SPECIAL REPORT: Coming to the realization

In late October, multiple private equity firms addressed a common theme during their third-quarter earnings calls: realizations in real estate.

Blackstone, the sector’s biggest firm by both equity raising and assets under management, reported it achieved realizations of $7.2 billion as of September 30 – its second-highest for the real estate business since inception. Driving the activity were the sales of the firm’s remaining stake in the listed retail real estate investment trust Brixmor Property Group, its China retail platform to China Vanke and the bulk of its Strategic Hotels portfolio to Anbang. 

“There is significant demand globally for income-producing assets, which is sustaining a robust realization pace for our real estate business,” said Blackstone chief financial officer Michael Chae during the firm’s earnings call. Total realizations for the business had reached $14 billion year-to-date – and the firm is on track to achieve $20 billion in annual real estate realizations for the third year in a row. 

“And we are not planning on slowing down, with clear visibility on a number of large monetizations over the next 12 months to 18 months,” Chae added. By comparison, the New York-based alternative investment manager invested or committed $2.4 billion during the quarter, including the acquisition of Blanchardstown, a 1.2 million-square-foot retail complex in Dublin, and $1.1 billion in US core-plus investments.

Also a net seller was Apollo Global Management, which announced $611 million of realizations during the third quarter and $2 billion year-to-date in its real estate business, compared with $567 million and $1.6 billion in deployment during the same periods, respectively.

Meanwhile, during Oaktree Capital Group’s earnings call, co-chairman and chief investment officer Bruce Karsh noted its real estate group was “very focused on realizations,” particularly with its 2011-vintage fund, Oaktree Real Estate Opportunities Fund V. 

Over the past few quarters, the spread between the acquisitions and dispositions activity of the top 10 PERE 50 firms has narrowed considerably, according to data provider Real Capital Analytics. The PERE 50 consists of the largest private equity real estate firms by non-core equity raised in the last five years.Whereas acquisitions were $16.65 billion and dispositions $4.41 billion during Q1, they were $4.54 billion and $5.03 billion, respectively, during Q2 and $5.8 billion and $4.6 billion during Q3, according to RCA.

In fact, managers such as Blackstone, Rockpoint Group and Westbrook Partners were net sellers during the period. The majority of the top 10 firms, however, declined to not only provide investment numbers, but to even identify themselves as net buyers or net sellers. 

On the one hand, “a lot of people like to say that they’re net sellers, even though it’s not really true,” said one top 10 firm. After all, investors in funds that are in harvesting mode want to hear that their managers are actively selling. However, that doesn’t necessarily imply the firms are actually net sellers, since they may also be actively buying assets as well, the person said.

On the other hand, some managers do not want to be identified as net sellers because it could potentially raise concerns among investors or prospective investors in funds that are being marketed or invested. An elevated level of dispositions could be misinterpreted as a lack of good buying opportunities in the market, the manager said.

One driver of increased selling activity is the late-stage real estate cycle, according to Jim Costello, senior vice-president at RCA. 

“You’ve achieved the strongest appreciation gains you’ll likely see,” Costello said. “The incentive becomes to return capital and deliver what you promised, since nobody talks about cap rates going down any further. They’re already well below historical norms in many cases.”

However, Ken Caplan, chief investment officer of Blackstone’s real estate business, asserted that the firm’s robust disposition activity was not linked to any kind of market timing. “We’ve been selling, we’ve had some significant dispositions as well. But it’s not because we see some end of the cycle, or some bubble period,” he said. “We continue to invest as well.” 

Indeed, despite $56 billion of realizations over the past 11 quarters, Blackstone’s real estate assets under management were up nearly 30 percent over that same period, Chae noted during the firm’s earnings call.

Instead, the dispositions have largely been the result of strong investor demand for real estate in a low-yield environment, said Caplan. “If that demand wasn’t there and we weren’t able to realize value, you would probably not see as high a level of disposition activity from us.”

Ralph Rosenberg, global head of real estate at KKR, agreed. “It’s difficult to be a market timer in real estate, given that it takes time to create asset-level income improvements and it takes time to sell assets. Furthermore, it is a tough strategy to be selling in anticipation of expecting a major market correction,” since it is difficult to predict when exactly a correction would occur, if one were to occur at all, he said.

“Before the crisis, real estate was considered an inflation hedge for many buyers. Now, it’s perceived as a fixed-income substitute. Sellers of assets in this market are satisfying the demand for yield, fueled by these fixed-income substitute buyers. Their lower cost of capital is the main reason why value-add and opportunistic managers have engaged in so much realization activity in real estate, not because of concerns about a market crash.”

In some cases, firms also have been exiting earlier than anticipated. “We’re selling way earlier than we’ve projected,” said one top 10 manager that has been an aggressive seller in recent years. 

“That’s a phenomenon that’s been going on for few years. We typically underwrite for a five-year hold. We’ve sold in two to three years, sometimes less.”

Tougher investment environment

But while some are actively selling, many of these firms also are still investing, albeit in a more constrained real estate environment. Overall, net investment volume among the top 10 PERE 50 firms was $11.9 billion in 2016 through the third quarter, down from $24.4 billion for all of 2015, according to RCA.

“It’s harder to find attractive deals, so our activity is lower than it has been,” said one top 10 manager.
“It’s because there’s so many crazy buyers out there. A lot of people are making bets on cap rates and fundamentals and growth and rental rates that we’re just not willing to make.”

Meanwhile, Blackstone has been much more targeted with its real estate investing, focusing on investments where it has a competitive advantage, such as deals with scale and complexity. It also has invested to capitalize on emerging workplace or employment trends, such as its $8 billion acquisition of BioMed Realty Trust, a US medical office owner, in January. 

For its part, KKR has continued to pursue its strategy of ‘buying complexity and selling simplicity.’ For example, in May, the firm, along with partner Madison Capital, acquired the Sullivan Center, an office and retail property in Chicago, for $267 million. It was considered a complicated deal because of various challenges associated with the asset, including the legal woes of one of the co-owners, its split ownership, a major tenant in arrears, and historic tax credits that placed restrictions on how the property could potentially be divided. 

The deal was renegotiated to allow 100 percent of the building to be sold to KKR and Madison and for a retail condominium, which was already occupied by Target, to be created and sold to Acadia Realty Trust two months later. “We created the office portion of the asset at a very attractive basis,” Rosenberg said.

“It’s a tougher investment environment today,” said Caplan. “There’s still areas where we continue to see outsized growth and opportunities, but it’s not a time where we can just buy the index and expect to see the same type of value.”