BLUEPRINT: From the castle keep

Tom Pulley and Anthony ‘Tony’ Tufariello. One quite laid back, the other fairly intense.

You are looking at the co-chief investment officers of the global real estate business at Fortress Investment Group, the New York firm that is publicly listed on the New York Stock Exchange that has grown to $66 billion of assets under management and for whom real estate is a very serious business. After all, in real estate, Fortress has found some of the most fertile ground for opportunistic and distressed investing coming out of the financial crisis. And, with a team of 80-plus professionals focused on the asset class, no wonder the team is coming out from under the umbrella of the firm’s credit business for which it accounts for approximately one third of investments. It is no small enterprise after all, having made 180 transactions and deployed $7 billion of equity since 2002.

Pulley and Tufariello are in the business of financial services garbage collection, as Fortress co chairman and principal – Peter Briger – termed it the last time we caught up with the firm back in the summer of 2011. The description well fits this team of sleeves rolled up, no-nonsense investors because real estate can be a rough and tough business, especially when playing in the arena that Fortress specializes in – namely distressed debt and opportunistic real estate. It needs a certain mindset and tenacity, and if appearances are anything to go by at least, they have it.

PERE caught up with Pulley and Tufariello in January to talk about Fortress and how it sees real estate. Since our first meeting, the deal count has ticked up steadily, the same senior people are here, the desire for distressed real estate deals remains unabated and the geographical theater of activity remains the same: The US, Japan and Europe.

But of course, evolution occurs at all franchises and Fortress is no exception. On the personnel-side, Pulley and Tufariello were in 2014 formally made co-chief investment officers of the global Real Estate business. The company is just in the process of updating their details on its website though it was not a promotion per se as the two have been doing this job for a while now. However, make no mistake, it holds significance because it amplifies how Fortress recognizes that its global Real Estate business needs a distinct leadership structure, more latitude and greater responsibility. Pulley focuses on Japan and the US while Tufariello focuses on US and Europe, though both jet the world incessantly. 

More news is that the company has been expanding headcount within its credit and real estate team by around 20 percent in the last year, with a major focus on asset management and Europe.

Further, as far as capital raising goes, the firm is extremely active. Fundraising is an area Fortress will not comment on, but it is known to be in the market not only with its second US and Europe dedicated opportunistic RE fund, but is also close to the finish line for Fortress Credit Opportunities IV. The predecessor fund attracted $2.7 billion of commitments. Then there is Fortress’ third Japan Opportunity fund also in market. They’ve raised over $10 billion in private equity structures for these business lines since 2008 and are rumored to be closing another $5 billion imminently. 

Plus, the real estate markets in the US and Europe have shifted since we last met the company leading to a slight alteration in its strategy. More of that to come. With all these developments, it made sense to interview the firm on what happened to be an extremely cold January morning when fog surrounded the upper levels of 1345 Avenue of the Americas in Manhattan. 

Trillion dollar opportunity 

It may have been freezing and foggy outside, but inside there is clarity coming from Pulley and Tufariello. For more than an hour, they explain how Fortress believes that there is a very large opportunity for a group like itself to seize. Pulley says: “Many think that because the US economy fundamentals are improving, which they are substantially, that the distressed debt opportunity in the US is disappearing. But we think that we are going to have this other wave as maturities come due over the next couple of years. It is our view that over 20 percent of those maturities coming due are going to have problems in refinancing and are going to need new capital in some form or fashion.” 

More specifically, Fortress is eyeing $1.2 trillion in maturing commercial real estate loans through 2018, as estimated by Maximus Advisors. Much of this debt was issued pre-crisis with high loan-to-value ratios, often exceeding 90 percent. The decline in national property values since peak levels has led to what it says is a “continuing financing shortfall” with more than $300 billion of CMBS contractually maturing between 2014 and 2017. Notwithstanding resolutions to date, the scale of maturities remains enormous and is expected to reach a new, higher peak in the coming years, says the firm. To borrow a metaphor from childhood, to Fortress this market is like a gigantic sandbox to play in and Fortress feels like the kid with a large bucket, spade, rakes and indeed all the play tools necessary to be successful.

