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Historic returns

Heitman started four decades ago as a mortgage origination shop. Today, the firm has $20 billion in assets around the world. PERE recently spoke with firm head Maury Tognarelli about Heitman's history, its pioneering move into Central Europe and where the company is headed next. By Aaron Lovell

Heitman president and chief executive officer Maury Tognarelli got his first taste of the real estate business growing up in Chicago. As his family grew, his parents continued to move the Tognarellis into larger houses—but kept the former residences to rent out.

“I got my first taste of that growing up,” he says. “I was on the maintenance team.”

These childhood property-management chores soon transformed into academic and professional interest, as well.

Tognarelli first worked at venerable Chicago real estate firm Heitman while studying for his business degree at Indiana University. As an undergraduate he returned to his hometown to intern at Heitman. He's worked there ever since.

After graduating in 1983, he joined the firm's private equity acquisitions group, which was scouting core assets for the company's separate account clients.

“It was a business that was fascinating to me,” Tognarelli says of his early interest in property. “It was more appealing to me at the time than stocks or bonds, because of the unique nature of each investment [in terms of] the asset, its location and what makes it successful.”

In 1992, he became the head of the acquisitions group and, in 1999, became president and chief operating officer. In 2002, he was named chief executive officer.

Over the past 25 years, as Tognarelli has moved through the ranks at Heitman, the firm itself has undergone rapid expansion of its business lines, moving from core properties and separate accounts to all manner of commingled funds across the globe. The firm currently has just over $20 billion invested in direct and indirect real estate investments on behalf of institutions, pensions, foundations, endowments and high net worth individuals from the US and abroad.

Mortgaging the future
Founded in 1966 by Norman Perlmutter as a mortgage origination and servicing shop, Heitman began investing in property about a decade later. By the mid-1990s it had acquired a series of funds from legendary Chicago investment house JMB Realty and was pursuing opportunities in the then-emerging markets of Central and Eastern Europe. By this time, Heitman had transformed from a mortgage-focused firm to one where 75 percent of its business was in fund and separate accounts investments.

As the firm enters its fifth decade, Heitman recently closed its second fund focused on value-added real estate opportunities in the US, Mexico and Canada. The firm is hoping to replicate the success it has enjoyed Central Europe in the Russian market. The firm also has plans to begin investing from its Tokyo office sometime next year.

Tognarelli puts Heitman's evolution in the context of the larger changes in the real estate market during the 1980s. At that time, Heitman was largely looking to invest in large pools of assets, diversified by geography and sector-type, for its separate accounts clients.

“As real estate began to evolve and you started to see specialists executing core strategies, specialists executing opportunistic strategies, and specialists executing value strategies, that's when Heitman started to expand what it had been doing for separate accounts in the core and value space and started offering value strategy funds,” Tognarelli explains.

In 1994, Heitman acquired the investment management business of another well known private investor in the Windy City—JMB Realty. In that acquisition, Tognarelli says, Heitman acquired JMB's leasing, property and asset management businesses, as well as 13 commingled funds that JMB had raised in the 1990s and some of its separate accounts clients.

“It was a synergistic opportunity,” Tognarelli says of the acquisition. “JMB's institutional investment management component really was a nice fit to Heitman's institutional investment management business, whereas our separate account relationship business was much larger compared to our commingled fund business. JMB's was the opposite: their fund business was much larger than their separate accounts. The assets were not overlapping. There were similar clients on both sides. Both being Chicago funds, it was an easy integration and would allow the firm to command a larger market share overall.”

The firm has since launched a series of decidedly more opportunistic funds, first in Central Europe in the mid-1990s, and, beginning in 2005, in North America. The firm's first US-focused fund, Heitman Value Partners, closed on $400 million, surpassing its $250 million target. Earlier this year, it closed a second North American vehicle on $800 million with commitments from 20 limited partners. These funds, Tognarelli says, grew out of the core investing the firm had been doing for years.

“We are value investors, whether it is in public market executions or private market executions,” Tognarelli says of the strategy. “We look for inefficiencies that we can take advantage of and return above-average returns to clients without the associated risk. So when you think of it from our perspective and the nature of our core investment strategy, investing in value-added strategies is just natural. It's part of our philosophy.”

He says the recently closed Heitman Value Partners II is around 45 percent committed. Like its predecessor, the fund will focus on retail, industrial, office and residential investments, as well as more specialized sectors like medical office, senior living, student housing and self-storage—bets that in the past have panned out well for Heitman.

“In some cases we've invested in strategies similar to ones where we placed money in the first fund,” Tognarelli says. “In fund two, we've added to the strategies, including data center opportunities that we've recently felt were very attractive.”

