Meet John Grayken. He is the founder and owner of Lone Star Funds, one of the biggest and most successful private equity real estate businesses in the world. He is also a self-made multi-billionaire, and many in the industry have read about him – but few have encountered him. That is because, as is well documented, he is an intensely private man. In 2009, this publication called him “shy.” In 2016, business magazine Forbes called him “shadowy.”
While he avoids publicity, his firm often cannot. Lone Star makes many headlines, and they are not always positive. It has bought assets competitors find too sensitive, and usually following widespread distressed situations. While many of Lone Star’s peers now focus on growth strategies, Grayken’s business sticks to guns originally crafted to benefit from the RTC and Savings and Loan crisis in the 1980s and 1990s.
Investors love this consistency. Lone Star’s vehicles have attracted high-profile US pensions such as the California State Teachers’ Retirement System, endowments like Howard Hughes Medical Institute (HHMI) and sovereign wealth funds such as Abu Dhabi Investment Authority, often on a repeat basis.
They have benefited from positive performances from all but one of Lone Star’s 21 funds to date. Grayken would not discuss track record, but it is understood from other sources that its flagship Lone Star Fund and Lone Star Real Estate Fund series, which account for more than $80 billion of the $85 billion Lone Star has raised since its inception in 1995, have regularly hit their 25 percent gross IRR and almost 2x equity multiple performance targets, as many a US pension fund document will verify. That is almost three decades of strong returns.
Investors also love Grayken’s alignment. His senior executives commit significant proportions of their net worth to his funds. His own skin in the game typically extends to 5 percent or more. Few fund managers have committed anywhere near as much. Lone Star funds are usually deployed quickly, their assets worked through at pace and their distributions made fast. Returns are never reinvested during a Lone Star vehicle’s investment period.
In fact, investors are so happy with his business they reconcile with some of its more sensitive plays and overlook the fact he represents possibly the highest-profile example of key person risk in the industry. “It’s a great risk,” states one ex-real estate head of a repeat Lone Star investor, who requested to remain anonymous.
“Without John, it’s a question,” remarks Jay Kolyer, ex-managing director, diversifying assets at HHMI.
“That question is front and center all the time,” says Michael Thomson, Lone Star’s former general counsel.
“The end will come when I can’t be as effective as I need to be,” Grayken tells PERE. “That time will come.”
“For longevity, you cannot blame your mistakes on anybody. Whatever it is, you need to own it. That’s how you improve”
But probably not soon. Grayken will not discuss fundraising, but it is understood from other sources that Lone Star is out marketing another of its flagship vehicles and will announce closings later this year. The firm’s investment periods typically last at least four years, so that would imply he will remain at the helm for a while. “I’m still in good physical shape,” he says.
While his career is ongoing, Grayken has done more than enough to warrant being named Lifetime Achievement Award winner in the 16th annual PERE Global Awards.
He joins other industry luminaries among the award’s former winners, which include Starwood Capital founder Barry Sternlicht, APG’s real estate mastermind Patrick Kanters and AXA Investment Managers’ real assets chief Isabelle Scemama. “I’m honored to get the award,” he says. “I hope you’ll let everyone who you work with know that I feel that way very much.”
That is about as sentimental as he gets in the almost two and a half hours we spend together. Grayken is friendly and accommodating. But there is also an unwavering conviction, deliberateness and precision in how he talks. In agreeing to PERE’s request for an interview, which customarily comes with accepting this award, he is breaking a habit of a lifetime. As such, he takes the same, serious approach he would with any business meeting.
Grayken’s attire for the interview says the same. We talk after he has participated in an hour-long photoshoot – another unfamiliar experience, though it does not make him uncomfortable. A residential block owned by London landlord Quintain, one of Lone Star’s property company investments, provides the setting. While other bosses have opted for more casual looks, like open-collar shirts or sports jackets, for interviews with journalists, he wears his customary, double-breasted, dark, pin-stripe suit. It is a uniform adopted from his time at investment bank Morgan Stanley in the 1980s. “I manage money for other people,” he explains. “I have clients. There’s nothing casual about the way I view that responsibility.”
Nonetheless, Grayken does reveal there are two sides to him. He is a family man. He mentions his four children on multiple occasions. He plans to watch them play sports for their school teams that weekend. He even discusses marriage – he has married twice – and parenthood – he did night-time feedings when his kids were babies. “Working and being with my family are the two things I like to do,” he says. “There’s really not anything else which competes.”
