AMERICAS NEWS: Greater as a whole

Colony Capital is one of the best-known firms in private equity real estate, and has made a name for itself as a distressed investor in particular. But despite its high-profile chairman, Tom Barrack, and equally high-profile deals, the Los Angeles-based real estate firm saw constraints in remaining a private company.

Colony currently manages a total of $19 billion of assets under management through 30 investment vehicles. But it is dwarfed by publicly-traded private equity firms that invest in real estate, such as The Blackstone Group ($284 billion), Oaktree Capital Management ($93.2 billion) and Kohlberg Kravis Roberts ($96.1 billion). 

PERE understands that Colony was finding it increasingly difficult to compete with such firms, both from a fundraising and investment perspective, given the massive amounts of balance sheet capital that these entities had at their disposal. To be a stronger contender against its listed counterparts, it would need to go public as well, said one industry observer.

On November 4, Colony Capital and its publicly-traded mortgage real estate investment trust, Colony Financial, announced an agreement for Colony Financial to acquire Colony Capital’s real estate and investment management businesses and operations for up to $657.5 million in stock. Under the proposed transaction, Colony Financial would be responsible for all of Colony Capital’s future investment activities going forward, including forming and sponsoring new private investment funds and vehicles.

The new entity, which will be renamed Colony Capital, would be one of the only real estate-focused private equity firms with a balance sheet. Because most of its assets are real estate assets, the company would retain Colony Financial’s tax-advantaged REIT status, in contrast to the limited partnership structures of other listed private equity shops.

Colony declined to comment on the transaction, which is anticipated to close during the first half of 2015. However, one source familiar with the firm said Colony’s biggest impediment to faster growth was having its liquid net worth tied up in its funds’ general partner co-investments. Consequently, the company was hampered in its ability to raise additional vehicles, and its constraints in fundraising in turn hamstrung its ability to capitalize on investment opportunities.

Becoming a public company would be “a game changer” for Colony, and allow it to significantly expand its private funds business, said the source. As a public company, the firm not only will be able to raise more funds, but also commit significantly greater amounts of capital to those vehicles through its GP co-investments, which in turn will help it to raise larger funds. Previously, some institutional investors would not invest in Colony’s funds because the firm was not able to meet their minimum thresholds for GP co-investment, the source said.

Other considerations have factored into Colony’s decision to go public. In a June report, Daniel Altscher, an analyst at FBR Capital Markets, noted that Colony Financial is seeking to diversify its business away from a mortgage REIT to either an equity REIT or an alternative asset management manager, which could command higher multiples. The roll-up of Colony Capital into Colony Financial also would reduce the latter’s operating expenses, by replacing the external management fees paid to Colony Capital with directly incurred costs, the two parties said in their joint announcement. 

In becoming a listed firm, however, Colony is taking a different path than the private equity shops that went before it. While other firms took the entire company public at once, Colony Capital filed an initial public offering only for Colony Financial in 2009. Colony Capital itself, however, was said to have not been ready to go public at that time, partly because it had other businesses it wanted to develop. 

The fact that it is ready to do so now is partly because of the growth of Colony Financial, Altscher told PERE. “Many mortgage REITs go externally managed initially, because it’s more beneficial to the shareholder,” he said. “But at some point, you reach a threshold where it becomes more economical to become internalized.”

In combining the balance sheet of Colony Financial and fee business of Colony Capital, the proposed transaction would create an entity that is “more powerful combined than separated,” he said. “It provides enhanced avenues that the company couldn’t or didn’t have before.”