The message that Pulley and Tufariello spell out is that Fortress has consistently been sourcing investments from broken, stressed and strained CMBS and other distressed debt and equity structures since the global financial crisis. Or as they put it, a decent portion of its investments are distress around the “demise and resolution” of the CMBS activity of 2006 and 2007. 

Says Tufariello: “We continue to be very focused on distressed debt and equity in the market place, which enables us to get to an asset at a very cheap basis and we see much of the same opportunity over the next couple of years.” It might be the same kind of opportunity, but in the eyes of the firm it is that much larger now.

Based on a loan-by-loan review of CMBS transactions managed by affiliates, Fortress thinks 20 percent of upcoming maturities are impaired and may need restructuring. It divided the CMBS into risk-categories from higher risk meaning debt service coverage ratios of less than 1.1x, to lower risk. Based upon this analysis and also previous default experience, Fortress arrived at the conclusion that one in five loans may default upon maturity.

For years past, Fortress has been getting control of assets in the US via broken structures. Few would have heard about too many of these, because the firm keeps these things under the radar, although investors get the 100-page quarterly report where all deals are laid bare. 

Until recently, Fortress has been investing in underlying assets in major US gateway cities. But as everyone knows, these major markets have more than recovered value erased in the crisis – Moody’s estimates put it at 116 percent of their pre-crisis peak. Meanwhile, non-major gateway markets have recovered less at 91 percent and are still trading at healthy discounts to replacement cost.
As Tufariello says: “A few years ago, we were very focused on major gateway cities. We have the same strategy of getting access via debt and recapitalizations, but San Francisco, New York and others have run past the peaks of 2007. We think the opportunity over the next couple of years is more in the non-gateway markets where values have not recovered but debt is becoming due without refinancing options. 

The theory is that as loans approach maturity default, capital constraints for capex and tenant improvements on troubled assets further deteriorate the competiveness of buildings. Fortress will use the debt as the entry point or catalyst to get control of these assets. Using their credit lens to reset the basis, deep pockets to fund repositioning, institutional access to cheap financing, and their operating capabilities to drive leasing and NOI, Pulley and Tufariello will make their returns. 

In the US, it has been finding one-off situations like this rather than going for large portfolio investments that tend to attract crowds. A good example would be in Philadelphia where it bought the loan collateralized by One Washington Square which had the exact elements Fortress was looking for. The loan attached to the building formerly known as the Penn Mutual Towers was in special servicing after its former owner tried unsuccessfully to renegotiate the debt. The occupancy level at the building had fallen to 77 percent but the firm was able to buy the loan and inside four months had gained control of the asset, thus saving a lot of time and money. The asset management team is now in the process of leasing it up. The stabilized asset should produce an NOI yield in excess of 10 percent in a market where comparable properties are selling for between 7 percent and 8 percent capitalization rates or $150 to $200 per square foot. That appears to be a healthy return on investment versus the market, reflecting an investment basis of approximately $80 per square foot. 

A more recent example of the firm’s strategy was completed three months ago. It involved the same scenario only this time it was a 340 room four-star hotel in the Caribbean. In this case the firm is looking at in excess of an 11.5 percent yield. It is currently in the process of foreclosing on the asset and there are lots of levers Fortress can pull to add value. Again, this was a scenario in which there is a defaulted CMBS loan, a receiver put in place, and limited capital to invest in the property. 

Says Pulley: “We have been able to generate excellent returns without using much leverage. If you look at our first US fund and add up what we paid versus how much we borrowed for investments and it would be around 55 percent. The same basic math applies to our Japan funds.” 

The way Fortress sees it, there should be a huge volume of investment opportunities to come. Says Pulley: “We haven’t been through the experience of so much paper hitting the wall at the same time.” Tufariello chimes: “Low rates have effectively bailed out the market.” Pulley adds again: “It may be a shallow part of the market right now. People are not yet looking at the underlying collateral. We think that is a substantial opportunity.” This may be no surprise to the real estate community, but if they are right, Fortress will be very busy.

