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Inside Goldman’s $10bn RE equity business

In serving the bank’s capital, Goldman Sachs Merchant Bank Division’s Real Estate Group has found its equity investing business is without peer.

Garman: MBD Real Estate Group is not an asset manager but an investing business

In 2013, when PERE last shone its spotlight on the principal real estate business of the Wall Street investment bank Goldman Sachs, the declarations from the sidelines were
of a spent force in the industry.

A combination of poor performances from its flagship Whitehall Street fund series, stemming from investments made immediately prior to the global financial crisis, and regulation curtailing the bank’s co-investment in the vehicles had hands ringing the death knell. “They are done,” one executive at a rival platform said then. “They’re out of the business,” said another.

Those determinations proved both right and wrong concurrently. It has been a decade since $2.3 billion was raised for Whitehall International 2008, the last fund in the series. The journey for Goldman Sachs’ Real Estate Principal Investment Area since has seen it morph into an altogether different proposition.

For one, its identity has changed: the REPIA brand is today more colloquial than actual, with official correspondence coming from the Goldman Sachs Merchant Banking Division’s Real Estate Group instead. More significant than branding, all external fundraising activity has been for its Broad Street Real Estate Credit fund series. In January, $4.2 billion was raised for the third fund in the series from investors that one time might have backed a Whitehall fund. Including leverage, the Broad Street series has accumulated more than $13 billion for a variety of real estate debt investments in the US and Europe.

The series has done much to exorcise Goldman’s ghosts in the private real estate marketplace. Despite running for two decades and producing some stellar returns along the way, Whitehall investments being written down to zero cents on the dollar in the aftermath of the financial crisis remain fresh in some memories. Successful turnarounds are understood to have been executed by the team since then.

“In 2009, our source of funding was unclear, our platform was in disarray and the opportunity set wasn’t there. By 2012, our platform started stabilizing, we got the right team in place and we started getting capital from the firm.”

– James Garman

Nevertheless, the final installments of the series are still understood to be cases of rescuing value versus turning a profit and the bank is not keen to share performance numbers. That is not the case for Broad Street, on the other hand, which it says has consistently generated gross returns of around 16 percent, 13 percent to investors. Such performances have seen investors queue for the series’ next installment, punting MBD Real Estate Group higher in the estimations of many in the industry.

An altogether smaller audience
Given its availability to external investors and its strong performances, Broad Street is courting the most attention among Goldman Sachs’ real estate endeavors today. As a
consequence, MBD’s Real Estate Group equity business has had an altogether smaller audience. And yet, $10.4 billion of the bank’s capital has been invested by the platform since James Garman and Alan Kava presented the bank with a plan to turn the business around in 2011 – a fundraising effort competitive with most private equity real estate businesses out there. Indeed, with $9.2 billion, or 88 percent, of that money funneled into equity transactions, compared to just $1.2 billion alongside the Broad Street funds, the platform is every bit more the equity player – despite external misconceptions.

The Volcker Rule of the US Dodd-Frank Wall Street Reform and Consumer Protection Act curtailed US financial organizations from committing more than 3 percent to some of their own private equity funds. Goldman Sachs was previously a 25-30 percent investor in its equity funds, and, keen to benefit from the almost global post-crisis recovery, the bank decided to move to a balance sheet-led funding model for its equity deals. The discernible difference in approach came in the capital structure: gone were fund co-investments. These were replaced with commitments to joint ventures with operating companies and other investors able to complement the needs of its capital. In short, MBD’s Real Estate Group had one backer for its equity deals – the bank.

An unintended consequence of this shift in dynamics has been MBD’s Real Estate Group shedding its former categorization as a private equity real estate business. Subsequently, its positioning in the marketplace has become challenging, benchmarking nigh on impossible. Today, the platform is just as likely to compete on opportunistic deals with former rivals Blackstone or Lone Star as it might with a CBRE Global Investors or AEW on core-plus or value-added deals. On another day, it could be taking on an Abu Dhabi Investment Authority or Canada Pension Plan Investment Board for a position in a multi-billion-dollar club transaction. Investor, manager, GP, LP: MBD Real Estate Group can nowadays be regarded as none and all of the above.

Tentative on a revival fund
“When we had the Whitehall product, there was a target return of approximately 20 percent. Whereas, by using the balance sheet, we have far more range in terms of the types of things we do,” Garman tells PERE at the Goldman’s London office on Fleet Street. “Some things, we’ll underwrite to, say, a 20 percent to 30 percent return because it’s a risky development project. Other things, we might look for a low to mid teens return because it’s more of a value-added opportunity.”

Garman: evaluates further equity funds from time to time

Nonetheless, while Garman declines to specify the results of MBD Real Estate Group’s equity investments, he is happy with its performance: “We think our track record, if we were to line it up against others, would look very good. In most of the things we’ve done, not everything, we’ve materially outperformed what we thought we’d do when we made our investment.”

