The deal hunter

When Doughty Hanson launched its real estate investing arm in 1999, it had a bit of help given the firm's long-established European buyout business. With offices already set up in Stockholm, Frankfurt and Milan, real estate head John Howard says it is no coincidence that Doughty Hanson's first property fund focused on Middle Europe. It was a good place to start.

Sitting in Doughty Hanson's office on London's fashionable Pall Mall—which affords a view of St. James's Park, the Tower of London and a grey London sky—Howard takes a moment to talk about the early days of his firm's private equity real estate foray.

“We were certainly early,” Howard says of the first fund and its focus on European real estate. “We were certainly one of the biggest.”

Closing on $630 million (€521 million) in equity in September 1999, Doughty Hanson Real Estate Fund I looked at all manner of transactions—from speculative development to value-add deals—in Central Europe, Scandinavia, Germany and Italy. But, like the fund's investment philosophy itself, the geographic and sector focus evolved over time, in response to market fundamentals. During a conversation with Howard, the concept of flexibility came up time and time again: flexibility to deal with changing markets, flexibility to deal with changing fundamentals and flexibility to deal with changing staff.

The firm is currently raising its second opportunity fund— and the first one following the high-profile departure of co-founder Mark Mogull, which was announced in 2004. The loss of Mogull, who was highly regarded in the industry, has raised questions among some market participants about the future direction of Doughty Hanson's real estate franchise.

“Turnaround of a team is always a sensitive issue,” Howard says. “There are always transition issues from one fund to the next. Does the strategy change? Does the team change? Does the size of the fund change?”

But, like the flexibility and evolution found in its investment strategy, the changes in the firm's management do not seem to dissuade Howard, who says the majority of the real estate team is continuing on with the next fund.

“It may be my background as an architect, but I take very seriously the fiduciary responsibility,” he says. “If you take money from someone to invest, I feel you have an obligation to finish the task. And we're doing that pretty well.”

As Doughty Hanson moves forward in the post-Mogull era, it plans to expand to new markets in Western Europe and build upon the platforms developed in the firm's successful first fund, which jumped from shopping malls in Finland and Sweden, to Italian residential and office plays, to London office buildings. As Howard himself makes clear, a lot of it comes down to being open to change.

ARCHITECTURALLY SPEAKING
Howard has seen change of his own throughout his life. He evokes the setting of Michael Cimino's 1978 film The Deerhunter when discussing the corner of Western Pennsylvania where he grew up. In fact, his grandfather, the head of the local Slovak Community Center, owned a tavern not unlike the watering hole frequented by the film's protagonists. But Howard was destined for other things—he eventually ended up in Northern Indiana where he studied architecture at the University of Notre Dame.

“In architecture, I was always more interested in the economics of the buildings, rather than the art of the building,” Howard explains. It was perhaps fortunate: as Howard began his career in the late 1970s, inflation and high interest rates meant that new construction was one of the furthest things from the minds of many real estate professionals. Howard went back to school, completing his MBA at the University of Chicago with an eye toward combining business with his undergraduate background.

Despite a number of opportunities at banks in Chicago, Howard took an offer at an Atlanta architecture firm. The firm was less interested in developing new buildings, so Howard got a crash course in adaptive re-use; for his first project, he helped turn a former hospital into a research center for home products company SC Johnson. The building was adjacent to one designed by Frank Lloyd Wright—something not lost on a student of architecture.

At the firm, Howard continued to work on re-use projects— turning former train stations into shopping centers, for example, before working alongside mall developer The Rouse Company on Underground Atlanta, the famous underground retail and entertainment complex built beneath a series of viaducts in the city's central business district. Howard became the design manager on the renovation, an experience that proved to be valuable.

“Anything I ever could have wanted to learn about planning retail, I learned [on that project],” he says.

Howard returned to Chicago and ended up working for architecture and development firm A. Epstein and Sons International. Though he was still working on the development side of real estate, Howard says he was more attracted to the last word in the firm's name. Ever since he had spent a college year abroad in Rome—the first major city he had ever lived in—Howard had been interested in working in the international arena.

Epstein afforded him the chance to do just that. He successfully completed a large-scale project in Japan, which led to another opportunity in Poland. A collaboration with development and investment firm Golub and Company turned into a position as the managing director for GE Capital Golub Europe—the position that led to Doughty Hanson in 1998 when the firm established its real estate platform.

“That's a long way to get from architecture to development,” he says of his career trajectory. “It's been a logical progression of applying experience to take the next step. What brought me to Doughty Hanson was really a need—because I had been trying to develop projects in Central Europe. I was trying to source money and deals, and it seemed like I could rarely get them both together at the same time.”

