BLUEPRINT: Upping its game

There are only a handful of global private equity firms that reasonably could be called ‘legendary’. There are fewer still that have formed dedicated real estate teams to invest in property as an asset class. So, when one comes along, it is right to take heed.

TPG Capital, formerly known as the Texas Pacific Group, is certainly in that category. The Fort Worth-based firm co-founded by David Bonderman and Jim Coulter, who famously turned around Continental Airlines in the early 1990s, is one of the marquee brands in the buyout industry and currently has $56.7 billion of private equity capital under management. It has invested in 269 portfolio companies to date, a few of which you may have heard of: Burger King, Del Monte Foods, Neiman Marcus and J Crew.

Still, it was not long ago that TPG decided to build a real estate investment platform and thus enter the property investment arena the way that The Carlyle Group and The Blackstone Group had done before – not to mention Kohlberg Kravis Roberts & Co more recently.  Officially forming TPG Real Estate in 2009, the firm has been stepping up its game quite quickly ever since. Indeed, it put $1 billion of equity to work in US and European real estate situations during this past year.

Kelvin Davis, the de facto head of real estate and former head of North American buyouts at TPG, sat down with PERE in the firm’s London offices for the first official interview that the private equity giant has granted about its real estate program. He was joined by TPG’s senior real estate man in Europe, Anand Tejani.

An early history in property

TPG’s recent history in real estate dates back to 2009, when the firm took part in the auction of a $4.5 billion nonperforming loan and real estate owned portfolio of the failed Corus Bank from the Federal Deposit Insurance Corporation (FDIC). Amid severe distress in the US financial sector, it teamed up with Starwood Capital Group to form a consortium, Northwest Investments, and won the bidding to pay 60 cents on the dollar for assets that principally were construction loans. That marked the realization and proof that real estate was a sector that TPG should take seriously, Davis says.

As Davis expands upon the story of TPG Real Estate, however, it becomes clear that the firm’s ‘entry’ into real estate in an organized fashion actually is tied up with the roots of TPG itself. “A little history is helpful,” he says.
Davis began his real estate career in 1985 with Trammel Crow and, after business school, joined the Robert M Bass Group in 1989. That is where he first met and worked with Bonderman and Coulter, as well as Tom Barrack.
The late 1980s and early 1990s found America at the precipice of a great recession that presented a whole series of interesting real estate opportunities, and it was at the Bass Group that Davis and Barrack began investing in distressed real estate on some scale. Shortly afterward, in 1991, they decided to leave and co-found Colony Capital, where Davis became president and chief operating officer. The next nine years were spent investing in Western Europe and the US.

Meanwhile, Coulter and Bonderman had left the Bass Group in 1992 to found Texas Pacific Group on the heels of their recapitalization of Continental Airlines. Over time, the firm prospered and grew off the back of various other investments, including real estate-intensive businesses, though that wasn’t a particular focus of the firm.

In 2000, Davis left Colony to join his former Bass colleagues, Bonderman and Coulter, at TPG. He did so at a time when the world was about to experience the bursting of the bubble, which made TPG anxious to rebuild and refocus on some of its ‘old economy’ industry areas, such as retail, energy, manufacturing, media & entertainment and healthcare. For the next nine years, Davis took overall responsibility for revitalizing this business, running North American buyouts for the firm.

During those years, Davis confesses that there had been some soul-searching at TPG about entering real estate in an organized fashion, but a number of other initiatives arose on the priority list. One of them was to consolidate and grow TPG’s business in Asia, which had been operating since the early 1990s through a joint venture with Blum Capital Partners. In 2005, TPG decided to consolidate its position in the venture, known as Newbridge Capital, which was a big undertaking. At the same time, the firm was investing in hedge fund activities via TPG-Axon Capital Management.

As a result, TPG basically watched from the sidelines as others took advantage of a bull run in real estate. Still, “it felt awfully late in the cycle to get involved,” Davis says. “The housing market in particular seemed to be an indication that real estate had gone too far. Candidly, we also saw that financing via the CMBS markets had gotten extremely aggressive and capital was overly plentiful. When that happens, it is very difficult to make interesting returns.”

Another chance at real estate

When the real estate market began heaving in 2008, the opportunity suddenly became much more interesting. TPG found itself operating within the parameters of the global financial crisis, and troubled financial institutions became a specific area of focus for the firm. In the summer of 2009, Tejani, who joined the firm in London in 2006, spent six months on secondment to the US to focus on opportunities in various financial institutions, including Corus Bank.

