February 9, 2015
Interviewed by: Privcap
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Risk-Taking The Dune Real Estate Way

Chief Investment Officer Cia Buckley Marakovits talks about the impact of doing just four or five deals a year on the firm’s latest $960M fund and its investors, and how such concentration risk can result in better GP risk management.

Chief Investment Officer Cia Buckley Marakovits talks about the impact of doing just four or five deals a year on the firm’s latest $960M fund and its investors, and how such concentration risk can result in better GP risk management.

Impacts of Dune’s Concentration Risk
With Cia Buckley Marakovits of Dune Real Estate Partners

Zoe Hughes, PrivcapRE: I’m joined here today by Cia Buckley Marakovits, Chief Investment Officer at Dune Real Estate Partners. Cia, thank you so much for joining me today.

Cia Buckley Marakovits, Dune Real Estate Partners: Sure. Nice to see you.

Hughes: In the wake of the crisis, real estate investors and managers have been much more focused on risk. There’s one aspect to Dune’s strategy that actually sits counter to many in the industry when it comes to risk analysis, and that’s concentration risk. Dune has actually raised its third fund, in October of last year—$960 million. Talk to me about that ability and that willingness to take concentration risk and what it really means for the strategy.

Marakovits: Sure, it’s a great question. Part of it is that we look at risk in a couple of different ways. I think the market often looks at size, geographic diversity and product type, which are all risks that have to be evaluated. But for high-yield investing, attention to each deal individually is just as important as some of those other risks.

One reason why we do a limited number of larger deals is that it really gets our focus, and every deal really matters to our fund. That’s a bit of a lesson learned when you talk about a $960million fund. If you’re investing $10 million of equity in a transaction, sometimes it’s a slippery slope of talking yourself into, “Well, it’s a good deal.” I’m a little nervous about a couple of things, but if it doesn’t go well, it’s $10 million in a large fund. We look at it a little differently; when it’s a concentrated deal, our whole team spends time on it. And that’s part of risk management.

Our structure is set up that we don’t have a traditional asset management function. The deal people, someone like me, will take a deal from beginning to end—from acquisition, execution through traditional asset management and through the exit. But to get back to size, we’ll do four or five larger transactions a year. That gets all the senior management team’s focus and it really forces the prioritization. In some ways, we obsess about each of those deals and it’s much harder to do that when you are looking at a lot of things.

Hughes: I believe you can actually do deal sizes of up to $100 million. So what does that mean—is it more of a focus on larger single assets or actually portfolios? What’s the mix, particularly in 2015, as you’re looking at deal flow?

Marakovits: We have done some portfolio investments. I would say we focus a bit more on single assets. And I would back up a bit on size for this. In some ways, $960 million sounds like a large fund. In some ways, we feel niche within urban markets. We focus on urban markets, not because they’re urban or they’re coastal, but because we focus on markets where you have the highest barriers to entry and where institutional investors want to invest, who ultimately end up being our buyers.

When you cut through that, if you buy an office building in New York that you hope an institutional investor will buy from you some day, it would be hard to do that at less than $50 million of equity. So, part of that gets back to size and attention. We focused on single assets a little bit along the lines of when you buy a portfolio, it might be more of a macro bet than a micro bet. And we’re making more micro bets in a macro environment.

Hughes: Given that concentration risk and that willingness to take concentration risk, how do you ensure that the fund is diversified enough and that, in the event of a downturn, how do you offset challenges to certain key assets?

Marakovits: When you look at the investor base of a lot of these funds, I’m not sure they invest with us for diversification reasons. But, we are really aware of concentration and we know that our investors don’t want to wake up one day and have us invested in 100% in office in the Southeast. The flipside is, we don’t think they expect to see a pie chart that’s evenly spaced that we’re hitting all the sectors.

When you go back to the history of high-yield funds, they’re meant to be taking advantage of dislocations in the market. So, it’s actually hard to create diversification when, during your investment period, different things are happening in different geographies or different markets. So, we’re very aware of concentration. Another way of saying it is that if we had 25% of our portfolio in apartments, each incremental apartment deal we look at, the bar will just get higher. We’re not saying we’re full up. We’re just saying, “Yeah, let’s just stay aware and let’s look at the whole portfolio effect of what we’re creating.”

Another part of diversification is how much residual risk you’re taking. How much cash flow? What are the underlying strategies creating the return? That, we think, is more meaningful for what we do than on the core side, where the reason they’re investing in that structure might be different from they’re investing with us.

Hughes: Talk about the dislocation in the market, the strategy that Dune is really employing, especially as you look out over 2015. Where are we in the real estate cycle?

Marakovits: We’re still de-levering. It’s an industry. Real estate is a capital-intensive industry which, i.e., means it’s a debt-financed asset class. And, like the rest, broadly, the markets—whether it’s government, financial institutions, even endowments—people are de-levering the household balance sheets. We’re still in a period of de-levering. I wouldn’t call that extreme distress, but there still isn’t as much debt capital as there used to be. So, we see opportunities in that de-levering.

