In the current lackluster environment for huge
private-equity deals and leveraged M&A buyouts that marked the previous
boom cycle, Blackstone Group LP has increasingly shifted its focus tocommercial
real estate investments. The firm, credited with timing the market perfectly in
the previous cycle with its acquisition and subsequent sell-off of the former
Equity Office Properties portfolio, is hoping to again capture lightning in a
bottle as investor demand heightens for core property assets in leading U.S.
and European markets.
Despite the improving economic landscape, Blackstone's net
income for its four main business segments fell 24% in the first quarter as the
growth in the values of its asset slowed, including a 23% drop in Blackstone's
real estate business from first-quarter 2011.
There appears to be a strong foundation behind the volatile
quarterly numbers, however. Blackstone reported $190 billion in assets under
management as of the end of the first quarter -- up almost 27% from a year
earlier -- including $48.3 billion in real estate, which was up 38% from a year
ago.
CRE generated the firm's highest revenue volume during the
quarter at $427.2 million. Steadily improving fundamentals drove a 4% increase,
or $1 billion, in the value of Blackstone’s carried portfolio, with the
majority of value appreciation in the firm’s office and retail properties.
Blackstone’s credit business posted $50.8 billion under
management, up 61% from last year, followed by smaller growth in private equity
and hedge funds.
Tony James, president and chief operating officer, and
Stephen A. Schwarzman, CEO and co-founder of the private-equity and alternative
investment titan, attributed the decline in profits to continuing global
uncertainty. But in calls with reporters and investors, they both expect
business conditions will improve in the second half of 2012 and into 2013, and
also noted that Blackstone has accumulated nearly $38 billion in dry powder for
acquisitions.
"[CRE] deal flow is robust as the investing environment
has remained favorable given the amount of distressed assets that need to
deleverage around the globe," said Schwarzman, the legendary private
equity financier and investment banker. "With little new supply and slowly
increasing demand for commercial space, fundamentals continue to improve from
the lows of the cycle. This has resulted in occupancy improvement and rent
growth in most of our core markets."
"For key office assets in the United States, occupancy
is up 300 basis points versus the prior year. In Northern California, our
strongest office market, site of the tech boom in the United States, office
rents are up more than 15% from the prior year. This gives you some sense of
what happens when the law of supply and demand reasserts itself."
To take advantage of the upswing, Blackstone's James noted
that the company could divert more of its capital raising efforts into core
commercial properties, as well as funds in Asia and other emerging markets. The
firm already tops all private-equity fundraisers in CRE, with its Blackstone
Real Estate Partners VII accumulating $6.6 billion in the first quarter.
"Investors are hungry for yield, they’re hungry for
inflation hedge, and we have, of course, tremendous market knowledge and
ownership of assets throughout all the major regions," James said, noting
Blackstone's successful closing of its global flagship fund in February.
In an asset class where fundraising has proven extremely
difficult of late, Blackstone has raised over $10 billion of total capital,
with a couple of billion more in commitments over the course of the year,
"which will make it the largest real estate opportunity fund ever raised
and multiples in terms of size of our nearest competitors, where that multiple
of size gives us the ability for competitive purposes to do larger and more
complex deals," Schwarzman said.
Blackstone is seeing similar trends in hospitality as in
office and retail, with virtually no new supply and modest increases in demand
leading to U.S. RevPAR gains.
"Positive absorption and declining vacancy is also
evident in our industrial, retail, and senior living assets," Schwarzman
said.
He also noted that Blackstone acquired a large portfolio of
grocery-anchored shopping centers last year from Brixmor, formerly Centro
Properties, in the largest deal in the world of any leverage type since the
collapse of Lehman Bros. nearly five years ago, where occupancy is at its
highest level since 2009 due to accelerating leasing activity.
