Believing Some Core Real Assets Now Overpriced, PE Giant KKR Ups Allocation to Opportunistic CRE
|Henry McVey, KKR's head of global macro and asset allocation.|
Kohlberg Kravis Roberts & Co. (KKR), a leading global investment firm with $61.5 billion in assets under management and a preference for spicier investments over commodities such as corn, is now showing a growing taste for commercial real estate
KKR has jumped back into property investments after largely being dormant in the post Great Recession era. This past week, it formed a joint venture with Hines and Pinto Realty Partners to develop a 971-acre master-planned business park in Houston, TX. When fully built out, the Pinto Business Park represents an opportunity of 9 million square feet.
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Back in April, its then newly formed real estate group headed by former Goldman Sachs executive Ralph Rosenberg, made its first U.S. retail investment. In partnership with YTC Pacific, it acquired Yorktown Center, a regional mall 20 miles from downtown Chicago, for $196 million.
Why is the firm investing in CRE now and why such two diverse investments?
Henry H. McVey, KKR's head of global macro and asset allocation, laid out the firm's reasoning this past week in a new Global Insights report he authored.
"First, we view real estate as an elegant way to own an income-producing inflation hedge," McVey wrote. "The current (Fed) policy of artificially holding nominal rates below nominal GDP is almost always inflationary over time."
"Second, we think that real estate is a pure-play on financial disintermediation. Specifically, as Wall Street shrinks its balance sheet commitments to the real estate industry, there is a significant opportunity for new entrants, particularly those with patient capital, to fill this void and earn attractive rates of return," he said.
"Given these favorable macro tailwinds, we are increasing our target allocation to real estate to 5% from 3%. To "pay" for this additional exposure, we are reducing to 0% our 2% allocation to gold, corn and other commodities -- particularly in the wake of corn's valuation increase of 50% over the last seven weeks."
KKR's latest allocation increase to real estate follows a 1% boost earlier this year. The combined increases represent about $1.8 billion more being targeted for CRE.
Core: Outright Expensive
"Although real-estate investments provide yield, growth, and inflation hedging (all key underpinnings to our long-term macro view), we do think selectivity is warranted at this stage in the cycle," McVey wrote. "Specifically, today we feel that a decent chunk of the prime, or core, global real estate asset class is fairly valued and, in some cases, outright expensive."
"By comparison, we believe there are compelling investments in the non-core and opportunistic segments of the real estate market that can provide investors with a more attractive risk-adjusted return profile," he wrote. "The key, we believe, is to understand which locations will benefit from secular growth drivers in employment, including manufacturing re-shoring, oil and gas exploration, education, and technological / health care advances."
McVey also said that given the magnitude and severity of the financial and government deleveraging that KKR says still needs to occur, there is a large and growing opportunity to provide CRE financing solutions, since traditional lenders are being forced to shrink their books.
"All told, the refinancing needs by the U.S. commercial real estate industry are estimated to total $1.7 trillion over the next five years," McVey said.
KKR: REITs Not Viable for Big Money
"Investors may use REITs to gain exposure to real estate, but we believe they should heed their many shortcomings, such as high correlation to other financial stocks, which in 2011 stood at a sizeable 86%," McVey wrote.
"In addition, publicly traded REITs constitute a relatively small part of the real estate investment universe, so institutional investors face a significant hurdle when trying to deploy large sums of capital through this segment of the real estate market," he wrote. "So we believe the REIT market really isn't a viable mainstream option for large institutions looking to invest sizeable sums of money to work on behalf of their pensioners or retirees."
"Our advice for the future," McVey wrote, "Given the diversity of opportunity sets we see ahead, we think having as much flexibility as possible to deploy capital, including the ability to provide equity, mezzanine, or even traditional loans, across a variety of industries and locations is likely to be a critical input to driving strong returns in the asset class."
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