Tuesday, November 11, 2008

Opportunity Funds Waiting for a Bottom

One of the overriding capital markets trends of the past few months has been the large number of real estate opportunity funds amassing war chests to go after distressed properties and debt. According to Preqin, real estate private equity funds raised $30.2 billion in the 3rd quarter with much of this focused on opportunistic acquisitions and distressed real estate debt. A few days ago, Blackstone CEO Tony James reported that his firm is sitting on $13 billion of capital while waiting for real estate valuations to bottom out. While no specific market has caught his eye, he does believe that the US market will be the first to bottom out and begin the long climb back up.

To date, there have only been ripples of activity in the distressed debt market. For example Lehman brothers, the poster child of distressed sellers, sold $4.2 billion of mezzanine debt at discounts as steep as 35% in the second quarter. Apparently that discount should have been steeper, and we’re starting to see some debt trading at less than fifty cents on the dollar. Overall, however, the market has been eerily quiet so far. Some suggest that this is because the high-leverage, interest-only CMBS loans made in the past few years have not yet come due and forced borrowers to refinance under today’s stricter underwriting standards. When they do mature, starting in 2009 and accelerating through 2012, when five year loans originated in 2007 mature, the cash that is now on the sidelines should be more than happy to come to the rescue as long as it can earn a 20%+ return. The question on the minds of the funds raising cash in today’s market is not if they will be able to buy distressed assets and debt, but when and at what prices. The answer is one on which fortunes will be made and lost in the next decade.

Llenrock Group

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