We are here, of course, to talk about his work. We can only imagine his family life, but for PERE, he is willing to open what has previously been – for most – a firmly closed door to his professional world. You will not see Grayken at industry events. “How does that serve my interests?” he asks. He rarely even rubs shoulders with other bosses in the market, let alone swaps notes with them. “I respect them a great deal. I’m friendly. But we don’t share information. I want to keep my information proprietary.”
When it comes to his work, he is decidedly unsentimental. Everything about Lone Star leads to meeting “the objective,” a word he uses throughout our conversation. He has set a corporate culture predicated on simple but strict principles and centered around one outcome: “making money for my investors.” By his reckoning, get that part right and the rewards sort themselves – for his investors, his executives and, of course, for him. It is a philosophy that has consistently worked. It has made him the third-richest man in private equity with a net worth of $7.6 billion, according to Forbes, behind Blackstone founder Stephen Schwarzman on $21.9 billion and Apollo boss Leon Black with $8.6 billion.
His secret? Unsurprisingly, many more strong than weak risk assumptions when making investments. “Generally, the rule of thumb is you need to be right four out of five times,” he says. But he adds a principle perhaps not all senior private markets figures adhere to. “And learn from your mistakes by taking responsibility for them,” he says. “For longevity, you cannot blame your mistakes on anybody. Whatever it is, you need to own it. That’s how you improve.” This second philosophy explains why Grayken is equally interested in discussing Lone Star’s misses as he is its hits.
“We’ve done deals I wish we hadn’t,” he says. The firm’s 2005-vintage Lone Star Fund V, for instance, returned 0.975x because of misjudgments in Japan. At the deal level, he singles out the firm’s $1.3 billion purchase of a consumer finance business in 2014 as an example of poor underwriting. “We underestimated the regulatory risk and environment.”
To minimize the misses, Grayken spends most of his working hours with the firm’s problematic transactions, where original underwriting has not materialized. He has a “tremendous amount of delegation and trust” for his investment committee – which also includes presidents William Young, Donald Quintin and André Collin, as well as the firm’s most senior investment directors – when it comes to sourcing deals for the firm’s pipeline. This enables him to dedicate his energy to any issues arising from the deals his colleagues make.
Describing his work as “totally reactive,” Grayken says: “The way I manage the business is I’m involved in all the various ideas formulating our investment policy. I’m involved in scrutinizing the underwriting and the analysis for when we take risk. Then, when the risk is on the books, I don’t get involved unless it deviates negatively from the objective. I’m only dealing with problems.”
This is the main way Grayken helps Lone Star meet its objective. He is uninterested in celebrating investments that shoot through their underwriting, which many have. For example, its bank forays following the Asian financial crisis made considerably more money than forecasted. In 2003, Lone Star completed the $1.2 billion purchase of controlling interest in Korea Exchange Bank, selling it in two stages by 2012 for a total of $5.2 billion.
The deal might make more still if an ongoing arbitration with Korean authorities expected to conclude soon falls in the firm’s favor.
Another was Tokyo Star Bank, in which Lone Star acquired a major stake in 2001 for about $390 million and exited a decade later for more than $2 billion. Of outcomes like these, he says: “Our view generally is the investment will hit its return target. If you do much better, and there have been a number of investments where we’ve done that, I don’t think it’s fair to take any credit. You didn’t see it coming. You got lucky.”
Subsequently, while certain Lone Star staffers recall instances when Grayken would personally shake their hands for a job well done, others suggest a meeting with him is not always welcome. “We used to joke about that,” recalls Thomson. “People would join [Lone Star] and want to spend time with John. We’d say, you really don’t want that. When things are working fine, he’s fine. When things aren’t working, or are at risk, like in Korea, you spend a lot of time with John as he gets hands-on.”
A double-edged deal
By “Korea,” Thomson is referring to Lone Star’s KEB investment. Seminal in stature for the firm, the deal demonstrates the lengths it will go to “meet the mandate” for its investors.
Grayken describes it as “a controversial deal but ultimately very profitable.” Lone Star initially received bids as high as $6 billion for the bank when it tried to sell, but Korean authority interventions thwarted multiple exit attempts. While a strong sale ultimately did transpire, Lone Star is still fighting for further compensation almost 20 years after the initial acquisition, after being made to accept a lower price when it sold its controlling stake to Hana Financial Group.
