NEWS ANALYSIS: The lost Citi

Citigroup had hoped Citi Property Investors would propel its real estate activities into the same league as its better-established banking activities, a newly-hired platform boss Joseph Azrack told reporters back in September 2004.

“Citigroup is a market leader in other areas,” he told one reporter. “In merchant banking and alternative investment, including real estate, it wants to be in the top three globally,” he said. Some reports suggested Azrack, who joined from AEW Capital Management, was set to lead an investment programme armed with a war-chest of up to $20 billion slated for future real estate investment.

Exactly what inroads it made into its ambitious plans will be debated for years to come. One thing is certain though: Citigroup’s flirtation with real estate investment management is drawing to a close nearly six years after it began.

Exactly what inroads it made into its ambitious plans will be debated for years

Last month, PERE revealed that New York-based Apollo Global Management, where Azrack moved to in the summer of 2008, was selected as the preferred bidder to buy the business in a deal expected to complete by the end of next quarter. In one swoop, Apollo will quadruple its headcount to more than 100 staff across Europe, North America and Asia. More importantly, it inherits a platform valued in January at approximately $8 billion. In short, Apollo joins the world’s biggest hitters in private equity real estate in place of CPI.

Neither Apollo nor CPI would comment on the transaction. But PERE understands that Apollo, founded by Leon Black in 1990, will pay a nominal fee upfront for the platform. Citigroup also potentially stands to benefit from future positive performances after the two firms predetermined an earn-out structure. One source close to the process said: “Obviously Apollo would be taking over with an expectation of a certain level of profitability embedded in the business.”

He added: “Apollo will now have a great base of institutional investors with which to have a relationship and a team highly complimentary to its existing structure. They know the people and the assets very well. While the transition won’t be seamless, it can be very efficient.”

The limited majority

Apollo’s winning bid came as a result of garnering enough support from the LPs in CPI’s three funds: the €1.16 billion CPI Capital Partners Europe; the $600 million CPI Capital Partners North America; and the $1.29 billion CPI Capital Partners Asia Pacific – each of which closed between 2006 and 2007. Citigroup and CPI senior executives also had significant say in Apollo’s final selection being major investors in the funds – Citi’s typical capital commitment per fund was $200 million.

One PERE source suggested that the vote was not unanimous, but it was sufficient to edge out Macquarie Capital Advisors, a suitor considered by some to have been a more than adequate alternative. And given a restrictive covenant between Macquarie Capital’s parent, Macquarie Group, and MGPA, the private equity real estate business it part-owns, had expired, the firm was in a strong position to bid for CPI. With no staffing overlaps to contend with, some outside observers believed CPI’s LPs should have favoured the Sydney-based operation.

We are talking about a business that Joe Azrack built and people he hired

Staffing was indeed important to the LPs, but the allure of reuniting an Apollo-branded Azrack with the business he first created was ultimately deemed more important. “If Apollo had any competitive advantage, I think that was it,” says the source. “We are talking about a business that Joe Azrack built and people he hired.”

While a number of senior executives resigned just prior to Apollo’s selection – most recently head of North American investments, Larry Ellman, and chief financial officer in Asia, Marco Ho – CPI’s most senior man, president and chief executive officer Roger Orf is staying, for now at least. At press time, it was believed he was in the midst of negotiating his responsibilities with Apollo.

Six years of CPI

The birth of Citi Property Investors in 2004 came amid prosperous times in the private equity real estate sector for Citigroup’s major rivals like Morgan Stanley and Goldman Sachs. Both were deep into their respective MSREF and Whitehall funds series while Citi’s exposure to real estate was comparatively minimal by comparison. Scars inflicted by the market downturn of the 1980s and the early 1990s when it was one of the world’s biggest mortgage lenders, and subsequently one of the world’s biggest sufferers of unpaid loans, had kept the bank out of real estate until then. Its return, as part of Citi Alternative Assets (also home to Citi’s private equity and hedge funds platforms) was always slated to be different.

