The founders of industrial specialist M7 say the mistakes of previous ventures taught them valuable lessons in how to manage debt and assets, a change of strategy that won them a raft of property and bank partners. David Hatcher reports
M7 Real Estate is a company of our time. The pan-European industrial property specialist was born out of an outfit that crashed in the global financial crisis. Its key protagonists re-invented themselves with remarkable speed and its move from the London property industry’s traditional West End base to funky new offices in the more in-vogue Southwark last August encapsulates the firm’s approach.
Independently owned and set up by 10 former GPT Halverton senior managers following its 2009 collapse at the market’s nadir, M7 soon formed crucial joint ventures with the likes of Westbrook Partners and Europa Capital, helping propel the business.
The company has since formed an enviable roster of partners such as Goldman Sachs, Oaktree Capital Management, M&G and Starwood Capital, all eager to take advantage of the higher-yielding returns M7’s specialist area, light industrial, provides.
Banks have also bought into the story, with the likes of Bank of America Merrill Lynch, Deutsche Bank, Santander and Lloyds helping to finance different vehicles.
M7’s co-investments in partnerships have been made possible by an innovative, £19m listed bond issue in 2013 and it is now also raising its own discretionary funds. In February the company’s 11 director-owners brought its five European asset management partner offices in house, giving stakes in the business to the MDs.
This has all been undertaken under the leadership of Richard Croft, one of the European property industry’s most colourful and well-known characters. His exit from GPT Halverton, which he calls “emotionally catastrophic”, has clearly been formative.
M7 manages £1.3bn of assets, 45% of them in the UK and 55% in Europe, and has 80 staff. Getting there involved learning many lessons to conjure a successful revival, not least to do with conservative risk and debt management.
“When we set up M7 we wrote a list of the things we did right from 1990 to 2008 and a list of everything we did wrong,” says Croft. “The first list was a lot shorter than the second list. Things that looked good in 2005-2006 turned out to be terrible.
“As a result, we invested pretty much all of our working capital in some revolutionary information management capability and moved our fees over to rents collected rather than gross asset value – we create income strategies, so it’s only fair we get paid on income. We now get paid the vast majority on exit.”
In-depth reporting is a particular M7 strength – a valuable tool in managing more granular asset classes. “Reporting to each equity provider is a constant focus, making sure they are updated on all the asset management,” says chief financial officer Andrew Jenkins, former CFO of JLL and the only founding director not previously at GPT Halverton, who oversees the structuring of M7’s vehicles.
M7’s first major joint venture was with Europa Capital in 2009, originally to buy £60m of UK light industrial assets, which was later expanded. Four years later the partnership sold its portfolio to M&G Real Estate for £140m and M7 was retained as asset manager.
Croft recalls: “When [Europa principal] Noel Manns asked why he should back us, I said: ‘Frankly I’ve just had the worst 18 months ever. I don’t think I’ve made a good decision in that time and that gives us a fairly unique insight on what we should do next’. Fortunately he thought that was worth backing, otherwise we’d never have got off the ground. We owe Noel a great deal.”
Key joint ventures
M7 later formed ventures with Westbrook Partners, in 2010 and 2011, to buy more UK light industrial assets, including a portfolio from the then under-pressure UBS Global Asset Management Triton fund.
Perhaps even more significant was an agreement in December 2010 whereby M7 created a company called VBRi to inherit distressed assets from a variety of borrowers Nationwide had lent to, as well as their debt, giving the lender a consensual counterparty. This January, most of the portfolio was sold to Goldman Sachs for around £110m and M7 was again retained as asset manager.
“The strongest endorsement of what we have done and how we’ve managed ourselves is that we’ve sold two big UK portfolios [for Nationwide and Europa] and been retained [by the new owners] on both,” Croft says.
Although rapidly establishing its track record as a relied-upon asset manager, M7 wanted to raise capital to co-invest in funds and share more upside in deals, and to boost its balance sheet for whenever the next “liquidity event” might come along. So it cast around for the best way to do that.
In 2013, the management came close to selling a 50% stake in their business, before taking an 11th-hour U-turn. Instead, they raised a bond in September 2013 that revolutionised the business.
“We were about to sell about 50% of the business to a private equity group to help seed funds and fuel expansion, but a couple of days before that deal we got cold feet,” recalls Croft. “I was on a flight and read about Eurobonds, and started to investigate whether we could list a bond as a fairly small company. We could and we did, and it’s still listed on the Channel Islands Stock Exchange. It gave us the equity to put assets on our balance sheet and do co-investment. That was the engine for growth.”
The bond was used to buy assets of its own, using senior debt from Santander and mezzanine debt from Oaktree, as well as for co-investment into future joint ventures. The five-year bond repays at a 15% rate and had an initial 1% early repayment penalty, which expires in September.
