Friday Letter Hybrid theory

There’s a parallel between what happened in the world of heavy metal music in the late 1990s and what is happening in the world of private equity real estate today.

As any heavy metal aficionado will tell you, 'nu metal' was born in the late 1990s after fans fell out of love with overhyped, mainstream bands. The scene promptly won critical acclaim.

Rolling Stone magazine, for example, reviewed California-based Linkin Park’s debut album, Hybrid Theory, and asked “is this a glitch in the matrix?” before describing the album as a mesh of popular styles. “They can slice and dice”, the review said.

It appears that a similar ideological evolution is playing out in the private equity real estate universe. This week, PERE revealed that in Japan, Secured Capital and Aviva Investors have formed a fund structure to test a hybrid theory of their own. The pair has launched a blind pool investment club’ that borrows its structure from traditional blind pool funds and the currently popular investment club.

The vehicle, which is expected to be announced to the market next week, is slated to attract between $250 million and $300 million from three or four institutional investors. It will focus on investing via a core-plus strategy in the Japanese office market – popular at the moment among private equity real estate firms – and is expected to generate a return of between 10 percent and 12 percent over a 12 to 18 month time-span.

This club fund represents a fusion of styles, new and old, both of which are very much in play today. Similar to traditional blind pool funds, investors in the Secured/Aviva vehicle are expected to commit their capital before they see any deals. But like investment clubs – particularly popular among the world’s largest investors – they would then have approval rights for investments, divestments and other major decisions. Aviva and Secured can hunt deals within its tightly specified strategy.

While possibly the first of its kind in Japan, perhaps in Asia too, it is certainly not the first attempt by private equity real estate fund managers to provide the customer with something new and innovative in recent history. Arguably, Brookfield Asset Management got the ball rolling in 2009 with its non-discretionary $5.5 billion Real Estate Turnaround Consortium, but other hybrid vehicles of a smaller scale have emerged too.

In Europe, Germany-focused IVG and Scandinavia-targeted Nordika Fastigheter, have their versions. The latter described Secured/Aviva’s vehicle as a “blueprint” of its own. In Asia meanwhile, look at China-focused Tan-EU, which manages a club fund comprising institutional investors in Europe and SOCAM Development, a Hong Kong-listed member company of China’s venerated Shui On Group.

The examples above vary in construct and, by the very nature of being part of a nascent movement, have already prompted debate in the private equity real estate community. How will investment decisions be made? Would an LP not in favour of a specific investment be able to opt out or would it be forced to go along with the majority? How would the club be selected? Wouldn’t the LP prefer to delegate decisions to a GP it has conducted due diligence on, rather than effectively underwrite an unknown club of other investors?

These are the kind of questions some GPs are currently mulling over with potential LPs nowadays, though without necessarily coming up with concrete answers. One GP confided that when discussions concerning its next fund turned to creating hybrid structures, this is where “the thinking has fallen apart”. Nevertheless, such talks are leading to action in increasing instances and it would seem that Secured and Aviva have found a model that could work for them and their investors.

Whether the construct of the hybrid vehicles on offer today actually are fully optimal, functional or not will be known as they play out. Regardless, one message the investor community should take away: Your managers are thinking about what heavy metal music you want to listen to these days and are trying to write innovative 'nu' songs accordingly.