Midsized private equity real estate firms in the US or Europe all share at least one common thread aside from their size: pretty much all of them have been approached by a litany of interested buyers.

“On the real estate investment manager front, the notion is everyone is being offered a buyout opportunity – or at least a taking chips off the table opportunity,” said Gil Menna, co-chair of REITs and real estate M&A practice at law firm Goodwin.

Chicago-based Harrison Street Real Estate Capital, which agreed last month to sell a 75 percent share to Toronto property services firm Colliers International, is one of seven private equity real estate firms – representing an aggregate of $30 billion in assets under management – to have sold full or partial stakes in 2018, according to Berkshire Capital Securities, an investment bank.

For prospective buyers, M&A targets share a similar profile. “You want to partner with managers that have been through cycles and have raised a series of funds,” said Ted Gooden, partner at Berkshire Capital. “There are a limited number of firms that have three or four, or even five, funds raised. This scarcity of supply of high-quality sellers with these characteristics relative to the breadth of demand from buyers is creating an intensively accelerated M&A environment.”

Gooden: buyers seek ‘managers that have been through cycles’

The main categories of interested buyers – which are looking not only at real estate but a range of asset classes within private markets – include institutional investors under pressure to find higher yielding alternatives to fixed income and equities; private equity firms expanding to compete with other alternative asset managers; Asian conglomerates and financial services firms that want access to real assets and geographic diversification; and insurance companies that have large pools of capital and want to own an asset management business, according to Gooden.

Private real estate M&A activity hit an all-time high last year, with 30 deals representing a combined value of $3.28 billion and a total seller AUM of $184 million, according to Berkshire Capital. This is double the deal volume just two years prior.

“It’s in a vibrant market like this when some of the better managers will take the dramatic move of even contemplating a strategic partner,” said Gooden.

Managers have different motivations for selling a stake in the firm. “What we have seen is a number of managers have fairly concentrated ownership, are at a stage where they are thinking about succession planning, and are considering future business plans that may include multiple product offerings, and as part of that process would naturally think about how they are capitalizing their business,” noted Bill Thompson, senior managing director and co-chief executive of the private capital advisory practice at New York-based investment banking advisory firm Evercore.

“In addition, the increase in capital seeking these investments has increased valuations and made it easier to monetize a portion of the business through a non-controlling partial sale.”

It is also not a coincidence that targeted firms have been in the midsize range, said Thompson, whose firm advised Starwood Capital Group and Rockpoint Group’s minority stake sales to Dyal Capital Partners and Blackstone, respectively. “As the LP market continues to focus on the two ends of the GP size spectrum, the large managers, and the niche, small managers, a number of managers in the middle are re-evaluating their organizational options and looking for strategic investors to help them expand and grow their business.”

Anne Kavanaugh, chief investment officer at Augsburg, Germany’s Patrizia, agreed there was no middle ground for real estate managers: “Investment managers need to either be small and nimble or offer scale.” Her firm last year decided to go for scale, effectively doubling its assets to $40 billion via three acquisitions.

The 2017 transaction volume level is not expected to repeat this year, however. “There will be continued activity with a few prominent real estate managers that will sell this year,” Gooden said. But those firms, mostly in the US, number less than 10, he estimated.

Gooden predicted this year’s transactions would be larger but fewer in number than last year, when the average deal size was $109 million, compared with $161 million in 2016. This is simply a function of limited supply, particularly in Europe. “There’s less than 20 independent companies that can manage on a pan-European basis,” he said. “If you look at just the industry structure, a good number of independents sold in the last year.”

On that list are London-based Internos Global Investors, which sold to Des Moines, Iowa-based Principal Financial Group; London’s Cording Real Estate Group, which now has Swiss bank Edmond de Rothschild as its majority owner; and the three European firms acquired by Patrizia: Triuva, Rockspring Property Investment Management and Sparinvest Property Investors.

Indeed, following last year’s buying spree, Patrizia will likely be more selective about potential new acquisitions for the firm. “There are usually opportunities available but we already have a strong platform in Europe servicing global capital,” said Kavanaugh. “So we have very specific criteria when it comes to future M&As, some of which may include activity in the proptech space.”

‘Small universe’

Menna pointed out that it was not just midsized firms that were limited in number, but real estate investment managers overall. “The universe is relatively small versus equities and fixed income. That’s in large part because real estate historically has been somewhat of a cottage industry but now is very much coming into its own.”

He agreed that private real estate M&A dealflow was likely to taper off this year. “It’s supply-demand dynamics,” he said. “Now supply is dwindling, but demand hasn’t softened. It may well be the case that we have fewer willing sellers and more willing buyers. Maybe transaction volume is lightening up because there are fewer willing sellers.”

Menna did not anticipate that demand would let up anytime soon, however. “The equity capital flows in private real estate as an alternative asset class are not ending; they’re robust,” he said. “That’s why people are interested in real estate investment managers because they can attract that capital.”

But, while most midsized managers are being courted, not everyone will agree to a sale. “There are definitely managers that are going to continue to grow their business through this cycle,” Gooden said. “They’re not either ready to partner or just not ready to sell right now.

“The industry is reshaping before our eyes. I think that’s what everyone is excited by, enthused by and concerned with.”

 

How to value a real estate investment manager

Determining the purchase price for a firm is by no means the result of simple math

When Colliers International and Harrison Street Real Estate Capital announced their stake sale transaction, the firms made a disclosure that this year’s other real estate M&A buyers and sellers did not: they provided the purchase price.

How such a price is determined is by no means clear-cut. “No simple metric is applied,” said Bill Thompson, senior managing director and co-chief executive of the private capital advisory practice at New York-based investment banking advisory firm Evercore. “Many of the larger buyers focus on discounted cashflow models and achieving targeted levels of return for their investors.”

Advisory firm Duff & Phelps typically calculates a firm’s value as a percentage of EBIDTA or AUM. “There are various factors that go into determining the value of a real estate investment manager,” said Sheryl Cefali, the firm’s managing director of transaction opinions. “The first thing is the terms of management contracts. Some contracts are more profitable than others. So that results in different levels of fees and profitability.”

A second factor is the growth and stability of the firm’s assets under management, and if management fees are recurring. Also considered is the strength of the firm’s management team. “Do they have a unique strategy?” Cefali asked. “Are they able to differentiate themselves in the marketplace?”

Lastly, a proven record to deliver high returns to its investors is also taken into account when valuing a company being sold.

The average value of a real estate investment management firm relative to its AUM has been 3 percent over the past five years, with 25 percent of transactions during that time period exceeding 4 percent of AUM, according to an analysis by Duff & Phelps.

Cefali declined to comment on specific firms, but based on PERE’s calculations, $450 million for a 75 percent stake gives Harrison Street an overall company value of $600 million. If that is in turn divided by its $14.6 billion in AUM, its value relative to AUM is above average at 4.1 percent.