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VOL 11 | ISSUE 1 | FEB 2015 | perenews.com
FOR THE WORLD’S PRIVATE REAL ESTATE MARKETS
THE SECOND WAVE
Why Fortress Investment Group is excited about 2015
BLUEPRINT | FORTRESS INVESTMENT GROUP
From the castle keep
Fortress Investment Group is one of the most active firms in private equity
real estate, hiring, capital raising and scouring the globe looking for assets.
Robin Marriott goes inside the turrets at its New York HQ to hear the latest
from co-chief investment officers, Tom Pulley and Anthony Tufariello
Photography by Donald Bowers
Anthony Tufariello and Thomas Pulley
BLUEPRINT | FORTRESS INVESTMENT GROUP
Fortress Real Estate leaders: more latitude, great responsibility
T
om Pulley and Anthony ‘Tony’ Tufariello. One quite
laid back, the other fairly intense.
You are looking at the co-chief investment officers of the global real estate business at Fortress Investment
Group, the New York firm that is publicly listed on the New
York Stock Exchange that has grown to $66 billion of assets
under management and for whom real estate is a very serious business. After all, in real estate, Fortress has found some
of the most fertile ground for opportunistic and distressed
investing coming out of the financial crisis. And, with a team
of 80-plus professionals focused on the asset class, no wonder
the team is coming out from under the umbrella of the firm’s
credit business for which it accounts for approximately one
third of investments. It is no small enterprise after all, having
made 180 transactions and deployed $7 billion of equity since
2002.
Pulley and Tufariello are in the business of financial
services garbage collection, as Fortress co chairman and
principal – Peter Briger – termed it the last time we caught
up with the firm back in the summer of 2011. The description
well fits this team of sleeves rolled up, no-nonsense investors because real estate can be a rough and tough business,
especially when playing in the arena that Fortress specializes
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PERE | FEB 2015
in – namely distressed debt and opportunistic real estate. It
needs a certain mindset and tenacity, and if appearances are
anything to go by at least, they have it.
PERE caught up with Pulley and Tufariello in January
to talk about Fortress and how it sees real estate. Since our
first meeting, the deal count has ticked up steadily, the same
senior people are here, the desire for distressed real estate
deals remains unabated and the geographical theater of
activity remains the same: The US, Japan and Europe.
But of course, evolution occurs at all franchises and Fortress
is no exception. On the personnel-side, Pulley and Tufariello
were in 2014 formally made co-chief investment officers of
the global Real Estate business. The company is just in the
process of updating their details on its website though it was
not a promotion per se as the two have been doing this job for
a while now. However, make no mistake, it holds significance
because it amplifies how Fortress recognizes that its global
Real Estate business needs a distinct leadership structure,
more latitude and greater responsibility. Pulley focuses on
Japan and the US while Tufariello focuses on US and Europe,
though both jet the world incessantly.
More news is that the company has been expanding headcount within its credit and real estate team by around 20
percent in the last year, with a major focus on asset management and Europe.
Further, as far as capital raising goes, the firm is extremely
active. Fundraising is an area Fortress will not comment on,
but it is known to be in the market not only with its second
US and Europe dedicated opportunistic RE fund, but is also
close to the finish line for Fortress Credit Opportunities
IV. The predecessor fund attracted $2.7 billion of commitments. Then there is Fortress’ third Japan Opportunity fund
also in market. They’ve raised over $10 billion in private
equity structures for these business lines since 2008 and are
rumored to be closing another $5 billion imminently.
Plus, the real estate markets in the US and Europe have
shifted since we last met the company leading to a slight
alteration in its strategy. More of that to come. With all these
developments, it made sense to interview the firm on what
happened to be an extremely cold January morning when fog
surrounded the upper levels of 1345 Avenue of the Americas
in Manhattan.
Trillion dollar opportunity
It may have been freezing and foggy outside, but inside there
is clarity coming from Pulley and Tufariello. For more than
an hour, they explain how Fortress believes that there is a
very large opportunity for a group like itself to seize. Pulley
says: “Many think that because the US economy fundamentals are improving, which they are substantially, that the
distressed debt opportunity in the US is disappearing. But
we think that we are going to have this other wave as maturities come due over the next couple of years. It is our view
that over 20 percent of those maturities coming due are going
to have problems in refinancing and are going to need new
capital in some form or fashion.”
More specifically, Fortress is eyeing $1.2 trillion in maturing commercial real estate loans through 2018, as estimated
by Maximus Advisors. Much of this debt was issued pre-crisis with high loan-to-value ratios, often exceeding 90 percent.
