The deal nets Blackstone majority ownership of logistics assets in prime markets and gives LBA an injection of cash while allowing it to continue managing the assets. It also exemplifies how recapitalizations are being used to transact in a market that has yet to find its footing.
Recaps and manager-led secondary transactions have been rising in popularity for several years as a growing pool of capital chases a shrinking pool of top-flight assets, according to John Ferguson, co-head of the real estate investment funds practice at the law firm Goodwin Procter. That imbalance has only grown more pronounced during pandemic.
“In the covid environment and certainly before the covid environment, we’ve been in a world where the opportunities tend to be scarcer than the capital,” Ferguson said. “People who have good assets, even if they’ve executed on the initial business plan on the GP side, aren’t so quick to give them up.”
Secondary transactions volumes were down across the board last year, falling from $85.4 billion in 2019 to $61.8 billion in 2020, according to Toronto-based secondaries manager Setter Capital’s annual report. But while fund secondaries dropped by 47.7 percent year over year, direct secondaries – which includes recaps – increased by 10 percent across all asset classes.
Real estate secondaries, both funds and direct, declined in 2020, but the drop-off was less significant for directs (down 19 percent from $1.29 billion to $1.04 billion) than for funds, which dropped 29 percent from $2.4 billion to $1.7 billion. And Setter’s survey found that much of this was initiated by managers, as 56 percent of respondents said “meaningfully more” managers coordinated tender offers to investors or attempted to liquidate or restructure their funds last year than the year before.
A balancing act
There are two driving forces behind the proliferation of manager-led secondaries, said Jarrett Vitulli, a senior managing director at the capital advisory Evercore: distress and success. Owners of troubled assets need liquidity to service loans, extend maturities and, potentially, reposition properties, all with reduced current cashflow. When existing investors are reluctant to contribute more capital and banks are unwilling to lend, bringing in preferred equity or new senior debt is the most viable option, he said.
Distressed properties and portfolios – particularly hotels, shopping centers and offices – are reorganizing their capital stacks by bringing in preferred equity and new debt to avoid defaults or forced sales into unsettled markets, Josh Zegen, managing principal of New York-based Madison Realty Capital, told PERE.
“Other than industrial or a couple of hotter asset classes, the primary recap you’re going to see moving forward is more of a distressed recap,” Zegen said. “In general, a lot of older money is going to get subordinated and new money is going to have to come in. That is a function of when you see markets where the bid-ask spread is very wide, this is a way to narrow that gap.”
Meanwhile, for high-performing funds nearing their target end dates – particularly those in increasingly competitive sectors – the prospect of a recap to extend a fund life can be appealing to some investors. But the key, Vitulli said, is also satisfying those that would like to exit as planned. That is where a recap can be most useful.
“If you’re a GP and half your LPs want to own an asset and half don’t, this is really the elegant solution,” he said. “You can run a competitive process, deliver a fair market valuation and then provide that true optionality for all your LPs, the ones that want to remain invested and those that would like to sell out.”
Blackstone ran such a process for the $14.6 billion recapitalization of its investment in BioMed Realty last year. Ultimately, more than 70 percent of the capital came from existing investors in Blackstone Real Estate Partners VIII that were keen on keeping their exposure to the flourishing life sciences sector.
Cashing in, not cashing out
Through its Real Estate Income Trust, Blackstone now owns a 60 percent stake in LBA’s two portfolios, which total 9.5 million square feet of prime last-mile logistics warehouses in California and Seattle. LBA Logistics Value Fund VII, a closed-end vehicle managed by LBA, will retain ownership of the other 40 percent.
Launched in 2019, Logistics Value Fund VII is LBA’s first single-asset fund to focus solely on the industrial sector. By recapitalizing these portfolios now, before the fund reaches the end of its life, LBA is capturing some of the appreciated value of the underlying assets without giving up its strong cashflow returns, a source familiar with the firm told PERE. “It’s an opportunity to return capital to investors yet still have the ability for them to own a valuable portfolio,” he said.
Blackstone is no stranger to being an equity source in these types of transactions, said Nadeem Meghji, senior managing director and the firm’s head of real estate Americas. It has participated in several recaps in recent years, including its acquisition of a 49 percent stake in Hudson Pacific’s Hollywood production studio portfolio this past summer. “You often see existing owners entertain these types of long-term partnerships where they see continued upside in high-quality portfolios and want to harvest that upside over time,” Meghji said.
As demand grows for industrial assets and a handful of other property types, Meghji said Blackstone has used a variety of structures, including recaps, to transact: “We’re seeing enormous investor demand for industrial and as a result we’re relying more than ever on our scale, our relationships and our creativity to access high-quality industrial assets in the best markets.”
Still, some, including consultants, capital raisers and at least one BREP VIII investor, have questioned the appropriateness of BioMed moving from one Blackstone-managed fund to another, highlighting the sensitivities around such transactions.
One way to avoid conflicts or questions of impropriety is to establish a procedure for recaps at the beginning of a fund’s life, Vitulli said, noting that more limited partner agreements have begun to incorporate stipulations for extension vehicles and exits.
LBA, for its part, addressed the topic of recaps at the onset of its most recent fund, the source familiar with the firm told PERE, having previously executed a similar transaction from a prior vehicle. Also, the fact that its most recent recap came in the middle of its current fund’s life meant it did not have to deal with conflicting investor sentiments – all will remain equally exposed to the portfolios until the fund sunsets.
Whether they are used to salvage distressed properties, extend the lives of successful vehicles or capitalize on portfolios mid-fund, Lori Campana, a partner at the Boston-based capital advisory Monument Group, expects recapitalizations to be a leading trend in the months ahead, particularly as groups navigate an uncertain market.
“There are some very strong assets in a lot of portfolios, but they’ve been in mothballs for a year, so GPs have to look for ways to preserve the upside and they will need more time,” Campana said. “LPs understand that and if they believe in the manager, they will allow that to happen.”