Hersch Klaff, big-game hunter in a retail jungle

March 10--Hersch Klaff, a one-time bidder for the Chicago Cubs, has partnered with some of the biggest names in the investment business -- the Pritzker family, Cerberus Capital Management, Lubert-Adler, Sun Capital and Blackstone, to name a few.

The chief executive of Klaff Realty LP has been an investor in several of the nation's biggest retail deals, including the $17 billion purchase of the Albertsons grocery chain in 2006 and, last year, the Cerberus-led $3.3 billion acquisition of several grocery chains, including Jewel-Osco, Chicago's biggest food retailer.

On Thursday, a group that includes Cerberus and Klaff announced a $9 billion deal to buy Safeway Inc., whose Dominick's chain was shut in December.

Klaff, who describes himself as "very risk averse," has made his mark not by developing new properties, but by purchasing what he believes is undervalued, mismanaged real estate and redeveloping it. One can buy existing real estate at less than replacement cost and have a bigger cushion on which to make mistakes, he explained.

"I like to buy good stuff," the real estate investor said. "It just doesn't look good."

That's one reason the 60-year-old Klaff, a South African native who moved to Chicago four decades ago, is eyeing J.C. Penney or Hoffman Estates-based Sears Holdings Corp., which operates Sears and Kmart stores.

"Some companies are dodos, and they're dodos," said Klaff, recalling a French museum where he saw an exhibit about the flightless bird that became extinct.

Klaff acknowledged he's monitoring Penney and Sears, which have struggled with declining sales in recent years, because they have valuable assets, including real estate, but their business models are anachronistic. They depend too much on large, multilevel stores in enclosed malls, he said.

"Eventually, a hunter is going to blow them away with a blunderbuss."

He'd like to be that hunter.

In its current form, Klaff said, Sears can't be turned around. He noted that Sears Holdings Chairman Edward Lampert's hedge fund recently cut its stake in the chain, and announced plans to spin off the Lands' End clothing unit and set up a separate real estate entity. Klaff said those are the right moves to help ensure Sears' long-term survival.

More focused on real estate, Klaff said he'd also reduce the size of Sears stores, focus on hard goods like Craftsman tools and perhaps sublease store space.

Klaff said he is watching to see how it all turns out, hoping to be involved.

"I would like Sears to be my swan song," Klaff declared over a fruit plate and yogurt at a Hard Rock Hotel restaurant about a block from his Chicago headquarters.

Kevin Poorman, chief executive of PSP Capital Partners, a private investment firm founded by Chicago billionaire and now U.S. Commerce Secretary Penny Pritzker, described Klaff this way: "He's very good at looking at the downside and seeing opportunities."

Klaff typically isn't an operating guy. In the deal for Jewel and other chains last year, the Cerberus team has Bob Miller overseeing operations. Miller is CEO of AB Acquisition LLC, the entity whose operations include Jewel-Osco.

"Bob and his team are exceptional operators who turned around Albertsons seven years ago into a profitable investment for us," Klaff said.

In 2006, the Cerberus group, which included Klaff, as well as Supervalu Inc. and CVS Corp., bought Albertsons and broke up the grocery chain. Supervalu acquired more than 1,100 Albertsons-owned stores in the deal, including Jewel. Cerberus acquired more than 650 Albertsons stores.

"We cleaned it up because it was run by big corporate America, and big corporate America is where the opportunities are," Klaff said. Among other things, the Cerberus-led group hired "better people" and gave them incentives.

"It led us to our next step, which was Supervalu, Klaff said. The grocery store operator has had "a lot of stress, poor management and poor strategies," Klaff said.

Last year, Klaff and his group bought five chains, including Jewel-Osco, from Supervalu for $100 million in equity and assumed $3.2 billion in debt. Klaff kicked in $82 million, some of that amount raised from family and friends, including Chicagoans such as Illinois GOP gubernatorial candidate Bruce Rauner.

Supervalu had assumed $6.1 billion in Albertsons' debt when it bought Jewel-Osco and other grocery chains, a debt load that haunted the company.

The Cerberus-led group already has spruced up many of the Jewel stores, partly because of Supervalu's neglect of the locations, but also as a response to rival Mariano's bigger investment in the Chicago market, Klaff said. Mariano's is forcing competitors to raise their game by renovating their stores and offering more upscale products.

"The new fight in town is not about milk -- it's about lobsters," Klaff said.

