KKR & Co. (KKR:US)’s real estate unit, which has made five U.S. deals since forming last year, plans to invest in Europe as it explores transactions including housing developments in London, the head of the division said.
“We’re bidding on a couple things right now,” Ralph Rosenberg, who joined KKR in March 2011 as its first head of real estate, said of London deals. “We’re looking at doing ground-up construction of rental and for-sale apartments.”
KKR has invested about $350 million of equity in property deals since Rosenberg’s arrival as part of a push by private- equity firms to expand in the business. KKR and TPG Capital created real estate units last year to diversify beyond corporate takeovers and exploit investor appetite for higher- yielding assets at a time of record-low interest rates on alternative investments such as government bonds.
KKR yesterday announced its most recent deal, a residential development in Williston, North Dakota, for workers in the state’s booming oil business. The company plans to invest as much as $150 million with two partners to develop apartments, houses, a park and sports field in the town.
The pace of KKR’s real estate investments is heightening the prospect the 36-year-old firm, led by founders Henry Kravis and George Roberts, might raise outside capital for its property unit next year. KKR is working on deals that “could easily consume another $200 million or $300 million of equity in the next quarter,” Rosenberg said in an interview.
The real estate unit has eight employees in New York and three in London who focus solely on acquisitions, Rosenberg said. The firm has three people in Beijing who spend substantial time on real estate and two in Mumbai. KKR also recently opened an office in Sao Paulo.
KKR has been investing in real estate mainly from its own cash and money from its KKR Financial Holdings LLC vehicle. In some cases it has used capital from its private equity funds.
In addition to the five U.S. deals, the real estate unit has made one in Europe. Kristi Huller, a KKR spokeswoman, declined to comment on the European transaction.
In London, the real estate unit is looking at financing development of rental apartments and condominiums, Rosenberg said. The company is seeking to meet demand for housing from both U.K. residents and international renters and homebuyers, he said.
“The market is a lot deeper than just the local market, given the interest from wealthy individuals in the Far East, Middle East and Europe,” he said.
The average home rent in greater London rose more than 6 percent in October from a year earlier to 1,240 pounds ($1,964), according to an index compiled by HomeLet. That was up 16 percent from the same month in 2010 and 32 percent from October 2009, when rents averaged 940 pounds per month.
“Average rental prices in greater London appear to be far more buoyant than the rest of the U.K.,” Ian Fraser, managing director of London-based HomeLet, said in a Nov. 13 report. “The continued increase in achieved rental values highlights the growing pressures on the supply and demand of rental stock in the capital.”
Telford Homes Plc (TEF), a London residential property developer, said last month that it has had strong demand from both overseas and U.K. buyers in the the city. It expects “significant profit growth” for the first six months of the fiscal year, Chief Executive Jon Di-Stefano said in an Oct. 22 statement.
“The strength of London as a global city, its international appeal, transport connections and a shortage of new homes make the group’s area of operation particularly attractive, especially on the back of a very successful Olympic Games,” the company said.
KKR’s investment in North Dakota plays into its strategy of making property deals tied to industries it is familiar with. The company is an active investor in energy-related fields, betting on new drilling techniques used to extract oil and natural gas from rock formations. The methods include high- pressure injections of chemically treated water to draw oil and gas from shale, a process known as hydraulic fracturing, or fracking, that has drawn criticism from environmentalists.
KKR last year led a group to buy Tulsa, Oklahoma-based Samson Investment Co. for $7.2 billion to capitalize on increased production of shale-based oil and gas. KKR made a fourfold return on its first shale-gas investment, East Resources Inc., when the Warrendale, Pennsylvania-based company was sold to Royal Dutch Shell Plc in 2010.
Energy, like real estate, is subject to boom and bust cycles. KKR’s investment in the largest leveraged buyout in history, the record $43.2 billion purchase of then-TXU Corp. in 2007, has been eroded by a decline in natural gas prices, which reduced how much unregulated electricity producers could charge. Now called Energy Future Holdings Corp., the company might be headed toward bankruptcy or reorganization, investors have said.
KKR’s investments under Rosenberg include a joint venture with Houston-based Hines to develop a master-planned business park in the Texas city comprising storage and distribution facilities. It also joined with two other companies to buy the management business of Sunrise Senior Living Inc. for $130 million as part of Health Care REIT Inc.’s acquisition of the senior-housing owner.
