Want to know how much Wes Edens’ shares were worth the day of the Fortress IPO? Try $2.3 billion. Curious about your firm’s private equity performance relative to Fortress? Curiosity satisfied: The firm generated annualized net IRRs of 40 percent since inception. And though you may know that Blackstone’s real estate arm has been successful, did you ever wonder just how successful? It’s all right there in black and white: $17 billion of assets under management and gross annualized returns of 38 percent.
But amid all the staggering figures, one number stood out. The platform with the highest returns for either company was not private equity or hedge funds or even private equity real estate. Rather, it was public real estate—specifically, Fortress’ listed German commercial property vehicle, Eurocastle, which has generated a total return to stockholders of 69 percent per annum.
If the public markets can generate that kind of return, it’s small wonder that Blackstone and Fortress are tapping them.
Yet while Fortress’ German office portfolio has performed spectacularly, its residential investments there have not quite lived up to their billing. Like many opportunistic players in the country, including Terra Firma and Cerberus, Fortress has, over the past several years, purchased huge portfolios of rental apartment buildings with the intention of selling the units back to individual tenants. Thus far, the strategy has not panned out.
“Some people assumed as much as 50 percent [of the residential units] would be sold,” one London-based private equity real estate executive recently told PERE. “And, in actual fact, the rumor is that less than 15 percent have been sold across portfolios.”
Reasons for the slow take-up are myriad: a historical reluctance among Germans to own their own homes, the country’s relatively low rents, the decline in real home prices over the past decade and the slow recovery of the Germany economy.
Just because the strategy didn’t work out, of course, doesn’t mean that the investments have not performed. Last year, Fortress listed a 20 percent stake in its German residential portfolio, Gagfah, raising €850 million and becoming Germany’s largest listed real estate company in the process. (According to the Fortress S-1 filing, Fortress’ stake in Gagfah was worth almost €5 billion at the end of 2006.)
“The German residential play has panned out from the perspective of capital market arbitrage,” says the private equity real estate pro. “Fortress bought cash flows for value x and sold them to the public for value y. Note that nothing happened to the actual units.”
Given the movement of capital into Germany, market practitioners say the arbitrage play is over. But investors clearly remain interested: Recently, Morley Fund Managmenet and Archstone Smith purchased large residential portfolios from Blackstone and Pramerica, respectively. Over the long-term, many observers believe that the German home ownership rate will increase, but it may take much longer than originally anticipated, which suggests that firms who do not have the finite-life restrictions of private equity firms will be the most active buyers.
Nevertheless, opportunity fund managers clearly remain bullish on German residential. Both Fortress and Terra Firma were reportedly bidders for Blackstone’s residential portfolio. And with German municipalities and state-owned corporations continuing to divest huge portfolios of real estate—estimates range as high as €80 billion of potential asset sales in the next two to three years—there will be plenty of product for hungry private equity real estate firms.
“The market is getting more international and more liquid,” says one German-focused property investor. “And foreign investors are going to penetrate more than they are doing today.
P.S. The April issue of PERE includes a special report on the German property markets, including in-depth articles on the country’s residential and hospitality sectors, as well as an interview with one of the country’s leading turnaround specialists. Click here to subscribe.