BLUEPRINT: Continental stars

Starwood Capital Group is back in investment mode in Europe. It is a simple and powerful message from the Greenwich, Connecticut-based firm, which recently made its first investments in Europe in three years.

Sean Arnold and Desmond Taljaard are the two men busy putting their stamp on the region for Barry Sternlicht’s firm. Arnold, senior vice president, is head of European acquisitions, while Taljaard is chief operating officer and heads up asset management.

Desmond
Taljaard

Our meeting took place shortly before the firm announced it had raised $2.8 billion for its two latest funds – the $1.83 billion Starwood Global Opportunity Fund VIII and the $965 million Starwood Capital Global Hospitality Fund II. By virtue of this feat, Starwood has become one of the few firms able to close out a large opportunistic fund – an effort underlined by the way the firm has shot up the annual PERE 30 rankings unveiled in the May issue of PERE magazine.

Raising two funds in parallel is the way Starwood has operated since its founder, chairman and chief executive officer returned full time to Starwood Capital in 2005, following a spell running the hospitality REIT Starwood Hotels & Resorts Worldwide. Investors approached Sternlicht specifically about creating hotel asset exposure, so the firm organised a separate hotel fund alongside a global real estate opportunity fund, which can co-invest 25 percent of its equity in the hotel vehicle.

The first time Starwood raised two concurrent vehicles was in 2005, when it raised a combined total of $2.375 billion. However, as Arnold and Taljaard are careful to explain, although Starwood has such close historical investment ties to the hospitality sector, it does more than just buy hotels.

In fact, the first deal to mark the firm’s European comeback this cycle is the acquisition of corporate debt backed by a portfolio of prime pan-European commercial real estate assets.

Historical hospitality

To be fair, it is easy to see why people’s perception of Starwood is of a firm that only invests in hospitality assets.

Through various mergers and acquisitions, Sternlicht built up the Starwood Hotels and Resorts group from a nearly bankrupt REIT, Hotel Investors Trust, in the 1990s into one of the biggest hotel groups in the world today. Starwood Capital and Starwood Hotels and Resorts, are frequently confused as being one and the same, but, as Taljaard puts it, they are more like “cousins”.

Taljaard is only half joking. “Normally it occupies the first 10 minutes of any conversation explaining that we are not related to Starwood Hotels other than through ancestry.” He does concede though that in the “small world we live in, we do own real estate that Starwood Hotels manages”.

The misconception that Starwood is a hotel investor in Europe is particularly understandable given the bulk of European investments for its last fund, Starwood Global Opportunity Fund VII, were in the hotel sector. Starwood’s most significant deal in the vehicle was the $3.2 billion takeover of French hotel group Société du Louvre with associated luxury brand business, Groupe Taittinger, in 2005. It also bought a large portfolio of Meridien hotels in a 50-50 joint venture with Lehman Brothers Holdings.

Sean Arnold

The history books though do show that Starwood isn’t so sector-specific. The firm began investing in Europe in the 1990s, with many of its early deals being joint venture partnerships with the likes of London-based Catalyst Capital and ING Real Estate. The firm opened an office in London around 2000, and became active executing deals in France, Germany and the UK from 2000 to 2005. It just so happened that via its takeover of Société du Louvre in 2005, the balance of Starwood’s investments in Europe were in the hotel segment.

“Really, we are not asset-class specific or geography-specific. We are simply looking for what we think is the most interesting risk, reward profile,” says Arnold.

Indeed Arnold explains that Starwood’s first European deal in three years, completed in March, was buying corporate debt backed by a portfolio of prime pan-European commercial real estate assets from a property company which the firm declines to name. The idea was to gain control of the assets via the debt. “It was a messy situation,” says Arnold. “We did a lot of work and we knew what the assets were worth and we were willing to take a position towards controlling the business.”

The opportunity came to Starwood through “good old-fashioned research”, says Arnold. Financial reports describing a bond downgrade on the corporate debt prompted Starwood to investigate the company and its assets from November 2008. After producing an internal investment memo in January 2009, and getting the deal sanctioned by Starwood’s investment committee, chaired by Sternlicht, the deal was closed in March 2009.

Originally, the idea was to gain control of the company and its assets by acquiring small pieces of debt, however being in close contact with the trading desks of banks provided a surprise chance. In closely monitoring the company’s debt pricing, it became clear that a significant owner of the debt wanted to sell.

