The year of opportunity

Along with champagne toasts at midnight, rum-soaked cakes studded with dried fruit and halls decked with boughs of holly, December brings with it another inevitable end-of-theyear tradition: that last refuge of film critics and late night talk show hosts known as the top 10 list.

Yet sometimes tradition needs to be upheld, especially at the end of this, PERE's first year of publication. And what a year it was.

Across almost every aspect of the private equity real estate industry, 2005 saw a level of activity nearly unparalleled in recent memory. On the fundraising trail, highyield fund managers have raised more than $35 billion of new capital; in Germany, Terra Firma acquired the Viterra housing portfolio for approximately €7 billion, one of the largest private equity real estate transactions ever; and in sectors that blur the line between operating companies and property assets—hospitality and retail to name but two — some of the industry's most significant acquisitions and exits have been taking place.

PERE's top 10 stories of 2005:

1) A war chest on the fundraising trail

2) Hospitality returns

3) Abbey's big disposal

4) Clubbing up for Heritage Fields

5) REITs take center stage

6) The battle for Seibu

7) Viterra finds a home

8) Funds hone in on Asia

9) Trump headlines West Side story

10) A retail shopping spree

Trying to pick only tenitems out of such a frenetic and dynamic 365-day period is neither a simple, nor entirely objective, task. Some of the stories were chosen for their prominence, be it the size of a particular deal or the actual firms or person-

alities involved, while other selections highlight a particular trend or development that shaped the course of the industry over the past 12 months; and some choices just seemed interesting to our editorial staff. Though we tried to include a range of stories that reflected the industry's breadth of geographies, property sectors and investment strategies, no doubt we excluded many important others.

In fact, the biggest story of the year may be one that we haven't covered. It is not a noteworthy deal or a well-documented trend, but rather the accumulation of all the stories that occurred not just this year, but in the fifteen or so prior, a development that has been gathering steam in recent years until finally coming to a head in 2005.

Simply put, the asset class is actually becoming an asset class.

Once a fringe investment strategy, private equity real estate has now become an accepted—and perhaps even necessary— part of an institutional investment portfolio. It is a term now found in the everyday language of pension funds, high-net worth individuals, MBA candidates and, yes, journalists. Today, it even has its own magazine.

It is certainly too early to offer an opinion on 2005's place in history, whether it will be seen as the peak of one of the industry's most remarkable bull runs or just another year in the industry's inexorable rise. Regardless, it seems that private equity real estate is here to stay. That's a development worth remembering—and one certainly worth toasting.

The war chest
Though general partners often equate raising capital with an unpleasant trip to the doctor's office, a more apt description for those who hit the fundraising trail in 2005 could have been a visit to the candy store.

Buoyed by investor interest in the asset class and a slate of mega-funds in the market, private equity real estate funds worldwide raised a staggering amount of capital—$37 billion in 2005. Though direct comparisons to previous surveys are difficult, Pension Consulting Alliance notes that opportunity funds closed on $17 billion of new capital in 2004 and approximately $11 billion in 2003.

While firms of all shapes and sizes were able to raise money last year, almost half of the fundraising totals—$18 billion—came from funds that closed on more than $1 billion. The largest vehicle raised in 2005 was Morgan Stanley Real Estate Fund V, which closed on $4.3 billion, approximately $2 billion larger than the firm's previous fund. Not to be outdone, investment banking rival Goldman Sachs raised approximately $3.2 billion for its latest Whitehall opportunity fund. And New York-based alternative investment firm Fortresswas able to raise $2 billion strictly for investments in the German residential sector.

With the exception of the Fortress vehicle above, many of the largest funds were raised with broad mandates, both in terms of sector focus and geography. Of all the dollars raised so far in 2005, approximately 40 percent were in vehicles that targeted more than one geographic region—and almost threequarters focused on more than one property sector.

Barring some shock to the real estate industry—not a far-off possibility—2006 looks to hold more of the same. At the end of November, funds either in the market or coming to market in the near future were targeting approximately $30 billion (see pg. 36). In today's environment, of course, the challenge is not raising money—it is finding profitable places to invest. Now that 2005 is coming to an end, private equity real estate funds have 37 billion reasons to start looking.

Checking back into hotels
Since 2000, the hospitality industry has taken a number of hits, including a recession in the US, the September 2001 terrorist attacks, the SARS outbreak in Asia and continuing armed conflict in the Middle East. But in the last twelve months, the industry has bounced back with a number of high-profile deals for landmark hotels, well known extendedstay chains and international hospitality portfolios. Players in the industry cited the improving fundamentals—as well as the return of business and pleasure travelers—as reasons for private equity real estate firms checking back into hotels, perhaps for an extended stay.

