Homegrown Equity

REVIEW SUMMARY
Company. TerraCap
Industry. Private equity funds
Key. Local insight in real estate can be a key to scoring big investment gains.

Robert Gray spent 24 years on Wall Street, raising billions of dollars for global powerhouse real estate funds at Morgan Stanley.

On a wall in his unassuming headquarters in Cape Coral hangs an aerial photo of the famed Canary Wharf development that shifted the center of London's office market. More than 95,000 people now work in the 15 million square feet of office space at Canary Wharf for which Gray arranged the financing — twice.

So it might pay to listen to Gray's perspective when he says he's most enthusiastic about Florida's market today than any other around the globe. He's confident enough that he and business partner Stephen Hagenbuckle have put $4.5 million of their own money into two private-equity funds they've formed to invest in Florida residential and commercial real estate.

Gray, Hagenbuckle and partner Michael Davis launched TerraCap Partners in 2008 and raised nearly $26 million to invest in residential real estate from Sarasota to Naples, a feat considering the financial turmoil sent investors scurrying out of real estate and into cash and government bonds. The private-equity fund has 91 high-net-worth investors, including one who invested $7 million.

The TerraCap partners say they're now starting to resell properties they acquired with the fund for two to three times the prices they paid, and they expect to continue that trend throughout the fund's five- to seven-year life. Returns so far have been boosted by conservative use of debt, they say.

Based on that success, the three partners are launching a second fund, TerraCap Partners II, which seeks to raise $200 million from a combination of individuals and institutions to invest in distressed commercial real estate across Florida. Gray says he's encouraged by the state's population-growth projections, low real estate valuations, limited supply, distressed sellers and limited competition for the properties the fund is seeking.

Of course, there are plenty of private-equity firms scouting deals in Florida today. But Hagenbuckle says many of them are outsiders who don't have the local knowledge that he and his partners do. A Florida native, Hagenbuckle is a successful technology entrepreneur who was a founder of Fort Lauderdale-based Landmark Bank and became a real estate investor in Southwest Florida.

That's key, because in many cases TerraCap will buy the troubled bank loans before a property goes into foreclosure. This is the kind of transaction that requires personal relationships with the borrowers and lenders. Distressed borrowers often prefer that route because there's no messy public disclosure from a foreclosure and property sale.

What's more, investors are seeking out the prospects of higher returns because of low bond yields and a muted outlook for stocks. Investing in real estate close to home has particular appeal to high-net-worth investors, Gray says.

Local and global
Hagenbuckle, 48, was born in Sanford near Orlando, but grew up on Marco Island where his father worked for the Mackle Brothers of the Deltona Corporation, the island's developers.

After earning a computer-science degree at the University of Florida, Hagenbuckle formed TechWare Consulting and grew the health care technology firm to 155 employees and $14 million in revenues before selling it in 1997 to Ciber, a publicly traded company. He then formed another technology firm called Orus Information Services, which he grew to 245 employees and $23 million in revenues, selling it in 2000 before the tech bust.

Hagenbuckle then became a founding shareholder of Landmark Bank in Fort Lauderdale and began investing in speculative land and residential development in Southwest Florida in 1997. Among other projects, he developed land in fast-growing areas such as south Lee County and Cape Coral, selling out before the bust.

In 2008, Hagenbuckle formed TerraCap Partners and Gray was initially one of the investors in the fund. They met through Jack Tymann, who retired as president of Westinghouse International, the company that developed communities in Naples before being acquired by Tampa developer Al Hoffman and renamed WCI Communities.

Before joining TerraCap full-time as a managing principal in March, Gray was senior managing director and global head of merchant banking for Cantor Fitzgerald. Prior to that he was a managing director at Morgan Stanley's real estate investment business, a $60 billion business, and chief investment officer of Morgan Stanley Mezzanine Partners Fund, a $1.5 billion fund. From 2002 to 2007, he headed Morgan Stanley's capital markets group for Europe.

Gray maintains an office for TerraCap at 30 Rockefeller Plaza in New York City, where he maintains a rich source of contacts. Hagenbuckle declines to cite TerraCap Partners II's fees, but he says they're in line with the industry standard of 2% of assets for the management fee plus 20% of the profits.

Focused strategy
With TerraCap Partners II, Gray and Hagenbuckle say they're going after a niche in the commercial real estate market where they think there's less competition: $2 million to $20 million deals.

That price is out of range for smaller investors and often ignored by the larger institutions hunting for bigger deals. Gray says TerraCap will be seeking financially distressed sellers with all-cash deals for commercial real estate properties.

Buying commercial real estate for 30% to 60% below replacement cost will help TerraCap lower rents and fill up the buildings for eventual resale. They anticipate reselling the buildings individually or packaged as a portfolio when conditions improve. They're targeting 25% rate of return for the fund, which will have a life of seven to nine years and will use some debt to boost returns.

In addition, buying existing buildings at steep discounts to replacement cost means they have time to lease the buildings to tenants without having to worry about new construction. “It pushes future supply out three to four years,” Gray says.

Because of the high vacancies, developer bankruptcies and bank failures, Gray and Hagenbuckle say many sellers are eager to sell commercial real estate at steep discounts. “There's plenty to buy,” Hagenbuckle says.

One of the advantages that TerraCap has over competing private-equity firms, says Hagenbuckle, is that he knows financially distressed sellers such as well-established local families who don't want the embarrassment of a foreclosure or distressed sale. TerraCap can step in and buy the bank loan from the lender before foreclosure proceedings begin, helping them avoid the public scrutiny. “It's a very human process at the end of the day,” Hagenbuckle says.

Gray and Hagenbuckle are encouraged by the population-growth projections and the decline in residential inventory over the last several years. That's because commercial development often follows residential growth. What's more, development restrictions along the coastal areas of Florida means there's a limited supply of land for building.

Top-quality, well-located office and retail properties will comprise most of the portfolio of TerraCap Partners II, with some hotel and industrial properties, Gray says. Areas of Florida they're targeting include Tampa, Orlando, Jacksonville, Miami and Palm Beach.

While investors remain cautious, they are increasingly seeking out local operators such as TerraCap, Hagenbuckle says. What's more, he's received calls from investment advisers seeking alternative investments beyond the usual mix of stocks and bonds for many high-net-worth clients.

The partners' personal $4.5 million investment in the fund points to their conviction, they say. “We're doing this whether there's a fund or not,” Gray says.