Arnold confirmed to his trading desk contacts Starwood’s interest as a buyer. At that point, Arnold calls Sternlicht and the answer comes back quickly that the firm should swoop. As luck would have it, in the aftermath of the deal, the company’s corporate debt prices rose, with the company selling certain assets to help pay down debt. Starwood didn’t get to control the company through the debt, but it did wind up with a significant investment. “We like investments like that. Heads you win, tails you win,” says Arnold. 

That was Starwood’s first deal this cycle. Just two people worked on it, one of them being Arnold. “Yes, it is a thin, entrepreneurial firm,” he confirms.

Lean and mean

On a simplistic level, Arnold and his five-strong team in Europe (including one assistant) will identify the opportunities and then hand over the project to Taljaard to execute the business plan and add value.
The merry band of Starwood dealmakers hunker down in a Central London office in Conduit Street, near the famous Regent Street.

In theory, these dealmakers are responsible for the entire European, Middle East and Africa region. However, in practice, they are more tightly focused on mature markets such as the UK, France and Germany.

Arnold has been with Starwood for about seven years, having first worked for the company in the US. He moved to London two and a half years ago to help rebuild the team. Prior to Starwood Capital, he worked at Starwood Financial, the commercial mortgage lender. Part of the rationale for bringing him over to Europe was to add to Starwood’s breadth of debt investment experience.

Taljaard, by contrast, has a corporate operations background. The British property professional has spent stints in property finance roles at Hilton Hotels, the British supermarket group Sainsbury’s and hotel and restaurant company, Whitbread Group. He joined Starwood three years ago from Whitbread.

French connection

Starwood’s current portfolio in Europe consists primarily of Société du Louvre, which Taljaard calls the “big cherry” in the fund holdings. The hotel group runs the luxury Crillon and Concorde Hotels & Resorts chain, which owns more than 10 hotels such as the landmark Hôtel de Crillon in Paris. It also owns the budget hotel group Louvre Hotels, which owns 845 hotels under the Kyriad Prestige, Kyriad, Campanile and Première Classe brands.

Around a third of the portfolio is owned by Starwood. The others are either managed or franchised assets – a good example of how Starwood has been operating. The firm likes to own the whole vertical business, manage the operating company as well as own much of the underlying real estate.

Campanile
Hotels

A management team in Paris is employed by Starwood’s portfolio company to run the luxury chain, while a separate management team runs the budget hotels, Arnold and Taljaard explain.   

The other big ticket investment that Taljaard had to get to grips with when he joined was a joint venture with Lehman Brothers that bought a package of mainly-European Meridien hotels.

The Meridien portfolio had fallen into default in the early 2000s, allowing Starwood to team up with the bank, Lehman Brothers Holdings, to recapitalise the assets. Some of the hotels have been subject to renovation and new investment capital, while some have been sold. Starwood has a total of 19 hotels left to play with.

In the past two and a half years, the JV with Lehman Brothers has sold four hotels, according to Taljaard, with the venture still on track to deliver good results.

Apart from these two very large investments – Société du Louvre and the Meridien hotels – Starwood’s other European investments in its last fund included two office developments in London: 200 Gray’s Inn Road and 25 Copthal Avenue. They bought them and subsequently either re-leased or stabilised them in 2005 and 2006 before selling in 2006 and 2007.

In France, Starwood also took on a 500,000-square-foot office development in Marseille’s docklands regeneration area in 2003. This deal was with London-based property investor, Catalyst Capital. The investors paid around €130 million to buy two properties at the development.

Such deals have left Taljaard “getting to grips” with the European portfolio for the past two years, as well as taking part in strategy meetings and adding value where possible.

But he has also helped on a recent Starwood acquisition – a deal which will do little to dispel the general assumption that Starwood is primarily a hotel investor.

Out of the Sternlicht playbook

Dutch hotel group, Golden Tulip, was struggling in early 2009, and by March had announced plans to go into voluntary receivership, taking with it 250 mainly-franchised hotels around the world.

The company’s problems stemmed from its expansion to 230 hotels in 40 countries just at a time when the hotel business was souring. By taking on a lot of onerous rental leases in the Netherlands and Germany, for example, Golden Tulip had obligated itself to high rental rates just when most of its hotels began to underperform.

