On the Record

Private Equity Intenational
February 2005

Global private equity real estate firm Colony Capital has invested approximately $12 billion in real estate-related assets and operating companies over the past thirteen years. Led by founder Tom Barrack, the Los Angeles based firm has inverted in everything from pubs in the UK to hotels in Atlantic City to a baseball dome in Japan. In a recent interview, Barrack talked about contrarian investing, predictions for the year ahead and why he loves casinos.

How has the private equity real estate market evolved since you founded Colony Capital in 1991?

Private equity real estate is really in the third trimester of its pregnancy. In the 1900's, the disruption in the banking sector and the resulting meltdown in the real estate industry caused an absence of available capital. This spurred the growth of private equity real estate, which began primarily as vulture funds adhering to a contrarian investment philosophy. Returns were directly disproportionate to the amount of capital in the marketplace and the early vintage funds produced extraordinary profits.

As the industry matured in the mid-90's and efficiency returned to the market, private equity real estate firms moved to distressed assets in Europe and Asia. In the US, private firms focused on value added real estate platforms concentrating on high alpha executions that required significant financial engineering.

Today, private equity real estate has become increasingly sophisticated, as institutions with varying specialties and specific expertise invest in niche sectors around the globe
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Where do you see those alpha opportunities now?

Right now, one fo the greatest opportunities in the US market is in the mortar between corporate operating platforms and real estate. Buyout firms typically hate real estate assets: they're lumpy, you can't leverage them and they want them off their balance sheet because they don't understand them. Real estate executives, on the other hand, hate operating assets. Colony has always been a forerunner in looking at operating companies. We've bought pubs in the United Kingdom a, railroads in Italy, and vineyards in France. And from a private real estate perspective, these are the types of investments where the inefficiencies are huge. Our ability to separate the underlying real estate from the operations of the corporate entity and figure out the right capital structure for bote gives us a competitive advantage.

Since 1997, Colony has acquired Harvey's Casino Resorts, Resorts International in Atlantic City and four casinos from Harrah's to Caesars. What makes the gaming sector attractive?
First, gaming has lots of natural barriers to entry. There is an unbelievable level of licensing scrutiny required by the regulatory agencies, both at the corporate and personal level. Most financial institutions aren't willing to walk through the Baton death march of the licensing process, so it eliminates 95 percent of our natural competitors.

Secondly, when Colony bought Harvey's in 1997, we saw an industry with only big, strategic players and no one to sell to except each other. We thought we could act as a liaison to all these larger companies. Now the consolidation in the industry has been great fuel for our acquisition program and we've been fortunate to be at the right place at the right time with both expertise and credibility in casino operation, licensing and real estate.

Colony has also made a lot of acquisitions overseas. What are the main difference in private equity era; estate between the US and abroad?

Europe is very different. Real estate is much less volatile as residual value, not cash flow, is the driving factor. Furthermore, supply is quite constrained and ownership is very much a local business, creating disadvantages for foreign investors. We've been able to use that to out advantage because we've been in Europe for 15 years — our operations in France and Italy are considered to be French and Italian, not American.

Asia still presents tremendous opportunities in, paradoxically, two different areas. On one hand you've got great distress in the non-performing loss sector and on the other, meteoric growth in the Chinese marketplace.

You've had a busy 2004. Any thoughts on the year ahead?

Overall, it's time to exercise caution. The unexpected "intervening event" always happens and right now, everyone is running into the real estate market. The opportunity has not been real estate; it's been "cheap debt". Our investment thesis in the past year was to take advantage of these frothy worldwide markets and sell everything we could at —hopefully— exorbitant prices.

On the buy side, there's been very little turbulence in the market to take advantage of. Everything feels pricey. So, we'll continue to look for one-off opportunities to invest where we have a competitive advantage and wait for that unforeseen event to capitalize on.