He’s brokered diplomatic deals, played squash with a Saudi prince, served in the administration of a US president and worked for the attorney of another US president. He also heads a movie company and hangs out with actor Rob Lowe.
Thomas Barrack – the billionaire businessman with a 40-year career that has taken him all over the globe and into many different worlds – has racked up experiences that few others in private equity real estate have. Earlier this year, he added one more to the list: taking his company public.
In April, Barrack’s Colony Capital rolled up its business into the publicly-traded mortgage real estate investment trust it managed, Colony Financial. With that move, the company joined a small club of listed private equity firms that also invest in real estate: The Blackstone Group, Oaktree Capital Management and Apollo Global Management, among others. In Barrack’s eyes, becoming public is the beginning of a new era for the firm, which he founded nearly a quarter of a century ago.
“We have matured from being a finite-life, transaction-oriented company to an infinite-life business of the business,” says Barrack, during a sit-down interview at Colony’s soon-to-be-closed headquarters in Santa Monica, California. “In order to build a brand and a culture, you have to change a team’s mentality from short-term gains in the private equity field to long-term equity value built over time on singles and doubles, and the public format does that.”
As a public company, Colony now will be able to grow on a much larger scale, as the past few months have shown: since the completion of the combination on April 2, the firm already has increased its balance sheet from $9 billion to $10 billion, and expects to double that amount over the next three to five years.
A bigger balance sheet will have major implications for Colony’s private funds business, as it will provide the firm with more balance sheet capital to seed new funds. The launch of these new fund products, in turn, are anticipated to help Colony significantly increase its fee-earning equity under management.
It’s no coincidence that since becoming a public company, Colony has been on a tear in Europe, having acquired the headquarters building of oil and gas company Statoil in Norway for $320 million, as well as two office campuses in Switzerland for approximately $180 million, in recent months. These assets are speculated to be the seed investments for a potential new European private equity real estate fund with a target size of at least $1 billion.
What’s more, the firm will be able to co-invest substantially more capital in each fund. As PERE reported last month, the firm is expected to co-invest 25 percent of the capital in its new $2.5 billion real estate debt fund. Of that co-investment amount, 23 percent will come from Colony’s senior management, and much of that capital will be locked up for five years, thanks to employment agreements that both Barrack and chief executive Richard Saltzman have signed with the company. Such a sizable co-investment is intended to attract larger amounts of third-party capital.
As a public entity, Colony also will have greater capabilities to build property type-specific operating platforms that may later be spun off themselves into the public markets. Indeed, it was Colony Financial, not Colony Capital, which acquired Cobalt Capital Partners’ 30-million-square-foot industrial portfolio and management platform at year-end 2014 for $1.6 billion.
In other changes for the firm, Colony at press time was in the process of relocating its headquarters from Santa Monica – where it shares a building with video game maker Riot Games – as well as two satellite offices to downtown Los Angeles, the city’s business district, which already is home to investment managers such as CBRE Global Investors and Oaktree Capital Management.
With Colony’s newly public status, Barrack has come full-circle since the early days of his real estate career, when the rules of the industry were still being written. Indeed, to hear about the 67-year-old’s career history is essentially to hear the history of institutional real estate investing itself.
Barrack, in fact, had never intended to have a career in real estate. “I think, like most things in life, it was an accidental intersection,” he says. After graduating law school from the University of San Diego, he got a job at the law firm of Herbert Kalmbach, the personal lawyer of President Richard Nixon. After a couple of months, the firm, aware of his Lebanese roots, sent him off to Saudi Arabia to negotiate a gas liquefaction contract for a large engineering client. While working on the project in Dhahran, he was asked to play squash with a young Saudi man. That man turned out to be one of the sons of the Saudi king. The chance meeting was yet another accidental turn of events, the first in a series of bonds that Barrack would form throughout the region.
