Oppo funds must control the basis on entry

Japan’s annualized second-quarter growth of 2.5 percent made for mixed reading. On one hand, it meant the land of the rising sun experienced the largest growth increase since 2001 and has seen seven consecutive quarters of expansion. On the other, the number was a good 150 basis points lower than preliminary estimates.

Consequently, the headlines smacked of disappointment. For the folks at PAG Real Estate, the real estate arm of the Hong Kong private equity firm PAG, however, the growth prospects of the country in which it will focus on deploying last month’s largest closed opportunity fund will be immaterial. From its SCREP series, the firm makes investments in anything from small multifamily blocks in Tokyo on a direct basis to giant, nation-covering nonperforming loan books indirectly.

The common strategic thread? Discounts. As the firm’s managing partner J-P Toppino told me: growth opportunities need not feature. For PAG, everything it buys must be on a “below market basis,” preferably in the 20-25 percent range, and from market – not book – pricing. “If there’s one thing I’ve learned from having private equity and hedge fund partners is that controlling the basis on which you’re going in is critical.”

Any oppo fund dressing up a 90 percent-let office block in a B+ location as distressed and plowing in, leveraged to the teeth, to juice returns better have other value angles to offer.

That is a strong message for investors today bent on migrating up the risk-return curve. Just because prime yields are unconscionably low, it is integral that the risk of overpaying for core property is not replaced with overpaying for core-plus property dressed up as value-add or opportunistic. Any oppo fund dressing up a 90 percent-let office block in a B+ location as distressed and plowing in, leveraged to the teeth, to juice returns better have other value angles to offer.

Ironically, as you will read in this issue’s Germany roundtable, that same hypothetical office is being courted these days in that market by core buyers, too. The discernible difference is lower leverage.

Back to SCREP VI. PAG’s fund attracted $1.9 billion from 20-odd investors: the most international, institutional capital raised for an opportunity fund by the firm, by any real estate manager in the whole sector in the month to press time, and largely for Japanese investments ever. The firm’s strategy saw its predecessor fund generate 30 percent-plus net IRRs. It has generated realized net returns of 19 percent since its inception in 1997. In that time, Abenomics has come in fits and spurts. While others bet on Japanese growth, it stuck to its discounted knitting and has been rewarded.