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Distressed Deals Losing Luster

New loan originations may trump scavenger investor rush.

A couple of significant news items came crashing onto the desks of industry execs recently. And these news items are swiftly bringing current market conditions into sharper focus. First, Normandy Real Estate Partners and Five Mile Capital Partners in late March bought the John Hancock Tower in Boston for $660.5 million, a far cry from the $1.3 billion paid three years ago by Broadway Partners.

The prized Class-A property was purchased from the trustees to manage the property back into an attractive, income-producing asset.

The absence of bidders underscores how risk-averse investors are when it comes to buying distressed properties. This stance is reflected by fund managers facing calls from investor clients to redeem holdings and as feasible exit strategies for troubled assets dwindle.

The second news headline to recently emerge was that research analysts at Clerestory Capital, a New York manager for a fund of funds, told its investor clients that over the past six months 32 real estate opportunity funds opted to stop or put fundraising efforts on hold. About $52 billion of potential opportunity funds were affected.

The primary reason offered was that general partners — the lead investors and fund sponsors — are finding few limited partners who are comfortable with market conditions surrounding the refinance or sale of troubled assets today. Another reason cited by Clerestory Capital was that fewer real opportunities exist in the face of many owners refusing to sell at scavenger prices.

Asset management reigns

Instead of chasing what has often turned out to be elusive deals for distressed properties and notes, lenders, investors and operators all are opting to focus on managing current loans on their books, or properties in their portfolios. And effective asset management is proving to be the strategy of choice, especially as investors watch developments like the fire sale of the John Hancock Tower.

The Netherlands-based ING Real Estate has indefinitely nixed a plan for its first-ever global opportunity fund. ING opted instead to focus on its massive €66.5 billion real estate asset management program. Due to fallout from the credit crunch, the global real estate giant's current assets under management are significantly less than the €107.2 portfolio it held at the end of 2007.

Fund and portfolio managers are seeking to distance themselves from the rest of the pack by flexing their asset management muscles. Such capabilities are attracting yield-hungry investors weary of the high-risk returns.

Awakening lenders

Even the dormant lending business today is concentrating on the asset management aspect of real estate finance. A property that is a candidate for financing now must be a high-quality asset in a major metropolitan market. The borrower must have a stellar credit rating and in most cases be seeking low leverage of approximately 65% loan-to-value on purchases, and as low as 50% loan-to-value on refinancings.

Oakland, Calif.-based research firm Foresight Analytics recently issued a report in which it estimates $250 billion of commercial and multifamily mortgages are set to mature in the U.S. this year alone, and over $800 billion between 2009 and 2011. Even though the firm is predicting growth in loan originations will be “minimal” in the next decade, there will be ample lending and debt investment opportunities for prudent lenders and their investors in the coming months and years.

To be sure, property owners and asset managers are diligently seeking resolution to troubled assets today. Thus loan originations — particularly viable refinance activities — will become a pivotal turning point for the commercial real estate finance and investment business. And high-yield investors are seeking to capitalize on the current void in the debt finance marketplace.

As managers continue to halt plans for opportunity and distressed investment funds, the bid-ask price gap for both properties and mortgage notes presents opportunities. The time is fast approaching when lenders will once again emerge. For instance, Wrightwood Capital just announced it has closed its latest high-yield lending fund.

Well-capitalized lenders that can price new loans based on current market risk will likely emerge as the leaders of the next real estate cycle. And these lenders will have their pick of the highest quality transactions in the coming months.

W. Joseph Caton is managing director of Oxford, Conn.-based Hartford One Group, a real estate finance consultant.

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