Batting for doubles
Thomas Duffell, PERE
Private equity entrepreneur Jean Salata has forged a glowing reputation in Asia after forming a $10bn business from the embers of Barings bank. With sector veteran Mark Fogle by his side, he wants a repeat in real estate. Thomas Duffell hears the story so far.
Every great entrepreneur has moments that prove pivotal. Unknown at the time for Jean Salata, one such moment was in 1995 when an earthquake shook Kobe, Japan. This natural disaster would unearth losses of S$2.2 billion ($1.5 billion; €1.45 billion) at one of the world’s oldest merchant banks, Barings, which led to its bankruptcy. The losses were caused by rogue trader Nick Leeson. The aftermath of the bankruptcy of the 233-year-old institution would lead Salata to spin out the Asian private equity business of Barings.
Sitting in a meeting room in the Central, Hong Kong, office of the firm he launched to continue the business – Baring Private Equity Asia (BPEA) – and flanked by his head of real estate, Mark Fogle, Salata explains his firm’s steady rise in corporate private equity and its establishment of a private equity real estate platform.
“There was a lot of confusion when ING stepped in to buy Barings. During this period we decided in Asia that we were probably better off having an independent platform than being part of this changing shareholder structure which was unclear,” recalls Salata of the gradual spin out which completed in 2000.
“The business started off fairly small and we initially received some balance sheet investment from ING – about $25 million – but we went out to raise third-party capital and our first fund was about $300 million.”
Today, BPEA has total committed capital of more than $10 billion, managed by more than 140 people in Hong Kong, Shanghai, Beijing, Mumbai, Singapore, Tokyo, Jakarta and Delhi. The firm’s latest corporate private equity fund – Baring Asia Private Equity Fund VI – garnered $4 billion against a $3 billion target.
While the real estate business is more nascent, with its maiden vehicle hauling approximately $400 million, including co-investment capital, by the summer of 2015, Salata and Fogle have high hopes it will follow suit in enjoying stronger levels of capital support in the future.
BPEA Real Estate was officially established in late 2011 with Fogle’s hire. But it was in the wake of the global financial crisis when Salata first saw the opportunity to move into property investing. He points to multiple factors occurring at once: increased distressed real estate dealflow coming across his desk; a changing competitive landscape for these deals; and the move of many institutional investors to broaden their relationships with investment managers to cover multiple alternative asset classes.
“We felt like there was a real opportunity there. At the same time, we didn’t feel we had the expertise to look at the asset class properly. We wanted to have a dedicated effort rather than it be part of our private equity program,” says Salata. “There was a push and a pull, but the final outcome was that Mark and I met again.”
Salata, who oversees all investment and divestment decisions made at the firm, as well as its strategic direction, was previously a director of Hong Kong-based AIG Global Investment, the Asian private equity investment arm of AIG. Fogle was also working at AIG Global Real Estate in Hong Kong and in a twist of fate, both Salata and Fogle reported to Cesar Zalamea, former president and CEO of AIG Global Investment and one of the veterans of the Asian financial industry at the time.
Fogle has over 30 years of real estate investment experience, including 25 in Asia featuring a period as managing director at AIG Global Real Estate where he grew the Asian business from a small lending operation into one of the largest private equity real estate players in the region. He has also worked as managing director and chief investment officer in Asia-Pacific at RREEF, the alternative investment and asset management arm of Deutsche Bank.
“I was already on my own, looking at starting my own platform, when Jean and I met. He told me he was getting into the real estate business,” Fogle says.
Fogle initially declined to join Salata, wanting to do his own thing. But, after attending BPEA’s annual general meeting in Hong Kong and having time with the firm’s 80-plus investor pool and getting a sense of Salata and the firm, he changed his mind.
“It’s the ‘who’s who’ of the global institutional investor community and they only had good things to say about Jean and the firm – and to someone who wasn’t an existing employee. There are many people in our business, but very few who are true, old-school fiduciaries. Jean is one of them. That for me is so important,” says Fogle.
The term fiduciary is used countless times by Salata and Fogle during the conversation and it is clear the pair’s shared investment principles played a key part in the formation of the real estate business.
“Truly remaining disciplined and being a fiduciary is what we both agree on. I think it’s in the DNA,” says Fogle.
Salata adds that he and Fogle immediately saw eye to eye on “the way we think about investment, about risk as we both had similar backgrounds.”
This approach to investing might appear at odds with the pan-Asian opportunistic real estate strategy which is the focus of the team. The maiden fund, BPE Asia Real Estate Fund, corralled $365 million and has an internal rate of return target of 20 percent. However, Fogle says the team is able to hit its targets through a cautious and diligent approach, rather than taking on excessive risk.
