US investors are rich, keen – and over here

This year, the long-awaited American funds have landed in Europe, in force. By Alex Catalano. Over the last twelve months a mind-boggling $1.9bn of real estate and property-related debt has been snapped up by US buyers. American real estate funds have vacuumed up FFr 5bn worth of distressed French property and loans, taken a stake in Sweden’s Castellum and bid for the military housing being sold off by the UK government. The US’ giant Teachers pension fund has bought in the UK and is eyeing France, while investor-developer Gerald Hines has acquired the nucleus of a pan-European shopping centre portfolio with his investments in Trema and Diagonal Mar. There are two distinct paths that this cash is taking. The first is the traditional direct equity route of buying assets, mainly in a partnership or club, to hold for the medium term. The second, which has arrived with a vengeance this year, especially in France, involves shorter-term opportunistic purchaser: the “vulture” fund. These can be ad-hoc groupings that come together to take advantage of specific deals, or more formal funds put together by individuals or Wall Street investment banks. The former category includes the consortium that swooped on Canary Wharf in 1997. It consisted of Cargill, one of the US’s largest private companies, and two wealthy American businessmen: Larry Tisch and Michael Price. Along with the Saudi Prince Al-Waleed bin Talal, Edmund Safra and Canadian developer Paul Reichmann, they bought the 4.5m m2 development in London’s docklands from the banks that had foreclosed on it. But this year it is the real estate funds like Goldman Sachs’ Whitehall and Morgan Stanley’s that have made the big splash. Set up by investment banks or astute individuals, they raised a large pool of money – much of it from mainstream institutions like pension funds – for opportunistic investment in property. This money is not looking for traditional equity investment in real estate: it is venture capital. As LaSalle Partners International’s European managing director Van Stults says : “They couldn’t care less for property itself as far as the characteristics it brings traditionally as an asset class. They are completely driven by returns – typically over 20% on equity capital, and they use gearing to a high extent.” The time span is also short: typically three to five years. The model that is being followed is the successes scored by similar vehicles in the US. In market shake-out of the 1980s, they were able to buy large portfolios of distressed loans and property from the Resolution Trust Corporation and other owners at large discounts. The portfolios were tidied up, repackaged, and sold back into a rising market. But the rebound in the US markets means that this venture capital has to look for new outlets if it is to continue earning the return investors expect. Today, competition has driven returns down to 10%-15%pa rather than 20%-30%. Hence the interest in Europe. These investors like big transactions, where they can acquire large portfolios at a significant discount. Currently there is a feeding frenzy in France, where the shake-out of the financial and institutional market is providing suitably big opportunities. “You can’t walk down the Champs Elysées without running into US investment bankers and their lawyers,” noted one adviser. The last 12 months have seen FFr 6.2bn of property and property-related debt go into US hands. The biggest investor in this arena to date is Goldman Sachs’ Whitehall Real Estate Fund, which has scooped two big portfolios from Credisuez and insurance company UAP. Whitehall is thought to have paid FFr1bn, 30% of the book value, in the UAP transaction, and acquired the FFr745m Credit Suez book at a 50% discount. The other significant purchase has been a FFr780m bag of mixed loans from Barclays Bank, purchased by a consortium of Cargill, Lehman Brothers, and LaSalle Partners, also thought to have been bought at a 50% discount. LaSalle is in here as an investor, but also as the partner with the local knowledge to manage and work out the portfolio – in France it has a joint venture with Société Générale. The Whitehall fund has also put some European property expertise on its team: Miles Darcy-Irvine’s Shaftesbury International – a French company despite its name – and Martin Myers’ Vines Management, which has experience of working with Barclays’ Bank in the UK . These groupings point to one of the big questions about the funds’ entry into Europe: can the US formula, applied to France, give the mouthwatering returns achieved at home? Or are the Americans drawing too simple a parallel with the situation in US: underestimating the difficulties. LaSalle’s Van Stults thinks having local understanding is critical: “You cannot even price a portfolio without intimate knowledge of the market – it affects timing and realisations.” The issues everyone acknowledges are the differences between the US/UK and the continental legal system and financial sectors. These are particularly relevant to large French loan portfolios, where investors will be negotiating foreclosures or dealing with syndicated debt with local banks participating. The UAP package, for example, involves 350 loans, while Barclays’ contained 193. “Napoleonic law is different: it treats the borrower much more benignly,” notes Richard Plummer of Pricoa. And, until now the French financial system has been a pretty cosy club. “You have to understand the nuances and understand French borrowers and owners,” says Van Stults. “The biggest cultural difference is that it is a smaller club. For example, in the banks there are a group of people, a community that has worked together for many years, and that creates relationships.” The other big question mark hanging over the French scene is whether the market will provide the short-term take-out needed by the funds. In the US, securitisation provided an exit route, as loans were bundled up and sold, or properties put into REITS. In