J.P. Morgan betting real estate investors take to 'small' makeover

J.P. Morgan Asset Management Global Real Assets executives expect that creating an opportunity fund investment “boutique” within the $46 billion real estate investment powerhouse will give them an edge in raising capital.

Industry executives interviewed for this story had trouble coming up with examples of other large multistrategy real estate investment firms that have tried launching a boutique.

With fundraising at its lowest level since 2003, access to capital is expected to be key to separating winners from losers for the near future, industry insiders say.

J.P. Morgan is presenting the subsidiary as a new firm that doesn't have the baggage of poor returns and tarnished reputations that plague existing real estate firms. In the past, large investment firms like J.P. Morgan took pains to ensure that all of their strategies carried their brand. J.P. Morgan executives say that in this environment, being new and different will be a huge competitive advantage.

J.P. Morgan Asset Management's new opportunity fund boutique will be known as Junius Real Estate Partners, after J. Pierpont Morgan's father, Junius Spencer Morgan. It will be wholly owned by J.P. Morgan Asset Management; however, the seven or eight team members will keep a “sizable portion of the profits” in the form of carried interest, Joseph Azelby, New York-based managing director and head of the global real assets group, said in an interview. The exact percentage will be finalized when the entire team has been hired.

Mr. Azelby said he expects Junius will come to the market in the next 12 to 36 months.

The structure will be similar to J.P. Morgan's India and China-based real estate investment groups, which have dedicated teams that share in the carried interest, he said.

“We think we have a unique model. We're building a highly focused and dedicated boutique that's backed by the resources of a platform that is very well known and, we think, highly respected in the marketplace,” said Mr. Azelby, who has been with J.P. Morgan Asset Management since 1986. He worked in the firm's mortgage investment strategy group in fixed income before joining the real estate and infrastructure group.

Being a large real estate investment firm with a global reach is a pretty hard sell to institutional investors, industry executives and consultants say. Most institutional investors saw their real estate portfolios plummet in value since 2007 and few have recovered. As a result, most large investors are now focusing on retaining control.

“It's a Catch-22 for investors. From the folks we speak to, which are mostly endowments and foundations, they want to invest with managers who are sharply focused on their area of core competency. This generally means smaller fund sizes and smaller platforms,” said Glenn Shannon, president of Shorenstein Properties, a San Francisco-based real estate investment firm. ”On the other hand, the manager needs to have sufficient scale to have the resources be a good fiduciary and to attract and retain talented professionals.”

Unlike J.P. Morgan's multistrategy real estate and infrastructure investment platform, the Junius unit will be focused on a single strategy: U.S. opportunistic commercial equity and debt investments, possibly investing in private real estate operating companies.

“We have a couple of competitive advantages,” Mr. Azelby said. “We have the strength of J.P. Morgan Asset Management. We have ... experience in the real estate market and we have a newly formed team on a very strong platform with no legacy challenges. It is a huge competitive advantage,” Mr. Azelby said.

This is not a great time to be attached to an investment management arm of an investment bank. Investment banks such as Citigroup Inc. and ING Group have sold or are in the process of selling their real estate investment businesses as they discard their investment management divisions, which they consider non-core businesses. Goldman Sachs' Whitehall Street International real estate investment group and Morgan Stanley Real Estate Investment Management also are being hurt by subpar performance, said Scott Farb, managing principal in the Los Angeles office of the real estate consulting and accounting firm Reznick Group.

“Large investment banks with real estate fund platforms are revisiting their go-forward strategies in light of their performance over the past two years, (new rules imposed by the) Dodd-Frank (Act) and the adverse publicity they have been receiving,” Mr. Farb said. “This (move by J.P. Morgan) is a new idea for investment banking, and it may be a better pitch to raise capital.”

Real estate investment managers are in a bind, industry insiders say. Investors now prefer real estate investment firms to be focused on a limited number of investment strategies and small enough to react swiftly if the investments do not go well, but the managers need to be large enough to have the capital and the resources to be good fiduciaries.

Junius' new chief, John Fraser says he grew up in the real estate investment management business, investing in boutique firms. Mr. Fraser was managing director and co-head of Investcorp Real Estate, New York, before joining J.P. Morgan Asset Management earlier this month. He said he was attracted, in part, by the unique structure.

Building a business associated with a firm of J.P. Morgan Asset Management's size in today's market is an essential ingredient to successful capital-raising and investment strategy, he said.

There is about $84 billion in distressed real estate today, including special servicers controlling commercial mortgage-backed securities and properties in foreclosure, Mr. Azelby estimated.

Beyond that, there are hundreds of billions of dollars worth of property with “unsustainable” capital structures, Mr. Azelby said.

Mr. Azelby said he expects a new wave of distressed assets to hit the market over the next three years, which should coincide with Junius' investment period.

J.P. Morgan is not the only firm teeing up to take advantage of the distressed real estate opportunity that industry executives have been predicting over the past two years.

“I never would want to suggest that it's not a highly competitive market,” Mr. Fraser said.

Brookfield Asset Management is raising a distressed real estate and debt fund with a $5.5 billion target and Carlyle Group is raising Carlyle Realty Partners VI, a debt and opportunistic fund with a $3 billion target.

“At a macro level, there is at least $1 trillion of debt coming due over the next three years and a fair amount of the debt that rolled over during the crisis was extended rather than restructured that will have capital needs and need for refinancing and fresh equity,” said Mark A. Grinis, global real estate investment funds leader, Ernst & Young LLC, New York.

A fund with appropriate scale and experienced investment team could find a lot of success in that arena, he said.

The fundraising environment is tough. Last year, only 89 real estate funds closed, raising $35.8 billion, a 28% decline from the $49.8 billion raised in 2009. The 2010 figure was the lowest since 2003 when $14.1 billion was raised, according to Preqin, a London-based alternative investment research firm. Half of the funds that managed to close in 2010 did not meet their fundraising targets: 11% attained 80% to 99% of the target; 27% raised 50% to 79%; and 13% raised less than half of the target.