The case for portfolio recapitalizations

iREOC Connect | JANUARY 2020 | 1

Park Madison Partners

David “Mac” McWhorter, executive director of the Institute for

Real Estate Operating Companies (iREOC), recently spoke with Nancy

Lashine, Robert Kohn and Warren Kotzas of Park Madison Partners.

An excerpt of their conversation follows.

Park Madison has become one of the premier placement

agents in the industry, but I understand you are adding to

your offerings, speciﬁcally recapitalization advisory. Why

have you moved into that niche?

Nancy Lashine:

Park Madison started in 2006 with a business

model focused on matching institutional investors with real estate

private-equity fund managers. We view ourselves as a bridge

between the GP and the LP, having participated in the place-

ment of over $16 billion over the past 13 years. During that time,

commingled funds — particularly closed-end funds — were typi-

cally the capital structure of choice. Recently, however, a grow-

ing number of managers and investors have been looking for

different types of structures. Maybe they originally invested in or

sponsored a closed-end fund, but now want to transition those

assets to a joint-venture structure or open-end fund, or another

structure that better ﬁts their current portfolio goals. For example,

as a closed-end fund comes to an end, it is sometimes obvious

that the portfolio is still performing but has not reached the full

potential of the underlying value-creation plan. Instead of liquidat-

ing, the manager might determine that recapitalizing will provide

the greatest optionality for their investors. So, we have evolved

our business to serve the same group of clients and investors

that we have been working with for all these years and whom we

know well, but we are now providing incremental services and

products that ﬁt their changing needs.

How do recapitalizations ﬁt into that?

Lashine:

Recapitalizations are a natural extension of what we

have always done because they allow us to provide solutions

for our clients — both managers and investors — all the way

through the life cycle of their investments. Given the experience

of our team on both the buy side and the sell side, we ﬁnd our-

selves uniquely positioned to provide advice in the recapitaliza-

tion space.

What exactly are you recapitalizing? How does it differ

from a reﬁnance or secondary process?

Rob Kohn:

People often use the terms interchangeably, but

they are really very different. Reﬁnancing involves the debt part

of the capital stack, while recapitalizations involve the equity

part. Often, the recapitalization happens at a portfolio level

and usually involves a new business plan. Secondaries, on the

other hand, usually involve one investor buying shares from

another. Nothing changes at the portfolio level.

Lashine: Recapitalizations are generally not just replacing one

partner with another, as you would with a secondary. Instead,

you are creating an entirely new structure and potentially

resetting the business plan. Existing management would stay in

place but, depending on the investor, there might be changes

to GP/LP control rights. So a new structure or vehicle often has

to be established for a recapitalization, which is very different

than a secondary sale.

Warren Kotzas: Digging a little deeper, traditional secondar-

ies are a standardized type of transaction that solves one type

of issue: the transfer of limited partnership positions to provide

liquidity to LPs in a fund, with everything within the fund struc-

ture staying the same. It provides liquidity to the LP, but not to

the manager. Recapitalizations, on the other hand, are complex

and refer to a series of different types of transactions, such as

fund restructurings, joint-venture buyouts, strip sales and other

structures. Recapitalizations require a bespoke solution that

looks at the big picture and considers the overall goals of both

the manager and underlying investors.

What kinds of vehicles are typically recapitalized?

Kotzas:

Most often, we are advising on recapitalizing vehicles

— typically structured as limited partnership closed-end funds —

that own multiple assets with new or refocused business plans.

If the assets are clean and the business plans are complete, the

best solution is likely a direct outright sale to the market rather

than a recap. Recapitalizations make the most sense when there

are timing or liquidity considerations, or opportunities at the asset

level that could use more time and capital to realize. For exam-

ple, an operator might ﬁnd that the fund has reached an end

with a few remaining assets in the vehicle having below-market

rents and upcoming tenant rollover. In such a scenario, additional

time and investment to bring rents to market may yield better

returns, but some of the investors may still prefer to exit rather

than continuing the fund. A recapitalization would allow the man-

ager to bring in new investors and capture that additional upside.

Are recapitalizations gaining in popularity?

Kotzas: We are deﬁnitely seeing a steady increase of trade

volume. Just in the past 12 months we have tracked a com-

bined total of $13 billion of recapitalization and secondary

CONTRIBUTORS

Nancy Lashine

Managing Partner and Founder

Robert Kohn

Partner

Warren Kotzas

Capital Advisor

MEMBER Interview

2 | JANUARY 2020 | iREOC Connect

MEMBER Interview

transactions. Increased volume makes sense because the

market is maturing. In the past 10 years, it has moved from

liquidity-motivated decisions spurred by the Global Financial

Crisis to portfolio- and asset-management decisions. Recapital-

izations are an effective portfolio-management tool, which can

be used to rebalance exposure to different managers, opera-

tors or investors. We expect transaction volume to continue to

increase as more investors enter the space.

