After 107 expressions of interest, five serious bids, two finalists, nine months and hundreds of hours of negotiations, the future of Lehman Brothers' private equity real estate group has been resolved. The group will spin-out in a management buyout.
Ever since 15 September 2008, the future of Lehman Brothers Real Estate Private Equity business (REPE) has been shrouded in uncertainty as the parent bank, Lehman Brothers Holdings Inc (Lehman), worked its way through bankruptcy proceedings. Last month, the largest LPs and Lehman agreed the “right course” of action was for the existing team to take over the management entity of REPE and management of its three opportunistic funds, said Jack McCarthy, Lehman's head of principal investments and private equity and managing director at restructuring advisor Alvarez and Marsal.
Lehman Brothers' New York HQ on Sept 15, 2008
The deal has been sealed for a reported $10 million, with the new team led by REPE's existing co-heads Brett Bossung and Mark Newman, chief financial officer Rodolpho Amboss and Kevin Dinnie, the group's global head of asset management. Mark Walsh, the bank's former global head of real estate and a founding co-head of Lehman's private equity real estate group, will also be a partner.
The deal, which is expected to close in early September, leaves Lehman retaining its position as GP and the cornerstone LP in the three real estate funds, Lehman Brothers Real Estate Partners I, II and III. Funds I and II were fully invested at the time of the bankruptcy with an aggregate $3.6 billion of proceeds returned to date. The $3.2 billion Fund III had $1.9 billion of dry powder as of year-end. As part of the management buyout (MBO) though, the LPs in the fund, including Lehman, will be allowed to forgo their unfunded commitments save for $300 million, which will be used to fund the legacy assets and to buy back discounted debt.
The road to the MBO though has not been easy.
According to people familiar with the matter, the REPE team had hoped to orchestrate an MBO as early as October to put them on the “front foot” and retain the right to call unfunded commitments. The team had just raised Fund III, investing just $1.2 billion as of September 2008. “If it wasn't for the bankruptcy, REPE was an ongoing viable business,” said the source. The length of time it took to decide on an MBO was “frustrating” to many LPs.
The bankruptcy process has also been followed by the departure of key personnel in REPE's European team, with John McCarthy, head of European asset management, and Gerald Parkes, head of REPE in Europe, both leaving in the past six months, sources told PERE.
McCarthy confirmed there were a number of options on the table following the Lehman bankruptcy, including an MBO, selling the firm's LP and GP stakes, third party management of the platform and a wholesale purchase of the management entity. The offers though were not acceptable. “Fairly early on we realised we were not going to get the valuations we thought appropriate for the LP stakes or the GP stakes.” In the end, he said, it was a “collaborative decision with LPs to stick with the existing management team”.
Part of the reason for choosing the Bossung-Newman team was the scale of REPE's portfolio, he added. With around 150 investments across three funds, involving thousands of properties – three-quarters of which were located outside the US – the existing team represented continuity to Lehman and LPs. They also had their own skin in the game and track records to defend, according to McCarthy.
The MBO – which has yet to decide a new name for REPE – will be focused in the near term on asset managing the legacy portfolio and will be paid a disposition and incentive fee to bridge the current net asset value of the funds against “where the historical carry would have kicked in”. McCarthy stressed though the fees, which will offset revenue lost owing to the forgoing of unfunded commitments, are “far from being a full reset to the traditional 2/20 model”. In addition, any carry earned on the portfolio would reduce the incentive fees on a dollar-for-dollar basis.
Despite the frustrations of existing LPs at the length of the process, another person familiar with the matter said some LPs were “disappointed” the unfunded commitments to Fund III were being terminated. In addressing the needs and wants of LPs in a global fund, he said, “it didn't make sense to continue investing in new deals”. However, he noted that by drawing a line under the old and the new, the MBO now has the ability to go out and raise new capital. “The team is pretty well positioned to build a successful business in the future given the breadth of the platform and depth of experience,” he added.
REPE employs around 100 people globally, much of them focused on asset management, finance and investor relations.
The spin-out does not include Lehman's real estate mezzanine funds, which, according to industry sources, are being eyed by Los Angeles debt investment firm Pacific Coast Capital Partners (PCCP). PCCP was unavailable for comment at press time.