KKR looks to flex its real estate muscle

Once maligned as a “one-trick pony,” the storied private equity firm is on a property buying spree

Dec.December 03, 2021 07:00 AM

KKR’s Henry Kravis (Photo-illustration by Paul Dilakian)

There’s a particular kind of “New York is back, baby!” vibe to the Edge, the observation deck at Hudson Yards where thrill-seekers can dangle from the tip of a skyscraper 1,131 feet above the city’s new power center. 

The notion that plenty of people are willing to pay nearly $200 a pop to shake off their pandemic funk via self-inflicted vertigo is what KKR & Co. was betting on when it paid $500 million for a controlling stake in the observatory this fall.

Just below the viewing deck at 30 Hudson Yards is KKR’s headquarters, which the firm closed on in 2019. It’s the spot from which the storied private equity firm’s real estate team plots its next big move. It’s been a decade since Henry Kravis and George Roberts started a dedicated property arm, and it’s done dabbling — it now wants to establish primacy in the field. 

It’s still a pretty nascent business for them relative to the largest players,” said Patrick Davitt, an analyst at Autonomous Research. “As they scale, there’s no reason they can’t get really big.”

Truth be told, though, it’s already late to the game. Kravis and Roberts pioneered the private equity industry in the 1970s. But their biggest rival, Blackstone Group, has a 20-year head start in real estate, which it has established as a cornerstone of the modern asset management business. Through megadeal after megadeal, Blackstone has become the largest private landlord in the country.

But KKR is catching up. Last year, it agreed to pay $860 million for a Brooklyn apartment portfolio. At the start of this year, it closed on a $4.7 billion deal to buy the annuity company Global Atlantic, which means it’s now competing with insurers making big commercial mortgages. In March, it made a $1.1 billion life-sciences play in San Francisco. In September, it launched a $1 billion joint venture to invest in health care real estate. And in October, it closed its largest real estate fund, raising $4.3 billion. It’s also been buying up billions of dollars’ worth of warehouses around the country. 

Many of the private equity giants went public in the last 15 years. And the founders of these firms, who defined an industry with their audacious takeovers and personal rivalries, are handing the reins to a new generation of executives who have mostly avoided the headlines. At KKR, Kravis and Roberts stepped down in October to make way for their protégés, Joseph Bae and Scott Nuttall.

And many of those companies are now moving away from those private equity roots and pumping more of their billions into real estate, seeing incredible riches in sectors from single-family rentals to life sciences and industrial. 

But it’s not as though those businesses are controversy-free. Where private equity companies were once pilloried as corporate raiders, they’re now buying up single-family homes in the midst of a housing crisis.

Meanwhile, the big moments of distress that led to some of private equity’s biggest wins haven’t yet materialized, leaving the new leaders searching for ways to make their mark. Blackstone and other investors in single-family rentals were able to rapidly expand, for example, by buying up mortgages on foreclosed properties after the financial crisis. This time around, there’s been no similar spike in defaults.

Now KKR’s building a new identity, and its real estate arm plays a big role.

Ten years ago we mapped out a whiteboard strategy,” Ralph Rosenberg, KKR’s head of real estate, said in an interview with The Real Deal last month. “We’re now seeing the full effect of this plan — and all the hard work that went into putting in place the right foundation — come together with the acceleration of our business.”

The new gate

Hollywood is full of colorful depictions of financial titans, from Michael Douglas’ Gordon Gekko in “Wall Street” to Leonardo DiCaprio’s Quaalude-popping Jordan Belfort in “The Wolf of Wall Street.”

The actors Jonathan Pryce and Peter Dvorsky played Kravis and Roberts, respectively, in the 1993 HBO adaptation of “Barbarians at the Gate,” the seminal business book that chronicled KKR’s takeover of RJR Nabisco and cemented the firm in the public consciousness.

Rosenberg, a former Goldman Sachs partner whom Kravis and Roberts hired to start the real estate arm in 2011, wears a neatly trimmed 1980s-style beard that gives him a resemblance to Harry Ellis, the blustery Nakatomi Corporation executive from “Die Hard.” The comparison, however, begins and ends with the look.