The episode also demonstrates the degree to which Grayken will personally go to protect his high-performing executives. He knew he faced fierce media scrutiny, even detention, if he flew to Korea to testify after his then-Korea head Paul Yoo was arrested on charges of stock price manipulation relating to a credit card business that was merged into the bank after Lone Star bought it. But Yoo’s lawyers were asking Grayken to come to clear their client’s name.
“They didn’t want me to go to Korea to testify and told me I would be detained if I did,” Grayken says. “But I felt it was important.”
In the end, he was held for two weeks before being released without a charge. “I had to submit to a lot of questioning about what happened.”
“It was kind of amazing. John went in the face of personal risk to support his guy who was being wronged,” recounts Thomson, who advised Grayken about the matter at the time. “I really applaud him for that. If you’re doing your part, he will stand by you.”
Three camps of leaver
If you are not doing your part, on the other hand, you may well be shown the door by Grayken. He says Lone Star leavers typically find themselves in one of three camps. “One is: they have been really successful, already made lots of money for their family or are ready to do something else.”
Lone Star has a veritable roster of high-profile leavers that fall into this camp: Roger Orf is an example in Europe. He later became chief executive officer of Citigroup’s former real estate business, Citi Property Investors. In Asia, Takehisa Takamatsu, Lone Star’s head of Japan, is another example. He left in 2015 and is more visible today in his philanthropic pursuits, including sponsoring the Tepper School of Business at Carnegie Mellon University in Pittsburgh.
Grayken’s former right-hand man, Ellis Short, who used his Lone Star winnings to buy then-Premier League football team Sunderland and Scotland’s famous Skibo Castle, has been the most active of the lot since moving on. He launched his own private equity real estate business, Kildare Partners, in 2013. Kildare is now a major player in European markets and last year broke into the US.
“I don’t get involved unless it deviates negatively from the objective. I’m only dealing with problems”
The second leaver camp is less fortunate. These are the individuals who, by Grayken’s reckoning, have not been up to the job. “They haven’t been able to meet the investment objectives and so I asked them to leave,” he says.
It is a ruthless streak gleaned from his formative years at Morgan Stanley and Robert M Bass Group. “If the deal went well, you did well. If the deal didn’t go well, you were out,” he says.
The third camp are folks with the wrong skillsets, or based in the wrong regions, for the opportunities Lone Star sees in the moment. Last year, the firm reduced its headcount in Asia by 25, placing Collin and Quintin in charge of all regional activities in the process.
Lone Star’s founder says there may be opportunities afforded by the covid-19 crisis, but that it is not obvious where the best plays are.
“Certain types of retail have structural demand diminished for the future. Other elements of commercial retail are more promising, and you have to differentiate between the two.”
“Offices are really difficult to try to understand what the long-term trends are going to be. It seems unlikely to me that things are going to go back to the way they were. It seems the aggregate demand for office space is going to be impaired. But then you have demand for high-quality offices that can meet today’s standards. Other segments will become obsolete.”
“It’s easy to say hospitality will recover on one hand. But business hotels: are we going to travel as businesspeople as much as we have? Seems unlikely.”
“Logistics is a booming business and it looks like demand will be strong for the foreseeable future. On the other hand, a lot of that is reflected in the prices you have to pay and assumptions you have to make about growth which, in some cases, would be dangerous to underwrite.”
Prior to that, Mark Newman, another high-profile veteran from his time leading Lehman Brothers’ private real estate business, left at the end of 2019 after five years, after it was determined an NPL opportunity in China would not materialize. “That’s why we de-emphasized there,” Grayken says. “If there’s nothing to do and we’re going to de-emphasize for the foreseeable future, then people either transfer to other regions or leave.”
The anonymous former investor says Grayken’s global fund model has enabled the firm to be dexterous in the geographies in which it chooses to invest: “They would rotate in and out of markets where they saw the opportunity.”
The same investor recalls asking Grayken for country exposure limits in an investor meeting. “I asked about maximums in places like UK or Korea and he says, ‘Maybe 100 percent.’”
Grayken explains: “You have an idea of what the regional allocation may be when you form a fund but you don’t know for sure. Things can change a lot. Then you tend to do more business where the returns are most appealing.”
After the global financial crisis, it was non-performing single-family residential mortgages in the US, then commercial mortgages in Europe featured prominently. For each, Lone Star and, in tandem, Hudson Advisors, scaled up while the opportunity lasted.
