Over the summer, Thomas Barrack – billionaire real estate magnate and friend to US president Donald Trump – chose his successor as chief executive of Colony Capital, the Los Angeles-based global real estate investment manager he founded 28 years ago.

His pick was Marc Ganzi, a telecom mogul and polo player who had a brief stint as a real estate developer in the 1990s. The appointment was announced at the same time as Colony’s $325 million acquisition of Ganzi’s firm, Digital Bridge, a Boca Raton, Florida-based digital infrastructure owner and manager.

In an August earnings call, Barrack summed up both moves as follows: “We’re going to simplify the business. We are going to turn to digital.”

He added: “We see more growth and more total return in the data and digital business… And that’s what we’re going to point all of our silos towards as we move out of those businesses in which we don’t have an edge and which we can’t scale. We want to be the top three or four in every business that we’re in.”

The strategy – which Barrack has called “the most compelling investment opportunity we see today” – has represented Colony’s biggest fundraising success to date, having closed a vehicle for it on $4.05 billion in May. Digital Colony Partners is a digital infrastructure fund focused on investments in macro towers; small, cell-distributed antenna systems; and data centers and fiber. The fund, in which Colony and Digital Bridge were joint venture partners, had an original $3 billion target.

Colony managed to pull off the fundraise during a period of corporate turmoil for the firm, resulting from a three-way merger with NorthStar Realty Finance and NorthStar Asset Management in 2017, a deal Barrack himself has called “a nightmare.” The past year alone was marked by four consecutive quarters of losses, a stock price remaining at near-historic lows, the firing of longtime chief executive Richard Saltzman and plans to cut its global workforce by 15 percent. Meanwhile, Barrack has come under increasing scrutiny for both his relationship with Trump and longstanding business ties in the Middle East.

PERE spoke with a dozen sources – half of which were investors and consultants – to learn how Colony has been able to raise billions of dollars, even during turbulent times and despite prior high-profile mistakes.

Executives familiar with Colony’s fundraising, say Colony’s ability to achieve a successful fundraise with Digital Colony Partners, in spite of the negative headlines, was due to Digital Bridge’s involvement with the fund. “Digital Colony investors were less concerned about Colony because Colony wasn’t the whole show,” says one executive. “So, you’re not really fully relying on Colony and therefore the turmoil was not as important.”

According to minutes from the South Carolina Retirement System’s April 2018 investment commission meeting, Digital Bridge will be primarily responsible for investment management for the fund, while Colony assisted with fundraising and will provide back-office functions such as compliance.

And although Colony and Digital Bridge did not announce the final close of Digital Colony Partners until June, the capital was already raised as of last fall – prior to the firm going public with the news of its corporate restructuring.

During the firm’s third-quarter 2018 earnings call last November, Barrack revealed $3.75 billion of outside capital had been raised alongside the firm’s own $250 million general partner commitment. It was during this same earnings call that the firm announced Saltzman’s departure, other senior management reshuffling and the staffing cuts.

Colony’s previous pivot

Following the success of Digital Colony Partners, Colony is now on its latest fundraise, Colony Distressed Credit Fund V, which reportedly has a $1.5 billion target. To date, the fund has attracted $428 million in a first close, including a $121 million GP co-investment.

Just as digital infrastructure represents a new pivot for Colony today, real estate debt also represented a strategic shift for the firm when it launched its new business in 2008, having previously focused on real estate equity strategies. After the global financial crisis, Colony stopped raising opportunistic real estate funds and credit became its main fundraising focus.

Colony’s first three real estate credit funds all met, or exceeded, their target sizes, according to PERE data: CDCF I, a 2008-vintage fund, closed at its $885 million target; while CDCF II drew in $780 million against a $750 million equity goal; and CDCF III attracted $1.2 billion in equity, exceeding a $1 billion target. While the firm collected $1.3 billion for CDCF IV, the capital raise fell short of the $2.5 billion targeted.

To date, the funds have performed in line with the firm’s expectations. “The CDCF series, with $5 billion of capital commitments across 117 transactions, has been remarkably consistent and the series have 17 percent realized gross IRRs for 67 realized investments,” a company spokesperson tells PERE. CDCF III, for example, had target gross returns of greater than 15 percent, according to a memorandum from consultant Wurts Associates to the Fresno County Employees’ Retirement Association.

CDCF II, a 2011-vintage fund, was generating a multiple of 1.44x and net internal rate of return of 10 percent as of September 30, 2018, according to a performance summary from the Florida State Board of Administration. Meanwhile, the 2015-vintage CDCF IV was generating a 1.12x total value paid-in multiple and net IRR of 8.8 percent, the report showed. However, PERE understands both CDCF III and CDCF IV are not fully divested. Only 20 percent of CDCF IV’s capital, for example, has been returned to investors to date.

