SPECIAL REPORT: Inside Oaktree

Last month’s IPO by Oaktree Capital Management offered a chance to glean more information about the real estate operation of the Los Angeles-based private equity firm, which was started by Howard Marks in 1995. PERE Magazine, May 2012 issue

Oaktree Capital Management’s initial public offering on the New York Stock Exchange on 12 April didn’t exactly set the investor world alight. Given that the Los Angeles-based private equity firm raised $380.2 million in its IPO – around 27 percent less than originally hoped for – things were a little disappointing. Still, Oaktree’s decision to go public has at least offered a chance to peek further inside the firm’s business and, for readers of PERE, that means a better understanding of its real estate group.

Some of the facts gleaned from the SEC filings necessary for Oaktree’s IPO might even offer up a surprise for some. For instance, did everyone in the global private equity real estate industry know that Oaktree has corralled $1.3 billion for OCM Real Estate Opportunities Fund (ROF) V, with a fundraising target of $1.5 billion for its VI? Additional information supplied about ROF V is that the investment period began in March 2011.

Most people would identify Oaktree – a firm founded by Howard Marks in 1995 – as a global distressed debt specialist, and they would be right. Filings show that the global investment manager has a total of $74.9 billion in assets under management, and some 32 percent of those assets are defined as distressed debt.
The next biggest business area is corporate debt, which accounts for 28 percent of assets, then ‘control investing’ at 23 percent, convertible securities at 10 percent and lastly real estate at 6 percent, meaning Oaktree has a real estate portfolio amounting to nearly $4.9 billion.

As a result, Oaktree isn’t among the largest real estate asset managers in terms of assets under management. Neither is it among the top 30 private equity real estate firms in the world as calculated by the PERE 30, our annual ranking that measures how much equity a firm has raised via closed-ended commingled funds for opportunistic or value-added strategies over the most recent five-year window.

A post-crisis player

Nevertheless, Oaktree is certainly a player in real estate. Indeed, it was one of the groups selected by the US Treasury to take part in the Public-Private Investment Program (PPIP), although reports in 2009 highlight that it was slower than others to announce a first close of a PPIP fund, with all parties having been given 12 weeks to raise a minimum of $500 million.

The postscript to this particular real estate effort is that Oaktree didn’t exactly go great guns into PPIP. Last year, it was reported that the firm had invested just 16 percent of the capital committed to its PPIP fund and had agreed to refund more than $2 million in fees received under programme. That is because Oaktree initially had charged the Treasury an annual management fee based on the amount of money the agency had pledged, rather than the actual capital invested.

Nevertheless, Oaktree has been cropping up in real estate deals of late, so it is clearly setting about the distressed market. Its opportunity funds invest in real estate, as well as real estate companies and securities, across all property types in the US, Europe and Asia.

Most of the big announcements have come in the US. For example, in August 2010, it was the winning bidder in a Federal Deposit Insurance Corporation (FDIC) auction of a $1.7 billion portfolio of approximately 200 distressed real estate loans originated by Ohio-based AmTrust Bank, as well as 80 properties located in several states throughout the US. It also purchased a $158 million portfolio originated by FirsTier Bank, which was acquired by the FDIC upon the bank’s failure in January 2011, through an auction under the agency’s Small Investor Program pilot sale.

Later in 2011, Oaktree purchased a 50 percent equity interest in an entity created by the FDIC. The value of the deal was just north of $30 million and was made through a joint venture with Alaska’s Calista Corporation, a business established on behalf of Alaska’s Native residents, and FACP Mortgage Investments.

That was the third such purchase from the FDIC made by Oaktree, notes Philip Feder, chair of the real estate practice at Paul Hastings, which represented the firm in all three deals. According to Feder, Oaktree’s strategy in acquiring the FDIC loan portfolios is to add value by restructuring the debt. “They want to make the loans either pay on a current basis or make deals with borrowers to refinance or give back the properties,” he told PERE at the time of that third deal.

More recently, in February, Oaktree was back in the news when it purchased the mezzanine debt on a 26-property portfolio valued at $337 million and took control of the assets via deed-in-lieu of foreclosure.

A dedicated team

As one might expect of a firm with a dedicated real estate fund business, Oaktree has a dedicated real estate team. According to its SEC filing, there are 26 real estate professionals under the business line ‘Real Estate Opportunities’, including 12 in Los Angeles, six in New York, four in Tokyo, three in Seoul and one in London. That ‘one’ in London is David Snelgrove, a vice president who joined the firm last year after six years at JPMorgan Asset Management, where he was vice president in its real estate special opportunities group.