“We are targeting 20 percent-plus IRRs, but we really focus on trying to get a 2x multiple on every transaction. Some other managers average out with the same return as we do. But if you look at the portfolio construct they have 10-15 deals, of which two have done a 5x to 10x multiple, another eight have done maybe a 1x multiple and then you have three or four losses; but the big ones offset the marginal deals and the bad deals. From a mentality standpoint, you are saying, ‘I have got to find those home runs every time,’” says Fogle.
“We bat for doubles. We are not trying to be Babe Ruth, because you can have a few strikeouts when swinging for the fences,” says Fogle. An example of this attitude is demonstrated in the firm’s first real estate exit, the sale of the AccraLaw office tower in Manila for around $75 million. It is understood the sale delivered an IRR of more than 30 percent for the fund, and close to a two times return on invested capital. BPE Asia Real Estate acquired the building in 2014 for approximately $50 million.
Salata says he likes to see this discipline in the real estate team and calls price one of the biggest risks in investing. “You lower the risk dramatically if you invest below the intrinsic value of an asset. I have seen the real estate team walk away from deals they could have done if they were willing to pay a bit more but they were not willing to do that. Over a cycle, that will help your returns quite a bit.”
The firm’s investors agree, with Robert Sessa, head of real estate at Employees Retirement System of Texas noting that BPEA Real Estate takes a conservative approach to pricing. “Everybody talks about downside protection and when we dug into some of the deals it really does look like they are very conservative in their underwriting and they have that mentality where they are always looking at that downside. That gave us a lot of comfort,” Sessa says. “They do take their fiduciary duty seriously and that is something we are focused on and actually require that in the documents. They espouse those qualities.”
Reforming the band
Joining Fogle at BPEA Real Estate is Malcolm Lai, Charles Lam, Peter Manga – former colleagues at AIG or RREEF – and Joji Thomas who joined from Pramerica Real Estate Investors (now PGIM Real Estate) and who worked with Charles when he was a managing director at Pramerica.
“We call it bringing the band back together,” jokes Fogle. “It was a case of making phone calls and saying, ‘Hey, I think you should come and meet Jean and see what we have planned.’ Again from a fiduciary standpoint, and from a people perspective, having a no-ego firm was one of the things that impressed them. They trusted me because we had worked together but introducing them to Jean was so important. People think that when you manage $10 billion you act in a certain way, but it’s one of the great things about Jean, having traveled with him quite a bit he treats the tea lady the same way he treats a CEO.”
Salata adds that when exploring the formation of a real estate business he considered a platform acquisition but believed it was more sustainable to build one organically. “Long term, to build a business you need to make sure the fit is right culturally. At the end of the day, we are making a lot of decisions based on information that is being put together by different parts of the whole team. If any part of that chain is weak we make inferior decisions as a result,” he says.
The shared fiduciary philosophy also bleeds in to how the real estate team approach investing with all deals having to go through one rigorous test of Fogle’s making.
“Any time there is a deal that is a little bit on the fringe of being too high a risk, I have the standard question which I ask a team member, ‘Your mother and father are retired, their last dollar is going in to this deal, this will either let them live out their life for the next 20-30 years well, or they are going to be homeless because you have lost the money. Are you going to put their last dollar in to this deal?’”
This fiduciary culture also impacts the firm’s hiring policy. Fogle says that when looking to build the team he wants to know any new hire’s mentors and supervisors as the environment in which people have trained and worked influences their risk mentality.
“Unfortunately for the real estate sector in Asia, maybe a good seven out of 10 people came out of the investment banking side of the business and then moved into funds. Most of our team have come out of credit where you are focused more on risk rather than having a deal junkie mentality.”
Salata adds that more real estate-focused professionals will be coming on board as the firm looks to grow its property assets under management.
“It’s very important that we grow the team so we will continue doing that as we grow the fund. If you look at us on the PE side we have taken the firm from maybe 30 people 10 years ago to about 140 now. Every time we have gone out to raise a new fund we have invested in building out the capacity of the firm in advance of that. Where people get in to trouble is they raise a lot more money but they don’t actually build out the capacity.”
With BPEA Real Estate’s debut property investment vehicle around two-thirds deployed fundraising for the second fund is just around the corner. “We expect that the next fund will be larger than our first, and should be done in a shorter period of time,” says Salata.
The firm concluded its fundraising of Fund I by the summer of 2015 and both described the initial capital raising experience as more difficult than originally anticipated.
“At the time, I was feeling quite euphoric as we both thought it would be easy to raise capital and I was very excited about the investment opportunity landscape,” says Fogle.
However, he recalls how many investors baulked at investing as they had their fingers burned by the pan-Asian opportunistic funds that suffered heavy losses during the global financial crisis. Another issue, according to Salata, was that many of the firm’s existing investor relationships are with the world’s largest pools of capital who write checks too large for the maiden fund. These same investors are also often not able, or willing, to back a first-time fund.
