ASIA NEWS: Flying Fortress

Given how well Fortress Investment Group’s maiden Japan-focused private equity real estate fund has performed since being launched in 2009, it was easy to predict a sequel fund by the New York-based alternative assets firm would prove popular with investors. However, in raising almost twice the equity of its first vehicle, there was surprise both outside and inside the firm.

In December, a little more than one year after launching the Fortress Japan Opportunity Fund (FJOF) II, the firm closed the vehicle on ¥130 billion (€1.1 billion; $1.47 billion) in equity thanks to commitments from 73 investors, 29 of which were from Japan. In the end, it was the biggest private equity real estate fund raised anywhere in Asia during 2012.

“We were surprised Fortress hit its hard cap,” said Nick Wong, principal at Cleveland-based real estate investment and consulting firm The Townsend Group, which through a mix of discretionary and non-discretionary capital committed almost $400 million to FJOF II. “I suspect there was a last minute rush by LPs to come in.”

Thomas Pulley, chief investment officer of Fortress Japan, believes the combination of a hard cap and the similarity of current deals to those in its first fund prompted the urgency. “Perhaps at the end, people began to increase their interest as they saw the upwelling of investor demand, but I think it was more a function of a recognition of the success to date of Fund I, the team we’ve built in Japan and the investments already in Fund II,” he said. “While the ability to underwrite existing deals is helpful for folks, it can sometimes lengthen the diligence process.”

Pulley added: “The enthusiasm of investors for this strategy and the demand we saw across a really broad base was very gratifying.”

Undoubtedly, Fortress’ fundraising was aided in part by a market with sparse competition. Before the start of the global financial crisis in 2008, large US financial institutions were among the most active buyers of Japanese real estate. Today, Morgan Stanley Real Estate Investing is less active in Japan than before, Goldman Sachs’ Real Estate Principal Investment Area has switched its focus to debt investing in the US and Europe and Bank of America Merrill Lynch, Citigroup and American International Group have left the market completely.

Even Lone Star Funds, once among the most active buyers of Japanese real estate and related financial products, has marginalized Japan in its investing strategy in favor of the US on behalf of its latest $5.5 billion real estate fund. Private equity real estate’s largest firm by equity raised, The Blackstone Group, is growing its presence in Japan, but Fortress’ ability to operate at scale in the market is almost unrivalled today.

Nevertheless, Fortress has had to silence doubters that scoffed at its arrival in 2007 as another US investment house looking to make its mark in Japanese real estate just as its compatriots were scaling back. Led by Pulley, the firm has taken on investments that rival groups did not fancy, such as $230 million of the corporate debt of fallen private equity real estate giant daVinci Holdings in 2010, and has reaped the rewards for its efforts. As of September 30, its first fund’s investments were projecting net IRRs of 22.4 percent and an equity multiple of 1.6x – just two years in.

Even at ¥130 billion, however, FJOF II’s coffers would hardly scratch the surface of the amount of nonperforming or sub-performing debt currently on the books of Japanese banks – Fortress’ primary investment target. According to the Bank of Japan, ¥57.9 trillion of the country’s real estate debt, equal to 11.9 percent of the total, fell into these categories as of last March. In the CMBS space, where Fortress also has gleaned a reputation for executing investments, Japan’s Securities Dealers Association is expecting ¥2.8 trillion to mature over the next two years.

For its part, Fortress has wasted little time taking advantage. FJOF II already has made 10 acquisitions accounting for ¥30 billion of its capital. Unsurprisingly, the firm expects the lot to be invested in two years.

Christian Mancini, chief executive officer of Savills in Japan, believes Fortress will hit its target. “The smoothest salesman in the world cannot cajole an LP out of his money in the absence of really meaningful execution capabilities,” he said. “The fact that Fortress has demonstrated over the past few years that they have nearly unassailable execution skills speaks for itself. That’s why the firm was able to convince investors this was the right jurisdiction for their money.”

Perhaps there should be little surprise that Fortress managed to raise almost twice the equity of its first fund after all.