Managers targeting failed banks

Real estate investment firms are taking capital off of the back burner and investing in failed banks to gain access to the real estate clogging the banks' balance sheets.

But the Federal Deposit Insurance Corp., charged with taking over failed banks, is moving at a slow simmer in disposing of those assets, causing a bubble of investment capital to form, industry insiders said.

Institutional investors had thought the managers' bank strategy might help to rescue their battered real estate portfolios. However, if more capital is raised than can be spent, the fix might end up causing more harm.

Real estate fund managers are sitting on a total of $188 billion of committed capital and are raising another $174 billion more in funds.

Their chief play right now is to buy real estate through bank acquisition.

Earlier this month, Square Mile Capital Management LLC bought a 40% stake in Specialty Finance Group, a subsidiary of Silverton Bank, Atlanta, from the FDIC after the agency took over the bank. The FDIC is keeping the remaining 60%.

“It is estimated that banks holding commercial real estate loans totaled almost $1.8 trillion, around 25% of the total loans outstanding,” noted Scott Farb, managing principal in real estate consulting and accounting firm Reznick Group PC's Los Angeles office.

Real estate investment firms worldwide had close to $200 billion in uninvested capital as of May 12, according to Preqin, a London-based research firm. They've been holding huge sums of capital for a while — as of Dec. 31, real estate investment firms had $188 billion.

On top of the mass of capital in real estate funds, some investment firms are going to institutional investors for direct investments in banks. For example, the Oregon Investment Council, Tigard, recently invested $100 million in Sageview Capital LP, which set up a bank holding company that will go out to buy real estate assets and debt. The council oversees the $51.5 billion Oregon Public Employees' Retirement Fund, Salem.

Real estate funds have time limits: typically four years to invest the capital and four years to nurture the properties and sell them. Relatively few deals were struck over past couple of years and time is ticking away.

“If they (real estate investment managers) don't find product, they don't get paid, and it's creating a desire to get more money out. We're seeing more competition for product,” said Lewis Feldman, partner/Los Angeles office chair at law firm Goodwin Procter LLP. “Demand is outstripping supply and prices are quite heady.”

The FDIC has 702 institutions on its “problem list” with total assets of $403 billion as of Dec. 31, Andrew Gray, FDIC spokesman, wrote in an e-mailed response to inquiries. He declined to give further information about those assets.

“We are getting multiple bids and bidding is getting more competitive, generally speaking. As the banking system recovers, we expect this trend in pricing and competitiveness to continue,” Mr. Gray wrote.

So far this year, 68 banks have failed, compared with 140 bank failures all of last year. Altogether about $500 billion in assets have passed through receivership since 2008. Although the FDIC does not have an exact breakout, Mr. Gray said real estate would represent “a substantial amount” of those assets.

But some real estate managers think the best time to buy bank portfolios has passed because with more bidders in the pool, prices are too high.

Recently, homebuilder Lennar Corp. led a group that bought companies holding loans seized from failed banks, Mr. Feldman noted. The consortium paid $132 million for $3 billion of distressed notes in exchange for 40% of the “upside” and a 5% management fee, amounting to $10 million per year, he said.

“There was a huge amount of money raised to invest in distressed opportunities and many of the opportunities got parked within banks,” Richard LeFrak, chairman, president and chief executive of real estate developer LeFrak Organization, said during a panel discussion at the Milken Institute Global Conference last month in Beverly Hills, Calif.

In October, LeFrak was in the consortium winning a $2.77 billion bid for a 40% stake in Chicago-based Corus Bank. The winning bidder group also included real estate investment firm Starwood Capital Group, private-equity firm TPG Capital and hedge fund Perry Capital. The consortium ended up with Corus Bank's portfolio of predominantly performing and non-performing construction loans and real estate assets with an unpaid principal balance of about $4.5 billion. The FDIC retained a 60% equity interest.

Because banks and special servicers on commercial mortgage-backed securities are holding real estate properties and debt instead of foreclosing or selling them, Mr. LeFrak said that real estate investment firms won't see any great commercial opportunities until the “gridlock inside the banks ... and the gridlock inside of CMBS ... starts unhinging.”

The only opportunities left are buying banks and assets from the FDIC and “bidding is very aggressive,” he said.