Schwarzman said although improving, real estate debt markets
are still constrained and competition for large complex transactions remains
limited -- which is a good thing for Blackstone, one of the world’s largest
providers of debt and equity capital. The firm deployed or committed $2.3
billion in capital in the first quarter, with 40% of this in Europe.
In addition to the retail power center portfolio acquired in
an off-market transaction from highly leveraged Brixmor, Blackstone has
acquired high-quality distressed industrial portfolios in the U.S. and the
U.K., and most recently agreed to buy 65 U.S. warehouse properties from
Australia-based Dexus Property Group, for $770 million. Blackstone also
recapitalized Parc 55, a 1,000 room hotel in San Francisco, one of the nation’s
strongest hotel markets.
"This is the distressed wave that people have been talking
about. All are being purchased at a significant discount to replacement
cost."
In terms of dispositions, Blackstone has sold or has under
contract to sell nearly $800 million in assets so far in 2012, includes the
sale of Pearlridge, a mall in Hawaii which closed in the second quarter.
Schwarzman noted Blackstone's sale of $1 billion in assets in the last 12
months, completed largely at significant premiums to carrying value.
"Although we were delayed in the second half of last
year with some of our plans for realizations due to market turbulence, the
market appears to be opening up more, particularly for properties that are
stabilized. As such, we expect more asset sales in the second half of this year
and into next year."
Schwarzman acknowledged that the limited partner investors
that drove such deals as the EOP acquisition "have been basically
traumatized by their experience in opportunity real estate," with many
casualties in the private-equity space during the downturn due to loan
maturities that couldn’t be refinanced.
"A large number of our competitors have gone out of
business and they’ve gone out of business because they were buying leveraged
real estate at very high prices," he said.
Company proposals to Blackstone for potential equity
infusions and refinancing offer "almost the same deal with different
names, where some piece of real estate was bought by somebody, it’s valuation
is in some cases down 20%, it needs sometimes more, it needs way more equity to
refinance it to the extent that they can live in a world of changed (lending)
ratios."
"Who’s going to put that money up? There are very few
people around who will actually do that and we are the dominant group left in
the world that will do that, so people come to us all the time."
Capital providers and their consultants who funded those
busted deals remain extremely cautious about exposing more money to this
sector, passing on opportunistic deals in favor of reliable core real estate
that don’t required much additional reinvestment or debt.
"What they’re worried about isn’t maximizing return;
they want some exposure to the asset class. They just don’t want to live
through these losses again."
"So I think this asset class is going to stay under
invested in, even though the opportunities are actually terrific. There will be
a few firms that raise funds, as they have, but those will be relatively small
funds compared to what most of them have done previously."
Blackstone does not expect realized income from investments
to peak until late this year and into 2013, mostly because its assets,
especially real estate are appreciating rapidly, with robust underlying
portfolio performance.
"Why give that away? We’ve got a wonderful compounding
going on. We’ve got rents going up, we’ve got occupancies going up, we’ve got
debt going down, and they’re leveraged. And I don’t understand, frankly, this
focus on premature liquidations. We’re in the business of managing money."
James attributed that to a combination of factors, including
shrinking stock, no new supply, the improving economy and the release of
pent-up leasing demand from 2008-10.
"All of that is coming through now and I think it’s
going to be good. I hope it will be even better, that the economy will at some
point get a bit more robust growth. We want to wait for that to happen, if it’s
going to."
In explaining the delayed realizations in real estate
disposition, "we tend to actually realize significantly more than that
mark," Schwarzman said. "And given the volatility of the market, it’s
very hard to get this right."
As lending ratios improve from 60%-65% to 75%-80% of loan to
value, the rising value of properties that Blackstone holds "will go
almost dollar for dollar to us as the holder of the real estate,"
Schwarzman said. At disposition, the return on equity for the new owner will be
about the same, but will push up the sale price beyond the simple fundamentals
of increasing rents and increasing occupancies.
"Giving that up to satisfy some type of target for
realizations is something we just wouldn’t do," he said.