France, these sub-markets are not yet properly developed, and it is far from clear who will step in as the long-term owners. The US funds are betting that that their entry into the market is the start of a bigger process which will bring in more liquidity and foreign capital. Van Stults lists various routes which might provide eventual take-outs: “Securitisation, the increase of the listed sector, or traditional French institutional owners, supplemented by foreign investors.” Charles Pridgeon, of Bankers Trust, which has advised Barclays, Suez and UAP on their sales, thinks as much as half the stock could be sold back to the original borrowers. To date, the big players have been concentrating their firepower on France. Hence, Morgan Stanley’s incursion into Sweden is an intriguing one. Others may dismiss this market as too small, but the US investment bank sees the deal as part of its strategy of investing in situations with growth potential. Its purchase of a 60% stake in Castellum, the property company that emerged out of Nordbanken’s bad debts, is about timing, growth and market dynamic: Morgan Stanley thinks the Swedish real estate market is near the bottom. In Castellum it is getting not only a share of a big commercial and residential portfolio, SKr 9.4bn worth book value, but also buying something that has operating management, to work the assets. Morgan Stanley’s fund can take a slightly longer view than others: it has a 13-year term. It is also planning to invest in London, where it is buying two office buildings and a development site in the City. These are perceived as classic opportunities to “add value” in a market which is recovering: they will be worked with a local partner. And Morgan Stanley’s fund is also one of the bidders for the UK’s Ministry of Defense portfolio of housing, in a consortium with a major quoted property company, British Land. Two other US investment banks, Lehman Brothers and Bankers Trust, are also vying to win this privatisation; they are part of a grouping which includes Beckwith Capital Partners and Hodge & Co. The MOD portfolio and Canary Wharf aside, the UK market has not provided the juicy mega-deals that opportunist funds like. UK banks have tended to hang onto their bad loans, working them through, while insurance companies do not have the sort of involvement in property development and funding that characterised the French market. Bankers Trust has put around $50m of its equity into deals, taking stakes in Bicester Retail Village and helping finance a portfolio purchase and a leisure fund. The Whitehall fund, which was actively bottom-fishing in the UK throughout the early 1990s, managed a lucrative handful of deals, but these could be described as rounding errors in the context of Goldman Sachs’ global firepower. Argo, the fund set up by JP Morgan and The O’Connor Group, hasn’t yet scored. Morgan Stanley and Whitehall are the well established funds that have the benefit of their investment banks’ presence and contacts in Europe; both have been scouting around the continent for several years. But there are also are clutch of new ones on the horizon: they include Apollo, Tiger, and Colony Capital. Mostly, they have been looking at France, where Charles Pridgeon estimates there is still maybe FFr 200-FFr300bn of bad property loans, of which some 15%-20% of which might come to the market. “The window of opportunity will remain open for six to nine months,” he says. And he predicts: “The next round of distressed loan deals will see a second wave of US investors: new faces, new bidders who didn’t feature in the last bids.” These are headed by men who built up a track record at mainstream Wall Street investment banks, and in the 1990s went on to raise a substantial pool of money to invest in property. They have already been buying in the US, and are now sniffing around Europe. One of these, Leon Black’s Apollo fund, has already arrived in UK. It is working with Pelham Partners, set up by Roger Orf, who formerly headed the European end of Goldman’s Whitehall fund. So far Pelham has bought £72m worth of property in the UK – so-called secondary commercial buildings which institutions are now finding too small or time-consuming to have in their portfolios. Pelham’s play is to buy at net initial yield in the low teens, which rises to 17% or 18% after funding, and 20-25% after re-leasing. “It’s a good deal from an American perspective,” says Roger Orf. “It’s a healthy income play, and the management team can add value. We harness capital with a local partner. ” Pelham’s time perspective for selling is five to seven years, “not a quick flip”. There is also a start in Spain, where Pelham has committed $7m to a joint venture that will buy and refurbish apartment buildings in Barcelona. Here, the local partners are MedResorts president David Stein and hotel-owner Jordi Robinate. “It’s a profitable opportunity, but I also feel that Spain is the next market from a bank perspective to be hard hit, and we want to be there with a partner with expertise,” says Orf. In contrast to the funds’ enthusiasm for Europe, mainstream US institutions have been leery of crossing the Atlantic, ever since a group of them got burnt when they backed an American-led takeover of Randsworth Trust, a British property company a decade ago. They are still proceeding with caution. Bad memories aside, there are objective reasons for them sticking close to home. “There are no more than 20 US funds big enough to consider direct investment in Europe, ” says Bruce Bossom, who heads up LaSalle Partners’ office in London. As he points out, the US market makes “compelling reading”. Large enough to provide diversity, it is also delivering the sort of returns that US institutions require – without the risk of an unknown market. Richard Plummer, a pan-European investment veteran who runs the Prudential of America’s TransEuropean property stable at Pricoa in London, explains: “US pension funds have to be satisfied that it is prudent to go abroad: that the