ASIA VIEW: Letting off steam

There are many ways to consider Morgan Stanley Real Estate Investing’s (MSREI) 2012 investment in the funds management business of Melbourne-based property investment manager Orchard Capital Investment.

Committing about A$200 million (€141.9 million; $164 million) of the equity of its seventh global opportunity fund, Morgan Stanley Real Estate Fund (MSREF) VII Global, or G7 as it is known colloquially, MSREI was able to capture a business responsible for A$1.1 billion worth of B-properties across Australia at a knock-down price. It did so during a choice time for valuations and has ultimately prospered for it.

That much became apparent as it all but completed the liquidate part of its buy-recapitalize-redistribute-asset manage-liquidate strategy for the funds’ assets at the turn of this year.

Kudos then to MSREI for sensing the opportunity in front of it and committing to what was actually a rather complicated process involving buying the assets’ debt, underwriting its recapitalization via rights issues and committing to a redistribution to the moms and pops that had been trapped in the fund. PERE understands that rival suitors that were circling at the time ended up dismissing an investment as too complex and the platform as too highly leveraged. 

In particular, buying Orchard’s debt from UK bank Lloyds and then using the proceeds of rights issues to repay itself looks, on retrospect, a wise bit of financial engineering by the investment bank. 

MSREI capitalized on an unfortunate situation for Orchard’s investors. But given they are now on course for an 85 cents on the dollar haircut compared to 91 cents previously, the retail investors of Orchard’s funds should regard the MSREI solution a better one in retrospect than what else may have been available even if, in absolute terms, the value rescued was fairly marginal.

In any event, it was victory for MSREI at the deal level – this investment should generate a 20 percent-plus IRR for G7. It should also play its part in bringing to MSREI victory at the fundraising level too. Remember, we’re talking about a real estate investment management business that, until its investors granted it an extension on the investment period of the $4.7 billion fund two years ago, was seriously looking at a precipice in terms of its future.

It will take deals like Orchard to help to crystalize its comeback and to provoke further investors to add to the $1 billion of equity committed so far to G8, which it is out for fundraising at the moment. A successful final closing for G8 will silence those who called time for the one-time private equity real estate market leaders. 

But wider than what is happening at Morgan Stanley, we should glean from this transaction what its real estate unit is saying about the market in Australia right now. We at PERE see the liquidation of Orchard – three years into a four year strategy it is worth adding – as one of the market main participants effectively calling time for the country. The sale of assets from the Orchard platform comes as it exits from its investment in Retire Australia, the care homes company. It has already sold large swathes of the Australian loans it purchased from UK banks Bank of Scotland and Lloyds, again only about three years ago. 

Indeed, we hear that of the A$2 billion or so of real estate that MSREI was exposed to through G7, as little as A$300 million remains on the books of that fund. Its holdings in Australia have been significantly monetized.
The indicators that we are heading up the proverbial investment clock face are mounting and you only need to look at MSREI’s activities down under to realize that. 

To conclude the point, those close enough would notice that one of its Orchard exits, the floatation of Arena REIT, was listed with an 8 percent distribution. But sheer demand for yield quickly has driven that return distribution down to 6 percent. They might have noticed also that some of the buyers of its office assets were Chinese developers that surely must be underwriting their acquisitions on the assumption of changing use from commercial to residential. Otherwise, their numbers surely wouldn’t stack up for an office investment, even if Australia’s leasing market is bottoming or showing early signs of a recovery.

So, beyond tipping the hat to MSREI for demonstrating it has retained the mettle for tackling complex property transactions during opportune times and pointing out what this deal might do for its fundraising prospects, its exit should also serve to inform us that Australian property is a fairly steamy place to be right now.