John Brady, managing director, heads up Oaktree’s global real estate group. He has been with the firm since 2007 and has an interesting resume, having worked at Tom Barrack’s Colony Capital as head of US acquisitions for four years.

Interestingly, Brady came to the rescue of Oaktree in a sense because the firm found itself without a global head of real estate for two years. Russ Bernard, the previous head, and several other members of Oaktree’s real estate team left in November 2005 to start Westport Capital Partners.

At the time, Bernard’s departure seemed to concern some investors, as evidenced by a January 2007 due diligence report by the Missouri State Employees’ Retirement System (MOSERS), which had committed $50 million to OCM Real Estate Opportunities Fund III. In the report, MOSERS alluded to its concern, but it added it was no longer so worried about the departures of Bernard and team because the fund, which was formed in September 2002 and raised $692 million in equity, had become fully invested.

The departure of Bernard, however, did lead to a two-year gap, during which there was no replacement head of real estate until Brady joined. While a replacement was being sought, Oaktree president and principal Bruce Karsh took over management of the group.

Painful separation

The departure of Bernard as principal and portfolio manager of the real estate group may not have proved painful for limited partners, but it was for Oaktree as the move led to an arbitration case brought by Bernard against Oaktree for alleged lost fees. The SEC filings, however, suggest it was Oaktree that finally won out the case, as the firm recorded how it was paid $11.2 million by Bernard in 2010 upon reaching a final settlement.

The problem arose in 2005, when Bernard resigned to form Westport Capital Partners and his new firm bought 60 Main Street, a commercial property in Connecticut. The problem – as was later found by the arbitrator in the subsequent court case – was that Bernard had identified 60 Main Street as a deal during his employment at Oaktree but had not disclosed its existence to the firm’s principals, according to Court of Appeal documents dated 22 February 2010 and published after Bernard appealed the original trial court’s arbitration award against him.

The arbitrator found Bernard breached his fiduciary duty to Oaktree by delaying the firm’s launch of a new fund – ROF IV – so that he could buy himself time to present 60 Main Street as a substitute investment for potential Fund IV investors to invest their money at Westport. Among Bernard’s stalling tactics – as the Court of Appeal documents put it – was misstating ROF IV’s intended launch date, declining to meet with potential new investors and failing to respond to those investors’ inquiries.

Based on his breach of fiduciary duty, Oaktree formally discharged Bernard in December 2005, one month after he had resigned and refused to pay him incentive fees to which he claimed he was entitled. In response, Bernard demanded arbitration over his fee dispute with Oaktree, and the process began in January 2007. That July, the arbitrator issued her award in Oaktree’s favour. She rejected Bernard’s claim that his incentive fees vested upon a fund reaching its performance benchmarks. She found instead that the fees vested only if Oaktree employed Bernard when the firm distributed the fees. The arbitrator further found Bernard breached his fiduciary duty to Oaktree by attempting to steer investors to Westport and 60 Main Street by delaying ROF IV’s launch.

As a result, the arbitrator awarded Oaktree $12.3 million for the management fees it lost from ROF IV’s delayed start. The arbitrator also awarded Oaktree $6.7 million in attorney fees, costs and interest. Nineteen days after the arbitrator served the award, Bernard filed a petition with the trial court to confirm it. The court later entered judgment for Oaktree confirming the award, and the appeal later affirmed the court’s decision.

The court findings against him, however, have not seemed to hinder Bernard or Westport. Last month, the firm closed Westport Capital Partner Fund III on more than $571 million in equity commitments – 15 percent above its target. A Westport spokeswoman adds: “There is a lot of misinformation about this case, but the firm’s LPs and others in the industry are aware of the facts. Westport is not going to provide any additional comment.”

Moving forward

With the dispute behind it, Oaktree seems to be looking forward to growing its real estate platform. According to the recent SEC filings, the firm is “focused on expanding” into products for real estate, as well as senior loans, emerging market credit and direct lending, and broadening its distribution, including strategic partnerships, sub-advisory and retail and high-net-worth offerings. The firm notes that hires therefore could follow in those areas.

Oaktree declined to comment about its future activities but, with its latest opportunity fund amassing $1 billion of firepower, it will be interesting to watch how the newly public firm goes about deploying it. Current investors in ROF V – thought to include the San Bernardino County Employees’ Retirement Association, South Carolina Retirement System and West Virginia Investment Management Board – certainly will.