And yet, despite the funds’ solid performance, re-ups have accounted for only 50-60 percent of the overall capital raised in the CDCF series, according to two sources close to Colony. Repeat investors in the series included the Florida State Board of Administration, the Teacher Retirement System of Louisiana and FCERA.

Some investors did not re-up because of changes that Colony made to its fund series. About half of CDCF investors were unhappy when Colony ceased to continue its dollar-for-dollar matching as a GP co-investor via its publicly traded subsidiary, Colony Financial, after Colony Capital was rolled up into Colony Financial and became a public company. Instead, the firm made a $200 million commitment to CDCF IV, or 19 percent of the fund’s total capital. “Investors are very frigid when you change a deal, and between CDCF III and CDCF IV, there was a change in the deal because there was no matching anymore,” a fundraising source says.

Others have not returned for reasons unrelated to Colony. One CDCF LP tells PERE it is not investing in CDCF V because it is no longer making fund commitments. Another non-re-upping CDCF LP, meanwhile, believes real estate credit is a less compelling opportunity than it once was: “It’s a much more difficult market, and so many managers have jumped on the bandwagon.”

Indeed, competition in real estate debt funds has increased considerably since Colony launched the CDCF series. In 2013, there were 62 real estate debt funds focused on loan originations in market, but as of H1 2019, the number had risen to 190, according to PERE data.

While many existing investors returned with CDCF IV, some had capped their allocations to real estate. “The re-ups in terms of the number of investors was good, but the capital from the re-ups was actually lower than anticipated,” says one person familiar with Colony fundraising.

With that fund, Colony ramped up its capital raising from high-net-worth investors through the wealth management divisions of four investment banks in Europe and the US. While high-net-worth investor capital accounted for less than 5 percent of the capital in Colony Investors VII and VIII, it represented 20 percent of the equity in CDCF III and 40 percent of CDCF IV, according to the source.

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Lack of investor overlap

Other top real estate managers have also sought to raise capital from high-net-worth investors, primarily to diversify their LP bases, including Blackstone, Brookfield and Starwood. However, Colony lost the support of many institutional investors – particularly US public pension plans – after Colony Investors VIII, its worst-performing fund, imploded after a series of failed deals in the wake of the global financial crisis.

PERE’s database lists 34 investors that publicly disclosed commitments to the vehicle, and of those institutions, only one, the Teacher Retirement System of Texas, continued to invest with Colony after Colony Investors VIII. However, PERE’s database is limited primarily to investors that make public investments disclosures, and Colony VIII had a total of 92 limited partners, according to a company spokesperson, indicating others might have made repeat commitments.

The 2007-vintage fund was producing a total value to paid (TVPI) multiple of 0.45x and a net IRR of -11.5 percent and a time weighted since-inception net return of -31.8 percent as of September 2018, according to a portfolio review from the San Diego Employees Retirement System.

In the review, SDCERS consultant Townsend Group noted the “returns for Colony Investors VIII were impacted by its peak 2007 vintage year,” and adds that funds formed in 2006 and 2007 “are not expected to meet their target returns.” Nonetheless, Colony Investors VIII performed worse than the other 2007 funds in SDCERS’ portfolio, which had an average TVPI of 0.86x and a net IRR of -3.1 percent.

The investor turnover has continued today, as the vast majority of existing Colony LPs in PERE’s database did not back Digital Colony Partners. Of the five limited partners that have publicly disclosed commitments to the fund – Oregon State Treasury, PensionDanmark, South Carolina Retirement System, Employees Retirement System of Texas and Teacher Retirement System of Texas – only Texas TRS was a returning investor, according to PERE research. Saudi Arabia’s Public Investment Fund, meanwhile, is also reportedly a first-time investor in the fund. All of the above investors declined to comment on why they backed Colony.

Colony declined to provide what percentage of Digital Colony Partners’ equity came from existing versus new investors, but PERE understands that several of the largest Colony VIII investors did indeed anchor the vehicle.

However, other investors and consultants tell PERE there were multiple reasons why they stopped backing, or chose not to back, Colony. Aside from performance, a major issue was the firm’s perceived misalignment with investors. One LP in the Colony Investors fund series alleges the firm made more in fees than it did in profits: “It’s not a well-aligned firm that has done right by investors.”

For example, one failed Colony Investors VIII deal was the firm’s $1.5 billion recapitalization of Meadowlands Xanadu, a large retail and entertainment development in New Jersey, in 2006. The project was taken over by creditors four years later, however, after Lehman Brothers, Xanadu’s construction lender, went bankrupt and Colony was unable to secure replacement financing. Colony was charging full fees on committed capital, even though the firm had significantly written down the investment, according to the LP. Other managers, by contrast, had reduced fees on written down investments.

