Real deals

Real estate opportunities starting to grow

Investors with much-needed cash are getting the cream of the crop

Real estate is starting to yield solid investment opportunities that are expected to grow considerably over the next two years, industry insiders say.

So far, the land rush that industry professionals had expected at the beginning of the global economic meltdown has not materialized.

“The debt crisis of 2008, 2009 and 2010 is the best opportunity that never happened,” quipped Mike Straneva, Americas and global director of transaction real estate in the Phoenix office of Ernst & Young LLC.

Investors with pools of capital are poised to purchase properties that lenders do not want to own through foreclosure, as well as properties that owners can't afford to keep when loans come due.

Jeff Giller, managing partner of Clairvue Capital Partners, a real estate investment firm in San Francisco, said an estimated $230 billion will be needed to rebalance the roughly $1 trillion in commercial mortgages coming due over the next three years and $50 billion for the approximately $125 billion of debt maturing in real estate private equity funds.

Money managers, real estate investment trusts and consortiums that include institutional investors are swooping in with much-needed cash to pick the best properties. Money managers, real estate investment management firms and hedge funds have amassed capital to buy real estate debt and rescue beleaguered property owners.

The owners include private equity real estate funds that bought properties using mostly debt in the high-flying days that reached a crescendo in 2007.

Institutional investors also are getting in on the buying, forming joint ventures to pick up substantial interests in mostly core properties with steady cash flows that have hit hard times.

One such investor is the Canada Pension Plan Investment Board, which entered into joint ventures to buy 45% stakes in several properties this year. The CPPIB acquired a 45% interest in 1221 Avenue of the Americas, New York, for US$576 million in debt and equity. At the same time, it formed a joint venture with SL Green Realty Corp. to purchase a 45% stake in 600 Lexington Ave., also in New York, for US$87 million.

Officials at the Toronto-based board, with C$138.6 billion (US$138.2 billion) in total assets, have estimated the properties had a combined value of US$1.45 billion.

“We're definitely seeing more creative acquisition work” as investors look to invest in the debt in order to get the property, said Jason Kopcak, managing director and head of whole loans at Cantor Fitzgerald & Co., New York, which started an investment banking business in 2008. “Private equity and hedge funds are buying the debt with the ultimate goal of buying the assets.”

Mr. Kopcak works with banks and hedge funds to helpwith dispositions of the real estate loans they own.

However, instead of buying a bag of miscellaneous real estate debt as they did in 2007 and 2008, hedge funds and other investors are becoming more specialized, only investing in the debt of certain real estate property types with which they are most comfortable, he said.

Speaking about banks that extended mortgages in hopes the real estate market would turn around, Jahn Brodwin, senior managing director at real estate consultant FTI Schonbraun McCann Group in New York, said: “We're just at the tip of it. The "extend and pretend' eventually has to come to an end.

By next year, as properties are sold, “there will be a big shuffling of the deck in the ownership of real estate,” said Mr. Brodwin.

“It looks like it did in the mid-1990s, when public REITs were buying everything,” he said.

Not for pennies

But don't look for the clock to rewind further to 1989, when the Resolution Trust Corp. was created. Real estate debt is not being unloaded wholesale for pennies on the dollar, as happened then.

Today's marketplace is different, said Ernst & Young's Mr. Straneva. Recent regulatory changes shifted the power to debtors from creditors. Banks do not have to write down loans as long as owners are paying the interest, even when the loan exceeds the property's value; low interest rates made making the interest payments on mortgages easier.

Interest rates are so low that Mr. Straneva said he's seen owners of land that was purchased to build an office building still able to make the interest payments on the mortgage by turning the property into a parking lot.

During the RTC days, debtors could fund a bankruptcy from property cash flows. But now a missed mortgage payment often starts a process that leads to the sale of the property by a receiver, and the debtor loses everything, he said.

“The owner must decide pretty quickly whether he will fund the bankruptcy out of his own pocket or bring in new capital,” he said. This creates an opportunity for those with new money.

What's more, new regulations allow lenders to divide troubled loans into good and bad tranches. Banks then can extend the good tranche and open the door for new capital to rescue the bad tranche, Mr. Straneva said. Institutions will invest in the bad tranches and get a piece of the ownership stake in return.

The Federal Deposit Insurance Corp. has begun selling off larger batches of commercial debt held by failed banks. According to the FDIC, there are now 860 failed banks on the agency's problem list that hold $379 billion in total assets.

Although the FDIC has sold half as many total loans so far this year than in all of 2009, a greater percentage this year have been for commercial real estate. Some 13% ($12.1 billion) of the $88 billion of loans sold through Oct. 31 were commercial real estate loans. By comparison, 9% ($15 billion) of the $171 billion of loans sold in 2009 were commercial real estate loans, said LaJuan Williams-Young, FDIC spokeswoman.Investors are bidding on bigger pools of real estate debt sold by the FDIC, especially now that more commercial loans are being sold. Besides the FDIC sales, smaller healthy banks also are considering selling real estate debt because rising prices on certain properties are making a sale more palatable, Mr. Straneva said.

The possibilities are tremendous, said Alan Feldman, CEO of Resource Real Estate Inc., a Philadelphia-based real estate investment firm. Banks, life insurance companies and commercial mortgage-backed securities special servicers are holding mortgages on properties that are not worth the debt. “All of those loans need to be replaced and the property has to be recapitalized,” Mr. Feldman said.

But not all properties are the same. Real estate right now is a persnickety marketplace. “There's a bell curve. There's a flight to quality and people are paying record prices,” Mr. Feldman said.

Property values in gateway cities such as New York and Washington are coming back faster because of more investor demand, said Clairvue's Mr. Giller. So far, banks are hanging tough on the most desirable properties, neither foreclosing nor cutting a deal because they still perceive value in the properties. Banks are most likely to foreclose on properties they can manage.

Undesirable properties

At the other end of the spectrum are the undesirable properties. “Hotels are a hybrid of real estate and operating businesses and are very tough to manage, (so) banks will hang in with the borrowers. Foreclosed-on shopping centers and hotels can turn into nightmares very quickly,” Mr. Giller said.

Mr. Giller said the vast middle between the more stable core and the riskier opportunistic assets is ripe for workouts because most money is chasing core for the income and opportunistic real estate for the anticipated higher returns.

“The real opportunity we see is debt assets, especially on multifamily properties that require things to be fixed,” Mr. Feldman said. He prefers to work with lenders because owners often no longer own an equity interest in the property. Clairvue primarily assists borrowers by offering rescue capital, mostly to private equity owners of real estate with troubled properties in their portfolios, Mr. Giller said.

Both Mr. Feldman and Mr. Giller agree that the next couple of years will be big.

Mr. Feldman added that he only sees the velocity of the loan defaults to begin to increase, with much of the sellers being special servicers.

“2011 and 2012 will be big years for debt restructuring,” Mr. Giller said. “Twenty percent to 40% of the commercial real estate debt that was issued in the middle of last decade is in trouble and will need to be worked out.”