Co-investment: Partnership offers big players control of the property game

Pension and wealth funds seek control via separate accounts and partnerships, writes Jane Roberts

Four years ago, after the financial crisis, property investment pundits predicted that large international investors would shun co- investment funds and deploy their dollars, euros or pounds directly into real estate, or through joint ventures or club deals.

Without a shadow of a doubt, that is what has happened. In Europe, as elsewhere on the international stage, cash-rich Dutch, Canadian and Asian pension funds, as well as the Middle Eastern and other sovereign wealth funds that have been buying the biggest assets, have usually preferred to deploy their capital this way.

They want control and they want to be close to the real estate, and if they mandate an investment manager, it is as likely to be on an advisory as a discretionary basis.

“It used to be funds only, plus segregated accounts in the CBRE Investors business,” says Pieter Hendrikse, chief executive, Europe, Middle East and Africa, at CBRE Global Investors, speaking of the recent past, before ING REIM and CBRE’s merger a year ago to create CBRE Global Investors.

“In Europe we used to have some separate accounts as a side car to funds,  or joint ventures in big buildings. Now we see more and more segmentation of large investors that don’t want a fund with 25 investors any more – and that is growing. In future we will talk more about structures and separate account mandates than about closed-ended funds.”

Hendrikse stresses that closed-ended funds will not disappear altogether and that there can be too much focus on structures. “Ultimately, you are responsible for the performance of an individual building; you can scale everything else on top of that.”

However, as with other investment managers that once operated in a growing funds market, the changes have meant that CBRE GI has scrambled to re-cast its business model. “Initially it was a bit uncomfortable,” says one senior manager in a big investment management business.

“Sovereign wealth funds and large investors are looking to investment managers such as ourselves to provide the services. They came and said: ‘We respect you as investment managers but we don’t want to give you a discretionary account.’ They are being quite cute and getting access to our knowledge without having to commit huge sums of money to one manager.”

Investor requirements are challenging

The loss of those “huge sums of money” is taxing investment managers – they need to replace the discretionary income – while the variety of bespoke requirements that international investor clients may have is another challenge.

“Some investors are awarding mandates with certain controls, but the strategic buying and selling decisions need to be approved by the client, and in our experience they are advisory only with no decision-making authority,” says Giles King, Europe, Middle East and Africa head of investor services at CBRE Global Investors.

CBRE GI has European mandates from  at least three South Korean and Malaysian pension funds. These are advisory and in some cases the clients also use other managers – including RREEF (see table) – for the same, or for different strategies.

“An Asian investor may look at it slightly differently to a Middle Eastern investor or to a US investor,” King says. “There are different approaches to accessing real estate, so you have to be flexible and managers are adapting. The main activity is with our Asian clients and we’re seeing strong capital flows into London.”

The incentive is that acquisition fees  for a typical international advisory mandate are on the high side, to compensate for  the higher risk: 0.5%, according to one manager, of what are £100m-plus transac-tions. They are also supplemented by ongoing management fees and there may be a disposal fee.

Few Asian investors or sovereign wealth funds have local teams, which is one reason why they like to use investment managers or co-invest, rather than buying direct, says LaSalle Investment Management’s European CEO, Simon Marrison.

“A broker can help you with asset selection, but are they aligned over time? Investment management is more strategic than just buying some buildings,” he says.

Local staff and structures needed

“There will be asset management that can drive asset value and to do that you need to have people on the ground. You need to have a holding structure to manage, depending on the country the asset is held in, and to be tax efficient, and that is more complicated if you multiply your investing strategy by numerous countries.”

BNP Paribas Real Estate Investment Management decided to restructure a year ago, putting segregated accounts and club deals under Karl Delattre in a new division called strategic investment asset management (SIAM).

Delattre and chief executive officer David Aubin recruited Lucie Bordelais Charneau as international head of strategic invest-ments to work with these clients.

“Large investors want a more bespoke approach,” Aubin believes. “They require a lot of structuring and assistance with due diligence, then management of the assets.”

On the whole, this has tended to favour the biggest managers with the largest teams operating in multiple jurisdictions, though there are exceptions.

More experienced international investors with their own European teams may pick smaller best-in-class managers: for example, Singapore’s sovereign wealth fund GIC has discretionary mandates for specialist assets with Orchard Street Investment Management and UNITE (see table).

Co-investment is now essential in any discretionary structure, which for large transactions favours the largest investment managers. “You have to be prepared to co-invest,” says Marrison. “It demonstrates your belief in the asset and your commit-ment to the asset management strategy.”

LaSalle’s parent company, Jones Lang Inc, has a co-investment alongside Quantum Global in its Plaza Global Real Estate Partners club, which is targeting $1bn of stock (see p20).