The decline in national property values since peak levels has
led to what it says is a “continuing financing shortfall” with
more than $300 billion of CMBS contractually maturing
between 2014 and 2017. Notwithstanding resolutions to date,
the scale of maturities remains enormous and is expected to
reach a new, higher peak in the coming years, says the firm.
To borrow a metaphor from childhood, to Fortress this market is like a gigantic sandbox to play in and Fortress feels like
the kid with a large bucket, spade, rakes and indeed all the
play tools necessary to be successful.
The message that Pulley and Tufariello spell out is that
Fortress has consistently been sourcing investments from
broken, stressed and strained CMBS and other distressed
debt and equity structures since the global financial crisis. Or
as they put it, a decent portion of its investments are distress
around the “demise and resolution” of the CMBS activity of
2006 and 2007.
Says Tufariello: “We continue to be very focused on distressed debt and equity in the market place, which enables us
to get to an asset at a very cheap basis and we see much of the
same opportunity over the next couple of years.” It might be
the same kind of opportunity, but in the eyes of the firm it is
that much larger now.
Based on a loan-by-loan review of CMBS transactions
managed by affiliates, Fortress thinks 20 percent of upcoming maturities are impaired and may need restructuring.
It divided the CMBS into risk-categories from higher risk
meaning debt service coverage ratios of less than 1.1x, to
Anthony Tufariello
Co-CIO of the real estate business
Anthony Tufariello, who joined Fortress in November
2008, has just recently received a new title as co- chief
investment officer of Fortress’ Real Estate business.
Prior to that he was a managing director of the credit
funds, responsible for all real estate investing including securities, debt and equity investments and also
remains a member of the management committee of Fortress. His resumé
is colorful to say the least
given his previous positions
at Morgan Stanley which
put him into close contact
with previous chairman and
chief executive officer, John
Mack. He was with Morgan
Stanley for a total of 21 years
and held a number of senior positions at that firm,
including being a member
of the firm’s management
committee, a member of the
sales and trading operating committee and co-chair
of the global large loan credit committee. His most
recent role at the Wall Street bank was managing a
complex business which included client agency businesses, principal lending activities (commercial real
estate, residential lending, warehouse lending and
secured cash flow lending) as well as managing the
trading desk across CMBS, ABS, CDOs and residential
products.
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BLUEPRINT | FORTRESS INVESTMENT GROUP
lower risk. Based upon this analysis and also previous default
experience, Fortress arrived at the conclusion that one in five
loans may default upon maturity.
For years past, Fortress has been getting control of assets
in the US via broken structures. Few would have heard about
too many of these, because the firm keeps these things under
the radar, although investors get the 100-page quarterly
report where all deals are laid bare.
Until recently, Fortress has been investing in underlying
assets in major US gateway cities. But as everyone knows,
these major markets have more than recovered value erased
in the crisis – Moody’s estimates put it at 116 percent of their
pre-crisis peak. Meanwhile, non-major gateway markets have
recovered less at 91 percent and are still trading at healthy
discounts to replacement cost.
As Tufariello says: “A few years ago, we were very focused
on major gateway cities. We have the same strategy of getting
access via debt and recapitalizations, but San Francisco, New
York and others have run past the peaks of 2007. We think
the opportunity over the next couple of years is more in the
non-gateway markets where values have not recovered but
debt is becoming due without refinancing options.
The theory is that as loans approach maturity default,
capital constraints for capex and tenant improvements
on troubled assets further deteriorate the competiveness
Thomas Pulley
Co-CIO of the real estate business
Thomas Pulley also has a new title of co-chief investment officer of the Real Estate business at Fortress.
Prior to that he was CIO of
Fortress Real Estate (Asia)
and continues to be a member of the firm’s management committee. He joined
Fortress in October 2007
from Credit Suisse where
he was head of the private
equity division in Japan. In
2000, he moved to Japan to
build and manage the Asian
investment program of DLJ
Real Estate Capital Partners (RECP), a real estate private equity fund organized by Credit Suisse. He was
one of four designated key men for DLJ Real Estate
Capital Partners III and a member of its investment
committee.
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Tufariello: targeting ‘demise and resolution’ of CMBS
of buildings. Fortress will use the debt as the entry point
or catalyst to get control of these assets. Using their credit
lens to reset the basis, deep pockets to fund repositioning,
institutional access to cheap financing, and their operating
capabilities to drive leasing and NOI, Pulley and Tufariello
will make their returns.
