Picture the scene: a 40-year-old Scott Kelley is with his mentor Jim Allwin. The pair are toasting the first Japanese recruits of Aetos Capital, a new Asian real estate investment management business that Allwin hired Kelley to lead just months before. The date is Thursday 6 September 2001.

Five days later the world was a different place. The terrorist attacks on New York’s World Trade Center, that caused so much death and destruction, more than upended the global real estate investment universe too. Kelley had forged a strong market reputation over 14 years within the safety of well-established Wall Street stalwart Morgan Stanley. But a career culminating in his role as global co-head of the bank’s real estate investment banking division took an altogether different direction when Allwin, ex-Morgan Stanley himself, poached him. Suddenly he found himself a principal faced with a market in stasis.

He says: “There was such shock across the world people spent more than a year simply assessing what the disaster meant for property in general.” Did he regret jumping ship? “It was too late,” he responds, “there was no time for second thoughts.”

Recalling the period, the now-48 year-old Kelley shows no residual sentiments of fear. Wearing smart-casual summer attire and sitting on a velvet couch in one of the business suites of the Park Hyatt, Paris, he talks like a man who has lived to tell his tale. He would go on to say that after a year of shock in which little happened, 2003 and 2004 were “terrific” investment years and that Aetos more than capitalised. While he  declines to discuss fund performance, PERE knows its inaugural fund, 2003’s $740 million Aetos Capital Asia I, is projecting returns of more than 30 percent IRR.

We caught up with Kelley more than a year on from another cataclysmic event for the global economy. The credit crunch and the resultant collapse of Morgan Stanley’s Wall Street rival Lehman Brothers certainly didn’t lead to mass human fatalities or urban destruction, but it did induce the market into another period of stagnation after the shock saw real estate prices crash by 50 percent or more across international markets. Today, the fair-haired, six-foot plus Kelley is predicting increased investment activity and there is evidence abound to support his view.

“Prices adjusted and then came back in 2003 and 2004 and I think after the shock we’ve just experienced, we’re going to see the same thing happen again,” he says assertively.

Not that Aetos is able to take on the opportunity of tomorrow with no battle scars from the recent few turbulent years. The firm’s $2.2 billion Aetos Capital Asia II fund is facing a battle to return equity, never mind generate meaningful returns; fundraising for the follow-on Aetos Capital Asia III fund was caught up in 2008’s widespread negative limited partner sentiment towards private equity real estate funds in general and, alongside numerous other efforts launched at that time, has failed to attract anyway near the $2.5 billion minimum originally targeted. But with capital raising showing signs of green shoots – Aetos itself has closed on $250 million for its fourth effort Aetos Capital Asia IV Strategic Partners – the firm is positioned to take advantage of improving conditions.

Kelley is in Paris to meet with investors and while he won’t confirm whether it is part of the firm’s fundraising efforts, it is understood Aetos expects to raise $1 billion for the vehicle by 2011.

Great presentational skills

“They’re raising new equity so I think they’ll come through okay,” suggests one rival manager. “Aetos are a surviving entity in this industry,” comments another. “Ultimately what returns you get can be irrelevant. What matters is how you handle yourself with investors. I think they handled themselves pretty well.”

Aetos’ investor list is as long as it is diverse – large US pension funds such as California Public Employees Retirement System, California State Teachers’ Retirement System, Kansas Public Employees Retirement System and the New York State Common Retirement Fund are in there; corporate pension funds like Citigroup Pension Fund, IBM Retirement Fund and Delta Airlines Benefits Trust are in there; foundations like the Rockefeller Foundation and the Rasmuson Foundation are in there; even fund of funds like Franklin Templeton are in there.

One of the investors in Aetos’ funds suggests a key reason behind the firm’s survival is the “great presentational skills” of Kelley himself although the man dismisses the suggestion: “I don’t think anyone is such a good salesman that if their business strategy doesn’t make sense they are going to persuade sophisticated investors to part with their capital,” he says.

Kelley is keen to explain that Aetos’ investment strategy has barely altered since Allwin, the man widely accredited for creating the now-gargantuan MSREF fund series, hired him to get the platform going. The firm began life focused on Japanese real estate, principally in traditional sectors like offices.

