October 15, 2008 E-mail this article
Print this article Written by Randyl Drummer
READY TO SWOOP? Industry Braces For New Era of Vulture Opportunity Without a Market Bottom, However, There’s Not Much Commercial Real Estate Firms Can Do Besides Watch and Wait For the Shakeout of Troubled Properties to Begin Let the jockeying begin. Brokerage firms, investment banks, turnaround specialists and other service providers are once again beginning to maneuver for position in anticipation of the long-expected sales frenzy that accompanies any major market correction when sellers and lenders reprice property assets at deep discounts and investors with hundreds of billions in pent-up private equity dollars swoop in search of bargains.
At least, that's how it's always worked in past crashes. But, so far at least, the market has not seen a wholesale drop in asset values. That isn't stopping firms schooled during past real estate bear markets, however, from preparing for the return of opportunistic investors.
For example, New York-based real estate investment banking firm Savills LLC, the U.S operation of the UK-based real estate giant, announced last week it has formed a distressed real estate division to help clients and their lenders restructure, recapitalize or form joint ventures to free up liquidity. Early in the decade, workout experts now on the Savills team advised clients in such spectacular bankruptcies as Enron, Kmart and Olympia & York.
"We're not there yet. We've only scratched the surface," Savills Senior Vice President Frederic J. Leffel, a veteran bankruptcy attorney and one of three executives heading the new unit, tells CoStar Advisor in describing the current market for distressed
property. "There’s a huge wave of debt maturities coming up in 2009, 2010 and '11, and that’s going to force the issue.
"With today's pricing, if you’re the owner of real estate, there’s no reason to sell unless you are forced to sell. But a huge wave of those forced situations is coming up, and that’s what we’re anticipating and planning for," Leffel said.
The Savills division will help companies, including lenders with real estate owned (REO) property on their books, rehabilitate or dispose of large and complex portfolios and assets. The group will help firms recapitalize by selling JV and preferred equity interests, finding gap funding and raising new debt and equity.
Special Times For Special Servicers
"We are seeing a tremendous demand for loan recovery services as a result of the recent turmoil in the credit markets," said Guy Johnson, president of Johnson Capital, which recently formed a commercial real estate special-servicing operation through a venture with Denver-based advisor Miller Frishman Group.
Formerly known as Sevo-Miller Inc., Miller Frishman was a workout specialist during the late 1980s and early 1990s, helping insurers and the Resolution Trust Corp. (RTC) work through and turn around troubled commercial mortgages and properties. Johnson’s services "will come as a welcome relief in this time of economic chaos," he added. Johnson Capital Special Servicing will offer workout services along with the firm’s mainline property
and construction management, note sales and brokerage services. Johnson already provides primary servicing for more than $4 billion in commercial mortgages, and the addition of special-servicing capability allows it to provide a "one-stop shop," Johnson said.
Editor's note: To track major development projects around the nation, read this week's In The Pipeline column. To receive the
column every week for free by e-mail, join our distribution list.
Other firms are jumping into the game for the first time as a direct result of the market dislocation.
"We're making a strategic attempt to take advantage of the current environment," said Matt Haden, partner in Los Angeles-based GCG Works LLC, a recently launched commercial real estate consulting and investment firm that helps private and institutional lenders, developers, investors and other real estate professionals manage their portfolios.
"Our primary clients are investors, developers and lenders, with a huge focus of our practice on helping lenders bolster their portfolio surveillance and collateral review and loan workout infrastructure," Haden said. "We’re advising clients to be proactive and get in there early, before the problems get too big. We can help them stress test their portfolios to see how they are performing. If they need to go through with a note sale, we’ve
got significant buyers. There are billions of dollars in vulture funds ready to snap up these opportunities."
Turnaround Industry Thriving
Other players like law firms have long cultivated active restructuring, turnaround and workout practices. Bracewell & Giuliani LLP, former New York City Mayor and Republican presidential primary candidate Rudy Giuliani's law firm, formed a task force Sept. 27 to help corporate clients understand the evolving federal bailout legislation. The firm said Oct. 7 that in a survey of 100 fund managers and traders, 91% expect bank write downs to continue and present a growing opportunity for distressed asset buyers.
"On the theory that every cloud has a silver lining, the financial crisis and the lower market valuations of highly-leveraged balance sheets are leading to distressed debt buying
opportunities as original lenders and investors dump their exposure. One investor’s problem loan is another investor’s bargain opportunity," according to the survey.