In the US, it has been finding one-off situations like this
rather than going for large portfolio investments that tend
to attract crowds. A good example would be in Philadelphia
where it bought the loan collateralized by One Washington
Square which had the exact elements Fortress was looking
for. The loan attached to the building formerly known as the
Penn Mutual Towers was in special servicing after its former
owner tried unsuccessfully to renegotiate the debt. The occupancy level at the building had fallen to 77 percent but the firm
was able to buy the loan and inside four months had gained
control of the asset, thus saving a lot of time and money. The
asset management team is now in the process of leasing it up.
The stabilized asset should produce an NOI yield in excess of
10 percent in a market where comparable properties are selling for between 7 percent and 8 percent capitalization rates
or $150 to $200 per square foot. That appears to be a healthy
return on investment versus the market, reflecting an investment basis of approximately $80 per square foot.
A more recent example of the firm’s strategy was completed three months ago. It involved the same scenario only
this time it was a 340 room four-star hotel in the Caribbean.
In this case the firm is looking at in excess of an 11.5 percent
yield. It is currently in the process of foreclosing on the asset
busy. Indeed, people are aware of it, but how many can play
and there are lots of levers Fortress can pull to add value.
into it? And keep playing into it? This latter point is one of
Again, this was a scenario in which there is a defaulted CMBS
those raised by limited partners that assess Fortress. One US
loan, a receiver put in place, and limited
limited partner PERE spoke with that
capital to invest in the property.
has just invested in Fortress Real Estate
Says Pulley: “We have been able to
Opportunities Fund II said the big quesgenerate excellent returns without using
tion was how could Fortress replicate its
much leverage. If you look at our first US
success with Fund I given the current US
fund and add up what we paid versus
market?
how much we borrowed for investments
This investor has a particular view that
and it would be around 55 percent. The
Fortress won’t be able to, but remember
same basic math applies to our Japan
he still invested with the group because
funds.”
they are “real estate guys” in an environThe way Fortress sees it, there should
ment where “the dynamics of the capital
be a huge volume of investment opportumarkets are just as in important as the
nities to come. Says Pulley: “We haven’t
property market”. He said: “It is critibeen through the experience of so much
cal to have an investment manager that
paper hitting the wall at the same time.”
participates in both of those and Fortress
Tufariello chimes: “Low rates have effecbrings that skill set to the table. If you
tively bailed out the market.” Pulley
don’t understand the debt capital marOne Washington Square, Philadelphia:
non gateway city
adds again: “It may be a shallow part
kets you are giving away returns.”
of the market right now. People are not
He added: “But I think what is interyet looking at the underlying collateral. We think that is a
esting is that this vintage going forward is not going to be
substantial opportunity.” This may be no surprise to the real
anywhere near as good as 2009 and 2010. Part of the answer
estate community, but if they are right, Fortress will be very
is that I have to trust my manager with a great track record.”
Check in, check out
Fortress owns a Japan hotel REIT called Invincible whose earnings are up five times since it
became involved
When Invincible REIT hit a cross default on its debt in late time they had provided financing to the REIT. The company
2010, the Tokyo Exchange listed company and its asset subsequently retired the refinanced debt with a syndicated
manager set out to find a sponsor in short order. Fortress bank loan, further reducing Invincible’s average interest
negotiated a deal with a CMBS creditor,
rate from 1.48 percent to 1.09 percent.
injected equity, extended a sponsor
And a successful public offering in July
loan and refinanced all of the compa2014 was 6x oversubscribed, raising
ny’s debt in July 2011, creating a stable
¥26 billion. Today, the company’s marcapital structure while also acquiring
ket cap is approximately ¥150 billion
the REIT manager. Since then, Fortress
compared to ¥13 billion at the time of
worked with the REIT manager to cut
Fortress’ acquisition. From a distressed
expenses by ¥200 million ($16 million)
REIT looking for a lifeline, the company
annually, improve occupancy from 92
has emerged with a strong capital base
percent to 96 percent and to further Hotel MyStays Sakaisuji-Honmachi, Tokyo: and substantial borrowing capacity to
acquired in 2014 finance accretive acquisitions. Earnlower borrowing costs, the sponsor
loan was refinanced in December 2013
ings were up over 5x from acquisition
with ¥20.4 billion of new debt and ¥3 billion of equity. Two through the first half of 2014 and the investment is valued
of Japan’s mega banks led the syndication, marking the first at approximately6x Fortress’s basis.