Aetos seeks to take, what Kelley coins as, “control positions” in its real estate investments. This can take the form of debt investing, but often comes via the equity of the capital stack. He explains: “What we are not in the business of doing is buying one part of the capital structure on, say 32 cents on the dollar and hoping it trades up to 58 cents. We bought a lot of distressed debt in the first fund, for example, but in situations we knew we could foreclose and get hold of the real estate.”
Indeed, the notion of Aetos (and perhaps Kelley’s) need for control surfaced a few times during our conversation. For a further example, the firm has never hired placement agents, opting instead to complete all capital raisings through its eight-strong investor relations team.

Narrow focus

We are focused on
opportunistic transactions
where you don’t see
competition from on-shore


As Aetos evolved its remit to include Chinese residential investments, offices in Beijing, Shanghai and Hong Kong were added to those already in Tokyo and New York, where Kelley is based. But Kelley insists Japan remains the core focus, and this was unaltered even after the untimely death of Allwin from brain cancer in October 2007. This is reflected by the fact its Tokyo office houses more than two-thirds of the staff from Aetos’ approximately 120 overall headcount.

Japan seems the country Kelley is most at home discussing. His relationship with its real estate market predates Aetos to his Morgan Stanley days and he argues this factor coupled with the firm’s initial one-country focus helped convince investors into committing capital to the first fund. Recalling the time, he says: “(Then) Japan was the one really big market in the world that needed opportunity capital. It was the end of ‘the lost decade’ – there were restructurings, distressed deals, low interest rates and high cap rates. There were a lot of compelling reasons for us to be there.”

He recalls a dearth of US rivals at the time, counting only Goldman Sachs, Lone Star and his old shop Morgan Stanley as truly active market players. He doesn’t believe Aetos created undue competition for his former employer though. Acknowledging his tenure at Morgan Stanley gifted him exposure to the world’s biggest institutions, he maintains: “There was no concern of crowding out. On both sides there was a conscious effort not to do that.”

When asked for a standout investment from Fund I, Kelley opts for the corporate acquisition of Matsushita Investment and Development Corporation, the real estate affiliate of Matsushita Electric Industrial Company, which made Panasonic-brand electronics. Hovering in the slipstream of a withdrawn bid by Japanese investor, Daiwa House, Aetos pounced on the firm (and its extensive portfolio of principally office assets) in a deal valued at $1.6 billion.

The ones we didn’t do

You would be hard pressed to find a fund raised between 2005 and 2008 that can show a rude bill of health. While ill-fated investments at Aetos did not generate headlines like Morgan Stanley Real Estate Investing (the Wall Street Journal announced MSREF VI faced a $5.4 billion loss in April) it too is focused on preserving as much capital as it can from its Aetos Capital Asia II fund, a contemporary vehicle. Closing on $2.22 billion in 2005 – when oversubscriptions to such vehicles were common – Aetos managed to raise the fourth largest private equity real estate fund in the world at the time. The vehicle’s assets were valued as high as $7 billion at one stage but Kelley admits regretting certain investments. “Everyone has deals they wouldn’t have done in retrospect,” he says. “We and others misjudged the level of correlation between what was happening around the world and what was happening in Japan when the debt market collapsed.” He explains that Japan “never seemed out of kilter” in terms of the relationship between the cost of borrowing and capital rates. “Having said that,” he counters, “when market sentiment turned negative, Japanese values eroded.”

Kelley believes the history books will be kinder to Aetos’ second fund than to some rivals’. This is partly down to its restraint during certain auctions, he says, though he admits: “You never get credit for the deals you didn’t do and there were tonnes of those.”

