PGIM – Moulding a simpler strategy

The Pricoa, Prudential and Pramerica names have been united for the first time under one brand – PGIM. Property debt and equity chiefs David Durning and Eric Adler tell Jane Roberts what’s next for their $150bn AUM segment of the PGIM business.

The new PGIM (pronunciation: pee-jim) is the international investment management business managing $947 billion of capital, owned by Newark, US-headquartered Prudential Financial. It was formerly called Prudential Investment Management in America, and Pramerica Investment Management everywhere else, because UK insurer Prudential plc has the rights to the Prudential name outside the US. PGIM is not an acronym, despite the capital letters.

PGIM Real Estate's Eric Adler (l) and David Durning
PGIM Real Estate’s Eric Adler (l) and David Durning

When the Financial Times reported the forthcoming name change last November, the chief executive of what would soon be PGIM, David Hunt, was upfront about the shortcomings of the Pramerica moniker. The Pramerica name had not always played well in newer areas of expansion like Southeast Asia he said. “The America part of that wasn’t necessarily something that people wanted to meet with. It’s a brand that I think never got a lot of support.”

Time will tell whether binning ‘Pramerica’ will generate more business, but it certainly makes life simpler, not least in terms of PGIM’s substantial real estate franchise, which at $150 billion accounts for about 15.5 percent of total AUM.

The new brand sweeps together the Pramerica and Prudential Real Estate Investors names previously used for investing in bricks and mortar assets and high-yield property debt, and the Pricoa (abroad) and Prudential Mortgage Capital (at home) names for commercial mortgage origination. The former Pramerica and Prudential Real Estate Investors are now called PGIM Real Estate, while the commercial mortgage investing arm will be PGIM Real Estate Finance.

‘Will be’, because the group didn’t quite manage a simultaneous, clean switch as David Durning, president and CEO of PGIM Real Estate Finance, explains: “The ‘doing business’ reason is the easy part; there are certain regulatory reasons why it just takes a while to get some of the new names in place.” Thus, the bit of his team which previously operated as Pricoa in Europe has changed to PGIM Real Estate Finance, but in the US and Japan, Prudential Mortgage Capital Co lives on a little longer and will be changing to PGIM REF later in the year.

Future collaboration

Historically, Durning’s $85 billion commercial mortgage business has operated separately from the $65 billion real estate equity business which is headed by PGIM Real Estate chief executive Eric Adler. But there is another change in the works, one which will see them collaborate in future on one area in particular, high-yield debt investing in the US.

More co-operation seems to fit the spirit of the times under the new brand, but in fact say Durning and Adler, their plans in US high-yield debt have been in train for a while. “We are in the process of putting it together: we have hired a team and we have a new portfolio manager. But it is not something we have announced yet,” Durning says.

The high-yield debt strategy is an innovation and has been proving a great real estate success story. While PGIM’s enormous CRE senior mortgage book has been around for 140 years, mainly originating fixed rate loans on behalf of the US Prudential general account, the high yield debt investing for third-party clients is a new and more profitable product, added after an opportunity opened up in the years after the financial crisis as the banks retreated from higher loan-to-value and more complex property lending.

It has been especially successful in Europe where the group hired former Rothschild duo Andrew Radkiewicz and Andrew Macland in 2009 to set it up and run it.

By contrast, the head of US high yield, Jack Taylor, left the group in December 2014 part-way through investing an $805 million debt fund and five years after joining. He went to Pine River Capital, taking his Prudential REI lieutenants with him.

In Europe, the team led by Radkiewicz, Macland and Matthew Crowther put down deeper roots and is now capital-raising for its sixth and biggest fund. According to the pitch book shown to prospective investors, PGIM Real Estate is targeting £1 billion for the latest European vehicle (see panel p.15).

Adler says high yield debt is a product that has more in common with equity investing, which was why it made sense to add it to the equity real estate business in the first place. “The approach we take to underwriting an equity piece or a high-yield debt piece is very similar. And our clients look at it as an interesting, downside-protected way of accessing real estate and getting equity-like returns, which happens to take the form of debt.”

