BLUEPRINT: Dog days of distress

Ronald Kravit and Lee Millstein lean on the side of a counter and make all sorts of faces at the behest of a photographer. You can easily tell they haven’t done much of this publicity stuff in their time, though. And no blame attached – why should they? Kravit, the head of US real estate investing, and Millstein, who runs European real estate and European distressed investing for Cerberus Capital Management work for a firm that has not sought out publicity or the limelight. Both men report directly to the firm’s founder, Stephen Feinberg who founded the firm in December 1992 and who for years remained firmly in the shadows.

Indeed, this whole idea to profile Cerberus Real Estate was not that of Cerberus, but more at the persistent suggestion of PERE. For good reason, though. Since it was founded in 1992, Cerberus has been a real force to be reckoned with in distressed securities and asset investing, private equity, middle market lending and real estate, and has captured the admiration of its limited partners. Since 2004, it has raised three dedicated real estate funds all over $1 billion, the latest being Cerberus Institutional Real Estate Partners III which closed on $1.4 billion in October 2013. In aggregate, the firm has raised more than $6 billion alone in the last 12 to 24 months available for US real estate and Europe NPLs from various sources including dedicated real estate funds, co-investment capital, separate mandates and capability via Cerberus’ private equity funds. Not only that, but in 2013 it was ranked by Cushman & Wakefield as the biggest buyer of European distressed real estate assets, which has been a major focus of the firm since the financial crisis. Under Millstein’s leadership, the firm acquired €6.295 billion in that first half of 2014, making it the second largest investor behind Lone Star. It struck one of the biggest deals in Europe this cycle – the £4.5 billion ($7.2 billion; €5.6 billion) face value acquisition of Project Eagle loans from Ireland’s National Asset Management Agency (NAMA) for £1.2 billion. 

Meanwhile, in the US, Cerberus portfolio company Albertson’s LLC acquired Safeway, one of the largest grocery retailers in the US, for $9 billion – a deal which Kravit worked on because of Safeway’s considerable real estate holdings. That transaction, which is expected to close this fourth quarter, will add Safeway to several other grocery chains, which are Albertsons, Acme, Jewel-Osco, Shaw’s and Star Market stores and related Osco and Sav-on in-store pharmacies that it acquired last year from SUPERVALU in a deal valued at $3.3 billion. 

But before we get into the recent eye-catching deals and capital raising activity, there are photos to complete. Kravit, who has been with the firm since 1996, has already been striking various poses for a good 10 minutes before he is joined by Millstein, who joined the firm in 2007 after serving for three years as head of corporate and investment banking at Cerberus portfolio company Aozora Bank in Tokyo. There has so far been a bit of banter between Millstein, Kravit and the secretary who tells Kravit to “smile.” At one point Kravit cracks a joke and sort of adopts a monster-like pose by stooping and making claws of his hands, going “grrrrrrrr” and saying “three-headed dog”. This is, of course, a reference to the firm’s name. As any student of Greek and Roman mythology knows, Cerberus is a multi-headed hellhound with a serpent’s tail, a mane of snakes and a lion’s claws and legend has it that the beast guards the entrance to the underworld to prevent the dead from escaping and the living from entering.

Kravit’s momentary comical pose works on several levels. There is a kind of truth and irony to it. Cerberus has a reputation for being relatively non-communicative with the press and Kravit himself has a kind of gruff and grumpy business persona. However, those that know him well say he’s misunderstood because in reality he is a warm, likeable person.

One investor says: “Cerberus puts on a very stern business face and he has to fit in there and be part of that management culture.” But then again, there is no denying Cerberus, which manages around $27 billion of capital, has a certain bite. Talk to anyone from New York, Boston and Chicago to Los Angeles and San Francisco, and they will also tell you the firm is one of best-known private equity firms in the US, and highly rated for its ability on complex transactions and to play across the entire capital stack. It is also a firm that has attracted considerable negative publicity stemming from its 2007 acquisition of US car manufacturer Chrysler for $7.4 billion, which was seen as a bad investment for a while, until the firm ended up at least breaking even after it sold the Chrysler Financial division to TD Bank for $6.3 billion in late 2010. Even the firm’s acquisition of 50.1 percent of General Motors’ lending business GMAC in April 2006 for $7.4 billion, which the dedicated real estate funds did not get a big piece of, now looks as though it will not be the disaster that many once predicted, a credit to the firm’s patience and persistence. And despite hitting headlines for reportedly culling about 10 percent of staff around the world in 2009, Cerberus has remarkable continuity among its senior team. Nearly 40 senior executives and managing directors have been with the firm for more than 10 years. Other private equity firms were doing the same, of course, but the newspapers stuck the knife in.