One near miss was a $3 billion portfolio of hotel investments being sold by All Nippon Airways, the Japanese airline. Aetos teamed up Barry Sternlicht’s Starwood Capital to bid on the 13-hotel portfolio but was way-off the price eventually paid by MSREI. According to subsequent reports by Reuters and the Wall Street Journal, MSREI was close to handing back the keys on the portfolio after watching its falling capital values evoke its debt covenants, but has since managed to arrange loan extensions.
Aetos’ relative prudence did not go unnoticed. As one Japanese banker, who has lent to the firm, puts it: “In my opinion they have a very strong team, a clear focus and will survive this period of adjustment better than most of their peers.”
With continued support, Kelley is looking at Japan’s next opportunity. Consolidation in the J-REIT sector is one area he believes Aetos can benefit from as merged entities release assets. “It will be similar to what happened in the US in the early 1990s,” he says referencing a period when there was more than 100 US REITs. “

A few really strong operators consolidated the industry making the market more viable. Something like that has to happen in Japan too.” And it is happening. The J-REIT market has shrunk to under the 40 mark thanks to recent consolidations between LCP Investment Corporation and Tokyo Growth REIT Investment; Nippon Residential Investment Corporation and Advance Residence Investment Corporation; LaSalle Japan REIT and Japan Retail Fund Investment Corporation; and New City Residence Investment Corporation and BLife Investment Corporation.

Intellectual credibility

Aetos’ exposure to China is small relative to its Japanese presence but the country has figured among the investments in Funds II and III. Kelley aims to continue riding its growth story despite the raft of government legislative measures adopted to stem overheating in the current market. “There was irrefutably a bubble in some of China’s markets,” he says, indicating some residential prices in Beijing and Shanghai rose 85 percent between January 2009 and January 2010, “but I don’t think you should broad-call Chinese property.”

Aetos is focused on residential development in China’s tier II cities such as Chengdu and Dalian and has a team of approximately 15 staff, led by another ex-Morgan Stanley executive, Kenny Tsae, dedicated to realising its strategy. An example of an Aetos investment in China can be found in Chengdu where it teamed up with Hong Kong-listed Longfor Properties to develop a 10-building scheme using capital from its second fund.

Kelley is keen to describe this project as it demonstrates Aetos’ execution capabilities in China, something he concedes was questioned in October 2008 when the firm pulled out of a joint venture investment in a development in Guangdong with Hong Kong-listed Agile Property Company. Made via Fund II, the venture was agreed in November 2007, but when Agile delayed fulfilling various financial checks and measures associated to the deal within the agreed timescale, and with market conditions worsening, Aetos saw an opportunity to retreat. The firm was understood to have been keen to avoid paying a premium relative to 2008’s falling values. Kelley wouldn’t confirm that but a report by Dow Jones at the time suggested the firm recouped its $164.1 million deposit and received an additional $38.6 million in “settlement”. Kelley will say, however: “In the fullness of time people will recognise what we did made sense.”

What we are not in the business of doing is buying
one part of the capital structure on, say 32 cents on the dollar and hoping it trades up to 58 cents


Looking forward, he insists investments in China must have intellectual credibility and while there has been a rise in RMB-powered investment houses competing for real estate in China, the smart money will find deals with little to no competition: “We are focused on opportunistic transactions where you don’t see competition from on-shore liquidity.  If you want to go for a five-star hotel in Guangzhou, be my guest. We aren’t going to do that.”

A small but enduring world

Kelley’s age and time spent at Morgan Stanley should indicate who his peers at the bank were. Other than Allwin, influences included Bill Walton (now leading Rockpoint Group) and Paul Kazilionis (now leading Westbrook Partners), while contemporaries still at Morgan Stanley included MSREI’s current leaders, chief executive officer Owen Thomas, chief investment officer Jay Mantz and head of Asia Hoke Slaughter. But Kelley has anecdotes of encounters with other industry big names including Apollo Global Management’s Joe Azrack and Citi Property Investors’ Roger Orf, the latter of which was one of the first real estate executives he met as a young graduate looking for work. Orf, then a vice president at Goldman Sachs, interviewed Kelley for a role back in 1986. He got an offer from Goldman and one from Trammell Crow (the now-property services firm was a very popular graduate choice back then) and one from Morgan Stanley – the latter he took.

He wanted to work in real estate after witnessing the handsome profits made from the sector by his father’s peers. “They all seemed to make a lot of money and not work very hard. That attracted me. Then I go pick the area of the business where you work like a dog,” he jokes.

The workload, he concedes isn’t likely to let up anytime soon but considering the era of stasis the firm has just emerged from and how many of his contemporaries have come unstuck – that’s surely no bad thing. Yes, Aetos and Kelley have their challenges with existing assets, but with continued support from investors and lenders alike, both are surviving to fight on.