As both Davis and Tejani recall, it was rumored at the time that Corus was teetering on the brink of financial ruin, and TPG knew the bank to be a very active real estate lender, particularly for condominiums.

“It was on our radar screen as a prospective real estate investment and perhaps a financial institution recapitalization,” says Davis. “Along the way, we connected with Barry Sternlicht at Starwood Capital Group, who was interested in Corus from the real estate standpoint. He recognized that we had financial institutions expertise that might be relevant, plus Barry and I had known each other for years since I was at Colony.”

During the summer and fall of 2009, Davis and Tejani led the TPG team that ultimately succeeded in acquiring the
$4.5 billion portfolio, paying a $2.8 billion acquisition price. TPG’s investment came from its private equity fund, TPG Partners VI, which closed on $19.8 billion in equity in September 2008.

“As our first official investment as TPG Real Estate, Corus has been a successful one and we probably are more than 75 percent though the liquidation of those assets,” reveals Davis. “We aggressively built the corporate infrastructure, including hiring a new senior team to help us resolve and manage the assets. We anticipate that the remaining assets will be liquidated over the next 12 months or so with some substantial distributions to come.”  
Davis adds: “It has been a good window into the US condominium market, which were the predominant assets in this portfolio. Later, that became of real value to us as we made US residential investment a theme for us.”

Seeking an advantage

On the back of the Corus deal, TPG found itself among a very different competitive field than it had seen in the real estate industry for many years. It also felt that its corporate buyout expertise could be an advantage, along with having individuals such as Davis that could claim long-standing real estate investment résumés.

If TPG could fuse those advantages, it believed it could present itself differently compared to many other outfits in the market. As a result, the firm specifically started to look out for investments that were “not in the bull’s eye” for corporate investors because of too much real estate in them and not in the bull’s eye of real estate investors because the situations were too corporate.

Indeed, Davis notes that those conditions have existed for most of its real estate acquisitions. “They are mostly investments in property-rich platforms where the circumstance has some level of financial motivation or operational distress, providing the impetus for our investment,” he explains.

Of course, not every deal has fit the mold. For example, the purchase of the Woolgate Exchange in London was a single-asset acquisition rather than a corporate takeover or investment, although the complexity of controlling the B note in the strained CMBS structure and using that position to acquire the asset does bear the hallmarks of a corporate approach.

Still, that is an exception. TPG primarily is looking out for transactions where it can leverage its corporate buyout and turnaround experience.

Building the team

In building the team to run the platform, TPG Real Estate began with “retired real estate guys,” Davis jokes, referring to himself. Indeed, Bonderman and Coulter asked him to transition to real estate, and he co-opted Tejani as in-house talent to initiate the business in Europe. The firm also turned to the outside in order to hasten its program and add more current capability than perhaps even Davis could offer immediately.

The first person Davis hired after interviewing dozens of people was Avi Banyasz, who joined the firm in New York in January 2011 as a partner, co-running the real estate team with San Francisco-based Davis.  Banyasz had been a managing principal at Westbrook Partners.

“Avi has been a terrific hire, bringing 13 years of experience at Westbrook with him,” says Davis. “He has a very shrewd sense for real estate and has affected a whole series of investments.”

Adam Metz also joined TPG in 2011 as a senior advisor, having previously served as chief executive of General Growth Properties. “Adam is very engaged with us, focusing on some retail strategies both in the US and Europe, and is on the boards of several investments we own,” explains Davis.

In January 2012, TPG hired Robert Weaver, who joined as a partner from Morgan Stanley Real Estate to focus on capital-raising efforts and also is based in New York. In addition, the firm recruited Jamie Sholem in New York from Goldman Sachs’ Real Estate Principal Investment Area and Tripp Johnson in San Francisco from Fortress Investment Group.

Tejani, meanwhile, co-opted Jeroen Regeur onto the real estate team in Europe after he worked on the deal to take over distressed Dutch real estate company Uni-Invest. Krysto Nikolic also joined the firm in London from AREA Property Partners.

In total, there are 15 dedicated real estate professionals currently working for TPG Real Estate. They plug into 350 other TPG professionals, located mainly in North America, who can step in to help if the real estate team needs additional resources on any given transaction.

The art of the deal

For the next hour, Davis romps through TPG Real Estate’s deal book thus far, giving PERE an insight into how the franchise is developing and how it is positioned. He does so with such enthusiasm, detail and economy of words that he covers a lot of ground in that short span of time – perhaps even too much ground for this report. His main point, however, is that he believes the transactions show how the markets have transitioned.