Barrack left Kalmbach’s firm to work for the Saudi prince, but in 1974, Kalmbach’s firm called him with a request. They wanted him to broker a deal involving their client, Lonnie Dunn, a Texan businessman, and Pacific Lighting Company investors who had bought land in Haiti to build a transshipment oil terminal on the island. The project, however, was stalled and only could go forward if Haiti signed a favored-nations agreement with Saudi Arabia. Barrack ended up striking a deal between Haitian dictator Jean-Claude ‘Baby Doc’ Duvalier and two Saudi princes to give the greenlight to Dunn’s transshipment terminal and an eventual sale of the property.
This success led Dunn to offer Barrack his first real estate job, managing Dunn’s property development company from 1974 to 1980. After the company was sold to G. Donald Love, chairman of Oxford Properties Group, Barrack continued running the US operations of the business until that company’s sale in the mid-1980s. He then left real estate for government, serving as Deputy Undersecretary of the US Department of the Interior under James G. Watt in the Reagan Administration. After his service in the federal government, he returned to the private sector to join E.F. Hutton, where he ran the stock brokerage firm’s real estate investment banking division out of its New York office. It was there that The Robert M. Bass Group came knocking.
All about the Bass
Robert Bass was one of four brothers from Fort Worth, Texas who inherited their fortune in the 1970s from their oil tycoon uncle, and The Robert M. Bass Group was the principal entity that invested his wealth. Barrack was hired in 1985 by David Bonderman, the firm’s chief takeover strategist, to head Bass’ real estate business, RMB Realty.
At the time, institutional real estate investing didn’t even exist yet. As Barrack recalls: “real estate was run by wild entrepreneurs who could defy the gravity of logic, who could borrow wheelbarrows of construction money from banks and savings and loans and harnessed insurance companies as partners. But it wasn’t a very professional business. It had good people in it, but real estate itself was not professional. And up until the 1990s, institutions themselves, public and corporate pensions, college endowments and foundations hardly invested in real estate. It wasn’t even an asset class.”
As such, Barrack didn’t deal with property transactions per se at Bass, but rather “white-knight investments in industries in a contrarian mode.” The Basses focused on complicated transactions involving real estate, such as the sale of Arvida Corporation, a community and resort developer, to Walt Disney Productions, for $200 million in stock in May 1984. The deal, orchestrated by Bass executive Richard Rainwater, was seen as a move by Disney to thwart a takeover attempt, as it gave the Bass family as much as a 6.9 percent stake in the media and entertainment company.
“It was an unbelievable education,” says Barrack, of his years at Bass. “It was the best education and one of the best learning experiences that I’ve ever had, the privilege of being a steward of that family wealth and of Robert Bass’ mentorship.”
Moreover, “Robert Bass was a genius at picking people,” he says. “It was where we learned the trade.” Indeed, many of Bass’ hires went onto become superstars of private equity and private equity real estate: Bonderman and Jim Coulter, who went on to start TPG; John Grayken, founder of Lone Star Funds, Kelvin Davis, who was a founding member of Colony and now head of real estate at TPG, and of course, Barrack himself. Both Grayken and Davis, incidentally, began their careers working for Barrack.
One notable deal that Barrack spearheaded at the firm was a partnership with the Aoki Group, a Japanese real estate group, to buy 62 Westin hotels for $1.35 billion from Allegis, United Airlines’ parent company. The new owners quickly turned around and sold the company’s crown jewel, The Plaza hotel in New York, for $390 million to developer Donald Trump, and the Mauna Kea Hotel in Hawaii to the Japanese railroad company Seibu for $310 million.
It was also at Bass that Barrack started investing in distress, which once again was “an accident.” In December 1987, the firm purchased American Savings & Loan, during what was then the largest government bailout of a savings association. Bass directed Barrack to manage American’s ‘bad’ bank, which contained $15 billion of troubled, delinquent and defaulted mortgages. “At the time, we had not a clue what to do with them,” Barrack recalls. “That business really hadn’t existed.”
