CANYON-JOHNSON LEVERAGES $1 BILLION TO PROVE DEVELOPERS ARE NOT AS ARROGANT AS THEY SEEM.

by Chris Wood

In 2000, during fundraising for the first Canyon-Johnson Urban Fund, a trustee for one of the country’s largest state pension plans sat patiently listening to the Canyon-Johnson pitch. One of the firm’s principals, Earvin “Magic” Johnson, clearly detailed the gap between the spending power of Urban America and the lack of high-quality goods and services in urban neighborhoods. At the conclusion of the presentation, the trustee leaned forward, cleared his throat, looked directly at the former NBA Hall of Famer-turned-developer and said, “That was a great speech, but what makes you think that we would want to invest in your people’s communities?”

Your people. The choice of words reveals an underlying friction between the ivory tower world of real estate development— one driven by valuation and capital return—and the vibrant, ethnically diverse urban communities that cling to culture and tradition in the face of gentrification. Where the two meet continues to be ground zero for Canyon-Johnson Urban Funds, a Los Angeles-based partnership between Canyon Capital Realty Advisors (CCRA) and Magic Johnson Enterprises formed in 1998 to help improve diverse inner-city communities. On April 16, the firm announced the closing of the $1 billion Canyon- Johnson Urban Fund III, an urban investment vehicle that eclipsed the combined $900 million the company raised in two predecessor funds, including the $300 million ultimately racked up during that first capital raise in 2000.

Canyon-Johnson Urban Fund III, which will be leveraged out to more that $4 billion, will “identify, enhance, and capture value through the development, redevelopment, acquisition, and repositioning of real estate in the densely populated, ethnically diverse neighborhoods with strong market fundamentals for retail and housing,” according to a press release. But the true guiding philosophy for how that money will be put into play is simply by “abandoning arrogance,” says Bobby Turner, managing partner of CCRA and Canyon-Johnson.

Don’t be fooled. Turner and Johnson espouse several well grounded business philosophies
and mandates to guide investments and operations at Canyon- Johnson—including triple bottom
line management, capital preservation over return, aggressive underwriting, and focused risk
mitigation. But it’s the abandonment of arrogance on which Turner consistently relies. “Two
words will always define urban development: arrogance and distrust,” he explains. “Distrust on behalf of a community that feels a developer is out to squeeze them of money and arrogance on the part of a developer that thinks he knows better than anyone what a community wants [and needs].

“[That dichotomy] makes everything different,” continues Turner, who co-founded CCRA after a stint at Drexel Burnham Lambert, the Wall Street investment banking firm that plunged into bankruptcy in the ’80s following illegal maneuvering in the junk bond market. (The company’s real estate division was the only department that emerged unscathed.) “It makes the risks different. It makes the returns different. It makes the underwriting different and requires revolutionary nuances in real estate investment. Primarily, it requires an ambassador of great will to bridge that gap between arrogance and distrust.”

That ambassador, of course, was Magic Johnson, whose very name struck a chord of authenticity among urban residents. Today, the firm’s two leaders—as different in appearance as in personality—are undeterred in a common goal: to venture into blighted neighborhoods that most investors scoff and inject them with quality construction, capital, and caché.

THE COLOR OF MONEY
None of this would be possible without Johnson, who has, indeed, created one of Urban America’s most recognized brands. (See “Brand Loyalty” on page 27.) The former NBA point guard followed his retirement in 1992 by becoming an HIV prevention crusader and establishing a lucrative career in retail real estate. Prompted in part by the devastating L.A. Riots, Johnson entered into a joint venture in 1995 with MacFarlane Urban Partners to invest a $51.5 million California Public Employees Retirement System (CalPERS) fund in retail properties in California’s underserved urban markets. But branding retail stores in less-than-appealing neighborhoods was a far cry from truly redeveloping blighted urban corridors. As such, when Johnson was introduced to Turner in 1998 by Johnson’s business manager and mutual friend Warren Grant, the proposition was exactly what Urban America needed. Turner’s ambitious plan? A long-term joint venture between CCRA and Magic Johnson Enterprises, starting with the creation of a $300 million urban real estate fund. “I remember at the time having some success in real estate but looking for a partner that could take me to the next level. With what Canyon Capital brought to the table, we could turn investors towards minorities and Urban America,” Johnson says. “We could build brand-new buildings, provide jobs in those buildings, provide a beautiful place to shop and live, and drive up property values for everyone.”

