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SPECIAL REPORT: From small acorns

KKR has a titanic reputation in the world of private equity, having grown into a global business with $61 billion in assets under management. Its hire of Ralph Rosenberg turned lots of heads, but it will be some time before its real estate division catches up. PERE Magazine April issue 2010.


Ralph
Rosenberg

Last month’s hire of Ralph Rosenberg as managing director and head of real estate investing for New York-based Kohlberg Kravis Roberts & Co marked the first stage in the creation of a huge real estate business. However, this creation will occur gradually over time, not overnight.

PERE spoke with Rosenberg and KKR’s chief administration officer Todd Fisher just eight days after Rosenberg started at the firm. During the hour-long conversation, the pair repeatedly described the journey ahead for the new platform, using adverbs such as “carefully” and “systematically.” Indeed, it would be risky to bet that KKR would execute on giant real estate privatisations or recapitalisations anytime soon.

As Fisher pointed out: “Hiring Ralph and announcing to the world that we are getting into real estate is not a sign that we’re going to be managing a billion or two billion dollars of real estate overnight. It’s a statement that our goal over the next five to 10 years is to create one of the great global real estate franchises.”

KKR’s measured approach, however, does not deviate from the fact we are talking about a private equity titan. The company has morphed considerably since its humble roots, when executing on $20 million deals was commonplace. The boutique buyout shop founded by ex-Bear Stearns executives Jerome Kohlberg Jr., Henry Kravis and George Roberts in 1976 is today the firm behind both the world’s first $1 billion buyout, the acquisition of Wometco Enterprises in 1984, and the world’s biggest buyout, the $48.4 billion acquisition of Energy Future Holdings.

KKR’s funds are massive too. KKR Associates 2006 Fund, a global private equity vehicle, closed on $17.6 billion in equity, and just last month the firm revealed plans for a new North America fund of between $8 billion and $10 billion at its first-ever investor day.

The start of KKR’s real estate story signals the next chapter of the firm’s evolution – not that it is new to real estate investing. Still, to date, the majority of its acquisitions in real estate have been part of wider investments. For instance, its $6.6 billion acquisition of Toys ‘R’ Us in 2005 through a joint venture with Vornado Realty Trust exposed the firm to 1,600 properties worldwide, as the New Jersey-based retailer is an owner-occupier. Portfolio companies like San Diego-based luxury hotelier KSL Resorts and Nashville-based healthcare operator HCA are other examples of where the same applies.

Quite frankly, there is KKR and then there is everybody else

Ralph Rosenberg

Central to Rosenberg’s appointment, however, is the belief that now is the right time to start accessing the real estate markets directly. He has been mandated to provide the best solutions for the real estate components of KKR’s $61 billion of assets under management around the globe, as well as advise and lead KKR on real estate situations across geographies, asset classes and up and down the capital stack. Indeed, straightforward direct deals could unfold just as easily as investments via complicated debt instruments.

“There has been lots of tumult in the real estate investment management community,” Fisher said. “We’ve seen a number of players exit the market, while others are facing significant challenges. At the same time, we’re seeing significant change in the assets themselves, particularly considering the amount of leverage coming due and the number of funds running out of time. We feel that, over the next five years, there’s going to be significant change and dislocation in the market, and that’s going to be interesting.”

A cultural fit

KKR spent the last two years evaluating its entry into real estate, but Fisher said only in the last six months did the firm meaningfully ramp up its campaign to find a candidate to lead its efforts in the sector. In that time, KKR spoke with “quite a few” candidates from a “small community of very talented people.” According to PERE sources, these included former Morgan Stanley Real Estate Investing heads Sonny Kalsi and Jay Mantz, among others. Ultimately, terms were agreed with Rosenberg, the former co-chief operating officer of Goldman Sachs’ Whitehall Street Real Estate funds series and ex-partner at hedge fund Eton Park Capital Management, but not before both agreed a cultural fit would be achieved by their union.

