BLUEPRINT: Stealth competition

When one thinks of Pacific Investment Management Company (PIMCO), the Newport Beach, California-based firm that began in 1971 and has almost $2 trillion in assets under management, what springs to mind? One of the world’s largest bond funds perhaps? Or its co-founder Bill Gross, who caused a stir last month when he said he felt guilty for having “gotten rich” at the expense of labor and that the era of taxing ‘capital’ at lower rates than labor should end? Maybe.

Far less likely is that you would think of opportunistic real estate investing. Nevertheless, PIMCO has more than $15 billion of opportunistic commercial and residential real estate assets under management, has raised no fewer than eight traditional private equity real estate funds since the global financial crisis and has a dedicated team of 29 professionals making opportunistic property investments in the US and Europe. 

As a measure of how little is known about the firm by its competitors and the market in general, PERE recently tested out some of the facts above during an evening cocktail reception in midtown Manhattan. The general response was a mixture of surprise and interest.

To be fair, except with its investors, PIMCO has preferred to remain out of the spotlight within the industry, and certainly with members of the press. For this reason, when the chance came up to meet key members of PIMCO’s opportunistic real estate business, PERE leapt at the chance. 

So it came to be that, at the end of October, PERE went to the Times Square skyscraper of German insurer Allianz, which owns PIMCO, to catch up with John Murray and Devin Chen, who joined the firm in 2009 and 2010 respectively after first working together more than a decade ago at JER Partners. In addition, beamed in via video link from PIMCO’s headquarters were Jennifer Bridwell, who joined in 2005 and whose role expanded in 2011 from head of mortgage strategies development to head of alternatives product development, and Daniel Ivascyn, head of the mortgage credit portfolio management team and lead portfolio manager for PIMCO’s credit hedge fund and mortgage opportunistic strategies. 

Given that this was the first time PIMCO had granted an interview to PERE and so little is known about its real estate activities, we began by asking for a skeletal overview of the business.

Exposing its roots 

PIMCO launched its opportunistic real estate investment platform in 2007. Part of a larger division of more than 100 individuals that work in hedge fund and opportunistic/distressed strategies, the team of 29 portfolio managers and investment professionals operate out of four offices in Newport Beach, New York, London and Munich. Importantly, that team is growing as Laurent Luccioni, the former head of Europe at MGPA who joined the firm at the end of April, is busy building out the team in Europe. 

Bridwell says PIMCO’s opportunistic real estate investing business was borne out of a conviction that there would be significant dislocation stemming from the global financial crisis and from the firm’s ability and willingness to raise capital. It began making investments towards the end of 2008, when it also started hiring aggressively to capitalize on the dislocated environment that it felt so strongly about.

“Most people know PIMCO very well as an established fixed income player, but our efforts have grown very dramatically since 2008 in areas such as opportunistic commercial and residential real estate and credit,” Bridwell says. “We were not raising and investing these types of funds in 2005 and 2006, when so many other firms were easily raising huge sums of money. That was a time when we were completely out of the market, having had grave concerns about almost anything that would qualify as securitized issuance.”

Bridwell adds: “Clients know us well of course, but most people are surprised to learn we have more than $15 billion of assets under management in private opportunistic strategies that fit into this (distressed mortgage/real estate category). It is a large effort for us now, and we are very proud to have delivered strong returns to our clients in these strategies.”

Talking of how and why he decided to join, Murray – PIMCO’s co-head of real estate opportunistic investing – says he and the firm saw a “huge opportunity” opening up after the financial crisis. “PIMCO saw a tremendous opportunity to increase its global presence in commercial real estate,” he explains. “There was a global changing of the guard going on, with major banks, syndicators and private equity real estate firms either disappearing or completely paralyzed in terms of capital. That is really where the opportunity came about. I saw PIMCO’s advantage of having a huge platform to source opportunistic deals and capital, and I joined in 2009 to help build the business. Since then, we have brought in Devin, Laurent and 19 others.”

Of course, PIMCO isn’t a complete newcomer to commercial real estate, having spent decades investing in the securitized mortgage markets. One might suppose that any firm that was as significant a player in the US securitized real estate market as PIMCO would have a hard time persuading investors they should commit to an opportunistic strategy when the music stopped. Not so, according to the firm. 