returns on a risk-adjusted basis add value, taking into account taxation and currency considerations.” He is just closing the successor to the $250m TransEuropean fund, and has managed to to attract two new US investors. TransEuropean has an impeccable US pedigree and well established track record, but nevertheless its headway with Stateside investors has been slow. “I can’t say we’re being bowled over in the US,” admits Plummer. Against this backdrop, the Teachers Insurance and Annuity Association’s entry into Europe is significant. It is the largest pension fund in the world, so the $100m-$200m odd it is spending on this side of the Atlantic is a drop in the bucket. But it signals the beginning of a longer-term commitment. “It’s the largest funds that are able to allocate a very small amount to see the long-term trend, develop their approach and strategies to invest safely and comfortably overseas without crashing in flames,” says Van Stults. Teachers entered via the UK early this year, and is now planning to spend $50-$100m in France, advised by Lafayette Partenaires, LaSalle’s joint venture with Société Générale. Here, it is targeting shopping centres and Parisian office projects. In the UK, Teachers has put around $75m in three deals (see table), with a couple more on the cards. “Teachers is looking at the medium to long term, it’s not a play on the market,” says Gerald Parkes of Parkes & Co, who advises the fund in the UK . “The levels of return it requires don’t have those yield hurdles to achieve. It is not taking the sort of risks that vulture funds take.” Other US investors who have taken recent equity stakes in property include Citibank and Gerald Hines. Citibank has gone into a joint venture with UK developer Arlington, taking a 40% stake in part of the business park being built in Oxford. It is also participating with £15m in a consortium which is funding Argent’s £350m development programme. These investments are part of Citibank’s strategy of providing venture capital for property a programme that included participating in the Messeturm development in Frankfurt. Citibank is now also investing in projects in Germany, France, Italy and Spain. It takes a three to six years view. Hines, a Houston-based developer and investor, has embarked on a course of global expansion. It initially started developing in Berlin in 1990, and has a $3bn programme of European projects (see EuroProperty, July) But the latest deal – taking a 50% stake in the French shopping centre group Trema – marks Hines’ arrival as an investor (see p 1). This purchase gives Hines a stake in seven centres spread in France, Italy and Spain. According to Randy Dumas, Hines Europe’s managing director, it is the nucleus of a larger pan-European portfolio, and he is hoping to acquire other similar properties. Hines’ traditional approach is to invest in partnership with institutional money; it has good links with both US and European funders. It will be following the pattern with Trema, probably bringing a US pension fund alongside. But while Teachers’ and Hines’ moves are welcome indicators of American interest, most informed observers judge that institutional money will trickle rather than flood into Europe. “There will be no ‘wall’ of US money over the next 12 months”, opines Tony Edgeley, the partner who deals with US investors at international agents Jones Lang Wootton. “If people put up sensible clubs or syndicates, with modest fees, they could attract $100m-$500m over the next year.” So far, it has been the UK and France that have captured the bulk of US investment. The reasons are fairly straightforward: market timing, and in the case of the UK, the fact that it is a sophisticated, liquid and transparent market with a familiar legal system and language. The tax regime is also important. France’s 18% transfer tax is a serious obstacle for the longer-terminvestors. “If France is serious about solving the bank and property crisis, it has to solve the tax problem,” says Van Stultz. Outside of these two countries, Spain looks to be the next destination. US investors are expecting a shake-out as the financial system starts to work its way through the loans and properties acquired in the 80’s boom. Morgan Stanley is eyeing Spain, while LaSalle plans to be there, perhaps with Société Générale or another partner, within the next 18 months. LaSalle’s Van Stults also thinks there’s a “very interesting situation” in Germany, where the ending of tax concessions may cause some shifts in ownership. And Roger Orf likes Holland, where the combination of a big yield gap and leverage can bring outstanding returns. Investor Partners Purchase Bankers Trust Marylebone Warwick Balfour £13m in leisure fund Hemingway £8m in £64.4m portfolio purchase Value Retail Small stakes in factory outlet schemes in Bicester Village, UK, and La Roca, Barcelona Blackstone Capital £3.5m -8.7% stake in Moorfield Estates Cargill/Tisch/Price/Reichmann/Prince Al-Waleed/Safra £750m purchase of Canary Wharf Cargill/Lehman/ Bros/LaSalle Partners FFr870m Barclays Bank portfolio Citibank Arlington/Kier £8.4m in Oxford Business Park – 40% stake Argent/Hermes £15m in consortium funding Argent development programmek; also equity in projects in Germany, France, Italy and Spain Hines 50% stake in 7 Trema centres worth FFr 2.8bn; Diagonal Mar project in Barcelona Morgan Stanley Real Estate Fund II Castellum – 60% stake for SKr 1.9bn Pelham Partners Capital & Provident £40m Norwich Union portfolio Portfolio Holdings £15m Provident Mutual portfolio Grosvenor Asset Management £27m portfolio £7m Barcelona residential venture Teachers Insurance and Annuity Association Haselmere £55m Kinnaird Park, Edinburgh Haselmere £17m processing centre, Bristol British Land £15m distribution unit, Banbury Whitehall Fund Bourne End £71m William Pears portfolio Bourne End £45m Marlowes shopping centre, Hemel Hempstead – 85% Shaftesbury International/Vines Management FFr745m Groupe Suez portfolio Shaftesbury International FFr 3.2bn UAP portfolio