A genial figure who preaches the gospel of KKR’s “one team” philosophy, Rosenberg, 57, comes across as humble even as he talks about the company’s grand ambitions. His goal is to make KKR a top-three company in all the sectors it plays in, ranging across 10 different investment vehicles on the debt and equity sides and with another three in the works.

The company’s real estate business has grown from $600 million drawn from its own balance sheet to $36 billion of assets under management. Its near-term plan is to double that figure over the next few years, and it sees the potential to double it again after that.

To get there, though, the company’s going to have to show results.

If you don’t perform, you’re not going to become a top player,” said Rob Lee, an analyst at KBW. “So far, so good, but you have to sustain that.”

KKR’s first two U.S. opportunistic equity funds posted net returns of 12 percent and 25.1 percent to investors, according to its most recent financial statements.

One way to track growth is through fundraising. KKR has raised six closed-end equity funds (three in the U.S., two in Europe and one in Asia) totaling nearly $13 billion since it first started raising capital for real estate in 2013, according to Preqin. That haul makes KKR the sixth most active fundraiser over the past five years. It’s helped that Rosenberg and his group have big money on speed dial.

If you’ve got a big name behind yourself, you can raise significant quantities of cash from a huge network of LPs relatively quickly and easily,” said Preqin’s David Lowery, who added that equally important is finding good deals to spend that money.

If you can find ways to deploy capital,” he said, “fundraising could accelerate quite quickly.”

Another advantage for KKR is the fact that its LPs — the pensions, sovereign wealth funds and other institutional investors it raises money from — have been consolidating the number of money managers they work with. 

That favors incumbents but leaves little room for those that can only do private equity buyouts, so KKR and its peers are trying to become more well-rounded. It’s the latest rebranding for the industry that was once called “bootstrap acquisitions” before it became “leveraged buyouts” and then “private equity.” Now, those companies want to be considered asset managers, more like the Fidelities or Vanguards of the world that serve as a one-stop-shop for investors. Except they’re chasing the higher returns found more often in the private markets. 

Rufus Hone, an analyst at BMO Capital Markets, said that stock investors prefer managers who can move money and gain insights across different asset classes and markets. 

More diversified alternative managers tend to attract premium valuations relative to single-strategy managers,” he said.

Of course, there’s one company that’s set the model.

Gray matter 

When it comes to real estate private equity, the $230 billion gorilla in the room is Blackstone, and it’s a comparison KKR is used to.

During a video presentation with Morgan Stanley in June, Rosenberg name-checked his firm’s biggest rival as he emphasized that KKR also has the firepower to make large purchases.

We are in the large-deal business. Don’t be confused,” he said, a big grin stretched across his face. “There is somebody other than Blackstone in the world that can do very large, multibillion-dollar transactions.”

Today, Blackstone is known for its industry-defining deals, such as the $23 billion purchase of Equity Office Properties and the $26 billion purchase of Hilton Hotels, but it wasn’t always that way. Jonathan Gray built up that business from a sideshow to the main attraction. Just under a third of its total assets under management are now in real estate — the same share as its private equity business — and Gray is first in line to run the company when co-founder and CEO Stephen Schwarzman steps down. 

At KKR, real estate makes up just 10 percent of the assets, and its $36 billion worth is a fraction of Blackstone’s. Rosenberg’s team isn’t under any delusion that they can grow their business sixfold overnight, but they are confident that in the next few years they can close the gap. It’s kind of like when an expansion team makes it to the postseason for the first time and puts the league on notice that there’s a new contender. 

The rivalry between the two companies goes way back and up to the highest levels.

Schwarzman infamously slammed KKR as a “one-trick pony” in a BusinessWeek cover story in 1998, four years after his company launched its first real estate fund. Years later, with Schwarzman having earned the tag of “poster boy for greed” from New York magazine, Kravis was reportedly deeply upset at the negative attention the Blackstone boss was bringing to their industry.

The two also sparred on the social scene. Kravis refused to attend a dinner at the New York Public Library honoring Schwarzman, who returned the favor by not inviting his rival to his 60th-birthday bash. Schwarzman reportedly explained the snub by pointing out that he had never been invited to Kravis’ apartment for dinner.