Indeed, people are aware of it, but how many can play into it? And keep playing into it? This latter point is one of those raised by limited partners that assess Fortress. One US limited partner PERE spoke with that has just invested in Fortress Real Estate Opportunities Fund II said the big question was how could Fortress replicate its success with Fund I given the current US market? 

This investor has a particular view that Fortress won’t be able to, but remember he still invested with the group because they are “real estate guys” in an environment where “the dynamics of the capital markets are just as in important as the property market”. He said: “It is critical to have an investment manager that participates in both of those and Fortress brings that skill set to the table. If you don’t understand the debt capital markets you are giving away returns.”
He added: “But I think what is interesting is that this vintage going forward is not going to be anywhere near as good as 2009 and 2010. Part of the answer is that I have to trust my manager with a great track record.” 

Pulley picks up on the theme. “I think the question being asked is how replicable is the strategy? But our answer to that is the on-going flow that we are building upon, and the infrastructure here at Fortress where we have been scavenging the globe looking for deals, with approximately 14,000 people bolted on who are in the servicing companies, further bolted onto the macro environment opening up in the US and Europe – a once in a lifetime CMBS unwind that is going to happen in the next three years.” Pulley further remarks: “We have 350 people scouring the world looking for investments. We look in the nooks and crannies of the system. Indeed, we built the entire system for this process. From sourcing, investment pipeline, review of that pipeline on a very regimented basis throughout the week, to how we handle underwriting, due diligence, and execution on the enforcement side, and what to do with the assets once we get our hands on it.” 

Fortress owns special servicers in key markets it targets. In the US, they own CW Financial, the second largest special servicer of CMBS. CW is named special servicer on $109 billion of loans, employs 142 staff across 5 cities and has an additional 1,050 people at its subsidiary, CompassRock. In Italy, there is Italfondiario, the largest non-bank special servicer in the country that started as a Fortress private equity fund investment more than ten years ago. For the UK, Spain, The Netherlands and Germany it has GMAC Financial Services’ European mortgage assets and operations that it bought in 2010 after the US government bailed out GMAC with $16.3 billion. 

Speaking of Europe, three and half years ago Fortress indicated it did not see the same level of opportunity as in the US. But that is another thing that has changed given the increased level of liquidation of loans and properties in Europe. Since 2008, the European bank nonperforming loan market has more than doubled from 2.8 percent to 7.8 percent of total loans – nearing 2001 peak Japanese levels. Morgan Stanley, Deutsche Bank and others originated billions of euros of European CMBS. They were complicated structures not only because of their aggressive tranching and subordination, but also because of bespoke structuring and embedded FX and interest rate swaps adding further uncertainty and complexity.

This is now a hunting ground for Fortress. As in the US, the company has been getting control of European assets through debt and has thus far been producing strong cash-on-cash results with moderate amounts of leverage, says Tufariello. Project Vermeer, an investment made in 2013, is the perfect example. In that case, Morgan Stanley’s once prolific European Eloc conduit program had originated a CMBS in 2008 on a 2007 €1 billion loan extended to the private Fordgate Group of the UK enabling Fordgate to buy 36 Dutch properties, 12 Belgium assets, 10 in Germany and 7 in Switzerland. Cutting a long story short, apparently Morgan Stanley got halfway through the securitization plan when the music stopped. In other words, half the bonds got sold, half didn’t. That created an opportunity for Fortress to buy the senior bonds from the originator, and then later in the market place. Its price basis was one third of what the original financing was. 

On this example, Fortress’ team swung into action, putting some of its top talent onto the investment. One senior team member had to read through a 450-page servicing agreement. At Fortress, it’s all hands on deck with sleeves rolled up.
As with the US, it is all about driving the NOI having reached the asset at a good price. What is striking about Fortress in Europe, however, is its absence from the list of major franchises that have taken part in NPL trades. Tufariello says the reason for that is Fortress prefers to look at smaller pools, avoid the competition, invest in “idiosyncratic” deals, drive NOI to create value, and also diversify investments. 

In other words, it executes a large number of individual transactions where the air is thinner. The first US and European RE fund was primarily US investment and it clocked up 30 different deals – a strike rate of about one a month. The first Japan RE fund, meanwhile, was equally prolific, making 23 investments. The second Japan RE fund has 30-plus investments in it. 

