Moving Into a Private Equity Mindset

 | Dec 26, 2013 | 5:00 PM EST  | Comments
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I often talk about the private equity mindset as a key to long-term investment. Most investors I talk to have a short-term mindset and consider themselves long term in nature if they hold a stock for six months.

That's a shame, as the real profits lie in the long-term time frame used by private equity funds. Buying assets when they are cheap and then holding them for a long period of time is the key to earning the highest possible rates of return for most of us. Only a rare few can use their double PhDs in higher math and high powered computers to beat the markets in the short term. Therefore, most of us are better off taking the longer, private-equity view of things.

Looking at what private equity funds are doing with their cash right now can be a fairly productive exercise. The initial public offerings (IPO) calendar continues to be clogged with private equity cash-out offerings. Private equity firms this year have done 181 cash-out IPOs, raising more than $57 billion, the second highest annual totals ever. One private equity manager has been widely quoted as saying he was selling everything that was not nailed down as asset values increased and investors clamored for deals.

This has led to a surplus of cash in private equity coffers. Some reports have estimated the cash balances on hand of private equity funds at almost $800 billion. It is not just the cash-outs that have led to the huge cash hoard. Funds have found it easy to raise money as returns from the 2008-09 period investments have ranged from excellent to spectacular. However, in a world of rising asset prices, many funds have found it much harder to get the money invested. When you are looking to earn several multiples on your money over a five- to seven-year time frame, you cannot afford to pay the top dollar the market is asking right now.

That's not to say that PE funds are not out kicking over rocks and looking for deals. Kohlberg Kravis Roberts (KKR) just finished raising $1.5 billion in its debut real estate fund. The fund will target real estate opportunities -- including property-level equity, debt, special situations transactions and businesses with significant real estate holdings in North America and western Europe. Carlyle Group (CG) just closed on the purchase of Metropolitan Real Estate Management, a global real estate fund of funds. Recent reports say the Blackstone Group (BX) has raised $600 million in the past two years by controlling about 21 million square feet of office buildings.

There are still plenty of commercial-real-estate-related issues that trade at discounts to book value, and long-term investors can join the private equity firms in the real estate opportunity. A share of Brookfield Property Partners, for example, currently trades at just 77% of book value. When they close on the purchase of Brookfield Office Properties (BPO) next year, this will be one of the largest best diversified commercial-real-estate portfolios available in the public markets. In addition to the long term upside of the property portfolio, the shares yield a comfortable 4.8% right now.

Apollo Commercial Real Estate (ARI) is affiliated with Apollo Global Management (APO), which is one of the largest private equity and alternative investment firms in the world. The company invests in and manages commercial first mortgage loans, commercial mortgage-backed securities, subordinate financings and other commercial real estate-related debt investments. The shares trade at 91% of book value and offer a yield of 9.49% at the current price. The relationship with its private-equity parent gives it a significant edge over competitors. Investors who want to follow the private equity cash into real estate would be wise to consider APO.

Private equity firms are still out kicking rocks and looking for assets that can provide the type of long-term returns their investors require. I will look at some other places private equity firms are putting some of their cash to work. For now, these commercial real estate vehicles offer a way to practice the private equity mindset for long-term profits.

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