It may be tough times in the commercial real estate market, but that's just the kind of situation that appeals to a certain kind of investor the notorious vultures.
And they're gathering in Los Angeles and Southern California to score some prime deals.
From niche players like Franklin Pacific Finance in Santa Monica to huge players like Orange County's Pimco bond fund, investors are eyeing the region's increasingly troubled commercial real estate market. They are amassing funds in the hundreds of millions of dollars to bid on bank notes for distressed commercial properties, or to buy commercial properties directly from troubled borrowers and owners.
"We're just starting to see the stress in the local commercial real estate market now, so we're on the lookout for distressed deals," said Marc Heenan, senior vice president at Franklin Pacific, which has raised $50 million so far.
A few players have already cut some small deals on distressed commercial property loans, such as Lion Real Estate Group LLC in Brentwood, which has bought four local apartment buildings from financially squeezed owners or from banks holding troubled loans.
But for the most part, investors are still on the sidelines, waiting for the commercial real estate market to bottom out and for banks to start moving troubled loans off their books. These "opportunity investors" are expecting a flood of foreclosures to hit when five-year loans on commercial properties taken out at the height of the boom in 2005 and 2006 mature over the next two years and borrowers face a tough time refinancing. Typically, commercial real estate loans are short term and require either balloon repayments or refinancing.
"People have to go out and try to refinance their five-year loans. That's when this will really come home," said Andrew Miller, managing partner with Denver's Miller Fishman Group, which has formed a joint venture with Irvine's Johnson Capital to invest in distressed real estate. "They will have to write a huge check to fill the gap. If they can't, that's when they will have to sell at a discount."
One local investment house that's biding its time is Buchanan Street Partners of Newport Beach, a boutique commercial real estate lending company acquired in the fall by TCW Group in downtown Los Angeles as part of the latter's entry into the distressed commercial real estate market.
Tim Ballard, Buchanan Street's chief investment officer, said his investment company has amassed a fund and is ready to invest between $250 million and $500 million in distressed commercial real estate notes throughout the western United States in coming months, including properties in Los Angeles County.
"We're already seeing default rates jump up on commercial property loans, so it's only a matter of months before the time is right," Ballard said.
Likewise, Newport Beach bond trading giant Pacific Investment Management Co. in the summer began raising $5 billion to invest in senior-level debt backed by both commercial and residential mortgages, according to the Bloomberg News Service.
So far, in Los Angeles County, the players are much smaller. One of the few investors that have actually bought troubled loans on commercial properties is Brentwood-based Lion Real Estate, which Buchanan Street veteran Mory Barak and former CB Richard Ellis Group Inc. broker Jeff Weller started in late 2007.
Barak and Weller have used about $10 million from well-heeled private investors to buy loans on four apartment buildings in Los Angeles: one in Hollywood, one in Santa Monica and two in Koreatown. The Hollywood property, a 26-unit building at 920 N. Wilcox Ave., was bought directly from a bank's loan portfolio. The other three were deals made with the apartment owners, who had taken out loans and subsequently found themselves either unable to refinance them or owing more on the loans than the current market value of the property.
"We buy distressed debt in a focus to get to the property," Barak said. "We want to get to the property on the lowest basis possible."
The two are now raising another $10 million and have their sights set on acquiring dozens more distressed loans on apartment properties like the Hollywood building.
"Our investors are high net worth individuals who understand the distressed debt play," Weller said.
But Barak and Weller are limiting themselves to the L.A. apartment market, saying that in the long run, it's one of the more conservative segments of the commercial real estate marketplace.
At Franklin Pacific, Senior Vice President Heenan said the firm is looking at all commercial real estate asset classes. So far, the company's focus has been outside California, since commercial real estate in other states hit the skids earlier than here. States with a lot of activity include Arizona, Ohio and Texas.
The pickings have been particularly good for retail and hotel properties, since those sectors have been hit the hardest by the recession. Office properties have been much slower to feel the pain and the right deals have not come along yet, Heenan said.
Part of the difficulty is that potential loan sellers have not been willing to part with their loans at prices the market will bear.
"There's a big spread between what I want to pay for these loans and what banks want to sell them for," Heenan said. "As a result, we're not seeing a lot of commercial mortgage-backed security notes selling."
Indeed, that's a major problem right now for potential investors in distressed notes on commercial property. Since the real estate downturn hit first in the residential market and later spread to the commercial side, it will take some time before commercial property paper deteriorates to the extent of residential mortgage notes.
This is the reverse of what happened in the L.A. region in the early 1990s, noted Paul Habibi, a real estate developer-turned-lecturer at the Ziman Center for Real Estate at the UCLA Anderson School of Management.
Back then, thanks to rampant overbuilding of office and retail properties during the '80s, the downturn hit the commercial side first and then the residential sector about two or three years later.
Habibi said that for now investors eyeing distressed notes for commercial real estate should be cautious.
"If you do have money, it still makes sense to wait on the sidelines as it will be a year or two before the commercial market hits the bottom of the cycle," he said.
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