BLUEPRINT: 'This is huge for us'

On first impression, Pete Reilly looks like he could have been a sports coach. One can easily imagine him in a dugout with his baseball cap on, chewing gum and barking out orders at the outfield players.

In reality though, the big, burly New York-born head of JPMorgan's real estate group in Europe is less overtly aggressive than the typical baseball coach. Perhaps being the son of a professor of nursing has made him more nurturing. The relatively soft spoken, polite family man presents what could be viewed as an institutionally acceptable image of a real estate man at the riskier end of the investment spectrum.

Peers at rival firms in Europe know him well, for Reilly has spent the past 10 years living in London, working for JPMorgan all of that time. But you will not hear rivals say a word against him. The only reasonable criticism seems to be that he and his team have not done much in the past couple of years. Yet inactivity is more of a badge of honour these days.

The slow investment pace has not been for lack of capital. In 2007, Reilly's real estate team raised its first ever 100 percent JPMorgan-managed real estate opportunity fund. The vehicle had an initial closing of just over €200 million and, while generally keeping its powder dry, has made two investments to date. He predicts there will be many more deals from the 2009 and 2010 vintages, about which Reilly is particularly excited.

Things have been somewhat busier on the corporate front. JPMorgan recently consolidated its real estate division with the infrastructure and maritime asset classes under the leadership of Joe Azelby, the head of the newly created Global Real Assets Group, all of which pursue core and opportunistic strategies. One of the most innovative products created within this newly established group is an Asian infrastructure fund that aims to raise $1.5 billion, according to internal documents.

The Dimon effect

Rightly or wrongly, JPMorgan under the stewardship of Jamie Dimon has emerged from the financial wreckage with more credit than most. Consequently, it is on the verge of renewed strength, not because it has risked all to become one of the largest banks on the planet, but because it hasn't risked as much as its counterparts. As the competition collapses, gets taken over or gets distracted looking for capital, JPMorgan appears to be winning the battle for survival. It was fit enough to take over Bear Stearns last year, and the marriage appears to have worked out better than that of Bank of America and Merrill Lynch.

Thanks to the perception that it is comparatively well capitalised, JPMorgan is enjoying a positive effect on its real estate business, says Reilly. The real estate lenders who still profess to be lending put JPMorgan and the funds they manage at (or close to) the top of their list of borrowers they are still prepared to lend to.

“It is no secret that JPMorgan is one of the firms that has been most successful at preserving the value of assets under management,” Reilly says. “But it is not just about pure numbers. Investors around the globe are focusing more on risk again and there will be different criteria going forward as to what kind of managers investors will be comfortable to trust their money with.”

Adds Reilly: “I think investors understand that from Jamie Dimon down, the bank has a reputation for managing the business very conservatively. That filters down to asset management and the real estate business. That is huge for us.”

The conservative reputation means that as the JPMorgan opportunity fund scouts deals across Europe, Reilly can look lenders square in the face when asking for lending terms. Not that accessing debt is going to be easy. In November, JPMorgan's opportunity fund became one of the earliest investors to dip its toe in the water since asset values began plunging alarmingly.

It agreed to buy an open air shopping park in Leicester, England, for £32 million (€35 million; $46 million). As he says, two years ago a fund sponsor like JPMorgan would have received 20 offers from lenders to finance the purchase of a fully let shopping centre. So how many serious lenders were there in November 2008?

Only three were prepared to look at it, according to Reilly, and only one prepared to lend on terms that Reilly found interesting. “That's a very significant difference in the market that has taken place during this cycle,” he says. “Having said that, we managed to get the deal financed at 65 percent loan-to-value.”

The flip-side to this is that St. Georges Retail Park in Leicester would not have appeared attractive to Reilly and the team two years ago. What made it of interest in November, however, was that the seller moved closer to the price JPMorgan thought appropriate. It was owned by a vehicle managed by UK property company Capital & Regional, which needed to reduce its gearing ratios.

Though there are still not that many sellers prepared to sell at what Reilly considers to be the “market clearing price”, he confirms there are more motivated sellers out there for sure, and this is beginning to lead to deals. “We have started to feel that the pricing of assets is making sense again in certain circumstances where the vendor is under pressure to sell, and we are starting to dip our toes in,” he says.

The risk attached to the investment is also different compared to 2007. Rather than a capital value risk, buying an asset today poses an income risk. In UK retail, for example, large chains have plunged into administration in recent times, and a flurry of worrying trading news suggests more will follow. So, though fully let, the risk at the Leicester shopping park is one of tenant defaults. This is the kind of risk that opportunity funds will be facing in the future, says Reilly, first of all in the UK and then followed by Continental Europe, which is six or nine months behind in terms of market cycle.

With other funds beginning to invest in the UK, there is gathering momentum for a clutch of opportunity funds to start deploying capital, and JPMorgan intends to lead the pack.

Reilly's fund has a broad mandate, including new developments and view towards Central and Eastern Europe. Sure enough, it identified a shopping centre project in Langenfeld near Dusseldorf, Germany.

