By Thomas Heath
Monday, October 13, 2008
Talk about sailing against the prevailing winds!
Esko Korhonen and his partners at Federal Capital Partners recently raised $230 million in a real-estate private-equity fund that will invest in Washington region office, retail and residential properties.
When Korhonen called to tell me his Georgetown investment firm had closed the fund, I thought he was joking -- or nuts.
Didn't he know our financial system is in a once-in-a-century meltdown? Didn't he know that banks aren't lending money? What if we have a depression and there is no one to work, live or buy goods in the buildings that you want to buy?
Perhaps I overreacted.
Korhonen, who cut his teeth in real estate investing with the Carlyle Group, assured me that he and his team have been around the block. The other principals include another Carlyle alumnus, Lacy Rice; Tom Carr, former chairman of CarrAmerica, which was sold to Blackstone Group in 2006; and Alex Marshall, another real estate veteran. The partners have 80 years in real estate investing between them. Korhonen and Rice founded FCP in 1999.
"We have been through a number of cycles," Korhonen said. They navigated the savings-and-loan crisis in the early 1990s while at Carlyle. Carr has gone through several real estate market gyrations. And the bursting of the tech bubble also was no picnic.
"The toughest part for everyone is going to be the impact on the macro economy," Korhonen said, adding that this region's economy, anchored by the federal government, is probably better insulated against economic cycles than most.
"This potentially is the most healthy real estate market in the country," he said. "Jobs is one of the most important things. So far, D.C. has sustained positive job growth. If that turns negative, it will have a major impact. It's absolutely critical that we need to loosen the credit markets and have credit flowing through the system again. That will ultimately happen as people gain more confidence."
Korhonen said FCP is well-positioned to take advantage of real estate deals should the wheezing economy do to real estate what it has done to stocks in the past month. They already bought three properties this year with the fund, including The Monterey, a 432-unit high-end apartment building in Bethesda; Park Berkshire, a 598-unit multifamily project in Forestville; and Toledo Plaza, a 242-unit property in Hyattsville.
For most of the last decade, FCP has bought and sold $1.3 billion in mid-Atlantic properties. It currently holds around $700 million in real estate. Its philosophy: Look for broken or undervalued assets, improve them, get the rents and leases flowing from high-grade tenants, and then either hold them for the operating income or sell them as high-grade assets to big insurance companies, banks and real estate firms.
Korhonen's mantra: cash flow, cash flow, cash flow.
"Our approach and our strategy has always been that what we want to look at is sustainable cash flow from the properties," he said.
The new fund, called FCP Fund I, LP, has a 10-year horizon in which to buy and sell real estate, and to make distributions to its investors. FCP investors include pension funds, endowments, wealthy families and individuals, and financial institutions.
Many of their investors can participate even more in the transactions, which could easily double the amount of equity they can put in some properties.
On top of that, Korhonen said FCP has a line of credit with a consortium of banks, led by J.P. Morgan Chase, that will allow it draw on more money to make deals. In addition to property, the fund will look at buying distressed loans or helping to finance deals with other real estate operators.
Korhonen said he and his team also will be looking at assets and loans that may come up for sale from the recently passed $700 billion federal bailout.
Korhonen's approach to real estate is similar to that of investors who are looking for deals on beaten-down stocks. He said FCP is poised to scoop up real estate at below-market prices.
"Given the environment today, and where we are looking at asset values declining, because we have dry powder we will be able to buy assets as they are revalued. Today, capital is scarce. Cash is king. As a result, we have capital, we are nimble. We have local market knowledge, good relations with lenders and we have flexibility. We are extremely well positioned for a difficult and credit-constrained market."
But what if everything goes south?
Korhonen has faith in the business cycle.
"It's difficult to call,'' he said. "It certainly looks like 2009 and 2010 are going to be difficult. There are a lot of issues . . . Ultimately, I think the government and [Federal Reserve] intervening, we will see some bottom in prices and ultimately see a ramp-up. The question is how long does that escalation in value take?"
Thomas Heath's "Value Added" column focuses on Washington's entrepreneurial set. It runs weekly on the WashBiz Blog athttp://www.washingtonpost.com/washbizblog.
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