| TCI founder Christopher Hohn. Photo: Bloomberg News |
It was toward the end of 2010 that CEO Christopher Hohn and other principals at the Children’s Investment Fund Management began toying with the idea of originating real estate loans. This was a bold move for the London-based $12 billion hedge fund firm, which was an active buyer of real estate debt in the secondary market but had no experience in loan origination.
With a sluggish postcrisis real estate market, “there was nothing good for sale in the secondary market anymore, with the right yield and the right quality of underlying asset,” says Martin Fräss-Ehrfeld, a TCI partner who oversees real estate investments. “We thought we’d investigate to see whether it made sense for us to start originating loans.”
Since 2011 the firm has completed ten deals, ranging in size from $36 million to $850 million, with a combined value of $2.9 billion and an average loan-to-value ratio of 49 percent. The loans, all of which have so-called trophy real estate assets — in Chicago, London, Milan or New York — as their underlying security, have generated an overall return of 10 to 12 percent. TCI has provided financing for the Four Seasons Hotel in downtown Manhattan, for which Silverstein Properties and CalSTRS borrowed $660 million, and for New York’s 432 Park Avenue, where Los Angeles–based real estate investors CIM Group and Harry Macklowe plan to build the tallest residential tower in the Western Hemisphere, which attracted a $400 million loan.
Investors pay a high rate to borrow from TCI — generally 10 percent or more — but there are mitigating factors, according to Fräss-Ehrfeld. In November 2013 TCI extended an $850 million loan to TDR Capital, a London-based private equity firm, to help with its takeover of David Lloyd Leisure, a leading fitness chain. TDR had the choice of raising capital through a bond issue, but Fräss-Ehrfeld says the bond would have restricted TDR’s ability to reinvest excess cash flow, instead mandating that it be used to pay down the debt.
“It was a huge advantage for us that we could offer the borrower the flexibility of being able to put excess cash back into the business,” he says. He believes the size of the loans TCI provides without the support of a syndicate, which would usually be needed for a real estate loan larger than $400 million, helps overcome the high lending rate, as does the fund’s track record.
Fräss-Ehrfeld offers up his firm’s success as an example of how alternative investment vehicles have been able to fill the funding gap as traditional bank lenders have retreated from loan origination. With conventional sources of capital drying up, hedge funds and private equity firms, strapped for yield in a low interest rate environment, have stepped in. In the U.S. the demand for real estate loans, especially in the commercial space, continues to recover strongly from its crisis-era doldrums. This is also the case in Europe.
“Changes in the regulatory environment mean the banks are required to maintain higher capital levels and are much more constrained in terms of what they can lend against,” says Jonathan Roth, president of Canyon Capital Realty Advisors, the real estate investment arm of $23 billion Canyon Partners in Los Angeles.
Despite the success of the strategy to date, Fräss-Ehrfeld says TCI has no plans to expand its funding beyond its core of North American and Western European cities where the stellar locations give the underlying assets a uniqueness that can’t be easily replicated elsewhere. “We only want to be in places with high barriers to entry,” he says. “You can’t build much more in Manhattan.”