In April, KKR paid $196 million for Yorktown Center, a shopping mall in the Chicago suburb of Lombard, Illinois. The seller was a local family that had developed it and managed it for about 40 years until it ran into cash constraints in 2007.
“It was perceived in the marketplace, rightfully so, as a B-quality mall,” Rosenberg said. KKR signed a permanent lease with Toys “R” Us Inc., a company of which it’s a part owner, and plans to spend about $30 million to renovate the food court and facade over the next two years.
KKR bought Yorktown Center at an investment yield of 7.5 percent, Rosenberg said. The yield, or capitalization rate, is the mall’s net operating income divided by purchase price.
“We’re going to take that 7.5 percent yield to a 9.5 percent yield,” Rosenberg said. “If we can achieve that operational strategy, owning that asset at a 9.5 percent yield on our basis is going to be pretty attractive.”
While KKR lacked a dedicated real estate unit before last year, the firm has made several property investments over the past two decades. In 1992 it backed the formation of KSL Recreation Corp., an investment vehicle led by former executives of ski-resorts operator Vail Associates Inc. KSL investments included the La Quinta Resort & Club and PGA West golf course near Palm Springs, California. KKR sold its interest in KSL in 2004 and shed KSL assets over time, including a stake in San Diego’s Hotel del Coronado last year.
KKR also sold the Motel 6 budget hotel chain, now owned by Blackstone Group LP (BX:US), to France’s Accor SA in 1990 and invested in Red Lion Hotels Corp., which went public in 1998.
In expanding in real estate, KKR and TPG lag behind Blackstone, the world’s largest private-equity firm and manager of about $54 billion of equity in property assets. The New York- based company this year raised a $13.3 billion real estate fund, a record for the industry.
Besides Blackstone, the biggest real estate funds until the 2008 credit crisis were inside Wall Street investment banks. The financial crisis ended or diminished the property fund units of Lehman Brothers Holdings Inc., Goldman Sachs Group Inc. and Morgan Stanley as they invested record funds with borrowed money when property prices were at all-time highs.
“A lot of the incumbent players in the commercial real estate space who ran money for institutional investors made mistakes that damaged their credibility with their institutional partners,” Rosenberg said. “Those institutional partners have a natural need to have real estate exposure and ultimately they need to figure out how they’re going to get that exposure.”
Rosenberg helped run Goldman Sachs’s Whitehall real estate unit until January 2004, when he moved to another Goldman division to co-manage a business that invested in corporate and asset-backed debt and equity, including property. He left the investment bank in 2006 to form a hedge fund called R6 Capital Management. At the beginning of 2008, Rosenberg and his R6 team joined Eton Park Capital Management, a hedge fund started by former Goldman Sachs partner Eric Mindich.
While interest in real estate is strong, some institutions are demanding fee reductions and more say in deals. Since the 1980s, the standard structure for private equity funds -- which KKR helped pioneer -- was a management fee of about 2 percent of the capital raised and 20 percent of any investment profits for the manager. As fund sizes grew into the billions, fees swelled to hundreds of millions of dollars, drawing protests from investors, who said fund managers weren’t incentivized to search for the most profitable deals since they were earning so much from fees alone.
In October, New Jersey’s state pension fund agreed to management fees of 0.95 percent on invested capital as part of a $350 million pledge to a TPG Real Estate fund in which it will be the sole outside investor. New Jersey has the ability to review investments before they’re made, a right not granted under traditional funds.
TPG has made 10 real estate deals using $2.1 billion of equity capital, according to a person with knowledge of the firm’s deals who asked not to be named because the details are private. Lisa Baker, a spokeswoman for TPG at Owen Blicksilver Public Relations Inc., declined to comment.
“Large institutional investors are seeking more transparency into investment strategies and are asking for input,” Rosenberg said. “On the extreme, the world is moving toward the separately managed account model for large sophisticated investors.”
In November 2011, KKR and Apollo Global Management LLC (APO:US) struck a deal with the Teacher Retirement System of Texas to manage as much as $3 billion each.
“We can use that partnership to invest in real estate as well, though we haven’t done it yet,” he said. “You’ll see more of those types of relationships.”
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