FROM: Don Pierce, Chief Investment Officer
SUBJECT: TPG Angelo Gordon - Essential Housing III
RECOMMENDATION:
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Approve a $150 million commitment to TPG Angelo Gordon - Essential Housing Fund III, subject to completion of operational due diligence and finalization of legal documents.
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BACKGROUND:
TPG Angelo Gordon’s Essential Housing Fund III (“EHF3” or the “Fund”) is a growing business platform that provides homebuilders in the United States with off-balance sheet financing for land inventory. The fund focuses on land inventory with very discrete attributes tailored to a specific point of the homebuilding cycle - namely, short-duration and close-to-production land that typically is in the final stages of development or held for imminent construction.
The fund is being offered by TPG Angelo Gordon, which is a firm with over $220bn of assets under management. Angelo Gordon was founded in 1988 and is comprised of two main platforms - credit and real estate. The firm had approximately $70bn of assets under management when it was acquired by TPG (a global $140bn multi-strategy alternative assets platform founded in 1992) in November 2023 to complement TPG’s existing private equity, growth equity, impact and market solutions strategies. The combined organization currently has over 1,800 employees spread across 31 offices globally and is active across public and private markets.
The genesis of this strategy began in 2020 through conversations with Lennar, who was seeking a financing partner as part of their overall strategy to evolve to an “asset-light” business model. As a result of this shift, Lennar is increasingly shifting towards holding less land inventory on their balance sheet (additionally, other homebuilders are increasingly adopting this model as well - there are currently over 10 homebuilder partners now participating in the fund strategy). This strategic move enhances the efficiency for these companies, both from an operational and a financial perspective, and EHF3 expects additional market share gains going forward.
Staff and NEPC believe that EHF3 is a compelling opportunity for SBCERA for the following reasons:
- Shared philosophical alignment and unified vision drives strengthening alliance.
o Through the creation of a short term ‘bank’ of pipeline assets, the platform has advantageously optimized various elements to benefit both parties.
§ For homebuilders, EHF3 offers a dependable and institutionally scaled solution that is a key part of their overarching corporate strategy (i.e., shift to asset-light model with greater off-balance sheet financing).
§ For EHF3, this strategy allows for reliable investment flow, ensuring predictable and contractual cash flows with limited downside, due to the inclusion of built-in structural features (e.g., builder deposits, shorter investment/harvest periods, ongoing amortization with no entitlement/development risk, etc.).
- First mover advantage and size deliver growing competitive advantage longer-term.
o As the first scaled institutional product, EHF3 has created either structural or functional exclusivity with homebuilders, granting the fund access to the largest and highest margin projects.
o This resulting diversified portfolio of projects is supported by a large asset management team and proprietary technology; these resources allow EHF3 to consistently and reliably serve as a programmatic partner for these land-banking activities.
o Finally, the diversity and velocity of project turnover within the fund drives cheaper financing with EHF3’s counterparties, allowing for the most attractive pricing versus competitive land bank offerings.
- Differentiated source and shape of risk-return framework is beneficial to SBCERA’s overall portfolio.
o EHF3 delivers a unique return stream to our portfolio that has substantial built-in downside protection - this allows for steady, predictable and uncorrelated returns over a relatively short period of time.
o Returns are contractual in nature given the requirements in place for homebuilder partners.
§ Homebuilder deposits of ~20% represent ‘first loss’ capital and are non-refundable.
§ EHF3 has ‘put-back’ rights to either push the project back to the homebuilder or select another project (with pre-approved criteria) in its stead.
§ As lots are taken down, EHF3 receives monthly cash flows that represent both a return of and return on capital deployed, which improves both the return and capital at risk framework.
While EHF3 is a relatively new strategy, it represents an attractive fit within SBCERA’s portfolio, namely as a scaled new source of uncorrelated returns backed by an established alternative asset management firm. The strategy has been well-constructed and generates benefits for all stakeholders. Moreover, it has strong philosophical alignment with SBCERA’s core investment beliefs and has been risk-tested through the volatile housing cycle of the past four years.
From an asset allocation perspective, SBCERA’s real estate allocation currently sits at 3.8% of plan assets, below the stated target of 5% (with a permitted range of 0-10%). The lower allocation has resulted from two main factors:
- A lower level of new deployment over recent years.
o 2023: $10 million deployed versus $100 million budget ($90 million shortfall)
o 2022: $45 million deployed versus $110 million budget ($65 million shortfall)
o 2021: $93 million deployed versus $110 million budget ($17 million shortfall)
- Shifting real estate valuations/capital calls/distributions within larger portfolio performance.
While this allocation surpasses our current real estate pacing plan for 2024 (currently $120 million, with an upcoming mid-year update), Staff and NEPC are recommending the Board approve the investment into EHF3 with a commitment of $150 million (approximately 100 bps of plan assets). Both Staff and NEPC are comfortable with the sizing given the aforementioned underallocation to real estate, the focus of the strategy (as a credit vehicle to investment-grade counterparties that view this as a key strategic core initiative), and our confidence in the strategy to produce reliable and consistent returns.
COMMITTEE REVIEW:
This item was reviewed by the Investment Committee at its March 14, 2024 meeting, and recommends Board approval with a 4-0 vote. Committee members Newcomer and Basle were absent and Trustees Bracco and Waner were appointed ad-hoc alternate members for this meeting.
BUDGET IMPACT:
Investment Costs are deducted from Net Asset Value.
STRATEGIC PLANNING GOAL/OBJECTIVE:
Prudent Fiscal Management
STAFF CONTACT:
Thomas Kim
ATTACHMENTS:
Exhibit A: Essential Housing Fund III Presentation
Exhibit B: Confidential Memo
Exhibit C: Confidential Memo
Exhibit D: Confidential Memo