Last month at the PERE Forum: Europe, Joseph Azrack, managing partner of real estate at Apollo Global Management, highlighted an intriguing near-term opportunity for real estate franchises: industry consolidation.
Azrack certainly knows a thing or two about this topic. After all, New York-based Apollo is one of the firms doing the consolidating at the moment. As everyone in private equity real estate knows, it is taking over Citi Property Investors, formerly led by, yes, Joseph Azrack.
For the 200-or-so delegates at the forum in London, it was notable to hear a man of Azrack’s calibre giving weight to a trend that many have been expecting for some time. But as Azrack himself acknowledged, taking over another private equity real estate platform is never easy, so we will have to wait to see how much of this happens.
Indeed, the complexity of firm mergers is a major reason why so few takeovers have actually happened in Europe, or indeed anywhere else in the world. It is hard to think of any, other than the December takeover of GPT Halverton, the European real estate fund platform of Australian REIT, The GPT Group, by London-based Internos Real Investors.
It has become clear that firm consolidations require a few preconditions in order to succeed. One, perhaps rather obviously, is a willing seller. Examining the Halverton/Internos deal for a moment, it is clear this was the case.
Like many UK REITS, Halverton had to mount a rescue rights issue in Australia to strengthen the balance sheet, but the problem was that it mis-sized the issue. When the company told shareholders it needed to go back to the public market to raise more, shareholders reportedly said yes, but on the proviso that Halverton offload the European real estate fund management arm. There was an absolute requirement to get out of the business.
It seems an obvious point, but trying to take over GPs who are unwilling to be removed is incredibly difficult. Not everyone in mainstream property necessarily gets this point – they see only groups that in their minds should be selling. Many go ambulance chasing not realising that they won’t catch up with the ambulance.
In the Halverton/Internos case, the deal was to buy the management contract for properties owned by the Australian firm, but Internos did not buy Halverton’s co-investment capital, or its principal positions. Those stayed in the vehicles. This was an important ingredient of the deal, because oftentimes the wish by a GP to monetise its co-invest can present a major obstacle for a potential buyer to overcome. According to market participants PERE has spoken with, the market is not currently prepared to pay much for co-investments in existing investments because of the declines in property values.
In some businesses, the co-invest can be pretty hefty. Lehman Brothers’ real estate private equity business reportedly had $700 million of equity interests from the parent company in its three funds, and this is partly why it took so long to sell the business – with Lehman Brothers Holdings ultimately staying in as an investor. Citi also has a significant amount of co-invest, and it is rumoured that Apollo is not buying the co-investment but is prepared to take on the uncommitted capital to the real estate funds Citi manages.
ING Real Estate Investment Management, which also is up for sale, has possibly as much as $3 billion of parent company co-investment in its global funds, according to one guestimate by someone who has received presentations from ING. One can only guess at the complexity involved. Not only is this a very large number, but the co-invest is coming from different parts of ING, as is often the case in these large global funds. It can come from the parent bank, the insurance division and the investment management company, for example. All that pooled capital adds another layer of negotiation and complexity when trying to sell the platform.
All this without even mentioning staff retention issues, regulatory capital requirements, and not least, limited partners. While typically the management can decide who to sell to, it is asking for trouble to orchestrate a takeover if the LPs do not support the buyer.
The good news is that we appear to be coming out of a declining market. Now that firms have fought their fires, those left in a strong position can look towards some potential acquisitions. Meanwhile, perhaps sufficient time has elapsed since the credit crunch for insurance companies and banks to come to a conclusion about the future of their real estate funds management operations in Europe.
So in Europe, consolidation has perhaps only just begun. In addition to ING, another platform for sale is HSH Real Estate, reportedly being sold by Germany’s HSH Nordbank. For excitement’s sake, I hope to see more firms being unbundled soon.