Age may have brought the temperature down somewhat: Kravis attended Schwarzman’s 70th-birthday celebration in Palm Beach, complete with acrobats, Mongolian soldiers and camels. 

But personal animosity is no reason to turn down a good business idea, and in many ways KKR is following in Blackstone’s footsteps. 

Just a few examples: Blackstone launched its publicly traded mortgage REIT, Blackstone Mortgage Trust, in 2012. KKR started its version, KKR Real Estate Finance Trust, in 2017.

In 2016, Blackstone launched Blackstone Real Estate Income Trust, a nontraded REIT that allows individual retail investors to put their money into the company’s least risky assets. KKR in May launched its version, KKR Real Estate Select Trust. 

Blackstone invests heavily in warehouses and built its own company to manage and operate those properties, Link Logistics. KKR’s warehouse management company is called Alpha Industrial Properties.

Blackstone built the largest single-family rental company, American Homes 4 Rent, which it sold in 2019. KKR launched its single-family management company, My Community Homes, in June.

KKR is “viewed as one of the large-cap managers with an opportunity to grow their flagship equity and credit funds, and to add new strategies over time,” said Doug Weill at Hodes Weill & Associates, which advises fund managers on real estate. “Whether they’ll get as big as Blackstone … that’s a tough playbook to follow.”

A spokesperson for Blackstone declined to comment.

Room raiders

If KKR’s real estate business has a signature deal, it could be said to be its $2.2 billion sale of a portfolio of nearly 150 warehouses to Oxford Properties Group this summer.

KKR had spent three years acquiring the 14.5 million square feet of warehouses through 50 transactions in 12 major markets across the country. 

Ankit Bhatt, Oxford’s director of investments, said he was impressed by the way KKR acquired the properties and then put them together into a thoughtfully constructed portfolio. Relatively few companies out there that can play that portfolio-builder role, he said.

There’s a vacuum of true national operators,” Bhatt said. “They’ve been very successful and done a great job at aggregating the portfolio.”

This is the role KKR sees for itself in the market. It can buy up properties or businesses piecemeal, then stitch them together and sell them to larger investors for what it calls a “portfolio premium.” 

KKR, which still owns about 35 million square feet of industrial property after the deal, remains active in the warehouse space, but the arena is getting very crowded.

In 2015, professional investors accounted for just about 8 percent of the purchases of warehouses in the country’s six top metros, according to Real Capital Analytics. By last year, that figure had climbed to nearly 25 percent.

In just the past year, prices have risen about 19 percent. RCA’s Jim Costello said industrial is the perfect asset class for private equity: It requires less in capital improvements than, say, an office building, and prices keep rising with increased demand from e-commerce.

The price growth at this level is indicative of investors just being hungry for assets and willing to pay up for the stability of the income stream that comes from owning the back end of the internet,” Costello said. “You kind of have to pinch yourself and ask, ‘Do we believe the math going into these price calculations?’”

Warehouses are just one component of the giant’s secular-tailwinds approach: Place big bets on life-sciences buildings, self-storage, student housing and apartments in Sunbelt states that nearly everyone agrees are as close as it gets to a sure thing.

If you look at the legacy of commercial real estate investment, up until around 10 years ago the whole world was dramatically overweight office and retail,” Rosenberg said. “We were incredibly fortunate to start our business 10 years ago with no historical exposure to these sectors, and this allowed us to build a franchise off of real estate 2.0.” 

In March, for example, KKR paid $1.1 billion to buy a 750,000-square-foot office complex in San Francisco, the second-largest market for life-sciences lab space in the country. It plans to repurpose that space for life-sciences tenants. Not only was it the second-biggest single-asset deal in the history of the Golden Gate City, it was inked at a hefty price: $1,440 per square foot. The company also picked up a stake in a 635,000-square-foot lab building in Boston’s Seaport District in September.

KKR is also buying properties in areas it thinks are seeing temporary disruptions. The Hudson Yards observation deck, for example, is a bet on tourism rebounding in New York. And last year, the company bought the $860 million portfolio of Brooklyn apartments alongside Dalan Management. It was the first major deal KKR did in the city, a market it had avoided up until that point because it thought prices were too high.

