Hard target

As Lone Star sets about raising its largest dedicated real estate fund, its focus for the capital is likely to be more on hard assets than before.

Private real estate investment analysts reading the tea leaves for clues as to the scale of the real estate debt opportunity versus that of hard assets could do worse than study the strategy of Dallas-based Lone Star Funds.

PERE reported this week how John Grayken’s firm has begun ‘pre-marketing’ for its third dedicated real estate fund, Lone Star Real Estate Fund (LSREF) III, after reaching the approximately 85 percent investment threshold for its second vehicle in the series. This time, It is understood to be targeting an equity raise of $6 billion.

On the face of it, that is a large amount of dry powder being amassed by a private equity firm renown in the industry primarily for wading through giant loan books, untangling value from various non- and sub-performing forms of property finance. You would be forgiven in assuming the arsenal that Lone Star wants to corral would be for more of the same. 

In fact, PERE hears that the acquisition of hard assets is expected to play a bigger part than it did in prior funds in the series. Loan book investments will continue to be scrutinized by the firm, if the market allows. However, the market is allowing for more loan book sales these days in Europe than in the US, prompting the firm to operate more on the equity side of the capital stack in the States.

Indeed, Lone Star recently has been bidding on hard assets in the US. While PERE does not yet have the details, it is understood that the firm has won the bidding for some hard assets just this week. And, as indicated by the size of the equity haul it is targeting, they won’t be small. While perhaps not on the scale of its venture with Wells Fargo and JPMorgan Chase to acquire Anglo Irish Bank’s $9.65 billion US loan book in 2011, you just need to look at January’s acquisition of Dutch real estate company Wereldhave’s 17 US assets for $720 million for an idea of the arena in which Lone Star is looking to operate. 

Europe likely will see more activity by Lone Star in distressed debt deals, as the activities of the firm during the latter part of the investment period of LSREF II have indicated. Following its purchase of a $6 billion UK property loan book from Commerzbank, again alongside Wells Fargo, approximately $2.6 billion of the $5.5 billion raised for its second LSREF fund will have been invested in Europe. Most of that was in distressed debt.

That is not to say that select hard asset purchases in Europe won’t happen. Transactions like the €1.1 billion purchase of TLG Immobilien, the listed commercial property company in Germany, will no doubt be contested when they arise. However, these likely will be the exception and not the rule. In addition, they more likely will come in countries like Spain, where most of the banks have already foreclosed on the properties on their books.

As you might have suspected, Asia again is expected to play second fiddle to both the US and Europe in the firm’s strategy for this forthcoming fund. In Fund II, the region originally was expected to account for up to 20 percent of its investments, but the reality actually was shy of that percentage. In May, the firm purchased a large office in Osaka, another hard asset deal, but expect such deals to supplement the firm’s more bullish investment drives in the US and Europe, not lead them. 

The bulk of Lone Star’s large transactions in Asia happened while Grayken’s former right-hand man, Ellis Short, was at the firm. Under his watch, the firm took down Korea Exchange Bank in 2003 in a deal then valued at $1.6 billion. After the firm’s multiple-part exit from the bank concluded last year, Short’s ties with the firm effectively were cut. Given Lone Star’s forthcoming capital-raising story and likely distressed debt focus in Europe, it will be interesting to see how Short’s search for capital on behalf of his start-up Kildare Partners fares.

Like Lone Star, Kildare is planning a raid on Europe’s distressed debt opportunities and, PERE understands, his firm is marketing to investors with whom he forged bonds while with the Dallas-based firm. Of course, the more hard assets are acquired by Lone Star’s incoming third fund, the less that really matters.