This high number of investments typically would mean a lot of capital calls for investors, but Fortress assesses the pipeline and bundles up capital calls to keep disturbance to a minimum. Also, the high cash-on-cash returns mean profits are recycled. The investors get a bigger dividend back later. 

As the pair turn their attention briefly to Japan where a lot of CMBS activity has already occurred, it is clear the strategy is strikingly different. What is really driving investments in Japan is the hospitality sector fuelled in part by the Olympics which arrive in Tokyo in 2020. Fortress started buying hotels in Japan from 2010 and assembled a portfolio of 67 hotels with a disposal value of $2.5 billion including the Sheraton Tokyo Disneyland, Narita Hilton and 40 business hotels primarily in Tokyo. Around 14 months ago, it exited a big portion of its hotels via an affiliated J REIT called Invincible Investment Corporation. Across the whole hotel portfolio, the NOI increased 20 percent-plus. 

One has to admit, the examples of how Fortress is operating in the US, Europe and Japan are pretty eclectic. No wonder it is hard to place the firm into a pigeon hole. 

Indeed, it is easier to explain what it is not. It is not a franchise that likes to do the equivalent of big game hunting in packs. It prefers to operate away from the competition and isn’t afraid of being involved in complex or controversial situations. Staff one minute can be working on providing a real estate loan to a Chinese property company to develop a large scale residential project in Brooklyn, as occurred in June 2014. The next minute they might be renegotiating whole tranches of a Morgan Stanley CMBS originated in Europe pre-credit crunch as was the case with Project Vermeer.
Sums up Pulley: “We are extremely comfortable with our ability to look at potentially contentious situations, evaluate the possible outcomes, play the chess game.”

Anthony Tufariello
Co-CIO of the real estate business
Anthony Tufariello, who joined Fortress in November 2008, has just recently received a new title as co- chief investment officer of Fortress’ Real Estate business. Prior to that he was a managing director of the credit funds, responsible for all real estate investing including securities, debt and equity investments and also remains a member of the management committee of Fortress. His resumé is colorful to say the least given his previous positions at Morgan Stanley which put him into close contact with previous chairman and chief executive officer, John Mack. He was with Morgan Stanley for a total of 21 years and held a number of senior positions at that firm, including being a member of the firm’s management committee, a member of the sales and trading operating committee and co-chair of the global large loan credit committee. His most recent role at the Wall Street bank was managing a complex business which included client agency businesses, principal lending activities (commercial real estate, residential lending, warehouse lending and secured cash flow lending) as well as managing the trading desk across CMBS, ABS, CDOs and residential products.

Thomas Pulley
Co-CIO of the real estate business
Thomas Pulley also has a new title of co-chief investment officer of the Real Estate business at Fortress. Prior to that he was CIO of Fortress Real Estate (Asia) and continues to be a member of the firm’s management committee. He joined Fortress in October 2007 from Credit Suisse where he was head of the private equity division in Japan. In 2000, he moved to Japan to build and manage the Asian investment program of DLJ Real Estate Capital Partners (RECP), a real estate private equity fund organized by Credit Suisse. He was one of four designated key men for DLJ Real Estate Capital Partners III and a member of its investment committee.

Check in, check out 

Fortress owns a Japan hotel REIT called Invincible whose earnings are up five times since it became involved.

When Invincible REIT hit a cross default on its debt in late 2010, the Tokyo Exchange listed company and its asset manager set out to find a sponsor in short order. Fortress negotiated a deal with a CMBS creditor, injected equity, extended a sponsor loan and refinanced all of the company’s debt in July 2011, creating a stable capital structure while also acquiring the REIT manager. Since then, Fortress worked with the REIT manager to cut expenses by ¥200 million ($16 million) annually, improve occupancy from 92 percent to 96 percent and to further lower borrowing costs, the sponsor loan was refinanced in December 2013 with ¥20.4 billion of new debt and ¥3 billion of equity. Two of Japan’s mega banks led the syndication, marking the first time they had provided financing to the REIT. The company subsequently retired the refinanced debt with a syndicated bank loan, further reducing Invincible’s average interest rate from 1.48 percent to 1.09 percent. And a successful public offering in July 2014 was 6x oversubscribed, raising ¥26 billion. Today, the company’s market cap is approximately ¥150 billion compared to ¥13 billion at the time of Fortress’ acquisition. From a distressed REIT looking for a lifeline, the company has emerged with a strong capital base and substantial borrowing capacity to finance accretive acquisitions. Earnings were up over 5x from acquisition through the first half of 2014 and the investment is valued at approximately6x Fortress’s basis.