Hughes: Even with the capital flows coming in, you’re still seeing those opportunities?

Marakovits: Yes, because, again, we only do four to five deals a year, so we might have a different perspective. If we were charged with doing 16 deals in New York, we have the ability to pick and choose and really be cherrypicking. We focus a lot on working with borrowers and there still are people who—because it’s been a long recovery—are in situations where equity needs to recapitalize things rather than debt. And it creates opportunity. So, I think of it as less about distress and more about restructuring and recapitalization.

Hughes: Are you surprised at the way the recovery has actually played out over the past six years?

Marakovits: Everyone thinks in five-year chunks: “It’s going to be better in five years.” Like everyone else, I would have thought five years in that fundamentals would have been better. Capital is better. Fundamentals, broadly speaking, are okay. We all expected more job growth. We all expected household formation to be more robust. It would affect both the rental side and the single-family housing side. I think we benefited from the last cycle didn’t have excess development or this would be even a longer cycle.

The industry talks a lot about [how] people are using space differently. I think that’s true in a lot of urban markets. In suburban markets, people took less space because they could and they wanted to maybe keep the same absolute rent payment per year because they didn’t know what the future was and were reluctant to take on extra commitment. So, I’m surprised it’s taken this long. But then I think, “I’m always optimistic as an American that we’ll find our way out of it.” And maybe that means real estate actually did pretty well from a capitalvalue standpoint, with limited recovery because we didn’t overbuild. So, with a little bit more power behind the recovery, without the overbuilding, real estate could do pretty well in the next period.

Hughes: Do you sense that we’re getting towards perhaps the top of the market? Or heading towards a correction, as it were?

Marakovits: I don’t think so yet, because one thing that has surprised me is that the lending community has had longer memories than they had in a prior cycle. That might be because the regulators made them have a longer memory, but bank behavior is different this time. CMBS market has learned lessons and has taken them on. It still has more to go through. Balance sheet lenders have a lot of other things they’re dealing with. That has all put a focus on credit, underwriting, transparency. Things take longer to get done and get through a system, because everyone’s doing a bit more than they were before.

That slows things down from a cycle standpoint. And I’ve been surprised that banks really have changed, given that fundamentals are good. Not amazing. The capital values are there. That I would have expected the credit creep faster than it’s happened.

Hughes: I know one topic that’s very close to your heart, and given our conversation about where we are in the cycle and what you’re seeing in the market today, is what does it take to be an opportunistic manager today? To be an opportunistic investor, what is the key thing?

Marakovits: I really think you have to be flexible. What’s very hard is that if you try to just stick to your strategy—what you said, here’s what we’re looking at—you have to be flexible because if that’s not there you have to be able to adapt. You need to pivot. It’s really what your role is, which is recognizing where the opportunities are. So being flexible, understanding—

Hughes: Are the investors giving you the flexibility to do that? Because, obviously, one thing we saw in the wake of the crisis was we don’t want strategy drift. We don’t want managers to go off and have wide discretion and wide mandates. Are they giving you flexibility to be opportunistic?

Marakovits: I think so. It’s all in a dialogue. And I think we all either experience snippets or hear snippets of what people have done in the new market. When you unravel the onion, or peel things back, it’s usually been in reaction to something very specific. But if you’re transparent and you have the dialogues with your investors and say, “Here’s how we’re thinking about things,” I think they understand. But it is important. We know what our role is for those, for our investors and probably because we have a diversified fund, we might have more latitude. So I might not be the right person for that, but it is important to live up to what you said you were going to do. That does matter.

Hughes: As an opportunistic manager today, what excites you the most? As you look out at the market, at 2015, what is exciting you the most?

Marakovits: I don’t like to say it like this, but global turmoil ends up being good for our business because it’s not the direction that it’s going, but just changes in the market create uncertainty. And uncertainty is good for people like us. Personally, I like paying less for gasoline. But I understand how quickly it turned creates lots of issues. That ends up being good when you’re in a business that is taking advantage of dislocation.

As long as we’ve been worried about interest rates going up, for how many years we’ve been worried about it, it does feel like it’s going to be happening sometime in the next 12 months. Again, it’s not about the direction, but the change. If happens more quickly than anticipated, it creates opportunity for us. So I don’t like to cheer for bad things, but I know that things not meeting people’s expectations, whatever it may be, creates opportunity for us.

Hughes: If I may ask you, having lived through the crisis and all the lessons you’ve learned, what motivates you today?

Marakovits: I always joke when people ask me that. I say “fear,” and it’s more fear of not meeting the expectations of an investor. I would say, and this is one of those things that women are often given advice on, I don’t want to let people down, and that tends to be a trait that women are often coached about. I would take the other side and say I actually think that’s a good thing. I personally feel that I owe it to people who trusted us, and to the employees of our company, that we need to be successful. It doesn’t mean that I’m not ambitious. It’s just more, “Hmm, if I don’t have to call someone—if I can make this better—this is what we’ll do.”

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