And the company is joining the single-family rental frenzy. But whereas private equity companies made a killing buying up distressed homes in the wake of the Great Financial Crisis, KKR is getting into the business while the sector is red-hot.

Don Walker, a housing analyst at John Burns Real Estate Consulting, said that could make it challenging to get the kinds of returns previous investors enjoyed.

There’s just not any opportunities to buy distressed homes anymore,” Walker said.

Succession: Season 3

KKR moved last year into its new offices at Hudson Yards, where it bought the top 10 floors at 30 Hudson Yards from the Related Companies. It’s now looking to expand its footprint there. 

(Little-known fact: Kravis and Roberts sat at a desk next to Related’s Steve Ross when they worked at Bear Stearns in the 1970s.)

The move represented a shift in the center of power for the city’s business elite. KKR had long been headquartered at the impossibly exclusive 9 West 57th Street.

Instead of rubbing shoulders with the masters of finance overlooking Central Park, KKR chose the Far West Side, where its employees and visitors now mingle with people from Facebook and CNN.

It used to be that the CEO lived on the Upper East Side and he or she would walk down Fifth Avenue into their Park Avenue skyscrapers,” said David Goldstein, a vice chair at commercial brokerage Savills. “I imagine KKR has the next set of decision-makers who are younger, perhaps a little more dynamic. Maybe they live in Tribeca. The decision-making is becoming more democratic.”

The location sets them apart. Apollo Global Management remains at 9 West, and Blackstone is staying put at its longtime headquarters at 345 Park Avenue. The Carlyle Group, headquartered in Washington D.C., is moving its New York offices to SL Green Realty’s One Vanderbilt. 

All this comes as KKR is going through a leadership change.

The ascension of Bae and Nutall, both 25-year veterans of the firm, to co-CEOs was a move several years in the making. However, people familiar with the thinking of Kravis and Roberts, who are staying on as co-executive chairs, say they plan to stay deeply involved in running the business and are downplaying any major change.

Across private equity, founders of the big firms are stepping aside to allow a new generation to take over, but it hasn’t always gone so smoothly.

At Carlyle, co-founders David Rubenstein and William Conway laid out a succession plan in 2017 that named two top executives, Kewsong Lee and Glenn Youngkin, as co-CEOs.

But Lee and Youngkin butted heads, and their internal conflict ended last year when Youngkin abruptly resigned.

A similar situation occurred at Apollo between the co-founders. Leon Black stepped down as CEO in March due to his ties to the disgraced financier Jeffrey Epstein, and it appeared that co-founder Josh Harris was in line to step into Black’s shoes. But a power struggle broke out between Harris and Marc Rowan, who ultimately won the job.

Cloud club

Kravis and Roberts made their company into a household name as one of the pioneers of the leveraged buyout business, but that was a different era. 

Blackstone supercharged its real estate business with the purchase of Sam Zell’s Equity Office Properties in 2007 for $23 billion, a move it was able to pull off through some high-wire dealing by selling off some of the biggest properties to Harry Macklowe right before the market crashed. It also bought Hilton that year, and sold the company a decade later for a $14 billion profit — one of the most lucrative leveraged buyouts of all time.

More recently, Blackstone announced it will sell the Cosmopolitan casino in Las Vegas for $5.65 billion — more than three times the $1.7 billion it paid to buy the troubled casino in 2014.

KKR’s got its own list of major league home runs. It pocketed over $7 billion on the 2007 buyout of European pharmacy company Alliance Boots, roughly quadrupling its investment when the company sold to Walgreens in 2015. 

That’s part of the reason why expectations for its real estate business are so high. KKR’s not used to being an afterthought. 

But it’s not a foregone conclusion that the private equity masters of the universe can show up with their checkbooks and muscle in on someone else’s ground.

Apollo tried to get into real estate in the 1990s when it teamed up with William Mack to launch Apollo Real Estate Advisors. That partnership ended in 2000 when Mack’s outfit spun out. Apollo relaunched its real estate group in 2008, but so far it’s underwhelmed.

KKR’s real estate arm has already surpassed Apollo’s, but that was never the goal. For KKR, anything less than being in the top three would be considered a disappointment. 

Because in high finance, just like with observation decks, being at the top matters. 


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