San Fran grand slam

Fortress hit the ball out of the park with its investment in Parkmerced, the 3,200 multi-family complex in ‘The City’

When PERE last interviewed Fortress back in the summer of 2011, there was one investment that really stuck out, and we featured it as part of the article. Parkmerced, the famous San Francisco multi-family project located on more than 150 acres in the southernmost section of “the City” was an investment that Fortress made in September 2010 on behalf of Fortress Credit Opportunities Fund II along with other managed funds. Now, if you still keep hold of back issues of PERE, you will discover from the article all about the history of Fortress and Parkmerced and how the asset had fallen into the hands of special servicer Aegon Realty Advisors. One would also have learned that the asset was suffering from multiple ill winds. The global financial crisis affecting real estate markets, student occupiers drifting away as program budgets cut deep at the local San Francisco State University, and a dysfunctional capital structure all played a part in the complex going south. It was, in short, a mess for a building steeped in history having been developed way back in 1939 by Metropolitan Life Insurance and designed by architect, Leonard Schultze. The first tenants, incidentally, moved in during 1944 right at the end of World War II.

In our article, we chronicled how Fortress had become financially involved in the first place via the debt. But the question is whatever happened to the investment from 2011? Well, as press clippings from last year show, Fortress eventually divested its interest in Parkmerced in October 2014 after a four-year holding period to group of investors led by New York developer Mark Karasick. But did it make a large return and if so how much? The problem is that Fortress will not discuss the investment due to confidentiality issues.

However, individuals familiar with the market and following the investment closely estimate a return commensurate with a well-executed plan. Having become involved, Fortress went about unwinding the complex capital structure, competing equity interests, substantial over-leverage, pending maturity defaults, a weak local economy and a lack of operating capital. It acquired various interests throughout the capital stack in off-market transactions and did what property investors should do – increase the NOI. It replaced property management, ratcheted up leasing and management efficiency by introducing better systems and controls, changed management culture to be more proactive and focused on returns, plus executed a few cost cuts. Occupancy levels started to rise. Indeed they went from 88 percent to 97 percent. Rents were increased as well from $2 a foot to more than $3.35, and NOI almost doubled. Finally, entitlements were achieved whereby over time some 5,900 additional units could be developed. The net result? According to market participants, Fortress invested over $150 million and generated a gross IRR of over 30 percent with a 2.5x equity multiple.


Fortress’ credit business, founded in 2002, began with the Drawbridge Special Opportunities fund. This is a $6 billion evergreen diversified fund with around 500 different investments. The Drawbridge fund, according to investors, boasts a compound net return of 11 percent for the past 12 years. However, after the financial crisis of 2008, Fortress recognized the enlarged credit opportunity and that it required an equity, longer-hold strategy, so the team raised a series of dedicated private-equity style credit closed ended vehicles. Fortress Credit Opportunities Funds and related accounts have raised $10 billion since 2008 and are about to close the fourth fund – FCOI V. In addition, in 2009 it raised a dedicated Japan distress vehicle, Fortress Japan Opportunity Domestic Fund, which closed in June 2010 and is showing up net IRRs of 31.5 percent. It has raised two Japan funds since 2008 and is deep into raising a third. Lastly, in 2011 it began raising a US and Europe dedicated real estate fund, Fortress Real Estate Opportunities Fund which raised $567 million and is showing net IRRs of 15.6 percent. Fund II is said to be in the market. Pulley says: “Real estate has always been about one third of the Credit business, but then we started to separate out the real estate platform commensurate with an investor base, some of which wanted greater pure real estate exposure.”