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BLUEPRINT INTERVIEW: Crossing over from Lehman

It has been four years since PERE last interview senior management at Lehman Brothers Real Estate Private Equity. In a 2006 feature called ‘Band of Brothers’, former editor Paul Fruchbom sat down with members of the senior team to discuss the rapid growth of the platform. At that time, the firm had corralled $4 billion for two global funds established in 2000 and 2005, making it one of the largest private equity real estate firms in the world. The firm was in a bullish mood and was looking ahead to expansion into Asia — something that it subsequently achieved.

But not even PERE’s former editor, who went on to become a Hollywood scriptwriter, could have made up what transpired in 2008. The amazing events are already part of financial folklore, with all the gory details of how Lehman came to file for bankruptcy protection on 15 September 2008 chronicled in books such as Andrew Ross Sorkin’s ‘Too Big to Fail’.

Yet out of that ensuing chaos, the senior management team at Lehman Brothers Real Estate Private Equity has remarkably stayed intact by spinning out with a new global platform, Silverpeak Real Estate Partners. It was formed to manage the $18 billion in assets that Lehman’s real estate private equity business assembled before its parent collapsed.  

In their first interview since then, global co-heads Brett Bossung and Mark Newman, based in New York and London respectively, tell their remarkable story.

Over the last 21 months, we consistently told our
investors: ‘We are not going
anywhere. We are focused
on managing the assets.’
Ultimately, as we told them,
we are going to grow the
business again, but we still
have circa $18 billion of real
estate to manage.

It has been about five months since an overwhelming majority of the investors in Lehman’s three funds voted in favour of the existing team and its newly established independent investment adviser, Silverpeak, buying the management contracts. Since then, the senior management team of Silverpeak and its international sub-advisor, Broadcliff Capital Partners, has been busy managing the global funds. Now, however, that team — consisting of Bossung, Newman, chief financial officer Rodolpho Amboss, asset management head Kevin Dinnie and Lehman’s former head of real estate Mark Walsh — is beginning to look further out.

“We can’t wait to move on,” Bossung and Newman say. “The task at hand was to focus on the assets, which we had been doing the entire time, and really prove to investors that the choice they made about us managing their existing investments was the proper one. Now, we are slightly turning our heads and looking to the future.” In other words, the pair doesn’t plan on running an operation restricted to what some might term a legacy business. 

The former Lehman team, after all, feels vindicated for the way they conducted themselves in the malaise ensuing Lehman’s filing, as well as for the performance of the three funds to date. The team could have disbanded, which would have made things considerably more difficult. Says Newman: “Were there moments in time when we all felt very challenged? Of course. But it was either ‘shoulder to the wheel’ or go off and do something else. We made an active decision, days after Lehman filed, to see this thing through. That was the message we delivered to our team around the world and to our investors, and that is what we did.”
Adds Bossung: “Over the last 21 months, we consistently told our investors: ‘We are not going anywhere. We are focused on managing the assets.’ Ultimately, as we told them, we are going to grow the business again, but we still have circa $18 billion of real estate to manage.”

Although the team declines to give exact details, the performance of the funds (based upon current projections) has been top half, maybe even top quartile. The first fund, with a vintage of 2001, looks likely to deliver an IRR of just over 30 percent and is in the final exit stages. The second fund, a $2.4 billion vehicle closed in 2005, is projecting high single-digit IRRs and has returned more than $1 billion in capital. The goal for the third fund is to return a majority of the invested capital to investors.

As part of the sale transaction, the commitment period for Fund III was closed and the majority of the unspent capital was returned to investors, though investors left the fund with a reasonable amount of liquidity to make further investments in the existing portfolio, either to defend it or invest in it by buying back debt at a discount. That is precisely the kind of thing that Silverpeak has been concentrating its efforts on these past months, but as Bossung and Newman make clear, they also are beginning to plan ahead to raising fresh capital.

When it comes to raising a new fund, Bossung and Newman say Silverpeak is unlikely to present a global offering, given the anti-global diversified sentiment that appears to prevail among many LPs at the moment. Indeed, they believe the environment is becoming much more “focused”.