Bridwell puts success partly down to a large client base and the view that the opportunistic real estate strategy is an ‘extension’ of being a huge investor in the securitized mortgage markets, both in residential and commercial property, for 30-plus years. And even though it had been such a big player in securitized real estate, PIMCO went public with its concerns, particularly about the US housing market and commercial real estate prices, prior to the crash with a series of “very well-publicized” warnings. “We were so vocally on-the-record about our concerns and were so careful about mortgage credit risk that it made conversations with clients (about opportunistic real estate investing) post-crisis so much easier and more credible,” she adds.

An opportunistic approach 

Chen talks about how he and Murray cut their teeth in real estate together while at Joe Robert’s firm, JER Partners. Apparently, it was good schooling to be at a firm so opportunistic in terms of different types of assets. Indeed, JER had a “very bottom-up, asset-level underwriting approach,” says Chen, and that experience has transferred over to his current role. “What we try to do here at PIMCO is access real estate in its cheapest form on a risk-adjusted basis, buying nonperforming loans from banks, empty buildings, CMBS or subordinated debt,” he explains.

PIMCO’s macroeconomic views are famous in financial markets, of course, and help the real estate team shape their views. However, Murray and Chen say it is equally important to understand not just the ‘broader’ picture but the detail. For example, they point out that they have dozens of credit analysts who they work with on a weekly basis to help them understand tenant risk. The analysts study these companies and provide the real estate team with analysis of the risk of tenant default.

Back in 2008, it was obvious that a lot of real estate assets were going to be sold by financial institutions. What PIMCO had was strong relationships with these banks – not just commercial banks but central banks as well. This is something that both Murray and Chen recognized when they considered joining. “Being at PIMCO meant we were going to see that deal flow,” they add. 

Murray, Chen and the newest recruit, Luccioni, all speak about the ‘flexibility’ of the platform, which comes from the mix of experience on the team but also a fairly accommodating mandate. “We have a variety of funds that have different strategies and different target returns, some of which focus on commercial real estate and some of which focus on commercial real estate and residential,” says Chen. “That gives us a little more flexibility as opposed to being in a tight box that focuses only on commercial or just 20 percent returns and 2x multiples. To the extent that we feel like a sector is too rich (in capital), we can migrate to another sector. Having that flexibility, especially on the heels of the crisis, gave us the best platform to deliver risk-adjusted returns.”

Bridwell is quite forthright on the approach of others. “The business environment, as best we can see it, is mostly about determining three things: Where is demand in the market? What are investors willing to do? How can we deliver something into that style box and demand theme?” she says. “That is backwards thinking.”

Bridwell continues: “The beauty of having trusted relationships with so many clients globally is we don’t operate that way. What we try to do is sit down a couple of times each year and determine what the portfolio managers want to invest in: Where are there going to be big opportunities to generate above-average and better risk-adjusted returns, not where are people raising money and what kind of returns do we need to target. We create mandates consistent with how we think we can generate returns, and we go out and educate our clients about what is really achievable.” 

The one thing that the PIMCO team is reluctant to discuss is its funds. On its website, the firm states that its real estate approach includes mortgage credit and opportunistic strategies primarily focused on residential, commercial and consumer-related assets. However, Bloomberg shed more light on the business on October 10, when it reported that the firm had raised $3.5 billion to buy distressed assets via its latest Bank Recapitalization and Value Opportunities (BRAVO) II fund. Bloomberg also reported how PIMCO was hoping to raise a total of more than $4 billion for the vehicle, which is due to close next year. The predecessor fund, BRAVO I, raised a reported
$2.35 billion. 

Exploring the four quadrants  

The PIMCO team next turns attention to the themes it has settled on for investment purposes. Underlining its flexibility, the firm’s transactions have spanned all four quadrants of commercial real estate (public and private debt and public and private equity) and have ranged from $20 million to $1 billion in size. Murray notes that some 70 percent of its deals are ‘off-market’, highlighting another reason why the firm is not often spoken about in private equity real estate circles. 

Roughly speaking, PIMCO’s recent tactical themes in both the US and Europe have included residential land transactions, equity investments in non-primary markets, structured credit and loan acquisitions and origination. Some of its recent deals include a new loan origination on a soon-to-be converted residential condo project in Manhattan, where the loan also includes an equity participation in the potential profits; a portfolio of 840 residential lots in 15 communities nationwide bought from a ‘motivated’ seller seeking to remove legacy assets from an open-ended investment vehicle; the purchase of a 624,000-square-foot office building in Chicago’s West Loop submarket; a performing note secured by a luxury Miami hotel that is being renovated; a roughly £750 million CMBS secured by approximately 988 UK properties; a €239 million CMBS secured by some 66 German properties; and a €30 million stake in an Irish REIT. 