This has lead to a recent acquisition of a data center in the San Francisco area. Heitman has been very good about being in the right place at the right time with these sorts of investments—Tognarelli describes this as the result of careful research.

“What we've done very well is identify areas ahead of the curve where there was some type of a capital market imbalance or some type of property market inefficiency that—with our research—we were able to identify ahead of others and collect investors to be able to execute the strategy and get in there and take positions,” he says. “We were able to do that in self-storage in the 1990s. We were able to do that in student housing in the early 2000s—and then followed by medical office.”

“Whereas in Western Europe, you would pay something like 6 or 7 percent for an office property, in Warsaw—just an hour away from Germany by plane—you were receiving 10 or 12 percent for the same credit from a Western national firm.”

European opportunity
One place Heitman invested before most other firms was Central Europe. Beginning in the mid-1990s, the firm began looking at investing in these emerging markets, particularly Poland.

“From our perspective it was really just the result of good research and understanding the risks and being able to make a compelling argument for support from our clients,” Tognarelli says of the move onto the continent.

“We saw what we perceived to be in Central Europe a capital-markets opportunity in the sense that the risks that were being perceived at the time by the capital markets in that area of the world significantly exceeded the real risks,” he says.

Heitman and team believed that the risks in Central Europe were lessening by the mid-1990s, as formerly communist governments became more democratic, economies stabilized and countries prepared to join the European Union and NATO. These economies were also becoming more attractive for foreign investors. The fact that these markets were dollar-based helped, too.

“We thought that the pricing… was very attractive,” Tognarelli explains. “Whereas in Western Europe, you would pay something like 6 or 7 percent for an office property, in Warsaw—just an hour away from Germany by plane—you were receiving 10 or 12 percent for the same credit from a Western national firm; a dollar-denominated lease so there wasn't any currency risk; and if you believe that those countries would ultimately migrate into stabilized political and economic regions, than you knew you would get returns not only from the real estate, but also from the compression in valuation rates that would occur. That's exactly what transpired in Central Europe between 1995 and today.”

As the firm expanded into Poland, Heitman ended up working with Chicago-based operating partner Golub and Company, which had an operating arm in Poland, and US life insurance company Northwestern Mutual, to develop the Warsaw Financial Center, a landmark office property in the region and a landmark deal in Central Europe. The European Bank for Reconstruction and Development also provided financing for the project.

Considered to be the largest office project in Eastern Europe at the time, the building was a 33-story high-rise that was completed in 1999. In 2005, the investor consortium sold a 77 percent stake in the project to Pramerica Real Estate Investors and Austria-based CA Immo AG for an undisclosed amount.

Looking at the deal, Tognarelli says Heitman was comfortable with the investor consortium, the dollar-denominated leases and the tenants, which were largely Western firms just starting to move into the Polish market. Obviously, the projected returns were very attractive, as well.

“Essentially we were able to be a participant in the development of what is—or was considered at the time—one of the highest profile buildings in the region,” he says. “It really has great visibility and identity within the marketplace.”

Following Heitman's lead, a number of private equity real estate firms from the US and Europe have invested in the property markets of Central and Eastern Europe. These days, the transparency is better and there is more liquidity—and more competition. In fact, Tognarelli says, it's becoming very similar to Western Europe.

“They are operating as Western regions do and the capital markets price it accordingly,” he says. “I do think it's competitive.

It's not London, it's not Paris. [But] to be in Warsaw or to be in Prague, I don't know that there's that big of a distinction any longer. There may be some pricing differential, but it's nowhere near what it was in 1995.”

In late 2002, Heitman closed its second vehicle focused on Central Europe on €175 million, called Heitman Central Europe Property Partners II. The fund's expanded geographic mandate included expanded Slovakia, Slovenia, Latvia, Lithuania, Estonia and Romania. Last year it closed on a €350 million third European fund.

Even a decade on, the firm continues to have a presence in the region—and is still expanding. In early 2004, after nearly 10 years of investing in office, industrial and retail projects, Heitman announced its first residential project in Central Europe, a joint venture with Engel General Developers to build €240 million in housing on seven sites in Hungary, Poland and the Czech Republic.

Heitman at a glance

Founded: 1966
Headquarters: Chicago
Other offces: Minneapolis, Los Angeles, London, Luxembourg, Frankfurt, Moscow, Tokyo
Assets under management: $20 billion
Private equity real estate: $12.4 billion
Public securities: $5.3 billion
Real estate debt: $2.3 billion
Key personnel: Maury Tognarelli, chief executive officer, president
Jerry Claeys III, chairman
Roger Smith, chief financial officer
Recent funds: Heitman Value Partners II Fund ($800 million; 2007)
Heitman European Property Partners III Fund (€350 million; 2006)
Heitman Value Partners ($400 million; 2005)