After a slow start and a lot of frustration in 2008/09, in the past 18 months Catalyst Capital has pulled off a string of deals for its first fund and made plans for a second. Jane Roberts reports
Back in 2007, Catalyst Capital’s six partners raised their first pan-European fund, expanding their earlier model of opportunistic, joint-venture investing by becoming investment managers of discretionary capital.
But like many others who raised opportunity funds four or five years ago, such as AREA Property Partners, MGPA, Orion, Perella Weinberg and Resolution, they struggled to spend their €230m of equity. The only early investment, Alpha Tower in Birmingham, was bought in 2008 at an apparent discount, which turned out to be anything but.
However, in the past 18 months, growing stress in European property markets has meant that the firm’s early spadework has started to pay off. Since mid 2010, Catalyst has agreed eight purchases in four countries, all but one of them assets that were in some way distressed, with the potential to be ‘fixed’.
Now, says founding partner Peter Kasch: “We have run out of money in our fund and are in discussion with investors about raising another. An opportunity will slowly emerge from banks in Europe, which is cash-starved and management-neglected assets. I don’t think anyone else has bought more in that category in the places we’ve invested: the UK, France, Germany and Poland.
“With virtually no economic growth – and in real estate, probably no capital or rental growth – the only way to make money is to create your own profit; you can’t just ride a wave. Over our 15-year history we haven’t grown huge because we focus on the assets; we get our finger-nails dirty. We select our assets carefully and go to work.”
Catalyst is pitching this track record to the 10 investors in its first fund and potential new ones, while gently massaging down expectations about returns.
When you deal with unmanaged and unloved assets, your return expectations are quite significant,” says managing partner Jonathan Petit. “But lack of debt means you’re having to deploy more equity and your returns are hit.”
Lower returns a mathematical certainty Kasch’s says investors should accept lower returns than the old 20% opportunity fund internal rate of return benchmark. These days, he argues, managers are taking less, not more, overall risk. “The pure real estate risk of these type of deals is more or less the same as before, but if you take on 60% instead of 80% debt, the financing risk is arguably less. So the overall risk is less and that justifies an overall lower level of returns in fact, the mathematics insists upon it.”
Some investors looking for opportunistic returns may have seen the light. Catalyst believes these investors are starting to focus on return on capital rather than high internal rates of return as the driving factor, but Kasch says this has rarely filtered through to the structure of incentives and promotes.
“Internal rates of return encourage managers to flip assets quickly, but ultimately what investors want is an optimal amount of money,” he believes. The target equity for the new fund is similar to that of the first, at about €250m. Kasch expects most of it to come from European rather than US investors; about half of Fund 1’s investors came from the US and half from Europe.
Last year the firm negotiated a nine-month extension to Fund 1’s commitment period, from October to June 2012. “We have a deal in due diligence, a shopping centre in Germany, and a couple of other possibilities which, if completed, will spend all the money,” Petit says. “If not, it gets returned.”
Having made the transition to being a fund manager, the partners are keen to continue with another fund, but also to keep the flexibility to form joint ventures with other sources of capital – as they did in the past with investors including Tom Hunter and making an investment in India.
“There is an interesting pool of money out there that’s sitting outside the fund management arena and would like to go into club or one-off type deals, so we are also having discussions about that,” says Petit. “It also keeps the wheels oiled in the hiatus between Funds 1 and 2.”
A talent for matching debt with equity
Kasch adds: “In our previous life we devel-oped a skill for finding a deal we liked then matching up senior debt and equity capital to make it happen.” But he admits that without a mandate, “putting things together on a deal-by-deal basis is a tough way to live”.
The fund has a mandate with Blackstone to buy and manage UK shopping centres, under European director Ilan Goldman. The venture came about when Catalyst bought Stratford shopping centre from Land Securities in mid 2010 for an all-in cost, including capital expenditure, of €108m.
The angle is to redevelop and extend the centre,” Kasch says, with student housing and an extended supermarket. “We bought it first, then sold half to Blackstone, firstly because it was a large investment for our fund and secondly because Blackstone has a student housing capability. We are working through planning and are in talks with a couple of supermarkets – though in today’s climate there’s a discussion about the rent.”
Last December the joint venture paid £85m for Blackpool’s Houndshill shopping centre. Like other asset managers, Catalyst spent time and money after 2008 attempting to structure joint ventures with banks to put in equity and asset manage problem property portfolios, splitting profits with the bank.
They came close at least twice: in 2009, to manage the European assets of aAIM’s failed fund, and more recently to refinance David Ross’s Kandahar portfolio, both with HBOS/Lloyds. “Everyone was receptive, but frankly, few deals got done,” says Kasch.
Several of the deals that did come through after Catalyst bought the Stratford centre involved many months of patient work. “We’d been stalking some of the 2011 deals for about two years,” Petit says. “At Front de Parc in Paris we had done due diligence and worked on a strategy, and the Polish deal was first discussed two years ago.” Partner Kean Hird runs the central Europe operation.
Kasch says many property people talk of “off-market transactions, but most deals we have done and will do involve banks, which will be obliged to go through a marketing process. The trick is to gain a competitive advantage by forming relationships with the people who are involved with the assets, to have better information.”
Front de Parc in Clichy is a case in point: Catalyst’s French partner, Fabrice de Clermont-Tonnerre, was able to contact a key tenant, McCann, which was considering moving out. Kasch says: “We met them three times before buying the building so knew the deal we could strike with them; others’ bids were based on uncertainty.”
Sounding out tenants before the deal
“At New Bridge Street, which was well- occupied but with an average unexpired lease term of around seven months, we went to a major tenant and signed an agreement for lease without owning the building.”
Clermont-Tonnerre’s contacts with Société Générale, the bank behind New Bridge Street’s receivership, meant they got an idea of where the bank stood in the area of price.
Such attention to detail limits the number of deals a small manager like Catalyst can take on, rules out bidding on large, non- performing loans portfolios and partly dictates the size of Fund 2. Could they bring in a partner with a large balance sheet, as Europa Capital did 18 months ago?
Chairman Julian Newiss admits there will be pressures on independent opportunity fund managers, but says: “We will be independent, until running funds requires a co-investment that outstrips our ability to provide it – and the bigger the fund, the more co-investment that is required.”
Instead they will focus on their niche and Kasch believes they will pick up “some of the granular stuff” from both the buyers of the European non-performing loan portfolios – Blackstone is an obvious guess considering their existing relationship – and from banks they have worked with. “We are looking forward to it,” Kasch says.