Carlyle believes it’s a good time to invest – especially in opportunity funds and shopping centres. Chris Bourke talks to chief executive Robert Hodges.
Carlyle Group is used to making headlines. In fact, there aren’t many days when the controversial global private equity firm – known for having employed high-profile advisers such as John Major, both George Bushes and George Soros – is out of the news.
Back in March, the private partnership, which has more than $82.7bn under management in 60 funds, suffered the embarrassment of seeing its Carlyle Capital hedge fund with $21.7bn of assets (mainly triple-A rated mortgage debt issued by Freddie Mac and Fannie Mae) go into liquidation, sending shivers through the world’s already unravelling credit markets.
In stark contrast, however, its European arm, which already runs two dedicated property funds, is attracting the kind of cash that would make most hedge fund managers weep. Last year, it took quoted company Freeport private and, last month, bought three shopping centres from Capital & Regional’s troubled Mall fund. It may now be targeting more distressed UK property companies.
The division, run by its youthful chief executive, 40-year old Robert Hodges, is boasting about having just closed the largest dedicated pan-European fund to date, one in a stream of so-called property “opportunity funds” aimed at taking advantage of falling property prices.
This new fund will be Carlyle’s third European real estate fund and closed last month after securing an impressive €2.2bn of equity from investors around the globe. It will be geared on a project-by-project basis, which Carlyle says will take its firepower to around €8bn. Quite a coup, for a commitment-shy market barren of debt.
“It was remarkably pain-free,” says Hodges, in a suitably pan-European accent he describes as Anglo-French, cultivated from spending much of the 1990s in Paris. “With a couple of exceptions, nearly all the investors from the second fund came with us. When we announced the fund’s closing in May, it sounded amazing that we had raised all that money in this market, but we first started thinking about the fund in the fourth quarter of 2006.”
Moving targets
Hodges is no time-waster, having already bought £1bn of assets across the Continent and splashed out $1bn on a portfolio of property debt. But he admits that the deal to buy Capital & Regional’s Mall portfolio was less than pain free.
“The Mall sale was complicated,” says Hodges. “While we were in talks with Morley and C&R, swap rates moved out by 130bps. It was just extraordinary. What made it more difficult was that values were moving at the same time – and our appreciation of where values were was probably different from theirs.
“So things changed a bit while we were looking at it, but we ended up getting there. We still talk to each other, but I’m glad it’s over,” Hodges admits.
Carlyle eventually agreed to buy the three shopping centres in Chester, Epsom and Edgware for £286m, at a 6% yield. The portfolio, which was being sold by C&R to avoid breaching bank covenants, was valued at £339m at the end of March, and the majority of Mall assets are valued at around 5%. It is understood that Carlyle originally offered £300m for the portfolio, but the price was chipped further after values continued to fall before it signed in June.
“When you’re in that due diligence process and when markets have been so volatile, it’s difficult trying to peg your final value because of all the different moving parts. It’s nice to get it behind you, and we plan on keeping these assets for five to seven years, or more. We know that the next 18 months are going to be pretty difficult in retail, but there is plenty we want to do at the centres,” Hodges says.
One of the biggest questions raised at the time of the Mall sale was: why would anyone buy UK retail when the news from the high street is so relentlessly gloomy? The sale to Carlyle was one of only two major UK shopping centre deals agreed in the second quarter, the other being British Land’s £116m sale of a Woking centre to a private investor.
“Those shops have the advantage of being really well located in their individual markets, and at least two have good value-add possibilities,” Hodges adds. “Sure, the sector’s going to have a difficult 12-18 months, but I think it will come back and I think these assets within that sector will perform well. They’re in areas where people have money to spend, over the long term.”
Therein lies the beauty of the private equity model in a falling market, says Hodges. While listed companies and funds have to concern themselves with the next quarter’s performance, the likes of Carlyle can bide their time, minus the distraction of public disclosure.