Turnaround specialists such as Alvarez & Marsel, hired last month by Lehman Brothers to help manage restructuring following its bankruptcy last month, have also become major players in the real estate landscape. More than $20 billion of the approximately $32.5 billion in real estate assets held by Lehman was senior and mezzanine debt.
The Turnaround Management Association trade group meets Oct. 27-29 in New Orleans to spotlight the city's revitalization efforts. The association, born during the saving & loan crisis of the late '80s, is marking its 20th anniversary this year and boasts a membership of 8,100.
Some of the top full-service real estate brokerage companies, for example, CB Richard Ellis Group Inc., have long offered asset management and advisory services that handle troubled properties.
"We've been providing focused asset repositioning offerings for about a year," said Bruce Rasher, who has served since April as director of operations of the asset repositioning management practice group within CBRE's global services business. "But CBRE has been providing pieces and parts of this offering for decades. Last fall, senior management was presented with a business plan to greatly increase the focus on asset repositioning and increase coordination."
The practice helps clients develop revitalization, repositioning and disposal strategies for challenged, underutilized and surplus industrial and institutional assets, including brownfields.
"When clients are demanding services like this, you have to be flexible and adapt to the market," Rasher tells Advisor. "CBRE is not launching a new business; we're simply creating more focus for what has been a longstanding business."
Pure-play brokerage firms may need to make adjustments to
effectively service distressed portfolios.
"Real estate brokerages whose bread and butter is sales and mortgage financing, if they are commission-based shops, they may have to do a little restructuring internally to gear up to play in this area. Repositioning and workouts sometimes take a long time and often don’t lend themselves to a commission-based
system," Savills' Leffel said.
Locked and Loaded
Some opportunity funds have been building up for years waiting for the economy to turn sour. Funds continue to grow even in the throes of the current financial crisis. U.S. private equity raised $222.6 billion in 264 funds through Sept. 30 -- up 11% from the $200.4 billion raised during the same period in 2007, according to Dow Jones Private Equity Analyst.
The market will decide when investors pull the trigger, and probably not for a while. Despite a bullish long-term outlook, the commercial real estate investment market is cold, if not frozen. Sales volume is down by more than two-thirds from last year and a gulf remains between asking prices and bids, with even well-leased assets in strong locations attracting fewer bidders. Leasing is down while vacancies and overall cap rates are up.
By some estimates, however, as much as 20% of closed sales involve distressed sellers -- a figure likely to grow next year and in 2010 as mortgage loans mature and banks take back
commercial property assets. With most buyers and sellers waiting on the sidelines for chaotic financial markets to settle down, firms hoping to help with the repositioning of assets and invest in distressed debt are proceeding cautiously.
"Few investors expect problems in the financial markets to ease any time soon, and even fewer expect debt availability and lending practices to return to where they were prior to the credit crunch," said Tim Conlon, partner and U.S. real estate sector leader for PricewaterhouseCoopers.
Though fundamentals have weakened across all property sectors, they’ve held up pretty well and are stronger than in past downturns. That bodes well for a healthy recovery eventually, according to investors polled for the third-quarter PricewaterhouseCoopers Korpacz Real Estate Investor Survey.
"The investor pool is now composed largely of more established players who can weather the storm," Conlon said. "While the outlook remains choppy in the near term, commercial real estate remains a viable long-term investment."
For now, however, the flow of debt for buyers of empty space has virtually stopped. Buyers are closely scrutinizing property performance, making it difficult for sellers to unload value-add properties, even though they're the assets most coveted by buyers.
For now, leveraged owners are just hoping to hold on to their properties and ride out the correction. Distress sales haven’t yet become widespread, but investors anticipate a burst of opportunities for hard cash buyers in coming months as distressed properties move back onto the market.
"Higher cap rates and more conservative underwriting on the part of investors and lenders are having a huge impact on what sellers are able to successfully market," said Susan M. Smith, editor of the survey and a director in the PricewaterhouseCoopers real estate services group. "Buyers are having a hard time obtaining favorable financing, so properties with assumable debt are receiving a lot of attention from buyers."
In addition to looking for deals on commercial paper and troubled mortgages, speculators are eyeing real estate in foreclosure-plagued Las Vegas, South Florida and other areas hurt by the collapsed housing market and financial downturn.
For example, Los Angeles-based LandCap Partners and Beverly Hills-based Kennedy Wilson recently joint ventured with an initial equity commitment of $100 million to acquire completed homes and condos held by homebuilders and financial institutions. The
JV also is targeting foreclosed residential properties that will be
resold at auction through a Kennedy Wilson affiliate.