New investors join the old hands

Some of today’s most active international investors are old hands in Europe: GIC, the Abu Dhabi sovereign wealth funds, Dutch pension funds and Canadian institutions such as the Canadian Pension Plan Investment Board are active because they have cash and see opportunities now, but new or relatively new players are crowding onto the pitch.

Ontario pension fund OMERS has only been investing internationally, via Oxford Properties, since the mid 2000s. Paul Brundage’s London-based team has done a string of deals in the past 12 months and is now looking for assets in Paris and German cities.

Canadian pension funds Healthcare of Ontario Pension Plan (HOOP) and Public Sector Pension Investment Board (PSP Investments) are relative newcomers.

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HOOP is co-investing with the Crown Estate and PSP is partnering with Grosvenor and London & Stamford – soon to be renamed London Metric. “Some are recruiting in-house for Europe and many have capable teams back home,” says Marrison.

One such example is ADIA, the Abu Dhabi Investment Authority, which in 2012 made its first investments in Europe for five years, after beefing up its European real estate team over the past three years.

ADIA is buying a portfolio of Marriott Hotels from RBS and has just structured a complex transaction to buy a Belgian office complex, with 12 banks, including the asset’s shareholder, Icelandic bank SJ1. The three-building, 678,000 sq ft Zuiderpoort acquisition is the largest transaction in Belgium for several years, according to selling agents Savills and DTZ.

The number of large Asian investors targeting London property is also growing, with Chinese sovereign wealth funds China Investment Corporation and Gingko Tree Investments having bought assets there this year.

CIC, which has previously invested via clubs and funds and is an investor in Canary Wharf, is buying its first direct UK asset, Winchester House in the City, in a deal structured by Invesco Real Estate.

Gingko Tree branches out into London Gingko Tree is owned by the Investment Company of the People’s Republic of China,  a vehicle of the Chinese Government’s State Administration of Foreign Exchange. The company is buying 40% of student housing developer University Partnerships Programme from Barclays, and will be joint owner with PGGM, which bought the other 60% in September. Gingko Tree also bought City office building Drapers Gardens earlier in the year, advised by RREEF.

As well buying drier assets, international investors are channelling capital into development or more active asset management projects, filling holes that would once have been plugged with debt.

Property companies, meanwhile, woke up early to the opportunity to co-invest. UK-quoted Grainger’s new German joint venture includes the National Pension Service of Korea and is in line with the residential company’s stated strategy to align itself with third-party institutional capital to make more efficient use of its balance sheet.

Co-investment has been used to reduce development risk by the likes of British Land, with Oxford Properties, on their Leadenhall scheme in the City; Land Securities, with CPPIB, at a project near Victoria Station; and Meyer Bergman, with two Canadian pension funds, on the development of a Bradford shopping centre.

There is an opportunity for investors to partner with the best and acquire assets at better returns than simply buying them after they are completed (see table). If these deals go well, international investors are unlikely to switch their capital back into funds in any great way, meaning that separate accounts and co-investing are likely to become an essential part of investment managers’ businesses through more than just one capital markets cycle.

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Joint-venture agreements include the key to deadlocks

Property joint ventures are usually structured as 50:50 ‘deadlocked’ co-investments, with  clauses determining how deadlocks over key issues are to be resolved – especially for chunky deals involving large pension funds or sovereign wealth funds.

“Deadlock 50:50 ventures are very typical for sovereign wealth funds,” says Giles Elliott, a partner at law firm Jones Day.
“That way they get complete alignment of interest, as opposed to investing in a fund structure.”

Jones Day advised British Land on its new joint-venture ownership agreement with Norges Bank Investment Management, after Norges bought London & Stamford’s 50% shareholding in the Meadowhall shopping centre in Sheffield this year.

“Many of the normal pre-deal structuring considerations had been addressed back in 2009, when British Land partnered with London & Stamford,” Elliott says.

“The joint venture between Norges and British Land is a straight deadlock 50:50 agreement and with these types of venture, the relationship between the parties is pretty crucial. There was an excellent understanding between them on how they saw Meadowhall going forward.”

Provisions concerning liquidity and investors’ exit strategies are less standard. Jones Day recently analysed termination provisions in 19 property joint ventures, many of which feature in the table on p17. It found that just over half had a non-disposal period, but it tended to be short (three years in half these cases) or linked to a specific event such as an initial public offering.

Two-thirds have provisions for escalation of the dispute to senior figures in the respective organisations in the case of deadlock, while between 80% and 90% have pre-emption rights. The most common is rights of first offer, where the seller gives the right to the non-seller to acquire its stake at a specified price.

As expected, the most common events of default are insolvency and material breach.

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