Many of the deals involved well known hotel brands and made headlines because of their size. This summer, Los Angeles-based Colony Capital announced the $1 billion acquisition of the Raffles portfolio, including its flagship luxury hotel in Singapore and the Swissotel chain. Colony also made a €1 billion investment in Paris-based Accor, a company that owns hotels under the Novotel, Sofitel and Red Roof Inn banners. Last spring, Starwood Capital acquired the troubled Le Meridien portfolio, a global collection of luxury hotels, in a deal with investment bank Lehman Brothers. The Greenwich, Connecticut-based firm also acquired a controlling stake in the French holding company Groupe Taittinger, owner of Société Du Louvre, Europe's second largest hotel network, for €1.2 billion.

There were plenty of other deals as well: JER Partners acquired economy extended-stay group Longhouse Hospitality; The Blackstone Group picked up the Rihga Royal hotel in New York City, the upscale hotel and resort group WyndhamInternational and the La Quintaextended stay chain; and HEI Hospitality purchased a Hilton hotel and convention center in Long Beach, California. But the frothy market in the US is making some players think twice. Outgoing Blackstonereal estate head John Kukral told a cable news station recently that the hotel play may be over.

Property in the UK
If Viterrawas the European residential prize of the year, then the Abbey National portfolio was its commercial equivalent— and one of the UK's largest transactions ever.

Abbey, the UK bank that was bought last year by Spain's Santander Central Hispano, announced plans to sell off 128 properties last April. The portfolio, which was owned by the bank's Scottish Mutual and Scottish Provident arms, contained over six million square feet of space in a range of commercial sectors all over the UK, as well as several landmark buildings in Edinburgh.

The portfolio seemed to attract initial bids from everyone who is anyone in the European private equity real estate industry: Morgan Stanley, GE Capital, Goldman Sachs, Morley Fund Management, Anglo Irish Bank and British property entrepreneur Vincent Tchenguiz were all linked to the deal. By the final round in July, the field had been whittled down to three: ING Real Estate, backed by JP Morgan; Prudential Property Investment Managers (PruPIM), with Royal Bank of Scotland and Goldman Sachs; and a consortium of Apollo Real Estate, REIT Asset Management, HBOS and two entrepreneurs.

ING eventually outlasted the field, with a bid understood to be around £1.2 billion—a bit lower than the £1.4 billion price tag suggested by earlier market rumors, but one that still represents a healthy above-average yield of 6.1 percent.

ING is planning to divide the portfolio between various clients and funds, and in November the firm raised £317 million through the flotation of an investment trust created to acquire 50 of Abbey's highest yielding properties.

Following the acquisition, Robert Houston, chief executive of ING Real Estate Investment Management (UK Funds) noted that “a portfolio of this magnitude and quality is unlikely to be available again in the near future”, perhaps explaining why so many firms were interested—and why two of them came back for seconds. A month after ING won the auction, the firm sold approximately £110 million and £90 million worth of properties to Morley and PruPIM, respectively.

The rest of the field, however, should not hold their breaths—ING has said it is not looking to sell off any more of the portfolio in the immediate future.

Heritage Fields forever
With more capital flowing into real estate, opportunistic investors were getting creative in 2005; abandoned factories, empty warehouses and worker dormitories were being seen less as eyesores and more as possible conversion projects. Decommissioned military bases could become an increasingly large part of that list, too, judging from one of the most interesting deals of the year.

In February, a consortium of private equity real estate investors won a military auction for the now-closed El Toro airfield in Irvine, California, which has been billed by some as one of the few remaining tracts of undeveloped land in Orange County. A diverse mix of investors that included Miami-based homebuilder Lennar; its former real estate financing arm LNR; Blackacre, the real estate arm of Cerberus; private equity real estate firm Rockpoint Group; and Michael Dell's MSD Capital all lined up $649.5 million in equity for the $1 billion deal. Coinvestment partners such as the Oregon Public Employees Retirement Fund, the California Public Employees Retirement Fund and the New York State Common Retirement Fund joined in as well.

The 3,178-acre base, known as Heritage Fields, will be converted to a mix of residential and commercial real estate, with 3,400 homes, 2.6 million square feet of commercial and industrial space, a college campus and a large public park for the city of Irvine.

The El Toro deal came on the eve of the latest round of Base Realignment and Closure Committee (BRAC) recommendations from the Pentagon. The BRAC list sailed through the US Congress this fall with limited opposition, shuttering or repositioning hundreds of installations and bases throughout the country, including the closure of 22 major facilities. Several of the larger properties, including Air Forces bases in New Mexico and South Dakota, a shipyard in Kittery, Maine and a submarine base in Groton, Connecticut, were spared, but a number of bases in hot real estate markets made the final list, such as a Navy base in Concord, California, Fort McPherson in Atlanta and Fort Monmouth in suburban New Jersey.

