Over the past 20 years, Oaktree Capital Group has been one of the most active investors in opportunistic real estate, calling distressed commercial real estate in particular its “bread-and-butter” strategy in the asset class. In recent years, however, the Los Angeles-based private equity firm has branched out into “step-out” strategies of its central real estate investment thesis. One such strategy was real estate debt, which began as a separate account in 2012 and then expanded into a commingled fund in late 2013.
During the firm’s earnings call last month, chief executive Jay Wintrob announced Oaktree’s latest step-out in its property business, value-add real estate, which he said would complement the firm’s success in opportunistic real estate.
However, unlike with real estate equity and debt, the differences between value-add and opportunistic are not always clear-cut.
Oaktree’s opportunistic real estate business consists of six areas of investment focus: commercial real estate, non-US real estate, residential real estate, commercial non-performing loans, corporate real estate and structured finance. While two of the above focus areas are debt-related, they nonetheless had little overlap with the firm’s real estate debt strategy, which was focused on performing real estate debt and real estate debt securities with target returns in the high single digits – too low for its opportunistic real estate business.
For the record, Oaktree has typically sought gross returns of 19 percent to 21 percent for opportunistic real estate, according to a 2015 investor presentation. Meanwhile, the gross return targets for value-add vehicles commonly have been 14 percent to 16 percent. Return targets aside, however, the line between the two approaches can get blurred.
In a January report, Oaktree made a number of distinctions between the two strategies, such as value-add deriving a higher portion of its return from current income than capital appreciation, and the reverse for opportunistic. The latter would also employ higher levels of leverage and potentially include distressed situations and ground-up development, the firm said.
Despite these definitions, there is still a fair amount of gray area. For example, as Oaktree explained in its report: “Our value-add strategy targets the same types of commercial properties as our opportunistic real estate strategy, but with a lower level of distress.” However, “distress” can be somewhat open to interpretation, since both strategies involve lease-up and repositioning. And it is not clear what exactly the firm considers to be the higher leverage levels for opportunistic versus the moderate levels for value-add.
Oaktree chairman Howard Marks himself acknowledged the potential confusion between the two strategies on last month’s investor call, noting that “one man’s opportunistic is another man’s value-add,” and “there is no bright-line demarcation.”
We have already seen traditionally opportunistic private equity real estate firms, such as Rockpoint, Blackstone and Carlyle move down the risk/return spectrum at the behest of their investors. But those managers have launched core-plus strategies, which usually involve a lower level of risk and return than value-add and therefore have greater distance from opportunistic. Pursuing a value-add strategy alongside an opportunistic strategy can be seen as too close for comfort, and it is telling that private equity real estate firms with both value-add and opportunistic funds in their armory are relatively rare. The opposite is true for real estate fund managers with strategies in both equity and debt.
Oaktree has shown that it can be successful with its real estate step-out strategies, if the backing by its investors is anything to go by. For example, the firm closed on approximately $1.1 billion for its Oaktree Real Estate Debt Fund, exceeding its original $1 billion target. And as Wintrob mentioned during the earnings call, Oaktree is already planning the launch of the successor vehicle, which could target more than $1 billion in equity.
However, an outsider can readily discern the distinctions between Oaktree’s real estate opportunistic and debt strategies. If the firm is going to be successful in its new value-add real estate strategy, it may need to more clearly delineate how the new approach will be different from its long-standing opportunistic strategy. Otherwise, “stepping out” this time around may prove to be a more significant challenge.