From Whitehall to Broad Street and back again

The story of Goldman Sachs’ Whitehall Street funds, 13 investment vehicles that provided the blueprint for opportunistic private real estate investing to an entire industry, has finally come to an end, some 28 years and $22 billion in capital raised after it began.

It concludes with the structured sale of Equity Inns, an American upmarket hotels business, to a non-traded REIT called American Realty Capital Hospitality Trust, in a deal valued at approximately $1.8 billion. Acquired during the leverage-guzzling boom of 2007, the 132-strong hotels business, franchised to Hilton, Hyatt, InterContinental and other upmarket hoteliers, was one standout investment for Whitehall’s biggest – but ultimately fatal – fund: the $4.2 billion Whitehall Street Global Real Estate 2007.

The deal was finally completed in February, some three years after it was struck, following various individual asset sales and a comprehensive restructuring including seller finance from the bank. Whitehall’s commentators say the exit epitomizes why, after such a long and distinguished run, the series was eventually brought to its knees. “This was a poster child for everything done wrong: paid too much and over-levered,” one executive familiar with the fund says.

Whitehall’s general partner and manager, Goldman Sachs Real Estate Principal Investment Area, now part of Goldman Sachs’ merchant bank division, originally paid $1.26 billion of equity, employing an additional $940 million of debt, to take Equity Inns private. The transaction valued its stock at 20 percent over an already inflated share price. In the end, the investment returned the fund’s capital, but it took a decade to produce a negligible return, PERE understands. That is hardly the alpha REPIA’s backers, including Goldman Sachs itself, had come to expect over an illustrious history spanning back to 1991 with the $142 million Whitehall Real Estate Street 1, a vehicle intended to buy loans from the Resolution Trust Corporation following the savings and loans meltdown in the US in the 1980s.

After a string of often mid-teen net returns for the series since that first vehicle, pre-global financial crisis deals like Equity Inns led to a performance for Global 2007 once reported as low as 19 cents on the dollar – and eventually the shuttering of Whitehall as the crisis took a hold. Whitehall Street International 2008 attracted $2.34 billion in capital, but that was shelved with only 40 percent of its equity committed as fires raged across REPIA’s asset base. And as they raged, REPIA’s attrition count grew as executives evacuated for new opportunities; by 2013, a nadir in the post-crisis cycle for private real estate, no more than 30 executives remained from a peak of around 130.

A post-recovery comeback

In the 11-plus years of recovery, and since the Whitehall funds last attracted a dollar, REPIA’s remaining executives, led by co-heads Alan Kava and James Garman, have changed the story. They have overseen a partial restoration of value for Global 2007, to 75 cents on the dollar, PERE has learned, the pair has also launched the Broad Street Real Estate Credit fund series, which has accumulated more than $13 billion of equity for loans issued in the US and Europe, including $4.2 billion for the latest fund last January. Most significantly, they have made more than $10 billion in balance sheet equity investments, many of which might have – if not for its eventual plight – otherwise found themselves in REPIA’s Whitehall series. Including these equity outlays, the wider Goldman Sachs business – including its special situations and investment management divisions – has in that time acquired as much as $50 billion of assets, including leverage, around the world. While the equity funds were iced, the bank remained a real estate investing power.

“Nobody is looking for a victory lap there. But from where [Goldman Sachs] was, it’s a far cry.”

– PERE source

REPIA’s headcount has swollen, too, to nearer 45 professionals, or as much as 250 if you include RMD, a loan servicing and asset management unit formerly known as Archon.

Critically, its real estate activities have rewarded REPIA’s investors and the bank alike handsomely over this time. Broad Street has consistently generated gross returns of 16 percent, 13 percent net; while its equity investments have “materially outperformed,” Garman commented in a prior PERE report.

“Nobody is looking for a victory lap there,” the anonymous executive says, “but from where [Goldman Sachs] was, it’s a far cry.” The bank outlines as much in a note to Global 2007’s investors, obtained by PERE, in which it says: “While an economic loss is clearly not what we envisioned when we raised and invested Whitehall 2007, in accordance to our recovery plan, we were able to substantially mitigate losses.”

In PERE’s prior report, we suggested a return to fundraising might be on the cards. That is now set to become reality: REPIA, and the real estate units of Goldman Sachs’ special situations group and asset management business, will combine to launch another fund.

It is understood the closed-end vehicle, expected to be the first of a series, will emerge sometime this summer. With a PPM due any week now, it is understood much of the headline detail has been agreed: it will have a fundraising target of between $2.5 billion and $3 billion for a blended core-plus-to-value-add strategy, in keeping with this current late stage in the market cycle. Returns are being pitched at an IRR of between 12 and 15 percent at the asset level, PERE understands. Indicative of its fees, gross to net proceeds should be in the region of 200 basis points and its lifespan will include a three-to-four-year investment period followed by a five-to-six-year holding period. In conversations with people familiar with the plans, the words “basic” and “moderate” are used in regard to the fund’s leverage – a far cry from some of the riskier financial engineering that Goldman Sachs, alongside its investment banking peers, engaged in before the crisis. Indeed, one source says he expects the leverage used to not exceed 60 percent at the fund level.

From principal profits to fees

Goldman Sachs’ return to private equity real estate funds might have credibility after its positive balance sheet dealings, but its bigger influence has come from the 150-year-old bank’s highest echelons. David Solomon, who succeeded long-serving chief executive Lloyd Blankfein in December, is vocal about switching tack from a principal investment orientation to a more fee-generative model.

“We are pleased to announce that merchant banking and the global special situations group, along with the principal strategic investment group within the securities division, the private real estate teams within Goldman Sachs Asset Management and the realty management division will unify into one direct alternative investing platform through the merchant banking division,” Solomon said in an memo to staff, seen by PERE, last month.

