When Deutsche Finance Group looked to crack the U.S. real estate market, it set its sights on a prime Manhattan corridor.
In August 2018, the German investment firm’s new U.S. subsidiary picked up the top floors of the Gucci building with New York-based developer Michael Shvo and Turkish real estate mogul Serdar Bilgili for $135 million. The partners are planning to redevelop 25 floors at 685 Fifth Avenue into Mandarin Oriental-branded luxury residences with views of Central Park and the Midtown skyline.
Over the last 24 months, Deutsche Finance — no relation to Deutsche Bank — has partnered in 13 U.S. real estate deals from Boston to San Francisco, totaling about $2 billion in equity. That marks one of the largest foreign buying sprees in recent years, after Chinese investors pulled back.
The group’s recent spate of direct investments in the United States has led to a dramatic expansion in the company’s scale. Deutsche Finance has quadrupled its assets under management to €6.9 billion from €1.5 billion at the end 2017. While the firm has invested in 47 countries since 2005, its recent growth has been concentrated in the more developed markets of the U.S. and Europe.
“They had been thinking about North America, and I think the Shvo-Bilgili thing was a catalyst for it — it allowed them to have a deal and create a platform around it,” said a source familiar with the firm’s history who asked not to be named. Deutsche Finance declined to be interviewed for this article.
Even as the pandemic has slowed transaction volume and made property owners and lenders alike question valuations, Deutsche Finance appears to be sticking to its strategy. In October, the firm and a group led by Shvo closed on the $650 million acquisition of the Transamerica Pyramid in San Francisco. And some of the German firm’s recent investments, such as a Boston life-sciences project, may even stand to benefit from the current environment.
Once the ball started rolling in the U.S., the massive amount of German capital waiting to be deployed — driven abroad by low to negative interest rates at home — would soon lead to one blockbuster deal after another.
“They have lower yield requirements and a lot of capital, so if they trust you — like they do with Deutsche Finance — then it’s a pretty interesting capital source,” the source said.
Birth of the club deal
The nature of Deutsche Finance’s business isn’t that easy to pin down.
The group has been active in the real estate, private equity and infrastructure space since its founding in 2005. “We are a business platform and not a business in the classical sense,” the firm’s founder and chairman Thomas Oliver Müller told a German trade publication in a January 2019 interview.
Deutsche Finance is backed by at least 15 financial institutions, including some of Germany’s largest pension funds, as well as more than 35,000 mom-and-pop retail investors in Germany.
Since 2008, Deutsche Finance has closed more than a dozen funds for private investors. But as part of its U.S. expansion, the group is experimenting with what it calls “club deal” funds, which allows small investors to invest alongside financial institutions.
The first such fund was launched in 2019, to raise $40 million in equity for a life sciences development near Boston. The fund raised its target within three weeks.
“This is a truly entrepreneurial real estate investment, in which the investors take an active part,” Theodor Randelshofer, head of Deutsche Finance’s sales division, said in an interview with German trade publication Finanzwelt early this year. “Retail investors had no access to this — until our first club deal in November 2019.”
Deutsche Finance is not alone in raising significant amounts of capital from retail investors in Germany. For example, Jamestown L.P. — an affiliate of Germany-based Jamestown US-Immobilien GmbH — has closed 38 U.S. real estate funds with capital from more than 80,000 small investors over the past three decades.
Pursuing investment opportunities around the globe, Deutsche Finance built up a sprawling network of properties spanning from Brazil and Chile to Indonesia and Vietnam, including not only office and residential properties but also hospitals, gas stations, casinos and ports.
“Fundamentally, all countries are on our investment shortlist,” Müller said in a 2018 interview. “There’s certainly always temporary attention on a specific country, but that has less to do with the country itself than with an asset manager on the ground that is offering us an interesting investment opportunity.”
But after taking significant book losses in Turkey amid that country’s currency crisis, Deutsche Finance began laying the groundwork for its big push into the U.S.
“We will make more Euro investments and overall focus more on Europe and the U.S.,” Deutsche Finance chief investment officer Sven Neubauer said in a 2018 interview. “That also means there will be fewer emerging markets in the portfolio.”
The first signature deal of Deutsche’s new Euro-American strategy closed in early 2017, when its newly founded London-based subsidiary, Deutsche Finance International, acquired the British capital’s landmark Olympia Exhibition Centre for €330 million in partnership with U.K. private-equity firm Yoo Capital, Bayerische Versorgungskammer and Versicherungskammer Bayern.
The acquisition and planned redevelopment of the Olympia marked “the successful start to a number of interesting ‘club deals’ and joint ventures for investors,” Neubauer said at the time.
That pipeline would include Deutsche Finance’s first direct investments in the U.S.
By August 2018, the firm launched Deutsche Finance America, headed by former Amstar Group president Jason Lucas.
Boots on the ground
It was a Turkish connection that brought Deutsche Finance to its first deal in the U.S.
Shvo and Bilgili sat at dinner with the broker who would ultimately help the partners line up financing they needed to get the Gucci building deal over the finish line.