“You have to change if you become part of a corporate firm and we cling possessively to the culture we’ve created, as it’s part of what makes the business,” says Jackson.
The bond’s 33 investors included some of M7’s partners, which put in £50,000 to £100,000 each. A friend of M7 underwrote £1.5m and invited the firm to pitch to a weekly, Monaco-based business lunch club. “We pitched and many of the investors came from there,” Croft says. “We’ve had a successful relationship since and many are investing in our new vehicles.”
M7 REIP II, the company’s first discretionary fund, was raised off the back of the bond last December with £16.1m of equity and the capacity to do £35m of deals. M7 expects the fund to be a precursor to a series of larger discretionary funds this year.
“We will launch a series of discretionary funds for Germany and the Netherlands predominantly, looking to buy portfolios from some of the broken managers and property companies,” Croft says. “We will only raise enough to buy what is in front of us, with €25m or €30m of equity plus debt.”
M7 also expects to find new partners to manage assets and form joint ventures with, and it is increasingly coming into contact with banks as the company’s reach broadens.
“The most important thing is banks get the asset class we manage,” says director Hugh Fraser, a former Eurohypo director responsible for arranging M7’s debt. “It is important that they get that weighted average lease terms will be between two and two and a half years and there is always going to be churn and asset management.
Lenders need to be flexible
“Covenant ratios can only look forward six months, rather than 12, because we manage short-term cashflow. Lenders also need to be flexible in letting us get on with the capex programmes we put in place.”
M7 has five financing mandates out to tender in the UK, Denmark, Germany, the Netherlands and Poland, totalling around €250m. These are thought to include an €85m mandate to refinance assets in its DaRE Danish venture with Oaktree (see table). Existing lender Realkredit Danmark plans to exit commercial real estate lending.
Late last year M7 tied up deals with two investment banking giants of the European property finance market. Its MStar joint venture with Starwood secured an €84m Deutsche Bank loan to refinance its Dutch and German assets; while BAML provided a €95m loan for the purchase of the Tamar European Industrial Fund.
M7’s other banking partners include Oaktree, which provided mezzanine debt to M7 REIP; Santander, which issued senior debt to M7 REIP, MStar and Archimedes; Starwood, which provides senior debt to MBay; and Lloyds, which provides senior debt to M7 REIP and M7 REIP II.
GPT Halverton was highly leveraged before the financial crisis but M7 has a more conservative take on financing, although Croft admits it is a great time to borrow, considering how low interest rates are.
“Gearing is a wonderful tool. It’s like a chainsaw; you can cut down trees with it and do amazing things, but if you lose control of it, you can lop off your leg and arm,” he says. “Now when we borrow, even if it is larger sums, we usually put in a decent amount of amortisation, because by the time you get to year five, you’ve derisked things somewhat.”
The arbitrage between interest rates and yields is an important marker for M7 when buying and considering fair value. Croft adds: “Buying at 8% when interest rates are nothing is not the same as buying at 7.5% when interest rates are 4%.
“What I look at most is the real debt cost and gross cap rate. In a functioning market, for secondary real estate, that gap is about 350bps. Generally, if you’re below 300bps you ought to be selling and if you’re above 450bps, you ought to be buying.”
For now that puts M7 in buying mode, and with its bank of partners and momentum in raising discretionary funds, it looks set to keep growing in the coming years.
M7 is latest chapter in long-running industrial saga
M7 is part of an industrial real estate dynasty shaped by a series of takeovers. Chief executive Richard Croft began working at IO Group in 1990 under John Sims, a pioneer of the UK light-industrial market.
The fund manager floated in 2002, but was taken over by Kevin McCabe’s Teesland in 2004, which, after its own series of takeovers, is now Valad Europe, run by Martyn McCarthy.
By this time Croft had become international investment director and was responsible for setting up the merged company’s international infrastructure across Europe — despite having opposed the takeover at first, insisting that the company should have stayed independent. As a result, he left to set up independent fund manager Halverton Real Estate Investment Management in 2005.
The business was backed by Australian-listed firm GPT Group, which steadily built its stake. At the very peak of the market, in July 2007, it eventually bought the last 50% of the company it did not own, for €70m.
Following the collapse of Lehman Brothers in October 2008, Croft, investment director Taco de Groot and new business director Teresa Gilchrist (now a director at M7) left the company over a disagreement about strategy.
Croft set up M7 in April 2009 and quickly secured backing from the likes of Europa Capital and Westbrook Partners, to take advantage of distressed market conditions.
GPT was hit hard by the financial crisis and it ultimately sold GPT Halverton for a nominal sum to Jos Short’s and Andrew Thornton’s Internos in December 2009.