Though renowned for his passion, drive, and dedication, Johnson nevertheless had reservations about the possibility of raising a $300 million fund for urban real estate, even with his demonstrated success in retail redevelopment. “It should have been a no-brainer to investors,” Johnson says. “But it felt Herculean in effort.” Responses such as those of the entitled state pension trustee did little to reaffirm the validity of their vision. While Turner remained upbeat, promising a six month window to close the fund, Johnson suspected it could take years.

He was right. Canyon-Johnson Urban Fund I took 30 months to rake in its $300 million, but the victory proved that institutional investors could be persuaded to commit to real estate in dense, ethnically diverse urban neighborhoods—that dollars, in fact, were blind to race. It was a watershed moment, not in the least for Johnson, who points to Urban Fund I as the first time investors, developers, and neighborhoods overcame the arrogance and mistrust between them in order to subscribe to the same basic conclusion. “Minorities are all about touch and feel, about real and permanent change and results,” Johnson says. “I get that, and my passion for real estate is the same. In a way, it is about pointing to a specific place,
a community, a street, and saying ‘I can change that.’”

The change-minded investors, which included CalPERS, CalSTRS, the Church Pension Fund, and New York City Pension Funds, invested capital into real estate from Miami to Milwaukee, from Chicago to Hollywood. And each project embraced the principles of Urban America that Turner and Johnson tout. Case in point: Baltimore’s Charles Village, which revitalized a community near Johns Hopkins University that, cut off from the glitz of the Inner Harbor, fell between drug-addled, prostitute-frequented neighborhoods to the east and south. In a partnership with local developer Struever Bros. Eccles & Rouse, Canyon-Johnson provided a $150 million facelift, delivering 68 lofts and 100 condos across two properties on St. Paul Street. Ground-floor retail provided neighborhood residents with shopping and employment opportunites at Barnes and Noble, Chipotle, Cold Stone Creamery, Signatures Stationery, and Starbucks,to name a few. “The streets behind me used to be pretty shady, exactly what you would see on [HBO crime drama] The Wire,” says Kenneth Sproat, a Baltimore resident who lives three blocks from Charles Village. “Now the whole neighborhood has changed. They have really built it up and improved it.”

Capital returns on the fund, too, have been respectable, averaging in the midteens,according to investment partners. That’s just fine with the numbers-minded Turner, who says the fiduciary mission of Canyon-Johnson is to preserve the wealth of its investors. To that end, the firm is dedicated to progressive and extensive risk mitigation via due diligence and underwriting, even hiring real estate outsiders to take a second look at assets. (See “Extreme Underwriting” on page 30.) “Implicit in risk reduction is yield reduction,and we’re absolutely okay with that,” Turner says. “Our partners are thrilled to get constant, nonvolatile 15 percent returns and at the same time have a wonderful tangential impact of improving and fostering opportunities for residents in minority communities.”

Fund investors agree. “It is hard to compare urban redevelopment with other real estate investment classes,” says Alan Snoddy, a senior vice president at New York City-based Church Pension Fund, which oversees pension funds for the Episcopal clergy and lay employees and has invested in all three Canyon-Johnson funds. “There has been and will be a lot of competition from asset-flipping funds, but that is comparing apples and oranges.

It takes time to revitalize an asset and a community. You have to actually look and see what they have created on an asset-by-asset basis, and there I think you’ll find they have done a great job.”

Solid Gold: Canyon-Johnson’s Sunset+Vine development changed the character of a
gritty Hollywood neighborhood while realizing an after-sale return of nearly $50 million.

THE CHANGING FACE OF URBAN
Indeed, the larger success of Canyon-Johnson is undeniably on the social improvement side. Though Turner and Johnson are both adamant that Canyon-Johnson’s No. 1 priority is to provide a solid return to investors, the communities that they have managed to transform will likely stand as the ultimate testament to the firm’s modus operandi. According to Turner, Canyon-Johnson funds I and II (which are 90 percent committed) have helped create more than 11,000 construction jobs, 5,000 permanent jobs, and more than 6,200 workforce housing units that will revitalize American downtowns.