Regarding one of its major themes, Ivascyn – to whom Murray, Chen and Luccioni report – explains that one of the reasons PIMCO became focused on land transactions was related to its activities in nonperforming loans. The firm has more than 100 individuals in that space, and they gave PIMCO an early lead in terms of pricing momentum in local markets. 

“We also saw REO rental activity,” Ivascyn adds. “A lot of private equity real estate firms aggressively were pursuing REO rentals, and we were looking at ways to get in front of that. We thought some of these land deals were far less crowded. That was the strategic thinking, and we took advantage of our expertise.”

Murray says opportunity exists in residential real estate because of the strong demographic story and lack of capital. With recent increases in US mortgage rates, affordability has become less compelling. However, he points out that, on a relative and historic basis, housing is affordable. Meanwhile, pent-up demand and household formations, as well as restricted capital flowing into the residential sector and the fact that “distress and pain” still resides within banks, is conspiring to present opportunities. 

To date, PIMCO has control of more than 5,000 residential lots dispersed among some 20 different master-planned communities acquired from banks or distressed financial institutions. These assets are located from southern California to the Southeast of the US, in markets “that aren’t the Manhattans of this country” but nevertheless do have compelling fundamentals.
“With homeowners now having capital, these are the properties best positioned to restart,” says Murray. “We also are unlocking value trapped in banks, where the borrower has been under water and couldn’t sell lots to builders because they were below the level at which the bank was willing to release them. We have been gaining control of these assets and selling the inventory.”

Chen takes up the second equity theme of non-primary US markets that are poised for improvement in fundamentals. “You can buy some of these assets at a discount to peak value and also replacement costs,” he explains, adding there are very attractive cash-on-cash returns to be had. 

The entry price means investments do not require robust rent growth in order to make returns. That said, any rental growth provides “pure upside.” Similarly if capital migrates to some of these non-primary markets, that represents upside as well. “We like that profile,” Chen says. “Over the last 12 to 18 months, we have closed on more than $1 billion of property in cities such as Chicago, Seattle and Houston.”

Give them some credit  

The other area where PIMCO has been active is in structured credit. This is the area where the firm feels it has expertise to underwrite the real estate component of an investment as well as a complicated underlying loan structure.

Clearly, global banks still have a lot of exposure to real estate via structured credit and ‘not-so structured’ credit, explain Murray and Chen. These banks are not hiring brokers to sell these assets; rather they are dealing with PIMCO on a direct and confidential basis because the firm already has a trading relationship with them. 

“Admittedly, those types of opportunities don’t show up in the price or the headlines, but often they offer the best relative value from our perspective,” says Murray. “Often times, we are taking controlling positions in bonds and working directly with the special servicer to accelerate resolution. We have often found those will price as a percent of par at similar levels to 100 percent adversely selected NPLs, which is where a lot of the traditional private equity real estate funds focus. However, in these cases, they are not 100 percent adversely selected loans – it may be a bad vintage with some bad loans in it, but not every loan is bad. In fact, in many cases, a substantial part consists of performing loans that would price at par today.”

Europe as a market is relevant to this strategy given that more than $20 billion in floating-rate loans are coming to a head in the next couple of years. For example, PIMCO bought a significant CMBS portfolio from Germany’s Bundesbank after Lehman Brothers had pledged some securitized real estate as collateral for rescue funding. Although it was a failed bank and a bad vintage, less than 20 percent of these loans were delinquent. 

Lastly, PIMCO is excited by loan acquisitions and even originations. “Over the last couple of years, one of the highest conviction trades for us has been in this area,” Chen says. He and Murray explain that these deals are “tweeners” in that they tend to not be low enough leverage for banks but, at the same time, one cannot really get to the underlying real estate either. “We think it provides great relative value, with IRRs in the high mid-teens,” they add.

In terms of sub-performing loans and subordinate debt, if PIMCO can buy debt at a discount and understand the collateral, it really likes that opportunity. For loan origination, the firm believes it is a good time to be in transitional markets.