Life at Lone Star
For those able to stay the course at Lone Star, Grayken has constructed a simple but financially rewarding pathway. Most employees start at Hudson Advisors, an asset management operation regarded by some as a “factory” from when it was used to process thousands of loans following the Asian and global financial crises.
Until recently, Hudson had one client: Lone Star. “Here, you manage the risks we’ve already taken,” he says. “If you show a degree of aptitude, you might shift into Lone Star and start underwriting. You’ll be part of a team assessing risk.”
Employees who excel are given decision-making powers about investments. “Before you’re talking on the investment calls as an underwriter where senior people are listening, that’s a decade. It’s usually four to five years longer still before it’s your deal.”
That is when Lone Star’s senior executives earn the most. Under Grayken’s philosophy of taking responsibility, it means they only earn carried interest on their deals, unlike other firms where carry is distributed more evenly. The most prolific become very wealthy as a result. “We’ve tried to design a system where there’s very close alignment between compensation and results for the investors. If our investors don’t make money, our people don’t make money. If they do, we do. Simple as that. There’s no mark-to-market, no big pay event in December just because it’s the end of the year.”
He is asked how he keeps a global headcount hungry, alongside fund programs that might start with a global remit but end up overweight in one region. For example, Lone Star Real Estate Fund III, which closed on $7 billion in 2013, was approximately 90 percent invested in Europe. He says his executives never need to worry about colleagues elsewhere calling all the dry powder. “If a deal meets our underwriting criteria and return target, we’ll do it.”
That said, he recognizes his money is always on a timer and is not afraid to wind up a fund early if opportunities do not arise. Lone Star Real Estate Fund V held a rare ‘one and done’ single closing of $5.8 billion in 2016, only to be reduced to $2.7 billion when opportunities seen during fundraising evaporated. “If we don’t see the opportunity to meet the investment objective, we won’t invest.”
Grayken accepts that disappoints investors. “They made a commitment based on your assessment of the market opportunity. If you can’t invest the money at the target during that investment period, that, in a sense, is a failure. On the other hand, if you lose money by making bad investments for them, they’ll be a hell of a lot more unhappy.”
For the most part, investors accept this, the anonymous former backer says: “When he doesn’t think he can make money with his model, he doesn’t push it. He does something else.”
Grayken says if Lone Star continues to hit its targets, the firm will keep enjoying high levels of investor support. “If you can make money for people, you never have any problem raising it,” he says.
Wheat from chaff
This brings us on to where Grayken intends to make money following a crisis not instigated by financial factors. He sees opportunities, he says. “But these markets are dangerous. There is a fundamental shift in usage of commercial real estate. Some of it might be temporary. Some structural and long-term.” Wrong calls made on assets experiencing a structural shift “can be deadly for business,” he warns.
To complicate matters for a macro-better like Grayken, each real estate asset class can now be split further into sub-asset classes, some of which are temporarily impeded, others structurally impaired. He has views on each main property food group but expects deep analysis is needed to separate wheat from chaff: “Once you find the recovery story in a particular segment, you need to find the opportunity,” he says.
“If our investors don’t make money, our people don’t make money. If they do, we do. Simple as that”
Given Grayken’s propensity for finding value in areas of dislocation, it is unlikely you will see Lone Star majoring on so-called ‘new economy’ areas like distribution, digital or life sciences real estate, though sectors that have risen sharply certainly will feature, such as student and senior residential.
Moreover, expect to find Lone Star working through segments within traditionally popular asset types like offices and retail properties to find value. In so doing, it is possible the more controversial entity-level transactions of the firm’s past will be less prominent as accelerated themes in real estate lead to dislocation at the asset level.
As such, Hudson Advisors could play more the asset manager than special servicer in this cycle. ESG considerations might need to become more prominent than before. Asked if Lone Star has a net carbon reduction plan, for instance, he replies: “We’re looking into that now,” adding: “You don’t want to be involved in buying assets that contribute to pollution. You don’t want conflict with the communities you do business with. That’s important to avoid in business.”
Ultimately, it comes back to the mandate, which he repeats is “very commercial” and “as uncomplicated as possible.”
“The purpose of the company is to serve the interests of the investors. That’s what our primary objective is: meet the mandate delegated to us by them. It’s not very complicated. It’s a return objective consistent with playing by the rules. That’s it.”
