Morgan Stanley and Goldman Sachs once possessed two of the boldest and most prolific private real estate franchises in the world, until the global financial crisis in 2008 all but wiped the investment banks from the market.

While peers including Citigroup and Bank of America Merrill Lynch stayed away after winding up or selling their platforms in the aftermath of the crisis, Morgan Stanley and Goldman Sachs decided to remain, regroup and go again – this time with decidedly half the bluster and seeking little publicity along the way.

Largely under the radar, the pair have rebuilt real estate principal investment businesses that had previously suffered heavy capital losses, leadership departures and investor distrust, all the while facing heightened regulatory blockades and an industry-wide reset on speculative, heavily geared investments.

Their tactics have worked. Indeed, the past 12 months have been pivotal in both groups’ journeys to revitalization. In September 2021, Morgan Stanley raised $3.1 billion for North Haven Real Estate Fund X Global, also known as G10, its largest vehicle raised since 2010 in the bank’s flagship opportunistic series. Goldman Sachs, meanwhile, passed an even starker milestone. The $3.5 billion fundraise for its Real Estate Partners program in April marked the bank’s first private equity real estate fund closing in 14 years, and with it a comeback into third-party equity fundraising.

Executives at both firms tell PERE their real estate platforms’ return to growth is the result of undergoing several changes, compared with their pre-2007 versions. That much has been observed on the outside too. “If you took the clock back to 2005, and compared that time versus today, perhaps you wouldn’t say there has been much success for both real estate businesses. But if you start the clock at 2009 to 2010, they both are in a healthier position today,” says Michael Levy, chief executive officer of Dallas-based manager Crow Holdings and former chief financial officer and chief operating officer at MSREI. 

“No doubt, there were significant industry questions about the viability of investment bank management platforms,” Levy continues. “But these firms have evolved their businesses to a point of strength, notwithstanding changes in personnel, times, and strategies. Both are raising billions of dollars of new capital from third-party investors. To me, that is the ultimate vote of confidence.”

That Morgan Stanley and Goldman Sachs’ real estate businesses are again standing tall, despite their mixed histories, is testament to their successful transitions. This achievement is especially remarkable in comparison to the other investment bank platforms that opted out of the market following the 2008 crisis and stayed away ever since. 

PERE’s annual ranking began measuring the top 200 firms in 2022, but formerly measured the top 30, 50 and 100 firms through the years from 2008 to 2021 (Source: PERE) Click to enlarge

Not that this transition came easy for either Morgan Stanley or Goldman Sachs. According to PERE coverage, the $4.2 billion Whitehall Street Global Real Estate 2007 fund ultimately was wound up valued at 75 cents on the dollar. This would have been far worse but for significant value restoration efforts after the crisis. For Morgan Stanley, its $8 billion MSREF VI fund had over 60 percent of its equity written down at one stage during the peak of the crisis. 

“Both firms stayed committed to the business,” says another former Morgan Stanley executive who asked to remain anonymous. “What helped MSREI stay afloat was the [core strategy] Prime Property Fund, and how it was able to grow its business off that vehicle and eventually rebuild the MSREF series. Goldman Sachs had the courage and conviction to take 100 percent of the risk and use balance sheet capital for investing.”

It also helps that the passage of time has blurred institutional memory of any financial crisis carnage. As another senior investment executive who wished to be anonymous points out, many investors that suffered poor performance from 2007-vintage funds have either retired or moved roles by now. 

Post-crisis regulation has played a meaningful part as well, despite initially appearing to consign both banks to retreating alongside their peers. Indeed, the Volcker Rule of the Dodd-Frank Wall Street Reform and Consumer Protection Act – regulation that required banks to put a higher risk rating on real estate debt and equity and reduce principal investment – as well as the international framework Basel that set measures on bank’s capital adequacy, stress testing and liquidity requirements, strongly influenced strategic pivots for both Morgan Stanley and Goldman Sachs.  

Until the new fund launch, for example, Goldman Sachs’ asset management platform invested in real estate equity using the bank’s balance sheet on the direct side, although it continued running its Broad Street real estate credit fund series, raising capital from external third parties. In 2019, the bank also restructured its real estate operation within Goldman Sachs Asset Management, combining the Real Estate Principal Investment Area, the platform running the Whitehall fund series, and the real estate teams of its Investment Management and Special Situations groups.

“For Goldman Sachs, it is not the global financial crisis itself that drove these strategic initiatives, but rather the regulatory response to the crisis,” says David Fanger, senior vice-president at Moody’s Inves­tor Service. “As such, it is now pursuing a much more capital-light asset management model, which means their expansion in alternatives is now far more focused on bringing in investor money.”

Reverting to regions

Making a comeback into real estate equity fundraising after 13 years has not been without challenges. 