By contrast, Durning says his investors, the Prudential Financial general account and other third-party clients, “are looking for a fixed-income type return. Most of our investments will mimic the performance of investment-grade bonds”.

However, he adds, “there is a portion that we do that is higher-yielding, but is still something that would be of interest to a fixed-income audience”. At the same time, says Adler, “in the US, what we’ve found is that the markets have become more sophisticated and competitive, and as they have, the line between high-yield and traditional debt has gotten blurred”. These, they say, were the reasons they decided to work jointly on high yield in the US.

Co-operation could bring more deal flow too. “We’re harnessing the power of the organisation,” Durning continues. “When you put the equity and debt sides together we’re the largest investment manager globally and we have very large sourcing networks. So we want to make sure we fully leverage our resources for our investors.”

International expansion

Durning’s other area of focus will continue to be pushing expansion of the commercial mortgage business internationally. Like US competitors such as MetLife, MassMutual and TIAA, which also have books of real estate mortgages running into the tens of billions of dollars each, originating new investments overseas is a way to keep up with the voracious appetites of their parents who need yield, as well as to add opportunities for diversification, and some fee income via investment management for other clients.

After setting up in Japan six years ago, an office opened in London in 2013 to lend in Europe. The business also writes mortgages in Canada as well as Australia and Mexico which are both countries where PGIM has real estate equity experience.

Durning hopes to lend at a rate of at least $1 billion a year in Europe, though “we wonder if it will be less busy this year” due to the EU referendum slowdown. In 2015, $1.3 billion out of $1.9 billion of new international loans were written in Europe and about two-thirds of that business was from the UK.

The London-based team, originally headed by Drew Abernethy and now by Bryan McDonnell, has lent several times in the Netherlands, once in Germany and last year for the first time in France and Spain when PGIM REF financed a logisitics portfolio. Asset classes have included hotels, self storage, student housing and car parks as well as offices and industrial.

“Our international clients want to simplify their own financing lines, so part of our value to them is to be a lender they can deal with who might use similar financing structures and strategies in Europe as in San Francisco or Toronto,” PGIM REF’s CEO observes. “Plus the international strategy gives us the opportunity to invest in one place when frankly another market might not be as attractive at that time.”

PGIM REF is seeking regulatory approval to lend into other jurisdictions, including the Nordics and Ireland but Durning would be just as happy to write more business in the UK, where among other things, the team is interested in more lending in London and in the emerging PRS build-for-rent residential sector. “We have very low exposure in London compared to other world cities where we invest. So we’re not in a hurry to get to other markets.”

Deciding where to play

Concentration on the deepest, most liquid real estate markets is also uppermost in Adler’s mind. The way to run a profitable real estate fund management business is changing. Three years into his CEO role, he has been cutting back on the number of locations PGIM Real Estate invests in and shrinking the number of its products. “We’ve got tremendous experience but it’s time to decide where to play.”

This has brought its challenges, he hints. Across all asset classes, the PGIM business model is to allow leadership teams responsibility for investment and business performance within global standards of controls, risk management and compliance. In real estate, “which is a very local business”, there have been a lot of autonomous teams since the business embarked on a period of rapid expansion from the 1990s.

He says: “The trick is, where to install centralised discipline and where to let the teams run free. It’s easy to come in and say, ‘fewer products, bigger products’, but getting teams to buy in and saying ‘those who don’t are in the wrong place’ is hard for any manager.”

Some left, including the team headed by David Pahl who in 1994 started the $1.5 billion US Property Fund series for German investors wanting US exposure.

Adler reckons PGIM Real Estate “has had as many as 65 to 70 different funds, although those aren’t all different strategies: some of them are the same series; some are separate accounts. I think we can get that down to under 50, maybe 40, and that will largely cover it. Fewer products, larger products, sustainable products that match what our large institutional clients need.”

In Europe alone, during 30 years of investing, assets were acquired in 23 countries, and going forward, Adler has pared this back to six core destinations: the UK, Germany and France, the two “main peripherals” Spain and Italy, and potentially Poland. The European high-yield debt fund has made investments in Benelux and the Netherlands, and “we’re sparingly investing in the Nordics where we’ve invested in the past in residential and we have some shopping centres. Everything else is off the table”.