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BLUEPRINT | FORTRESS INVESTMENT GROUP
Pulley picks up on the theme. “I think the question being
asked is how replicable is the strategy? But our answer to
that is the on-going flow that we are building upon, and the
infrastructure here at Fortress where we have been scavenging the globe looking for deals, with approximately 14,000
people bolted on who are in the servicing companies, further bolted onto the macro environment opening up in the
US and Europe – a once in a lifetime CMBS unwind that
is going to happen in the next three years.” Pulley further
remarks: “We have 350 people scouring the world looking
for investments. We look in the nooks and crannies of the
system. Indeed, we built the entire system for this process.
From sourcing, investment pipeline, review of that pipeline
on a very regimented basis throughout the week, to how we
handle underwriting, due diligence, and execution on the
enforcement side, and what to do with the assets once we get
our hands on it.”
Fortress owns special servicers in key markets it targets.
San Fran grand slam
Fortress hit the ball out of the park with its investment in Parkmerced, the 3,200 multi-family
complex in ‘The City’
When PERE last interviewed Fortress back in the summer of 2011, there was one investment that really stuck
out, and we featured it as part of the article. Parkmerced,
the famous San Francisco multi-family project located
on more than 150 acres in the southernmost section of
“the City” was an investment that Fortress made in September 2010 on behalf of Fortress Credit Opportunities
Fund II along with other managed funds. Now, if you still
keep hold of back issues of PERE, you will discover from
the article all about the history
of Fortress and Parkmerced and
how the asset had fallen into the
hands of special servicer Aegon
Realty Advisors. One would also
have learned that the asset was
suffering from multiple ill winds.
The global financial crisis affecting real estate markets, student
occupiers drifting away as program budgets cut deep at the
local San Francisco State University, and a dysfunctional capital
structure all played a part in the
complex going south. It was, in short, a mess for a building steeped in history having been developed way back
in 1939 by Metropolitan Life Insurance and designed by
architect, Leonard Schultze. The first tenants, incidentally,
moved in during 1944 right at the end of World War II.
In our article, we chronicled how Fortress had become
financially involved in the first place via the debt. But the
question is whatever happened to the investment from
2011? Well, as press clippings from last year show, Fortress
eventually divested its interest in Parkmerced in October
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2014 after a four-year holding period to group of investors
led by New York developer Mark Karasick. But did it make
a large return and if so how much? The problem is that
Fortress will not discuss the investment due to confidentiality issues.
However, individuals familiar with the market and following the investment closely estimate a return commensurate with a well-executed plan. Having become
involved, Fortress went about unwinding the complex
capital structure, competing equity interests, substantial overleverage, pending maturity
defaults, a weak local economy
and a lack of operating capital. It acquired various interests
throughout the capital stack in
off-market transactions and did
what property investors should
do – increase the NOI. It replaced property management,
Parkmerced: a 2.5x
ratcheted up leasing and management efficiency by introducing better systems and controls,
changed management culture to be more proactive and
focused on returns, plus executed a few cost cuts. Occupancy levels started to rise. Indeed they went from 88 percent to 97 percent. Rents were increased as well from $2 a
foot to more than $3.35, and NOI almost doubled. Finally,
entitlements were achieved whereby over time some
5,900 additional units could be developed. The net result?
According to market participants, Fortress invested over
$150 million and generated a gross IRR of over 30 percent
with a 2.5x equity multiple.
Evolution
Fortress’ credit business, founded in 2002, began with the
Drawbridge Special Opportunities fund. This is a $6 billion
evergreen diversified fund with around 500 different investments. The Drawbridge fund, according to investors,
boasts a compound net return of 11 percent for the past 12
years. However, after the financial crisis of 2008, Fortress
recognized the enlarged credit opportunity and that it required an equity, longer-hold strategy, so the team raised
a series of dedicated private-equity style credit closed
ended vehicles. Fortress Credit Opportunities Funds and
related accounts have raised $10 billion since 2008 and are
about to close the fourth fund - FCOI V. In addition, in 2009
In the US, they own CW Financial, the second largest special
servicer of CMBS. CW is named special servicer on $109
billion of loans, employs 142 staff across 5 cities and has an
additional 1,050 people at its subsidiary, CompassRock. In
Italy, there is Italfondiario, the largest non-bank special servicer in the country that started as a Fortress private equity
fund investment more than ten years ago. For the UK, Spain,
The Netherlands and Germany it has GMAC Financial
Services’ European mortgage assets and operations that it
bought in 2010 after the US government bailed out GMAC
with $16.3 billion.
Pulley: 350 people ‘scouring’ the world
it raised a dedicated Japan distress vehicle, Fortress Japan
Opportunity Domestic Fund, which closed in June 2010
and is showing up net IRRs of 31.5 percent. It has raised
two Japan funds since 2008 and is deep into raising a third.