“Back then, the field of global players was not very big, and there were a few firms that did all the larger deals,” says Sophie van Oosterom, global head of real estate at London-based manager Schroders and former European head of asset management at Lehman Brothers Real Estate Partners, the private equity real estate business of the stricken Wall Street bank. “Immediately after the GFC, most players reverted to regional strategies rather than global. Today, many players have filled the global space successfully, with global teams and a global track record.

“You would have thought that the same players that were out there then – and successful in the real estate space – would have seen an opportunity earlier to come back as a global player.”

While Goldman Sachs rebuilt its real estate equity business with a focus on balance sheet investing, Morgan Stanley pivoted to being more of a core investor from a predominately opportunistic investor pre-GFC. 

Around  87 percent of Morgan Stanley’s $55 billion in assets under management, as of December 31, 2021, were not held within its North Haven series – formerly called Morgan Stanley Real Estate Funds – for example, but rather in its open-end core vehicles.

Nori Gerardo Lietz, senior lecturer at Harvard Business School and former chief strategist for private real estate at Zug-based manager Partners Group, recalls that when MSREI acquired the open-end core vehicle Prime Property Fund as part of its takeover of Australian manager Lend Lease’s US investment management business in 2003, the fund “was kind of looked down upon, because it was pedestrian, and all it did was generate management fees.” 

Lietz gives credit to John Klopp, who joined MSREI as its head of Americas and global real estate head for debt investing in February 2010. “He came in and elevated the importance of the Prime Property Fund Series, because that was actually profitable,” says Lietz. 

“And he also suspended fundraising for the opportunity funds for a while, until the stigma could be dissipated.” 

Today, Klopp is the head of the firm’s global real assets. 

It was only in 2015 when the firm closed its eighth global opportunistic real estate fund on $1.7 billion, some five years after its predecessor fund’s $4.7 billion closing in 2010. Fund nomenclature also changed, with the series rebranded to North Haven from MSREF, understood to be due to the sponsorship stipulations laid out within the Volcker Rule. 

One commonality in both firms’ higher risk and return strategy evolution is their move toward a more conservative investing approach. Even though it came in an opportunistic fund wrapper, North Haven Real Estate Fund VIII in fact carried a lower risk approach to investing in real estate, with a focus on income streams and a lower loan-to-value ratio of close to 55 percent, as PERE has reported. Goldman Sachs’ Real Estate Investment Partners, meanwhile, currently has a blended core-plus to value-add risk and return profile and is expected to have a maximum loan-to-value ratio of 60 percent. 

According to van Oosterom, this revised approach to leverage, deal structuring, enhanced alignment with the operating partners and operating expertise, and the broader understanding that real estate performance is not just about cap rate contraction and long lease contracts but more about  operational (tenant) management and long-term relevance, were some of the biggest learnings that came out of the crisis.  

Lietz, nonetheless, does not think the investing approach has dramatically changed. “I think it’s just nomenclature. The dividing line between value-add and opportunistic is very blurred. I agree that many firms don’t do speculative development anymore, because that is deemed on the fringe. But they are still buying buildings that have leasing issues.”

Lessons (un)learned

Both Morgan Stanley and Goldman Sachs have demonstrated willingness to invest in the resurrection of their real estate investment businesses, and that has received investor endorsement, judging by their recent fundraises. Indeed, some investors that backed Goldman’s earlier Whitehall series are reported to have committed to the latest fund. 

“When you go through a global financial crisis, and your investors sustain the types of losses that they did, you need to rebuild trust,” says Levy. “I think both firms have been patient in rebuilding trust, and that is a very hard job. It takes long periods of time, especially for institutions that typically think on a quarterly basis. I’m sure there are lots of tactical questions, but they have far better-balanced business models today.”

“These firms will be more resilient than they were before the GFC,” says van Oosterom. “But I’m not sure if they would be more resilient than all other firms. Most firms in the market today have leaders who grew up professionally during the crisis and have their fair share of lessons learned. 

“Moreover, while the current market circumstances are challenging for real estate, the ongoing crisis is not real estate-led, and so better investment opportunities might arise from it.”

Irrespective of the impact of the next downturn on the fortunes of the industry, there are still some unresolved questions from the previous crisis, say onlookers like Lietz. She is unsure whether certain fundamental issues in the banking industry have still been addressed, including the conflict of interest inherent in a real estate business being affiliated with an investment bank. “These businesses are not independently run subsidiaries,” she says. 

For her, there is also the issue of accountability. Certain executives at investment banking platforms leading up to the crisis – when they were taking higher risks with their investments – have since reappeared at other organizations. “My observation over decades, particularly in the private equity industry, is that when these executives are wildly successful, they are credited for their innate brilliance and investment acumen. When they fail, it is because of the market,” she says. “You can’t have it both ways.”