Keeping it simple 

After an hour in the company of PIMCO, it seems like things are going well for the firm and there are significant hints that performance has been good. Though it won’t provide details of performance, one is under the impression that investors are more than happy so far. It also helps that investors currently have a “ravenous appetite” for yield at the moment.
Ivascyn says PIMCO will continue to “keep it simple,” with a clear objective to produce results for investors. He also says the general regulations associated with ‘too big to fail’ are playing to PIMCO’s strengths. “What would derail our effort would be poor investment performance,” he underlines. 

Ivascyn continues: “We do not want to make things harder than they need to be, and we are cognizant of significant risks to economies, commercial real estate, housing markets and regions of the world that still are very dangerous. Southern Europe is the obvious example of an area that presents a lot of opportunity but where there are considerable risks as well.”
Summing up the firm, Ivascyn adds: “We don’t want to become overly complacent and solely focused on buying without understanding the fundamentals. We want to be able to leverage the fact that we have a very broad mandate, be careful of a market environment that has plenty of risks and continue to focus on the delivery of investment performance. If we do that, we think we will be highly successful in this phase.”

With that, the interview is over. PIMCO presents the impression of a firm that has been quietly successful over the last five years. It has operated fine without the broader acclaim, even though one gets the feeling that it would like it anyway. On other hand, it doesn’t feel like PIMCO will suddenly open up as much as other firms about its funds and operations. For the moment, it will remain stealthy competition to the industry’s better-known private equity real estate firms.

Pacific Investment Management Company
Headquarters: Newport Beach, California
Opportunistic RE under management: $15 billion
Real estate staff: 30
Key personnel: John Murray and Devin Chen (co-heads of real estate); Laurent Luccioni (head of EMEA)
Geographic focus: US and Europe


The new recruit
Having joined from MGPA this year, Luccioni is looking to build upon the PIMCO team in Europe and execute more deals 

Just seven months ago, Laurent Luccioni joined PIMCO as head of commercial real estate for Europe, the Middle East and Africa, with a mandate to help build the firm’s real estate platform in Europe. 

Speaking from the firm’s offices on Baker Street in west London, Luccioni says one factor in joining PIMCO had to do with its ‘flexibility’ of investing. The former head of Europe at MGPA explains that a platform nowadays has to be able to move across markets and capital structures. “There are not many platforms that are clear-thinking and have been able to achieve such flexibility,” he adds. 

Luccioni also argues that, because PIMCO is looking across markets and capital structures, such an investment firm needs “broad skills,” including an understanding of how credit and public markets work, as well as macro-
economic and sovereign risk – all of which require resources. “The culture built up here has been one of sharing information,” he says. 

Luccioni notes that building the business in Europe is about PIMCO’s track record and continuing to earn the trust of investors. ‘Delivery’ is another key requisite for success. He explains that he has been trying to replicate the job that John Murray and Devin Chen have achieved in North America by building a team that fits PIMCO’s “flexibility of capital” ethos. 

PIMCO’s European real estate team is based in London and has been growing quickly with a mix of professionals ranging from those with a ‘hard asset’ background to a structuring background with experience in commercial mortgage-backed securities. Other senior members of the team include James Gilbert, a former investment professional at AREA Property Partners, and Lee Galloway, who is more experienced in CMBS and debt origination. Both pre-dated Luccioni’s arrival, but new recruits are being hired, at least one of whom has a bank background and will be announced shortly. 

Over the past two years, PIMCO has made a string of investments in Europe. At the beginning of 2012, it acquired a roughly £750 million CMBS secured by some 988 diverse UK properties. It gained control of the servicing by acquiring the entire CMBS structure. 

Later in 2012, PIMCO bought into another CMBS structure, a €239 million deal with the notes secured by 66 German properties. It was reported at the time how the bonds were purchased from Germany’s Bundesbank after Lehman Brothers had used the assets as collateral for rescue finance in 2008. 

More recently, PIMCO has gone into Ireland by taking a €30 million stake, or 9.99 percent, in the country’s first REIT, Green REIT, which went public in July and is chasing value-added deals in Dublin. PIMCO has co-investment rights and, in October, Green REIT announced its first deal, a £127.6 million acquisition of a commercial real estate portfolio from Denmark’s Danske Bank at an initial yield of 8.5 percent. 

Just last month, it emerged that PIMCO – separate from Green REIT – had invested around €140 million in a portfolio of 25 assets in Dublin known as the Ulysses portfolio. Formerly owned by Irish private investor Liam Carroll, it was put up for sale by receiver Ernst & Young. 

Luccioni, who recently was in Spain scouting further deals, says the European team currently is examining investments in other markets such as France and Germany.