A Colony spokesperson disputes this claim: “Colony has consistently adhered to the fees and terms of the LP agreements and has worked with LPs to provide concessions when appropriate. Significant fee concessions were made in Colony VIII.”

A consultant familiar with Colony funds, however, agrees with the Colony Investors LP: “It is an organization that is designed more to enrich the executives rather than put in the right fiduciary structure for their investors.”

He points to the mismatch between the company’s underperformance and the compensation that former executive vice-chairman David Hamamoto and other NorthStar executives received prior to leaving Colony in 2017 and early 2018. Hamamoto received $53 million in total compensation, while Al Tylis, Daniel Gilbert and Debra Hess were paid $31 million, $24 million and $9 million, respectively, in 2017, according to an April 2018 proxy statement. Meanwhile, Colony reported a $333 million net loss for full-year 2017.

Questions at the top

The lack of stability in the Colony senior leadership team – which was marked by departures of the NorthStar executives and Saltzman, as well as the appointments of a new CEO, president and chief financial officer in the past two years – has also been a concern, the consultant adds.

Governance issues are another principal reason the consultant has not endorsed Colony: “How the funds were run led to the poor performance of the funds…The investments that they made were too risky and designed to produce very high returns if the market did well without much consideration to downside risk.”

Some funds were heavily concentrated in deals that soured. With the 2007-vintage Europe-focused Colyzeo Investors II, for example, the firm’s investments in French hospitality company Accor and French retailer Carrefour accounted for more than 65 percent of the fund’s total equity, according to an investor in the fund. Accor ultimately generated “a negative to neutral” return for the fund, while the Carrefour transaction became a write-off, because of a combination of the listed company’s falling share prices and Colony’s non-controlling positions in the firms, the investor says.

Both companies were also investments in Colony Investors VIII, and together with the $9 billion public-to-private takeover of Station Casinos, accounted for more than half of that fund’s equity, according to a source familiar with the fund. Station Casinos declared bankruptcy in 2009, with Barrack calling the deal the “worst investment ever” in a 2015 interview with PERE.

Some also cite a lack of transparency. The Colony Investors LP says investors were not given sufficient time to ask questions during the firm’s annual meetings, while the consultant says some of Colony’s disclosures were less detailed than those of its listed peers. The Colzyeo Investors LP, however, presents a balanced view: “I’ve seen a lot worse, but I’ve seen much better… Some firms, when everything goes well, exude information, as soon as it turns, they go into their shell and you never hear from them. Colony at least has owned up to some of their cock-ups and have admitted mistakes.”

Yet investors accepted the transparency and alignment issues while Colony’s funds continued to perform well. “I think the behavior was always the same, but when your returns are good, people are willing to rationalize it and then once the returns started being terrible, the tolerance for that behavior was less,” the Colony Investors LP says.

Forgiving investors

The consultant questions why some investors have continued to give capital to Colony, given the firm’s challenges: “Why would investors be so forgiving for prior missteps in an environment where there are so many more pristine players with a better fiduciary structure in place?”

He acknowledges the firm has had a knack for identifying investment themes that are attracting capital and is skilled at launching products that fit. “Because of this heavy weight of capital, they have been generally able to attract capital,” he says. “In a bull market, people seem to forget past transgressions.”

One fundraising source recalls some investors that committed to the CDCF series were unfazed by Colony’s spotty track record, partly because of the firm’s brand recognition: “Investors on the credit fund responded to the Colony name with great enthusiasm. And this is despite some big hiccups and [the fact] that some investments went spectacularly wrong. The response from investors was unilaterally very, very positive, because Colony was recognized as thoughtful, imaginative and performing as a manager.”

The belief the firm managed poorly-performing investments better than some of its competitors also led some investors to continue investing with Colony, despite having previously lost money with the firm. “For Colyzeo II, some of the bad deals were offset by efforts from management, frankly for free, to get the equity back to investors, as opposed to forget it and move on, like some other investment managers have done,” the Colyzeo LP says. “So at least Colony tried to be as close to 1x as possible.”

Steve LeBlanc, former managing director of private market investments at the Teacher Retirement System of Texas, and now founding partner of Austin-based manager CapRidge Partners, holds a similar view: “As an investor, you must take risks. You have partners who invest capital for the pension plan. Not every investment is going to be a success. There’s going to be ups and downs and booms and busts. What you want is a partner who is direct, open, honest, will continue to work on bad deals as hard, if not harder, than they would on good deals; and who has a thought process – an investment thesis – that analyzes taking risk and getting paid to take that risk.”