JPMorgan found the Langenfeld mall deal interesting enough to approach a handful of potential investors about holding an early close in order to fund the investment. A joint venture agreement was struck with the operating partner controlling the site and work began almost immediately on the scheme. But then the credit crunch arrived. For the next year and a half, there would be no further deals for JPMorgan's opportunity fund.

In the meantime, the bank has progressed the German shopping centre, called Markt Karee. Langenfeld has a wealthy population and is one of only a handful of cities in Germany that is debt free, says Reilly, making it an attractive place to open a retail mall. Its operating partner had control of the land, and also the relevant planning permits.

Not only that, but it had pre-leased over 65 percent of the commercial space. So the risk was in the construction and in leasing the remaining units. Despite the credit crunch, Markt Karee opened in the first week of November 2008 on budget, on time and fully leased.

History of Europe

JPMorgan is one of the largest asset managers in the world and now one of the most stable, but unlike peers it has not had in
Europe a large presence in the opportunity real estate class.

Indeed, ask a few European investors and it quickly becomes apparent that not much is even known about JPMorgan’s capabilities in Europe or indeed its history in the sector.
JPMorgan has not been in the business of raising mega real estate funds, even back home in the US. However, its experience
in opportunity funds stretches back to the very origins of the investment style. In 1993, excited by the opportunities arising out of the RTC but hampered by US banking regulations restricting commercial banks ability to invest in real estate, JPMorgan decided to set up a jointly sponsored fund with fellow New York-based firm, The O’Connor Group.

The first couple of funds were US-only, buying distressed assets amid the RTC. But then the joint venture created two international funds called the Peabody Funds. Initially, Reilly was working for The O’Connor Group having joined the firm
in 1984.

The years were fruitful, but by 1998 the pipeline of US opportunistic deals was drying up but opportunities were
opening up in Europe and elsewhere. In response, the pair st up the Peabody Funds to invest globally. That year, Reilly
joined JPMorgan and moved to London to oversee the European investments of the Peabody Funds. Back then, JPMorgan
Partners, the private equity division of JPMorgan, housed those investments.
 
The Peabody Funds moved in and out of Europe’s main markets from 1998 to 2004 to take advantage of the fractional, yet transforming and harmonising market. “It was a great opportunity,” says Reilly.

Around half of the global Peabody Fund was invested in Europe by 2004 when the fund’s investment period came to an end. With very little transparency in most markets, no common currency, no common laws or regulations and markets at different cycles of stress or recession, Europe offered the fund a plethora of opportunity during those years. Peabody executed deals in France, Italy, Germany, Spain, Poland and the UK.

Among the more complex of these deals was the acquisition of Hausbau, a German housing company, in 1999. The fund sold
the residential property company to GE Real Estate in 2005 for a reported €190 million. Another example was the take private of a property company in Italy in a joint venture with two other opportunity funds and Pirelli Real Estate.

The year 2005 was very significant for JPMorgan. A convergence of events led the bank to launch its first 100 percent JPMorgan real estate fund in Europe. The Peabody Funds had become fully invested, and the responsibility fo r the European
business was transferred from JPMorgan Partners to JPMorgan Asset Management.
 
Rather than an opportunity fund, the first product launched by JPMorgan Asset Management was an openended, pan-European mid-risk fund. JPMorgan created an opportunity fund in 2007, he says, because operating partners started to find many opportunities which fell outside the mid-risk mandate of the open-end vehicle.

Fast forward two years and the bank is keen to take opportunistic advantage of the state of the European market again.

JPMorgan’s European real estate group is centralised in London, where there are around 35 people, of which 20 are investment professionals. The group employs a total of 50 people, including back office staff in Luxembourg and India.
 
JPMorgan’s model differs in an important aspect from most large Wall Street banks, however. While rivals have real estate professionals in cites such as Milan, Paris, Frankfurt and Madrid, everyone at JPMorgan is in London. Reilly says the centralised nature of the business makes sense in terms of JPMorgan’s “best practice” method of working, but he says that things may change over time as the portfolio grows.

For example, the business is considering deploying a member of the London team to Paris. “We are at that level of working
together now that we can think about opening an office elsewhere,” he says. “Eventually people want to go home and
we are trying to balance the long-term retention with how JPMorgan thinks about the business and the risks that come with hiring people.”
 
As JPMorgan in Europe prepares to become more active, Reilly says: “Our view is still that 2009 and 2010 are probably going to be two of the best vintage years for opportunity funds in the past 20 years – better than the last global downturn. When we think about private equity investing at JPMorgan we think about ‘where is the next opportunity?’ In Europe, we feel the market has started to come our way.”

With that, Reilly shifts his frame back to his desk. Now that JPMorgan’s balance sheet proven its resilience, there is much work to be done.

Peter Reilly and JPMorgan at a glance

Pete Reilly

European Real Estate Group (a division of JPMorgan Asset Management)