The distressed property loan market has a new player. Los Angeles-headquartered Oaktree Capital Management was named preferred bidder for Lloyds Banking Group’s £260m “Project Harrogate” portfolio, pipping a rival bid from Kennedy Wilson and Deutsche Bank for the latest prize in UK bank deleveraging.
The coup is a first foray into the UK’s non-performing loan (NPL) arena for the alternative investment private equity group. It is working with Capital & Regional as asset manager, with whom it jointly purchased the 1.1m sq ft Kingfisher Shopping Centre in Redditch for about £130m in April.
But despite nosing around the NPL market for the past six months and keeping an office in London since 1999, Oaktree is little known in the market. Purchasers of distressed loan books like to keep their heads below the parapet, so who is the other dark horse in the Lloyds saga?
The shroud of mystery surrounding the firm is drawn even tighter by a general unwillingness by usually garrulous commentators to talk about Oaktree.
Philip Cropper, head of real estate finance at CBRE, bucked the trend. However, because he was involved in Project Harrogate with a different client, he is bound by a confidentiality agreement. Nevertheless, he was able to say: “While the distressed market exists, I think [Oaktree] will be a more obvious feature in the UK. They have a lot of capital and are used to dealing with difficult situations – they are turn-around people.
“My sense is that they are trying to build a greater presence in Europe, as many private equity funds are. A lot of their clients want exposure to the wider global market. They see opportunity over here.”
Oaktree has 13 offices in 10 countries, including Amsterdam, Frankfurt, London, Paris and Tokyo. It has almost US$79bn (£49bn) of clients’ funds under management, with the lion’s share, 72%, in North America. Europe is its next biggest market, with about 15% or US$12bn invested.
NPL portfolio sales will become increasingly common throughout Europe, although the trend has generally been homeland led. Cropper adds: “We will see more, although to date it has been driven by the UK and Ireland – SocGen and Credit Suisse aside.”
Private equity firms that buy distressed loan books effectively do banks’ dirty work for them. Tens of potentially rough negotiations can be packaged up and sold to a third party with no legacy and no cuddly customer relations image to maintain. The hefty discount banks offer is far outweighed by removing a swathe of risky assets, freeing up Tier 1 capital and, perhaps, removing the need to deal with acrimonious clients.
‘Distressed opportunities’ has been an integral strategy for Oaktree since 1988, and is a business division it runs from its London, Los Angeles and Frankfurt offices. It has US$25.7bn of distressed assets under management, not including Project Harrogate, which, as Estates Gazette went to press, had not completed.
Oaktree’s ‘Real estate opportunities’ division has been going since 1994 and manages about US$5bn worth of assets. It has dedicated property personnel in its Knightsbridge SW1 office. No names as such, except former Segro chief executive Ian Coull, who became a senior adviser to the firm in April. Distressed and inefficient property opportunities are its main steer.
In 2010, Oaktree set up Knightsbridge Student Housing and has a stake in estate agents Countrywide. Those who are aware of Oaktree perceive it as “corporate”, in the sense that it will back a housebuilder or hotel group. However, trading in loan books is not new in the US and Oaktree is the serial loan trader.
Its Los Angeles-based head of global real estate, John Brady, said recently: “We derive important competitive advantages from Oaktree’s collaborative culture, including enhanced access to deal flow in terms of both volume and quality, and partnership opportunities with other Oaktree investment groups.”
Project Harrogate consists of 57 loans to 32 parties. The £260m price tag paid by Oaktree reflected a 60% discount on the nominal value of the portfolio, although the most recent valuation of the assets was only £310m.
Most of its distressed properties are outside London. There is a large office complex in the Channel Islands, the £53m, 372,000 sq ft Kingsgate shopping centre in Dunfermline, the £34m, 400,000 sq ft Vancouver Quarter shopping centre in King’s Lynn and the £31m, 250,000 sq ft Rushes in Loughborough. These assets reflect the portfolio’s major worth. The remainder is a mixed bag of office, industrial, hotel, high-street retail and residential in Scotland, Northern Ireland and England. Many assets are already in receivership and the average loan-to-value ratio stands at 200%, showing how far capital values have fallen.
Oaktree is an IRR-driven investor – its primary objective will be to sell. With the assets it doesn’t liquidate or get rid of immediately, it will make a net present value calculation. If it has to invest cash in a scheme, it will want to know exactly how long before it makes a profit.
It will actively manage a proportion of the assets, to deliver returns by change of use, redevelopment or refurbishing and reletting. If it feels the borrower is not behaving properly, such as not selling assets quickly enough, it will appoint administrators. Regardless of its exact approach, it will want a significant proportion of the loan book sold within 12 to 18 months and take a longer-term view with only a few, high-potential assets.
This approach reflects its broad investment philosophy. Oaktree focuses on inefficient markets, such as those seen in the UK in recent years. It states in its prospectuses: “Investment opportunities in distressed debt typically arise as a result of lowered credit standards and the unwise extension of credit, followed by the onset of economic weakness or some other igniter.”
Oaktree doesn’t macro-forecast and is not concerned with how interest rates or inflation will affect its assets or its tenants’ ability to pay rent. Rather, it takes a bottom-up approach, preferring to have in-depth knowledge of obligated companies and their securities.
The company prioritises preventing loss: “If we avoid the losers, the winners will take care of themselves.” Perhaps easier said than done and somewhat counter-intuitive – a risk-averse investor in intrinsically risky assets. Suffice to say, securing assets at rock-bottom prices is central to its strategy.
One senior property figure with direct contact with Oaktree who wanted to remain anonymous says: “They look for 20%-plus IRR returns and prices have to fall to hit that return.
“But they are good people – your classic American private equity house – doing what many other private equity houses operating in this area are doing – looking at distressed loan deals.”
The difference is that Oaktree Capital Management is now taking part in the UK game rather than spectating.
