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Vulture Funds Plan to Buy Assets Ahead of Bailout

SEPTEMBER 29, 2008

By LINGLING WEI and PETER GRANT


For months, vulture funds and other yield-hunting investors have been poised to buy distressed commercial real-estate assets from ailing institutions. Now, some of them think it may soon be time to pounce.

Those investors feel that if they move quickly, they will be able to snap up deals before the government implements its $700 billion bailout plan, which could be voted on by the House as early as Monday. They point out that banks and other sellers of the soured securities and mortgages may be more willing to do deals with them because, unlike the government plan, they aren't insisting on provisions such as a limit on executive compensation.

"We'll try to buy some of the assets ahead of the transfer," said Chris Hoeffel, a managing director at Bahrain-based Investcorp, which recently formed a $1 billion fund to buy high-yielding commercial real-estate debt.

Other opportunistic investors, though, say they likely will stick to the sidelines for now. They are skeptical that the government's purchase of distressed assets will accurately establish what they are worth. So far, there have been few transactions, despite the desperation of banks to sell, because of disagreements over pricing.

Also, the bailout means that the funds now face competition from the world's largest fund: the U.S. government. Spencer Garfield, a managing director at Hudson Realty Capital, a New York manager of real-estate funds with more than $1.5 billion in assets, said that despite the competition from the government in the short run, "ultimately, the government will serve as a conduit for selling the assets back to the private sector, probably over the next five years."

While residential mortgages have been the primary cause of the global financial crisis, financial institutions also are burdened with about $100 billion in commercial mortgages and mortgage securities. More than 50 newly formed vulture funds are targeting these assets, which are potentially more attractive than residential mortgages because they produce income. Following the real-estate collapse of the early 1990s, investors made profits by buying commercial assets from the Resolution Trust Corp.

New York investor Lloyd Goldman, who made huge profits by being an early buyer of RTC assets, predicts that the investors who move early will again get the best bargains. "The first trades will create the market," he said.

New York investor Lloyd Goldman, whose company BLDG Management controls property across the U.S. valued at more than $2 billion, says he will be able to outbid the government on certain mortgages because he understands the underlying real estate better. "It's all about grading assets," he said.

Details remain sketchy on what process the government will use to value and buy the distressed assets. In some ways, valuing mortgages on commercial property may be easier than for residential property, which doesn't produce income streams. But many of those streams will be tricky to value because of deteriorating economic conditions that are driving up office vacancies, increasing retailer bankruptcies and weakening hotel rates.

At the same time, the default rate on commercial debt has remained much lower than the rate on residential mortgages. Some financial institutions say they will be unwilling to sell their assets to the government or others at huge discounts for this reason.
The government likely will turn to the private sector for help in valuing and buying distressed assets in the bailout plan -- and many companies will be happy for a sideline business.

"Any group that's still standing is going to be saying, 'We're not going to be making mortgages for a while. What can we do with our expertise?" ' said Paul Fried, a principal with AFC Realty Capital Inc., a real-estate investment banking boutique.
Write to Lingling Wei at lingling.wei@dowjones.com and Peter Grant at peter.grant@wsj.com

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