“It is likely that instead of being a large diversified global fund, we are more inclined to adopt a regional fund format, with a US-based fund operating under the Silverpeak name and an international Europe-based fund under Broadcliff,” they say.  “We think this format fits well with investor sentiment and allows for more control by, and interaction with, the limited partners.”

We don’t have a desire to grow just for growth’s sake. We don’t want to wake up and suddenly find we have 200 people.

In addition, the pair is considering partnering with large global investors, some of whom have long-standing relationships with the team and have indicated interest in discussing separate account mandates, direct investing and asset management engagements. “Some of these large organisations have a lot of capital and want to invest with a well-regarded platform that has proven capabilities in investment, asset management, finance, investor relations, reporting and so on,” explains Bossung.

Bossung and Newman both say they aim for Silverpeak to be a high-quality real estate investment business, but it is unlikely to return to the kind of scale seen during the mega-fund era. “We are looking at creating a smaller to mid-scale business with a blue-chip investor base,” says Bossung.

“We don’t have a desire to grow just for growth’s sake. We don’t want to wake up and suddenly find we have 200 people.”

When the team does gets back to making fresh investments, those deals also are less likely to be the large, complex, speedy, structured transactions Lehman typically entered into, such as the €1.7 billion purchase in December 2005 of 73 hotels from Intercontinental Hotels Group in Europe alongside Canada’s Realstar and GIC – a portfolio, by the way, that was recently refinanced.

Newman points out that few of these deals are available and he is not yet seeing a classically distressed market, in which one would expect to see more shedding of assets. “I think the environment is challenged,” he says, pointing to the weakness of government balance sheets.

That said, there is always opportunity. “I am super excited,” Newman says. “From my point of view, the greater the challenge is, the greater the opportunity.”

Bossung adds: “The team has gone through a lot, but we are not done. We think we can grow a tight investment business for a long time. There is a little bit of redemption in having come through this – in stabilising the business and in delivering results to our investors. Now, we can move on and become a relevant player in this business, and that is what we intend to do.” 

Path to redemption

How the senior management team of Lehman Brothers Real Estate Private Equity survived a tumultuous 20 months since the bank’s collapse

The senior management team at Silverpeak had been on a rollercoaster for 20 months since the collapse of Lehman Brothers. This May, however, the former Lehman real estate private equity team finally took over as the new independent investment adviser to its three funds and that tumultuous ride ended.

Recalling the aftermath of September 2008, Bossung and Newman say: “It was a very dramatic and unusual situation.”

Though Lehman filed for bankruptcy protection, none of the private equity entities of Lehman Brothers, including the real estate private equity business, went bankrupt. US workout specialist Alvarez & Marsal was appointed administrator of Lehman’s affairs, and the firm became the new management to whom Bossung, Newman and the real estate private equity team reported. Previously, they had answered to Lehman’s investment management division.

Immediately prior to the bankruptcy filing, Lehman Brothers Real Estate Partners Fund II and Fund III had lines of credit, which were secured by the LPs’ commitments to each fund. As soon as Lehman filed, however, it triggered an event of default under those lines of credit. The loans had to be repaid, and there was a capital call of more than $100 million. As the largest limited partner, Lehman was required to put up 20 percent of the equity.

Alvarez & Marsal had to make the decision early on whether to fund that commitment. Failure to do so would have constituted default and could have meant the failure of the private equity real estate business, although ultimately that would have been a decision for the LPs.

The decision was taken, however, to back what was viewed as a fundamentally good business, explain Bossung and Newman, and significantly more than $100 million of capital was put into the funds by Lehman and the investors.

That was a crucial first step in stabilising and ultimately arranging the transfer of the management of the business.

On the edge

Initially, Alvarez & Marsal tried to sell the platform to a third party. This would have meant a new home for the business, and possibly the end of the existing senior team.

