Barrack, Lender to Stars, Skips Drama for Mortgage Debt

Tom Barrack says he’s done with drama.

The real estate mogul is the brains and spirit behind a decision in 2008 to use his private equity firm, Colony Capital Inc., to take over Michael Jackson’s Neverland estate for $23.5 million in debt. Barrack has put it back on the market -- for a cool $100 million.

But Barrack also took a beating during the financial crisis by plunking billions into flashy casinos and trophy properties that went sour. Now, he has a new tack: investing in boring but lucrative real estate debt.

To show how radically Barrack has changed course, he recently took Colony public in such a low-key way -- merging it into Colony Financial, a publicly traded real estate investment trust -- that many paid scant attention. Contrast that with the media circus around rival Blackstone Group LP when that powerhouse went public in 2007.

“We’ve gotten more conservative,” says Barrack, known for, among other things, hanging out with actor Rob Lowe and saving photographer Annie Leibovitz from bankruptcy by buying out her $24 million of debt.

Backing away from the risky, high-profile leveraged buyouts that Barrack had become synonymous with, Colony instead has raised $7 billion for a series of investment vehicles that focus on lending and distressed property debt. In addition to posting stellar returns, they’ve churned out steady interest income. All this is a prerequisite for morphing into a mortgage REIT, whose price reflects its yield.

Original Style

In a sense, Barrack, 68, is reverting to the style of investing that first brought him widespread acclaim. After founding Colony in 1991, he made much of his fortune by investing in out-of-favor assets, including soured Middle East real estate and bad German real estate loans.

But Colony lost its footing during the private equity craze of the mid-2000s. It backed an $8.5 billion purchase of Station Casinos, which ended up going bankrupt. It also took such a beating on Xanadu, a $2 billion New Jersey Meadowlands retail and entertainment complex, that Barrack declared it “Xana-don’t.” By 2010, Colony’s flagship private equity fund had lost 60 percent of its value.

The reborn Colony, Barrack says in a telephone interview, offers a calmer, steadier course without skimping on returns. For Barrack and his partners, who took an almost 20 percent ownership stake in April initially valued at $660 million, the idea is to create a Blackstone-like entity but with a few Barrack-like wrinkles.

More Coming

“It’s no different than Blackstone, except it’s a REIT with a large balance sheet of capital,” he says. “It’s the first structure of its kind. You’ll see more of them.”

According to Barrack, the move will provide a slew of benefits, starting with generous tax breaks associated with REITs. As important, the deal gave Colony access to a $9 billion cache of assets, chiefly loans and industrial properties its REIT unit already owned directly. That war chest gives Colony more inner financial firepower than many big private equity firms that rely predominantly on outside money.

Barrack aims to use the trove in part to pump additional cash into the investment funds Colony raises. Its first fund since going public will be a new distressed credit vehicle, according to a person with knowledge of the matter. Colony has pledged $500 million to the fund, which has a $2.5 billion target size, said the person, who asked not to be named because the information is private. Barrack declined to comment.

Investors Approve

About $6 billion of Colony’s existing holdings, including Miramax Film and a 53 percent stake in the manager of Colony American Homes, a single-family rental company that owns 20,000 homes, were left out of the merger. All future Colony investments, Barrack says, will be made through his reconfigured firm, whose direct holdings and managed capital totaled $18 billion after the deal.

Investors liked it, with Colony gaining 7 percent including dividends through July 9 since the move was announced in November. That compared with a weighted average 3 percent fall for the Pine River Mortgage REIT Index of 19 stocks. Barrack personally owns 16 percent of Colony, a stake valued $478 million.

His total net worth is an estimated $1.3 billion, according to the Bloomberg Billionaires Index, a figure that includes investments in Colony deals he made outside its funds. He declines to discuss his personal wealth.

Barrack, whom Fortune a decade ago dubbed the world’s greatest real estate investor, based on average yearly returns of 21 percent since 1991, still smarts from the shellacking he took during the financial crisis.

Soured Loans

He quickly rebooted. Pivoting from buyouts, he amassed billions of dollars of soured real estate loans and offered credit as banks curtailed lending. Though he didn’t stop targeting companies -- Walt Disney Co.’s Miramax Film and First Republic Bank, both bought post-crisis, “have been our most successful recent deals,” says Barrack -– the bulk of his money has gone into debt.

Colony’s first two credit pools, which drew combined commitments of $2.3 billion in 2008 and 2011, notched annual returns after fees of 18.2 percent and 12.4 percent, respectively, through the end of last year, according to investors. The first fund beat the median return for real estate debt funds started in 2008 by about seven percentage points, according to London-based research firm Preqin.

After that showing, Colony attracted $1.6 billion for its third credit fund, which it completed raising last year. The $2.5 billion credit fund the firm is said to be raising now would be the fourth.

Eyeing Europe

While the first two pools trafficked mainly in U.S. debt, Colony lately has trained its sights on Europe because of a dearth of bank lending there. “There is no new real estate debt in that market,” Barrack says. “We see an opportunity to make loans to distressed borrowers.”

So long as property values hover near historic peaks, Barrack says, he’ll tilt toward debt. “If you invest conservatively in the capital stack, you won’t lose money,” he says. “That means looking to loans. We’re doing singles and doubles, not startling macro investments.”

He’s not similarly restrained on the subject of going public. In addition to tax breaks and a muscular balance sheet, the listing will enable Colony to buy other asset managers using its stock as currency. Barrack believes the deal will spark comparable deals -- of REITs merging with their own investment managers or with totally unrelated managers whose executives want to cash out.

“Tom is a trailblazer,” says Blackstone real estate chief Jon Gray. “I wouldn’t be surprised to see other firms follow his lead.”

But cashing out, Barrack says, isn’t high on his agenda:

“I love what I’m doing,” says Barrack, who agreed not to sell any Colony stock for five years. “If you ask how much longer I want to do it, the answer, in various forms, is until I am in the box.”

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