Listed opportunity is ripe for US debt funds

The time is right for two major private equity firms to be taking their real estate debt platforms public, writes Meghan Morris.

Besides a three-initial company name, TPG and KKR share other common threads, including the trajectory of their real estate debt businesses.

The platforms began operating just two months apart in 2014, KKR Real Estate Finance Trust with $838 million (€752 million) in equity commitments and TPG Real Estate Finance Trust with $767 million. Now, the debt platforms are hitting the public markets within months of each other, with KKR raising $210 million in its May initial public offering andTPG ling inApril with the Securities and Exchange Commission to go public.

The two private equity giants join peers including Starwood Capital Group, Black- stone and Apollo Global Management that entered the public markets with their real estate debt platforms in years past. However, the time is now particularly ripe for both debt businesses to go public and create a stable capital base.

TPG and KKR have both achieved scale, with the former amassing a $3 billion commercial real estate debt portfolio and the latter a $1.1 billion portfolio as of March 31. With size, brand and track record established over the last three years, along with significant GP co-investments that signified alignment, the companies ticked the right boxes to then consider the public markets.

While both firms have long had the backing of institutional investors, they are now seeking to diversify their investor base, to provide a cushion in case institutional investors decide to turn away from real estate in a downturn or a portfolio reallocation.

TPG’s and KKR’s private equity peers paved the way for the new entrants, in that investors were already familiar with listed real estate debt REITs as a product. Compared with the first iteration of mortgage REITs, which used high leverage and made riskier investments, real estate debt REITs now adopt lower leverage levels and are more conservative in their investments, which make them appealing to investment managers like Makena Capital Management and Colony NorthStar, which are KREF’s top non-KKR shareholders.

Returns

Public markets investors typically have lower return expectations than those investing through private debt vehicles.This allows the REITs to be more flexible than they can be as private entities if their opportunity sets change, allowing them to shift in focus from subordinate loans to mezzanine, for example. The platforms are therefore more competitive long term in a commercial real estate world with ever-changing players.

Investors’ lower return expectations also decrease the lenders’ cost of capital since they use less leverage, savings they can pass on to borrowers.A lender’s lower cost of bor- rowing is key as a market differentiator for a space that has been filling up with non-bank lender entrants since banks have pulled back on lending post-GFC.

A flexible mandate further allows REITs to be less dependent on partners in other areas of the capital stack. For example, a REIT may not need a major bank as an A-note participant in a deal if it can take the more senior position, not restrained by the need for a higher-yielding subordinate loan.

The public market has its drawbacks, to be sure. Some deals lend themselves better to private debt funds, such as a major trans- action that will cause a larger drawdown, than a REIT,whichhasquarterlymetricsand cash ow needs to consider.

Also, for both debt and equity REITs, the public markets are typically the proxy by which people express concern or excitement about an industry, leading to potential for volatility. At the end of last year, some REITs struggled with trading below net asset value, so many companies were buying back shares to remove the discount instead of investing the capital in the real estate debt market.

Despite these concerns, TPG’s and KKR’s peers’ success in the space bodes well for the new entrants. Blackstone MortgageTrust, for example, traded 15 percent higher in mid- June than it did at the same time in 2016, and stock for the real estate debt platforms from Starwood, Apollo and Ares were likewise all higher priced over the same period.

Following years of preparation, KKR’s May IPO demonstrated the rm’s ability to bring a product to market that found institutional reception. After TPG, who’s next?

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