Unsurprisingly, Garman is tentative on the topic of reviving a private equity real estate fund series. “Should we do an equity fund again? We evaluate it from time to time but nothing has been decided. We have rebuilt our equity investing business on the balance sheet. It’s been much bigger than we thought. And then we’ve added this credit strategy, which we didn’t have in the previous cycle. That’s a whole range of things for us to do. In certain strategies we also co-operate closely with our colleagues in the firm’s Special Situations Group, which has worked out very well.”

MBD Real Estate today has about 30 professionals in the US, 20 in Europe and another 300, if you count the Goldman Sachs Realty Management Division, the asset management and loan servicing shop previously known as ARCHON. That is a far cry from the 130 executives on the roll during REPIA’s peak (plus 1,500 at ARCHON). But despite the headcount reduction, the platform Garman and Kava preside over today is far more nimble and, critically, it has a dependable source of capital in its parent and its affiliates. He speaks openly about life at REPIA in the immediate aftermath of the financial crisis. It was a darker place he would rather not return to.

“In 2009, our source of funding was unclear, our platform was in disarray and the opportunity set wasn’t there. By 2012, our platform started stabilizing, we got the right team in place and we started getting capital from the firm. Then the opportunity set started. Now, our platform is in great shape, we have a great team and our capital sources are properly funded between the credit fund and the balance sheet.”

Different kinds of partners
One example of the opportunity set materializing, both in terms of assets and also partners, came in the UK student housing sector. In 2016, it formed a joint venture with charitable foundation the Wellcome Trust valued at £2 billion ($2.79 billion; €2.26 billion) to take on the country’s the underserved market.

Peter Pereira Gray, managing partner and chief executive of its investment division, admits he would have been reticent to recommend a union with the investment bank platform in its prior form. He has turned down a Whitehall fund marketed to the foundation before and would have done so again. “We wouldn’t have done this deal with Goldman if it has been fund money. It would have come in a structure with a required liquidity point and that might, or might not, have lined up with the cycle. But we did this happily with Goldman on the basis it was balance sheet money.”

Alongside residential specialist Greystar, the partners formed IQStudentAccommodation by combining iQ, the student housing business of Wellcome Trust, and Prodigy Living, which was owned by Goldman Sachs and Greystar, in a deal that saw the formation of a business with 23,500 beds across 25 UK towns and plenty of firepower to expand with the addition of the £850 million-plus Pure portfolio of assets in December. IQSA is now one of the largest players in the UK. Pereira Gray says the tie-up solved a growth issue for iQ and an operational challenge for Prodigy Living, but was only possible because of the nature
of Goldman Sachs’ equity.

“Goldman can make long-term decisions and that puts them in an exceptional place to take on complex deals.”

Another came in the form of the purchase and redevelopment of the Pascal Towers in Paris-La Défense in a joint venture with French real estate developer and fund manager Altarea
Cogedim. The project required the revitalization of almost 700,000 square feet across two buildings at a cost of about €200 million in equity, split equally between the partners.

Stephane Theuriau, Atarea Cogedim’s chief executive at the time recalls that while limited life capital was not an issue, MBD Real Estate Group’s ability to operate on such a product at a far more modest gearing level than before was a key attraction. “We took a five-year view on La Défense and a big position,” Theuriau recollects. Unlike Pereira Gray, he says
the firm might have partnered with a Whitehall fund “because effectively they’re discretionary so, from a governance standpoint, it’s the same thing. But if they had told us they want to do it at 70 percent LTV we would not have done the deal.”

The leverage level for the venture is around 50 percent but Theuriau still projects an IRR north of 20 percent from the venture, even if it is currently at the construction phase.

Defiant in insolation

Neither Pereira Gray nor Theuriau envision MBD Real Estate Group will revert to raising third-party, commingled funds anytime soon. “I think they are very good at what they’re doing and I would encourage them to stick to their knitting,” Pereira Gray says. “If it’s not broken, don’t fix it,” adds Theuriau. “Why change? This team is very disciplined and people seem to be happy with how they’re doing.”

Should the platform stick to its knitting, it would mean the institutional investor universe at large would not directly be able to benefit from its investing acumen beyond the Broad
Street series, which by virtue of their credit focus, means capped returns. PERE posited the notion the bank might one day push for a return to private equity fundraising to accommodate client demand, and drew a comparison with fellow investment bank Morgan Stanley’s platform, Morgan Stanley Real Estate Investing, which suffered similar headwinds but has since restored its fortunes with two successful global fundraises.

Garman is resolute in his response: “It’s not an asset management business. It’s an investing business. The people that run the firm know we are deploying the firm’s capital and they don’t want us to feel pressure. They want us to make good investing decision.” But he added: “If we did decide to do an equity vehicle, it would probably be aligned to a specific strategy. And we would want to ensure we could invest meaningful capital alongside our clients.” MBD Real Estate Group might be better known in the market for its credit funds than its equity outlays, but as the platform has no distinct peer group, that does not seem to matter to its co-head. Serving the bank and its investing clients is what counts most. “I think we’re the only ones doing it the way we do it,” Garman concludes, “and everything we do is complementary to other parts of the firm.”