A LIVING CONSTITUTION
While Howard came from Golub's European operation, Mogull joined Doughty Hanson from the European Bank of Reconstruction and Development, which was one of the only places for private equity real estate funds to get capital commitments in the early days.

The strong bench of real estate talent was supplemented by the strong name recognition of its parent. The legacy of Nigel Doughty and Richard Hanson's buyout firm has helped the real estate operation over its six-year history, but its influence was particularly felt when the real estate fund first set out to carve its own niche.

“Certainly at the start of the business, we relied—as a first-time fund—on the Doughty Hanson franchise,” Howard says. “The firm's 20-year track record of top-quartile investing provided a global view and institutional discipline that a team of real estate entrepreneurs could learn from.”

Yet the real estate arm quickly developed its own philosophy towards investing in Europe, combining the team's own experience on the continent's emerging markets with Doughty Hanson's regional expertise and local offices.

“Turnaround of a team is always a sensitive issue. There are always transition issues from one fund to the next.”

“The philosophy was—and continues to be—about creation of value and active management,” he says.

Doughty Hanson was also able to tap into the network established by the firm's buyout arm and, starting with this base, the real estate arm has expanded to it's current roster of eight offices—London, Stockholm, Milan, Frankfurt, Paris, Luxembourg, Munich and an affiliate in Prague. It plans to open an office in Madrid this year.

“We've adopted a broad strategy for Europe, so that we can fine-tune that strategy for specific country markets at various times in the real estate cycle,” Howard says.

“You need a team to be based locally, not just have a post box,” he adds. “If you aren't local—when you're based in London, Paris or New York and you're flying in and out of markets—it's hard to get off-market deals. You tend to get the low hanging fruit.”

“You need a team to be based locally, not just have a post box.”

Perhaps most indicative of the group's comprehensive approach to Europe is the fact that it only recently established its presence in Paris last year, with the appointment of real estate professional Lahlou Khélifi. Though Paris is oftentimes viewed as a private equity firm's first step into continental Europe, with Doughty Hanson's extensive built-in network of offices around the continent, an office on the Seine almost seemed like an afterthought.

GEOGRAPHY LESSONS
While the first fund modeled its geographic mandate on the offices of Doughty Hanson's buyout operation—focusing on investments in Scandinavia, Germany, Italy and Central Europe—it soon found it best to allow for flexibility in order to evolve and respond to changing market fundamentals. As the German market went south, for example, the fund began looking at other countries. Limited partners agreed that the firm's home market— the UK—would be acceptable to add to the investment remit; the first fund completed two transactions on its home shores

“When everyone else is moving East, we're moving West.”

The revision in strategy paid off with scores like the ITN building in London. Doughty Hanson acquired the former London Times building on Gray's Inn Road near London's Fleet Street, home to television and journalism groups like Independent Television News, London Weekend Television and ITV, in April 2001. Before selling it in 2005 to Catalyst Capital for £112 million— and chalking up a 38 percent return—the fund instituted a £3.5 capital improvement program and increased rental income by 18 percent.

The first fund also made inroads throughout Europe. In 2004, it completed its first real estate investment in Finland in what was believed to be the largest cross-border transaction in the country. Purchased from Ilmarinen Mutual Pension Insurance Company, the eight retail properties in the transaction were largely based in Helsinki-area shopping centers like Iso Omena, Kluuvi, Myyrmanni and Megahertsi. In January, the firm sold two of the properties to a Finnish real estate company.

Howard contends that the firm's local focus led to its success in the deal—in addition to the fact that, as an institutional investor, Ilmarinen might have been familiar with the Doughty Hanson name.

“Having an office in Stockholm—having already acquired three shopping centers in Sweden—and working in Denmark, we were perceived as a local player by the seller,” he says. “We went in with not just our money, but solutions to the seller's concerns—[rather than] just the largest price.” Ilmarinen was interested in keeping a minority position in the properties after the sale—something Doughty Hanson was willing to offer the pension.

In addition to establishing a local presence throughout Europe, Howard estimates that more than 11 of the fund's 21 deals were what he considers solutions-based deals—transactions where the firm was responding to some sort of real estate problem faced by a seller, be it tax issues, a need to dispose of properties, balance sheet issues, contamination problems, fixing physical inadequacies or accommodating an expanding business. For example, the firm built a Milan headquarters for L'Oréal Italia in its first fund, while also helping another Italian firm with the disposition of properties acquired over 100 years of mergers and acquisitions.

DOUGHTY HAN SON & COMPANY