The REIT stuff
This one is perhaps cheating since it hasn't, strictly speaking, happened yet; but if there was one story this year with the potential to transform the European property market, it was the proposed introduction of REITs in Europe's two biggest real estate markets.

Real Estate Investment Trusts, tax efficient listed vehicles that enable retail investors to increase their property exposure without the expense and inconvenience of buying a building, were first introduced in the US in the 1960s. Although some European countries have had their own version for years—the Netherlands, for example, first introduced them in 1969—the old world has generally lagged behind. Despite the fact that the continent's GDP is comparable to that of the US, 50 percent of REITs globally by market cap are in North America and only 20 percent in Europe.

This could all change if proposals for German and British versions of the REIT pass next year. In Germany there was some concern that the recent election result, which has seen the two major parties forced into an uneasy coalition despite their differing economic priorities, could derail the process. However, the parties have agreed that REITs are vital to provide capital for the country's moribund property market, and are hoping to see them in place by early 2007. Norbert Walter, the chief economist of Deutsche Bank Group, has suggested that the market cap of German REITs could reach €100 billion in five years, doubling the size of the European market.

In the UK, the Treasury, led by Chancellor Gordon Brown, put out a discussion paper on the subject of REITs alongside its budget last March, asking for feedback from the property industry. No final decision has yet been made—some reports have cited a Treasury spokesman who has warned that the proposal could be dropped at any moment—but the government has said it is hoping to introduce them by May 2006.

If both proposals pass the new REITs could significantly alter the European private equity real estate business by providing large pools of capital, co-investors—and an important exit route.

Distressed and diversified
Time could be running out for the distressed deal in Japan, as transactions in the country's real estate market increasingly become strategy plays. But the Seibu Railway Company deal—one of this year's most-watched corporate takeovers— proved that the Japanese distressed sector might still be a source for opportunistic investors.

Seibu, a diverse Japanese conglomerate in the old-school sense, was pursued by a number of suitors after announcing plans to seek outside investors. The search for third party capital began last year, following charges of alleged fraud that surfaced against former head Yoshiaki Tsutsumi. He was convicted this fall.

The company is known for its suburban Tokyo commuter railroad, as well as a rail-freight service, a limo company and a bus concern. It also has a number of real estate assets including hotels under the Prince banner, ski resorts and golf courses, as well as the Toshimaen theme park, waterslide and onsen in suburban Tokyo. Yet the company's most notable asset may be the Seibu Lions, a professional baseball team, which Seibu's new head called “the group's symbol” earlier this year.

In November, New York-based hedge fund Cerberus Capital Management ended up taking a 30 percent stake in the company for ¥94 billion ($800 million; €681 million); Japanese group Nikko Principal Investment put up another ¥47 million for a 15 percent share. The two firms, however, are still fighting off a $4.8 billion counteroffer from Tsutsumi's two brothers for 100 percent control of the company.

The deal came at a time of renewed interest in Japan. This year, Aetos Capital, which closed its second Asian opportunity fund on more than $2 billion, entered into a deal to acquire a stake in the unprofitable resort and hotel assets of Matsushita Investment and Development, the real estate are of Matsushita Electric Industrial Group. Colony Capital also announced plans to focus on the country's real estate sector, while private equity firm Lone Star and investment bank Goldman Sachs both plan to publicly list their Japanese golf course portfolios in the near future.

Hands across Deutschland
Even those Americans or Australians with more interest in Florida or Shanghai than in Europe can't have failed to notice this deal. This year—any year, in fact—Viterra was the big one. The €7 billion acquisition wasn't just a sizable property deal: it was the largest private equity deal Europe has ever seen.

Cleaning up balance sheets and refocusing on their core business through the sale of residential real estate portfolios has been highly fashionable among Germany's corporations and municipalities for some time. The utility E.on joined the bandwagon in the summer of 2004 by inviting bids for its real estate arm Viterra, which owned a portfolio of 150,000 apartments covering almost every major German city. Analysts estimated its value at roughly €6 billion.

E.on, experienced in the M&A process through the sale of other subsidiaries such as metering unit Ruhrgas, decided to run a dual-track exit process. As well as inviting wholesale bids for Viterra, it also let it be known that an IPO of the housing giant was another possibility. The company also allowed an unusually long auction process in order to give bidders sufficient time to understand the portfolio's full value. As one banker who worked on the deal put it, “E.on has been selling a lot of things recently, and they've got very, very good at it.”

