KKR's latest growth seeded 10 years ago

KKR & Co. Inc.'s real estate business chalked up a 270% growth spurt in the past year, but it was an accomplishment 10 years in the making.

The business, which makes equity and credit investments in everything from opportunistic flagship funds to a mortgage real estate investment trust, reported assets under management of $32 billion as of June 30, a far cry from KKR's early forays into real estate made from its private equity funds.

"Our vision was to create an integrated model of equity and credit under a single leadership," said Ralph Rosenberg, New York-based partner and global head of KKR real estate. KKR offers real estate strategies to both institutional and retail investors.

"We tapped into the firm's relationships with global institutional investors but also with global retail distributors and started creating retail products," Mr. Rosenberg said.

Mr. Rosenberg joined KKR in 2011 from now-defunct hedge fund manager Eton Park Capital Management, where he was a partner. Mr. Rosenberg built KKR's real estate venture by using balance sheet capital before raising the $1.2 billion KKR Real Estate Partners Americas LP, which closed in 2013, bringing KKR's total real estate AUM that year to $1.5 billion.

"We started that strategic rollout by using KKR's own balance sheet to get proof of concept," Mr. Rosenberg said. KKR is typically the largest investor in any of its funds, he added.

As of June 30, KKR Real Estate Partners Americas has invested $1 billion, realized $1.4 billion and produced a gross internal rate of return of 16.7% and a net IRR of 11.8%. Despite its name, the fund aimed to invest 25% in Western Europe, Mr. Rosenberg said.

In 2015, KKR augmented its real estate capability by adding a real estate credit strategy. Since then, the firm has launched three credit products: one publicly listed mortgage real estate investment trust and two closed-end risk-retention funds investing in the securities market, which developed as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act. That act required that managers of asset-backed securities retain 5% of the value of new issuances, he said.

The real estate business and particularly KKR's credit strategy got a boost on Feb. 1 when KKR's $4.7 billion acquisition of insurance company Global Atlantic Financial Group Ltd. closed. The acquisition of Global Atlantic contributed $98 billion to KKR's AUM in the first quarter, earnings release materials show.

"Management of all of the real estate exposure on the Global Atlantic balance sheet was transferred over to our real estate team," Mr. Rosenberg said.

KKR did not break out how much Global Atlantic has in real estate assets. Global Atlantic had $12 billion in private market assets including real estate when the deal closed.

Global Atlantic's real estate portfolio is consistent with a traditional insurance company real estate portfolio. It includes first mortgage exposure that is 40% to 50% loan-to-value, he said.

"It's a different risk profile than our mortgage REIT," Mr. Rosenberg said.

KKR also actively manages and trades a commercial mortgage-backed securities portfolio for Global Atlantic, he said.

"The reason the Global Atlantic real estate credit exposure is really strategic for us is scale," Mr. Rosenberg said. "The number allows us to talk to borrowers about both transitional financing and stabilized financing."

KKR real estate executives are pushing to continue that growth trajectory. Craig Larson, head of investor relations, said in KKR's second-quarter earnings call on Aug. 3 that the firm held a final close of its second European real estate fund at $2.1 billion, three times the size of its first European real estate fund. It also saw a $3 billion first close for its third KKR Real Estate Partners Americas fund.

"With these closures, we are now a clear top five opportunistic real estate manager," Mr. Larson said.

Even so, KKR will have a way to go before eclipsing another New York private equity firm, Blackstone Inc., which had $207.5 billion in real estate assets as of June 30, up 24.5% from $166.7 billion a year earlier.

KKR ranks 24th on Pensions & Investments' just-released list of the top real estate managers ranked by total worldwide assets as of June 30. Top ranked MetLife Investment Management had $137 billion as of June 30. (Blackstone did not participate in this year's survey.)

However, KKR is building its assets under management at a triple-digit clip, compared to MetLife's global real estate asset growth of 2.8%. As for assets managed for U.S. tax-exempt institutions, KKR's AUM was up 47% to $5.3 billion; Nuveen, which is No. 1 on the list, saw 14% growth to $92 billion.

KKR real estate executives have always had their eyes set on offering multiple real estate strategies investing across the globe, Mr. Rosenberg said.

Among KKR's independent real estate strategies are U.S. opportunistic, Asian opportunistic, European opportunistic, a domestic institutional core-plus open-ended fund strategy and a publicly listed REIT in the U.S. offered to individual investors.

"They are independent strategies but jointly run risk management and investment management by a collective team of professionals who all work with me and are all subject to an aligned compensation and rewards system, with one pool that I have responsibility to distribute on an annual basis." Mr. Rosenberg said.

KKR executives are consistent across its real estate business in the themes they like and others that don't provide an adequate risk/reward profile, he said.

These days, KKR is selective with its investments due to the "valuation shock" caused by the pandemic, Mr. Rosenberg said. "We have selective exposure to office but only in what we deem to be growth markets," he said. KKR has favored investment in apartments in Sunbelt cities as well as lending to multifamily developers, Mr. Rosenberg said.

KKR has expanded the real estate strategies it offers by hiring executives rather than acquiring firms. "We typically have hired a proven industry veteran in each of these disciplines or lifted out a small team," Mr. Rosenberg said.

For example, in August, KKR hired Andres Dallal and Joseph Mastrocola from W.P. Carey Inc., a net-lease REIT, to head a new triple-net-lease real estate platform, Strategic Lease Partners, he said. Funding to acquire $3 billion in assets is coming primarily from KKR's credit and real estate funds.

"We provide them (the individual or team) with all of the institutional support you need when you start building a new company," Mr. Rosenberg said.

Another example of a hire is Matt Salem, a New York-based partner and head of real estate credit who joined KKR from Rialto Capital Management in 2015, the year KKR formed its real estate credit business. In 2017, when KKR closed its first risk-retention fund, he co-headed KKR's real estate credit strategy with Chris Lee, who is now a partner and head of real estate Americas.

KKR executives credit the Dodd-Frank Act for opening up a new investment opportunity — the risk-retention strategy — for credit managers, including KKR.

"Wall Street firms were forming risk-retention bonds that they could not hold and needed someone like us to be counterparty to sell risk to," Mr. Rosenberg said.

"In 2017, we … recognized there were very, very few players in the real estate credit markets who had the ability to be in the risk-retention business … where you have to hold the risk-retention bonds for 10 years," Mr. Rosenberg said.

And that is a high barrier to entry, he added.

"Many have tried and failed because LPs have to believe that the GP will be around for 10 years to manage this risk exposure," Mr. Rosenberg said. "We raised a little over $1 billion in our first fund focused on purchasing the junior tranches of these commercial mortgage-backed securities."

KKR raised $950 million for its second risk-retention fund in 2020.