The sentiment is the same in South America where the focus is trained on Mexico, a country where PGIM has been a leading investor for many years, and also in Asia. Two months ago PGIM closed its latest pan-Asia fund, Asia Property Fund III, with €580 million of capital. Like some of PGIM’s US funds, the Asia series can pursue value via a range of investment styles in a single fund, from core to value add and including debt – one of that fund’s first deals is providing a subordinated loan to assist the funding of a development at Wentworth Point, Sydney.

But it will invest only in Japan, Australia, Singapore and China, with the option to go from Singapore to Malaysia and to South Korea. “We’ve done a lot of residential in Thailand in the past for example,” Adler says. “Money can be made there but we’d have to invest a lot of our energy to continue and we’ve decided not to.”

Nervous investment market

Last year PGIM Real Estate completed $14 billion of acquisitions and dispositions globally in 257 transactions. It still sees plenty of good deals, but like other investors, Adler says it notes the new caution in some of the world’s biggest property markets brought on by very low cap rates. Investment volumes have slowed in the US which accounted for $9.5 billion out of 2015’s $14 billion PGIM tally, compared to $2.5 billion in Europe, $1 billion in Latin America, $500 million in Asia and $465 million in high-yield debt.

The group hasn’t bought much in London, “which I compare to the hottest of the US gateway cities. Trying to do scale in London now is very difficult if you want to keep disciplined”.

PGIM sees different markets “de-correlating” around the world and so Adler believes “it is a great time to be picking and choosing where you want to go. But it’s masked by the fact that cap rates are low everywhere. So you’ve got an investment market that’s very nervous.

“In the US it’s just been four straight years of uninterrupted growth across all the asset classes…..People are asking ‘how long can this party last?’ You need to look through that to the underlying supply and demand dynamics.”

Adler’s vision for PGIM Real Estate is a business “with a coherent product architecture” anchored by large, diversified, pan-regional open-ended funds and value-add funds and a modest number of additional very targeted specialist strategies, like the senior housing fund series in the US for example. The holy grail is to add in both Asia and Europe a relative-return, benchmarked open-ended product like the “bread-and-butter” PRISA fund in the US and equivalent value-add products.

With this goal, it is interesting to hear from Adler that the American institutions which feature prominently in PGIM’s roster of 500 investing clients “seem more interested in European core than I’ve ever seen before…Cap rates are low everywhere and they are starting to see that Europe can be a place where, if you pick the right managers, you can get steady income growth for a while.

“And so, this holy grail is looking more do-able than ever.” And it’s certain that whatever the next new product is, it will be branded ‘PGIM’.

Radkiewicz’s European high-yield debt team has £1bn fund in its sights

Six years, five funds and more than 60 deals later, the European high-yield debt team established for PGIM Real Estate by Andrew Radkiewicz and Andrew Macland is raising its sixth and largest fund.

Targeting £1 billion of capital and a 12 percent net IRR, 6 percent of it coupon-based, European Debt Fund VI has received commitments from a range of PGIM’s large stable of US pension plan clients, including Pennsylvania PSERS, New Mexico SIC and Texas Teachers. PGIM is co-investing $50 million.

Fund VI will invest in Western Europe with at least 70 percent of deals in the UK and Germany and up to 30 percent potentially available for other markets. Target sectors are office, retail, industrial and residential with up to 15 percent possible in others such as hotels or healthcare.

The fund lends mezzanine and preferred equity and structured loans such as whole loans where the team will syndicate senior pieces, typically after the borrower has had time to implement asset management plans.

The strategy is to allow as much flexibility as possible within one fund in line with the wider PGIM Real Estate’s focus on large, investor-friendly funds. Previously, the high-yield team has done deals outside its main funds where they couldn’t be accommodated within the fund strategy. It set up a separate fund (Fund V) to invest on behalf of Dutch investor APG in Dutch debt and Fund VI is the follow-on fund to Fund IV, which raised €820 million in 2013 and has returned a net IRR of 15.1 percent.

Radkiewicz became global head of real estate debt at PGIM Real Estate after Jack Taylor left and is expected to be involved in future plans for the US high-yield debt business.