SPECIAL REPORT: KKR casts its die

Kohlberg Kravis Roberts (KKR) has just raised 20 percent more equity than it reportedly was chasing for its first private equity real estate fund.

Yet, in speaking about this success, the global head of real estate at the New York-based buyout titan is as sober in his rhetoric as he was three years ago, when he first took on the challenge of building the firm’s global property platform.

In closing on $1.2 billion of equity for its KKR Real Estate Partners America (REPA) fund – the largest first-time real estate opportunity fund to have been raised since the global financial crisis – Ralph Rosenberg has cause for celebration. Instead, the ex-Goldman Sachs executive chooses to use his latest interview with PERE to reinforce the message that this is an early chapter in KKR’s ambition to construct a “best-in-class organization.” As he did in his interview three years ago, he continues to talk of maintaining “intellectual honesty” as the now 15-person platform continues its expansion. 

Rosenberg is cognizant of how capital-raising and deployment totals today are approaching pre-crisis levels. While rivals like The Blackstone Group have been investing heavily of late, he acknowledges that KKR has missed out on deals. “Had we had an established platform with the 15 staff we have today, my sense is we would have invested more capital between 2011 and 2013,” he says. 

Rosenberg submits: “Are we appropriately positioned with our market reach, our team and our capital to make prudent, risk-adjusted return decisions for our LP partners? If we can say yes to that, we don’t have to worry about what Blackstone or The Carlyle Group or any of those other guys are doing.”
Rosenberg reiterates how, first and foremost, he and his team still are focused on being “a fiduciary to important partners of the firm in any cycle environment.” The essential ingredient to achieving that status, he says, is doing “what we think is right. We are independent thinkers.” 

Building a fund business 

Despite Rosenberg’s ambition for KKR to pave its own path, the platform has borrowed thematically from other corners of the private real estate investing universe. For one, it adopted a deal-by-deal investing approach during its first two years of operation to demonstrate its prowess in the marketplace before using many of those deals to market and then seed the REPA fund. Furthermore, like the investment banks for which he and many of his early recruits previously worked, the firm has invested heavily in its deals and consequently has become a major LP in its own fund.

The introduction of the predominantly America-focused REPA fund also has revealed to the market that KKR intends to tackle the asset class on a regional basis and not via one global fund. Though technically not yet on the drawing board, KKR is likely to follow the same model as its private equity business and have regional vehicles for Europe and Asia. 

“I think it’s fair to assume that, as the strategy evolves over time, we will have dedicated capital that is focused on both Europe and Asia,” Rosenberg says. He declines to offer more details about future funds, but he does say market events could impact the timing.

It took two years for REPA to be launched, but Rosenberg points to KKR’s existing infrastructure in the two regions (KKR has 19 offices globally) and the early deals in both regions that already have taken place. Naturally, KKR’s activities in each region will evolve at their own pace: up to 25 percent of REPA’s equity can be invested in Europe, while Asian investments thus far have come from KKR capital sources outside of the real estate division.

In the meantime, a pool of mainly US institutional investors, including state pension plans, insurance businesses, corporates and high-net-worth family offices, are among the first to test-drive what is predominantly a domestically orientated pilot vehicle.

Comfort zone  

Sitting alongside the fund, KKR has committed $286 million in equity from its employees and KKR Financial Holdings, one of the firm’s listed investment units, in addition to the GP commitment. One former executive at a sovereign wealth fund, who asked to remain anonymous, points out that, in putting up approximately one-fifth of the platform’s capital, KKR is easily addressing the issue of aligning LP and GP interests. “It would give me confidence that there is a good alignment of interest and that the focus of the sponsor is on the return and not just on fees,” he says.

Rosenberg describes KKR’s co-investment as just as much a part of its “balance sheet strategy” as it is intended to make LPs feel comfortable. “From our perspective, we like having significant amounts of our own capital inside the vehicle because we like the market opportunity in its own right for the return expectation of our own balance sheet,” he explains.

In a further indication of how KKR will treat all of its real estate funds as its property platform evolves, Rosenberg reveals: “The day we go back to the market to raise another vehicle, assuming our balance sheet continues to be liquid and to grow, my expectation is that we’re going to have a sizeable commitment from the balance sheet in future vehicles as well.”

Rosenberg nonetheless appreciates the importance of making these first investors, which have shown faith in the firm’s real estate strategy, feel comfortable. To that end, seeding the fund with the platform’s first investments – and transferring them at cost – played an important part as well. At first closing, nine investments were included in the fund. By the time the fund was closed to investors, that total had reached fourteen.

One director at a capital advisory firm, who also requested anonymity, regards KKR’s approach of heavily seeding its opening fund with investments as the organic growth alternative to starting in the asset class by buying an existing management platform and inheriting a track record in the asset class. “This way, they’ve shown they can do some good deals and already will have seen some valuation mark-ups,” he says.

Cautiously opportunistic 

KKR’s opening fund can be deployed into equity and debt investments, special situations and real estate-heavy enterprises, offering the firm the flexibility to access investments via a wide array of entry points. Rosenberg reiterates how his team is using the whole firm to support the real estate platform, tapping into 37 years of private equity investing and the overlap of knowledge gleaned from its 84 private equity portfolio companies to source and vet potential transactions.

Although KKR has the latitude to engage in complex situations, its deals to date have sounded an altogether more conservative tone. Its reportedly £125 million (€150 million; $204 million) acquisition of three retail parks from London-based fund manager Resolution Property in June is a case in point. In that situation, Resolution had reached the harvesting point of its own fund and needed to sell to wind the vehicle down. Similarly, River Plaza, an office building in Paris, was purchased after one of Aberdeen Asset Management’s German funds required liquidity. 

KKR currently is under offer on four further purchases – one each in France, Spain, the UK and stateside – and Rosenberg says each of those is the result of the assets becoming “non-strategic or non-core to the sellers’ ongoing strategy.”

Such deals are hardly the stuff of private equity real estate lore, according to one US-based placement agent, who also spoke anonymously. KKR’s REPA fund is targeting returns at the investment level of between 16 percent and 20 percent and, net to investors, that is expected to work out to approximately 11 percent to 15 percent. Rosenberg describes the returns as reflective of a hybrid between value-added and opportunistic strategies.

“That does sound low for a strategy meant to generate returns by turning things around,” comments the agent. The director at the capital advisory firm and the former sovereign wealth fund executive, however, suggest such returns should be expected from a firm looking to put such a large amount of capital to work, particularly in the US and Europe. “I don’t think the return is unreasonable, but what it does show is that opportunities increasingly are harder to come by and 15 percent is becoming the new 20 percent.”

“Is it really an adjustment?” Rosenberg ponders. “You could say that, but we think it is realistic in this low interest rate environment in the US and in Europe. When 10-year Treasuries in the US are at 3 percent, creating returns that are 1,000 basis points over the risk-free rate is pretty good.” 

In another departure from rival private equity real estate firms, and in support of its return profile, Rosenberg notes how KKR’s maiden fund has a leverage cap of 70 percent. Further suggestive of a conservative approach to opportunistic investing, he adds: “We’re taking the position that we want to create returns without having to rely on aggressive capital structures. A lot of guys in the market will borrow up to 80 percent, but I don’t think it is prudent to do that in today’s environment.” 

Rosenberg’s attitude to debt serves as another reminder that, although KKR now has joined the opportunistic investing party, it is unlikely to overstretch itself in the space under his watch. Quite deliberately, this is a firm that wants to be considered as offering a different approach. The early support from investors in its maiden fund suggests that this conservatively opportunistic style already is paying off