In 1989, the Resolution Trust Corporation (RTC) was established and the assets of failed savings and loans associations started going to auction. Barrack and Bonderman formed a new partnership that would bid on the first major RTC portfolio. About the same time, Bonderman wanted to buy Continental Airlines, another distressed opportunity in a highly regulated business. Bass pledged to be a cornerstone investor in both acquisitions as Barrack and Bonderman struck out on their own to pursue these investments. “At the time, we didn’t know that either of these investments was a business,” he says. “We thought it was a trade or transaction.”
“Worst investment ever”
Similar to real estate, distress had yet to have a place in most institutional real estate portfolios. Nonetheless, Barrack founded Colony Capital in 1991, and during its first four years, the firm became one of the largest buyers of RTC assets. He received backing through a club fund that included GE Capital, The Cargill Foundation, Merrill Lynch, The Broad Foundation and two family offices for the firm’s first transaction. The following year, Colony raised $395 million for its first commingled institutional opportunity fund, Colony Investors I.
During those years, Colony converted troubled assets into ones that could be traded on Wall Street through REITs and securitizations, says Barrack. The 1999 repeal of the Glass-Steagall Act, which had restricted affiliations between commercial banks and securities firms, launched the origination and syndication of real estate debt as a significant business for both Main Street banks and Wall Street investment banks, he says.
Then, in the mid-1990s, Colony expanded to Europe, where it set up its regional headquarters in Paris, to capitalize on the distressed opportunities that were starting to materialize there. Around the same time, the firm also went to Asia to buy assets from troubled banks in Japan, Korea and Taiwan.
Over the years, Colony expanded its investment scope outside of distressed real estate. For example, the firm acquired French professional football team Paris Saint-Germain in 2006, which subsequently was sold to the Qatar Investment Authority. In a separate account, Barrack purchased Miramax Films and its film library from the Walt Disney Company for about $660 million in 2010. Miramax returned its investor capital in less than a year.
In July 2010, Colony joined General Atlantic and the management of First Republic Bank to buy the bank from Bank of America for $1.86 billion in equity. The consortium repositioned the bank and took it public a few years later at a significant gain. First Republic Bank was the largest lender of jumbo loan residential mortgages and the value was in the operating entity, not just the real estate, Barrack says. He calls First Republic – where Colony invested $1.5 billion of equity and returned 3x equity when the firm took it public – “one of our best investments.”
“Tom obviously has been able to move from just being a real estate investor to a more broad-based investor, where he’s seen value in places where maybe others hadn’t,” says Bonderman. “He’s really broadened his reach and built a business.”
In deviating from distressed real estate, however, Colony, has occasionally stumbled. “All of us have made mistakes – me being at the top of the list, as far as really looking at the business of the business rather than a transaction,” Barrack says.
One of them was its public-to-private takeover of Station Casinos for $9 billion in November 2007. The company declared bankruptcy in 2009, and Barrack calls the deal the “worst investment ever.” The deal led to reported write downs of approximately 60 percent in the $4 billion Colony Investors VIII, although PERE understands that more than a third of that loss has since been recouped.
In retrospect, Barrack maintains that Colony chose the right theme – hospitality with gaming – because of the high barriers to entry and Colony’s edge in that market. At the time, it was the only private equity firm to be licensed as a gaming operator, and had previously taken Harvey’s private before profitably selling it to Harrah’s.
The single-biggest misstep in the deal, however, was its financial structure, as Colony was the first private equity firm to finance an operating company/property company transaction with commercial mortgage-backed securities. “We had not thought to put in our documents that the originating bank had to be a corresponding agent with control in a restructuring, so as a consequence, we had no one with whom to have a discussion,” Barrack says.
Back then, “no one thought about theme drift,” he adds. “That’s what an opportunity fund was. But as time went on, themes developed, and investors didn’t want operating companies mixed with real estate.”
