Diversifying Deals

Commercial real estate plays many roles in the current private equity surge.

Several key attributes of the private equity industry underscore its growing importance in the U.S. commercial real estate market. Specifically, private equity groups raised $215 billion in 2006 and are projected to raise $400 billion in 2007, according to CFO magazine. In addition, more than $197 billion of private equity-driven mergers took place in 1Q07, and more than 900 companies were taken private last year, according to Forbes magazine and Investment U research. Much of that activity involved commercial real estate in some capacity.

A Multifaceted Role
Commercial real estate is unique in its role as contributor, target, and beneficiary of the recent private equity surge. Commercial real estate-based private equity deals have used liberal amounts of debt to acquire companies based upon enterprise cash flow and underlying asset values. A key asset, corporate-owned real estate often is pledged as collateral for debt or sold to pay down debt and generate investor returns. Undervalued and excess corporate real estate often is stripped out and sold to private investors who specialize in repositioning such assets. For example, Kohlberg, Kravis, Roberts & Co. acquired Toys R Us in 2006 and subsequently formed a joint venture with Vornado Realty Trust to maximize the real estate portfolio’s value.

Increasing amounts of private equity cash also are targeting commercial real estate as narrowly segmented investment funds search for new asset classes. A prime example is the Blackstone Group’s $38.9 billion acquisition of Equity Office Properties earlier this year. Competitive bidding drove up the portfolio’s price, and then Blackstone quickly sold off a portion of the acquisition, which reflects the multifaceted role real estate plays in the private equity arena.

Finally, without question commercial real estate is a beneficiary of the recent rise in private equity. Specifically, the real estate market has benefited from venture capital, mezzanine financing, and hard-money loans that complement, and sometimes displace, traditional real estate funding sources. Real estate capital sources have grown rapidly in past the few years with the substantial amounts of private money available.

It is difficult to judge private equity’s long-term effect on commercial real estate based upon the past few years’ activity. By nature, real estate is a long-term investment: The recent capital flows and transactions represent shrewd financial engineering rooted in the substantial liquidity in the marketplace. Buyouts certainly have created an urgency for companies to unload or unlock their real estate holdings’ value, and abundant real estate capital has supported increasing asset values in all commercial property categories. However, it also has supported transactions that may not stand the test of time.

Thomas Wenkstern

Thomas Wenkstern is senior vice president of UGL-Equis Corp. in Dallas. Contact him at (972) 763-4100 or thomas.wenkstern@equiscorp.com.