“The distinction this time around is that we are talking about equity investments,” Azrack told Financial News at the time. “The plan is to invest Citigroup proprietary capital side-by-side with client money for high-net-worth individuals and institutions wanting to invest in real estate funds.” At that time, Citigroup had approximately $5 billion of real estate on its books, 10 percent of which was in Europe.

Azrack soon targeted Europe as a key starting point for CPI, opening another London office in addition to those Citi already occupied in the US. Initially, the platform was staffed by US executives relocating to London, including Citi Alternative Investments’ European managing director Michael Walton.

Orf joined in October 2004. From an initial breakfast meeting in London’s West End with Azrack, CPI courted Orf, who was then European head of Lone Star Funds, via a number of discussions with other “persuasive” Citigroup figures, including ex-Goldman Sachs head and US Treasury Secretary Robert Rubin. Walton shortly moved on to manage Halladale-controlled real estate fund manager Rynda en Primeur, but through Orf, the nucleus of CPI was firmly in place.

Further senior hires ensued including Michael Astarita as chief financial officer from JP Morgan Fleming; David Schaefer from Macquarie Bank to lead CPI in Asia; Larry Ellman in North America; former DTZ investment officer Stuart Webster as chief investment officer for Europe; and current European head Neil Hasson from DLJ Real Estate Capital Partners, among others.

Through the looking glass

By early 2007, CPI had raised more than $3.5 billion in equity commitments from a mixture of international LPs including US pension funds, the New Jersey Division of Investment, New York State Teachers Retirement System, Australia’s Post Superannuation scheme and Oxford Properties Group, which invests on behalf of the Ontario Municipal Employees Retirement System.

The firm wasted no time investing its resources. At its biggest in June 2008, CPI had more than $13.5 billion in gross assets managed across offices in New York, Los Angeles, London, Germany, Hong Kong and Frankfurt filled with more than 145 staff. Ironically, this was also when Azrack was lured from CPI to Apollo. While Azrack was handing over the reigns to Orf, the firm was making a headline-grabbing $800 million co-investment with Israeli investor Gazit-Globe in Austria’s Meinl European Land, a Central and Eastern European developer in need of capital and an image makeover amid an illegal share-buy back scandal. Despite the change in leadership CPI remained in the market for attractive acquisitions as Orf targeted more entity-level investments like Meinl and its €250 million investment in German residential company Deutsche Annington, made in 2005, as well as in debt investments.

Arguably the writing was on the wall for the sale of CPI as early as 2008 when the US government took a 27 percent position in Citigroup as part of its banking sector bail-out strategy

CPI was in acquisition mood but within months, Lehman Brothers had collapsed. Soon question marks surfaced over the investment banking real estate fund model as real estate values began to crash market by market. Like its competitors, CPI did not escape with unscathed valuations. The value of its North American investments, for example, fell 28.2 percent a year to June 2009, according to the Wall Street Journal citing an annual report by the New York Teachers Retirement System.

Arguably the writing was on the wall for the sale of CPI as early as 2008 when the US government took a 27 percent position in Citigroup  as part of its banking sector bail-out strategy. Consequently, the bank faced pressure to strengthen its balance sheet by disposing of certain assets. Eventually, CPI became part of Citi Holdings, the group of assets set aside ready for sale.  As 2009 approached CPI took defensive steps, such as handing back $400 million of equity commitments raised for a follow-up Asia vehicle, as it adopted an asset management-focused strategy.

True enough, in August 2009, CPI was placed on the market and a fierce bidding process followed culminating in Apollo’s victory last month. Apollo was picked ahead of bids from Macquarie Capital, ING Real Estate Investment Management and Northwood Investors, among others.

Opinion is split as to whether the CPI’s LPs made the right selection. One rival fund manager said: “The LPs must have been so annoyed with Citi to go with Apollo, and the same guy [Azrack] that deserted them back in 2008.”

But another said: “For Apollo it absolutely makes sense to take on a portfolio they are familiar with.” One more added: “The LPs rightly want to go with someone who wants them and will look after their interests.”

Citigroup’s famous logo reads “Citi never sleeps”. Perhaps the bank will awaken to another real estate investing opportunity in years to come. But through this exit to Apollo, its once-sizable ambitions in the sector have been well and truly put to bed.