What’s most notable about Cerberus is the ability of its CEO and co-founder, Steve Feinberg, to “see around corners” and take action in the most challenging environments. Says Millstein, “At the height of the crisis, Steve saw the NPL opportunity, and we were one of the first firms active in Europe.” Similarly, in 2008 Cerberus hired Josh Weintraub, formerly of Bear Stearns and Scott Seltzer, a Morgan Stanley veteran in 2008, to make a bold move into the mortgage backed securities business when most were fleeing that space.

Once the shots are finally done, we head into a room to talk some more about the business. We already had a 45 minute session a few weeks back when Millstein and Kravit talked about the history of Cerberus in real estate, and also up-to-date matters such as its focus on Europe. This meeting was just to get the shots done and to talk a little more.

The conversation remains pretty factual and though the two answer all questions put to them, they do so without giving too much information away or blowing their own trumpet. But then again, remember, Cerberus rarely gives interviews like this. They prefer to get on with it. They do, however, provide names and numbers of investors, advisors, and various other people to talk to about them, and we take them up on the offer.

Brian Boyer, director of equities at Wespath Investment Management, says the firm is perceived as one of the larger, successful NY-based real estate investors. “They have done a fair number of high-profile deals, though I don’t think they seek out the spotlight. They are not a publicity-hungry firm. The fund that is investing right now – Cerberus Institutional Real Estate Partners III – has a heavy focus on distress investing in Europe. Cerberus is an established operation and we like that. They have a pretty broad charter. They look at platform, equity and debt deals, with a sizable team and significant capital to bring to bear.”

Adds Boyer: “We are in all three of their funds and have been with them since 2004. I would say they do a fine job of keeping investors informed. They have good financial reports that are detailed and extensive about their underlying businesses. Maybe they are not as high-profile to the public investment community, but they certainly have an open kimono when it comes to their existing investors.”

Andrew Richard, an investment banker at Credit Suisse who has worked closely with Cerberus, including the real estate team, says: “Being at Cerberus, they invest in real estate but also other asset classes, so they come at it with the discipline of not just real estate relative to other real estate, but relative to other asset classes whether the credit market or corporate market. That’s how the judge everything.”

David Julier, director of the private markets group, real estate, at DuPont Capital Management, adds: “It is their ability to source distressed and opportunistic deal flow on a global platform. That, in conjunction with having the investment experience up and down the capital stack. They do a good job at finding the attractive risk-adjusted returns wherever that may be geographically or in the capital structure. They also have thorough understanding and ability to invest across all asset types.”

What’s the story?

The recent history of Cerberus is pretty straight forward. It goes where it sees opportunity. In the late 1990s, for example, it was all about Asia and in particular, Japan where Millstein has large experience. “A lot of the lessons we learned in Asia in the 90s have been directly relevant to our distressed investments in the US and Europe,” said Millstein. “Regardless of geography, it’s about finding a deal that works for everyone.”

After Millstein joined the firm in 2007, Cerberus concentrated its real estate activities over the next couple of years on US RMBS, CMBS and structured credit which is a way to play the US commercial and residential real estate market through more complex structures.

Says Millstein: “US RMBS, CMBS and structured credit is where the firm saw the opportunity in ‘08, ‘9 and ‘10. Cerberus built a team in that space that has to be more than 40 people today.” But starting in late 2009, Millstein explains, the firm sensed European bank deleveraging would be “the play”. All through the crisis, Cerberus kept a team in Europe of around 25, but it has expanded that to 50, including more than 30 investment professionals. On top of that, there are 18 to 20 on its servicing and asset management team. Ron Rawald is the most senior pair of boots on the ground in Europe and the main focus has been real estate in Germany, the UK, Ireland, Italy and Spain. Inside of these countries it has been about NPL portfolios, hard assets sales and trades by banks or state backed asset management agencies or companies with debt repayment issues. 

Kravit adds: “We are never forced to invest in any market because our capital has that flexibility. But I think our investors trust us that we are going to find what we think are the best opportunities globally and that is where we are going to jump.”