Shift to distressed debt
Post-crisis, Colony has been less active in commingled fundraising on the equity side. The firm has not raised an opportunity fund since Colony Investors VIII, a 2006 vintage fund. Meanwhile, the firm has raised modest amounts of capital for its value-add fund series, Colony Realty Partners (CRP), which pursues cash-flowing investments across property types in North America. The firm gathered $356.85 million for CRP III in March 2009, and Colony collected $109 million for CRP IV in January 2014, according to filings with the US Securities and Exchange Commission.
What has caught on with investors, however, is the firm’s distressed real estate debt platform, which has raised close to $8 billion in commingled funds and special accounts and targets loan acquisitions, high-yielding originations and special situations. Colony launched its first commingled fund for the strategy, Colony Distressed Credit Fund (CDCF I), in 2008, and founded Colony Financial the following year.
After collecting $885 million for CDCF I, the firm followed up with equity hauls of $780 million for CDCF II in May 2012 and $1.2 billion for CDCF III last October. Limited partners in CDCF III included the Florida State Board of Administration, Fresno County Employees’ Retirement Association, and the Teacher Retirement System of Louisiana, according to documents from those pension plans. About 25 percent of the LPs, including Louisiana Teachers, were first-time investors with Colony. Colony declined to comment, but PERE understands that CDCF III is nearly fully invested.
Although people close to Colony have said that the poor performance of Colony Investors VIII was one of the principal reasons for the strategy shift, Barrack dismisses such claims. He points out that Colony was one of the few opportunity funds that survived the crisis. Most opportunity funds of the 2007 vintage also took a hit. “Everybody else had to resaddle and ride a new pony,” says Barrack. “So some people decided to go forward, but everybody turned to a credit platform.”
Aside from its commingled funds, the firm has raised billions of dollars through separate accounts for the distressed debt strategy. Colony’s acquisition professionals work in tandem with the firm’s internal loan servicing and underwriting group, Colony Asset Management Company, which has more than 100 professionals and manages loans in every US state.
As of year-end 2013, CDCF I was generating a net return of 15.2 percent and net multiple of 1.5x and was ranked as a top-quartile fund, according to a May 2014 document from the Teachers Retirement System of Louisiana. Meanwhile, CDCF II was yielding 13.1 percent and 1.1x, and was ranked as a second-quartile fund.
CDCF III’s investments are expected to be evenly split between the US and Europe. Colony’s US investments primarily have been in originations for transitional assets, properties that are being upgraded or being repositioned from one use to another. Although the US is considered the safest, most predictable and transparent real estate market in the world, “it’s hugely non-homogenous, so there are always deals to be done,” says Barrack. “But the deals to be done are in micro-shots, transitional, and on the credit side of the equation.”
Of greater interest to Barrack, however, is Europe, where the firm has increased its staff in recent years to more than 50 professionals across six offices. “Europe, I think, is the unique opportunity, because the shadow banking industry does not exist there, and the banking industry itself has virtually stopped,” he says.
Indeed, in addition to its recent acquisitions in Norway and Switzerland, Colony expanded into the German real estate market last month with the purchase of a 50 percent stake in fund and asset manager Hamburg Trust from HTH Hamburg Trust Holding. Hamburg Trust recently launched its first real estate fund for charitable foundations and also plans to form two special alternative investment funds.
“It is pretty apparent that Colony Capital is moving deeper into the European real estate market,” Daniel Altscher and Cole Allen, analysts at FBR Capital Markets, wrote in a research note last month. “Any way you slice it and dice it, Colony’s presence in Europe is expanding.”
Another recent deal that Colony helped to execute in Europe was Constellation Hotels Group’s acquisition of the Maybourne Group, the owner and operator of the Claridges, Connaught and Berkeley hotels in London, resolving a bitter four-year dispute between the group’s shareholders. In 2014, Colony bought the debt underlying Northern Irish developer Paddy McKillen’s shares in the group, which helped to protect McKillen’s 36 percent interest in the hotels until the sale of his and the Barclay brothers’ stakes to Constellation. Colony, along with Blackstone, had sold the hotels to Coroin, the holding company for Maybourne Group set up by McKillen and other investors, a decade earlier. Constellation is a Middle Eastern investment firm with whom Barrack has had a close relationship for decades.