Alvarez & Marsal, advised by investment bank Lazard and the law firm of Weil, Gotshal & Manges, ultimately could not sell the business to a strategic buyer at a time when real estate markets everywhere were nosediving and so many financial institutions were wobbling.

At the same time as dealing with the private equity real estate business, moves were afoot to deal with other private equity parts of Lehman. The Lehman Brothers Merchant Banking business, for example, which had less committed capital than the real estate private equity platform, was bought out by its management. The spin-out as Trilantic Capital Partners in April 2009 won backing from Reinet Investments, the investment vehicle of South African billionaire Johann Rupert. Reinet paid $10 million for a 49 percent stake and took over Lehman’s $230 million of uninvested LP commitments.

In contrast, the management of the real estate private equity business had less control of its sale process. The Lehman estate had requested that the management team simply make itself available to all potential buyers. The team stood ready to discuss and work with any potential acquirers, but there was concern that if management were a potential buyer it might have chilled the process.

There turned out to be no acceptable or viable buyer for the whole platform in the process orchestrated by Alvarez & Marsal and Lazard, but the management team did not participate in the sale process as an interested party. It did, however, tell investors, employees, operating partners, lenders and counterparties that it would stay to manage the assets even though there was great uncertainty about the outcome of the sale process.

Digging in

Meanwhile, in the days, weeks, and months following the filing, there was an amazing amount of work to be done.

Investors were anxious to understand what was happening to their investments, while employees feared for their future. There also were a host of operating partners around the world, as well as lenders and hedge counterparties for whom the quality of the funds’ position had changed.

One of the first things to do, though, was to examine the LP agreements for the three global funds to assess the legal impact of the filing. Such documents often say nothing about such an unpredictable event, as was the case with Lehman. 

With support from the funds’ investor advisory committees, Morgan Stanley and Cox Castle were engaged as financial and legal advisors to the committees throughout the sale process. At the same time as the maelstrom of information requests, the real estate market was close to freefall, so the real estate private equity team had to urgently re-evaluate investments that needed money and asses the solvency of operating companies and joint venture partners, not to mention assessing derivative issues with its banking partners.

In addition, there was the process of getting Alvarez & Marsal up to speed with the real estate private equity business from a standing start. Lehman had gathered together hundreds of LPs over a decade, after all, and the workout firm needed to understand their position.

Game change

By early 2009, it had become clear there wasn’t going to be a sale of the business. Instead, Alvarez & Marsal and Lazard worked on the assumption that Lehman would remain the GP. They decided to hold a new process to find an investment adviser to the three funds.

Through early 2009, various parties expressed interest in buying the advisory contracts. A shortlist was eventually whittled down to four or five bidders, although the management team never knew exactly how many.

It was only then that Morgan Stanley, adviser to the investment advisory committee of each fund, and Alvarez & Marsal asked the existing management team to come forward as a bidder. All bidders were essentially offering to pay a sum to become the investment adviser and deliver the whole of the required services in exchange for receiving management fees.

Drafting terms

Following a round of negotiations and explanations, bidders were reduced to just two parties, the existing management and a rival bid reportedly from New York-based AREA Property Partners. Finally, after the largest investors by number and value had been consulted, the existing management team’s offer to take on business was preferred in June 2009.

The process, however, was far from over. There needed to be a contract between the management team and Alvarez & Marsal to take on the role of the investment adviser. At the same time, there was the whole process of negotiating changes to the three LP agreements to bring in the new investment advisor under a standard set of amendments. 

Understandably, investors had concerns. What happened if senior members of the management team didn’t stay? What if Lehman subsequently went insolvent?

Once those issues were ironed out with key clauses and other relevant terms, the general partner and Alvarez & Marsal sent out a memorandum proposing the set of amendments to LPs. The management team then went on a roadshow to meet with the investors they had pitched not so long before the bank’s collapse for Fund III.

In March 2010, the transaction was finally approved by an overwhelming majority of the LPs to create Silverpeak, the new investment adviser. It then took from March to the end of May 2010 to close the transaction.

With that, a new global private equity real estate business was born.