Why would an investor want to be part of a recap rather

than just going into a standard private-equity fund?

Kohn:

Investors have three broad choices when it comes to pri-

vate real estate fund investments. They can invest in traditional

blind-pool closed-end funds, where they can underwrite the

manager and proposed strategy based on past performance,

without a portfolio of assets in place. They can purchase shares

in the secondary market, where they can underwrite the assets

and manager, but the fund is already well under way and the

strategy is playing out, for better or worse. Or they can become

part of a recapitalization, where they can underwrite the man-

ager and assets, as well as be part of a new strategy based on

the manager’s intimate knowledge of the assets and local mar-

kets. Investors like the speciﬁcity recapitalizations can provide,

especially in the current economic climate. This is a vehicle and

a transaction type that allows the real estate private-equity mar-

ket to be more dynamic and more liquid, delivering better results

to managers, operators and investors.

How do you deal with conﬂict of interest when the GP

is the one that gathers the new capital and sets the new

strategy?

Lashine:

Therein lies the opportunity for an organization like

Park Madison Partners. If there was no conﬂict of interest, the

parties could probably solve this themselves. However, because

it is often complicated and involves multiple divergent interests,

it usually makes sense to have someone like Park Madison

involved. We shed light on the situation, consider alternative

solutions, and act as a bridge between all the parties.

Kotzas: We are a neutral intermediary that makes sure that any

conﬂicts are brought to light and dealt with. It is important that

everybody can see what is going on, understands why it is hap-

pening and has the chance to understand that a recapitalization

is the most appropriate solution in certain situations. You need

options for each stakeholder to make the decision based on

their needs and preferences. Managers could provide a rollover

option, a status quo option and a liquidity option, depending on

the speciﬁcs of the structures. You provide complete transpar-

ency of information; you conduct a disciplined, fair process; and

then you give people a choice on what is right for them.

If somebody wants to begin a recap process, where do

they begin?

Kotzas:

The sponsor typically needs to start with their limited

partner advisory board to discuss the merits of a recap versus

an outright sale. The manager needs to have a clear answer to

this, and communicate it in an effective and transparent man-

ner. The manager’s ﬁrst duty is to their existing investors. So a

recap needs to make economic sense to all parties involved or

it typically doesn’t go anywhere.

Kohn: Engaging an adviser early in the process is also crucial.

Advisers can help devise the right approach, solution and com-

munications strategy. The manager needs to deﬁne and articu-

late the ultimate objective, and then be able to communicate

their goals and strategies to existing investors. Transparency is

key to the entire process. You want to give all interested parties

the information they need to make the appropriate decision.

Existing investors have to consider their ﬁduciary obligations to

beneﬁciaries, and potential new investors have to understand

the business plan and value proposition of the restructured

partnership. There are several interested parties with their

own unique considerations, so managing the communication

between them effectively is critical to a successful process.

When does recapitalization work best?

Kohn:

Recapitalizations work best for successful vehicles

that just need more time or capital after the original business

plans have reached the end of their underwritten timeline or

budget, and there is still value creation that can be captured

either through additional time, additional capital, or both. It’s

not really an option for a portfolio of core stabilized assets with

no remaining value left in any of the underlying business plans.

Putting aside any potential structural or legal issues, a core

portfolio would typically command efﬁcient pricing through a

direct sales effort, while value-add business plans allow a spon-

sor to demonstrate the value of a continuation vehicle.

Lashine: Real estate doesn’t always ﬁt neatly into a traditional

private-equity structure. Sometimes those structures work

beautifully, gains are realized and distributed in six or seven

years, and everything is great. But sometimes that structure

doesn’t work for all of the assets in a portfolio, and it might be

because it never did work. It might be because of something

that happened cyclically at a point of time in the market, per-

haps in capital markets, certain property types, or a speciﬁc

geography. But, for some reason, that structure may not be

optimal for certain real estate assets on a go-forward basis. In

those situations, recaps may offer an elegant solution.

Kotzas: In the real world, all kinds of crazy things can happen

with real estate assets. Recapitalizations give us the ability to

pivot, react, and re-create. They allow us to access the advan-

tages of private equity funds while adjusting for the on-the-

ground realities of real estate. That makes recapitalizations a

very powerful tool.

OVERVIEW

Park Madison Partners is a boutique New York-based capital markets

and advisory ﬁrm for global real estate alternative investments. Since

its formation in 2006, Park Madison has participated in the placement

of over $16 billion in private equity capital for a wide range of real

estate vehicles and strategies. Our team is experienced on the buy-

side and sell-side of the real estate industry, including specialization

in recapitalizations as both investment principals and third-party

advisors. Our unique expertise in real estate capital markets allows us

to offer highly customized liquidity solutions to real estate managers

across a variety of structures.

CONTACT

John Sweeney, Principal | Park Madison Partners

[email protected] | 212-448-7345