Tuesday, September 1, 2009 0 comments ++[ CLICK TO COMMENT ]++

The Grave Dancer fell into a grave but is trying to climb his way out

The Grave Dancer is none other than contrarian investor Sam Zell. Unfortunately for him, his Tribune buyout blew up, although it should be noted that he put down very little money so he probably didn't lose much. Bloomberg reports that Sam Zell is trying to make a comeback with a distressed buyout fund:

Sam Zell, undaunted by his failure to keep Chicago-based publisher Tribune Co. out of bankruptcy, put together a $625 million fund to buy distressed securities backed by assets including commercial real estate.

The 67-year-old billionaire filed a private-placement notice last month for Zell Credit Opportunities Fund LP, described as a private-equity fund that received its initial backing from a pair of unidentified investors.


Zell expressed interest in May in mortgages secured by commercial real estate, a category that includes land, hotels, office buildings, and apartment and condominium complexes. By purchasing mortgages at a discount, vulture investors can foreclose on the underlying property should the borrower default, a strategy known as “loan to own.”

“On the debt side, the opportunity is extraordinary,” Zell told Citigroup Inc. clients and guests at the Citi Private Bank 2009 Real Estate Dialogues meeting. “If you’re buying a high-quality piece of paper now, it will be more likely to rise in value than fall,” according to a marketing brochure on the conference.

About $1.5 trillion of commercial real estate loans are expected to come due during the next five years, according to Goff, who now runs Goff Capital Partners LLC, a real estate investment firm in Fort Worth, Texas. Meanwhile, building prices, rents and occupancy rates are falling, delinquencies and defaults are rising, and banks are tightening credit standards, making it more difficult for borrowers to refinance loans.

One of the difficulties with private equity, hedge fund, and other alternative investors, is that it's hard to tell who was riding the liquidity wave and the perpetually-rising asset valuations in the last 30 years; and who was actually good and have talent. A lot of private equity funds, which are nothing more than LBOs (leveraged buyout funds), seem to have done really well when money wash cheap and asset price performance was unhinged from the economy, but they have hit a brick wall lately. It would have been unthinkable as recently as two years ago to see a leading PE fund like Cerberus facing redemption problems (Cerberus management is whitwashing the matter by suggesting the redemptions are "not a reflection of a lack of confidence, but a reflection of demands of liquidity" but I'm not so sure.) Sam Zell mostly has a great long-term record, especially in his specialty, real estate, but the environment is nothing like the past. If anything, the environment is probably like a weaker version of Japan in the 90's.

The distressed fund being started by Zell appears to be small but I think Zell will probably do well. It goes back to his core strategy as a real estate vulture. As quoted above, distressed investors can buy the debt and seize control upon default. As one of the analysts, James Corl of Siguler Guff & Co, in the Bloomberg article suggested, "[m]ost of the equity in the industry is wiped out." So debtholders will be calling the shots. It remains to be seen who will be taking the losses on the equity (I suspect it's private equity, which basically means pension funds/endowments/etc.)

Since the equity is likely worth zero in most cases, amateur investors probably have no chance to profit off commercial real estate. It's very difficult for small investors to buy bonds or loans. We see some small investors gambling on the equity—General Growth Properties for example—but that appears to be a high risk 's essentially speculation. In any case, it's probably best that small investors stay away since there is a small, althought non-zero, probability of us ending up in a Japan-style real estate bust. My newbie opinion for what it's worth is that the best bonds are likely to be corporate bonds. There is still a chance that the corporate bond market will sell off sharply. I have mentioned in the past that the bond market is pricing in a rosy recovery rate for high yield bonds, which runs counter to what rating agencies are projecting. There was a story today saying that Pimco is saying the same thing with the data point that recoveries on defaulted bonds have fallen below 20%.


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