“A first-time fund is always a tough hurdle to deal with because you are just dealing with an unknown. We have passed on other opportunities because of issues such as that. But when we looked at Baring, the one thing we did like was that they had this broader platform to tap into, we had done a lot of referencing on Mark and his team and finding out how they work,” says Sessa.
“When we put this to our investment committee we said this was a risk, we didn’t know if there would be some personality conflicts and, in a year or two, they don’t get on and have to part ways. But from what we could tell, it seemed like a good fit.”
Despite these setbacks the firm raised around 80 percent of capital from institutional investors, including US pension funds and corporates, European private wealth managers as well as a US and Hong Kong family offices and a Middle Eastern pension fund.
“The flip side is that now you are on your second fund, you do have a track record, and you are trying to scale up, these issues are no longer on the table. Our expectation is that we are going to have a much broader crossover and appeal to the existing PE investor base on the next fund,” says Salata.
Leveraging investor relationships is not the only advantage for the real estate business, he adds, explaining that he wants the two business lines to create greater “synergy.”
Liam Coppinger, Hong Kong-based managing director, private equity at Manulife Capital, says the existing private equity business is a significant advantage for BPEA Real Estate. Baring was one of Manulife’s first commitments in Asia and the investor has committed to Fund V, as well as its real estate fund and Fund VI.
“Baring is one of our oldest and largest relationships in Asia and we have recently done a co-investment with them on the private equity side so we have multiple touch points,” says Coppinger. “When we evaluated the real estate fund it was one of our first commitments in the space and we got comfortable with Mark’s credit-driven investment approach, but also by spending time with Jean and understanding his involvement in the real estate program as well. The investment team is certainly strong, but they also can leverage the resources and operating platform of the private equity business which is especially helpful in Asia where the markets are so different and some are very challenging to invest in.”
“Our firm is managed in a very integrated manner,” says Salata. “The real estate team is an integral part of everything we are doing and there are no silos. Sharing offices, one meeting, common investment committee members and quite a bit of working together on deals. There is a lot of co-operation going on across the region between the team members on both the PE and the real estate sides.”
In fact, the private equity and real estate teams even partnered on an investment in Japan using capital from their respective funds. They jointly invested over $200 million into a Japanese retail business, a home improvement retailer with 15 large stores across metropolitan Tokyo.
And while it is still early days for the real estate business of BPEA, Salata expects comparatively big things from the asset class. “From my perspective, I think the real estate business could be as big, or bigger, than private equity for the firm. I think we are just scratching the surface of what the potential is here.”
BPEA Real Estate will not be launching a core strategy any time soon, despite calls from investors
Many investors have been pursuing exposure to Asian core property for yield in a low-growth environment. As such, many traditional opportunistic fund managers have started offering core strategies to meet this demand.
Yet, BPEA Real Estate does not see money to be made in Asian core. “We had a core mandate for about three years that we let lapse. We just don’t believe in the core space in Asia,” says Fogle. “Investors are asking for a 6-7 percent IRR. In Asia it sounds easy to do but if interest rates go up 25-50 basis points, that 6 percent IRR becomes 4 percent IRR, and so you are doing a lot of work not to deliver the return.”
He also expects to be receiving more incoming calls from investors about core Asia, but does not believe the opportunity is there today. “Most of the ‘Class A’ buildings in Asia are owned by families or REITs so those core funds are now buying class B office buildings with 50-70 percent leverage, which is not core.”
Shifting the focus
BPEA Real Estate says its focus is always pan-regional and ignores more obvious markets in Asia, like China, in favor of countries such as the Philippines
“If you asked me when we started the real estate fund if we would be investing much money in the Philippines I would have said probably not,” says Salata.
Over the past two years, BPEA has made multiple investments in the country through its debut fund. This included its biggest capital outlay, a $75 million structured debt investment in a large office development in Clark in November 2015.
“We have the resources to cover the region and find pockets of growth. It’s not a macro bet on growth in Asia,” Salata adds.
Fogle says the firm has always been contrarian and that although it covers 10 countries in the region, each fund will probably only gets exposure to four. As BPEA Real Estate looks to raise more capital for its second fund, the countries it will invest in may change too, he says.
“The strategy will stay the same. It will be just different countries around the region and different cycles. I’m very excited, because I think there will be distressed opportunities within the next 12-24 months of launching the next fund, mainly because there have been some overheated countries we think are at, or nearing, correction.”
This approach has gone down well with investors. Texas ERS’ Sessa says: “That was a positive that they had a multi-country strategy and there was no bias to one particular country, they weren’t Japan-centric or China-centric or whatever it might be. For us in Austin, Texas, part of the reason of hiring them is their expertise in where investments should be made and not just invest in China because that’s where they have the biggest team. ”
Manulife’s Coppinger adds: “I do also like their multi-market investment strategy which gives them the flexibility to pursue the most attractive risk-adjusted investment opportunities in Asia without being restricted to one country or property sector.”