Inc and IndCor Properties Inc: Those were game changers for that fund and that vintage.
Describe Brixmor and IndCor.
Brixmor (NYSE: BRX), was a $9 billion deal in total value. We did it in June 2011. It was a shopping-center company with a very complicated capital structure. It was also over-leveraged, with very little capital to invest in leasing. We bought it, cleaned up the capital structure, simplified the business, invested capital behind leasing and we took it public. We just sold our last piece of Brixmor a few weeks ago. [The offering raised $1.16 billion on Aug. 10.] Brixmor resulted in a $4 billion gain.
With the other large transaction, IndCor, a warehouse landlord, through 18 acquisitions we built a portfolio of logistics facilities that we sold for more than $8 billion. That was a strong performer.
How did you guide these companies through the economic disruptions of 2008-2010?
Beside the fact that we bought great companies and real estate, they were financed … and built to withstand a crisis. We never anticipated the magnitude of what we lived through. We got back to investing before others did. We were looking at how things were playing out.
While there was not an all-clear signal when we invested again in the fall of 2009, we had confidence based on what we saw in our portfolio. We thought we were going to come out of the downturn. We were pretty active investors at a distressed point of the market. We were able to get great value.
What made you think it was safe in 2009?
We are really students of the data coming out of our own assets. We are a highly communicative team. We communicate like bees, the CEO of Hilton said. We were paying very careful attention to what we were seeing … not only inbound calls from prospective tenants. We also tracked conversations with tenants about their lease renewals.
In the summer of 2009, the team started to feel like we were no longer in a situation where the knife was falling. We knew that from our own investments that we were managing. It gave us confidence that it was time to start new transactions. We’re always focused on where we’re buying relative to the replacement cost of an asset. We like to be at a discount to replacement cost.
We’ve seen — in every real estate cycle — asset values revert toward replacement cost. They have to do that for any developer to justify new investments. If you can do that, you have an advantage. We saw the opportunity to buy assets, many of which had a host of things going wrong around liquidity issues. We were able to buy at a very high discount to replacement cost. That gave us confidence that we were in at a very safe level.
Any key additions to the team in this period?
The financial crisis presented an opportunity for our business not only in terms of investment but in terms of talent. Our traditional competitors, generally the largest financial institutions in the world — AIG, Goldman Sachs, Lehman Brothers — many of these groups got out of the real estate business for one reason or another. What that allowed us to do was identify great talent that otherwise may not have gone to Blackstone.
Throughout the life of BREP VI, we doubled the size of our team. We had 100 people and were approaching 200 when we concluded the investment period of the fund. I came over in the fall of 2010 after working at Goldman Sachs. James Seppala, senior managing director, real estate, is another Goldman Sachs alum [and] is now our head of European acquisitions. Also, Nadeem Meghji, co-head of U.S. acquisitions, came over in 2008 after working at Lionstone Group.
How did BREP VI contribute to the firm’s evolution?
This fund was pretty unique in its vintage. It got a lot of attention from LPs and the press because of its size and a couple of newsworthy transactions.
Coming through the crisis with such a great performance … really demonstrated to our LPs that we had built a very special business that really knew how to manage risk and to really take advantage of opportunities.
Because many of our competitors in real estate went away, we became a more unique business around the world. BREP VI allowed our real estate business to become a bigger part of what Blackstone is.
Prior to the financial crisis, everyone thought of us as a private equity buyout firm. The real estate unit has become a bigger part of the firm’s overall performance. People on the outside became more conscious about what we were doing. After the BREP VI fundraise, we were able to work with new LPs who hadn’t invested with us in the past. Their curiosity was piqued and they’ve become LPs since then. It allowed us to grow our capital and work with more LPs.
You’re now among the most senior real estate investment professionals at Blackstone Real Estate. What do you bring to the table?
My transaction, investor relations, and fundraising experience has been very important in my current role as global chief operating officer, serving as a main point of connection to coordinate efforts between many different aspects of our business. To produce great results, it’s critical that our talented team operates within a well-managed, highly communicative and meritocratic organization. I’m grateful to have found a group of partners who share those values and have empowered me to promote them within our business.