“You don’t have the same ‘constraints of valuation’ as a lot of public companies do,” explains Hodges. “We can have a business plan of four, five or six years when we buy an asset, and know we have the time to execute it. We have an overall view of where we’re going with each individual asset, and normally we can take the time to actually get there.”
However, the attractions of private equity have also been the sector’s biggest targets of criticism. The excessive profits, the gargantuan pay packets, the impenetrable veil of secrecy – the sector has been accused of these and a multitude of other sins by the press and politicians over the past two years. One year ago, however, the credit crunch suddenly killed off cheap debt and, subsequently, much of the sector’s dealings, especially its M&A activity.
“Carlyle is pretty active in providing information on investments. As an industry, we need to do that,” says Hodges. “Some of the criticism has been justified and some was just people knocking the sector – there’s always someone who’s earning too much.
Attractions bring criticism
“But the corporate side of private equity has become a different environment, there are far fewer deals being done and far fewer exits being made, it’s a lot quieter. But for real estate, it’s good to have that access to capital, to be able to make investments now.”
Moreover, Carlyle’s new fund is the latest in a string of so-called opportunity funds, with each one repeating the same old mantra of “there has never been a better time for cash buyers”. However, the big difference with Carlyle is that it appears to be putting its money where its mouth is. The majority of opportunity funds are yet to make their first purchase, despite having been launched over six months ago.
“There’s going to be a load more opportunities,” said Hodges. “We’re not at the end of the process of assets being sold by motivated sellers. The next six months should be pretty hectic, especially in the UK and Spain. We should see a real acceleration of things coming to market.”
Carlyle’s second pan-European real estate fund had 26% of its €743m portfolio in the UK by the time it was fully invested in the middle of last year. Hodges said he expects the third fund to have a similar, or greater, exposure to the UK. Aside from the Mall portfolio, the fund’s other UK assets are the two phases of the 675,000 sq ft Piccadilly Place office portfolio in Manchester, bought from Argent last summer for £110m.
Hodges is not ruling out more corporate activity in the UK either. It was over a year ago that Carlyle took the quoted Freeport private (see box) and a second deal could be on the cards. “I think there could be. The question is, when are values going to stop falling? Just in absolute terms, look at some of the housebuilders and see how their values have come off – it’s extraordinary. They still have some fundamental problems, which means they aren’t attractive right now, but at some stage they have to be,” he says.
“We’ve got the ability to do big deals by ourselves, or we have a European buyout team here and we occasionally look at deals together. We can vary in scale quite easily.”
Hodges said the fund may also buy some more property debt, following Carlyle’s very quiet purchase of a $1bn loan portfolio in May. The group signed a confidentiality agreement and will not disclose the seller. It was someone they are “friendly” with – and who is unlikely to be courting publicity about having to flog off discounted debt.
“There is loads of debt being offered to us. We haven’t done anything else yet, but we are looking. The bulk is coming from the banks – all the usual suspects.”
Freeport deal shows the benefits of private equity
One year has now passed since Carlyle bought troubled quoted property company Freeport, a developer of branded retail outlets in Europe. The group was widely acknowledged as being something of a basket case at the time. Although Carlyle actually dropped the bid in May last year, it was forced to continue with it after a stock exchange ruling.
Hodges says he has no regrets, and cites the deal as another example of why the private equity model has an advantage in real estate.
“We haven’t been talking about it much, precisely because a lot of people were talking about Freeport when it was in the public arena.
“Freeport had some major problems, in terms of both management and of assets. It had a liquidity problem and a bunch of unhappy shareholders that every month or every quarter were getting more and more unhappy. Its share price was punished by the market, and it was genuinely – as a public company – a pretty unhappy ship.
“There was actually no real intrinsic reason for Freeport to be a public company – it had three assets in very different locations.
“However, since we bought the company, we haven’t had those pressures. Both footfall and turnover have risen sharply, and we are building another outlet in France.”