Rosenberg’s hire reflects a business finding an industry veteran willing to integrate into its long-established corporate culture. That was essential, Fisher said, as KKR is a company with numerous business lines – private equity, infrastructure, energy and various securities and equities platforms. Rosenberg and his yet-created team will add a real estate line, but each line will work with each other.

As Fisher explained: “We aren’t talking about people sitting in a silo somewhere.” Transaction by transaction, both new and existing, KKR’s real estate team will be leveraged by its other businesses and likewise they will leverage from the firm’s other businesses. Rosenberg is the first piece of a new cog in KKR’s synergetic machine.

“Many people with my sort of experience might have gravitated towards doing something with more autonomy and independence,” Rosenberg said. In joining KKR, he has conceded those things but he insisted: “I’m giving those up in a positive way, not a constraining way. KKR is probably the most powerful culture of any of the cultures I have worked with in terms of how they value the synergies created across the various industry verticals.” Finishing on that point, he added, “Quite frankly, there is KKR and then there is everybody else.”

In fact, it has not taken long for KKR staff across its 14 offices worldwide to take advantage of its new real estate expert. “Ralph has been on the ground for eight days,” Fisher said. “I can count at least four of the private equity teams independently contacting him because they are working on something where they see something particularly interesting with a real estate angle.” KKR’s capital solutions team also has been in contact.

Rosenberg readily admits he needs to grow staff numbers to help facilitate this internal service. Initially working with two other individuals currently at KKR, the team could grow to five or six professionals in New York by the end of the year. Although Rosenberg didn’t outline specific details on how the team would grow, he noted that all of KKR’s business lines are active in London and Asia and that real estate would be no different.

“This expertise is something we haven’t had before,” Fisher said. “Now that it’s inside, the phone is ringing and that is a sign of our culture.”

A real estate force in its own right

KKR’s real estate team will provide valuable assistance to the firm’s various business lines, but Rosenberg said they would not be “handing over the baton and saying ‘good luck’.” Moreover, leverage from the real estate team might empower another team to handle it for themselves next time a similar transaction transpires. In the meantime, Rosenberg does have the small matter of growing KKR into a real estate force in its own right.

The firm’s first straight real estate deals are likely to be small, although Rosenberg has many large pools of capital at his disposal, each with its own risk appetite. One such pool is $15 billion held within its asset management group, but there are plenty of others beside. Rosenberg stressed, however, that there is no immediate allocation: “I think that would be a dangerous and inappropriate approach. We are going to be disciplined and intellectually honest about how much we invest, when we invest and in what form we invest.”
This is a relief for Rosenberg, as he pointed out that pre-determined allocations have “gotten people tripped up over time.” He added: “If you look at the problems created over the last cycle, many were created because the structure of the organisation was not set up to be intellectually honest and disciplined about how they faced the market and when they should say no.”

Our job is to service our clients and be a steward of their capital. Given that, you would naturally expect that, over time, there could be distinct and dedicated capital coming out of our investor relationships targeting real estate

Ralph Rosenberg



Rosenberg explained that managers incentivised and pressured to put money to work would do so, even on bad deals. “That is not going to happen here; our culture won’t allow it,” he said. “I have not had one conversation with any partner at KKR about how much we’re going to put to work by the end of the year.”
When it does invest, however, KKR will be an opportunistic investor. “We aren’t in the business of buying core property or triple-A CMBS,” Rosenberg said. “[We want] anything that has a double-digit return all the way up to equity-style returns. We have flexibility across that spectrum.”

KKR currently has no debut deal to talk of, but it is expected to examine opportunities stemming from the vast deleveraging currently unfolding across global markets. The excess in commercial real estate took years to create and will take years to unfold – and KKR wants to invest as it happens. Rosenberg added: “Before you even count core real estate, you’re talking about a $1 trillion industry. There’s plenty of room for a player like us.”