It has raised a lot of dedicated money for Europe and since 2011 it has executed €11 billion of transactions. It maintains offices in London, Frankfurt, Madrid, Baarn near Amsterdam, and recently opened in Belfast. A new office is planned for Dublin. 

There have been too many deals to note all of them here, but a whole series of six or seven portfolios has been bought from Lloyds Banking Group., There was also Project Eagle, a pool of loans owned by Northern Ireland-based debtors and secured by assets in Northern Ireland, the Republic of Ireland, the UK, and elsewhere in Europe. In addition, it acquired from National Australia Bank (NAB) a £625 million NPL portfolio.


Most of the recent capital that the team deploys comes from multiple sources, not just dedicated RE funds, but a number of funds that have the capability to invest in real estate such as its flagship Cerberus Institutional Partners series, plus a number of dedicated funds. By way of example, it has a client that recently allocated $1 billion to the European strategy alone. All of its capital is discretionary and Cerberus’ risk and allocation committee allocates the dollars, not Millstein and Kravit.

In print, it might come across that Kravit and Millstein are boasting when it comes to fundraising success, but in reality they are just answering a question when they say they have had to turn money away. Says Kravit: “We are constantly talking to investors and we get lots of inbounds after they read we were the first or second most active in Europe. I think in the last two years there has been a lot more cash flowing. When we were raising Fund III it was very difficult. In the first 12 months, no-one was interested in Europe and then all of a sudden the markets opened up and we got another $1 billion. It is all about timing.” Millstein adds: “Once Fund III closed, we continued to see demand from our investors for European NPLs, so we did those narrowly focused funds.”

At Cerberus there are four key businesses: private equity, distressed securities, corporate middle market lending and real estate. They sometimes work together, but then again, some businesses fade at any given point in the cycle. Take corporate distress, for example. In the US, the firm has stayed out given the lack of opportunities in the sector. By contrast, real estate is extremely busy and the fact that investors are generally increasing allocations to property feeds into that.

This leads to a discussion about the state of the US real estate market and how Cerberus thinks about risk.

First of all, the firm has not been totally immune from mistakes. In the US, it has a big mezzanine real estate business and got hit on a number of positions in the global financial crisis. However, it did sell a lot of assets and stopped making fresh investments at the top of the market and did a better job of managing risk than many others. “Were we perfect? No. Do we make mistakes? Yes. But we think we have learned and are very disciplined,” says Kravit. “We work things really hard and are patient when there’s a potential for a turnaround. We also don’t put good money after bad money. And, we focus on downside protection – that is a fundamental tenet of our business.”

Risk, discipline

David Sherman, president of Metropolitan Real Estate, says there were plenty of “smart people” that got stuck in the financial crisis because they were too junior in the capital structure, “too aggressive going-in”. He explained: “But Cerberus was generally more senior in the capital structure, more conservative, and more careful.”

Speaking of recent transactions in Europe, he adds: “They have done some very interesting structured transactions where they limited risk. One was a German housing transaction in early 2012 where there was a €1 billion loan and they effectively came into and led a restructuring. The key to the restructuring was they converted a substantial amount of the debt to equity, put in their own money – it was a relatively small investment – and took over the asset management. The fee income from the asset management provided a return to the investors regardless of whether the assets went up in value. Basically they earned the return by working hard, not by taking risk.”

Sherman adds: “They are always thinking how to structure transactions balancing risk and return. They say, ‘Maybe we are going to give up the opportunity to make a 4x, but we have got good downside protection and an attractive return.’ They have also been much more disciplined than some other global opportunistic funds at sticking to transactions that fit their expertise and avoiding style drift.” They also limit positions to be no more than around 5 percent of the fund, he comments.

A big factor in risk management is discipline and due diligence. Cerberus says it performs a huge amount of due diligence, sometimes up to 150 people working on a transaction. “No one goes as deep in terms of analysis and level of questions,” says Millstein. “I am not sure if we are famous or infamous for the depth of our due diligence. We hired people from some of our competitors, and they are usually shocked at the level of analysis and diligence and how far we dig.

The sell-side advisors can track the amount we do and the questions we ask. If we are looking at a portfolio of two hundred or three hundred loans we literally look at every piece of collateral, every loan, every borrower, all lease agreements and have 150 people working on the deal. We have heard stories of people buying a portfolio, and they didn’t bother to go check and find out that no one is actually paying the rents. The due diligence has to be done.” 