Thus it was more than a year before groups such as Fortress, Whitehall and Cerberuswent away empty handed, and Deutsche Annington, a property company owned by London buyout shop Terra Firma, emerged victorious. The €7 billion price tag caused more than a little shock—rumors abounded that the buyer felt it had overpaid and was attempting to renegotiate.

But Terra Firma, led by Guy Hands, claim to be happy — and have slyly pointed out that, on a per square meter basis, Viterrawas far from the most expensive German residential deal of recent years. Now they can only hope that their eventual exit price will also exceed the dreams of analysts.

Far-Eastern ambitionsFunds closed in 2005 focused solely on Asia

Fund	Strategy	Fund size ($ m)
Aetos Capital Asia II	Japan diversified	$2,200
AMB Japan Fund I	Japan industrial	$560
CapitaLand China Development	China diversified	$400
CapitaRetail Japan Fund	Japan retail	$412
CarlyleAsia RE Partners	Asia diversified	$410
Charter Hall Opportunity Fund IV	Australia diversified	A$165
HDFC Property Fund	India diversified	$230
La Salle Asia Opportunity Fund II	Asia diversified	$1,000
ProLogis Japan Properties Fund II	Japan logistics	$750
Primary RE Advisors Fund I	India diversified	$30
Total		$6,117

West Side story
It had all the elements of a great drama: one of the largest land deals ever in America's most expensive residential market; a price tag of $1.8 billion; two of the most well-known names in the real estate industry; a private equity firm linked to former heads of state; and, of course, lawsuits, controversy and acrimony.

When Washington, DC-based private equity firm The Carlyle Group acquired a tract of land and three apartment buildings on the West Side of Manhattan earlier this summer, the deal was notable not only for its size, but also for its participants. On the side of the sellers was real estate developer and TV personality Donald Trump, whose original vision for the property included a 152-story building. Sharing top billing with The Donald were his partners, a consortium of Hong Kong investors that included Vincent Lo, star of “The Winner”, the Chinese version of Trump's hit reality show, “The Apprentice”.

The lineup of the buyers was equally, if not more, impressive. Though The CarlyleGroup once employed former British prime minister John Major and former US president George HW Bush as senior advisors, even Carlyle's reputation may have been overshadowed by the presence of Sam Zell, one of the fathers of the private equity real estate industry. Upon the closing of the initial transaction, Equity Residential, the residential REIT founded by the legendary real estate investor, purchased the three existing buildings for $809 million.

Even for an industry notable for its outsized personalities, this was an exceptional cast of characters—and then, naturally, the plot thickened.

Less than a month after the sale was made public, Trump sued his business partners, claiming that the sale price was well below what others, including Colony Capital, were willing to pay. Things didn't end happily for The Donald, however—not only did he lose the case, but the terms of his original agreement forced Trump to roll his proceeds from the New York deal into the $1 billion purchase of the Bank of America building in San Francisco.

Will there be a happy ending for Carlyle or Zell? Stay tuned for the final act.

Shopping for deals
Private equity firms tend to make investments in packs, from telecom companies and theater chains to telephone directories and regional airlines. Private equity real estate firms are also somewhat trend-sensitive and this year saw retail deals hit the big time, with some of the most well-known names in private equity taking down some of the biggest names in US shopping, including Toys ‘R’ Us, Neiman Marcus, Brookstone, ShopKo and Mervyn's. The dual-nature of the typical chain store, which combines a retail operating business with real estate, led to a number of club deals, bringing private equity firms together with real estate opportunity funds and investment trusts.

For example, buyout shops Kohlberg Kravis Roberts and Bain Capital paired up with New York-based REIT Vornado Realty Trust on the $7 billion acquisition of toy retailer Toys ‘R’ Us, reportedly with the intention of selling off some of the company's real estate. Equally impressive was the $5.1 billion acquisition of high-end retailer Neiman Marcus by private equity firms Texas Pacific Group and Warburg Pincus.

And in 2005, it wasn't just retail operating companies that were drawing interest. Buyers were looking at sale-leasebacks of retail properties as well. This fall, Developers Diversified Realty and Macquarie Bank subsidy Macquarie DDR Trust, both REITs, announced plans to acquire almost $400 million worth of real estate from the retailer Mervyn's; under the terms of the deal, the trusts will lease the 2.7 million square feet of space back to the company, which was acquired by Cerberus, Lubert-Adler and Sun Capital Partners in 2004.

Interest in the sector could continue beyond 2005. When department store Saks recently sold its Northern department store chain to retail group Bon-Ton Stores, the circling private equity players were reportedly turned off by the fact that Saks' mid-range group leases much of their space. By contrast, its high-end department store, Saks Fifth Avenue, owns most of its property—those stores are expected to be on the auction block as soon as next year.