Golden
opportunity

The deal was attractive to Starwood as it was looking to grow Société du Louvre’s hotel business outside of Europe. Suddenly, there was a chance to combine the two companies in a move that would create the eighth largest hotel chain in the world.

But what was not necessarily self-evident to anyone taking a cursory look at Golden Tulip, explains Taljaard, was that it had a number of interesting joint venture partners in emerging markets such as Brazil, Morocco, Ghana and the Middle East.

The joint venture partners, according to Taljaard, were either private equity firms or former private equity partners. The challenge was that the Golden Tulip branding is somewhere between three and a half-star and four-star brand, whereas the average brand at Louvre Hotels was closer to two stars. Golden Tulip’s joint venture partners, however, were looking for one and two-star brands to introduce to their local business.

“All of a sudden it went from quite an interesting idea to a potentially strategic step change in terms of driving value for Louvre Hotels,” says Taljaard.

The fact that it was mainly a franchise business meant it was also cheaper to buy. Starwood won a competitive auction after Taljaard and two of Arnold’s colleagues went over to the Netherlands to meet the receivers.

The Starwood delegation met the receivers at 7am in Amsterdam airport, where they delivered a three-hour presentation, including the usual explanations they were not Starwood Hotels & Resorts.

Arnold frames the [Golden Tulip] deal as “right out of the Barry Sternlicht playbook in the 1990s when he grew Starwood hotels, buying up smaller groups.

The receivers didn’t know the Louvre hotel company either, yet despite that Starwood convinced the receivers they were the party to deal with and the transaction closed in July last year. Since then, two new hotels have opened in Shanghai.

Arnold frames the deal as “right out of the Barry Sternlicht playbook in the 1990s when he grew Starwood hotels, buying up smaller groups”.

The third deal Starwood has completed in Europe, announced in November, was the purchase of City Tower at 40 Basinghall Street, in London, for around £30 million (€34 million; $46 million).

We are not allocators. We are kind of a classic deal shop constantly comparing the opportunities we can find here in Europe versus what we can find in other markets.

Arnold

There could also have been a fourth deal in Europe for Starwood after the firm worked hard to acquire a performing loan in Germany backed by three million-square-feet of commercial property being sold by an international investment bank. The deal got all the way to being signed off by Starwood’s investment committee, but ultimately broke down in the due diligence stage. 

Three out of four ain’t bad, though, to borrow a Meatloaf-inspired phrase.

Arnold and Taljaard report the firm invested around $500 million of equity last year from its private equity funds (the firm also raised $921 million through the IPO of a mortgage REIT, Starwood Property Trust), with Europe making up just under 20 percent of the total. There are two interesting things to note about that statistic. For the past three years, Europe has accounted for zero. The other point is that the other 80 percent was invested in the US, where Starwood is finding some compelling opportunities. Europe therefore is Starwood’s only investment region outside its home territory.    

“We are not allocators,” Arnold says. “We are kind of a classic deal shop constantly comparing the opportunities we can find here in Europe versus what we can find in other markets.” 

He hopes that market continues to spew out opportunities. “We still think that by and large the opportunities will materialise in the debt. It is going to take some time to materialise, but we expect there to be a fair amount of things to do. You hear some people saying ‘It’s time to go to the beach.’ We don’t subscribe to that mentality.”

He adds: “We are looking and waiting for something we deem to be compelling. We have looked at pub deals, cinema deals, healthcare and all the traditional food groups and with the exception of development, we are excited about it.” 

And with nearly $2.8 billion of fresh equity to invest, they should be.  


Capital raising the Starwood way

Starwood Capital Group has repeated its strategy of raising a hospitality fund alongside a global opportunity fund, last month closing its eighth opportunity vehicle and its second hotel fund.


Fund

Equity ($)

Year

Starwood Global Opportunity Fund VIII

$1,829m

2010

Starwood Capital Hospitality Fund II

$965m

2010

Starwood Capital Hospitality Fund I

$900m

2005

Starwood Global Opportunity Fund VII

$1,475m

2005

Starwood Global Opportunity Fund VI

$567m

2002

Starwood Opportunity Fund V

$516m

1999

Starwood Opportunity Fund IV

$830m

1997

Starwood Mezzanine Investors

$220m

1994

Starwood Global Opportunity Fund III

$102m

1993

Starwood Global Opportunity Fund I and IA

$52m

1991