He interprets Mariano's dividend cut as a move aimed at conserving cash for its expansion. Mariano's is saying, "'I'm all in.'"

"We're sitting interested, watching, upgrading," Klaff said. "It's all about fresh."

In late 2013, California-based Safeway shuttered the Dominick's chain, a major player on the Chicago grocery scene. The Cerberus-led group has bought some of the Chicago-area stores.

Under Cerberus, decision-making at the newly acquired grocery chains is more decentralized; regional presidents have more responsibilities, Klaff said.

"It's an operating company with real estate as opposed to real estate with an operating company," Klaff said. "It can be turned around and improved, which we've done before."

Cerberus owns about 40 percent of AB Acquisition LLC; Klaff and his group own about 15 percent, and he sits on the board.

If the grocery stores are turned around and improved, "we'll make a lot more money with the business doing well than if it did badly and we had to turn to the real estate," he said.

Still, he said, grocery chains' real estate acts as an "insurance policy."

Klaff owns little else in the Chicago area these days. Intersections where he owned buildings in the past include Randolph and Wabash, State and Jackson, State and Washington, and Clark and Diversey.

He and his partners once bought a building at Rush and Oak and leased it to luxury retailer Barneys, which then built a new store there.

"Eventually, we sold the land back to them at a big price," Klaff said.

The key to his business is taking something and making it something different, including divvying up spaces into smaller lots, renovating them and leasing them to smaller tenants for higher rents.

"Change-of-use renovation -- that is all we've done," Klaff said.

He's not interested in "typical one-off" office buildings or shopping centers that "anybody with money -- and there's a lot of money and low criteria in terms of returns" -- can buy.

He said it's "time to hunt elsewhere" because there's little growth left in the U.S. retail industry and few investment prospects except for "very large whales" that "are distressed, like a department store chain like Sears or Penney's" that can be restructured, Klaff said. "Sears is the perennial. One day. Maybe. Who knows?"

"These companies we buy in this group are unique," he said. "There are such huge barriers to entry, and it's difficult for others to compete."

That's why he has to find partners.

"I have an idea and say, 'Who am I taking this one to?'" Klaff said.

He has done deals with Dean Adler of Philadelphia-based Lubert-Adler, whom he communicates with at least five or six times a day via email or phone.

The groups of which he's a part like to "buy assets through the backdoor in very complex situations like bankruptcy in very big deals in which no one else can compete," he said.

Tim Hadro, a former lender for JPMorgan Chase and its predecessors, said Klaff started out as a bank customer, but the two are now friends, and Hadro invests in some of Klaff's funds.

A 2003 National Real Estate Investor story told of how Klaff and his partners bought designation rights -- essentially options on leases usually mired in bankruptcy court -- on 220 liquidating Service Merchandise stores. The story said Klaff had taken positions on dozens of Kmart stores over the years, including a two-story Chicago store that was split into a Kohl's and a Burlington Coat Factory, and a Naperville store that was split into a Marshalls and a Linens 'n Things.

"It's a good example of being able to look at a situation where some see a problem and he sees an opportunity," Hadro said.

Jon GrayBlackstone in New York, said he worked with Klaff on a Kmart property deal about 20 years ago and found him "very creative," with Klaff suggesting that the property might be carved into different pieces for different retailers.

"He brought us in as a capital partner, and he was operating partner," Gray said of Klaff. "He has a great nose for value."

In 2005, a group that included Klaff was outbid for Toys R Us by Bain, KKR and Vornado, which snagged the retailer for $6.6 billion.

"The guys who bought Toys R Us are the creme de la creme," Klaff said. "It's like God, God and God."

But Toys R Us has struggled, proving that "it doesn't matter who you are, but what you know," he said.

Earlier deals in which Klaff was involved include Mervyn's, a former Target unit. Klaff and his partners bought Mervyn's in 2004 and sold the department store operator in 2007. In 2008, Mervyn's fell into bankruptcy.

Klaff said it was largely because the California economy went off a cliff in the recession.

A lawsuit, however, claimed that the retailer's real estate assets were stripped of value and were used partly to service the leveraged buyout's debt. In 2012, Cerberus, Klaff and other defendants agreed to pay $166 million to some creditors to resolve the claims, but Klaff said the deal was still profitable.

Klaff said great retailers should be able to pay rent.