To know that central tenet about John Grayken is to know how Grayken ticks professionally. As such, if you read this feature, you might now feel you have met him.
Clear line of sight
John Grayken always knew he wanted to run his own business. He figured out how during his time at the University of Pennsylvania, Harvard, Morgan Stanley and Robert M Bass Group.
Grayken is a self-made man in the classic sense of the term. Born in 1956 to Irish-German parents in Cohasset, a suburb of Boston, he describes his early family life as modest and middle-class. His father worked in insurance and his mother was a homemaker. He was the only one of four children – he had three sisters – who wanted to own a business. “It was an instinctive thing,” he says.
He played hockey after his father introduced him to it in the 1970s, and loved watching defensemen Bobby Orr play for his local Boston Bruins. As a teenager at those games, Grayken could see Orr through the glass around the rink. “To be as close to him as I am to you, watching him play, was amazing,” he recounts, describing Orr as the sport’s first “offensive defenseman.”
Grayken was a defenseman, too. “My first coach asked to see how I handled a puck. He said, ‘That’s good. Now go play defense.’” Nevertheless, he would play through high school and at the University of Pennsylvania. “I loved playing hockey,” he says. But this never distracted from his primary aim of being in business.
The boom years
An MBA at Harvard University followed his economics degree at UPenn. “If you studied business at the undergraduate level, you don’t need an MBA. But if you haven’t, and you don’t have a lot of business experience, then I think it’s a great degree and would recommend it.” Grayken’s value on education extended far into his professional years, sponsoring an International Real Estate program at Penn’s Wharton School as recently as 2017.
“I never would have gotten into Morgan Stanley if I hadn’t got into Harvard,” says Grayken. He still speaks of the Wall Street giant in glowing terms, holding the bank chiefly responsible for giving him working principles he still upholds. “That was a place which has really high standards about everything: how you dressed, how you wrote, how you presented, the thoroughness of your analysis. It was of tremendous benefit to me for the rest of my career to see that level of professionalism.”
Grayken worked for Morgan Stanley for three years in the mid-80s when “Wall Street was booming.” He looks back on the period with fond memories. “It was a time when it seemed making money was back in fashion and being in business was something to be admired.”
He reels off the names of high achievers from institutions like Salomon Brothers and describes regulation introduced during the Ronald Reagan administration, like the Gramm-Rudman Act, which altered the way the government would handle the country’s deficit. The act was a piece of regulation that stemmed public expenditure and enabled greater flexibility for private investment. “It was an amazing time,” he says.
His next chapter was more entrepreneurial. Robert M Bass Group, the Fort Worth, Texas-based family business, was largely accredited as a forerunner of the private equity industry. It was a magnet for entrepreneurial types just like him.
“I had an opportunity after Morgan Stanley to be involved in a real estate development project in Nashville in which Robert Bass, one of the Bass Brothers, was providing the equity,” he says. The project, an office building, was not, ultimately, a success. “It more or less coincided with the crash in the property market in the US, which precipitated the RTC crisis,” he recounts. But the resultant lesson in underwriting risk – “we were expecting a certain level of lease-up, which didn’t happen” – gave him the tools to make the most of the crisis.
Closed-end’s opening days
In the process, he became one of the architects of private equity real estate. He was keeping legendary company. Also at Robert M Bass Group was David Bonderman, who founded TPG, as was Tom Barrack, the founder of Colony Capital. His former employer Morgan Stanley and its investment banking rival Goldman Sachs had also activated in the opportunistic real estate space with their MSREF and Whitehall Street Fund series. These would be the figures, funds and organizations that kickstarted the use of closed-end private funds to buy real estate assets in the mid-1990s.
Grayken’s first vehicle and the predecessor to the Lone Star funds, Brazos Fund, came after doing follow-on deals for Robert M Bass. They included properties, but also the restructuring of the bad bank that was created in conjunction with the failure of American Savings Bank, a failed savings and loan run out of California, a valuable experience for Grayken’s later bank acquisitions. Brazos attracted $250 million in outside capital, including a seed $30 million from Bass. “They sound like small numbers, but they were big back then,” says Grayken. The fund’s aim was to continue buying “RTC assets and other mortgage-related assets being sold by the banking industry.” Its investments also included Grayken’s first cross-border deal in Canada, which was a loan book transaction. “That experience led to a lot of borders being crossed eventually,” says Grayken.
By this stage, he was well on course to realize his childhood ambition.