Time is money

In the movie Field of Dreams, Kevin Costner's character hears the famous refrain: “If you build it, they will come.” When it comes to the types of underperforming property assets often acquired by opportunity funds, a more appropriate phrase may be: “If you improve it, they will come,” or, at the very least, come back.

When private equity real estate funds make an acquisition, the good ones will tell you that their wheels have likely been turning for months before they actually take possession of a property. Thus, once title is in hand, they are ready to hit the ground running.

Given the limited life of private equity real estate vehicles, such expediency is a requirement for achieving the highest returns possible. The famed buyout shop KKR set an industry standard by putting “100-day plans” in place for each of its portfolio companies—blueprints that outlined what major changes and operating strategies needed to be completed or implemented in the first three months post-acquisition. Many investors in the private equity and real estate arenas have followed suit. Time, after all, is money.

“In our world, the private equity business, time is our enemy.”

In the real estate world, some of the changes needed to overhaul a property can be small, relatively inexpensive and done almost immediately, such as replacing ineffective management or brightening up a building's public spaces. However, the heavy lifting can often take months or even years, depending on the asset, be it a luxury hotel in New York City or a retail center in Japan.

MODERNIZING MIDTOWN
When Blackstone acquired Manhattan's Rihga Royal hotel last year, the hotel needed new blood. Its furnishings were outdated, its appearance was tired and it lacked some of the amenities of other highend hotels in the area.

Yet despite its lackluster appearance, the hotel's potential was apparent, according to David Hirsh and Ken Caplan, managing directors in the private equity firm's real estate group who worked on the deal.

Blackstone acquired the 514-room Rihga for $183 million (€142 million) last March. Immediately upon acquisition, Blackstone began to move on a $75-million renovation of the property. Key elements of the new hotel included rebranding the property as The London NYC, a top-end luxury hotel, and bringing in noted designer David Collins and renowned British chef Gordon Ramsay, who will make his US debut at the property.

After the completion of the renovation, Blackstone anticipates that The London NYC will be squarely in competition with the upper echelon of hotels in Manhattan, including the Ritz Carlton, the Mandarin Oriental and the Peninsula.

“Given the bones of the hotel, it really was an attractive price,” says Caplan, who oversaw the acquisition of the 16-year-old Rihga, which is located in close proximity to the theater district in Midtown Manhattan.

Blackstone's investment represented more than $500,000 per room when measured by the number of rooms that were initially in service at the Rihga, according to Hirsh and Caplan. However, the firm expects to add about 50 rooms to the hotel's capacity, bringing the total rooms to 564 and the investment's cost “per key” down to almost half of replacement cost.

“To build this hotel today—you couldn't do it for less than $1 million per room,” says Hirsh, who oversees the management of the hotel and the renovation project. The pair noted that not only was the hotel in top physical condition, it also possessed a unique attribute: all the rooms were suites, each averaging 525 square feet, larger than others in the market. However, its aesthetics left something to be desired, primarily because the previous owner, who had intended to renovate the property, ran into financial problems when the bottom fell out of the New York City hotel market in 2001.

Until Blackstone took possession, the average rate at the Rihga was about $300 per night. In the upscale London NYC, the average rate is expected to stabilize around $500 per night, according to Hirsh and Caplan—about $200 less expensive than the typical five-star Manhattan hotels it will compete with, but above the rates charged by four-star properties.

“We're trying to fit into the sweet spot between the 4-star and 5-star competitors,” says Hirsh. “The London NYC will have location, service and a large guest room, immaculately fitted, at a price point a couple hundred bucks less per night than the top-end New York hotels.”

To overhaul the property, the firm brought in renowned designer David Collins to revamp the hotel's guest rooms and public spaces with a modern design. They also hired popular London chef Gordon Ramsay, who Blackstone has worked with on several of its hotel investments overseas, to make his American debut with the property's restaurant and bar.

In addition to raising the luxury quotient, Blackstone hopes that the choices of Collins and Ramsay, known for his edgy personality on his cooking show Hell's Kitchen, will create a property with a little bit more life than the typically staid luxury hotels in midtown.

“We're trying to create a five-star experience in midtown that has some elements of a downtown hotel,” says Hirsh. And, he adds, one that hopefully draws more business from the entertainment industry, as well as customers attracted to the hip hotels farther south. “The London NYC is very modern in its design and a little bit more edgy than you'd find in a typical five-star property.”

After bringing in the creative talent, the next step was to get the renovations done and get them done as fast as possible.

“In our world, the private equity business, time is our enemy so it's of paramount importance for us to get things done as quickly as possible,” says Hirsh. “But we can't compromise quality or execution for that.”

Blackstone began renovations on the property shortly after Christmas last year, approximately eight months after it took possession of the hotel. It expects to complete the work by the end of the year, with the exception of nine super-luxury suites that will occupy the top two floors and the hotel's fitness center. Those are expected to be finished next summer.