"All we did was make Mervyn's pay market rent for their own properties," unlike the chain's previous owner, Target, Klaff said. "Hello? How about Bed Bath & Beyond," which pays market rents for most of its stores.

Bed Bath & Beyond makes money, as does Kohl's, which also rents stores and is profitable. "My point is, a great retailer makes money and pays rent," Klaff said. The only reason Sears has made money is because it owns so much of its real estate, Klaff said.

"You don't get money for free in this world," he said. "That means that the business has to be good, which goes back to what's the big deal of charging rent when some of the greatest retailers in the world only rent properties?"

Klaff also recently raised about $80 million for a fund to invest in Uruguay, specifically agricultural lands that grow corn and soybeans. He said land there is relatively cheap, a half to a third less expensive than in the United States.

Uruguay is safe with little corruption, its people well-educated, its water ample and the weather moderate, Klaff said. Among other things, he also thinks it's a good bet because of a looming shortage of arable land and a demand for protein worldwide that soybeans help satisfy.

Nearly 80 people have invested in the first fund, which required a minimum contribution of $100,000. Klaff has a farm with horses there. Plans are underway to raise $100 million for a second Uruguay fund.

He also owns real estate in Brazil, including one hotel and another being built.

Studying accounting in South Africa turned out to be his passport to the United States. His father, who went to South Africa as a 15-year-old Lithuanian refugee, urged Klaff to move to the United States.

"He thought the world would begin and end in America," Klaff said of his father.

He got his visa when a Chicago accounting firm hired him over the phone. He later went into real estate and became an investor.

"Few things are the same around the world," Klaff said. "One is numbers."

Tribune reporter Ameet Sachdev contributed.

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Hersch Klaff

Job: CEO, Klaff Realty LP in Chicago

Lives: Glencoe

Family: Married with three children

Self-description: "The world's most un-technical person." A friend opened a Facebook account for him, but it's largely inactive, even as Klaff gets alerts from people who want to friend him.

"When I go on Facebook now, there are 87 whatever they are," he said. "If I ever started, I'd get obsessed by it, and I don't want to take the mental time to be obsessed by it, because I've got other things I'd rather do."

Work environment: His headquarters is on Michigan Avenue, but even when he's in town, he's rarely there, instead conducting business in Starbucks on the North Shore.

"Starbucks in Glencoe -- that's his office," said Tim Hadro, a former JPMorgan Chase lender who initially had Klaff as a customer but now has invested in his funds. "There are more deals done there than half of the offices downtown."

Shopping philosophy: "Like all good men," he rarely buys anything for himself, "except for music and books, and now you can't shop for that because it's all online."

Dress: Usually casual.

"Hersch has achieved a level of success, so he can dress the way he wants instead of dressing to impress," Hadro said.

At a summer meeting on the North Shore, Klaff might wear shorts and a T-shirt, and in the winter, it's not unusual for him to wear sweatpants and T-shirts to discuss business, Hadro said.

Adds Jon Gray, global head of real estate for Blackstone in New York, "Hersch isn't exactly the most corporate guy."

Interests: travel, books, Pilates, art -- particularly Latin American art. Institutions that he has supported include Writers Theatre in Glencoe and the Selwyn Segal Society for the Jewish Handicapped in Johannesburg. He has helped finance a few low-budget independent movies, including "Mulberry Child" and "A Thousand Kisses Deep."

Admired investor: Klaff aspires to be a "mini-Sam Zell." Zell made his billions in real estate investing, but his purchase of Tribune Co. ended up in bankruptcy court. Still, "what he lost on the Tribune was like me losing my Starbucks card," Klaff said. "If you don't lose sometimes, you're not playing enough."

The deal that got away: Nearly five years after being outbid for the Chicago Cubs, Klaff said people often ask him whether he's relieved that his plans didn't pan out. On the contrary, Klaff said. He often thinks about what might have been. "I'm unhappy I didn't get the Cubs," he said. Klaff thought the Cubs would have made a good investment.

"Sure, they're great baseball fans," he said of the Ricketts family, the Cubs' owners. But the team stinks, and "I'd rather have someone who came from Mars" if that's what it took to turn the team around, he said. Take the Glazer family, the longtime U.S. investors in England'sManchester United soccer team.

"I can promise you they weren't kicking around soccer balls when they were kids," yet they've helped build Manchester United into one of the most valuable franchises in sports, Klaff said.

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