Proposed Investment in Northwood Real Estate Partners (Series IV)

Memorandum to: State Investment Council
From: Christopher McDonough, Acting Director
Subject: Proposed Investment in Northwood Real Estate Partners, L.P. (Series IV)

The New Jersey Division of Investment (“Division”) is proposing an investment of $200 million in Northwood Real Estate Partners, L.P. (Series IV) (the “Fund”). The Division previously made a $75 million commitment in Northwood Real Estate Partners L.P (Series III) and $75 million commitment in Northwood Real Estate Co-Investors, L.P. for a total of $150 million in December 2012. This memorandum is presented to the State Investment Council (the “Council”) pursuant to N.J.A.C. 17:16-69.9.

The Division is recommending this investment based on the following factors:

Track Record: Northwood Investors LLC (“Northwood”) manages its assets through a series of fund raises and co-investments. As of June 30, 2013, Northwood has invested approximately $2.1 billion of equity to achieve a 17% gross Internal Rate of Return (“IRR”) and 2.3x gross Multiple on Invested Capital (“MOIC”). We note, however, given that the majority of investments were made starting in 2010, the track record to date is largely unrealized. Of the $2.1 billion invested, $171 million has been realized for a 17% gross IRR and a 1.5x gross multiple.

As the former President and CEO of Blackstone Real Estate Advisors, John Kukral has successfully invested through several real estate and economic cycles. During Mr. Kukral’s tenure at Blackstone from 1994 to 2005, he oversaw the firm’s real estate investments of approximately $5.8 billion of equity in over 160 separate transactions; achieving a 37% gross IRR on realized and partially realized investments as of December 31, 2005. Furthermore, of the $5.8 billion invested, only $40 million in principal losses were realized (0.7% of invested capital).

Demonstrated Investment Discipline: Northwood has demonstrated a disciplined investment approach during the real estate market downturn. Despite finishing its initial capital raise of $1.25 billion in 2008, Northwood only made one investment during the 2007 to 2010 time period. Many of Northwood’s competitors invested in heavily leveraged transactions during this period of hyper-liquidity and consequentially lost substantial capital as the result of the market correction. As previously noted, Northwood’s only investment in this time period, made in August 2008, was participation in the senior mezzanine tranche collateralized by a global portfolio of Hilton hotels and other corporate assets which delivered a 14% gross IRR and 1.7x MOIC.

Northwood’s focus on capital preservation and resiliency to short-term volatility lead to conservative leverage across its portfolio. The current portfolio leverage (as of June 30, 2013) is 47% on a Loan to Value basis.

Opportunistic investment structure: Northwood is structured to invest through market cycles by opportunistically investing in multiple property types and across the capital structure (i.e., debt and equity). The fund’s ability to execute on its long-term value creation plans and emphasis on attractive unlevered yields provides superior risk-adjusted returns. Additionally, Northwood drives substantial value by internally managing operationally intensive property types, including office, residential, retail and hospitality.

A report of the Investment Policy Committee (“IPC”) summarizing the details of the proposed investment is attached.

Division Staff and its real estate consultant, R.V. Kuhns and Associates, Inc., undertook extensive due diligence on the proposed investment in accordance with the Division’s Alternative Investment Due Diligence Procedures.

As part of its due diligence process, staff determined that the fund has not engaged a third-party solicitor (a “placement agent”) in connection with New Jersey’s potential investment.

We will work with representatives of the Division of Law and outside counsel to review and negotiate specific terms of the legal documents to govern the investment. In addition, the proposed investment must comply with the Council’s regulation governing political contributions (N.J.A.C. 17:16-4).

Please note that the investment is authorized pursuant to Articles 69 and 71 of the Council’s regulations. The Northwood Real Estate Partners, L.P. (Series IV) Fund will be considered a non-core real estate investment, as defined under N.J.A.C. 17:16-71.1.

A formal written due diligence report for the proposed investment was sent to each member of the IPC and a meeting of the Committee was held on November 8, 2013. In addition to the formal written due diligence report, all other information obtained by the Division on the investment was made available to the IPC.

We look forward to discussing the proposed investment at the Council’s November 21, 2013 meeting.

Source: State of New Jersey State Investment Council