“We will have a fully renovated hotel approximately 20 months after we closed on the property, “says Hirsh. “In the grand scheme of things, when you're spending $75 million, it's hard to move much faster than that.”

With the renovations winding down and almost half the rooms complete, it was equally important to concentrate not just on the aesthetics of the building, but also on filling the hotel's rooms by spreading the message to potential customers.

“We have now begun to execute our marketing plan, to identify our new customers, and to try to bring them in to preview the project,” says Hirsh. To that end, marketing and PR staff went into overdrive, with articles about Ramsay's US debut, David Collins' design and the property's overhaul appearing in feature pages throughout New York.

But, as the transition approached, not everything was about stories in glossy magazines. With the overhaul nearly complete and London NYC's debut at hand, even the smallest details are important.

“The staff needed to be trained, for example,” says Hirsh. “The housekeeping staff needed to get used to the idiosyncrasies of the new rooms. The staff that is out in front of the customer— doormen, bellmen and front desk clerks—is being retrained to provide customer service levels consistent with the newly renovated London NYC.”

The hotel is scheduled to open for business as the re-branded London NYC on November 1, with Ramsay's restaurants due to open two weeks later.

TESTING JAPAN'S RETAIL WATERS
Sometimes, private equity real estate firm take possession of a specific hotel, office complex or shopping center and concentrate their efforts on turning around an individual site. Other times, investors hope to execute a similar plan across a larger collection of assets acquired at different times and in different places.

While moving quickly to update properties once they are acquired is key, the plan for what happens once ownership is transferred sometimes has its genesis weeks or months beforehand as private equity real estate firms craft their business plan.

In Japan, for example, The Carlyle Group identified neighborhood shopping centers as an attractive area for investment. Although these properties were fairly stable assets that provided good yield from rental income, they had yet to be proven as an attractive investment target based on liquidity.

To that end, Carlyle recently announced a joint venture with SOW, a Tokyo-based real estate consultancy and asset management firm, to acquire a portfolio of at least ten shopping centers worth up to $300 million outside major metropolitan areas near some of Japan's regional cities.

“We look for well-positioned properties in the markets and stay away from those in fundamentally inferior positions,” says Rio Minami, head of Carlye's Japanese real estate team. In other words, centers with upside position thanks to poor management and poor marketing, among other factors.

“Bundling up stable assets throughout the nation will create an attractive, risk-diversified portfolio with good liquidity,” says Minami.

Unlike the US market, where real estate investors spread their attention more evenly across sectors, many who invest in Japanese realty tend to chase office investments, especially in the capital.

“Class A office towers in Tokyo are not our focus because they are too competitive” says Minami. By comparison, Japan's retail sector remains less crowded and “has a lot of room to grow.”

“We are going after the kind of neighborhood or regional shopping centers where people would go to do their shopping everyday,” adds Minami. “The beauty is these shopping centers, located around regional cities, have yet to attract the flock of investors who are chasing Tokyo's office towers at prestigious addresses.”

The joint venture will target assets that range between $20 million and $50 million. Typically, the properties will be anchored by major tenants—often international, national or regional brands— and may include grocery stores, home centers and other shops for the local consumer.

As individual products, the shopping centers have challenges. Even though neighborhood shopping centers have stable traffic from customers seeking necessities close to home, they can sometimes appear tired and in need of improvements.

“People can get bored with shopping centers,” says Minami, adding that some say the centers must evolve and change every three to five years to hold the attention of a fickle shopping public.

At the time Carlyle and SOW announced the partnership, they also announced the acquisition of the first pieces of the portfolio— Power Center Otsu in Otsu City, Shiga and LOC Town Odate Nishi in Odate City, Akita for a combined $72 million.

Carlyle's decision to join forces with SOW and seek opportunities in the mid-size retail sector happened simultaneously, says Minami. From the outset, the parameters they set required them to chase off-market, private deals and not to pursue situations where they would have to bid on properties.

Once the joint venture identifies and acquires a shopping center, the first six months to a year are the key time period in which to overhaul its performance. Immediately after acquisition, SOW has taken over management of the assets, cut unnecessary expenses and engineered changes to the tenant roster, bringing in “healthy tenants,” according to Minami.

In the case of PowerCenter Otsu, that meant a renovation to the public area and adding new stores and popular brands to the center's mix of approximately two dozen tenants. In all, the changes there allowed the joint venture to improve the shopping center's yield by 30 percent in the first six months.

“The key is to provide a quick impact shortly after acquisition,” says Minami.

Once Carlyle and SOW have completed the overhaul of each individual center and the partnership reaches its goals, they hope to bundle the properties and put them on the market as stable, income-producing assets. Carlyle hopes such stable properties should attract attention from the same type of real estate investors competing for those Tokyo office towers today.