Victor MacFarlane’s proudest business accomplishment isn’t his involvement in the grand, 80-story Time Warner Center in New York City. Nor is it his 20-year track record of providing superior returns for his institutional clients. According to MacFarlane, he’s most proud of purchasing and revitalizing a shopping center that serves both high- and low-income predominantly black communities in Los Angeles County.
MacFarlane, CEO of MacFarlane Partners (No. 1 on the BE Private Equity Firms list with $20.1 billion in capital under management), says the 186,800-square-foot shopping center in Ladera Heights showed many in the investment community that money can be made in areas that serve low-income communities. “They thought it was all going to be social investing,†MacFarlane recalls. “To demonstrate that you can make a difference in these communities, and make money, was a huge, wonderful thing.â€
The project, undertaken by Johnson/MacFarlane Partners, a joint venture between Earvin “Magic†Johnson’s Johnson Development Corp. and MacFarlane Partners, acquired a 75% interest in the property back in 1996 with capital from a $50 million investment from CalPERS, the retirement fund for California’s public employees and the nation’s largest pension fund. MacFarlane, 57, says the big institutions thought investing in the urban markets meant little, if any, return on investment. “Another institutional investor had neglected the center. The community wasn’t shopping there because the wrong element had taken over. So we turned it around, made it safe.â€
The shopping center became the home of one of the first Magic Johnson Starbucks and Magic Johnson TGI Friday’s and helped revitalize a community. But don’t call it charity. It’s pure business. In fact, the property generated a 30% return when it was sold nine years later for $52 million. “When we first started talking about this urban investment program, skeptics thought we were talking about social investing,†MacFarlane says. “But we were saying no, we can deliver institutional level returns by investing in this area.â€
That sort of vision is how MacFarlane built up an impressive real estate portfolio that consists of retail and affordable housing in inner cities, luxury residential and mixed-use high rises in upscale locations, transit-oriented developments along commuter corridors, and master-planned communities. And while the slowing real estate market has him concerned, he’s confident his San Francisco-based company is positioned well enough to reap healthy returns–even in this unstable environment. It certainly doesn’t hurt that the firm’s returns have historically exceeded 20%.
“There wouldn’t be any blacks in real estate private equity without Victor’s towering successes,†says Derrick Banks Mashore, CEO of Coda Capital Investments L.L.C., a New York-based real estate private equity firm. “He’s the godfather, the pioneer, a dominant player in the urban space, and one of the most successful investors of our era.â€
CAPITAL GAINS
For MacFarlane, the sweet spots–where his team focuses its investment activity–are in the urban areas of gateway cities. These urban areas serve as a departure or arrival point for international flights. With the exception of Chicago, all their target markets are located on the West Coast or along the Eastern Seaboard. “Real estate is about people. If you’re in a suburban area where you’re going to build a power center, that means somebody has to drive there,†he says. “If you’re building in a high-density location, you can basically figure out what your demand is. You also get to take advantage of existing infrastructure, transit lines, etc.â€
MacFarlane’s ascent has not been without problems. He went through times so lean in the early days that his firm barely met its cash flow needs. “A number of times I had to borrow–from friends, banks, wherever I could get it–to meet the next payroll,†he recalls. But the husband and father of five says stubbornness kept him going. “And the belief that we had something to offer. But it could have gone another way.â€
In this game, capital is king. Real estate private equity firms typically raise institutional capital and try to leverage that capital as an equity investment in real estate assets. Over the years, they’ll manage those assets or develop an exit strategy that allows them to either sell or refinance in such a way that investors get a full return of their equity and a return on their capital that is commensurate with the risks they have taken. Similar to private equity firms that invest in companies, real estate private equity firms raise money; acquire, develop, or renovate properties; and often generate ongoing fees for managing those properties.
MacFarlane, a Middletown, Ohio, native who holds an M.B.A. from the University of Pittsburgh; a Juris Doctor from UCLA; and a bachelor’s degree from the University of New Mexico, admits that there’s limited access to capital these days. “The dramatic events impacting the capital markets have impacted us,†he says, adding that though his firm is well-capitalized, it can’t get the same type of project financing that had been the norm for years and, as a result, some projects will be delayed until capital markets stabilize. “Whereas last year it may have been easy for us to get a 75% construction loan, today you’ll only get 60% or 65%, if you can get it, and it’s only well-capitalized firms that can still get these loans.†He points out, however, that there are still opportunities, since fewer players are involved, for well-capitalized investors who can operate under these conditions. “There are always opportunities, in every cycle–they just may look a little bit different.â€
FROM AETNA TO ENTREPRENEUR
MacFarlane has seen his share of ups and downs in his 30 years in real estate. He started his career at Aetna Life and Casualty, where he ran a couple of the insurance giant’s acquisition regions and then a third of its asset management portfolio. After four years, he joined a private real estate syndicator. Before the tax laws were changed in 1985, there were tax advantages for syndication–getting together groups of wealthy individuals to pool their funds and invest them in real estate through those partnerships.