Mitch Sikora, CEO of Manhattan-based JTP Capital, suggested Bilgili reach out to Deutsche Finance, with whom the developer has an existing relationship. (One of Deutsche Finance International’s co-founders, Frank Roccogrande, had co-founded and spent seven years as senior managing partner of BLG Capital, according to the firm’s website.)
The Munich-based private equity firm then brought Germany’s biggest pension company into the deal.
The Shvo-led group then expanded its reach, buying up three hotels in Miami’s South Beach for a total of $243 million and a 54-unit residential and retail development site in Beverly Hills for $130 million in 2019.
The group then pivoted to prime office properties, starting with the Coca-Cola Building at 711 Fifth Avenue in Manhattan, which they acquired for $937 million just months after Coca-Cola had sold it to another buyer.
Deutsche Finance’s last pair of office buys were different from the earlier deals in one respect: Bilgili’s BLG Capital was no longer involved.
Over the summer, the Turkish developer filed two lawsuits against Shvo and Deutsche Finance, accusing them of scheming to cut him out of a $376 million deal to buy Chicago’s “Big Red” office building at 333 South Wabash Avenue and the $650 million acquisition of the Transamerica building.
In Bilgili’s second suit against Shvo, which has already been discontinued, his lawyers claimed that Bilgili was “instrumental in securing” the group’s German institutional investors, which were “initially reluctant to do business with Michael Shvo because he had been indicted for and pleaded guilty to tax fraud.”
Shvo’s lawyers have rejected those claims, arguing that the suit was “a transparent attempt to cloak his defamatory allegations against Mr. Shvo with judicial immunity.”
Meanwhile, the pandemic has also led to another legal headache for Shvo and Deutsche Finance, in the form of a lease dispute with a major retail tenant at 530 Broadway, which they bought for $382 million in March.
Ralph Lauren subsidiary Club Monaco, which accounts for one-fifth of the mixed-use property’s annual base rent, sued the landlord entity in September to prevent its lease from being terminated, claiming the purpose of the lease had been frustrated by the pandemic. In mid-October, the court granted an injunction blocking Shvo from evicting the tenant.
This rent dispute has also caused some complications for the $210 million mortgage which LoanCore Capital provided to finance the acquisition.
In response to the suit, Shvo said in an October affidavit, “It is wholly inequitable and contrary to law that [the] landlord must continue to pay the mortgage for the building, with its significant monthly debt service, while [the] tenant deliberately deprives [the] landlord of its rent stream, which is essential to paying the debt service.”
An $80 million piece of that debt was set to be included in a commercial mortgage-backed security deal. But in June, the loan was removed from the package, according to Fitch Ratings.
Mom-and-pop investors still seem to be backing Deutsche Finance’s U.S. investments, even amid the pandemic.
The firm is partnering with developers DLJ Real Estate Capital Partners and Leggat McCall on part of the Boynton Yards complex in Somerville, Massachusetts, including a 289,000-square-foot laboratory building at 101 South Street, and a nearby parcel with 600,000 buildable square feet.
The Boston development is a proof of concept for a new offering Deutsche Finance is pitching. The company raised $40 million in equity for the project through a “club deal” fund, accepting contributions from investors of as little as $25,000 each — and managed to close the fund in just three weeks.
While Deutsche Finance’s first club deal fund gave retail investors a chance to bet on a new development in an up-and-coming asset class, the group’s second such offering — once again backed by property in the U.S. — is more traditional.
The company is now in the process of raising $50 million in equity for the Big Red building, an iconic 45-story, 1.2 million-square-foot office tower in the Central Loop of Chicago.
German rating agency Scope Analysis has given the fund high marks for tenant creditworthiness, a recent renovation by the previous owners, and Deutsche Finance’s highly developed competence in structuring club deals. But it also warned that the impact of coronavirus on the U.S. office market remains unclear.
Beyond Deutsche Finance, German institutional investors in general have long been big players in U.S. real estate. In the first three quarters of 2020, Germany was the second largest source of foreign investment in U.S. property after Canada with $2.2 billion in deals closed, according to Real Capital Analytics.
In addition to deals involving Deutsche Finance’s institutional partners, that figure was boosted by the sale of an office tower at 330 Madison Avenue in Midtown Manhattan, which German insurer Munich RE bought from the Abu Dhabi Investment Authority for $900 million in March.
German investment has slowed down significantly since the outbreak of the pandemic, dropping the country into third place behind South Korea. And all of Deutsche Finance’s recent acquisitions were already in contract prior to the pandemic.
Still, in early October, Deutsche Finance announced that it had already raised $41 million for the Big Red fund, a sign that the fund is on track to close ahead of its planned year-end deadline.
“Will German investors continue to invest in the U.S. in the foreseeable future? It would seem to me that their investment activity will still be limited in the near term … because of the ongoing Covid-19 mayhem,” Real Capital Analytics’ Jim Costello said. “That said, to the extent that cross-border capital is coming to the U.S., German capital will continue to be a leading source of capital.”
Editor’s note: All quotes in the story from German trade publications were translated.