LeBlanc says Colony, with which Texas TRS has invested for nearly two decades, communicated bad news early, was transparent and worked hard on solutions.  “That allows you to reinvest with them and have confidence in their future performance,” he says.

While LeBlanc declines to elaborate on Texas Teachers’ specific assessment of Colony, he sums up the pension plan’s general evaluation approach as follows: “They want partners over the long term… These are long-term investments and long-term relationships, so you’re not taking one quarter or one investment downturn and saying, you’re fired.”

Although LeBlanc’s experience investing with Colony contrasts with those of other former LPs, one of the executives familiar with the firm’s fundraising explains that not all investors were necessarily treated the same – those that were larger institutions and had longstanding relationships with the firm had “privileged access.”

The future of Colony

Having gone all-in on digital infrastructure, Colony sees the sector as the future of not only the firm, but of real estate.

“As our experiential world gives way to a new future – a data-driven world – real estate in its current format with long-dated contractual revenue streams from traditional tenants will have to change and adapt or face substantial obsolescence,” Barrack said in the firm’s Digital Bridge acquisition announcement. “In fact, location, location, location is giving way to connect, connect, connect. This pivot presents a new investable frontier across the globe for those who are armed with the proper resources and experience.”

Some Colony watchers have reacted positively to the firm’s strategic shift. “We believe the digitization of real estate is a secular growth trend. Hence, we view Colony’s initiatives in this space as promising,” wrote Jade Rahmani and Ryan Tomasello, research analysts at investment bank Keefe, Bruyette & Woods, in a July research note.

Colony has thus far shown itself to have a competitive advantage, having raised one of the first dedicated digital infrastructure funds, as well as having appointed an incoming chief executive who has been investing in the sector for 25 years. Meanwhile, the Digital Colony investment team has already deployed 44 percent of the fund’s equity less than a year into its investment period. An additional 10 percent of capital is expected to be invested by the end of the third quarter.

Despite Colony’s early mover status, however, competition is mounting in digital infrastructure, with firms GI Partners and SDC Capital having also launched or raised their debut funds targeting the strategy.

Meanwhile, Colony’s pivot to digital infrastructure is not expected to be a seamless transition. “Significant work is still needed across Colony’s disparate asset base (in many cases over a period of years), so the evolution of Colony’s new strategy will take time,” Rahmani and Tomasello wrote in their research note.

One executive close to Colony acknowledges this: “I’m under no illusions that this is a quick fix. This is something that is going to take time and there’s a lot of trust that has to be rebuilt.”

As it weathers a difficult period in its history, Colony is seeking to turn the page by changing both the direction of the firm and the composition of its team. But while the company may see digital infrastructure as a clean slate, many investors have not been so quick to forget the past.


The jet set

One example of how Colony is considered less transparent than some of its peers can be seen in how it makes some of its public disclosures

Colony is far from the only private equity real estate firm to use private aircraft for business purposes, or to also use that aircraft for personal reasons. The difference is in how such information is disclosed. Colony’s full disclosure appears in the firm’s latest proxy statement as follows. It makes no mention of business use, payments related to business use or use by other Colony executives:

“In January 2019, the Company, through its subsidiary, Colony Capital Advisors, LLC, has entered into an amended and restated time sharing agreement with Thomas J. Barrack, Jr., the Company’s Executive Chairman and Chief Executive Officer, under which Mr. Barrack may use the Company’s aircraft for personal travel. Under this arrangement, Mr. Barrack pays the Company for personal usage based on the incremental cost to the Company, including direct and indirect variable costs, but in no case more than the maximum reimbursement permitted by the Federal Aviation Regulations under the agreement. Mr. Barrack reimbursed the Company $0.7 million for personal flights taken during the year ended December 31, 2018.”

Colony Private JetBy contrast, Washington-based private equity firm The Carlyle Group specifies the payment amounts for business use and further broke down those amounts by executive, as shown in the excerpted disclosure below:

“In the normal course of business, our personnel have made use of aircraft owned by entities controlled by Messrs. Lee, Conway, D’Aniello, and Rubenstein. Messrs. Lee, Conway, D’Aniello, and Rubenstein paid for their purchases of the aircraft and bear all operating, personnel and maintenance costs associated with their operation for personal use. Payment by us for the business use of these aircraft by Messrs. Lee, Conway, D’Aniello, and Rubenstein and other of our personnel is made at market rates, which during 2018 totaled $844,028 for Mr. Lee, $9,008 for Mr. Conway, $167,550 for Mr. D’Aniello, and $613,800 for Mr. Rubenstein.”

Other firms, such as KKR, provide less detailed disclosure around private aircraft, but only use the planes for business purposes.

In response to a PERE inquiry on Colony Capital’s private aircraft disclosures, a company spokesman said: “No fund LP is ever billed for private air travel.”