Carlyle's billions

PERE magazine finds Eric Sasson waiting in the bar area of Canary Wharf's Four Seasons hotel. Having just completed a meeting there, the hotel is ideally located for his short hop to City Airport and the return leg to Paris from where he has led The Carlyle Group's European real estate business since 2001.

Despite meeting earlier than expected Sasson is happy to chat over a soft drink about the challenges and opportunities ahead.

Presenting a youthful and energetic figure, Sasson occasionally checks his Blackberry as he talks about Carlyle Real Estate Partners III, the firm's latest fund offering which corralled €2.2 billion ($3.4 billion) in equity commitments this year. By the time it closed in June, Carlyle's investment professionals had invested approximately one third of the equity (€715 million) in 10 assets. That's a fairly good record given transaction volumes dropped in the second half of 2007, but the figure presents an obvious question. With such a large pan European fund remaining at its disposal and exciting deals abounding, how does Carlyle chose which ones to pursue? How does it cope with the different types of complex deals that are emerging?

“This is a new situation,” Sasson says. “From a human resource point of view it is very hard to choose which battle to enter. We get tons of situations everywhere in Europe but the hard part is deciding which ones to look into more.”

Though he says manpower is an issue, Carlyle employs an expansive team in Europe. There are approximately 50 real estate professionals working out of six offices in Paris, London, Frankfurt, Madrid, Stockholm and Milan. Typically, the team invests capital in single assets, be they developments or repositioning opportunities, with Carlyle keeping asset management in-house, hence the large team. The firm is proud of the fact asset managers sit next to the investment professionals in their respective markets.

Sasson says the first thing Carlyle does when appraising a deal is try to agree on the net asset value (NAV) of the potential investment. This is no easy matter in today's markets but Sasson says the team is well positioned to cope because its members have been assembled for their deep understanding of underlying real estate, rather than, say, their expertise in capital markets.

As a rough benchmark, if the discount to NAV is 30 percent or more, then the deal is of interest to Carlyle. Anything below 30 percent and the associated costs make it less attractive, so it is dropped, according to Sasson.

Assuming the deal offers at least a 30 percent discount to NAV, the firm will then analyze how realistic a deal is given the shareholder structure, the position of the lender and so forth. This has become even more important today. Sasson says a lot of the current discounts on assets are purely theoretical, so the “deal” will not pass the second phase of analysis.

Given that complex corporate deals are being offered to Carlyle, it does face a certain challenge. The real estate team is large but the individuals are employed for their real estate knowledge, not for being leaders in corporate situations. “The way we do business is very bricks and mortar,” admits Sasson. “We can take on any portfolio and strip it down to understand what the NAV is.” But when it comes to more complex situations, Sasson says his approach is not to try to add professionals with corporate skills. Instead, the firm is happy to buy in third party experience and advice. And of course, there is also the LBO team at Carlyle to help out.

Eclectic mix
Though working well-located single assets is the traditional strategy, recent investments out of the third fund provide a clue as to the diversity of deals flowing to the firm.

In June, the US firm acquired three shopping centers in the UK from the Mall Fund, a listed vehicle that has come under pressure to liquidate some assets in the face of falling property values. Carlyle paid £286 million ($361 million) for Chester Mall, in the north of England, and malls in Epsom and Edgware, on the edge of London. The price it paid was a significant reduction compared to an end of March valuation of £339.8 million. Given the weakness of UK retail property, this may look like a strange deal, but the price discount and the fact that two out of the three centers have development upside explains why Carlyle committed. The mall in Edgware, for example, is trading well and has a dominant catchment, but it also has a strip of developable land. “We could not do the deal if they were all dry investments,” says Sasson.

The second interesting deal occurred in May but received little, if any, publicity. The firm acquired a CMBS package called the Windermere portfolio backed by assets in Finland, France, Germany and Italy. The debt portfolio was originally packaged by Lehman Brothers, which wanted to take the assets off its balance sheet. “We looked at the portfolio and the discount and the deal looked good,” says Sasson. Although this is not the first time Carlyle has bought debt in Europe for one of its real estate funds, buying debt is something the firm might do with more frequency in the future. Sasson however expects those opportunities to be short-lived, with attractive opportunities remaining for about another six months.

On a more long-term note, Carlyle is looking to Central and Eastern Europe, where the economic growth story has attracted many other private equity real estate funds. And although the firm has yet to open out staff on the ground in a local office in the region, Sasson says it is hard to imagine the firm without offices from Moscow down to Istanbul in the fullness of time. For the moment, however, Carlyle's German office covers Central Europe while the Italian office looks at Romania and its neighboring countries in South East Europe. Advice, of course, is always on hand from Carlyle's Central Europe buyout fund team.

For Sasson, the strategy is not an abandonment of Carlyle's traditional real estate ethos or structure. Indeed, the thrust of the strategy is to develop and reposition single assets in established markets.

Carlyle in Europe