US firms, global strategies

The world of private equity real estate—not a huge community to begin with—is getting smaller as more and more US-based firms look at ways they can take their strategies to Europe and beyond. By Aaron Lovell

In early 2006, Behringer Harvard made their first investment in Europe. The Dallas-based real estate investment firm teamed up with Hamburg-based HCI Capital to acquire a five-story office property near Schipol Airport on the outskirts of Amsterdam.

It was a modest investment, but turned out to be the first step in the evolution of the firm's European investment strategy. Later in the year, Behringer Harvard announced a full-fledged joint venture with HCI to invest $1.3 billion (€1 billion) in European real estate, looking at product across the sectors and with a regional focus on the Netherlands, Germany and the UK.

“Real estate has become more and more global, and in a global view European real estate still holds and promises a lot of potential,” Oliver Georg, a managing director at HCI, said in a conference call at the time of the announcement. “Through solid, improving economic fundamentals in Europe, there is a strong potential for rental growth combined with a realistic opportunity for yield compression.”

The partnership, which is targeting short- and mid-term opportunistic and value-added investments, acquired two more office buildings in Amsterdam this fall. Speaking recently about the firm's move abroad, Jason Mattox, executive vice president at Behringer Harvard, says it had always been a part of the firm's overall growth plan. “This has been a long-standing goal,” he says.

Going global
The firm's growth from a US-focused player to one with an international presence is something many firms are seeking to emulate as they look to establish platforms abroad in Europe, Latin America or Asia. The benefits to a move abroad are myriad, but close to the top of any list is a growing need for geographic diversification.

“The larger real estate investment community has turned in a verdict that investing overseas is part of proper diversification,” Mattox says.

As institutional investors have increased their allocations to real estate, many have also expressed an interest in increasing their geographic diversification—if a fund manager is experienced.

“Investors like their fund mangers on the ground,” Dee Dee Sklar, managing director and financial institutions head at West LB Capital Markets, says of real estate fund LPs. “They like their fund managers to either have direct geographical presence or solid local operating partners. Investors do a great amount of due diligence to decide on countries and fund strategies.”

Susan Stupin, a managing director with The Prescott Group, a firm that has done real estate advisory work around the globe and has plans to expand its investment program to Europe in the near future, says moving into some emerging European markets also offers investors a “unique opportunity to be part of the expansion of the economy.”

To a lesser extent, Stupin also says that, while US firms are exporting their own expertise abroad, they can also learn from their local operating partners, particularly in areas like green buildings and energy-efficient design which have advanced in places like Europe and the Middle East.

US- and global-focused firms are able to bring intellectual capital into new markets, says Sklar of West LB. For example, in some markets, she says, firms can increase leasing at a property by doing something as simple as keeping the rental office open over the weekend.

Other investors are encouraged by the continued development of more liquid markets in Europe, spurred on by the introduction of tax-efficient real estate investment trusts: These vehicles were introduced in the UK this year, while Germany continues to mull a similar vehicle.

For Behringer Harvard, a firm that has a number of real estate investment trusts in the US, the development of REIT-style vehicles in Europe also encouraged the firm's expansion into Europe. Mattox says that the new structures are helping to increase liquidity and interest in institutional-grade real estate.

Dipping a toe in the water
In an increasingly globalized world, overseas expansion is increasingly seen as a natural step in the evolution of a private equity real estate firm. For a large investment bank, taking an investment platform abroad might be relatively easy—especially if it already has people on the ground and an international presence. For a smaller investment firm, it can be a trickier proposition.

Once a target market is identified and thoroughly researched, a firm will usually proceed with a local operating group and look to test their investment thesis vis-à-vis a small deal, a path pursued by Heitman in Poland or Walton Street Partners in Mexico. As the firm becomes more confident and comfortable, it will most likely increase its activity and incrementally grow into the new market, practitioners say, eventually establishing a more formal partnership with a local operator or investment firm.

Sometimes another business line at the firm—like a real estate investment bank or leveraged buyout arm—can provide entrée in new markets. For firms with international investment banking or advisory practices, doing project financing and raising capital in a new market can sometimes lead to an expansion of the group's investment platform. This was the case with The Prescott Group, which is looking to establish a European office in France or Germany, and has done various advising work in Europe, Mexico and Australia.

“In some cases, it has been used to dip a toe in the water by advising clients active in those markets,” Stupin says, adding that advisory work is an important way to meet potential operating partners.

Stupin also says that US firms can also look into establishing a joint venture arrangement with a European wealth management firm, a path that Prescott is exploring. A joint office in Europe gives a US firm the opportunity to expand their franchise in a new market—and have access to other markets throughout Eastern and Western Europe.

Know your partner
Moving into any new market, foreign investors need to be aware of the country's legal and regulatory climate and, to a lesser degree, communication issues—and these must be factored into a firm's strategy.

“There is an education challenge,” says Maury Tognarelli, chief executive officer and president of Chicago-based Heitman, a real estate firm that expanded into Poland and Central Europe in the mid-1990s and is now looking at Russia. “You are dealing with a completely different culture, a different political structure, a different economic environment and a different real estate market. You really have to make an up-front investment to get comfortable with all of those dynamics.”

Along with the cultural differences, Tognarelli adds that the time difference adds another layer of complexity, as the management of people and assets is made more difficult when offices are separated by several time zones. Once firms master those challenges, he says, they can focus on learning about the country's property market.

In addition to knowing the new markets and their inherent risk, many GPs who have made the jump stress the need to have a quality local partner. After all, this group will usually be the partnership's face in the country and its on-the-ground presence. In many cases, the partner will be in charge of dayto-day property management—and an integral part of any sort of lease-up strategy, for example. This makes having the right partner, in Mattox's words, “bottom-line essential.”

Stupin says selecting the right partner is an important part of any expansion—and one deserving of plenty of scrutiny. “Who are you dealing with?” she asks. “Who is your operating partner? How well do they know the marketplace?”

But once those questions are answered and the platform is up-and-running, opening additional overseas offices gets easier, market participants say. After opening their initial European office, Heitman went on to add offices in other European countries and, in 2005, established an Asian presence with an office in Tokyo. It got easier for the firm to expand, Tognarelli says, because the firm already had a sense of the tax and regulatory challenges in each country.

“It's not as complicated a step as your first one,” he says. “You've got a much higher degree of comfort with the issues. Your expectations are much better reflected in what you see going forward.”

Firms are establishing these offices as the markets of Europe and Asia present an attractive investment proposition for successful US firms. But moving into a new market—be it suburban Amsterdam or the heart of Sofia—a firm can't lose sight of the strategy and philosophy that made it successful in the first place.

“You don't have assets overseas for the sake of having assets overseas,” Mattox says. “You have to have a purpose.”