As for Asia, Colony has remained relatively quiet in the region since raising and investing Colony Asia Investors I, a value-added vehicle that captured $250 million in 2003. While Asians have welcomed foreign investors to resolve their troubled situations, the region doesn’t offer many distressed transactions at the moment, according to Barrack.
Barrack says he is not exploring another opportunity fund for the foreseeable future. Instead, generally speaking, Colony currently favors structuring its equity investments as sector-specific platforms. Colony American Homes, its $3.5 billion buy-to-rent housing business, is a case in point. In October 2012, Colony invested approximately $35 million for an interest in 1,177 single-family rental homes, through a joint venture with US mortgage agency Fannie Mae. Today, CAH is one of the largest owners of single-family rental housing in the US, with nearly 20,000 homes in 10 states. It also has launched a related business, Colony American Finance, which provides loans to owners of single-family rental homes.
“In growing operating platforms, you breed optionality,” he says. “You’re creating an institutional structure and an entrepreneurial product that then has manifold options – to go public, to spin the manager, to spin the assets, to refinance the assets, to grow the assets in place.”
In the case of Colony American Homes, the firm had filed for an initial public offering in May 2013 but subsequently withdrew those plans because the valuations for the stock were lower than expected. The problem was that investors continued to buy more properties, which kept vacancy rates at approximately 20 percent, according to Barrack.
However, now that most single-family rental businesses have stopped actively buying, and the securitization of buy-to-rent portfolios has allowed firms to return more cash to their investors, an IPO could be a more viable opportunity in the coming year.
“If the public markets come back, we’ll take it public,” he says. “Otherwise, the leverage in place is phenomenal. Our last securitization was 189 over, so it’s a great capital structure.”
Another potential IPO candidate would be Colony’s light industrial platform. “We’re culling some of the product that we have and trading it up for higher quality product,” says Barrack. “It’s like a bouquet, we’re constantly pruning it.” Although he declines to provide specifics, he says that Colony plans to grow the platform “substantially,” either through the infusion of private capital or a public spinoff. Its ultimate size, however, will depend on market conditions, he says.
The self-effacing Barrack credits much of his success to his work ethic. “I was never the best student, I was never the best athlete,” he says. “Early on, I realized that the ability I had was that I could suffer more pain than most people. And that meant I had to work harder, get up earlier and go to places others would not go.”
Bonderman, however, sees other differentiators that have set Barrack apart from his peers. “Tom is a very smart real estate guy, very creative, but also a very good guy,” he says, adding that he and Tom remain close and talk on the phone an average of once a week. “People like him, which is important in this kind of business.”
That popularity has extended across borders; indeed, of all of his rules for success, the advice, “Develop a sixth cultural sense,” has arguably served him best. “When we’re in France, Colony is a French company,” Barrack says. “We’ve been there for nearly 20 years, we’ve got great banking relationships and we’ve got great political relationships. We understand the culture. The same with the UK, the same with Spain, the same with Portugal, and we’ve done well in all of those countries over two decades.”
In fact, in 2010, French president Nicolas Sarkozy awarded him the country’s Chevalier de la Legion d’honneur, which is considered the highest decoration in France, awarded for excellent civil and military conduct. Barrack sits on the board of two French corporations, hotel chain Accor and retailer Carrefour.
Meanwhile, Barrack’s strong ties with Middle Eastern investors can be seen in many of the firm’s highest-profile deals. Colony teamed up with Saudi Prince Alwaleed bin Talal to buy the Fairmont and Raffles hotel chains in 2006. Meanwhile, QIA was one of Colony’s partners in its acquisition of Miramax Films and its film library from the Walt Disney Company for about $660 million in 2011.
“What’s the edge? Is the edge only cost of capital?” he asks. “The edge, which I learned at the Bass Group, is these long-line relationships. You build relationships in tiny little inches over decades. But you can lose them in an instant.”