“This unified investing platform will enable us to accomplish several strategic objectives over time. These include the raising of additional third-party capital from our institutional and private wealth clients, a more consistent and co-ordinated marketing approach across strategies and an enhanced ability to attract and retain the most talented investment professionals.”

“This will produce a higher multiple for the stock price,” PERE’s source says. Goldman Sachs stock has risen in value by 122 percent since December 2008, shortly after the crash of Wall Street rival Lehman Brothers. But that growth pales in comparison to private equity real estate giant Blackstone, which has grown some 540 percent in the same timeframe. “The new CEO is really focused on servicing clients, creating recurring fee revenue businesses, a better quality of revenue.”

The imminent real estate fund is part of a wider strategy aimed at simplifying the bank’s proposition to institutional investors. As such, the conjoined platform, which could have as many as 400 staff working for it, will require a large marketing effort as it relinquishes a reliance on its own capital channels, depending instead on more outside capital.

“This will produce a higher multiple for the stock price. The new CEO is really focused on servicing clients, creating recurring fee revenue businesses, a better quality of revenue.”

– PERE source

For REPIA, approximately 15 institutional relationships were fostered via the Broad Street credit funds, including sovereign wealth funds and European pension funds. How many of Goldman Sachs’ joint venture or Broad Street investors also decide to take positions in the comeback equity fund will interest the market; how many Whitehall investors return for another equity property fund is another matter entirely, onlookers say.

UK charitable foundation the Wellcome Trust is one investor that partnered REPIA in a $2 billion student housing joint venture with the bank using its balance sheet. It has expressed reservations about working with the bank using fund equity following its own shift in strategy away from fund investing. Peter Pereira Gray, managing partner and chief executive of its investment division, told PERE last year: “We wouldn’t have done this deal with Goldman if it had been fund money. It would have come in a structure with a required liquidity point and that might, or might not, have lined up with the cycle.”

According to a senior executive at Morgan Stanley Real Estate Investing, the property platform of peer bank Morgan Stanley, which also took a reputation hit following the financial crisis, regaining the faith of old investors might be challenging. “My advice? Don’t bother going to seed investors from the past. Find new investors,” he says.

MSREI’s own flagship series, the Morgan Stanley Real Estate Funds, followed a similar trajectory to Whitehall. Its comeback was four years ago with the closing of its eighth fund on $1.7 billion, a significant reset from the $8 billion raised for its own almost fatal sixth vehicle in the lead-in to the crisis.

The capital was raised from a slew of new backers, including Australia’s sovereign Future Fund, but against a number of limiting caveats and conditions. Following a strong performance, however – PERE understands the fund is projecting IRRs of about 30 percent and a 2x equity multiple with about 50 percent of its assets exited already – it was able to raise a more substantial $2.7 billion for its ninth fund last January. It is eyeing a 10th vehicle at the turn of this year.

“The big difference between us and Goldman is we stuck to it,” comments the Morgan Stanley executive. “Goldman stopped everything. Maybe investors will have a really hard time believing their story.”

Perhaps naturally for a brand that has long courted as much consternation and envy as it has admiration, other private equity real estate executives, including former REPIA staffers, question its rationale for returning to the fundraising trail more than a decade after leaving it.

“This is a push-product,” comments one. “I think it’s a risk management tool to de-risk the bank’s position.”

Indeed, several sources mention the switch from internal to external capital to invest through the current cycle peak. “If you are late cycle, you don’t want to be 100 percent your own money. You want others’ money and to earn fees off that.”

Nevertheless, PERE understands that, in keeping with its tradition of co-investing substantial equity in its funds, sometimes more than 40 percent, the bank will again look to substantially invest in its own fund, to the tune of between 20-25 percent.

While initial fears the Volcker Rule of the Dodd-Frank Wall Street Reform and Consumer Act of 2010 would see real estate funds of US financial organizations lumped together with their private equity and hedge fund peers – and so slapped with a 3 percent principal co-investment limit – subsequent interpretations reflect a less prohibited reality. Reflecting on a three-year implementation period for Volcker, PERE’s source says: “Until firm comments on the law came out, nobody was clear it would work this way. Now it is clear.”

“They built a good track record over the last 10 years. A comeback is not surprising. What is surprising is it didn’t happen earlier.”

PERE source

Further, it is thought the incoming fund will be substantially pre-seeded with balance sheet investments made after February this year, to give investors partial sight of the portfolio they would buy into, possibly as much as between 30 and 40 percent of the vehicle’s total asset base, “so investors can see what they can get,” the source says.

Feedback to PERE on the notion of Goldman Sachs’ return to private equity real estate fundraising has been mixed. “Their track record is pretty good. If they want to raise funds, I don’t think they’ll have an issue,” comments one rival manager.

“It’s a super commercial place,” remarks another. “They built a good track record over the last 10 years. A comeback is not surprising. What is surprising is it didn’t happen earlier.”

At its peak, REPIA controlled around $70 billion of assets. PERE understands Goldman Sachs has designs on building a real estate asset manager that would surpass that figure, placing it among institutional private real estate’s largest organizations once again. A successful comeback fundraising would go some way to achieving that aim.

goldman sachs declined to comment for this article.

Goldman Sachs’ new real estate fund:
what and who to know

While details of the bank’s comeback vehicle are still being determined, here is what PERE understands so far:

The fund is expected to be managed by a merged entity comprising the real estate businesses of the bank’s merchant bank division, its special situations group and assets management business. Combined, their current real estate asset base comes to circa $26bn