But MacFarlane knew his path lay elsewhere. He grew up poor, sharing a couch with his sister until he was 13 because neither had a bed. He wanted to make sure he’d never be poor again, and he couldn’t guarantee that working for the syndicator. So in 1987 he launched his first company, MacFarlane Realty Advisors (MRA), to provide real estate investment management services to institutional investors. MacFarlane started developing and building an apartment complex on the north side of Denver in the midst of a downturn. “In figuring out a way to hold on to that asset, I learned a lot of lessons about the value of liquidity and having good real estate for the long term. I eventually sold it six or seven years later, for a profit, but at the time I didn’t think I was ever going to make a profit on it.â€
In the early 1990s, CalPERS allocated capital to MRA to invest in real estate. MRA, and later, MacFarlane Partners wound up managing a portfolio of real estate assets with a market value of approximately $300 million. But the firm at the time was hemorrhaging cash. “As opposed to, say, John Rogers, the stock-and-bond guy, if he gets $50 million from a pension fund, it’s just him and his computer–he’s in business and probably making money. But a real estate investment management business needs a lot of people and therefore a lot of skill to be profitable,†MacFarlane says. “You need acquisition people, you need asset management people, and you need a back office. All that stuff for a consultant to say that you’re a qualified risk. Typically they also want to know that you have done it for a long time, at some scale, for others. So it’s a very difficult business to break into.â€
THE MINNOW SWALLOWS THE WHALE
At this time, serendipity stepped in. While MacFarlane was looking for ways to either sell MRA or merge it with another firm, Mellon Bank was looking to sell its real estate investment management subsidiary, Mellon/McMahan. It was a broken firm, so traditional, larger companies weren’t interested even though it had a who’s who list of clients including the pension plans of General Motors, AT&T, and Verizon. “Because we were small and losing money, we needed Mellon/McMahan. So I took a risk and bought it.â€
MRA, which had $300 million in assets and five employees at the time, was also a lot smaller than Mellon/McMahan, which employed more than 80 people and managed $1.8 billion in assets. “I remember when I bought it a news article asked if the minnow was swallowing the whale,†MacFarlane says. His firm didn’t have the money for the deal, but he somehow convinced Mellon that he did and then went to see lenders. “Once you have a deal, it’s a lot easier to raise the money,†MacFarlane says with a chuckle. When the deal closed, he let go two-thirds of Mellon’s staff and proceeded to reinvigorate the business. In 1996, he sold most of it–it had been renamed MacFarlane Partners–to GE Capital Services, which changed the name of the firm again to GE Capital Investment Advisors. The deal did not include MacFarlane’s urban business.
After a three-year period during which MacFarlane worked for GE Capital as part of the terms of the deal, he revisited his fledgling urban business. GE hadn’t acquired this when it bought the original MacFarlane Partners because there weren’t any assets there to speak of. It had been started in response to the 1992 riots in Los Angeles, when CalPERS asked all its real estate investment managers to figure out a way to invest profitably in the state’s inner cities. MacFarlane Partners was the only one that responded.
Teaming up with Johnson Development, MacFarlane presented their proposal to CalPERS, which invested $50 million in the team’s strategic vision. Johnson/MacFarlane Partners found that these neighborhoods were densely populated but had fewer stores. That meant the community had greater purchasing power than expected–something other investors had overlooked. That deal set the stage for others like it, and MacFarlane has never looked back.
As MacFarlane Partners continued to post gains, the funds attracted capital and what was once meant to remain a small boutique firm became an industry powerhouse–all within the urban space. The company’s largest increase in value to date is the 49.5% of the Time Warner Center retail space and the property’s parking structure from Apollo Real Estate Advisors and the Related Cos. in a deal valued well in excess of $500 million. MacFarlane Partners also acquired a $359 million participating interest in the New York City project’s $1.22 billion GMAC commercial mortgage construction loan. The investment agreement includes The Shops at Columbus Circle, encompassing 338,500 square feet of shops, restaurants, and entertainment venues, and a tri-level underground garage that can accommodate 504 cars and offers 24-hour valet parking.
Though market conditions remain unstable, the urban niche is here to stay. “Of course the credit markets are inhibiting deal making,†says Coda Investment’s Mashore, “but the urban space will continue to be highly prized among many different types of investors, particularly where it’s well-located.†And where there are deals to be made, MacFarlane will be there.