First, in 2009, there was the Corus transaction amid the distress of financial institutions. Then, in 2010, TPG acquired Catellus Development, a $527 million retail and development subsidiary, from ProLogis amid dislocation in the REIT market. The firm followed that up in 2011 with the $1.1 billion purchase of US homebuilder Taylor Morrison from its UK parent in the wake of the collapse of the US housing market.

In 2012, as some parts of the US swung into recovery, TPG Real Estate made two growth market investments. It made a $900 million purchase of a Silicon Valley office and research and development portfolio from Mission West Properties to form a platform now called M West and a $276 million investment in Parkway Properties, an Orlando, Florida-based office REIT.

The same year, TPG Real Estate entered Europe’s distressed real estate market via a €1 billion recapitalization of Dutch property company Uni-Invest, which since has been renamed Merin BV. For that transaction, the firm teamed up with Ivanhoe Cambridge and London’s Patron Capital.

Davis explains that, since the deal to buy the Corus portfolio in 2009, TPG Real Estate has tried to invest “thematically.” For example, in 2010, it focused on the opportunities in the underlying US housing market.

“If you asked yourself what was the most distressed US market in 2009 and 2010, you would have to say single-family housing,” says Davis. “We had an interesting insight because we were selling thousands of condominiums. We were seeing that there was more latent demand in US housing than perhaps was being reflected in the headlines in cities with either positive employment trends or just favorable demographics, such as Miami.”

TPG Real Estate observed that this kind of demand historically had led to an average of about 1.5 million new homes per year. At the peak of the market, the US was producing 2 million homes per year but, in the middle of the crisis, that dropped to less than 600,000. Household formations, however, still were running between 800,000 and 900,000 per year (down from a long-term average of 1.2 million), which meant the country was not building as many homes as there were new households being formed.

By the end of 2010, TPG Real Estate believed US housing was reaching its low point, with single-family home starts down 75 percent. Davis says there were few options for acquiring a major homebuilding company at that time, but some good fortune played a part. A TPG professional in London had a good relationship with the senior management of Taylor Wimpey, a British homebuilder with a North American arm called Taylor Morrison. Through this relationship, Davis connected with Taylor Wimpey chief executive Pete Redfern in late 2010.

Although Redfern decided he wanted to hire JPMorgan to help him sell the North American business rather than strike a deal with TPG, the private equity firm nevertheless took part in the sale process and ended up buying Taylor Morrison in 2011 in conjunction with Oaktree Capital Management and a third smaller investor. The venture bought the company for about $1.1 billion – or 1x its book value – although that book value had been written down quite dramatically through the downturn. In concert with the senior management team at Taylor Morrison, the new owners went about aggressively positioning the company for a recovery by buying more than
$1 billion of land.

Though well below national long-term averages, single-family home starts have doubled since that low point. Recently, the new owners took Taylor Morrison public as Taylor Morrison Home, with TPG selling about 20 percent of its stake. This represents something close to a $1 billion gain in the firm’s investment at this point.

Secondary success

One of the other themes that TPG found interesting was the 200 to 300 basis point spread between high-quality office properties in a city such as New York and secondary cities such as Atlanta or Phoenix. “We thought that, over time, it was inevitable that spread would tighten,” Davis says. “We tried to figure how we could play the theme of high-quality office buildings in select secondary markets. At the same time, smaller REITs in America were trading at substantial discounts to their larger peers.”

Fortunately, TPG found an opportunity in Parkway Properties, where those two themes intersected. The small-cap REIT had office investments in places such as Atlanta, Houston, Tampa and Phoenix, but no one seemed to be paying too much attention to it, much less to the fact that the former long-term CEO had departed and a new entrepreneurial CEO had taken over. The new CEO was selling assets in tertiary markets like Memphis and Jackson, Mississippi, and recycling capital into promising secondary markets.

TPG liked the story and negotiated a private investment in public equity transaction for 43 percent of the REIT, structured as a combination of both common and convertible preferred stock (which subsequently converted to common upon a shareholder vote). Originally, it was a $200 million investment, but the stock subsequently rose and the REIT organized a secondary equity issue. TPG had pre-emptive rights and bought another $76 million of that secondary offering. The REIT used TPG’s capital and the extra attention afforded to it to scale up and acquire assets opportunistically in strong markets.

“In America, there has been a lot of attention on New York, San Francisco and Boston,” says Davis. “But when you get underneath where jobs are being created and where people actually want to live, the highest job growth in absolute numbers and percentages is Houston, largely because of the energy boom. Silicon Valley also tops the list because of the tech industry. When you get underneath the success of cities like Phoenix, Austin and Charlotte, you can see these markets have growth drivers – meaning people want houses and firms want office space.”