Finally, Millstein adds: “You need dedicated resources and once sourced right and priced, you have to manage the assets. Having the servicing and asset management team is absolutely critical. You can buy it well, but if you don’t manage it well, forget it.”

Private equity approach

The crossover of capital and skills between Cerberus private equity and real estate is another defining aspect. It also explains why a lot of what it has done has been “eclectic” to quote Kravit. “That’s the best part of Cerberus. We all work together,” he says because it often looks at private equity deals or corporate lending opportunities where there is a real estate bent to it.

There are a number of those situations the firm has either executed or is looking at, the most perfect example being an enormous grocery business. Cerberus is suddenly America’s second biggest grocery business. In March of this year its portfolio company Albertson’s announced that it was acquiring Safeway for $9.4 billion. The acquisition, expected to close soon came on top of buying several grocery brands and pharmacies from SUPERVALU last year. 

Westpath’s Boyer observes: “Basically they have been buying struggling retail grocer operations, rationalizing them, and using the real estate as an edge.” Credit Suisse’s Richard says: “I view Cerberus as one of the shops that does more creative deals. The real estate team partners up very well with the corporate side and that creates a lot of synergies for them.”

Says Kravit: “We found a great management team and now we are the second largest grocer in the country. There is a lot of real state embedded in a lot of grocery retailers. So I work very closely with my colleagues to execute that strategy.” He confirms the real estate angles include sale leasebacks and development at stores and so on.

Such deals come against a backdrop of fewer straightforward US distressed real estate deals nowadays. Most of the distress went 1 to 3 years ago leaving these more complex, corporate situations. And, while Cerberus is still finding some selective opportunity in the US such as RMBS and CMBS, the US market has definitely become harder for firms like these. The amount of capital looking to park itself in North America is certainly making it tougher, and Kravit provides an example of a “crazy kind of risk return” on some piece of paper involving mezzanine debt on an 85 percent loan-to-value financing for an office asset. “The floodgate has opened for financing in the US and we are starting to see that in Europe,” adds Millstein.


Despite the challenges of valuations, however, Millstein and Kravit insist the firm has not altered its return hurdles. Millstein says that, “to date, we are the second largest buyer of NPLs in Europe but we have not changed our return hurdles at all.” Adds Kravit: “If it happens that we cannot meet them, we will pull back and look for the next opportunity, like we are being disciplined in the US.”

Indeed, interestingly, Kravit reveals that the firm does not put target returns in its marketing materials. “If people ask us, we say we haven’t lowered our return thresholds. We go up and down the capital structure, and we will take a 16, or a 15 if we are more senior. We will trade upside for downside protection. That is one of our hallmarks. Everything is about downside protecting, risk mitigation and structure, which is why we do a lot of work only in jurisdictions where we have comfort that it is like the US. Even in the US, jurisdictions vary widely. In New York, if you go after an asset it can take you 2 to 3 years. In Texas, it takes about 21 days to foreclose. In the UK, you can get a receiver in 24 hours. Knowing this, we do a lot of bankruptcy deals and we have five attorneys on staff with bankruptcy experience.”

If one were to sum up what Kravit and Millstein say about distressed real estate investing and how to be successful, it would be something like this: it takes experience, be conservative in underwriting, don’t lose discipline, be intense, stay focused, do more due diligence than almost anyone, have local people not just for valuation but for asset managing and servicing, don’t fade in an auction process, do what you say you will do on time, treat borrowers well, be good at figuring out new markets, and protect the downside at all times.

There are many strands to pick up on. Kravit says at Cerberus, “We are totally focused on stories and being where other people aren’t. We were one of the first groups to be in Asia back in the 1990s, one of the first to go to Europe and one of the first to go after private equity real deals backed by real estate. And now it takes a lot of experience. Quite frankly, today you cannot go in with 25-year-old guys and expect them to do a great job. This is not for the faint of heart. It takes a lot of relationships, getting in front of people and having the credibility that you are going to close. One of the reasons why we have done seven or eight transactions with Lloyds Banking Group in the UK is they got a lot of comfort knowing when we showed up to one of these auctions we would do exactly what we said we were going to do. We didn’t do a lot of re-trading and we closed on time.”