No interview with KKR would be complete without asking whether there was a plan for a dedicated real estate fund. Although the firm would not comment on such plans and Rosenberg was keen not to discuss fundraising matters directly, he noted that many of KKR’s investors have allocations specifically for real assets, including real estate, and as such dedicated capital would be appropriate. “Our job is to service our clients and be a steward of their capital,” he said. “Given that, you would naturally expect that, over time, there could be distinct and dedicated capital coming out of our investor relationships targeting real estate.”
Indeed, KKR has more than 320 investors, including California’s heavyweight pension funds – the California Public Employees’ Retirement System and the California State Teachers’ Retirement System – among other US and international institutions. Oregon Investment Council, China Development Industrial Bank and Nordcapital also are investors, according to PEI Connect, the data website of PERE’s sister publication, Private Equity International.

Furthermore, Rosenberg noted that LP reaction to KKR’s entry into real estate has been positive. “It’s still early days, but many of the limited partners that have responded think it makes sense,” he added.
KKR will not be a heavyweight real estate investor in the short term, but its strategy extends well beyond the here and now. A titan in other sectors, look at this company again in 10 years time and you may well see a titan of real estate too.

The journey of Ralph Rosenberg

How his experience at Goldman Sachs and prescient timing put him on the path to KKR
Central to KKR’s hiring of Ralph Rosenberg was his track record of reading markets accurately and subsequently knowing when to pull the trigger or holster the gun. “He operated in the real estate business during some of the best times and he found the right time to exit when thing were looking more difficult,” said KKR’s chief administration officer Todd Fisher.

Fisher was referring to Rosenberg’s 17-year tenure at Goldman Sachs, during which time he was co-chief operating officer of its Whitehall Street Real Estate fund series and co-head of its special situations group. Recalling his decision to depart Goldman, Rosenberg added: “At the time, I felt the markets were getting relatively top-heavy in terms of where credit spreads and asset prices were.”

Predicting a distressed cycle and “potential conflicts of interest” to come, Rosenberg resigned from Goldman Sachs in the winter of 2006 and launched his own investment business, R6 Capital Management. “That experience was interesting,” he recalled. “The markets were still expensive and I didn’t have an appetite to take any risk – I really wanted to protect capital during that period of time.” The problem for Rosenberg was that his investors had committed capital, $500 million in total, to be invested for opportunistic result. “My net returns were still positive, but they weren’t 15 percent,” he added.

I learned at a young age to appreciate the value of teamwork, consensus building and synergies that could be created and utilised in the marketplace

Ralph Rosenberg

When Bear Stearn’s residential mortgage book began to unwind, Rosenberg saw the writing on the wall and felt his efforts would be better utilised elsewhere. So, in the summer of 2007, he returned capital back to R6’s investors and merged his business into well-established hedge fund Eton Park Capital Management, becoming a partner in the process. Eton Park enabled him “to get access to a much bigger capital base with a global footprint and a culture very consistent with Goldman Sachs.”

Rosenberg’s references to Goldman Sachs are telling, and he admitted: “Goldman Sachs defined me in many respects, both personally and professionally. I was there 17 years and have very strong relationships with many of the senior people there.” Among them are his ex-bosses: Daniel Neidich, now head of Dune Real Estate Partners; David Viniar, currently Goldman Sachs’ chief financial officer; Jon Winkelried, the bank’s former co-chief operating officer; and Gary Cohn, its current chief operating officer.

Of Goldman Sachs, Rosenberg said: “I learned at a young age to appreciate the value of teamwork, consensus building and synergies that could be created and utilised in the marketplace.” Given the similar corporate philosophy of KKR, it is little wonder he was regarded as the ideal candidate to lead the buyout giant into the realm of real estate.


Ralph Rosenberg will be interviewed live on-stage at the PERE Forum: Europe in London on 9-10 June. Click here to find out more.