The approach certainly seems to be working for the investment in Parkway. Its market capitalization was $260 million when TPG first invested in it, but it now has a market cap of around $1.3 billion – a five-fold increase in roughly one year. Since the announcement of TPG’s investment, Parkway has been one of the strongest-performing REITs out of the 150 listed in the US – with the stock trading around $19 at the time of this interview, up from TPG’s initial purchase price of $11.25 per share.

The European opportunity

While TPG Real Estate was working out growth plays in the US, Tejani was on the lookout in Europe for equivalent deals to Corus Bank arising from the region’s financial distress. He noted that many players expected a wave of acquisition opportunities around 2010, but that really didn’t materialize as banks seemed unwilling or unable to take further financial hits.

As a result, TPG began to examine how it could play in situations where things “really had to happen,” Tejani says. That effectively meant recapitalisation deals where the firm could “create a solution.”

Uni-Invest proved to be an example of that. The Dutch office and industrial property company had been acquired by Lehman Brothers in 2003, and the investment bank had refinanced Uni-Invest’s debt via a securitization in 2005. However, by 2010, everyone knew the company was in trouble, as was the Dutch office market. Uni-Invest couldn’t renew leases or engage real estate brokers and employees were leaving en masse. Bids for the company were being made by other parties.

As the bonds approached legal final maturity in February 2012, TPG had the idea to recapitalize Uni-Invest in conjunction with its senior bondholders. TPG and its partners in the deal – Ivanhoé Cambridge and Patron Capital – ended up taking over the company via the debt at a discount of greater than 60 percent of its historic capitalization.
Since then, the new owners have brought in new management, improved lease renewal rates and are rationalizing the portfolio. More importantly, with €500 million of debt taken off its balance sheet, Uni-Invest is positioned to make fresh acquisitions when the opportunity arises.

Capital sources and growth

So far, TPG Real Estate’s deals have been funded by the parent firm’s primary private equity fund, TPG Partners VI, or one of its two separate accounts with Ivanhoé Cambridge, the real estate subsidiary of Caisse de dépôt et placement du Québec, and the New Jersey Division of Investment.

The $350 million account with New Jersey was made public in the pension plan’s meeting minutes, which even disclosed the fee terms. According to those documents, TPG Real Estate gets a management fee of 95 basis points on invested capital and 20 percent carry over an 8 percent hurdle. The firm has allowed discretion to New Jersey in that the investor can review all investments prior to allocating capital.

In a memorandum signed by director Timothy Walsh, New Jersey noted that TPG Real Estate’s investments seemed to be performing well. “Investments have performed as well as (or better than) original underwriting and currently are marked at a 1.3x gross multiple. It is important to note that had this track record been that of a commingled fund, it would place as a top-quartile performer relative to its peers of the same vintage year. In addition to the performance just noted, the division takes comfort in the top-quartile track record of each of the senior level team members at their previous firms.”

However, the challenge that clearly lies before TPG is how it can grow its real estate platform in terms of its capital base. Davis insists its sources of capital remain “plentiful and highly engaged.” Clearly, there are restrictions over what the firm can say about its fundraising activities, but it appears that a traditional commingled fund could be on the horizon. That said, it doesn’t seem to be an urgent priority.

“We are very fortunate to have the support of Ivanhoé Cambridge, New Jersey and, of course, the breadth of TPG investors on whose behalf we are investing today,” Davis says. “Over time, we will need to build more and more varied relationships for an increasingly active program. In the last year alone, we have invested about $1 billion in equity and we see a lot more interesting opportunities.”

Also not a priority is a corporate acquisition of a real estate investment manager, given the way TPG has built its real
estate team organically. Instead, the firm feels the team it has brought together possesses its own expertise and has gelled with the firm’s corporate ethos. “I don’t anticipate any broad platform acquisition at this point in time, but I do anticipate we will continue to grow,” says Davis.

TPG Real Estate doesn’t yet have any professionals in Asia, although its private equity professionals in that region come across real estate deals from time to time. Davis notes that the real estate team has collaborated with colleagues in Japan on several real estate deals, including last year’s recapitalization of a condominium company called Joint Corp, which filed for bankruptcy protection in 2009 under $1.9 billion of debts. It also bought a nonperforming loan portfolio in Japan and acquired a residential development platform in India. For the time being though, the dedicated team of 15 is looking more at the US and Europe for deals.

“The challenge is to build momentum and not make any mistakes,” says Davis. “These investments need to keep working, we need to make more of them and we need to keep upping our game.”