Lastly, in 2011 it began raising a US and Europe dedicated
real estate fund, Fortress Real Estate Opportunities Fund
which raised $567 million and is showing net IRRs of 15.6
percent. Fund II is said to be in the market. Pulley says:
“Real estate has always been about one third of the Credit
business, but then we started to separate out the real estate platform commensurate with an investor base, some
of which wanted greater pure real estate exposure.”
Speaking of Europe, three and half years ago Fortress
indicated it did not see the same level of opportunity as in
the US. But that is another thing that has changed given
the increased level of liquidation of loans and properties
in Europe. Since 2008, the European bank nonperforming
loan market has more than doubled from 2.8 percent to 7.8
percent of total loans – nearing 2001 peak Japanese levels.
Morgan Stanley, Deutsche Bank and others originated billions of euros of European CMBS. They were complicated
structures not only because of their aggressive tranching and
subordination, but also because of bespoke structuring and
embedded FX and interest rate swaps adding further uncertainty and complexity.
This is now a hunting ground for Fortress. As in the US,
the company has been getting control of European assets
through debt and has thus far been producing strong cashon-cash results with moderate amounts of leverage, says
Tufariello. Project Vermeer, an investment made in 2013,
is the perfect example. In that case, Morgan Stanley’s once
prolific European Eloc conduit program had originated a
CMBS in 2008 on a 2007 €1 billion loan extended to the private Fordgate Group of the UK enabling Fordgate to buy 36
Dutch properties, 12 Belgium assets, 10 in Germany and 7 in
Switzerland. Cutting a long story short, apparently Morgan
Stanley got halfway through the securitization plan when the
music stopped. In other words, half the bonds got sold, half
didn’t. That created an opportunity for Fortress to buy the
senior bonds from the originator, and then later in the market place. Its price basis was one third of what the original
financing was.
On this example, Fortress’ team swung into action, putting some of its top talent onto the investment. One senior
team member had to read through a 450-page servicing
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BLUEPRINT | FORTRESS INVESTMENT GROUP
agreement. At Fortress, it’s all hands on deck with sleeves
rolled up.
As with the US, it is all about driving the NOI having
reached the asset at a good price. What is striking about
Fortress in Europe, however, is its absence from the list
of major franchises that have taken part in NPL trades.
Tufariello says the reason for that is Fortress prefers to look
at smaller pools, avoid the competition, invest in “idiosyncratic” deals, drive NOI to create value, and also diversify
investments.
In other words, it executes a large number of individual
transactions where the air is thinner. The first US and
European RE fund was primarily US investment and it
clocked up 30 different deals – a strike rate of about one a
month. The first Japan RE fund, meanwhile, was equally prolific, making 23 investments. The second Japan RE fund has
30-plus investments in it.
This high number of investments typically would mean
a lot of capital calls for investors, but Fortress assesses the
pipeline and bundles up capital calls to keep disturbance to a
minimum. Also, the high cash-on-cash returns mean profits
are recycled. The investors get a bigger dividend back later.
As the pair turn their attention briefly to Japan where a lot
of CMBS activity has already occurred, it is clear the strategy
is strikingly different. What is really driving investments in
Japan is the hospitality sector fuelled in part by the Olympics
which arrive in Tokyo in 2020. Fortress started buying hotels
in Japan from 2010 and assembled a portfolio of 67 hotels
with a disposal value of $2.5 billion including the Sheraton
Tokyo Disneyland, Narita Hilton and 40 business hotels
primarily in Tokyo. Around 14 months ago, it exited a big
portion of its hotels via an affiliated J REIT called Invincible
Investment Corporation. Across the whole hotel portfolio,
the NOI increased 20 percent-plus. (See box on page 29)
One has to admit, the examples of how Fortress is operating in the US, Europe and Japan are pretty eclectic. No
wonder it is hard to place the firm into a pigeon hole.
Indeed, it is easier to explain what it is not. It is not a franchise that likes to do the equivalent of big game hunting in
packs. It prefers to operate away from the competition and
isn’t afraid of being involved in complex or controversial situations. Staff one minute can be working on providing a real
estate loan to a Chinese property company to develop a large
scale residential project in Brooklyn, as occurred in June
2014. The next minute they might be renegotiating whole
tranches of a Morgan Stanley CMBS originated in Europe
pre-credit crunch as was the case with Project Vermeer.
Sums up Pulley: “We are extremely comfortable with our
ability to look at potentially contentious situations, evaluate
the possible outcomes, play the chess game.”
Pulley and Tufariello: playing the chess game
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