Adds Millstein; “Listen, this is a massive amount of work. It is not just submitting a price. Our view is we don’t want to waste our time or reputation by fading. The other thing that is critical in the loans space more so than in the hard asset space is there is a borrower there. There is reputation risk to the bank who is servicing those assets, and we treat the borrower and their tenants well. We go well beyond complying with the law – you know, banks get calls. So we need to be part of the community, and having local teams is really important.”

Europe play

Of course, Cerberus is not the firm for you if you want to plug a hole in your portfolio with a certain asset class. They won’t help you fill a void because the firm is going where it sees the opportunity. This, one could argue, can lead to accusations of concentration risk either geographically or in the capital stack. Then again, presumably managers also have investments with managers other than Cerberus to give them what they want.

For the moment, Cerberus seems confident to pile further into the opportunity in Europe. Europe’s Asset Quality Review (AQR) remains a big stick for financial organizations to sell off noncore real estate. Government backed asset management groups continue to sell off their property assets, and various corporates have motivations for sales as well. Just looking at so-called bad banks, Spain’s Sareb has the most non-core real estate exposure left estimated at €107 billion. Next is the UK’s Asset Resolution Limited with €70 billion, then Ireland’s NAMA with €57.2 billion, Germany’s Erste Abwicklungsanstalt with €10.4 billion and the same country’s FMS-Wertmanagement with €9.7 billion, followed by The Netherlands’ Propertize with €7.4 billion. Austria, Slovenia and Portugal also have bad banks, and Cushman & Wakefield says others may be created following the completion of the AQR. Of the non-core assets still held by bad banks, 51 percent are residential collateral and a further 31 percent is commercial real estate.

Millstein says the pipeline is huge and growing. At press time, it was finalizing the acquisition of Sotogrande, the largest privately owned residential development in Adalusia in Spain for around €225 million. It boasts two beach clubs, hotels, a marina and a host of sports facilities, including five top-notch golf courses, a golf academy, two world-famous polo fields, numerous tennis and paddle courts and a sailing club. It is being sold by the real estate unit of NH Hotel Group. Meanwhile, over in Italy, the firm is working on its fourth deal. Millstein and Kravit are careful to decline to confirm details of those or other deals.

Asked about Cerberus’ strategy, Kravit says it going to “continue to go down the road of Europe, continue being disciplined in the US, and continue looking at selected opportunities in Asia.” There might also be a few opportunities in the Americas that will pop up. For example, one deal in Costa Rica which is “distressed but it is totally different” is being worked upon. In Latin America so far, the firm has looked in Brazil, Colombia, Argentina, and Chile. It has invested in Mexico in the past, but it has not found the right opportunity in these countries of late. Central Europe is another location where it is looking.

Summing up, Millstein says: “We think we are good at figuring out new markets. We’d never invested in Spain before 2010, and we are all over it now.”

If this all sounds without modesty and a bit gung-ho in print, that’s because Kravit and Millstein both talk matter-of-factly. The pair insist Cerberus will not stray from what they are good at, by going into core real estate, for example. Kravit explains what he thinks investors will say about the firm. “They will say we are very intense, very disciplined and very focused because we don’t stray from what we told people we are going to do,” – “And we don’t stretch,” interjects Millstein.

Concludes Kravit: “Other than that, we don’t go after things that we don’t think we are very good at. We have been disciplined doing distress – focused on something where there is a story behind it, where we can add value, and create additional value. We are dedicated and passionate. There is experience and deep knowledge of this business here with 35 people in senior management ranks that have been here more than 12 years. Our investors trust us a lot and that is pretty important in this day and age.”

Cerberus Capital Management (Real Estate)
HQ: New York
Founded: 1992
Assets under management: $27 billion
Latest fund: Cerberus Institutional Real Estate Partners III, closed on $1.4 billion in October 2013

Ronald Kravit
Position: Head of US investing
Joined: 1996
Previous firms: Maxxam Property Company, G Soros Realty Advisors

Lee Millstein
Position: Head of European and Asian distressed (including real estate)
Joined: 2007
Previous firms: Morgan Stanley, Aozora Bank

Ronald Rawald
Position: Head of European real estate
Joined: 2006
Previous firms: Fortress Investment Group, Aetos Capital

Thomas Wagner
Position: Chief operating officer
Joined: 2006
Previous firms: GE Real Estate, Chemical Bank