——————————-
[ the company ]
Canyon-Johnson Urban Fund

■ Founded: 1998
■ Headquarters: Los Angeles
■ Committed Equity Under Management:$1.9 billion
■ Portfolio Size: Company has facilitated more than $4 billion in value-added urban revitalization and
development across 26 properties.
■ Notable Projects: Miami Free Zone, Miami; State Place, Chicago; Sunset+Vine, Hollywood, Calif.;Charles Village, Baltimore, Md.; One Hanson Place, Brooklyn, N.Y.
■ On the Boards: Block 21, Austin, Texas; 110 Green Street, Brooklyn, N.Y.; Terrazo, Nashville, Tenn.; Hilton Washington, Washington, D.C.
————————–

Those types of numbers tend to get noticed. “Not too long ago, many affordable housing redevelopment projects in Baltimore were shelved when federal funding for affordable housing dried up,” attests Maryland Gov. Martin O’Malley. “Today, with help from innovative, civic-minded developers like Canyon-Johnson, many of these projects are back online, furthering Baltimore’s renaissance by providing quality housing, strengthening existing neighborhoods, and attracting homeowners back into the city.”

The always colorful Austin, Texas, Mayor Will Wynn, who has, on occasion, exited his car to yell at truck drivers blocking downtown traffic, likewise chooses not to mince words when it comes to Canyon-Johnson’s impact on his city. “It is funny when I try to remind Austin citizens about this now, but 10 years ago, downtown Austin was in the ditch,” says Wynn, who spent 20 years in commercial real estate development prior to being elected mayor in 2000. “Austin is young, safe, educated, dynamic, and growing, but at the same time, there are spots that need a rifle shot approach, a surgical redevelopment. For that, Canyon-Johnson is the perfect fund and development partner to step in and do what a typical institutional mind-set would be reluctant to do.”

For Austin, that project is Block 21, a massive development that will eventually include 196 condos, 250 hotel rooms, 47,000 square feet of ground- and second- fl oor retail, and a 2,200-seat, state-of-the art concert venue, all in a neighborhood that Wynn describes as some of the “worst and woefully underutilized real estate in the city.” Partnering with Austin-based Stratus Properties, Canyon-Johnson aims not only to deliver the 38-story, $260 million community by 2010, but to do so in a manner suitable for LEED Platinum certification. “The stature and passion, intellect and drive of this partnership are undeniably attractive,” Wynn says. “But beyond that, I’m always thinking: If anyone is really going to drill down and change this city for reasons [other than] a profitable return, these guys could be it.”

On that prediction, Turner and Johnson concur. “Every developer should invest in urban, right? That’s where everyone wants to be now,” Turner says. “But here is the warning to all: Historical success in suburban markets has no application to urban markets. The skill sets are different—I promise you.”

Canyon-Johnson’s prowess on that end is even getting academic attention. At Harvard Business School, Nicolas Retsinas, director of the Harvard Joint Center for Housing Studies, teaches a case study on the firm’s $115 million Sunset+Vine project, which sold in for just under $165 million after winning several awards, including the Grand “Best in the West” Award for Best Commercial Retail Project at the Pacific Coast Builders Conference 2004 Gold Nugget Awards.

“Their strategy is as much about community building as it is a way to enhance the value of the real estate investment that they are part of, and I think that’s special,” says Retsinas, who uses Canyon-Johnson to illustrate that emerging business markets exist within the United States as well as overseas. “There are a lot of groups that try to do the same thing on the [same] scale as Canyon-Johnson, but [Canyon-Johnson’s] track record is pretty impressive.”

Johnson views the increased attention to urban real estate investment with pride. “When Bobby and I first started, we were new kids on the block, but we proved it,” he says, flashing his famous smile. “Others are following—even as we continue to apply our method—and that’s great.”

Are they worried about more players in the urban arena? As long as developers maintain humility, abandon arrogance, and look to the urban resident as a partner and savvy consumer, Canyon-Johnson welcomes the competition. “We’ve lost deals,“ Johnson says. “But we’ve never lost a deal because we were outworked. No one will ever outwork us.”

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